{"filename":"202932_1994.txt","cik":"202932","year":"1994","section_1":"Item 1. BUSINESS\nGeneral Development of Business\nPro-Fac Cooperative, Inc. ('Pro-Fac' or 'the Cooperative') is an agricultural cooperative corporation formed in 1960 under New York law to process and market crops grown by its members. Only growers of crops marketed through Pro-Fac (or associations of such growers) can become members of Pro-Fac; a grower becomes a member of Pro-Fac through the purchase of common stock. Its approximately 700 members are growers (or associations of growers) located principally in New York, Pennsylvania, Illinois, Michigan, Washington, Oregon, Iowa, Nebraska, North Dakota, Florida, California, and Georgia. The principal office of Pro-Fac is at 90 Linden Place, Rochester, New York 14625; its telephone number is (716) 383- 1850.\nPro-Fac owns 33 food processing plants and other distribution and office facilities in 11 states, all of which are leased to and operated by Curtice-Burns Foods, Inc. ('Curtice Burns'), which processes the crops that are marketed through Pro-Fac by its members and markets the finished food products, as well as other products not manufactured from Pro-Fac crops. See 'Relationship with Curtice Burns.'\nPro-Fac crops include fruits (cherries, apples, blueberries, peaches, and plums), vegetables (snap beans, beets, cucumbers, peas, sweet corn, carrots, cabbage, squash, tomatoes, asparagus, potatoes, southern peas, dry beans, turnip roots, and leafy greens), and popcorn. These products, which are processed in facilities leased to Curtice Burns, are highly seasonal. Partly for this reason, Pro-Fac also permits Curtice Burns to process products unrelated to Pro-Fac crops in these facilities. Such unrelated products include cheese sauce, soups and prepared ethnic foods, salad dressings, certain snack foods, and non-fruit fillings and puddings. These products are not seasonal, and their production permits better utilization of the Pro-Fac facilities year round, reducing the overhead burden on all products. Pro-Fac is compensated for this use of its facilities through the payments made by Curtice Burns under the facilities financing provisions of the Integrated Agreement (the 'Agreement') with Curtice Burns as discussed below and financing payments under the operations financing provisions of the Agreement. See also discussion in Note 2 of the 'Notes to Financial Statements.'\nPro-Fac's business is conducted in one industry segment, the marketing of its members' crops through Curtice Burns. Curtice Burns is a food processing corporation with which Pro-Fac has a contractual relationship (see 'Relationship with Curtice Burns'). Pro-Fac has only one class of similar products, raw fruits and vegetables and popcorn.\nDuring the fiscal year ended June 25, 1994, Pro-Fac was not involved in any bankruptcy, receivership, or similar pro- ceeding; with any reclassification, merger, or consolidation; or with any acquisition or disposition of any material amount of assets other than in the ordinary course of business. During such period, Pro-Fac did not make any material changes in the manner in which it conducts its business.\nRecent Developments\nOn September 27, 1994, Pro-Fac and Curtice Burns entered into a Merger Agreement pursuant to which Pro-Fac will purchase all of the shares of Class A common stock and Class B common stock of Curtice Burns for $19.00 per share, or approximately $167.0 million in the aggregate. Pro-Fac will immediately commence a tender offer for all of the shares to be followed, if successful, by a merger of a subsidiary of Pro-Fac into Curtice Burns.\nPro-Fac has advised Curtice Burns that it expects to complete its tender offer on or about November 1, 1994.\nRelationship with Curtice Burns\nSee Note 2 'Notes to Financial Statements' regarding potential change of control of Curtice Burns. Pro-Fac has a contractual relationship with Curtice Burns, a New York business corporation engaged in the processing and sale of food products. The relationship between Pro-Fac and Curtice Burns is governed by an Agreement between them, consisting of five sections: operations financing; marketing; facilities financing; management; and settlement. The management of Pro-Fac believes that its relationship with Curtice Burns is unique among agricultural cooperatives and that this relationship has contributed materially to the successful operations of Pro-Fac. Curtice Burns is a publicly held corporation and files reports and other information with the Securities and Exchange Commission; its Class A common stock is listed on the American Stock Exchange and the Midwest Stock Exchange.\nBroadly speaking, Pro-Fac has contracted with Curtice Burns to operate the plants owned by Pro-Fac and to process and market as finished food products the crops produced by the members of Pro-Fac. Pro-Fac sells to Curtice Burns all of the crops produced and delivered to it by its members. Curtice Burns pays Pro-Fac as the purchase price for those crops the commercial market value ('CMV') of the crops, which is defined in the Agreement between Pro-Fac and Curtice Burns as the weighted average price paid by other commercial processors for similar crops sold under preseason contracts and in the open market in the same or competing market area.\nCurtice Burns pays rent for the use of the fixed and intangible assets leased to it by Pro-Fac. The rental payments are equal to the amortization of the leased assets plus any other costs such as taxes and utilities which may be incurred by Pro-Fac associated with the ownership of the facilities. Curtice Burns also pays a basic financing charge equal to the interest expenses incurred by Pro-Fac in financing its facilities leased to Curtice Burns and in carrying the loans of funds which have been loaned to Curtice Burns. In addition, Curtice Burns pays or receives an adjustment based upon the earnings or losses of Curtice Burns on all products, determined according to a formula which reflects the respective adjusted equity investments of the two companies. As a result, Pro-Fac cannot assure its members that it will always have sufficient proceeds from all sources to pay full CMV to its members. See also discussion in Note 2 of the 'Notes to Financial Statements.'\nPro-Fac and Curtice Burns were both formed with support from Agway Inc. ('Agway'). As a farm supply business operated as a cooperative Agway had an interest in ensuring a market for crops grown by its grower members. Agway initiated meetings between representatives of small New York food processors and their suppliers and suggested the outlines of a relationship between them. Agway provided Pro-Fac with advice concerning operating as a cooperative, and Agway's involvement assisted Pro-Fac in enlisting members. Agway provided Curtice Burns with financial support and retains a substantial investment in Curtice Burns, which enables Agway to elect 70 percent of the Directors of Curtice Burns. Agway owns no stock of Pro- Fac, although two directors of Agway, Donald E. Pease and Christian F. Wolff, Jr., served as directors of Pro-Fac until their resignations in fiscal 1994.\nOperating originally only in Upstate New York, Pro-Fac and Curtice Burns have grown through the acquisition of food processing and marketing plants and facilities in the states of Colorado, Pennsylvania, Indiana, Michigan, Washington, Iowa, Ohio, Nebraska, Georgia, Texas, and Oregon as well as additional acquisitions in Upstate New York and Canada. The advisability of an acquisition is ordinarily assessed jointly by Pro-Fac and Curtice Burns, with Pro-Fac assessing its interest in and ability to organize as members of Pro-Fac the growers who supply the crops to the company to be\nacquired, and Curtice Burns assessing its ability to process and market profitably the products of that company.\nCurtice Burns produces and markets a variety of processed food products, including canned and frozen fruits and vegetables, condiments, potato chips and other snack foods, puddings, fruit fillings and toppings, canned products containing meat, salad dressings, specialty food products, and popcorn. These products are distributed to various consumer markets in all 50 states. Curtice Burns markets products sold both under its own brands and under its customers' brands. Pro-Fac currently supplies approximately 65 percent of the raw agricultural crops used by Curtice Burns in its processing and marketing operations.\nIn March 1994, Curtice Burns advised Pro-Fac that in view of the possibility that Curtice Burns might be acquired by a third party, Pro-Fac should not rely on Curtice Burns to purchase any crops from Pro-Fac or its growers in calendar 1995 and beyond. In addition, Curtice Burns notified Pro-Fac that Curtice Burns will not commit to purchase a substantial portion of the crops historically purchased from Pro-Fac in the 1995 growing season. As a result, Pro-Fac has given notice to its affected members terminating Pro-Fac's obligation to purchase these crops beginning next year. The affected Pro-Fac growers are principally Pro-Fac's New York fruit and vegetable growers, Illinois and Nebraska popcorn growers, and Northwest potato growers who represent more than half of Pro-Fac's membership and have accounted for approximately $29.9 million or 50 percent of the total crops delivered by Pro-Fac to Curtice Burns in the past year. In the arbitration proceedings currently pending between Curtice Burns and Pro-Fac, Pro-Fac has asserted, among other matters, that Curtice Burns is in default under the Integrated Agreement for improper termination of crops and has claimed damages that Pro-Fac estimates at more than $50 million. See Note 2 of the 'Notes to Consolidated Financial Statements.' Curtice Burns believes that its only obligation to purchase crops from Pro-Fac is as set forth in the Profit Plan as approved each year by the Boards of Directors of both Pro-Fac and Curtice Burns. Because the most recent approved Profit Plan was for fiscal year 1995 (which Plan corresponds to the 1994 calendar year crops), Curtice Burns believes that it is not currently obligated to purchase any crops from Pro-Fac for calendar year 1995 or later.\nThe Agreement between Pro-Fac and Curtice Burns extends to 1997, and provides for two successive renewals, each for a term of five years, at the option of Curtice Burns. Curtice Burns has the right to terminate the Agreement with 60-days notice provided that it would then be obligated to purchase the assets owned by Pro-Fac which are utilized in the business of Curtice Burns.\nCurtice Burns currently is involved in a restructuring program and change of control initiative which could affect Pro-Fac. See 'Recent Developments,' Management's Discussion and Analysis of Financial Condition and Results of Operations, 'Curtice Burns Restructuring Program' and 'Potential Change in Control of Curtice Burns.'\nFinancial Information About Industry Segments\nAs described above, the business of Pro-Fac is conducted in only one industry segment, the marketing of its members' crops through Curtice Burns. Since Pro-Fac's business is conducted in only one industry segment, there were no intersegment sales or transfers.\nThe financial statements for the fiscal years ended June 25, 1994, June 26, 1993, and June 26, 1992, which are included in this report, relate solely to that industry segment.\nNarrative Description of Business\nIn its industry segment, Pro-Fac deals in one class of similar products, raw fruits and vegetables and popcorn.\nThe principal products produced and services rendered by Pro-Fac in its industry segment and the principal markets for, and methods of distribution of, such products and services and raw material sources are discussed above.\nBacklog of Orders\nBacklog of orders has not historically been significant in the business of Pro-Fac.\nGovernmental Contracts\nNo portion of the business of Pro-Fac is subject to renegotiation of profits with, or termination by, any governmental agency.\nCompetitive Conditions\nAs Pro-Fac sells all of the products it receives from its members to Curtice Burns, competitive conditions in the food processing industry affect Pro-Fac indirectly, through their effect on the earnings of Curtice Burns and their resulting effect on the purchase price which Curtice Burns must pay Pro-Fac for crops and the payments Curtice Burns must make for the use of Pro-Fac facilities and funds. See 'Relationship with Curtice Burns,' including the discussion regarding the termination of crop agreements.\nCurtice Burns competes with national and major regional food manufacturers, particularly in the sale of its branded products. Many of the national manufacturers have substantially greater resources than Curtice Burns. The principal methods of competition in the food industry are ready availability of product, a broad line of products, product quality, price, and advertising and sales promotion. Curtice Burns distributes its products primarily in areas which can be quickly served from its production and distribution facilities. Pricing is generally competitive with that of other food processors for products of comparable quality.\nWhile the major national brands are dominant in branded products on a national level, Curtice Burns is a significant factor in many of the marketing areas served by one or more of its regional brands.\nSeasonality of Business\nThe overall sales of Curtice Burns are not highly seasonal since the demand for its products is fairly constant throughout the year. Exceptions to this general rule include some products that have higher sales volume in the cool weather months (such as canned fruits and vegetables, chili, fruit fillings and toppings, and sauerkraut) and others that have higher sales in the warm weather months (such as potato chips, salad dressings, and condiments). However, the manufacture of products made from raw fruits and vegetables is predominantly seasonal, with production occurring during the summer and fall harvest seasons of the various crops processed. Thus, Curtice Burns must maintain substantial inventories throughout the year of those finished products made from seasonal produce.\nProfit margins for canned fruits and vegetables have been subject to industry supply and demand cycles, which are attributable to changes in growing conditions, acreage planted, inventory carry-overs, and other factors. Curtice Burns has emphasized the merchandising of its own brands and expanded service and product development for its high-volume private label and food service customers. See 'Relationship with Curtice Burns.'\nWorking Capital\nShort-term bank financing, principally for seasonal working capital requirements, is obtained by both Pro-Fac and Curtice Burns. A fruit and vegetable food processor such as Curtice Burns requires seasonal borrowing because, while cash inflows from sales are spread somewhat ratably throughout the year, cash outflows are concentrated in limited production seasons tied to the harvest seasons of the crops processed. Under agreements with the Springfield Bank for Cooperatives ('the Bank'), Pro-Fac and Curtice Burns must participate on a proportionate basis in the average short-term bank borrowings outstanding during the year. At least 55 percent of such borrowings are obtained by Pro-Fac from the Bank and then loaned by Pro-Fac to Curtice Burns at a rate of interest equal to that charged Pro-Fac by the Bank. The balance is borrowed by Curtice Burns at its option at the prime rate or at money market rates directly from six commercial banks. Curtice Burns and Pro-Fac each guarantees repayment of the short-term borrowings of the other.\nResearch and Development\nPro-Fac does not spend any material amount on research activities relating to the development of new products or the improvement of existing products.\nCompliance With EPA Regulations\nExpenditures for facilities and improvements relating to protection of the environment are made from the capital budget of Pro-Fac, and the completed facilities are leased to Curtice Burns.\nThe operations of Curtice Burns are subject to regulations imposed by various governmental agencies, including the Environmental Protection Agency ('EPA'), as well as certain comparable state agencies. Curtice Burns is also subject to standards imposed by regulatory agencies pertaining to the occupational health and safety of its employees. Curtice Burns believes that its standards and procedures generally equal or exceed those imposed by such regulatory agencies.\nThe disposal of solid and liquid waste material resulting from the preparation and processing of food and the emission of odors inherent in the processing of food are also subject to various federal, state, and local laws and regulations relating to the protection of the environment. Such laws and regulations have had an important effect on the food processing industry as a whole, requiring substantially all firms in the industry to incur material expenditures for modification of existing processing facilities and for construction of new waste treatment facilities.\nAmong the various programs for the protection of the environment which have been adopted to date, the most important for the operations of Curtice Burns are the discharge permit programs administered by the EPA and environmental protection agencies in those states in which Curtice Burns does business. Under those programs, permits are required for processing facilities which discharge industrial wastes into streams and other bodies of water, and Curtice Burns is required to meet certain discharge standards in accordance with compliance schedules established by such agencies. Curtice Burns has to date received permits for all facilities for which renewal permits are required, and each year submits applications for renewal permits for some of the facilities. Such renewal permits are currently being processed under normal agency procedures and it is expected that they will be issued in due course.\nIn recent years, expenditures for facilities related to the protection of the environment have not represented a significant percentage of total capital expenditures. The table below shows the total capital expenditures of Curtice Burns and Pro-Fac and the amounts devoted to the construction of environmental facilities for each of the last five fiscal years:\nAdditional expenditures as may be necessary for compliance with environmental laws will be made from future capital budgets, and it is expected that they will continue to constitute a similar portion of the annual capital expenditures of Pro-Fac for equipment which is leased to Curtice-Burns. Pro-Fac and Curtice-Burns estimate that the capital expenditures of Pro-Fac for environmental control facilities, principally waste water treatment facilities, for the current fiscal year will be approximately $2,668,000 and for fiscal 1996 will be approximately $1,855,000. However, the estimate for 1996 is based on recent experience rather than detailed budget proposals.\nFinancial Information About Foreign and Domestic Operations and Export Sales\nPro-Fac makes no export sales. It sells all of the crops grown by its members to Curtice Burns, which processes such crops at plants owned by Pro-Fac and leased to and operated by Curtice Burns. All such plants are located within the United States.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nReference is made to 'Relationship with Curtice Burns.'\nThe following table describes the properties leased or owned by Curtice Burns as of the end of the 1994 fiscal year. Unless otherwise indicated, all properties are leased from Pro-Fac.\nType of Property Square (by Division) Location Feet - - - --------------- -------- ------\nCOMSTOCK-MICHIGAN FRUIT:\nOffice building, manufacturing plant, and warehouse for cheese sauce, snack dips, puddings, and fruit fillings and toppings . . . . . . . . . . . . . . Benton Harbor, MI 239,252\nDistribution center. . . . . . . . . . . Coloma, MI 400,000 Manufacturing plant and ware- house for canned fruits and vegetables, fruit fillings and toppings . . . . . . . . . . . . . . . . Fennville, MI 370,600\nWarehouse for maraschino cherries, frozen fruits and vegetables, fruit fillings and supplies . . . . . . . . . . . . . . Sodus, MI 243,138\nType of Property Square (by Division) Location Feet - - - --------------- -------- ------\nCOMSTOCK-MICHIGAN FRUIT: (Cont'd.)\nProperty held for resale . . . . . . . . Clifton, NJ 250,000\nWarehouse and office; public storage facility (1). . . . . . . Vineland, NJ 198,000\nWarehouse for finished goods . . . . . . Alton, NY 60,060\nProperty held for resale . . . . . . . . Alton, NY 170,000\nFreezing Plant for green beans; warehouse for frozen goods; office and dry storage . . . . . . . . . Barker, NY 150,100\nFreezing plant for peas, snap beans, corn, and carrots . . . . . . . . Bergen, NY 122,009\nCold storage and repack facility for frozen fruits and vegetables and public storage warehouse. . . . . . . . . . . . Brockport, NY 429,052\nCutting, curing and packaging plant for sauerkraut . . . . . . . . . . Gorham, NY 55,534\nCanning plant and warehouse for peas, corn, lima beans, beets, and dried bean products; freezing plant for corn . . . . . . . . . . . . . . . . Leicester, NY 205,599\nDistribution center and warehouse. . . . . . . . . . . . . . . . LeRoy, NY 137,300\nCanning plant and warehouse for snap beans and carrots; freezing plant for snap beans, corn and cabbage . . . . . . . . . . . . Oakfield, NY 203,403\nCanning plant and warehouse for snap beans . . . . . . . . . . . . . . . So. Dayton, NY 151,140\nCanning plant and warehouse for fruit fillings and toppings, fruit specialty products and applesauce . . . . . . . . . . . . . . . Red Creek, NY 137,264\nProperty held for resale . . . . . . . . Rushville, NY 315,701\nCutting, curing, and canning plant for sauerkraut . . . . . . . . . . Shortsville, NY 103,686\nCutting and curing plant for sauerkraut . . . . . . . . . . . . . . . Waterport, NY 21,626\nManufacturing plant - popcorn. . . . . . Ridgway, IL 50,000\nClosed plant held for resale . . . . . . Wall Lake, IA 39,000\nManufacturing plant - popcorn. . . . . . North Bend, NE 50,000\nType of Property Square (by Division) Location Feet - - - ---------------- -------- ------\nBROOKS FOODS:\nOffice building, canning plant, and warehouse for dried bean products and tomato products. . . . . . . . . . . . . Mt. Summit, IN 200,000\nCURTICE BURNS SNACK FOOD GROUP:\nSNYDER SNACK FOODS:\nOffice, plant and warehouse for potato chips and corn snack foods. . . . . . . . . . . . . . . Berlin, PA 190,225\nTIM'S:\nAdministrative, plant, warehouse and distribution center (1). . . . . . . Auburn, WA 37,600\nHUSMANS SNACK FOODS:\nOffice, plant and warehouse for potato chips, and other snack food . . . . . . . . . . . . . . . Cincinnati, OH 113,576\nNALLEY'S FINE FOODS:\nOffice building, warehouse and tank farm for pickles. . . . . . . . Enumclaw, WA 87,313\nOffice building, manufacturing plant, and warehouse for pickles, canned meat products, salad dressings, peanut butter and snack foods. . . . . . . . . . . . . . . Tacoma, WA 438,000\nSales offices and distribution warehouse for chips and snacks (1) . . . . . . . . . . . . . . . Spokane, WA 16,300\nParking lot and pickle vat yards (1). . . . . . . . . . . . . . . . Tacoma, WA 162,570\nCucumber receiving and grading station (1). . . . . . . . . . . Cornelius, OR 11,700\nSales offices and distribution warehouses for chips and snacks (1) . . . . . . . . . . . . . . . Portland, OR 14,365\nCucumber receiving and grading station (1). . . . . . . . . . . Mount Vernon, WA 30,206\nNALLEY'S CANADA LTD.:\nOffice, manufacturing plant and distribution warehouse for chips and snacks, dressings, pickles, syrup, peanut butter, canned products and oatmeal (1) . . . . . . . . Anacis Island, BC 108,000\nType of Property Square (by Division) Location Feet\nNALLEY'S CANADA LTD. (Cont'd.):\nMain office (1). . . . . . . . . . . . . Burnaby, BC 8,350\nOffice building and warehouse for chips and snack food distribution (1) . . . . . . . . . . . . Kelowna, BC 15,900\nOffice, manufacturing plant and ware- house for salad dressings, syrup, chip dip, and pickles (2). . . . . . . . Vancouver, BC 48,000\nSOUTHERN FROZEN FOODS:\nOffice, freezing plant, cold storage and repackaging facility for southern vegetables, breaded vegetables and other vegetables and fruits . . . . . . . . . . . . . . . Montezuma, GA 545,942\nOffice, freezing plant and cold storage for southern vegetables . . . . . . . . . . . . . . . Alamo, TX 110,000\nFINGER LAKES PACKAGING:\nCan manufacturing plant. . . . . . . . . Lyons, NY 147,376\nCORPORATE HEADQUARTERS:\nHeadquarters office (1) (Includes office space for Comstock Michigan Fruit Division as well as Corporate Conference Center). . . . . . . . . . . . . . . . . Rochester, NY 62,500\nSales Office (1) . . . . . . . . . . . . Cordova, TN 1,000\nClosed facility held for resale. . . . . Denver, CO 80,000\nHeld for resale (subleased to Oberto sausage) . . Albany,OR 140,000\nClosed plant held for resale . . . . . . Des Moines, IA 82,958\n- - - ----------------- 1. Leased from third parties, although the related equipment may be owned by Pro-Fac.\n2. Owned by Curtice Burns or one of its wholly-owned sub- sidiaries.\nPro-Fac owns all processing facilities, warehouses, and other plant and equipment utilized in Curtice Burns' business, except for the facility owned by Nalley's Canada Ltd., or those leased from third parties. Curtice Burns, including its subsidiaries, owns one property in Canada and occupies 37 other properties, 26 of which are used under the facilities financing section of the Agreement with Pro-Fac and 11 of which are leased from third\nparties. In the properties leased from third parties, however, substantially all of the operating equipment is owned by Pro-Fac. Under the facilities financing section of the Agreement with Curtice Burns, Curtice Burns pays all taxes, insurance, and other operating costs, as well as an amount equal to the annual amortization taken on the assets. In addition to the 26 Pro- Fac properties mentioned above, seven Pro-Fac properties are not being utilized for production and are held for resale. The net book value of these properties held for resale was $11,898,000 at June 25, 1994.\nIf the Agreement with Curtice Burns above should be terminated, Curtice Burns would have the option of purchasing all plant and equipment covered by the facilities financing section at its then book value as well as associated intangible assets. The calculation for this buyout is in dispute. See Note 2 to 'Notes to Financial Statements'. The Agreement extends to June 27, 1997 and provides for two successive renewals, each for five years, at the option of Curtice Burns.\nFor the fiscal years ended June 25, 1994, June 26, 1993, and June 26, 1992 payments to Pro-Fac under the facilities financing section of the Agreement relating to the leased assets amounted to $43,830,000, $53,826,000, and $26,928,000, respectively, an amount equal to the amortization of the assets. On June 25, 1994, the net book value of Pro-Fac's fixed assets used by Curtice Burns was $141,322,000.\nIn the opinion of management of Curtice Burns and Pro-Fac, all of the properties described in this Item 2 are suitable for the use intended and adequately maintained. The extent of utilization of such properties varies from property to property and from time to time. Since the business of Curtice Burns is conducted in principally one industry segment.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn conjunction with the sale of the National Oats division by Pro-Fac and Curtice Burns, Pro-Fac terminated the membership of the Harvest States Cooperative ('Harvest States') in the Cooperative. Harvest States was the only supplier of oats to the Curtice Burns National Oats division. As a result of this action, Harvest States filed a claim against Pro-Fac for, among other things, the receipt of payments for future oats purchases after the sale of National Oats division through fiscal 1995.\nUnder the agreement between the two entities, Curtice Burns agreed to indemnify Pro-Fac as to certain expenses arising out of the termination of the membership of Harvest States in Pro-Fac. It was agreed that any settlement payments would be deemed an expense of Curtice Burns under the division of earnings with Pro-Fac.\nThe exact amount of any potential settlement related to this issue cannot be estimated at June 25, 1994, but management does not believe that this is a material exposure to the Cooperative.\nOn July 11, 1994, Curtice Burns commenced arbitration proceedings against Pro-Fac under the Integrated Agreement by serving a Demand for Arbitration on Pro-Fac. In the arbitration, Curtice Burns is seeking, among other relief, a declaration confirming its right to terminate the Integrated Agreement and to purchase the assets owned by Pro-Fac upon tender of the then current book value thereof, determined in accordance with generally accepted accounting principles, a declaration confirming the effect of termination of the Integrated Agreement on the obligations of Curtice Burns under the Integrated Agreement and a declaration confirming that Curtice Burns does not have any obligations under the Integrated Agreement to purchase crops except as set forth in the fiscal 1995 Profit Plan. Curtice Burns is also seeking an award of damages sustained by Curtice Burns in an amount to be determined by the arbitrators, but in no event less than the difference in value between the Dean Foods $20 per share offer and the market price per share of Curtice Burns' common stock following any public\nannouncement that the Dean Foods acquisition proposal has been withdrawn. On August 2, 1994, Curtice Burns filed a petition in the Supreme Court of New York for an order compelling Pro-Fac to proceed with the arbitration which was subsequently withdrawn.\nOn August 4, 1994, Pro-Fac served Curtice Burns with Pro- Fac's Response and Counterdemand for Arbitration (the 'Response'). In the Response, Pro-Fac asserted (1) that Pro- Fac is entitled to a 50 percent share of the profits from the consummation of the of the pending acquisition proposal from Dean Foods, which share Pro-Fac calculated to be greater than $5.75 per share of Curtice Burns' common stock; (2) that Curtice Burns cannot terminate the Integrated Agreement at all or not before, at the earliest, June 1996; (3) that the book value of Pro-Fac's assets for the purposes of calculating the price at which Curtice Burns may buy those assets and terminate the Integrated Agreement should not take into account the unilateral writedowns by Curtice Burns of the Hiland and meat snack assets; (4) that Curtice Burns is in default under the Integrated Agreement for improper termination of crops; and (5) that Curtice Burns is in default under the Integrated Agreement for failing to manage the business of Pro-Fac. Pro-Fac also claimed damages that it estimated at more than $50 million. In the Response, Pro- Fac also generally denied Curtice Burns' allegations in its Demand for Arbitration (see 'Recent Developments').\nThere are no other material pending legal proceedings other than ordinary routine litigation incidental to the business to which Pro-Fac is a party or to which any of its property is subject. Further, no such proceedings are known to be contemplated by governmental authorities.\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 STOCK AND RELATED SECURITY HOLDER MATTERS.\nThe information required by this item is contained in Notes 6 and 7 to the Financial Statements.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nSix-Year Summary\n(Dollars in Thousands, Except Capital Stock Data)\n* Excludes an additional allocation of 1991 net proceeds which was distributed to members in fiscal 1992. This allocation of $3,727 (6.09 percent of 1991 CMV) was distributed 25 percent in cash and the remainder in the form of qualified retains. See 'Statement of Changes in Shareholders' and Members' Capitalization' and also Notes 6 and 7 to the 'Notes to Financial Statements.'\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe purpose of this review is to highlight the more significant changes in the major items of Pro-Fac's statement of net proceeds from fiscal 1992 through 1994.\nMost of the proceeds of Pro-Fac are derived from the sale to Curtice-Burns Foods, Inc. ('Curtice Burns') of the crops of its members and hence depend primarily upon the volume and commercial market value ('CMV') of these crops (which accrues to Pro-Fac at the time of delivery). In addition, proceeds depend upon the profitability of the finished products made from Pro-Fac crops and raw materials from other sources which are then processed and sold by Curtice Burns during the course of the fiscal year. Under the Integrated Agreement ('the Agreement') between the two companies presently in effect, the total purchase price for crops and the financing charge are both based in part on the results of operations of Curtice Burns.\nBecause of the profit split provisions within the Agreement between Curtice Burns and Pro-Fac, business conditions and trends affecting Curtice Burns' profitability will also affect the profitability of Pro-Fac. See Note 2 of 'Notes to Financial Statements.'\nCHANGES FROM FISCAL 1993 TO FISCAL 1994\nCurtice Burns' Results of Operations -- General\nIn addition to the results of operations there were two significant developments in fiscal 1994: the completion of the first phase of a major restructuring program designed to enhance Curtice Burns' shareholder value; and significant progress in the effort to sell Curtice Burns to serve Agway's purpose of liquidating its interest in Curtice Burns.\nRestructuring Program The Conceptual Vision and Strategy\nThe restructuring program first initiated in fiscal 1993 was based on Curtice Burns' new vision of a company smaller in sales but more profitable, as measured by return on sales and equity, and possessing the financial and management resources sufficient to drive growth in carefully selected product line markets in which Curtice Burns can prosper for the long term. Thus, the strategy was to focus on a more limited number of product lines which now have a strong, competitive position.\nThe Plan outlined in 1993 is to restructure the business to a more profitable base. At the same time, the remaining businesses were to be managed to optimize earnings growth by installing corporate-wide purchasing, and a corporate-wide focus of capital spending.\nThe third leg of the strategy was to accelerate Curtice Burns's national sales and distribution programs by executing new product programs in store-brand retail dressings, salsa and chunky soups, and the 'More Fruit\/More Flavor' pie filling program.\nExecution of the Program\nThe first step of the restructuring program was to divest businesses that were unprofitable or declining for Curtice Burns but would fit strategically with other business portfolios. During fiscal 1993, Curtice Burns divested Lucca Frozen Foods. A loss of approximately $2.7 million (before dividing with Pro-Fac and before taxes) was recognized on this transaction. At the end of fiscal 1993, Curtice Burns wrote down the assets and provided for the expenses to dispose of the Hiland potato chips and meat snacks businesses during fiscal 1994. On November 22, 1993, Curtice Burns sold certain assets of the Hiland Potato Chip business for $2 million at closing, plus\napproximately $1 million paid in installments over three months. On February 22, 1994, Curtice Burns sold the meat snacks business located in Denver, Colorado and Albany, Oregon to Oberto Sausage Company of Kent, Washington. Under the agreement, Oberto has purchased certain assets and assumed certain liabilities of the meat snacks operation, excluding plant, equipment, and trademarks. Curtice Burns will lease its Albany Oregon manufacturing facility and equipment and license its trademarks, trade names, etc. to Oberto until February 1995, at which time Oberto is contractually obligated to purchase these assets. The sale of the Hiland and meat snacks businesses did not result in any significant gain or loss in fiscal 1994 after giving effect to the restructuring charges recorded in fiscal 1993; however, charges of $3.1 million were incurred in fiscal 1994 to adjust previous estimates. In the fiscal year ended June 26, 1993, Curtice Burns incurred losses of $13.2 million from the meat snacks and Hiland potato chip businesses before dividing such losses with Pro-Fac and before taxes.\nThus, a major part of the restructuring plan was successfully executed during fiscal 1994.\nOn November 19, 1993, Curtice Burns sold the oats portion of the National Oats business for $39 million. The oats business contributed approximately $1.4 million of earnings in fiscal 1993 before dividing with Pro-Fac and before taxes. The sale of the oats business resulted in an approximate $10.9 million gain. The popcorn portion of the National Oats Division was transferred to the Comstock Michigan Fruit Division.\nDuring fiscal 1993 and 1994, Curtice Burns also made staff reductions in selected locations throughout Curtice Burns. A $1 million accrual relating to such costs was recorded as part of the fiscal 1993 restructuring charge.\nAs reported above, Curtice Burns incurred restructuring charges in fiscal 1993 of $61.0 million (before dividing such charges with Pro-Fac and before taxes), which included the loss incurred on the sale of the Lucca frozen entree business, anticipated losses on the sale of the meat snacks and Hiland businesses, and other costs (primarily severance and losses prior to sale) in conjunction with the restructuring program. Virtually all of this charge was a revaluation of assets, rather than cash expense.\nHaving completed the first phase of the restructuring program in fiscal 1993, the second phase was approved by Curtice Burns's Board of Directors in August 1994. In connection with the second phase, the company is evaluating several alternatives regarding the Nalley's snack food business in the United States, including its possible sale to a third party. A charge, not to exceed $12 million before split with Pro-fac and before taxes, for this phase of the restructuring program will be recorded during the first quarter of fiscal 1995.\nWith respect to the potential sale of the snack food business, Curtice Burns has signed a letter of intent with Country Crisp Foods of Salt Lake City, Utah. The letter of intent is subject to a number of conditions, including successful financing by the purchaser and the negotiation of a definitive purchase agreement. Country Crisp, a regional snack food company operating in the inter-mountain states of Colorado, Utah, Wyoming, Idaho, Nevada and New Mexico, will continue to market the Nalley's brand snacks under a licensing arrangement with Curtice Burns. If this sale is finalized, it may result in a revision to the aforementioned reserve.\nPotential Change of Control of Curtice Burns\nOn March 23, 1993, the Curtice Burns announced that Agway Inc., which owns 99 percent of Curtice Burns' Class B shares and approximately 14 percent of Class A shares, was considering the potential sale of its interest in Curtice Burns. At its meeting held on August 9 and 10, 1993, the Curtice Burns Board of Directors authorized Curtice Burns' management, with the\nadvice of its investment bankers, to pursue strategic alternatives for Curtice Burns. These options included negotiations with Pro-Fac relative to Pro-Fac gaining control of the business; the possible sale of the entire equity of Curtice Burns to a third party; and the implementation of additional restructuring actions that may include recapitalizing Curtice Burns to buy out Pro-Fac. Under the Agreement with Pro-Fac, title to substantially all of Curtice Burns' fixed assets is held by Pro-Fac, and Pro- Fac provides the major portion of the financing of Curtice Burns' operations. Under the Agreement Curtice Burns has an option to purchase these assets from Pro-Fac at their book value. However, as mentioned in Note 2 of the 'Consolidated Financial Statements,' there presently exists, among other things, a disagreement with Pro-Fac as to how such settlement amount would be calculated. Exercise of the option would result in the termination of the Agreement with Pro-Fac. In such event, Curtice Burns would be required to repay all debt owed to Pro-Fac.\nOn June 8, 1994, the Curtice Burns Board of Directors voted to pursue an offer from Dean Foods Company for a maximum of $20 per share which was contingent upon Curtice Burns buying Pro-Fac's assets at book value and upon the sale of the Nalley's Fine Foods Division and the Nalley's Canada, Ltd. subsidiary, both excluding the chips and snack businesses, to George A. Hormel and Company.\nOn July 11, 1994, Curtice Burns demanded that certain disputes between Curtice Burns and Pro-Fac arising under the Integrated Agreement be submitted for arbitration. Curtice Burns sought a decision that, among other things (i) Pro-Fac would not be entitled to one-half of the profits from a sale of the business, (ii) that certain asset writedowns by Curtice Burns as of June 26, 1993 would reduce the amount owed Pro-Fac on termination of the Integrated Agreement and (iii) Curtice Burns had not breached the Integrated Agreement in several respects.\nCurtice Burns also sought an award of damages against Pro-Fac in the event that a pending proposal by Dean Foods to purchase Curtice Burns was withdrawn, such damages to be at least equal to the difference between $20 per share and the market price per share of the Curtice Burns' stock following any public announcement of a withdrawal of the proposal. Curtice Burns also sought reimbursement for the legal fees and expenses of the arbitration.\nPro-Fac submitted its Response and Counterdemand on August 3, 1994 in which it sought a decision confirming certain of its rights under the Integrated Agreement, denied the allegations set forth in the Curtice Burns' Demand for Arbitration and made certain additional claims against Curtice Burns.\nHowever, resolution of these disputes is anticipated in conjunction with the Merger Agreement dated September 27, 1994, as described below.\nOn September 27, 1994, Pro-Fac and Curtice Burns entered into a Merger Agreement pursuant to which Pro-Fac will purchase all of the shares of Class A common stock and Class B common stock of Curtice Burns for $19.00 per share, or approximately $167.0 million in the aggregate. Pro-Fac will immediately commence a tender offer for all of the shares to be followed, if successful, by a merger of a subsidiary of Pro-Fac into Curtice Burns. Pro-Fac has advised Curtice Burns that it expects to complete its tender offer on or about November 1, 1994.\nIn connection with the proposed purchase of Curtice Burns, Pro-Fac has obtained the commitment of the Springfield Bank to provide up to $200 million in long-term financing and up to $86 million in seasonal financing. In addition, Pro-Fac intends to issue up to $160 million principal amount\nof senior subordinated debt privately placed through Dillon, Read and Co.Inc. Upon completion of the merger transaction, Pro-Fac would have an equity investment of $133 million in Curtice Burns, most of which was existing financing to Curtice Burns under the Integrated Agreement.\nDuring fiscal 1994, Curtice Burns expensed $3.5 million of legal, accounting and other expenses relative to the change in control issue and allocated half of those expenses to Pro- Fac. Pro-Fac has disputed this allocation and the fiscal 1994 financial statements do not reflect the charge as management believes it should not be included as a component of the fiscal 1994 earnings split. Resolution of this dispute is anticipated in conjunction with the Merger Agreement described above.\nCurtice Burns's fiscal 1994 net earnings were $10.1 million or $1.17 per share compared to a loss of $23.8 million or $2.77 per share for fiscal 1993. Included in the fiscal 1994 results was a charge against earnings of $.5 million, equivalent to $.06 per share, to adjust deferred taxes to the higher rate as legislated by Congress and as required under Financial Accounting Standards Board No. 109. Also included in fiscal 1994 results was a net gain of $7.8 million ($3.1 million after dividing with Pro-Fac and after taxes) comprised of a gain on sale of $10.9 million, net of a charge of $3.1 million to adjust previous estimates regarding activities initiated in fiscal 1993, and a charge of $3.5 million of legal, accounting, investment banking and other expenses ($1.7 millon after dividing with Pro-Fac and after taxes) relating to the potential change in control of Curtice Burns. Included in the fiscal 1993 results were restructuring charges of $61.0 million ($29.9 million after dividing with Pro-Fac and after taxes). Net earnings, excluding these items, was approximately $9.1 million (equivalent to $1.05 per share) for fiscal 1994 and $5.9 million (equivalent to $.68 per share) for fiscal 1993, an increase of 54.2 percent.\nPretax earnings before dividing with Pro-Fac increased $77.4 million from the prior year. The major elements of this change are:\nThe major changes from the prior year for product line earnings (before dividing with Pro-Fac and before taxes), excluding operations sold or to be sold are as follows:\nThe increased profitability in the vegetable category was driven by the price increases permitted by the national short crop due to poor weather conditions in the Midwest during the 1993 growing season.\nThe fruit category was negatively affected by increased trade promotion and advertising related to reformulated fruit fillings and promotions on pumpkin pie filling.\nThe snack foods category has continued to be affected by the competitive pressures of the salty snacks business and the decline in consumption for the potato chip category.\nThe change in condiments and specialty products was primarily because the profitability of peanut butter was negatively affected by both a sales volume decline and an increase in costs. While the canned meats and entree product line produced increased volume, increased trade promotions and selling costs exceeded the effect of the sales increase.\nThe following sets forth the major changes in the consolidated statement of income from the prior year.\nNet sales for the year ended June 25, 1994 decreased $49.5 million or 5.6 percent from the prior year. This decrease is comprised of the following:\nThe disposition of businesses reduced sales by $59.0 million as shown above. The increase in vegetable sales volume resulted from higher demand created by a vegetable crop shortage caused by flooding in the Midwest and a drought in the South during the 1993 growing season. The decrease in sales volume for snack foods is due to the continued competitive pressures of the salty snack business and the decline in consumption for the potato chip category.\nCost of sales decreased $40.0 million. As a percent of sales, costs decreased to 71.4 percent from 72.0 percent. Gross profit decreased $9.5 million or 3.8 percent. These changes resulted primarily from dispositions and changes in volume, price and product mix.\nSelling, administrative and general expenses decreased $20.2 million or 9.7 percent. Cost reductions include a $.7 million decrease in trade promotions, a $13.1 million decrease in advertising and selling costs and a $6.4 million decrease in administrative costs.\nInterest expense decreased $1.3 million or 6.9 percent resulting from a $.2 million increase due to loan volume on Pro-Fac related debt and a $1.5 million reduction due to lower interest rates.\nIncome before taxes improved $38.7 million or 194.1 percent, primarily due to the factors described above.\nPro-Fac Results of Operations -- General\nThe 1994 commercial market value of crops delivered during the production season decreased to $59,216,000 from $59,800,000 in fiscal 1993. This 1.0 percent decrease was the net result of a 2.5 percent tonnage increase offset by the effect of price and mix variations from the commodities.\nFor the year ended June 25, 1994, the change in net proceeds and the allocation to members compared to the prior year is summarized below:\nThe $40,399,000 positive change in proceeds from Curtice Burns is caused by the 1993 restructuring charge which resulted in a negative amount of proceeds of $21.8 million for that year. The fiscal 1994 amount of $18.6 million reflects improved earnings at Curtice Burns and a share of the gain in sale of assets of $3.9 million during 1994.\nCHANGES FROM FISCAL 1992 TO FISCAL 1993\nCurtice Burns' Results of Operations -- General\nPretax earnings before dividing with Pro-Fac decreased $62.2 million from the prior year. The major elements of this change are:\nExcluding the restructuring charges recorded in fiscal 1993, the Company was slightly less profitable in 1993 in comparison to the prior year, but results of operations comprised many increases to product line earnings that were offset by significant losses incurred in the meat snacks, Hiland snack food, Nalley's U.S. Chips and Snacks, and vegetable businesses.\nCurtice Burns benefited from strong performances from some of its regional brands and from its can-making operations. The major changes from the prior year for product line earnings (before dividing with Pro-Fac and before taxes), excluding operations sold or to be sold are as follows:\nPrice increases instituted in the fourth quarter of fiscal 1992 were maintained in fiscal 1993 in the can making operation and improved margins from the prior year. The increased profits from the fruit filling category were primarily due to reduced raw product costs that improved margins for that category.\nThe entree category also achieved higher margins as a result of moving the production for the Lucca canned operation to the Nalley's Fine Foods Division. As previously discussed, the Hiland and meat snacks operations were placed for sale as part of the restructuring program to divest unprofitable or declining businesses. The decrease in earnings relative to the snack operations other than Hiland, meat snacks and Nalley's U.S. Chips and Snacks is due to the continuing competitive pressures in the snack industry that prevent the implementation of price increases that would improve margins without the incurrence of a loss of market share.\nDuring fiscal 1993 Curtice Burns continued to experience pressure on earnings from the depressed commodity vegetable business.\nThe following sets forth the major changes in the consolidated statement of income from the prior year.\nNet sales for the year ended June 26, 1993 decreased $18.3 million or 2.0 percent from the prior year. This decrease is comprised of the following:\nVariance in Millions of Dollars\nThe disposition of the soft drink bottling business in July 1992 and Lucca frozen entrees in December 1992 reduced sales by $17.7 million as shown above.\nThe volume decrease for condiments and specialty products resulted from lower cheese sauce and ketchup sales. Sales volume for cheese sauce decreased in the first part of the fiscal year due to a loss of business partially reinstated later in the year. The ketchup decrease in sales was due to the discontinuation of the private label business for that product. The variance due to price and mix in the fruit category resulted from a decreased raw product purchase price for cherries which was passed along in part to customers.\nCost of sales decreased $19.7 million. As a percent of sales, costs decreased to 72.0 percent from 72.7 percent. Gross profit increased $1.4 million or .6 percent. These changes resulted primarily from increases in volume partially offset by effects of price and product mix changes.\nSelling, administrative and general expenses increased $5.8 million or 2.9 percent. This variance includes an $8.6 million increase in trade promotions, a $1.9 million decrease in advertising and selling costs, a $3.3 million benefit due to operational changes in Curtice Burns's salaried vacation policy, and a $2.4 million increase in other administrative costs. The increase in trade promotions directly contributed to the increased sales volume and increased margins discussed above.\nInterest expense decreased $3.3 million or 14.4 percent resulting from a $.9 million decrease due to a reduction in debt and a $2.4 million reduction due to lower interest rates.\nPro-Fac's share of Curtice Burns's profits decreased $31.3 million, of which $30.5 million was due to the restructuring charges.\nIncome before taxes decreased $30.9 million, primarily due to the restructuring charges discussed above.\nTaxes on income decreased $.9 million or 18.3 percent. Curtice Burns's effective tax rate was significantly impacted by the writedown of goodwill and other intangibles having a lower tax basis than book value.\nNet income decreased $30 million, almost entirely due to the restructuring program (after allocating to Pro-Fac its share of the loss) and Curtice Burns's effective tax rate as previously discussed.\nPro-Fac's Results of Operations -- General\nThe 1993 commercial market value of crops delivered during the production season decreased to $59,800,000 from $64,152,000 in fiscal 1992. This decrease of 6.8 percent was the net result of a 12.0 percent tonnage increase offset by the effect of price and mix variations for the commodities. Significant supplies of cherries in 1992 drove CMV for that crop down so that even though the volume delivered to Pro-Fac increased 64 percent from the prior year the dollar amount of CMV decreased by 39 percent.\nFor the year ended June 26, 1993, the change in net proceeds and the allocation to members compared to the prior year is summarized below:\nPro Forma Combined Results of Operations\nThe following analysis of the pro forma combined results of operations of Pro-Fac and Curtice Burns for the fiscal year ended June 25, 1994, as compared to the prior fiscal year, is based on the combined pro forma condensed statement of operations for that period set forth in Note 3 to the accompanying financial statements of Pro-Fac and is subject to the caveats and limitations set forth in Note 3.\nBecause most revenues and expenses of Pro-Fac result from, or are offset by, transactions with Curtice Burns, the pro forma combined results of operations of the two entities depend predominantly on the results of operations of Curtice Burns. The results of operations of Curtice Burns are discussed in general terms under 'Curtice Burns' Results of Operations - General' above.\nSales and revenues decreased $49.5 million or 5.6 percent. The change is comprised of a $59.0 million decrease due to the disposition of businesses, a $6.0 million increase due to changes in volume other than the dispositions and an increase of $3.5 million due to changes in price and mix.\nCost of sales decreased $40.1 million. As a percent of sales, costs decreased to 71.4 percent from 72.0 percent. Gross profit decreased $9.4 million or 3.8 percent. These changes resulted primarily from dispositions and changes in price and product mix.\nSelling, administrative and general expenses, other than the restructuring gains\/(losses) decreased $19.6 million or 9.5 percent. Cost changes include a $.7 million decrease in trade promotions, a $13.1 million reduction in advertising and selling costs, and a $5.8 million reduction of other administrative costs.\nInterest expense decreased $2.6 million or 15.5 percent; $1.5 million decrease due to lower rates and $1.1 million decrease due to reduction in debt.\nIncome before taxes increased $78.1 million, primarily due to the restructuring gains and losses and the increased profitability of the canned and frozen vegetable product lines.\nLiquidity and Capital Resources\nSubstantially all cash not distributed by Pro-Fac to its members or security holders is either invested in assets leased to Curtice Burns or loaned to Curtice Burns to finance its operations. In order to gauge the working capital and other resources available to the companies, the combined pro forma condensed financial statements should be used. The relationship with Pro-Fac and the combined financial statements are shown in Notes 2 and 3 to the Consolidated Financial Statements. Such financial statements should not be used as a basis for determining shareholders' interest in Pro-Fac, but only as a measure of the total financial resources available to Curtice Burns and Pro-Fac.\nCertain borrowing agreements require that the companies maintain specified levels with regard to working capital, current ratio, ratio of net worth to assets, ratio of long- term debt to net worth, tangible net worth, net income, coverage of interest and fixed charges and the incurrence of additional debt. The companies are in compliance with, or have obtained waivers for, restrictions and requirements under the terms of the borrowing agreements. The revolving lines of credit under such agreements have been renewed through November of 1994. Such agreements provide for adjustments in interest rates and covenants and grant to both short-term and long-term lenders, or entitle such lenders to obtain, liens on substantially all assets of Curtice Burns and Pro-Fac as collateral for borrowings under such agreements.\nShould the resolution of Agway's potential sale of its interest in Curtice Burns result in Curtice Burns exercising its option to purchase from Pro-Fac the property and equipment and certain other assets used by the Curtice Burns in its business, the amount required to accomplish this (including the repayment of debt) as calculated by Curtice Burns would be approximately $267.7 million (as measured at the book value on June 25, 1994). Of this amount, $101.5 million represents short- and long-term debt, $24.9 million relates to intangible assets and $141.3 million relates to leased fixed assets. As there is presently a disagreement with Pro-Fac regarding the calculation of the fiscal 1994 earnings split, management of Pro-Fac believes that the amount of short- and long-term debt receivable from Curtice Burns at June 25, 1994 is $103.3 million. The $267.7 million at June 25, 1994 compares to $303.8 million at June 26, 1993, which was comprised of $103.8 million of short- and long-term debt, $26.5 million relating to intangible assets and $173.5 million leased fixed assets. The decrease in leased assets during the period of $32.2 million is primarily\nthe result of the reduction of leased assets due to the sale of businesses and depreciation of assets exceeding additions. However, as discussed in Note 2 to the Consolidated Financial Statements, there has been a disagreement with Pro-Fac on that purchase price and the calculation of the fiscal 1994 earnings split. Resolution of these issues is anticipated with the completion of the transaction agreed to in the Merger Agreement described at 'Recent Developments.'\nCash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income. In the fiscal year, net cash provided by operating activities of the combined companies of $39.0 reflects net income of $10.1 million for Curtice Burns and $24.5 million for Pro-Fac. Amortization of assets amounted to $25.7 million. Inventories decreased $.3 million and accounts receivable decreased $5.7 million. Changes in other assets and liabilities amounted to $27.3 million.\nCash flows from investing activities include the acquisition and disposition of property, plant and equipment and other assets held for or used in the production of goods. Net cash provided by investing activities of $22.4 million in the period was comprised of $19.6 million paid for purchases of property, plant and equipment, $1.3 million received for disposals of fixed assets, and a $1.4 million increase in the investment of Springfield Bank for Cooperatives. During the period, $42.1 million was received in proceeds from the disposition of the oats portion of the National Oats business and the Hiland Potato Chip business. Proceeds from dispositions have been applied to debt.\nNet cash used in financing activities of $65.1 million in the period was comprised of payments on short-term debt of $.5 million, payments on long-term debt of $50.2 million, payments on capital leases of $2.1 million, issuance of capital stock of $.7 million, less repurchases of $3.2 million, and dividends paid of $9.9 million.\nShort- and Long-Term Trends\nThe fruit and vegetable portion of the business can be positively or negatively affected by weather conditions nationally and the resulting impact on crop yields. Favorable weather conditions can produce high crop yields and an oversupply situation. This results in depressed selling prices and reduced profitability on the inventory produced from that year's crops. Excessive rain or drought conditions can produce low crop yields and a shortage situation. This typically results in higher selling prices and increased profitability. While the national supply situation controls the pricing, the supply can differ regionally because of variations in weather. The 1993 floods in the Midwest and the drought in the South have increased prices, even though the crops in Curtice Burns's growing areas have been at normal levels.\nSeasonal lines of credit of $100.0 million were available to Curtice Burns and Pro-Fac up to September 1993, $86 million after that date, and the maximum borrowing on those lines was $81.0 million. The balance outstanding at June 25, 1994 was $11.5 million.\nThere are no current plans for the acquisition of businesses. Capital expenditures are expected to approximate $20.0 million in the next year.\nScheduled payments on long-term debt will approximate $15 million in the coming year. Net cash provided from operations and the cash proceeds from the planned sales of excess facilities should be sufficient to cover the scheduled payments on long-term debt and planned capital expenditures as well as anticipated dividends of approximately $10 million in the coming year. Proceeds from the sale of business units, if any, will be applied to debt.\nImpact of Inflation and Changing Prices\nGeneral inflation levels have not significantly affected Pro- Fac sales and revenues. The sales prices of Pro-Fac crops sold to Curtice Burns have been more affected by agricultural crop size, prices and trends.\nFavorable Tax Ruling and Developments\nIn December 1991, the national office of the Internal Revenue Service issued a technical advice memorandum ('TAM') concluding that virtually all of Pro-Fac's income arises from patronage sources. As a result of the TAM, in January 1992 an additional distribution of patronage proceeds for fiscal 1991 was made to members in the amount of $3,727,000. Patronage proceeds available for distribution are determined by the Board of Directors each year, as stipulated in the Bylaws. As the longer term effects of the TAM are further researched and analyzed, it is possible that the Board may calculate future patronage proceeds available for distribution utilizing a different formula than that used for 1992, 1993, and 1994.\nIn August of 1993, the Internal Revenue Service issued a determination letter which concluded that the Cooperative is exempt from federal income tax to the extent provided by Section 521 of the Internal Revenue Code, 'Exemption of Farmers' Cooperatives from Tax.' Unlike a non-exempt cooperative, a tax-exempt cooperative is entitled to deduct cash dividends it pays on its capital stock in computing its taxable income. The exempt status is retroactive to fiscal year 1986 and is anticipated to apply to future years as long as there is no significant change in the way in which the Cooperative operates. In conjunction with this ruling, the Cooperative has filed for tax refunds for fiscal years 1986 to 1990 in the amount of approximately $5.8 million and interest payments of approximately $3.4 million. In addition, it is anticipated that the Cooperative will file for tax refunds for fiscal years 1991 and 1992 in the amount of approximately $3.1 million and interest payments of approximately $.4 million. No such refund amounts have been reflected in the financial statements of Pro-Fac as of June 25, 1994. It is anticipated that the refund amounts will be recognized upon receipt.\nAccounting for Income Taxes\nIn February 1992, the Financial Accounting Standards Board issued SFAS 109, 'Accounting for Income Taxes.' SFAS 109 eliminates and simplifies part of the requirements of the previously issued SFAS 96. The Statement is effective for fiscal years beginning after December 15, 1992, with retro- active adoption permitted. The Cooperative has retro- actively adopted the provisions of this standard as of June 29, 1991. There was no effect on the Cooperative for this accounting change.\nOther Matters\nThe Financial Accounting Standards Board issued Statement of Accounting Standards No. 115, 'Accounting for Certain Investments in Debt and Equity Securities' ('SFAS No. 115'), effective for fiscal years beginning after December 15, 1993. SFAS 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. At acquisition, debt and equity securities will be classified into one of three categories, and at each reporting date, the classification of the securities will be assessed as to its appropriateness. Management anticipates that the implementation of SFAS No. 115 will not have a material effect on the Cooperative's results of operations and financial position.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following additional financial data are submitted as part of Item 14 - Exhibits, Financial Statement Schedules and Reports on Form 8-K, of this report:\nSchedule II - Amounts receivable from related parties and underwriters, promoters and employees other than related parties.\nSchedule IV - Indebtedness of and to related parties - not current.\nSchedule IX - Short-term borrowings.\nSchedules other than those listed above are omitted because they are either not applicable or not required, or the required information is shown in the financial statements or the notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Members, Shareholders and Board of Directors of Pro-Fac Cooperative, Inc.\nIn our opinion, the financial statements listed under Item 8 of this Form 10-K present fairly, in all material respects, the financial position of Pro-Fac Cooperative, Inc. at June 25, 1994 and June 26, 1993, and the results of its operations and cash flows for each of the three fiscal years in the period ended June 25, 1994 in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Cooperative'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.\nThere currently exists several disputes between Curtice-Burns Foods, Inc. and the Cooperative. Both Curtice-Burns Foods, Inc. and the Cooperative have requested arbitration to resolve these matters. In addition, both the Cooperative and a third party have made an offer to acquire the outstanding common stock of Curtice-Burns Foods, Inc. The outcome of such transactions could affect the Integrated Agreement with the Cooperative. These matters are described in Note 2 to the financial statements.\nOur audits of the financial statements also included an audit of the financial statement schedules listed in the accompanying index and appearing under Item 14 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.\nPRICE WATERHOUSE LLP\nRochester, New York September 28, 1994\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nManagement is responsible for the preparation and integrity of the financial statements and related notes which appear on pages 29 through 45. These statements have been prepared in accordance with generally accepted accounting principles.\nThe Cooperative's accounting systems include internal controls designed to provide reasonable assurance of the reliability of its financial records and the proper safeguarding and use of its assets. Such controls are monitored through the internal and external audit programs.\nThe financial statements have been audited by Price Waterhouse LLP, independent accountants, who were responsible for conducting their examination in accordance with generally accepted auditing standards. Their resulting report is on the preceding page.\nThe Board of Directors exercises its responsibility for these financial statements through its Finance and Audit Committee, which consists entirely of non-management board members. The independent accountants have full and free access to the Finance and Audit Committee. The Finance and Audit Committee periodically meets with the independent accountants with management present to discuss accounting, auditing and financial reporting matters.\nRoy A. Myers General Manager\nWilliam D. Rice Assistant Treasurer\nSeptember 28, 1994\nStatement of Net Proceeds (Dollars in Thousands)\nThe accompanying notes are an integral part of these financial statements.\nBalance Sheet (Dollars in Thousands) Assets\nThe accompanying notes are an integral part of these financial statements.\nStatement of Cash Flows (Dollars in Thousands)\nThe accompanying notes are an integral part of these financial statements.\nStatement of Changes in Shareholders' and Members' Capitalization (Dollars in Thousands)\nThe accompanying notes are an integral part of these financial statements.\nNOTES TO FINANCIAL STATEMENTS\nNote 1. SUMMARY OF ACCOUNTING POLICIES\nThe accompanying financial statements have been prepared in accordance with generally accepted accounting principles including the following major accounting policies:\nFiscal Year - Fiscal 1994 ended on June 25, 1994, and fiscal 1993 ended on June 26, 1993, the last Saturday in June. All future fiscal years will end on the last Saturday in June. The fiscal year ended on the last Friday in June in fiscal 1992. The years ended June 25, 1994, June 26, 1993, and June 26, 1992 each comprised 52 weeks.\nLeases - The Cooperative leases its property, plant, equipment and intangibles to Curtice Burns Foods, Inc. ('Curtice Burns') under an agreement described in Note 2. Such leases are recorded under the financing method of accounting. See further discussion in Note 4.\nInvestment in Springfield Bank for Cooperatives ('Springfield' or 'the Bank') - The Cooperative's investment in Springfield is comprised of revolving securities which are presently being redeemed by the Bank on the basis of a six- year cycle. These securities are not physically issued by the Bank, but the Cooperative is notified as to their monetary value. The investment is carried on the Cooperative's books at cost (the cash purchases of securities each year in an amount equal to a percentage of the annual interest paid by the Cooperative on its borrowings from the Bank) plus the Cooperative's share of the undistributed earnings of the Bank (that portion of patronage refunds not distributed currently in cash).\nThe current portion of the investment represents securities which are expected to be redeemed by the Bank during the subsequent fiscal year.\nIncome Taxes - In February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes,' ('SFAS 109') with retro-active adoption permitted. The Cooperative has adopted the provisions of this standard as of June 29, 1991. Deferred income taxes arise from the issuance of non- qualified retains (see Note 5). Income taxes are recorded under the liability method specified by SFAS 109 in 1992, 1993 and 1994.\nFinance receivable relating to goodwill and other intangibles - - - - Under the provisions of the Agreement with Curtice Burns, the Cooperative has provided financing for a portion of the goodwill and other intangible assets which represent the excess of the fair value of net tangible assets acquired in purchase transactions. The decrease in the receivable related to intangibles in fiscal 1993 is attributable to the restructuring efforts initiated by Curtice Burns (see Note 8).\nReclassification - Certain items for fiscal 1993 and 1992 have been reclassified to conform with 1994 presentations.\nEarnings Per Share Data Omitted - Net income or net proceeds per share amounts are not presented because earnings are not distributed to members in proportion to their common stock holdings. For example, patronage related earnings (representing those earnings derived from patronage-sourced business) are distributed to members in proportion to the dollar value of deliveries under Pro-Fac contracts rather than based on the number of shares of common stock held.\nNote 2. AGREEMENT WITH CURTICE BURNS FOODS, INC.\nPro-Fac has a contractual relationship with Curtice Burns under an Agreement ('the Agreement') consisting of five sections: Operations Financing, Marketing, Facilities Financing, Management, and Settlement, which extends\nto 1997 and provides for two successive five-year renewals at the option of Curtice Burns.\nThe provisions of the Agreement include the financing of certain assets utilized in the business of Curtice Burns and provide a sharing of income and losses between Curtice Burns and Pro-Fac. Should Curtice Burns terminate the Agreement, Curtice Burns has the option of purchasing those assets financed by Pro-Fac at the book value at that time.\nRevenues received from Curtice Burns under the Agreement for the years ended June 25, 1994, June 26, 1993, and June 26, 1992, include: commercial market value of crops delivered, $59,216,000, $59,800,000, and $64,152,000, respectively; interest income, $15,617,000, $16,515,000, and $19,869,000, respectively; and additional proceeds from profit sharing provisions, $18,599,000 gain, $21,800,000 loss, and $9,505,000 gain, respectively. In addition, Pro-Fac received financing amortization payments of $43,830,000, $53,826,000, and $26,232,000 for the years ended June 25, 1994, June 26, 1993, and June 26, 1992, respectively.\nIn March 1994, Curtice Burns advised Pro-Fac that in view of the possibility that Curtice Burns might be acquired by a third party, Pro-Fac should not rely on Curtice Burns to purchase any crops from Pro-Fac or its growers in calendar 1995 and beyond. In addition, Curtice Burns notified Pro-Fac that Curtice Burns will not commit to purchase a substantial portion of the crops historically purchased from Pro-Fac in the 1995 growing season. As a result, Pro-Fac has given notice to its affected members terminating Pro-Fac's obligation to purchase these crops beginning next year. The affected Pro-Fac growers are principally Pro-Fac's New York fruit and vegetable growers, Illinois and Nebraska popcorn growers, and Northwest potato growers who represent more than half of Pro-Fac's membership and have accounted for approximately $29.9 million or 50 percent of the total crops delivered by Pro-Fac to Curtice Burns in the past year. In the arbitration proceedings currently pending between Curtice Burns and Pro-Fac, Pro-Fac has asserted, among other matters, that Curtice Burns is in default under the Integrated Agreement for improper termination of crops and has claimed damages that Pro-Fac estimates at more than $50 million. Curtice Burns believes that its only obligation to purchase crops from Pro-Fac is as set forth in the Profit Plan as approved each year by the Boards of Directors of both Pro-Fac and Curtice Burns. Because the most recent approved Profit Plan was for fiscal year 1995 (which Plan corresponds to the 1994 calendar year crops), Curtice Burns believes that it is not currently obligated to purchase any crops from Pro-Fac for calendar year 1995 or later. Management believes these matters will be resolved in conjunction with the Merger Agreement described above.\nPotential Change of Control of Curtice Burns\nOn March 23, 1993, the Curtice Burns announced that Agway Inc., which owns 99 percent of Curtice Burns' Class B shares and approximately 14 percent of Class A shares, was considering the potential sale of its interest in Curtice Burns. At its meeting held on August 9 and 10, 1993, the Curtice Burns Board of Directors authorized Curtice Burns' management, with the advice of its investment bankers, to pursue strategic alternatives for Curtice Burns. These options included negotiations with Pro-Fac relative to Pro- Fac gaining control of the business; the possible sale of the entire equity of Curtice Burns to a third party; and the implementation of additional restructuring actions that may include recapitalizing Curtice Burns to buy out Pro-Fac. Under the Agreement with Pro-Fac, title to substantially all of Curtice Burns' fixed assets is held by Pro-Fac, and Pro- Fac provides the major portion of the financing of Curtice Burns' operations. Under the Agreement Curtice Burns has an option to purchase these assets from Pro-Fac at their book value. However, there presently exists a disagreement with Pro-Fac as to how such settlement amount would be calculated. Exercise of the option would result in the termination of the Agreement with Pro-Fac. In such event, Curtice Burns would be required to repay all debt owed to Pro-Fac.\nOn June 8, 1994, the Curtice Burns Board of Directors voted to pursue an offer from Dean Foods Company for a maximum of $20 per share which was contingent upon Curtice Burns buying Pro-Fac's assets at book value and upon the sale of the Nalley's Fine Foods Division and the Nalley's Canada, Ltd. subsidiary, both excluding the chips and snack businesses, to George A. Hormel and Company.\nOn September 27, 1994, Pro-Fac and Curtice Burns entered into a Merger Agreement pursuant to which Pro-Fac will purchase all of the shares of Class A common stock and Class B common stock of Curtice Burns for $19.00 per share, or approximately $167.0 million in the aggregate. Pro-Fac will immediately commence a tender offer for all of the shares to be followed, if successful, by a merger of a subsidiary of Pro-Fac into Curtice Burns. Pro-Fac has advised Curtice Burns that it expects to complete its tender offer on or about November 1, 1994.\nIn connection with the proposed purchase of Curtice Burns, Pro-Fac has obtained the commitment of the Springfield Bank to provide up to $200 million in long-term financing and up to $86 million in seasonal financing. In addition, Pro-Fac intends to issue up to $160 million principal amount of senior subordinated debt privately placed through Dillon, Read and Co, Inc. Upon completion of the merger transaction, Pro-Fac would have an equity investment of $133 million in Curtice Burns, most of which was existing financing to Curtice Burns under the Integrated Agreement.\nDuring fiscal 1994, Curtice Burns expensed $3.5 million of legal, accounting and other expenses relative to the change in control issue and allocated half of those expenses to Pro- Fac. Pro-Fac has disputed this allocation and the financial statements do not reflect the charge as management believes it should not be included as a component of the fiscal 1994 earnings split. Resolution of this dispute is anticipated in conjunction with the Merger Agreement described above.\nNote 3. DEBT\nShort-Term Debt\nShort-term borrowings are made by the Cooperative under a seasonal line of credit with Springfield which currently provides for borrowings up to $46,000,000. Outstanding borrowings at June 25, 1994 amounted to $11,500,000 at 5.5 percent. The maximum amount of short-term borrowings outstanding during the 52-week period ended June 25, 1994 was $46,000,000. The approximate average aggregate short-term borrowings were: fiscal 1994 -$30,464,000, fiscal 1993 - $39,444,000, fiscal 1992 - $47,764,000 The approximate daily weighted average interest rates were: fiscal 1994 - 4.6 percent, fiscal 1993 - 4.6 percent, and fiscal 1992 - 6.2 percent.\nThe Cooperative's short-term borrowings are loaned to Curtice Burns under the same conditions and at the same rates as the Cooperative obtained from its lenders. Provisions of the Agreement between the two companies do however, allow Pro- Fac, with sufficient notice to Curtice Burns, to accelerate the repayment of outstanding debt.\nLong-Term Debt\nThe Cooperative's long-term debt consists of the following:\nThe term loans due Springfield are payable as follows: $14.0 million annually fiscal 1995 through fiscal 2002; $12 million in fiscal 2003; $10.0 million in fiscal 2004 and $7.0 million in fiscal 2005. The term loans are collateralized by fixed assets and the Cooperative's investment in Springfield (see Note 1). In addition, Curtice Burns guarantees all of the Cooperative's bank debt and the Cooperative guarantees Curtice Burns' short-term notes payable to commercial banks and certain other debt. The total lines of credit available to the companies for seasonal borrowings expire annually unless extended or renewed. Curtice Burns had no short-term notes payable to commercial banks at June 25, 1994, June 26, 1993, or June 26, 1992. Other Curtice Burns debt which Pro- Fac guarantees amounted to $106,000 at June 25, 1994 and $6,294,000 at June 23, 1993.\nPro-Fac's other debt of $120,000 is payable in nine installments from fiscal 1996 to fiscal 20005. The rate on this debt is 4 percent.\nBased on an estimated borrowing rate at 1994 fiscal year end of 8.0 percent for long-term debt with similar terms and maturities, the fair value of the Cooperative's long-term debt outstanding is approximately $136,779,000 at June 25, 1994.\nAdditional Information with Respect to Borrowing Arrangements\nBecause Pro-Fac's income is largely determined by the income of Curtice Burns and because Pro-Fac guarantees the debt of Curtice Burns and Curtice Burns guarantees the debt of Pro-Fac (substantially all of which is advanced to Curtice Burns), management and lenders use combined pro forma financial statements to assess the financial strength of the two companies. Specifically, the combined statement of operations, balance sheet and statement of cash flows portray the financial results, cash flows and equity of Curtice Burns and Pro-Fac. Management believes that combined financial statements are useful because they provide information concerning Pro-Fac's ability to continue present credit arrangements and\/or obtain additional borrowings in the future.\nCertain borrowing agreements require that the companies maintain specified levels with regard to working capital, tangible net worth, fixed charges and the incurrence of additional debt. The Cooperative is in compliance with, or has obtained waivers for, restrictions and requirements under the terms of the borrowing agreements.\nSuch financial statements are neither necessary for a fair presentation of the financial position of Pro-Fac nor appropriate as primary statements for Curtice Burns' shareholders or for Pro-Fac shareholders and members because they combine earnings, assets and liabilities and cash flows which are legally attributable to either Curtice Burns' shareholders or to Pro-Fac shareholders and members, but not to both. Accordingly, the condensed pro forma financial statements presented below are special purpose in nature and should be used only within the context described.\nCombined Pro Forma Condensed Statement of Operations Unaudited\n(A) Amounts represent the balance of the fiscal 1994 share of earnings between Curtice Burns and Pro-Fac which is currently under dispute. See discussion at Note 2.\nTransactions between Curtice Burns and Pro-Fac have been eliminated for purposes of this combined statement of operations.\nCombined Pro Forma Condensed Balance Sheet Unaudited\nNotes to combined balance sheet:\n(A) Current assets of Pro-Fac consist principally of amounts due from Curtice Burns with respect to the Agreement described in Note 2. Such amounts are eliminated for purposes of this balance sheet.\n(B) Property, plant and equipment owned by Pro-Fac (with net book value $141.3 million at June 25, 1994) is leased to Curtice Burns on a financing basis. Such leased assets are reclassified as property, plant and equipment for purposes of this balance sheet.\n(C) The majority of Curtice Burns' lease obligations are payable to Pro-Fac and amount to $141.3 million at June 25, 1994, of which $17.6 million is payable currently. The related Curtice Burns liability and Pro-Fac receivable are eliminated for purposes of this balance sheet.\n(D) Long-term borrowings by Curtice Burns form Pro-Fac under the Agreement are eliminated for purposes of this balance sheet.\n(E) Shareholders' equity of Curtice Burns consists of Class A common stock, $6.6 million; Class B common stock, $2.0 million; additional paid-in capital, $14.2 million; and retained earnings, $58.1 million.\n(F) Amount represents the balance of the fiscal 1994 share of earnings between Curtice Burns and Pro-Fac which is currently under dispute. See discussion at Note 2.\nCombined Pro Forma Condensed Statement of Cash Flows Unaudited\n(A) Amount represents the balance of the fiscal 1994 share of earnings between Curtice Burns and Pro-Fac which is currently under dispute. See discussion at Note 2.\nTransactions between Curtice Burns and Pro-Fac have been eliminated for purposes of this combined statement of cash flows.\nNote 4. LEASES\nAt June 25, 1994 and June 26, 1993 Pro-Fac had investments in financing leases of $141,322,000 and $173,513,000, respectively, of which $17,645,000 and $21,184,000, were due currently.\nMinimum rent payments to be received during each of the next five fiscal years are as follows: 1995-$17,645,000; 1996-$15,829,000; 1997-$14,590,000; 1998-$13,276,000; and 1999-$11,963,000. The minimum rent payments do not include executory costs, since such costs are paid directly by Curtice Burns and they do not include interest, since interest amounts are determined and billed to Curtice Burns based upon Pro-Fac's borrowing costs required to finance the leased assets.\nNote 5. TAXES ON INCOME\nIn December 1991, the national office of the Internal Revenue Service issued a technical advice memorandum ('TAM') concluding that virtually all of Pro-Fac's income arises from patronage sources. As a result of the TAM, in January 1992 an additional distribution of patronage proceeds for fiscal 1991 was made to members in the amount of $3,727,000. Patronage proceeds available for distribution are determined by the Board of Directors each year, as stipulated in the Bylaws. As the longer term effects of the TAM are further researched and analyzed, it is possible that the Board may calculate future patronage proceeds available for distribution utilizing a different formula than that used for 1992 and 1993.\nA summary of taxable income\/(loss) and the related (benefit)\/provision for income taxes for fiscal 1994, 1993 and 1992 follows.\nIn August of 1993, the Internal Revenue Service issued a determination letter which concluded that the Cooperative is exempt from federal income tax to the extent provided by Section 521 of the Internal Revenue Code, 'Exemption of Farmers' Cooperatives from Tax.' Unlike a non-exempt cooperative, a tax-exempt cooperative is entitled to deduct cash dividends it pays on its capital stock in computing its taxable income. This exempt status is retroactive to fiscal year 1986 and is anticipated to apply to future years as long as there is no significant change in the way in which the Cooperative operates. In conjunction with this ruling, the Cooperative has filed for tax refunds for fiscal years 1986 to 1990 in the amount of\napproximately $5.8 million and interest payments of approximately $3.4 million. In addition, it is anticipated that the Cooperative will file for tax refunds for fiscal years 1991 and 1992 in the amount of approximately $3.1 million and interest payments of approximately $.4 million. No such refund amounts have been reflected in the Cooperative's financial statements as of June 26, 1994. It is anticipated that the refund amounts will be recognized upon receipt.\nA benefit has not been recorded for the net operating loss carryforward resulting from 1993 operations due to the uncertainties surrounding utilization in future years.\nDeferred tax assets have been established for the future tax benefit of the redemption on non-qualified retains.\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes,' ('SFAS 109') and the Cooperative has adopted the provisions of this standard as of June 29, 1991. There was no effect on the 1992 provision for income taxes for this accounting change as the Cooperative was previously accounting for income taxes in accordance with SFAS 96.\nNote 6. CAPITALIZATION\nPreferred Stock - Preferred stock originates from the conversion at par value of retains. Preferred stock is non- voting, except that the holders of preferred and common stock would be entitled to vote as separate classes on certain matters which would affect or subordinate the rights of the class. The preferred stock is segregated by the original year of issue in the records of the Cooperative.\nThe Cooperative is entitled to redeem or retire all or any portion of its outstanding preferred stock, at par value, upon 90 days notice.\nCommon Stock - The common stock purchased by members is related to the crop delivery of each member. Regardless of the number of shares held, each member has one vote.\nCommon stock may be transferred to another grower only with approval of the Pro-Fac Board of Directors. If a member ceases to be a producer of agricultural products which he markets through the Cooperative, then he must sell his common stock to another grower acceptable to the Cooperative. If no such grower is available to purchase the stock, then the member must provide one year's advance written notice of his intent to withdraw, after which the Cooperative must purchase his common stock at par value. (See Note 7 for common stock dividend information.)\nDue to the uncertainty surrounding the potential change of control of Curtice Burns and its implications to the Integrated Agreement, The Board of Directors, during 1994, approved a moratorium on all transactions involving common stock and waived the restriction on the utilization of agent farmers to satisfy supply commitments. As a Merger Agreement between the Cooperative and Curtice Burns was entered into on September 27, 1994, it is anticipated that the Board of Directors will re-evaluate the above described restrictions.\nAt June 25, 1994 and June 26, 1993, there were outstanding subscriptions, at par value, for 9,270 and 24,788 shares of common stock, respectively. These shares are issued as subscription payments are received.\nRetained Earnings Allocated to Members ('Retains') - Retains arise from patronage income and are allocated to the accounts of members within 8.5 months of the end of each fiscal year.\nQualified Retains - Qualified retains are freely transferable and normally mature into preferred stock in December of the fifth year after allocation. Qualified retains are taxable income to the member in the year the allocation is made.\nNon-Qualified Retains - Non-qualified retains may not be sold or purchased. The present intention of the board of directors is that the non-qualified retains allocation be redeemed in five years through partial payment in cash and issuance of preferred stock. The non-qualified retains will not be taxable to the member until the year of conversion. Non-qualified retains may be subject to later adjustment if such is deemed necessary by the Board of Directors because of events which may occur after the retains were allocated.\nEarned Surplus (Unallocated and Apportioned) - Earned surplus consists of accumulated income after distribution of earnings allocated to members, dividends and after state and federal income taxes. Earned surplus is reinvested in the business in the same fashion as retains. (See Note 5.)\nStabilization Program - Each year a portion of the earnings is available for the commercial market value stabilization program. The amount designated for the program is determined at the discretion of the board of directors based upon the amount needed to accumulate the maximum authorized, which is 15 percent of the previous year's commercial market value of crops delivered. In a year when revenues are insufficient to pay 100 percent of commercial market value, the stabilization program, with board approval, will provide for extra payments to be made up to the amount previously designated for the program. The amount designated to the program was $8,970,000 at June 25, 1994.\nMarket for Pro-Fac Securities - There is no established market for trading Pro-Fac common stock. All trades have been arranged on a private basis between buyers and sellers.\nTransfers of preferred stock and qualified retained earnings can be arranged on a regular basis through the Buffalo offices of First Albany Corporation or Trubee, Collins and Company, registered securities broker dealers. Transfers of preferred stock can also be arranged on a regular basis through the Erie, Pennsylvania office of Advest, registered securities broker dealer. There can be no assurance this market will have the necessary volume of transactions to continue in the future.\nNote 7. DIVIDENDS ON CAPITAL STOCK\nDividends on preferred and common stock are declared at the discretion of the board of directors and are paid out of legally available funds. Preferred shareholders are entitled to a dividend of up to 12 percent of the par value of the stock if declared by the board. Pursuant to New York State laws, applicable to agricultural cooperatives, dividends have been declared and paid subsequent to the fiscal year to which they relate. In fiscal 1994 and 1993, dividends on preferred stock were paid at a rate of 6.25 and 7.25 percent, respectively, of the par value and dividends on common stock were paid at a rate of 5 percent of the par value.\nSubsequent to June 25, 1994, the Cooperative declared a cash dividend of 6.75 percent of the par value of preferred stock and 5.5 percent of the par value of the common stock, payable on July 15, 1994. These dividends amounted to $4,914,000 and will appear in the fiscal 1995 Statement of Net Proceeds.\nNote 8. RESTRUCTURING PROGRAM\nThe Conceptual Vision and Strategy\nThe restructuring program first initiated in fiscal 1993 was based on Curtice Burns' new vision of a company smaller in sales but more profitable, as measured by return on sales and equity, and possessing the financial and management resources sufficient to drive growth in carefully selected product line markets in which Curtice Burns can prosper for the long term. Thus, the strategy was to focus on a more limited number of product lines which now have a strong, competitive position.\nThe Plan outlined in 1993 is to restructure the business to a more profitable base. At the same time, the remaining businesses were to be managed to optimize earnings growth by installing corporate-wide purchasing, and a corporate-wide focus of capital spending.\nThe third leg of the strategy was to accelerate Curtice Burns' national sales and distribution programs by executing new product programs in store-brand retail dressings, salsa and chunky soups, and the 'More Fruit\/More Flavor' pie filling program.\nExecution of the Program\nThe first step of the restructuring program was to divest businesses that were unprofitable or declining for Curtice Burns but would fit strategically with other business portfolios. During fiscal 1993, Curtice Burns divested Lucca Frozen Foods. A loss of approximately $2.7 million (before dividing with Pro-Fac and before taxes) was recognized on this transaction. At the end of fiscal 1993, Curtice Burns wrote down the assets and provided for the expenses to dispose of the Hiland potato chips and meat snacks businesses during fiscal 1994. On November 22, 1993, Curtice Burns sold certain assets of the Hiland Potato Chip business for $2 million at closing, plus approximately $1 million paid in installments over three months. On February 22, 1994, Curtice Burns sold the meat snacks business located in Denver, Colorado and Albany, Oregon to Oberto Sausage Company of Kent, Washington. Under the agreement, Oberto has purchased certain assets and assumed certain liabilities of the meat snacks operation, excluding plant, equipment, and trademarks. Curtice Burns will lease its Albany Oregon manufacturing facility and equipment and license its trademarks, trade names, etc. to Oberto until February 1995, at which time Oberto is contractually obligated to purchase these assets. The sale of the Hiland and meat snacks businesses did not result in any significant gain or loss in fiscal 1994 after giving effect to the restructuring charges recorded in fiscal 1993; however, charges of $3.1 million were incurred in fiscal 1994 to adjust previous estimates. In the fiscal year ended June 26, 1993, Curtice Burns incurred losses of $13.2 million from the meat snacks and Hiland potato chip businesses before dividing such losses with Pro-Fac and before taxes.\nOn November 19, 1993, Curtice Burns sold the oats portion of the National Oats business for $39 million. The oats business contributed approximately $1.4 million of earnings in fiscal 1993 before dividing with Pro-Fac and before taxes. The sale of the oats business resulted in an approximate $10.9 million gain. The popcorn portion of the National Oats Division was transferred to the Comstock Michigan Fruit Division.\nDuring fiscal 1993 and 1994, Curtice Burns also made staff reductions in selected locations throughout Curtice Burns. A $1 million accrual relating to such costs was recorded as part of the fiscal 1993 restructuring charge.\nThus, a major part of the restructuring plan was successfully executed during fiscal 1994.\nAs reported above, Curtice Burns incurred restructuring charges in fiscal 1993 of $61.0 million (before dividing such charges with Pro-Fac and before taxes), which included the loss incurred on the sale of the Lucca frozen entree business, anticipated losses on the sale of the meat snacks and Hiland businesses, and other costs (primarily severance and losses prior to sale) in conjunction with the restructuring program. Virtually all of this charge was a revaluation of assets, rather than cash expense.\nHaving completed the first phase of the restructuring program in fiscal 1993, the second phase was approved by Curtice Burns' Board of Directors in August 1994. In connection with the second phase, the company is evaluating several alternatives regarding the Nalley's snack food business in the United States, including its possible sale to a third party. A charge, not exceed $12 million before split with Pro-fac and before taxes, for this phase of the restructuring program will be recorded during the first quarter of fiscal 1995.\nWith respect to the potential sale of the snack food business, Curtice Burns has signed a letter of intent with Country Crisp Foods of Salt Lake City, Utah. The letter of intent is subject to a number of conditions, including successful financing by the purchaser and the negotiation of a definitive purchase agreement. Country Crisp, a regional snack food company operating in the inter-mountain states of Colorado, Utah, Wyoming, Idaho, Nevada and New Mexico, will continue to market the Nalley's brand snacks under a licensing arrangement with Curtice Burns. If this sale is finalized, it may result in a revision to the aforementioned reserve.\nNote 9. OTHER MATTERS\nHarvest States Cooperative\nIn conjunction with the sale of the National Oats division by Curtice Burns, Pro-Fac terminated the membership of the Harvest States Cooperatives ('Harvest States') in Pro-Fac. Harvest States was the National Oats divisions's only supplier of oats. As a result of this action, Harvest States filed a claim against Pro-Fac for, among other things, the receipt of payments for future oats purchases after the sale of National Oats division through fiscal year 1995.\nUnder an agreement with Curtice Burns, Curtice Burns agreed to indemnify Pro-Fac as to certain expenses arising out of the termination of the membership of Harvest States in Pro- Fac. It was agreed that any settlement payments would be deemed an expense of Curtice Burns under the division of earnings with Pro-Fac. The exact amount of any potential settlement related to this issue cannot be estimated at June 25, 1994, but management does not believe that this is a material exposure to Curtice Burns.\nSubsequent Events\nIn July 1994, a plant operated by the Curtice Burns' Southern Frozen Foods division, located in Montezuma, Georgia, was damaged by fire. The plant itself is owned by Pro-Fac and leased to Curtice Burns under the terms of the Integrated Agreement. Management is currently in the process of assessing the extent of damage to the facility. All material costs associated with the facility repairs and business interruption are anticipated to be covered under the Curtice Burns' insurance policies. The Springfield Bank for Cooperatives is loss payee on the property insurance policy under the terms of the Security Agreement with lenders. See Note 5.\nOn September 27, 1994, Pro-Fac and Curtice Burns entered into a Merger Agreement pursuant to which Pro-Fac will purchase all of the shares of Class A common stock and Class B common stock of Curtice Burns for $19.00 per share, or approximately $167.0 million in the aggregate. Pro-Fac will immediately commence a tender offer for all of the shares to be followed, if successful, by a merger of a subsidiary of Pro-Fac into Curtice Burns.\nPro-Fac has advised Curtice Burns that it expects to complete its tender offer on or about November 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\nThe following are the directors of Pro-Fac:\n(1) Member of the Finance and Audit Committee, which sometimes functions as an executive committee of the Board.\n(2) Member of the Board of Directors of Curtice Burns Foods, Inc.\n(3) Ex-officio member of Finance and Audit committee and other committees of the Board as President of Pro-Fac.\n(4) Regional Representation:\nThe business of Pro-Fac is conducted pursuant to policies established by its Board of Directors. The territorial area in which Pro-Fac operates has been divided into geographical regions based on natural divisions of product and location. In addition, some regions have been further divided into districts. The members within each region or district are represented on the Board by at least one director. The board designates the number of directors to be elected from each region or district, based on the value of raw product delivered, so as to attain reasonably balanced representation on the Board. At present, there are five regions of Pro-Fac covering the following areas and represented by the number of directors indicated:\nDirectors are elected for three-year terms. The directors of Pro-Fac are all engaged as growers in the production of agri- cultural products, and have been so engaged for at least five years.\nThe following are the executive officers of Pro-Fac:\nRobert V. Call, Jr. President - A grower based in Batavia, New York - a member of Pro-Fac since 1961, Treasurer from 1973-1984, and President since 1986.\nAlbert P. Fazio, Vice President - A grower based in Vancouver, Washington - a member of Pro-Fac since 1975 and Vice President since March 1993, Secretary March 1991 to March 1993.\nSteven D. Koinzan, Secretary - A grower based in Valentine, Nebraska - a member of Pro-Fac since 1982.\nBruce R. Fox, Treasurer - A grower based in Shelby, Michigan - a member of Pro-Fac since 1974, Treasurer since November 1984 and Secretary from November 1978 to November 1984.\nThomas R. Kalchik - 20 Skelby Moor Lane, Fairport, New York 14450 - Vice President of Member Relations since June 1990, Assistant Secretary since August 1983, Director of Member Relations from August 1983 to June 1990, Assistant Director of Member Relations from September 1981 to August 1983, and Area Manager from January 1977 to September 1981.\nRoy A. Myers - 72 Waterview Circle, Rochester, New York 14625 - General Manager since June 1987, Assistant General Manager from August 1983 to June 1987 - he has been an Executive Vice President of Curtice Burns since June 1987 and a Vice President of Curtice Burns from August 1983 to June 1987 and President of the Corporate Services Division of Curtice Burns since January 1979.\nWilliam D. Rice - 5 Brightford Heights Road, Rochester, New York 14610 - Assistant Treasurer since 1970 - he is Senior Vice President- Administration, Secretary, and Treasurer of Curtice Burns - employed by Curtice Burns since 1969.\nOfficers are elected for one-year terms.\nThere are no family relationships among any directors or executive officers.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nPro-Fac reimburses Curtice Burns annually for the salaries and expenses of three Curtice Burns employees who perform Pro-Fac membership relations functions.\nFor the fiscal year ended June 25, 1994, the salary expense paid by Pro-Fac was $180,000 and the employee expense (travel and telephone) was $68,000. Each director of Pro-Fac received an annual fee of $6,000 (except the President who received $12,000) plus an additional fee of $200 per day (except the President who received $400) for attendance at Board and other designated meetings. Pro-Fac directors were also reimbursed for their out-of-pocket expenses.\nPro-Fac has no pension or retirement plan under which retirement benefits are proposed to be paid to any of its officers or directors.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAs of June 25, 1994, the following were the only persons known to Pro-Fac to be the beneficial owners of more than 5 percent of any class of the voting securities of Pro-Fac:\nThe following table shows, as of June 25, 1994, both classes of equity securities of Pro-Fac, the number and percentage of shares issued and outstanding which are beneficially owned by each director and by all directors and officers as a group.\n(1) No Pro-Fac equity securities are owned by Curtice Burns.\n(2) Certain of the directors named above may have the opportunity, along with the other members producing a specific crop, to acquire beneficial ownership of additional shares of the common stock of Pro-Fac within a period of approximately 60 days commencing February 1, 1995 if Pro-Fac determines that a permanent change is required in the total quantity of that particular crop marketed through it.\n(3) In the above table, each director who has direct beneficial ownership of common or preferred shares by reason of being the record owner of such shares has sole voting and investment power with respect to such shares, while each director who has direct beneficial ownership of common or preferred shares as a result of owning such shares as a joint tenant has shared voting and investment power regarding such shares. Each director who has indirect beneficial ownership of common or preferred shares resulting from his status as a shareholder or a partner of a corporation or partnership which is the record owner of such shares has sole voting and investment power if he controls such corporation or partnership. If he does not control such corporation or partnership, he has shared voting and investment power. Pro-Fac does not believe that the percentage ownership of any such corporation or partnership by a director is material, since in the aggregate no director beneficially owns in excess of 5 percent of either the common or preferred shares of Pro- Fac.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAll of the directors of Pro-Fac elected by its members are members of the Cooperative and deliver various quantities of raw product to it, either individually or through partnerships, corporations, or other production units. The prices paid to such directors for produce are in all cases identical to the prices paid all others for like produce.\nWhen Curtice Burns finds it necessary to purchase on the open market additional quantities of crops of the kinds purchased from Pro-Fac, the members of Pro-Fac are given the first opportunity to supply those crops. Thus, certain of the directors of Pro-Fac, like other members, may from time to time sell agricultural products to Curtice Burns. Prices paid in such transactions are identical to those paid in other open market transactions for similar produce on the same dates.\nNo other material transactions between Pro-Fac and its officers or directors, other than the payment of ordinary compensation and directors' fees as described above, the sale of common stock to support membership production obligations, and the issuance of retains and preferred stock, have taken place within the past three years.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K An index of financial statements is set forth in Part II, Item 8 of this report.\nThe following additional financial data should be read in conjunction with the financial statements included in Item 8 of this Form 10-K Annual Report:\nSchedule II - Amounts receivable from related parties and underwriters, promoters and employees other than related parties.\nSchedule IV - Indebtedness of and to related parties - not current.\nSchedule IX - Short-term borrowings.\nSchedules other than those listed above are omitted because they are either not applicable or not required, or the required information is shown in the financial statements or the notes thereto.\nThe following exhibits are filed herein or have been previously filed with the Securities and Exchange Commission:\nReports on Form 8-K\nNo Reports on Form 8-K were filed by Pro-Fac during the last quarter of the fiscal year covered by this report.\nPRO-FAC COOPERATIVE, INC.\nSCHEDULE II\nAmounts receivable from related parties and underwriters, promoters, and employees other than related parties.\nThe cash needs of a fruit and vegetable food processor such as Curtice Burns fluctuate greatly during the year because of the peak cash outflow required during a limited production season that is tied to the harvest season of the crops involved, while the cash inflow from sales is more ratably spread throughout the year. By reason of the agreements with Pro-Fac, these peak cash needs are supplied to Curtice Burns by Pro-Fac. Such receivables from Curtice Burns include:\n1. Advances under a short-term line of credit.\n2. Accrued interest on all short-term and long-term borrowings that will be paid by Curtice Burns to Pro-Fac when Pro-Fac pays its lenders.\n3. Raw product delivered to Curtice Burns for which Pro-Fac has agreed on extended terms under the marketing section of the Integrated Agreement.\n4. Amounts due under the profit split provisions of the operations financing section of the Integrated Agreement.\nPRO-FAC COOPERATIVE, INC.\nSCHEDULE IV\nIndebtedness of and to related parties - not current\nUnder the terms of the operations financing section of the Integrated Agreement between Pro-Fac and Curtice Burns, Pro-Fac lends to Curtice Burns all funds not required for its own operations or for purchases of assets to be leased to Curtice Burns. Funds loaned to Curtice Burns bear the same conditions and interest rates as Pro-Fac has obtained from its lenders. The interest rates on such borrowings at June 25, 1994, June 26, 1993 and June 26, 1992, were 6.7 percent, 6.2 percent, and 7.1 percent, respectively.\nPRO-FAC COOPERATIVE, INC.\nSCHEDULE IX - SHORT-TERM BORROWINGS FOR THE THREE YEARS ENDED JUNE 25, 1994\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant had duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Dated: 8\/10\/94\nPRO-FAC COOPERATIVE, INC.\nBy: \/s\/ Roy A. Myers ------------------------- Roy A. Myers General Manager\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints ROY A. MYERS AND WILLIAM D. RICE, 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 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, 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 satisfying 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.\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 - - - ----------- ----- ------- [S] [C] [C]\n\/s\/ Robert V. Call, Jr. President; Director 8\/11\/93 - - - -------------------------- Robert V. Call, Jr.\n\/s\/ Roy A. Myers General Manager 8\/10\/94 - - - -------------------------- (Principal Executive Roy A. Myers Officer)\n\/s\/ Albert P. Fazio Vice President; 8\/10\/94 - - - -------------------------- Director Albert P. Fazio\n\/s\/ Bruce R. Fox Treasurer; Director 8\/10\/94 - - - -------------------------- (Principal Financial Bruce R. Fox Officer)\n\/s\/ Steven D. Koinzan Secretary; Director 8\/10\/94 - - - -------------------------- Steven D. Koinzan\n\/s\/ William D. Rice Assistant Treasurer 8\/10\/94 - - - -------------------------- (Principal Accounting William D. Rice Officer)\n\/s\/ Dale Burmeister Director 8\/10\/94 - - - -------------------------- Dale Burmeister\n\/s\/ Glen Lee Chase Director 8\/10\/94 - - - -------------------------- Glen Lee Chase\nSignature Title Date - - - ------------- ----- ----\n\/s\/ Tommy R. Croner Director 8\/10\/94 - - - -------------------------- Tommy R. Croner\n\/s\/ Kenneth Mattingly Director 8\/10\/94 - - - -------------------------- Kenneth Mattingly\n\/s\/ Allan D. Mitchell Director 8\/10\/94 - - - -------------------------- Allan D. Mitchell\n\/s\/ Allan W. Overhiser Director 8\/10\/94 - - - -------------------------- Allan W. Overhiser\n\/s\/ Paul E. Roe Director 8\/10\/94 - - - -------------------------- Paul E. Roe\n\/s\/ Edward L. Whitaker Director 8\/10\/94 - - - -------------------------- Edward L. Whitaker\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT.\nNo proxy statement, form of proxy or other proxy soliciting material has been or will be sent to security holders with respect to the 1994 annual meeting. Pro-Fac's 1994 annual report to security holders has not yet been sent to its security holders. Copies of such report will be sent to the Commission when it is sent to the security holders.\nEXHIBIT INDEX\nNumber Description - - - ------ -----------\n3(A) Certificate of Incorporation of the registrant, as amended, incorporated by reference to the Annual Report on Form 10-K of the registrant for the fiscal year ended June 27, 1986, wherein such exhibit is designated as Exhibit 3(A).\n3(B) Certificate of Amendment to Certificate of Incorporation, incorporated by reference to the Quarterly Report on Form 10-Q of the registrant for the quarter ended December 25, 1987, wherein such exhibit is designated Exhibit 6(a).\n3(C) Certificate of Amendment to the Certificate of Incorporation of registrant, incorporated by reference to the Registration Statement of the registrant on Form S-2, Registration No. 33-26797, filed February 2, 1989, wherein such exhibit is designated as Exhibit 4(B).\n3(D) Certificate of Amendment to the Certificate of Incorporation incorporated by reference to the Annual Report on Form 10-K of the registrant for the fiscal year ended June 26, 1993, wherein such exhibit is designated Exhibit 3(D).\n3(E) By-laws of the registrant, as amended to date for the fiscal year ended June 26, 1992, incorporated by reference wherein such exhibit is designated as Exhibit 3(E).\n10(A) Integrated Agreement between the registrant and Curtice Burns, dated as of June 27, 1992 for the fiscal year ended June 26, 1992, incorporated by reference wherein such exhibit is designated as Exhibit 10(A).\n10(B) (i) Master Agreement between the registrant and the Springfield Bank for Cooperatives, dated October 8, 1981, incorporated by reference to the Registration Statement of the registrant on Form S-1, Registration No. 2-75576, filed January 4, 1982, wherein such exhibit is designated Exhibit 10(G)(i).\n(ii) Modification of Master Agreement between the Registrant and Springfield Bank for Cooperatives, dated November 22, 1989, incorporated by reference to the Annual Report on Form 10-K of the Registrant for the fiscal year ended June 29, 1990, wherein such exhibit is designated Exhibit 10(E)(ii).\n(iii) Modification of Master Agreement between the Registrant and Springfield Bank for Cooperatives, dated March 15, 1990, incorporated by reference to the Registration Statement of the registrant on Form S-2, Registration No. 33-46619, filed March 30, 1992, wherein such exhibit is designated Exhibit 10(D)(iii).\n(iv) Term Loan Agreement Nos. T-5715-G and T-5716-G between the Registrant and Springfield Bank for Cooperatives dated December 20, 1991, incorporated by reference to the Registration Statement of the registrant on Form S- 2, Registration No. 33-46619, filed March 30, 1992, wherein such exhibit is designated Exhibit 10(D)(iv).\n(v) Term Loan Agreement Nos. T-5718-G and T-5719-G between the registrant and Springfield Bank for Cooperatives dated December 20, 1991, incorporated by reference to the Registration Statement of the registrant on Form S- 2, Registration No. 33-46619, filed March 30, 1992, wherein such exhibit is designated Exhibit 10(D)(v).\nNumber Description - - - ----- -----------\n(vi) Term Loan Agreement Nos. T-5720F and T-5721F between the Registrant and Springfield Bank for Cooperatives, dated December 20, 1991, incorporated by reference to the Registration Statement of the registrant on Form S- 2, Registration No. 33-46619, filed March 30, 1992, wherein such exhibit is designated Exhibit 10(D)(vi).\n(vii) Seasonal Loan Agreement Nos. S-5933 and S-5934 between the Registrant and Springfield Bank for Cooperatives, dated November 25, 1991, incorporated by reference to the Registration Statement of the registrant on Form S- 2, Registration No. 33-46619, filed March 30, 1992, wherein such exhibit is designated Exhibit 10(D)(vii).\n(viii) Agreement of Guaranty executed by Curtice Burns, dated July 2 1990, incorporated by reference to the Registration Statement of the registrant on Form S-2, Registration No. 33-46619, filed March 30, 1992, wherein such exhibit is designated Exhibit 10(D)(viii).\n(ix) Modification of Guaranty executed by Curtice Burns, dated February 20, 1991, incorporated by reference to the Registration Statement of the registrant on Form S- 2, Registration No. 33-46619, filed March 30, 1992, wherein such exhibit is designated Exhibit 10(D)(ix).\n(x) Modification of agreements with Springfield Bank for Cooperatives\n10(C) Pro-Fac Guaranty of Curtice Burns Indebtedness, as Amended, incorporated by reference to the Annual Report on Form 10-K of the registrant for the fiscal year ended June 26, 1993, wherein such exhibit is designated Exhibit 10(C).\n10(D) Waiver of Events of Default Under Financing Agreements and Amendments to Financing Agreements dated September 21, 1993, incorporated by reference to the Annual Report on Form 10-K of the registrant for the fiscal year ended June 26, 1993, wherein such exhibit is designated as Exhibit 10(D).\n21 Subsidiaries of the Registrant\n27 Financial Data Schedule\nReports on Form 8-K\nNo Reports on Form 8-K were filed by Pro-Fac during the last quarter of the fiscal year covered by this report.","section_15":""}
{"filename":"763043_1994.txt","cik":"763043","year":"1994","section_1":"Item 1. Business --------\nGeneral\nBiocraft Laboratories, Inc. (the \"Company\") manufactures and markets various dosages of generic drugs. Generic drugs are the chemical and therapeutic equivalents of brand name drugs which generally have gained market acceptance while under patent protection. Although subject to strict Food and Drug Administration (\"FDA\") standards, generic drugs are sold under their chemical (generic) names, typically at prices substantially below those of their brand name equivalents.\nSales of generic drugs have increased significantly in recent years, due in part to greater awareness and acceptance of generic drugs by physicians, pharmacists and the public. Among the factors which have contributed to this increased awareness and acceptance are the modification of state laws to permit pharmacists to substitute generic drugs for brand name drugs (where authorized or not expressly prohibited by the prescribing physician), and the publication by the FDA of a list of therapeutic equivalent drugs which provides physicians and pharmacists with the names of generic drug alternatives. In addition, since generic drugs are typically sold at prices significantly below the price of brand name drugs,\nthe prescribing of generic drugs has been encouraged, and in many cases required, by various government agencies and by many private health programs as a cost-saving measure in the purchase of, or reimbursement for, prescription drugs.\nProducts and Product Development\nThe Company presently manufactures various dosages of 25 prescription drugs, and one prescription veterinary drug constituting an aggregate of 73 products. Governmental approvals were required and obtained for each of these products. The Company's products are sold in various oral dosage forms, including compressed tablets, two-piece hard-shell capsules, powders for oral solution or suspension and liquids. As of March 31, 1994, the Company was awaiting FDA approvals to market 14 generic drugs constituting 26 products. The Company intends to submit to the FDA applications to approve 11 new generic drugs constituting a variety of products during fiscal 1995. See \"Government Regulations.\"\nThe 26 drugs manufactured by the Company can be divided into 11 categories. The number of products in each category is shown in parentheses.\n1. Penicillin and Semi-Synthetic Penicillin Drugs (23): These antibiotic drugs include Penicillin V Potassium and the semi-synthetic penicillin drugs Amoxicillin, Ampicillin, Cloxacillin, Dicloxacillin and Oxacillin.\n2. Cephalosporin Drugs (10): These antibiotic drugs are Cephradine and Cephalexin.\n3. Other Antibiotic Drugs (6): These drugs are Cinoxacin, Clindamycin, Minocycline HCl, Neomycin and Nystatin.\n4. Analgesic Drug (3): This drug is Ketoprofen.\n5. Anti-Infective Drugs (5): These drugs are Trimethoprim and a combination of Sulfamethoxazole and Trimethoprim.\n6. Anti-Depressant Drugs (8): These drugs are Amitriptyline Hydrochloride and Imipramine Hydrochloride.\n7. Bronchial Dilator Drugs (5): These drugs are Albuterol and Metaproterenol.\n8. Cardiovascular Drugs (3): These drugs are Disopyramide Phosphate and Amiloride Hydrochloride with Hydrochlorothiazide.\n9. Gastrointestinal Drug (3): This drug is Metoclopramide.\n10. Anti-Spasmodic Drug (2): This drug is Baclofen.\n11. Veterinary Drugs (5): The drug in this category is Amoxicillin, an antibiotic sold under the registered trademark \"Biomox.\"\nThe Company also manufactures the active ingredients it uses in its semi- synthetic penicillin drugs at its Waldwick, New Jersey facility and bulk form Cephalexin at its Mexico, Missouri facility. Such active ingredients are from time to time sold in bulk form, generally in small amounts. Chemical intermediates for antibiotic production are also manufactured in its Mexico, Missouri\nfacility. In March 1994, the Company received FDA approval to manufacture bulk form Amoxicillin and Ampicillin in its plant in Missouri.\nThe Company's research and development activities generally consist of new generic drug product development, clinical studies for generic and non-generic drugs and research for developing new bulk manufacturing processes. In the fiscal years ended March 31, 1992, 1993 and 1994, total research and development expenditures were approximately $8,755,000, $8,662,000 and $9,923,000, respectively.\nThe Company's primary product development strategies are to manufacture and sell in generic form antibiotic drugs for which the Company can maintain certain cost controls by manufacturing the chemical intermediates and\/or active ingredients in bulk. Generally, the Company also selects non-antibiotic drugs for which the Company anticipates initially limited competition due to such factors as extensive FDA approval requirements, complexity of manufacture or limited availability of raw materials. In all cases, the Company seeks to obtain FDA approval to market a new generic drug product by, or shortly after, the patent expiration date of the equivalent brand name drug in order to be among the first generic drug companies to offer a generic equivalent at a substantially lower price. Since the development of a generic drug product, including its formulation, testing and FDA approval,\ngenerally takes approximately three to four years, development activities for a product may begin several years in advance of the patent expiration date of the brand name drug equivalent. Consequently, the Company is presently selecting drugs it expects to market several years in the future.\nThe Company is developing certain drugs which the FDA has determined require clinical studies in order to obtain approval of a generic equivalent. Completion of these clinical studies involves larger numbers of subjects and longer periods of time and results in greater expenditures than do bioequivalency studies which are required for most generic drugs. The Company is currently awaiting FDA approval of one such drug, Sucralfate, an ulcer medication.\nThe Company is considering developing, manufacturing and selling drugs which require New Drug Applications. The process of obtaining FDA approval of these types of drugs typically requires greater expenditures by the Company than approval of most generic drugs and often takes many years to complete. To market these drugs, it will be necessary to familiarize physicians, pharmacists and the public with the effects of such drugs. Since the Company has no experience in this type of marketing, no assurance can be given that the Company will have the ability itself, or that it will be able to make arrangements with others, to market these drugs in such manner.\nMarketing and Customers\nThe Company sells its products primarily through 12 salaried employees. Sales of drugs in dosage forms are made primarily to distributors, drug wholesalers, drugstore chains, mass merchandisers, other drug manufacturers, health care institutions and government agencies. More than half of the Company's gross sales of drugs in dosage form is made under its own label and the balance is made under customers' labels; however, in all cases the Company is named on the label as the manufacturer.\nThe Company sells dosage form products to approximately 400 customers. No single customer accounted for over 10% of total net sales in fiscal 1992, 1993 or 1994.\nIn fiscal 1992, 1993 and 1994, sales of cephalosporins constituted approximately 27%, 24% and 27%, respectively, of total gross sales. For the fiscal years ended March 31, 1992, 1993 and 1994, penicillin and semi-synthetic penicillin drugs accounted for approximately 41%, 33% and 36%, respectively, of total gross sales.\nA key element of the Company's marketing strategy is to attempt to maintain sufficient inventories of products in order to fill customer orders generally within a one to four week period. This strategy requires a substantial amount of working capital to\nmaintain inventories at a level sufficient to meet anticipated demand.\nCompetition\nThe Company competes in varying degrees with numerous foreign and domestic companies in the health care industry, including other manufacturers of generic drugs (among which are several major pharmaceutical companies) and manufacturers of brand name drugs. Many of the Company's competitors have greater financial and other resources and are, therefore, able to expend more effort than the Company in areas such as marketing and product development.\nThe principal competitive factors in the generic pharmaceutical market are the ability to introduce generic versions of brand name drugs promptly after patent expiration, price, quality and customer service.\nRaw Materials\nThe principal raw materials of the Company's business are active ingredients for non-penicillin drugs and bulk pharmaceutical chemicals. The bulk pharmaceutical chemicals are used to\nmanufacture bulk form antibiotics. Both types of raw materials are generally available from multiple sources.\nBecause the FDA requires specification of raw material suppliers in applications for approval of drug products, if raw materials from a specified supplier were to become unavailable, the required FDA approval of a new supplier could cause a delay in the manufacture of the drug involved. To date, the Company has not experienced any significant delay and it does not expect any such delays in the future.\nEmployees\nAs of April 1, 1994, the Company had approximately 750 full-time employees. Approximately 115 administrative and professional personnel are engaged, at least part of their time, in product development, including market research, product selection and formulation, and in seeking FDA approvals of dosage form products. Approximately 290 employees are represented by a local collective bargaining unit whose agreement with the Company expires June 30, 1994. An agreement in principle has been reached with the collective bargaining unit concerning a new agreement. Management believes that its relations with employees are satisfactory.\nGovernment Regulation\nAll pharmaceutical manufacturers are subject to extensive regulation by the federal government, principally by the FDA, and to a lesser extent by state and local governments. The Federal Food, Drug and Cosmetic Act, the Controlled Substances Act and other federal statutes and regulations govern or influence the testing, manufacture, safety, labeling, storage, record keeping, approval, pricing, advertising and promotion of the Company's products. Noncompliance with applicable requirements can result in fines, recall and seizure of product, total or partial suspension of production, delays in receiving approval of new drug applications, refusal to enter into government supply contracts and criminal prosecution. The FDA also has the authority to revoke approvals of drugs.\nFDA approval is required before each dosage form of any new drug can be marketed. All applications for FDA approval must contain information relating to bioequivalency, product formulation, stability, manufacturing processes, packaging, labeling and quality control. Validation of manufacturing processes is also generally required before a Company may market new products. There are generally two types of applications currently used to obtain FDA approval of a new drug.\n1. New Drug Application (\"NDA\"). Generally, with respect to drugs with active ingredients not previously approved by the FDA, a\nprospective manufacturer must conduct and submit to the FDA complete clinical studies to prove that drug's safety and efficacy. An NDA may also be submitted for a drug with a previously approved active ingredient if the abbreviated procedure discussed below is not available.\n2. Abbreviated New Drug Application (\"ANDA\"). The Drug Price Competition and Patent Term Restoration Act of 1984 (the \"Drug Price Act\") established an abbreviated procedure for obtaining FDA approval for generic drugs already approved for sale in the United States. Under the ANDA procedure, which applies to most previously approved drugs, the FDA waives the requirement of conducting complete clinical studies of safety and efficacy and instead requires data illustrating that the generic drug formulation is bioequivalent to a previously approved drug. \"Bioequivalence\" indicates that the rate of absorption and the levels of concentration of a generic drug in the body needed to produce a therapeutic effect are substantially equivalent to those of the previously approved drug. In certain cases, however, the FDA may require clinical studies in order to show generic equivalence to a previously approved drug.\nAlthough antibiotic and veterinary drugs are classified separately for purposes of FDA approval, the procedure for such drugs conforms substantially to the NDA\/ANDA procedures.\nNone of the products currently marketed by the Company, other than veterinary drugs, have required a full NDA or the equivalent application.\nThe Drug Price Act also created new statutory protections for brand name drugs. Under certain circumstances the term of a product or use patent can be extended for up to five years or provide an exclusivity period of two to ten years.\nUnder the Drug Price Act, the effective date of approval of most generic drugs will ordinarily be delayed until the expiration of patents covering the product or until a court has determined the patent to be invalid or not infringed. If a manufacturer files an ANDA certifying that it believes a patent is invalid or not infringed and successfully defends itself in patent litigation, it may receive exclusive marketing rights for the generic version of the product for a period of 180 days. These provisions do not apply to antibiotics.\nThe Generic Drug Enforcement Act of 1992 was enacted in May 1992 as a result of findings of corruption in the FDA's process of approving generic drugs. The law establishes procedures to bar individuals who have been convicted of certain crimes from working for companies that manufacture or distribute such products and delays the review and approval of ANDAs submitted by or with the assistance of debarred individuals. The law also provides, under certain circumstances, for debarment of corporations and \"high\nmanagerial agents\" as defined in the Act, withdrawal of approvals of ANDAs and civil penalties for both individuals and corporations. The Company does not expect the law to have a material impact on the review or approval of the Company's ANDAs.\nAmong the requirements for new drug approvals is the requirement that the prospective manufacturer's methods conform to the FDA's current good manufacturing practices standards (\"cGMP Regulations\"). The cGMP Regulations must be followed at all times during which the approved drug is manufactured. In complying with the standards set forth in these regulations, the Company must continue to expend time, money and effort in the areas of production and quality control in order to achieve compliance. Failure to so comply risks possible FDA action such as the suspension of manufacturing, withdrawal of ANDAs or the seizure of drug products. The Company is in discussions with the FDA over issues arising from an inspection in May 1994. The FDA has requested that it take additional steps to remedy alleged noncompliance with cGMP Regulations primarily as they relate to some of the Company's products. The Company believes that its marketed products meet appropriate standards and are safe and effective, and that it is in substantial compliance with cGMP Regulations. Although the Company cannot predict the outcome of these discussions and no assurances can be made, it is hopeful that\na mutually acceptable resolution can be reached with the FDA without litigation. Pending resolution of such issues, new drug approvals may continue to be delayed.\nIn November 1990, Congress passed, as part of the Omnibus Budget Reconciliation Act of 1990, The Medicaid Prudent Purchasing Act (the \"Medicaid Rebate Act\"). The Medicaid Rebate Act, with respect to generic pharmaceuticals, requires all manufacturers whose products are covered by the Medicaid Program, to rebate to each state a percentage (currently 11% in the case of products sold by the Company) of the manufacturer's average net sales price, for all products dispensed by pharmacists pursuant to Medicaid. Additional rules, which apply with respect to nongeneric pharmaceuticals, are not currently applicable to the Company. In addition, several states, including New Jersey, New York, California, Pennsylvania and Connecticut, have enacted similar legislation with respect to programs other than Medicaid.\nThe Company also is governed by federal, state and local laws of general applicability, such as laws regulating working conditions. In addition, the Company is subject, as are manufacturers generally, to various federal, state and local environmental protection laws and regulations, including those governing the discharge of materials into the environment.\nCompliance with such environmental provisions is not expected to have a material effect on the earnings, cash requirements or competitive position of the Company in the foreseeable future. See \"Legal Proceedings\" with respect to pending environmental matters.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ----------\nThe executive offices and production, laboratory and warehouse facilities of the Company occupy an aggregate of approximately 347,000 square feet in seven facilities. The Company's principal executive offices, its 49,000 square foot warehouse and distribution center are located in Fair Lawn, New Jersey.\nPenicillin and semi-synthetic penicillin dosage form production operations and a quality control laboratory are located in the Company's plant of approximately 37,000 square feet in Elmwood Park, New Jersey, approximately 4 miles from the executive offices. The Company's plant in Paterson, New Jersey, one mile from the Elmwood Park facility, is approximately 48,000 square feet and is used for the manufacture of dosage form products other than penicillins and cephalosporins. Dosage form cephalosporin drug products are produced at the Company's 56,000 square foot facility\nlocated in Fairfield, New Jersey, approximately 15 miles from the executive offices. It also contains a quality control laboratory.\nThe Company manufactures the active ingredients used in its semisynthetic penicillin drugs at its plant of approximately 15,000 square feet in Waldwick, New Jersey, approximately 5 miles from the executive offices. The Waldwick plant also houses the Company's laboratories for microbiology, quality control for bulk form penicillin manufacturing and research and development for bulk form antibiotics. Raw materials and finished inventory for the Waldwick plant are stored in a warehouse of approximately 17,000 square feet which is adjacent to the Waldwick plant.\nThe Company completed construction of a facility to manufacture pharmaceutical intermediates and bulk antibiotics in Mexico, Missouri in fiscal 1992. The plant is approximately 125,000 square feet and contains manufacturing, laboratory, office and warehouse facilities. In addition, the complex includes a solvent recovery facility and a waste disposal plant.\nAll of the above property is owned by the Company. Management believes that the Company's facilities are suitable for its requirements. These facilities have additional capacity for expansion of production of existing and new products. The Company owns substantially all of its manufacturing equipment and believes that such equipment is well maintained and suitable for its requirements.\nItem 3.","section_3":"Item 3. Legal Proceedings -----------------\nBetween November 23 and November 29, 1993, five separate actions were commenced in the United States District Court for the District of New Jersey against the Company and Harold Snyder, Beatrice Snyder, Beryl L. Snyder, Brian S. Snyder and Jay T. Snyder, all of whom are officers and directors of the Company, and Steven J. Sklar, who is an officer of the Company, purporting to allege securities fraud and common law claims on behalf of purchasers of the Company's stock. Thereafter, pursuant to an Order of the Court, the five actions were consolidated under the caption In re Biocraft Laboratories, Inc. Securities -------------------------------------------- Litigation, and a Consolidated and Amended Class Action Complaint (the - - ---------- \"Complaint\") was served on March 8, 1994. The Complaint purports to allege securities fraud claims under Sections 10 (b) and 20 of the Securities Exchange Act of 1934, 15 U.S.C. (S)(S) 78(b) and 78t, and SEC Rule 10b-5, 17 C.F.R. (S)(S) 240.10b-5, as well as claims for common law fraud and negligent misrepresentation, based on alleged misrepresentations and omissions in the Company's publicly filed statements and press releases regarding the Company's compliance with the FDA concerning the Company's manufacture of its products. Plaintiffs seek compensatory and punitive damages in an unspecified amount, as well as attorneys' fees and other costs of\nthe lawsuit. On May 9, 1994, the Company moved to dismiss the Complaint on the grounds that, among other things, it fails to state a claim upon which relief can be granted.\nIn February 1986, Hoffmann-LaRoche, Inc. (Roche) obtained a declaratory judgment that the Company was not entitled to withhold royalties under a license for the right to manufacture and sell a patented drug, which patent expired in June 1988. In February 1994 this matter was settled by the Company and the case was dismissed. The Company paid Hoffmann-LaRoche, Inc. $250,000.\nIn September 1980, the Company entered into an administrative consent order with the New Jersey Department of Environmental Protection (DEP) pursuant to which the Company agreed to among other things, monitor and take certain action to remediate contamination of the groundwater beneath the Company's Waldwick, New Jersey plant by use of microbiological decontamination wells which were installed in fiscal 1981. This order has been modified to include action to be taken to monitor and, if necessary remediate, possible contamination of the groundwater below the property adjacent to the Waldwick facility. The Company does not expect the continued cost of this remediation to be material.\nOn June 8, 1989, the United States Environmental Protection Agency (EPA) notified the Company that it was a potentially responsible party (PRP) along with other generators of industrial\nwaste, the site owners and operators, and transporters of wastes to the site, for the alleged release of hazardous substances from a waste management site in Elkton, Maryland, known as the \"Spectron Site.\" The Company has participated with other PRPs in investigating and remediating the site under a Consent Order entered into with EPA in August 1989. As of March 31, 1994, the Company has paid to the PRP group approximately $224,000, all of which was paid in previous years, for its share of cleanup costs, based on volumetric allocation of waste shipments to the Spectron Site. On March 19, 1990, EPA sent another letter to the Company notifying it of potential liability for planned additional remedial work at the Spectron Site. This additional remedial work arises from alleged releases of hazardous substances at the Spectron Site during the period of 1968 to 1982, known as the Galaxy Period. The Company has decided to join with other PRPs in the negotiation of a Consent Order with EPA for the additional remedial work related to the Galaxy Period.\nThe Company is also one of more than 400 defendants in an action entitled \"Transtech Industries, Inc. et al v. A & Z Septic Clean, et al\" pending in the federal district court for New Jersey, regarding hazardous waste allegedly shipped to the Kin-Buc Landfill in New Jersey; has been notified by the North Carolina Department of Environment, Health and Natural Resources that it believes that the Company was one of approximately 1,500 entities that caused hazardous material to be shipped to a waste treatment facility\npreviously operated by the Seaboard Chemical Corporation at Jamestown, North Carolina; and is one of more than 900 entities notified that it has shipped hazardous waste to a site in Caldwell County, North Carolina.\nThe Company is in discussions with the FDA over issues arising from an inspection in May 1994. The FDA has requested that it take additional steps to remedy alleged noncompliance with cGMP regulations primarily as they relate to some of the Company's products. The Company believes that its marketed products meet appropriate standards and are safe and effective, and that it is in substantial compliance with cGMP regulations. Although the Company cannot predict the outcome of these discussions and no assurances can be made, it is hopeful that a mutually acceptable resolution can be reached with the FDA without litigation.\nSee also Note 11 of \"Notes to Consolidated Financial Statements\".\nItem 4.","section_4":"Item 4. Submission of Matters to Vote of Security Holders -------------------------------------------------\nNot applicable.\nExecutive Officers of the Company - - ---------------------------------\nHAROLD SNYDER has been President of the Company since 1964 and in 1985 was elected Chairman and Chief Executive Officer. Prior to founding the Company in 1964, Mr. Snyder held various managerial and technical positions in the pharmaceutical industry.\nBEATRICE SNYDER has been Secretary of the Company since 1964, and was elected to the office of Senior Vice President in 1985.\nHARMON ARONSON has been Manager of the Company's non-penicillin production since 1979. In 1985 he was elected the Company's Vice President - Non-Penicillin Dosage Operations.\nMELVIN KAUFMAN was Chief Operations Manager of the Company from July 1983 to January 1985 and was subsequently elected the Company's Vice President - Antibiotics Operations. From 1980 to July 1983 he served as Director of Bulk Manufacturing of Wyeth Laboratories, Inc., a manufacturer of pharmaceuticals and a subsidiary of American Home Products Corp.\nGERALD MOSKOWITZ has been Sales Manager of the Company since 1965 and in 1985 was elected the Company's Vice President - Sales.\nSTEVEN J. SKLAR has been Chief Financial Officer since July, 1990. He was elected the Company's Vice President and Treasurer in December 1989. Prior to joining the Company he was a partner at Botein Hays & Sklar, and through that firm, rendered professional services to the Company from 1984 through 1989. From 1985 to 1987 he was a full-time member of the faculty of New York University School of Law and he continues to teach there periodically.\nBERYL L. SNYDER was elected the Company's Assistant Secretary in August, 1993. She has been Vice President since May 1990 and General Counsel to the Company since 1984.\nBRIAN S. SNYDER was elected the Company's Vice President and Controller in May 1990. He has been the Company's Controller since 1983. From 1977 to 1983 he held various sales and production positions with the Company.\nJAY T. SNYDER was elected the Company's Vice President - Research and Product Development in May 1990. He has been Director of Product Development since 1988. From 1982 to 1988 he was plant manager of the Company's penicillin dosage form facility and from 1977 to 1982 held various production positions with the Company.\nLEONARD E. BUSTAMANTE was elected the Company's Vice President of Quality Management in August, 1993. From 1990 to 1993 he served as Director of Quality Control for Barre-National, Inc.\nJOY BLOODSAW has been with the Company since 1982 and has been Director of Purchasing since 1985. On August 19, 1992 she was elected the Company's Associate Vice President - Purchasing.\nHARVEY RICHARDS has been responsible for Regulatory Affairs at the Company since 1968 and on April 15, 1993 was elected the Company's Associate Vice President - Regulatory Affairs.\nMCKEE MOORE was elected Associate Vice President of Sales in April, 1994. He had been employed with the Company as Chief Sales Representative since 1991. Prior to this time, he was employed by Geneva Generics.\nHarold Snyder and Beatrice Snyder are husband and wife. Beryl L. Snyder, Brian S. Snyder and Jay T. Snyder are the children of Harold and Beatrice Snyder. Officers of the Company are elected by the directors for a term of one year and hold office until their respective successors are elected and qualified.\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 Stock Exchange under the symbol \"BCL\". The material under the caption \"Market for the Registrant's Common Stock, Dividends and Related Stockholder Matters\" on page 6 of the Annual Report is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data -----------------------\nThe material under the caption \"Selected Financial Highlights\" on the inside cover 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 material under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 4 through 6 of the Annual Report is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data -------------------------------------------\nThe Financial Statements of the Company as of March 31, 1994 and 1993, for each of the years in the three-year period ended March 31, 1994 and related notes thereto are contained on pages 7 through 16 of the Annual Report and are incorporated herein by reference. The financial statement schedules are included herein at pages to. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", on page 4 of the Annual Report, for selected quarterly financial data.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and --------------------------------------------------------------- Financial Disclosure --------------------\nThe information otherwise required by this item was previously reported in the Company's Current Report on Form 8-K dated November 2, 1992.\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 ----------------------------------------------\nItems 10, 11, 12 and 13 have been omitted because on or before July 29, 1994, Registrant will file with the Commission pursuant to Regulation 14A a definitive proxy statement. The information called for by these items is set forth in that proxy statement and is incorporated herein by reference.\nThe information called for by Item 10 with respect to executive officers of the Registrant appears following Item 4 under Part I of this Report.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8K --------------------------------------------------------------\n(a) 1. Financial statements are contained on pages 7 through 16 of the Annual Report and are incorporated herein by reference.\n2. Financial statement schedules\nThe following consolidated financial statement schedules of the Company are included herein at the pages indicated in parentheses:\nSchedule V - Property and Equipment (F-1) Schedule VI - Accumulated Depreciation and Amortization of Property and Equipment (F-2) Schedule VIII - Valuation and Qualifying Accounts (F-3)\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 - see index on page I-1, I-2 and I-3.\n(b) Not applicable\nSchedule V ----------\nBIOCRAFT LABORATORIES, INC.\nProperty and Equipment\nYears ended March 31, 1994, 1993 and 1992\n(In thousands)\n*Includes equipment under capital leases amounting to $84.\nSchedule VI -----------\nBIOCRAFT LABORATORIES, INC.\nAccumulated Depreciation and Amortization of Property and Equipment\nYears ended March 31, 1994, 1993 and 1992\n(In thousands)\nSchedule VIII -------------\nBIOCRAFT LABORATORIES, INC.\nValuation and Qualifying Accounts\nYears ended March 31, 1994, 1993 and 1992\n(In thousands)\n- - --------------- (A) Accounts written off.\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.\nBIOCRAFT LABORATORIES, INC.\nDate: June 30, 1994 \/s\/ Harold Snyder --------------------------- (Harold Snyder) 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.\nSignature Title Date --------- ----- ----\n\/s\/ Harold Snyder Director, Chairman of June 30, 1994 - - --------------------- the Board, President Harold Snyder and Chief Executive Officer (principal executive officer)\n\/s\/ Beatrice Snyder Senior Vice President, June 30, 1994 - - --------------------- Secretary and Director Beatrice Snyder\n\/s\/ Beryl L. Snyder Vice President, June 30, 1994 - - --------------------- General Counsel, Beryl L. Snyder Assistant Secretary and Director\n\/s\/ Brian S. Snyder Vice President, June 30, 1994 - - --------------------- Controller and Director Brian S. Snyder\n\/s\/ Jay T. Snyder Vice President, Research June 30, 1994 - - --------------------- & Product Development Jay T. Snyder and Director\n\/s\/ Steven J. Sklar Vice President, June 30, 1994 - - --------------------- Chief Financial Officer Steven J. Sklar and Treasurer\n\/s\/ Gerard Klein - - -------------------------- Director June 30, 1994 Gerard Klein\n\/s\/ James J. Rahal, Jr. - - -------------------------- Director June 30, 1994 James J. Rahal, Jr. M.D.\n\/s\/ Madelon DeVoe Talley - - -------------------------- Director June 30, 1994 Madelon DeVoe Talley\n- - -------------------------- Director June , 1994 Marvin M. Thalenberg, M.D.\n- - -------------------------- Director June , 1994 G. Harold Welch, Jr.\nEXHIBIT INDEX\nI-1\nEXHIBIT INDEX (cont'd)\nI-2\nEXHIBIT INDEX (cont'd)\nI-3\nGRAPHICS APPENDIX LIST\nPAGE WHERE GRAPHIC APPEARS DESCRIPTION OF GRAPHIC OR CROSS REFERENCE - - -------------------------------------------------------------------------------- Bar graph titled Net sales in millions of dollars, indicates net sales of $84.3, $113.2 and $143.1 million in the year ended March 31, 1992, 1993 and 1994, respectively. - - -------------------------------------------------------------------------------- Bar graph titled Net earnings (loss) in millions of dollars, indicates a net loss of $6.7 million and net earnings of $5.9 million and $6.1 million in the year ended March 31, 1992, 1993 and 1994, respectively. - - --------------------------------------------------------------------------------","section_15":""}
{"filename":"791269_1994.txt","cik":"791269","year":"1994","section_1":"Item 1. BUSINESS CHRYSLER CORPORATION\nGENERAL\nChrysler Corporation was incorporated under the laws of the State of Delaware on March 4, 1986, and is the surviving corporation following mergers with a number of its operating subsidiaries, including Chrysler Motors Corporation which was originally incorporated in 1925.\nChrysler Corporation and its consolidated subsidiaries (\"Chrysler\") operate in two principal industry segments: automotive operations and financial services. Automotive operations include the research, design, manufacture, assembly and sale of cars, trucks and related parts and accessories. Financial services include the operations of Chrysler Financial Corporation and its consolidated subsidiaries (\"CFC\"), which are engaged principally in wholesale and retail vehicle financing, servicing nonautomotive leases and loans, automotive dealership facility development and management, and property, casualty and other insurance. Chrysler also participates in short-term vehicle rental activities through certain of its subsidiaries (the \"Car Rental Operations\") and manufactures electronics products and systems through its Chrysler Technologies Corporation subsidiary. Chrysler's principal executive offices are located at Chrysler Center, 12000 Chrysler Drive, Highland Park, Michigan 48288-0001. The telephone number of those offices is (313) 956-5741.\nAUTOMOTIVE OPERATIONS\nChrysler manufactures, assembles and sells cars and trucks under the brand names Chrysler, Dodge, Plymouth, Eagle and Jeep(R), and related automotive parts and accessories, primarily in the United States, Canada and Mexico (\"North America\"). Passenger cars are offered in various size classes and models. Chrysler produces trucks in light-duty, sport-utility and van\/wagon models, which constitute the largest segments of the truck market. Chrysler also purchases and distributes certain passenger cars manufactured in Japan by Mitsubishi Motors Corporation (\"MMC\"), as well as cars manufactured in the United States by MMC's subsidiary, Diamond-Star Motors Corporation (\"Diamond-Star\").\nAlthough Chrysler currently sells most of its vehicles in the United States, Canada and Mexico, Chrysler also participates in other international markets through its wholly owned subsidiary, Chrysler Motors de Venezuela, S.A., and indirectly through its minority investments in Beijing Jeep Corporation, Ltd., and Arab American Vehicles Company. Chrysler sells to independent distributors in Europe and other world markets vehicles which are produced in North America and by Eurostar Automobilwerk Ges.mb.H & Co. KG (\"Eurostar\"), a joint venture between Chrysler and Steyr-Daimler-Puch Fahrzeugtechnik of Graz, Austria.\nThe automotive industry in North America is highly competitive with respect to a number of factors, including product quality, price, appearance, size, special options, distribution organization, warranties, reliability, fuel economy, dealer service and financing terms. As a result, Chrysler's ability to increase vehicle prices and to use retail sales incentives effectively are significantly affected by the pricing actions and sales programs of its principal competitors. Moreover, the introduction of new products by other manufacturers may adversely affect the market shares of competing products made by Chrysler. Also, many of Chrysler's competitors have larger worldwide sales volumes and greater financial resources, which may place Chrysler at a competitive disadvantage in responding to substantial changes in consumer preferences, governmental regulations, or adverse economic conditions in North America.\nChrysler's long-term profitability depends upon its ability to introduce and market its new products effectively. The success of Chrysler's new products will depend on a number of factors, including the economy, competition, consumer acceptance, new product development, the effect of governmental regulation and the strength of Chrysler's marketing and dealer networks. As both Chrysler and its competitors plan to introduce new products, Chrysler cannot predict the market shares its new products will achieve. Moreover, Chrysler is substantially committed to its product plans and would be adversely affected by events requiring a major shift in product development.\nChrysler's plan is to focus on its core automotive business. As part of this plan, Chrysler has sold certain assets and businesses which are not related to its core automotive business, and may sell other such assets in the future.\nThe Automotive Industry in the United States\nChrysler's automotive operations, including product design and development activities, manufacturing operations and sales, are conducted mainly in North America. Chrysler's principal domestic competitors in the United States are General Motors Corporation and Ford Motor Company. In addition, a number of foreign automotive companies own and operate manufacturing and\/or assembly facilities in the United States (\"transplants\"), and there are a number of other foreign manufacturers that distribute automobiles and light-duty trucks in the United States.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nAutomotive Operations - Continued\nThe Automotive Industry in the United States- Continued\nThe tables below set forth comparative market share data for domestic retail sales of cars and trucks for the major domestic manufacturers (including cars and trucks imported by them) and for foreign-based manufacturers, and unit sales of passenger cars and trucks (including imports to the United States) by Chrysler.\n- ------------------------- (1) All U.S. retail sales data are based on publicly available information on manufacturers from the American Automobile Manufacturers Association and data on foreign company imports from Ward's Automotive Reports, a trade publication. (2) \"Foreign-Based Manufacturers\" include imports and vehicles assembled and sold in the United States by foreign companies. (3) U.S. truck retail market share includes minivans.\nCompetition from foreign car and truck manufacturers, in the form of both exports to the United States and sales by transplants, has been substantial in recent years. The market share for foreign passenger cars sold in the United States (including transplants) was 35.4 percent in 1994, compared to 34.0 percent in 1993. The market share for foreign trucks sold in the United Stated (including transplants) was 15.3 percent in 1994, compared to 14.8 percent in 1993. Vehicles assembled in the United States by Japanese manufacturers have significantly contributed to the market share obtained by foreign-based manufacturers. Japanese transplant sales accounted for approximately 16.1 percent of the U.S. passenger car market and 5.6 percent of the U.S. truck market in 1994, compared to 14.8 percent and 5.4 percent, respectively, in 1993.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nAutomotive Operations - Continued\nThe Automotive Industry in the United States - Continued\nDuring the first three months of 1994, Japanese exports to the United States were subject to voluntary restraints limiting the number of new passenger cars (excluding station wagons) that could be exported. These restraints were put in place in 1981 and ended on March 31, 1994. For the 12 months ended March 31, 1994, the Japanese export limit was 1.65 million cars, while actual shipments during that period were 1.39 million cars. Although the voluntary restraint agreement has expired, it is unlikely that exports of passenger cars to the United States from Japan would surpass the 1.65 million level in the near future given the high assembly capacity put in place in the U. S. by Japanese manufacturers and the relatively high cost of vehicles imported from Japan due to the recent appreciation of the Japanese yen in relation to the U.S. dollar.\nChrysler Canada Ltd.\nChrysler's consolidated subsidiary, Chrysler Canada Ltd. (\"Chrysler Canada\"), operates manufacturing and assembly facilities and sales and distribution networks in Canada. Chrysler Canada, whose operations are substantially integrated with Chrysler's U.S. operations, manufactures components and assembles front-wheel-drive minivans, front-wheel-drive mid-size and large sedans, and rear-wheel-drive vans.\nIn 1994 and 1993, Chrysler Canada produced 695,606 and 643,356 vehicles, respectively, the majority of which were sold outside of Canada. Chrysler Canada's retail sales totaled 247,752 vehicles in 1994 and 226,819 vehicles in 1993, the majority of which were manufactured outside of Canada. Chrysler Canada's retail unit sales of cars accounted for 15.7 percent and 14.6 percent of the Canadian car market in 1994 and 1993, respectively. In 1994, retail unit sales of trucks accounted for 25.7 percent of the Canadian truck market compared with 26.3 percent in 1993. In 1994, Chrysler Canada ranked third in the Canadian industry in retail unit sales of both cars and trucks.\nChrysler de Mexico\nChrysler's consolidated subsidiary, Chrysler de Mexico S.A. (\"Chrysler Mexico\"), operates assembly and manufacturing facilities in Mexico, producing vehicles and components for both Mexican and export markets. Chrysler Mexico also distributes in the Mexican market finished vehicles imported from Chrysler's U.S. and Canadian operations.\nChrysler Mexico's vehicle sales accounted for 13.1 percent of the Mexican wholesale car market and 19.4 percent of the Mexican wholesale truck market in 1994, compared with 13.3 percent and 23.6 percent, respectively, in 1993. Within the Mexican industry, Chrysler Mexico's wholesale unit sales ranked fourth in cars and third in trucks in 1994. In 1994, overall wholesale industry sales in Mexico are estimated to have been approximately 620,000 units, compared with 604,400 units in 1993, an increase of 2.6 percent.\nIn 1994, Chrysler Mexico exported 117,489 cars, compared with 104,712 cars in 1993. In 1994, Chrysler Mexico also exported 43,910 trucks, compared with 36,660 trucks in 1993. In addition, Chrysler Mexico provides certain major automobile components to Chrysler, including engines and air conditioner condensers.\nThe economic uncertainty in Mexico following the devaluation of the Peso may result in reduced vehicle sales in Mexico in 1995. As a result, exports to Mexico of Chrysler vehicles manufactured in the U.S. and Canada may decrease, and sales of vehicles in Mexico may be less profitable in 1995, as compared to 1994. If U.S. and Canada vehicle industry sales continue at present or higher levels, imports to the U.S. and Canada of Chrysler vehicles manufactured in Mexico may increase, and such sales may be more profitable in 1995, as compared to 1994. The devaluation of the Peso did not significantly impact Chrysler's 1994 operating results. Chrysler cannot predict the impact that the devaluation of the Peso, and the resulting uncertainty surrounding the Mexican economic and political environments, will have on its operating results in 1995.\nNorth American Free Trade Agreement\nThe North American Free Trade Agreement (\"NAFTA\") unites Mexico, Canada and the United States into the world's largest trading region, a market with more than 360 million consumers. NAFTA provides for the phase-out of trade regulations which restricted vehicle imports and exports between Mexico and the U.S. and Canada. During 1994, trade benefits of NAFTA resulted in commercial growth between Mexico and the United States as both economies benefitted from reduced trading restrictions. In December of 1994, however, the value of the Peso declined significantly in relation to the U.S. Dollar. In addition, the Canadian Dollar experienced a decline in relation to the U.S. Dollar in January of 1995. While it is uncertain how these economic events will affect Chrysler in the short-term, Chrysler's management believes that the fundamentals of NAFTA will benefit the North American automobile industry in the long-term.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nAutomotive Operations - Continued\nInternational Operations\nChrysler's automotive operations outside North America consist primarily of Eurostar's manufacturing operations in Austria and the export of finished vehicles and component kits produced in North America to independent foreign distributors and local manufacturers. Chrysler owns an assembly facility in Venezuela, has equity interests in companies with manufacturing and assembly facilities in China and Egypt, and has established joint ventures with certain other foreign manufacturers. Chrysler will continue to focus on growth opportunities in major markets such as Europe, Japan and China and will explore developing markets in South America, Eastern Europe and the Asia-Pacific region. New manufacturing and joint venture operations could be established if market conditions, sales levels and profitability opportunities are consistent with Chrysler's corporate objectives.\nChrysler shipped 136,462 vehicles to international markets in 1994, an increase of 28 percent from 1993. Chrysler sold 70,294 units in European markets and 66,168 units in other world markets, primarily Japan, Taiwan and the Middle East. During 1994, Chrysler exported 24,272 kits to worldwide affiliates for assembly. The majority of the kits were Jeep products shipped to China, Indonesia and Venezuela. In addition, Chrysler began exporting the Neon and Cirrus passenger cars in 1994.\nEurostar began production and distribution of Chrysler minivans in March 1992 for the European market. Eurostar sold 38,830 minivans in 1994, compared to 33,738 in 1993. In 1993, Chrysler entered into an agreement with Steyr-Daimler-Puch Fahrzeugtechnik to assemble Jeep Grand Cherokees in Austria for the European and other world markets. Production under the agreement was launched in the fourth quarter of 1994.\nChrysler presently does not have significant risks related to changes in currency exchange rates as Chrysler is primarily a North American automotive company. Chrysler does, however, have growing international sales and continuing international component sourcing. When Chrysler sells vehicles outside the United States or purchases components from suppliers outside the United States, transactions are frequently denominated in currencies other than U.S. dollars. The primary foreign currencies in which Chrysler has activities are the German Mark, French Franc, Japanese Yen, Canadian Dollar and Mexican Peso. To the extent possible, receipts and disbursements in a specific currency are offset against each other. In addition, Chrysler periodically initiates hedging activities by entering into currency exchange agreements, consisting primarily of currency forward contracts and purchased currency options, to minimize revenue and cost variations which could result from fluctuations in currency exchange rates. At December 31, 1994, Chrysler had currency exchange agreements for the German Mark, French Franc and Japanese Yen. Chrysler's operating results may be affected by changes in currency exchange rates during the period in which transactions are executed, to the extent that hedge coverage does not exist. However, the impact of any changes in currency exchange rates on unhedged transactions is not expected to be material to Chrysler's operating results or financial position.\nChrysler does not use derivative financial instruments for trading purposes. Chrysler's hedging activities are based upon purchases and sales which are expected to be transacted in foreign currencies. Generally, these purchases and sales are committed for the current and forthcoming calendar year. The currency exchange agreements which provide hedge coverage typically mature within two years of origination. These hedging instruments are periodically modified as existing commitments are fulfilled and new commitments are made. Chrysler's management believes that its hedging activities have been effective in reducing Chrysler's limited risks related to currency exchange fluctuations.\nMitsubishi Motors Corporation\nChrysler imports and distributes in the United States and Canada selected models of passenger cars manufactured by MMC in Japan. In 1994, Chrysler sold 28,849 MMC-manufactured vehicles in the United States, representing 1.3 percent of Chrysler's U.S. retail vehicle sales. In 1993, Chrysler sold 69,646 MMC-manufactured vehicles in the United States, representing 3.4 percent of Chrysler's U.S. retail vehicle sales. In addition to passenger cars, Chrysler purchases 2.5-liter and 3.0-liter V-6 engines for use in the production of certain minivans and other vehicles, and intends to buy approximately 415,000 of these engines from MMC during the 1995 model year.\nDiamond-Star produces small sporty cars in the United States for Chrysler and Mitsubishi Motor Sales of America (\"MMSA\"). Chrysler sold its 50 percent interest in Diamond-Star to MMC, its partner in the joint venture, in October 1991. Chrysler subsequently sold its equity interest in MMC, selling 93.9 million shares of MMC stock in 1992 and 1993 for approximately $544 million in cash, net of related expenses. Pursuant to a distribution agreement that terminates in July 1999, Chrysler retains the right to purchase a portion of Diamond-Star's production capacity. In addition, Chrysler will provide engines and transmissions for use in certain Diamond-Star vehicles. Chrysler's sales of Diamond-Star cars in 1994 and 1993 represented 1.7 and 2.1 percent, respectively, of Chrysler's U.S. retail vehicle sales in each period.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nAutomotive Operations - Continued\nMitsubishi Motors Corporation - Continued\nUnder the terms of the United States Distribution Agreement (\"USDA\") in effect between Chrysler and MMC, which terminates in March 1998, Chrysler and MMSA share co-exclusive rights to distribute various MMC passenger car and light-duty truck models which are available for sale in the United States. In practice, Chrysler and MMSA share the distribution of certain models and exclusively distribute other models.\nAgreements similar to the USDA are in effect covering the Canadian market. In practice, Chrysler Canada acts as sole distributor of MMC products.\nSegment Information\nIndustry segment and geographic area data for 1994, 1993 and 1992 are summarized in Part II, Item 8, Notes to Consolidated Financial Statements, Note 17.\nSeasonal Nature of Business\nReflecting retail sales fluctuations of a seasonal nature, production varies from month to month in the automotive business. In addition, the changeover period related to new model introductions has traditionally occurred in the third quarter of each year. Accordingly, third quarter operating results are generally less favorable than those in the other quarters of the year.\nAutomotive Product Plans\nIn 1989, Chrysler changed the organizational structure of its automotive design and development activities by establishing cross-functional product development groups called \"platform teams.\" The platform team system is designed to improve communications, reduce the design and development time of new vehicles, improve product quality, and reduce the cost of developing new vehicle lines. The utilization of platform teams has enabled Chrysler to focus corporate resources on the continuous improvement of its car and truck offerings.\nIn the fall of 1992, Chrysler introduced the first of its all-new passenger car platforms resulting from the new platform team concept. The Chrysler Concorde, Dodge Intrepid and Eagle Vision compete in the upper-middle segment and employ a \"cab-forward\" design, creating more interior passenger space without significantly increasing vehicle size or weight. Chrysler's share of the U.S. basic middle segment was 9.9 percent for 1994, compared to 9.7 percent for 1993. In early 1993, a new Chrysler New Yorker and a touring derivative called the LHS, which were also based on this platform, were introduced in the basic large segment.\nIn 1993, Dodge introduced the first truck designed under the platform team system, a new full-size Ram pickup. This new pickup also marks the first full-scale production use of a new \"big gas\" V-10 engine which was also used as a basis for the design of the Dodge Viper V-10 engine. In the fall of 1994, Dodge introduced a Club Cab version of the Ram pickup to pursue another segment of the growing truck market. Dodge's share of the U.S. full-size pickup truck market grew to 14.5 percent in 1994 from 7.1 percent in 1993.\nIn January of 1994, Chrysler introduced the subcompact Dodge and Plymouth Neon, which provide both driver and passenger airbags and apply Chrysler's \"cab-forward\" design used by the upper-middle segment vehicles. A two-door coupe was added to the lineup in the third quarter of 1994. Chrysler's share of the U.S. subcompact segment rose to 11.9 percent in 1994 from 11.4 percent in 1993.\nChrysler introduced an all-new compact car marketed as the Chrysler Cirrus in the third quarter of 1994. The Cirrus offers newly designed engines, includes driver and passenger airbags, and also applies the \"cab-forward\" design. The Cirrus was awarded the Motor Trend Car of the Year Award for its contemporary styling, roominess, overall quality, and value. A Dodge version of the vehicle, the Dodge Stratus, will be introduced in the first quarter of 1995. In addition, a Plymouth version of the vehicle, the Plymouth Breeze, will be added in the 1996 model year.\nChrysler added the Dodge Avenger in the third quarter of 1994 and will introduce the Chrysler Sebring in the first quarter of 1995. These two-door coupes compete in the high profile mid-specialty segment and are built exclusively for Chrysler by Diamond-Star.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nAutomotive Operations - Continued\nAutomotive Product Plans - Continued\nChrysler will introduce an all-new minivan in the first half of 1995. The new Chrysler Town & Country, Dodge Caravan, and Plymouth Voyager will provide many unique product features, including a driver's side sliding door. Chrysler held 43.4 percent and 46.7 percent of the U.S. minivan segment in 1994 and 1993, respectively. In spite of increased competition in this segment, Chrysler sold 513,163 minivans in the United States in 1994, compared to 502,053 in 1993. Worldwide shipments of minivans in 1994 and 1993 were 617,318 and 567,801 units, respectively.\nAutomotive Marketing\nNew passenger cars and trucks are sold at retail by dealers who have sales and service agreements with the manufacturer. The dealers purchase cars, trucks, parts and accessories from the manufacturer for sale to retail customers. In the United States, Chrysler had 4,687 dealers at December 31, 1994 compared with 4,726 at December 31, 1993. Chrysler Canada had 607 dealers at December 31, 1994 compared with 601 dealers at December 31, 1993.\nChrysler's ability to maintain, expand and improve the quality of its dealer organization will have an important impact on future sales. Chrysler maintains programs to provide dealership operating capital through equity investments where sufficient private capital is not available. The programs anticipate that the dealer receiving such assistance will eventually purchase Chrysler's equity investment from the dealer's share of the dealership profits. Chrysler's equity interest in U.S. and Canadian dealerships totaled $28 million in 64 dealerships as of December 31, 1994, compared with $37 million in 91 dealerships as of December 31, 1993.\nChrysler continues to focus on quality customer service. The new Chrysler Customer Center is designed to promote customer satisfaction and communicate customer concerns to dealers and internally to vehicle platform teams.\nManufactured and Purchased Components and Materials\nChrysler continues to focus on its core automotive business. Chrysler manufactures most of its requirements for engines, transmissions and transaxles, certain body stampings and electronic components, and processes approximately 80 percent of its requirements for fabricated glass parts.\nChrysler used approximately 1,250 suppliers of productive materials in 1994, compared to approximately 1,380 used in 1993. Chrysler purchases a larger portion of its materials, parts and other components from unaffiliated suppliers than do its principal domestic competitors. Chrysler expects to continue purchasing its requirements for these items rather than manufacturing them.\nGovernment Regulation\nVehicle Regulation Fuel economy, safety and emissions regulations and standards applicable to motor vehicles have been issued from time to time under a number of federal statutes, including the National Traffic and Motor Vehicle Safety Act of 1966 (the \"Safety Act\"), the Clean Air Act, Titles I and V of the Motor Vehicle Information and Cost Savings Act and the Noise Control Act of 1972. In addition, the State of California has promulgated exhaust emission standards, some of which are more stringent than the federal standards. Other states may, under the Clean Air Act, adopt vehicle emission standards identical to those adopted by the State of California. The States of New York, Massachusetts, and Connecticut have adopted such standards and several other states are considering similar action. Federal courts have generally upheld New York and Massachusetts' adoption of the California standards.\nVehicle Emissions Standards Under the Clean Air Act, auto manufacturers are required, among other things, to significantly reduce tailpipe emissions of polluting gases from automobiles and light trucks and to increase the length of time vehicles are subject to recall for failure to meet emission standards to ten years or 100,000 miles, whichever occurs first. This Act imposes standards for model years through 2003 that require further significant reductions in motor vehicle emissions. This Act also may require production of certain vehicles capable of operating on fuels other than gasoline or diesel fuel (alternative fuels) under a pilot test program to be conducted principally in California beginning in the 1996 model year. Chrysler is actively pursuing the development of flexible fuel vehicles capable of operating on both gasoline and M-85 methanol blend fuels as well as the development of vehicles capable of operating on compressed natural gas.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nAutomotive Operations - Continued\nGovernment Regulation - Continued\nVehicle Regulation - Continued\nThe California Air Resources Board has received federal approval, pursuant to the Clean Air Act, for a series of passenger car and light truck emission standards, effective through the 2003 model year, that are more stringent than those prescribed by the Clean Air Act for the corresponding periods of time. These California standards are intended to promote the development of various classes of low emission vehicles. California also requires that a specified percentage of each manufacturer's California sales volume, beginning at two percent in 1998 and increasing to ten percent in 2003, must be zero-emission vehicles (\"ZEVs\") that produce no emissions of regulated pollutants. Chrysler has entered into a consortium of vehicle manufacturers, electric utilities and the U.S. Department of Energy to develop new battery technology for use in electric vehicles which would qualify as ZEVs and has built a limited number of experimental prototype electric vehicles using existing advanced battery technology.\nOn December 19, 1994, the Administrator of the United States Environmental Protection Agency (\"EPA\") responded to a petition filed by the Ozone Transport Commission (\"OTC\"), a group of 12 Northeast states and the District of Columbia. The response held that the states comprising the OTC must either adopt the California vehicle emissions standards or a 49 state program advocated by the American Automobile Manufacturers Association (of which Chrysler is a member) and the Association of International Automobile Manufacturers. The Administrator's decision does not require the states that adopt California's general vehicle emission standards to adopt California's ZEV requirement, but permits the states to adopt the ZEV requirement if they elect to do so. Both New York and Massachusetts have adopted the California general standards as well as the California ZEV requirement. Connecticut has adopted the general standards but not the ZEV requirement.\nCAFE The Motor Vehicle Information and Cost Savings Act, as amended by the Energy Policy and Conservation Act, requires vehicle manufacturers to provide vehicles that comply with federally mandated fuel economy standards. Under this Act, a manufacturer earns credits for exceeding the applicable fuel economy standards; however, fuel economy credits earned on cars may not be used for trucks. Failure to meet the average fleet fuel economy standards can result in the imposition of penalties unless a manufacturer has sufficient fuel economy credits from the preceding three years or projects that will generate sufficient credits over the succeeding three years. Chrysler is in substantial compliance with existing CAFE requirements and anticipates continued compliance with such requirements. In addition, the Energy Tax Act of 1978 imposes a graduated \"Gas Guzzler\" tax on automobiles with a fuel economy rating below specified levels.\nFrom time to time there have been federal legislative and administrative initiatives that would increase corporate average fuel economy standards from their current levels. In addition, the National Highway Traffic Safety Administration (\"NHTSA\") has initiated rulemaking to set light truck CAFE standards for the 1998 - 2006 model years. A significant increase in those requirements could be costly to Chrysler and could result in significant restrictions on the products Chrysler offers.\nVehicle Safety Under the Safety Act, NHTSA is required to establish federal motor vehicle safety standards that are practicable, meet the need for motor vehicle safety and are stated in objective terms. NHTSA has announced its intention to upgrade certain existing standards and to establish additional standards in the future. Chrysler expects to be able to comply with those standards.\nVehicle Recalls Under the Clean Air Act the EPA may require manufacturers to recall and repair customer-owned vehicles that fail to meet emission standards established under that Act. Similarly, the Act authorizes the State of California to require recalls for vehicles that fail to meet its emissions standards.\nThe Safety Act authorizes NHTSA to investigate reported vehicle problems and to order a recall if it determines that a safety-related defect exists. NHTSA is conducting an engineering analysis of the rear liftgate latches in Chrysler's 1984-1994 model year minivans (approximately 4 million latches) as a result of allegations that some latches opened during collisions. Chrysler has provided NHTSA with extensive information in support of Chrysler's position that no safety-related defect exists with respect to the latches. If, however, NHTSA concludes that the information gathered may warrant a formal investigation, it may issue a Recall Request Letter asking that Chrysler voluntarily repair or replace the latches. If NHTSA issues such a letter and Chrysler declines to conduct a recall, NHTSA may proceed with a formal investigation or close the matter. If NHTSA proceeds with a formal investigation and determines that a defect exists, it may seek to compel a recall. Chrysler continues to discuss this matter with NHTSA.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nAutomotive Operations - Continued\nGovernment Regulation - Continued\nVehicle Regulation - Continued\nChrysler's emissions and safety-related recall costs vary widely from year to year, and could be significant in future years depending on the corrective action required to remedy a particular condition and the number of vehicles involved.\nStationary Source Regulation Chrysler's assembly, manufacturing and other operations are subject to substantial environmental regulation under the Clean Air Act, the Clean Water Act, the Resource Conservation and Recovery Act, the Pollution Prevention Act of 1990 and the Toxic Substances Control Act, as well as a substantial volume of state legislation paralleling and, in some cases, imposing more stringent obligations than the federal requirements. These regulations impose severe restrictions on air and water-born discharges of pollution from Chrysler facilities, the handling of hazardous materials at Chrysler facilities and the disposal of wastes from Chrysler operations. Chrysler is faced with many similar requirements in its operations in Canada and is facing increased governmental regulation and environmental enforcement in Mexico.\nWhile Chrysler is unable to predict the exact level of expenditures that will be required to develop and implement new technology in its North American facilities, since federal and state requirements are not fully defined, Chrysler expects its capital requirements for the period 1995 through 1999 will be approximately $700 million. Of this total, Chrysler estimates that $136 million will be spent in 1995 and $138 million will be spent in 1996. Substantially all of these expenditures are included in Chrysler's planned disbursements for new product development and the acquisition of productive assets over the 1995 to 1999 period. In addition, the extensive federal-state permit program established by the Clean Air Act may reduce operational flexibility and cause delays in upgrading of Chrysler's production facilities in the United States.\nClean Air Act Pursuant to the Clean Air Act, the states are required to amend their implementation plans to require more stringent limitations and other controls on the quantity of pollutants which may be emitted into the atmosphere to achieve national ambient air quality standards established by the EPA. In addition, the Clean Air Act requires reduced emissions of substances that are classified as hazardous, toxic or that contribute to acid deposition, imposes comprehensive permit requirements for manufacturing facilities in addition to those required by various states, and expands federal authority to impose severe penalties and criminal sanctions. The Clean Air Act also allows states to adopt standards more stringent than those required by the Clean Air Act. Most recent reports filed with the EPA pursuant to the Superfund Amendments and Reauthorization Act of 1986 indicate that for calendar year 1992 releases and emissions of chemicals and toxics by Chrysler were reduced by more than 70 percent from comparable 1987 levels.\nEnvironmental Liabilities The EPA and various state agencies have notified Chrysler that it may be a potentially responsible party (\"PRP\") for the cost of cleaning up hazardous waste storage or disposal facilities pursuant to the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") and other federal and state environmental laws. A number of lawsuits allege that Chrysler violated CERCLA or other environmental laws and seek to recover costs associated with remedial action. In most instances, Chrysler is only one of a number of PRPs who may be found to be jointly and severally liable for remediation costs at the 97 sites involved in the foregoing matters at December 31, 1994. Chrysler may also incur remediation costs at an additional 40 of its active or deactivated facilities.\nEstimates of future costs of pending environmental matters are necessarily imprecise due to numerous uncertainties, including the enactment of new laws and regulations, the development and application of new technologies, and the apportionment and collectibility of remediation costs among responsible parties. Chrysler may ultimately incur significant expenditures over an extended period of time in connection with the foregoing environmental matters, and therefore has established reserves totalling $310 million for the estimated costs associated with all of its environmental remediation efforts. Chrysler believes that these reserves will be sufficient to resolve these matters. After giving effect to these reserves, management believes, based on currently known facts and circumstances and existing laws and regulations, that the disposition of these matters will not have a material adverse effect on Chrysler's consolidated financial position. Future developments could cause Chrysler to change its estimate of the total costs associated with these matters, and those changes could be material to Chrysler's consolidated results of operations for the period in which the developments occur. Chrysler is unable to estimate such changes in costs, if any, that may be incurred in connection with these matters.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nFINANCIAL SERVICES\nChrysler's principal subsidiary, CFC, is a financial services organization engaged in wholesale and retail vehicle financing, servicing nonautomotive leases and loans, property, casualty and other insurance, and automotive dealership facility development and management. All of CFC's stock is owned by Chrysler. CFC, a Michigan corporation, is the continuing corporation resulting from a merger on June 1, 1967 of a financial services subsidiary of Chrysler into a newly acquired, previously unaffiliated finance company incorporated in 1926.\nCFC's primary objective is to provide financing for automotive dealers and retail purchasers of Chrysler's products. CFC sells significant amounts of automotive receivables acquired in transactions subject to limited recourse provisions. CFC remains as servicer for which it is paid a servicing fee. At the end of 1994, CFC had nearly 3,100 employees and its portfolio of receivables managed, which includes receivables owned and serviced for others, totaled $32.9 billion.\nCFC has sold various nonautomotive assets over the last several years, thereby making CFC more dependant on Chrysler. Thus, lower levels of sales of Chrysler automotive products could result in a reduction in the level of finance operations of CFC.\nCFC's portfolio of finance receivables managed includes receivables owned and receivables serviced for others. Receivables serviced for others primarily represent sold receivables which CFC services for a fee. At December 31, 1994, receivables serviced for others accounted for 61 percent of CFC's portfolio of receivables managed. Total finance receivables managed at the end of each of the five most recent years were as follows:\nAutomotive Financing CFC conducts its automotive finance business principally through its subsidiaries Chrysler Credit Corporation, Chrysler Credit Canada Ltd., and, in Mexico, Chrysler Comercial S.A. de C.V., (together \"Chrysler Credit\"). Chrysler Credit is the major source of automobile and light-duty truck wholesale (also referred to as dealer \"floor plan\") and retail financing for Chrysler dealers and their customers throughout North America. Chrysler Credit also offers its floor plan dealers working capital loans, real estate and equipment financing and financing plans for fleet buyers, including daily rental car companies independent of, and affiliated with, Chrysler. The automotive financing operations of Chrysler Credit are conducted through 94 branches in the United States, Canada and Mexico.\nCFC's Mexican subsidiary, Chrysler Comercial S.A. de C.V. (\"Chrysler Comercial\"), contributed $11 million, $18 million and $15 million in 1994, 1993 and 1992, respectively, to CFC's earnings before income taxes. Chrysler Comercial's total assets were $433 million and $477 million at December 31, 1994 and 1993, respectively. The economic uncertainty in Mexico following the devaluation of the Peso may have an unfavorable impact on Chrysler Comercial's retail and wholesale volume and credit losses.\nDuring 1994 CFC financed or leased approximately 830,000 vehicles at retail in the United States, including approximately 525,000 new Chrysler passenger cars and light-duty trucks, representing 24 percent of Chrysler's U.S. retail and fleet deliveries. In 1994, the average monthly payment for new vehicle retail installment sale contracts acquired in the United States was $375. The average percentage of dealer cost financed was 94 percent and the average original term was 55 months. CFC also financed at wholesale approximately 1,647,000 new Chrysler passenger cars and light-duty trucks representing 73 percent of Chrysler's U.S. factory shipments in 1994. Wholesale vehicle financing accounted for 74 percent of the total automotive financing volume of CFC in 1994 and represented 31 percent of automotive finance receivables outstanding at December 31, 1994.\nItem 1. BUSINESS - CONTINUED Part I - Continued\nFinancial Services - Continued\nNonautomotive Financing CFC has downsized its nonautomotive operations through sales and liquidations over the last several years. Chrysler Capital Corporation (\"Chrysler Capital\") manages nonautomotive leases and loans to clients in over 15 industries throughout the United States. At December 31, 1994, Chrysler Capital managed $2.3 billion of nonautomotive finance receivables compared to $2.7 billion at December 31, 1993. In addition, CFC managed a portfolio of secured small business loans totaling $0.5 billion at December 31, 1994, compared to $0.6 billion at December 31, 1993.\nInsurance Chrysler Insurance Company and its subsidiaries (\"Chrysler Insurance\") provide specialized insurance coverages for automotive dealers and their customers in the United States and Canada. Chrysler Insurance provides physical damage, garage liability, workers' compensation and property and contents coverage directly to automotive dealers. Chrysler Insurance also provides collateral protection and single interest insurance to retail automobile customers and their financing sources.\nReal Estate Management Chrysler Realty Corporation (\"Chrysler Realty\"), which is engaged in the ownership, development and management of Chrysler automotive dealership properties in the United States, typically purchases, leases or options dealership facilities and then leases or subleases these facilities to Chrysler dealers. At December 31, 1994, Chrysler Realty controlled 876 sites (of which 289 were owned by Chrysler Realty).\nFunding During 1994, CFC issued $1.8 billion of term debt and increased the level of short-term notes outstanding (primarily commercial paper) to $4.3 billion. Receivable sales continued to be a significant source of funding during 1994, as CFC realized $6.4 billion of net proceeds from the sale of automotive retail receivables compared to $7.8 billion of net proceeds from the sale of automotive retail receivables in 1993. In addition, revolving wholesale receivable sale arrangements provided funding which aggregated $3.8 billion and $4.6 billion at December 31, 1994 and 1993, respectively.\nCFC uses derivative financial instruments to manage its exposure arising from changes in interest rates and currency exchange rates as part of its asset and liability management program. These derivative financial instruments include interest rate swaps, interest rate caps, forward interest rate contracts, and currency exchange agreements. CFC does not use derivative financial instruments for trading purposes.\nDue to changing interest rates, interest rate derivatives are used to stabilize interest margins. The Company hedges against borrowings denominated in currencies other than the borrowers' local currency. Such borrowings are translated in the financial statements at the rates of exchange established under the related currency exchange agreements. Forward interest rate contracts are used to manage exposure to fluctuations in funding costs for anticipated securitizations of retail receivables.\nCFC's outstanding debt at December 31, for each of the five most recent years was as follows:\nItem 1. BUSINESS - CONTINUED Part I - Continued\nCAR RENTAL OPERATIONS\nThrough its Pentastar Transportation Group, Inc. (\"Pentastar\") subsidiary, Chrysler owns Thrifty Rent-A-Car System, Inc. (\"Thrifty\"), and Dollar Systems, Inc. (\"Dollar\", formerly Dollar Rent A Car Systems, Inc.). Both Thrifty and Dollar are engaged in leasing vehicles to independent businesses they have licensed to use their trade names, systems and technologies in the daily rental of cars for business, personal and leisure use. They also maintain and operate a number of their own locations. In September 1992, Chrysler announced a realignment of a part of the Car Rental Operations under Pentastar and the consolidation and phase out of certain of those operations. As part of that realignment, Chrysler subsequently transferred to Dollar ownership of General Rent-A-Car (\"General\"), which also rents cars for business, leisure and personal use, exclusively through corporate owned locations. Consolidation of General's operations into those of Dollar's was completed in 1994. Additionally, Snappy Car Rental, Inc., which engages in renting automobiles on a short-term basis, was sold in September 1994.\nRESEARCH AND DEVELOPMENT\nFor the years ended December 31, 1994, 1993 and 1992, Chrysler spent $1.3 billion, $1.2 billion, and $1.1 billion, respectively, for company-sponsored research and development activities. These activities relate to the development of new products and services and the improvement of existing products and services, as well as compliance with standards that have been and are being promulgated by the government.\nEMPLOYEES\nAt December 31, 1994, Chrysler had a total of approximately 121,000, employees worldwide, approximately 97,000 of which were employed in the United States. In the United States and Canada, approximately 95 percent of Chrysler's hourly employees and 22 percent of its salaried employees are represented by unions. Of these represented employees, 98 percent of hourly and 91 percent of salaried employees are represented by the United Automotive, Aerospace, and Agricultural Implement Workers of America (\"UAW\") or the National Automobile, Aerospace and Agricultural Implement Workers of Canada (\"CAW\").\nIn 1993, Chrysler negotiated three-year national agreements with the UAW and CAW in the United States and Canada, respectively, without an interruption of production. The UAW contract provides for essentially the same levels of wages and benefits as negotiated by Chrysler's major domestic competitors. The UAW contract retains the job and income security protection program and health care coverage. The job and income security benefit caps were negotiated at the previous contract amount of $612 million with new Supplemental Unemployment Benefits Contingency Accounts of $106 million. The contract also adopted provisions expected to abate future increases in labor costs including Cost of Living Allowance diversions, lower new hire rates, and a broadened approach to managed health care.\nChrysler's pension plans, group life, and health care benefits for active, inactive, and retired employees generally follow the structure of benefits common to the automotive industry. See Part II, Item 8, Notes to Consolidated Financial Statements, Notes 1, 11 and 12 for further information on postemployment benefits, pension plans, and nonpension postretirement benefits.\nINTELLECTUAL PROPERTY\nChrysler has intellectual property rights, including patents, proprietary technology, trademarks, trade dress, service marks, copyrights, and licenses under such rights of others, relating to its businesses, products, and manufacturing equipment and processes. Chrysler grants licenses to others under its intellectual property rights and receives fees and royalties under some of these licenses. While Chrysler does not consider any particular intellectual property right to be essential, it does consider the aggregate of such rights very important to the overall conduct of its businesses.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nAUTOMOTIVE OPERATIONS\nThe statements concerning ownership of Chrysler's properties are made without regard to taxes or assessment liens, rights of way, contracts, easements or like encumbrances or questions of survey and are based on the records of Chrysler. Chrysler knows of no material defects in title to, or adverse claims against, any of such properties, nor any existing material liens or encumbrances against Chrysler or its properties, except the mortgage loan on Chrysler's Sterling Heights Assembly Plant (Sterling Heights, Michigan).\nItem 2. PROPERTIES - CONTINUED Part I - Continued\nChrysler's manufacturing plants include a foundry, machining plants, metal stamping plants, engine plants, transmission plants, electronic parts plants, an air conditioning equipment plant, glass fabricating plants and other component parts plants. In addition to Michigan, manufacturing plants in the United States are located in Alabama, Indiana, New York, Ohio, Texas and Wisconsin.\nChrysler's U.S. passenger car assembly plants are located in Sterling Heights and Detroit, Michigan; Belvidere, Illinois and Newark, Delaware. The U.S. truck assembly plants are located in Warren and Detroit, Michigan; Fenton, Missouri; and Toledo, Ohio. An assembly plant located in Fenton, Missouri, which was previously idled in 1991, is being equipped with new machinery and tooling and will begin producing minivans in 1995. Parts depots, warehouses and sales offices are situated in various sections of the United States, while Chrysler's principal engineering and research facilities and its general offices are located in Michigan.\nAutomotive properties outside the U.S. are owned or leased principally by Chrysler Canada and Chrysler Mexico. Other manufacturing and assembly plants of subsidiaries outside the U.S. are located in Venezuela and Austria.\nIn 1991, Chrysler dedicated its new technology center in Auburn Hills, Michigan. The initial project, which consisted of 3.3 million square feet of floor space and included design, vehicle engineering, manufacturing engineering and pilot build facilities associated with the development of new Chrysler cars and trucks, was completed and fully occupied in the first half of 1994. In the third quarter of 1992, the Board of Directors approved a subsequent project to build an administrative building which is currently under construction. The administrative building, which will add approximately 1.0 million square feet of floor space to the facility, is scheduled for completion in the first half of 1996.\nIn the opinion of management, Chrysler's properties include facilities which are suitable and adequate for the conduct of its present assembly and component plant requirements.\nFINANCIAL SERVICES\nAt December 31, 1994, the following facilities were utilized by CFC in conducting its business:\n(a) executive offices of CFC, Chrysler Credit Corporation, Chrysler Insurance and certain other domestic subsidiaries of CFC in Southfield, Michigan;\n(b) a total of 82 branches of Chrysler Credit located throughout the United States;\n(c) headquarters of remaining Chrysler First Inc. operations in Allentown, Pennsylvania, and a total of 3 offices of such corporation in the United States;\n(d) headquarters of Chrysler Capital in Stamford, Connecticut and a total of 12 offices of such corporation located throughout the United States;\n(e) headquarters of Chrysler Realty in Troy, Michigan; and\n(f) a total of 12 offices used as headquarters and branch offices in Canada and Mexico.\nAll of the facilities described above were leased by CFC.\nAt December 31, 1994, a total of 289 automobile dealership properties generally consisting of land and improvements were owned by Chrysler Realty leased primarily to Chrysler franchised dealers.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS Part I - Continued\nChrysler and its subsidiaries are parties to various legal proceedings, including some purporting to be class actions, and some which demand large monetary damages or other relief that would require significant expenditures. Chrysler believes that each of the product and environmental proceedings described below constitutes ordinary routine litigation incidental to the business conducted by Chrysler. See also Note 8 of Notes To Consolidated Financial Statements.\nProduct Matters\nMany of the legal proceedings seek damages for personal injuries claimed to have resulted from alleged defects in the design or manufacture of products distributed by Chrysler. The complaints filed in those matters specify approximately $1.1 billion in compensatory and $1.9 billion in punitive damages in the aggregate as of December 31, 1994. These amounts represent damages sought by plaintiffs and, therefore, do not necessarily constitute an accurate measure of Chrysler's ultimate cost to resolve those matters. Further, many complaints do not specify a dollar amount of damages or specify only the jurisdictional minimum. These amounts may vary significantly from one period to the next depending on the number of new complaints filed or pending cases resolved in a given period.\nNumerous complaints seek damages for personal injuries sustained in accidents involving alleged rollovers of Jeep CJ vehicles. These complaints represent approximately $312 million of the compensatory and $785 million of the punitive damages specified above. Pursuant to an indemnification agreement with Chrysler, Renault has agreed to indemnify Chrysler against a portion of certain costs arising from accidents involving alleged Jeep CJ vehicle rollovers that occurred between April 1, 1985 and March 31, 1994.\nMany of the remaining complaints seek compensatory and punitive damages for personal injuries sustained in accidents involving alleged defects in occupant restraint systems, seats, heater cores, or various other components in several different vehicle models. Some complaints seek repair of the vehicles or compensation for the alleged reduction in vehicle value.\nChrysler may ultimately incur significant expenditures over an extended period of time in connection with the foregoing matters, and therefore has established reserves which it believes will be sufficient to resolve these matters. After giving effect to these reserves, management believes, based on currently known facts and circumstances, that the disposition of these matters will not have a material adverse effect on Chrysler's consolidated financial condition. Future developments could cause Chrysler to change its estimate of the ultimate cost of resolving these matters, and these changes could be material to Chrysler's consolidated results of operations for the period in which the developments occur. Chrysler is unable to estimate such changes in costs, if any, that may be incurred in connection with these matters.\nEnvironmental Matters\nThe EPA and various state agencies have notified Chrysler that it may be a PRP for the cost of cleaning up hazardous waste storage or disposal facilities pursuant to the CERCLA and other federal and state environmental laws. A number of lawsuits allege that Chrysler violated CERCLA or other environmental laws and seek to recover costs associated with remedial action. In most instances, Chrysler is only one of a number of PRPs who may be found to be jointly and severally liable for remediation costs at the 97 sites involved in the foregoing matters at December 31, 1994. Chrysler may also incur remediation costs at an additional 40 of its active or deactivated facilities.\nIn particular, the Indiana Department of Environmental Management initiated an administrative proceeding in August 1985 alleging improper disposal of waste at a Chrysler facility in Indianapolis. This proceeding, which seeks to require Chrysler to conduct a site assessment and undertake remedial action, may result in the imposition of civil penalties in excess of $100,000.\nEstimates of future costs of pending environmental matters are necessarily imprecise due to numerous uncertainties, including the enactment of new laws and regulations, the development and application of new technologies, and the apportionment and collectibility of remediation costs among responsible parties. Chrysler may ultimately incur significant expenditures over an extended period of time in connection with the foregoing environmental matters, and therefore has established reserves totalling $310 million for the estimated costs associated with all of its environmental remediation efforts. Chrysler believes that these reserves will be sufficient to resolve these matters. After giving effect to these reserves, management believes, based on currently known facts and circumstances and existing laws and regulations, that the disposition of these matters will not have a material adverse effect on Chrysler's consolidated financial position. Future developments could cause Chrysler to change its estimate of the total costs associated with these matters, and these changes could be material to Chrysler's consolidated results of operations for the period in which the developments occur. Chrysler is unable to estimate such changes in costs, if any, that may be incurred in connection with these matters.\nItem 3. LEGAL PROCEEDINGS - Continued Part I - Continued\nOther Matters\nIn December 1990 and January 1991, eight class action lawsuits were commenced by separate plaintiffs against Chrysler and certain of its directors in the Court of Chancery of the State of Delaware for New Castle County, Delaware. The Complaints in these suits are very similar and allege that the directors breached their fiduciary duties to stockholders by amending Chrysler's Share Purchase Rights Plan in a manner designed to entrench themselves in office and to impair the right of stockholders to avail themselves of offers to purchase their shares by an acquiror not favored by management. The Complaints ask for (a) certification of the class, (b) rescission of and an injunction against implementation of the Rights Plan amendments, (c) an order that Chrysler cooperate with Kirk Kerkorian, the holder of 9.8% of Chrysler's common stock at the time the complaints were filed, and take steps to enhance its attractiveness as a merger\/acquisition candidate, and (d) damages and costs. On January 9, 1991, the eight suits were consolidated into one. On January 28, 1991, Chrysler filed an Answer and Affirmative Defenses in the consolidated case. On March 7, 1991, the parties agreed to allow an Amended Complaint to be filed which purports to assert a derivative claim brought on behalf of Chrysler, in addition to class action claims as originally filed. In this regard, the Amended Complaint alleges injury to Chrysler as a direct result of violations of fiduciary duties by the individual defendants. On July 25, 1991, Chrysler filed a motion to dismiss the consolidated lawsuit. On July 27, 1992, the Court entered a memorandum opinion dismissing the complaint as to all claims for relief other than rescission. Chrysler later filed a Motion for Reargument which was denied on August 11, 1992. The Corporation and the named directors are continuing with the defense of this matter.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone during the fourth quarter ended December 31, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT (AS OF FEBRUARY 2, 1995)\n- ---------------------------- (1) The \"Officer Since\" date shown is the date from which the named individual has served continuously as an officer of either Chrysler Corporation or the former Chrysler Motors Corporation which, effective December 31, 1989, was merged with and into Chrysler Corporation.\n(2) Also a member of the Board of Directors.\nThere are no family relationships, as defined for reporting purposes, between any of the executive officers named above and there is no arrangement or understanding between any of the executive officers named above and any other person pursuant to which he was selected as an officer. All of the executive officers named above, except Messrs. Eaton and Henson have been in the employ of Chrysler Corporation or its subsidiaries for more than five years. During the last five years, and immediately preceding employment by Chrysler Corporation, Messrs. Eaton and Henson were high level executives at General Motors Corporation.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nChrysler's common stock is listed on the stock exchanges specified on pages 1 and 2 of this Form 10-K under the trading symbol (C). There were approximately 143,000 shareholders of record of Chrysler's common stock at December 31, 1994. The following table sets forth the high and low sale prices of Chrysler's common stock as reported on the composite tape and the quarterly dividends declared for the last two years.\nDividends on the common stock are payable at the discretion of the Chrysler's Board of Directors out of funds legally available therefor. Chrysler's ability to pay dividends in the future will depend upon its financial results, liquidity and financial condition and its ability to meet its new product development and facility modernization spending programs. Chrysler's ability to pay dividends is also affected by the provision in its credit agreement that it must maintain a ratio of indebtedness to total capitalization (each as defined) at the end of each quarter at certain specified levels.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA Part II - Continued\nThe table below summarizes recent financial information for Chrysler. For further information, refer to Chrysler's consolidated financial statements and notes thereto presented under Item 8 of this Form 10-K.\n- ---------------------------- (1) Earnings for the year ended December 31, 1994 include favorable adjustments to the provision for income taxes aggregating $132 million. These adjustments related to: (1) the recognition of tax credits related to expenditures in prior years for qualifying research and development activities, in accordance with an Internal Revenue Service settlement which was based on recently issued U.S. Department of Treasury income tax regulations, and (2) the reversal of valuation allowances related to tax benefits associated with net operating loss carryforwards.\n(2) Results for the year ended December 31, 1993 include a pretax gain of $205 million ($128 million after applicable income taxes) on the sale of Chrysler's remaining 50.3 million shares of MMC stock, a pretax gain of $60 million ($39 million after applicable income taxes) on the sale of Chrysler's plastics operations, a $4.68 billion after-tax charge for the adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and a $283 million after-tax charge for the adoption of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\"\n(3) Earnings for the year ended December 31, 1992 include a pretax gain of $142 million ($88 million after applicable income taxes) on the sale of 43.6 million shares of MMC stock, a $218 million favorable effect of a change in accounting principle relating to the adoption of SFAS No. 109, \"Accounting for Income Taxes,\" a $101 million pretax charge ($79 million after applicable income taxes) relating to the restructuring of Chrysler's short-term vehicle rental subsidiaries, and a $110 million pretax charge ($69 million after applicable income taxes) relating to investment losses experienced by Chrysler Canada.\n(4) Results for the year ended December 31, 1991 include a pretax gain of $205 million ($127 million after applicable income taxes) on the sale of Chrysler's 50 percent equity interest in Diamond-Star, the favorable effect of a $391 million ($242 million after applicable income taxes) noncash, nonrecurring credit provision relating to a plant capacity adjustment and a $257 million after-tax charge for the cumulative effect of a change in accounting principle related to the timing of the recognition of the costs of sales incentive programs.\n(5) Earnings for the year ended December 31, 1990 include a pretax return to income of $101 million ($63 million after applicable income taxes) resulting from a reduction in the estimated costs recognized in 1989 in connection with the restructuring of Chrysler's automotive operations.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF Part II - Continued FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion and analysis should be read in conjunction with the consolidated financial statements and notes thereto.\nFINANCIAL REVIEW\nChrysler reported earnings before income taxes and the cumulative effect of changes in accounting principles of $5.8 billion in 1994, compared with $3.8 billion in 1993. The earnings in 1993 included a gain on sales of automotive assets and investments totaling $265 million. Excluding the effects of these items, Chrysler's pretax earnings for 1993 were $3.6 billion.\nChrysler reported net earnings for 1994 of $3.7 billion, or $10.11 per common share, compared to a net loss for 1993 of $2.6 billion, or $7.62 per common share. Net earnings for 1994 included favorable tax adjustments aggregating $132 million. The net loss for 1993 resulted from a charge of $4.68 billion, or $13.57 per common share, for the cumulative effect of a change in accounting principle related to the adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Also included in the 1993 results was a charge of $283 million, or $0.82 per common share, for the cumulative effect of a change in accounting principle relating to the adoption of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" and a $72 million favorable adjustment of Chrysler's deferred tax assets and liabilities as a result of the increased U.S. federal income tax rate.\nThe improvement in earnings in 1994 over 1993 was primarily the result of an increase in sales volume, a reduction in lower-margin fleet sales in proportion to total retail sales and reduced sales incentives, partially offset by increased profit-based employee costs. During 1994, Chrysler's worldwide factory sales of cars increased 2 percent to 1,051,750 units, while worldwide factory sales of trucks increased 18 percent to 1,710,353 units. Combined U.S. and Canadian dealers' days supply of vehicles increased to 69 days at December 31, 1994 from 63 days at December 31, 1993.\nDuring 1994, U.S. and Canada vehicle industry retail sales were 16.7 million cars and trucks, an increase of 8 percent from the 15.4 million units sold in 1993. Despite an increase in its combined car and truck sales, Chrysler's U.S. and Canada retail market share in 1994 decreased slightly in comparison to 1993. Decreases in car market share were partially offset by increases in truck market share, as shown below:\n---------------------- (1) All retail sale and market share data include fleet sales.\nThe decline in Chrysler's U.S. car market share during 1994 resulted from reduced sales to fleet customers and reduced sales in certain segments resulting from changeovers to all-new 1995 models. The increase in U.S. truck market share in 1994 was the result of increased sales of full-size Dodge Ram pickup trucks introduced in late 1993. Despite increased retail unit sales in 1994, market shares in the minivan and small sport-utility segments decreased slightly from 1993, principally as a result of market demand in excess of Chrysler's 1994 production capacity for minivans and Jeep(R) vehicles.\nCFC's earnings before income taxes and the cumulative effect of changes in accounting principles were $315 million in 1994, compared to $267 million in 1993. The increase in 1994 was primarily due to higher volumes of automotive financing, reduced credit loss provisions and lower costs of bank facilities. CFC reported net earnings of $195 million and $129 million for 1994 and 1993, respectively. CFC's net earnings for 1993 included charges totaling $30 million for the adoptions of SFAS No. 106 and SFAS No. 112.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF Part II - Continued FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nFINANCIAL REVIEW - Continued\nDuring 1994 and 1993, Chrysler continued to take various actions to strengthen its financial condition, improve liquidity and add to its equity base in order to ensure its ability to carry out its capital spending plans. During 1994 and 1993, Chrysler contributed a total of $6.1 billion to its pension fund. At December 31, 1994, Chrysler had plan assets in excess of its projected pension benefit obligation (\"PBO\") of $244 million, compared to a PBO in excess of plan assets of $3.9 billion at December 31, 1992. During 1993, Chrysler issued 52 million shares of common stock for net proceeds of $1.95 billion. During 1994 and 1993, Chrysler sold assets and investments for proceeds totaling approximately $786 million.\nChrysler's revenues and results of operations are principally derived from the U.S. and Canada automotive marketplace. During 1994, combined U.S. and Canada automobile industry sales increased 8 percent from the 1993 levels, as the economic recoveries in the U.S. and Canada continued. Overall, Chrysler experienced sales growth consistent with the U.S. and Canada automobile industry. In response to the economic recovery, Chrysler is increasing its worldwide production capacity by approximately 500,000 units per year by 1996.\nChrysler vehicles manufactured in Mexico represented approximately 9 percent of Chrysler's 1994 worldwide factory car and truck sales. Approximately two-thirds of these vehicles were exported to the U.S., Canada and other markets. Sales in Mexico of vehicles manufactured in the U.S. and Canada were not significant in 1994. The economic uncertainty in Mexico following the devaluation of the Peso may result in reduced vehicle sales in Mexico in 1995. As a result, exports to Mexico of Chrysler vehicles manufactured in the U.S. and Canada may decrease, and sales of vehicles in Mexico may be less profitable in 1995, as compared to 1994. If U.S. and Canada vehicle industry sales continue at present or higher levels, imports to the U.S. and Canada of Chrysler vehicles manufactured in Mexico may increase, and such sales may be more profitable in 1995, as compared to 1994. The devaluation of the Peso did not significantly impact Chrysler's 1994 operating results. Chrysler cannot predict the impact that the devaluation of the Peso and the resulting uncertainty surrounding the Mexican economic and political environments will have on its operating results in 1995.\nDuring the first half of 1995, Chrysler will begin production of its all-new minivans, and will cease production of its existing minivan models. Chrysler expects this changeover will result in a decline in minivan production in 1995 which Chrysler currently estimates at approximately 65,000 units.\nChrysler has benefitted from several factors, including: (1) continuing economic recoveries (including low interest rates) and strong automobile sales in the U.S. and Canada, where Chrysler's sales are concentrated, (2) a cost advantage in comparison to vehicles manufactured in Japan (or vehicles containing significant material components manufactured in Japan) as a result of favorable exchange rates between the Japanese Yen and the U.S. Dollar, and (3) a shift in U.S. and Canada consumer preferences toward trucks, as Chrysler manufactures a higher proportion of trucks to total vehicles than its principal competitors in the U.S. and Canada. A significant deterioration of any of these factors could adversely affect Chrysler's operating results.\nCOMPARISON OF SELECTED ELEMENTS OF REVENUES AND EXPENSES\nChrysler's total revenues were as follows:\nThe increase in sales of manufactured products in 1994 primarily reflects the 12 percent increase in factory unit sales to 2,762,103 units in 1994. The 1993 increase was largely due to a 14 percent increase in factory unit sales from the 2,175,447 units in 1992. Average revenue per unit, net of sales incentives, was $17,663, $16,461 and $15,086 in 1994, 1993 and 1992, respectively. The increases in average revenue per unit in 1994 and 1993 were principally due to reduced sales incentives and sales of an increased proportion of trucks to total vehicles.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF Part II - Continued FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nCOMPARISON OF SELECTED ELEMENTS OF REVENUES AND EXPENSES - Continued\nThe decreases in finance and insurance income in 1994 and 1993 were primarily attributable to reduced nonautomotive financing revenue, resulting from sales and liquidations of CFC's nonautomotive receivables, partially offset by increased levels of automotive finance receivables. Total automotive financing volume in 1994, 1993 and 1992 was $70.4 billion, $59.8 billion and $46.6 billion, respectively. The increases in automotive financing volume over the last two years was largely due to higher volumes of wholesale financing provided to automotive dealers. Financing support provided in the United States by CFC for new Chrysler vehicle retail deliveries (including fleet) and wholesale vehicle sales to dealers and the number of vehicles financed during the last three years were as follows:\nOther income increased during 1994, as compared to 1993 and 1992, as a result of increased interest income, reflecting Chrysler's increased cash, cash equivalents and marketable securities balances in 1994.\nTotal expenses were as follows:\nCosts, other than items below increased over the three years primarily due to the increases in factory unit sales volume. Included in costs, other than items below in 1992 is a $110 million investment loss for reducing investments of Chrysler Canada and certain of its employee benefit plans in a real estate concern to their estimated net realizable value. Excluding the 1992 investment loss, costs, other than items below as a percent of net sales of manufactured products were 77 percent, 79 percent and 84 percent in 1994, 1993 and 1992, respectively. These improvements were primarily due to lower per unit sales incentives and increased capacity utilization.\nDepreciation of property and equipment remained comparable in 1994, 1993 and 1992. Increases resulting from Chrysler's capital spending program were offset by reductions at CFC resulting from the sales and downsizing of its nonautomotive financing operations. Special tooling amortization increased in 1994 over the 1993 and 1992 levels, primarily as a result of the shortening of the remaining service lives of certain special tools in 1994.\nSelling and administrative expenses increased in 1994 from the 1993 and 1992 levels, as a result of increased advertising costs and increased profit-based employee costs. During 1993, increased profit-based employee costs were offset by reduced costs at CFC due to the downsizing of its nonautomotive financing operations.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF Part II - Continued FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nCOMPARISON OF SELECTED ELEMENTS OF REVENUES AND EXPENSES - Continued\nPension expense decreased in 1994 due to improved funding of the plans, partially offset by increases resulting from the reduction in the discount rate used to measure pension expense in 1994 and benefit increases from Chrysler's 1993 national contracts with its principal bargaining units. Pension expense decreased in 1993 due to improved funding of the plans. Contributions during 1994, 1993 and 1992 were $2.6 billion, $3.5 billion and $816 million, respectively.\nNonpension postretirement benefit expense increased slightly in 1994, as increases resulting from the reduction in the discount rate used to measure nonpension postretirement benefit expense in 1994 were partially offset by cost savings associated with the implementation of new managed care initiatives. Nonpension postretirement benefit expense increased significantly in 1993 due to the adoption of SFAS No. 106, which requires that the costs of health and life insurance benefits for retirees be accrued as expense in the period in which employees provide services.\nThe decline in interest expense in 1994 was primarily due to reductions in CFC's effective cost of borrowings, resulting from CFC's higher levels of commercial paper, which has lower costs than borrowings under CFC's bank facilities. The decline in interest expense in 1993 was primarily the result of CFC's lower average borrowings, reflecting CFC's 1993 sales of its nonautomotive financing operations, the proceeds from which were used to reduce outstanding indebtedness. CFC's average effective cost of borrowings was 8.0 percent, 8.6 percent and 7.8 percent in 1994, 1993 and 1992, respectively. The decrease in CFC's 1994 average effective cost of borrowings reflects lower bank facility costs and higher levels of commercial paper. The increase in CFC's average effective cost of borrowings in 1993 as compared to 1992 was primarily due to the amortization of up-front fees and costs associated with CFC's former bank facilities, which were replaced in 1994.\nThe results of operations for 1992 included a restructuring charge of $101 million relating to the realignment of Chrysler's short-term vehicle rental subsidiaries under Pentastar Transportation Group and the consolidation and phase-out of certain of these operations. This restructuring charge included the write-down of goodwill, lease termination costs, losses associated with the disposal of tangible assets, and other related charges.\nOperating results for 1993 and 1992 included gains on sales of automotive assets and investments of $265 million and $142 million, respectively. The 1993 pretax gain was composed of a $205 million gain on the sales of an aggregate of 50.3 million shares of MMC stock and a $60 million gain on the sale of Chrysler's plastics operations. The 1992 pretax gain resulted from the sale of 43.6 million shares of MMC stock.\nChrysler's effective tax rates in 1994, 1993 and 1992 were 36.3 percent, 37.1 percent and 45.9 percent, respectively. The provision for income taxes in 1994 included adjustments aggregating $132 million for: (1) the recognition of tax credits related to expenditures in prior years for qualifying research and development activities, in accordance with an Internal Revenue Service settlement which was based on recently issued U.S. Department of Treasury income tax regulations, and (2) the reversal of valuation allowances related to tax benefits associated with net operating loss carryforwards. The 1993 provision for income taxes included a favorable adjustment of Chrysler's deferred tax assets and liabilities to the increased U.S. federal tax rate. The 1992 effective tax rate was higher than the effective tax rates in 1994 and 1993 as a result of higher nondeductible expenses, primarily goodwill amortization.\nLIQUIDITY AND CAPITAL RESOURCES\nChrysler's combined cash, cash equivalents and marketable securities totaled $8.4 billion at December 31, 1994 (including $757 million held by CFC), compared to $5.1 billion and $3.6 billion at December 31, 1993 and 1992, respectively. The increase in 1994 was the result of cash generated by operating activities, partially offset by capital expenditures and pension contributions. The increase in 1993 was the result of cash generated by operating activities, the issuance of 52 million shares of new common stock and the sale of assets and investments, partially offset by debt repayments, pension contributions and capital expenditures.\nChrysler's long-term profitability will depend on its ability to develop and market its products successfully. Chrysler's expenditures for new product development and the acquisition of productive assets were $13.7 billion for the three-year period ended December 31, 1994. Expenditures for these items during the succeeding three-year period are expected to be at similar or higher levels. At December 31, 1994, Chrysler had commitments for capital expenditures, including commitments for assets currently under construction, totaling approximately $1.0 billion.\nItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF Part II - Continued FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED\nLIQUIDITY AND CAPITAL RESOURCES - CONTINUED\nChrysler's pension assets exceeded its PBO by $244 million at December 31, 1994, compared to a PBO in excess of plan assets of $2.2 billion and $3.9 billion at December 31, 1993 and 1992, respectively. These reductions in the unfunded pension obligation resulted from Chrysler's contributions of $2.6 billion and $3.5 billion to the pension fund in 1994 and 1993, respectively. In addition to the contributions in 1994, the projected pension benefit obligation was reduced by an increase in the discount rate used to measure the obligation. The favorable impact of the 1993 contributions was partially offset by increases in the PBO caused by the reduction in the discount rate used to measure the obligation and pension benefit increases which were included in Chrysler's new national labor agreements with its principal collective bargaining units.\nDuring 1994, Chrysler replaced its $1.5 billion revolving credit agreement, which was to expire in June 1996, with a new $1.7 billion agreement, expiring in July 1999. The new agreement provides for reduced interest rates and commitment fees, less restrictive financial covenants and the removal of the lenders' ability to obtain security interests in Chrysler's assets. None of the commitment was drawn upon at December 31, 1994.\nAt December 31, 1994, Chrysler (excluding CFC) had debt maturities totaling $695 million in 1995, 1996 and 1997. In December 1994, Chrysler's Board of Directors approved a $1 billion common stock repurchase program commencing in the first quarter of 1995, subject to market conditions. Chrysler believes that cash from operations and its cash position will provide sufficient liquidity to meet its capital expenditure, debt maturity and other funding requirements.\nChrysler's ability to market its products successfully depends significantly on the availability of vehicle financing for its dealers and, to a lesser extent, the availability of financing for retail and fleet customers, both of which CFC provides.\nTerm debt borrowings, commercial paper borrowings and receivable sales are CFC's primary funding sources. During 1994, CFC raised $1.8 billion from term debt placements and increased the amount of its commercial paper outstanding by $1.5 billion.\nReceivable sales continued to be a significant source of funding for CFC, which realized $6.4 billion and $7.8 billion of net proceeds from the sale of automotive retail receivables during 1994 and 1993, respectively. In addition, CFC's wholesale receivable sale arrangements provided funding which aggregated $3.8 billion and $4.6 billion at December 31, 1994 and 1993, respectively.\nDuring 1993 and 1992, $3.3 billion in aggregate cash proceeds were received from the sale of substantially all of the net assets of the consumer and inventory financing businesses of Chrysler First Inc. and the sale of certain assets of Chrysler Capital. Proceeds from these sales were used to reduce outstanding indebtedness.\nAt December 31, 1994, CFC had U.S. and Canadian bank facilities aggregating $5.2 billion and receivable sale agreements totaling $1.7 billion. At December 31, 1994, no amounts were outstanding under CFC's U.S. and Canadian bank facilities or receivable sale agreements.\nAt December 31, 1994, CFC had debt maturities of $5.1 billion in 1995 (including $4.3 billion of commercial paper), $1.7 billion in 1996, and $692 million in 1997. CFC believes that cash provided by operations, receivable sales and the issuance of term debt and commercial paper will be sufficient to enable it to meet its funding requirements.\nNEW ACCOUNTING STANDARDS\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" effective for fiscal years beginning after December 15, 1994. In October 1994, the FASB issued SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures,\" as an amendment to SFAS No. 114. These new accounting standards require creditors to evaluate the collectibility of both contractual interest and principal of receivables when evaluating the need for a loss accrual. Chrysler believes that the implementation of these new accounting standards will not have a material impact on its consolidated operating results or financial position. Chrysler will adopt these standards effective January 1, 1995, as required.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Part II - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS\n- -------------------------- See notes to consolidated financial statements.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED BALANCE SHEET\n- -------------------------- See notes to consolidated financial statements.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS\n- -------------------------- See notes to consolidated financial statements.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION AND FINANCIAL STATEMENT PRESENTATION\nThe consolidated financial statements of Chrysler Corporation and its consolidated subsidiaries (\"Chrysler\") include the accounts of all significant majority-owned subsidiaries and entities. Intercompany accounts and transactions have been eliminated in consolidation. Amounts for 1993 and 1992 have been reclassified to conform with current period classifications.\nREVENUE RECOGNITION\nVehicle and parts sales are generally recorded when such products are shipped to dealers. Provisions for sales allowances and incentives are made at the time of sale and treated as sales reductions.\nInterest income from finance receivables of Chrysler Financial Corporation (\"CFC\"), a wholly owned subsidiary, is recognized using the interest method. Lending fees and certain direct loan origination costs are deferred and amortized to interest income using the interest method over the contractual terms of the finance receivables. Recognition of interest income is generally suspended when a loan becomes contractually delinquent for periods ranging from 60 to 90 days. Income recognition is resumed when the loan becomes contractually current, at which time all past due interest income is recognized.\nCFC sells significant amounts of automotive receivables in transactions subject to limited recourse provisions. CFC generally sells its receivables to a trust and remains as servicer, for which it is paid a servicing fee. CFC retains excess servicing cash flows, a limited interest in the principal balances of the sold receivables and certain cash deposits provided as credit enhancements for investors.\nGains or losses from the sale of receivables are recognized in the period that such sales occur. In determining the gain or loss for each qualifying sale, the investment in the sold receivable pool is allocated between the portion sold and the portion retained based on their relative fair values on the date of sale.\nDEPRECIATION AND TOOL AMORTIZATION\nProperty and equipment are stated at cost less accumulated depreciation. Depreciation is generally provided on a straight-line basis. At December 31, 1994, the weighted average service lives of assets were 34 years for buildings (including improvements and building equipment), 14 years for machinery and equipment and 11 years for furniture and fixtures. Special tooling costs are amortized over the years that a model using that tooling is expected to be produced, and within each year based on the units produced. Amortization is deducted directly from the asset account. During any given model year, special tools will contain tooling with varying useful lives.\nEffective April 1, 1994, Chrysler revised the estimated service lives of certain special tools and property and equipment. These revisions were based on updated assessments of the service lives of the related assets and resulted in the recognition of additional amortization of special tools of $246 million in 1994 and lower depreciation of property and equipment of $45 million in 1994.\nPRODUCT-RELATED COSTS\nExpenditures for advertising, sales promotion and other product-related costs are expensed as incurred, and the estimated costs of product warranty are accrued at the time of sale. Advertising expense was $1.1 billion, $858 million and $873 million in 1994, 1993 and 1992, respectively. Research and development costs were $1.3 billion, $1.2 billion and $1.1 billion in 1994, 1993 and 1992, respectively.\nCASH AND CASH EQUIVALENTS\nHighly liquid investments with a maturity of three months or less at the date of purchase are classified as cash equivalents.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED\nMARKETABLE SECURITIES\nEffective January 1, 1994, Chrysler adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" This new accounting standard specifies the accounting and reporting requirements for changes in the fair values of investments in debt and equity securities which have readily determinable fair values. Prior to 1994, marketable equity securities were carried at cost, which approximated market, while debt securities were carried at cost adjusted for amortized premium or discount. Adoption of this accounting standard did not have a material effect on Chrysler's financial statements.\nUnder SFAS No. 115, these debt and equity securities are segregated into one of the following categories--trading, available-for-sale and held-to-maturity. Trading securities and available-for-sale securities are carried at their fair values. Changes in the fair values of trading securities are recorded in the statement of earnings. Changes in the fair values of available-for-sale securities are recorded as a component of shareholders' equity until such securities are sold. Held-to-maturity securities are carried at cost adjusted for amortized premium or discount.\nAt December 31, 1994, Chrysler had investments in securities (including cash equivalents) with an aggregate carrying value of $7.9 billion accounted for in accordance with SFAS No. 115. These securities consisted primarily of commercial paper, federal government agency securities and corporate debt. At December 31, 1994, securities categorized as available-for-sale and held-to- maturity totaled $5.5 billion and $2.4 billion, respectively. Substantially all such securities have maturities within one year.\nALLOWANCE FOR CREDIT LOSSES\nAn allowance for credit losses is generally established during the period in which finance receivables are acquired. The allowance for credit losses is maintained at a level deemed appropriate based on loss experience and other factors. Retail automotive receivables not supported by a dealer guaranty are charged to the allowance for credit losses net of the estimated value of repossessed collateral at the time of repossession. Nonautomotive finance receivables are reduced to the estimated fair value of the collateral when such receivables are determined to be impaired.\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" effective for fiscal years beginning after December 15, 1994. In October 1994, the FASB issued SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures,\" as an amendment to SFAS No. 114. These new accounting standards require creditors to evaluate the collectibility of both contractual interest and principal of receivables when evaluating the need for a loss accrual. Chrysler believes that the implementation of these new accounting standards will not have a material impact on its consolidated operating results or financial position. Chrysler will adopt these standards effective January 1, 1995, as required.\nINVENTORIES\nInventories are valued at the lower of cost or market. The cost of approximately 51 percent and 44 percent of inventories at December 31, 1994 and 1993, respectively, was determined on a Last-In, First-Out (\"LIFO\") basis. The balance of inventory cost was determined on a First-In, First-Out (\"FIFO\") basis.\nINTANGIBLE ASSETS\nThe purchase price of companies in excess of the value of net identifiable assets acquired (\"goodwill\") is amortized on a straight-line basis over periods of up to 40 years. The amount is reported net of accumulated amortization of $723 million and $643 million at December 31, 1994 and 1993, respectively. Intangible assets also included intangible pension assets of $44 million and $2.1 billion at December 31, 1994 and 1993, respectively.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED\nPOSTEMPLOYMENT BENEFITS\nEffective January 1, 1993, Chrysler adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which required the accrual of benefits provided to former or inactive employees after employment but prior to retirement. Prior to 1993, Chrysler accrued for certain of these benefits at the time an employee's active service ended and expensed certain other benefits on the basis of cash expenditures. Adoption of this accounting standard resulted in the recognition of an after-tax charge of $283 million, or $0.82 per common share, for the cumulative effect of this change in accounting principle.\nDERIVATIVE FINANCIAL INSTRUMENTS\nChrysler manages risk arising from fluctuations in interest rates and currency exchange rates by utilizing derivative financial instruments. Chrysler does not use derivative financial instruments for trading purposes. For the year ended December 31, 1994, Chrysler adopted SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\"\nWhen Chrysler sells vehicles outside the United States or purchases components from suppliers outside the United States, transactions are frequently denominated in currencies other than U.S. dollars. Periodically, Chrysler initiates hedging activities by entering into currency exchange agreements, consisting principally of currency forward contracts and purchased currency options, to minimize revenue and cost variations which could result from fluctuations in currency exchange rates. These hedge instruments typically mature within two years of origination. The currency exchange agreements are treated as off-balance sheet financial instruments, with related gains and losses recorded in the settlement of the underlying transactions. In the event of an early termination of a currency exchange agreement designated as a hedge, the gain or loss continues to be deferred and is included in the settlement of the underlying transaction.\nCFC utilizes interest rate swaps, interest rate caps, forward interest rate contracts and currency exchange agreements as part of its asset and liability management program. Due to changing interest rates, interest rate exchange agreements, which are treated as off-balance sheet financial instruments, are utilized to stabilize interest margins. Interest differentials resulting from interest rate swap and cap agreements are recorded on an accrual basis as an adjustment to interest expense. In the event of an early termination of an interest rate exchange agreement designated as a hedge, gains or losses are deferred and recorded as an adjustment to interest expense over the remaining term of the underlying debt. Forward interest rate contracts are periodically used to manage exposure to fluctuations in funding costs for anticipated securitizations of retail receivables. Unrealized gains or losses on forward interest rate contracts that qualify for hedge accounting treatment are deferred. Unrealized gains or losses on forward interest rate contracts that do not qualify for hedge accounting treatment are included in the statement of earnings. Realized gains or losses for hedge instruments are included in the determination of the gain or loss from the related sale of retail receivables. CFC and its subsidiaries hedge borrowings denominated in currencies other than the borrowers' local currency with currency exchange agreements, which are reflected in the consolidated balance sheet. As a result, such borrowings are translated in the financial statements at the rates of exchange established under the related currency exchange agreements.\nNOTE 2. INVENTORIES AND COST OF SALES\nInventories, summarized by major classification, were as follows:\nInventories valued on the LIFO basis would have been $328 million and $259 million higher than reported had they been valued on the FIFO basis at December 31, 1994 and 1993, respectively.\nTotal manufacturing cost of sales aggregated $39.0 billion, $33.1 billion and $28.7 billion for 1994, 1993 and 1992, respectively.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 3. FINANCE RECEIVABLES, RETAINED INTERESTS IN SOLD RECEIVABLES AND OTHER RELATED AMOUNTS\nFinance receivables, retained interests in sold receivables and other related amounts were as follows:\nRetained interests in sold receivables and other related amounts are generally restricted and subject to limited recourse provisions. At December 31, 1994, CFC was a party to an interest rate cap agreement related to $134 million of its retained interests. This agreement, which is designated as a hedge instrument, resulted in no impact on interest income at CFC. At December 31, 1994, CFC was also a party to a forward interest rate contract (notional amount $500 million) to manage its exposure to fluctuations in funding costs for an anticipated securitization of retail receivables during the first quarter of 1995.\nContractual maturities of total finance receivables as of December 31, 1994, were (in millions of dollars): 1995 - $5,219; 1996 - $1,371; 1997 - $1,108; 1998 - $862; 1999 - $549; and 2000 and thereafter - $1,430. Actual cash flows will vary from contractual cash flows due to future sales of finance receivables and prepayments.\nChanges in the allowance for credit losses were as follows:\nNonearning finance receivables, including receivables sold subject to limited recourse, totaled $282 million and $333 million at December 31, 1994 and 1993, respectively, which represented 0.9 percent and 1.2 percent of such receivables outstanding, respectively.\nNOTE 4. PROPERTY AND EQUIPMENT\nProperty and equipment, summarized by major classification, were as follows:\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 5. ACCRUED LIABILITIES AND EXPENSES\nAccrued liabilities and expenses consisted of the following:\nNOTE 6. DEBT\nLong-term debt consisted of the following:\n- -------------------------\n(1) The weighted average interest rates include the effects of interest rate exchange agreements.\nAt December 31, 1994, aggregate annual maturities of consolidated debt, including principal payments on capital leases, were as follows (in millions of dollars): 1995 - $5,456; 1996 - $1,705; 1997 - $1,009; 1998 - $999; and 1999 - $1,577.\nCFC enters into currency exchange agreements to manage its exposure to fluctuations in currency exchange rates related to specific funding transactions. Certain borrowings in U.S. Dollars, German Marks and Swiss Francs are hedged with currency exchange agreements in the local currency of the borrowing entity. As a result, such borrowings are translated in the financial statements at the rates of exchange established under the related currency exchange agreement. The amount of such borrowings was $734 million. If CFC had not entered into currency exchange agreements, the amount would have been $220 million higher at December 31, 1994.\nTo mitigate risks associated with changing interest rates on certain of its debt, CFC has entered into interest rate exchange agreements. CFC manages exposure to counterparty credit risk by entering into such agreements only with major financial institutions that are expected to fully perform under the terms of such agreements. The notional amounts are used to measure the volume of these agreements. The impact on interest expense of interest rate exchange agreements was immaterial in 1994, 1993 and 1992. Chrysler cannot predict the impact that such agreements may have on interest expense in the future.\nInterest rate swaps related to term debt are matched with specific obligations, altering the interest rate characteristics of the associated debt. Interest rate swaps are also utilized to reduce exposure to interest rate fluctuations on the anticipated issuances of commercial paper. Interest rate swaps associated with commercial paper are matched with groups of such obligations on a layered basis. An aggregate of $4.3 billion of commercial paper was outstanding at December 31, 1994.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 6. DEBT - CONTINUED\nThe following table summarizes CFC's interest rate derivatives related to its debt obligations as of December 31, 1994 and 1993:\nDuring 1994, CFC replaced its revolving credit and receivable sale agreements, which were to expire in 1995, with new agreements providing for credit lines totaling $5.2 billion and receivable sale agreements totaling $1.7 billion, expiring in 1998. These agreements contain restrictive covenants, which, among other things, require CFC to maintain a minimum net worth. None of the commitments were drawn upon at December 31, 1994.\nDuring 1994, Chrysler replaced its $1.5 billion revolving credit agreement, which was to expire in June 1996, with a new $1.7 billion revolving credit agreement expiring in July 1999. The new agreement provides for reduced interest rates and commitment fees, less restrictive financial covenants and the removal of the lenders' ability to obtain security interests in Chrysler's assets. None of the commitment was drawn upon at December 31, 1994.\nNOTE 7. INCOME TAXES\nEffective January 1, 1992, Chrysler adopted SFAS No. 109, \"Accounting for Income Taxes,\" which resulted in a favorable cumulative effect of the change in accounting principle of $218 million, or $0.74 per common share.\nEarnings before income taxes and the cumulative effect of changes in accounting principles were attributable to the following sources:\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7. INCOME TAXES - CONTINUED\nThe provision for income taxes on earnings before income taxes and the cumulative effect of changes in accounting principles included the following:\nChrysler does not provide for U.S. income tax or foreign withholding taxes on the undistributed earnings of foreign subsidiaries, as such cumulative earnings of $1.9 billion are intended to be permanently reinvested in those operations. It is not practicable to estimate the amount of unrecognized deferred tax liability for the undistributed foreign earnings.\nA reconciliation of income taxes determined using the statutory U.S. rate (35 percent for 1994 and 1993; 34 percent for 1992) to actual income taxes provided was as follows:\nThe adjustment to the provision for income taxes for the recognition of prior years research and development tax credits in 1994 represents the tax benefits related to expenditures in prior years for qualifying research and development activities, in accordance with an Internal Revenue Service settlement which was based on recently issued U.S. Department of Treasury income tax regulations.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA-Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7. INCOME TAXES - CONTINUED\nThe tax-effected temporary differences and carryforwards which comprised deferred tax assets and liabilities were as follows:\nChrysler's tax credit carryforwards expire at various dates through the year 2009; alternative minimum tax credit carryforwards have no expiration dates. NOL carryforwards totaled $313 million at December 31, 1994, and may be used through the year 2008. The valuation allowance was principally related to certain subsidiaries' NOL carryforwards. Changes in the valuation allowance were as follows:\nNOTE 8. COMMITMENTS AND CONTINGENT LIABILITIES\nLITIGATION\nVarious claims and legal proceedings have been asserted or instituted against Chrysler, including some purporting to be class actions, and some which demand large monetary damages or other relief which would require significant expenditures. Although the ultimate cost of resolving these matters cannot be precisely determined, Chrysler maintains reserves which it believes will be sufficient to resolve these matters. After giving effect to these reserves, management believes, based on currently known facts and circumstances, that the disposition of these matters will not have a material adverse effect on Chrysler's consolidated financial position. Future developments could cause Chrysler to change its estimate of the ultimate cost of resolving these matters, and such changes could be material to Chrysler's consolidated results of operations for the period in which such developments occur. Chrysler is unable to estimate such changes in costs, if any, which may be required in connection with these matters.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 8. COMMITMENTS AND CONTINGENT LIABILITIES - CONTINUED\nENVIRONMENTAL MATTERS\nThe United States Environmental Protection Agency and various state agencies have notified Chrysler that it may be a potentially responsible party (\"PRP\") for the cost of cleaning up hazardous waste storage or disposal facilities pursuant to the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") and other federal and state environmental laws. Chrysler is also a party to a number of lawsuits filed in various jurisdictions alleging CERCLA or other environmental claims. In virtually all cases, Chrysler is only one of a number of PRPs who may be found to be jointly and severally liable. In addition, Chrysler has identified additional active or deactivated facilities at which it may be responsible for closure activities or cleaning up hazardous waste. Estimates of future costs of such environmental matters are necessarily imprecise due to numerous uncertainties, including the enactment of new laws and regulations, the development and application of new technologies, the identification of new sites for which Chrysler may have remediation responsibility and the apportionment and collectibility of remediation costs among responsible parties. Chrysler may ultimately incur significant expenditures over an extended period of time in connection with the foregoing environmental matters, and therefore maintains reserves for the estimated costs associated with all of its environmental remediation efforts, including CERCLA and related matters, expected closure activities and voluntary environmental cleanup efforts. Chrysler believes that these reserves will be sufficient to resolve these matters. After giving effect to these reserves, management believes, based on currently known facts and circumstances and existing laws and regulations, that the disposition of these matters will not have a material adverse effect on Chrysler's consolidated financial position. Future developments could cause Chrysler to change its estimate of the total costs associated with these matters, and such changes could be material to Chrysler's consolidated results of operations for the period in which such developments occur. Chrysler is unable to estimate such changes in costs, if any, which may be required in connection with these matters.\nOTHER MATTERS\nThe majority of Chrysler's lease payments are for operating leases. At December 31, 1994, Chrysler had the following minimum rental commitments under noncancelable operating leases: 1995 - $325 million; 1996 - $263 million; 1997 - - $134 million; 1998 - $61 million; 1999 - $48 million; and 2000 and thereafter - - $143 million. Future minimum lease commitments have not been reduced by minimum sublease rentals of $252 million due in the future under noncancelable subleases.\nRental expense for operating leases, with original expiration dates beyond one year, was $407 million, $410 million and $383 million in 1994, 1993 and 1992, respectively. Sublease rentals of $60 million, $61 million, and $60 million were received in 1994, 1993, and 1992, respectively.\nChrysler had commitments for capital expenditures, including commitments for facilities currently under construction, approximating $1.0 billion at December 31, 1994.\nAt December 31, 1994, Chrysler had guaranteed obligations of others in the amount of $224 million, none of which were secured by collateral.\nNOTE 9. STOCK OPTIONS AND PERFORMANCE-BASED COMPENSATION\nThe Chrysler Corporation 1991 Stock Compensation Plan (the \"1991 Plan\") provides that Chrysler may grant stock options to officers, key employees and nonemployee directors and also may grant reload stock options (which are options granted when outstanding options are exercised by payment in stock), stock appreciation rights (payable in cash or stock, at the sole discretion of the Stock Option Committee) and limited stock appreciation rights (payable in cash in the event of a change in control). The 1991 Plan also provides for awarding restricted stock units and performance stock units, which reward service for specified periods or attainment of performance objectives. The Chrysler Corporation Stock Option Plan (the \"Plan\"), initially adopted in 1972 and readopted in 1982, was amended to incorporate certain features of the 1991 Plan.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 9. STOCK OPTIONS AND PERFORMANCE-BASED COMPENSATION - CONTINUED\nUnder the Plan and the 1991 Plan, outstanding options, consisting of ten-year nonqualified stock options, have exercise prices of not less than the market value of Chrysler common stock at date of grant. Options generally become exercisable on up to 40 percent of the shares after one year from the date of grant, 70 percent after two years and 100 percent after three years. Information with respect to options granted under the Plan and the 1991 Plan, including the conversion of AMC options outstanding at the date of the AMC acquisition, was as follows:\nShares available for granting options at the end of 1994, 1993 and 1992 were 15.1 million, 1.5 million, and 4.4 million, respectively. At December 31, 1994, 5.6 million options with prices ranging from $16.07 to $54.32 were not yet exercisable under the terms of the Plan and the 1991 Plan.\nIn addition to the Plan and the 1991 Plan, Chrysler has programs under which additional compensation is paid to hourly and salaried employees based upon various measures of Chrysler's performance. Such performance-based compensation programs include incentive compensation and profit sharing paid to certain hourly and salaried employees.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10. SHAREHOLDERS' EQUITY\nInformation with respect to shareholders' equity was as follows (shares in millions):\nThe annual dividend on the Series A Convertible Preferred Stock (the \"Preferred Stock\") is $46.25 per share. The Preferred Stock is convertible, unless previously redeemed, at a rate (subject to adjustment in certain events) of 27.78 shares of common stock for each share of Preferred Stock. The Preferred Stock is not redeemable prior to January 22, 1997. Thereafter, Chrysler may redeem the Preferred Stock, in whole or in part, at $523.13 per share of Preferred Stock for the period ending December 31, 1997 and thereafter declining ratably annually to $500.00 per share after December 31, 2001, plus accrued and unpaid dividends.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 10. SHAREHOLDERS' EQUITY - CONTINUED\nIn February 1988, the Board of Directors declared and distributed a dividend of one Preferred Share Purchase Right (a \"Right\") for each then outstanding share of Chrysler's common stock and authorized the distribution of one Right with respect to each subsequently issued share of common stock. Each Right, as most recently amended, entitles a shareholder to purchase one one-hundredth of a share of Junior Participating Cumulative Preferred Stock of Chrysler at a price of $120. The Rights are attached to the common stock and are not represented by separate certificates or exercisable until the earliest to occur of (i) 10 days following the time (the \"Stock Acquisition Time\") of a public announcement or communication to Chrysler that a person or group of persons has acquired or obtained the right to acquire 15 percent or more of Chrysler's outstanding common stock, and (ii) 10 business days after a person or group announces or commences a tender offer that would result, if successful, in the bidder owning 15 percent or more of Chrysler's outstanding common stock. If the acquiring person or group acquires 15 percent or more of the common stock (except pursuant to a tender offer made for all of Chrysler's common stock, and determined by Chrysler's independent directors to be fair and in the best interests of Chrysler and its shareholders) each Right (other than those held by the acquiror) will entitle its holder to buy, for $120, a number of shares of Chrysler's common stock having a market value of $240. Similarly, if after the Stock Acquisition Time, Chrysler is acquired in a merger or other business combination and is not the surviving corporation, or 50 percent or more of its assets, cash flow or earning power is sold, each Right (other than those held by the surviving or acquiring company) will entitle its holder to purchase, for $120, shares of the surviving or acquiring company having a market value of $240. Chrysler's directors may redeem the Rights at $0.05 per Right, and may amend the Rights or extend the time during which the Rights may be redeemed, only prior to the Stock Acquisition Time. Additionally, at any time after a person acquires 15 percent or more, but less than 50 percent, of Chrysler's common stock, Chrysler's directors may exchange the Rights (other than those held by the acquiror), in whole or in part, at an exchange ratio of one share of common stock (or a fractional share of preferred stock with equivalent voting rights) per Right. The Rights will expire on February 22, 1998.\nOf the 1.0 billion shares of authorized common stock at December 31, 1994, 97 million shares were reserved for issuance under Chrysler's various employee benefit plans and the conversion of the Preferred Stock.\nPrimary earnings (loss) per common share amounts were computed by dividing earnings (loss) after deduction of preferred stock dividends by the average number of common and dilutive equivalent shares outstanding. Fully diluted per-common-share amounts assume conversion of the Preferred Stock, the elimination of the related preferred stock dividend requirement, and the issuance of common stock for all other potentially dilutive equivalents outstanding. Fully diluted per-common-share amounts are not applicable for loss periods.\nNOTE 11. PENSION PLANS\nChrysler's pension plans provide noncontributory and contributory benefits. The noncontributory pension plans cover substantially all of the hourly and salaried employees of Chrysler and certain of its consolidated subsidiaries. Benefits are based on a fixed rate for each year of service. Additionally, contributory benefits and supplemental noncontributory benefits are provided to substantially all salaried employees of Chrysler and certain of its consolidated subsidiaries under the Salaried Employees' Retirement Plan. This plan provides contributory benefits based on the employee's cumulative contributions and a supplemental noncontributory benefit based on years of service during which employee contributions were made, and the employee's average salary during the consecutive five years in which salary was highest in the 15 years preceding retirement.\nContributions to the pension trust fund for U.S. plans are in compliance with the Employee Retirement Income Security Act of 1974, as amended. All pension trust fund assets and income accruing thereon are used solely to pay pension benefits and administer the plans. Chrysler made pension fund contributions totaling $2.6 billion in 1994, $3.5 billion in 1993 and $816 million in 1992.\nAt December 31, 1994, plan assets were invested in a diversified portfolio that consisted primarily of debt and equity securities, including 17.9 million shares of Chrysler common stock with a market value of $879 million. During 1994, $17 million of dividends were received on Chrysler common stock.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11. PENSION PLANS - CONTINUED\nThe components of pension expense were as follows:\nDuring 1994, 1993 and 1992, the cost of voluntary early retirement programs, which are periodically offered to certain salaried and hourly employees, was $68 million, $40 million and $48 million, respectively.\nPension expense is determined using assumptions at the beginning of the year. The projected benefit obligation (\"PBO\") is determined using the assumptions at the end of the year. Assumptions used to determine pension expense and the PBO were:\nThe increase in the discount rate for U.S. Plans from 7.38 percent as of December 31, 1993 to 8.63 percent as of December 31, 1994 resulted in a $1.3 billion decrease in the PBO at December 31, 1994 and is expected to result in a $99 million decrease in the 1995 expense.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11. PENSION PLANS - CONTINUED\nThe following table presents a reconciliation of the funded status of the plans with amounts recognized in the consolidated balance sheet:\nIncluded in other assets on the consolidated balance sheet as of December 31, 1994 and 1993 was noncurrent prepaid pension expense of $4.1 billion and $1.6 billion, respectively.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 12. NONPENSION POSTRETIREMENT BENEFITS\nChrysler provides health and life insurance benefits to substantially all of its hourly and salaried employees and those of certain of its consolidated subsidiaries. Upon retirement from Chrysler, employees may become eligible for continuation of these benefits. However, benefits and eligibility rules may be modified periodically. Prior to 1993, the expense recognized for these benefits was based primarily on cash expenditures for the period. Effective January 1, 1993, Chrysler adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the accrual of such benefits during the years employees provide services.\nThe adoption of this accounting standard resulted in an after-tax charge of $4.68 billion, or $13.57 per common share, in 1993. This charge represented the immediate recognition of the transition obligation of $7.44 billion, partially offset by $2.76 billion of estimated tax benefits. The transition obligation is the aggregate amount that would have been accrued in the years prior to the adoption of SFAS No. 106, had this standard been in effect for those years. Implementation of SFAS No. 106 did not increase Chrysler's cash expenditures for postretirement benefits.\nComponents of nonpension postretirement benefit expense were as follows:\nThe following table summarizes the components of the nonpension postretirement benefit obligation recognized in the consolidated balance sheet at December 31, 1994 and 1993:\nNonpension postretirement benefit expense is determined using assumptions at the beginning of the year. The ANPBO is determined using the assumptions at the end of the year. Assumptions at December 31, 1994 and 1993 were:\nThe increase in the discount rate to 8.6 percent as of December 31, 1994 resulted in a $1.1 billion decrease in the ANPBO in 1994, and is expected to result in a $68 million decrease in nonpension postretirement benefit expense in 1995. During 1994, Chrysler implemented new managed care initiatives which reduced the expected health care inflation rate for 1995.\nA one percentage point increase in the assumed health care inflation rate in each year would have increased the ANPBO at December 31, 1994 by $1.0 billion and would have increased the aggregate of the service and interest cost components of nonpension postretirement benefit expense in 1994 by $116 million.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 13. SALES OF AUTOMOTIVE ASSETS AND INVESTMENTS\nDuring 1994, Chrysler sold its wire harness operations and certain of its soft trim operations, and entered into five-year supply agreements with each of the purchasers. Aggregate net proceeds from the sales and the supply agreements were approximately $325 million. The related pretax gains of approximately $250 million were deferred and are being recognized over the periods of the respective supply agreements.\nIn 1993, Chrysler sold its plastics operations for net proceeds of $132 million. The sale resulted in a pretax gain of $60 million ($39 million after applicable income taxes). Also during 1993, Chrysler sold its remaining 50.3 million shares of Mitsubishi Motors Corporation (\"MMC\") stock for net proceeds of $329 million, resulting in a pretax gain of $205 million ($128 million after applicable income taxes).\nIn 1992, Chrysler sold 43.6 million shares of MMC stock for net proceeds of $215 million, resulting in a pretax gain of $142 million ($88 million after applicable income taxes).\nNOTE 14. INVESTMENT ADJUSTMENT AND RESTRUCTURING CHARGE\nIncluded in costs, other than items below for the year ended December 31, 1992 was a pretax charge of $110 million ($69 million after applicable income taxes) to reduce investments of Chrysler Canada Ltd. and certain of its employee benefit plans in a real estate investment concern to their estimated net realizable value.\nEarnings for the year ended December 31, 1992 also included a $101 million pretax restructuring charge ($79 million after applicable income taxes) relating to the realignment of a part of Chrysler's short-term vehicle rental subsidiaries (the \"Car Rental Operations\") under Pentastar Transportation Group, Inc. and to provide for the consolidation and phase out of certain of those operations. This restructuring charge included the write-down of goodwill, lease termination costs, losses associated with the disposal of tangible assets and other related charges.\nNOTE 15. SUPPLEMENTAL CASH FLOW INFORMATION\nSupplemental disclosures to the consolidated statement of cash flows were as follows:\nDuring 1994, CFC acquired $300 million of marketable securities in a non-cash transaction relating to the securitization of retail receivables.\nNOTE 16. FINANCIAL INSTRUMENTS\nThe estimated fair values of financial instruments have been determined by Chrysler using available market information and the valuation methodologies described below. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein may not be indicative of the amounts that Chrysler could realize in a current market exchange. The use of different assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 16. FINANCIAL INSTRUMENTS - CONTINUED\nAmounts related to Chrysler's financial instruments were as follows:\n- ---------------------- (1) The carrying value of finance receivables excludes $2.0 billion of direct finance and leveraged leases classified as finance receivables in the consolidated balance sheet at December 31, 1994 and 1993. The carrying value of retained interests excludes $41 million and $57 million of retail lease securities at December 31, 1994 and 1993, respectively. (2) The carrying value of debt excludes $17 million and $22 million of obligations under capital leases classified as debt in the consolidated balance sheet at December 31, 1994 and 1993, respectively. (3) Currency exchange agreements are recorded on the consolidated balance sheet as a reduction to the carrying value of debt.\nThe carrying values of cash and cash equivalents, accounts receivable and accounts payable approximated fair values due to the short-term maturities of these instruments.\nThe methods and assumptions used to estimate the fair values of other financial instruments are summarized as follows:\nMarketable securities\nThe fair values of marketable securities were estimated using quoted market prices.\nFinance receivables, retained interests in sold receivables and other related amounts - net\nThe carrying value of variable-rate finance receivables was assumed to approximate fair value since they are priced at current market rates. The fair value of fixed-rate finance receivables was estimated by discounting expected cash flows using rates at which loans of similar maturity would be made as of the date of the consolidated balance sheet. The fair values of excess servicing cash flows and other amounts due CFC arising from receivable sale transactions were estimated by discounting expected cash flows.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 16. FINANCIAL INSTRUMENTS - CONTINUED\nDebt\nThe fair value of public debt was estimated using quoted market prices. The fair value of other long-term debt was estimated by discounting future cash flows using rates currently available for debt with similar terms and remaining maturities.\nCurrency exchange agreements\nThe fair values of currency exchange agreements were estimated by discounting the expected cash flows using market exchange rates and relative market interest rates over the remaining terms of the agreements. Currency exchange agreements are more fully described in NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES and NOTE 6. DEBT.\nInterest rate exchange agreements\nThe fair values of interest rate swaps, interest rate caps and forward interest rate contracts were estimated by discounting expected cash flows using quoted market interest rates. Interest rate exchange agreements are more fully described in NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, NOTE 3. FINANCE RECEIVABLES, RETAINED INTERESTS IN SOLD RECEIVABLES AND OTHER RELATED AMOUNTS and NOTE 6. DEBT.\nCurrency forward contracts and purchased currency options\nThe fair values of currency forward contracts and purchased currency options were estimated based on quoted market prices for contracts of similar terms. Currency forward contracts and purchased currency options are more fully described in NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES.\nAlthough not a counterparty to certain derivative financial instruments entered into between securitization trusts and third parties, CFC receives an indirect beneficial interest from such instruments. Such indirect beneficial interests are subject to reduction in the event of a counterparty's nonperformance. If a counterparty had failed to perform at December 31, 1994, CFC would have been exposed to a $27 million loss.\nThe fair value estimates presented herein were based on information available as of the date of the consolidated balance sheet. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been revalued since the date of the consolidated balance sheet and, therefore, current estimates of fair value may differ from the amounts presented herein.\nNOTE 17. INDUSTRY SEGMENT AND GEOGRAPHIC AREA DATA\nINDUSTRY SEGMENT DATA\nChrysler operates in two principal industry segments, Car and Truck and Financial Services. The Car and Truck segment is composed of the automotive operations of Chrysler, which includes the research, design, manufacture, assembly and sale of cars, trucks and related parts and accessories. The Car Rental Operations and Chrysler's defense electronics business, Chrysler Technologies Corporation, each represent less than 10 percent of revenues, operating profits and identifiable assets, and have been included in the Car and Truck segment. The Financial Services segment is composed of CFC, which is engaged in wholesale and retail vehicle financing, property and casualty insurance, and servicing nonautomotive loans and leases. Information concerning operations by industry segment was as follows:\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 17. INDUSTRY SEGMENT AND GEOGRAPHIC AREA DATA - CONTINUED\nINDUSTRY SEGMENT DATA - CONTINUED\nInterest expense of the Financial Services segment has been netted against operating earnings, which is consistent with industry practice. The individual segments do not add to the consolidated amounts due to the elimination of intersegment transactions.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 17. INDUSTRY SEGMENT AND GEOGRAPHIC AREA DATA - CONTINUED\nGEOGRAPHIC AREA DATA\nInformation concerning operations by principal geographic area was as follows:\nTransfers between geographic areas are based on prices negotiated between the buying and selling locations.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCONFORMED\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Directors Chrysler Corporation Highland Park, Michigan\nWe have audited the accompanying consolidated balance sheet of Chrysler Corporation and consolidated subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings and cash flows for each of the three years in the period ended December 31, 1994. 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 consolidated financial statements present fairly, in all material respects, the financial position of Chrysler Corporation and consolidated subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in the notes to the financial statements, the Company adopted new Statements of Financial Accounting Standards and, accordingly, changed its method of accounting for certain investments in debt and equity securities in 1994, its method of accounting for postretirement benefits other than pensions and postemployment benefits in 1993, and its method of accounting for income taxes in 1992.\nDeloitte & Touche LLP Detroit, Michigan January 16, 1995\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nCONFORMED\nMANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING\nChrysler's management is responsible for preparing the financial statements and other financial information in this Annual Report. This responsibility includes maintaining the integrity and objectivity of financial data and the presentation of Chrysler's results of operations and financial position in accordance with generally accepted accounting principles. The financial statements include amounts that are based on management's best estimates and judgments.\nChrysler's financial statements have been audited by Deloitte & Touche LLP, independent auditors. Their audits were conducted in accordance with generally accepted auditing standards and included consideration of the internal control system and tests of transactions as part of planning and performing their audits.\nChrysler maintains a system of internal controls that provides reasonable assurance that its records reflect its transactions in all material respects and that significant misuse or loss of assets will be prevented. Management believes the system of internal controls is adequate to accomplish these objectives on a continuous basis. Chrysler maintains a strong internal auditing program that independently assesses the effectiveness of the internal controls and recommends possible improvements. Management considers the recommendations of the General Auditor and Deloitte & Touche LLP concerning the system of internal controls and takes appropriate actions to respond to these recommendations.\nThe Board of Directors, acting through its Audit Committee composed solely of nonemployee directors, is responsible for determining that management fulfills its responsibilities in the preparation of financial statements and the maintenance of internal controls. In fulfilling its responsibility, the Audit Committee recommends independent auditors to the Board of Directors for appointment by the shareholders. The Committee also reviews the consolidated financial statements and adequacy of internal controls. The Audit Committee meets regularly with management, the General Auditor and the independent auditors. Both the independent auditors and the General Auditor have full and free access to the Audit Committee, without management representatives present, to discuss the scope and results of their audits and their views on the adequacy of internal controls and the quality of financial reporting.\nIt is the business philosophy of Chrysler Corporation and its subsidiaries to obey the law and to require that its employees conduct their activities according to the highest standards of business ethics. Management reinforces this philosophy by numerous actions, including issuing a Code of Ethical Behavior and maintaining a Business Practices Committee and a Business Practices Office to support compliance with the Corporation's policies.\nR. J. Eaton G. C. Valade - ------------ ------------- R. J. EATON G. C. VALADE Chairman of the Board and Executive Vice President and Chief Executive Officer Chief Financial Officer\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nSUPPLEMENTAL INFORMATION\nCHRYSLER CORPORATION AND CONSOLIDATED SUBSIDIARIES SELECTED QUARTERLY FINANCIAL DATA (unaudited)\n- ------------------------- (1) Results for the first quarter of 1993 included the unfavorable effects of changes in accounting principles of $4.68 billion related to the adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and $283 million related to the adoption of SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\"\n(2) Earnings for the second quarter of 1993 included a gain of $60 million ($39 million after applicable income taxes) related to the sale of Chrysler's plastics operations and a gain of $111 million ($70 million after applicable income taxes) related to the sale of 27 million shares of Mitsubishi Motors Corporation (\"MMC\") stock.\n(3) Earnings for the third quarter of 1993 included a gain of $94 million ($58 million after applicable income taxes) related to the sale of Chrysler's remaining 23.3 million shares of MMC stock.\n(4) Earnings for the fourth quarter of 1994 included favorable adjustments to the provision for income taxes aggregating $132 million. These adjustments related to: (1) the recognition of tax credits related to expenditures in prior years for qualifying research and development activities, in accordance with an Internal Revenue Service settlement which was based on recently issued U.S. Department of Treasury income tax regulations, and (2) the reversal of valuation allowances related to tax benefits associated with net operating loss carryforwards.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nSUPPLEMENTAL INFORMATION\nCHRYSLER (WITH CFC AND CAR RENTAL OPERATIONS ON AN EQUITY BASIS) STATEMENT OF EARNINGS (unaudited)\nThis Supplemental Information, \"Chrysler (with CFC and Car Rental Operations on an Equity Basis),\" reflects the results of operations of Chrysler with its investments in Chrysler Financial Corporation (\"CFC\") and its investments in short-term vehicle rental subsidiaries (the \"Car Rental Operations\") accounted for on an equity basis rather than as consolidated subsidiaries. This Sup- plemental Information does not purport to present results of operations in accordance with generally accepted accounting principles because it does not comply with Statement of Financial Accounting Standards (\"SFAS\") No. 94, \"Consolidation of All Majority-Owned Subsidiaries.\" The financial covenant contained in Chrysler's revolving credit facility is based on this Supplemental Information. In addition, because the operations of CFC and the Car Rental Operations are different in nature than Chrysler's manufacturing operations, management believes that this disaggregated financial data enhances an understanding of the consolidated financial statements.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nSUPPLEMENTAL INFORMATION\nCHRYSLER (WITH CFC AND CAR RENTAL OPERATIONS ON AN EQUITY BASIS) BALANCE SHEET (unaudited)\nThis Supplemental Information, \"Chrysler (with CFC and Car Rental Operations on an Equity Basis),\" reflects the financial position of Chrysler with its investments in CFC and the Car Rental Operations accounted for on an equity basis rather than as consolidated subsidiaries. This Supplemental Information does not purport to present financial position in accordance with generally accepted accounting principles because it does not comply with SFAS No. 94, \"Consolidation of All Majority-Owned Subsidiaries.\" The financial covenant contained in Chrysler's revolving credit facility is based on this Supplemental Information. In addition, because the operations of CFC and the Car Rental Operations are different in nature than Chrysler's manufacturing operations, management believes that this disaggregated financial data enhances an understanding of the consolidated financial statements.\nItem 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY Part II - Continued DATA - Continued\nSUPPLEMENTAL INFORMATION\nCHRYSLER (WITH CFC AND CAR RENTAL OPERATIONS ON AN EQUITY BASIS) STATEMENT OF CASH FLOWS (unaudited)\nThis Supplemental Information, \"Chrysler (with CFC and Car Rental Operations on an Equity Basis),\" reflects the cash flows of Chrysler with its investments in CFC and the Car Rental Operations accounted for on an equity basis rather than as consolidated subsidiaries. This Supplemental Information does not purport to present cash flows in accordance with generally accepted accounting principles because it does not comply with SFAS No. 94, \"Consolidation of All Majority-Owned Subsidiaries.\" The financial covenant contained in Chrysler's revolving credit facility is based on this Supplemental Information. In addition, because the operations of CFC and the Car Rental Operations are different in nature than Chrysler's manufacturing operations, management believes that this disaggregated financial data enhances an understanding of the consolidated financial statements.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS Part II - Continued 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 10-K is incorporated by reference from Chrysler Corporation's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders, which will be filed with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of the fiscal year, all of which information is hereby incorporated by reference in, and made part of, this Form 10-K, except that 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) The following documents are filed as part of this report:\n1. Financial Statements\nFinancial statements filed as part of this Form 10-K are listed under Part II, Item 8.\n2. Financial Statement Schedules\nNo schedules are included because they are not required under the instructions contained in Regulation S-X or because the information called for is shown in the financial statements and notes thereto.\n3. Exhibits:\n*3-A-1 Copy of Certificate of Incorporation of Chrysler Corporation, as amended and restated and in effect on May 21, 1987.\n*3-A-2 Copy of Certificate of Amendment of Certificate of Incorporation of Chrysler Corporation dated May 19, 1994, as in effect on May 20, 1994.\n3-B Copy of By-Laws of Chrysler Corporation, as amended as of June 10, 1993. Filed as Exhibit 3-B to Chrysler Corporation Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1993, and incorporated herein by reference.\n*3-C Copy of Certificate of Designation for Chrysler Corporation Junior Participating Cumulative Preferred Stock.\n*3-D Copy of Certificate of Designation, Preferences and Rights of Series A Convertible Preferred Stock.\n4-A Certificate of Incorporation and By-Laws of Chrysler Corporation. See Exhibits 3-A through 3-D above.\n4-B-1 Copy of Certificate of Ownership and Merger merging Chrysler Motors Corporation into Chrysler Corporation, effective on December 31, 1989. Filed as Exhibit 4-B-1 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1989, and incorporated herein by reference.\n- ----------------------- *Filed herewith.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n4-B-2 Copy of Agreement of Merger and Plan of Reorganization, dated as of March 6, 1986, among Chrysler Corporation, Chrysler Corporation (now Chrysler Corporation) and New Chrysler, Inc., annexed as Exhibit A to Registration Statement No. 33-4537 on Form S-4 of Chrysler Holding Corporation (now Chrysler Corporation), and incorporated herein by reference.\n4-C-1 Copy of Rights Agreement, dated as of February 4, 1988, and amended and restated as of December 14, 1990, between Chrysler Corporation and First Chicago Trust Company of New York (formerly Morgan Shareholder Services Trust Company), as rights Agent, relating to Rights to purchase Chrysler Corporation Junior Participating Cumulative Preferred Stock. Filed as Exhibit 1 to Chrysler Corporation Current Report on Form 8-K, dated December 14, 1990, and incorporated herein by reference.\n4-C-2 Amendment No. 1, dated as of December 1, 1994, to the Rights Agreement, dated as of February 4, 1988, and amended and restated as of December 14, 1990, between Chrysler Corporation and First Chicago Trust Company of New York (formerly known as Morgan Shareholder Services Trust Company), as Rights Agent. Filed as Exhibit 1 to Chrysler Corporation Current Report on Form 8-K, dated December 1, 1994, and incorporated herein by reference.\n4-D-1 Conformed copy of Indenture, dated as of July 15, 1987, between Chrysler Corporation and State Street Bank and Trust Company (successor to Manufacturers Hanover Trust Company), as Trustee, relating to Debt Securities, Appendix B thereto relating to 10.95% Debentures Due 2017 and Appendix C thereto relating to 10.40% Notes Due 1999. Filed as Exhibit 4-D-1 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1987, and incorporated herein by reference.\n4-D-2 Conformed copy of Indenture, dated as of March 1, 1985, between Chrysler Corporation and State Street Bank and Trust Company (successor to Manufacturers Hanover Trust Company), as Trustee, relating to Debt Securities and Appendix B thereto relating to 13% Debentures Due 1997. Filed as Exhibit 4-B to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1985, and incorporated herein by reference.\n4-D-3 Form of Supplemental Indenture, dated as of May 30, 1986, between Chrysler Holding Corporation (now Chrysler Corporation), Chrysler Corporation and Manufacturers Hanover Trust Company, as Trustee, relating to Debt Securities. Filed as Exhibit 4-E-2 to the Post-Effective Amendment No. 1 to Registration Statement No. 33-4537 on Form S-4 of Chrysler Holding Corporation (now Chrysler Corporation), and incorporated herein by reference.\n4-D-4 Copy of Supplemental Indenture, dated as of December 31, 1989, between Chrysler Corporation and Manufacturers Hanover Trust Company, as Trustee, relating to Debt Securities. Filed as Exhibit 4-D-4 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1989, and incorporated herein by reference.\n4-D-5 Conformed copy of Third Supplemental Indenture, dated as of May 1, 1990, between Chrysler Corporation and Manufacturers Hanover Trust Company, as Trustee, relating to Debt Securities and Appendix D to Indenture dated as of March 1, 1985 between Chrysler Corporation and Manufacturers Hanover Trust Company relating to Debentures Due 2020. Filed as Exhibit 4-D-5 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by reference.\n4-D-6 Conformed copy of Trust Agreement, dated as of May 1, 1990, between Chrysler Corporation and Manufacturers Hanover Bank (Delaware), Trustee, relating to the Auburn Hills Trust. Filed as Exhibit 4-D-6 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1990, and incorporated herein by reference.\n4-E Copy of $1,675,000,000 Revolving Credit Agreement, dated as of July 29, 1994, among Chrysler Corporation, the several Banks party to the Agreement and Chemical Bank, as Agent for the Banks. Filed as Exhibit 4E to the Chrysler Corporation Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference.\n4-F-1 Copy of Indenture, dated as of June 15, 1984, between Chrysler Financial Corporation and Manufacturers Hanover Trust Company, as Trustee, United States Trust Company of New York, as successor Trustee, related to Senior Debt Securities of Chrysler Financial Corporation. Filed as Exhibit (1) to the Current Report of Chrysler Financial Corporation on Form 8-K, dated June 26, 1984, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n4-F-2 Copy of Indenture, dated as of September 15, 1986, between Chrysler Financial Corporation and Manufacturers Hanover Trust Company, Trustee, United States Trust Company of New York, as Successor Trustee, related to Chrysler Financial Corporation Senior Debt Securities. Filed as Exhibit 4-E to the Quarterly Report of Chrysler Financial Corporation on Form 10-Q for the quarter ended September 30, 1986, and incorporated herein by reference.\n4-F-3 Copy of Amended and Restated Indenture, dated as of September 15, 1986, between Chrysler Financial Corporation and Manufacturers Hanover Trust Company, Trustee, United States Trust Company of New York, as Successor Trustee, related to Chrysler Financial Corporation Senior Debt Securities. Filed as Exhibit 4-H to the Quarterly Report of Chrysler Financial Corporation on Form 10-Q for the quarter ended June 30, 1987, and incorporated herein by reference.\n4-F-4 Copy of Indenture, dated as of February 15, 1988, between Chrysler Financial Corporation and Manufacturers Hanover Trust Company, Trustee, United States Trust Company of New York, as Successor Trustee, related to Chrysler Financial Corporation Senior Debt Securities. Filed as Exhibit 4-A to Registration No. 33-23479 of Chrysler Financial Corporation, and incorporated herein by reference.\n4-F-5 Copy of First Supplemental Indenture, dated as of March 1, 1988, between Chrysler Financial Corporation and Manufacturers Hanover Trust Company, Trustee, United States Trust Company of New York, as successor Trustee, to the Indenture, dated as of February 15, 1988, between such parties, related to Chrysler Financial Corporation Senior Debt Securities. Filed as Exhibit 4-L to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1987, and incorporated herein by reference.\n4-F-6 Copy of the Second Supplemental Indenture, dated as of September 7, 1990, between Chrysler Financial Corporation and Manufacturers Hanover Trust Company, Trustee, United States Trust Company of New York, as Successor Trustee, to the Indenture, dated as of February 15, 1988, between such parties, related to Chrysler Financial Corporation Senior Debt Securities. Filed as Exhibit 4-M to the Quarterly Report of Chrysler Financial Corporation on Form 10-Q for the quarter ended September 30, 1990, and incorporated herein by reference.\n4-F-7 Copy of Third Supplemental Indenture, dated as of May 4, 1992, between Chrysler Financial Corporation and United States Trust Company of New York, as Successor Trustee, to the Indenture, dated as of February 15, 1988 between such parties, relating to Chrysler Financial Corporation Senior Debt Securities. Filed as Exhibit 4-N to the Quarterly Report of Chrysler Financial Corporation on Form 10-Q for the quarter ended June 30, 1992, and incorporated herein by reference.\n4-G-1 Copy of Indenture, dated as of February 15, 1988, between Chrysler Financial Corporation and IBJ Schroder Bank & Trust Company, Trustee, related to Chrysler Financial Corporation Subordinated Debt Securities. Filed as Exhibit 4-B to Registration No. 33-23479 of Chrysler Financial Corporation, and incorporated herein by reference.\n4-G-2 Copy of First Supplemental Indenture, dated as of September 1, 1989, between Chrysler Financial Corporation and IBJ Schroder Bank & Trust Company, Trustee, to the Indenture, dated as of February 15, 1988, between such parties, related to Chrysler Financial Corporation Subordinated Debt Securities. Filed as Exhibit 4-N to the Current Report of Chrysler Financial Corporation on Form 8-K dated September 1, 1989 and filed September 13, 1989, and incorporated herein by reference.\n4-H-1 Copy of Indenture, dated as of February 15, 1988, between Chrysler Financial Corporation and Irving Trust Company, Trustee, related to Chrysler Financial Corporation Junioi Subordinated Debt Securities. Filed as Exhibit 4-C to Registration No. 33-23479 of Chrysler Financial Corporation, and incorporated herein by reference.\n4-H-2 Copy of First Supplemental Indenture dated as of September 1, 1989, between Chrysler Financial Corporation and Irving Trust Company, Trustee, to the Indenture, dated as of February 15, 1988, between such parties, related to Chrysler Financial Corporation Junior Subordinated Debt Securities. Filed as Exhibit 4-O to the Current Report of Chrysler Financial Corporation on Form 8-K dated September 1, 1989 and filed on September 13, 1989, and incorporated herein by reference.\n10-A-1 Copy of Chrysler Corporation Stock Option Plan, as amended and in effect on and after December 8, 1983 and before May 14, 1986, assumed by Chrysler Corporation (formerly Chrysler Holding Corporation). Filed as Exhibit 10-D-8 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1983, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-A-2 Copy of Chrysler Corporation Stock Option Plan, as amended and in effect on and after May 14, 1986 and before November 5, 1987, assumed by Chrysler Corporation (formerly Chrysler Holding Corporation). Filed as Exhibit 10-A-8 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1986, and incorporated herein by reference.\n10-A-3 Copy of Chrysler Corporation Stock Option Plan, as amended and in effect on and after November 5, 1987 and before February 4, 1988. Filed as Exhibit 10-A-8 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1987, and incorporated herein by reference.\n10-A-4 Copy of Chrysler Corporation Stock Option Plan, as amended and in effect on and after February 4, 1988 and before June 7, 1990. Filed as Exhibit 10-A-9 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1987, and incorporated herein by reference.\n10-A-5 Copy of Chrysler Corporation Stock Option Plan, as amended and in effect on and after June 7, 1990. Filed as Exhibit 10-A-10 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.\n10-A-6 Copy of Chrysler Corporation Stock Option Plan, as amended through December 2, 1993. Filed as Exhibit 10-A-6 to the Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.\n10-A-7 Copy of American Motors Corporation 1980 Stock Option Plan as in effect on August 5, 1987. Filed as Exhibit 28-B to Post-Effective Amendment No. 1 on Form S-8 to Registration Statement No. 33-15544 on Form S-4 of Chrysler Corporation, and incorporated herein by reference.\n10-A-8 Copy of Chrysler Corporation 1991 Stock Compensation Plan, as in effect on and after May 16, 1991 and before December 2, 1993. Filed as Exhibit 10-A-32 to the Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference.\n10-A-9 Copy of Chrysler Corporation 1991 Stock Compensation Plan, as amended and in effect on and after December 2, 1993 and before May 19, 1994. Filed as Exhibit 10-A-9 to the Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference.\n*10-A-10 Copy of Chrysler Corporation 1991 Stock Compensation Plan, as amended and in effect on and after May 19, 1994.\n*10-B-1 Copy of Chrysler Corporation Incentive Compensation Plan, as amended and in effect on and after May 19, 1994.\n*10-B-2 Copy of Chrysler Corporation Long-Term Performance Plan, as amended and in effect on and after May 19, 1994.\n10-B-3 Copy of Chrysler Supplemental Executive Retirement Plan, as amended through December 20, 1993. Filed as Exhibit 10-B-3 to Chrysler Corporation Annual Report on Form 10- K for the year ended December 31, 1993 and incorporated herein by reference.\n*10-B-4 Copy of Chrysler Corporation Discretionary Incentive Compensation Plan as in effect on and after December 1, 1994.\n10-C-1 Copy of agreement, dated July 12, 1990, between Chrysler Corporation and Lee A. Iacocca. Filed as Exhibit 10-C-5 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.\n10-C-2 Copy of agreement, dated June 22, 1992 between Chrysler Corporation and Lee A. Iacocca, amending agreement dated July 12, 1990, between Chrysler Corporation and Lee A. Iacocca. Filed as Exhibit 10-C-6 to the Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.\n- -------------------- *Filed herewith.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-C-3 Copy of agreement, dated June 11, 1992, between Chrysler Corporation and Lee A. Iacocca. Filed as Exhibit 10-C-7 to the Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.\n10-C-4 Copy of agreement, dated March 14, 1992, between Chrysler Corporation and Robert J. Eaton. Filed as Exhibit 10-C-8 to the Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference.\n10-D Conformed copy of Participation Agreement for Sale and Leaseback Financing of Chrysler Technology Center Facilities among Chrysler Corporation, Manufacturers Hanover Bank (Delaware), as Trustee, and AH Service Corporation, dated as of May 1, 1990. Filed as Exhibit 10-E-11 to Chrysler Corporation Annual Report on Form 10-K for the year ended December 31, 1990 and incorporated herein by reference.\n10-E-1 Copy of Income Maintenance Agreement made December 20, 1968 among Chrysler Financial Corporation, Chrysler Corporation and Chrysler Motors Corporation (now dissolved). Filed as Exhibit 13-D to Registration Statement No. 2-32037 of Chrysler Financial Corporation, and incorporated herein by reference.\n10-E-2 Copy of Agreement made April 19, 1971 among Chrysler Financial Corporation, Chrysler Corporation and Chrysler Motors Corporation (now dissolved), amending the Income Maintenance Agreement among such parties. Filed as Exhibit 13-B to Registration Statement No. 2-40110 of Chrysler Financial Corporation and Chrysler Corporation, and incorporated herein by reference.\n10-E-3 Copy of Agreement made May 29, 1973 among Chrysler Financial Corporation, Chrysler Corporation and Chrysler Motors Corporation (now dissolved), further amending the Income Maintenance Agreement among such parties. Filed as Exhibit 5-C to Registration Statement No. 2-49615 of Chrysler Financial Corporation, and incorporated herein by reference.\n10-E-4 Copy of Agreement made as of July 1, 1975 among Chrysler Financial Corporation, Chrysler Corporation and Chrysler Motors Corporation (now dissolved), further amending the Income Maintenance Agreement among such parties. Filed as Exhibit D to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1975, and incorporated herein by reference.\n10-E-5 Copy of Agreement made June 4, 1976 between Chrysler Financial Corporation and Chrysler Corporation further amending the Income Maintenance Agreement between such parties. Filed as Exhibit 5-H to Registration Statement No. 2-56398 of Chrysler Financial Corporation, and incorporated herein by reference.\n10-E-6 Copy of Agreement made March 27, 1986 between Chrysler Financial Corporation, Chrysler Holding Corporation (now Chrysler Corporation) and Chrysler Corporation further amending the Income Maintenance Agreement among such parties. Filed as Exhibit 10-F to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1986, and incorporated herein by reference.\n10-G-1 Copy of Revolving Credit Agreement, dated as of May 23, 1994, among Chrysler Financial Corporation, Chemical Bank, as Agent, the several commercial banks party thereto as Co-Agents, and Chemical Securities Inc., as Arranger. Filed as Exhibit 10-A to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-2 Copy of Fourth Amended and Restated Commitment Transfer Agreement, dated as of May 23, 1994, among Chrysler Financial Corporation, the several financial institutions parties thereto and Chemical Bank, as agent. Filed as Exhibit 10-B to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-3 Copy of Guarantee Agreement, dated as of May 23, 1994, made by Chrysler Financial Corporation to and in favor of Guaranteed Parties as defined therein. Filed as Exhibit 10-C to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-4 Copy of Revolving Credit Agreement, dated as of May 23, 1994, among Chrysler Credit Canada Ltd., Royal Bank of Canada, as agent, Canadian Imperial Bank of Commerce and Bank of Nova Scotia, as co-agents, and the Lenders partes thereto. Filed as Exhibit 10-D to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-G-5 Copy of Short Term Receivables Purchase Agreement, dated as of May 23, 1994, among Chrysler Financial Corporation, Chrysler Credit Corporation, U.S. Auto Receivables Company, American Auto Receivables Company, Chemical Bank, as agent, the several commercial banks parties thereto, and Chemical Bank Agency Services Corporation, as Administrative Agent. Filed as Exhibit 10-E to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-6 Copy of Short Term Participation and Servicing Agreement, dated as of May 23, 1994, among American Auto Receivables Company, Chrysler Credit Corporation, the banks and other financial institutions named as purchasers therein, Chemical Bank, as Agent, and Chemical Bank Agency Services Corporation, as Administrative Agent. Filed as Exhibit 10-F to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 19984, and incorporated herein by reference.\n10-G-7 Copy of Short Term Bank Supplement, dated as of May 23, 1994, among U.S. Auto Receivables Company, Chrysler Credit Corporation and Manufacturers and Traders Trust Company, as Trustee, to the Pooling and Servicing Agreement dated as of May 31, 1991 with respect to CARCO Auto Loan Master Trust Short Term Bank Series. Filed as Exhibit 10-G to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-8 Copy of Long Term Receivables Purchase Agreement, dated as of May 23, 1994, among Chrysler Financial Corporation, Chrysler Credit Corporation, U.S. Auto Receivables Company, American Auto Receivables Company, the several commercial banks parties thereto, Chemical Bank, as Agent, and Chemical Bank Agency Services Corporation, as Administrative Agent. Filed as Exhibit 10-H to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-9 Copy of Long Term Participation and Servicing Agreement, dated as of May 23, 1994, among American Auto Receivables Company, Chrysler Credit Corporation, the banks and other financial institutions named as purchasers therein, Chemical Bank, as Agent, and Chemical Bank Agency Services Corporation, as Administrative Agent. Filed as Exhibit 10-I to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-10 Copy of Long Term Bank Supplement, dated as of May 23, 1994, among U.S. Auto Receivables Company, Chrysler Credit Corporation and Manufacturers and Traders Trust Company, as Trustee, to the Pooling and Servicing Agreement dated as of May 31, 1991 with respect to CARCO Auto Loan Master Trust Bank Series. Filed as Exhibit 10-J to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-11 Copy of Short Term Receivables Purchase Agreement, dated May 23, 1994, among Chrysler Financial Corporation, Chrysler Credit Canada Ltd., the chartered banks named therein as purchasers, and Royal Bank of Canada, as Agent. Filed as Exhibit 10-K to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-12 Copy of Short Term Retail Purchase and Servicing Agreement, dated May 23, 1994, among Chrysler Credit Canada Ltd., the chartered banks named therein as parties thereto, and Royal Bank of Canada, as Agent. Filed as Exhibit 10-L to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-13 Copy of Long Term Receivables Purchase Agreement, dated May 23, 1994, among Chrysler Financial Corporation, Chrysler Credit Canada Ltd., the chartered banks named therein as purchasers, and Royal Bank of Canada, as Agent. Filed as Exhibit 10-M to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-14 Copy of Long Term Retail Purchase and Servicing Agreement, dated May 23, 1994, among Chrysler Credit Canada Ltd., the chartered banks named therein as parties thereto, and Royal Bank of Canada, as Agent. Filed as Exhibit 10-N to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-G-15 Copy of Bank Series 1994-1 Supplement, dated as of May 23, 1994, among Chrysler Credit Canada Ltd., Royal Bank of Canada, as Agent, the several banks parties thereto, and The Royal Trust Company, as Custodian, to the Master Custodial and Servicing Agreement, dated as of September 1, 1992. Filed as Exhibit 10-O to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-G-16 Copy of Bank Series 1994-2 Supplement, dated as of May 23, 1994, among Chrysler Credit Canada Ltd., Royal Bank of Canada, as Agent, the several banks parties thereto, and The Royal Trust Company, as Custodian, to the Master Custodial and Servicing Agreement, dated as of September 1, 1992. Filed as Exhibit 10-P to the Current Report on Form 8-K of Chrysler Financial Corporation dated May 23, 1994, and incorporated herein by reference.\n10-H-1 Copy of Securitization Closing Agreement, dated as of February 1, 1993, among Chrysler Financial Corporation, certain Sellers, certain Purchasers, and certain Purchaser Parties. Filed as Exhibit 2-E to the Current Report of Chrysler Financial Corporation on Form 8-K dated February 1, 1993, and incorporated herein by reference.\n10-H-2 Copy of First Amendment to Business Asset Purchase Agreement dated as of January 29, 1993, among NationsBank Financial Services Corporation, the other Purchasers parties thereto and the Sellers parties thereto and Chrysler Financial Corporation. Filed as Exhibit 2-D to the Current Report of Chrysler Financial Corporation on Form 8-K dated February 1, 1993, and incorporated herein by reference.\n10-I Copy of Asset Purchase Agreement, dated as of February 1, 1993, among Chrysler Rail Transportation Corporation, Chrysler Capital Transportation Services, Inc. and United States Rail Services, a division of United States Leasing International, Inc. Filed as Exhibit 10-IIIIII to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10-J-1 Copy of Amended and Restated Trust Agreement, dated as of April 1, 1993, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank Delaware, as Owner Trustee, with respect to Premier Auto Trust 1993-2. Filed as Exhibit 4.1 to the Quarterly Report of Premier Auto Trust 1993-2 on Form 10-Q for the quarter ended June 30, 1993, and incorporated herein by reference.\n10-J-2 Copy of Indenture, dated as of April 1, 1993, between Premier Auto Trust 1993-2 and Bankers Trust Company, as Indenture Trustee, with respect to Premier Auto Trust 1993-2. Filed as Exhibit 4.2 of the Quarterly Report of Premier Auto Trust 1993-2 on Form 10-Q for the quarter ended June 30, 1993, and incorporated herein by reference.\n10-K-1 Copy of Amended and Restated Trust Agreement, dated as of June 1, 1993, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank Delaware, as Owner Trustee, with respect to Premier Auto Trust 1993-3. Filed as Exhibit 4.1 to the Quarterly Report of Premier Auto Trust 1993-3 on Form 10-Q for the quarter ended June 30, 1993, and incorporated herein by reference.\n10-K-2 Copy of Indenture, dated as of June 1, 1993, between Premier Auto Trust 1993-3 and Bankers Trust Company, as Indenture Trustee. Filed as Exhibit 4.2 to the Quarterly Report of Premier Auto Trust 1993-3 on Form 10-Q for the quarter ended June 30, 1993, and incorporated herein by reference.\n10-L Copy of Series 1993-1 Supplement, dated as of February 1, 1993, among U.S. Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and Manufacturers and Traders Trust Company, as Trustee, with respect to CARCO Auto Loan Master Trust. Filed as Exhibit 3 to the Trust's Registration Statement on Form 8-A dated March 15, 1993, and incorporated herein by reference.\n10-M Copy of Receivables Purchase Agreement, made as of April 7, 1993, among Chrysler Credit Canada Ltd., Chrysler Financial Corporation and Association Assets Acquisition Inc., with respect to CARS 1993-1. Filed as Exhibit 10- OOOO to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-N Copy of Receivables Purchase Agreement, made as of June 29, 1993, among Chrysler Credit Canada Ltd., Chrysler Financial Corporation and Associated Assets Acquisition Inc., with respect to CARS 1993-2. Filed as Exhibit 10- PPPP to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-O-1 Copy of Pooling and Servicing Agreement, dated as of August 1, 1993, among Auto Receivables Corporation, Chrysler Credit Canada Ltd., Montreal Trust Company of Canada and Chrysler Financial Corporation, with respect to CARCO 1993-1. Filed as Exhibit 10-QQQQ to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-O-2 Copy of Standard Terms and Conditions of Agreement, dated as of August 1, 1993, among Auto Receivables Corporation, Chrysler Credit Canada Ltd. and Chrysler Financial Corporation, with respect to CARCO 1993-1. Filed as Exhibit 10-RRRR to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-O-3 Copy of Purchase Agreement, dated as of August 1, 1993, between Chrysler Credit Canada Ltd., and Auto Receivables Corporation, with respect to CARCO 1993-1. Filed as Exhibit 10-SSSS to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-P Copy of Lease Receivables Purchase Agreement, dated September 3, 1993, among CXC Incorporated, Chrysler Systems Inc., and Chrysler Financial Corporation. Filed as Exhibit 10-UUUU to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-Q Copy of Lease Receivables Purchase Agreement, dated September 22, 1993, among the CIT Group\/Equipment Financing, Inc., Chrysler Systems Inc., and Chrysler Financial Corporation. Filed as Exhibit 10-VVVV to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-R Copy of Asset Purchase Agreement, dated as of July 31, 1993, between Chrysler Rail Transportation Corporation and General Electric Railcar Leasing Services Corporation. Filed as Exhibit 10-WWWW to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-S Copy of Amended and Restated Loan Agreement, dated as of June 1, 1993, between Chrysler Realty Corporation and Chrysler Credit Corporation. Filed as Exhibit 10-XXXX to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-T Copy of Loan Agreement, dated as of March 31, 1993, between Manatee Leasing, Inc. and Chrysler Credit Corporation. Filed as Exhibit 10-YYYY to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-U Copy of Origination and Servicing Agreement, dated as of June 4, 1993, among Chrysler Leaserve, Inc., General Electric Capital Auto Lease, Inc., Chrysler Credit Corporation and Chrysler Financial Corporation. Filed as Exhibit 10-ZZZZ to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-V-1 Copy of Amended and Restated Trust Agreement, dated as of September 1, 1993, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank Delaware, as Trustee, with respect to Premier Auto Trust 1993-5. Filed as Exhibit 4.1 to the Quarterly Report of Premier Auto Trust 1993-5 on Form 10-Q for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-V-2 Copy of Indenture, dated as of September 1, 1993, between Premier Auto Trust 1993-5 and Bankers Trust Company, as Indenture Trustee, with respect to Premier Auto Trust 1993-5. Filed as Exhibit 4.2 to the Quarterly Report of Premier Auto Trust 1993-5 on Form 10-Q for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-W Copy of Asset Purchase Agreement, dated as of October 29, 1993, between Marine Asset Management Corporation and Trico Marine Assets, Inc. Filed as Exhibit 10-CCCCC to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-X Copy of Asset Purchase Agreement, dated as of December 3, 1993, between Chrysler Rail Transportation Corporation and Allied Railcar Company. Filed as Exhibit 10-OOOO to the Annual Report on Form 10-K of Chrysler Financial Corporation for the year ended December 31, 1993, and incorporated herein by reference.\n10-Y Copy of Secured Loan Purchase Agreement, dated as of December 15, 1993, among Chrysler Credit Canada Ltd., Leaf Trust and Chrysler Financial Corporation. Filed as Exhibit 10-PPPP to the Annual Report on Form 10-K of Chrysler Financial Corporation for the year ended December 31, 1993, and incorporated herein by reference.\n10-Z Copy of Series 1993-2 Supplement, dated as of November 1, 1993, among U.S. Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and Manufacturers and Traders Trust Company, as Trustee, with respect to CARCO Auto Loan Master Trust. Filed as Exhibit 3 to the Registration Statement on Form 8-A of CARCO Auto Loan Master Trust dated December 6, 1993, and incorporated herein by reference.\n10-AA-1 Copy of Amended and Restated Trust Agreement, dated as of November 1, 1993, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank Delaware, as Owner Trustee, with respect to Premier Auto Trust 1993-6. Filed as Exhibit 4-A to the Annual Report on Form 10-K of Premier Auto Trust 1993-6 for the year ended December 31, 1993, and incorporated herein by reference.\n10-AA-2 Copy of Indenture, dated as of November 1, 1993, between Premier Auto Trust 1993-6 and The Fuji Bank and Trust Company, as Indenture Trustee, with respect to Premier Auto Trust 1993- 6. Filed as Exhibit 4-B to the Annual Report on Form 10-K of Premier Auto Trust 1993-6 for the year ended December 31, 1993, and incorporated herein by reference.\n10-BB Copy of Secured Loan Purchase Agreement, dated as of March 29, 1994, among Chrysler Credit Canada Ltd., Leaf Trust and Chrysler Financial Corporation. Filed as Exhibit 10-ZZZ to the Quarterly Report of Chrysler Financial Corporation on Form 10-Q for the quarter ended March 31, 1994, and incorporated herein by reference.\n10-CC-1 Copy of Amended and Restated Trust Agreement, dated as of February 1, 1994, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank Delaware, as Owner Trustee, with respect to Premier Auto Trust 1994-1. Filed as Exhibit 4.1 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1994-1 for the quarter ended March 31, 1994, and incorporated herein by reference.\n10-CC-2 Copy of Indenture, dated as of February 1, 1994, between Premier Auto Trust 1994-1 and The Fuji Bank and Trust Company, as Indenture Trustee, with respect to Premier Auto Trust 1994-1. Filed as Exhibit 4.2 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1994-1 for the quarter ended March 31, 1994, and incorporated herein by reference.\n10-DD Copy of Secured Loan Purchase Agreement, dated as of July 6, 1994, among Chrysler Credit Canada Ltd., Leaf Trust and Chrysler Financial Corporation. Filed as Exhibit 10-BBBB to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended June 30, 1994, and incorporated herein by reference.\n10-EE-1 Copy of Amended and Restated Trust Agreement, dated as of May 1, 1994, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank, Delaware, as Owner Trustee, with respect to Premier Auto Trust 1994-2. Filed as Exhibit 4.1 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1994-2 for the Quarter ended June 30, 1994, and incorporated herein by reference.\n10-EE-2 Copy of Indenture, dated as of May 1, 1994, between Premier Auto Trust 1994-2 and The Fuji Bank and Trust Company, as Indenture Trustee, with respect to Premier Auto Trust 1994-2. Filed as Exhibit 4.2 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1994-2 for the quarter ended June 30, 1994, and incorporated herein by reference.\n10-FF-1 Copy of Amended and Restated Trust Agreement, dated as of June 1, 1994, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank, Delaware, with respect to Premier Auto Trust 1994-3. Filed as Exhibit 4.1 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1994-3 for the quarter ended June 30, 1994, and incorporated herein by reference.\n10-FF-2 Copy of Indenture, dated as of June 1, 1994, between Premier Auto Trust 1994-3 and The Fuji Bank and Trust Company, as Indenture Trustee, with respect to Premier Auto Trust 1994-3. Filed as Exhibit 4.2 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1994-3 for the quarter ended June 30, 1994, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-GG-1 Copy of Master Receivables Purchase Agreement among Chrysler Credit Canada Ltd., CORE Trust and Chrysler Financial Corporation, dated as of November 29, 1994. Filed as Exhibit 10-FFF to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10-GG-2 Copy of Terms Schedule among Chrysler Credit Canada Ltd., CORE Trust and Chrysler Financial Corporation dated as of December 2, 1994, with respect to the sale of retail automotive receivables to CORE Trust. Filed as Exhibit 10-GGG to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10-HH Copy of Terms Schedule among Chrysler Credit Canada Ltd., CORE Trust and Chrysler Financial Corporation dated as of December 22, 1994, with respect to the sale of retail automotive receivables to CORE Trust. Filed as Exhibit 10-HHH to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10-II Copy of Asset Purchase Agreement dated as of December 14, 1994, between Chrysler Capital Income Partners, L.P. and First Union Commercial Corporation. Filed as Exhibit 10-III to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10-JJ Copy of Receivables Purchase Agreement, dated as of December 15, 1994, among Chrysler Financial Corporation, Premier Auto Receivables Company and ABN AMRO Bank, N.V., as Agent with respect to the sale of retail automotive receivables to Windmill Funding Corporation. Filed as Exhibit 10-JJJ to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1994, and incorporated herein by reference.\n10-KK Copy of Pooling and Servicing Agreement, dated as of August 1, 1990, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and The Fuji Bank and Trust Company, as Trustee, with respect to CARCO DEALRs Wholesale Trust 1990-A. Filed as Exhibit 10-HHH to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1990, and incorporated herein by reference.\n10-LL Copy of Amendment, dated as of September 23, 1991, to the Pooling and Servicing Agreement, dated August 1, 1990, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and The Fuji Bank and Trust Company, as Trustee, with respect to CARCO DEALRs Wholesale Trust 1990-A. Filed as Exhibit 10-NN to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference.\n10-MM Copy of Receivables Purchase Agreement, dated as of August 16, 1990, between Chrysler Auto Receivables Company, as Buyer, and Chrysler Credit Corporation, as Seller, with respect to CARCO DEALRs Wholesale Trust 1990-A. Filed as Exhibit 10-III to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1990, and incorporated herein by reference.\n10-NN Copy of Receivables Sales Agreement, dated as of August 16, 1990, between Chrysler Financial Corporation and Chrysler Credit Corporation, with respect to CARCO DEALRs Wholesale Trust 1990-A. Filed as Exhibit 10-JJJ to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1990, and incorporated herein by reference.\n10-OO Copy of Pooling and Servicing Agreement, dated as of October 1, 1990, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and The Fuji Bank and Trust Company, as Trustee, related to Money Market Auto Loan Trust 1990-1. Filed as Exhibit 4-A to the Registration of Certain Classes of Securities Report of Money Market Auto Loan Trust 1990-1 on Form 8-A, and incorporated herein by reference.\n10-PP Copy of Amendment No. 1 to the Pooling and Servicing Agreement, dated as of June 29, 1992, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and The Fuji Bank and Trust Company, as Trustee, with respect to Money Market Auto Loan Trust 1990-1. Filed as Exhibit 4-B to the Quarterly Report of Money Market Auto Loan Trust 1990-1 on Form 10-Q for the quarter ended June 30, 1992, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-QQ Copy of Pooling and Servicing Agreement, dated as of May 1, 1991, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and The Fuji Bank and Trust Company, as Trustee, with respect to Select Auto Receivables Trust 1991-1. Filed as Exhibit 4-A to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-1 for the quarter ended September 30, 1991, and incorporated herein by reference.\n10-RR Copy of Standard Terms and Conditions of Agreement, dated as of May 1, 1991, between Chrysler Auto Receivables Company, as Seller, and Chrysler Credit Corporation, as Servicer, with respect to Select Auto Receivables Trust 1991-1. Filed as Exhibit 4-B to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-1 for the quarter ended September 30, 1991, and incorporated herein by reference.\n10-SS Copy of Purchase Agreement, dated as of May 1, 1991, between Chrysler Financial Corporation and Chrysler Auto Receivables Company with respect to Select Auto Receivables Trust 1991-1. Filed as Exhibit 4-C to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-1 for the quarter ended September 30, 1991, and incorporated herein by reference.\n10-TT Copy of Pooling and Servicing Agreement, dated as of May 31, 1991, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and Manufacturers and Traders Trust Company, as Trustee, with respect to CARCO Auto Loan Master Trust. Filed as Exhibit 2 to the CARCO Auto Loan Master Trust Registration Statement on Form 8-A, and incorporated herein by reference.\n10-UU Copy of Pooling and Servicing Agreement, dated as of July 1, 1991, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and The Fuji Bank and Trust Company, as Trustee, with respect to Select Auto Receivables Trust 1991-2. Filed as Exhibit 4-A to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-2 for the quarter ended September 30, 1991, and incorporated herein by reference.\n10-VV Copy of Standard Terms and Conditions of Agreement, dated as of July 1, 1991, between Chrysler Auto Receivables Company, as Seller, and Chrysler Credit Corporation, as Servicer, with respect to Select Auto Receivables Trust 1991-2. Filed as Exhibit 4-B to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-2 for the quarter ended September 30, 1991 and incorporated herein by reference.\n10-WW Copy of Purchase Agreement, dated as of July 1, 1991, between Chrysler Financial Corporation and Chrysler Auto Receivables Company with respect to Select Auto Receivables Trust 1991-2. Filed as Exhibit 4-C to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-2 for the quarter ended September 30, 1991, and incorporated herein by reference.\n10-XX Copy of Pooling and Servicing Agreement, dated as of September 1, 1991, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and The Fuji Bank and Trust Company, as Trustee, with respect to Select Auto Receivables Trust 1991-3. Filed as Exhibit 4-A to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-2 for the quarter ended September 30, 1991, and incorporated herein by reference.\n10-YY Copy of Standard Terms and Conditions of Agreement, dated as of September 1, 1991, between Chrysler Auto Receivables Company, as Seller, and Chrysler Credit Corporation, as Servicer, with respect to Select Auto Receivables Trust 1991-3. Filed as Exhibit 4-B to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-3 for the quarter ended September 30, 1991, and incorporated herein by reference.\n10-ZZ Copy of Purchase Agreement, dated as of September 1, 1991, between Chrysler Financial Corporation and Chrysler Auto Receivables Company with respect to Select Auto Receivables Trust 1991-3. Filed as Exhibit 4-C to the Quarterly Report on Form 10-Q of Select Auto Receivables Trust 1991-3 for the quarter ended September 30, 1991, and incorporated herein by reference.\n10-AAA Copy of Pooling and Servicing Agreement, dated as of November 1, 1991, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and The Fuji Bank and Trust Company, as Trustee, with respect to Select Auto Receivables Trust 1991-5. Filed as Exhibit 4-A to the Annual Report on Form 10-K of Select Auto Receivables Trust 1991-5 for the year ended December 31, 1991, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-BBB Copy of Standard Terms and Conditions of Agreement, dated as of November 1, 1991, between Chrysler Auto Receivables Company, as Seller, and Chrysler Credit Corporation, as Servicer, with respect to Select Auto Receivables Trust 1991-5. Filed as Exhibit 4-B to the Annual Report on Form 10-K of Select Auto Receivables Trust 1991-5 for the year ended December 31, 1991, and incorporated herein by reference.\n10-CCC Copy of Purchase Agreement, dated as of November 1, 1991, between Chrysler Financial Corporation and Chrysler Auto Receivables Company with respect to Select Auto Receivables Trust 1991-5. Filed as Exhibit 4-C to the Annual Report on Form 10-K of Select Auto Receivables Trust 1991-5 for the year ended December 31, 1991, and incorporated herein by reference.\n10-DDD Copy of Pooling and Servicing Agreement, dated as of December 1, 1991, among U.S. Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and LaSalle National Bank, as Trustee, with respect to CFC-15 Grantor Trust. Filed as Exhibit 10-PPPP to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference.\n10-EEE Copy of Pooling and Servicing Agreement, dated as of January 1, 1992, among Chrysler Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and LaSalle National Bank, as Trustee, with respect to CFC-16 Grantor Trust. Filed as Exhibit 10-QQQQ to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference.\n10-FFF Copy of Standard Terms and Conditions of Agreement, dated as of January 1, 1992, between Chrysler Auto Receivables Company, as Seller, and Chrysler Credit Corporation, as Servicer, with respect to CFC-16 Grantor Trust. Filed as Exhibit 10-RRRR to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference.\n10-GGG Copy of Purchase Agreement, dated as of January 1, 1992 between Chrysler Financial Corporation and Chrysler Auto Receivables Company with respect to CFC-16 Grantor Trust. Filed as Exhibit 10-SSSS to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1991, and incorporated herein by reference.\n10-HHH Copy of Sale and Servicing Agreement, dated as of January 1, 1992, among Premier Auto Trust 1992-1, as Issuer, U.S. Auto Receivables Company, as Seller, and Chrysler Credit Corporation, as Servicer, with respect to Premier Auto Trust 1992-1. Filed as Exhibit 10-QQQQ to the Registration Statement of Chrysler Financial Corporation, on Form S-2 (Registration Statement No. 33-51302) on November 24, 1992, and incorporated herein by reference.\n10-III Copy of Trust Agreement, dated as of January 1, 1992, between U.S. Auto Receivables Company and Chemical Bank Delaware, as Owner Trustee, with respect to Premier Auto Trust 1992-1. Filed as Exhibit 10-RRRR to the Registration Statement of Chrysler Financial Corporation on Form S-2 (Registration Statement No. 33-51302) on November 24, 1992, and incorporated herein by reference.\n10-JJJ Copy of Purchase Agreement, dated as of January 1, 1992, between Chrysler Financial Corporation, as Seller, and U.S. Auto Receivables Company, as Purchaser, with respect to Premier Auto Trust 1992-1. Filed as Exhibit 10-SSSS to the Registration Statement of Chrysler Financial Corporation on Form S-2 (Registration Statement No. 33-51302) on November 24, 1992, and incorporated herein by reference.\n10-KKK Copy of Pooling and Servicing Agreement, dated as of January 1, 1992, among Chrysler Financial Corporation, as Master Servicer, Chrysler First Business Credit Corporation, as Seller, and Security Pacific National Bank, as Trustee, with respect to U.S. Business Equity Loan Trust 1992-1. Filed as Exhibit 4-A to the Quarterly Report on Form 10-Q of U.S. Business Equity Loan Trust 1992-1 for the quarter ended March 31, 1992, and incorporated herein by reference.\n10-LLL Copy of First Amendment, dated as of November 8, 1991, to the Series 1991-3 Supplement, dated as of June 30, 1991, among Chrysler Credit Corporation, as Servicer, U.S. Auto Receivables Company, as Seller, and Manufacturers and Traders Trust Company, as Trustee, with respect to CARCO Auto Loan Master Trust. Filed as Exhibit 4-H to the Quarterly Report on Form 10-Q of CARCO Auto Loan Master Trust for the quarter ended March 31, 1992, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-MMM Copy of Indenture, dated as of March 1, 1992, between Premier Auto Trust 1992-2 and Bankers Trust Company, with respect to Premier Auto Trust 1992-2 Asset Backed Notes. Filed as Exhibit 4-A to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-2 for the quarter ended March 31, 1992, and incorporated herein by reference.\n10-NNN Copy of a 6-3\/8% Asset Backed Note with respect to Premier Auto Trust 1992-2 Asset Backed Notes. Filed as Exhibit 4-B to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-2 for the quarter ended March 31, 1992, and incorporated herein by reference.\n10-OOO Copy of Trust Agreement, dated as of March 1, 1992, between U.S. Auto Receivables Company and Manufacturers Hanover Bank (Delaware) with respect to Premier Auto Trust 1992-2 Asset Backed Certificates. Filed as Exhibit 4-C to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-2 for the quarter ended March 31, 1992, and incorporated herein by reference.\n10-PPP Copy of Indenture, dated as of May 1, 1992, between Premier Auto Trust 1992-3 and Bankers Trust Company with respect to Premier Auto Trust 1992-3. Filed as Exhibit 4-A to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-3 for the quarter ended June 30, 1992, and incorporated herein by reference.\n10-QQQ Copy of a 5.90% Asset Backed Note with respect to Premier Auto Trust 1992-3. Filed as Exhibit 4-B to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-3 for the quarter ended June 30, 1992, and incorporated herein by reference.\n10-RRR Copy of Trust Agreement, dated as of April 1, 1992, as amended and restated as of May 1, 1992, between Premier Auto Receivables Company and Manufacturers Hanover Bank (Delaware) with respect to Premier Auto Trust 1992-3. Filed as Exhibit 4-C to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-3 for the quarter ended June 30, 1992, and incorporated herein by reference.\n10-SSS Copy of Receivables Purchase Agreement, dated as of April 15, 1992, between Chrysler Credit Canada Ltd., Chrysler Financial Corporation and Associated Assets Acquisition Inc. with respect to Canadian Auto Receivables Securitization 1992-1. Filed as Exhibit 10-IIIII to the Registration Statement on Form S-2 of Chrysler Financial Corporation (Registration Statement No. 33- 51302) on November 24, 1992, and incorporated herein by reference.\n10-TTT Copy of Indenture, dated as of July 1, 1992, between Premier Auto Trust 1992-4 and Bankers Trust Company with respect to Premier Auto Trust 1992-4. Filed as Exhibit 4-A to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-4 for the quarter ended September 30, 1992, and incorporated herein by reference.\n10-UUU Copy of 5.05% Asset Backed Note with respect to Premier Auto Trust 1992-4. Filed as Exhibit 4-B to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-4 for the quarter ended September 30, 1992, and incorporated herein by reference.\n10-VVV Copy of Trust Agreement, dated as of July 1, 1992, between Premier Auto Receivables Company and Chemical Bank Delaware, with respect to Premier Auto Trust 1992-4. Filed as Exhibit 4- C to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-4 for the quarter ended September 30, 1992, and incorporated herein by reference.\n10-WWW Copy of Receivables Purchase Agreement, dated as of August 18, 1992, between Chrysler Credit Ltd., Chrysler Financial Corporation and Associated Assets Acquisition Inc. with respect to Canadian Auto Receivables Securitization 1992-2. Filed as Exhibit 10-OOOOO to the Registration Statement on Form S-2 of Chrysler Financial Corporation (Registration Statement No. 33- 51302) on November 24, 1992, and incorporated herein by reference.\n10-XXX Copy of Indenture, dated as of September 1, 1992, between Premier Auto Trust 1992-5 and Bankers Trust Company with respect to Premier Auto Trust 1992-5. Filed as Exhibit 4-A to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-5 for the quarter ended September 30, 1992, and incorporated herein by reference.\n10-YYY Copy of a 4.55% Asset Backed Note with respect to Premier Auto Trust 1992-5. Filed as Exhibit 4-B to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-5 for the quarter ended September 30, 1992, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-ZZZ Copy of Trust Agreement, dated as of September 1, 1992, between Premier Auto Receivables Company and Manufacturers Hanover Bank (Delaware) with respect to Premier Auto Trust 1992-5. Filed as Exhibit 4-C to the Quarterly Report on Form 10-Q of Premier Auto Trust 1992-5 for the quarter ended September 30, 1992, and incorporated herein by reference.\n10-AAAA Copy of Series 1992-2 Supplement to the Pooling and Servicing Agreement, dated as of October 1, 1992, among U.S. Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and Manufacturers and Traders Trust Company, as Trustee, with respect to CARCO Auto Loan Master Trust, Series 1992-2. Filed as Exhibit 3 to Form 8-A of CARCO Auto Loan Master Trust on October 30, 1992, and incorporated herein by reference.\n10-BBBB Copy of Master Custodial and Servicing Agreement, dated as of September 1, 1992 between Chrysler Credit Canada Ltd. and The Royal Trust Company, as Custodian. Filed as Exhibit 10-TTTTT to the Registration Statement on Form S-2 of Chrysler Financial Corporation (Registration Statement No. 33-51302) on November 24, 1992, and incorporated herein by reference.\n10-CCCC Copy of Trust Indenture, dated as of September 1, 1992, among Canadian Dealer Receivables Corporation and Montreal Trust Company of Canada, as Trustee. Filed as Exhibit 10-UUUUU to the Registration Statement on Form S-2 of Chrysler Financial Corporation (Registration Statement No. 33-51302) on November 24, 1992, and incorporated herein by reference.\n10-DDDD Copy of Servicing Agreement, dated as of October 20, 1992, between Chrysler Leaserve, Inc. (a subsidiary of General Electric Capital Auto Lease, Inc.) and Chrysler Credit Corporation, with respect to the sale of Gold Key Leases. Filed as Exhibit 10-YYYYY to the Registration Statement on Form S-2 of Chrysler Financial Corporation (Registration Statement No. 33-51302) on November 24, 1992, and incorporated herein by reference.\n10-EEEE Copy of First Amendment dated as of August 24, 1992 to the Series 1991-1 Supplement dated as of May 31, 1991, among U.S. Auto Receivables Company (\"USA\"), as seller (the \"Seller\"), Chrysler Credit Corporation, as servicer (the \"Servicer\") and Manufacturers and Traders Trust Company, as trustee (the \"Trustee\"), to the Pooling and Servicing Agreement dated as of May 31, 1991, as assigned by Chrysler Auto Receivables Company to USA on August 8, 1991, as amended by the First Amendment dated as of August 6, 1992, among the Seller, the Servicer and the Trustee, with respect to CARCO Auto Loan Master Trust. Filed as Exhibit 4-M to the Quarterly Report on Form 10-Q of CARCO Auto Loan Master Trust for the quarter ended September 30, 1992, and incorporated herein by reference.\n10-FFFF Copy of Second Amendment dated as of August 24, 1992 to the Series 1991-3 Supplement dated as of June 30, 1991, among U.S. Auto Receivables Company (\"USA\"), as seller (the \"Seller\"), Chrysler Credit Corporation, as servicer (the \"Servicer\") and Manufacturers and Traders Trust Company, as trustee (the \"Trustee\"), to the Pooling and Servicing Agreement dated as of May 31, 1991, as assigned by Chrysler Auto Receivables Company to USA on August 8, 1991, as amended by the First Amendment dated as of August 6, 1992, among the Seller, the Servicer and the Trustee, with respect to CARCO Auto Loan Master Trust. Filed as Exhibit 4-O to the Quarterly Report on Form 10-Q of CARCO Auto Loan Master Trust for the quarter ended September 30, 1992, and incorporated herein by reference.\n10-GGGG Copy of Sale and Servicing Agreement, dated as of November 1, 1992, among Premier Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and Premier Auto Trust 1992-6, as Purchaser, with respect to Premier Auto Trust 1992-6. Filed as Exhibit 10-PPPPPP to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10-HHHH Copy of Trust Agreement, dated as of November 1, 1992, among ML Asset Backed Corporation, Premier Auto Receivables Company and Chemical Bank Delaware as Owner Trustee, with respect to Premier Auto Trust 1992-6. Filed as Exhibit 10-QQQQQQ to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10-IIII Copy of Sale and Servicing Agreement, dated as of January 1, 1993, among Premier Auto Receivables Company, as Seller, Chrysler Credit Corporation, as Servicer, and Premier Auto Trust 1993-1, as Purchaser, with respect to Premier Auto Trust 1993-1. Filed as Exhibit 10-RRRRRR to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\n10-JJJJ Copy of Trust Agreement, dated as of January 1, 1993, among ML Asset Backed Corporation, Premier Auto Receivables Company and Chemical Bank Delaware, as Owner Trustee, with respect to Premier Auto Trust 1993-1. Filed as Exhibit 10-SSSSSS to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10-KKKK Copy of Receivables Purchase Agreement, dated as of November 25, 1992, between Chrysler Credit Canada Ltd., Chrysler Financial Corporation and Associated Assets Acquisitions Inc. with respect to Canadian Auto Receivables Securitization 1992- 3. Filed as Exhibit 10-TTTTTT to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10-LLLL Copy of Purchase Agreement, dated as of January 25, 1993, among Chrysler Credit Canada Ltd., Auto 1 Limited Partnership and Chrysler Financial Corporation, with respect to Auto 1 Trust. Filed as Exhibit 10-UUUUUU to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10-MMMM Copy of Master Lease Agreement, dated as of January 25, 1993, among Chrysler Credit Canada Ltd., Chrysler Canada Ltd. and Auto 1 Limited Partnership, with respect to Auto 1 Trust. Filed as Exhibit 10-VVVVVV to the Annual Report of Chrysler Financial Corporation on Form 10-K for the year ended December 31, 1992, and incorporated herein by reference.\n10-NNNN Copy of Amended and Restated Trust Agreement, dated as of August 1, 1993, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank Delaware, as Owner Trustee, with respect to Premier Auto Trust 1993-4. Filed as Exhibit 4.1 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1993-4 for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-OOOO Copy of Indenture, dated as of August 1, 1993, between Premier Auto Trust 1993-4 and Bankers Trust Company, as Indenture Trustee, with respect to Premier Auto Trust 1993-4. Filed as Exhibit 4.2 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1993-4 for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-PPPP Copy of Lease Receivables Purchase Agreement, dated as of December 23, 1992, among Chrysler Systems Leasing Inc., Chrysler Financial Corporation and Sanwa Business Credit Corporation. Filed as Exhibit 10-TTTT to the Quarterly Report on Form 10-Q of Chrysler Financial Corporation for the quarter ended September 30, 1993, and incorporated herein by reference.\n10-QQQQ Copy of Amended and Restated Trust Agreement, dated as of August 1, 1994, among Premier Auto Receivables Company, Chrysler Financial Corporation and Chemical Bank Delaware, as Owner Trustee, with respect to Premier Auto Trust 1994-4. Filed as Exhibit 4.1 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1994-4 for the quarter ended September 30, 1994, and incorporated herein by reference.\n10-RRRR Copy of Indenture, dated as of August 1, 1994, between Premier Auto Trust 1994-4 and Bankers Trust Company, as Indenture Trustee. Filed as Exhibit 4.2 to the Quarterly Report on Form 10-Q of Premier Auto Trust 1994-4 for the quarter ended September 30, 1994, and incorporated herein by reference.\n*11 Statement regarding computation of earnings per common share.\n*12 Statement regarding computation of ratios of earnings to fixed charges and preferred stock dividends.\n*21 Subsidiaries of the Registrant. *23 Consent of Deloitte & Touche LLP, independent auditors for Chrysler Corporation.\n*24 Powers of Attorney executed by officers and directors who signed this Annual Report on Form 10-K by an attorney-in-fact.\n*27 Financial Data Schedule for year ended December 31, 1994.\n- -------------------- *Filed herewith\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, Part IV - Continued AND REPORTS ON FORM 8-K - CONTINUED\nIn lieu of filing certain instruments with respect to the long-term debt of the type described in Item 601 (b)(4) of Regulation S-K with respect to the long-term debt of Chrysler Corporation and its consolidated subsidiaries, Chrysler Corporation agrees to furnish a copy of such instruments to the Securities and Exchange Commission on request.\n(b) Reports on Form 8-K:\nA report on Form 8-K, dated December 1, 1994, was filed during the quarter ended December 31, 1994, reporting the amendment of the Amended and Restated Rights Agreement, dated as of December 14, 1990 under Item 5 of such Form 8-K.\nCONFORMED\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.\nCHRYSLER CORPORATION\nBy R. J. Eaton ---------------------------- R. J. EATON Chairman of the Board and Chief Executive Officer February 2, 1995\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.\nPrincipal executive officers:\nCONFORMED\nSIGNATURES\n* By R. D. Houtman ------------------------------- R. D. HOUTMAN Attorney-in-Fact February 2, 1995","section_15":""}
{"filename":"277821_1994.txt","cik":"277821","year":"1994","section_1":"ITEM 1. BUSINESS.\nNational Education Corporation (the \"Company\") provides training and educational services and products to individuals, businesses and governments. The Company was originally incorporated in California in 1954 and reincorporated in Delaware in 1972. The Company's business is conducted primarily through three operating entities: ICS Learning Systems, Inc. (\"ICS\"), which offers distance education opportunities; Steck-Vaughn Publishing Corporation (\"Steck-Vaughn\"), one of the largest publishers of supplemental educational materials; and National Education Training Group, Inc. (\"NETG\"), one of the largest providers of multimedia products to educate and train corporate and government employees, with specific emphasis on information systems training. Historically, the Company also has conducted business through a fourth operating entity, National Education Centers, Inc. (\"Education Centers\"); however, in 1994 those operations were reclassified as discontinued operations as the Company has pursued a strategy to sell off or otherwise dispose of Education Centers' operations. See \"Discontinued Operations: Education Centers\" below in this Item 1.\nCOMPANY RESULTS AND DEVELOPMENTS IN 1994\nThe following provides a brief discussion of the Company's significant developments in 1994. A more detailed discussion of each of the Company's primary operating entities appears later in this Item 1; a more detailed description of the Company's results of operations appears in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" starting on page 17 below.\nYear End 1994. For 1994, the Company reported revenues of $241.6 million, which were 7.8% higher than revenues of $224.2 million in 1993. Increased revenues from continuing operations at ICS, Steck-Vaughn and National Education International, Inc. (which provides training services to foreign governments, primarily in the Middle East) were offset, in part, by reduced revenues at NETG. For 1994, the Company recorded a net loss from continuing operations of $14.5 million, compared to net income from continuing operations of $10.1 million in 1993. The $24.6 million decline in income from continuing operations was due to the adoption in 1994 by the Company of Statement of Position 93-7 (discussed in the next paragraph), and a one-time gain in 1993 of $21.3 million on the initial public offering of Steck-Vaughn shares, partially offset by an unusual charge in 1993 of $9.2 million recorded at NETG for the write-down of certain acquired intangible assets. For 1994, the Company recorded a net loss of $63.9 million, as compared to a net loss of $9.6 million in 1993. The increased net loss for 1994 over 1993 primarily related to a 1994 loss from discontinued operations of $9.4 million and a second quarter 1994 charge of $40.0 million to write-down Education Centers' assets, provide for estimated gains\/losses on the sale of certain Education Centers' schools, and to provide for the estimated costs of closing and teaching-out certain Education Centers' schools. In addition, the net loss in 1993 included a $23.6 million unusual restructuring charge for the write-down of certain assets and estimated costs of closing fourteen Education Centers' schools announced in the third quarter of 1993.\nIn December 1993, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position No. 93-7, \"Reporting on Advertising Costs\" (the \"SOP\"). The SOP generally requires advertising costs, other than direct response advertising, to be expensed as incurred. The SOP is effective for financial statements for fiscal years beginning after December 15, 1994, but may be adopted early. In the fourth quarter of 1994, the Company adopted the SOP, effective January 1, 1994. Adoption of the SOP caused the Company to expense all of ICS' advertising, selling and promotion costs (\"ICS Marketing Costs\") as they were incurred in 1994, rather than deferring and amortizing the ICS Marketing Costs as in prior periods. In addition, SOP transition rules required amortization during 1994 of $19.8 million worth ICS Marketing Costs that had been deferred from periods prior to December 31, 1993; accordingly, 1994 quarterly results for the Company have been restated in Note 16 to the Company's Consolidated Financial Statements to reflect adoption of the SOP (see page below). For more information on adoption by ICS of the SOP, please see Item 7, \"Management's Discussion and Analysis\nof Financial Condition and Results of Operations,\" beginning on page 17 below, and Note 1 to the Company's Consolidated Financial Statements, beginning on page below.\nICS Learning Systems, Inc. In 1994, ICS achieved a 21.2% increase in revenues, from $101.3 million in 1993 to $122.8 million in 1994. These results were directly related to a 61,106, or 19.6%, increase in enrollments world-wide, which arose, in part, from an expanded telesales operation that improved the conversion of prospective students into enrollments, new product introductions, the acquisition of MicroMash (discussed below), and a 17.0% growth in revenues from ICS' Business and Industrial Training Division. However, ICS experienced an operating loss in 1994 of $3.9 million, as compared to operating income of $21.4 million in 1993. The 1994 operating loss at ICS resulted solely from the change in accounting of ICS Marketing Costs required by the SOP.\nIn 1994, ICS' computer and related training continued as its fastest growing product line and has achieved compound annual growth since 1988 of 39% in revenue and 27% in enrollments. Also during 1994, ICS introduced the following new courses: Master Computer Programming, PC Specialist with Multi-Media, Appliance Repair, Professional Locksmithing, Medical Office Assistant, Professional Secretary with Computer, and Total Health, Body and Mind, a comprehensive multimedia fitness and health course on CD-ROM.\nEffective January 1, 1994, ICS acquired M-Mash, Inc. (commonly known as \"MicroMash\"), a leader in computer based training (CBT) for the accounting industry. MicroMash sells a wide variety of exam preparation and continuing professional education (\"CPE\") products for the entire accounting and tax professional industry. MicroMash sells primarily through direct response marketing, but also markets and sells to major corporate and government bodies.\nBased on statistics compiled by the Distance Education and Training Council (\"DETC\"), the accrediting body for independent study schools recognized by the United States Department of Education, ICS continues as the industry leader in generating new enrollments. During 1994, more than 48,000 students enrolled in ICS' high school diploma program and more than 35,000 students enrolled in ICS' eleven two-year associate degree programs in business and technology. An additional 289,000 students worldwide pursued courses in other ICS career and hobby-related areas.\nSteck-Vaughn Publishing Corporation. Historically, Steck-Vaughn has experienced strong annual growth rates in revenues and operating income; however, in 1994, Steck-Vaughn recorded revenues that were flat compared to 1993. This change in historical growth rates was chiefly attributed to several factors. Adverse winter weather conditions, which affected the midwest, mid-Atlantic and northeast regions of the United States, hampered sales conditions in early 1994. In addition, Steck-Vaughn's sales force expansion and related reorganization in the beginning of 1994 required more time than anticipated to assimilate, reducing sales productivity. Moreover, a continuing trend towards site-based selling, which is driving the decision making process down to the faculty level and requires a greater number of sales calls per revenue dollar, resulted in an increase in selling costs. Finally, revenues were impacted by funding pressures on adult education centers. Operating income was negatively impacted by lower than planned revenues and increased costs from a reorganized sales force. In addition, Steck-Vaughn maintained its aggressive product development effort, producing and releasing more than 220 new products in 1994.\nIn November 1994, Steck-Vaughn acquired the assets, including the product lines, of Berrent Publications, Inc. (\"Berrent Publications\"), an educational materials publisher in New York. Berrent Publications' product lines, which had only been marketed regionally, consist primarily of test preparation and assessment materials and complement Steck-Vaughn's offerings to this market. Steck-Vaughn will market these products through its existing sales organization, with the Steck-Vaughn\/Berrent Publications Division continuing to develop new product offerings.\nDue to the rapidly expanding number of products offered, and to address the trend toward site-based purchasing in the instructional materials marketplace, Steck-Vaughn reorganized and expanded its sales force effective January 2, 1994. During 1993, each salesperson was responsible for the whole product range, which included elementary, high school, library and adult education markets. Beginning in 1994, the sales force was segmented into two groups. One group focused on the elementary, junior high school and library markets, while the other group\nfocused on the high school and adult education markets. This reorganization allows the two groups to focus their expertise, time and energy in a more productive way.\nNational Education Training Group, Inc. NETG experienced a large operating loss for 1994; however, NETG was able to show substantial improvement from its operating loss in 1993 based, in part, on reductions in product development costs, general and administrative expenses and amortization of acquired intangible assets. NETG's operating loss of $14.0 million for 1994 compared favorably with an operating loss before unusual items of $26.0 million for 1993, which, along with an unusual charge of $9.2 million in 1993 to write-down certain acquired intangible assets, resulted in a total segment loss of $35.2 million for 1993. Revenues of $61.9 million in 1994 decreased 9.3% compared to 1993 revenues of $68.3 million, based in part from a lower volume of contract backlog at the beginning of 1994 as compared to the beginning of 1993, and from a small reduction in the volume of new orders at NETG's domestic operations in 1994. New orders increased in the international operation due to increased new business activity in the United Kingdom operation; however, decreasing contract backlog, which more than offset the new orders business, and the sale of NETG-Canada in 1993 resulted in reduced revenues in the international operation.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nRevenues and operating income (loss) by industry segment for the Company's continuing operations for the past three years are as follows (for more detailed information, please see Note 15 to Consolidated Financial Statements, beginning on page below):\nDESCRIPTION OF BUSINESS BY INDUSTRY SEGMENTS\nICS LEARNING SYSTEMS, INC.\nICS Learning Systems, Inc. provides training and education to consumers and companies under the following names: ICS Learning Systems, English Language Institute, International Correspondence Schools, North American Correspondence Schools, and the ICS Center for Degree Studies (collectively referred to as \"ICS\"). ICS offers more than 50 independent study courses in the United States and more than 100 courses abroad in disciplines ranging from high school completion requirements through occupational training. In addition, ICS offers associate technology degree programs in business and engineering. All of ICS' independent study courses in the United States are accredited by the Distance Education and Training Council (\"DETC\"), the accrediting body for independent study schools recognized by the United States Department of Education. ICS also offers over 1,200 training products and 10,000 hours of training to industrial clients under the name \"ICS Business and Industrial Training.\"\nIn addition, with the acquisition of MicroMash in 1994, ICS established a presence in the large and diverse field of professional and continuing education. MicroMash offers over 70 professional exam and continuing professional education products to the financial and accounting industries.\nCurricula and Product Development. Curricula are carefully designed to reflect the most important trends in employment opportunities, consumer interest, professional development and industrial training needs. New courses introduced during 1994 include Master Computer Programming, PC Specialist with Multi-Media, Professional Secretary with Computer, Appliance Repair, Professional Locksmithing, Medical Assistant, and a CD-ROM based product on health and fitness. In 1994, ICS continued its project to convert all existing print-based products to an electronic format. With the installation of a digital data network to facilitate on-line editing, filing and retrieval, and transfer of products, and the purchase of sophisticated digital product development and revision software, ICS now has the complete capability to produce and update a wide range of multimedia and on-line digitally based products. This format also facilitates the transfer of documents directly to high technology printers in digital format, which eventually will allow ICS to reduce inventory requirements and virtually eliminate any material obsolescence, and will position ICS to move further into the electronic delivery markets.\nTraditionally, ICS distance education courses have been structured around \"graded lessons\" in which the student receives one section of instructional material at a time, which must be completed before proceeding to the next section. Courses are designed to be completed by the typical student in periods ranging from 6 to 24 months, depending on the course selected. A computerized student information\/testing system permits students, through touch-tone telephones or voice response, to obtain immediate testing and feedback on test results. Over 95% of the 2.0 million exams graded by ICS during 1994 were graded electronically by either the information\/testing system via telephone or by electronic scanner. With improved technology, the cost of grading an exam is at an all-time low while the speed of correcting an exam and turnaround to the student have never been faster. ICS utilizes a voice-activated computer record access system that allows students to obtain key information from their records, 24 hours a day, without operator assistance.\nTuition for ICS' distance education courses ranges from approximately $400 to $2,500, which, in many cases, includes auxiliary equipment for the courses, such as personal computers for certain PC courses. Students generally pay a portion of the tuition upon enrollment and the balance on a monthly basis. While many ICS students complete their entire distance education course, ICS estimates that, on average, students complete in the range of approximately 40% to 65% of lessons, depending on the course. ICS' accounting treatment recognizes independent study contract revenues when cash is received, but only to the extent that such cash can be retained under existing refund policies of the DETC or applicable law. ICS is not dependent on students' entitlement to financial aid from the federal government.\nICS has established telesales departments in its U.S. and major foreign operations, by which in-bound telephone inquires are answered by its in-house telesales staff. These telesales professionals seek to enroll students over the telephone without needing to send the customer ICS' traditional sales literature. During the past two years, new telesales departments have been established in Canada, Australia and the U.S., adding to the existing telesales operations in the United Kingdom. The telesales operations improved the number of prospective students converted into enrollments and, accordingly, contributed to the 19.6% increase in enrollments at ICS from 1993 to 1994.\nDuring 1994, ICS produced its first two products on CD-ROM technology. \"Total Health, Body and Mind\" was launched in July and is sold in retail software stores and through software catalogs. ICS has an agreement for marketing this and other software based products with one of the leading software marketing and distribution firms. The second CD-ROM product is part of the \"PC Specialist with Multi-Media\" course and provides students with a wide exposure to multimedia development techniques. ICS has several additional CD-ROM products in development.\nIn addition, ICS is reformulating several of its existing products for digital on-line delivery via \"ICS On-Line,\" an electronic campus established by ICS in 1993 on the fastest growing on-line service in the United States, America Online (\"AOL\"). ICS was one of the first distance education providers to establish this service and currently offers the following online services through links between personal computers: ICS Library, ICS Bookstore, Electronic Bulletin Board, On-Line Classroom and On-Line Enrollment. ICS students access ICS On-Line by subscribing to AOL; accordingly, ICS students who use ICS On-Line have access to the hundreds of features available on the AOL service.\nIn 1994, ICS' Business and Industrial Training Division expanded its marketing efforts by equipping its sales force with PC technology and training. ICS also converted the Division's catalog of 1,200 products to a computer data base, giving each sales representative the ability to create quickly custom curricula for their clients. The Division has established a telesales operation to generate new customer leads and to sell products over the phone. In addition, in 1994, the Division dramatically increased the revenue it generates from corporate \"Tuition Assistance Programs\" (\"TAP\") through development of new marketing materials and expansion of the sales force committed to the TAP market.\nShortly after acquiring MicroMash, ICS began to invest in expanding the MicroMash product line. During 1994, MicroMash acquired rights to select video training products to complement its computer based training (CBT) product line. In December, MicroMash began its expansion into other professional training markets through the acquisition of an established \"Bar Review\" course used by prospective lawyers to prepare for state bar exams.\nAlso during 1994, MicroMash produced Windows-based enhancements to its products and completed development of a series of multimedia training products with \"Video Clips,\" a series of situational videos on its CD-ROM training products to enhance the situational learning of the professional.\nAdvertising and Marketing. ICS markets its independent study courses throughout its United States and international operations utilizing direct response advertising through print, television media and direct mail marketing. ICS also offers courses in many English speaking countries throughout the world; in 1994, ICS enrolled students from more than 150 different countries. Telemarketing also is used in the United States, Canada, the United Kingdom, and Australia. ICS has over 200 telesales representatives who speak directly to the customers about enrolling in courses.\nCompetition. The distance education and training industry is highly competitive. ICS faces direct competition from United States and foreign independent study providers and indirect competition from community colleges, vocational and technical schools, two-year colleges and universities, and, to a lesser extent, governmental entities and other \"distance learning\" companies and schools, including electronic universities. In recent years, technological changes have increased the variety of choices available to students in selecting the type of education\nand the manner in which it is delivered, thereby increasing the entities with which ICS competes for student enrollments. ICS believes that the principal competitive factors in its industry are breadth and quality of course offerings, price and quality of customer services. Overall, the Company believes that ICS competes favorably on the basis of these factors.\nSTECK-VAUGHN PUBLISHING CORPORATION\nSteck-Vaughn is one of the country's largest publishers of supplemental educational materials, offering educators a broad range of quality products that address educational needs from early childhood through adulthood. The term \"supplemental materials\" generally refers to softcover, curriculum-based books, workbooks and other support materials that are used in conjunction with or instead of traditional hardcover \"basal\" textbooks. Steck-Vaughn also publishes reference and nonfiction products for school and public libraries, as well for purchase by the general public through bookstores.\nIn July 1993, Steck-Vaughn completed an initial public offering of 2,668,000 shares of its common stock at $12.00 per share, generating approximately $29,775,000 of net proceeds. This initial public offering represented approximately 18.3% of Steck-Vaughn's stock, the remainder of which is held by the Company. The net proceeds were reduced by expenses of $1,074,000 that were incurred in connection with the initial public offering. On April 1, 1993, Steck-Vaughn had declared a $19,999,000 dividend payable to the Company. The dividend and certain intercompany balances were later paid from proceeds from the offering. During 1994, Steck-Vaughn announced a program to repurchase from the public market up to 500,000 shares of its common stock; as of December 31, 1994, Steck-Vaughn had repurchased 230,200 shares, effectively raising the Company's ownership of Steck-Vaughn's common stock from 81.7% as of the public offering to 83.0% as of December 31, 1994.\nProduct Development. Steck-Vaughn continually evaluates, updates and adds to its product lines through internal development of new educational materials, performance of development contracts by outside authors, production of revised and supplementary materials based on existing products, and acquisitions of educational materials from authors and publishers. In 1994 alone, Steck-Vaughn produced and released more than 220 new products.\nRecent product development and acquisition achievements include the following:\n* In April 1993, Steck-Vaughn acquired THE MAGNETIC WAY(TM) product line from Creative Edge, Inc., which product line consists of magnetized boards with metallic coated visual overlays. These products are used by teachers and students to build hands-on displays paralleling curriculum topics for social studies, language arts, reading and science. In addition, Steck-Vaughn introduced a lower-priced, smaller set of similar products in the fall of 1993, as well as a number of new learning packages in Science and Social Studies in 1994, to extend the original THE MAGNETIC WAY(TM) product line.\n* In November 1994, Steck-Vaughn acquired from Berrent Publications its product lines of test preparation and assessment materials, which lines complement Steck-Vaughn's offerings to this market.\n* In December 1994, Steck-Vaughn became the exclusive distributor to schools and public libraries in the United States for the Larousse Kingfisher Chambers line of books, which line expands and complements Steck-Vaughn's library division line of products with additional reference, nonfiction and fiction titles.\nSales and Marketing. Steck-Vaughn markets all of its products through multiple distribution channels, including its national sales and telesales organization. Additionally, Steck-Vaughn markets and sells its products\nthrough a distributor organization that services public libraries, trade outlets, and other nontraditional school markets. Steck-Vaughn has begun to establish a presence in foreign markets where English language curriculum and library products are in demand. Steck-Vaughn's customer service group emphasizes prompt and accurate delivery of published materials.\nDuring 1994, the instructional materials marketplace continued its trend toward site-based selling, as more personnel at the school and faculty level participated in the buying decisions for educational materials. While site-based selling is a relative strength of Steck-Vaughn, site-based selling requires a greater number of sales calls per revenue dollar, resulting in increased selling costs.\nBased in part on the trend toward site-based selling, Steck-Vaughn expanded and realigned its sales force, effective January 2, 1994, into two groups. One group concentrates on the elementary and junior high schools and school libraries, and the other group focuses on the high school and adult education markets. Prior to this reorganization, Steck-Vaughn's sales force was a smaller group that focused on all Steck-Vaughn markets. The reorganized sales force can focus the expertise, time and energy of its members in a more productive way.\nCompetition. Many companies larger and smaller than Steck-Vaughn compete with Steck-Vaughn in the educational publishing field. No single company is dominant in the industry segments for which Steck-Vaughn publishes. Steck-Vaughn believes that the principal competitive factors in its industry are breadth and quality of product offerings, price, quality of support services and market responsiveness. Overall, the Company believes that Steck-Vaughn competes favorably on the basis of these factors, and that growth has occurred due to new products and increased sales and market penetration.\nNATIONAL EDUCATION TRAINING GROUP, INC.\nEstablished in the late 1960s, the Company's NETG subsidiary specializes in providing multimedia products to educate, train and transfer skills to corporate and government employees. Headquartered in Naperville, Illinois, NETG offers multimedia training solutions to help organizations worldwide maximize their performance and their investments in people and technology.\nMarkets and Products. NETG's line of over 600 training products addresses all audience levels, providing analytical perspective as well as practical skills and knowledge in information technology, desktop computing, and management and professional development.\nNETG provides multimedia training that combines data, text, audio, video, animation and graphics with computer technology as appropriate to meet the needs of its markets and customers. NETG courses have been offered on virtually every technology-based medium and are provided in the formats of mainframe computer-based training, video, diskette, CD-ROM and interactive video. The NETG course library is divided into three primary product lines: Information Technologies, Desktop Computing, and Management and Professional Development.\n1. Information Technologies Product Line. NETG's Information Technologies product line focuses on training information system professionals and users in new technologies. NETG currently offers and supports a large line of multimedia-based training curricula for Information Technologies, with courses in Client\/Server Concepts, Front End Development Languages and Tools, Back End Database Servers, Object- Oriented Development, GUI Design, UNIX, Networking and Enterprise Systems (IBM Mainframe).\n2. Desktop Computing Product Line. NETG's Desktop Computing product line focuses on training end users in business applications on personal computers and workstations. NETG uses current technologies, including CD-ROM and Local Area Networks (LANs), to create sophisticated training and work support systems. The product line includes training products covering many popular business application programs used in the workplace, including the following: Microsoft(R) Windows(TM), Microsoft(R) Word, Lotus(R) 1-2-3(R), Windows NT(TM),\nMicrosoft(R) Excel, Lotus Notes(R), DOS, Microsoft(R) PowerPoint(R), Lotus Ami Pro(TM), OS\/2(R), Microsoft(R) Access(R) and WordPerfect(R).\nIn addition, NETG has developed a set of skills-based courses known collectively as SKILL BUILDER(R) products. SKILL BUILDER(R) courses provide simulations of the actual software to be learned. The courses feature specific business case scenarios that allow participants to quickly learn relevant skills they can immediately apply to their jobs. Major SKILL BUILDER(R) titles include the following: Microsoft Windows 3.1, Microsoft Windows NT, OS\/2 2.0, Microsoft Mail 2.0 for Windows, Lotus Notes 3.0, Microsoft Windows for Workgroups 3.1, Microsoft Word 6.0 for Windows, Wordperfect 5.1 for Windows, Ami Pro 3.01, Lotus 1-2-3 4.0 for Windows, Microsoft Access, Microsoft Excel 5.0 for Windows and Microsoft PowerPoint 4.0.\n3. Management and Professional Development Product Line. NETG offers multimedia courses for improving personal, management and business skills that are essential for highly productive and professional employees. Topics include Reskilling Business, Total Quality Management, Fundamental Skills, Interpersonal Skills, Management Skills and Customer Service.\nCustomized Services. NETG-Spectrum in Bedford, Massachusetts, is the consulting and custom development division of NETG. For more than 15 years, Spectrum has provided a full range of services in the design and delivery of custom multimedia training and performance systems. Spectrum helps clients achieve their business goals by combining its expertise in education, multimedia, technology and project management to produce effective training tailored to clients' needs.\nIntegration with Instructor-Led Training. NETG also offers Instructor-Led Training (ILT) as part of a total integrated training delivery strategy. Although NETG's primary training delivery method is media-based, NETG can provide businesses with an integrated curriculum track to meet specific needs. NETG combines the benefits of both delivery methods to meet particular cost and time factors for its customers.\nCustomer Assistance. NETG's Customer Assistance, located in Naperville, Illinois, provides customers with 24-hour, seven day per week, toll-free order processing and technical assistance. Support analysts provide answers to software and hardware questions, and assistance in the installation and ongoing use of courseware products. All costs for technical assistance are included in the price of NETG's products. In addition, NETG has established a LAN-based call tracking and reporting system that allows support analysts to electronically track customer inquiries, problems and solutions for faster response time to customers.\nInternational Distribution, Service, Marketing and Sales. NETG and its sister subsidiaries in the United Kingdom, the Netherlands, Germany and Austria are all direct subsidiaries of NETG Holding, Inc., a direct subsidiary of the Company (\"NETG Holding\"). Together, the subsidiaries of NETG Holding form an international organization with 76 sales offices and more than 450 employees, and an international network of agents and distributors in 50 countries, including Argentina, Australia, Bahrain, Bolivia, Brazil, Canada, Denmark, Egypt, France, Hong Kong, India, Japan, Korea, Malaysia, New Zealand, Nigeria, Norway, Peru, Russia, Saudi Arabia, Singapore, South Africa, Sweden, Taiwan, Turkey, the United Arab Emirates, and Venezuela.\nNETG Sales Organization and Distribution Channels. NETG's revenues are generated primarily by its field sales force that focuses on large business and government organizations. Customers license NETG's products and services under agreements that, depending on the customer's needs, provide access to all or part of NETG's product lines on a limited or unlimited basis. During the third quarter of 1994, NETG introduced in the United States a new product licensing agreement, known as the \"Multimedia Licensing Agreement\" (or \"MLA\"). The MLA provides NETG customers additional flexibility in licensing specific products from NETG, and has allowed NETG to use additional distribution channels. Moreover, in 1994 NETG developed an inside sales organization in the United States to address the training needs of small and medium sized companies. The inside sales group\nconcentrates its efforts on licensing NETG products to clients via telephone. A telemarketing lead generation group also was created in 1994 to support the needs of both inside and field sales groups.\nCompetition. According to Training magazine's October 1994 Industry Report, the total training market in North America is in excess of $50 billion annually for industry and government. Eighty percent of that (more than $40 billion) is spent on overhead and internal training staff salaries. The remaining 20% ($9.9 billion) is divided into five outside expenditures categories of which 4% ($1.8 billion) is off-the-shelf materials, where NETG directly competes. NETG is one of the largest multimedia training companies in this very large, highly fragmented and competitive market.\nNETG competes in the training market on the factors of timeliness of new courses, instructional effectiveness, breadth of subject matter and delivery media, price and solution-oriented customer support. Overall, NETG believes that it is competitive on the basis of these factors. In 1995 and beyond, NETG anticipates stiffening competition from other suppliers of media-based training, which include major competitors CBT Systems, DPEC, SRA (a division of McGraw Hill, Inc.) and Comsell.\nFINANCIAL INFORMATION ON THE COMPANY'S FOREIGN OPERATIONS\nThe following table shows consolidated net revenues of the Company in foreign countries for 1994, 1993 and 1992 (for more detailed information, please see Note 15 to Consolidated Financial Statements beginning on page below). These revenues are derived principally from the foreign operations of ICS and NETG:\nConsolidated operating results are reported in United States dollars. Because the foreign subsidiaries of the Company conduct operations in the currencies of the countries in which they are based, all financial statements of the foreign subsidiaries must be translated into United States dollars. As the value of the United States dollar increases or decreases relative to these foreign currencies, the United States dollar value of items on the financial statements of the foreign subsidiaries is reduced or increased, respectively. Therefore, changes in dollar sales of the foreign subsidiaries from year to year are not necessarily indicative of changes in actual revenues recorded in local currency.\nThe Company's ability to continue operations outside of the Unites States or maintain the profitability of such operations is to some extent subject to control and regulation by the United States government and foreign governments. The Company's foreign operations are primarily located in the United Kingdom, Canada, Australia and Germany, which historically have controlled and regulated businesses in the same manner as the United States.\nDISCUSSION OF ADDITIONAL BUSINESS FACTORS\nRESEARCH AND DEVELOPMENT\nThe amount spent during 1994, 1993 and 1992 on Company-sponsored research and development activities was approximately $19 million, $24 million and $20 million, respectively. In 1994, the Company continued to invest in research and development to ensure new product availability for future revenue generation. The Company\nspends substantial sums primarily in the development of new products at NETG and Steck-Vaughn, and curricula for ICS.\nSEASONALITY OF THE BUSINESS\nSteck-Vaughn's sales are relatively higher in the third quarter of the year due to its customers purchasing products in anticipation of classes commencing in the fall. ICS' business is moderately seasonal with more students studying during the latter part of the year. NETG's business is seasonal due to the sales cycle from a disproportionate number of long-term, large contracts for NETG's products and services that are renewed in the fourth quarter of the year. There is no customer to whom sales are made in an amount that exceeds two percent or more of the Company's consolidated annual net revenues.\nADDITIONAL INFORMATION\nUnearned future tuition revenue for ICS, which represents amounts estimated to be recognized as revenue in subsequent years as services and courseware are provided, is described in Note 12 to Consolidated Financial Statements on page below.\nFinancial information about industry segments is described in Note 15 to Consolidated Financial Statements on page below.\nCompliance with federal, state or local provisions concerning the discharge of materials into the environment or otherwise relating to the protection of the environment had no material effect in 1994 on the Company's capital expenditures, earnings or competitive position.\nThe Company employed approximately 3,147 persons as of January 31, 1994, including 1,605 at the Company's Education Centers subsidiary that has been reclassified as discontinued operations. See \"Discontinued Operations: Education Centers\" below.\nDISCONTINUED OPERATIONS: EDUCATION CENTERS\nHistorically, in addition to ICS, Steck-Vaughn and NETG, the Company has conducted business through Education Centers; however, in 1994 those operations were reclassified as discontinued business operations, and the Company has pursued a strategy to sell off or otherwise dispose of Education Centers' operations.\nEducation Centers has been one of the largest operators of private postsecondary schools in the United States; however, in 1993, it became more difficult for students at a number of locations, especially in urban areas, to obtain access to federally guaranteed student loans. Certain provisions of the Higher Education Act of 1992, as well as the Omnibus Budget Reconciliation Act, caused some lenders to terminate participation in federally guaranteed student loan programs. These difficulties prompted Education Centers to restructure its operations. Anticipating that decreased access to funding would result in further operating losses in some of its schools for the year ending December 31, 1993 and future years, in 1993 Education Centers elected to cease new student enrollments at 15 of its 48 schools (two of which have since begun again taking new enrollments), and in 1994 Education Centers elected to cease new student enrollments at an additional 6 schools.\n1994 Performance. Currently, Education Centers operates 36 schools (including seven that are no longer taking new enrollments and are scheduled to close permanently in the next six months, following the time that all existing students have been provided an opportunity to complete their scheduled courses of study); Education Centers has closed twelve schools in the past two years. The Company's consolidated statement of operations for 1994 includes a second quarter $40.0 million charge to write-down Education Centers' assets, provide for estimated gains\/losses on the sale of certain Education Centers' schools, and to provide for the estimated costs of closing and\nteaching-out certain Education Centers' schools. In addition, in 1994, the Company recorded a $9.4 million operating loss from Education Centers' discontinued operations. In 1993, Education Centers had an operating loss before unusual items of $5.5 million, along with an unusual charge of $23.6 million, which charge included a write-down of assets and estimated costs of closing 14 schools announced in the third quarter of 1993.\nSale and Other Disposition of Schools. Education Centers has, since June 1994, negotiated with several potential buyers for one or more of Education Centers' schools. In 1994, Education Centers was unable to consummate a transaction with a potential buyer of Education Centers' entire operations. Currently, Education Centers is negotiating with a potential buyer under the terms of a letter of intent to sell certain of Education Centers' schools. In addition, Education Centers has had discussions with a number of other potential purchasers of one or more schools.\nThe sale of each school typically is conditioned on, among other things, re-certification of the school by the United States Department of Education as eligible for its students to receive federal student aid. In the event that the Department of Education refuses to re-certify any school, or such school, while still owned and operated by Education Centers, loses its certification for students to receive federal student aid (which can occur based on, among other reasons, its former students maintaining too high of a default rate in repayment of student loans made under federal student loan programs), Education Centers may determine to cease taking new enrollments at such school, and close that school after all existing students have been provided an opportunity to complete their scheduled courses of study.\nBusiness and Curricula. Each school provides various combinations of classroom, laboratory, hands-on and externship training for entry-level occupations in one or more of five major disciplines: Medical, Electronics, Business, Automotive, and Aviation. Programs ranging in length from 8 to 36 months are offered to individual students as well as government agencies with a training mandate and organizations having employee training needs that are met by Education Centers' curricula. Tuition for the programs ranges from $4,000 to $25,000 depending on length of course and subject matter. Tuition for government and industry training engagements varies from contract to contract as a function of contract training hours. All courses offered by Education Centers were developed internally or with the assistance of consultants.\nCompletion and Job Placement. The completion rate for 1994 was 60%, as compared to 59.5% for 1993, with better rates in short-term programs. Over the past three years Education Centers has placed almost 23,900 graduates in jobs. Education Centers maintains placement personnel in each school, has fully computerized its job placement tracking system, and has initiated communication and training programs to achieve its placement goals. Education Centers monitors its overall placement rate, including monitoring graduates for at least three months after placement, as an indicator of the success of Education Centers' schools.\nFinancial Aid and Accreditation. Federal and state financial aid represented approximately 85 percent of Education Centers' revenues in 1994. Grant programs, principally the Pell grant, entitle certain students to receive funds for tuition and other educational expenses, based on financial need. These grants may be available to students with family incomes of less than $25,000 per year; historically, many Education Centers' students qualified for these grants. There is no assurance that future governmental programs providing financial assistance to Education Centers' students will remain available at levels which have existed in prior fiscal years. Please see \"Sale and Other Disposition of Schools\" above, and please see \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\" beginning on page 21 below.\nAll schools operated by Education Centers are accredited by either the Accrediting Commission of Career Schools and Colleges of Technology or the Accrediting Council for Independent Colleges and Schools, and each school holds one or more state licenses allowing the school to operate or recruit students in such states. Each school undergoes periodic accrediting evaluations by teams of qualified examiners.\nAdvertising, Marketing and Competition. Education Centers markets its courses to individual students, organizations, and governmental agencies. It utilizes various direct response advertising media including television, direct mail, and newspapers, and maintains a staff to make sales calls and to prepare proposals to governmental and quasi-governmental organizations and agencies based on training needs analyses or the existing government request for proposal process.\nEducation Centers encounters active competition in the marketing of vocational and technical training programs from junior colleges and other public institutions, military training programs, and other proprietary schools. Education Centers competes on curriculum content and availability, location, tuition and other fees charged, the duration of the course, and the job placement success rate. Overall, the Company believes Education Centers' competitive position is satisfactory.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following table provides information regarding executive officers of the Company, including their ages as of March 17, 1995:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\n(a) The Company's corporate headquarters are located in leased facilities aggregating 40,000 square feet in Irvine, California.\n(b) The Company owns real property consisting of approximately 2.2 acres of land with a 22,000 square foot building in Nutley, New Jersey, for an Education Centers school.\n(c) The Company owns an 180,000 square foot building on 15 acres of land and 80,000 square feet of buildings on leased land in Tulsa, Oklahoma, for an Education Centers school.\n(d) The Company owns the land and buildings in Oakland Park, Florida, that formerly served as a dormitory for the Company's former Ft. Lauderdale, Florida Education Centers school. These buildings, which the Company currently has listed for sale, aggregate approximately 107,000 square feet of space on approximately 4.8 acres of land.\n(e) The Company owns real property in Scranton, Pennsylvania, for the principal offices of ICS. This building consists of 120,000 square feet of space on 14.3 acres of land.\n(f) The Company owns an 82,000 square foot building on approximately 31 acres of land in Ransom, Pennsylvania for an ICS warehouse.\n(g) The Company owns the land and building serving as the warehouse for Steck-Vaughn Company. The building, located in Austin, Texas on approximately 13 acres of land, contains 101,000 square feet of space.\n(h) The Company owns 22,000 square feet of buildings on approximately 4.8 acres of land in West Des Moines, Iowa, for an Education Centers school.\n(i) The Company owns 60,000 square feet of buildings on approximately 3.1 acres of land in Blairsville, Pennsylvania, for an Education Centers school.\n(j) The Company owns 10,000 square feet of buildings on approximately .5 acres of land in Minneapolis, Minnesota, for an Education Centers school.\n(k) The Company has approximately 120 leases for its operating units and offices, including the following: Education Centers' headquarters in Irvine, California - approximately 24,000 square feet; NETG's headquarters in Naperville, Illinois - approximately 130,000 square feet; Steck-Vaughn's headquarters in Austin, Texas - approximately 31,000 square feet; and NETG-Spectrum's headquarters in Bedford, Massachusetts - approximately 52,500 square feet.\nOverall, the Company's properties are suitable and adequate for the Company's needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is a party to litigation matters and claims which are routine in the course of its operations and, while the results of litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of such matters will not have a materially adverse effect on the Company's 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 the Company's stockholders during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThe Company's Common Stock is listed on the New York Stock Exchange and the Pacific Stock Exchange. The high and low market prices for the Company's stock during each quarter for the last two years are as follows:\nThe number of stockholders of record of the Company's Common Stock as of March 17, 1995 was 2,778. The number of record holders is based upon the actual number of holders registered on the stock transfer books for the Company at such date and does not include holders of shares in \"street names\" or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depository trust companies.\nNo cash or stock dividends have been declared or paid on the Company's Common Stock during 1994 or 1993. The Company has no present intent to pay cash dividends; in addition, the Company's Credit Agreement with its lending institutions restricts the payment of cash dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nNational Education Corporation and Subsidiaries\nFIVE YEAR FINANCIAL HIGHLIGHTS\n* See Notes to Consolidated Financial Statements for discussion of the 1993 and 1992 unusual items.\nEffective January 1, 1994, the Company changed its method of accounting for advertising and other deferred marketing costs. See Note 1 to Consolidated Financial Statements for further discussion.\nIn 1990, the Company reached an agreement with its former chairman and chief executive officer to settle damages under his employment agreement and all other claims asserted by him arising out of the termination of his employment. Accordingly, the Company settled in an amount of $5,346,000 which has been reflected as an unusual charge in its 1990 operating results. Also in 1990, the Company received from its insurance underwriter an amount of $5,500,000 to settle its contribution to class action settlement costs of $11,850,000 recorded in 1989 for class action lawsuits against the Company and certain present and former officers and directors. This amount was recorded as an unusual gain in the 1990 operating results.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nNational Education Corporation and Subsidiaries\n1994 Compared to 1993\nRevenues of $241,614,000 for the year ended December 31, 1994 were $17,442,000 or 7.8% higher than revenues of $224,172,000 in the prior year. Loss from continuing operations was $14,473,000 or $.49 loss per fully diluted share compared to income from continuing operations of $10,138,000 or $.32 per fully diluted share in 1993. Net loss of $63,925,000 or $2.16 loss per share compared to net loss of $9,619,000 or $.32 loss per share in 1993.\nEffective June 30, 1994, the Company adopted a plan to dispose of its Education Centers subsidiary. The plan resulted in a charge of $40,032,000 ($1.35 loss per share) to write-down assets, provide for estimated gains\/losses on the sale of certain schools, and to provide for the estimated costs of closing and teaching-out certain schools. The revenues and expenses of the Education Centers have been netted and segregated as discontinued operations for 1994, and prior period statements of operations have been restated to reflect this change.\nIn December 1993, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position No. 93-7 (\"SOP\"), \"Reporting on Advertising Costs\". The SOP generally requires advertising costs, other than direct-response advertising, to be expensed as incurred. The SOP is effective for financial statements for fiscal years beginning after December 15, 1994, but may be adopted early. In the fourth quarter of 1994, the Company adopted the SOP at its ICS Learning Systems subsidiary effective January 1, 1994. In adopting the SOP in 1994, ICS' total advertising, selling and promotion costs were expensed as incurred rather than deferred and amortized as in prior periods. Furthermore, the transition rules of the SOP required amortization of the deferred balances existing as of the beginning of the year in accordance with the Company's previous accounting policy. The SOP does not permit restatement of prior periods (1993 and 1992). The effect of the transition rules is to reflect as an expense in the year of adoption (1994), both the current year's advertising, selling and promotion costs, and the amortization of balances deferred as of the beginning of the year. Adoption of the SOP in 1994, resulted in a charge of $27,410,000 ($21,181,000 after tax or $.72 per share). The charge consists of two components. First, a charge of $19,836,000 results from the amortization of the deferred marketing balance as of December 31, 1993 into 1994. Second, a charge of $7,574,000 results from increased selling and promotion spending above the amortization that would have been expensed in accordance with the Company's previous accounting policy. For comparative purposes only, assuming the Company had adopted the SOP effective January 1, 1992, income before taxes would have decreased $3,411,000 ($2,251,000 after tax or $.08 per share) in 1993 and increased $1,679,000 ($1,108,000 after tax or $.04 per share) in 1992.\nIncreased revenues from continuing operations related to ICS, Steck-Vaughn and National Education International, which provides training services to foreign governments primarily in the Middle East, were partially offset by reduced revenues at NETG. The decline in income from continuing operations of $24,611,000 was due to the 1994 adoption of the SOP discussed above, and a nonrecurring 1993 after tax gain of $21,260,000 ($.71 per share) resulting from an initial public offering of 2,668,000 shares of Steck-Vaughn Publishing Corporation common stock partially offset by the 1993 unusual charge of $9,232,000 ($6,558,000 after tax or $.22 loss per share) recorded at NETG for the write-down of certain acquired intangible assets. Excluding the effects of the net unusual items, income from continuing operations in 1994 was favorably impacted by reduced operating losses at NETG and a gain on sale of a partnership interest of a start-up operation in the amount of $3,247,000 ($2,143,000 after tax or $.07 per share). The net loss was primarily related to the loss from discontinued operations and the loss on disposal of discontinued operations of the Education Centers totaling $49,452,000 in 1994. The loss from discontinued operations decreased from the prior year due to the nonrecurring unusual charge of $23,626,000 ($16,363,000 after tax or $.55 loss per share) resulting from a restructuring charge for the write-down of certain assets and the estimated costs of closing the 14 schools announced in the third quarter of 1993.\nICS Learning Systems revenues of $122,815,000 increased $21,496,000 or 21.2% from revenues of $101,319,000 in 1993. Operating loss of $3,927,000 decreased $25,295,000 from operating income of $21,368,000 in the prior year solely due to the change in accounting for advertising, selling and promotion costs required by the SOP as discussed earlier. The revenues at ICS increased primarily due to strong revenue performance at the domestic operation. The international operations experienced a slight increase in revenues. Domestic revenues grew significantly due to a 32.7% increase in enrollments, revenues from MicroMash, and increases in Business and Industrial Division revenues. The significant domestic enrollment increase primarily resulted from the success of the expanded telesales efforts, which enroll students directly over the phone and have produced a higher conversion of leads to enrollments and tuition down payments upon enrollment than that experienced in the prior year. In addition, a shift in product mix towards higher priced computer related courses contributed to the revenue growth. During the first quarter, ICS acquired MicroMash, a leading provider of computer based interactive courses for accounting professionals and students. Through this acquisition, ICS is strategically positioned to aggressively pursue the continuing professional education marketplace. Business and Industrial Division revenues grew during the year as a result of further selling penetration of the existing marketplace. The revenue increase at the international operation primarily resulted from higher revenues at the Australia\/New Zealand, Canada and International Mail Sales (IMS) operations. The combined Australia\/New Zealand operation experienced strong enrollment growth of 17.9% as a result of the successful telesales efforts which increased conversion of leads to enrollments. The higher revenues at Canada and IMS primarily resulted from increased student payments partially reduced by a decrease in Canada's enrollments. The United Kingdom experienced lower revenues due to lower student payments despite flat enrollments as compared to the prior year. The operating loss at ICS results solely from the adoption of the SOP in 1994. The following table provides the total advertising, selling and promotion spending for the years presented.\nAs a result of the increased promotion and selling spending of $11,981,000 in 1994 over 1993, revenues increased $21,496,000 and unearned future tuition revenue on student contracts at ICS increased $36,883,000 or 29.2% to $163,050,000. Based upon previous experience, it is estimated that approximately 45% of the unearned future tuition revenue will ultimately be recognized as revenue. As ICS continues to increase its advertising, selling and promotion costs to support the growth in the student population, operating margins will be lower than in previous years. As required by the SOP, expensing these costs as incurred fully burdens the current year with expenses that benefit future years with the related revenue stream. Higher course service costs at the domestic operation were primarily related to the significant volume increases and changes in product mix towards a higher percentage of lower margin computer related courses. General and administrative costs were higher during the year primarily due to costs associated with MicroMash and the initial costs to convert and integrate new information systems. These costs were partially offset by lower insurance costs related to favorable loss experience.\nSteck-Vaughn Publishing Corporation revenues of $53,608,000 were $452,000 or .9% higher than revenues of $53,156,000 in the prior year. Operating income of $10,425,000 decreased $3,141,000 or 23.2% as compared to operating income of $13,566,000 in 1993. The slight increase in revenue was attributable to a general price increase of 6.7% and a modest increase in sales of the elementary school product line which benefited from growth primarily in the Math, Reading, and Science products and a full year of Magnetic Way product sales. The adult education product line experienced a decrease in revenues due to a reduction in software sales of GED products, new competition for GED products and tight funding in the adult education sector. In addition, a decline in sales of mature library products was not entirely offset by sales of newer products, resulting in lower library revenues. Several factors contributed to these results. Selling conditions in early 1994 were hampered by adverse winter weather conditions which affected the midwest, mid-Atlantic and northeast regions of the United States. Additionally, the sales force expansion and related reorganization effective January 1994, resulted in longer than anticipated assimilation and reduced sales productivity. Finally, a continuing trend towards site-based selling, which is a competitive strength of Steck-Vaughn, is driving the decision making process down to the faculty level requiring a greater number of sales calls per revenue dollar, resulting in an increase in selling costs. Operating income decreased significantly during 1994 primarily due to an increase in publishing costs, product development expenses, and selling and promotion costs. Higher publishing costs primarily resulted from the higher distributor\nand Magnetic Way sales which have lower profit margins and resulted in a slight increase in publishing costs as a percentage of revenues. Publishing costs and materials, which include product development and product acquisition expenses, increased over the prior year due to Steck-Vaughn's commitment to develop new and revised products and to acquire certain library products to position Steck-Vaughn for growth in the supplemental educational marketplace. By continuing to expand its product offerings, Steck-Vaughn expects to continue to capitalize on the anticipated increasing demand for supplemental educational, library and adult education products despite severe budgetary pressure on schools located in certain geographic areas of the country. Selling and promotion costs increased during the year due to the expansion of the sales organization during January 1994. The expansion and related reorganization resulted in the segmentation of the sales force into two groups. One group focuses on the elementary, junior high and library marketplaces while the other group focuses on the high school and adult education marketplaces. This segmentation positions Steck-Vaughn to maximize the opportunities of their rapidly expanding product offerings and to respond to additional requirements resulting from the trend towards site-based selling. General and administrative expenses decreased in 1994 primarily due to lower insurance expenses caused by favorable loss experience and reduced management incentive compensation expenses.\nNETG revenues of $61,937,000 decreased $6,322,000 or 9.3% from revenues of $68,259,000 in the prior year. Operating losses of $13,993,000 decreased $11,957,000 from losses before unusual items of $25,950,000 in the prior year. During the third quarter of 1993, NETG recorded an unusual charge of $9,232,000 which resulted from the write-down of certain acquired intangible assets. The decrease in revenues at the domestic and international operations primarily resulted from lower contract backlog at the beginning of 1994 as compared to 1993 and slightly lower volume of new orders in the domestic operation. In addition, the decrease in revenues was partially attributable to the introduction in the third quarter of a new product licensing agreement, called Multimedia Licensing Agreement (MLA), which simplifies the customers' ability to acquire NETG products; however, unlike sales contracts used in prior years, the MLA does not require upfront commitments to acquire product upon the signing of a contract. As the number of customers signing MLAs increases, new orders will become less meaningful as a key indicator of future revenue activity. New orders increased in the international operation due to increased new business activity in the United Kingdom operation; however, decreasing contract backlog, which more than offset the new orders business, and the sale of NETG-Canada in 1993 resulted in reduced revenues in the international operation. During December 1993, NETG sold certain assets and liabilities of NETG-Canada to SHL Systemhouse, Inc. at approximately book value. The sales agreement also provided for certain future royalties on the sale of NETG products in Canada. Operating losses before unusual items decreased significantly in the domestic operation during 1994 primarily due to reductions in product development costs, general and administrative expenses and amortization of acquired intangible assets. Reengineering the processes in product development and focusing the 1994 development efforts to concentrate in areas such as multimedia end user desktop computing and client\/server computing resulted in a 46.5% reduction in product development expenses. The decrease in general and administrative expenses primarily resulted from lower employee headcount and favorable loss experience which resulted in lower insurance expenses partially offset by higher consulting costs. Amortization of acquired intangible assets decreased in 1994 due to the write-down of certain acquired intangible assets in 1993 which was recorded as an unusual charge of $9,232,000. Despite slightly lower selling and promotion expenses, these expenses increased as a percentage of revenue during 1994 primarily as a result of the revenue decline.\nNational Education International (NEI) revenues of $2,927,000 increased $1,675,000 or 133.8% above the prior year revenues of $1,252,000. Operating income of $958,000 increased $742,000 over the prior year income of $216,000. The higher revenue and operating income levels are attributable to multi-year training contracts with Egypt and Kuwait, which span from one to four years in duration. As of December 31, 1994, these contracts carried a contract backlog of $4,348,000.\nIn December 1994, the Company sold its interest in a start-up partnership venture previously entered into for the development of an automated enrollment and financial aid application process. As a result of the sale, which was accounted for as a sale of stock, the Company recorded a gain on sale of $3,247,000 ($2,143,000 after tax or $.07 per share).\nGeneral corporate expenses of $7,302,000 decreased $4,230,000 or 36.7% from expenses of $11,532,000 in the prior year. The decrease in corporate expenses primarily resulted from a one-time contract settlement charge in 1993, favorable loss experience which resulted in lower insurance expenses, reduced outside consulting costs primarily from the company-wide financial reengineering effort and other cost reductions.\nOperating results of ICS and NETG foreign operations by geographic region experienced similar changes in revenues and income as previously discussed. Foreign currency gains of $492,000 were recorded during 1994 compared to losses of $243,000 in 1993. The current year currency gains primarily resulted from the rise in the exchange rates of the British pound and the German mark and their effect on the U.S. dollar denominated current intercompany balances at NETG-U.K. and NETG-Germany payable to the U.S. operations.\n1993 Compared to 1992\nRevenues of $224,172,000 for the year ended December 31, 1993 were $5,903,000 or 2.7% higher than revenues of $218,269,000 in the prior year. Income from continuing operations was $10,138,000 or $.32 per fully diluted share as compared to loss from continuing operations of $6,284,000 or $.21 loss per fully diluted share in 1992. Net loss of $9,619,000 or $.32 loss per share compared to net income of $515,000 or $.02 per share in 1992.\nEffective June 30, 1994, the Company adopted a plan to dispose of its Education Centers subsidiary. The revenues and expenses of the Education Centers have been restated and segregated for 1993 and 1992 to reflect this change.\nThe increase in revenue primarily results from increased revenues at ICS and Steck-Vaughn partially offset by reduced revenues at NETG. The growth in income from continuing operations was primarily due to the net revenue increase and an after tax gain of $21,260,000 ($.71 per share) resulting from an initial public offering of 2,668,000 shares of Steck-Vaughn Publishing Corporation common stock in 1993. The public offering reduced the Company's ownership of Steck-Vaughn from 100% to 81.7%. Partially offsetting this gain was an unusual charge of $9,232,000 ($6,558,000 after tax or $.22 loss per share) at NETG which resulted from the write-down of certain acquired intangible assets in 1993. The net loss during the year was primarily due to the loss from discontinued operations which includes an unusual charge of $23,626,000 ($16,363,000 after tax or $.55 loss per share) recorded at the Education Centers resulting from a restructuring charge for the write-down of certain assets and the estimated costs of closing 14 schools announced in the third quarter of 1993.\nICS Learning Systems revenues of $101,319,000 increased $11,027,000 or 12.2% from revenues of $90,292,000 in 1992. Operating income of $21,368,000 increased $2,588,000 or 13.8% from operating income of $18,780,000 in the prior year. The revenue and operating income increases at ICS primarily resulted from a 10.1% increase in enrollments, the transfer of the Industrial Print Division from NETG to ICS as of January 1, 1993 and a higher student population carry-in at the beginning of the year in comparison to the prior year. The enrollment increase at ICS was primarily due to continued improvement in converting leads to enrollments resulting from telesales and other telemarketing efforts in the domestic operations and certain international locations. The acquisition of the Industrial Print operation enhanced ICS' ability to effectively penetrate the business and corporate industrial marketplaces. Partially offsetting the revenue and operating increases was the impact of lower average exchange rates at the international locations, particularly in the United Kingdom. Selling and promotion costs decreased as a percentage of revenues in the domestic operations while they were partially offset by increases in such costs in the international operations. The decrease in the domestic operations was primarily due to the efficiencies associated with telesales and other telemarketing efforts, and proportionately lower costs associated with the Industrial Print Division. Higher selling and promotion costs as a percentage of revenue were experienced at the international operations as a result of increased marketing efforts designed to continue stimulating enrollment growth.\nSteck-Vaughn Publishing Corporation revenues of $53,156,000 were $8,032,000 or 17.8% higher than revenues of $45,124,000 in the prior year. Operating income of $13,566,000 increased $1,010,000 or 8.0% as compared to operating income of $12,556,000 in 1992. The revenue and operating income increases at Steck-Vaughn were primarily due to the successful marketing of new and revised products introduced during the past several years by the expanded sales and marketing organization and new product acquisitions during the year. The sales and marketing organization was significantly expanded during 1992 which facilitated the growth experienced during 1993; however, the full impact of this expansion increased costs during 1993 resulting in higher selling and\nmarketing expense as a percentage of revenue. Due to the rapidly expanding product offerings, Steck-Vaughn reorganized its sales force effective January 2, 1994. During 1993, each salesperson was responsible for the whole product range which included elementary, high school, library and adult education markets. Beginning in 1994, the sales force was segmented into two groups. One group focuses on the elementary and library markets while the other group focuses on the high school and adult education marketplaces.\nNETG revenues of $68,259,000 decreased $14,323,000 or 17.3% from revenues of $82,582,000 in the prior year. Operating losses before unusual items of $25,950,000 increased $4,096,000 from losses of $21,854,000 in the prior year. During the third quarter of 1993, NETG recorded an unusual charge of $9,232,000 which resulted from the write-down of certain acquired intangible assets. The decrease in revenue and increased operating loss at NETG primarily resulted from lower contract backlog at the beginning of the year and the transfer of the Industrial Print operation to ICS effective January 1, 1993. New orders and contracts increased 39.5% during the later half of the year resulting in an 11.2% increase for the year. Product development expenses increased $3,028,000 or 28.6% during the year as NETG continued to develop new training products in the areas of client\/server computing, business process reengineering, end user desktop computing, and personal and professional development. As a result of the decreased revenue and increased product development expense, course materials and service costs increased significantly as a percentage of revenue. Despite lower selling and promotion expenses, these expenses increased as a percentage of revenue during 1993 primarily as a result of the significant revenue decline. During December 1993, NETG sold certain assets and liabilities of NETG-Canada to SHL Systemhouse, Inc. (Systemhouse) at approximately book value. The sales agreement also provides for certain future royalties on the sale of NETG products in Canada. The net assets and operating results of NETG Canada are not material to the operations of NETG.\nGeneral corporate expenses of $11,532,000 increased $774,000 or 7.2% from expenses of $10,758,000 in the prior year. The increase in corporate expenses primarily resulted from initial investments in the reengineering of certain company-wide finance processes and information systems.\nOperating results of ICS and NETG foreign operations by geographic region experienced similar changes in revenues and income as previously discussed. Foreign currency losses of $243,000 were recorded during 1993 compared to losses of $2,570,000 in 1992. The prior year currency losses primarily resulted from the significant exchange rate decline of the British pound sterling and its effect on the U.S. dollar denominated current intercompany balance at NETG-U.K. payable to the U.S. operations.\nLiquidity and Capital Resources\nThe Company's primary sources of liquidity are cash, investment securities and cash provided from operations. At December 31, 1994, the Company had $28,130,000 in cash and investment securities, of which $16,959,000 was held in the account of Steck-Vaughn.\nAs of December 31, 1994, the Company had a revolving bank credit agreement in the amount of $10,000,000, of which $5,000,000 was outstanding. On February 28, 1995, the Company amended its revolving bank credit agreement with its existing bank to increase the available amount to $13,500,000, which matures on December 31, 1995. The credit agreement, which is secured by the stock of principal subsidiaries, will initially provide borrowings at prime plus 1 percent or, at the Company's option, at LIBOR plus 2 percent, with incremental borrowing rate increases at June 30 and September 30, 1995.\nUnder the intercompany agreement between the Company and Steck-Vaughn, the Company has the ability to borrow up to $10,000,000 from Steck-Vaughn. Effective February 28, 1995, the Company and Steck-Vaughn entered into a revolving loan agreement which provides that any borrowing by the Company will bear interest at LIBOR plus 2 percent, and will be secured by the Company's holdings of Steck-Vaughn stock. Steck-Vaughn also received an option to repurchase from the Company up to 290,000 shares of Steck-Vaughn stock held by the Company, at $6.50 per share. The option becomes exercisable one year after grant, expires December 31, 1996, and may be redeemed by the Company prior to exercise or expiration for the greater of $750,000 or the amount necessary to increase to 25 percent the annualized yield to Steck-Vaughn on all amounts borrowed by the Company under the revolving loan agreement.\nCash outflows from 1994 operating activities of $1,362,000 were $9,680,000 lower than cash flows from 1993 operating activities of $8,318,000 due primarily to higher advertising spending at ICS.\nIn addition, net cash flows for 1994 were further impacted by the acquisitions of MicroMash and Berrent Publications in the amount of $6,430,000, cash outflow of $21,085,000 at the Education Centers and additional investments in property, plant and equipment at ICS to support the continued growth in that operation.\nThe Company expects that cash, marketable securities, the bank and Steck-Vaughn credit facilities, cash provided from operations and the continued funding of Education Centers' students under government student financial aid programs, subject to a timely disposition of schools, will be sufficient to provide for planned working capital requirements, debt service, and capital expenditures for the foreseeable future.\nDuring 1994, the Company adopted a plan to dispose of its Education Centers subsidiary. As a result, the Company recorded a charge of $40,032,000 to write-down assets to estimated net realizable value and provide for estimated costs of disposing of the operation. During the second half of the year, the Company negotiated with an interested buyer to sell the total operations of the Education Centers. In December, the Company terminated the negotiations with this interested buyer due to significant complexities in issues raised in the regulatory review process. In January 1995, the Company announced that it had signed a letter of intent with a buyer to purchase certain of its Education Centers' schools. The Company is undertaking discussions with other potential buyers with specific geographic and\/or curricula interests related to the remaining schools. In the event the Company is unable to sell certain schools anticipated for sale due to a lack of buyers, default rate issues or other factors, the Company may initiate the teachout of these schools in 1995, and if appropriate, increase the reserve for the loss on disposal of discontinued operations.\nAt December 31, 1994 and 1993, the excess of cost over net assets of businesses acquired (goodwill) at NETG was $42,158,000 and $43,495,000, respectively. At each balance sheet date, the Company reviews the recoverability of intangible assets by comparing projected operating income on an undiscounted basis to the net book value of the related assets. Despite the improvement in operating losses at NETG in 1994 and management's projection of the recoverability of its goodwill on an undiscounted basis as of December 31, 1994, management continues to explore various alternatives to either minimize the future risk of NETG or maximize the value of NETG to shareholders. In the event management develops a definitive plan to significantly redirect the strategic plan at NETG, the Company at that time will again assess the recoverability of goodwill.\nThe Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (FAS 109). FAS 109 requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial statement and tax basis of assets and liabilities. As of December 31, 1994, the Company had a gross deferred tax asset of $73,556,000 (see Notes to Consolidated Financial Statements). A significant portion of the deferred tax asset is comprised of U.S. Federal and international net operating loss carryforwards. At December 31, 1994, the Company had available federal consolidated net operating loss carryforwards of $71,000,000 (exclusive of certain \"SRLY\" losses) expiring through 2009. In addition, the Company had federal SRLY loss carryforwards totaling $16,967,000 ($5,769,000 deferred tax asset) expiring in years 1998 through 2007 that may only be used to offset income generated by the particular entities that generated the losses.\nFAS 109 requires that the Company record a valuation allowance when it is \"more likely than not that some portion of the deferred tax asset will not be realized\". The Company has recorded a valuation allowance of $30,613,000, including full allowance against the SRLY loss carryforwards.\nThe ultimate realization of deferred tax assets, net of the valuation allowance, of $42,943,000 depends on the Company's ability to generate sufficient taxable income in the future. A portion of this asset will be realized through the reversal of taxable temporary differences totaling $17,298,000 reflected as deferred tax liabilities in the financial statements. Eliminating the effects of adopting the SOP in 1994, the improving profitability of the continuing operations, together with the reversal of taxable temporary differences, provides the basis for management's conclusion that it is more likely than not that the Company will generate sufficient taxable income to realize its deferred tax asset.\nThe effect of inflation had little impact on the Company in 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Company's consolidated financial statements at December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and the Report of Price Waterhouse LLP, Independent Accountants, are included in this Annual Report on Form 10-K on pages through below.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThe Company has no information to report in response to this item.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY.\n(a) The information required by Item 10 with respect to the directors of the Company is incorporated herein by reference from material that will be filed with the Securities and Exchange Commission within 120 days of the Company's fiscal year end (December 31, 1994), either as part of a Proxy Statement for the Company's Annual Meeting of Stockholders or as an amendment to this Form 10-K.\n(b) The information required by Item 10 with respect to executive officers of the Company is furnished in a separate item captioned \"Executive Officers of the Company\" and included in Part I of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by Item 11 is incorporated herein by reference from material that will be filed with the Securities and Exchange Commission within 120 days of the Company's fiscal year end (December 31, 1994), either as part of a Proxy Statement for the Company's Annual Meeting of Stockholders or as an amendment to this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by Item 12 is incorporated herein by reference from material that will be filed with the Securities and Exchange Commission within 120 days of the Company's fiscal year end (December 31, 1994), either as part of a Proxy Statement for the Company's Annual Meeting of Stockholders or as an amendment to this Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by Item 13 is incorporated herein by reference from material that will be filed with the Securities and Exchange Commission within 120 days of the Company's fiscal year end December 31, 1994), either as part of a Proxy Statement for the Company's Annual Meeting of Stockholders or as an amendment to this Form 10-K.\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* incorporated by reference from a previously filed document ** denotes management contract or compensatory plan or arrangement\n(1) Incorporated by reference to Exhibit 19-2 filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1987.\n(2) Incorporated by reference to Exhibit 10 filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990.\n(3) Incorporated by reference to Exhibit 10.1 filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1992, filed March 22, 1993.\n(4) Incorporated by reference to Exhibit 10(b) filed with Registrant's Registration Statement on Form S-8 (No. 2-86904), filed October 3, 1983.\n(5) Incorporated by reference to Exhibit 10.15 filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1987, filed March 30, 1988.\n(6) Incorporated by reference to Exhibit 10.17 filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, filed April 1, 1991.\n(7) Incorporated by reference to Exhibit \"A\" filed with Registrant's 1990 Proxy Statement, filed April 2, 1990.\n(8) Incorporated by reference to Exhibit \"A\" filed with Registrant's 1991 Proxy Statement, filed April 1, 1991.\n(9) Incorporated by reference to Exhibit 4.1 filed with Registrant's Current Report on Form 8-K, dated October 29, 1986, filed October 30, 1986.\n(10) Incorporated by reference to Exhibit 10.19 filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, filed April 1, 1992.\n(11) Incorporated by reference to Exhibit 4.2 filed with Amendment No. 1 to Registrant's Registration Statement on Form S-3 (No. 33- 5552), filed May 16, 1986.\n(12) Incorporated by reference to Exhibit 4 filed with Registrant's Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1990.\n(13) Incorporated by reference to Exhibit 4 filed with Registrant's Current Report on Form 8-K, dated February 20, 1991, filed February 27, 1991.\n(14) Incorporated by reference to Exhibit 10.17 filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, filed April 1, 1992.\n(15) Incorporated by reference to Exhibit 10.18 filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, filed April 1, 1992.\n(16) Incorporated by reference to Exhibit 10.9 filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1987, filed March 30, 1988.\n(17) Incorporated by reference to Exhibit 10.8 filed with Amendment No. 1 to Steck-Vaughn Publishing Corporation's Registration Statement on Form S-1, File No. 33-62334, filed June 17, 1993.\n(18) Incorporated by reference to Exhibit 10.9 filed with Amendment No. 1 to Steck-Vaughn Publishing Corporation's Registration Statement on Form S-1, File No. 33-62334, filed June 17, 1993.\n(19) Incorporated by reference to Exhibit 10.13 filed with Steck-Vaughn Publishing Corporation's Registration Statement on Form S-1, File No. 33-62334, filed May 7, 1993.\n(20) Incorporated by reference to Exhibit 10.23 filed with Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, filed August 11, 1994.\n(21) Incorporated by reference to Exhibit 10.14 filed with Steck-Vaughn Publishing Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, filed August 11, 1994.\n(22) Incorporated by reference to Exhibit 10.12 filed with Steck-Vaughn Publishing Corporation's Annual Report on Form 10-K for the year ended December 31, 1994, filed March 29, 1995.\n(23) Filed herewith.\n(b) No reports on Form 8-K were filed during the fourth quarter of 1994.\n(c) The exhibits required by this Item are listed under Item 14(a)(3) above.\n(d) The consolidated financial statements required by this Item are listed under Item 14(a)(2).\nSIGNATURES\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.\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.\nNATIONAL EDUCATION CORPORATION\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of National Education Corporation\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 24 present fairly, in all material respects, the financial position of National Education Corporation and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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.\nAs discussed in Note One to the consolidated financial statements, the Company changed its method of accounting for advertising costs in 1994.\nPrice Waterhouse LLP\nCosta Mesa, California February 6, 1995\nNational Education Corporation and Subsidiaries\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee Notes to Consolidated Financial Statements.\nNational Education Corporation and Subsidiaries\nCONSOLIDATED BALANCE SHEETS\nSee Notes to Consolidated Financial Statements.\nNational Education Corporation and Subsidiaries\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nNational Education Corporation and Subsidiaries\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee Notes to Consolidated Financial Statements.\nNational Education Corporation and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION AND BASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of the Company and all subsidiaries. Certain prior year amounts have been reclassified to conform with 1994 presentation. Prior year statements of operations and statements of cash flows have been restated to exclude the discontinued operations of the Education Centers.\nREVENUES AND EXPENSES\nICS Tuition Revenues are recognized when cash is received, but only to the extent such cash is earned and can be retained by the Company. Cash received in excess of revenue recognized is recorded as deferred contract revenues. Generally, the Company follows the guidelines of the Distance Education Training Council in determining retention rights. All operating costs are expensed as incurred.\nIn December 1993, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants (AICPA) issued Statement of Position No. 93-7 (\"SOP\"), \"Reporting on Advertising Costs\". The SOP generally requires advertising costs, other than direct-response advertising, to be expensed as incurred. The SOP is effective for financial statements for fiscal years beginning after December 15, 1994, but may be adopted early. In the fourth quarter of 1994, ICS adopted the SOP effective January 1, 1994. In adopting the SOP in 1994, ICS' total advertising, selling and promotion costs are expensed as incurred in 1994 rather than deferred and amortized as in prior periods. Adoption of the SOP in 1994, resulted in a charge of $27,410,000 ($21,181,000 after tax or $.72 per share). The charge consists of two components. First, a charge of $19,836,000 results from the amortization of the deferred marketing balance as of December 31, 1993 into 1994. Second, a charge of $7,574,000 results from increased selling and promotion spending above the amortization that would have been expensed in accordance with the Company's previous accounting policy. There remains a deferred marketing balance of $1,470,000 which will be amortized in the first and second quarters of 1995. As shown in Note 16 (Quarterly Financial Data), all periods presented for 1994 only, were restated to reflect the adoption of the SOP. The SOP does not permit restatement of the periods for 1993.\nSteck-Vaughn Publishing Revenues are recognized upon shipment of product. Plant costs, which include costs associated with text layout and publishing set-up, are deferred and amortized to expense with the sale of the product produced during the first printing. A portion of selling and marketing expenses are deferred and fully amortized within the calendar year to better match the expenses with revenues due to the seasonal nature of revenue realization. Expenses associated with the development of product catalogs are deferred and amortized to expense over the useful life of the catalog which is typically six months to one year.\nNETG Contract Revenues consist of multimedia licensing agreements (MLAs), access agreements and custom contract revenues. Revenues under MLAs and access agreements, which are generally one year in length, are recognized upon shipment of the selected courseware. Custom contract revenues under time and materials contracts are recognized as costs are incurred, and revenues from fixed price contracts are recognized using the percentage-of-completion method. Course service costs, which include product development costs, are expensed as incurred. Sales and marketing costs are expensed within the calendar year except for sales commissions on training contracts sold, which are deferred and amortized to expense as contract revenues are recognized.\nINCOME TAXES\nIncome taxes are accounted for using an asset and liability approach which requires the recognition of deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the financial statement and tax bases of assets and liabilities at the applicable enacted tax rates.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nEARNINGS (LOSS) PER SHARE\nPrimary earnings (loss) per share are computed based on the weighted average number of common shares outstanding during the respective periods, including dilutive stock options. Fully diluted earnings (loss) per share are computed based on the assumption that the convertible debentures had been converted to common stock, with a corresponding increase in net income to reflect a reduction in related interest expense, less applicable taxes.\nINVESTMENT SECURITIES\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (FAS 115), which resulted in a change in the accounting for debt and equity securities held for investment purposes. Prior to January 1, 1994, the Company carried debt and equity securities at the lower of aggregate cost or market value. In accordance with FAS 115, the Company's debt and equity securities are now considered as either held-to-maturity or available-for-sale. Held-to-maturity securities represent those securities that the Company has both the positive intent and ability to hold to maturity and are carried at amortized cost. Available-for-sale securities represent those securities that do not meet the classification of held-to-maturity, are not actively traded and are carried at fair value. Unrealized gains and losses on these securities are excluded from earnings and are reported as a separate component of stockholders' equity, net of applicable taxes, until realized. Since the adoption of this standard, the Company recorded decreases in available-for-sale securities of $36,000 and a related deferred tax asset of $15,000 resulting in a net decrease of $21,000 in stockholders' equity.\nINVENTORIES AND SUPPLIES\nInventories and supplies at Steck-Vaughn are valued at the lower of market or cost which is determined using the last-in, first-out (LIFO) method. At December 31, 1994 and 1993, the allowance to reduce the carrying value to the LIFO basis was $1,868,000 and $1,114,000, respectively.\nOther inventories, primarily consisting of course materials and supplies, are stated at the lower of first-in, first-out cost or market.\nLAND, BUILDINGS AND EQUIPMENT\nLand, buildings and equipment are stated at cost and are depreciated principally using the straight-line method over the estimated useful lives of the various classes of property.\nACQUIRED INTANGIBLE ASSETS\nAcquired intangible assets, which include rental contracts, product and text materials, course development costs, copyrights, and other identified intangibles, are amortized ratably over various useful lives which do not exceed ten years. Acquired intangible assets representing the excess of cost over acquired net assets purchased by the Company in conjunction with various acquisitions are amortized ratably over lives which do not exceed forty years.\nAt December 31, 1994 and 1993, the Company had $47,649,000 and $45,556,000, respectively, of excess of cost over net assets of businesses acquired of which $42,158,000 and $43,495,000, respectively, is related to NETG. At each balance sheet date, the Company reviews the recoverability of intangible assets by comparing projected operating income on an undiscounted basis to the net book value of the related assets.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDEFERRED CONTRACT REVENUES\nDeferred contract revenues represent the portion of training contract payments and student tuition received in advance of services being performed.\nMINORITY INTEREST\nMinority interest in equity of consolidated subsidiary represents the minority stockholders' proportionate share of the equity of Steck-Vaughn Publishing Corporation. During 1994, Steck-Vaughn Publishing Corporation repurchased 230,200 shares of its outstanding common stock which effectively increased the Company's ownership interest to 83.0%.\nFOREIGN CURRENCY TRANSLATION\nAssets and liabilities of international subsidiaries have been translated at current exchange rates. Revenues, expenses and cash flows have been translated at average rates of exchange in effect during the year. Resulting cumulative foreign exchange translation adjustments have been recorded as a separate component of stockholders' equity. Also included in this component of stockholders' equity are exchange gains and losses on hedges of foreign intercompany accounts of a long-term nature. Gains and losses on foreign currency transactions are recorded to other income and expense.\nNOTE 2 - BUSINESS COMBINATIONS\nIn November 1994, the Company, through Steck-Vaughn Publishing Corporation, purchased substantially all of the assets of Berrent Publications, Inc. (Berrent), a publisher of test preparation and assessment materials. The transaction was accounted for as a purchase and the operating results of Berrent have been included in the Company's consolidated financial statements since the date of acquisition. The net assets and operating results of Berrent are not material to the consolidated financial statements of the Company.\nDuring the first quarter of 1994, the Company, through ICS Learning Systems, purchased the stock of M-Mash, Inc. (MicroMash), a leading provider of computer-based, interactive courses for accounting professionals and students. The transaction was accounted for as a purchase and the operating results of MicroMash have been included in the Company's consolidated financial statements since the effective date of acquisition. The net assets and operating results of MicroMash are not material to the consolidated financial statements of the Company.\nIn April 1993, the Company, through Steck-Vaughn Publishing Corporation, purchased certain assets of Creative Edge, Inc. (Magnetic Way product line), a provider of educational products and materials for the elementary and secondary school marketplace. The transaction was accounted for as a purchase and the operating results of Creative Edge have been included in the Company's consolidated financial statements since the date of acquisition. The net assets and operating results of Creative Edge are not material to the consolidated financial statements of the Company.\nNOTE 3 - BUSINESS DISPOSITIONS\nIn June 1994, the Company adopted a plan to discontinue the operation of its Education Centers subsidiary. As a result, the Company recorded a second quarter charge of $40,032,000 ($1.35 loss per share) to write-down assets to estimated net realizable value and provide for estimated costs of disposing of the operation. No tax benefits were provided on this charge.\nDuring January 1995, the Company signed a letter of intent with a prospective buyer to purchase all of the assets and substantially all of the operating liabilities of certain of the schools. The Company is conducting discussions with other potential buyers with interests related to the remaining schools to be sold. Based upon current assumptions, management believes that the amount reserved for disposition costs is adequate.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe Education Centers are being accounted for as discontinued operations in the results of operations, and prior period statements of operations and statements of cash flows have been reclassified to reflect this treatment. Results of operations for the Education Centers were as follows:\nThe estimated net realizable value of the Education Centers assets has been segregated on the December 31, 1994 balance sheet as net assets held for disposition. Liabilities associated with the cost of completing the disposition have been segregated as accrued disposition costs. Prior period balance sheet information and related footnotes have not been restated to reflect the discontinuance of the Education Centers.\nIn December 1994, the Company sold its interest in a partnership venture whose purpose was to develop an automated enrollment and financial aid application process. As a result of the sale, the Company recorded a gain on sale of $3,247,000 ($2,143,000 after tax or $.07 per share).\nNOTE 4 - UNUSUAL ITEMS\nDuring the third quarter of 1993, the Company recorded an unusual item charge of $9,232,000 ($6,558,000 after tax or $.22 loss per share) related to NETG which resulted from the write-down of certain acquired intangible assets.\nDuring the fourth quarter of 1992, the Company recorded an unusual charge of $2,506,000 ($1,528,000 after tax or $.05 per share) at NETG. This charge represented severance payments, lease termination charges and fixed asset and leasehold improvement write-downs.\nNOTE 5 - PUBLIC OFFERING OF SUBSIDIARY COMMON STOCK\nDuring the third quarter of 1993, Steck-Vaughn Publishing Corporation completed an initial public offering of 2,668,000 shares of its common stock at $12.00 per share. The offering resulted in proceeds of $29,775,000 of which $20,000,000 were remitted to the Company as payment for a previously declared dividend. The proceeds were reduced by expenses of $1,074,000 which were incurred in connection with the offering, of which $393,000 was paid to Richard C. Blum and Associates (RCBA). The Chairman of the Board of RCBA is Richard C. Blum, a director of the Company. The completion of the offering decreased the Company's ownership of Steck- Vaughn from 100% to 81.7% at the date of the offering. As a result of the offering, the Company recorded an after tax gain of $21,260,000 or $.71 per share which is included in the results of operations for the year ended December 31, 1993. The gain was nontaxable and deferred tax expense was not provided for on this gain given the Company's ability and intent to indefinitely postpone the payment of tax in the future.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 6 - INCOME TAXES\nIncome (loss) before tax from continuing operations was taxed under the following jurisdictions:\nTaxes (benefits) on income from continuing operations were provided as follows:\nDeferred tax liabilities and assets reflected in the balance sheet as of December 31, 1994 and December 31, 1993 are comprised of the following:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe 1994 income tax provision includes an increase in the valuation allowance for deferred tax assets of $20,672,000. The valuation reserve increase primarily relates to losses on discontinued operations for which no tax benefit has been provided.\nAt December 31, 1994, the Company had federal net operating loss carryforwards of approximately $71,000,000 expiring through 2009. In addition, the Company had available $1,275,000 of alternative minimum tax credit carryforwards, with no expiration date, which may be utilized to offset future regular tax liabilities. If certain substantial changes in the Company's ownership should occur, there could be an annual limitation on the amount of carryforwards available for utilization. The Company also has available federal net operating loss carryforwards of approximately $13,200,000 at Spectrum, a subsidiary of NETG, expiring through 2003. This amount may be utilized to offset Spectrum's future taxable income. A valuation allowance against the remaining Spectrum loss carryforward has been provided in the financial statements.\nDuring 1991, the Company received a notice of proposed adjustment from the Internal Revenue Service for the years 1985 and 1986 for matters primarily relating to the tax benefit of certain acquisitions. Management continues to vigorously contest the matter and believes that the ultimate tax liability and related interest thereon will not have a material adverse effect on the consolidated financial position of the Company.\nA reconciliation of the income tax provision (benefit) with the amount computed by applying the federal statutory tax rate to pretax income from continuing operations is as follows:\nProvision has not been made for U.S. or additional foreign taxes on the undistributed earnings of the Company's foreign subsidiaries. Those earnings are expected to be reinvested in the foreign operations. Such earnings would become subject to additional U.S. and foreign taxes if remitted as dividends. It is not practicable to estimate the amount of additional tax that might be payable on the foreign earnings; however, the Company believes that U.S. foreign tax credits would for the most part eliminate any additional U.S. tax.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7 - INVESTMENT SECURITIES\nThe amortized cost and estimated fair value of the investment securities are as follows:\nInvestments in debt securities classified as held-to-maturity at December 31, 1994, have various maturity dates which do not exceed one year.\nUsing the specific identification method, realized gains and losses on the available-for-sale investment securities are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 8 - LAND, BUILDINGS AND EQUIPMENT\nMachinery and equipment and furniture and fixtures under capital leases was $2,460,000 and $1,100,000 with related accumulated depreciation and amortization of $593,000 and $602,000 at December 31, 1994 and 1993, respectively.\n1993 balances have not been restated to exclude Education Centers.\nNOTE 9 - ACQUIRED INTANGIBLE ASSETS\nNOTE 10 - DEBT\nAs of December 31, 1994, the Company had a revolving bank credit agreement in the amount of $10,000,000, of which $5,000,000 was outstanding. On February 28, 1995, the Company amended its revolving bank credit agreement with its existing bank to increase the available amount to $13,500,000, which matures on December 31, 1995. The credit agreement, which is secured by the stock of principal subsidiaries, will initially provide borrowings at prime plus 1 percent or, at the Company's option, at LIBOR plus 2 percent, with incremental borrowing rate increases at June 30 and September 30, 1995. Commitment fees are paid on the unused line of credit and there are certain restrictions on dividend payments, indebtedness and covenants regarding the Company's financial performance and condition.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nUnder the intercompany agreement between the Company and Steck-Vaughn, the Company has the ability to borrow up to $10,000,000 from Steck-Vaughn. Effective February 28, 1995, the Company and Steck-Vaughn entered into a revolving loan agreement which provides that any borrowing by the Company will bear interest at LIBOR plus 2 percent, and will be secured by the Company's holdings of Steck-Vaughn stock. Steck-Vaughn also received an option to repurchase from the Company up to 290,000 shares of Steck-Vaughn stock held by the Company, at $6.50 per share. The option becomes exercisable one year after grant, expires December 31, 1996, and may be redeemed by the Company prior to exercise or expiration for the greater of $750,000 or the amount necessary to increase to 25 percent the annualized yield to Steck-Vaughn on all amounts borrowed by the Company under the revolving loan agreement.\nAt December 31, 1994, the Company had outstanding $20,000,000 of senior subordinated convertible debentures due February 15, 2006 which are convertible at any time prior to maturity into common stock at $4.00 per share. The senior debentures were issued to certain entities affiliated with Richard C. Blum & Associates, L.P. (RCBA) or over which RCBA exercises discretionary investment control and bore interest at 7% per year until February 15, 1993 and 10% thereafter. The senior debentures are redeemable at the option of the Company, in whole or in part, commencing August 15, 1994 at 105% of the principal amount through February 15, 2002, and thereafter at 100%, providing that the Company's common stock equals or exceeds 150% of the conversion price for a specified trading period prior to the notice of redemption. The senior debentures are subject to an annual sinking fund requirement beginning February 15, 2002 sufficient to retire 100% of the aggregate principal amount of the senior debentures prior to maturity. The Chairman of the Board of RCBA is Richard C. Blum, a director of the Company. Based on the December 31, 1994 closing price of the Company's common stock as traded on the New York Stock Exchange of $4.125, the fair value of the senior subordinated convertible debentures, assuming conversion into the Company's common stock, is $20,625,000.\nAt December 31, 1994, the Company had outstanding $57,494,000 of 6.5% convertible subordinated debentures due May 14, 2011 which are convertible at any time prior to maturity into common stock at $25.00 per share. The debentures are redeemable at the option of the Company, in whole or in part, at specified amounts ranging from 106.5% to 100.65% of the principal amount through May 14, 1996, and thereafter at 100%. The debentures are subject to an annual sinking fund requirement beginning May 15, 1997 sufficient to retire 70% of the aggregate principal amount of the debentures prior to maturity. Based on the December 31, 1994 closing price of the Company's convertible subordinated debentures as traded on the New York Stock Exchange of $50.50, the fair value of the convertible subordinated debentures is $29,034,000.\nMortgage notes aggregating $5,763,000 at December 31, 1994 were collateralized by certain real and personal property having a net book value of $6,256,000. At December 31, 1994, the fair value of the mortgage notes approximated their carrying value.\nAggregate maturities of long-term debt in each of the following years are: 1996-$1,234,000, 1997-$1,259,000, 1998-$622,000, and 1999-$622,000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 11 - COMMITMENTS AND CONTINGENCIES\nAggregate commitments at December 31, 1994 under noncancelable operating leases for land, buildings and equipment are as follows:\nSome of the leases contain renewal options, escalation clauses and requirements that the Company pay taxes, insurance and maintenance costs. Total rent expense aggregated $10,841,000, $11,695,000 and $12,294,000 for years ended December 31, 1994, 1993, and 1992, respectively.\nAt December 31, 1994, there were no material commitments outstanding for capital expenditures.\nIn the ordinary course of business, the Company is generally subject to claims, complaints and legal actions. In the opinion of management, these matters will not have a material adverse effect upon the financial position of the Company.\nNOTE 12 - UNEARNED FUTURE TUITION REVENUE\nUnearned future tuition revenue on student contracts at ICS Learning Systems totaled $163,050,000 at December 31, 1994 and $126,167,000 at December 31, 1993. Based upon previous experience, it is estimated that approximately 45% of the unearned future tuition revenue will ultimately be recognized as revenue. Unearned future tuition revenue will be included in revenues in future years when services and courseware are provided as described in Note 1.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 13 - STOCKHOLDERS' EQUITY\nThe Company has stock option plans that authorize the granting of options to key employees and directors to purchase common stock subject to certain conditions, such as continued employment. Options are generally granted at the fair market value of the Company's common stock at the date of grant, vest and become exercisable prorata over the four years following the date of grant, and expire in ten years.\nChanges during the years ended December 31, 1994, 1993 and 1992 under the plans were as follows:\nCommon shares reserved for future grants under the above option plans totaled 1,018,000 and 986,000 at December 31, 1994 and 1993, respectively. Of the 1,354,000 shares previously granted and outstanding at December 31, 1994, 694,000 shares were vested and exercisable at prices ranging from $2.25 to $14.44 per share.\nThere are no charges to income in connection with the issuance of options. Upon exercise, proceeds from the sale of shares under the stock options plans are credited to common stock and additional paid-in capital.\nIn October 1986, the Company declared a dividend of one preferred stock purchase right for each share of common stock. Under certain conditions, each right may be exercised to purchase one-hundredth of a share of a new series of participating junior preferred stock at a purchase price of $75.00, subject to adjustment.\nThe rights may be exercised only after a public announcement that a person has acquired or obtained the right to acquire 20% or more of the Company's outstanding common stock, or after commencement or public announcement of an offer for 30% or more of the Company's outstanding common stock. The rights, which do not have voting rights, may be redeemed by the Company at a price of $.05 per right within ten days after the announcement that a person has acquired 20% or more of the outstanding common stock of the Company and the redemption period may be extended under certain circumstances. In the event that the Company is acquired in a merger or other business combination transaction, provision shall be made so that each holder of a right shall have the right to receive that number of shares of common stock of the surviving company which at the time of the transaction would have a market value of two times the exercise price of the right. The Board of Directors, upon the 1991 issuance of the $20,000,000 senior subordinated convertible debentures to entities affiliated with Richard C. Blum & Associates, Inc. (RCBA Affiliates), excluded all shares issuable to RCBA Affiliates upon conversion of the senior debentures from the provisions of the rights plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 14 - STATEMENTS OF CASH FLOWS\nFor purposes of presenting the Consolidated Statements of Cash Flows, the Company considers all highly liquid debt securities to be cash equivalents.\nSupplementary information excluding Education Centers:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 15 - INDUSTRY SEGMENT DATA\nInformation about the Company's operations (excluding Education Centers except for identifiable assets balances) in different industries is as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe following table sets out the amount of consolidated net revenues, operating income and identifiable assets by geographic area:\nThe Company's operations are conducted in the United States, Canada, United Kingdom, Germany, Australia and several other foreign countries.\nOperating income by segment and geographic area includes net revenues less operating expenses. The operating income by segment and geographic area excludes general corporate expenses, net interest expense and income taxes. Unusual items are more fully described in the Notes to the Consolidated Financial Statements. Intersegment sales were immaterial for all years presented. Identifiable assets are those assets used in the Company's operations in each segment and geographic area and exclude corporate assets and Education Centers assets held for disposition.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 16 - QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following table summarizes quarterly financial data for 1994 and 1993. All periods presented were restated for 1994 only, to reflect the adoption of the SOP. The SOP does not permit restatement of the periods for 1993.\nNATIONAL EDUCATION CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (dollars in thousands)\n(A) 1993 and 1992 balances have not been restated to exclude Education Centers.\n(B) This amount primarily represents the restatement of the Company's discontinued operations.\n(C) This amount primarily represents the write-off of intangible assets in connection with previous acquisitions for the Company's National Education Training Group of $9,232,000 and National Education Centers of $2,766,000.\nEXHIBITS FILED HEREIN","section_15":""}
{"filename":"99780_1994.txt","cik":"99780","year":"1994","section_1":"Item 1. Business.\nGeneral Development of Business. Trinity Industries, Inc. (the \"Registrant\") was originally incorporated under the laws of the State of Texas in 1933. On March 27, 1987, Trinity became a Delaware corporation by merger into a wholly-owned subsidiary of the same name.\nNarrative Description of Business and Financial Information About Industry Segments. The Registrant is engaged in the manufacture, marketing, and leasing of a variety of metal products consisting principally of (1) \"Railcars\" (i.e. railroad freight cars), principally tank cars, hopper cars, gondola cars, intermodal cars and miscellaneous other freight cars; (2) \"Marine Products\" such as boats, barges and various offshore service vessels for ocean and inland waterway service and military vessels for the United States Government and, to a limited extent, various size vessels for international ocean transportation companies; (3) \"Construction Products\" such as highway guardrail and highway and railway bridges, power plants, mills, etc, highway safety products, passenger loading bridges and conveyor systems for airports and other people and baggage conveyance requirements, ready-mix concrete production and aggregates including distribution, and providing raw material to owners, contractors and sub- contractors for use in the building and foundation industry; (4) \"Containers\" such as (a) extremely large, heavy pressure vessels and other heavy welded products including industrial silencers, desalinators, evaporators, and gas processing systems, (b) pressure and non-pressure containers for the storage and transportation of liquefied gases, brewery products and other liquid and dry products, and (c) heat transfer equipment for the chemical, petroleum and petrochemical industries; (5) \"Metal Components\" such as weld fittings (tees, elbows, reducers, caps, flanges, etc.) used in pressure piping systems and container heads (the ends of pressure and non-pressure containers) for use internally and by other manufacturers of containers; and (6) \"Leasing\" of Registrant manufactured railcars and barges to various industries.\nVarious financial information concerning the Registrant's industry segments for each of the last three fiscal years is included in the Registrant's 1994 Annual Report to Stockholders on page 22 under the heading \"Segment Information\", and such section is incorporated herein by reference.\nRailcars. The Registrant manufactures railroad freight cars, principally pressure and non-pressure tank cars, hopper cars, intermodal cars and gondola cars used for transporting a wide variety of liquids, gases and dry cargo. Tank cars transport products such as liquefied petroleum gas, liquid fertilizer, sulfur, sulfuric acids and corn syrup. Covered hopper cars carry cargo such as grain, dry fertilizer, plastic pellets and cement. Open-top hoppers haul coal, and top-loading gondola cars transport a variety of heavy bulk commodities such as scrap metals, finished flat steel products, machinery and lumber. Intermodal cars transport various products which have been loaded in containers.\nMarine Products. The Registrant manufactures a variety of marine products pursuant to customer orders. It produces various types of vessels for offshore service including supply, crew, fishing and other types of boats. The Registrant is currently constructing various military vessels for both the United States Army and Navy. The Registrant produces river hopper barges which are used to carry coal, grain and miscellaneous commodities. The purchasers of the Registrant's marine products include inland waterway marine operators, offshore oil and gas drillers and operators, international ocean transportation companies, barge transport companies and domestic and foreign governmental authorities.\nConstruction Products. The construction products manufactured by the Registrant include beams, girders, columns, highway guardrail and highway safety devices and related barrier products, ready-mix concrete and aggregates, passenger loading bridges, and baggage handling systems. These products are used in the bridge, highway construction and building industries and airports. Some of the sales of beams, girders and columns are to general contractors and subcontractors on highway construction projects. Generally, customers for highway guardrail and highway safety devices are highway departments or subcontractors on highway projects. Passenger loading bridges and conveyor systems are generally sold to contractors, airports, or airlines as part of airport terminal equipment. Ready-mix concrete and aggregates are used in the building and foundation industry and customers include primarily owners, contractors and sub- contractors.\nContainers. The Registrant is engaged in manufacturing metal containers consisting of extremely large, heavy pressure vessels and other heavy welded products, including industrial silencers, desalinators, evaporators, and gas processing systems and for the storage and transportation of liquefied petroleum (\"LP\") gas and anhydrous ammonia fertilizer. Pressure LP gas containers are utilized at industrial plants, utilities, small businesses and in suburban and rural areas for residential heating and cooking needs. Fertilizer containers are manufactured for highway and rail transport, bulk storage, farm storage and the application and distribution of anhydrous ammonia. The Registrant also makes heat transfer equipment for the chemical, petroleum and petrochemical industries and a complete line of custom vessels, standard steam jacketed kettles, mix cookers, and custom-fabricated cooking vessels for the food, meat, dairy, pharmaceutical, cosmetic and chemical industries.\nMetal Components. The metal components manufactured by the Registrant are made from ferrous and non-ferrous metals and their alloys and consist principally of butt weld type fittings, flanges and pressure and non-pressure container heads. The weld fittings include caps, elbows, return bends, concentric and eccentric reducers, full and reducing outlet tees, and a full line of pipe flanges, all of which are pressure rated. The Registrant manufactures and stocks, in standard, extra-heavy and double- extra-heavy weights and in various diameters, weld caps, tees, reducers, elbows, return bends, flanges and also manufactures to customer specifications. The basic raw materials for weld fittings and flanges are carbon steel, stainless steel, aluminum, chrome-moly and other metal tubing or seamless pipe and forgings. The Registrant sells its weld fittings and flanges to distributors and to other manufacturers of weld fittings.\nContainer heads manufactured by the Registrant are pressed metal components used in the further manufacture of a finished product. Since the manufacture of container heads requires a substantial investment in heavy equipment and dies, many other manufacturers order container heads from the Registrant. Container heads are manufactured in various shapes and may be pressure rated or non-pressure, depending on the intended use in further manufacture. Other pressed shapes are also hot- or cold-formed to customer requirements.\nLeasing. The Company has one wholly-owned leasing subsidiary, Trinity Industries Leasing Company (\"TILC\"), which was incorporated in 1979. TILC is engaged in leasing specialized types of railcars, consisting of both tank cars and hopper cars, to industrial companies in the petroleum, chemical, grain, food processing, fertilizer and other industries which supply cars to the railroads. At March 31, 1994, TILC had under lease 10,366 railcars. TILC owns 219 river hopper barges which are operated under an agreement which provides for management of the barges. The barges are generally used for movement of commodities on the inland waterway system, primarily the Mississippi and Missouri Rivers.\nSubstantially all equipment leased by TILC was purchased from the Registrant at prices comparable to the prices for equipment sold by the Registrant to third parties. As of March 31, 1994, TILC had equipment on lease or available for lease purchased from the Registrant at a cost of $536.1 million. Generally, TILC purchases the equipment to be leased only after a lessee has committed to lease such equipment.\nThe volume of equipment purchased and leased by TILC depends upon a number of factors, including the demand for equipment manufactured by the Registrant, the cost and availability of funds to finance the purchase of equipment, the Registrant's decision to solicit orders for the purchase or lease of equipment and factors which may affect the decision of the Registrant's customers as to whether to purchase or lease equipment.\nAlthough the Registrant is not contractually obligated to offer to TILC equipment proposed to be leased by the Registrant's customers, it is the Registrant's intention to effect all such leasing transactions through TILC. Similarly, while TILC is not contractually obligated to purchase from the Registrant any equipment proposed to be leased, TILC intends to purchase and lease all equipment which the Registrant's customers desire to lease when the lease rentals and other terms of the proposed lease are satisfactory to TILC, subject to the availability and cost of funds to finance the acquisition of the equipment.\nMarketing, Raw Materials, Employees and Competition. The Registrant operates only in the continental United States. The Registrant sells substantially all of its products through its own salesmen operating from offices in Montgomery, Alabama; Elizabethtown and Paducah, Kentucky; Shreveport, Louisiana; Flint, Michigan; St. Louis, Missouri; Gulfport, Mississippi; Asheville, North Carolina; Cincinnati and Girard, Ohio; Beaumont, Dallas\/Ft. Worth, Houston and Navasota, Texas; and Centerville, Utah. Independent sales representatives are also used to a limited extent. The Registrant markets railcars, containers and metal components throughout the United States. Except in the case of weld fittings, guardrail, and standard size LP gas containers, the Registrant's products are ordinarily fabricated to the customer's specifications pursuant to a purchase order.\nThe principal materials used by the Registrant are steel plate, structural steel shapes and steel forgings. There are numerous domestic and foreign sources of such steel and most other materials used by the Registrant.\nThe Registrant currently has approximately 14,700 employees, of which approximately 13,450 are production employees and 1,250 are administrative, sales, supervisory and office employees.\nThere are numerous companies located throughout the United States that are engaged in the business of manufacturing various railcars and containers of the types manufactured by the Registrant, and these industries are highly competitive. Companies manufacturing products which compete with the Registrant's construction products consist of numerous other structural fabricators and ready-mix concrete producers, most of which are smaller than the Registrant. Small shipyards located on inland waterways and medium to large size shipyards located on or near ports on navigable waterways produce marine products which compete with those manufactured by the Registrant. Both domestic and foreign manufacturers of metal components, some of which are larger than the Registrant, compete with the Registrant. A number of well-established companies actively compete with TILC in the business of owning and leasing railcars, as well as banks, investment partnerships and other financial and commercial institutions.\nRecent Developments. Information concerning the Registrant's business acquisitions are included in the Registrant's 1994 Annual Report to Stockholders under the heading \"Business Acquisitions,\" (pages 23 through 24) and such section is incorporated herein by reference.\nOther Matters. The Registrant is not materially affected by 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. To date, the Registrant has not suffered any material shortages with respect to obtaining sufficient energy supplies to operate its various plant facilities or its transportation vehicles. Future limitations on the availability or consumption of petroleum products (particularly natural gas for plant operations and diesel fuel for vehicles) could have an adverse effect upon the Registrant's ability to conduct its business. The likelihood of such an occurrence or its duration, and its ultimate effect on the Registrant's operations, cannot be reasonably predicted at this time.\nAll machinery and equipment and the buildings occupied by the Registrant are maintained in good condition. The Registrant estimates that its plant facilities were utilized during the fiscal year at an average of approximately 60 percent of present productive capacity for railcars, 70 percent for Marine Products, 75 percent for Construction Products, 65 percent for Containers, and 75 percent for Metal Components.\nItem 3.","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings. See page 28 of the Registrant's 1994 Annual Report to Stockholders which is incorporated herein by reference for a discussion of 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 the fourth quarter of fiscal year 1994.\n___________________\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\nMarket for the Registrant's common stock and related stockholder matters are incorporated herein by reference from the information contained on page 3 under the caption \"Corporate Profile\" and on page 15 under the caption \"Financial Summary\" of the Registrant's 1994 Annual Report to Stockholders.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nSelected financial data is incorporated herein by reference from the information contained on page 15 under the caption \"Financial Summary\" of the Registrant's 1994 Annual Report to Stockholders.\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 are incorporated herein by reference from the Registrant's 1994 Annual Report to Stockholders, pages 16 through 17.\nOther persons, who are not executive officers of the Registrant, are listed on page 30 under the caption \"Division Officers\" of the Annual Report to Stockholders, and such caption is hereby incorporated by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nFinancial statements of the Registrant at March 31, 1994 and 1993 and for each of the three years in the period ended March 31, 1994 and the auditor's report thereon, and the Registrant's unaudited quarterly financial data for the two year period ended March 31, 1994, are incorporated by reference from the Registrant's 1994 Annual Report to Stockholders, pages 18 through 29.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure.\nNo disclosure required.\n______________________\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nInformation concerning the directors and executive officers of the Registrant is incorporated herein by reference from the Registrant's definitive proxy statement for the Annual Meeting of Stockholders on July 20, 1994, page 3, under the caption \"Election of Directors\".\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation on executive compensation is incorporated herein by reference from the Registrant's definitive proxy statement for the Annual Meeting of Stockholders on July 20, 1994, page 6 under the caption \"Executive Compensation and Other Matters\".\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation concerning security ownership of certain beneficial owners and management is incorporated herein by reference from the Registrant's definitive proxy statement for the Annual Meeting of Stockholders on July 20, 1994, page 2, under the caption \"Voting Securities and Stockholders\", and page 3, under the caption \"Election of Directors\".\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation concerning certain relationships and related transactions is incorporated herein by reference from the Registrant's definitive proxy statement for the Annual Meeting of Stockholders on July 20, 1994, pages 3 through 4, under the caption \"Election of Directors\", and page 15, under the caption \"Certain Transactions\".\n___________________\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) 1&2. Financial statements and financial statement schedules. The financial statements and schedules listed in the accompanying indices to financial statements and financial statement schedules are filed as part of this Annual Report Form 10-K.\n3. Exhibits. The exhibits listed on the accompanying index to exhibits are filed as part of this Annual Report Form 10-K.\n(b) Reports on Form 8-K No Form 8-K was filed during the fourth quarter of fiscal 1994.\nTrinity Industries, Inc.\nFinancial Statements and Financial Statement Schedules\nfor Inclusion in Annual Report Form 10-K\nYear Ended March 31, 1994\nEXHIBIT (23)\nConsent of Independent Auditors\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of Trinity Industries, Inc. of our report dated May 10, 1994, included in the 1994 Annual Report to Stockholders of Trinity Industries, Inc.\nOur audits also included the financial statement schedules of Trinity Industries, Inc. 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. 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 set forth therein.\nWe also consent to the incorporation by reference in Post-Effective Amendment No. 3 to the Registration Statement (Form S-8, No. 2-64813), Post-Effective amendment No. 1 to the Registration Statement (Form S-8, No. 33-10937), Post-Effective Amendment No. 1 to the Registration Statement (Form S-3, No. 33-12526), Amendment No. 1 to the Registration Statement (Form S-3, No. 33-57338), Registration Statement (Form S-8, No. 33-35514), Registration Statement (Form S-8, No. 33- 73026), Registration Statement (Form S-4, No. 33-51709) of Trinity Industries, Inc. and in the related Prospectuses of our report dated May 10, 1994, with respect to the consolidated financial statements and schedules of Trinity Industries, Inc. included or incorporated by reference in this Annual Report (Form 10-K) for the year ended March 31, 1994.\nERNST & YOUNG\nDallas, Texas June 28, 1994\nSCHEDULE VI\nSCHEDULE X Trinity Industries, Inc. Supplementary Income Statement Information (in millions)\nYear Ended March 31 1994 1993 1992 Maintenance and repairs . . $34.5 $30.8 $27.6\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.\nTrinity Industries, Inc. Registrant\nBy: \/s\/ F. Dean Phelps, Jr. F. Dean Phelps, Jr. Vice President June 28, 1994\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons of the Registrant and in the capacities and on the dates indicated:\nDirectors: Principal Executive Officer: \/s\/David W. Biegler \/s\/ W. Ray Wallace David W. Biegler W. Ray Wallace Director President and Chairman June 28, 1994 June 28, 1994\nPrincipal Financial Officer: \/s\/ K. W. Lewis Barry J. Galt K. W. Lewis Director Senior Vice President June 28, 1994 June 28, 1994\nPrincipal Accounting Officer: \/s\/Dean P. Guerin \/s\/ F. Dean Phelps, Jr. Dean P. Guerin F. Dean Phelps, Jr. Director Vice President June 28, 1994 June 28, 1994\n\/s\/ Jess T. Hay Jess T. Hay Director June 28, 1994\n\/s\/Edmund M. Hoffman Edmund M. Hoffman Director June 28, 1994\n\/s\/Ray J. Pulley Ray J. Pulley Director June 28, 1994\n\/s\/Timothy R. Wallace Timothy R. Wallace Director June 28, 1994\nEXHIBIT 13 Corporate Profile\nTrinity Industries, Inc. is a large manufacturer of heavy metal products with manufacturing and fabrication operations in six business segments: Railcars, Marine Products, Construction Products, pressure and non-pressure Containers, Metal Components, and Leasing. The Company, headquartered in Dallas, Texas, produces at sixty-seven facilities containing over twelve million square feet of manufacturing space in eighteen states.\nThe Company has a continuing strategy of growth through internal expansion and strategic acquisitions within its established business segments.\nTrinity's stockholders of record numbered more than 2,700 at March 31, 1994. Its common stock is traded on the New York Stock Exchange under the symbol TRN.\nHighlights (in millions except per share data) Year Ended March 31 1994 1993 1992 Revenues. . . . . . . . . . . . . . . . $1,784.9 1,540.0 1,273.3\nIncome before cumulative effect of change in accounting for income taxes . . . . $ 68.3 45.0 24.3 Cumulative effect of change in accounting for income taxes. . . . . . 7.9 - - Net income. . . . . . . . . . . . . . . $ 76.2 45.0 24.3\nIncome per common and common equivalent share before cumulative effect of change in accounting for income taxes. $ 1.69 1.27 0.71\nCumulative effect of change in accounting for income taxes. . . . . . 0.20 - -\nNet income per common and common equivalent share . . . . . . . . . . . $ 1.89 1.27 0.71\nCash dividends per share (1). . . . . . . $ 0.64 0.53 0.53 Stockholders' equity. . . . . . . . . . $ 570.5 507.3 379.0\nTotal assets: Excluding Leasing Subsidiary. . . . . $ 959.5 735.4 716.1 Leasing Subsidiary. . . . . . . . . . $ 347.3 353.7 305.1 $1,306.8 1,089.1 1,021.2\nCapital expenditures (net of business acquisitions): Excluding Leasing Subsidiary. . . . . $ 45.2 36.2 24.1 Leasing Subsidiary. . . . . . . . . . $ 37.6 74.5 64.3 $ 82.8 110.7 88.4\n(1) Net income per common and common equivalent share and Cash dividends per share for the years ended March 31, 1993 and 1992 are restated for the three-for-two stock split distributed on August 31, 1993.\n1994 President's Letter Trinity Industries, Inc.\nThe past year has been a good one for Trinity Industries, Inc. Increased demand for our products spurred internal expansion and strategic acquisitions. Our continued dedication to providing quality products, outstanding service, and competitive prices has been apparent in our ability to maintain or improve our market share in virtually every business segment we serve. Each of our business segments is strong and competitive. Yet, we constantly are seeking ways to operate more efficiently. In this rapidly changing technological age, our employees receive valuable training using advanced methods which result in production enhancement. We constantly monitor technological advancements to provide our employees with the necessary tools for producing quality products in a timely and cost effective manner.\nOur employees have demonstrated a remarkable team effort which has improved communications between all employees. This communication results in more productive employee teams which are capable of meeting production challenges. Our employees are better trained and more experienced than ever before. The Company is committed to manufacturing quality products at competitive prices in surroundings that are secure for employees, environmentally discerning, and socially conscious. Opportunities exist worldwide for our various business segments. Our product diversification is attracting considerable interest both nationally and internationally and has led us to make strategic acquisitions over the past year. All of these factors serve to strengthen our workforce and streamline our operations. Our employees, as well as our customers, suppliers, and stockholders are realizing the benefits of this company-wide effort.\nFor its 1994 fiscal year, Trinity reported record revenues and net income. There was an increase in revenues and income before cumulative effect of accounting change for income taxes of 16% and 52%, respectively. In the twelve month period ended March 31, 1994, revenues were $1.78 billion, and the Company recorded income before cumulative effect of change in accounting for income taxes of $68.3 million, or $1.69 per share. Net income was $76.2 million, or $1.89 per share. For the twelve months of the prior fiscal year, net income of $45.0 million, or $1.27 per share, was recorded on revenues of $1.54 billion. In the three months ended March 31, 1994, revenues totalled $452.7 million. Income before cumulative effect of change in accounting for income taxes of $15.2 million, or $0.38 per share, was recorded. In the prior year's comparable quarter, net income of $14.7 million, or $0.40 per share, was recorded on revenues of $388.9 million.\nBoth our Railcars and Marine Products business segments are experiencing growth and are in the enviable position of having an increase in orders on hand. We see the replacement of aging railcars as the contributing factor to the reinvigorated railcar industry. Our Marine Products segment is, likewise, seeing an increased demand for marine vessels and barge replacements. We are maintaining a program of construction, renovation and expansion to accommodate this growth, and we are installing advanced computer and robotics systems to aid in planning, assembly and delivery of our products. Barring a significant downturn in the economy, the increasing demand for both of these business segments should continue.\nTrinity's Construction Products segment continues to generate new business through strategic entries into markets throughout the United States and expansion of our product lines. We expect to see continued growth opportunities in the upgrading of our nation's transportation system and improvements in residential, commercial and industrial markets.\nOur Containers segment is composed of two different groups of products. The first group of products is custom specialty vessels to the chemical, petrochemical, refining, food and other industries requiring large, heavy, close tolerance welding and machining in a variety of metals. Although there has been intense competition during the past year, customers are now seeking numerous quotes from us. Probably being fueled by the effective dates of the recent clean air act, this leading indicator usually forecasts a sharp increase in orders on hand.\nThe second group of products is more oriented to volume production of many similar containers - rather than one of a kind. Generally referred to as the Liquified Petroleum Gases (\"LPG\") containers, this group of products is influenced by the increase in homebuilding. We have invested in substantial upgrades in our finishing processes which gives our LPG Containers a superior appearance - similar to that of major home appliances. This investment has resulted in Trinity moving ahead in market position.\nOur Metal Components segment continues to provide reliable, responsive service to the chemical, petrochemical, process and refining industries with an even broader offering of quality products anticipated in the year ahead. We will maintain our focus by expanding product lines, striving for the best manufacturing technology available, pursuing cost effective measures, and meeting the needs of our customers.\nServing customers as an alternative to ownership of Trinity products is our Leasing segment. Leasing of railcars and LPG tanks by Trinity to qualified customers gives the customer flexibility in cash management and administrative procedures. The Leasing segment assists in the marketing of Trinity's products.\nWe expect each of our business segments to prosper in the coming year as they support each other, serve expanding markets, and contribute to the success of our customers and Trinity. Our infrastructure and operating strategy will provide us with the competitive edge for the future.\nMy outlook for Trinity is one of great optimism for the rest of this decade. Based on our current performance, I foresee more success in the coming year as we meet the needs of our customers. As we work together to provide quality products, deliver excellent service, and compete for the best market value -- customers, suppliers, stockholders, and employees will benefit, and Trinity will prosper. It has been a very good year, and I am extremely grateful to each of you for your loyalty and support. Together, we will make fiscal 1995 even better.\nRailcars\nTrinity's Railcars segment manufactures a full line of freight and tank railcars and related railcar parts and components. Trinity markets railcars to railroads, leasing companies and private shippers (major corporations and associations who choose to own their own railcars for movement of their commodities and products). Railcars are used to transport bulk products and commodities including coal, grain, cement, plastic raw materials, petroleum products, chemicals, intermodal containers (products bundled in shipping containers designed to fit on railcars and other modes of transportation to minimize shipping costs), lumber, and similar products. Trinity has estab- lished itself as a leading manufacturer of quality railcar products.\nThe Railcars segment reported an increase in operating profit of 97.8% on a 36.4% increase in revenues for fiscal 1994. Revenues were $730.6 million and operating profit was $53.2 million for the year ended March 31, 1994. In the prior fiscal year, revenues of $535.5 million and operating profit of $26.9 million were reported.\nTrinity is focused on providing exceptional value in the railcar products it markets. Internal quality assurance programs involve all Trinity employees in providing quality products and service to customers. QuEST, Trinity's quality assurance program, draws on the suggestions and input of experienced, front line production employees in order to lower operating costs and strive for greater quality of Trinity products.\nRailcar orders on hand at March 31, 1994 were at a record level reflecting customers' confidence in Trinity's abilities as a manufacturer of quality railcar products. Innovative manufacturing, competitive pricing, and quality workmanship combine to position Trinity's Railcars segment as a leader in the railcar industry.\nMarine Products\nTrinity's Marine Products segment builds a full line of marine vessels and inland river hopper barges and ocean-going tanker barges, and provides repair of marine vessels and cleaning facilities for barges. Marine vessels and barges generally range from 100 feet to more than 350 feet and include such commercial marine vessels as fishing boats, tugs, supply boats, large offshore barges, inland hopper barges, crew boats, ferries, oceanographic survey boats, tour boats, riverboat casinos, patrol boats, tow boats, and hydrographic survey boats. Trinity's commercial customer base includes many of the major industrial corporations of North America. Trinity builds various smaller and medium size marine vessels for the United States Navy, United States Army and Corps of Engineers. Other customers include several foreign governments and companies. Trinity's broad base of different types of marine vessels and its many years of experience and dependable production have made it an important supplier of marine vessels and barges.\nThe Marine Products segment revenues were $360.7 million and operating profit was $28.9 million for the year ended March 31, 1994. In the prior fiscal year, revenues of $403.2 million and operating profit of $30.8 million were reported.\nThe Marine Products segment concentrates on a high level of customer service and satisfaction. At March 31, 1994, there were a wide variety of marine vessels on order from a diversified group of commercial and governmental customers. The marine vessel and barge building segment is experiencing strong, wide based demand for its products. Recent governmental legislation and regulations which mandate different \"double skin\" construction procedures will have a beneficial effect on demand in the future. Prospects for the Marine Products segment are bright.\nConstruction Products\nTrinity's Construction Products segment fabricates a broad line of products used by governmental, industrial, commercial and utility customers. Diversified product lines include structural components of highway and railway bridge beams and girders, highway safety products, passenger loading bridges, conveyor systems, and ready-mix concrete and aggregates. Trinity is well known to the federal and state governments as a significant supplier of highway and railway bridges, guardrail, highway safety devices, and related barrier products for the nations highway system. During the past two years, Trinity has diversified into the ready- mix concrete and aggregates industry. Demand is brisk for these products in the geographic area served by the Company. (See Trinity's Expansion of Construction Products Segments on page 14.)\nOperating profit for the fiscal year increased 57.5% on a revenue increase of 17.8%. The Construction Products segment revenues were $333.1 million and operating profit was $35.6 million for the year ended March 31, 1994. In the prior fiscal year, revenues of $282.7 million and operating profit of $22.6 million were reported.\nTrinity's Construction Products segment is prepared for continued success meeting the market demands expected in the markets it serves.\nContainers\nTrinity's Containers segment manufactures a full line of vessels in three broad categories. The Company fabricates:\n(a) containers for the transportation and storage of liquefied petroleum gases, food and beverage products, and other liquid and dry products ranging in size from as small as 50 gallons to as large as 120,000 gallons. Pressure and nonpressure containers are built, as appropriate, to Department of Transportation and American Society of Mechanical Engineer's standards. Products consist of cylinders, domestic tanks, truck tank and transport barrels, storage vessels, and custom fabrication. Customers include residential, industrial, governmental, and commercial users;\n(b) extremely large, heavy pressure vessels and other heavy welded products. Vessels range to thicknesses of 14 inches, diameters up to 40 feet, lengths exceeding 500 feet, and weights up to 1,000 tons. Vessels, generally, are constructed of carbon steel but may be constructed of exotic materials such as alloy, stainless steel, aluminum, clad, and weld overlay. Products include pressure vessels, storage tanks, refinery and chemical reactors, industrial silencers, heat recovery systems, desalinators, evaporators, digesters for pulp paper industry, and custom weldments. Customers are major industrial users particularly in the petroleum, chemical, food processing and utility industries; and,\n(c) heat transfer equipment. Heat transfer equipment is used to increase or decease temperature of liquid product passing through the vessel. Heat transfer equipment is generally built to an exact set of design standards and configurations provided by the customer. Customers are major industrial users in the petroleum and chemical industries.\nThe Containers segment revenues were $155.6 million and operating profit was $9.8 million for the year ended March 31, 1994. In the prior fiscal year, revenues of $141.1 million and operating profit of $15.0 million were reported.\nWith new technological advances relating to painting and finishing of containers, the recent changes in law concerning clean air regulations, the improvement in the residential housing industry and the economy in general, the Containers segment is anticipated to improve its competitive position.\nMetal Components\nTrinity's Metal Components segment manufactures and markets two different broad lines of products: (a) fittings and flanges; and (b) container heads. Fittings consist principally of butt weld type fittings. Flanges are pressure rated pipe flanges. Container heads are the rounded ends on containers.\nWeld fittings include elbows, return bends, concentric and eccentric reducers, full and reducing outlet tees. Flanges and fittings are manufactured from carbon steel, stainless steel, aluminum, chrome-moly and other metal tubing and seamless pipe and forgings. Trinity sells its weld fittings and flanges to distributors and to other manufacturers of weld fittings.\nContainer heads manufactured by Trinity are pressed metal components used in the further manufacture of a finished product. The manufacture of container heads requires a substantial investment in machinery and equipment. Many other manufacturers order container heads from Trinity rather than make the investment required to produce container heads. Container heads are manufactured in various shapes and may be pressure rated or nonpressure, depending on the intended use in further manufacture.\nThe Metal Components segment revenues were $99.7 million and operating profit was $11.7 million for the year ended March 31, 1994. In the prior fiscal year, revenues of $96.8 million and operating profit of $13.8 million were reported.\nAs the industries served by the Metal Components segment continue to modernize, repair, and expand facilities, the Metal Components segment should enjoy increased demand for its products.\nLeasing\nTrinity gains market flexibility with its wholly-owned leasing subsidiary, Trinity Industries Leasing Company. Trinity can offer customers an alternative to purchasing railcars. The leasing of Trinity's railcars allows customers to retain working capital and reduce administrative expenses while providing them access to Trinity's highly regarded maintenance, testing and repair facilities. Trinity has more than 9,000 railcars in its lease portfolio furnishing the Company with a consistent flow of income, tax deferrals, and equity in long-life assets.\nThe Leasing segment revenues were $104.6 million and operating profit was $15.3 million for the year ended March 31, 1994. In the prior fiscal year, revenues of $79.6 million and operating profit of $7.5 million were reported.\nBecause of the consolidation of Trinity Industries Leasing Company under Statement of Financial Accounting Standards Number 94 (See Summary of Significant Accounting Policies and Leasing notes in Notes to Consolidated Financial Statements), intercompany interest income aggregating $ 5.0 million is eliminated from Trinity's consolidated financial statements.\nTrinity's Expansion of the Construction Products Segment\nA few years ago, Trinity decided it was time to broaden the number of products sold in the Construction Products segment. After studying various products in the construction products lines of business and prospective favorable geographical regions, it was determined that selected markets in the state of Texas would be important geographical areas for rebuilding as the state and nation recovered from economic difficulty. The right opportunity was presented, and Trinity diversified into the concrete ready-mix and aggregate business. This diversification is in harmony with Trinity's philosophy of providing quality products, superior service, and competitive pricing. Aggregates are the natural resource used in making concrete and may be consumed as a raw material in the ready- mix concrete business or sold separately.\nManagement Discussion of Operations and Financial Condition\nOperations\nRecord revenues of $1.78 billion were recorded for the fiscal year ended March 31, 1994, an increase of $244.9 million compared to fiscal 1993. Significant increases in demand in the Railcars, Construction Products, Containers, and Leasing segments lead to the record year. Revenues recorded by the Metal Components segment remained comparable to the previous fiscal year. Revenues recorded declined when compared to Marine Products previous fiscal year's record revenues. Demand for railcars has increased causing upward adjustments to production rates to accommodate increases in business. The Construction Products segment's revenues were favorably affected by additional business acquisitions of certain concrete operations. (See Business Acquisitions in the Notes to Consolidated Financial Statements). The Containers and Metal Components segments experienced expanding markets. Total operating profit increased from $74.6 million in fiscal 1993 to $116.6 million in fiscal 1994 due primarily to higher operating profit recorded in the Rail- cars, Construction Products, and Leasing segments, partially offset by slightly lower operating profit recorded in the Marine Products, Containers and Metal Components segments.\nContinuing a trend which accelerated in fiscal 1993, production and deliveries in the Railcars segment increased in fiscal 1994. Operating profit as a percentage of revenues increased in fiscal 1994 compared to the previous fiscal year as greater efficiencies were achieved as a result of ongoing participation in quality assurance programs established in previous years. Indicating future expansion in production, the segment ended the fiscal year with a record number of railcars to be produced. Trinity continues to be very active in the railcar market with a variety of car types including coal, grain, plastic pellet, cement, intermodal and a variety of tank railcars. Increased revenues and operating profit in fiscal 1994 are primarily the result of expanded demand. This demand is attributed to a continuing railcar replacement cycle, demand for new types of railcars as the transporting of certain commodities across the country shifts from over-the-road trucking to rail, a net increase in the amount of goods and products that are shipped by rail, and the general improvement in the economy.\nIn the Marine Products segment, demand for the segment's products, marine vessels and barges, continues to be strong and broad based. The decline in current fiscal year results compared to results from the previous fiscal year is due primarily to the record revenues and operating profit recorded in the previous fiscal year from the completion of a multi-vessel, quick production contract. The replacement market for vessels and barges is leading to expanded production. The Marine Products segment is further positioning itself for future growth and contribution to operating profit through strategic business acquisitions. (See Business Acquisitions in the Notes to Consolidated Financial Statements).\nConstruction Products segment's revenues and operating profit increased in the current fiscal year compared to the previous fiscal year. These results signify the effect of the decision to emphasize infrastructure products, including highway guardrail and safety barriers, and construction materials and aggregates. Continued expansion of the ready mix concrete markets helped to boost the segment's revenues and operating profit.\nGeneral improvement in the chemical and petroleum industries and new housing starts is leading to improvement in the Containers segment, particularly the market for LPG tanks. Competitive markets for the Company's large pressure vessels are partially offsetting segment operating profit. Industry demand for products in the Metal Components segment has risen in the current fiscal year. General improvement in the economy has generated some expansion in the industries served by this segment. Leasing segment's operating profit was higher in fiscal 1994 due primarily to additions of new freight and tank railcars to the fleet, sales of selected car types previously for lease, and a slight reduction in overall repair and maintenance expenses in the current fiscal year.\nRecord revenues of $1.54 billion were recorded by the Company for the fiscal year ended March 31, 1993, an increase of $266.7 million compared to fiscal 1992. Significant increases in demand in the Railcars, Marine Products, Construction Products and Leasing segments lead to the record fiscal year. Revenues recorded by the Containers and Metal Components segments remained comparable to the previous fiscal year. Marine Products' segment's revenues increased due to work performed on several large contracts. Demand for railcars continued to grow as the replacement market moved forward. The Construction Products segment's revenues were favorably affected by the business acquisition of Syro Steel Company (\"Syro\") (See Business Acquisitions in the Notes to Consolidated Financial Statements) and additional business acquisitions of certain concrete operations. (See Business Acquisitions in the Notes to Consolidated Financial Statements). Total operating profit increased from $43.4 million in fiscal 1992 to $74.6 million in fiscal 1993 due primarily to higher operating profit recorded in the Railcars, Marine Products, Construction Products, and Leasing segments, partially offset by slightly lower operating profit recorded in the Containers and Metal Components segments.\nDemand for Marine Products in fiscal 1993 continued to increase in a variety of different types of vessels and barges. The increase in operating profit reflected the trend, which began in fiscal 1992, of performance on higher margin contracts and efficiencies connected with higher production. The benefit derived from investments in new operating facilities and the refurbishment and reopening of other operating facilities during the current and past few years favorably affected operating profit. Production and deliveries in the Railcars segment increased in fiscal 1993 resulting in improved operating profit. Orders on hand at the end of the fiscal year were approximately twice as high as the previous fiscal year end. Increased revenues and operating profit in fiscal 1993 were primarily the result of expanded demand. Construction Products segment's operating profit increased as the business acquisition of Syro enhanced the segment's market presence in the highway safety products market. The expansion of the ready-mix concrete market helped to boost the segment's operating profit.\nCompetitive conditions in the Containers segment, particularly the market for LPG tanks, accounted for the increase in revenues while causing a slight decline in operating profit. Industry demand for products in the Metal Components segment remained strong. Leasing segment's operating profit was higher in fiscal 1993 due primarily to additions of railcars during the last quarter, which had little or no maintenance expenses, and on average, had a high rental rate compared to the remainder of the lease fleet.\nSelling, engineering and administrative expenses were up slightly in fiscal 1994 compared to fiscal 1993. Increases due to additional personnel from fiscal 1994 business acquisitions and increased Railcars segment business, offset somewhat by the absence of expenses present in the prior fiscal year related to the business acquisition of Syro. Selling, engineering and administrative expenses increased to $93.4 million in fiscal 1993 from $77.5 million in fiscal 1992 due principally to expenses associated with additional personnel from fiscal 1993 business acquisitions in the concrete division of the Construction Products segment and the custom vessel division of the Containers segment, additional expenses associated with increased business in the Railcars and Marine Products segments, and expenses related to the business acquisition of Syro.\nInterest expense of the Leasing Subsidiary decreased by $4.4 million in fiscal 1994 compared to fiscal 1993 due primarily to the conversion of Leasing Subsidiary debt to common stock of the Company in the fourth quarter of fiscal 1993 (see Long-term Debt in the Notes to Consolidated Financial Statements). Interest expense of Leasing Subsidiary increased by $2.7 million in fiscal 1993 compared to fiscal 1992 due primarily to additional borrowings to fund railcar purchases.\nRetirement plans expense decreased to $9.2 million in fiscal 1994 from $10.2 million in fiscal 1993. The decrease is due primarily to the reduction of the actuarial accrual related to a certain supplemental retirement benefit agreement, offset by increases in personnel due to fiscal 1994 business acquisitions. Retirement plans expense increased to $10.2 million in fiscal 1993 from $9.0 million in fiscal 1992. The increase was due primarily to a general increase in total personnel caused primarily by fiscal 1993 business acquisitions and improved business in the Railcars and Marine Products segments.\nNet interest expense of $4.0 million in fiscal 1994 increased as compared to $3.3 million in fiscal 1993 primarily due to the increase in the usage of short-term debt to finance business acquisitions, offset by a decline in long- term debt due to regularly scheduled principal payments. Net interest expense of $3.3 million in fiscal 1993 decreased as compared to $6.4 million in fiscal 1992 as balances of both long-term debt, excluding Leasing Subsidiary, and short-term debt declined. The decline in long-term debt was due to scheduled principal payments, and to a lesser degree, to the conversion of debt to common stock of the Company in the fourth quarter of fiscal 1993 (see Long-term Debt in the Notes to Consolidated Financial Statements). Greater use of net cash flows from operations to sustain operating requirements created less reliance on short-term debt.\nThe provision for income taxes in fiscal 1994 expressed as a percent of income before income taxes is a 40.2 percent rate as compared to a 37.6 percent rate in fiscal 1993 and a 38.8 percent rate in fiscal 1992. The increase between fiscal 1994 and 1993 is due principally to the increase in the statutory federal income tax rate and the increase in the provision for state income taxes. The decrease between fiscal 1993 and 1992 was due principally to the decrease in the provision for state income taxes stated as a percentage.\nIn February, 1992, the Financial Accounting Standards Board issued SFAS No. 109, \"Accounting for Income Taxes.\" The Company was required to adopt SFAS No. 109 in fiscal 1994 and change from the deferred to the liability method of computing income tax. The Company recognized the cumulative effect of the change in method as of April 1, 1993 resulting in an increase to net income of $7.9 million. (see Income Taxes in the Notes to the Consolidated Financial Statements)\nLiquidity and Financial Resources\nDuring fiscal 1994, internally generated funds and short-term borrowing were used to support capital expenditures and payments for business acquisitions. Capital expenditures, excluding Leasing Subsidiary, for fiscal 1994 were $45.2 million. Capital expenditures projected for fiscal 1995 are $50 million. Payments for acquisitions in fiscal 1994, net of cash acquired, totalled $36.2 million. Future operating requirements are expected to be financed principally with net cash flows from operations. Internally generated funds, short-term and long-term debt will continue to be used to finance business acquisitions. Additions to TILC's railcar fleet are anticipated to be financed through internally generated funds, the issuance of equipment trust certificates, or similar debt instruments.\nThe percentages of long-term debt and stockholders' equity to total capital (long-term debt and stockholders' equity) of $848.4 million (of which Leasing Subsidiary's long-term debt is $236.0 million) were 32.8 percent (of which Leasing Subsidiary's long-term debt is 27.8 percent of total capital) and 67.2 percent, respectively.\nInflation\nChanges in price levels did not significantly affect the Company's operations in fiscal 1994, 1993 or 1992.\nConsolidated Income Statement (in millions except per share data) Year Ended March 31 1994 1993 1992\nRevenues. . . . . . . . . . . . . . . . . . . . $1,784.9 $1,540.0 $1,273.3\nOperating costs: Cost of revenues. . . . . . . . . . . . . . . 1,541.2 1,333.7 1,118.0 Selling, engineering and administrative expenses . . . . . . . . . . . . . . . . . . 94.2 93.4 77.5 Interest expense of Leasing Subsidiary. . . . 23.7 28.1 25.4 Retirement plan expense . . . . . . . . . . . 9.2 10.2 9.0 1,668.3 1,465.4 1,229.9 Operating profit. . . . . . . . . . . . . . . . 116.6 74.6 43.4\nOther (income) expenses: Interest income . . . . . . . . . . . . . . . (1.6) (1.2) (1.2) Interest expense - excluding Leasing Subsidiary . . . . . . . . . . . . . . . . . 5.6 4.5 7.6 Other, net. . . . . . . . . . . . . . . . . . (1.6) (0.8) (2.7) 2.4 2.5 3.7 Income before income taxes and cumulative effect of change in accounting for income taxes . . . 114.2 72.1 39.7 Provision (benefit) for income taxes: Current . . . . . . . . . . . . . . . . . . . 45.1 25.7 20.4 Deferred. . . . . . . . . . . . . . . . . . . (1.3) 1.4 (5.0) Effect of statutory rate increase . . . . . . 2.1 - - 45.9 27.1 15.4 Income before cumulative effect of change in accounting for income taxes. . . . . . . . . . 68.3 45.0 24.3 Cumulative effect as of April 1, 1993 of change in accounting for income taxes . . . . . . . . 7.9 - - Net income. . . . . . . . . . . . . . . . . . . $ 76.2 $ 45.0 $ 24.3\nIncome per common and common equivalent share before cumulative effect of change in accounting for income taxes. . . . . . . . . . $ 1.69 $ 1.27 $ 0.71 Cumulative effect of change in accounting for income taxes . . . . . . . . . . . . . . . . . 0.20 - - Net income per common and common equivalent share. . . . . . . . . . . . . . . . . . . . . $ 1.89 $ 1.27 $ 0.71\nWeighted average number of common and common equivalent shares outstanding . . . . . . . . 40.3 35.4 34.2\nSee accompanying notes to consolidated financial statements.\nConsolidated Balance Sheet\nMarch 31 (in millions except per share data) 1994 1993\nAssets Cash and cash equivalents . . . . . . . . . . . . . . $ 8.7 $ 7.5\nReceivables . . . . . . . . . . . . . . . . . . . . . 264.9 203.2\nInventories . . . . . . . . . . . . . . . . . . . . . 328.8 211.2\nProperty, plant and equipment, at cost: Excluding Leasing Subsidiary. . . . . . . . . . . . 590.8 509.8 Leasing Subsidiary. . . . . . . . . . . . . . . . . 479.2 476.9\nLess accumulated depreciation: Excluding Leasing Subsidiary. . . . . . . . . . . . (263.0) (223.5) Leasing Subsidiary. . . . . . . . . . . . . . . . . (139.9) (132.2)\nOther assets. . . . . . . . . . . . . . . . . . . . . 37.3 36.2 $1,306.8 $1,089.1\nLiabilities and Stockholders' Equity\nShort-term debt . . . . . . . . . . . . . . . . . . . $ 192.0 $ 15.0\nAccounts payable and accrued liabilities. . . . . . . 161.6 140.1\nBillings in excess of cost and related earnings . . . 12.6 32.0 Long-term debt: Excluding Leasing Subsidiaries. . . . . . . . . . . 41.9 49.2 Leasing Subsidiaries. . . . . . . . . . . . . . . . 236.0 244.0\nDeferred income taxes . . . . . . . . . . . . . . . . 73.9 85.9\nOther liabilities . . . . . . . . . . . . . . . . . . 18.3 15.6 736.3 581.8\nStockholders' equity: (shares in millions) Common stock - par value $1 per share; authorized at March 31, 1994 - 100.0 shares and March 31, 1993 - 40.0 shares; shares issued and outstanding in 1994 - 39.7; in 1993 - 26.1 . . 39.7 26.1 Capital in excess of par value. . . . . . . . . . . 213.4 214.5 Retained earnings . . . . . . . . . . . . . . . . . 317.4 266.7 570.5 507.3 $1,306.8 $1,089.1\nSee accompanying notes to consolidated financial statements.\nConsolidated Statement of Cash Flows (in millions) Year Ended March 31 1994 1993 1992 Cash flows from operating activities: Net income. . . . . . . . . . . . . . . . . . . . . $ 76.2 $ 45.0 $24.3 Adjustments to reconcile net income to net cash provided (required) by operating activities: Depreciation: Excluding Leasing Subsidiary . . . . . . . . . . 39.5 37.0 32.6 Leasing Subsidiary . . . . . . . . . . . . . . . 17.3 22.3 15.6 Deferred provision (benefit) for income taxes . . (1.3) 1.4 (5.0) (Gain) loss on sale of property, plant and equipment. . . . . . . . . . . . . . . . . . (0.2) 1.7 (0.4) Cumulative effect of change in accounting for income taxes . . . . . . . . . . . . . . . . . . (7.9) - - Effect of statutory rate increase . . . . . . . . 2.1 - - Other . . . . . . . . . . . . . . . . . . . . . . 0.1 1.1 (0.1) Change in assets and liabilities: Increase in receivables. . . . . . . . . . . . . (58.1) (7.0) (17.9) (Increase) decrease in inventories . . . . . . . (110.9) 9.9 3.5 (Increase) decrease in other assets. . . . . . . 0.4 (2.2) (3.8) Increase (decrease) in accounts payable and accrued liabilities . . . . . . . . . . . . 14.0 26.7 (3.6) Increase (decrease) in billings in excess of cost and related earnings . . . . . . . . . . . (19.4) (17.5) 41.9 Increase (decrease) in other liabilities . . . . 2.6 (1.0) (2.6) Total adjustments. . . . . . . . . . . . . . . (121.8) 72.4 60.2\nNet cash provided (required) by operating activities . . . . . . . . . . . . . . (45.6) 117.4 84.5\nCash flows from investing activities: Proceeds from sale of property, plant and equipment 29.3 5.5 42.2 Capital expenditures: Excluding Leasing Subsidiary . . . . . . . . . . . (45.2) (36.2) (24.1) Leasing Subsidiary . . . . . . . . . . . . . . . . (37.6) (74.5) (64.3) Payment for purchase of acquisitions, net of cash acquired . . . . . . . . . . . . . . . (36.2) (20.6) (27.2) Cash of acquired subsidiary . . . . . . . . . . . . 0.5 0.7 -\nNet cash required by investing activities . . . . (89.2) (125.1) (73.4)\nCash flows from financing activities: Issuance of common stock. . . . . . . . . . . . . . 8.9 5.9 0.4 Net borrowings under short-term debt. . . . . . . . 177.0 (5.0) (26.0) Proceeds from issuance of long-term debt. . . . . . 20.0 60.0 65.0 Payments to retire long-term debt . . . . . . . . . (45.9) (34.0) (35.0) Dividends paid. . . . . . . . . . . . . . . . . . . (24.0) (17.8) (17.3) Net cash provided (required) by financing activities. . . . . . . . . . . . . . 136.0 9.1 (12.9)\nNet increase (decrease) in cash and cash equivalents. 1.2 1.4 (1.8) Cash and cash equivalents at beginning of period. . . 7.5 6.1 7.9\nCash and cash equivalents at end of period. . . . . . $ 8.7 $ 7.5 $ 6.1\nExcluding Leasing Subsidiaries, interest paid in fiscal 1994, 1993, and 1992 was $5.0, $4.0, and $7.6, respectively. Leasing Subsidiaries' interest paid in fiscal 1994, 1993, and 1992 was $23.8, $28.4, and $26.2, respectively.\nSee accompanying notes to consolidated financial statements.\nNotes to Consolidated Financial Statements\nSummary of Significant Accounting Policies\nThe financial statements of Trinity Industries, Inc. and its consolidated subsidiaries (\"Trinity\" or the \"Company\") include the accounts of all significant majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nThe Company accounts for its wholly-owned Leasing Subsidiary in accordance with Statement of Financial Accounting Standard No. 94, \"Consolidation of All Majority-Owned Subsidiaries,\" which requires the consolidation of all majority-owned subsidiaries, unless control is temporary or does not reside with the majority owner. The Company's financial statements include the consolidation of the accounts of Trinity Industries Leasing Company (\"TILC\"). TILC is sometimes referred to as the \"Leasing Company\" or \"Leasing Subsidiary\".\nFor purposes of the Consolidated Statement of Cash Flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Financial instruments which potentially subject the Company to concentrations of credit risk are primarily cash investments and receivables. The Company places its cash investments in investment grade, short-term debt instruments and limits the amount of credit exposure to any one commercial issuer. Concentrations of credit risk with respect to receivables are limited due to the large number of customers in the Company's customer base, and their dispersion across different industries and geographic areas. The Company maintains an allowance for losses based upon the expected collectibility of all receivables.\nFor financial accounting, profits on long-term contracts are recorded on the percentage-of-completion method. Allocation of profits to various periods is based on costs incurred, units delivered, or other appropriate measures. Provision is made for losses when they become known.\nTILC enters into lease contracts with third parties with terms generally ranging between one and fifteen years, wherein certain equipment manufactured by Trinity is leased for a specified type of service over the term of the contract. TILC accounts for leases principally by the operating method.\nInventories and investments are valued at the lower of cost or market. Inventory cost is determined principally on the specific identification method. Market is replacement cost or net realizable value.\nDepreciation and amortization are generally computed by the straight-line method on the estimated useful lives of the assets. The costs of ordinary maintenance and repair are charged to expense, while renewals and major replacements are capitalized.\nNet income per common and common equivalent share are based on the weighted average shares outstanding plus the assumed exercise of dilutive stock options (less the number of treasury shares assumed to be purchased from the proceeds using the average market price of Trinity's common stock). For the years ended March 31, 1994 and 1993, there was no convertible debt outstanding that would require the calculation of fully diluted earnings per share. In fiscal 1993, the convertible debt in the form of 8 percent convertible subordinated debentures and 6.75 percent convertible debentures were converted. For the year ended March 31, 1992 the computation of fully diluted earnings per share was anti-dilutive.\nCertain reclassifications have been made to prior year statements to conform to the current year presentation.\nSegment Information\nThe Company manufactures and sells or leases a variety of metal products consisting principally of (1) freight railcars, principally tank cars and hopper cars (\"Railcars\"); (2) boats and barges for ocean and inland waterway service (\"Marine Products\"); (3) construction products such as highway guard- rail, beams, girders, and columns used in construction of, highway and railway bridges, power plants, mills, etc., passenger loading bridges and conveyor systems, and ready mix concrete and aggregates (\"Construction Products\"); (4) pressure and non-pressure containers for the storage and transportation of liquefied gases, other liquid, and dry products (\"Containers\"); (5) weld fittings (tees, elbows, reducers, caps, flanges, etc.) used in pressure piping systems and container heads (the ends of pressure and non-pressure containers) for use internally and by other manufacturers of containers (\"Metal Components\"); and (6) railcar and barge leasing to various industries (\"Leasing\").\nFinancial information for these segments is summarized in the following table. The Company operates principally in the continental United States. Interseg- mental sales are shown at market prices.\nCorporate operating profit elimination consists principally of the administrative overhead of the Company.\nCorporate assets consist primarily of cash and cash equivalents, other assets, notes receivable, land held for investment, and certain property, plant and equipment.\nThe Railcars segment includes revenues from one customer which accounted for 11.6 percent of consolidated revenues in fiscal 1994.\nIn the Segments of Business table below, the caption 'Additions (net) to property, plant and equipment' does not include Business Acquisitions.\nReceivables (in millions) March 31 1994 1993\nAccounts receivable: Excluding Leasing Subsidiary. . . . . $248.4 $173.0 Leasing Subsidiary. . . . . . . . . . 5.0 5.8 253.4 178.8\nContract receivables not yet billed. . 12.5 25.6 265.9 204.4\nAllowance for doubtful accounts. . . . ( 1.0) ( 1.2) $264.9 $203.2\nInventories (in millions) March 31 1994 1993\nFinished goods . . . . . . . . . . . . $ 28.2 $ 15.5 Work in process. . . . . . . . . . . . 41.9 28.2 Cost related to long-term contracts, net of progress billings of $2.1 and $5.1 at March 31, 1994 and 1993, respectively. . . . . . . . 77.1 62.7 Raw materials and supplies . . . . . . 181.6 104.8 $328.8 $211.2 Property, Plant and Equipment (in millions) March 31 1994 1993\nExcluding Leasing Subsidiary: Land . . . . . . . . . . . . . . . . . . . . . . . . $ 29.5 $ 26.4 Buildings and improvements . . . . . . . . . . . . . 179.3 163.0 Machinery. . . . . . . . . . . . . . . . . . . . . . 361.0 302.1 Construction in progress . . . . . . . . . . . . . . 21.0 18.3 590.8 509.8\nLeasing Subsidiary: Equipment on lease (predominately long-term) . . . . 479.2 476.9 $1,070.0 $986.7 Business Acquisitions\nThe Company made certain business acquisitions during fiscal 1994, 1993 and 1992. All but one have been accounted for by the purchase method. The acquisition of Syro Steel Company in fiscal 1993 has been accounted for by the pooling of interests method. Except for Syro, the operations of these companies have been included in the consolidated financial statements from the effective dates of the acquisitions.\nIn fiscal 1992, the businesses acquired include: (i) Certain assets of Stearns Airport Equipment Company, Inc. for cash and a note. Stearns manufactures airport terminal equipment, primarily passenger loading bridges and baggage handling systems; (ii) certain assets of Transit Mix Concrete Company for cash. Transit Mix is a ready-mix concrete producer; (iii) certain inventory and property, plant and equipment of Johnstown Axle Works Corporation for cash. Johnstown forges railroad car axles and related products; and (iv) certain property, plant and equipment of Coast Engineering and Manufacturing Company for cash. These assets are utilized in the manufacture of marine products. The aggregate purchase price of these acquisitions was approximately $31.2 million. There was no goodwill in the acquisitions.\nIn fiscal 1993, except for Syro, the businesses acquired include: (i) certain assets of TARMAC Texas, Inc., Redland Stone Products, Inc., and Cle-Tex Materials, Inc. for cash and 100 percent of the common stock of Cowboy Concrete Corporation for 189,332 shares of Trinity common stock. These businesses are ready-mix concrete producers; (ii) certain property, plant and equipment of Eastern Shipyards, Inc. These assets are utilized in the manufacture of marine products; and (iii) certain inventory and property, plant and equipment of Custom Vessel Corporation to be used in the manufacture of custom container vessels for cash and 20,000 shares of Trinity common stock. The aggregate purchase price of these acquisitions was approximately $26.8 million. There was no goodwill in the acquisitions.\nAlso in fiscal 1993, the Company acquired, by subsidiary merger, all of the outstanding shares of common stock of Syro in exchange for 1,621,448 shares of Trinity's common stock. Syro manufactures and distributes a wide variety of fabricated steel products, including highway safety barrier systems, piling products, roll formed products, corrugated plate products, steel service center operations, and other products. The pooling of interests accounting method was used to account for the merger and, accordingly, the financial statements for all periods prior to the date of the merger were restated to include the accounts of Syro for all periods presented. Syro's previously reported financial results have been conformed to the fiscal year end of the Company. Revenues, net income and earnings per share of the separate companies for the period preceding the acquisition were: (in millions except per share data)\nNet Income Per Common Net and Common Revenues Income Equivalent Share Year ended March 31, 1992: Trinity. . . . . . . . . . . $1,192.3 $22.1 $0.69 Syro . . . . . . . . . . . . 81.0 2.2 Combined . . . . . . . . . . $1,273.3 $24.3 $0.71\nSyro sold material of approximately $6.2 in 1992 to affiliated companies. At March 31, 1992 Syro had accounts receivable of $1.9 from these affiliated companies.\nIn fiscal 1994, the businesses acquired include: (i) certain assets of Caruthersville Shipyard Inc. and Xenium Fiberglass Corporation for cash. These assets are utilized in the manufacture of marine products;(ii) certain assets of A & M Operating Company, Inc. for cash. These assets are used in the manufacture of railcars; (iii) certain assets of Redland Stone Products Company, STCC, Inc., Bluebonnet Paving, Inc., Triple S Crushed Stone Company, Waco Sand and Gravel Company, and Beazer West, Inc. for cash and 100 percent of the common stock of Myre Construction Company for 103,494 shares of Trinity common stock. These businesses are ready-mix concrete producers; and (iv) 100 percent of the common stock of Platzer Shipyard, Inc. for cash and 67,139 shares of Trinity common stock. This business manufactures and repairs barges. The aggregate purchase price of these acquisitions was approximately $56.0 million. There was no goodwill in the acquisitions. Contribution of these acquisitions to revenues and operating profit is not material.\nStock Options\nThe Company has a Stock Option and Incentive Plan (\"Plan\") which provides that incentive or Non-qualified stock options for a maximum of 1,500,000 shares of common stock may be granted to directors, officers and key employees. Incentive options may be granted over a period not to exceed ten years at a price not less than fair market value on the date of grant. The Plan terminated a similar prior stock option plan of which 1,001,007 options granted were outstanding at March 31, 1994. The Plan provides that, to the extent options granted under this Plan or any prior stock option plan are forfeited, expire or cancelled, they may again be granted pursuant to the provisions of this Plan. The Plan provides that if shares already owned by the optionee are surrendered as full or partial payment of the exercise price of an option, a new option (the \"Reload Option\") may be granted equal to the number of shares surrendered. The exercise price of Reload Options shall be the fair market value on the effective date of the grant.\nStockholder's Rights Plan\nThe Company has adopted a Stockholder's Rights Plan. Effective April 27, 1989, the Company paid a dividend distribution of one purchase right for each outstanding share of the Company's $1.00 par value common stock. Each right entitles the stockholder to purchase from the Company one one-hundredth of a share of Series A Junior Participating Preferred Stock at an exercise price of one hundred and seventy-five dollars. The rights are not exercisable or detachable from the common stock until ten business days after a person acquires beneficial ownership of twenty percent or more of the Company's common stock or if a person or group commences a tender or exchange offer upon consummation of which that person or group would beneficially own twenty percent or more of the common stock.\nIf any person becomes a beneficial owner of twenty percent or more of the Company's common stock other than pursuant to an offer, as defined, for all shares determined by certain directors to be fair to the stockholders and otherwise in the best interests of both the Company and its stockholders (other than by reason of share purchases by the Company), each right not owned by that person or related parties enables its holder to purchase, at the right's then current exercise price, shares of the Company's common stock having a calculated value of twice the right's exercise price.\nThe rights, which are subject to adjustment, may be redeemed by the Company at a price of one cent per right at any time prior to their expiration on April 27, 1999 or the point at which they become exercisable.\nLong-term Debt (in millions except per share data) March 31 1994 1993\nExcluding Leasing Subsidiary: 6.3-11.4 percent industrial development revenue bonds payable in varying amounts through 2005 . . . . . . . . $ 7.1 $ 10.5 4.5-10.5 percent promissory notes, generally payable annually through 1996 . . . . . . . . . . . . . . . . . 34.8 38.7 41.9 49.2 Leasing Subsidiary: 6.96-15.5 percent equipment trust certificates to institutional investors generally payable in semi- annual installments of varying amounts through 2003 . . 223.5 230.7 11.3 percent notes payable monthly through 2003. . . . . 12.5 13.3 236.0 244.0 $277.9 $293.2\nLong-term debt excluding the Leasing Subsidiary:\nThe Company is required to maintain certain financial ratios, as defined. Principal payments due during the next five years are: 1995 - $8.9; 1996 - $30.8; 1997 - $0.5; 1998 - $0.1; and 1999 - $0.1.\nLong-term debt of Leasing Subsidiary:\nThe trustees of the equipment trusts have been assigned title to rail- cars with a cost of $437.8 at March 31, 1994 for the life of the respective equipment trusts. Leases relating to such railcars financed by equipment trust certificates have been assigned as collateral. Trinity is required to pay fees to TILC to maintain net earnings, as defined, at 150 percent of fixed charges, as defined. Pursuant to this agreement, $0, $1.4, and $0.5 have been paid by Trinity to TILC in fiscal 1994, 1993, and 1992, respect- ively. Trinity is also required to pay to TILC the current tax benefit which results from the inclusion of TILC in Trinity's federal income tax return. These amounts are eliminated for consolidated financial presenta- tion of Trinity. TILC is required to maintain certain financial ratios, as defined. Principal payments due during the next five years are: 1995 - $30.7; 1996 - $30.4; 1997 - $31.4; 1998 - $27.5; and 1999 - $27.4.\nThe fair value of non-traded, fixed rate outstanding debt, estimated using discounted cash flow analysis, approximates its carrying value.\nIn fiscal 1993, 8 percent convertible subordinated debentures and 6.75 percent convertible debentures were converted. Assuming this convertible debt had converted as of April 1, 1992, supplementary earnings per share for fiscal 1993 would have been $1.24.\nCondensed Combined Financial Information of Consolidated Leasing Subsidiaries\nMarch 31 (in millions) 1994 1993\nAssets Total assets (principally railcars and barges). . . . . . $495.1 $490.6 Liabilities and Stockholder's Equity Total liabilities (principally long-term debt). . . . . . $340.3 $354.8\nStockholder's equity (including retained earnings of $116.5 and $104.8 in 1993 and 1992, respectively) . . . 154.8 135.8 $495.1 $490.6\nYear Ended March 31 1994 1993 1992\nIncome Revenues . . . . . . . . . . . . . . . . . . . . . $104.6 $79.6 $72.8\nIncome before income taxes and cumulative effect of change in accounting for income taxes. . . . . $ 20.9 $17.8 $18.1 Provision for income taxes . . . . . . . . . . . . 9.9 6.1 6.3 Income before cumulative effect of change in accounting for income taxes . . . . . . . . . . . 11.0 11.7 11.8 Cumulative effect as of April 1, 1993 of change in method of accounting for income taxes . . . . . . 8.1 - - Net income . . . . . . . . . . . . . . . . . . . . $ 19.1 $11.7 $11.8\nFuture minimum rental revenues on leases in each fiscal year are approximately $59.5 in 1995, $52.2 in 1996, $44.1 in 1997, $36.1 in 1998, $28.4 in 1999, and $104.5 thereafter.\nConsolidating Financial Statements of Trinity Industries, Inc.\nThe following financial statements present the consolidating income statement and consolidating balance sheet of Trinity. Certain accounts have been reclassified to correspond to consolidated financial statement presentation of Trinity. Presentation of accounts does not conform to separate entity financial presentation. These consolidating financial statements are presented to provide additional analysis of, and should be read in conjunction with, the consolidated financial statements of Trinity.\nConsolidating Income Statement Leasing Subsid- Elimi- Year Ended March 31, 1994 (in millions) Trinity iary nations Total\nRevenues. . . . . . . . . . . . . . . . . $1,718.8 $104.6 $ (38.5) $1,784.9\nOperating costs: Cost of revenues . . . . . . . . . . . . 1,514.3 65.4 (38.5) 1,541.2 Selling, engineering and administrative expenses. . . . . . . . . . . . . . . . 94.0 0.2 - 94.2 Interest expense of Leasing Subsidiary . - 23.7 - 23.7 Retirement plans expense . . . . . . . . 9.2 - - 9.2 Equity in income of Leasing Subsidiary before income taxes . . . . . . . . . . (20.9) - 20.9 - 1,596.6 89.3 (17.6) 1,668.3 Operating profit. . . . . . . . . . . . . 122.2 15.3 (20.9) 116.6\nOther (income) expenses: Interest income. . . . . . . . . . . . . (1.6) - - (1.6) Interest expense - excluding Leasing Subsidiaries. . . . . . . . . . . . . . 10.6 (5.0) - 5.6 Other, net . . . . . . . . . . . . . . . (1.0) (0.6) - (1.6) 8.0 (5.6) - 2.4 Income before income taxes and cumulative effect of change in accounting for income taxes . . . . . . . . . . . . . . 114.2 20.9 (20.9) 114.2\nProvision (benefit) for income taxes: Current. . . . . . . . . . . . . . . . . 45.1 4.0 (4.0) 45.1 Deferred . . . . . . . . . . . . . . . . (1.3) 3.3 (3.3) (1.3) Effect of statutory rate increase. . . . 2.1 2.6 (2.6) 2.1 45.9 9.9 (9.9) 45.9 Income before cumulative effect of change in accounting for income taxes . . . . . 68.3 11.0 (11.0) 68.3 Cumulative effect as of April 1, 1993 of change in accounting for income taxes. . 7.9 8.1 (8.1) 7.9 Net income. . . . . . . . . . . . . . . . $ 76.2 $ 19.1 $(19.1) $ 76.2\nConsolidating Balance Sheet Leasing Subsid- Elimi- March 31, 1994 (in millions) Trinity iary nations Total\nAssets\nCash and cash equivalents. . . . . . . . . $ 8.5 $ 0.2 $ - $ 8.7 Receivables. . . . . . . . . . . . . . . . 259.9 5.0 - 264.9 Inventories. . . . . . . . . . . . . . . . 328.8 - - 328.8 Property, plant and equipment, at cost: Excluding Leasing Subsidiary. . . . . . . 590.8 - - 590.8 Leasing Subsidiary. . . . . . . . . . . . - 536.2 (57.0) 479.2 Less accumulated depreciation: Excluding Leasing Subsidiary. . . . . . . (263.0) - - (263.0) Leasing Subsidiary. . . . . . . . . . . . - (139.9) - (139.9) Note receivable from parent. . . . . . . . - 90.8 (90.8) - Investment in Leasing Subsidiary . . . . . 154.8 - (154.8) - Other assets . . . . . . . . . . . . . . . 62.2 2.8 (27.7) 37.3 $1,142.0 $495.1 $(330.3) $1,306.8\nLiabilities and Stockholders' Equity\nShort-term debt. . . . . . . . . . . . . . $ 192.0 $ - $ - $ 192.0 Accounts payable and accrued liabilities . 153.1 8.5 - 161.6 Billings in excess of cost and related earnings. . . . . . . . . . . . . 12.6 - - 12.6 Long-term debt: Excluding Leasing Subsidiary. . . . . . . 132.7 - (90.8) 41.9 Leasing Subsidiary. . . . . . . . . . . . - 236.0 - 236.0 Deferred income taxes. . . . . . . . . . . 5.8 95.8 (27.7) 73.9 Deferred income. . . . . . . . . . . . . . 59.9 - (59.9) - Other liabilities. . . . . . . . . . . . . 15.4 - 2.9 18.3 Stockholders' equity . . . . . . . . . . . 570.5 154.8 (154.8) 570.5 $1,142.0 $495.1 $(330.3) $1,306.8\nIncome Taxes (in millions except per share data)\nEffective April 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" This Statement requires a change from the deferred to the liability method of computing income taxes. As permitted by Statement No. 109, the Company has elected not to restate the financial statements of any prior period. The cumulative effect of applying the change in accounting method is a decrease in the Company's deferred tax liability and a nonrecurring credit of $7.9 or $0.20 per share.\nThe provision for federal income taxes is determined on a consolidated return basis. The Company and the Leasing Subsidiary file a consolidated federal income tax return. The significant components of the provision (benefit) for income taxes follow:\nYear Ended March 31 1994 1993 1992 Current Federal. . . $42.5 $23.5 $18.8 State. . . . 4.7 2.2 1.6 47.2 25.7 20.4 Deferred. . . . . (1.3) 1.4 (5.0) Total . . . . . . $45.9 $27.1 $15.4\nDeferred income tax was provided in the financial statements for timing differences between financial and taxable income. Components of the deferred provision (benefit) for income taxes computed at the statutory rate for fiscal 1993 and 1992 follow:\nYear Ended March 31 1993 1992 Excess of tax depreciation over financial depreciation................. $ 6.4 $(4.4) Profits on long-term contracts recorded on the percentage of completion method for financial purposes and related items.......................... 0.4 - Pensions and other benefits............. (5.2) (2.0) Accounts receivable and inventory valuation.............................. (1.6) (0.5) Alternative minimum tax credit.......... 2.3 2.0 Other................................... (0.9) (0.1) Total deferred provision (benefit)... $ 1.4 $(5.0)\nThe components of deferred liabilities and assets at March 31, 1994 follow: March 31 Deferred tax liabilities: Excess of tax depreciation over financial statement depreciation....... $100.1 Total deferred tax liabilities...... $100.1\nDeferred tax assets: Profits on long-term contracts recorded on the percentage of completion method for financial purposes and related items...................... $ 1.3 Pensions and other benefits.............. 21.3 Accounts receivable and inventory valuation.............................. 0.7 Other.................................... 2.9 Total deferred tax assets........... 26.2 Net deferred tax liabilities............. $ 73.9\nThe provision for income taxes in fiscal 1994, 1993 and 1992 results in effective tax rates different than the statutory rates. The reconciliation between the effective and statutory rates follows: 1994 1993 1992\nStatutory rate.............. 35.0% 34.0% 34.0% State taxes................. 2.7 2.0 2.7 Effect of 1% rate increase on deferred taxes............ 1.8 - - Other....................... 0.7 1.6 2.1 Effective tax rate.......... 40.2% 37.6% 38.8%\nIn fiscal 1994, 1993 and 1992 income taxes of $44.7, $22.8 and $20.2, respectively, were paid.\nEmployee Benefit Plans (in millions)\nPension plans are in effect which provide income and death benefits for eligible employees. The Company's policy is to fund retirement costs accrued to the extent such amounts are deductible for income tax purposes. Plan assets include cash, short-term debt securities, and other investments. Benefits are based on years of credited service and compensation.\nNet periodic pension expense for fiscal 1994, 1993, and 1992 included the following components: Year Ended March 31 1994 1993 1992 Service cost-benefits earned during the period $ 6.2 $ 8.2 $ 6.2 Interest cost on projected benefit obligation. 6.3 5.2 4.9 Actual return on assets. . . . . . . . . . . . (1.5) (4.6) (5.0) Net amortization and deferral. . . . . . . . . (4.4) (0.6) 1.1 Accrual of profit sharing contribution . . . . 2.6 2.0 1.8 Net periodic pension expense . . . . . . . . . $ 9.2 $ 10.2 $ 9.0\nAssumptions used for valuation of the projected benefit obligation were: Year Ended March 31 1994 1993 1992 Discount rates . . . . . . . . . . . . . . . . 8.25% 9% 9% Rates of increase in compensation levels . . . 5.25% 6% 6% Expected long-term rate of return on assets. . 9% 9% 9%\nAmounts recognized in the Company's consolidated balance sheet follow: March 31 1994 1993 Actuarial present value of benefit obligation: Vested benefit obligation. . . . . . . . . . $ 49.4 $ 39.8 Accumulated benefit obligation . . . . . . . $ 61.3 $ 48.9 Projected benefit obligation . . . . . . . . . $ 78.6 $ 64.8 Plan assets at fair value. . . . . . . . . . . 63.1 58.9 Projected benefit obligation in excess of plan assets. . . . . . . . . . . (15.5) (5.9) Unrecognized net asset at April 1, 1985. . . . (2.3) (3.2) Unrecognized net asset at January 1, 1986. . . (1.0) (1.2) Unrecognized net obligation at January 1, 1987. - 0.5 Unrecognized net loss at March 31. . . . . . . 12.9 1.7\nAccrued pension expense. . . . . . . . . . . . $ (5.9) $ (8.1)\nThe Company has a contributory profit sharing plan for employees of the Company and certain affiliates. Under the plan, eligible employees are allowed to make voluntary pre-tax contributions. The Company's contribution to this plan, as defined, is based on consolidated earnings and dividends.\nContingencies\nIn May, 1994, a jury sitting in the United States District Court for the Southern District of New York returned a verdict against Mosher Steel Company, a former subsidiary of Trinity Industries, Inc. and Trinity Industries, Inc. in an action brought against Mosher by Morse-Diesel, Inc. In August, 1982, Mosher entered into a subcontract with Morse-Diesel for the fabrication and erection of structural steel for the construction of the Marriott Marquis Hotel in Times Square, New York City, New York. In August, 1984, Morse-Diesel commenced the action stated above against Mosher and Trinity for damages allegedly caused by Mosher's and its erection subcontractor's performance of the structural steel contract.\nJudgement against Mosher will be entered in the amount of $25,775,933 plus statutory interest from September, 1985.\nMosher has been advised by legal counsel that it has substantial defenses and remedies available, and it will pursue all available avenues in the post-trial and appellate review processes. While Mosher's ultimate liability in this matter is difficult to assess, it is management's belief that the final outcome is not reasonably likely to have a material adverse affect on the Company's consolidated financial position.\nMosher and Trinity have not been involved in the fabrication of structural steel for multi-story buildings since 1989.\nThe Company is involved in various other claims and lawsuits incidental to its business. In the opinion of management, these claims and suits in the aggregate will not have a material adverse affect on the Company's consolidated financial statements.\nReport of Independent Auditors\nThe Board of Directors and Stockholders Trinity Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of Trinity Industries, Inc. as of March 31, 1994 and 1993, and the related consolidated statements of income, cash flows and stockholders' equity for each of the three years in the period ended March 31, 1994. 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 Trinity Industries, Inc. at March 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 1994, in conformity with generally accepted accounting principles.\nERNST & YOUNG\nDallas, Texas May 10, 1994\nEXHIBIT 99.1\nSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\nFORM 11-K ANNUAL REPORT PURSUANT TO SECTION 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended March 31, 1994 Commission File Number 1-6903\nPROFIT SHARING PLAN FOR EMPLOYEES OF TRINITY INDUSTRIES, INC. AND CERTAIN AFFILIATES (Full Title of the plan)\nTRINITY INDUSTRIES, INC. (Name of issuer of the securities held pursuant to the plan)\nDelaware 75-0225040 (State of Incorporation) (I.R.S. Employer Identification No.)\n2525 Stemmons Freeway Dallas, Texas 75207-2401 (Address of principal executive offices) (Zip Code)\nIssuer's telephone number, including area code (214) 631-4420\nProfit Sharing Plan for Employees of Trinity Industries, Inc. and Certain Affiliates Index to Annual Report on Form 11-K\n(a) Financial Statements\nDescription Page Report of independent auditors . . . . . . . 4\nStatement of financial condition as of March 31, 1994 and 1993 . . . . . . . . . . . 5 - 6\nStatement of income and changes in Plan equity for the years ended March 31, 1994, 1993 and 1992 . . . . . . . . . . . . . . . . 7 - 9\nNotes to financial statements . . . . . . . . 10\nSchedules - Schedules I, II, and III have been omitted because the information required is included in the Financial Statements or the notes thereto.\n(b) Exhibits\nNumber Title Page 1 Consent of independent auditors 18\nSIGNATURES\nPursuant to the requirements of the Securities Exchange Act of 1934, the trustees have duly caused this Annual Report to be signed by the undersigned thereunto duly authorized.\nProfit Sharing Plan for Employees of Trinity Industries, Inc. and Certain Affiliates\n\/s\/ F. Dean Phelps, Jr. F. Dean Phelps, Jr. Vice President June 28, 1994\nReport of Independent Auditors\nThe Board of Directors Trinity Industries, Inc.\nWe have audited the accompanying statements of financial condition of the Profit Sharing Plan for Employees of Trinity Industries, Inc. and Certain Affiliates (the \"Plan\") as of March 31, 1994 and 1993, and the related statements of income and changes in plan equity for each of the three years in the period ended March 31, 1994. These financial statements are the responsibility of the Plan'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 condition of the Plan at March 31, 1994 and 1993, and the income and changes in plan equity for each of the three years in the period ended March 31, 1994, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The accompanying supplemental schedules of assets held for investment and reportable transactions are presented for purposes of complying with the Department of Labor's Rules and Regulations for Reporting and Disclosure under the Employee Retirement Income Security Act of 1974, and are not a required part of the basic financial statements. The supplemental schedules have been subjected to the auditing procedures applied in our audit of the 1994 financial statements and, in our opinion, are fairly stated in all material respects in relation to the 1994 basic financial statements taken as a whole.\nERNST & YOUNG Dallas, Texas June 3, 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.\nProfit Sharing Plan for Employees of Trinity Industries, Inc. and Certain Affiliates Notes to Financial Statements March 31, 1994\n1. Description of the Plan\nGeneral - The Profit Sharing Plan for Employees of Trinity Industries, Inc. and Certain Affiliates (the \"Plan\") was adopted by the Board of Directors of Trinity Industries, Inc. (the \"Board\") on December 11, 1986 and became effective January 1, 1987, for eligible employees of Trinity Industries, Inc. and Certain Affiliates (the \"Employer\"). The Plan is a defined contribution plan designed to comply with the provisions of Title I of the Employee Retirement Income Security Act of 1974 (\"ERISA\"). The following is a brief description of the Plan. Participants should refer to the Plan document for complete information regarding the Plan. The Plan's fiscal year end is March 31.\nParticipation - Eligible employees, as defined, who desire to contribute to the Plan, must elect to contribute on the form or forms provided by the Committee and authorize the Employer to make payroll deductions for contributions to the Plan.\nContributions - Each Plan participant agrees to contribute not less than two percent nor more than ten percent of their compensation in one percent increments as designated by the participant. A participant's salary reduction may not exceed $9,240 and $8,994 per calendar year ended 1994 and 1993, respectively. A salary reduction and contribution agreement must be entered into by each employee as the employee begins participation in the Plan and may be amended by such employee each quarter.\nEmployer matching contribution shall be made if Company earnings are at least $0.33 per share of common stock and sufficient to pay dividends to stockholders ($0.64, $0.53 and $0.53 per share for the years ended March 31, 1994, 1993, and 1992, respectively). Dividends per share have been adjusted for the three-for-two stock split distributed on August 31, 1993. If the Employer matching contribution is made, then each participant with at least five years of service, shall receive an amount equal to 50 percent of that portion of such participant's employee contribution which does not exceed six percent of such participant's total compensation for the year. If the Employer matching contribution is made, then each participant with less than five years of service shall receive an amount equal to 25 percent of that portion of such participant's employee contribution which does not exceed six percent of such participant's total compensation for the year.\nEmployer contributions are net of forfeitures, as defined. Employer contributions for a given plan year shall be deposited in the Profit Sharing Trust for Employees of Trinity Industries, Inc. and Certain Affiliates (the \"Trust Fund\") as defined below, no later than the date on which the Employer files its Federal income tax return for such year.\nThe Employer and Texas Commerce Bank - Dallas (the \"Trustee\"), have entered into a Trust Agreement under which the latter acts as Trustee under the Plan. Texas Commerce Bank - Dallas is the successsor Trustee to First City Bank of Dallas, N.A. pursuant to the acquisition by Texas Commerce Bank - Dallas of the assets and certain liabilities of the former First City Bank of Dallas, N.A.\nIn its capacity as Trustee, Texas Commerce Bank - Dallas invests the employee contributions and Employer contributions in the following investment options (hereafter collectively referred to as the \"Trust Fund\"):\n(a) Trinity Stock Investment Account (\"Stock Account\") holds shares of Employer common stock purchased on behalf of the participants. Idle cash is invested in interest-bearing accounts until such time as it can be utilized to purchase Employer common stock.\n(b) Guaranteed Investment Contract Investment Account (the \"Guaranteed Investment Account\") invests in guaranteed investment contracts issued by an insurance company selected annually by the Committee. At March 31, 1994, the guaranteed investment contracts had guaranteed annual rates of return of 8.80% (GAC 4854), 9.06% (GAC 5764), 9.06% (GAC 5027) , 6.70% (GAC 15960), 6.24% (GAC 627-05387), and 5.15% (GAC 7219).\n(c) Putnam Mutual Funds Investment Accounts (the \"Putnam Mutual Funds\") invests in three mutual funds selected by the Committee. At March 31, 1994, the funds are U.S. Government Income Trust, Growth and Income, and Voyager.\nParticipants may elect the extent to which assets are invested in the options described above in increments of 10 percent or 25 percent. At March 31, 1994, 1993 and 1992, the majority of participants had elected to participate in the guaranteed investment contracts.\nBenefits - Distribution of a participant's account balance is payable upon retirement at or after age 65, total disability, death, or termination of employment. Distribution is equal to the salary reduction contribution and related earnings plus the vested portion of the Employer contribution and related earnings.\nWithdrawal of up to 100 percent of the employee contribution can be made only to meet \"immediate and heavy financial needs\" (medical care, college tuition, the purchase of a primary residence, or to prevent the foreclosure on a primary residence) as long as the funds are not available for such needs from other sources. No withdrawal can be made against the earnings on the employee contributions or against the Employer contribution and related earnings. These restrictions no longer apply when the participant reaches age 59 1\/2.\nLoans for \"immediate and heavy financial needs\" may be made for a minimum of $1,000 up to a maximum of $50,000, not to exceed 50 percent of the Employee contribution and related earnings and not to exceed 50 percent of the vested portion of the Employer contribution and related earnings. Loans are subject to rules and regulations established by the Plan Administrator, as defined in the Plan.\nVesting - The Employer contribution and related earnings (losses) vest to participants, depending upon the number of years of vesting service, as defined, completed by such participant as follows: Years of Service Percentage Vested Less than 1 0 1 but less than 2 20 2 but less than 3 40 3 but less than 4 60 4 but less than 5 80 5 or more 100\nA participant is 100 percent vested in their Employer contribution and allocated portion of related earnings (losses) upon their attainment of age 65 and is always 100 percent vested in their employee contribution and related earnings (losses) on such contribution.\nAdministration of the Plan - The Plan is administered by a Profit Sharing Committee (the \"Committee\") consisting of at least three persons who are appointed by the Board. The members of the Committee serve at the pleasure of the Board, and any committee member who is an employee of the Employer shall not receive compensation for his services.\nA separate account is maintained for each participant. The Plan provides that account balances for participants are adjusted periodically as follows:\n(a) Employee contributions are generally allocated on a quarterly basis;\n(b) Participant's share of the Employer contribution shall be allocated to the participant's account as of a date no later than the last day of the Plan year;\n(c) Earnings and appreciation or depreciation of investment assets of the Trust Fund for each calendar quarter shall be allocated to the accounts of participants, former participants and beneficiaries who had unpaid balances in their accounts on the last day of such calendar quarter in proportion to the balances in such accounts at the beginning of the calendar quarter.\nUpon request, distributions shall be made no earlier than the later of the last day of the calendar quarter in which entitlement occurs or the date on which the Committee determines the final balances. Distributions from the Stock Account shall be made in cash unless otherwise designated by the participant.\nIncome tax status - The Plan has received a determination letter from the Internal Revenue Service stating that the Plan is a qualified plan under Section 401(a) of the Internal Revenue Code (the \"Code\") and that the Trust is exempt from federal income tax under Section 501(a) of the Code.\nEmployee contributions and Employer contributions are not included in the participant's federal taxable income in the year such contributions are made. A participant shall not be subject to federal income taxes with respect to participation in the Plan until the amounts are withdrawn or distributed.\nAmendment or termination of the Plan - The Employer may amend the Plan at any time. However, no amendment, unless made to secure approval of the Internal Revenue Service or other governmental agency, may operate retroactively to reduce or divest the then vested interest in the Plan of any participant, former participant or beneficiary, or to reduce or divest any benefit payable under the Plan unless all participants, former participants and beneficiaries then having vested interests or benefit payments affected thereby consent to such amendment.\nThe Employer may terminate the Plan at any time. Upon complete or partial termination, the accounts of all participants affected thereby shall become 100 percent vested, and the Committee shall direct the Trustee to distribute the assets in the Trust Fund, after receipt of any required approval by the Internal Revenue Service and payment of any expenses properly chargeable thereto, to participants, former participants, and beneficiaries in proportion to their respective account balances.\n2. Significant Accounting Policies\nInvestments and investment income - Investment in the common stock of the Employer and the Putnam Mutual Funds are valued at the last reported sales price on the last business day of the Plan year as reported on a national securities exchange. The investments in guaranteed investment contracts are valued at cost which approximates market value.\nSecurity transactions are recorded on a trade date basis. The statement of income and changes in Plan equity include net unrealized appreciation or depreciation in market value on investments. The Plan's financial statements are prepared on an accrual basis.\nRealized gains and losses - Realized gains and losses have been calculated using historical cost (first in, first out).\n3. Investments\nInvestments are as follows:\nMarch 31, 1994 March 31, 1993 Cost Market Cost Market Trinity common stock $ 5,433,189 $ 9,280,170 $ 4,527,091 $ 7,176,868\nGuaranteed investment contracts\nGAC 4854 7,100,022 7,100,022 6,479,177 6,479,177 GAC 5764 4,885,851 4,885,851 4,479,966 4,479,966 GAC 5432 - - 3,225,021 3,225,021 GAC 7219 3,800,180 3,800,180 - - GAC 5027 4,015,742 4,015,742 3,655,118 3,655,118 GAC 15960 3,013,308 3,013,308 2,853,853 2,853,853 GAC 627-05387 3,248,989 3,248,989 351,000 351,000 26,064,092 26,064,092 21,044,135 21,044,135\nPutnam mutual funds U.S. Govt. Income Trust 2,750,108 2,566,037 2,250,225 2,222,162\nGrowth & Income 2,819,423 2,753,306 1,619,358 1,684,458\nVoyager 1,778,542 1,872,152 807,724 853,411 7,348,073 7,191,495 4,677,307 4,760,031\nParticipant loans 567,573 567,334 449,691 449,509 $39,412,927 $43,103,091 $30,698,224 $33,430,543\n4. Unrealized Appreciation (Depreciation) of Investments\nUnrealized appreciation (depreciation) of investments in Trinity common stock, Putnam mutual funds, and Participant loans for the years ended March 31, 1994, 1993, and 1992 were determined as follows:\nNet Investments Investments increase at market at cost (decrease) March 31, 1994 Trinity common stock March 31, 1994 $ 9,280,170 $ 5,433,189 $3,846,981 March 31, 1993 7,176,868 4,527,091 2,649,777 2,103,302 906,098 1,197,204\nPutnam mutual funds March 31, 1994 7,191,495 7,348,073 (156,578) March 31, 1993 4,760,031 4,677,307 82,724 2,431,464 2,670,766 (239,302)\nParticipant loans March 31, 1994 567,334 567,573 (239) March 31, 1993 449,509 449,691 (182) 117,825 117,882 (57)\nIncrease in unrealized appreciation of investments $ 4,652,591 $ 3,694,746 $ 957,845\nMarch 31, 1993 Trinity common stock March 31, 1993 $ 7,176,868 $ 4,527,091 $2,649,777 March 31, 1992 4,016,528 3,717,959 298,569 3,160,340 809,132 2,351,208\nPutnam mutual funds March 31, 1993 4,760,031 4,677,307 82,724 March 31, 1992 361,165 367,985 (6,820) 4,398,866 4,309,322 89,544\nParticipant loans March 31, 1993 449,509 449,691 (182) March 31, 1992 222,840 222,957 (117) 226,669 226,734 (65)\nIncrease in unrealized appreciation of investments $ 7,785,875 $ 5,345,188 $2,440,687\nMarch 31, 1992 Trinity common stock March 31, 1992 $ 4,016,528 $ 3,717,959 $ 298,569 March 31, 1991 2,939,045 3,186,159 (247,114) 1,077,483 531,800 545,683\nPutnam mutual funds March 31, 1992 361,165 367,985 (6,820)\nParticipant Loans March 31, 1992 222,840 222,957 (117)\nIncrease in unrealized appreciation of investments $ 1,661,488 $ 1,122,742 $ 538,746\n5. Expenses\nThe expenses incurred by the Trustee in the performance of its duties, including the Trustee's compensation and the services of an actuary, shall be paid by the Plan unless paid by the Employer. The Employer paid $196,608, $237,576, and $270,107 for actuarial services and trustee fees on behalf of the Plan for the fiscal years ended March 31, 1994, 1993, and 1992, respectively.\nIndex to Exhibits\nNumber Description Page 1 Consent of Independent Auditors 18\nConsent of Independent Auditors\nWe consent to the incorporation by reference in Post Effective Amendment No. 1 to the Registration Statement (Form S-8, File No. 33- 10937) pertaining to the Profit Sharing Plan for Employees of Trinity Industries, Inc. and Certain Affiliates and in the related Prospectus of our report dated June 3, 1994, with respect to the financial statements and schedules of the Profit Sharing Plan for Employees of Trinity Industries, Inc. and Certain Affiliates included in this Annual Report (Form 11-K) for the year ended March 31, 1994.\nERNST & YOUNG Dallas, Texas June 28, 1994\nProfit Sharing Plan for Employees of Trinity Industries, Inc. And Certain Affiliates Assets Held for Investment March 31, 1994\nUnits, shares, or face Current Identity amount Cost value\nTrinity common stock 244,215 $ 5,433,189 $ 9,280,170\nGuaranteed Investment Contracts Allstate Life Insurance Co. GAC 4854, 8.80% 7,100,022 7,100,022 GAC 5027, 9.06% 4,015,742 4,015,742\nJohn Hancock Mutual Life GAC 7219, 5.15% 3,800,180 3,800,180\nMassachusetts Mutual Life Insurance Co. GAC 5764, 9.06% 4,885,851 4,885,851\nProvident Life & Accident Insurance Co. GAC 627-05387, 6.24% 3,248,989 3,248,989\nTravelers Insurance Co. GAC 15960, 6.70% 3,013,308 3,013,308 26,064,092 26,064,092\nPutnam mutual funds U. S. Govt. Income Trust 199,847 2,750,108 2,566,037\nGrowth & Income 212,446 2,819,423 2,753,306\nVoyager 166,562 1,778,542 1,872,152 7,348,073 7,191,495\nParticipant loans 567,573 567,334\n$39,412,927 $43,103,091","section_15":""}
{"filename":"9801_1994.txt","cik":"9801","year":"1994","section_1":"Item 1. Business.\nGeneral.\nBanta Corporation (the \"Corporation\"), together with its subsidiaries, is one of the larger printing organizations in the United States, providing a broad range of printing and graphic arts services. The Corporation was incorporated in Wisconsin in 1901. Its principal executive offices are located at 225 Main Street, Box 8003, Menasha, Wisconsin, 54952-8003. The Corporation had a total of 4,304 employees at the end of fiscal 1993.\nThe Corporation operates in one business segment-Printing Services. Market classifications of the Corporation's sales are commercial (catalogs, direct mail and single-use products); books (educational, general, trade, data manuals and software services); magazines; and other (prepress services and production of point-of-purchase displays and postage stamps). The Corporation's operations were conducted at 23 production facilities located in Wisconsin, Minnesota, California, Illinois, Massachusetts, Missouri, North Carolina, Utah, and Virginia at the end of fiscal 1993.\nThe following table sets forth the approximate percentage of consolidated net sales contributed by each class of similar products and services which accounted for ten percent or more of consolidated net sales for any of the last three fiscal years.\n1993 1992 1991 Commercial 44% 46% 47% Books 34 30 31 Magazines 12 13 12 Other 10 11 10 ------ ------ ------ TOTAL 100% 100% 100% ====== ====== ======\nDuring 1990, the Corporation announced its intention to sell its Banta Ventures, Inc. (\"BVI\") subsidiary and its net assets were written down to estimated realizable value. Accordingly, the financial statements incorporated by reference herein reflect BVI as a Discontinued Operation for all periods presented. An estimated loss of $8,500,000 from the disposition, net of applicable income tax credits of $1,200,000, was recorded in the third quarter of 1990. During the third quarter of 1991, the Corporation revised its estimate of the realizable value of BVI and recorded an additional $7,600,000 loss provision, net of applicable income tax credits of $3,000,000.\nDuring the second quarter of 1992, the Corporation completed the sale of the majority of the BVI operations for $12,000,000 cash, 100,000 convertible preferred shares of the buyer, a $2,500,000 note and the assumption of selected liabilities by the buyer. During the second quarter of 1993, the preferred shares were converted into common shares of the buyer which were then sold in a secondary public offering resulting in net proceeds to the Corporation of approximately $3,500,000.\nIn March of 1994 the Corporation purchased substantially all of the assets and assumed selected liabilities of Danbury Printing & Litho, Inc. (\"Danbury\"). The purchase price for this transaction, including liabilities assumed, aggregated approximately $22 million. This acquisition will be accounted for as a purchase. Danbury, which will primarily serve direct marketing customers within the commercial printing market classification, reported 1993 sales of approximately $35 million.\nCustomers.\nThe Corporation sells its products and services to a large number of customers and ordinarily does not have long-term contracts with its customers. Production agreements covering one to three years are becoming more frequent for magazine and catalog production. Production of postage stamps is performed exclusively pursuant to long-term\ncontracts between the Corporation, or its joint venture partners, and the United States Postal Service (\"USPS\"). Substantially all sales are made to customers through employees of the Corporation and it's subsidiaries based on customer specifications. The fifteen largest customers accounted for approximately 25%, 22% and 21% of net sales during 1993, 1992 and 1991, respectively. No customer accounted for more than 10% of the Corporation's net sales in 1993, 1992 or 1991. In the opinion of management, the loss of any single customer would not have a material long-term adverse effect on the Corporation.\nBacklogs.\nThe Corporation is primarily a manufacturing services company and provides its customers with printing and converting services. Lead time for services varies, depending upon the type of customer, the industry being serviced and seasonal factors. Backlogs would be expressed in terms of time scheduled on equipment and not dollar value. Consequently, the dollar value of backlogs is not readily available.\nMarkets Served.\nBelow is a description of the primary markets the Corporation serves:\n* Commercial\nThe Corporation provides catalogs primarily for the consumer, industrial and retail catalog markets. Bindery services provide ink-jet labeling and demographic binding (which allows several different versions of the same catalog to be bound simultaneously). Distribution services provided by various Banta operating units, including computerized mail distribution planning systems which assist our customers in minimizing postage costs, are an integral part of catalog printing services.\nPrinted materials for direct marketing customers are provided by three Banta units (including Danbury). These products vary in format and size and include magazine and catalog inserts, bill stuffers, brochures, booklets, cards and target market products designed to sell a product or solicit a response.\nCatalog and direct marketing materials are primarily distributed through the USPS as third class or bulk rate postage. Substantial escalation in postage rates, as experienced in 1991, significantly impacts the cost of doing business for the Corporation's customers and may affect future growth opportunities for these markets.\nOne of the Corporation's subsidiaries, Ling Products, Inc., provides printed products to the fast-food industry and converts poly film and paper into single-use products for the food service industry and health care industry. In addition, Ling Products extrudes films, using both cast and blown extruders, for use in its manufacturing processes and for sale to external customers. Its health care products include plastic garment covers, examination gowns, stretcher sheets, examination table paper, pillow covers and gloves for personnel who come into contact with patients having highly communicable diseases.\n* Books\nThe Corporation is one of the largest printers of consumable elementary and high school workbooks in the United States. The Corporation prints other products for publishers of educational and general book markets including textbooks (primarily soft cover), testing materials and paperbound books. Print opportunities in the consumable educational workbook market decreased during the last several years. Publisher consolidations have resulted in fewer companies offering educational products which has reduced the number of projects printed. These newly combined companies have tightened cost and inventory controls. Additionally, the much publicized effort to improve the nation's educational system has prompted schools to try alternate teaching methods. Some of these efforts have replaced consumable workbooks with other materials.\nTo reduce its concentration in the elementary and high school markets, the Corporation has increased its marketing efforts for other softcover books including college texts, general books, data manuals and software documentation for the computer industry. The Corporation's operating units serving the computer and software industries print manuals, using both offset printing and high speed photocopying, and offer complete \"turnkey services\" including computer disk replication, product packaging and distribution. In 1993, the Corporation expanded the array of services it offers customers in this market. New services include 1-800 telephone order fulfillment services, which allows orders to be received directly by our fulfillment facility. The Corporation's CYCLESpeed (SM) service is a new manufacturing system that emphasizes shorter, more frequent production of print orders to minimize our customers' inventory and provides constant monitoring of inventory levels.\nThe Corporation's book units also produce multimedia products for educational publishers, industry and professional and trade associations.\nOther customers include publishers of trade books, religious books, cookbooks and manuals.\n* Magazines\nThe Corporation's two plants serving the magazine market print, sort and mail magazines representing more than 500 different titles. These magazines include primarily short-to-medium run publications (usually less than 350,000 copies) which are generally distributed to subscribers by mail. The Corporation's magazine customers are publishers of specialty magazines, including religious, business and professional journals and hobby, craft and sporting publications. During 1993, the Corporation began providing its customers with computerized mailing list and distribution services.\n* Other\nPrepress services are provided by four of the Corporation's operating units to publishers, printers and advertising agencies. Such services include the conversion of full-color photographs, art and text into color separated film for use in the production of printing plates utilizing computer technology, electronic scanners and cameras.\nKCS Industries Inc., a subsidiary of the Corporation, produces point-of- purchase products such as custom designed signs, displays, labels and decals for a variety of customers including those in the brewing, cosmetic, food, appliance, automotive and home entertainment industries. KCS Industries also produces postage stamps in booklet, coil and sheet format for the USPS.\nCompetition.\nThe Corporation is subject to competition from a large number of companies, some of which have greater resources and capacity than the Corporation. The major competitive factors in the Corporation's business are price, quality of finished products, distribution capabilities, ongoing customer service and availability of printing time on equipment which is appropriate in size and function for a given project. The consolidation of customers within certain of the Corporation's markets provides both greater competitive pricing pressures and opportunities for increased volume solicitation. In recent years, excess capacity in the printing industry has resulted in downward pricing pressures. The Corporation believes it compares favorably with its competitors.\nThere are seasonal fluctuations in the usage of printing equipment which in times of low demand and excess capacity can give rise to increased pricing pressure. In the educational market, for instance, activity is greater in the first half of the year, and in the catalog and direct marketing markets, activity is greater in the second half of the year.\nRaw Materials.\nThe principal raw material used by the Corporation is paper. Most of the Corporation's production facilities are located in heavily concentrated papermaking areas, and the Corporation can generally obtain quality paper at competitive prices. The Corporation is not dependent upon any one source for its paper or other raw materials.\nOvercapacity in paper markets during 1993, 1992 and 1991 caused paper to be readily available and resulted at certain times in significant price reductions. The Corporation's average cost of paper fluctuated in 1993 with lower costs during the first six months. A midyear price increase averaged about 10% on most coated paper and much of that increase eroded in the fourth quarter. Overall, the average cost of paper to our customers was about 2% higher in 1993 than in 1992. During 1992 and 1991, the paper prices were on average, 9.1% and 6.5% less, respectively, than in the prior year. However, during the last six months of 1992, paper prices increased modestly.\nThe Corporation uses a number of other raw materials, including ink, polyethylene resin (used in film extrusion), solvents, adhesives, wire, packaging materials and subcontracted components. Costs for these materials, other than polyethylene resins, were stable during recent years. Resin prices decreased about 20% during 1991 following the Persian Gulf war, increased about 24% in 1992 and decreased about 10% in 1993.\nDevelopment.\nIn the graphic arts industry, most research and development is done by equipment and material suppliers. The Corporation generally does not engage in long-range research and development relating to equipment and has not spent significant amounts of money for such purposes. One of the purposes of the Corporation's technical research and development effort is to establish a competitive advantage in existing markets by focusing on improving operating procedures, increasing machine speeds and improving monitoring of paper usage. The Corporation's research and development effort also includes investigations of new markets both for products currently produced by the Corporation, as well as applications of newer technology including the development of certain proprietary inks, coatings, adhesives and machine modifications. During the last several years, eleven professional and technical employees have worked exclusively on research and development activities. Additionally, approximately forty persons from quality control and engineering devoted a portion of their time to research and development.\nThe Corporation has environmental compliance programs primarily for control of internal and external air quality, ground water quality, disposal of waste material and all aspects of the work environment concerning employee health. Capital expenditures for air quality equipment have approximated 2% to 4% of total capital expenditures in each of the last three years. Planned capital expenditures for environmental control equipment are expected to be in the same range for 1994. The Corporation also incurs ongoing costs in monitoring compliance with environmental laws, in connection with disposal of waste materials and in connection with laws governing the remediation of sites at which the Corporation has previously disposed of waste materials. Requirements by EPA and state officials nationwide, relating to disposal of wastes in landfill sites, are increasing and result in higher costs for the Corporation and its competitors. Costs for environmental compliance and waste disposal have not been material to the Corporation in the past, but the Corporation presently believes that expenditures for these purposes will have a negative impact on its earnings and those of its competition in the future. These increased costs should not have a material impact on the Corporation's competitive position, assuming similar expenditures are required to be made by competitors. The Corporation does not believe at the present time that any costs, claims or penalties that may be incurred or assessed under environmental laws, in connection with known environmental assessment and remediation matters, beyond any reserves already provided will have a material adverse effect upon the operations or consolidated financial position of the Corporation.\nEXECUTIVE OFFICERS OF THE CORPORATION\nName, Age, Position Business Experience During Last Five Years\nCalvin W. Aurand, Jr.; 63;. . . . . Chairman of the Board and Chief Executive President, Chairman of the Officer of the Corporation since July Board and Chief Executive 1989; President of the Corporation since Officer March 1989; President and Chief Operating Officer of American Bank Note Company (printer of currency, stamps and stock and bond certificates), 1985-February, 1989.\nGerald A. Henseler; 53; . . . . . . Executive Vice President and Chief Executive Vice President and Financial Officer of the Corporation since Chief Financial Officer 1992; Senior Vice President, Chief Financial Officer and Treasurer of the Corporation prior thereto.\nRonald D. Kneezel; 37;. . . . . . . Secretary of the Corporation since Secretary, Vice President and December 1, 1991; Vice President and General Counsel General Counsel of the Corporation since July, 1988.\nRobert A. Kreider; 39;. . . . . . . Treasurer of the Corporation since Treasurer and Corporate November 1992, Corporate Controller since Controller July 1989; Assistant Treasurer April 1991 - October 1992; Controller of a subsidiary of the Corporation prior thereto.\nJames E. Milslagle; 54; . . . . . . Vice President of the Corporation since Vice President Human Resources May 1988.\nDennis J. Meyer; 38;. . . . . . . . Vice President of the Corporation since Vice President Marketing January, 1994; Vice President, Quebecor Printing (manufacturer of printed materials) 1990-1993; Director of Marketing, Maxwell Communications Corporation (manufacturer of printed materials) 1986-1990.\nJohn E. Tiffany; 55;. . . . . . . . Vice President of the Corporation since Vice President Manufacturing October, 1988.\nAllan J. Williamson; 62;. . . . . . President of Banta Company, a division of President of Banta Company, the Corporation, since January, 1991; a division of the Corporation Executive Vice President of Banta Company prior thereto.\nThere are no family relationships between the executive officers of the Corporation.\nAll of the executive officers are elected or appointed annually. Each officer holds office until his successor has been elected or appointed or until his death, resignation or removal.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Corporation and its subsidiaries own operating plants located in Wisconsin, Minnesota, Missouri, North Carolina, Utah and Virginia, as well as several warehouse facilities for storage of materials. As of the end of fiscal 1993, these owned facilities include approximately 2,592,000 square feet of space utilized as follows: office space 268,000, manufacturing 1,406,000 and warehouse 918,000. The Corporation leases its headquarters office located in Menasha, Wisconsin. The Corporation leases four production facilities in Wisconsin; two in Massachusetts; and one each in California, Illinois, Minnesota and Utah, as well as warehouse space in numerous locations. These leased facilities contain approximately 995,000 square feet of space. The buildings owned and leased by the Corporation are primarily of steel and brick construction.\nOne plant owned by the Corporation and certain equipment are pledged to secure issues of industrial revenue bonds in the principal amount of $3,240,000 as of January 1, 1994.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Corporation is not involved in any material pending legal proceedings, as defined by this item.\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.\nAs of March 11, 1994, there were approximately 1,778 holders of record of the Corporation's Common Stock.\nUnder long-term debt agreements to which the Corporation is a party, payment of cash dividends is restricted. As of January 1, 1994, approximately $56,032,000 was not restricted under these agreements.\nThe information set forth under the caption \"Dividend Record and Market Prices\" in the Corporation's Annual Report to Shareholders for the fiscal year ended January 1, 1994, (a copy of which is filed as an exhibit to this report) is hereby incorporated herein by reference in answer to the remainder of this Item.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information set forth under the caption \"Five-Year Summary of Selected Financial Data\" in the Corporation's Annual Report to Shareholders for the fiscal year ended January 1, 1994, (a copy of which is filed as an exhibit to this report) is hereby incorporated herein by reference in answer to this Item.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe information set forth under the caption \"Management's Discussion and Analysis of Financial Position and Operations\" in the Corporation's Annual Report to Shareholders for the fiscal year ended January 1, 1994, (a copy of which is filed as an exhibit to this report) is hereby incorporated herein by reference in answer to this Item.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Consolidated Balance Sheets of the Corporation and subsidiaries as of January 1, 1994 and January 2, 1993, and the related Consolidated Statements of Earnings, Cash Flows and Shareholders' Investment for the fiscal years ended January 1, 1994, January 2, 1993 and December 28, 1991, together with the related notes thereto, set forth in the Corporation's Annual Report to Shareholders for the fiscal year ended January 1, 1994, (a copy of which is filed as an exhibit to this report) are hereby incorporated herein by reference in answer to a portion of this Item.\nThe information set forth under the caption \"Unaudited Quarterly Financial Information\" in the Corporation's Annual Report to Shareholders for the fiscal year ended January 1, 1994 (a copy of which is filed as an exhibit to this report) is hereby incorporated herein by reference in answer to a portion of this item.\nThe information set forth under the caption \"Report of Independent Public Accountants\" in the Corporation's Annual Report to Shareholders for the fiscal year ended January 1, 1994 (a copy of which is filed as an exhibit to this report) is hereby incorporated herein by reference in answer to the remainder of this Item.\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 \"Election of Directors\" contained in the Corporation's definitive proxy statement for the annual meeting of shareholders on April 26, 1994, as filed with the Securities Exchange Commission, is hereby incorporated herein by reference. Reference is also made to the information under the heading \"Executive Officers of the Corporation\" included under Item 1 of Part I of this report.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information under the captions \"Board of Directors\" and \"Executive Compensation\" (other than the information under the subheading \"Board Compensation Committee Report on Executive Compensation\") contained in the Corporation's definitive proxy statement for the annual meeting of shareholders on April 26, 1994, as filed with the Securities and Exchange Commission, is hereby incorporated herein by reference in answer to this Item.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information under the caption \"Stock Ownership of Management\" contained in the Corporation's definitive proxy statement for the annual meeting of shareholders on April 26, 1994, as filed with the Securities and Exchange Commission, is hereby incorporated herein by reference in answer to this Item.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information under the captions \"Board of Directors\" and \"Executive Compensation\" (other than the information under the subheading \"Board Compensation Committee Report on Executive Compensation\") contained in the Corporation's definitive proxy statement for the annual meeting of shareholders on April 26, 1994, as filed with the Securities and Exchange Commission, is hereby incorporated herein by reference in answer to this Item.\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:\nPAGE REFERENCE\nANNUAL REPORT FORM 10-K TO SHAREHOLDERS\n1. Financial Statements: Consolidated Balance Sheets January 1, 1994 and January 2, 1993 20 For the fiscal years ended January 1, 1994, January 2, 1993 and December 28, 1991: Consolidated Statements of Earnings 21 Consolidated Statements of Cash Flows 22 Consolidated Statements of Shareholders' Investment 23 Notes to Consolidated Financial Statements 24-30 Report of Independent Public Accountants 31 Consent of Independent Public Accountants 12\n2. Financial Statement Schedules: Report of Independent Public Accountants 12 Schedule V - Plant and Equipment 13 Schedule VI - Accumulated Depreciation and Amortization of Plant and Equipment 14 Schedule VIII - Valuation and Qualifying Accounts 15 Schedule IX - Short Term Borrowings 16 Schedule X - Supplementary Income Statement Information 17\nAll other schedules have been omitted since the required information is included in the consolidated financial statements or notes thereto, or because the information is not required or applicable.\n3. Exhibits:\n3. (a) Articles of Incorporation, as amended (1) (b) Amendments to Bylaws (c) Bylaws, as amended\n4. (a) Note Purchase Agreements dated December 9, 1986 (2) (b) Amendment to Note Purchase Agreements dated December 9, 1986 (3) (c) Note Purchase Agreement dated June 24, 1988 (4) (d) Amendment to Note Purchase Agreements dated December 9, 1986 (5) (e) Promissory Note Agreement dated July 17, 1990 (6) (f) Rights Agreement dated October 29, 1991 (7)\n[Note: The registrant has outstanding certain issues of industrial revenue bonds, none of which authorize the issuance of securities in an amount exceeding 10% of the registrant's consolidated assets. The registrant hereby agrees to furnish to the Commission upon request a copy of any instrument with respect to long-term debt not being registered under which the total amount of securities authorized does not exceed 10% of the registrant's consolidated assets.]\n*10.(a) Supplemental Retirement Plan for Key Employees (8) (b) Amendment to Supplemental Retirement Plan for Key Employees (9) (c) Prior Amendments to Supplemental Retirement Plan (10) (d) Management Incentive Award Plan (11) (e) Amendment to Management Incentive Award Plan (12) (f) Form of Agreements with Gerald A. Henseler and Allan J. Williamson (13) (g) Form of Agreements with Calvin W. Aurand, Jr. and Ronald D. Kneezel (14) (h) Form of Agreements with Robert A. Kreider, Dennis J. Meyer, James E. Milslagle and John E. Tiffany (15) (i) Letter of Agreement with Calvin W. Aurand, Jr. (16) (j) 1985 Deferred Compensation Plan for Key Employees, as amended and restated (17) (k) 1988 Deferred Compensation Plan for Key Employees, as amended and restated (18) (l) Basic Form of Deferred Compensation Agreements under 1985 and 1988 Deferred Compensation Plans for Key Employees (19) (m) Deferred Compensation Plan for Directors (20) (n) Form of Deferred Compensation Agreements for Directors (21) (o) Revised Form of Indemnity Agreements with Directors and Certain Officers (22) (p) 1987 Incentive Stock Option Plan; 1987 Nonstatutory Stock Option Plan (23) (q) Amendment to 1987 Nonstatutory Stock Option Plan (24) (r) Executive Trust Agreement (25) (s) Amendment to Executive Trust Agreement (t) Long-term Incentive Plan (26) (u) Amendment to Long-term Incentive Plan (27) (v) 1991 Stock Option Plan (28) (w) Agreement with Allan J. Williamson (29) (x) Description of Supplemental Long-term Disability Plan (30)\n13. Annual Report to Shareholders for fiscal year ended January 1, 1994.\nWith the exception of those portions specifically incorporated herein by reference (See Part I, Item 1 and Part II, Items 5, 6, 7 and 8) said report is furnished solely for the information of the Commission and is not to be deemed \"filed\" as part of this report.\n21. List of Subsidiaries.\n(1) Exhibit No. 19(b) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(2) Exhibit No. 4(c) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(3) Exhibit No. 4(b) to Form 10-Q for the quarter ended July 2, 1988 is hereby incorporated herein by reference.\n(4) Exhibit No. 4(a) to Form 10-Q for the quarter ended July 2, 1988 is hereby incorporated herein by reference.\n(5) Exhibit No. 4(d) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(6) Exhibit No. 4 to Form 10-Q for the quarter ended September 29, 1990 is hereby incorporated herein by reference.\n(7) Exhibit No. 4.1 to the Form 8-K dated October 29, 1991 is hereby incorporated herein by reference.\n(8) Exhibit No. 14 to Form 10-K for the year ended December 29, 1979 is hereby incorporated herein by reference.\n(9) Exhibit No. 10(c) to Form 10-K for the year ended December 31, 1988 is hereby incorporated herein by reference.\n* Exhibits 10(a) through 10(x) are management contracts or compensatory plans or arrangements.\nAll documents incorporated herein by reference are filed with the Commission under File No. 0-6187.\n(10) Exhibit No. 19(a) to Form 10-K for the year ended December 31, 1983, Exhibit No. 19(a) to Form 10-Q for the quarter ended June 30, 1984 and Exhibit No. 10(f) to Form 10-K for the year ended December 28, 1985 are hereby incorporated herein by reference.\n(11) Exhibit No. 10(e) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(12) Exhibit No. 19(e) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(13) Exhibit No. 10 to Form 10-K for the year ended January 1, 1983 is hereby incorporated herein by reference.\n(14) Exhibit No. 10(k) to Form 10-K for the year ended December 31, 1988 is hereby incorporated herein by reference.\n(15) Exhibit No. 10(g) to Form 10-K for the year ended December 28, 1991 is hereby incorporated herein by reference.\n(16) Exhibit No. 10(l) to Form 10-K for the year ended December 31, 1988 is hereby incorporated herein by reference.\n(17) Exhibit No. 10(j) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(18) Exhibit No. 10(k) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(19) Exhibit No. 10(l) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(20) Exhibit No. 10(q) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(21) Exhibit No. 10(p) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(22) Exhibit No. 10(a) to Form 10-Q for the quarter ended March 28, 1992 is hereby incorporated herein by reference.\n(23) Exhibit No. 6(a) to Form 10-Q for the quarter ended July 4, 1987 is hereby incorporated herein by reference.\n(24) Exhibit No. 19(a) to Form 10-Q for the quarter ended October 3, 1987 is hereby incorporated herein by reference.\n(25) Exhibit No. 10(r) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(26) Exhibit No. 10(t) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(27) Exhibit No. 19(f) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(28) Exhibit No. 10(u) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(29) Exhibit No. 10(v) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(30) Exhibit No. 10(a) to Form 10-Q for the quarter ended October 2, 1993 is hereby incorporated herein by reference.\nAll documents incorporated herein by reference are filed with the Commission under File No. 0-6187.\nREPORT OF INDEPENDENT ACCOUNTANTS\nWe have audited, in accordance with generally accepted standards, the consolidated financial statements included in the Banta Corporation annual report to shareholders and incorporated by reference in this Form 10-K, and have issued our report thereon dated January 31, 1994. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in the index in item 14(a) are the responsibility of the Corporation'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. The 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, January 31, 1994.\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports, included and incorporated by reference in this Form 10-K, into Banta Corporation's previously filed Form S-8 Registration Statements Nos. 33- 13584, 33-40036 and 33-54576.\nARTHUR ANDERSEN & CO.\nMilwaukee, Wisconsin, March 21, 1994.\nBANTA CORPORATION SCHEDULE V - PLANT AND EQUIPMENT YEARS ENDED JANUARY 1, 1994 (1993), JANUARY 2, 1993 (1992), AND DECEMBER 28, 1991 (1991)\n(1) Represents primarily the transfer of the remaining video operations assets that were previously recorded as assets held for sale in 1992 and the purchase of plant and equipment of Bushman Press in 1991. This column also includes certain reclassification in all three years.\nBANTA CORPORATION SCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PLANT AND EQUIPMENT YEARS ENDED JANUARY 1, 1994 (1993), JANUARY 2, 1993 (1992), AND DECEMBER 28, 1991 (1991)\n(1) In 1993, represents a reclassification of previously provided reserves related to certain equipment. In 1992, represents the transfer of Video Operation that were previously recorded as Assets Held for Sale. This column also includes certain reclassifications.\nBANTA CORPORATION SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JANUARY 1, 1994 (1993), JANUARY 2, 1993 (1992), AND DECEMBER 28, 1991 (1991)\nBANTA CORPORATION SCHEDULE IX - SHORT-TERM BORROWINGS YEARS ENDED JANUARY 1, 1994 (1993), JANUARY 2, 1993 (1992), AND DECEMBER 28, 1991 (1991)\nCommercial paper borrowings are supported by lines of credit aggregating $40,000,000 at January 1, 1994. Commercial paper maturities generally do not exceed 90 days. Bank borrowings are arranged on an as-needed basis at various terms.\nBANTA CORPORATION SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION YEARS ENDED JANUARY 1, 1994 (1993), JANUARY 2, 1993 (1992), AND DECEMBER 28, 1991 (1991)\nDepreciation and amortization of intangible assets and deferred charges, taxes other than payroll and income taxes, royalties, and advertising costs did not exceed one percent of consolidated sales.\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, thereunto duly authorized.\nBANTA CORPORATION\nDATE: March 23, 1994 BY: \/s\/ CALVIN W. AURAND, JR. Calvin W. Aurand, Jr., 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.\n\/s\/ CALVIN W. AURAND, JR. March 23, 1994 Calvin W. Aurand, Jr. President, Chairman of the Board, Chief Executive Officer and Director\n\/s\/ GERALD A. HENSELER March 23, 1994 Gerald A. Henseler, Executive Vice President, Chief Financial Officer, and Director\n\/s\/ ROBERT A. KREIDER March 23, 1994 Robert A. Kreider, Treasurer\n\/s\/ GEORGE T. BROPHY March 23, 1994 George T. Brophy, Director\n\/s\/ BERNARD S. KUBALE March 23, 1994 Bernard S. Kubale, Director\n\/s\/ DONALD TAYLOR March 23, 1994 Donald Taylor, Director\n\/s\/ ALLAN J. WILLIAMSON March 23, 1994 Allan J. Williamson, Director\nBANTA CORPORATION - File No. 0-6187 Form 10-K, Year Ended January 1, 1994\nEXHIBIT INDEX Exhibit Number\n3. (a) Articles of Incorporation, as amended (1) (b) Amendments to Bylaws (c) Bylaws, as amended\n4. (a) Note Purchase Agreements dated December 9, 1986 (2) (b) Amendment to Note Purchase Agreements dated December 9, 1986 (3) (c) Note Purchase Agreement dated June 24, 1988 (4) (d) Amendment to Note Purchase Agreements dated December 9, 1986 (5) (e) Promissory Note Agreement dated July 17, 1990 (6) (f) Rights Agreement dated October 29, 1991 (7)\n10. (a) Supplemental Retirement Plan for Key Employees (8) (b) Amendment to Supplemental Retirement Plan for Key Employees (9) (c) Prior Amendments to Supplemental Retirement Plan (10) (d) Management Incentive Award Plan (11) (e) Amendment to Management Incentive Award Plan (12) (f) Form of Agreements with Gerald A. Henseler and Allan J. Williamson (13) (g) Form of Agreements with Calvin W. Aurand, Jr. and Ronald D. Kneezel (14) (h) Form of Agreements with Robert A. Kreider, Dennis J. Meyer, James E. Milslagle and John E. Tiffany (15) (i) Letter Agreement with Calvin W. Aurand, Jr. (16) (j) 1985 Deferred Compensation Plan for Key Employees, as amended and restated (17) (k) 1988 Deferred Compensation Plan for Key Employees, as amended and restated (18) (l) Basic Form of Deferred Compensation Agreements under 1985 and 1988 Deferred Compensation Plans for Key Employees (19) (m) Deferred Compensation Plan for Directors (20) (n) Form of Deferred Compensation Agreements for Directors (21) (o) Revised Form of Indemnity Agreements with Directors and Certain Officers (22) (p) 1987 Incentive Stock Option Plan; 1987 Nonstatutory Stock Option Plan (23) (q) Amendment to 1987 Nonstatutory Stock Option Plan (24) (r) Executive Trust Agreement (25) (s) Amendment to Executive Trust Agreement (t) Long-term Incentive Plan (26) (u) Amendment to Long-term Incentive Plan (27) (v) 1991 Stock Option Plan (28) (w) Agreement with Allan J. Williamson (29) (x) Description of Supplemental Long-term Disability Plan (30)\nBANTA CORPORATION - File No. 0-6187 Form 10-K, Year Ended January 1, 1994\nEXHIBIT INDEX CONTINUED\nExhibit Number\n13. Annual Report to Shareholders for fiscal year ended January 1, 1994\nWith the exception of those portions specifically incorporated herein by reference (See Part I, Item 1 and Part II, Items 5, 6, 7 and 8) said report is furnished solely for the information of the Commission and is not to be deemed \"filed\" as part of this report.\n21. List of Subsidiaries\n(1) Exhibit No. 19(b) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(2) Exhibit No. 4(c) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(3) Exhibit No. 4(b) to Form 10-Q for the quarter ended July 2, 1988 is hereby incorporated herein by reference.\n(4) Exhibit No. 4(a) to Form 10-Q for the quarter ended July 2, 1988 is hereby incorporated herein by reference.\n(5) Exhibit No. 4(d) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(6) Exhibit No. 4 to Form 10-Q for the quarter ended September 29, 1990 is hereby incorporated herein by reference.\n(7) Exhibit No. 4.1 to the Form 8-K dated October 29, 1991 is hereby incorporated herein by reference.\n(8) Exhibit No. 14 to Form 10-K for the year ended December 29, 1979 is hereby incorporated herein by reference.\n(9) Exhibit No. 10(c) to Form 10-K for the year ended December 31, 1988 is hereby incorporated herein by reference.\n(10) Exhibit No. 19(a) to Form 10-K for the year ended December 31, 1983, Exhibit No. 19(a) to Form 10-Q for the quarter ended June 30, 1984 and Exhibit No. 10(f) to Form 10-K for the year ended December 28, 1985 are hereby incorporated herein by reference.\n(11) Exhibit No. 10(e) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(12) Exhibit No. 19(e) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(13) Exhibit No. 10 to Form 10-K for the year ended January 1, 1983 is hereby incorporated herein by reference.\nAll documents incorporated herein by reference are filed with the Commission under File No. 0-6187.\n(14) Exhibit No. 10(k) to Form 10-K for the year ended December 31, 1988 is hereby incorporated herein by reference.\n(15) Exhibit No. 10(g) to Form 10-K for the year ended December 28, 1991 is hereby incorporated herein by reference.\n(16) Exhibit No. 10(l) to Form 10-K for the year ended December 31, 1988 is hereby incorporated herein by reference.\n(17) Exhibit No. 10(j) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(18) Exhibit No. 10(k) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(19) Exhibit No. 10(l) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(20) Exhibit No. 10(q) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(21) Exhibit No. 10(p) to Form 10-K for the year ended January 3, 1987 is hereby incorporated herein by reference.\n(22) Exhibit No. 10(a) to Form 10-Q for the quarter ended March 28, 1992 is hereby incorporated herein by reference.\n(23) Exhibit No. 6(a) to Form 10-Q for the quarter ended July 4, 1987 is hereby incorporated herein by reference.\n(24) Exhibit No. 19(a) to Form 10-Q for the quarter ended October 3, 1987 is hereby incorporated herein by reference.\n(25) Exhibit No. 10(r) to Form 10-K for the year ended December 30, 1989 is hereby incorporated herein by reference.\n(26) Exhibit No. 10(t) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(27) Exhibit No. 19(f) to Form 10-Q for the quarter ended April 3, 1993 is hereby incorporated herein by reference.\n(28) Exhibit No. 10(u) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(29) Exhibit No. 10(v) to Form 10-K for the year ended December 29, 1990 is hereby incorporated herein by reference.\n(30) Exhibit No. 10(a) to Form 10-Q for the quarter ended October 2, 1993 is hereby incorporated herein by reference.\nAll documents incorporated herein by reference are filed with the Commission under File Number 0-6187.","section_15":""}
{"filename":"714655_1994.txt","cik":"714655","year":"1994","section_1":"Item 1. Business\nBiogen, Inc. (\"Biogen\" or the \"Company\") is a biopharmaceutical company principally engaged in the business of developing and manufacturing drugs for human health care through genetic engineering. Biogen currently derives revenues from a number of products sold by licensees around the world. During 1994, Biogen's licensees generated total sales of approximately $1.7 billion from these products. In the future, Biogen expects to derive additional revenues from sales of proprietary products which Biogen will market. Biogen's leading product candidate is recombinant beta interferon, a protein being developed for use as a therapy for multiple sclerosis. A Phase III clinical trial of recombinant beta interferon in patients with multiple sclerosis was completed in 1994. The Company intends to seek a license in the United States and market approval in the countries of the European Union for beta interferon in the first half of 1995.\nBiogen focuses its research and development efforts on areas where it has particular scientific and competitive strengths: inflammatory diseases, respiratory diseases and certain cancers and viruses. Biogen is conducting preclinical tests on three anti-inflammatory product candidates from its T-cell activation, T-cell\/B-cell interaction and cell adhesion programs. These product candidates are being tested for therapeutic uses in a broad range of acute and chronic inflammatory and autoimmune diseases. Biogen is also conducting preclinical tests on an antimucolytic agent for treatment in cystic fibrosis and several other pulmonary diseases. In addition, Biogen has earlier-stage research programs directed toward finding therapies for renal failure and restenosis and developing products for human gene therapy.\nBiogen Proprietary Products and Major Research Programs\nBiogen's research is focused on biological systems and processes where its scientific expertise in molecular biology, cell biology, immunology and protein chemistry can lead to a greater understanding of disease processes and, as a result, to the creation of new pharmaceuticals. Biogen selects product candidates from its research programs to test in clinical trials, focusing its efforts on those agents which it believes have the greatest potential competitive advantages and large commercial markets. Described below are Biogen's beta interferon product and major research programs.\nRecombinant Beta Interferon\nNatural beta interferon is a protein produced by fibroblast cells in response to viral infection. Biogen is developing recombinant beta interferon for use as a therapy in multiple sclerosis. Multiple sclerosis is a progressive neurological disease in which the body loses the ability to transmit messages among nerve cells, leading to a loss of muscle control, paralysis and in some cases death. Patients with active relapsing multiple sclerosis experience an uneven pattern of disease progression, characterized by periods of stability interrupted by flareups of the disease after which the patient returns to a new baseline of functioning. In July 1994, Biogen announced the results of a Phase III clinical trial in the United States of recombinant beta interferon for the treatment of multiple sclerosis. Based on the data from the trial, which was sponsored by the National Institutes of Health, recombinant beta interferon appeared to slow the progression of disability and to reduce the number of flareups of the disease in patients with active relapsing multiple sclerosis. Biogen intends to seek a license in the United States and market approval in the countries of the European Union for recombinant beta interferon in the first half of 1995. As part of its world-wide strategy to commercialize recombinant beta interferon, Biogen transferred manufacture of the product from its former joint venture in Europe to a production facility in Cambridge. The Company uses a different production process at the Cambridge facility and is conducting bio-equivalency studies in a small number of healthy human volunteers, comparing the drug manufactured in Europe and the drug manufactured in Cambridge. See also \"Patents and Other Proprietary Rights.\"\nMajor Research Programs\nInflammation Program\nBiogen scientists have been working to understand the activities of white blood cells involved in the inflammation process. Biogen has focused on two events central to inflammation: (1) the activation of T-cells, specialized white blood cells which initiate and control the immune response; and (2) the adhesion of white blood cells to the endothelium (blood vessel walls) and their migration through the endothelium into surrounding tissues where they cause inflammation. Activation and adhesion of white blood cells depend upon the binding of pairs of receptor molecules which appear on the surface of white blood cells and endothelial cells. When these pairs of receptors bind together, their interactions create cellular \"pathways\" for activation and adhesion events. Biogen has investigated several of these cellular pathways and identified new receptors in certain of these pathways.\nBased on its research, Biogen has selected three cellular pathways as the promising points of therapeutic intervention to prevent inflammation: (1) the LFA-3\/CD2 pathway, which activates T-cells, (2) the VCAM-1\/VLA-4 pathway, which is necessary for the adhesion of several types of white blood cells to endothelial cells, and (3) the CD40L\/CD40 pathway, which activates B-cells which produce antibodies. Biogen believes that products which interrupt these pathways will block the inflammation process at an early stage, thus preventing tissue damage more effectively than currently available therapies. Moreover, such products should result in selective inhibition of the immune system, rather than the broad suppression associated with many therapies currently available or under development. In in vitro and in vivo experiments the product candidates from the inflammation program have shown promising inhibitory effects. The Company expects to commence Phase I clinical trials of at least one product candidate from the inflammation program by 1996.\nGelsolin\nThick viscid secretions in the airways of cystic fibrosis (\"CF\") patients are believed to cause progressive pulmonary destruction. A major contributor to the viscosity of CF mucus is the release of a large amount of filamentous actin by degenerating inflammatory cells which migrate in large numbers to the airways of CF patients. Biogen and its collaborators believe that severing actin filaments contaminating the CF airway mucus may lead to clinical improvement in CF patients. Biogen is developing a recombinant form of an actin severing agent, human r-P gelsolin, for reducing airway obstruction in CF and several other pulmonary diseases. The Company is presently conducting preclinical studies of gelsolin product candidates.\nOther Research Programs\nAs part of its further research efforts, Biogen is investigating the use of growth factors to prevent or treat the degeneration of the kidney which results from renal failure, methods of preventing restenosis and various human gene therapies.\nResearch Costs\nDuring 1994, 1993 and 1992, Biogen's research and development costs were approximately $91.2 million, $79.3 million and $60.4 million, respectively.\nThere can be no assurance that any of the products described above or resulting from Biogen's research programs will be successfully developed, prove to be safe and efficacious at each stage of clinical trials, meet applicable regulatory standards, be capable of being produced in commercial quantities at reasonable costs or be successfully marketed.\nPrincipal Products Being Marketed or Developed by Biogen Licensees\nIntron A Alpha Interferon\nAlpha interferon is a naturally occurring protein produced by normal white blood cells. Biogen has been granted patents in the United States and in Europe covering the production of alpha interferons through recombinant DNA techniques and has applications pending in numerous other countries. See \"Patents and Other Proprietary Rights.\" Biogen's worldwide licensee for recombinant alpha interferon, Schering-Plough Corporation (\"Schering-Plough\"), first began commercial sales of its Intron A brand of alpha interferon in the United States in 1986 for hairy-cell leukemia. Schering-Plough now sells Intron A in more than 60 countries for more than 16 indications, including hepatitis B, hepatitis C, genital warts and Kaposi's sarcoma.\nSales of Intron A by Schering-Plough were $426 million in 1994, the majority of which were generated outside the United States. Currently the largest market for Intron A is in Japan for the treatment of hepatitis C. In 1994, Japan instituted a 17% government-mandated decrease in the price of alpha interferon and imposed restrictions on off-label use. The United States Food and Drug Administration (\"FDA\") has approved Intron A for the treatment of hepatitis B and hepatitis C in the United States. Schering-Plough has undertaken studies using Intron A for a number of additional indications. These include late phase studies of Intron A for the treatment of chronic myelogenous leukemia, bladder cancer, non-Hodgkin's lymphoma, malignant melanoma, and head and neck cancer, and earlier phase trials for Crohn's disease and as a therapy for patients with HIV infection. Royalties from Schering-Plough accounted for approximately 40% of Biogen's revenues (excluding interest) in 1994.\nHepatitis B Vaccines and Diagnostics\nHepatitis B is a blood-borne disease which causes a serious infection of the liver and substantially increases the risk of liver cancer. More than 250 million people worldwide have chronic hepatitis B virus infections. Biogen holds several important patents related to hepatitis B antigens produced by genetic engineering techniques. See \"Patents and Other Proprietary Rights.\" These antigens are used in recombinant hepatitis B vaccines and in diagnostic test kits used to detect hepatitis B infection. In total, sales of hepatitis B vaccines and diagnostic products by Biogen licensees exceeded $1.0 billion in 1994.\nHepatitis B Vaccines\nAt least 20 countries around the world, including the United States, recommend vaccination against hepatitis B for all infants. The United States Centers for Disease Control and the American Academy of Pediatrics have also recommended universal immunization of ten-year-old children and at-risk adolescents. In 1994, France instituted a vaccination program for infants and adolescents. The United States Occupational Safety and Health Administration has recommended that all persons with an occupational exposure to blood and other infectious material receive the hepatitis B vaccine.\nSmithKline Beecham Biologicals s.a. (\"SmithKline\") and Merck & Co., Inc. (\"Merck\") are the two major worldwide marketers of hepatitis B vaccines. Biogen has licensed to SmithKline exclusive rights under Biogen's hepatitis B patents to market hepatitis B vaccines in the major countries of the world, excluding Japan. SmithKline's vaccine is approved in the United States and in over 60 other countries. In 1990, SmithKline and Biogen entered into a sublicense arrangement with Merck under which Biogen currently receives royalties. Royalties from SmithKline and Merck together accounted for approximately 42% of Biogen's revenues (excluding interest) in 1994. Biogen has also licensed rights under its hepatitis B patents to Merck and The Green Cross Corporation non-exclusively in Japan.\nIn 1994, the English Chancery Court upheld the favorable decision received by SmithKline in a foreign arbitration with Biogen regarding the rate of royalties payable under the agreement between the parties governing non-U.S. sales of hepatitis B vaccines by SmithKline. As a result, Biogen made a payment of $2.6 million to SmithKline in 1994. In 1993, SmithKline initiated arbitration in the United States regarding similar royalty provisions in a separate agreement governing sales of hepatitis B vaccines by SmithKline in the United States. The Company believes that a decision in the United States similar to the foreign arbitration decision is not probable.\nHepatitis B Diagnostics\nBiogen has licensed its proprietary hepatitis B rights non-exclusively, on an antigen-by-antigen basis, to diagnostic kit manufacturers. Biogen currently has hepatitis B license or supply agreements for diagnostic use with more than a dozen companies, including Abbott Laboratories, the major worldwide marketer of hepatitis B diagnostic kits, Ortho Diagnostic Systems, Inc., Roche Diagnostic Systems, Inc. and Organon Teknika B.V.\nGamma Interferon\nGamma interferon is a protein produced by cells of the immune system. Biogen developed a recombinant gamma interferon for Biogen Medical Products Limited Partnership (\"BMPLP\") under a development agreement with BMPLP. In Japan, Biogen's licensee, Shionogi & Co., Ltd. (\"Shionogi\"), markets recombinant gamma interferon under the trademark Imunomax -Gamma for renal cell carcinoma. Biogen supplies Shionogi with its clinical and commercial needs for recombinant gamma interferon. In general, gamma interferon has experienced disappointing results in clinical trials for tested indications.\nOther Products\nDuring the first quarter of 1994, Biogen entered into a license agreement with Eli Lilly and Company (\"Lilly\") under which Biogen granted Lilly rights under certain of Biogen's patents related to gene expression. Lilly uses the patented vectors and methods in several products that are on the market or in development. Under the license agreement Biogen receives royalties on sales of these products. Upon execution of the license agreement, Lilly paid Biogen approximately $10 million in royalties related to sales which occurred prior to 1994.\nHirulog Thrombin Inhibitor\nIn October 1994, Biogen decided to discontinue its major activities associated with development of its Hirulog thrombin inhibitor, based on the results of the Phase III trial of Hirulog in angioplasty. Although positive efficacy benefits were seen in selected patient populations, the trial results failed to demonstrate a significant positive effect, compared to the heparin control, on the primary efficacy end- point in the overall patient population. Hirulog appeared to demonstrate efficacy equivalent to the heparin control, although patients treated with Hirulog had a more than 50% lower incidence of major bleeding complications. Biogen is seeking a marketing partner for Hirulog .\nPatents and Other Proprietary Rights\nBiogen has filed numerous patent applications in the United States and various other countries seeking protection of a number of its processes and products, and patents have issued on a number of these applications. Issues remain as to the ultimate degree of protection that will be afforded to Biogen by such patents. There is no certainty that these patents or others, if obtained, will be of substantial protection or commercial benefit to Biogen. Furthermore, it is not known to what extent Biogen's other pending patent applications will ultimately be granted as patents or whether those patents that have been issued will prevail if they are challenged in litigation.\nTrade secrets and confidential know-how are important to Biogen's scientific and commercial success. Although Biogen seeks to protect its proprietary information, there can be no assurance that others will not either develop independently the same or similar information or obtain access to Biogen's proprietary information.\nRecombinant Alpha Interferon\nBiogen has more than 50 patents in countries around the world, including the United States and countries of the European Patent Office, covering the production of recombinant alpha interferons. Biogen continues to seek related patents in the United States and other countries.\nFour infringement suits have been filed in Biogen's name to enforce its non-US alpha interferon patents. The first suit was filed in Vienna, Austria against Boehringer Ingelheim Zentrale GmbH (\"BI\") and two of its subsidiaries. The Austrian Court has stayed Biogen's infringement case pending a decision by the Austrian Patent Office on BI's petition to revoke Biogen's European (Austrian) patent on grounds peculiar to Austrian law. Biogen expects an initial decision from the Austrian Patent Office in mid 1995. A final decision is unlikely before early 1996. The second suit was filed in Dusseldorf, Germany against Dr. Karl Thomae GmbH and two other BI companies. The German trial and appeal courts ruled in favor of Biogen and have enjoined Thomae from the further manufacture, use or sale of recombinant alpha-2(c) interferon. The third suit was filed in Warsaw, Poland against Boehringer Ingelheim Pharma GmbH (\"BI Pharma\"). Biogen expects a trial in early 1996 in Poland. The fourth suit was filed in June 1994 in Tokyo, Japan against Amgen Limited. The suit seeks to enjoin Amgen from its clinical testing and planned commercialization of consensus interferon. Biogen does not expect a decision in this case before 1997.\nRecombinant Hepatitis B Antigens\nBiogen has more than 75 patents in countries around the world, including three in the United States and two in countries of the European Patent Office, and several patent applications, covering the recombinant production of hepatitis B surface, core and \"e\" antigens. Biogen continues to seek related patents in the United States and other countries.\nBiogen's first European hepatitis B patent was opposed by five companies. The Opposition Division of the European Patent Office maintained the patent over those oppositions. Two of the opponents appealed the Opposition Division's decision to the Technical Board of Appeal, which is the final arbiter of European oppositions. In June 1994, the Technical Board maintained Biogen's patent in amended form.\nBiogen's second European hepatitis B patent was opposed by four companies. In 1992, the Opposition Division held that Biogen's second European hepatitis B patent lacked inventive step. Biogen appealed this decision to the Technical Board of Appeal. In July 1994, the Technical Board reversed the Opposition Division and maintained the Biogen patent.\nBiogen has filed three infringement suits to enforce its hepatitis B patents, in England against Medeva plc (\"Medeva\"), in Israel against Bio-Technology General (Israel) Ltd. (\"BTG\"), and in Singapore against Scitech Medical Products Pte Ltd. and Scitech Genetics Pte Ltd. The action against Medeva seeks to enjoin Medeva's planned production and distribution of a hepatitis B vaccine. In November 1993, the United Kingdom High Court of Justice ruled in favor of Biogen and enjoined Medeva from infringement of one of Biogen's European (UK) patents. The Court then stayed the injunction pending Medeva's appeal. In October 1994, the United Kingdom Court of Appeal reversed the High Court and held the Biogen patent to be invalid. Biogen has received provisional leave from the United Kingdom House of Lords to appeal this decision. If the House of Lords withdraws the leave to appeal or does not reverse the decision of the Court of Appeal and hold the Biogen patent valid and infringed, the Biogen hepatitis B patent will no longer be enforceable in the United Kingdom or in any of the various United Kingdom patent registration countries. In 1992, BTG brought an action against Biogen seeking a compulsory license under Biogen's Israeli hepatitis B patent and Biogen filed an infringement suit against BTG, seeking to enjoin BTG's planned production, sale and distribution of hepatitis B vaccine. Both cases are continuing in Israel. In 1993, Biogen sued Scitech Products and Scitech Genetics in Singapore. Since Singapore is a United Kingdom patent registration country, Biogen's continued prosecution of this case depends on a favorable outcome in the United Kingdom House of Lords on Biogen's appeal of the decision holding Biogen's European (UK) patent invalid.\nRecombinant Beta Interferon\nThe European Patent Office and certain countries have granted patents to Biogen covering the recombinant production of beta interferon. In other countries, including the United States, Biogen has filed patent applications and continues to seek patents covering the recombinant production of beta interferon and related technology.\nBiogen's European patent was opposed by one company. In December 1993, the European Patent Office's Opposition Division dismissed the opposition and maintained Biogen's patent. The opponent appealed this decision to the Technical Board of Appeal. Biogen expects a decision on the appeal in early 1996. In the United States, Biogen's claims to key intermediates in the recombinant production of beta interferon were involved in an interference to determine who was the first to invent those intermediates in the United States. Priority of invention was awarded to another party in the interference. Biogen's pending United States claims to the production of recombinant beta interferon were not part of that interference. Prosecution of these claims continues.\nOther parties have also filed patent applications in various countries covering the recombinant production of beta interferon, and, in particular, key intermediates in that production, as well as beta interferon itself. One such party has been granted several patents in the European Patent Office and in certain countries on these key intermediates. The same party was awarded priority to those intermediates in the United States interference. Biogen has obtained non-exclusive rights to manufacture, use and sell recombinant beta interferon under these patents in various countries of the world, including the United States, Japan and most European countries. Another party has been granted various patents in the United States and in other countries on beta interferon itself. Biogen has obtained worldwide, non-exclusive rights under these patents to make, use and sell recombinant beta interferon. Two other patents issued in 1994 to competitors of Biogen with claims related to beta interferon; one in the United States and one in the European Patent Office. With respect to the United States patent, Biogen believes there are substantial issues of validity, enforceability and scope of claims. With respect to the European patent, Biogen has been aware of it for many years and believes that it has no applicability to Biogen's recombinant beta interferon product. Biogen does not believe that either patent will prevent its commercialization of recombinant beta interferon for the treatment of multiple sclerosis.\nRecombinant Gamma Interferon\nIn 1988 and 1990, Genentech, Inc. (\"Genentech\") was granted several patents in the United States and Europe claiming recombinant gamma interferon and intermediates and methods for the production of recombinant gamma interferon. In January 1990, Genentech and Biogen and BMPLP entered into a cross-license agreement under which Genentech and Biogen\/BMPLP each licensed to the other its United States patent rights relating to certain gamma interferons and their intermediates and processes of production for certain fields of use. At the same time, Biogen granted Genentech a non-exclusive worldwide sublicense for certain proteins under certain of its licensed process patents relating to the secretion of proteins. Biogen opposed the Genentech European gamma interferon patent in the European Patent Office. The European Patent Office maintained the Genentech patent in a decision that cannot be appealed.\nOther Patents\nIn January 1994, Biogen filed suit in Osaka, Japan, against Sumitomo Pharmaceutical Co., Ltd. (\"Sumitomo\"). The suit seeks to enjoin Sumitomo from importing and selling its recombinant human growth hormone products in Japan. Biogen believes that these products are made by a process that infringes certain of its licensed patents relating to the secretion of proteins. Biogen does not expect a decision in the case until 1997.\nIn January 1994, Biogen granted Eli Lilly and Company (\"Lilly\") a non-exclusive license under certain of Biogen's patents for gene expression. Lilly uses the patented vectors and methods in several products that are on the market or in development.\nThird Party Patents\nBiogen is aware that others, including various universities and companies working in biotechnology, have also filed patent applications and have been granted patents in the United States and in other countries claiming subject matter potentially useful or necessary to Biogen's business. Some of those patents and applications claim only specific products or methods of making such products, while others claim more general processes or techniques useful or now used in the biotechnology industry. Genentech has been granted patents and is prosecuting other patent applications in the United States and certain other countries which it may allege are currently used by Biogen and the rest of the biotechnology industry to produce recombinant proteins in microbial hosts. Genentech has offered to Biogen and others in the industry non-exclusive licenses under those patents and patent applications for various proteins and in various fields of use, but not for others. Schering-Plough, Biogen's exclusive licensee for recombinant alpha interferon, is licensed under certain of these patents for the manufacture, use and sale of recombinant alpha interferon. The ultimate scope and validity of Genentech's patents, of other existing patents, or of patents which may be granted to third parties in the future, the extent to which Biogen may wish or be required to acquire rights under such patents, and the availability and cost of acquiring such rights currently cannot be determined by Biogen.\nThere has been, and Biogen expects that there may continue to be, significant litigation in the industry regarding patents and other intellectual property rights. Such litigation could create uncertainty and consume substantial resources.\nCompetition and Marketing\nCompetition in the biotechnology and pharmaceutical industries is intense and comes from many and varied sources. Biogen does not believe that it or any of the other industry leaders can be considered dominant in view of the rapid technological change in the industry. Biogen experiences significant competition from specialized biotechnology firms in the United States, Europe and elsewhere and from many large pharmaceutical, chemical and other companies. Certain of these companies have substantially greater financial, marketing and human resources than Biogen. The pharmaceutical companies have considerable experience in undertaking clinical trials and in obtaining regulatory approval to market pharmaceutical products. In addition, certain of Biogen's products may be subject to competition from products developed using alternatives to biotechnology techniques.\nMuch competition is directed towards establishing proprietary positions through research and development. A key aspect of such competition is recruiting and retaining qualified scientists and technicians. Biogen believes that it has been successful in attracting skilled and experienced scientific personnel. Biogen believes that leadership in the industry will be based on managerial and technological superiority and may be influenced significantly by patents and other forms of protection of proprietary information. See \"Patents and Other Proprietary Rights\". The achievement of such a position depends upon Biogen's ability to attract and retain skilled and experienced personnel, its ability to identify and exploit commercially the products resulting from biotechnology and the availability of adequate financial resources to fund facilities, equipment, personnel, clinical testing, manufacturing and marketing.\nMany of Biogen's competitors are working to develop products similar to those under development by Biogen. The timing of the entry of a new pharmaceutical product into the market can be an important factor in determining the product's eventual success and profitability. Early entry may have important advantages in gaining product acceptance and market share. Moreover, for certain diseases with limited patient populations, the FDA is prevented under the Orphan Drug Act, for a period of seven years, from approving more than one application for the \"same\" product for a single orphan drug designation, unless a later product is considered clinically superior. Accordingly, the relative speed with which Biogen can develop products, complete the testing and approval process and supply commercial quantities of the product to the market is expected to have an important impact on Biogen's competitive position. In addition, competition among products approved for sale may be based, among other things, on patent position, product efficacy, safety, reliability, availability and price.\nRegulation\nBiogen's current and contemplated activities and the products and processes that will result from such activities are and will be subject to substantial government regulation.\nBefore new pharmaceutical products may be sold in the United States and other countries, clinical trials of the products must be conducted and the results submitted to appropriate regulatory agencies for approval. These clinical trial programs generally involve a three-phase process. Typically, in Phase I, trials are conducted in volunteers or patients to determine the early side effect profile and, perhaps, the pattern of drug distribution and metabolism. In Phase II, trials are conducted in groups of patients with a specific disease in order to determine appropriate dosages, expand evidence of the safety profile and, perhaps, determine preliminary efficacy. In Phase III, large scale, comparative trials are conducted on patients with a target disease in order to generate enough data to provide the statistical proof of efficacy and safety required by national regulatory agencies. The receipt of regulatory approvals often takes a number of years, involving the expenditure of substantial resources and depends on a number of factors, including the severity of the disease in question, the availability of alternative treatments and the risks and benefits demonstrated in clinical trials. On occasion, regulatory authorities may require larger or additional studies, leading to unanticipated delay or expense.\nIn connection with the commercialization of products resulting from Biogen's projects, it is necessary, in a number of countries, to comply with certain regulations relating to the manufacturing and marketing of such products and to the products themselves. For example, the commercial manufacturing, marketing and exporting of pharmaceutical products require the approval of the FDA in the United States and of comparable agencies in other countries. The FDA has established mandatory procedures and safety standards which apply to the manufacture, clinical testing and marketing of pharmaceutical products in the United States. The process of seeking and obtaining FDA approval for a new product and the facilities in which it can be produced is likely to take a number of years and involve the expenditure of substantial resources. In addition, the regulatory approval processes for products in the United States, Canada and Europe are undergoing or may undergo changes. Biogen cannot determine what effect any changes in regulatory approval processes may have on its business.\nIn the United States, the federal government regularly considers reforming health care coverage and costs. Resulting legislation or regulatory actions may have a significant effect on the Company's business. Biogen's ability to commercialize successfully human pharmaceutical products also may depend in part on the extent to which reimbursement for the costs of such products and related treatments will be available from government health administration authorities, private health insurers and other organizations. Currently, substantial uncertainty exists as to the reimbursement status of newly approved health care products by third-party payors.\nBiogen's policy is to conduct relevant research in compliance with the current United States National Institutes of Health Guidelines for Research Involving Recombinant DNA Molecules (the \"NIH Guidelines\") and all other federal and state regulations. By local ordinance, Biogen is required, among other things, to comply with the NIH Guidelines in relation to its facilities in Cambridge, Massachusetts, and is required to operate pursuant to certain permits.\nVarious laws, regulations and recommendations relating to safe working conditions, laboratory practices, the experimental use of animals and the purchase, storage, movement, import and export and use and disposal of hazardous or potentially hazardous substances, including radioactive compounds and infectious disease agents, used in connection with Biogen's research work are or may be applicable to its activities. These include, among others, the United States Atomic Energy Act, the Clean Air Act, the Clean Water Act, the Occupational Safety and Health Act, the National Environmental Policy Act, the Toxic Substances Control Act and the Resource Conservation and Recovery Act, national restrictions on technology transfer and import, export and customs regulations. The extent of government regulation which might result from future legislation or administrative action cannot accurately be predicted. Certain agreements entered into by Biogen involving exclusive license rights may be subject to national or supranational antitrust regulatory control, the effect of which also cannot be predicted.\nEmployees\nAt January 1, 1995, Biogen employed 433 full-time employees, of whom 78 held Ph.D. and\/or M.D. degrees. Of the 433 employees, 169 were engaged in, or directly supported, research and development and 128 were involved in, or directly supported, manufacturing, quality assurance\/quality control, regulatory, medical operations and preclinical and clinical development. Biogen maintains consulting arrangements with a number of scientists at various universities and other research institutions in Europe and the United States, including the eight outside members of its Scientific Board.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nSubstantially all of Biogen's facilities are located in Cambridge, Massachusetts, where the Company leases a total of approximately 220,000 square feet of office and research and development space in all or part of five buildings. Most of the Company's operations are contained in a 67,000 square foot building housing a pilot production plant, laboratories and office space, in a building with 64,000 square feet of space containing laboratories, purification and aseptic bottling facilities and office space, in a multitenant building where the Company occupies approximately 54,000 square feet of office space and in a 17,000 square foot building designed for specialized research laboratories. The leases for these sites terminate in 1998 (with the right to renew), 2004, 1998 (with the right to renew) and 2004, respectively.\nIn 1993, the Company began construction of a 150,000 square foot building in Cambridge, Massachusetts which will house laboratories and office space. The anticipated cost of construction, including the land, is approximately $36 million. Upon completion of the building, the Company has the option, subject to certain conditions, to obtain a secured term loan with a bank for up to $25 million for a period of up to ten years. The building is scheduled for completion in 1995.\nIn 1994, the Company opened its European headquarters which consists of 1,450 square meters of office space in a multitenant building in Nanterre, France. The lease for this space terminates in 2003.\nThe Company believes that its pilot production plant in Cambridge, Massachusetts and existing outside sources will allow it to meet its production needs for clinical trials and its initial commercial production needs for its beta interferon product. Biogen believes that the facilities are in compliance with appropriate regulatory standards. The Company expects that additional facilities and outside sources will be required to meet the Company's future research and production needs.\nItem 3.","section_3":"Item 3. Legal Proceedings\nDuring the fourth quarter of 1994, a total of six class action lawsuits were initiated against the Company and several of its directors and officers. On March 3, 1995, these cases were consolidated into a single proceeding in the United States District Court for the District of Massachusetts. The lawsuits generally allege that the Company and the named directors and officers violated federal securities laws in connection with the Company's public disclosures, including disclosures relating to its Hirulog thrombin inhibitor and other disclosures made in connection with patent matters related to beta interferon. The plaintiffs seek damages in unspecified amounts.\nFor a description of legal proceedings relating to patent rights, see Item 1, \"Business-Patents and Other Proprietary Rights.\"\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nExecutive Officers\nThe following is a list of the executive officers of the Company and their principal positions with the Company. Each individual officer serves at the pleasure of the Board of Directors.\nName Age Positions\nJames L. Vincent 55 Chairman of the Board of Directors, Chief Executive Officer\nJames R. Tobin 50 President and Chief Operating Officer\nMichael J. Astrue 38 VicePresident-GeneralCounsel,Secretary andClerk\nKenneth M. Bate 44 Vice President - Marketing and Sales\nFrank A. Burke, Jr. 51 Vice President - Human Resources\nLawrence S. Daniels 52 Vice President - Strategic Planning\nJoseph M. Davie 55 Vice President - Research\nIrving H. Fox. 51 Vice President - Medical Affairs\nTimothy M. Kish 43 Vice President - Finance, Chief Financial Officer and Treasurer\nJames C. Mullen 36 Vice President - Operations\nR. Maurice Powell, Jr.39 Vice President - QA\/QC\nIrvin D. Smith 62 Vice President - Development Operations\nThe background of these officers is as follows:\nJames L. Vincent joined the Company as its Chief Executive Officer in October 1985. He also served as Chief Operating Officer and President from April 1988 until February 1994. He is also Chairman of the Board of Directors of the Company. Before joining Biogen, Mr. Vincent served as Group Vice President, Allied Corporation and as President, Allied Health & Scientific Products Company, a subsidiary of Allied Corporation. Before joining Allied Corporation, Mr. Vincent was with Abbott Laboratories, Inc. where he served in various capacities, including Executive Vice President, Chief Operating Officer and Director of the parent corporation. Mr. Vincent is, in addition, on the Board of Trustees of Duke University and the Board of Trustees of the University of Pennsylvania, as well as a member of the Board of Overseers of Wharton Graduate Business School of the University of Pennsylvania.\nJames R. Tobin joined the Company as its President and Chief Operating Officer in February 1994. Prior to joining the Company, Mr. Tobin served in various capacities at Baxter International, including Executive Vice President from 1988 until 1992 and President and Chief Operating Officer from 1992 until 1993. Mr. Tobin is a director of Creative BioMolecules, Inc. and Medisense Inc.\nMichael J. Astrue was appointed Vice President - General Counsel, Secretary and Clerk of the Company in June 1993. Prior to joining the Company, Mr. Astrue was a partner in the Boston law firm of Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. and a managing director of its wholly-owned consulting firm, ML Strategies, from November 1992 to June 1993. From June 1989 through November 1992, Mr. Astrue served as General Counsel of the United States Department of Health and Human Services. From April 1988 through June 1989, Mr. Astrue served as Associate Counsel to the President of the United States.\nKenneth M. Bate was appointed Vice President - Marketing and Sales in August 1993 after serving as Vice President - Finance and Chief Financial Officer since August 1990 and as Treasurer of the Company since December 1991. From 1978 until 1990, Mr. Bate was employed by Peter Kiewit & Sons, Inc. and its subsidiaries in various financial capacities, most recently as Vice President - Treasurer.\nFrank A. Burke, Jr., was appointed Vice President - Human Resources in May 1986 after serving for 12 years in various human resource management positions at Allied-Signal, Inc., most recently as Director of Compensation and Employee Benefits of the Engineered Materials Sector.\nLawrence S. Daniels was appointed Vice President - Strategic Planning of the Company in August 1993 after serving as Vice President - Marketing and Business Development since November 1991. Prior to joining the Company, Mr. Daniels served for nine years in planning and administrative functions for Allied-Signal, Inc., most recently as Vice President, Corporate Strategy Development.\nJoseph M. Davie, M.D., Ph.D. was appointed Vice President - Research of the Company in April 1993. Prior to joining the Company, Dr. Davie was employed by Searle Corporation where he served as Senior Vice President - Science and Technology from January 1993 to April 1993, President - Research and Development from July 1987 to January 1993 and Senior Vice President - Discovery Research from January 1987 to July 1987.\nIrving H. Fox, M.D. was appointed Vice President - Medical Affairs in February 1990. Dr. Fox joined Biogen following a 14-year career at the University of Michigan, where he held professorships in internal medicine and biological chemistry, and from 1978 to 1990, was program director of the Clinical Research Center at the University of Michigan Hospital.\nTimothy M. Kish was appointed Vice President - Finance, Treasurer and Chief Financial Officer of the Company in August 1993 after serving as Corporate Controller of the Company since 1986. Prior to joining Biogen, Mr. Kish was Director of Finance for Allied Health & Scientific Products Company, a subsidiary of Allied Corporation. Before joining Allied, Mr. Kish served in various capacities at Bendix Corp., most recently as Executive Assistant to the President.\nJames C. Mullen became Biogen's Vice President - Operations in December 1991 after serving as Senior Director - Operations since February 1991. Mr. Mullen joined the Company in 1989 as Director - Facilities and Engineering and then served as Acting Director - Manufacturing and Engineering. Before coming to Biogen, Mr. Mullen held various positions of responsibility from 1984 through 1988 at SmithKline-Beckman Corporation, most recently as Director, Engineering - SmithKline and French Laboratories, Worldwide.\nR. Maurice Powell, Jr. was appointed Vice President-QA\/QC in November 1994. Prior to joining Biogen, Mr. Powell served in various capacities from 1978 to 1994 at Baxter Healthcare Corporation, most recently as Vice President of Manufacturing, Quality and Regulatory Management from 1993 to 1994 and Vice President of Regulatory Affairs and Quality Assurance from 1992 to 1993.\nIrvin D. Smith, Ph.D. was appointed Vice President - Quality Assurance\/Quality Control and Drug Development in August 1993 after serving as General Manager of Bioferon, Biogen's former joint venture in Germany, since July 1991. The name of his position was changed to Vice President-Development Operations in 1994. Dr. Smith was a private consultant from March 1990 to July 1991 and President and Chief Executive Officer of Applied BioSystems from October 1987 to March 1990.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe section entitled \"Market for Securities\" in the Company's 1994 Annual Report to Shareholders is hereby incorporated by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe section entitled \"Selected Financial Data\" in the Company's 1994 Annual Report to Shareholders is hereby incorporated by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Company's 1994 Annual Report to Shareholders is hereby incorporated by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe sections entitled \"Consolidated Balance Sheets,\" \"Consolidated Statements of Income,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Statements of Shareholders' Equity,\" \"Notes to Consolidated Financial Statements\" and \"Report of Independent Accountants\" in the Company's 1994 Annual Report to Shareholders are hereby incorporated 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, Promoters and Control Persons\nDirectors\nThe sections entitled \"Election of Directors\" and \"Trading Reports\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders, which the Company intends to file with the Commission no later than April 30, 1995, are hereby incorporated by reference.\nExecutive Officers\nInformation concerning the Company's Executive Officers is set forth in Part I of this Annual Report on Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe sections entitled \"Election of Directors\", \"Executive Compensation\", \"Joint Report on Compensation Philosophy\" and \"Performance Graph\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders, which the Company intends to file with the Commission no later than April 30, 1995, are hereby incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe section entitled \"Share Ownership\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders, which the Company intends to file with the Commission no later than April 30, 1995, is hereby incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe section entitled \"Employment Arrangements with the Company and Certain Transactions\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders, which the Company intends to file with the Commission no later than April 30, 1995, 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) Financial Statements and Financial Statement Schedules.\nThe following documents are filed as a part of this report:\n1. Financial Statements, as required by Item 8 of this Form, incorporated by reference herein from the 1994 Annual Report to Shareholders attached hereto as Exhibit 13:\nItem Location Consolidated Balance Sheets Annual Report under the caption \"Biogen, Inc. and Subsidiaries Consolidated Balance Sheets.\"\nConsolidated Statements of Income Annual Report under the caption \"Biogen, Inc. and Subsidiaries Consolidated Statements of Income.\"\nConsolidated Statements of Cash Flows Annual Report under the caption \"Biogen, Inc. and Subsidiaries Consolidated Statements of Cash Flows.\"\nConsolidated Statements of Shareholders' Equity Annual Report under the caption \"Biogen, Inc. and Subsidiaries Consolidated Statements of Shareholders' Equity.\"\nNotes to Consolidated Financial Statements Annual Report under the caption \"Biogen, Inc. and Subsidiaries Notes to Consolidated Financial Statements.\"\nReports of Independent Accountants Annual Report under the caption \"Report of Independent Accountants.\"\nWith the exception of the portions of the 1994 Annual Report to Shareholders specifically incorporated herein by reference, such report shall not be deemed filed as part of this Annual Report on Form 10-K.\n(2) Financial Statement Schedules: None\n(3) Exhibits\nExhibit No. Description\n(3.1) Articles of Organization, as amended (g)\n(3.2) By-Laws, as amended (k)\n(4.1) Form of Common Stock Share Certificate (m)\n(4.2) Certificate of Designation of Series A Junior Participating Preferred Stock (f)\n(4.3) Rights Agreement dated as of May 8, 1989 between Registrant and The First National Bank of Boston, as Rights Agent (f)\n(10.1) Independent Consulting and Project Agreement dated as of June 29, 1979 between Registrant and Kenneth Murray (a)**\n(10.2) Letter Agreement dated March 12, 1993 with Dr. Kenneth Murray relating to renewal of Independent Consulting Agreement (k)**\n(10.3) Minute of Agreement dated February 5, 1981 among Registrant, The University Court of the University of Edinburgh and Kenneth Murray (a)**\n(10.4) Independent Consulting Agreement dated as of June 29, 1979 between Registrant and Phillip A. Sharp (a)**\n(10.5) Letter Agreement dated December 10, 1992 with Phillip Sharp relating to chairmanship of Scientific Board and renewal of Independent Consulting Agreement (k)**\n(10.6) Project Agreement dated as of December 14, 1979 between Registrant and Phillip A. Sharp (a)**\n(10.7) Share Restriction and Repurchase Agreement dated as of December 15, 1979 between Registrant and Phillip A. Sharp (a)**\n(10.8) Consulting Agreement dated as of April 1, 1991, as amended, between Registrant and Alexander G. Bearn (i)**\n(10.9) Form of Amendment dated July 1, 1988 to Independent Consulting Agreement between Registrant and Scientific Board Members (e)**\n(10.10) Form of Extension of Independent Consulting Agreement between Registrant and Scientific Board Members (g)**\n(10.11) Form of Share Purchase Agreement between Registrant and Scientific Board Members (a)**\n(10.12) Form of Stock Option Agreement between Registrant and each of Alan Belzer, Harold W. Buirkle, James W. Stevens and Roger H. Morley (c)**\n(10.13) Letter regarding employment of James L. Vincent dated September 23, 1985 (b)**\n(10.14) Form of Stock Option Agreement with James L. Vincent under 1985 Non-Qualified Stock Option Plan (k)**\n(10.15) Letter dated December 13, 1989 regarding employment of Dr. Irving H. Fox (h)**\n(10.16) Letter dated August 13, 1990 regarding employment of Mr. Kenneth M. Bate (i)**\n(10.17) Letter dated October 23, 1991 regarding employment of Mr. Lawrence S. Daniels (k)**\n(10.18) Letter dated April 7, 1993 regarding employment of Dr. Joseph M. Davie (l)**\n(10.19) Letter dated January 12, 1994 regarding employment of James R. Tobin (n)**\n(10.20) Letter dated August 30, 1993 regarding employment of Irvin D. Smith, Ph.D. (n)**\n(10.21) Form of Indemnification Agreement between Registrant and each Director and Executive Officer (e)**\n(10.22) Second Amended and Restated Agreement and Certificate of Limited Partnership dated as of May 15, 1984 among Biogen Medical Products, Inc. as General Partner and certain limited partners (g)\n(10.23) First Amendment dated December 22, 1986 to Agreement and Certificate of Limited Partnership (c)\n(10.24) Technology License Agreement dated May 15, 1984 between Biogen B.V. and Biogen Medical Products Limited Partnership (g)\n(10.25) Development Contract dated May 15, 1984 between Biogen B.V. and Biogen Medical Products Limited Partnership (g)\n(10.26) Amendment dated December 22, 1986 to Development Contract (c)\n(10.27) Amendment dated January 1, 1987 to Development Contract (d)\n(10.28) Extension Agreement dated October 10, 1989 relating to Development Contract (g)\n(10.29) Extension Agreement dated December 31, 1993 relating to Development Contract (n)\n(10.30) Extension Agreement dated December 31, 1994 relating to Development Contract *\n(10.31) Joint Venture Option Agreement dated May 15, 1984 between Biogen Inc. and Biogen Medical Products Limited Partnership (g)\n(10.32) Purchase Option Agreement dated May 15, 1984 between Biogen B.V. and the limited partners of Biogen Medical Products Limited Partnership (g)\n(10.33) Guaranty dated May 15, 1984 to Biogen Medical Products Limited Partnership by Registrant guaranteeing certain obligations of Biogen Medical Products, Inc., Biogen B.V. and Biogen Inc. to the Partnership (g)\n(10.34) Demand Loan Agreement dated October 1, 1989 between Biogen Medical Products Limited Partnership and Biogen Medical Products, Inc. (g)\n(10.35) Standard Form Commercial Lease dated January 29, 1981 between Ira C. Foss and Ira C. Foss, Jr., as Trustees of Eastern Realty Trust, and B. Leasing, Inc. (g)\n(10.36) Letter of May 24, 1989 exercising option under Standard Form Commercial Lease dated January 29, 1981 (g)\n(10.37) Lease Extension Agreement dated February 20, 1990 between Eastern Realty Trust and Registrant (g)\n(10.38) Standard Form Commercial Lease dated June 1, 1989 between Eastern Realty Trust and Registrant (g)\n(10.39) Cambridge Center Lease dated October 4, 1982 between Mortimer Zuckerman, Edward H. Linde and David Barrett, as Trustees of Fourteen Cambridge Center Trust, and B. Leasing, Inc. (a)\n(10.40) First Amendment to Lease dated January 19, 1989 amending Cambridge Center Lease dated October 4, 1982 (k)\n(10.41) Second Amendment to Lease dated March 8, 1990 amending Cambridge Center Lease dated October 4, 1982 (k)\n(10.42) Third Amendment to Lease dated September 25, 1991 amending Cambridge Center Lease dated October 4, 1982 (k)\n(10.43) Lease dated October 6, 1993 between North Parcel Limited Partnership and Biogen Realty Limited Partnership (n)\n(10.44) 1983 Employee Stock Purchase Plan as amended through April 3, 1992 and restated (j)**\n(10.45) 1982 Incentive Stock Option Plan as amended through March 25, 1993 and restated with form of Option Agreement (l)**\n(10.46) 1985 Non-Qualified Stock Option Plan as amended through March 25, 1993 and restated with form of Option Agreement (l)**\n(10.47) 1987 Scientific Board Stock Option Plan as amended through April 3, 1992 and restated with form of Option Agreement (j)**\n(10.48) Voluntary Executive Supplemental Savings Plan *,**\n(10.49) Supplemental Executive Retirement Plan *,**\n(10.50) Voluntary Board of Directors Savings Plan *,**\n(10.51) Exclusive License and Development Agreement dated December 8, 1979 between Registrant and Schering Corporation (a)\n(10.52) Amendatory Agreement dated May 14, 1985 to Exclusive License and Development Agreement dated December 8, 1979 (b)\n(10.53) Amendment and Settlement Agreement dated September 29, 1988 to Exclusive License and Development Agreement dated December 8, 1979 (k)\n(10.54) Amendment dated March 20, 1989 to Exclusive License and Development Agreement dated December 8, 1979 (k)\n(10.55) License Agreement (United States) dated March 28, 1988 between Registrant and SmithKline Beecham Biologicals, s.a. (as successor to Smith Kline-R.I.T, s.a.) (k)\n(10.56) License Agreement (International) dated March 28, 1988 between Registrant and SmithKline Beecham Biologicals, s.a. (as successor to Smith Kline-R.I.T., s.a.) (k)\n(10.57) Sublicense Agreement dated as of February 15, 1990 among Registrant, SmithKline Beecham Biologicals, s.a (as successor to SmithKline Biologicals, s.a.) and Merck and Co., Inc. (k)\n(10.58) Supplemental Amendment and Agreement dated as of March 1, 1994 between the Registrant and Schering Corpotration (o)\n(11) Computation of Earnings per Share *\n(12) None\n(13) Incorporated portions from Biogen, Inc. 1993 Annual Report to Shareholders *\n(22) Subsidiaries of the Registrant *\n(24.1) Consent of Price Waterhouse (Included in Part IV hereof)\n(29) None\n(a) Previously filed with the Commission as an exhibit to Registration Statement on Form S-1, File No. 2-81689 and incorporated herein by reference.\n(b) Previously filed with the Commission as an exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1985, as amended, File No. 0-12042 and incorporated herein by reference.\n(c) Previously filed with the Commission as an exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1986, as amended, File No. 0-12042 and incorporated herein by reference.\n(d) Previously filed with the Commission as an exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1987, File No. 0-12042 and incorporated herein by reference.\n(e) Previously filed with the Commission as an exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1988, File No. 0-12042 and incorporated herein by reference.\n(f) Previously filed with the Commission as an exhibit to Registration Statement on Form 8-A, File No. 0-12042, filed May 26, 1989 and incorporated herein by reference.\n(g) Previously filed with the Commission as an exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1989, File No. 0-12042, and incorporated herein by reference.\n(h) Previously filed with the Commission as an exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1990, File No. 0-12042, and incorporated herein by reference.\n(i) Previously filed with the Commission as an exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1991, File No. 0-12042, and incorporated herein by reference.\n(j) Previously filed with the Commission as an exhibit to Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992, File No. 0-12042, and incorporated herein by reference.\n(k) Previously filed with the Commission as an exhibit to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, File No. 0-12042, and incorporated herein by reference.\n(l) Previously filed with the Commission as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, File No. 0-12042, and incorporated herein by reference.\n(m) Previously filed with the Commission as an exhibit to Registration Statement on Form S-3, File No. 33-51639, and incorporated herein by reference.\n(n) Previously filed with the Commission as an exhibit to Registrant's Annual Report on Form 10-K for the year ended December 31, 1994, File No. 0-12042, and incorporated herein by reference.\n(o) Previously filed with the Commission as an exhibit to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994, File No. 0-12042, and incorporated herein by reference.\n* Filed herewith\n** Management contract or compensatory plan or arrangement\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.\nBIOGEN, INC.\nBy:\/s\/ James L. Vincent James L. Vincent, Chairman of the Board and Chief Executive Officer\nDated March 6, 1995\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\/ James L. Vincent Chairman, Board of Directors March 6, James L. Vincent (principal executive officer)\n\/s\/ Timothy M. Kish Vice President-Finance(principal March 6, 1995 Timothy M. Kish financial and accounting officer)\n\/s\/ Alexander Bearn Director March 6, 1995 Alexander Bearn\n\/s\/ Harold W. Buirkle Director March 6, 1995 Harold W. Buirkle\n\/s\/ Alan Belzer Director March 6, 1995 Alan Belzer\n\/s\/ Roger H. Morley Director March 6, 1995 Roger H. Morley\n\/s\/ Kenneth Murray Director March 6, 1995 Kenneth Murray\n\/s\/ Phillip A. Sharp Director March 6, 1995 Phillip A. Sharp\n\/s\/ James W. Stevens Director March 6, 1995 James W. Stevens\n\/s\/ James R. Tobin Director March 6, 1995 James R. Tobin\nEXHIBIT INDEX\nExhibit No. Description\n(10.30) Extension Agreement dated December 31, 1994 relating to Development Contract.\n(10.48) Voluntary Executive Supplemental Savings Plan.\n(10.49) Supplemental Executive Retirement Plan.\n(10.50) Voluntary Board of Directors Savings Plan\n(11) Computation of Earnings per Share.\n(13) Incorporated portions from Biogen, Inc. 1994 Annual Report to Shareholders.\n(22) Subsidiaries of the Registrant.\n(24.1) Consent of Price Waterhouse LLP","section_15":""}
{"filename":"717233_1994.txt","cik":"717233","year":"1994","section_1":"Item 1. Business\nFormation\nLiberty Equipment Investors-1983 (\"Registrant\"), a New York limited partnership, was organized March 30, 1983 and is currently governed by the New York Revised Limited Partnership Act. Maiden Lane Partners Inc., a Delaware corporation (the \"General Partner\"), is Registrant's sole general partner. The General Partner is a wholly-owned subsidiary of ML Leasing Equipment Corp. (\"MLLEC\") (which is an indirect wholly-owned subsidiary of Merrill Lynch & Co., Inc. and the successor in interest to Merrill Lynch Leasing Inc. and Merlease Leasing Corp.) and is an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"Merrill Lynch\").\nRegistrant is engaged in the business of operating, leasing and holding for investment, equipment, or interests therein (\"Equipment\"), manufactured by non-affiliated companies. See note 8 to the financial statements included in Item 8 hereof for information on Registrant's segment activities. (See \"Financial Statements and Supplementary Data\" included in Item 8 hereof).\nRegistrant offered through Merrill Lynch up to 40,000 units of limited partnership interest (\"Units\") and depository receipts for certificates of partnership interest (\"Depository Receipts\") at $1,000 per Unit. The Units and Depository Receipts were registered under the Securities Act of 1933 under Registration Statement No. 2-82749, which was declared effective on September 7, 1983 (the \"Registration Statement\") and the offering was commenced on September 14, 1983. Reference is made to the prospectus filed with the Securities and Exchange Commission pursuant to Rule 424(b) under the Securities Act of 1933, as supplemented by a supplement dated September 14, 1983 which has been filed pursuant to Rule 424(c) under the Securities Act of 1933. Pursuant to Rule 12b-23 of the Securities and Exchange Commission's General Rules and Regulations promulgated under the Securities and Exchange Act of 1934, the description of Registrant's business set forth under the heading \"Risk and Other Important Factors\" at pages 17 through 25 and under the heading \"Investment Objectives and Policies\" at pages 25 through 33 of the above-referenced prospectus as supplemented is hereby incorporated herein by reference.\nUpon termination of the offering of Units on October 25, 1983, Registrant accepted subscriptions for 40,000 Units, representing funds aggregating $40,000,000.\nThe Equipment\nRegistrant's interest in equipment owned at year-end 1994 consisted of five intercity buses (adjusted to reflect the disposition of 81 buses since inception); a limited partner interest in the Trigen Trenton District Energy Company (\"TDEC\"), formerly known as Trenton District Energy Company, a New Jersey limited partnership, which has constructed a cogeneration district heating system; and diagnostic imaging equipment and leasehold improvements to a facility which houses the equipment. The facility, located in Seattle, Washington, operates as a free- standing medical diagnostic imaging center. Registrant's investment in the San Jose cogeneration facility was disposed on September 30, 1991. Registrant's 45 reverse vending machines were sold to its lessee in August 1992 (described below) and, in the fourth quarter of 1993, Registrant's 917 remaining 45-foot long, 102-inch wide dry-van piggyback trailers were sold to its lessee (described below).\nPiggyback Trailers\nRegistrant originally acquired 1,675 trailers of which 675 galavan trailers were manufactured by BRAE Trailers, Inc. (\"BRAE\") and 1,000 fiberglass reinforced trailers were manufactured by Monon Trailer Inc. (\"Monon\"), a division of Evans Transportation Company. The total invoice cost of the trailers, tires, decals and positioning was $22,451,419 of which $8,836,419 was paid in cash and the balance of $13,615,000 was funded by an eight-year term loan with The First National Bank of Chicago (\"First Chicago\"), for an initial interest rate of 14.02%.\nOn November 15, 1985, Registrant borrowed $5,000,000 from the First Bank National Association (\"First Bank\") (formerly First National Bank of Minneapolis) which was utilized to prepay $4,671,544 of the First Chicago loan described above and to pay a prepayment charge of $255,900. The First Bank loan, as amended, was paid off concurrent with the sale of the BRAE trailers on January 31, 1992 (see below).\nOn April 4, 1986 Registrant obtained additional financing from First Bank in the amount of $7,600,000, which was utilized to prepay the balance of the First Chicago loan and a portion of the related $523,000 prepayment charges. Of the $7.6 million loan, the $4 million traunche carried a rate of 9.5% and was fully paid by April 1, 1991. The $3,600,000 traunche carried an interest rate of 9.98% per annum. The remaining loan balance was fully repaid with proceeds from the sale of trailers on October 15, 1993 (see below).\nOn January 31, 1992, Registrant sold and assigned the Transamerica Equipment Leasing Company, Inc. (\"TELCO\") lease for its 652 remaining BRAE trailers to Greenbrier Capital Corporation (\"Greenbrier\"), the trailer manager, and sold the trailers to Greenbrier for $3,750 per trailer or a total sales price of $2,445,000. Concurrent with the sale, Registrant repaid the $502,114 principal plus interest and fees related to the loan secured by those trailers. The sale proceeds were significantly less than the net book value of those trailers at December 27, 1991. Accordingly, Registrant wrote down the carrying value of these 652 trailers by approximately $1,386,000 to net realizable value in the fourth quarter of 1991.\nIn addition, each of Registrant's 652 BRAE trailers was substantially of the same value as Registrant's Monon trailers. The market value at that time, coupled with the fact that Registrant did not expect to realize future cash flows equal to Registrant's net carrying value for the Monon trailers, indicated that there had been an impairment of the carrying value of the Monon trailers. Accordingly, Registrant wrote down its carrying value of the Monon trailers by $2.1 million in the fourth quarter of 1991.\nRegistrant entered into a purchase agreement dated as of October 1, 1993 whereby Registrant sold its remaining 917 trailers to TELCO effective as of the respective lease expiration date of each trailer. All 917 trailers were subject to a lease to TELCO with scheduled expiration dates of September 30, 1993 for 282 trailers, October 15, 1993 for 339 trailers and November 22, 1993 for 296 trailers. The purchase price for the trailers was $3,650 per trailer, or a total of $3,347,050 for all 917 trailers. On October 15, 1993, Registrant consummated the sale of 621 trailers for a total price of $2,266,650, representing trailers with leases expiring on September 30, 1993 and October 15, 1993. On November 22, 1993, the remaining 296 trailers were sold to TELCO for a total price of $1,080,400.\nConcurrent with the sale transaction on October 15, 1993, Registrant repaid the then-remaining $651,397 balance of the non- recourse bank loan secured by the trailers, including accrued interest thereon, and the bank released Registrant from all future obligations related to the trailer loan.\nRevenues generated by all of Registrant's trailers amounted to $1,407,939 (49% of total revenues of Registrant) in 1993 and $1,796,966 (56%) in 1992.\nRegistrant entered into an eight-year management agreement with BRAE Intermodal Corporation, which, during 1985, was acquired by and is now a wholly-owned subsidiary of Greenbrier. Under the management agreement, Greenbrier managed the trailers on behalf of Registrant, including arranging for the inspections, maintenance, re-leasing, and monitoring of the trailers. For its services under the management agreement, Greenbrier, during the initial lease period, was entitled to receive a management fee equal to $36 per month for each of the Monon trailers. On September 16, 1991 Registrant amended its management agreement for the Monon trailers whereby the monthly management fee would be based upon 3.03% of monthly trailer rentals based upon the monthly lease rates at that time of $155.40 per trailer for the Monon trailer lease equal to $4.71 per trailer. The management agreement was terminated concurrent with the sale of the remaining trailers referred to above.\nIntercity Buses\nThe original 86 40-foot intercity buses acquired by Registrant were manufactured by either Eagle International Inc., Motor Coach Industries, Inc., Transportation Manufacturing Corporation or Prevost Car, Inc., and were acquired by Registrant for an aggregate invoice cost (including the cost of tires, accessories and engine warranty extension) of $13,975,414. An additional cost of $99,220 was paid for delivery charges and federal and state taxes where applicable. Of the 86 buses, 18 were purchased and placed in service in 1983 and the balance were purchased and placed in service by August 17, 1984.\nThrough 1994, Registrant sold 80 of its intercity buses to former lessees, charter operators, distributors, and other various organizations. In addition, one bus was stolen for which insurance proceeds were received. Sale proceeds and insurance proceeds were used to pay down the loan principal (referred to below). At the beginning of the year Registrant owned 18 buses, of which 11 were off lease. Registrant sold 13 buses in 1994 for $588,129. At year-end 1994 Registrant owned five buses which were all off lease and available for sale.\nRevenues from the buses amounted to $38,341 (8% of total revenues of Registrant) in 1994, $351,912 (12%) in 1993 and $590,396 (18%) in 1992.\nRegistrant continued to experience off-lease time during 1994. Since the end of the second quarter, all of the remaining buses have been off-lease. Due to current market conditions and the increasing age of Registrant's buses, it is expected that the buses will remain off-lease until they are sold. Given the then- expected poor prospects for the sale or re-lease of a significant portion of Registrant's bus portfolio in 1991, in management's opinion, the value of the equipment had been permanently impaired. To reflect this impairment, Registrant wrote down the book value of its buses by $1,900,000 in the fourth quarter of 1991. Registrant determined that additional write-downs were not necessary in 1994, 1993 or 1992.\nThe buses were managed for Registrant by BusLease, Inc., a Texas corporation (\"BLI\"), under a management agreement entered into at the time the buses were placed in service. BLI was responsible for the day-to-day operations of the buses including arranging for the re-leasing of the buses, collecting all rents, obtaining insurance for the buses, and monitoring the maintenance for the buses. The management agreement was for a term of 10 years but could be terminated at an earlier date as to any bus sold, destroyed or withdrawn and may have been terminated with respect to any bus at the option of Registrant at the end of the lease term for such bus. For its services as manager, BLI received a fixed monthly management fee of $275 per bus, which became subject to increase after December 31, 1985 in proportion to increases in the Gross National Product Price Deflator.\nBLI and its parent, Greyhound Lines, Inc. (\"GLI\") GLI, filed for protection from creditors under Chapter 11 of the United States Bankruptcy Code on June 4, 1990. In accordance with the BLI Plan of Reorganization, substantially all the assets of BLI were sold to Continental Asset Services, Inc. (\"CASI\"). Registrant entered into a management agreement with CASI which agreement is substantially the same as the former BLI agreement. This agreement became effective at the closing of the BLI asset sale on August 21, 1991.\nOn November 6, 1992, CASI sold certain of its assets and liabilities to TMO Acquisition Corporation (\"TMOAC\"), a Delaware corporation and, at the time, a wholly-owned subsidiary of The Dial Corp. On November 6, 1992, in connection with the sale, and pursuant to an Assignment, Assumption and Amendment Agreement by and between CASI, TMOAC and Hausman Bus Sales, Inc. (\"Hausman\"), substantially all terms of the management agreements and sale agreements between Registrant and CASI were jointly assigned to, and assumed by, TMOAC and Hausman. The assumption of the management agreements and sale agreements by TMOAC and Hausman was effective November 6, 1992. TMOAC and Hausman are not affiliated with the General Partner. As of December 30, 1994, the management agreement had been terminated, however, the bus manager continues to serve as selling agent to Registrant with respect to the remaining buses. In 1994, management fees incurred by Registrant for its buses totaled $11,820.\nTo fund the bus acquisitions, Registrant entered into a Loan Agreement with the First Bank National Association (\"First Bank\"), on February 20, 1984, as amended on June 20, 1984, pursuant to which Registrant borrowed $2,806,439 on March 15, 1984, and $2,160,236 on May 3, 1984. Pursuant to a Supplemental Loan Agreement dated June 20, 1984, on August 14, 1984, Registrant borrowed an additional $2,676,108. These loans were subsequently restructured in 1986.\nOn May 15, 1991 Registrant repaid the bus loan balance of approximately $2.9 million utilizing approximately $1 million of funds from Registrant's working capital and operating reserves and a $1.9 million unsecured loan from the General Partner. The loan from the General Partner was payable over twelve months and accrued interest at the General Partner's floating cost of funds (which approximated 5% per year). This rate was lower than the interest rate on the previous bank loan and the rate did not yield any profit for the General Partner. During 1991, Registrant repaid portions of the loan from the General Partner with proceeds received from bus dispositions, and in February 1992 Registrant repaid the remaining $1.1 million outstanding balance.\nThe industry followed the financial developments at GLI, the nation's largest scheduled bus line, with more than passing interest during the second half of the year. Although most bus operators do not compete directly with GLI, many have small line runs that connect to GLI's system, and all are concerned by fleet values that would be damaged by a GLI bankruptcy or liquidation action. Both of these scenarios were averted just prior to year- end 1994 when GLI completed a financial restructuring by exchanging convertible debt for stock and by issuing additional shares.\nThe equipment markets were steady throughout 1994 as previous stocks of MC9 coaches returned to equipment dealers were sold. Used bus prices are expected to remain steady with little change from 1994 as the general economy and the bus industry remains sound, and reflecting the fact that bus manufacturers have not announced any new models for early in 1995.\nReverse Vending Machines\nIn 1983, Registrant entered into a Purchase Agreement with Golden Recycle Company, a Colorado corporation (\"GRC\"), a wholly-owned subsidiary of Adolph Coors Brewing Company, a corporation not affiliated with the General Partner or its affiliates, pursuant to which Registrant purchased a total of 45 aluminum reverse vending machines (\"CanBanks\"), at an aggregate cost of $803,755.\nIn July 1985, Registrant entered into a long-term net lease with Reynolds Metals Company (the \"Lessee\") for all of Registrant's forty-five CanBanks. Under the terms of the lease, the Lessee made an initial payment of $250,000 and was required to make fixed payments of $14,545 per month through July 31, 1992. Registrant sold the CanBanks to the lessee in August 1992 for an aggregate purchase price of $22,500. During 1992, income under the lease totaled $48,598, or 2% of gross revenues.\nCogeneration District Heating Facility\nOn December 28, 1983, Registrant purchased a 49.89% interest (the \"Interest\") in the Trigen Trenton District Energy Company L.P. (\"TDEC\"), formerly Trenton District Energy Company, a New Jersey limited partnership formed for the sole purpose of constructing, acquiring, installing and operating a district heating system located in downtown Trenton, New Jersey.\nRegistrant was a general partner of TDEC with all of the rights, but not all of the obligations thereto. Specifically, Registrant was not jointly and severally liable, as the other general partners were, for all of the obligations arising under most financing arrangements. Registrant was originally liable only with respect to obligations of TDEC to the City of Trenton, New Jersey pursuant to an Urban Development Action Grant of approximately $4 million.\nRegistrant's Interest in TDEC was originally purchased for $6.1 million on January 2, 1985, through a $3.6 million equity contribution and the assumption of $2.5 million of non-recourse notes payable from the Registrant's share of distributable cash from TDEC. Under the terms of the amended limited partnership agreement of TDEC, described below, Registrant is to receive 11.8% of all Distributable Cash generated by TDEC until its non- recourse purchase price notes are paid in full, and 7.5% of all Distributable Cash after its non-recourse notes are paid in full. The terms of the non-recourse notes were amended to require that payments were to be made by the Registrant from 73% of all annual cash distributions it receives from its TDEC Interest while the non-recourse notes are outstanding.\nNo cash distributions were received by Registrant in 1994, 1993 or 1992.\nIn 1987 the New Jersey Department of Environmental Protection issued an order against TDEC as a result of violations of certain minimum environmental emission standards. To correct the violation, TDEC incurred substantial capital and operating expenditures. The partners of TDEC expressed concern over the long-term economic viability of the facility and decided to seek additional third party equity to be utilized for continued expansion of the facility. Registrant concluded that there had been an impairment in the value of Registrant's interest in TDEC and decided not to fund any additional losses. Therefore, Registrant wrote down its investment in TDEC, net of related non- recourse debt, to a value of zero and discontinued accruing additional losses.\nOn October 16, 1987, Registrant converted its general partnership interest to that of a limited partner with a 7.5% limited partner's interest in TDEC. Registrant entered into an amended limited partnership agreement dated as of November 20, 1987 with the then existing partners of TDEC, under which Trenton Energy Corporation was admitted as the new managing general partner and the City of Trenton was admitted as a special limited partner. Upon its admission as managing general partner, Trenton Energy Corporation made an equity contribution of $4 million, arranged for restructuring of all of TDEC's then current debt obligations, and also arranged for an additional $13 million of tax exempt debt financing, the proceeds of which were utilized for the expansion of the TDEC project.\nCogeneration Power Plant\nRegistrant entered into a Purchase Contract dated as of July 31, 1984 to acquire from Catalyst\/IPT Cogeneration Corporation (\"Seller\"), a California corporation, all of the right, title and interest of Seller (the \"San Jose Interest\") in and to San Jose Cogeneration Limited Partnership (\"San Jose\"), a California limited partnership. Seller was then the existing general partner of San Jose and, upon consummation of Registrant's purchase of the San Jose Interest, Registrant became the general partner of, and owned a 99.99% interest in, San Jose. San Jose was organized on September 12, 1983, for the purpose of constructing, installing, owning and operating a cogeneration power plant (the \"Facility\") to be located on the campus of San Jose State University (the \"University\"). The purchase price paid for the San Jose Interest was $3,951,000 in cash, and a secured non-recourse note of Registrant in the principal amount of $200,000.\nIn October 1991 Registrant completed the divestiture of its complete interest in the San Jose cogeneration facility. Registrant was required to pay outstanding liabilities of approximately $200,000 to effectuate this transaction. As a result of this transaction, Registrant recorded an accounting gain on disposition of approximately $790,000 in the fourth quarter of 1991.\nMedical Diagnostic Equipment\nRegistrant entered into a purchase and assumption agreement dated as of April 17, 1984 with Digital Diagnostics, Inc., a Washington corporation (\"Digital\") not affiliated with the General Partner or its affiliates, which had devised a plan for the design, equipment operation and supervision of a diagnostic imaging center in Seattle, Washington. Pursuant to the purchase and assumption agreement, Registrant purchased Digital's entire right, title and interest in, and took assignment of on-order positions with respect to, certain new diagnostic imaging equipment (the \"Scanning Equipment\") manufactured by Picker International, Inc. The Scanning Equipment consists of a computer tomography (\"CT\") scanner, a magnetic resonance (\"MR\") scanner and ancillary computer and scanning equipment.\nUnder the purchase and assumption agreement, Registrant also took assignment of the lease of the premises where the equipment would be operated as part of a diagnostic imaging center and purchased from Digital all leasehold improvements (the \"Leasehold Improvements\"), and contracts related to such premises. The Scanning Equipment, the Leasehold Improvements and the premises are collectively referred to as the \"Center\". In connection with all equipment sold and assigned to Registrant, Digital has assigned to Registrant all warranties and any rights to upgrades from the respective equipment manufacturers and contractors.\nAs of December 30, 1994, the total invoice cost paid by Registrant for the Scanning Equipment, the Leasehold Improvements, and all assigned contracts and agreements related thereto was approximately $3.9 million, representing the actual amount expended by Digital (and reimbursed to Digital) or paid to the manufacturers or contractors for the Center.\nOn May 31, 1988 Registrant entered into an Amended and Restated Joint Venture Agreement (the \"New Venture Agreement\"). Under the terms of the New Venture Agreement, two additional partners were admitted to the Venture: Medical Imaging Partners L.P. (\"MIP\"), a limited partnership whose general partner was an entity affiliated with the General Partner (the current general partner being a wholly owned subsidiary of Raytel Corporation), and Imaging Services, Inc. (\"ISI\"), a Washington corporation.\nEach partner in the joint venture is entitled to a defined Priority Distribution representing a cumulative, non-compounded annual distribution equal to 14% of each partner's investment. After Priority Distributions to venture partners are paid, distributable cash is shared 41.4% by Registrant, 48.75% by MIP, 5% by ISI and 4.85% by Digital.\nUnder the current 10 year management agreement expiring in 1998, or such earlier time as the New Venture Agreement is terminated, the Center will be managed by 2001 Management Associates, Inc. (\"2001\"), an affiliate of Digital, and will receive a base management fee equal to 8% of defined net revenues of the New Venture. In addition, under certain circumstances, and if certain annual budgeted operating results are exceeded, 2001 can earn a management bonus of up to 20% of defined Excess Net Revenues.\nThe New Venture Agreement continues until April 17, 1999, unless terminated earlier. The Center lease currently terminates on August 31, 1995 unless renewed . Termination of the lease would terminate the New Venture Agreement. Registrant has notified MIP and ISI that it does not intend to renew the lease.\nDuring 1994, the Center generated $2,543,024 in net operating revenues which, after deducting expenses, has resulted in net operating income before priority payments of $468,183 and priority distributions to Registrant of $309,139 compared with $2,838,213, $617,312, and $389,910, respectively, in 1993 and $3,396,230, $920,070 and $511,215, respectively, in 1992.\nThe Center has not generated sufficient operating cash flow to fulfill its obligation to make priority payments to Registrant in full and such condition is expected to continue. Registrant had recognized revenue related to the Center's contractual obligation to make these past priority payments. Based upon the Center's expected future inability to fulfill these prior obligations Registrant took a charge of $350,000 to reserve against this receivable in the fourth quarter of 1991.\nGross revenues and net income from the operation of the Center depend principally upon the rate of utilization of the Scanning Equipment, the fees collected for procedures, and the expenses of operating, maintaining and managing the Center. The economic outlook for outpatient services in general continues to be positive. The trends and movements within the health care industry continue to support and encourage patients and physicians to utilize outpatient facilities and to limit and restrict the time a person spends in a hospital as a patient. In addition, Federal and State governments are still contemplating new health care reform legislation which would, among other things, encourage the utilization of outpatient diagnostic and treatment centers. However, the success of the Center will depend not only on the general acceptance of outpatient services, but on the specific market conditions within the Center's referral area and its reputation within the community.\nWindplant\nRegistrant engaged U.S. Windpower, Inc., a Delaware Corporation (\"USW\") not affiliated with the General Partner or its affiliates, to produce, construct and install a windpower electric generating facility (\"Windplant\") located in Altamont Pass, California. The Windplant was acquired in 1983 and was designed to produce approximately 1 million kilowatt-hours of electricity per year under average annual wind conditions.\nDuring the second quarter of 1988, Registrant entered into an Amended and Restated Option Agreement with USW pursuant to which on July 29, 1988 USW paid Registrant $1,380,000, (the \"Option Price\") and advanced to Registrant $470,000 (which was applied to the sale price) in exchange for the right, at USW's discretion, to purchase Registrant's Windplant during the period from December 27, 1988 through January 31, 1989 for a sale price of $5,100,000.\nOn January 31, 1989 USW exercised its option to purchase the Registrant's investment in the Windplant and paid Registrant $5,100,000. The sale price proceeds were used to retire manufacturer's debt and accrued interest payable to USW.\nCompetition\nThe equipment leasing industry is highly competitive, offering users alternatives to the purchase of nearly every type of equipment. Competitive conditions vary considerably depending upon the type of equipment and the market conditions existing in the areas in which Registrant operates. Registrant is in competition with equipment managers, leasing companies and institutions engaged in leasing or otherwise marketing or remarketing equipment as well as with other owner-operators of equipment serving the business areas served by Registrant's equipment. In many industries manufacturers have established their own in-house leasing operations for the rental of their equipment and in other industries some manufacturers have established vendor leasing programs under which third-party leasing companies, in cooperation with the manufacturer, acquire equipment from the manufacturer subject to leases to third-party lessees.\nMany of the firms with which Registrant will compete have considerably greater financial resources and experience than Registrant and its affiliates in managing, leasing and operating equipment. As a result of having greater financial resources, many of Registrant's competitors have newer, more advanced equipment and much lower inventories. In addition, manufacturer- owned lessors and lessors under vendor leasing programs have an advantage over Registrant in that the manufacturer's salesmen have an on-going relationship with equipment users.\nFinally, when Registrant considers selling its equipment, it will encounter competition from limited partnerships, equipment managers, leasing companies and other institutions engaged in the sale of used equipment comparable to and competitive with Registrant's equipment. Many of such competitors have considerably greater financial resources and expertise than the General Partner and its affiliates in selling equipment.\nEmployees\nRegistrant has no employees. The business of Registrant is managed by the General Partner. ML Leasing Management Inc., an affiliate of the General Partner, performs certain management and administrative services for Registrant.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nA description of the Equipment of Registrant is contained in Item 1 above.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no legal proceedings pending against Registrant which are anticipated to have a material impact on Registrant's financial statements. However, for a discussion of certain legal matters related to Registrant's buses, see \"Item 1 -- Business - The Equipment -- Intercity Buses\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nOn October 14, 1994 Registrant mailed to its limited partners a Proxy Statement Furnished in Connection with the Solicitation of Consents relating to an amendment to Registrant's Partnership Agreement. The solicitation was successfully concluded whereby a majority of limited partners consented to the amendment. Pursuant to the amendment, the requirement that limited partners consent to any sale, abandonment or disposition of all or substantially all of Registrant's assets has been eliminated to the extent that, in the determination of the General Partner, such sale, abandonment or disposition is in the best interests of Registrant.\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Equity and Related Stockholder Matters\nThere is no established trading market for the Units and Depository Receipts. The number of owners of Units as of January 31, 1995 was 2,688, all of such owners holding Depository Receipts for Units.\nRegistrant does not distribute dividends. Registrant distributes Distributable Cash from Operations, and proceeds arising from Sale or Refinancing, to the extent available, quarterly. The following distributions have been made during the Registrant's prior two fiscal years:\n*Includes return of capital\nItem 6.","section_6":"Item 6. Selected Financial Data\nItem 6. Selected Financial Data - continued\nItem 7.","section_7":"Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nAt December 30, 1994, Registrant had $1,434,993 in cash and cash equivalents which included $1,339,650 in commercial paper. The balance is maintained in a demand deposit cash account. Included in these funds are reserves for working capital, operating requirements and cash distributions to the Partners. Approximately $242,000 were distributed to Partners in the first quarter of 1995.\nRegistrant generated positive cash flow in 1994 from sales of buses and from its medical imaging facility investment. These generated funds were utilized to meet operational obligations and provide for distributions to Partners.\nRegistrant continued to experience off-lease time for its bus fleet during 1994. Since the end of the second quarter, all of the remaining buses have been off-lease. Due to current market conditions and the increasing age of Registrant's buses, it is expected that Registrant's buses will remain off-lease until they are sold. During 1994, Registrant sold 13 buses resulting in five buses remaining at December 30, 1994.\nThe occupancy lease for Registrant's medical facility currently terminates on August 31, 1995 unless renewed. Termination of the lease would terminate the joint venture agreement. Registrant has notified its venture partners that it does not intend to renew the lease.\nAs of December 30, 1994, Registrant's remaining investments include five buses discussed above, its investment in the Seattle- based First Hill medical imaging facility and its TDEC investment (which is considered to have relatively small, if any, value over its associated debt).\nOn October 14, 1994 Registrant mailed to its limited partners a Proxy Statement Furnished in Connection with the Solicitation of Consents relating to an amendment to Registrant's Partnership Agreement. The solicitation was successfully concluded whereby a majority of limited partners consented to the amendment. Pursuant to the amendment, the requirement that limited partners consent to any sale, abandonment or disposition of all or substantially all of Registrant's assets has been eliminated to the extent that, in the determination of the General Partner, such sale, abandonment or disposition is in the best interests of Registrant.\nDuring 1995, Registrant will continue to focus on opportunistically realizing value for its remaining investments in buses and the medical imaging facility, including selling or otherwise disposing of the assets and liquidating its interest in TDEC. Registrant seeks to complete all such sales or dispositions in an orderly manner with estimated dissolution occurring, depending upon a number of presently unknown circumstances, in 1995.\nIt is currently estimated that Registrant's 1995 cash flow to be realized from operating its remaining assets, together with asset sales proceeds and working capital reserves, will provide Registrant with adequate funds to satisfy all of its obligations and provide for additional distributions to Partners.\nAsset Impairment and Estimated Useful Life of Assets\nRegistrant assesses the impairment of assets on a quarterly basis or immediately upon the occurrence of a significant event in the marketplace or an event that directly impacts its assets or related contracts. The methodology varies depending on the type of asset but typically consists of comparing the net carrying value of the asset to either: 1) the undiscounted expected future cash flows generated by the asset plus estimated salvage value, if any, less estimated selling commissions at the end of the cash flow stream (usually corresponding to the end of the current lease term of the asset), and\/or 2) the current market values obtained from industry sources. The market values used are conservative wholesale values.\nIf the net carrying value of a particular asset is materially higher than the estimated net realizable value, Registrant will write down the net carrying value of the asset accordingly; however, Registrant does not write its assets down to a value below the asset-related non-recourse debt. Registrant relies on industry sources and its experience in the particular marketplace to determine whether an asset impairment is other than temporary.\nEach year, Registrant compares the estimated useful life of its assets to similar assets owned by others in the particular industry and assesses useful life in light of changing technology in the particular industry. Registrant also assesses the estimated useful life of its equipment immediately upon the occurrence of a significant event in the marketplace or an event that directly impacts its assets or related contracts.\nResults of Operations\n1994 vs. 1993\nOverall Results\nRegistrant's net income for the year ended December 30, 1994 was significantly lower than net income for the same period in 1993 reflecting the sale of the remaining trailers in 1993, buses going off-lease, sales of buses, and lower revenues from Registrant's medical imaging facility. In addition, Registrant had lower gains from the sale of equipment in 1994 when compared to 1993.\nTotal revenues decreased in 1994 compared to 1993 reflecting: (1) the sale, in 1993, of Registrant's remaining trailers which generated revenues of approximately $1,408,000 in 1993, (2) lower revenues from Registrant's medical imaging facility, which generated revenues to Registrant of approximately $309,000 and $390,000 in 1994 and 1993, respectively, primarily due to reduced magnetic resonance patient volume and reduced fees the Center is contractually permitted to charge providers of health care services, (3) bus revenues of approximately $38,000 in 1994 compared to approximately $352,000 in 1993 primarily as a result of buses sold and buses going off-lease and (4) lower gains from the sale of equipment, primarily due to a higher volume of equipment sold in 1993.\nTotal expenses decreased in 1994 compared to 1993 reflecting: (1) lower property operating expenses and depreciation and amortization expense as a result of the sale of the remaining trailers in 1993 and the sale of buses and (2) no interest expense incurred in 1994 as a result of the repayment of all remaining trailer debt during 1993.\nResults By Segment\nEquipment Leasing:\nRegistrant's equipment leasing segment generated operating revenues of approximately $38,000 in 1994 compared to approximately $1,760,000 in 1993. This decrease was due to the sale of all remaining trailers in 1993 and to sales of buses and buses going off-lease.\nRegistrant's equipment leasing segment incurred property operating expenses of approximately $27,000 in 1994 compared to approximately $128,000 in 1993. Additionally, depreciation and amortization expense was approximately $42,500 in 1994 compared to approximately $498,000 in 1993. These decreases are due primarily to the sale of all remaining trailers in 1993 and sales of buses in 1993 and 1994. Additionally, Registrant incurred no interest expense in 1994 as a result of the repayment of all remaining trailer debt in 1993.\nMedical Imaging:\nRegistrant's medical imaging segment, which consists of one diagnostic imaging facility, generated revenues to Registrant of approximately $309,000 in 1994 compared to approximately $390,000 in 1993. The decrease in revenues reflects reduced magnetic resonance patient volume and reduced patient fees the Center is contractually permitted to charge providers of health care services.\n1993 vs. 1992\nOverall Results\nRegistrant's 1993 operations resulted in net income of approximately $1.9 million compared to net income of approximately $1.6 million in 1992. The favorable change reflects lower total expenses partially offset by lower total revenues.\nRegistrant's revenues decreased in 1993 when compared to the prior year as a result of lower revenues from Registrant's trailers, buses and medical imaging facility. Registrant's trailer revenue decreased by approximately $390,000 in 1993 compared to 1992 primarily reflecting the sale of all remaining trailers in the fourth quarter of 1993. Registrant's bus revenue decreased by approximately $240,000 in 1993 compared to 1992 primarily as a result of bus sales. Registrant's medical imaging facility generated revenues that were approximately $120,000 lower in 1993 compared to 1992, reflecting reduced patient volume and reduced patient fees the center is contractually allowed to charge providers of health care service. Registrant also earned no income from sale-type lease in 1993 due to the sale of Registrant's interest in reverse aluminum can vending machines in August of 1992. These decreases in revenues were partially offset by a larger gain from asset disposals in 1993 due mostly to the sale of Registrant's trailers.\nRegistrant's expenses were lower in 1993 compared to 1992 as a result of: (1) lower depreciation and amortization expense in 1993 primarily reflecting the sale of trailers and buses during 1992 and 1993, (2) lower interest expense primarily reflecting repayments of the trailer loan in January 1992 and October 1993 upon the sale of the trailers, and scheduled repayments of trailer debt during 1993 and 1992, (3) lower property operating expenses, reflecting lower management fees and other operating expenses for the buses and trailers as a result of 1992 and 1993 equipment sales and lower property taxes on Registrant's medical imaging facility; and (4) the loss on the disposal of Registrant's interest in reverse aluminum can vending machines in 1992.\nResults by Segment\nResults of operation of Registrant's equipment leasing segment, which comprised a majority of Registrant's operations in 1993 and 1992, are presented as follows:\nRegistrant's equipment leasing segment generated operating revenues of approximately $1.8 million in 1993 compared to approximately $2.4 million in 1992. This decrease was due, to: (a) a decrease in trailer revenue of approximately $390,000 due mostly to the sale of all remaining trailers in the fourth quarter of 1993 and (b) a decrease in bus revenue by approximately $240,000 due mostly to sales of buses.\nRegistrant's equipment leasing segment incurred operating expenses of approximately $620,000 in 1993 compared to approximately $1,131,000 due primarily to lower management fees and other operating expenses as a result of 1992 and 1993 equipment sales.\nInflation\nThe low levels of inflation during 1994, 1993, and 1992 had no significant effect on Registrant's operations.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nLIBERTY EQUIPMENT INVESTORS - 1983\nIndependent Auditors' Report\nBalance Sheets as of December 30, 1994 and December 31, 1993\nStatements of Operations for the Years Ended December 30, 1994, December 31, 1993 and December 25, 1992\nStatements of Cash Flows for the Years Ended December 30, 1994, December 31, 1993 and December 25, 1992\nStatements of Changes in Partner's Capital for the Years Ended December 30, 1994, December 31, 1993 and December 25, 1992\nNotes to Financial Statements for the Years Ended December 30, 1994, December 31, 1993 and December 25, 1992\nINDEPENDENT AUDITORS' REPORT\nLiberty Equipment Investors - 1983:\nWe have audited the accompanying financial statements of Liberty Equipment Investors-1983 (the \"Partnership\"), listed in the accompanying table of contents. These financial statements are the responsibility of the Partnership's general partner. 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 the general partner, 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 presently fairly, in all material respects, the financial position of the Partnership at December 30, 1994 and December 31, 1993 and the results of its operations and its cash flows for each of the three years in the period ended December 30, 1994 in conformity with generally accepted accounting principles.\n\/s\/ Deloitte & Touche LLP New York, New York March 16, 1995\nLIBERTY EQUIPMENT INVESTORS - 1983\nBALANCE SHEETS AS OF DECEMBER 30, 1994 AND DECEMBER 31, 1993\nContinued on following page.\nLIBERTY EQUIPMENT INVESTORS - 1983\nBALANCE SHEETS AS OF DECEMBER 30, 1994 AND DECEMBER 31, 1993 (Continued)\nSee Notes to Financial Statements.\nLIBERTY EQUIPMENT INVESTORS - 1983\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 30, 1994, DECEMBER 31, 1993 AND DECEMBER 25, 1992\nContinued on following page.\nLIBERTY EQUIPMENT INVESTORS - 1983\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 30, 1994, DECEMBER 31, 1993 AND DECEMBER 25, 1992 (Continued)\nSee Notes to Financial Statements.\nLIBERTY EQUIPMENT INVESTORS - 1983\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 30, 1994, DECEMBER 31, 1993 AND DECEMBER 25, 1992\nContinued on following page.\nLIBERTY EQUIPMENT INVESTORS - 1983\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 30, 1994, DECEMBER 31, 1993 AND DECEMBER 25, 1992 (Continued)\nContinued on following page.\nLIBERTY EQUIPMENT INVESTORS - 1983\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 30, 1994, DECEMBER 31, 1993 AND DECEMBER 25, 1992 (Continued)\nSee Notes to Financial Statements.\nLIBERTY EQUIPMENT INVESTORS - 1983\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 30, 1994, DECEMBER 31, 1993 AND DECEMBER 25, 1992\nContinued on following page.\nLIBERTY EQUIPMENT INVESTORS - 1983\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 30, 1994, DECEMBER 31, 1993 AND DECEMBER 25, 1992 (Continued)\nSee Notes to Financial Statements.\nLIBERTY EQUIPMENT INVESTORS - 1983\nNOTES TO FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 30, 1994, DECEMBER 31, 1993, AND DECEMBER 25, 1992\n1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nLiberty Equipment Investors - 1983 (the \"Partnership\") was formed and the Certificate of Limited Partnership was filed under the Uniform Limited Partnership Act of the State of New York on March 30, 1983. The Partnership subsequently elected to be governed by the New York Revised Limited Partnership Act.\nUnder the terms of the Agreement of the Limited Partnership (the \"Partnership Agreement\"), on October 25, 1983, Maiden Lane Partners Inc., the general partner (\"MLPI\" or the \"General Partner\"), admitted additional limited partners to the Partnership with capital contributions amounting to $40,000,000. Prior to that date, the only capital transactions were contributions of $5,000 by MLPI and $200 by the initial limited partners. As provided in the Partnership Agreement, MLPI made an additional cash contribution of $399,045, which, together with its previous cash contribution, represented 1% of the total Partnership capital contributions.\nThe purpose of the Partnership is to operate and lease equipment, and direct and indirect interests therein.\nPursuant to the terms of the Partnership Agreement, the General Partner is 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.\nBasis of Accounting and Fiscal Year\nThe Partnership's records are maintained on the accrual basis of accounting for financial reporting and tax purposes.\nThe Partnership accounts for its 7.5% limited partnership interest in the Trigen Trenton District Energy Company partnership (\"TDEC\") under the cost method of accounting.\nThe Partnership records its investment in its First Hill medical imaging venture under the equity method of accounting.\nThe fiscal year of the Partnership ends on the last Friday of each calendar year. Fiscal years 1994 and 1992 consisted of 52 weeks. Fiscal year 1993 consisted of 53 weeks.\nProperty and Depreciation\nPartnership property under management contract and held for lease is depreciated on a straight-line basis with the following estimated useful lives:\nIntercity Buses 15 years\nDry-van Piggyback Trailers 14 years\nMedical Diagnostic Imaging Equipment 5-6 years\nThe cost of the properties includes the related acquisition fees.\nRevenue Recognition\nRental income is recognized as earned according to the terms of the individual lease agreements.\nAsset Impairment\nThe Partnership assesses the impairment of assets on a quarterly basis or immediately upon the occurrence of a significant event in the marketplace or an event that directly impacts its assets or related contracts. The methodology varies depending on the type of asset but typically consists of comparing the net carrying value of the asset to either: 1) the undiscounted expected future cash flows generated by the asset plus estimated salvage value, if any, less estimated selling commissions at the end of the cash flow stream (usually corresponding to the end of the current lease term of the asset), and\/or 2) the current market values obtained from industry sources. The market values used are conservative wholesale values.\nIf the net carrying value of a particular asset is materially higher than the estimated net realizable value, the Partnership will write down the net carrying value of the asset accordingly; however, the Partnership generally does not write its assets down to a value below the asset-related non-recourse debt. The Partnership relies on industry sources and its experience in the particular marketplace to determine whether an asset impairment is other than temporary.\nCash Flows\nFor purposes of the Statements of Cash Flows, the Partnership considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nIncome Taxes\nNo provision for income taxes has been included in the Partnership's financial statements since all income and losses are allocated to the partners for inclusion in their respective tax returns.\nIn accordance with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", the Partnership has included in Note 9 certain disclosure related to differences in the book and tax bases of accounting.\nInsurance\nThe Partnership's equipment-related insurance is maintained by its respective equipment manager or lessee. While the buses are held by the equipment manager for sale, the buses are covered under the equipment manager's casualty insurance policy. Additionally, the Partnership maintains contingent auto liability which covers the buses while they are held by the equipment manager and additional contingent physical damage insurance. Insurance coverage for the Partnership's medical imaging center and equipment includes comprehensive and general liability. Property losses have not had a material impact on the Partnership's financial statements.\n2. CASH AND CASH EQUIVALENTS\nOn December 30, 1994, the Partnership had $1,434,993 in cash and cash equivalents which included $1,339,650 invested in commercial paper. The balance is maintained in a demand deposit cash account. Approximately $242,000 was distributed to partners in the first quarter of 1995.\nOn December 31, 1993, the Partnership had $2,977,607 in cash and cash equivalents which included $1,746,098 invested in commercial paper, $1,047,024 in banker's acceptances and the balance is maintained in demand deposit cash accounts.\n3. PROPERTY\nThe following details the Partnership's investment in property under management contract and held for lease:\nA) The Partnership owned 5 buses as of December 30, 1994, reflecting the sale of 13 buses during the year. The buses were under management and sale agreements whereby TMO Acquisition Corp. (\"TMOAC\") and Hausman Bus Sales, Inc. (\"Hausman\") were the equipment managers and placed the buses under operating leases, collected the rental payments, and remitted the rentals to the Partnership net of management fees and operating expenses, and currently act as agent for the Partnership in selling buses.\nOn November 6, 1992, Continental Asset Services, Inc. (\"CASI\"), the previous equipment manager, sold certain of its assets and liabilities to TMOAC, a Delaware corporation and, at the time, a wholly-owned subsidiary of The Dial Corp. On November 6, 1992, in connection with the sale, and pursuant to an Assignment, Assumption and Amendment Agreement by and between CASI, TMOAC and Hausman, substantially all terms of the management agreements and sale agreements between the Partnership and CASI were jointly assigned to, and assumed by, TMOAC and Hausman. The assumption of the management agreements and sale agreements by TMOAC and Hausman was effective November 6, 1992. TMOAC and Hausman are not affiliated with the General Partner.\nThere were no buses on lease at December 30, 1994. Revenue generated by the Partnership's buses amounted to $38,341 (8% of total revenues of the Partnership) in 1994, $351,912 (12%) in 1993, and $590,396 (18%) in 1992.\nThe Partnership continued to experience off-lease time for most of its remaining bus fleet in the first quarter of 1994 and for all of its bus fleet by the end of the second quarter and through the end of 1994. Due to current market conditions and the increasing age of the Partnership's buses, it is expected that the Partnership's buses will remain off-lease until they are sold.\nB) In 1984, the Partnership entered into a joint venture agreement pursuant to which the Partnership acquired medical diagnostic imaging equipment and related leasehold improvements to be operated at the First Hill Diagnostic Imaging Center (the \"Center\") in Seattle, Washington. The Partnership also took assignment of the lease of the premises where the equipment would be operated as part of a diagnostic imaging center. As of December 30, 1994, the Partnership had acquired approximately $3.9 million of such equipment including a computer tomography scanner, a magnetic resonance scanner, and various leasehold improvements.\nThe joint venture (the \"New Venture\") is currently operated under an agreement dated May 31, 1988 among the Partnership, Digital Diagnostics, Inc. (\"Digital\"), Medical Imaging Partners L.P. (\"MIP\"), a limited partnership whose general partner was an entity affiliated with the General Partner (the current general partner being a wholly owned subsidiary of Raytel Corporation), and Imaging Services, Inc. (\"ISI\"), a Washington corporation. The Partnership is jointly and severally liable with the other venture partners for certain obligations of the New Venture. The joint venture agreement (the \"New Venture Agreement\") expires on April 17, 1999, unless terminated earlier.\nUnder the current 10 year management agreement expiring in 1998, or such earlier time as the New Venture Agreement is terminated, the Center will be managed by 2001 Management Associates, Inc. (\"2001\"), an affiliate of Digital, and will receive a base management fee equal to 8% of defined net revenues of the New Venture. In addition, under certain circumstances, and if certain annual budgeted operating results are exceeded, 2001 can earn a management bonus of up to 20% of defined Excess Net Revenues.\nThe Center lease currently terminates on August 31, 1995, unless renewed. Termination of the lease would terminate the New Venture Agreement. The Partnership has notified MIP and ISI that it does not intend to renew the lease.\nEach partner in the New Venture is entitled to a defined priority distribution representing a cumulative, non- compounded annual distribution equal to 14% of each partner's investment. After priority distributions to venture partners are paid, distributable cash is shared 41.4% by the Partnership, 48.75% by MIP, 5% by ISI and 4.85% by Digital. Under a management agreement, 2001 Management Associates, Inc. (\"2001\"), an affiliate of Digital, manages the Center and will receive a base management fee equal to 8% of defined net revenues of the venture. Priority cash distributions received by the Partnership amounted to $309,139, or 66%, of the Partnership's total revenues in 1994, $389,910, or 14%, in 1993 and $511,215, or 16%, in 1992.\nThe Center has not generated sufficient operating cash flow to fulfill its obligation to make priority payments to the Partnership in full and such condition is expected to continue. The Partnership had recognized revenue related to the Center's contractual obligation to make these past priority payments. Based upon the Center's expected future inability to fulfill these prior obligations the Partnership took a charge of $350,000 to reserve against this receivable in the fourth quarter of 1991.\nTrailers Sold in Prior Years\nThe dry-van piggyback trailers were operated under a management agreement corresponding with the expiration of the leases, whereby the equipment manager provided maintenance, periodic inspection, and arrangements to re-lease the dry-van piggyback trailers as necessary, in return for a monthly fee. The management agreement was terminated upon the sale of the remaining trailers.\nOf the Partnership's trailers, 652 were subject to a lease to Transamerica Equipment Leasing Company, Inc. (\"TELCO\") through September 27, 1991 at a monthly rate of $151.00 per trailer. On January 31, 1992, the Partnership sold and assigned the related lease to these 652 trailers to Greenbrier Capital Corporation, the trailer manager, for $3,750 per trailer or a total sales price of $2,445,000. The Partnership's remaining trailers were also leased to TELCO at a monthly rate of $155.40 per trailer.\nThe Partnership entered into a purchase agreement dated as of October 1, 1993 whereby the Partnership sold its remaining 917 trailers to TELCO effective as of the respective lease expiration date of each trailer. All 917 trailers were subject to a lease to TELCO with scheduled expiration dates of September 30, 1993 for 282 trailers, October 15, 1993 for 339 trailers and November 22, 1993 for 296 trailers. The purchase price for the trailers was $3,650 per trailer, or a total of $3,347,050 for all 917 trailers. On October 15, 1993, the Partnership consummated the sale of 621 trailers for a total price of $2,266,650, representing trailers with leases expiring on September 30, 1993 and October 15, 1993. On November 22, 1993, the remaining 296 trailers were sold to TELCO for a total price of $1,080,400.\nThe Partnership recognized a gain of $526,860 on the disposal of the remaining 917 trailers in 1993.\nConcurrent with the sale transaction on October 15, 1993, the Partnership repaid the then-remaining $651,397 balance of the non- recourse bank loan secured by the trailers (including interest accrued thereon).\nRevenues generated by the dry-van piggyback trailers amounted to $1,407,939 (49% of total revenues of the Partnership) in 1993 and $1,796,966 (56%) in 1992.\n4. NET INVESTMENT IN SALES-TYPE LEASE\nIn August of 1992, the Partnership sold its interest in the 45 reverse aluminum can vending machines to the then current lessee for $22,500.\n5. INVESTMENT IN PARTNERSHIP\nTDEC, a New Jersey limited partnership, was formed for the sole purpose of constructing, acquiring, and installing a cogeneration heating system located in Trenton, New Jersey. The Partnership's original investment in TDEC was approximately $6.1 million.\nTDEC was restructured as of November 20, 1987, under the terms of the amended Agreement of Limited Partnership of Trenton District Energy Company (the \"TDEC Agreement\"). Under the terms of the TDEC Agreement, the Partnership will receive 11.8% of all Distributable Cash generated by TDEC until its non-recourse purchase price notes (see note 6) are paid in full, and 7.5% of all Distributable Cash after its non-recourse notes are paid in full. No cash distributions were received in 1994, 1993 or 1992.\n6. NOTES PAYABLE-TDEC\nThe notes are non-recourse and bear interest at a rate of 11% per annum and are payable currently. However, the notes are collateralized by and payable only from the Partnership's share of the distributable cash generated by TDEC.\nAs part of the partnership restructuring effectuated by the execution of the TDEC agreement, the terms of the non-recourse notes were amended to require that payments were to be made by the Partnership from 73% of all annual cash distributions it receives from its interest in TDEC. To the extent that the 73% share of the Partnership's cash distribution received is insufficient to pay any required scheduled note payment, such unpaid amount will be payable from 73% of all future cash distributions the Partnership receives from its interest in TDEC, with interest accruing on such unpaid amounts at 11%. Since 1985, TDEC has not made any cash distributions.\nAt December 30, 1994, the $3,419,078 debt balance represents the aggregate amount of principal payments required for notes payable in 1995.\n7. TRANSACTIONS WITH GENERAL PARTNER\nDuring the years ended December 30, 1994, December 31, 1993 and December 25, 1992, the Partnership incurred the following fees and expenses in connection with services provided by the General Partner:\nAt December 30, 1994 and December 31, 1993, amounts payable to the General Partner and\/or Affiliate consisted of the following:\n8. SEGMENT INFORMATION\nThe following analysis provides segment information for the three main industries in which the Partnership operates. The equipment leasing segment consists of intercity buses, dry-van piggyback trailers (for 1993 and 1992 only) and the net investment in sales- type canbank lease (for 1992 only). The medical imaging segment is comprised of the Partnership's investment in the First Hill medical imaging center. The alternative energy segment comprises the Partnership's investment in TDEC.\n9. RECONCILIATION TO INCOME TAX METHOD OF ACCOUNTING\nThe differences between the method of accounting used for income tax reporting and the method of accounting used in the accompanying financial statements are as follows:\nContinued on following page.\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\nRegistrant has no executive officers or directors. The General Partner manages the Registrant's affairs and has general responsibility and authority in all matters affecting its business. The directors and executive officers of the General Partner are:\n(1)Directors hold office until their successors are elected and qualified. All executive officers serve at the pleasure of the Board of Directors.\nKevin K. Albert, 42, a Managing Director of Merrill Lynch Investment Banking Group (\"ML Investment Banking\"), joined Merrill Lynch in 1981. Mr. Albert works in the Equity Private Placement Group and is involved in structuring and placing a diversified array of private equity financing including common stock, preferred stock, limited partnership interests and other equity-related securities. Mr. Albert is also a director of Whitehall Partners Inc. (\"Whitehall\"), an affiliate of the General Partner and the general partner of Liberty Equipment Investors L.P. - 1984; a director of ML Media Management Inc. (\"ML Media\"), an affiliate of the General Partner and a joint venturer of Media Management Partners, the general partner of ML Media Partners, L.P.; a director of ML Film Entertainment Inc. (\"ML Film\"), an affiliate of the General Partner and the managing general partner of the general partners of Delphi Film Associates II, III, IV, V and ML Delphi Premier Partners, L.P.; a director of ML Opportunity Management Inc. (\"ML Opportunity\"), an affiliate of the General Partner and a joint venturer in Media Opportunity Management Partners, the general partner of ML Media Opportunity Partners, L.P.; a director of MLL Antiquities Inc. (\"MLL Antiquities\"), an affiliate of the General Partner and the administrative general partner of The Athena Fund II, L.P.; a director of ML Mezzanine Inc. (\"ML Mezzanine\"), an affiliate of the General Partner and the sole general partner of the managing general partner of ML-Lee Acquisition Fund, L.P.; a director of ML Mezzanine II Inc. (\"ML Mezzanine II\"), an affiliate of the General Partner and sole general partner of the managing general partner of ML-Lee Acquisition Fund II, L.P. and ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.; a director of Merrill Lynch Venture Capital Inc. (\"ML Venture\"), an affiliate of the General Partner and the general partner of the Managing General Partner of ML Venture Partners I, L.P. (\"Venture I\"), ML Venture Partners II, L.P. (\"Venture II\"), and ML Oklahoma Venture Partners Limited Partnership (\"Oklahoma\"); a director of Merrill Lynch R&D Management Inc. (\"ML R&D\"), an affiliate of the General Partner and the general partner of the General Partner of ML Technology Ventures, L.P.; and a director of MLL Collectibles Inc. (\"MLL Collectibles\"), an affiliate of the General Partner and the administrative general partner of The NFA World Coin Fund, L.P. Mr. Albert also serves as an independent general partner of Venture I and Venture II.\nRobert F. Aufenanger, 41, a Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research and a Director of the Partnership Management Department, joined Merrill Lynch in 1980. Mr. Aufenanger is responsible for the ongoing management of the operations of the equipment and project related limited partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners. Mr. Aufenanger is also a director of Whitehall, ML Media, ML Film, ML Opportunity, MLL Antiquities, ML Venture, ML R&D, MLL Collectibles, ML Mezzanine and ML Mezzanine II.\nRobert W. Seitz, 48, a First Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research and a Managing Director within the Corporate Credit Division of Merrill Lynch, joined Merrill Lynch in 1981. Mr. Seitz is the Private Client Senior Credit Officer and is also responsible for the firm's Partnership Management and Asset Recovery Management Departments. Mr. Seitz is also director of Whitehall, ML Media, ML Opportunity, ML Venture, ML R&D, ML Film, MLL Antiquities and MLL Collectibles.\nSteven N. Baumgarten, 39, a Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research, joined Merrill Lynch in 1986. Mr. Baumgarten shares responsibility for the ongoing management of the operations of the equipment and project related limited partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners. Mr. Baumgarten is also a director of ML Film.\nMichael A. Giobbe, 36, an Assistant Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research, joined Merrill Lynch in 1986. Mr. Giobbe currently shares the responsibility for managing the assets owned by the equipment and project related limited partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners.\nDavid G. Cohen, 32, an Assistant Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research, joined Merrill Lynch in 1987. Mr. Cohen's responsibilities include controllership and financial management functions for certain partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners.\nMessrs. Aufenanger and Giobbe are executive officers of Mid-Miami Diagnostics Inc. (\"Mid-Miami Inc.\"). On October 28, 1994 both Mid-Miami Inc. and Mid-Miami Diagnostics, L.P. filed voluntary petitions for protection from creditors under Chapter 7 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York.\nItem 11.","section_11":"Item 11. Executive Compensation\nRegistrant does not pay the executive officers or directors of the General Partner any remuneration. The General Partner does not presently pay any remuneration to any of its executive officers or directors. See Note 7 to the Financial Statements included in Item 8 hereof, however, for sums paid by Registrant to affiliates in the years ending December 30, 1994, December 31, 1993 and December 25, 1992.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nIn addition to its interest in Registrant as general partner, the General Partner owns .2 Units. No officers or directors of the General Partner own any interests in Registrant.\nTo the knowledge of the General Partner, as of February 1, 1995, officers and directors of the General Partner in aggregate own less than .01% of the outstanding common stock of Merrill Lynch & Co., Inc., the ultimate parent of the General Partner.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nAll of the directors of Registrant's General Partner are executive officers of affiliates that have received fees for services provided to Registrant as described in Note 7 to the Financial Statements included in Item 8 hereof.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Financial Statements, Financial Statement Schedules and Exhibits\nFinancial Statements and Financial Statement Schedules\nSee Item 8. \"Financial Statements and Supplementary Data - Table of Contents.\"\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.\nLIBERTY EQUIPMENT INVESTORS-1983 By: Maiden Lane Partners Inc. General Partner\nDated: March 29, 1995 \/s\/ Robert F. Aufenanger Robert F. Aufenanger 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 in the capacities and on the dates indicated.\nSignature Title Date\n\/s\/ Kevin K. Albert Director of the General March 29, 1995 (Kevin K. Albert) Partner\n\/s\/ Robert F. Aufenanger Director and President March 29, 1995 (Robert F. Aufenanger) of the General Partner (chief executive officer)\n\/s\/ Robert W. Seitz Director and Vice March 29, 1995 (Robert W. Seitz) President of the General Partner\n\/s\/ David G. Cohen Treasurer of the March 29, 1995 (David G. Cohen) General Partner (chief accounting officer and chief financial officer)","section_15":""}
{"filename":"786617_1994.txt","cik":"786617","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings. -----------------\nOn March 16, 1993, the United States of America, by the Attorney General of the United States acting at the request of the Environmental Protection Agency, filed a civil complaint against the Company in the United States District Court for the South District of Indiana, Evansville Division, as civil action No. NA 93-19-C, alleging violations of the Federal Water Pollution Control Act (the \"Act\"). Subsequently, this action was moved to the Indianapolis Division and assigned Cause No. IP93-0692-C. The complaint seeks, among other things, an injunction preventing the Company from discharging wastewater in violation of the Act from one of its processing facilities, and a civil penalty of up to $25,000 per day for each violation of the Act. A trial has been scheduled to commence in July, 1995. In the event this matter results in an unfavorable outcome, it is not possible to estimate the amount of civil penalties or other expenditures, if any, that the court may award. The Company continues to vigorously contest this matter. Management believes that the outcome will not have a material adverse effect on the Company's consolidated financial position or results of operations.\nThe Company believes that its operations are in substantial compliance with applicable environmental laws and regulations. The Company has, however, in the past paid monetary sanctions for violations of its wastewater discharge permits.\nThere can be no assurance that the Company will not experience future regulatory proceedings and lawsuits relating to the environmental impact of its operations. The Company cannot predict what, if any, effect such future proceedings or lawsuits may have on its operations.\nThe Company is, at any time, involved in ordinary routine litigation incidental to its business. Such litigation is not considered material to the Company's operations.\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. ---------------------------------------------------------------------\nCOMMON STOCK\nThe Company's certificate of incorporation permits the issuance of up to 40,000,000 shares each of Class A common stock, $.01 par value, and Class B common stock, $.01 par value. On November 7, 1994, there were 9,533,378 shares of Class A common stock issued (including 933,854 shares held in treasury) and 8,502,834 shares of Class B common stock issued and outstanding. The Transfer Agent and Registrar for both classes of common stock is Chemical Trust Company of Los Angeles, California.\nThe Class A common stock has one vote per share, while the Class B common stock has ten votes per share in all matters submitted to a vote of the Company's stockholders. Except as required by law or the certificate of incorporation, holders of Class A or Class B common stock shall vote together as a single class. Holders of Class A and Class B common stock are entitled to receive such dividends and other distributions as may be determined by the Board of Directors out of any funds of the Company legally available therefor; provided, however, that no dividend may be declared and paid on the Class B common stock unless a dividend is also declared and paid on the Class A common stock, and, in such an event, the dividend per share of Class B common stock may not exceed 90% of the dividend per share of Class A common stock. Certain members of the Hudson family own substantially all of the Class B common stock which concentrates voting control over the Company in James T. Hudson and the Hudson family. The Class B common stock voting power is sufficient to, among other things, approve or prevent extraordinary corporate transactions, such as mergers, consolidations or sales of substantially all of the Company's assets and to elect or remove the members of the Board of Directors.\nTransfer of the Class B common stock may only be made to a \"permitted transferee\" as defined in the Company's certificate of incorporation, but shares of Class B common stock may be converted by the holder into an equal number of shares of Class A common stock at any time. The Company may not issue additional shares of Class B common stock without the approval of a majority of the votes of the outstanding shares of Class A common stock and Class B common stock, each voting separately as a class, except in connection with stock splits and stock dividends. The board of directors and the holders of a majority of the outstanding shares of Class B common stock may approve the conversion of all of the Class B common stock into shares of Class A common stock.\nIn the event of a liquidation of the Company, all assets available for distribution after payment of all prior claims would be divided among and paid ratably to the holders of Class A common stock and Class B common stock.\nSubject to any conversion rights of the holders of Class B common stock, holders of Class A and Class B common stock have no preemptive rights to subscribe for or receive any part of the authorized stock of the Company, additional or increased issues of stock of any class or of any obligations convertible into any class or classes of stock. Further, no stockholder has the right to cumulate votes in the election of directors.\nOn November 7, 1994, the 8,599,524 shares of Class A common stock then outstanding were held by approximately 1,314 holders of record (excluding persons holding shares in nominee names). The Transfer Agent and Registrar for the Class A common stock is Chemical Trust Company of California in Los Angeles.\nThe Company's Class A common stock is currently traded on the New York Stock Exchange (\"NYSE\") under the symbol \"HFI.\" The following table sets forth the quarterly high and low sales prices for the Class A common stock as reported on the NYSE.\nThe Class B common stock is not traded on the NYSE or any other exchange, and the Company is not aware of any public market for such shares. On November 7, 1994, 8,502,834 shares of Class B common stock were outstanding; these shares were held by approximately 21 holders of record. James T. Hudson beneficially owns 99.9 percent of the outstanding Class B common stock.\nOn October 13, 1994, the Company filed a registration statement with the Securities and Exchange Commission to register 4,600,000 shares of Class A common stock of which 2,500,000 shares are to be newly issued Class A common stock of the Company and 1,500,000 shares (2,100,000 if the underwriters over- allotment is exercised in full) are being offered by certain stockholders of the Company.\nDEBENTURES\nIn October 1986, the Company sold $70,000,000 in principal amount of 8% convertible subordinated debentures due 2006 (the \"Old Debentures\"). Each Old Debenture, as issued, could be converted into shares of the Company's common stock. Following the reclassification of the Company's common stock in fiscal 1987, the Old Debentures were convertible only into shares of Class A common stock (herein called \"Class A Old Debentures\"). During the Company's exchange offer relating to reclassification of its common stock, holders of Class A Old Debentures were given the option of making such Debentures convertible into shares of Class B common stock (herein called \"Class B Old Debentures\").\nDuring fiscal 1988, the Company offered the holders of its Old Debentures the option of exchanging those Old Debentures for newly issued 14% convertible subordinated debentures due 2008 (the \"New Debentures\"). Under the exchange offer, each $1,000 in principal amount of Class A Old Debentures could be exchanged for $650 in principal amount of New Debentures; each $1,000 in principal amount of Class B Old Debentures could be exchanged for $600 in principal amount of New Debentures. The exchange offer was concluded on August 31, 1988. As a result of the exchange offer, there were outstanding on that date $17,410,000 of Class A Old Debentures, $946,000 of Class B Old Debentures and $32,496,000 of New Debentures. Because New Debentures were not exchanged for Old Debentures on a dollar-for-dollar basis, the exchange offer resulted in the retirement of $19,073,000 in principal amount of long-term debt and an extraordinary after-tax gain to the Company of $10,855,000.\nDuring the second quarter of fiscal 1993, the Company called all of the New Debentures. Approximately 75 percent of the New Debentures were converted to Class A common stock at a conversion price of $12.25 per share, with the remainder exchanged for cash including a 4.8% premium over par. This conversion resulted in a decrease in long-term debt and corresponding increase in stockholders' equity.\nDuring the fourth quarter of fiscal 1994, the Company called all of the Class A Old Debentures and the Class B Old Debentures. Approximately $8.1 million of Class A Old Debentures were converted into shares of Class A common stock at a conversion price of $21.00 per share during fiscal 1994. By October 7, 1994, approximately $13.7 million of the Class A Old Debentures were converted to Class A common stock and all $26,000 of the Class B Old Debentures were converted to Class B common stock, with the remainder exchanged for cash including a 1.6% premium over par. This conversion resulted in a decrease in long-term debt and an increase in stockholders' equity in fiscal 1994, and also will result in a decrease in long-term debt and an increase in stockholders equity in fiscal 1995.\nDIVIDEND POLICY\nThe Company's Board of Directors has declared cash dividends every fiscal quarter since the Company's initial public offering in February 1986. Since April 1987, the Board has declared quarterly dividends of $.03 per share of Class A common stock and $.025 per share of Class B common stock. The Company's certificate of incorporation restricts the per share dividends declared and paid on Class B common stock to not more than 90 percent of the per share dividends declared and paid on Class A common stock.\nPayment of future dividends will depend upon the Company's financial condition, results of operations and other factors deemed relevant by the Board of Directors. Additionally, the Company has entered into certain loan agreements that restrict its ability to pay dividends. The Company's primary credit facility restricts dividend payments to a maximum of $2.75 million in any fiscal year.\nItem 6.","section_6":"Item 6. Selected Financial Data. -----------------------\nThe following table sets forth selected consolidated financial data of the Company for each of the last five fiscal years ended October 1, 1994. The information has been derived from the consolidated financial statements of the Company which have been audited by Coopers & Lybrand L.L.P., independent certified public accountants. This data should be read in conjunction with the Company's consolidated financial statements and the notes thereto and \"Management's Discussion and Analysis of Results of Operations and Financial Condition.\" The Company's fiscal year is a 52- or 53-week period ending each year on the Saturday closest to September 30.\n(1) Amounts for fiscal years 1990 through 1993 have been restated for the adoption of Statement of Financial Accounting Standards No. 109.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results ----------------------------------------------------------------------- of Operations. -------------\nGeneral\nHistorically, the Company's operating results have been heavily influenced by two external factors: the cost to the Company of feed grains and the price received by the Company for its commodity-based finished products. These two factors have fluctuated significantly and independently. Inflation has not materially affected results of operations.\nIn recent years the Company has undertaken a business strategy focused largely on the following: increased production and sale of further-processed poultry and other processed food products, and increased sales to larger customers such as club store and fast food chains. This strategy decreased the proportion of feed grain costs in relation to total cost of sales, which reduced the impact of commodity cost fluctuations. In addition, the sales prices of further-processed products are less sensitive to commodity poultry price fluctuations. Another result of this strategy has been increased sales to large customers under firm-price or cost-plus contracts utilizing dedicated plant arrangements. Although an increase in feed grain costs or a decrease in finished product prices could have an adverse effect on the Company, management believes that the implementation of this strategy has reduced the Company's vulnerability to such price fluctuations.\nWhile the Company believes the above factors will result in more predictable and stable profit margins, increased sales to large customers and sales of further-processed products have tended to increase costs relating to commissions, advertising, distribution, demonstration and storage expenses. For example, introductions of new products in fiscal 1992 and 1993 into Sam's Club stores, a division of Wal-Mart (\"Sam's Club\"), required the Company to sponsor and pay for in-store product demonstrations, thereby increasing selling expenses in those years. Although there can be no assurances, the Company expects that future selling expenses as a percentage of sales will approximate current levels.\nFiscal 1994 Compared with Fiscal 1993\nSales from the Company's operations were $1,040.8 million for fiscal 1994, an increase of $120.3 million, or 13.1%, over fiscal 1993. The sales increase primarily resulted from the following:\n. Chicken sales increased 17.3% to $533.4 million in fiscal 1994 from $454.9 million in fiscal 1993 due to higher finished product prices, a change in the product mix to include additional further-processed and convenience products and a 13.7% increase in volume. The volume increase was primarily due to increased sales in international markets.\n. Portioned entree sales increased 22.3% to $175.5 million in fiscal 1994 from $143.5 million in fiscal 1993 primarily due to higher finished product prices and a 15.8% increase in volume which was primarily due to new sales to the Burger King system and sales of meal kit products.\n. Luncheon meat sales increased 3.0% to $164.7 million in fiscal 1994 from $159.9 million in fiscal 1993 due to higher finished product prices.\n. Turkey sales increased 12.5% to $113.2 million in fiscal 1994 from $100.6 million in fiscal 1993 due to higher finished product prices and sales of additional further-processed products.\nCost of sales was $885.2 million for fiscal 1994, an increase of $83.2 million, or 10.4%, over fiscal 1993. As a percentage of sales, cost of sales decreased to 85.1% in fiscal 1994 from 87.1% in fiscal 1993 primarily due to a higher percentage of sales of further-processed products and improved operating efficiencies. This improvement was partially offset by a 6.9% increase in feed costs per ton.\nGross profit was $155.6 million for fiscal 1994, an increase of $37.0 million, or 31.3%, over fiscal 1993. As a percentage of sales, gross profit increased to 14.9% in fiscal 1994 from 12.9% in fiscal 1993 largely due to the improvements described above.\nSelling and general and administrative expenses were $104.5 million in fiscal 1994, an increase of $19.8 million, or 23.4%, over fiscal 1993. As a percentage of sales, selling and general and administrative expenses increased to 10.0% in fiscal 1994 from 9.2% in fiscal 1993. This increase was due to higher advertising, distribution, demonstration, and product handling expenses primarily related to increased international sales, meal kit products and Sam's Club sales. In addition, there was an increase in incentive compensation accruals.\nOperating income was $51.1 million in fiscal 1994, an increase of $17.2 million, or 50.8%, over fiscal 1993. This increase was primarily due to the improvements in the Company's operations as described previously.\nInterest expense was $6.2 million in fiscal 1994, a decrease of $1.8 million, or 22.9%, from fiscal 1993. This decrease was due primarily to the redemption of 14% Convertible Subordinated Debentures in the second quarter of fiscal 1993.\nFiscal 1993 Compared with Fiscal 1992\nSales from the Company's operations were $920.5 million for fiscal 1993, an increase of $111.3 million, or 13.8%, over fiscal 1992. The sales increase primarily resulted from the following:\n. Chicken sales increased 10.2% to $454.9 million in fiscal 1993 from $412.9 million in fiscal 1992 due to higher finished product prices, changes in product mix to include additional further-processed and convenience products and a 1.3% increase in volume which was primarily due to new sales to the Burger King system, increased sales to Sam's Club and the\nCompany's entrance into new international markets such as Russia and Eastern Europe, Mexico and Central America, Southeast Asia and the Middle East.\n. Portioned entree sales increased 34.4% to $143.5 million in fiscal 1993 from $106.8 million in fiscal 1992 due to higher finished product prices and a 27.8% increase in volume. Volume increased due to increased sales to Sam's Club and sales of new products such as meal kits and sandwiches.\n. Luncheon meat sales increased 5.3% to $159.9 million in fiscal 1993 from $151.9 million in fiscal 1992 due to increased volume of 5.5% which was partially offset by a slight decline in finished product prices.\n. Turkey sales increased 28.6% to $100.6 million in fiscal 1993 from $78.2 million in fiscal 1992 primarily due to a 32.2% increase in volume resulting from late Thanksgiving and Christmas orders placed after fiscal 1992 year-end and also increased sales of further- processed products such as deli turkey breasts. This increase was partially offset by a slight decline in finished product prices.\nCost of sales was $802.0 million for fiscal 1993, an increase of $69.0 million, or 9.4%, over fiscal 1992. As a percentage of sales, cost of sales decreased to 87.1% in fiscal 1993 from 90.6% in fiscal 1992 primarily due to a higher percentage of further-processed product sales, a 4.2% decrease in feed costs per ton and improved operating efficiencies.\nGross profit increased to $118.5 million for fiscal 1993, an increase of $42.3 million, or 55.5%, over fiscal 1992. As a percentage of sales, gross profit increased to 12.9% in fiscal 1993 from 9.4% in fiscal 1992 largely due to the improvements described above.\nSelling and general and administrative expenses were $84.6 million in fiscal 1993, an increase of $16.2 million, or 23.6%, over fiscal 1992. As a percentage of sales, selling and general and administrative expenses increased to 9.2% in fiscal 1993 from 8.4% in fiscal 1992. This increase was due to higher commissions, advertising, distribution, demonstration, rebates, storage and product handling expenses relating to Sam's Club sales, meal kit and portioned entree products and increased international sales.\nOperating income was $33.9 million in fiscal 1993, an increase of $26.1 million, or 336.3%, over fiscal 1992. This increase was primarily due to the improvements in the Company's operations discussed above.\nLiquidity and Capital Resources\nWorking capital at October 1, 1994 was $100.1 million compared with $103.8 million at October 2, 1993 and the current ratio was 1.87 to 1 and 2.28 to 1 at October 1, 1994 and October 2, 1993, respectively. The Company's total capitalization, as represented by long-term obligations plus stockholders' equity, was $284.4 million on October 1, 1994, compared with $262.9 million on October 2, 1993. Long-term obligations represented 26.4% and 33.8% of total capitalization on October 1, 1994 and October 2, 1993, respectively.\nNotes payable due under the Company's unsecured credit agreements were $16.8 million on October 1, 1994 compared with no outstanding balance on October 2, 1993. Notes payable increased due to the higher levels of capital spending during fiscal 1994. Total long-term obligations decreased $13.8 million as a result\nof $8.1 million of 8% Convertible Subordinated Debentures being converted into Class A common stock and scheduled long-term debt repayments of $5.7 million.\nClass A common stock and additional capital increased $9.9 million to $97.6 million at October 1, 1994 from $87.7 million at October 2, 1993. The increase was due primarily to $8.1 million of 8% Convertible Subordinated Debentures converted into common stock, stock options exercised under the Company's Stock Option Plan and stock issued under the Company's Employee Stock Purchase Plan (from treasury stock).\nThe Company's cash flow provided by operating activities was $36.3 million for fiscal 1994 compared with $29.0 million for fiscal 1993. The increase was due primarily to higher net income.\nFor fiscal 1994 and 1993, the Company had capital expenditures of $49.2 million and $21.5 million, respectively. Those expenditures were primarily for upgrading and expanding production facilities and related equipment. The capital expenditures have been financed by operations, borrowings under the Company's credit agreement and\/or lease arrangements.\nThe Company recently announced plans to build a new chicken complex near Henderson, Kentucky the capacity of which will be dedicated to Boston Chicken. Additionally, during the third quarter of fiscal 1994, the Company began construction of a beef processing plant in Columbus, Nebraska that will supply hamburger patties to the Burger King system. It is expected that during fiscal 1995 capital expenditures for these and other projects will be approximately $94.0 million. To achieve this level of capital expenditures, the Company will be required to obtain waivers from certain lenders. Management believes that such waivers will be obtained. However, there can be no assurance that such waivers will be granted. The capital expenditures will be financed by operations, borrowings under the Company's credit agreements, lease arrangements and proceeds of a proposed offering of Class A common stock announced by the Company following the end of fiscal 1994.\nHistorically, the Company's operations have been financed through internally generated funds, borrowings, lease arrangements and the issuance of common stock. On April 26, 1994, the Company entered into a $100 million unsecured revolving credit agreement that expires June 30, 1997. At October 1, 1994, the Company had available under this agreement $85.0 million. The credit agreement, among other things, limits the payment of dividends to approximately $2.8 million in any fiscal year and limits annual capital expenditures and lease obligations. It requires the maintenance of minimum levels of working capital and tangible net worth and that the current ratio, leverage ratio and cash flow coverage ratio be maintained at certain levels. It also limits the creation of new secured debt to $25.0 million and new unsecured short-term debt with parties outside the credit agreement to $20.0 million. Additionally, an event of default will exist if the aggregate outstanding voting power of James T. Hudson and his immediate family in the Company is reduced below 51%.\nOn May 18, 1994, the Company entered into an unsecured term loan agreement with a financial institution giving the Company the right to borrow up to $50.0 million of senior notes fixed at a rate to be determined at drawdown. The Company had not borrowed under the agreement at October 1, 1994. The agreement expires February 24, 1996.\nOn July 8, 1994, the Company entered into an unsecured short-term line of credit agreement with a financial institution giving the Company the right to borrow up to $10.0 million. The agreement expires June 1, 1995. At October 1, 1994, the Company had $10.0 million, payable on demand, outstanding under this agreement. Additionally, on August 10, 1994, the Company entered into an unsecured short-term line of credit agreement with a financial institution giving the Company the right to borrow up to $10.0 million. Borrowings under this agreement, if any, are due and payable within 30 days. The Company had not borrowed under this agreement at October 1, 1994.\nTax Matters\nThe Internal Revenue Service has examined the Company's 1989 and 1990 federal income tax returns and has issued a notice of deficiency asserting additional taxes of $22.4 million and penalties of $5.8 million. If an assessment is ultimately upheld, it will result in the acceleration of previously recorded deferred income taxes. However, since most of the items in dispute relate to the timing of the recognition of income or deductions, a portion of the income taxes for years subsequent to 1990 would be refundable. Management is contesting the notice of deficiency and the case has been docketed for a hearing in early 1995 in federal tax court. Management believes that ultimate resolution of these matters will not have a material impact on the Company's financial position or results of operations.\nAccounting Policies\nBeginning in fiscal 1994, the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes,\" which requires that deferred tax liabilities and assets be recognized for any difference between the tax basis of assets and liabilities and their financial reporting amounts measured by using presently enacted tax laws and rates. The Company elected to apply the provisions of SFAS 109 retroactively to September 28, 1986.\nThe Company uses the farm price method of inventory valuation for income tax reporting which results in current deferred income taxes for financial reporting. The Company anticipates that it will be able to maintain its inventory at current levels and, accordingly, does not expect a significant portion of the current deferred income tax to be paid in the near future.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. -------------------------------------------\nTo the Board of Directors and Stockholders Hudson Foods, Inc.\nWe have audited the consolidated financial statements and the financial statement schedules of Hudson Foods, Inc. and subsidiaries as listed in the index on page 28 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 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 Hudson Foods, Inc. and subsidiaries as of October 2, 1993, and October 1, 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended October 1, 1994, 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 L.L.P.\nTulsa, Oklahoma October 26, 1994\nHUDSON FOODS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET\nThe accompanying notes are an integral part of the consolidated financial statements.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS\nThe accompanying notes are an integral part of the consolidated financial statements.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS\nThe accompanying notes are an integral part of the consolidated financial statements.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nFollowing is a summary of significant accounting policies employed by Hudson Foods, Inc. and subsidiaries (\"the Company\") in the preparation of the consolidated financial statements.\nPRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries.\nCASH AND CASH EQUIVALENTS. The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. At October 2, 1993 and October 1, 1994, cash and cash equivalents included temporary cash investments in certificates of deposit, U.S. treasury bills, repurchase agreements and U.S. government agency securities of $12,960,000 and $12,500,000, respectively. Cash equivalents are stated at cost, which approximates market value, and have been used to offset book overdrafts.\nCONCENTRATIONS OF CREDIT RISK. Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables from large domestic companies. The Company generally does not require collateral from its customers. Such credit risk is considered by management to be limited due to the Company's broad customer base. In fiscal years 1992, 1993 and 1994, one customer accounted for approximately 15.7%, 17.9% and 17.7% of consolidated sales, respectively.\nINVENTORIES. Inventories are stated at the lower of cost (first-in, first-out method) or market. Inventory cost includes the cost of raw materials and all applicable costs of processing.\nPROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment are stated at cost. When assets are sold or retired, the costs of the assets and the related accumulated depreciation are removed from the accounts and the resulting gains or losses are recognized. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Interest costs of approximately $2,874,000, $1,467,000 and $1,702,000 were capitalized during 1992, 1993 and 1994, respectively.\nEARNINGS PER SHARE. Earnings per share are based on the weighted average number of shares outstanding. The primary earnings per share computation assumes that outstanding dilutive stock options were exercised and the proceeds used to purchase common shares. Earnings per share, assuming full dilution, gives effect to the conversion of outstanding convertible debentures and the exercise of dilutive stock options. In addition, 1992 earnings per share include the effect of the contingently issuable shares associated with the acquisition of Pierre Frozen Foods, Inc.\nEXCESS COST OF INVESTMENT OVER NET ASSETS ACQUIRED. The excess cost of investment over net assets acquired is being amortized using the straight-line method over periods ranging from 33 to 40 years. Accumulated amortization was $3,729,000 and $4,244,000 at October 2, 1993 and October 1, 1994, respectively.\nINCOME TAXES. The Company utilizes the asset and liability approach for financial accounting and reporting for income taxes as set forth in Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"): Accounting for Income Taxes. SFAS 109 utilizes the liability method and deferred income taxes are recorded to reflect the expected tax consequences in future years of differences between the tax basis of assets and liabilities and their financial reporting amounts at each year-end.\nFISCAL YEAR. The Company utilizes a 52-53 week accounting period which ends on the Saturday closest to September 30.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n2. INVENTORIES\n3. PROPERTY, PLANT AND EQUIPMENT\n4. FINANCING ARRANGEMENTS\nThe Company's line of credit agreement (the \"Agreement\"), which expires June 30, 1997, provides for aggregate borrowings or letters of credit up to $100 million. At October 2, 1993, the Company had issued $7.2 million in letters of credit, and at October 1, 1994, had $6.8 million of short-term debt outstanding and had issued $8.2 million in letters of credit. The Agreement, among other things, limits the payment of dividends to approximately $2.8 million in any fiscal year and limits annual capital expenditures and lease obligations. It requires the maintenance of minimum levels of working capital and tangible net worth and that the current ratio, leverage ratio and cash flow coverage ratio be maintained at certain levels. It also limits the creation of new secured debt to $25.0 million and new unsecured short-term debt with parties outside the credit agreement to $20.0 million. At October 2, 1993 and October 1, 1994, $92.8 million and $85.0 million, respectively, was unused under the Agreement.\nOn May 18, 1994, the Company entered into an unsecured term loan agreement with a financial institution giving the Company the right to borrow up to $50.0 million of senior notes with a fixed interest rate determined at the date of initial borrowing. The Company had not borrowed under the agreement at October 1, 1994. The agreement expires February 24, 1996.\nOn July 8, 1994, the Company entered into an unsecured short-term line of credit agreement with a financial institution giving the Company the right to borrow up to $10.0 million. The agreement expires June 1, 1995. At October 1, 1994, the Company had $10.0 million, payable on demand, outstanding under this agreement. Additionally, on August 10, 1994, the Company entered into an unsecured short-term line of credit agreement with a financial institution giving the Company the right to borrow up to $10.0 million. Borrowings under this agreement, if any, are due and payable within 30 days. The Company had not borrowed under this agreement at October 1, 1994.\n5. ACCRUED LIABILITIES\nHUDSON FOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n6. LONG-TERM OBLIGATIONS\nOn September 6, 1994, the Company called the 8% convertible subordinated debentures. Bondholders had the option of redeeming their debentures at 101.6% of the stated principle amount plus accrued interest, or converting their debentures into Class A common stock at $21 per share. As of October 1, 1994, the Company had converted $8.1 million of the debentures into 388,388 shares of common stock. Subsequent to October 1, 1994, the Company converted an additional $5.5 million of the debentures into 264,789 shares of common stock and redeemed the remaining $3.8 million, recognizing a $132,000 loss on the extinguishment.\nCertain of the Company's loan agreements require the maintenance of minimum working capital, and that net tangible asset, debt-to-equity and working capital ratios be maintained at specified levels. Also, such loan agreements contain limitations on capital expenditures, additional indebtedness and payment of dividends.\nThe fair value of the Company's long-term obligations is based on discounted future cash flows using current interest rates. The fair value of the Company's long-term obligations at October 1, 1994, including current portion, is estimated to be approximately $80.4 million.\nAt October 1, 1994, the aggregate amount of long-term obligations which will become due during each of the next five fiscal years is as follows: $5,109,000 in 1995; $5,216,000 in 1996; $20,301,000 in 1997; $22,259,000 in 1998; and $9,898,000 in 1999.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n7. INCOME TAXES\nBeginning in fiscal year 1994, the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes,\" which requires that deferred income tax liabilities and assets be recognized for differences between the tax basis of assets and liabilities and their financial reporting amounts, measured by using presently enacted tax laws and rates. The Company elected to apply the provisions of SFAS 109 retroactively to September 28, 1986. As a result, a deferred tax liability and a corresponding increase in property, plant and equipment of $13,535,000 was recognized for the difference between the assigned values and the tax basis of assets and liabilities previously acquired in 1986 (Corbett Enterprises, Inc.), 1987 (Thies Companies, Inc.) and 1990 (Pierre Frozen Foods, Inc.). The adoption of SFAS 109 did not effect net income or earnings per share since increases in depreciation expense, due to adjustments for prior business combinations, were offset by the amortization of the deferred income taxes.\nConsolidated income tax expense for each of the three years in the period ended October 1, 1994 consists of the following:\nReconciliations of the statutory federal income tax rate with the effective income tax rate for each of the three years in the period ended October 1, 1994 are as follows:\nHUDSON FOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS An analysis of the Company's net current and long-term deferred tax liabilities (assets) at October 2, 1993 and October 1, 1994 is as follows:\nThe Internal Revenue Service has examined the Company's 1989 and 1990 Federal income tax returns and has issued a notice of deficiency assessing additional taxes of $22.4 million and penalties of $5.8 million. If an assessment is ultimately upheld, it will result in the acceleration of previously recorded deferred income taxes. However, since most of the items in dispute relate to the timing of the recognition of income or deductions, a portion of the income taxes for years subsequent to 1990 would be refundable. Management is contesting the notice of deficiency and the case has been docketed for a hearing in early 1995 in federal tax court. Management believes that ultimate resolution of these matters will not have a material impact on the Company's financial position or results of operations.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. EMPLOYEE BENEFIT AND COMPENSATION PLANS\nSTOCK OPTION PLAN. The 1985 Stock Option Plan (the \"Option Plan\"), as amended, reserves 1,200,000 and 300,000 shares of the Company's Class A common stock for issuance as incentive stock options and nonqualified stock options, respectively. The Option Plan provides for the grant of options to key employees upon terms and conditions determined by a committee of the Board of Directors.\nOptions expire no later than the tenth anniversary of the date of grant, and are exercisable at a price which is at least 100% of the fair market value of such shares on the date of grant (110% in the case of individuals holding at least 10% of the Company's Class A common stock).\nA summary of stock option activity related to the Option Plan for each of the three years in the period ended October 1, 1994 is as follows:\nEMPLOYEE STOCK PURCHASE PLAN. The Company has reserved 1,000,000 shares of common stock for purchase under the 1990 Employee Stock Purchase Plan (the \"Purchase Plan\"), the purpose of which is to make available to eligible employees a means of purchasing shares of the Company's common stock at current market prices. Under the terms of the Purchase Plan, the Company contributes an amount annually, in cash or Class A stock, equal to 15% of the undistributed total of participants' contributions for the past ten years. All full-time employees of the Company (except those owning 10% or more of the Company's Class A stock) are eligible to participate in the Purchase Plan.\nRETIREMENT PLAN. In November 1985, the Company adopted a 401(k) Plan which, as amended, provides for Company matching of 50% of employee contributions not exceeding 4% of the participants' salary. The Company's contribution was $723,000 in 1992; $919,000 in 1993; and $1,168,000 in 1994.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n9. COMMITMENTS AND CONTINGENCIES\nThe Company leases distribution facilities, transportation and delivery equipment, poultry farms, and other equipment under operating leases expiring during the next five to ten years. Management expects that in the normal course of business the leases will be renewed or replaced by other leases.\nIn November and December 1992, under sale-leaseback agreements, the Company sold certain equipment with a net book value of $4.5 million for $19.2 million cash. Annual payments under the operating lease agreements are $3.5 million. The gain of $14.7 million is being amortized over the terms of the leases. At October 2, 1993 and October 1, 1994, the unamortized portion of the deferred gain is included in the balance sheet captions \"accrued liabilities\" ($2,777,000 for both years) and \"deferred income taxes and deferred gain\" ($9,731,000 and $6,954,000, respectively).\nTotal rental expense (net of amortized gain) was $21,158,000 in 1992; $20,603,000 in 1993; and $23,042,000 in 1994.\nAt October 1, 1994, future minimum rental payments required under leases that have initial or remaining noncancellable terms in excess of one year are as follows: $18,727,000 in 1995; $16,762,000 in 1996; $13,619,000 in 1997; $8,303,000 in 1998; and $4,347,000 in 1999.\nThe Company maintains a self-insurance program for employee health care and workman's compensation costs. Self-insurance costs are accrued based upon the aggregate of the liability for reported claims and an estimated liability for claims incurred but not yet reported.\nOn March 16, 1993, the United States of America, by the Attorney General of the United States acting at the request of the Environmental Protection Agency, filed a civil complaint against the Company alleging violations of the Federal Water Pollution Control Act (the \"Act\"). The complaint seeks, among other things, an injunction preventing the Company from discharging wastewater in violation of the Act from one of its processing facilities, and a civil penalty of up to $25,000 per day for each violation of the Act. A trial has been scheduled to commence in July 1995. In the event this matter results in an unfavorable outcome, it is not possible to estimate the amount of civil penalties or other expenditures, if any, that the court may award. The Company continues to vigorously contest this matter. Management believes that the outcome will not have a material adverse effect on the Company's consolidated financial position or results of operations.\nThe Company is involved in litigation incidental to its business. Such litigation is not considered by management to be significant.\n10. RELATED PARTY TRANSACTIONS\nLease payments for transportation equipment made to the Company's chairman amounted to $907,000 in 1992; $936,000 in 1993; and $956,000 in 1994.\nCertain officers and employees of the Company own turkey and broiler farms and enter into grower contracts with the Company which provide for the payment of grower fees. The Company's arrangements with these officers and employees are similar to contracts with unrelated growers and, as such, do not include an ongoing commitment by the Company. Grower fees paid to these officers and employees amounted to $891,000 in 1992; $651,000 in 1993; and $689,000 in 1994.\nAt October 2, 1993 and October 1, 1994, other current assets include $215,000 and $217,000, respectively, and other assets include $3,356,000 and $3,933,000, respectively, of accounts and notes receivable from an officer and director and entities controlled by this person.\n11. SUBSEQUENT EVENT\nOn October 12, 1994, the Company announced plans for a public offering of up to 2,500,000 shares of Class A common stock. The Company's proceeds from the offering are intended to be used for capital expenditures, including the construction of an integrated chicken processing complex near Henderson, Kentucky. Also, the Company announced that certain of its major stockholders will offer up to an additional 2,100,000 shares of Class A common stock. The Company will not receive any proceeds from the sale of the shares by such major stockholders.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n12.STOCKHOLDERS' EQUITY\nOn February 6, 1987, the Company's Restated Certificate of Incorporation was amended to create two classes of common stock. The amendment authorized the issuance of up to 40,000,000 shares of Class A common stock, par value $.01 per share, and 40,000,000 shares of Class B common stock, par value $.01 per share. Upon adoption of the amendment, each outstanding share of common stock converted automatically into a share of Class A common stock. During fiscal 1987, the Company concluded a one-time-only exchange offer in which holders of Class A common stock were given the opportunity to exchange their shares for an equivalent number of shares of Class B common stock. The Class B common stock has ten votes per share in most matters submitted to a vote of the Company's stockholders, while the Class A common stock has one vote per share. As a result of the exchange offer, voting control of the Company rests with the holders of Class B common stock. In addition, the dividend per share of Class B common stock may not exceed 90 percent of the dividend per share of Class A common stock. The number of outstanding Class A shares at October 2, 1993 and October 1, 1994 were 7,672,049 and 8,300,039, respectively.\nHUDSON FOODS, INC. AND SUBSIDIARIES\nSUPPLEMENTAL QUARTERLY FINANCIAL DATA (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\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. --------------------------------------------------\nIncorporated by reference from the sections captioned \"Election of Directors,\" \"Executive Officers\" and \"Section 16 Requirements\" contained in the Company's Proxy Statement for Annual Meeting of Stockholders, February 10, 1995 and Adjournments (the \"Proxy Statement\").\nItem 11.","section_11":"Item 11. Executive Compensation. ----------------------\nIncorporated by reference from the section captioned \"Executive Compensation\" contained in the Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management. --------------------------------------------------------------\nIncorporated by reference from the section captioned \"Principal Stockholders\" contained in the Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. ----------------------------------------------\nIncorporated by reference from the sections captioned \"Executive Compensation--Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions\" contained in the 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 a part of this report.\n1. Financial statements. --------------------\n2. Financial statement schedules. -----------------------------\n3. Exhibits required by Item 601 of Regulation S-K. -----------------------------------------------\n(b) Reports on Form 8-K.\nThe Company filed no Current Reports on Form 8-K during fiscal 1994.\n- -----------------------\n\/1\/ Incorporated by reference from Hudson Foods, Inc. Form S-4 Registration Statement No. 33-15274, as amended, filed with the Securities and Exchange Commission on June 23, 1987.\n\/2\/ Incorporated by reference from Hudson Foods, Inc., Form S-3 Registration Statement No. 33-56019, as amended, filed with the Securities and Exchange Commission on October 13, 1994.\n\/3\/ Incorporated by reference from Hudson Foods, Inc. Form S-1 Registration Statement No. 33-8889, as amended, filed with the Securities and Exchange Commission on September 19, 1986.\n\/4\/ Incorporated by reference from Hudson Foods, Inc. Form S-8 Registration Statement No. 33-27738, as amended, filed with the Securities and Exchange Commission on March 23, 1989.\n\/5\/ Incorporated by reference from Hudson Foods, Inc. Form S-1 Registration Statement No. 33-2505, as amended, filed with the Securities and Exchange Commission on December 31, 1985.\n\/6\/ Incorporated by reference from Hudson Foods, Inc. Quarterly Report on Form 10-Q for the quarterly period ended July 2, 1994, filed with the Securities and Exchange Commission on August 1, 1994.\n\/7\/ Incorporated by reference from Hudson Foods, Inc., Form 8-K Current Report dated October 13, 1994, filed with the Securities Exchange Commission on October 13, 1994.\n\/8\/ Incorporated by reference from Hudson Foods, Inc., Form 10-K for the fiscal year ended October 2, 1993, filed with the Securities and Exchange Commission on December 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.\nHUDSON FOODS, INC.\nNovember 9, 1994 By \/s\/ James T. Hudson --------------------- James T. Hudson 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.\nNovember 9, 1994 By \/s\/ James T. Hudson -------------------- James T. Hudson Chairman of the Board, Chief Executive Officer and Director\nNovember 9, 1994 By \/s\/ Michael T. Hudson ----------------------- Michael T. Hudson President, Chief Operating Officer and Director\nNovember 9, 1994 By \/s\/ Charles B. Jurgensmeyer ----------------------------- Charles B. Jurgensmeyer Principal Financial and Accounting Officer and Director\nNovember 9, 1994 By ----------------------------- Elmer W. Shannon Director\nNovember 9, 1994 By \/s\/ Jerry L. Hitt ----------------------------- Jerry L. Hitt Director\nNovember 9, 1994 By ----------------------------- Kenneth N. May Director\nNovember 9, 1994 By \/s\/ James R. Hudson ----------------------------- James R. Hudson Director\nNovember 9, 1994 By ----------------------------- Jane M. Helmich Director\nHUDSON FOODS, INC. AND SUBSIDIARIES SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES (Other than related parties) For the Three Years in the Period Ended October 1, 1994 (Dollars in Thousands)\n- ------------------------------\n\/(1)\/ Interest charged on the outstanding balance at a rate based on the Company's short-term borrowing rate plus 0.5%.\n\/(2)\/ The Company has a collateral assignment agreement providing for the payment of the receivable with the proceeds of certain insurance policies.\nHUDSON FOODS, INC. AND SUBSIDIARIES SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT For the Three Years in the Period Ended October 1, 1994 (Dollars in Thousands)\n- -------------------------------------\n\/(1)\/ Represents additions to construction in progress less inter-account transfers.\n\/(2)\/ Includes additions to and retirements from property, plant and equipment for idle assets, assets destroyed by fire and\/or miscellaneous.\n\/(3)\/ Amounts have been restated for the adoption of Statement of Financial Accounting Standards No. 109. See Note 7 of the Notes to Consolidated Financial Statements at page 21.\n\/(4)\/ Includes land and buildings acquired in the Company's purchase of a manufacturing plant in Caryville, Tennessee.\nDepreciation is computed using the straight-line method over the following useful lives: Building and improvements 20 - 30 years Machinery and equipment 7 - 10 years\nHUDSON FOODS, INC. AND SUBSIDIARIES SCHEDULE VI - ACCUMULATED DEPRECIATION For the Three Years in the Period Ended October 1, 1994 (Dollars in Thousands)\n- -----------------------------\n\/(1)\/ Includes additions to and retirements from accumulated depreciation for idle assets, assets destroyed in fire and\/or miscellaneous.\n\/(2)\/ Amounts have been restated for the adoption of Statement of Financial Accounting Standards No. 109. See Note 7 of the Notes to Consolidated Financial Statements at page 21.\nHUDSON FOODS, INC. AND SUBSIDIARIES SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS For the Three Years in the Period Ended October 1, 1994 (Dollars in Thousands)\n- ------------------------------\n\/(1)\/ Collections of previously charged off amounts.\nHUDSON FOODS, INC. AND SUBSIDIARIES SCHEDULE IX - SHORT-TERM BORROWINGS For the Three Years in the Period Ended October 1, 1994 (Dollars in Thousands)\n- ------------------------------\n\/(1)\/ Computed by determining the average amount outstanding on a monthly basis for all applicable notes.\n\/(2)\/ Computed by dividing short-term interest expense by the average short-term debt outstanding.\nHUDSON FOODS, INC. AND SUBSIDIARIES SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION For the Three Years in the Period Ended October 1, 1994 (Dollars in Thousands)\nINDEX OF EXHIBITS\n- -----------------\n\/1\/ Incorporated by reference from Hudson Foods, Inc. Form S-4 Registration Statement No. 33-15274, as amended, filed with the Securities and Exchange Commission on June 23, 1987.\n\/2\/ Incorporated by reference from Hudson Foods, Inc., Form S-3 Registration Statement No. 33-56019, as amended, filed with the Securities and Exchange Commission on October 13, 1994.\n\/3\/ Incorporated by reference from Hudson Foods, Inc. Form S-1 Registration Statement No. 33-8889, as amended, filed with the Securities and Exchange Commission on September 19, 1986.\n\/4\/ Incorporated by reference from Hudson Foods, Inc. Form S-8 Registration Statement No. 33-27738, as amended, filed with the Securities and Exchange Commission on March 23, 1989.\n\/5\/ Incorporated by reference from Hudson Foods, Inc. Form S-1 Registration Statement No. 33-2505, as amended, filed with the Securities and Exchange Commission on December 31, 1985.\n\/6\/ Incorporated by reference from Hudson Foods, Inc. Quarterly Report on Form 10-Q for the quarterly period ended July 2, 1994, filed with the Securities and Exchange Commission on August 1, 1994.\n\/7\/ Incorporated by reference from Hudson Foods, Inc., Form 8-K Current Report dated October 13, 1994, filed with the Securities Exchange Commission on October 13, 1994.\n\/8\/ Incorporated by reference from Hudson Foods, Inc., Form 10-K for the fiscal year ended October 2, 1993, filed with the Securities Exchange Commission on December 30, 1993.","section_15":""}
{"filename":"701345_1994.txt","cik":"701345","year":"1994","section_1":"Item 1. Business\nUSAir Group, Inc. (\"USAir Group\" or the \"Company\") is a corporation organized under the laws of the State of Delaware. The Company's executive offices are located at 2345 Crystal Drive, Arlington, Virginia 22227 (telephone number (703) 418-5306). USAir Group's primary business activity is ownership of all the common stock of USAir, Inc. (\"USAir\"), Allegheny Airlines, Inc. (which was formerly Pennsylvania Commuter Airlines, Inc.) (\"Allegheny\"), Piedmont Airlines, Inc. (\"Piedmont\") (formerly Henson Aviation, Inc.), Jetstream International Airlines, Inc. (\"Jetstream\"), USAir Fuel Corporation (\"USAir Fuel\"), USAir Leasing and Services, Inc. (\"USAir Leasing and Services\") and Material Services Company, Inc. In May 1987, the Company acquired Pacific Southwest Airlines, which merged into USAir on April 9, 1988. In November 1987, the Company completed its acquisition of Piedmont Aviation, Inc., which merged into USAir on August 5, 1989. On July 15, 1992, the Company sold three wholly-owned subsidiaries, Piedmont Aviation Services, Inc., Air Service, Inc. and Aviation Supply Corporation. The former subsidiaries were engaged in fixed base operations and the sale and repair of aircraft and aircraft components. During the third quarter of 1992, the Company merged one wholly-owned subsidiary, Allegheny Commuter Airlines, Inc., into another, Pennsylvania Commuter Airlines, Inc. (now Allegheny Airlines, Inc.).\nUSAir, a certificated air carrier engaged primarily in the business of transporting passengers, property and mail, is the Company's principal operating subsidiary, accounting for approxi- mately 93% of USAir Group's operating revenues in 1994. USAir is one of nine passenger carriers classified as \"major\" airlines (those with annual revenues greater than $1 billion) by the U.S. Department of Transportation (\"DOT\"). USAir enplaned more than 59.8 million passengers in 1994, and is the sixth largest United States air carrier ranked by revenue passenger miles (\"RPMs\") flown.\nAt January 4, 1995, USAir provided regularly scheduled jet service through 119 airports to more than 152 cities in the continental United States, Canada, the Bahamas, Bermuda, the Cayman Islands, Jamaica, Puerto Rico, Germany, France, Mexico and the Virgin Islands. USAir ceased scheduled service to the United Kingdom in January 1994. See \"British Airways Investment Agree- ment\" below. USAir's executive offices are located at 2345 Crystal Drive, Arlington, Virginia 22227 (telephone number (703) 418-7000), and its primary connecting hubs are located at the Pittsburgh, Charlotte\/Douglas, Philadelphia and Baltimore\/Washington Interna- tional (\"BWI\") Airports. As discussed below in \"Significant Impact of Low Cost, Low Fare Competition,\" a substantial portion of USAir's RPMs is flown within or to and from the eastern United States.\nUSAir Group and USAir have incurred substantial operating and net losses since 1989. As discussed in greater detail below, USAir is actively seeking to reduce its annual operating costs by $1 billion through a combination of labor and other cost reductions.\nUSAir began negotiating with the unions representing certain of its employees in March 1994. As described below in \"Agreement in Principle with Pilots Union,\" USAir signed an agreement in principle on March 29, 1995 with the negotiating committee of the Air Line Pilots Association (\"ALPA\") Master Executive Council for substantial concessions. ALPA represents USAir's pilots and the Master Executive Council is ALPA's governing body. This agreement in principle is subject to many significant conditions, as described below. It is uncertain whether USAir will be successful in reaching agreements with its other unions and whether or when any transactions with any of the unions will be consummated. As discussed below in \"Major Airline Operations,\" in March 1995, USAir announced that it would cut capacity throughout its system by five percent by July 1995 as part of its efforts to forge a profitable airline built on the strengths of its hubs and other major east coast urban centers. In addition, the Company is evaluating and considering the risks associated with various strategic options, including further downsizing.\nThe Company ended the first quarter of 1995 with approximately $400 million in cash and short-term investments, substantially higher than previously expected primarily due to the timing of certain working capital activity. However, market, economic and other factors discussed below could adversely affect the Company's future liquidity position. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nAgreement in Principle with Pilots' Union\nOn March 29, 1995, USAir and the negotiating committee of the ALPA Master Executive Council signed an agreement in principle on wage and other concessions in exchange for financial returns and governance participation for USAir's organized labor groups and other employees. The agreement in principle is subject to many significant conditions, including, without limitation, approval by the USAir pilot Master Executive Council, ratification by the pilots, negotiation and ratification of acceptable agreements between USAir and its three other organized labor groups, either the restructuring of the terms of USAir Group's publicly held $437.50 Series B Cumulative Convertible Preferred Stock, without par value (the \"Series B Preferred Stock\"), or the continued deferral of dividends on this stock, approval of the boards of directors of the Company and USAir and of the shareholders of the Company and the execution of definitive documentation.\nThe board of directors of USAir Group (the \"Board\") held a special meeting on April 5, 1995 to review the agreement in principle with ALPA. It did not take any action with respect to the proposed agreement. The Company plans to hold one or more additional special Board meetings to consider developments in USAir's ongoing negotiations with its unions and to analyze and consider further the agreement in principle or any other agreement reached with ALPA and any other agreements that may be reached with USAir's other labor unions. Various parties who would be affected\nby the agreement in principle have expressed their unwillingness to accept, or reservations about, certain terms of the tentative agreement currently under discussion. Negotiations with respect to this agreement are continuing. In addition, USAir continues to negotiate with representatives of its other unions, but it is uncertain whether any agreements will be reached.\nNo assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. If a transaction with one or more unions is consummated, it would affect materially the disclosure contained herein. The terms of any proposed transaction would be described in a proxy statement to the Company's stockholders.\nSignificant Impact of Low Cost, Low Fare Competition\nMost of USAir's operations are in competitive markets. USAir and its regional affiliates experience competition in varying degrees with other air carriers and with all forms of surface transportation. USAir competes with at least one major airline on most of its routes between major cities. Vigorous price competi- tion exists in the airline industry, and competitors have frequent- ly offered sharply reduced discount fares in many of these markets. Airlines use discount fares and other promotions to stimulate traffic during normally slack travel periods, to generate cash flow and to increase relative market share in selected markets. Discount and promotional fares are often subject to various restrictions such as minimum stay requirements, advance ticketing, limited seating and refund penalties. USAir has often elected to match those discount or promotional fares. To the extent that low fares continue and their depressive effect on revenues is not offset by stimulation of additional traffic or by reduced costs, USAir's and the Company's earnings and liquidity will continue to be materially and adversely affected.\nThe dramatic expansion of low fare competitive service in many of USAir's markets in the eastern U.S. during 1994 and USAir's competitive response of reducing its fares up to 70% in certain affected primary and secondary markets in order to preserve its market share contributed to greater losses in 1994 than in 1993. The growth of the operations of low cost, low fare carriers in USAir's markets in the eastern U.S. continues to represent an intense competitive challenge for USAir, which has higher operating costs than its competitors. USAir believes that it must reduce its operating costs substantially if it is to survive in this low fare competitive environment.\nIn September 1993, Southwest Airlines, Inc. (\"Southwest\"), a low cost, low fare, \"no frills\" air carrier which had not previous- ly provided service to or in the eastern U.S., inaugurated service to Chicago and Cleveland from BWI at fares substantially below those previously offered by USAir and other airlines in the same markets. BWI is one of USAir's hub airports. USAir responded by matching most of Southwest's fares and increasing the frequency of service in related markets. In late spring and early summer 1994,\nSouthwest expanded service between BWI and Chicago and initiated its low fare service between BWI and St. Louis and between BWI and Birmingham, Alabama and Louisville, Kentucky. In response, USAir matched most of Southwest's reduced prices where significant traffic diversion was expected.\nUSAir believes that Southwest and other low cost carriers with a significant cost advantage over USAir likely will expand their operations to additional markets. For example, in December 1993, Southwest completed its acquisition of Morris Air, a regional air carrier with operations concentrated in the western U.S. This acquisition will enable Southwest to divert resources to expand its operations in the eastern U.S. Furthermore, in June 1994, Southwest entered into a long-term agreement for the use of four additional gates at BWI, where it currently operates from two gates. Southwest will likely commence its use of those gates in the third quarter of 1995. In addition, Southwest has reportedly ordered approximately 25 airplanes scheduled for delivery in 1995. Southwest could deploy those aircraft in markets served by USAir. Finally, as discussed below, Southwest recently reached an agreement with its pilots that provides for no wage increases for five years. USAir views Southwest, which has one of the lowest cost structures in the industry, as a serious competitive threat. Any escalation by Southwest of low fare competition in USAir's markets could have a material and adverse effect on USAir's revenues, cash flow and liquidity.\nIn October 1993, Continental Airlines (\"Continental\"), which had reorganized under bankruptcy proceedings earlier in 1993, inaugurated low fare service on certain routes in the eastern U.S. USAir is a competitor in most of the markets served by these routes. Continental's operating costs are substantially lower than those of USAir. Under its new program, Continental linked certain cities independently of its hubs while continuing to provide many of the same services that are available on its hub flights, including advance seat assignment, frequent traveler mileage credits and interline connections. At that time, USAir made a measured response by matching most of the low fares offered by Continental where the carriers were directly competitive.\nDuring 1994, Continental increased its competitive threat by substantially expanding the low fare program in additional markets also served by USAir. In February 1994, to avoid a loss of market share in the eastern U.S., USAir began to substantially lower its fares in primary and secondary markets affected by the expansion of Continental's low cost, low fare service branded \"Continental Lite.\" In late June 1994, Continental again expanded its service in the eastern U.S. after reducing its Denver, Colorado operation. By July 1994, markets from which USAir had historically generated approximately 40% of its passenger revenue had the reduced fares in place, reflecting fare reductions in certain markets of up to 70% from previous levels. In September 1994, Continental escalated competition by further reducing service at its Denver hub and establishing a flight crew base at Greensboro, North Carolina. These measures enabled Continental to expand further its high\nfrequency, low fare service described above in additional short- haul markets served by USAir. By late 1994, USAir competed with Continental in primary and secondary markets from which USAir then generated approximately 46% of its passenger revenue. Continental could continue to redeploy its assets and offer other low fare service in additional markets served by USAir, although, as discussed below, Continental has recently begun to reduce its Continental Lite service. See \"Industry Restructuring.\"\nIn addition, other low cost carriers may enter other USAir markets. For example, America West Airlines (\"America West\") commenced service in April 1994 between Columbus, Ohio, where it operates a hub, and Philadelphia, where USAir has a hub operation. Other carriers, including some of the larger carriers, have also developed or indicated their intent to develop similar low fare short-haul service, such as United Air Lines' (\"United\") low cost, low fare operation in the western United States discussed below. New low cost airlines, including but not limited to ValuJet Airlines (\"ValuJet\"), Carnival Air Lines, Inc. (\"Carnival\"), Kiwi International Air Lines, Inc. (\"Kiwi\"), Air South, Inc. (\"Air South\"), Eastwind Airlines (\"Eastwind\") and Nations Air Express (\"Nations Air\") have initiated or announced plans to initiate service in some of USAir's markets. Nations Air initiated service between Philadelphia and both Boston and Pittsburgh in March 1995 at fares substantially below those previously offered by USAir in those markets. USAir immediately matched the fares offered by Nations Air. Eastwind has indicated its intention to fly initially from Trenton, New Jersey to Boston and thereafter possibly to add service to Washington, D.C., Pittsburgh, Chicago and Florida.\nBy the end of February 1995, fare levels within the primary and secondary Continental Lite market network had increased from their dramatically lower levels in 1994. However, USAir, which suffered a 9.6% decline in yield (passenger revenue per RPM) in 1994 from 1993, does not expect yields to return to their mid-1993 levels. While USAir believes it has benefitted from some of Continental's and other airlines' schedule reductions discussed below in \"Industry Restructuring,\" these carriers continue to represent competitive threats to USAir. USAir does not believe that there has been a change in the public demand for generally lower air fares. Regardless of recent capacity and fare changes in the east coast markets, improved financial performance at USAir will depend largely on whether its efforts to cut costs, as described below, are successful.\nFactors beyond the Company's control, such as a downturn in the economy, a dramatic increase in fuel prices or intensified industry fare wars, could have a material adverse effect on the Company's and USAir's prospects, liquidity and financial condition. Because the Company and USAir are highly leveraged and currently do not have access to bank credit and receivables facilities which had supplied a substantial portion of their liquidity, or to public debt and equity markets because of their financial condition and current financial outlook, they are more vulnerable to these factors than are financially stronger competitors. In addition,\ndespite the fact that a recent independent audit concluded that USAir is being operated safely and in compliance with regulations of the Federal Aviation Administration (the \"FAA\"), due to the two aircraft accidents involving USAir in 1994 and the negative publicity associated with these accidents, USAir may be particu- larly susceptible to adverse passenger reactions should any other aircraft accident or incident involving USAir occur in the future. See \"Major Airline Operations\" for a discussion of the safety audit and the Company's other recent safety initiatives. USAir is currently engaged in discussions to arrange a replacement receiv- ables facility. There can be no assurance that USAir will be successful in reaching a new agreement to sell its receivables. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nIndustry Restructuring\nMajor carriers that compete with USAir have implemented, or are in the process of implementing, measures to reduce their operating costs. For example, United has substantially reduced its personnel costs as part of a recapitalization transaction completed in July 1994. The resulting lower operating costs will give United a competitive advantage over carriers with higher costs. United initiated its low cost, low fare operation in the western U.S. in October 1994. As described below under \"Major Airline Operations,\" USAir reduced its service between San Francisco and Los Angeles in November 1994 and plans to close its crew base in San Francisco in the first half of 1995. United could initiate additional low cost, low fare service in other markets served by USAir. Delta Air Lines, Inc. (\"Delta\") is currently engaged in a restructuring initiative announced in April 1994 that is intended to reduce substantially its operating costs through measures which include the elimination of up to 15,000 positions, or approximately 20% of its work force. Delta is currently in discussions with certain of its employees regarding concessions. American Airlines (\"Ameri- can\") has announced a restructuring of its non-union workforce and that it is seeking $750 million in concessions and productivity gains from its unionized workers. Trans World Airlines, Inc. (\"TWA\") has negotiated productivity improvements with its unionized employees and has proposed a restructuring transaction in which, among other things, certain creditors would swap debt for equity. As discussed below, Continental announced plans in January 1995 to eliminate up to 4,000 jobs. In January 1995, Southwest announced that its pilots had ratified a 10-year labor contract that provides for no wage increases in the first five years, providing for grants of stock options to the pilots instead. USAir expects that the implementation of this labor contract will further enhance Southwest's low cost advantage over USAir and other carriers. The announcements by Delta, American, TWA, Continental and Southwest illustrate the trend among the major U.S. airlines to restructure in order to reduce their operating costs and enable them to compete in a low fare environment. See \"Major Airline Operations\" below for a discussion of USAir's cost reduction initiatives.\nIn its negotiations with its unions, USAir has offered an ownership stake in the Company. There are recent examples of companies in the airline industry which have obtained employee concessions in agreements also resulting in the recapitalization of the companies, including employee ownership stakes and employee participation in corporate governance. Most recently, in July 1994, UAL Corporation, parent of United, consummated a recapital- ization which resulted in majority ownership and board membership for certain employee groups in exchange for concessions. In other cases, airlines have filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code, and some airlines have ceased operation altogether when their operating costs remained excessive in relation to their revenues, and their liquidity became insufficient to sustain their operations.\nIn early 1995, various carriers announced planned cutbacks in service in the eastern U.S. The \"intra-east coast\" area represents 67% of USAir's departures and slightly greater than half of its seat capacity. In March 1995, USAir announced that it will cut capacity throughout its system by five percent by July 1995. See \"Major Airline Operations.\" In January 1995, Continental announced plans to reduce capacity by at least 10% and to eliminate 4,000 jobs nationwide as part of an effort to eliminate unprofitable routes. Continental began cutting many of its Continental Lite flights and stated that it intends to reduce Continental Lite capacity by 40% by late summer 1995. Continental also announced plans to delay or reschedule deliveries of jets from The Boeing Company (\"Boeing\"). American has reduced its operations at Raleigh\/Durham (\"RDU\"). In January 1995, American and Chicago- based Midway Airlines (\"Midway\") announced that American agreed to lease seven airport gates at RDU to Midway. Midway stated that it plans to move its operations headquarters to RDU and to operate at least 60 flights from there by the end of the year. Northwest Airlines, Inc. (\"Northwest\") has significantly reduced its activi- ties in Washington, D.C. and Boston. By May 1995, TWA's daily departures in the intra-east coast area will have decreased by almost 75% from their peak in March 1994. United, which drastical- ly cut the number of its daily departures in the intra-east coast area from January 1993 to May 1994, has announced plans for further reductions of almost 40% by May 1995. The result of these cutbacks is that the older, established carriers will have decreased service in the area by approximately 14% from May 1994 to May 1995. However, several smaller carriers, including but not limited to ValuJet, Carnival, Kiwi, Air South, Eastwind and Nations Air, have increased the number of departures in this region during the same time period or have announced plans to introduce or increase service in this region.\nIn April 1994, Delta and Virgin Atlantic Airways (\"Virgin Atlantic\") announced that they had reached a code share marketing agreement that would enable Delta to feed traffic to Virgin Atlantic for travel between the U.S. and Heathrow Airport in London. This arrangement was approved by the U.K. government in 1994 and by the DOT in February 1995. The Company believes that the Delta\/Virgin Atlantic arrangement will compete with the code\nshare service discussed below in \"British Airways Investment Agreement - Code Sharing\" offered by USAir and British Airways Plc (\"BA\") between certain U.S. cities and London. United and Lufthansa German Airlines (\"Lufthansa\") have implemented a code share arrangement which includes transatlantic service from certain U.S. cities to Europe and beyond. United and Lufthansa implemented the first phase of their service in June 1994. The resulting impact of these code share arrangements on the Company's results of operations and financial condition cannot be predicted at this time, but is not expected to be material.\nIn February 1995, several major carriers, including Delta, American, Northwest, United, TWA and USAir, imposed limits on the commissions they pay travel agents for domestic air fares. Formerly, most major airlines paid a fixed commission of approxi- mately 10% on the price of a ticket for the distribution of all domestic tickets. The new cap limits commission payments to $50 for a round-trip domestic ticket with a base fare above $500 and $25 for a one-way domestic ticket with a base fare above $250. The new limits on commissions are designed to reduce one of airlines' largest expenses. USAir believes that it will experience cost savings through its implementation of a limit on the commissions it pays travel agents for domestic air fares. As a result of the new limits on commissions, some travel agents have announced plans to charge some customers a fee for writing tickets. Other travel agents have filed lawsuits against the airlines that imposed commission caps, including USAir, claiming that the airlines violated antitrust laws. See Item 3. \"Legal Proceedings.\"\nVarious U.S. carriers have begun to implement electronic ticketing or \"paperless travel\" in an attempt to cut their operating costs and to increase travelers' convenience. Elec- tronic ticketing eliminates the need to issue a paper ticket to the passenger. USAir is evaluating electronic ticketing alternatives and hopes to offer this product later in 1995. Electronic ticketing is expected to reduce airline distribution costs, but at this early stage in the evolution of electronic ticketing, the magnitude and extent of distribution cost savings cannot be predicted. Some airlines, including USAir, are also exploring the use of self-ticketing machines in airports, which could also eventually reduce distribution costs.\nGeneral Industry Conditions\nDemand for air transportation historically has tended to mirror general economic conditions. During the most recent economic recession in the United States, the change in industry capacity failed to mirror the reduction in demand for domestic air transportation due primarily to continued delivery of new aircraft and, secondarily, to the operation of certain major U.S. carriers under the protection of Chapter 11 of the Bankruptcy Code for extended periods. While industry capacity has leveled off and the general economy has improved, the Company expects that the airline industry will remain extremely competitive for the foreseeable future, primarily due to the dramatic change which has occurred in\nindustry pricing and which has resulted in generally lower fares. See \"Significant Impact of Low Cost, Low Fare Competition\" above. In 1994, the U.S. airline industry had its best year since the recession began in July 1990, with several airlines posting profits, although the major carriers continue to be burdened with large amounts of debt. However, unlike the results of some of its competitors, the Company's results did not improve in 1994. The Company believes that for the foreseeable future the demand for higher yield \"business fares\" will remain essentially flat and relatively inelastic while the lower yield \"leisure\" market will continue to grow with the general economy. This trend will make it more difficult for the domestic airlines, including USAir, to sustain meaningful yield increases in the future. Therefore, the Company believes it must reduce its cost structure substantially in order to survive.\nHistorically, the Company's airline operations have been subject to seasonal variations in demand. First quarter results have often been adversely affected by winter weather and, with certain exceptions, reduced travel demand. Typically, the industry's performance has been the best in the third quarter, while the Company's results have been the best in the second quarter. The restructuring of USAir's route system in recent years to emphasize its strengths in the northeastern U.S. and to capitalize in the first, second and fourth quarters on passenger traffic to Florida may result in changes in historic seasonality.\nOf the eleven airlines classified as \"major\" carriers by the DOT in January 1991, two have ceased operations and three filed for bankruptcy protection, reorganized and emerged from bankruptcy in 1993 and 1994. Airlines operating under Chapter 11 often engage in discount pricing to generate the cash flow necessary for their survival. In addition, when these airlines emerge from bankruptcy they may have substantially reduced their debt and lease obliga- tions and other operating costs, as was the case when Continental, TWA and America West emerged. These reduced costs may permit the reorganized carriers to enter new markets and offer discount fares, which may be intended to generate cash flow, preserve and enhance market share and rehabilitate the carriers' image in the market- place. Since its reorganization, Continental has entered many of USAir's markets in the eastern U.S. and offered fares that were substantially lower than those that were previously available, although it has recently begun to reduce its Continental Lite service. See \"Significant Impact of Low Cost, Low Fare Competi- tion\" and \"Industry Restructuring\" above. The availability of the assets of bankrupt carriers enabled certain financially stronger participants in the market, including, to a lesser extent, USAir, to purchase routes, aircraft, takeoff and landing slots and other assets. While capacity has been removed in certain domestic markets, these bankruptcies and failures and the substantial debt burden of many carriers illustrate the difficulties that the airline industry continues to face today.\nBritish Airways Announcement Regarding Additional Investment in the Company\nAs described in greater detail in \"British Airways Investment Agreement\" below, on January 21, 1993, the Company and BA entered into an Investment Agreement (as subsequently amended, the \"Investment Agreement\"). Pursuant to the Investment Agreement, BA has to date invested approximately $400 million in certain preferred stock of the Company. The Company has deferred quarterly dividend payments on all outstanding series of preferred stock beginning with payments due September 30, 1994. Further, as of December 31, 1994, the Company was unable to pay dividends on any outstanding shares of its common stock, par value $1.00 per share (\"Common Stock\") or preferred stock due to limitations under Delaware law. See \"Deferral of Dividends\" below and Item 8A. Note 8(a) to the Company's consolidated financial statements. The Company benefitted from the additional equity provided by BA and also from the resulting enhancement of the Company's image in the marketplace and in the investment community. However, on March 7, 1994, BA announced that because of the Company's continued substantial losses it would make no additional investments in the Company until the outcome of the Company's efforts to reduce its costs is known. See \"Significant Impact of Low Cost, Low Fare Competition\" above and Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\" At the same time, BA indicated it would continue to cooperate with USAir on the code sharing arrangements discussed below.\nDeferral of Dividends\nBecause of the Company's poor financial results, on Septem- ber 29, 1994, the Company announced that it was deferring the quarterly dividend payment due September 30, 1994 on the 358,000 shares of the Company's 9 1\/4% Series A Cumulative Convertible Redeemable Preferred Stock (\"Series A Preferred Stock\"). The Series A Preferred Stock is owned by affiliates of Berkshire Hathaway Inc. On March 13, 1995, Berkshire Hathaway Inc. announced that it had recorded a pre-tax charge of $268.5 million to recognize a decline in the value of its investment in the Series A Preferred Stock that had an original cost of $358 million.\nThe Company has also deferred quarterly dividend payments on all its other outstanding series of preferred stock, including the Series F Cumulative Convertible Senior Preferred Stock, without par value (the \"Series F Preferred Stock\"), and Series T Cumulative Convertible Exchangeable Senior Preferred Stock, without par value (the \"Series T Preferred Stock\"), both of which are owned by BA, as well as on the publicly held Series B Preferred Stock. For a description of the effects of the deferral of dividends, see Item 8A. Note 8 to the Company's consolidated financial statements.\nThe Company, organized under the laws of the State of Delaware, is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware\nlaw. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends on all outstanding common and preferred stock issuances. See Item 5A. \"Market for USAir Group's Common Equity and Related Stockholder Matters.\" The Company has not paid a dividend on its Common Stock since the second quarter of 1990. Even if the Company is successful in restructuring its costs, there can be no assurance when or if preferred dividend payments will resume.\nRating Agencies' Downgrade of the Company's and USAir's Securities\nThe Company's and USAir's debt and equity securities are presently rated below investment grade by Standard and Poor's Corporation (\"S&P\") and Moody's Investors Service, Inc. (\"Moody's\"). In February 1994, as a result of USAir's low fare initiative in certain markets and its high cost structure, S&P and Moody's placed the securities of the Company and USAir on watch with negative implications. On March 24, 1994, S&P downgraded the Company's and USAir's securities. On September 29, 1994, following the Company's announcement that it had deferred payment of preferred dividends, Moody's and S&P further downgraded their ratings of the Company's and USAir's securities. S&P continues to keep the securities of the Company and USAir on watch with negative implications. The ratings of the Company's and USAir's debt and equity securities make it more difficult for the Company and USAir to effect additional financing. On January 19, 1995, Moody's announced that it is revising its ratings practice on airline equipment trust and pass through obligations and would consider assigning higher ratings to certain of these securities. At the same time Moody's placed under review all existing airline equipment trust certificates and pass through obligations (includ- ing those of USAir) for possible upgrade. At this time, USAir does not believe that an upgrade by Moody's would have any material positive or negative effect on its ability to effect additional financings. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nMajor Airline Operations\nAs discussed above, USAir is the Company's principal operating subsidiary, accounting for approximately 93% of USAir Group's operating revenues in 1994. USAir Group and USAir have incurred substantial losses since 1989.\nYields at USAir started to erode in the fourth quarter of 1993 and declined versus the comparable quarter of 1992 due to the proliferation of discount and promotional fares which were designed to stimulate passenger traffic. Yields were even weaker in 1994 due primarily to USAir's action to reduce fares to remain competi- tive with low cost, low fare carriers in many of USAir's markets in the eastern U.S. During 1993, systemwide traffic was relatively weak. In 1994, USAir's traffic was stronger than in 1993, although the Company estimates that USAir's two aircraft accidents during\nthe third quarter of 1994 resulted in reduced passenger traffic that produced a revenue shortfall of approximately $150 million for the year. By early 1995, traffic at USAir had recovered from the effects of the accidents and approached a level normally associated with USAir's capacity in the marketplace.\nUSAir implemented several operational changes during 1991 through 1994 in efforts to return to profitability, as discussed in detail below, and it has announced plans for additional changes in 1995.\nIn March 1995, USAir disclosed plans to cut capacity through- out its system by five percent as part of its efforts to return to profitability. It intends to emphasize the strengths of its hubs in Pittsburgh, Charlotte, Philadelphia and Baltimore, as well as other major east coast urban centers. USAir expects that this downsizing will produce over $100 million in annual financial benefits. As a result of USAir's new capacity plan, by July 1995, point-to-point flights will comprise less than 10% of the USAir system. Approximately 240 flights will be eliminated and about 70 flights will be added. The additional service will include flights to Frankfurt from Philadelphia and Boston, as discussed below, and more flights to the west coast from Charlotte. USAir plans to use regional aircraft in markets where passenger loads have been consistently too low to sustain continued jet service. See \"Regional Airline Operations.\" These changes will be phased in during April, May and June.\nUSAir, whose operating costs are the highest among the major U.S. airlines, is actively pursuing several initiatives in an effort to enhance revenues and to reduce its costs significantly in order to survive in the current low fare competitive environment. The Company's goal is to achieve a pre-tax margin of 3.0% in the next one to two years and a 7.5% pre-tax margin longer term. USAir implemented certain revenue enhancement and cost reduction programs in 1994 and expects to continue and expand these programs and initiate others in 1995, as discussed below. The Company believes that it must reduce USAir's annual operating expenses by approxi- mately $1 billion in order to achieve its margin goals.\nThe Company is seeking to realize half, or approximately $500 million, of the $1 billion of annual savings through reductions in personnel costs, which are the largest single component of USAir's operating costs (approximately 39%). USAir is engaged in discus- sions with the leadership of its unionized employees regarding the $500 million annual savings in personnel costs it desires to achieve through wage and benefit reductions, improved productivity and other cost savings. In August 1994, USAir received a proposal regarding cost savings from ALPA, which represents USAir's pilot employees, and shortly thereafter the Company announced that the terms of ALPA's proposal were largely unacceptable. Although discussions between the Company and ALPA continued, ALPA ceased negotiations in early October following USAir's announcement of its plan, described below, to dispose of its Boeing 767 fleet and certain other aircraft. On October 25, 1994, Gerald L. Baliles,\nformer Governor of Virginia, was appointed by Secretary of Transportation Federico Pena as facilitator in the negotiations. Former Governor Baliles also served in 1993 as chairman of the National Commission to Ensure a Strong Competitive Airline Industry. Discussions with the facilitator began on October 28, 1994. On February 6, 1995, USAir received a proposal from ALPA, the International Association of Machinists (\"IAM\") and the Transport Workers Union (the \"TWU\"). On February 22, 1995, the Company responded with a counterproposal to these unions. On March 29, 1995, USAir reached an agreement in principle with ALPA. The agreement in principle is subject to many significant condi- tions. See \"Agreement in Principle with Pilots' Union\" above. USAir is continuing to negotiate with the labor unions representing certain of its other employees. The timing and outcome of USAir's discussions with its other labor unions are uncertain. No assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. Even if the savings described above are achieved, it remains uncertain whether they will be adequate in light of the Company's financial condition and competitive position. As a result of these uncertainties, several key management personnel have recently left USAir, and more may follow unless the Company's financial outlook improves.\nThe Company plans to achieve the majority of the remaining $500 million in annual cost savings through a combination of organizational and structural changes, reengineering and other initiatives including:\n* centralization of its purchasing functions;\n* customer service realignment, including the transfer of commuter handling to USAir Express operators;\n* improvements in operations performance to increase crew productivity;\n* cargo, catering and communications outsourcing;\n* maintenance operations organizational changes;\n* a reengineering of its maintenance operations, reservations, information services and operations research area; and\n* rationalization of its jet fleet which will include the elimination of certain fleet types, as described below.\nCertain of the above initiatives are part of the Company's \"Management Action Plan.\" The Company expects to achieve at least $250 million to $300 million of these savings in 1995. There can be no assurance that these savings will be fully realized.\nIn addition to the above cost-cutting initiatives, the Company is focusing on other significant Management Action Plan items designed to enhance revenues or further reduce costs. These include:\n* \"quick turn\" service (discussed below);\n* a new inventory management system that allows USAir to better allocate seats within various fare levels to produce a traffic mix that maximizes revenues;\n* synergies through the BA alliance (code sharing, frequent flyer programs and joint sales promotions, ground handling and purchasing); and\n* a premium \"Business Select\" service (discussed below).\nIn February 1994, USAir inaugurated its quick turn, point-to- point service mentioned above in 18 city-pair markets using 22 aircraft in a move intended to increase the utilization of its existing aircraft, facilities and personnel and thereby reduce its unit costs on those flights. The trial program consisting of 22 aircraft was shown to produce the desired results and in July 1994, USAir expanded the quick turn service to approximately 165 markets using approximately 100 aircraft. Currently, USAir is using quick turn as an operating standard system-wide to increase aircraft utilization and to improve schedules wherever expedient. Although the expanded quick turn program is producing the intended results with regard to aircraft utilization, there can be no assurance that the quick turn service will generate sufficient additional revenue to offset the increased costs associated with this service.\nIn addition, USAir hopes to attract additional higher yield business passenger revenue through its implementation of a convertible passenger cabin which allows USAir to offer a premium service branded \"Business Select\" to these passengers, as referred to above. USAir initiated the Business Select service in certain markets on January 4, 1995. As of March 1995, Business Select was available on 30 aircraft. USAir expects to determine whether to expand Business Select later in 1995. At least one other major U.S. airline, American, has announced plans to implement similar service.\nThe Company is also evaluating other strategic options, including further downsizing, which may be available to address the difficult financial and competitive factors facing USAir.\nFrom 1991 through the present, USAir has taken various steps to reduce its operating costs and to augment or enhance its service and, in addition or related to the initiatives described above, it plans to make other efforts to achieve these goals. These histori- cal and future efforts are described below.\nOn May 2, 1991, USAir ceased operating its fleet of British Aerospace BAe 146-200 (\"BAe-146\") aircraft, ceased serving eight airports in California, Oregon and Washington, and eliminated some flights at BWI and Cleveland Hopkins International Airports. Although other service was added to partially offset these reductions, the net effect was a decrease of approximately three percent in USAir's system available seat miles (\"ASMs\"), and a net reduction in scheduled departures of ten percent from January 1991 service levels. In connection with this restructuring, USAir closed four flight crew bases, two heavy maintenance facilities and one reservations office (these measures are collectively referred to as the \"May 1991 Restructuring\"). (In April 1993, USAir reintroduced long-haul service at John Wayne Airport in Orange County, California, one of the airports that USAir ceased serving in the May 1991 Restructuring). USAir has not resumed operation of its BAe-146 aircraft. USAir owns one and leases seventeen of these aircraft. USAir has continued to pay rent, insure the BAe-146 aircraft and perform its other obligations under the BAe-146 leases, except that USAir has not performed mandatory airworthiness directives on these aircraft or engines as required by the leases. USAir is storing the aircraft and related spare engines in accordance with FAA-approved procedures and manufacturer guide- lines. Maintenance reserves for the cost of airworthiness directives compliance and lease return requirements have been accrued by the Company. In the fourth quarter of 1994 the Company recorded a non-recurring charge of approximately $132.8 million for such non-operating aircraft. USAir continues, however, to pursue remarketing opportunities for the BAe-146 aircraft.\nIn 1992, USAir purchased 62 jet take-off and landing slots and 46 commuter slots at LaGuardia Airport (\"LaGuardia\") and six jet slots at Washington National Airport from Continental for $61 million. USAir also assumed Continental's leasehold obligations associated with the East End Terminal at LaGuardia, which commenced operations in September 1992, and a flight kitchen at LaGuardia. As a result of the acquisition, USAir expanded its operations at LaGuardia, including the initiation of non-stop service to nine additional cities, five of which are in Florida. USAir Express carriers used the commuter slots to expand service primarily to cities in the northeastern United States. USAir sold substantially all the assets associated with the flight kitchen operation in October 1992.\nUSAir Group reached an agreement during 1992 with the creditors of the Trump Shuttle to manage and operate the Shuttle under the name \"USAir Shuttle\" for a period of up to ten years. Under the agreement, USAir Group has an option to purchase the shuttle operation on or after October 10, 1996. The USAir Shuttle commenced operations in April 1992 between New York City, Boston and Washington D.C.\nDuring 1993 and 1994 USAir and BA implemented code sharing arrangements pursuant to the Investment Agreement. As of Decem- ber 31, 1994, USAir and BA had implemented code sharing to 52 of the 65 airports currently authorized by the DOT. See \"British Airways Investment Agreement\" below.\nIn early 1994, USAir implemented certain measures previously announced in 1993 to reduce its operating costs. These measures included a workforce reduction of approximately 2,500 full time positions and revision of USAir's vacation, holiday and sick leave policy for non-union employees. The workforce reduction, which was completed by the end of the first quarter of 1994, was comprised primarily of the elimination of approximately 1,800 customer service, 200 flight attendant and 200 maintenance positions. USAir recorded a non-recurring charge of approximately $68.8 million primarily in the third quarter of 1993 for severance, early retirement and other personnel-related expenses in connection with the workforce reduction.\nIn March 1994, USAir (i) purchased from United certain takeoff and landing slots at Washington National Airport and LaGuardia; (ii) purchased from United certain gates and related space at Orlando International Airport and (iii) granted to United options to purchase certain gates and related space, and a right of first refusal to purchase certain takeoff and landing slots, at Chicago O'Hare International Airport. In December 1993, USAir had reached an agreement with United to negotiate a code sharing agreement with United regarding USAir's flights to and from Miami and United's flights between Miami and Latin America. Consummation of this agreement was subject to a number of conditions. For a variety of reasons, including rapidly changing market conditions and other priorities within both companies, neither USAir nor United actively pursued the negotiation of a code sharing agreement. At this time, it appears unlikely the parties will consummate a code sharing agreement.\nIn May 1994, USAir announced plans to subcontract air freight and mail operations at 35 cities, which has affected approximately 600 of the fleet service employees. The United Steel Workers of America (\"USWA\") and several individual employees subsequently sought an injunction in a U.S. district court against the implemen- tation of those plans. On July 14, 1994, the court denied the plaintiffs' request for a preliminary injunction based on its finding that the plaintiffs did not have legal standing to represent USAir employees and had failed to demonstrate that they would suffer irreparable harm as a result of the subcontracting. In early 1995, USAir announced plans to subcontract air freight and mail operations at four additional cities.\nIn November 1994, USAir reduced substantially the frequency of its service between Los Angeles and San Francisco. It plans to close its crew base in San Francisco in the first half of 1995. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for information regarding a $25.9 million charge recorded as a result of this action.\nIn February 1995, USAir reduced the number of departures at Newark International Airport from 51 to 35 and further decreased the number to 18 effective March 5. These moves are part of USAir's strategy to use assets where they can be the most produc- tive. The changes will result in lower staffing levels in customer service and maintenance.\nIn response to the entry of certain low cost, low fare competitors at BWI and as part of USAir's measures to reduce the cost and increase the efficiency of its short haul service, USAir substantially expanded its operations at BWI in 1994. Also in 1994, USAir added several new destinations to its flight schedule, including Mexico City; St. Maarten; Jamaica; and Portland, Oregon. In February 1995, USAir announced plans to realign its Frankfurt service. It intends to increase the number of weekly flights from 14 to 21 in June 1995 for the summer season and will introduce non- stop service from Philadelphia and Boston. It will continue to offer non-stop service from Pittsburgh, and its Charlotte-Frankfurt service will include a stop in Boston. The realignments are designed to allow USAir to maximize its transatlantic performance and to take advantage of the large population bases in Philadelphia and Boston.\nIn order to reduce aircraft ownership costs and to reduce its fleet size, USAir has been pursuing the sale or lease of jet aircraft and has not been renewing certain aircraft leases upon their expiration. USAir currently plans to reduce its operating fleet by 21 jet aircraft in 1995 from December 31, 1994 levels through sales, leases, lease returns and groundings. USAir plans to retire or dispose of, at various times, 15 Boeing 737-300, five Boeing 767-200ER, two Boeing 737-200 and six Boeing 727-200 aircraft. These plans are subject to change if a labor deal is consummated, but the Company cannot predict at this time the potential impact of a labor deal on its fleet reduction plans. USAir had previously announced that its entire fleet of 12 767- 200ER aircraft was on the market. As part of its fleet reduction plan, on February 22, 1995, USAir entered into an agreement with General Electric Capital Corporation (\"GE Capital\") to sell 11 B- 737-300 aircraft during 1995, two of which were sold during the first quarter. USAir has also entered into an agreement in principle with a leasing company to sell two additional Boeing 737- 300 aircraft during 1995. USAir will record a slight financial statement loss from the sales of these 737-300 aircraft to GE Capital and the leasing company but cannot estimate the financial statement impact of other potential transactions at this time. Moreover, in furtherance of its fleet reduction, USAir will explore opportunities to sell, lease or terminate leases for additional aircraft, with the exception of Boeing 757-200 aircraft. USAir has taken delivery of four Boeing 757-200 aircraft in the first quarter of 1995 and intends to purchase the remaining three scheduled to be delivered in 1995, for which financing commitments have been obtained. If any of USAir's five Boeing 767-200ER aircraft currently on the market were sold, they would be phased out of the fleet in the following order: U.S. domestic service first and the\nBA wet lease service (described below in \"British Airways Invest- ment Agreement - U.S.-U.K. Routes\") second. The timing of the disposal of the Boeing 767-200ER aircraft is dependent on economi- cally feasible sale or lease opportunities. Excluding any Boeing 767-200ER dispositions, USAir's capacity, as measured by ASMs, is expected to decrease approximately 2.5% in 1995 compared with 1994. Pursuant to resolutions of the Company's Board and the board of directors of USAir, USAir is required to use the net proceeds of any sales of assets, after payment of any associated lease and mortgage obligations, to repurchase, defease or redeem outstanding debt.\nPreviously, on May 12, 1994, USAir reached an agreement with Boeing to reschedule the delivery of 40 737-series aircraft from the 1997-2000 time period to the years 2003-2005. As part of the same agreement, USAir relinquished all of its options to purchase 737-series, 757-series and 767-series aircraft during the 1996-2000 time period. In early 1995, USAir reached agreements in principle with Boeing and Rolls-Royce plc to reschedule the delivery dates for eight 757-200 aircraft from 1996 to 1998. As a result of these recent agreements, the Company's capital commitments have been substantially reduced for the 1995 to 2000 time period. See Note 4(d) to the Company's consolidated financial statements for the future aircraft commitments schedule reflecting these agreements with Boeing and Rolls-Royce plc. USAir is using the Boeing 757-200 aircraft, which seats 182 passengers, on long haul routes, in high demand markets where potential passenger traffic may not currently be accommodated on smaller aircraft at peak travel times and in replacement of certain 737-300 long range aircraft that are to be sold to GE Capital. USAir considers the 757-200 aircraft to be more suitable for these missions than the Boeing 767-200ER and Boeing 737 aircraft types.\nUSAir has recently implemented several additional safety initiatives. In November 1994, USAir elected a former general in the United States Air Force, General Robert C. Oaks, to the new position of Vice President-Corporate Safety and Regulatory Compliance, reporting directly to the Chairman and Chief Executive Officer. The Company and USAir have each established a new committee of their boards of directors, the Safety Committees, which have oversight of all corporate safety matters. In addition, USAir retained an aviation consulting firm, PRC Aviation, to conduct a full audit of USAir's safety operations. The audit was completed in early 1995. In the opinion of the safety auditors, USAir is being operated safely in compliance with FAA regulations. PRC Aviation identified and recommended opportunities for safety enhancements. USAir has established an Audit Response Council that is addressing the recommendations made in the audit report.\nIn summary, since 1989, USAir Group and USAir have incurred substantial losses. Their results of operations have been adversely affected by the growth of low cost, low fare competition, particularly in 1994. Therefore, in order for USAir to remain competitive, it has attempted to reduce costs, enhance service and become more efficient by engaging in historical and current\ninitiatives and by formulating plans for the future discussed above in this description of \"Major Airline Operations.\"\nUSAir's operating statistics during the years 1990 through 1994 are set forth in the following table (1):\n* Scheduled service only (excludes charter flights). ** All service. c = cents\n(1) Statistics include free frequent travelers and the related miles flown. (2) Passenger load factor is the percentage of aircraft seating capacity that is actually utilized (RPMs\/ASMs). (3) Breakeven load factor represents the percentage of aircraft seating capacity that must be utilized, based on fares in effect during the period, for USAir to break even at the pre- tax income level, adjusted to exclude non-recurring and unusual items. (4) Adjusted to exclude non-recurring and unusual items. (5) Financial statistics for 1994 and 1993 exclude revenue and expense generated under the BA wet lease arrangement. (6) Certain statistics have been recalculated to reflect expense reclassifications.\nFor a discussion of USAir's frequent traveler program, see Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Frequent Traveler Program.\"\nRegional Airline Operations\nMost regional airlines in the United States are affiliated with a major or smaller jet carrier. USAir provides reservations and, at certain stations, ground support services, in return for service fees, to ten regional carriers (including Allegheny, Piedmont and Jetstream) which operate under the name \"USAir Express.\" These airlines share USAir's two-letter designator code and feed connecting traffic into USAir's route system at several points, including its major hub operations at Pittsburgh, Char- lotte, Philadelphia and BWI. At January 4, 1995, USAir Express carriers served 185 airports in the United States, Canada and the Bahamas, including 90 also served by USAir. During 1994, USAir Express' combined operations enplaned approximately 9.2 million passengers.\nPiedmont's collective bargaining agreement with ALPA, which represents its pilot employees, became amendable on December 1, 1992. On February 22, 1994, the National Mediation Board (the \"NMB\"), which had assigned a mediator to the negotiations between Piedmont and ALPA on a new agreement, declared these negotiations at an impasse and commenced a thirty-day \"cooling-off\" period. On March 27, 1994, two days following the expiration of this period at midnight on March 25, 1994, Piedmont reached agreement on a new collective bargaining agreement that becomes amendable on March 31, 1998. The new agreement was ratified by Piedmont's pilot employees on May 2, 1994 and provides for increases in salary and benefits for the term of the agreement in exchange for productivity improvements.\nIn July 1992, Allegheny Commuter Airlines, Inc. merged into Pennsylvania Commuter Airlines, Inc. (now Allegheny Airlines, Inc.). The pilots of each of these companies were represented by ALPA and were covered by collective bargaining agreements. Interim agreements were reached with both pilot groups on July 1, 1992. Negotiations on a unified collective bargaining agreement covering all pilots of the merged company began in September 1992 and continued through September 1, 1994. Allegheny reached agreement with the pilots on September 1, 1994. The contract expires on August 31, 1998. The flight attendants of each of these companies, represented by the Association of Flight Attendants (the \"AFA\"), were also covered by collective bargaining agreements. Negotia- tions on a unified collective bargaining agreement covering all flight attendants of the merged company began in April 1992. Two tentative agreements were reached but were not ratified by the combined membership. On December 19, 1994, a third tentative agreement was reached which was ratified by the membership on January 30, 1995. The new Allegheny flight attendant agreement became effective February 1, 1995 and becomes amendable on January 31, 2000. Both the pilot and flight attendant agreements with Allegheny provide for increases in salary and benefits for the term of the agreements in exchange for productivity improvements.\nUSAir's reduction in jet aircraft and its continuing efforts to reduce costs and enhance revenue by eliminating less profitable routes has resulted in the cessation of or reduction in jet flying between certain city pairs. In some cases, subject to possible changes should a labor deal be consummated, existing or former jet routes may be turned over to USAir Express with the goal of maintaining portions of the revenue base (particularly the hub connecting traffic) with lower cost operations. The change from jet routes to regional airline service and the operating expenses of operating smaller turboprop aircraft have resulted in the Company pursuing the 30-seat and larger market for its owned regional operations. Over time, the Company intends to upgrade routes operated by smaller turboprops to aircraft of 30 seats or larger or to have those routes flown by non-owned USAir Express carriers. In August 1994, USAir, Allegheny and USAir Leasing and Services sold to Mesa Air Group, Inc. (formerly Mesa Airlines, Inc.) (\"Mesa\") the Beechcraft 1900 and Shorts 360 regional operations previously operated by Allegheny, certain spare parts, station and ground equipment and a maintenance facility in Reading, Pennsylvania. The transaction resulted in the divestiture of 22 aircraft by Allegheny in 1994 and the consolidation of Allegheny's operations to one fleet type, the de Havilland Dash 8-100. Connecting traffic has not been materially affected because connecting feed formerly provided by Allegheny is now provided by Mesa or other USAir Express carriers.\nPiedmont and Allegheny intend to enlarge their Dash 8 fleets in 1995 by pursuing operating leases for those aircraft when such aircraft are available upon economically feasible terms. In 1994, Piedmont added four new Dash 8s and Allegheny added six new Dash 8s by entering into operating leases with an affiliate of the aircraft manufacturer. In 1995, Allegheny has added three Dash 8s through operating leases and has an agreement in principle to lease five additional used aircraft from an affiliate of the aircraft manufacturer. One of Piedmont's lessors has advised, however, that it will not renew leases for four used Dash 8s that expire in 1995. In addition, as discussed below in Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nFlight Equipment\nAt December 31, 1994, USAir operated the following jet aircraft:\n(1) Of the owned aircraft, 115 were pledged as collateral for various secured financing obligations aggregating $2.2 billion at December 31, 1994. (2) The terms of the leases expire between 1995 and 2015. Includes two 737-300 aircraft that were returned to the lessor in April 1995. (3) The above table excludes one owned and two leased Boeing 767- 200ER which USAir leased to BA under a wet lease arrangement at December 31, 1994. See \"British Airways Investment Agreement - U.S.-U.K. Routes.\" (4) Includes aircraft that USAir has agreed to sell. See Item 1. \"Business - Major Airline Operations.\" The average age of these aircraft is 8.9 years.\nAt December 31, 1994, USAir Group's three regional airline subsidiaries operated the following propeller-driven aircraft:\n(1) Of the owned aircraft, 13 were pledged as collateral for various secured financing obligations aggregating $50.3 million at December 31, 1994, five were owned by USAir Leasing and Services, and four were owned by USAir. (2) The terms of the leases expire between 1995 and 2010.\nUSAir is a party to purchase agreements that provide for the future acquisition of new jet aircraft. Jetstream is party to an agreement with Dornier LuftFahrt Gmbh which provides for the firm acquisition by operating lease of 20 Dornier 328-100 series aircraft by December 1995 and 20 options to acquire such aircraft. Allegheny and Piedmont have agreements to acquire additional Dash 8 aircraft. USAir Leasing and Services has a commitment to sell its five owned J-31s in 1995. Jetstream intends to return the 28-seat Embraer Brasilia to a lessor in 1995 and to sublease the 30-seat Brasilia to another air carrier. See Note 4(d) to the Company's consolidated financial statements for outstanding commitments and options for the purchase of flight equipment. The Company's subsidiary airlines maintain inventories of spare engines, spare parts, accessories and other maintenance supplies sufficient to meet their operating requirements.\nUSAir owns one and leases 17 BAe 146-200 aircraft, leases two Boeing 727-200, owns six Boeing 737-200, and owns seven Fokker- 1000 aircraft that were parked in storage facilities and not in its operational fleet at December 31, 1994. USAir recorded substantial charges during 1994 to recognize costs associated with repair parts, inventory and future lease payments for certain parked aircraft. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" In addition, certain of the Company's subsidiaries lease ten owned Fokker- 1000 aircraft and nine owned Boeing 737-200 aircraft to outside parties.\nUSAir is a participant in the Civil Reserve Air Fleet (\"CRAF\"), a voluntary program administered by the Air Mobility Command (the \"AMC\"). The General Services Administration of the United States government also requires that airlines participate in CRAF in order to receive United States government business. The United States government is the largest customer of USAir. USAir's commitment under CRAF is to provide three Boeing 767 aircraft in support of military operations, probably for aeromedical missions, as specified by the AMC. To date, the AMC has not requested USAir to activate any of its aircraft under CRAF.\nGround Facilities\nUSAir leases the majority of its ground facilities, including executive and administrative offices in Arlington, Virginia adjacent to Washington National Airport; its principal operating, overhaul and maintenance bases at the Pittsburgh and Charlotte\/ Douglas International Airports; major training facilities in Pittsburgh and Charlotte; central reservations offices in several cities; and line maintenance bases and local ticket, cargo and administrative offices throughout its system. USAir owns property\nin Fairfax, Virginia, a training facility in Winston-Salem, North Carolina, a reservations and training facility in San Diego, California, and a reservations facility in Orlando, Florida. USAir's property in Fairfax, Virginia is leased to the U.S. government and is currently for sale. Allegheny owns its principal ground facilities in Middletown, Pennsylvania. Jetstream leases its principal ground facilities in Dayton, Ohio. Piedmont leases its principal ground facilities in Salisbury, Maryland, Norfolk, Virginia and Jacksonville, Florida.\nThe Company's airline subsidiaries utilize public airports for their flight operations under lease arrangements with the govern- ment entities that own or control these airports. Airport authorities frequently require airlines to execute long-term leases to assist in obtaining financing for terminal and facility construction. Any future requirements for new or improved airport facilities and passenger terminals will require additional expenditures and long-term commitments. Several significant projects which affect large airports on USAir's route system are discussed below.\nThe new terminal at Pittsburgh International Airport commenced operation in October 1992. The construction cost of the new terminal, approximately $800 million, was financed largely through the issuance of airport revenue bonds. As the principal tenant of the new facility, USAir pays a portion of the cost of the new terminal through rents and other charges pursuant to a use agreement which expires in 2018. USAir's terminal rental expense at Pittsburgh was approximately $46 million annually in 1994. The new facility has provided additional gate capacity for USAir and has enhanced the efficiency and quality of its hub services at Pittsburgh. In addition to the annual terminal rental expense, USAir is recognizing approximately $13 million annual rental expense for property and equipment typically owned by USAir at other airports. The annual terminal rental expense is subject to adjustment, depending on the actual airport operating costs, among other factors. These rents are reflected in Note 4(b), \"Lease Commitments\", to the Company's and USAir's respective consolidated financial statements.\nThe East End Terminal at LaGuardia, which cost approximately $177 million to construct, opened in the third quarter of 1992. USAir, USAir Express and the USAir Shuttle operations at LaGuardia are conducted from this new terminal and the adjoining USAir Shuttle terminal. The East End Terminal has 12 jet gates. USAir recognizes approximately $32 million in annual rental expense for the new terminal and is responsible for all maintenance and operating costs.\nIn 1993, USAir and the City of Philadelphia reached an agreement to proceed with certain capital improvements at Philadel- phia International Airport, where USAir has its third largest hub. The improvements include approximately $85 million in various terminal renovations and a new $220 million commuter airline runway expansion project, exclusive of financing costs. Depending on the\ntiming of certain federal environmental reviews, USAir expects construction on the terminal project will begin in 1995 and will be completed in 1996 or 1997. The runway expansion project may begin in 1995 and is not expected to be completed until 1999 or 2000. The Company expects that its annual costs of operations at Philadelphia International Airport will increase by approximately $14 million once construction is complete, representing more than a 40% increase.\nThe Washington National Airport Authority, which operates Washington National Airport, is currently undertaking a $1 billion capital development project at Washington National Airport, which includes construction of a new terminal currently expected to commence operation in the first quarter of 1997. Based on current projections, the Company estimates that its annual operating expenses at Washington National Airport will more than double, increasing by approximately $10 million to $15 million.\nIn January 1995, USAir announced plans to dispose of its hangar at Indianapolis. The closing of this facility is expected to save approximately $2.4 million per year in rental payments. Initial costs associated with the closing are estimated to be $4.5 million for employee relocation.\nUSAir intends to divest six of nine gates it holds at Newark International Airport. It is currently negotiating with another carrier with respect to the disposition of those gates. USAir anticipates that the divestiture will result in an annual rent reduction of approximately $4 million.\nDuring 1990, Congress enacted legislation to permit airport authorities, with prior approval from the DOT, to impose passenger facility charges (\"PFCs\") as a means of funding local airport projects. These charges, which are collected by the airlines from their passengers, are limited to $3.00 per enplanement, and to no more than $12.00 per round trip. The legislation provides that the airlines will be reimbursed for the cost of collecting these charges and remitting the funds to the airport authorities. To date, more than 230 airports, including airports in Boston, Baltimore, Washington, Newark, New York City, Philadelphia, Orlando and Tampa (which are major markets served by USAir), have imposed PFCs. These airports receive more than $1 billion annually in PFCs. As a result of downward competitive pressure on fares, USAir and other airlines have been unable in many instances to pass on the cost of the PFCs to passengers.\nWith respect to the magnitude of airport rent and landing and other user fees generally, federal law prohibits States and their subdivisions from collecting these fees, other than reasonable rental charges, landing fees and other service charges, from aircraft operators for the use of airport facilities. Controver- sies have arisen in recent years concerning the allocation of airport costs among the airlines, general aviation and concession- aires operating at the airport. In addition, during 1993 and 1994, the controversy surrounding the diversion by airport and other\ngovernmental authorities of airport revenues continued to grow. Airport revenues typically consist primarily of rents and landing and other user fees paid by the airlines operating at the airport. Under federal law, federal transportation funds could be denied to certain airports that engage in diversion of these revenues. In August 1994, Congress enacted legislation which strengthens prohibitions on revenue diversion. The DOT recently established procedures for the resolution of disputed charges imposed by airports. It is too early to tell how the DOT will resolve disputes between airport operators and the carriers under these new procedures.\nItem 3.","section_3":"Item 3. Legal Proceedings\nUSAir has been named as party to, or may be affected by, legal proceedings brought by owners and residents of property located in the vicinity of certain commercial airports. The plaintiffs generally seek to enjoin certain aircraft operations at those airports or to obtain awards of damages on the defendant airport operators and air carriers as a result of alleged aircraft noise or air pollution. The relative rights and liabilities among property owners, airport operators, air carriers and Federal, state and local governments are the subject of ongoing interpretation by the courts. Any liability imposed on airport operators or air carriers, or the granting of any injunctive relief against them, could result in higher costs to air carriers, including the Company's airline subsidiaries.\nThe Equal Employment Opportunity Commission and various state and local fair employment practices agencies are investigating charges by certain job applicants, employees and former employees of the Company's subsidiaries involving allegations of employment discrimination in violation of Federal and state laws. The plaintiffs in these cases generally seek declaratory and injunctive relief and monetary damages, including back pay. In some instances they also seek classification adjustment, compensatory damages and punitive damages.\nThe above proceedings are in various stages of litigation and investigation, and the outcome of these proceedings is difficult to predict. In the Company's opinion, however, the disposition of these matters is not likely to have a material adverse effect on its financial condition or results of operations.\nUSAir is involved in legal proceedings arising out of its two aircraft accidents that occurred in July and September 1994 near Charlotte, North Carolina and Pittsburgh, Pennsylvania, respective- ly. The NTSB held hearings beginning in September 1994 relating to the July accident and January 1995 relating to the September accident. In April 1995, the NTSB issued its finding of probable causes with respect to the accident near Charlotte. It assigned as probable causes flight crew errors and the failure of air traffic control to convey weather and windshear hazard information. The NTSB has not yet issued its final accident investigation report for the accident near Pittsburgh. USAir expects that it will be at\nleast two to three years before the accident litigation and related settlements will be concluded. USAir believes that it is fully insured with respect to this litigation and has recovered its claims related to the loss of the two aircraft. Therefore, the Company believes that the litigation will not have a material adverse effect on the Company's financial condition or results of operations. However, due to these two aircraft accidents, it is probable that the Company's insurance costs will increase upon renewals of various policies in 1995. See Item 1. \"Business - Insurance.\"\nIn 1989 and 1990, a number of U.S. air carriers, including USAir, received two Civil Investigative Demands (\"CIDs\") from the DOJ (a CID is a request for information in the course of an antitrust investigation and does not constitute the institution of a civil or criminal action) related to investigations of price fixing in the domestic airline industry.\nThe investigations by the DOJ culminated in the filing of a lawsuit against Airline Tariff Publishing Company (\"ATPCo\") and eight major air carriers, including USAir, alleging that the defendants had agreed to fix prices in violation of Section 1 of the Sherman Act through the methods used to disseminate fare data to ATPCo, an airline-owned fare publishing service. To avoid the costs associated with protracted litigation and an uncertain outcome, USAir and another carrier decided to settle the lawsuit by entering into a consent decree to modify their fare-filing practices in certain respects and to implement compliance programs that would include education of employees regarding the carrier's responsibilities under the consent decree. Accordingly, the consent decree and the U.S. Government's complaint were filed contemporaneously in the U.S. District Court for the District of Columbia in December 1992. On November 1, 1993, after it had reviewed comments filed regarding the consent decree, the Court entered the decree. In March 1994, the remaining six air carrier defendants agreed to the entry of a separate consent decree to settle the lawsuit. USAir petitioned the Court to have its consent decree amended to conform with the other settlement and the Court entered an amended consent decree on September 21, 1994.\nOn March 19, 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit. The class action suit, which was filed in July 1990, alleged that the airlines used ATPCo to signal and communicate carrier pricing intentions and otherwise limit price competition for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers paid $45 million in cash and issued $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. USAir's share of the cash portion of the settlement, $5 million, was recorded in results of operations for the second quarter of 1992. The certificates, mailed to approximately 4.1 million claimants between December 15 and 31, 1994, provide a dollar-for- dollar discount against the cost of a ticket generally of up to a\nmaximum of 10 percent per ticket, depending on the cost of the ticket. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certifi- cates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates, and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on further passenger revenue and cash flows. USAir has employed the incremental cost method to estimate a range of costs attributable to the exercise of the certificates, based on the assumption that the estimated maximum number of certificates to be redeemed for travel on USAir will be related to USAir's market share relative to the total market share of the six carriers involved in the settlement. USAir's estimated percentage of such market share is less than nine percent. Incremental costs include unit costs for passenger food, beverages and supplies, fuel, reservations, communications, liability insurance, and denied boarding compensation expenses expected to be incurred on a per passenger basis. USAir has estimated that its incremental cost will not be material based on the equivalent free trips associated with the settlement.\nOn October 11, 1994, USAir and seven other carriers entered into a settlement agreement with a group of State Attorneys General resolving similar issues with the states. The settlement entitles passengers traveling within the United States on state government business to a 10% discount off the published fares of each of the settling carriers and will be available for 18 months or until the combined discount amount reaches $40 million. Following a notice and public comment period, the reviewing judge will conduct a hearing to determine whether this settlement is a fair one. The hearing is scheduled for May 10, 1995. The Company does not expect that this settlement will have a material adverse effect on its financial condition or results of operations. As was the case with the settlement of the private antitrust litigation, it is difficult to predict the amount of discounted state travel that will occur on USAir. Thus, a dollar impact of the settlement cannot be estimat- ed.\nIn February and March 1995, several class action lawsuits were filed in various federal district courts by travel agencies and a travel agency trade association alleging that most of the major U.S. airlines, including USAir, violated the antitrust laws when they individually capped travel agent commissions at $50 for round- trip domestic tickets with base fares above $500 and at $25 for one-way domestic tickets with base fares above $250. USAir intends to vigorously defend itself against the allegations made in these lawsuits. The plaintiffs are seeking unspecified treble damages for restraint of trade and an injunction to prevent the airlines from implementing or maintaining the cap on commissions. Because the lawsuits are in the first stages of litigation, USAir is unable to predict at this time their ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn March 1995, a number of U.S. carriers, including USAir, received a CID from the DOJ related to an investigation of incentives paid to travel agents over and above the base commission payments, which are the subject matter of the suits recently brought by travel agencies, as discussed above. USAir responded to an earlier CID on this topic during 1994. USAir is required to produce documents and respond to interrogatories in connection with this CID. USAir intends to comply with the requirements of the CID. Because this matter is in the investigatory stage, USAir is unable to predict at this time its ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn February 1995, two members of USAir's frequent traveler program filed a class action lawsuit in Pennsylvania state court against USAir after it raised the required minimum level of miles necessary to earn a free ticket. The plaintiffs allege breach of contract and seek unspecified damages and specific performance of the contract allegedly breached. USAir denies the allegations. The ultimate resolution of this lawsuit and its potential impact on the Company's financial condition and results of operations cannot be predicted at this time.\nUSAir and certain of the Company's other subsidiaries have received notices from the U.S. Environmental Protection Agency and various state agencies that it is a potentially responsible party with respect to the remediation of existing sites of environmental concern. Only two of these sites have been included on the Superfund National Priorities List. USAir and the other subsidiar- ies continue to negotiate with various governmental agencies concerning known and possible cleanup sites. These companies have made financial contributions for the performance of remedial investigations and feasibility studies at sites in Moira, New York; Escondido, California; Newberry Township, Pennsylvania; Elkton, Maryland; and Salisbury, Maryland.\nBecause of changing environmental laws and regulations, the large number of other potentially responsible parties and certain pending legal proceedings, it is not possible to reasonably estimate the amount or timing of future expenditures related to environmental matters. The Company provides for costs related to environmental contingencies when a loss is probable and the amount is reasonably estimable. Although management believes adequate reserves have been provided for all known contingencies, it is possible that additional reserves could be required in the future which could have a material effect on results of operations. However, the Company believes that the ultimate resolution of known environmental contingencies should not have a material adverse effect on the Company's financial position or results of operations based on the Company's experience with similar environmental sites.\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 1994.\nPart II\nItem 5A. Market for USAir Group's Common Equity and Related Stockholder Matters\nStock Exchange Listings\nThe Common Stock of the Company is traded on the New York Stock Exchange (Symbol U). On February 28, 1995, there were approximately 61,856,000 shares of Common Stock of the Company outstanding. The stock was held by 36,857 stockholders of record. The holders reside throughout the United States and abroad.\nMarket Prices of Common Stock\nPresented below are the high and low sale prices of the Common Stock of the Company as reported on the New York Stock Exchange Composite Tape during 1994 and 1993:\nHolders of the Common Stock are entitled to receive such dividends as may be lawfully declared by the Board of Directors of the Company. A Common Stock dividend of $.03 per share was paid in every quarter from the second quarter of 1980 through the second quarter of 1990. In September 1990, however, the Company suspended the payment of dividends on Common Stock for an indefinite period. The Company is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends until its capital surplus becomes positive. Surplus is the remainder of (i) net assets (total assets less total liabilities), less (ii) total capital (that amount of preferred and common equity designated as capital by a company's board of directors). At December 31, 1994, the Company's capital deficit was approximately $199.3 million. The Company's net assets were in a deficit balance of approximately $138.2 million, and its total capital was approximately $61.1 million (the $61.1 million is all attributable to the Company's Common Stock; capital for all of the Company's preferred stock issuances is a nominal amount of one cent per share). In order for the Company to return to a capital\nsurplus position, it must realize substantial profits or increase its equity through other measures, such as the sale of additional common or preferred stock. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Item 8A. Notes 8 and 9 to the Company's consolidated financial statements.\nForeign Ownership Restrictions\nIn connection with BA's 1993 investment in the Company, the Company's stockholders approved an amendment to its restated certificate of incorporation (\"Charter\") at the 1993 annual meeting that is designed to prevent the loss of USAir's operating certifi- cates due to foreign ownership or control of the Company's voting securities exceeding the level permitted by relevant Federal law. Under current law, foreign citizens cannot own or control more than 25% of the Company's voting securities.\nThe Charter provides that: (i) transfers of the Company's voting securities to non-U.S. citizens (\"Aliens\") on or after May 27, 1993 are prohibited; (ii) Aliens that acquire beneficial ownership of the Company's voting securities on or after May 27, 1993 have no voting rights; (iii) the Company can compel these Aliens to sell their securities to U.S. citizens; (iv) the Company can redeem or exchange the voting securities beneficially owned by these Aliens; and (v) the independent directors of the Company, who are those directors other than those employed by or affiliated with BA or the Company, have broad powers to construe and apply these provisions of the Charter, including the determination as to whether Aliens have become the beneficial owners of the Company's voting securities.\nItem 5B. Market for USAir's Common Equity and Related Stockholder Matters\nThere is no established public trading market for USAir's Common Stock, which is all owned by USAir Group. No dividends were paid in 1994 or 1993. USAir is subject to statutory restrictions on the payment of dividends according to capital surplus require- ments of Delaware law. At December 31, 1994, USAir's capital surplus was exhausted and therefore, under Delaware law, USAir is legally restricted from paying dividends until its capital surplus becomes positive. Surplus is the remainder of (i) net assets (total assets less total liabilities), less (ii) total capital (that amount of preferred and common equity designated as capital by a company's board of directors). At December 31, 1994, USAir's capital deficit was approximately $273.2 million. USAir's net assets were in a deficit balance of approximately $273.2 million, and its total capital was a nominal amount. In order for USAir to return to a capital surplus position, it must realize substantial profits or increase its equity through other measures, such as the sale of additional common or preferred stock. See Item 7. \"Manage- ment's Discussion and Analysis of Financial Condition and Results of Operations\" and Item 8B. Note 7 to USAir's consolidated financial statements.\nCovenants related to USAir's 10% and 9 5\/8% senior unsecured notes currently do not permit the payment of dividends by USAir to USAir Group. However, these covenants do not restrict USAir from loaning or advancing funds to USAir Group.\nItem 6.","section_5":"","section_6":"Item 6. Selected Financial Data\nSelected financial data for USAir Group is presented below:\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condi- tion and Results of Operations\nThe following discussion relates to the financial results and condition of USAir Group, Inc. (the \"Company\"). USAir, Inc. (\"USAir\") is the Company's principal subsidiary and accounts for approximately 93% of its operating revenue. Therefore, the following discussion is based primarily upon USAir's results of operations and prospects.\nThe primary factor that currently influences the Company's financial results and its future prospects is USAir's high cost structure amid the low cost, low fare environment which character- izes the U.S. airline industry. The Company has recorded net losses in excess of $3 billion on revenues of approximately $40 billion since 1988, which was its most recent profitable year.\nThe U.S. airline industry has undergone dramatic and permanent changes in recent years, generally resulting in lower operating costs and fares. As discussed in more detail below, the current competitive environment is the result of several factors including the emergence and expansion of low cost, low fare carriers, the protection and cost restructuring opportunities afforded to certain carriers while operating under Chapter 11 of the Bankruptcy Code, and other cost restructuring initiatives among major airlines, including employee concessions in exchange for equity ownership. USAir believes that it must reduce its operating costs substantial- ly if it is to survive in this low cost, low fare competitive environment.\nUSAir began negotiating with the unions representing certain of its employees in 1994 and, as described in Item 1. \"Business - Agreement in Principle with Pilots' Union,\" signed an agreement in principle on March 29, 1995 with the negotiating committee of the Air Line Pilots Association (\"ALPA\") Master Executive Council. ALPA represents USAir's pilots and the Master Executive Council is ALPA's governing body. The agreement in principle is subject to many significant conditions. It is uncertain whether USAir will be successful in reaching agreements with its other unions and whether or when any transactions with one or more of the unions will be consummated. As discussed below, the Company has taken various steps to reduce its non-labor costs including a five percent reduction in capacity to be phased in during April to June 1995. In addition, the Company is evaluating and considering the risks associated with various strategic options, including further downsizing.\nLow Cost, Low Fare Environment\nThe growth and expansion of low cost, low fare carriers into USAir's markets in the eastern U.S. and the improved competitive position of other major airlines which have substantially reduced their operating costs together represent an urgent competitive\nchallenge for USAir, which has higher operating costs than its competitors. Unless USAir is able to reduce its operating costs, competition from lower cost airlines in USAir's markets will continue to have a material adverse impact on USAir's cash position and therefore, its ability to sustain operations. See \"Liquidity and Capital Resources\" below.\nIn October 1993, Continental Airlines (\"Continental) inaugu- rated its low cost, low fare \"Continental Lite\" service on certain routes in the eastern U.S. also served by USAir. During 1994, Continental substantially expanded the Continental Lite service into additional markets also served by USAir. Continental has operating costs that are substantially lower than those of USAir. In February 1994, to avoid a loss of market share in the eastern U.S., USAir began to substantially lower its fares in primary and secondary markets affected by the expansion of Continental's low cost, low fare service. By late 1994, USAir competed with Continental in primary and secondary markets from which USAir then generated approximately 46% of its passenger revenue and offered fares in these markets up to 70% lower than the beginning of 1994. In January 1995, Continental announced its intention to reduce its capacity, to eliminate 4,000 jobs, and to reduce its Continental Lite service by 40% during 1995. This action has affected markets in which USAir and Continental compete. However, any impact on the Company's results of operations or financial position cannot be estimated at this time. See Item 1. \"Business - Significant Impact of Low Cost, Low Fare Competition\" and \"Industry Restructuring.\"\nIn September 1993, Southwest Airlines, Inc. (\"Southwest\"), a low cost, low fare air carrier which had not previously provided service to or in the eastern U.S., inaugurated service from Baltimore\/Washington International Airport (\"BWI\") at fares substantially below those previously offered by USAir and other airlines in the same markets. BWI is one of USAir's hub airports. USAir responded by matching most of Southwest's fares and increas- ing the frequency of service in related markets. Southwest further expanded its service from BWI during 1994 and USAir reduced its fares to avoid the loss of traffic. USAir believes that Southwest and other low cost carriers likely will expand their operations to additional markets also served by USAir. See Item 1. \"Business - Significant Impact of Low Cost, Low Fare Competition.\"\nIn 1993, Northwest Airlines, Inc. (\"Northwest\") and Trans World Airlines, Inc. (\"TWA\") sought and obtained from unionized employees substantial concessions and productivity improvements. In exchange, these employees have received ownership interests in those companies. In 1994, United Airlines, Inc. (\"United\") completed a transaction which traded employee concessions for a substantial ownership stake. The stated intent and purpose of these labor concessions are to enable these carriers to lower their operating costs. United initiated a low cost, low fare operation in the western U.S. in October 1994. USAir substantially reduced the frequency of its service between San Francisco and Los Angeles in November 1994 and will close its crew base in San Francisco in the first half of 1995. See the discussion in \"Results of\nOperations\" below for information regarding a $25.9 million charge recorded as a result of this action. United could initiate additional low cost, low fare service in other markets served by USAir.\nDelta Air Lines (\"Delta\") is currently engaged in a restruc- turing initiative, announced in April 1994, that is intended to reduce its operating costs through measures which include the elimination of up to 15,000 positions, or approximately 20% of its work force. Delta is currently in discussion with certain of its employees regarding concessions. American Airlines (\"American\") has announced a restructuring of its non-union workforce and that it is seeking $750 million in concessions and productivity gains from its unionized workers. TWA has negotiated further productivi- ty improvements with its unionized employees and has proposed another restructuring transaction in which, among other things, certain creditors would swap debt for equity. As discussed above, Continental plans to reduce its workforce by 4,000 and reduce service levels. Southwest has agreed with its pilots on a new ten year contract that provides for no wage increases in the first five years, providing for grants of stock options to the pilots instead. The announcements by Delta, American, TWA, Continental and Southwest further illustrate the trend among the major U.S. airlines to restructure in order to reduce operating and other costs and enable them to compete in a low fare environment. See Item 1. \"Business - Industry Restructuring.\"\nThe Company is actively pursuing several initiatives in an effort to enhance its revenues and to reduce USAir's costs. The Company's goal is to achieve a pre-tax margin of 3.0% in the next one to two years and a 7.5% pre-tax margin longer term. The Company believes that it must reduce USAir's annual operating expenses by approximately $1 billion in order to achieve its margin goals.\nThe Company is seeking to realize half, or approximately $500 million, of the $1 billion of annual savings through reductions in personnel costs, which are the largest single component of USAir's operating costs. USAir is engaged in discussions with the leadership of its unionized employees regarding the $500 million annual savings in personnel costs it desires to achieve through wage and benefit reductions, improved productivity, and other cost savings and has reached an agreement in principle with ALPA. The agreement in principle is subject to many significant conditions. See Item 1. \"Business - Agreement in Principle with Pilots' Union.\" The timing and outcome of USAir's discussions with its other labor unions are uncertain. No assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. Even if the savings described above are achieved, it remains uncertain whether they will be adequate in light of the Company's financial condition and competitive position. See Item 1. \"Business - Major Airline Operations.\"\nThe Company plans to achieve the remaining $500 million in annual cost savings through a combination of initiatives including: organizational and process re-engineering; rationalization of USAir's jet fleet; centralization of USAir's purchasing function; operations research initiatives intended to improve operational efficiency and maximize passenger revenue generation; and the outsourcing of certain cargo, catering, and communications positions. The Company currently expects to realize at least $250 million to $300 million savings from these initiatives during 1995 and will continue to pursue additional savings. However, there can be no assurance that these savings will be fully realized. See Item 1. \"Business - Major Airline Operations\" for additional discussion about the various initiatives.\nUSAir has implemented several programs intended to enhance its results of operations. These include USAir's quick turn program which results in increased utilization of aircraft, facilities, and personnel. In January 1995, USAir introduced a convertible passenger cabin in certain markets which will allow USAir to offer a premium service, branded \"Business Select,\" to higher yield business passengers. USAir expects to determine whether to expand the Business Select service later in 1995. This modification involves substantial one-time implementation costs and there can be no assurance that other airlines will not implement similar service. At least one other major U.S. airline has announced plans to initiate service which USAir believes is similar to Business Select. See Item 1. \"Business - Major Airline Operations\" for additional information about these programs.\nIn March 1995, USAir announced plans to cut capacity through- out its system by five percent as part of its efforts to return to profitability. It intends to emphasize the strengths of its hubs in Pittsburgh, Charlotte, Philadelphia and Baltimore, as well as other major east coast urban centers. USAir expects that this downsizing will produce over $100 million in annual financial benefits. See Item 1. \"Business - Major Airline Operations.\" In addition, the Company is evaluating and considering other strategic options, including further downsizing, which may be available to address the difficult financial and competitive factors facing USAir.\nIn order to reduce aircraft ownership costs and to reduce its fleet size, USAir has been pursuing the sale and lease of jet aircraft and has not renewed certain aircraft leases upon their expiration. USAir currently plans to reduce its operating fleet by 21 jet aircraft in 1995 from December 31, 1994 levels. USAir has taken delivery of four Boeing 757-200 aircraft in the first quarter of 1995 and intends to purchase the remaining three Boeing 757-200 aircraft scheduled to be delivered in the remainder of 1995, for which financing commitments have been obtained. It plans to retire or dispose of, at various times, 15 Boeing 737-300, five Boeing 767-200ER, two Boeing 737-200 and six Boeing 727-200 aircraft. These plans are subject to change if a labor deal is consummated, but the Company cannot predict at this time the potential impact of a labor deal on its fleet reduction plans. USAir has entered into\nan agreement with General Electric Capital Corporation (\"GE Capital\") to sell 11 Boeing 737-300 aircraft during 1995, two of which were sold in the first quarter of 1995. USAir has also reached an agreement in principle to sell two Boeing 737-300 aircraft to a leasing company during 1995. USAir believes that it will recognize a slight financial statement loss as a result of the sales of the Boeing 737-300 aircraft and cannot estimate the financial statement impact of other potential transactions at this time. Pursuant to resolutions of the boards of directors of the Company and USAir, USAir is required to use the net proceeds from contemplated aircraft sales to repay debt. Excluding any Boeing 767-200ER dispositions, USAir's capacity, as measured by available seat miles (\"ASMs\"), is expected to decrease approximately 2.5% in 1995 compared with 1994. See Item 1. \"Business - Major Airline Operations.\"\nIn its negotiations with its unions, USAir has offered an ownership stake in the Company. There are recent examples of companies in the airline industry which have obtained employee concessions in agreements also resulting in the recapitalization of the companies, including employee ownership stakes and employee participation in corporate governance. In other cases, airlines have filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code, and some airlines have ceased operation altogether when their operating costs remained excessive in relation to their revenues, and their liquidity became insufficient to sustain their operations. In addition, other factors beyond the Company's control, such as a downturn in the economy, a dramatic increase in fuel prices or intensified industry fare wars, could have a material adverse effect on the Company's and USAir's prospects, liquidity and financial condition. Because the Company and USAir are highly leveraged and currently do not have access to bank credit and receivables facilities which had supplied a substantial portion of their liquidity, or to public debt and equity markets because of their financial condition and current financial outlook, they are more vulnerable to these factors than their financially stronger competitors. See Item 1. \"Business - Significant Impact of Low Cost, Low Fare Competition\" and \"Liquidity and Capital Resources.\"\nBecause of the Company's poor financial results, it began to defer quarterly dividend payments on all series of its preferred stock in September 1994. Furthermore, the Company is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. Capital surplus is the amount of net assets which remain after deducting the capital portion of preferred and common equity. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends on all outstanding common and preferred stock issuances until its capital surplus becomes positive. Even if the Company is successful in restructuring its costs, there can be no assurance when or if preferred dividend payments will resume. See Notes 8 and 9 to the Company's consolidated financial statements.\nFrequent Traveler Program\nEach major airline has developed a frequent traveler program that offers its passengers incentives to maximize travel on that particular carrier. Participants in such programs typically earn \"mileage credits\" for every trip they fly that can be redeemed for airline travel or, in some cases, for other benefits. Under USAir's Frequent Traveler Program (\"FTP\"), participants generally receive mileage credits equal to the greater of actual miles flown or 750 miles (500 miles effective May 1, 1995) for each paid flight on USAir or USAir Express, or actual miles flown on one of USAir's FTP airline partners. Participants generally receive a minimum of 1,000 mileage credits for each paid flight on USAir Shuttle (500 miles effective May 1, 1995). Participants flying on first or business class tickets receive additional credits. Participants may also earn mileage credits by utilizing certain credit cards, staying at participating hotels or by renting cars from participat- ing car rental companies.\nMileage credits can be redeemed for certificates for various travel awards, including fare discounts, first class upgrades and tickets on USAir or other airlines participating in USAir's FTP. Certain awards also include hotel and car rental awards. Award certificates may not be brokered, bartered or sold, and have no cash value. USAir and its airline partners limit the number of seats allocated per flight for award recipients. The number of seats varies depending upon flight, day, season and destination. Award travel for all but USAir's most frequent travelers generally is not permitted on blackout dates, which correspond to certain holiday periods in the United States or peak travel dates to foreign destinations. Hotel and car awards are valid at partici- pating locations, subject to availability, and are not available for use on specified blackout dates. USAir reserves the right to terminate the FTP or portions of the program at any time, and the FTP's official rules, partners, special offers, blackout dates, awards and mileage levels are subject to change with or without prior notice.\nUSAir accounts for its FTP under the incremental cost method, whereby travel awards are valued at the incremental cost of carrying one additional passenger. Such costs are accrued when FTP participants accumulate sufficient miles to be entitled to claim award certificates. Incremental costs include unit costs for passenger food, beverages and supplies, fuel, reservations, communications, liability insurance and denied boarding compensa- tion expenses expected to be incurred on a per passenger basis. No profit or overhead margin is included in the accrual for incremen- tal costs. No liability is recorded for airline, hotel or car rental award certificates that are to be honored by other parties because there is no cost to USAir for these awards.\nEffective January 1, 1995, USAir increased the minimum mileage level required for a free domestic flight from 20,000 to 25,000. FTP participants had accumulated mileage credits for approximately 3,697,000 awards (using the new 25,000 mile level) at December 31,\n1994. The accumulated awards at the previous 20,000 mile level would have been 4,596,000 at December 31, 1994, compared with 3,896,000 awards at December 31, 1993 (also at the 20,000 mile level). Because USAir expects that some award certificates will never be redeemed, the calculations of the accrued liability for incremental costs at December 31, 1994 and 1993 were based on approximately 86% and 88%, respectively, of the accumulated credits. Mileage for FTP participants who have accumulated less than the minimum number of mileage credits necessary to claim an award is excluded from the calculation of the accrual. Most participants belong to more than one frequent traveler program and it is not possible to project when or if participants will accrue additional mileage credits required to earn an award. Incremental changes in the liability resulting from additional mileage credits are recorded as part of the regular review process.\nUSAir's customers redeemed approximately 927,000, 841,000 and 626,000 awards for free travel on USAir in 1994, 1993 and 1992, respectively, representing approximately 7.0%, 8.0% and 4.9% of USAir's revenue passenger miles (\"RPMs\") in those years, respec- tively. The number of award redemptions in 1994 may have been stimulated by the impending increase in the minimum mileage level required for a free domestic flight and could also be related to customers' fear about USAir's poor financial performance and future prospects. During 1993, two \"free ticket for segments flown\" promotions were completed which increased the number of awards used for free travel on USAir. These promotions were offered in response to similar promotions offered by USAir's competitors. USAir does not believe that usage of FTP awards results in any significant displacement of revenue passengers. USAir has the ability, through its inventory management system, to identify markets and flights expected to have high load factors and, through capacity controls, to maximize use of FTP awards on flights with lower demand and available seats. Also, blackout dates forestall the usage of awards on peak travel days. Furthermore, USAir's exposure to the displacement of revenue passengers is not signifi- cant, as the number of USAir flights that depart 100% full is minimal. In the third quarter of 1994, when the highest number of free frequent traveler miles were flown, for example, fewer than 4.0% of USAir's flights departed 100% full. During this same quarterly period, approximately 3.1% of USAir's flights departed 100% full and also had one or more passengers on board who were traveling on FTP award tickets.\nAirlines often use other competitive promotions, such as offering extra credits or reduced award thresholds under certain conditions, as incentives to stimulate travel. To the extent these promotions are determined to be an integral part of the FTP, they are accounted for in the same manner as free travel earned through mileage credits.\nA recent decision by the U.S. Supreme Court involving American held that members of frequent traveler programs may file contract claims against airlines in state courts. In February 1995, members of USAir's frequent traveler program filed a class action lawsuit\nagainst USAir after it raised the required minimum level of miles necessary to earn a free ticket. See Item 3. \"Legal Proceedings.\" It is possible that additional lawsuits, including class action suits, could be brought against carriers, including USAir, by members of frequent traveler programs. In addition, the DOT has expressed concern about potential consumer fraud relating to frequent traveler programs and their restrictions on the use of awards. It is uncertain whether USAir will be named party in any further litigation or if the DOT will take any action with respect to frequent traveler programs. The Company cannot determine the potential effect, if any, of the existing or potential class action lawsuits or possible DOT actions on its results of operations and financial condition.\nIndustry Globalization and Regulation\nThe trend toward globalization of the airline industry has accelerated in recent years as certain U.S. and foreign carriers have formed marketing alliances. Certain foreign carriers have made substantial investments in U.S. carriers which have frequently been tied to marketing alliances or, less frequently, reciprocal investments by the U.S. carrier in its foreign partner. Foreign investment in U.S. air carriers is restricted by statute and may be subject to review by the U.S. Department of Transportation (\"DOT\") and, on antitrust grounds, by the U.S. Department of Justice (\"DOJ\").\nOn January 21, 1993, USAir Group and BA entered into an Investment Agreement (\"Investment Agreement\") under which a wholly- owned subsidiary of BA has to date purchased certain preferred stock of the Company for $400.7 million. On March 7, 1994, BA announced that it would not make any additional investments in the Company until results of its efforts to reduce its costs are known. Under the Investment Agreement, USAir and BA have entered into a code sharing arrangement under which certain domestic USAir flights, connecting to certain BA transatlantic flights, may be listed on computerized reservation systems either under USAir's or BA's two letter designation code, subject to authorization by the DOT. As of March 1, 1995, USAir and BA offered code share service to and from 52 of the 65 airports authorized by the DOT. On January 13, 1995, USAir and BA filed applications to renew for another one year term the existing authorizations which were granted on March 17, 1994. The DOT has taken no action with respect to the renewal applications. Therefore, the existing authorizations have been extended automatically until final action is taken by the DOT. In January 1994, USAir and BA filed applica- tions with the DOT to code share to 65 additional domestic and seven additional foreign destinations. The DOT has not yet acted on these applications. See Item 1. \"Business - British Airways Investment Agreement\".\nUSAir believes that the code sharing arrangement provides greater access to international traffic and that its and BA's customers benefit from better on-line connections as well as coordinated check-in and baggage checking procedures. The DOT may\ncontinue to link further renewals of the code share authorization to the United Kingdom's (\"U.K.\") liberalization of U.S. air carrier access to the U.K. markets. However, the code sharing arrangement is expressly permitted under the bilateral air services agreement between the U.S. and U.K. USAir expects that the authorization will be renewed in the future; however, there can be no assurance that this will occur. USAir does not believe that the DOT's failure to renew the code share authorization or grant the pending application would result in a material adverse change in its financial condition. However, further investment in the Company by BA, as contemplated in the Investment Agreement, may be less likely. See Item 1. \"Business - British Airways Announcement Regarding Additional Investments in the Company\" and \"- British Airways Investment Agreement.\"\nAs part of its initiative in the transportation industry, the Clinton Administration had indicated that the DOT would conduct a comprehensive examination of the \"high density rule\" which limits airline operations at Chicago O'Hare, New York's LaGuardia (\"LaGuardia\") and John F. Kennedy International, and Washington National (\"National\") Airports by restricting the number of takeoff and landing slots. As part of its study, the DOT will determine whether the operating limitations imposed by the rule can be elimi- nated or modified to better utilize available capacity at these airports. The DOT has not yet released the results of its study. USAir holds a substantial number of slots at LaGuardia and National, including slots purchased from Continental in 1992 and those assigned a value when the Company acquired Piedmont Aviation, Inc. in 1987. Any DOT action which would eliminate those slots or compel USAir to transfer those slots could have a material adverse effect on USAir's operations and financial position. Revision of the high density rule at National, however, would require legisla- tion by Congress.\nResults of Operations\n1994 Compared with 1993\nAdverse weather during the first quarter, the two aircraft accidents which occurred during the third quarter, the intense competitive environment characterized by the growth of low cost, low fare airlines in USAir's markets, widespread industry fare discounting, and USAir's cost structure are factors that had a negative effect on the Company's results of operations during 1994. To the extent that certain of these factors continue to be present, particularly USAir's higher cost structure relative to its competitors, the Company's results of operations and financial condition will continue to be materially and adversely affected.\nThe Company recorded a net loss of $684.9 million on revenue of $7.0 billion for 1994, compared with a net loss of $393.1 million on revenue of $7.1 billion for 1993. The Company estimates that severe winter weather in the first quarter of 1994 negatively affected its results of operations by approximately $50 million and that the effect of the two aircraft accidents during the third and\nfourth quarters of 1994 produced a revenue shortfall of approxi- mately $150 million from forecast amounts.\nThe financial results for 1994 include: (i) a $172.9 million charge related to USAir's grounded BAe-146 fleet and to USAir's decision to cease operations of its remaining Boeing 727 aircraft in 1995; (ii) a $54.0 million charge for obsolete inventory and rotables to reflect market values; (iii) a $25.9 million charge related to USAir's decision to reduce substantially service between Los Angeles and San Francisco in November 1994; (iv) a $28.3 million gain resulting from the sale of certain aircraft and assets to Mesa Air Group, Inc. (formerly Mesa Airlines, Inc.) (\"Mesa\") and the accounting treatment of the hull insurance recovery on the aircraft destroyed in the September accident; and (v) a $1.7 million charge related to the sale of assets to Mesa. The following table indicates where these items appear in the Company's consolidated statement of operations which is found in Part II, Item 8A. of this report ($ millions, brackets denote expense):\nIn addition to the above charges, USAir recorded a $50 million addition to passenger transportation revenue in the fourth quarter of 1994 to adjust estimates made during the first three quarters of 1994.\nThe financial results for 1993 included: (i) a $43.7 million charge for the cumulative effect of an accounting change, as required by Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits;\" (ii) a $68.8 million charge for severance, early retirement, and other person- nel-related expenses for a workforce reduction of approximately 2,500 full-time positions; (iii) a $36.8 million charge based on a projection of the repayment of certain employee pay reductions; (iv) a $13.5 million charge for certain airport facilities at locations where USAir has, among other things, discontinued or reduced its service; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership, which operates a computerized reservations system; and (vi) an $18.4 million credit related to non-operating aircraft. The following table indicates where these items (excluding the accounting change) appear in the Company's statement of operations which is found in Part II, Item 8A. of this report ($ millions, brackets denote expense):\nOperating Revenue - Increases in traffic which were stimulated by the lower fares during 1994 were not sufficient to offset USAir's lower yields (revenue per RPM) experienced during 1994. The Company expects that capacity, as measured by ASMs, will decrease by approximately 2.5% in 1995 compared with 1994, and yields will be relatively unchanged for the entire year 1995 compared with 1994. The Company believes that for the foreseeable future the demand for higher yield \"business fares\" will remain essentially flat and relatively inelastic while the lower yield \"leisure\" market will continue to grow with the general economy. This trend will make it more difficult for the domestic airlines, including USAir, to achieve meaningful yield increases in the future.\nAs discussed above, severe winter weather in the first quarter of 1994 had a material adverse effect on the Company's operations and financial results. Passenger transportation revenue increased during the second quarter compared with 1993 because increases in passenger traffic more than offset the dilutive effect of the lower fares. However, this trend did not continue in the third and fourth quarters primarily due to the reduced number of passengers following the two aircraft accidents. By early 1995, USAir's traffic had recovered from the effects of the accidents and approached a level normally associated with USAir's capacity in the marketplace.\nThe Company's Passenger Transportation Revenue decreased $197.4 million (3.0%) in 1994 compared with 1993, $159.6 million of which is attributable to USAir and the remainder to the Company's wholly-owned regional airlines. Despite the negative effect of the adverse weather during the first quarter and the two accidents during the third quarter, USAir's scheduled traffic as measured by RPMs increased by 7.7% during 1994 on 2.6% of additional capacity, as measured by ASMs, resulting in a 3.0 percentage point increase in passenger load factor, a measure of capacity utilization. However, USAir's yield decreased by 9.6% in 1994 compared with 1993 due to several factors including lower fares resulting from increased competition from low cost, low fare carriers in USAir's markets and industry fare discounting promotions. USAir expects that its yield for the year 1995 will be relatively unchanged compared with 1994. The Company expects that the low fares offered in response to low cost, low fare competition will generally remain in place and, even if traffic is stimulated, will continue to materially and adversely affect its results of operations unless USAir is successful in reducing its operating costs.\nIn March 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit, which alleged that the airlines used the Airline Tariff Publishing Company to signal and communi- cate carrier pricing intentions and otherwise limit price competi- tion for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers have issued $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates, and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir has estimated that any incremental cost associated with the settlement will not be material based on the nominal equivalent free trips associated with the settlement. The travel certificates were mailed to claimants in December 1994 and may be applied towards travel purchased between January 1995 and December 1998.\nOn October 11, 1994, USAir and seven other carriers entered into a settlement agreement with a group of State Attorneys General resolving similar issues with the states. The settlement entitles passengers traveling within the United States on state government business to a 10% discount off the published fares of each of the settling carriers and will be available for 18 months or until the combined discount amount reaches $40 million. Following a notice and public comment period, the reviewing judge will conduct a hearing to determine whether this settlement is a fair one. The hearing is scheduled for May 10, 1995. The Company does not expect that this settlement will have a material adverse effect on its financial condition or results of operations. As was the case with the settlement of the private antitrust litigation, it is difficult to predict the amount of discounted state travel that will occur on USAir. Thus, a dollar impact of the settlement cannot be estima- ted.\nThe Company's Cargo and Freight revenue decreased $10.2 million (5.9%) due to USAir's $10.1 million (5.9%) decrease caused by overall lower volumes and lower mail yields during 1994. The $121.6 million (34.3%) increase in the Company's Other Revenue ($125.2 million or 33.8% for USAir) is the result of several factors including the wet lease arrangement between USAir and BA, increased volume and rate for cancellation and rebooking fees, and fees from companies which participate in USAir's frequent traveler program. These increases are largely offset by increases in other operating expenses. The duration of the British Airways wet lease revenue is expected to be no more than a three year period for each of the three aircraft involved. One each of the three aircraft began the wet lease service in the months of June 1993, October\n1993, and January 1994. The Company expects that the increased levels in the other categories will continue.\nExpense - The Company's Personnel Costs increased $48.4 million (1.7%) primarily due to USAir's $55.2 million (2.0%) increase in personnel costs. Excluding the effect of the unusual charges discussed and presented in the tables above, USAir's personnel costs increased $157.3 million (6.1%) in 1994 compared with 1993 due to the expiration during 1993 of employee wage reductions, subsequent contractual and general salary increases, and a lower discount rate used during 1994 in the calculation of pension and postretirement benefit expense. These increases more than offset any expense reductions realized as a result of the workforce reduction during 1994. Aviation Fuel expense decreased $38.2 million (5.4%), primarily because of USAir's $35.6 million (5.2%) decrease, which is the result of an 8.8% reduction in the cost of fuel partially offset by a 3.8% increase in consumption compared with 1993. Fuel prices are expected to increase during 1995. Further, a 4.3 cent per gallon tax on transportation fuels is scheduled to become effective within the airline industry on October 1, 1995. This tax increase would result in over $50 million of additional annual expense for the Company. However, in early 1995 legislation was introduced to repeal the tax on transportation fuels scheduled to become effective October 1, 1995 in the airline industry. There can be no assurance if or when this legislation will be passed. See Item 1. \"Business - Jet Fuel\" and Note 2 to the Company's consolidated financial statements. The Company's Commissions expense decreased $13.6 million (2.3%) and $10.6 million (1.9%) at USAir as a result of decreased passenger revenue. In early 1995, several large carriers, including USAir, announced limits on the amount of travel agent commissions they will pay. See Item 1. \"Business - General Industry Conditions\" and Note 4 to the Company's consolidated financial statements. The Company's Other Rent and Landing Fees expense decreased $9.3 million (2.1%) and $9.4 million (2.2%) at USAir primarily due to lower operating costs at certain airport facilities. See Item 2. \"Properties.\" The Company's Aircraft Rent increased $91.0 million (19.2%) primarily due to USAir's $89.8 million (20.8%) increase. Excluding the effect of the unusual charges discussed and presented in the tables above, USAir's aircraft rent decreased $25.7 million (6.0%) in 1994 compared with 1993 due to the expiration or renegotiation of several aircraft leases and additional wet lease service over 1993 levels. The Company's Aircraft Maintenance increased $18.1 million (4.8%) primarily because of USAir's $26.9 million (8.7%) increase which resulted from the $18.4 million credit in 1993 (see above table) and initial repairs on certain of USAir's newer aircraft in 1994. The Company's Depreciation and Amortization expense increased $55.2 million (15.7%) due to USAir's $61.0 million (18.8%) increase. Excluding the effect of\nthe unusual charges discussed and presented in the tables above, USAir's depreciation and amortization expense increased $16.6 million (5.3%) in 1994 compared with 1993 primarily due to the delivery of new Boeing 757-200 aircraft. The $158.0 million (11.4%) increase in the Company's Other Expenses, Net is due to USAir's $146.0 million (10.9%) increase. Excluding the effect of the unusual charges discussed and presented in the tables above, USAir's other expenses, net increased $65.0 million (4.9%) in 1994 compared with 1993 largely due to increases in several passenger volume-related expense categories and expenses related to the increase in USAir's other revenue category discussed above.\nThe Company's Interest Income improved by $14.5 million as a result of higher cash levels and more favorable interest rates in 1994. USAir's results include intercompany transactions which are eliminated from the Company's results. The Company's Interest Expense increased $34.1 million (13.7%) primarily as a result of interest incurred on certain aircraft-secured and unsecured financings completed during 1993 and 1994. Interest Capitalized decreased $4.0 million (22.5%) because average deposits for future aircraft deliveries were lower during 1994 compared with 1993. Other, Net reflects an $83.7 million improvement primarily due to the $28.3 million gain discussed above and improved equity results from USAir's 11% ownership investment in the Galileo International Partnership, which owns and operates the Galileo Computerized Reservation System (\"CRS\"), and USAir's 21% ownership investment in the Apollo Travel Services Partnership, which markets the Galileo CRS in the U.S. and Mexico.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). The adoption of FAS 109 resulted in no cumulative adjustment. Results for 1994 and 1993 do not include any income tax credit due to the FAS 109 limitations in recognizing a current benefit for net operating losses. See Note 6 to the Company's consolidated financial statements for additional information.\n1993 Compared with 1992\nThe Company recorded a net loss of $393.1 million on revenue of $7.1 billion in 1993 compared with the 1992 net loss of $1.2 billion on revenue of $6.7 billion. Several unusual items, which include the cumulative effect of accounting changes, make it diffi- cult to compare these results. After excluding the effect of the unusual items discussed below, which amount to $153.2 million and $759.3 million in 1993 and 1992, respectively, the net loss would have been $239.9 million in 1993 ($5.69 per common share after preferred dividend requirement) compared with a loss of $469.6 million in 1992 ($11.09 per common share after preferred dividend requirement).\nThe Company's 1993 financial results contain $153.2 million of unusual items discussed above. The Company's 1992 financial results contain $759.3 million of unusual items, including (i) a $628.1 million charge for the cumulative effect of an accounting change, as required by Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"); (ii) a $107.4 million charge related to aircraft which have been withdrawn from service; (iii) a $34.1 million loss related to the sale of ten McDonnell Douglas 82 (\"MD-\n82\") aircraft which USAir had on order but eliminated from its fleet plan; and (iv) a $10.3 million gain resulting from the sale of three of the Company's subsidiaries during 1992. The following table indicates where these items (excluding the accounting change) appear in the Company's consolidated statement of operations which is found in Part II, Item 8A. of this report ($ millions, brackets denote expense):\nOperating Revenue - The Company's Passenger Transportation Revenue increased by $356.5 million (5.8%) in 1993 compared with 1992, primarily due to the $296.0 million (5.1%) increase at USAir. USAir's RPMs increased by 0.4% during 1993 on 0.3% less capacity, as measured by ASMs, resulting in a 0.4 percentage point increase in passenger load factor, a measure of capacity utilization. USAir's yield increased by 4.7% in 1993 compared with 1992 due to the lower level of fare discounting in 1993 versus 1992. Several factors during 1992 led to an industry-wide 50%-off sale for summer travel that year.\nThe Company's Other Revenue increased by $38.8 million (12.3%) in 1993. USAir's increase of $90.5 million (32.3%) was partially offset at the Company level by a decrease in non-airline subsidiary revenue resulting from the sale of three wholly-owned subsidiaries in July 1992. USAir's 32.3% improvement was the result of several factors including the wet lease arrangement between USAir and BA, increased volume and rate for cancellation and rebooking fees, contract services performed for USAir Shuttle under a management agreement, and fees from companies which participate in USAir's frequent traveler program. These increases were largely offset by increases in operating expenses. The USAir Shuttle service revenue is related to USAir's agreement to manage the USAir Shuttle which began in 1992 and will continue for up to ten years from that date.\nExpense - The Company's total operating expenses increased $146.3 million (2.1%) in 1993 compared with 1992. The Company's Personnel Costs increased by $217.7 million (8.3%), $205.6 million of which is attributable to USAir. Without the effect of the unusual charges discussed above, USAir experienced an increase in employee salaries of $91.4 million (4.7%) and an increase in employee benefits of $11.8 million (2.1%). The increase in employee salaries is generally due to contractual and general salary increases which occurred during 1993. The amount saved as a result of USAir's 12-month salary reduction program was approxi- mately the same in 1993 and 1992. The $11.8 million increase in employee benefits is the result of increased pension expense,\noffset partially by a decrease in other postretirement benefit expense. The increased pension expense in 1993 resulted from the establishment of a defined contribution pension plan for USAir's non-contract employees on January 1, 1993. The defined benefit plan for these employees was frozen at December 31, 1991.\nThe Company's Aviation Fuel Expense decreased $43.2 million (5.7%) due to USAir's $42.8 million (5.9%) decrease which resulted from a lower cost per gallon and decreased consumption. The Company's Commissions increased by $27.2 million (4.8%), reflecting USAir's $22.1 million (4.1%) increase which resulted from the increase in Passenger Transportation Revenue. The Company's Other Rent and Landing Fees increased $56.9 million (14.6%) due to USAir's $57.3 million (15.3%) increase which was primarily the result of increased facility rental expense following the opening of the new terminal at Pittsburgh in October 1992. The Company's Aircraft Rent expense decreased $57.4 million (10.8%) due to USAir's $64.4 million (13.0%) decrease. Without the unusual charges discussed above, USAir's aircraft rent expense increased $8.0 million (1.9%) due to the addition of new leased aircraft in 1993. Excluding the effect of the unusual items discussed above, the Company's and USAir's Aircraft Maintenance expense increased by $37.6 million (10.6%) and $33.3 million (11.3%), respectively, resulting from USAir's timing of aircraft maintenance cycles. The Company's Other Operating Expense decreased by $57.4 million (4.0%), reflecting a $24.4 million (1.8%) decrease at USAir and a $58.4 million decrease which resulted from the sale of three wholly-owned subsidiaries in July 1992, offset by increases at the Company's other wholly-owned subsidiaries.\nThe Company's Interest Capitalized decreased $10.0 million (36.1%) as the level of outstanding purchase deposits decreased with the delivery of new aircraft and changes in delivery sched- ules. The $9.5 million (21.8%) improvement in the Company's Other Non-operating Expense, net is driven by the unusual gains and losses described above.\nEffective January 1, 1993, the Company adopted FAS 109. The adoption of FAS 109 resulted in no cumulative adjustment. Results for 1993 do not include any income tax credit due to the FAS 109 limitations in recognizing a current benefit for net operating losses. See Note 6 to the Company's consolidated financial statements for additional information.\nInflation and Changing Prices\nInflation and changing prices do not have a significant effect on the Company's operating revenues and expenses (other than depreciation and amortization) because such revenues and expenses generally reflect current price levels.\nDepreciation and amortization expense is based on historical cost. For assets acquired through the purchase of Pacific Southwest Airlines, USAir's historical cost is based on fair market value of the assets on May 29, 1987. In the case of Piedmont\nAviation, Inc., USAir's historical cost is based on the fair market value of the assets on November 5, 1987, reduced by the tax effect of that portion of fair market value not deductible for tax purposes in the form of depreciation and amortization. Therefore, aggregate depreciation and amortization is lower than if this expense reflected today's replacement costs for existing productive assets. In evaluating how inflation would increase depreciation expense, however, consideration should also be given to the reduction in other operating expenses, such as aircraft maintenance and aviation fuel, that would be achieved from the operating efficiencies of newer, more technologically advanced productive assets.\nLiquidity and Capital Resources\nCash provided by operations was approximately $1 million in 1994. At December 31, 1994, cash and cash equivalents totaled approximately $429.5 million and short-term investments totaled approximately $22.1 million. These amounts exclude approximately $161.1 million which was deposited in trust accounts to collateral- ize letters of credit or workers compensation policies and classified as \"Other Assets.\" Due to the coincidence of certain semiannual, quarterly and monthly debt and lease payments, substantial scheduled payments of more than $170 million were due and paid in the month of January 1995. The Company ended the first quarter of 1995 with approximately $400 million in cash and short- term investments, substantially higher than previously expected primarily due to the timing of certain working capital activity. However, market, economic and other factors discussed below could adversely affect the Company's future liquidity position.\nThe Company and USAir are highly leveraged. In order to meet debt service, lease and other obligations and to finance daily operations, the Company and USAir require substantial liquidity and working capital. In view of the Company's limited liquidity in relation to the size of USAir's operations and its associated obligations, developments may occur that are beyond the control of the Company and USAir which could have a material adverse effect on the Company's prospects, liquidity and financial condition, including intensified fare wars, substantial increases in jet fuel prices, adverse weather conditions, negative public perception regarding safety, and further incursion by low cost, low fare carriers into USAir's markets. USAir is seeking in discussions with the leadership of its unionized employees substantial wage reductions, improved productivity and other cost savings and has reached an agreement in principle with ALPA that is subject to various significant conditions. See Item 1. \"Business - Agreement in Principle with Pilots' Union.\" However, if unforeseen adverse developments occur, if the Company and USAir are unable to finance unencumbered assets, or if timely agreements with the unions are not finalized and consummated, the Company and USAir may pursue other restructuring alternatives. See Item 1. \"Business - Signifi- cant Impact of Low Cost, Low Fare Competition\" and \"Low Cost, Low Fare Competition\" above.\nThe Company has deferred the dividend payments on all series of its preferred stock. The aggregate annual dividend requirements related to all series of the Company's preferred stock total approximately $80 million. Furthermore, the Company is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends on all outstanding common and preferred stock issuances until its capital surplus becomes positive. Even if the Company is successful in restructuring its costs, there can be no assurance when or if dividend payments will resume. See Notes 8 and 9 to the Company's consolidated financial statements for additional information.\nThe Company currently is not party to a revolving credit facility. The Company has historically utilized such a facility to supplement its liquidity from time to time. On April 26, 1994, the Company terminated its revolving credit facility with a group of banks (\"Credit Agreement\"). As a result, 66 jet and turboprop aircraft and certain spare engines with a net book value of approximately $260 million at that time were released from a mortgage related to the Credit Agreement. Certain of the Boeing 737-300 aircraft which USAir has agreed to sell are among the 66 unencumbered aircraft. Pursuant to resolutions of the boards of directors of the Company and USAir, USAir is required to use any proceeds from the contemplated aircraft sales to repay certain debt. USAir has notified one of its creditors that it intends to prepay approximately $60 million in aircraft-secured debt in May 1995 and will use proceeds from asset sales to make the payment.\nUSAir's revolving accounts receivable sale program (\"Receiv- ables Agreement\") expired in December 1994. USAir was unable to sell receivables under the agreement during 1994 because of failure to comply with financial covenants required to be maintained in connection with that agreement. USAir is currently engaged in discussions with the financial institution that was party to the Receivables Agreement regarding a new agreement. There can be no assurance that USAir will be successful in reaching a new agreement to sell its receivables.\nOn May 12, 1994, USAir reached an agreement with Boeing to reschedule the delivery of 40 737-series aircraft from the 1997- 2000 time period to the years 2003-2005. In addition, as part of the same agreement, USAir relinquished all of its options to purchase aircraft during the 1996-2000 time period. In early 1995, USAir reached an agreement in principle with Boeing and Rolls-Royce plc to reschedule the delivery dates for eight 757-200 aircraft from 1996 to 1998. As a result of these recent agreements, the Company's capital commitments have been substantially reduced for the 1995-2000 time period. See Note 4 to the Company's consolidat- ed financial statements for the future aircraft commitments schedule reflecting these agreements with Boeing and for future expenditures required to comply with Stage 3 noise level require- ments of the FAA. During 1993 to the present time, USAir's\nagreements with Boeing to defer and reschedule certain Boeing 737- series and 757-200 deliveries reduced USAir's capital expenditures by over $1 billion between 1993 and 1996 from previously planned amounts.\nThe Company's and USAir's debt and equity securities are presently rated below investment grade by Standard and Poor's Corporation (\"S&P\") and Moody's Investors Service, Inc. (\"Moody's\"). In February 1994, as a result of USAir's low fare initiative in certain markets and its high cost structure, S&P and Moody's placed the securities of the Company and USAir on watch with negative implications. On March 24, 1994, S&P downgraded the Company's and USAir's securities. On September 29, 1994, following the Company's announcement that it had deferred payment of preferred dividends, Moody's and S&P further downgraded their ratings of the Company's and USAir's securities. S&P continues to keep the securities of the Company and USAir on watch with negative implications. The ratings of the Company's and USAir's debt and equity securities make it more difficult for the Company and USAir to effect additional financing. On January 19, 1995, Moody's announced that it is revising its rating practice on airline equipment trust and pass through obligations and would consider assigning higher ratings to certain of these securities. At the same time, Moody's placed under review all existing airline equipment trust certificates and pass through obligations (including those of USAir) for possible upgrade. At this time, USAir does not believe that an upgrade by Moody's would have any material positive or negative effect on USAir's ability to effect additional financings.\nUSAir and the Company have filed with the Securities and Exchange Commission a shelf registration for various debt and equity securities. Approximately $187 million of securities remain available for sale on the shelf registration and may be sold from time to time depending on market conditions. The Company will continue to evaluate opportunities in the financial markets. However, the Company believes that the availability of those opportunities will be directly related to USAir's success in restructuring its costs and its resulting financial prospects.\nThe Company and USAir are party to certain financial contracts to reduce exposure to fluctuations in the price of jet fuel and interest rates. Under the jet fuel arrangements, USAir pays a fixed rate per notional gallon of fuel and receives in return a floating rate per notional gallon based on the market rate during the month of settlement. Under the interest rate agreements, the Company pays a fixed rate on a notional principal amount and receives a floating rate on the notional principal in return. Decreases in the market cost of jet fuel and market interest rates below the rates specified in the contracts require the Company and USAir to make cash payments. However, the Company and USAir believe these contracts do not present a material risk to the Company's financial position or liquidity due to the relatively simple terms of the agreements, their purpose, and their short\nremaining duration. See Note 2 to the Company's consolidated financial statements for additional information.\nUSAir and certain of the Company's other subsidiaries have received notices from the U.S. Environmental Protection Agency and various state agencies that they are potentially responsible parties with respect to the remediation of existing sites of environmental concern. The Company believes that the ultimate resolution of known environmental contingencies should not have a material adverse effect on its liquidity or financial position based on the Company's experience with similar environmental sites. See Note 4 to the Company's consolidated financial statements.\nDuring 1994, the Company's investment in new aircraft acquisi- tions and purchase deposits totaled $270.6 million (which includes $224.6 million presented as \"non-cash\" on the Company's consolidat- ed statement of cash flows since debt was incurred upon delivery of aircraft or to satisfy equipment deposit progress payments). USAir took delivery of five new Boeing 757-200 aircraft during 1994. The Company invested $134.1 million in non-aircraft property during 1994 (e.g., ground support equipment, computer equipment, software, aircraft rotables and hushkits, and take-off and landing slots), partly offset by $75.1 million in proceeds from disposition of assets which includes the sale of certain aircraft and assets to Mesa and insurance proceeds related to a jet aircraft involved in the September 1994 accident. Net cash provided by financing activities was $183.4 million, which includes (i) $172.2 million net proceeds received by USAir upon the sale of $175 million principal amount of 9 5\/8% Senior Notes due 2001 through an underwritten public offering and (ii) $136.7 million of new debt issued which is secured by aircraft delivered before 1994, offset by $87.1 million of scheduled debt payments and $49.7 million of preferred dividend payments. In addition, as discussed above, the Company incurred $270.6 million of debt upon delivery of five Boeing 757-200 aircraft and to satisfy equipment deposit progress payments. USAir has committed financing for its 1995 scheduled aircraft deliveries.\nDuring 1993, the Company's investment in new aircraft acquisi- tions and purchase deposits totaled $545.3 million (which includes $343.2 million presented as \"non-cash\" on the Company's consolidat- ed statement of cash flows since debt was incurred upon delivery of aircraft or to satisfy equipment deposit progress payments). USAir took delivery of 11 Boeing 757-200, one Boeing 767-200, and six MD- 82 aircraft during the year. The MD-82s were immediately sold to a third party. In addition, USAir sold two other MD-82 aircraft which had been delivered in the fourth quarter of 1992. Proceeds from the sale of the MD-82s approximated $168 million. The Company completed financing arrangements for, including the $337.7 million issue of Pass Through Certificates (\"Certificates\") which USAir sold through an underwritten public offering on November 1, 1993, or internally funded, all of its 1993 aircraft expenditures. The Company invested $159.0 million in non-aircraft property during 1993 (e.g., ground support equipment, computer equipment, software, aircraft rotables and hush kits, take-off and landing slots).\nOn January 21, 1993, a wholly-owned subsidiary of BA purchased 30,000 shares of the 7% Series F Cumulative Convertible Senior Preferred Stock (\"Series F Preferred Stock\"), for $300 million. Substantially all of the $300 million received by the Company from the sale of the Series F Preferred Stock was used to pay down debt under the Company's Credit Agreement. The Series F Preferred Stock is subject to mandatory redemption on January 15, 2008.\nOn May 4, 1993, the Company sold 11.5 million shares of $1 par value Common Stock at $20.75 per share which netted proceeds of approximately $231 million. BA partially exercised its preemptive right to maintain its proportionate ownership percentage by purchasing, on June 10, 1993, 9,919.8 shares of redeemable Series T-2 Cumulative Exchangeable Senior Preferred Stock (\"Series T-2 Preferred Stock\") for approximately $99.2 million. For additional information, see Note 8 to the Company's consolidated financial statements. On March 7, 1994, BA announced that it would not make any additional investments in the Company until the outcome of measures by the Company to reduce costs and improve its financial results is known.\nOn July 8, 1993, USAir sold $300 million principal amount of 10% Senior Notes due 2003 (\"10% Notes\") through an underwritten public offering. The offering netted proceeds of approximately $294 million. The 10% Notes are unconditionally guaranteed by the Company.\nAll net proceeds received by USAir or the Company from the Common Stock offering, the sale to BA of the Series T-2 Preferred Stock, the sale of the 10% Notes and 9 5\/8% Notes were added to the working capital of the Company for general corporate purposes.\nIn 1992, the Company's investment in new aircraft acquisitions and purchase deposits, net of deposits refunded, totaled $458.7 million (which includes $219.6 million presented as \"non-cash\" on the Company's consolidated statement of cash flows since debt was incurred upon delivery of aircraft or to satisfy equipment deposit progress payments). The Company purchased eight Fokker and four de Havilland Dash 8 aircraft during 1992. The acquisition of these aircraft was financed through a combination of secured debt financings and interim debt financings. In addition, USAir took delivery of four MD-82s, two of which were immediately sold to a third party. The remaining two aircraft delivered in 1992 were sold to a third party in early 1993. Cash outflows for other property during the period totaled $277.2 million, which includes $61 million paid to Continental for landing and take-off slots at LaGuardia and National Airports and $50 million paid to TWA for London routes from BWI and Philadelphia International Airports. See Item 1. \"Business - British Airways Investment Agreement - U.S.-U.K. Routes.\" Proceeds from disposition of assets of $429.5 million were realized during the year, primarily from sale- leaseback transactions, the sale of the two MD-82 aircraft, and the sale of three wholly-owned subsidiaries.\nAt December 31, 1994, USAir Group's ratio of current assets to current liabilities was .49 to 1 and the debt component of USAir Group's capitalization structure was greater than 100% (also greater than 100% if the three series of redeemable preferred stock are considered to be debt) due to the existence of a net capital deficiency.\n(this space intentionally left blank)\nItem 8A. Financial Statements and Supplementary Information USAir Group, Inc.\nIndependent Auditors' Report\nThe Stockholders and Board of Directors USAir Group, Inc.:\nWe have audited the consolidated balance sheets of USAir Group, Inc. and subsidiaries (\"Group\") as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows, and changes in stockholders' equity (deficit) for each of the years in the three-year period ended December 31, 1994. These consoli- dated financial statements are the responsibility of Group'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 USAir Group, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for the three-year period ended December 31, 1994 in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that Group will continue as a going concern. As discussed in Note 4(a) to the consolidated financial statements, Group has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 4(a). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nAs discussed in Note 11 to the consolidated financial statements, effective January 1, 1993, Group changed its method of accounting for postemployment benefits and effective January 1, 1992, Group changed its method of accounting for postretirement benefits other than pensions.\nKPMG Peat Marwick LLP Washington, D. C. February 22, 1995, except as to Notes 4(a) and 4(c) which are as of April 10, 1995\nUSAir Group, Inc. Notes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies\n(a) Basis of Presentation\nThe accompanying consolidated financial statements include the accounts of USAir Group, Inc. (\"USAir Group\" or the \"Company\") and its wholly-owned subsidiaries USAir, Inc. (\"USAir\"), Piedmont Airlines, Inc. (\"Piedmont\"), Jetstream International Airlines, Inc. (\"Jetstream\"), Allegheny Airlines, Inc. (\"Allegheny\") (formerly Pennsylvania Commuter Airlines, Inc. (\"PCA\")), USAir Leasing and Services, Inc. (\"Leasing\"), USAir Fuel Corporation and Material Services Company, Inc. All significant intercompany accounts and transactions have been eliminated.\nAt December 31, 1992, USAM Corp. (\"USAM\"), a subsidiary of USAir, owned 11% of the Covia Partnership (\"Covia\") which owned and operated a computerized reservation system (\"CRS\"). In September 1993, Covia purchased the assets of the corporation that owned and operated the Galileo CRS which provided CRS services to travel agent subscribers in Europe. Covia was immediately separated into three new entities and, as a result, USAM owns 11% of the Galileo International Partnership which owns and operates the Galileo CRS, approximately 11% of the Galileo Japan Partnership which markets the Galileo CRS in Japan, and approximately 21% of the Apollo Travel Services Partnership which markets the Galileo CRS in the U.S. and Mexico. USAM accounts for these investments using the equity method because it is represented on the board of directors of each of the partnerships and therefore participates in policy making processes.\nOn August 1, 1992, two wholly-owned USAir Group regional airline subsidiaries, Allegheny Commuter Airlines, Inc. and PCA, merged. The combined entity is now called Allegheny Airlines, Inc.\nOn July 15, 1992, USAir Group completed the sale of three of its wholly-owned subsidiaries: Piedmont Aviation Services, Inc., Air Service, Inc. and Aviation Supply Corporation. The Company realized a gain of $10.3 million as a result of the sale. The three former subsidiaries engaged in fixed base operations and the sale and repair of aircraft and aircraft components. These subsidiaries were included in the accounts until their sale.\nUSAir Group's principal operating subsidiary, USAir, and three regional airline subsidiaries, Piedmont, Jetstream and Allegheny, operate within one industry (air transportation); therefore, no segment information is provided.\nCertain 1993 and 1992 amounts have been reclassified to conform with 1994 classifications.\n(b) Cash and Cash Equivalents and Short-Term Investments\nFor financial statement purposes, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates market value. Short-term investments consist of certificates of deposit and commercial paper with original maturities greater than three months but less than one year. Short-term investments are stated at cost plus accrued interest, which approximates market value.\n(c) Materials and Supplies\nInventories of materials and supplies are valued at average cost and are charged to operations as consumed. An allowance for obsolescence is provided for flight equipment expendable parts.\n(d) 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. Maintenance and repairs, including the overhaul of aircraft components, are charged to operating expense as incurred and costs of major improvements are capitalized for both owned and leased assets. Interest related to deposits on aircraft purchase contracts and facility and equipment construction projects is capitalized as additional cost of the asset or as leasehold improvement if the asset is leased. Depreciation and amortization for principal asset classifications is provided on a straight-line basis to estimated residual values over estimated depreciable lives as follows:\nProperty acquired under capital lease is amortized on a straight-line basis over the term of the lease and charged to Depreciation and Amortization Expense.\n(e) Goodwill, Other Intangibles and Other Assets\nGoodwill, the cost in excess of fair value of identified net assets acquired, is being amortized on a straight-line basis over 40 years. The $629 million goodwill resulting from the acquisition of Pacific Southwest Airlines (\"PSA\") and Piedmont Aviation, Inc. (\"Piedmont Aviation\"), both in 1987, is being amortized as Depreciation and Amortization Expense. Accumulated amortization at December 31, 1994 and 1993 related to the PSA and Piedmont acquisitions was $113 million and $97 million, respectively. The $11 million goodwill resulting from USAM's CRS investments is being amortized as other non-operating expense, consistent with the classification of income or loss on the investments. USAM's associated accumulated amortization at December 31, 1994 and 1993 was $2 million and $1 million, respectively. USAir evaluates whether or not goodwill is impaired by comparing the goodwill balances with estimated future undiscounted cash flows which, in USAir's judgment, are attributable to the goodwill. This analysis is performed separately for the goodwill which resulted from each acquisition.\nIntangible assets consist mainly of purchased operating rights at various airports, purchased route authorities, capitalized software costs and the intangible assets associated with the underfunded amounts of certain pension plans. The operating rights, valued at purchase cost or appraised value if acquired from PSA or Piedmont Aviation, are being amortized over periods ranging from ten to 25 years as Depreciation and Amortization Expense. The purchased route authorities are being amortized over periods of 25 years as Depreciation and Amortization Expense. Capitalized software costs are being amortized as Depreciation and Amortization Expense over five years, the expected period of benefit. Accumu- lated amortization related to intangible assets at December 31, 1994 and 1993 was $80 million and $72 million, respectively.\nBased on the most recent analyses, USAir believes that goodwill and other intangible assets were not impaired at Decem- ber 31, 1994.\nThe increase in Other Assets, net in 1994 is primarily attributable to changes in non-current pension assets. USAir's Other Assets balance includes a $47 million receivable from British Airways Plc related to the relinquishment of two U.S. to London routes.\n(f) Restricted Cash and Investments\nRestricted cash and investments consist primarily of deposits in trust accounts to collateralize letters of credit or workers compensation policies. These amounts are classified as Other Assets on the accompanying balance sheets.\n(g) Deferred Gains on Sale and Leaseback Transactions\nGains on aircraft sale and leaseback transactions are deferred and amortized over the term of the leases as a reduction of rental expense.\n(h) Passenger Revenue Recognition\nPassenger ticket sales are recognized as revenue when the transportation service is rendered. At the time of sale, a liability is established (Traffic Balances Payable and Unused Tickets) and subsequently eliminated either through carriage of the passenger, through billing from another carrier which renders the service or by refund to the passenger.\n(i) Frequent Traveler Awards\nUSAir accrues the estimated incremental cost of providing outstanding travel awards earned by participants in its Frequent Traveler Program when such award levels are reached.\n(j) Investment Tax Credit\nInvestment tax credit benefits have been recorded using the \"flow-through\" method as a reduction of the Federal income tax provision.\n(k) Advertising Costs\nAdvertising costs are expensed when incurred as other operat- ing expense. Advertising expense for 1994, 1993 and 1992 was $63 million $59 million and $84 million, respectively.\n(l) Income (Loss) Per Common Share\nIncome (loss) per common share is computed by dividing net income (loss), after deducting preferred stock dividend require- ments, by the weighted average number of shares of Common Stock outstanding, net of treasury stock. The Company has deferred quarterly dividend payments on all series of its preferred stock beginning September 30, 1994. However, the accumulated unpaid dividends and interest on unpaid dividends continue to be deducted from net income or loss in order to calculate income or loss per common share (see Notes 8 and 9). The 1994 preferred dividend requirement includes dividends deferred (including interest) of $32.8 million, or $0.55 per common share. USAir Group's outstand- ing redeemable Series A Cumulative Convertible Preferred Stock (\"Series A Preferred Stock\"), Series B Cumulative Convertible Preferred Stock (\"Series B Preferred Stock\"), redeemable Series F Cumulative Senior Preferred Stock (\"Series F Preferred Stock\"), redeemable Series T Cumulative Convertible Exchangeable Senior Preferred Stock (\"Series T Preferred Stock\") and Common Stock equivalents are anti-dilutive. See Note 10 regarding Common Stock held in trust by an ESOP.\n(2) Financial Instruments\n(a) Terms of Certain Financial Instruments\nUSAir has entered into hedging arrangements to reduce its exposure to fluctuations in the price of jet fuel. Net settlements are recorded as adjustments to aviation fuel expense. The total notional number of gallons under these arrangements was 86 million and 194 million at December 31, 1994 and 1993, respectively. Under these arrangements, the Company will pay $0.496 to $0.521 per notional gallon in 1995 and receive a floating rate per notional gallon based on current market prices. In 1994, the Company paid $0.481 to $0.594 per notional gallon and received a floating rate per notional gallon based on current market prices. Decreases in the market price of fuel to levels below the fixed prices require cash payments by the Company and cause an increase in the Company's aviation fuel expense. The hedging arrangements represent approxi- mately 7% and 16% of USAir's expected 1995 and actual 1994 fuel consumption, respectively. USAir is party to such hedging arrangements with several entities. Although the agreements, which expire in 1995, expose the Company to credit loss in the event of nonperformance by the other parties to the agreements, the Company does not anticipate such nonperformance because of the favorable creditworthiness status of the other parties. The Company may continue to enter into such arrangements, depending on market conditions.\nThe Company has entered into interest rate swap transactions to manage interest rate exposure. Net settlements are recorded as an adjustment to interest expense. The Company is party to such interest rate swap agreements with banks and other financial institutions. The notional principal amount of these agreements was $150 million at December 31, 1994 and 1993. Under these swap agreements, the Company pays interest at fixed rates averaging 9.8% at December 31, 1994 and 1993, and receives floating rate interest payments based on three-month LIBOR. Although the agreements, which expire in 1995, expose the Company to credit loss in the event of non-performance by the other parties to the agreements, the Company does not anticipate such non-performance because of the favorable creditworthiness status of the other parties.\nAn aggregate of $32 million of future principal payments of USAir's long-term debt due 1998 through 2000 is payable in Japanese Yen. This foreign currency exposure has been hedged to maturity by USAir's participation in foreign currency contracts. Although the Company is exposed to credit loss in the event of non-performance by the counterparty to the contracts, the Company does not anticipate such non-performance because of the favorable credit- worthiness status of the other party.\n(b) Fair Value of Financial Instruments\nUnless a quoted market price indicates otherwise, the fair values of cash and investments generally approximate carrying values because of the short maturity of these instruments. The\nCompany has estimated the fair value of long-term debt based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of similar remaining maturities. The estimated fair values of the Series A Preferred Stock, the Series F Preferred Stock and the Series T Preferred Stock are obtained by consulting with an independent external valuation source. The fair values of interest rate swap agree- ments, energy swap agreements and foreign currency contracts are obtained from dealer quotes whereby these values represent the estimated amount the Company would receive or pay to terminate such agreements.\nThe estimated fair values of the Company's financial instru- ments, none of which are held for trading purposes, are summarized as follows (brackets denote liability):\n* Amounts included in Other Assets on the Company's consolidated balance sheets.\n(3) Long-Term Debt\nDetails of long-term debt are as follows:\nMaturities of long-term debt and debt under capital leases for the next five years are as follows:\n(in thousands) 1995 $ 85,538 1996 84,765 1997 96,005 1998 165,535 1999 89,635 Thereafter 2,459,438\nInterest rates on $529 million principal amount of long-term debt at December 31, 1994 are subject to adjustment to reflect prime rate and other rate changes.\nOn April 26, 1994, the Company terminated its credit agreement dated March 30, 1987, as amended, with a group of banks (\"Credit Agreement\"). During 1994, there were no borrowings under the Credit Agreement. As a result of the termination, 66 jet and turboprop aircraft and certain spare engines with a net book value of approximately $260 million at that time were released from a\nmortgage related to the Credit Agreement. The Company had been in violation of certain covenants at March 31, 1994. The Credit Agreement was scheduled by its terms to expire on September 30, 1994.\nDuring 1993 and 1992, the maximum amount of Credit Agreement borrowings outstanding at any month end was $250 million and $450 million, respectively. All outstanding Credit Agreement borrowings were paid off in May 1993 and no other funds were borrowed during the remainder of 1993. The average amount of Credit Agreement borrowings outstanding and the weighted average interest rate for 1993 were $37 million and 5.8%, respectively. The average amount of Credit Agreement borrowings outstanding and the weighted average interest rate for 1992 were $174 million and 6.2%, respectively.\nEquipment financings totaling $2.2 billion were collateralized by aircraft and engines with a net book value of $2.3 billion at December 31, 1994.\n(4) Commitments and Contingencies\n(a) Operating Environment\nThe U.S. airline industry has undergone dramatic and permanent changes in recent years, generally resulting in lower operating costs and fares. The current competitive environment is the result of several factors including the emergence and expansion of low cost, low fare carriers, the protection and cost restructuring opportunities afforded to certain carriers while operating under Chapter 11 of the Bankruptcy Code, and other cost restructuring initiatives among major airlines, including employee concessions in exchange for equity ownership. The Company has incurred annual operating losses for every year since 1990 and has a net capital deficiency at December 31, 1994. The Company is currently in negotiations with employee labor groups in an effort to obtain employee concessions that will substantially reduce operating costs. On March 29, 1995, USAir and the negotiating committee of the Air Line Pilots Association (\"ALPA\") Master Executive Council, which represents USAir's pilots, signed an agreement in principle on wage and other concessions in exchange for financial returns and governance participation for USAir pilots. The agreement in principle is subject to many significant conditions, including approval of the boards of directors of the Company and USAir and of the shareholders of the Company and the execution of definitive documentation. USAir continues to negotiate with representatives of its other unions but it is uncertain whether any final agree- ments will be reached. No assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. In addition, the Company is evaluating other strategic decisions that could be implemented to improve the operating results of the airline. The Company believes that it must reduce its operating costs substan- tially if it is to survive in this low cost, low fare competitive environment.\n(b) Lease Commitments\nThe Company's airline subsidiaries lease certain aircraft, engines, computer and ground equipment, in addition to the majority of their ground facilities. Ground facilities include executive offices, overhaul and maintenance bases and ticket and administra- tive offices. Public airports are utilized for flight operations under lease arrangements with the municipalities or agencies owning or controlling such airports. Substantially all leases provide that the lessee shall pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased property. Most leases also include renewal options and some aircraft leases include purchase options.\nThe following amounts applicable to capital leases are included in property and equipment:\nAt December 31, 1994, obligations under capital and noncancel- able operating leases for future minimum lease payments were as follows:\nJetstream has the option to lease an additional 20 aircraft. If the options for aircraft leases are exercised, deliveries could begin as early as 1996 and the projected lease payments presented above would increase.\nRental expense under operating leases for 1994, 1993 and 1992 was $748 million, $781 million and $707 million, respectively. The $748 million rental expense for 1994 excludes charges of $103 million related to USAir's grounded BAe-146 fleet and $13 million primarily related to USAir's decision to cease operations of its remaining Boeing 727-200 aircraft in 1995. The $707 million rental expense for 1992 excludes a charge of $72 million related to USAir's grounded BAe-146 fleet.\n(c) Legal Proceedings\nThe Company and various subsidiaries have been named as defendants in various suits and proceedings which involve, among other things, environmental concerns and employment matters. These suits and proceedings are in various stages of litigation, and the status of the law with respect to several of the issues involved is unsettled. For these reasons the outcome of these suits and proceedings is difficult to predict. In the Company's opinion, however, the disposition of these matters is not likely to have a material adverse effect on its financial condition or results of operations.\nUSAir is involved in legal proceedings arising out of its two aircraft accidents that occurred in July and September 1994 near Charlotte, North Carolina and Pittsburgh, Pennsylvania, respec- tively. The National Transportation Safety Board (the \"NTSB\") held hearings beginning in September 1994 relating to the July accident and January 1995 relating to the September accident. In April 1995, the NTSB issued its finding of probable causes with respect to the accident near Charlotte. It assigned as probable causes flight crew errors and the failure of air traffic control to convey weather and windshear hazard information. The NTSB has not yet issued its final accident investigation report for the accident near Pittsburgh. USAir expects that it will be at least two to three years before the accident litigation and related settlements will be concluded. USAir believes that it is fully insured with respect to this litigation and has recovered its hull claims related to the loss of the two aircraft. Therefore, the Company believes that the litigation will not have a material adverse effect on the Company's results of operations or financial condition. However, due to these two aircraft accidents, it is probable that the Company's insurance costs will increase upon renewals of various policies in 1995.\nUSAir and certain of the Company's other subsidiaries have received notices from the U.S. Environmental Protection Agency and various state agencies that it is a potentially responsible party with respect to the remediation of existing sites of environmental concern. Only two of these sites have been included on the Superfund National Priorities List. USAir and the other subsidiar-\nies continue to negotiate with various governmental agencies concerning known and possible cleanup sites. These companies have made financial contributions for the performance of remedial investigations and feasibility studies at sites in Moira, New York; Escondido, California; Newberry Township, Pennsylvania; Elkton, Maryland; and Salisbury, Maryland.\nBecause of changing environmental laws and regulations, the large number of other potentially responsible parties and certain pending legal proceedings, it is not possible to reasonably estimate the amount or timing of future expenditures related to environmental matters. The Company provides for costs related to environmental contingencies when a loss is probable and the amount is reasonably estimable. Although management believes adequate reserves have been provided for all known contingencies, it is possible that additional reserves could be required in the future which could have a material effect on results of operations. However, the Company believes that the ultimate resolution of known environmental contingencies should not have a material adverse effect on the Company's financial position or results of operations based on the Company's experience with similar environmental sites.\nIn March 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit, which alleged that the airlines used the Airline Tariff Publishing Company to signal and communi- cate carrier pricing intentions and otherwise limit price competi- tion for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers have issued $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir estimates that any incremental cost associated with the settlement will not be material based on the nominal equivalent free trips associated with the settlement. The travel certificates were mailed to claimants in December 1994 and may be applied towards travel purchased between January 1995 and December 1998.\nOn October 11, 1994, USAir and seven other carriers entered into a settlement agreement with a group of State Attorneys General resolving similar issues with the states. The settlement entitles passengers traveling within the United States on state government business to a 10% discount off the published fares of each of the settling carriers and will be available for 18 months or until the combined discount amount reaches $40 million. Following a notice and public comment period, the reviewing judge will conduct a hearing to determine whether this settlement is a fair one. The\nhearing is scheduled for May 10, 1995. The Company does not expect that this settlement will have a material adverse effect on its financial condition. As was the case with the settlement of the private antitrust litigation, it is difficult to predict the amount of discounted state travel that will occur on USAir. Thus, a dollar impact of the settlement cannot be estimated.\nIn February and March 1995, several class action lawsuits were filed in various Federal district courts by travel agencies and a travel agency trade association alleging that most of the major U.S. airlines, including USAir, violated the antitrust laws when they individually capped travel agent commissions at $50 for round- trip domestic tickets with base fares above $500 and at $25 for one-way domestic tickets with base fares above $250. USAir intends to vigorously defend itself against the allegations made in these lawsuits. The plaintiffs are seeking unspecified treble damages for restraint of trade and an injunction to prevent the airlines from implementing or maintaining the cap or commission. Because the lawsuits are in the first stages of litigation, USAir is unable to predict at this time their ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn March 1995, a number of U.S. carriers, including USAir, received a Civil Investigative Demand (\"CID\") from the Department of Justice related to an investigation of incentives paid to travel agents over and above the base commission payments, which are the subject matter of the suits recently brought by travel agencies as discussed above. USAir responded to an earlier CID on this topic during 1994. USAir is required to produce documents and respond to interrogatories in connection with this CID. USAir intends to comply with the requirements of the CID. Because this matter is in the investigatory stage, USAir is unable to predict at this time its ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn February 1995, two members of USAir's frequent traveler program filed a class action lawsuit in Pennsylvania state court against USAir after it raised the required minimum level of miles necessary to earn a free ticket. The plaintiffs allege breach of contract and seek unspecified damages and specific performance of the contract allegedly breached. USAir denies the allegations. The ultimate resolution of this lawsuit and its potential impact on the Company's financial condition and results of operations cannot be predicted at this time.\n(d) Aircraft Commitments\nUSAir and The Boeing Company (\"Boeing\") reached an agreement in principle in early 1995 regarding the deferral of eight 757-200 aircraft from 1996 to 1998.\nThe following schedule of USAir's new aircraft deliveries and scheduled payments at December 31, 1994 (including progress payments, payments at delivery, buyer furnished equipment, spares, and capitalized interest) reflects USAir's agreement in principle with Boeing discussed above:\nIn addition, USAir has a commitment to purchase hushkits for certain of its McDonnell Douglas DC-9-30 aircraft and a substantial portion of its Boeing 737-200 aircraft. The installation of these hushkits will bring the aircraft into compliance with Federal Aviation Administration (\"FAA\") Stage 3 noise level requirements. The projected payments associated with the purchase of the hushkits are: $10.5 million - 1995; $44.3 million - 1996; $45.5 million - 1997; $45.2 million - 1998; and $25.0 million - 1999.\n(e) Concentration of Credit Risk\nUSAir Group does not believe it is subject to any significant concentration of credit risk. At December 31, 1994, most of the Company's receivables related to tickets sold to individual passengers through the use of major credit cards (45%) or to tickets sold by other airlines (17%) and used by passengers on USAir or the regional airline subsidiaries. These receivables are short-term, generally being settled shortly after sale. Bad debt losses, which have been minimal in the past, have been considered in establishing allowances for doubtful accounts.\n(f) Guarantees\nAt December 31, 1994, USAir guaranteed payments of certain debt obligations of the Galileo International Partnership amounting to approximately $9 million.\n(5) Sale of Receivables\nThe revolving receivables sales facility (\"Receivables Agreement\") to which USAir had been a party expired on December 21, 1994. USAir was unable to sell receivables under the Receivables Agreement during 1994 because it was in violation of certain financial covenants. USAir had no outstanding amounts due under the Receivables Agreement at December 31, 1993. The average dollar amount of outstanding sales during 1993 and 1992 was $255 million and $100 million, respectively. USAir is currently engaged in discussions to arrange a replacement facility. There can be no assurance that USAir will be successful in reaching a new agreement to sell its receivables.\n(6) Income Taxes\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). FAS 109 required a change from the deferred method under Accounting Principles Board Opinion No. 11 to the asset and liability method of accounting for income taxes. No cumulative adjustment at January 1, 1993, and no income tax credit for the years ended December 31, 1994 and 1993, were recognized due to the FAS 109 limitation in recognizing benefits for net operating losses.\nThe Company files a consolidated Federal income tax return with its wholly-owned subsidiaries.\nThe components of the provision (credit) for income taxes are as follows:\nThe significant components of deferred income tax expense\/ (benefit) for the years ended December 31, 1994 and 1993, are as follows:\nFor the year ended December 31, 1992 deferred income taxes result from differences in the recognition of revenue and expenses and investment tax credits for tax and financial reporting purposes. The major items resulting in these differences and the related tax effects are shown in the following chart: ---- (in thousands)\nEquipment depreciation and amortization $ 70,441 Gain on sale and leaseback transactions (55,238) Net operating loss carryforward 53,753 Employee benefits (36,015) Tax benefits purchased\/sold 6,752 Investment tax credits (2,372) Leasing transactions (33,296) Frequent traveler program (2,815) Other (1,210) -------- Total deferred provision (credit) $ 0 ========\nA reconciliation of taxes computed at the statutory Federal tax rate on earnings before income taxes to the provision (credit) for income taxes is as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993 are presented below:\nThe valuation allowance for deferred tax assets as of January 1, 1993, was $420 million. The valuation allowance increased $145 million in 1993 and $240 million in 1994.\nAt December 31, 1994, the Company had unused net operating losses of $1.9 billion for Federal tax purposes, which expire in the years 2005-2009. The Company also has available, to reduce future taxes payable, $775 million alternative minimum tax net operating losses expiring in 2007 to 2009, $50 million of invest- ment tax credits expiring in 2002 and 2003, and $21 million of\nminimum tax credits which do not expire. The Federal income tax returns of the Company through 1986 have been examined and settled with the Internal Revenue Service.\n(7) British Airways Plc Investment\nOn January 21, 1993, USAir Group and BA entered into an investment agreement (the \"Investment Agreement\") under which a wholly-owned subsidiary of BA purchased certain series of convert- ible preferred stock during 1993 (see Note 8 - Redeemable Preferred Stock) and BA entered into code sharing and wet lease arrangements with USAir contemplated by the Investment Agreement. On March 7, 1994, BA announced that it would not make any additional invest- ments in the Company until the outcome of measures by the Company to reduce its costs and improve its financial results is known.\nAt December 31, 1994, the preferred stock held by BA con- stituted approximately 21.5% of the total voting interest in the Company. To the extent permitted by foreign ownership restrictions which are applicable by statute regulations or interpretation by regulatory authorities, including the U.S. Department of Transpor- tation (\"DOT\") (\"Foreign Ownership Restrictions\"), the preferred stock owned by BA votes on all matters presented to the Company's stockholders for a vote and has voting power equal to the underly- ing shares of Common Stock. Pursuant to the Investment Agreement, on January 21, 1993, BA designated three of its officers to serve on the Company's and USAir's boards of directors.\nIn addition to BA's holdings of the Company's preferred stock at December 31, 1994, BA has the option, which it has announced it will not exercise under current circumstances, to purchase, at a minimum, an additional $450 million of the Company's preferred stock. Under certain circumstances, BA is entitled, at its option, to purchase, on or prior to January 21, 1996, 50,000 shares of Series C Cumulative Convertible Senior Preferred Stock (\"Series C Preferred Stock\") resulting in an additional cash investment in the Company of $200 million, and, on or prior to January 21, 1998, 25,000 shares of Series E Cumulative Convertible Senior Preferred Stock (\"Series E Preferred Stock\") resulting in an additional cash investment in the Company of $250 million. If the DOT approves all the transactions and acts contemplated by the Investment Agreement, at the election of either BA or the Company on or prior to January 21, 1998, BA's purchase of the Series C Preferred Stock (unless previously consummated) and BA's purchase of the Series E Preferred Stock must be consummated under certain circumstances.\nOn March 15, 1993, the DOT issued an order (\"DOT Order\") stating, among other things, that BA's initial investment does not impair USAir's citizenship under current U.S. Foreign Ownership Restrictions. However, the DOT instituted a proceeding to consider whether USAir will remain a U.S. citizen if the transactions and acts contemplated by the Investment Agreement, including the possible sale of Series C Preferred Stock and Series E Preferred Stock, to BA, are consummated. The DOT has indefinitely suspended the period for comments from interested parties pending its\nresolution of requests by other airlines for production of additional documents from USAir. The DOT Order states that the DOT expects and advises USAir and BA not to proceed with the closing of the purchase of the Series C Preferred Stock or the Series E Preferred Stock until the DOT has completed its review of USAir's citizenship. In any event, on March 7, 1994, BA announced it would not make any additional investments in the Company under current circumstances. The Company cannot predict the outcome of the proceedings or if further transactions contemplated under the Investment Agreement, including the sale of Series C and Series E Preferred Stock to BA, will be consummated. The sale of additional preferred stock to BA on June 10, 1993 (see Note 8(c)) did not result in BA's ownership of voting stock in the Company exceeding applicable Foreign Ownership Restrictions and therefore does not affect the Company's U.S. citizenship under those restrictions.\n(8) Redeemable Preferred Stock and Dividend Restrictions\n(a) Series A Preferred Stock and Dividend Restrictions\nAt December 31, 1994, the Company had 358,000 shares of its 9 1\/4% Series A Cumulative Convertible Redeemable Preferred Stock (\"Series A Preferred Stock\"), without par value, outstanding which were convertible into 9,239,944 shares of the Company's Common Stock at a conversion price of approximately $38.74 per share. The Series A Preferred Stock ranks pari passu with the Series F Cumulative Convertible Senior Preferred Stock (\"Series F Preferred Stock\"), without par value, and Series T-_ Cumulative Convertible Exchangeable Senior Preferred Stock (\"Series T Preferred Stock\"), without par value, and senior to the Series B Cumulative Convert- ible Preferred Stock (\"Series B Preferred Stock\"), without par value, Junior Participating Preferred Stock, Series D (\"Series D Preferred Stock\"), without par value, and the Common Stock, with respect to dividend payments and the distribution of assets. At December 31, 1994, the Series A Preferred Stock is entitled to approximately 25.8099 votes per share, or a total of 9,239,944 votes, and votes together with the Series F Preferred Stock, the Series T Preferred Stock and the Common Stock, on all matters submitted to a vote of stockholders of the Company.\nThe Series A Preferred Stock is redeemable on August 7, 1999 at $1,000 per share. The Company has the right to redeem the stock at a 10% premium until that time. The agreement relating to the sale of the Series A Preferred Stock imposes certain restrictions on the purchaser's ability to increase its ownership of, and to transfer, its stock in USAir Group. The Series A Preferred Stock is owned by affiliates of Berkshire Hathaway Inc. (\"Berkshire\"). There have been no changes in the balance sheet value of the Series A Preferred Stock since its issuance in 1989.\nThe Company has deferred quarterly dividend payments on all outstanding series of preferred stock. The annual dividends on the Series A Preferred Stock amount to approximately $33.1 million. So long as preferred dividends are deferred, the Series A Preferred Stock will continue to cumulate dividends at its stated dividend\nrate of 9.25% plus additional dividends (interest) on the balance of the deferred dividends at the higher of the stated dividend rate or the prime rate plus five percentage points. Accordingly, the redemption value of the Series A Preferred Stock at December 31, 1994 is $374.8 million (the face amount of the issuance of $358.0 million plus unpaid dividends and interest of $16.8 million).\nUnder the terms of the Series A Preferred Stock, Berkshire has the right to elect two additional directors to the Board of the Company after a scheduled dividend payment has not been paid for thirty days. Berkshire has informed the Company that it does not intend to exercise this right at this time. Further, Berkshire's Chairman Warren E. Buffet and Vice Chairman Charles T. Munger serve as directors on the Company's and USAir's Boards of Directors. Messrs. Buffet and Munger have advised the Company that they will not stand for re-election to the Company's and USAir's Boards in 1995. Under the terms of the Series B Preferred Stock, the holders of that security would have the right to elect two additional directors to the Board if six quarterly dividends are not paid. That right will become effective on February 15, 1996 if dividends are not resumed prior to that time. If Berkshire were to exercise its right or the holders of the Series B Preferred Stock were to exercise their right to nominate additional directors, BA would have the right to designate additional nominees for election as directors to the Board pursuant to its Investment Agreement with the Company.\nThe Company, organized under the laws of the State of Delaware, is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends on all outstanding common and preferred stock issuances. Surplus is the remainder of (i) net assets (total assets less total liabilities), less (ii) total capital (that amount of preferred and common equity designated as capital by a company's board of directors). At December 31, 1994, the Company's capital deficit was approximately $199.3 million. The Company's net assets were in a deficit balance of approximately $138.2 million, and its total capital was approximately $61.1 million (the $61.1 million is all attributable to the Company's common stock; capital for all of the Company's preferred stock issuances is a nominal amount of one cent per share). In order for the Company to return to a capital surplus position, it must realize substantial profits or increase its equity through other measures, such as the sale of additional common or preferred stock. Even if the Company is successful in restructuring its costs, there can be no assurance when or if preferred dividend payments will resume.\n(b) Series F Preferred Stock\nAt December 31, 1994, the Company had outstanding 30,000 shares of its 7% Series F Preferred Stock which was convertible into 15,458,851 shares of the Company's Common Stock at a conver-\nsion price of approximately $19.41 per share. The Series F Preferred Stock ranks pari passu with the Series A Preferred Stock and Series T Preferred Stock and senior to the Series B Preferred Stock, Series D Preferred Stock, and the Common Stock, with respect to dividend payments and the distribution of assets. At Decem- ber 31, 1994, each share of Series F Preferred Stock was entitled to 515.295 votes per share to the extent permitted by the existing Foreign Ownership Restrictions and votes with the Company's Series A Preferred Stock, the Series T Preferred Stock and the Company's Common Stock as a single class. Under Foreign Ownership Restric- tions, no more than 25% of the Company's voting interest may be held by persons other than U.S. citizens. In accordance with the terms of any preferred stock held by BA, conversion rights and voting rights may not be exercised to the extent that doing so would result in a loss of the Company's or any of its subsidiaries' operating certificates and authorities under Foreign Ownership Restrictions, and it is assumed for this purpose that Series F Preferred Stock will be fully converted before any other preferred stock held by BA.\nThe Series F Preferred Stock is convertible at any time on or after January 21, 1997 to the extent that such conversion would not violate U.S. Foreign Ownership Restrictions. Series F Preferred Stock may be converted at the option of the Company at any time after January 21, 1998 if the average composite closing market price of Common Stock during any 30-day calendar period is at least 133% of the conversion price. The Series F Preferred Stock is mandatorily redeemable on January 21, 2008. If BA has not purchased the Series C Preferred Stock by January 21, 1996, then the Company may at its option redeem, in whole or in part, Series F Preferred Stock at the higher of market value or the price of $10,000 per share, plus accrued dividends. The Series F Certifi- cate provides that if on any one occasion on or prior to Janu- ary 21, 1996, any court or regulatory authority issues a final order that any material part of the Investment Agreement is unenforceable (except pursuant to bankruptcy or like event), then the conversion price of Series F Preferred Stock shall be reduced by 10.2564%. There have been no changes in the balance sheet value of the Series F Preferred Stock since its issuance in 1993.\nThe Company deferred quarterly dividend payments on all outstanding series of preferred stock beginning with payments due September 30, 1994. The annual dividends on the Series F Preferred Stock amount to approximately $21.0 million. So long as preferred dividends are deferred, the Series F Preferred Stock will continue to cumulate dividends at its stated dividend rate of 7.0% plus additional dividends (interest) on the balance of the deferred dividends at the stated dividend rate. Accordingly, the redemption value of the Series F Preferred Stock at December 31, 1994 is $307.0 million (the face amount of the issuance of $300.0 million plus unpaid dividends and interest of $7.0 million). The Company is currently unable to pay dividends due to limitations under Delaware law. See discussion above in Note 8(a).\n(c) Series T Preferred Stock\nUnder the Investment Agreement, BA has preemptive and optional purchase rights to maintain its proportionate ownership of the Company's Common Stock and convertible securities, measured in terms of the BA percentage (\"BA Percentage\") which approximates BA's fully diluted ownership percentage based on BA's current and potential holdings in the Company. The BA Percentage is calculated without regard to Foreign Ownership Restrictions at the time of the calculation. BA may exercise such preemptive or optional purchase rights by purchasing, from time to time, a series of Series T Preferred Stock.\nAt December 31, 1994, the Company had two series of the Series T Preferred Stock outstanding. On June 10, 1993, BA exercised its preemptive purchase right by purchasing 9,919.8 shares of a series of the Series T Preferred Stock (\"Series T-2 Preferred Stock\") for approximately $99.2 million and exercised its optional purchase right by purchasing 152.1 shares of a series of Series T Preferred Stock (\"T-1 Preferred Stock\") for approximately $1.5 million. BA's preemptive right was triggered by the issuance of Common Stock, as described in Note 9 - Stockholders' Equity, and BA's optional purchase rights were triggered by the Company's issuance of additional shares of Common Stock through the exercise of options under various employee stock option plans and through the sale of shares to certain defined contribution plans during the period from January 21, 1993 to March 31, 1993. BA has advised the Company that it will not exercise its optional purchase rights to buy additional series of Series T Preferred Stock triggered by the Company's issuance of Common Stock pursuant to certain employee benefit plans during the second, third and fourth quarters of 1993 and during 1994.\nThere have been no changes in the balance sheet value of the Series T-1 Preferred Stock and Series T-2 Preferred Stock since their issuance in 1993.\nThe terms of all series of the Series T Preferred Stock are substantially similar to those of the Series F Preferred Stock except as noted. Each share of Series T-2 Preferred Stock carries a conversion price of $26.40 and is convertible into approximately 378.7879 shares of Common Stock or Non-Voting Class ET stock. Each share of Series T-1 Preferred Stock has a conversion price of $20.50 and is convertible into approximately 487.8049 shares of Common Stock or Non-Voting Class ET stock. With respect to the Series T Preferred Stock, dividends are payable quarterly in arrears, at 50 basis points over the three month LIBOR rate. Any shares of the Series T Preferred Stock held by any person other than BA or its subsidiaries may be redeemed for cash at any time at the option of the Company at $10,000 plus accrued dividends plus a redemption premium equal to $700 from the date of issue until the first anniversary thereof and reduced by $46.67 on each anniversary thereafter.\nThe Series T Preferred Stock is exchangeable, at the option of the Company, for that principal amount of floating rate convertible subordinated notes of the Company (the \"T Notes\") equal to the liquidation preference of the shares to be exchanged and bearing interest at the dividend rate. Any accrued dividends on the Series T Preferred Stock to be exchanged will be treated as accrued interest on the T Notes. Each $10,000 aggregate principal amount of such T Notes will be entitled to a number of votes equal to the number of votes to which each share of Series T Preferred Stock was entitled at the time of its exchange for T Notes, subject to adjustment. If issued, T Notes will have terms otherwise consis- tent with the terms of the Series T Preferred Stock.\nThe Company has deferred quarterly dividend payments on all outstanding series of preferred stock beginning with payments due September 30, 1994. The annual dividends on the Series T Preferred Stock amount to approximately $6.6 million. So long as preferred dividends are deferred, the Series T Preferred Stock will continue to cumulate dividends at its dividend rate of the three-month LIBOR rate plus one-half of a percentage point plus additional dividends (interest) on the balance of the deferred dividends at the dividend rate. Accordingly, the redemption value of the Series T Preferred Stock at December 31, 1994 is $102.7 million (the face amount of the issuance of $100.7 million plus unpaid dividends and interest of $2.0 million). The Company is currently unable to pay dividends due to limitations under Delaware law. See discussion above in Note 8(a).\n(9) Stockholders' Equity\n(a) Common Stock\nThe Company had 150,000,000 authorized shares of Common Stock, par value $1, at December 31, 1994 and 1993. If BA purchases the Series C Preferred Stock (see Note 7 - British Airways Plc Investment), the number of authorized shares of various classes of Common Stock will increase to 300,000,000. BA has indicated, however, that it will not make any additional investments in the Company under current circumstances. At December 31, 1994, approximately 51,781,000 shares were reserved for issuance upon the conversion of preferred stock and for offerings under employee stock purchase, stock option, stock incentive and retirement plans. The Company is currently unable to pay dividends due to limitations under Delaware law. See discussion above in Note 8(a).\nOn May 4, 1993, the Company sold 11.5 million shares of previously unissued Common Stock at $20.75 per share through a public, underwritten offering. The offering netted proceeds of approximately $231 million.\n(b) Preferred Stock and Senior Preferred Stock\nAt December 31, 1994, the Company had 5,000,000 authorized shares of preferred stock, without nominal or par value, of which 358,000 shares were issued as Series A Preferred Stock, approxi-\nmately 43,000 shares were issued as Series B Preferred Stock and 1,035,000 shares were reserved as Series D Preferred Stock. Also, at December 31, 1994, the Company had 3,000,000 authorized shares of Senior Preferred Stock, without nominal or par value, of which 30,000 shares were issued as Series F Preferred Stock and approxi- mately 10,000 were issued as Series T Preferred Stock.\n(c) Series B Preferred Stock\nAt December 31, 1994, the Company had 4,263,050 Depositary Shares, representing 42,630.5 shares of its $437.50 Series B Preferred Stock outstanding. Each Depositary Share represents 1\/100 of a share of the Series B Preferred Stock. The Series B Preferred Stock is convertible at any time, at the option of the holder, at the rate of 249.25 shares of Common Stock of the Company per preferred share, or 2.4925 shares of Common Stock per Deposi- tary Share. The Series B Preferred Stock ranks junior to the Company's Series A Preferred Stock, the Series F Preferred Stock and the Series T Preferred Stock and senior to the Series D Preferred Stock and the Common Stock with respect to dividend payments and the distribution of assets, whether upon liquidation or otherwise. Except under certain circumstances, the holders of Series B Preferred Stock have no voting rights.\nThe Series B Preferred Stock is redeemable, at the option of the Company and with consent of the holders of Series F Preferred Stock, (i) in whole but not in part, only in certain circumstances, for so long as any shares of Series A Preferred Stock are outstand- ing; and (ii) in whole or in part if no shares of Series A Preferred Stock are outstanding, in each case initially at a redemption price of approximately $53.06 per 1\/100 of a share and thereafter at prices declining to $50 per 1\/100 of a share (equivalent to $5,000 per share of Series B Preferred Stock) on or after May 15, 2001, plus dividends accrued and accumulated but unpaid to the redemption date.\nThe Company has deferred quarterly dividend payments on all outstanding series of preferred stock beginning with payments due September 30, 1994. The annual dividends on the Series B Preferred Stock amount to approximately $18.7 million. So long as preferred dividends are deferred, the Series B Preferred Stock will continue to cumulate dividends at its stated dividend rate of 8.75% but is not subject to additional dividends (interest) on the balance of the deferred dividends. Accordingly, the liquidation preference of the Series B Preferred Stock at December 31, 1994 is $220.1 (the face amount of the issuance of $213.2 million plus unpaid dividends of $6.9 million). The Company is currently unable to pay dividends due to limitations under Delaware law. See discussion above in Note 8(a).\n(d) Preferred Stock Purchase Rights\nEach outstanding share of Common Stock is accompanied by one Preferred Share Purchase Right (\"Right\") and each outstanding share of Series A Preferred Stock, Series F Preferred Stock and Series T\nPreferred Stock is accompanied by a Right for each share into which it is convertible. Each Right entitles the holder to buy 1\/100th of a share of Series D Preferred Stock at an exercise price of $175 per Right. The Rights expire on June 29, 1996. As long as the Rights remain outstanding, the Company will issue one Right with each new share of Common Stock issued upon the conversion of any preferred stock into, or the exercise of any options for, Common Stock, as long as such preferred stock or options were outstanding prior to the Rights becoming exercisable.\nGenerally, the Rights become exercisable only if a party other than, under certain circumstances, BA acquires 20% or more of the Company's Common Stock or announces a tender offer for 20% or more of the Common Stock. The Rights are redeemable at $.03 per Right at any time before 20% or more of the Company's Common Stock has been acquired. If at any time after the Rights become exercisable and before they have been redeemed the Company is involved in a merger or other business combination transaction, the Rights will automatically entitle a holder, other than a holder of 20% or more of the Company's Common Stock, to receive, upon exercise of each Right, a number of shares of Common Stock, or a number of common shares of the acquiring company, as the case may be, having a market value of two times the exercise price of each Right. In addition, at any time after the acquisition of 30% or more of the Common Stock by any person and prior to the acquisition by such person of 50% or more of the Common Stock, the Board of the Company may exchange the Rights (other than Rights owned by such person which have become void), in whole or in part, at an exchange ratio of one share of Common Stock, or 1\/100th of a share of Series D Preferred Stock, per Right.\nUntil the first to occur of the redemption or expiration of the Rights, the Company will issue one Right with each new share of Common Stock issued upon the conversion of any securities into, or the exercise of any options or warrants for, Common Stock if such securities, options or warrants were outstanding prior to when Rights became exercisable.\n(e) Treasury Stock\nIn 1989, the Company's Board authorized the repurchase from time to time of up to 9.4 million shares of its Common Stock in open market transactions. In 1989, approximately 2.1 million shares were repurchased in addition to 635,000 that it held in treasury prior to that time. The Company sold approximately 1,864,000 shares, 500,000 shares, and 390,000 shares of its treasury stock during 1994, 1993, and 1992, respectively. As of December 31, 1994, there were no shares of Common Stock held in treasury. Due to the capital surplus requirements of Delaware law, the Company is currently unable to repurchase shares of its Common Stock.\n(f) Employee Stock Option and Purchase Plans\nAt December 31, 1994, approximately 5.0 million shares of Common Stock were reserved for the possible exercise of options under the 1992 Stock Option Plan (\"1992 Plan\"). Under the 1992 Plan, employees whose pay was reduced, generally during a 12 month period in 1992 and 1993, received options to purchase 50 shares of Common Stock at a price of $15 per share for each $1,000 of salary reduction. Participating employees have five years from the grant date to exercise such options. All outstanding options under the 1992 plan were fully vested at December 31, 1994.\nAt December 31, 1994, 5.3 million shares of Common Stock were reserved for the granting of stock options or restricted stock under the Company's 1984 Stock Option and Stock Appreciation Rights (\"SARs\") Plan and 1988 Stock Incentive Plan. These plans provide that options may be granted as either nonqualified or incentive stock options. Options awarded under the two plans prior to 1992, except for those that reverted, have vested. Options awarded during 1992, 1993 and 1994 become exercisable generally within three years from date of grant. Optionees may also receive SARs which permit them to receive, in lieu of the right to exercise the stock option, an amount equivalent to the difference between the stock option price and the fair market value of the Common Stock on the date of exercising the right. This amount may be paid in stock, in cash, or in any combination of the two. Also, restricted stock award grants for 15,800 shares and 57,000 shares were outstanding at December 31, 1994 and 1993, respectively. Deferred compensation related to the restricted stock, which vests over periods of up to five years, amounted to $16 thousand and $0.3 million at December 31, 1994 and 1993, respectively.\nAs of December 31, 1994, options to acquire approximately 9 million shares under all three plans, including 76,200 options with tandem SARs, were outstanding at a weighted average exercise price of $18.14. Of those outstanding, approximately 8.3 million options were exercisable at December 31, 1994. Options were exercised to purchase approximately 5,000 shares and 33,500 shares of Common Stock at average exercise prices of $9.63 and $17.24 during 1994 and 1993, respectively.\n(10) Employee Stock Ownership Plan\nIn August 1989, USAir established an Employee Stock Ownership Plan (\"ESOP\"). The Company sold 2,200,000 shares of Common Stock to an Employee Stock Ownership Trust to hold on behalf of USAir's employees, exclusive of officers, in accordance with the terms of the Trust and the ESOP. Financing of approximately $111.4 million for the Trust's purchase of the shares was provided by USAir through a 9 3\/4% loan to the Trust, and an additional $2.2 million was contributed to the Trust by USAir. The loan is being repaid with contributions made by USAir. The contributions are made in amounts equal to the periodic loan payments as they come due, less dividends available for loan payment. As the loan is repaid over time, participating employees receive allocations of the Common\nStock purchased by the Trust. The initial maturity of the loan is 30 years. However, the ESOP provides that if USAir's profitability as measured by return on sales exceeds certain goals during the life of the ESOP, USAir's contributions and the repayment of the loan will be accelerated. Annual contributions made by USAir and therefore loan repayments made by the Trust were $11.4 million in each of 1994, 1993 and 1992. The interest portion of these contributions was $10.5 million in 1994, $10.5 million in 1993 and $10.6 million in 1992. Approximately 438,000 shares of Common Stock have been allocated to employees. USAir recognized approxi- mately $4 million of compensation expense related to the ESOP in each of 1994, 1993 and 1992 based on shares allocated to employees (the \"shares allocated\" method). Deferred compensation related to the ESOP amounted to approximately $91 million, $95 million and $98 million at December 31, 1994, 1993 and 1992, respectively. Shares held by the ESOP trust are included in shares outstanding for the Company's income (loss) per share calculation.\n(11) Employee Benefit Plans\n(a) Pension Plans\nThe Company's subsidiaries have several pension plans in effect covering substantially all employees. One qualified defined benefit plan covers USAir maintenance employees and provides benefits of stated amounts for specified periods of service. Qualified defined benefit plans for substantially all other employees provide benefits based on years of service and compensa- tion. The qualified defined benefit plans are funded, on a current basis, to meet requirements of the Employee Retirement Income Security Act of 1974.\nThe defined benefit pension plan for USAir non-contract employees was frozen at the end of 1991 for all non-contract participants, resulting in a one-time book gain of approximately $107 million in 1991. All non-contract plan participants became 100% vested at the time of the freeze. As a result of this plan curtailment, the accrual of service costs related to defined benefits for USAir non-contract and certain other employees ceased at the end of 1991. USAir implemented a defined contribution pension plan for non-contract employees in January 1993.\n(this space intentionally left blank)\nThe funded status of the qualified defined benefit plans at December 31, 1994 and 1993 was as follows:\nUnrecognized transition assets are being amortized over periods up to 27 years. The weighted average discount rate used to determine the actuarial present value of the projected benefit obligation was 9.0% and 7.6% as of December 31, 1994 and 1993, respectively. The expected long-term rate of return on plan assets used in 1994 and 1993 was 9.5%. Rates of 3% to 6% were used to estimate future salary levels. At December 31, 1994, plan assets consisted of approximately 8% in cash equivalents and short-term debt investments, 27% in equity investments, and 65% in fixed income and other investments. At December 31, 1993, plan assets consisted of approximately 8% in cash equivalents and short-term debt investments, 37% in equity investments, and 55% in fixed income and other investments.\nThe following items are the components of the net periodic pension cost for the qualified defined benefit plans:\nNet pension cost for 1993 presented above excludes a settle- ment charge of approximately $33.9 million, related to \"early-out\" incentive programs offered to a limited number of USAir employees during the years. No such charges were incurred in 1994 or 1992.\nNon-qualified supplemental pension plans are established for certain employee groups, which provide incremental pension payments from the Company's funds so that total pension payments equal amounts that would have been payable from the Company's principal pension plans if it were not for limitations imposed by income tax regulations.\n(this space intentionally left blank)\nThe following table sets forth the non-qualified plans' status at December 31, 1994 and 1993:\nNet periodic supplementary pension cost for the non-qualified supplemental pension plans included the following components:\nThe discount rate used to determine the actuarial present value of the projected benefit obligation was 9.0% and 7.5% as of December 31, 1994 and 1993, respectively. Rates of 3% to 5% were used to estimate future salary levels.\nIn addition to the qualified and non-qualified defined benefit plans described above, USAir also contributes to certain defined contribution plans primarily for employees not covered under a collective bargaining agreement. Company contributions are based on a formula which considers the age and pre-tax earnings of each employee and the amount of employee contributions. The Company's contribution expense was $43 million and $42 million for 1994 and 1993, respectively. The Company recognized no such expense in 1992 because the plans became effective January 1, 1993.\n(b) Postretirement Benefits Other Than Pensions\nUSAir offers medical and life insurance benefits to employees hired prior to March 29, 1993 who retire from USAir and their eligible dependents. The medical benefits provided by USAir are coordinated with Medicare benefits. Retirees generally contribute amounts towards the cost of their medical expenses based on years of service with the Company. USAir provides uninsured death benefit payments to survivors of retired employees for stated dollar amounts, or in the case of retired pilot employees, death benefit payments determined by age and level of pension benefit. The plans for postretirement medical and death benefits are funded on the pay-as-you-go basis.\nUSAir adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"), during 1992 and elected to record the January 1, 1992 Accumulated Postretirement Benefit Obligation (\"APBO\") using the immediate recognition approach. The cumulative effect of adopting FAS 106 was $745.7 million ($628.1 million net of tax benefit).\nThe following table sets forth the financial status of the plans as of December 31, 1994 and 1993:\nThe components of net periodic postretirement benefit cost are as follows:\nThe postretirement benefit expense for 1993 presented above excludes a charge of approximately $15.5 million related to \"early- out\" programs offered to a limited number of employees during the year. No such charges were incurred in 1994 or 1992.\nThe discount rate used to determine the APBO was 9.0%, 7.75% and 8.75% at December 31, 1994, 1993 and 1992, respectively. The assumed health care cost trend rate used in measuring the APBO was 9.5% in 1994, declining by 1% per year after 1994 to an ultimate rate of 4.5%. If the assumed health care cost trend rate were increased by one percentage point, the APBO at December 31, 1994 would be increased by 11% and 1994 periodic postretirement benefit cost would increase 13%.\n(c) Postemployment Benefits\nUSAir adopted Statement of Financial Accounting Standards No. 112, \"Employer's Accounting for Postemployment Benefits\" (\"FAS 112\"), during 1993. FAS 112 requires the use of an accrual method to recognize postemployment benefits such as disability-related benefits. The cumulative effect at January 1, 1993 of adopting FAS 112 was $43.7 million.\n(12) Supplemental Balance Sheet Information\nThe components of certain accounts in the accompanying balance sheets are as follows:\n(13) Non-Recurring and Unusual Items\n(a) 1994\nThe Company's results for 1994 include (i) a $132.8 million charge related to USAir's grounded BAe-146 fleet, recorded in the fourth quarter of 1994; (ii) a $54.0 million charge for obsolete inventory and rotables to reflect market value, recorded in the fourth quarter of 1994; (iii) a $50 million addition to passenger transportation revenue in the fourth quarter of 1994 to adjust estimates made during the first three quarters of 1994; (iv) a $40.1 million charge primarily related to USAir's decision to cease operations of its remaining Boeing 727 aircraft in 1995, recorded in the third quarter of 1994; (v) a $25.9 million charge related to USAir's decision to substantially reduce service between Los Angeles and San Francisco and close its San Francisco crew base, recorded in the third quarter of 1994; (vi) a $28.3 million gain resulting from the sale of certain aircraft and assets to Mesa Air Group, Inc. (formerly Mesa Airlines, Inc.) (\"Mesa\") and the accounting treatment of the hull insurance recovery on the aircraft destroyed in the September accident, recorded in the third quarter of 1994; and (vii) a $1.7 million charge related to the sale of assets to Mesa, recorded in the third quarter of 1994.\n(b) 1993\nThe Company's results for 1993 include non-recurring charges of (i) $43.7 million for the cumulative effect of an accounting change, as required by FAS 112 which was adopted during the third quarter of 1993, retroactive to January 1, 1993; (ii) $68.8 million for severance, early retirement and other personnel-related expenses recorded primarily during the third quarter of 1993 in connection with a workforce reduction of approximately 2,500 full- time positions between November 1993 and the first quarter of 1994;\n(iii) $36.8 million based on a projection of the repayment of certain employee pay reductions, recorded in the fourth quarter of 1993; (iv) $13.5 million for certain airport facilities at locations where USAir has, among other things, discontinued or reduced its service, recorded in the fourth quarter of 1993; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership which operates a computerized reserva- tions system, recorded in the fourth quarter of 1993; and (vi) $18.4 million credit related to non-operating aircraft recorded in the second quarter of 1993.\n(c) 1992\nThe Company's results for 1992 include (i) a charge of $628.1 million for the cumulative effect of an accounting change as required by FAS 106, effective January 1, 1992; (ii) a $107.4 million charge related to certain aircraft which have been withdrawn from service, recorded in the fourth quarter of 1992; (iii) a $34.1 million non-operating loss related to the sale of ten MD-82 aircraft which USAir eliminated from its fleet plan, recorded in the fourth quarter of 1992; and (iv) a $10.3 million gain on the sale of three wholly-owned subsidiaries, recorded in the third quarter of 1992 (see Note 1).\n(14) Selected Quarterly Financial Data (Unaudited)\nThe following table presents selected quarterly financial data for 1994 and 1993:\nSee Note 13 - Non-Recurring and Unusual Items.\nNote: The sum of the four quarters may not equal yearly totals due to rounding of quarterly results.\nCertain 1993 amounts have been reclassified to conform with 1994 classifications.\n(this space intentionally left blank)\nItem 8B. Financial Statements and Supplementary Information USAir, Inc.\nIndependent Auditors' Report\nThe Stockholder and Board of Directors USAir, Inc.:\nWe have audited the consolidated balance sheets of USAir, Inc. and subsidiary (\"USAir\") as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows, and changes in stockholder's equity (deficit) for each of the years in the three-year period ended December 31, 1994. These consolidated financial statements are the responsibility of USAir'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 USAir, Inc. and subsidiary as of December 31, 1994 and 1993, and the results of their operations and their cash flows for the three-year period ended December 31, 1994 in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that USAir will continue as a going concern. As discussed in Note 4(a) to the consolidated financial statements, USAir has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 4(a). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nAs discussed in Note 9 to the consolidated financial statements, effective January 1, 1993, USAir changed its method of accounting for postemployment benefits and effective January 1, 1992, USAir changed its method of accounting for postretirement benefits other than pensions.\nKPMG Peat Marwick LLP Washington, D. C. February 22, 1995, except as to Notes 4(a) and 4(c) which are as of April 10, 1995\nUSAir, Inc. Notes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies\n(a) Basis of Presentation\nThe accompanying consolidated financial statements include the accounts of USAir, Inc. (\"USAir\") and its wholly-owned subsidiary USAM Corp. (\"USAM\"). USAir is a wholly-owned subsidiary of USAir Group, Inc. (\"USAir Group\" or \"the Company\"). All significant intercompany accounts and transactions have been eliminated.\nAt December 31, 1992, USAM owned 11% of the Covia Partnership (\"Covia\") which owned and operated a computerized reservation system (\"CRS\"). In September 1993, Covia purchased the assets of the corporation that owned and operated the Galileo CRS which provided services to travel agent subscribers in Europe. Covia was immediately separated into three new entities and, as a result, USAM owns 11% of the Galileo International Partnership which owns and operates the Galileo CRS, approximately 11% of the Galileo Japan Partnership which markets the Galileo CRS in Japan and approximately 21% of the Apollo Travel Services Partnership which markets the Galileo CRS in the U.S. and Mexico. USAM accounts for these investments using the equity method because it is represented on the board of directors of each of the partnership and therefore participates in policy making processes.\nCertain 1993 and 1992 amounts have been reclassified to conform with 1994 classifications.\n(b) Cash and Cash Equivalents and Short-Term Investments\nFor financial statement purposes, USAir considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates market value. Short-term investments consist of certificates of deposit and commercial paper with original maturities greater than three months but less than one year. Short-term investments are stated at cost plus accrued interest, which approximates market value.\n(c) Materials and Supplies\nInventories of materials and supplies are valued at average cost and are charged to operations as consumed. An allowance for obsolescence is provided for flight equipment expendable parts.\n(d) 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.\nMaintenance and repairs, including the overhaul of aircraft components, are charged to operating expense as incurred and costs of major improvements are capitalized for both owned and leased assets. Interest related to deposits on aircraft purchase contracts and facility and equipment construction projects is capitalized as additional cost of the asset or as leasehold improvement if the asset is leased. Depreciation and amortization for principal asset classifications is provided on a straight-line basis to estimated residual values over estimated depreciable lives as follows:\nProperty acquired under capital lease is amortized on a straight-line basis over the term of the lease and charged to Depreciation and Amortization Expense.\n(e) Goodwill, Other Intangibles and Other Assets\nGoodwill, the cost in excess of fair value of identified net assets acquired, is being amortized on a straight-line basis over 40 years. The $629 million goodwill resulting from the acquisition of Pacific Southwest Airlines (\"PSA\") and Piedmont Aviation, Inc. (\"Piedmont Aviation\"), both in 1987, is being amortized as Depreciation and Amortization Expense. Accumulated amortization at December 31, 1994 and 1993 related to the PSA and Piedmont acquisitions was $113 million and $97 million, respectively. The $11 million goodwill resulting from USAM's CRS investments is being amortized as other non-operating expense, consistent with the classification of income or loss on the investments. USAM's associated accumulated amortization at December 31, 1994 and 1993 was $2 million and $1 million, respectively. USAir evaluates whether or not goodwill is impaired by comparing the goodwill balances with estimated future undiscounted cash flows which, in USAir's judgment, are attributable to the goodwill. This analysis is performed separately for the goodwill which resulted from each acquisition.\nIntangible assets consist mainly of purchased operating rights at various airports, purchased route authorities, capitalized software costs and the intangible assets associated with the underfunded amounts of certain pension plans. The operating rights, valued at purchase cost or appraised value if acquired from PSA or Piedmont Aviation, are being amortized over periods ranging from ten to 25 years as Depreciation and Amortization Expense. The purchased route authorities are being amortized over periods of 25 years as Depreciation and Amortization Expense. Capitalized software costs are being amortized as Depreciation and Amortization Expense over five years, the expected period of benefit. Accumu- lated amortization related to intangible assets at December 31, 1994 and 1993 was $80 million and $72 million, respectively.\nBased on the most recent analyses, USAir believes that goodwill and other intangible assets were not impaired at Decem- ber 31, 1994.\nThe increase in Other Assets, net in 1994 is primarily attributable to changes in non-current pension assets. USAir's Other Assets balance includes a $47 million receivable from British Airways Plc related to the relinquishment of two U.S. to London routes.\n(f) Restricted Cash and Investments\nRestricted cash and investments consist primarily of deposits in trust accounts to collateralize letters of credit or workers compensation policies. These amounts are classified as Other Assets on the accompanying balance sheets.\n(g) Deferred Gains on Sale and Leaseback Transactions\nGains on aircraft sale and leaseback transactions are deferred and amortized over the term of the leases as a reduction of rental expense.\n(h) Passenger Revenue Recognition\nPassenger ticket sales are recognized as revenue when the transportation service is rendered. At the time of sale, a liability is established (Traffic Balances Payable and Unused Tickets) and subsequently eliminated either through carriage of the passenger, through billing from another carrier which renders the service or by refund to the passenger. Approximately $23 million and $29 million of amounts owed to wholly-owned subsidiaries of USAir Group for passenger transportation revenue are included in Traffic Balances Payable and Unused Tickets at December 31, 1994 and 1993, respectively.\n(i) Frequent Traveler Awards\nUSAir accrues the estimated incremental cost of providing outstanding travel awards earned by participants in its Frequent Traveler Program when such award levels are reached.\n(j) Investment Tax Credit\nInvestment tax credit benefits have been recorded using the \"flow-through\" method as a reduction of the Federal income tax provision.\n(k) Advertising Costs\nAdvertising costs are expensed when incurred as other operating expense. Advertising expense for 1994, 1993 and 1992 was $63 million, $59 million and $83 million, respectively.\n(2) Financial Instruments\n(a) Terms of Certain Financial Instruments\nUSAir has entered into hedging arrangements to reduce its exposure to fluctuations in the price of jet fuel. Net settlements are recorded as adjustments to aviation fuel expense. The total notional number of gallons under these agreements was 86 million and 194 million at December 31, 1994 and 1993, respectively. Under these arrangements, USAir will pay $0.496 to $0.521 per notional gallon in 1995 and receive a floating rate per notional gallon based on current market prices. In 1994 USAir paid $0.481 to $0.594 per notional gallon and received a floating rate per notional gallon based on current market prices. Decreases in the market price of fuel to levels below the fixed prices require cash payments by USAir and cause an increase in USAir's aviation fuel expense. The hedging arrangements represent approximately 7% and 16% of USAir's expected 1995 and actual 1994 fuel consumption, respectively. USAir is party to such hedging arrangements with several entities. Although the agreements, which expire in 1995, expose USAir to credit loss in the event of nonperformance by the other parties to the agreements, USAir does not anticipate such nonperformance because of the favorable creditworthiness status of the other parties. USAir may continue to enter into such arrange- ments, depending on market conditions.\nAn aggregate of $32 million of future principal payments of the Equipment Financing Agreements due 1998 through 2000 are payable in Japanese Yen. This foreign currency exposure has been hedged to maturity by participation in foreign currency contracts. Although USAir is exposed to credit loss in the event of non- performance by the counterparty to the contracts, USAir does not anticipate such non-performance because of the favorable credit- worthiness status of the other party.\n(b) Fair Value of Financial Instruments\nUnless a quoted market price indicates otherwise, the fair values of cash and investments generally approximate carrying values because of the short maturity of these instruments. USAir has estimated the fair value of long-term debt based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of similar remaining\nmaturities. The fair values of energy swap agreements and foreign currency contracts are obtained from dealer quotes whereby these values represent the estimated amount USAir would receive or pay to terminate such agreements.\nThe estimated fair values of USAir's financial instruments, none of which are held for trading purposes, are summarized as follows (brackets denote liability):\n* Amounts are included in Other Assets on USAir's consolidated balance sheets.\n(this space intentionally left blank)\n(3) Long-Term Debt\nDetails of long-term debt are as follows:\nMaturities of long-term debt and debt under capital leases for the next five years are as follows:\n(in thousands) 1995 $ 80,714 1996 80,536 1997 91,630 1998 160,616 1999 84,105 Thereafter 2,432,601\nInterest rates on $480 million principal amount of long-term debt at December 31, 1994 are subject to adjustment to reflect prime rate and other rate changes.\nEquipment financings totaling $2.2 billion were collateralized by aircraft and engines with a net book value of $2.2 billion at December 31, 1994.\n(4) Commitments and Contingencies\n(a) Operating Environment\nThe U.S. airline industry has undergone dramatic and permanent changes in the last several years, generally resulting in lower operating costs and fares. The current competitive environment is the result of several factors including the emergence and expansion of low cost, low fare carriers, the protection and cost restructur- ing opportunities afforded to certain carriers while operating under Chapter 11 of the bankruptcy code, and other cost restructur- ing initiatives among major airlines, including employee conces- sions in exchange for equity ownership. USAir has incurred annual operating losses for every year since 1990 and has a net capital deficiency at December 31, 1994. USAir is currently in negotia- tions with employee labor groups in an effort to obtain employee concessions that will substantially reduce operating costs. On March 29, 1995, USAir and the negotiating committee of the Air Line Pilots Association (\"ALPA\") Master Executive Council, which represents USAir's pilots, signed an agreement in principle on wage and other concessions in exchange for financial returns and governance participation for USAir pilots. The agreement in principle is subject to many significant conditions, including approval of the boards of directors of the Company and USAir and of the shareholders of the Company and the execution of definitive documentation. USAir continues to negotiate with representatives of its other unions but it is uncertain whether any final agree- ments will be reached. No assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. In addition, USAir is evaluating other strategic decisions that could be implemented to improve the operating results of the airline. USAir believes that it must reduce its operating costs substantially if it is to survive in this low cost, low fare competitive environment.\n(b) Lease Commitments\nUSAir leases certain aircraft, engines, computer and ground equipment, in addition to the majority of its ground facilities. Ground facilities include executive offices, overhaul and mainte- nance bases and ticket and administrative offices. Public airports are utilized for flight operations under lease arrangements with the municipalities or agencies owning or controlling such airports. Substantially all leases provide that the lessee shall pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased property. Most leases also include renewal options and some aircraft leases include purchase options.\nThe following amounts applicable to capital leases are included in property and equipment:\nAt December 31, 1994, obligations under capital and noncancel- able operating leases for future minimum lease payments were as follows:\nThe above table excludes $107 million future sublease rental revenues related to equipment under operating leases. Rental expense under operating leases for 1994, 1993 and 1992 was $703 million, $739 million and $678 million, respectively. The $703 million rental expense for 1994 excludes charges of $103 million related to USAir's grounded BAe-146 fleet and $13 million primarily related to USAir's decision to cease operations of its remaining Boeing 727 aircraft in 1995. The $678 million rental expense for 1992 excludes a charge of $72 million related to USAir's grounded BAe-146 fleet.\n(c) Legal Proceedings\nUSAir has been named as defendant in various suits and proceedings which involve, among other things, environmental concerns and employment matters. These suits and proceedings are in various stages of litigation, and the status of the law with respect to several of the issues involved is unsettled. For these reasons the outcome of these suits and proceedings is difficult to predict. In USAir's opinion, however, the disposition of these matters is not likely to have a material adverse effect on its financial condition or results of operations.\nUSAir is involved in legal proceedings arising out of its two aircraft accidents that occurred in July and September 1994 near Charlotte, North Carolina and Pittsburgh, Pennsylvania, respective- ly. The National Transportation Safety Board (the \"NTSB\") held hearings beginning in September 1994 relating to the July accident and January 1995 relating to the September accident. In April 1995, the NTSB issued its finding of probable causes with respect to the accident near Charlotte. It assigned as probable causes flight crew errors and the failure of air traffic control to convey weather and windshear hazard information. The NTSB has not yet issued its final accident investigation report for the accident near Pittsburgh. USAir expects that it will be at least two to three years before the accident litigation and related settlements will be concluded. USAir believes that it is fully insured with respect to this litigation and has recovered its hull claims related to the loss of the two aircraft. Therefore, USAir believes that the litigation will not have a material adverse effect on USAir's results of operations or financial condition. However, due to these two aircraft accidents, it is probable that USAir's insurance costs will increase upon renewals of various policies in 1995.\nUSAir and certain of the Company's other subsidiaries have received notices from the U.S. Environmental Protection Agency and various state agencies that it is a potentially responsible party with respect to the remediation of existing sites of environmental concern. Only two of these sites have been included on the Superfund National Priorities List. USAir and the other subsidiar- ies continue to negotiate with various governmental agencies concerning known and possible cleanup sites. These companies have made financial contributions for the performance of remedial investigations and feasibility studies at sites in Moira, New York; Escondido, California; Newberry Township, Pennsylvania; Elkton, Maryland; and Salisbury, Maryland.\nBecause of changing environmental laws and regulations, the large number of other potentially responsible parties and certain pending legal proceedings, it is not possible to reasonably estimate the amount or timing of future expenditures related to environmental matters. USAir provides for costs related to environmental contingencies when a loss is probable and the amount is reasonably estimable. Although management believes adequate reserves have been provided for all known contingencies, it is\npossible that additional reserves could be required in the future which could have a material effect on results of operations. However, USAir believes that the ultimate resolution of known environmental contingencies should not have a material adverse effect on USAir's financial position based on USAir's experience with similar environmental sites.\nIn March 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit, which alleged that the airlines used the Airline Tariff Publishing Company to signal and communi- cate carrier pricing intentions and otherwise limit price competi- tion for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers have issued $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir estimates that any incremental cost associated with the settlement will not be material based on the nominal equivalent free trips associated with the settlement. The travel certificates were mailed to claimants in December 1994 and may be applied towards travel purchased between January 1995 and December 1998.\nOn October 11, 1994, USAir and seven other carriers entered into a settlement agreement with a group of State Attorneys General resolving similar issues with the states. The settlement entitles passengers traveling within the United States on state government business to a 10% discount off the published fares of each of the settling carriers and will be available for 18 months or until the combined discount amount reaches $40 million. Following a notice and public comment period, the reviewing judge will conduct a hearing to determine whether this settlement is a fair one. The hearing is scheduled for May 10, 1995. USAir does not expect that this settlement will have a material adverse effect on its financial condition. As was the case with the settlement of the private antitrust litigation, it is difficult to predict the amount of discounted state travel that will occur on USAir. Thus, a dollar impact of the settlement cannot be estimated.\nIn February and March 1995, several class action lawsuits were filed in various Federal district courts by travel agencies and a travel agency trade association alleging that most of the major U.S. airlines, including USAir, violated the antitrust laws when they individually capped travel agent commissions at $50 for round- trip domestic tickets with base fares above $500 and at $25 for one-way domestic tickets with base fares above $250. USAir intends to vigorously defend itself against the allegations made in these\nlawsuits. The plaintiffs are seeking unspecified treble damages for restraint of trade and an injunction to prevent the airlines from implementing or maintaining the cap on commissions. Because the lawsuits are in the first stages of litigation, USAir is unable to predict at this time their ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn March 1995, a number of U.S. carriers, including USAir, received a Civil Investigative Demand (\"CID\") from the Department of Justice related to an investigation of incentives paid to travel agents over and above the base commission payments, which are the subject matter of the suits recently brought by travel agencies as discussed above. USAir responded to an earlier CID on this topic during 1994. USAir is required to produce documents and respond to interrogatories in connection with this CID. USAir intends to comply with the requirements of the CID. Because this matter is in the investigatory stage, USAir is unable to predict at this time its ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn February 1995, two members of USAir's frequent traveler program filed a class action lawsuit in Pennsylvania state court against USAir after it raised the required minimum level of miles necessary to earn a free ticket. The plaintiffs allege breach of contract and seek unspecified damages and specific performance of the contract allegedly breached. USAir denies the allegations. The ultimate resolution of this lawsuit and its potential impact on the Company's financial condition and results of operations cannot be predicted at this time.\n(d) Aircraft Commitments\nUSAir and The Boeing Company (\"Boeing\") reached an agreement in principle in early 1995 regarding the deferral of eight 757-200 aircraft from 1996 to 1998.\nThe following schedule of USAir's new aircraft deliveries and schedule payments at December 31, 1994 (including progress payments, payments at delivery, buyer furnished equipment, spares and capitalized interest) reflects USAir's agreement in principle with Boeing discussed above:\nIn addition, USAir has a commitment to purchase hushkits for certain of its McDonnell Douglas DC-9-30 aircraft and a substantial portion of its Boeing 737-200 aircraft. The installation of these hushkits will bring the aircraft into compliance with Federal Aviation Administration (\"FAA\") Stage 3 noise level requirements. The projected payments associated with the purchase of the hushkits are: $10.5 million - 1995; $44.3 million - 1996; $45.5 million - 1997; $45.2 million - 1998; and $25.0 million - 1999.\n(e) Concentration of Credit Risk\nUSAir does not believe it is subject to any significant concentration of credit risk. At December 31, 1994, most of USAir's receivables related to tickets sold to individual passen- gers through the use of major credit cards (45%) or to tickets sold by other airlines (17%) and used by passengers on USAir or USAir Group's regional airline subsidiaries. These receivables are short-term, generally being settled shortly after sale. Bad debt losses, which have been minimal in the past, have been considered in establishing allowances for doubtful accounts.\n(f) Guarantees\nAt December 31, 1994, USAir guaranteed payments of certain debt obligations of the Galileo International Partnership amounting to approximately $9 million. In addition, at December 31, 1994, USAir guaranteed payments of debt and lease obligations of Piedmont Airlines, Inc. and Jetstream International Airlines, Inc., wholly- owned subsidiaries of USAir Group, amounting to $123 million.\n(5) Sale of Receivables\nThe revolving receivables sales facility (\"Receivables Agreement\"), to which USAir had been a party, expired on Decem- ber 21, 1994. USAir was unable to sell receivables under the Receivables Agreement during 1994 because it was in violation of certain financial covenants. USAir had no outstanding amounts due under the Receivables Agreement at December 31, 1994. The average dollar amount of outstanding receivable sales during 1993 and 1992 was $255 million and $100 million, respectively. USAir is currently engaged in discussions to arrange a replacement facility. There can be no assurance that USAir will be successful in reaching a new agreement to sell its receivables.\n(6) Income Taxes\nEffective January 1, 1993, USAir adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). FAS 109 required a change from the deferred method under Accounting Principles Board Opinion No. 11 to the asset and liability method of accounting for income taxes. No cumulative adjustment at January 1, 1993, and no income tax credit for the years ended December 31, 1994 and 1993, were recognized due to the FAS 109 limitation in recognizing benefits for net operating\nlosses. USAir files a consolidated Federal income tax return with its parent USAir Group pursuant to a tax allocation agreement.\nThe components of the provision (credit) for income taxes are as follows:\nThe significant components of deferred income tax expense\/ (benefit) for the years ended December 31, 1994 and 1993, are as follows:\n(this space intentionally left blank)\nFor the year ended December 31, 1992, deferred income taxes result from differences in the recognition of revenue and expenses and investment tax credits for tax and financial reporting purposes. The major items resulting in these differences and the related tax effects are shown in the following chart: ---- (in thousands)\nEquipment depreciation and amortization $ 67,582 Gain on sale and leaseback transactions (55,514) Net operating loss carryforward 55,671 Employee benefits (35,737) Tax benefits purchased\/sold 7,464 Investment tax credits (2,372) Leasing transactions (33,527) Frequent traveler program (2,815) Other (752) ------- Total deferred provision (credit) $ 0 =======\nA reconciliation of taxes computed at the statutory Federal tax rate on earnings before income taxes to the provision (credit) for income taxes is as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993 are presented below:\n(continued on next page)\nThe valuation allowance for deferred tax assets as of January 1, 1993, was $438 million. The valuation allowance increased $131 million in 1993 and $234 million in 1994.\nAt December 31, 1994, USAir had unused net operating losses of $1.8 billion for Federal tax purposes, which expire in the years 2005-2009. USAir also has available, to reduce future taxes payable, $740 million alternative minimum tax net operating losses expiring in 2007 to 2009, $48 million of investment tax credits expiring in 2002 and 2003, and $21 million of minimum tax credits which do not expire. The Federal income tax returns of the Company through 1986 have been examined and settled with the Internal Revenue Service.\n(7) Stockholder's Equity and Dividend Restrictions\nUSAir Group owns all of the outstanding Common Stock of USAir. USAir, organized under the Laws of the State of Delaware, is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. At December 31, 1994, USAir's capital surplus was exhausted and therefore, under Delaware law, USAir is legally restricted from paying dividends to USAir Group. Surplus is the remainder of (i) net assets (total assets less total liabilities), less (ii) total capital (that amount of preferred and common equity designated as\ncapital by a company's board of directors). At December 31, 1994, USAir's capital deficit was approximately $273.2 million. USAir's net assets were in a deficit balance of approximately $273.2 million, and its total capital was a nominal amount. In order for USAir to return to a capital surplus position, it must realize substantial profits or increase its equity through other measures, such as the sale of additional common or preferred stock.\nCovenants related to USAir 10% and 9 5\/8% Senior Unsecured Notes currently do not permit the payment of dividends by USAir to USAir Group.\n(8) Employee Stock Ownership Plan\nIn August 1989, USAir established an Employee Stock Ownership Plan (\"ESOP\"). USAir Group sold 2,200,000 shares of its Common Stock to an Employee Stock Ownership Trust to hold on behalf of USAir's employees, exclusive of officers, in accordance with the terms of the Trust and the ESOP. Financing of approximately $111.4 million for the Trust's purchase of the shares was provided by USAir through a 9 3\/4% loan to the Trust, and an additional $2.2 million was contributed to the Trust by USAir. The loan is being repaid with contributions made by USAir. The contributions are made in amounts equal to the periodic loan payments as they come due, less dividends available for loan payment. As the loan is repaid over time, participating employees receive allocations of the Common Stock purchased by the Trust. The initial maturity of the loan is 30 years. However, the ESOP provides that if USAir's profitability as measured by return on sales exceeds certain goals during the life of the ESOP, USAir's contributions and the repayment of the loan will be accelerated. Annual contributions made by USAir and therefore loan repayments made by the Trust were $11.4 million in each of 1994, 1993 and 1992. The interest portion of these contributions was $10.5 million in 1994, $10.5 million in 1993 and $10.6 million in 1992. Approximately 438,000 shares of Common Stock have been allocated to employees. USAir recognized approximately $4 million of compensation expense related to the ESOP in each of 1994, 1993 and 1992 based on shares allocated to employees (the \"shares allocated\" method). Deferred compensation related to the ESOP amounted to approximately $91 million, $95 million and $98 million at December 31, 1994, 1993 and 1992, respectively.\n(9) Employee Benefit Plans\n(a) Pension Plans\nUSAir has several pension plans in effect covering substan- tially all employees. One qualified defined benefit plan covers USAir maintenance employees and provides benefits of stated amounts for specified periods of service. Qualified defined benefit plans for substantially all other employees provide benefits based on years of service and compensation. The qualified defined benefit plans are funded, on a current basis, to meet requirements of the Employee Retirement Income Security Act of 1974.\nThe defined benefit pension plan for USAir non-contract employees was frozen at the end of 1991 for all non-contract participants, resulting in a one-time book gain of approximately $107 million in 1991. All non-contract plan participants became 100% vested at the time of the freeze. As a result of this plan curtailment, the accrual of service costs related to defined benefits for USAir non-contract and certain other employees ceased at the end of 1991. USAir implemented a defined contribution pension plan for non-contract employees in January 1993.\nThe funded status of the qualified defined benefit plans at December 31, 1994 and 1993 was as follows:\nUnrecognized transition assets are being amortized over periods up to 27 years. The weighted average discount rate used to determine the actuarial present value of the projected benefit obligation was 9.0% and 7.6% as of December 31, 1994 and 1993, respectively. The expected long-term rate of return on plan assets used in 1994 and 1993 was 9.5%. Rates of 3% to 6% were used to estimate future salary levels. At December 31, 1994, plan assets consisted of approximately 8% in cash equivalents and short-term debt investments, 27% in equity investments, and 65% in fixed income and other investments. At December 31, 1993, plan assets consisted of approximately 8% in cash equivalents and short-term debt investments, 37% in equity investments, and 55% in fixed income and other investments.\nThe following items are the components of the net periodic pension cost for the qualified defined benefit plans:\nNet pension cost for 1993 presented above excludes a charge of approximately $33.9 million related to \"early-out\" incentive programs offered to a limited number of USAir employees during the years. No such charges were incurred in 1994 or 1992.\nNon-qualified supplemental pension plans are established for certain employee groups, which provide incremental pension payments from USAir's funds so that total pension payments equal amounts that would have been payable from USAir's principal pension plans if it were not for limitations imposed by income tax regulations.\nThe following table sets forth the non-qualified plans' status at December 31, 1994 and 1993:\nNet periodic supplementary pension cost for the non-qualified supplemental pension plans included the following components:\nThe discount rate used to determine the actuarial present value of the projected benefit obligation was 9.0% and 7.5% as of December 31, 1994 and 1993, respectively. A rate of 3% was used to estimate future salary levels.\nIn addition to the qualified and non-qualified defined benefit plans described above, USAir also contributes to certain defined contribution plans primarily for employees not covered under a collective bargaining agreement. USAir contributions are based on a formula which considers the age and pre-tax earnings of each employee and the amount of employee contributions. USAir's contribution expense was $43 million and $42 million for 1994 and 1993, respectively. USAir recognized no such expense in 1992 because the plans became effective January 1, 1993.\n(b) Postretirement Benefits Other Than Pensions\nUSAir offers medical and life insurance benefits to employees hired prior to March 29, 1993 who retire from the Company and their eligible dependents. The medical benefits provided by USAir are coordinated with Medicare benefits. Retirees generally contribute amounts towards the cost of their medical expenses based on years of service with USAir. USAir provides uninsured death benefit payments to survivors of retired employees for stated dollar amounts, or in the case of retired pilot employees, death benefit payments determined by age and level of pension benefit. The plans for postretirement medical and death benefits are funded on the pay-as-you-go basis.\nUSAir adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"), during 1992 and elected to record the January 1, 1992 Accumulated Postretirement Benefit Obligation (\"APBO\") using the immediate recognition approach. The cumulative effect of adopting FAS 106 was $745.5 million ($638.8 million net of tax benefit).\nThe following table sets forth the financial status of the plans as of December 31, 1994 and 1993:\nThe components of net periodic postretirement benefit cost are as follows:\nThe postretirement benefit expense for 1993 presented above excludes a charge of approximately $15.5 million related to \"early- out\" programs offered to a limited number of employees during the year. No such charges were incurred in 1994 or 1992.\nThe discount rate used to determine the APBO was 9.0%, 7.75% and 8.75% at December 31, 1994, 1993 and 1992, respectively. The assumed health care cost trend rate used in measuring the APBO was 9.5% in 1994, declining by 1% per year after 1994 to an ultimate rate of 4.5%. If the assumed health care cost trend rate were increased by 1 percentage point, the APBO at December 31, 1994 would be increased by 11% and 1994 periodic postretirement benefit cost would increase 13%.\n(c) Postemployment Benefits\nUSAir adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"FAS 112\"), during 1993. FAS 112 requires the use of an accrual method to recognize postemployment benefits such as disability-related benefits. The cumulative effect at January 1, 1993 of adopting FAS 112 was $43.7 million.\n(10) Supplemental Balance Sheet Information\nThe components of certain accounts in the accompanying balance sheets are as follows:\n(11) Non-Recurring and Unusual Items\n(a) 1994\nUSAir's results for 1994 include (i) a $132.8 million charge related to its grounded BAe-146 fleet, recorded in the fourth quarter of 1994; (ii) a $54.0 million charge for obsolete inventory and rotables to reflect market value, recorded in the fourth quarter of 1994; (iii) a $50 million addition to passenger transportation revenue in the fourth quarter of 1994 to adjust estimates made during the first three quarters of 1994; (iv) a $40.1 million charge primarily related to USAir's decision to cease operations of its remaining Boeing 727 aircraft in 1995, recorded in the third quarter of 1994; (v) a $25.9 million charge related to USAir's decision to substantially reduce service between Los Angeles and San Francisco and close its San Francisco crew base, recorded in the third quarter of 1994; and (vi) an $18.6 million gain resulting from the accounting treatment of the hull insurance recovery on the aircraft destroyed in the September accident, recorded in the third quarter of 1994.\n(b) 1993\nUSAir's results for 1993 include non-recurring charges of (i) $43.7 million for the cumulative effect of an accounting change, as required by FAS 112 which was adopted during the third quarter of 1993, retroactive to January 1, 1993; (ii) $68.8 million for severance, early retirement and other personnel-related expenses recorded primarily during the third quarter of 1993 in connection with a workforce reduction of approximately 2,500 full-time positions between November 1993 and the first quarter of 1994; (iii) $36.8 million based on a projection of the repayment of certain employee pay reductions, recorded in the fourth quarter of 1993; (iv) $13.5 million for certain airport facilities at locations where USAir has, among other things, discontinued or\nreduced its service, recorded in the fourth quarter of 1993; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership, which operates a computerized reserva- tion system, recorded in the fourth quarter of 1993; and (vi) $18.4 million credit related to non-operating aircraft, recorded in the second quarter of 1993.\n(c) 1992\nUSAir's results for 1992 include (i) a charge of $628.1 million for the cumulative effect of an accounting change as required by FAS 106, effective January 1, 1992; (ii) a $107.4 million charge related to certain aircraft which have been withdrawn from service, recorded in the fourth quarter of 1992; and (iii) a $34.1 million non-operating loss related to the sale of ten MD-82 aircraft which USAir eliminated from its fleet plan, recorded in the fourth quarter of 1992.\n(12) Selected Quarterly Financial Data (Unaudited)\nThe following table presents selected quarterly financial data for 1994 and 1993:\nSee Note 11 - Non-Recurring and Unusual Items.\nNote: The sum of the four quarters may not equal yearly totals due to rounding of quarterly results.\nCertain 1993 amounts have been reclassified to conform with 1994 classifications.\nItem 9.","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Account- ing and Financial Disclosure\nNone\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of USAir Group, Inc.\nEach of the persons listed below is currently a director of the Company and was elected in 1994 by the stockholders of the Company. Each director of the Company is also a director of USAir. Except as noted otherwise, the following biographies disclose the age and describe the business experience of each director for at least the past five years. As required by the Investment Agree- ment, the Board amended the Company's By-Laws on January 21, 1993 to increase the authorized number of directors by three and immediately thereafter elected Messrs. Marshall, Maynard and Stevens to fill the new directorships. Under the Investment Agreement, the Company is required to use its best efforts to ensure that the slate of persons nominated by the Company for election as directors of the Company includes that number of persons designated by BA that is the percentage of the total then authorized number of directors, which is currently 16, of the Company that is nearest to but not greater than the percentage (but in no event greater than 25%) of the aggregate voting power of the securities that vote with the Common Stock as a single class for the election of directors of the Company then held by BA and its wholly-owned subsidiaries. Under this provision of the Investment Agreement, BA is entitled to designate three directors to the Board and has accordingly designated Messrs. Marshall, Maynard and Stevens. Messrs. Buffet and Munger have advised the Company that they will not stand for re-election as directors of the Company and of USAir at the 1995 annual meeting. They had previously announced that their continued service as directors of the Company and of USAir was dependent upon USAir successfully reaching a timely agreement with its organized labor groups that, in the opinion of Messrs. Buffett and Munger, provided USAir with sufficient labor cost savings which, when combined with other cost reduction programs being implemented by USAir, would afford USAir a reason- able opportunity to achieve profitability in a low fare competitive environment. On March 13, 1995, in announcing the decision of Messrs. Buffett and Munger not to stand for re-election, Berkshire Hathaway Inc. stated, \"To date, USAir has not been successful in achieving necessary labor cost savings.\"\nServed as Director since -------- Warren E. Buffett, 64 ................................. 1993\nMr. Buffett has been Chairman and Chief Executive Officer of Berkshire Hathaway Inc. (insurance, candy, retailing, manufacturing and publishing) since 1970. He is also a Director of Capital- Cities\/ABC, Inc., The Coca-Cola Company, The Gil- lette Company and Salomon Inc. Mr. Buffett is a member of the Finance and Planning Committee of the Board.\nEdwin I. Colodny, 68 ................................. 1975\nMr. Colodny is of counsel to the law firm of Paul, Hastings, Janofsky & Walker. He retired as Chair- man of the Company and of USAir in July 1992. He served as Chief Executive Officer of USAir from 1975 until retiring as an employee of USAir in June 1991. Mr. Colodny is a Director of Martin Marietta Corporation, Comsat Corporation and Esterline Technologies, Inc., and is a member of the Board of Trustees of the University of Rochester. He is a member of the Finance and Planning and Nominating Committees of the Board.\nMathias J. DeVito, 64 ................................. 1981\nMr. DeVito is Chairman of the Board of The Rouse Company (real estate development and management). He also serves as a Director of First Maryland Bancorp and subsidiaries of The Rouse Company. He is a member of the Board of the Business Committee for the Arts, Chairman of the Board of Empower Baltimore Management Corporation and former Chair- man of the Greater Baltimore Committee. Mr. DeVito is Chairman of the Compensation and Benefits Com- mittee and a member of the Finance and Planning Committee of the Board.\nGeorge J. W. Goodman, 64 .............................. 1978\nMr. Goodman is President of Continental Fidelity, Inc. which provides editorial and investment ser- vices. He is the author of a number of books and articles on finance and economics under the pen name \"Adam Smith\" and is the host of a television series of that name seen on public broadcasting stations in the U.S. and on other networks abroad. He is a Director of Cambrex Corporation. Mr. Goodman also serves as a member of the Advisory Committee of the Center for International Relations\nat Princeton University, and is a Trustee of the Urban Institute. He is a member of the Compensa- tion and Benefits and Finance and Planning Commit- tees of the Board.\nJohn W. Harris, 48 .................................... 1991\nMr. Harris is President of The Harris Group (real- estate development). From 1972 through 1991, he was President of The Bissell Companies, Inc. (real- estate development). He is a Director of Southern Bell Telephone and Telegraph Company. Mr. Harris is former Chairman of the Greater Charlotte Chamber of Commerce and a member of the Board of Trustees of the University of North Carolina and serves on the boards of several community service organiza- tions. He is a member of the Audit and Compensa- tion and Benefits Committees of the Board.\nEdward A. Horrigan, Jr., 65 ........................... 1987\nMr. Horrigan is the former Chairman of the Board of Directors of Liggett Group Inc. (consumer prod- ucts), a position he had held from May 1993 until his retirement in December 1994. He is also the retired Vice Chairman of the Board of RJR Nabisco, Inc. and retired Chairman and Chief Executive Officer of R. J. Reynolds Tobacco Company, Winston- Salem, North Carolina (consumer products). He is a Director of the Haggai Foundation. Mr. Horrigan is a member of the Audit and Nominating Committees of the Board.\nRobert LeBuhn, 62 ..................................... 1966\nMr. LeBuhn was the Chairman of Investor Interna- tional (U.S.), Inc. (investments) until his retire- ment in January 1995. He is now a private investor and is a Director of Acceptance Insurance Compa- nies, Amdura Corp., Lomas Financial Corp., Cambrex Corporation and Enzon, Inc. He is Trustee and President of the Geraldine R. Dodge Foundation, Morristown, New Jersey and is a member of the New York Society of Security Analysts. He is Chairman of the Finance and Planning Committee and a member of the Nominating Committee of the Board.\nSir Colin Marshall, 61 ................................ 1993\nSir Colin was elected Chairman of BA in February 1993. Previously, he had been Chief Executive of BA and a member of BA's Board of Directors since 1983. Sir Colin is a Director of HSBC Holdings Plc, IBM, United Kingdom Holdings Limited and Qantas Airways Limited. He is a member of the\nFinance and Planning Committee of the Board.\nRoger P. Maynard, 52 .................................. 1993\nMr. Maynard has been Director of Corporate Strategy of BA since 1991. Previously, from 1987, he had held various positions at BA, including Director of Investor Relations & Marketplace Performance and Executive Vice President North America. Mr. Maynard is a member of the Nominating and Compensation and Benefits Committees of the Board.\nJohn G. Medlin, Jr., 61 ............................... 1987\nMr. Medlin is Chairman of the Board and, until December 31, 1993, was Chief Executive Officer of Wachovia Corporation (bank holding company). Mr. Medlin also serves as a Director of BellSouth Company, Burlington Industries, Inc., Media Gener- al, Inc., National Services Industries, Inc., RJR Nabisco, Inc. and Nabisco Holdings Corporation. He is Chairman of the Nominating Committee and a member of the Compensation and Benefits Committee of the Board.\nHanne M. Merriman, 53 ................................. 1985\nMrs. Merriman is the Principal in Hanne Merriman Associates (retail business consultants). Previ- ously, she served as President of Nan Duskin, Inc. (retailing), President and Chief Executive Officer of Honeybee, Inc., a division of Spiegel, Inc., and President of Garfinckel's, a division of Allied Stores Corporation. Mrs. Merriman is a Director of CIPSCO, Inc. Central Public Service Company, State Farm Mutual Automobile Insurance Company, The Rouse Company, Ann Taylor Stores Corporation and T. Rowe Price Mutual Funds. She is a member of the Nation- al Women's Forum and a Trustee of The American- Scandinavian Foundation. She was a member of the Board of Directors of the Federal Reserve Bank of Richmond, Virginia from 1984-1990 and served as Chairman in 1989-1990. Mrs. Merriman is Chairman of the Audit Committee and is a member of the Nominating Committee of the Board.\nCharles T. Munger, 71 ................................. 1993\nMr. Munger is Vice Chairman of Berkshire Hathaway Inc. (insurance, candy, retailing, manufacturing and publishing) of which he has been an officer and Director since 1975. He is Chairman of Daily Journal Corporation and is a Director of Salomon Inc. and Wesco Financial Corporation. Mr. Munger\nis a member of the Audit Committee of the Board.\nFrank L. Salizzoni, 56 ................................ 1994\nMr. Salizzoni was elected President and Chief Operating Officer of the Company and USAir, effec- tive April 1, 1994, and was elected to the Board on May 25, 1994. Previously, Mr. Salizzoni was Vice Chairman and Chief Financial Officer of Trans World Airlines and Trans World Corporation until 1987, when he became Vice Chairman and Chief Financial Officer of TW Services, Inc. (food service). He was Chairman and Chief Executive Officer of TW Services from April 1987 until August 1989, just before that company went private. Mr. Salizzoni was associated with Mancusco and Co. (investments) from August 1989 until he was elected Executive Vice President-Finance of the Company and of USAir in November 1990. Mr. Salizzoni is a Director of H&R Block, Inc., and SKF USA, Inc.\nSeth E. Schofield, 55 ................................. 1989\nMr. Schofield was elected Chairman of the Board of the Company and USAir in June 1992. In June 1991 he was elected President and Chief Executive Offi- cer of the Company and of USAir. In June 1990 he was elected President and Chief Operating Officer of USAir. He had served as Executive Vice Presi- dent-Operations of USAir since 1981. Mr. Schofield joined USAir in 1957 and has held various corporate staff positions. Mr. Schofield is a Director of the Erie Insurance Group, the PNC Bank, N.A., USX Corp., the Greater Washington Board of Trade, the Flight Safety Foundation and the Greater Pittsburgh Council of the Boy Scouts of America. Mr. Scho- field is Chairman of the Board of Directors of the Greater Pittsburgh Chamber of Commerce, and a Board Member of the Pennsylvania Business Roundtable, Penn's Southwest Association, the Virginia Business Council and a member of the Desai Capital Manage- ment Advisory Board. He is also a member of the Allegheny Conference on Community Development and the Federal City Council and serves on the Board of Trustees of the University of Pittsburgh and West- minster College.\nRaymond W. Smith, 57 .................................. 1990\nMr. Smith is Chairman of the Board and Chief Execu- tive Officer of Bell Atlantic Company, which is engaged principally in the telecommunications business and is one of the seven regional companies formed as a result of the divestiture of the Bell System. Previously, Mr. Smith had served as Vice\nChairman and President of Bell Atlantic and Chair- man of The Bell Telephone Company of Pennsylvania. He is a member of the Board of Directors of Core- States Financial Company, a trustee of the Univer- sity of Pittsburgh and is active in many civic and cultural organizations. He is a member of the Compensation and Benefits and Nominating Committees of the Board.\nDerek M. Stevens, 56 .................................. 1993\nMr. Stevens has been Chief Financial Officer of and a Director of BA since 1989. Previously, from 1981, he was Finance Director of TSB Group plc (financial institution). Mr. Stevens is a member of the Audit Committee of the Board.\nThe law firm of Paul, Hastings, Janofsky and Walker, with which Mr. Colodny is affiliated on an Of Counsel basis, provided legal services to USAir during 1994 and is expected to provide such services during 1995.\nThe following persons are executive officers of the Company.\nFor purposes of Rule 405 under the Securities Act of 1933, as amended, Messrs. Lagow, Long, Aubin, Fornaro, Frestel, Harper and Ms. Risque Rohrbach are deemed to be executive officers of the Company.\nThere are no family relationships among any of the officers listed above. No officer was selected pursuant to any arrangement between him or her and any other person. Officers are elected annually to serve for the following year or until the election and qualification of their successors. All the executive officers except Ms. Risque Rohrbach and Messrs. Lagow, Salizzoni, Aubin, Fornaro and Harper have been actively engaged in the business and affairs of the Company and USAir during the past five years. The business experience of the officers listed above since at least January 1, 1990 is as follows:\nMr. Schofield was elected Executive Vice President of the Company in July 1989. At that time he was also elected Vice Chairman of the Board of the Company and of USAir. Mr. Schofield served as Executive Vice President-Operations of USAir until his election as President and Chief Operating Officer of USAir in June 1990. Effective on July 1, 1991, Mr. Schofield was elected President and Chief Executive Officer of both the Company and USAir. Effective on July 1, 1992, Mr. Schofield was elected Chairman of the Board of both the Company and USAir.\nMr. Salizzoni was Vice Chairman and Chief Financial Officer of Trans World Airlines and Trans World Corporation until 1987, when he became Vice Chairman and Chief Financial Officer of TW Services, Inc. He was Chairman and Chief Executive Officer of TW Services\nfrom April 1987 until August 1989, just before that company went private. Mr. Salizzoni was associated with Mancusco and Co. from August 1989 until he was elected Executive Vice President-Finance of the Company and of USAir in November 1990. Mr. Salizzoni was elected President and Chief Operating Officer of the Company and USAir in 1994.\nMr. Lagow was Senior Vice President-Market Planning of Northwest Airlines until February 1988, when he became Senior Vice President-Planning of United Airlines. Mr. Lagow held that position until he was elected Executive Vice President-Marketing of USAir in February 1992.\nMr. Lloyd engaged in the private practice of law in Washing- ton, D.C. from 1967 until his election as Vice President, General Counsel and Secretary of the Company and as Senior Vice President and General Counsel of USAir in 1987. He served in those capaci- ties until his election as Executive Vice President, Secretary and General Counsel of the Company and Executive Vice President and General Counsel of USAir in January 1991.\nMr. Long served as Senior Vice President-Administration of USAir until his election as Senior Vice President-Customer Operations of USAir in June 1989. He served in that capacity until his election as Senior Vice President-Customer Services in March 1991. Mr. Long served as Senior Vice President-Customer Services until his election as Executive Vice President-Customer Services in May 1992.\nMr. Aubin was Executive Advisor to the Vice Chairman, President and Chief Executive Officer of Air Canada prior to joining USAir and, prior to that position, he served as Senior Vice President Technical Operations and Chief Technical Officer of Air Canada. He was elected Senior Vice President-Maintenance Opera- tions of USAir in January 1994.\nMr. Fornaro was Vice President-Research of Jesup & Lamont Securities until February 1988, when he became Senior Vice President-Marketing of Braniff, Inc. In August 1988, Mr. Fornaro became Senior Vice President-Market Planning of Northwest Airlines, the position he held until February 1992. He was elected Senior Vice President-Planning of USAir in March 1992.\nMr. Frestel was associated with The Atchison, Topeka & Santa Fe Railway for 22 years prior to joining USAir, most recently as Vice President-Personnel and Labor Relations, and was a Director of that company from June 1988 until his election as Senior Vice President-Human Resources of USAir in January 1989.\nMr. Harper was Senior Vice President-Marketing and Information Systems at Axe-Houghton Management (investment management) until his election as Vice President and Controller of the Company and USAir in December 1991. He served in that position until his election as Senior Vice President-Information Systems of USAir in October 1992. Mr. Harper was elected Senior Vice President -\nFinance and Chief Financial Officer of the Company and USAir in 1994.\nMs. Risque Rohrbach served as a member of the White House legislative liaison team (1981-1986) and as Assistant to the President and Secretary to the Cabinet (1987-1988). In 1989 and 1990, she was a resident fellow at Harvard University's Institute of Politics and a consultant to the Department of Energy. She was Assistant Secretary of Labor for Policy at the U.S. Department of Labor during 1991-1992 and a public policy and communications consultant during 1993. Ms. Risque Rohrbach was elected Vice President-Public and Community Relations of the Company and Senior Vice President-Public and Community Relations of USAir in January 1994.\nItem 11.","section_11":"Item 11. Executive Compensation\nCompensation of Directors\nIn 1994, each incumbent director, except Messrs. Schofield and Salizzoni, was paid a retainer fee of $18,000 per year for service on the Board of the Company and a fee of $600 per Board meeting or committee meeting attended. Consistent with a comprehensive cost reduction program at USAir, the retainer fee was reduced by 20% to $14,400 for an eighteen-month period commencing January 1, 1992 and ending on June 30, 1993. As of January 1, 1995, the retainer fee has been reduced to $14,000 per year. Mr. LeBuhn, Chairman of the Finance and Planning Committee, Mr. DeVito, Chairman of the Compensation Committee, and Mrs. Merriman, Chairman of the Audit Committee, each receives an additional fee of $2,000 per year for serving in those respective capacities. Mr. Medlin, Chairman of the Nominating Committee, receives an additional fee of $1,000 per year for serving in that capacity. Each of Messrs. Schofield and Salizzoni receives a salary in his capacity as an officer of USAir and receives no additional compensation as a director of the Company and USAir.\nIn 1987 the Company established a retirement plan for directors who are not also employees of the Company and its subsidiaries. The plan provides that such directors shall be eligible to receive retirement benefits thereunder if they have attained seventy years of age and served at least five consecutive years on the Board or, if they have not attained age seventy, have served for at least ten consecutive years on the Board. Eligible directors receive an annual retirement benefit equal to the highest annual retainer in effect for active directors during the five years prior to retirement. If the annual retainer for active directors is increased, the annual retirement benefit paid to retired directors is increased by an amount equal to 50% of the increase in retainer paid to active directors. If a director dies prior to retirement and had served for at least five consecutive years on the Board, the deceased director's surviving spouse is eligible under the plan to receive, for a period of five years following such death, an annual death benefit equal to 50% of the annual retainer paid to such director at the time of his or her\ndeath. If a retired eligible director dies, the director's surviving spouse is eligible under the plan to receive, for a period of five years following such death, 50% of the annual retirement benefit payable to the director at the time of his or her death. The plan is administered by the Compensation and Benefits Committee.\nCompensation of Executive Officers\nThe Summary Compensation Table below sets forth the compensa- tion paid during the years indicated to each of the Chief Executive Officers and the four remaining most highly compensated executive officers of the Company (including its subsidiaries).\nSummary Compensation Table\n(a) Mr. Salizzoni was named President and Chief Operating Officer of the Company and USAir effective April 1, 1994. (b) Mr. Lagow's employment with USAir commenced on February 7, 1992. (c) Amounts disclosed reflect reductions in salary during (i) 1993 of $24,365, $12,250, $14,942, $10,904 and $8,750, and (ii) 1992 of $87,019, $43,750, $49,272, $38,942 and $31,250 for Messrs. Schofield, Salizzoni, Lagow, Lloyd and Frestel, respectively, which were implemented for all USAir officers for a fifteen-month period commencing on January 1, 1992 and ending on March 29, 1993 pursuant to a comprehensive cost reduction program at USAir.\n(d) Paid to Mr. Lagow in the form of a \"sign-on bonus.\" (e) Amounts disclosed include for (i) 1994, $108,633, $10,391, $18,705, and $30,518, (ii) 1993, $271,288, $33,259, $73,215, and $48,805 and (iii) 1992, $171,410, $22,523, $47,974 and $31,717, received by Messrs. Schofield, Salizzoni, Lloyd and Frestel, respectively, to cover incremental tax liability resulting from income derived from the lapsing of restrictions on the disposition of Restricted Stock. Restricted Stock is Common Stock subject to certain restrictions on disposition. Any amounts disclosed in the column that are in excess of the amounts disclosed in the preceding sentence represent income derived from personal travel on USAir. (f) At December 31, 1994, Messrs. Schofield, Salizzoni, Lloyd and Frestel owned 10,000, 3,000, 1,000 and 1,000 shares of Restricted Stock, respectively. At the fair market value of the Common Stock on that date, these holdings of Restricted Stock were valued at $42,500, $12,750, $4,250 and $4,250, respectively. Restricted Stock is eligible to receive divi- dends; however, the Company has not paid dividends on its Common Stock since the second quarter of 1990. (g) Non-qualified stock option grant on April 1, 1994, the date Mr. Salizzoni was named President and Chief Operating Officer of the Company and USAir. (h) Under USAir's split dollar life insurance plan, described under \"Additional Benefits\" below, individual life insurance coverage is available to the named officers. During 1992, each officer paid the amount of the premium associated with the term life component of the coverage. In 1993, USAir commenced paying the premium associated with this coverage. In 1992, 1993 and 1994, USAir paid the remainder of the premium associated with the whole life component of the coverage. If all assumptions as to life expectancy and other factors occur in accordance with projections, USAir expects to recover the premiums it pays with respect to the whole life component of the coverage. The following amounts reflect the value of the benefits accrued during the years indicated, calculated on an actuarial basis, ascribed to the insurance policies purchased on the lives of the named officers (plus, with respect to 1993 and 1994, the dollar value of premiums paid by USAir with respect to term life insurance): 1994--Mr. Schofield--$31,194; Mr. Salizzoni--$27,722; Mr. Lagow--$10,225; Mr. Lloyd--$18,424 and Mr. Frestel--$21,188; 1993--Mr. Schofield--$29,328, Mr. Salizzoni--$26,010, Mr. Lagow--$9,716, Mr. Lloyd--$17,291 and Mr. Frestel--$18,661; 1992--Mr. Schofield--$38,495; Mr. Salizzoni--$34,382; Mr. Lagow--$12,902; Mr. Lloyd--$21,382 and Mr. Frestel--$19,821. During 1994 and 1993, USAir made contributions to the accounts of Messrs. Schofield, Salizzoni, Lagow, Lloyd and Frestel in certain defined contribution pension plans in the following amounts: 1994--$43,627, $38,192, $26,000, $22,000 and $24,678, respectively, and 1993--$34,974, $26,212, $22,805, $18,897 and $18,702, respec- tively. (i) Amount disclosed also reflects $101,246 for reimbursement of relocation expenses.\n(j) Upon the commencement of his employment, USAir agreed to pay Mr. Lagow $1 million over four years, which amount was intended to compensate him for restricted stock and stock options which he forfeited when he left his former employer. The amount disclosed includes the second installment, $250,000, of the total payment. (k) Amount disclosed includes the first installment, $250,000, of the total payment referred to in footnote (j). (l) Amount disclosed also reflects $4,715 for reimbursement of relocation expenses.\nOption\/SAR Grants in Last Fiscal Year\nThe following table provides information on option grants in fiscal year 1994 to the named executive officers. No option grants were made to Messrs. Schofield, Lagow, Lloyd or Frestel.\n(a) These options were granted as of April 1, 1994. Twenty-five percent of these options will vest on the first anniversary of their grant (April 1, 1995), an additional 25% will vest on the second anniversary of their grant (April 1, 1996), and the remaining 50% will vest on the third anniversary of their grant (April 1, 1997). None of these options is accompanied by stock appreciation rights. (b) Based on total grants of options to purchase 321,000 shares of Common Stock awarded during 1994. (c) The exercise price and tax withholding obligation related to exercise may be paid by delivery of previously-owned shares or by offset of the underlying shares, subject to certain conditions. (d) Represents the increase in aggregate market value of all shares of Common Stock outstanding as of April 1, 1994, from that date to May 1, 2004 at the assumed rate of stock price appreciation specified.\nAggregated Option\/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option\/SAR Values\nThe following table provides information on the number of options held by the named executive officers at fiscal year-end 1994. None of the officers exercised any options during 1994 and\nnone of the unexercised options held by these officers was in-the-money based on the fair market value of the Common Stock on December 31, 1994 ($4.25 per share).\nRetirement Benefits\nPrior to 1993, USAir's Retirement Plan (the \"Retirement Plan\") for its salaried employees was comprised of two qualified plans. The Retirement Plan was designed so that the two plans, when aggregated, would provide noncontributory benefits based upon both years of service and the employee's highest three-year average annual compensation during the last ten calendar years of service. The primary plan is a defined benefit plan which provides a benefit based on the factors mentioned above. The primary plan is integrated with the Social Security program so that the benefits provided thereunder are reduced by a portion of the employee's benefits from Social Security. USAir's contributions to the primary plan are not allocated to the account of any particular employee. The primary plan was frozen on December 31, 1991, and accordingly, retirement benefits payable under the plan were determinable on that date.\nThe secondary plan is a target benefit defined contribution plan. The secondary plan was established in 1983 as a result of changes to the Internal Revenue Code (the \"Code\"), which lowered the maximum benefit payable from a defined benefit plan. In the event that the benefit produced under the primary plan formula cannot be accrued for any employee covered by such plan because of the limit on benefits payable under defined benefit plans, contributions will be made on behalf of such employee to the secondary plan. Such contributions will be calculated to provide the benefit produced under the formula in the primary plan in excess of such limit, to the extent permitted under the Code's limitation on the contributions to defined contribution plans. USAir's contributions to the secondary plan are allocated to individual employees' accounts. During 1994, no contributions were made to any executive officer's account. The secondary plan was also frozen on December 31, 1991.\nUnder the Retirement Plan, benefits usually begin at the normal retirement age of 65. The Retirement Plan also provides benefits for employees electing early retirement from ages 55 through 64. If such an election is made, the benefits may be reduced to reflect the longer interval over which the benefits will\nbe paid. Executive officers participate in the Retirement Plan on the same basis as other employees of USAir.\nContributions to and benefits payable under the Retirement Plan must be in compliance with the applicable guidelines or maximums established by the Code. USAir has adopted an unfunded supplemental plan which will provide those benefits which would otherwise be payable to officers under the Retirement Plan, but which, under the Code, are not permitted to be funded or paid through the qualified plans maintained by USAir. Benefit accruals under the supplemental plan also ceased upon the freezing of the Retirement Plan on December 31, 1991. Such supplemental plan provides that any benefits under the unfunded supplemental plan will be paid in the form of a single, lump sum payment. Such supplemental plans are specifically provided for under applicable law and have been adopted by many corporations under similar circumstances. Messrs. Schofield, Salizzoni, Lloyd and Frestel are currently entitled to receive retirement benefits in excess of the limitations established by the Code.\nThe following table presents the noncontributory benefits payable per year for life to employees under the Retirement Plan and the unfunded supplemental plan described above, assuming normal retirement in the current year. The table also assumes the retiree would be entitled to the maximum Social Security benefit in addition to the amounts shown.\nThe values reflected in the above chart represent the applica- tion of the Retirement Plan formula to the specified amounts of compensation and years of service. The compensation covered by the\nRetirement Plan is salary and bonus, as reported in the Summary Compensation Table. The credited years of service under the Retirement Plan for each of the individuals included in the Summary Compensation Table are as follows: Mr. Schofield-30 years, Mr. Salizzoni-1 year, Mr. Lagow-none, Mr. Lloyd-5 years and Mr. Frestel-3 years.\nUSAir has entered into agreements with Messrs. Lagow, Salizzoni, Lloyd and Frestel which provide for a supplement to their retirement benefits under the Retirement Plan. This supplement is designed to provide such persons with those benefits they would have received had they been employed by USAir for the minimum number of years to be entitled to full retirement benefits under the Retirement Plan.\nUSAir adopted, effective January 1, 1993, a defined contribu- tion retirement program for its eligible non-contract employees (the \"Retirement Savings Plan\") as a replacement for the Retirement Plan described above. Under the Retirement Savings Plan, eligible employees may elect to contribute on a tax-deferred basis up to 13% of their pre-tax compensation, subject to a maximum annual contribution of $9,240 in 1994. USAir will also contribute to each employee's account in the Retirement Savings Plan (i) a matching contribution equal to 50% of each employee's contribution, subject to a maximum of 2% of the employee's annual pre-tax compensation; (ii) a basic contribution which ranges, depending on the employee's age, from 2% to 8% of the employee's annual pre-tax compensation; and (iii) if USAir's pre-tax profit margin, as defined, exceeds certain thresholds, a profit sharing contribution up to a maximum of 7.5% of an employee's annual pre-tax compensation. USAir made no contributions under the profit sharing component of the Retirement Savings Plan in 1994. Pre-tax compensation is defined for purposes of the Retirement Savings Plan as base pay plus bonus, plus an employee's tax deferred contributions under such Plan up to a maximum of $150,000 in 1994. USAir also established a non-qual- ified supplemental defined contribution plan (the \"Supplemental Savings Plan\") in 1993, which credits amounts to accounts of certain officers who participate in the Retirement Savings Plan but who are adversely affected by the maximum benefit limitations under qualified plans imposed by the Code. Amounts obligated to be paid by USAir under the Supplemental Savings Plan will be deposited in a trust established for the benefit of the participants. See the \"All Other Compensation\" column of the Summary Compensation Table for the amounts contributed or allocated in 1994 to Messrs. Schofield, Salizzoni, Lagow, Lloyd and Frestel under the Retirement Savings Plan and the Supplemental Savings Plan.\nUnder the Retirement Savings Plan and the Supplemental Savings Plan, participants may direct the investment of their contributions and USAir's contributions to their accounts among certain invest- ment funds. Participants' contributions are fully vested when made. USAir's contributions vest when the participant has been employed by USAir for at least two years.\nAdditional Benefits\nUSAir has in effect an Officers' Supplemental Benefit Plan, which provides certain benefits to a current or retired officer's spouse and children under age 19 following the officer's death. These benefits include: (i) dependent survivors' monthly income benefit and (ii) dependent survivors' health care insurance.\nA dependent survivors' monthly income benefit is payable to the eligible spouse or children of a deceased officer or retired officer in an amount equal to 20% of the monthly basic rate of salary payable to the officer the day prior to death or, in the case of a deceased retired officer, the day prior to retirement. Monthly income benefits will be reduced by the amount of any spouse protection benefit payable from Retirement Plan funds, and are subject to cessation upon the occurrence of certain specified events. In no case are monthly income benefits payable for more than 19 years following the date of death.\nThe eligible surviving spouse or children of a deceased officer or retired officer are also entitled to receive dependent survivors' health care insurance, which provides the medical, major medical and dental insurance benefits generally available to dependents of salaried employees of USAir. Eligibility for this coverage ceases upon the occurrence of certain specified events.\nUSAir also maintains a split-dollar life insurance plan under which individual term life insurance is available to its officers in the amount of three times base salary. The plan also provides for accrual of a cash value component for each officer who holds a policy. Under the plan, during 1994, USAir paid the premiums on the term and whole life insurance components of the policy. The premium attributable to the term life insurance of the policy is treated as income to the participant. At death, prior to transfer of the policy to the participant, the beneficiary receives the amount of the coverage less any amount necessary to reimburse the employer for its investment, and the beneficiary is entitled to any additional proceeds. Upon transfer of the policy to the partici- pant, the participant is entitled to the cash surrender value of the policy in excess of the amount payable to the employer for recovery of its investment. See the \"All Other Compensation\" column of the Summary Compensation Table for information concerning compensation with respect to Messrs. Schofield, Salizzoni, Lagow, Lloyd and Frestel that was attributable to the split dollar life insurance plan.\nArrangements Concerning Termination of Employment and Change of Control\nUSAir currently has employment contracts (the \"Employment Contracts\") with the executive officers (the \"Executives\") named in the Summary Compensation Table. The terms of the Employment Contracts extend until the earlier of the fourth anniversary thereof or the Executive's normal retirement date and are subject to automatic one-year annual extensions on each anniversary date\n(to the fourth anniversary of such anniversary date) unless advance written notice is given by USAir. In exchange for each Executive's commitment to devote his or her full business efforts to USAir, the agreements provide that each Executive will be re-elected to a responsible executive position with duties substantially similar to those in effect during the prior year and will receive (1) an annual base salary at a rate not less than that in effect during the previous year; (2) incentive compensation as provided in the contract; and (3) insurance, disability, medical and other benefits generally granted to other officers. In the event of a change of control, as defined in each Employment Contract, the term of each Employment Contract is automatically extended until the earlier of the fourth anniversary of the change of control date or the Executive's normal retirement date. As a result of amendments to the Employment Contracts entered into in June 1992, the acquisition of 20% or more of the outstanding securities of the Company under circumstances in which the acquiror would obtain the power to elect 20% or more of the members of the Board was added to the definition of a change of control under the Employment Contracts. To the extent permitted by Foreign Ownership Restrictions and assuming the consummation of the Second Purchase (the \"Second Closing\") results in BA's electing at least 20% of the Board, the Second Closing would be treated as a change of control and would result in extension of the term of each Employment Contract until the earlier of the fourth anniversary of the Second Closing or the Executive's normal retirement date. On March 7, 1994, BA announced that it would not make any additional investments in the Company until the outcome of the measures to reduce the Company's costs and improve its financial results is known. See Item 1. \"Business - British Airways Announcement Regarding Additional Investments in the Company; Code Sharing.\"\nThe Employment Contracts provide that, should USAir or any successor fail to re-elect the Executive to his or her position, assign the Executive to inappropriate duties which result in a diminution in the Executive's position, authority or responsibili- ties, fail to compensate the Executive as provided in the Employ- ment Contract, transfer the Executive in violation of the Employ- ment Contract, fail to require any successor to USAir to comply with the Employment Contract or otherwise terminate the Executive's employment in violation of the Employment Contract, the Executive may elect to treat such failure as a breach of the Employment Contract if the Executive then terminates employment. As liquidat- ed damages as the result of an event not following a change of control that is deemed to be a breach of the Employment Contracts, USAir or its successor would be required to pay the Executive an amount equal to his or her annual base salary for the then remaining term of the Employment Contract, and to continue granting certain employee benefits for the then remaining term of the Executive's Employment Contract. If the breach follows a change of control, the Executive would be entitled to receive (i) an amount equal to the product of three times the sum of the Executive's annual base salary plus an annual bonus; (ii) a lump sum equal to the actuarial equivalent of the pension benefits which the Executive would have received had he or she remained employed by\nUSAir until the end of the term of the Employment Contract, (iii) medical benefits until such time as the Executive qualifies for group medical benefits from another employer; (iv) travel benefits for the Executive's life; (v) reimbursement of reductions in salary sustained by the Executive as a result of a comprehensive cost reduction program initiated by USAir in October 1991; and (vi) continuation of certain other benefits during the remainder of the term of the Employment Contract. In addition, except under the circumstances described in the immediately following paragraph, during the 30-day period immediately following the first anniversa- ry of a change of control any Executive could elect to terminate his or her Employment Contract for any reason and receive the liquidated damages described in the immediately preceding sentence. Each Employment Contract provides that if USAir breaches the Employment Contract, as described above, each Executive shall be entitled to recover from USAir reasonable attorney's fees in connection with enforcement of such Executive's rights under the Employment Contract. Each Employment Contract also provides that any payments the Executive receives in the event of a termination shall be increased, if necessary, such that, after taking into account all taxes he or she would incur as a result of such payments, the Executive would receive the same after-tax amount he or she would have received had no excise tax been imposed under Section 4999 of the Code.\nIn order to facilitate consummation of the acts and transac- tions contemplated by the Investment Agreement, the Executives agreed in January 1993 to an amendment to their Employment Contracts that will become effective upon the Second Closing (i) to eliminate their right to elect to terminate their Employment Contracts without any reason during the 30-day period immediately following the first anniversary of the Second Closing; (ii) that USAir may transfer the Executive's employment to any location that meets certain criteria in the Employment Contracts without such relocation constituting a breach of the Employment Contracts; (iii) that consummation of the Second Closing would be treated as the only change of control with respect to BA; and (iv) that following the Second Closing, USAir may make certain changes in benefit plans affecting the Executives that are not material, as that term is defined in the Employment Contracts, provided that the changes apply to all eligible officers of USAir and are approved by a majority of the directors of the Company not elected by BA. As discussed above, BA announced on March 7, 1994 that it will not make any additional investments in the Company under current circumstances.\nCurrently, under the Company's 1984 Stock Option and Stock Appreciation Rights Plan (the \"1984 Plan\") and 1988 Stock Incentive Plan (the \"1988 Plan,\" and together with the 1984 Plan, the \"Plans\"), pursuant to which employees of the Company and its subsidiaries have been awarded stock options and stock appreciation rights with respect to Common Stock and, in the case of the 1988 Plan, shares of Restricted Stock, occurrence of a change of control, as defined, would make all granted options immediately exercisable without regard to the vesting provisions thereof. In\naddition, grantees would be able, during the 60-day period immediately following a change of control, to surrender all unexercised stock options not issued in tandem with stock apprecia- tion rights under the Plans to the Company for a cash payment equal to the excess, if any, of the fair market value of the Common Stock over the exercise prices of such stock options or the positive value of any stock appreciation rights. As described above, in June 1992, the Company amended the definition of a change of control in the Plans with the result that, to the extent permitted by Foreign Ownership Restrictions and assuming the Second Closing results in BA's electing at least 20% of the Board, the Second Closing would be treated as a change of control thereunder. As of March 1, 1995, there were unexercised stock options to purchase 473,795 shares of Common Stock (of which 73,400 had tandem stock appreciation rights) under the 1984 Plan and unexercised stock options to purchase 3,396,500 shares of Common Stock (none of which had tandem stock appreciation rights) under the 1988 Plan. (As of March 1, 1995, 2,980,500 of the 3,396,500 options outstanding under the 1988 Plan and 315,795 of the 473,795 options outstanding under the 1984 Plan were exercisable pursuant to their normal vesting schedule.) As of March 1, 1995, the weighted average exercise price of all these outstanding stock options was approximately $22.06. On March 1, 1995, the closing price of a share of Common Stock on the NYSE was $6.00. See the \"Aggregated Option\/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option\/SAR Values\" table for information regarding stock options held by the Executives named in that table.\nCurrently, 15,000 shares of Restricted Stock previously granted to the Executives may (i) become free of transfer restric- tions upon their normal vesting schedule or (ii) be subject to accelerated vesting upon a termination of employment which triggers the payment of liquidated damages under the Employment Contracts, as discussed above, regardless of whether the termination occurred following a change of control as defined in the Employment Contracts. See \"Beneficial Security Ownership\" for information regarding Restricted Stock owned by the Executives.\nWith respect to Mr. Lagow, in order to induce him to accept its offer of employment in 1992, USAir agreed, among other things, to pay Mr. Lagow $1 million in four equal installments, each installment being due and payable on the first four anniversaries of the commencement of his employment by USAir, provided Mr. Lagow remains employed by USAir. This payment was intended to compensate Mr. Lagow for stock options and restricted stock which he forfeited when he left his former employer. In the event of a change of control under his Employment Contract or wrongful termination thereunder, USAir has also agreed to pay Mr. Lagow in a lump sum any unpaid balance of this obligation.\nNotwithstanding anything to the contrary set forth in any of the Company's or USAir's filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that incorporates by reference this Annual Report, in whole or in\npart, the following Report and Performance Graph shall not be incorporated by reference into any such filings.\nReport of the Compensation and Benefits Committee of the Board of Directors\nThe policies of the Compensation and Benefits Committee of the Board (the \"Compensation Committee\") with respect to compensation of the Company's executive officers are to:\n* attract and retain talented and experienced senior management by offering compensation that is competitive with respect to other major U.S. airlines and other U.S. companies of compara- ble size; and\n* motivate senior management to provide a high-quality product to consumers with the ultimate goal of maximizing profitabili- ty and stockholder returns by offering incentive and long-term compensation that is linked to return on sales and the market value of the Common Stock.\nThe compensation package for executive officers of the Company is comprised of three elements - base salary, annual cash incentive compensation, and long-term incentive compensation. The Compensa- tion Committee plays an active role in the oversight and review of all compensation paid to executive officers of the Company. Ordinarily, the Compensation Committee and the full Board, in consultation with the Senior Vice President-Human Resources of USAir and, if warranted, an independent compensation consultant, annually review the total compensation package of the Company's executive officers, including the Chairman and Chief Executive Officer and the four other officers named in the Summary Compensa- tion Table. This review did not occur during the last fiscal year. Because of the Company's continued financial losses, no salary increases were contemplated for executive officers in 1994 and hence a competitive salary review was deemed unnecessary. In past years when a salary review was undertaken, the Compensation Committee reviewed the market rate for peer-level positions of the other major domestic passenger airlines, including, but not limited to, Delta, United and American. Delta, United and American (or their parent companies) are included in the S&P Airline Index, which has been used in prior years' Performance Graphs. Based primarily on this comparison, the Compensation Committee estab- lished the base salary for the Chief Executive Officer and other executive officers.\nWhile the Compensation Committee reviews the salaries of the other major airlines to establish a market rate, the Committee does not necessarily \"target\" any specific range, such as the lower end, median or upper end of the comparison range, when setting the Chief Executive Officer's base salary. As discussed below, in 1992, after an independent compensation consultant conducted a study of comparable airline officers' salaries, the Compensation Committee recommended an increase in the Chief Executive Officer's base salary to the median level of the comparison range reflected in the\nstudy, but Mr. Schofield declined to accept an increase. According to publicly available information, the current base salary of the Company's Chief Executive Officer is lower than the base salaries for the chief executive officers of Delta, United, American and Southwest. Mr. Schofield does not participate in Compensation Committee or Board deliberations or decision-making regarding any aspect of his compensation.\nThe Chief Executive Officer has an employment agreement with the Company which guarantees a certain level of base salary. Mr. Schofield's employment agreement provides that he will receive base salary at least equal to the highest base salary paid during the preceding twelve-month period. In the event that the Company violates this provision of the agreement, Mr. Schofield may terminate his employment for \"good reason\" under the agreement and receive a payout of compensation and benefits for the remainder of the four-year employment period protected by the agreement. The four other executive officers named in the Summary Compensation Table have similar employment agreements which also guarantee a certain level of base salary.\nThe principal elements of the Company's compensation paid to the executive officers in the last completed fiscal year are discussed below.\nBase Salary. As reported by the Compensation Committee in prior reports, the Compensation Committee had reduced the salaries of the executive and other officers for a fifteen-month period commencing on January 1, 1992 and ending on March 29, 1993. This salary reduction was part of a comprehensive Company-wide salary reduction program. Each of the executive officers of the Company agreed to the reductions in salary, waiving the base salary guarantees in their employment agreements, where applicable.\nHistorically, the Compensation Committee has awarded merit increases based on measuring individual performance against objectives. However, due to the Company's poor financial perfor- mance since 1989, the Compensation Committee had not awarded merit increases in executive officer base salaries since 1989. From 1989 to 1993, salaries were increased only as a result of a promotion or an increase in responsibilities.\nIn 1992, after the commencement of the salary reduction program, the Company commissioned an independent compensation consultant to conduct a comprehensive study of the salaries of comparable airline officers. The study disclosed that the base salaries of the Company's executive officers (prior to reduction under the salary reduction program) were substantially below those salaries for analogous positions at major competitors. After reviewing the results of the study and considering its desire to motivate and retain the Company's key executive officers, and the officers' individual performance and experience, the Compensation Committee established new base salaries for executive officers (other than the Chief Executive Officer) at the conclusion of the salary reduction period in 1993, targeting the median of the\ncomparative range reflected in the study. Based on the salary review, the Compensation Committee proposed a new base salary for the Chief Executive Officer of $590,000. However, because of the Company's poor financial performance, Mr. Schofield declined to accept an increase in base salary and his salary was restored to its pre-reduction level of $500,000. The new base salaries for the other four executive officers named in the Summary Compensation Table became effective in April 1993. As stated above, as a result of the Company's continuing financial losses, no salary increases were considered by the Compensation Committee during 1994. Except as set forth below, the base salaries established by the Compensa- tion Committee in 1993 remained effective throughout 1994 and remain in effect today.\nOn April 1, 1994, Mr. Salizzoni was promoted from Executive Vice President-Finance to the position of President and Chief Operating Officer. At the time of his promotion, the Compensation Committee approved an increase in his base salary commensurate with his increased responsibilities.\nCommencing in March 1994, the Company has been engaged in negotiations with its labor unions to effectuate a comprehensive expense reduction program which includes a proposal to permanently reduce employee salaries. This expense reduction program is designed to return the Company to profitability. In light of this initiative, Messrs. Schofield and Salizzoni requested a reduction in their base salaries as a demonstration of leadership. In November 1994, the Compensation Committee approved a reduction in the base salaries of the Chief Executive Officer and the President and Chief Operating Officer. Effective in December 1994, their base salaries were reduced in accordance with the following schedule:\n* 10% of the amount of salary between $5,000 and $20,000; * 15% of the amount of salary between $20,000 and $50,000; * 20% of the amount of salary between $50,000 and $100,000; and * 25% of the amount of salary over $100,000.\nBoth executive officers signed waivers of the applicable provisions of their employment agreements guaranteeing a higher level of base salary.\nAnnual Cash Incentive Compensation. The Compensation Committee adopted the Executive Incentive Compensation Plan effective on January 1, 1988. The plan is administered by the Compensation Committee. All officers, including the executive officers, of the Company are eligible to participate in the plan.\nThe Compensation Committee is authorized to grant awards under this plan only if the Company achieves a two percent or greater return on sales (\"ROS\") for a fiscal year. The target level of performance is four percent ROS. The maximum level of performance recognized under the plan is a six percent ROS. Additionally, for each officer of the Company, the Compensation Committee has previously set an incentive compensation target percentage and a\nmaximum percentage. If the Company achieves the target performance of four percent ROS, the full target percentage set by the Committee for the individual officer is applied to the individual's base salary for the year to determine the cash bonus award (the \"Target Award\") for the individual. Target Awards for executive officers range from 30% to 50% of base salary.\nThe Compensation Committee is authorized to approve awards under the plan for performance which is less than or greater than the target performance of four percent ROS. If the Company achieves the minimum performance level of two percent ROS, the executive would be paid only half of the Target Award. For performance levels greater than two percent ROS but less than four percent ROS, a proportionate percentage of the Target Award would be paid. In the event that the Company's performance level exceeds the target performance of four percent ROS, the Company would pay amounts greater than the Target Award. If the Company achieves the maximum target performance of six percent ROS, the executive would receive the maximum percentage which is twice the Target Award. The maximum awards for executive officers, set by the Compensation Committee pursuant to the plan, range from 60% to 100% of base salary. For performance levels greater than four percent ROS but less than six percent ROS, a proportionate percentage of the Target Award would be paid. The plan also provides that the Compensation Committee may adjust awards to executive officers based on individual performance; however, in no event may the award exceed 250% of the Target Award for such individual. The Compensation Committee has never made any such adjustments.\nThe Compensation Committee last approved payments to executive officers under this plan for the fiscal year ended December 31, 1988. The Company has failed to achieve the minimum two percent ROS performance level in any fiscal year since 1988 and, therefore, the Compensation Committee has not made any awards under the plan since then. The Compensation Committee will continue to review the effectiveness of the plan and, if the Compensation Committee deems appropriate, could recommend changes to the plan in the future.\nLong Term Incentive Programs\nStock Options. The executive officers of the Company partici- pate in the Company's 1984 Stock Option and Stock Appreciation Rights Plan (the \"1984 Plan\") and the 1988 Stock Incentive Plan (the \"1988 Plan\"). Both the 1984 Plan and the 1988 Plan are administered by the Compensation Committee. The Compensation Committee is authorized to grant options under these plans only at an exercise price equal to the fair market value of a share of Common Stock on the effective date of the grant.\nThe Compensation Committee determines the size of any option grant under the plans based upon (i) the Compensation Committee's perceived value of the grant to motivate and retain the individual executive; (ii) a comparison of long-term incentive practices within the commercial airline industry; (iii) a comparison of awards provided to peer executives within the Company; and (iv) the\nnumber of outstanding options held by the grantee and the exercise prices of these options. Although the Compensation Committee supports and encourages stock ownership in the Company by its executive officers, it has not promulgated any standards regarding levels of ownership by executive officers.\nDuring 1994, the only executive officers to be granted options were newly hired executive officers and executive officers who received promotions. As stated above, on April 1, 1994, Mr. Salizzoni was promoted to the position of President and Chief Operating Officer. At the time of his promotion, the Compensation Committee awarded Mr. Salizzoni the option to purchase 100,000 shares of Common Stock, under the terms of the 1988 Plan. The stock option awards made in 1994 were non-qualified options and were subject to a vesting schedule under which 25% of the options vested on the first anniversary of the award, 25% of the options will vest on the second anniversary of the award, and the remaining 50% of the options will vest on the third anniversary of the award.\nIn connection with the company-wide salary reduction program in 1992 and 1993, the Company established the 1992 Stock Option Plan (the \"1992 Plan\"). The 1992 Plan is also administered by the Compensation Committee. Under the 1992 Plan, the Compensation Committee granted every employee of the Company who participated in the salary reduction program non-qualified options to purchase 50 shares of Common Stock at $15 per share for each $1,000 of salary foregone during the reduction period. The Compensation Committee granted executive officers options under the 1992 Plan in accord- ance with the same formula applicable to all other employees of the Company.\nRestricted Stock. Under the terms of the 1988 Plan, the Compensation Committee is authorized to grant awards of Restricted Stock. From 1988-1990, the Compensation Committee granted Restricted Stock to a total of nine executive officers, some of whom are no longer employed by USAir. These awards were all subject to a five year vesting schedule, with restrictions lapsing on a percentage of the award on each anniversary of the award. No awards of Restricted Stock have been granted by the Compensation Committee since 1990.\nDuring 1994, the restrictions expired on a total of 20,000 shares of Restricted Stock held by the Chief Executive Officer, which shares were originally granted in 1989 and 1990. Restric- tions also expired during 1994 on 10,000 shares of Restricted Stock held by Messrs. Salizzoni, Lloyd and Frestel, which shares were originally granted in 1989 and 1990.\nThe Omnibus Budget Reconciliation Act of 1993 added Section 162(m) to the Internal Revenue Code. Section 162(m) provides that companies will not be entitled to a tax deduction for certain compensation paid to any executive officer to the extent that the compensation exceeds $1 million in a taxable year. In December 1994, the Securities and Exchange Commission issued amendments to\nthe proposed regulations under Section 162(m). The Compensation Committee is studying Section 162(m) and the proposed regulations thereunder and is in the process of determining whether to recommend that the Company take the necessary measures to conform its compensation to Section 162(m).\nThe Compensation Committee will continue to review all executive compensation and benefits matters presented to it and will act based on the best information available in the best interests of the Company, its shareholders and employees.\nMathias J. DeVito, Chairman George J. W. Goodman John W. Harris Roger P. Maynard John G. Medlin, Jr. Raymond W. Smith\nPerformance Graph\nThe above graph compares the performance of the Company's Common Stock during the period January 1, 1990 to December 31, 1994 with the S&P 500 Index and a peer issuer index (the \"Peer Issuer Index\"). It also depicts the S&P Airline Index during the relevant time period, which was the index used in previous performance graphs of the Company. The graph depicts the results of investing $100 in the Company's Common Stock, the S&P 500 Index and the Peer Issuer Index, as well as the S&P Airline Index, at closing prices on December 29, 1989. The stock price performance shown on the graph above is not necessarily indicative of future price perfor- mance. The Peer Issuer Index consists of AMR Corporation, Delta, Southwest and the Company. The S&P Airline Index consists of AMR Corporation, Delta, UAL Corporation and the Company.\nThe Company has selected the Peer Issuer Index for use in the above and future performance graphs in lieu of the S&P Airline Index because one of the companies in the S&P Airline Index, UAL Corporation, underwent a complex recapitalization in 1994 which makes it difficult to compare the return over time on an initial investment in UAL Corporation to the return on similar investments in the other corporations contained in that index. This is due in part to the fact that holders of common stock of UAL Corporation prior to the recapitalization received a combination of cash and various securities in exchange for their common stock pursuant to the recapitalization. To determine the December 31, 1994 value of the UAL Corporation component of the S&P Airline Index, the Company used its good faith efforts to value at December 31, 1994 each element of the combination of cash and securities received by common stockholders of UAL Corporation in 1994 as a result of the recapitalization. The replacement index, the Peer Issuer Index, is identical to the S&P Airline Index except for the deletion of UAL Corporation and the addition of Southwest Airlines, Inc. The Company believes that the substitution of Southwest Airlines, Inc. makes the Peer Issuer Index a more accurate benchmark against which to compare the stock price performance of the Company over time.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following information pertains to Common Stock, Series A Preferred Stock, Series F Preferred Stock, Series T Preferred Stock and Depositary Shares (\"Depositary Shares\"), each representing 1\/100 of a share of Series B Preferred Stock, beneficially owned by all directors and executive officers of the Company as of March 1, 1995. Unless indicated otherwise, the information refers to ownership of Common Stock. Unless indicated otherwise by footnote, the owner exercises sole voting and investment power over the securities (other than unissued securities, the ownership of which has been imputed to such owner).\n(continued on next page)\n(1) The persons listed also own a number of Preferred Share Purchase Rights (the \"Rights\") equal to their Common Stock holdings, or, in the case of the Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock, Common Stock receivable upon conversion. In addition, such Rights are issuable on a one-for-one basis with respect to shares of Common Stock receivable upon exercise of stock options or conversion of Depositary Shares. (2) Percentages are shown only where they exceed one percent of the number of shares outstanding and, in the case of Common Stock holdings are based on shares of Common Stock outstanding on March 1, 1995. (3) Various affiliates of Berkshire Hathaway Inc. (\"Berkshire\") are recordholders of 358,000 or 100% of the outstanding shares of Series A Preferred Stock. Messrs. Buffett and Munger are Chairman and Chief Executive Officer and Vice Chairman, respectively, of Berkshire and may be deemed to control that company. Messrs. Buffett and Munger each disclaims beneficial ownership of Series A Preferred Stock. Series A Preferred Stock is currently convertible into 9,239,944 shares of Common Stock, which represent approximately 10.2% of the total voting\ninterest represented by Common Stock, Series F Preferred Stock, Series T Preferred Stock and Series A Preferred Stock at March 1, 1995. (4) The listing of Mr. Colodny's holding includes 58,000 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options. (5) Mr. Goodman's holdings of Depositary Shares are convertible into 498.5 shares of Common Stock. (6) A wholly-owned subsidiary of BA is recordholder of 30,000 or 100% of the outstanding shares of Series F Preferred Stock, 152.1 or 100% of the outstanding shares of the Series T-1 Preferred Stock and 9,919.8 or 100% of the outstanding shares of the Series T-2 Preferred Stock pursuant to the Investment Agreement. Messrs. Marshall, Maynard and Stevens are Chair- man, Director of Corporate Strategy and Chief Financial Offic- er, respectively, of BA and have been designated by BA to act as directors of the Company pursuant to the Investment Agreement. Messrs. Marshall, Maynard and Stevens each dis- claims beneficial ownership of Series F Preferred Stock and Series T Preferred Stock. (7) The listing of Mr. Salizzoni's holding includes 177,800 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options and 3,000 shares of Restricted Stock. (8) The listing of Mr. Schofield's holding includes 395,069 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options, and 10,000 shares of Restricted Stock. (9) Mr. Schofield's holding of Depositary Shares is convertible into 185,442 shares of Common Stock. (10) The listing of Mr. Lagow's holding reflects shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options. (11) The listing of Mr. Lloyd's holding includes 163,992 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options and 1,000 shares of Restricted Stock. (12) The listing of Mr. Frestel's holding includes 102,000 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options and 1,000 shares of Restricted Stock. (13) The listing of all directors' and officers' holdings includes, in the case of Depositary Shares, the number of shares of Common Stock into which the Depositary Shares are convertible, and also includes 1,312,591 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options and 15,800 shares of Restricted Stock.\nThe only persons known to the Company (from Company records and reports on Schedules 13D and 13G filed with the Securities and Exchange Commission) which owned, as of March 1, 1995, more than 5% of its Common Stock, Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock are listed below:\n(1) Represents percent of class of stock outstanding on March 1, 1995. (2) Number of shares as to which such person has shared voting power-358,000; shared dispositive power-358,000. (3) These shares of Series A Preferred Stock are owned directly by affiliates of Berkshire, are convertible, under certain circumstances and subject to certain antidilution adjustments, into 9,239,944 shares of Common Stock and represent approxi- mately 10.2% of the combined voting power of the outstanding Common Stock, Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock, voting as a single class, at March 1, 1995. A number of Rights, equal to the number of shares of Common Stock into which the Series A Preferred Stock is convertible, is also owned by this person. As disclosed above, two directors of the Company, Messrs. Buffett and Munger, may be deemed to control Berkshire and disclaim beneficial ownership of Series A Preferred Stock. (4) Number of shares as to which BA has sole voting power and sole dispositive power-30,000.\n(5) BritAir Acquisition Corp. Inc. is a wholly-owned subsidiary of BA and owns Series F Preferred Stock and Series T Preferred Stock pursuant to the Investment Agreement. Series F Preferred Stock and Series T Preferred Stock are convertible, under certain circumstances on or after January 21, 1997 and subject to certain antidilution adjustments and Foreign Ownership Restrictions, into a total of 15,458,851 and 3,831,695 shares of Common Stock, respectively. Together, the Series F Pre- ferred Stock and Series T Preferred Stock represent approxi- mately 21.3% of the combined voting power of the outstanding Common Stock, Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock, voting as a single class, at March 1, 1995. A number of Rights, equal to the number of shares of Common Stock into which the Series F Preferred Stock and Series T Preferred Stock are convertible, is owned by this person. As disclosed above, three directors of the Company, Messrs. Marshall, Maynard and Stevens, have been designated by BA to act as directors of the Company pursuant to the Invest- ment Agreement and disclaim beneficial ownership of Series F Preferred Stock and Series T Preferred Stock. (6) Reflects 152.1 or 100% of the outstanding shares of Series T-1 Preferred Stock and 9,919.8 or 100% of the outstanding shares of Series T-2 Preferred Stock. BA has sole voting power and sole dispositive power as to all these outstanding shares of Series T Preferred Stock. (7) The Schedule 13G dated February 8, 1995 disclosing this ownership declares that the filing of the Schedule 13G should not be construed as an admission that Franklin Resources, Inc. is the beneficial owner of any securities covered by the Schedule 13G. Franklin Resources, Inc. is an investment company registered under Section 8 of the Investment Company Act of 1940 and an investment adviser registered under Section 203 of the Investment Advisers Act of 1940. Its Schedule 13G states that it was making the filing on a voluntary basis as if all the shares were beneficially owned by Franklin Resourc- es, Inc., its subsidiaries, and investment companies advised by those subsidiaries with respect to the exercise of invest- ment discretion. Number of shares as to which reporting person has sole voting power - 4,830,665 shares; shared voting power: 21,500 shares; shared dispositive power: 4,852,165 shares. (8) Of these shares, 2,166,414 are held by such person under the USAir, Inc. Employee Stock Ownership Plan (shared voting power and shared dispositive power - 2,166,414 shares), 941,923 are held by such person as trustee under various collective investment funds for employee benefit plans and other index accounts (sole voting power - 327,177 shares and sole disposi- tive power - 941,923 shares) and 38 are held by such person as trustee\/co-trustee under various personal trust accounts (shared voting power - 38 shares).\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\n(i) The following consolidated financial statements of USAir Group are included in Part II, Item 8A of this report:\n- Consolidated Statements of Operations for each of the Three Years Ended December 31, 1994 - Consolidated Balance Sheets at December 31, 1994 and 1993 - Consolidated Statements of Cash Flows for each of the Three Years Ended December 31, 1994 - Consolidated Statements of Changes in Stockholders' Equity (Deficit) for each of the Three Years Ended December 31, 1994 - Notes to Consolidated Financial Statements\n(ii) The following consolidated financial statements of USAir are included in Part II, Item 8B of this report:\n- Consolidated Statements of Operations for each of the Three Years Ended December 31, 1994 - Consolidated Balance Sheets at December 31, 1994 and 1993 - Consolidated Statements of Cash Flows for each of the Three Years Ended December 31, 1994 - Consolidated Statements of Changes in Stockholder's Equity (Deficit) for each of the Three Years Ended December 31, 1994 - Notes to Consolidated Financial Statements\n2. Financial Statement Schedules\n(i) Independent Auditors' Report on the Consolidated Financial Statement Schedule of USAir Group.\n- Consolidated Financial Statement Schedule - Three Years Ended December 31, 1994:\nVIII - Valuation and Qualifying Accounts and Re- serves\n(ii) Independent Auditors' Report on the Consolidated Financial Statement Schedule of USAir.\n- Consolidated Financial Statement Schedule - Three Years Ended December 31, 1994:\nVIII - Valuation and Qualifying Accounts and Re- serves\nAll other schedules are omitted because they are not appli- cable or not required, or because the required information is either incorporated herein by reference or included in the financial statements or notes thereto included in this report.\n(b) Reports on Form 8-K\nDuring the quarter ended December 31, 1994, the Company and USAir filed a Current Report dated November 18 on Form 8-K regarding USAir's plans to use the net proceeds of any sales of assets to repurchase, defease or redeem its outstanding debt. The Company and USAir filed a Current Report dated January 27, 1995 on Form 8-K regarding the press release dated January 27, 1995 of USAir Group, Inc. and USAir, Inc., with unaudited consolidated statements of operations for each company.\n3. Exhibits\nDesignation Description\n3.1 Restated Certificate of Incorporation of USAir Group (incorporated by reference to Exhibit 3.1 to USAir Group's Registration Statement on Form 8-B dated January 27, 1983), including the Certificate of Amend- ment dated May 13, 1987 (incorporated by reference to Exhibit 3.1 to USAir Group's and USAir's Quarterly Report on Form 10-Q for the quarter ended March 31, 1987), the Certificate of Increase dated June 30, 1987 (incorporated by reference to Exhibit 3 to USAir Group's and USAir's Quarterly Report on Form 10-Q for the quarter ended June 30, 1987), the Certificate of Increase dated October 16, 1987 (incorporated by reference to Exhibit 3.1 to USAir Group's and USAir's Quarterly Report on Form 10-Q for the quarter ended September 30, 1987), the Certificate of Increase dated August 7, 1989 (incorporated by reference to Exhibit 3.1 to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989), the Certificate of Increase dated April 9, 1992 (incorporated by reference to Exhibit 3.1 to USAir Group's and USAir's Annual Report on Form 10-K for the year ended December 31, 1992), the Certificate of Increase dated January 21, 1993 (incorporated by reference to USAir Group's and\nUSAir's Annual Report on Form 10-K for the year ended December 31, 1992), and the Certificate of Amendment dated May 26, 1993 (incorporated by reference to Appendix II to USAir Group's Proxy Statement dated April 26, 1993).\n3.2 By-Laws of USAir Group.\n3.3 Rights Agreement, dated as of July 29, 1989, as amended and restated as of January 21, 1993, between USAir Group and Chemical Bank, as Rights Agent (incorporated by reference to Exhibit 28.4 to USAir Group's Current Report on Form 8-K dated January 21, 1993).\n3.4 Restated Certificate of Incorporation of USAir (in- corporated by reference to Exhibit 3.1 to USAir's Registration Statement on Form 8-B dated January 27, 1983).\n3.5 By-Laws of USAir.\n4.1 Amended Certificate of Designation, Preferences, and Rights of the Series D of Junior Preferred Stock of USAir Group (incorporated by reference to Exhibit 4(c) to USAir Group's Current Report on Form 8-K dated August 11, 1989).\n4.2 Certificate of Designation of Series A Cumulative Convertible Preferred Stock of USAir Group (incorpo- rated by reference to Exhibit 4(b) to USAir Group's Current Report on Form 8-K dated August 11, 1989).\n4.3 Certificate of Designation of Series B Cumulative Convertible Preferred Stock of USAir Group (incorpo- rated by reference to Exhibit 3.3 to Amendment No. 4 to USAir Group's Registration Statement on Form S-3 (Registration No. 33-39540) dated May 17, 1991).\n4.4 Agreement between USAir Group and Berkshire Hathaway Inc. dated August 7, 1989 (incorporated by reference to Exhibit 4(a) to USAir Group's Current Report on Form 8- K dated August 11, 1989).\n4.5 Certificate of Designation of Series F Cumulative Convertible Senior Preferred Stock of USAir Group (incorporated by reference to Exhibit 28.2 to USAir Group's Current Report on Form 8-K dated January 21, 1993).\n4.6 Form of Certificate of Designation of Series T-_ Cumulative Exchangeable Convertible Senior Preferred Stock of USAir Group (incorporated by reference to Appendix VII to USAir Group's Proxy Statement dated April 26, 1993). Neither USAir Group nor USAir is\nfiling any instrument (with the exception of holders of exhibits 10.1(a-c)) defining the rights of holders of long-term debt because the total amount of securities authorized under each such instrument does not exceed ten percent of the total assets of USAir. Copies of such instruments will be furnished to the Securities and Exchange Commission upon request.\n10.1(a) Supplemental Agreement No. 16, dated July 19, 1990, to Purchase Agreement No. 1102 between USAir and The Boeing Company (incorporated by reference to Exhibit 10.2(a) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1990).\n10.1(b) Supplemental Agreement No. 17, dated November 28, 1990, to Purchase Agreement No. 1102 between USAir and The Boeing Company (incorporated by reference to Exhibit 10.2(b) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1990).\n10.1(c) Supplemental Agreement No. 18, dated December 23, 1991, to Purchase Agreement No. 1102 between USAir and The Boeing Company (incorporated by reference to Exhibit 10.2(c) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.2 Purchase Agreement No. 1725 dated December 23, 1991 between USAir and The Boeing Company (incorporated by reference to Exhibit 10.3 to USAir Group's and USAir's Annual Report on Form 10-K for the year ended Decem- ber 31, 1991).\n10.3 USAir, Inc. Executive Incentive Compensation Plan (incorporated by reference to Exhibit 10.3 to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.4 USAir, Inc. Officers' Supplemental Benefit Plan (incor- porated by reference to Exhibit 10.5 to USAir's Annual Report on Form 10-K for the year ended December 31, 1980).\n10.5 USAir, Inc. Supplementary Retirement Benefit Plan (incorporated by reference to Exhibit 10.5 to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.6 USAir, Inc. Supplemental Executive Defined Contribution Plan.\n10.7 USAir Group's 1984 Stock Option and Stock Appreciation Rights Plan (incorporated by reference to Exhibit A to USAir Group's Proxy Statement dated March 30, 1984).\n10.8 USAir Group's 1988 Stock Incentive Plan (incorporated by reference to Exhibit 10.15 to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1987).\n10.9 USAir Group's 1992 Stock Option Plan (incorporated by reference to Exhibit A to USAir Group's Proxy Statement dated March 30, 1992).\n10.10 Employment Agreement between USAir and its Chief Executive Officer.\n10.11 Employment Agreement between USAir and its President and Chief Operating Officer.\n10.12 Employment Agreement between USAir and its Executive Vice President-Marketing.\n10.13 Employment Agreement between USAir and its Executive Vice President and General Counsel.\n10.14 Employment Agreement between USAir and its Senior Vice President-Human Resources.\n10.15(a) Agreement between USAir and its President and Chief Operating Officer providing supplemental retirement benefits.\n10.15(b) Agreement between USAir and its Executive Vice Presi- dent-Marketing providing supplemental retirement benefits.\n10.15(c) Agreement between USAir and its Executive Vice Presi- dent and General Counsel providing supplemental retire- ment benefits.\n10.15(d) Agreement between USAir and its Senior Vice President- Human Resources providing supplemental retirement benefits.\n10.16(a) Trust Agreement dated as of August 1, 1989 between USAir Group and Wachovia Bank and Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 10.10(a) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.16(b) Trust Agreement dated as of August 1, 1989 between USAir and Wachovia Bank and Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 10.10(b) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.17 Investment Agreement dated as of January 21, 1993 between USAir Group and British Airways Plc (incor- porated by reference to Exhibit 28.1 to USAir Group's\nand USAir's Current Report on Form 8-K filed on Janu- ary 28, 1993, as amended by Amendment No. 1 on Form 8 filed on April 13, 1993).\n10.17(a) Amendment dated as of February 21, 1994 to the Invest- ment Agreement dated as of January 21, 1993 between USAir Group and British Airways Plc (incorporated by reference to Exhibit 10.13(a) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1993).\n11 Computation of primary and fully diluted earnings per share of USAir Group for the five years ended Decem- ber 31, 1994.\n21 Subsidiaries of USAir Group and USAir.\n23.1 Consent of the Auditors of USAir Group to the incorpo- ration of their report concerning certain financial statements contained in this report in certain regis- tration statements.\n23.2 Consent of the Auditors of USAir to the incorporation of their report concerning certain financial statements contained in this report in certain registration statements.\n24.1 Powers of Attorney signed by the directors of USAir Group, authorizing their signatures on this report.\n24.2 Powers of Attorney signed by the directors of USAir, authorizing their signatures on this report.\n27 Financial Data Schedule\n(this space intentionally left blank)\nSignatures\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, USAir Group, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUSAir Group, Inc.\nBy: \/s\/Seth E. Schofield --------------------------------- Seth E. Schofield Chairman and Chief Executive Officer (Principal Executive Officer)\nDate: April 12, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of USAir Group, Inc. and in the capacities and on the dates indicated.\nApril 12, 1995 By: \/s\/Seth E. Schofield --------------------------------- Seth E. Schofield Chairman and Chief Executive Officer (Principal Executive Officer)\nApril 12, 1995 By: \/s\/John W. Harper --------------------------------- John W. Harper Senior Vice President-Finance (Principal Financial Officer)\nApril 12, 1995 By: \/s\/Ann Greer-Rector --------------------------------- Ann Greer-Rector Vice President & Controller (Principal Accounting Officer)\nApril 12, 1995 By: * -------------------------------- Warren E. Buffett Director\nApril 12, 1995 By: * --------------------------------- Edwin I. Colodny Director\nApril 12, 1995 By: * -------------------------------- Mathias J. DeVito Director\nApril 12, 1995 By: * -------------------------------- George J. W. Goodman Director\nApril 12, 1995 By: * --------------------------------- John W. Harris Director\nApril 12, 1995 By: * --------------------------------- Edward A. Horrigan, Jr. Director\nApril 12, 1995 By: * --------------------------------- Robert LeBuhn Director\nApril 12, 1995 By: * --------------------------------- Sir Colin Marshall Director\nApril 12, 1995 By: * --------------------------------- Roger P. Maynard Director\nApril 12, 1995 By: * --------------------------------- John G. Medlin, Jr. Director\nApril 12, 1995 By: * --------------------------------- Hanne M. Merriman Director\nApril 12, 1995 By: * -------------------------------- Charles T. Munger Director\nApril 12, 1995 By: * --------------------------------- Frank L. Salizzoni Director\nApril 12, 1995 By: * --------------------------------- Raymond W. Smith Director\nApril 12, 1995 By: * -------------------------------- Derek M. Stevens Director\nBy: \/s\/John W. Harper ------------------------------ John W. Harper Attorney-In-Fact\nSignatures\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, USAir, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUSAir, Inc.\nBy: \/s\/Seth E. Schofield --------------------------------- Seth E. Schofield Chairman and Chief Executive Officer (Principal Executive Officer)\nDate: April 12, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of USAir, Inc. and in the capacities and on the dates indicated.\nApril 12, 1995 By: \/s\/Seth E. Schofield --------------------------------- Seth E. Schofield Chairman and Chief Executive Officer (Principal Executive Officer)\nApril 12, 1995 By: \/s\/John W. Harper --------------------------------- John W. Harper Senior Vice President-Finance (Principal Financial Officer)\nApril 12, 1995 By: \/s\/Ann Greer-Rector --------------------------------- Ann Greer-Rector Vice President & Controller (Principal Accounting Officer)\nApril 12, 1995 By: * -------------------------------- Warren E. Buffett Director\nApril 12, 1995 By: * --------------------------------- Edwin I. Colodny Director\nApril 12, 1995 By: * -------------------------------- Mathias J. DeVito Director\nApril 12, 1995 By: * -------------------------------- George J. W. Goodman Director\nApril 12, 1995 By: * --------------------------------- John W. Harris Director\nApril 12, 1995 By: * --------------------------------- Edward A. Horrigan, Jr. Director\nApril 12, 1995 By: * --------------------------------- Robert LeBuhn Director\nApril 12, 1995 By: * --------------------------------- Sir Colin Marshall Director\nApril 12, 1995 By: * --------------------------------- Roger P. Maynard Director\nApril 12, 1995 By: * --------------------------------- John G. Medlin, Jr. Director\nApril 12, 1995 By: * --------------------------------- Hanne M. Merriman Director\nApril 12, 1995 By: * -------------------------------- Charles T. Munger Director\nApril 12, 1995 By: * --------------------------------- Frank L. Salizzoni Director\nApril 12, 1995 By: * --------------------------------- Raymond W. Smith Director\nApril 12, 1995 By: * -------------------------------- Derek M. Stevens Director\nBy: \/s\/John W. Harper ------------------------------ John W. Harper Attorney-In-Fact\nIndependent Auditors' Report On Consolidated Financial Statement Schedule - USAir Group, Inc.\nThe Stockholders and Board of Directors USAir Group, Inc.\nUnder date of February 22, 1995, except as to notes 4(a) and 4(c) which are as of April 10, 1995, we reported on the consolidated balance sheets of USAir Group, Inc. and subsidiaries (\"Group\") as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows, and changes in stockholders' equity (deficit) for each of the years in the three-year period ended December 31, 1994, included in Item 14(a)1(i) in this annual report on Form 10-K for the year 1994. In connection with our audits of the aforementioned consolidated financial statements, we also audited the consolidated financial statement schedule as listed in Item 14(a)2(i). This consolidated financial statement schedule is the responsibility of Group's management. Our responsi- bility is to express an opinion on the consolidated financial statement schedule based on our audits.\nIn our opinion, this consolidated 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.\nThe audit report on the consolidated financial statements of USAir Group, Inc. and subsidiaries referred to above contains an explanatory paragraph that states that Group's recurring losses from operations and net capital deficiency raise substantial doubt about its ability to continue as a going concern. The consolidated financial statement schedule in Item 14(a)2(i) in this annual report on Form 10-K for the year does not include any adjustments that might result from the outcome of this uncertainty.\nKPMG Peat Marwick LLP\nWashington, D. C. February 22, 1995, except as to notes 4(a) and 4(c) of the consoli- dated financial statements which are as of April 10, 1995\nUSAir Group, Inc. Schedule VIII Valuation and Qualifying Accounts and Reserves\n(in thousands)","section_15":""}
{"filename":"796317_1994.txt","cik":"796317","year":"1994","section_1":"Item 1 -- Business\nCortland First Financial Corporation is a Bank Holding Company and commenced business on October 1, 1986. First National Bank of Cortland is a wholly owned subsidiary of Cortland First Financial Corporation and its only operating entity.\nGovernment Regulation and Supervision As a holding company, Cortland First Financial Corporation is subject to supervision by the Federal Reserve system and is required to file an annual report with the Federal Reserve Board, and is subject to examination by that Board as well. Its subsidiary bank, First National Bank of Cortland, is subject to supervision by the Office of the Comptroller of the Currency as well as the Federal Deposit Insurance Corporation (FDIC). The administrative office of Cortland First Financial Corporation is located at 65 Main Street, Cortland, New York, in Cortland County.\nService Area and Competition The company conducts its banking operation primarily in Cortland County and the surrounding areas. First National Bank of Cortland currently employs 123 people in its six banking offices located in Cortland, Cortlandville, Marathon, McGraw, Cincinnatus, and Tully. A seventh banking facility was added in early 1994 in Whitney Point, which expanded our service area into neighboring Broome County and added greater convenience to those customers in the southern portion of our current market.\nFirst National Bank of Cortland is an independent commercial bank committed to serving the financial needs of customers in the local communities. The bank is in competition with other financial institutions in the area, many of which are branches of large institutions such as Marine Midland, Fleet, and Key Bank. Other organizations compete for deposits and loans as well, and include insurance companies, money market funds, federal credit unions, and other local independent banking operations.\nServices Offered In addition to providing the traditional loan and deposit service to its customers, the Bank also provides several specialized customer services including 24-hour automated teller machines in four locations: Main Office, 65 Main Street, Cortland; Groton Avenue Office, 1125 Groton Avenue, Cortlandville; Tully Office, Route 80 at I-81, Tully and our Whitney Point office on Route 11 in Whitney Point; as well as a 24-hour cash dispensing machine in our Marathon Office located at 14 East Main Street, Marathon. A full range of trust services including financial planning, estate planning, and custodial services are handled by the Bank. Other banking services include annuities, safe deposit boxes, travelers checks, money orders, wire transfers, collections, and foreign exchange. Traditional deposit products include checking accounts, Negotiable order of withdrawal (NOW) and savings accounts, time deposits, and individual retirement accounts. Lending services include residential, farm, business loans, Small Business Administration loans, installment loans, credit card loans, home equity loans, biweekly mortgages, auto, and student loans.\nFirst National Bank of Cortland has no foreign assets except for a nominal amount of Canadian currency.\nManagement is not aware of any exposure to potential environmental liability under the Superfund. Management is also not aware of any known trends, events, or uncertainties that will have, or that are reasonably likely to have, a material effect on the liquidity, capital resources, or operations of the Corporation or its subsidiary.\nThe following pages display the statistical disclosure by bank holding companies required by the Securities Act Industry Guide 3.\nMESSAGE TO SHAREHOLDERS\nEstablished in 1986, Cortland First Financial Corporation is a relatively new company. However, its only operating subsidiary, First National Bank of Cortland, has been a community cornerstone since 1869. Celebrating 125 years of stability, integrity, and service in 1994, we took a look back at our history and found that behind every challenge lies the opportunity for continued growth. Rooted in the philosophy that got us here, the challenge today is to look for sustainable growth in a future that is far from predictable.\nI am pleased to report that, while in many ways 1994 was a very challenging year, once again your bank has succeeded in achieving solid growth - growth that can be measured financially as well as growth that has been visible in our branch development, computer utilization and customer service initiatives.\nFirst National Bank of Cortland remains an independent community bank. In today's economic climate, growth is hard fought. Market share will be won by prudent yet progressive management and dedicated employees who recognize that service quality is the only real differentiator in the highly competitive world of financial services.\nFirst the numbers: In 1994, we were able to achieve yet another growth year in which total assets reached an all-time high closing at $198,800,000, an increase of more than $10,000,000. This increase represents a 5.3% growth over 1993 assets of $188,700,000. The Board of Directors also approved record cash dividends to shareholders in 1994. Total dividends paid to shareholders in 1994 amounted to $840,000 or $1.25 per share. The combination of gain in the market value of a share of stock purchased January 1, 1994, plus the cash dividends, produced a handsome total return of 47.9% for shareholders in 1994.\nEarnings continued to be very strong in 1994. Net income of $2,700,000 produced a return on average assets of 1.37%, significantly above the national average of 1.18% reported by the FDIC, as of the end of the third quarter. On a per-share basis, net income in 1994 was $4.00 versus $4.06 in 1993. Planned expenditures for computer-related equipment and new branch construction held earnings slightly below the previous year's record earnings.\nTotal shareholder equity increased by 1.8% to $20,400,000, providing a very strong capital-to-assets ratio of 10.89%. Total shareholder equity and book value were impacted by Statement of Financial Accounting Standards Board (FASB) No. 115 which requires recognition of unrealized gains or losses in investment securities. The significant rise in interest rates over the past year produced an unrealized loss in those securities classified as available-for-sale which, after tax considerations, had the effect of reducing equity by $875,320. It is not anticipated that this loss will ever be realized since the bank historically does not sell its investment securities. Banking regulators have chosen not to include the unrealized losses or gains for purposes of calculating regulatory capital. (Please refer to the Management's Discussion and Analysis section for further information.)\nOnce again, we are proud that the bank rating firms continued to award their highest ratings to our bank in 1994. Bauer Financial Reports, Inc. recognized the bank with its Five-Star rating; Veribanc, Inc. bestowed its Blue Ribbon rating; and, The Sheshunoff Company, Inc. awarded an \"A+\" rating.\nTechnologically speaking, 1994 provided an opportunity to consolidate the enhancements and conveniences achieved when we installed our new Unisys computer system in 1993. This system forms the basis which will keep First National in the forefront of technology for years to come.\nIn April, we opened our seventh banking office, located in the northern Broome County community of Whitney Point. The office, located approximately fourteen miles north of the city of Binghamton, is capably managed by Roberta Bush and her staff, and is off to an excellent beginning.\nIn November, we commenced a major renovation of the Main Office's adjacent building at 73 Main Street, acquired in 1990, which will house our expanded Trust and Investment Department on the ground floor and the loan department on the second floor, with the third floor available for future expansion. A new credit department supporting the bank's lending activities will occupy space on the second floor of our present building, adjacent to the loan department. The two buildings will be joined at the second floor level and serviced by the existing elevator. The building has been beautifully remodeled inside and out in keeping with the historic nature of the downtown location.\nWe are excited about the expansion of our Trust and Investment division. We are planning an expansion of our Trust Department in 1995 and expect significant growth in this area. With the Mutual Partners asset allocation program introduced in 1994, we expect that mutual fund investment opportunities for our customers will be an important factor in the long-term prospects for this area. This department offers a full range of personal trust, investment and custodial services as well as employee benefit programs.\nIn 1994, we welcomed two new members to the Board of Directors, Mary Alice Bellardini, Mayor of the Village of Homer, and John Buck, President of Buck Environmental Laboratories, Inc. Each of these individuals brings a wealth of talent and abilities to our bank.\nFinally, a much-deserved salute to all of our dedicated staff, employees and Board of Directors, without whom we would have no reason for celebrating a century and a quarter of service to our community. Indeed it is a proud tradition that brings the bank to where it is today. More than pride in the past, however, we take pride in the talent and attitude of our people today, enabling us to build on the legacy we have inherited.\nWe encourage our staff's involvement in activities and organizations which help make our communities better places, and many of our staff members are so involved. Last year, we were especially proud of Sharon Yaple, Vice President for Marketing and Retail Customer Services. In addition to her very active involvement in our 125th anniversary celebration and new branch opening, she chaired the 1995 United Way campaign which exceeded its prior year's record fund-raising effort. Also, Bob Derksen, Vice President and CFO, was the recipient of the St. George Medal awarded by the NYS Division of the American Cancer Society. The St. George Award is the most significant division award bestowed at the national level and awarded to division volunteers for outstanding service. Denise Connor, who works in our Finance and Accounting Department, was recognized by the Cortland Rotary Club with its first annual \"Pride of Workmanship Award,\" an award given to employees who demonstrate the ability to \"Do it once - Do it well - Build a Better America.\"\nHistorically, the local economy lags the national economic cycle by six to twelve months; however, during the current recovery in the national economy, our local economy has been slower to recover, due principally to a net loss of jobs in the manufacturing sector over the past year. With interest rates continuing to rise as the Fed attempts to limit inflationary concerns, we expect 1995 to present its share of unique challenges. With our strong capitalization, well-trained and competent staff and dedicated Board of Directors, I am confident that the Bank will once again rise to meet these new challenges and opportunities.\nSincerely,\nDavid R. Alvord President and Chief Executive Officer\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 -- Properties\nThe Registrant operates the following branches:\nName of Office Location County Date Established\nHome Office 65 Main Street Cortland March 1, 1869 Cortland, NY\nCincinnatus Main Street Cortland January 1, 1943 Cincinnatus, NY\nGroton Avenue 1125 Groton Avenue Cortland June 22, 1987 Cortland, NY\nMarathon 14 E. Main Street Cortland August 15, 1957 Marathon, NY\nMcGraw 30 Main Street Cortland May 1, 1967 McGraw, NY\nTully Route 80 at I-81 Onondaga January 26, 1989 Tully, NY\nWhitney Point 2950 NYS Route 11 Broome April 7, 1994 Whitney Point, NY\nThe Tully and Whitney Point offices are leased. The other banking premises are owned.\nItem 3","section_3":"Item 3 -- Legal Proceedings\nThere are no pending legal proceedings, other than routine litigation incidental to the business of the Bank, to which the Registrant or the Bank is a party or of which any of their property is the subject. In management's opinion, no pending action, if adversely decided, would materially affect the Bank's or the Registrant's financial condition.\nItem 4","section_4":"Item 4 -- Submission of Matters to a Vote of Security Holders\nNo matters were submitted for security holder vote during the fourth quarter of 1994.\nPART II\nItem 5","section_5":"Item 5 -- Market for Registrant's Common Stock and Related Shareholders Matters\nRegulatory Ratios: Total Risk-Based Capital 20.32% Tier I Risk-Based Capital 19.22 Leverage 10.76\nThe minimum risk-based capital per regulatory requirements for the \"well capitalized\" category is 10%.\nCommon Stock Data: The common stock of Cortland First Financial Corporation is inactively traded in the over-the-counter market. Market makers for the stock are Ryan, Beck & Company (800-342-2325), Monroe Securities, Inc. (716-546-5560), and First Albany Corporation (800-336-3245). There were 526 shareholders of record as of December 31, 1994. Prices & dividends are adjusted for the stock split declared August 16, 1993. Stock prices below are based on low \"offer\" prices and high \"bid\" prices for the quarter.\nItem 6","section_6":"Item 6 -- Selected Financial Data Five Year Comparative Summary (In thousands of dollars)\nItem 7","section_7":"Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operation\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:\nCortland First Financial Corporation is a one-bank holding company that was formed in 1986. Its only subsidiary and operating entity is First National Bank of Cortland, chartered in 1869. First National Bank of Cortland is an independent commercial bank delivering financial services from five (5) offices in Cortland County (Cortland, Cortlandville, Marathon, McGraw, and Cincinnatus), one (1) office in southern Onondaga County (Tully), and our newest office in northern Broome County (Whitney Point) which was opened in April of 1994. The primary regulator of Cortland First Financial Corporation is the Federal Reserve Bank of New York in New York City, while its subsidiary, First National Bank of Cortland, is regulated by the Office of the Comptroller of the Currency in Washington, D.C.\nCONSOLIDATED BALANCE SHEETS:\nTotal resources of $198,759,128 on December 31, 1994, compared to $188,683,125 at year-end 1993, an increase of $10,076,003 or 5.3%. Daily average outstandings for 1994 amounted to $195,819,527, compared to $191,445,749 for 1993, an increase of $4,373,778 or 2.3%.\nLoans - Total loans at year-end 1994 were $109,908,726, less the Allowance for Loan and Lease Losses (ALLL) of $1,225,737, leaving a net balance of $108,682,989, compared to $104,619,149 in 1993, an increase of $4,063,840 or 3.9%. At year-end 1994, loans secured by real estate amounted to $63,127,003, compared to $62,074,873 on December 31, 1993, which represents 55.7% and 57.2% of total loans, respectively. The majority of these outstandings are in short-term, fixed-rate biweekly mortgages and variable-rate home equity loans. Our commercial and agricultural loans at year-end 1994 amounted to $21,805,908, compared to $21,467,717 last year, a very small increase of $338,191 or 1.6%, indicating a flat commercial loan demand in 1994. We did see an increased demand in our installment loans. Outstandings of $18,556,764 at year-end 1993 rose to $23,305,713 on December 31, 1994, an increase of $4,748,949 or 25.6%. All loans granted were to entities within Cortland County and those immediately adjoining counties which are in our local service areas.\nOur ALLL represents 1.12% of our net loans outstanding as of year-end 1994, compared to 1.02% as of year-end 1993. Our 1994 net charge-offs of $153,952 compared favorably to $245,796 in the previous year, a decrease of $91,846 or 37.4%. The adequacy of our ALLL is evaluated as of the end of each quarter, and is judged to be more than adequate to absorb the inherent loss in the portfolio as of year-end. The overall excellent quality of our loan portfolio is indicated by the amount of non-performing loans as a percentage of gross loans at 0.18% on September 30, 1994, compared to 0.71% reported by our national peer group (all insured commercial banks having assets between $100 million and $300 million, with three or more banking offices, located in a non-metropolitan area), on average.\nSecurities - Investment securities at year-end 1994 amounted to $70,380,051, compared to $67,587,439 in 1993. As required by FASB No. 115 \"Accounting for Certain Investments in Debt and Equity Securities,\" we classified our investment securities as held-to-maturity or available-for-sale. Held-to-maturity securities are reported at cost, while the available-for-sale securities are reported at fair value. The available-for-sale portfolio at year-end 1994 amounted to $47,082,664 (cost $48,562,493 less net unrealized loss of $1,479,829), compared to $49,991,061 at year-end 1993 (cost $48,959,887 plus net unrealized gain of $1,031,174).\nDue to a general rise in market interest rates between 1993 and year-end 1994, the market value of securities available for sale declined by $2,511,003. Keep in mind, however, that the unrealized loss of $1,479,829 at year-end 1994 would only be realized upon sale or liquidation of the available-for-sale portfolio. The Bank does not have a trading portfolio and does not expect to have one in the future.\nDeposits - On a daily average basis deposit growth in 1994 was relatively flat with an increase of 1.3%. However, deposits did increase from $167,302,184 at December 31, 1993 to $176,967,403 at December 31, 1994, an increase of $9,665,219 or 5.8%. The lack of growth on a daily average basis is attributed to the very modest level of economic growth occurring within the region.\nShareholders' Equity - Shareholders' equity increased from $20,062,562 at December 31, 1993, to $20,423,557 in 1994, an increase of 1.8% in spite of the accounting treatment required by FASB No. 115 for recognition of market value in the investment securities portfolio. In recent years, shareholders' equity has grown at an average rate of almost 10% per annum and, without the effect of FASB No. 115, would have increased by 9.5% in 1994. In fact, banking regulators do not require market value adjustments when calculating capital. Capital for regulatory purposes at year-end was $21,298,877 in 1994 and $19,449,016 at year-end 1993. The Bank has the ability and intent to hold its securities to maturity, thereby not incurring actual losses in the securities accounts. Book value per share increased to $30.39 in 1994, up from $29.86 in 1993, also an increase of 1.8%. The same principles just described also impact book values. Book value per share based on regulatory capital would have been $31.69 in 1994, up from $28.94 in 1993 and $26.08 in 1992. The degree of regulatory action, the availability of funding through brokered deposits, and the level of FDIC risk-based premiums are all dictated by capital ratios. Cortland First Financial Corporation's risk-based capital ratios far exceed the minimum requirements even for the highest capital level (well capitalized).\nLiquidity - Liquidity management involves the ability to meet the cash-flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Securities available-for-sale amounted to $47,082,664 as of December 31, 1994, compared to $49,991,061 at year-end 1993. This, coupled with being a substantial net seller of federal funds in the amount of $8,278,000 on a daily average basis in 1994, compared to $6,485,000 in 1993, indicates a highly liquid position.\nTrust Department - At year-end 1994, the book value of the assets held in this department amounted to $49,872,335, compared to $50,129,768 in 1993. Trust Department assets are not part of the consolidated balance sheets.\nInterest Rate Risk - IRR exposure arises when a change in interest rates results in a change in the value of a financial instrument. The Asset\/Liability Committee of the Bank monitors its interest risk exposure on a regular basis. The interest rate shock report as of December 31, 1994, showed net interest income for the Bank would decrease by $309,600 (after tax) if interest rates increase by 200 basis points in 1995, and it would increase by $355,800 (after tax) if interest rates decline by 200 basis points, suggesting that the Bank has an acceptable rate risk exposure.\nCONSOLIDATED STATEMENTS OF INCOME:\nCortland First Financial Corporation reported net income of $2,689,861 for 1994, compared to $2,729,403 in 1993 and $2,208,076 in 1992. Return on average assets (ROA) of 1.37% at year-end compared to 1.43% in 1993 and 1.40% (before FASB No. 106 accounting change) in 1992. Our return on average shareholders' equity (ROE) of 13.25% in 1994 compared to 14.70% in 1993 and 12.99% (after FASB No. 106 accounting change) in 1992. For 1994, we were able to maintain a high net interest margin of 5.51%, compared to 5.50% in 1993 and 5.45% in 1992. Our budgeted net interest margin for 1995 is 5.35%, as we do not expect to maintain our 1994 levels due to increased pressure on the cost of interest- bearing liabilities. We expect that this negative impact on earnings may be offset by higher loan volume and increased deposits in 1995 as funds begin to flow back to CDs from competing investment vehicles. As a well-capitalized and financially sound institution, we continue to pay the lowest possible FDIC premium, which amounted to $384,282 in 1994, compared to $377,957 in 1993 and $356,985 in 1992. All indications are that the FDIC will reduce this premium by the end of 1995, which would give us a reduction in premium for 1995 or 1996. Salaries, wages, and employee benefits amounted to $3,595,566 in 1994, compared to $3,342,654 in 1993 and $3,229,601 in 1992. Occupancy expense of bank premises of $505,396 in 1994 increased $54,280 or 12.0% from $451,116 in 1993, compared to $430,806 in 1992. Most of the $54,280 increase in occupancy expense in 1994 was due to the opening of our Whitney Point branch in April of that year and heavy snow removal expenses for the winter of 1994. Computer and equipment expenses amounted to $593,697 in 1994, compared to $553,747 in 1993 and $460,015 in 1992. The purchase of new hardware and software in April 1993 accounts for an additional increase of three-month depreciation in 1994.\nWe continue to monitor our expenditures very closely in a commitment to cost control, and we expect, in spite of additional expenses in 1995 due to a major expansion into the Cullen building next door, to continue to have excellent income potential for 1995.\nItem 8","section_7A":"","section_8":"Item 8 -- Financial Statements and Supplementary Data The consolidated financial statements, footnotes, and suplementary data follow:\nIncluded in 1994 proceeds from maturities of investment securities are $5,074,752 and $11,794,119 relating to held-to-maturity securities and available-for-sale securities, respectively. Purchases of investment securities for 1994 include $11,779,528 and $10,904,485 relating to held-to-maturity securities and available-for-sale securities, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the years ended Dec. 31, 1994, 1993, 1992\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation: The accompanying financial statements include the accounts of Cortland First Financial Corporation (the Company) and its wholly owned subsidiary, First National Bank of Cortland (the Bank). Intercompany transactions have been eliminated in consolidation.\nCash Flows: Cash equivalents include amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.\nAccounting For Postretirement Benefits: The Bank provides postretirement medical and life insurance plans that cover substantially all of its employees. The plans are non-contributory; however, retiree contributions may be required if certain age and length of service criteria are not met.\nIn December of 1992, the Bank adopted Statement of Financial Accounting Standard No. 106, \"Employers Accounting for Postretirement Benefits Other Than Pensions,\" which requires accrual basis accounting.\nThe Bank elected to recognize, as of January 1, 1992, the entire accumulated postretirement benefit obligation of $540,615. The cumulative effect on prior years of $319,877 (after reduction for income tax benefit) of this change in accounting principle is included in net income for 1992. The effect of the change in 1992 was to decrease income before the cumulative effect adjustment by approximately $14,000 or $.02 per share (adjusted for 1993 stock split).\nThe following sets forth the plan's funded status reconciled with the amounts reported in the company's statement of financial position at December 31, for the combined medical and life insurance plans:\nA 12% annual rate of increase in the per capita costs of covered health care benefits was assumed for 1994, gradually decreasing to 6% by the year 2032. 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, 1994, by $90,359 and increase the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for 1994 by $15,127. A discount rate of 7.5% was used to determine the accumulated postretirement benefit obligation.\nFair Value of Financial Instruments: Statement of Financial Accounting Standard 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, 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 assumption 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. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank.\nThe following methods and assumptions were used by the Bank in estimating its fair value disclosures for financial instruments:\nCash and Cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair value.\nInvestment securities: Fair values for investment securities are based on quoted market prices or dealer quotes.\nLoans: Fair values for loans are estimated using discounted cash flow analysis, based on interest rates approximating those currently being offered for loans with similar terms and credit quality. The fair value of accrued interest approximates carrying value.\nDeposits: The fair values disclosed for non-interest bearing accounts and accounts with no stated maturity are, by definition, equal to the amount payable on demand at the reporting date. The fair value of time deposits was estimated by discounting expected monthly maturities at interest rates approximating thosecurrently being offered on time deposits of similar terms. The fair value of accrued interest approximates carrying value.\nShort-term borrowings: These funds reprice daily and, therefore, current book value was used as an estimate of fair value.\nOff-balance sheet instruments: Off-balance sheet financial instruments consist of standby letters of credit, with fair value based on fees currently charged to enter into agreements with similar terms and credit quality.\nThe net carrying amounts and fair values of financial instruments as of December 31, 1994 are as follows:\nThe fair value of off-balance sheet financial instruments, principally standby letters of credit, is not significant.\nTrust Assets: Property (other than cash deposits) held by the Bank in fiduciary or agency capacities for its customers is not included in the accompanying balance sheets, since such items are not assets of the Bank.\nInvestment Securities: Effective December 31, 1993 the Bank has adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" As required by this pronouncement, the Bank has classified its investments in debt securities as held-to-maturity or available-for-sale. Held-to-maturity securities are those for which the Bank has the positive intent and ability to hold to maturity, and are reported at cost, adjusted for amortization of premiums and accretion of discounts. Debt securities not classified as held-to-maturity are classified as available-for-sale and reported at fair value, with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of the applicable income tax effect. None of the Bank's investment securities have been classified as trading securities.\nPurchases and sales of investment securities are recorded as of settlement date; gains and losses are based on identification of specific securities.\nFees on Loans: Loan origination fees and certain direct loan origination costs are deferred and the net amount is amortized as a yield adjustment. The Bank is generally amortizing these amounts over the contractual life of the related loans. However, for fixed-rate mort-gage loans that are generally made for a 20-year term, the Bank has anticipated prepayments and used an estimated life of 7.5 years.\nAllowance for Possible Loan Losses: The allowance for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The allowance is increased by provisions charged to operating expenses and reduced by net charge-offs. The level of the allowance is based on management's evaluation of potential losses in the loan portfolio, as well as prevailing economic conditions.\nEffective January 1, 1995, the Bank is required to adopt Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan.\" This pronouncement requires certain impaired loans to be measured based on discounted cash flows or, if collateral dependent, on the fair value of collateral. Adoption of this pronouncement is not expected to have a significant effect on the Bank's financial statements for 1995.\nBank Premises, Furniture and Equipment: Bank premises, furniture and equipment are stated at cost less accumulated depreciation. Annual provisions for depreciation are computed by the straight-line or declining balance methods over the estimated useful lives of the assets. Repairs and maintenance are charged to expenses as incurred, whereas capital additions and betterments are capitalized.\nOther Real Estate: Other real estate is carried at cost or fair value, less estimated disposal costs, whichever is lower.\nIncome Taxes: Effective January 1, 1993, the Bank adopted FASB Statement No. 109 \"Accounting for Income Taxes\" which requires an asset and liability approach to recognizing the tax effects of temporary differences between tax and financial reporting. In prior years, the Bank accounted for the tax effects of timing differences between tax and financial reporting using Accounting Principles Board opinion No. 11. This change had no significant effect on the 1993 financial statements.\nRetirement Benefits: The Bank has a defined contribution pension plan, administered by its Trust Department, for all eligible employees. Contributions to the plan are determined based upon percentages of compensation for eligible employees and are funded as accrued. Pension expense for 1994, 1993, and 1992 was $97,101, $112,906 and $110,576, respectively. The Bank also has a defined contribution 401(k) savings plan, administered by its Trust Department, for all eligible employees. Contributions to the plan are determined by the Board of Directors, at its discretion, and are funded as accrued. Up to certain limitations, employees may also contribute to this plan. Expense under this plan was $81,523 in 1994, $72,155 in 1993, and $76,569 in 1992.\nThe Bank maintains a supplemental retirement plan for its President and Chief Executive Officer. The Bank has transferred funds to its Trust Department to fund the estimated benefit liability upon retirement. Plan expense of $58,005, $21,443 and $9,844 was recognized for the years ended December 31, 1994, 1993, and 1992, respectively.\nStock Split: During August 1993, the Company effected a two-for-one stock split through the issuance of one additional share of $5 par value common stock for every share then outstanding.\nPer-Share Amounts: Earnings per share are computed on the basis of weighted average shares outstanding, retroactively adjusted for the stock split (672,000 for 1994, 1993, and 1992). Cash dividends per share are based on declared rates, retroactively adjusted for the stock split.\nINVESTMENT SECURITIES The amortized cost and approximate fair value of investment securities at December 31, 1994 and 1993 are as follows:\nAt December 31, 1994 securities having a book value of $43,756,344 were pledged to collateralize public fund deposits as required by law.\nThe amortized cost and estimated market value of investment securities at December 31, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nALLOWANCE FOR POSSIBLE LOAN LOSSES Changes in the loan loss allowance during the years ended December 31, 1994, 1993 and 1992 are summarized as follows:\nSubstantially all of the Bank's borrowers are concentrated within Cortland and adjacent counties.\nBANK PREMISES, FURNITURE AND EQUIPMENT Bank premises, furniture and equipment are comprised of the following:\nCOMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit and letters of credit which involve, to varying degrees, elements of credit risk in excess of amounts recognized in the consolidated balance sheet. The contract amount of those commitments and letters of credit reflects the extent of involvement the Bank has in those particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of the instruments. The Bank uses the same credit policies in making commitments and letters of credit as it does for on-balance-sheet instruments.\nFinancial instruments whose contract amounts represent credit risk:\nCommitments to extend credit are agreements to lend to a customer 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. Since some of the commitment amounts are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.\nStandby letters of credit written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions.\nThe credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Since the letters of credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.\nFor both commitments to extend credit and letters of credit, the amount of collateral obtained, if deemed necessary by the Bank upon the extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies, but includes residential and commercial real estate.\nThe Bank's current risk-based capital ratio, which included the aforementioned commitments, is more than twice the minimum of 8.00% required by the regulators.\nPrincipal operating leases are for bank premises. At December 31, 1994, aggregate future minimum lease payments under non-cancelable operating leases with initial or remaining terms equal to or exceeding one year consist of the following: 1995 - $51,620; 1996 - $51,620; 1997 - $51,620; 1998 - $51,620; and 1999 - $51,620 and $551,480 thereafter. Total rental expense amounted to $53,575 in 1994, $41,799 in 1993, and $56,299 in 1992.\nThe Bank is subject to legal limitation on the amount of dividends that can be paid to the Company. Dividends are limited to retained net profits, as defined. At December 31, 1994, approximately $5,400,000 was available for the declaration of dividends by the Bank.\nINCOME TAXES The income tax provision for 1994, 1993, and 1992 is summarized as follows:\nThe provision for income taxes includes the following:\nThe components of deferred income taxes at December 31, 1994 and 1993 are as follows:\nFor 1992, deferred income taxes resulting from timing differences in the recognition of income and expense for tax and financial reporting purposes related principally to provision for loan losses, loan fees and compensation expense.\nA reconciliation between the statutory federal income tax rate and the effective income tax rate for 1994, 1993, 1992 is as follows:\nA deferred tax benefit of $220,738 was recognized in 1992 in connection with the cumulative effect of accounting for postretirement benefits.\nRELATED PARTY TRANSACTIONS Directors and executive officers of the Bank and their affiliated companies were customers of, and had other transactions with, the Bank in the ordinary course of business during 1994. It is the Bank's policy that all loans and commitments included in such transactions are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than the normal risk of collectibility or present other unfavorable features. Loan transactions with related parties are summarized as follows:\nBalance at December 31, 1993 $2,992,026 New loans and advances 2,635,674 Loan payments 1,227,570 Balance at December 31, 1994 $4,400,130\nLINES OF CREDIT At December 31, 1994, the Bank had available lines of credit totaling $3,000,000 which were unused.\nPARENT COMPANY FINANCIAL INFORMATION Condensed financial statement information of Cortland First Financial Corporation is as follows:\nREPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders Cortland First Financial Corporation and Subsidiary\nWe have audited the accompanying consolidated balance sheets of Cortland First Financial Corporation and Subsidiary as of December 31, 1994 and 1993, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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 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 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 Cortland First Financial Corporation and Subsidiary at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs further discussed in the notes to financial statements, the Company adopted SFAS No. 109 (Accounting for Income Taxes) and SFAS No. 115 (Accounting for Investments in Certain Debt and Equity Securities) in 1993 and SFAS No. 106 (Accounting for Postretirement Benefits Other Than Pensions) in 1992.\nCOOPERS & LYBRAND L.L.P. Syracuse, New York January 13, 1995\nDistribution of Assets, Liabilities, and Shareholders' Equity: The following table sets forth the amounts of the Corporation's daily average assets, liabilities, and shareholders' equity for the period indicated, the amounts of the interest earned and interest paid thereon, the average interest rate earned for each type of earning asset, and the average rate paid for each type of interest bearing liability. Interest earned on non-accruing loans is included in the interest earned on loans only when collected. The average balances of non-accruing loans are included in the average balances of loans. Taxable equivalent adjustments have been made based on applicable marginal Federal and State tax rates.\nInterest Rates and Interest Differential:\nThe following table sets forth for the periods indicated a survey of the changes in interest earned and interest paid resulting from changes in volume and changes in rates. Interest earned on non- accruing loans is included in the interest earned on loans only when collected, i.e., on the cash basis, but the average balances of such loans are included in the average balances of loans. The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.\nINVESTMENT PORTFOLIO - MATURITY SCHEDULE\nThe following schedule sets forth the maturities of both available-for-sale and held-to-maturity securities at December 31, 1994. Amounts and weighted average yields of such securities are based on amortized cost for all securities. Yield of tax exempt securities have been computed on a tax equivalent basis using a marginal Federal and State income tax rate. (Excludes Federal Reserve Bank and other stock of $207,000.)\nAt December 31, 1994, 78% of the state and municipal securities portfolio, based upon par value was rated \"A\" or higher, and 77% \"AA\" or higher. Obligations of the State of New York and its political subdivisions constituted $17,765,998 par value or 25% of the portfolio at that date, with a market value of $17,800,655.\nThere were no securities of a single issuer which constituted more than 10% of shareholders equity as of December 31, 1994.\nGap analysis indicates the sensitivity to fluctuations in interest rates by providing information regarding maturity repricing and cash flows for both assets and liabilities. Cash and Federal funds sold are assigned to immediate repricing since they represent overnight sales. Investment securities are scheduled according to the final maturity date in the case of fixed rate issues and by next repricing date for variable rate securities. Loans are assigned by final maturity for fixed rate loans with no scheduled amortizing payments, while loans with amortizing payments are scheduled according to amortized paybacksince this would represent a repricing opportunity on funds received as payments. Variable rate loans are assigned to the next repricing date. Demand loans are categorized as immediately repriceable. Non-interest bearing deposits repricing within three months are at least equal to the amount of cash and due from banks. The remaining interest bearing, savings, and money market accounts which represent core deposits are spread across the Gap buckets to yield a 3 1\/2 year average maturity. Fixed rate certificates of deposit are assigned by final maturity date, while variable rate are assigned as of the next repricing date. Fixed assets, other assets, other liabilities, and equity are assigned to the over five year category since they represent stable, non-repricing components.\nNon-accruing Loans\nThe Company does not accrue interest on certain non-performing loans. Non- accrual status is normally reserved for loans 90 days or more past due unless both well secured and in the process of collection.\nPotential Problem Loans\nAt December 31, 1994, the Company had $7,457,000 in commercial and consumer loans for which payments are presently current, but the borrowers are currently experiencing financial difficulties. Those loans are subject to constant management attention and are reviewed weekly. The Registrant had no restructured loans as defined by SFAS 15 in the portfolio. Loans which are current for which collection is doubtful are not normally placed in non-accrual status. Such loans are on a watch list to allow monitoring by management.\nLoans classified for regulatory purposes as loss, doubtful, substandard, or special mention that are not included above, do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, nor do they represent material credits about which management is aware of information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.\nLoan Concentration\nThere are no concentrations of loans which amount to more than 10% of total loans other than those which have been separately disclosed, i.e., rental estate, consumer, commercial, agricultural, and municipal. All loans granted are to entities within Cortland County and those immediately adjoining counties which are in our local service area. We have no outside area loans in our portfolio.\nAllowance for Possible Loan Losses\nThe allowance for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The allowance is increased by provisions charged to operating expenses and reduced by net charge-offs. The adequacy of the allowance is based on management evaluation of the last three years historical loss experience, specific allocations for losses detailed in the loan loss review, and an additional allocation based on the total outstandings in the loan portfolio. Additional factors considered in the evaluation include the levels and trends in delinquencies and non-accruals, underwriting guidelines and collection procedures, the experience and ability of the lending staff, and current economic conditions within our lending area. The Company has a diverse customer base with no known significant concentrations of credit that would affect the allowance.\nSummary of Loan Loss Experience\nThe following table summarizes the Company's loan loss experience for the two years ended December 31, 1994.\nDeposits\nThe exhibit below presents daily average amounts and rates of deposits by type for the years ended December 31, 1994 and December 31, 1993.\nMaturities of time certificates of deposit of $100,000 or more outstanding at December 31, 1994, are summarized as follows:\nAmount (in thousands of dollars) 3 months or less $2,554 Over 3 through 6 months 918 Over 6 through 12 months 1,648 Over 12 months 907 Total $6,027\nNon-interest bearing deposits disclosed represent all demand deposits which are non-interest bearing. These deposits are held by individuals, partnerships, corporations, and municipalities. There are no significant deposits from trust activities.\nReturn on Equity and Assets\nThe following table shows operating and capital ratios for the last two years. Year Ended December 31, 1994 1993 Return on Assets Net Income\/Average Total Assets 1.37% 1.43%\nReturn on Equity Net Income\/Average Shareholder Equity 13.25% 14.70%\nDividend Payout Ratio Cash Dividends Declared\/Net Income 31.23% 29.55%\nCapital Ratio Average Shareholder Equity\/ Average Total Assets 10.37% 9.70%\nItem 9","section_9":"Item 9 -- Changes In and Disagreements with Accountants on Accounting and Financial Disclosure Not Applicable.\nPART III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 -- Directors and Executive Officers of the Registrant Directors are listed in the Annual Proxy Statement, dated February 28, 1995, pages 2 through 4, incorporated herein by reference.\nItem 11","section_11":"Item 11 -- Executive Compensation Annual Proxy Statement, dated February 28, 1995, pages 6 through 10, incorporated herein by reference.\nItem 12","section_12":"Item 12 -- Security Ownership of Certain Beneficial Owners and Management Annual Proxy Statement, dated February 28, 1995, pages 2 through 4, incorporated herein by reference.\nItem 13","section_13":"Item 13 -- Certain Relationships and Related Transactions Annual Proxy Statement, dated February 28, 1995, pages 4 and 10, incorporated herein by reference.\nPART IV Item 14","section_14":"Item 14 -- Exhibits, Financial Statement Schedules, and Reports on 8-K\n(a) Documents filed as part of this report:\n(2) Financial statement schedules are omitted from this Form 10-K since the required information is not applicable to the Registrant. (3) Listing of Exhibits:\nThe following documents are attached as Exhibits to this Form 10-K as indicated by the page number or exhibit or are incorporated by reference to the prior filings of the Registrant with the Commission.\nForm 10-K Exhibit Number Exhibit Page\n3.1 Certificate of Incorporation of Cortland First Financial Corporation *\n3.2 Bylaws of the Company *\n4 Specimen Stock Certificates *\n22 List of Registrant's Subsidiary E-1\n* Exhibit is incorporated herein by reference to the identically numbered exhibit to the Form S-4 Registration Statement filed by the Company with the Securities an Exchange Commission on August 18, 1986.\nItem 14 (b) There were no reports filed on Form 8-K during the fourth quarter of 1994.\nItem 14 (c) See Item 14 (a) (3) above.\nItem 14 (d) See Item 14 (a) (2) above.\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.\nCORTLAND FIRST FINANCIAL CORPORATION (Registrant) Date March 27, 1995 By \\s\\ David R. Alvord\nDavid R. Alvord, President and Chief Executive Officer\nDate March 27, 1995 By \\s\\ Bob Derksen\nBob Derksen, 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 dates indicated.\nDavid R. Alvord, President, CEO and Director Date March 27, 1995\nDonald S. Ames, Director Date March 27, 1995\nMary Alice Bellardini, Director Date March 27, 1995\nJohn S. Buck, Director Date March 27, 1995\nRobert M. Lovell, Director Date March 27, 1995\nHarry D. Newcomb, Director Date March 27, 1995\nRichard J. Shay, Director Date March 27, 1995\nCharles H. Spaulding, Director Date March 27, 1995\nDavid J. Taylor, Director Date March 27, 1995\nEsther F. Twentyman, Director Date March 27, 1995\nStuart Young, Director Date March 27, 1995\nExhibit 22 -- Subsidiaries\nSubsidiary of the Registrant\nFirst National Bank of Cortland is a wholly owned subsidiary of Cortland First Financial Corporation.","section_15":""}
{"filename":"278041_1994.txt","cik":"278041","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Company, through its subsidiaries, operates a diversified fleet of U. S., and international flag vessels that provide international and domestic maritime transportation services to commercial customers and agencies of the United States government primarily under medium- to long- term charters or contracts. The Company's fleet consists of 28 ocean-going vessels, 14 towboats, 129 river barges, 1,650 LASH barges and related shoreside handling facilities. The Company's strategy is to (i) identify customers with marine transportation needs requiring specialized vessels or operating techniques, (ii) seek medium- to long-term charters or contracts with those customers and, if necessary, modify, acquire or construct vessels to meet the requirements of those charters or contracts, and (iii) secure financing for the vessels predicated primarily on those charter or contract arrangements. The Company believes that this strategy has produced valuable long-term relationships with its customers and stable operating cash flows.\nThe Company is the only significant operator of the LASH (lighter aboard ship) system, which it pioneered in 1969. The Company's fleet includes ten large LASH vessels, four LASH feeder vessels and 1,650 LASH barges. In its liner services, the Company uses the LASH system primarily to gather cargo on rivers, in island chains and in harbors that are too shallow for traditional vessels and to transport to and from those areas large items, such as forest products, natural rubber and steel, that cannot be transported efficiently in containerized vessels. In addition, the LASH system enables barges to be rapidly loaded onto and unloaded from the large LASH vessels without shoreside support facilities while minimizing the number of times that the cargo is handled. Because the Company's LASH barges are used primarily to transport large items, the Company's LASH fleet often has a competitive advantage over containerized vessels. Additionally, because containerized and breakbulk vessels cannot operate in certain of the areas where the Company's LASH system operates, the Company often has a competitive advantage over such vessels.\nThe Company's diversified ocean-going fleet also includes (i) two international flag and two U.S. flag pure car carriers that are specially designed to transport automobiles; (ii) the only two U.S. flag ice- strengthened multi-purpose vessels, which supply Pacific rim military bases and scientific operations in the Arctic and Antarctic; (iii) three roll-on\/roll-off vessels that permit rapid deployment of rolling stock, munitions and other military cargoes requiring special handling; (iv) two PROBO vessels that can carry various refined petroleum products and dry bulk cargoes on back-to-back voyages because of their ability to rapidly self-clean their cargo holds between voyages\nwith minimal shoreside support; (v) one international flag cape-size bulk carrier; (vi) one U.S. flag semi-submersible barge; and (vii) one molten sulphur carrier, which is used to carry molten sulphur from Louisiana and\/or Texas to a processing plant on the Florida Gulf Coast. The Company also operates 14 inland waterway towboats and 111 super-jumbo river barges that transport coal from Indiana to Florida for an electric utility via shoreside unloading facilities owned and operated by the Company.\nThrough its principal operating subsidiaries, Central Gulf Lines, Inc. (\"Central Gulf\"), LCI Shipholdings, Inc. (\"LCI\"), Forest Lines Inc. (\"Forest Lines\") and Waterman Steamship Corporation (\"Waterman\"), the Company engages primarily in four types of services: (i) international flag LASH liner service between U. S. Gulf and East Coast ports and ports in northern Europe, and a subsidized U. S. flag LASH liner service between U. S. Gulf and East Coast ports and ports in South Asia, the Middle East and northern Africa; (ii) time charters to and other contracts with the Military Sealift Command (\"MSC\") for use in its military prepositioning program and to service scientific operations in the Arctic and Antarctic; (iii) time charters to transport Toyota and Honda automobiles from Japan to the United States and Hyundai automobiles from Korea primarily to the United States and Europe; and (iv) domestic transportation and services, primarily involving its coal and sulphur contracts and its ownership of an inter-modal transfer and warehouse facility in Memphis, Tennessee. The Company also has investments in several overseas entities that own and operate specialized cargo carriers.\nThe Company currently has time charters or contracts to carry cargoes for commercial customers that include International Paper Company, Freeport-McMoRan, Inc., The Goodyear Tire and Rubber Company, Toyota Motor Corporation, Honda Motor Co., Ltd. and Hyundai Motor Company. The Company has one of the number of vessels on charter to the MSC operating nine vessels for the MSC under charters or contracts that typically contain options permitting MSC to extend the charter or contract on similar terms and conditions for one or more extension periods. With two exceptions, the MSC has always exercised its renewal options on the Company's charters or contracts, and the Company generally has been successful in winning charter or contract renewals when they are rebid.\nThe Company's business historically has generated stable cash flows because most of its medium- to long-term charters provide for a daily charter rate that is owed whether or not the charterer utilizes the vessel (unless the vessel is unavailable for the charterer's use) and most of its medium- to long-term contracts guarantee a minimum amount of cargo for transportation. The Company is partially insulated from increases in certain operating expenses because time charters generally require the charterer to pay certain voyage costs, including fuel, port and stevedoring expenses, and often include cost escalation features covering certain of the expenses paid by the Company.\nHISTORY\nCentral Gulf was founded in 1947 by the late Niels F. Johnsen and his sons, Niels W. Johnsen, the Company's current Chairman, and Erik F. Johnsen, its current President. Central Gulf was privately held until 1971 when it was acquired by Trans Union Corporation. In 1978, the Company was formed to act as a holding company for Central Gulf, LCI and other affiliated companies in connection with the 1979 spin- off by Trans Union of the Company's common stock to Trans Union's stockholders. In 1986, the Company acquired the assets of Forest Lines, and, in 1989, the Company acquired the stock of Waterman. Since its spin-off from Trans Union, the Company has continued to act solely as a holding company, and its only significant assets consist of the capital stock of its subsidiaries.\nLINER SERVICES\/CONTRACTS OF AFFREIGHTMENT\nInternational Flag. Under the name \"Forest Lines\" the Company operates two international flag LASH vessels and a self- propelled, semi-submersible feeder vessel on a scheduled liner service. Forest Lines normally makes 11 round trip sailings per LASH vessel per year between U. S. Gulf and East coast ports and ports in northern Europe. Approximately one-half of the aggregate eastbound cargo space is reserved for International Paper Company under a long- term contract of affreightment. The remaining space is provided on a voyage affreightment basis to commercial shippers. Historically, approximately 20% has been used by other paper manufacturers. The remaining 30% has been used by various commercial shippers to carry general cargo. Since 1969, when the LASH liner service commenced operation, the vessels generally have been fully utilized on their eastbound voyages.\nThe Company has had ocean transportation contracts with International Paper since 1969 when the Company had two LASH ships built to accommodate International Paper's trade. The Company's contract of affreightment with International Paper is for the carriage of wood pulp, liner board and other forest products, the characteristics of which are well suited for transportation by LASH vessels because the LASH system minimizes damage to such cargo by reducing the number of times that the cargo is handled. In addition, the LASH system permits the Company to load and unload these products at the shipper's and the receiver's facilities, which are generally located on river systems that container and breakbulk vessels do not serve. The Company's current contract with International Paper is for a ten-year term ending in 2002.\nOver the years the Company has established a base of commercial shippers to which it provides space on the westbound Forest Lines service. The principal cargoes carried westbound are high-grade paper products, aluminum slabs, steel products and other general cargo. Over the last five years, the westbound utilization rate for these vessels averaged approximately 88% per year.\nU. S. Flag. Waterman is a party to an operating differential subsidy agreement with the U. S. Maritime Administration, an agency of the Department of Transportation (\"MarAd\"), that permits the Company to operate U. S. flag vessels on designated international trade routes and receive subsidy payments from the United States government approximating the excess of certain vessel expenses, primarily wages, over comparable costs of the Company's principal foreign flag competitors on the same trade routes. Under the subsidy agreement the Company operates a scheduled liner service that makes approximately 16 round voyages per year (four per vessel) between U. S. Gulf and Atlantic ports and ports in the Red Sea, Persian Gulf and Indian Ocean (Trade Route No. 18) and ports in Indonesia, Malaysia and Singapore (Trade Rouge No. 17). The subsidy agreement also permits the Company to make per year up to 18 calls at Egyptian ports on the Mediterranean and up to 12 calls to south and east Africa ports. The Company also operates FLASH vessels as feeder vessels in this service in southeast Asia. In 1994, the Company received approximately $21.7 million under its subsidy agreement. The Company's subsidy agreement with MarAd expires on December 31, 1996, and there can be no assurance that it will be renewed. See \"Item 1. Business - Regulation\" for a discussion of the subsidy program.\nOn the eastbound portion of this service, a significant part of each vessel's cargo traditionally has been shipped to lesser developed countries under the Public Law-480 program, pursuant to which the United States government sells or donates surplus food products for export to developing countries. 75% of this cargo is reserved for carriage by U.S. flag vessels, if they are available at reasonable rates. Awards under the Public Law-480 program are made on a voyage-to-voyage basis through periodic competitive bidding. The remaining eastbound cargo consists of general cargo, including some military equipment. Over the last five years, these vessels generally have been fully utilized on their eastbound voyages.\nOn the westbound portion of this service, the Company provides a significant portion of its cargo space to Goodyear for the transportation of natural rubber under a contract of affreightment expiring in February 1996. Space is also provided on a voyage-to-voyage basis to other importers of natural rubber, including Uniroyal Goodrich Tire Co., Bridgestone\/Firestone, Inc. and certain members of the Rubber Trade Association. The Company has had a continuing relationship with such companies and the Association since the early 1970s. The Company's LASH barges are ideally suited for large shipments of natural rubber because damage to rubber due to compression is minimal as compared to the damage that can occur when shipments are made in traditional breakbulk vessels. As a result, Waterman is the largest U.S. flag carrier of natural rubber from southeast Asia to the United States. The remaining westbound cargo generally consists of coffee, jute, guar, piece goods and other general cargo. Over the last five years, these vessels generally have been fully utilized on their westbound voyages.\nMILITARY SEALIFT COMMAND\nGeneral. The Company has had contracts with the MSC (or its predecessor) almost continuously for several decades. At the present time, the Company's subsidiaries have nine vessels under contract to the MSC. These vessels are employed in the MSC's prepositioning programs, which strategically place military cargo throughout the world, or are chartered to the MSC to service long-term scientific operations. The Company believes that the demand for military prepositioning vessels will increase during the next decade, notwithstanding planned reductions in overall military spending, because these vessels are vital to the military's ability to respond quickly to international incidents throughout the world without incurring the significant costs of operating foreign bases, some of which also may not be available because of changing political situations.\nMSC charters and contracts are awarded through competitive bidding, for fixed terms with options allowing the MSC to extend the charters or contracts for additional periods. With two exceptions, the MSC has always exercised its extension options, and the Company generally has been successful in winning renewals when the charters and contracts are rebid. All charters and contracts require the MSC to pay certain voyage costs, including fuel, port and stevedoring expenses, and certain charters and contracts include cost escalation features covering certain of the expenses paid by the Company.\nLASH Vessels. The Company charters four U. S. flag LASH vessels to the MSC under time charters that expire in April 1996, May 1996, July 1996 and October 1996, respectively, and provide the MSC with options to renew each contract for one or two additional 17-month periods. These vessels are in the MSC's prepositioning force stationed in the Indian Ocean area.\nIce-Strengthened Multi-purpose Vessels. The Company owns and operates the only two U.S. flag ice-strengthened multi-purpose vessels. These vessels are capable of transporting containerized and breakbulk cargo and are used by the MSC to resupply Pacific rim military bases and to supply scientific projects in the Arctic and Antarctic. One of the vessels is being operated under a charter with the MSC that will expire in November 1996 and may be extended for an additional 17-month period at the option of the MSC. The other vessel is being operated under a charter with the MSC that will expire in November 1995 and may be extended for an additional 17-month period at the option of the MSC.\nRoll-On\/Roll-Off Vessels. In 1983 Waterman was awarded a contract to operate three U. S. flag roll-on\/roll-off vessels under time charters to the MSC for use by the United States Navy in its maritime prepositioning ship (\"MPS\") program. These vessels represent three of the four MPS vessels currently in the MSC's Atlantic fleet, which provides support for the U. S. Marine Corps. These ships are designed primarily to carry rolling stock and containers, and can each carry support equipment for 17,000\nmilitary personnel. Waterman sold the three vessels to unaffiliated corporations shortly after being awarded the contract, but retained the right to operate the vessels under operating agreements. The MSC time charters commenced in late 1984 and early 1985 for initial five-year periods and were renewable at the MSC's option for additional five-year periods up to a maximum of twenty- five years. In 1993, the Company reached agreement with MSC to make certain reductions in future charter hire payments in consideration of fixing the period of these charters for the full twenty-five years. The charters will now terminate in the years 2009 and 2010. The operating agreements are for corresponding periods and are renewed as the charters are renewed.\nSemi-submersible Barge. In late 1989, the Company acquired, for approximately $4.4 million, and commenced operation of a U. S. flag semi-submersible barge, the Caps Express. The Caps Express was initially deployed under a charter to the MSC and was used extensively in Operation Desert Shield\/Desert Storm. The charter expired in April 1991 and the MSC did not exercise its renewal option under the charter. Since that time, the Caps Express has been operated in the commercial market.\nPURE CAR CARRIERS\nU. S. Flag. In 1986, the Company entered into multi-year charters to carry Toyota and Honda automobiles from Japan to the United States. To service these charters, the Company had constructed two U. S. flag pure car carriers which are specially designed to carry 4,000 and 4,660 automobiles, respectively. Both vessels were built in Japan, but are registered under the U.S. flag, making them two of only four U.S. flag pure car carriers in the Japanese trade. In order to be competitive with foreign flag vessels operated by foreign crews, the Company worked in close cooperation with the unions representing the Company's U.S. citizen shipboard personnel. Service under these charters commenced in the fourth quarter of 1987. These charters were renewed for additional multi-year terms.\nInternational Flag. Since 1988, the Company has transported Hyundai automobiles from Korea primarily to the United States and Europe under two long-term charters. To service these charters, the Company had two new pure car carriers constructed by a shipyard affiliated with Hyundai. Each of the vessels has a carrying capacity of 4,800 automobiles.\nUnder each of the car carrier charters, the charterers are responsible for voyage costs including fuel, port and stevedoring expenses while the Company is responsible for normal operating expenses including crew wages, repairs and insurance. The Hyundai charters also include escalation features covering certain of the expenses paid by the Company. During the terms of these charters, the Company is entitled to its full fee irrespective of the number of voyages completed or the number of cars carried per voyage.\nBULK CARRIER\nIn 1990 the Company acquired a 148,000 dwt cape size dry bulk carrier. The vessel has been fully employed under various charters in specific trading areas where bulk cargoes move on a regular basis.\nFLOAT-ON\/FLOAT-OFF VESSELS\nDuring 1994 the Company entered into a long-term contract to provide ocean transportation services to a major mining company producing copper concentrates at its mine in West Irian Jaya, Indonesia. The Company has acquired two semi-submersible barge carrying vessels and is having constructed 26 cargo barges to be used with the aforementioned vessels. The Company will also acquire a small container vessel in order to fulfill the requirements of the contract, which is expected to commence in late 1995. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nDOMESTIC TRANSPORTATION SERVICES\nCoal. In 1981, the Company entered into a 22-year contract expiring in 2004 with a Florida based rural electric generation and transmission cooperative for the transportation of coal from Mt. Vernon, Indiana to Gulf County, Florida. Under this contract, which was awarded pursuant to competitive bidding, the Company is annually guaranteed transportation of a minimum of 2.7 million tons of coal through its operation of 14 chartered towboats, 108 chartered super- jumbo river barges and three such barges that it owns. Under this contract, the Company typically has transported three million tons of coal per year. To protect both parties against cost variations, the contract contains escalation and de-escalation clauses designed to adjust the contract price for fluctuations in fuel costs, wages and other operating expenses. The Company is also responsible for unloading the barges at the discharge point in Gulf County, Florida and transferring the coal into railcars. To facilitate this process, the Company owns and operates an automated terminal facility. The terminal can be operated by relatively few employees and is capable of loading and unloading three times the amount of coal currently transported through the facility under the contract.\nThe Company contracted in October 1994, to purchase a U.S. flag Coal Carrier. The vessel will be placed under long-term charter to a major electric utility company based in Massachusetts to carry part of its fuel supply. The ship will also be used to carry coal and other bulk commodities for account of other major charterers. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nMolten Sulphur. The Company recently entered into a 15-year transportation contract with an affiliate of a major sulphur producer for which it had built a 24,000 deadweight ton molten sulphur carrier that carries molten sulphur from Louisiana\nand\/or Texas to a fertilizer plant on the Florida Gulf Coast. Under the terms of this contract, the Company will be guaranteed the transportation of a minimum of 1.8 million tons of sulphur per year. The contract also gives Freeport three five-year renewal options. The vessel delivered and began service during late 1994. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nLITCO Facility. During 1991, the Company entered into an agreement with Cooper\/T. Smith Stevedoring pursuant to which the Company acquired a 50% interest in a newly constructed, all weather rapid cargo transfer facility in the river port of Memphis, Tennessee for handling LASH barges transported by subsidiaries of the Company in its LASH liner services. The terminal began operation in May 1992 and provides 287,500 square feet of enclosed warehouse and loading\/discharging stations for LASH barge, rail, truck and heavy-lift operations. In June 1993, the Company purchased the other 50% interest for $1.9 million from Cooper\/T. Smith Stevedoring, which will continue to manage the facility under a management agreement with the Company.\nINVESTMENTS IN SPECIALIZED VESSELS\nLiquid Petroleum Gas. In 1985, the Company purchased a one-third interest in A\/S Havtor, a Norwegian company that owned interests in and chartered-out on a long-term basis vessels specializing in the transportation of liquid petroleum gas and various chemical products. In 1985, the Company also purchased a 14.2% interest in A\/S Havtor Management, a Norwegian ship management company affiliated with A\/S Havtor. During the first quarter of 1993, the Company sold an 18.5% interest in A\/S Havtor thereby reducing its interest to approximately 14.8%. During 1994 A\/S Havtor, certain associated companies and a portion of A\/S Havtor Management were merged into a publicly listed company, Havtor AS. The Company's interest in Havtor AS is approximately 12.6%, including both direct and indirect holdings. Havtor AS operates mainly a fleet of about 25 liquified petroleum gas carriers, 7 dry bulk carriers and is also joint owner with the Company in the two PROBO vessels. Subsequent to year end, Havtor AS signed a letter of intent whereby A\/S Havtor Management and the gas carrier activities of Kvaerner a.s would be merged into Havtor AS. This merger would result in Havtor AS having ownership interest varying between 10% and 100% in 46 gas carriers, 6 drycargo carriers, 2 PROBO vessels and 1 product carrier in addition to other minor participations.\nDuring 1990, the Company increased its participation in the liquid petroleum gas market by acquiring a 10% interest in a 56,000 cubic meter liquid petroleum gas carrier that was delivered and began operation during 1993.\nCombination Dry Cargo\/Petroleum Products. LCI holds a 50% equity interest in two foreign entities, one of which owns two combination dry cargo\/petroleum products (PROBO) vessels, and the other of which operates the vessels under long-term charters to a European marketing and profit-sharing pool consisting of these two vessels and four identical sister ships. Under these charters, the pool operates and markets the vessels in exchange for monthly payments that are periodically adjusted under a profit- sharing formula. PROBO vessels are able to carry various refined petroleum products and drybulk cargoes on back-to-back voyages because of their ability to rapidly self- clean their cargo holds between voyages with minimal shoreside support.\nANCILLARY SERVICES\nThe Company has several subsidiaries providing ship charter brokerage, agency, barge fleeting and other specialized services to the Company's subsidiaries and, in the case of ship charter brokerage and agency services, to unaffiliated companies. The income produced by these services substantially covers the related overhead expenses. These services facilitate the Company's operations by allowing it to avoid reliance on third parties to provide these essential shipping services. The Company also has a 50% equity interest in a firm offering ship management services in Singapore.\nMARKETING\nThe Company maintains marketing staffs in Washington, D. C., New York, New Orleans, Houston, Chicago, Baltimore, San Francisco, Rotterdam and Singapore and maintains a network of marketing agents in major cities around the world who market the Company's liner, charter and contract services. The Company markets its Trans-Atlantic LASH liner service under the trade name \"Forest Lines\", and its LASH liner service between the U. S. Gulf and Atlantic coast ports and South Asia ports under the Waterman house flag. The Company advertises its service in trade publications in the United States and abroad.\nINSURANCE\nThe Company maintains protection and indemnity (\"P&I\") insurance to cover liabilities arising out of the ownership or operation of vessels with Assuranceforeningen GARD and the Standard Steamship Owners' Protection & Indemnity Association (Bermuda) Ltd., which are mutual shipowners' insurance organizations commonly referred to as P&I clubs. Both clubs are participants in and subject to the rules of their respective international group of P&I associations. The premium terms and conditions of the P&I coverage provided to the Company are governed by the rules of each club.\nThe Company maintains hull and machinery insurance policies on each of its vessels in amounts related to the value of each vessel. This insurance coverage,\nwhich includes increased value, freight and time charter hire, is maintained with a syndicate of hull underwriters from the United States, British, French and Scandinavian insurance markets. The Company maintains war risk insurance on each of the Company's vessels in an amount equal to each vessel's total insured hull value. War risk insurance is placed through Underwriters at Lloyds and Norwegian war risk insurance markets and covers physical damage to the vessels and P&I risks for which coverage would be excluded by reason of war exclusions under either the hull policies or the rules of the applicable P&I club.\nThe Company also maintains loss of hire insurance with underwriters from the Norwegian market to cover its loss of revenue in the event that a vessel is unable to operate for a certain period of time due to loss or damage arising from the perils covered by the hull and machinery policy.\nInsurance coverage for shoreside property, shipboard consumables and inventory, spare parts, workers' compensation, office contents, and general liability risks are maintained with underwriters in the United States and British markets. The Company also carries insurance to meet certain liabilities that could arise from the discharge of oil or hazardous substances in U.S., international and foreign waters.\nInsurance premiums for the coverage described above vary from year to year depending upon the Company's loss record and market conditions. In order to reduce premiums, the Company maintains certain deductible and co-insurance provisions that it believes are prudent and generally consistent with those maintained by other shipping companies and in recent years has increased the self-insurance portion under its insurance program.\nREGULATION\nThe Company's operations between the United States and foreign countries are subject to the Shipping Act of 1916 (the \"Shipping Act\"), which is administered by the Federal Maritime Commission, and certain provisions of the Federal Water Pollution Control Act, the Oil Pollution Act of 1990 and the Comprehensive Environmental Response Compensation and Liability Act, all of which are administered by the U. S. Coast Guard, and certain other international, federal, state and local laws and regulations, including international conventions and laws and regulations of the flag nations of its vessels. Pursuant to the requirements of the Shipping Act, the Company has on file with the Federal Maritime Commission tariffs reflecting the outbound and inbound prices currently charged by the Company to transport cargo between the United States and foreign countries as a common carrier. These tariffs are filed by the Company either individually or in connection with its participation as a member of rate or conference agreements, which are agreements that (upon becoming effective following filing with the Federal Maritime Commission ) permit the members to agree concertedly upon rates and practices relating to the carriage of goods in U. S. and\nforeign ocean commerce. Tariffs filed by a company unilaterally or collectively under rate or conference agreements are subject to Federal Maritime Commission approval. Once a rate or conference agreement is filed, rates may be changed in response to market conditions on 30 days' notice, with respect to a rate increase, and one day's notice, with respect to a rate decrease.\nThe Merchant Marine Act of 1936 (the \"Merchant Marine Act\") authorizes the Federal government to pay an operating differential subsidy to U. S. flag vessels employed in the foreign trade of the United States. Under the subsidy program, MarAd is authorized to pay qualified U.S. flag operators (i) the differential between U. S. and foreign crew wage costs and (ii) the differential between U.S. and foreign costs of protection and indemnity insurance, hull and machinery insurance, and maintenance and repairs not compensated by insurance, so that U.S. ships can compete on an equal footing with their lower-cost foreign competitors. To qualify for the subsidy, vessels must be built in the United States, documented under the U.S. flag and be at least 75% owned by U.S. citizens. Under subsidy contracts, which are typically 20 years in length, operators provide service on \"essential trade routes\" as determined by MarAd. Each subsidized operator is required to employ its vessels between a stated minimum and maximum number of sailings each year. Currently, four liner operators, including Waterman, and 13 bulk carrier operators hold subsidy contracts for a total of 54 liner and 29 bulk ships. Total U.S. governmental subsidy appropriations for the fiscal year ending September 30, 1994 were $240.9, and $214.4 has been appropriated for the fiscal year ending September 30, 1995. Approximately 85% of the aggregate subsidy is paid to offset crew wage differentials.\nSince 1981, the Federal government has entered into no new subsidy contracts. In 1991, the Bush administration announced that current contracts would be honored, but no new ODS contracts would be entered into as the old contracts expire. The Clinton administration has continued this policy. Waterman's subsidy contract expires on December 31, 1996, and all other subsidy agreements with U.S. flag liner operators expire on December 31, 1997. This year, the Clinton administration proposed legislation that would implement a new subsidy program. If enacted, this program would authorize funding for 50 U. S. flag ships for up to ten years. Both Waterman and Central Gulf would intend to apply for participation in this new program. There can be no assurance that the bill will be adopted by Congress, that if adopted it will be signed by the President, or that if enacted into law, it will provide funding to all or some of the Waterman and Central Gulf vessels. Therefore, it is possible that the existing program will be terminated, that no replacement program will be enacted, or that a replacement program will provide substantially less funding than the current program. Alternative steps are under consideration so as to continue its competitive position.\nSeven of the Company's U.S. flag LASH vessels were constructed with the aid of construction differential subsidies and Title XI loan guarantees administered by MarAd, the receipt of which obligates the Company to comply with various dividend and other financial restrictions. Vessels constructed with the aid of construction differential\nsubsidies may not be operated in domestic coastwise trade or domestic trade with Hawaii, Puerto Rico or Alaska without the permission of MarAd and without repayment of the construction differential subsidy under a formula established by law. Recipients of Title XI loan guarantees must pay an annual fee of up to 1% of the loan amount.\nUnder the Merchant Marine Act, U.S. flag vessels are subject to requisition or charter by the United States whenever the President declares that the national security requires such action. The owners of any such vessels must receive just compensation as provided in the Merchant Marine Act, but there is no assurance that lost profits, if any, will be fully recovered. In addition, during any extension period under each MSC charter or contract, the MSC has the right to terminate the charter or contract on 30 days' notice. However, the MSC has never exercised such termination right with respect to the Company.\nCertain of the Company's operations, including its subsidized U.S. flag LASH liner service and its carriage of U.S. foreign aid cargoes, as well as the Company's coal and molten sulphur transportation contracts and its Title XI financing arrangements, require the Company to be as much as 75% owned by U.S. citizens. The Company monitors its stock ownership to verify its continuing compliance with these requirements and has never had more than 1% of its common stock held of record by non-U.S. citizens. However, the Company's charter and stock transfer procedures do not prohibit the acquisition of its common stock by non-U.S. citizens. However, the Company believes that it is able to maintain compliance with these requirements.\nThe Company is required by various governmental and quasi-governmental agencies to obtain permits, licenses and certificates with respect to its vessels. The kinds of permits, licenses and certificates required depend upon such factors as the country of registry, the commodity transported, the waters in which the vessel operates, the nationality of the vessel's crew, the age of the vessel and the status of the Company as owner or charterer. The Company believes that it has or can readily obtain all permits, licenses and certificates necessary to permit its vessels to operate.\nCOMPETITION\nThe shipping industry is intensely competitive and is influenced by events largely outside the control of shipping companies. Varying economic factors can cause wide swings in freight rates and sudden shifts in traffic patterns. Vessel redeployments and new vessel construction can lead to an overcapacity of vessels offering the same service or operating in the same market. Changes in the political or regulatory environment can also create competition that is not necessarily based on normal considerations of profit and loss. The Company's strategy is to reduce competitive pressures and the effects of cyclical market conditions by operating specialized vessels in identifiable market segments and deploying a substantial number of its vessels under medium- to long-term charters or contracts and on trade routes where it has\nestablished market shares. The Company also seeks to compete effectively in the traditional areas of price, reliability and timeliness of service.\nCompetition principally comes from numerous breakbulk vessels and, occasionally, containerized vessels.\nMuch of the Company's revenue is generated by contracts with the MSC and contracts to transport Public Law-480 U.S. government-sponsored cargo, a cargo preference program requiring that 75% of all foreign aid \"Food for Peace\" cargo must be transported on U.S. flag vessels, if they are available at reasonable rates. The Company competes with all U.S. flag companies, including Overseas Shipholding Group, Inc., OMI Corporation, Marine Transport Lines, Inc., Farrell Lines, Inc., Lykes Brothers Steamship Company, Sea-Land Service, Inc. and American President Lines, Inc. for the MSC work and the Public Law-480 cargo. Additionally, the Company's principal foreign competitors include Hoegh Lines, Star Shipping, Wilhelmsen Lines, and the Shipping Corporation of India.\nThe Company's international flag LASH liner service faces competition from foreign flag liner operators and, to a lesser degree, from U. S. flag liner operators, including those receiving operating differential subsidies. In addition, during periods in which the Company participates in conference agreements or rate agreements, competition includes not only the other participants obligated to charge the same rates, but also non-participants charging lower rates.\nBecause the Company's LASH barges are used primarily to transport large items, such as forest products, natural rubber and steel, that cannot be transported as efficiently in containerized vessels, the Company's LASH fleet often has a competitive advantage over these vessels for this type of cargo. In addition, the Company believes that the ability of its LASH system to operate in shallow harbors and river systems and its specialized knowledge of these harbors and river systems give it a competitive advantage over operators of containerized and breakbulk vessels, which are too large to operate in these areas.\nThe Company's pure car carriers operate worldwide in markets where foreign flag vessels with foreign crews predominate. The Company believes that its U.S. flag pure car carriers can continue to compete effectively if it continues to receive the cooperation of its unions in controlling costs.\nEMPLOYEES\nThe Company employs approximately 409 shipboard personnel and 335 shoreside personnel. The Company considers relations with its employees to be excellent.\nAll of the Company's U.S. shipboard personnel and certain shoreside personnel are covered by collective bargaining agreements. Central Gulf, Waterman and other U.S. shipping companies are subject to collective bargaining agreements for shipboard personnel in which the shipping companies servicing U.S. Gulf and East coast ports also must make contributions to pension plans for dockside workers. The Employee Retirement Income Security Act of 1974, as amended, provides for liabilities for withdrawal from a multi- employer pension plan if an employer reduces its operations below a minimum level. It is possible that the failure or withdrawal of any shipping company employer may cause other employers (such as the Company) to increase their plan contributions or result in additional potential liability. The Company has experienced no strikes or other significant labor problems during the last ten years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nVessels. Of the 28 ocean-going vessels in the Company's fleet, 23 are owned by the Company, three are operated under operating contracts and two are owned and operated by a Norwegian partnership in which the Company has a 50% interest. Of the approximately 1,650 LASH barges operated in conjunction with the Company's LASH and FLASH vessels, the Company owns approximately 1,330 barges and leases 320 barges under leases with 12- year terms expiring in late 2003 and early 2004. The Company also owns approximately 50 additional LASH barges, which are not required for current vessel operations. All of the Company's barges are registered under the U.S. flag. The Company time charters-in 108 super-jumbo river barges (and owns three such barges) and 14 towboats specially built to meet the requirements of the Company's coal transportation contract. The Company also owns 18 standard river barges which are chartered to unaffiliated companies on a short-term basis. Until May 1993, these barges were bareboat chartered-in from affiliates of the Company. Upon the expiration of these bareboat charters, the Company purchased the barges from these affiliates for $1.6 million in the aggregate.\nExcept for the approximately 50 LASH barges that are not required for the Company's operations, all of the vessels owned, operated or leased by the Company are in good condition. Since 1988, the Company has completed life extension work on six LASH vessels, completed the refurbishment of approximately 1,300 related barges and acquired 167 LASH barges. Management believes that the useful lives of these vessels have been extended by this work through at least 2003. Under governmental regulations, insurance policies and certain of the Company's financing agreements and charters, the Company is required to maintain its vessels in accordance with standards of seaworthiness, safety and health prescribed by governmental regulations or promulgated by certain vessel classification societies. Vessels in the fleet are maintained in accordance with governmental regulations and the highest classification standards of the American Bureau of Shipping or, for certain vessels registered overseas, of Norwegian Veritas or Lloyds Register classification societies.\nCertain of the vessels and barges owned by the Company's subsidiaries are mortgaged to various lenders to secure such subsidiaries' long-term debt. See Note B of the Notes to the Company's Consolidated Financial Statements included elsewhere herein.\nOther Properties. The Company leases its corporate headquarters in New Orleans, its administrative and sales office in New York and office space in Houston, Chicago and Washington, D. C. The Company also leases space in St. Charles and Orleans Parishes, Louisiana for the fleeting of barges. Additionally, the Company leases a terminal in Memphis, Tennessee that is a totally enclosed multi-modal cargo transfer facility. In 1994, the aggregate annual rental payments under these operating leases were approximately $2.3 million.\nThe Company owns two separate facilities in St. Charles Parish, Louisiana and one facility in Jefferson Parish, Louisiana that are used primarily for the storage and fleeting of barges. The Company also owns a terminal in Gulf County, Florida that is used in its coal transportation contract.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant in various lawsuits that have arisen in the ordinary course of its business in which claimants seek damages of various amounts for personal injuries, property damage and other matters. All material claims asserted under lawsuits of this nature are believed to be covered by insurance.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None\nITEM 4a. EXECUTIVE OFFICERS AND DIRECTORS OF THE REGISTRANT\nSet forth below is information concerning the directors and executive officers of the Company. Directors are elected by the shareholders for one year terms. Executive officers serve at the pleasure of the Board of Directors.\nNiels W. Johnsen, 72, has been the Chairman and Chief Executive Officer of the Company since its commencement of operations in 1979 and is also Chairman and Chief Executive Officer of each of the Company's principal subsidiaries. He previously served as Chairman of Trans Union Corporation's ocean shipping group of companies from December 1971 through May 1979. He was one of the founders of Central Gulf in 1947 and held various positions with Central Gulf until Trans Union acquired Central Gulf in 1971. He is also a director and trustee of Atlantic Mutual Companies, an insurance company and a director of Reserve Fund, Inc., a money market fund.\nErik F. Johnsen, 69, has been the President, Chief Operating Officer and Director of the Company since its commencement of operations in 1979 and is also the President and Chief Operating Officer of each of the Company's principal subsidiaries except Waterman where he is Chairman of the Executive Committee. Along with his brother, Niels W. Johnsen, he was one of the founders of Central Gulf in 1947 and has served as its President since 1966. Mr. Johnsen is also a director of First Commerce Corporation, a bank holding company.\nHarold S. Grehan, Jr., 67, is Vice President of the Company. He joined Central Gulf in 1958 and became Vice President in 1959, Senior Vice President in 1973 and Executive Vice President and Director in 1979. He participated in the development of the Company's LASH program and has direct responsibility for conventional and LASH vessel traffic movements.\nNiels M. Johnsen, 49, is Vice President of the Company. Mr. Johnsen has served as a director of the Company since April 1988. He joined Central Gulf on a full time basis in 1970 and held various positions with the Company before being named Vice President in 1986. He is also President of N. W. Johnsen & Co., Inc., a subsidiary of the Company engaged in ship and cargo charter brokerage. He is the son of Niels W. Johnsen.\nErik L. Johnsen, 37, is Vice President of the Company. He joined Central Gulf in 1979 and held various positions with the Company before being named Vice President in 1987. He is responsible for all operations of the Company's vessel fleet and leads the Company's Ship Management Group. He is also President of Sulphur Carriers, Inc., a wholly- owned subsidiary of the Company. He is the son of Erik F. Johnsen.\nStanley E. Morrison, 67, is Treasurer of the Company, a position he assumed when he joined Central Gulf in 1959.\nGary L. Ferguson, 54, is Vice President and Chief Financial Officer of the Company. He joined Central Gulf in 1968 where he held various positions with the Company prior to being named Controller in 1977, and Vice President and Chief Financial Officer in 1989.\nLaurance Eustis, 81, has served as a director of the Company since 1979. He is the Chairman of the Board of Eustis Insurance, Inc., mortgage banking and general insurance, located in New Orleans, Louisiana. Mr. Eustis is also a director of First Commerce Corporation, a bank holding company, and Pan American Life Insurance Company.\nRaymond V. O'Brien, Jr., 67, has served as a director of the Company since 1979. He is also a director of Emigrant Savings Bank. He served as Chairman of the Board and Chief Executive Officer of the Emigrant Savings Bank from January 1978 through December 1992.\nEdwin Lupberger, 58, has served as a director of the Company since April 1988. Mr. Lupberger is the Chairman of the Board, Chief Executive Officer and Director of Entergy Corporation and its wholly-owned subsidiaries. He also is a director of First Commerce Corporation, a bank holding company.\nEdward K. Trowbridge, 66, has served as a director of the Company since April 1994. He served as Chairman of the Board and Chief Executive Officer of the Atlantic Mutual Companies from July 1988 through November 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.\nThe information called for by Item 5 is included in the 1994 Annual Report to Shareholders in the section entitled \"Common Stock Prices and Dividends for Each Quarterly Period of 1993 and 1994\" and is incorporated herein by reference to page 23 of Exhibit 13 filed with this 10-K.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information called for by Item 6 is included in the 1994 Annual Report to Shareholders in the section entitled \"Summary of Selected Consolidated Financial Data\" and is incorporated herein by reference to page 1 of Exhibit 13 filed with this 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information called for by Item 7 is included in the 1994 Annual Report to Shareholders in the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and is incorporated herein by reference to pages 7 through 9 of Exhibit 13 filed with this 10-K.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated balance sheets as of December 31, 1994, and December 31, 1993, and the related consolidated statements of income, changes in stockholders' investment and cash flows for each of the three years in the period ended December 31, 1994 are included in the 1994 Annual Report to the Shareholders and are incorporated herein by reference to pages 10 through 14 of Exhibit 13 filed with this 10-K. Such statements have been audited by Arthur Andersen & Co., independent public accountants, as set forth in their report included in such Annual Report and incorporated herein by reference to page 24 of Exhibit 13 filed with this 10- K.\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 The information called for by Item 10 is incorporated herein by reference to Item 4a, Executive Officers and Directors of the Registrant.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information called for by Item 11 is included on pages 6, 7 and 8 of the Company's definitive proxy statement dated March 13, 1995, filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for by Item 12 is included on pages 2, 3, 4 and 5 of the Company's definitive proxy statement dated March 13, 1995, filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by Item 13 is included on pages 2, 3, 4, 5 and 8 of the Company's definitive proxy statement dated March 13, 1995, filed pursuant to Section 14(a) of the Securities Exchange Act of 1934, and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nThe following financial statements, schedules and exhibits are filed as part of this report: (a) 1. Financial Statements The following financial statements and related notes are included in the Company's 1994 Annual Report to Shareholders and are incorporated herein by reference to pages 10 through 24 of Exhibit 13 filed with this 10-K.\nConsolidated Balance Sheets at December 31, 1994 and 1993\nConsolidated Statements of Income for the years ended December 31, 1994, 1993, and\nConsolidated Statements of Changes in Stockholders' Investment for the years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nReport of Independent Public Accountants\n2. Financial Statement Schedules None.\n3. Exhibits\n(3) Restated Certificate of Incorporation, as amended, and By-Laws of the Registrant (filed with the Securities and Exchange Commission as Exhibit 3 to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 and incorporated herein by reference)\n(4) Specimen of Common Stock Certificate (filed as an exhibit to the Company's Form 8-A filed with the Securities and Exchange Commission on April 25, 1980 and incorporated herein by reference)\n(4.1) Form of Indenture between the Company and the Bank of New York, as Trustee, with respect to 9% Senior Notes due July 1, 2003 (filed as Exhibit 4(c) to Amendment No. 1 to the Company's Registration Statement on Form S-2 (Registration No. 33-62168) and incorporated herein by reference).\n(4.2) Form of 9% Senior Notes due July 1, 2003 (included in Exhibit (4.1) hereto and incorporated herein by reference).\n(11) Statement regarding Computation of Earnings per Share (13) 1994 Annual Report to Shareholders\n(21) Subsidiaries of International Shipholding Corporation\n(b) No reports on Form 8-K were filed during the last quarter of the period covered by this Report.\n(c) The Index of Exhibits and required Exhibits are included following the signatures beginning at page 26 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.\nINTERNATIONAL SHIPHOLDING CORPORATION (Registrant)\n\/S\/ Gary L. Ferguson March 24, 1995 By ______________________________ Gary L. Ferguson 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 dates indicated.\nINTERNATIONAL SHIPHOLDING CORPORATION (Registrant)\n\/S\/ Niels W. Johnsen March 24, 1995 By ____________________________ Niels W. Johnsen Chairman of the Board, Director and Chief Executive Officer\n\/S\/ Erik F. Johnsen March 24, 1995 By _____________________________ Erik F. Johnsen President and Director\n\/S\/ Harold S. Grehan, Jr. March 24, 1995 By _____________________________ Harold S. Grehan, Jr. Vice President and Director\n\/S\/ Laurance Eustis March 24, 1995 By __________________________ Laurance Eustis Director\n\/S\/ Edwin Lupberger March 24, 1995 By __________________________ Edwin Lupberger Director\n\/S\/ Raymond V. O'Brien, Jr. March 24, 1995 By ___________________________ Raymond V. O'Brien, Jr. Director\n\/S\/ Niels M. Johnsen March 24, 1995 By ___________________________ Niels M. Johnsen Vice President and Director\n\/S\/ Edward K. Trowbridge March 24, 1995 By ____________________________ Edward K. Trowbridge Director\n\/S\/ Erik L. Johnsen March 24, 1995 By ____________________________ Erik L. Johnsen Vice President and Director\n\/S\/ Gary L. Ferguson March 24, 1995 By ____________________________ Gary L. Ferguson Vice President and Chief Financial Officer\n\/S\/ Deanie E. Jones March 24, 1995 By _____________________________ Deanie E. Jones Chief Accounting Officer\nINTERNATIONAL SHIPHOLDING CORPORATION\nEXHIBIT INDEX","section_15":""}
{"filename":"795986_1994.txt","cik":"795986","year":"1994","section_1":"Item 1. Business\n(a) General Development of Business.\nThermo Instrument Systems Inc. (the Company or the Registrant) is a worldwide leader in the development, manufacture, and marketing of analytical instruments used to detect and measure air pollution, nuclear radioactivity, complex chemical compounds, toxic metals, and other elements in a wide variety of materials. The Company also provides laboratory-based environmental and radiochemical analytical testing, nuclear health physics, and environmental science and engineering services. The Company was incorporated in Delaware in May 1986 as a wholly owned subsidiary of Thermo Electron Corporation (Thermo Electron) to succeed to instruments businesses that were previously conducted by several Thermo Electron subsidiaries.\nThe Company historically has expanded both through the acquisition of companies and product lines and through internal development of new products and technologies. During the past several years the Company has completed several complementary acquisitions that have provided additional technologies, specialized manufacturing or product development expertise, and broader capabilities in marketing and distribution. In 1993*, the Company's acquisitions included the radiation safety measurement and radiometry divisions of FAG Kugelfischer George Shafer AG for a purchase price of $12.6 million; Hilger Analytical Ltd. for a purchase price of $2.9 million; Spectra-Physics Analytical for a purchase price of $67.3 million; and Gamma-Metrics for a purchase price of $20.1 million. In 1992 the Company's acquisitions included Nicolet Instrument Corporation for a purchase price of $179 million and Gas Tech Inc. for a purchase price of $28.1 million. In 1990 the Company acquired Finnigan Corporation for a purchase price of $110 million. Also, effective April 5, 1993, the Company sold the biomedical and clinical products business of its Nicolet Instrument Corporation subsidiary to Thermo Electron for approximately $67.9 million in cash. On January 31, 1994, the Company announced its intention to acquire, subject to regulatory approvals and the satisfaction of certain conditions to closing, several businesses within the EnviroTech Measurements & Controls group of Baker Hughes Incorporated for a cash purchase price of approximately $93 million. The businesses to be acquired manufacture products used for process control, process measurement, and laboratory analysis.\nAs of January 1, 1994, Thermo Electron owned 81% of the Company's common stock outstanding and, therefore, has the power to elect all of the Company's Directors. Thermo Electron intends for the foreseeable future to maintain at least 80% ownership of the Company so that it may continue to file consolidated U.S. federal income tax returns with the Company. This will require the purchase by Thermo Electron of additional shares and\/or convertible debentures of the Company from time to time as the number of outstanding shares issued by the Company increases. These purchases may be made either on the open market or directly from the Company at prevailing market prices, or pursuant to conversions of the Company's 7% subordinated convertible note due 1996 or the 3 3\/4% senior convertible note due 2000 held by Thermo Electron. See Notes 3 and 8 to Consolidated Financial Statements in the Registrant's 1993 Annual Report to Shareholders for a description of the Company's outstanding stock options and convertible debentures. During 1993, Thermo Electron purchased 1,754,100 shares of the Company's common stock, on the open market, for a total price of $48.4 million. - --------------------- *References to 1993, 1992, and 1991 herein are for the fiscal years ended January 1, 1994, January 2, 1993, and December 28, 1991, respectively. 2PAGE\n(b) Financial Information About Industry Segments.\nThe Company's products and services are divided into two segments: Instruments and Services. The principal products and services rendered by the Company in these two segments are described in detail below (see \"Principal Products and Services\").\nFinancial information concerning the Company's industry segments is provided in Note 10 to Consolidated Financial Statements in the Registrant's 1993 Annual Report to Shareholders and is incorporated herein by reference.\n(c) Description of Business.\n(i) Principal Products and Services\nInstruments\nInstruments manufactured and marketed by the Company employ a variety of advanced technologies and spectral, electroanalytical, and separation techniques to determine the composition or structure and physical properties of natural and synthetic substances. The Company's instruments can be broadly categorized by their uses as analytical or monitoring instruments.\nAnalytical Instruments\nThe Company's principal analytical instrument products are atomic emission and absorption spectrometers, Fourier transform infrared (FT-IR) and FT-Raman spectrometers, mass spectrometers, and high performance liquid chromatographs.\nAtomic Emission (AE) and Atomic Absorption (AA) Spectrometers identify and measure trace quantities of metals, and other elements in a wide variety of materials, including environmental samples (such as soil, water, and wastes), foods, drugs, cosmetics, and alloys. The Company sells its products to a wide range of customers in manufacturing industries such as producers of aircraft, automobiles and trucks, computers, chemicals, food, pharmaceuticals, and primary metals; service industries such as waste management companies and commercial testing laboratories; and government and university laboratories.\nThe Company is a leading manufacturer of sequential AE spectrometers, in which elements are analyzed one at a time, and simultaneous AE spectrometers, in which many elements can be measured at one time. The Company produces AA spectrometers in single-, double- and four-channel models. The Company is the only major producer of multichannel AA spectrometers, which provide several operational advantages over single-channel instruments, including speed of analysis, increased accuracy, reduced sample consumption, and analysis over an extended range of concentrations.\nThe Company's FT-IR and FT-Raman spectrometers are designed to nondestructively determine the chemical composition and physical properties of materials. These instruments are used in many areas of chemical research, industrial quality control and process monitoring, and for solving a wide variety of materials analysis problems. The Company offers a variety of models ranging from newly introduced models designed for routine applications to highly advanced research-grade FT-IR spectrometers.\nThe Company is a leading manufacturer of commercial mass spectrometers and has pioneered many of the significant developments and applications of mass spectrometry. The Company's mass spectrometry products identify and measure the components of a sample for organic chemical compounds or for inorganic 3PAGE\ncompounds. These instruments are used by customers in environmental analysis and pollution control; in research and production of pharmaceuticals; in biochemistry; in analysis of foods, chemicals, and petrochemicals; and in health and forensic science. The Company provides both stand-alone mass spectrometers and combined systems that use chromatographs purchased from other companies. These products span a range of sensitivity, specificity, separation technologies, data-handling capabilities, sizes, and prices.\nThe Company also sells high performance liquid chromatography, capillary electrophoresis, and related instruments and equipment used principally in the research and development production monitoring of pharmaceuticals, chemicals, and personal-care products, and for environmental monitoring. These instruments separate the chemical components of substances for purposes of identification and measurement. Capillary electrophoresis is a relatively new separation technique that is based on a combination of chromatographic and electroanalytical technologies and is particularly useful in biochemical, pharmaceutical, and environmental research. In addition, the Company manufactures and markets digital oscilloscopes and multichannel transient recorders, as well as X-ray imaging systems used for quality control in the electronics industry.\nMonitoring Instruments\nThe Company also manufactures monitoring instruments for two principal markets: the detection and measurement of nuclear radiation, and the monitoring of air pollutants including toxic and combustible gases.\nThe Company's nuclear radiation monitoring instruments detect and measure alpha, beta, gamma, neutron, and X-ray radiation emitted by natural sources and by radioactive materials used in nuclear power plants and certain governmental, industrial, and medical facilities. The Company is a leading manufacturer of a broad range of stand-alone and portable instruments and computer-integrated instrument systems used to ensure the safety of personnel from exposure to nuclear radiation. Nuclear power plants and U.S Department of Energy (DOE) facilities purchase approximately 85% of the radiation monitoring instruments sold by the Company. In addition, a key product line made available through the Gamma-Metrics acquisition is equipment that provides on-line, real-time analysis of elements in bulk raw materials, such as coal and cement. These analyzers are used by utilities to determine the sulfur content of coal to ensure compliance with air quality standards and by the cement industry to test raw materials to assure product quality and uniformity. The businesses acquired from FAG Kugelfischer Georg Schafer AG provide two classes of products. The radiation safety-measurement products division is a major supplier of instruments and systems that are manufactured to European standards for personnel protection and environmental monitoring. The radiometry division manufactures industrial gauging and process control instruments used principally by manufacturers of flat sheet materials, including metals, plastics, rubber, paper, and fibers.\nThe Company's air-monitoring instruments measure pollutants in ambient air and from stationary sources such as industrial smokestacks. The principal pollutants measured are oxides of nitrogen, sulfur dioxide, carbon monoxide, ozone, and volatile organic compounds (VOCs). These instruments are used by utility and industrial customers to ensure compliance with environmental regulations, by government agencies to monitor air quality, and by research facilities. The Occupational Safety and Health Administration's safety requirements for protecting workers from toxic or explosive atmospheres in confined spaces are addressed with detectors, instruments, and systems for sensing, monitoring, and warning of such dangers. These worker-safety products are used in a wide range of applications, from large petrochemical plants, utilities, and industrial manufacturing facilities to commercial buildings. 4PAGE\nIn addition to analytical and monitoring instruments, the Company supplies related accessories, spare parts, and instrument maintenance and training programs at its own and its customers' facilities.\nServices\nThrough a network of facilities in the United States, the Company provides comprehensive laboratory-based environmental testing, analysis, and related services to detect and measure hazardous wastes and radioactive materials, on-site sampling and analysis in support of decontamination programs, and dosimetry services to measure personnel exposure to radiation. In addition, the Company provides a range of environmental consulting and engineering services to private- and public-sector clients, including environmental impact studies, surveying and site planning, transportation engineering and construction inspection.\nCustomers and Marketing\nInstruments\nThe Company sells many of its products and services to customers whose activities are subject to numerous environmental quality, pollution control, and occupational safety and health regulations and laws enacted by federal, state, and local governments and by international accord. Customers include industrial manufacturers, environmental laboratories, utilities, waste management and treatment facilities, and government agencies. The Company's analytical instruments also are used in biomedical applications such as analysis of drugs and drug metabolites; and in academic and industrial chemical research; in forensic science; in energy and mineral resource exploration and production; in metals processing; and in a range of product quality assurance and process monitoring applications.\nThe Company sells its products through its own marketing and sales force in North America, Europe, and Asia and receives additional market coverage through authorized representatives throughout the world. Some products are distributed through original equipment manufacturer (OEM) agreements. The Company's products are installed and serviced in most major markets by the Company's personnel. Installation and service in some countries is provided by authorized representatives. Customers may purchase service contracts from the Company to cover equipment no longer under warranty, and service work also is provided on a time, materials, and expense basis. Training courses on both the operation and maintenance of the Company's products are conducted for customers and authorized representatives who service the products.\nServices\nThe market for the Company's services results primarily from customers who need to comply with federal, state, and local regulations that relate to environmental protection, the management and treatment of hazardous wastes, and the need to upgrade and expand infrastructure in response to economic development. These customers typically rely on independent laboratories and environmental science and engineering consultants, such as the Company's, for ongoing analysis and monitoring of such wastes and direction for compliance with various environmental regulations.\nA substantial portion of the Company's analytical laboratory and environmental science services sales are made to existing customers on a repeat basis. Environmental science services are often performed as multiyear studies. In addition to federal, state, and local governments, customers include public 5PAGE\nutilities, consulting and construction engineers, waste management companies, oil refineries, mining companies, chemical manufacturers, architects and engineering firms, and a variety of service companies involved with real estate transactions. The Company participates in industrial trade shows and technical conferences concerning pollution control, water quality, environmental management, specific cleanup efforts (e.g. Superfund), and industrial hygiene.\n(ii) & (xi) New Products; Research and Development\nThe Company maintains active programs for the development of new products using both new and existing technologies and for enhancing existing products by improving their price-performance ratio. The development of new applications for analytical instrument products is an especially important element of the growth strategy for these products. Although the Company's products are subject to obsolescence due to technological developments, sudden obsolescence is not characteristic of the Company's business.\nResearch and development expenses for the Company were $34,510,000, $26,138,000, and $16,318,000 in 1993, 1992, and 1991, respectively.\n(iii) Raw Materials\nThe Company manufactures many of the parts and subsystems used in its products, including optical components and proprietary circuitry. Other components, including packaging materials, integrated circuits, microprocessors, and computers, are manufactured by others. The raw materials, components, and supplies purchased by the Company are either available from a number of different suppliers or from alternative sources that could be developed without a material adverse effect upon the Company's business.\n(iv) Patents, Licenses, and Trademarks\nThe Company's policy is to protect its intellectual property rights, including applying for and obtaining patents when appropriate. The Company also enters into licensing agreements with other companies in which it grants or receives rights to specific patents and technical know-how. Patent protection is believed to provide the Company with competitive advantages with respect to certain instruments such as its mass spectrometers with ion traps. The Company also considers technical know-how, trade secrets, and trademarks to be important to its business.\n(v) Seasonal Influences\nThere are no significant seasonal influences on the Company's Instruments segment revenues. Certain environmental services, such as field sampling, may decline in winter months, but such seasonal influences are not expected to have a material effect on Services segment revenues.\n(vi) Working Capital Requirements\nThere are no special inventory requirements or credit terms extended to customers that would have a material adverse effect on the Company's working capital requirements.\n(vii) Dependency on a Single Customer\nThe Company's Instruments segment is not dependent upon any single customer, or a few customers. The Company's Services segment derived approximately 31%, 6PAGE\n30%, and 21% of its revenues in 1993, 1992, and 1991, respectively, from contracts or subcontracts with the federal government. No single customer accounted for more than 10% of the Company's revenues in any of the past three years.\n(viii) Backlog\nThe backlog of firm orders for the Instruments segment at the end of 1993 and 1992 was $115,620,000 and $98,067,000, respectively. The backlog of firm orders for the Services segment at the end of 1993 and 1992 was $26,196,000 and $34,061,000, respectively. The Company anticipates that substantially all of the backlog at the end of 1993 will be shipped or completed within the current fiscal year.\n(ix) Government Contracts\nApproximately 31% of the Company's Services segment revenue in 1993 was derived from contracts or subcontracts with the federal government that are subject to renegotiation of profits or termination. The Company does not have any knowledge of threatened or pending renegotiation or termination of any material contract or subcontract.\n(x) Competition\nInstruments\nThe Company generally competes on the basis of technical advances that result in new products and improved price-performance ratios, reputation among customers as a quality leader for products and services, and active research and application-development programs. To a lesser extent, the Company competes on the basis of price.\nThe Company believes it is among the principal manufacturers specializing in analytical instrumentation, although it faces significant competition from other companies and technologies in most of its product lines and its relative position in certain markets cannot be determined due to insufficient data. The Company believes it is the leading supplier of mass spectrometers, FT-IR spectrometers, FT-IR and FT-Raman microscopes, and optical plasma-emission spectrometers and a major supplier of atomic absorption spectrometers. In liquid chromatography, the Company believes its competitors include several larger companies and numerous specialty manufacturers. In its remaining analytical instrument product lines, the Company believes its competitors are mainly smaller, specialized firms.\nThe Company is a leading manufacturer of ambient air monitoring instruments and a major manufacturer of source monitoring and worker-safety monitoring instruments. Some engineering companies compete for large ambient air monitoring installations, but they do not manufacture the individual instruments that form a major part of the system, therefore, they will often buy these from the Company on an OEM basis.\nServices\nHundreds of independent analytical testing laboratories and engineering and consulting firms compete for environmental services business nationwide. Many of these firms use equipment and processes similar to those of the Company. Competition is based not only on price, but also on reputation for accuracy, quality, and the ability to respond rapidly to customer requirements. In addition, many industrial companies have their own in-house analytical testing capabilities. 7PAGE\n(xii) Environmental Protection Regulations\nThe Company believes that compliance with federal, state, and local environmental regulations will not have a materially adverse effect on its capital expenditures, earnings, or competitive position.\n(xiii) Number of Employees\nAs of January 1, 1994, the Company's Instruments and Services segments employed 3,326 and 707 people, respectively.\n(d) Financial Information about Exports by Domestic Operations and about Foreign Operations.\nFinancial information about exports by domestic operations and about foreign operations is summarized in Note 10 to Consolidated Financial Statements in the Registrant's 1993 Annual Report to Shareholders and is incorporated herein by reference.\n(e) Executive Officers of the Registrant.\nPresident Title (Year First Became Name Age Executive Officer) - --------------------- --- ------------------------------------- Arvin H. Smith 64 President and Chief Executive Officer (1986) John N. Hatsopoulos* 59 Vice President and Chief Financial Officer (1988) Denis A. Helm 54 Senior Vice President (1986) Earl R. Lewis 50 Senior Vice President (1990) Richard W. K. Chapman 49 Vice President (1994) Barry S. Howe 38 Vice President (1994) John T. Keiser 57 Vice President (1986) Paul F. Kelleher 51 Chief Accounting Officer (1986)\n* John N. Hatsopoulos and George N. Hatsopoulos, a director of the Company, are brothers.\nEach executive officer serves until his successor is chosen or appointed and qualified or until earlier resignation, death, or removal. All executive officers, except Mr. Chapman, have held comparable positions for at least five years either with the Company or with its parent company, Thermo Electron. For the past five years, Mr. Chapman has held management positions at the Company's Finnigan subsidiary, first as marketing manager and, beginning in 1992, as president. Messrs. Helm, Lewis, Chapman, Howe, and Keiser are full-time employees of the Company. Messrs. Smith, Hatsopoulos, and Kelleher are full-time employees of Thermo Electron, but devote such time to the affairs of the Company as the Company's needs reasonably require.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe location and general character of the Company's principal properties as of January 1, 1994, are as follows:\nInstruments\nThe Company owns approximately 697,000 square feet of office, engineering, laboratory, and production space, principally in California, Colorado, Florida, New Mexico, Wisconsin, Germany, and England, and leases approximately 694,000 8PAGE\nsquare feet of office, engineering, laboratory, and production space under leases expiring from 1994 to 2017, principally in California, Massachusetts, Connecticut, Wisconsin, Japan, and Germany. As of January 1, 1994, the Company has an $11,536,000 mortgage loan which is secured by 200,000 square feet of property in California which has a net book value of $16,826,000.\nServices\nThe Company owns approximately 44,000 square feet of office, engineering, laboratory, and production space, principally in California and New Mexico, and leases approximately 195,000 square feet of office, engineering, laboratory, and production space under leases expiring from 1994 to 2008, principally in Massachusetts, New Hampshire, New Jersey, New Mexico, New York, and Vermont.\nThe Company believes that its facilities are in good condition and are suitable and adequate to meet current needs, and that suitable replacements are available on commercially reasonable terms for any leases which expire in 1994 in the event that the Company is unable to renew such leases on reasonable terms.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company has been notified that the Environmental Protection Agency has determined that a release or a substantial threat of a release of a hazardous substance, as defined in the Comprehensive Environmental Response Compensation and Liability Act of 1980 (CERCLA or the Superfund law), occurred at two sites to which chemical or other wastes generated by the manufacturing operations of subsidiaries of the Company (including Nicolet) were sent. These notifications allege that these subsidiaries may be potentially responsible parties with respect to the remedial actions needed to control or clean up any such releases. Under CERCLA, responsible parties can include current and previous owners of the site, generators of hazardous substances disposed of at the site, and transporters of hazardous substances to the site. Each responsible party can be jointly and severally liable, without regard to fault or negligence, for all costs associated with the remediation of the site. In each instance the Company believes that its subsidiary is only one of several companies which received such notification and who may likewise be held liable for any such remedial costs. The Company also is involved with one site under California law where the Company may be required to participate in remediation.\nThe Company evaluates its potential liability as a responsible party for these environmental matters on an ongoing basis based upon factors such as the estimated remediation costs, the nature and duration of the Company's involvement with the site, the financial strength of other potentially responsible parties, and the availability of indemnification from previous owners of acquired businesses. Estimated liabilities are accrued in accordance with Statement of Financial Accounting Standards No. 5, \"Accounting for Contingencies.\" To date, the Company has not incurred any significant liability with respect to any of these sites and the Company anticipates that future liabilities related to sites with which the Company is currently involved will not have a materially adverse effect on the Company's business, results of operations or financial condition.\nOn September 27, 1993, Analytica of Branford, Inc. (Analytica) filed a complaint against the Company's Finnigan Corporation subsidiary (Finnigan) in U.S. District Court for the District of Connecticut. The complaint alleges that Finnigan has used apparatus, and has manufactured and sold products which aid and instruct end-purchasers to use the apparatus, in a manner so as to infringe a U.S. patent entitled \"Method of Producing Multiply Charged Ions and For 9PAGE\nDetermining Molecular Weights of Molecules By Use of the Multiply Charged Ions of Molecules\", and asks for injunctive relief, profits, unspecified damages, and attorney's fees. The Company believes that the Finnigan products and applications which Analytica seeks to challenge may include mass spectrometers equipped with electrospray ionization sources which are used for multiple charged ion analysis of high molecular weight compounds. Finnigan has filed its answer denying infringement and also has counterclaimed for a declaration that the Analytica patent be held invalid and not infringed. Discussions between the parties and discovery has begun. No trial date has been set.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nOn December 30, 1993, at a Special Meeting of Shareholders, the shareholders approved an amendment to the Corporation's Restated Certificate of Incorporation that increased the authorized common stock of the Corporation to 125 million shares. The vote was as follows: 37,635,472 shares voted in favor, 7,398 shares voted against and 562 shares abstained. There were no broker \"non-votes\" recorded on the proposal. In addition, the shareholders approved an increase of two million shares in the number of shares reserved for issuance under the Corporation's equity incentive plan. The vote was as follows: 37,536,834 shares voted in favor, 106,261 shares voted against and 337 shares abstained. There were no broker \"non-votes\" recorded on the proposal.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nInformation concerning the market and market price for the Registrant's Common Stock, $.10 par value, and dividend policy is included under the sections entitled \"Common Stock Market Information\" and \"Dividend Policy\" in the Registrant's 1993 Annual Report to Shareholders and is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe information required under this item is included under the sections entitled \"Selected Financial Information\" and \"Dividend Policy\" in the Registrant's 1993 Annual Report to Shareholders 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 under this item is included under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Registrant's 1993 Annual Report to Shareholders and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Registrant's Consolidated Financial Statements as of January 1, 1994 are included in the 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 on Accounting and Financial Disclosures\nNot applicable. 10PAGE\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe information concerning directors required under this item is incorporated herein by reference from the material contained under the caption \"Election of Directors\" in the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the close of the fiscal year. The information concerning delinquent filers pursuant to Item 405 of Regulation S-K is incorporated herein by reference from the material contained under the heading \"Disclosure of Certain Late Filings\" under the caption \"Stock Ownership\" in the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the close of the fiscal year.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required under this item is incorporated herein by reference from the material contained under the caption \"Executive Compensation\" in the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the close of the fiscal year.\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 from the material contained under the caption \"Stock Ownership\" in the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the close of the fiscal year.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required under this item is incorporated herein by reference from the material contained under the caption \"Relationship with Affiliates\" in the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A, not later than 120 days after the close of the fiscal year. 11PAGE\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a), (d) Financial Statements and Schedules.\n(1) The consolidated financial statements set forth in the list below are filed as part of this Report.\n(2) The consolidated financial statement schedules set forth in the list below are filed as part of this Report.\n(3) Exhibits filed herewith or incorporated herein by reference are set forth in Item 14(c) below.\nList of Financial Statements and Schedules Referenced in this Item 14.\nInformation incorporated by reference from Exhibit 13 filed herewith:\nConsolidated Statement of Income Consolidated Balance Sheet Consolidated Statement of Cash Flows Consolidated Statement of Shareholders' Investment Notes to Consolidated Financial Statements Report of Independent Public Accountants\nCertain Financial Statement Schedules filed herewith:\nSchedule I: Marketable Securities Schedule IV: Indebtedness of and to Related Parties Non-current Schedule VIII: Valuation and Qualifying Accounts Schedule IX: Short-term Borrowings\nAll other schedules are omitted because they are not applicable or not required, or because the required information is shown either in the financial statements or the notes thereto.\n(b) Reports on Form 8-K.\nDuring the quarter ended January 1, 1994 the Registrant was not required to file, and did not file, any Current Report on Form 8-K.\n(c) Exhibits.\nSee Exhibit Index on the page immediately preceding exhibits. 12PAGE\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 8, 1994 THERMO INSTRUMENT SYSTEMS INC.\nBy: Arvin H. Smith Arvin H. Smith 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 indicated, as of March 8, 1994.\nSignature Title\nBy: Arvin H. Smith President, Chief Executive Officer Arvin H. Smith\nBy: John N. Hatsopoulos Vice President, Chief Financial Officer John N. Hatsopoulos\nBy: Paul F. Kelleher Chief Accounting Officer Paul F. Kelleher\nBy: Marshall J. Armstrong Director Marshall J. Armstrong\nBy: Frank Borman Director Frank Borman\nBy: Elias P. Gyftopoulos Director Elias P. Gyftopoulos\nBy: George N. Hatsopoulos Chairman of the Board and Director George N. Hatsopoulos\nBy: Robert C. Howard Director Robert C. Howard\nBy: Frank Jungers Director Frank Jungers\nBy: Robert A. McCabe Director Robert A. McCabe\nBy: Director Polyvios C. Vintiadis 13PAGE\nReport of Independent Public Accountants ----------------------------------------\nTo the Shareholders and Board of Directors of Thermo Instrument Systems Inc.\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Thermo Instrument Systems Inc.'s Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 17, 1994. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in Item 14 on page 12 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 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.\nBoston, Massachusetts, February 17, 1994.\n14PAGE\nSCHEDULE I\nTHERMO INSTRUMENT SYSTEMS INC.\nMARKETABLE SECURITIES\nas of\nJanuary 1, 1994\n(In thousands)\nAmount at Which Each Issue is Carried in Market the Name of Issuer and Title of Each Principal Cost of Value of Balance Issue Amount Each Issue Each Issue Sheet - -------------------------------- --------- ---------- ---------- --------- Funds invested in a repurchase agreement with Thermo Electron (a) $148,975 $148,975 $148,975 $148,975\nCorporate Bonds: Thermedics Inc. (b) 6,323 5,805 9,138 6,145\nOther: Time deposits 8,466 8,466 8,466 8,466 Cash 20,001 20,001 20,001 20,001 -------- -------- -------- -------- 28,467 28,467 28,467 28,467 -------- -------- -------- -------- Total Cash, Cash Equivalents, and Short-term Investments $183,765 $183,247 $186,580 $183,587 ======== ======== ======== ========\n(a) As described in Note 1 to Consolidated Financial Statements in the Registrant's 1993 Annual Report to Shareholders. (b) As described in Note 7 to Consolidated Financial Statements in the Registrant's 1993 Annual Report to Shareholders. Thermedics Inc. is a majority-owned subsidiary of Thermo Electron.\n15PAGE\nSCHEDULE IV\nTHERMO INSTRUMENT SYSTEMS INC.\nINDEBTEDNESS OF AND TO RELATED PARTIES NON-CURRENT\n(In thousands)\nBalance at Balance at Beginning Deductions End of Name of Creditor (a) of Year Additions (b) Year - ------------------------------ ---------- --------- ---------- ----------\nYear Ended January 1, 1994 Thermo Electron - Promissory Note - Due 1995 $ 48,000 $ - $ (48,000) $ - Thermo Electron - Promissory Note - Due 1995 $ - $ 20,000 $ (20,000) $ - Thermo Electron - 3 3\/4% Subordinated Convertible Note - Due 2000 $ - $140,000 $ - $140,000 Thermo Electron - 7% Subordinated Convertible Note - Due 1996 $ 3,434 $ - $ (700) $ 2,734\nYear Ended January 2, 1993\nThermo Electron - Promissory Note - Due 1995 $ - $ 48,000 $ - $ 48,000 Thermo Electron - 7% Subordinated Convertible Note - Due 1996 $ 3,434 $ - $ - $ 3,434\nYear Ended December 28, 1991\nThermo Electron - 6 5\/8% Subordinated Convertible Note - Due 2001 $ - $ 15,000 $ (15,000) $ - Thermo Electron - 7% Subordinated Convertible Note - Due 2000 $ 6,000 $ - $ (6,000) $ - Thermo Electron - 7% Subordinated Convertible Note - Due 1996 $ 6,434 $ - $ (3,000) $ 3,434\n(a) As described in Note 8 to Consolidated Financial Statements in the Registrant's 1993 Annual Report to Shareholders. (b) Deductions represent conversions of subordinated convertible notes into common stock of the Registrant and payment of promissory notes.\n16PAGE\nSCHEDULE VIII\nTHERMO INSTRUMENT SYSTEMS INC.\nVALUATION AND QUALIFYING ACCOUNTS\n(In thousands)\nBalance Charges at to Dis- Bad Less: Begin- Costs Acqui- posi- Debts Accounts Balance ning of and sitions tions Recov- Written at End Description Year Expenses (a) (a) ered off of Year - ------------------- ------- -------- ------- ------ ------ -------- -------\nYear Ended January 1, 1994\nAllowance for Doubtful Accounts $7,276 $ 970 $1,322 $(586) $1,241 $(1,767) $8,456\nYear Ended January 2, 1993\nAllowance for Doubtful Accounts $7,096 $ 666 $ 985 $ - $ (42) $(1,429) $7,276\nYear Ended December 28, 1991\nAllowance for Doubtful Accounts $6,924 $1,156 $ - $ - $ 89 $(1,073) $7,096\n(a) As described in Note 2 to Consolidated Financial Statements in the Registrant's 1993 Annual Report to Shareholders.\n17PAGE\nSCHEDULE IX\nTHERMO INSTRUMENT SYSTEMS INC.\nSHORT-TERM BORROWINGS\n(In thousands except percentages)\nYear-End During the Year --------------- ------------------------- Weight- Average Weight- ed Highest of ed Average Quarter- Quarter- Average Interest end end Interest Year Ended Category (a) Balance Rate Balance Balances Rate (b) - ----------------- ------------------ ------- ------- -------- -------- -------\nJanuary 1, 1994 Thermo Electron(c) $ - - $93,172 $28,414 3.6%\nBank $37,516 6.5% $37,516 $21,894 7.3%\nJanuary 2, 1993 Thermo Electron(c) $28,127 3.5% $46,913 $18,760 3.1%\nBank $14,037 9.3% $19,399 $11,119 9.8%\nDecember 28, 1991 Bank $ 4,419 8.8% $ 5,604 $ 4,486 8.8%\n(a) This schedule does not include current maturities of long-term obligations. (b) Calculations are based on the average daily interest rates in effect during the periods the loans were outstanding. (c) As described in Note 8 to Consolidated Financial Statements in the Registrant's 1993 Annual Report to Shareholders.\n18PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ---- 3.1 Restated Certificate of Incorporation of the Registrant, as amended.\n3.2 By-Laws of the Registrant (filed as Exhibit 3(b) to the Registrant's Annual Report on Form 10-K for the year ended January 2, 1993 [File No. 1-9786] and incorporated herein by reference).\n4.1 Fiscal Agency Agreement dated as of August 2, 1991 among the Registrant, Thermo Electron Corporation, and Chemical Bank as fiscal agent, relating to $86,250,000 principal amount 6 5\/8% subordinated convertible debentures due 2001 (filed as Exhibit 4(a) to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991 [File No. 1-9786] and incorporated herein by reference).\n4.2 Fiscal Agency Agreement dated as of September 15, 1993, among the Registrant, Thermo Electron Corporation and Chemical Bank as fiscal agent, relating to the $70,000,000 principal amount of 3 3\/4% senior convertible debentures due 2000 (filed as Exhibit 4 to the Registrant's Form 10-Q for the quarter ended October 2, 1993 [File No. 1-9786] and incorporated by reference).\n4.3 Subordinated convertible note purchase agreement by and between the Registrant and Thermo Electron Corporation as of August 2, 1991 (filed as Exhibit 10(h) to the Registrant's Form 10-Q for the quarter ended September 28, 1991, and incorporated herein by reference).\n4.4 Senior convertible note purchase agreement by and between the Registrant and Thermo Electron Corporation as of September 15, 1993 (filed as Exhibit 10(a) to the Reistrant's Form 10-Q for the quarter ended October 2, 1993 [File No. 1-9786] and incorporated by reference).\n4.5 Promissory Note to Thermo Electron Corporation in the original principal amount of $48,000,000 (filed as Exhibit 10 to the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 26, 1992, incorporated herein by reference).\nThe Registrant hereby agrees, pursuant to Item 601(b) (4) (iii) (A) of Regulation S-K, to furnish to the Commission upon request, a copy of each instrument with respect to other long-term debt of the Registrant or its subsidiaries.\n10.1 Amended and Restated Corporate Services Agreement, dated as of January 3, 1993, between Thermo Electron Corporation and the Registrant (filed as Exhibit 10(a) to the Registrant's Annual Report on form 10-K for the year ended January 2, 1993 [File No. 1-9786] and incorporated herein by reference). 19PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ---- 10.2 Tax Allocation Agreement dated as of May 29, 1986, between Thermo Electron and the Registrant (filed as Exhibit 10(b) to the Registrant's Registration Statement on Form S-1 [Reg. No. 33-6762] and incorporated herein by reference).\n10.3 Thermo Electron Corporate Charter, as amended and restated effective January 3, 1993 (filed as Exhibit 10(f) to the Registrant's Annual Report on Form 10-K for the year ended January 2, 1993 [File No. 1-9786] and incorporated herein by reference).\n10.4 Form of Indemnification Agreement with Directors and Officers (filed as Exhibit 10(g) to the Registrant's Annual Report on Form 10-K for the year ended December 29, 1990 [File No. 1-9786] and incorporated herein by reference).\n10.5 Asset and Stock Purchase Agreement dated January 14, 1993 among the Registrant, Spectra-Physics Analytical, Inc. and Spectra-Physics, Inc. (filed as Exhibit 10(j) to the Registrant's Annual Report on Form 10-K for the year ended January 2, 1993 [File No. 1-9786] and incorporated herein by reference).\n10.6 Plan for sale of shares by the Registrant to Thermo Electron (filed as Exhibit 10(dd) to the Registrant's Form 10-Q for the quarter ended July 3, 1993 [File No. 1-9786] and incorporated herein by reference).\n10.7 Master Repurchase Agreement dated January 1, 1994 between the Registrant and Thermo Electron Corporation.\n10.8-10.15 Reserved\n10.16 Deferred Compensation Plan for Directors of the Registrant (filed as Exhibit 10(f) to the Registrant's Registration Statement on Form S-1 [Reg. No. 33-6762] and incorporated herein by reference).\n10.17 Directors Stock Option Plan of the Registrant (filed as Exhibit 10(i) to the Registrant's Annual Report on Form 10-K for the year ended December 28, 1991 [File No. 1-9786] and incorporated herein by reference).\n10.18 Incentive Stock Option Plan of the Registrant (filed as Exhibit 10(c) to the Registrant's Registration Statement on Form S-1 [Reg. No. 33-6762] and incorporated herein by reference). (Maximum number of shares issuable is 1,500,000 shares, after adjustment to reflect share increase approved in 1990 and 3-for-2 stock splits effected in January 1988 and July 1993). 20PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ----\n10.19 Nonqualified Stock Option Plan of the Registrant (filed as Exhibit 10(d) to the Registrant's Registration Statement on Form S-1 [Reg. No. 33-6762] and incorporated herein by reference). (Maximum number of shares issuable is 1,500,000 shares, after adjustment to reflect share increase approved in 1990 and 3-for-2 stock splits effected in January 1988 and July 1993).\n10.20 Equity Incentive Plan of the Registrant (filed as Appendix A to the Proxy Statement dated April 27, 1993 of the Registrant [File No. 1-9786] and incorporated herein by reference). (Maximum number of shares issuable is 2,150,000 shares, after adjustment to reflect share increase approved in December 1993 and 3-for-2 stock split effected in July 1993).\n10.21 Former Thermo Environmental Corporation Incentive Stock Option Plan (filed as Exhibit 10(d) to Thermo Environmental's Registration Statement on Form S-1 [Reg. No. 33-329] and incorporated herein by reference). (Maximum number of shares issuable is 618,750 shares, after giving effect to share increase approved in 1987 and adjustment to reflect 3-for-2 stock split effected in July 1993).\n10.22 Former Thermo Environmental Corporation Nonqualified Stock Option Plan (Filed as Exhibit 10(e) to Thermo Environmental's Registration Statement on Form S-1 [Reg. No. 33-329] and incorporated herein by reference). (Maximum number of shares issuable is 618,750 shares, after giving effect to share increase approved in 1987 and adjustment to reflect 3-for-2 stock split effected in July 1993).\nIn addition to the stock-based compensation plans of the Registrant, the executive officers of the Registrant may be granted awards under stock-based compensation plans of the Registrants' parent, Thermo Electron Corporation, and its subsidiaries, for services rendered to the Registrant or to such affiliated corporations. Such plans are listed under Exhibits 10.23-10.65.\n10.23 Thermo Electron Corporation Incentive Stock Option Plan (filed as Exhibit 4(d) to Thermo Electron's Registration Statement on Form S-8 [Reg. No. 33-8993] and incorporated herein by reference). (Maximum number of shares issuable is 6,023,437 shares, after adjustment to reflect share increases approved in 1984 and 1986, and share decrease approved in 1989, and 3-for-2 stock splits effected in October 1986 and October 1993). 21PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ---- 10.24 Thermo Electron Corporation Nonqualified Stock Option Plan (filed as Exhibit 4(e) to Thermo Electron's Registration Statement on Form S-8 [Reg. No. 33-8993] and incorporated herein by reference). (Plan amended in 1984 to extend expiration date to December 14, 1994; maximum number of shares issuable is 6,023,437 shares, after adjustment to reflect share increases approved in 1984 and 1986, and share decrease approved in 1989, and 3-for-2 stock splits effected in October 1986 and October 1993).\n10.25 Thermo Electron Corporation Equity Incentive Plan (filed as Exhibit A to Thermo Electron's Proxy Statement dated April 12, 1989 [File No. 1-8002] and incorporated herein by reference). (Plan amended in 1989 to restrict exercise price for SEC reporting persons to not less than 50% of fair market value or par value; maximum number of shares issuable is 2,700,000 shares, after adjustment to reflect 3-for-2 stock split effected in October 1993).\n10.26 Thermo Electron Corporation - Thermedics Inc. Nonqualified Stock Option Plan (filed as Exhibit 4 to a Registration Statement on Form S-8 of Thermedics Inc. [Reg. No. 2-93747] and incorporated herein by reference). (Maximum number of shares issuable is 450,000 shares, after adjustment to reflect share increase approved in 1988, 5-for-4 stock split effected in January 1985, 4-for-3 stock split effected in September 1985, and 3-for-2 stock splits effected in October 1986 and November 1993).\n10.27 Thermo Electron Corporation - Thermo Instrument Systems Inc. (formerly Thermo Environmental Corporation) Nonqualified Stock Option Plan (filed as Exhibit 4(c) to a Registration Statement on Form S-8 of Thermo Instrument Systems Inc. [Reg. No. 33-8034] and incorporated herein by reference). (Maximum number of shares issuable is 225,000 shares, after adjustment to reflect 3-for-2 stock split effected in July 1993).\n10.28 Thermo Electron Corporation - Thermo Instrument Systems Inc. Nonqualified Stock Option Plan (filed as Exhibit 10.12 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended January 3, 1987 [File No. 1-8002] and incorporated herein by reference). (Maximum number of shares issuable is 320,152 shares, after giving effect to share increase approved in 1988 and adjustment for 3-for-2 stock splits effected in January 1988 and July 1993). 22PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ---- 10.29 Thermo Electron Corporation - Thermo Process Systems Inc. Nonqualified Stock Option Plan (filed as Exhibit 10.13 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended January 3, 1987 [File No. 1-8002] and incorporated herein by reference). (Maximum number of shares issuable is 108,000 shares, after adjustment to reflect 6-for-5 stock splits effected in July 1988 and March 1989, and 3-for-2 stock split effected in September 1989).\n10.30 Thermo Electron Corporation - Thermo Power Corporation (formerly Tecogen Inc.) Nonqualified Stock Option Plan (filed as Exhibit 10.14 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended January 3, 1987 [File No. 1-8002] and incorporated herein by reference).\n10.31 Thermo Electron Corporation - Thermo Cardiosystems Inc. Nonqualified Stock Option Plan (filed as Exhibit 10.11 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended December 29, 1990 [File No. 1-8002] and incorporated herein by reference). (Maximum number of shares issuable is 130,500 shares, after adjustment to reflect share increases approved in 1990 and 1992, 3-for-2 stock split effected in January 1990, 5-for-4 stock split effected in May 1990 and 2-for-1 stock split effected in November 1993).\n10.32 Thermo Electron Corporation - Thermo Energy Systems Corporation Nonqualified Stock Option Plan (filed as Exhibit 10.12 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended December 29, 1990 [File No. 1-8002] and incorporated herein by reference).\n10.33 Thermo Electron Corporation - ThermoTrex Corporation (formerly Thermo Electron Technologies Corporation) Nonqualified Stock Option Plan (filed as Exhibit 10.13 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended December 29, 1990 [File No. 1-8002] and incorporated herein by reference). (Maximum number of shares issuable is 180,000 shares, after adjustment to reflect 3-for-2 stock split effected in October 1993).\n10.34 Thermo Electron Corporation - Thermo Fibertek Inc. Nonqualified Stock Option Plan (filed as Exhibit 10.14 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended December 28, 1991 [File No. 1-8002] and incorporated herein by reference). (Maximum number of shares issuable is 400,000 shares, after adjustment to reflect 2-for-1 stock split effected in September 1992). 23PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ---- 10.35 Thermo Electron Corporation - Thermo Voltek Corp. (formerly Universal Voltronics Corp.) Nonqualified Stock Option Plan (filed as Exhibit 10.17 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended January 2, 1993 [File No. 1-8002] and incorporated herein by reference). (Maximum number of shares issuable is 37,500 shares, after adjustment to reflect 3-for-2 stock split effected in November 1993).\n10.36 Thermo Electron Corporation - Thermedics Detection Inc. Nonqualified Stock Option Plan (filed as Exhibit 10.20 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended January 2, 1993 [File No. 1-8002] and incorporated herein by reference).\n10.37 Thermo Energy Systems Corporation Incentive Stock Option Plan (filed as Exhibit 10.18 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended January 2, 1993 [File No. 1-8002] and incorporated herein by reference). (Maximum number of shares issuable is 900,000 shares, after adjustment to reflect share increase approved in December 1993).\n10.38 Thermo Energy Systems Corporation Nonqualified Stock Option Plan (filed as Exhibit 10.19 to Thermo Electron's Annual Report on Form 10-K for the fiscal year ended January 2, 1993 [File No. 1-8002] and incorporated herein by reference). (Maximum number of shares issuable is 900,000 shares, after giving effect to share increase approved in December 1993).\n10.39 Thermedics Inc. Incentive Stock Option Plan (filed as Exhibit 10(d) to Thermedics' Registration Statement on Form S-1 [Reg. No. 33-84380] and incorporated herein by reference). (Maximum number of shares issuable is 1,931,923 shares, after adjustment to reflect share increases approved in 1986 and 1992, 5-for-4 stock split effected in January 1985, 4-for-3 stock split effected in September 1985, and 3-for-2 stock split effected in November 1993).\n10.40 Thermedics Inc. Nonqualified Stock Option Plan (filed as Exhibit 10(e) to Thermedics' Registration Statement on Form S-1 [Reg. No. 33-84380] and incorporated herein by reference). (Maximum number of shares issuable is 1,931,923 shares, after adjustment to reflect share increases approved in 1986 and 1992, 5-for-4 stock split effected in January 1985, 4-for-3 stock split effected in September 1985, and 3-for-2 stock split effected in November 1993).\n10.41 Thermedics Inc. Equity Incentive Plan (filed as Appendix A to the Proxy Statement dated May 10, 1993 of Thermedics [File No. 1-9567] and incorporated herein by reference). (Maximum number of shares issuable is 1,500,000 shares, after adjustment to reflect 3-for-2 stock split effected in November 1993). 24PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ---- 10.42 Thermo Cardiosystems Inc. Incentive Stock Option Plan (filed as Exhibit 10(f) to Thermo Cardiosystems' Registration Statement on Form S-1 [Reg. No. 33-25144] and incorporated herein by reference). (Maximum number of shares issuable is 1,143,750 shares, after adjustment to reflect share increase approved in 1992, 3-for-2 stock split effected in January 1990, 5-for-4 stock split effected in May 1990 and 2-for-1 stock split effected in November 1993).\n10.43 Thermo Cardiosystems Inc. Nonqualified Stock Option Plan (filed as Exhibit 10(g) to Thermo Cardiosystems' Registration Statement on Form S-1 [Reg. No. 33-25144] and incorporated herein by reference). (Maximum number of shares issuable is 1,143,750 shares, after adjustment to reflect share increase approved in 1992, 3-for-2 stock split effected in January 1990, 5-for-4 stock split effected in May 1990 and 2-for-1 stock split effected in November 1993).\n10.44 Thermo Voltek Corp. (formerly Universal Voltronics Corp.) 1985 Stock Option Plan (filed as Exhibit 10.14 to Thermo Voltek's Annual Report on Form 10-K for the fiscal year ended June 30, 1985 [File No. 0-8245] and incorporated herein by reference). (Maximum number of shares issuable is 200,000 shares, after adjustment to reflect 1-for-3 reverse stock split effected in November 1992 and 3-for-2 stock split effected in November 1993).\n10.45 Thermo Voltek Corp. (formerly Universal Voltronics Corp.) 1990 Stock Option Plan (filed as Exhibit 10.2 to Thermo Voltek's Annual Report on Form 10-K for the fiscal year ended June 30, 1990 [File No. 1-10574] and incorporated herein by reference). (Maximum number of shares issuable is 400,000 shares, after adjustment to reflect share increase in 1993, 1-for-3 reverse stock split effected in November 1992 and 3-for-2 stock split effected in November 1993).\n10.46-10.50 Reserved\n10.51 ThermoTrex Corporation (formerly Thermo Electron Technologies Corporation) Incentive Stock Option Plan (filed as Exhibit 10(h) to ThermoTrex's Registration Statement on Form S-1 [Reg. No. 33-40972] and incorporated herein by reference). (Maximum number of shares issuable is 1,945,000 shares, after giving effect to share increases approved in 1992 and 1993, and 3-for-2 stock split effected in October 1993). 25PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ---- 10.52 ThermoTrex Corporation (formerly Thermo Electron Technologies Corporation) Nonqualified Stock Option Plan (filed as Exhibit 10(i) to ThermoTrex's Registration Statement on Form S-1 [Reg. No. 33-40972] and incorporated herein by reference). (Maximum number of shares issuable is 1,945,000 shares, after giving effect to share increases approved in 1992 and 1993, and 3-for-2 stock split effected in October 1993).\n10.53 ThermoTrex Corporation - ThermoLase Inc. Nonqualified Stock Option Plan (filed as Exhibit 10.53 to ThermoTrex's Annual Report on Form 10-K for the year ended January 1, 1994 [File No. 1-10791] and incorporated herein by reference).\n10.54 ThermoLase Inc. Nonqualified Stock Option Plan (filed as Exhibit 10.54 to ThermoTrex's Annual Report on Form 10-K for the year ended January 1, 1994 [File No. 1-10791] and incorporated herein by reference).\n10.55 ThermoLase Inc. Incentive Stock Option Plan (filed as Exhibit 10.55 to ThermoTrex's Annual Report on Form 10-K for the year ended January 1, 1994 [File No. 1-10791] and incorporated herein by reference).\n10.56 Thermo Fibertek Inc. Incentive Stock Option Plan (filed as Exhibit 10(k) to Thermo Fibertek's Registration Statement on Form S-1 [Reg. No. 33-51172] and incorporated herein by reference).\n10.57 Thermo Fibertek Inc. Nonqualified Stock Option Plan (filed as Exhibit 10(l) to Thermo Fibertek's Registration Statement on Form S-1 [Reg. No. 33-51172] and incorporated herein by reference).\n10.58 Thermo Power Corporation (formerly Tecogen Inc.) Incentive Stock Option Plan (filed as Exhibit 10(h) to Thermo Power's Registration Statement on Form S-1 [Reg. No. 33-14017] and incorporated herein by reference). (Maximum number of shares issuable is 950,000 shares, after adjustment to reflect share increases approved in 1990, 1992 and 1993).\n10.59 Thermo Power Corporation (formerly Tecogen Inc.) Nonqualified Stock Option Plan (filed as Exhibit 10(i) to Thermo Power's Registration Statement on Form S-1 [Reg. No. 33-14017] and incorporated herein by reference). (Maximum number of shares issuable is 950,000 shares, after giving effect to share increases approved in 1990, 1992 and 1993).\n10.60 Thermo Power Corporation Equity Incentive Plan (filed as Appendix A to the Proxy Statement dated February 18, 1994 of Thermo Power Corporation [File No. 1-10573] and incorporated herein by reference). 26PAGE\nEXHIBIT INDEX ------------- Exhibit Number Reference Page - ------- --------- ---- 10.61 Thermo Process Systems Inc. Incentive Stock Option Plan (filed as Exhibit 10(h) to Thermo Process' Registration Statement on Form S-1 [Reg. No. 33-6763] and incorporated herein by reference). (Maximum number of shares issuable is 1,850,000 shares, after adjustment to reflect share increases approved in 1987, 1989 and 1992, 6-for-5 stock splits effected in July 1988 and March 1989, and 3-for-2 stock split effected in September 1989).\n10.62 Thermo Process Systems Inc. Nonqualified Stock Option Plan (filed as Exhibit 10(i) to Thermo Process' Registration Statement on Form S-1 [Reg. No. 33-6763] and incorporated herein by reference). (Maximum number of shares issuable is 1,850,000 shares, after adjustment to reflect share increases approved in 1987, 1989 and 1992, 6-for-5 stock splits effected in July 1988 and March 1989, and 3-for-2 stock split effected in September 1989).\n10.63 Thermo Process Systems Inc. Equity Incentive Plan [filed as Exhibit 10.63 to Thermedics' Annual Report on Form 10-K for the year ended January 1, 1994 [File No. 1-9567] and incorporated herein by reference.)\n10.64 Thermo Process Systems Inc. - Thermo Remediation Nonqualified Stock Option Plan (filed as Exhibit 10(l) to Thermo Process Systems Inc.'s Quarterly Report on Form 10-Q for the fiscal quarter ended January 1, 1994 [File No. 1-9549] and incorporated herein by reference).\n10.65 Thermo Remediation Inc. Equity Incentive Plan (filed as Exhibit 10.7 to Thermo Remediation's Registration Statement on Form S-1 [Reg. No. 33-70544] and incorporated herein by reference).\n11 Statements re: Computation of Earnings per Share.\n13 Annual Report to Shareholders for the year ended January 1, 1994 (portions incorporated herein by reference).\n21 Subsidiaries of the Registrant.\n23 Consent of Arthur Andersen & Co.","section_15":""}
{"filename":"31364_1994.txt","cik":"31364","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company conducts substantially all of its retail businesses from stores located in leased premises. Substantially all of these leases will expire within the next twenty-five years. In the normal course of business, however, it is expected that leases will be renewed or replaced by leases on other properties. Most of the Company's store leases provide for a fixed minimum rental together with a percentage rental based on sales.\nThe material office and distribution center properties owned or leased by the Company at January 29, 1994 are as follows:\n- ---------------\n(1) Includes the Company headquarters.\n(2) In January, 1993 the Company assumed a lease for an office and distribution facility of approximately 587,000 square feet (lease expires 2005). The Company's existing Orlando facility and the Largo distribution center facility were consolidated into the new facility during 1993. Existing Orlando facilities which are owned are being offered for sale.\n(3) Construction was financed pursuant to revenue bond issues. Because these properties are currently leased subject to nominal purchase options with development authorities which the Company anticipates it will exercise, they are listed as owned by the Company.\n(4) The Company closed the Hammond distribution center and subleased the former Hammond, Louisiana office and distribution center.\nThe Company considers that all property owned or leased is well maintained and in good condition.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the ordinary course of its business, the Company and its subsidiaries are parties to various legal actions which the Company believes are routine in nature and incidental to the operation of the business of the Company and its subsidiaries. The Company believes that the outcome of the proceedings to which the Company and its subsidiaries currently are parties will not have a material adverse effect upon its operations or financial condition.\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 the fiscal year ended January 29, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK, DEBT SECURITIES AND RELATED STOCKHOLDER MATTERS\nThe Company's common stock is listed on the New York Stock Exchange (Symbol: ECK) and started trading on August 6, 1993. The approximate number of shareholders of record on March 26, 1994 was 974. The Company has not paid or declared any dividends on its common stock.\nThe Company's 11 1\/8% Debentures are listed on the American Stock Exchange.\nThe Notes are listed on the New York Stock Exchange.\nThe Company is subject to restrictive covenants under its Credit Agreement and the Notes which restrict the payment of dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following historical selected financial data for the years presented below has been derived from the Company's consolidated financial statements. The historical financial data for the three fiscal years ended January 29, 1994 has been derived from, and should be read in conjunction with, the Company's audited consolidated financial statements and related notes which are incorporated by reference in Item 8","section_7":"","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and auditors' report for the Company as set forth under Item 14 of this Form 10-K are incorporated herein by reference.\nUnaudited information on selected quarterly financial data of the Company for the years ended January 29, 1994 and January 30, 1993 required by this Item is presented below (in thousands):\nEarnings (loss) per common share are computed independently for each of the quarters. Therefore, the sum of the quarterly earnings per share may not equal the annual earnings (loss) per common 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, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT\nDIRECTORS AND EXECUTIVE OFFICERS\nThe name, age and office or principal occupation of the executive officers and directors of the Company and certain information relating to their business experience are set forth below:\nMr. Turley is Chairman of the Board, President and Chief Executive Officer of the Company, positions he has held since 1975. He joined Old Eckerd in 1966 and has served as Senior Vice President (1971-1974) and President and Chief Executive Officer (1974-1975) prior to being elected to Chairman of the Board, President and Chief Executive Officer. He is also a director of Barnett Banks, Inc., Sprint Corporation and Springs Industries, Inc.\nMr. Newman is President, Chief Operating Officer and Director of the Company, positions he has held since July 6, 1993. Prior to joining the Company, Mr. Newman served as President, Chief Executive Officer and a director of F&M Distributors, Inc. (\"F&M\"), a drug store chain, since 1986. Prior to joining F&M, he was the Executive Vice President of Household Merchandising, a retail firm, from 1984 to 1985 and the Senior Vice President of Merchandising for F.W. Woolworth, a retail firm, from 1980 to 1984. Mr. Newman is also a director of FabriCenters of America, a retail firm.\nMr. Boyle was appointed Vice Chairman of the Board in February 1993. Prior thereto he was Senior Vice President\/Finance and Administration of the Company, a position he has held for more than the past five years. He joined Old Eckerd as Senior Vice President\/Finance and Administration in 1983.\nDr. Doluisio is Dean of the College of Pharmacy, University of Texas, Austin, Texas. Dr. Doluisio has been Dean since 1973 and has served as chairman of the American Pharmaceutical Association, the American Association of College of Pharmacy Council of Deans, the American Association for the Advancement of Science and as a trustee of the United States Pharmacopeia.\nMr. Dunn is retired Chairman of the Board and Chief Executive Officer of Maas Brothers\/Jordan Marsh, a division of Allied Stores Corporation, New York, New York. In his 39-year career with Allied Stores, starting as an executive trainee, Mr. Dunn held numerous management positions including that of executive group manager of Allied Stores for Jordan Marsh and Maas Brothers in Florida, Cain-Sloan in Tennessee and Joske's in Texas. Mr. Dunn is also a director of Tech Data Corporation and Younkers, Inc.\nMr. Fitzgibbons has been a director of Merrill Lynch Capital Partners since 1988. He has been a Partner of Merrill Lynch Capital Partners since 1993; an Executive Vice President of Merrill Lynch Capital Partners from 1988 to 1993; a Senior Vice President of Merrill Lynch Capital Partners from 1987 to 1988; a Managing Director of the Investment Banking Division of Merrill Lynch & Co. (\"ML & Co.\") since 1978; and Vice President of Merrill Lynch from 1974 to 1988. He is also a director of Amstar Corporation, Borg-Warner Security Corporation, Borg-Warner Automotive, Inc., Consumer Markets, Inc., ESSEX Industries, Inc., Unifax, Inc., AmeriFoods Companies, Inc., White Swan, Inc. and United Artists Theatre Circuit, Inc.\nMr. Lehr is former Chairman of the Board of 3M Company, St. Paul, Minnesota. In his 39-year career with 3M Company, starting as an engineer, Mr. Lehr held numerous management positions and from 1980 to March 1986, when he retired, was Chairman of the Board and Chief Executive Officer. He also serves as a director of various IDS Funds.\nMr. Michas has been a director of Merrill Lynch Capital Partners since 1989. He has been a Partner of Merrill Lynch Capital Partners since 1993; a Senior Vice President of Merrill Lynch Capital Partners from 1990 to 1993; a Vice President of Merrill Lynch Capital Partners from 1987 to 1989; a Managing Director of the Investment Banking Division of ML & Co. since 1991; a Director of the Investment Banking Division of ML & Co. from 1990 to 1991; and a Vice President of the Investment Banking Division of ML & Co. from 1987 to 1989. He is also a director of Amstar Corporation, Borg-Warner Security Corporation, Borg-Warner Automotive, Inc. and Blue Bird Body Corporation.\nMr. Sidhu has been a director of Merrill Lynch Capital Partners since 1988. He has been a Partner of Merrill Lynch Capital Partners since 1993; a Senior Vice President of Merrill Lynch Capital Partners since 1987; a Vice President of Merrill Lynch Capital Partners from 1985 to 1987; a Managing Director of the Investment Banking Division of ML & Co. from 1989 to 1993; and a Director of the Investment Banking Division of ML & Co. from 1987 to 1989. He is also a director of Clinton Mills, Inc., First-USA, Inc., John Alden Financial Corporation and Wherehouse Entertainment, Inc.\nMr. Kelly was appointed Senior Vice President\/Merchandising in February 1993. Prior thereto he served as Vice President of Merchandising of Eckerd Drug Company, formerly Old Eckerd's principal subsidiary (\"Eckerd Drug Company\") and now the Company's principal division, for more than the past five years.\nMr. Santo was appointed Senior Vice President\/Administration in February 1993. Prior thereto he was Vice President\/Legal Affairs of the Company, a position he has held for more than the past five years. In addition, Mr. Santo was appointed Secretary of the Company effective January 1, 1992.\nMr. Wright was appointed Senior Vice President\/Finance in February 1993. Prior thereto he was Vice President and Controller of the Company, a position he has held since September 1988. Mr. Wright became Vice President of the Company in June 1986. In addition, Mr. Wright has served as Vice President of Finance of Eckerd Drug Company since May 1985.\nMr. Myers was appointed Senior Vice President\/Pharmacy in February 1993. Prior thereto he was Vice President of the Company, a position he has held for more than the past five years. In addition, Mr. Myers has served as Vice President of Pharmacy Services of Eckerd Drug Company for more than the past five years.\nMr. Boos was appointed Vice President of the Company in April 1991. In addition, Mr. Boos has been Vice President of Real Estate and Development of Eckerd Drug Company since August 1985. Mr. Boos joined Eckerd Drug Company in 1982.\nMr. Peacock is Vice President of the Company, a position he has held for more than the past five years. Mr. Peacock is also a Senior Regional Vice President for the North Texas Region of Eckerd Drug Company.\nMessrs. Turley, Boyle, Doluisio, Dunn, Fitzgibbons and Lehr have been directors of the Company since May 1986. Mr. Sidhu became a director of the Company in April 1988 and Mr. Michas became a director of the Company in April 1990, and Mr. Newman became a director in July 1993.\nThe Board of Directors of the Company is divided into three classes serving staggered three-year terms. The terms of office of Messrs. Boyle, Doluisio and Sidhu will expire in 1994, the terms of office of Messrs. Michas, Dunn and Newman will expire in 1995 and the terms of office of Messrs. Fitzgibbons, Turley and Lehr will expire in 1996.\nMessrs. Doluisio, Dunn and Lehr serve as members of the Audit Committee, Messrs. Fitzgibbons, Dunn and Lehr serve as members of the Executive Compensation and Stock Option Committee, and Messrs. Turley, Dunn and Fitzgibbons serve as members of the Executive Committee, of the Board of Directors of the Company. Officers of the Company serve at the discretion of the Board of Directors. Messrs. Fitzgibbons, Sidhu and Michas are employees of Merrill Lynch Capital Partners and serve on the Board of Directors of the Company as representatives of the Merrill Lynch Investors.\nOfficers are elected for a one-year term by the Board of Directors at its annual meeting. There is no family relationship between any of the aforementioned officers or directors of the Company.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth certain information for the 1993, 1992 and 1991 fiscal years with respect to the Chief Executive Officer, each of the four most highly paid executive officers of the Company who were serving as executive officers at January 29, 1994 and one of the five most highly compensated executive officers of the Company during fiscal 1993 who was no longer an executive officer at January 29, 1994.\nSUMMARY COMPENSATION TABLE\n- --------------- (1) The Company entered into employment agreements with each of the named executive officers that provide for severance payments upon the occurrence of events such as death or termination. See \"Employment Agreements.\"\n(2) The amounts shown in this column consist of (i) tax \"gross up\" payments made with respect to certain compensation, including payments made with respect to the named executive officers' Management Notes (see (Footnotes continued on following page)\n(Footnotes continued from preceding page) note (6)) that are reflected under the heading \"All Other Compensation,\" and (ii) with respect to Mr. Turley, certain perquisites. See note (3).\n(3) Included in this amount are an automobile allowance of $27,812 and payments for long-term disability insurance of $18,480.\n(4) Mr. Newman's employment with the Company commenced on July 6, 1993. Under Mr. Newman's employment agreement, the aggregate amount of his annual bonus and Long Term Incentive Plan payouts are guaranteed to be not less than $250,000 in each of 1993 and 1994.\n(5) Each named executive officer participates in The Jack Eckerd Corporation Profit Sharing Plan (the \"Profit Sharing Plan\") and The Jack Eckerd Corporation Executive Excess Plan (the \"Executive Excess Plan\"). The Executive Excess Plan replaces benefits under the Profit Sharing Plan (and The Jack Eckerd Corporation Pension Plan) which are reduced under provisions of the Internal Revenue Code. The amounts allocable in 1993 to the named executive officers under the Profit Sharing Plan and the Executive Excess Plan (with respect to the Profit Sharing Plan) were not calculable as of the date hereof. The amounts allocable in 1992 were as follows: Mr. Turley, $16,622, Mr. Lambert, $9,870, Mr. Boyle, $8,533, Mr. Roberson, $3,106, and Mr. Santo, $3,111.\n(6) The balances of the amounts shown in 1992 consist of the following amounts paid to each named executive officer equaling the principal amounts due on the named executive officers' Management Notes and the excess, if any, of the interest due on their Management Notes over the interest payable by the Company on their Convertible Debentures: Mr. Turley, $452,475, Mr. Lambert, $199,958, Mr. Boyle, $288,718, Mr. Roberson, $114,529, and Mr. Santo, $116,426. In 1992, payment on the Management Notes was accelerated and the Company made additional payments to the named executive officers in an amount equal to the remaining principal amount due on their Management Notes. The Management Notes were repaid in full and there are no future obligations by the Company or the named executive officers on these Management Notes. See \"Compensation Committee Interlocks and Insider Participation.\"\n(7) Mr. Lambert retired from his positions as Senior Vice President of the Company and President of Eckerd Drug Company and became a consultant to the Company effective September 30, 1993. Amounts paid to Mr. Lambert after September 30, 1993 which are included in his 1993 salary totalled $120,502. See \"Separation Agreements.\"\n(8) Mr. Roberson resigned from his employment with the Company effective March 31, 1994. See \"Separation Agreements.\"\n(9) No restricted stock was awarded during the year ended January 29, 1994. As of January 29, 1994 the named executive officers restricted stock holdings (number of shares and value) were as follows: Mr. Turley, 28,081, $554,600, Mr. Lambert, 15,431, $304,762, Mr. Roberson, 6,755, $133,411 and Mr. Santo, 6,013, $118,757. Mr. Newman and Mr. Boyle had no restricted stock holdings at January 29, 1994.\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table presents information concerning grants of stock options during the 1993 fiscal year to each of the named executive officers. No stock appreciation rights were granted during the 1993 fiscal year.\n- ---------------\n(1) Based on a total of 855,915 options granted to all employees. All options granted to the named executive officers were granted on August 12, 1993. Commencing three years after date of grant, the options are exercisable to the extent of 50%, with an additional 25% exercisable after each of the next two successive years.\n(2) The market price on the date of grant used herein was the initial public offering price.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES (1)\nThe following table presents information concerning the exercise of stock options during the 1993 fiscal year and the value of unexercised stock options at the end of the 1993 fiscal year with respect to the named executive officers. No SARs are currently outstanding.\n- ---------------\n(1) None of the named executive officers exercised any options during the 1993 fiscal year.\nLONG-TERM INCENTIVE PLANS--AWARDS IN LAST FISCAL YEAR (1)\nThe following table presents information regarding Long-Term Incentive Plan Awards made during the 1993 fiscal year to each of the named executive officers.\n- ---------------\n(1) All amounts shown represent grants made pursuant to the Company's Executive Three Year Bonus Plan. The bonus awards are granted annually and the payment of such awards are contingent on the attainment of certain performance criteria. The total payment with respect to a grant is based on the annual average increase in the Company's earnings before interest and taxes, as adjusted, and the average annual return on investment, during a three-year performance period consisting of the current year and the succeeding two years, subject to achieving certain specified minimum performance objectives for the three-year period, and are calculated as a percentage of a participant's annual base salary as of the beginning of a three-year performance period. The maximum amount of the bonus award is 50% of the participating executives' annual base salary at the beginning of a performance period. Since a target award is not applicable, the target amount is representative of the amount which would be paid on the payout date based on the previous fiscal year's performance results.\nTHE JACK ECKERD CORPORATION PENSION PLAN\nThe Jack Eckerd Corporation Pension Plan (the \"Pension Plan\") is qualified under the Code and is non-contributory. Employees who retire or terminate as vested participants are entitled to receive retirement benefits under a final average compensation formula. To the extent benefits cannot be provided under the Pension Plan due to the limitations imposed by Sections 415 and 401(a)(17) of the Code, such benefits will be provided for Messrs. Turley, Lambert and Boyle under The Jack Eckerd Corporation Executive Excess Plan (the \"Excess Plan\") which is not qualified under the Code. Mr. Roberson and Mr. Santo do not participate in the Excess Plan. Mr. Newman is not eligible to participate in this plan because he has not met the minimum length of service requirement.\nThe following table sets out the estimated Minimum Annual Retirement Benefits payable at age 65 for the noted levels of final average annual compensation and years of service:\nPENSION PLAN TABLE\n- ---------------\n(1) The Pension Plan provides for a Minimum Annual Retirement Benefit at age 65 after 25 years of service equal to 24% of final average compensation plus 15.5% of final average compensation in excess of an employee's average Social Security maximum taxable wage base for the 35 years ending with the employee's Social Security normal retirement age. The Minimum Annual Retirement Benefit includes the income which could be provided by a monthly annuity for life purchased with the Profit Sharing Plan vested account balance. Final average compensation is the average compensation (including base salary, Key Management Bonus, and Executive Three-Year Bonus) (\"Salary,\" \"Bonus,\" and \"Long-Term Incentive Plan Payouts\" in the Summary Compensation Table) for the highest consecutive five of the final ten years of employment. It also includes certain perquisites. The retirement benefit amounts shown are age 65 single life annuity amounts and are not subject to any deduction for Social Security or other offset amounts. The years of service and the current level of compensation recognized for retirement purposes (which would be used to calculate average annual compensation) for the named executive officers are as follows: Mr. Turley, 27 years and $716,181, Mr. Lambert, 23 years and $431,788, Mr. Boyle, 10 years and $372,321, Mr. Roberson, 16 years and $223,319, and Mr. Santo, 17 years and $202,703. The final average compensation for retirement purposes for the relevant five-year period is as follows: Mr. Turley $957,623, Mr. Lambert, $569,811, Mr. Boyle, $492,938, Mr. Roberson, $216,720, and Mr. Santo, $212,597.\n(2) Mr. Newman is not eligible to participate in this plan because he has not met the minimum length of service requirements.\nTHE EXECUTIVE SUPPLEMENTAL BENEFIT PLAN\nThe Executive Supplemental Benefit Plan (the \"ESBP\") is a non-qualified, non-contributory plan that provides for supplemental retirement and death benefits for the executive officers, including the named executive officers, and other key management employees of the Company and its subsidiaries.\nThe following table sets out the estimated annual benefits payable at age 65 for the noted levels of mid-point salaries:\nCOVERED ANNUAL BENEFIT SALARY(1) PAYABLE(2) ---------------- ------------------------ $ 100,000 $ 25,000 200,000 50,000 300,000 75,000 400,000 100,000 500,000 125,000 600,000 150,000 700,000 175,000\n- ---------------\n(1) Under the ESBP, the Company is obligated to pay a participant commencing at age 65 an annual amount equal to 25% of the participant's covered salary in equal monthly installments for 15 years. The covered salary is the mid-point salary of a salary range for a particular executive position that is calculated by the Company. It does not relate to the figures provided in the Summary Compensation Table. The mid-point range for 1993 recognized for retirement purposes of the named executive officers are as follows: Mr. Turley, $512,400, Mr. Newman, $484,500, Mr. Lambert, $318,200, Mr. Boyle, $263,000, Mr. Roberson, $163,200 and Mr. Santo, $135,000. The years of service for 1993 recognized for retirement purposes were the same as those provided with respect to the Pension Plan. The ESBP also provides that, in the event of the death of a participant prior to retirement, the participant's beneficiary is entitled to receive either (a) a lump sum payment equal to four times the participants covered salary, or (b) an amount equal to 90% of the participant's covered salary for the first year after death plus 45% of the covered salary annually for the next nine years.\n(2) Assumes the sum of the participant's age and the number of years of service (which cannot be less than 5) is at least 70. If less than 70, benefits are prorated pursuant to a formula.\nEMPLOYMENT AGREEMENTS\nMessrs. Boyle and Turley entered into employment agreements with the Company which became effective April 30, 1986 that provided for base salaries of $216,000 and $410,000, respectively, and for such bonuses under the Company's bonus plan as the Board, in its discretion, shall determine. Each employment agreement provides for an initial term of employment of three years and, thereafter, is automatically renewed on a year-to-year basis, unless terminated by the Company or such employee.\nEach of the above employment agreements provides that (i) upon the death of the employee, the Company will make a lump sum payment to his beneficiary, estate or representative in an amount equal to his current annual base salary and (ii) upon involuntary termination of employment for disability or any reason other than for cause, the Company will make a lump sum payment to such employee equal to two times such employee's current annual base salary (or, if greater, the base salary which would have been paid to such employee during the remaining term of his employment agreement if he had not been terminated) plus a pro rata portion of any bonus payable to the employee under certain bonus compensation plans in the year of such disability or involuntary termination and, subject to certain limitations, will continue such employee's life, disability and hospitalization insurance and medical and dental plans for a two-year period. The employment agreement with Mr. Lambert and the Company, which provided similar terms, was terminated effective September 30, 1993 pursuant to a consulting agreement. See \"Separation Agreements.\"\nIn October 1988 the Company entered into an employment agreement with Mr. Santo that provides that upon involuntary termination of employment (except for cause) the Company will pay him a severance payment in an amount equal to his then current annual base salary in monthly\ninstallments plus a pro rata portion of certain bonus compensation payable under certain bonus plans, and, subject to certain limitations, the Company will continue certain insurance and medical benefits. The severance payments and benefits are payable for one year or 18 months, depending on length of service. The agreement is for a one-year term and is automatically renewed on a year-to-year basis, unless terminated by the Company or Mr. Santo. Mr. Roberson had an employment agreement which had substantially the same terms as Mr. Santo's employment agreement which was terminated effective March 31, 1994. See \"Separation Agreements.\"\nOn June 9, 1993, the Company entered into an employment agreement with Mr. Newman whose period of employment as President of the Company commenced July 6, 1993. The agreement provides that upon involuntary termination of employment (except for cause) the Company will pay Mr. Newman a severance payment in an amount equal to two times his then current annual base salary in monthly installments plus a pro rata portion of certain bonus compensation payable under certain bonus plans, and, subject to certain limitations, the Company will continue certain insurance and medical benefits. The severance payments and benefits are payable for two years. The agreement is for a two-year term and is automatically renewed on a year-to-year basis, unless terminated by the Company or Mr. Newman.\nSEPARATION AGREEMENTS\nHarry W. Lambert, who served as Senior Vice President of the Company and President of Eckerd Drug Company for more than the past five years, retired from both positions effective September 30, 1993. Mr. Lambert entered into a consulting agreement with the Company which became effective October 1, 1993 (the \"Consulting Agreement\"), pursuant to which Mr. Lambert has agreed to act as a consultant and advisor to the Company. In consideration of such services, Mr. Lambert is entitled to compensation in the amount of $30,000 per month until March 31, 1994 and $19,726 per month from April 1, 1994 until April 15, 1997, the date the Consulting Agreement terminates, and will continue to participate in certain of the Company's employee benefit programs.\nRichard W. Roberson, who served as Senior Vice President of the Company, President of the Vision Group and Chairman of the Board and Chief Executive Officer of Insta- Care, entered into a separation agreement with the Company effective as of March 31, 1994 in conjunction with the sale of the assets of the Vision Group to an investor group which includes Mr. Roberson. See \"Item 13. Certain Relationships and Related Transactions.\" Under the terms of the separation agreement, the Company will pay Mr. Roberson an aggregate of $200,000 in quarterly payments of $25,000 commencing July 15, 1994 and ending on April 15, 1996, which payments are contingent upon his continued employment with Visionworks.\nMANAGEMENT RESTRICTED STOCK\nPrior to the consummation of the IPO, the Management Investors and certain other employees of Eckerd owned shares of Class B common stock, 60% of which was fully vested. The remaining non-vested shares of Class B common stock were designed to vest upon the achievement of specified levels of financial performance and other criteria. Immediately prior to the consummation of the IPO, all shares of vested Class B common stock and 50% of the non-vested shares of Class B common stock were exchanged for Common Stock at the rate of 0.69118 shares of Common Stock for each share of Class B common stock (prior to the Stock Split). The remaining shares of non-vested Class B common stock were exchanged at the same exchange ratio for shares of Common Stock subject to certain restrictions (the \"Management Restricted Stock\"). The Management Restricted Stock will vest automatically on July 31, 1998 provided that the holder thereof is then employed by the Company. The Management Restricted Stock may vest earlier over a three-year period upon the achievement by the Company of certain levels of performance as indicated by the market price of the Common Stock of the Company during each of the 12-month periods ended July 31, 1994, 1995 and 1996 (each of the dates or events upon which the Management Restricted Stock may vest is referred to as a \"Restricted Stock Event\").\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nAt January 29, 1994, the Company's Executive Compensation and Stock Option Committee consisted of Lewis W. Lehr, Donald F. Dunn and Albert J. Fitzgibbons, III. Mr. Turley, an executive officer of the Company, was a member of the Executive Compensation and Stock Option Committee until August 5, 1993, at which time he was replaced by Mr. Dunn. Mr. Fitzgibbons is Executive Vice President and a member of the Board of Directors of Merrill Lynch Capital Partners and is a Managing Director of ML & Co., which are affiliates of the Company.\nMerrill Lynch Capital Partners is a Delaware corporation and a wholly owned subsidiary of ML & Co. which initiates and structures transactions commonly referred to as leveraged or management buyouts involving publicly owned companies, privately owned companies and subsidiaries and divisions of both publicly and privately owned companies, and manages a fund of equity capital committed by institutional investors for investment in the equity portion of leveraged buyout transactions.\nMerrill Lynch Capital Partners is the direct or indirect managing partner of Merrill Lynch Capital Appreciation Partnership No. II, L.P., ML Offshore LBO Partnership No. II, ML Employees LBO Partnership No. I, L.P., Merrill Lynch KECALP L.P. 1986, Merrill Lynch Capital Appreciation Partnership No. B-IX, L.P., ML Offshore LBO Partnership No. B-IX, MLCP Associates L.P. No. II, Merrill Lynch KECALP L.P. 1989, ML IBK Positions, Inc., Merchant Banking L.P. No. IV, ML Oklahoma Venture Partners, Limited Partnership and ML Venture Partners II, L.P., which are stockholders of the Company. Merrill Lynch Interfunding, Inc., an affiliate of Merrill Lynch Capital Partners, is also a stockholder of the Company.\nIn January 1987, the Company entered into a sale and leaseback agreement involving 72 Eckerd Drug stores, in a transaction arranged by and including certain affiliates of ML & Co. Pursuant to this agreement, the Company sold 72 Eckerd Drug stores for $48.1 million and is obligated to lease them back for a minimum term of ten years. The Company paid a fee equal to 1 1\/2% of the sales price, or approximately $721,500, to an affiliate of ML & Co. for arranging the transaction. Lease payments by the Company, payable semi-annually, are approximately $5.9 million per annum. In addition, an affiliate of ML & Co. will receive a management fee of approximately $100,000 per annum, payable out of such lease payments during the term of the lease. The Company believes that the terms of this agreement were no less favorable to the Company than could have been obtained from unaffiliated third parties.\nIn April 1989, the Company entered into a Master Lease (the \"Master Lease\") with a third-party lessor (\"Lessor\") established by an affiliate of ML & Co. Under the Master Lease the Lessor finances the purchase of sites for development as Visionworks and Eckerd Drug stores and finances the construction of the buildings and the acquisition of equipment. The selection of sites and construction of improvements was undertaken by the Company acting as the Lessor's agent pursuant to a construction agency agreement (the \"Agreement for Lease\"). Under the Agreement for Lease, the Company constructed the improvements and leased the properties from the Lessor pursuant to the Master Lease. As of January 29, 1994, there were 12 stores leased under the Master Lease with a total acquisition and construction cost of approximately $18.4 million. The Company pays a structure fee to the ML & Co. affiliate equal to 1% of the cost of the land, building and equipment leased under the Master Lease plus an administration fee. The Company paid the ML & Co. affiliate fees totalling $44,000, $45,000 and $408,000 for the years ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively. The Company believes that the terms of this arrangement were no less favorable to the Company than could have been obtained from unaffiliated third parties.\nIn July 1989, the Company entered into a Placement Agency Agreement with Merrill Lynch Money Markets, Inc., an affiliate of ML & Co. Under the Placement Agency Agreement, Merrill Lynch Money Markets, Inc. acted as the exclusive Placement Agent for the private placement to accredited investors of the Company's unsecured notes with maturities of up to 270 days from date of issue. The Company did not pay Merrill Lynch Money Markets, Inc. any amounts in connection with this facility during the year ended January 29, 1994. The Company believes that the terms of this\narrangement were no less favorable to the Company than could have been obtained from unaffiliated third parties.\nOn June 15, 1993, the Company, EDS and EH II amended the EH II Management Agreement (the \"EH II Management Agreement Amendment\"). Pursuant to the EH II Management Agreement Amendment, EH II paid to Eckerd an accrued and previously deferred management fee, including interest payable thereon, of approximately $22.0 million and an advance, representing prepayment by EH II of the management fee to be earned by Eckerd in the future, of approximately $18.0 million. Such advance was evidenced by the EH II Note. The EH II Management Agreement was terminated, and the EH II Note was repaid, upon consummation of the IPO.\nEckerd also entered into an Exchange Agreement dated as of July 23, 1990 (the \"EDS Exchange Agreement\") pursuant to which the holders of EDS common stock had the right to exchange their shares for shares of Class A common stock of Eckerd on a share-for-share basis (subject to anti-dilution adjustments) and which granted Eckerd rights of first refusal on the common stock and certain assets of EH II. The Company and the stockholders of EDS amended the Exchange Agreement as of July 29, 1993 to provide for the exchange of EDS common stock for Common Stock at the rate of 1.95 shares of Common Stock for each share of EDS common stock (prior to the Stock Split). Such exchange rate was determined based upon the analysis and opinion of Bear, Stearns & Co. Inc., one of the representatives of the underwriters in the IPO. The Merrill Lynch Investors owned approximately 74.14% of the common stock of EDS.\nCertain members of management (the \"Management Group\") purchased, at the effective time of the Acquisition, an aggregate of $8.36 million principal amount of convertible debentures of the Company in exchange for $3.14 million in recourse notes and $5.22 million in non-recourse notes (the \"Management Notes\"). In April 1992, the Management Notes, which then totaled $2.83 million, were paid in their entirety and the convertible debentures which totaled $8.09 million were exchanged for 1,304,289 shares of Class A common stock of Eckerd. During 1992 and 1993 a total of seven members of the Management Group left the Company. The Company repurchased the Common Stock (507,939 shares) from these former members of the Management Group for cash and notes totaling $13.35 million.\nMerrill Lynch, Pierce, Fenner & Smith Incorporated (\"Merrill Lynch\"), an affiliate of each of ML & Co. and Merrill Lynch Capital Partners, acted as one of the representatives of the underwriters in the IPO and received underwriting commissions and related fees of approximately $1.85 million in connection therewith.\nIn addition, in its role as sole underwriter in the issuance of the Notes, Merrill Lynch received approximately $4.0 million in underwriting discounts from the Company.\nCOMPENSATION OF DIRECTORS\nMembers of the Board of Directors who are not employees of the Company are paid for their services as members of the Board an annual fee of $18,000 and a fee of $1,500 for each Board or Committee meeting attended, unless the Committee meeting is held in conjunction with a Board meeting, in which case the Committee member is paid a fee of $1,000 for attending the Committee meeting. Employee directors receive no fee for Board or Committee services.\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 Common Stock as of March 26, 1994 by (i) each of the directors of the Company, (ii) each of the named executive officers of the Company (iii) each person known by the Company to be the beneficial owner of approximately five percent or more of the outstanding Common Stock and (iv) all of the Company's directors and executive officers as a group. Unless otherwise indicated, the Company believes that the beneficial owner has sole voting and investment power over such shares. The following table treats the 136,808 shares of Management Restricted Stock as issued and outstanding.\n- --------------- * Less than one percent\n(1) Shares of Common Stock beneficially owned by the Merrill Lynch Investors are owned of record as follows: 941,148 shares by Merrill Lynch Interfunding, Inc., 9,816,294 shares by Merrill Lynch Capital Appreciation Partnership No. II, L.P., 249,567 shares by ML Offshore LBO Partnership No. II, 244,022 shares by ML Employees LBO Partnership No. I, L.P., 98,597 shares by Merrill Lynch KECALP L.P. 1986, 1,350,577 shares by Merrill Lynch Capital Appreciation Partnership No. B-IX, L.P., 791,101 shares by ML Offshore LBO Partnership No. B-IX, 21,419 shares by MLCP Associates L.P. No. II., 133,856 shares by Merrill Lynch KECALP L.P. 1989, 895,676 shares by ML IBK Positions, Inc., 46,513 shares by Merchant Banking L.P. No. IV, 15,491 shares by ML Oklahoma Venture Partners, Limited Partnership and 92,843 shares by ML Venture Partners II, L.P. The address for the Merrill Lynch Investors and each of the aforementioned record holders is c\/o Merrill Lynch & Co., Inc., Merrill Lynch World Headquarters, North Tower, 18th Floor, New York, New York 10281-1201.\n(2) Includes 165,452 shares of Common Stock beneficially owned by Equitable Variable Life Insurance Company. The address for The Equitable Life Assurance Society of the United States and Equitable Variable Life Insurance Company is 1285 Avenue of the Americas, 19th Floor, New York, New York 10019.\n(3) Includes 1,036,400 shares of Common Stock and 605,022 shares of Non-Voting Common Stock beneficially owned by J.P. Morgan Capital Corporation (\"MCC\"). MCC may convert shares of Non-Voting Common Stock into shares of Common Stock to the extent that it would not own more than 4.9% of the voting securities of the Company. The address for MCC is 60 Wall Street, New York, NY 10260.\n(4) The address for the Company Employees' Profit Sharing Plan is P.O. Box 4689, Clearwater, Florida 34618. NationsBank of Georgia, N.A. is the trustee of the Company Employees' Profit (Footnotes continued on following page)\n(Footnotes continued from preceding page) Sharing Plan. Total does not reflect the 192,000 shares of Common Stock of the Company that the Company has irrevocably committed to deposit to the Company Employees' Profit Sharing Plan over the next three years.\n(5) Total does not reflect the 40,234 shares of Common Stock transferred by Mr. Turley to certain family members. Mr. Turley disclaims beneficial ownership of such shares. Total includes options covering 44,421 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Includes 28,081 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events but does not reflect the 6,650 shares of Management Restricted Stock transferred by Mr. Turley and certain family members. Mr. Turley disclaims beneficial ownership of such shares.\n(6) Total does not reflect 127,393 shares of Common Stock transferred to certain irrevocable trusts established by Mr. Boyle. Mr. Boyle disclaims beneficial ownership of such shares. Total includes options covering 20,800 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Total does not reflect 15,432 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events transferred by Mr. Boyle to certain family members. Mr. Boyle disclaims beneficial ownersip of such shares.\n(7) Total includes options covering 3,334 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Includes 277 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events.\n(8) Total includes options covering 3,334 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Includes 277 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events.\n(9) Messrs. Fitzgibbons, Michas and Sidhu are directors of the Company and officers of Merrill Lynch Capital Partners, ML & Co. and Merrill Lynch, Pierce, Fenner & Smith Incorporated. Each disclaims beneficial ownership of shares of Common Stock beneficially owned by the Merrill Lynch Investors. The business address for Messrs. Fitzgibbons, Michas and Sidhu is set forth in Note 2 above.\n(10) Total includes options covering 3,334 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Total includes 277 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events.\n(11) Total includes options covering 3,334 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Total includes 277 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events.\n(12) Total includes options covering 4,675 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter, including options covering 295 shares of Common Stock which vest upon the occurrence of Restricted Stock Events.\n(13) Total includes options covering 4,717 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter, including options covering 277 shares of Common Stock which vest upon the occurrence of Restricted Stock Events.\n(14) Total includes options covering 20,800 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Includes 15,431 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events.\n(15) Total includes options covering 10,400 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Includes 6,755 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events.\n(16) Total does not reflect the 3,696 shares of Common Stock transferred by Mr. Santo to certain family members. Mr. Santo disclaims beneficial ownership of such shares. Total includes options covering 9,100 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter. Includes 6,013 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events but does not reflect 743 shares of Management Restricted Stock transferred by Mr. Santo to certain family members. Mr. Santo disclaims beneficial ownership of such shares.\n(Footnotes continued on following page)\n(Footnotes continued from preceding page)\n(17) The total number of all directors and officers as a group includes Harry W. Lambert who retired from his positions with the Company effective September 30, 1993 and is currently a consultant and advisor to the Company.\n(18) Total includes options covering 168,524 shares of Common Stock which are exercisable as of March 26, 1994 or within 60 days thereafter, including options covering 941 shares of Common Stock which vest upon the occurrence of Restricted Stock Events. Total includes 78,500 shares of Management Restricted Stock which vest upon the occurrence of Restricted Stock Events.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company sold the business and assets of its Vision Group effective January 30, 1994 to an investment group which included Richard W. Roberson, President of Vision Group and Senior Vice President of the Company, for an amount in cash and notes, approximately equal to the book value of the assets. Mr. Roberson is not a member of the Board of Directors and took no part in the Board's decision to approve the sale to the investment group.\nSee \"Item 11. Executive Compensation--Compensation Committee Interlocks and Insider Participation.\"\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nListed below are all financial statements, notes, schedules, and exhibits filed as part of this Form 10-K annual report:\n(a)(1) Financial statements and Schedules\nThe following financial statements and schedules of the Company together with the Report of Independent Certified Public Acocuntants dated March 18, 1994 on pages 42 through 61 of this Form 10-K are filed herewith:\nECKERD CORPORATION AND SUBSIDIARIES\nFinancial Statements:\nReport of Independent Certified Public Accountants\nConsolidated Balance Sheets as of January 29, 1994 and January 30,\nConsolidated Statements of Operations for the Years Ended January 29, 1994, January 30, 1993 and February 1, 1992,\nConsolidated Statements of Stockholders' Equity (Deficit) for the Years Ended January 29, 1994, January 30, 1993 and February 1, 1992\nConsolidated Statements of Cash Flows for the Years Ended January 29, 1994, January 30, 1993 and February 1, 1992\nNotes to Consolidated Financial Statements\nSchedules:\nV --Property, Plant and Equipment VI --Accumulated Depreciation and Amortization of Plant and Equipment VIII --Reserves\nAll other schedules for the Company are omitted as the required information is inapplicable or the information is presented in the respective consolidated financial statements or related notes.\nAlso filed in this report is the consent of KPMG Peat Marwick to the incorporation by reference of their auditors' report dated March 18, 1994, relating to the consolidated financial statements appearing in this report, into Registration Statement Numbers 33-49977 and 33-50755 on Form S-8 and Registration Statement Numbers 33-10721 and 33-50223 on Form S-3.\n(a)(2) Exhibits\nExhibits filed by incorporation herein by reference:\n(b) Reports on Form 8-K\nThe Company filed a report on Form 8-K dated January 4, 1994 announcing an agreement in principle to sell its Vision Group division.\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.\nMarch 31, 1994 ECKERD CORPORATION\nBy \/s\/ SAMUEL G. WRIGHT --------------------------------- Samuel G. Wright Senior Vice President-Finance\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 date indicated.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors ECKERD CORPORATION AND SUBSIDIARIES:\nWe have audited the accompanying consolidated balance sheets of Eckerd Corporation and subsidiaries as of January 29, 1994 and January 30, 1993, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for each of the years in the three-year period ended January 29, 1994. 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 Eckerd Corporation and subsidiaries at January 29, 1994 and January 30, 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended January 29, 1994, in conformity with generally accepted accounting principles.\nTampa, Florida March 18, 1994\nECKERD CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JANUARY 29, 1994 AND JANUARY 30, 1993 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nECKERD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED JANUARY 29, 1994, JANUARY 30, 1993, AND FEBRUARY 1, 1992 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nECKERD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) YEARS ENDED JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nECKERD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(1) ORGANIZATION OF BUSINESS\n(a) Acquisitions and Merger\nOn April 30, 1986, all of the outstanding capital stock of Jack Eckerd Corporation (predecessor company) was acquired by certain affiliates of Merrill Lynch Capital Partners, Inc., affiliates of certain banks which provided a portion of the financing for the acquisition and certain members of management. The acquisition has been accounted for using the purchase method of accounting. The cost of acquiring the capital stock has been allocated to assets based on fair market values at April 30, 1986 as determined by American Appraisal Associates, Inc.\nThe excess of cost over net assets acquired at May 1, 1986, as well as subsequent acquisitions, are being amortized on a straight-line basis over a period of 20 years.\nDuring 1992 and 1993, Eckerd Corporation (Company) purchased fifty-two drug stores (7 stores were closed subsequent to the acquisition) in three transactions at an aggregate cost of $41,926. The operations of such stores, which have been included in the consolidated financial statements from dates of acquisition, are not material to the Company and, accordingly, pro forma comparative operating numbers are not presented.\n(b) Initial Public Offering and Common Stock Exchange\nOn August 12, 1993, the Company completed an initial public offering (IPO) in which it issued and sold 5,175,000 shares of its Common Stock par value $.01 per share (Common Stock) for $14.00 per share. In addition in connection with the IPO, the Company amended its Restated Certificate of Incorporation to effect, among other things: i) the reclassification of its Class A common stock and Class B common stock into Common Stock at certain specified rates (Reclassification); ii) a 2-for-3 reverse stock split (Stock Split); iii) the adoption of certain provisions, such as a classified board of directors and the prohibition of stockholder action by written consent, which could make non-negotiated acquisitions of the Company more difficult, and iv) the change of the Company's name from \"Jack Eckerd Corporation\" to \"Eckerd Corporation.\"\nIn connection with the consummation of the IPO, the shareholders of EDS Holdings Inc. (EDS) exchanged their shares for shares of the Company's common stock. This transaction was accounted for as a combination of companies under common control in a manner similar to a pooling of interests.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Principles of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany accounts have been eliminated in the consolidation.\n(b) Definition of Fiscal Year\nThe fiscal year ends on the Saturday nearest January 31. Fiscal years 1993, 1992 and 1991 ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively, consisted of 52 weeks.\n(c) Merchandise Inventories\nInventories consist principally of merchandise held for resale and are based on physical inventories taken throughout the year. Inventories are stated at the lower of cost (last-in, first-out--LIFO) or market. At January 29, 1994 and January 30, 1993, if the first-in, first-out (FIFO) method of valuing\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) inventories had been used by the Company, inventories would have been higher than reported by approximately $66,100 and $57,600, respectively.\n(d) Income Taxes\nEffective January 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS), \"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 of a change in tax rates on deferred tax assets or liabilities is recognized in income in the period that included the enactment.\nPreviously, the Company accounted for income taxes under Accounting Principles Board Opinion No. 11, which did not give recognition to future events other than the recovery of assets and settlement of liabilities at their carrying amounts. The adoption of SFAS No. 109 had no material effect on the Company's financial position or results of operations. Prior years' financial statements were not restated.\n(e) Depreciation Policy and Maintenance and Repairs\nPlant and equipment is depreciated principally by the straight-line method over the estimated useful lives of such assets. The principal lives used to compute depreciation are:\nBuildings........................................... 16-45 Furniture and equipment............................. 1-10 Transportation equipment............................ 1-8 Leasehold improvements.............................. 2-20 --------- ---------\nMaintenance and repairs are charged to expense as incurred. The Company's policy is to capitalize expenditures for renewals and betterments and to reduce the asset accounts and the related allowance for depreciation for the cost and accumulated depreciation of items replaced, retired or fully depreciated.\nThe 1992 balances for plant and equipment have been restated to reflect the write-off of certain fully depreciated assets during 1993.\n(f) Favorable Lease Interests\nFavorable lease interests represent the present value of the excess of current market rents at dates of acquisition over the below market rents of the Company's then existing operating leases of real property (principally store locations). Such costs are amortized by the interest method over the lives of the favorable leases averaging approximately twenty years.\n(g) Unamortized Debt Expenses\nUnamortized debt expenses represent underwriting discounts, professional fees and other costs related to the two issues of subordinated debentures which are amortized over the life of the related debentures; and professional fees and other costs related to the Company's long-term debt refinancings (see note 4) which are amortized over the life of the related agreements.\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) (h) Original Issue Debt Discount\nOriginal issue debt discount is the difference between the principal amount of the two issues of subordinated debentures and their issue price to the public. Such discount which is treated as a reduction of the principal amount of such debentures is amortized to provide a level interest cost over the term of the respective debenture issues.\n(i) Advertising Costs\nAdvertising costs are expensed when incurred and were $26,758, $45,918 and $47,998 for the years ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively.\n(j) Reclassifications\nCertain amounts have been reclassified in the 1991 and 1992 financial statements to conform to the 1993 financial statement presentation.\n(k) Statement of Cash Flows\nThe Company considers all liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nDuring 1992, the Company converted debentures, which were held by certain members of management, totaling $8,092 to 1,304,289 shares of Common Stock.\nCash paid for interest was $120,329, $128,896 and $116,661 for the years ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively.\n(1) Earnings (Loss) Per Share\nPrimary earnings per share have been computed based on the weighted average number of shares of common stock outstanding during each fiscal year (29,392,805 in 1993, 26,573,902 in 1992, and 25,677,103 in 1991) restated for the August 12, 1993 Reclassification and Stock Split.\n(3) EMPLOYEES' BENEFIT PLANS\n(a) Profit Sharing Plan\nThe Company has in effect a noncontributory profit sharing plan which covers all regular, full-time employees. The Company makes annual contributions to the Plan at the discretion of the Company's Board of Directors. All funds are held by a bank as trustee under a trust agreement. Included in operating and administrative expenses are charges accrued for contributions to the Plan of $8,765, $7,433 and $8,517 for January 29, 1994, January 30, 1993 and February 1, 1992, respectively.\nPlan assets at fair value, consisting of fixed income securities, the Company's stock and listed stocks, amounted to approximately $199.4 million for the plan year ended December 31, 1993.\n(b) Pension Plans\nThe Company has in effect a noncontributory pension plan covering all full-time employees who qualify as to age and length of service. Benefits are computed based on the average annual compensation for the five consecutive years that produce the highest average during the final ten years of creditable service. The Company's policy is to fund the Plan in accordance with minimum Internal Revenue Service (IRS) requirements.\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(3) EMPLOYEES' BENEFIT PLANS--(CONTINUED) The Company accounts for pension costs in accordance with Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions.\"\nThe following table sets forth the funded status of the Company's pension plan as of the most recent actuarial measurement dates, December 31, 1993 and 1992:\nNet periodic pension costs for the years ended January 29, 1994, January 30, 1993 and February 1, 1992 included the following (income) expense components:\nThe Company has in effect an Executive Supplemental Benefit Plan to provide additional income for its executives after their retirement as well as pre-retirement death benefits to beneficiaries of such executives. Annual benefits will generally be no greater than 25 percent of the participant's salary mid-point on the date the participant retires or separates from service with the Company.\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(4) LONG-TERM DEBT\nLong-term debt at January 29, 1994 and January 30, 1993 was:\nThe aggregate minimum annual maturities of long-term debt for the next five fiscal years are: 1994, $1,905; 1995, $67,765; 1996, $85,870; 1997, $85,583 and 1998, $95,040. Although the Tranche A term loan commitment requires a repayment of $28,348 during fiscal year 1994, the Company has excess availability under the revolving credit commitment, and accordingly, has not treated the 1994 required repayment as current.\n(a) On June 15, 1993, The Company entered into a new Credit Agreement, which provides for i) a $650,000 term loan facility (Senior Term Loans) consisting of a six-year amortizing Tranche A term loan facility of $500,000 (Tranche A Term Loans) and a seven-year amortizing Tranche B term loan facility of $150,000 (Tranche B Term Loans); and ii) a $300,000 six-year revolving credit facility ($30,000 of which is available as a swingline loan facility and $155,000 as a letter of credit and bankers' acceptance facility) (Revolving Loans).\nThe Company used the proceeds of (i) Tranche A Term Loan borrowings of $500,000, (ii) Tranche B Term Loan borrowings of $150,000, and (iii) Revolving Loan borrowings of $70,000 to (a) repay in full all amounts outstanding under the prior credit agreement dated as of July 13, 1990, as amended, with Morgan Guaranty Trust Company of New York and other lenders, which consisted of a revolving credit facility and a term loan facility; (b) to prepay in full the Hancock Senior Notes and the 11.75% Senior Notes, (c) to deposit with a trustee an amount sufficient to satisfy and discharge in full all indebtedness under the Floating Rate Notes; (d) to redeem approximately $295,200 of the 13% Discount Debentures (the remaining $50,000 was subsequently redeemed with the proceeds from the\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(4) LONG-TERM DEBT--(CONTINUED) issuance of the 9 1\/4% Senior Subordinated Notes (note 4(b)); (e) to redeem the 14 1\/2% Preferred Stock in full; and (f) to pay fees and expenses in connection with these transactions.\nAn extraordinary charge of $44,354 (net of tax benefit of $929) was recognized during the year ended January 29, 1994 in connection with the early repayment of debt and preferred stock from the proceeds of the new Credit Agreement, IPO and the Note issuance (note 4(b)).\nThe Tranche A Term Loans and the Revolving Loans bear interest at various rates approximating, at the Companys option (i) Prime plus 1 3\/4% or (ii) Adjusted LIBOR plus 2 3\/4%. The spread above Prime and LIBOR may decrease by 1\/2 of 1% in two separate instances if certain levels of funded debt and ratios of funded debt to specified measures of earnings are achieved by the Company.\nThe Tranche B Term Loans bear interest at various rates approximating, at the Company's option (i) Prime plus 2% or (ii) Adjusted LIBOR plus 3%.\nInterest on Prime borrowings will be paid quarterly. Interest on LIBOR borrowings will be payable at the end of the relevant interest period (one, two, three or six month periods, except that with respect to six-month periods, interest shall be payable every three months). The Company is required to pay a commitment fee of 1\/2 of 1% per annum on the undrawn amount of the term loan and revolving facilities. The Company is also required to pay Letter of Credit fees and Bankers' Acceptance fees.\nDuring 1993, the Company entered into interest rate cap agreements relating to the Credit Agreement. The cap agreements are for $200,000 and mature at various dates over the next three years. The cap agreements have an approximate 6% interest rate.\nPrincipal of the Tranche A Term Loans and the Tranche B Term Loans will be amortized on the following schedule:\nTRANCHE A TRANCHE B FISCAL YEAR TERM LOAN TERM LOAN ----------- ----------- ----------- 1994...................................... $ 28,348 -- 1995...................................... 66,146 -- 1996...................................... 85,045 -- 1997...................................... 85,045 -- 1998...................................... 85,044 9,449 1999...................................... 80,320 18,899 2000...................................... -- 113,393 ----------- ----------- ----------- -----------\nPrincipal of the Tranche A Term Loans will be amortized in quarterly payments and mature in full on July 31, 1999. Principal of the Tranche B Term Loans will be amortized in semi-annual payments and mature in full on June 15, 2000. The Company has the right to prepay any borrowings under the Credit Agreement in whole or in part at any time.\nThe Company is required to prepay borrowings under the Credit Agreement with (i) 50% of the consolidated excess cash flow (as calculated in accordance with the Credit Agreement) of the Company for the preceding fiscal year; (ii) in any fiscal year, the excess of the aggregate net proceeds of dispositions of assets of the Company and its subsidiaries over $6,000; (iii) in any fiscal year, the net proceeds of any incurrence of debt (other than indebtedness permitted under the Credit Agreement); and (iv) all of the net proceeds of any equity issuance until such prepayment or prepayments equal $75,000 (approximately 8,000 remain at January 29, 1994), and thereafter, 75% of such net proceeds.\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(4) LONG-TERM DEBT--(CONTINUED) Prepayments are to be applied pro rata between outstanding Tranche A Term loans and Tranche B Term Loans, applied pro rata among scheduled payments, and, after such loans are paid in full, to the Swingline Loans and then the Revolving Loans.\nThe borrowings under the Credit Agreement are secured by a pledge of all capital stock of the Company's subsidiaries, as well as substantially all personal property, including inventory and accounts receivable and certain real property (as defined), contain certain restrictive covenants which provide limitations on the Company with respect to incurring debt, the incurring of liens, making investments, payment of dividends and purchase of shares of stock of the Company, payment of lease expenses, consolidations and mergers, sale of assets, and transactions with affiliates. The Credit Agreement also requires the Company to satisfy certain financial ratios. At January 29, 1994, the Company was in compliance with these covenants.\n(b) On November 2, 1993, the Company issued $200,000 aggregate principal amount of 9 1\/4% Senior Subordinated Notes (Notes) due February 15, 2004. The Notes are unsecured and subordinated to all existing and future senior debt (as defined) of the Company and are redeemable at the option of the Company, in whole or in part, at any time after February 15, 1999 at various redemption prices (as defined) plus accrued interest to the date of redemption. Interest is payable semi-annually on February 15 and August 15 of each year, commencing February 15, 1994.\nThe Company used the net proceeds from the issuance of the Notes to redeem the remaining $50,000 of the 13% Discount Subordinated Debentures and $145,000 of the 11 1\/8% Subordinated Debentures (note 4(c)).\n(c) The 11 1\/8% subordinated debentures are subordinated to all existing and future senior debt (as defined) of the Company, and are redeemable at the option of the Company, in whole or in part, at anytime at 100% of their principal amount plus accrued interest to the date of redemption. During 1993, $145,000 face amount of these subordinated debentures were redeemed by the Company (note 4(b)).\n(d) The variable rate demand industrial development revenue refunding bonds currently have an interest rate which is a daily rate established by First National Bank of Chicago and is indicative of current bid-side yields of high grade tax-exempt securities. At the Company's option, and under certain conditions, the interest rate may be changed to a monthly rate or a fixed rate. The bonds are secured by the related buildings, leases and letters of credit.\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(5) INCOME TAXES\nFor fiscal years 1993, 1992 and 1991, the income tax provision before utilization of net operating losses and extraordinary item amounted to $2,556, $2,864 and $2,927, which differs from amounts computed by applying the Federal and State statutory rates of 38% in the year ended January 29, 1994 and 34% for the years ended January 30, 1993 and February 1, 1992 to earnings (loss) before income taxes and extraordinary items. The actual tax differs from the expected tax (benefit) as follows:\n\"Other\" consists principally of alternative minimum tax which is caused by differences in net operating loss utilization rates and depreciation. The amount of alternative minimum tax paid is available in future years to offset regular corporate income tax.\nFor the years ended January 30, 1993 and February 1, 1992, the Company utilized approximately $762 and $1,680, respectively, of net operating loss carryforwards for financial statement purposes.\nThe Company has Federal income tax loss carryforwards of approximately $332,600 for income tax purposes which are available to offset future taxable income, if any, through 2008.\nThe Company's Federal income tax returns have been examined through year-end 1984 and any assessments have been paid or accrued. The Federal income tax returns for 1985, 1986, 1987 and 1988 are currently being examined. The Company believes that an adequate provision for income taxes has been made for all open years.\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(5) INCOME TAXES--(CONTINUED) Temporary differences and carryforwards which give rise to deferred tax assets and liabilities are as follows:\nUpon adoption of Statement 109, effective January 31, 1993, the Company determined a valuation allowance requirement in the amount of $108.9 million.\n(6) REDEEMABLE PREFERRED STOCK\nAs discussed in note 4(a), seventy-five thousand shares of 14 1\/2% cumulative redeemable preferred stock with a stated value of $1,000 ($.01 par value) were redeemed during 1993. Dividends of $4,924 were paid during 1993.\n(7) STOCKHOLDERS' EQUITY\n(a) Common Stock\nThe Company's authorized common stock consists of 100,000,000 shares of Common Stock, par value $.01 per share (of which 3,518,728 shares are Nonvoting Common Stock (Series I), par value $.01 per share).\n(b) Preferred Stock\nThe Company's authorized preferred stock consists of 20,000,000 shares. The preferred stock is issuable in series with terms as fixed by the Board of Directors. No preferred stock has been issued.\n(c) Stock Options\nThe Company reserves 1,666,667 shares of its Common Stock for the granting of stock options and other incentive awards to officers, directors and key employees under the 1993 Stock Option and Incentive Plan of Eckerd Corporation. Options are granted at prices which are not less than the fair market value of a share of common stock on the date of grant. Commencing three years after the date of grant, all options are exercisable to the extent of 50%, with an additional 25% exercisable after each of the next two successive years. Unexercised options expire ten years after the date of grant. Options\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(7) STOCKHOLDERS' EQUITY--(CONTINUED) granted under prior plans were surrendered and granted under the terms of the 1993 plan. Shares under option and option prices have been adjusted to reflect the Reclassification and the Stock Split (note 1(b)).\nAs of January 29, 1994, January 30, 1993 and February 1, 1992, 222,668, 363,451 and 96,929 shares of Common Stock were available for grant. At January 29, 1994, options for 450,393 shares of Common Stock were exercisable at $.56-$14.00 per share. At January 30, 1993, options for 490,777 shares of Common Stock were exercisable at $.56-$30.00 per share. At February 1, 1992, options for 488,357 shares of Common Stock were exercisable at $.56-$20.62 per share.\nA summary of changes during the years ended January 29, 1994, January 30, 1993 and February 1, 1992 is set forth below:\nOptions previously granted at prices greater than $14.00 per share were modified to $14.00 per share at the date of the IPO.\nNo accounting entries will be made until after the options have been exercised at which time the par value of shares sold will be credited to common stock and the excess of the proceeds of the sale over par value of shares sold will be credited to capital in excess of par value.\n(8) COMMITMENTS\nThe Company conducts the major portion of its retail operations from leased store premises under leases that will expire within the next 25 years. Such leases generally contain renewal options exercisable at the option of the Company. In addition to minimum rental payments, certain leases provide for payment of taxes, maintenance, and percentage rentals based upon sales in excess of stipulated amounts.\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(8) COMMITMENTS--(CONTINUED) The rental expense for the years ended January 29, 1994, January 30, 1993 and February 1, 1992 was:\nAt January 29, 1994, minimum rental commitments under noncancelable leases were as follows:\nFISCAL YEAR ----------- 1994.............................................. $ 102,834 1995.............................................. 98,440 1996.............................................. 93,590 1997.............................................. 86,977 1998.............................................. 75,255 Thereafter........................................ 471,496 ----------- $ 928,592 ----------- -----------\nIn 1987, the Company entered into an operating lease agreement for 72 stores with a third-party lessor established by an affiliate of Merrill Lynch & Co. (which, through affiliated entities, controls a majority of the Company's common stock). The lease agreement has certain restrictive covenants, which, upon violation by the Company, gives the lessor the right to require the lessee to purchase the leased stores at the remaining balance of the lease contract. At January 29, 1994, the balance subject to the repurchase terms is $38,046. At January 29, 1994, the Company was in compliance with these covenants.\nDuring 1993, the Company sold certain photo processing equipment to an unrelated third party for approximately $35,000, and entered into a five-year lease with respect to such equipment. No gain or loss was recorded in connection with this transaction. Annual lease payments of $6,892 are required over the term of the lease.\nDuring 1993, the Company and Integrated Systems Solutions Corporation (ISSC) entered into a Systems Operations Service Agreement (Service Agreement) pursuant to which ISSC will manage the Company's entire information systems operation, including the implementation of a new point-of-sale system with scanning capabilities. The Service Agreement has a ten year term and the total payments to be made by the Company are expected to be between $320,000 and $440,000 over such term, depending on the optional services utilized.\n(9) TRANSACTIONS WITH RELATED PARTIES\nIn April 1989, the Company entered into a \"Master Lease\" agreement with a third-party lessor established by an affiliate of Merrill Lynch & Co. (which, through affiliated entities controls a majority of the Company's common stock) whereby such lessor would finance the acquisition of store sites and the construction of buildings and acquisition of equipment. As of January 29, 1994, there were 12 stores leased under the agreement with an aggregate cost of approximately $18,400. The Company pays the\nECKERD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS, EXCEPT SHARE AMOUNTS)\n(9) TRANSACTIONS WITH RELATED PARTIES--(CONTINUED) Merrill Lynch affiliate a structure fee of 1% of the cost of land, buildings and equipment financed under the Master Lease plus an administration fee. The Company paid the Merrill Lynch affiliate fees aggregating $44, $45 and $408 for the years ended January 29, 1994, January 30, 1993 and February 1, 1992, respectively.\nIn July 1989, the Company entered into a Placement Agency Agreement with an affiliate of Merrill Lynch & Co. whereby such affiliate would act as exclusive placement agent for the private placement of up to a maximum of $200,000 at any one time, of unsecured notes. The Company did not issue any of these unsecured notes during the years ended January 29, 1994 and January 30, 1993. There were no notes outstanding under this facility at January 29, 1994 and January 30, 1993.\nDuring 1993, Merrill Lynch & Co., as one of the representatives of the underwriters in the IPO, received underwriting commissions and related fees of $1,847. In addition, as sole underwriter in the issuance of the Notes, Merrill Lynch & Co. received approximately $4,000 in underwriting discounts from the Company.\n(10) SUBSEQUENT EVENT\nEffective January 30, 1994, the Company entered into an agreement in principal to sell certain assets of its Vision Group division. The Company does not expect to recognize any significant gain or loss upon disposition.\nSCHEDULE V\nECKERD CORPORATION AND SUBSIDIARIES PROPERTY, PLANT AND EQUIPMENT YEARS ENDED JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS)\n- ---------------\nNotes:\n(a) Transfers from construction in progress and reclassifications.\n(b) Acquisition of certain drug store assets.\nSCHEDULE VI\nECKERD CORPORATION AND SUBSIDIARIES ACCUMULATED DEPRECIATION AND AMORTIZATION OF PLANT AND EQUIPMENT YEARS ENDED JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS)\n- ---------------\nNotes: (a) Reclassifications.\nDepreciation is expensed principally by the straight line method over the estimated useful lives of such assets as follows: Buildings 16-45 years; furniture and equipment 1-10 years; transportation equipment 1-8 years and leasehold improvements 2-20 years.\nSCHEDULE VIII\nECKERD CORPORATION AND SUBSIDIARIES RESERVES YEARS ENDED JANUARY 29, 1994, JANUARY 30, 1993 AND FEBRUARY 1, 1992 (IN THOUSANDS)\n- ---------------\nNotes:\n(a) This reserve is deducted from receivables in the balance sheets.\nEXHIBIT INDEX ECKERD CORPORATION FORM 10-K FOR THE FISCAL YEAR ENDED JANUARY 29, 1994\n- ---------------\n* Incorporated by reference.","section_15":""}
{"filename":"846729_1994.txt","cik":"846729","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a party to routine litigation incidental to its business, primarily involving claims for personal injuries and property damage incurred in the transportation of freight. The Company believes adverse results in one or more of these cases would not have a material adverse effect on its competitive position, financial position or its results of operations. The Company maintains insurance in an amount which Management believes is currently sufficient to cover its risks.\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\nAmerican Freightways Corporation's Common Stock has been traded under the symbol \"AFWY\" on the National Market System of the National Association of Securities Dealers Automated Quotation System (NASDAQ). The following table sets forth, for the periods indicated, the range of high and low prices for the Company's Common Stock as reported by NASDAQ through February 13, 1995. The latest price for the Company's Common Stock on February 13, 1995, as reported by the NASDAQ was $20.50 per share. At February 13, 1995, there were approximately 2,116 holders of record of the Company's Common Stock. The following market prices have been adjusted to reflect a 2-for-1 stock split paid on May 27, 1993, to shareholders of record on May 7, 1993.\nThe Company has not paid cash dividends in the past and does not intend to pay cash dividends in the foreseeable future. Under certain of the Company's loan agreements, the Company is subject to certain restrictions on its ability to pay dividends. See Note 3 to the Consolidated Financial Statements incorporated by reference herein.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data are derived from consolidated financial statements of the Company. The data should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the Consolidated Financial Statements, related notes and other financial information included elsewhere herein.\n(1) Assumes the change in accounting method for recognition of revenue as required by EITF 91-9 occurred January 1, 1990.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis Item is incorporated by this reference to Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994, pages 25 through 31.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe report of independent auditors and consolidated financial statements included on pages 32 through 40 of the Annual Report to Shareholders for the year ended December 31, 1994, are incorporated herein by reference.\nQuarterly Results of Operations on page 39 of the Annual Report to Shareholders for the year ended December 31, 1994, 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 REGISTRANT\nThe executive officers and directors of American Freightways as of February 13, 1995, are as follows:\nThe remainder of this Item 10, Directors and Executive Officers of the Registrant, is incorporated by this reference to Registrant's Notice and Proxy Statement for its Annual Meeting of Shareholders to be held on Tuesday, March 28, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis Item is incorporated by this reference to applicable portions of the Registrant's Notice and Proxy Statement for its 1995 Annual Meeting of Shareholders to be held on Tuesday, March 28, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis Item is incorporated by this reference to applicable portions of the Registrant's Notice and Proxy Statement for its 1995 Annual Meeting of Shareholders to be held on Tuesday, March 28, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND TRANSACTIONS\nThis Item is incorporated by this reference to applicable portions of the Registrant's Notice and Proxy Statement for its 1995 Annual Meeting of Shareholders to be held on Tuesday, March 28, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (l) and (2) The response to this portion of Item 14 is submitted as a separate section of this report.\n(3) The exhibits as listed in the Exhibit Index, are submitted as a separate section of this report.\n(b) Current Reports on Form 8-K:\nNone.\n(c) See Item 14(a)(3) above.\n(d) The response to this portion of Item 14 is submitted as a separate section of this report.\nINDEX TO EXHIBITS\n3(a) Amended and Restated Articles of Incorporation of American Freightways Corporation.\n3(b) Amended and Restated Bylaws of American Freightways Corporation.\n10(a) Loan and Security Agreement among Union Planters National Bank, the Registrant and certain subsidiaries dated January 18, 1989, incorporated by reference from the Registrant's Registration Statement on Form S-1 dated March 30, 1989, No. 33-27073.\n10(b) Amended Stock Purchase Plan for Certain employees of Registrant and subsidiaries incorporated by reference to Registrant's Registration Statement on Form S-1 dated February 19, 1991, No. 33 38997.\n10(c) Non-statutory Stock Option Plan for Independent Directors incorporated by reference to Registrant's Registration Statement on Form S-1 dated February 19, 1991, No. 33-38997.\n10(d) Note Agreement among Prudential Capital Corporation, the Registrant and certain subsidiaries dated December 5, 1991 incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n10(e) Credit Agreement among NationsBank of Texas, N. A., as Agent, the Registrant and certain subsidiaries dated April 14, 1992 incorporated by reference to Registrant's Form 10-Q for the quarterly period ended March 31, 1992.\n10(f) Amendment Number 1 to Note Agreement among Prudential Capital Corporation, the Registrant and certain subsidiaries dated December 5, 1991 incorporated by reference to Registrant's Form 10-Q for the quarterly period ended June 30, 1992.\n10(g) Promissory Note among NationsBank of Texas, N.A., the Registrant and certain subsidiaries dated August 15, 1992, incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n10(h) First Amendment to Credit Agreement among NationsBank of Texas, N.A., as Agent, the Registrant and certain subsidiaries dated December 30, 1992, incorporated by reference to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n10(i) 1993 Chairman Stock Option Plan incorporated by reference to Registrant's Notice and Proxy Statement for its Annual Meeting of Shareholders held on Thursday, April 22, 1993.\n10(j) 1993 Non-Employee Director Stock Option Plan incorporated by reference to Registrant's Notice and Proxy Statement for its Annual Meeting of Shareholders held on Thursday, April 22, 1993.\n10(k) 1993 Stock Option Plan for Key Employees incorporated by reference to Registrant's Registration Statement on Form S-8 dated June 2, 1993.\n10(l) $50,000,000 Master Shelf Agreement ($10,000,000 note attached) with The Prudential Insurance Company of America dated September 3, 1993, incorporated by reference to Registrant's Form 10-Q for the quarterly period ended September 30, 1993.\n10(m) Second Amendment to Credit Agreement among NationsBank of Texas, N.A., as Agent, the Registrant and certain subsidiaries dated February 1, 1994, incorporated by reference to Registrant's Form 10-K for the fiscal year ended December 31, 1993.\n10(n) $10,000,000 Note dated February 2, 1994, issued under the $50,000,000 Master Shelf Agreement with The Prudential Insurance Company of America dated September 3, 1993, incorporated by reference to Registrant's Form 10-K for the fiscal year ended December 31, 1993.\n10(o) American Freightways Corporation Excess Benefit Plan dated September 1, 1993, incorporated by reference to Registrant's Form 10-K for the fiscal year ended December 31, 1993.\n10(p) American Freightways Corporation Amended and Restated Excess Benefit Plan dated December 28, 1993, incorporated by reference to Registrant's Form 10-K for the fiscal year ended December 31, 1993.\n10(q) Amended Stock Purchase Plan for Certain employees of Registrant and subsidiaries incorporated by reference to Registrant's Registration Statement on Form S-8 dated March 18, 1994.\n10(r) $10,000,000 Note dated April 13, 1994, issued under the $50,000,000 Master Shelf Agreement with The Prudential Insurance Company of America dated September 3, 1993, incorporated by reference to Registrant's Form 10-Q for the quarterly period ended June 30, 1994.\n10(s) Amended and Restated Credit Agreement among NationsBank of Texas, N.A., as Agent, the Registrant and certain subsidiaries dated October 20, 1994.\n10(t) Letter Amendment No. 3 to Note Agreement with The Prudential Insurance Company of America dated October 19, 1994.\n10(u) Letter Amendment No. 1 to Master Shelf Agreement with The Prudential Insurance Company of America dated October 19, 1994.\n10(v) Letter Amendment No. 2 to Master Shelf Agreement with The Prudential Insurance Company of America dated December 14, 1994.\n13 Annual Report to Stockholders for the fiscal year ended December 31, 1994.\n22 Subsidiaries of Registrant\n24 Consent of Ernst & Young LLP\n27 Financial Data Schedule\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 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. Dated this 13th day of February, 1995.\nAmerican Freightways Corporation\nBy: \/s\/James R. Dodd ---------------- James R. Dodd Chief Financial Officer; Director (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.\n\/s\/F. S. Garrison February 13, 1995 - --------------------------------------- ----------------- F. S. Garrison Date Chairman of the Board of Directors, Chief Executive Officer (Principal Executive Officer)\n\/s\/James R. Dodd February 13, 1995 - --------------------------------------- ----------------- James R. Dodd Date Chief Financial Officer; Director (Chief Accounting Officer)\n\/s\/Tom Garrison February 13, 1995 - --------------------------------------- ----------------- Tom Garrison Date Director\n\/s\/T. J. Jones February 13, 1995 - --------------------------------------- ----------------- T. J. Jones Date Director\n\/s\/Frank Conner February 13, 1995 - --------------------------------------- ----------------- Frank Conner Date Director\n\/s\/Ben A. Garrison February 13, 1995 - --------------------------------------- ----------------- Ben A. Garrison Date Director\n\/s\/Ken Reeves February 13, 1995 - --------------------------------------- ----------------- Ken Reeves Date Director\nANNUAL REPORT ON FORM 10-K--ITEM 8, ITEM 14(A)(1) AND (2), (C) AND (D) AMERICAN FREIGHTWAYS CORPORATION AND SUBSIDIARIES LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of American Freightways Corporation and subsidiaries included in the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994 are incorporated by reference in Item 8:\nConsolidated Balance Sheets as of December 31, 1994 and 1993.\nConsolidated Statements of Income for the years ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992.\nNotes to Consolidated Financial Statements--December 31, 1994.\nThe following consolidated financial statement schedules of American Freightways Corporation and subsidiaries are included in Item 14(d):\nAMERICAN FREIGHTWAYS CORPORATION AND SUBSIDIARIES\nConsolidated Financial Statement Schedule:\nSchedule VIII Valuation and Qualifying Accounts\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 or are inapplicable, and therefore have been omitted.\nSCHEDULE VIII\nVALUATION AND QUALIFYING ACCOUNTS\nAMERICAN FREIGHTWAYS CORPORATION\nNote 1 - Recoveries of amounts previously written off.\nNote 2 - Uncollectible accounts written off.","section_15":""}
{"filename":"97349_1994.txt","cik":"97349","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings\nLitigation-Information relative to legal proceedings pending against Texaco Inc. and subsidiary companies is presented in Note 17, Contingent Liabilities, on page 59 of Texaco Inc.'s 1994 Annual Report to Stockholders, which note is incorporated herein by reference.\nAs of December 31, 1994, Texaco Inc. and its subsidiaries were parties to various proceedings instituted by governmental authorities arising under the provisions of applicable laws or regulations relating to the discharge of materials into the environment or otherwise relating to the protection of the environment, none of which is material to the business or financial condition of the Company. The following is a brief description of proceedings which, because of the amounts involved, require disclosure under applicable Securities and Exchange Commission regulations.\nOn June 9, 1992, an administrative complaint was served on Texaco Chemical Company (\"TCC\")* by the U.S. Environmental Protection Agency (\"EPA\"), Region VI, alleging certain violations of the State Implementation Plan at TCC's Port Neches, Texas chemical plant. The EPA is seeking civil penalties of $149,000. Texaco Inc. is contesting liability.\nOn December 28, 1992, an administrative complaint was served on TCC by the EPA, Region VI, alleging hazardous waste, PCB, release notification and reporting violations at TCC's Port Neches chemical plant. The EPA is seeking civil penalties of $3.8 million. Texaco Inc. is contesting liability.\nOn January 21, 1994, an administrative proceeding was initiated by the Texas Natural Resource Conservation Commission (\"TNRCC\"), alleging violations of the Texas Solid Waste Disposal Act and the Texas Water Code at TCC's Port Neches chemical plant. The TNRCC is seeking civil penalties of $381,840 and remediation of alleged violations. Texaco Inc. is contesting liability.\nOn May 23, 1994, the EPA, Region VII, instituted an administrative proceeding alleging that on 12 occasions pipelines owned by Texaco Trading and Transportation Inc. (\"TTTI\") released oil into surface waters in violation of the Federal Clean Water Act. The agency is seeking a penalty of $10,000 for each release. TTTI is contesting liability.\nOn February 15, 1995, Texaco Refining and Marketing Inc. (\"TRMI\") and Star Enterprise (\"Star\") settled an administrative matter pending before the Pennsylvania Department of Environmental Resources. The State alleged that hydrocarbons were discharged into groundwaters at the Pittsburgh Terminal, formerly owned by TRMI, in violation of Pennsylvania's Clean Streams Act and Solid Waste Disposal Act.\nOn February 22, 1995, Texaco Refining and Marketing (East) Inc. and Star entered into an Agreed Judicial Consent Order to settle an action contemplated against them and another company by the TNRCC alleging violations of the Texas Solid Waste Disposal Act and Texas Water Code at Star's Port Arthur, Texas refinery.\n_______________ * Texaco Chemical Company was sold on April 21, 1994 and, by agreement, Texaco Inc. retains obligations applicable to events occurring prior to the closing date.\nIn February 1995, TRMI settled an investigative matter conducted by the California Air Resources Board to determine TRMI's and other gasoline marketers' compliance with California's additive injection requirements during 1992 and 1993.\nIn February 1995, Texaco Inc., Texaco Caribbean Inc. and Texaco Puerto Rico Inc. settled a suit filed in 1991 against the three companies by the Virgin Islands Water and Power Authority (\"WAPA\"). The suit alleged that a leak from an underground storage tank at a Texaco service station in St. Croix contaminated a WAPA water well.\nIn addition, Texaco Inc., on behalf of itself and its subsidiaries and affiliates, has agreed to participate in the U.S. Environmental Protection Agency's Toxic Substances Control Act (\"TSCA\") Section 8(e) Compliance Audit Program. There are 125 participants in this program. As a participant, Texaco has agreed to audit its files for materials which under current EPA guidelines would be subject to substantial risk notification under Section 8(e) of TSCA and to pay stipulated penalties for each such report submitted under this program. Based on its audit to date, Texaco estimates that its liability will be in excess of $100,000, but is unable to calculate the exact amount at this time. However, under this program, Texaco's liability cannot exceed $1 million in the aggregate. No administrative proceeding is pending; however, Texaco will be required to enter an Administrative Order On Consent pursuant to this program in late 1995 or 1996.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\n______________________\nExecutive Officers of Texaco Inc.\nThe executive and other elected officers of Texaco Inc. as of March 24, 1995 are:\nFor more than five years, each of the officers of Texaco Inc. listed above, except for William C. Bousquette, has been actively engaged in the business of Texaco Inc. or one of its subsidiary or affiliated companies.\nMr. Bousquette joined Texaco in January 1995 as Senior Vice President and Chief Financial Officer. Prior to joining Texaco, Mr. Bousquette was Executive Vice President and Chief Financial Officer of Tandy Corporation. Mr. Bousquette joined Tandy in 1990 as Chief Financial Officer.\nThere is no family relationship among any of the officers of Texaco Inc.\nPART II\nThe following information, contained in Texaco Inc.'s 1994 Annual Report to Stockholders, is incorporated herein by reference. The page references indicated are to the actual and complete paper document version of Texaco Inc.'s 1994 Annual Report to Stockholders, as provided to stockholders:\nPART III\nThe following information, contained in Texaco Inc.'s Proxy Statement dated March 27, 1995, relating to the 1995 Annual Meeting of Stockholders, is incorporated herein by reference. The page references indicated are to the actual and complete paper document version of Texaco Inc.'s 1995 Proxy Statement, as provided to stockholders:\nPART IV\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K The following information, contained in Texaco Inc.'s 1994 Annual Report to Stockholders, is incorporated herein by reference. The page references indicated are to the actual and complete paper document version of Texaco Inc.'s 1994 Annual Report to Stockholders, as provided to stockholders: (a) The following documents are filed as part of this report:\nFinancial statements and schedules of certain affiliated companies have been omitted in accordance with the provisions of Rule 3.09 of Regulation S-X.\nFinancial Statement Schedules are omitted as permitted under Rule 4.03 and Rule 5.04 of Regulation S-X.\n3. Exhibits _ (3.1) Copy of Restated Certificate of Incorporation of Texaco Inc., as amended to and including November 9, 1994, including Certificate of Designations, Preferences and Rights of Series B ESOP Convertible Preferred Stock, Series D Junior Participating Preferred Stock, Series F ESOP Convertible Preferred Stock and Series G, H, I and J Market Auction Preferred Shares. _ (3.2) Copy of By-Laws of Texaco Inc., as amended to and including February 26, 1993. (This document was previously filed as Exhibit 3.2 to Texaco Inc.'s Annual Report on Form 10-K for 1992 dated March 17, 1993, SEC File No. 1-27, and is being filed herein only for EDGAR purposes.) _ (4) Instruments defining the rights of holders of long-term debt of Texaco Inc. and its subsidiary companies are not being filed, since the total amount of securities authorized under each of such instruments does not exceed 10 percent of the total assets of Texaco Inc. and its subsidiary companies on a consolidated basis. Texaco Inc. agrees to furnish a copy of any instrument to the Securities and Exchange Commission upon request. _ (10(iii)(a)) Texaco Inc.'s Stock Incentive Plan, incorporated by reference to pages A-1 through A-8 of Texaco Inc.'s proxy statement dated April 5, 1993, SEC File No. 1-27. _ (10(iii)(b)) Texaco Inc.'s Stock Incentive Plan, incorporated by reference to pages IV-1 through IV-5 of Texaco Inc.'s proxy statement dated April 10, 1989, as such Plan was amended by Exhibit A to Texaco Inc.'s proxy statement dated March 29, 1991, incorporated herein by reference, SEC File No. 1-27.\n_ (10(iii)(c)) Texaco Inc.'s Incentive Bonus Plan, incorporated by reference to page IV-5 of Texaco Inc.'s proxy statement dated April 10, 1989, SEC File No. 1-27. _ (10(iii)(d)) Description of Texaco Inc.'s Supplemental Pension Benefits Plan, incorporated by reference to pages 8 and 9 of Texaco Inc.'s proxy statement dated March 17, 1981, SEC File No. 1-27. _ (10(iii)(e)) Description of Texaco Inc.'s Revised Supplemental Plan, incorporated by reference to pages 24 through 27 of Texaco Inc.'s proxy statement dated March 9, 1978, SEC File No. 1-27. _ (10(iii)(f)) Description of Texaco Inc.'s Revised Incentive Compensation Plan, incorporated by reference to pages 10 and 11 of Texaco Inc.'s proxy statement dated March 13, 1969, SEC File No. 1-27.\t _ (11) Computation of Earnings Per Share of Common Stock of Texaco Inc. and Subsidiary Companies. _ (12.1) Computation of Ratio of Earnings to Fixed Charges of Texaco on a Total Enterprise Basis. _ (12.2) Definitions of Selected Financial Ratios. _ (13) Copy of those portions of Texaco Inc.'s 1994 Annual Report to Stockholders that are incorporated by reference into this Annual Report on Form 10-K. _ (21) Listing of significant Texaco Inc. subsidiary companies and the name of the state or other jurisdiction in which each subsidiary was organized. _ (23) Consent of Arthur Andersen LLP. _ (24) Powers of Attorney for the Directors and certain Officers of Texaco Inc. authorizing, among other things, the signing of Texaco Inc.'s Annual Report on Form 10-K on their behalf. - (27) Financial Data Schedule.\n(b) _ Reports on Form 8-K. During the fourth quarter of 1994, Texaco Inc. filed Current Reports on Form 8-K relating to the following events: 1. October 25, 1994 (date of earliest event reported: October 25, 1994) Item 5.","section_5":"Item 5. Other Events-reported that Texaco issued an Earnings Press Release for the third quarter and first nine months of 1994. Texaco appended as an exhibit thereto a copy of the Press Release entitled \"Texaco Reports Results for the Third Quarter and First Nine Months of 1994\" dated October 25, 1994. 2. December 1, 1994 (date of earliest event reported: November 29, 1994) Item 5. Other Events-reported that Texaco had entered into a memorandum of understanding with Apache Corporation outlining the terms of the sale of certain producing fields to Apache. Texaco appended as an exhibit thereto a copy of the Press Release entitled \"Texaco Announces Sale of Producing Properties to Apache Corporation\" dated November 29, 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, in the Town of Harrison, State of New York, on the 27th day of March, 1995.\nTEXACO INC. (Registrant)\t Carl B. Davidson By ---------------------------- (Carl B. Davidson)\t Vice President and Secretary\nAttest: R. E. Koch By ------------------------ (R. E. Koch) Assistant Secretary\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 date indicated.\nAlfred C. DeCrane, Jr. .. Chairman of the Board and Chief Executive Officer (Principal Executive Officer) William C. Bousquette ... Senior Vice President and Chief Financial Officer (Principal Financial Officer) Robert C. Oelkers ....... Comptroller (Principal Accounting Officer)\nDirectors: Robert A. Beck Thomas S. Murphy\t John Brademas Charles H. Price, II Willard C. Butcher Robin B. Smith Edmund M. Carpenter William C. Steere, Jr. Alfred C. DeCrane, Jr. Thomas A. Vanderslice Franklyn G. Jenifer William Wrigley Allen J. Krowe\nR. E. Koch By -------------------------------------- (R. E. Koch) Attorney-in-fact for the above-named officers and directors\nMarch 27, 1995\nINDEX TO EXHIBITS\nThe exhibits designated by an asterisk are incorporated herein by reference to documents previously filed by Texaco Inc. with the Securities and Exchange Commission, SEC File No. 1-27.\nExhibits\t (3.1) Copy of Restated Certificate of Incorporation of Texaco Inc., as amended to and including November 9, 1994, including Certificate of Designations, Preferences and Rights of Series B ESOP Convertible Preferred Stock, Series D Junior Participating Preferred Stock, Series F ESOP Convertible Preferred Stock and Series G, H, I and J Market Auction Preferred Shares\t\n(3.2) Copy of By-Laws of Texaco Inc., as amended to and including February 26, 1993. (This document was previously filed as Exhibit 3.2 to Texaco Inc.'s Annual Report on Form 10-K for 1992 and is being filed herein only for EDGAR purposes).\t\n(10(iii)(a)) Texaco Inc.'s Stock Incentive Plan, incorporated by reference to pages A-1 through A-8 of Texaco Inc.'s proxy statement dated April 5, 1993. *\n(10(iii)(b)) Texaco Inc.'s Stock Incentive Plan, incorporated by reference to pages IV-1 through IV-5 of Texaco Inc.'s proxy statement dated April 10, 1989, as such Plan was amended by Exhibit A to Texaco Inc.'s proxy statement dated March 29, 1991, incorporated herein by reference. *\n(10(iii)(c)) Texaco Inc.'s Incentive Bonus Plan, incorporated by reference to page IV-5 of Texaco Inc.'s proxy statement dated April 10, 1989. *\n(10(iii)(d)) Description of Texaco Inc.'s Supplemental Pension Benefits Plan, incorporated by reference to pages 8 and 9 of Texaco Inc.'s proxy statement dated March 17, 1981. *\n(10(iii)(e)) Description of Texaco Inc.'s Revised Supplemental Plan, incorporated by reference to pages 24 through 27 of Texaco Inc.'s proxy statement dated March 9, 1978. *\n(10(iii)(f)) Description of Texaco Inc.'s Revised Incentive Compensation Plan, incorporated by reference to pages 10 and 11 of Texaco Inc.'s proxy statement dated March 13, 1969. *\n(11) Computation of Earnings Per Share of Common Stock of Texaco Inc. and Subsidiary Companies.\t\n(12.1) Computation of Ratio of Earnings to Fixed Charges of Texaco on a Total Enterprise Basis.\t\n\t\t\t\n(12.2) Definitions of Selected Financial Ratios.\n(13) Copy of those portions of Texaco Inc.'s 1994 Annual Report to Stockholders that are incorporated by reference into this Annual Report on Form 10-K.\t\n(21) Listing of significant Texaco Inc. subsidiary companies and the name of the state or other jurisdiction in which each subsidiary was organized.\t\n(23) Consent of Arthur Andersen LLP.\t\n(24) Powers of Attorney for the Directors and certain Officers of Texaco Inc. authorizing, among other things, the signing of Texaco Inc.'s Annual Report on Form 10-K on their behalf.\n(27) Financial Data Schedule.\nCALTEX GROUP OF COMPANIES COMBINED FINANCIAL STATEMENTS\nDecember 31, 1994\nCALTEX GROUP OF COMPANIES COMBINED FINANCIAL STATEMENTS DECEMBER 31, 1994\nINDEX\nPage ----\nGeneral Information 1-2\nIndependent Auditors' Report 3\nCombined Balance Sheet 4-5\nCombined Statement of Income 6\nCombined Statement of Retained Earnings 7\nCombined Statement of Cash Flows 7\nNotes to Combined Financial Statements 8-18\nNote: Financial statement schedules are omitted as permitted by Rule 4.03 and Rule 5.04 of Regulation S-X.\nCALTEX GROUP OF COMPANIES GENERAL INFORMATION\nThe Caltex Group of Companies (Group) is jointly owned 50% each by Chevron Corporation and Texaco Inc. The private joint venture was created in Bahrain in 1936 by its two owners to produce, transport, refine and market crude oil and refined products. The Group is comprised of the following companies:\n* Caltex Petroleum Corporation, a company incorporated in Delaware, that through its many subsidiaries and affiliates, conducts refining, marketing and transporting activities in the Eastern Hemisphere;\n* P. T. Caltex Pacific Indonesia, an exploration and production company incorporated and operating in Indonesia;\n* American Overseas Petroleum Limited, a company incorporated in the Bahamas, that, through its subsidiaries, manages certain exploration and production operations in Indonesia in which Chevron and Texaco have interests, but not necessarily jointly or in the same properties.\nA brief description of each company's operations and the Group's environmental activities follows:\nCaltex Petroleum Corporation (Caltex) -------------------------------------\nThrough its subsidiaries and affiliates, Caltex operates in 61 countries with some of the highest economic and petroleum growth rates in the world, principally in Africa, Asia, the Middle East, New Zealand and Australia. Certain refining and marketing operations are conducted through joint ventures, with equity interests in 14 refineries in 11 countries. Caltex' share of refinery inputs approximated 920,000 barrels per day in 1994. Caltex continues to improve its refineries with investments designed to provide higher yields and meet environmental regulations. Construction of a new 130,000 barrels per day refinery in Thailand is progressing with completion anticipated in 1996. At year end 1994, Caltex had over 8,000 employees, of which about 3% were located in the United States.\nWith a strong presence in its principal operating areas, Caltex has an average market share of 17.4% with refined product sales of approximately 1.3 million barrels per day in 1994. Caltex built 119 new branded retail outlets during 1994 and refurbished 177 existing locations in its aim to upgrade its retail distribution network.\nCaltex conducts international crude oil and refined product logistics and trading operations from a subsidiary in Singapore. Other offices are located in London, Dallas, Capetown, Bahrain and Tokyo. The company has an interest in a fleet of vessels and owns or has equity interests in numerous pipelines, terminals and depots. Currently, Caltex is active in the petrochemical business, particularly in Japan and South Korea.\nP. T. Caltex Pacific Indonesia (CPI) ------------------------------------\nCPI holds a Production Sharing Contract in Central Sumatra for which the Indonesian government granted an extension to the year 2021 during 1992. CPI also acts as operator for four other petroleum contract areas in Sumatra, which are jointly held by Chevron and Texaco. Exploration is pursued through an area comprising 2.446 million acres with production established in the giant Minas and Duri fields, along with more than 80 smaller fields. Gross production from fields operated by CPI for 1994 was 718,000 barrels per day. CPI entitlements are sold to its shareholders, who use it in their systems or sell it to third parties. At year-end 1994, CPI had over 6,400 employees, all located in Indonesia.\nCALTEX GROUP OF COMPANIES GENERAL INFORMATION\nAmerican Overseas Petroleum Limited (AOPL) ------------------------------------------\nIn addition to coordinating the CPI activities, AOPL, through its subsidiary Amoseas Indonesia Inc., manages Texaco's and Chevron's undivided interest holdings which include ten contract areas in Indonesia, excluding Sumatra. Oil production is currently established in two contract areas, while exploration was being pursued in seven others. Before year end 1994, two of those seven exploration areas had been relinquished. The remaining area is in Darajat, West Java, which contains geothermal reserves sufficient to supply a 55-megawatt power generating plant for over 30 years. Production of the geothermal reserves began in 1994 and amounted to 62,185,795 KWH. AOPL's 1994 share of crude oil production amounted to 18,600 barrels per day. At year end, AOPL had 254 employees, of which about 13% were located in the United States.\nEnvironmental Activities ------------------------\nThe Group's activities are subject to environmental, health and safety regulations in each of the countries in which it operates. Such regulations vary significantly in degree of scope, standards and enforcement. The Group's policy is to comply with all applicable environmental, health and safety laws and regulations. The Group has an active program to ensure its environmental standards are maintained, which includes closely monitoring applicable statutory and regulatory requirements, as well as enforcement policies, in each of the countries in which it operates, and conducting periodic environmental compliance audits. At December 31, 1994, the Group had accrued $12 million for various remediation activities. The environmental guidelines and definitions promulgated by the American Petroleum Institute provide the basis for reporting the Group's expenditures. For the year ended December 31, 1994, the Group, including its equity share of nonsubsidiary companies, incurred capital costs of $233 million and nonremediation related operating expenses of $132 million. The major component of the Group's expenditures is for the prevention of air pollution. In addition, as of December 31, 1994, reserves relative to the future cost of restoring and abandoning existing oil and gas properties were $27 million. Based upon existing statutory and regulatory requirements, investment and operating plans and known exposures, the Group believes environmental expenditures will not materially affect its liquidity, financial position or results of operations.\nIndependent Auditors' Report ----------------------------\nTo the Stockholders The Caltex Group of Companies:\nWe have audited the accompanying combined balance sheets of the Caltex Group of Companies as of December 31, 1994 and 1993, and the related combined statements of income, retained earnings, and cash flows for each of the years in the three-year period ended December 31, 1994. These combined financial statements are the responsibility of the Group's management. Our responsibility is to express an opinion on these combined 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 combined financial statements referred to above present fairly, in all material respects, the financial position of the Caltex Group of Companies as of December 31, 1994 and 1993 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the combined financial statements, effective January 1, 1992, the Group adopted the provisions of the Financial Accounting Standards Board's Statements of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and No. 109, \"Accounting for Income Taxes.\" As discussed in Note 2, effective January 1, 1994, the Group adopted the provisions of the Financial Accounting Standards Board's SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\"\nKPMG Peat Marwick LLP\nDallas, Texas February 14, 1995\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(1) Summary of Significant Accounting Policies\nPrinciples of Combination\nThe combined financial statements of the Caltex Group of Companies (Group) include the accounts of Caltex Petroleum Corporation and subsidiaries, American Overseas Petroleum Limited and subsidiary and P.T. Caltex Pacific Indonesia after the elimination of intercompany balances and transactions. A subsidiary of Chevron Corporation and two subsidiaries of Texaco Inc. (stockholders) each own 50% of the outstanding common shares. The Group is primarily engaged in exploring, producing, refining and marketing crude oil and refined products in the Eastern Hemisphere. The Group employs accounting policies that are in accordance with generally accepted accounting principles in the United States.\nTranslation of Foreign Currencies\nThe U.S. dollar is the functional currency for all principal subsidiary operations. Nonsubsidiary companies in Japan and Korea use the local currency as the functional currency.\nInventories\nCrude oil and refined product inventories are stated at the lower of cost (primarily determined on the last-in, first-out (LIFO) method) or current market value. Costs include applicable purchase and refining costs, duties, import taxes, freight, etc. Materials and supplies are valued at average cost.\nInvestments and Advances\nInvestments in and advances to nonsubsidiary companies in which 20% to 50% of the voting stock is owned by the Group, or in which the Group has the ability to exercise significant influence, are accounted for by the equity method. Under this method, the Group's equity in the earnings or losses of these companies is included in current results, and the related investments reflect the equity in the book value of underlying net assets. Investments in other nonsubsidiary companies are carried at cost and related dividends are reported as income.\nProperty, Plant and Equipment\nExploration and production activities are accounted for under the \"successful efforts\" method. Depreciation, depletion and amortization expenses for capitalized costs relating to the producing area, including intangible development costs, are computed using the unit-of-production method.\nAll other assets are depreciated by class on a uniform straight-line basis. Depreciation rates are based upon the estimated useful life of each class of property.\nMaintenance and repairs necessary to maintain facilities in operating condition are charged to income as incurred. Additions and betterments that materially extend the life of properties are capitalized. Upon disposal of properties, any net gain or loss is included in other income.\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(1) Summary of Significant Accounting Policies - Continued\nEnvironmental Matters\nCompliance with environmental regulations is determined in consideration of the existing laws in each of the countries in which the Group operates and the Group's own internal standards. The Group capitalizes expenditures that create future benefits or contribute to future revenue generation. Remediation costs are accrued based on estimates of known environmental exposure even if uncertainties exist about the ultimate cost of the remediation. Such accruals are based on the best available nondiscounted estimated costs using data developed by third party experts. Costs of environmental compliance for past and ongoing operations, including maintenance and monitoring, are expensed as incurred. Recoveries from third parties are recorded as assets when realization is determined to be probable.\n(2) Changes In Accounting Principles\nThe Group adopted SFAS No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective January 1, 1992, using the immediate recognition option. SFAS No. 106 requires accrual, during the employees' service with the Group, of the cost of their retiree health and life insurance benefits. Prior to 1992, postretirement benefits were included in expense as the benefits were paid. The adoption of SFAS No. 106 resulted in a cumulative after-tax charge of $26 million.\nEffective January 1, 1992, deferred income taxes are recognized according to the asset and liability method specified in Statement of Financial Accounting Standards (SFAS) No. 109 \"Accounting for Income Taxes\" by applying individual jurisdiction tax rates applicable to future years to differences between the financial statement and tax basis carrying amounts of assets and liabilities. The effect of tax rate changes on previously recorded deferred taxes is recognized in the current year. The adoption of SFAS No. 109 resulted in a cumulative benefit of $77 million.\nEffective January 1, 1994, the Group adopted SFAS No. 112 \"Employers' Accounting for Postemployment Benefits.\" SFAS No. 112 requires companies to accrue for the cost for benefits provided to former or inactive employees after employment but prior to retirement. Adoption of this standard did not materially impact the combined financial statements of the Group.\nThe Group adopted SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" effective January 1, 1994. SFAS No. 115 requires that investments in equity securities that have readily determinable fair values and all investments in debt securities be classified into three categories based on management's intent. Such investments are to be reported at fair value except for debt securities intended to be held to maturity which are to be reported at amortized cost. Previously, all such investments were accounted for at amortized cost. The cumulative effect of this change at January 1, 1994 was an increase in stockholders' equity of $70 million, after related taxes, representing unrealized net gains applicable to securities categorized as available-for-sale under the new standard. Such securities are primarily held by nonsubsidiary companies accounted for by the equity method.\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(3) Inventories\nThe excess of current cost over the stated value of inventory maintained on the LIFO basis was approximately $56 million and $40 million at December 31, 1994 and 1993, respectively.\nDuring 1994, 1993 and 1992, inventory quantities maintained on the LIFO basis were reduced at certain locations. The inventory reductions resulted in a decrease in the earnings of consolidated subsidiaries and nonsubsidiary companies at equity of approximately $12 million and $2 million in 1994 and 1992, respectively, and an increase in earnings of $1 million in 1993.\nCharges of $104 million reduced income in 1993 to reflect a market value of certain inventories lower than their LIFO carrying value. Earnings of $34 million and $14 million were recorded in 1994 and 1992, respectively, to reflect a partial recovery of prior year charges.\n(4) Nonsubsidiary Companies at Equity\nInvestments in and advances to nonsubsidiary companies at equity at December 31 include the following (in millions):\nShown below is summarized combined financial information for these nonsubsidiary companies (in millions):\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(4) Nonsubsidiary Companies at Equity - Continued\nRetained earnings at December 31, 1994, includes $1.4 billion representing the Group's share of undistributed earnings of nonsubsidiary companies at equity.\nCash dividends received from these nonsubsidiary companies were $43 million, $37 million, and $30 million in 1994, 1993, and 1992, respectively.\nSales to the other 50 percent owner of Nippon Petroleum Refining Company, Ltd. of products refined by Nippon Petroleum Refining Company, Ltd. and Koa Oil Company, Ltd. were approximately $2 billion, $1.9 billion, and $2 billion in 1994, 1993, and 1992, respectively.\n(5) Notes Payable\nShort-term financing consists primarily of demand loans, promissory notes, acceptance credits and overdrafts. The weighted average interest rates on short-term financing at December 31, 1994, and 1993 were 6.8% and 4.7%, respectively.\nUnutilized lines of credit available for short-term financing totaled $678 million at December 31, 1994.\n(6) Long-Term Debt and Capital Lease Obligations\nLong-term debt and capital lease obligations, with related interest rates at December 31, 1994, consist of the following (in millions):\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(6) Long-Term Debt and Capital Lease Obligations - Continued\nAt December 31, 1994 and 1993, $124 million and $101 million, respectively, of short-term borrowings were classified as long-term debt. Settlement of these obligations is not expected to require the use of working capital in 1995, as the Group has both the intent and ability to refinance this debt on a long-term basis. At December 31, 1994 and 1993, $170 million and $101 million, respectively, of long-term committed credit facilities were available with major banks to support notes payable classified as long-term debt.\nContractual maturities subsequent to December 31, 1994 follow (in millions): 1995 - $157 (included on the combined balance sheet as a current liability and excluding short-term borrowings classified as long-term debt); 1996 - $101; 1997 - $61; 1998 - $94; 1999 - $137; 2000 and thereafter - $322.\n(7) Employee Benefits\nThe Group has retirement plans covering substantially all eligible employees. Generally, these plans provide defined benefits based on final or final average pay, as defined. The benefit levels, vesting terms and funding practices vary among plans.\nThe funded status of retirement plans, primarily foreign and inclusive of nonsubsidiary companies at equity, at December 31 follows (in millions):\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(7) Employee Benefits - Continued\n(8) Operating Leases\nThe Group has various operating leases involving service stations, equipment and other facilities for which net rental expense was $121 million, $110 million, and $95 million in 1994, 1993 and 1992, respectively.\nFuture net minimum rental commitments under operating leases having noncancelable terms in excess of one year are as follows (in millions): 1995 - $55; 1996 - $67; 1997 - $52; 1998 - $47; 1999 - $44; 2000 and thereafter - $106.\n(9) Commitments and Contingencies\nOn January 25, 1990, Caltex Petroleum Corporation and certain of its subsidiaries were named as defendants, along with privately held Philippine ferry and shipping companies and the shipping company's insurer, in a lawsuit filed in Houston, Texas State Court. After removal to Federal District Court in Houston, the litigation's disposition turned on questions of federal court jurisdiction and whether the case should be dismissed for forum non conveniens. The plaintiffs' petition purported to be a class action on behalf of at least 3,350 parties, who were either survivors of, or next of kin of persons deceased in a collision in Philippine waters on December 20, 1987. One vessel involved in the collision was carrying Group products in connection with a freight contract. Although the Group had no direct or indirect ownership in or operational responsibility for either vessel, various theories of liability were alleged against the Group. No specific monetary recovery was sought although the petition contained a variety of demands for various categories of compensatory as well as punitive damages. These issues were resolved in the Group's favor by the Federal District Court in March 1992, through a forum non conveniens dismissal, and that decision is now final. Subsequent to that dismissal, but consistent with its terms, cases were filed against the Group entities in the Philippine courts (over and above those previously filed there subsequent to the collision, all of which are in various stages of litigation and are being vigorously resisted). However, and notwithstanding the Houston Federal District Court dismissal, the plaintiffs filed another lawsuit, alleging the same causes of action as in the Texas litigation, in Louisiana State Court in New Orleans. The Group removed that case to Federal District Court in New Orleans from which it was remanded back to Louisiana State Court. The Group then sought injunctive and other relief from the Federal District Court in Houston in order to ensure that that Court's previous dismissal would be given proper effect. On having its request for relief denied, the Group then filed an expedited appeal to the U. S. Fifth Circuit Court of Appeals. That Court's ruling is expected shortly. Management is contesting this case vigorously. It is not possible to estimate the amount of damages involved, if any.\nThe Group may be subject to loss contingencies pursuant to environmental laws and regulations in each of the countries in which it operates that, in the future, may require the Group to take action to correct or remediate the effects on the environment of prior disposal or release of petroleum substances by the Group. The amount of such future cost is indeterminable due to such factors as the nature of the new regulations, the unknown magnitude of any possible contamination, the unknown timing and extent of the corrective actions that may be required, and the extent to which such costs are recoverable from third party insurance.\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(9) Commitments and Contingencies - Continued\nThe Group is also involved in certain other litigation and Internal Revenue Service tax audits that could involve significant payments if such items are all ultimately resolved adversely to the Group.\nWhile it is impossible to ascertain the ultimate legal and financial liability with respect to the above mentioned contingent liabilities, the aggregate amount that may arise from such liabilities is not anticipated to be material in relation to the Group's combined financial position, results of operations, or liquidity.\nUnconditional purchase obligations in 1992 and 1993 were not considered material. However, in April 1994, a Group subsidiary entered into a contractual commitment, effective October 1996, for a period of eleven years, to purchase refined products in conjunction with the financing of a refinery that is presently under construction by a nonsubsidiary company. Total future estimated commitments (in billions) for the Group under this and other similar contracts, based on current pricing and projected growth rates, are: 1995 - $.6, 1996 - $.9, 1997 - $1.1, 1998 - $1.3, 1999 - $1.5, and 2000 to expiration of contracts - $9.6. Purchases (in billions) under similar contracts were $.5, $.6, and $.4 in 1994, 1993, and 1992, respectively.\nThe Group is in the process of finalizing sales of certain property required by a local government. The Group will be compensated for the value of the property transferred and the cost of replacing operating assets affected by the transfer. While the compensation is to be fully utilized in the reconstruction program over a five year period, the excess of the compensation over the net book value of the property and the dismantled operating assets will be recognized in earnings in early 1995. The impact to the Group's earnings is currently estimated to be a net after-tax gain of approximately $155 million.\n(10) Financial Instruments\nCertain Group companies are parties to financial instruments with off-balance sheet credit and market risk, principally interest rate risk. As of December 31, the Group had commitments outstanding for interest rate swaps and foreign currency transactions for which the notional or contractual amounts are as follows (in millions):\nThe Group enters into interest rate swaps in managing its interest rate risk, and their effects are recognized in the statement of income at the same time as the interest expense on the debt to which they relate. The swap contracts have remaining maturities up to eight years. The fair values of these swaps are not material.\nThe Group enters into forward exchange contracts to hedge against some of its foreign currency exposure stemming from existing liabilities and firm commitments. Forward exchange contracts hedging existing liabilities have maturities of up to seven years, and those contracts hedging firm commitments have maturities of under a year. Gains and losses on the forward exchange contracts are recognized in income concurrent with the income recognition of the underlying hedged transaction. The fair values of these forward exchange contracts are not material.\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(10) Financial Instruments - Continued\nThe Group's activity in commodity-based derivative contracts, that must be settled in cash, is not material.\nThe Group's long-term debt, excluding capital lease obligations, of $704 million and $497 million at December 31, 1994 and 1993, respectively, had fair values of $696 million and $511 million at December 31, 1994 and 1993, respectively. The fair value estimates were based on the present value of expected cash flows discounted at current market rates for similar obligations. The reported amounts of financial instruments such as cash and cash equivalents, notes and accounts receivable, and all current liabilities approximate fair value because of their short maturity.\nAt December 31, 1994, the Group had investments in debt securities available-for-sale and debt securities held to maturity at amortized costs of $63 million (maturity less than ten years) and $77 million (maturity less than one year), respectively. The fair value of these securities approximates amortized costs. The investment in marketable equity securities is not material. At December 31, 1994, the Group's carrying amount for investments in nonsubsidiary companies accounted for at equity included $83 million for net-of-tax unrealized net gains on investments held by these nonsubsidiaries.\nCertain Group companies were contingently liable as guarantors for $2 million and $7 million at December 31, 1994 and 1993, respectively. The Group also had commitments of $99 million and $36 million at December 31, 1994 and 1993, respectively, in the form of letters of credit which have been issued on behalf of Group companies to facilitate either the Group's or other parties' ability to trade in the normal course of business. In addition, the Group is contingently liable at December 31, 1994, for a maximum of $192 million, to a nonsubsidiary for precompletion sponsor support of its project finance obligations.\nThe Group is exposed to credit risks in the event of non-performance by counterparties to financial instruments. For financial instruments with institutions, the Group does not expect any counterparty to fail to meet their obligations given their high credit ratings. Other financial instruments exposed to credit risk consist primarily of trade receivables. These receivables are dispersed among the countries in which the Group operates, thus limiting concentrations of such risk.\nThe Group performs ongoing credit evaluations of its customers and generally does not require collateral. Letters of credit are the principal security obtained to support lines of credit when the financial strength of a customer or country is not considered sufficient. Credit losses have been historically within management's expectations.\n(11) Taxes\nTaxes charged to income consist of the following (in millions):\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(11) Taxes - Continued\nThe provision for income taxes, substantially all foreign, has been computed on an individual company basis at rates in effect in the various countries of operation. The actual tax expense differs from the \"expected\" tax expense (computed by applying the U.S. Federal corporate tax rate to income before provision for income taxes) as follows:\nDeferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of assets and liabilities. Temporary differences and tax loss carryforwards which give rise to deferred tax assets and liabilities at December 31, 1994 and 1993 are as follows (in millions):\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(11) Taxes - Continued\nThe valuation allowance has been established to record deferred tax assets at amounts where recoverability is more likely than not. Net income was decreased in 1994 by $3 million and increased by $36 million and $5 million in 1993 and 1992, respectively, for changes in the deferred tax asset valuation allowance.\nUndistributed earnings for which no deferred income tax provision has been made approximated $3.8 billion at December 31, 1994. Such earnings have been or are intended to be indefinitely reinvested. These earnings would become taxable in the U.S. only upon remittance as dividends. It is not practical to estimate the amount of tax that might be payable on the eventual remittance of such earnings. Upon remittance, certain foreign countries impose withholding taxes which, subject to certain limitations, are then available for use as tax credits against a U.S. tax liability, if any.\n(12) Cash Flows\nFor purposes of the statement of cash flows, all highly liquid debt instruments with original maturities of three months or less are considered cash equivalents.\nThe \"Changes in Operating Working Capital\" consists of the following (in millions):\n\"Net Cash Provided by Operating Activities\" includes the following cash payments for interest and income taxes (in millions):\nNo significant non-cash investing or financing transactions occurred in 1994, 1993 or 1992.\n(13) Other\nOn December 14, 1994, Caltex Australia Limited (CAL), a subsidiary of the Group, entered into a conditional agreement to form a petroleum refining and marketing joint venture with Ampol Limited, a competitor, effective January 1, 1995. The agreement was subject to completion of certain conditions which included, among others, confirmation by the Australian Trade Practices Commission (TPC) that the merger would not contravene local laws. On February 2, 1995, CAL received notification of the TPC's opinion that the merger would lessen competition and, therefore, would contravene Australian regulations. CAL and Ampol Limited are currently evaluating alternative options to address the TPC ruling and have not yet formed a joint venture.\nCALTEX GROUP OF COMPANIES\nNOTES TO COMBINED FINANCIAL STATEMENTS\n(14) Oil and Gas Exploration, Development and Producing Activities\nThe financial statements of Chevron Corporation and Texaco Inc. contain required supplementary information on oil and gas producing activities, including disclosures on equity affiliates. Accordingly, such disclosures are not presented herein.\nAPPENDIX\nDESCRIPTION OF GRAPHIC MATERIAL INCLUDED IN EXHIBIT 13 - TEXACO INC.'S 1994 ANNUAL REPORT TO STOCKHOLDERS.\nThe following information is depicted in graphic or image form in Texaco Inc.'s 1994 Annual Report to Stockholders filed as Exhibit 13 to Texaco's Inc.'s 1994 Annual Report on Form 10-K and all page references included in the following descriptions are to the actual and complete paper format version of Texaco Inc.'s 1994 Annual Report to Stockholders as provided to Texaco Inc.'s shareholders.\nThis Appendix is separated into two parts. Part A (Items A1-A22) describes the graphic and image material contained in the portion of Texaco Inc.'s 1994 Annual Report to Stockholders which is incorporated by reference, into Texaco Inc.'s 1994 Annual Report on Form 10-K, in response to Form 10-K Items 1 and 2-Business and Properties. Part B (Items B1-B17) describes the graphic material contained in the portion of Texaco Inc.'s 1994 Annual Report to Stockholders which is incorporated by reference, into Texaco Inc.'s 1994 Annual Report on Form 10-K, in response to Form 10-K Item 7","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":"111001_1994.txt","cik":"111001","year":"1994","section_1":"ITEM 1. BUSINESS\n(a) On July 2, 1990, DEKALB Energy Company (``DEKALB'' or the ``Company'') purchased from Royal Producing Corp. - Texas, an interest in thirty-six onshore oil and gas fields, most of which were located in the Texas Gulf Coast. On July 3, 1990, the Company transferred its interest in certain of these acquired fields in exchange for cash and an increased interest in one of the fields obtained through the acquisition. The purchase price was funded through the Company's revolving credit agreement. On July 12, 1990, the Company issued $75 million of 9 7\/8% notes due July 15, 2000, in a public offering. The net proceeds of $74.4 million were used to reduce the line of credit borrowing.\nOn October 16, 1992, the Company sold substantially all of its U.S. oil and gas properties to Louis Dreyfus Gas Holdings Inc. The Company did not sell its Canadian or California properties. The effective date of the transaction was July 1, 1992. Proceeds from the transaction were used primarily to reduce the Company's long-term debt.\nOn August 5, 1993, the Company sold all of its California gas wells to Samedan Oil Corporation. The effective date of the transaction was July 1, 1993. Proceeds from the transaction were used to repurchase long-term debt. The Company's only remaining assets in the U.S. are a non-operated interest in an oil well in California and acreage adjacent thereto.\nOn December 21, 1994, the Company entered into a merger agreement with Houston-based Apache Corporation (``Apache'') under which outstanding shares of DEKALB Class A Stock and Class B (nonvoting) Stock will be converted into between .85 and .90 shares of Apache Common Stock depending upon the price of Apache's Stock during a period shortly before the merger. DEKALB's holders of Class A Stock will be asked to approve this transaction at a shareholders' meeting that will be held during this spring.\n(b) DEKALB is engaged in only one industry segment on a continuing basis.\n(c) DEKALB is engaged in the exploration for, and the development and production of, crude oil and natural gas in Canada. The Company's wholly-owned Canadian subsidiary, DEKALB Energy Canada Ltd., concentrates its exploration and development activity in the Provinces of Alberta and British Columbia. Since the disposition of the U.S. assets in 1992 and 1993, DEKALB's only U.S. activity is an interest in one non-operated California well.\nDEKALB's operations are largely dependent upon its ability to discover or acquire reserves of oil and natural gas, to produce oil and natural gas in commercial quantities, and to obtain additional unproved oil and gas lands by lease, option, concession, or otherwise. The prices obtained for the sale of oil and natural gas depend upon numerous factors, most of which are beyond the control of the Company, including the domestic and foreign production rates of oil and natural gas, market demand, and the effect of government regulations and incentives.\nThe Company uses the full cost method of accounting, under which the cost of all exploration and development activities (both successful and unsucessful) is capitalized and subsequently amortized to expense using the unit-of-production method based upon production and estimates of proved reserve quantities. Unevaluated costs and related capitalized interest costs are excluded from the amortization base until the properties associated with these costs are evaluated and determined to be productive or impared. Should the net evaluated capitalized cost (net of deferred income taxes) exceed the estimated after-tax present value of oil and gas reserves (using prices in effect at the end of each quarter being reported) plus the unimpared value of unevaluated properties on a country-by-country basis, the excess would be charged to expense. No write-down of the Company's capitalized costs was required under this\nITEM 1. BUSINESS (continued)\nmethod in 1994, nor would a write-down be required using current prices. However, should natural gas prices continue to decline from current levels, the Company could be required to record an impairment of its oil and gas properites in 1995.\nCompetition\nThere is a high degree of competition in the oil and gas industry for the acquisition of prospective oil and gas properties and oil and gas reserves, and in the marketing and transportation of natural gas. A number of the companies with which DEKALB competes are substantially larger and have greater financial resources than DEKALB.\nMarketing\nOil produced by DEKALB is sold to crude oil purchasers or refiners at market prices which depend on worldwide crude prices adjusted for location and quality of the oil. Natural gas produced by DEKALB is sold to major aggregators of natural gas, gas marketers and direct users under long and short-term contracts. These contracts provide for sales at specified prices, or at prices which are subject to change due to market conditions. The Company also enters into hedge contracts from time to time to reduce the Company's exposure to oil and gas price fluctuations.\nThe Company diversifies the markets for its Canadian gas production by selling directly or indirectly to customers through aggregators and brokers in the United States and Canada. The Company transports natural gas via the Company's firm transportation contracts to California (12 million cubic feet per day) and the Province of Ontario, Canada (4 million cubic feet per day) through end-users' firm transportation contracts. In addition, the Company has contracted for the sale of 5 million cubic feet per day of natural gas to the Hermiston Cogeneration Project in the Pacific Northwest of the United States. The Hermiston Project is expected to commence purchases of natural gas in the third quarter of 1996.\nEnvironmental Matters\nIn general, the exploration and production activities of the Company are subject to certain federal, provincial, state, and local laws and regulations relating to environmental quality and pollution control. Such laws and regulations increase the cost of these activities and may prevent or delay the commencement or continuance of a given operation. The Company charged $0.4 million in 1994, $0.6 million in 1993 and $0.6 million in 1992 against income for future removal and site restoration costs. The 1994 and 1993 amounts related primarily to the Canadian operations.\nGeneral\nIn 1994, two Canadian customers each accounted for 11% of the Company's sales. The Company does not believe that the loss of these customers would have a material adverse effect upon the Company.\nAt December 31, 1994, the Company had 95 employees in Canada, and 1 employee in the United States.\n(d) Geographic Segment Information for 1992 is included in Part II, Item 8, Note L of the Consolidated Financial Statements. Information for the U.S. and Canada has been combined for 1994 and 1993 due to the immateriality of the U.S. information in relation to the Company as a whole.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOffices\nDEKALB leases approximately 40,000 square feet of office space in Calgary, Alberta, Canada from which it directs its business.\nAcreage\nThe following table summarizes DEKALB's interest in developed and undeveloped oil and gas acreage located in the Provinces of Alberta and British Columbia, Canada as of December 31, 1994. U.S. acreage is not significant and has been combined with the Canadian acreage.\n(a) Undeveloped acreage represents leased acres on which wells have not been drilled or completed to a point that would permit the production of commercial quantities of oil or gas.\nProductive Wells and Drilling Activity\nThe Company owns varying working interests in producing oil and gas wells located in the Provinces of Alberta and British Columbia, Canada and one well in the State of California. The Company also owns interests in twelve gas processing plants located in the Province of Alberta, Canada.\nThe following table summarizes DEKALB's interest in the productive oil and gas wells as of December 31, 1994.\n(1) One or more completions in the same well bore are counted as one well. The data in the above table includes 20 oil wells (12 net) and 61 gas wells (57 net) that are multiple completions in Canada. The only U.S. well is completed in one zone.\nITEM 2. PROPERTIES (continued)\nThe following table summarizes the number of net productive exploratory and development wells in which DEKALB participated, the number of net dry exploratory and development wells drilled and the net total wells drilled for the years ended December 31, 1994, 1993, and 1992:\nSales\nThe following table summarizes DEKALB's net oil and gas sales for the years ended December 31, 1994, 1993, and 1992:\nITEM 2. PROPERTIES (continued)\nAverage Prices and Cost per Unit of Sales\nThe following table shows the average sales prices received by DEKALB and the lease operating expense per equivalent barrel of oil for the years ended December 31, 1994, 1993, and 1992:\nReserves\nThe estimated proved developed and undeveloped oil and gas reserves of DEKALB, as of December 31, 1994, 1993, and 1992, and the standardized measure of discounted future net cash flows attributable thereto, are included in Supplementary Financial Information.\nReserve estimates for U.S. operated wells were reported by the Company to the U.S. Department of Energy during 1994 and were prepared on a basis consistent with the reserve estimates contained herein. Reserve estimates submitted to the U.S. Department of Energy were prepared as of December 31, 1993 and 1992 based on December 31, 1993 and 1992 reserve reports, respectively, and represent the gross remaining recoverable reserves assigned to the properties operated by DEKALB. Effective July 1, 1993 DEKALB sold substantially all of its remaining U.S. holdings to Samedan Oil Corporation. The only U.S. assets retained by DEKALB are a single non-operated oil well in California and acreage adjacent thereto.\nDecember 31, 1994 reserve forecasts utilized December 1994 actual prices for gas and natural gas liquids and the December 31st postings for oil and condensate in accordance with Securities and Exchange Commission (SEC) Guidelines and do not reflect current prices. The Company has also incorporated future removal and site restoration costs of $6.8 million ($1.0 million present value) as of December 31, 1994, $6.9 million ($0.8 million present value) as of December 31, 1993, and $7.7 million ($1.1 million present value) as of December 31, 1992 into the forecasts.\nSince December 31, 1994, there have been no material discoveries, extensions or revisions which would either favorably or adversely affect the Company's proved reserve quantities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nManagement is of the opinion there are no pending legal proceedings that would have a material effect on the consolidated financial position, results of operations, or liquidity of the Company.\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 in the fourth quarter of 1994.\nExecutive Officers of the Registrant\nThe names, ages, and positions of the executive officers of the Company, with their business experience during the past five years, are shown below. Officers are elected annually by the Board of Directors.\nOfficer Age ------- ---\nDonald McMorland.............................................67 President, Vice Chairman of the Board and Director\nMr. McMorland was elected President and Vice Chairman of the Board on May 13, 1994. He was Chairman of the Board of Alberta & Southern Gas Co. Ltd. from October 1, 1991 until June 30, 1994. He was Executive Vice President and Chief Operating Officer of that company until he was elected President and Chief Executive Officer in July 1990. He resigned as President and Chief Executive Officer in October 1993. He was also Senior Vice President and a director of Alberta Natural Gas Company Ltd. until he resigned as an officer in April 1991 and as a director in December 1991.\nJohn H. Witmer, Jr...........................................54 Vice President, General Counsel and Secretary\nMr. Witmer was elected Senior Vice President, General Counsel and Secretary on March 2, 1989. He relinquished the position of Senior Vice President and was elected Vice President on November 19, 1992. He has been Senior Vice President, General Counsel and Secretary of DEKALB Genetics Corporation for the past five years.\nRichard G. Nash..............................................52 Vice President, Exploration and Land - DEKALB Energy Canada Ltd.\nMr. Nash has served as Vice President, Exploration and Land of DEKALB Energy Canada Ltd. since July 20, 1992. He joined DEKALB Energy Canada Ltd. as Vice President, Exploration in 1986.\nJohn Leteta..................................................59 Vice President, Finance and Treasurer\nMr. Leteta was appointed Vice President, Finance and Treasurer on September 17, 1994. He had retired from DEKALB Energy Canada Ltd. in 1991 after thirty-one years of service. During that time, he last served DEKALB Energy Canada Ltd. as Vice President of Finance and Administration.\nLarry G. Evans...............................................39 Vice President, Production - DEKALB Energy Canada Ltd.\nMr. Evans has served as Vice President, Production of DEKALB Energy Canada Ltd. since August 1993. From August 1990 to August 1993, he served as Vice President, Engineering. Prior to that date, he served as Manager of Engineering.\nBruce A. Craig...............................................41 Vice President, Marketing - DEKALB Energy Canada Ltd.\nMr. Craig has served as Vice President, Marketing of DEKALB Energy Canada Ltd. since November 1992 when he joined the Company. Prior to joining DEKALB Energy Canada Ltd., he served as Manager, Oil and Gas Marketing for Kerr-McGee Canada Ltd. (formerly Maxus Energy Canada Ltd.)\nEddy Y. Tse..................................................44 Chief Accounting Officer\nMr. Tse was elected Chief Accounting Officer on November 11, 1992. He has also served as Chief Accounting Officer of DEKALB Energy Canada Ltd. since November 1992 and as Controller since July 1991. Prior to that date, he served DEKALB Energy Canada Ltd. as the Manager of Taxes.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S STOCK AND RELATED STOCKHOLDERS' MATTERS\nA. As of February 28, 1995 there were approximately 920 record holders of Class A Stock and approximately 2,100 record holders of Class B (nonvoting) Stock. Class B shares are currently being traded on the NASDAQ\/NMS over-the-counter market and the Toronto Stock Exchange.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 6. SELECTED FINANCIAL DATA (continued)\nITEM 6. SELECTED FINANCIAL DATA (continued)\nNOTES:\n(1) Return on sales was calculated by dividing earnings (loss) from continuing operations by total operating revenues. (2) Return on assets was calculated by dividing earnings (loss) from continuing operations by beginning total continuing assets. (3) Return on equity was calculated by dividing earnings (loss) from continuing operations by beginning shareholders' equity. (4) Total debt as a % of capitalization was calculated by dividing total debt by shareholders' equity plus total debt. (5) Gas is converted to oil at 6,000 cubic feet per barrel. (6) Book value per share was calculated by dividing shareholders' equity by the total year-end shares outstanding. (7) Includes the effect of hedge contracts. Prices before the effect of hedging were $15.43 for the 1994 combined operations, $17.45 for the U.S. and $18.74 for Canada in 1992, $18.77 for the U.S. and $19.75 for Canada in 1991, and $22.07 for the U.S. and $22.73 for Canada in 1990. There were no oil hedge contracts in place during 1993. (8) Includes the effect of the Royal acquisition. (9) 1992 includes six months of U.S. expenditures on all divested properties, and 12 months of California and Canadian properties; 1993 includes six months of U.S. expenditures on divested California properties, and 12 months of expenditures in Canada and on the one remaining oil well in California. (10) There were no U.S. expenditures incurred during 1994. 1992 includes six months of U.S. operating data on divested properties, and 12 months of California properties. For 1993, six months of U.S. operating data on divested properties, and 12 months of the remaining California property has been combined with Canadian operating data due to the immateriality in relation to the operating results as a whole. 1994 again represents the combined U.S. and Canadian operations. (11) U.S. reserve data has been combined with Canada for 1993 due to the immateriality of the U.S. reserves in relation to the total Company reserves as a whole. No U.S. reserves have been assigned at December 31, 1994. (12) Includes the effect of hedge contracts. 1994 prices before the effect of hedging averaged $1.47 for the combined operations.\nReference is made to Management's Discussion and Analysis of Financial Condition and Results of Operations and to the Financial Statements and Supplementary Financial Information for a discussion of the Company's operations and financial position.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW --------\n1994 earnings and earnings per share from continuing operations rose 20.1% and 20.3%, respectively, compared with 1993. These improved results were reflective of significantly higher natural gas prices during the first nine months of 1994, as well as increasing oil prices in the last half of 1994 and the positive impact of the Company's hedging activities. 1994 results also reflect the impact of the lower Canadian dollar exchange rate, resulting in lower U.S. dollar equivalent expenses.\nNet earnings for 1994 were $4.2 million lower and $77.1 million higher than in 1993 and 1992, respectively. 1993 earnings included a one-time tax benefit of $5.3 million due to the adoption of Statement of Financial Accounting Standard (SFAS) 109 ``Accounting for Income Taxes''. The net loss in 1992 was primarily due to the loss of $34.9 million pre-tax ($32.3 million after-tax) on the disposition of substantially all of the Company's U.S. oil and gas properties to Louis Dreyfus Gas Holdings Inc., and the writedown of oil and gas properties of $53.3 million pre-tax ($40.6 million after-tax).\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nDISPOSITION OF ASSETS ---------------------\nIn November 1994, the Company announced the sale of its interest in a gas plant, leasehold, and other tangible property in the Claresholm area in the Province of Alberta, Canada. The sale was effective November 1, 1994 for proceeds of $9.0 million. During the third quarter of 1994, the Company sold its interest in leasehold and tangible property in the Buick Creek area of the Province of British Columbia, Canada for proceeds of $0.4 million. In March 1994, the Company sold its interest in leasehold and tangible property in the Rigel area of the Province of British Columbia, Canada for proceeds of $3.6 million. In accordance with the full cost method of accounting, the proceeds received for the 1994 dispositions were credited to the full cost pool; therefore, no gains or losses were recorded on the sales.\nEffective July 1, 1993, the Company sold all of its California gas wells to Samedan Oil Corporation for $5.1 million. Consistent with the full cost method of accounting on a cost center basis, the Company recorded a $0.5 million pre-tax and after-tax gain on the disposition of the California gas wells in the third quarter of 1993. The Company also closed its exploration office in Bakersfield in 1993. The Company's only remaining assets in the U.S. are a non-operated working interest oil well in California and acreage adjacent thereto.\nOn July 9, 1992, the Company announced that it had entered into a definitive agreement to sell substantially all of its U.S. oil and gas properties to Louis Dreyfus Gas Holdings Inc. On October 16, 1992, the Dreyfus transaction was approved by the shareholders at a special shareholders' meeting, and the closing of the transaction was completed on the same day. The Company did not sell its California properties in this transaction. The Company received $104.0 million of gross proceeds from the sale, which included approximately $6.0 million of cash flow from the properties from the effective date (July 1, 1992). In addition, Dreyfus assumed certain liabilities. In 1992 a loss on the disposition of $34.9 million was recorded ($32.3 million after- tax).\nSales revenues and volumes, lease operating expenses and depreciation, depletion and amortization (DD&A) associated with the U.S. divested properties for the six months ended June 30, 1993 and 1992, are shown under Note C, Disposition of Assets in the Notes to the Consolidated Financial Statements.\nDRILLING ACTIVITY ----------------- Consistent with its focus on long-term growth through exploration and development, the Company participated in the drilling of 68 exploration and development wells (49.96 net wells) during 1994, with a success rate of 78% (82% on a net well basis). Fifty-six gas targets and twelve oil targets were drilled, primarily in the Nevis and Kaybob areas of Alberta, and in northeast British Columbia. Of particular significance was a successful 100% Company-owned and operated well drilled in the first quarter on the Hunter prospect in northeast British Columbia, where 26 feet of gas pay in the Halfway zone was encountered, with an established production test rate of 6.4 MMCF per day before royalties at 375 psi flowing tubing pressure. The well is expected to be tied in during the first half of 1995.\nThe Company participated in the drilling of 26 net wells in 1993 and 16 net wells in 1992.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nOPERATING REVENUES ------------------\n1994 operating revenues of $46.3 million increased slightly from $45.9 million in 1993. The increase was mainly due to higher gas prices during the first nine months of 1994 and the positive impact of the Company's hedging activities, partially offset by decreased gas production and low oil prices during the first half of the year, and weakening gas prices in the last quarter. The 23.8% decline in 1994 operating revenues compared to 1992 results primarily from the disposition of the U.S. oil and gas properties in prior years.\nGas revenues for 1994 increased to $31.5 million from $30.2 million in 1993 and $30.7 million in 1992. This was due to improved gas prices which rose to an average of $1.61 per thousand cubic feet (MCF) during the first nine months of 1994, compared to $1.40 and $1.23 during the 1993 and 1992 comparative periods, respectively. A significant weakening in gas prices was seen in the 1994 fourth quarter, however, with an average Company gas price of $1.32 per MCF compared to $1.56 and $1.45 in 1993 and 1992, respectively. System gas prices received during the first nine months of 1994 were 18.8% and 33.3% higher than in the 1993 and 1992 comparative periods, respectively. Fourth quarter system gas prices were $1.00 per MCF compared to $1.56 in 1993 and $1.38 in 1992. Direct gas sales (short-term and spot) prices for the first nine months of 1994 were $1.41, up 9.3% and 80.8% compared to 1993 an 1992, respectively. For the fourth quarter, direct gas sales prices were $0.91 per MCF in 1994, $1.49 in 1993 and $1.35 in 1992. System and direct gas sales accounted for approximately 42% and 58%, respectively, of total Company 1994 gas sales volumes.\n1994 gas sales volumes were down 2.3% from 1993 and 14.5% from 1992. This decline was principally due to the disposition of the Company's U.S. oil and gas properties in 1992 and 1993 (see Note C, ``Disposition of Assets,'' in the Notes to the Consolidated Financial Statements). In addition, a unitization adjustment was recorded in the second quarter of 1993, resulting in additional gas volumes relating to prior periods of approximately 220 MMCF. General field declines, compressor installations and repairs, and several plant turnarounds also resulted in some curtailment of production during the first half of 1994. Gas volumes for the third and fourth quarters were 13.0% and 3.8% higher, respectively, in 1994 versus 1993.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nOPERATING REVENUES (CONTINUED) ------------------------------\nThe Company's 1994 oil and condensate prices were 2.9% and 12.5% lower compared to 1993 and 1992, respectively. During the first six months of 1994, the Company received an average of $14.36 per barrel versus $17.49 in 1993. These prices followed changes in the WTI oil price, which averaged $16.28 per barrel during the first half of 1994 compared with $19.82 per barrel in the 1993 comparative period. A significant recovery was seen in the second half of 1994, however, with the Company's oil and condensate prices and the WTI oil price averaging $16.69 and $18.08 per barrel, respectively. Natural gas liquids prices similarly followed those of oil and condensate, with the Company receiving an average price of $2.18 per barrel less in the first half of 1994 versus 1993, but a 36 cent higher price in the second half of 1994 versus 1993. Combined 1994 oil, condensate and natural gas liquids volumes decreased slightly from 1993. The decrease in oil, condensate and natural gas liquids volumes of 799 Mbbls compared to 1992, again related to the disposal of the U.S. properties in 1992 and 1993.\nDuring 1994, the Company tied in approximately 17.1 MMCFD of gas production. Forty-five gas wells in the Province of Alberta and nine oil wells in the Province of British Columbia were brought onto production during 1994. The Company's new plant in the Godin area in the Province of Alberta also commenced gas processing in December 1994. The plant was at full capacity beginning in January 1995 with a capability of approximately 10.0 MMCF per day.\nTo protect against oil and natural gas price fluctuations, the Company has entered into various hedge contracts for a portion of its oil and gas (see Note H, ``Commitments and Contingencies and Off-Balance Risks, Hedge Contracts,''in the Notes to the Financial Statements). A net gain of $1.5 million was recognized as a component of operating revenues in 1994 as a result of these hedge contracts. The effect of the gain on average prices was 34 cents per BOE based on total Company volumes.\nOPERATING EXPENSES ------------------\n1994 lease operating expenses and other direct charges were down 6.5% compared to 1993, and 38.1% compared to 1992. These declines primarily result from the disposition of the Company's U.S. properties in 1992 and 1993 (see Note C, ``Disposition of Assets'' in the Notes to the Consolidated Financial Statements), processing rate adjustments relating to current and prior years' production from two of the Company's non-operated fields, and a lower Canadian dollar exchange rate. In addition, a third party gas processing fee adjustment for 1991 and 1992 of $.6 million was recorded in the second quarter of 1993. During the 1994 fourth quarter, higher non-operated and third party processing costs, processing revenue adjustments relating to prior years and workover costs were incurred, which partially offset the decreases during the first nine months of 1994. Excluding the impact of the Canadian dollar exchange rate, the Company has maintained a constant per barrel of oil equivalent lease operating cost figure for 1994, 1993 and 1992.\n1994 depreciation, depletion and amortization expense (``DD&A'') fell $0.5 million from 1993, primarily due to the disposition of the Company's higher cost California properties in 1993, lower sales volumes and a lower Canadian DD&A rate resulting from lower exchange rates. 1994 DD&A expense decreased $7.9 million from 1992, principally due to the sale of the U.S. assets and writedowns of oil and gas properties in 1992.\n1994 general and administrative expense decreased by $0.3 million and $3.3 million compared to 1993 and 1992, respectively. This was primarily due to the lower Canadian dollar and the closure of the California and Denver offices in 1993 and 1992, partially offset by increased costs resulting from increased Canadian office staff levels.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nOPERATING EXPENSES (CONTINUED) ------------------------------\nIn 1992, the Company recorded a $53.3 million writedown of its Canadian and U.S. oil and gas properties. The $0.5 million gain on disposal in 1993 resulted from the sale of the California gas wells to Samedan Oil Corporation. The $34.9 million loss in 1992 related to the sale of the U.S. oil and gas properties to Louis Dreyfus Gas Holdings Inc.\nNON-OPERATING ITEMS -------------------\n1994 interest expense, net of interest income and capitalized interest, increased 6.6% compared to 1993. The increase was due to additional interest charges on the Company's Canadian revolving term credit facility, partially offset by lower capitalized interest and exchange rates, and lower U.S. interest costs as a result of the repurchase of a portion of the Company's public notes in 1993. 1994 net interest expense was $2.9 million below 1992, mainly due to the repurchase of $18.4 million in 1993 and $55.3 million in 1992 of the Company's publicly held notes.\nNet other income in 1994 related mainly to settlement of a prior year lawsuit for which an allowance had previously been provided, and gas contract and transportation adjustments. Offsetting these 1994 income items were a net foreign exchange loss arising from translation of monetary items related to the Canadian operations and a provision for merger costs incurred to year end (see ``Prospective and Other Information ''further in this section). Net other income in 1993 primarily related to a gas contract settlement. In 1992, the Company recorded a $2.0 million gain on the sale of its 5% interest in Natural Gas Clearinghouse (``NGC''). Equity earnings from the partnership interest in NGC of $0.8 million were also recognized in 1992.\nINCOME TAXES ------------\nIn 1994, the income tax expense reflected a different effective tax rate (47.0%) from the statutory Canadian income tax rate of 44.34%, mainly due to non-income and other tax charges (capital and withholding taxes).\nAt December 31, 1994, the Company had various offsetting tax matters pending relating to the Canadian operations which have not been provided for in the financial statements. In the opinion of management the net impact of these matters will not have a material effect on the consolidated financial position, results of operations, or liquidity of the Company, and will be provided for in the financial statements if required upon resolution of each item.\nThe Company adopted Statement of Financial Accounting Standard (``SFAS'') No. 109, ``Accounting for Income Taxes'' as of January 1, 1993. A one-time benefit adjustment of $5.3 million was recognized in the first quarter of 1993.\nThe tax benefit of $9.8 million for 1992 resulted from the disposition of U.S. assets and the writedown of oil and gas properties in 1992.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nCASH FLOWS FROM OPERATING ACTIVITIES ------------------------------------\n1994 cash flows from operating activities before changes in assets and liabilities increased $1.8 million from 1993 and decreased $4.7 million from 1992. 1994 and 1993 reflects the Company as a primarily Canadian operation, while 1992 included revenues from the U.S. assets which were subsequently sold. The increase in 1994 from 1993 is primarily due to higher operating revenues, as well as lower operating expenses which are impacted by the lower Canadian dollar exchange rate.\nCash flows from continuing operations decreased by 25.1% from 1993, mainly due to a lower year-end accounts payable and other current liabilities balance, and an increase in accounts receivable and other current assets. In addition, the Company received U.S. tax refunds of $5.6 million from tax loss carrybacks during 1993.\nTaxes paid in 1994, 1993, and 1992 primarily relate to the Canadian Large Corporations Tax, withholding taxes and franchise taxes.\nCash flows from discontinued operations in 1994, 1993 and 1992 relate to settlement of pending litigation from prior years.\nCASH FLOWS FROM INVESTING ACTIVITIES ------------------------------------\nPurchases of property, plant and equipment were $43.0 million in 1994 compared to $22.9 million in 1993 and $25.1 million in 1992, reflecting a significant increase in capital spending related to exploration and development.\nDuring 1994, the Company disposed of its interest in various property in the Buick Creek and Rigel areas of the Province of British Columbia, Canada, the Claresholm area of the Province of Alberta, Canada, and other miscellaneous assets for total proceeds of $13.7 million. In accordance with the full cost method of accounting, the proceeds were credited to the full cost pool, therefore no gains or losses were recorded on the sales (see Note C, ``Disposition of Assets,'' in the Notes to the Consolidated Financial Statements).\n1993 proceeds of $0.9 million from the sale of property, plant and equipment were received primarily as a result of the sale of several small Canadian properties. 1993 proceeds of $6.2 million from the sale of U.S. assets were composed of $5.1 million from the sale of the California gas wells to Samedan Oil Corporation in the third quarter of 1993, and additional proceeds received in the first quarter of 1993 of $1.1 million relating to the 1992 disposition of U.S. assets to Dreyfus.\nProceeds from the disposition of U.S. assets to Dreyfus, excluding post effective date revenues retained and offset against the purchase price, were $97.1 million in 1992. Additional 1992 divestiture proceeds of $7.8 million were received primarily as a result of the sale of some smaller U.S. properties. Also, $7.5 million was received during the second quarter of 1992 from the sale of the Company's interest in NGC.\nCASH FLOWS FROM FINANCING ACTIVITIES ------------------------------------\nCash flows from financing activities resulted in an inflow of $1.6 million in 1994 compared with outflows of $13.0 million and $99.6 million for 1993 and 1992, respectively.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nCASH FLOWS FROM FINANCING ACTIVITIES (CONTINUED) ------------------------------------------------\nNet short-term and long-term borrowings under the Canadian revolving term credit facility increased in 1994 by $5.0 million over the year. The Company repaid $1.8 million of its revolving term credit facility during the first quarter of 1994, and drew down $14.3 million in the second and third quarters to fund the Company's increased capital spending and repurchases of stock. With the sale of the Claresholm property (see Note C ``Disposition of Assets'' in the Notes to the Financial Statements), the Company repaid $7.5 million in the 1994 fourth quarter.\nDiscretionary cash outflows for the 1995 calendar year are anticipated to equal or exceed cash flow from operating activities, therefore, the Company does not intend to make any repayments on the revolving term credit facility during 1995. Accordingly, the revolving term credit facility has been reclassified to long-term debt at December 31, 1994 for financial statement purposes (see Note G, ``Debt'' in the Notes to the Consolidated Financial Statements with respect to repayment requirements). There was no change in the Company's long-term publicly held note balances during 1994.\nAs announced in 1989, the Company's Board of Directors authorized the purchase of up to one million shares of the Company's Class A Stock or Class B (nonvoting) Stock. On July 27, 1994, the Board passed a resolution to authorize the repurchase from time to time, of up to one million shares of Class A Stock and\/or Class B (nonvoting) Stock. This resolution replaced and is in lieu of any authority to repurchase stock granted in any prior resolution. A total of 220,000 shares were purchased during the second and third quarters of 1994 at an average price of $15.39, 77,500 of which were purchased subsequent to the July 27, 1994 resolution.\nIn 1993, the Company repurchased $18.4 million of its publicly held notes ($1.9 million of its 9 7\/8 % notes and $16.5 million of its 10% notes) and 7,191 shares of its common stock. The Company also borrowed $5.7 million under its revolving term credit facility in December 1993.\nDuring 1992, the Company used proceeds from asset sales to pay down a net $99.3 million in debt and repurchased $55.3 million of its publicly held notes ($43.9 million of its 9 7\/8% notes and $11.4 million of its 10% notes). The Company also repaid its line of credit in full, representing a net $42.0 million reduction during 1992, and repaid other debt totalling $2.0 million. In addition, the Company repurchased 31,365 shares of its stock in the open market for $0.3 million during 1992.\nLIQUIDITY ---------\nThe Company plans to fund its capital expenditures, working capital needs and interest payments through its operating cash flow and a combination of term debt and the revolving term credit facility. At December 31, 1994, the Company had $15.0 million in cash and short-term investments, and $11.2 million available under its Canadian revolving term credit facility (see Note F to the Consolidated Financial Statements).\nPROSPECTIVE AND OTHER INFORMATION ---------------------------------\nOn December 21, 1994, the Company announced it had entered into a merger agreement with Houston-based Apache Corporation (``Apache``), whereby the outstanding shares of DEKALB Class A Stock and Class B (nonvoting) Stock will be converted into Apache Common Stock at a conversion rate as specified in the agreement. The Board of Directors is recommending approval and adoption of the merger, which is expected to be considered at a Special Meeting of the shareholders in the second quarter of 1995. Reference is made to the Form S-4 Registration Statement filed by Apache with the Securities and Exchange Commission on January 17, 1995 (Registration No. 33-57321).\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)\nPROSPECTIVE AND OTHER INFORMATION (CONTINUED) ---------------------------------------------\nGiven its successful drilling program and capital spending for 1994, the Company has more than replaced 1994 production of about 4,400 MBOE's. Deliverability at December 31, 1994 was 67 million cubic feet per day net working interest after royalty compared to 57 million cubic feet per day at December 31, 1993. The Company plans to maintain an active exploration, development and acquisitions program. Capital expenditures for the first half of 1995 are budgeted to be approximately $14 million.\nThe Company announced in November 1994 its intention to repurchase $22.1 million of its 10% public notes in the second quarter of 1995, at which time they will be callable at par. The Company is currently reviewing this option in light of increasing interest rates in both the U.S. and Canada. If this option is pursued, the repurchase will be funded through the Company's operating cash flow, cash reserves, and revolving term credit facility.\nOn April 12, 1994 the Company's Class B (nonvoting) Stock began trading on the Toronto Stock Exchange in addition to the NASDAQ\/NMS. The additional listing is in recognition of the Company's focus on its Canadian asset base, and is intended to increase the Company's profile among Canadian analysts and attract additional Canadian investors.\nOther Future Uncertainties --------------------------\nThe prices obtained for the sale of oil and natural gas have a significant impact on the Company's future earnings and cash flows. The Company sells its gas on the spot market and under short and long-term contracts. A majority of gas contracts do not have fixed prices; therefore, gas prices are subject to volatility depending on fluctuations in the gas market. Oil prices generally follow worldwide oil prices, which are subject to fluctuations resulting from world supply and demand. Oil and gas prices also affect the estimated present value of the Company's reserves, which is a component of the quarterly full cost ceiling test. Spot market prices for natural gas decreased significantly in the fourth quarter of 1994, and have continued to deteriorate subsequent to year end. An impairment of the Company's capitalized costs would not be required using current prices. However, should natural gas prices continue to decline from current levels, the Company could be required to record a non-cash writedown of its oil and gas properties during 1995. To protect against exposure to future price fluctuations, the Company has entered into hedge contacts for a portion of its oil and gas production.\nThe Company's future oil and gas production is dependent in part on the replacement of production with new reserves and its ability to market its deliverable quantities of production. The Company plans to concentrate on exploring for additional gas reserves and developing shut-in gas properties where economically feasible. The Company will also continue to pursue oil prospects where there is potential for significant reserve additions and immediate opportunities for development. In marketing its reserves, the Company plans to continue to increase geographical diversity within the customer portfolio, targeting, in particular, California and the U.S. Pacific Northwest markets. In addition, the Company intends to continue to shift more natural gas production into direct sales contracts, which generally are one year in length. 1995 production volumes are expected to more than equal 1994 volumes.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY FINANCIAL INFORMATION\nAUDITORS' REPORT\nTo the Shareholders and Board of Directors of DEKALB Energy Company:\nWe have audited the consolidated balance sheets of DEKALB Energy Company as at December 31, 1994 and 1993, and the consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994. These consolidated 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 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 consolidated financial statements present fairly, in all material respects, the consolidated financial position of DEKALB Energy Company as at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in accordance with United States generally accepted accounting principles.\nCOOPERS & LYBRAND ----------------- Calgary, Alberta Coopers & Lybrand February 13, 1995\nRESPONSIBILITIES FOR FINANCIAL STATEMENTS\nThe financial statements on the following pages for the years ended December 31, 1994, 1993, and 1992 were prepared by management in accordance with generally accepted accounting principles appropriate in the circumstances.\nThe integrity and objectivity of data in these financial statements and related financial data are the responsibility of management. The financial statements are presented on the accrual basis of accounting and, accordingly, include some amounts based on judgments of management. Management maintains what it believes to be an adequate system of internal accounting controls. More fundamentally, the Company seeks to ensure objectivity and integrity of its accounts by its selection of qualified personnel, by organizational arrangements that provide an appropriate division of responsibility, and by communicating its policies and standards throughout the organization.\nDEKALB Energy Company has engaged Coopers & Lybrand, Chartered Accountants, to audit these financial statements. Their report is included herein which advises that the audit was conducted in accordance with generally accepted auditing standards. Those standards require that they plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. They include examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. They also include assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.\nThe Board of Directors pursues its responsibility for these financial statements through its Audit Committee composed of outside directors. Coopers & Lybrand has full and free access to the Audit Committee and has met with it to discuss auditing and financial reporting matters.\nDONALD MCMORLAND JOHN LETETA ---------------- ----------- Donald McMorland John Leteta President Vice President, Finance and Treasurer\nEDDY Y. TSE ----------- Eddy Y. Tse Chief Accounting Officer\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA. Accounting Policies and Procedures\n(1) Principles of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions between consolidated companies have been eliminated.\n(2) Statement of Cash Flows\nThe Company classifies highly liquid investments with original maturities of three months or less as cash and cash equivalents. Cash equivalents are stated at cost which approximates market. The cash flows from contracts that have been accounted for as hedges have been classified as cash flows from operating activities.\n(3) Oil and Gas Properties\nThe Company uses the full cost method of accounting, under which the cost of all exploration and development activities (both successful and unsuccessful) is capitalized and subsequently amortized to expense using the unit-of-production method based upon production and estimates of proved reserve quantities. Unevaluated costs and related capitalized interest costs are excluded from the amortization base until the properties associated with these costs are evaluated and determined to be productive or impaired. Should the net evaluated capitalized costs (net of deferred income taxes) exceed the estimated after- tax present value of oil and gas reserves and unimpaired value of unevaluated properties on a country-by-country basis, the excess would be charged to expense. Included in the estimated present value are Canadian provincial tax credits expected to be realized beyond the date at which the legislation, under its provisions, could be repealed. To date, the Canadian provincial government has given no intention to repeal this legislation (see Supplementary Financial Information). Proceeds from disposals of oil and gas properties are applied as reductions of capitalized costs. Gains or losses are only recognized on the sale of oil and gas properties involving significant amounts of reserves.\n(4) Future Removal and Site Restoration Costs\nEstimated dismantlement, abandonment and clean-up costs, net of estimated salvage values, if any, are expensed on the unit-of- production basis using proved oil and gas reserves.\n(5) Other Property, Plant and Equipment\nIt is the policy of the Company to capitalize expenditures for major renewals and betterments at cost and to charge to operating expenses the cost of current maintenance and repairs. Provisions for depreciation have been computed principally on the straight- line method based on expected useful lives. Rates used for depreciation are based principally on the following expected lives: Equipment - 2 to 10 years; Other - 20 years; and Leasehold improvements - term of lease.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nA. Accounting Policies and Procedures (Continued)\nThe cost and accumulated allowances for depreciation and amortization relating to assets retired or otherwise disposed of are eliminated from the respective accounts at the time of disposition. The resultant gain or loss is included in current operating results.\n(6) Income Taxes\nEffective January 1, 1993, the Company adopted the liability method of accounting for income taxes under Statement of Financial Accounting Standard (SFAS) No. 109. The adoption of SFAS No. 109 resulted in a one time benefit adjustment of $5.3 million in the first quarter of 1993. No taxes have been accrued on the unremitted earnings of the Canadian subsidiary as these are intended to be permanently invested in Canada. The amount of the unrecognized deferred tax liability has not been calculated as its determination is not practicable.\nPrior to 1993, income taxes were calculated in accordance with Accounting Principles Board Opinion No. 11. Investment tax credits were recognized using the flow through method whereby current income tax expense was reduced by investment tax credits utilized.\n(7) Foreign Currency Translation\nThe Company's reporting currency is U.S. dollars. The functional currency for the Canadian subsidiary is Canadian dollars. Translation adjustments resulting from translating foreign currency financial statements into U.S. dollar equivalents are reported separately and accumulated in a separate component of shareholders' equity. Aggregate exchange gains and losses arising from the translation of foreign currency transactions, excluding long-term intercompany debt, are included in income.\n(8) Earnings Per Share Calculation\nEarnings (loss) per share is calculated by dividing the earnings (loss) by the weighted average shares outstanding during each year. The 1992 computation of weighted average shares outstanding excludes anti-dilutive shares.\n(9) Gas Balancing\nThe Company uses the sales method to account for gas imbalances. The Company did not have any significant gas imbalances outstanding at December 31, 1993 or 1994.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nA. Accounting Policies and Procedures (Continued)\n(10) Concentration of Credit Risk\nSubstantially all of the Company's receivables are within the oil and gas industry. Although diversified within many companies, collectibility is dependent upon the general economic conditions of the industry. Beginning in December 1992, the Company has invested excess cash in high-grade securities through a U.S. investment firm in New York City, and in term deposits with a Canadian chartered bank.\n(11) Hedge Contracts\nThe Company enters into various contracts to hedge a portion of its oil and gas production against fluctuating prices. The results of these contracts are included in revenues as the oil or gas is produced.\n(12) Financial Statement Presentation\nCertain prior year figures have been reclassified to conform to the 1994 financial statement presentation.\nB. Plan of Merger\nOn December 21, 1994, the Company announced it had entered into a merger agreement with Houston-based Apache Corporation (``Apache''), whereby the outstanding shares of DEKALB Class A Stock and Class B (nonvoting) Stock will be converted into Apache Common Stock at a conversion rate as specified in the agreement. The Board of Directors is recommending approval and adoption of the merger, which is expected to be considered at a Special Meeting of the shareholders in the second quarter of 1995. Apache has filed a Form S-4 Registration Statement with the Securities and Exchange Commission on January 17, 1995 (Registration No. 33-57321).\nFor the year ended December 31, 1994, $0.5 million of merger costs incurred to year end were expensed in the Consolidated Financial Statements. If the merger proceeds, various additional restructuring costs associated with the merger will be expensed as incurred.\nC. Disposition of Assets\nIn November 1994, the Company announced the sale of its interest in a gas plant, leasehold and other tangible property in the Claresholm area in the Province of Alberta, Canada. The sale was effective November 1, 1994 for proceeds of $9.0 million. During the third quarter of 1994, the Company sold its interest in leasehold and tangible property in the Buick Creek area of the Province of British Columbia, Canada for proceeds of $0.4 million. In March 1994, the Company disposed of its interest in leasehold and tangible property in the Rigel area of the Province of British Columbia, Canada for proceeds of $3.6 million. In accordance with the full cost method of accounting, the proceeds received for the 1994 dispositions were credited to the full cost pool; therefore, no gains or losses were recorded on the sales.\nOn August 5, 1993, the Company announced the sale of all its California gas wells to Samedan Oil Corporation for $5.1 million, effective July 1, 1993. Consistent with the full cost method of accounting on a cost center basis, the Company recorded a $0.5 million pre-tax and after-tax gain on the disposition of the California gas wells in the third quarter of 1993. The Company also closed down its exploration office in Bakersfield. The only U.S. assets retained by the Company after this sale are a working interest in a single non-operated oil well in California and acreage adjacent thereto.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nC. Disposition of Assets (Continued)\nSales revenues and volumes, lease operating expenses, and depreciation, depletion and amortization (DD&A) for the 1993 divested California properties were as follows:\nOn July 9, 1992, the Company announced that it had entered into a definitive agreement to sell substantially all of its U.S. oil and gas properties to Louis Dreyfus Gas Holdings Inc. (``Dreyfus''). On October 16, 1992, the Dreyfus transaction was approved by the shareholders at a special shareholders' meeting and the closing of the transaction was completed on the same day. The Company did not sell its California properties. The Company received $104 million of gross proceeds from the sale, which included approximately $6.0 million of cash flow from the properties from the effective date (July 1, 1992). In addition, Dreyfus assumed certain liabilities. A pre-tax loss of $34.9 million ($32.3 million after-tax) was recorded on the sale in 1992.\nSales revenues and volumes, lease operating expenses, and DD&A for the 1992 divested properties were as follows:\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nD. Non-Operating Items ($ in thousands)\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nE. Income and Other Taxes ($ in thousands)\nEffective January 1, 1993, the Company adopted the liability method of accounting for income taxes under Statement of Financial Accounting Standards (SFAS) No. 109. Prior to 1993, deferred income taxes were calculated in accordance with Accounting Principles Board Opinion No. 11. The adoption of SFAS 109 resulted in a one time benefit adjustment of $5.3 million which was recognized in the first quarter of 1993.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nE. Income and Other Taxes (Continued) ($ in thousands)\nIncome and other taxes for continuing operations was a provision of $6,029 in 1994, $5,995 in 1993 and a benefit of $9,788 in 1992. Deferred tax expense (benefit) results from the following types of differences in the timing of the recognition of revenues and expense for tax and financial statement purposes.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nE. Income and Other Taxes (Continued) ($ in thousands)\nTotal tax provisions (benefits) resulted in effective tax rates differing from that of the statutory income tax rates. The reasons for these differences are:\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nE. Income and Other Taxes (Continued) ($ in thousands)\nThe components of the net deferred tax liabilities under SFAS No. 109 are as follows:\nThe Company has recorded a valuation allowance for all U.S. federal tax operating loss carryforwards and U.S. future deductible amounts net of future taxable income amounts under SFAS No. 109 since the Company has limited future taxable income in the United States to realize these benefits.\nFor U.S. tax purposes there are approximately $31.4 million in tax operating loss carryforwards remaining as at December 31, 1994. These losses, if not utilized, will expire in 2007. Investment tax credits of approximately $1.4 million are available to offset U.S. income taxes payable after December 31, 1994. If not utilized, these credits will expire by 2003.\nFor Canadian tax purposes there are approximately $.5 million of investment tax credits available to offset Canadian federal income taxes payable after December 31, 1994. If not utilized, these credits will begin to expire in 1995 through to 2002.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nG. Debt ($ in thousands)\n(1) Term Debt\nAggregate maturities on the term debt for the years ending December 31, 1995 through 1998 and thereafter, are as follows:\nOn or after April 15, 1995, the Company will be permitted to redeem in full the $22.1 million outstanding of 10% long-term publicly held notes, at a price equal to 100% of the principal amount, plus accrued interest to the redemption date. If this option is pursued, the proceeds for redemption of these notes will come from existing cash of approximately $ 15 million, operating cash flow and additional financing from the revolving term credit facility described below.\nThe term debt agreements contain restrictions on the disposition of assets of the Company and limitations on the amount of sale and leaseback transactions. These restrictions are not expected to affect the pending merger with Apache Corporation (see Note B, ``Plan of Merger'' in the Notes to the Consolidated Financial Statements).\nIn 1992, upon receipt of the proceeds from the disposition of the U.S. assets, the Company repurchased $55.3 million of its publicly held notes. An additional $18.4 million was purchased during 1993.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nG. Debt (Continued)\n(2) Revolving Term Credit Facility\nEffective November 19, 1992, DEKALB Energy Canada Ltd. (``DECL'') entered into a revolving term credit facility with the Royal Bank of Canada (the ``Lender``), which allows borrowings of up to $30.0 million Canadian funds or the equivalent amount in U.S. funds. DECL may borrow in Canadian dollars at Canadian prime (8.0% at December 31, 1994), in U.S. dollars at U.S. prime (8.50% at December 31, 1994) plus one-eighth of one percent or under a number of other financing alternatives. Commitment fees are paid on the unused portion of the commitment to the extent it exceeds $10.0 million Canadian dollars. This agreement replaced DECL's $13 million Canadian funds facility. The weighted average interest rate was 6.69%, 5.50% and 7.54% for the years ending December 31, 1994, 1993 and 1992, respectively.\nAt December 31, 1994, DECL had $14.3 million Canadian funds ($10.2 million U.S.) outstanding under this revolving term credit facility. The facility is guaranteed by DEKALB Energy Company. The current term of the facility is up for renewal on June 30, 1995, at which time the Company expects a twelve month extension, subject to the annual review of the Lender. However, if the term is not extended by the Lender, the commitment will be reduced to the amount of the borrowings then outstanding or two-thirds of DECL's reserve value, whichever is less. DECL is then required to pay down the commitment in 20 quarterly installments. The first installment is due six months after the cancellation date. The Company intends to repay the outstanding line of credit using internally generated cash. However, as discretionary cash outflows for the 1995 calendar year are expected to approximately equal or exceed the Company's cash flow from operating activities, the Company does not intend to make any repayments during 1995. Accordingly, the revolving term credit facility has been reclassified to long-term debt for financial statement purposes.\nUnder the terms of the revolving term credit facility, the Company may not enter into an amalgamation of any type without the prior written consent of the Lender. Such consent may not be reasonably withheld and is expected to be obtained in normal course with respect to the pending merger with Apache Corporation (see Note B, ``Plan of Merger'' in the Notes to the Consolidated Financial Statements).\nThe revolving term credit facility contains a debt to equity covenant for DECL during the term of the agreement, and a cash flow covenant during the repayment period after the termination of the facility. DECL must notify the Lender when various adverse events occur. The Lender, at its discretion, may require DECL to collateralize certain of its properties.\nAt December 31, 1994, the Company had no collateralized oil and gas properties.\nIn 1992, upon receipt of the proceeds from the disposition of U.S. assets, the Company repaid its U.S. line of credit.\nH. Commitments and Contingencies and Off-Balance Sheet Risks\nCommitments and Contingencies\n(1) The Company and its subsidiaries are defendants in various legal actions arising in the course of their current and discontinued business activities. In the opinion of management, these actions will not result in a material effect on the consolidated financial position, results of operations, or liquidity of the Company.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nH. Commitments and Contingencies and Off-Balance Sheet Risks (Continued)\n(2) At December 31, 1994, the Company had various offsetting tax matters pending relating to the Canadian operations which have not been provided for in the financial statements. In the opinion of management the net impact of these matters will not have a material effect on the consolidated financial position, the results of operations, or liquidity of the Company, and will be provided for in the financial statements if required upon resolution of each item.\n(3) The Company has noncancellable agreements with terms ranging from 1 to 10 years to lease office space and equipment, and for terms ranging from 15 to 30 years for pipeline transportation capacity. Minimum payments due under the terms of the agreements are as follows:\nRental expense for operating leases for the years ended December 31, 1994, 1993, and 1992 was $347,000, $370,000 and $1,054,000 respectively.\n(4) The Company maintains a voluntary retirement plan for its employees requiring the Company to contribute certain amounts each year to the plan (see Note K, ``Defined Contribution Plans''in the Notes to the Consolidated Financial Statements).\nOff-Balance Sheet Risks\nAt December 31, 1994, the Company had in its name, stand-by letters of credit in the amount of $0.3 million, which covered 15 months of pipeline demand charges from Alberta Natural Gas Co. Ltd.\nCommodity Price Hedge Contracts\nThe Company has from time to time entered into various commodity derivative contracts contracts to protect against fluctuations in prices for natural gas and crude oil. In 1994, the Company used swap contracts to hedge approximately 24% of its gross gas production and 13% of its gross oil production at prices averaging $2.22 per MCF and $18.71 per barrel, respectively. Gains of approximately $1.5 million have been included in operating revenues for the year.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nH. Commitments and Contingencies and Off-Balance Sheet Risks (Continued)\nCommodity Price Hedge Contracts (Continued)\nThe Company has entered into NYMEX based swap contracts with a third party for the 1995 fiscal year as follows:\nUnrealized profits on these contracts at year end based upon prices in effect at December 30, 1994 were approximately $1.9 million.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nH. Commitments and Contingencies and Off-Balance Sheet Risks (Continued)\nCommodity Price Hedge Contracts (Continued)\nThe swap contracts are conducted with a major financial institution which the Company believes presents a minimal credit risk. The Company is exposed to potential market risk should commodity prices increase beyond the prices that have been hedged, or should differential spreads decrease below what has been hedged. Basis differential swap contracts are implemented to guarantee a price spread between NYMEX market prices and a desired point. This has the effect of fixing transportation costs related to the sale of a commodity to ensure a netback price at a specific sales location.\nI. Capital Stock and Incentive Plans\nClass A Stock and Class B (Nonvoting) Stock\nThe holders of Class A Stock and Class B (nonvoting) Stock have the same rights in all respects, including rights with respect to dividends and other distributions, except that (i) the holders of Class B (nonvoting) Stock have no voting rights other than as required by the Delaware General Corporation Law, (ii) the holders of Class A Stock may exchange, at their election, any of their shares for an equal number of shares of Class B (nonvoting) Stock on a continuing basis and (iii) the Board of Directors of the Company may distribute (1) voting stock of subsidiaries of the Company to the holders of Class A Stock of the Company and (2) non-voting stock of subsidiaries of the Company to the holders of Class B (nonvoting) Stock of the Company.\nPreferred Stock\nThe Company has 500,000 shares of $1 par value preferred stock authorized and unissued.\nIncentive Plans\nIn 1990, the Company adopted a Long-Term Incentive Plan ( the ``Plan'') which provides for the awarding, from time to time, of stock options, restricted stock, stock appreciation rights (SARs), performance awards and stock indemnification rights (SIRs). The Compensation Committee of the Board may make awards of SARs, SIRs, restricted stock, performance awards, or stock options to certain officers and other key employees of the Company. Stock options may be granted at no less than fair market value of the Company's stock at the date of grant and are exercisable within periods specified by the Compensation Committee. The Plan replaced an Incentive Stock Option Plan and a non-qualified stock option plan. All stock options granted prior to December 31,1990, were granted under these latter two plans and continue in effect, but no new stock options may be awarded under these plans. At December 31, 1994, 252,395 shares of Class A Stock subject to options and 7,050 shares of Class B (nonvoting) Stock subject to options were exercisable under the Plan. The Company had 646 shares available for future grants either as Class A or Class B shares, under the Plan at December 31, 1994.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nI. Capital Stock and Incentive Plans (Continued)\nCertain current and former officers of the Company were participants in a Phantom Stock Plan. The Phantom Stock Plan expired in November of 1992. The Company paid $.5 million to the remaining participants.\nSubsequent to the expiration of the previous Phantom Stock Plan, the Company granted 77,380 phantom units exercisable in 1993 at $16.00 per unit, to certain former officers of the Company. All of the new phantom units were exercised in 1993, resulting in a $.1 million payment. This payment had been accrued as part of the loss on the sale of the U.S. assets in 1992.\nIn 1994, the Company granted 20,000 phantom units to officers of the Company exercisable beginning in 1994 at a price range of $14.00 to $15.25 per unit. At December 31, 1994, none of these units had been exercised.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nJ. Pension Plans\nPrior to the sale of the U.S. assets in 1992, the Company's U.S. employees participated in a noncontributory pension plan which was designed to provide benefits based on such employees' career earnings. As part of the sale of the U.S. assets, this plan was terminated, and assets were distributed.\nThe Company maintains a noncontributory pension plan covering certain management employees which is not funded. Benefits are based on each participant's years of service, final average compensation (in the U.S.), or average of three highest paid years (in Canada) and estimated benefits received from certain other plans. At December 31, 1993, the U.S. did not have any active employees in the plan. Eight previous U.S. employees continue to receive benefits under the plan. The 1994 interest cost of $153,000 associated with the U.S. employees was accumulated as part of the loss on the sale of U.S. assets in 1992 and therefore did not result in an expense in 1994.\nTotal pension expense for the years ended December 31, 1994, 1993, and 1992, was $159,000, $85,000 and $2,134,000, respectively.\nThe components of total pension expense are as follows ($ in thousands):\nActuarial assumptions for 1994 and 1993 are as follows:\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nJ. Pension Plans (Continued)\nA reconciliation of accrued pension liability, included in other long-term liabilities on the financial statements, is as follows ($ in thousands):\nK. Defined Contribution Plans\nPrior to the sale of the U.S. assets in 1992, the Company's U.S. employees participated in a voluntary thrift plan which provided that the Company contribute a minimum of $.50 for every dollar contributed by employees up to 6% of their salaries. Additional discretionary amounts could have been contributed when warranted by results of operations. Company contributions charged to expense under this plan were $243,000 for the year ended December 31, 1992.\nFollowing the sale of the U.S. assets in 1992, this plan was discontinued and the assets were distributed to the individuals. The remaining U.S. eligible employees participated in a voluntary thrift plan with the same basic design as the previous plan; however, it contained an aged based contribution in addition to the $.50 match and the additional discretionary payments. Following the 1993 sale of assets in California, this plan is no longer active. During 1994 the Company distributed the assets of this plan to its members. Company contributions charged to expense under this plan were $15,000 and $38,000 for the years ended December 31, 1994 and 1993, respectively.\nThe Company's Canadian employees participate in a voluntary retirement plan established in 1991. The Company contributes not less than 1% and not greater than 5.5% of the salary for each employee who participates in the plan, regardless of the employees' contribution to the plan. In addition, the Company contributes a minimum of $.50 for every dollar contributed by employees up to 3% of their salaries. Additional discretionary amounts may also be contributed when warranted by results of operations. Company contributions charged to expense under this plan were $403,000, $507,000, and $375,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nL. Operations by Geographic Area\nInformation on the Company's continuing operations by geographic area for the year ended December 31, 1992 is shown below. U.S. operations have been combined with Canada for 1994 and 1993 due to the immateriality of the U.S. operations in relation to the Company's operations as a whole. Operating earnings from continuing operations are total revenues less operating expenses of the geographic area, excluding interest and general corporate items.\nIn 1994, two Canadian customers each accounted for 11% of the Company's sales. In 1993, the Company had three Canadian customers who accounted for 18%, 16% and 11% of sales, respectively. In 1992, the Company had one Canadian customer who accounted for 11% of sales.\nM. Discontinued Operations\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nM. Discontinued Operations (Continued)\nOther\nThe Company sold the stock of its commodities brokerage business in 1986 and Lindsay Manufacturing Co. in 1989. The 1992 losses resulted from changes in estimated future expenses related to the above transactions. As a result of the Company's cumulative loss position in the U.S., no tax benefit was recognized for the losses.\nN. Oil and Gas Disclosures\nCapitalized costs at December 31, 1994 (all relating to assets located in Canada) which have been excluded from the amortization base as prescribed by the Securities and Exchange Commission Financial Reporting Release No. 14 are as follows:\nThe properties associated with the above excluded costs are being evaluated in the normal course of the Company's exploration activities. While it is not possible to determine the exact period in which these costs will be transferred to the amortization base, it is estimated that the majority will be included within five years after the costs were incurred.\nAny material impairment to the properties associated with the excluded costs will be moved to the full cost amortization base.\nO. 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 Cash Equivalents\nThe carrying amount approximates the fair value due to the short term maturity of these instruments.\nDEKALB Energy Company\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nO. Disclosures About Fair Value of Financial Instruments (Continued)\nLong-Term Debt\nThe fair value of the Company's publicly held notes at December 31, 1994 is estimated to be $51.0 million, or $0.3 million under stated book value, based upon estimates provided to the Company by independent sources. The fair value of the Company's revolving term credit facility approximates the carrying amount.\nP. Postemployment Benefits\nIn November 1992, the Financial Accounting Standards Board introduced Statement No. 112, ``Employer's Accounting for Postemployment Benefits'' effective for fiscal years beginning after December 15, 1993. No provision for any future obligation has been made by the Company for postemployment benefits arising from the proposed merger with Apache (see Note B,``Plan of Merger '') as the amounts, if any, cannot be reasonably estimated. Other estimated postemployment benefits are not material.\nQ. Future Removal and Site Restoration Costs\nAt December 31, 1994, the Company estimated future removal and site restoration costs to be $6.8 million ($1.0 million present value). These costs are included in DD&A expense using the unit- of-production method based on proved oil and gas reserves. The Company charged $0.4 million in 1994, $0.6 million in 1993 and $0.6 million in 1992.\nDEKALB Energy Company\nSUPPLEMENTARY FINANCIAL INFORMATION (Unaudited)\nDEKALB Energy Company\nSUPPLEMENTARY FINANCIAL INFORMATION (Unaudited)\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVES As of or for the year ended December 31, 1994, 1993, and 1992 ($ in millions*)\nDEKALB Energy Company\nSUPPLEMENTARY FINANCIAL INFORMATION (Unaudited)\nThe following table sets forth the changes in the Standardized Measure of Discounted Future Cash Flow relating to Proved Oil and Gas Reserves ($ in millions)\nCAPITALIZED COSTS RELATED TO OIL AND GAS PROPERTIES ($ in thousands)\nDEKALB Energy Company\nSUPPLEMENTARY FINANCIAL INFORMATION (Unaudited)\nDEKALB Energy Company\nSUPPLEMENTARY FINANCIAL INFORMATION (Unaudited)\nThe following quarterly items are all pre-tax amounts:\nThe quarters ended March 31 and June 30, 1993 include Canadian and California operations. All 1994 results and the quarters ended September 30 and December 31, 1993 include Canadian operations and the remaining California well subsequent to the sale of the California gas assets effective July 1, 1993. A pre-tax and after-tax gain of $0.5 million was recognized in income in the third quarter of 1993 in connection with the sale. The first quarter of 1993 also includes a one time benefit adjustment of $5.3 million as a result of the Company's adoption of Financial Accounting Standard No. 109 ``Accounting for Income Taxes ''as of January 1, 1993.\nFor further discussion, see Management's Discussion and Analysis of Financial Condition and Results of Operations.\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 about Executive Officers is shown under the heading Executive Officers of the Registrant, in Item 4 of this filing.\nThere are four directors whose terms of office expire in 1995 and two directors whose terms of office will expire in 1997. Each has served continuously as a director of the Company since the date indicated beside the particular director's name. Also set forth below is the principal employment during the past five years of the directors.\nName and Principal Occupation Age Director Since Directors Whose Terms Expire in 1995:\nBruce P. Bickner 51 May 5, 1979 Mr. Bickner is Chairman of the Board of Directors. He was Chairman of the Board and Chief Executive Officer until January 1992 when he was also elected President. He relinquished the positions of President and Chief Executive Officer in November 1992. He has been Chairman, Chief Executive Officer and a Director of DEKALB Genetics Corporation for the past five years, as well as a director of Castle Bancgroup, Inc. He is a member of the Executive Committee of the Company.\nH. Blair White 67 March 9, 1967 Mr. White is a senior partner in the law firm of Sidley & Austin. He is a Director of DEKALB Genetics Corpor- ation, R.R. Donnelley & Sons Company and Kimberly- Clark Corporation. Mr. White is Chairman of the Compensation Committee and an alternate member of the Executive Committee of the Company.\nDonald McMorland 67 April 26, 1989 Mr. McMorland was elected President and Vice Chairman of the Board on May 13, 1994. He was Chairman of the Board of Alberta & Southern Gas Co. Ltd. from October 1, 1991 until June 30, 1994. He was Executive Vice President and Chief Operating Officer of that company until he was elected President and Chief Executive Officer in July 1990. He resigned as President and Chief Executive Officer in October 1993. He was also Senior Vice President and a director of Alberta Natural Gas Company Ltd. until he resigned as an officer in April 1991 and as a director in December 1991.\nDirector Whose Term Expires in 1995 (Class of 1996):\nThomas H. Roberts, Jr. (1) 70 January 5, 1951 Mr. Roberts is Vice Chairman of the Executive Committee of the Board of Directors. He is a director of IMC Global, Inc. and Pride Petroleum Services, Inc. Mr. Roberts is a member of the Executive Committee and Chairman of the Audit Committee of the Company.\nDirectors Whose Terms Expire in 1997:\nCharles C. Roberts (1) 70 September 7,1957 Mr. Roberts is Chairman of the Executive Committee of the Board of Directors. He is also a member of the Compensation Committee of the Company.\nWilliam J. Wooten 70 April 26, 1989 Mr. Wooten was president of the Moran Corporation until June 1987, at which time he became a petroleum consultant. He is a member of the Compensation and Audit Committees of the Company.\n(1) Thomas H. Roberts, Jr. and Charles C. Roberts are brothers-in-law.\nCOMPLIANCE WITH SECTION 16 OF THE EXCHANGE ACT\nSection 16 (a) of the Securities Exchange Act of 1934 requires the Company's officers, directors and persons who own more than ten percent of a registered class of the Company's equity securities (``Reporting Persons'') to file reports of ownership and changes in ownership with the SEC. Reporting persons are required by SEC regulation to furnish the Company with copies of all Section 16 (a) reports they file. Based solely on its review of copies of such forms received by it, the Company believes that during 1994 its Reporting Persons complied with all Section 16 (a) reporting requirements applicable to them, except that Mr. Leteta inadvertently filed late his Form 3 Initial Statement of Beneficial Ownership of Securities.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table sets forth the annual and long term compensation paid by the Company and its subsidiaries for the years indicated to those persons set forth below:\nSUMMARY COMPENSATION TABLE (1)\n(1) Where applicable, Canadian dollars were translated into U.S. dollars at the 1992, 1993 and 1994 average exchange rates of .8278, .7748 and .7319, respectively, which were the rates used for the Company's income statements during those years.\n(2) Mr. Craig was hired in November 1992.\n(3) Mr. Tkachyk left the Company's employ on May 13, 1994.\n(4) Mr. McMorland was appointed President and Vice Chairman of the Board on May 13, 1994.\n(5) Mr. Finnegan passed away on September 17, 1994.\n(6) 1994 All Other Compensation total of $211,150 consists of termination payments of $203,286 and $7,864 credited to the Supplementary Retirement Plan.\n(7) 1994 All Other Compensation is a $10,352 contribution to the Supplemental Retirement Plan.\n(8) 1994 All Other Compensation is a $16,031 contribution to Supplementary Retirement Plan.\n(9) 1994 All Other Compensation is a $6,518 contribution to the Supplementary Retirement Plan.\n(10) 1994 All Other Compensation total of $17,204 consists of: $6,138 contribution to the Canadian Registered Retirement Savings Plan; and $11,066 credited to the Supplementary Retirement Plan.\nOPTION\/SAR GRANTS DURING 1994\nAGGREGATED OPTION\/SAR EXERCISES IN 1994 AND DECEMBER 31, 1994 OPTION\/SAR VALUE\nIf the proposed merger with Apache referred to in Item 7 is consummated, Apache will assume each outstanding Company stock option that remains unexercised. In addition, each holder of a Company stock option, including those named in the above table, may elect, prior to the effectiveness of such merger, to surrender their Company stock options, in whole or in part, without regard to whether such options are then fully exercisable, in exchange for shares of Apache Common Stock. The treatment of Company stock options in connection with the proposed merger with Apache is more fully described in the Proxy\/Statement Prospectus included in the Registration Statement on Form S-4 (Registration No. 33-57321) filed by Apache with the Securities and Exchange Commission under the Securities Act of 1933, as amended, with respect to the Merger.\nESTIMATED ANNUAL RETIREMENT BENEFITS FOR YEARS OF SERVICE INDICATED\nThe following table shows the estimated annual retirement benefits payable upon retirement to participants in the Company's retirement plans for the indicated levels of remuneration and years of service.\nThe defined benefit plan for named executives is based upon the average annual compensation of the three highest paid years. The compensation covered by the plan is salary and bonus. Such amounts for each of the named executive officers are set forth in the summary compensation table.\nThe credited years of service for each of the named executive officers is:\nThe benefits in the plan are calculated by determining the annualized earnings of the three highest paid years and multiplying this by the number of years of service times two percent. This benefit would be offset by the Canada Pension Plan benefits, the Canadian Old Age Security Plan benefits, and benefits associated with employer contributions to a Registered Retirement Savings Plan and Supplementary Retirement Plan. The latter two plans are defined contribution plans. The benefit table assumes that the participant will retire at age 65. If not, the benefit will be reduced by three percent for every year between ages 55 and 60 and one percent between ages 60 and 65.\nEMPLOYMENT AGREEMENTS\nMessrs. Nash, Craig, and Evans do not have written employment agreements with the Company. However, the Company has agreed with them that their 1995 base salaries shall be $92,300, $90,900 and $93,000, respectively. They have performance-related bonus opportunities which could be as high as $32,400, $27,300, and $28,100, respectively.\nOn May 13, 1994 Mr. McMorland was appointed Vice Chairman of the Board and President of the Company. His compensation is covered under a consulting contract dated June 1, 1994. This contract may be terminated by either party upon one month's prior written notice. The Company is committed to pay a monthly minimum fee of $6,000.00 plus $640 per day in excess of 28 days during any fiscal quarter. In addition, the Company covers all of Mr. McMorland's direct business expenses. In addition, in May 1994 Mr. McMorland was granted 10,000 phantom units, which are Stock Appreciation Rights, at $14.00 per unit. These units were 100% vested on November 18, 1994.\nEach individual is paid in Canadian dollars. Amounts shown in this paragraph are in U.S. dollars calculated by converting Canadian dollars to U.S. dollars at $0.71.\nCOMPENSATION OF DIRECTORS\nExcept as noted herein, directors of the Company are paid $13,000 annually, plus $1,000 per day for attending meetings of the Board of Directors. Directors are paid $800 for attending meetings of committees of the Board of Directors, or for attending other meetings at the request of the Company, plus expenses for attending such meetings. Bruce P. Bickner, Chairman of the Board, in lieu of being paid the fees referenced above, will be paid $70,000 for his additional duties as Chairman.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nMr. Charles C. Roberts was a member of the Compensation Committee of the Board of Directors during 1994 and was an officer of the Company. He held the office of Chairman of the Executive Committee during 1994. The only compensation he received in such capacity was the compensation normally paid to members of the Board of Directors. During his employment by the Company prior to his retirement in March 1988, Charles C. Roberts held various officer positions, including Vice Chairman of the Board.\nH. Blair White, a Director of the Company, is a partner in the law firm of Sidley & Austin. Sidley & Austin provided legal services to the Company during the past year.\nDonald McMorland was an officer of Alberta and Southern Gas Co. Ltd. (\"A&S\") until he resigned in October 1993. Mr. McMorland remained as Chairman of the Board of A&S until June 30, 1994. As of November 1, 1993, A&S had essentially ceased its gas marketing function in Canada. A&S is wholly-owned by Pacific Gas and Electric Company (\"PG&E\"). Pacific Gas Transmission Company (\"PGT\") is wholly-owned by PG&E. The Company entered into a 30- year firm transportation agreement with PGT beginning November 1, 1993. The agreement provides that PGT will transport gas for the Company from the Canadian border to Kern River, California. Yearly payments to PGT are expected to be approximately $2.0 million. In 1994 the Company paid PGT $2.2 million. DEKALB paid PG&E $0.5 MILLION IN 1994 for short-term transportation within California.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth as of December 31, 1994 the beneficial ownership of the Class A Stock and the Class B (nonvoting) Stock of the Company (including shares as to which a right to acquire ownership exists (e.g., through the exercise of stock options) within the meaning of Rule 13d-3 (d)(1) under the Securities Exchange Act) of each director, of the six executive officers named in the various compensation tables, and of all directors and all executive officers as a group:\n(1) Unless otherwise noted, the named individual has sole voting and investment power with respect to the shares of Class A Stock and sole investment power with respect to the shares of Class B (nonvoting) Stock listed. The Securities and Exchange Commission defines \"beneficial owner of a security\" as including any person who has sole or shared voting or investment power with respect to such security.\n(2) Includes 54,810 shares of Class A Stock subject to an option at an exercise price of $12.25 per share; 38,140 shares of Class A Stock subject to an option at an exercise price of $8.53 per share; and 7,050 shares of Class B (nonvoting) Stock subject to an option at an exercise price of $7.39 per share, all of which may be exercised within 60 days after December 31, 1994.\n(3) Includes 3,000 shares of Class A Stock subject to an option at an exercise price of $11.50 per share and 5,417 shares of Class A Stock subject to an option at an exercise price of $14.00 per share which may be exercised within 60 days after December 31, 1994.\n(4) Includes 6,773 shares of Class A Stock subject to an option at an exercise price of $12.25 per share; 7,058 shares of Class A Stock subject to an option at an exercise price of $14.00 per share; 2,500 shares of Class A Stock subject to an option at an exercise price of $22.25 per share; 1,500 shares of Class A Stock subject to an option at an exercise price of $20.00 per share; and 3,929 shares of Class A Stock subject to an option at an exercise price of $13.00 per share, all of which may be exercised within 60 days after December 31, 1994.\n(5) Includes 10,345 shares of Class A Stock subject to an option at an exercise price of $12.25 per share; 500 shares of Class A Stock subject to an option at an exercise price of $2.096 per share; 1,200 shares of Class A Stock subject to an option at an exercise price of $22.25 per share; 1,500 shares of Class A Stock subject to an option at an exercise price of $20.00 per share; and 7,681 shares of Class A Stock subject to an option at an exercise price of $13.00 per share; 17,490 shares of Class A Stock subject to an option at an exercise price of $14.00 per share, all of which may be exercised within 60 days after December 31, 1994.\n(6)Includes 7,900 shares of Class A Stock subject to an option at an exercise price of $12.25 per share; 4,255 shares of Class A Stock subject to an option at an exercise price of $14.00 per share; 500 shares of Class A Stock subject to an option at an exercise price of $2.096 per share; 2,500 shares of Class A Stock subject to an option at an exercise price of $19.125 per share; 1,900 shares of Class A Stock subject to an option at an exercise price of $20.00 per share; and 6,671 shares of Class A Stock subject to an option at an exercise price of $13.00, all of which may be exercised within 60 days after December 31, 1994.\n(7) Charles C. Roberts has shared voting and investment power (with Mary R. Roberts) with respect to 42,168 shares of Class A Stock and shared investment power (with Mary R. Roberts) with respect to 625 shares of Class B (nonvoting) Stock. Includes 18,100 shares of Class A Stock subject to an option at an exercise price of $8.53 per share that may be exercised within 60 days after December 31, 1994. As of December 31, 1994, Charles C. Roberts, his spouse and their descendants and their spouses, and trusts created for their benefit, owned an aggregate of (excluding shares subject to option) 872,454 shares (37.911%) of the Company's then outstanding Class A Stock.\n(8) Thomas H. Roberts, Jr. and Charles C. Roberts are brothers- in-law.\n(9) Thomas H. Roberts, Jr. has sole voting and investment power with respect to 164,011 shares of Class A Stock, sole investment power with respect to 67,603 shares of Class B (nonvoting) Stock, shared voting and investment power (with Michael J. Roberts) with respect to 25,920 shares of Class A Stock. Includes 23,300 shares of Class A Stock subject to an option at $8.53 per share that may be exercised within 60 days after December 31, 1994. As of December 31, 1994, Thomas H. Roberts, Jr. and his descendants and their spouses, and trusts created for their benefit, owned an aggregate of (excluding shares subject to option) 748,954 shares (32.544%) of the Company's then outstanding Class A Stock. Not included in these shares are 123,500 shares of Class A Stock as to which Catherine H. Roberts-Suskin (the daughter of Mr. Roberts) has disclaimed beneficial ownership. See note (4) on Page 64.\n(10) Includes shares reported on the last Form 4 filed by Mr. Tkachyk prior to the date of his termination of employment.\n(11) Included in these shares are 260,659 shares of Class A Stock and 7,050 shares of Class B (nonvoting) Stock subject to options that may be exercised within 60 days after December 31, 1994.\nPRINCIPAL STOCKHOLDERS\nThe following table sets forth as of December 31, 1994 the beneficial ownership of the Company's Class A Stock of each person known by the Company to own beneficially more than 5% of such class of securities. Included are shares of Class A Stock subject to an option which may be exercised within 60 days after December 31, 1994.\n(1) The Securities and Exchange Commission defines \"beneficial owner of a security\" as including any person who has sole or shared voting or investment power with respect to such security.\n(2) Thomas H. Roberts, Jr. is the father of Thomas H. Roberts, III and the uncle of Douglas C. Roberts, John T. Roberts and Virginia Roberts Holt. Douglas C. Roberts, Virginia Roberts Holt and John T. Roberts are brothers and sister and are the cousins of Thomas H. Roberts, III.\n(3) Includes 23,300 shares of DEKALB Class A Stock subject to an option at $8.53 per share.\n(4) Based on a Schedule 13D filed with the Securities and Exchange Commission. Such Schedule indicates that Amy L. Domini and William B. Perkins beneficially own such shares as co-trustees of trusts which hold such shares and that the grantors, beneficiaries, and in certain cases, the co- trustees of such trusts include Catherine H. Roberts-Suskin and Susan Shawn Roberts. Such Schedule 13D indicates that Catherine H. Roberts-Suskin also beneficially owns 60,256 of such shares as co-trustee of certain of such trusts and may be deemed to beneficially own an additional 123,500 of such shares solely by virtue of her power to remove and replace the trustees of one of those trusts, but that she disclaims beneficial ownership of such 123,500 shares. See note (10) on page 62.\n(5) Douglas C. Roberts has sole voting and investment power with respect to 179,152 of such shares of Class A Stock and Lynne K. Roberts has sole voting and investment power with respect to the remaining 98,824 shares of Class A Stock. Douglas C. Roberts and Lynne K. Roberts are husband and wife.\n(6) Virginia Roberts Holt has sole voting and investment power with respect to 101,053 of such shares of Class A Stock and Terrance K. Holt has sole voting and investment power with respect to the remaining 176,584 shares of Class A Stock. Virginia Roberts Holt and Terrance K. Holt are husband and wife.\n(7) John T. Roberts has sole voting and investment power with respect to 131,180 of such shares of Class A Stock and Robin R. Roberts has sole voting and investment power with respect to the remaining 143,493 shares of Class A Stock. John T. Roberts and Robin R. Roberts are husband and wife.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee Item 11, ``COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION'', with respect to Mr. White and Mr. McMorland.\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 and schedules other than those listed are omitted for the reason that they are not required, are not applicable, or that equivalent information has been included in the financial statements or notes thereto.\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (3) Exhibits\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (3) Exhibits (continued)\nFootnotes: ----------\n(1) Incorporated by reference to Exhibit to Amendment No. 1 to Form 10-K for the fiscal year ended August 31, 1986, dated May 19, 1987.\n(2) Incorporated by reference to Exhibit to Form 10-K for the fiscal year ended December 31, 1988, dated March 13, 1989.\n(3) Incorporated by reference to Exhibit 4 A to Registration Statement on Form S-3 (Registration No. 33 - 12534).\n(4) Incorporated by reference to Exhibit to Form 10-Q for the quarter ended March 31, 1990, dated May 11, 1990.\n(5) Incorporated by reference to Exhibit to Form 10-K for the fiscal year ended December 31, 1991, dated March 11, 1992.\n(6) Incorporated by reference to Exhibit to Form 8-K dated October 16, 1992.\n(7) Incorporated by reference to Exhibit to Form 10-K for the fiscal year ended December 31, 1992 dated March 12, 1993.\n(8) Incorporated by reference to Exhibit to Form 10-K for the fiscal year ended December 31, 1994, dated March 7, 1994.\n(9) Incorporated by reference to Exhibit to Form 8-K dated December 21, 1994.\n*Indicates management contracts, compensatory plans or arrangements.\n(b) Reports on Form 8-K\nA Form 8-K dated September 17, 1994 was filed detailing the filing requirement for Item 5 - the announcement of the death of Michael E. Finnegan, Executive Vice President and Chief Financial Officer of the Company.\nA Form 8-K dated December 21, 1994 was filed detailing the filing requirement for Item 5 - Agreement and Plan of Merger entered into among Apache Corporation, XPX Acquisitions, Inc. (``Sub''), a wholly owned subsidiary of Apache, and the Company providing for the merger of the Sub into the Company in a transaction under Delaware Law by which the Company would become a wholly owned subsidiary of Apache; and Item 7 - Financial Statements and Exhibits related to the above transaction.\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.\nDEKALB Energy Company\nDate: March 7, 1995\nBy: DONALD MCMORLAND ---------------- Donald McMorland 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 on this 7th day of March, 1995.\nSignature Title --------- -----\nJOHN LETETA Vice President Finance and ----------- Treasurer John Leteta\nEDDY Y. TSE Chief Accounting Officer ----------- Eddy Y. Tse\nDIRECTORS\nBRUCE P. BICKNER THOMAS H. ROBERTS, JR. ---------------- ---------------------- Bruce P. Bickner Thomas H. Roberts, Jr.\nDONALD MCMORLAND ---------------- -------------- Donald McMorland H. Blair White\nCHARLES C. ROBERTS ------------------ ----------------- Charles C. Roberts William J. Wooten\nAUDITORS' REPORT\nTo the Shareholders and Board of Directors of DEKALB Energy Company:\nOur report on the consolidated financial statements of DEKALB Energy Company is included on page 22 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed on page 65 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 herein.\nCalgary, Alberta COOPERS & LYBRAND February 13, 1995 ----------------- Coopers & Lynrand\nEXHIBIT 10.11 DEKALB ENERGY COMPANY TEMPORARY CONSULTING CONTRACT BETWEEN DEKALB ENERGY COMPANY AND DONALD MCMORLAND\nTHIS CONTRACT is entered into effective as of June 1, 1994, by and among DEKALB Energy Canada Ltd. and DEKALB Energy Company (collectively hereinafter called ``DEKALB''), on the one hand and McMorland Consulting Services Ltd. (hereinafter called the ``Consultant''), on the other hand, to provide consulting services (hereinafter called the ``Work'') upon the terms and conditions herein set forth:\n1. SCOPE OF WORK -------------\n(a) The Consultant shall provide the services of a senior consultant to DEKALB to perform such services as may be assigned to it by the Chairman of the Board of DEKALB or by the Board of Directors of DEKALB.\n(b) The Consultant shall assign Donald McMorland to perform the Work. The Consultant shall not have the right to have the Work performed by an individual other than Donald McMorland. Therefore, this Contract shall immediately terminate if Donald McMorland dies, becomes disabled or is otherwise unable to perform his duties.\n(c) Donald McMorland, in his individual capacity, shall hold the office and perform the duties of President of DEKALB and shall perform the all of his duties as such in accordance with applicable law, DEKALB's By-laws and the directives of the Chairman of the Board of DEKALB and the Board of Directors of DEKALB. Since DEKALB shall provide no employee compensation to Donald McMorland for performing that function, Consultant shall indemnify DEKALB. and hold DEKALB harmless from any claim for such compensation as an employee that might be made by Donald McMorland.\n2. TERM ---- (a) Notwithstanding the date that this Contract is executed, it shall be in effect commencing June 1, 1994.\n(b) The provisions respecting liability, indemnification, settlement of accounts, taxes and confidentiality and all obligations which have accrued hereunder prior to the date of termination of the Contract shall survive the termination of the Contract and shall remain enforceable thereafter.\n(c) The parties hereby agree that each party shall have the right, in their absolute discretion, to terminate this Contract by providing the other party with one month's prior written notice.\n(d) The parties further agree that when this Contract is terminated, with or without cause, DEKALB shall have no obligation to make any form of severance payment to Consultant.\n3. REMUNERATION ------------ DEKALB shall pay the Consultant, as full and complete compensation for the Work, an amount equal to the fee set forth below.\nThe fee shall be determined on a per diem basis subject to a monthly minimum fee of $8,400 per month, exclusive of the Goods and Services Tax (``GST'').\nEXHIBIT 10.11 DEKALB ENERGY COMPANY TEMPORARY CONSULTING CONTRACT BETWEEN DEKALB ENERGY COMPANY AND DONALD MCMORLAND (Continued)\nIn the event the Consultant is required to provide services in excess of twenty-eight (28) days duration during any fiscal quarter, the Consultant shall be compensated for each full day in excess of the twenty-eight (28) day threshold at the rate of $900 per day or $450 per half day.\nAll amounts quoted herein are quoted in Canadian funds and shall be payable in Canadian funds.\n4. EXPENSES -------- (a) Subject to Subclauses (b) and (c), below, the Consultant shall also be entitled to receive reimbursement for all reasonable expenses incurred in the performance of the Work, including reasonable health and travel insurance coverages, provided, however, that, where reasonably possible, such expenses shall first be approved by DEKALB.\n(b) All travel undertaken by the Consultant on behalf of DEKALB shall conform to the travel policies, standards and practices established by DEKALB from time to time.\n(c) The expenses reimbursed to the Consultant shall be exclusive of any GST paid by the Consultant if the Consultant is a goods and services tax registrant. In such a case, the Consultant shall identify separately as a part of the invoice any GST that the Consultant is required to collect in respect to the Consultant's charges for reimbursable expenses.\n5. INVOICING AND PAYMENT --------------------- (a) Every month the Consultant shall invoice DEKALB for the total amount payable as determined in Clause 3 and Clause 4, above. The invoice shall provide an arithmetic calculation of fees payable and a detailed list of expenses, including receipts and allocation of GST as stipulated.\nThe invoice, in duplicate, shall be submitted to:\nDEKALB Energy Canada Ltd. 700 - 9th Avenue S.W. Calgary, Alberta T2P 3V4 Attn: Michael E. Finnegan\n(b) Subject to its right to hold back amounts owing as set forth in Clause 6, DEKALB shall use all reasonable efforts to pay each invoice within forty-five (45) days of its receipt. DEKALB shall have the right to question the propriety of any charge made in an invoice for a period of one (1) year following termination of this Contract, notwithstanding payment of the invoice.\n6. HOLDBACK -------- DEKALB shall be entitled to withhold payment to the Consultant for any portion of the invoice which it disputes.\nEXHIBIT 10.11 DEKALB ENERGY COMPANY TEMPORARY CONSULTING CONTRACT BETWEEN DEKALB ENERGY COMPANY AND DONALD MCMORLAND (Continued)\n7. CONFIDENTIALITY AND OWNERSHIP OF WORK ------------------------------------- (a) All pertinent resources, information, material and papers prepared or provided by the Consultant in pursuance of this Contract shall be the sole property of DEKALB or its affiliates.\n(b) The Consultant shall maintain in the strictest confidence all information made available or acquired from DEKALB or its affiliates, for the performance of the Work and all information resulting from the performance of the Work, and shall use such information only in the performance of the work.\n8. LIABILITY AND INDEMNIFICATION -----------------------------\n(a) The Consultant shall be indemnified by DEKALB in accordance with the applicable provisions of the Restated Certificate of Incorporation of DEKALB Energy Company.\n(b) Donald McMorland, in his capacity as an officer of DEKALB shall be indemnified in accordance with the applicable provisions of the Restated Certificate of Incorporation of DEKALB Energy Company and in accordance with the Indemnification Agreement dated April 26, 1989 signed by him.\n9. Taxes -----\n(a) The Consultant shall pay and be responsible for income and payroll taxes (except such taxes specifically assessed against DEKALB or its affiliates) and other taxes of a similar or dissimilar nature.\n(b) DEKALB shall have no obligation to pay Goods and Services Tax on invoices submitted pursuant to Clause 5 unless the Consultant provides identification of its Goods and Services Tax Registration Number on the respective invoice and identifies the total amount of Goods and Services Tax included in the invoice.\n10. COMPLIANCE WITH LAWS AND POLICIES --------------------------------- (a) In performing the Work, the Consultant, and its employees, shall comply with all the DEKALB policies and all applicable laws, ordinances, codes and regulations of all jurisdictions having or asserting jurisdiction in respect of the Work. If unfamiliar with DEKALB's policies, the Consultant shall request, review and abide by all pertinent DEKALB policies, including but not limited to, the code of business conduct and policy on travel arrangements.\n(b) The Consultant's breach of any material provision of this Contract shall, at DEKALB's discretion, be deemed to constitute cause for immediate termination of this Contract.\nEXHIBIT 10.11 DEKALB ENERGY COMPANY TEMPORARY CONSULTING CONTRACT BETWEEN DEKALB ENERGY COMPANY AND DONALD MCMORLAND (Continued)\n11. APPLICABLE LAW --------------\n(a) The validity and interpretation of this Contract and the legal relation of the parties shall be governed by the laws in force from time to time in the Province of Alberta.\n(b) The Courts of the Province of Alberta and Canada shall have exclusive jurisdiction to determine all matters in dispute hereunder and the parties hereby attorn to the jurisdiction of such Courts.\n12. INDEPENDENT CONTRACTOR ----------------------\nIn furnishing its services hereunder, the Consultant shall be acting as an independent contractor in relation to DEKALB and not as an employee of DEKALB. Accordingly, the Consultant shall have no authority to act for or on behalf of DEKALB or to bind DEKALB without its express written consent and shall not be considered as having employee status for the purpose of any employee benefit plan applicable to DEKALB's employees generally. It is understood by the parties that Consultant shall only devote a portion of its time to its services to DEKALB hereunder and remains free to perform services for others, whether as a consultant or otherwise; provided that, services shall not be provided to others if it would create a conflict of interest with Consultant's responsibilities to DEKALB or if it would result in the disclosure of DEKALB's Confidential Information.\n13. MISCELLANEOUS -------------\n(a) All notices or other communications required or permitted under this Contract shall be served in writing by personal service or registered mail, return receipt requested. Notice by mail shall be addressed to each party at the address set forth below.\n(b) This Contract supersedes all other agreements previously made between the parties relating to the subject matter contained herein. No amendment, modification or termination of, or addition to, this Contract shall be valid unless and until executed in writing by the parties to this Contract.\n(c) This Contract shall be binding upon and inure to the benefit of the parties hereto, including any of their successors and permitted assignees.\n(d) This Contract may be executed in two or more counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument.\n(e) The parties hereto acknowledge that this Contract and the terms contained herein may be made public in accordance with the applicable securities laws.\nEXHIBIT 10.11 DEKALB ENERGY COMPANY TEMPORARY CONSULTING CONTRACT BETWEEN DEKALB ENERGY COMPANY AND DONALD MCMORLAND (Continued)\nIN WITNESS WHEREOF, the parties have executed this Contract effective as of the date set forth above.\nDEKALB Energy Company McMorland Consulting 700 - 9th Avenue S.W. Services Ltd. Calgary, Alberta T2P 3V4 3440 Lakeside Crescent, S.W. Canada Calgary, Alberta T3E 6A6 Canada\nBRUCE P. BICKNER DONALD MCMORLAND --------------------- ----------------- Bruce P. Bickner Donald McMorland Chairman of the Board President\nDEKALB Energy Canada Ltd. 700 - 9th Avenue S.W. Calgary, Alberta T2P 3V4 Canada\nBRUCE P. BICKNER --------------------- Bruce P. Bickner Chairman of the Board\nEXHIBIT 10.12 DEKALB ENERGY COMPANY TEMPORARY CONSULTING CONTRACT BETWEEN DEKALB ENERGY COMPANY AND JOHN LETETA\n(DEKALB Energy Company Letterhead)\nNovember 28, 1994\nJohn Leteta 4 Lake Lucerne Close SE Calgary, Alberta T2J 3H8\nDear John:\nThis letter will confirm our offer of temporary employment in the position of Vice President, Finance and Treasurer, effective September 20, 1994.\nYour annual rate of compensation will be $150,000 (Cdn.) which will be payable semi-monthly. You will be paid 10% of the total compensation you receive as vacation pay on your final pay cheque. Your company benefits will remain unchanged from your retiree benefit status: extended medical insurance coverage for you and your spouse, and $50,000 basic life insurance. You will continue to be deducted once per month for current benefit premiums.\nEither party may terminate this agreement on one month's notice.\nYour employment will not reduce the benefits from the Retiring Allowance Agreement Plan and the Supplementary Retirement Plan.\nIf you are in agreement with this offer, please sign one copy of this letter in the space provided below and return it to me at your earliest convenience.\nYours truly, The above agreed to and accepted this 29 day of November, 1994\nDONALD MCMORLAND JOHN LETETA ---------------- ----------- Donald McMorland John Leteta President\nEXHIBIT 11 DEKALB Energy Company STATEMENT RE COMPUTATION OF PER SHARE EARNINGS\nEXHIBIT 21 SUBSIDIARIES OF DEKALB ENERGY COMPANY\nThe following table sets forth principal subsidiaries of the registrant and indicates as to each such subsidiary the state or other jurisdiction under the laws of which it was organized and the percentage of voting securities thereof owned by the registrant.\nEXHIBIT 24.1 CONSENT OF AUDITORS\nWe consent to the incorporation by reference in the registration statement of DEKALB Energy Company on Form S-8, File Nos. 2-63440 (Post-Effective Amendment No. 6), No. 2-58358 (Post-Effective Amendment No. 1), No. 2-71978 (Post-Effective Amendment No. 1), and No. 33-36642 and Registration Statement No. 33-12534 (Amendment No. 3) on Form S-3 of our report dated February 13, 1995, on our audits of the consolidated financial statements and financial statement schedules of DEKALB Energy Company as of December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994, which report is included in the Annual Report on Form 10-K.\nCalgary, Alberta COOPERS & LYBRAND March 7, 1995 ----------------- Coopers & Lybrand\nEXHIBIT 24.2 DEKALB ENERGY COMPANY CONSENT OF INDEPENDENT PETROLEUM ENGINEERS\n(Ryder Scott Letterhead)\nWe hereby consent to the reference to Ryder Scott Company under ``Supplemental Financial Information - Estimated Net Quantities of Proved Reserves'' of DEKALB Energy Company in this Form 10-K and to the inclusion of Ryder Scott Company's Report of Independent Petroleum Engineers as an Exhibit in this Form 10-K.\nRYDER SCOTT COMPANY ------------------- PETROLEUM ENGINEERS\nRyder Scott Company Petroleum Engineers\nDated: February 15, 1995\nEXHIBIT 28 DEKALB ENERGY COMPANY REPORT OF INDEPENDENT PETROLEUM ENGINEERS\n(Ryder Scott Letterhead)\nFebruary 6, 1995\nDEKALB Energy Canada Ltd. 700 - 9th Avenue S.W. Calgary, Alberta T2P 3V4\nGentlemen:\nAt your request, Ryder Scott Company Petroleum Engineers (Ryder Scott) has reviewed estimates of proved hydrocarbon liquid and gas reserves as of January 1, 1995 attributable to interests of DEKALB Energy Canada Ltd. (DEKALB) in certain wells or locations. In our opinion, the overall proved reserves for the reviewed properties as estimated by DEKALB are reasonable. The estimates of reserves reviewed by Ryder Scott were prepared by engineers and geologists on the staff of DEKALB. The wells or locations for which estimates of reserves were reviewed by Ryder Scott comprised approximately 83.9 percent of the total discounted future net income at 10 percent attributable to the total interests of DEKALB, according to economic forecasts supplied by DEKALB. The summary tables below present the estimated net remaining proved reserves as of January 1, 1995 prepared by the staff of DEKALB and reviewed by Ryder Scott for the total company. Hydrocarbon liquid volumes are expressed in standard 42 gallon barrels. All gas volumes are expressed in millions of cubic feet (MMCF) at the official temperature and pressure bases of the areas where the gas reserves are located.\nSEC CASE Estimated Net Remaining Proved Reserves Attributable to the Interests of DEKALB Energy Canada Ltd. As of January 1, 1995\nThe estimated quantities of reserves in this report are related to hydrocarbon prices. DEKALB has assured us that December 1994 hydrocarbon prices were used in the preparation of their projections as required by SEC guidelines; however, actual future prices may vary significantly from December 1994 prices. Therefore, quantities of reserves actually recovered may differ significantly from the estimated quantities presented in this report.\nEXHIBIT 28 DEKALB ENERGY COMPANY REPORT OF INDEPENDENT PETROLEUM ENGINEERS (Continued)\nReview Procedure and Opinion ----------------------------\nIn our opinion, DEKALB `s estimates of future reserves for the wells and locations reviewed by Ryder Scott were prepared in accordance with generally accepted procedures for the estimation of future reserves. In general, we were in acceptable agreement on an overall company net equivalent barrel basis (at 6 MCF per barrel) with the estimates prepared by DEKALB's staff.\nCertain technical personnel of DEKALB are responsible for the preparation of reserve estimates on new properties and for the preparation of revised estimates, when necessary, on old properties. These personnel assembled the necessary data and maintained the data and work papers in an orderly manner. Ryder Scott consulted with these technical personnel and had access to their work papers and supporting data in the course of our review.\nIn performing our review, we relied upon data furnished by DEKALB with respect to property interests owned, production and well tests from examined wells, geological maps, well logs, core analyses, and pressure measurements. These data were accepted as authentic and sufficient for determining the reserves unless, during the course of our examination, a matter of question came to our attention in which case the data were not accepted until all questions were satisfactorily resolved. Our review included such tests and procedures as we considered necessary under the circumstances to render the conclusions set forth herein.\nReserve Estimates -----------------\nIn general, the reserves for the wells and locations reviewed by Ryder Scott were estimated by performance methods or the volumetric method; however, other methods were used in certain cases where characteristics of the data indicated such methods were more appropriate.\nThe estimates of reserves by the performance method utilized extrapolations of various historical data in those cases where such data were definitive. Reserves were estimated by the volumetric method in those cases where there was inadequate historical data to establish a definitive trend or where the use of production performance data as a basis for the reserve estimates was considered to be inappropriate and the volumetric data were adequate for a reasonable estimate.\nThe reserves presented herein are estimates only and should not be construed as being exact quantities. Moreover, estimates of reserves may increase or decrease as a result of future operations.\nThe proved reserves, which are attributable to the wells and locations reviewed by Ryder Scott, conform to the definition as set forth in the Securities and Exchange Commission's Regulation S-X Part 210.4-10 (a) as clarified by subsequent Commission Staff Accounting Bulletins and are based on the following definition criteria:\nEXHIBIT 28 DEKALB ENERGY COMPANY REPORT OF INDEPENDENT PETROLEUM ENGINEERS (Continued)\nProved reserves of crude oil, condensate, natural gas, and natural gas liquids are estimated quantities that geological and engineering data demonstrate with reasonable certainty to be recoverable in the future from known reservoirs under existing conditions. Reservoirs are considered proved if economic producibility is supported by actual production or formation tests. In certain instances, proved reserves are assigned on the basis of a combination of core analysis and electrical and other type logs which indicate the reservoirs are analogous to reservoirs in the same field which are producing or have demonstrated the ability to produce on a formation test. The area of a reservoir considered proved includes (1) that portion delineated by drilling and defined by fluid contacts, if any, and (2) the adjoining portions not yet drilled that can be reasonably judged as economically productive on the basis of available geological and engineering data. In the absence of data on fluid contacts, the lowest known structural occurrence of hydrocarbons controls the lower proved limit of the reservoir. Proved reserves are estimates of hydrocarbons to be recovered from a given date forward. They may be revised as hydrocarbons are produced and additional data become available. Proved natural gas reserves are comprised of non-associated, associated, and dissolved gas. An appropriate reduction in gas reserves has been made for the expected removal of natural gas liquids, for lease and plant fuel and the exclusion of non-hydrocarbon gases if they occur in significant quantities and are removed prior to sale. Reserves that can be produced economically through the application of improved recovery techniques are included in the proved classification when these qualifications are met: (1) successful testing by a pilot project or the operation of an installed program in the reservoir provides support for the engineering analysis on which the project or program was based, and (2) it is reasonably certain the project will proceed. Improved recovery includes all methods for supplementing natural reservoir forces and energy, or otherwise increasing ultimate recovery from a reservoir, including (1) pressure maintenance, (2) cycling, and (3) secondary recovery in its original sense. Improved recovery also includes the enhanced recovery methods of thermal, chemical flooding, and the use of miscible and immiscible displacement fluids. Estimates of proved reserves do not include crude oil, natural gas, or natural gas liquids being held in underground storage.\nGeneral -------\nIn general, the estimates of reserves for the wells and locations reviewed by Ryder Scott are based on data available through September 1994.\nGas imbalances, if any, were not taken into account in the gas reserve estimates reviewed by Ryder Scott.\nNeither we nor any of our employees have any interest in the subject properties and neither the employment to do this work nor the compensation is contingent on our estimates of reserves for the properties which were reviewed.\nThis report was prepared for the exclusive use of DEKALB. The data and work papers used in the preparation of this report are available for examination by authorized parties in our offices. Please contact us if we can be of further service.\nVery truly yours,\nRYDER SCOTT COMPANY PETROLEUM ENGINEERS\nKENT A WILLIAMSON\nKent A. Williamson, P.E. Group Vice President","section_15":""}
{"filename":"73902_1994.txt","cik":"73902","year":"1994","section_1":"Item 1. BUSINESS\nOgden Corporation, a Delaware corporation (hereinafter together with its consolidated subsidiaries referred to as \"Ogden\" or the \"Company\"), has its executive offices located at Two Pennsylvania Plaza, New York, New York 10121, pursuant to a lease that expires on April 30, 2008 and which contains an option by Ogden to renew for an additional five years.\nOgden is a diversified company primarily engaged in providing a wide range of services through the various operating groups within each of its two business segments.\nAt December 31, 1993, Ogden owned approximately 84% of the issued and outstanding shares of common stock of Ogden Projects, Inc. (\"OPI\"). During 1994, pursuant to an offer made by Ogden to purchase OPI's remaining 16% of outstanding shares, Ogden and OPI entered into an Amended and Restated Agreement and Plan of Merger dated as of September 27, 1994 (the \"Merger\"). The Merger was approved by the OPI shareholders on December 29, 1994 at which time OPI became a wholly-owned subsidiary of Ogden. The merger provided that OPI shareholders of record on November 22, 1994 (except Ogden and shareholders exercising dissenter's rights) would be entitled to receive 0.84 of a share of Ogden common stock for each share of OPI common stock and cash for any fractional shares. The transaction required the issuance of 5,139,939 shares of Ogden common stock valued at $18.375 per share on December 29, 1994 for a total purchase price of $94,446,000.\nAt December 31, 1994, in connection with Ogden's acquisition of the publicly traded shares of OPI, Ogden reclassified its business segments. Ogden now classifies its business segments as Services (formerly \"Operating Services\") and Projects, (formerly \"Waste-to-Energy Operations\"). Independent power activities, formerly part of Operating Services, are now part of Projects, reflecting consolidation of the overall management of these activities within OPI. Projects now includes the Waste-to-Energy, Independent Power, Water and Wastewater groups, and certain Construction Activities. Within the Services segment, certain business activities have been reclassified. The Environmental Services group no longer includes independent power; the Government Services group has been renamed Technology Services; and all facility management service contracts for government customers have been transferred to the Facility Management Services group. The following table and the discussions that follow reflect these reclassifications.\nSet forth in the following table is the amount of revenue attributable to each of the groups within Ogden's Services and Projects business segments for each of the last three fiscal years (In Thousands):\nThe amounts of revenue, operating profit or loss and identifiable assets attributable to each of Ogden's two business segments for each of the last three fiscal years are set forth on page 44 of Ogden's 1994 Annual Report to Shareholders, certain specified portions of which are incorporated herein by reference.\nSERVICES\nThe operations of Ogden's Services business segment are performed by Ogden Services Corporation and its subsidiaries (\"Ogden Services\") through its five major operating groups as follows: Aviation Services; Entertainment Services; Environmental Services; Technology Services; and Facility Management Services.\nOgden Services, through joint ventures, partnerships and wholly-owned subsidiaries within each of the foregoing major operating groups, provides a wide range of services to private and public facilities throughout the United States and many foreign countries. Its principal customers include airlines, transportation terminals, sports arenas, stadiums, banks, owners and tenants of office buildings, state, local and Federal governments, universities and other institutions and large industrial organizations that are leaders in such fields as plastics, chemicals, drugs, tires, petroleum and electronics.\nMany customers are billed on cost-plus, fixed-price or time and materials basis. Where services are performed on a cost-plus basis, the customer reimburses the appropriate Ogden Services' group for all acceptable reimbursable expenditures made in connection with the job and also pays a fee, which may be a percentage of the reimbursable expenditures, a specific dollar amount, or a combination of the two. Fixed-price contracts, in most cases, contain escalation clauses increasing the fixed price in the event, and to the extent, that there are increases in payroll and related costs.\nMany of the contracts in the Aviation and Facility Management Services' groups are written on a month-to-month basis or provide for a longer or indefinite term but are terminable by either party on notice varying from 30 to 180 days.\nAVIATION SERVICES\nAviation Services provides specialized support services to 185 airlines at 90 locations throughout the United States, Canada, Europe, Latin America and the Pacific Rim. The specialized support services provided by this group include comprehensive ground handling, ramp, passenger, cargo and warehouse, aviation fueling and in-flight catering services. These services are performed through contracts with individual airlines, through consolidated agreements with several airlines, and contracts with various airport authorities.\nDuring 1994 Aviation Services began to pursue opportunities associated with the privatization of airport operations and related airport projects. To capitalize on these opportunities, Ogden intends to combine its Aviation Services skills with the development, financing and construction management expertise of its Projects business segment. Ground Handling and Specialized Support Services\nGround handling services include diversified ramp operations such as baggage unloading and loading, aircraft cleaning, aircraft maintenance, flight planning, de-icing, cargo handling, warehouse operations and passenger-related services such as ticketing, check-in, porter (\"sky-cap\") service, passenger lounge operations and other miscellaneous services.\nGlobal expansion by the Aviation group has resulted in providing comprehensive ground handling and related services at many international locations throughout Europe, Canada, South America and other countries. These locations include eight different airports throughout Germany; Heathrow Airport in England; Schiphol International Airport in the Netherlands; Auckland International Airport in New Zealand; the Czech Republic through a 50% interest in a Prague-based airport handling company; Pearson International Airport in Toronto and the Mirabel and Dorval Airports in Montreal; the Simon Bolivar International Airport in Caracas, Venezuela; VIP lounge operation and ground handling services at the Arturo Merino Benitez Airport in Santiago, Chile and the Mexico International Airport in Mexico City. Ogden Aviation continues to perform services at St. Maarten's and Air Aruba's aviation ground service operations at Reina Beatrix International Airport in Aruba through a corporation jointly owned by Ogden and Air Aruba.\nDuring 1994 Aviation Services: (i) began providing ground handling services at Jorge Chavez International Airport in Lima, Peru and airports located in Chicago, Los Angeles and Vancouver, British Columbia, (ii) added ramp handling services to its existing ground handling services operations at Guarulhos International Airport in Sao Paulo and Galeao International Airport in Rio de Janeiro, Brazil, (iii) sold its ground handling operations at Gatwick and four other United Kingdom regional airports and acquired an air cargo ground handling company which provides services at the London Heathrow Airport, (iv) formed joint ventures with the Kashmirwala Group in Pakistan to begin ground handling services at Karachi International Airport and with a Turkish company to provide aircraft cleaning, security and commissary supplies to carriers at Ataturk Airport in Istanbul and other locations in Turkey, and (v) expanded its cargo\/warehouse services in North America through contract awards at four new airports.\nFueling Services\nAviation operates fueling facilities, including storage and hydrant fueling systems for the fueling of aircraft. This operation assists airlines in designing, arranging financing for, and installing underground fueling systems. These fueling operation services are principally performed in the North American market. However, Aviation has signed a 10-year contract to serve as sole fueling handling agent at Tocumen International Airport in Panama City, Panama and has been awarded a 5-year contract to fuel aircraft at the Luis Munoz International Airport in San Juan, Puerto Rico commencing in 1995.\nIn-Flight Catering\nAviation operates 18 in-flight kitchens for over 85 airline customers at a number of locations, including John F. Kennedy International and LaGuardia Airports in New York; Newark International Airport in New Jersey; Los Angeles and San Francisco International Airports in California; Miami International Airport in Florida; Washington Dulles International near Washington, D.C.; McCarren International in Las Vegas, Nevada; and Honolulu International in Hawaii. The Aviation in-flight kitchen at Honolulu International also provides catering services to two cruise ships owned by NAVATEK, a Hawaiian cruise line. During 1994, Aviation acquired inflight catering kitchens in the Canary Islands and Palma de Mallorca in Spain.\nAirport Privatization and Related Projects\nDuring 1994 Aviation Services and one of its partners,the Macau Services Corporation (a subsidiary of the Civil Aviation Authority of China) led a consortium which was awarded a 19-year contract, with a 16-year exclusivity arrangement, to provide ramp and cargo handling, passenger services, and aircraft line maintenance at the new Macau International Airport, expected to be operational in November 1995. The consortium, of which Aviation Services is the managing partner with a 29% participation, will provide all necessary passenger and ramp equipment and build cargo and engineering facilities, an aircraft hangar and a state-of-the-art training center at the airport. The consortium's investment in infrastructure improvements and equipment in the new Macau airport is expected to exceed $40 million.\nENTERTAINMENT SERVICES\nThe Entertainment Services group provides total facility management services; presentation of concerts and family shows; food, beverage and novelty concessions; and janitorial, security, parking, and other maintenance services. These services are provided to a wide variety of public and private facilities including more than 100 stadiums, convention and exposition centers, arenas, parks, amphitheaters, and fairgrounds located in the United States, Mexico, Canada, Brazil, Spain and the United Kingdom. Entertainment also operates a racetrack and five off-track betting parlors in Illinois.\nThe facility management and concession arrangements under which this group operates are individually negotiated and vary widely as to terms and duration. Concession contracts and leases usually provide for payment by Entertainment of commissions or rentals based on a stipulated percentage of gross sales or net profits, sometimes with a minimum rental or payment. Most of the facility management contracts are on a cost-plus-a-fee basis but a number of such contracts provide for a sharing of profits and losses between Entertainment and the facility owner.\nEntertainment offers its customers a wide range of project-development options, including the operational design review, consultation during construction, and assistance with financing arrangements, as well as operations of facilities, usually in return for long-term services and concession contracts. In some cases Ogden Corporation guarantees Entertainment's performance of these contracts as well as the financing arrangements.\nFood, Beverage and Novelty Services at Stadiums and Arenas\nFood, beverage and novelty services are provided by Entertainment in the United States at a number of locations including the following: Rich Stadium (Buffalo, New York); the USAir Arena (Landover, Maryland); the Milwaukee Exposition and Convention Center (Milwaukee, Wisconsin); the Los Angeles Convention Center (Los Angeles, California); the Kingdome (Seattle, Washington); Veterans Stadium (Philadelphia, Pennsylvania); Market Square Arena (Indianapolis, Indiana); McNichols Arena (Denver, Colorado); Cobo Hall (Detroit, Michigan); Tempe Diablo Stadium (Tempe, Arizona); University of Oklahoma Stadium (Norman, Oklahoma); and the MGM Grand Gardens Arena (Las Vegas, Nevada). In 1994 Entertainment was awarded a 5-year contract to provide food and beverage and merchandise services for Wrigley Field in Chicago, Illinois and began providing food and beverage services at 110,000- seat Maracano Stadium, located in Rio de Janeiro, Brazil.\nIn Canada, food, beverage and novelty concessions are provided at the Saint John Regional Exhibition Centre located in New Brunswick, Canada and at Lansdowne Park in Ottawa, Canada. During 1994, Entertainment was awarded a 20-year contract to provide food and beverage services at General Motors Place, a new sports and entertainment arena under construction in Vancouver, British Columbia which is scheduled to open in late 1995. This facility will be the home of the National Hockey League's Vancouver Canucks and the newly awarded National Basketball Association franchise, the Vancouver Grizzlies.\nFood, Beverage and Novelty Services at Amphitheaters\nEntertainment also provides food and beverage services at amphitheaters throughout the United States including the Starlake Amphitheater (near Pittsburgh, Pennsylvania); the Fiddler's Green Amphitheatre (Englewood, Colorado); and the Sandstone Amphitheatre (Kansas City, Missouri). During 1994 Entertainment was awarded several new amphitheater contracts, including the following: (i) a 10-year food and beverage contract at the Mega Star Amphitheater located in Eufaula, Oklahoma; (ii) a 15-year food and beverage contract at the all-seasons Connecticut Center for Performing Arts in Hartford, Connecticut, (iii) a 10-year exclusive food and beverage contract at the all-seasons Camden Amphitheater located in Camden, New Jersey which is expected to open in May 1995; (iv) a 20-year agreement pursuant to which Entertainment will provide food and beverage services and support for the long-term financing at the Polaris Amphitheater in Columbus, Ohio; and (v) a 20-year contract to provide food and beverage services, parking and support for the long-term financing at the Cellar Door Amphitheater located near Manassas, Virginia, expected to open during 1995.\nFacility Management and Concession Services\nEntertainment, through long-term management and concession agreements, provides management services, food, beverage and novelty concessions and maintenance services at various convention centers, arenas and public facilities including the Pensacola Civic Center in Pensacola, Florida; the Sullivan Arena and Egan Convention Center in Anchorage, Alaska; the Rosemont Horizon, near Chicago, Illinois; the Target Center in Minneapolis; The Great Western Forum in Los Angeles; and Anaheim Stadium, a 70,000 seat stadium located in Anaheim, California.\nDuring 1994 Entertainment provided design and consulting services at the 19,000 seat Victoria Station Arena in Manchester, England scheduled to open during 1995, which Entertainment will manage and operate, upon completion, pursuant to a 20-year lease. During early 1995, Entertainment secured a 20- year contract to provide total facility management services at the 10,000- seat Newcastle Arena, a new sports and entertainment arena located in Newcastle, England which will feature ice hockey, concerts and other events. Entertainment will provide consulting services during the design and development phase of the arena which is scheduled to open in November 1995.\nDuring 1994 this service group was also awarded a 20-year contract to provide complete facility management and concession services at the 12,000- seat Oberhausen Arena located in Oberhausen, Germany which is scheduled to open in 1996. The arena will feature ice hockey, handball, basketball and concerts. During August 1994 Entertainment began providing facility management services to the Northlands Coliseum in Edmonton, Alberta pursuant to a 5-year contract. The Coliseum is home to the Edmonton Oilers of the National Hockey League.\nDuring 1994 Entertainment arranged for the financing and assisted in the design and construction of the Ottawa Palladium, a 19,000-seat multipurpose indoor arena under construction in Ottawa, Canada, which is owned by a third party and which is scheduled to open in 1996. Entertainment has been awarded a 30-year contract to provide complete facility management and concession services at the arena which will be the home of the Ottawa Senators of the National Hockey League. Ogden has agreed that the Ottawa Palladium, under Entertainment's management, will generate a minimum amount of revenues computed in accordance with its 30-year contract. The owners of the Ottawa Palladium have entered into a 30-year license agreement with the owner of the\nOttawa Senators, pursuant to which the Ottawa Senators are expected to play their home games at the arena commencing in 1996.\nPursuant to a management agreement between the City of Anaheim, California and a wholly owned subsidiary of Ogden, Entertainment manages and operates the Arrowhead Pond, a facility owned by and located within the City of Anaheim. The Arrowhead Pond is a multi-purpose facility capable of accommodating professional basketball and hockey, concerts and other attractions, and has a maximum seating capacity of approximately 19,400. Ogden has agreed that the Arrowhead Pond, under Entertainment's management, will generate a minimum amount of revenues computed in accordance with the 30-year management agreement with the City. Entertainment also has a 30-year lease agreement with The Walt Disney Company at the Arrowhead Pond where the Anaheim Mighty Ducks, a National Hockey League team owned by The Walt Disney Company, plays its home games.\nIn Mexico, Entertainment owns a 27% equity interest in a Mexican company which manages the Sports Palace, a 22,000 seat arena, and the Autodrome, a 45,000 seat open air facility, located in Mexico City, as well as the new Autodrome Fundidora Amphitheater in Monterey, Mexico that is able to accommodate 18,000 people. Entertainment also owns 51% of a company that provides food and beverage concessions at the Sports Palace and the new Autodrome amphitheater referred to above.\nOther Activities\nDuring 1994 Entertainment acquired an equity interest in Parques Tecnocultiroles, S.A. (\"Partecsa\"), a Spanish Corporation based in Seville, Spain. Partecsa has been awarded a 30-year contract with an 8-year renewal option to convert, remodel, manage and operate Cartuja, a multi-attraction theme park located on a 200 acre site in Seville, Spain where the 1992 Exposition Fair was held. Partecsa has requested Entertainment to perform advisory services relating to the conversion and future operation of Cartuja. Upon completion of its conversion Partecsa has agreed to award Entertainment, subject to the execution of a definitive agreement, the exclusive rights to provide the food and beverage concessions at Cartuja for a four (4) year period.\nEntertainment also leases and operates a thoroughbred and harness racetrack and six off-track betting parlors in Illinois where it telecasts races from Fairmount Park and other racing facilities. Restaurants and other food and beverage services are provided by Entertainment at these facilities. A large portion of the track's revenue is derived from its share of the pari-mutuel handle, which can be adjusted by state legislation. Other income is derived from admission charges, parking, programs and concessions.\nEntertainment also provides concessions at zoos located in Seattle, Washington and Cleveland, Ohio.\nENVIRONMENTAL SERVICES\nThe Environmental Services group provides a comprehensive range of environmental, infrastructure and energy consulting, engineering and design services to industrial and commercial companies, electric utilities and governmental agencies. The Environmental group's services include analysis and characterization, remedial investigations, analytical testing, engineering and design, data management, project management, and regulatory assistance. These services are provided to detect, evaluate, solve and monitor environmental problems and health and safety risks, environmental, civil, geotechnical, transportation and sanitary engineering, urban and regional planning and storm water management, as well as regulatory assistance, nuclear safety and engineering, and consulting services relating to nuclear waste management, security engineering and design services.\nEnvironmental provides services to a variety of clients in the public and private sectors in the United States and abroad. Principal clients include major Federal agencies, particularly the Department of Defense and the Department of Energy, as well as major corporations in the chemical, petroleum, transportation, public utility and health care industries and Federal and state regulatory authorities. Approximately 33% of Environmental's revenues are derived from contracts or subcontracts with departments or agencies of the United States Government. United States Government contracts may be terminated, in whole or in part, at the convenience of the government or for cause. In the event of a convenience termination, the government is obligated to pay the costs incurred by Environmental under the contract plus a fee based upon work completed.\nAs of December 31, 1994, Environmental's backlog of orders amounted to approximately $143 million, of which approximately $40 million represented government orders that were not yet funded; as of December 31, 1993, the comparable amounts were $120 million and $37 million, respectively.\nThe Environmental group continues to provide professional environmental engineering services, including program management, environmental analysis, testing and restoration to the United States Navy CLEAN Program (Comprehensive Long Term Environmental Action Navy) pursuant to a 10-year contract awarded during 1991. Thus far the Environmental group has provided these services at Navy bases in Hawaii, Guam, Japan, Hong Kong, the Philippines, Australia and Korea.\nPursuant to its three year contract with the U.S. Air Force Center for Environmental Excellence, the Environmental group continues to oversee the removal of storage tanks and contaminated soil from Air Force bases across the United States and in U.S. territories. The Environmental group also remains as one of four contractors selected by the U.S. Air Force to competitively bid for work over a five year period to identify, investigate and remediate environmental contamination problems at Kelly Air Force Base, Texas. Environmental also performs remediation services and environmental studies for the U.S. Army Corps. of Engineers in Alaska and Texas, and environmental compliance and training services pursuant to a 5-year contract with the National Guard Bureau and the Air National Guard Readiness Center.\nThe Environmental group continues to develop its mixed waste analytical business through its analytical laboratory in Fort Collins, Colorado which opened during 1993 and analyzes mixtures of nuclear and non-nuclear hazardous waste. This mixed waste laboratory provides testing services for the Department of Energy and other Federal government agencies involved in the cleanup of government facilities.\nEnvironmental is continuing to pursue international markets through its wholly-owned environmental, and geotechnical consulting firm in Spain; its environmental services contract with the U.S. Army Corps of Engineers, European District,to provide environmental site assessments in Germany; its contract to work with the Chevron Overseas Petroleum, Inc.'s Tengizchevroil Joint Venture Project; its discussions with the Republic of Kazakhstan to develop an environmental protection public health and safety plan; and its IEAJ affiliate in Japan, a leading consultant to the nuclear industry.\nTECHNOLOGY SERVICES\nThe Technology Group provides services through its five technology-based operating units: Atlantic Design Company, Inc. (Atlantic Design); Applied Data Technology, Inc. (ADTI), acquired in 1995; W.J. Schafer Associates, Inc. (WJSA); Systems Engineering, Applied Engineering; and Biomedical. These operating units produce a broad range of technology and scientific solutions for public and private industry, including the development and manufacture of commercial technology products, the development of new applications for advanced technologies, and analysis, integration, testing and implementation services. Principal business areas are: computer hardware\/software systems and technologies, telecommunications systems, advanced communications and sensor systems and technologies, management and logistics services, biomedical research and repository services, air combat maneuvering instrumentation systems, and after-action reporting and display systems.\nAtlantic Design\nThis unit, with principal offices located in Charlotte, North Carolina and engineering facilities located in Fairfield, New Jersey and locations within New York state, provides engineering design, drafting and technical services, as well as turn-key, integrated services in electronics contract manufacturing and assembly and, through its Lenzar operation in Florida, develops and markets medical products and custom image capturing products. Atlantic Design provides services to customers primarily in the computer, medical and electronic industries, including IBM, General Electric, Seiko, Compaq, Martin Marietta, AT&T, EMC2 Corporation, Netrix Corporation and Pratt and Whitney.\nAtlantic Design's services also include the design of mechanical, electro- mechanical and electronic equipment; technical writing; engineering analysis; building, testing and repairing electronic assemblies and equipment; and the development of prototype equipment for a variety of industries.\nADTI\nDuring January 1995, Technology Services strengthened its group through the acquisition of ADTI located in San Diego, California. ADTI is a leading supplier of air combat maneuvering instrumentation systems and after-action reporting and display systems. ADTI's range systems are installed at Navy and Air Force aircraft training ranges to facilitate air-to-air combat exercises and monitor, record and graphically display the exact maneuvers of the aircraft on the ranges and simulate the various weapons systems aboard the aircraft. These range automated systems are used by the U.S. Navy and Air Force to train pilots for combat conditions and by the Department of Defense in training pilots to avoid \"friendly fire\" incidents. ADTI's systems are currently installed at four of the 14 domestic ranges, including the range at the Top Gun school at Miramar, California. The range systems business includes new ranges, expansion and upgrade of existing ranges, product support and related programs.\nADTI also developed a proprietary flight line test set designed to test and trouble-shoot the Auxiliary Power Unit (\"APU\") on-board a Boeing air-to-air refueling aircraft. The APU tester was developed to fill the military's demand for a practical low cost flightline support unit that will isolate faults within the APU on-board the Boeing aircraft.\nWJSA\nThis unit provides technology and engineering services and consultation in space-based and free electron laser technology and high energy systems research to the Ballistic Missile Defense Organization as well as technical research to the other agencies within the Department of Defense and the U.S. Government. This unit is also currently working under contract with the Defense Nuclear Agency to define and analyze sensor architectures that assess bomb damage to underground targets. WJSA is also involved in a program with the Department of Energy to develop an advanced technique for producing large-scale electric power. WJSA continues its efforts under contract with the Coleman Research Corporation to provide system engineering and technical assistance support for the Theater High Altitude Area Defense Project.\nSystems Engineering, Applied Engineering\nThis units provides systems and software engineering and computer\/telephone-related products and services to Government agencies and private industry. Some of their largest clients are the U.S. General Services Administration (GSA), the Department of Defense, and the Office of Personnel Management. During 1994, these units were awarded several large contracts ranging from one to five years in duration. This included two information technology (IT) contracts with GSA; one to provide IT requirements studies for automated business systems to agencies located in and around Washington, D.C. and another to analyze, design and develop business, scientific and mathematical systems for agencies located throughout the Western United States; another contract was awarded with the U.S. Navy to provide engineering and technical services for advanced strategic and tactical communications systems and systems integration programs on major Navy combat vessels.\nBiomedical\nThis unit provides biomedical research, support and biological repository services for such customers as the National Institute of Health, the Walter Reed Army Institute of Research, the U.S. Food and Drug Administration, the Center for Disease Control and Prevention, the National Cancer Institute and other health agencies, commercial firms and not-for-profit organizations sponsoring research, primarily in the area of new drug development and testing.\nFACILITY MANAGEMENT SERVICES\nThe Facility Management Services group provides a comprehensive range of facility management, maintenance and manufacturing support services to industrial, commercial, electric utilities, and education and institutional customers throughout the United States and Canada. Beginning in 1995 the facility management services operations of the Technology Services group were transferred to Facility Management Services.\nThe range of services provided include total facility management; facility operations and maintenance; operations, maintenance and repair of production equipment; security and protection; housekeeping; landscaping and grounds care; energy management; warehousing and distribution; project and construction management; and skilled craft support services.\nThis service group's commercial and office building customers include the World Trade Center and the American Express Tower in New York, Phillips Petroleum Headquarters in Bartlesville, Oklahoma, various governmental agencies and AT&T at several sites in New Jersey. Facility's industrial and manufacturing customers include IBM, Chrysler, Colgate Palmolive, Goodyear, BF Goodrich, US West, Exxon, Dow Chemical, American Cyanamid, MITRE Corporation and Martin Marietta.\nThe group continues its support to the institutional and educational marketplace whose customers include the University of Miami; New York University; Clark Atlanta University in Georgia; and Concordia University in Montreal, Canada.\nFacility Management Services, in conjunction with Projects, also provides services to the waste-to-energy plants in operation, or being built, by Ogden Martin Systems, Inc. on a cost-plus basis as negotiated between Ogden Martin and Ogden Facility Services.\nOTHER SERVICES\nOgden Services also provides services relating to the removal and encapsulation of asbestos-containing materials from office buildings and other facilities and arranges for the transport of such material to approved disposal sites. Asbestos-remediation jobs are being performed principally in the greater Manhattan-New York metropolitan area. The market for asbestos removal and encapsulation services by office buildings and large residential complexes, industrial plants, airports and other public facilities has been greatly reduced over the past several years and Ogden Services' continued involvement in this industry is reviewed on an annual basis.\nThrough Universal Ogden Services, a joint venture based in Seattle, Washington, services are provided to a wide range of facilities where people live for extended periods of time, such as remote job sites and oil rigs. Food and housekeeping services are currently provided to offshore oil production platforms and drilling rigs in the Gulf of Mexico, the North Sea, the West Coast of Africa and South America, for oil production and drilling companies. Logistical support services, including catering, housing, security, operations, and maintenance are provided to remote industrial campsites located in the United States and abroad.\nPROJECTS\nThe operations of Ogden's Projects business segment are conducted by Ogden's wholly owned subsidiary Ogden Projects, Inc. and its subsidiaries (\"OPI\") whose principal business is conducted through it's four major operating groups: Waste-to-Energy; Independent Power; Water and Wastewater; and Construction Activities.\nWASTE-TO-ENERGY\nThe Waste-to-Energy group operates facilities which combust municipal solid waste to make saleable energy in the form of electricity or steam. This group completed construction of its first waste-to-energy facility in 1986 and currently operates 27 waste-to-energy facilities at 26 locations. Waste-to- Energy has one facility under construction, is the owner or lessee of 17 of its facilities, has been awarded three additional facilities that are not yet under construction, and has taken steps toward expanding its waste-to-energy business internationally.\nIn most cases, the Waste-to-Energy group, through wholly-owned subsidiaries (\"Operating Subsidiaries\"), provides waste-to-energy services pursuant to long-term service contracts (\"Service Agreements\") with local governmental units sponsoring the waste-to-energy project (\"Client Communities\"). The group has projects currently under development for which there is no sponsoring Client Community and may in the future undertake other such projects.\n(a) Terms and Conditions of Service Agreements. Projects generally have been awarded by Client Communities pursuant to competitive procurement. However, Waste-to-Energy has also built and is operating projects that were not competitively bid.\nFollowing execution of a Service Agreement between the Operating Subsidiary and the Client Community, several conditions must be met before construction commences. These usually include, among other things, financing the facility, executing an agreement providing for the sale of the energy produced by the facility, purchasing or leasing the facility site, and obtaining of required regulatory approvals, including the issuance of environmental and other permits required for construction. In many respects, satisfaction of these conditions is not wholly within this group's control and, accordingly, implementation of an awarded project is not assured, or may occur only after substantial delays. Waste-to-Energy incurs substantial costs in preparing bids and, if it is the successful bidder, implementing the project so it meets all conditions precedent to the commencement of construction. In some instances Waste-to-Energy has made contractual arrangements with communities that provide partial recovery of development costs if the project fails to go into construction for reasons beyond its control.\nEach Service Agreement is different in order to reflect the specific needs and concerns of the Client Community, applicable regulatory requirements, and other factors. The following description sets forth terms that are generally common to these agreements: (i) the Operating Subsidiary designs the facility, generally applies for the principal permits required for its construction and operation, and helps to arrange for financing, and then constructs and equips the facility on a fixed price and schedule basis. The actual construction and installation of equipment is performed by contractors under the supervision of the Operating Subsidiary. The Operating Subsidiary bears the risk of costs exceeding the fixed price of the facility and may be charged liquidated damages for construction delays, unless caused by the Client Community or by unforeseen circumstances beyond its control, such as changes of law (\"Unforeseen Circumstances\"). After the facility successfully completes acceptance testing, the Operating Subsidiary operates and maintains the facility for an extended term, generally 20 years or more; (ii) the Operating Subsidiary generally guarantees that the facility will meet minimum processing capacity and efficiency standards, energy production levels, and environmental standards. The Operating Subsidiary's failure to meet these guarantees or to otherwise observe the material terms of the Service Agreement (unless caused by the Client Community or by Unforeseen Circumstances) may result in liquidated damages to the Operating Subsidiary or, if the breach is substantial, continuing, and unremedied, the termination of the Service Agreement. In the case of such Service Agreement termination, the Operating Subsidiary may be obligated to discharge project indebtedness; (iii) the Client Community is generally required to deliver minimum quantities of municipal solid waste (\"MSW\") to the facility and, regardless of whether that quantity of waste is delivered to the facility, to pay a service fee. Generally, the Client Community also provides or arranges for debt financing. Additionally, the Client Community bears the costs of disposing ash residue from the facility and, in many cases, of transporting the residue to the disposal site. Generally, expenses resulting from the delivery of unacceptable and hazardous waste to the facility, and from the presence of hazardous materials on the site, are also borne by the Client Community. In addition, the Client Community is also generally responsible to pay increased expenses and capital costs resulting from Unforeseen Circumstances, subject to limits which may be specified in the Service Agreement; (iv) Ogden typically guarantees each Operating Subsidiary's performance under its respective Service Agreement.\nAfter construction is completed and the facility is accepted, the Client Community pays the Operating Subsidiary a fixed operating fee which escalates in accordance with specified indices, reimburses the Operating Subsidiary for certain costs specified in the Service Agreement including taxes, governmental impositions (other than income taxes), ash disposal and utility expenses, and shares with the Operating Subsidiary a portion of the energy revenues (generally 10%) generated by the facility. If the facility is owned by the Operating Subsidiary, the Client Community also pays as part of the Service Fee an amount equal to the debt service due to be paid on the bonds issued to finance the facility. At most facilities, Waste-to-Energy may earn additional fees from accepting waste from the Client Community or others utilizing the capacity of the facility which exceeds the amount of waste committed by the Client Community.\nWaste-to-Energy operates transfer stations in connection with some of its waste-to-energy facilities and, in connection with the Montgomery County, Maryland, project, OPI will use a railway system to transport MSW and ash residue to and from the facility. Waste-to-Energy leases and operates a landfill located at its Haverhill, Massachusetts, facility, and leases, but does not operate, a landfill in connection with its Bristol, Connecticut, facility.\n(b) Other Arrangements for Providing Waste-to-Energy Services. Waste- to-Energy owns two facilities that are not operated pursuant to Service Agreements with Client Communities, and is currently developing, and may undertake in the future, additional such projects. In such projects, OPI must obtain sufficient waste under contracts with haulers or communities to ensure sufficient project revenues. In these cases, Waste-to-Energy is subject to risks usually assumed by the Client Community, such as those associated with Unforeseen Circumstances and the supply and price of municipal waste to the extent not contractually assumed by other parties. This group's current contracts with waste suppliers for these two facilities provide that the fee charged for waste disposal service is subject to limited increases in the event that costs of operation increase as a result of Unforeseen Circumstances. On the other hand, in these cases, Waste-to-Energy generally retains all of the energy revenues from sales of power to utilities or industrial power users and disposal fees for waste accepted at these facilities. Accordingly, OPI believes that such projects carry both greater risks and greater potential rewards than projects in which there is a Client Community.\nFor the projects that are not operated pursuant to a Service Agreement, tipping fees, which are generally subject to escalation in accordance with specified indices, and energy revenues are paid to the Waste-to-Energy group. Electricity generated by these projects is sold to public utilities and in one instance, steam and a portion of the electricity generated is sold to industrial users. Under certain of the contracts under which waste is provided to these facilities, Waste-to-Energy may be entitled to fee adjustments to reflect certain Unforeseen Circumstances.\n(c) Project Financing. Financing for projects is generally accomplished through the issuance of a combination of tax-exempt and taxable revenue bonds issued by a public authority. If the facility is owned by the Operating Subsidiary, the authority lends the bond proceeds to the Operating Subsidiary and the Operating Subsidiary contributes additional equity to pay the total cost of the project. For such facilities, project-related debt is included as a liability in Ogden's consolidated financial statements. Generally, such debt is secured by the revenues pledged under the respective indenture and is collateralized by the assets of the Operating Subsidiary and otherwise provides no recourse to Ogden, subject to construction and operating performance guarantees and commitments.\n(d) Waste-to-Energy Projects. Certain information with respect to projects as of February 28, 1995 is summarized in the following table:\n(e) Technology. The principal feature of the Martin Technology is the reverse-reciprocating stoker grate upon which the waste is burned. The patent for the basic stoker grate technology used in the Martin Technology expired in 1989. OPI has no information that would cause it to believe that any other company uses the basic stoker grate technology that was protected by the expired patent. Moreover, OPI believes that unexpired patents on other portions of the Martin Technology would limit the ability of other companies to effectively use the basic stoker grate technology in competition with OPI. There are several unexpired patents related to the Martin Technology including: (i) Grate Bar for Grate Linings, Especially in Incinerators - expires 2\/9\/99; (ii) Method and Arrangement for Reducing NOx Emissions from Furnaces - expires 7\/19\/00; (iii) Method and Apparatus for Regulating the Furnace Output of Incineration Plants - expires 9\/4\/07; (iv) Method for Regulating the Furnace Output in Incineration Plants - expires 1\/1\/08; and (v) Feed Device with Filling Hopper and Adjoining Feed Chute for Feeding Waste to Incineration Plants - expires 4\/23\/08. More importantly, OPI believes that it is Martin's know-how in manufacturing grate components and in designing and operating mass-burn facilities, Martin's worldwide reputation in the waste-to-energy field, and OPI's know-how in designing, constructing and operating waste-to-energy facilities, rather than the use of patented technology, that is important to OPI's competitive position in the waste-to-energy industry in the United States. OPI does not believe that the expiration of the patent covering the basic stoker grate technology or patents on other portions of the Martin Technology will have a material adverse effect on OPI's financial condition or competitive position.\n(f) The Cooperation Agreement. Under an agreement between Martin GmbH fur Umuelt-und Energietechnik of Germany (\"Martin\") and OPI (the \"Cooperation Agreement\"), OPI has the exclusive rights to market the proprietary technology (the \"Martin Technology\") of Martin in the United States, Canada, Mexico, Bermuda, certain Caribbean countries, most of Central and South America, and Israel. In addition, in Germany, Turkey, Saudi Arabia, Kuwait, the Netherlands, Denmark, Norway, Sweden, Finland, Poland, and Italy OPI has exclusive rights to use the Martin Technology, but only on a full service design, construct, and operate basis. The Cooperation Agreement provides that OPI may acquire, own, commission, and\/or operate facilities that use technology other than the Martin Technology that have been constructed by entities other than OPI or its affiliates. Martin is obligated to assist OPI in installing, operating, and maintaining facilities incorporating the Martin Technology. The fifteen year term of the Cooperation Agreement renews automatically each year unless notice of termination is given, in which case the Cooperation Agreement would terminate 15 years after such notice. Additionally, the Cooperation Agreement may be terminated by either party if the other fails to remedy its material default within 90 days of notice. The Cooperation Agreement is also terminable by Martin if there is a change of control (as defined in the Cooperation Agreement) of Ogden Martin Systems, Inc. (\"OMS\"), a wholly-owned subsidiary of OPI or any direct or indirect parent of OMS not approved by its respective board of directors. Although termination would not affect the rights of OPI to design, construct, operate, maintain, or repair waste-to-energy facilities for which contracts have been entered into or proposals made prior to the date of termination, the loss of OPI's right to use the Martin Technology could have a material adverse effect on OPI's future business and prospects.\n(g) International Business Development. In 1994, Waste-to-Energy continued the development of its waste-to-energy business in selected international markets. An office in Munich, Germany, was opened in 1993 and, as indicated above, extended its right to use the Martin Technology to develop full service projects in much of Europe. In Europe, waste-to-energy facilities have been built as turn-key construction projects and then operated by local governmental units or by utilities under cost-plus contracts. Waste-to-Energy emphasizes developing projects which it will build and then operate for a fixed fee. Some European countries are seeking to substantially reduce their dependency on landfilling. For example, Germany has enacted legislation which would prevent the landfilling of untreated raw municipal waste by the end of the decade.\nThe trend toward privatization of municipal services in Latin America continues to remain strong. The market for waste-to-energy is in a formative stage and, with few exceptions, continues to lag behind other infrastructure project development in most Latin American countries. Waste-to-energy services in Latin America will be offered through strategic alliances with Latin American firms and by coordinating marketing efforts with other business development efforts of Ogden's Services segment.\nOgden plans to open an office in Hong Kong in 1995. OPI has entered into an agreement with CTCI Corporation in Taiwan to jointly pursue waste-to- energy operation and maintenance contracts in that country. Certain other Asia Pacific countries are seeking alternatives to landfilling and are also moving toward privatization of municipal services. The development of this market by OPI will be managed through the Hong Kong office, with emphasis on establishing teaming agreements with local firms to pursue select project opportunities.\n(h) Backlog. Waste-to-Energy's backlog as of December 31, 1994, is set forth under (d) above. As of the same date of the prior year, the estimated unrecognized construction revenues for projects under construction was $224,257,000, and the estimated construction revenues for projects awarded but not yet under construction was $254,486,000 (including U.S. dollar equivalent of $99,620,000 expressed in Canadian Dollars). The change in the amount for projects under construction reflects construction progress on two projects. Generally, the construction period for a waste-to-energy facility is approximately 28 to 34 months.\nINDEPENDENT POWER\nThe Independent Power group, through wholly-owned subsidiaries, develops, operates and, in some cases, owns power projects (\"alternative energy projects\") which cogenerate electricity and steam or generate electricity alone for sale to utilities both in the United States and abroad. In 1994, the independent power business of Projects and of Services' Environmental Services group were combined under Projects' Independent Power group. The Independent Power group intends to develop additional projects which use, among other fuels, wood, tires, other wastes, coal, oil, natural gas, or water. Independent Power is currently pursuing further opportunities to own and\/or operate independent power projects domestically and abroad.\nIndependent Power will seek to participate in the operation of the independent power project facilities pursuant to long-term operations and maintenance contracts from which it will seek operating profits. In many cases, capital may be invested in the ownership of the project (usually through acquiring an interest in a corporate or partnership entity that owns the power production facilities and the contracts for the supply of fuel and the purchase of power from these facilities), to derive investment earnings and possibly tax benefits. In some cases, if Independent Power has expended funds in and dedicated resources to development of the project, it will seek a developers fee at the time the construction financing of the project is completed.\nMany alternate energy projects are awarded to private power producers on the basis of open, competitive bidding, in which pricing of capacity and electric energy is the dominant selection criterion. Because these awards are often vigorously contested by a number of independent power producers, the returns on such projects are often driven to very low levels. The Independent Power group therefore seeks opportunities in which power purchase contract terms can be set by negotiations and in which the group is able to stress its abilities to operate facilities in a highly reliable manner and to provide operational guarantees of performance that may be attractive to the power purchaser.\nThe Independent Power group, through Catalyst New Martinsville Hydroelectric Corporation, manages and operates a hydroelectric power generating facility under a long-term lease with the City of New Martinsville, West Virginia. The plant has been in operation since 1988 and rated at approximately 40 megawatts of power. The plant's electrical output is sold to the Monongahela Power Company under a long-term power sales agreement. The Independent Power group, as a 50\/50 partner in the Heber Geothermal Company (\"HGC\") (a partnership with Centennial Geothermal, Inc.), leases and operates a 47-megawatt (net) power plant in Heber, California. The power is sold to Southern California Edison. The working interest in the geothermal field, which is adjacent to and supplies fluid to the power plant, is owned by a partnership composed of an Independent Power group subsidiary and Centennial Field, Inc., an unaffiliated company. The Independent Power group also has the contracts to operate and maintain both the geothermal field, which currently produces approximately eight million pounds per hour of fluid, and the power plant.\nDuring December 1994 the acquisition of the Second Imperial Geothermal Company (SIGC) and its principal asset, a leasehold interest in a 48 megawatt geothermal power plant located in Heber, California, was completed. SIGC is a party to a 30-year power purchase contract with Southern California Edison. Prior to the acquisition, the Independent Power group (through the Environmental group) was the operations and maintenance contractor at SIGC. This acquisition will compliment the geothermal field operated by the Independent Power group in Heber, California.\nDuring 1994 the Independent Power group's operations were expanded into the Latin American market through the acquisition of an equity interest in Energia Global, Inc. (EGI) which resulted in a long term contract to operate two hydroelectric plants owned by EGI's Costa Rica subsidiary and which are under construction in Costa Rica. During the design and construction phase of these two plants, the Independent Power group will serve as a consultant.\nWATER AND WASTEWATER\nThe Water and Wastewater group, through Ogden Water Systems, Inc., intends to develop, operate and, in some cases, own projects that purify water, treat wastewater, and treat and manage biosolids and compost organic wastes. As with the waste-to-energy business, water and wastewater projects involve various contractual arrangements with a variety of private and public entities including municipalities, lenders, joint venture partners (which provide financing or technical support), and contractors and subcontractors which build the facilities. In 1994, Ogden Water Systems, Inc. formed a joint venture, the Ogden Yorkshire Water Company, with a wholly-owned subsidiary of Yorkshire Water, plc, a major British water and wastewater utility. The purpose of the joint venture is to develop, design, construct, maintain, operate, and in some cases own, water and wastewater treatment facilities in the United States, Canada, and Latin America. The joint venture is actively bidding on public procurements for such services and seeking acquisition opportunities. Ogden Water Systems, Inc., is also pursuing opportunities in water and wastewater treatment facilities in countries outside of the territory of the joint venture.\nCONSTRUCTION ACTIVITIES\nThe construction of each of Projects' waste-to-energy facilities is the responsibility of its Construction Activities group. Construction of Independent Power, Water and Wastewater projects and any other construction activities undertaken in connection with Ogden's Services business are expected to be the responsibility of this group. A general contractor is usually responsible for the procurement of bulk commodities used in the construction of the facility, such as steel and concrete. These commodities are generally readily available from many suppliers.\nThe Construction Activities group generally directs the procurement of all major equipment utilized in a project, which equipment is also generally readily available from many suppliers. The stoker grates utilized Waste-to- Energy in facilities constructed by the group are required to be obtained from Martin pursuant to the Cooperation Agreement.\nDuring the construction period for waste-to-energy facilities owned by Client Communities, construction income is recognized on the percentage-of- completion method based on the percentage of costs incurred to total estimated costs.\nPROJECTS' FOREIGN BUSINESS DEVELOPMENT\nProjects' Waste-to-Energy, Independent Power, Water and Wastewater and Construction groups are involved in the development of projects in foreign countries where opportunities for the services provided by these groups are highly dependent upon the elimination of historic legal and political barriers to the participation of foreign capital and foreign companies in the financing, construction, ownership and operation of waste-to-energy, power production and water and wastewater facilities. For example, in many countries, the production, distribution and delivery of electricity has traditionally been provided by governmental or quasi-governmental agencies. Although a number of these countries have recently liberalized their laws and policies with regard to the participation of private interests and foreign capital in their electric sectors, not all have done so, and not all that have done so may afford acceptable opportunities for Projects.\nThe development, construction, ownership and operation of waste-to-energy, independent power production, and water and wastewater facilities in foreign countries also exposes Projects to several potential risks that typically are not involved in such activities in the United States.\nMany of the countries in which Projects is or intends to be active in developing its waste-to-energy, independent power, water and wastewater and construction projects are lesser developed countries or developing countries. The financial condition and creditworthiness of the potential purchasers of power and services provided by Projects--which may be a governmental or private utility or industrial consumer--or of the suppliers of fuel for alternate energy projects or of waste for waste-to-energy projects in these countries may not be as strong as those of similar entities in the developed countries. The obligations of the purchaser under the power purchase agreement, the services recipient under the related service agreement and the supplier under the fuel supply agreement may not be guaranteed by any host country governmental or other creditworthy agency.\nWaste-to-Energy and Independent Power projects in particular, are keenly dependent on the reliable and predictable delivery of fuel, municipal solid waste in the case of waste-to-energy, meeting the quantity and quality requirements of the project facilities. Projects will in all cases seek to negotiate long-term contracts for the supply of fuel with creditworthy and reliable suppliers under terms that will permit it to project the future cost of fuel through the life of the contract. However, the reliability of fuel deliveries may be compromised by one or more of several factors that may be more acute or may occur more frequently in developing countries than in developed countries, including a lack of sufficient infrastructure to support deliveries under all circumstances, bureaucratic delays in the import, transportation and storage of fuel in the host country, customs and tariff disputes and local or regional unrest or political instability .\nPayment for electricity to project companies in which Projects may invest, and for related operating services that it may provide, will often be made in whole or part in the domestic currencies of the host countries. Conversion of such currencies into U.S. dollars may not be assured by a governmental or other creditworthy host country agency, and may be subject to limitations in the currency markets, as well as restrictions of the host country. In addition, fluctuations in value of such currencies against the value of the U.S. dollar may cause the group's participation in such projects to yield less return than expected. Transfer of earnings and profits in any form beyond the borders of the host country may be subject to special taxes or limitations imposed by host country laws.\nIn addition, Projects will generally participate in projects, the facilities for which will be fixed and practically immovable. The provision of electric power, waste disposal and water and wastewater services are treated as a matter of national or key economic importance by the laws and politics of many host countries. There is therefore some risk that the assets constituting the facilities of the projects in which it participates could be temporarily or permanently expropriated or nationalized by a host country, or made subject to martial or exigent law or control.\nProjects will seek to manage and mitigate these risks through all available means that it deems appropriate. They will include: careful political and financial analysis of the host countries and the key participants in each project; guarantees of relevant agreements with creditworthy entities; political risk and other forms of insurance; participation by international finance institutions, such as affiliates of the World Bank, in financing of projects in which it participates; and joint ventures with other companies to pursue the development, financing and construction of these projects.\nGAIN ON SALE OF LIMITED PARTNERSHIP INTERESTS\nIn 1991, limited partnership interests in, and the related tax benefits of, the partnership that owns the Huntington, New York, facility were sold by Waste-to-Energy to third-party investors. In 1992 Waste-to-Energy sold the subsidiary that held the remaining limited partnership interests in, and certain related tax benefits of, that partnership. During 1994, an Operating Subsidiary of the Waste-to-Energy group that is the owner of the Onondaga County, New York, facility sold limited partnership interests and tax benefits to third party investors. Under both the Huntington and Onondaga limited partnership agreements, Operating Subsidiaries are general partners and retain responsibility for the operation and maintenance of the facilities.\nOTHER ACTIVITIES\nProjects also intends to develop, operate and, in some cases, own projects that process recyclable paper products into containerboard for reuse in the commercial sector. As with it's Waste-to-Energy group, such projects involve various contractual arrangements with a variety of private and public entities, including municipalities, lenders, joint venture partners (which may provide some of the financing or technical support), purchasers of the plant output, and contractors and subcontractors which build the facilities. In addition, such projects require significant amounts of energy in the form of steam, which may be provided by present or future waste-to-energy projects operated by the Waste-to-Energy group.\nIn 1993, Projects discontinued the fixed-site hazardous waste business conducted through American Envirotech, Inc., an indirect subsidiary. In light of substantial and adverse changes in the market for hazardous waste incineration services and regulatory uncertainty stemming from EPA pronouncements, Projects ceased all development activities. Although Projects continues to hold permits and certain related assets pending resolution of certain litigation, any other related assets have been disposed of or otherwise abandoned. (See \"Item 3. Legal Proceedings and Environmental Matters\" of this Form 10-K.)\nOTHER INFORMATION\nMARKETS, COMPETITION AND GENERAL BUSINESS CONDITIONS\nOgden's Services and Projects business segments can be adversely affected by general economic conditions, war, inflation, adverse competitive conditions, governmental restrictions and controls, natural disasters, energy shortages, weather, the adverse financial condition of customers and suppliers, various technological changes and other factors over which Ogden has no control.\nThe economic climate can also adversely affect several of Ogden's Services' operations, including, but not limited to, fewer airline flights, reduced inflight meals and flight cancellations in Services' Aviation group; cost cutting and budget reductions in Services' Technology group and Facility group; and, reduced event attendance in Services' Entertainment group. In addition, disputes between owners of professional sports organizations and the professional players of such organizations have affected and may continue to affect the operations of the Entertainment group.\nOgden's Projects business segment, through its Waste-to-Energy group, markets its services principally to governmental entities, including city, county, and state governments as well as public authorities or special purpose districts established by one or more local government units for the purpose of managing the collection and\/or disposal of municipal solid waste (\"MSW\"). Since 1989 there has been a decline in the number of communities requesting proposals for waste-to-energy facilities. Ogden believes that this decline has resulted from a number of factors that adversely affected communities' willingness to make long-term capital commitments to waste disposal projects, including: declining prices at which energy can be sold; declining alternative disposal costs; uncertainties about the impact of recycling on the waste stream; and continuing concerns arising from the Clean Air Act Amendments of 1990 and the regulatory actions currently being proposed pursuant to its terms. Ogden believes that waste-to-energy facilities and recycling are complimentary methods of managing a community's waste disposal needs. The fact that many of Ogden's Client Communities have recycling rates in excess of national averages demonstrates that a properly sized waste-to-energy facility does not hinder achievement of aggressive recycling goals. Ogden does not believe there will be a near term return to frequent public procurement for waste-to-energy facilities.\nMSW is typically supplied to Ogden's waste-to-energy facilities pursuant to long-term contracts. In most of the markets that Projects' Waste-to- Energy group currently serve, the cost of waste-to-energy services to its current Client Communities is competitive with the cost of other disposal alternatives, mainly landfilling.\nCompliance with regulations promulgated by the United States Environmental Protection Agency (the \"EPA\") in 1991 will to some extent increase the cost of landfilling, although landfills may be less expensive in some cases, in the short term, than waste-to-energy facilities. Landfills generally do not commit their capacity for extended periods. Much of the landfilling done in the United States is done on a spot market or through short term contracts (less than 5 years). Accordingly, landfill pricing tends to be more volatile as a result of periodic changes in waste generation and available capacity than Ogden's pricing, which is based on long-term contracts. Ogden believes that landfills have not been required to comply with permitting requirements relating to the emission of air pollutants and that this provides landfills with a competitive advantage. Another factor affecting the competitiveness of waste-to-energy fees are the additional charges imposed by Client Communities and included in such fees to support recycling programs, household hazardous waste collections, citizen education, and similar initiatives. The cost competitiveness of waste-to-energy facilities also depends on the prices at which the facility can sell the energy it generates. Another factor affecting the demand for new waste-to-energy projects was a 1994 United States Supreme Court decision invalidating state and local laws and regulations mandating that waste generated within a given jurisdiction be taken to a designated facility. Waste-to-energy facilities also compete with other disposal technologies such as mixed solid-waste composting. Mixed waste composting is not a proven technology, and Ogden believes that it has not been applied successfully to date in a large scale facility.\nMass-burn waste-to-energy systems compete with various refuse-derived fuel (\"RDF\") systems in which MSW is preprocessed to remove various non- combustibles and is shredded for sizing prior to burning. Ogden believes that the large-scale facilities being contracted for today are primarily mass-burn systems. Although OPI operates four RDF projects, these were all acquired after construction. Other technologies utilized in mass-burn type facilities in the United States include those of Von Roll, W+E, Takuma, Volund, Steinmueller, Deutsche Babcock, O'Connor, and Detroit Stoker.\nThere is substantial competition within the waste-to-energy field. Ogden competes with a number of firms, some of which have greater financial resources than Ogden. Some competitors have licenses or similar contractual arrangements for competing technologies in the waste-to-energy field, and a limited number of competitors have their own proprietary technology.\nCompetition for projects is intense in all markets in which Projects does business or intends to do business. There are numerous companies in the United States and in several foreign countries that pursue these projects. Many of these companies have more experience, capital and other resources than does Ogden.\nEQUAL EMPLOYMENT OPPORTUNITY\nIn recent years, governmental agencies (including the Equal Employment Opportunity Commission) and representatives of minority groups and women have asserted claims against many companies, including some Ogden subsidiaries, alleging that certain persons have been discriminated against in employment, promotions, training, or other matters. Frequently, private actions are brought as class actions, thereby increasing the practical exposure. In some instances, these actions are brought by many plaintiffs against groups of defendants in the same industry, thereby increasing the risk that any defendant may incur liability as a result of activities which are the primary responsibility of other defendants. Although Ogden and its subsidiaries have attempted to provide equal opportunity for all of its employees, the combination of the foregoing factors and others increases the risk of financial exposure.\nEMPLOYEE AND LABOR RELATIONS\nAs of January 31, 1995, Ogden and its subsidiaries employed approximately 45,000 people.\nCertain employees of Ogden are employed pursuant to collective bargaining agreements with various unions. During 1994 Ogden successfully renegotiated collective bargaining agreements in certain of its business sectors with no strike-related loss of service. Ogden considers relations with its employees to be good and does not anticipate any significant labor disputes in 1995.\nENVIRONMENTAL REGULATORY LAWS\nOgden's business activities are pervasively regulated pursuant to federal, state, and local environmental laws. Federal laws, such as the Clean Air Act and Clean Water Act, and their state counterparts, govern discharges of pollutants to air and water. Other federal, state, and local laws, such as RCRA, comprehensively govern the generation, transportation, storage, treatment, and disposal of solid waste, including hazardous waste (such laws and the regulations thereunder, \"Environmental Regulatory Laws\").\nThe Environmental Regulatory Laws and other federal, state, and local laws, such as the Comprehensive Environmental Response Compensation and Liability Act (\"CERCLA\") (collectively, \"Environmental Remediation Laws\"), make Ogden potentially liable on a joint and several basis for any environmental contamination which may be associated with its activities at sites, including landfills, which OPI has owned, operated, or leased or at which there has been disposal of residue or other waste handled or processed by OPI. OPI leases and operates a landfill in Haverhill, Massachusetts, and leases a landfill in Bristol, Connecticut, in connection with its projects at those locations. Some state and local laws also impose liabilities for injury to persons or property caused by site contamination. Some Service Agreements provide for indemnification of the Operating Subsidiaries from some such liabilities.\nThe Environmental Regulatory Laws require that many permits be obtained before the commencement of construction and operation of any waste-to-energy facility, including: air quality permits, stormwater discharge permits, solid waste facility permits in most cases, and,in many cases, wastewater discharge permits. There can be no assurance that all required permits will be issued, and the process of obtaining such permits can often cause lengthy delays, including delays caused by third party appeals challenging permit issuance. Failure to meet conditions of these permits or of the Environmental Regulatory Laws and the corresponding regulations can subject an Operating Subsidiary to regulatory enforcement actions by the appropriate governmental unit, which could include monetary penalties, and orders requiring certain remedial actions or limiting or prohibiting operation. To date, OPI has not incurred material penalties, been required to incur material capital costs or additional expenses, nor been subjected to material restrictions on its operations as a result of violations of environmental laws, regulations, or permits. Certain of the Environmental Regulatory Laws also authorize suits by private parties for damages and injunctive relief. Repeated unexcused failure to comply with environmental standards may also constitute a default by the Operating Subsidiary under its Service Agreement.\nThe Environmental Regulatory Laws and federal and state governmental regulations and policies governing their enforcement are subject to revision. New technology may be required or stricter standards may be established for the control of discharges of air or water pollutants or for solid waste or ash handling and disposal. Thus, as new technology is developed and proven, it may be required to be incorporated into new facilities or major modifications to existing facilities. This new technology may often be more expensive than that used previously.\nThe Clean Air Act Amendments of 1990 required EPA to promulgate New Source Performance Standards (\"NSPS\") and Emission Guidelines (\"EG\") applicable to new and existing municipal waste combustion units for particulate matter (total and fine), opacity (as appropriate), sulfur dioxide, hydrogen chloride, oxides of nitrogen, carbon monoxide, dioxins and dibenzofurans. The EPA proposed NSPS and EG regulations on September 20, 1994, incorporating all the requirements mandated by the 1990 Amendments. OPI, as well as other individual members of the industry, the industry trade association, affected client communities and their organizations and environmental groups have all submitted extensive comments to EPA on these proposed regulations. EPA is developing the regulations under a court order which requires that they be in their final form by September 1, 1995. Due to the extensive nature of the comments submitted, as well as developments in the Congress which could suspend new regulations, it is not clear at what time nor in what form the final regulations will indeed be published. The form of the proposed rules would require that most of Ogden's existing facilities be retrofitted for control equipment to achieve some or all of the mercury, nitrogen oxide, organics and acid gases emissions limits.\nThe NSPS and EG, which OPI believes will be issued in final form in 1995, will require capital improvements or operating changes to most of the facilities operated by Ogden. The exact timing and cost of such modifications cannot be stated definitively because State regulations embodying these have generally not been finally adopted. The costs to meet new rules for existing facilities owned by Client Communities will be borne by the Client Communities. For projects owned or leased by Ogden and operated under a Service Agreement, the Client Community has the obligation to fund such capital improvements, to which Ogden must make an equity contribution, generally 20%. Such equity contributions are likely to range, in total for all such facilities, from $9 million to $15 million. With respect to a project owned by Ogden and not operated pursuant to a Service Agreement, such capital improvements may cost between $8 million and $15 million. Ogden believes that most costs incurred to meet EG and operating permit requirements at facilities it operates may be recovered from Client Communities and other users of its facilities through increased tipping fees permitted under applicable contracts.\nThe Clean Air Act also requires each state to implement a state implementation plan that outlines how areas out of compliance with federally- established national ambient air quality standards will be returned to compliance. The state plans must include an operating permit program. Most states are now in the process of implementing these requirements. The state implementation plans and the operating permits to be issued under them may place new requirements on waste-to-energy facilities. Under federal law, the new operating permits may have a term of up to 12 years after issuance or renewal, subject to review every 5 years.\nThe Environmental Remediation Laws prohibit disposal of hazardous waste other than in small, household-generated quantities at Ogden's municipal solid waste facilities. The Service Agreements recognize the potential for improper deliveries of hazardous wastes and specify procedures for dealing with hazardous waste that is delivered to a facility. Although certain Service Agreements require the Operating Subsidiary to be responsible for some costs related to hazardous waste deliveries, to date, no Operating Subsidiary has incurred material hazardous waste disposal costs.\nPUBLIC UTILITY REGULATORY POLICIES ACT\nOgden's business is subject to the provisions of the federal Public Utility Regulatory Policies Act (\"PURPA\"). Pursuant to PURPA, the Federal Energy Regulatory Commission (\"FERC\") has promulgated regulations that exempt qualifying facilities (facilities meeting certain size, fuel and ownership requirements) from compliance with certain provisions of the Federal Power Act, the Public Utility Holding Company Act of 1935, and, except under certain limited circumstances, state laws regulating the rates charged by, or the financial and organizational activities of, electric utilities. PURPA was promulgated in 1978 to encourage the development of cogeneration facilities and small facilities making use of non-fossil fuel power sources, including waste-to-energy facilities. The exemptions afforded by PURPA to qualifying facilities from the Federal Power Act and the Public Utility Holding Company Act of 1935 and most aspects of state electric utility regulation are of great importance to OPI and its competitors in the waste- to-energy industry.\nState public utility commissions must approve the rates, and in some instances other contract terms, by which public utilities purchase electric power from Ogden's projects. PURPA requires that electric utilities purchase electric energy produced by qualifying facilities at negotiated rates or at a price equal to the incremental or \"avoided\" cost that would have been incurred by the utility if it were to generate the power itself or purchase it from another source. While public utilities are not required by PURPA to enter into long-term contracts, PURPA creates a regulatory environment in which such contracts can typically be negotiated.\nIn January and February, 1995, the FERC issued two orders in which it modified its previous interpretation of PURPA and held that state laws and regulatory orders directing utilities to purchase electricity from qualifying facilities at rates in excess of the utility's projected avoided costs were preempted by PURPA and that contracts providing for such above-avoided cost rates were void. Such laws and regulations have been used in the past by states to encourage the development of environmentally beneficial facilities such as waste-to-energy facilities. The FERC stated in both orders that it intends to apply its reinterpretation of PURPA only on a prospective basis and that it will not entertain requests by utilities to invalidate power sales agreements entered into pursuant to such state laws and regulatory orders unless the purchasing utility raised the issue of the legality of the rate at the time of contract execution. Ogden does not believe any of the power sales agreements related to its waste-to-energy facilities is subject to challenge based on the prospective nature of the orders. However, numerous petitions have been filed with the FERC seeking rehearing of its January, 1995 order, including by electric utilities challenging the prospective nature of the relief granted by the FERC. Ogden cannot predict the ultimate outcome of these proceedings or whether any of the agreements for the sale of electricity from its facilities will be affected thereby.\nFLOW CONTROL\nMany states have mandated local and regional solid waste planning, and require that new solid waste facilities may be constructed only in conformity with these plans. State laws may authorize the planning agency to require that waste generated within its jurisdiction be brought to a designated facility, which may help that facility become economically viable but preclude the development of other facilities in that jurisdiction. Such ordinances are sometimes referred to as legal flow control. In 1994, the United States Supreme Court ruled that the flow control ordinance of Clarkstown, New York was unconstitutional as a local regulation of interstate commerce that is unauthorized by Congress and therefore violative of the United States Constitution. The Court's decision has been applied by other courts to invalidate or question other similar laws and ordinances.\nOgden does not believe this decision would materially impact Ogden's existing facilities or its ability to develop new ones. This view is based on a number of considerations. Most of the contracts pursuant to which Ogden provides disposal services require the Client Community to deliver stated minimum quantities of waste on a put-or-pay basis. Furthermore, only a few of the Client Communities served by Ogden relied solely on legal flow control to provide waste to Ogden's facilities, a factor influenced in part by past difficulties in enforcing legal flow control ordinances. Although some municipalities may experience temporary difficulties in meeting delivery commitments as they address required changes in their waste disposal plans, such difficulties should not be long-lived as indicated by the experience of municipalities served by OPI which adopted alternative measures. Ogden believes that there are other methods for providing incentives to use integrated waste systems incorporating waste to energy that do not entail legal flow control, which incentives should not be affected by the Court's decision. These include mandating that charges for utilization of the system be maintained at competitive levels and that revenue shortfalls be funded from tax revenues or special assessments on residents. This type of incentive will be utilized at the facility being constructed and which will be operated by Ogden in Montgomery County, Maryland.\nCongressional action authorizing flow control was brought at the end of the 1994 Congressional session, but passage was defeated on the last day of the session by a single vote. Legislation is again pending in the current session of Congress.\nFurthermore, in most of the municipalities where OPI provides services, information available to Ogden indicates that the cost to the Client Community of waste to energy is competitive with alternative disposal facilities, and therefore Ogden's facilities should be able to compete for waste economically. As indicated, however, certain additional waste disposal services are financed by the Client Community's increasing the cost for disposal at waste-to-energy facilities, and these services may have to be paid for by other mechanisms.\nIn addition, state laws have been enacted in some jurisdictions that may also restrict the intrastate and interstate movement of solid waste. Restrictions on importation of waste from other states have generally been voided by Federal courts as invalid restrictions on interstate commerce. Bills proposed in past sessions of Congress would authorize such designations and restrictions. Bills of this nature have been introduced in the current session of Congress.\nASH RESIDUE\nIn 1994, the United States Supreme Court held that municipal solid waste ash residue having hazardous characteristics is subject to RCRA's provisions for management as a hazardous waste relating to transportation, disposal and treatment downstream of the point of generation. No ash residue from a fully operational facility operated by Ogden has been characterized as hazardous under the present or past EPA prescribed test procedures and such ash residue is currently disposed of in permitted landfills as non-hazardous waste. In certain states, ash residue from certain waste-to-energy facilities of other vendors or communities has, on occasion, been found to have hazardous characteristics under these test procedures. The Supreme Court's ruling has not had a significant impact on Ogden's business. Following that decision and related EPA actions made adjustments to its operations and, as required by EPA guidance, did tests that show that the ash residue leaving its facilities is not hazardous.\nThe trade association of which Ogden is a member, Ogden and other industry members have filed an action against the EPA in federal court challenging certain actions taken by EPA since the Court's ruling which could require some waste-to-energy facilities to obtain permits under RCRA in connection with the conditioning of ash. Ogden believes that pending EPA rulings will resolve this issue so that such permitting is not required at its facilities. However, a conclusion must await final agency action.\nOTHER MATTERS\nIn October, 1992, Congress enacted, and the President signed into law, comprehensive energy legislation, several provisions of which are intended to foster the development of competitive, efficient bulk power generation markets throughout the country. Although the impact of the legislation cannot be fully known because Federal and State regulatory agencies are still engaged in the process of developing policies and promulgating implementing regulations, OPI believes that, over the long term, the legislation will create business opportunities both in the waste-to-energy field as well as in other power generation fields.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\n(a) Services\nThe principal physical properties of Services are the fueling installations at various airports in the United States and Canada and the corporate premises located at Two Pennsylvania Plaza, New York, New York 10121 under lease, which expires on April 30, 2008 and which contains an option by Ogden to renew for an additional five years.\nAtlantic Design Company's corporate offices are located in Charlotte, North Carolina. Atlantic Design owns a 51,000 square foot operating facility on 3.5 acres of land in Vestal, New York. Atlantic Design also leases operating facilities at various locations in Florida, New Jersey and New York. The leases range from a term of one year to as long as ten years.\nOgden Services Corporation, through wholly-owned subsidiaries, owns and leases buildings in various areas in the United States and several foreign countries which house office, laboratory and warehousing operations. The leases range from a month-to-month term to as long as five years.\nThe Aviation in-flight food service operation facilities, aggregating approximately 600,000 square feet, are leased, except at Newark, New Jersey; Miami, Florida; and Las Vegas, Nevada, which are owned.\nEntertainment owns and operates Fairmount Park racetrack, which conducts thoroughbred and harness racing on a 150-acre site with a long-term lease expiring in 2017 located in Collinsville, Illinois, eight miles from downtown St. Louis. Entertainment also owns a 148-acre site located at East St. Louis, Illinois.\nOgden Abatement and Decontamination Services owns a 12,000 square-foot warehouse and office facility located in Long Island City, New York.\nTechnology leases most of its facilities, consisting almost entirely of office space. This includes an 11-year lease which began in 1986 for its headquarters facility in Fairfax, Virginia, for approximately 119,000 square feet as well as office space in other locations throughout the United States under lease terms of five years or less.\nEnvironmental's headquarters is located in Fairfax, Virginia, where Environmental currently occupies approximately 27,000 square feet of space in the headquarters building of ERC International, Inc. (\"ERCI\"), a wholly-owned subsidiary of Ogden. Environmental's lease payments include the cost of certain services and allocations which are shared with ERCI. Environmental has agreed to continue to occupy and sublease from ERCI not less than 24,000 square feet of space in the building for the remainder of the lease term expiring in 1997.\nEnvironmental also leases an aggregate of approximately 347,000 square feet of office and laboratory space in 40 separate locations in 17 states in the United States. These leases are generally short term in nature, with terms which range from five to ten years or less and include (i) the headquarters office described above, (ii) office and laboratory space in Nashville and Oak Ridge, Tennessee; San Diego, California; Pensacola, Florida; and Phoenix, Arizona, and (iii) laboratory office space owned in Fort Collins, Colorado. In addition to its Fairfax, Virginia headquarters, Environmental maintains regional headquarters in San Diego, California and Nashville, Tennessee.\nMany of the other Services segment facilities operate from leased premises located principally within the United States.\n(b) Projects\nOPI's principal executive offices are located in Fairfield, New Jersey, in an office building located on a 5.4-acre site owned by OPI.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS AND ENVIRONMENTAL MATTERS\n(a) Legal Proceedings\nThe Company is a party to various legal proceedings involving matters arising in the ordinary course of business. The Company does not believe that there are any pending legal proceedings for damages against the Company, including the legal proceeding described below, the outcome of which would have a material adverse effect on the Company on a consolidated basis.\nIn December 1993 and January 1994, individuals who had been shareholders of American Envirotech, Inc. (\"AEI\"), a company which in 1992 had been acquired in a merger by a subsidiary of the Company, sued the Company and several of its subsidiaries in state courts in Fort Worth and Houston, Texas. The plaintiffs claim that AEI's termination of its project development in 1993 breached the merger agreement, and that in connection with the termination the Company and its subsidiaries breached fiduciary duties and committed fraud. The Fort Worth plaintiffs seek damages in an unspecified amount. The Houston plaintiffs seek $37 million in actual damages as well as significant punitive damages. Both cases are in pre-trial proceedings. On March 2, 1995, the Fort Worth court indicated that it would grant plaintiffs' summary judgement motion, and find that the defendants breached the contract.\nThe Company believes that AEI properly terminated its contract in accordance with its terms, that it acted at all times fairly and in compliance with its obligations; and, based on the advice of counsel, that it has meritorious defenses. The Company also believes, based on the advice of counsel, that questions of fact exist and therefore, the Fort Worth court erred in granting summary judgment. The Company intends to take whatever actions are necessary, at the appropriate time, to overcome the impact of the summary judgment ruling, and if it is successful all issues will be tried by a jury. Otherwise the case will be tried as to non-contractual claims and damages only. The Company believes that plaintiffs have not been damaged because the project could not have been completed on a successful basis, and under the merger agreement payments to the plaintiffs were contingent upon successful financing and profitable operations. The Company will vigorously defend these lawsuits and pursue all appropriate appeal rights, if necessary. No assurances can be given as to the ultimate outcome of either case.\n(b) Environmental Matters\nOgden conducts regular inquiries of its subsidiaries regarding litigation and environmental violations which include determining the nature, amount and likelihood of liability for any such claims, potential claims or threatened litigation.\nIn the ordinary course of its business, subsidiaries of Ogden may become involved in Federal, state, and local proceedings relating to the laws regulating the discharge of materials into the environment and the protection of the environment. These include proceedings for the issuance, amendment, or renewal of the licenses and permits pursuant to which the subsidiary operates. Such proceedings also include actions brought by individuals or local governmental authorities seeking to overrule governmental decisions on matters relating to the subsidiaries' operations in which the subsidiary may be, but is not necessarily, a party. Most proceedings brought against an Ogden subsidiary by governmental authorities or private parties under these laws relate to alleged technical violations of regulations, licenses, or permits pursuant to which the subsidiary operates. Ogden believes that such proceedings will not have a material adverse effect on Ogden and its subsidiaries on a consolidated basis.\nOgden's operations are subject to various Federal, state and local environmental laws and regulations, including the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response Compensation and Liability Act (CERCLA) and Resource Conservation and Recovery Act (RCRA). Although Ogden's operations are occasionally subject to proceedings and orders pertaining to emissions into the environment and other environmental violations, Ogden believes that it is in substantial compliance with existing environmental laws and regulations and to the best of its knowledge neither Ogden nor any of its operations have been named as a potential responsible party at any site.\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 Ogden during the fourth quarter of 1994.\nEXECUTIVE OFFICERS OF OGDEN\nSet forth below are the names, ages, position and office, and year appointed, of all \"executive officers\" (as defined by Rule 3b-7 of the Securities Exchange Act of 1934) of Ogden as of March 31, 1995:\nThere is no family relationship by blood, marriage or adoption (not more remote than first cousins) between any of the above individuals and any Ogden director, except that R. Richard Ablon, an Ogden director and President and Chief Executive Officer, is the son of Ralph E. Ablon, an Ogden director and Chairman of the Board.\nThe term of office of all officers shall be until the next election of directors and until their respective successors are chosen and qualified.\nThere are no arrangements or understandings between any of the above officers and any other person pursuant to which any of the above was selected as an officer.\nExcept as set forth below, the foregoing table lists the principal occupation and employment of the named individual and the position or similar position that he\/she has held since January 1, 1990:\nRalph E. Ablon has been Chairman of the Board of Ogden since 1962 and served as its Chief Executive Officer prior to May 1990.\nR. Richard Ablon has been President and Chief Executive Officer of Ogden since May 1990. From January, 1987 to May 1990, he was President and Chief Operating Officer, Operating Services, Ogden. Mr. Ablon has served as Chairman of the Board and Chief Executive Officer of Ogden Projects, Inc., since November 1990.\nConstantine G. Caras has been Executive Vice President and Chief Administrative Officer since July 1990. Since September 1986 he has served as Executive Vice President of Ogden Services Corporation.\nScott G. Mackin has been considered an Executive Officer of Ogden since 1992. He has been President and Chief Operating Officer of Ogden Projects, Inc. since January 1991. From November 1990 to January 1991, he was Co- President, Co-Chief Operating Officer, General Counsel and Secretary at Ogden Projects, Inc. Between 1987 and 1990 Mr. Mackin served in various executive capacities of Ogden Projects, Inc.\nPhilip G. Husby has been Senior Vice President and Chief Financial Officer of Ogden since January 1, 1991. From April 1987 to December 31, 1990, he served as Senior Vice President and Chief Administrative Officer of Ogden Financial Services, Inc., an Ogden subsidiary.\nLynde H. Coit has been a Senior Vice President and General Counsel of Ogden since January 17, 1991. From April 1989 to January 1991, he was Senior Vice President and General Counsel of Ogden Financial Services, Inc., an Ogden subsidiary. From January 1988 to March 1989, he was a partner of the law firm of Nixon, Hargrave, Devans & Doyle and prior thereto he was employed by that firm.\nDavid L. Hahn was elected Senior Vice President of Ogden in January 1995. He has served as Vice President-Marketing of Ogden Services Corporation for more than the past five years.\nRodrigo Arboleda was elected Senior Vice President of Ogden in January 1995. Since 1992, he has served as Senior Vice President-Business Development for Latin America of Ogden Services Corporation. From 1989 to 1992 he owned and served as the President and Chief Executive Officer of Interamerican Consulting Group, Inc., a consulting firm located in Miami, Florida specializing in management, financing, and restructuring of troubled companies.\nNancy R. Christal has been Vice President - Investor Relations of Ogden since February 1992 and served as Ogden's Director, Investor Relations from January 1991 to February 1992. From April 1990 to January 1991, she was Director, Investor Relations at Ogden Projects, Inc. From 1985 to March 1990 she served first as Manager and then as Assistant Vice President, Investor Relations at Chemical Bank.\nPart II\nItem 5.","section_5":"Item 5. MARKET FOR OGDEN'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPursuant to General Instruction G (2), the information called for by this item is hereby incorporated by reference from Page 49 of Ogden's 1994 Annual Report to Shareholders.\nAs of March 1, 1995, the approximate number of Ogden common stock Shareholders was 12,700.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nPursuant to General Instruction G (2), the information called for by this item is hereby incorporated by reference from Page 26 of Ogden's 1994 Annual Report to Shareholders.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPursuant to General Instruction G (2), the information called for by this item is hereby incorporated by reference from Pages 24 and 25 of Ogden's 1994 Annual Report to Shareholders.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPursuant to General Instruction G (2), the information called for by this item is hereby incorporated by reference from Pages 26 through 46 and Page 49 of Ogden's 1994 Annual Report to Shareholders.\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 OGDEN\nPursuant to General Instruction G (3), the information regarding directors called for by this item is hereby incorporated by reference from Ogden's 1995 Proxy Statement to be filed with the Securities and Exchange Commission.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nPursuant to General Instruction G (3), the information called for by this item is hereby incorporated by reference from Ogden's 1995 Proxy Statement to be filed with the Securities and Exchange Commission. The information regarding officers called for by this item is included at the end of Part I of this document under the heading \"Executive Officers of Ogden.\"\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPursuant to General Instruction G (3), the information called for by this item is hereby incorporated by reference from Ogden's 1995 Proxy Statement to be filed with the Securities and Exchange Commission.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPursuant to General Instruction G (3), the information called for by this item is hereby incorporated by reference from Ogden's 1995 Proxy statement to be filed with the Securities and Exchange Commission.\nPart IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Listed below are the documents filed as a part of this report:\n1). All financial statements contained on pages 27 through 46 and the Independent Auditors' Report on page 47 of Ogden's 1994 Annual Report to Shareholders are incorporated herein by reference.\n2). Financial statement schedules as follows:\n(i) Schedule II - Valuation and Qualifying Accounts for the years ended December 31, 1994, 1993 and 1992.\n3). Those exhibits required to be filed by Item 601 of Regulation S-K:\nEXHIBITS\n2.0 Plans of Acquisition, Reorganization, Arrangement, Liquidation or Succession.\n2.1 Agreement and Plan of Merger, dated as of October 31, 1989, among Ogden, ERCI Acquisition Corporation and ERC International, Inc.*\n2.2 Agreement and Plan of Merger among Ogden Corporation, ERC International, Inc., ERC Acquisition Corporation and ERC Environmental and Energy Services Co., Inc., dated as of January 17, 1991.*\n2.3 Amended and Restated Agreement and Plan of Merger among Ogden Corporation, OPI Acquisition Corp. and Ogden Projects, Inc., dated as of September 27, 1994.*\n3.0 Articles of Incorporation and By-laws.\n3.1 Ogden's Restated Certificate of Incorporation as amended.*\n3.2 Ogden's By-Laws, as amended through March 17, 1994.*\n4.0 Instruments Defining Rights of Security Holders.\n4.1 Fiscal Agency Agreement between Ogden and Bankers Trust Company, dated as of June 1, 1987, and Offering Memorandum dated June 12, 1987, relating to U.S. $85 million Ogden 6% Convertible Subordinated Debentures, Due 2002.*\n4.2 Fiscal Agency Agreement between Ogden and Bankers Trust Company, dated as of October 15, 1987, and Offering Memorandum, dated October 15, 1987, relating to U.S. $75 million Ogden 5-3\/4% Convertible Subordinated Debentures, Due 2002.*\n4.3 Indenture dated as of March 1, 1992 from Ogden Corporation to The Bank of New York, Trustee, relating to Ogden's $100 million debt offering.*\n10.0 Material Contracts\n10.1 Credit Agreement by and among Ogden, The Bank of New York, as Agent and the signatory bank Lenders thereto dated as of September 20, 1993.*\n10.2 Stock Purchase Agreement, dated May 31, 1988, between Ogden and Ogden Projects, Inc.*\n10.3 Tax Sharing Agreement, dated January 1, 1989, between Ogden, Ogden Projects, Inc. and subsidiaries, Ogden Allied Services, Inc. an subsidiaries, and Ogden Financial Services, Inc. and subsidiaries.*\n10.4 Stock Purchase Option Agreement, dated June 14, 1989, between Ogden and Ogden Projects, Inc. as amended on November 16, 1989.*\n10.5 Preferred Stock Purchase Agreement, dated July 7, 1989, between Ogden Financial Services, Inc. and Image Data Corporation.*\n10.6 Rights Agreement between Ogden Corporation and Manufacturers Hanover Trust Company, dated as of September 20, 1990.*\n10.7 Executive Compensation Plans and Arrangements\n(a) Ogden Corporation 1986 Stock Option Plan.*\n(b) Ogden Corporation 1990 Stock Option Plan.* (i) Ogden Corporation 1990 Stock Option Plan as Amended and Restated as of January 19, 1994.*\n(c) Ogden Services Corporation Executive Pension Plan.*\n(d) Ogden Services Corporation Select Savings Plan.* (i) Ogden Services Corporation Select Savings Plan Amendment and Restatement as of January 1, 1995. Transmitted herewith as Exhibit 10.7 (d)(i).\n(e) Ogden Services Corporation Select Savings Plan Trust.* (i) Ogden Services Corporation Select Savings Plan Trust Amendment and Restatement dated as of January 1, 1995. Transmitted herewith as Exhibit 10.7 (e)(i).\n(f) Ogden Services Corporation Executive Pension Plan Trust.*\n(g) Changes effected to the Ogden Profit Sharing Plan effective January 1, 1990.*\n(h) Employment Letter Agreement between Ogden and Lynde H. Coit dated January 30, 1990.*\n(i) Employment Agreement between Ogden and R. Richard Ablon dated as of May 24, 1990.* (i) Letter Amendment Employment Agreement between Ogden and R. Richard Ablon dated as of October 11, 1990.*\n(j) Employment Agreement between Ogden and C. G. Caras dated as of July 2, 1990.* (i) Letter Amendment to Employment Agreement between Ogden Corporation and C.G. Caras, dated as of October 11, 1990.*\n(k) Employment Agreement between Ogden and Philip G. Husby as of July 2, 1990.*\n(l) Termination Letter Agreement between Maria P. Monet and Ogden dated as of October 22, 1990.*\n(m) Letter Agreement between Ogden Corporation and Ogden's Chairman of the Board, dated as of January 16, 1992.*\n(n) Employment Agreement between Ogden and Ogden's Chief Accounting Officer dated as of December 18, 1991.*\n(o) Employment Agreement between Scott G. Mackin and Ogden Projects, Inc. dated as of January 1, 1994.*\n(p) Ogden Corporation Profit Sharing Plan.*\n(i) Ogden Profit Sharing Plan as amended and restated January 1, 1991 and as in effect through January 1, 1993.*\n(ii) Ogden Profit Sharing Plan as amended and restated effective as of January 1, 1995. Transmitted herewith as Exhibit 10.7 (p)(ii).\n(q) Ogden Corporation Core Executive Benefit Program.*\n(r) Ogden Projects Pension Plan.*\n(s) Ogden Projects Profit Sharing Plan.*\n(t) Ogden Projects Supplemental Pension and Profit Sharing Plans.*\n(u) Ogden Projects Employee's Stock Option Plan.* (i) Amendment, dated as of December 29, 1994 to the Ogden Projects Employees' Stock Option Plan. Transmitted herewith as Exhibit 10.7 (u)(i).\n(v) Ogden Projects Core Executive Benefit Program.*\n(w) Form of amendments to the Ogden Projects, Inc. Pension Plan and Profit Sharing Plans effective as of January 1, 1994.*\n(i) Form of Amended Ogden Projects, Inc. Profit Sharing Plan, effective as of January 1, 1994. Transmitted herewith as Exhibit 10.7 (w)(i).\n(ii) Form of Amended Ogden Projects, Inc. Pension Plan, effective as of January 1, 1994. Transmitted herewith as Exhibit 10.7 (w)(ii).\n10.8 First Amended and Restated Ogden Corporation Guaranty Agreement made as of January 30, 1992 by Ogden Corporation for the benefit of Mission Funding Zeta and Pitney Bowes Credit Corporation.*\n10.9 Ogden Corporation Guaranty Agreement as of January 30, 1992 by Ogden Corporation for the benefit of Allstate Insurance Company and Ogden Martin Systems of Huntington Resource Recovery Nine Corporation.*\n11 Ogden Corporation and Subsidiaries Detail of Computation of Earnings Applicable to Common Stock for the years ended December 31, 1994, 1993 and 1992. Transmitted herewith as Exhibit 11.\n13 Those portions of the Annual Report to Stockholders for the year ended December 31, 1994, which are incorporated herein by reference. Transmitted herewith as Exhibit 13.\n21 Subsidiaries of Ogden. Transmitted herewith as Exhibit 21.\n23 Consent of Deloitte & Touche LLP. Transmitted herewith as Exhibit 23.\n27 Financial Data Schedule (EDGAR Filing Only). Transmitted herewith as Exhibit 27.\n* Incorporated by reference as set forth in the Exhibit Index of this Annual Report on Form 10-K.\n(b) No Reports on Form 8-K were filed by Ogden during the fourth quarter of 1994. However, on January 3, 1995 Ogden filed a Form 8-K Current Report pursuant to the merger transaction resulting in Ogden Projects, Inc. becoming a wholly-owned subsidiary of Ogden effective December 29, 1994.\nSIGNATURES\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.\nOGDEN CORPORATION\nDate: March 16, 1995 By \/S\/ R. Richard Ablon R. Richard Ablon 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 indicated.\nSIGNATURE TITLE\n\/S\/ Ralph E. Ablon Chairman of the Board & Director RALPH E. ABLON\n\/S\/ R. Richard Ablon President & Chief Executive Officer R. RICHARD ABLON and Director\n\/S\/ Philip G. Husby Senior Vice President, Treasurer and PHILIP G. HUSBY Chief Financial Officer\n\/S\/ Robert M. DiGia Vice President, Controller and Chief ROBERT M. DIGIA Accounting Officer\n\/S\/ David M. Abshire Director DAVID M. ABSHIRE\n\/S\/ Norman G. Einspruch Director NORMAN G. EINSPRUCH\n\/S\/ Constantine G. Caras Director CONSTANTINE G. CARAS\n\/S\/ Attallah Kappas Director ATTALLAH KAPPAS\n(i)\n\/S\/ Terry Allen Kramer Director TERRY ALLEN KRAMER\n\/S\/ Maria P. Monet Director MARIA P. MONET\n\/S\/ Judith D. Moyers Director JUDITH D. MOYERS\n\/S\/ Homer A. Neal Director HOMER A. NEAL\n\/S\/ Stanford S. Penner Director STANFORD S. PENNER\n\/S\/ Jesus Sainz Director JESUS SAINZ\n\/S\/ Frederick Seitz Director FREDERICK SEITZ\n\/S\/ Robert E. Smith Director ROBERT E. SMITH\n\/S\/ Helmut F. O. Volcker Director HELMUT F.O. VOLCKER\n\/S\/ Abraham Zaleznik Director ABRAHAM ZALEZNIK\n(ii)\nINDEPENDENT AUDITORS' REPORT\nOgden Corporation:\nWe have audited the consolidated financial statements of Ogden Corporation and subsidiaries as of December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 3, 1995, which report includes an explanatory paragraph relating to the adoption of Statements of Financial Accounting Standards No. 106, 109, 112, and 115; such consolidated financial statements and report are included in your 1994 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedules of Ogden Corporation and subsidiaries, listed in Item 14. These consolidated financial statement schedules are the responsibility of the Corporation'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.\n\/s\/Deloitte & Touche LLP\nNew York, New York February 3, 1995","section_15":""}
{"filename":"16422_1994.txt","cik":"16422","year":"1994","section_1":"Item 1 Business.\na. General Development of Business.\nCalifornia Water Service Company (the \"Company\") is a public utility water company which owns and operates 20 water systems serving 38 cities and communities and adjacent territories in California with an estimated population of more than 1,500,000.\nThe Company, one of the largest investor-owned water companies in the United States, was incorporated under the laws of the State of California on December 21, 1926. Its principal executive offices are located at 1720 North First Street, San Jose, California, and its mailing address is Post Office Box 1150, San Jose, California 95108 (telephone number:1-408-451-8200).\nEffective April 8, 1994 the Company's Common Stock began trading on the New York Stock Exchange under the symbol CWT. The Company was previously in the over-the-counter market and quoted by the National Association of Securities Dealers Automated Quotation System (NASDAQ) under the symbol CWTR\nDuring the fiscal year ended December 31, 1994 (the \"1994 fiscal year\"), there were no significant changes in the kind of products produced or services rendered by the Company, or in the Company's markets or methods of distribution.\nRegulation and Rates.\nThe Company is subject to regulation of its rates, service and other matters affecting its business by the Public Utilities Commission of the State of California (\"Commission\" or \"PUC\").\nThe Company's systems, which are operated as 20 separate districts in the State of California, are not integrated with one another, and except for allocation of general office expenses and the determination of cost of capital, the expenses and revenues of individual districts are not affected by operations in other districts. Cost of capital (i.e. return on debt and equity) is determined on a Company-wide basis. Otherwise, the PUC requires that each district be considered a separate and distinct entity for rate-making purposes.\nThe Commission requires that water rates for each Company operating district be determined independently. Each year the Company attempts to file general rate increase applications for approximately one-third of its operating districts. According to its rate case processing procedures for water utilities, the Commission attempts to issue decisions within eight months of acceptance of the Application. Rates are set prospectively for a three-year period, with a provision for step increases to maintain the authorized rate of return. Offset rate adjustments are also allowed as required for changes in purchased water, power and pump tax costs.\nDuring 1994, general rate increase applications were filed with the Commission requesting rate relief of $3,023,000 in six Company districts representing 15 percent of the Company's customer base. The applications requested a rate of return on common equity of 12 percent. However, the Commission staff has recommended a rate of return of 10.9 percent. Public hearings for these cases were completed February 1995 and the Commission's decision is expected in mid- May. In the meantime, step rate increases for 15 districts totaling approximately $2,102,000 became effective in January 1995.\nIn July 1994 the Commission issued a decision of general rate cases filed in July 1993, for three districts representing 13 percent of customer base, resulting in the authorization of $540,000 in additional revenue and authorizing a return on common equity of 10.2 percent\nIn 1994 the Commission issued its long awaited decision in its investigation of the financial and operational risks for water utilities. While the Commission concluded that no fundamental change in its ratemaking procedures is necessary, it authorized water utilities to accrue interest on balancing and memorandum accounts. Additionally, the decision allows water utilities to request prospective recovery for unanticipated Safe Drinking Water Act compliance costs. The Company does not expect the decision to have a material effect on its operations.\nEffective March 14, 1994, the Commission closed all voluntary conservation memorandum accounts. The Company has filed an advice letter seeking authority to transfer $1,748,000 in conservation expenses from the drought memorandum accounts to its expense balancing accounts. These amounts would be recoverable on a district by district basis through the Commission's offset procedures which allow surcharges to amortize account balances.\nOffset rate increases of $1,944,000 and $2,327,000 were authorized during the year for water production cost increases and balancing account undercollections, respectively. Additionally, the Commission approved rate increases of $292,000 to recover increased costs from the 1993 general office renovation, $87,000 for a new water tank in the South San Francisco district, and $215,000 for post-retirement benefits other than pensions. This latter rate increase relates to an expense which was incurred as a result of accounting changes mandated by Statement of Financial Accounting Standards No. 106.\nIn January 1995 a consultant retained by the Commission's Division of Ratepayer Advocates delivered a report on the reasonableness of the Second Amended Contract between the Company, Stockton-East Water District, the City of Stockton and certain other governmental bodies, pertaining to the sale and delivery of water to the Company's Stockton District by the Stockton-East Water District. The report alleges that the Company was required to receive prior Commission approval before entering into the Second Amended Contract and furthermore challenges the reasonableness of the Second Amended Contract for ratemaking purposes. However the report does not include specific ratemaking recommendations. It is difficult and premature at this time to assess the potential impact on the Company if the report were to be adopted by the Commission. However, the Company anticipates that if there is any adverse financial impact as a result of the report, such impact would be prospective, affecting only future rates for the Stockton district. Hearings have not yet been scheduled on the report by the assigned administrative law judge. Following hearings at which the Company intends to present evidence to rebut the report, the assigned administrative law judge will render a proposed decision for comment and then Commission consideration. The management of the Company intends to vigorously defend its position that the Second Amended Contract did not require prior Commission approval and is reasonable for ratemaking purposes.\nb. Financial Information about Industry Segments.\nThe Company has only one business segment.\nc. Narrative Description of Business.\nThe business of the Company consists of the production, purchase, storage, purification, distribution and sale of water for domestic, industrial, public, and irrigation uses, and for fire protection. The Company's business fluctuates according to the demand for water, which is partially dictated by seasonal conditions, such as summer temperatures or the amount and timing of rain during the year. The Company holds such franchises or permits in the communities it serves as it judges necessary to operate and maintain its facilities in the public streets. The Company distributes its water to customers in accordance with accepted water utility methods, which include pumping from storage and gravity feed from high elevation reservoirs.\nThe Company has various contracts under which it operates three municipally owned water systems and two reclaimed water distribution systems and provides billing services for certain cities.\nGeographical Service Areas and Number of Customers at Year-End.\nThe principal markets for the Company's products are users of water within the Company's service areas. The Company's geographical service areas and the approximate number of customers served in each at December 31, 1994, are as follows:\nSAN FRANCISCO BAY AREA Mid-Peninsula (San Mateo and San Carlos) 35,300 South San Francisco (including Colma and Broadmoor) 15,300 Bear Gulch (including Menlo Park, Atherton, Woodside and Portola Valley) 17,100 Los Altos (including Los Altos and portions of Cupertino, Los Altos Hills, Mountain View and Sunnyvale) 17,800 Livermore 14,900 100,400\nSACRAMENTO VALLEY Chico (including Hamilton City) 20,700 Oroville 3,500 Marysville 3,800 Dixon 2,700 Willows 2,200 32,900\nSALINAS VALLEY Salinas 23,000 King City 1,900 24,900\nSAN JOAQUIN VALLEY Bakersfield 54,400 Stockton 40,800 Visalia 26,200 Selma 4,600 126,000\nLOS ANGELES AREA East Los Angeles (including portions of City of Commerce and Montebello) 26,400 Hermosa Beach and Redondo Beach (including a portion of Torrance) 24,800 Palos Verdes (including Palos Verdes Estates, Rancho Palos Verdes, Rolling Hills Estates and Rolling Hills) 23,400 Westlake (a portion of Thousand Oaks) 6,700 81,300\nTOTAL 365,500\nWater Supply\nThe Company's water supply is obtained from wells, surface runoff or diversion and by purchase from public agencies and other suppliers. The effects of the recent California drought (which ended after the 1992-93 winter) and 1994 winter rains are discussed below. Except for periods of drought, the Company in the past has had adequate water supplies to meet the existing requirements of its service areas. During drought periods, some districts experienced water rationing.\nThe Company delivered approximately 100 billion gallons of water during the 1994 fiscal year of which approximately 51% was obtained from wells and 49% was purchased from the following suppliers:\n% of Supply District Purchased Source of Purchased Supply\nSAN FRANCISCO BAY AREA\nMid-Peninsula 100% San Francisco Water Department\nSouth San Francisco 83% San Francisco Water Department\nBear Gulch 95% San Francisco Water Department\nLos Altos 82% Santa Clara Valley Water District\nLivermore 65% Alameda County Flood Control and Water Conservation District\nSACRAMENTO VALLEY Oroville 70% Pacific Gas and Electric Company 6% County of Butte\nSAN JOAQUIN VALLEY\nBakersfield 20% Kern County Water Agency Stockton 75% Stockton-East Water District\nLOS ANGELES AREA\nEast Los Angeles 89% Central Basin Municipal Water District Hermosa Beach and Redondo Beach 95% West Basin Municipal Water District\n% of Supply District Purchased Source of Purchased Supply\nLOS ANGELES AREA (Continued)\nPalos Verdes 100% West Basin Municipal Water District\nWestlake 100% Russell Valley Municipal Water District\nThe balance of the required supply for the above districts is obtained from wells, except for Bear Gulch where the balance is obtained from surface runoff from a local watershed.\nThe Chico, Marysville, Dixon and Willows districts in the Sacramento Valley, the Salinas and King City districts in the Salinas Valley, and the Selma and Visalia districts in the San Joaquin Valley obtain their entire supply from wells. In these districts, although groundwater levels declined during the six consecutive years of below normal precipitation (1986-1992), they remain, in the opinion of the Company, adequate for anticipated future needs. However, in the Salinas Valley, declining water tables have resulted in salt water intrusion in some areas adjacent to Monterey Bay. Operational changes have been made in the Salinas district in an attempt to retard the movement of salt water toward the Company's production wells. Pumping of vulnerable wells has been curtailed and supply supplemented by boosting water from other zones. The Company continues to cooperate with the Monterey County Water Resources Agency and other groups on long-term mitigation plans.\nPurchases for the Los Altos, Livermore, Oroville, Stockton and Bakersfield districts are pursuant to long-term contracts expiring on various dates after 2011. A new 30 year contract for the Livermore District with Zone 7 of the Alameda County Flood Control and Water Conservation District was signed on November 16, 1994. The supplies for the East Los Angeles, Hermosa-Redondo, Palos Verdes and Westlake districts are provided to the Company by public agencies pursuant to an obligation of continued nonpreferential service to persons within their boundaries.\nPurchases for the South San Francisco, Mid-Peninsula and Bear Gulch districts are pursuant to long-term contracts with the San Francisco Water Department expiring June 30, 2009.\nThe 1993-1994 water season was California's fourth driest year on record, leading the Department of Water resources to declare a 'drought watch' in May of 1994. But these fears began to be allayed as early as November 1994 when a series of storms began pouring rain and snow throughout the state's watersheds.\nBy late January 1995, cumulative average Sierra snowpack was at 175 percent of normal, storage in the state's 155 reservoirs was at more than 90 percent of average and the drought watch was cancelled. These promising figures substantially improve the likelihood that 100 percent of state water project deliveries will be made in 1995.\nSubstantial water reserves remain in the groundwater aquifers that supply Company districts served by well water. While recovery from drought-related depletion of these reserves was interrupted by drier than normal conditions in 1994, the mean groundwater levels in these districts were stable. In addition, districts located in regions with existing groundwater management mechanisms showed noticeable improvements in storage. Regional groundwater management planning is receiving greater attention throughout the state as its importance as a tool for addressing long-term water supply concerns is realized. The passage of legislation that enables management of this resource by existing local government agencies further stimulated this attention.\nDespite the promise of an abundant water year, California is expected to have long-term water supply problems. To compensate for this trend, the Company continues to promote water conservation programs initiated during the drought on a district-by-district basis outlined in our water management plans and as permitted by the Commission.\nSignificant developments affecting future water supply occurred in several of our districts. On August 16, 1994 the State Water Resources Control Board (SWRCB) informed the Monterey County Board of Supervisors that it was initiating an investigation into the groundwater supply issues in the Salinas Valley. This is a prelude to a possible adjudication of the groundwater basin by the SWRCB should Monterey County fail to develop short and long-term solutions to the nitrate contamination and saltwater intrusion threatening the aquifers. In a related matter the SWRCB refused to consider a separate investigation of groundwater use in our King City district. This action will save the Company a considerable amount of litigation expense.\nIn Solano County, the location of our Dixon district, the Solano County Water Agency agreed to reimburse the Company for costs it incurred as a party to the Putah Creek adjudication. This action will determine the rights to water from Putah Creek which recharges the groundwater from which our Dixon district derives its water supply.\nUtility Plant Construction Program and Acquisitions.\nThe Company is continually extending and enlarging its facilities as required to meet increasing demands and to maintain its service. Capital expenditures for these purposes and for the replacement of existing facilities amounted to approximately $28 million in 1994. Financing was obtained from funds from operations, short-term bank borrowings, sale of common stock, advances for construction, and contributions in aid of construction as set forth in the section entitled \"Statement of Cash Flows\" on page 26 of the Company's 1994 Annual Report and is incorporated herein by reference. Advances for construction of main extensions are received by the Company from subdivision developers under the rules of the PUC. These advances are refundable without interest over a period of years. Contributions in aid of construction consist of nonrefundable cash deposits or facilities received from developers.\nThe Company now estimates that additions and improvements to its facilities during 1995 will amount to approximately $20,700,000 (exclusive of additions and improvements financed through advances for construction and contributions in aid of construction), which is expected to be financed with internally generated funds and short-term borrowings to be refinanced by funds from the anticipated issuance of approximately $20,000,000 of long-term debt in 1995.\nQuality of Supplies.\nThe Company maintains procedures to produce potable water in accordance with accepted water utility practice. All water entering the distribution systems from surface sources is chlorinated and in most cases filtered. Samples of water from each district are analyzed regularly by Company bacteriologists.\nCompetition and Condemnation.\nThe Company is a public utility regulated by the PUC. The Company provides service within filed service areas approved by the PUC. Under the laws of the State of California, no privately owned public utility may compete with the Company in any territory already served by the Company without first obtaining a certificate of public convenience and necessity from the PUC. Under PUC practice, such certificate will be issued only on a showing that the Company's service in such territory is inadequate.\nCalifornia law also provides that whenever a public agency constructs facilities to extend a utility service into the service area of a privately owned public utility, such an act constitutes the taking of property and for such taking the public utility is to be paid just compensation.\nUnder the constitution and statutes of the State of California, municipalities, water districts and other public agencies have been authorized to engage in the ownership and operation of water systems. Such agencies are empowered to condemn properties already operated by privately owned public utilities upon payment of just compensation and are further authorized to issue bonds (including revenue bonds) for the purpose of acquiring or constructing water systems. To the Company's knowledge, no municipality, water district or other public agency has pending any action to condemn any of the Company's systems.\nEnvironmental Matters.\nThe Company is subject to environmental regulation by various governmental authorities. Compliance 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, as of the date of filing of this Form 10-K, any material effect on the Company's capital expenditures, earnings or competitive position. No such material effect is anticipated for the fiscal years ending December 31, 1995 and 1996.\nHuman Resources.\nAs of December 31, 1994, the Company had 624 employees, of whom 158 were executive and administrative officials and supervisory employees, and 466 were members of unions. The Company presently has two-year collective bargaining agreements expiring December 31, 1995, with the Utility Workers of America, AFL-CIO, representing the majority of employees, and the International Federation of Professional and Technical Engineers, AFL-CIO, representing certain engineering department employees. The Company plans to enter negotiations to renew the collective bargaining agreements prior to their expiration. The agreements have been successfully renewed in the past without a labor interruption.\nd. Financial Information about Foreign and Domestic Operations and Export Sales.\nThe Company makes no export sales.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2.Properties.\nThe Company's physical properties consist of offices and water systems for the production, storage, purification, and distribution of water. These properties are located in or near the service areas listed above in the section entitled \"Water Supply.\" The Company maintains all of its properties in good operating condition.\nThe Company holds all its principal properties in fee, subject to the lien of the indenture securing the Company's first mortgage bonds, of which there were outstanding at December 31, 1994, $128,944,000 in principal amount.\nItem 3.","section_3":"Item 3.Legal Proceedings.\nThe Company is involved in only routine litigation which is incidental to the business.\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 in the fourth quarter of fiscal year 1994.\nExecutive Officers of the Registrant.\nName Positions and Offices with the Company Age\nC. H. Stump Chairman of the Board since 1991. 69 Director since 1976 and Member of Executive Committee since 1977. Mr. Stump was Secretary of the Company from 1959 to 1966, Secretary and Treasurer from 1966 to 1975, Executive Vice President from 1975 to 1981, President and Chief Operating Officer from 1981 to 1986, and President and Chief Executive Officer from 1986 to May 1992.\nDonald L. Houck President and Chief Executive Officer 62 since May 1992. Director since 1988. Mr. Houck was Executive Vice President and Chief Operating Officer from 1986 to 1992 and a Vice President since 1977. Prior to that, Mr. Houck was a supervising engineer with the California Public Utilities Commission with eighteen years experience in the rate-making process.\nGerald F. Feeney Vice President, Chief Financial Officer and 50 Treasurer since November 1994. Controller, Assistant Secretary and Assistant Treasurer from 1976 to 1994. From 1970 to 1976, Mr. Feeney was an audit manager with Peat Marwick Mitchell & Co.\nFrancis S. Ferraro Vice President since August 1989. Mr. 45 Ferraro previously had 15 years experience in regulatory matters with the California Public Utilities Commission, from June 1985 through August 1989 in the capacity of an administrative law judge.\nJames L. Good Vice President since December 1994. 31 Mr. Good was Director of Congressional Relations for the National Association of Water Companies from 1991 to 1994.\nRaymond H. Taylor Vice President since April 1990. Mr. Taylor 49 had been director of water quality since 1986 and previously had been employed by the Environmental Protection Agency before joining the Company in 1982.\nHelen Mary Kasley Secretary and Legal Counsel since 43 1993. From 1990 to 1992, Mrs. Kasley was Secretary. From 1986 to 1990, she was an associate attorney with McCutchen, Doyle, Brown & Enersen.\nCalvin L. Breed Controller, Assistant Secretary and Assistant 39 Treasurer since November 1994. Previously Mr. Breed served as Treasurer of TCI International, Inc.\nJohn S. Simpson Assistant Secretary since 1992. Mr. 50 Simpson has been Manager of New Business Development for the past nine years and has held various management positions with the Company since 1967.\nNo officer or director has any family relationship to any other executive officer or director. No executive officer is appointed for any set term. There are no agreements or understandings between any executive officer and any other person pursuant to which he was selected as an executive officer, other than those with directors or officers of the Company acting solely in their capacities as such.\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 contained in the Section captioned \"Quarterly Financial and Common Stock Market Data\" on pages 34 and 35 of the Company's 1994 Annual Report and is incorporated herein by reference. The number of holders listed in such section includes the Company's record holders and also individual participants in security position listings.\nItem 6.","section_6":"Item 6.Selected Financial Data.\nThe information required by this item is contained in the section captioned \"California Water Service Company Ten Year Financial Review\" on pages 16 and 17 of the Company's 1994 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 this item is contained in the sections captioned \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" on pages 18 through 21 of the Company's 1994 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 this item is contained in the sections captioned \"Balance Sheet,\" \"Statement of Income,\" \"Statement of Common Shareholders' Equity,\" \"Statement of Cash Flows,\" \"Notes to Financial Statements\" and \"Independent Auditors' Report\" on pages 22 through 35 of the Company's 1994 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.\nInformation regarding executive officers of the Company is included in a separate item captioned \"Executive Officers of the Registrant\" contained in Part I of this report. The information required by this item as to directors of the Company is contained in the section captioned \"Election of Directors\" on pages 2 through 6 of the Proxy Statement and is incorporated herein by reference. (The Proxy Statement was filed under EDGAR on March 10, 1995).\nItem 11.","section_11":"Item 11.Executive Compensation.\nThe information required by this item as to directors and executive officers of the Company is contained in the section captioned \"Compensation of Executive Officers\" on pages 8 through 11 of the Proxy Statement and is incorporated herein by reference. (The Proxy Statement was filed under EDGAR on March 10, 1995).\nItem 12.","section_12":"Item 12.Security Ownership of Certain Beneficial Owners and Management.\nThe information required by this item is contained in the sections captioned \"Election of Directors,\" \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" pages 2 through 6 and 13, respectively, of the Proxy Statement and is incorporated herein by reference. (The Proxy Statement was filed under EDGAR on March 10, 1995).\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) Financial Statements:\nBalance Sheet as of December 31, 1994 and 1993.\nStatement of Income for the years ended December 31, 1994, 1993, and 1992.\nStatement of Common Shareholders' Equity for the years ended December 31, 1994, 1993, and 1992.\nStatement of Cash Flows for the years ended December 31, 1994, 1993, and 1992.\nNotes to Financial Statements, December 31, 1994, 1993, and 1992.\nThe above financial statements are contained in sections bearing the same captions on pages 22 through 35 of the Company's 1994 Annual Report and are incorporated herein by reference.\n(2) Financial Statement Schedule:\nSchedule Number\nIndependent Auditors' Report January 20, 1995.\nII Valuation and Qualifying Accounts and Reserves--years ending December 31, 1994, 1993, and 1992.\nAll other schedules are omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\n(3) Exhibits required to be filed by Item 601 of Regulation S-K.\nSee Exhibit Index on page 25 of this document which is incorporated herein by reference.\nThe exhibits filed herewith are attached hereto (except as noted) and those indicated on the Exhibit Index which are not filed herewith were previously filed with the Securities and Exchange Commission as indicated. Except where stated otherwise, such exhibits are hereby incorporated by reference.\nExhibits filed herewith and attached hereto under separate cover 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) Report on Form 8-K.\nNone required to be filed during the last quarter of 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.\nCALIFORNIA WATER SERVICE COMPANY\nDate: March 15, 1995 By \/s\/ Donald L. Houck DONALD L. HOUCK, 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:\nDate: March 15, 1995 \/s\/ William E. Ayer WILLIAM E. AYER, Member, Board of Directors\nDate: March 15, 1995 \/s\/ Robert W. Foy ROBERT W. FOY, Member, Board of Directors\nDate: March 15, 1995 \/s\/ Edward D. Harris, Jr. EDWARD D. HARRIS, JR. M.D., Member, Board of Directors\nDate: March 15, 1995 \/s\/ Donald L. Houck DONALD L. HOUCK President, Chief Executive Officer, Member, Board of Directors\nDate: March 15, 1995 \/s\/ Robert K. Jaedicke ROBERT K. JAEDICKE, Member, Board of Directors\nDate: March 15, 1995 \/s\/ Linda R. Meier LINDA R. MEIER, Member, Board of Directors\nDate: March 15, 1995 \/s\/ J. W. Weinhardt J. W. WEINHARDT, Member, Board of Directors\nDate: March 15, 1995 \/s\/ C. H. Stump C. H. STUMP, Chairman of the Board, Member, Board of Directors\nDate: March 15, 1995 \/s\/ Edwin E. van Bronkhorst EDWIN E. VAN BRONKHORST, Member, Board of Directors\nDate: March 15, 1995 \/s\/ Gerald F. Feeney GERALD F. FEENEY, Vice President, Chief Financial Officer and Treasurer\nDate: March 15, 1995 \/s\/ Calvin L. Breed CALVIN L. BREED, Controller, Assistant Secretary and Assistant Treasurer\nIndependent Auditors' Report\nShareholders and Board of Directors California Water Service Company:\nUnder date of January 20, 1995, we reported on the balance sheet of California Water Service Company as of December 31, 1994 and 1993, and the related statements of income, common shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1994, as contained in the 1994 annual report to shareholders. These financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1994. In connection with our audits of the aforementioned financial statements, we also audited the related financial statement schedule as listed in accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such 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.\nSan Jose, California \/s\/ KPMG Peat Marwick,LLP January 20, 1995\nEXHIBIT INDEX Sequential Page Numbers Exhibit Number in this Report\n3. Articles of Incorporation and By-Laws:\n3.1 Restated Articles of Incorporation dated 25 March 20, 1968 Certificate of Ownership Merging Palos Verdes Water Company into California Water Service Company dated December 22, 1972; Certificate of Amendment of Restated Articles of Incorporation dated April 7, 1975; Certificate of Amendment of Restated Articles of Incorporation dated April 16, 1984; Certificate of Amendment of Restated Articles of Incorporation dated July 31, 1987; Certificate of Amendment of Restated Articles of Incorporation dated October 19, 1987 (Exhibit 3.1 to Form 10-K for fiscal year 1987, File No. 0-464)\n3.2 Certificates of Determination of Preferences 25 for Series C Preferred Stock (Exhibit 3.2 to Form 10-K for fiscal year 1987, File No. 0-464)\n3.3 Certificate of Amendment of the Company's 25 Restated Articles of Incorporation dated April 27, 1988. (Exhibit 3.3 to Form 10-K for fiscal year 1989, File No. 0-464)\n3.4 By-Laws dated September 21, 1977, as 25 amended 24 November 19, 1980, April 21, 1982, June 15, 1983, September 17, 1984, and November 16, 1987 (Exhibit 3.3 to Form 10-K for fiscal year 1987, File No. 0-464).\n3.5 Amendment to By-laws dated May 16, 1988. 25 (Exhibit 3.5 to Form 10-K for fiscal year 1991, File No. 0-464)\n4. Instruments Defining the Rights of Security 26 Holders, including Indentures:\nMortgage of Chattels and Trust Indenture 26 dated April 1, 1928; Eighth Supplemental Indenture dated November 1, 1945, covering First Mortgage 3.25% Bonds, Series C; Fifteenth Supplemental Indenture dated November 1, 1965, covering First Mortgage 4.85% Bonds, Series J; Sixteenth Supplemental Indenture dated November 1, 1966, covering First Mortgage 6.25% Bonds, Series K; Seventeenth Supplemental Indenture dated November 1, 1967, covering First Mortgage 6.75% Bonds, Series L; Twenty-First Supplemental Indenture dated October 1, 1972, cover First Mortgage 7.875% Bonds, Series P; Twenty-Fourth Supplemental Indenture dated November 1, 1973, covering First Mortgage 8.50% Bonds, Series S (Exhibits 2(b), 2(c), 2(d), Registration Statement No. 2-53678, of which certain exhibits are incorporated by reference to Registration Statement Nos. 2-2187, 2-5923, 2-9681, 2-10517 and 2-11093.)\nTwenty-Sixth Supplemental Indenture dated May 1, 26 1976 (Exhibit 4 to Form 10-K for fiscal year 1986, File No. 0-464).\nTwenty-Seventh Supplemental indenture dated 26 November 1, 1977; Twenty-Eighth Supplemental Indenture dated May 1, 1978; Twenty-Ninth Supplemental Indenture dated November 1, 1979 (Exhibit 4 to Form 10-K for fiscal year 1989, File No. 0-464).\nThirty-Fifth Supplemental Indenture dated as of 26 November 1, 1992, covering First Mortgage 8.63% Bonds, Series DD. (Exhibit 4 to Form 10-Q dated September 30, 1992, File No. 0-464)\nThirty-Sixth Supplemental Indenture dated as of 26 May 1, 1993, covering First Mortgage 7.90% Bonds Series EE (Exhibit 4 to Form 10-Q dated June 30, 1993, File No. 0-464)\nThirty-Seventh Supplemental Indenture dated as 26 of September 1, 1993, covering First Mortgage 6.95% Bonds, Series FF (Exhibit 4 to Form 10-Q dated September 30, 1993, File No. 0-464)\nThirty-Eighth Supplemental Indenture dated as 26 of October 15, 1993, covering First Mortgage 6.98% Bonds, Series GG (Exhibit 4 to Form 10-K for fiscal year 1994, File No. 0-464)\nSequential Page Numbers Exhibit Number in this Report\n10. Material Contracts.\n10.1 Water Supply Contract between the Company 27 and the County of Butte relating to the Company's Oroville District; Water Supply Contract between the Company and the Kern County Water Agency relating to the Company's Bakersfield District; Water Supply Contract between the Company and Stockton East Water District relating to the Company's Stockton District. (Exhibits 5(g), 5(h), 5(i), 5(j), Registration Statement No. 2-53678, which incorporates said exhibits by reference to Form 1O-K for fiscal year 1974, File No. 0-464).\n10.2 Settlement Agreement and Master Water Sales 27 Contract between the City and County of San Francisco and Certain Suburban Purchasers dated August 8, 1984; Supplement to Settlement Agreement and Master Water Sales Contract, dated August 8, 1984; Water Supply Contract between the Company and the City and County of San Francisco relating to the Company's Bear Gulch District dated August 8, 1984; Water Supply Contract between the Company and the City and County of San Francisco relating to the Company's San Carlos District dated August 8, 1984; Water Supply Contract between the Company and the City and County of San Francisco relating to the Company's San Mateo District dated August 8, 1984; Water Supply Contract between the Company and the City and County of San Francisco relating to the Company's South San Francisco District dated August 8, 1984. (Exhibit 10.2 to Form l0-K for fiscal year 1984, File No. 0-464).\n10.3 Water Supply Contract dated January 27, 27 1981, between the Company and the Santa Clara Valley Water District relating to the Company's Los Altos District (Exhibit 10.3 to Form 10-K for fiscal year 1992, File No. 0-464)\n10.4 Amendments No. 3, 6 and 7 and Amendment 27 dated June 17, 1980, to Water Supply Contract between the Company and the County of Butte relating to the Company's Oroville District. (Exhibit 10.5 to Form 10-K for fiscal year 1992, File No. 0-464)\nSequential Page Numbers Exhibit Number in this Report\n10.5 Amendment dated May 31, 1977, to Water 28 Supply Contract between the Company and Stockton-East Water District relating to the Company's Stockton District. (Exhibit 10.6 to Form 10-K for fiscal year 1992, File No. 0-464)\n10.6 Second Amended Contract dated September 25, 28 1987 among the Stockton East Water District, the California Water Service Company, the City of Stockton, the Lincoln Village Maintenance District, and the Colonial Heights Maintenance District Providing for the Sale of Treated Water. (Exhibit 10.7 to Form 10-K for fiscal year 1987, File No. 0-464).\n10.7 Dividend Reinvestment Plan. (Exhibit 10.8 to 28 Form 10-Q dated March 31, 1994, File No. 0-464)\n10.8 Water Supply Contract dated April 19, 1927, 28 and Supplemental Agreement dated June 5, 1953, between the Company and Pacific Gas and Electric Company relating to the Company's Oroville District. (Exhibit 10.9 to Form 10-K for fiscal year 1992, File No. 0-464)\n10.9 California Water Service Company Pension Plan 28 (Exhibit 10.10 to Form 10-K for fiscal year 1992, File No. 0-464)\n10.10 California Water Service Company Supplemental 28 Executive Retirement Plan. (Exhibit 10.11 to Form 10-K for fiscal year 1992, File No.0-464)\n10.11 California Water Service Company Salaried 28 Employees' Savings Plan. (Exhibit 10.12 to Form 10-K for fiscal year 1992, File No. 0-464)\n10.12 California Water Service Company 28 Directors Deferred Compensation Plan (Exhibit 10.13 to Form 10-K for fiscal year 1992, File No. 0-464)\n10.13 Board resolution setting forth 28 the terms of the retirement plan, as amended, for Directors of California Water Service Company (Exhibit 10.14 to Form 10-K for fiscal year 1992, File No. 0-464)\nSequential Page Numbers Exhibit Number in this Report\n10.14 Registration statement on Form S-3, 29 dated September 8, 1994 regarding the sale of 550,000 shares of Registrant's common stock (filed with the Commission on September 8, 1994, Registration No. 33-55233, File No. 0-464)\n10.15 Water Supply Contract dated November 16, 1994, 30 between the Company and Alameda County Flood Control and Water Conservation District relating to the Company's Livermore District\n13. Annual Report to Security Holders, Form 10-Q 46 or Quarterly Report to Security Holders:\n1994 Annual Report. The sections of the 1994 Annual Report which are incorporated by reference in this 10-K filing. This includes those sections referred to in Part II, Item 5, Market for Registrant's Common Equity and Related Shareholder Matters; Part II, Item 6, Selected Financial Data; Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations; and Part II, Item 8, Financial Statement and Supplementary Data.\n27. Financial Data Schedule as of December 31, 1994 70","section_15":""}
{"filename":"77360_1994.txt","cik":"77360","year":"1994","section_1":"Item 1. Business\n(a) General Development of the Business.\nThe Registrant was incorporated in 1966 under the laws of Minnesota. In the past year, the Registrant has not changed its form of organization or mode of conducting business. The Registrant grows through internal development and acquisitions. As in the past, periodic dispositions of assets or business units are possible when they no longer fit with the long-term strategies of the Registrant.\nEffective January 1, 1994, the Registrant acquired the net assets and the subsidiaries of Schroff GmbH (Schroff) from Fried. Krupp AG Hoesch-Krupp for a cash purchase price of approximately $140 million net of cash acquired. Schroff manufactures and sells enclosures, cases, subracks and accessories for commercial electronic and instrumentation applications, with world-wide 1993 sales of approximately $160 million. While Schroff faces significant competition in each of its markets, it is the largest manufacturer of electronic enclosures and 19 inch subracks in the European market, in which the majority of Schroff sales are made. The Registrant views Schroff as complementary to the electrical enclosure business of Hoffman Engineering and intends to develop these businesses using their respective strengths in technology, manufacturing, marketing and market position.\nIn September 1994, Pentair announced that it was exploring strategic alternatives for its paper businesses, including their possible sale. That course of action was chosen to achieve several objectives. First, to permit Pentair to focus its commitment and resources in the industrial products sector, continuing the strong growth and leading market positions these businesses have achieved. Second, to permit the paper businesses to seek their own opportunities and long-term goals. Third, to make Pentair a more understandable company to the investment community and its shareholders.\nThat process is ongoing. In February 1995, Pentair announced the sale of its uncoated paper business, Cross Pointe Paper, to Noranda Forest for approximately $200 million. The sale is expected to close at the beginning of April 1995. Efforts continue toward completing the strategic alternatives for Niagara of Wisconsin and for the joint venture interest in Lake Superior Paper Industries, the company's other paper businesses.\nPentair expects that its strategic refocusing will be completed in the course of 1995. Whatever the eventual outcome, Pentair is poised to aggressively expand into its chosen industrial markets.\n(b) Financial Information about Industry Segments.\nThe Registrant's business is conducted in three industry segments. The Specialty Products segment manufactures woodworking machinery; portable power tools; and pumps and pumping systems. The General Industrial Equipment segment manufactures electrical and electronic enclosures and wireways; industrial lubricating systems and material dispensing equipment; automotive service equipment; and sporting ammunition. The Paper Products segment manufactures printing papers in a variety of types and grades. Business segment financial information is found on page 29 and pages 52-53 (Note 18) of the 1994 Annual Report to Shareholders.\nNarrative Description of Business.\nDescription of the Specialty Products Segment:\nProducts and marketing.\nThe following table sets forth, for each of the last three years, the Specialty Products segment product class net sales in excess of 10 percent of the Registrant's consolidated net sales .\nWoodworking Machinery. The Registrant, through its subsidiary Delta International Machinery Corp. (Delta), manufactures, markets, and services a line of general-purpose woodworking machinery, such as saws, planers, joiners, grinders, drill presses, shapers, lathes, and other quality machines. Delta sells its products in the United States, Canada, and other foreign countries under its \"Delta\" brand name through a network of independent and mail order distributors, hardware stores and home centers.\nPortable Electric Tools. The Registrant, through its subsidiary Porter-Cable Corporation (Porter-Cable), manufactures and markets a variety of portable electric tools, such as saws, sanders, drills and routers, used in woodworking, industrial maintenance, and construction trades. Porter-Cable markets its products under the brand name \"Porter-Cable\" through a network of independent, specialty tool, and mail order distributors, hardware stores and home centers.\nPumps and Pumping Systems. The Registrant, through its F.E. Myers Co. Division of McNeil (Ohio) Corporation (Myers), manufactures and markets a wide variety of pumps for residential, environmental engineering, and industrial use. Products are distributed through a network of distributors, wholesalers, dealers, and installers. In addition, Myers distributes products to the do-it-yourself market for retail sale through home centers and hardware stores under the names \"Water Ace\" and \"Shur Dri\".\nCompetitive conditions.\nDelta participates in the middle range of the overall market for general purpose woodworking machinery. The addressed market is focused on high quality, feature oriented products and value added services for the home shop, contractor, and small shop markets. Delta markets the industry's broadest line of products for its addressed market. Delta's numerous competitors do have individual products which compete with certain of Delta's products. Competition in this market focuses on quality, features, service and price.\nPorter-Cable competes in the professional portable electric tool market which is highly competitive. Porter-Cable faces several major competitors across its addressed market. Product innovation, features, performance, quality, service, delivery and price are all competitive factors.\nMyers addresses the water pump and system market. Myers faces many competitors across its product lines. Price, delivery, and quality are competitive factors.\nDescription of the General Industrial Equipment Segment:\nProducts and marketing.\nThe following table sets forth, for each of the last three years, the General Industrial Equipment segment product class net sales in excess of 10 percent of consolidated net sales.\nElectrical Enclosures. Through the Hoffman Engineering Company division of Federal-Hoffman, Inc. (Hoffman Engineering), the Registrant manufactures enclosures and wireways for electrical and industrial instrumentation applications and markets these products primarily through independent manufacturer's representatives and electrical and electronic equipment distributors throughout North America and the United Kingdom.\nElectronic Enclosures. Through Schroff GmbH and its international subsidiaries (Schroff), the Registrant manufactures enclosures and wireways for electronic instrumentation applications. Schroff is a large European manufacturer of cabinets, cases, subracks, microcomputer packaging systems and accessories. Schroff serves the worldwide industrial electronics industry including key segments such as computers, test & measurement, private LANs\/data communication, industrial control and factory automation, medical and telecommunications.\nSporting Ammunition. Through the Federal Cartridge Company division of Federal-Hoffman, Inc. (Federal Cartridge), the Registrant manufactures and markets sporting and law enforcement ammunition, and components. These products are distributed throughout the United States through a network of distributors; directly to large retail chains; and directly to law enforcement agencies (governmental).\nIndustrial Lubricating Systems and Material Dispensing Equipment. The Registrant, through its Lincoln Industrial division of McNeil (Ohio) Corporation (Lincoln Industrial), manufactures components and designs systems for manual and automatic delivery of measured quantities of lubricants for industrial applications. Lincoln Industrial also manufactures components and designs, fabricates, and installs high-volume liquid and semi-solid dispensing systems. Both segments serve original equipment and retrofit markets. Lubricating and materials dispensing systems are marketed in the United States by approximately 100 specially qualified systems distributors with design, installation, and service capability. Basic lubricating equipment and accessories are marketed through industrial supply and specialty distributors. A special direct sales group markets a wide variety of Lincoln Industrial products to original equipment manufacturers in a variety of industries. Lincoln Industrial also manufactures lubricating components and systems at its facility in Walldorf, Germany for distribution to European, Middle East, Far East and African markets, and to a lesser extent to the United States. The remainder of the world market, including the Pacific Rim, is served from Lincoln Industrial's St. Louis, Missouri manufacturing facility.\nAutomotive Service Equipment. The Registrant, through its Lincoln Automotive division of McNeil (Ohio) Corporation (Lincoln Automotive), manufactures and markets lubrication, repair, and service equipment for a broad range of vehicles. Products are sold through a key group of approximately 600 aftermarket wholesalers. Certain products are sold to large auto parts chain stores. Certain lubricating equipment, tools, and jacks and lifting equipment are sold under private label programs. Garage, service station, car dealership service department, and fast oil change lubricating systems are marketed through petroleum equipment and service distributors with design and installation capability.\nCompetitive conditions.\nHoffman Engineering is the largest North American manufacturer of electrical enclosures and wireways, having a market share estimated to be about 25%. It is currently the only manufacturer with national distribution and its competitors are generally smaller, regional manufacturers. Hoffman Engineering also participates in the North American electronic enclosures market, facing competition from a large number of firms, with three or four established firms leading the market. In both markets, the most significant competitive factors are price, product innovation, service, quality, breadth of product line, and delivery.\nSchroff is a large manufacturer in Europe's electronic enclosure market and a technical leader. Schroff, like Hoffman, has a comprehensive product range. Schroff faces competition from a large number of firms, some very large and some smaller. Significant competitive factors are product innovation and quality.\nFederal Cartridge and its two primary competitors, Winchester and Remington, have a combined market share of approximately 90% in the U.S. sporting ammunition market, with the balance coming from smaller domestic competitors and foreign ammunition manufacturers. Quality, delivery, price and terms are significant competitive factors.\nLincoln Industrial and Lincoln Automotive face three to five major competitors and several smaller competitors across their product lines. Competition involving industrial lubricating systems and material dispensing equipment tends to center around quality, systems capability, and application knowledge. Price becomes a more significant competitive factor for vehicle servicing equipment.\nDescription of the Paper Products and Joint Venture Segments:\nProducts and marketing.\nThe following table sets forth, for each of the last three years, the Registrant's net sales ($ millions), percent of consolidated net sales and tons shipped (thousands) for each paper product class.\nfn1 Lake Superior Paper Industries is a joint venture in Duluth, Minnesota; only 50% of the joint venture's sales and tonnage are included. Since this joint venture is accounted for on the equity method, its sales are not included in consolidated sales.\nCoated Paper. The Registrant, through its subsidiary Niagara of Wisconsin Paper Corporation (Niagara), manufactures coated groundwood publication-grade paper (nos. 4 and 5) used for applications requiring high-resolution printing and reproduction of color pictures, such as magazines, periodicals, catalogs, and general commercial printing.\nUncoated Papers. Cross Pointe Paper Corporation (Cross Pointe), a subsidiary of the Registrant, through its subsidiaries, Miami Paper Corporation, Dayton Paper Corp. and Flambeau Paper Corp., manufactures a variety of uncoated papers, primarily for commercial printing, text and cover, and book publishing markets, and operates a centralized converting and distribution operation (IDC) in West Chicago, Illinois.\nSupercalendered (SCA) Printing and Publication Grade Papers. The Registrant has a 50% interest in a joint venture, Lake Superior Paper Industries (Lake Superior), which produces supercalendered paper known as SCA. End use markets include magazine publication, catalogues and advertising inserts. SCA is sold directly to printers and end users through Lake Superior's own sales and marketing personnel. Adjacent to Lake Superior, is a recycled pulp mill facility, of which 24% is owned by LSPI Fiber Co. Registrant owns 50% of LSPI Fiber Co. and accounts for it on the equity method. LSPI Fiber Co. sells recycled pulp to LSPI and other paper mills.\nCompetitive conditions.\nThe Paper Products segment output of Niagara and Cross Pointe is sold in highly competitive markets with between 10 to 15 competitors in each. Many competitors have greater production capacity and, in many cases, captive sources of raw materials. Lake Superior is the largest North American producer of SCA, but is subject to substantial competition from European manufacturers, and makers of other grades of printing and publication paper. Price, quality, innovation and service are significant competitive factors in the markets served by the Paper Products segment.\nRaw materials.\nThe raw materials used in the manufacture of paper are bleached kraft pulps, pulp substitutes, pulpwood, groundwood pulp, waste paper, certain chemicals, clays, starches, and additives. The Registrant does not own its own timberlands or manufacture its own kraft pulp.\nPurchases of kraft pulp and waste paper are significant components of the Registrant's fiber needs. The raw materials are supplied by several manufacturers, some under long-term contracts. The balance of fiber needs, comprised primarily of groundwood pulp, sulphite pulp and secondary fiber (pulp recovered by recycling waste paper), is produced at the various mills. The Registrant has recently installed or expanded its recycled fiber capacity at its Cross Pointe mills and has invested in a joint venture recycled pulp facility in Duluth, Minnesota.\nThe Registrant also purchases chemicals, clays, logs for pulp, waste paper, and other paper-making components from various sources. Adequate supplies of these materials are expected to be available to meet the Registrant's needs.\nBacklog.\nThe following table shows backlog (in days) and approximate sales value (at average selling price) at December 31:\nA substantial portion of paper sales are produced to meet specific customer orders. Although the level of backlogs provides some indication of the strength of the paper markets, other factors such as the trend of retail sales and customer and printer inventory levels must be considered. The current backlog is considered adequate. All backlogs are expected to be filled within the current year.\nInformation Regarding All Segments:\nWorking capital items.\nFederal Cartridge's working capital builds from January through September as inventories are increased to meet third quarter shipping schedules and receivables increase due to fall dating for early order programs used in the sporting ammunition business. Management continues to focus on reducing working capital requirements through management of receivable and inventory levels.\nStatus of new products.\nThe industries in which the segments participate are essentially mature and do not experience the introduction of many products that materially change the nature of the industry. Individual manufacturers generally make improvements or apply new technologies to existing products.\nRaw materials.\nThe raw materials used in the manufacturing process include steel(bar and sheet) various metals including brass and lead, gunpowder and plastic. Selected motors, castings, plastic parts and components are also purchased. The supply of all raw materials and components is currently adequate.\nDelta and Porter-Cable import select tools in their product offerings. Design and engineering of these products is performed primarily by Delta. The manufacturing process is controlled and monitored for most of these products in factories dedicated to Delta production. Supply of these products is currently adequate and timely.\nPatents, trademarks, licenses, franchises and concessions.\nThe businesses own a number of U.S. and foreign patents and trademarks. They were acquired over many years and relate to many products and improvements. No one patent or trademark is of material importance to the company as a whole.\nSeasonal aspects.\nFor the Registrant as a whole there is no strongly seasonal aspect.\nBacklog.\nThe Specialty Products and General Industrial Equipment segments normally do not experience backlogs for substantial periods of time. The nature of the businesses emphasizes maintaining inventories sufficient to satisfy customer needs on a timely basis, and production and sourcing is geared towards providing adequate inventories in order to minimize customer back orders. Accordingly, backlogs are not material to understanding the sales trends or manufacturing fluctuations of the segment.\nDependence on limited number of customers.\nThe Registrant as a whole is not dependent on a single customer or on a few customers. The loss of a limited number of customers would not have a material adverse impact on the Registrant.\nGovernment contracts.\nThe Registrant has no material portion of sales under government contracts that may be subject to renegotiation of profits or termination of contracts at the election of the government.\nEmployees.\nAs of December 31, 1994, the Registrant and its subsidiaries employed approximately 10,300 persons, of which 2,475 were represented by unions having collective bargaining agreements.\nLabor contracts negotiated in 1994 were: Molders and Allied Workers Local 45 - Ashland, Ohio (extended to May 1, 1997), 49 employees; Clerical Workers Local 47 - Niagara, Wisconsin (extended to May 14, 1997), 25 employees; and Molders and Allied Workers Local 19 - Guelph, Ontario, Canada (extended to July 1, 1997) 7 employees.\nContracts expiring in 1995: International Association of Machinists Local 59 - Ashland, Ohio (expires April 6, 1995); United Paperworkers International Union Local 1166 - Niagara, Wisconsin (was extended from January 31, 1995 and now expires April 30, 1995); International Association of Machinists Local 9 - St. Louis, Missouri (expires April 30, 1995); United Steel Workers of America Local 8630 - Tupelo, Mississippi (expires May 1, 1995); Patternworkers League - Ashland, Ohio (expires September 1, 1995); and Teamsters Local 984 - Memphis, Tennessee (expires December 15, 1995).\nThe Registrant considers its employee relations to be good and feels future contracts can be negotiated for the benefit of the business and the employees.\n(d) Financial Information about Foreign Operations.\nThe Registrant operates primarily in North America and Europe. See discussion of foreign operations incorporated by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Registrant's corporate offices, located at 1500 County Road B2 West, St. Paul, Minnesota 55113-3105, are leased and consist of approximately 22,000 square feet; the lease expires in December 1999. The Registrant also has an option to terminate the lease during the period December 1994 to June 1995. Information about the Registrant's principal manufacturing facilities and other properties is presented below by industry segment. These facilities are adequate and suitable for the purposes they serve. Unless noted all facilities are owned.\nSpecialty Products Segment\nNOTES:\n(1) Certain pulp and paper production equipment is leased. One lease expires in 1996 with options to renew for two terms of three years each. Another lease expires in 1999 with options to renew for three terms of two years each. The third lease expires in 2006 with an option to purchase after seven years and options to renew for up to eight years . Under each lease, Niagara has the option to purchase the equipment at the then-current market value at the end of the initial term or at the end of each renewal term. (2) Consists of 10,700 square feet of space under a lease expiring in 1997. (3) Consists of 202,000 square feet under a lease expiring in 1998 and 253,000 square feet under a lease expiring in 2001. (4) The Flambeau mill power plant is leased until 2007 with options to renew for three terms of five years each. (5) The production equipment is leased under 25-year leases through 2012 with options to renew for periods of five to seven years and options to purchase the equipment in 1997, and at the expiration of the lease term and of any renewal term.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Registrant or its subsidiaries have been made parties to actions filed, or have been given notice of potential claims, relating to the conduct of its business, including those pertaining to product liability, environmental and employment matters. Major matters which may have an impact on the Registrant are discussed below. The Registrant believes that it is remote that the outcome of such matters will have a material adverse effect on the Registrant's financial position or future results of operations, based on current circumstances known to the Registrant.\nFederal-Hoffman, Inc. Federal Cartridge, a division of Federal-Hoffman, has been named by the EPA as a Potentially Responsible Party (PRP) in connection with a waste disposal site in Greer, South Carolina. The EPA issued an administrative order effective April 29, 1992 to Federal-Hoffman and 96 other entities to compel the cleanup of the Aqua-Tech Environmental, Inc. site. Federal-Hoffman is working with a group of other PRPs to negotiate with the EPA regarding the cleanup of the site. A surface cleanup of the site is complete. Under interim allocations by the PRP group, Federal Cartridge paid $442,000 toward the cost of the surface cleanup. Under current final allocation proposals, Federal-Hoffman anticipates no additional payout for the surface cleanup.\nOn March 16, 1995, the EPA notified Federal Cartridge that it is a PRP related to the subsurface of the site. The PRP group anticipates beginning a study of the soil and groundwater to determine the extent of subsurface contamination. The cost of such study, any necessary remediation and the size of allocation, if any, to Federal-Hoffman is unknown to the Registrant at this time. Federal-Hoffman however, anticipates its allocation in the subsurface action to be positively impacted by the nature of its waste and the fact that virtually all of its waste was accounted for and removed during the surface remediation.\nIn October 1992, Hoffman Engineering, a division of Federal-Hoffman was also named as a PRP in connection with the Aqua-Tech site. Hoffman settled out of the surface removal as a de minimis party, and anticipates doing the same for the subsurface remediation. Based on current information available to it, the Registrant believes that this matter is unlikely to result in material future liability.\nPorter-Cable Corporation. In November 1993, the Tennessee Department of Environment and Conservation (TDEC) issued to Porter-Cable Corporation (Porter-Cable) and Rockwell International Corporation (Rockwell) an administrative order requiring them to investigate, and if necessary, clean up alleged groundwater contamination at a manufacturing facility located in Madison County, Tennessee. The facility was acquired by Porter Cable from Rockwell in 1981. Porter Cable is currently engaged in discussions with Rockwell to reach an agreement regarding indemnification from or cost sharing with Rockwell, based upon Tennessee and Federal law, for costs and expenses related to investigation of the site. The Registrant believes that this matter is unlikely to result in material liability or material changes in operations. No estimate of the projected response cost liability can be made based on information currently known to the Company.\nCross Pointe Paper Corporation. In February 1994, the Miami mill (Miami) of Cross Pointe Paper Corporation was named a PRP in connection with the IWD\/Cardington landfill in Moraine, Ohio. Waste haulers with whom Miami contracted to transport its flyash and paper and wood waste allegedly took it to this landfill for some time prior to its closure in 1980. The EPA has identified 22 other PRPs at this time. The cost of remediation of the site is estimated to be approximately $12 to $15 million. Miami is investigating its alleged involvement at this site.\nNiagara of Wisconsin Paper Corporation. In March 1994, Niagara of Wisconsin Paper Corporation (Niagara) was notified by the Michigan Department of Natural Resources (MDNR) that Niagara's sludge lagoons violate MDNR regulations. Niagara is discussing with the MDNR the closure schedule of the lagoons and the need for expanded groundwater monitoring at the site. Monitoring done to date indicates some groundwater contamination, but at this time the extent is unknown. It is likely that some remediation will be required; but the Registrant does not anticipate that the cost of any such remediation will have a material impact on Registrant's financial condition or operations.\nCalifornia Proposition 65 Notice. Two divisions of Registrant's subsidiaries have received notices pursuant to California Health and Safety Code Section 25249 (Proposition 65). In February 1994, F.E. Myers (Myers), a division of McNeil (Ohio) Corporation, received a notice regarding alleged violations arising from discharge of lead from submersible water pumps into drinking water since February 27, 1988. Two private environmental groups sent the notice to and subsequently filed suit against Myers and three other pump manufacturers and one pump distributor. Under Proposition 65, the penalty for each violation is $2,500 per day. Myers is responding to the claims raised in the lawsuit. In light of a recent settlement proposal by plaintiffs, Registrant believes that it is unlikely that this matter will result in material liability.\nIn October 1994, Federal Cartridge (Federal), a division of Federal-Hoffman, Inc. received a notice regarding alleged violations of Proposition 65 arising from exposure of firearm users to lead from ammunition. A private environmental group sent the notice to Federal and 75 other ammunition and firearms manufacturers and sellers. Federal is currently investigating the claims set forth in this notice.\nProduct Liability Claims. As of March 4, 1995, the Registrant or its subsidiaries are defendants in approximately 177 product liability lawsuits and have been notified of approximately 100 additional claims. The Registrant has had and currently has in place insurance coverage it deems adequate for its needs. A substantial number of these lawsuits and claims are insured by Penwald, a regulated insurance company wholly owned by Registrant. See discussion in Item 7 (MD&A - Insurance Subsidiary) and Item 8 (Note 1 to the Financial Statements). Accounting reserves covering the deductible portion of liability claims not covered by Penwald have been established and are reviewed on a regular basis. The Registrant has not experienced unfavorable trends in either the severity or frequency of product liability claims.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nDuring the fourth quarter, no matter was submitted to a vote of security holders.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.\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 Operation.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nFor information required under Items 5 through 8, see the Registrant's Annual Report to Shareholders for the year ended December 31, 1994, as referenced on page 2 of this report.\nItem 9.","section_9":"Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNo changes in accountants or disagreements between the Registrant and its accountants regarding accounting principles or financial statement disclosures have occurred within the 24 months prior to the date of the Registrant's most recent financial statements.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following are the executive officers of the Registrant. Their term of office extends until the next annual meeting of the Board of Directors, scheduled for April 19, 1995, or until their successors are elected and have qualified.\nWinslow H. Buxton 55 Chairman since January 15, 1993; President and Chief Executive Officer since August 1992; Chief Operating Officer, August 1990 - August 1992; Vice President - Paper Group, January 1989 - August 1990.\nWilson Blackburn 42 Vice President, Paper Operations since September 1994; President, Cross Pointe Paper Corporation (subsidiary of Registrant) since September 1994; President, Lake Superior Paper (joint venture of Registrant), April 1993 - September 1994; President and CEO of PWA Rolland Decor Inc., 1990-1993; Vice President, Operations, Rolland Inc., 1989-1990. (In connection with the sale of Cross Pointe Paper Corporation to Noranda Forest, Mr. Blackburn has resigned effective April 1, 1995.)\nRichard J. Cathcart 50 Executive Vice President, Corporate Development since March 6, 1995; Vice President, Business Development of Honeywell, Inc. 1994 - March 1995; Vice President and General Manager of Honeywell's Worldwide Building Control Division 1992 - 1994; Vice President and General Manager, Honeywell's U.S. Operations of Building Control Division, 1988-1991.\nJoseph R. Collins 53 Senior Vice President - Specialty Products since August 1991; Acting Chief Financial Officer, June 1993 - March 1994; President, Delta International Machinery Corporation (subsidiary of the Registrant), October 1984 - August 1991.\nDavid D. Harrison 47 Senior Vice President and Chief Financial Officer since March 1994; Vice-President, Finance and Information Technology of the GE Canada Appliance Component subsidiary of General Electric, August 1992 - March 1994; and Vice President, Finance and Deputy Executive Officer of the GE Europe Lighting Component subsidiary of General Electric, January 1990 - July 1992.\nRonald V. Kelly 58 Senior Vice President - Long Range Planning since September 1994; Senior Vice President - Paper Products, August 1991 - September 1994; Vice President - Specialty Products, March 1989 - August 1991.\nGerald C. Kitch 57 Senior Vice President - General Industrial Equipment since August 1991; Vice President - General Industrial Equipment, March 1989 - August 1991.\nDebby S. Knutson 40 Vice President, Human Resources since September 1994; Assistant Vice President, Human Resources , August 1993 - September 1994; Vice President, Human Resources of Hoffman Engineering (division of Registrant) July 1990 - August 1993; Director of Human Resources at Hoffman, December 1988 - July 1990.\nAllan J. Kolles 63 Senior Vice President and Assistant to the Chief Executive Officer since August 1994; Vice President, Human Resources, March 1985 - August 1994.\nRoy T. Rueb 54 Vice President, Treasurer since October 1986 and Secretary since June 1994.\nMark T. Schroepfer 48 Vice President Finance and MIS since June 1994; Vice President, Controller, January 1990 - June 1994.\nThere is no family relationship between any of the executive officers or directors.\nItem 11.","section_11":"Item 11. Executive Compensation.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nFor information required under Items 11 and 12, see the Registrant's Proxy Statement for the 1995 Annual Meeting of Shareholders referenced on page 2 of this report.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nNo relationships or transactions existed that require disclosure under Item 13.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) Financial Statements and Exhibits.\n1. The following consolidated financial statements of Pentair, Inc. and subsidiaries, together with the Report of Independent Certified Public Accountants, found on pages 34 to 53 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1994, are hereby incorporated by reference in this Form 10-K.\nPage of Annual Report Report of Independent Certified Public Accountants34\nConsolidated Statements of Income for Years Ended December 31, 1994, 1993 and 1992\nConsolidated Balance Sheets as of December 31, 1994 and 1993 36 - 37\nConsolidated Statements of Cash Flows for Years Ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements 40 - 53\n2. The additional financial data listed below is included as exhibits to this Form 10-K Report and should be read in conjunction with the consolidated financial statements presented in the 1994 Annual Report to Shareholders.\nReport of Independent Certified Public Accountants\nSchedule for the years ended December 31, 1994, 1993 and 1992:\nVIII- Valuation and Qualifying Accounts\n3. The following exhibits are included with this Report on Form 10-K (or incorporated by reference) as required by Item 601 of Regulation S-K.\nExhibit Number Description\n(3.1) Restated Articles of Incorporation as amended through April 25, 1989.\n(3.2) Resolution Establishing and Designating $7.50 Callable Cumulative Convertible Preferred Stock, Series 1988, as a series of Preferred Stock of Pentair, Inc.\n(3.3) Resolution Establishing and Designating 8% Callable Cumulative Voting Convertible Preferred Stock, Series 1990, as a series of Preferred Stock of Pentair, Inc.\n(3.4) Second Amended and Superseding By-Laws as amended through January 19, 1993.\n(4.1) Restated Articles of Incorporation, as amended, and Second Amended and Superseding By-Laws, as amended (see Exhibits 3.1 - 3.4 above).\n(4.2) Rights Agreement dated December 26, 1986 between the Company and First Trust Company, Inc.\n(4.3) Amendment to Rights Agreement dated July 22, 1988 between the Company and Norwest Bank Minnesota, National Association, as successor Rights Agent (Amending Exhibit 4.2).\n(4.4) Second Amendment to Rights Agreement dated December 15, 1989 between the Company and Norwest Bank Minnesota, National Association, as successor Rights Agent (Amending Exhibit 4.2).\n(4.5) Bid Loan Agreement dated December 14, 1988 between the Company, Continental Bank N.A. for itself and as Agent, Morgan Guaranty Trust Company of New York, Morgan Bank (Delaware), First Bank National Association, Norwest Bank Minnesota, N.A., and Mellon Bank, N.A.\n(4.6) First Amendment to Bid Loan Agreement dated January 1, 1991 between the Company, Continental Bank N.A. for itself and as Agent, Morgan Guaranty Trust Company of New York, Morgan Bank (Delaware), First Bank National Association, Norwest Bank Minnesota, N.A., and NBD Bank, N.A. (Amending Exhibit 4.5).\n(4.7) Second Amendment to Bid Loan Agreement dated as of February 11, 1994 between Pentair, Inc., Continental Bank N.A. for itself and as Agent, Morgan Guaranty Trust Company of New York, J.P. Morgan Delaware, First Bank National Assocation, Norwest Bank Minnesota, N.A., and NBD Bank, N.A. (Amending Exhibit 4.5).\n(4.8) $125,000,000 Facility Agreement dated as of February 11, 1994 between Pentair, Inc., Continental Bank N.A. for itself and as Agent, Morgan Guaranty Trust Company of New York for itself and as Agent, NBD Bank, N.A., and J. P. Morgan Delaware.\n(4.9) Amendment Number One to Facility Agreement dated as of November 1, 1994 between Pentair, Inc., Bank of America Illinois (formerly known as Continental Bank N.A.) for itself and as Agent, Morgan Guaranty Trust Company of New York for itself and as Agent, NBD Bank, N.A., and J. P. Morgan Delaware. (Amending Exhibit 4.8)\n(4.10) $45,000,000 Facility Agreement dated as of February 11, 1994 between Pentair, Inc., First Bank National Association, for itself and as Agent, and Norwest Bank Minnesota N.A.\n(4.11) Amendment Number One to Facility Agreement dated as of November 1, 1994 between Pentair, Inc., First Bank National Association, for itself and as Agent, and Norwest Bank Minnesota N.A.(Amending Exhibit 4.10)\n(4.12) DM 115,000,000 Facility Agreement dated as of February 11, 1994 between EuroPentair, GmbH as Borrower, Pentair, Inc., as Guarantor, Morgan Guaranty Trust Company of New York for itself and as Agent, Continental Bank N.A., for itself and as Agent, NBD Bank, N.A. and Dresdner Bank.\n(4.13) Amendment Number One to Facility Agreement dated as of November 1, 1994 between EuroPentair, GmbH as Borrower, Pentair, Inc., as Guarantor, Morgan Guaranty Trust Company of New York for itself and as Agent, Bank of America Illinois(formerly known as Continental Bank N.A.), for itself and as Agent, NBD Bank, N.A. and Dresdner Bank. (Amending Exhibit 4.12)\n(4.14) Amendment Number Two to Facility Agreement dated as of February 15, 1995 between EuroPentair, GmbH as Borrower, Pentair, Inc., as Guarantor, Morgan Guaranty Trust Company of New York for itself and as Agent, Bank of America Illinois(formerly known as Continental Bank N.A.), for itself and as Agent, NBD Bank, N.A. and Dresdner Bank . (Amending Exhibit 4.12)\n(4.15) Restatement of Credit Agreement dated July 11, 1989 between Federal-Hoffman, Inc. and First Bank National Association.\n(4.16) Second Amendment to Restatement of Credit Agreement dated as of January 19, 1993 between Federal-Hoffman, Inc., Pentair, Inc., and First Bank National Association (Amending Exhibit 4.15) .\n(4.17) Third Amendment to Restatement of Credit Agreement dated as of December 31, 1994 between Federal-Hoffman, Inc., Pentair, Inc., and First Bank National Association (Amending Exhibit 4.15)\n(4.18) $35,000,000 Note Purchase Agreement dated March 25, 1991 between Pentair, Inc. and Nationwide Life Insurance Company.\n(4.19) $25,000,000 Note Purchase Agreement dated December 13, 1991 between Pentair, Inc. and Principal Mutual Life Insurance Company.\n(4.20) $15,000,000 Note Purchase Agreement dated November 1, 1992 between Pentair, Inc. and Nationwide Life Insurance Company.\n(4.21) $15,000,000 Note Purchase Agreement dated January 15, 1993 between Pentair, Inc. and Principal Mutual Life Insurance Company.\n(4.22) $70,000,000 Senior Notes Purchase Agreement dated as of April 30, 1993 between Pentair, Inc. and United of Omaha Life Insurance Company, Companion Life Insurance Company, Principal Mutual Life Insurance Company, Nippon Life Insurance Company of America, Lutheran Brotherhood, American United Life Insurance Company, Modern Woodmen of America, The Franklin Life Insurance Company and Ameritas Life Insurance Corp.\n(10.1) Agreements dated February 8, 1978 and February 9, 1982 between the Company and D. Eugene Nugent.\n(10.2) Agreement dated February 8, 1984 (Amending Exhibit 10.1).\n(10.3) Agreement dated December 17, 1985 (Amending Exhibit 10.1).\n(10.4) Agreement dated May 7, 1990 (Amending Exhibit 10.1).\n(10.5) Company's Supplemental Employee Retirement Plan effective June 16, 1988.\n(10.6) Company's 1986 Nonqualified Stock Option Plan.\n(10.7) Company's 1990 Omnibus Stock Incentive Plan.\n(10.8) Company's Management Incentive Plan as amended to January 12, 1990.\n(10.9) Employee Stock Purchase and Bonus Plan as amended and restated effective January 1, 1992.\n(10.10) Company's Flexible Perquisite Program as amended to January 1, 1989.\n(10.11) Form of 1986 Management Assurance Agreement (Revised 1990) between the Company and certain executive officers.\n(10.12) Company's Third Amended and Restated Compensation Plan for Non-Employee Directors as amended to January 1, 1992.\n(10.13) Company's Outside Directors Nonqualified Stock Option Plan dated January 22, 1988.\n(10.14) First Amendment to Outside Directors Nonqualified Stock Option Plan (Amending Exhibit 10.13).\n(10.15) Second Amendment to Outside Directors Nonqualified Stock Option Plan (Amending Exhibit 10.13).\n(10.16) Pentair, Inc. Deferred Compensation Plan effective January 1, 1993.\n(10.17) Lake Superior Paper Industries Venture Council By-Laws and Management Protocol.\n(10.18) Second Amended and Restated Joint Venture Agreement dated December 31, 1987 between Pentair Duluth Corp. and Minnesota Paper, Incorporated.\n(10.19) First Amendment to Second Restated Joint Venture Agreement, First Amendment to Venture Council By-Laws, and First Amendment to Management Protocol, all dated May 30, 1989, between Pentair Duluth Corp. and Minnesota Paper, Incorporated (Amending Exhibits 10.17 and 10.18).\n(10.20) Cash Deficiency Agreement dated December 31, 1987 among Pentair Duluth Corp., as Joint Venturer, Associated Southern Investment Company, as Owner Participant, The Connecticut Bank and Trust Company, National Association, as Indenture Trustee, and First National Bank of Minneapolis, as Owner Trustee. Cash Deficiency Agreements also were entered into with respect to each of the other four Owner Participants: Dana Lease Finance Corporation, NYNEX Credit Company, Public Service Resources Corporation, and Southern Indiana Properties, Inc.\n(10.21) Keepwell Agreement and Assignment dated December 31, 1987 among Pentair, Inc., as Sponsor, Pentair Duluth Corp., as Joint Venturer, and First National Bank of Minneapolis, as Owner Trustee; although First Minneapolis executed this filed document as Owner Trustee for Associated Southern Investment Company, additional Keepwell Agreements and Assignments were entered into by First Minneapolis as Owner Trustee for the other four Owner Participants listed in the description of Exhibit 10.20 above.\n(10.22) Definition of Terms for Financing Agreement dated December 31, 1987 and the Transaction Documents Referred to Therein: Sale and Leaseback of Undivided Interest in Lake Superior Paper Industries' Supercalendered Paper Mill; although this filed document supplies the definitions applicable to the agreements filed as Exhibits 10.20 and 10.2 above, there were four additional sets of definitions that supply the definitions for the other sets of agreements referred to in the descriptions of those Exhibits with respect to the various Owner Participants.\n(10.23) Loan and Stock Purchase Agreement dated March 7, 1990 between the Company and the Pentair, Inc. Employee Stock Ownership Plan Trust, acting through State Street Bank and Trust Company, as Trustee.\n(10.24) $56,499,982 Promissory Note dated March 7, 1990 of the Pentair, Inc. Employee Stock Ownership Plan Trust, acting through State Street Bank and Trust Company, as Trustee, to the Company.\n(11) Statement regarding computation of earnings per share.\n(13) Annual Report to Shareholders for period ended December 31, 1994.\n(21) Subsidiaries of Registrant.\n(24) Consent of Deloitte & Touche.\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.\nPENTAIR, INC.\nBy \/s\/ David D. Harrison David D. Harrison Senior Vice President and Chief Financial Officer\nDated: March 29, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has also been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nBy \/s\/ Winslow H. Buxton Dated: March 29, 1995 Winslow H. Buxton, Chairman, President and Chief Executive Officer, Director\nBy \/s\/ George N. Butzow Dated: March 29, 1995 George N. Butzow, Director\nBy \/s\/ Charles A. Haggerty Dated: March 29, 1995 Charles A. Haggerty, Director\nBy \/s\/ Harold V. Haverty Dated: March 29, 1995 Harold V. Haverty, Director\nBy \/s\/ Quentin J. Hietpas Dated: March 29, 1995 Quentin J. Hietpas, Director\nBy \/s\/ B. Kristine Johnson Dated: March 29, 1995 B. Kristine Johnson, Director\nBy \/s\/ Walter Kissling Dated: March 29, 1995 Walter Kissling, Director\nBy \/s\/ D. Eugene Nugent Dated: March 29, 1995 D. Eugene Nugent, Director\nBy \/s\/ Richard M. Schulze Dated: March 29, 1995 Richard M. Schulze, Director\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nPentair, Inc.:\nWe have audited the consolidated financial statements of Pentair, Inc. and subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 10, 1995, except for Note 4, as to which the date is February 21, 1995; such financial statements and report are included in your 1994 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedule of Pentair, Inc. and subsidiaries listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such 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.\nDELOITTE & TOUCHE\nMinneapolis, Minnesota February 10, 1995, except for Note 4, as to which the date is February 21, 1995\nSCHEDULE VIII\nPENTAIR, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 31\nEXHIBIT INDEX\nExhibit Number Description\n(3.1) Restated Articles of Incorporation as amended through April 25, 1989 (Incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q for the quarter ended March 31, 1989).\n(3.2) Resolution Establishing and Designating $7.50 Callable Cumulative Convertible Preferred Stock, Series 1988, as a series of Preferred Stock of Pentair, Inc. (Incorporated by reference to Exhibit 4.1 to Amendment No. 1 to the Company's Current Report on Form 8-K filed December 30, 1988).\n(3.3) Resolution Establishing and Designating 8% Callable Cumulative Voting Convertible Preferred Stock, Series 1990, as a series of Preferred Stock of Pentair, Inc. (Incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed March 21, 1990).\n(3.4) Second Amended and Superseding By-Laws as amended through January 19, 1993 (Incorporated by reference to Exhibit 3.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n(4.1) Restated Articles of Incorporation, as amended, and Second Amended and Superseding By-Laws, as amended (see Exhibits 3.1 - 3.4 above).\n(4.2) Rights Agreement dated December 26, 1986 between the Company and First Trust Company, Inc. (Incorporated by reference to Exhibit 1 to the Company's Registration Statement on Form 8-A filed December 26, 1986).\n(4.3) Amendment to Rights Agreement dated July 22, 1988 between the Company and Norwest Bank Minnesota, National Association, as successor Rights Agent (Amending Exhibit 4.2) (Incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K filed August 2, 1988).\n(4.4) Second Amendment to Rights Agreement dated December 15, 1989 between the Company and Norwest Bank Minnesota, National Association, as successor Rights Agent (Amending Exhibit 4.2) (Incorporated by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K filed December 28, 1989).\n(4.5) Bid Loan Agreement dated December 14, 1988 between the Company, Continental Bank N.A. for itself and as Agent, Morgan Guaranty Trust Company of New York, Morgan Bank (Delaware), First Bank National Association, Norwest Bank Minnesota, N.A., and Mellon Bank, N.A. (Incorporated by reference to Exhibit 4.2 to Amendment No. 1 to the Company's Current Report on Form 8-K filed December 30, 1988).\n(4.6) First Amendment to Bid Loan Agreement dated January 1, 1991 between the Company, Continental Bank N.A. for itself and as Agent, Morgan Guaranty Trust Company of New York, Morgan Bank (Delaware), First Bank National Association, Norwest Bank Minnesota, N.A., and NBD Bank, N.A. (Amending Exhibit 4.5) (Incorporated by reference to Exhibit 4.9 to the Company's Annual Report on Form 10K for the year ended December 31, 1990).\n(4.7) Second Amendment to Bid Loan Agreement dated as of February 11, 1994 between Pentair, Inc., Continental Bank N.A. for itself and as Agent, Morgan Guaranty Trust Company of New York, J.P. Morgan Delaware, First Bank National Assocation, Norwest Bank Minnesota, N.A., and NBD Bank, N.A. (Amending Exhibit 4.5) (Incorporated by reference to Exhibit 4.3 to the Company's Current Report on Form 8-K filed March 14, 1994).\n(4.8) $125,000,000 Facility Agreement dated as of February 11, 1994 between Pentair, Inc., Continental Bank N.A. for itself and as Agent, Morgan Guaranty Trust Company of New York for itself and as Agent, NBD Bank, N.A., and J. P. Morgan Delaware (Incorporated by reference to Exhibit 4.1 to the Company's Current Report on Form 8-K filed March 14, 1994).\n(4.9) Amendment Number One to Facility Agreement dated as of November 1, 1994 between Pentair, Inc., Bank of America Illinois (formerly known as Continental Bank N.A.) for itself and as Agent, Morgan Guaranty Trust Company of New York for itself and as Agent, NBD Bank, N.A., and J. P. Morgan Delaware. (Amending Exhibit 4.8)\n(4.10) $45,000,000 Facility Agreement dated as of February 11, 1994 between Pentair, Inc., First Bank National Association, for itself and as Agent, and Norwest Bank Minnesota N.A. (Incorporated by reference to Exhibit 4.2 to the Company's Current Report on Form 8-K filed March 14, 1994).\n(4.11) Amendment Number One to Facility Agreement dated as of November 1, 1994 between Pentair, Inc., First Bank National Association, for itself and as Agent, and Norwest Bank Minnesota N.A.(Amending Exhibit 4.10)\n(4.12) DM 115,000,000 Facility Agreement dated as of February 11, 1994 between EuroPentair, GmbH as Borrower, Pentair, Inc., as Guarantor, Morgan Guaranty Trust Company of New York for itself and as Agent, Continental Bank N.A., for itself and as Agent, NBD Bank, N.A. and Dresdner Bank (Incorporated by reference to Exhibit 4.4 to the Company's Current Report on Form 8-K filed March 14, 1994).\n(4.13) Amendment Number One to Facility Agreement dated as of November 1, 1994 between EuroPentair, GmbH as Borrower, Pentair, Inc., as Guarantor, Morgan Guaranty Trust Company of New York for itself and as Agent, Bank of America Illinois(formerly known as Continental Bank N.A.), for itself and as Agent, NBD Bank, N.A. and Dresdner Bank. (Amending Exhibit 4.12)\n(4.14) Amendment Number Two to Facility Agreement dated as of February 15, 1995 between EuroPentair, GmbH as Borrower, Pentair, Inc., as Guarantor, Morgan Guaranty Trust Company of New York for itself and as Agent, Bank of America Illinois(formerly known as Continental Bank N.A.), for itself and as Agent, NBD Bank, N.A. and Dresdner Bank . (Amending Exhibit 4.12)\n(4.15) Restatement of Credit Agreement dated July 11, 1989 between Federal-Hoffman, Inc. and First Bank National Association (Incorporated by reference to Exhibit 4.10 to the Company's Form 10-K for the year ended December 31, 1989).\n(4.16) Second Amendment to Restatement of Credit Agreement dated as of January 19, 1993 between Federal-Hoffman, Inc., Pentair, Inc., and First Bank National Association (Amending Exhibit 4.15) (Incorporated by reference to Exhibit 4.13 to the Company's Form 10-K for the year ended December 31, 1992).\n(4.17) Third Amendment to Restatement of Credit Agreement dated as of December 31, 1994 between Federal-Hoffman, Inc., Pentair, Inc., and First Bank National Association (Amending Exhibit 4.15).\n(4.18) $35,000,000 Note Purchase Agreement dated March 25, 1991 between Pentair, Inc. and Nationwide Life Insurance Company. (Incorporated by reference to Exhibit 4.14 to the Company's Registration Statement on Form S-8 filed August 6, 1991).\n(4.19) $25,000,000 Note Purchase Agreement dated December 13, 1991 between Pentair, Inc. and Principal Mutual Life Insurance Company. (Incorporated by reference to Exhibit 4.15 to the Company's Registration Statement on Form S-8 filed January 13, 1992).\n(4.20) $15,000,000 Note Purchase Agreement dated November 1, 1992 between Pentair, Inc. and Nationwide Life Insurance Company (Incorporated by reference to Exhibit 4.16 to the Company's Form 10-K for the year ended December 31, 1992).\n(4.21) $15,000,000 Note Purchase Agreement dated January 15, 1993 between Pentair, Inc. and Principal Mutual Life Insurance Company (Incorporated by reference to Exhibit 4.17 to the Company's Form 10-K for the year ended December 31, 1992).\n(4.22) $70,000,000 Senior Notes Purchase Agreement dated as of April 30, 1993 between Pentair, Inc. and United of Omaha Life Insurance Company, Companion Life Insurance Company, Principal Mutual Life Insurance Company, Nippon Life Insurance Company of America, Lutheran Brotherhood, American United Life Insurance Company, Modern Woodmen of America, The Franklin Life Insurance Company and Ameritas Life Insurance Corp (Incorporated by reference to Exhibit 4.17 to the Company's Form 10-K for the year ended December 31, 1993).\n(10.1) Agreements dated February 8, 1978 and February 9, 1982 between the Company and D. Eugene Nugent (Incorporated by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-2 filed June 24, 1983).\n(10.2) Agreement dated February 8, 1984 (Amending Exhibit 10.1) (Incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10-K for the year ended December 31, 1983).\n(10.3) Agreement dated December 17, 1985 (Amending Exhibit 10.1) (Incorporated by reference to Exhibit 10.6 to the Company's Annual Report on Form 10-K for the year ended December 31, 1985).\n(10.4) Agreement dated May 7, 1990 (Amending Exhibit 10.1). (Incorporated by reference to Exhibit 10.4 to the Company's Annual Report on Form 10K for the year ended December 31, 1990).\n(10.5) Company's Supplemental Employee Retirement Plan effective June 16, 1988 (Incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n(10.6) Company's 1986 Nonqualified Stock Option Plan (Incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1986).\n(10.7) Company's 1990 Omnibus Stock Incentive Plan (Incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n(10.8) Company's Management Incentive Plan as amended to January 12, 1990 (Incorporated by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n(10.9) Employee Stock Purchase and Bonus Plan as amended and restated effective January 1, 1992 (Incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n(10.10) Company's Flexible Perquisite Program as amended to January 1, 1989 (Incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n(10.11) Form of 1986 Management Assurance Agreement (Revised 1990) between the Company and certain executive officers (Incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n(10.12) Company's Third Amended and Restated Compensation Plan for Non-Employee Directors as amended to January 1, 1992. (Incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-8 filed January 13, 1992).\n(10.13) Company's Outside Directors Nonqualified Stock Option Plan dated January 22, 1988 (Incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n(10.14) First Amendment to Outside Directors Nonqualified Stock Option Plan (Amending Exhibit 10.13) (Incorporated by reference to Exhibit 10.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n(10.15) Second Amendment to Outside Directors Nonqualified Stock Option Plan (Amending Exhibit 10.13) (Incorporated by reference to Exhibit 10.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n(10.16) Pentair, Inc. Deferred Compensation Plan effective January 1, 1993 (Incorporated by reference to Exhibit 10.21 to the Company's Form 10-K for the year ended December 31, 1992).\n(10.17) Lake Superior Paper Industries Venture Council By-Laws and Management Protocol (Incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1985).\n(10.18) Second Amended and Restated Joint Venture Agreement dated December 31, 1987 between Pentair Duluth Corp. and Minnesota Paper, Incorporated (Incorporated by reference to Exhibit 10.25 to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n(10.19) First Amendment to Second Restated Joint Venture Agreement, First Amendment to Venture Council By-Laws, and First Amendment to Management Protocol, all dated May 30, 1989, between Pentair Duluth Corp. and Minnesota Paper, Incorporated (Amending Exhibits 10.17 and 10.18) (Incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n(10.20) Cash Deficiency Agreement dated December 31, 1987 among Pentair Duluth Corp., as Joint Venturer, Associated Southern Investment Company, as Owner Participant, The Connecticut Bank and Trust Company, National Association, as Indenture Trustee, and First National Bank of Minneapolis, as Owner Trustee. Cash Deficiency Agreements also were entered into with respect to each of the other four Owner Participants: Dana Lease Finance Corporation, NYNEX Credit Company, Public Service Resources Corporation, and Southern Indiana Properties, Inc. (Incorporated by reference to Exhibit 10.1 to Amendment No. 1 to the Company's Current Report on Form 8-K filed April 26, 1988).\n(10.21) Keepwell Agreement and Assignment dated December 31, 1987 among Pentair, Inc., as Sponsor, Pentair Duluth Corp., as Joint Venturer, and First National Bank of Minneapolis, as Owner Trustee; although First Minneapolis executed this filed document as Owner Trustee for Associated Southern Investment Company, additional Keepwell Agreements and Assignments were entered into by First Minneapolis as Owner Trustee for the other four Owner Participants listed in the description of Exhibit 10.20 above (Incorporated by reference to Exhibit 10.2 to Amendment No. 1 to the Company's Current Report on Form 8-K filed April 26, 1988).\n(10.22) Definition of Terms for Financing Agreement dated December 31, 1987 and the Transaction Documents Referred to Therein: Sale and Leaseback of Undivided Interest in Lake Superior Paper Industries' Supercalendered Paper Mill; although this filed document supplies the definitions applicable to the agreements filed as Exhibits 10.20 and 10.21 above, there were four additional sets of definitions that supply the definitions for the other sets of agreements referred to in the descriptions of those Exhibits with respect to the various Owner Participants (Incorporated by reference to Exhibit 10.3 to Amendment No. 1 to the Company's Current Report on Form 8-K filed April 26, 1988).\n(10.23) Loan and Stock Purchase Agreement dated March 7, 1990 between the Company and the Pentair, Inc. Employee Stock Ownership Plan Trust, acting through State Street Bank and Trust Company, as Trustee (Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed March 21, 1990).\n(10.24) $56,499,982 Promissory Note dated March 7, 1990 of the Pentair, Inc. Employee Stock Ownership Plan Trust, acting through State Street Bank and Trust Company, as Trustee, to the Company (Incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed March 21, 1990).\n(11) Statement regarding computation of earnings per share.\n(13) Annual Report to Shareholders for period ended December 31, 1994.\n(21) Subsidiaries of Registrant.\n(24) Consent of Deloitte & Touche.","section_15":""}
{"filename":"748714_1994.txt","cik":"748714","year":"1994","section_1":"ITEM 1. BUSINESS _______________________________________________________________\nGeneral\nTHE COMPANY\nNational Pizza Company (the \"Company\" or \"Registrant\") is the successor to certain Pizza Hut operations commenced in 1962 by O. Gene Bicknell, the Chairman of the Board of the Company.\nAt March 29, 1994, the Company operated 363 Pizza Hut restaurants and delivery units pursuant to franchise agreements with Pizza Hut, Inc. (\"PHI\"), a wholly-owned subsidiary of PepsiCo, Inc. The Pizza Hut restaurant system is the largest pizza chain in the world and the Company is the largest Pizza Hut franchisee.\nOn November 26, 1989, the Company acquired a majority interest in Skipper's, Inc., a corporation based in Bellevue, Washington (\"Skipper's\"), which at March 29, 1994 operates 188 quick service seafood restaurants in 12 states and franchises 16 units in eight states and 2 units in British Columbia. Pursuant to a merger effective January 12, 1990, Skipper's became a wholly- owned subsidiary of the Company.\nOn June 8, 1993, the Company signed completed the acquisition of NRH Corporation. NRH was the operator and franchisor of Tony Roma's A Place For Ribs. At March 29, 1994, the Company operated 26 Company restaurants in four states and franchised 105 units in 20 states and 32 units in international locations.\nThe Company is a Kansas corporation incorporated in 1974 under the name Southeast Pizza Huts, Inc. In 1984, the name of the Company was changed to National Pizza Company. Subject to stockholder approval at the Company's annual meeting of stockholders to be held on July 12, 1994, the Company intends to change its name to NPC International, Inc. Its principal executive offices are located at 720 W. 20th Street, Pittsburg, Kansas and its telephone number is (316) 231-3390.\nFinancial Information About Industry Segments\nThe restaurant industry is the only business segment in which the Registrant operates.\nPIZZA HUT OPERATIONS\nPizza Hut Restaurant System\nThe first Pizza Hut restaurant was opened in 1958 in Wichita, Kansas by the original founders of the Pizza Hut system. Pizza Hut, Inc. (PHI), the franchisor of the Company, was formed in 1959.\nIn 1977, PHI was acquired by PepsiCo, Inc., which continued expanding the Pizza Hut system. The Pizza Hut system is the largest pizza chain in the world, both in sales and number of units. As of December 31, 1993 the Pizza Hut system had over 10,400 restaurants, delivery kitchens and kiosks with locations in all 50 states and many foreign countries. Approximately 60% of the domestic Pizza Hut units are operated by PHI.\nPizza Hut restaurants generally offer full table service and a similar menu, featuring pizza, pasta, sandwiches, a salad bar, soft drinks and, in most restaurants, beer. Most dough products are made fresh several times each day, and only 100% natural cheese products are used. Product ingredients are of a high quality and are prepared in accordance with proprietary formulas established by PHI. The restaurants offer pizza in five sizes with a variety of toppings. Customers may also choose among thin crust, traditional hand-tossed and thick crust pan pizza, as well as Pizza Hut's value-priced BIGFOOT pizza. With the exception of the Personal Pan Pizza, all food products are prepared at the time of order.\nPizza sales account for approximately 85% of the Company's Pizza Hut operations revenues. Sales of alcoholic beverages are less than 2% of net sales.\nNew product introduction is vital to the continued success of any restaurant system, and PHI maintains a research and development department which develops new products and recipes, tests new procedures and equipment, and approves suppliers for Pizza Hut products. All new products are developed by PHI, and franchisees are prohibited from offering any other products in their restaurants unless approved by PHI.\nPizza Hut also delivers pizza products to their customers. Prior to 1985, most delivery was done out of existing restaurants. In 1985, the system began to aggressively pursue home delivery through delivery \/ carryout kitchens. Customer orders are made to a computerized customer service center (CSC), a \"single unit solution\" (SUS, a facility similar to a CSC, but smaller in scale), or directly to the kitchen.\nA successful delivery operation yields lower profit margins as a percentage of sales than the Company's Pizza Hut restaurants due to higher labor costs, but the return on invested capital is greater.\nThe Company's Pizza Hut Operations\nThe Company is the largest Pizza Hut franchisee in the world and, at March 29, 1994, operated 363 Pizza Hut restaurants and delivery kitchens. The Company's franchise agreements grant to the Company the exclusive right to operate Pizza Hut restaurants in certain designated areas. The Company currently operates restaurants in the states shown in the table below.\nOn March 1, 1994, the Company completed its acquisition of two Pizza Hut restaurants in Missouri previously operated by another Pizza Hut franchisee. This was the first successful acquisition of another Pizza Hut franchisee since 1988. On March 28, 1994, the Company entered into an agreement in principle to acquire 17 Pizza Hut restaurants from another Pizza Hut franchisee. A related agreement with Pizza Hut, Inc. specifies that eleven of these units will be subsequently exchanged for twelve more PHI-owned restaurants in the Southeast. The transaction is expected to close in June, 1994.\nOn April 5, 1994, the Company announced the signing of a non- binding memorandum of intent with its franchisor Pizza Hut, Inc., which would involve the exchange of 84 restaurants owned by the Company on March 29, 1994 with 50 units owned by PHI. The Company signed a binding asset exchange agreement with PHI (the \"Asset Exchange Agreement Agreement\") on June 7 and formally renewed its franchise agreement for a period of 15 years. On the same day, approximately 40 stores, primarily in California, were transferred to PHI as part of the agreement. The remaining exchanges are expected to be completed by August, 1994.\nIf consummated, the 17 unit acquisition and the PHI asset exchanges will result in a net change in the Company's locations as shown in the table below.\nUnit Development\nThe following table sets forth information concerning the growth in the number of Pizza Hut restaurants and delivery kitchens operated by the Company:\nAt March 29, 1994, the Company provided delivery services at 80 full-service Pizza Hut restaurants and at 97 delivery-only outlets. Delivery service is provided utilizing a CSC telephone system in ten metropolitan markets: Springfield, Missouri; Hagerstown, Maryland; Bakersfield, California; Montgomery and Birmingham, Alabama; Shreveport, Louisiana; Jackson and Long Beach, Mississippi; Little Rock, Arkansas; and Memphis, Tennessee. Under the CSC system, all customers within the trade area place telephone orders through a single clearing number, and the pizza is dispatched from the Company's delivery kitchen nearest the customer. Customers call the restaurant delivery kitchens directly in other locations.\nRelationships with Pizza Hut, Inc.\nThe Company's franchise agreements with PHI (the \"Franchise Agreements\") provide, among other things, for standards of operation and physical condition of the Company's restaurants, the provision of services, the geographical territories in which the Company has exclusive rights to open and operate Pizza Hut restaurants and delivery kitchens, the term of the franchise and renewal options, the Company's development rights and obligations and various provisions relating to the transfer of interests in the Company's franchise rights.\nPHI determines standards of operation for all Pizza Hut restaurants, including standards of quality, cleanliness and service. Further, the Franchise Agreements allow the franchisor to set specifications for all furnishings, interior and exterior decor, supplies, fixtures and equipment. See \"Business - Supplies and Equipment.\" PHI also has the right to determine and change the menu items offered by, and to inspect all restaurants of, its franchisees, including the Company. All such standards may be revised from time to time. Upon the failure to comply with such standards, PHI has various rights, including the right to terminate the applicable Franchise Agreements, redefine the franchise territory or terminate the Company's rights to establish additional restaurants in that franchise territory. The Franchise Agreements may also be terminated upon the occurrence of certain events, such as the insolvency or bankruptcy of the Company or the commission by the Company or any of its officers, directors or principal stockholders (other than its public stockholders) of a felony or other crime that, in the sole judgment of PHI is reasonably likely to adversely affect the Pizza Hut system, its trademark, the goodwill associated therewith or PHI's interest therein. At no time during the Company's history has PHI sought to terminate any of the Company's Franchise Agreements, redefine its franchise territories or otherwise limit the Company's franchise rights. The Company believes it is in compliance with all material provisions of the Franchise Agreements.\nUnder the Franchise Agreements, extensive structural changes, major remodeling and renovation and substantial modifications to the Company's restaurants necessary to conform to the then current Pizza Hut system image may be required by PHI, but not more often than once every seven years. The Company has not been required to make any such changes, renovations or modifications. PHI may also request the Company introduce new food products that could require remodeling or equipment changes. PHI can require changes of decor or products only after it has tested such changes in at least 5% of Pizza Hut system restaurants.\nPHI is required to provide certain continuing services to the Company, including training programs, the furnishing of operations manuals and assistance in evaluating and selecting locations for restaurants.\nIn early 1990, PHI offered franchisees the opportunity to sign a new twenty year franchise agreement (the \"1990 Franchise Agreement\"). The 1990 Franchise Agreement required franchise fees of 4% of sales, as defined, for all restaurants and delivery kitchens and increases in certain advertising contributions. The 1990 Franchise Agreement also sought to redefine certain rights and obligations of the franchisee and franchisor. The 1990 Franchise Agreement did not alter the franchisee's territorial rights and maintained, subject to some minor limitations, the exclusivity of the Pizza Hut brand within the geographical limits of the territory defined by each franchise agreement.\nOn June 7, 1994, the Company entered into the Asset Exchange Agreement with PHI which in essence conformed the Company's existing Franchise Agreements to the 1990 Franchise Agreement. As part of the Asset Exchange Agreement, the Company will exchange 84 of its operating Pizza Hut restaurants and delivery kitchens for 50 Pizza Hut restaurants and delivery kitchens owned by PHI contiguous to the Company's southeastern operating area and certain additional rights under the 1990 Franchise Agreement. In a related transaction, an additional eleven units acquired from another franchisee would also be exchanged with twelve PHI-owned units, also in the Southeast.\nThe 1990 Franchise Agreement grants to the Company the exclusive right to develop and operate restaurants within designated geographic areas through March 29, 2010. The Company has the option to renew each Franchise Agreement prior to its expiration for a single renewal term of 15 years by entering into the then- current form of the PHI franchise agreement, including the then- current fee schedules, provided the Company is not then in default of its obligations under that Franchise Agreement, including the development schedule, and has complied with the requirements therof throughout the term of the agreement.\nThe Franchise Agreements under which the Company operates require the payment of monthly fees to PHI. Under the 1990 Franchise Agreement (as it applies to the Company), the Company's royalty payments for all units owned will increase to 4% of gross sales beginning in July, 1996, from the Company's current effective rate of 2.06%. This rate reflects the royalty rate which was proposed by PHI to Pizza Hut franchisees as part of the 1990 Franchise Agreement and is lower than the rate under PHI's current franchise agreement.\nPizza Huts acquired after the signing of the 1990 Franchise Agreement will continue with the terms and conditions of the acquired units, but are likely to be similar to those found in the 1990 Franchise Agreement signed by the Company.\nFor the fiscal years ended March 29, 1994, March 30, 1993, and March 31, 1992 the Company incurred total franchise fees payable to PHI of approximately $4,461,000, $4,236,000, and $4,250,000, respectively. The Franchise Agreements require the Company to pay initial franchise fees to PHI in amounts of up to $15,000 for each new restaurant opened. The Company is required to contribute or expend a certain percentage of its sales for local and national advertising and promotion. See \"Business - Advertising and Promotion.\"\nFailure to develop a franchise territory as required would give PHI the right to operate Pizza Hut restaurants in that territory. Such failure would not affect the Company's rights with respect to the Pizza Hut restaurants then in operation or under development by the Company in any such territory. The Company is required to obtain the prior written approval of PHI for the location of each new restaurant.\nThe Franchise Agreements prohibit the transfer or assignment of any interest in the franchise rights granted thereunder or in the Company without the prior written consent of PHI, which consent may not be unreasonably withheld if certain conditions are met. All franchise agreements also give PHI a right of first refusal to purchase any interest in the franchise rights or in the Company if a proposed transfer by the Company or a controlling person would result in a change of control of the Company. PHI also has a right of first refusal with respect to any Pizza Hut franchise right proposed to be acquired by the Company from any other Pizza Hut franchisee. The right of first refusal, if exercised, would allow PHI to purchase the interest proposed to be transferred upon the same terms and conditions and for the same price as offered by the proposed transferee.\nThe Company has the right to develop additional Pizza Hut restaurants and delivery kitchens in its exclusive franchise territories. However, since going public, expansion by acquisition has been one of the Company's primary methods of growth. After 1990, PHI exercised its right of first refusal as described above on all proposed transactions between the Company and other Pizza Hut franchisees. In March, 1994, the Company received permission to acquire a two-unit franchise in Missouri and to acquire 17 additional units from another franchisee. Pizza Hut, Inc. nevertheless retains the right of first refusal on any proposed acquisition in the future, and the Company cannot be assured it will receive such permission on proposed future acquisitions, if any.\nPizza Hut, Inc., through the Franchise Agreements, requires principals of the Company to maintain \"control\" over the Company, which PHI defines as 51% of the voting securities of the Company. Accordingly, a portion of the controlling stockholder's shares is restricted to insure compliance with this requirement. Holders of common stock who are not principals of the Company are not subject to any of the restrictions of the Franchise Agreements.\nAdvertising and Promotion\nThe Company is required under its Franchise Agreements to be a member of the International Pizza Hut Franchise Holders Association, Inc. (\"IPHFHA\"), an independent association of substantially all PHI franchisees. IPHFHA requires its members to pay dues, which are spent primarily for national advertising and promotion. Current dues are 2% of restaurant net sales and net delivery sales. Dues may be increased up to a maximum of 3% by the affirmative vote of 51% of the members. A joint advertising committee, consisting of two representatives each from PHI and IPHFHA, directs the national advertising campaign. PHI is not a member of IPHFHA but has agreed to make contributions with respect to those restaurants it owns on a per-restaurant basis to the joint advertising committee at the same rate as its franchisees (less IPHFHA overhead).\nThe Franchise Agreements also require the Company to participate in cooperative advertising associations designated by PHI on the basis of certain marketing areas defined by PHI. Each Pizza Hut restaurant, including restaurants operated by PHI, contributes to such cooperative advertising associations an amount currently equal to 2% of gross sales. Certain of the Company's Franchise Agreements provide that the amount of the required contribution may be increased at the sole discretion of PHI. The cooperative advertising associations are required to use their funds to purchase only broadcast media advertising within their designated marketing areas. All advertisements must be approved in writing by PHI, except with respect to product or menu item prices.\nSupplies and Equipment\nThe Franchise Agreements require the Company to purchase all equipment, supplies and other products and materials required in the operation of its restaurants and delivery kitchens from suppliers who have been approved by PHI. PepsiCo Food Systems, Inc. (\"PFS\"), a wholly-owned subsidiary of PepsiCo, offers purchasing and distribution services to the Company and substantially all other Pizza Hut franchisees. Although the Franchise Agreements only require the Company to purchase certain spice blends from PFS or another supplier designated by PHI, the Company currently purchases substantially all of its food products and supplies from PFS and may continue to do so. The Company believes, however, it would not experience difficulties in obtaining its required food products and supplies from other sources. The Franchise Agreements limit the amount of profit that PHI and PFS may realize on sales to Pizza Hut franchisees. PHI is a wholly-owned subsidiary of PepsiCo, Inc., and most of the Pizza Hut units sell Pepsi Cola and other PepsiCo, Inc. beverages, but the Company is not obligated to purchase any such products.\nCompetition\nThe restaurant business is highly competitive with respect to price, service, location, food quality and presentation, and is affected by changes in taste and eating habits of the public, local and national economic conditions and population and traffic patterns. The Company competes with a variety of restaurants offering moderately priced food to the public, including other pizza restaurants. The Company also competes with locally-owned restaurants, which offer pizza as well as many other types of popularly priced food. The Company believes other companies can easily enter its market segment, which could result in the market becoming saturated, thereby adversely affecting the Company's revenues and profits. There is also active competition for the type of commercial real estate sites suitable for the Company's restaurants.\nIn the delivery portion of the segment, Pizza Hut is not currently the dominant concept.\nEmployees\nAt March 29, 1994, the Company's Pizza Hut operations had approximately 8,400 employees, including 149 headquarters and staff personnel, two vice presidents, seven regional managers, 46 area general managers, 870 restaurant management employees and approximately 7,326 restaurant employees (of whom approximately 80% are part-time). The Company experiences a high rate of turnover of its part-time employees, which it believes to be normal in the restaurant industry. The Company is not a party to any collective bargaining agreements and believes its employee relations to be satisfactory. The maintenance and expansion of the Company's restaurant business is dependent on attracting and training competent employees. The Company believes that the restaurant manager plays a significant role in the success of its business. Accordingly, the Company has established bonus plans pursuant to which certain of its supervisory employees may earn cash bonuses based upon both the sales and profits of their restaurants.\nTrade Names, Trademarks and Service Marks\nThe trade name \"Pizza Hut\" and all other trademarks, service marks, symbols, slogans, emblems, logos and designs used in the Pizza Hut system are owned by Pizza Hut, Inc. All of the foregoing are of material importance to the Company's business and are licensed to the Company under its Franchise Agreements for use with respect to the operation and promotion of the Company's restaurants.\nSeasonality\nThe Company's Pizza Hut operations has not experienced significant seasonality in its sales.\nSKIPPER'S OPERATIONS\nRestaurant Format\nSkipper's operates and franchises restaurants primarily under the name Skipper's Seafood 'n Chowder House. Skipper's restaurants feature a limited quick-service menu, featuring fish, shrimp, clams and other seafood items. The nautical decor of the restaurants is casual, suitable for family dining. With its limited-service format, all meal orders are taken at the cash register. Beginning in fiscal 1994, some entrees are cooked in advance and held in a special holding area to maintain food at the proper temperature. Customers pick up these ready-made entrees, as well as their drinks, chowder and salads from the front counter and carry them to their table. If cooked to order, entrees are delivered to the customer when prepared.\nThe Company operates or franchises restaurants in 12 states and internationally as follows:\nUnit Development\nThe following table sets forth information concerning the growth in the number of Skipper's Company-owned and franchised restaurants.\nMenu and Food Preparation\nSkipper's emphasizes high quality seafood and poultry products. Food is cooked either at the time or in advance of each order. Much of the necessary food preparation, such as filleting and breading seafood products and preparing clam chowder, is performed on the restaurant premises several times a day.\nSeafood entrees on Skipper's menu include fish fillets, scallops, shrimp and clams. All of Skipper's fried entree items are deep fried in pure vegetable shortening. The restaurants also serve baked or broiled fish. Skipper's menu also includes clam chowder, french fried potatoes, baked potatoes, coleslaw, entree salads and fish and chicken sandwiches.\nBeer is served at most restaurants. Skipper's believes that beer, which accounts for only a small portion of revenues, is important in attracting and maintaining its adult customer base and increasing food purchases.\nSupplies and Equipment\nSkipper's ability to maintain consistent quality throughout its chain of restaurants depends upon acquiring food products, other consumables, and other products from reliable sources. To most effectively achieve this consistency and to reduce the costs of products, Skipper's contracts centrally for all major raw food, paper products and other restaurant supplies through its purchasing department. Skipper's negotiates directly with a processor or manufacturer (and will do so on behalf of franchisees if franchisees so desire) and then contracts with a distributor for company-wide distribution. Skipper's also centralizes purchases of restaurant equipment for its company-operated restaurants and for such franchisees as may wish to use this service.\nSkipper's is generally not dependent upon any one supplier for availability of its products because its food and other products are available from a number of acceptable sources. Skipper's has a policy of maintaining alternate suppliers for most of its baseline products.\nFranchising\nSkipper's commenced franchising in 1978 and now has 18 franchised units located in twelve states and British Columbia, Canada.\nSkipper's franchise program was designed both for single unit owner\/operators and for multi-unit franchise owners who would operate several Skipper's restaurants. There were no outstanding agreements with any franchise owner for the development of additional franchise restaurants at March 29, 1994.\nThe franchise owners paid an initial franchise fee of $10,000. In addition, Skipper's receives a royalty of 4.725% on the first $500,000 in annual gross revenues and 5% of revenues over $500,000 of each franchise restaurant. In addition to these payments, franchise restaurant owners are also required to pay Skipper's an amount equal to 0.8% of gross revenues for administration of the advertising program.\nSkipper's has currently suspended new domestic franchising while it concentrates on concept refinement.\nSupervision and Control\nSkipper's restaurants are open seven days a week and serve both lunch and dinner. Each of the restaurants has a manager and an assistant manager who are responsible for daily operations of the restaurant, including food preparation, quality control, service, maintenance, personnel, and record keeping. All of the Skipper's restaurant managers have completed a comprehensive management training program. Each area general manager is responsible for approximately six restaurants. Detailed operations manuals reflecting current operations and control procedures are provided to each restaurant and district manager as well as others in the organization.\nA point-of-sale cash register system was placed into operation in all company-operated restaurants in 1986. It provides cost savings through the use of detailed product and consumer information. The system provides detailed information daily to assist management in decision making.\nAccounting is centralized in Pittsburg, Kansas. Additional financial and management controls are maintained at the individual restaurants, where inventory, labor and food data are recorded to monitor food usage, food waste, labor costs, and other controllable costs.\nAdvertising\nWith customer research as an information base, the marketing department directs sales program development, advertising, public relations, field marketing activities, menu pricing and content, restaurant decor and product packaging.\nSkipper's advertising programs are developed by the Company's central marketing department and agency. Television, radio and direct mail are the primary advertising media, with a creative focus on product quality and value-pricing.\nCompetition\nIn general, the restaurant business is highly competitive and its often affected by changes in taste and eating habits of the public, local and national economic conditions affecting spending habits, population and traffic patterns. The principal basis of competition in the industry is the quality and price of the food products offered. Site selection, quality and speed of service, advertising and attractiveness of facilities are also important.\nSkipper's restaurants compete with moderately priced and fast food restaurants located in their respective vicinities as well as seafood chain restaurants in Skipper's market areas.\nEmployees\nAt March 29, 1994, Skipper's operations had approximately 2,800 employees including 27 headquarters and staff personnel, 4 regional managers, 27 area general managers, 1 franchise manager, 321 restaurant management employees and approximately 2,420 restaurant employees (of whom approximately 80% are part-time). Skipper's experiences a high rate of turnover of its part-time employees, which it believes to be normal in the restaurant industry. Skipper's is not a party to any collective bargaining agreements and believes its employee relations to be satisfactory.\nTrade Names, Trademarks and Service Marks\nThe trade name \"Skipper's\" and all other trademarks, service marks, symbols, slogans, emblems, logos, and designs used in the Skipper's restaurant system are of material importance to Skipper's business. Further, Skipper's licenses these marks to its franchisees under its franchise agreements for use with respect to the operation and promotion of their Skipper's restaurants.\nSeasonality\nSkipper's sales and earnings are usually slightly higher immediately before Christmas and during Lent (March \/ April).\nTONY ROMA'S OPERATIONS\nRestaurant Format\nRomacorp, Inc. operates and franchises casual-themed restaurants under the name Tony Roma's A Place For Ribs. The restaurants offer a full and varied menu, including ribs, salads, steaks, seafood, chicken and other menu items. The decor of the restaurants is casual, suitable for family dining. Recent renovations and new restaurants feature brighter lighting and decor packages to attract a broader segment of customers. All entrees are prepared to order. The location of the Company-owned and franchised restaurants is as follows:\nRomacorp operates two of its restaurants as joint ventures. In general, the Company receives a fee for managing the restaurants and remits to the partners an agreed-upon percentage of gross sales. In the event the restaurants do not generate sufficient cash flow, the Company funds the deficit necessary to provide sufficient working capital and partner distributions.\nUnit Development\nThe following table sets forth information concerning the growth in the number of Tony Roma's Company-owned and franchised restaurants. Information provided for periods prior to the acquisition of Tony Roma's by the Company is reported based on the concept's prior fiscal years.\nMenu and Food Preparation\nAll entrees served at Tony Roma's restaurants are prepared to order. To the extent possible, food is partially prepared in advance to reduce cooking time and assure a pleasurable dining experience. Its menu includes ribs, steak, chicken, seafood, sandwiches and salads. Tony Roma's signature product, barbecued baby back ribs, and other rib dishes account for about 45% of food sales. Guest checks average from approximately $9.00 for lunch and $13.00 for dinner. Alcohol beverages are is served in all restaurants, and accounts for approximately 13% of sales.\nSupplies and Equipment\nTo assure consistent product quality and to obtain quantity discounts, Tony Roma's purchases its food and restaurant equipment from its operations office in Dallas, TX. The Company negotiates directly with meat processors for its ribs inventory, which is maintained in two warehouses in Iowa. Inventory is then shipped to restaurants via two commercial distributors. Produce and dairy products are obtained locally. Tony Roma's food and equipment pricing is also generally available to the franchisee community.\nTony Roma's is generally not dependent upon any one supplier for availability of its products; its food and other products are generally available from a number of acceptable sources. Tony Roma's has a policy of maintaining alternate suppliers for most of its baseline products. The Company does not manufacture any products nor act as a middleman.\nFranchising\nAlthough the first Tony Roma's opened in 1972, franchising wasn't a key element of Tony Roma's growth strategy until 1984. At March 29, 1994, the Company had 60 franchisees operating 137 units world wide. The largest franchise holder operates a chain of 10 Tony Roma's restaurants in Japan. Although there are some individual unit franchisees, the Company seeks to attract franchisees who can develop several restaurants.\nNew domestic franchisees pay an initial franchise fee of $50,000 and a continuing royalty of 4% of gross sales. In addition, franchisees are required to contribute 0.5% of gross sales to a joint marketing account and may be required to participate in local market advertising cooperatives. All potential franchisees must meet certain operational and financial criteria.\nIn return for the domestic franchisee's initial fee and royalties, the Company provides a variety of services, including: real estate services, including site selection criteria and review\/advice on construction cost and administration; architectural services in the form of prototype designs and an in- house design team to help with decor considerations; pre-opening and opening assistance, which include an on-site training team to assist in recruitment, training, organization, inventory planning and quality control; centralized and system-wide purchasing opportunities; in-store managers training programs, coordinated and assisted advertising and marketing programs; and various administrative and training programs developed by the Company.\nInternational franchisees receive a modified version of the above services. Currently, international franchises require an initial fee of $30,000 and royalty rate of 3% of gross sales. International franchise holders also contribute 0.25% to a joint marketing account.\nSupervision and Control\nCompany operated restaurants are typically run by one general manager, two to three assistant managers and a kitchen manager. General managers report to one of seven district managers who, in turn, report to one of two regional managers. All of the Tony Roma's restaurant managers have completed a comprehensive management training program. Detailed operations manuals reflecting current operations and control procedures are provided to each restaurant and district manager as well as others in the organization.\nA point-of-sale cash register system is in place in all Company-operated restaurants. It provides cost savings through the use of detailed product and consumer information. The system is polled daily and provides detailed information to assist management in decision making. The Company anticipates installing a new state-of-the-art point of sale system in all Company-owned restaurants in fiscal 1995.\nAccounting is centralized in Pittsburg, Kansas. Additional financial and management controls are maintained at the individual restaurants, where inventory, labor and food data are recorded to monitor food usage, food waste, labor costs, and other controllable costs.\nAdvertising\nWith customer research as an information base, the marketing department directs sales program development, advertising, public relations, field marketing activities, menu pricing and content, restaurant decor and product packaging.\nCompetition\nThe restaurant industry is intensely competitive with respect to price, value, service, location and food quality. Tony Roma's has developed high brand identity within the casual theme segment and is the only national chain to focus on ribs. On a regional basis, the Company competes with smaller chains which also specialize in ribs.\nEmployees\nAt March 29, 1994, Tony Roma's operations had approximately 1,300 employees including 28 headquarters and staff personnel, 2 regional managers, 7 district managers, 124 restaurant management employees and approximately 1,138 restaurant employees (of whom approximately 80% are part-time). Tony Roma's is not a party to any collective bargaining agreements and believes its employee relations to be satisfactory.\nTrade Names, Trademarks and Service Marks\nThe trade name \"Tony Roma's\" and all other trademarks, service marks, symbols, slogans, emblems, logos, and designs used in the Tony Roma's restaurant system are of material importance to its business. The domestic trademark and franchise rights are owned by Romacorp, Inc. and international trademarks\/franchise rights are owned by Roma Systems, Inc., a wholly owned subsidiary of Romacorp, Inc. Tony Roma's licenses the use these marks to its franchisees under its franchise agreements for use with respect to the operation and promotion of their Tony Roma's restaurants.\nSeasonality\nTony Roma's does not experience significant seasonality in its revenues.\n* * * * * * * *\nGovernment Regulation\nAll of the Company's operations are subject to various federal, state and local laws that affect its business, including laws and regulations relating to health, sanitation, alcoholic beverage control and safety standards. To date, federal and state environmental regulations have not had a material effect on the Company's operations, but more stringent and varied requirements of local governmental bodies with respect to zoning, building codes, land use and environmental factors have in the past increased, and can be expected in the future to increase, the cost of, and the time required for opening new restaurants. Difficulties or failures in obtaining required licenses or approvals could delay or prohibit the opening of new restaurants. In some instances, the Company may have to obtain zoning variances and land use permits for its new restaurants. The Company believes it is operating in compliance with all material laws and regulations governing its operations.\nThe Company is also subject to the Fair Labor Standards Act, which governs such matters as minimum wages, overtime and other working conditions. A substantial majority of the Company's food service personnel are paid at rates related to the minimum wage and, accordingly, increases in the minimum wage result in higher labor costs.\nLegislation mandating health coverage for employees, if passed, will increase benefit costs since most hourly restaurant employees are not currently covered under Company plans. The Company cannot always effect immediate price increases to offset higher costs, and no assurance can be given that the Company will be able to do so in the future.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES __________________________________________________________________\nPIZZA HUT OPERATIONS\nPizza Hut restaurants historically have been built according to minimum identification specifications established by PHI relating to exterior style and interior decor. Variation from such specifications is permitted only upon request and if required by local regulations or to take advantage of specific opportunities in a market area.\nThe distinctive Pizza Hut red roof is the identifying feature of Pizza Hut restaurants throughout the world. Pizza Hut restaurants are generally free-standing, one-story buildings, usually with wood and brick exteriors, and are substantially uniform in design and appearance. Property sites range from 15,000 to 40,000 square feet and accommodate parking for 30 to 70 cars. Typically, Pizza Hut restaurants contain from 1,800 to 3,200 square feet, including a kitchen area, and have seating capacity for 70 to 125 persons.\nThe cost of land, building and equipment for a typical Pizza Hut restaurant varies with location, size, construction costs and other factors. The Company currently estimates that the average cost to construct and equip a new restaurant in its existing franchise territories (other than Los Angeles) is approximately $450,000 to $550,000, or $700,000 to $900,000 including the cost of land acquisition. The cost to construct and equip a typical new restaurant in the Los Angeles franchise area is approximately $550,000 to $650,000, exclusive of the cost of land acquisition or leasing.\nThe Company continually renovates and upgrades its existing restaurants. Such improvements generally include new interior decor, expansion of seating areas, and installation of more modern equipment.\nThe Company anticipates that the capital investment necessary for each delivery-only kitchen is approximately $85,000 in equipment and $35,000 in leasehold improvements. The cost of a customer service center is approximately $100,000 in equipment and improvements.\nThe Pizza Hut restaurants and delivery units operated by the Company at March 29, 1994, are owned or leased as follows:\nThe amount of rent paid to unrelated persons is determined on a flat rate basis or as a percentage of sales or as a combination of both. Some leases contain provisions requiring cost of living adjustments.\nThe Company's Pizza Hut operations also have 13 non-operating locations. Of these, eight are leased from unrelated parties, two are land and buildings owned by the Company, and three are undeveloped parcels of land. The Company intends to sell or sublease these locations.\nRent paid to affiliates is determined as a combination of a flat rate or as a percentage of sales in excess of specified amounts. Generally, the percentage rate is 6% where both land and buildings are leased and 3% where buildings only are leased.\nApproximately 185 leases have initial terms which will expire within the next five years. Nearly all of these leases contain provisions allowing for the extension of the lease term.\nThe Company owns its principal executive and administrative offices in Pittsburg, Kansas, containing approximately 46,000 square feet of commercial office space. In addition, the Company leases from third parties office space for its regional offices in Hagerstown, Maryland; Birmingham, Alabama; Jackson, Mississippi; Springfield, Missouri; West Lake, California; and Gulfport, Mississippi.\nSKIPPER'S OPERATIONS\nSkipper's selects all company-operated restaurant sites and must approve all franchised restaurant locations. Sites are selected using a screening model to analyze locations with an emphasis on demographics (such as, population density, age and income distribution); analysis of restaurant competition in the area; and an analysis of the site characteristics, including accessibility, traffic counts, and visibility.\nSkipper's generally locates its restaurants in commercial\/retail areas near residential concentrations rather than downtown business districts. Skipper's favors locations which are in or near regional or district shopping centers and follows a general policy of clustering its restaurants geographically to achieve economies in restaurant supervisory and advertising costs.\nThe current cost of constructing and equipping a Skipper's restaurant typically ranges from $300,000 to $400,000 for building and land improvements and $135,000 to $185,000 for equipment. The cost of land varies considerably depending on geographic and site location. Land costs vary from $150,000 to $400,000. Skipper's has developed a standardized restaurant design using a free- standing wood frame building to be situated on a one-half acre site. The design is regularly revised and refined.\nThe 188 Company-operated Skipper's restaurants at March 29, 1994, are owned and leased as follows:\nSkipper's also has 30 locations which are not currently used for Skipper's restaurants. Of these, 13 are properties leased from unrelated parties, 11 are land and buildings owned by Skipper's and six are buildings owned on leased land. Skipper's intends to sublease or sell these excess properties.\nMost of Skipper's leases contain percentage rent clauses (typically 5% to 6% of gross sales) against which the minimum rent is applied, and most are net leases under which Skipper's pays taxes, maintenance, insurance, repairs and utility costs.\nAll company-owned restaurant locations are free of major encumbrances.\nTONY ROMA'S OPERATIONS\nTony Roma's selects all company-operated restaurant sites, and must approve all franchised restaurant locations. Sites are selected using a screening model to analyze locations with an emphasis on demographics (such as, population density, age and income distribution); analysis of restaurant competition in the area; and an analysis of the site characteristics, including accessibility, traffic counts, and visibility.\nThe current cost of constructing and equipping a Tony Roma's restaurant typically ranges from $550,000 to $650,000 for building and land improvements and $200,000 to $250,000 for equipment. The cost of land varies considerably depending on geographic and site location. Land costs vary from $500,000 to $800,000. Tony Roma's has developed a standardized restaurant design using a free- standing wood frame building to be situated on a 1-1\/2 acre site. The design is regularly revised and refined.\nAll land and buildings are leased from unrelated parties on the 26 Company-operated Tony Roma's restaurants at March 29, 1994.\nTony Roma's has no excess real estate at March 29, 1994.\nMost of Tony Roma's leases contain percentage rent clauses (typically 5% to 6% of gross sales) against which the minimum rent is applied, and most are net leases under which Tony Roma's pays taxes, maintenance, insurance, repairs and utility costs.\nAll company-owned restaurant locations are free of major encumbrances.\n* * * * * *\nSee Note 7 of Notes to Consolidated Financial Statements for information with respect to the Company's lease obligations included in the 1994 Annual Report to Stockholders for the year ended March 29, 1994 (the \"Annual Report \"), which is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS __________________________________________________________________\nThe Company and its subsidiaries are engaged in ordinary and routine litigation incidental to its business, but management does not anticipate that any amounts which it may be required to pay by reason thereof, net of insurance reimbursements, will have a materially adverse effect on the Company's financial position.\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 ended March 29, 1994.\nEXECUTIVE OFFICERS OF THE COMPANY\nSee item 10, Part III, \"Directors and Executive Officers and Directors of the Registrant\" of this Form 10-K\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS __________________________________________________________________\n\"Stockholder Data\" on pages 28 of the Annual Report is incorporated herein by reference. Restrictions on the payment of dividends are incorporated herein by reference to Note 4 of the Notes to Consolidated Financial Statements on page 23 of the Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA __________________________________________________________________\nThe \"Ten Year Financial Summary\" on page 13 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 __________________________________________________________________\n\"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 14 to 17 of the Annual Report is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA __________________________________________________________________\nThe following financial statements of the Registrant and independent auditor's report set forth on pages 18 to 27 of the Annual Report are incorporated herein by reference:\nConsolidated Balance Sheets -- As of March 29, 1994, and March 30, 1993.\nConsolidated Statements of Income -- Years ended March 29, 1994, March 30, 1993, and March 31, 1992.\nConsolidated Statements of Stockholders' Equity -- Years ended March 29, 1994, March 30, 1993, and March 31, 1992.\nConsolidated Statements of Cash Flows -- Years ended March 29, 1994, March 30, 1993, and March 31, 1992.\nNotes to Consolidated Financial Statements.\nReport of Independent Auditors.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE __________________________________________________________________\nNo disagreements on accounting and financial disclosure have occurred.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT __________________________________________________________________\nThe name, age and background of each of the Company's Directors are contained under the caption \"Election of Two Directors\" on pages 2 to 3 of the Proxy Statement dated June 13, 1994, for the Annual Meeting of Stockholders to be held on July 12, 1994, as filed with the Securities and Exchange Commission on June 13, 1994 (the \"Proxy Statement\") is incorporated herein by reference in response to this item.\nThe executive officers of the Company and their current positions and ages are as follows:\nO. Gene Bicknell founded the Company and has served as Chairman of the Board since 1962. He also served as Chief Executive Officer of the Company until July, 1993.\nJ. Mitchell Boyd joined the Company as President of National Pizza on June 1, 1992 and was appointed Chief Executive Officer in July, 1993. From December, 1989 to June, 1992, Mr. Boyd pursued various personal business interests. From 1986 to December, 1989, he was vice chairman and chief executive officer of Shoney's Inc.\nMarty D. Couk joined the Company as a restaurant manager trainee in April, 1979. He served in various capacities at the Company, including Field Specialist (1982), Area General Manager (1983) and Regional Manager (1987). He was promoted to Vice President of Pizza Hut Operations in December, 1992 and Senior Vice President of Pizza Hut Operations in September, 1993.\nR. Frank Brown joined the Company as President of Skipper's in September, 1993. For the previous 17 years, he served as vice president of franchising and president of Capt. D's Seafood Restaurants, another quick-service seafood chain.\nGerald A. Brunotts joined the Company in May, 1993 to serve as President of NRH Corporation (now Romacorp, Inc.), owner and operator of Tony Roma's. From January, 1990 until May, 1993, Mr. Brunotts was a consultant to the restaurant industry. Prior to that, he was a Vice President with Shoney's Inc.\nRobert M. McDevitt joined the Company as Vice President Marketing in August, 1992. From 1990 to 1992, he was vice president marketing with Host Communications. Prior to that, Mr. McDevitt was senior vice president marketing with Long John Silvers, operator of a quick service seafood chain. Mr. McDevitt terminated with the Company in May, 1994.\nJames K. Schwartz was appointed Vice President Finance, Treasurer, Assistant Secretary and Chief Financial Officer in January, 1993. He joined the Company in October, 1991 and served as Vice President Accounting and Administration. Prior to that, Mr. Schwartz was a manager with the international accounting firm of Ernst & Young. He is a certified public accountant.\nDavid G. Short joined the Company in June, 1993 as part of the NRH Corporation acquisition and was appointed to Vice President Legal and General Counsel in July, 1993. He was vice president, legal and general counsel for NRH Corporation since September, 1990 and, previous to that, vice president-legal, general counsel and secretary of TGI Fridays, Inc.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION __________________________________________________________________\n\"Executive Compensation\" on pages 5 to 9 of the Proxy Statement is incorporated herein by reference in response to this item.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT __________________________________________________________________\n\"Principal Stockholders\" and \"Stock Ownership of Directors and Management\" on pages 2 and 5 of the Proxy Statement are incorporated herein by reference in response to this item.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS __________________________________________________________________\nAt March 29, 1994, the Company leased five properties from O. Gene Bicknell, Chairman, and one property from Gordon W. Elliott, Vice Chairman, at rental rates comparable to terms obtained from unrelated lessors. Rent expense under these leases for fiscal 1994 was $222,000. Rental paid to affiliates is determined as a combination of a flat rate or as a percentage of sales in excess of specified amounts. The percentage rate is 6% where both land and buildings are leased and 3% where buildings only are leased.\nThe Board of Directors in January, 1993, authorized the purchase of certain real estate comprised principally of ten Pizza Hut restaurants owned by Mr. Bicknell. The Company engaged an outside appraisal company to perform a MAI appraisal of the properties. The Board of Directors, upon review of the proposal and the appraisals, and with Mr. Bicknell abstaining from any participation in the vote, approved the purchase of these sites for the appraised values. At March 29, 1994, the Company had completed all transactions on these properties. Due to the delay in processing the sale of the final two properties, the Company extended a $1,000,000 loan to Mr. Bicknell during the fiscal year ended March 29,1994, all except $50,000 of which was repaid by year end.\nDuring the fiscal year ended March 26, 1991, the Company and one of its executives entered into a joint venture agreement to purchase a business aircraft for approximately $2,000,000. The purchase was funded 25% and 75% by the Company and the executive, respectively. During the fiscal year ended March 29, 1994 the Company incurred rental expense under the month-to-month lease of $258,000. Management believes the lease is at least as favorable as could be obtained from unrelated parties.\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 this Report\n1) Financial Statements\nAll financial statements of the registrant as set forth under Item 8 of this Report on Form 10-K.\n2) Financial Statement Schedules\nSchedules other than those listed above are omitted because they are not required or are not applicable, or the required information is shown in the financial statements or notes thereto. Columns omitted from schedules filed have been omitted because the information is not applicable.\n3) Exhibits (numbered in accordance with Item 601 of Regulation S-K)\nPage Number or Exhibit Incorporation Number Description by Reference to\n3.1 Restated Articles of Incorporation Exhibit 3(a) to Form S-1 Registration Statement effective August 14, 1984 File #2-91885\n3.2 Certificate of Amendment to Amended by Form 8 filed Restated Articles of Incorporation May 30, 1991 dated August 7, 1986, Certificate of Amendment to Restated of Articles of Incorporation dated July 31, 1987 and Certificate of Change of Location of Registered Office dated October 20, 1987\n3.3 Bylaws Exhibit 3(b) to Form S-1 Registration Statement effective August 14,1984 File #2-91885\n4.1 Specimen Stock Certificate Exhibit 4 to Form S-1 Registration Statement effective August 14, 1984 File #2-91885\n4.2 Specimen Stock Certificate Exhibit 4.2 to Form 10-K For Class B Common Stock filed June 16, 1992\n10.1 Standard Form of Superseding Exhibit 10(a) to Form S-1 Franchise Agreement between Registration Statement the Company and Pizza Hut, Inc. effective August 14, 1984 dated July 20, 1981 File #2-91885\n10.2 Schedule of Superseding Exhibit 10(b) to Form S-1 Franchise Agreements Registration Statement effective August 14, 1984 File #2-91885\n10.3 Franchise Agreement between Exhibit 10(c)(1) to Form the Company and Pizza Hut, Inc. S-1 Registration Statement dated January 1, 1983 for the effective August 14, 1984 West Los Angeles, California File #2-91885 franchise territory\n10.4 Letter Agreement dated February Exhibit 10(c)(2) to Form 10, 1984 between the Company and S-1 Registration Statement Pizza Hut, Inc. for the Los effective August 14, 1984 Angeles County franchise territory File #2-91885\n10.5 Blanket Amendment to Franchise Exhibit 10(d) to Form S-1 Agreements Registration Statement effective August 14, 1984 File #2-91885\n10.6 Second Blanket Amendment to Exhibit 10(d)(2) to Form Franchise Agreements dated S-1 Registration Statement as of November 18, 1985 effective November 27, 1985; File #33-1588\n10.7 Leases between the Company and Exhibit 10(e) to Form S-1 Messrs. Bicknell and Elliott Registration Statement effective August 14, 1984 File #2-91885\n10.8 Note Purchase Agreement Exhibit 10(r) to Form 10-Q between National Pizza Company filed August 4, 1988 as Seller and the Prudential Insurance Company of America and Pruco Life Insurance Company as Purchasers dated June 29, 1988\n10.9 Note Agreement between National Exhibit 10(u) to Form 10-K Pizza Company and the Prudential filed June 25, 1990 Insurance Company of America dated January 25, 1990\n10.10 Note Agreement between National Exhibit 10.10 to Form 10-K Pizza Company and Prudential Life for the year ended Insurance Company of America March 26, 1991 dated March 13, 1991\n10.11 National Pizza Company 1984 Exhibit 10(t) to Form 10-K Amended and Restated Stock filed June 25, 1990 Option Plan\n10.12 Form of Franchise Agreement Exhibit 10(x) to Form 10-K between Skipper's, Inc. and filed June 25, 1990 its franchisees\n10.13 Amended and Restated Revolving Exhibit 10(u) to Form 10-Q Credit Agreement among National filed February 9, 1990 Pizza Company, Continental Bank, N.A., Bank of Oklahoma, N.A., The Bank of Tokyo Trust Company and Continental Bank, N.A., as Agent, dated November 17, 1989\n10.14 Second Amendment to Amended Exhibit 10.14 to Form 10-K and Restated Revolving Credit for the year ended Agreement among National Pizza March 26, 1991 Company, Continental Bank, N.A., The Bank of Tokyo Trust Company, U.S. Bank of Washington, National Association, and Continental Bank, N.A., as Agent, dated February 5,\n10.15 Airplane Lease between O. Gene Exhibit 10.24 to Form 10-K Bicknell as Lessor and National for the year ended Pizza Company as Lessee dated March 26,1991 May 9, 1990\n10.16 Pyramid Project Pizza Hut Food Exhibit 10.16 to Form 10-K and Beverage Agreement dated filed June 16, 1992 August 9, 1991\n10.17 Pyramid Project Pizza Hut Exhibit 10.17 to Form 10-K Concessions Agreement dated filed June 16, 1992 August 9, 1991\n10.18 Interim Mud Island Food and Exhibit 10.18 to Form 10-K Beverage Concession Agreement filed June 16, 1992 dated May 4, 1992\n10.19 Senior Note Purchase Agreement Exhibit 10.19 to Form 10-K made by and between PM Group filed June 16, 1992 Life Insurance Company, Pacific Mutual Life Insurance Company, and Massachusetts Mutual Life Insurance Company and National Pizza Company dated May 15, 1992 (sample document)\n10.20 Third Amendment to Amended Exhibit 10-20 to Form 10-K & Restated Revolving Credit for the year ended Agreement among National Pizza March 30, 1993 Company, Continental Bank, N.A., The Bank of Tokyo Trust Company, U.S. Bank of Washington, National Association, and Continental Bank, N.A., as Agent, dated June 1, 1992\n10.21 Fourth Amendment to Amended Exhibit 10.21 & Restated Revolving Credit to Form 10-K for the Agreement among National Pizza year ended March 30, 1993 Company, Continental Bank, N.A., The Bank of Tokyo Trust Company, U.S. Bank of Washington, National Association, and Continental Bank N.A., as Agent, dated October 1,\n10.22 Fifth Amendment to Amended Exhibit 10.22 & Restated Revolving Credit to Form 10-K for the Agreement among National Pizza year ended March 30, 1993 Company, Continental Bank, N.A. The Bank of Tokyo Trust Company U.S. Bank of Washington, National Association, and Continental Bank N.A., as Agent, dated May 28, 1993\n10.23 Sixth Amendment to Amended Exhibit 10.23 & Restated Revolving Credit to Form 10-K for the Agreement among National Pizza year ended March 30, 1993 Company, Continental Bank, N.A., The Bank of Tokyo Trust Company U.S. Bank of Washington, National Association, and Continental Bank N.A., as Agent, dated June 11, 1993\n10.24 Real Estate Purchase Agreement Exhibit 10.24 between the Company and O. Gene to Form 10-K for the Bicknell regarding the sale year ended March 30, 1993 of eight Maryland properties dated March 30, 1993\n10.25 Profit Sharing Plan of National Pizza Exhibit 10.25 Company dated July 1, 1992 and to Form 10-K for the First Amendment dated January 1, 1993 year ended March 30,\n10.26 Senior Note Purchase Agreement made Exhibit 10.26 by and between Pacific Mutual Life to Form 10-K for the Insurance Company, Pacific Corinthian year ended March 30, 1993 Life Insurance Company, Lutheran Brotherhood and National Pizza Company dated March 30, 1993\n10.27 Stock Purchase Agreement dated Exhibit B to Form 8-K May 18, 1993 by and among National filed May 28, 1993 Pizza Company, NRH Corporation and selling stockholders\n10.28 Amendment #1 to the Stock Purchase Exhibit A to Form 8-K Agreement relating to the sale of filed June 23, 1993 NRH Corporation dated June 9, 1993\n10.29 Second Amendment dated October 19, Exhibit 10.29 1993, to the Profit Sharing Plan of to Form 10-K for the National Pizza Company year ended March 29, 1994\n10.30 Seventh Amendment to Amended Exhibit 10.30 & Restated Revolving Credit to Form 10-K for the Agreement among National Pizza year ended March 29, 1994 Company, Continental Bank, N.A., The Bank of Tokyo Trust Company U.S. Bank of Washington, National Association, and Continental Bank N.A., as Agent, dated December 20, 1993.\n10.31 Asset Exchange Agreement by Exhibit 10.31 and among National Pizza to Form 10-K for the Company, Pizza Hut, Inc. and year ended March 29, 1994 Pizza Hut of San Diego, Inc. dated June 7, 1994\n11 Statement regarding computation of per Exhibit 11 share earnings for the year ended to From 10-K for the March 29, 1994, March 30, 1993, and year ended March 29,1994 March 31, 1992.\n13 1994 Annual Report to Stockholders Exhibit 13 to Form 10-K for the year ended March 29, 1994\n21 List of Subsidiaries Exhibit 21 to Form 10-K for the year ended March 29, 1994\n23.1 Consent of Ernst & Young Exhibit 23.1 to Form 10-K for the year ended March 29, 1994\n99 Proxy Statement for Annual Meeting Definitive proxy of Stockholders to be held filed June 13, 1994 July 12, 1994 via EDGAR\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed for the fiscal quarter ended March 29, 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 the 13th day of June, 1994 on its behalf by the undersigned, thereunto duly authorized.\nNATIONAL PIZZA COMPANY\nBy James K. Schwartz Vice President, Chief Financial Officer, Treasurer, Assistant Secretary (Principal Financial Officer)\nBy Douglas K. Stuckey Corporate Controller (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 indicated on the 13th day of June, 1994.\nO. Gene Bicknell Chairman of the Board and Director\nGordon W. Elliott Vice Chairman and Director\nJ. Mitchell Boyd President, Chief Executive Officer and Director (Principal Executive Officer)\nJames K. Schwartz Vice President Finance, Chief Financial Officer, Treasurer and Assistant Secretary (Principal Financial Officer)\nDavid G. Short Secretary\nFran D. Jabara Director\nRobert E. Cressler Director\nJohn W. Carlin Director\n[FN] NOTES (1) On June 8, 1993, National Pizza Company acquired the stock of NRH Corporation, owner\/franchisor of Tony Roma's. Approximately $11,763,000 of the purchase price was allocated to fixed assets in the following amounts: $6,879,000 to leasehold improvements; $4,470,000 to furniture and equipment; and $414,000 to construction in progress.\n(2) Represents completion of construction.","section_15":""}
{"filename":"6948_1994.txt","cik":"6948","year":"1994","section_1":"ITEM 1. BUSINESS --------\nGENERAL\nApplied Magnetics Corporation (the \"Company\" or \"Applied Magnetics\"), incorporated in California in 1957, was reincorporated in Delaware in 1987 pursuant to a merger into a wholly owned subsidiary, also named Applied Magnetics Corporation. The reincorporation merger was approved at the Annual Meeting of Stockholders in February 1987.\nThe Company presently operates in one industry segment, namely, components for the computer peripheral industry with one major product group, recording heads for rigid disk drives.\nApplied Magnetics is a leading independent supplier of magnetic recording heads and of head stack assemblies for rigid disk drives. The Company supplies advanced inductive thin-film (\"thin-film\") disk head products, magnetoresistive (\"MR\") disk head products and ferrite disk head products, including ferrite metal-in-gap (\"MIG\") and double-MIG disk heads and head stack assemblies.\nPrior to and during fiscal 1994, the Company also manufactured and sold recording heads for tape drives which are used in the computer peripheral industry. On December 10, 1994, the Company sold its Tape Head business unit to Seagate Technology, Inc. (\"Seagate\"), pursuant to a Stock Purchase Agreement (the \"Seagate Agreement\"). The consideration paid by Seagate was $21.5 million cash, of which $1.0 million is held in escrow as a standard hold-back, for one year, to indemnify the buyer for any claims relating to the representations and warranties made by the Company in connection with the divestiture. Another $6.5 million is held in escrow pending completion by the Company of certain performance obligations to supply tape related products and services to Seagate under certain agreements. Except for those arrangements to provide tape-related products and services to Seagate, the Company is no longer engaged in the design, development, manufacture and sale of recording heads for tape drives.\nIn recent years, the Company has pursued a product strategy in which it has concentrated its resources on its disk head business with particular emphasis on thin-film and MR technologies and on developing capability for producing smaller form factor nanoslider thin-film disk heads. The Company's customers include, among others, Conner Peripherals, Maxtor, Quantum, Western Digital, IBM and NEC.\nPerformance improvements in microprocessors and the related, continuing proliferation of powerful operating systems and applications software, which require increased data storage capacity and faster data transfer rates, have resulted in increasing demand for greater data storage capacity and performance in smaller form factor disk drives. In addition, the rapid market growth of notebook and sub-notebook computers has increased demand for smaller form factor disk drives. Due to these trends, thin-film disk heads, which generally permit greater storage capacities per disk and provide higher data transfer rates than ferrite disk heads, represent one of the fastest growing segments of the recording head industry.\nThe Company has focused its long-range growth strategy on thin-film and MR disk head technologies and believes that MR disk heads, which afford greater recording densities and other performance advantages as compared to thin-film heads, represent the next important magnetic recording head technology. The Company was one of the first independent suppliers to ship test samples of MR disk heads. In fiscal 1994, the Company began shipping nanoslider MR disk heads in prototype volumes.\nThe Company believes that, overall, the market for ferrite disk heads is declining. However, advances in ferrite disk head technology have occasionally permitted storage capacities per disk, for drives using these devices, to approach those achieved with thin-film disk heads. As a result, for certain disk drive applications, the Company's advanced ferrite disk heads, including its MIG and double MIG products, have offered required performance while providing cost advantages over thin-film disk heads. During fiscal 1993, the industry experienced significant overcapacity conditions in thin-film disk head supplies and intense price competition for these products. As a consequence, many customers that had previously selected ferrite disk head products for cost reasons revised their disk head requirements and, instead, selected competitively priced thin-film products.\nMarket conditions for the disk drive industry served by the Company during fiscal year 1993 reflected rapid changes in, and more abbreviated, product life cycles, intense price erosion and excess supplies of disk drives and disk drive components, particularly thin-film disk heads. In connection with these developments and in response to significant order cancellations and reschedules and related product and technology transitions, in September, 1993, the Company recorded, for fiscal year 1994, a restructuring charge of approximately $50 million. This charge included approximately $40 million for write downs of equipment and tooling to estimated net realizable values and $10 million for costs attributable to the planned consolidation of certain of the Company's manufacturing facilities.\nDue to lower sales volume and significant production and quality problems experienced by the Company during fiscal year 1994, the Company continued to experience major operating losses and financial difficulties, including negative cash flows and significant limitations on cash and working capital during the year ended September 30, 1994.\nThe Company has taken a number of actions to reverse these difficulties, improve its cash and working capital position, reduce operating losses and return to profitability. In June, 1994, the Company announced that it had engaged Lehman Brothers, Inc., as financial advisors to assist the Company in exploring various strategic alliances and other opportunities to maximize shareholder value. In August, 1994, the Company engaged the consulting firm of Grisanti, Galef & Goldress (\"GG&G\") to provide crisis management and turnaround assistance and advice to the Company. It also appointed Mr. Craig D. Crisman, a partner in GG&G who has considerable experience in turnaround engagements, as the Company's Chief Executive Officer. Significant cost reductions have been implemented, including reductions in employment, curtailment of capital expenditures, consolidations of manufacturing activities, production and other resources and sales of excess properties and assets. The implementation of aggressive cash management practices and the Company's sale of its tape head business unit to Seagate in December, 1994, have, together with other cost reductions and control practices, improved the Company's cash and working capital resources.\nINDUSTRY OVERVIEW\nRigid disk drives are the predominant data storage device used in computers. Disk drives include one or more rigid disks onto and from which data are recorded and retrieved by recording heads positioned by an actuator to fly within micro-inches of one or both sides of each disk. A recording head (or \"slider\") attached to a flexure or suspension arm comprises a head gimbal assembly (\"HGA\"). Multiple HGAs, assembled together with other components, comprise a head stack assembly (\"HSA\"). Although some drive manufacturers assemble HSAs from HGAs purchased from head manufacturers, the Company has experienced increased demand for disk head products in the HSA configuration.\nDisk drive manufacturers develop a variety of different drive programs to meet different design, performance and cost requirements. Magnetic recording head suppliers, such as the Company, work with drive manufacturers to determine the performance characteristics required for the heads to be used in a new drive design and develop customized heads and HSAs for each drive program. Head suppliers seek to have their heads \"designed-in\" for a particular drive program and to become qualified as a primary supplier for the new drive. Achieving such a \"design-in\" position is usually a significant competitive\nadvantage relative to suppliers who are not initially qualified on the new drive program.\nThe development and commencement of production of disk head products for a new drive program involves major expenditures for product design, production engineering and capital equipment. Often, certain production processes must also be adjusted to accommodate the unique specifications of the new design. While the Company has been successful in achieving design- in status on some disk drive programs during fiscal 1994, it has experienced production yield, quality and manufacturing difficulties on some disk head products which have adversely affected its ability to obtain the desired production ramp levels on a timely basis. These difficulties also led to unfavorable financial conditions, including significant operating losses and limitations on cash and working capital resources. The Company has taken a number of steps to improve yields, reduce costs and strengthen its cash and working capital resources. However, the disk head industry is intensely competitive and if these production problems and the related financial conditions, including operating losses and limitations on capital resources, continue or reoccur, the Company's ability to successfully achieve design-in positions on future, new disk head products and its ability, once having achieved design-in status on such products, to execute on production programs could be adversely affected. Accordingly, there are no assurances that the Company will be able to continue these design-in successes. Further, its financial difficulties, limited resources and aggressive cash management\/cost reduction activities may limit or delay the Company's ability to direct sufficient technical, research and other resources, on a timely basis, to new products or new generations of existing products in response to customer demands.\nTECHNOLOGY\nMagnetic recording heads are electromechanical devices that record (\"write\") data onto and retrieve (\"read\") data from the magnetic layers of digital data storage media, either disk or tape. The principal elements of an inductive magnetic recording head are a magnetic core, which is interrupted by a non-magnetic gap, and an electrically conducting coil wrapped or deposited in turns around the core. To write data, a current is passed through the coil, thereby inducing a magnetic field in the core. Since the core is interrupted by a non-magnetic gap, the magnetic field must \"fringe\" out from the gap, and in doing so, it magnetizes a segment of the media. Reversing the direction of the current reverses the polarity of the next magnetized segment of the media, thus allowing data to be encoded as a pattern of reversing polarities. To read data, the previously encoded media is passed by the head and the reversing magnetic polarities induce reversing magnetic fields in the core. These reversing magnetic fields in the core generate correspondingly reversing\ncurrents in the coil which are sensed and decoded by the drive circuitry.\nDisk drive storage capacity and performance are largely determined by the magnetic properties and interface of the recording head and disk. The number of coil turns and magnetic materials of the recording head are each optimized to achieve required performance. The number of coil turns and coil pitch characteristics (including the geometry of the coils and the distance between the coils) are selected to provide appropriate writing and maximum read-back signal levels. Higher densities require that the head fly both closer to the disk and at more uniform flying heights across the disk. This is influenced by the size and mass of the head and its hydrodynamic characteristics.\nGenerally, rigid disk drives use either ferrite or thin-film heads. Historically, ferrite disk heads have represented more cost-effective design alternatives for rigid disk drives than thin-film disk heads. However, as demand for high performance, small form factor rigid disk drives has grown, there has been a corresponding increase in demand for disk heads that provide higher areal densities and data transfer rates. This technology and market shift has resulted in disk head specifications that increasingly require higher performance thin-film heads. For certain disk drive applications, technology advances and improvements relating to MIG and double MIG disk head designs and production processes have occasionally allowed, and may, in the future allow ferrite disk heads to serve as a design alternative to thin-film disk heads, with competitive or enhanced price-performance characteristics. However, due to the increasing supply of competitively priced thin-film disk heads and the tendency of many major disk drive customers to select thin-film products rather than ferrite disk heads, the Company continues to expect that on an overall basis, demand for these devices will continue to decline.\nFerrite disk heads incorporate either conventional ferrite technology or ferrite-MIG technology. Conventional devices are constructed with a material which is limited to relatively low levels of magnetic field strength and attempts to produce stronger magnetic fields limit disk head performance at higher areal densities. MIG construction overcomes this limitation and allows the device to produce much stronger magnetic fields without saturation, thus permitting operation at much higher areal densities.\nThin-film head technology offers several performance advantages over ferrite technology, primarily higher areal densities, improved signal-to- noise ratios and higher data transfer rates. Thin-film heads are produced with processes adapted from semiconductor manufacturing operations in which\nthin-films of magnetic, conductive and insulating materials are deposited on a non-magnetic substrate to form the magnetic core and the electrical coils of the head. This process permits a greater degree of precision and repeatability, greater miniaturization and lower mass than can be achieved with ferrite production methods in which the electrical coil is usually hand-wound on a machined ferrite core.\nThe Company believes that MR disk heads represent the next important magnetic recording head technology. In contrast to an inductive disk head, which is designed to \"read\" and \"write\" data using a simple inductive element, an MR disk head uses an inductive element to \"write\" data onto the media and a separate MR element to \"read\" data from the media. The MR read element incorporates a magnetoresistor whose electrical resistance changes in the presence of a magnetic field. As the encoded media is passed by the read element, the disk drive circuitry senses and decodes the changes in electrical resistance caused by the reversing magnetic polarities. The greater sensitivity of MR read elements provides higher signal output per unit of recording track width on the media surface. As a result, MR disk heads have certain design and performance advantages over inductive heads, particularly in high performance small form factor disk drive applications. In addition, MR disk heads can read data from a rotating disk independent of the speed of rotation, thus allowing these devices to read data more reliably from small form factor disk media in which linear velocities are inherently lower. MR disk heads also allow for optimization of read and write gaps independently. This cannot be accomplished with inductive heads which incorporate a single gap for both read and write functions.\nPRODUCTS\nTHIN-FILM AND MR DISK HEADS. The Company currently produces thin-film HGAs and HSAs in nanoslider and microslider form factors. During fiscal 1994, the Company became qualified and began to make volume production shipments on a number of new disk drive programs, some of which require nanoslider thin-film products. The Company's thin-film microslider and nanoslider products are produced in volume for 3.5-inch disk drives to achieve areal densities of up to approximately 300 megabits of data per square inch. The nanoslider disk drive programs for which the Company has become and is seeking to become qualified are primarily for high capacity, low profile 3.5-inch disk drives for use in workstations and next generation personal computers, and for 2.5-inch and smaller form factor drives for use in notebook products.\nDevelopment and commercialization of MR disk heads continued to be a major focus for the Company in fiscal 1994. During fiscal year 1994, the Company continued to ship prototype and qualification samples of MR disk head products to selected customers for drive applications with recording densities of up to 650 megabits per square inch.\nThe Company has also made important progress in the design and production of new, advanced thin-film disk heads including higher efficiency products which increase the output signal for a given number of coil turns. Advances have also been made in the Company's efforts to develop and offer thin-film and MR disk heads with fully etched air bearing (\"FEAB\") or other negative air pressure bearing surfaces. The implementation of these designs and processes improves production yields and enhances the hydrodynamic characteristics of the disk heads, allowing the head to fly at lower, more uniform heights, thus contributing to higher areal densities.\nFERRITE DISK HEADS. The Company offers primarily ferrite-MIG HGAs and HSAs in microslider and minislider form factors. The use of ferrite heads in high performance disk drives presents technological challenges. However, advances in MIG technology resulted in situations in which certain ferrite disk heads are more competitive, for certain drive applications, than thin-film products. While certain ferrite disk head designs may still be utilized in selective disk drive programs thus providing a limited market for the Company's ferrite disk head products, on a case-by-case basis, the Company believes that overall demand for ferrite disk heads continues to decline. Further, because the Company's thin-film disk head production is vertically integrated, the Company believes that obtaining sales of thin-film products generally represents more attractive opportunities for revenue growth and profit improvement than ferrite disk head business.\nTAPE HEADS. During fiscal 1994, through its Tape Head business unit, the Company supplied various metal-core tape heads for both conventional one-half inch open reel and QIC tape drives and IBM-compatible 18-track MR heads for one-half inch cartridge tape drives and was involved in the development and production of MR tape heads for QIC tape drives. The Company's sales of tape heads for the year ended September 30, 1994, represented 6.8% of consolidated net sales. The Company sold this business unit to Seagate on December 10, 1994. However, pursuant to certain ongoing contractual arrangements, it will continue to sell to Seagate various tape- related goods and services.\nCUSTOMERS AND MARKETING\nThe Company's customers include, among others, Conner, Maxtor, Quantum and IBM. The Company's top four customers\naccounted for 86% of the Company's net sales in the year ended September 30, 1994. Conner, Maxtor, Quantum and IBM represented approximately 53%, 13%, 10% and 10%, respectively, of net sales during the year ended September 30, 1994. During fiscal 1993, Conner, Maxtor, Quantum and IBM represented approximately 21%, 28%, 18% and 17%, respectively, of net sales.\nDue to the small number of disk drive manufacturers and computer system companies requiring independent sources of supply for magnetic recording heads, the Company's customer base is likely to remain concentrated. In addition, the customer base may become more concentrated when, as and if disk drive manufacturers that do not have their own internal capabilities for designing and producing disk heads adopt and implement further vertical integration strategies. See \"Competition\". While the Company believes that industry conditions and economic factors will continue to create an environment in which drive manufacturers will require, as their primary source of supply, independent suppliers of magnetic recording heads and in which vertically integrated disk drive and systems companies will require alternative or \"secondary\" sources of supply, the further consolidation or integration of one or more of the Company's major customers with other disk drive or disk head firms could have an adverse effect on the Company's business.\nMaxtor has recently announced continuing operating losses and significant actions to reorganize and consolidate its operations. If these or other similar developments restrict or limit the development of major, new disk drive programs for which the Company anticipates supplying disk heads or prevent this customer from completing existing, major disk drive programs for which the Company supplies disk heads, such matters could have an adverse affect on the Company's business.\nThe Company believes that the most effective means of marketing and selling magnetic recording disk heads is by establishing close customer relationships at the engineering level, which permits technical collaboration and may result in the Company's heads being designed-in for particular drives. Through its product planning and marketing efforts, the Company seeks to identify those high performance disk drive programs that it believes will achieve high volume and concentrates its engineering resources on these programs.\nThe Company's magnetic recording disk heads are sold in the United States and foreign countries by its direct sales personnel and through its subsidiaries in Singapore, Malaysia and Ireland. Some of the Company's United States sales activities are conducted through independent sales representatives. Historically, the Company sold its products in Japan through its Japanese subsidiary. As of December 1992, in accordance with a License and Technology Development Agreement (\"HML Agreement\")\nbetween it and Hitachi Metals, Ltd. (\"HML\"), the Company granted certain exclusive marketing rights in Japan to HML and retained rights to market products to only one Japanese manufacturer.\nThe Company has been successful in achieving some design-in positions with certain customers on certain disk drive programs. However, in the past, the Company has experienced difficulties in consistently achieving design-in positions. Further, in some cases its products have not achieved the technical, performance or pricing objectives required by the customers. In fiscal 1994, having achieved design-in positions on certain programs, the Company experienced significant production yield and quality problems which led to significant operating losses and, in some cases, the Company was not able to deliver production volumes in accordance with the delivery schedules to which it had initially agreed. Accordingly, there can be no assurance that the Company will successfully obtain design-in positions on a sufficient number of the new disk drive programs that it is currently pursuing or that it expects to pursue, or that, after having achieved this position on any given customer program, it will not experience difficulties in obtaining desired levels of production volumes on a timely basis. The failure to secure and satisfactorily perform against orders for volume shipments of thin-film disk heads could result in customer cancellations, reschedules and diversion of certain orders to the Company's competitors. To the extent any significant orders for the Company's thin-film disk heads are canceled, rescheduled or diverted, such actions could have an adverse effect on the Company's operations.\nRESEARCH AND DEVELOPMENT\nThe Company commits substantial resources to research and development in order to meet its customers' continuing demands for higher performance disk heads for successive disk drive product families. The Company has augmented its research and development programs with the financial and technical resources of certain strategic partners. In addition to the HML Agreement, the Company has pursued joint product development agreements with certain major disk drive manufacturers for MR disk head development. Under the HML and other agreements, the Company recognized as income $14.1 million and $15.1 million in fiscal years 1994 and 1993. The development effort under two of the agreements with the disk drive companies was completed or substantially completed by the end of fiscal 1994, development efforts are continuing under one agreement and have been suspended under another agreement.\nResearch and development expenses totaled $38.8 million in fiscal 1994, before giving effect to $14.1 million in development funding that was recognized as cost offsets. Research and\ndevelopment expenses in fiscal 1993 totaled $32.6 million, before giving effect to $15.1 million in development funding that was recognized as cost offsets.\nResearch and development activities relate to creating technological advances required for new product development and the advancement of production processes required in new product production (e.g. development of smaller form factor products, advanced coil structures, constant flying height technologies and the development of MR technology). In addition, development activities focus on conceptual formulation, design and testing of new product alternatives and construction of prototypes. Substantially all research and development activities relating to disk head products are performed at the Company's Goleta, California operations. A dedicated group of engineering and technical personnel has focused on product design and process development for the Company's MR disk head products. In addition, the Company also has engineering and technical staff dedicated to various production operations to provide manufacturing process and integration support for nanoslider products.\nWhile demand for nanoslider thin-film disk heads was strong during fiscal 1994, during this year the Company experienced production yield, quality and manufacturing difficulties. As a result, on some programs it was not able to ramp production volumes to desired levels in order to satisfy scheduled deliveries. These conditions, in turn, resulted in loss of revenues and operating losses during fiscal 1994. While the Company has taken, and is taking, a number of actions to improve the efficiency, quality and timeliness of the process by which its new and emerging products and product designs transition from the development stage into volume production, there are no assurances that this process may be adversely affected by similar problems or difficulties that might arise with respect to other new products or technologies that the Company may pursue in the future.\nThe Company's technology development is primarily devoted to commercialization of MR disk head technology. The Company has been developing MR technology since 1979. The Company expended $33.6 million in MR disk head development in fiscal year 1994, and expects to expend approximately an additional $53.0 million through the end of fiscal 1995. The expenditures in 1993 and 1994 were partially offset by payments received under the HML Agreement and the joint product technology development agreements with four disk drive manufacturers described above.\nThe Company does not currently have any ongoing technology development agreements which provide for it to receive any significant payments during fiscal 1995, for research and\ndevelopment efforts relating to MR products or other new or advanced technology disk head products. While it may continue to consider and pursue opportunities relating to such arrangements, it believes that its existing cash resources and expected operating results will provide sufficient financial resources, on an independent basis, to fund its ongoing MR research and development activities in a manner consistent with its current operating plans.\nUnder the HML Agreement, the Company has granted to HML an exclusive, non-transferable license to use the Company's technology to manufacture in Japan thin-film, MR and certain ferrite disk head products, HSAs, HGAs and components (the \"Licensed Products\") and a nonexclusive license to have Licensed Products made by HML subsidiaries and affiliates worldwide. Additionally, the Company has granted HML and its subsidiaries and affiliates certain exclusive rights to market and sell Licensed Products to disk drive and head manufacturers in Japan and has retained exclusive marketing rights to Licensed Products and improvements to Licensed Products in the rest of the world. HML has paid the Company $35 million, net of $1.0 million in Japanese withholding taxes, for joint development, and related licenses, for thin-film and MR disk head technology. In addition to this funding, HML is contributing engineering personnel, technology and know-how to the joint development program.\nMANUFACTURING\nThe Company's thin-film and ferrite heads have different \"front-end\" or slider fabrication processes but similar \"back-end\" suspension assembly processes.\nFRONT END FABRICATION\nTHIN-FILM. Thin-film heads are manufactured using a semiconductor- like fabrication process in which the coil and other critical structures of the magnetic sensor are created utilizing photolithography, vacuum deposition, wet chemical etching and precision electroplating technologies. The Company's fabrication process uses both three-inch and six-inch round non-magnetic ceramic wafers made of alumina titanium carbide. Six-inch wafers can produce 4.5 times more microsliders than three-inch wafers and six times more nanosliders than three-inch wafers. Volume production of six-inch wafers commenced in September 1992 and by September 1994 constituted over 80% of the Company's thin-film slider production. During the second quarter of fiscal 1994, the Company completed construction of a six-inch wafer fabrication facility for the volume production of MR heads.\nIn fiscal 1995, the Company will discontinue producing wafers for its thin-film and MR disk head products from its older, 3 inch lines and all wafers for thin-film and MR disk heads will be produced from 6 inch lines. This action is expected to improve production efficiencies and reduce costs.\nThe Company fabricates all of its wafers at its Goleta, California facilities. The wafer moves through a sequence of processes employing photolithography, electroplating and sputtering techniques to deposit and form the magnetic elements of several thousand heads in thin-film layers on the surface of the wafer. The magnetic elements are made by depositing as many as twenty-one layers of various materials including gold, copper, and alloys of nickel and iron, using photo masking and selective etching techniques. Finished wafers are then tested, at the Goleta facilities, and sliced into \"rows\". These \"rows\" are then mounted on bars that serve as holding fixtures and then shipped to the Company's Malaysian facilities for further processing as a result of which approximately 1,000 or 1,800 sliders can be produced from three-inch wafers and 4,500 or 8,400 sliders from six-inch wafers, depending on whether microsliders or nanosliders are being manufactured. Each slider is ground and lapped to small tolerances in order to achieve the electromagnetic capabilities and hydrodynamic characteristics specified for the completed head.\nThe production yield, quality and manufacturing difficulties experienced by the Company during fiscal 1994 included problems relating to its ability to produce wafers for thin-film disk heads with acceptable production yields from the Company's six-inch line. The Company has implemented additional manufacturing and process control procedures and other steps which resulted in improved yields in its wafer fabrication activities, including the six-inch line, during the last quarter of fiscal 1994, and continuing into the first quarter of 1995. While the Company will continue to monitor these control procedures and implement new or supplemental manufacturing and control procedures to sustain wafer yields at acceptable levels, there can be no assurances that its efforts to maintain production yields at acceptable levels will not be adversely affected by similar or other difficulties that may arise with respect to new products, new product designs or changes in manufacturing processes which would result in lower than acceptable production yields. To the extent, if any, the Company's ability to execute customer orders is adversely affected by lower than acceptable production yields or other difficulties, the Company's ability to generate sufficient cash flows from operations to meet its operating and capital expenditure requirements consistent with management's intentions to return the Company to profitability by the end of fiscal 1995 could be adversely affected.\nThe Company expects that demand for thin-film disk head products will continue to increase. The Company's ability to achieve desired increases in production output levels from its six inch wafer fabrication line in order to respond to increased market demands in its thin-film products is, to a large extent, dependent on its ability to fund capital expenditures needed to improve and refine certain processes and process equipment. If, because of restrictions on cash and other capital resources, the Company is unable to obtain the required funds in sufficient amounts and at required times, its future revenues could be adversely affected.\nThe Company believes that demand for disk heads with FEAB or other negative air pressure bearing surfaces, which enhance the hydrodynamic characteristics of the disk heads, will increase and that it has made important progress in its efforts to develop processes relating to these designs and in implementing these designs in a number of its thin-film disk head programs. The Company is also converting some of its conventional processes and equipment so as to increase its capabilities in this area. However, circumstances may arise in which the demand for disk head products with these features may exceed, on a temporary basis, the Company's manufacturing capacity.\nFERRITE. Ferrite disk heads consist of a polycrystalline or single crystal ferrite core bonded to a slider body. The slider body is manufactured from ferrite (monolithic) or non-magnetic ceramic (composite) materials and is processed through several high precision grinding and lapping operations. The Company purchases its requirements of both monolithic and composite ferrite sliders from outside vendors. These sliders are delivered to facilities in Korea, Malaysia or China where the coils are wound with fine copper wire using either manual or automatic processes. Procurement of sliders from established vendors allows the Company to avoid making capital expenditures for ferrite slider production capacity.\nBACK-END ASSEMBLY\nSliders are attached to a stainless steel suspension, forming an HGA. The Company performs assembly and testing of thin-film and ferrite HGAs at its facilities in Ireland, Korea and Malaysia. Assembly and testing operations were also conducted, previously, at the Company's Singapore facility until those operations were consolidated with the Malaysian facility in the latter half of fiscal 1994. The Company has undertaken substantial capital expenditures for the mechanization of its HGA production processes, which has resulted in increased productivity, reduced critical device tolerances and improved quality. In addition to increasing manufacturing output, these improvements have resulted in more uniform performance by the Company's HGAs, which the Company believes provides it with a\ncompetitive advantage. The Company manufactures a substantial portion of its stainless steel suspension requirements at a manufacturing facility in Korea. The Company has been assembling complex ferrite HSAs since the mid- 1970s.\nFOREIGN OPERATIONS\nWith the exception of its wafer fabrication operations, and certain slider fabrication operations, which are located in Goleta, California, the Company conducts substantially all of its production, assembly and test operations at its facilities in Korea and Malaysia. Since July, 1994, following the consolidation, into its Malaysian facility, of certain assembly and test operations formerly done at the Singapore business unit, the Company's Singapore subsidiary has been engaged in customer service and support operations relating to several disk drive customers who conduct operations in that country.\nThe Company has contractual relationships with unaffiliated parties who provide manufacturing and assembly operations on a contract-labor basis for the Company in Korea and in the People's Republic of China (\"PRC\"). The PRC operations are monitored by an office maintained by the Company in Hong Kong. During fiscal 1995, the Company expects to terminate these contractual arrangements and close the Hong Kong office as it consolidates these operations at other facilities. The Company supports its European markets primarily from its facility in Dublin, Ireland.\nThe Company's operations in Korea have, from time to time in recent years, been affected by labor disruptions and slow-downs. In addition to risks of labor disruptions, civil unrest and political instability, the Company's foreign operations subject it to risks associated with obtaining governmental permits and approvals, currency exchange fluctuations, currency restrictions, trade restrictions and changes in tariff and freight rates. Further, language barriers and distances between the Company's domestic and foreign operations occasionally contribute to logistic and communication difficulties in manufacturing and production activities.\nThe Company has consolidated much of its manufacturing and assembly operations at its facility in Penang, Malaysia which, at September 30, 1994, employed approximately 3,200 persons. Because the number of employees in this region is increasing and because employers currently located in this region are expanding their operations, there may, from time to time, be situations in which there are shortages of labor resources having the desired skills and experience for the Company's operations at its Malaysian facility. These developments could adversely affect shipment levels or result in higher labor costs.\nSOURCES OF SUPPLY\nThe Company relies on Sumitomo, Ltd. as its principal supplier of substrates which are used to produce wafers for the Company's thin-film and MR disk heads and on multiple independent suppliers for photoresist, wire and other materials used in the manufacture of thin-film disk heads and ferrite sliders. Although the Company has not experienced significant limitations on the availability of these materials, shortages could occur in the future. These developments could disrupt the Company's production volume and have an adverse effect on the Company.\nBACKLOG\nThe Company receives purchase orders from its customers, or in some cases master purchase agreements, which express the customer's intentions to purchase, at stated unit prices, certain quantities of products during a specified period. Although the customers are not obligated under these agreements to purchase the total quantities, the purchase of a smaller quantity may result in an increased unit price for the number purchased. Further, some orders are subject to rescheduling provisions which permit increases or decreases in volume of shipments during a specified period. In addition, at times of supply shortages, the Company believes it is a common practice for disk drive manufacturers to place orders in excess of actual requirements. The Company has experienced cancellation and rescheduling of orders, reductions in quantities and repricing as customer requirements change.\nThe contractual arrangements between the Company and most of its customers permit the Company to assert claims for cancellation costs and expenses in these circumstances. However, the resolution of these claims is often a lengthy and extensively negotiated process, resulting in a compromise arrangement in which, among other things, the Company and the customer may agree that the claim amount to be paid is reduced or that the Company will continue to deliver and the customer will accept all or part of the canceled order over an extended period of time at reduced unit prices. The significant order cancellations and reschedules which occurred in September, 1993, resulted, generally, in compromise arrangements of this nature.\nIn previous years, particularly those in which the disk drive industry was undergoing overcapacity and intense price competition conditions, certain of the Company's customers have delayed shipment dates and requested extended payment terms and price concessions. It is possible that these circumstances could reoccur in future periods as a result of which the Company's revenues and profitability could be adversely affected. Further,\nas a result of the foregoing factors, the Company's backlog may not be indicative of product shipments in any future period.\nThe Company's backlog of unfilled orders for thin-film or ferrite disk heads and tape heads as of September 30, 1994 and September 30, 1993 is set forth below. Orders in backlog with specified delivery dates are, generally, for delivery within six months. The Company's backlog is subject to substantial fluctuations depending on the timing of orders, shipments and release dates with respect to the Company's principal customers. Further, in December, 1994, the Company completed the sale of its Tape Head operations to Seagate and following the divestiture, its production and sale of tape related goods and services will be limited to that required in order for it to comply with certain continuing contractual obligations between it and the buyer. See Item 1, \"Business - General\".\nCOMPETITION\nThe Company competes with other independent recording head suppliers, two major disk drive companies and some systems companies that produce magnetic recording heads used in their own products. In the case of thin- film heads, some systems companies who manufacture disk drives internally, such as IBM, Fujitsu and NEC (each with significantly greater financial, technical and marketing resources than the Company), are vertically integrated and produce thin-film heads for their own use. Quantum and Seagate, both of which are major independent disk drive manufacturers, and IBM occasionally make their thin-film disk head products available on the market to competing drive manufacturers.\nIn fiscal 1994, Quantum Corporation, a major disk drive manufacturer, acquired from Digital Equipment that firm's controlling interest in Rocky Mountain Magnetics, a joint venture with Storage Technology and Digital's thin-film disk head operations. Rocky Mountain Magnetics is primarily engaged in the development, production and sale of MR disk heads. Relative to Applied Magnetics, these companies have greater financial and operational resources and may have closer and faster access to disk drive technology development, thus allowing them a competitive advantage over the Company.\nHowever, the Company believes that disk drive customers and systems companies that are not vertically integrated continue to represent significant opportunities for sales of the Company's disk head products for competitive and other reasons. Moreover, the Company believes that certain vertically integrated companies will continue to rely on independent suppliers of disk head products, for competitive and other reasons, as alternative sources of supply or in some cases as primary sources of supply for discrete disk head solutions.\nThe Company believes that Read-Rite Corporation has had substantially greater sales of thin-film disk head products than the Company and is presently its primary competitor among independent thin-film disk head manufacturers. Read-Rite has formed a joint venture with Sumitomo Metal Industries, Ltd. to manufacture and distribute thin-film heads to Japanese customers. In addition, in fiscal 1994, Read-Rite acquired Sunward Technologies, Inc., a manufacturer of ferrite disk head products. While this acquisition will allow Read-Rite to compete with the Company in both product offerings, the same price-performance considerations related to offering ferrite, as compared to thin-film disk head products, for different disk drive applications, that have applied to the Company are likely to affect this competitor and may contribute to greater stability in product pricing decisions. See \"Item 1. Business, Technology\".\nKomag, a large independent supplier of disk media, Asahi Glass, a large diversified Japanese industrial concern, and Hewlett Packard Company have recently announced the formation of Headway Technologies, Inc., a joint venture to develop, produce and market MR disk heads.\nThe principal competitive factors in the markets the Company addresses are price, product performance and quality, product availability, responsiveness to customers and technological sophistication. The Company believes that it competes favorably with respect to these factors, but there is no assurance that it will continue to be able to do so. The financial difficulties experienced by the Company during fiscal 1994 and the limitations on its scientific, technical, cash and working capital resources have required the Company to impose greater focus and management controls on research and development projects and, in certain cases, to delay, postpone or curtail certain advanced technology research and development efforts. However, the Company believes that it has continued to make satisfactory progress and achievements in program-specific development efforts involving both thin-film and MR disk head products. Additional or more severe financial conditions, operating losses and restrictions on capital resources could have an adverse effect on the Company's research and development activities in these areas. The Company currently experiences limited competition from domestic U.S. independent head manufacturers in ferrite disk heads but believes that its primary competitors, TDK and its SAE subsidiary, each have revenues from ferrite disk heads comparable to those of the Company.\nIn previous years, the Company believes that its ability to offer both thin-film and ferrite disk head technologies has allowed its customers to select the desired price-performance characteristics for specific drive programs and, therefore, provided the Company a competitive advantage over those competitors with narrower product lines. However, as the turmoil and uncertainty in the industry increased in the latter part of 1993, combined with significant price erosion in thin-film disk heads, these products currently represent attractive price-performance alternatives to ferrite disk heads. As a consequence, the Company anticipates that, while there may continue to be situations in which ferrite disk heads provide a more attractive solution for particular disk drive applications, given relevant price-performance considerations, the competitive benefits of being able to offer both ferrite and thin-film disk products will be outweighed by price, performance, quality, time-to-market and other considerations involving thin-film disk heads.\nThe disk head industry is intensely competitive and largely dependent on sales to a limited number of disk drive manufacturers and systems companies. The Company's ability to\nobtain new orders depends on its ability to anticipate technological changes, develop products to meet individualized customer requirements and timely deliver products that meet customer specifications at competitive prices. The market for the Company's disk head products could be adversely affected if one or more disk drive manufacturers were to vertically integrate by acquiring disk head manufacturing capability. In addition, the disk drive industry is highly cyclical. Disk drive manufacturers may quickly lose market share as a result of the technological innovations of their competitors or various other factors. A reduction in orders from, or loss of a customer, which could occur as a result of these or a wide variety of other reasons, could have a material adverse effect on the Company's operations and financial condition, including collection of accounts receivable and realization of inventories relating to that customer.\nRECENT DEVELOPMENTS\nAs a result of its deteriorating financial condition, operating losses and declining revenues during fiscal 1994 and continuing into 1995, the Company took a number of actions intended to assure the Company's survivability, to maximize shareholder value and to set the Company on a course leading to a return to profitability. In June, 1994, the Company announced that it had retained Lehman Brothers, Inc. as financial advisors to assist in exploring strategic alliances and other opportunities to maximize shareholder value. In August, 1994, the Company announced that it had retained Grisanti, Galef & Goldress, Inc. (\"GG&G\") a consulting firm with considerable crisis management and turnaround experience, to assist the Company in its efforts to conserve and generate cash and working capital, reduce costs, stem operating losses and return to profitability. Further, Mr. Craig D. Crisman, a partner in GG&G, was appointed as President and Chief Executive Officer and as a member of the Board of Directors.\nSubstantial changes in the Company's executive management team have been implemented and significant reductions in the Company's employment force have taken place. In November, 1994, the Company announced and on December 10, 1994, it completed, the sale of its Tape Head business unit to Seagate for $21.5 million cash, of which the Company has received $14.0 million. Of the remaining funds, $1.0 million is held in escrow as a standard hold-back, for one year, to indemnify the buyer for any claims relating to the representations and warranties provided by the Company in connection with the divestiture. Another $6.5 million is held in escrow pending the completion by the Company of certain performance milestones, most of which are scheduled for completion within twelve (12) months following the sale of this business unit, under the Company's agreements to provide certain tape-related goods and services to the buyer following the sale.\nThe Company believes that all or substantially all the funds being held in escrow will eventually be distributed to it. However, if for any reason claims are made by, and resolved in favor of, the buyer to the extent that all or a significant portion of the escrowed funds are not distributed to the Company, this could have an adverse impact on the Company's liquidity.\nIn November, 1994, the Company also announced that it had entered into a commitment letter with The CIT Group\/Business Credit, Inc. (\"CIT\") for an asset-based credit facility of up to $35.0 million. The closing of the transaction, which is subject to preparation and execution of definitive loan documentation and certain other closing conditions, is expected to occur in early January, 1995.\nIn November, 1994, the Company also announced that it entered into an agreement to dismiss a securities class action suit brought against it and several present and former officers in U.S. District Court for the Central District of California. No findings or admissions of liability on the part of the Company or the named defendants have been made and the Company will not have to make any cash payments to resolve the suit. Moreover, while the Company believes the allegations in the suit are totally without merit, it will not have to undergo protracted and expensive litigation to defend the case and will, instead, be able to focus its resources, skills and energies towards operational goals and objectives. The agreement is subject to the terms of a definitive written agreement which is to be submitted to the court for preliminary approval. See Item 3, \"Legal Proceedings\".\nThe Company has also implemented consolidations of manufacturing operations at several domestic and foreign facilities which have resulted in cost reductions and the sale or expected sale of excess properties and assets. Moreover, the Company has implemented aggressive cash management practices and operating plans for fiscal 1995, that are being closely managed.\nOn the basis of these actions and other, continuing management actions that are being taken to reduce costs, limit and control capital expenditures, achieve operational objectives, resolve yield problems and production difficulties and manage cash and working capital resources, the Company's objective is to return to profitability by the end of fiscal 1995, provided there are no significant external adverse developments including, but not limited to, market conditions similar to those experienced in fiscal 1993, major consolidation of customers or competitors, significant and unanticipated technological developments or other considerations.\nINTELLECTUAL PROPERTY AND PROPRIETARY RIGHTS\nThe Company regards elements of its manufacturing process, product design, and equipment as proprietary and seeks to protect its proprietary rights through a combination of employee and third party non-disclosure agreements, internal procedures and patent protection. The Company has been issued a number of United States patents and has multiple patent applications pending. There is no assurance that patents will issue with respect to such applications or that any patents issued to the Company will protect the Company's competitive position. The Company believes its competitive position is more dependent on the technological know-how and creative skills of its personnel.\nIn addition, the Company and IBM hold cross licenses with respect to certain patents held by each of them. Such cross licenses do not include any patents filed by IBM after January 1, 1991. The Company is currently in negotiation with IBM regarding extensions of existing licenses. Further, under an agreement with Hutchinson Technology, Inc., the Company and Hutchinson hold cross licenses with respect to certain patents held by each of them concerning suspension assemblies to make, use and sell such products. The Company's purpose of entering into the Hutchinson Agreement was to avoid possible future infringements, thereby reducing the prospects for disputes and litigation. See \"Sources of Supply\".\nIn connection with the sale of its Tape Head business unit to Seagate in December, 1994, the Company and Seagate entered into a broad cross license with respect to certain patents held by each of them.\nThe Company believes that its success depends on the innovative skills and technological competence of its employees and upon proper protection of its intellectual properties. Despite the Company's protective measures, however, competitors or customers could obtain information that the Company regards as proprietary.\nThe Company has from time to time been notified of claims that it may be infringing patents owned by others. If it appears necessary or desirable, the Company may seek licenses under patents which it is allegedly infringing. Although patent holders commonly offer such licenses, no assurance can be given that licenses will be offered or that the terms of any offered licenses will be acceptable to the Company. The failure to obtain a key patent license from a third party could cause the Company to incur substantial liabilities and to suspend the manufacture of the products utilizing the patented invention.\nEMPLOYEES\nAs of September 30, 1994, the Company had approximately 5,500 employees of whom approximately 800 are located in California, approximately 4,600 are located in Asia and approximately 100 are located in Ireland. The Company believes that its future success will depend in large part upon its ability to continue to attract, retain, train and motivate highly skilled and dedicated employees. The Company's employees located in Korea are represented by a labor union, and the Company's Korean operations have, from time to time in recent years, been affected by labor disruptions and slow downs.\nENVIRONMENTAL REGULATIONS AND WATER SUPPLY RESTRICTIONS\nThe Company uses certain hazardous chemicals in its manufacturing process and is subject to a variety of environmental and land use regulations related to the use, storage discharge and disposal of such chemicals and the conduct of its manufacturing operations. The state of California recently enacted legislation generally referred to as \"permit by rule.\" This legislation requires permits for any treatment or transportation of materials considered hazardous wastes. Although the Company believes it will receive the necessary permits prior to the time required by this legislation, there is no assurance that such permits will be issued in a timely manner or at all. A failure by the Company to comply with present or future regulations, or to obtain all permits as required under such regulations, could subject it to liability or result in production suspension or delay. In addition, environmental and land use regulations could restrict the Company's ability to expand its present production facilities or establish additional facilities in other locations, or could require the Company to acquire costly equipment, or to incur other significant expenses for compliance with environmental regulations or to clean up prior discharges. The Company, which is subject to water use restrictions, uses a significant amount of water in its manufacturing process. Although to date the Company has been able to obtain sufficient water supplies without significantly increased costs, stricter water use restrictions may be mandated and additional expenditures for water reclamation and conservation may be required. The Company has been identified as a potentially responsible party at a hazardous waste facility operated by the Omega Chemical Corporation in Whittier, California. Based on Company records of shipments to this site and preliminary estimates of cleanup costs, it appears that any exposure to the Company will not be material.\nSEASONALITY\nGenerally, the Company's revenues for the first quarter (October 1- December 31) of its fiscal year tend to be lower than the last quarter of the preceding fiscal year and may be lower than those of one or more succeeding quarters. To some extent this is due to inventory and production planning and scheduling requirements imposed by some customers during the last quarter of the calendar year. This is also due to the holidays which occur during the period and related temporary plant close- downs at some of the Company's manufacturing locations during these holidays. There are occasional exceptions to this general condition. For example, during the course of a calendar year, market conditions may rapidly shift from oversupply to cutback conditions during the first half of the year to an increase in demand for products during the latter half.\nThe disk drive industry is cyclical and has been characterized by periods of intense product demand requiring high production levels followed by periods of oversupply, order cancellations, pricing pressure and reduced production levels. During periods of high demand, the Company has expanded production facilities but at times has been unable to expand facilities and hire and train production personnel rapidly enough to meet the demand for its products. Conversely, in periods of lower demand, the Company has had excess production capacity and has experienced margin declines.\nWORKING CAPITAL\nThe manufacture of recording heads, particularly thin-film and MR disk heads, is capital intensive. In fiscal 1994, revenues fell below 1993 volumes, and the Company experienced manufacturing difficulties and production yield problems. These factors combined to reduce the Company's cash balance from $49.4 million at September 30, 1993, to $20.8 million at September 30, 1994. In addition, as a result of significant operating losses and capital expenditures during fiscal 1994, at September 30, 1994, the Company had a negative working capital of $36.4 million as compared to a positive working capital of $33.9 million at September 30, 1993.\nAs a result, the Company's ability to make major capital investments in equipment, tooling and facilities to support improvements and investments in its thin-film disk head products and technology has been constrained. The Company has, however, successfully managed its working capital to make selected capital expenditures during this period. In response to these developments, in the fourth quarter of fiscal 1994, the Company implemented cost and cash expenditure controls that included staff reductions and aggressive cash management practices.\nThe Company has also negotiated accelerated payment terms with some of its key customers and is exploring other financing alternatives, including new loan and credit facilities, extensions or renewals of existing facilities, lease financing opportunities and other cash and working capital sources.\nDuring fiscal 1994, the Company experienced a net use of cash in the amount of $12.9 million for operating activities which included the receipt of $15.9 million of joint development funding received under the HML Agreement and the Development Agreements, and decreases in accounts receivable and inventory of $19.1 million and $10.9 million, respectively. During fiscal 1994, net cash from financing activities was $9.0 million, primarily from utilization of the Company's unsecured credit facility with a Malaysian bank. During this period, the Company made capital expenditures of $31.5 million, primarily related to increasing thin-film disk head production capacity and development of MR disk head technology. Additionally, the Company entered into $12.0 million of operating leases with terms of three (3) years.\nAt September 30, 1994, total debt, including notes payable, was $67.2 million, an increase of $10.0 million from the balance outstanding at September 30, 1993. The Company had fully drawn down its unsecured Malaysian credit facility to $46.1 million, which has no stated maturity but is callable on demand from a bank in Malaysia where the Company has substantial manufacturing operations. The Company also had outstanding $10.0 million under a revolving credit facility with a commercial bank. The credit facility provides for up to $10.0 million in aggregate commitments, is supported by a letter of credit issued for the account of HML, subject to reimbursement by the Company and the interest rate under this credit facility was 5.4% for the year ended September 30, 1994. This credit facility was amended to extend the maturity to March 15, 1995. All other terms of the facility remain unchanged.\nThe Company also had outstanding a $10.0 million note with Conner, pursuant to a Note Purchase Agreement, which is secured by accounts receivable arising from sales to Conner and by certain capital equipment. The underlying loan, which matures December 31, 1994, is convertible, at Conner's election at any time, into shares of the Company's Common Stock at a conversion price of $10.25 per share. On December 21, 1994, in connection with the contemplated credit agreement between the Company and CIT, described above in \"Recent Developments\", the Company and Conner entered into an agreement to extend the maturity date of the Note Purchase Agreement to the earlier of January 10, 1995, or the closing date of the CIT credit agreement.\nIn 1995, the Company plans approximately $49.0 million in capital expenditures relating primarily to its thin-film and MR disk head production capacity and development of related technologies. During the next twelve months, the Company believes that additional sources of capital will be required in order to fund the planned production ramp-up of thin- film and MR disk heads and to maintain planned levels of research and development and capital expenditure levels required for these disk head technologies. The Company has implemented an operating and cash management plan, the objective of which is to provide sufficient cash flows from operations to meet its operating and capital expenditure requirements consistent with management's intentions to return the Company to profitability by the end of fiscal 1995. Management believes that it will be able to reduce its funding requirements for planned but not committed capital expenditures required to develop and achieve volume production of certain disk head products if market demand for those products does not materialize or declines. However, if the Company is unable to increase sales and maintain production yields at acceptable levels in order to permit it to execute customer orders for the new drive programs in a manner consistent with management's intentions to return to profitability by the end of fiscal 1995, there could be a significant adverse impact on liquidity, which would require the Company to obtain additional capital from external sources. There are no assurances that such sources of capital will be available or that the terms associated with external funding sources will be satisfactory to the Company. If the Company is unable to obtain sufficient capital it would need to curtail its capital, research and development and working capital expenditures which would adversely affect the Company's future years' operations and competitive position.\nThe Company's accounts receivable and inventory balances are heavily concentrated with a small number of customers. Sales to Conner, Maxtor, Quantum and IBM accounted for 53%, 13%, 10% and 10%, respectively, of the Company's sales in 1994. If any large customer of the Company became unable to pay its debts to the Company, liquidity would be adversely affected. Further, while management has not been informed of any facts or circumstances suggesting that the Malaysian bank intends, during fiscal 1995 to cease making the Malaysian Credit Facility available, should the bank decide, for any reason, to make all or any significant portion unavailable in fiscal 1995, the Company would need to pursue alternative financing sources. Moreover, the Company has reached informal agreements and understandings with some of its customers to make payments on accelerated terms. Generally, these arrangements may be canceled at any time and the customers could revert to payments in accordance with usual and customary terms. Should one or more of these customers determine that all or a significant portion of the Company's trade accounts which are currently being paid on accelerated terms should revert to standard terms, there could be a significant impact on liquidity\nunless the Company has been able to obtain additional or supplementary sources of capital. However, this liquidity risk may be partially ameliorated by the credit available under the contemplated CIT Credit Facility under which available loan proceeds could, generally, increase as the Company's trade accounts receivable increase. See \"Recent Developments\".\nThe Company operates in a number of foreign countries. Purchases of certain raw materials and certain labor costs are paid for in foreign currencies, as well as repayments of a portion of the Company's Malaysian debt denominated in ringgitts. Raw material purchases in yen are selectively hedged. The Malaysian debt maturities are also hedged. The Company effects these hedges primarily with forward contracts in order to reduce the effects of currency rate fluctuations on its results of operations. However, such fluctuations can have a significant effect on reported cash balances. The effect of foreign currency exchange rate changes was a $1.2 million increase in fiscal 1994, and a $1.0 million decrease in fiscal 1993 in cash and equivalents held in foreign currency.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's continuing manufacturing operations are located in California, Malaysia, Korea and Ireland. These manufacturing facilities comprise over 900,000 square feet, substantially all of which are owned by the Company. The Company is offering for sale certain of its facilities in Korea comprising approximately 93,000 square feet. In addition, one separate facility is owned by the Company in connection with a subsidiary which had been previously divested. This facility is currently leased to the acquirors of the subsidiary.\nThe Company does not believe it will be required to acquire or lease significant additional facilities at least through fiscal 1995. Moreover, the Company anticipates that it will, during fiscal 1995, undergo some further consolidation of certain of its manufacturing facilities.\nThe following table sets forth information concerning the principal manufacturing and sales facilities of the Company and other properties owned by the Company. Except as noted below with respect to certain facilities that are no longer required and are being offered for sale, the Company considers the utilization and productive capacity of these facilities adequate and suitable for its business as it is presently being conducted. During fiscal 1994, the Company sold its facilities in Golden Valley, Minnesota and Monument, Colorado, comprising approximately 81,000 and 17,000 square feet, respectively. In the first quarter of fiscal 1995, the sale of an approximate 6,000 square feet facility owned by the Company's Singapore\nsubsidiary was completed and, in connection with the sale of its Tape Head business unit to Seagate, the Company transferred ownership of its 30,000 square feet facility in Santa Maria, California.\n[FN] \/(1)\/ This facility is leased by the Company to the acquiror of a subsidiary which was previously sold by the Company.\n\/(2)\/ One of the facilities at Chung Ju, comprising approximately 93,000 square feet is being offered for sale or lease.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn November 18, 1994, the Company announced that it had entered into an agreement to dismiss the 1993 securities class action suit brought against the Company and certain present and former Company officers in U.S. District Court for the Central District of California. Settlement of the suit is subject to the terms of a definitive agreement which is expected to be submitted to the court for preliminary approval during December, 1994. The settlement is ultimately subject to final court approval after notice to the class members of the terms. Under the terms of this settlement, the Company will not be required to make any cash payments but will contribute shares of its common stock having an aggregate value of $1.25 million. The stock, along with $2.75 million from the Company's insurance carrier, will be distributed, after court approval, to a class consisting of all persons who purchased the Company's common stock during the period of October 22, 1992, through October 1, 1993.\nThe Company is not a party, nor are its properties subject to, any material pending legal proceedings other than ordinary routine litigation incidental to the Company's business and the matters described above.\nPART II -------\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nNONE\nITEMS 5. through 8.\nThe information called for by Part II of Form 10-K (Item 5","section_5":"","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 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT --------------------------------------------------\nThe following table sets forth information as to the name, age, and office(s) held by each director and executive officer of the Company as of December 29, 1994:\nHarold R. Frank has been Chairman of the Board of the Company for more than five years. Mr. Frank also serves as a member of the boards of directors of Circon Corporation, La Cumbre Savings Bank and Key Technology, Inc.\nDr. R.C. Mercure, Jr. became director of the Company in October 1982. He serves as Professor and Director, Engineering Management Program, University of Colorado at Boulder. Dr. Mercure previously served as Vice President, Colorado Venture Management, Inc., a management consulting firm, and is a director of Imex Medical Systems.\nHerbert M. Dwight, Jr. became a director of the Company in August 1989. He has been President of Optical Coating Laboratory, Inc., a manufacturer of precision optical thin-film products and components, since August 1991. Previously, Mr. Dwight was a founder, President, Chairman and Chief Executive Officer of Spectra-Physics, Inc., a manufacturer of laser products and scientific instruments. Mr. Dwight is also a director of Applied Materials, Inc., Laserscope, Inc. and Trans Ocean, Ltd., a sea container leasing corporation.\nMr. Crisman is a partner in the firm of Grisanti, Galef & Goldress, Inc. (\"GG&G\") which firm was engaged by the Company on August 1, 1994, to provide crisis management and turnaround services to the Company. He was appointed Chief Executive Officer on August 1, 1994, and, subsequently, assumed the additional duties of President and Chief Financial Officer. During the five years preceding his appointment as Chief Executive Officer and as a Director of the Company, Mr. Crisman, acting as a partner in GG&G, has been engaged, as a crisis management consultant, in business turnaround assignments involving a number of different enterprises in various industry segments.\nRaymond P. Le Blanc has served as Vice President since September 1985 and as Secretary and General Counsel since 1982. He joined the Company in February 1974.\nPeter T. Altavilla has been employed by the Company for approximately seven (7) years. He served as Assistant Controller until August 11, 1994, when he was elected to his present position.\nJohn Ross became employed by the Company on June 1, 1993. Prior to this date he had served as Director, Wafer Fab Operations, at Read-Rite, Inc., a competitor, since March, 1991. Before joining Read-Rite, Mr. Ross served as Vice-President, Operations, at Tegal Corporation, a company that makes and sells semiconductor manufacturing equipment.\nCertain information with respect to the Company's directors required by Part III of Form 10-K, Item 10, will be set forth in the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days of the Company's fiscal year ended September 30, 1994, and such information is incorporated herein by this reference.\nITEMS 11. - 13.\nThe information called for by Part III of Form 10-K (Item 11","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS --------------------------------------------------- ON FORM 8-K -----------\nI. FINANCIAL STATEMENTS\n(1) The financial statements listed below are set forth in the Company's Annual Report to Shareholders for the fiscal year ended September 30, 1994, and are incorporated herein by this reference.\nAnnual Report Page No. -------------\nConsolidated Statements of Operations for 11 the Years Ended September 30, 1994, 1993 and 1992\nConsolidated Balance Sheets, 12 September 30, 1994 and 1993\nConsolidated Statements of Cash Flows 13 for the years ended September 30, 1994, 1993, and 1992\nConsolidated Statements of Shareholders' 14 Investment for the Years Ended September 30, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements 15-25\nReport of Independent Public Accountants 26\n(2) Supplemental financial statement schedules required to be filed as a part of this report:\nForm 10-K Page No. ----------\nSupplemental Note to Consolidated 38 Financial Statements, September 30, 1994\nSchedules for the years ended 39-43 September 30, 1994, 1993 and 1992\nII. AMOUNTS RECEIVABLE FROM RELATED PARTIES 39 AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES\nV. PROPERTY, PLANT AND EQUIPMENT 40\nVI. ACCUMULATED DEPRECIATION AND 41 AMORTIZATION\nVIII. VALUATION AND QUALIFYING ACCOUNTS 42\nIX. SHORT-TERM BORROWINGS 43\nNotes to Supplemental Financial Statement 44-45 Schedules\nReport of Independent Public Accountants on 46 Schedules and Supplemental Note to Consolidated Financial Statements\nSchedules other than those listed above are omitted since they are not applicable, not required, or the information required to be set forth therein is included in the consolidated financial statements or notes thereto incorporated by reference in this report.\nIndividual financial statements of the Company are omitted because the Company is primarily an operating company and all subsidiaries included in the consolidated financial statements filed are totally held and long-term debt (excluding debt guaranteed by the Company) of certain consolidated subsidiaries is, in the aggregate, not significant.\n(3) Exhibits:\nExhibit Number Description ------ -----------\n3 Certificate of Incorporation and Bylaws (1) Amended and Restated Bylaws (2) Amendment to Bylaws dated June 14, 1989 (3) Certificate of Incorporation (as amended) (4)\n4 Instruments defining the rights of securities holders including indentures Rights Agreement, dated as of October 19, 1988, between Applied Magnetics Corporation and First Interstate Bank of California, as Rights Agent (2)\n9 Voting trust agreement. None\n10 (a) Applied Magnetics Corporation 1982 Long-Term Incentive Plan (5)\n(b) Applied Magnetics Corporation Nonstatutory Stock Option Plan (6)\n(c) Applied Magnetics Corporation 1986 Long-Term Incentive Plan (6)\n(d) Applied Magnetics Corporation 1988 Stock Option Plan (7)\n(e) Applied Magnetics Corporation 1989 Long-Term Incentive Plan (8)\n(f) Loan Agreement dated February 13, 1992 between Applied Magnetics Corporation and Union Bank, N.A., as amended (9)\n(g) License and Technology Development Agreement dated as of September 25, 1992, between Applied Magnetics Corporation and Hitachi Metals, Ltd. (9)\n(h) Letter Agreement dated October 30, 1992 between Applied Magnetics Corporation and Dr.Richard D. Balanson (9)\n(i) Applied Magnetics Corporation 1992 Stock Option Plan (9)\n(j) Note Purchase Agreement dated as of December 2, 1992 between Applied Magnetics Corporation and Conner Peripherals, Inc. (9)\n(k) Letter Agreement dated as of December 22, 1992 between Applied Magnetics Corporation and The Prudential Insurance Company of America (9)\n(l) Purchase Agreement between the Company and Delta Bravo, Inc. for the purchase of capital stock of Magnetic Data, Inc., a Delaware corporation and Brumko Magnetics Corp., a Nebraska Corporation (10)\n(m) Retention Agreement dated November 3, 1993, between the Company and Kathryn E. Gehrke (11)\n(n) Cross License and Joint Research and Development Agreement effective as of November 5, 1993, between the Company and Hutchinson Technology Incorporated (11)\n(o) Applied Magnetics Corporation 1994 Employee Stock Option Plan (12)\n(p) Applied Magnetics Corporation 1994 Nonemployee Directors' Stock (12) Option Plan\n(q) Letter Agreement dated February 8, 1994 between the Company and O.M. Fundingsland, formerly Executive Vice President of the Company (12)\n(r) Letter Agreement dated January 12, 1994 between the Company and Louis W. Rayer, formerly Vice President of the Company (12)\n(s) Retention Agreement dated January 2, 1994, between the Company and Raymond P. Le Blanc, Vice President, Secretary and General Counsel of the Company (12)\n(t) Letter Agreement dated as of November 14, 1994, between the Company and the CIT Group\/Business Credit, Inc.\n(u) Stock Purchase Agreement by and among the Company, Seagate Technology, Inc. and Applied Tape Technology, Inc.\n(v) Letter Agreement dated September 12, 1994, between the Company and William R. Anderson\n(w) Letter Agreement dated June 21, 1994, between the Company and Dr. Richard D. Balanson\n(x) Letter Agreement dated September 12, 1994, between the Company and Kathryn E. Gehrke\n(y) Letter Agreement dated August 1, 1994, between the Company and Grisanti, Galef & Goldress, Inc.\n11 Statement re computation of per share earnings.\n12 Statement re computation of ratios. None.\n13 Annual Report to Shareholders.\n18 Letter re change in accounting principles. None.\n20 (a) Press release (dated September 30, 1993) announcing expected operating loss for the Company's fourth quarter of fiscal 1993 and a restructuring charge of approximately $50 million. (17)\n(b) Press release (dated October 22, 1993) announcing Company's intent to vigorously defend several lawsuits filed in the U.S. District Court, Central District of California, accusing the Company and certain executive officers of violating federal securities laws. (14)\n(c) Press release (dated January 19, 1994) announcing the Company's unaudited first quarter results for fiscal 1994.\n(d) Press release (dated January 27, 1994) announcing the Company's strategic alliance with Storage Technology, Inc. for the manufacturing and development of technology for thin-film tape heads.\n(e) Press release (dated February 3, 1994) announcing the addition of Mr. Nic Pignati (General Manager of final assembly) and George Shaw (General Manager of Malaysian operations) to the senior management team.\n(f) Press release (dated April 4, 1994) announcing the consolidation of the Company's southeast Asian operations transferring the manufacturing operations of Applied Magnetics Singapore to Applied Magnetics Malaysia and second quarter operating losses.\n(g) Press release (dated April 20, 1994) announcing the Company's unaudited second quarter results.\n(h) Press release (dated May 17, 1994) announcing the Company's receipt of ISO 9002 certification of all foreign plants\n(i) Press release (dated June 7, 1994) announcing lower than expected results for third quarter of fiscal 1994\n(j) Press release (dated June 17, 1994) announcing the Company's retention of Lehman Brothers, Inc. for assistance in securing strategic alliances, a reduction in the work force and the resignation of Dr. Richard D. Balanson.\n(k) Press release (dated July 20, 1994) announcing the unaudited third quarter results of fiscal 1994.\n(l) Press release (dated August 2, 1994) announcing the retention of Grisanti, Galef & Goldress (\"GG&G\") as a consulting firm to assist the Company in affecting a turnaround strategy and the appointment of Craig D. Crisman as President, Chief Executive Officer and a Director.\n(m) Press release (dated August 17, 1994) announcing another reduction in employment.\n(n) Press release (dated September 12, 1994) announcing the resignation of William R. Anderson as President and Chief Operating Officer.\n(o) Press release (dated November 1, 1994) announcing the Company's unaudited fiscal year 1994 results.\n(p) Press release (dated November 8, 1994) announcing the Company's intentions to sell the Tape Division operation in Santa Maria to Seagate Technology, Inc.\n(q) Press release (dated November 15, 1994) announcing the Commitment Letter between the Company and The CIT Group\/Business Credit, Inc. (\"CIT\") for an asset-based credit facility of up to $35 million.\n(r) Press release (dated November 18, 1994) announcing the settlement and agreement of dismissal of a 1993 securities class action suit brought against the Company and several present and former officers in the U.S. District Court for the Central District of California.\n(s) Press release (dated December 12, 1994) announcing the completion of the sale of the Tape Division to Seagate Technology, Inc.\n21 Subsidiaries of the registrant.\n22 Published report regarding matters submitted to vote of security holders. None.\n23 Consent of experts and counsel. Consent of Arthur Andersen LLP dated December 27, 1994.\n24 Power of Attorney. None\n27 Financial Data Schedules.\n28 Information from reports furnished to state insurance regulatory authorities. None\n29 Additional Exhibits. None\n(1) Filed as exhibits to the Company's Registration Statement on Form S-3 (Registration No. 33-13653) filed on April 21, 1987, and incorporated herein by reference.\n(2) Filed as an exhibit to the Company's Current Report on Form 8-K dated October 19, 1988, and incorporated herein reference\n(3) Filed as an exhibit to the Company's Annual Report on Form 10-K dated December 21, 1989, and incorporated herein by reference\n(4) Filed as an exhibit to the Corporation's Quarterly Report on Form 10-Q dated May 4, 1989 and incorporated herein by reference\n(5) Filed as an exhibit to the Company's definitive Proxy Statement filed pursuant to Regulation 14A on January 27, 1983, and incorporated herein by reference.\n(6) Filed as an exhibit to the Company's definitive Pro%y Statement filed pursuant to Regulation 14A on December 23, 1985, and incorporated herein by reference.\n(7) Filed as an exhibit to the Company's definitive Proxy Statement filed pursuant to Regulation 14A on January 7, 1988, and incorporated herein by reference.\n(8) Filed as an exhibit to the Company's definitive Proxy Statement filed pursuant to Regulation 14A on December 30, 1988 and incorporated herein by reference.\n(9) Filed as an exhibit to the Company's Annual Report on Form 10-K dated December 22, 1992, as amended by Form 8, filed February 12, 1993 and incorporated herein by reference.\n(10) Filed as an Exhibit to the Company's Report on Form 10-Q dated May 14, 1993 and incorporated herein by reference.\n(11) Filed as an Exhibit to the Company's current Report on Form 8-K dated December 2, 1993 and incorporated herein by reference.\n(12) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q dated March 31, 1994, and incorporated herein by reference.\n(b) Reports on Form 8-K. The Company filed a report on Form 8-K during the quarter ended September 30, 1994, reporting, under Item 5 of such Form, the retention of Grisanti, Galef & Goldress, Inc. as consultants to provide crisis management and turnaround services. The Company also filed current reports on Form 8-K during the quarter ended December 31, 1994, reporting, under Item 5 of such Form, (a) the Company's settlement of a 1993 securities class action suit filed in the U.S. District Court for the Central District of California against the Company and certain executive officers under the federal securities laws, (b) the Company's intentions to sell its Tape Head operations to Seagate Technology, Inc. and (c) a commitment letter between the Company and The CIT Group\/Business Credit, Inc. for an asset-based credit facility of up to $35 million.\n(13) Filed as an exhibit to the Company's Annual Report on Form 10-K dated December 28, 1991 and incorporated herein by reference.\n(14) Filed as an exhibit to the Company's Current Report on Form 8-K dated September 28, 1992 and incorporated herein by reference.\n(15) Filed as an Exhibit to the Company's Current Report on Form 8-K dated September 30, 1992 and incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of Section 13(d) 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.\nAPPLIED MAGNETICS CORPORATION\nBy: ____________________________ Date: December 29, 1994 Craig D. Crisman President, Chief Executive Officer and Chief Financial Officer (Principal Financial Officer)\nBy: ____________________________ Date: December 29, 1994 Peter T. Altavilla Corporate Controller (Principal 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 Company and in the capacities and on the dates Indicated.\n\/s\/ _______________________________________ December 29, 1994 Harold R. Frank, Chairman of the Board\n\/s\/ _______________________________________ December 29, 1994 R.C. Mercure, Jr., Director\n\/s\/ _______________________________________ December 29, 1994 Herbert M. Dwight, Jr., Director\n\/s\/ _______________________________________ December 29, 1994 Craig D. Crisman, Director, President and Chief Executive Officer\nSupplemental Note to Consolidated Financial Statements\nAPPLIED MAGNETICS CORPORATION AND SUBSIDIARIES SUPPLEMENTAL NOTE TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1994\n11. INVENTORIES\nThe components of inventory were as follows (in thousands):\nSCHEDULE II APPLIED MAGNETICS CORPORATION AND SUBSIDIARIES SCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES For the Years Ended September 30, 1994, 1993 and 1992 (in thousands)\nThe accompanying Notes to Supplemental Financial Statement Schedules are an integral part of this schedule.\nSCHEDULE V\nAPPLIED MAGNETICS CORPORATION AND SUBSIDIARIES SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT For the Years Ended September 30, 1994, 1993 and 1992 (in thousands)\nThe accompanying Notes to Supplemental Financial Statement Schedules are an integral part of this schedule.\nSCHEDULE VIII APPLIED MAGNETICS CORPORATION AND SUBSIDIARIES SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended September 30, 1994, 1993 and 1992 (in thousands)\nThe accompanying Notes to Supplemental Financial Statement Schedules are an integral part of this schedule.\nSCHEDULE IX\nAPPLIED MAGNETICS CORPORATION AND SUBSIDIARIES SCHEDULE IX - SHORT-TERM BORROWINGS For the Years Ended September 30, 1994, 1993 and 1992 (dollars in thousands)\nThe accompanying Notes to Supplemental Financial Statement Schedules are an integral part of this schedule.\nNotes to Supplemental Financial Statement Schedules\nAPPLIED MAGNETICS CORPORATION AND SUBSIDIARIES NOTES TO SUPPLEMENTAL FINANCIAL STATEMENT SCHEDULES SEPTEMBER 30, 1994\n(A) Reference is made to Note 1 of the Notes to Consolidated Financial Statements in the Company's Annual Report to Shareholders for the fiscal year ended September 30, 1994, with respect to accounting policies for property, plant and equipment.\n(B) Represents translation adjustments made in accordance with Statement of Financial Accounting Standards No. 52. See Note 1 of Notes to Consolidated Financial Statements.\n(C) Additions charged to costs and expenses do not include amortization of two facilities included in Other Assets of $.2 million in fiscal 1994 and $.3 million in each of the fiscal years 1993 and 1992, accretion of the discount on a long-term note of $.7 million in fiscal 1994 and $.6 million in fiscal 1993, and amortization of manufacturing processes of $.1 million in fiscal 1992.\n(D) Represents actual interest expense on short-term borrowings divided by the average monthly amount of short-term borrowings outstanding during the period.\n(E) Represents loans issued to Company Officers, which are interest free and will be forgiven in equal annual installments, provided their employment is not terminated. The loan to Dr. Balanson was issued on March 2, 1992 and subsequently amended on October 21, 1992. He terminated on July 31, 1994, and the principal balance of the loan was subsequently paid. The loan to Ms. Gehrke was issued on November 3, 1994 and pursuant to the termination agreement dated September 12, 1994, was forgiven.\n(F) In June, 1992 the Company developed plans to divest its non-core businesses. See Note 8 of the Notes to Consolidated Financial Statements. As a result, Supplemental Financial Statement Schedules V, VI and VIII reflect activities of discontinued operations only through June 30, 1992.\n(G) Net transfers for the year ended September 30, 1992 represent the transfer to Other Assets of the net book value of two facilities distributed to the Company in the form of a dividend in connection with the sale of the Nortronics subsidiary. Net transfers for the year ended September 30, 1994, represent the transfer of the net book value of one building included in the sale of the Optical Products Division, and transfer of the net book value to Other Assets of a vacant building in Korea held for sale.\n(H) Other for the year ended September 30, 1992, represents activities of discontinued operations only through June 30, 1992. Other for the year ended September 30, 1993, represents write- down of equipment to estimated net realizable value as a result of various factors, including the unexpectedly rapid market transition from ferrite to thin-film and from thin-film microslider to the nanoslider form factor. See Note 6 of Notes of Consolidated Financial Statements. Other for the year ended September 30, 1993, and September 30, 1994, also includes reclassification of balances from cost to accumulated depreciation as a result of reconciliation of the fixed asset data base to the general ledger balances.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES AND SUPPLEMENTAL NOTE TO CONSOLIDATED FINANCIAL STATEMENTS\nTo Applied Magnetics Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Applied Magnetics Corporation's Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated December 22, 1994.\nOur audits were made for the purpose of forming an opinion on those statements taken as a whole. Schedule II - Amounts Receivable from Related Parties and Underwriters, Promoters and Employees other than Related Parties; Schedule V - Property, Plant and Equipment; Schedule VI - Accumulated Depreciation and Amortization; Schedule VIII - Valuation and Qualifying Accounts; and Schedule IX - Short-Term Borrowings and the related Notes and the Supplemental Note to Consolidated Financial Statements are the responsibility of the Company's management and are presented for purposes of complying with the Securities and Exchange Commissions rules and are not part of the basic consolidated financial statements. These schedules and supplemental note 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 LLP\nLos Angeles, California December 22, 1994","section_15":""}
{"filename":"7383_1994.txt","cik":"7383","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral\nArmco Inc. (\"Armco\" or the \"Company\") was incorporated as an Ohio corporation in 1917 as a successor to a New Jersey corporation incorporated in 1899. Based on sales revenues, Armco is the second largest domestic producer of stainless flat-rolled steels and is the largest domestic producer of electrical steels. The Company owns a 50% partnership interest in National- Oilwell, a distributor of oil country tubular goods and a manufacturer of drilling, production and other oil and gas equipment that operates a network of oil field supply stores throughout North America. Armco also owns Douglas Dynamics, Inc., the largest North American manufacturer of snowplows for four- wheel drive pick-up trucks and utility vehicles and provides insurance services through businesses it intends to sell or liquidate.\nAs part of its strategy to focus on the production of specialty flat- rolled steel, Armco has continued to evaluate the growth potential and profitability of its businesses and investments, and to rationalize or divest those that do not represent a strategic fit or offer growth potential or positive cash flow. In 1992, 1993 and 1994, Armco divested or otherwise rationalized several unprofitable or non-strategic operations.\nOn January 28, 1994, Armco signed a letter of intent to sell its ongoing insurance operations to Vik Brothers Insurance, Inc. (\"Vik Brothers\"), a privately owned property and casualty insurance holding company. On August 2, 1994, Armco and Vik Brothers signed a definitive agreement, subject to a number of conditions, including approvals by regulatory authorities. Under the terms of the agreement, Armco would be paid approximately $65 million at closing and $15 million in three years, subject to potential adjustment for adverse experience in certain insurance reserves. As a result of restructuring certain obligations arising from the 1992 merger plan for the insurance companies that are being liquidated, any proceeds from the sale are pledged as security for certain note obligations due to these insurance companies and would be retained in the investment portfolio of these companies.\nIn April 1994, Armco Steel Company, L.P. (\"ASC\"), a carbon steel joint venture with Kawasaki Steel Corporation (\"Kawasaki\"), completed an initial public offering and recapitalization. As part of this transaction, the business and assets of ASC were transferred to a newly formed company named AK Steel Holding Corporation (\"AK Steel\"). In the recapitalization, Armco received 1,023,987 shares of common stock of AK Steel and was released from certain obligations to make future cash payments to the former joint venture.\nIn August 1994, Armco sold its conversion business plant in Bridgeville, Pennsylvania, and, in September 1994, sold, to its partner, Acerinox S.A., 90% of its investment in North American Stainless (\"NAS\"), a 50-percent joint venture that finishes chrome nickel flat-rolled stainless steel. Armco, through its subsidiary, First Stainless, Inc., maintains a five percent limited partnership interest in NAS and Armco will supply NAS with chrome nickel stainless steel coils on an annual contract basis at market rates.\nIn October 1994, Armco announced that Eastern Stainless Corporation (\"Eastern Stainless\"), an 84%-owned subsidiary of Armco, and Avesta Sheffield Holding Company (\"Avesta Sheffield\") reached an agreement in principle for the sale of all of the assets of Eastern Stainless to Avesta Sheffield for cash and the assumption of certain liabilities. A definitive agreement for the sale was signed on February 9, 1995, and on March 14, 1995, Eastern Stainless, Armco and Avesta Sheffield completed the sale. The cash proceeds of the sale were applied to the satisfaction of the Eastern Stainless obligations not assumed by Avesta Sheffield, Armco assumed the net liabilities of Eastern Stainless not assumed by Avesta Sheffield or satisfied by the cash proceeds and Eastern Stainless was dissolved without any shareholder distribution.\nIn December 1994, Armco sold its Bowman Metal Deck division, a producer of carbon steel roof, floor and bridge deck, its Tex-Tube division, a manufacturer of electric welded steel pipe, and its Armco Stainless & Alloy Products plant in Baltimore, Maryland.\nBusiness Segments\nThe information on the amounts of revenue, operating results and identifiable assets attributable to each of Armco's business segments, set forth in Note 8 of the Notes to Financial Statements in Armco's Annual Report to Shareholders for the year ended December 31, 1994, is incorporated by reference herein.\nAdditional information about Armco's business segments and equity investments is set forth in Management's Discussion and Analysis in Armco's Annual Report to Shareholders for the year ended December 31, 1994, which is incorporated by reference herein.\nSpecialty Flat-Rolled Steel\nPlants in Armco's Specialty Flat-Rolled Steel business segment produce and finish stainless and electrical steel sheet and strip. Its principal manufacturing plants are in Butler, Pennsylvania, and Zanesville, Ohio, where Armco produces flat-rolled stainless and electrical steel sheet and strip products, and in Coshocton, Ohio, where Armco finishes premium quality flat- rolled stainless steel in sheet and strip form. Stainless steel plate products were finished at Eastern Stainless, which was sold on March 14, 1995. The segment also includes the results of European trading companies which buy and sell steel and manufactured steel products. Following the start-up of a new thin-slab continuous caster being installed at Armco's Mansfield, Ohio facilities, the segment will also include sales of specialty steels produced by, and the related operating results of, the Mansfield facilities.\nThe specialty steel industry is a relatively small but distinct segment of the overall steel industry that represented approximately 2% of domestic steel tonnage but accounted for approximately 10% of domestic steel revenues in 1994. Specialty steels refer to alloy tool steel, electrical steel and stainless sheet, strip, plate, bar, rod and wire products. Specialty steels differ from basic carbon steel by their metallurgical composition. They are made with a high alloy content, which enables their use in environments that demand exceptional hardness, toughness, strength and resistance to heat, corrosion or abrasion or combinations thereof. Unlike high-volume carbon steel, specialty steel is generally produced in relatively small quantities utilizing special processing techniques designed to meet more exacting specifications and tolerances.\nStainless steel, which represents the largest part of the specialty steel market, contains elements such as chromium, nickel and molybdenum that give it the unique qualities of resistance to rust, corrosion and heat; high strength; good wear characteristics; natural attractiveness; and ease of maintenance. Stainless steel is used in the automotive and aerospace industries, and in the manufacture of food handling, chemical processing, pollution control, medical and health equipment and other products where its combination of strength, durability and attractiveness is desirable. Electrical steels are iron- silicon alloys and, through special production techniques, possess unique magnetic properties that make them desirable for use as energy efficient core material in such applications as electrical transformers, motors and generators.\nArmco expects that the demand for stainless steel will continue to be positively affected by its increasing use in the manufacture of consumer durable goods and industrial applications. Per capita stainless steel usage in many highly developed countries significantly exceeds per capita usage in the United States and Armco believes that this is an indication of the growth potential of demand for stainless steel in the United States. In addition, the 1990 amendments to the Clean Air Act have resulted in the increasing use of corrosion-resistant materials in a number of applications for which stainless steel is well suited, including industrial pollution control devices and motor vehicle exhaust systems for use in the United States, where Armco now has the leading market share. Another factor that Armco believes will affect demand positively is the increasing issuance of new car bumper-to- bumper warranties and the use of stainless steel in passenger restraint systems. Stainless steel products\ngenerate higher average profit margins than carbon steel products and, depending on the stainless grade, sell at average prices of three to five times those of carbon steel.\nArmco produces flat-rolled stainless steel and alloy electrical steel sheet and strip products that are used in a diverse range of consumer durables and industrial applications. Since the acquisition of Cyclops Industries, Inc. in April 1992, approximately 70% of Armco's sales of specialty flat- rolled steel has been stainless steel and 30% has been electrical steel. Major markets served are industrial machinery and electrical equipment, automotive, construction and service centers.\nIn the stainless steel market, Armco is the leading domestic producer of chrome grades used primarily in the domestic market for automotive exhaust components. Stainless steel, which formerly was not used in parts of the exhaust system other than the catalytic converter, is now used in the entire exhaust system from manifold to tailpipe by many auto manufacturers. Armco has developed a number of specialty grades for this application, many of which are patented. Armco is also known for its \"bright anneal\" chrome grade finishes utilized for automotive and appliance trim and other chrome grades used for cutlery, kitchen utensils, scissors and surgical instruments. Specialty chrome nickel grades produced by Armco are used in household cookware, restaurant and food processing equipment and medical equipment.\nOther Armco stainless products include functional stainless steel manufactured for automotive, agricultural, heating, air conditioning and other manufacturing uses. Before the sale of Eastern Stainless in March 1995, Armco's stainless products also included stainless steel plate, principally in flat plate form, for use in industrial applications where high resistance to heat, stress or corrosion is required.\nArmco is the only United States manufacturer of a complete line of flat- rolled electrical steel products and is the sole domestic producer of certain high permeability oriented electrical steels. It is also the only domestic manufacturer utilizing laser scribing technology. In this process, the surface of electrical steel is etched with high-technology lasers which refine the magnetic domains of the steel resulting in superior electrical efficiency. Major electrical product categories are: Regular Grain Oriented (\"RGO\"), used in the cores of energy-efficient power and distribution transformers; Cold Rolled Non-Oriented (\"CRNO\"), used for electrical motors and lighting ballasts; and TRAN COR[registered trademark]H, which is used in power transformers and is the only high permeability electrical steel made domestically.\nArmco had trade orders on hand for its Specialty Flat-Rolled Steel segment (excluding Eastern Stainless) of $187.3 million at December 31, 1994, and $142.1 million at December 31, 1993. The backlog increased in 1994 due to stronger demand and an improving economy. While substantially all of the orders on hand at year-end 1994 are expected to be shipped in 1995, such orders, as is customary in the industry, are subject to modification, extension or cancellation.\nArmco's specialty steelmaking operations are concentrated in Pennsylvania and Ohio, which permits cost-efficient materials flow between plants. Armco's Butler, Pennsylvania facility, which is situated on 1,300 acres with 3.2 million square feet of buildings, continuously casts 100% of its steel. At Butler, melting takes place in three 165-ton electric arc furnaces that feed the world's largest (175-ton) argon-oxygen decarburization unit for refining molten metal that, in turn, feeds two double strand continuous casters. The melt capacity at Butler was approximately 875,000 tons by year-end 1994. Butler also operates a hot-strip mill, anneal and pickle units and a fully- automated tandem cold-rolling mill. It also has various intermediate and finishing operations for both stainless and electrical steels.\nArmco's Zanesville, Ohio plant, with 508,000 square feet of buildings on 88 acres, is a dedicated finishing plant for some of the steel produced at the Butler facility and has a Sendzimer cold-rolling mill, anneal and pickle facilities, high temperature box anneal and other decarburization and coating units.\nThe finishing plant in Coshocton, Ohio, located on 650 acres, is housed in a 500,000 square-foot plant and has three Sendzimer mills, four anneal and pickle facilities, three \"bright anneal\" lines, two 4-high mills for cold reduction and other processing equipment, including temper rolling, slitting and packaging facilities.\nFollowing the startup of a new thin-slab continuous caster being installed at Armco's Mansfield, Ohio facilities, which is expected to be completed early in the second quarter of 1995, the Mansfield facilities will melt and finish specialty steels, including automotive chrome. Production of specialty steel at Mansfield is expected to begin in the third quarter of 1995. Sales of these specialty steel products and the related operating results will be reported in the Specialty Flat-Rolled Steel segment.\nIn the fourth quarter of 1994, Armco announced an expanded capital improvement program under which it will spend up to $95 million over the next two years to upgrade and expand its specialty steel finishing facilities. The program is intended to reduce existing production constraints, increasing specialty steel finishing capacity by approximately 180,000 tons per year, particularly in electrical steels, specialty sheet and strip products, and non-automotive chrome stainless. About $60 million of this total will be spent to upgrade existing equipment at the Butler, Coshocton, Mansfield and Zanesville plants. The remaining $35 million of investment is targeted for proposed new pickling and box annealing facilities. In addition to increasing revenues as a result of expanded finishing capacity, the capital improvements are expected to provide quality improvements and significant annual cost savings.\nOther Steel and Fabricated Products\nThe businesses currently included in the Other Steel and Fabricated Products segment are described below:\n-- Carbon steel operations at Mansfield, Ohio produce commodity grades of carbon steel sheet, much of which is coated at a dedicated galvanizing facility at Dover, Ohio. Under a plan to upgrade the facilities at Mansfield to enhance their steel production capability and improve the operating performance of both the Mansfield and Dover, Ohio operations, Armco has begun installing a thin-slab caster and related plant modifications at Mansfield. Installation is expected to be completed early in the second quarter of 1995. The caster is designed to produce carbon steels, and functional grades of chrome stainless steels and nonoriented grades of electrical steels. The sales of these stainless and electrical steels and the related operating results will be reported in the Specialty Flat-Rolled Steel segment. The Mansfield plant currently consists of a 1.4 million square-foot facility, including a melt shop with two electric arc furnaces (170-ton and 100-ton), a 100-ton argon-oxygen decarburization unit, a six-stand hot strip mill, a five- stand tandem cold rolling mill and a newly retrofitted Sendzimer mill for chrome stainless finishing. In the second quarter of 1994, Armco idled the Mansfield and Dover production facilities. The Mansfield plant is expected to remain idled until the thin-slab caster is completed. The Dover plant resumed limited production in early 1995. Armco recognized a special charge of $20 million in the first quarter of 1994 for the cost of benefits to employees on layoff and other costs of idling the facilities, as well as costs associated with planned permanent work force reductions.\n-- Douglas Dynamics, Inc. is the largest North American manufacturer of snowplows for four-wheel drive pick-up trucks and utility vehicles. Douglas Dynamics, Inc., which is headquartered in Milwaukee, Wisconsin, has snowplow manufacturing plants in Rockland, Maine, Milwaukee, Wisconsin and Johnson City, Tennessee and sells its snowplows and other light truck equipment through independent distributors throughout the United States and Canada.\n-- Sawhill Tubular produces steel pipe and tubing, electric welded and mandrel-drawn steel tubing and electric-resistance welded steel pipe at its plants in Pennsylvania and Ohio.\nArmco had trade orders on hand for its Other Steel and Fabricated Products segment of $38.6 million at December 31, 1994 and $73.0 million at December 31, 1993. The segment's backlog decreased in 1994 primarily as a result of the idling of the Mansfield and Dover facilities. While\nsubstantially all of the orders on hand at year-end 1994 are expected to be shipped in 1995, such orders, as is customary in these industries, are subject to modification, extension or cancellation.\nEmployees\nAt December 31, 1994, Armco had approximately 5,500 employees in its continuing operations and approximately 1,500 employees in its insurance and discontinued operations. Most of Armco's domestic production and maintenance employees are represented by international, national or independent local unions, although some operations are not unionized.\nArmco has agreements with the local unions at the specialty steel plants in Butler, Pennsylvania and Zanesville, Ohio which terminate September 30, 1996, and June 30, 1996, respectively. In June 1993, the United Steelworkers of America (\"USWA\") employees at Armco's Mansfield and Dover, Ohio plants ratified new six-year contracts, which became effective September 1, 1993. In the second half of 1994, the USWA employees and management at the Mansfield and Dover plants reached local agreements which provide for additional improvements in manning levels and work practices.\nCompetition\nArmco faces intense competition from within the domestic steel industry, from manufacturers of competing products other than steel, including aluminum, plastics, composites and ceramics, and from foreign steel producers as well as foreign producers of components and other products. Many of these foreign producers have lower labor costs and many are owned, controlled or subsidized by their respective governments. Their decisions with regard to production and sales may be influenced more by political and social considerations than prevailing market forces. Many foreign steel producers continue to ship into the United States market despite decreasing profit margins or losses. Depending on a number of market factors, including the strength of the dollar, import levels, and the effectiveness of our nation's trade laws, pricing of the Company's products could be adversely affected. Competition is based primarily on price, with factors such as reliability of supply, service and quality also being important in certain segments.\nImport penetration for stainless sheet and strip was 23.4% in 1994 compared to 23.9% in 1993. Import penetration of electrical steels was 20.3% in 1994 compared to 22.7% in 1993.\nIn 1993, Armco, Allegheny Ludlum Corporation, the USWA and the independent unions at Armco's plants in Butler, Pennsylvania and Zanesville, Ohio filed a petition requesting that the U.S. government impose both antidumping and countervailing duties on imports of grain-oriented electrical steel from Italy. In addition, Allegheny Ludlum Corporation and the USWA petitioned the U.S. government to assess antidumping duties on imports of grain-oriented electrical steel from Japan. In 1994, the Department of Commerce announced a countervailing duty margin of 24.42% and anti-dumping duties of 60.79% on imports of oriented electrical steel from Italy, and an anti-dumping duty of 31.08% against Japan. Primarily as a result of the imposition of these duties, imports of oriented electrical steel from these countries were severely curtailed during the latter half of 1994 and Armco was able to improve its position in the market and maintain firmer prices. The foreign producers have filed appeals with the court of international trade.\nControl of unfairly traded foreign steel products was made more difficult when, in 1994, the U.S. government agreed to the General Agreement on Tariffs and Trade (or GATT). This agreement weakened existing U.S. trade laws by making it more difficult to win trade cases filed against foreign countries or companies believed to be unfairly selling in the U.S. marketplace.\nCompetition is also presented by the so-called \"mini-mills\", which generally have smaller, non-unionized work-forces and are relatively free of many of the employer, environmental and other obligations that traditionally have burdened steel producers. Nucor Corporation, a mini-mill steel company, has announced its intention to enter the automotive chrome stainless steel business, with the addition of an argon-oxygen-decarburization (AOD) vessel at its Crawfordsville, Indiana melt shop. Production is scheduled to begin in the second quarter of 1995, with targeted shipments of 50,000\ntons in 1995 and 100,000 tons in 1996. Nucor Corporation's entry will intensify competition in the automotive chrome stainless market, which totals about 400,000 tons per year. Armco is currently the leading U.S. producer of automotive chrome stainless steel.\nRaw Materials and Energy Sources\nRaw material prices represent a major component of per ton production costs in the specialty steel industry. The principal raw materials used by Armco in the production of specialty steels are iron and steel scrap, molybdenum, chrome and nickel, and their ferroalloys, stainless steel scrap, silicon and zinc. These materials are purchased in the open market from various outside sources. Since much of this purchased raw material is not covered by long-term contracts, availability and price are subject to world market conditions. Chrome and nickel and certain other materials in mined alloy form can be acquired only from foreign sources, many of them located in developing countries that may be subject to unstable political and economic conditions that might disrupt supplies or affect the price of these materials. A significant portion of the chrome and nickel requirements, however, is obtained from stainless steel scrap rather than mined alloys. While certain raw materials have been in short supply from time to time, Armco currently is not experiencing and does not anticipate any problems obtaining appropriate materials in amounts sufficient to meet its production needs. Armco also uses large amounts of electricity and natural gas in the manufacture of its products. It is expected that such energy sources will continue to be reasonably available in the foreseeable future. Compliance with the Clean Air Act, as amended in November 1990, may increase the operating costs of the utilities providing services to Armco's facilities, and in turn may result in increased costs to Armco for utility services.\nEnvironmental Matters\nArmco, in common with other United States manufacturers, is subject to various federal, state and local requirements for environmental controls relating to its operations. Armco has devoted, and will continue to devote, significant resources to control air and water pollutants, to dispose of wastes, and to remediate sites of past waste disposal. Armco estimates capital expenditures for pollution control in its manufacturing operations will be about $27 million for the years 1995-1998, with the largest expenditures being made in the Specialty Flat-Rolled Steel segment. Approximately $14 million is related to control of air pollution pursuant to regulations currently promulgated under the Clean Air Act, as amended, and corresponding state laws. These projections, which have been prepared internally and without independent engineering or other assistance, reflect Armco's current analysis of probable required capital projects for pollution control. During the period 1991 through 1994, Armco's capital expenditures for pollution control projects amounted to approximately $10 million including $7 million in 1994. Statutory and regulatory requirements in this area continue to evolve and, accordingly, the type and magnitude of expenditures may change.\nArmco has been named as a defendant, or identified as a potentially responsible party, in various governmental proceedings regarding cleanup of certain past waste disposal sites. Armco is also a defendant in various private lawsuits alleging property damage and personal injury from waste disposal sites. Joint and several liability could be imposed on Armco or other parties for these matters, thus, theoretically, one party could be held liable for all costs related to a site. While such governmental and private actions are being contested, the outcome of individual matters cannot be predicted with assurance. However, based on its experience with such cases and a review of current claims, Armco expects that in most cases any ultimate liability will be apportioned between Armco and other financially viable parties.\nFrom time to time, Armco has been and may be subject to penalties or other requirements as a result of administrative actions by regulatory agencies and to claims for indemnification for properties it has previously owned or leased. In addition, environmental exit costs may be incurred if Armco decides to dispose of additional properties. It is Armco's policy not to accrue such costs until a decision is made to dispose of a property.\nBased on current facts and circumstances known to Armco, Armco's experience with site remediation, an understanding of current environmental laws and regulations, environmental\nassessments, the existence of other financially viable parties, expected remediation methods and the years in which Armco is expected to make payments toward each remediation (which range from the current year to 30 years or more in the future), Armco believes that the ultimate liability for environmental remediation matters identified to date will not materially affect its consolidated financial condition or liquidity. However, it is possible that due to fluctuations in Armco's results, future developments with respect to such matters could have a material effect on the results of operations of future interim or annual periods.\nFurthermore, the identification of additional sites, changes in known circumstances with respect to identified sites, the failure of other parties to contribute their share of remediation costs, decisions to dispose of additional properties and other changed circumstances may result in increased costs to Armco, which could have a material effect on its consolidated financial condition, liquidity and results of operations in future interim or annual periods. However, it is not possible to determine whether additional loss, due to changed circumstances, will occur or to reasonably estimate the amount or range of any potential additional loss.\nStatutes and regulations relating to the protection of the environment have resulted in higher operating costs and capital investments by the industries in which Armco operates. Although it cannot predict precisely how changes in environmental requirements will affect its businesses, Armco does not believe such requirements would affect its competitive position.\nResearch and Development\nArmco carries on a broad range of research and development activities aimed at improving its existing products and manufacturing processes and developing new products and processes. Armco's research and development activities are carried out primarily at a central research and technology laboratory located in Middletown, Ohio. This laboratory is engaged in applied materials research related to iron and steel, non-ferrous materials and new materials. In addition, the materials and metallurgy departments at each operating unit develop and implement improvements to products and processes that are directly connected with the activities of such operating unit.\nArmco spent $14.6 million, $12.9 million and $24.0 million, respectively, on research in the years ended December 31, 1994, 1993 and 1992 (including $0.9 million, $3.9 million and $9.4 million, respectively, funded by affiliates, primarily ASC, which is no longer an affiliate, in 1993 and 1992).\nEquity and Other Investments\nArmco Steel Company, L.P.\nASC was a joint venture limited partnership formed in 1989 by Armco and Kawasaki. With plants located in Middletown, Ohio and Ashland, Kentucky, ASC produced primarily high strength, low carbon flat-rolled steel. These products were supplied to the automotive, appliance and manufacturing markets, as well as to the construction industry and independent steel distributors and service centers.\nIn April 1994, ASC completed an initial public offering and recapitalization. As part of this transaction, the business and assets of ASC were transferred to AK Steel. In the recapitalization, Armco received 1,023,987 shares, or 4.2%, of the AK Steel common stock and was released from certain obligations to make future cash payments to the former joint venture. The number of shares received and other terms of the restructuring and recapitalization were determined by arm's-length negotiations.\nArmco Financial Services Group\nAFSG currently consists primarily of insurance companies that Armco intends to sell (the \"AFSG companies to be sold\") and companies that have ceased writing new business and are being liquidated (the \"runoff companies\").\nThe AFSG companies to be sold provide multiple-line casualty insurance, including personal and commercial automobile, workers' compensation, homeowners, multiperil, personal and commercial property and general liability insurance, and consist primarily of Northwestern National Casualty Company (\"NNCC\"), Pacific National Insurance Company and Statesman Insurance Company (\"Statesman\").\nOn January 28, 1994, Armco signed a letter of intent to sell its ongoing insurance operations to Vik Brothers Insurance, Inc., a privately owned property and casualty insurance holding company. On August 2, 1994, Armco and Vik Brothers signed a definitive agreement, subject to a number of conditions, including approvals by regulatory authorities. The sale is expected to close by April 7, 1995. Under the terms of the agreement, Armco would be paid approximately $65.0 million at closing and $15 million in three years, subject to potential adjustment for adverse experience in certain insurance reserves. As a result of restructuring certain obligations arising from the 1992 merger plan for the runoff companies, any proceeds from the sale are pledged as security for certain note obligations due to the runoff companies and would be retained in the investment portfolio of the AFSG runoff companies.\nThe insurance business is highly competitive. Many of the competitors of the AFSG companies to be sold offer more diversified lines of insurance and have substantially greater financial resources. In addition, the insurance regulators having supervisory authority over Armco's insurance operations retain substantial control over certain corporate transactions, including the sale of the AFSG companies to be sold and the liquidation of the runoff companies. They also have broad powers to interpret statutory accounting requirements and to initiate rehabilitation and liquidation proceedings.\nThe liability for unpaid losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on past experience, for losses incurred but not reported. Such liability is necessarily based on estimates and, while management believes that the amount is fairly stated, the ultimate liability may be in excess of or less than the amount provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed and any adjustments resulting therefrom are reflected currently in the earnings of the AFSG companies to be sold. The liability for unpaid losses and loss adjustment expenses is not discounted.\nThe AFSG companies to be sold estimate losses for reported claims on an individual case basis. Case reserves are based on experience with a particular type of risk and the available information surrounding each individual claim. Case reserves are reviewed on a regular basis. As additional facts become available, the case reserves are adjusted as necessary. The stability of the case reserving process is monitored through comparison with ultimate settlement.\nThe estimates of losses for incurred but not reported claims (IBNR), as well as additive reserves for reported claims, are developed primarily from an analysis of historical patterns of the development of paid and incurred losses (dollars and claim counts) by accident year for each line of business. Salvage and subrogation estimates are developed from patterns of actual recoveries.\nAllocated loss adjustment expense reserves are developed from an analysis of historical patterns of the development of paid allocated loss adjustment expenses to incurred losses, by accident year, by line of business. These historical patterns are then applied to projected ultimate losses for each line of business.\nUnallocated loss adjustment expense reserves are developed utilizing a cost accounting system. The cost accounting system is based on historical costs modified for anticipated changes in operations and selections of alternative costs.\nIn December 1992, the Financial Accounting Standards Board issued SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\" The statement establishes the conditions required for a contract to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. The AFSG companies to be sold adopted SFAS No. 113 in 1993. Prior to the adoption of the new statement, assets and liabilities were reported net of the effects of reinsurance. Subsequent to the adoption of the new statement, ceded reinsurance balances due from unaffiliated insurers are reported separately as assets. Ceded reinsurance balances due from affiliated insurers continue to be reported in liabilities. As permitted by the statement, prior period financial statements have been restated.\nLoss and loss adjustment expense reserves are stated at management's estimate of the ultimate cost of settling all incurred but unpaid claims. Loss and loss adjustment expense reserves are not discounted.\nActivity with respect to loss and loss adjustment expense reserves for the last three years is as follows:\nThe following table reconciles reserves determined in accordance with accounting principles and practices prescribed or permitted by insurance statutory authorities (Statutory reserve) to reserves determined in accordance with generally accepted accounting principles (\"GAAP\") at December 31, as follows:\nEffective on January 1, 1993 the AFSG companies to be sold adopted a new statutory accounting principle allowing the recognition of salvage and subrogation recoverable in the determination of the statutory reserve for losses and loss expenses. Prior year financial statements have not been restated for the change in accounting principle.\nEffective on January 1, 1993, the AFSG companies to be sold adopted Statement of Financial Accounting Standards (\"SFAS\") No. 106 and SFAS No. 112 pertaining to postretirement and postemployment benefits. The new accounting principles were adopted for both statutory and GAAP reporting purposes. However, certain differences exist between statutory and GAAP accounting principles that resulted in larger unallocated loss adjustment expense reserves for statutory reporting purposes.\nThe following table presents a calendar year runoff of the reserve for losses and loss adjustment expenses for the years 1985 through 1994. The top line of the table shows the reserve for losses and loss adjustment expenses recorded as of December 31 for each of the indicated years. This reserve represents the estimated amount of losses and loss expenses for claims arising in all years that are unpaid at the balance sheet date, including losses and loss adjustment expenses that had been incurred but not yet reported. Each column shows the reserve amount at the indicated calendar year end and cumulative data on payments and the re-estimated reserves for all accident years making up that calendar year end reserve. The last entry for each calendar year in the lower section of the table represents the incurred loss and loss expense developed, subsequent to the balance sheet date, through 1994. The estimates are increased or decreased as more information concerning the frequency and severity of claims becomes available. The deficiency depicted for a given year is cumulative for that year and all prior years.\nThe following table shows a $50 million deficiency in 1990 and a $36 million deficiency in 1991 on unpaid losses and LAE gross of reinsurance recoverables. The AFSG companies to be sold experienced a significant number of large losses in 1990 and 1991, predominantly in multi-peril and commercial auto. The deficiencies that occurred in 1990 and 1991 are a result of additional unprecedented developments on these large losses. In addition, approximately $13 million of the deficiency for 1990 pertains to additional development and reserve strengthening that occurred on the 1990 and prior accident year loss and loss expense reserves of Statesman, a company acquired in October 1990. The AFSG companies to be sold implemented new reserving procedures to improve the future adequacy of reserve levels.\nThe AFSG companies to be sold limit the maximum net loss which can arise from large risks by reinsuring (ceding) certain levels of risks with other reinsurers. The table also shows the deficiency on net loss and loss expense reserves, which is significantly lower than the deficiency in the table above. Significant development on large losses exceeding the AFSG companies to be sold net retention during 1990 and 1991 resulted in a significantly smaller impact on reserve adequacy on a net of reinsurance basis.\nThe table does not present accident or policy year development data which readers may be more accustomed to analyzing; therefore, analysis of the effect of loss and loss expense reserving on any particular accident year cannot be discerned. The table reflects adjustments to income in each year for all prior years. Conditions and trends that have affected development of the reserve in the past may not occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.\nThe runoff companies estimate that 60% of future claims will be paid in the next five years and that substantially all of the claims will be paid by the year 2017. The ultimate amount of the claims as well as the timing of the claims payments are estimated based on the annual review of loss reserves performed by the runoff companies' independent and consulting actuaries. While there have been no charges recorded with respect to the runoff companies since 1990, in the future there may be further adverse developments with respect to the runoff companies, which, if not otherwise offset through favorable commutations or other actions, will require additional charges to income.\nNational-Oilwell\nArmco, through a wholly owned subsidiary, has a 50% partnership interest in National-Oilwell, which was formed in 1987 when Armco and USX Corporation each contributed their oil field equipment operations to National-Oilwell in exchange for equal interests in the new partnership. National-Oilwell is a distributor of oil country tubular goods, a manufacturer of drilling, production and other oil and gas equipment, and an operator of satellite repair and service centers and also operates a network of oil field supply stores throughout North America through which it distributes products to the oil and gas industries worldwide. National-Oilwell has operations in the United States, Canada, the United Kingdom, Venezuela, Australia and Singapore. National-Oilwell operates in a highly competitive environment. National- Oilwell is not considered a core business of Armco and, as such, Armco continues to consider various options with respect to its investment in this business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2.\tPROPERTIES\nArmco owns and leases property primarily in the United States. This property includes manufacturing facilities, offices and undeveloped property. The locations of Armco's principal plants and materially important physical properties are described in ITEM 1. \"BUSINESS\" and are used by the Specialty Flat-Rolled Steel and Other Steel and Fabricated Product businesses. Armco believes that all its operating facilities are being adequately maintained and are in good operating condition.\nAll of Armco's principal plants and properties are held in fee. Portions of the Houston plant, shutdown in 1983, are leased from the Gulf Coast Waste Disposal Authority (Texas). Armco has an option to purchase the leased facilities at the end of the lease period.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are various claims pending against Armco and its subsidiaries involving product liability, patent, insurance arrangements, environmental, antitrust, hazardous waste, employee benefits and other matters arising out of the conduct of the business of Armco.\nReserve Mining Litigation. On July 17, 1992, Armco was sued in the ------------------------- United States District Court, District of Minnesota, Fifth Division, by a group of former salaried employees of Reserve Mining Company (\"Reserve\"), a joint venture between a subsidiary of Armco and LTV Corporation (\"LTV\") that produced iron ore pellets. The complaint in Adamson, et al. v. Armco alleges ------------------------ that Armco is liable for certain unpaid welfare benefits, including vacation, severance, supplemental layoff, life insurance and health insurance benefits. While Armco cannot determine the possible exposure, if any, from this lawsuit, plaintiffs preliminarily calculated the benefits at about $12 million. On February 17, 1993, the Court dismissed state law, ERISA and fiduciary claims with prejudice and plaintiffs' independent fiduciary claims without prejudice. Plaintiffs filed an amended complaint, in response to which Armco filed a motion to dismiss. On October 22, 1993, the Court granted Armco's motion to dismiss in its entirety. On November 22, 1993, Plaintiffs filed a notice of appeal on the February 17 and October 22 decisions. The appeal was argued before the Eighth Circuit Court of Appeals on June 13, 1994. On January 5, 1995, the judgment of the District Court was affirmed by the Eighth Circuit Court of Appeals. Plaintiffs filed a Petition for Rehearing on February 1, 1995. On March 24, 1995, the Petition for Rehearing was denied by the Court.\nIn August 1992, an action styled Warner, Donovan, et al. v. Armco Inc. ------------------------------------- was filed in the U.S. District Court, District of Minnesota by members of the United Steelworkers of America (\"USWA\")\nwho declined to participate in the USWA v. Armco settlement. The complaint ------------------------- alleges breaches of the Basic Labor\nAgreement, Supplemental Unemployment Benefit Plan, Insurance Agreement, Pension Agreement and Program of Hospital-Medical Benefits for Pensioners and Surviving Spouses and seeks an unspecified amount of damages. On February 17, 1993, the Court granted Armco's motion to dismiss plaintiffs' state law claims. The plaintiffs' claims based on the labor agreements remain pending. Plaintiffs filed an amended complaint, in response to which Armco filed a motion to dismiss certain claims therein. On October 22, 1993, the Court granted Armco's motion. On November 8, 1993, Armco filed an answer to the allegations in the amended complaint not subject to the motion to dismiss. Discovery is in progress.\nOn April 25, 1994, an action entitled Larry B. Ricke, Trustee v. Armco -------------------------------- was filed in the United States District Court for the District of Minnesota by the Trustee appointed by the Pension Benefit Guaranty Corporation (\"PBGC\") for the purpose of recovering from Reserve assets to satisfy Reserve's liability for pension benefit entitlements which are in addition to those guaranteed by the PBGC. The complaint alleges that Armco is liable for the unfunded nonguaranteed benefits under the Pension Plan of Reserve in the amount of $9.2 million plus interest. The pension benefits which are the subject of this action were part of the class settlement of USWA v. Armco. Approximately ------------- fifteen hundred members of the class signed individual releases (19 members who did not are plaintiffs in Warner, Donovan, et al. v. Armco Inc.) releasing ------------------------------------- Armco from all claims, liabilities, etc. based upon or which arise out of any Reserve Employee Pension Benefit Plan. Armco filed a Motion to Dismiss the complaint on the basis of said releases which the court denied on March 28, 1995. Armco is considering whether to pursue an appeal of this ruling.\nWhile Armco's management believes that it has substantial defenses against these Reserve-related claims, if these creditors and other Reserve creditors are successful in such claims, Armco could become liable for these and other Reserve nondebt obligations in an amount which could be substantial.\nEastern Stockholder Litigation. On or about March 13, 1995, an action ------------------------------- entitled Pension Benefit Guaranty Corporation vs. Armco Inc. and Eastern ---------------------------------------------------------------- Stainless Corporation was filed in the United States District Court for the --------------------- Southern District of Ohio by the PBGC as a Class B shareholder of Eastern Stainless. The complaint is captioned as a shareholder derivative and class action on behalf of all Class B shareholders. The plaintiffs allege breach of fiduciary duty as well as certain other claims arising from Armco's status as a majority shareholder in Eastern Stainless. The damages are alleged to be in excess of $12 million. The Class B shares were redeemable by Eastern Stainless for $1 a share or approximately $13 million. On March 15, 1995, Eastern Stainless was dissolved without any shareholder distribution. Armco believes that it has substantial defenses available to it with respect to the complaint.\nCRS Litigation. On October 31, 1990, a third-party complaint was served --------------- on Armco in the Circuit Court of Montgomery County, Maryland by the owner of a 6.3 mile potable water tunnel designed by defendant, CRS Sirrine (\"CRS\") and its predecessor companies, and constructed by Armco and Clevecon Inc. (\"Clevecon\"). Armco built 3.4 miles of the tunnel; Clevecon built the remaining 2.9 miles. No portion of the tunnel, which was completed in early 1984, has ever been functional. Washington Suburban Sanitary Commission filed suit against CRS seeking damages in the amount of $200 million. CRS filed third-party complaints against Armco and Clevecon seeking damages to the extent of any liability of CRS attributable to Armco's or Clevecon's negligence or negligent misrepresentation in connection with the installation of the potable water tunnel and the third-party defendants' alleged defective workmanship in connection with the same. Armco's motion to dismiss or, in the alternative, for summary judgment was denied by the Court. CRS subsequently settled the claims against it by Washington Suburban Sanitary Commission and continued to prosecute its third-party claims against Armco and Clevecon. Oral argument on Armco's re-filed summary judgment motion was held on January 3, 1994. The circuit court denied Armco's summary judgment motion and the case proceeded to trial. On January 28, 1994, a directed verdict was entered by the court in favor of Armco. On January 9, 1995, the Court of Special Appeals of Maryland affirmed, per curiam, Armco's directed verdict against CRS. CRS has petitioned the Maryland Court of Appeals (the state's highest court) for discretionary leave to appeal the judgment of the Court of Special Appeals and Armco has filed a response in opposition.\nCornerstones Litigation. An action was filed by Cornerstones Municipal ------------------------ Utility District (\"Cornerstones\") and William St. John, as representative of a class of owners of real property situated within Cornerstones, in the District Court of Harris County, Texas, in July 1989, alleging that Armco Construction Products supplied defective pipe for a sanitary sewer system in three residential subdivisions. The petition sought in excess of $40 million in damages. On May 29, 1991, plaintiffs filed a Third Amended Petition adding Kingsbridge Municipal Utility District (\"Kingsbridge\") and John Keplinger, as representative of a class of owners of real property situated within Kingsbridge, as additional plaintiffs. The residents of Kingsbridge made similar allegations and sought certification of the class of Kingsbridge homeowners in an effort to recover damages for an allegedly faulty sanitary sewer system in four residential subdivisions. The amended petition sought in excess of $40 million in damages on behalf of the Kingsbridge and the Cornerstones plaintiffs. On January 13, 1992, the Court granted Armco's Motion for Summary Judgment and dismissed all of the Cornerstones plaintiffs' claims on the basis of the statute of limitations. The plaintiffs appealed the decision to the Fourteenth Court of Appeals. On May 21, 1992, since defendants had not moved for summary judgment against Kingsbridge, the Court of Appeals dismissed Kingsbridge from the appeal. In January 1993, the Court of Appeals reversed the dismissal of the Cornerstones action and remanded it to the trial court. In May 1993, the Supreme Court of Texas granted Armco's application for leave to appeal the judgment of the Court of Appeals and heard argument on the matter on September 14, 1993. On November 24, 1993, the Supreme Court reversed the judgment of the Court of Appeals and remanded the case to the lower court for disposition of unaddressed issues. On remand, in an opinion filed on November 10, 1994, the Court of Appeals reinstated the trial court's grant of summary judgment in favor of Armco on the basis that the Cornerstones claims are barred by the statute of limitations. On December 8, 1994, the Court of Appeals denied plaintiffs' petition for rehearing. On March 1, 1995, the Cornerstones plaintiffs filed an application for writ of error to the Supreme Court of Texas. Armco is preparing a response in opposition. The Kingsbridge action remains pending before the trial court.\nIn addition, there are three multiple-party homeowners actions which remain pending on behalf of property owners in the Cornerstones Municipal Utility District. The first of these actions, Vincent and Linda Adduci, et ----------------------------- al. v. Armco Steel Corporation, et al., was filed in the 127th District Court -------------------------------------- of Harris County, Texas on or about April 3, 1992, by approximately 87 residents, including the lead plaintiffs, against the same defendants as in the Cornerstones case. On or about September 11, 1992, Harris W. Arthur and ------------ other plaintiff homeowners commenced a similar action, styled Harris W. --------- Arthur, et al. v. Monsanto Company, et al., in the 133rd Judicial District ------------------------------------------ Court of Harris County. On or about March 22, 1993, a third action, captioned William C. Irons, et al. v. Turner, Collie & Braden, Inc., et al., was filed ----------------------------------------------------------------- in the 152nd Judicial District Court of Harris County by the lead plaintiff and approximately 100 additional residents. All three cases are substantially based upon the same theories as the Cornerstones case and were separately ------------ filed after an effort to have the Cornerstones complaints certified as a class ------------ action was denied by the court. These three actions each seek an unspecified amount of damages.\nArmco Chile Prodein, S.A. Litigation. On or about November 15, 1991, ------------------------------------- Armco and Armco Chile Prodein, S.A. (\"Armco Chile\") were sued for damages in the United States District Court for the Southern District of Alabama by a maritime cargo carrier. The plaintiff's claims were based upon allegations of fraud, negligent misrepresentation, negligent interference with contractual relations and wrongful arrest. Plaintiff's allegations arose out of a series of transactions in which it was engaged by Armco Chile to transport fiberglass reinforced pipe from Jacksonville, Florida to Talcahuano, Chile. The plaintiff made three such shipments of pipe. After discovering damage to the first and second shipments of pipe, which defendants contended was due to negligence by plaintiff, Armco Chile arrested, pursuant to Chilean law, the vessel which plaintiff utilized to carry the third shipment of pipe. The plaintiff alleged, among other things, that the arrest was wrongful and that the alleged wrongful arrest resulted in such severe damage to the plaintiff's business interests and reputation that the plaintiff went out of business. The plaintiff's experts claimed that the damages suffered by plaintiff range from $38 million to $47 million. Both Armco and Armco Chile filed motions for summary judgment. On January 25, 1993, the court granted summary judgment discharging Armco and subsequently denied plaintiff's motions for reconsideration of the summary judgment granted to Armco. On April 30, 1993, a jury verdict on plaintiff's wrongful arrest and lost profits claims was\nrendered in favor of the plaintiff and against Armco Chile in the amount of $10,500,000. Judgment on the verdict was entered by the Court on May 7, 1993. Thereafter, Armco Chile filed a motion seeking judgment as a matter of law or, alternatively, for a new trial. On October 12, 1993, finding that the jury's verdict on liability and damages was against the weight of the evidence, the trial court granted the defendant's post-trial motion, entering judgment in favor of Armco Chile against the plaintiff. The court also granted Armco's motion for a conditional new trial in the event the judgment was overturned on appeal. The plaintiff appealed this ruling to the Eleventh Circuit Court of Appeals. On September 12, 1994, the Eleventh Circuit Court of Appeals affirmed per curiam the ruling of the district court. The plaintiff filed a petition for rehearing en banc which was denied by the Eleventh Circuit of Appeals on November 14, 1994. The time for filing a petition for writ of certiorari to the U.S. Supreme Court has expired.\nEnvironmental Proceedings. Some of Armco's operations are subject to -------------------------- consent orders or judgments under local, state or federal environmental laws and regulations which require Armco to comply with certain discharge standards and to add certain pollution abatement equipment. Armco has received a number of notices identifying Armco as a potentially responsible party under federal or state laws imposing liability for costs in connection with alleged releases of hazard substances from various waste treatment or disposal sites. It is routinely asserted that joint and several liability will be applied; thus, a single party could be held liable for all costs related to a site. However, Armco's experience has been that liability is usually apportioned on the basis of volume and\/or toxicity of materials sent to a site. In many cases, Armco is one of several hundred parties. In a few instances, Armco is one of only a few parties or solely liable. In most instances, Armco expects that any ultimate liability will be apportioned between Armco and other financially viable parties. Armco has also received some claims for indemnification for properties it previously owned or leased. Armco intends to assert all meritorious legal and equitable defenses which are available to it with respect to environmental matters. See \"Item 1 - BUSINESS--Environmental Matters\". The following paragraphs provide information about unresolved environmental matters that have been reported in previous 10-K or 10-Q filings and certain new matters.\nOn July 31, 1989, the United States filed a civil action in the United States District Court for the Southern District of Texas, Houston Division, against 85 parties under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") for cost recovery and injunctive relief associated with the French Limited Superfund site (the \"French Limited Site\") near Crosby, Texas. Concurrently, the United States government filed a Consent Decree requiring the defendants to reimburse the United States in the amount of $1.3 million, to pay certain future oversight costs and to undertake remedial action at the French Limited Site. The Decree was approved and entered by the court. The remedy outlined in the Decree has been implemented and remediation is expected to be complete in 1996. Armco's estimated remaining share of costs, which is fully accrued, is approximately $1.3 million.\nArmco was one of four remaining defendants in several class actions filed on behalf of residents near the French Limited Site; these actions were settled in late 1992 and dismissed with prejudice. Approximately 300 individuals who chose not to settle in the original actions were joined in the case, Rosa Ann Barrett, et al. v. Atlantic Richfield Company (\"ARCO\"), et al., ----------------------------------------------------------------------- which was in the United States District Court for the Southern District of Texas, Houston Division (\"Houston\"). On June 20, 1994, the court granted summary judgment against all but two of the Barrett plaintiffs on the grounds ------- that they had not established a factual basis for their personal injury claims. Settlement of the claims of the two remaining plaintiffs subsequently was finalized, and Armco's share of the settlement was $1,356. On September 20, 1994, the court entered a final order denying plaintiffs' motion for rehearing or new trial and dismissing all of plaintiffs' claims in this case. The Barrett plaintiffs filed a notice of appeal on October 19, 1994. In ------- another case, which was filed in the Houston court, Rhonda Sills v. ARCO, et. ------------------------- al., which also alleged personal injury, the court entered its order granting --- summary judgment against the plaintiffs on October 17, 1994. Plaintiffs filed a notice of appeal on February 6, 1995. In the case styled John D. Bertling, ----------------- et al. v. ARCO, et al., which was filed in the Houston Court in May 1994 and ---------------------- raised claims of business losses, Mr. Bertling has accepted a settlement offer made by Armco and two other defendants. Armco's share of the settlement is $4,244.36.\nArmco and Traverse Bay Area Intermediate School District (\"TBA\") entered into a Consent Decree with the State of Michigan in May 1994, resolving claims of contamination of TBA property. Under the Consent Decree, Armco paid $528,070 for past costs; and will pay 60% of additional state oversight costs as well as for part of the site remediation. Armco's share of the remediation cost is expected to be about $530,000.\nAn action styled The United States of America, State of Maryland v. -------------------------------------------------- Azrael, et al. v. Armco Steel Corporation, et al. was filed in the United ------------------------------------------------- States District Court for the District of Maryland pursuant to Section 107 of CERCLA to recover monies expended by the United States and the State of Maryland in response to a release and threatened release (federal allegation) and an imminent and substantial danger to the public health or welfare presented by the release or substantial threat of release (state allegation) of hazardous substances from a waste disposal site at the intersection of Kane and Lombard Streets in Baltimore, Maryland. Armco was served with a third- party complaint on April 19, 1991. The third-party complaint alleges that Armco arranged for the disposal and\/or treatment or arranged with a transporter for transport for disposal or treatment of hazardous waste to the Kane and Lombard site. A determination has not been made as to how much waste, if any, Armco sent to the site. Based on settlement discussions to date, Armco expects to settle the suit at an amount that is not material.\nOn or about September 29, 1989, the United States filed a civil action in the United States District Court for the District of Minnesota under CERCLA for declaratory relief and cost recovery associated with the Arrowhead Refining Superfund site (the \"Arrowhead Site\") in Hermantown, Minnesota, naming Armco as a defendant. The current estimated cost to clean up the Arrowhead Site is about $20 million. Armco settled the case with the United States Environmental Protection Agency (\"USEPA\") and other potentially responsible parties (PRP's\") for payment of $4,988,920 in November 1994 (which is in addition to $2.4 million Armco paid in prior years and credit for $2.5 million which was previously paid by LTV). Armco expects no further payment requirements for remediation of this site.\nOn July 19, 1993, Armco received a request from USEPA under Section 3007 of the Resource Conservation and Recovery Act (\"RCRA\") for information as part of an ongoing investigation into compliance with a Consent Agreement and Final Order dated October 27, 1988, (the \"Consent Order\") relating to two inactive waste surface impoundments located at the former E.G. Smith plant in Cambridge, Ohio. Armco had sold the Flour City Cambridge, Ohio plant in February, 1993, but retained title to 21.5 acres of the Cambridge facility, including the surface impoundments. Armco submitted a revised closure plan for this site in September 1993. Armco has established reserves which it believes will be adequate to cover the required closure. The Department of Justice notified Armco in March 1994 that it was prepared to file a complaint in this matter alleging that there was non-compliance with the Consent Order in about 1989 and 1990. A tentative settlement with the Department of Justice has been reached but a consent order implementing the settlement has not yet been negotiated. A penalty of $100,000 is expected; other costs are not expected to be material.\nIn September 1992, National Supply Company, Inc., a wholly owned subsidiary of Armco (\"National Supply\") and a 50% general partner in National- Oilwell, received a letter from USEPA, which asserted that National Supply and\/or National-Oilwell was a PRP under CERCLA with respect to the Odessa Drum Company, Inc. Superfund site located in Odessa, Ector County, Texas. Armco settled this matter for $119.\nArmco is one of four companies that are identified by the USEPA as PRP's at the Fultz Landfill Superfund site in Byesville, Ohio; Armco received the initial CERCLA information request about this site in 1985. USEPA's estimate for remediation costs is about $15 million. Armco is negotiating jointly with USEPA and the Department of Justice to settle its liability. The initial proposal from the Department of Justice was unacceptable to Armco and Armco is preparing a counter proposal. The outcome of negotiations or litigation can not be determined at this time, however, even if Armco were to have accepted the Department of Justice's initial proposal, the amount which would be expected to be paid out over the next several years would not be material to Armco.\nArmco received a unilateral order in September 1994 from USEPA to complete remediation of contaminated soil on certain property in New Boston, Ohio which had been sold to New Boston Industrial Corporation several years ago. Prior to the sale, the salvage contractor hired by the current owner (which was then occupying the property as a tenant) engaged in intentional conduct which resulted in contamination. Armco and the current owner have collected $825,000 on a $1 million performance bond which had been obtained to secure the contractor's performance. These funds were used for remediation and oversight of the cleanup. Armco is conducting the remaining cleanup which is estimated to cost about $5.2 million; all contaminated soil which had previously been excavated has been shipped off-site; additional soil samples will be taken to determine whether additional excavation is necessary. Armco is seeking contribution from other PRPs, but no estimate as to the amount of such contribution can be made at this time.\nIn July of 1990, Eastern Stainless Corporation entered into a Consent Order with the Maryland Department of Environment to resolve a complaint alleging various violations of environmental requirements. This Order was followed by a voluntary Consent Judgment on April 17, 1992 and an amendment of the Consent Judgment in August of 1993. Pursuant to the Order and Judgment, Eastern Stainless spent a total of about $5.4 million in 1991 through 1994 on various pollution prevention projects. In addition, Eastern Stainless paid a $0.3 million penalty. Armco believes Eastern Stainless was in compliance with the Consent Judgment at the time Eastern Stainless was sold to Avesta Sheffield, Inc. By Court Order, dated March 10, 1995, Avesta was substituted for Eastern Stainless as the responsible party under the Consent Order, and Armco expects to have no further liability in regard to the Consent Judgment.\nOn July 22, 1993, Armco received a request from the Kansas Department of Health and Environment (\"KDHE\") for information regarding a former Armco Construction Products Division plant located in Topeka, Kansas and now owned by Contech Construction Products, Inc. (\"Contech\"). Armco answered KDHE's information request in August 1993 and KDHE has indicated it will pursue Contech and two other parties regarding this matter. Armco is working with Contech to resolve any indemnification obligation Armco may have under the agreement conveying the property to Contech. Based on the type of contamination at issue and the presence of other potentially responsible parties, Armco does not believe its liability will be material.\nIn December 1993, Armco and one other company received a notice of nonbinding preliminary allocation of proportionate responsibility from the Pennsylvania Department of Environmental Resources (\"PADER\") for the William Taylor Estate site. PADER has decided to conduct additional investigations at this site. Based on current information about type of contamination and the presence of other potentially responsible parties, Armco does not expect its liability to be material.\nOn February 16, 1994, the Missouri Department of Natural Resources and the USEPA jointly issued a Part B permit to the Kansas City facility under RCRA. Armco petitioned the Environmental Appeals Board for review of most of such permit provisions. The appeal was resolved through negotiation. Armco is initiating the investigation and remediation required under the revised permit which was issued in November, 1994. Initial investigation costs may reach $1 million; there is not sufficient information regarding soil and groundwater conditions to reasonably estimate remediation costs at the present time.\nThe Malitovsky Drum Superfund site in Pittsburgh, Pennsylvania, in which Armco was a named PRP was resolved through entry of a Consent Decree on February 21, 1995, in the U.S. District Court for the Western District of Pennsylvania. Armco had previously deposited $118,333 in a PRP trust fund as its share of liability in this matter. No further liability is anticipated for this matter.\nOn January 18, 1994, Armco received a 104(e) request for information under CERCLA from USEPA regarding shipments to the Granville Solvents site in Ohio. In August 1994, USEPA entered into an Administrative Order on Consent (\"AOC\") with a number of potentially responsible parties at the Granville Solvents Site in Ohio. Armco did not sign the AOC because the terms were deemed unacceptable. Issues of particular concern were stipulated penalties for migration of contaminants,\nlack of specificity as to what remediation would be required at the site and lack of a meaningful procedure to resolve disputes between the parties and USEPA. Four of the signatories to the AOC, who claim to have an assignment of rights by other companies who signed the AOC, initiated a contribution action on September 9, 1994, in the U.S. District Court for the Southern District of Ohio against all the potentially responsible parties, including Armco, who did not sign the AOC. Armco made a settlement offer to all the AOC signatories under which Armco would pay about 15% of remediation costs, which are currently estimated at $5 million. This offer was rejected by the plaintiffs and has been withdrawn. A scheduling order for discovery is being developed.\nOn February 27, 1995, the Ohio Environmental Protection Agency issued a Notice of Violation (\"NOV\") to Armco's Zanesville, Ohio facility alleging noncompliance with both a 1993 Order and various state regulations regarding hazardous waste management. Armco is reviewing the NOV, implementing appropriate corrective measures and preparing a response. No proposed penalties were included in the NOV and Armco cannot reasonably estimate potential penalties based on current information.\n\tIn the opinion of management, the ultimate liability resulting from the claims described in the preceding paragraphs in the \"Legal Proceedings\" section will not materially affect the consolidated financial position or liquidity of Armco and its subsidiaries; however, it is possible that due to fluctuations in Armco's operating results, future developments with respect to such matters could have a material effect on its financial condition, liquidity and results of operations in future interim or annual periods.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to a vote of the security holders of Armco during the fourth quarter of the year ended December 31, 1994.\nExecutive Officers of Armco\nThe executive officers of Armco as of March 15, 1995, were as follows*:\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 incorporated herein by reference from pages 38, 45 and 48 of the Annual Report to Shareholders for the year ended December 31, 1994.\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 information required by this Item is incorporated herein by reference from pages 12-22 following the caption \"Management's Discussion and Analysis\" of the Consolidated Financial Statements in the Annual Report to Shareholders for the year ended December 31, 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is incorporated herein by reference from pages 23-43 of the Annual Report to Shareholders for the year ended December 31, 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\n\tNone.\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 as to executive officers of Armco is contained in Part I of this report under \"Executive Officers of Armco\" and is incorporated herein by reference. The information required as to directors is incorporated herein by reference from the information set forth under the caption \"ELECTION OF DIRECTORS\" in the registrant's Proxy Statement for the 1995 Annual Meeting of Shareholders filed with the Securities and Exchange Commission pursuant to Rule 14a-6 of the Securities Exchange Act of 1934, as amended (the \"Proxy Statement\").\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated herein by reference from the information set forth in the Proxy Statement under the caption \"EXECUTIVE COMPENSATION\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe security ownership in Armco stock of directors, certain executive officers and directors and executive officers as a group and of persons known by Armco to be the beneficial owners of more than five percent of any class of Armco's voting securities is incorporated herein by reference from the information set forth in the Proxy Statement under the caption \"MISCELLANEOUS -- Stock Ownership\".\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\nI.\tDocuments Filed as a Part of this Report\nA. Financial Statements and Financial Statement Schedules Page\n1. Statement of Consolidated Operations for the Years Ended December 31, 1994, 1993 and 1992 *\n2. Statement of Consolidated Financial Position as of December 31, 1994 and 1993 *\n3. Statement of Consolidated Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 *\n4. Notes to Financial Statements *\n5. Independent Auditors' Report *\n6. Independent Auditors' Report 26\n7. Financial Statement Schedule for the Years Ended December 31, 1994, 1993 and 1992\nII-- Valuation and Qualifying Accounts 27\n8. Responsibility for Financial Reporting *\n9. National-Oilwell Consolidated Financial Statements and Financial Statement Schedules as of December 31, 1994 and 1993 and for the years ended December 31, 1994, 1993 and 1992 28 - 43\n10. Armco Financial Services Group companies to be sold Consolidated Financial Statements and Financial Statement Schedules as of December 31, 1994 and 1993 and for the years ended December 31, 1994, 1993 and 1992 44 - 72\n---------------\n* Incorporated in this annual report on Form 10-K by reference to pages 23-43 of the Annual Report to Shareholders for the year ended December 31, 1994.\nFinancial Statements and Financial Statement Schedules Omitted\nThe financial statements and financial statement schedules for Armco Inc. and consolidated subsidiaries, and for Armco Financial Services Group companies to be sold and National-Oilwell, other than those listed above, are omitted because of the absence of conditions under which they are required, or because the information is set forth in the notes to financial statements.\nB. Exhibits\nThe following is an index of the exhibits included in the Form 10-K Annual Report.\n3(a). Articles of Incorporation of Armco Inc., as amended as of May 12, 1993 (1)\n3(b). Regulations of Armco Inc. (2)\n4. Armco hereby agrees to furnish to the Securities and Exchange Commission, upon its request, a copy of each instrument defining the rights of holders of long-term debt of Armco and its subsidiaries, omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K.\n10(a). Deferred Compensation Plan for Directors*\n10(b). 1993 Long-Term Incentive Plan of Armco Inc. (3)*\n10(c). Severance Agreements (4)*\n10(d). 1988 Restricted Stock Plan (5)*\n10(e). Executive Supplemental Deferred Compensation Plan Trust (6)*\n10(f). Executive Supplemental Deferred Compensation Plan (7)*\n10(g). Pension Plan for Outside Directors (8)*\n10(h). Rights Agreement dated as of June 27, 1986 between Armco Inc. and Fifth Third Bank, as successor to Harris Trust and Savings Bank, as amended as of June 24, 1988 (9)\n10(i). Key Management Severance Policy (10)*\n10(j). Minimum Pension Plan (11)*\n10(k). Stainless Steel Toll Rolling Services Agreement (12)\n10(l) Equity Exchange Agreement (13)\n10(m) Stock Purchase Agreement among Armco Inc., Armco Financial Services Corporation and Vik Brothers Insurance, Inc. (14)\n10(n) Asset Sale Agreement By and Among Armco Inc., Eastern Stainless Corporation, Avesta Sheffield East, Inc. and Avesta Sheffield Holding Co. dated as of February 9, 1995 (15)\n11. Computation of Income (Loss) Per Share\n13. Annual Report to Shareholders for the year ended December 31, 1994. (Filed for information only, except for those portions that are specifically incorporated in this Form 10-K Annual Report for the year ended December 31, 1994.)\n21. List of subsidiaries of Armco Inc.\n23. Independent Auditors' Consents\n27. Financial Data Schedule\n28. Schedule P - Analysis of Losses and Loss Expenses\n99. Description of Armco Capital Stock\nThe annual reports (Form 11-K) for the year ended December 31, 1994 for the Armco Inc. Retirement and Savings Plan and the Armco Inc. Thrift Plan for Hourly Employees will be filed by amendment as exhibits hereto, as permitted under Rule 15d-21.\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit to the Form 10-K pursuant to Item 14(c) of Form 10-K. ______________________\n(1) Incorporated by reference from Exhibit 4.2 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993.\n(2) Incorporated by reference from Exhibit 3.2 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994.\n(3) Incorporated by reference from Exhibit 10 to Armco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993.\n(4) Incorporated by reference from Exhibit 10(a) to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (SEC File No. 001-00873).\n(5) Incorporated by reference from Exhibit 10(i) to Armco's Annual Report on Form 10-K for the year ended December 31, 1988 (SEC File No. 001-00873).\n(6) Incorporated by reference from Exhibit 10(b) to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (SEC File No. 001-00873).\n(7) Incorporated by reference from Exhibit 10(c) to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (SEC File No. 001-00873).\n(8) Incorporated by reference from Exhibit 10(p) to Armco's Annual Report on Form 10-K for the year ended December 31, 1989 (SEC File No. 001-00873).\n(9) Incorporated by reference from Exhibit 1 to Armco's Form 8-A dated July 7, 1986 and Exhibit 1.1 to Armco's Form 8 dated July 11, 1988 (SEC File No. 001-00873).\n(10) Incorporated by reference from Exhibit 10(p) to Armco's Annual Report on Form 10-K for the year ended December 31, 1990.\n(11) Incorporated by reference from Exhibit 10(r) to Armco's Annual Report on Form 10-K for the year ended December 31, 1991.\n(12) Incorporated by reference from Exhibit 10(s) to Armco's Annual Report on Form 10-K for the year ended December 31, 1993.\n(13) Incorporated by reference from Exhibit 2 to Armco's Form 8-K dated April 7, 1994.\n(14) Incorporated by reference from Exhibit 10 to Armco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.\n(15) Incorporated by reference from Exhibit 2 to Armco's Form 8-K dated March 14, 1995.\n------------------\nII. Reports on Form 8-K\nThe following reports on Form 8-K were filed by Armco since September 30, 1994:\nReport Date Description ----------- ----------- October 3, 1994 Reporting that Armco, Eastern Stainless, an 84%- owned subsidiary of Armco, and Avesta Sheffield reached an agreement in principle for the sale of all of the assets of Eastern Stainless to Avesta Sheffield for cash and the assumption of certain liabilities.\nMarch 14, 1995 Reporting that on March 14, 1995, Armco, Eastern Stainless, an 84%-owned subsidiary of Armco, and Avesta Sheffield completed the sale of substantially all of the assets of Eastern Stainless to Avesta Sheffield and providing pro forma financial information with respect to the sale. Also reporting that a minority shareholder of Eastern Stainless filed a complaint against Armco and Eastern Stainless seeking various relief based upon Armco's relationship with Eastern Stainless.\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 as of March 31, 1995.\nARMCO INC.\nBy JAMES F. WILL ------------------------------- James F. Will President and Chief Executive Officer\n\tPursuant 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 31, 1995.\nBy JAMES F. WILL By PAUL H. HENSON ------------------------------- ------------------------------- James F. Will Paul H. Henson President, Director Chief Executive Officer and Director\nBy DAVID G. HARMER By ------------------------------- ------------------------------- David G. Harmer John H. Ladish Vice President and Director Chief Financial Officer\nBy PETER G. LEEMPUTTE By BRUCE E. ROBBINS ------------------------------- ------------------------------- Peter G. Leemputte Bruce E. Robbins Vice President and Controller Director\nBy By BURNELL R. ROBERTS ------------------------------- ------------------------------- John J. Burns, Jr. Burnell R. Roberts Director Director\nBy DAVID A. DUKE By JOHN D. TURNER ------------------------------- ------------------------------- David A. Duke John D. Turner Director Director\nBy JOHN C. HALEY ------------------------------- John C. Haley Director\nINDEPENDENT AUDITORS' REPORT\nArmco Inc.:\nWe have audited the consolidated financial statements of Armco Inc. and consolidated subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 3, 1995, which report includes an explanatory paragraph for changes in Armco Inc.'s methods of accounting for postretirement benefits other than pensions, income taxes, certain investments in debt and equity securities, and postemployment benefits; such consolidated financial statements and report are included in your 1994 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedule of Armco Inc. and consolidated subsidiaries, listed in Item 14. This consolidated financial statement schedule is 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 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.\nDELOITTE & TOUCHE LLP\nPittsburgh, Pennsylvania February 3, 1995\n[LOGO]ERNST & YOUNG LLP *One Houston Center *Phone: 713 750 1500 Suite 2400 713 750 1501 1221 McKinney Street Houston, Texas 77010-2007\nReport of Independent Auditors ------------------------------\nPartners National-Oilwell\nWe have audited the accompanying consolidated balance sheets of National- Oilwell and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, partners' capital, and cash flows for each of the three years in the period ended December 31, 1994. 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 National-Oilwell and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\n\/s\/ ERNST & YOUNG LLP\nJanuary 26, 1995\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994\n1. Organization and Basis of Presentation\nNational-Oilwell (\"Company\") is a partnership organized under the laws of Delaware. The partnership was formed in April 1987 to consolidate the oilfield manufacturing and distribution operations of Armco Inc. (\"Armco\") and USX Corporation (\"USX\"). National-Oilwell is a general partnership between National Supply Company, Inc., a wholly-owned subsidiary of Armco and Oilwell, Inc., a wholly-owned subsidiary of USX. Each of the partners has a 50% interest in the partnership. All references to the Company in these financial statements are synonymous with National-Oilwell as previously described.\nThe Company distributes an extensive line of oilfield supplies, oilfield equipment and tubular products and designs and manufactures a variety of oilfield equipment for use in oil and gas drilling, completion and production activities. The Oilfield Distribution segment is comprised of the Distribution Services and Tubular Distribution business units. This segment distributes products through a large network of oilfield supply stores and also procures and distributes oil country tubular goods manufactured by third parties. The Oilfield Equipment segment consists of the Drilling Systems and Equipment and Pumping Systems business units. This segment designs and manufactures drilling equipment, marine equipment, and an extensive line of pumps used in a variety of oil and gas and industrial applications.\n2. Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. Substantially all of the Company's subsidiaries have elected a December 31 year-end. All significant intercompany transactions and balances have been eliminated in consolidation.\nProperty, Plant and Equipment\nProperty, plant and equipment are recorded at cost. Expenditures for major improvements which extend the lives of property and equipment are capitalized while minor replacements, maintenance and repairs are charged to operations as incurred. Disposals are removed at cost less accumulated depreciation with any resulting gain or loss reflected in operations. Depreciation is provided using the straight-line method over the estimated useful lives of individual items.\nInventories\nInventories consist of (a) standardized oilfield products and oil country tubular goods, (b) manufactured equipment and (c) spare parts for the manufactured equipment. Inventories are stated at the lower of cost or market using the first-in, first-out (FIFO) or average cost method of valuing inventories.\nForeign Currency\nThe functional currency for the Company's Canadian, United Kingdom, Australian and Venezuelan subsidiaries is the local currency. The cumulative effects of translating the balance sheet accounts from the functional currency into the U.S. dollar at current exchange rates are included in cumulative foreign currency translation adjustment in partners' equity. The U.S. dollar is used as the functional currency for the Singapore subsidiary. For all operations, gains or losses from remeasuring foreign currency transactions into the functional currency are included in income.\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nConcentration of Credit Risk\nThe Company grants credit to its customers which are primarily in the oil and gas industry. The Company performs periodic credit evaluations of its customers' financial conditions and generally does not require collateral. Receivables are generally due within 30 days. The Company maintains reserves for potential losses and such losses have consistently been within management's expectations.\nIncome Taxes\nThe Company provides for income taxes under the liability method pursuant to Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting basis 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. The Company made income tax payments of $557,000, $392,000 and $573,000 during the years ended December 31, 1994, 1993 and 1992, respectively.\nRevenue Recognition\nRevenue from the sale of products is recognized upon passage of title to the customer, which in most cases coincides with shipment of the related products.\nFair Value of Financial Instruments\nThe Company's financial instruments consist primarily of cash and cash equivalents, receivables, payables, and debt instruments. Cash equivalents include only those investments having a maturity of three months or less at the time of purchase. The book values of these financial instruments are considered to be representative of their respective fair values. See Note 5 for the terms and carrying values of the Company's various debt instruments.\nResearch and Development Costs\nResearch and development costs are expensed as incurred. During 1994, 1993 and 1992, research and development costs were $579,000, $1,115,000, and $2,077,000, respectively.\nReclassifications\nCertain amounts from the prior year financial statements have been reclassified to conform with the 1994 presentation.\n3. Inventories\nInventories consist of:\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\n4. Property, Plant, and Equipment\nProperty, plant, and equipment consist of:\nEquipment included in gross assets acquired under capital leases totaled -0- at December 31, 1994 and $3,379,000 at December 31, 1993. Related amortization included in the accumulated depreciation and amortization balance totaled -0-, and $2,105,000 at December 31, 1994 and 1993, respectively.\n5. Notes Payable\nAt December 31, 1994, the Company had bank lines of credit totaling approximately $50 million, of which $20 million had been utilized for letters of credit with no loans outstanding. The primary revolving credit agreement (the Credit Agreement) expires in March 1995 and is secured by inventory, receivables, property, plant and equipment, and the stock of the Company's subsidiaries. The Credit Agreement contains certain financial covenants relative to net worth, leverage ratio, working capital and cash flow. The Company has complied with all covenants. A weekly borrowing base formula is used to determine credit availability. The interest rate in the Credit Agreement fluctuates with short-term interest rates. The interest rate in effect at December 31, 1994 was 10.25%. A commitment fee of 1\/2% per annum is charged on the unused portion of the Credit Agreement. The weighted average interest rate was approximately 8.5% and 8.0% for 1994 and 1993, respectively. Interest paid was $3,444,000 during 1994, $3,693,000 during 1993 and $4,943,000 during 1992.\nDuring the year, the Credit Agreement was amended to allow for the sale of certain production equipment product lines with the resultant adjustments to the financial covenants. Other amendments and consents were processed during the year as appropriate.\nThe Company is currently negotiating a new revolving credit facility (the \"Revolver\"). The Revolver is expected to consist of a three-year nonamortizing credit facility which includes a sub-facility for issuance of letters of credit.\nIn October 1994, the Company paid all outstanding principal and interest due to the Company's two owners relative to each of their $6,500,000 subordinated notes due March 1995.\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\n6. Commitments and Contingencies\nCommitments\nThe Company leases land, buildings and storage facilities, vehicles, and data processing equipment under operating leases extending through the year 2004. The Company's annual lease commitments for operating leases at December 31, 1994 were as follows:\nRent expense for the years ended December 31, 1994, 1993 and 1992 was $8,691,000, $10,372,000 and $11,325,000, respectively.\nContingencies\nThe Company is the subject of, or a party to, various claims, regulatory agency audits, and pending or threatened legal actions involving a variety of matters. The total liability on these matters at December 31, 1994 cannot be determined; however, in the opinion of management, any ultimate liability resulting, to the extent not otherwise provided for, should not materially affect the financial position, liquidity, or results of operations of the Company.\n7. Pension Plans\nThe Company and its consolidated subsidiaries have several pension plans covering substantially all of its employees. The two largest are considered defined-contribution pension plans and cover most of the domestic employees and employees of the Canadian subsidiary. Contributions to the plans are based on employees' years of service equating to a percentage of current earnings. For the years ended December 31, 1994, 1993 and 1992, domestic pension expense for the defined-contribution plan was $1,745,000, $1,812,000 and $1,888,000 respectively, and the funding is current. Pension expense of the foreign operations for the defined-contribution plan totaled $169,000 for 1994, $193,000 for 1993, and $154,000 for 1992.\nNational-Oilwell (U.K.) Ltd., the Company's U.K. subsidiary, has a defined- benefit pension plan covering substantially all employees in that country. Benefits paid to retirees are based upon age at retirement, years of credited service, and average compensation. Contributions to the plan are determined by an independent actuary on the basis of annual valuations. The U.K. pension plan assets are invested primarily in U.K. and overseas equities, U.K. government securities, overseas bonds, and cash deposits. There are no unamortized prior service costs. The plan assets at fair market value were $27,389,000 at December 31, 1994 and $30,666,000 at December 31, 1993. The projected benefit obligation was $20,630,000 at December 31, 1994 and $22,440,000 at December 31, 1993. Net periodic pension cost recognized as (income)\/expense for the years ended December 31, 1994, 1993 and 1992 was ($69,000), $699,000 and $986,000, respectively.\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\n8. Other Postretirement Benefit Plans\nIn addition to the Company's defined-contribution and defined-benefit pension plans, the Company has defined-benefit postretirement plans covering most of the domestic employees. One plan provides life insurance benefits for most domestic employees. The other plan provides medical and life benefits for former hourly employees associated with a discontinued manufacturing facility and medical benefits for their spouses. The medical plan allows for basic or optional coverage. The basic component is noncontributory and the optional coverage rates are based upon pro rata level of cost sharing between the Company and its retirees. The life insurance plans are noncontributory. None of the plans were amended during 1994, 1993 or 1992. The Company's policy is to fund the cost of postretirement health care and life benefits as they are incurred.\nIn 1992, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The Company elected immediate recognition of the transition obligation at January 1, 1992 as a cumulative effect of a change in accounting principle. The effect of adopting the new rules increased 1992 net periodic postretirement benefit cost for the above defined-benefit plans by $195,000 and the cumulative effect adjustment as of January 1, 1992 increased net loss by $3,337,000. The following table shows the plans' combined funded status reconciled with amounts recognized in the Company's Consolidated Balance Sheet at December 31, 1994 and 1993:\nThe recorded benefit obligation in excess of the accumulated postretirement benefit obligation represents unrecognized gains. The 1994 actuarial valuation for the medical and life benefit plan related to the discontinued manufacturing facility includes a change in assumption related to cost-sharing considerations with participants' current employers. The resulting unrecognized gain is being amortized over the average remaining service period of active plan participants.\nNet periodic retirement benefit cost includes the following components:\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nThe 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 10.0% for 1995, 9.5% for 1996, decreasing by 0.5% per year to 5.5% by 2005, and 5.5% per year thereafter. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation for the medical plan as of December 31, 1994 by $61,000, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by $6,000.\nThe weighted-average discount rate used to determine the accumulated postretirement benefit obligation was approximately 8% at December 31, 1994 and 7% at December 31, 1993.\n9. Income Taxes\nAs a partnership, the Company is not subject to U.S. federal taxes on its income. The general partners include in their federal and state tax returns the partnership's results of operations. Accordingly, no provision for U.S. federal income taxes has been made by the Company.\nThe Company adopted the liability method of accounting for income taxes as required by the Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" effective January 1, 1992. The cumulative effect of adopting Statement 109 decreased net loss by $4,473,000 in 1992 (there was no pretax effect of adopting the Statement).\nThe geographical sources of income (loss) before income taxes and cumulative effect of changes in accounting principles were as follows:\nTax rates related to foreign income range from 30% to 50%.\nSignificant components of the Company's deferred tax assets and liabilities were as follows:\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nThe income tax liability of the Company's foreign and domestic subsidiaries is reflected in the Company's financial statements. Deferred income taxes, attributable to the foreign subsidiaries, result primarily from temporary differences in depreciation and other expenses for tax and financial statement purposes. At December 31, 1994, the Company had tax loss carryforwards available at certain foreign subsidiaries totaling $21 million. The tax loss carryforwards have no expiration date; however, they are only available against income arising from the same line of business.\n10. Special Charges\/(Credits)\nSpecial charges\/(credits) consist of the following:\nSales of Product Lines\n---- The Company completed the sales of certain production equipment product lines not considered part of its core businesses under asset sales agreements during the last half of 1994. Sale of the fluid control systems, rod pump, sucker rod, and hydraulic product lines resulted in a gain of $15.6 million. Proceeds received in 1994 totaled approximately $41.0 million and were used to reduce debt. As a result of the sales, the Company will no longer manufacture these products but will continue as a distributor. It is estimated future revenues will be reduced by approximately $18.0 million due to these product line sales; however, the impact on net income in 1994, as well as in subsequent years, was not and is not expected to be significant.\n---- During 1993, the Company implemented a business strategy to focus on its core businesses and divest marginal or unprofitable product lines. In the fourth quarter of 1993, the Company recorded a $10.0 million charge for the estimated loss on the sale of its wellhead business under an asset sales agreement signed in December 1993. This charge included an $8.5 million writedown of inventories and property, plant and equipment to estimated net realizable values and $1.5 million for transition and other direct costs of disposal. Proceeds from the wellhead business sale of $28.7 million, which closed in January 1994, were used to reduce debt. There were no significant costs expensed in 1994 related to the disposition of this product line.\nEmployee Termination Benefits\n---- In conjunction with the formal announced shutdown of the Stockport, England, plant on January 9, 1995, the Company expensed approximately $3.2 million in 1994 relating to employee termination benefits. These benefits are calculated pursuant to the terms of the United Kingdom preexisting employee benefit plan. Benefit payments of $1.2 million were paid in the fourth quarter of 1994 related to the termination of 77 employees. Approximately $0.5 million of these benefit payments were accrued in 1992. The remaining reserve of $2.5 million is for 115 employees and will be paid in 1995.\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\n---- The majority of the employee termination benefits in 1992 related to the Company's United Kingdom operations. In connection with the closing of the London, England, office and the rationalization of the Company's subsea wellhead manufacturing efforts in the United Kingdom, the Company recorded employee termination benefits of $3.8 million in 1992 related to approximately 225 employees. Approximately 77, 124, and 20 employees were actually terminated in 1994, 1993 and 1992, respectively, with the actual cost charged against the reserve. As of December 31, 1994, the reserve for these employee terminations is -0-.\nExit Costs\n---- The consolidation of the Company's Houston, Texas, manufacturing operations resulted in exit costs of $0.6 million in 1994. These costs primarily included equipment relocation costs and lease termination costs. The remaining liability at December 31, 1994 represents $0.2 million for lease termination costs related to abandoned facilities.\n1993 and 1992 ------------- The 1992 decision to close the Company's New Iberia, Louisiana, oilfield equipment manufacturing facility resulted in exit costs of approximately $0.9 million which primarily consisted of inventory writedowns and relocation of machinery and equipment. The plant closure was completed in 1993 for a total cost of approximately $1.3 million. Accordingly, the reserve for this plant closure was -0- at December 31, 1993.\nExit costs in 1992 also included $1.1 million in the U.K. related to lease termination costs as a result of management's plans to vacate the London, England, and Aberdeen, Scotland, wellhead sales, service and administrative offices. The remaining reserve at December 31, 1994 of approximately $0.3 million represents the future lease costs of the Aberdeen, Scotland, office.\nReversal of Reserves\nThe reversal of reserves in 1994, 1993, and 1992 were recorded as credits to special charges. These items primarily relate to an $18.5 million reserve initially recorded in 1991 to accrue for the estimated loss on the shutdown and disposition of the plant and related machinery and equipment at Garland, Texas. The $1.3 million reversal primarily relates to excess transition expense accruals no longer needed when the plant shutdown was completed in 1992. The $1.8 million reversal primarily related to excess machinery, equipment and inventory relocation accruals no longer needed after movement to the Company's other facilities was completed in 1993. The $2.1 million reversal primarily related to excess accruals for potential demolition and environmental cleanup no longer needed when the facility was finally sold in 1994.\n11. Related Party Transactions\nThe Company maintains ongoing business relationships with Armco Inc. and USX Corporation, the parent companies of the general partners, and their subsidiaries. Significant related party transactions with these companies included:\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nAt December 31, 1994, the Company leases office space for its headquarters facility, as well as other operating locations, from the parent companies or their subsidiaries. Future minimum lease payments applicable to these leasing agreements total $5,031,000. Rental expense to related parties totaled $1,342,000, $1,165,000 and $1,203,000 for 1994, 1993 and 1992, respectively, and is excluded from purchases.\nA $31 million cash distribution was made to the owners in December 1994.\n12. Business Segments and Geographic Areas\nThe Company's operations consist of two segments, the oilfield distribution segment and the oilfield equipment segment. The oilfield distribution segment distributes an extensive line of oilfield supplies, oilfield equipment and tubular products. The oilfield equipment segment designs and manufactures a variety of oilfield equipment for use in oil and gas drilling, completion and production activities. Intersegment sales and transfers are accounted for at commercial prices.\nDuring the years ended December 31, 1994, 1993 and 1992, no single customer accounted for 10% or more of consolidated revenues.\nSummarized financial information with respect to business segments and geographic areas is as follows:\nBusiness Segments (in thousands)\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\nGeographic Areas (in thousands)\nCorporate general and administrative expense related to worldwide manufacturing and other support functions benefit both United States and international operations. An allocation has been made to each business segment and geographic area based on an estimate of the corporate effort attributable to the respective business segment or geographic area. The expenses allocated totaled approximately $18,000, $21,700 and $24,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nNATIONAL-OILWELL\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)\n13. Quarterly Financial Data (Unaudited):\nINDEPENDENT AUDITORS' REPORT\nArmco Inc.:\nWe have audited the statement of consolidated net assets of Armco Financial Services Group - Companies to be Sold as of December 31, 1994 and 1993 and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included Financial Statement Schedule I, Summary of Investments - Other than Investments in Related Parties; Schedule II, Condensed Financial Information; Schedule IV, Reinsurance; Schedule V, Valuation and Qualifying Accounts; and Schedule VI, Supplemental Information Concerning Property-Casualty Insurance Operations. 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 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, such consolidated financial statements present fairly, in all material respects, the financial position of Armco Financial Services Group - Companies to be Sold at December 31, 1994 and 1993 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, 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.\nAs discussed in Notes 3 and 7 to the consolidated financial statements, effective January 1, 1993 the Company changed its method of accounting for reinsurance contracts and postretirement benefits other than pensions. As discussed in Note 1 to the consolidated financial statements, effective December 31, 1993 the Company changed its method of accounting for investments in debt securities.\n\/s\/ Deloitte & Touche LLP\nMilwaukee, Wisconsin March 15, 1995\n(continued)\nARMCO FINANCIAL SERVICES GROUP - COMPANIES TO BE SOLD\nARMCO FINANCIAL SERVICES GROUP - COMPANIES TO BE SOLD\nNotes to Consolidated Financial Statements For the Years Ended December 31, 1994, 1993 and 1992\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nArmco Financial Services Group - Companies to be Sold (AFSG - Companies to be Sold or the Company) consists of the net assets of Armco Inc.'s (Armco) insurance companies which Armco intends to sell and which continue underwriting activities. These activities principally represent the transactions of Northwestern National Holding Company, Inc. (NNHC), which is a wholly owned subsidiary of Armco Financial Services Corporation (AFSC), which is a wholly owned subsidiary of Armco. Prior to 1993, Armco accounted for the operating results of the AFSG companies to be sold under the cost recovery method, whereby net income was not recognized until realized through a sale of the businesses, while net losses were charged against income as incurred. Armco now presents these businesses as discontinued operations.\nNNHC owns 100% of the common and preferred stock of Northwestern National Casualty Company and its wholly owned subsidiaries, NN Insurance Company and SICO, Inc. and its wholly owned subsidiary, Statesman Insurance Company (Statesman), and Statesman's wholly owned subsidiary Timeco, Inc. (collectively, SICO) (collectively, NNCC), Pacific National Insurance Company and its wholly owned subsidiary, Pacific Automobile Insurance Company (collectively, PNIC), and Certified Finance Corporation (CFC). CFC had not commenced operations as of December 31, 1994.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of NNHC and its subsidiaries NNCC, PNIC and CFC (collectively, the Company). Significant intercompany accounts and transactions have been eliminated.\nBusiness Segment - The Company operates in a single business segment, property and casualty insurance.\nBasis of Presentation - The accompanying financial statements have been prepared on the basis of generally accepted accounting principles (GAAP) which vary from statutory reporting practices prescribed for insurance companies by regulatory authorities (see Note 9).\nInvestments - Fixed maturity investments include bonds and mortgage-backed securities. Fixed maturity investments which the Company has the positive intent and ability to hold to maturity (\"held to maturity\") are reported at amortized cost. Fixed maturity investments which are available for sale (\"available for sale\") are reported at market value. Equity securities are common stocks which are reported at market value. The difference between cost and market value of fixed maturity investments available for sale is reflected as a component of net assets. Short-term investments (cash equivalents) are reported at cost which approximates market value.\nIn May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The statement requires fixed maturity investments which are available for sale to be recorded at market value. The Company adopted SFAS No. 115 on December 31, 1993 and reclassified certain investments from the \"held to maturity\" class into the \"available for sale\" class on the same date. The financial statement effect of adopting the statement was to increase investments by $13,321,000 and net assets by $13,321,000. Amounts reported in the Statement of Consolidated Cash Flows for 1993 are based on the classification of securities prior to the adoption of SFAS No. 115.\nInvestment income consists primarily of interest which is recognized on an accrual basis. Interest income on mortgage-backed securities is determined on the effective yield method based on estimated principal payments. Realized capital gains and losses, calculated as the difference between proceeds and book value, are determined by specific identification of the investments sold.\nRecognition of Premium Revenues - Premiums, net of reinsurance ceded, are earned on a pro rata basis over the term of the policy.\nDeferred Policy Acquisition Costs - Policy acquisition costs that vary with and are directly related to the production of premiums are deferred and amortized over the terms of the policies to which they relate. Amortization for the years ended December 31, 1994, 1993 and 1992 was $45,837,000 , $46,456,000 and $49,912,000, respectively. The Company does not include anticipated investment income when assessing the recoverability of deferred policy acquisition costs.\nDepreciation - Depreciation on property and equipment is provided primarily on the straight-line basis over the estimated useful lives of the respective assets. Depreciation periods range from 3 to 10 years for personal property and from 5 to 40 years for real property.\nGoodwill - Goodwill, which represents the excess of cost over the fair value of net assets of acquired subsidiaries, is amortized on a straight-line basis over periods not exceeding 40 years. The Company assesses whether its goodwill is impaired at each balance sheet date based on an evaluation of undiscounted projected cash flows through the remaining amortization period. If an impairment is determined, the amount of such impairment is calculated based on the estimated fair value of the asset.\nCash Flow - For purposes of reporting cash flows, the Company considers all highly liquid short-term investments purchased with maturities of three months or less to be cash equivalents.\nInsurance Liabilities - The liability for unpaid losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on past experience, for losses incurred but not reported. Such liability is necessarily based on estimates and, while management believes that the amount is fairly stated, the ultimate liability may be in excess of or less than the amount provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed and any adjustments resulting therefrom are reflected in earnings currently. The Company does not discount the liability for unpaid losses and loss adjustment expenses. The liability for losses and loss adjustment expenses is reported net of a receivable for salvage and subrogation of $8,033,000, $7,746,000 and $7,523,000 at December 31, 1994, 1993 and 1992, respectively.\nParticipating Policy Contracts - Participating business represents approximately 13%, 14% and 13% of total premiums in force at December 31, 1994, 1993 and 1992, respectively. Participating business is composed entirely of workers' compensation policies. The amount of dividends to be paid on these policies is determined based on the provisions of the individual policies. Dividend expense for the years ended December 31, 1994, 1993 and 1992, was $2,579,000, $2,414,000 and $2,966,000, respectively.\n2. INVESTMENTS\nThe amortized cost and market value of the Company's fixed maturity investments as of December 31, 1994 that are designated as held to maturity are as follows:\nThe amortized cost and market value of the Company's fixed maturity investments as of December 31, 1994 that are designated as available for sale are as follows:\nThe amortized cost and market value of the Company's fixed maturity investments as of December 31, 1993 that are designated as held to maturity are as follows:\nThe amortized cost and market value of the Company's fixed maturity investments as of December 31, 1993 that are designated as available for sale are as follows:\nNet assets decreased by $33,065,000 from December 31, 1993 to December 31, 1994 due to unrealized losses on fixed maturity investments designated as available for sale.\nThe amortized cost and market value of the Company's fixed maturity investments at December 31, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nProceeds from fixed maturity investment sales and gross realized gains and losses during 1994 are as follows:\nProceeds from fixed maturity investment sales and gross realized gains and losses during 1993 are as follows:\nProceeds from sales and maturities of investments during 1992 were $267,030,000. Gross gains of $11,060,000 and gross losses of $978,000 were realized on those sales.\nAt December 31, 1994 and 1993, the Company's fixed maturity investments carried at amortized cost of $53,169,000 and $52,845,000, respectively, were on deposit with regulatory authorities.\nTotal investment income, investment expense and net investment income for the years ended December 31, 1994, 1993 and 1992 were as follows:\n3. REINSURANCE ACTIVITY\nThe Company limits the maximum net loss which can arise from large risks or risks in concentrated areas of exposure by reinsuring (ceding) certain levels of risks with other insurers, either on an automatic basis or under general reinsurance contracts known as \"treaties\" or by negotiation on substantial individual risks.\nReinsurance contracts do not relieve the Company from its obligations to policyholders. In the event that reinsuring companies are unable to meet their obligations under the agreements, the Company would continue to have primary liability to policyholders for losses incurred. The Company evaluates the financial condition of its reinsurers and evaluates concentrations of credit risk when determining reinsurance placements. At December 31, 1994 reinsurance receivables of $28,674,000 and prepaid reinsurance premiums of $2,014,000 were associated with a single reinsurer. The Company has never suffered a significant loss due to reinsurers being unable to meet their obligations.\nThe following tables summarize amounts related to reinsurance assumed and ceded as of December 31, 1994, 1993 and 1992 and for the years then ended, respectively.\nIn December 1992, the FASB issued SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts.\" The statement establishes the conditions required for a contract to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. The Company adopted SFAS No. 113 on January 1, 1993. Prior to the adoption of the new statement, assets and liabilities were reported net of the effects of reinsurance. Subsequent to the adoption of the new statement, ceded reinsurance balances due from unaffiliated insurers are reported separately as assets. Ceded reinsurance balances due from affiliated insurers continue to be reported in liabilities. As permitted by the statement, prior period financial statements have been restated.\n4. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES\n\tThe following table provides a reconciliation of the beginning and ending reserve balances for unpaid losses and loss adjustment expenses, on a gross of reinsurance basis, to the gross amounts reported in the Company's Statement of Consolidated Net Assets.\nThe preceding reconciliation shows that a deficiency of $455,000, $5,294,000 and $10,852,000 emerged in 1994, 1993 and 1992, respectively, on prior accident year claims. These deficiencies resulted primarily from settling case basis reserves for private passenger auto liability established in prior years for amounts more than were expected. A portion of the increases in ultimate incurred losses and LAE for those years also pertains to charges for future unallocated loss adjustment expenses on claims already incurred.\nThe Company's exposure to environmental and asbestos-related claims has generally involved insureds that are a peripheral defendant with de minimus exposure. In establishing the liability for losses and loss adjustment expenses related to environmental and asbestos claims, management considers facts currently known and the current state of the law and coverage litigation. Case reserves have been established when sufficient information has developed to indicate the involvement of a specific insurance policy. In addition, liabilities have been established to cover additional exposures on both known and unasserted claims, and costs related to litigation. The methodology for estimating incurred but not reported reserves is based on historical claim development information by line of business and accident year, without segregation of environmental and asbestos-related claim data. Estimates of the liabilities are reviewed and updated continually.\n5. TRANSACTIONS WITH AFFILIATES\nThe Company has entered into a number of agreements or arrangements with affiliated companies in connection with intercompany services. The net amounts charged to operations during 1994, 1993 and 1992, were as follows:\nThe net amount due from affiliates at December 31, 1994 and 1993, which includes fees and assessments paid by the Company on behalf of affiliates, were $90,000 and $803,000, respectively.\n6. INCOME TAXES\nArmco and the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109) effective January 1, 1993. SFAS No. 109 requires an asset and liability approach for financial accounting. Armco accounted for the operating results of the AFSG - Companies to be Sold under the cost recovery method, whereby net income is not recognized until realized through a sale of the business, while net losses are charged against income as incurred. These businesses are now presented as discontinued operations with a portion of the consolidated Armco federal tax provision\/benefit being allocated to the Company in accordance with the intraperiod tax allocation provisions of SFAS No. 109. In 1994, Armco's total federal income tax benefit was allocated to its continuing operations because it related primarily to changes in circumstances that caused a change in judgment about the realization of deferred tax assets in future years. In 1993, because Armco was in a consolidated net operating loss position for both financial reporting and federal income tax purposes, no federal income tax provision or benefit was allocated to the Company. Because Armco accounts for the Company as an investment which it intends to sell, the cumulative effect of adopting SFAS No. 109 and the deferred federal tax assets and liabilities applicable to the Company are recorded on the books of Armco, rather than by the Company.\nThe Company and its subsidiaries file state income tax returns in several states on both a separate company and combined basis. A provision (benefit) of $52,000, $223,000 and $(166,000) is reported in the Statement of Consolidated Operations for the years ended December 31, 1994, 1993 and 1992, respectively. The entire 1994 provision represents a current year state income tax provision of $52,000. The 1993 provision includes a current year state income tax provision of $224,000 and adjustments to prior years state income taxes of $(1,000). The 1992 benefit includes a current year state income tax provision of $27,000 and a refund from prior year state income taxes of $(193,000).\n7. PENSION, PROFIT SHARING AND BENEFIT PLANS\nArmco sponsors a separate noncontributory, trusteed retirement plan covering substantially all of the Company's employees. Pension costs relating to this retirement plan are computed based on accepted actuarial methods. It is the Company's policy to fund pension costs as they accrue, but, in no event at less than the amount required by, nor more than the maximum amount allowable under, the Employee Retirement Income Security Act of 1974 (ERISA). 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.\nThe following table sets forth the retirement plan's funded status and amounts recognized in the financial statements of the Company at December 31, 1994, 1993 and 1992:\nThe following assumptions were used in determining the actuarial present value of the projected benefit obligation as of December 31, 1994, 1993 and 1992.\nThe Company, along with other affiliates, has a benefit plan which provides medical and dental benefits for eligible retired employees. Substantially, all employees become eligible for these benefits if they reach normal retirement age while working for the Company. These benefits are funded as claims are paid. In December 1990, the FASB issued SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The standard requires the accrual of expense for these benefits during the years the employee is actively employed. The Company adopted SFAS No. 106 on January 1, 1993. The cumulative effect of the accounting change resulted in a decrease in 1993 income of $14,000,000.\nThe following table sets forth the benefit plan's funded status and amounts recognized in the balance sheets of the companies participating in the plan as of December 31, 1994 and 1993.\nThe accrued postretirement benefit liability applicable solely to the Company was $16,081,000 and $14,633,000 as of December 31, 1994 and December 31, 1993, respectively.\nNet postretirement benefit cost for 1994 and 1993 includes the following components:\nNet postretirement benefit cost applicable solely to the Company for the years ended December 31, 1994 and December 31, 1993 was $1,912,000 and $15,174,000, respectively.\nThe following table sets forth key assumptions used in reporting year-end disclosures.\nThe 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 one percentage point in each year would increase the plan's accumulated postretirement benefit obligation as of December 31, 1994 by $2,228,000, and the aggregate service cost and interest cost components of the plan's net periodic postretirement benefit cost for the year by $372,000.\nThe Company also has a noncontributory, trusteed profit sharing plan. Annual contributions to the plan (limited to a maximum of 15% of participating salaries) are based upon operating results of the Company. No expense was recorded for the years ended December 31, 1994, 1993 and 1992.\nThe Company provides medical, dental and life insurance benefits to eligible participants on long-term disability, at no cost to the participant. Prior to 1993, the Company expensed these benefits on a pay-as-you-go basis. In December 1992, the FASB issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This statement requires recognition of an employer's obligation to provide benefits to former and inactive employees after employment but before retirement. The Company adopted SFAS No. 112 in 1993. The cumulative effect of the accounting change, reported on the Statement of Consolidated Operations as a component of other expenses, resulted in a decrease in 1993 income of $715,000. The liability for postemployment benefits at December 31, 1994 and 1993 were $686,000 and $715,000, respectively.\n8. NOTE PAYABLE\nAs partial financing of the acquisition of SICO, the Company entered into a $14,000,000 term loan agreement with a local bank in 1990. Under the terms of the loan agreement, the Company was required to make principal payments of $700,000 at each quarter end. On March 31, 1994, the Company made a principal payment of $700,000. On April 18, 1994, the outstanding balance of $2,100,000 was repaid in full.\n9. NET ASSETS\nNNHC depends on dividends from its subsidiaries to service debt and pay expenses. The payment of shareholder dividends by insurance companies without the prior approval of the state insurance regulators is limited to formula amounts based on net investment income, and capital and surplus determined in accordance with statutory accounting principles. At December 31, 1994, approximately $2.1 million of dividends are available without prior regulatory approval.\nOn April 25, 1994, NNHC contributed to NNCC all of the issued and outstanding capital stock of SICO, Inc. and its subsidiaries.\nNNCC paid dividends to NNHC of $795,000, $3,170,000 and $3,896,500 during the years ended December 31, 1994, 1993 and 1992, respectively.\nIn accordance with the terms of an order dated April 10, 1985 of the Insurance Commissioner of the State of California (the Commissioner), PNIC may not pay any dividend or other distribution unless the dividend is approved by the Commissioner. PNIC received approval for and paid dividends to NNHC of $1,000,000 during the year ended December 31, 1992.\nSICO paid dividends to NNHC of $2,110,000 during the year ended December 31, 1994 and $1,500,000 during the year ended December 31, 1992.\nThe Company prepares statutory-basis financial statements in accordance with accounting practices prescribed by domiciliary insurance departments. Prescribed statutory accounting practices include state laws, regulations and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (NAIC). The following information has been prepared on the basis of prescribed statutory accounting principles which differ from GAAP. The principal differences relate to deferred acquisition costs and assets not admitted for statutory reporting.\n10. FAIR VALUES OF FINANCIAL INSTRUMENTS\nSFAS No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of the fair value of financial instruments. In developing the fair value of financial instruments, the Company uses available market quotes and data, provided by external pricing services, as well as valuation methodologies where appropriate. As considerable judgment is required in interpreting market data and performing valuation methodologies, the fair value estimates presented below are not necessarily indicative of the amounts the Company might pay or receive in actual current market transactions. Furthermore, as a number of the Company's significant assets and liabilities are excluded from the provisions of SFAS No. 107, the disclosures below do not reflect the Company's statement of net assets on a fair value basis, nor the fair value of the Company as a whole.\nThe following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:\nFinancial Assets\nFair values for fixed maturity investments are based on quoted market prices.\nEquity securities are valued based on quoted market prices.\nCash and cash equivalents are highly liquid investments with maturities of less than three months; carrying value approximates fair value.\nAccrued investment income is valued at carrying value as it is short-term in nature.\nInsurance premium balances receivable are generally collected on a monthly basis. Due to the short-term nature of these receivables, their carrying value approximates fair value.\nFinancial Liabilities\nThe Company's insurance reserves are specifically excluded from the provisions of SFAS No. 107.\nOther financial liabilities are valued at their carrying value due to their short-term nature. As permitted under SFAS No. 107, other financial liabilities exclude postretirement and postemployment benefit obligations for purposes of this disclosure.\nThe fair value of the Company's note payable is based on current rates offered to the Company for debt of the same remaining maturities.\n11. COMMITMENTS\nThe Company leases certain office facilities and equipment under operating leases. Minimum rental commitments under noncancelable leases are as follows:\nTotal rental expense was $2,541,000, $2,512,000 and $2,291,000 in 1994, 1993 and 1992, respectively.\n12.\tLITIGATION\nThe Company is involved in various lawsuits that have arisen from the normal conduct of business. These proceedings are handled by corporate and outside counsel. It is the opinion of management that the outcome of these proceedings will not have a material effect on the Company's financial condition or liquidity; however, it is possible that due to fluctuations in the Company's results, future developments with respect to changes in the ultimate liability could have a material effect on future interim or annual results of operations.\n13.\tPENDING TRANSACTION\nOn August 2, 1994, Armco entered into a definitive purchase agreement to sell the Company to Vik Brothers Insurance, Inc., a privately held, Raleigh, North Carolina based property and casualty insurance holding company. The sale is expected to close by April 7, 1995. In connection with the transaction, Vik would pay approximately $65 million at closing, and approximately $15 million, in three years, reduced by a potential adjustment for adverse experience in insurance reserves.\nARMCO FINANCIAL SERVICES GROUP - SCHEDULE II COMPANIES TO BE SOLD (Parent Only)\nCondensed Financial Information Notes to Condensed Financial Information for the Years Ended December 31, 1994, 1993 and 1992\n1. The accompanying condensed financial information should be read in conjunction with the consolidated financial statements of the AFSG - Companies to be Sold.\n2. Long-term debt consists of the following:\nAs partial financing of the acquisition of SICO, the Company entered into a $14,000,000 term loan agreement with a local bank in 1990. Under the terms of the loan agreement, the Company was required to make principal payments of $700,000 on March 31 and each quarter end thereafter until repaid in full. On March 31, 1994, the Company made a principal payment of $700,000. On April 18, 1994, the outstanding balance of $2,100,000 was repaid in full.\n3. NNHC depends on dividends from its subsidiaries to service debt and pay expenses. The payment of shareholder dividends by insurance companies without the prior approval of the state insurance regulators is limited to formula amounts based on net investment income, and capital and surplus determined in accordance with statutory accounting principles. At December 31, 1994, approximately $2.1 million of dividends are available without prior regulatory approval.\nOn April 25, 1994, NNHC contributed to NNCC all of the issued and outstanding capital stock of SICO, Inc. and its subsidiaries.\nNNCC paid dividends to NNHC of $795,000 , $3,170,000 and $3,896,500 during the years ended December 31, 1994, 1993 and 1992, respectively.\nIn accordance with the terms of an order dated April 10, 1985 of the Insurance Commissioner of the State of California (the Commissioner), PNIC may not pay any dividend or other distribution unless the dividend is approved by the Commissioner. PNIC received approval for and paid dividends to NNHC of $1,000,000 during the year ended December 31, 1992.\nSICO paid dividends to NNHC of $2,110,000 during the year ended December 31, 1994 and $1,500,000 during the year ended December 31, 1992.\n4. In May 1993, the FASB issued SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The statement requires fixed maturity investments which are available for sale to be recorded at market value. The Company adopted SFAS No. 115 on December 31, 1993.\nARMCO FINANCIAL SERVICES GROUP - COMPANIES TO BE SOLD\nDisclosure of Certain Data on Loss and Loss Expense Reserves\nThe liability for unpaid losses and loss adjustment expenses includes an amount determined from loss reports and individual cases and an amount, based on past experience, for losses incurred but not reported. Such liability is necessarily based on estimates and, while management believes that the amount is fairly stated, the ultimate liability may be in excess of or less than the amount provided. The methods for making such estimates and for establishing the resulting liability are continually reviewed and any adjustments resulting therefrom are reflected in earnings currently. The Company does not discount the liability for unpaid losses and loss adjustment expenses.\nAFSG - Companies to be sold estimates losses for reported claims on an individual case basis. Case reserves are based on experience with a particular type of risk and the available information surrounding each individual claim. Case reserves are reviewed on a regular basis. As additional facts become available, the case reserves are adjusted as necessary. The stability of the case reserving process is monitored through comparison with ultimate settlement.\nThe estimates of losses for incurred but not reported claims (IBNR), as well as additive reserves for reported claims, are developed primarily from an analysis of historical patterns of the development of paid and incurred losses (dollars and claim counts) by accident year for each line of business. Salvage and subrogation estimates are developed from patterns of actual recoveries.\nAllocated loss adjustment expense reserves are developed from an analysis of historical patterns of the development of paid allocated loss adjustment expenses to incurred losses, by accident year, for each line of business. These historical patterns are then applied to projected ultimate losses for each line of business.\nUnallocated loss adjustment expense reserves are developed utilizing a cost accounting system. The cost accounting system is based on historical costs modified for anticipated changes in operations and selections of alternative costs.\nIn December 1992, the FASB issued SFAS No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration contracts.\" The statement establishes the conditions required for a contract to be accounted for as reinsurance and prescribes accounting and reporting standards for those contracts. The Company adopted SFAS No. 113 in 1993. Prior to the adoption of the new statement, assets and liabilities were reported net of the effects of reinsurance. Subsequent to the adoption of the new statement, ceded reinsurance balances due from unaffiliated insurers are reported separately as assets. Ceded reinsurance balances due from affiliated insurers continue to be reported in liabilities. As permitted by the statement, prior period financial statements have been restated.\nLoss and loss adjustment expense reserves are stated at management's estimate of the ultimate cost of settling all incurred but unpaid claims. Loss and loss adjustment expense reserves are not discounted.","section_15":""}
{"filename":"818080_1994.txt","cik":"818080","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nNorfolk Radio\nRegistrant's radio station, WMXN-FM in Norfolk, Virginia leases\nits office and studio space under a ten year lease. The station\nalso leases space on a tower for its broadcast antenna and space\nin a building that houses its transmission equipment.\nWMXN-FM owns its office furniture, studio equipment, and\ntransmission equipment.\nWMXN-FM holds a license from the FCC that is used in connection\nwith broadcasting operations at the station.\nOther Properties\nParadigm and BBAD operate out of leased office space in\nCalifornia. Paradigm and BBAD own their office furniture and\noffice equipment. Registrant believes that the properties leased\nby Paradigm and BBAD and the furniture and equipment owned by\nthose companies are in reasonably good condition and are adequate\nfor the operation of the company.\nTCS owns the land and studio buildings at each of its three\nlocations (Columbus, Georgia; Terre Haute, Indiana; and St.\nJoseph, Missouri) as well as broadcasting transmitters, antennas\nand towers at each location. In addition, TCS owns technical\nbroadcasting equipment as well as the furniture and fixtures at\nTCS's three stations.\nRegistrant believes that the properties owned by the stations and\nthe other equipment and furniture and fixtures owned are in\nreasonably good condition and are adequate for the operations of\nthe stations.\nThe physical assets of Registrant's remaining investments are not\nincluded in the consolidated balance sheet of Registrant.\nItem 3.","section_3":"Item 3. Legal Proceedings\nRefer to \"Item 1. Business - Maryland Cable Corp.\" for\ninformation regarding the bankruptcy filing made by Maryland\nCable Corp. and Maryland Cable Holdings Corp.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nThere were no matters which required a vote during the fourth\nquarter of the fiscal year covered by this report.\nPart II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Stockholder\nMatters\nA public market for Registrant's Units does not now exist, and it\nis not anticipated that such a market will develop in the future.\nAccordingly, accurate information as to the market value of a\nUnit at any given date is not available.\nAs of January 16, 1995, the number of owners of Units was 14,920.\nEffective November 9, 1992, Registrant was advised that Merrill\nLynch, Pierce, Fenner & Smith Incorporated (\"Merrill Lynch\" or\n\"MLPF&S\") introduced a new limited partnership secondary service\nthrough Merrill Lynch's Limited Partnership Secondary Transaction\nDepartment (\"LPSTD\"). This service will assist Merrill Lynch\nclients wishing to buy or sell Registrant Units.\nBeginning with December 1994 client account statements, MLPF&S\nimplemented new guidelines for valuing limited partnerships and\nother direct investments reported on client account statements.\nAs a result, MLPF&S no longer reports general partner estimates\nof limited partnership net asset value on its client account\nstatements, although Registrant's general partner may continue to\nprovide its estimate of net asset value in quarterly reports to\nunit holders. Pursuant to the new guidelines, estimated values\nfor limited partnership investments will be provided annually to\nMLPF&S by independent valuation services. The estimated values\nwill be based on financial and other information available to the\nindependent services on the prior August 15th. MLPF&S clients\nmay contact their Merrill Lynch Financial Consultants or\ntelephone the number provided to them on their account statements\nto obtain a general description of the methodology used by the\nindependent valuation services to determine their estimates of\nvalue. The estimated values provided by the independent services\nare not market values and Unit holders may not be able to sell on\ntheir MLPF&S statements upon a sale. In addition, Unit holders\nmay not realize the amount shown on their account statements upon\nthe liquidation of Registrant over its remaining life.\nRegistrant does not distribute dividends, but rather\nDistributable Cash From Operations, Distributable Refinancing\nProceeds, and Distributable Sale Proceeds, to the extent\navailable. On June 6, 1989, Registrant made a federal tax\nallowance cash distribution in an amount equal to 33% of the 1988\nfederal taxable income to all limited partners owning Units in\n1988 in proportion to their federal taxable income from the\nownership of Units. The total amount distributed was $2,040,121.\nIn the fourth quarter of 1994, Registrant made a cash\ndistribution of $8,971,760 to its Limited Partners and $90,624 to\nits General Partner following the disposition of Maryland Cable.\nItem 6.","section_6":"Item 6. Selected Financial Data\nCertain items have been restated to conform to 1994 presentation\nfor discontinued operations.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial\nCondition and Results of Operations\nLiquidity and Capital Resources\nAt December 31, 1994, Registrant had $1,752,059 in cash and cash\nequivalents.\nIn the fourth quarter of 1994, Registrant distributed $8,971,760\nto its Limited Partners and $90,624 to its General Partner\nfollowing the disposition of Maryland Cable.\nAt December 31, 1993, Registrant had $3,739,678 in cash and cash\nequivalents.\nDuring 1994, Registrant continued its operations phase while\nselling or disposing of a significant portion of its investments.\nRegistrant consummated the disposition of Maryland Cable on\nSeptember 30, 1994 and the sale of the Windsor Cable Systems on\nMay 18, 1994. In addition, Registrant consummated the sale of\nWMXN-FM on February 21, 1995. Registrant is currently marketing\nTCS for potential sale in 1995. The status of Registrants'\ninvestments is discussed in more detail below. Refer to \"Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nML Media Opportunity Partners, L.P.\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 31, 1994 and December 31, 1993\nConsolidated Statements of Operations for the years ended December 31, 1994, December 31, 1993 and December 31, 1992\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, December 31, 1993 and December 31, 1992\nConsolidated Statements of Changes in Partners' Deficit for the years ended December 31, 1994, December 31, 1993 and December 31, 1992\nNotes to Consolidated Financial Statements for the years ended December 31, 1994, December 31, 1993 and December 31, 1992\nSchedule III - Condensed Financial Information of Registrant as of December 31, 1994, December 31, 1993 and December 31, 1992\nINDEPENDENT AUDITORS' REPORT\nML Media Opportunity Partners, L.P.:\nWe have audited the accompanying consolidated financial\nstatements and the related financial statement schedule of ML\nMedia Opportunity Partners, L.P. (the \"Partnership\") and its\naffiliated entities, listed in the accompanying table of\ncontents. These consolidated financial statements and financial\nstatement schedule are the responsibility of the Partnership's\ngeneral partner. Our responsibility is to express an opinion on\nthe consolidated financial statements and financial statement\nschedule based on our audits.\nWe conducted our audits in accordance with generally accepted\nauditing standards. Those standards require that we plan and\nperform the audit to obtain reasonable assurance about whether\nthe financial statements are free of material misstatement. An\naudit includes examining, on a test basis, evidence supporting\nthe amounts and disclosures in the financial statements. An\naudit also includes assessing the accounting principles used and\nsignificant estimates made by the general partner, as well as\nevaluating the overall financial statement presentation. We\nbelieve that our audits provide a reasonable basis for our\nopinion.\nIn our opinion, such consolidated financial statements present\nfairly, in all material respects, the financial position of the\nPartnership and its affiliated entities at December 31, 1994 and\n1993 and the results of their operations and their cash flows for\neach of the three years in the period ended December 31, 1994 in\nconformity with generally accepted accounting principles. Also,\nin our opinion, such financial statement schedule, when\nconsidered in relation to the basic consolidated financial\nstatements taken as a whole, present fairly in all material\nrespect the information set forth therein.\nINDEPENDENT AUDITORS' REPORT (continued)\nThe accompanying consolidated financial statements and financial\nstatement schedule have been prepared assuming that the\nPartnership will continue as a going concern. As discussed in\nNote 2 to the consolidated financial statements, the Partnership\nhas sold or is in the process of selling or disposing of a\nsignificant portion of its investments. In addition, the\nPartnership was in default under the TCS Television Partners,\nL.P. (\"TCS\") note agreements and will be unable to satisfy its\nongoing debt obligations under these agreements. The Partnership\nhas decided to pursue a sale of the TCS stations. These\ncircumstances raise substantial doubt about the Partnership's\nability to continue as a going concern. Management's plans\nconcerning these matters are also described in Note 2.\nAccordingly, the consolidated financial statements and financial\nstatement schedule do not include adjustments that might result\nfrom the outcome of the uncertainties referred to herein.\n\/s\/ Deloitte & Touche LLP\nNew York, New York\nMarch 9, 1995\n(Continued on the following page)\nSupplemental Disclosure of Non-Cash Investing and Financing\nActivities:\nEffective in 1992, the Partnership controlled the operations of\nParadigm and consolidated its ownership interest in Paradigm.\nEffective in 1993, the Partnership controlled the operations of\nTCS and as a result consolidated TCS's total assets and total\nliabilities.\nEffective July 1, 1993, the Partnership sold the business and\nassets of IMPLP and Intelidata.\nEffective September 30, 1993, Maryland Cable consummated the sale\nof the Leesburg System.\nSee Notes to Consolidated Financial Statements.\nML MEDIA OPPORTUNITY PARTNERS, L.P.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, DECEMBER 31, 1993, AND\nDECEMBER 31, 1992\n1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES\nML Media Opportunity Partners, L.P. (the \"Partnership\"), was\nformed and the Certificate of Limited Partnership was filed under\nthe Delaware Revised Uniform Limited Partnership Act on June 23,\n1987. Operations commenced on March 23, 1988 with the first\nclosing of the sale of units of limited partnership interest.\nMedia Opportunity Management Partners (the \"General Partner\") is\na joint venture, organized as a general partnership under New\nYork law, between RP Opportunity Management, L.P., a limited\npartnership under Delaware law, and ML Opportunity Management\nInc., a Delaware corporation and an indirect wholly-owned\nsubsidiary of Merrill Lynch & Co., Inc. The General Partner was\nformed for the purpose of acting as general partner of the\nPartnership. The General Partner's total capital contribution\nwas $1,132,800 at December 31, 1994 which represents 1% of the\ntotal Partnership capital contributions.\nPursuant to the terms of the Amended and Restated Agreement of\nLimited Partnership, the General Partner is liable for all\ngeneral obligations of the Partnership to the extent not paid by\nthe Partnership. The limited partners are not liable for the\nobligations of the Partnership in excess of the amount of their\ncontributed capital.\nThe purpose of the Partnership is to acquire, finance, hold,\ndevelop, improve, maintain, operate, lease, sell, exchange,\ndispose of and otherwise invest in and deal with media businesses\nand direct and indirect interests therein.\nAs of December 31, 1994, the Partnership's primary investments\nconsisted of:\n99% ownership of ML Cable Partners, which had held a\nparticipation in the senior bank debt of Maryland Cable (see\nNote 2);\nOwnership of 351,665 shares of common stock (an ownership\npercentage of approximately 2.4%) of Western Wireless\nCorporation (\"WWC\"), a cellular telecommunications operator\nbased in California; (see Note 6)\n51.005% ownership of TCS Television Partners, L.P. (\"TCS\"),\nwhich owns (i) 20% of the outstanding common stock of Fabri\nDevelopment Corporation, which in turn owns and operates two\nnetwork affiliated television stations serving Terre Haute,\nIndiana and St. Joseph, Missouri, and (ii) 100% of the\noutstanding common stock of TCS Television, Inc., which in\nturn owns the 80% of the outstanding common stock of Fabri\nDevelopment Corporation not owned by TCS, as well as 100% of\nthe outstanding common stock of Avant Development\nCorporation, which owns and operates a network affiliated\ntelevision station serving Columbus, Georgia;\n100% ownership of WMXN-FM (\"WMXN-FM\"), a radio station in\nNorfolk, Virginia; (sold on February 21, 1995)\n50% ownership of Paradigm Entertainment, L.P. (\"Paradigm\"),\na California based company involved in the production of\ntelevision and cable programming (see Note 6 regarding the\nallocation of profits and losses) which owns approximately\n52% of Bob Banner Associates Development (\"BBAD\") based upon\ncapital contributions;\n36.8% ownership of Media Ventures Investments, Ltd.\n(\"Investments\", formerly Media Ventures International\nLimited, \"Media Ventures\"), a United Kingdom corporation\nformed to develop or acquire European media and\nentertainment companies; and a 13.8% ownership of MV\nTechnology Limited (\"MVT\").\nBasis of Accounting and Fiscal Year\nThe Partnership's records are maintained on the accrual basis of\naccounting for financial reporting and tax purposes.\nInvestments, MVT, and GCC are accounted for on the cost method of\naccounting. The Partnership carried its interest in Investments\nunder the equity method of accounting in 1992 and prior years.\nThe Partnership carried its interest in Paradigm under the equity\nmethod of accounting in 1991. The fiscal year of the Partnership\nshall be the calendar year.\nSee Note 3 regarding the discontinued operations of TCS, WMXN-FM\nand Paradigm\/BBAD.\nCertain 1992 and 1993 items have been reclassified to conform to\n1994 presentation for discontinued operations.\nBarter Transactions\nAs is customary in the broadcasting industry, the Partnership\nengages in the bartering of commercial air time for various goods\nand services. Barter transactions are recorded based on the fair\nmarket value of the products and\/or services received. The goods\nand services are capitalized or expensed as appropriate when\nreceived or utilized. Revenues are recognized when the\ncommercial spots are aired. All such revenues and expenses are\nincluded in the Partnership's loss from discontinued operations.\nBroadcast Program Rights\nThe Partnership's television stations' broadcast program rights\nrepresent license agreements for the right to broadcast programs\nwhich are available at the balance sheet date. Amortization is\nrecorded on a straight-line basis over the period of the license\nagreements or upon run usage. Amortization is included in the\nPartnership's loss from discontinued operations.\nProperty and Depreciation\nProperty, plant and equipment is stated at cost, less accumulated\ndepreciation, and is included in the net liabilities of the\nPartnership's discontinued operations. Property, plant and\nequipment is depreciated using the straight-line method over the\nfollowing estimated useful lives:\nBuildings 30 years Other 5-7 years\nExpenditures for maintenance and repairs are charged to operating\nexpense as incurred, and improvements, replacement equipment and\nadditions are capitalized and depreciated over the remaining life\nof the assets.\nIntangible Assets and Deferred Charges\nIntangible assets and deferred charges are being amortized on a\nstraight-line basis over various periods as follows:\nGoodwill approximately 20-40 years Franchise life of the franchise Other Intangibles various Deferred Charges 3-10 years\nIntangible assets, deferred charges and related amortization are\nincluded in the Partnership's net liabilities from discontinued\noperations and loss from discontinued operations, respectively.\nAsset Impairment\nThe Partnership assesses the impairment of assets on a regular\nbasis or immediately upon the occurrence of a significant event\nin the marketplace or an event that directly impacts its assets.\nThe methodology varies depending on the type of asset but\ntypically consists of comparing the net book value of the asset\nto either: (1) the undiscounted expected future cash flows\ngenerated by the asset, and\/or (2) the current market values\nobtained from industry sources.\nIf the net book value of a particular asset is materially higher\nthan the estimated net realizable value, and the asset is\nconsidered to be permanently impaired, the Partnership will write-\ndown the net book value of the asset accordingly; however, the\nPartnership does not write its assets down to a value below the\nasset-related non-recourse debt. The Partnership relies on\nindustry sources and its experience in the particular marketplace\nto determine whether an asset impairment is other than temporary.\nIncome Taxes\nNo provision for income taxes has been made for the Partnership\nbecause all income and losses are allocated to the partners for\ninclusion in their respective tax returns. However, the\nPartnership owns corporations which are consolidated in the\naccompanying financial statements which are taxable entities.\nEffective January 1, 1993, the corporations owned by the\nPartnership adopted Statement of Financial Accounting Standards\nNo. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"). For the\ncorporations owned by the Partnership which are consolidated in\nthe accompanying financial statements, SFAS No. 109 requires the\nrecognition of deferred income taxes for the tax consequences of\ndifferences between the bases of assets and liabilities for\nincome tax and financial statement reporting, based on enacted\ntax laws. Valuation allowances are established, when necessary,\nto reduce deferred tax assets to the amount expected to be\nrealized. For the Partnership, SFAS No. 109 requires the\ndisclosure of the difference between the tax bases and the\nreported amounts of the Partnership's assets and liabilities (see\nNote 9).\nStatement of Cash Flows\nShort-term investments which have an original maturity of ninety\ndays or less are considered cash equivalents. Interest paid in\n1994, 1993 and 1992 was $3,424,172, $10,708,585 and $10,192,232,\nrespectively.\nStatement of Financial Accounting Standards No. 112\nEffective January 1, 1994, the Partnership adopted Statement of\nFinancial Accounting Standards No. 112, \"Employers' Accounting\nfor Postemployment Benefits\" (\"SFAS No. 112\"). This\npronouncement establishes accounting standards for employers who\nprovide benefits to former or inactive employees after\nemployment, but before retirement. These benefits include, but\nare not limited to, salary-continuation, disability related\nbenefits including workers' compensation, and continuation of\nhealth care and life insurance benefits. The statement requires\nemployers to accrue the obligations associated with service\nrendered to date for employee benefits accumulated or vested\nwhere payment is probable and can be reasonably estimated. The\neffect of the adoption of SFAS No. 112 was not material to the\nPartnership's financial position or results of operations as of\nand for the year ending December 31, 1994.\n2. Liquidity\nAt December 31, 1994, the Partnership had $1,752,059 in cash and\ncash equivalents.\nAt December 31, 1993, the Partnership had $3,739,678 in cash and\ncash equivalents.\nIn the fourth quarter of 1994, the Partnership distributed\n$8,971,760 to its Limited Partners and $90,624 to its General\nPartner following the disposition of Maryland Cable (see below).\nDuring 1994, the Partnership continued its operations phase while\nselling or disposing of a significant portion of its investments.\nThe Partnership consummated the disposition of Maryland Cable on\nSeptember 30, 1994 and the sale of the Windsor Cable Systems on\nMay 18, 1994. In addition, the Partnership consummated the sale\nof WMXN-FM on February 21, 1995. The Partnership is currently\nmarketing TCS for potential sale in 1995 and, on January 13,\n1995, entered into a non-binding letter of intent to sell the\nstock of Avant Development Corporation, the corporation which\nowns television station WRBL-TV (see below). The status of the\nPartnership's investments is discussed in more detail below.\nDuring 1995, the Partnership will attempt to sell or otherwise\ndispose of all of its remaining investments in media properties,\nand then liquidate; however, there can be no assurance that the\nPartnership will be successful in completing such actions prior\nto December 31, 1995.\nDisposition of Maryland Cable\nOn September 30, 1994, the Amended Prepackaged Plan of\nReorganization of Maryland Cable and Holdings (the \"Prepackaged\nPlan\") was consummated. Pursuant to the Prepackaged Plan,\nMaryland Cable and Holdings were liquidated into Maryland Cable\nPartners, L.P., a newly formed limited partnership (\"Newco\"). As\na result of the liquidation, Newco acquired all of the assets of\nMaryland Cable, subject to all of the liabilities of Maryland\nCable that were not discharged pursuant to the Prepackaged Plan.\nUnder the Prepackaged Plan, the Partnership received a 4.9%\ninterest in Newco in satisfaction of (i) the $3,600,000 in\nsubordinated promissory notes held by the Partnership, plus\naccrued interest thereon, (ii) the $5,379,833 in deferred\nmanagement fees payable to the Partnership, and (iii) certain\nother amounts payable to the Partnership. The Partnership\nimmediately exercised its right to sell its 4.9% interest in\nNewco to the Water Street Corporate Recovery Fund I, L.P. (the\nholder of 85% of the outstanding principal amount of the 15-3\/8%\nSubordinated Discount Notes due 1998 of Maryland Cable) and\ncertain other holders of the Notes for an aggregate price of\n$2,846,423. Upon the consummation of the Prepackaged Plan, ML\nCable Partners, which is 99% owned by the Partnership, received\npayment in full of the unpaid portion of the $6,830,000\nparticipation in the senior bank debt of Maryland Cable held by\nML Cable Partners, together with accrued interest thereon. In\naddition, MultiVision Cable TV Corp. received a payment of\n$500,000 in partial settlement of severance and other costs\nrelating to the termination of MultiVision as manager of the\nMaryland Cable cable systems. The Partnership recognized a gain\nfor financial reporting purposes on the disposition of Maryland\nCable of approximately $130 million. Such gain resulted\nprimarily from forgiveness of debt at the subsidiary level and is\nclassified as an extraordinary gain on the Partnership's\nConsolidated Statements of Operations.\nIncluded in this gain is a $450,000 management fee which the\nPartnership is entitled to receive for managing the Maryland\nCable Systems from January 1, 1994 through September 30, 1994.\nSale of Windsor\nOn May 18, 1994, the Partnership completed the sale of the assets\nof the Windsor Systems to Tar River Communications Inc. (\"Tar\nRiver\") for $3,443,200, subject to post-closing adjustments. At\nclosing, the Partnership repaid the $2,050,058 of principal and\ninterest then due under the Windsor Note, as required by the\nterms of the Windsor Note. In addition, as required by the Asset\nPurchase Agreement with Tar River, at closing, $342,160 was\nplaced into two separate escrow accounts to cover the potential\ncosts of improving pole attachments as well as other possible\npost-closing expenses. A significant portion of the remaining\n$1,050,982 of sale proceeds will be used to cover certain pre-\nclosing liabilities to third parties, as well as the final\nclosing costs of the transaction, such as legal fees. The\nPartnership recognized a gain of $600,000 for financial reporting\npurposes on the sale of the Windsor Systems.\nWMXN-FM\nDuring 1994, WMXN-FM generated sufficient revenues, through the\nLMA (see below) to cover its operating costs (before management\nfees).\nThe Partnership entered into an Option Agreement, effective\nJanuary 25, 1994, with US Radio , Inc. (\"US Inc.\"), a Delaware\ncorporation, and an affiliated entity, US Radio, L.P. (\"US\nRadio\"), a Delaware limited partnership, neither of which is\naffiliated with the Partnership. Pursuant to the Option\nAgreement, the Partnership granted US Inc. an option (the\n\"Call\"), exercisable at any time prior to January 15, 1995, to\npurchase substantially all of the assets of WMXN-FM (the\n\"Assets\") for a cash price of $3.5 million. On September 23,\n1994, US Inc. exercised the Call. On October 24, 1994, the\nPartnership and US Radio of Norfolk, Inc. (\"US Norfolk\"), an\naffiliate of US Inc. to which US Inc. assigned its option to\npurchase WMXN-FM, filed an application with the FCC requesting\nassignment of the license of WMXN-FM from the Partnership to US\nNorfolk.\nFollowing receipt of FCC approval, on February 21, 1995, US\nNorfolk purchased WMXN-FM for approximately $3.5 million, subject\nto future adjustment based on a post-closing accounting\nreconciliation between US Norfolk and the Partnership required by\nthe Asset Purchase Agreement. The Partnership does not currently\nanticipate that such potential future adjustment will be\nmaterial. Following payment of a transaction fee to a third\nparty unaffiliated with the Partnership, approximately $3.3\nmillion was remitted to the Partnership. In addition, on March\n7, 1995 approximately $400,000 was returned to the Partnership\nfrom WMXN-FM's cash balances.\nEffective January 31, 1994, the Partnership entered into a Time\nBrokerage Agreement (the \"LMA\") with US Radio. The LMA called\nfor the Partnership to make broadcasting time available on WMXN-\nFM to US Radio and for US Radio to provide radio programs to be\nbroadcast on WMXN-FM, subject to certain terms and conditions,\nincluding the rules and regulations of the FCC. In exchange for\nproviding broadcasting time to US Radio, the Partnership received\na monthly fee approximately equal to its cost of operating WMXN-\nFM. The LMA continued until the consummation of the acquisition\nof WMXN-FM by US Norfolk (see below).\nTCS\nAlthough the broadcast television industry experienced overall\ngrowth in advertising revenues in 1994, TCS was in default of\ncovenants under its note agreements as of December 31, 1994, and\nfailed to make scheduled principal payments totalling $2,300,000\non February 28, 1994, May 31, 1994, August 31, 1994 and November\n30, 1994. In addition, TCS did not make a required principal\npayment of $575,000 due February 28, 1995. TCS also expects to\ndefault on the majority of its scheduled principal payments for\nthe remainder of 1995. TCS engaged in discussions with its note\nholders regarding a potential restructuring of TCS's note\nagreements, but ultimately decided to pursue a sale of the TCS\nstations. The Partnership engaged Furman Selz Incorporated to\nassist in marketing the TCS television stations for sale. The\nmarketing of the sale of such stations commenced in December of\n1994. It is the Partnership's intention to actively pursue a\nsale of the TCS television stations. On January 13, 1995, the\nPartnership entered into a non-binding letter of intent to sell\nthe stock of Avant Development Corporation (\"Avant\"), a 100%-\nowned corporate subsidiary of TCS, Inc. which owns WRBL-TV. The\nsale of Avant is subject to negotiation of a definitive purchase\nand sale agreement and numerous other conditions. The ultimate\ntransfer of the license of WRBL-TV to a potential buyer, via the\nsale of the stock of Avant, will also be subject to the prior\napproval of the FCC. The Partnership may not ultimately be able\nto reach a final agreement with potential purchasers on terms\nacceptable to the Partnership. During the process of marketing\nthe TCS television stations, while TCS remains in default, the\nnote holders have the option to exercise their rights under the\nnotes, which rights include the right to foreclose on the stock\nof the operating subsidiaries that own the three TCS stations,\nbut not the other assets of the Partnership. Whether or not the\nPartnership is able to sell the TCS television stations, it is\nunlikely that the Partnership will recover more than a nominal\namount of its investment in TCS.\nRefer to Note 4 for further information regarding TCS's debt.\nDuring the fourth quarter of 1992, TCS concluded that there had\nbeen an impairment of the value of the enterprise and, as a\nresult, wrote-down its intangible assets (goodwill) by a total of\n$6 million, which resulted in the Partnership's $2,460,000 share\nof this write-down for financial reporting purposes.\nParadigm\nParadigm and\/or BBAD are not currently producing television\nprograms, and the Partnership has not advanced any funds to\nParadigm and\/or BBAD since the second quarter of 1992. Paradigm\nand\/or BBAD took several steps in 1992 and 1993 to reduce\noperating costs, primarily by reducing the number, and\ncompensation, of employees. However, Paradigm and\/or BBAD did\nnot operate profitably during 1993, and were dependent on outside\nsources, primarily Bob Banner Associates Inc. (\"Associates\") to\nfinance BBAD's monthly operating costs. The Partnership elected\nnot to fund such operating costs. The Partnership has no\nobligation to advance any additional funds to Paradigm and\/or\nBBAD and actively sought a strategic partner that would share in\nmeeting Paradigm's and\/or BBAD's potential future funding needs,\nbut was unable to identify such a partner. Paradigm and\/or BBAD\nhave no liability for borrowed funds. The Partnership has agreed\nin principle with Associates on the terms of an agreement under\nwhich Paradigm would retain the three television movies and the\nseries developed by it, and the other projects and program\nconcepts developed by Paradigm and\/or BBAD would be assigned to\nAssociates, and Paradigm would retain a percentage interest in\nall such projects and concepts. It is the Partnership's\nintention, following the execution of a definitive agreement\nencompassing these terms, to attempt to sell its interest in\nParadigm and\/or BBAD. However, it is unlikely that the\nPartnership will recover more than a nominal portion, if any, of\nits original investment in Paradigm and\/or BBAD. Due in part to\nthe Partnership's unwillingness to advance additional funds to\nfund the continuing operating losses and possible winding down of\nParadigm's and BBAD's operating activities, the Partnership\nrecorded in the second quarter of 1993 a writedown of\napproximately $516,000 of certain assets of Paradigm and BBAD to\nreduce the Partnership's net investment to a net realizable value\nof zero.\nGCC\/WWC\nRefer to Note 6 for information regarding GCC\/WWC.\nInvestments, EMP, Ltd. and MVT\nRefer to Note 6 for information regarding Investments, EMP, Ltd.,\nand MVT.\nIMP\/Intelidata\nEffective July 1, 1993, the Partnership entered into three\ntransactions to sell the business and assets of IMPLP\/IMPI and\nIntelidata. In two separate transactions, the Partnership sold\nthe entire business and substantially all of the assets of\nIMPLP\/IMPI and a portion of the business and assets of Intelidata\nto Phillips Business Information, Inc. (\"PBI\") for future\nconsideration based on the revenues of IMPLP\/IMPI and the portion\nof the Intelidata business acquired by PBI. PBI is not\naffiliated with the Partnership. At closing, PBI made advances\nof $100,000 and $150,000 to IMPLP\/IMPI and Intelidata,\nrespectively, which advances would be recoverable by PBI from any\nfuture consideration payable by PBI to the Partnership. In\naddition, PBI agreed to assume certain liabilities of IMPLP\/IMPI\nand Intelidata.\nIn the third transaction, the Partnership sold the remaining\nbusiness and assets of Intelidata, which were not sold to PBI, to\nRomtec plc (\"Romtec\") in exchange for future consideration, based\non both the amount of assets and liabilities transferred to\nRomtec and the combined profits of the portion of the Intelidata\nbusiness acquired by Romtec and another, existing division of\nRomtec. In addition, certain liabilities of Intelidata were\nassumed by Romtec. Romtec is not affiliated with the\nPartnership.\nAs a result of the above transactions, the Partnership recorded a\nwritedown of approximately $364,000 of certain assets of\nIMPLP\/IMPI\/Intelidata in the second quarter of 1993 to reduce the\nPartnership's net investment to a net realizable value of zero.\nSubsequent to the sale of the businesses, the Partnership\nadvanced net additional funds totaling approximately $0.1 million\nto IMPLP\/IMPI and Intelidata to fund cash shortfalls resulting\nfrom the pre-sale claims of certain creditors. The Partnership\nanticipates that it may make additional such advances to\nIMPLP\/IMPI and Intelidata during 1995. The total of any the\nPartnership obligations to fund such advances, including certain\ncontractual obligations, is not currently anticipated to exceed\nthe amount of the writedown. It is unlikely that the Partnership\nwill recover any portion of its investment in\nIMPLP\/IMPI\/Intelidata.\nSummary\nIn summary of the Partnership's liquidity status, the\napproximately $1,750,000 the Partnership has available for\nworking capital may be utilized to support anticipated funding\nneeds or possible restructurings as appropriate, of its\ninvestments. The Partnership has no contractual commitment to\nadvance funds to any of its existing investments.\n3. DISCONTINUED OPERATIONS\nCable Television Systems Segment\nDue to the disposition of Windsor and Maryland Cable, discussed\nin Note 2, the Partnership has presented its Cable Television\nSystems Segment (comprised of Maryland Cable and Windsor) as\ndiscontinued operations. The December 31, 1993 Consolidated\nBalance Sheet and the December 31, 1993 and 1992 Consolidated\nStatements of Operations and Consolidated Statements of Cash\nFlows have been restated to present such discontinued operations.\nThe net liabilities of the discontinued operations of this\nsegment on the Consolidated Balance Sheets are comprised of the\nfollowing:\nSummarized results of the discontinued operations of this segment\non the Consolidated Statements of Operations are as follows:\nAny losses incurred by this segment subsequent to March 31, 1994\nhave been offset against the gain on disposition for the year\nended December 31, 1994.\nProduction Segment\nDue to the expected disposition of Paradigm in 1995, the\nPartnership's Production Segment is presented as discontinued\noperations at December 31, 1994. The December 31, 1993\nConsolidated Balance Sheet and the December 31, 1993 and 1992\nConsolidated Statement of Operations and Consolidated Statement\nof Cash Flows have been restated to present such discontinued\noperations.\nThe net liabilities of the discontinued operations of this\nsegment on the Consolidated Balance Sheets are comprised of the\nfollowing:\nSummarized results of the discontinued operations of this segment\non the Consolidated Statements of Operations are as follows:\nTelevision and Radio Station Segment\nDue to the disposition of WMXN-FM (see Note 2) on February 21,\n1995 and the Partnership's decision to sell TCS, the Partnership\nhas presented its Television and Radio Station Segment (comprised\nof WMXN-FM and TCS) as discontinued operations. The December 31,\n1993 Consolidated Balance Sheet and the December 31, 1993 and\n1992 Consolidated Statements of Operations and Consolidated\nStatements of Cash Flows, have been restated to present such\ndiscontinued operations.\nThe net liabilities of discontinued operations of this segment on\nthe Consolidated Balance Sheets are comprised of the following:\nSummarized results of the discontinued operations of this segment\non the Consolidated Statements of Operations are as follows:\nTCS was accounted for under the equity method through March 26,\n1993.\nThe Partnership expects to recognize a gain on the disposition of\nits Television and Radio Station Segment and will record such\ngain on upon consummation of the disposal.\nBusiness Information Services Segment\nEffective July 1, 1993, the Partnership sold the business and\nassets of IMPLP\/IMPI and Intelidata (the Business Information\nServices Segment). The results of the Business Information\nServices Segment have been reported separately in the December\n1993 and 1992 Consolidated Statements of Operations as\ndiscontinued operations. Summarized results of the discontinued\noperations of this segment are as follows:\n4. BORROWINGS\nAt December 31, 1994 and December 31, 1993 the aggregate amount\nof borrowings reflected on the balance sheets of the Partnership;\n(included in the net liabilities of the discontinued operations\nof the Television and Radio Station Segment) is detailed as\nfollows:\nA-B-C)On June 1, 1990, TCS entered into note purchase agreements\nwith a group of insurance companies which provided for\nsenior secured borrowings of $35 million (the \"Senior\nSecured Notes\") and subordinated secured borrowings of $10\nmillion (the \"Subordinated Notes\"). These commitments, as\nrestructured (see below), require mandatory payments each\nyear until 1997. The agreements contain covenants that\ninclude requirements to maintain certain financial tests and\nratios (including notes to cash flow ratio and interest to\ncash flow ratio) and restrictions and limitations on capital\nexpenditures, sale of assets, consulting fees, corporate\noverhead, investments, and leases.\nTCS also entered into a security and pledge agreement dated\nas of June 1, 1990 with a bank, whereby it is a condition to\nthe purchasers' obligation under the note purchase\nagreements that TCS grant to the security trustee a security\ninterest in and lien upon (i) all of the capital stock of\neach corporation which owns or operates one or more of TCS's\nstations and (ii) all of TCS's present and future right,\ntitle and interest in the subsidiary notes, to secure TCS's\nindenture obligations.\nOn December 14, 1992, TCS negotiated agreements to amend its\nnote agreements. TCS had been unable to generate sufficient\nfunds from operations to fully meet its obligations under\nits note purchase agreements. The Senior Secured Notes and\nthe Subordinated Notes were amended to reschedule principal\npayments. In addition, the amended agreements contain\ncertain options for required prepayments and restrictions\nrequiring excess cash to be paid based upon a calculation\noutlined in the agreements. As payment for a transaction\nfee, the senior lenders were issued additional notes due May\n31, 1997, in the amount of $350,000 (the \"Senior Secured Fee\nNotes\"). Also, upon sale of the TCS stations or retirement\nof the debt, the subordinated lenders will receive\ncompensation equal to 20% (or 25% in some circumstances) of\nthe value of the assets of TCS after subtracting all\noutstanding debt. All previous defaults under the Senior\nSecured Notes and the Subordinated Notes were waived.\nUnder the amended note agreements, the Senior Secured Notes\nand the Senior Secured Fee Notes accrue interest at the rate\nof 10.69% per annum payable on the last day of February,\nMay, August and November. However, TCS has the option to\ndefer payment of interest on the Senior Secured Fee Notes\nuntil May 31, 1997. All interest so deferred will be\ncompounded quarterly at the stated rate of 10.69%. In\naddition, the amended loan agreement required accrued\ninterest due through December 14, 1992 on the Subordinated\nNote of $1,326,804 to be reclassified into the original\nSubordinated Note amount of $10,000,000. The restated\nSubordinated Note total of $11,326,804 accrues interest at\nthe rate of 12.69% per annum compounded quarterly on the\n15th of March, June, September and December until either\ncertain conditions are met (refer to the amended note\nagreement for specific conditions), or until December 15,\n1995.\nSee Note 2 regarding defaults under the amended TCS loan\nagreements.\nAt December 31, 1994, the annual aggregate amounts of\nprincipal payments required for the borrowings reflected in\nthe consolidated balance sheet of the Partnership are,\nunless accelerated as discussed in Note 2, as follows:\nBased upon the restrictions of debt as described above,\napproximately $54 million of assets (which are included in\nNet Liabilities of Discontinued Operations on the\naccompanying Consolidated Balance Sheets) are restricted\nfrom distribution by the entities in which the Partnership\nhas an interest.\n5. TRANSACTIONS WITH THE GENERAL PARTNER AND ITS AFFILIATES\nDuring the years ended December 31, 1994, 1993, and 1992, the\nPartnership incurred the following expenses in connection with\nservices provided by the General Partner and its affiliates:\nIn addition, the Partnership, through the Windsor Systems and\nMaryland Cable, entered into an agreement with MultiVision, an\naffiliate of the General Partner, whereby MultiVision provided\nthe Windsor Systems (through June 29, 1992) and Maryland Cable\n(through its sale in 1994) with certain administrative services.\nThe reimbursed cost to the Windsor Systems and Maryland Cable for\nthese services amounted to $848,067 for the year ended December\n31, 1994, $977,414 for the year ended December 31, 1993, and\n$936,356 for the year ended December 31, 1992. These costs do\nnot include programming costs that were charged to the Windsor\nSystems and Maryland Cable under a cost allocation agreement. In\naddition, MultiVision Cable TV Corp. received a payment of\n$500,000 in partial settlement of severance and other costs\nrelating to the termination of MultiVision as manager of the\nMaryland Cable Systems. Effective June 30, 1992, the Partnership\nentered into a management agreement with Cablevision Systems\nCorporation, which is not affiliated with the Partnership, to\nmanage the day-to-day operations and maintain the books and\nrecords of the Windsor Systems through the sale of the Windsor\nSystems in 1994. These responsibilities were subject to the\ndirection and control of the General Partner.\nThe total customer base managed by MultiVision declined\nsignificantly during 1992 as a result of divestitures by\ncompanies other than the Partnership, which had utilized the\nmanagerial services of MultiVision, leading to slightly higher\nprogramming prices for all its managed systems, including the\nMaryland Cable and Windsor Systems.\n6. OTHER INVESTMENTS\nGCC\/WWC\nOn May 24, 1989, the Partnership entered into a subscription and\npurchase agreement (the \"Subscription Agreement\") to purchase\n500,000 shares of Series A Convertible Preferred Stock\n(\"Preferred Stock\") of General Cellular Corporation (\"GCC\") at\n$30 per share, for a total subscription of $15 million. GCC was\na California-based owner and operator of cellular telephone\nsystems.\nIn 1990, the Partnership wrote down the value of its preferred\nstock in GCC of $15,000,000, because of GCC's inability at that\ntime to raise the financing critical to its viability as a going\nconcern.\nOn March 17, 1992, a plan of reorganization under Chapter 11 of\nthe U.S. Bankruptcy Code became effective, in which GCC was\nrecapitalized by an investor group. As part of the plan of\nreorganization, GCC's outstanding debt was reduced from\napproximately $97 million to $20 million. Under the plan, the\nPartnership's 500,000 shares of Preferred Stock were converted to\n199,281 shares of common stock, prior to the effect of the\nPartnership's exercise of rights pursuant to a rights offering.\nThe rights offering provided that existing shareholders,\nincluding the Partnership, could purchase additional ownership in\nGCC. Each right consisted of the right to purchase from GCC a\nunit consisting of one share of common stock and $9.09 in\nprincipal amount of senior notes, for a total unit price of\n$19.09. On March 4, 1992, the Partnership exercised 52,384\nrights, for a total price of $1,000,011. By exercising these\nrights, the Partnership purchased: a) 52,384 shares of common\nstock of GCC, which increased the Partnership's ownership\nposition in GCC to 251,665 shares; and b) senior notes with a\nface value of $476,171. On August 19, 1992, GCC redeemed the\nsenior notes, repaying to the Partnership $476,171, plus accrued\ninterest.\nOn October 26, 1992, GCC completed a second rights offering\npursuant to which existing shareholders, including the\nPartnership, were issued rights to purchase one additional share\nof common stock for each 1.75 shares owned, for a price of\n$10.00. The Partnership purchased 100,000 additional shares for\nan investment of $1,000,000. In addition, the Partnership sold\n43,809 rights to purchase shares for a price of $120,000 to an\nunaffiliated entity. Additionally, effective November 3, 1993,\nthe Partnership sold 61,160 rights to purchase shares for a price\nof $100,000 to several unaffiliated entities. GCC raised\n$25,281,000 in the offering to assist it in completing its\nbusiness plan of purchasing and operating clusters of cellular\nsystems in certain geographic areas.\nOn January 20, 1994, the majority stockholders of GCC and certain\nholders of interest in MARKETS Cellular Limited Partnership\n(\"Markets\"), and PN Cellular, Inc. (\"PNCI\") executed a Memorandum\nof Intention (the \"Memorandum\") pursuant to which the parties\nthereto expressed their intent to effect a proposed business\ncombination of GCC and Markets.\nThe Partnership executed an Exchange Agreement and Plan of Merger\n(\"Agreement\"), dated July 20, 1994, to which the majority\nstockholders of GCC and the majority owners of Markets are\nparties. Pursuant to the Agreement, the Partnership exchanged\nits shares in GCC for an equal number of shares in Western\nWireless Corporation (\"WWC\"), a new company which was organized\nto own the equity interest of GCC and Markets. Following the\nconsummation of the business combination on July 29, 1994, WWC\nbecame the owner of 100% of the Partnership interests in Markets\nand approximately 95% of the outstanding common stock of GCC.\nWWC holds and operates cellular licenses covering approximately\n5.6 million net pops (defined as the population in an area\ncovered by a cellular franchise) including pending acquisitions.\nThe Partnership's shares represent approximately 2.4% of WWC.\nThe parties have entered into a stockholders agreement containing\ncertain restrictions on transfer, registration rights and\ncorporate governance provisions.\nTCS\nOn January 17, 1990, the Partnership entered into a limited\npartnership agreement with Riverdale Media Corporation\n(\"Riverdale\"), forming TCS. The agreement was subsequently\namended to include Commonwealth Capital Partners, L.P.\n(\"Commonwealth\") as a limited partner. Initially, Riverdale was\nthe general partner of TCS, and owned 20.01% of the entity. The\nPartnership and Commonwealth were limited partners owning 41% and\n38.99%, respectively. Riverdale contracted with ML Media\nOpportunity Consulting Partners, a wholly-owned subsidiary of the\nPartnership, to provide management services for TCS.\nOn June 19, 1990, TCS completed its acquisition of three network\naffiliated television stations; WRBL-TV, the CBS affiliate\nserving Columbus, Georgia; WTWO-TV, the NBC affiliate serving\nTerre Haute, Indiana; and KQTV-TV, the ABC affiliate serving St.\nJoseph, Missouri (the \"TCS Stations\").\nThe purchase price of $49 million, a non-compete payment of $7\nmillion, and starting working capital and closing costs of\napproximately $5 million were funded by the sale by TCS of senior\nnotes totaling $35 million and subordinated notes totaling $10\nmillion, and equity of $16 million. The Partnership's total\nequity contribution and incurred costs were approximately $8.3\nmillion as of December 31, 1994 (including approximately $170,000\nnoted below). In addition, the Partnership had loaned TCS\napproximately $400,000 for working capital purposes during 1991.\nOn December 14, 1992, the Partnership concluded agreements to\nrestructure the debt and ownership arrangements of TCS.\nConcurrent with the new debt arrangements (as detailed in Note\n5), the equity partners in TCS agreed to seek regulatory approval\nto alter the ownership structure of the company. On March 26,\n1993, the Partnership was granted such approval by the FCC. As a\nresult, on March 26, 1993, the Partnership and Commonwealth\npurchased the 20.01% ownership interest held by Riverdale. On\nMarch 26, 1993, a wholly-owned subsidiary of the Partnership\nbecame the new sole general partner of TCS and the Partnership's\ntotal ownership interest in TCS increased from 41% to 51.005% (1%\nof which is the general partner interest). The Partnership\nutilized approximately $170,000 of its working capital reserve to\nacquire the additional 10.005% interest.\nRefer to Note 2 regarding defaults under TCS loan agreements, and\nto Note 3 regarding the discontinued operations of TCS.\nParadigm\/BBAD\nOn May 31, 1991, the Partnership, Productions, GLP Co. and\nAssociates entered into a new agreement (the \"Revised Paradigm\nAgreement\") that amended the original Paradigm Agreement. Under\nthe terms of the Revised Paradigm Agreement, effective June 16,\n1991 the general partner interests of GLP Co. and Associates in\nParadigm were converted to limited partner interests. GLP Co.\nand Associates each retained their 25% ownership in Paradigm and\nthe Partnership retained its 50% beneficial interest. Under the\nterms of the Revised Paradigm Agreement, Paradigm retained\nownership of all program concepts developed by Paradigm prior to\nJune 15, 1991, but assigned the task of further developing these\nprogram concepts to GLP Co. and\/or Associates as independent\ncontractors. Per the Revised Paradigm Agreement, if GLP Co. or\nAssociates were to develop any new program concepts during the\nperiod in which they were acting as independent contractors for\nParadigm, GLP Co. or Associates would be required to offer\nParadigm the right to finance the production of such program\nconcepts. Regardless of Paradigm's decision to finance the\nfurther development of the new program concepts, Paradigm would\nreceive a share of the profits and fees, if any, from such new\nprogram concepts.\nThe consulting agreements described above expired on December 31,\n1991. Effective with the expiration, Associates continued,\nwithout a formal agreement, to develop projects to offer to\nParadigm. As was the case under the Revised Paradigm Agreement,\nthe Partnership had the option of financing such projects in\nreturn for equity interests in such projects. During 1992, the\nPartnership advanced approximately $1.0 million to Paradigm to\nfund Paradigm's operations and the production of its television\nprograms. Offsetting these advances during 1992, Paradigm\nreturned to the Partnership $2.5 million of such advances, which\nParadigm received from broadcasters as fees for movies produced.\nEffective June 23, 1992, Paradigm formed a general partnership\nwith Associates to start a new production company, BBAD. Pursuant\nto this new general partnership arrangement between Paradigm and\nAssociates, during 1992 Paradigm advanced approximately $942,000\nand Associates advanced approximately $457,000 to fund BBAD's\noperations and the development of certain programming concepts.\nInitially, Paradigm owned 67% and Associates owned 33% of BBAD,\nbased on their capital contributions to BBAD. In addition,\nAssociates contributed an additional approximately $0.7 million\nand Paradigm contributed approximately $0.3 million from existing\ncash balances during 1993 to fund BBAD's operations. As of\nDecember 31, 1994, the Partnership had advanced a total of\napproximately $7.5 million to Paradigm (net of funds returned by\nParadigm).\nThrough the end of 1993, Paradigm had produced three television\nmovies which had aired as well as one syndicated series (which\nwas discontinued after thirteen episodes), and BBAD had produced\none television movie which had aired and one series. BBAD had\nalso developed other program concepts which may be produced as\neither movies or series for television.\nRefer to Note 2 and 3 for further information regarding Paradigm\nand BBAD.\nInvestments, EMP, Ltd., and MVT\nOn September 1, 1989, the Partnership entered into various\nagreements with Peter Clark (\"Clark\") and Alan Morris (\"Morris\")\nto form U.K. entities (the \"Media Ventures Companies\") that would\ndevelop and invest in media businesses in Europe. Pursuant to\nthe terms of these agreements, the Partnership advanced $2.0\nmillion to Investments and its predecessors between 1989 and\nDecember 31, 1991. During 1991, and following the Partnership's\ndecision not to advance additional funds to the Media Ventures\nCompanies beyond the Partnership's initial $2.0 million\ncommitment, the Media Ventures Companies secured funding from a\nthird party, ALP Enterprises, Inc. (\"ALP Enterprises\") to allow\nthe Media Ventures Companies to continue their operations. Due\nto: (i) the Partnership's unwillingness to advance additional\nfunds to the Media Ventures Companies; and (ii) the Media\nVentures Companies' resultant reliance on funding from ALP\nEnterprises, the Partnership's ownership in the Media Ventures\nCompanies was diluted -- through a number of restructurings of\nthe ownership of the Media Ventures Companies -- as ALP\nEnterprises advanced funds to the Media Ventures Companies.\nAs of December 31, 1993, the Media Ventures Companies had\nstarted, or made investments in, a number of media businesses,\nincluding an investment in 1992 in Teletext U.K., Ltd.\n(\"Teletext\"), a newly formed U.K. corporation organized to\nacquire U.K. franchise rights to provide data in text form to\ntelevision viewers via television broadcast sidebands. The\ninvestment of the Media Ventures Companies in Teletext was\ninitially held by European Media Partners, Ltd. (\"EMP, Ltd.\"),\nthe primary operating holding company organized by the Media\nVentures Companies. Following a July 30, 1993 restructuring,\nEMP, Ltd. was owned 13.8% by the Partnership, 45.6% by Clarendon\n(a company controlled by the founders and management of the Media\nVentures Companies), and 40.6% by ALP Enterprises. The\nPartnership also owned 36.8% of the common stock of Investments\n(which was, and remains essentially inactive), ALP Enterprises\nowned 13.8%, Clarendon owned 41.4% and Charles Dawson (who\nmanages a business in which the Media Ventures Companies have an\ninvestment) owned 8.0%.\nDuring 1994, the Media Ventures Companies continued to distribute\ntelevision programs and to monitor the Teletext investment held\nby MVT (see below) while attempting to expand the operations of\nthe Media Ventures Companies into new areas of European media.\nInvestments, MVT, EMP, Ltd. and their affiliates are currently\nreliant on their cash balances, existing operations, and\/or\nadditional funding from ALP Enterprises or other, as yet\nunidentified, financing sources to fund their continuing\noperations. The Partnership expects to advance no further funds\nto Investments, MVT or their affiliates beyond those funds\nalready advanced by the Partnership.\nEffective August 12, 1994, the Partnership and EMP, Ltd.\nrestructured the ownership of EMP, Ltd. and certain of its\nsubsidiaries in order to enable EMP, Ltd. to attract additional\ncapital from ALP Enterprises and other potential third party\ninvestors. In the restructuring, based on certain\nrepresentations from EMP, Ltd. and ALP Enterprises, the\nPartnership sold to Clarendon and ALP Enterprises for nominal\nconsideration the Partnership's shares in EMP, Ltd.\nSimultaneously, the Partnership and EMP, Ltd. entered into an\nagreement whereby EMP, Ltd.'s 10% interest in Teletext was\ntransferred, together with a pound sterling 350,000 loan\n(approximately $543,000 at then-current exchange rates) from EMP, Ltd.\nto a newly formed entity, MVT. After the transfer, the Partnership\nowns 13.8% of the issued common shares of MVT, while EMP, Ltd. owns the\nremaining 86.2%. MVT's sole purpose is to manage its 10%\ninterest in Teletext. The Partnership has the right to require\nEMP, Ltd. to purchase the Partnership's interest in MVT at any\ntime between December 31, 1994 and December 31, 1997. EMP, Ltd.\nhas the right to require the Partnership to sell the\nPartnership's interest in MVT to EMP, Ltd. at any time between\nSeptember 30, 1995 and September 30, 1998. MVT will pay an\nannual fee to EMP, Ltd. for management services provided by EMP,\nLtd. in connection with overseeing MVT's investment in Teletext.\nFollowing the restructuring, the Partnership no longer has any\ninterest in EMP, Ltd. The Partnership elected not to advance\nfurther funds to investments or MVT. It is likely the\nPartnership will not recover the majority of its $2 million\ninvestment in Investments either from Investments or from MVT.\n7. SUMMARIZED FINANCIAL INFORMATION OF EQUITY AFFILIATES\nThe following table presents summarized financial information of\nthe Partnership's investment in Investments, which was accounted\nfor under the equity method in 1992 only:\n8. FAIR MARKET VALUE\nStatement of Financial Accounting Standards No. 107, \"Disclosures\nabout Fair Value of Financial Instruments\", requires companies to\nreport the fair value of certain on- and off-balance sheet assets\nand liabilities which are defined as financial instruments.\nConsiderable judgment is necessarily required in interpreting data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Partnership 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.\nAssets, including cash and cash equivalents and accounts receivable, and liabilities, such as trade payables, are carried at amounts which approximate fair value.\nBorrowings\nAs of December 31, 1994, due to the uncertainty of the Partnership's ability to meet its obligations under the TCS notes and the uncertainty relating to the ultimate outcome of the Partnership's efforts to sell the TCS television stations, the General Partner considers the estimation of the fair market value of the TCS debt obligations (included in net liabilities of discontinued operations in the accompanying consolidated balance sheets) to be impracticable.\nAs of December 31, 1993, considering the uncertainty of the Partnership's ability to meet its obligations under the Amended Credit Agreement, Senior Subordinated Discount Notes, Windsor Note, and the TCS notes, management believed that using the Partnership's future cash flows related to debt-service to estimate the fair value of these loans was not appropriate. In addition, because of the uncertainty related to the ultimate outcome of the Partnership's restructuring efforts (see Note 2), the General Partner considered estimation of the fair value of these loans based on collateral value and other methods to be impracticable.\nOther Financial Instruments\nThe Partnership owns 351,665 shares of common stock of WWC (see Note 6). It is not practicable to estimate the fair value of this investment because of the lack of a quoted market price and the inability to estimate fair value without incurring excessive costs. The approximate $1.3 million carrying amount as of December 31, 1994 and December 31, 1993, represents the adjusted cost of the investment, which management believes is not impaired. No dividends were received during the years ended December 31, 1994 and December 31, 1993.\n9. ACCOUNTING FOR INCOME TAXES\nAs discussed in Note 1, the corporations owned by the Partnership adopted SFAS No. 109 effective January 1, 1993. The cumulative effect of this change in accounting principle was immaterial and there was no effect on the provision for income taxes in the year of adoption.\nCertain entities owned by the Partnership are taxable entities and thus are required under SFAS No. 109 to recognize deferred income taxes. The components of the net deferred tax asset (included in the net liabilities of discontinued operations in the accompanying consolidated balance sheets) at December 31, 1994 and 1993 are as follows:\nThe change in the net deferred tax asset for the year ended December 31, 1994 consisted of a reduction of approximately $39.1 million due to the disposition of Maryland Cable and an increase of approximately $.5 million due primarily to an increase in the net operating loss carryforward. The entire net change was offset by a corresponding reduction in the valuation allowance.\nThe change in the net deferred tax asset for the year ended December 31, 1993 amounted to an increase of approximately $10,400,000 due to an increase in the net operating loss carryforward offset by a corresponding reduction due to a change in the valuation allowance.\nNo provision for income taxes was required for the year ended December 31, 1992.\nAt December 31, 1994, the taxable entities have available net operating loss carryforwards which may be applied against future taxable income. Such net operating loss carryforwards expire at various dates from 2007 through 2009.\nFor the Partnership, the differences between the tax bases of assets and liabilities and the reported amounts at December 31, 1994 and 1993 are as follows:\n10. MINORITY INTEREST\nParadigm\/BBAD\nThe Partnership's consolidated financial statements include 100% of the assets, liabilities and results of operations of Paradigm and its affiliate, BBAD. The Partnership holds a 50% interest in Paradigm and owns approximately 52% in BBAD through Paradigm based upon capital contributions. The remaining approximately 48% of BBAD is owned by Associates, an entity which is not otherwise affiliated with the Partnership except as a 25% limited partner in Paradigm. The Partnership's net loss was decreased by approximately $27,000 and $518,000 for the years ended December 31, 1994 and December 31, 1993, respectively as a result of the minority interest in BBAD. Minority interest is presented along with the discontinued operations of the Production segment of the consolidated financial statements.\nTCS\nAs discussed in Note 6, on March 26, 1993, the Partnership's total ownership interest in TCS increased to 51.005% and thus the Partnership has included TCS in the consolidated financial statements as of December 31, 1994 and December 31, 1993.\nNo minority interest has been recorded for the periods ended or as of December 31, 1994 and December 31, 1993 due to cumulative losses which have been incurred and the lack of an obligation on the part of the minority shareholder to fund such losses.\nML MEDIA OPPORTUNITY PARTNERS, L.P. AS OF DECEMBER 31, 1994 AND DECEMBER 31, 1993\nSCHEDULE III CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nML Media Opportunity Partners, L.P. Condensed Balance Sheets as of December 31, 1994 and December 31, 1993\nSee Notes to Condensed Financial Statements.\nSCHEDULE III CONDENSED FINANCIAL INFORMATION OF REGISTRANT Cont'd\nML Media Opportunity Partners, L.P. Condensed Statements of Operations For the Years Ended December 31, 1994, December 31, 1993, and December 31, 1992\nSee Notes to Condensed Financial Statements.\nSCHEDULE III CONDENSED FINANCIAL INFORMATION OF REGISTRANT Cont'd\nML Media Opportunity Partners, L.P. Condensed Statements of Operations For the Years Ended December 31, 1994, December 31, 1993, and December 31, 1992\nSee Notes to Condensed Financial Statements.\nSCHEDULE III CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Cont'd)\nML Media Opportunity Partners, L.P. Condensed Statements of Cash Flow For the Years Ended December 31, 1994, December 31, 1993, and December 31, 1992\nSCHEDULE III CONDENSED FINANCIAL INFORMATION OF REGISTRANT (Cont'd)\nML Media Opportunity Partners, L.P. Condensed Statements of Cash Flow For the Years Ended December 31, 1994, December 31, 1993, and December 31, 1992\nSee Notes to Condensed Financial Statements.\nSchedule III CONDENSED FINANCIAL INFORMATION OF REGISTRANT Cont'd\nML Media Opportunity Partners, L.P. Notes To Condensed Financial Statements For the Years Ended December 31, 1994 December 31, 1993, and December 31, 1992\n1. Organization\nML Media Opportunity Partners, L.P. (the \"Partnership\") wholly owns WMXN-FM, holds a 50% interest in Paradigm, a 13.8% interest in MVT, a 93.5% interest in IMPLP\/IMPI, a 100% interest in Intelidata and 51.005% interest in TCS. All of the preceding investments and the Partnership's other majority-owned subsidiaries shall herein be referred to as the \"Subsidiaries.\" The Partnership carries its interest in GCC at cost.\nCertain 1992 and 1993 items have been reclassified to conform to 1994 presentation for discontinued operations.\n2. Investment in Subsidiaries\nThe Partnership's investment in the Subsidiaries is accounted for under the equity method in the accompanying condensed financial statements.\nThe following is a summary of the financial position and results of operations of the Subsidiaries (included in consolidated financial statements).\nSchedule III CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nML MEDIA OPPORTUNITY PARTNERS, L.P. NOTES TO CONDENSED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994 DECEMBER 31, 1993, AND DECEMBER 31, 1992\n3. Cash and Cash Equivalents\nAt December 31, 1994, the Partnership had $1,752,059 in cash and cash equivalents of which $1,672,365 was invested in commercial paper. In addition, the Partnership had $79,694 invested in cash and demand deposits.\nAt December 31, 1993, the Partnership had $3,521,683 in cash and cash equivalents of which $597,467 was invested in banker acceptances and $2,854,509 was invested in commercial paper. In addition, the Partnership had $69,707 invested in cash and demand deposits.\nItem 9.","section_9":"Item 9. Changes in and Disagreement with Accountants and Accounting and Financial Disclosure\nNone. Part III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Partnership\nRegistrant has no executive officers or directors. The General Partner manages the Registrant's affairs and has general responsibility and authority in all matters affecting its business. The responsibilities of the General Partner are carried out either by executive officers of EHR Opportunity Management, Inc. and IMP Opportunity Management, Inc. as general partners of RP Opportunity Management, L.P. or executive officers of ML Opportunity Management Inc., acting on behalf of the General Partner. The executive officers and directors of RP Opportunity Management, L.P. and ML Opportunity Management Inc. are:\nRP Opportunity Management, L.P. (the \"Management Company\")\nServed in Present Name Capacity Since (1) Position Held\nDirector and President I. Martin Pompadur 6\/15\/87 IMP Opportunity Management\nExecutive Vice President Elizabeth McNey Yates 4\/01\/88 IMP Opportunity Management\nML Opportunity Management Inc. (\"MLOM\")\nServed in Present Name Capacity Since (1) Position Held\nKevin K. Albert 2\/19\/91 President 6\/22\/87 Director\nRobert F. Aufenanger 2\/02\/93 Executive Vice President 3\/28\/88 Director\nRobert W. Seitz 2\/02\/93 Vice President 2\/01\/93 Director\nJames K. Mason 2\/01\/93 Director\nSteven N. Baumgarten 3\/07\/94 Vice President\nDavid G. Cohen 3\/07\/94 Treasurer\n(1) Directors hold office until their successors are elected and qualified. All executive officers serve at the pleasure of the Board of Directors of the respective entity.\nI. Martin Pompadur, 59, is the Chairman and Chief Executive Officer of GP Station Partners which is the General Partner of Television Station Partners, L.P. a private limited partnership that owns and operates four network affiliated television stations. He is the Chairman and Chief Executive Officer of PBTV, Inc., the Managing General Partner of Northeastern Television Investors Limited Partnership, a private limited partnership which owns and operates WBRE-TV, a network affiliated station in Wilkes-Barre Scranton, Pennsylvania. Mr. Pompadur also is a Chairman and Chief Executive Officer of U.S. Cable Partners, a general partner of U.S. Cable Television Group, L.P. (\"U.S. Cable\") which owns and operates cable systems in ten states. He is also the President and a Director of RP Media Management (\"RPMM\"), a joint venture which is a partner in Media Management Partners (\"MMP\"), an affiliate of the General Partner and the general partner of ML Media Partners, L.P., which presently owns two network affiliated television stations, several cable television systems and several radio stations. Mr. Pompadur is the Chief Executive Officer of ML Media Partners, L.P. Mr. Pompadur is also Chief Executive Officer of MultiVision Cable TV Corp. (\"MultiVision\"), a cable television multiple system operator (\"MSO\") organized in January 1988 and owned principally by Mr. Pompadur to provide MSO services to cable television systems acquired by entities under his control. Mr. Pompadur is a principal owner, member of the Board of Directors and Secretary of Caribbean International News Corporation (\"Caribbean\"). Caribbean owns and publishes EL Vocero, the largest Spanish language daily newspaper in the U.S.\nElizabeth McNey Yates, 32, Executive Vice President of RP Opportunity Management, L.P., joined RP Companies Inc., an entity controlled by Mr. Pompadur, in April 1988 and has senior executive responsibilities in the areas of finance, operations, administration and acquisitions. Ms. Yates is an Executive Vice President of RPMM and Senior Vice President of MMP.\nKevin K. Albert, 42, a Managing Director of Merrill Lynch Investment Banking Group (\"ML Investment Banking\"), joined Merrill Lynch in 1981. Mr. Albert works in the Equity Private Placement Group and is involved in structuring and placing a diversified array of private equity financings including common stock, preferred stock, limited partnership interests and other equity-related securities. Mr. Albert is also a director of Maiden Lane Partners, Inc. (\"Maiden Lane\"), an affiliate of the General Partner and the general partner of Liberty Equipment Investors - 1983; a director of Whitehall Partners Inc. (\"Whitehall\"), an affiliate of MLOM and the general partner of Liberty Equipment Investors L.P. - 1984; a director of ML Media Management Inc. (\"ML Media\"), an affiliate of MLOM and a joint venturer of Media Management Partners, the general partner of ML Media Partners, L.P.; a director of ML Film Entertainment Inc. (\"ML Film\"), an affiliate of MLOM and the managing general partner of the general partners of Delphi Film Associates II, III, IV, V and ML Delphi Premier Partners, L.P.; a director of MLL Antiquities Inc. (\"MLL Antiquities\"), an affiliate of MLOM and the administrative general partner of The Athena Fund II, L.P.; a director of ML Mezzanine II Inc. (\"ML Mezzanine II\"), an affiliate of MLOM and sole general partner of the managing general partner of ML-Lee Acquisition Fund II, L.P. and ML-Lee Acquisition Fund (Retirement Accounts) II, L.P.; a director of ML Mezzanine Inc. (\"ML Mezzanine\"), an affiliate of MLOM and the sole general partner of the managing general partner of ML-Lee Acquisition Fund, L.P.; a director of Merrill Lynch Venture Capital Inc. (\"ML Venture\"), an affiliate of MLOM and the general partner of the Managing General Partner of ML Venture Partners I, L.P. (\"Venture I\"), ML Venture Partners II, L.P. (\"Venture II\"), and ML Oklahoma Venture Partners Limited Partnership (\"Oklahoma\"); a director of Merrill Lynch R&D Management Inc. (\"ML R&D\"), an affiliate of MLOM and the general partner of the General Partner of ML Technology Ventures, L.P.; and a director of MLL Collectibles Inc. (\"MLL Collectibles\"), an affiliate of MLOM and the administrative general partner of The NFA World Coin Fund, L.P. Mr. Albert also serves as an independent general partner of Venture I and Venture II.\nRobert F. Aufenanger, 41, a Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research and a Director of the Partnership Management Department, joined Merrill Lynch in 1980. Mr. Aufenanger is responsible for the ongoing management of the operations of the equipment and project related limited partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners. Mr. Aufenanger is also a director of Maiden Lane, Whitehall, ML Media, ML Film, MLL Antiquities, ML Venture, ML R&D, MLL Collectibles and ML Mezzanine and ML Mezzanine II.\nRobert W. Seitz, 48, is a First Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research and a Managing Director within the Corporate Credit Division of Merrill Lynch, joined Merrill Lynch in 1981. Mr. Seitz is the Private Client Senior Credit Officer and also is responsible for the firm's Partnership Management and Asset Recovery Management Departments. Mr. Seitz is also a director of Maiden Lane, Whitehall, ML Media, ML Venture, ML R&D, ML Film, MLL Antiquities, and MLL Collectibles.\nJames K. Mason, 42, a Managing Director of ML Investment Banking, is a senior member of the Telecom, Media and Technology group. He joined Merrill Lynch Investment Banking in 1978. Mr. Mason is responsible for advising Merrill Lynch's entertainment and media industry clients on such matters as financings, divestitures, restructurings, mergers and acquisitions. Mr. Mason is also a director of ML Media.\nSteven N. Baumgarten, 39, a Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research, joined Merrill Lynch in 1986. Mr. Baumgarten shares responsibility for the ongoing management of the operations of the equipment and project related limited partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners. Mr. Baumgarten is also a director of ML Film.\nDavid G. Cohen, 32, an Assistant Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research, joined Merrill Lynch in 1987. Mr. Cohen's responsibilities include controllership and financial management functions for certain partnerships for which subsidiaries of ML Leasing Equipment Corp., an affiliate of Merrill Lynch, are general partners.\nMr. Pompadur and Ms. Yates were each executive officers of Maryland Cable Corp. and Maryland Cable Holdings Corp. at and during the two years prior to the filing by Maryland Cable and Holdings on March 10, 1994 of a consolidated plan of reorganization under Chapter 11 of the United States Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. For more information regarding such filings, refer to \"Item 1. Business -- Maryland Cable Corp.\".\nMr. Aufenanger is an executive officer of Mid-Miami Diagnostics Inc. (\"Mid-Miami Inc.\"). On October 28, 1994 both Mid-Miami Inc. and Mid-Miami Diagnostics, L.P. filed voluntary petitions for protection from creditors under Chapter 7 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Southern District of New York.\nItem 11.","section_11":"Item 11. Executive Compensation\nRegistrant does not pay the executive officers or directors of the General Partner any remuneration. The General Partner does not presently pay any remuneration to any of its executive officers or directors. See Note 5 to the Financial Statements included in Item 8 hereof, however, for sums paid by Registrant to affiliates for the years ended December 31, 1994, December 31, 1993 and December 31, 1992.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nAs of February 1, 1995, no person was known by the Registrant to be the beneficial owner of more than 5 percent of the Units.\nTo the knowledge of the General Partner, as of February 1, 1995, the officers and directors of the General Partner in aggregate own less than .01% of the outstanding common stock of Merrill Lynch & Co., Inc.\nIMP Opportunity Management, Inc. is 100% owned by Mr. I. Martin Pompadur.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nRefer to Note 5 to the Financial Statements included in Item 8 hereof, and in Item 1 for a description of the relationship of the General Partner and its affiliates to Registrant and its subsidiaries.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Financial Statements, Financial Statement Schedules and Exhibits\nFinancial Statements and Financial Statement Schedules\nSee Item 8. \"Financial Statements and Supplementary Data\".\n(b) Reports on Form 8-K\nOn October 17, 1994, Registrant filed a report on Form 8-K discussing the consummation of the amended Prepackaged Plan of Reorganization of Maryland Cable and Holders.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nML MEDIA OPPORTUNITY PARTNERS, L.P. By: Media Opportunity Management Partners General Partner\nBy: ML Opportunity Management Inc.\nDated: March 17, 1995 \/s\/ Kevin K. Albert Kevin K. Albert 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 Registrant in the capacities and on the dates indicated.\nRP OPPORTUNITY MANAGEMENT, L.P.\nBy: IMP Opportunity Management Inc. a general partner\nSignature Title Date\n\/s\/ I. Martin Pompadur Director and March 17, 1995 (I. Martin Pompadur) President(principal executive officer of the Registrant)\nML OPPORTUNITY MANAGEMENT INC. (\"MLOM\")\nSignature Title Date\nEach with respect to MLOM unless otherwise noted)\n\/s\/ Kevin K. Albert Director and March 17, 1995 (Kevin K. Albert) President\n\/s\/ Robert F. Aufenanger Director and March 17, 1995 (Robert F. Aufenanger) Executive Vice President\n\/s\/ James K. Mason Director March 17, 1995 (James K. Mason)\n\/s\/ Robert W. Seitz Director and Vice March 17, 1995 (Robert W. Seitz) President\n\/s\/ David G. Cohen Treasurer March 17, 1995 (David G. Cohen) (principal accounting officer and principal financial officer of the Registrant)","section_15":""}
{"filename":"789292_1994.txt","cik":"789292","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE PARTNERSHIP. Cable TV Fund 12-D, Ltd. (the \"Partnership\") is a Colorado limited partnership that was formed pursuant to the public offering of limited partnership interests in the Cable TV Fund 12 Limited Partnership Program (the \"Program\"), which was sponsored by Jones Intercable, Inc. (the \"General Partner\"). Cable TV Fund 12-A, Ltd. (\"Fund 12-A\"), Cable TV Fund 12-B, Ltd. (\"Fund 12-B\") and Cable TV Fund 12-C, Ltd. (\"Fund 12-C\") are the other partnerships that were formed pursuant to the Program. In 1986, the Partnership, Fund 12-B and Fund 12-C formed a general partnership known as Cable TV Fund 12-BCD Venture (the \"Venture\"), in which the Partnership owns a 75 percent interest, Fund 12-B owns a 9 percent interest and Fund 12-C owns a 15 percent interest. The Partnership and the Venture were formed for the purpose of acquiring and operating cable television systems.\nThe Partnership does not directly own any cable television systems. The Venture owns the cable television systems serving Palmdale, Lancaster and Rancho Vista and the military installation of Edwards Airforce Base, all in California (the \"Palmdale\/Lancaster System\"); Albuquerque, New Mexico (the \"Albuquerque System\") and Tampa, Florida (the \"Tampa System\"). See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe cable television systems owned by the Venture at December 31, 1994 are described below:\nThe following sets forth (i) the monthly basic plus service rates charged to subscribers, (ii) the number of basic subscribers and pay units and (iii) the range of franchise expiration dates for the Systems. The monthly basic service rates set forth herein represent, with respect to systems with multiple headends, the basic service rate charged to the majority of the subscribers within the system. While the charge for basic plus service may have increased in 1993 in some cases as a result of the FCC's rate regulations, overall revenues may have decreased due to the elimination of charges for additional outlets and certain equipment. In cable television systems, basic subscribers can subscribe to more than one pay TV service. Thus, the total number of pay services subscribed to by basic subscribers are called pay units. As of December 31, 1994, the Venture's Systems operated approximately 4,400 miles of cable plant, passing approximately 424,000 homes, representing an approximate 55% penetration rate. Figures for numbers of subscribers, miles of cable plant and homes passed are compiled from the General Partner's records and may be subject to adjustments.\nFranchise expiration dates range from February 1999 to October 2005.\nFranchise expiration dates range from January 1999 to August 2001.\nThe Tampa franchise expires in December 1997. In 1990, the City of Tampa notified the Venture of its belief that the Venture was not in compliance with certain provisions of the franchise agreement. In September 1994,\nthe City of Tampa and the Venture entered into a Second Amendment to Franchise Agreement providing for modifications to the franchise agreement as full and satisfactory resolution of the outstanding issues.\nPROGRAMMING SERVICES\nProgramming services provided by the Systems include local affiliates of the national broadcast networks, local independent broadcast channels, the traditional satellite services (e.g., American Movie Classics, Arts & Entertainment, Black Entertainment Network, C-SPAN, The Discovery Channel, Lifetime, Entertainment Sports Network, Home Shopping Network, Mind Extension University, Music Television, Nickelodeon, Turner Network Television, The Nashville Network, Video Hits One, and superstations WOR, WGN and TBS. The Partnership's Systems also provide a selection, which varies by system, of premium channel programming (e.g., Cinemax, Encore, Home Box Office, Showtime and The Movie Channel).\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 STOCK AND RELATED SECURITY HOLDER MATTERS\nWhile the Partnership is publicly held, there is no public market for the limited partnership interests, and it is not expected that a market will develop in the future. As of February 15, 1995, the approximate number of equity security holders in the Partnership was 18,242.\nItem 6.","section_6":"Item 6. Selected Financial Data\n** The above financial information represents the consolidated operations of Cable TV Fund 12-BCD Venture, in which Cable TV Fund 12-D has an approximate 76 percent equity interest.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nCABLE TV FUND 12-D\nResults of Operations\nAll of Cable TV Fund 12-D's (\"Fund 12-D's\") operations are represented by its approximate 76 percent interest in Cable TV Fund 12-BCD Venture (the \" Venture\"). Thus, Management's Discussion and Analysis of the Venture should be consulted for pertinent comments regarding Partnership performance.\nFinancial Condition\nFund 12-D's investment in the Venture has decreased by $9,726,971 when compared to the December 31, 1993 balance representing a deficit of $13,799,137. This deficit is due to Fund 12-D's share of Venture losses, which are principally the result of depreciation and amortization charges being greater than equity invested. These losses are expected to be recovered upon liquidation of the Venture.\nCABLE TV FUND 12-BCD VENTURE\nResults of Operations\n1994 Compared to 1993\nRevenues of Cable TV Fund 12-BCD Venture (the \"Venture\") increased $3,691,546, or approximately 4 percent, from $89,131,530 in 1993 to $92,823,076 in 1994. Between December 31, 1993 and 1994, the Venture added 14,878 basic subscribers, an increase of approximately 7 percent. This increase in basic subscribers accounted for approximately 37 percent of the increase in revenues. Increases in advertising sales revenue accounted for approximately 28 percent of the increase in revenues. Increases in premium service and pay-per-view revenues accounted for approximately 27 percent of the increase. The increase in revenues would have been greater but for the reduction in basic rates due to new basic rate regulations issued by the FCC in May 1993 with which the Venture complied effective September 1, 1993. No other single factor significantly affected the increase in revenues.\nOperating, general and administrative expenses in the Venture's systems increased $4,057,270, or approximately 8 percent, from $52,073,984 in 1993 to $56,131,254 in 1994. Operating, general and administrative expense represented 58 percent and 60 percent of revenue in 1993 and in 1994, respectively. The increase in operating, general and administrative expense was due to increases in subscriber related costs, programming fees and marketing related costs. No other single factor significantly affected the increase in operating, general and administrative expenses. Management fees and allocated overhead from Jones Intercable, Inc. increased $1,086,904, or approximately 10 percent, from $10,505,360 in 1993 to $11,592,264 in 1994 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses from Jones Intercable, Inc. Depreciation and amortization expense decreased $992,963, or approximately 4 percent, from $25,651,237 in 1993 to $24,658,274 in 1994. The decrease is due to the maturation of the Venture's asset base.\nThe Venture's operating income decreased $459,665 or approximately 51 percent, from $900,949 in 1993 to $441,284 in 1994. This decrease is the result of increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc. exceeding the increases in revenue and offset by the decreases in depreciation and amortization expenses. Operating income before depreciation and amortization decreased $1,452,628, or approximately 5 percent, from $26,552,186 in 1993 to $25,099,558 in 1994. This decrease is due to the increase in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc. exceeding the increase in revenues.\nInterest expense increased $1,318,943, or 11 percent, from $11,989,130 in 1993 to $13,308,073 in 1994 due to higher interest rates and higher outstanding balances on interest bearing obligations.\nNet loss increased $1,291,826, or approximately 11 percent, from $11,584,416 in 1993 to $12,876,242 in 1994 due to the factors discussed above.\n1993 Compared to 1992\nRevenues of the Venture increased $5,564,003, or approximately 7 percent, from $83,567,527 in 1992 to $89,131,530 in 1993. Between December 31, 1992 and 1993, the Venture added 7,498 basic subscribers, an increase of approximately 4 percent. This increase in basic subscribers accounted for approximately 32 percent of the increase in revenues. Basic service rate adjustments were responsible for approximately 38 percent of the increase in revenues. Increases in advertising sales revenue accounted for approximately 12 percent of the increase in revenues. Increases in pay-per-view revenue accounted for approximately 14 percent of the increase. The increase in revenues would have been greater but for the reduction in basic rates due to the basic rate regulations issued by the FCC in May 1993 with which the Venture complied effective September 1, 1993. No other single factor significantly affected the increase in revenues.\nOperating, general and administrative expenses in the Venture's systems increased $3,941,804, or approximately 8 percent, from $48,132,180 in 1992 to $52,073,984 in 1993. Operating, general and administrative expense represented 58 percent of revenue in 1993 and in 1992. The increase in operating, general and administrative expense was due to increases in subscriber related costs, programming fees and marketing related costs. No other single factor significantly affected the increase in operating, general and administrative expenses. Management fees and allocated overhead from Jones Intercable, Inc. increased $746,870, or approximately 8 percent, from $9,758,490 in 1992 to $10,505,360 in 1993 due to the increase in revenues, upon which such fees and allocations are based, and an increase in allocated expenses from Jones Intercable, Inc. Depreciation and amortization expense decreased $1,113,583, or approximately 4 percent, from $26,764,820 in 1992 to $25,651,237 in 1993. The decrease was due to the maturation of the Venture's asset base.\nThe Venture recorded operating income of $900,949 for 1993 compared to an operating loss of $1,087,963 for 1992. This change is the result of increases in revenue and the decreases in depreciation and amortization expenses exceeding the increases in operating, general and administrative expenses and management fees and allocated overhead from Jones Intercable, Inc. Operating income before depreciation and amortization increased $875,329, or approximately 3 percent, from $25,676,857 in 1992 to $26,552,186 in 1993. This increase was due to the increase in revenues exceeding the increase in operating, general and administrative expenses and administrative fees and allocated overhead from Jones Intercable, Inc.\nInterest expense decreased $33,744, or less than 1 percent, from $12,022,874 in 1992 to $11,989,130 in 1993 due to lower interest rates on interest bearing obligations, which were offset, in part, by higher balances on such obligations. The 1992 expense primarily represented the Sunbelt litigation settlement. The settlement was accrued by the Venture in 1992 and paid by the Venture in March 1993.\nNet loss decreased $3,299,949, or approximately 22 percent, from $14,884,365 in 1992 to $11,584,416 in 1993 due to the factors discussed above. These losses are expected to continue in the future.\nFinancial Condition\nCapital expenditures for the Venture totaled approximately $21,000,000 during 1994. Service drops to homes accounted for approximately 30 percent of the capital expenditures. New plant construction accounted for approximately 19 percent of the capital expenditures. Approximately 7 percent of capital expenditures was for converters. The upgrade of the Venture's Albuquerque, New Mexico system accounted for approximately 5 percent of capital expenditures. The remaining expenditures related to various system enhancements. These capital expenditures were funded primarily from cash generated from operations and borrowings under the Venture's credit facility. Expected capital expenditures for 1995 are approximately $20,000,000. Service drops to homes are anticipated to account for approximately 32 percent. Approximately 23 percent of budgeted capital expenditures is for new plant construction. The remainder of the expenditures are for various system enhancements in all of the Venture's systems. Funding for these expenditures is expected to be provided by cash on hand, cash generated from operations and borrowings from the Venture's credit facility. The Venture has sufficient sources of capital available in its ability to generate cash from operations and to borrow under its credit facility to meet its presently anticipated needs.\nThe Venture's debt arrangements consist of $93,000,000 of Senior Notes placed with a group of institutional lenders and a revolving credit agreement with a group of commercial bank lenders.\nThe Senior Notes have a fixed interest rate of 8.64 percent and a final maturity date of March 31, 2000. The Senior Notes call for interest only payments for the first four years, with interest and accelerating amortization of principal payments for the next four years. Interest is payable semi-annually. The Senior Notes carry a \"make-whole\" premium, which is a prepayment penalty, if the notes are prepaid prior to maturity. The make-whole premium protects the lenders in the event that prepaid funds are reinvested at a rate below 8.64 percent, and is calculated per the note agreement.\nThe revolving credit period on the Venture's $90,000,000 credit facility expired on March 31, 1994. The then-outstanding balance of $84,300,000 converted to a term loan payable in quarterly installments which began June 30, 1994. The Venture repaid $758,700 of this loan in the second quarter. In September 1994, however, the General Partner completed negotiations to extend the revolving credit period and revised the commitment to $87,000,000. The balance outstanding at December 31, 1994 was $86,541,300. Under the new terms of this credit facility, the loan will convert to a term loan on March 31, 1996 with quarterly installments beginning June 30, 1996 and a final payment due March 31, 2000. Interest is at the Venture's option of LIBOR plus 1.25 percent to 1.75 percent, the CD rate plus 1.375 percent to 1.875 percent or the Base Rate plus 0 percent to .50 percent. The effective interest rates on amounts outstanding on the Venture's term credit facility as of December 31, 1994 and 1993 were 7.26 percent and 5.08 percent, respectively.\nBoth lending facilities are equal in standing with the other, and both are equally secured by the assets of the Venture.\nRegulation and Legislation\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation in the cable television industry. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The Venture has filed cost-of-service showings for its systems and thus anticipates no further reductions in rates. The cost-of-service showings have not yet received final approval from franchising authorities, however, and there can be no assurance that the Partnership's cost-of-service showing will prevent further rate reductions until such final approval is received. See Item 1 for further discussion of the provisions of the 1992 Cable Act and the FCC regulations promulgated thereunder.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements\nCABLE TV FUND 12-D\nFINANCIAL STATEMENTS\nAS OF DECEMBER 31, 1994 AND 1993\nINDEX\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Cable TV Fund 12-D:\nWe have audited the accompanying consolidated balance sheets of CABLE TV FUND 12-D (a Colorado limited partnership) and subsidiary as of December 31, 1994 and 1993, and the related consolidated statements of operations, partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the General Partner'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 Cable TV Fund 12-D and subsidiary as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\n\/s\/ ARTHUR ANDERSEN LLP ARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1995.\nCABLE TV FUND 12-D (A Limited Partnership)\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.\nCABLE TV FUND 12-D (A Limited Partnership)\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated balance sheets.\nCABLE TV FUND 12-D (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nCABLE TV FUND 12-D (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nCABLE TV FUND 12-D (A Limited Partnership)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes to consolidated financial statements are an integral part of these consolidated statements.\nCABLE TV FUND 12-D (A Limited Partnership)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nCable TV Fund 12-D (\"Fund 12-D\"), a Colorado limited partnership, was formed on February 5, 1986, under a public program sponsored by Jones Intercable, Inc. Fund 12-D was formed to acquire, construct, develop and operate cable television systems. Jones Intercable, Inc., is the \"General Partner\" and manager of Fund 12-D. The General Partner and its subsidiaries also own and operate cable television systems. In addition, the General Partner manages cable television systems for other limited partnerships for which it is general partner and, also, for affiliated entities.\nContributed Capital\nThe capitalization of Fund 12-D is set forth in the accompanying consolidated statements of partners' capital (deficit). No limited partner is obligated to make any additional contributions to partnership capital. The General Partner purchased its interest in Fund 12-D by contributing $1,000 to partnership capital.\nAll profits and losses of Fund 12-D are allocated 99 percent to the limited partners and 1 percent to the General Partner, except for income or gain from the sale or disposition of cable television properties, which will be allocated to the partners based upon the formula set forth in the Partnership Agreement, and interest income earned prior to the first acquisition by Fund 12-D of a cable television system, which was allocated 100 percent to the limited partners.\nFormation of Joint Venture and Venture Acquisitions and Sales\nOn March 17, 1986, Funds 12-B, 12-C and 12-D formed Cable TV Fund 12-BCD Venture (the \"Venture\"). The Venture was formed for the purpose of acquiring certain cable television systems. The Venture owns and operates the cable television systems serving certain areas in and around Albuquerque, New Mexico; Palmdale, California; and Tampa, Florida.\nOn September 20, 1991, the Venture entered into a purchase and sale agreement with an unaffiliated party to sell the cable television system serving the area in and around California City, California for $2,620,000. Closing on this transaction occurred on April 1, 1992. The proceeds were used to repay a portion of the amounts outstanding under the Venture's credit facility.\nThe Venture's acquisitions were accounted for as purchases with the individual purchase prices allocated to tangible and intangible assets based upon an independent appraisal. The method of allocation of purchase price was as follows: first, to the fair value of the net tangible assets acquired; second, to the value of subscriber lists; third, to franchise costs; and fourth, to cost in excess of interests in net assets purchased. Brokerage fees paid to an affiliate of the General Partner and other system acquisition costs were capitalized and included in the cost of intangible assets.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying consolidated financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. Fund 12-D's tax returns are also prepared on the accrual basis.\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include 100 percent of the accounts of Fund 12-D and those of the Venture reduced by the approximate 24 percent minority interest in the Venture. All inter-partnership accounts and transactions have been eliminated.\nProperty, Plant and Equipment\nDepreciation is provided using the straight-line method over the following estimated service lives:\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nIntangible Assets\nCosts assigned to franchises and cost in excess of interests in net assets purchased are amortized using the straight-line method over the following remaining estimated useful lives:\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\nCash and Cash Equivalents\nFor purposes of the Statements of Cash Flows, the Venture considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nReclassifications\nCertain prior year amounts have been reclassified to conform with the 1994 presentation.\n(3) TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES\nBrokerage Fees\nThe Jones Group, Ltd., an affiliate of the General Partner, performs brokerage services for the Venture in connection with Venture acquisitions and sales. For brokering two acquisitions in the Tampa system for the Venture, The Jones Group, Ltd. was paid fees totaling $13,120, or 4 percent of the transaction prices, during 1992. Additionally, The Jones Group, Ltd. received $65,500, or 2.5 percent of the transaction price, during 1992 for brokering a sale in the Palmdale system. There were no brokerage fees paid during the years ended December 31, 1994 and 1993.\nManagement Fees, Distribution Ratios and Reimbursements\nThe General Partner manages Fund 12-D and the Venture and receives a fee for its services equal to 5 percent of the gross revenues of the Venture, excluding revenues from the sale of cable television systems or franchises. Management fees paid to the General Partner by the Venture were $4,641,154, $4,456,577 and $4,178,376 during 1994, 1993 and 1992, respectively.\nAny partnership distributions made from cash flow (defined as cash receipts derived from routine operations, less debt principal and interest payments and cash expenses) are allocated 99 percent to the limited partners and 1 percent to the General Partner. Any distributions other than interest income on limited partnership subscriptions earned prior to the acquisition of Fund 12-D's first cable television system or from cash flow, such as from the sale or refinancing of a system or upon dissolution of the partnership, will be made as follows: first, to the limited partners in an amount which, together with all prior distributions, will equal the amount initially contributed by the limited partners; the balance, 75 percent to the limited partners and 25 percent to the General Partner.\nThe Venture reimburses the General Partner for certain allocated overhead and administrative expenses. These expenses represent the salaries and related benefits paid to corporate personnel, rent, data processing services and other corporate facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to the Venture. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner with respect to each entity managed. Remaining overhead costs are allocated based on total revenues and\/or assets managed for the partnership. Effective December 1, 1993, the allocation method was changed to be based only on revenue, which the General Partner believes provides a more accurate method of allocation. Systems owned by the General Partner and all other systems owned by partnerships for which Jones Intercable, Inc. is the general partner are also allocated a proportionate share of these expenses. The General Partner believes that the methodology used in allocating overhead and administrative expenses is reasonable. Overhead and administrative expenses allocated to the Venture by the General Partner were $6,951,110, $6,048,783 and $5,580,114 in 1994, 1993 and 1992, respectively.\nThe Venture was charged interest during 1994 at an average interest rate of 10 percent on the amounts due the General Partner, which approximated the General Partner's weighted average cost of borrowing. Total interest charged the Venture by the General Partner was $33,627, $15,477 and $126,073 in 1994, 1993 and 1992, respectively.\nPayments to\/from Affiliates for Programming Services\nThe Venture receives programming from Superaudio, The Mind Extension University and Jones Computer Network, affiliates of the General Partner. Payments to Superaudio totaled $135,346, $134,179 and $132,091 in 1994, 1993 and 1992, respectively. Payments to The Mind Extension University totaled $124,043, $79,002 and $76,676, in 1994, 1993 and 1992, respectively. Payments to Jones Computer Network, which initiated service in 1994, totaled $71,961.\nThe Venture receives a commission from Product Information Network, an affiliate of Intercable, based on a percentage of advertising sales and number of subscribers. Product Information Network, which initiated service in 1994, paid commissions to the Venture totalling $81,592.\n(4) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment as of December 31, 1994 and 1993, consisted of the following:\n(5) DEBT\nDebt consists of the following:\nThe Venture's debt arrangements consist of $93,000,000 of Senior Notes placed with a group of institutional lenders and a revolving credit agreement with a group of commercial bank lenders.\nThe Senior Notes have a fixed interest rate of 8.64 percent and a final maturity date of March 31, 2000. The Senior Notes call for interest only payments for the first four years, with interest and accelerating amortization of principal payments for the next four years. Interest is payable semi-annually. The Senior Notes carry a \"make-whole\" premium, which is a prepayment penalty, if the notes are prepaid prior to maturity. The make-whole premium protects the lenders in the event that prepaid funds are reinvested at a rate below 8.64 percent, and is calculated per the note agreement.\nThe revolving credit period on the Venture's $90,000,000 credit facility expired on March 31, 1994. The then-outstanding balance of $84,300,000 converted to a term loan payable in quarterly installments which began June 30, 1994. The Venture repaid $758,700 of this loan in the second quarter. In September 1994, however, the General Partner completed negotiations to extend the revolving credit period and revised the commitment to $87,000,000. The balance outstanding at December 31, 1994 was $86,541,300. Under the new terms of this credit facility, the loan will convert to a term loan on March 31, 1996 with quarterly installments beginning June 30, 1996 and a final payment due March 31, 2000. Interest is at the Venture's option of LIBOR plus 1.25 percent to 1.75 percent, the CD rate plus 1.375 percent to 1.875 percent or the Base Rate plus 0 percent to .50 percent. The effective interest rates on amounts outstanding on the Venture's term credit facility as of December 31, 1994 and 1993 were 7.26 percent and 5.08 percent, respectively.\nBoth lending facilities are equal in standing with the other, and both are equally secured by the assets of the Venture.\nDuring 1992 and 1994, the Venture incurred costs associated with renegotiating its debt arrangements. These fees were capitalized and are being amortized using the straight-line method over the life of the debt agreements.\nDuring 1988, the Venture entered into an interest rate cap agreement covering outstanding debt obligations of an additional $25,000,000. The Venture paid a fee of $957,500. The agreement protects the Venture from interest rates that exceed 10 percent for five years from the date of the agreement. The fee was charged to interest expense over the life of this agreement using the straight-line method.\nInstallments due on debt principal for each of the five years in the period ending December 31, 1999 and thereafter, respectively, are: $258,434, $14,247,151, $18,716,325, $25,176,742, $31,723,304 and $90,280,792, respectively.\n(6) INCOME TAXES\nIncome taxes have not been recorded in the accompanying consolidated financial statements because they accrue directly to the partners. The Federal and state income tax returns of Fund 12-D are prepared and filed by the General Partner.\nFund 12-D's tax returns, the qualification of the partnership as such for tax purposes, and the amount of distributable income or loss are subject to examination by Federal and state taxing authorities. If such examinations result in changes with respect to the Fund 12-D's qualification as such, or in changes with respect to the Fund 12-D's recorded income or loss, the tax liability of the general and limited partners would likely be changed accordingly.\nTaxable losses reported to the partners is different from that reported in the consolidated statements of operations due to the difference in depreciation allowed under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable income or losses and the losses reported in the consolidated statements of operations.\n(7) COMMITMENTS AND CONTINGENCIES\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation in the cable television industry. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The Venture has filed cost-of-service showings in its systems and anticipates no further reductions in rates. The cost-of-service showings have not received final approval from franchising authorities.\nOffice and other facilities are rented under various long-term lease arrangements. Rent paid under such lease arrangements totaled $345,531, $454,229 and $450,295, respectively, for the years ended December 31, 1994, 1993 and 1992. Minimum commitments under operating leases for the five years in the period ending December 31, 1999 and thereafter are as follows:\n(8) SUPPLEMENTARY PROFIT AND LOSS INFORMATION\nSupplementary profit and loss information is presented below:\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 Partnership itself has no officers or directors. Certain information concerning the directors and executive officers of the General Partner is set forth below.\nMr. Glenn R. Jones has served as Chairman of the Board of Directors and Chief Executive Officer of the General Partner since its formation in 1970, and he was President from June 1984 until April 1988. Mr. Jones was elected a member of the Executive Committee of the Board of Directors in April 1985. Mr. Jones is the sole shareholder, President and Chairman of the Board of Directors of Jones International, Ltd. He is also Chairman of the Board of Directors of the subsidiaries of the General Partner and of certain other affiliates of the General Partner. Mr. Jones has been involved in the cable television business in various capacities since 1961, is a past and present member of the Board of Directors of the National Cable Television Association, and is a former member of its Executive Committee. Mr. Jones is a past director and member of the Executive Committee of C-Span. Mr. Jones has been the recipient of several awards including the Grand Tam Award in 1989, the highest award from the Cable Television Administration and Marketing Society; the Chairman's Award from the Investment Partnership Association, which is an association of sponsors of public syndications; the cable television industry's Public Affairs Association President's Award in 1990, the Donald G. McGannon award for the advancement of minorities and women in cable; the STAR Award from American Women in Radio and Television, Inc. for exhibition of a commitment to the issues and concerns of women in television and radio; and the Women in Cable Accolade in 1990 in recognition of support of this organization. Mr. Jones is also a founding member of the James Madison Council of the Library of Congress and is on the Board of Governors of the American Society of Training and Development.\nMr. Derek H. Burney was appointed a Director of the General Partner in December 1994 and Vice Chairman of the Board of Directors in January 1995. He is also a member of the Executive Committee of the Board of Directors. Mr. Burney joined BCE Inc., Canada's largest telecommunications company, in January 1993 as Executive Vice President, International. He has been the Chairman of Bell Canada International Inc., a\nsubsidiary of BCE, since January 1993 and, in addition, has been Chief Executive Officer of BCI since July 1993. Prior to joining BCE, Mr. Burney served as Canada's ambassador to the United States from 1989 to 1992. Mr. Burney also served as chief of staff to the Prime Minister of Canada from March 1987 to January 1989 where he was directly involved with the negotiation of the U.S. - Canada Free Trade Agreement. In July 1993, he was named an Officer of the Order of Canada. Mr. Burney is chairman of Bell Cablemedia plc. He is a director of Mercury Communications Limited, Videotron Holdings plc, Tele-Direct (Publications) Inc., Teleglobe Inc., Bimcor Inc., Maritime Telegraph and Telephone Company, Limited, Moore Corporation Limited and Northbridge Programming Inc.\nMr. James B. O'Brien, the General Partner's President, joined the General Partner in January 1982. Prior to being elected President and a Director of the General Partner in December 1989, Mr. O'Brien served as a Division Manager, Director of Operations Planning\/Assistant to the CEO, Fund Vice President and Group Vice President\/Operations. Mr. O'Brien was appointed to the General Partner's Executive Committee in August 1993. As President, he is responsible for the day-to-day operations of the cable television systems managed and owned by the General Partner. Mr. O'Brien is also President and a Director of Jones Cable Group, Ltd., Jones Global Funds, Inc. and Jones Global Management, Inc., all affiliates of the General Partner. Mr. O'Brien is a board member of Cable Labs, Inc., the research arm of the U.S. cable television industry. He also serves as a director of the Cable Television Administration and Marketing Association and as a director of the Walter Kaitz Foundation, a foundation that places people of any ethnic minority group in positions with cable television systems, networks and vendor companies.\nMs. Ruth E. Warren joined the General Partner in August 1980 and has served in various operational capacities, including system manager and Fund Vice President, since then. Ms. Warren was elected Group Vice President\/Operations of the General Partner in September 1990.\nMr. Kevin P. Coyle joined The Jones Group, Ltd. in July 1981 as Vice President\/Financial Services. In September 1985, he was appointed Senior Vice President\/Financial Services. He was elected Treasurer of the General Partner in August 1987, Vice President\/Treasurer in April 1988 and Group Vice President\/Finance and Chief Financial Officer in October 1990.\nMr. Christopher J. Bowick joined the General Partner in September 1991 as Group Vice President\/Technology and Chief Technical Officer. Previous to joining the General Partner, Mr. Bowick worked for Scientific Atlanta's Transmission Systems Business Division in various technical management capacities since 1981, and as Vice President of Engineering since 1989.\nMr. Timothy J. Burke joined the General Partner in August 1982 as corporate tax manager, was elected Vice President\/Taxation in November 1986 and Group Vice President\/Taxation\/Administration in October 1990.\nMr. Raymond L. Vigil joined the General Partner in June 1993 as Group Vice President\/Human Resources. Previous to joining the General Partner, Mr. Vigil served as Executive Director of Learning with USWest. Prior to USWest, Mr. Vigil worked in various human resources posts over a 14-year term with the IBM Corporation.\nMs. Cynthia A. Winning joined the General Partner as Group Vice President\/Marketing in December 1994. Previous to joining the General Partner, Ms. Winning served since 1994 as the President of PRS Inc., Denver, Colorado, a sports and event marketing company. From 1979 to 1981 and from 1986 to 1994, Ms. Winning served as the Vice President and Director of Marketing for Citicorp Retail Services, Inc., a provider of private-label credit cards for ten national retail department store chains. From 1981 to 1986, Ms. Winning was the Director of Marketing Services for Daniels & Associates cable television operations, as well as the Western Division Marketing Director for Capital Cities Cable. Ms. Winning also serves as a board Member of Cities in Schools, a dropout intervention\/prevention program.\nMs. Elizabeth M. Steele joined the General Partner in August 1987 as Vice President\/General Counsel and Secretary. From August 1980 until joining the General Partner, Ms. Steele was an associate and then a partner at the Denver law firm of Davis, Graham & Stubbs, which serves as counsel to the General Partner.\nMr. Larry Kaschinske joined the General Partner in 1984 as a staff accountant in the General Partner's former Wisconsin Division; was promoted to Assistant Controller in 1990 and named Controller in August 1994.\nMr. James J. Krejci is currently President of the International Division of International Gaming Technology International headquartered in Reno, Nevada. Prior to joining IGT in May 1994, Mr. Krejci was Group Vice President of Jones International, Ltd. and a Group Vice President of the General Partner. Prior to May 1994, he also served as Group Vice President of Jones Futurex, Inc., an affiliate of the General Partner engaged in manufacturing and marketing data encryption devices, Jones Interactive, Inc., a subsidiary of Jones International, Ltd. providing computer data and billing processing facilities and Jones Lightwave, Ltd., a company owned by Jones International, Ltd. and Mr. Jones, which is engaged in the provision of telecommunications services. Mr. Krejci has been a Director of the General Partner since August 1987.\nMs. Christine Jones Marocco was appointed a Director of the General Partner in December 1994. She is the daughter of Glenn R. Jones. Ms. Marocco is also a director of Jones International, Ltd.\nMr. Daniel E. Somers was appointed a Director of the General Partner in December 1994 and also serves on the General Partner's Audit Committee. From January 1992 to January 1995, Mr. Somers worked as Senior Vice President and Chief Financial Officer of Bell Canada International Inc. and was appointed Executive Vice President and Chief Financial Officer on February 1, 1995. He is also a Director of certain of its affiliates. Prior to joining Bell Canada International Inc. and since January 1989, Mr. Somers was the President and Chief Executive Officer of Radio Atlantic Holdings Limited. Mr. Somers is a member of the North American Society of Corporate Planning, the Financial Executives Institution and the Financial Analysts Federation.\nMr. Robert S. Zinn was appointed a Director of the General Partner in December 1994. Mr. Zinn joined the General Partner in January 1991 and is a member of its Legal Department. He is also Vice President\/Legal Affairs of Jones International, Ltd. Prior to joining the General Partner, Mr. Zinn was in private law practice in Denver, Colorado for over 25 years.\nMr. David K. Zonker was appointed a Director of the General Partner in December 1994. Mr. Zonker has been the President of Jones International Securities, Ltd., a subsidiary of Jones International, Ltd. since January 1984 and he has been its Chief Executive Officer since January 1988. From October 1980 until joining Jones International Securities, Ltd. in January 1984, Mr. Zonker was employed by the General Partner. Mr. Zonker is a member of the Board of Directors of various affiliates of the General Partner, including Jones International Securities, Ltd. Mr. Zonker is licensed by the National Association of Securities Dealers, Inc. and he is a past chairman of the Investment Program Association, a trade organization based in Washington, D.C. that promotes direct investments. He is a member of the Board of Trustees of Graceland College, Lamoni, Iowa; the International Association of Financial Planners and the American and Colorado Institutes of Certified Public Accountants.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no employees; however, various personnel are required to operate the cable television systems owned by the Partnership. Such personnel are employed by the General Partner and, pursuant to the terms of the limited partnership agreement of the Partnership, the cost of such employment is charged by the General Partner to the Partnership as a direct reimbursement item. See Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGERS\nNo person or entity owns more than 5 percent of the limited partnership interests of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe General Partner and its affiliates engage in certain transactions with the Partnership as contemplated by the limited partnership agreement of the Partnership. The General Partner believes that the terms of such transactions are generally as favorable as could be obtained by the Partnership from unaffiliated parties. This determination has been made by the General Partner in good faith, but none of the terms were or will be negotiated at arm's-length and there can be no assurance that the terms of such transactions have been or will be as favorable as those that could have been obtained by the Partnership from unaffiliated parties.\nThe General Partner charges the Partnership a management fee, and the Partnership reimburses the General Partner for certain allocated overhead and administrative expenses in accordance with the terms of the limited partnership agreement of the Partnership. These expenses consist primarily of salaries and benefits paid to corporate personnel, rent, data processing services and other facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to the Partnership. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner with respect to the partnership managed. Remaining overhead costs are allocated based on revenues and\/or the costs of assets managed for the Partnership. Systems owned by the General Partner and all other systems owned by partnerships for which Jones Intercable, Inc. is the general partner, are also allocated a proportionate share of these expenses.\nThe General Partner also advances funds and charges interest on the balance payable from the Partnership. The interest rate charged the Partnership approximates the General Partner's weighted average cost of borrowing.\nFrom time to time, The Jones Group, Ltd., an affiliate of the General Partner, performs brokerage services for the Venture in connection with Venture acquisitions and sales from or to unaffiliated entities.\nThe Systems receive stereo audio programming from Superaudio, a joint venture owned 50% by an affiliate of the General Partner and 50% by an unaffiliated party, educational video programming from Mind Extension University, Inc., an affiliate of the General Partner, and computer video programming from Jones Computer Network, Ltd., an affiliate of the General Partner, for fees based upon the number of subscribers receiving the programming.\nProduct Information Network (\"PIN\"), an affiliate of the General Partner, provides advertising time for third parties on the Systems. In consideration, the revenues generated from the third parties are shared two-thirds and one-third between PIN and the Venture. During the year ended December 31, 1994, the Venture received revenues from PIN of $81,592.\nThe activities of Fund 12-C and Fund 12-D are limited to their equity ownership in the Venture. See the following related party disclosure for the Venture. The charges to the Venture for related party transactions are as follows for the periods indicated:\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-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.\nCABLE TV FUND 12-C, LTD., a Colorado limited partnership By: Jones Intercable, Inc.\nBy: \/s\/ Glenn R. Jones --------------------------- Glenn R. Jones Chairman of the Board and Chief Executive Officer Dated: March 13, 1995\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: \/s\/ Glenn R. Jones --------------------------- Glenn R. Jones Chairman of the Board and Chief Executive Officer Dated: March 13, 1995 (Principal Executive Officer)\nBy: \/s\/ Kevin P. Coyle --------------------------- Kevin P. Coyle Group Vice President\/Finance Dated: March 13, 1995 (Principal Financial Officer)\nBy: \/s\/ Larry Kaschinske --------------------------- Larry Kaschinske Controller Dated: March 13, 1995 (Principal Accounting Officer)\nBy: \/s\/ James B. O'Brien --------------------------- James B. O'Brien Dated: March 13, 1995 President and Director\nBy: \/s\/ Raymond L. Vigil --------------------------- Raymond L. Vigil Dated: March 13, 1995 Group Vice President and Director\nBy: \/s\/ Robert S. Zinn --------------------------- Robert S. Zinn Dated: March 13, 1995 Director\nBy: \/s\/ David K. Zonker ----------------------- David K. Zonker Dated: March 13, 1995 Director\nBy: ----------------------- Derek H. Burney Dated: Director\nBy: ----------------------- James J. Krejci Dated: Director\nBy: ----------------------- Christine Jones Marocco Dated: Director\nBy: ----------------------- Daniel E. Somers Dated: Director\nINDEX TO EXHIBITS","section_15":""}
{"filename":"45919_1994.txt","cik":"45919","year":"1994","section_1":"ITEM 1. BUSINESS and ITEM 2.","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company from time to time becomes involved in various claims and lawsuits incidental to its businesses, including defamation actions. In the opinion of management, after consultation with counsel, any ultimate liability arising out of currently pending claims and lawsuits will not have a material effect on the financial condition or operations of the Company.\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.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nIncorporated herein by reference from the Company's Annual Report to Stockholders for the year ended December 31, 1994 at page 32.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated herein by reference from the Company's Annual Report to Stockholders for the year ended December 31, 1994 at page 30.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated herein by reference from the Company's Annual Report to Stockholders for the year ended December 31, 1994 at pages 14 through 18.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following information is set forth in the Company's Annual Report to Stockholders for the year ended December 31, 1994, which is incorporated herein by reference: All Consolidated Financial Statements (pages 19 through 22); all Notes to Consolidated Financial Statements (pages 23 through 29); and the \"Independent Auditors' Report\" (page 31). With the exception of the information herein expressly incorporated by reference, the Company's Annual Report to Stockholders for the year ended December 31, 1994 is not deemed filed as part 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.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. MANAGEMENT\nIncorporated herein by reference from the information in the Company's definitive proxy statement dated March 30, 1995 for the May 19, 1995 Annual Meeting of Stockholders under the caption \"Management -- Directors and Executive Officers\" on pages 4 and 5.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference from the information in the Company's definitive proxy statement dated March 30, 1995 for the May 19, 1995 Annual Meeting of Stockholders under the caption \"Executive Compensation and Other Information\" on pages 5 through 7.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated herein by reference from the information in the Company's definitive proxy statement dated March 30, 1995 for the May 19, 1995 Annual Meeting of Stockholders under the caption \"Security Ownership of Management and Principal Stockholders\" on pages 2 and 3.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNone.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) The following consolidated financial statements are incorporated by reference from the Company's Annual Report to Stockholders for the year ended December 31, 1994 attached hereto:\nConsolidated Balance Sheets, December 31, 1994 and 1993\nConsolidated Statements of Operations, Years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows, Years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Stockholders' Equity, Years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nIndependent Auditors' Report\n(a)(2) The following accountants' report and financial schedule for years ending December 31, 1994, 1993 and 1992 are submitted herewith:\nIndependent Auditors' Report 10-K Schedule\nSchedule VIII - Valuation and Qualifying Accounts\nAll other schedules are omitted as the required information is inapplicable.\n(a)(3) Exhibits\n(a)(3) Exhibits (continued).\n(a)(3) Exhibits (continued).\n____________________ *Filed herewith.\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed during the fourth quarter of 1994.\n(c) Exhibits -- The response to this portion of Item 14 is submitted as separate section of this report on pages 27 to 49.\n(d) Financial Statement Schedule -- The response to this portion of Item 14 is submitted as a separate section of this report on page 26.\nThe agreements set forth above describe the contents of certain exhibits thereunto which are not included. However, such exhibits will be furnished to the Commission upon request.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Harte-Hanks Communications, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHARTE-HANKS COMMUNICATIONS, INC.\nBy: \/s\/ Larry D. Franklin --------------------------------- Larry D. Franklin President & Chief Executive Officer\nBy: \/s\/ Richard L. Ritchie --------------------------------- Richard L. Ritchie Senior Vice President, Finance & Chief Financial and Accounting Officer\nDate: March 29, 1995\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 indicated.\n\/s\/ Houston H. Harte \/s\/ Dr. Peter T. Flawn -------------------------------- ------------------------------- Houston H. Harte, Chairman Dr. Peter T. Flawn, Director\n\/s\/ Larry D. Franklin \/s\/ Christopher M. Harte ------------------------------- ------------------------------- Larry D. Franklin, Director Christopher M. Harte, Director\n\/s\/ Edward H. Harte \/s\/ James L. Johnson --------------------------------- ------------------------------- Edward H. Harte, Director James L. Johnson, Director\n\/s\/ Andrew B. Shelton --------------------------------- Andrew B. Shelton, Director\nINDEPENDENT AUDITORS' REPORT 10-K SCHEDULES\nThe Board of Directors and Stockholders Harte-Hanks Communications, Inc.:\nUnder date of January 25, 1995, we reported on the consolidated balance sheets of Harte-Hanks Communications, Inc. and subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of operations, cash flows and stockholders' equity for each of the years in the three-year period ended December 31, 1994, as contained in the 1994 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 1994. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in Item 14(a)(2). This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\nIn our opinion, such financial statement schedule, 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.\nKMPG PEAT MARWICK LLP\nSan Antonio, Texas January 25, 1995\nHarte-Hanks Communications, Inc. and Subsidiaries\nFinancial Statement Schedules\nSchedule VIII Valuation and Qualifying Accounts\n(in thousands)","section_15":""}
{"filename":"840251_1994.txt","cik":"840251","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nEAST LINE LITIGATION AND FERC PROCEEDING In August 1992, two East Line refiners, Navajo Refining Company (\"Navajo\") and El Paso Refinery, L.P. (\"El Paso\") filed separate, though similar, civil lawsuits against the Partnership arising from the Partnership's alleged failure to provide additional pipeline capacity to Phoenix and Tucson, Arizona from El Paso, Texas. The Navajo action also sought an injunction to prohibit the Partnership from reversing the direction of flow (from westbound to eastbound) of its six-inch diameter pipeline between Phoenix and Tucson. In addition, El Paso filed a protest\/complaint with the FERC in September 1992 seeking to block the reversal of the six-inch pipeline and challenging the Partnership's proration policy as well as the Partnership's existing East Line tariffs.\nFERC PROCEEDING - --------------- On September 29, 1992, the FERC's Oil Pipeline Board ordered an investigation into the issues raised in the El Paso filing and, on October 19, 1992, the FERC assigned an administrative law judge to the case. The FERC ruled in April 1993, and has subsequently confirmed on rehearing, that the challenges to proration, line reversal and East Line tariffs must proceed under a complaint proceeding. That ruling expressly places the burden of proof on the complaining parties, who must show that the Partnership's rates and practices there at issue violate the requirements of the Interstate Commerce Act.\nIn August 1993, Chevron U.S.A. Products Company (\"Chevron\") filed a complaint with the FERC challenging the Partnership's West Line tariffs and claiming that a service charge at the Partnership's Watson Station is in violation of the Interstate Commerce Act. In September 1993, the FERC ruled that the Partnership's West Line tariffs are deemed \"just and reasonable\" under the Energy Policy Act of 1992 (\"EPACT\") and may only be challenged on the basis of \"changed circumstances\" and consolidated the various outstanding matters into a single proceeding. Navajo, which, under a 1985 FERC rate case settlement, had been prohibited from challenging the Partnership's rates until November 1993, filed a complaint against certain East Line and West Line rates in December 1993. ARCO Products Company (\"ARCO\") and Texaco Refining and Marketing Inc. (\"Texaco\") filed their own complaint challenging certain West Line rates in January 1994. Refinery Holding Company, L.P., a partnership formed by El Paso's long-term, secured creditors that purchased El Paso's refinery in May 1993 is the only other major outside party to the FERC proceeding.\nOn April 20, 1994, the FERC ruled that, because of Navajo's complaint against certain West Line rates, certain other parties seeking to challenge West Line rates would not need to demonstrate \"changed circumstances\" in order to do so. However, the Partnership requested reconsideration of that portion of the ruling pertaining to parties other than Navajo and, on July 20, 1994, the FERC reversed a portion of the April 20, 1994 ruling, reaffirming that, other than with respect to Navajo, the Partnership's West Line rates are deemed just and reasonable under the provisions of EPACT. Accordingly, any shipper other than Navajo that wishes to challenge the Partnership's West Line rates will need to demonstrate \"changed circumstances.\" On September 16, 1994, the FERC denied certain other parties' request for a rehearing of the July 20, 1994 ruling. On December 12, 1994, ARCO, Texaco and Chevron filed testimony in which they sought to demonstrate the required \"changed circumstances\" in order to challenge the Partnership's West Line rates. ARCO and Texaco have also sought review by the United States Court of Appeals for the District of Columbia of the FERC's rulings on the \"grandfathering\" of the West Line rates under EPACT.\nAt the direction of the FERC Administrative Law Judge, on February 14, 1994, the Partnership submitted to the parties to the FERC proceeding a cost and revenue study for its South Line, detailing unadjusted rate base, operating expenses and revenues for the calendar year 1993.\nOn June 24, 1994, the complainants filed their cases-in-chief with the FERC, seeking refunds for shipments between 1990 and 1993 aggregating in the range of $15 million to $20 million, as well as tariff rate reductions of between 40% and 50% for future shipments. Three sets of joint testimony were filed, one by Chevron and Navajo, a second by El Paso and Refinery Holding Company, L.P., and a third by ARCO and Texaco. While each set of testimony was different in certain respects, the claims for relief are generally based on cost of service calculations developed from the detailed information included in the Partnership's cost and revenue study, but with the complainants applying different rate-making methodologies than the Partnership believes to be appropriate.\nOn August 17, 1994, the FERC Staff submitted its case-in-chief in the FERC proceeding, in which the FERC Staff also developed costs of service for the Partnership's East and West Lines based on adjusted 1993 operating costs, but did not present testimony concerning reparations or specific tariff rate reductions. On January 30, 1995 and March 6, 1995, the FERC Staff filed exhibits modifying its original presentation in certain respects. In a number of respects, the FERC Staff has employed rate-making methodologies that were generally similar to those presented by the complainants. In their testimony, both the FERC Staff and several complainants, among other things, argue against the Partnership's entitlement to an income tax allowance in its cost of service. The FERC Staff and several complainants utilize the Partnership's capital structure at the time of its formation in December 1988, or a hypothetical capital structure, for the purpose of establishing the Partnership's 1985 starting rate base under FERC Order 154-B. In addition, the FERC Staff and complainants generally excluded the majority of the Partnership's civil and regulatory litigation expense from their cost of service calculations. Each of these positions is detrimental to the Partnership's existing rate structure and, if adopted by the FERC in a final decision, would result in a substantial payment of reparations and reduction of existing rates.\nWhile recognizing that FERC rate-making methodology is subject to interpretation and leaves certain issues for determination on a case-by-case basis, Partnership management believes that certain of the positions taken by the complainants and the FERC Staff in their testimony are contrary to existing FERC precedent. For example, the entitlement of a pipeline partnership to include an allowance for income taxes in its cost of service has recently been ruled upon favorably by the FERC Administrative Law Judge in the Lakehead Pipe Line Company, Limited Partnership rate case; that ruling is presently on appeal before the FERC. The Partnership's rates being challenged in the FERC proceeding were established pursuant to FERC-approved settlements resolving a prior rate proceeding and have not been changed since 1991, when they were adjusted in accordance with those agreements. The Partnership continues to believe that its rates and practices are lawful under FERC precedent and will continue its vigorous defense of that position. However, because of the complexity of the issues involved and the nature of FERC rate-making methodology, it is possible that the rates at issue in the FERC proceeding will not ultimately be found just and reasonable. If the FERC were to deny the Partnership's entitlement to an allowance for income taxes in its cost of service, or otherwise reach adverse decisions on certain other key issues in the proceeding which result in significant reparations being paid and a significant reduction in the Partnership's current tariffs, such adverse outcome could have a material adverse effect on the Partnership's results of operations, financial condition and ability to maintain its current quarterly cash distribution.\nThe present procedural schedule calls for the Partnership to submit its case-in- chief in response to the shippers' and FERC Staff's testimony on April 4, 1995 and for hearings to commence before a FERC Administrative Law Judge in October 1995.\nEAST LINE CIVIL LITIGATION - -------------------------- The civil actions brought by Navajo and El Paso (\"El Paso Refining, Inc., and El Paso Refinery, L.P. v. Santa Fe Pacific Pipelines, Inc. and Santa Fe Pacific Pipeline Partners, L.P.\", No. 92-9144, County Court No. 5, El Paso County) were filed in New Mexico and Texas, respectively, seeking actual, punitive and consequential damages arising from the Partnership's alleged failure to provide additional pipeline capacity to Phoenix and Tucson from El Paso. The Navajo action also sought an injunction to prohibit the Partnership from reversing the direction of flow (from westbound to eastbound) of its six-inch diameter pipeline between Phoenix and Tucson, which was planned to occur, and did occur, during the third quarter of 1992 upon completion of the second phase of the East Line expansion. This six-inch pipeline had previously flowed from Phoenix to Tucson but was temporarily reversed, in August 1991, to accommodate East Line shipments to Phoenix during the Partnership's expansion of the eight-inch diameter pipeline that flows from Tucson to Phoenix. Generally, the lawsuits allege that the refiners proceeded with significant refinery expansions under the belief that the Partnership would provide whatever pipeline capacity was required to transport their product into Arizona, and that they were damaged by their inability to ship additional volumes into that highly competitive market. This belief of Navajo and El Paso was purportedly obtained from oral representations by General Partner personnel and from language contained in a January 1989 settlement agreement with Navajo, relating to a 1985 FERC rate case.\nOn July 28, 1993, the Partnership reached a settlement with Navajo whereby Navajo agreed to dismiss its pending civil litigation in New Mexico and withdraw any challenge to the direction of flow of the six-inch pipeline, including any such challenge in the FERC proceeding. The Partnership agreed to make certain cash payments to Navajo over three years and to undertake and complete an additional pipeline capacity expansion between El Paso and Phoenix if certain events related to volume levels and proration of pipeline capacity should occur within the next five years.\nEl Paso's August 1992 civil action, as amended, claims unspecified actual damages, which appear to include the $190 million cost of its refinery expansion, plus punitive and consequential damages. In October 1992, El Paso filed a petition for reorganization under Chapter 11 of the federal bankruptcy laws and halted refinery operations. In November 1993, the El Paso bankruptcy was converted from a Chapter 11 to a Chapter 7 proceeding, and an interim trustee was appointed. In February 1994, a permanent trustee and a new judge were named to handle these proceedings. During 1994, the bankruptcy trustee for El Paso retained legal counsel for purposes of pursuing this litigation. In addition, initial rounds of discovery were conducted by both parties in late- 1994 and early-1995. Should the action proceed to trial, it is anticipated that such trial would begin in early to mid-1996, however, to date, there have been no hearings before the court and there is no pre-trial schedule. The Partnership intends to vigorously defend itself in this action.\nENVIRONMENTAL MATTERS The Partnership is, from time to time, subject to environmental clean up and enforcement actions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\" or \"Superfund\" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site. Since August 1991, the Partnership, along with several other respondents, has been involved in one cleanup ordered by the United States Environmental\nProtection Agency (\"EPA\") related to ground water contamination in the vicinity of the Partnership's storage facilities and truck loading terminal at Sparks, Nevada. In addition, the Partnership is also involved in six ground water hydrocarbon remediation efforts under administrative orders issued by the California Regional Water Quality Control Board at, or adjacent to, its facilities at Colton, Concord, Mission Valley, Brisbane, San Jose and West Sacramento, California.\nThe investigation and remediation at the Sparks terminal is also the subject of a lawsuit brought in January 1991 entitled \"Nevada Division of Environmental Protection v. Santa Fe Pacific Pipelines, Inc., Southern Pacific Transportation Company, Shell Oil Company, Time Oil Company, Berry-Hinckley Terminal, Inc., Chevron U.S.A., Inc., Texaco Refining and Marketing, Inc., Air BP, a division of BP Oil, Unocal Corporation, and Golden Gate Petroleum Company\", Case No. CV91- 546, in the Second Judicial District Court of the State of Nevada in and for the County of Washoe. This lawsuit was subsequently joined by the County of Washoe Health District and the City of Sparks, Nevada. The various parties seek remediation of the contamination at and adjacent to the Sparks terminal as well as unspecified, but potentially significant, damages and statutory penalties.\nIn addition, the Partnership was named as one of the defendants in a number of other lawsuits brought by property owners seeking unspecified, but potentially substantial, damages for alleged property value diminishment attributable to soil or groundwater contamination arising from the defendants' operations.\nIn October 1994, the Second Judicial District Court ruled that all of the outstanding cases against the respondent group, including the state, county, city and property owner cases, shall be consolidated for trial purposes. In February 1995, the Court established a procedural schedule which calls for the trial to commence in January 1996. The Partnership is vigorously defending itself in these actions, although it will continue to pursue settlement discussions to reduce the costs and uncertainties of extended litigation.\nWith respect to the Sparks remediation, in September 1992, the EPA approved the respondents' remediation plan and an estimate of remediation costs was made in accordance with that plan. As a result, the Partnership recorded a $10 million provision for environmental costs in the third quarter of 1992 which included the Partnership's estimated share of remediation costs at Sparks and at two other facilities. A contractor has been selected for the installation of the remediation system. In January 1995, system design, engineering and permitting activities began, and it is expected that the system will be operational by September 1995. A Joint Defense, Mediation and Arbitration Agreement Among Defendants has been reached by the ten participants, which establishes cost allocation percentages among the participants.\nAs previously reported, in 1993, the EPA issued a Notice of Violations to the Partnership associated with an oxygenate blending equipment malfunction at the Partnership's Phoenix terminal. During the fourth quarter of 1994, the Partnership agreed to pay the EPA a fine of $300,000 arising from this Notice of Violations.\nReference is made to Note 4 to the Partnership's consolidated financial statements, beginning on page of this Report, for additional discussion of these matters.\nOTHER The Partnership is also party to a number of other legal actions arising in the ordinary course of business. While the final outcome of these legal actions cannot be predicted with certainty, it is the opinion of management that none of these other legal actions, when finally resolved, will have a material adverse effect on the consolidated financial condition of the Partnership; nevertheless, it is possible that the Partnership's results of operations, in particular quarterly or annual periods, could be materially affected by the ultimate resolution of these matters.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Information as to the principal markets on which the Registrant's common units are traded, the high and low sales prices of such units and distributions declared on such units for the two years ended December 31, 1994, and the approximate number of record holders of such units is set forth in Note 8 to the Partnership's consolidated financial statements on page of this Report.\nPrior to December 31, 1993, holders of the 11,000,000 publicly traded units (at that time denominated as \"preference units\") were entitled to certain preferences with respect to cash distributions. With the Partnership having met certain financial criteria as of December 31, 1993, all limited partner interests have equivalent rights with respect to cash distributions and, during 1994, the 11,000,000 preference units were redenominated and registered as common units.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. The following table sets forth, for the periods and at the dates indicated, selected consolidated financial data for the Partnership:\n(a) 1993 operating expenses include a $27.0 million provision for environmental and litigation costs and 1992 operating expenses include a $10.0 million provision for environmental costs.\n(b) Effective January 1, 1992, the Partnership adopted new accounting standards for postretirement and postemployment benefits (Statements of Financial Accounting Standards Nos. 106 and 112).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\n1994 COMPARED WITH 1993 - ----------------------- The Partnership reported 1994 net income of $76.9 million, or $3.93 per unit, compared to net income of $41.6 million, or $2.13 per unit, in 1993. Results of operations included a $3.1 million credit in 1994 resulting from changes in eligibility requirements for postretirement medical benefits and, in 1993, provisions for environmental and litigation costs aggregating $27.0 million. Excluding the 1994 credit and the 1993 provisions, adjusted 1994 net income of $73.9 million, or $3.78 per unit, was 8.5% higher than adjusted net income of $68.1 million, or $3.48 per unit, in 1993.\nTotal 1994 revenues of $228.1 million were 4% above 1993 levels. Trunk revenues of $179.3 million were $7.5 million higher than in 1993 primarily due to 5% growth in total volumes transported. Commercial and military volumes were 5% and 9% higher, respectively, than in 1993, and the average length of haul was even. Despite the higher volumes, storage and terminaling revenues were even with 1993. Other revenues increased $1.1 million due to higher tank rentals and new terminal services.\nTotal operating expenses of $117.0 million were $24.1 million lower than in 1993, due largely to the 1993 provisions for environmental and litigation costs aggregating $27.0 million. Excluding the 1993 provisions, operating expenses would have been $2.9 million, or 2.5%, higher than in 1993, with higher power cost ($1.8 million), facilities cost ($1.7 million), depreciation and amortization ($0.8 million) and general and administrative expenses ($0.4 million), partially offset by lower field operating expenses ($1.8 million), accounting for that increase. The increase in power cost resulted from higher volumes, increased power rates and greater use of drag reducing agent to increase pipeline capacity on selected routes. Facilities costs increased as a result of higher right-of-way rentals and property taxes. General\nand administrative expense increased less than 2% as the net result of higher general legal expense and reduced overhead recoveries on recollectible projects for customers or governmental agencies, largely offset by lower East Line litigation, employee incentive compensation and information services costs. The decrease in field operating expenses is largely attributable to nonrecurring 1993 pipeline inspection costs associated with the potential conversion of one of the Partnership's pipelines to crude oil service and generally lower major maintenance expense. Excluding the 1993 provisions, environmental remediation and East Line litigation costs recorded as operating expense aggregated $3.8 million and $6.2 million in 1994 and 1993, respectively.\nOther income, net increased significantly in 1994 as the result of a $3.1 million gain resulting from changes in eligibility requirements for postretirement medical benefits and higher interest income in 1994.\n1993 COMPARED WITH 1992 - ----------------------- The Partnership reported 1993 net income of $41.6 million, or $2.13 per unit, compared to net income of $37.7 million, or $1.93 per unit, in 1992, with the variance due largely to the effects of environmental and litigation provisions and a 1992 accounting change. Excluding the effects of provisions for environmental and litigation costs aggregating $27 million in 1993 and a $10 million provision for environmental costs in 1992, 1993 net income would have been $68.1 million, or $3.48 per unit, compared to net income of $63.9 million, or $3.27 per unit, before the cumulative effect of an accounting change in 1992.\nTotal 1993 revenues of $219.5 million were 7% above prior year levels. Trunk revenues of $171.8 million were $10.7 million higher than in 1992 due to higher volumes, a longer average length of haul, a favorable shift of volumes from the East Line to the West Line and the full year effect in 1993 of a May 1992 California intrastate tariff increase. Total volumes transported increased 3% in 1993, with commercial volumes 3.6% higher, and military volumes approximately 10% lower, than in 1992. The longer average haul reflects increased deliveries to Arizona and Nevada, as well as increased deliveries to Tucson from Los Angeles as a result of reduced supply from El Paso refineries in 1993. The refinery formerly owned by El Paso Refinery, L.P., which had been out of service since that company entered bankruptcy in October 1992, began operating at a reduced level during the third quarter of 1993. Management expected that a portion of this refinery's production would continue to be shipped to Arizona, resulting in a shift of certain volumes from the West Line back to the East Line, which did occur in 1994. Storage and terminaling revenues were $3.2 million higher due to a January 1993 terminal services rate increase. Other revenues increased $0.5 million due to higher volumes.\nTotal 1993 operating expenses of $141.1 million included a $15.0 million provision to increase the Partnership's existing reserve for environmental remediation and investigation costs and a $12.0 million provision to reflect anticipated legal fees and other costs related to certain East Line civil litigation as well as a related Federal Energy Regulatory Commission (\"FERC\") proceeding. Total 1992 operating expenses of $113.7 million included a $10.0 million provision for environmental remediation costs. Excluding the environmental and litigation provisions, 1993 operating expenses of $114.1 million were $10.5 million, or 10%, higher than in 1992, with higher field operating expenses ($5.4 million), general and administrative expenses ($3.0 million), power cost ($0.8 million), facilities costs ($0.7 million) and depreciation and amortization ($0.6 million) accounting for that increase. The increase in field operating expenses is largely attributable to higher major maintenance costs due to preventative pipeline repairs associated with the Partnership's ongoing internal inspection program and flood damage repairs, partially offset by lower environmental remediation costs subsequent to recording the $15.0 million provision in September 1993. Also contributing to higher field operating expenses were $1.5 million in\npipeline inspection costs associated with the potential conversion of one of the Partnership's pipelines to crude oil service, greater usage of drag reducing agent to increase capacity on certain lines and higher salary costs. The increase in general and administrative expense is largely attributable to higher outside legal and consulting costs associated with the East Line civil litigation and FERC proceeding that were incurred prior to recording the $12.0 million litigation provision in September 1993. The increase in power cost reflects increased volumes and length of haul. The increase in facilities costs primarily resulted from higher right-of-way rentals and property taxes. This increase in property taxes and the increase in depreciation and amortization expense resulted from the Partnership's expanding capital asset and software base.\nFINANCIAL CONDITION - LIQUIDITY AND CAPITAL RESOURCES For the year ended December 31, 1994, cash flow from operations before working capital and minority interest adjustments totaled $92.1 million, compared to $82.8 million in 1993. Working capital cash requirements increased $3.7 million in 1994 due to timing differences in collection of accounts receivable and payment of accrued obligations. Significant uses of cash in 1994 included cash distributions of $55.9 million and capital expenditures of $17.9 million, resulting in a net increase in cash and cash equivalents of $16.8 million for the year. Total cash and cash equivalents of $48.9 million at December 31, 1994 included $14.0 million for the fourth quarter 1994 cash distribution, which was paid in February 1995.\nSince the useful lives of the pipeline system and terminal properties are generally long and technological change is limited, replacement of facilities is relatively infrequent. The principal need for capital, therefore, has been in connection with capacity expansions, service enhancements, compliance with increasingly stringent environmental and safety regulations and installation of Supervisory Control and Data Acquisition (\"SCADA\") equipment and related operations systems software.\nFor the year ended December 31, 1994, Partnership capital expenditures aggregated $17.9 million. Capital expenditures for environmental and safety projects included additions and modifications to storage tanks and vapor recovery systems to comply with more stringent regulations, oily water handling facilities and fire protection improvements. Such expenditures aggregated approximately $5 million in 1994 and are expected to increase over time in response to increasingly rigorous governmental environmental and safety standards.\nThe planned 1995 capital program aggregates approximately $32 million, of which approximately $14 million is planned for income-enhancing projects, with the balance expected to be invested in sustaining projects. The Partnership presently anticipates that ongoing capital expenditures will average approximately $25 to $30 million per year over the next five years, however additional facility improvements, pipeline expansions or acquisitions may be pursued under certain circumstances.\nThe Partnership is currently investigating the feasibility of providing pipeline service from the San Francisco Bay area to Colton, California by expanding existing capacity on its North Line and building a new line between Fresno and Colton. The total investment in this project could exceed $100 million, depending on the pipeline capacity and routing selected. If sufficient shipper throughput commitments are obtained and project approval is received in early 1995, the new pipeline could be in service by late 1996.\nThe Partnership expects that it will generally finance its ongoing capital program with internally-generated funds, however the Partnership may use borrowed funds or proceeds from additional equity\nofferings to finance a portion of significant capital expenditures such as the pipeline project that may be undertaken to link Northern and Southern California. Future capital expenditures will continue to depend on numerous factors, some of which are beyond the Partnership's control, including demand for refined petroleum products in the pipeline system's market areas, governmental regulations and the availability of sufficient funds from operations to pay for such expenditures.\nDue to the capital-intensive nature of the Partnership's business, inflation generally causes an understatement of operating expenses because depreciation is based on the historical costs of assets rather than the replacement costs of assets.\nLong-term debt aggregated $355 million at December 31, 1994 and consisted of $344 million of First Mortgage Notes (the \"Notes\") and an $11 million borrowing under the Partnership's bank term credit facility. The Partnership intends to refinance some or all of the Notes as the various series become payable. To facilitate such refinancing and provide for additional financial flexibility, the Partnership presently has available the multi-year term credit facility, with a $60 million aggregate limit, and a $20 million working capital facility with three banks. The term facility may continue to be used for refinancing a portion of the Notes and for capital projects, while the working capital facility is available for general short-term borrowing purposes.\nOTHER MATTERS\nRATE REGULATION The Partnership's interstate common carrier pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission (\"FERC\"). Intrastate common carrier operations in California are subject to regulation by the California Public Utilities Commission (\"CPUC\"). In 1994, tariffs subject to FERC and CPUC regulation accounted for approximately 55% and 45% of total transportation revenues, respectively.\nIn 1985, the FERC adopted a cost-based methodology for establishing allowable rates for liquid petroleum pipelines, however this methodology continues to be subject to clarification in individual cases and leaves many issues for determination on a case-by-case basis. In July 1994, the FERC issued Order 561-A establishing a new rate-making methodology that allows oil pipelines to adjust their transportation tariffs as long as those rates do not exceed prescribed ceiling levels determined by reference to annual changes in the Producer Price Index for Finished Goods, minus one percent. The FERC Order, which became effective January 1, 1995, allows pipelines to apply for cost of service-based rates in those cases where the carrier can demonstrate that a \"substantial divergence\" exists between the rates that would be allowed under cost-based rate-making and the rates produced by indexation. The FERC also recently issued Order 572-A, effective January 1, 1995, which allows carriers that can demonstrate that they do not have significant market power in the relevant markets served to establish market-based rates in those markets. The access to cost-based and market-based rates is significant because the Partnership believes the index selected by the FERC does not adequately reflect historical cost of service increases and, accordingly, the Partnership may need to pursue cost-based or market-based tariff adjustments in future rate filings. The Partnership does not expect that interstate tariff indexing will result in a significant increase in trunk revenues in 1995.\nEAST LINE LITIGATION AND FERC PROCEEDING Certain of the Partnership's shippers have filed civil suits and initiated a FERC proceeding alleging, among other things, that the shippers had been damaged by the Partnership's failure to fulfill alleged promises to expand the East Line's capacity between El Paso, Texas and Phoenix, Arizona to meet shipper demand. The FERC proceeding also involves claims, among other things, that certain of the Partnership's tariffs and charges on the East and West Lines are excessive. The remaining civil action, brought by El Paso Refinery, L.P. (\"El Paso\") and its general partner, claims unspecified actual damages, which appear to include the $190 million cost of a refinery expansion completed in 1992, plus punitive and consequential damages.\nDuring the quarter ended September 30, 1993, the Partnership recorded a $12 million provision for litigation costs, which reflects the terms of settlement of one of the civil actions as well as anticipated legal fees and other costs related to the FERC proceeding and El Paso's civil action. Subsequently, lesser amounts of such litigation costs have, from time to time, been recorded as current period expense to maintain the reserve at a level deemed adequate.\nManagement believes that it has acted properly with respect to expansion of the East Line and the direction of flow of the six-inch pipeline from Phoenix to Tucson, Arizona, which are the primary issues in the remaining civil action. Management also believes that the Partnership's current tariffs are just and reasonable and that, so long as certain of the underlying assumptions and interpretations of rate-making methodology made by the Partnership with respect to these tariffs are ruled upon favorably, these tariffs will be upheld should the FERC proceeding progress to its completion. However, because of the nature of the FERC rate-making methodology, it is not possible to predict with certainty whether the Partnership's assumptions and rate-making approach will be upheld by the FERC or whether any reparations will be ordered paid to the complainants or any prospective rate reductions will be required. A decision by the FERC which results in significant reparations being paid and a significant reduction in the Partnership's current tariffs could have a material adverse effect on the Partnership's results of operations, financial condition and ability to maintain its current quarterly cash distribution.\nENVIRONMENTAL MATTERS The Partnership's transportation and terminal operations are subject to extensive regulation under federal, state and local environmental laws concerning, among other things, the generation, handling, transportation and disposal of hazardous materials and the Partnership is, from time to time, subject to environmental cleanup and enforcement actions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\" or \"Superfund\" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site. The Partnership is presently involved in approximately 45 soil and ground water remediation projects, at and adjacent to various terminal and pipeline locations, either under mandate by government agencies or in the ordinary course of business. In a number of these cleanup projects, the Partnership is participating with other entities ranging from large integrated petroleum companies to certain less financially sound parties.\nThe Partnership accrues for environmental costs that relate to an existing condition caused by past operations. Such costs include initial site surveys and environmental studies of potentially contaminated sites, costs for remediation and restoration of sites determined to be contaminated and ongoing monitoring costs, as well as fines, damages and other costs, when estimable. Estimates of the Partnership's ultimate liabilities associated with environmental costs are particularly difficult to make with certainty due to the number of variables involved, including the early stage of investigation at\ncertain sites, the lengthy time frames required to complete remediation at most locations, the number of parties involved, the number of remediation alternatives available, the uncertainty of potential recoveries from third parties and the evolving nature of environmental laws and regulations.\nThe Partnership's balance sheet at December 31, 1994 and 1993 includes reserves for environmental costs aggregating $22.7 million and $23.2 million, respectively, which reflect the estimated cost of completing all remediation projects presently known to be required, either by government mandate or in the ordinary course of business, as well as the cost of performing preliminary environmental investigations at several locations. Approximately 80% of the accrued costs at December 31, 1994 are expected to be paid over the next five years. Certain remediation projects, including the largest project at Sparks, Nevada, are expected to continue for a period of approximately ten years. The environmental reserves are monitored on a regular basis by Partnership management and are adjusted, from time to time, to reflect changing circumstances and estimates. During 1993, the Partnership completed a comprehensive re-evaluation of its potential liabilities associated with environmental remediation activities and, as a result, recorded a $15 million provision to increase its existing reserve for environmental remediation and related costs and, during 1992, a $10 million provision was recorded for environmental remediation costs at Sparks and two sites in California.\nEffective January 1, 1995, the Partnership's pollution insurance coverage was renewed with an increase in the per-occurrence deductible from $100,000 to $1,000,000. The Partnership may attempt to secure coverage with a lower deductible during 1995, however, environmental remediation costs, resulting from any new product releases not covered by insurance, are likely to increase in 1995.\nDEMAND FOR REFINED PETROLEUM PRODUCTS Demand for transportation and terminaling services is principally a function of product consumption and competition in markets served by the pipeline system. Commercial volumes are generally dependent upon such factors as prevailing economic conditions, demographic changes, transportation and terminaling alternatives and, to a lesser degree, product prices. Military volumes are dependent upon the level of activity at military bases served by the Partnership.\nManagement anticipates that commercial deliveries of refined petroleum products will continue to gradually increase as the economies of Arizona and Nevada continue to grow and as the California economy recovers from the economic downturn that has been apparent since late 1990. Military volumes, which accounted for 5% of total 1994 volumes, showed improvement over 1993 but are not expected to increase over the foreseeable future. As of year end 1994, four military bases historically served by the Partnership had been closed and realignment of certain other bases continues to occur.\nDuring 1994, the pipeline systems, on average, operated at approximately 75% of capacity. While capacity utilization on individual system segments generally ranged from 70% to 90% of capacity, the lines from the Los Angeles area to San Diego and Colton, California operated at or near full capacity for a portion of the year.\nOverall, volumes have been moderately seasonal, with somewhat lower than average volumes being transported during the first and fourth quarters of each year, although deliveries to specific locations also experience seasonal variations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Partnership's consolidated financial statements, together with the report thereon of Price Waterhouse LLP dated January 27, 1995, are set forth on pages through of this Report.\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. The Registrant has no officers, directors or employees. Set forth below is certain information concerning the directors and executive officers of the General Partner.\nEdward F. Swift, age 71, is a director of the General Partner, Chairman of the Audit Committee and a member of the Compensation and Benefits Committee and Committee on Directors. He has been a consultant to Lehman Brothers (investment bankers) since 1990 and previously had been an advisory director of Shearson Lehman Hutton, Inc. (investment banker and broker-dealer) since 1988. Mr. Swift is also a director of Santa Fe.\nOrval M. Adam, age 64, is a director of the General Partner, Chairman of the Compensation and Benefits Committee and a member of the Audit Committee and Committee on Directors. He retired in January 1991 from his position as Senior Vice President and Chief Financial Officer of Santa Fe, which he held since April 1988. Mr. Adam is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.\nWilford D. Godbold, Jr., age 56, is a director of the General Partner and a member of the Audit Committee and Committee on Directors. Mr. Godbold has served as President and Chief Executive Officer of Zero Corporation (container manufacturer) since 1984. Mr. Godbold is also a director of Zero Corporation, Pacific Enterprises and Southern California Gas Company.\nRobert D. Krebs, age 52, is a director of the General Partner, Chairman of the Committee on Directors and a member of the Compensation and Benefits Committee. Mr. Krebs has served as Chairman, President and Chief Executive Officer of Santa Fe since June 1988 and, previously, served as President and Chief Executive Officer of Santa Fe from July 1987. As Chairman, Mr. Krebs is a director of Santa Fe and is also a director of The Atchison, Topeka and Santa Fe Railway Company, Santa Fe Energy Resources, Inc., Santa Fe Pacific Gold Corporation, Phelps Dodge Corporation, Northern Trust Corporation and Catellus Development Corporation.\nDenis E. Springer, age 49, is a director of the General Partner and a member of the Compensation and Benefits Committee and Committee on Directors. Mr. Springer has been Senior Vice President and Chief Financial Officer of Santa Fe since October 1993. Mr. Springer previously served Santa Fe as Senior Vice President, Treasurer and Chief Financial Officer since January 1992, Vice President, Treasurer and Chief Financial Officer since January 1991 and Vice President- Finance from April 1988 to December 1990. Mr. Springer is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner, and The Atchison, Topeka and Santa Fe Railway Company.\nIrvin Toole, Jr., age 53, is President, Chief Executive Officer and Chairman of the Board of Directors of the General Partner. From November 1988 until assignment to his present position in September 1991, Mr. Toole served as Senior Vice President, Treasurer and Chief Financial Officer, and previously as Vice President-Administration from February 1986 to November 1988. Mr. Toole is also Chairman of the Board of Directors of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.\nRobert L. Edwards, age 39, is a director of the General Partner and has been Senior Vice President-Business Development and Planning of the General Partner since January 1995. Previously, Mr. Edwards was Senior Vice President, Treasurer and Chief Financial Officer from December 1991 through January 1995. Mr. Edwards served Santa Fe from July 1990 through November 1991 as Vice President- Administration; from March 1989 through June 1990 as Vice President-Human Resources and Administration; and from June 1988 through February 1989 as Assistant Vice President-Executive Department. Prior to that, Mr. Edwards held various executive positions with the General Partner since May 1985. Mr. Edwards is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.\nBarry R. Pearl, age 45, has been Senior Vice President, Treasurer and Chief Financial Officer of the General Partner since January 1995. Mr. Pearl previously served as Senior Vice President-Business Development and Planning between January 1992 and January 1995, as Vice President-Business Development and Planning between November 1988 and January 1992 and as Vice President- Operations between May 1986 and November 1988.\nJohn M. Abboud, age 52, has been Senior Vice President of the General Partner since 1985. In his current capacity, Mr. Abboud is responsible for operations, engineering and environmental affairs.\nLyle B. Boarts, age 51, has been Vice President-Human Resources of the General Partner since November 1988. Previously, Mr. Boarts was Director of Human Resources since June 1986.\nR. Gregory Cunningham, age 49, has been Vice President-General Counsel since January 1994. Previously, he served as General Counsel of the General Partner since January 1991 and, prior to such date, as General Attorney since November 1985.\nBurnell H. DeVos III, age 41, has served as Controller and Secretary of the General Partner since January 1993. Mr. DeVos was Assistant Controller of the General Partner from May 1989 through December 1992.\nPatrick L. Avery, age 42, has served as Vice President-Environmental and Safety of the General Partner since October 1993. Mr. Avery was Corporate Environmental Manager at Amerada Hess Corporation from October 1992 to October 1993. Previously, he held various positions at ARCO Products Company since 1982, including Director-California Government Relations and Environmental Health and Safety Manager at ARCO's Los Angeles refinery.\nWilliam M. White, age 49, has served as Vice President-Engineering of the General Partner, with responsibility for engineering and construction, since January 1993. Mr. White previously was Manager-Northern District from May 1986 through December 1992.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. The directors, officers and employees of the General Partner receive no direct compensation from the Partnership for their services to the Partnership. The Partnership reimburses the General Partner for all direct costs incurred in managing the Partnership and all indirect costs (principally salaries and other general and administrative costs) allocable to the Partnership.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\n(a) Security Ownership of Certain Beneficial Owners\nTo the best of the General Partner's knowledge, the following persons are the only persons who are beneficial owners of more than five percent of the Registrant's equity securities:\nAs discussed in Items 1 and 2 of this Report, Santa Fe Pacific Pipelines, Inc. is also the general partner of the Partnership and is a wholly owned indirect subsidiary of Santa Fe Pacific Corporation, also referred to herein as \"Santa Fe.\" On February 7, 1995, the stockholders of Santa Fe approved an Agreement and Plan of Merger between Santa Fe and Burlington Northern Inc. (\"BNI\"), pursuant to which Santa Fe is to merge with and into BNI, with BNI to be the surviving corporation. Like Santa Fe, BNI and its subsidiaries are also principally engaged in railroad transportation operations. Upon completion of the merger, BNI will change its name to Burlington Northern Santa Fe Corporation. Gerald Grinstein, BNI's chairman and chief executive officer, will be chairman of the surviving corporation. Robert D. Krebs, chairman, president and chief executive officer of Santa Fe, will be president and chief executive officer of the surviving corporation. Two-thirds of the directors of the surviving corporation will be designated by BNI, and one-third of the directors of the surviving corporation will be designated by Santa Fe. The merger was also approved by BNI's stockholders, but is still subject to a number of conditions, including approval by the Interstate Commerce Commission.\n(b) Security Ownership of Management\nAs of March 1, 1995, common units beneficially held by all directors and officers as a group represent less than 1% of the Partnership's outstanding units.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The Registrant and the Operating Partnership are managed by the General Partner pursuant to the Amended and Restated Agreement of Limited Partnership of the Partnership (the \"Partnership Agreement\"), and the Amended and Restated Agreement of Limited Partnership of the Operating Partnership (the \"Operating Partnership Agreement\").\nUnder the Partnership Agreement and Operating Partnership Agreement, the General Partner and certain related parties are entitled to reimbursement of all direct and indirect costs and expenses related to the business activities of the Partnership and the Operating Partnership. These costs and expenses include compensation and benefits payable to officers and employees of the General Partner, payroll\ntaxes, corporate office building rentals, general and administrative costs, and legal and other professional services fees. These costs to the Partnership totaled $44.2 million, $43.0 million and $37.1 million in 1994, 1993 and 1992, respectively.\nThe Partnership Agreement provides for incentive distribution payments to the General Partner out of the Partnership's \"Available Cash\" (as defined in the Partnership Agreement) which increase as quarterly distributions to unitholders exceed certain specified targets. The incremental incentive distributions payable to the General Partner are 8%, 18% and 28% of all distributions of Available Cash that exceed, respectively, $0.60, $0.65 and $0.70 per unit. Such incentive distributions aggregated $1.2 million in each of the years 1994, 1993 and 1992.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(b) Reports on Form 8-K filed during the quarter ended December 31, 1994: None\nSIGNATURES\nSanta Fe Pacific Pipeline Partners, L.P., pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P. (Registrant) By: Santa Fe Pacific Pipelines, Inc., as General Partner\nDated: March 24, 1995 By: \/s\/ IRVIN TOOLE, JR. --------------------------------------------------- Irvin Toole, Jr. 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 with Santa Fe Pacific Pipelines, Inc., as General Partner, and on the date indicated.\nSignature Title - ------------------------------ -------------------------------------- Chairman, President and Chief Executive Officer \/s\/ IRVIN TOOLE, JR. (Principal Executive Officer) - ------------------------------ Irvin Toole, Jr. and Director\nSenior Vice President- \/s\/ ROBERT L. EDWARDS Business Development and Planning - ------------------------------ Robert L. Edwards and Director\nSenior Vice President, Treasurer \/s\/ BARRY R. PEARL and Chief Financial Officer - ------------------------------ Barry R. Pearl (Principal Financial Officer)\n\/s\/ BURNELL H. DEVOS III Controller and Secretary - ------------------------------ Burnell H. DeVos III (Principal Accounting Officer)\nEDWARD F. SWIFT* - ------------------------------ Edward F. Swift Director\nORVAL M. ADAM* - ------------------------------ Orval M. Adam Director\nWILFORD D. GODBOLD, JR.* - ------------------------------ Wilford D. Godbold, Jr. Director\nROBERT D. KREBS* - ------------------------------ Robert D. Krebs Director\nDENIS E. SPRINGER* - ------------------------------ Denis E. Springer Director\n*By: \/s\/ BARRY R. PEARL -------------------------- Barry R. Pearl, attorney in fact\nDated: March 24, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE PARTNERS OF SANTA FE PACIFIC PIPELINE PARTNERS, L.P.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14 (a) (1) on page 22 present fairly, in all material respects, the financial position of Santa Fe Pacific Pipeline Partners, L.P. and its majority-owned operating partnership at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Partnership's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits 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 4 to the consolidated financial statements, certain of the Partnership's shippers have initiated a Federal Energy Regulatory Commission (\"FERC\") proceeding alleging, among other things, that certain of the Partnership's tariffs and charges are excessive. Management believes that the Partnership's rates are just and reasonable and its practices are lawful under FERC precedent; however, it is not possible to predict with certainty the ultimate outcome of this proceeding.\nNote 6 includes a description of a change in the method of accounting for postretirement and postemployment benefits effective January 1, 1992.\nPRICE WATERHOUSE LLP\nLos Angeles, California January 27, 1995\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P.\nCONSOLIDATED BALANCE SHEET\n(In thousands)\nSee Notes to Consolidated Financial Statements.\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P.\nCONSOLIDATED STATEMENT OF INCOME\n(In thousands, except per unit amounts)\nSee Notes to Consolidated Financial Statements.\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P.\nCONSOLIDATED STATEMENT OF CASH FLOWS\n(In thousands)\nSee Notes to Consolidated Financial Statements.\nSANTA FE PACIFIC PIPELINE PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ---------------------------------------------------\nORGANIZATION AND BASIS OF ACCOUNTING The accompanying consolidated financial statements include the accounts of Santa Fe Pacific Pipeline Partners, L.P. (the \"Trading Partnership\") and SFPP, L.P., (the \"Operating Partnership\"), collectively referred to as the \"Partnership\", on a consolidated basis. The Trading Partnership is a publicly traded limited partnership organized under the laws of the state of Delaware in 1988 which owns a 99% limited partnership interest in the Operating Partnership, through which the Partnership conducts all its operations. The Operating Partnership was acquired by the Trading Partnership in December 1988 and is engaged in the transportation of refined petroleum products and related services. The Operating Partnership is managed by its general partner, Santa Fe Pacific Pipelines, Inc. (the \"General Partner\"), which, by virtue of this 1% general partner interest, represents the minority interest in the Partnership's consolidated financial statements. The General Partner, which is a wholly owned indirect subsidiary of Santa Fe Pacific Corporation (\"Santa Fe\"), also holds the 1% general partner interest in the Trading Partnership and, therefore, in total, holds a 2% general partner interest in the Partnership on a consolidated basis. In addition, the General Partner owns 8,148,148 Partnership common units, representing an approximate 42% limited partner interest in the Trading Partnership. The remaining approximate 56% limited partner ownership in the Trading Partnership is represented by 11,000,000 publicly traded common units.\nPrior to December 31, 1993, holders of the 11,000,000 publicly traded units (at that time denominated as \"preference units\") were entitled to certain preferences with respect to cash distributions. With the Partnership having met certain financial criteria as of December 31, 1993, all limited partner interests have equivalent rights with respect to cash distributions and, during 1994, the 11,000,000 preference units were redenominated and registered as common units.\nREVENUE RECOGNITION Substantially all revenues are derived from pipeline transportation and storage and terminaling charges and are recognized in income upon delivery. Other revenues, primarily incidental service charges and tank and land rentals, are recognized as earned.\nOperating revenues received from two major petroleum companies exceeded 10% of total 1994 revenues and, individually, account for 16.1% and 12.4% of total operating revenues. In 1993, these two customers accounted for 16.9% and 12.9%, and a third customer accounted for 10.2%, of total operating revenues. In 1992, these same customers accounted for 17.1%, 13.7% and 10.8% of total operating revenues.\nThe Partnership's interstate common carrier pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission (\"FERC\") under a rate-making methodology that is subject to clarification and reconsideration in individual cases and leaves many issues for determination on a case-by-case basis. The Partnership's California intrastate common carrier pipeline operations are subject to rate regulation by the California Public Utilities Commission.\nPROPERTIES, PLANT AND EQUIPMENT Properties are stated at cost and include capitalized interest on borrowed funds. Additions and replacements are capitalized. Expenditures for maintenance and repairs are charged to income. Upon sale or retirement of depreciable properties, cost less salvage is charged to accumulated depreciation.\nProperties are depreciated on a straight-line basis over the estimated service lives of the related assets. Rates for the Partnership's interstate pipeline properties are prescribed by the FERC. The Partnership's intrastate pipeline properties and its terminal properties are depreciated using similar rates. The following annual rates were used in computing depreciation:\nDepreciation expense aggregated $17,447,000 in 1994, $16,921,000 in 1993 and $16,148,000 in 1992.\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 revenue generation, are expensed. Liabilities are recorded when environmental assessments and\/or clean-ups are probable and the costs can be reasonably estimated.\nINCOME PER UNIT Income per unit is computed based upon net income of the Partnership less an allocation of income to the general partner of the Trading Partnership in accordance with the partnership agreement, and is based upon 19,148,148 common units. The quarterly allocation of net income to the general partner of the Trading Partnership (which is always equivalent to the minority interest in net income) is based on its percentage of cash distributions from Available Cash at the end of each quarter (see Note 7). The general partner of the Trading Partnership was allocated 2.07% of net income before minority interest in each of the years 1994, 1993 and 1992.\nCASH EQUIVALENTS AND SHORT-TERM INVESTMENTS The Partnership considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nINCOME TAX For federal and state income tax purposes, the Partnership is not a taxable entity. Accordingly, the taxable income or loss resulting from the operations of the Partnership is ultimately includable in the federal and state income tax returns of the general and limited partners, and may vary substantially from the income or loss reported for financial reporting purposes.\nRECLASSIFICATIONS Certain comparative prior year amounts have been reclassified to conform with the current year presentation.\nNOTE 2 - DETAIL OF SELECTED BALANCE SHEET ACCOUNTS - --------------------------------------------------\nNOTE 3 - LONG-TERM DEBT - ----------------------- Long-term debt consists of the following:\nThe Partnership intends to refinance the Series B Notes on a long-term basis upon their maturity and, therefore, has included them in long-term debt at December 31, 1994. The Series F Notes become payable in annual installments ranging from $31.5 million in 1999 to the final payment of $49.5 million in December 2004. The Notes may also be prepaid beginning in 1999 in full or in part at a price equal to par plus, in certain circumstances, a premium.\nThe First Mortgage Notes (the \"Notes\") are secured by mortgages on substantially all of the properties of the Partnership (the \"Mortgaged Property\"). The Notes contain covenants specifying certain limitations on the Partnership's operations including the amount of additional debt or equity that may be issued, cash distributions, investments and property dispositions. Management does not believe such limitations will adversely affect the Partnership's ability to fund its operations or planned capital expenditures.\nThe Partnership arranged a $60 million multi-year term credit facility and a $20 million working capital facility with three banks in October 1993. The term facility is available for refinancing a portion of the Partnership's long-term debt and capital projects, and may be utilized on a revolving basis through October 1998, with any outstanding balance at that time converted to a three- year amortizing term loan. Borrowings under the term facility are also secured by the Mortgaged Property and are generally subject to the same terms and conditions of the Notes. In December 1994, the Partnership refinanced the Series A Notes by borrowing $11 million under this facility. The Partnership has selected an interest rate on this loan that is presently determined by reference to a short-term Eurodollar rate, and was 6.9375% at December 31, 1994.\nAdvances under the $20 million working capital credit facility can be used for general Partnership purposes and would be secured by certain of the Partnership's accounts receivable. This facility may not be utilized for a 45- day period, the designation of such period to be at the Partnership's discretion, during each year. This facility also provides for certain interest rate options, and is subject to annual renewal and other reasonable and customary terms and conditions. To date, the working capital facility has not been utilized.\nInterest on the Notes is payable semiannually in June and December. Interest on the bank term loan is generally payable quarterly. Total interest paid was $37,326,000 during each of the years 1994, 1993 and 1992. Interest capitalized during the years 1994, 1993 and 1992 aggregated $206,000, $598,000 and $760,000, respectively.\nThe fair value of the Partnership's long-term debt is approximately $425 million at December 31, 1994. Such estimate represents the present value of interest and principal payments on the Notes discounted at present market yields, and assumes the Series F Notes will be prepaid in full in 1999 at par plus a premium. The fair market value of the term loan is considered to be equal to its principal amount.\nNOTE 4 - COMMITMENTS AND CONTINGENCIES - --------------------------------------\nEAST LINE LITIGATION AND FERC PROCEEDING Certain of the Partnership's shippers have filed civil suits and initiated a Federal Energy Regulatory Commission (\"FERC\") proceeding alleging, among other things, that the shippers had been damaged by the Partnership's failure to fulfill alleged promises to expand the East Line's capacity between El Paso, Texas and Phoenix, Arizona to meet shipper demand. The FERC proceeding also involves claims, among other things, that certain of the Partnership's tariffs and charges on its East and West Lines are excessive. In July 1993, the Partnership reached a settlement with one of these shippers, Navajo Refining Company (\"Navajo\"), whereby, among other things, Navajo agreed to dismiss its pending civil litigation in New Mexico and the Partnership agreed to make certain cash payments to Navajo over three years. The remaining civil action, brought by El Paso Refinery, L.P. (\"El Paso\") and its general partner, claims unspecified actual damages, which appear to include the $190 million cost of a refinery expansion completed in 1992, plus punitive and consequential damages.\nDuring the quarter ended September 30, 1993, the Partnership recorded a $12 million provision for litigation costs, which reflects the terms of the Navajo settlement as well as anticipated legal fees and other costs related to the FERC proceeding and El Paso's civil action. Subsequently, lesser amounts of such litigation costs have, from time to time, been recorded as current period expense to maintain the reserve at a level deemed adequate.\nManagement believes that it has acted properly with respect to expansion of the East Line and the direction of flow of the six-inch pipeline from Phoenix to Tucson, Arizona, which are the primary issues in El Paso's civil action. Management also believes that the Partnership's current tariffs are just and reasonable and that, so long as certain of the underlying assumptions and interpretations of rate-making methodology made by the Partnership with respect to these tariffs are ruled upon favorably, these tariffs will be upheld should the FERC proceeding progress to its completion. However, because of the nature of the FERC rate-making methodology, it is not possible to predict with certainty whether the Partnership's assumptions and rate-making approach will be upheld by the FERC or whether any reparations will be ordered paid to the complainants or any prospective rate reductions will be required. A decision by the FERC which results in significant reparations being paid and a significant reduction in the Partnership's current tariffs could have a material adverse effect on the Partnership's results of operations, financial condition and ability to maintain its current quarterly cash distribution.\nENVIRONMENTAL The Partnership's transportation and terminal operations are subject to extensive regulation under federal, state and local environmental laws concerning, among other things, the generation, handling, transportation and disposal of hazardous materials and the Partnership is, from time to time, subject to environmental cleanup and enforcement actions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\" or \"Superfund\" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site.\nAlong with several other respondents, the Partnership is presently involved in one cleanup ordered by the United States Environmental Protection Agency related to ground water contamination in the vicinity of the Partnership's storage facilities and truck loading terminal at Sparks, Nevada. The investigation and remediation at the Sparks terminal is also the subject of lawsuits brought by the State of Nevada, the City of Sparks and several property owners seeking unspecified but, in the aggregate, potentially substantial fines and damages.\nIn addition, the Partnership is involved in six ground water hydrocarbon remediation efforts under administrative orders issued by the California Regional Water Quality Control Board and one remediation effort with the United States military and, from time to time, may be involved in groundwater investigations or remediations for other governmental agencies. The Partnership is also involved in soil and ground water remediation projects, at and adjacent to various other terminal and pipeline locations, that have not been mandated by government agencies but are conducted in the ordinary course of business. In a number of these cleanup projects, the Partnership is participating with other entities ranging from large integrated petroleum companies to certain less financially sound parties.\nThe Partnership accrues for environmental costs that relate to an existing condition caused by past operations. Such costs include initial site surveys and environmental studies of potentially contaminated sites, costs for remediation and restoration of sites determined to be contaminated and ongoing monitoring costs, as well as fines, damages and other costs, when estimable. Estimates of the Partnership's ultimate liabilities associated with environmental costs are particularly difficult to make with certainty due to the number of variables involved, including the early stage of investigation at certain sites, the lengthy time frames required to complete remediation at most locations, the number of parties involved, the number of remediation alternatives available, the uncertainty of potential recoveries from third parties and the evolving nature of environmental laws and regulations.\nThe Partnership's balance sheet at December 31, 1994 and 1993 includes reserves for environmental costs aggregating $22.7 million and $23.2 million, respectively, which reflect the estimated cost of completing all remediation projects presently known to be required, either by government mandate or in the ordinary course of business, as well as the cost of performing preliminary environmental investigations at several locations. Approximately 80% of the accrued costs at December 31, 1994 are expected to be paid over the next five years. Certain remediation projects, including the largest project at Sparks, are expected to continue for a period of approximately ten years. The environmental reserves are monitored on a regular basis by Partnership management and are adjusted, from time to time, to reflect changing circumstances and estimates. During 1993, the Partnership completed a comprehensive re-evaluation of its potential liabilities associated with environmental remediation activities and, as a result, recorded a $15 million provision to increase its existing reserve for environmental remediation and related costs and, during 1992, a $10 million provision was recorded for environmental remediation costs at Sparks, Nevada and two sites in California.\nBased on the information presently available, it is the opinion of management that the Partnership's environmental costs, to the extent they exceed recorded liabilities, will not have a material adverse effect on the Partnership's financial condition; nevertheless, it is possible that the Partnership's results of operations in particular quarterly or annual periods could be materially affected as conditions change or additional information becomes available.\nOTHER CLAIMS AND LITIGATION The Partnership is also party to a number of other legal actions arising in the ordinary course of business. While the final outcome of these other legal actions cannot be predicted with certainty, it is the opinion of management that none of these other legal actions, when finally resolved, will have a material adverse effect on the consolidated financial condition of the Partnership; nevertheless, it is possible that the Partnership's results of operations, in particular quarterly or annual periods, could be materially affected by the ultimate resolution of these matters.\nLEASE COMMITMENTS The General Partner leases space in an office building and certain computer equipment, the rent on which is charged to the Partnership. The General Partner's total lease commitments not subject to cancellation at December 31, 1994 are as follows: $2,100,000 in 1995 and $1,215,000 in 1996.\nThe Partnership also leases certain rights-of-way and land under agreements that can be canceled at any time should they not be required for operations. The annual payments associated with these leases aggregated approximately $5 million in 1993, however a substantial portion of this amount became subject to renegotiation effective January 1, 1994. To date, the Partnership and the lessor have been unable to reach an agreement on the base annual rental payments for the next ten-year period, although it is expected that this matter will be resolved through arbitration during 1995. While the lessor has requested a significant increase in the annual lease payment for 1994 and future years, it is not presently possible to predict the annual rent associated with these leases. Rental expense for all operating leases was $8,335,000, $7,130,000 and $6,600,000 for the years 1994, 1993 and 1992, respectively.\nNOTE 5 - RELATED PARTY TRANSACTIONS - -----------------------------------\nThe Partnership has no employees and is managed by the General Partner. Under certain partnership and management agreements, the General Partner and Santa Fe or its subsidiaries are entitled to reimbursement of all direct and indirect costs related to the business activities of the Partnership. These expenses, which are included in field operating and general and administrative expenses in the Partnership's statement of income, totaled $44.2 million, $43.0 million and $37.1 million for the years 1994, 1993 and 1992, respectively, and include compensation and benefits payable to officers and employees of the General Partner, payroll taxes, corporate office building rentals, general and administrative costs, tax information and reporting costs and legal and other professional services fees.\nNOTE 6 - PENSION AND POSTRETIREMENT PLANS - -----------------------------------------\nThe General Partner is included with certain other affiliates in the trusteed non-contributory Santa Fe Pacific Retirement Plan (the \"Plan\") which fully complies with ERISA requirements. The Plan covers substantially all officers and employees of Santa Fe and its subsidiaries not covered by collective bargaining agreements. Benefits payable under the Plan are based on years of service and compensation during the sixty highest paid consecutive months of service during the ten years immediately preceding retirement. Santa Fe's funding policy is to contribute annually at a rate not less than the ERISA minimum, and not more than the maximum amount deductible for income tax purposes. Since the General Partner is included with certain other affiliates, detailed Plan information for the General Partner is not available in all cases, however, as of September 30, 1994, the fair value of Plan assets allocated to employees associated with the Partnership's operations was $50.4 million, and the actuarial present value of projected Plan obligations, discounted at 8.5%, was $47.5 million. The expected return on the market value of Plan assets was 9.75% and compensation levels were assumed to increase at 4.0% per year. Primarily as a result of the excess of Plan assets over liabilities, pension income of $200,000, $435,000 and $605,000 was recognized in 1994, 1993 and 1992, respectively.\nAs of June 1994, salaried employees who have rendered ten years of service after attaining age 45 are eligible for both medical benefits and life insurance coverage during retirement. Prior to June 1994, salaried employees who had attained age 55 and who had rendered ten years of service were eligible. This change in eligibility requirements resulted in a $3.1 million curtailment gain in 1994 relating to employees who are no longer currently eligible for postretirement benefits, and a negative plan amendment due to a reduction in the accumulated postretirement benefit obligation related to remaining eligible active employees. This curtailment gain is included in other income in the Partnership's statement of income. The retiree medical plan is contributory and provides benefits to retirees, their covered dependents and beneficiaries. Retiree contributions are adjusted annually. The plan also contains fixed deductibles, coinsurance and out-of-pocket limitations. The life insurance plan is non-contributory and covers retirees only.\nEffective January 1, 1992, the General Partner and the Partnership adopted Statement of Financial Accounting Standards (\"FAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", and FAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" FAS No. 106 requires that an actuarial method be used to accrue the expected cost of postretirement health care and other benefits over employees' years of service. FAS No. 112 relates to benefits provided to former or inactive employees after employment but before retirement and requires recognition of these benefits if they are vested and payment is probable and reasonably estimable. Prior to 1992, the costs of postretirement and postemployment benefits were generally expensed when paid. For the Partnership, the cumulative effect of the accounting change attributable to years prior to 1992 was to decrease 1992 net income by $16,407,000, net of minority interest of $347,000. The impact of FAS No. 106 comprised approximately 95% of the change.\nNet periodic postretirement benefit cost in 1994, 1993 and 1992 was $1,500,000, $1,557,000 and $2,231,000, respectively, and included the following components:\nThe Partnership's policy is to fund benefits payable under the medical and life insurance plans as they come due. The following table shows the reconciliation of the plans' obligations, using a September 30 measurement date, to amounts accrued at December 31, 1994 and 1993:\nThe unrecognized prior service credit will be amortized straight-line over the average future service to full eligibility of the active population. For 1995, the assumed health care cost trend rate for managed care medical costs is 11% and is assumed to decrease gradually to 5% by 2006 and remain constant thereafter. For medical costs not in managed care, the assumed health care cost trend is 13% in 1995 and is assumed to decrease gradually to 5% by 2006 and remain constant 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 for the medical plan by $1.8 million and the combined service and interest components of net periodic postretirement benefit cost recognized in 1994 by $170,000. In 1994, the assumed health care cost trend rate for managed care medical costs was 11.5% and was assumed to decrease gradually to 5% by 2006 and remain constant thereafter. For medical costs not in managed care, the assumed health care cost trend was 14% in 1994 and was assumed to decrease gradually to 5% by 2006 and remain constant thereafter. The weighted-average discount rate assumed in determining the accumulated postretirement benefit obligation was 8.5% and 7% in 1994 and 1993, respectively. The assumed weighted-average salary increase was 4% in both 1994 and 1993.\nNOTE 7 - PARTNERS' CAPITAL AND CASH DISTRIBUTIONS - -------------------------------------------------\nChanges in partners' capital were as follows:\nThe Partnership makes quarterly cash distributions of substantially all of its available cash, generally defined as consolidated cash receipts less consolidated cash expenditures and such retentions for working capital, anticipated capital expenditures and contingencies as the General Partner deems appropriate or as are required by the terms of the Notes. Distributions are made 98% to the common unitholders and 2% to the General Partner, subject to the payment of incentive distributions to the General Partner which increase as quarterly distributions to unitholders exceed certain specified target levels. The incremental incentive distributions payable to the General Partner are 8%, 18% and 28% of all quarterly distributions of available cash that exceed, respectively, $0.60, $0.65 and $0.70 per unit. Such incentive distributions aggregated $1,202,000 in each of the years 1994, 1993 and 1992.\nCash distributions declared for each of the years 1994, 1993 and 1992 aggregated $2.80 per unit. In January 1995, the Partnership announced a fourth quarter 1994 distribution of $0.70 per unit, payable in February 1995.\nPrior to December 31, 1993, in the event that there was not sufficient available cash to pay the minimum distribution of $0.55 per unit to all unitholders at the end of a quarter, holders of the 11,000,000 publicly traded units (at that time denominated as \"preference units\") were entitled to receive the minimum quarterly distribution, plus any arrearages, prior to any distribution of available cash on the 8,148,148 common units held by the General Partner. With the Partnership having met certain financial criteria, this subordination period ended on December 31, 1993, and all units henceforth have equivalent rights with respect to cash distributions. During 1994, the 11,000,000 preference units were redenominated and registered as common units.\nNOTE 8 - SUMMARIZED QUARTERLY OPERATING RESULTS - ----------------------------------------------- AND COMMON UNIT INFORMATION (UNAUDITED) --------------------------------------\nQuarterly results of operations are summarized below:\nNotes: Third quarter 1993 included a $27.0 million provision for environmental and litigation costs. The sum of net income (loss) per unit for the four quarters of 1993 does not equal net income per unit for the full year due to the effect of rounding differences.\nSanta Fe Pacific Pipeline Partners, L.P. common units are traded on the New York Stock Exchange, under the symbol SFL. The quarterly price range per unit and cash distributions declared per unit for 1994 and 1993 are summarized below:\nAs of January 31, 1995, there were approximately 18,000 unitholders.\nEXHIBIT INDEX SEQUENTIAL PAGE NO.\n(b) Reports on Form 8-K filed during the quarter ended December 31, 1994: None","section_15":""}
{"filename":"37076_1994.txt","cik":"37076","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nFirstar Corporation is a registered bank holding company incorporated in Wisconsin in 1929. Firstar Corporation (\"Firstar\") is the largest bank holding company headquartered in Wisconsin. Firstar's 15 bank subsidiaries in Wisconsin had total assets of $10.0 billion at December 31, 1994. Its eleven Iowa banks, one Illinois bank and one Minnesota bank had total assets of approximately $2.7 billion, $959 million and $1.2 billion, respectively, as of December 31, 1994. Firstar has one bank in Phoenix, Arizona with total assets of $102 million. Firstar's principal subsidiary, Firstar Bank Milwaukee, N.A., had total assets of $6.0 billion which represented 40 percent of Firstar's consolidated assets at December 31, 1994, and is the largest commercial bank in Wisconsin.\nFirstar provides banking services throughout Wisconsin and Iowa and in the Chicago, Minneapolis- St. Paul and Phoenix metropolitan areas. Its Wisconsin bank subsidiaries operate in 135 locations, with offices in eight of the ten largest metropolitan population centers of the state, including 74 offices in the Milwaukee metropolitan area. Its Iowa bank subsidiaries operate in 43 locations; its Illinois bank subsidiaries in 15 locations; its Minnesota bank subsidiary in 24 locations; its Arizona bank in three locations; and a trust subsidiary in Florida in two locations. Firstar's bank subsidiaries provide a broad range of financial services for companies based in Wisconsin, Iowa, Illinois and Minnesota, national business organizations, governmental entities and individuals. These commercial and consumer banking activities include accepting demand, time and savings deposits; making both secured and unsecured business and personal loans; and issuing and servicing credit cards. The bank subsidiaries also engage in correspondent banking and provide trust and investment management services to individual and corporate customers. Firstar Milwaukee, N.A., Firstar Bank Cedar Rapids, N.A. and Firstar Bank Madison, N.A. also conduct international banking services consisting of foreign trade financing, issuance and confirmation of letters of credit, funds collection and foreign exchange transactions. Nonbank subsidiaries provide retail brokerage services, trust and investment management services, residential mortgage banking activities, title insurance, business insurance, consumer and credit related insurance, and corporate computer and operational services.\nAt December 31, 1994, Firstar and its subsidiaries employed 7,680 full-time and 2,196 part-time employees, of which approximately 970 full-time employees are represented by a union under a collective bargaining agreement that expires on August 31, 1996. Management considers its relations with its employees to be good.\nCOMPETITION\nBanking and bank-related services is a highly competitive business. Firstar's subsidiaries compete primarily in Wisconsin and the Midwestern United States. Firstar and its subsidiaries have numerous competitors, some of which are larger and have greater financial resources. Firstar competes with other commercial banks and financial intermediaries, such as savings banks, savings and loan associations, credit unions, mortgage companies, leasing companies and a variety of financial services and advisory companies located throughout the country.\nSUPERVISION\nFirstar's business activities as a bank holding company are regulated by the Federal Reserve Board under the Bank Holding Company Act of 1956 which imposes various requirements and restrictions on its operations. The activities of Firstar and those of its banking and nonbanking subsidiaries are limited to the business of banking and activities closely related or incidental to banking.\nThe business of banking is highly regulated, and there are various requirements and restrictions in the laws of the United States and the states in which the subsidiary banks operate including the requirement to maintain reserves against deposits and adequate capital to support their operations, restrictions on the nature\nand amount of loans which may be made by the banks, restrictions relating to investment (including loans to and investments in affiliates), branching and other activities of the banks.\nFirstar's subsidiary banks with a national charter are supervised and examined by the Comptroller of the Currency. The subsidiary banks with a state charter are supervised and examined by their respective state banking agency and either by the Federal Reserve if a member bank of the Federal Reserve or by the FDIC if a nonmember. All of the Firstar subsidiary banks are also subject to examination by the Federal Deposit Insurance Corporation.\nIn recent years Congress has enacted significant legislation which has substantially changed the federal deposit insurance system and the regulatory environment in which depository institutions and their holding companies operate. The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\"), the Comprehensive Thrift and Bank Fraud Prosecution and Taxpayer Recovery Act of 1990 and the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") have significantly increased the enforcement powers of the federal regulatory agencies having supervisory authority over Firstar and its subsidiaries. Certain parts of such legislation increase the cost of doing business for depository institutions and their holding companies. FIRREA also provides that all commonly controlled FDIC insured depository institutions may be held liable for any loss incurred by the FDIC resulting from a failure of, or any assistance given by the FDIC, to any of such commonly controlled institutions. Federal regulatory agencies have implemented provisions of FDICIA with respect to taking prompt corrective action when a depository institution's capital falls to certain levels. Under the new rules, five capital categories have been established which range from \"critically undercapitalized\" to \"well capitalized\". Failure of a depository institution to maintain a capital level within the top two categories will result in specific actions from the federal regulatory agencies. These actions could include the inability to pay dividends, restricting new business activity, prohibiting bank acquisitions, asset growth limitations and other restrictions on a case by case basis.\nIn addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy. Changes to such monetary policies have had a significant effect on operating results of financial institutions in the past and are expected to have such an effect in the future; however, the effect of possible future changes in such policies on the business and operations of Firstar cannot be determined.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of all the executive officers (16) of Firstar as of December 31, 1994. All of these officers are elected annually by their respective boards of directors. All of the officers have been employed by Firstar and\/or one or more of its subsidiaries during the past five years, except Mr. Schoenke, who was previously employed by another banking company and joined Firstar as an executive officer in 1990. There are no family relationships between any of the executive officers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOn December 31, 1994, Firstar had 222 banking locations, of which 159 were owned and 63 were leased. All of these offices are considered by management to be well maintained and adequate for the purpose intended. See Note 7 of the Notes to Consolidated Financial Statements included under Item 8 of this document for further information on properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nFirstar and its subsidiaries are subject to various legal actions and proceedings in the normal course of business, some of which involve substantial claims for compensatory or punitive damages. Although litigation is subject to many uncertainties and the ultimate exposure with respect to these matters cannot be ascertained, management does not believe that the final outcome will have a material adverse effect on the financial condition of Firstar.\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\nSee Item 6","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n* excludes check kiting loss\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nHIGHLIGHTS\nFirstar reported earnings in 1994 of $207.7 million, a 1.7% increase over the $204.3 million earned in 1993. On a per common share basis, 1994 net income increased 2.2% to $3.22 from $3.15 earned in 1993. In 1992, net income was $166.0 million, or $2.62 per common share.\nWhile net income has increased in 1994, the effect of a higher stockholders' equity base reduced the return on equity in 1994. Return on average common equity declined to 16.97% in 1994 compared with 18.61% in 1993 and 17.43% in 1992. Firstar has measured its performance against a peer group of 30 other bank holding companies ranging in asset size from $10 billion to $25 billion. Firstar has placed within the top 25% of this group as measured by the return on equity for the past six years.\nThis slowdown in the momentum of improvement during 1994 reflects the impact of a $22 million pre-tax charge against earnings taken in the second quarter for a check kiting fraud. This loss reduced 1994 earnings per share by 20 cents. While this loss had an impact on Firstar's earning trends, Firstar's overall financial soundness remained unaffected.\nReturn on average assets for 1994 was 1.51% compared with 1.59% in 1993 and 1.36% in 1992.\nMajor factors affecting underlying earnings during 1994 were:\n- Net interest margin declined to 5.03% in 1994 from 5.21% in 1993. During 1992 the margin was 5.27%.\n- Strong loan growth of 11.1% offset the effects of the decline in margins, helping increase net interest revenue by 4.9%.\n- The provision for loan losses was reduced further in 1994 reflecting the lower level of nonperforming assets and related net loan charge-offs.\n- Growth in major fee revenue businesses continued, with trust and investment management fees up 7.0% and credit card revenue up 4.6% during 1994. These gains in fee revenue were, however, offset by reduced mortgage banking revenues as a result of a market driven contraction in origination volumes.\n- Operating expenses declined by just under 1% during 1994 after excluding the check kiting loss.\n- These factors combined to improve Firstar's efficiency ratio to 60.6% in 1994 compared to 62.6% in 1993 and 64.0% in 1992.\nFurther reductions in nonperforming assets were realized in 1994. Total nonperforming assets were $56.8 million at the end of the year, a reduction of 12.4% from year-end 1993. Nonperforming assets now represent .58% of total loans and other real estate.\nStockholders' equity increased to $1.31 billion at the end of 1994. Market capitalization was $1.77 billion. Capital strength, by all measures, remains strong. Firstar's capital ratios are in the top quartile of its peer group and it has the highest capital rating by its regulatory agency.\nNET INTEREST REVENUE\nNet interest revenue, which comprises interest and loan-related fees less interest expense, is the principal source of earnings for Firstar. Net interest revenue is affected by a number of factors including the level, pricing and maturity of earning assets and interest-bearing liabilities, interest rate fluctuations and asset quality. Net interest margin is net interest revenue expressed as a percentage of average earning assets. To permit comparisons, net interest revenue and margins in the accompanying discussion and tables have been adjusted to show tax-exempt income, such as interest on municipal securities and loans, on a taxable-equivalent basis. Table 1 shows the components of net interest revenue, net income and net interest margin for the last three years.\nTABLE 1\nCONDENSED INCOME STATEMENTS -- TAXABLE-EQUIVALENT BASIS\nNet interest revenue increased 4.9% to $626.6 million during 1994. This follows a similar 4.7% increase in 1993. The growth in both years benefited from higher average earning asset balances, driven principally by continued strong loan growth. This positive impact was somewhat offset by a reduction in the net interest margin, particularly in 1994.\nThe net interest margin for 1994 was 5.03% compared with 5.21% in 1993 and 5.27% in 1992. The margin declined moderately from the record high levels of the prior two years. Interest rates increased dramatically during 1994 with the prime rate rising from 6.00% at the beginning of the year to 8.50% at year-end. Rates paid on fund sources increased by .14%, or 14 basis points, in 1994 as more reliance was put on higher cost purchased funds. On the asset side, higher rates earned on commercial loans was more than offset by declines in rates on consumer lending and the securities portfolio, reducing the overall yield on earning assets by five basis points. The impact of interest-free funds supporting earning assets was not a factor in 1994 as shown by the one basis point increase in margin attributable to these deposits. The level of earning assets supported by interest-free funds was 21.3% in 1994 compared with 21.8% in 1993 and 20.4% in 1992. The six basis point decline in net interest margin during 1993 resulted from the reduced benefit of interest-free funds partially offset by a modest increase in the interest spread reflecting the general decline in interest rates during that period. Firstar expects that further reductions in its net interest margin are likely as interest rates stabilize or\nincrease moderately from current levels. Firstar remains within the top quartile of its peer group with respect to net interest margin.\nForegone interest on nonperforming loans and other real estate reduced net interest revenue by $3.8 million in 1994, $4.6 million in 1993 and $8.3 million in 1992. This resulted in corresponding reductions in net interest margin of .03% in 1994 and .03% in 1993 and .05% in 1992. The nominal impact is a reflection of Firstar's continued low level of nonperforming assets.\nTable 2 shows the components of interest revenue and expense along with changes related to volumes and rates. Total interest revenue increased by 7.9% to $967.0 million. This resulted from higher average earning assets, up 8.6%, which was partially offset by the slightly lower yield on earning assets. Interest income on commercial loans rose by 16.3% due to both higher balances and interest rates. Consumer loan interest, while up 4.5%, was impacted by the lower net interest rate which was 47 basis points less than 1993. This reduced rate on consumer loans reflects the refinancing activity and general lower rates available late in 1993. Securities income has declined as higher rate investments have matured and were replaced with securities with currently lower market yields. During 1993, total interest revenue declined by 3.6%, to $896.3 million. This resulted from lower overall interest rates, which was partially offset by the 5.7% increase in average earning assets. The rate received on earning assets declined from 8.58% in 1992 to 7.82% in 1993.\nTABLE 2\nANALYSIS OF INTEREST REVENUE AND EXPENSE\n- ------------ Calculations are computed on a taxable-equivalent basis using a tax rate of 35% in 1994 and 1993 and 34% in 1992.\nThe change attributable to both volume and rate has been allocated proportionately to the changes due to volume and rate.\nTotal interest expense increased by 13.9% in 1994, to $340.4 million. Interest expense on deposits increased modestly with the impact of deposit growth being offset by lower interest rates paid in most categories of deposits. The cost of short-term borrowed funds increased 175% with both higher usage of this funding source and increased interest rates. The interest rate on liabilities increased from 3.34% in 1993 to 3.48% in 1994. During 1993, total interest expense declined by 16.8% to a level of $298.9 million. The interest rates on liabilities was reduced from 4.16% in 1992 to 3.34% in 1993.\nOTHER OPERATING REVENUE\nTotal other operating revenue amounted to $335.2 million, a decrease of $7.0 million or 2.1% from 1993. Excluding the impact of mortgage origination revenues, other operating revenue rose by 1.5% in 1994 and 10.3% in 1993. This growth reflects the continuing effort to emphasize non-interest revenue. This focus provides several benefits to Firstar. Much of Firstar's fee revenue is not subject to the fluctuations that are inherent in the interest rate cycle. Firstar's broad customer base provides opportunities for expanded revenues as the marketplace looks to financial institutions for services beyond traditional lending and deposit activities. Table 3 shows the composition of other operating revenue.\nTABLE 3\nANALYSIS OF OTHER OPERATING REVENUE\nOther operating revenue now represents 35% of Firstar's revenue. An industry measure of fee revenue prominence is the ratio of this revenue stream to average assets. During 1994 this ratio was 2.43% compared to 2.66% in 1993 and 2.46% in 1992. These figures place Firstar sixth among the 30 banking organizations with total assets of $10 billion to $25 billion.\nTrust and investment management fees are the single largest source of fee revenue, contributing $117.9 million, over one-third of other operating revenue. This level represents a 7.0% growth in revenue in 1994 which in turn followed a 14.9% rise in the previous year. The development and addition of new business was a factor in both years. Additionally, the reduction in the market value of assets resulting from general market conditions, restricted the growth in revenue during 1994. Expanded services are being offered through Firstar's banking network. Additional marketing efforts are also being directed to institutional investors beyond the Midwest. The introduction of fifteen proprietary mutual funds and the serving as custodian\/transfer agent for 175 publicly registered mutual funds have enhanced trust revenues. Trust assets under management increased by 1.9% during 1994 to $15.1 billion at the end of the year. Additional assets held in custody accounts were $38.5 billion.\nRevenue from service charges on deposit accounts declined by 2.3% in 1994, to a level of $72.4 million. This reduction was primarily due to higher rate credits given to business customers for services, thus reducing\nthe level of cash payments necessary. The opposite trend was evident in 1993, where the lower rate environment generated increased cash payments for services and increased service charge revenue by 11.7%.\nCredit card service revenues are the third largest source of fee revenue totaling $55.8 million during 1994, which was a 4.6% increase over 1993. This follows a 2.8% increase the previous year. The introduction of new credit card products and growth in merchant fee activity have aided in the revenue growth of the past two years. Firstar services 570,000 active card holders, has 33,300 merchant accounts and provides credit card programs to more than 750 financial institutions. This customer base, which covers the Upper Midwest and includes Wisconsin, Iowa, Illinois, Minnesota, Upper Michigan, Nebraska and the Dakotas, provides a market for the sale and expansion of other financial products.\nData processing fee income declined 5.5% in 1994 and 11.5% in 1993. A shrinking customer base due to continuing bank consolidations through mergers or acquisitions and conversions by smaller community banks to in-house data processing systems have acted to reduce revenues. Intense price competition has also occurred due to the shrinking market for sales and has affected revenue levels through pricing changes and some loss of customers.\nRevenue from mortgage banking activities has fluctuated dramatically during the last three years as a result of the refinancing boom which peaked in 1993. Revenue from mortgage originations reached $19.0 million in 1993, an increase of $11.4 million over 1992 and then declined by $12.0 million during 1994. Mortgage origination volume was $1.5 billion in 1993 and declined by one third to $1.0 billion in 1994. Mortgage loan servicing revenue has shown continued increases during this period, increasing 50% in 1993 and 13% in 1994. Mortgage loans serviced for others were $2.5 billion at the end of 1994, a 25% increase from a year earlier. Firstar has expanded its mortgage banking activities through coordinated marketing efforts within Firstar's banking network.\nThe past two years saw continued growth in insurance activity, with a 11.7% increase in 1994 to $11.6 million, compared with a 23.3% increase during 1993. This line of business generates revenue from the sale of annuities and insurance products and represents an important element in Firstar's strategy to continually expand fee revenue.\nBrokerage revenue declined by 20.3% during 1994 to $6.9 million, as a result of the generally unfavorable market conditions. This followed a very strong growth in the prior two years.\nThe remaining sources of other operating revenue, excluding securities transactions and other nonrecurring revenue, derive from a wide range of services and collectively increased by 4.1% in 1994 and 3.0% in 1993.\nOTHER OPERATING EXPENSES\nTotal operating expenses increased 2.9% to $604.9 million in 1994 compared with an increase of 5.4% in 1993. Excluding the impact of a check kiting fraud, operating expenses declined by just under 1% during 1994. Information on the components of other operating expense is shown in Table 4.\nTABLE 4 ANALYSIS OF OTHER OPERATING EXPENSE\nPersonnel costs, which include salaries and fringe benefits, are the largest component of operating expenses, representing more than one-half of operating costs. This expense rose by 2.9% in 1994 compared with 10.2% in 1993. Salaries rose by 3.2% in 1994 and 8.2% in 1993. The salary increase during 1994 was limited to the effect of merit increases. Full-time equivalent employees remained, for the most part, level during the year. One-half of the 1993 increase in salaries was attributed to bank acquisitions.\nEmployee benefit costs rose by only 1.2% in 1994 after increasing 19.8% in 1993. Firstar adopted Statement of Financial Accounting Standards No. 106, \"Accounting for Postretirement Benefits Other Than Pensions\" in 1993. The statement requires employers to recognize postretirement benefits on an accrual basis over employee service periods, as contrasted to the expensed-as-incurred method of accounting. Excluding the impact of Statement No. 106, which increased costs by $7.0 million, employee benefit costs rose by 5.7% during 1993.\nEquipment expense increased by 2.3% in 1994 compared to a decline of 1.2% in 1993. Firstar continues to invest in upgraded data processing equipment, ensuring that its data processing capabilities are up-to-date in order to provide quality service in a cost effective manner.\nNet occupancy expense declined by 5.8% in 1994 reflecting the impact of a partial acceleration of a deferred gain on a building sale of $2.1 million in 1994. Also affecting comparison between years was the costs associated with office closings of $2.2 million in 1993 and $1.5 million in 1992.\nFDIC insurance is an uncontrollable cost, with the premium established by the federal regulatory agency. The FDIC sets varying premium amounts based upon capitalization levels and soundness criteria. Firstar's capital strength has permitted payments at the lowest rate levels. The FDIC is currently considering reducing the premium levels which could result in a significant reduction in Firstar's cost of FDIC insurance.\nThe amortization of intangibles includes amounts associated with goodwill, core deposit intangibles and purchased mortgage loan servicing rights. During 1993 and 1992, additional amortization of mortgage servicing rights was taken due to the high volume of the underlying mortgage loans which were refinanced. Expense associated with the amortization of mortgage servicing rights was $.7 million in 1994, $5.2 million in 1993 and $8.3 million in 1992. This expense fluctuates with changing interest rates and loan prepayment trends. The remaining unamortized mortgage loan servicing rights were $4.7 million at the end of 1994.\nNet other real estate operations produced income of $1.5 million in 1994 as a result of gains realized on the sale of properties. This contrasts to net expenses of $2.1 million in 1993 and $4.3 million in 1992. The current low level of other real estate held should continue to be reflected in reduced expenses.\nThe $22 million check kiting loss was recorded in the second quarter of 1994 when it was discovered that two affiliated commercial customers were involved in a series of fraudulent check transactions. The customers are in bankruptcy proceedings and although Firstar is pursuing its legal rights, there is no assurance of any recovery.\nAll other expenses include a wide range of items and were decreased by 3.2% in 1994 and increased by less than 1% in 1993.\nA measure of the success in managing operating expense is expressed in the ratio of expense to revenue and is referred to as the efficiency ratio. The objective is to reduce this ratio through revenue growth, cost control or a combination of both. Excluding the check kiting loss, this ratio was 60.6% in 1994, 62.6% in 1993 and 64.0% in 1992 and placed Firstar above the median level of its peer companies. Firstar continues to seek ways to improve its efficiency with a goal of operating at a 60% level in 1995.\nPROVISIONS FOR LOAN LOSSES\nThe provision for loan losses is used to cover actual loan losses and to adjust the size of the reserve relative to the amount and quality of loans. In determining the adequacy of the reserve, management considers the financial strength of borrowers, loan collateral, current and anticipated economic conditions and other factors. The 1994 provision for loan losses was $17.1 million, compared with $24.6 million in 1993 and $44.8 million in 1992. The reduced level of nonperforming assets and lower net charge-offs have permitted Firstar to reduce its provision for loan losses.\nINCOME TAXES\nIncome tax expense was $103.0 million in 1994, compared to $93.7 million in 1993 and $71.5 million in 1992. The effective tax rate was 33.1% in 1994, 31.4% in 1993 and 30.1% in 1992. The effective tax rate rose in 1994 as compared to 1993 due to a reduction in tax-exempt municipal interest income, an increase in state tax expense and the benefit of the adoption of Statement No. 109 in 1993. The effective tax rate rose in 1993 compared to 1992 due to a 1% increase in the federal corporate tax rate.\nBALANCE SHEET ANALYSIS\nChanges in the balance sheet of a financial institution reflect both the forces of the marketplace and the company's response to these conditions. Firstar's strategy in managing balance sheet growth is based upon the goals of enhancing soundness and providing a broad range of services for customers.\nTotal assets at the end of 1994 reached $15.1 billion, an increase of $1.3 billion or 9.5% over a year earlier. Approximately one third of this increase was attributable to a bank acquisition. Average total assets for 1994 were $13.8 billion, an increase of 7.3% over 1993.\nTable 5 shows the geographic distribution of Firstar's banking assets. Firstar has expanded beyond its Wisconsin base through select acquisitions. Assets outside of Wisconsin now represent 34% of consolidated assets. Firstar's acquisition activity will focus on attractive markets in the upper Midwest that will complement the existing Firstar banking network. The combination of internal growth and acquisitions provides new opportunities to build and diversify Firstar's earnings within an economically stable region.\nTABLE 5\nSUBSIDIARY AVERAGE ASSETS\n- ------------ Assets have been adjusted for intercompany amounts.\nSignificant acquisition activity occurred during 1994. Firstar announced three merger agreements in the third quarter of the year which will add to its existing franchises.\nThe merger with First Colonial Bankshares Corporation, a $1.8 billion bank holding company with 30 offices in the Chicago area was announced in July. The transaction was completed on January 31, 1995, and, along with its existing Illinois locations, gives Firstar a $3 billion banking franchise with 45 offices in the Chicago area market.\nIn August, a second major acquisition was announced. This, with Investors Bank Corp., a $1.1 billion thrift with 12 offices and a large mortgage banking business in the Minneapolis\/St. Paul market, will double both the size of Firstar's Minnesota banking operations and corporate wide mortgage banking business. This transaction should be completed in the second quarter of 1995.\nA third pending acquisition will add $80 million of assets to Firstar Bank Davenport through the acquisition of First Moline Financial Corp. of Moline, Illinois. Also, the previously announced acquisition of First Southeast Banking Corporation was completed in the fourth quarter of 1994, adding over $400 million of assets to Firstar's southeast Wisconsin banking franchise.\nLOANS AND INVESTMENTS\nEarning assets, shown in Table 6, averaged $12.4 billion, an increase of $988 million, or 8.6% over 1993. Loans, the largest category of earning assets, represented 74.4% of earning assets as compared with 72.7% in 1993. On average, loans totaled $9.3 billion, an increase of $928 million or 11.1% over 1993. Excluding the impact of loans added through bank acquisitions, average loans grew by 10.0%. This followed a 5.1% increase in average loans in 1993. This growth was especially strong in the Wisconsin (excluding the lead bank) and Minnesota markets which recorded loan growth in excess of 18%. The Iowa banks and the lead bank located in Milwaukee showed loan growth in the 7-8% range. Firstar expects this trend of increased loan demand to continue into 1995.\nTABLE 6 AVERAGE EARNING ASSETS\nCommercial loans, which account for 60% of the loan portfolio, increased by $583 million, or 11.8% on average, to $5.5 billion during 1994. Excluding bank acquisitions which occurred during the past two years, commercial loans have increased by 10.4%. This follows the 7.0% growth achieved in 1993.\nConsumer loans averaged $3.7 billion, an increase of $345 million or 10.2% over 1993. Excluding the affect of acquisitions, consumer loans rose by 9.3%. Increased levels of mortgage loans and installment debt aided in this growth. The lower interest rates available in 1993 and early 1994 prompted increased consumer debt assumption. Credit card balances reversed the previous downward trend in 1994, increasing by 1.5% in 1994. Firstar's new cards offering variable rates and rebates have been well accepted and should result in continued loan growth.\nFirstar securitized $290 million of residential mortgage loans at the end of 1994. These loans, now carrying a U.S. agency guarantee, are included in securities held to maturity. This action gives Firstar increased liquidity through the ability to borrow funds using repurchase agreements collateralized by the securitized loans.\nTotal securities, including both held to maturity and available for sale securities, represent 24% of earning assets. They averaged $3.0 billion during 1994, an increase of $31 million, or 1.1% over 1993. Tables 7 and 8 show the maturity range and changing mix of the investment portfolio. The average maturity of the portfolio was 3.3 years as of the end of 1994.\nTABLE 7 MATURITY RANGE AND AVERAGE YIELD OF SECURITIES\n- ------------ Rates are calculated on a taxable-equivalent basis using a tax rate of 35%. The maturity information on mortgage-backed obligations is based on anticipated payments.\nTABLE 8 SECURITIES\nShort-term investments, which include interest-bearing deposits with banks, trading account securities, and federal funds sold and resale agreements, averaged $227 million in 1994, an increase of $29 million, or 14.6%, from a year earlier.\nFUND SOURCES\nAverage fund sources, consisting of deposits and borrowed funds, increased by $838 million, or 7.3%, to $12.3 billion in 1994. Total deposits averaged $10.7 billion, an increase of $142 million, or 1.3%. Bank acquisitions accounted for most of this increase in average deposits. Table 9 shows the composition of Firstar's fund sources.\nTABLE 9\nAVERAGE FUND SOURCES\nCore deposits, which include transaction accounts and other stable time deposits, are Firstar's prime source of funding. These deposits averaged $10.2 billion in 1994, essentially level with 1993. Increased competition for consumer deposits and heightened consumer sensitivity to interest rates have limited Firstar's core deposit growth. Increased emphasis will be placed on generating more core deposits in 1995 through competitive pricing of deposit products.\nMore reliance was placed on purchased fund sources during 1994 to support the growth in loan balances. Other time deposits, primarily certificates of deposit over $100,000, increased $120 million, to $450 million on average. Short-term borrowed funds were increased by $703 million to an average level of $1.5 billion.\nCREDIT RISK MANAGEMENT\nSince the mid-1980's, credit management has been refined through procedural and personnel changes. Emphasis on credit quality standards and diversification of risk have been key strategies. The benefits of this program are seen in the significant reductions in nonperforming assets and overall credit quality achieved during the past several years. During this period nonperforming assets as a percentage of loans and other real estate have declined from 1.87% in 1990 to .58% at the end of 1994. Put in perspective of Firstar's peer group of banks, this placed Firstar ninth within the group for asset quality.\nNonperforming assets consist of loans that are not accruing interest, loans with renegotiated credit terms and collateral acquired in settlement of nonperforming loans. The composition of these assets is shown in Table 10. These nonperforming assets totaled $56.8 million at December 31, 1994 and represented .58% of Firstar's $9.8 billion of loans and other real estate. This is a $8.1 million, or 12.4%, reduction from a year earlier.\nTABLE 10\nNONPERFORMING ASSETS AND PAST DUE LOANS\n- ------------ * Nonperforming loans which were included in other real estate under \"in substance foreclosure\" accounting rules were $10.5 million, $10.5 million, and $5.0 million at December 31, 1992, 1991, and 1990, respectively. Such \"in substance foreclosed\" loans were reclassified to loans in 1993.\nCommercial real estate related nonperforming assets totaled $26.9 million at the end of 1994, a reduction of 26% from a year earlier. These nonperforming assets represented 1.17% of their respective loan category. Firstar experienced an increase in real estate related nonperforming assets several years ago, although to a much lesser extent than many other financial institutions. These assets reached a high of $93.7 million at the end of 1990. As can be seen, significant progress has been made in reducing this category of nonperforming assets.\nThe remaining commercial loan portfolio had a nonperforming asset ratio of .67% compared to .66% a year earlier. This is reflective of the overall consistent financial strength of Firstar's commercial borrowers.\nNonperforming consumer loans have also declined from previously higher levels. At year-end 1994, they represented a very minimal .14% of outstandings.\nWhile further reductions of nonperforming assets are not likely, the attainment of this low level is an indication of Firstar's overall high asset quality.\nLoans ninety days or more past due on December 31, 1994, totaled $24.1 million, compared with $21.8 million a year earlier. These loans are on a full accrual basis and are judged by management to be collectible in full. In addition, Firstar had $22 million of loans at December 31, 1994, on which interest is accruing, but, because of existing economic conditions or circumstances of the borrower, doubt exists as to the ability of the borrower to comply with the present loan terms. While these loans are identified as requiring additional monitoring, they do not necessarily represent future nonperforming assets.\nAdditional indicators of asset quality can be found in the geographic distribution, industry diversification and type of lending represented in the loan portfolio. Credit policies have been changed over the past several years to reduce vulnerability to potential adverse economic trends. Marketing efforts have been directed to Firstar's primary market segments which are consumer, small business and middle market customers in communities where Firstar banks are located. This emphasis on smaller, locally based credits brings with it a diversified group of customers without any significant industry concentration. Firstar does not participate in any significant syndicated lending or highly leveraged transactions.\nCommercial real estate lending includes construction loans, income property loans and other commercial loans where real estate is involved as collateral. Midwestern real estate did not experience the rapid price appreciation that occurred in other areas, spurring over-investment in development projects and subsequent collapse of demand. Consequently, the earlier recessionary economy has not put as much pressure on some of Firstar's borrowers. Policy limits control this type of lending. Approximately sixty percent of these loans represent owner-occupied commercial properties. The remaining portion involves loans to developers and investors. The average loan size in the developer portion of the portfolio was $250,000 and reflects the regional focus and customer diversification of the portfolio.\nThe reserve for loan losses is reviewed and adjusted quarterly, subject to evaluation of economic conditions and expectations, historical experience and the risk rating of individual loans. Table 11 shows the activity affecting the reserve for loan losses for the last five years. The reserve totaled $172.6 million at the end of 1994, compared with $174.9 million a year earlier.\nTotal net charge-offs of $22.9 million represented .25% of average loans during 1994, the same level as experienced in 1993.\nAs a regional financial institution, Firstar lends to a diversified group of Midwestern borrowers and, to a much lesser degree, to national companies with Midwest operations. Net charge-offs in this commercial segment of the portfolio were $10.8 million, or .32% of average loans. This compares with $6.1 million of net charge-offs in 1993, representing .20% of loans. This charge-off level, while up from the prior year, remains lower than earlier years.\nCommercial real estate loans experienced a net recovery of prior years' charge-offs in 1994 of $732,000. This compares with nominal net charge-offs of .03% in 1993. These charge-off levels are unusually low and Firstar would expect that commercial real estate charge-offs will in the long run approximate the overall charge-off rate of the other commercial lending areas.\nTABLE 11\nRESERVE FOR LOAN LOSSES\nConsumer lending includes loans to individuals in communities served by Firstar's banks. These loans include both open-ended credit arrangements subject to an overall limit per customer, such as credit card and home equity loans, and closed-end loans subject to specific contractual payment schedules, such as installment loans and residential mortgages. Consumer net charge-offs were $13.4 million in 1994, compared with $14.6 million in 1993 and $19.1 million in 1992. The net charge-offs of .36% in 1994 compares with .43% and .61% in 1993 and 1992, respectively. Credit card net charge-offs have declined from 2.90% in 1991 to 1.93% during 1994 reflecting both lower charge-offs and higher recovery rates. This progressive reduction in\nconsumer charge-off levels reinforces the conclusion about the economic strength of Firstar's marketplace. Consumer charge-offs are expected to remain at or near this level.\nTABLE 12\nCOMPOSITION OF LOANS\n- ------------ * Comparable data not available\nLIQUIDITY AND INTEREST RATE RISK MANAGEMENT\nTwo objectives of Firstar's asset and liability management strategy include the maintenance of appropriate liquidity and management of interest rate risk. Liquidity management aligns sources and uses of funds to meet the cash flow requirements of customers and Firstar. Interest rate risk management seeks to generate growth in net interest revenue and manage exposure to risks associated with interest rate movements and provide for acceptable and predictable results. Although conceptually distinct, liquidity and interest rate sensitivity must be managed together since action taken with respect to one often influences the other.\nThe scheduled maturity of loans can provide a source of asset liquidity. Table 13 shows the range of loan maturities as of December 31, 1994. Short-term investments, such as federal funds, repurchase agreements and interest-bearing deposits, are another source of liquidity. These investments stood at $376 million at the end of 1994. The securities portfolio provides liquidity through scheduled maturities, as shown in Table 7, and the ability to use these securities in borrowing transactions. Additionally, those securities designated as available for sale were $51 million at the end of 1994 and can be sold to meet liquidity needs.\nTABLE 13\nMATURITY DISTRIBUTION OF LOANS\n- ------------ The maturity is based upon contractual terms and Firstar may however extend the maturity at prevailing rates and terms in the normal course of business.\nOf the above loans due after one year, $4,147,088,000 have predetermined interest rates and $2,019,961,000 have floating or adjustable interest rates.\nTABLE 14\nMATURITY RANGE OF TIME DEPOSITS\nThe requirement of liquidity is diminished by the predominance of core deposits, which account for 83% of Firstar's fund sources. Stable core deposits do not require significant amounts of liquidity to meet the net withdrawal demands of customers on a short or intermediate term basis. Other sources of liquidity are short-term borrowed funds and time deposits which totaled $2.7 billion at the end of 1994. Firstar's ability to refinance maturing amounts and, when necessary, increase this funding base is a significant factor in its liquidity management.\nThe absolute level and volatility of interest rates can have a significant impact on earnings. The objective of interest rate risk management is to identify and manage the sensitivity of net interest revenue to changing interest rates. Firstar uses computer simulation modeling as its primary method of quantifying and evaluating interest rate risk. Simulation modeling is performed at least quarterly and is used to quantify the impact on net interest revenue of various assumptions about interest rate and balance sheet changes and the use of off-balance sheet derivatives and financial instruments. The use of simulation modeling also enables Firstar to develop and test alternative asset and liability management strategies. Interest rate risk and the results of the simulation modeling is reviewed quarterly by bank, regional and corporate committees who assess the interest rate risk position and approve corresponding strategies. The objective of Firstar's asset liability management policy is to maintain adequate capital and liquidity and manage interest rate risk to produce an acceptable level of net interest revenue. Firstar's guideline is to employ an asset liability management strategy which limits the potential impact of projected interest rate changes to 5% of net income over the subsequent four quarters. In the most recent simulation, which excludes pending acquisitions, net interest revenue was forecast for 1995 under four interest rate scenarios. First, if current rates continued unchanged at the fourth quarter 1994 level with a prime rate of 8.50%, and then under most likely, high and low interest rate scenarios in which the prime rate changes to 9.25%, 10.50% and 7.00% respectively, by the fourth quarter of 1995.\nCompared to 1994 net interest revenue in 1995 would increase by $21 million if rates in the fourth quarter of 1994 remained unchanged throughout 1995. Under the most likely and low scenarios, net interest revenue in 1995 would increase by $9 million and $22 million, respectively, compared to 1994. Under the high scenario, net interest revenue would decline by $9 million compared to 1994.\nThe simulation model is supplemented with a tool used in the banking industry for measurement of interest rate risk known as the gap analysis. This measures the difference between assets and liabilities repricing or maturing within specified time periods. The gap analysis does however, have some limitations such as not reflecting the magnitude which assets or liabilities may reprice within a given interest rate scenario. A positive gap indicates that there are more rate sensitive assets than rate sensitive liabilities repricing within a given time frame. A positive gap would generally imply a favorable impact on net income in periods of rising rates. Conversely, a negative gap indicates a liability sensitive position. Table 15 shows Firstar's interest sensitivity under a traditional gap approach.\nWhile Firstar believes the above assumptions for the gap analysis and simulations are reasonable, actual interest rates and other factors could be significantly different from those assumed. Such differences could produce actual results which are different from projected results and the differences could be significant.\nTABLE 15\nASSET AND LIABILITY INTEREST SENSITIVITY\nFirstar seeks to manage interest rate risk by adjusting the pricing and levels of assets and liabilities along with the use of off-balance sheet derivative financial instruments. Firstar enters into interest rate swaps and interest rate caps and floors as part of this process. These derivative instruments synthetically alter the repricing characteristics of designated assets and liabilities. Additional information on derivative financial instruments are included in Notes 17 and 18 to the Consolidated Financial Statements.\nFirstar's off-balance sheet financial derivative portfolio has a notional value of $1.7 billion as of December 31, 1994. During 1993 and early 1994, Firstar's simulation modeling indicated a risk to net interest revenue in a falling rate environment. Under this scenario income on variable rate loans would be reduced and not matched by corresponding reductions in the cost of deposits being used to fund these loans. Such deposits, savings passbook, interest bearing transactions and money market accounts were deemed to have already reached their lowest cost point based on competitive considerations. Consequently, Firstar, in 1993 and early 1994, entered into approximately $1.3 billion of new off-balance sheet financial derivative instruments to mitigate this risk. Interest rates have subsequently increased and while Firstar is currently a net payor on the instruments, it is also realizing an increased net yield on the designated hedged assets and liabilities.\nNet cash flows of off-balance sheet derivative instruments used to manage interest rate risk contributed $930 thousand to net interest revenue during 1994 compared with $5.7 million in 1993 and $8.8 million in 1992. Expressed in terms of net interest margin, the financial derivative portfolio had no impact in 1994 compared with .05% in 1993 and .09% in 1992. Using the most likely interest rate scenario, it is expected that derivative financial instruments will result in a reduction of net interest margin of .10% in 1995.\nCapital\nTotal stockholders' equity increased 13.0% to $1.31 billion as of December 31, 1994. Stockholders' equity represented 8.65% of total assets at the end of 1994 compared to 8.38% a year earlier.\nFirstar redeemed its adjustable rate preferred stock at the end of 1993 at a price of $103 per share, or $51.5 million. This action removed a higher cost equity component.\nDividends paid to common stockholders totaled $75.1 million, or $1.16 per share, a 16% increase over 1993. This represented a 36% payout of net income for 1994. It is Firstar's target to maintain a dividend payout level approximately equal to the median of its peer group.\nBank regulatory agencies have established capital adequacy standards which are used extensively in their monitoring and control of the industry. These standards relate capital to level of risk by assigning different weightings to assets and certain off-balance sheet activity. Capital is measured by two risk-based ratios: Tier I capital and total capital, which includes Tier II capital. The rules require that companies have minimum ratios of 4% and 8% for Tier I and total capital, respectively. As of December 31, 1994, Firstar had Tier I capital of 11.68% and total capital of 13.46%, significantly exceeding regulatory minimum standards. The components of these capital levels are shown in Table 16.\nAdditionally, a Tier I leverage ratio is also used by bank regulators as another measure of capital strength. This ratio compares Tier I capital to total reported assets reduced by goodwill. The regulatory minimum level of this ratio is 3%, and it acts as a constraint on the degree to which a company can leverage its equity base. Firstar's Tier I leverage ratio was 8.58% at December 31, 1994.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 provided additional guidelines that considers capital levels and other factors. The guidelines established five supervisory groupings of capital adequacy. Firstar is considered \"well capitalized\" which is the highest group.\nMaintaining a strong capital position is important to Firstar's long-term strategies which emphasize soundness, profitability and growth. Higher capital levels contribute to overall financial soundness as a cushion against cyclical economic trends which can effect the banking industry. Strong capital levels also will permit future growth through both internal asset generation and bank acquisitions.\nTABLE 16\nCAPITAL COMPONENTS AND RATIOS\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFIRSTAR CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\n- ------------ The average balances are not covered by the Independent Auditors' Report.\nSee accompanying notes to consolidated financial statements.\nFIRSTAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes to consolidated financial statements.\nFIRSTAR CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nFIRSTAR CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nFIRSTAR CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994, 1993 AND 1992\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe significant accounting policies of Firstar Corporation and its subsidiaries are summarized as follows:\nPrinciples of consolidation--The consolidated financial statements include the accounts of Firstar and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. Results of operations of companies purchased are included from the date of acquisition. Financial statements have been restated to include companies acquired under pooling of interests when material. Certain prior year amounts have been reclassified to conform to current year classifications.\nSecurities--Purchases of securities that are made with the positive intent and ability to hold them to maturity are carried at cost, adjusted for amortization of premium and accretion of discount using a level yield method. Securities to be held for indefinite periods of time and not intended to be held to maturity or on a long-term basis are classified as available for sale and carried at market value. Valuation adjustments are recorded as an adjustment to stockholders' equity. Securities held for indefinite periods of time may include securities that management intends to use as part of its asset\/liability management strategy or have been acquired in business acquisitions and are designated to be sold. Gains or losses on sales of securities are computed on the basis of specific identification of the adjusted cost of each security. Trading securities are carried at market. Valuation adjustments are included in other revenue in the consolidated statements of income.\nLoans--Loans, which include lease financing receivables, are stated at the principal amount. Interest is accrued on all loans not discounted by applying the interest rate to the amount outstanding. On discounted loans, income is recognized on a basis which results in approximately level rates of return over the term of the loans. Loan origination and commitment fees and certain direct loan origination costs are being deferred where material and the net amount amortized as an adjustment of the related loans' yield. These amounts are being amortized over the contractual life of the related loans. Where it is not reasonable to expect that income will be realized, accrual of income ceases and these loans are placed on a \"cash basis\" for purposes of income recognition. Loans upon which foreclosure action is commenced or for which borrowers have begun bankruptcy proceedings are reviewed individually as to continuation of interest accrual. Mortgage loans held for sale are carried at the lower of aggregate cost or market, after consideration of related loan sale commitments.\nReserve for loan losses--The reserve for loan losses is maintained at a level adequate to provide for potential loan losses through charges to operating expense. The reserve is based upon a continuing review of loans which includes consideration of actual net loan loss experience, changes in the size and character of the loan portfolio, identification of problem situations which may affect the borrowers' ability to repay and evaluation of current economic conditions. Loan losses are recognized through charges to the reserve. Installment and credit card loan losses are charged to the reserve based upon fixed delinquency periods. All other loans are evaluated individually and charged to the reserve to the extent that outstanding principal balances are deemed uncollectible. Any subsequent recoveries are added to the reserve.\nOther Real Estate--Other real estate, the balance of which is included in other assets, includes primarily properties acquired through loan foreclosure proceedings or acceptance of deeds in lieu of foreclosure. These properties are recorded at the lower of the carrying value of the related loans or the fair market value of the real estate acquired less the estimated costs to sell the real estate. Initial valuation adjustments, if any, are charged against the reserve for loan losses. Subsequent reevaluations of the properties, which indicate reduced value, are recognized through charges to operating expense. Revenues and expenditures related to holding and operating these properties are included in other operating expense.\nBank premises and equipment--Bank premises and equipment are stated at cost less depreciation, which has been accumulated on the straight-line basis.\nIntangible assets--Intangible assets attributable to the value of core deposits and goodwill acquired are included in other assets and are amortized over fifteen to twenty-five years, on a straight-line basis. The value of mortgage servicing rights acquired is amortized in relation to the servicing revenue expected to be earned. Firstar periodically evaluates the carrying value and remaining amortization periods of intangible assets for impairment. Adjustments are recorded when the benefit of the intangible asset decreases due to disposition of branches or deposits with regard to goodwill and core deposit premium, and prepayments of serviced loans for purchased mortgage servicing rights.\nIncome taxes--Firstar and its subsidiaries file a consolidated federal income tax return. The effect of items of income and expense that are recognized for financial reporting purposes in periods other than those in which they are recognized for tax purposes are reflected as a current or deferred tax asset or liability based on current tax laws. Accordingly, income taxes provided in the consolidated statements of income include charges or credits for deferred income taxes related to temporary differences.\nForeign currency transactions--Monetary assets and liabilities recorded in foreign currencies are translated at the rate of exchange in effect at each year-end. Income statement items are translated monthly using the average rate for the month. Firstar enters into forward exchange contracts on behalf of its customers and hedges its risk by entering into offsetting transactions with other counterparties. The fair value of these transactions are included in other assets and liabilities and the related gain or loss is recorded in other revenue.\nCash and cash equivalents--For purposes of the consolidated statements of cash flows, cash and cash equivalents are considered to include the balance sheet caption cash and due from banks.\nDerivative and other financial instruments--Firstar enters into interest rate swaps and other financial instruments to manage interest rate risks arising from financial assets and financial liabilities and also as an intermediary for transactions with its customers. Interest rate instruments entered into as an intermediary are accounted for as trading instruments and are recorded in the balance sheet at fair value. Realized and unrealized changes in fair values are recognized in other operating revenue.\nAmounts receivable or payable under financial instruments used to manage interest rate risks are recognized as interest income or expense using the accrual method. Gains and losses on financial instruments qualifying as hedges of existing assets or liabilities are included in the carrying amount of those assets and liabilities. Gains and losses on early termination of interest rate swaps are included in the carrying amount of the related loan or debt and amortized as yield adjustments over the remaining term of the loan or debt. Fees paid or received in connection with interest rate floors and caps are deferred and amortized over the life of the instrument.\nIncome per common share--Net income per common share is based on the weighted average number of shares of common stock outstanding during each year, after giving effect to common stock splits and the amortization of restricted stock. The weighted average shares were 64,611,000 in 1994, 63,747,000 in 1993 and 61,879,000 in 1992. For calculation purposes, earnings are reduced by preferred stock dividends. Common stock equivalents are not significant in any year presented.\nNOTE 2. MERGERS AND ACQUISITIONS\nThe following table summarizes completed acquisitions:\nThe bank acquisitions shown above, accounted for as pooling of interests, were not material to prior years' reported operating results and, accordingly, previously reported results have not been restated.\nOn January 31, 1995, Firstar Corporation completed its merger with First Colonial Bankshares Corporation in a transaction accounted for as a pooling of interests. Firstar Corporation issued .7725 shares of Firstar common stock for each share of First Colonial Bankshares Corporation common stock. The total number of shares of Firstar common stock issued was approximately 7,700,000 shares.\nA summary of unaudited pro forma financial information giving effect to the merger with First Colonial Bankshares Corporation is shown below. The unaudited financial information is not indicative of the results that would have been realized had the entities been a single company during these periods, nor is it indicative of the actual results the combined company will report in the future. Firstar will present restated financial statements to reflect this transaction beginning with the fiscal quarter ended March 31, 1995.\nIn 1994, Firstar Corporation announced a merger agreement with Investors Bank Corp., a $1.1 billion thrift holding company in Wayzata, MN. The transaction will be accounted for as a pooling of interests with the issuance of approximately 3,000,000 shares of Firstar stock.\nIn 1994, Firstar Corporation announced a merger agreement with First Moline Financial Corporation, an $80 million thrift holding company in Moline, IL. The transaction will be accounted for as a purchase with the issuance of approximately 300,000 shares of Firstar stock.\nNOTE 3. INTANGIBLE ASSETS\nIntangible assets, net of accumulated amortization, are summarized as follows:\nNOTE 4. SECURITIES\nThe amortized cost and approximate market values of securities are as follows:\nThe amortized cost and approximate market value of securities at December 31, 1994, by contractual maturity, are shown below. Maturities of mortgage backed obligations were estimated based on anticipated payments.\nGross gains of $78,000, $232,000 and $1,106,000 and gross losses of $2,000, $50,000 and $125,000 were realized on securities sales in 1994, 1993 and 1992, respectively.\nThe amortized cost of securities pledged to secure public or trust deposits, securities sold under repurchase agreements and for other purposes as required or permitted by law was $806,461,000 at December 31, 1994 and $712,696,000 at December 31, 1993.\nNOTE 5. LOANS\nThe composition of loans, including lease financing receivables, is summarized below. Loans are presented net of unearned discount which amounted to $17,989,000 and $10,938,000 at December 31, 1994 and 1993, respectively. Commercial loans pledged to secure public deposits were $5,526,000 on December 31, 1994 and $15,444,000 on December 31, 1993. Firstar serviced $2,551 million, $2,045 million and $1,672 million of mortgage loans for other investors as of December 31, 1994, 1993 and 1992, respectively. Residential mortgage loans held for resale were $22,511,000 and $215,950,000 on December 31, 1994 and 1993, respectively.\nLoans on which income is recognized only as cash payments are received or is accrued at less than the original contract rate are summarized below.\nThe effect of nonperforming loans on interest revenue was as follows:\nCertain executive officers, directors, shareholders, and their associates of Firstar and significant subsidiaries are loan customers of the banking subsidiaries. Loans outstanding to such parties were $101.1 million on December 31, 1994 and $109.3 million on December 31, 1993. During 1994 new loans of $16.5 million were made and loan payments of $24.7 million were received. These loans were made in the ordinary course of business and on substantially the same terms as those prevailing for comparable transactions with other persons.\nNOTE 6. RESERVE FOR LOAN LOSSES\nAn analysis of the reserve for loan losses is as follows:\nThe Financial Accounting Standards Board issued Statement No. 114, \"Accounting by Creditors for Impairment of a Loan\", which is effective in 1995. The Statement established procedures for determining the appropriate reserve for loan losses for loans deemed impaired. The calculation of reserve levels would be based upon the discounted present value of expected cash flows received from the debtor or other measures of value such as market prices or collateral values. This statement was adopted January 1, 1995 and did not have any significant impact on the current level of the reserve for loan losses and is not expected to effect 1995 operating results.\nNOTE 7. BANK PREMISES AND EQUIPMENT\nBank premises and equipment are summarized as follows:\nDepreciation charged to other operating expense amounted to $34,187,000, $34,385,000 and $33,418,000 in 1994, 1993 and 1992, respectively. Rental expense for bank premises and equipment amounted to $30,045,000, $30,079,000 and $28,843,000 in 1994, 1993 and 1992, respectively. Contingent rentals and sublease rental income amounts were not significant.\nOccupancy expense is net of amortization of a total of $68 million of pre-tax deferred gain on a building sale which is being amortized through 1997, at which time the related leaseback expires. This amortization was $9,029,000 in 1994 and $6,312,000 in 1993 and 1992.\nFirstar and its subsidiaries are obligated under noncancellable operating leases for various bank premises and equipment. These leases expire intermittently over the years through 2034. The minimum rental commitments under noncancellable leases for the next five years are shown below.\nNOTE 8. SHORT-TERM BORROWED FUNDS\nShort-term borrowed funds are summarized as follows:\nFederal funds purchased, which totaled $1,636 million at December 31, 1994, generally represent one-day borrowings obtained primarily from financial institutions in Firstar's marketplace in conjunction with their customer correspondent relationships with the subsidiary banks. Securities sold under repurchase agreements, which totaled $454 million at December 31, 1994, represent borrowings maturing within one year that are secured by U.S. Treasury and federal agency securities. Other short-term borrowed funds comprise primarily treasury, tax and loan notes.\nNOTE 9. LONG-TERM DEBT\nLong-term debt is summarized as follows:\nFirstar issued $100,000,000 of 10 1\/4% notes under an indenture dated as of May 1, 1988. The notes, which are subordinated to all unsubordinated indebtedness of Firstar for borrowed money, are unsecured and mature May 1, 1998. The indenture contains a provision which restricts the disposition of or subjecting to lien any common stock of certain subsidiaries.\nFirstar issued $50,000,000 of 10% notes under an indenture dated as of June 1, 1986. The notes are unsecured and mature June 1, 1996. The indenture contains a provision which restricts the disposition of or subjecting to lien any common stock of certain subsidiaries.\nOther debt at December 31, 1994 includes notes of $2,706,000 which bear interest at 11.50% and mature in 1996 and loans sold under a repurchase agreement of $10,000,000 which mature in 1999 and bear interest at a variable LIBOR based rate.\nLong-term debt has aggregate maturities for the five years 1995 through 1999 as follows: $75,000 in 1995, $46,616,000 in 1996, $78,397,000 in 1998 and $10,000,000 in 1999.\nFirstar has repurchased portions of the 10 1\/4% and 10% notes and incurred losses of $25,000, $57,000 and $605,000, in 1994, 1993 and 1992, respectively.\nNOTE 10. STOCKHOLDERS' EQUITY\nThe authorized and outstanding shares of Firstar are as follows:\nUnder the Firstar Shareholder rights plan each share of common stock entitles its holder to one-half right. Under certain conditions, each right entitles the holder to purchase one one-hundredth of a share of series C preferred stock at a price of $85, subject to adjustment. The rights will only be exercisable if a person or group has acquired, or announced an intention to acquire, 20% or more of the outstanding shares of Firstar common stock. Under certain circumstances, including the existence of a 20% acquiring party, each holder of a right, other than the acquiring party, will be entitled to purchase at the exercise price Firstar common shares having a market value of two times the exercise price. In the event of the acquisition of Firstar by another company subsequent to a party acquiring 20% or more of Firstar common stock, each holder of a right is entitled to receive the acquiring company's common shares having a market value of two times the exercise price. The rights may be redeemed at a price of $.01 per right prior to the existence of a 20% acquiring party, and thereafter, may be exchanged for one common share per right prior to the existence of a 50% acquiring party. The rights will expire on January 19, 1999. The rights do not have voting or dividend rights and until\nthey become exercisable, have no dilutive effect on the earnings of Firstar. Under the rights plan, the Board of Directors of Firstar may reduce the thresholds applicable to the rights from 20% to not less than 10%.\nPreferred shares, when issued, rank prior to common shares both as to dividends and liquidation but have no general voting rights. The series C preferred stock, none of which is outstanding, is entitled to 100 votes per share and other rights such that the value of a one one-hundredth interest in a series C preferred share should approximate the value of one common share.\nFirstar redeemed all of its series B preferred stock on December 29, 1993 at $103 per share plus accrued dividends. Dividends deducted from net income for purposes of determining net income applicable to common stockholders were $3,266,000 in 1993 and $3,747,000 in 1992.\nIn conjunction with long-term incentive plans, 30,235 shares of restricted common stock are being held in escrow for executive officers as of December 31, 1994. The shares cannot be sold prior to the end of a three-year period and are subject to adjustment in accordance with the terms of the award.\nFirstar reacquired 234,200 shares of its common stock during 1994 which are expected to be reissued in 1995 in connection with a specific purchase business combination.\nOn January 31, 1995 Firstar issued 38,775 shares of Series D preferred stock in connection with its merger with First Colonial Bankshares Corporation. These shares are convertible into 832,112 shares of Firstar common stock and are redeemable after June 30, 1997.\nNOTE 11. STOCK OPTIONS\nFirstar has an incentive stock plan that provides for a maximum grant of 5,600,000 stock options, stock appreciation rights and\/or shares of stock. The options expire ten years and one month after the date of grant.\nThe following table summarizes option activity under these plans:\nAt December 31, 1994, options to acquire 989,500 shares were exercisable. In January 1995, options to acquire 499,300 shares of common stock at $27.38 to $27.50 per share were granted.\nNOTE 12. OTHER OPERATING EXPENSE\nA summary of other operating expense is as follows:\nNOTE 13. EMPLOYEE BENEFIT PLANS\nFirstar and its subsidiaries have non-contributory defined benefit pension plans covering substantially all employees. The benefits are based upon years of service and the employee's compensation during the last five years of employment. The funding policy is to contribute annually the minimum amount necessary to satisfy federal minimum funding standards. Plan assets are primarily invested in listed stocks and U.S. Treasury and federal agency securities. The table below summarizes data relative to the plans.\nFirstar also has unfunded pension plans covering certain employees. Interest rates used in calculating the actuarial values are essentially the same as in the previously described plans. The table below summarizes data relative to the plans.\nFirstar has profit sharing plans under which eligible employees can participate by contributing a portion of their salary for investment in one or more trust funds. Contributions are made to the account of each participant based upon profitability or at the discretion of the board of directors. Amounts expensed in connection with this plan were $10,382,000 in 1994, $9,667,000 in 1993 and $8,539,000 in 1992.\nIn addition to pension benefits, certain health care benefits are made available to active and retired employees. The table below summarizes data relative to this benefit program. The program is unfunded and the transition obligation is being amortized over 20 years.\nFor measurement purposes, an 11% annual rate of increase in the per capita cost of covered health care benefits was assumed, decreasing to 6% by 2004 and remaining at that level thereafter. The health care cost trend rate assumption has an effect on the amounts reported. To illustrate, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement accumulated benefit obligation by $4,954,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by $405,000. The discount rate used in determining the accumulated postretirement benefit obligation was 8.50% and 7.75% at December 31, 1994 and 1993, respectively.\nNOTE 14. INCOME TAXES\nStatement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", was adopted by Firstar on January 1, 1993. The cumulative effect of adoption of Statement No. 109 did not have a significant effect on net income in 1993.\nThe taxes applicable to net income were as follows:\nIncome tax expense differed from the amount computed by applying the federal statutory rate of 35% (34% in 1992) to income before taxes as shown below:\nThe significant components of deferred income tax expense attributable to income from continuing operations are as follows:\nThe significant components of the net deferred tax asset were as follows:\nThe deferred tax asset increased due to tax benefits recorded on securities which were marked-to-market in accordance with Statement No. 115 and the acquisition of First Southeast Banking Corp.\nThe valuation allowance has been recognized primarily to offset deferred tax assets related to state net operating loss carryforwards totaling approximately $187,000,000 which expire at various times within the next 15 years. If realized, the tax benefit for these items will reduce current tax expense for that period. Net deferred tax assets of $2,358,000 including a valuation allowance of $1,275,000 were added in 1994 due to the acquisition of First Southeast Banking Corp.\nOther assets include net deferred income tax charges of $75,638,000 and $71,298,000 at December 31, 1994 and 1993, respectively. Furthermore, amounts originally reported for 1993 have been reclassified to reflect actual tax return results.\nNOTE 15. COMMITMENTS AND CONTINGENT LIABILITIES\nFirstar has outstanding at any time a significant number of commitments to extend credit to its customers. These commitments include revolving credit agreements, term loan commitments, short-term borrowing agreements and standby letters of credit. These commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.\nCommitments to extend credit are agreements to lend to a customer as long as there is not a 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.\nCredit card commitments are unsecured agreements to extend credit. Such commitments are reviewed periodically, at which time the commitments may be maintained, increased, decreased or canceled depending upon evaluation of the customer's credit worthiness and other considerations.\nStandby and commercial letters of credit are conditional commitments issued by Firstar to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions.\nFirstar uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Firstar evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management's credit evaluation of the party.\nFirstar originates and sells residential mortgage loans as a part of various mortgage-backed security programs sponsored by United States government agencies or government-sponsored agencies, such as the Federal Home Loan Mortgage Corporation, the Federal National Mortgage Association and the Government National Mortgage Association. These sales are often subject to certain recourse provisions in the event of default by the borrower.\nThe following is a summary of such commitments:\nFirstar and its subsidiaries are subject to various legal actions and proceedings in the normal course of business, some of which involve substantial claims for compensatory or punitive damages. Although litigation is subject to many uncertainties and the ultimate exposure with respect to these matters cannot be ascertained, management does not believe that the final outcome will have a material adverse effect on the financial condition of Firstar.\nNOTE 16. REGULATORY RESTRICTIONS ON SUBSIDIARY DIVIDENDS AND CASH\nFederal regulations require Firstar to maintain as reserves, minimum cash balances based on deposit levels at subsidiary banks. Cash balances restricted from usage due to these requirements were $248 million and $267 million at December 31, 1994 and 1993, respectively.\nFirstar's subsidiary banks are restricted by regulation as to the amount of funds which can be transferred to the parent in the form of loans and dividends. As of December 31, 1994, $128 million could be loaned to Firstar by the subsidiary banks subject to strict collateral requirements, and $250 million could be loaned to Firstar by the subsidiary banks in the form of dividends. In addition each subsidiary bank could pay dividends to Firstar in an amount which approximates Firstar's equity in their 1995 net income. The payment of dividends by any subsidiary bank may also be affected by other factors beyond this regulatory limitation, such as maintenance of adequate capital for such subsidiary bank.\nNOTE 17. DERIVATIVE FINANCIAL INSTRUMENTS\nRate Risk Management\nAs part of its asset and liability management, Firstar uses various types of interest rate contracts for the purpose of managing its interest rate risks. The use of interest rate contracts enables Firstar to synthetically alter the repricing characteristics of designated earning assets and interest-bearing liabilities. The following tables summarize the notional amounts of interest rate contracts at December 31, 1994, used by Firstar in its asset and liability management process:\nIndex amortizing interest rate swaps are used to convert variable rate loans to a fixed rate basis. The amortizing feature of these swaps serves to extend the maturity after a predetermined mandatory period if the three-month LIBOR index rate is above a pre-established reference rate on a quarterly basis. Additionally, the notional amount of the swaps is reduced on a quarterly basis based upon pre-established rates beginning in 1997.\nInterest rate swaps used to convert fixed rate loans to variable rate loans or vice versa have a total notional value of $112 million on December 31, 1994.\nInterest rate swaps with periodic caps involve the exchange of LIBOR based variable interest payments with one party receiving a fixed basis point shim over the LIBOR index, subject to a 25 basis point cap in quarterly increases in rates receivable by Firstar. These swaps were entered into in 1993 and early 1994, when interest rates were at cycle lows, to preserve the net interest margin on variable rate loans which were funded by low cost savings and transaction deposit accounts. These swaps hedge loans of $230 million and deposits of $700 million.\nInterest rate floors provide for the receipt of payments when the three month LIBOR rate is below a predetermined interest rate floor. Firstar entered into $195 million of floors to hedge variable rate loans against a decline in interest rates. Floors were also entered into to hedge $106 million of deposits where such deposits have a guaranteed interest rate.\nInterest rate caps provide for the receipt of payments when the three month LIBOR rate exceeds predetermined interest rate caps. These instruments manage interest rate risk on certain securities and loans.\nThe maturity range of derivative financial instruments as of December 31, 1994 is as follows:\n- ------------ All interest rates represent rates in effect on December 31, 1994.\nIndex rate for interest rate caps\/floors is three month LIBOR.\nThe notional values of derivative financial instruments represent the amounts on which interest payments are exchanged between the counterparties. Those notional values do not represent direct credit exposures. Firstar is exposed to credit-related losses in the event of nonperformance by counterparties to these instruments but does not expect any counterparty to fail to meet their obligations. Where appropriate, Firstar requires collateral based upon the positive market value of the exposure taking into account bi-lateral netting agreements with certain counterparties. Based on market values, Firstar's credit exposure was $3.6 million at December 31, 1994.\nFirstar enters into both mandatory and optional commitments to sell groups of residential mortgage loans that it originates or purchases as part of its mortgage banking activities. Firstar commits to sell the loans at specified prices in a future period typically within 90 days. The risk associated with these commitments consists primarily of loans not closing in sufficient volumes and at appropriate yields to meet the sale commitments. Firstar had contracts totaling $22 million and $202 million on December 31, 1994 and 1993 respectively. Gains or losses on these contracts are included in the determination of the market value of mortgages held for sale.\nTrading Activities\nFirstar also acts as an intermediary for customers in their management of interest rate and foreign currency rate risk. In this regard, Firstar will enter into interest rate swaps, caps, floors and foreign exchange contracts with customers to minimize their exposure to market risk. Firstar enters into essentially offsetting transactions with other counterparties. Customer related derivative activity is marked to market value. The credit exposure at December 31, 1994 of $21.1 million is represented by the fair value of contracts with a positive value. Gross credit exposure amounts disregard the value of any collateral. Revenue from this intermediary activity was $3.2 million and $1.8 million in 1994 and 1993 respectively.\nInformation on these transactions is shown below:\nNOTE 18. FAIR VALUE OF FINANCIAL INSTRUMENTS\nStatement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments\", requires that Firstar disclose estimated fair values for its financial instruments. Fair value estimates were based on relevant market data and information about the various financial instruments. These estimates do not reflect any premium or discount that could result from offering for sale at one time Firstar's entire holdings of a particular financial instrument. Because no market exists for a significant portion of Firstar's financial instruments, fair value estimates are based on judgements regarding current economic conditions, risk characteristics of various financial instruments, future expected loss experience, and other factors. These estimates are subjective and involve uncertainties and matters of significant judgement and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.\nFair value estimates are based on existing on and off balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities which are not considered financial instruments. Significant assets that are not considered financial instruments include goodwill, core deposit intangibles, certain customer relationships and fixed assets. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered.\nFair value estimates, methods, and assumptions are set forth below for Firstar's financial instruments.\nCash and short-term investments--The carrying amounts for short-term investments (which include interest-bearing deposits with banks, federal funds sold and resale agreements) approximate fair value because they mature in 90 days or less and do not represent unanticipated credit concerns.\nSecurities--Estimated fair value for securities is based on quoted market prices. The fair value of certain small issues and municipal securities which are not readily available through market quotations is assumed to equal carrying value as these securities generally have short terms. These securities do not represent a significant portion of the portfolio.\nLoans--Fair values were estimated for loans with similar financial characteristics. The commercial loan portfolio was separated into credit risk categories by variable and fixed rate loans. The fair value of performing loans, except for internally criticized commercial and lease financing loans, was calculated by discounting cash flows using an estimated discount rate that reflects current market rates, the type of loan, credit risk inherent in the loan category and repricing characteristics. Fair value for criticized commercial loans was calculated by reducing the carrying value by an amount that reflects the estimated principal loss. This loss was based on internal credit analysis of specific borrowers taking into consideration past loan loss experience and trends in loan quality. For lease financing loans, carrying value was considered to approximate fair value.\nThe fair value of credit card loans was estimated using the net present value method. Credit card portfolios are not actively traded and the discount rate used reflects an estimated rate of return based on the credit quality of the portfolio. This estimate does not include the value that relates to estimated cash flows from new loans generated from existing cardholders over the remaining life of the portfolio. For residential mortgages, fair value was estimated by discounting cash flows adjusted for anticipated prepayments using discount rates based on current market rates for similar loans.\nDeposits--The fair value of deposits with no stated maturity, such as interest bearing and non-interest bearing demand, savings and money market accounts, is equal to the amount payable on demand. The fair value of certificates of deposit is based on the discounted value of contractual cash flows using current market rates for similar types of deposits.\nBorrowed funds--The carrying value of short-term borrowed funds approximate fair value as they are payable within three months or less. The estimated fair value of long-term debt is based on broker quotations, when available. Debt for which quoted prices were not available was valued using cash flows discounted at a current market rate for similar types of debt.\nDerivative financial instruments--The fair value of interest rate swap agreements is based on the present value of the swap primarily using dealer quotes. Fair values for caps and floors were obtained using an option pricing model. These values represent the estimated amount Firstar would receive or pay to terminate the contracts or agreements taking into account current interest rates and market volatility. The fair value of commitments to extend credit and standby letters of credit was estimated using fees currently charged to enter into similar agreements. The fair value of credit card lines is based on cardholder fees currently being charged.\nThe estimated fair value of Firstar's financial instruments is summarized as follows:\nNOTE 19. PARENT CORPORATION CONDENSED FINANCIAL STATEMENTS\nBALANCE SHEETS\nSTATEMENTS OF INCOME\nSTATEMENTS OF CASH FLOWS\n[KPMG Letterhead]\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Firstar Corporation:\nWe have audited the accompanying consolidated balance sheets of Firstar Corporation and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended December 31, 1994. These consolidated financial statements are the responsibility of the Corporation'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 Firstar Corporation and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles.\n[Signature]\nKPMG Peat Marwick LLP\nMilwaukee, Wisconsin January 19, 1995\nFIRSTAR CORPORATION AND SUBSIDIARIES SUMMARY OF QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nFIRSTAR CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME AND FINANCIAL RATIOS\nFIRSTAR CORPORATION AND SUBSIDIARIES\nCONSOLIDATED AVERAGE BALANCE SHEETS, NET INTEREST REVENUE AND RATE ANALYSIS\nInterest and rates are calculated on a taxable equivalent basis, using a tax rate of 35% in 1994 and 1993 and 34% in 1992, 1991 and 1990. The rate calculations include the effect of certain loans on which income is recognized only as cash payments are received or is accrued at less than the original contract rate.\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 Notice of the 1995 Annual Meeting and Proxy Statement filed pursuant to Regulation 14A is incorporated herein by reference.\nThe executive officers of Firstar Corporation are listed under Item 1 of this document.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Notice of the 1995 Annual Meeting and Proxy Statement filed pursuant to Regulation 14A is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Notice of the 1995 Annual Meeting and Proxy Statement filed pursuant to Regulation 14A is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Notice of the 1995 Annual Meeting and Proxy Statement filed pursuant to Regulation 14A 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 financial statements of Firstar Corporation are filed as a part of this document under Item 8. Financial Statements and Supplementary Data.\nConsolidated Balance Sheets as of December 31, 1994 and 1993\nConsolidated Statements of Income for the Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nIndependent Auditors' Report\n(A)2. FINANCIAL STATEMENT SCHEDULES\nAll financial statement schedules have been included in the consolidated financial statements or are either not applicable or not significant.\n(A)3. EXHIBITS\n- ------------ * Executive Compensation Plans\nA copy of the exhibits listed herein can be obtained by writing to Mr. William H. Risch, Senior Vice President-Finance and Treasurer, Firstar Corporation, P.O. Box 532, Milwaukee, Wisconsin 53201.\n(B) No reports on Form 8-K were filed during the fourth quarter of 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.\nFIRSTAR CORPORATION\n-------------------------------------- Roger L. Fitzsimonds March 20, 1995 Chairman and Chief Executive Officer\nPursuant to the requirement 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.\nDIRECTORS\nMichael E. Batten* John H. Hendee, Jr.* Daniel F. McKeithan, Jr.* Robert C. Buchanan* Jerry M. Hiegel* George W. Mead II* George M. Chester, Jr.* Joe Hladky* Guy A. Osborn* Roger H. Derusha* C. Paul Johnson* Judith D. Pyle* James L. Forbes* James H. Keyes* Clifford V. Smith, Jr.* Holmes Foster* Sheldon B. Lubar* William W. Wirtz* Joseph F. Heil, Jr.*\nINDEX TO EXHIBITS","section_15":""}
{"filename":"722692_1994.txt","cik":"722692","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nSurgical Care Affiliates, Inc. (\"SCA\" or the \"Company\") was incorporated under the laws of Tennessee in 1982 and was reincorporated under the laws of Delaware in 1986. SCA develops, owns and operates outpatient surgical care centers. On December 1, 1993, SCA distributed to its shareholders all of its shares of HealthWise of America, Inc., its wholly-owned managed care subsidiary.\nSURGERY CENTERS\nAn outpatient or ambulatory surgical care center is a facility that is designed, equipped and staffed for performance of the surgical procedures which generally do not require overnight hospitalization and which the treating physician chooses not to or cannot perform in his or her office. Approximately 500 types of surgical procedures can be performed in the Company's centers. SCA believes that outpatient surgical care centers help control health care costs. In the areas where SCA centers operate, the Company believes that the fees charged by its outpatient surgical centers are less than the fees charged by hospitals for similar services performed on an outpatient basis. Because of the cost advantages of ambulatory surgical care centers and continuing cost containment pressures, private health insurers and Medicare and Medicaid programs have added ambulatory surgery as a covered benefit.\nThe Company's ownership interest in surgical care centers typically consists of all the capital stock of corporations which are general partners of a limited or general partnership which owns and operates the center. In some instances, separate partnerships have been formed to own or lease the real estate and equipment. The other general and limited partners of the partnerships are physicians who practice in the communities where the surgical care center is located or, in the case of joint ventures, other local health care providers. SCA and participating partners share the center's operating income or loss and receive distributions of any excess cash on a quarterly basis.\nDuring 1994, SCA acquired five centers and built five centers. SCA is currently building two centers and expects to build or acquire a total of 10-12 centers in 1995.\nThe table below sets forth certain information concerning each of the outpatient surgery centers owned at December 31, 1994.\n(1) includes direct and indirect ownership interests\nORGANIZATIONAL STRUCTURE OF SURGICAL CARE CENTERS\nIn connection with the development of outpatient surgical care centers, the Company generally forms a limited or general partnership to operate the center. A subsidiary of SCA is typically a general partner and local physicians or health care providers are limited or general partners in such partnerships. SCA sells partnership interests in these partnerships to physicians who utilize the Company's surgical care centers, but typically maintains a majority interest in the partnerships operating each center. The proceeds from the sale of the partnership interests provide the partnership with the necessary equity to offset part of the capital investment in the surgical center and also provide start-up working capital. The use of such partnerships can generate local medical community support for its surgical care centers by providing physicians with a continuing participation in these centers. The Company believes that in order to fully realize these objectives, at least 15 physicians should initially own partnership interests in each of its surgical care centers.\nSCA and participating physicians receive a pro rata share, based on their ownership interest in a surgical care center, of the center's operating income or loss and receive distributions of any excess cash on a quarterly basis. The participating physicians may also own interests in the real property and equipment relating to the Company's centers and are allocated a corresponding amount of the depreciation related thereto. The Company enters into a management agreement with each operating partnership pursuant to which the Company provides management, administrative and purchasing services and support, and financial guarantees. The Company charges a management fee for these services based on a percentage of annual charges ranging from 5% to 7%. For the years ended December 31, 1992, 1993 and 1994, management fees of $10,273,866, $13,260,505, and $16,933,346, respectively, were recorded by SCA.\nMANAGEMENT AND OPERATION OF SURGICAL CARE CENTERS\nThe typical SCA surgical care center is a freestanding facility of 8,500 to 12,500 square feet with four to six fully equipped operating rooms and ancillary areas for reception, preparation, recovery and administration. The Company's centers are normally open weekdays from 6:00 a.m. to approximately 4:00 p.m. The Company estimates that a four-operating room surgical care center can accommodate up to 6,000 procedures per year.\nEach of the Company's centers is available for use only by licensed physicians, oral surgeons and podiatrists who have admitting privileges in nearby hospitals. Typically, each center has a medical advisory committee which reviews the professional credentials of physicians applying for staff privileges and reviews the quality of care at the center. The Company's surgical care centers generally require a staff of between 10 and 25 employees, depending on case load. The staff includes one or more medical directors, anesthesiologists, registered nurses, operating room technicians, a business manager\/bookkeeper and clerical workers. Generally, the medical director is a practicing surgeon who is responsible for and supervises the\nquality of medical care provided at the center. SCA believes that attracting personnel of high professional standing in the local community is crucial to the success of the individual center.\nAll surgical procedures performed in the Company's centers are non-emergency, low risk procedures that are generally performed to correct conditions that are not life-threatening. Approximately 500 different types of procedures can be performed in the Company's centers. The procedures most commonly performed at the Company's surgical care centers within various specialties are:\n* Ear, nose and throat--removal of tonsils and adenoids and insertion of ear drainage tubes. * Gynecology--laparoscopy, tubal ligation, and dilation and curettage. * Orthopedic--arthroscopy, fracture repair and tendon repair. * Oral--wisdom teeth extraction and dental restoration. * General Surgery--hernia repair, biopsy and removal of lesions of the female breast and pilonidal cysts. * Plastic surgery--facelifts, rhinoplasty, eyelid surgery and breast augmentation. * Urology--cystoscopy, vasectomy and circumcision. * Ophthalmology--removal of cataracts and lens implantation. * Neurosurgery--hand surgery and nerve repair. * Podiatry--foot surgery.\nThe decision to use one of the Company's centers is generally made by the patient's physician after discussion with the patient. An evaluation of the procedure and the patient's overall health must also be made by the center's anesthesiology staff.\nThe Company's surgical care centers do not perform surgery on an emergency basis. Patients arrive at the center approximately one hour before scheduled surgery to allow time for admitting, laboratory tests and medical history. A local or general anesthetic is administered and the surgery is performed.\nAfter completion of surgery, patients usually spend up to three hours in the recovery area before release by the center's anesthesiology staff. The patient is called on the day following the surgery to check on the patient's condition. When a surgical center patient requires an extended period for recuperation, the patient is transferred to a hospital.\nThe Company currently has 31 centers with a total of 72 overnight recovery rooms. Patients can remain overnight in these rooms, but, because of licensing regulations, cannot stay in the center any longer than 23 1\/2 hours. This allows the attending physicians to perform more intensive procedures which may require overnight recovery and observation. The Company expects to add overnight recovery rooms to existing centers and include them in new centers where allowed by the applicable State law. Medicare patients cannot be kept overnight by regulation.\nSCA centers' general fees range between $600 and $4,000 for each procedure. The center's fee does not include either the anesthesiologist's charges or the charges of the patient's physician, both of which are billed separately. Each of the Company's centers collects fees directly from insurance carriers, Medicare or Medicaid, employers or patients. The Company seeks to minimize bad debts by verifying insurance coverage or by advance collection from the patient. SCA estimates that approximately 20% of its centers' patients are covered by commercial insurance, 31% by Medicare, 11% by Blue Cross and 7% self-pay. The Company estimates that 21% of its patients in 1994 were members of a health maintenance or preferred provider organization. The Company estimates that approximately 10% of patients are covered by Medicaid, Workman's Compensation and CHAMPUS.\nThe Company bills in a variety of different ways which are usually dictated by a contract between the Company and payors. In a majority of situations, the Company bills the payor a negotiated amount. This negotiated fee arrangement applies to patients covered under Medicare, Medicaid, some Blue Cross plans and patients enrolled in health maintenance or preferred provider organizations.\nUnder the Medicare program, the largest single payor to the Company, the Secretary of Health and Human Services determines amounts prospectively for categories of procedures performed at outpatient surgery centers. On October 1, 1992, Medicare increased its reimbursement rates to surgery centers by 3.5%. In 1993, Medicare announced that reimbursement rates would not be increased for the fiscal years beginning October 1, 1993 and 1994.\nMedicare rates for the reimbursement for inter-ocular lens were significantly reduced by $50 (from $200 to $150) beginning January 1, 1994. Medicare may reduce reimbursement rates again beginning October 1, 1995.\nIn the 1994 Congressional session, the Clinton Administration, as well as numerous members of Congress introduced a variety of legislative proposals designed to change access to and payment for health care services in the United States. Although no such health reform initiative was passed by Congress in 1994, it is uncertain what effect, if any, reform to the health care system would have on the Company. Various states have also enacted health care reform plans or are in the process of doing so. The Company cannot predict how such proposals may impact the way that it does business. A reduction in the rates set by Medicare could have an adverse effect on the Company. Other kinds of cost controls or limits on the ability to raise prices could also have a negative impact. The Company does believe, however, that it is a low cost provider of surgery. To the extent that higher cost providers of surgery, namely hospitals, also see their reimbursement rates lowered, there could be a movement of cases from the outpatient units at hospitals to surgery centers. This could increase the profits of the Company since variable costs on incremental volume are lower than average costs. The Company believes that its experienced management team and low cost structure will allow it to remain competitive regardless of changes in health care practices.\nTECHNOLOGICAL DEVELOPMENTS\nOver the last several years there has been a significant improvement in the medical technology and equipment used by physicians during surgery. The use of fiber optics has resulted in the perfection of the laparoscope and arthroscope which now allow certain invasive procedures to be performed on an outpatient basis. Specifically, the gallbladder is now being removed on an outpatient basis using the fiber optic laparoscope and surgical laser. Arthroscopically assisted ligament reconstruction and rotator cuff repair are also now being done by orthopedic surgeons on an outpatient basis. Other surgeries starting to gravitate to an outpatient basis include: Vaginal Hysterectomies, Oophorectomy (removal of the ovaries), Ablation of Endometriosis (laser treatment of abnormal uterine tissue), Modified Radical Mastectomies (excision of breast tissue), and Thyroidectomy (removal of thyroid glands). The Company expects these technologies to continue to be perfected in the future resulting in a larger percentage of surgery being performed on an outpatient basis.\nEXPANSION PLANS\nThe Company intends to increase the number of its centers by developing new freestanding facilities, developing centers with hospitals and others through joint arrangements and acquiring existing centers, and to increase utilization of its existing centers through aggressive marketing programs.\nSCA's strategy for the development of ambulatory services focuses on:\n* Establishing settings where physicians can practice to their maximum efficiency, and\n* Providing managerial and administrative services through a nationwide corporate structure, and\n* Providing opportunities for local physicians to participate with SCA in the ownership of health care facilities.\nSCA provides each of its outpatient health care centers a full range of development and operating services from the corporate headquarters including the following:\nCapitalization - As needed, the SCA corporate office provides working capital to fund anticipated start-up losses and loans or guarantees loans to fund property and equipment expansion.\nSystems - SCA provides standardized data processing systems to its centers both for internal operational control and for the orderly conduct of business office functions. This includes a full-range financial reporting and accounting package, a claims processing\/accounts receivable system, inventory and accounts payable systems and a patient record keeping system.\nArchitecture\/Site Development - SCA provides comprehensive site development services, including the review of local market conditions to assist in site selection, land acquisition and zoning, building design and construction management.\nAdministration - SCA reviews and analyzes patient and staff flows and facility efficiency and utilization. Company personnel are responsible for the implementation of SCA operational planning and control policies.\nMarketing Services - SCA supports local marketing activities, including the analysis of market conditions and patient referral patterns and the development of prices and services which are competitive with those offered by other health care providers in the locality.\nPurchasing - SCA, where appropriate, executes master agreements for purchasing ambulatory care equipment and supplies to provide to each center the economies available through volume purchases.\nRegulatory\/Certificate of Need Support - SCA conducts necessary feasibility studies, prepares and files applications for certificates of need and develops local support for its applications. SCA provides support for Medicare certification and local Department of Health licensure.\nCorporate Supervision & Problem Solution - Drawing upon the extensive backgrounds of SCA senior management in the development and successful operation of large proprietary health care systems, the Company provides ongoing management and supervision of each center.\nDEVELOPMENT OF NEW FREESTANDING SURGICAL CARE FACILITIES\nSCA believes that its growth will partially depend upon its ability to develop new freestanding centers. While such development projects involve start-up periods of losses, the successful development of a new center can produce significant rates of return on investment over the longer term. The Company's corporate personnel are engaged in identifying and analyzing communities throughout the United States which show appropriate support for an outpatient surgical care center. Upon selection of appropriate sites, the Company files certificate of need applications in connection with such locations, if required. In most development projects selected by the Company, a certificate of need is not required. The development of a typical surgical care center typically requires approximately $150,000 for development costs and capital funds of approximately $2,500,000 to $3,000,000 for property and equipment. Land costs also may range from $200,000 to $600,000. These costs have been financed principally through long term debt financing.\nJOINT ARRANGEMENTS\nThe Company also believes that growth will be obtained by the development of surgery centers under joint arrangements with hospitals and health maintenance organizations (\"HMOs\"). These facilities will typically be\nfreestanding either on the hospital campus or located in the surrounding medical community. All operations of the center will be separate and distinct from the internal operations of the hospital or HMO. The Company will have the responsibility of developing, financing and operating these centers with the hospital or HMO owning an interest in the operating entity as well as the physical facility.\nSCA and Hospital Sisters Services Incorporated, affiliated with the Hospital Sisters of the Third Order of St. Francis, entered into a joint venture with physician partners and developed the Eau Claire Surgery Center in Eau Claire, Wisconsin in March, 1986.\nSCA and Holy Spirit Ventures, Inc., a subsidiary of the Sisters of Christian Charity Health Care Corporation, entered into a joint venture and purchased the Grandview Surgery Center in Camp Hill, Pennsylvania. This center was opened in May of 1989.\nA surgery center in Rockville, Maryland, developed by a joint venture composed of the Company and MD-IPA, a health maintenance organization operating in Maryland and southeastern Pennsylvania, opened in April 1986. This center is a joint venture also involving local physicians from the Rockville area.\nSCA opened a surgery center in Baltimore, Maryland in a joint venture with HCCA Services, Inc., a division of Care-First, Inc, an HMO in the greater Baltimore area, and area physicians. The Center opened in May, 1990.\nSCA acquired a center in Redlands, California on April 30, 1990, which is a joint venture between SCA, RSI, Inc., a subsidiary of Redlands Community Hospital and area physicians.\nSCA built a center in Dover, Delaware in 1991, which is a joint venture between SCA and a subsidiary of Central Delaware Health Care Corporation, owner of Kent General Hospital.\nThe Company built centers in 1994 in Paoli, Pennsylvania and St. Joseph, Missouri, both of which are joint ventures with hospitals. In Paoli, the venture partner is Mainline Health Systems, Inc., and in St. Joseph, the partner is Heartland Hospital\nThe Company joint ventured several existing surgery centers in 1994 with local hospitals as shown below:\nCenter Hospital ------ -------- Little Rock Surgery Center St. Vincent Infirmary Medical Center Evansville Surgery Center Deaconess Hospital Memphis Surgery Center Baptist Memorial Health Care System Physicians' Surgical Care Center Florida Hospital Physician's Surgery Center Lee Memorial Hospital\nSCA also has two joint ventures with hospitals to build new centers in Eugene, Oregon and Gainesville, Georgia.\nACQUISITIONS\nThe acquisition of existing centers has provided the Company with an entry into new markets and an immediate source of revenues and cash flow. During 1994, SCA purchased five centers.\nThe Company expects to continue to grow through acquisitions. This can be accomplished either by buying individual centers or by buying a chain of centers.\nSURGERY CENTER CLOSINGS\nIn 1994, the Company closed one center in Indianapolis and announced that it would close or sell three other centers in 1995. SCA recorded a charge in the fourth quarter to provide for losses expected to occur as a result of this decision.\nOf the four centers closed, or to be closed, two were acquired in previous years. The Company was unable to improve the performance of these centers, largely because the centers were built in locations that were inconvenient to doctors and patients. Both facilities were leased and the rental rates were too high to allow for profitable operations.\nThe other two centers were built in locations where competition from other providers was intense. The centers also were unable to obtain managed care contracts.\nThe Company does not anticipate the need to close any additional centers based on existing market conditions.\nHEALTH MAINTENANCE ORGANIZATION\nPrior to December 1, 1993, through HealthWise of America, Inc. (\"HOA\"), its wholly-owned subsidiary, SCA owned a majority interest in an HMO in Lexington, Kentucky, and in Baltimore, Maryland. In 1993, the Company's Board of Directors decided that the long-term value of SCA would be enhanced if the surgery centers and HMOs were operated individually as separate companies. On December 1, 1993, SCA distributed to its shareholders all of the outstanding shares of Common Stock of HOA (the \"Distribution\"). The Distribution was made on the basis of one share of HOA for every ten shares of SCA Common Stock held. As a result of the Distribution, SCA no longer has any ownership interest in HOA.\nThe results of SCA's managed care operation have been reflected as a discontinued operation in the financial statements for all periods presented.\nCOMPETITION\nSCA faces strong competition in obtaining physician and patient\nutilization of its outpatient surgical care centers, obtaining certificates of need, developing new centers and acquiring existing outpatient surgical care centers. The Company's chief competitors are hospitals and other outpatient surgery centers. Medical Care America, Inc., a larger company than SCA and a wholly owned subsidiary of Columbia\/HCA Healthcare Corporation, and other companies are competing in the marketplace.\nIn competing for physician and patient utilization, important competitive factors are convenience, cost, quality, physician loyalty and community relations. Hospitals have many competitive advantages in attracting physicians and ambulatory patients, including established community position, physician loyalty, potential price competitiveness through cost controls or cross- subsidies and convenience for physicians making rounds or performing inpatient surgery in the hospital.\nIn obtaining certificates of need and developing new outpatient surgical care centers, the Company competes with major hospitals and large proprietary hospital corporations, outpatient surgery corporations and local physician groups. These competitors may possess substantially greater personnel and financial resources than the Company. In addition, local hospitals and physicians may oppose a certificate of need application. The Company also competes with several other corporations which are attempting to acquire existing surgical care centers.\nREGULATION\nGENERAL\nOperations of surgical care centers are subject to federal, state and local government regulations. Licensing of new surgical care centers is subject to various governmental requirements. Surgical care centers are also subject to periodic inspection by state licensing agencies to determine whether the standards of medical care, patient safety, equipment and cleanliness are being met. It is anticipated that governmental regulation will become more comprehensive in the future, but the extent and resultant impact on the Company's operations, earnings and construction and acquisition programs cannot be determined at this time.\nCertain states in which the Company operates or intends to operate have statutes requiring certificates of need as a prior condition to surgical care center construction, acquisition, expansion or introduction of new services. These statutes may limit the Company's ability to develop outpatient surgical care centers.\nCertain states have adopted hospital rate review legislation which generally provides that a state commission must monitor, review or approve the rates for various hospital and, in certain states, surgical care or diagnostic center services. Such rate review programs have not had an adverse effect on the Company's operations. No assurances can be given of the future significance of such programs or whether similar legislation will be adopted in other states in which the Company may operate.\nFRAUD AND ABUSE\nThe provisions of the Social Security Act addressing illegal renumeration (the \"anti-kickback statute\") prohibit providers and others from soliciting, receiving, offering or paying, directly or indirectly, any renumeration in return for either making a referral for a Medicare or Medicaid covered service or item or ordering any covered service or item. Violations of this statute may be punished by a fine of up to $25,000 or imprisonment for up to five years, or both. In addition, the Medicare and Medicaid Patient and Program Protection Act of 1987 (the \"Protection Act\") imposes civil penalties for a violation of these prohibitions, including exclusion from the Medicare and Medicaid programs by the Secretary of Health and Human Services (\"HHS\").\nThe Office of the Inspector General (\"OIG\") of the Department of Health and Human Services has indicated that it is giving increased scrutiny to health care joint ventures involving physicians and other referral sources. Although the OIG has not stated publicly a policy about joint ventures, in May 1989, it published a Fraud Alert that outlined questionable features of \"suspect\" joint ventures. The Company believes that its activities are being conducted in compliance with such laws. Because of the changing interpretations of such law, however, no assurance can be given in this regard.\nOn January 29, 1992, regulations were published in the Federal Register implementing the OIG sanction and civil money penalty provisions established in the Protection Act. The regulations (the \"Exclusion Regulations\") provide that the OIG may exclude a Medicare provider from participation in the Medicare Program for a five-year period upon a finding that the anti-kickback statute has been violated. The regulations expressly incorporate a test adopted by three federal circuit courts providing that if one purpose of remuneration that is offered, paid, solicited or received is to induce referrals, then the statute is violated. The regulations also provide that after the OIG establishes a factual basis for excluding a provider from the program, the burden of proof shifts to the provider to prove that the anti-kickback statute has not been violated.\nThe Protection Act authorized the OIG to publish regulations outlining certain categories of activities that would be deemed not to violate the fraud and abuse anti-kickback provisions. Final regulations outlining certain business practices that would be deemed not to violate the anti-kickback statute were published in the Federal Register on July 29, 1991. The Company has determined that SCA sponsored partnerships generally do not meet all of the criteria of the \"investment interest\" safe harbor as set forth in the 1991 safe harbor regulations. On September 21, 1993, proposed regulations were published in the Federal Register setting forth an expanded listing of safe harbor provisions. One of those proposed safe harbor regulations is designed to protect payments to investors in ambulatory surgery centers who are surgeons who refer patients directly to the center and perform surgery themselves on referred patients. As one of the conditions for meeting this proposed safe harbor requires, all of the investors must be surgeons who are in a position to refer patients directly to the center. Because not all of the investors in a SCA-sponsored partnership are surgeons, the proposed safe harbor would not provide protection if that criteria is read to exclude non-physician investors\nsuch as an SCA subsidiary. The Company is unable to predict whether this proposed safe harbor regulation will become final and, if so, in what form. In recent years Congress and some state legislatures have considered various proposals that would have prohibited, or at least severely limited, the ability of physicians and other referral sources to refer Medicare or Medicaid patients to ventures with which the referral source has a financial relationship.\nLimited partners in SCA affiliated partnerships receive cash distributions based upon the available cash flow, if any, of such partnerships. Since many of the limited partners are physicians or other entities in a position to make or influence referrals, the distribution of available cash flow could come under scrutiny under the anti-kickback statute. In August, 1993, Congress passed legislation that, effective December 31, 1994, expanded the self-referral ban to include a number of health care services provided by entities with which the physicians have an ownership interest or a financial relationship (\"OBRA '93). OBRA '93 does not specifically prohibit referrals by physicians with an ownership interest in, or financial relationship with, an ambulatory surgery center, provided that the surgery services are not provided as \"outpatient hospital services.\" Should legislation be implemented prohibiting physicians from referring patients to any health care facility in which the physician has any beneficial interest, SCA's operations could be adversely impacted.\nIn the event that Federal or individual state regulations prohibit the ownership of surgery centers by physicians, the Company would seek to purchase the interests held by its limited partner physicians. Some of the limited partnership agreements contain a provision which allows the Company to purchase the interest of each limited partner for an amount equal to a multiple of the partner's allocation of taxable income in the most recent calendar year. The Company may issue cash or stock, including unregistered stock, at its option to purchase the limited partners' interests. The Company believes that it has the financial resources necessary to buy-out all of its limited partners if required.\nIn June 1994, the American Medical Association severely restricted the ability of physicians to refer to entities in which such physicians have ownership, except when the physician directly provides care or services at the facility and in very limited circumstances such as lack of available capital from non-physician sources and situations in which the facility is an extension of the physician's practice. In the event that the American Medical Association changes its ethical requirements to preclude all referrals by physicians and such ethical requirements are applied retroactively to facilities which, at the time of adoption, are owned in whole or in part by referring physicians, physician referrals to Company owned ASCs could be adversely affected.\nIt is possible that a prohibition on physician ownership could adversely affect the Company's future operations. The Company believes that a majority of its current physician limited partners utilize the surgery centers because they are highly efficient and convenient to the physicians' practice of medicine. For these reasons, the Company believes that the majority of physicians would continue to perform surgery at the surgery centers even if\nthey were no longer limited partners. It is possible, however, that some physicians would perform surgery elsewhere if ownership is no longer allowed.\nINSURANCE\nThe Company maintains professional coverage for all centers on a claims made basis with limits of coverage which the Company believes are adequate.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following is a list of the Company's executive officers as of December 31, 1994, with their ages, positions with the Company and year which each became an executive officer with the Company.\nJoel C. Gordon 66 Chairman of the Board 1982 & Chief Executive Officer\nWilliam J. Hamburg 45 President and Chief 1984 Operating Officer\nTarpley B. Jones 37 Senior Vice President and 1992 Chief Financial Officer\nMr. Gordon has been Chairman of the Board of the Company since its founding in 1982 and has served as its Chief Executive Officer since 1987. Mr. Gordon had been in private investing in Nashville, Tennessee prior to his association with the Company in 1982. Mr. Gordon serves on the Board of Genesco, Inc., an apparel manufacturer, Third National Bank in Nashville, Tennessee and HealthWise of America, Inc.\nMr. Hamburg joined the Company as a Vice President in March 1984, was appointed Executive Vice President in 1986, and President and Chief Operating Officer in 1992.\nMr. Jones was selected to become Senior Vice President and Chief Financial Officer on January 1, 1992. Prior to joining the Company he was Treasurer, Senior Vice President and Chief Financial Officer, and then Executive Vice President and Chief Financial Officer, at Comdata Holdings Corporation and Comdata Network, Inc. Comdata provides financial and information services to the trucking and gaming industries.\nEMPLOYEES\nOn December 31, 1994, the Company had approximately 2,300 full-time and part-time employees. Of these, 25 are corporate personnel. The remaining employees, most of whom are nurses and office personnel, work at the surgery centers.\nNone of the Company's employees are covered by a collective bargaining agreement.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters occupy approximately 11,000 square feet of an office building located in Nashville, Tennessee, under a lease expiring in January, 1996. The Company also leases certain of the buildings in which its centers operate and the equipment used in certain of its centers, either from limited partnerships comprised of a subsidiary of the Company as general partner and local physicians as limited partners or from physicians who sold the center to the Company. The Company owns interests ranging from 1% to 60% in the operations of these real estate partnerships and in some instances may participate in any net proceeds from the sale of the properties. In some cases, the Company's limited partnerships lease their property from unaffiliated parties.\nThe following table sets forth the location and type of property leased and the duration of the leases as of December 31, 1994:\n___________________\n(1) Plus insurance, taxes and maintenance.\nThe remainder of the Company's properties are owned and subject to mortgage. The Company believes that its facilities are adequate for its immediate needs.\nIn 1985, SCA purchased a building containing approximately 53,000 square feet in Lancaster, Pennsylvania. SCA developed the property as a medical office building and sold the building at its cost to a limited partnership having as its general partner an SCA subsidiary and as its limited partners physicians who use the Lancaster Surgery Center and tenants in the medical office building. The Lancaster Surgery Center leases approximately 13,700 square feet of the building.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no legal proceedings which could have, in the judgment of management, a material adverse effect upon the Company's financial position or results of operations taken as a whole.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCK HOLDER MATTERS\nThis information is incorporated by reference from the Company's Annual Report to Security Holders for fiscal year ended December 31, 1994, pp. 20.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThis information is incorporated by reference from the Company's Annual Report to Security Holders for fiscal year ended December 31, 1994, pp. 2 and 3.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis information is incorporated by reference from the Company's Annual Report to Security Holders for fiscal year ended December 31, 1994, pp. 19 and 20.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThis information is incorporated by reference from the Company's Annual Report to Security Holders for fiscal year ended December 31, 1994, pp. 10-18.\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 executive officers of the Company is included in Item 1, Business. Information with respect to the Company's directors is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 11, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThis information is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 11, 1995, except for the items appearing under the heading \"Compensation Committee Report on Executive Compensation\" and \"Comparative Performance Graph\" which are excluded in accordance with Item 402(a)(8) of Regulation S-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThis information is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 11, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThis information is incorporated by reference from the Company's Proxy Statement relating to the Annual Meeting of Shareholders to be held on May 11, 1995.\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a) Index to Consolidated Financial Statements, Financial Statement Schedules and Exhibits.\nAnnual Report to Security Holders\n(1) Financial Statements: Page ----\nReport of Independent Public 9 Accountants --\nConsolidated Statements of Income for the Years Ended December 31, 1992, 1993 and 1994 10 -- Consolidated Balance Sheets for the Years Ended December 31, 1993 and 1994 11 -- Consolidated Statements of Share- holders' Equity for the Years Ended December 31, 1992, 1993 and 1994 12 -- Consolidated Statements of Cash Flow for the Years Ended December 31, 1992, 1993 and 1994 13 -- Notes to Consolidated Financial Statements 14 -- (2) Financial Statement Schedule: -----------------------------\nReport of Independent Public Accountants - Deloitte & Touche LLP S-1\nSchedule II - Valuation and Qualifying Accounts S-2\nAll 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.\n(3) Exhibits\n_____________________\n(1) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-1, Registration No. 2-88175.\n(2) Incorporated by reference to exhibits filed with the Registrant's Annual Report on 10-K for the year ended December 31, 1989, File No. 0-13364.\n(3) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-8, Registration No. 33-11639.\n(4) Incorporated by reference to the Registrant's annual report on 10-K for the year ended December 31, 1986, File No. 0-13364.\n(5) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-2, Registration No. 33-14622.\n(6) Incorporated by reference to exhibits filed with the Registrant's annual report on Form 10-K for the year ended December 31, 1990, File No. 0-13364.\n(7) Incorporated by reference to exhibits filed with the Registrant's annual report on Form 10-K for the year ended December 31, 1991, File No. 0-13364.\n(8) Incorporated by reference to exhibits filed with the Registrant's annual report on Form 10-K for the year ended December 31, 1992, File No. 0-13364.\n(9) Incorporated by reference to exhibits Filed with the Registrant's annual report on Form 8-K dated December 31, 1993.\n(10) Incorporated by reference to exhibits filed with Registrant's annual report in Form 10-K for the year ended December 31, 1993, File No. 0-13364.\nEXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS\nThe following is a list of all executive compensation plans and arrangements filed as Exhibits to this Annual Report on Form 10-K.\nEmployment Agreement dated January 1, 1990 between the Registrant and Joel C. Gordon - Form 10-K for the fiscal year ended December 31, 1989, File No. 0-13364, Exhibit 10(d).\nEmployment Agreement dated January 1, 1992, as amended, between the Registrant and William J. Hamburg - Form 10-K for the fiscal year ended December 31, 1992, File No. 0-13364, Exhibit 10(l).\nEmployment Agreement dated April 25, 1994, between the Registrant and Tarpley B. Jones - Form 10-K for the fiscal year ended December 31, 1994, File No. 0-13364, Exhibit 10(k).\nIncentive Stock Plan of 1986, as amended, - Form 10-K for the fiscal year ended December 31, 1993, File No. 0-13364, Exhibit 10(i)\n1990 Non-Qualified Stock Option Plan for Non-Employee Directors - Form 10-K for the fiscal year ended December 31, 1990, File No. 0-13364, Exhibit 10(k).\nAgreement of the Registrant, SCA-Kentucky Health Plan, Inc. (now HealthWise of America, Inc.), Chesapeake Health Plan, Inc. and Kenneth J. Melkus, with executed Employment Agreement and Option Agreement attached. Form 10-K for the year ended December 31, 1993, File No. 0-13364, Exhibit 10(s).\nOption Agreement among SCA-Kentucky Health Plan, Inc. (now HealthWise of America, Inc. and Kenneth J. Melkus. Form 10-K for the year ended December 31, 1993, File No. 0-13364, Exhibits 10(t).\nAmendment to Employment Agreement dated September 1, 1994 between the Registrant and Joel C. Gordon - Form 10-K for the fiscal year ended December 31, 1994, File No. 0-13364, Exhibit 10(c).\nAmendment to Employment Agreement dated September 1, 1994 between the Registrant and William J. Hamburg - Form 10-K for the fiscal year ended December 31, 1994, File No. 0-13364, Exhibit 10(r).\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.\nSURGICAL CARE AFFILIATES, INC.\nBY: \/s\/ JOEL C. GORDON ---------------------------- JOEL C. GORDON CHAIRMAN & CHIEF EXECUTIVE OFFICER\nDate: March 30, 1995\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 Board of Directors Surgical Care Affiliates, Inc. Nashville, Tennessee\nWe have audited the consolidated financial statements of Surgical Care Affiliates, Inc. as of December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994 and have issued our report thereon dated February 22, 1995; such consolidated financial statements and report are included in your 1994 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedule of Surgical Care Affiliates, Inc., listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such 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.\nDELOITTE & TOUCHE LLP\nNashville, Tennessee February 22, 1995\nS-1\nSURGICAL CARE AFFILIATES, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(1) See Summary of Significant Accounting Policies for discussion of change in accounting estimate in 1993.\nS-2 EXHIBIT INDEX\n_____________________\n(1) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-1, Registration No. 2-88175.\n(2) Incorporated by reference to exhibits filed with the Registrant's Annual Report on 10-K for the year ended December 31, 1989, File No. 0-13364.\n(3) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-8, Registration No. 33-11639.\n(4) Incorporated by reference to the Registrant's annual report on 10-K for the year ended December 31, 1986, File No. 0-13364.\n(5) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-2, Registration No. 33-14622.\n(6) Incorporated by reference to exhibits filed with the Registrant's annual report on Form 10-K for the year ended December 31, 1990, File No. 0-13364.\n(7) Incorporated by reference to exhibits filed with the Registrant's annual report on Form 10-K for the year ended December 31, 1991, File No. 0-13364.\n(8) Incorporated by reference to exhibits filed with the Registrant's annual report on Form 10-K for the year ended December 31, 1992, File No. 0-13364.\n(9) Incorporated by reference to exhibits Filed with the Registrant's annual report on Form 8-K dated December 31, 1993.\n(10) Incorporated by reference to exhibits filed with Registrant's annual report in Form 10-K for the year ended December 31, 1993, File No. 0-13364.","section_15":""}
{"filename":"745471_1994.txt","cik":"745471","year":"1994","section_1":"Item 1. Business\nThe registrant, Connecticut General Realty Investors III Limited Partnership (the \"Partnership\"), was formed on April 12, 1984, under the Uniform Limited Partnership Act of the State of Connecticut to invest in primarily residential and, to a lesser extent, commercial real properties. On July 2, 1984, the Partnership commenced an offering of $25,000,000 (subject to increase up to $50,000,000) of Limited Partnership Interests (the \"Units\") at $1,000 per Unit, pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 2-90944).\nA total of 24,856 Units was sold to the public prior to the offering's termination on July 1, 1986. The holders of 6,480 Units were admitted to the Partnership in 1984; the holders of 11,519 Units were admitted to the Partnership in 1985; the holders of the remaining 6,857 Units were admitted to the Partnership in 1986. From the 24,856 Units sold, the Partnership received net proceeds of $22,408,052. The Limited Partners of the Partnership will share in the ownership of the Partnership's real property investments according to the number of Units held. The Partnership is engaged solely in the business of real estate investment. A presentation of information about industry segments is not applicable.\nThe General Partner of the Partnership is CIGNA Realty Resources, Inc.- Fifth (the \"General Partner\"), which is a wholly owned subsidiary of CIGNA Financial Partners, Inc. (\"CFP\", formerly Connecticut General Management Resources, Inc.), which is in turn a wholly owned subsidiary of Connecticut General Corporation, which is in turn a wholly owned subsidiary of CIGNA Holdings, Inc. which is a wholly owned subsidiary of CIGNA Corporation (\"CIGNA\"), a publicly held corporation whose stock is traded on the New York Stock Exchange.\nThe Partnership has acquired four residential complexes and one shopping center located respectively in Ohio, Oklahoma, Louisiana, Illinois and Florida. In order to acquire these properties, the Partnership invested $16,372,438 in cash, took or assumed $35,684,061 in mortgages, incurred $3,673,982 in acquisition fees and expenses, established reserves for improvements of $720,000 and established working capital reserves of $1,242,800.\nIn December 1993, the Partnership refinanced the first and second mortgages encumbering the Waterford Apartments property. The first mortgage, funded with multifamily housing revenue bonds issued by the Tulsa County Home Finance Authority, and the second mortgage were replaced with a new first mortgage. The replacement financing was also funded with newly issued multifamily housing revenue bonds issued by the Tulsa County Home Finance Authority. As a requirement of the new financing, the Waterford property had to be classified as single asset ownership. Since the Partnership owns multiple properties, a new partnership was created to house the Waterford property as its sole real estate asset. Waterford Partnership, a general partnership, was organized in the State of Connecticut with the Partnership as its managing general partner (99.9% interest) and the General Partner (0.1% interest) as the other general partner. The interest of the General Partner in the new partnership is is held in trust for the benefit of The Tulsa Corporation, a newly organized Delaware corporation, the stock of which is 100% owned by the Partnership. The Tulsa Corporation was created with the sole purpose of acting as the beneficiary of the General Partner's ownership interest in the Waterford Partnership. The new structure has no economic effect on the Partners nor does it require any changes in financial reporting for the Partnership.\nVersailles Village Apartments is located in Forest Park, Ohio, part of Hamilton County in the northwest section of Greater Cincinnati. Cincinnati unemployment for 1994 is 3.8% versus state wide unemployment of 4.2%. The northwest apartment market contains approximately 12,000 units, 144 of which came \"on line\" in 1994. Limited new multifamily construction is planned for 1995. The northwest Cincinnati apartment market continues to be stable. Market occupancy has consistently been in the low to mid nineties during the year. The property is able to achieve high occupancy, averaging 96% for 1994, by offering slightly lower monthly rents, currently averaging $503. As an older property, Versailles competes by offering a well-maintained complex which has amenities similar to the competition, but with larger floor plans and slightly lower monthly rents. While the market for apartments in Greater Cincinnati has stabilized, the supply of available units will impede any upward movement in rental rates. Conditions are not expected to change significantly during 1995.\nWaterford Apartments is located in South Tulsa. Increases in employment and personal income growth percentages in Tulsa grew ahead of the national average with expansion in the services and government sectors accounting for much of the growth. Multifamily construction had been at a virtual standstill since 1990 but in 1994 a new 288-unit complex came into the market in anticipation of an increased demand. There are approximately 18,000 units in the southeast submarket where Waterford is located. Occupancy in the market has been in the low nineties for 1994 with Waterford averaging physical occupancy of 93%. Waterford is located only five miles outside the central business district in a well-maintained and vintage neighborhood. The property is a Class \"A\" luxury apartment complex which benefits not only from its prime location but excellent on-site service, mature landscaping and a variety of amenities. Rents at the property in late 1994 averaged $478 per month versus $486 per month for the market. The property not only competes with other luxury apartments in the market, but with single family home purchases, as apartment rents are comparable to monthly mortgage payments. Rents at the property are expected to increase slowly in 1995.\nStonebridge Manor Apartments is in the Parish of Jefferson, in an area known as the Westbank, just south of the Mississippi River across from New Orleans. This area is in the midst of an economic recovery. The New Orleans employment base has been shifting from an over reliance on the oil and gas industry to the service and tourism sectors, as well as an expansion of the casino\/gaming industry. A sports multiplex facility, the New Orleans Sports Arena, is scheduled to open in phases through 1997 and will bring additional jobs and capital into the area. Physical occupancy at Stonebridge averaged 96% for 1994 while the market averaged 94%. The property was also able to collect rents that exceeded the market average ($468 per month for the property versus $376 per month for the market). Stonebridge is able to perform well in the market due to its location with easy access to downtown New Orleans, the airport, and major highway arteries.\nStewarts Glen III is the third phase (104 units) of a three phase, 488 unit apartment complex, located in Willowbrook, Illinois, a township in Dupage County. Despite rising interest rates, home ownership remains a viable option for residents in the County and represents some additional competition for Stewarts Glen. The submarket contains approximately 3,600 units. Dupage County has seen strong population and employment growth over the last five years and this trend is expected to continue. The county's unemployment percentage for 1994 was 3.7%, one of the lowest in the state. The median income of Willowbrook, an affluent and professional township, is $50,000, one of the highest in the state. Multifamily construction has remained at very low levels due to a lack of approved\/zoned land and the demand for apartment units has remained steady. Rents at the property averaged $774 per month, ahead of the market average of $767 per month. Stewarts Glen is typically ahead of the market in terms of physical occupancy with a 98% average for 1994. Rents have stabilized to the point where concessions are no longer necessary at the property or within its competitive market. In addition, rents at the property are expected to rise slightly in 1995.\nApproximate occupancy levels for the properties on a quarterly basis are set forth in the table in Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Partnership owns directly (subject to existing first mortgage loans and purchase money notes)the properties described in Item 1 herein.Promenades Plaza, the Partnership's commercial property, was sold September 22, 1994. Residential properties generally have lease terms of one year or less. In the opinion of the General Partner, the Partnership's properties continue to be adequately insured.\nThe following list compares approximate occupancy levels by quarter for the Partnership's investment properties during 1990, 1991, 1992, 1993 and 1994:\nItem 3.","section_3":"Item 3. Legal Proceedings\nNeither the Partnership nor its properties are party to or the subject of any material legal proceedings.\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.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Security Holder Matters\nAs of December 31, 1994, there were approximately 1,252 record holders of Units. There is no established public trading market for Units. The General Partner will not redeem or repurchase the Units.\nThe Revenue Act of 1987 adopted provisions which have an adverse impact on investors in a \"publicly traded partnership\" (\"PTP\"). A PTP is a partnership whose interests are traded on an established securities market or readily tradable on a secondary market (or the substantial equivalent thereof). If Registrant were classified as a PTP, (i) Registrant may be taxed as a corporation, or (ii) income derived from an investment in Registrant would be treated as non-passive income. In Notice 88-75, the IRS established alternative safe harbors that allow interests in a partnership to be transferred or redeemed in certain circumstances without causing the partnership to be characterized as a PTP. Units of Registrant are not listed or quoted for trading on an established securities exchange. However, CFP will, upon request, provide a Limited Partner desiring to sell or transfer Units with a list of secondary market firms which may provide a means for matching potential sellers with potential buyers of Units, if any. Frequent sales of Units utilizing these services could cause the Registrant to be deemed a PTP. The Registrant has adopted a policy prohibiting transfers of Units in secondary market transactions unless, notwithstanding such transfers, Registrant will satisfy at least one of the safe harbors. Although such a restriction could impair the ability of an investor to liquidate its investment, the service provided by CFP described above should allow a certain number of transfers to be made in compliance with the safe harbor. It is anticipated that such policy will remain in effect until such time, if ever, as further clarification of the Revenue Act of 1987 permits Registrant to lessen the scope of these restrictions.\nThe Partnership made no cash distributions to its Partners in 1994 or 1993. The Partnership suspended quarterly distributions to Partners as of the fourth quarter of 1988 to enable it to fund operating deficits from certain of its properties. Reference is made to the Notes to Financial Statements for a description of payments to the State of Connecticut on behalf of limited partners that were charged to limited partner capital accounts.\nThere are no material legal restrictions upon the Partnership's ability to make distributions in accordance with the provisions of the Partnership Agreement. The Partnership intends to renew its policy of making quarterly distributions of distributable cash from operations once the Partnership cash reserves exclusive of working capital reserves have sufficient funds to retire the Partnership's $3,400,000 recourse promissory note.\nItem 6.","section_6":"Item 6. Selected Financial Data (a)\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nFrom the $24,856,000 of Gross Proceeds of the offering, after deduction of selling expenses and other offering costs, the Partnership had $22,408,052 with which to make investments in real properties, to pay legal fees and other costs (including acquisition fees related to such investments), for working capital reserves and for capital expenditure reserves. From the proceeds of the offering, the Partnership set aside reserves of $370,000 and $350,000 to fund capital improvement programs at Versailles Village and Promenades Plaza, respectively. In addition, a development reserve of $750,000 was set aside from the balance of the proceeds from the refinancing of Promenades Plaza in 1986. These reserves were exhausted during 1989.\nIn early 1989, the Partnership decided to undertake an additional $2.5 million development program at Promenades Plaza Shopping Center and the Partnership secured the necessary construction financing that year. The renovation program at the Promenades Plaza Shopping Center was essentially completed during 1990, adding total new space of 14,624 square feet. The Partnership secured permanent financing to replace the construction loan on April 1, 1991. The difference between the payoff amount on the construction loan and the amount of the permanent financing of $160,634 was used to partially fund continuing capital expenditures at the center. Capital expenditures totalled $725,000 in 1991 and $223,000 in 1992, including $125,000 relating to the roof repair project. Capital improvements for 1993 totalled $217,400, including $198,700 for the roof repair project.\nIn 1989, the Partnership sold an outparcel which was developed in conjunction with the access improvements at the Promenades Plaza Shopping Center for a sales price of $403,000. The proceeds from the sale were used to augment the funding of the development program. A second outparcel was under contract at December 31, 1992, and the sale was completed on January 27, 1993. The outparcel was sold for $500,000 netting the Partnership $452,500 after commissions and closing costs. The outparcel, developed in conjunction with the $2.5 million development program, had a net book value of $376,083. The Partnership recognized a gain of $76,417 in 1993. The proceeds were used to supplement Partnership reserves for Promenades' operating deficits after debt service and capital improvements.\nAs a result of Promenades' continual cash flow deficits, the ongoing need for capital improvements, (including reworking space vacated by one of the anchors and a required $525,000 contribution to the expansion of the supermarket tenant), and the debt maturity, the General Partner determined that it was in the best interest of the Partnership to sell Promenades Plaza. Based on the overbuilt retail market in which the property operates, the poor visibility from main routes, the property's operating results, and the commitment to fund a portion of the supermarket's expansion, the General Partner expected that the net proceeds realized from a sale would be significantly less than the carrying value of the property. Accordingly, the Partnership recorded a loss of $5,000,000 due to permanent impairment of assets as of December 31, 1993.\nThe Promenades Plaza first mortgage loan and recourse promissory note matured on January 1, 1994. The first mortgage note was extended until May 1, 1994 at existing terms to allow time for a sale. The promissory note was extended until March 25, 1994 at a 4.38% interest rate. The extension date was set to coincide with the maturity of the Stonebridge Manor recourse promissory note. On March 25, 1994, the two recourse promissory notes, totalling $3,400,000 were refinanced for a period of three years. The interest only payments are at a fixed rate of 6.6% for the first two years with no prepayment of principal. The interest only payment for the third year is a floating rate equal to Mellon Bank's prime rate. During the third year, the note is prepayable in full at any time. The note will continue to carry a corporate guarantee from CIGNA.\nOn May 1, 1994, the Partnership's extension on Promenades' first mortgage loan expired. As an alternative to payment of the entire loan balance on May 1, 1994, the Partnership agreed with the first mortgage lender to pay an additional debt service payment to extend the maturity to June 1, 1994 while negotiations continued on the sale of the property. The lender requested an additional debt service payment due June 1, 1994 to extend the loan an additional\nmonth to July 1, 1994. Effective with the extension payment due June 1, 1994 (May interest due June 1), the Partnership defaulted. During June, the Partnership executed a contract with a potential buyer subject to a number of contingencies, including the buyer's ability to obtain financing and the performance of due diligence. As a result of the default, the first mortgage lender commenced foreclosure proceedings. The foreclosure was stayed by the Court due to the pending sale of the property and the Partnership and the first mortgage lender entered into a cash collateral agreement. The Court required the Partnership to complete its sale of the property by October 17, 1994.\nOn September 22, 1994, the Partnership completed the sale of Promenades Plaza to Sterling Promenades Limited Partnership for a gross sales price of $6,572,000. After closing costs and payment of the first mortgage loan obligations, the Partnership netted approximately $261,000 which was added to Partnership reserves. For book purposes, the property had a carrying value of approximately $6,240,000 (net of permanent impairment losses aggregating $5,700,000 recorded in 1991 and 1993) and the Partnership recorded a gain of approximately $25,000. For tax purposes, the Partnership has not recorded impairment losses previously and recorded a loss of approximately $4,504,000 on the sale.\nOperations at Promenades for 1994 generated a cash flow deficit, (inclusive of capital improvements, leasing commissions and debt service on both the first mortgage and promissory note), of approximately $183,000 through the date of sale. Repayment of the $2,500,000 promissory note was not able to be made from the sale of Promenades, but will be repaid from the Partnership's remaining assets. The promissory note is not secured by the Promenades' property but is a general recourse obligation of the Partnership.\nIn August 1988, the Partnership refinanced the three mortgage loans incurred in connection with the acquisition of the Versailles Village Apartments. After repayment of the loans and paying other costs associated with the refinance, $235,000 remained. By the end of 1991, the excess proceeds had been used to fund a program of capital improvements. As an older complex, Versailles' rental rates are set below the market average to enable it to compete with the newer facilities, which have more amenities. A significant amount of maintenance expense and continued capital improvements is required to maintain the competitiveness of the property.\nThe Versailles Village first mortgage was scheduled to mature in September 1993. The Partnership received extensions until March 30, 1994, while documents were finalized on the property's refinance with the existing first mortgage lender. The Versailles Village debt refinance was completed on March 30, 1994 with the property's first mortgage lender. The terms include a principal balance of $4,200,000 for seven years at 8% based on a 25 year amortization schedule. The loan will be assumable with approval and payment of a 1% transfer fee. The loan will be pre-payable over the term of the loan at the greater of yield maintenance, tied to treasuries, or 1% of the outstanding loan balance. The difference between the loan at maturity and the net refinance proceeds of $138,505 was added to the Partnership's reserves. As a requirement of the refinance, the Partnership set up a tax escrow account with the mortgage lender and deposited four months of the estimated tax bill, $32,275, on March 30, 1994. The Partnership's plans call for a two year hold.\nAfter the expiration date of the seller's guarantee in November 1987, the Stonebridge Manor Apartments operated at a deficit. As a result, in March 1990, the Partnership refinanced the mortgage note incurred in the acquisition of the property which included a payoff of the existing balance at a reduced amount. Beginning with the third quarter of 1990, the quarter subsequent to the refinance, the property has been experiencing positive cash flow. On March 25, 1994, the Stonebridge $900,000 promissory note was refinanced along with the Promenades $2,500,000 promissory note. The property's first mortgage note matures April 1, 1995. The Partnership is in the process of securing a refinance with Hibernia National Bank for $5,300,000 for a period of three years at 10.15% with twenty year amortization. Prepayment is closed for the first year, open at 1% during the second year and open without penalty during the third year. Origination fees and closing costs are expected at approximately $100,000. The Partnership expects that the property will be sold in late 1997 or early 1998 prior to debt maturity.\nDuring 1994, the Partnership refinanced the debt for Stewarts Glen III with the existing lender. The maturity date has been extended from February 1995 to April 1996 and the interest rate was lowered to 8.55%. The cost of\nthe refinance was minimal. The Partnership's current strategy assumes a sale in early 1996 at debt maturity.\nDuring 1991, the Partnership benefitted from a reduction in debt service requirements for the Waterford first mortgage note. The Partnership had been receiving quarterly returns from an interest equalization account established at the time of the property's original bond financing. This escrow account was established to fund shortfalls in debt service requirements, if necessary. If debt service payments on the mortgage were made at the minimum 9% pay rate, and a positive balance remained once bond obligations were met, the difference was deposited into this account until the balance reached the required minimum of $652,457. Once the minimum was attained, the difference was available to the Partnership. The net reduction in debt service payments was $277,000 for 1992 and $322,246 in 1993. In December 1993, the Waterford bond-related debt was replaced with new bond financing. The replacement financing has a fixed rate and does not have an interest equalization feature.\nDuring the third quarter of 1993, the Partnership utilized reserves of $770,000 to resolve a dispute with the holder of Waterford's purchase money note regarding outstanding payments due. In December 1993, the remaining balance on the note was paid in full from the proceeds of the new bond-related first mortgage refinancing.\nThe Waterford property's first mortgage and purchase money note were refinanced on December 17, 1993 with $11,755,000 in industrial revenue bonds issued by the Tulsa County Home Finance Authority and credit enhanced by AXA Reassurance, SA. The new financing is similar to the bond financing which it replaced and was issued by the same county housing authority. The bond issue consists of $11,355,000 of tax exempt bonds (Series A Bonds) which mature on December 1, 2018, and $400,000 in taxable bonds (Series B Bonds) which mature December 1, 1998. The interest rates on both series are fixed at 5.355% and 5.9455% (inclusive of Trustee fees and administrative costs) for the Series A and Series B bonds, respectively. The AXA insurance policy expires on December 1, 2004, however, the Partnership is required to obtain a new credit enhancer by December 1, 2003. The bonds can be prepaid in 2001 at 102% and at par in 2002 and thereafter.\nIn order to facilitate the low-interest bond backed financing, the Partnership set up a new ownership structure for the property, with no financial statement impact on the Partnership. Reference is made to Item 1. Business for a description.\nThe Partnership utilized the proceeds from the new bond financing along with Partnership reserves to payoff the existing first and second mortgage loans, fund the cost of the refinance, set-up a $100,000 cash collateral account, and set up a maintenance escrow account. The Partnership's contribution totalled $817,648 which included $165,191 from Partnership reserves and the $652,457 interest equalization account recorded on the Partnership's balance sheet as a debt escrow fund. Total cost of issuance was $1,473,272, which included a surety fee for the credit enhancer of $963,910 and other issuance costs of $509,362.\nThe credit enhancer on the new financing required a maintenance escrow agreement which the Partnership entered into as of December 1, 1993. The purpose of the agreement was to allow an escrow agent to control a reserve set aside by the Partnership for payment of necessary property repairs as determined by a consultant hired by the credit enhancer. The Partnership deposited $28,500 at closing which will be released to pay for repairs as completed. In addition, the bond documents call for additional contributions to the maintenance escrow account in an amount equivalent to 1% of gross revenues monthly. Funds are to be released as repairs are made.\nThe Series A issue has been designed with a cash collateral account rather than a sinking fund. Upon closing, a $100,000 contribution was made to the cash collateral account representing a quasi debt service reserve. The cash collateral account was created to meet lender guidelines which required that 10% of the bond issue be amortized by the end of the ten year credit enhancement period. By utilizing a cash collateral account, the Partnership is able to retain the full amount of the tax-exempt bond issue which may increase the value of a premium if the property is sold prior to the bonds maturity. Contributions to the cash collateral account are scheduled to begin on December 1, 1998.\nUnder the new bond structure, interest only payments of $52,541 are to be made monthly to the trustee to service the semi-annual payments due on the bonds. The Series B bonds interest payment will change in December 1995 when principal payments begin. The $400,000 principal amortizes based on a schedule of bond maturities by December 1998.\nThe Partnership plans to sell the Waterford property late in 1998 prior to required contributions to the Series A cash collateral account.\nEach of the apartment properties continue to produce positive results for the Partnership. Cash generated from property operations will be used to fund Partnership expenses and supplement reserves. Distributions to partners will not resume until the Partnership retires the $3,400,000 recourse note obligation.\nAt December 31, 1994, the Partnership had $1,662,708 in cash and cash equivalents which will be used to fund working capital requirements and the Partnership's reserves. Overall, the portfolio generated positive adjusted cash from operations after debt service, capital improvements and partnership expenses for the year ended December 31, 1994. The Partnership expects that overall, the operations for 1995 after debt service, capital improvements, and partnership expenses will provide positive cash flow to the Partnership's reserves.\nResults of Operations\nPartnership net operating income (total revenue less property operating expenses, general and administrative expenses, fees and reimbursements to affiliates and provision for doubtful accounts) decreased in 1994 to approximately $3,631,000 from approximately $3,733,000 in 1993.\nAt Versailles Village, net operating income increased approximately $69,000 in 1994 compared with 1993. The increase was the result of a slight increase in average occupancy and rent increases coupled with decreased repairs and maintenance expenses as 1993 included a painting project.\nNet operating income at Stonebridge Manor increased approximately $46,000 in 1994 from 1993, due to an increase in rental rates. The increase in income was partially offset by an increase in expenses.\nIncreased expenses in 1994 at Waterford Apartments attributed to repairs and maintenance, utilities and bad debt, coupled with a slight decrease in average occupancy, decreased net operating income approximately $52,000 in 1994 compared with 1993.\nAt Stewarts Glen, modest rental rate increases in 1994 resulted in increased net operating income of approximately $23,000 versus 1993.\nNet operating income at Promenades Plaza decreased approximately $226,000 in 1994 due primarily to the sale of the property on September 22, 1994.\nThe balance of the change in the Partnership's 1994 net operating income compared with 1993 was increased interest income earned on trust accounts associated with Waterford's bond financing.\nResults - 1994 Compared with 1993\nGenerally, decreases in the income statement accounts are the result of the sale of Promenades Plaza on September 22, 1994. For the fourth quarter of 1993, Promenades Plaza accounted for approximately $258,000 of rental income, $47,000 of other income, $99,000 of property operating expenses, $45,000 of general and administrative expenses, $143,000 of interest expense and $123,000 of depreciation and amortization.\nExcluding the loss of fourth quarter 1994 rental income from the sale of Promenades Plaza, rental income\nincreased approximately $23,000 for the year ended December 31, 1994, as compared with 1993. Rental rate increases implemented in 1993 and 1994 at Stonebridge Manor increased rental income approximately $80,000 for the year ended December 31, 1994, as compared with 1993. Decreased average occupancy at Promenades Plaza for the six months ended June 30, 1994, as compared with the same period of 1993, coupled with the loss of rental income from the sale date through September 30, 1994, decreased rental income approximately $92,000 for the applicable periods. Rental rate increases in 1994 at Versailles Village and Stewarts Glen, coupled with a slight increase in average occupancy at Versailles, resulted in increased rental income at each property for 1994 of approximately $23,000 and $16,000 respectively. A slight decrease in average occupancy at Waterford for 1994 resulted in an approximately $4,000 decrease in rental income compared with 1993.\nThe increase in interest income for the year ended December 31, 1994, as compared with 1993, was the result of interest earned on trust accounts associated with Waterford's bond financing.\nProperty operating expenses increased at Stonebridge for the year ended December 31, 1994, as compared with 1993, due to increased carpet and tile replacements and exterior painting. At Waterford Apartments, property operating expenses increased as a result of higher utility and insurance costs and parking lot repairs. Expense savings in 1994 at Versailles due to a 1993 painting project, partially offset the 1994 increases at Stonebridge and Waterford.\nThe decrease in general and administrative expense for the year ended December 31, 1994, as compared with 1993, was the result of payroll savings in 1994 at Waterford and Stewarts Glen due to staffing changes and the absence of non-recurring legal fees recorded in the second and third quarters of 1993 at Promenades. The decrease was partially offset by increased advertising expenditures at Waterford in 1994.\nThe provision for doubtful accounts was primarily the result of collectibility problems at Promenades Plaza.\nMortgage litigation fees incurred in 1993 were related to the resolution of Waterford's second mortgage litigation.\nThe increase in interest expense for the year ended December 31, 1994, as compared with 1993, was the result of a default rate of interest on the Promenades first mortgage between the June 1, 1994 default and the September 22, 1994 property sale. In addition, a low effective interest rate in 1993 on Waterford's variable rate bond financing versus 1994's fixed rate bond financing contributed to the increase. Offsetting a portion of the increase were: savings from the lower rates on the Promenades Stonebridge promissory notes refinanced during the first quarter of 1994; the Versailles Village first mortgage March 30, 1994 refinance, lowering the interest rate from 10% to 8%; and the Stewarts Glen November 1, 1994 refinance, decreasing the interest rate from 9.94% to 8.55%.\nThe decrease in depreciation and amortization for the year ended December 31, 1994, as compared with 1993, was the result of the permanent impairment loss for Promenades and the amortization of the surety fee related to Waterford's variable rate bond financing in the fourth quarter of 1993. The decrease was partially offset by the write-off of the unamortized leasing commissions relating to vacated tenants at Promenades.\nThe 1994 gain on sale of property was the result of the sale at Promenades Plaza in September 1994. The 1993 gain on sale of property was the result of an outparcel sale at Promenades Plaza in January 1993.\nResults - 1993 Compared with 1992\nRental income rose approximately $40,000 for the year ended December 31, 1993, as compared with 1992, as a result of increases at each of the Partnership's properties except Promenades Plaza. Rental rate increases implemented during 1992 and improved occupancy in 1993 increased rental income at Waterford by approximately $42,000. Rental rate increases implemented in 1993 at Versailles, and in 1992 and 1993 at Stonebridge, increased rental income approximately $12,000 and $68,000, respectively. Higher average occupancy percentages at the Stewarts Glen Apartments in 1993 versus 1992 contributed approximately $23,000 to the increase. Promenades Plaza's base rent was down with the loss of one of its anchors in March 1993, and its percentage rent was down as\nthe supermarket tenant's sales volume was affected by the oversupply of retail space in the immediate area.\nOther income decreased for the year ended December 31, 1993, as compared with 1992, due to decreased corporate rentals at Stewarts Glen and Stonebridge Manor, and decreased recapture of operating expenses at Promenades Plaza. Operating expense recapture at Promenades Plaza was recorded as income in 1992 based on estimated expense amounts. Actual expenses were lower and an adjustment was posted to reduce income in 1993. In addition, 1992 included a one-time laundry redecorating fee at Stewarts Glen from a new laundry contract.\nProperty operating expenses increased for the year ended December 31, 1993, as compared with 1992, due to planned increases in non-routine maintenance at Versailles Village and planned increases in routine maintenance at Stonebridge Manor due to the age of the properties. At Versailles Village, non-routine maintenance consisted of carpet replacements, air conditioning and roof repairs, and exterior painting. In addition, due to rate hikes and additional usage from the colder winter, Versailles Village had substantial increases to utilities. An increase in the assessed value coupled with an increase in the mill rate produced higher real estate taxes at Promenades Plaza. Planned decreases in non- routine maintenance at Waterford partially offset the increases.\nGeneral and administrative expenses, inclusive of mortgage litigation fees, were up for the year ended December 31, 1993, as compared with 1992, due to increased payroll costs at Stewarts Glen, Stonebridge, Waterford and Versailles Village slightly offset by decreased payroll at Promenades Plaza. Planned decreases in advertising at Waterford coupled with decreases at Stonebridge more than offset the increased advertising at Versailles Village. In addition, included in 1993 are legal costs incurred relative to the Waterford purchase money note settlement agreement.\nThe provision for doubtful accounts for both years was the result of continuing collectibility problems at Promenades Plaza.\nThe decrease in interest expense for the year ended December 31, 1993, as compared with 1992, was the result of increased returns from Waterford's interest equalization account from lower interest rates and final adjustments to debt balances recorded in the fourth quarter of 1993 relative to the Waterford debt refinance.\nThe increase in depreciation and amortization for the year ended December 31, 1993, as compared with 1992, was due mainly to the additional deferred charge amortization for the Waterford mortgage refinance. The unamortized balance of the surety fee capitalized from old debt was expensed.\nThe gain on sale of property was the result of an outparcel sale at Promenades Plaza in January 1993.\nInflation\nWith inflation at a low rate during 1994, 1993 and 1992, the effect of inflation and changing prices on current revenue and income from operations has been minimal.\nAny significant inflation in future periods is likely to increase rental rates (from leases to new tenants or renewals of leases to existing tenants) assuming no major changes in market conditions. At the same time, it is anticipated that property operating expenses will be similarly affected. Assuming no major changes in occupancy levels, increases in rental income are expected to cover inflation driven increases in the cost of operating the properties and in property taxes. Inflation may also result in capital appreciation of the Partnership's investment properties over a period of time as rental rates and replacement costs of properties increase.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nCONNECTICUT GENERAL REALTY INVESTORS III LIMITED PARTNERSHIP (a Connecticut limited partnership)\nIndex Page\nReport of Independent Accountants 17 Financial Statements: Balance Sheets, December 31, 1994 and 1993 18 Statements of Operations, For the Years Ended December 31, 1994, 1993 and 1992 19 Statements of Partners' Capital (Deficit), For the Years Ended December 31, 1994, 1993 and 1992 20 Statements of Cash Flows, For the Years Ended December 31, 1994, 1993 and 1992 21 Notes to Financial Statements 22\nSchedules: III - Real Estate and Accumulated Depreciation, December 31, 1994 30\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 financial statements or related notes.\nReport of Independent Accountants\nTo the Partners of Connecticut General Realty Investors III Limited Partnership\nIn our opinion, the financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Connecticut General Realty Investors III Limited Partnership at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Partnership's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits 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 LLP Hartford, Connecticut February 13, 1995\nCONNECTICUT GENERAL REALTY INVESTORS III LIMITED PARTNERSHIP (a Connecticut limited partnership)\nNotes to Financial Statements\n1. Organization and Basis of Accounting\nThe general partner of Connecticut General Realty Investors III Limited Partnership (the \"Partnership\") is CIGNA Realty Resources, Inc. - Fifth (the \"General Partner\"), an indirect, wholly owned subsidiary of CIGNA Corporation.\nIn December 1993, the Partnership refinanced the first and second mortgages encumbering the Waterford Apartments property. The first mortgage, funded with multifamily housing revenue bonds issued by the Tulsa County Home Finance Authority, and the second mortgage were replaced with a new first mortgage. The replacement financing was also funded with newly issued multifamily housing revenue bonds issued by the Tulsa County Home Finance Authority. As a requirement of the new financing, the Waterford property had to be classified as single asset ownership. Since the Partnership owns multiple properties, a new partnership was created for the Waterford property as its sole real estate asset. Waterford Partnership, a general partnership, was organized in the State of Connecticut with the Partnership as its managing general partner (99.9% interest) and the General Partner (0.1% interest) as the other general partner. The interest of the General Partner in the new partnership is held in trust for the benefit of The Tulsa Corporation, a newly organized Delaware corporation, the stock of which is 100% owned by the Partnership. The Tulsa Corporation was created with the sole purpose of acting as the beneficiary of the General Partner's ownership interest in Waterford Partnership. The new structure has no economic effect on the Partners nor does it require any changes in financial reporting for the Partnership.\nThe Partnership's records are maintained on the accrual basis of accounting for financial reporting purposes and are adjusted for federal income tax reporting. The net effects of the adjustments as of December 31, 1994, 1993 and 1992, principally relating to the accounting for property impairment, and differences in depreciation methods, are summarized as follows:\n2. Summary of Significant Accounting Policies\na) Property and Improvements: Property and improvements are carried at cost less accumulated depreciation. The cost represents the initial purchase price and subsequent capitalized costs and adjustments, including certain acquisition expenses and additionally for 1993, permanent impairment losses. Depreciation of property and improvements is calculated on the straight-line method based on the estimated useful lives of the various components (5 to 30 years). Maintenance and repair expenses are charged to operations as incurred. Amounts received under the guarantee agreements from the sellers of the Waterford Apartments, Stonebridge Manor and Stewart's Glen Apartments Phase III were treated as a reduction of property purchase price.\nAs a result of inherent changes in market values of real estate property and improvements, the Partnership reviews potential impairment annually. The undiscounted future cash flows for each property, as estimated by the Partnership, is compared to the net book value. If the carrying value is greater than the sum of the estimated future undiscounted cash flows, and deemed permanent, an impairment loss is recorded.\nIn November 1993, the Financial Accounting Standards Board issued a Proposed Statement of Financial Accounting Standards, \"Accounting for the Impairment of Long-Lived Assets\". Under the Proposed Statement, entities should continue to compare the sum of the expected undiscounted future net cash flows to the carrying value of the asset. If an impairment exists, the loss shall be measured as the amount by which the carrying value of the asset exceeds the fair value of the asset. Fair value of the asset shall be measured by its market value if an active market for that asset exists. If no market price is available, a forecast of expected discounted future net cash flows should be used. The discount rate applied should be commensurate with the risk involved. The effective date of a final statement is fiscal years beginning after June 15, 1995. Since the Partnership had no impairment losses in 1994, the statement, if it had been effective at December 31, 1994, would have had no effect on the Partnership's assets or results. The effect of the Proposed Statement on the financial position and results of operations of the Partnership in the year of adoption can not be reasonably estimated.\nb) Cash and Cash Equivalents: Short-term investments with a maturity of three months or less at the time of purchase are generally reported as cash equivalents.\nc) Escrow Deposits and Escrowed Debt Service Funds: Escrow deposits consist of funds held to pay property taxes and insurance, as required by the first mortgage lender for Stewart's Glen and Waterford, a maintenance escrow, as required by the Waterford mortgage lender, and a utility deposit for Stonebridge Manor. Escrowed debt service funds relate to Waterford and include a debt service reserve and cash collateral reserve.\nd) Other Asset: The other asset was a standby cash deposit related to the debt refinancing of Stewart's Glen Apartments in 1994. The cash deposit was returned to the Partnership in January 1995.\ne) Deferred Charges: Deferred charges consist of costs incurred in obtaining financing for certain of the Partnership's properties which are amortized over the lives of the respective loans, and in 1993, the balance also consisted of leasing commissions, which were amortized using the straight-line method over the respective lease terms.\nf) Partners Capital: Offering costs comprised of sales commissions and other issuance expenses have been charged to the partners' capital accounts as incurred.\ng) Income Taxes: No provision for income taxes has been made as the liability for such taxes is that of the partners rather than the Partnership.\nh) Basis of Presentation: Certain amounts in the 1993 and 1992 financial statements have been reclassified to conform to the 1994 presentation.\n3. Investment Properties\nThe Partnership purchased four apartment complexes located in Ohio, Oklahoma, Louisiana and Illinois and one shopping center located in Florida. At December 31, 1994, the Partnership owned four residential properties which were operating with leases in effect generally for a term of one year or less. On September 22, 1994, the Partnership completed the sale of Promenades Plaza to Sterling Promenades Limited Partnership. Each investment property is pledged as security for its respective non-recourse long-term debt.\nOn January 27, 1993, the Partnership sold an outparcel at the Promenades Plaza Shopping with a $452,665 historic cost and a net book value of $376,083 for a sales price of $500,000, netting the Partnership $452,500 after commission and closing costs. The Partnership recognized a gain on the sale of $76,417 in 1993.\nThe credit enhancer on the Waterford financing required a maintenance escrow agreement which the Partnership entered into as of December 1, 1993. The purpose of the agreement was to allow an escrow agent to control a reserve set aside by the Partnership for payment of necessary property repairs as determined by a consultant hired by the credit enhancer. The Partnership deposited an initial amount of $28,500 on December 17, 1993 which will be released to pay for repairs as completed. In addition, the bond documents call for additional contributions to the maintenance escrow account in an amount equivalent to 1% of gross revenues monthly. Funds are to be released as repairs are made.\n4. Deferred Charges\nDeferred charges at December 31, 1994 and 1993 consist of the following: 1994 1993\nSurety fee - Waterford financing $963,910 $963,910 Costs of obtaining financing 740,117 893,359 Deferred leasing commissions -- 282,346 1,704,027 2,139,615 Accumulated amortization (288,677) (515,197) $1,415,350 $1,624,418\n5. Leases\nThe Promenades Plaza Shopping Center, which was sold on September 22, 1994 (see Note 9), was leased under leases which were accounted for as operating leases and had lease terms ranging from less than one year to nine years.\nCertain of the commercial leases provided for additional rents based upon a percentage of tenant sales over a specified amount. Amounts earned by the Partnership for such rents in 1994, 1993 and 1992 were $71,669, $60,505 and $89,793, respectively. Certain of these leases also contained escalation and expense recapture clauses which provided that tenants pay their pro rata share of any increases in common area maintenance, taxes and operating expenses over base period amounts. The Partnership earned $113,031 in 1994, $175,060 in 1993 and $208,790 in 1992 as a result of such provisions.\n6. Notes and Mortgages Payable\nExcept as noted, the Partnership's debt is non-recourse to the Partnership and is secured by the investment properties. Notes and mortgages payable at December 31, 1994 and 1993 consist of the following:\nDecember 31 1994 1993 8% mortgage note for Versailles Village Apartments. Principal and interest of $32,416 payable monthly from May 1, 1994 $4,159,177 $-- until April 1, 2001, when the balance of $3,704,876 will be due.\n10% mortgage note for Versailles Village Apartments. Principal and interest of $36,890 payable monthly from October 1, 1988, until September 1, 1993, when the balance was due. The loan was extended -- 4,041,049 at existing terms until March 31, 1994, and refinanced on March 30, 1994.\n8.875% mortgage note for Promenades Plaza Shopping Center. Interest only payable monthly until January 1, 1992. Principal and interest of $49,850 were payable monthly from February 1, 1992, until January 1, 1994 when the balance was due. -- 5,856,794 The loan was extended until May 1, 1994 at existing terms. The property was sold on September 22, 1994.\n9.08% promissory recourse note for Promenades Plaza Shopping Center. Interest payments were due quarterly until January 1, 1994 when the balance was due. The loan was extended until March 25, 1994 at 4.38%. The loan was consolidated, extended and modified with the Stonebridge Manor Apartments -- 2,500,000 promissory note as the Partnership promissory recourse note dated March 25, 1994. The loan is not secured by the property but is guaranteed by an affiliate of the General Partner.\nMortgage notes for Waterford Apartments at interest rates as stated on bonds issued by lender to fund loan. Series 1993 A Bonds; $11,355,000; 5.35%; interest only payments of $50,624 12\/1\/93 to 12\/1\/2018 due monthly; 10% of bond principal required in cash collateral account by the end of the surety period, 12\/1\/2003; cash\ncollateral set up at closing with $100,000; contributions to collateral begin 12\/1\/98; bond maturity, 12\/1\/2018. 11,755,000 11,755,000 Series 1993 B Bonds; $400,000; 5.75%; interest only payments of $1,917 due monthly 12\/1\/93 to 12\/1\/95, principal and interest of $12,750 due monthly 12\/1\/95 to 6\/1\/96, $11,605 6\/1\/96 to 12\/1\/96, $12,984 12\/1\/96 to 6\/1\/97, $11,816 6\/1\/97 to 12\/1\/97, $12,338 12\/1\/97 to 6\/1\/98, $12,002 6\/1\/98 to 12\/1\/98; fully amortized by 12\/1\/98.\n10.12% mortgage note for Stonebridge Manor Apartments. Interest only payable monthly until April 1, 1992. Principal and interest of $47,868 payable monthly 5,311,831 5,346,751 from May 1, 1992 until April 1, 1995 when the balance of $5,305,661 will be due.\n10.5% promissory recourse note for Stonebridge Manor Apartments. Interest only payable semiannually commencing on September 25, 1990, until March 25, 1994, when the principal was due. The loan was consolidated, extended and modified with the Promenades Plaza Shopping Center promissory note as the Partnership -- 900,000 promissory recourse note dated March 25, 1994. This loan is not secured by the property but is guaranteed by an affiliate of the General Partner.\n8.55% mortgage note for Stewart's Glen Apartments Phase III. Interest only at 9.94% payable monthly until February 1, 1991. Principal and interest of $47,306 payable monthly from March 1, 1991, until November 1, 1994, when the note was 4,861,583 4,935,269 modified to 8.55% interest only payments of $34,639 payable monthly from December 1, 1994 until April 1, 1996, the extended maturity date.\nPartnership recourse promissory note dated March 25, 1994 and due March 25, 1997. Interest only payments at 6.6% for the first two years with no prepayment provision. The interest only payments for the third year will be at a floating 3,400,000 -- rate equal to Mellon Bank's prime rate. During the third year, the note can be prepaid in full at any time. The note is guaranteed by an affiliate of the General Partner.\nTotal notes and mortgages payable $29,487,591 $35,334,863\nOn May 1, 1994, the Partnership's extension on Promenades' first mortgage loan expired. As an alternative to payment of the entire loan balance on May 1, 1994, the Partnership agreed with the first mortgage lender to pay an additional debt service payment to extend the maturity to June 1, 1994 while negotiations continued on the sale of the property. The lender requested an additional debt service payment due June 1, 1994 to extend the loan an additional month to July 1, 1994. Effective with the extension payment due June 1, 1994 (May interest due June 1), the Partnership defaulted. During June, the Partnership executed a contract with a potential buyer subject to a number of contingencies, including the buyer's ability to obtain financing and the performance of due diligence. As a result of the default, the first mortgage lender commenced foreclosure proceedings. The foreclosure was stayed by the Court due to the pending sale of the property and the Partnership and the first mortgage lender entered into a cash collateral agreement. The Court required the Partnership to complete its sale of the property by October 17, 1994. On September 22, 1994, the Partnership completed the sale of Promenades Plaza.\nThe Waterford property's first and second mortgage debt was refinanced on December 17, 1993, with $11,755,000 in industrial revenue bonds issued by the Tulsa County Home Finance Authority and credit enhanced by AXA Reassurance, SA. The new financing is similar to the bond financing which it replaces and has been issued by the same county housing authority. The bond issue consists of $11,355,000 of tax exempt bonds (Series A Bonds) which matures on December 1, 2018, and $400,000 in taxable bonds (Series B Bonds) which mature December 1, 1998. The interest rate on both series are fixed at 5.35% and 5.75% for the Series A and Series B bonds, respectively. The AXA insurance policy expires on December 1, 2004. The bonds can be prepaid in 2001 at 102% and at par in 2002 and thereafter.\nThe Series A issue has been designed with a cash collateral account rather than a sinking fund. Upon closing a $100,000 contribution was made to the cash collateral account representing a quasi debt service reserve. The cash collateral account was created to meet surety guidelines which required that 10% of the bond issue be amortized by the end of the ten year credit enhancement period. Contributions to the cash collateral account are scheduled to begin on December 1, 1998.\nUnder the new bonds, interest only payments of $52,541 are made monthly to the trustee to service the semi-annual payments due on the bonds. The Series B bonds interest payment will change in December 1995 when principal payments begin. The $400,000 principal amortizes by December 1998 based on a schedule of bond maturities.\nThe Partnership is in the process of securing a refinance of Stonebridge Manor Apartment's first mortgage note with a scheduled maturity of April 1, 1995, for $5,300,000 for a period of three years at 10.15% with twenty year amortization. Prepayment is closed for the first year, open at 1% during the second year and open without penalty during the third year.\nFive year maturities of long-term debt are summarized as follows:\n1995 $5,381,035 1996 5,050,630 1997 3,603,462 1998 202,480 1999 80,299 Thereafter 15,169,685\n7. Transactions with Affiliates\nFees and other expenses incurred by the Partnership related to the General Partner or its affiliates during the periods ended December 31, 1994, 1993 and 1992 are as follows:\n1994 1993 1992\nProperty management fees(a) $335,978 $335,157 $339,603 Printing 6,150 5,622 7,562 Reimbursement (at cost) for out-of-pocket expenses 41,366 44,774 46,793\n(a) In 1994, 1993 and 1992, $290,347, $297,806 and $293,001, respectively, of these fees were for services contracted by CIGNA Investments, Inc., an affiliate of the General Partner, on behalf of the Partnership but paid directly by the Partnership to independent third party property management companies.\nIn addition, the recourse promissory notes for Promenades Plaza Shopping Center and Stonebridge Manor were guaranteed by an affiliate of the General Partner for an annual fee of 2% and 1.25% on the outstanding balance, respectively, prior to consolidation, modification and extension effective on March 25, 1994. After consolidation, the note guarantee carries an annual fee of 2% of the outstanding balance.\n8. Partners' Capital\nDuring 1991, the State of Connecticut enacted new income tax legislation, a part of which affects partnerships. The portfolio income allocations made by the Partnership to the limited partners are considered Connecticut based income and subject to Connecticut tax. On April 13, 1994, the Partnership paid the tax due on its 1993 Form CT-G State of Connecticut Group Income Tax Return. The Partnership has elected to pay the tax due on the limited partners' share of portfolio income and, therefore, paid tax due of $1,683 directly to the State of Connecticut. The Partnership also accrued the 1994 estimated payment of $3,672 as of December 31, 1994. These amounts were treated as reductions of partners' capital and reported as distributions in the accompanying financial statements.\n9. Sale of Property\nAs a result of Promenades' continual cash flow deficits, the ongoing need for capital improvements, and the debt maturity, the General Partner determined that it was in the best interest of the Partnership to sell Promenades Plaza. The General Partner expected that the net proceeds realized from a sale would be significantly less than the carrying value of the property and accordingly, the Partnership recorded a loss of $5,000,000 due to permanent impairment of assets as of December 31, 1993.\nOn September 22, 1994, the Partnership completed the sale of Promenades Plaza to Sterling Promenades Limited Partnership for a gross sales price of $6,572,000. The property had a carrying value of $6,239,957 (net of permanent impairment losses of $5,000,000 in 1993 and $700,000 in 1991). After deducting closing costs of $307,206, the Partnership recorded a gain of $24,837.\n10. Partnership Agreement\nPursuant to the terms of the Partnership Agreement as amended January 1, 1988, net income or loss and cash distributions from operations, as well as any net losses arising from the sale or disposition of investment properties, are to be allocated 1% to the General Partner and 99% to the Limited Partners. Cash distributions are allocated to the Partners following the receipt by an affiliate of the General Partner of a partnership management fee of 9% of \"Adjusted Cash From Operations\", as defined in the Partnership Agreement.\nDistributable cash from the sale or disposition of investment properties is to be generally allocated in the following order:\nTo the Limited Partners up to the amount of their Original Invested Capital;\nTo the General Partner, an additional amount depending upon the percentage of Gross Proceeds committed to investment in properties;\nTo the Limited Partners in an amount, which when added to prior distributions from operations, equals an 8% cumulative noncompounded return on their adjusted invested capital;\nTo an affiliate of the General Partner as a subordinated disposition fee; and\nWith respect to the remainder, 85% to the Limited Partners and 15% to the General Partner.\nGenerally, income from the sale or disposition of investment property is allocated as follows:\nTo each Partner having a deficit balance in the same ratio of such balance to the aggregate balance of all Partners;\nTo each Partner to the extent of cash distributed from the sale; and\nAny remaining gain 1% to the General Partner and 99% to the Limited Partners.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants 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 General Partner of the Partnership, CIGNA Realty Resources, Inc.- Fifth, a Delaware corporation, is an indirectly, wholly owned subsidiary of CIGNA Corporation, a publicly held corporation whose stock is traded on the New York Stock Exchange. The General Partner has responsibility for and control over the affairs of the Partnership.\nThe directors and executive officers of the General Partner as of February 28, 1995 are as follows:\nName Office Served Since\nR. Bruce Albro Director May 2, 1988\nPhilip J. Ward Director May 2, 1988\nJohn Wilkinson Director September 7, 1993\nJohn D. Carey President, Controller September 7, 1993 September 4, 1990\nVerne E. Blodgett Vice President, Counsel April 2, 1990\nJoseph W. Springman Vice President, Assistant September 7, 1993 Secretary\nDavid C. Kopp Secretary September 29, 1989\nMarcy F. Blender Treasurer August 1, 1994\nThere is no family relationship among any of the foregoing directors or officers. There are no arrangements or understandings between or among said officers or directors and any other person pursuant to which any officer or director was selected as such.\nThe foregoing directors and officers are also officers and\/or directors of various affiliated companies of CIGNA Realty Resources, Inc. - Fifth, including CIGNA Financial Partners, Inc. (the parent of CIGNA Realty Resources, Inc. - Fifth), CIGNA Investments, Inc., CIGNA Corporation (the parent of CIGNA Investments, Inc.), Connecticut General Corporation (the parent of CIGNA Financial Partners, Inc.).\nThe business experience of each of the directors and executive officers of the General Partner of the Partnership is as follows:\nR. BRUCE ALBRO - DIRECTOR\nMr. Albro, age 52, a Senior Managing Director of CIM, joined Connecticut General's Investment Operations in 1971 as a Securities Analyst in Paper, Forest Products, Building and Machinery. Subsequently, he served as a Research Department Unit Head, as an Assistant Portfolio Manager, then as Director of Equity Research and a member of the senior staff of CIGNA Investment Management Company and as a Portfolio Manager in the Fixed Income area. He then headed the Marketing and Merchant Banking area for CII. Prior to his current assignment of Division Head, Portfolio Management Division, he was an insurance portfolio manager, and prior to that, he was responsible for Individual Investment Product Marketing. In addition, Mr. Albro currently serves as President of the CIGNA Funds Group and other CIGNA affiliated mutual funds. Mr. Albro received a Master of Arts degree in Economics from the University of California at Berkeley and a Bachelor of Arts degree in Economics from the University of Massachusetts at Amherst.\nPHILIP J. WARD - DIRECTOR\nMr. Ward, age 46, is Senior Managing Director and Division Head of CIGNA Investment Management (CIM), in charge of the Real Estate Investment Division of CIM. He was appointed to that position in December 1985. Mr. Ward joined Connecticut General's Mortgage and Real Estate Department in 1971 and became an officer in 1976. Since joining the company he has held real estate investment assignments in Mortgage and Real Estate Production and in Portfolio Management. Prior to his current position, Mr. Ward held assignments in CIGNA Investments Inc., responsible for the Real Estate Production area, CIGNA Realty Advisors, Inc. and Congen Realty Advisory Company, all wholly-owned subsidiaries of CIGNA Corporation and\/or Connecticut General. Mr. Ward has held various positions with the General Partner. His experience includes all forms of real estate investments, with recent emphasis on acquisitions and joint ventures. Mr. Ward is a 1970 graduate of Amherst College with a Bachelor of Arts degree in Economics. He is a member of the Society of Industrial and Office Realtors, the National Association of Industrial and Office Parks, the Urban Land Institute and the International Council of Shopping Centers. He is a member of the Board of Directors of DeBartolo Realty Corporation and Cadillac Fairview, Inc.\nJOHN WILKINSON - DIRECTOR\nMr. Wilkinson, age 51, is Senior Vice President and Chief Financial Officer of the CIGNA Individual Insurance Division. He was appointed to that position in January 1992. Mr. Wilkinson joined the company in 1970 and became an officer in 1978. In 1981 he joined CIGNA Individual Financial Services Division (now CIGNA Individual Insurance) and was appointed Vice President in 1988 in that Division. Mr. Wilkinson continued to work in the Insurance Marketing area as Vice President until he was appointed to his current position. Mr. Wilkinson is a 1965 graduate of the U.S. Naval Academy. He is a Registered Principal of CIGNA Financial Advisors, Inc., a Fellow of the Society of Actuaries, a member of the American Academy of Actuaries, a Chartered Life Underwriter and Chartered Financial Counsellor.\nJOHN D. CAREY - PRESIDENT, CONTROLLER\nMr. Carey, age 31, joined CIGNA in 1990. Prior to joining CIGNA, he held the position of manager at KPMG Peat Marwick in the audit department and was a member of the Real Estate Focus Group. His experience includes accounting and financial reporting for public and private real estate limited partnership syndications. Mr. Carey is a graduate of Central Connecticut State University with a Bachelor of Science Degree and is a Certified Public Accountant.\nVERNE E. BLODGETT - VICE PRESIDENT, COUNSEL\nMr. Blodgett, age 57, is an Assistant General Counsel of CIGNA Corporation. He joined Connecticut General Life Insurance Company in 1975 as an investment attorney and has held various positions in the Legal Division of Connecticut General Life Insurance Company prior to his appointment as Assistant General Counsel in 1981. Mr. Blodgett received a Bachelor of Arts degree from Yale University and graduated with honors from the University of Connecticut School of Law. He is a member of the Connecticut and the American Bar Associations.\nJOSEPH W. SPRINGMAN - VICE PRESIDENT, ASSISTANT SECRETARY\nMr. Springman, age 53, is Managing Director and department head responsible for asset management. He joined CIGNA's Real Estate operations in 1970. He has held positions as an officer or director of several real estate affiliates of CIGNA. His past real estate assignments have included Development and Engineering, Property Management, Director, Real Estate Operations, Portfolio Management and Vice President, Real Estate Production. Prior to assuming his asset management post, Mr. Springman was responsible for production of real estate and mortgage investments. He received a Bachelor of Science degree from the U.S. Naval Academy.\nDAVID C. KOPP - SECRETARY\nMr. Kopp, age 49, is Secretary of CII, Corporate Secretary of Connecticut General Life Insurance Company and Assistant Corporate Secretary and Assistant General Counsel, Insurance and Investment Law of CIGNA Corporation. He also serves as an officer of various other CIGNA Companies. He joined Connecticut General Life Insurance Company in 1974 as a commercial real estate attorney and held various positions in the Legal Department of Connecticut General Life Insurance Company prior to his appointment as Corporate Secretary in 1977. Mr. Kopp is an honors graduate of Northern Illinois University and served on the law review at the University of Illinois College of Law. He is a member of the Connecticut Bar Association and is Past President of the Hartford Chapter, American Society of Corporate Secretaries.\nMARCY F. BLENDER - TREASURER\nMarcy F. Blender, age 38, is Assistant Vice President, Bank Resources of CIGNA Corporation. In this capacity she is responsible for bank relationship management, bank products and services, bank compensation and control, and bank exposure management. Marcy joined Insurance Company of North America (INA) in 1979. She has held a variety of financial and investment positions with INA and later with the merged CIGNA Corporation before assuming her current responsibilities in 1992. She received a B.A. degree from Rutgers University and an M.B.A. from Drexel University. She is a Certified Public Accountant.\nItem 11.","section_11":"Item 11. Executive Compensation\nOfficers and directors of the General Partner receive no current or proposed direct compensation from the Partnership in such capacities. However, certain officers and directors of the General Partner received compensation from the General Partner and\/or its affiliates (but not from the Partnership) for services performed for various affiliated entities, which may include services performed for the Partnership, but such compensation was not material in the aggregate.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nNo person or group is known by the Partnership to own beneficially more than 5% of the outstanding Units of interest of the Partnership.\nThere 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.\nAs of February 28, 1995, the individual directors and the directors and officers, as a group, of the General Partner beneficially owned Partnership Units and shares of the common stock of CIGNA, parent of the General Partner, as set forth in the following table:\nUnits Shares Beneficially Beneficially Percent Name Owned(a) Owned(b) of Class\nR. Bruce Albro (c) 0 6,076 * Philip J. Ward (d) 0 17,680 * John Wilkinson (e) 0 13,753 *\nAll directors and officers Group (8) (f) 0 44,069 *\n* Less than 1% of class\n(a) No officer or director of the General Partner possesses a right to acquire beneficial ownership of additional Units of interest of the Partnership. (b) The directors and officers have sole voting and investment power over all the shares of CIGNA common stock they own beneficially. (c) Shares beneficially owned includes options to acquire 3,920 shares and 2,156 shares which are restricted as to disposition. (d) Shares beneficially owned includes options to acquire 10,985 shares and 2,274 shares which are restricted as to disposition. (e) Shares beneficially owned includes options to acquire 11,251 shares and 2,027 shares which are restricted as to disposition. (f) Shares beneficially owned by directors and officers include 28,511 shares of CIGNA common stock which may be acquired upon exercise of stock options and 10,111 shares which are restricted as to disposition.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe General Partner of the Partnership is generally entitled to receive 1% of cash distributions, when and as cash distributions are made to the limited partners, and is generally allocated 1% of profits or losses. In 1994, the Partnership distributed no cash from operations. The General Partner was allocated a share of Partnership income in 1994 of $17,526 which includes the entire gain on sale of Promenades of $24,837. Reference is also made to the Notes to Financial Statements included in this annual report for a description of such distributions and allocations. The relationship of the General Partner (and its directors and officers) to its affiliates is set forth in Item 10 above.\nCII provided asset management services to the Partnership during 1994 at fees calculated at 5% of gross revenues from the Versailles Village Apartments, Waterford Apartments, Stonebridge Manor Apartments and Stewart's Glen Apartments and 6% of gross revenues from the Promenades Plaza Shopping Center less amounts earned by independent third party property management companies contracted by CII on behalf of the Partnership. In 1994, such affiliate earned asset management fees amounting to $45,631 for such services, of which $7,117 was unpaid as of December 31, 1994. Non-affiliated third party independent property managers contracted by CII earned $290,347 of management fees, of which $8,858 was unpaid as of December 31, 1994.\nCFP provided partnership management services for the Partnership at fees calculated at 9% of adjusted cash from operations in any one year. CFP did not earn or receive partnership management fees in 1994.\nThe recourse promissory notes for Promenades Plaza Shopping Center and Stonebridge Manor, which were modified, extended and consolidated March 25, 1994, carry a corporate guarantee by CIGNA Corporation. The Partnership incurred a guarantee fee of $66,313 for 1994, of which $17,000 was unpaid at December 31, 1994.\nThe General Partner and its affiliates may be reimbursed for their direct expenses incurred in the administration of the Partnership. In 1994, the General Partner and its affiliates were entitled to reimbursement for such out of pocket expenses in the amount of $47,516, of which $950 was unpaid as of December 31, 1994.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a) 1. Financial Statements. See Index to Financial Statements in Item 8.\n2. Financial Statement Schedules\n(a) Real Estate and Accumulated Depreciation. See Index to Financial Statements in Item 8.\n3. Exhibits\n3 Partnership Agreement, incorporated by reference to Exhibit A to the Prospectus of Registrant, dated July 2, 1984, filed pursuant to Rule 424(b) under the Securities Act of 1933, File No. 2-90944.\n3(a) Amendment to Partnership Agreement, dated as of July 1, 1985, incorporated by reference to Exhibit 3(a) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1984.\n4 Certificate of Limited Partnership, dated April 16, 1984, incorporated by reference to Exhibit 4 to Form S-11 Registration Statement under the Securities Act of 1933, File No. 2-90944.\n10(a) Acquisition and Disposition Services Agreement, dated July 2, 1984, between Connecticut General Realty Investors III Limited Partnership and CIGNA Capital Advisers, Inc., incorporated by reference to exhibit 10(a) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(b) Supervisory Property Management Agreement, dated July 2, 1984, between Connecticut General Realty Investors III Limited Partnership and CIGNA Capital Advisers, Inc., incorporated by reference to exhibit 10(b) to Registrants Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(c) Agreements concerning Certain Capital Contributions, between Connecticut General Management Resources, Inc. and CIGNA Realty Resources, Inc.-Fifth, incorporated by reference to exhibit 10(c) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(d) Purchase and Sale Agreement, dated as of January 17, 1985, relating to the Acquisition of Versailles Village Apartments, incorporated by reference to Exhibit 10(d) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1984.\n(e) Bill of Sale and Assignment between Stonebridge Manor, a Louisiana Partnership in Commendam, and Connecticut General Realty Investors III Limited Partnership, dated November 26, 1985, relating to the acquisition of the Stonebridge Manor Apartments, incorporated by reference to Exhibit 10(h) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985.\n(f) Act of Credit Sale and Assumption of Mortgage between Stonebridge Manor, a Louisiana Partnership in Commendam, and Connecticut General Realty Investors III Limited Partnership dated November 26, 1985, relating to the acquisition of the Stonebridge Manor Apartments, incorporated by reference to Exhibit 10(i) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985.\n(g) Purchase and Sale Agreement between Waterford, LTD. and Connecticut General Realty Investors III Limited Partnership, dated October 31, 1985, relating to the acquisition of the Waterford Apartments, incorporated by reference to Exhibit 10(k) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985.\n(h) Promissory Note between Connecticut General Realty Investors III Limited Partnership, as Maker, and Waterford, LTD., as Payee, dated October 31, 1985, relating to the acquisition of the Waterford Apartments, incorporated by reference to Exhibit 10(l) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985.\n(i) Purchase and Sale Agreement between First Capital Income Properties Limited, Series V, and Connecticut General Realty Investors III Limited Partnership, relating to the acquisition of the Promenades Plaza Shopping Center, incorporated by reference to Exhibit 10(m) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985.\n(j) Mortgage Consolidation and Modification Agreement between Connecticut General Realty Investors III Limited Partnership and The Equitable Life Assurance Society of the United States, dated as of December 10, 1986, relating to the Promenades Plaza Shopping Center, incorporated by reference to Exhibit 10(n) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986.\n(k) Real Estate Purchase Agreement between Willowbrook Associates II and CIGNA Financial Partners, Inc., relating to Stewart's Glen Apartments Phase III, dated as of April 14, 1987, incorporated by reference to Exhibit 10(p) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(l) Amendment to Real Estate Purchase Agreement, dated July 20, 1987, between Willowbrook Associates II and Phase III Apartment Venture, relating to the acquisition of Stewart's Glen Apartments Phase III, incorporated by reference to Exhibit 10(s) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(m) Management and Leasing Agreement between Phase III Apartment Venture and Chasewood Properties, effective as of July 24, 1987, incorporated by reference to Exhibit 10(t) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(n) Mortgage, Security Agreement and Financing Statement and Promissory Note between Connecticut General Realty Investors III Limited Partnership and Massachusetts Mutual Life Insurance Company, dated January 25, 1988, relating to Stewart's Glen Apartments Phase III, incorporated by reference to Exhibit 10(v) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987.\n(o) Mortgage Note between Connecticut General Realty Investors III Limited Partnership and the John Hancock Mutual Life Insurance Co., dated as of August 12, 1988, relating to Versailles Village Apartments, incorporated by reference to Exhibit 10(w) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988.\n(p) Promissory Note between Connecticut General Realty Investors III Limited Partnership and Aetna Life Insurance Company, dated March 28, 1990, relating to Stonebridge Manor Apartments incorporated by reference to Exhibit 10 (p) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989.\n(q) Promissory Note between Connecticut General Realty Investors III Limited Partnership and Mellon Bank National Association, dated March 28, 1990, relating to Stonebridge Manor Apartments incorporated by reference to Exhibit 10 (q) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989.\n(r) Mortgage and Note Modification Agreement between Connecticut General Realty Investors III Limited Partnership and The Equitable Life Assurance Society of the United States, dated June 30, 1989, relating to Promenades Plaza Shopping Center incorporated by reference to Exhibit 10 (r) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989.\n(s) Promissory Note between Connecticut General Realty Investors III Limited Partnership and Barnett Bank of Southwest Florida, dated June 30, 1989, relating to Promenades Plaza Shopping Center incorporated by reference to Exhibit 10 (s) to Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989.\n(t) Promissory Note between Registrant and John Hancock Mutual Life Insurance Company, dated March 24, 1994, relating to Versailles Village Apartments incorporated by reference to Form 10-Q for the quarter ended March 31, 1994.\n(u) Documents and Agreements concerning the December 17, 1993 debt refinance of the Registrant's Waterford Apartments property with industrial revenue bonds issued by the Tulsa County Home Finance Authority and credit enhanced by AXA Reassurance, SA incorporated by reference to Form 10-Q for the quarter ended March 31, 1994.\n(v) Consolidation, Extension, Modification, and Restatement of Promissory Notes between Registrant and Mellon Bank, N.A., dated March 25, 1994 relating to Stonebridge Manor Apartments and Promenades Plaza Shopping Center incorporated by reference to Form 10-Q for the quarter ended March 31, 1994.\n(w) Contract for Purchase and Sale dated July 19, 1994, First Amendment to Contract for Purchase and Sale dated August 18, 1994, and Second Amendment to Contract for Purchase and Sale dated September 21, 1994 between the Registrant and Sterling Promenades Limited Partnership, a Florida limited partnership incorporated by reference to Form 8-K dated September 22, 1994.\n(x) Loan Modification Agreement between Connecticut General Realty Investors III Limited Partnership and Massachusetts Mutual Life Insurance Company, dated November 1, 1994, relating to Stewart's Glen Apartments.\n27 Financial Data Schedules.\n(b) Reports on Form 8-K:\nIn a report filed on Form 8K dated September 22, 1994, the Partnership reported the sale of Promenades Plaza to Sterling Promenades Limited Partnership.\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.\nCONNECTICUT GENERAL REALTY INVESTORS III LIMITED PARTNERSHIP\nBy: CIGNA Realty Resources, Inc. - Fifth General Partner\nDate: March 28, 1995 By: \/s\/ John D. Carey John D. Carey, President\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 (with respect to the General Partner) and on the date indicated.\n\/s\/ Philip J. Ward Date: March 28, 1995 Philip J. Ward, Director\n\/s\/ R. Bruce Albro Date: March 28, 1995 R. Bruce Albro, Director\n\/s\/ John Wilkinson Date: March 28, 1995 John Wilkinson, Director\n\/s\/ John D. Carey Date: March 28, 1995 John D. Carey, President, Controller (Principal Executive Officer) (Principal Accounting Officer)\n\/s\/ Marcy F. Blender Date: March 28, 1995 March F. Blender, Treasurer (Principal Financial Officer)","section_15":""}
{"filename":"216039_1994.txt","cik":"216039","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nGrubb & Ellis Company, a Delaware corporation organized in 1980, is the successor by merger to a real estate brokerage company first established in California in 1958. Grubb & Ellis Company and its wholly and majority owned subsidiaries (the \"Company\") provide real estate services to real estate owners\/investors and tenants. Such services include commercial brokerage and property and facilities management through its wholly owned operations and majority owned subsidiary, Axiom Real Estate Management, Inc. (\"Axiom\"). Additionally, the Company has for a number of years provided mortgage brokerage, appraisal, consultation and asset management services. The Company also provided residential brokerage services until November 1994 when it sold its remaining residential real estate business in Southern California.\nBased on revenue, the Company is one of the largest commercial real estate services companies in the United States. Through Axiom, the Company is also one of the largest property management firms in the country with approximately 70 million square feet of property under management. As of the year ended December 31, 1994, the Company had 87 offices in 58 cities in 16 states and the District of Columbia, with approximately 1,050 real estate agents, 670 non-agent employees and 1,200 Axiom property management staff (the cost of the property management staff is substantially reimbursed by clients).\nThe Company maintains informal business relationships with full-service real estate firms in England, France, Italy, Germany, the Netherlands, Asia and the Pacific Basin and has established its own representative offices in Sweden and London. The Company has a nonexclusive alliance with Mexus Services Corporation (\"Mexus\"), for purposes of client business referral. Mexus specializes in providing consulting services to U.S. firms seeking to do business in Mexico.\nIn 1994, commercial brokerage was the major source of revenue for the Company, followed by property management, and appraisal and consulting services. The balance of the Company's revenue was derived from real estate investment advisory and other services. The Company believes that commercial brokerage is likely to continue to be its major source of revenue for the foreseeable future.\nBUSINESS DEVELOPMENT AND STRATEGY\nHaving established operations in California, Arizona, Colorado, Washington and Hawaii from 1958 through 1980, the Company merged with a real estate investment trust in 1981 and became a publicly traded Company. The Company then proceeded to develop a national network of commercial brokerage offices, primarily by purchasing established real estate services firms in selected markets during the period from 1981 through 1986. The Company refinanced the resulting acquisition indebtedness in 1986 with the proceeds from the sale of $10 million in senior notes, $25 million in subordinated notes and a warrant to purchase common stock pursuant to an agreement with The Prudential\nInsurance Company of America (\"Prudential\"). The acquisitions have enabled the Company to provide diversified services to multi-regional and national clients. Most of the acquired companies no longer use their original company names and are identified solely as Grubb & Ellis Company. During this acquisition period, the Company also acquired residential brokerage offices in Georgia and Texas and expanded its operations in California through acquisitions in Southern California.\nIn September 1992, the Company formed Axiom, a property and facilities management joint venture with International Business Machines Corporation (\"IBM\"). The purpose of the joint venture is to provide commercial property management real estate services, and third-party and corporate facilities management on a nationwide basis. The Company holds a 74% interest, and IBM owns 26% of Axiom. Additional shares of Axiom's common stock have been reserved for the issuance of equity incentives to management. As of December 31, 1994, Axiom managed approximately 19 million square feet of office space for IBM.\nThe Company's rapid acquisition strategy implemented from 1981 through 1986 resulted in a significant increase in fixed costs and overhead. In response to this increased cost structure, and a declining and adverse real estate market in the late 1980's, the Company began to close unprofitable and non-strategic offices beginning in 1990. In 1990, the Company closed 15 property management and commercial and residential brokerage offices in locations judged to be non- strategic. In 1991, the Company closed four additional offices and also sold its Texas residential operations. In January 1992, the Company sold its Georgia residential operations. In February 1993, the Company completed the sale of the real estate advisory business of Grubb & Ellis Realty Advisers, Inc., a wholly owned subsidiary of the Company, to a privately held concern.\nIn early March 1993, the Company sold its Northern California residential real estate brokerage operations. The sale included 13 residential real estate offices as well as a relocation office. In October 1993, the Company closed its residential mortgage services operations in Northern California, and in February 1994, closed its unprofitable appraisal and consulting offices in Atlanta, Chicago, Dallas, Denver and Phoenix.\nIn January 1994, Axiom closed certain offices pursuant to its strategic objectives, and the Company, independent of Axiom, resumed property management services in some of those locations. In November 1994, the Company sold its remaining residential real estate operations in Southern California, consisting of nine residential offices and one relocation office.\nFrom 1990 to late 1992, the Company actively pursued equity financing to strengthen its liquidity and meet its short- and long-term working capital needs, as the severe economic recession had hindered its ability to meet debt principal and interest obligations to Prudential. On January 29, 1993, the stockholders of the Company approved a proposal for restructuring the debt and equity of the Company (the \"1993 Recapitalization\"), which involved a cash investment of $12.9 million by Warburg, Pincus Investors, L.P., a Delaware limited partnership (\"Warburg\"), and $900,000 by Joe F. Hanauer (\"Hanauer\"), a private investor who became Chairman of the Board of the Company. The investment was made in exchange for convertible preferred stock and warrants to purchase common stock and the renegotiation of the Company's indebtedness of approximately $40 million to Prudential, including the conversion of approximately $15 million of that indebtedness into convertible preferred stock and warrants to purchase common stock. As a result of the 1993 Recapitalization and certain other transactions, Warburg and Hanauer together held approximately 39.2% and Prudential held approximately 26.3% of the Company's equity at the end of 1993 on a fully diluted basis but before exercise of outstanding warrants.\nAt the end of 1993, the Company projected that without additional capital, the Company would be unable beyond the near term to meet its working capital needs and service its principal obligations to Prudential. Negotiations to modify debt agreements and financial covenants with Prudential and to obtain a $10 million interim financing loan from Warburg were substantially completed in March 1994. Hanauer assumed the additional responsibilities of Chief Executive Officer in July 1994. On September 12, 1994, stockholders of the Company approved a proposal for restructuring the debt and equity of the Company (the \"1994 Recapitalization\") and in November 1994, such transactions were completed with Warburg and Prudential as more fully described below (see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and Note 4 of Notes to Consolidated Financial Statements).\nThrough a stockholders' rights offering which was completed in November 1994, common stockholders, other than Warburg and Prudential, purchased 84,542 shares of common stock for total proceeds of $201,000 and, pursuant to a Standby Agreement, Warburg purchased 4,277,433 shares of common stock for total consideration of $10.2 million. Warburg paid for its shares with $4.0 million in cash and through cancellation of $6.2 million of indebtedness outstanding under its interim financing loan.\nDebt agreements with Prudential were modified to provide, among other things, deferral of principal payments until November 1, 1997 and thereafter on the $15 million principal amount of the 9.9% senior notes, 10.65% payment-in-kind notes and the revolving credit facility all of which would have been due during the period from 1994 through 1996 (see Note 4 of Notes to Consolidated Financial Statements).\nCertain provisions of the Company's outstanding convertible preferred stock were amended to provide, among other things, elimination of the mandatory redemption and certain anti-dilution provisions and an increase in the dividend rate commencing in 2002. Additionally, Warburg and Prudential were issued additional warrants to purchase common stock and certain terms of existing warrants were modified.\nAs a result of the 1994 Recapitalization, Warburg and Hanauer together hold approximately 57.0% and Prudential holds approximately 18.5% of the Company's equity on a fully diluted basis but before exercise of outstanding warrants and options.\nDuring 1994, the Company settled two significant lawsuits related to closed operations. As of December 31, 1994, the Company had either sold or closed nearly all of its targeted unprofitable offices and non-strategic businesses in response to recessionary business conditions. With the completion of the 1994 Recapitalization and development of its 1995 business plan, management believes it is well positioned to devote its resources to expanding its core commercial real estate business and to take advantage of the improving markets for commercial real estate.\nCOMMERCIAL BROKERAGE\nThe Company acts as a sales or leasing agent for commercial properties, which include office, industrial, retail and hotel properties, as well as undeveloped land. Properties range in size and type from single, free-standing locations to multi-level, mixed-use projects. Offices are typically\nlocated in or near major metropolitan areas. In 1994, to enhance operating efficiencies and reduce expenses, the Company realigned its previous four-region structure to form three commercial brokerage regions: Pacific Southwest (Southern California and Arizona); Pacific Northwest (Washington, Oregon and Northern California); and Eastern (Colorado, Connecticut, Florida, Georgia, Illinois, Massachusetts, Michigan, New Jersey, New York, Ohio, Pennsylvania, Texas, Virginia and Washington, D.C.). Commercial brokerage comprised approximately 83% of the Company's operating revenue for the year ended December 31, 1994. At December 31, 1994, the Company had approximately 1,050 commercial salespersons.\nThe majority of commercial brokerage salespersons, who are primarily leasing agents, focus their activities on one type of commercial property (office, industrial or retail) in a specific market area. Most of the Company's other commercial salespersons broker the sale of commercial investment property or undeveloped land. The majority of salespersons are independent contractors with the Company, although in certain offices, salespeople are hired as employees.\nRESIDENTIAL BROKERAGE\nThrough the date of sale in November 1994, the Company's remaining residential brokerage operations were focused on sales of homes in higher-priced neighborhoods located in Southern California. The Company also provided relocation services through its network of offices and through membership in two national residential referral associations. Commissions from residential brokerage constituted approximately 10% of the Company's operating revenue for the year ended December 31, 1993. The Company fully reserved for the closure\/sale of its remaining residential brokerage operations in Southern California during the fourth quarter of 1993, therefore, operating revenues and expenses from residential brokerage operations in 1994 are included in \"Other income, net\", but have no impact on net income.\nFrom 1989 through 1994, the Company provided residential mortgage brokerage services through Grubb & Ellis Mortgage Services, Inc. (\"GEMS\"), a wholly owned subsidiary of the Company. The Company closed the remaining office in Southern California during 1994.\nMANAGEMENT AND CONSULTING SERVICES\nIn 1994, management and consulting services included the Company's property management operations, appraisal, consulting, and asset services.\nProperty Management\nSubstantially all of the Company's facilities and property management services are conducted through Axiom, which managed approximately 70 million square feet of property, including approximately 19 million square feet of IBM facilities as of December 31, 1994.\nThe Company provides property and facilities management services to owners of office, retail, industrial and multi-family residential real estate. These services include tenant relations, facilities and construction management, financial reporting and analysis, and engineering consultation. Property management clients include pension funds, developers, financial institutions, corporate and individual owners and syndicators. The principal markets for the Company's property management services are in Connecticut, Georgia, Illinois, New Jersey, New York, Ohio, Pennsylvania, Texas and Washington, D.C.\nProperty and facilities management fees constituted approximately 12% of the Company's operating revenue for the year ended December 31, 1994.\nAppraisal and Consulting\nThe Company offers appraisal and consulting services through offices in California, Ohio and New York. Most of these offices are located within commercial brokerage services offices. Appraisal and consulting services primarily include valuation of single properties and real estate portfolios, expert witness testimony, market and feasibility studies and investment analysis.\nAsset Services\nGrubb & Ellis Asset Services Company (\"GEASC\"), a wholly owned subsidiary of the Company, was formed to coordinate the delivery of the Company's services to federal agencies and financial institutions with troubled real estate assets and to oversee the Company's auction business. In April 1994, the Company was notified by the Resolution Trust Company (the \"RTC\") that it had proposed to exclude the Company and GEASC from RTC contracting as the Company had not filed certain reports with the RTC. The Company filed a response to the RTC's proposed exclusion and was notified in February 1995 that the Company and GEASC were excluded from such business for an indefinite period of time. The Company is currently evaluating its options.\nOther Services\nOther revenue is derived from commercial mortgage brokerage operations and from the Company's partnership and joint venture activities. Partnership and joint venture activities are not a significant portion of the Company's business, and the Company does not anticipate expansion of activity in this area.\nCOMPETITION\nAlthough the Company ranks among the largest national commercial real estate services organizations in the United States in terms of revenue, the real estate brokerage industry is fragmented and highly competitive. Thus, the Company's most significant competition in a particular market may be one or both of the other two national firms, and\/or regional and local firms, in any combination. In addition, companies not previously engaged primarily in the real estate services business, but with substantial financial resources, now provide real estate or real estate-related services. For example, certain insurance companies, Wall Street investment firms and major real estate developers participate in more traditional commercial brokerage activities.\nAs a result of the recent recessionary economy and depressed real estate markets in much of the country, a number of real estate services firms have decreased their size and\/or left the business entirely during the last four years. Real estate companies may compete on the pricing of services, service delivery capability (for example, the ability to deliver multiple services to a client or the ability to deliver the same services in a number of different markets) and\/or proven record of success. Due to the relative strength and longevity of the Company's position in the markets in which it presently operates its ability to offer clients a range of ancillary real estate services on a local, regional and national basis, decreased competition in certain markets and its improved capital base, the Company believes that it can operate successfully in the future in this highly competitive industry.\nENVIRONMENTAL REGULATIONS\nA number of states and localities have adopted laws and regulations imposing environmental controls, disclosure rules and zoning restrictions which have impacted the management, development, use, and\/or sale of real estate. Additionally, new or modified regulations could develop in a manner which have not, but could, adversely affect the Company's commercial brokerage and property management operations (see Note 8 of Notes to Consolidated Financial Statements). The Company believes it is in compliance in all material respects with all environmental laws or regulations applicable to its operations.\nSEASONALITY\nThe Company has typically experienced its lowest quarterly revenue in the first quarter of each year with higher and more consistent revenue in the second and third quarters. The fourth quarter has historically provided the highest quarterly level of revenue due to increased activity caused by the desire of clients to complete transactions by year-end. Revenue in any given quarter during 1994, 1993 and 1992, as a percentage of total annual revenue, ranged from a high of 30.8% to a low of 19.8%, as adjusted to eliminate the effect of operations sold or closed.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nInapplicable.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe information called for by Item 3 is included in Note 8 of Notes to the Consolidated Financial Statements under Item 8 of this Report, which Note is incorporated herein by reference.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nGRUBB & ELLIS COMPANY PART II\n_____________________\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe principal markets for the Company's common stock are the New York and Pacific Stock Exchanges. The following table sets forth the high and low sales prices of the Company's common stock on the New York Stock Exchange for each quarter of 1994 and 1993.\nAs of February 15, 1995, there were 2,593 registered holders of the Company's common stock.\nNo cash dividends were declared on the Company's common or preferred stock in 1994 or 1993.\nAny dividend payments with respect to the common stock will be subject to the restrictions in a certain debt agreement with Prudential. The agreement prohibits the payment of cash dividends on and repurchases of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFive-year Comparison of Selected Financial and Other Data for the Company:\n__________________________________________\n\/(1)\/ Net income (loss) and per share data reported on the above table reflect expenses related to special charges and unusual items in the amounts of $13.5 million in 1993, $44.9 million in 1992, $37.0 million in 1991 and $18.0 million in 1990. A favorable adjustment of $2.2 million to special charges and unusual items is included in the 1994 results. For information regarding comparability of this data as it may relate to future periods, see discussion in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 9 of the Notes to Consolidated Financial Statements.\n\/(2)\/ Loss per common share and equivalents were $3.40, $2.95 and $1.82 for the years ended December 31, 1992, 1991 and 1990, respectively, prior to the one-for-five reverse stock split on January 29, 1993.\n\/(3)\/ Weighted average common shares and equivalents were 17,546,513, 16,682,858 and 16,389,526 for the years ended December 31, 1992, 1991 and 1990, respectively, prior to the one-for-five reverse stock split on January 29, 1993.\nFive Year Comparison of Selected Financial and Other Data for the Company:\n(1) Book value per common share was $(2.86), $.39 and $3.35 as of December 31, 1992, 1991 and 1990, respectively, prior to the one-for-five reverse stock split on January 29, 1993.\n(2) Common shares outstanding were 18,007,481, 16,758,016 and 16,564,858 as of December 31, 1992, 1991 and 1990, respectively, prior to the one-for-five reverse stock split on January 29, 1993.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nOVERVIEW\nOver the four-year period ending in 1993, the Company's business and financial condition were substantially impaired due to the general economic recession and a severe decline in activity levels and prices within the commercial and residential real estate sectors. During 1994, the Company substantially completed the process begun in 1990 of selling or closing unprofitable offices and non-strategic businesses and new management continued to downsize operations and lower operating costs. In November 1994, the Company completed a financial restructuring (the \"1994 Recapitalization\"), including a rights offering to stockholders, amendments to existing debt agreements with The Prudential Insurance Company of America (\"Prudential\") and amendments to existing preferred stock. The 1994 Recapitalization resulted in a total reduction of liabilities of approximately $6.2 million and an increase in equity of approximately $42.2 million and provided a way for the Company to deal positively with several converging aspects of its business, including an improving market for commercial real estate and the ability to settle protracted litigation stemming from discontinued operations.\nDuring 1994, the Company's revenue was derived substantially from commercial brokerage activities. Property management, appraisal and consulting fees provided the majority of the remaining revenue. The decrease in 1994 operating revenues from 1993 levels was due to the sale of the Company's real estate advisory business and Northern California residential brokerage operations in February and March of 1993, respectively, and the inclusion of revenues for the Company's Southern California residential brokerage operations (which were sold in November 1994) in \"Other income, net\" in 1994.\n1994 COMPARED TO 1993\nOPERATING REVENUE\nTotal operating revenue for 1994 was $183.6 million, a decrease of 8.5% from $200.7 million in 1993. Excluding revenue from the Northern California residential brokerage operations and real estate advisory services which were sold during the first quarter of 1993, and certain other offices which at the end of 1993 were sold, closed, or expected to be closed, as well as government contracting business conducted through April 1994, operating revenue of $183.1 million increased by $17.0 million or 10.2% over 1993.\nOperating revenue from commercial brokerage offices increased in 1994 by $10.2 million or 7.2% over 1993. Increases in operating revenue occurred primarily in the Pacific Northwest region and the Midwest\/Texas area of the Eastern region as a result of improving markets for commercial real estate and the Company's increasing market share in specific markets.\nOperating revenue from the Company's residential brokerage operations of $20.3 million in 1993 consisted of $3.1 million from the Northern California operations which were sold in March 1993 and $17.2 million from the Southern California operations. The Company fully reserved for the closure\/sale of its remaining residential brokerage operations in Southern California during the\nfourth quarter of 1993, therefore, operating revenues and expenses from the Southern California operations were included in \"Other income, net\" in 1994, but have no impact on net income.\nReal estate services fees, commissions and other fees of $31.6 million in 1994 decreased by $7.0 million or 18.2% from $38.6 million in 1993. The decrease in revenues relates primarily to the closure, or provision to close, certain mortgage brokerage, appraisal and consulting offices at the end of 1993.\nCOSTS AND EXPENSES\nReal estate brokerage and other commission expense (salespersons' participation) is the Company's major expense and is a direct function of gross brokerage commission levels. Salespersons' participation expense as a percentage of total operating revenue decreased from 49.9% in 1993 to 47.7% in 1994. The decrease in participation expense as a percentage of revenue was primarily related to the fact that the Company did not reflect the revenues or expenses of the Southern California residential brokerage operations in operating income for 1994, as the provision for the closure of such operations was recorded at the end of 1993. Excluding the impact of residential brokerage operations from 1993, participation expense as a percentage of revenue was virtually the same as 1994 at 47.8%.\nTotal costs and expenses, other than salespersons' participation expense, of $91.9 million for 1994 decreased by 21.1% from $116.5 million in 1993. The decrease primarily resulted from a decrease in special charges and unusual items and, as explained below, because the expenses of the residential brokerage operations are included in \"Other income, net\" in 1994. Further excluding the cost and expenses of businesses closed or sold in 1993 and 1994, and the special charges and unusual items, 1994 costs and expenses increased by $4.2 million or 4.7% over 1993. Such expense increases were primarily a result of several key management positions being filled in the latter part of 1993 and additional investments in technology anticipated to improve profits in future years.\nThe Company recorded favorable adjustments of $2.2 million to special charges and unusual items in 1994 as a result of reversals of previously established reserves associated with the closure of certain offices which were accomplished more efficiently than initially estimated at the end of 1993, and the sale of the Company's remaining residential brokerage operations in November 1994. In 1993, special charges and unusual items of $13.5 million were recorded including the write-down of the remaining unamortized goodwill of $10.1 million, office closure and severance costs of $2.9 million and other charges of $500,000 as described further below.\nDuring the years 1990 through 1993, the Company incurred special charges and unusual items as a result of efforts to reposition the Company to operate more efficiently in response to recessionary market conditions. During late 1992 and through 1994, the Company retained a new executive management team and completed certain recapitalization transactions necessary for the business to continue as a going concern (see Item 1, \"Business\" and Note 4 of Notes to Consolidated Financial Statements). Such efforts included downsizing operations and focusing the Company's activities on its core businesses, as well as realigning into a more centralized operation with less middle management.\nThe Company's evaluation of the carrying value of goodwill for 1991, 1992 and 1993 was significantly impacted by a continuation of the recessionary cycle and the severe downturn in the real estate markets. In 1991 and 1992, the Company wrote-off goodwill of $18.9 million and $29.5 million, respectively, associated with business entities acquired in a period of rapid expansion during the 1980's when real estate activity was at increased levels and profit margins were substantially higher than those found in the market today. The Company's analysis of goodwill performed in the fourth quarter of 1993 indicated that the commercial brokerage business would operate at a loss without the planned restructuring and recapitalization efforts and would, therefore, be unable to recover goodwill. Accordingly, the remaining goodwill of $10.1 million was written off as of December 31, 1993.\nAs part of new management's comprehensive reevaluation of the Company's business strategy at the end of 1993, the Company determined that it would close certain offices and terminate certain employees. Accordingly, as of December 31, 1993, the Company accrued $3.4 million related to office lease termination and other miscellaneous office closing costs, net of expected sublease income. Based on historical operating results, the Company expected that future operating results would be positively impacted by approximately $1.7 million per annum as a result of the closing of offices, termination of employees and other restructuring efforts. The Company began implementation of these restructuring efforts during the first quarter of 1994 and substantially completed them by December 31, 1994. During 1994, the Company paid $3.5 million in cash and made non-cash reductions of $2.2 million to the severance obligation and office closure reserves.\nInterest expense to related parties of $2.8 million in 1994 increased by $349,000 over the 1993 amount of $2.5 million primarily as a result of interest on the interim financing loan provided by Warburg, Pincus Investors, L.P. (\"Warburg\") in connection with the 1994 Recapitalization ($175,000) and higher interest on the revolving credit facility related to greater use in 1994 compared to 1993 ($142,000).\nINCOME TAXES\nThe 1994 provision for income taxes was $307,000 compared to $575,000 in 1993. The 1994 tax provision consists of federal, state and local income taxes assessed on profitable subsidiaries of the Company, whereas the 1993 tax provision has no federal income tax component. The 1994 federal income tax component relates solely to the Company's subsidiary Axiom, which reports on a separate basis for tax purposes.\nThe Company reported a taxable loss of $8.7 million on its 1993 consolidated federal income tax return and estimates that it will report a taxable loss of approximately $13 million for 1994. As of December 31, 1994, the Company had net current and noncurrent deferred tax assets of $4.5 million and $21.2 million, respectively. Approximately $12.8 million of the net noncurrent deferred tax assets relate to tax net operating loss carryforwards which will be available to offset future taxable income through 2009. The Company has recorded a valuation allowance for the entire amount of the net current and noncurrent deferred tax assets as of December 31, 1994 and will continue to do so until such time that management believes that it is more likely than not that the Company will generate taxable income sufficient to realize such tax benefits. See Note 5 of Notes to Consolidated Financial Statements for additional information.\nNET INCOME\nNet income of $2.3 million for 1994 compared favorably to a net loss of $18.2 million for the previous year. Net income for 1994 included $2.2 million of favorable adjustments to special charges and unusual items, whereas the net loss for 1993 included charges of $13.5 million. Net loss per common share was $.05 in 1994 compared to a net loss per common share of $5.08 in 1993. Net loss applicable to common stockholders is calculated by reducing net income (loss) by undeclared dividends and accretion of liquidation preference on preferred stock of $2.6 million and $2.2 million in 1994 and 1993, respectively.\nSTOCKHOLDERS' DEFICIT\nDuring 1994, stockholders' deficit decreased by $43.4 million from 1993 year-end primarily as a result of 1994 net income of $2.3 million; common stock issued in connection with the 1994 Recapitalization of $9.9 million and $681,000 issued in connection with litigation settlements; and reclassification of preferred stock of $32.1 million as a result of the elimination of the mandatory redemption provision in connection with the 1994 Recapitalization, net of $2.2 million of undeclared dividends (accretion of liquidation preference) on preferred stock. The book value per common share increased from $(16.96) at December 31, 1993 to $(2.90) per common share at December 31, 1994 as a result of the above mentioned changes and the increase in the number of shares of common stock outstanding from approximately 4.1 million at December 31, 1993, to 8.8 million at December 31, 1994, primarily related to the 1994 Recapitalization.\n1993 COMPARED TO 1992\nOPERATING REVENUE\nTotal operating revenue for 1993 was $200.7 million, a decrease of 10.0% from $223.0 million in 1992. The decrease was the result of the sales of the Northern California residential brokerage operations and real estate advisory services during the first quarter of 1993. Excluding these operations, operating revenue increased 5.0% to $197.3 million in 1993 compared to $188.0 million in 1992.\nOperating revenue from commercial brokerage offices increased in 1993 by $4.9 million or 3.5% over 1992. This was the first year-to-year increase in operating revenue from the commercial brokerage operations since 1988. Increases in operating revenue occurred in the Eastern and Pacific Southwest regions, partially offset by a decline in the Pacific Northwest region.\nOperating revenue from the Company's residential brokerage operations of $20.3 million in 1993 decreased by $28.9 million or 58.8% from 1992, primarily due to the sale of the Company's Northern California residential brokerage operations. The Northern California residential brokerage operations contributed $3.1 million to 1993 operating revenue compared to $33.1 million in 1992. Operating revenue from the remaining Southern California residential brokerage operations increased in 1993 by $1.0 million to $17.2 million or 5.9% over 1992. The increase in operating revenue was attributable to increased residential buyer activity resulting primarily from lower interest rates during 1993.\nReal estate services fees, commissions and other fees of $38.6 million in 1993 increased by $881,000 or 2.3% over 1992. The increase relates primarily to higher revenue from the property management and mortgage brokerage operations of $5.1 million net of a decrease in appraisal and consulting and other revenues of approximately $4.2 million.\nCOSTS AND EXPENSES\nSalespersons' participation expense as a percentage of total operating revenue decreased from 52.5% in 1992 to 50.0% in 1993. The decrease in participation as a percentage of revenue was primarily the result of the sale of the Northern California residential brokerage operations.\nTotal costs and expenses, other than salespersons' participation expense, of $116.5 million for 1993 decreased by 27.9% from $161.7 million in 1992. The decrease primarily resulted from a decrease in special charges and unusual items (see discussion below) to $13.5 million in 1993 from $44.9 million incurred in 1992. Additionally, cost and expenses decreased in 1993 as compared to 1992 as a result of the sales of the Northern California residential brokerage operations and real estate advisory operations. Further excluding the cost and expenses of the real estate advisory and Northern California residential brokerage operations, and the special charges and unusual items, 1993 cost and expenses decreased by 3.8% or $4.1 million from 1992. This reduction in operating expenses was primarily attributable to management's efforts to aggressively reduce fixed overhead expenses by closing unprofitable field offices and streamlining operations.\nThe Company recorded special charges and unusual items of $13.5 million in 1993 and $44.9 million in 1992. As described above, goodwill write-downs of $10.1 million and $18.9 million were recorded in 1993 and 1992, respectively, as a result of management's determination that goodwill would not be recoverable from future operations. In connection with the related management decisions to downsize and realign operations, severance, office closure and other costs were accrued in the amounts of $3.4 million and $7.0 million in 1993 and 1992, respectively. Additionally, the 1992 special charges and unusual items include $16.2 million in reserves for claims and settlements in connection with several significant lawsuits and potential liability exposure arising from the Company's brokerage business, as well as reserves of $2.8 million for the decline in the value of properties held in joint ventures and partnerships.\nInterest expense to related parties of $2.5 million in 1993 decreased by $1.7 million from $4.2 million in 1992 primarily related to the January 1993 exchange of $15 million of the then outstanding 10.65% Subordinated Notes for 150,000 shares of 5% Junior Convertible Preferred Stock and five-year warrants to purchase 200,000 shares of common stock at $5.50 per share. This transaction resulted in a $1.6 million reduction to interest expense in 1993 when compared to 1992.\nINCOME TAXES\nThe 1993 provision for income taxes was $575,000 compared to $605,000 in 1992. The tax provisions consist of state and local income taxes assessed on profitable subsidiaries of the Company.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standard (SFAS) No. 109, Accounting for Income Taxes, which was issued in February, 1992. SFAS No. 109 supersedes SFAS No. 96, Accounting for Income Taxes, which was adopted by the Company in 1987, and changes the criteria for recognition and measurement of deferred tax assets. As permitted under SFAS No. 109, the Company elected not to restate the financial statements of prior years. The cumulative effect of the change and the effect of the change on pretax income for the year ended December 31, 1993 was not material.\nNET LOSS\nThe net loss for 1993 was $18.2 million compared to a net loss of $59.7 million for the previous year. Net loss per common share was $5.08 in 1993 compared to a net loss per common share of $17.01 in 1992, giving effect to the one-for-five reverse stock split on January 29, 1993. Losses in 1993 and 1992 were primarily the result of the special charges and unusual items of $13.5 million and $44.9 million, respectively.\nLIQUIDITY AND CAPITAL RESOURCES\nDuring 1994, cash and cash equivalents increased by $7.0 million over the 1993 year-end level. The increase was attributable to cash provided by financing activities of $9.3 million, net of cash used in investing and operating activities of $1.9 million and $466,000, respectively. Net cash provided by financing activities of $9.3 million consisted primarily of the gross consideration of $10.4 million from the 1994 Recapitalization in November 1994, net of $641,000 of debt refinancing and offering costs. Outstanding borrowings of $6.2 million under the Warburg interim financing loan were repaid from Warburg's purchase of common stock under its Standby Agreement. Net cash used in investing activities of $1.9 million in 1994 primarily relates to $2.2 million of purchases of equipment and leasehold improvements. Net cash used in operating activities was significantly impacted by claims and settlements, office closure and severance costs for which reserves were provided at the end of 1993 and 1992 (see Consolidated Statements of Cash Flows, decrease in other liability accounts). Excluding such items from the net cash used in operating activities in 1994 would have resulted in $9.5 million of positive cash flow from operations.\nThe Company has historically experienced the highest use of operating cash in the first quarter of the year, primarily related to the payment of year-end compensation and deferred commissions payable balances which attain peak levels as a result of fourth quarter business activity. Additionally, quarterly revenues are typically at their lowest level in the first quarter.\nAs of December 31, 1994, the Company had current accrued severance and office closure costs of approximately $2.2 million of which $876,000 of accrued severance costs and $893,000 of accrued office closure costs, net of expected sublease income, are expected to be paid in cash. As of December 31, 1994, the Company had long-term accrued severance costs of $277,000 which are expected to be paid in cash in 1996. Approximately $1.5 million of the $2.2 million of long-term accrued office closure costs, net of expected sublease income, is expected to be paid in cash over the next seven years (see Note 8\nof the Notes to Consolidated Financial Statements). The funding of these cash requirements is expected to come from cash flow from operations.\nDuring 1994, working capital improved by $25.1 million from a deficit of $17.8 million at December 31, 1993, to $7.3 million at December 31, 1994. The improvement was primarily related to the $8.6 million reclassification of debt (Revolving Credit Note and Senior Notes) from current to noncurrent as a result of the 1994 Recapitalization described below, a $6.2 million reclassification of accrued claims and settlements from current to noncurrent and an increase in cash and cash equivalents of $7.0 million. The reclassification of accrued claims and settlements from current to noncurrent was the result of management's change in the estimate, upon consultation with counsel, of the expected timing of the resolution of current litigation.\nDuring 1994, the Company made significant progress towards restructuring its long-term debt and equity. Through a Stockholders Rights Offering which was completed in November 1994, common stockholders, other than Warburg and Prudential, purchased 84,542 shares of common stock for total proceeds of $201,000 and pursuant to a Standby Agreement, Warburg purchased 4,277,433 shares of common stock for total proceeds of $10.2 million. Warburg paid for its shares with $4.0 million in cash and through cancellation of $6.2 million of indebtedness outstanding under its interim financing loan.\nDebt agreements with Prudential were modified to provide, among other things, deferral of principal payments until November 1, 1997 and thereafter on the $15 million of principal amount of the 9.9% Senior Notes, 10.65% Payment-in-Kind Notes and the Revolving Credit Note which would have been due from 1994 through 1996 (see Note 4 of Notes to Consolidated Financial Statements).\nCertain provisions of the Company's outstanding convertible preferred stock were amended to provide for, among other things, elimination of the mandatory redemption and certain anti-dilution provisions and an increase in the dividend rate commencing in 2002. Additionally, Warburg and Prudential were issued additional warrants to purchase common stock and certain terms of existing warrants were modified.\nThe Company believes that its short-term and long-term cash requirements will be met by operating cash flow. With the completion of the 1994 Recapitalization and development of its 1995 business plan, management believes it will be able to clearly focus on expanding its core commercial real estate business and should be well prepared to take advantage of the improving markets for commercial real estate. However, if the Company's goals are not substantially achieved because of adverse economic conditions or other unfavorable events, the Company may find it necessary to further reduce expense levels, or undertake other actions as may be appropriate. In such event, the Company anticipates that its ability to raise financing on acceptable terms would be severely limited and there can be no assurance that the Company would be able to raise additional financing.\nDIVIDENDS\nAny dividend payments by the Company on the common stock will be subject to restrictions on the payment of dividends in the Prudential debt agreements and the payment of all accrued and unpaid dividends on the Preferred Stock. Any dividend payments by Axiom will be subject to restrictions in its credit facility agreement with IBM.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Grubb & Ellis Company\nWe have audited the accompanying consolidated balance sheets of Grubb & Ellis Company and Subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31, 1994. 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. We did not audit the financial statements of Axiom Real Estate Management, Inc., a 74% owned subsidiary, which statements reflect total assets of $6,445,166 and $5,837,845 as of December 31, 1994 and 1993, respectively, and total revenues of $22,533,316, $21,422,586 and $7,054,979 for the years ended December 31, 1994 and 1993 and the period September 1, 1992 through December 31, 1992. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to data included for Axiom Real Estate Management, Inc., is based solely on 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 and related 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 related schedules. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Grubb & Ellis Company and Subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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.\nSan Francisco, California Ernst & Young LLP February 8, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Board of Directors Axiom Real Estate Management, Inc.:\nWe have audited the accompanying balance sheets of Axiom Real Estate Management, Inc. as of December 31, 1994 and 1993 and the related statements of income, stockholders' equity 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 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 Axiom Real Estate Management, Inc. as of December 31, 1994 and 1993, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.\nPittsburgh, Pennsylvania Coopers & Lybrand L.L.P. January 27, 1995\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (IN THOUSANDS)\nASSETS\nThe accompanying notes are an integral part of the consolidated financial statements.\nGRUBB AND ELLIS COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND SHARES)\nLIABILITIES\nThe accompanying notes are an integral part of the consolidated financial statements.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND SHARES)\nThe accompanying notes are an integral part of the consolidated financial statements.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND SHARES)\nThe accompanying notes are an integral part of the consolidated financial statements.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993, AND 1992 (IN THOUSANDS)\nThe accompanying notes are an integral part of the consolidated financial statements.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation:\nThe consolidated financial statements include the accounts of Grubb & Ellis Company, its wholly and majority owned and controlled subsidiaries and controlled partnerships (the \"Company\"). The Company consolidates its majority owned subsidiary, Axiom Real Estate Management, Inc. (\"Axiom\"), which provides real estate property and facilities management services. However, of the seven members of Axiom's Board of Directors, the Company may elect only two and the minority shareholder may elect one. The Company and the minority shareholder voting together as a class may elect four additional directors, including the Chief Executive Officer, Chief Operating Officer and two unaffiliated directors, one of whom is nominated by the Company and one of whom is nominated by the minority shareholder. All significant intercompany accounts and transactions with unconsolidated joint ventures and partnerships accounted for under the equity method of accounting have been eliminated.\nRevenue Recognition:\nReal estate sales commissions are generally recognized at the earlier of receipt of payment, close of escrow or transfer of title between buyer and seller. Receipt of payment occurs at the point at which all Company services have been performed, title to real property has passed from seller to buyer, if applicable, and no contingencies exist with respect to entitlement to the payment. Real estate leasing commissions are generally recognized at the earlier of receipt of payment or tenant occupancy, assuming the Company has possession of a signed lease agreement and no significant contingencies exist. All other commissions and fees are recognized at the time the related services have been performed by the Company, unless significant future contingencies exist.\n\"Other income, net\" includes revenues and expenses recognized subsequent to 1993 related to offices which the Company determined in 1993 to close in 1994. Such revenues and expenses were $17,939,000 and $17,939,000, respectively, in 1994. Also included are the revenues and expenses of miscellaneous transactions and the disposition of real estate investments.\nCosts and Expenses:\nReal estate brokerage and other commission expense (salespersons' participation) is recognized concurrently with the recording of the related revenue. All other costs and expenses are recognized when incurred.\nEquipment and Leasehold Improvements:\nEquipment and leasehold improvements are recorded at cost. Depreciation of equipment is computed using the straight-line method over their estimated useful lives ranging from three to seven years. Leasehold improvements are amortized using the straight-line method over their useful lives not to exceed the terms of the respective leases. Maintenance and repairs are charged to expense as incurred.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nAccrued Claims and Settlements:\nThe Company maintains partially self-insured programs for errors and omissions, general liability, workers' compensation and certain employee health care costs. Reserves for such partially self-insured programs are included in accrued claims and settlements and are based on the aggregate of the liability for reported claims and an actuarially-based estimate of incurred but not reported claims, net of expected insurance reimbursements.\nIncome Taxes:\nDeferred income taxes, if any, are recorded to reflect the tax consequences in future years of the differences between the tax bases of assets and liabilities and their financial reporting amounts. Investment tax credits are accounted for under the flow-through method, whereby the provision for income taxes is reduced in the year the tax credits first become available.\nEarnings (Loss) Per Common Share and Equivalents:\nEarnings (loss) per common share and equivalents computations are based on the weighted average number of common shares outstanding after giving effect to potential dilution from common stock options and warrants. Primary earnings (loss) per common share is the same as fully diluted earnings (loss) per common share for each year presented. Common share and per share amounts have been adjusted to give retroactive effect to the one-for-five reverse stock split on January 29, 1993. The calculation of earnings (loss) per common share includes net income (loss) adjusted for amounts applicable to the Senior and Junior Convertible Preferred Stock related to accretion of liquidation preference (for the periods during which the preferred stock was subject to mandatory redemption) and undeclared dividends as follows (in thousands):\nCash and Cash Equivalents:\nThe Company had cash balances of $2,096,000 and $1,275,000 at December 31, 1994 and 1993, respectively, restricted to use for errors and omissions insurance claims associated with the Company's errors and omissions insurance captive. Additionally, Axiom had cash balances of $2,490,000 and $1,103,000 at December 31, 1994 and 1993, respectively, which as a result of the structuring of the Company's majority ownership interest in Axiom, were not available for use by the Company.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nCash and Cash Equivalents (Continued):\nFor purposes of the Statement of Cash Flows, cash equivalents include investments in highly liquid debt instruments which are purchased with a maturity of ninety days or less. Cash payments for interest for the three years ended December 31, 1994, 1993 and 1992 were approximately $1,418,000, $1,005,000 and $2,717,000, respectively. Cash payments for income taxes for the three years ended December 31, 1994, 1993 and 1992 were approximately $363,000, $515,000 and $949,000, respectively.\nReal Estate Investments:\nReal estate investments held for sale are recorded at the lower of cost or net realizable value. The Company had a valuation allowance on real estate investments and real estate owned of approximately $3,778,000 and $3,792,000 at December 31, 1994 and 1993, respectively. In connection with the disposition of real estate investments, the Company sold a property in 1993 with a book value of approximately $413,000 in exchange for a note receivable of $1,190,000. As of December 31, 1994, the note receivable balance was $1,085,000 and revenue of $884,000 has been deferred and will be recognized under the cost recovery method.\nReclassifications:\nCertain prior year amounts have been reclassified to conform to the current year's presentation.\n2. REAL ESTATE BROKERAGE COMMISSIONS RECEIVABLE\nReal estate brokerage commissions receivable consisted of the following at December 31, 1994 and 1993 (in thousands):\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n3. EQUIPMENT AND LEASEHOLD IMPROVEMENTS\nEquipment and leasehold improvements consisted of the following at December 31, 1994 and 1993 (in thousands):\n4. LONG-TERM DEBT AND RECAPITALIZATION\nLong-term debt consisted of the following at December 31, 1994 and 1993 (in thousands):\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. LONG-TERM DEBT AND RECAPITALIZATION (CONTINUED)\nAggregate maturities of long-term debt, excluding discount amortization, for the next five years are as follows: 1995 - $508,000; 1996 - $78,000; 1997 - $5,023,000; 1998 - $5,026,000; 1999 - $5,029,000; and thereafter, $10,850,000.\n1994 Recapitalization:\nOn November 1, 1994, the Company, Warburg, Pincus Investors, L.P. (\"Warburg\") and The Prudential Insurance Company of America (\"Prudential\") completed certain related party financing transactions (the \"1994 Recapitalization\") pursuant to agreements (the \"Agreements\") providing for, among other things, (1) additional equity capital through a rights offering and Standby Agreement by Warburg, (2) amendments to a debt agreement with Prudential, (3) issuance of additional warrants to purchase common stock of the Company and (4) amendments to the existing Junior and Senior Convertible Preferred Stock and warrants held by Warburg and Prudential. The debt amendments with Prudential include a provision for supplemental principal payments commencing July 1, 1998 if the Company meets certain financial tests. In addition, certain covenants of the debt agreement remain in place, but will not be in effect until April 1, 1997.\nStockholder Rights Offering:\nThrough a Stockholder Rights Offering which expired October 31, 1994, common stockholders, other than Warburg and Prudential, purchased 84,542 shares of common stock at the subscription price of $2.375 per share for total proceeds of $201,000. Pursuant to a Standby Agreement, Warburg purchased 4,277,433 shares of common stock, not purchased by common stockholders in the Rights Offering, at the subscription price of $2.375 per share for total proceeds of approximately $10,159,000. As provided for in the Standby Agreement, Warburg paid for its shares with $4,000,000 in cash and through cancellation of $6,159,000 of indebtedness outstanding under an interim financing loan, including accrued interest of approximately $159,000. Warburg had made the interim financing loan pursuant to an agreement entered into in March 1994, which was terminated in connection with the consummation of the 1994 Recapitalization. Direct costs of $469,000 were capitalized in connection with the Stockholder Rights Offering.\n9.9% Senior Notes:\nThe 9.9% Senior Notes were issued to Prudential in 1986 and were subsequently modified in 1992 to require annual principal payments of $2 million on November 1, 1993 and 1994 and $3 million on November 1, 1995 and 1996. The 9.9% Senior Notes require semi-annual interest payments. No principal payments have been made on the 9.9% Senior Notes since the issue date. In connection with the 1994 Recapitalization, the principal payment terms were modified requiring two approximately equal installments on November 1, 1997 and 1998.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. LONG-TERM DEBT AND RECAPITALIZATION (CONTINUED)\n10.65% Payment-in-Kind Notes:\nIn January 1993, Prudential agreed, among other things, to convert $10 million of the then outstanding 10.65% Subordinated Notes into $10 million of 10.65% Payment-in-Kind Notes (the \"10.65% PIK Notes\") due November 1, 1999 (the \"1993 Recapitalization\"). The 10.65% PIK Notes require semi-annual interest payments, although until all of the 9.9% Senior Notes have been retired, the interest may be paid in kind by the issuance of additional 10.65% PIK Notes. Prior to the 1994 Recapitalization, principal payments were required in the amount of one third of the principal amount of the 10.65% PIK Notes outstanding on November 1 of each of 1997 and 1998 and all remaining outstanding principal amounts on November 1, 1999. In connection with the 1994 Recapitalization, the terms of the principal payments were modified requiring two approximately equal installments on November 1, 2000 and 2001. Additionally, the interest rate will increase from 10.65% to 11.65% per annum on January 1, 1996. Interest expense is being recorded on the level yield method at an effective yield rate of 11.5%. The outstanding amount of the 10.65% PIK Notes is net of $920,000 canceled by Prudential in payment of the exercise price of a warrant pursuant to the terms of the 1993 Recapitalization and unamortized discount of $323,000 and $493,000 at December 31, 1994 and 1993, respectively.\nRevolving Credit Note:\nIn January 1993, the Company issued to Prudential a $5 million Revolving Credit Note due December 31, 1994 as a modification of the 1991 revolving Line of credit which was to expire on February 15, 1993. The Revolving Credit Note bears interest at 3.5% above LIBOR and has certain repayment requirements and other financial covenants. Prior to the 1994 Recapitalization, upon maturity, the Company had the option of converting the note into a term note which would mature on December 31, 1996, have an interest rate of LIBOR plus 5% and require equal semi-annual principal payments beginning June 30, 1995. In connection with the 1994 Recapitalization, Prudential canceled the conversion option, extended the maturity date to November 1, 1999 and waived the Company's obligation to repay all of the outstanding principal for a 60-day period in 1994 and in subsequent years until after April 1, 1997.\nOther Notes Payable:\nOther notes payable of the Company are secured by various assets with carrying values of approximately $6,856,000 and $6,249,000 at December 31, 1994 and 1993, respectively.\nAxiom Credit Facility:\nThe Company's subsidiary, Axiom, has a $2,050,000 credit facility with IBM which expires August 31, 1995. There were no borrowings outstanding under this credit facility as of December 31, 1994. This credit facility is collateralized by substantially all of Axiom's assets and contains certain covenants, including the maintenance of minimum levels of net worth, financial ratios and restrictions on the payments of dividends.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. LONG-TERM DEBT AND RECAPITALIZATION (CONTINUED)\nJunior Convertible Preferred Stock:\nIn January 1993, the Company issued 150,000 shares of 5% Junior Convertible Preferred Stock (\"Junior Preferred\") and five-year warrants to purchase 200,000 shares of common stock at an exercise price of $5.50 per share in exchange for $15 million of the then outstanding 10.65% Subordinated Notes. Each share of Junior Preferred is convertible, at the option of the holder, into shares of common stock of the Company determined by dividing the $100 stated value per share by the conversion price of $5.6085. Prior to the 1994 Recapitalization, each share of Junior Preferred was subject to mandatory conversion based on specific financial ratios and\/or conditions. Holders of Junior Preferred are entitled to receive, out of any funds legally available, cumulative dividends payable in cash at a rate of 5% per annum compounded annually.\nThe 1994 Recapitalization provided for the elimination of the mandatory redemption provision and an increase in the dividend rate effective January 1, 2002 to 10% per annum with further increases of 1% per annum effective January 1, 2003 and January 1, 2004 and 2% per annum effective January 1, 2005 and each January 1 thereafter.\nWith respect to dividend rights and rights on redemption and liquidation, winding up and dissolution, the Junior Preferred ranks prior to any other equity securities of the Company, including all classes of common stock and any series of preferred stock of the Company other than the Senior Convertible Preferred Stock, which ranks prior to Junior Preferred.\nDuring 1994 and prior to the 1994 Recapitalization, the carrying value of the Junior Preferred was adjusted by accretion of liquidation preference due upon liquidation in the amount of $653,000, and accretion of direct costs of $27,000. On a cumulative basis, undeclared dividends and accretion of direct costs amounted to $1,340,000 and $58,000, respectively. In connection with the 1994 and 1993 Recapitalizations, the carrying value of the Junior Preferred was adjusted by direct costs of $17,000 and $183,000, respectively.\nSenior Convertible Preferred Stock:\nIn January 1993, the Company issued to Warburg and Joe F. Hanauer (\"Hanauer\") for $13,750,000 in cash, an aggregate of 137,160 shares of 12% Senior Convertible Preferred Stock (\"Senior Preferred\"), five-year warrants to purchase 500,000 and 200,000 shares of common stock at exercise prices of $5.00 and $5.50 per share, respectively, and five-year warrants to purchase up to 400,000 shares of common stock (the \"Contingent Warrants\") which become exercisable at a formula price only in the event the Company incurs a defined liability in excess of $1.5 million.\nEach share of Senior Preferred is convertible, at the option of the holder, into shares of common stock of the Company determined by dividing the $100 stated value per share by the conversion price of $2.6564 for Warburg and $2.6716 for Hanauer. Prior to the 1994 Recapitalization, each share of Senior Preferred was subject to mandatory conversion based on specific financial\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. LONG-TERM DEBT AND RECAPITALIZATION (CONTINUED)\nSenior Convertible Preferred Stock (Continued):\nratios and\/or conditions and anti-dilution provisions with respect to the issuance of common stock and common stock equivalents at less than the conversion price or exercise price. Holders of Senior Preferred are entitled to receive, out of any funds legally available, cumulative dividends payable in cash at a rate of 12% per annum compounded annually.\nThe 1994 Recapitalization provided for the elimination of the mandatory redemption provision and an increase in the dividend rate so that at such time the dividend rate on the Junior Preferred increases above the dividend rate of the Senior Preferred, the dividend rate on the Senior Preferred will increase by the same amount. As a result of the application of the anti-dilution provisions previously existing in the Senior Preferred, the number of shares issuable upon conversion of the Senior Preferred increased from 4,551,201 shares to 5,161,456 shares. With respect to dividend rights and rights on redemption and on liquidation, winding up and dissolution, the Senior Preferred ranks prior to any other equity securities of the Company, including all classes of common stock and any other series of preferred stock of the Company.\nDuring 1994 and prior to the 1994 Recapitalization, the carrying value of the Senior Preferred was adjusted by accretion of liquidation preference due upon liquidation in the amount of $1,520,000 and the accretion of direct costs of $160,000. On a cumulative basis, undeclared dividends and accretion of direct costs amounted to $3,029,000 and $336,000, respectively. In connection with the 1994 and 1993 Recapitalizations, the carrying value of the Senior Preferred was adjusted by direct costs of $100,000 and $1,070,000, respectively.\nNew Warrants and Amendments to Existing Warrants:\nAs consideration for acquiring shares of stock not purchased in the Stockholder Rights Offering in connection with the Standby Agreement, and agreeing to other financing transactions, the Company issued to Warburg a warrant to purchase 325,000 shares at an exercise price of $2.375 per share, exercisable within 5 years. As consideration for modifying the terms of the 9.9% Senior Notes, 10.65% PIK Notes and Revolving Credit Note, waiving noncompliance with and deferring application of certain covenants of the Prudential debt agreement, and agreeing to other financing transactions, the Company issued to Prudential a warrant to purchase 150,000 shares at an exercise price of $2.375 per share, exercisable within 5 years. Loan costs of $225,000 were capitalized in connection with the Prudential warrant and are being amortized over the weighted average remaining terms of the debt agreements with Prudential.\nIn connection with the 1994 Recapitalization, the Company's warrants to purchase common stock issued to Warburg and Prudential in connection with the 1993 Recapitalization were amended to reduce the exercise price to $3.50 per share, eliminate certain anti-dilution provisions, and in the case of the warrants held by Prudential, extend the expiration date from January 1998 until December 1998. Prudential waived the anti-dilution provisions of its existing warrants in connection with the 1994 Recapitalization.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4. LONG-TERM DEBT AND RECAPITALIZATION (CONTINUED)\nAs a result of the 1994 Recapitalization and application of the anti-dilution provisions previously existing in the warrants held by Warburg and Hanauer, the aggregate number of shares issuable upon conversion of such warrants increased from 726,182 to 1,034,885 shares. Loan costs of $34,000 were capitalized in connection with the Prudential warrant amendments and are being amortized over the weighted average remaining terms of the debt agreements with Prudential. The contingent warrants held by Warburg, originally issued with the Senior Preferred, to acquire up to 373,818 shares under certain circumstances, were canceled.\nPrudential Long-term Debt Restrictions:\nIn connection with the 1993 Recapitalization, Prudential and the Company signed an agreement (the \"New Note Agreement\") which contains significant restrictions on the payment of cash dividends and purchases of stock of the Company. The New Note Agreement also contains significant restrictions on the Company's (and certain of its subsidiaries') ability to, among other things, (i) incur debt and liens upon their properties, (ii) enter into guarantees and make loans, investments and advances, (iii) merge or enter into similar business combinations, (iv) conduct any business other than their present businesses, (v) sell assets, including receivables, (vi) make capital expenditures and (vii) enter into certain other transactions.\nThe New Note Agreement between the Company and Prudential contains various affirmative and negative covenants, which require, among other things, that the Company (combined with certain of its subsidiaries and taken as a whole) maintain a ratio of consolidated current assets to consolidated current liabilities (the \"Working Capital Ratio\") as defined in the New Note Agreement, excluding the current portion of long-term debt, of greater than 1:1 at the end of each of its fiscal quarters.\nAt December 31, 1993 the Company did not meet certain covenants and restrictions as established in the New Note Agreement, including the Working Capital Ratio. However, in connection with the 1994 Recapitalization, Prudential agreed to waive the requirements of the Working Capital Ratio, cumulative loss provisions and covenants restricting the Company's capital expenditures until April 1, 1997.\n5. INCOME TAXES\nThe provision for income taxes for the year ended December 31, 1994 consisted of federal, state and local income taxes. The provision for income taxes for the years ended December 31, 1993 and 1992 consisted entirely of state and local taxes due currently.\nAt December 31, 1994, the following income tax carryforwards were available to the Company (in thousands):\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5. INCOME TAXES (CONTINUED)\nAs of December 31, 1994, the Company had a federal tax net operating loss carryforward of $38.2 million and a federal investment tax credit carryforward of $278,000, after taking into effect the reduction in tax attributes resulting from the cancellation of indebtedness pursuant to Section 108(b)(2) of the Internal Revenue Code (the \"Code\"). The 1993 Recapitalization constituted an ownership change within the meaning of Section 382 of the Code thereby limiting the amount of post-ownership change taxable income which may be offset by the above net operating loss carryovers attributable to periods prior to the ownership change. The annual amount of net operating losses allowed under Section 382 will be approximately $825,000. Net operating losses attributable to periods subsequent to the ownership change are approximately $21.7 million and are not subject to the limitation under Section 382.\nThe Company's effective tax rate on its income (loss) before taxes differs from the statutory regular tax rate as follows:\nAt December 31, 1994, net deferred tax assets totaled approximately $25.7 million. The total valuation allowance recognized for net deferred tax assets was also approximately $25.7 million. The valuation allowance decreased by approximately $900,000 during 1994.\nThe differences between the tax bases of assets and liabilities and their financial reporting amounts that give rise to significant portions of deferred income tax liabilities or assets are: real estate investment valuation allowances, equity in partnership gains and losses, property and equipment depreciation and accrued expenses.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5. INCOME TAXES (CONTINUED)\nThe components of the Company's deferred tax (liabilities) and assets are as follows as of December 31, 1994 (in thousands):\n6. STOCK OPTIONS, STOCK PURCHASE AND EMPLOYEE 401(K) PLANS\nStock Option Plans:\nThe information set forth below regarding stock option plans gives effect to the one-for-five reverse stock split in 1993. Changes in stock options were as follows for the years ended December 31, 1994, 1993 and 1992:\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. STOCK OPTIONS, STOCK PURCHASE AND EMPLOYEE 401(K) PLANS (CONTINUED)\nStock Option Plans (Continued):\nThe Company's 1990 Amended and Restated Stock Option Plan as amended, provides for grants of options to purchase the Company's common stock. The plan was amended effective May 1993 to authorize a fixed number of 1,350,000 shares for the plan. At December 31, 1994, 1993 and 1992, 1,065,749, 627,633 and 70,282 shares were available for the grant of options, respectively. Stock options under this plan are granted at prices from 50% up to 100% of the market price per share at the dates of grant, the terms and vesting schedules of which are determined by the Compensation Committee of the Board of Directors.\nThe Company's 1993 Stock Option Plan for Outside Directors provides for automatic grants to newly-elected non-management members of the Board of Directors of options to purchase 10,000 shares of common stock, at exercise prices set at the market price at the date of grant. The plan has authorized 50,000 shares for issuance. The options expire five years from the date of grant and vest over three years from such date. At December 31, 1994 and 1993, options to purchase 30,000 and 10,000 shares, respectively, were outstanding under the plan. As of December 31, 1994, 3,334 shares have vested.\nEmployee Common Stock Purchase Plan:\nIn 1987, the Company adopted an employee stock purchase plan which enables eligible employees to purchase common stock of the Company at discounted prices. In August 1993, the plan was amended to authorize up to 200,000 shares of stock for issuance under this plan. As of December 31, 1994, 93,826 shares were available for issue. During 1994, 1993 and 1992, 6,174, 6,342 and 19,240 shares, respectively, were purchased under this plan.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. STOCK OPTIONS, STOCK PURCHASE AND EMPLOYEE 401(K) PLANS (CONTINUED)\nEmployee 401(k) Plans:\nThe Company has a defined contribution plan covering eligible employees other than employees of Axiom. The Company contributes on a discretionary basis to the plan based upon specified percentages of voluntary employee contributions, which contributions may be made in common stock or cash, or a combination of both. Axiom has a 401(k) plan that does not provide for employer contributions to be made in stock. Discretionary contributions by the Company and other expenses for the plans amounted to approximately $548,390, $418,000, and $32,000 for 1994, 1993, and 1992, respectively.\n7. RELATED PARTY TRANSACTIONS\nThe Company participates in joint ventures, partnerships and trusts in which officers, directors and salespersons of the Company may also participate as investors. Such persons or their affiliates frequently provide property management and other real estate services to these entities, and such persons may manage or otherwise control such joint ventures or partnerships.\nRevenue earned by the Company for services rendered to affiliates, including joint ventures, officers and directors and their affiliates (\"Related Parties\"), was as follows for the years ended December 31, 1994, 1993, and 1992 (in thousands):\nThe Company rents office space from Related Parties. Such rent expense for the years ended December 31, 1994, 1993 and 1992 was $1,122,000, $1,312,000 and $1,502,000, respectively.\nAt December 31, 1993, the Company had $494,000 of notes and other receivables from Related Parties, which were fully reserved. See Note 4 to the Notes to Consolidated Financial Statements for information regarding long-term debt with Prudential, a Related Party.\nA limited partnership which is affiliated with the Company is a partner in a joint venture formed to develop an office building in Southern California. As permanent financing for the project, the joint venture borrowed $5.8 million on a non-recourse basis from a Related Party in September 1990, secured by an unamortized first mortgage on the property at a rate of 10.02% per year and a term of five years.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. RELATED PARTY TRANSACTIONS (CONTINUED)\nDuring 1993, the Company paid approximately $50,000, to a Related Party for administration of the Company's employee health plan for four of its offices.\nIn connection with the 1993 Recapitalization, certain Related Parties received reimbursement of expenses totaling approximately $783,000, and one Related Party received fees of $325,000. In connection with the 1994 Recapitalization, the Company entered into agreements with certain Related Parties (see Note 4 to Notes to Consolidated Financial Statements) and paid approximately $70,000 in legal fees on behalf of Prudential.\n8. COMMITMENTS AND CONTINGENCIES\nReal Estate Joint Ventures and Partnerships:\nThe Company has guaranteed, in the aggregate amount of $4 million, the contingent liabilities of one of its wholly-owned subsidiaries with respect to two limited partnerships in which the subsidiary formerly acted as general partner.\nNoncancelable Operating Leases:\nThe Company has noncancelable operating lease obligations for office space and certain equipment ranging from one to eight years, and sublease agreements under which the Company acts as sublessor. The office space leases provide for annual rent increases based on the Consumer Price Index, or other specified terms, and typically require payment of property taxes, insurance and maintenance costs.\nFuture minimum payments under noncancelable operating leases with an initial term of one year or more were as follows at December 31, 1994 (in thousands):\nAs a component of the Company's restructuring charges related to the downsizing and closing of certain offices, the Company has accrued for approximately $3,561,000 of the above expected future minimum rental payments net of expected sublease income of approximately $1,209,000, as of December 31, 1994.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. COMMITMENTS AND CONTINGENCIES (CONTINUED)\nNoncancelable Operating Leases (Continued):\nLease and rental expense for the years ended December 31, 1994, 1993 and 1992 amounted to $15,339,000, $19,552,000 and $27,510,000, respectively, net of sublease income of $1,087,000, $1,214,000 and $1,138,000, respectively.\nLegal Matters:\nThe Company is involved in various claims and lawsuits arising out of the conduct of its business, as well as in connection with its participation in various joint ventures, partnerships, a trust and appraisal business, many of which may not be covered by the Company's insurance policies. In the opinion of management, the eventual outcome of such claims and lawsuits is not expected to have a material adverse effect on the Company's financial position or results of operations. See Note 9 to the Notes to Consolidated Financial Statements for a discussion of legal settlements during 1994.\nOn March 14, 1994, Johsz, et al. v. Koll Company, et al., was filed in the -------------------------------------- Orange County (California) Superior Court against the Koll Company, Grubb & Ellis Company, Koll Center Newport Number 10, a California general partnership (\"Koll\"), and Southern California Edison Company (\"Edison\"). The complaint was served on the Company in June 1994. A second complaint, Younkin, Maiona, et al. ----------------------- v. Koll Company, et al., based on similar causes of action was filed in the same ------------------------ court on December 13, 1994 and served on the Company in February 1995. The plaintiffs in these two cases, three former Company brokers, a former Company employee, a current Company employee, and their spouses, allege that the brokers and employees acquired cancer from electromagnetic waves produced by the electric transformer owned by Edison and situated in a vault below office space leased by the Company in a building owned by Koll. The complaints allege negligence, battery, negligent infliction of emotional distress, fraudulent concealment, loss of consortium and, against Edison only, strict liability. Specific damages were not pled, but punitive as well as compensatory damages are sought. Discovery is ongoing. A trial date of August 7, 1995 has been set for the Johsz case. -----\nJohn W. Matthews, et al. v. Kidder, Peabody & Co., et al. and HSM Inc., et -------------------------------------------------------------------------- al., filed on January 23, 1995 in the United States District Court for the ---- Western District of Pennsylvania, is a purported class action on behalf of approximately 6,000 limited partners who invested approximately $85 million in three public real estate limited partnerships (the \"Partnerships\") during the period beginning in 1982 and continuing through 1986. HSM Inc. is a wholly-owned subsidiary of the Company. The complaint alleges violations under the Racketeer Influenced and Corrupt Organizations Act, securities fraud, breach of fiduciary duty and negligent misrepresentation surrounding the defendants' organization, promotion, sponsorship and management of the Partnerships. No discovery has been conducted. No plaintiff class has been certified. Specific damages were not pled, but treble, punitive as well as compensatory damages and restitution are sought.\nThe Company intends to vigorously defend the Johsz, Younkin and Matthews --------------------------- actions. Management believes it has meritorious defenses to contest the claims asserted in those actions. Based upon available information, the Company is not able to determine the financial impact, if any, of such actions, but based upon available information, believes that the outcome will not have a material adverse effect on the Company's financial position or results of operations.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. SPECIAL CHARGES AND UNUSUAL ITEMS\nThe Company's management periodically evaluates its business strategy and direction and the carrying value of certain assets. Over the four-year period ended December 31, 1994, management implemented a variety of restructuring and recapitalization measures necessary for the Company to continue as a going concern. The financial impact of these measures, as well as other special charges, have been recorded in \"Special Charges and Unusual Items\" as follows (in millions):\nExcess of Cost Over Net Assets of Acquired Companies (\"Goodwill\"):\nDuring 1991, 1992 and 1993, the Company evaluated the carrying value of its goodwill to determine whether it would be recoverable from future operations. A number of factors were reviewed including operating results, business plans, budgets and economic projections. The evaluation was significantly impacted by the continuation of the recessionary cycle and the severe downturn in the real estate markets. In 1991 and 1992, the Company wrote-off goodwill associated with certain business entities acquired in a period of rapid expansion during the 1980's when real estate activity was at increased levels and profit margins were substantially higher than those found in the market today. As of December 31, 1992, all of the remaining unamortized goodwill was associated with commercial brokerage operations. In 1993, the Company completed a recapitalization and acquired a new executive management team which determined that additional market capitalization and a variety of restructuring efforts were needed in order for the business to\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. SPECIAL CHARGES AND UNUSUAL ITEMS (CONTINUED)\nExcess of Cost Over Net Assets of Acquired Companies (\"Goodwill\") (Continued):\ncontinue as a going concern. The restructuring efforts in 1994 included downsizing operations and refocusing the Company's activities on its core business (commercial brokerage) functions as well as realigning the operational structure into a more centralized operation with less middle management. Recapitalization efforts in 1994 included the restructuring of the Company's debt and the infusion of cash by Warburg (See Note 4). The Company's analysis of goodwill performed in the fourth quarter of 1993 indicated that the commercial brokerage business would operate at a loss without the planned restructuring and recapitalization efforts and therefore be unable to recover goodwill. Accordingly, the remaining goodwill was written off as of December 31, 1993.\nSeverance and Office Closure Costs:\nDuring 1991, 1992 and 1993, the Company accrued estimated employee severance and office closure costs when plans were adopted to close certain unprofitable offices. During 1994, the Company paid $3.5 million in cash (relating to the termination of 37 employees and the closure of 28 offices) and made non-cash reductions of $2.2 million to these reserves. Approximately $1.2 million of the non-cash reductions in the employee severance and office closure cost reserves were a result of closing certain offices more efficiently than initially estimated and are reflected as a credit to \"Special Charges and Unusual Items\" in 1994. Also reflected as a credit to \"Special Charges and Unusual Items\" in 1994 is the non-cash adjustment of $750,000 related to the reversal of a portion of the remaining net office lease liability of the Company's residential brokerage operations which were sold in November 1994. Should the buyer of the Southern California residential brokerage operations perform under the remaining lease liability that it assumed (which extends to November 1997), remaining office closure reserves of approximately $750,000 will be reduced in future periods. Of the $4.7 million of remaining accrued severance and office closure costs at December 31, 1994, the Company estimates approximately $3.6 million will be paid in cash.\nEquity Joint Venture and Other Property Investments:\nAs a consequence of the recessionary cycle and depressed real estate markets, the Company made provisions to increase its valuation allowance of its partnership and joint venture investments during 1992 and 1991 to reflect reductions in estimated net realizable values. Estimated net realizable value was based on the then current market value less disposition costs.\nLegal Expense and Estimated Settlement Provisions:\nThe legal expense and estimated settlement provision for 1992 included an estimate for potential professional liability exposure arising from the activities of the Company's salesforce for incurred but not reported cases and the estimated costs of several significant lawsuits, two of which were settled in 1994.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. SPECIAL CHARGES AND UNUSUAL ITEMS (CONTINUED)\nLegal Expense and Estimated Settlement Provisions (Continued):\nIn June 1994, the Company settled two consolidated actions, Donald C. --------- Anderson, et al. v. Grubb & Ellis Company, et al., and Gabriel L. Aguilar, et ----------------------------------------------------------------------------- al. v. Grubb & Ellis Company, et al., filed on behalf of the limited partners -------------------------------------- of a limited partnership formed to purchase an office\/retail building in California in 1985 in which the Company and certain of its affiliates acted as the syndicator, the general partner of the partnership and the property manager of the investment property. The Company's portion of the settlement involved a cash payment and approximately 50,000 shares of common stock of the Company. In July 1994, the Company settled a potential claim of a former joint venture partner relating to a partnership involving the ownership and operation of commercial real estate for cash and 250,000 shares of common stock of the Company.\nOther, Net:\nIn 1993, \"Other, net\" includes $1,543,000 of gains from the sales of the Company's real estate advisory business and Northern California residential real estate operations which were transacted in the first quarter of 1993. In 1994, \"Other, net\" includes a $250,000 gain from the sale of the remaining residential real estate operations in Southern California.\n10. CONCENTRATION OF CREDIT RISK\nFinancial instruments that potentially subject the Company to credit risk consist principally of trade receivables and interest-bearing investments. Users of real estate services account for a substantial portion of trade receivables and collateral is generally not required. The risk associated with this concentration is limited due to the large number of users and their geographic dispersion.\nThe Company places substantially all its interest-bearing investments with major financial institutions and limits the amount of credit exposure to any one financial institution in accordance with policy and pursuant to restrictions in the New Note Agreement with Prudential.\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n11. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\n\/(a)\/ See Note 9 for a discussion of special charges and unusual items recorded in the fourth quarter of 1993 and credits to special charges and unusual items recorded during 1994. Certain operating revenue and operating income (loss) amounts have been reclassified from those reported on the Form 10-Q to conform to the presentation in the December 31, 1994 Statement of Operations.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nGRUBB & ELLIS COMPANY\nPART III ______________\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information called for by Item 10 is incorporated by reference from the registrant's definitive proxy statement to be filed pursuant to Regulation 14A no later than 120 days after the end of the 1994 fiscal year.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information called for by Item 11 is incorporated by reference from the registrant's definitive proxy statement to be filed pursuant to Regulation 14A no later than 120 days after the end of the 1994 fiscal year.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for by Item 12 is incorporated by reference from the registrant's definitive proxy statement to be filed pursuant to Regulation 14A no later than 120 days after the end of the 1994 fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by Item 13 is incorporated by reference from the registrant's definitive proxy statement to be filed pursuant to Regulation 14A no later than 120 days after the end of the 1994 fiscal year.\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 Reports of Independent Auditors and Consolidated Financial Statements are submitted herewith:\n. Reports of Independent Auditors.\n. Consolidated Balance Sheets at December 31, 1994 and December 31, 1993.\n. Consolidated Statements of Operations for the years ended December 31, 1994, 1993 and 1992.\n. Consolidated Statements of Stockholders' Equity (Deficit) for the years ended December 31, 1994, 1993 and 1992.\n. Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992.\n. Notes to Consolidated Financial Statements.\n2. The following Consolidated Financial Statement Schedules are submitted herewith:\nII. Valuation and Qualifying Accounts\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 or are inapplicable, and therefore have been omitted.\n3. Exhibits required to be filed by Item 601 of Regulation S-K:\n(3) ARTICLES OF INCORPORATION AND BYLAWS\n3.1 Certificate of Amendment to the Restated Certificate of Incorporation of the Registrant, effective November 1, 1994.\n3.2 Certificate of Incorporation of the Registrant, as restated effective November 1, 1994 (not yet filed with the Secretary of State of the State of Delaware).\n3.3 Grubb & Ellis Company Bylaws, as amended effective June 1, 1994, incorporated herein by reference to Exhibit 4.21 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n3.4 Amendment to the Grubb & Ellis Company Bylaws, effective as of June 1, 1994, incorporated herein by reference to Exhibit 4.20 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n(4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES\n4.1 Senior Note, Subordinated Note and Revolving Credit Note Agreement between The Prudential Insurance Company of America and the Registrant dated as of November 2, 1992, incorporated herein by reference to Exhibit 4.6 to the Registrant's Current Report on Form 8-K filed on February 8, 1993 (Commission File No. 1-8122).\n4.2 Letter agreement between The Prudential Insurance Company of America and the Registrant dated March 26, 1993, incorporated herein by reference to Exhibit 4.10 to the Registrant's Quarterly Report on Form 10-Q filed on May 15, 1993 (Commission File No. 1-8122).\n4.3 Letter agreement between The Prudential Insurance Company of America and the Registrant dated April 19, 1993, incorporated herein by reference to Exhibit 4.11 to the Registrant's Quarterly Report on Form 10-Q filed on May 15, 1993 (Commission File No. 1-8122).\n4.4 Letter agreement between The Prudential Insurance Company of America and the Registrant dated October 26, 1993, incorporated herein by reference to Exhibit 4.21 to the Registrant's registration statement on Form S-8 filed on November 12, 1993 (Registration No. 33-71484).\n4.5 Letter agreement between The Prudential Insurance Company of America and the Registrant dated March 28, 1994, incorporated herein by reference to Exhibit 4.5 to the Registrant's Annual Report on Form 10-K filed on March 31, 1994 (Commission File No. 1-8122).\n4.6 Modification to Note and Security Agreement between the Registrant and The Prudential Insurance Company of America dated as of March 28, 1994, incorporated by reference to Exhibit 4.17 to the Registrant's Amendment to its Annual Report on Form 10-K\/A filed on April 29, 1994 (Commission File No. 1-8122).\n4.7 Amendment dated July 20, 1994 to the Senior Note, Subordinated Note and Revolving Credit Note Agreement between the Registrant and The Prudential Insurance Company of America, incorporated herein by reference to Exhibit 10.2 to the Registrant's registration statement on Form S-3 filed on July 22, 1994 (Registration No. 33-54707).\n4.8 Securities Purchase Agreement between The Prudential Insurance Company of America and the Registrant, dated as of November 2, 1992, incorporated herein by reference to Exhibit 28.4 to the Registrant's Current Report on Form 8-K filed on November 12, 1992 (Commission File No. 1-8122).\n4.9 Securities Purchase Agreement among Warburg, Pincus Investors, L.P., Joe F. Hanauer and the Registrant, dated as of November 2, 1992, incorporated herein by reference to Exhibit 28.3 to the Registrant's Current Report on Form 8-K filed on November 12, 1992 (Commission File No. 1-8122).\n4.10 Summary of terms of proposed bridge loan and rights offering executed by Warburg, Pincus Investors, L.P., The Prudential Insurance Company of America and the Registrant as of March 28, 1994, incorporated herein by reference to Exhibit 4.11 to the\nRegistrant's Annual Report on Form 10-K filed on March 31, 1994 (Commission File No. 1-8122).\n4.11 Cash Collateral Account Agreement between Bank of America N.T.& S.A. and the Registrant dated as of March 29, 1994, incorporated herein by reference to Exhibit 4.12 to the Registrant's Annual Report on Form 10-K filed on March 31, 1994 (Commission File No. 1-8122).\n4.12 Intercreditor Agreement between Warburg, Pincus Investors, L.P. and The Prudential Insurance Company of America dated as of March 28, 1994, incorporated herein by reference to Exhibit 4.13 to the Registrant's Annual Report on Form 10-K filed on March 31, 1994 (Commission File No. 1-8122).\n4.13 Promissory Note in the amount of $250,000 dated as of January 8, 1990 executed by the Registrant in favor of DW Limited Partnership, incorporated herein by reference to Exhibit 4.14 to the Registrant's Annual Report on Form 10-K filed on March 31, 1994 (Commission File No. 1-8122).\n4.14 Specimen of Stock Subscription Warrant No. S-4 issued to the Joe F. Hanauer Trust, dated January 29, 1993, exercisable for 25,954 shares of the Registrant's Common Stock, incorporated herein by reference to Exhibit 4.18 to the Registrant's registration statement on Form S-8 filed on November 12, 1993 (Registration No. 33-71484).\n4.15 Promissory Note in the amount of up to $10 million dated as of March 29, 1994, executed by the Registrant in favor of Warburg, Pincus Investors, L.P., incorporated herein by reference to Exhibit 4.15 to the Registrant's Amendment to its Annual Report on Form 10-K\/A filed on April 29, 1994 (Commission File No. 1-8122).\n4.16 Loan and Security Agreement between the Registrant and Warburg, Pincus Investors, L.P. dated as of March 29, 1994, incorporated herein by reference to Exhibit 4.16 to the Registrant's Amendment to its Annual Report on Form 10-K\/A filed on April 29, 1994 (Commission File No. 1-8122).\n4.17 Form of Rights Certificate in connection with 1994 Rights Offering of the Registrant, incorporated herein by reference to Exhibit 4.3 to the Registrant's registration statement on Form S-3 filed on July 22, 1994 (Registration No. 33-54707).\n4.18 Specimen of Stock Subscription Warrant No. 16 issued to The Prudential Insurance Company of America, restated as of November 1, 1994, exercisable for 200,000 shares of the Registrant's Common Stock, incorporated herein by reference to Exhibit 4.23 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n4.19 Specimen of Stock Subscription Warrant No. 17 issued to The Prudential Insurance Company of America, as of November 1, 1994, exercisable for 150,000 shares of the Registrant's Common Stock, incorporated herein by reference to Exhibit 4.24 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n4.20 Specimen of Stock Subscription Warrant No. 18 issued to Warburg, Pincus Investors, L.P., restated as of November 1, 1994,\nexercisable for 687,358 shares of the Registrant's Common Stock, incorporated herein by reference to Exhibit 4.25 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n4.21 Specimen of Stock Subscription Warrant No. 19 issued to Warburg, Pincus Investors, L.P., as of November 1, 1994, exercisable for 325,000 shares of the Registrant's Common Stock, incorporated herein by reference to Exhibit 4.26 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n4.22 Amended Senior Note executed by the Registrant in favor of The Prudential Insurance Company of America in the amount of $6,500,000, dated as of November 1, 1994, incorporated herein by reference to Exhibit 4.27 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n4.23 Amended Senior Note executed by the Registrant in favor of The Prudential Insurance Company of America in the amount of $3,500,000, dated as of November 1, 1994, incorporated herein by reference to Exhibit 4.28 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n4.24 Amended Payment-In-Kind Note executed by the Registrant in favor of The Prudential Insurance Company of America in the amount of $10,900,834.333, dated as of November 1, 1994, incorporated herein by reference to Exhibit 4.29 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n4.25 Amended Revolving Credit Note executed by the Registrant in favor of The Prudential Insurance Company of America in the amount of $5,000,000, dated as of November 1, 1994, incorporated herein by reference to Exhibit 4.30 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\nOn an individual basis, instruments other than Exhibits listed above under Exhibit 4 defining the rights of holders of long-term debt of the Registrant and its consolidated subsidiaries and partnerships do not exceed ten percent of total consolidated assets and are, therefore, omitted; however, the Company will furnish supplementally to the Commission any such omitted instrument upon request.\n(10) MATERIAL CONTRACTS\n10.1* Grubb & Ellis Company 1990 Amended and Restated Stock Option Plan, as amended as of May 28, 1993, incorporated herein by reference to Exhibit 4.1 to the Registrant's registration statement on Form S-8 filed on November 12, 1993 (Registration No. 33-71580).\n10.2* Description of Grubb & Ellis Company Senior Management Compensation Plan, incorporated herein by reference to Exhibit 10.17 to the Registrant's Annual Report on Form 10-K filed on March 30, 1992 (Commission File No. 1-8122).\n10.3 Stock Purchase and Stockholder Agreement dated May 6, 1992, among GE New Corp., the Registrant and International Business Machines\n* Management contract or compensatory plan or arrangement.\nCorporation, incorporated herein by reference to Exhibit 28.2 to the Registrant's Quarterly Report on Form 10-Q filed on May 15, 1992 (Commission File No. 1-8122).\n10.4 Master Management Agreement dated May 6, 1992 between International Business Machines Corporation and GE New Corp., incorporated herein by reference to Exhibit 28.2 to the Registrant's Quarterly Report on Form 10-Q filed on May 15, 1992 (Commission File No. 1-8122).\n10.5 Master Financing Agreement dated August 5, 1992 between IBM Credit Corporation and Axiom Real Estate Management, Inc., incorporated herein by reference to Exhibit 28.4 to the Registrant's Quarterly Report on Form 10-Q filed on August 13, 1992 (Commission File No. 1- 8122).\n10.6 Credit Agreement dated as of August 31, 1992, between Axiom Real Estate Management, Inc. and the Registrant, incorporated herein by reference to Exhibit 28.6 to the Registrant's Quarterly Report on Form 10-Q filed on November 16, 1992 (Commission File No. 1-8122).\n10.7 Purchase Agreement dated February 16, 1993 between the Registrant and JMB Institutional Realty Advisers, L.P., incorporated herein by reference to Exhibit 10.20 to the Registrant's Quarterly Report on Form 10-Q filed on May 15, 1993 (Commission File No. 1-8122).\n10.8 Purchase Agreement dated March 4, 1993 between the Registrant and Fox and Carskadon\/Better Homes and Gardens, incorporated herein by reference to Exhibit 10.21 to the Registrant's Quarterly Report on Form 10-Q filed May 15, 1993 (Commission File No. 1-8122).\n10.9 Stockholders' Agreement among Warburg, Pincus Investors, L.P., The Prudential Insurance Company of America, Joe F. Hanauer and the Registrant dated January 29, 1993, incorporated herein by reference to Exhibit 28.1 to the Registrant's Current Report on Form 8-K filed on February 8, 1993 (Commission File No. 1-8122).\n10.10 Amendment to Stockholders' Agreement among Warburg, Pincus Investors, L.P., The Prudential Insurance Company of America, Joe F. Hanauer and the Registrant, dated as of July 1, 1993, incorporated herein by reference to Exhibit 10.15 to the Registrant's Quarterly Report on Form 10-Q filed on August 16, 1993 (Commission File No. 1-8122).\n10.11*1993 Stock Option Plan for Outside Directors, incorporated herein by reference to Exhibit 4.1 to the Registrant's registration statement on Form S-8 filed on November 12, 1993 (Registration No. 33-71484).\n10.12*Separation Agreement between the Registrant and Wilbert F. Schwartz dated as of April 25, 1994, incorporated herein by reference to Exhibit 10.23 to the Registrant's Amendment to its Annual Report on Form 10-K\/A filed on April 29, 1994 (Commission File No. 1-8122).\n10.13 Standby Agreement dated July 21, 1994 between the Registrant and Warburg, Pincus Investors, L.P., incorporated herein by reference to Exhibit 10.1 to the Registrant's registration statement on Form S-3 filed on July 22, 1994 (Registration No. 33-54707).\n10.14 Second Amendment to the Stockholders' Agreement dated November 1, 1994, among the Registrant, Warburg, Pincus Investors, L.P., The\n* Management contract or compensatory plan or arrangement.\nPrudential Insurance Company of America, and Joe F. Hanauer, incorporated herein by reference to Exhibit 10.19 to the Registrant's Quarterly Report on Form 10-Q filed on November 14, 1994 (Commission File No. 1-8122).\n10.15 Agreement dated November 8, 1994 among the Registrant, Newco Realty Corp., Dennis Gordon, John Tillotson, Javier Uribe, and Charles Neubauer, incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed on December 1, 1994 (Commission File No. 1-8122)\n10.16 Servicemark License Agreement dated November 17, 1994 between the Registrant and Newco Realty Corp., incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed on December 1, 1994 (Commission File No. 1-8122)\n10.17 Guaranty dated November 8, 1994 executed by Dennis Gordon, Javier Uribe, John Tillotson and Charles Neubauer, incorporated herein by reference to Exhibit 10.3 to the Registrant's Current Report on Form 8-K filed on December 1, 1994 (Commission File No. 1-8122)\n10.18*Description of Grubb & Ellis Company Management Separation Arrangements.\n(11) Statement regarding Computation of Per Share Earnings\n(21) Subsidiaries of the Registrant\n(23) Consents of Independent Auditors\n23.1 Consent of Ernst & Young LLP 23.2 Consent of Coopers & Lybrand L.L.P.\n(24) Powers of Attorney\n(27) Financial Data Schedule\n(b) Reports on Form 8-K:\nDuring the fourth quarter of 1994, a Current Report on Form 8-K dated October 24, 1994 was filed, reporting under Item 5 the registrant's earnings for third quarter 1994. In addition, a Current Report on Form 8-K dated November 17, 1994 was filed, reporting under Item 2 the sale of certain assets related to the registrant's Southern California residential brokerage operations, and a Current Report on Form 8-K dated November 17, 1994 was filed, reporting under Item 7 financial information related to such sale.\n*Management contract or compensatory plan or arrangement.\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 30th day of March, 1995.\nGRUBB & ELLIS COMPANY (REGISTRANT)\n* by ________________________________ Joe F. Hanauer 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.\nMarch 30, 1995\n_______________________________________ Robert J. Hanlon, Jr. Chief Financial Officer and Senior Vice President\nMarch 30, 1995 _______________________________________ James E. Klescewski Vice President and Corporate Controller\nMarch 30, 1995 * ______________________________________ Joe F. Hanauer, Chairman of the Board and Director\n* March 30, 1995 ______________________________________ R. David Anacker, Director\n* March 30, 1995 ______________________________________ Reuben S. Leibowitz, Director\n* March 30, 1995 ______________________________________ John D. Santoleri, Director\n* March 30, 1995 ______________________________________ Lawrence S. Bacow, Director\n* March 30, 1995 ______________________________________ Robert J. McLaughlin, Director\n*Pursuant to Powers of Attorney\n__________________________________ By: Robert J. Walner, Attorney-in-Fact\nGRUBB & ELLIS COMPANY AND SUBSIDIARIES\nEXHIBIT INDEX\/(A)\/\nFOR THE YEAR ENDED DECEMBER 31, 1994\n(A) Exhibits incorporated by reference are listed in Item 14(a)3 of this report.","section_15":""}
{"filename":"62996_1994.txt","cik":"62996","year":"1994","section_1":"ITEM 1. BUSINESS.\nMasco manufactures home improvement, building and home furnishings products for the home and family. Masco believes that it is the largest domestic manufacturer of faucets, plumbing supplies, kitchen and bath cabinets and furniture, and that it is a leading domestic producer of a number of other home improvement, building and home furnishings products. Masco was incorporated under the laws of Michigan in 1929 and in 1968 was reincorporated under the laws of Delaware.\nExcept as the context otherwise indicates, the terms \"Masco\" and the \"Company\" refer to Masco Corporation and its consolidated subsidiaries.\nINDUSTRY SEGMENTS\nThe following table sets forth for the three years ended December 31, 1994, the contribution of the Company's industry segments to net sales and operating profit:\n(1) Amounts are before general corporate expense.\nAdditional financial information concerning the Company's operations by industry segments as of and for each of the three years ended December 31, 1994, is set forth in Item 8 of this Report in the Note to the Company's Consolidated Financial Statements captioned \"Segment Information.\"\nHOME IMPROVEMENT AND BUILDING PRODUCTS\nThe Company is among the country's largest manufacturers of brand-name consumer products designed for the improvement and building of the home, including faucets, kitchen and bath cabinets, kitchen appliances, bath and shower enclosure units, spas and hot tubs, other shower and plumbing specialties and accessories, door locks and other builders' hardware, air treatment products, venting and ventilating equipment and water pumps. These products are sold for the home improvement and home construction markets through mass merchandisers, hardware stores, home centers and other outlets to consumers and contractors.\nThe Company manufactures a variety of single and double handle faucets. DELTA(R) and PEERLESS(R) single and double handle faucets are used on kitchen, lavatory and other sinks and in bath and shower installations. DELTA faucets are sold primarily through manufacturers' representatives to distributors who sell the faucets to plumbers, building contractors, remodelers, retailers and others. PEERLESS faucets are sold primarily through manufacturers' representatives directly to retail outlets such as mass merchandisers, home centers and hardware stores and are also sold under private label. The Company's ARTISTIC BRASS(R) and SHERLE WAGNER(TM) faucets and accessories are produced for the decorator markets and are sold through wholesalers, distributor showrooms and other outlets. In\naddition to its domestic manufacturing, the Company manufactures faucets in Denmark, Italy and Canada.\nSales of faucets approximated $667 million in 1994, $608 million in 1993 and $528 million in 1992. The percentage of operating profit on faucets is somewhat higher than that on products within the Home Improvement and Building Products Segment as a whole. The Company believes that the simplicity, quality and reliability of its faucet mechanisms, its marketing and merchandising activities, and the development of a broad line of products have accounted for the continued strength of its faucet sales.\nThe Company manufactures stock, semi-custom and custom kitchen and bath cabinetry in a variety of styles and in various price ranges. The Company sells cabinets under a number of trademarks, including MERILLAT(R), KRAFTMAID(R), STARMARK(R) and FIELDSTONE(R), with sales in both the home improvement and new construction markets. In addition to its domestic manufacturing, the Company manufactures cabinetry in Germany and England. Sales of kitchen and bath cabinets were approximately $665 million in 1994, $570 million in 1993 and $515 million in 1992.\nThe Company's brass and copper plumbing system components and other plumbing specialties are sold to plumbing, heating and hardware wholesalers and to home centers, hardware stores, building supply outlets and other mass merchandisers. These products are marketed primarily for the wholesale trade under the BRASS-CRAFT(R) trademark and for the \"do-it-yourself\" market under the PLUMB SHOP(R) and HOME PLUMBER(R) trademarks and are also sold under private label.\nOther kitchen and bath consumer products sold by the Company include THERMADOR(R) cooktops, ovens, ranges and related cooking equipment and refrigerators, which are marketed through appliance distributors and dealers. The Company's acrylic and gelcoat bath and shower units and whirlpools are sold under the AQUA GLASS(R) trademark primarily to wholesale plumbing distributors for use in the home improvement and new home construction markets. Luxury bath and shower enclosures are manufactured and sold by the Company under the HUPPE(R) trademark. The Company's spas and hot tubs are sold under the HOT SPRING SPA(R) and other trademarks directly to retailers for sale to residential customers.\nOther specialty home improvement and building products include premium quality brass rim and mortise locks and knobs, trim and other builders' hardware which are manufactured and sold under the BALDWIN(R) trademark for the home improvement and new home construction markets. WEISER(R) door locks and related hardware are sold through contractor supply outlets, hardware distributors and home centers. SAFLOK(TM) electronic locks and WINFIELD(TM) mechanical locks are sold primarily to the hospitality market.\nIn 1994 the Company added several plumbing specialties and bath accessories to its line of products through the acquisition of Melard Corporation, Zenith Products Corporation, American Shower & Bath Corporation and NewTeam Group. The Company expanded its kitchen cabinet businesses during 1994 by the acquisition in Germany of Alma Kuchen Aloys Meyer GmbH and Co.\nHOME FURNISHINGS PRODUCTS\nThe Company is the leading domestic manufacturer of brand-name consumer products for the furnishing of the home, including furniture, upholstery and other fabrics, mirrors, lamps and other decorative accessories.\nThe Company manufactures a broad array of home furnishings products at a wide range of price points and utilizes a variety of distribution channels to market its products. A complete line of traditional, transitional and contemporary wood and upholstered furniture is sold under the HENREDON(R) trademark through Henredon galleries located in furniture stores, and also through designer showrooms, furniture outlets and department stores. DREXEL(R) and HERITAGE(R) wood and upholstered furniture and home furnishings accessories are marketed through Drexel Heritage galleries located in furniture stores, through showcase stores which primarily feature Drexel Heritage\nfurniture and also through independent furniture outlets. The Lexington Furniture Industries group produces youth-correlated furniture, moderately priced bedroom and dining room groups, occasional and upholstered furniture and woven wicker and rattan products, which are sold through national and regional chains and independent furniture dealers, department stores and interior designers. Universal Furniture Limited manufactures dining room, bedroom, occasional wood and upholstered furniture, which is sold primarily through furniture retailers and department stores under UNIVERSAL(R), BENCHCRAFT(R) and other trademarks. The Company believes that Universal is the largest supplier in the United States of wood dining room furniture, much of which is shipped in unassembled form from the Company's Far East factories to assembly and distribution centers in the United States. The Berkline Corporation, acquired in 1994, manufactures family or home entertainment room motion furniture, which is sold primarily through furniture retailers and department stores under the BERKLINE(R) trademark. The Company also manufactures and sells designer upholstered products and upholstered furniture under private label to furniture stores and other retailers. Sales of the Company's furniture products approximated $1.57 billion in 1994, $1.34 billion in 1993 and $1.19 billion in 1992.\nThe Company's textile group includes Robert Allen Fabrics, Inc., Ametex Fabrics, Inc., Sunbury Textile Mills, Inc., Ametex U.K. Limited and Ramm, Son & Crocker Limited. Robert Allen markets fabrics, which are used primarily for residential furnishings, through independent sales representatives to designers and retailers. Company-operated and independent showrooms have also been established to sell fabrics and display and sell many of the Company's other home furnishings products. Ametex and Ametex U.K. design and convert moderately priced fabrics for use in commercial and residential furnishings, which are sold through independent sales representatives to furniture and other furnishings manufacturers, fabric jobbers and the hospitality market. Sunbury manufactures high-quality jacquard woven fabrics which are sold through sales representatives primarily to furniture manufacturers and decorative jobbers for furniture and other decorative applications. Ramm, Son & Crocker is a United Kingdom supplier of high-quality printed fabrics to the furniture and decorative fabric markets.\nAdditional markets for the Company's furnishings business include the hospitality and institutional markets and the design trade. The Company supplies furniture and accessories to contract accounts for the hotel and motel industry as well as for commercial, governmental and institutional applications. The Company's Beacon Hill showrooms, located in design centers, offer wide selections of high-end furniture, fabrics and accessories, many of which are not generally available through traditional retail channels.\nGENERAL INFORMATION CONCERNING INDUSTRY SEGMENTS\nNo material portion of the Company's business is seasonal or has special working capital requirements, although the Company maintains a higher investment in inventories for certain of its businesses than the average manufacturing company. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Receivables and Inventories,\" included in Item 7 of this Report. The Company does not consider backlog orders to be a material factor in its industry segments, and no material portion of its business is dependent upon any one customer or subject to renegotiation of profits or termination of contracts at the election of the federal government. Compliance with federal, state and local regulations relating to the discharge of materials into the environment, or otherwise relating to the protection of the environment, is not expected to result in material capital expenditures by the Company or to have a material effect on the Company's earnings or competitive position. In general, raw materials required by the Company are obtainable from various sources and in the quantities desired.\nINTERNATIONAL OPERATIONS\nThe Company, through its subsidiaries, has manufacturing plants in Belgium, Canada, the People's Republic of China, Denmark, France, Germany, Hong Kong, Indonesia, Italy, Malaysia, Mexico, the Philippines, Singapore, Sweden, Taiwan, Turkey and the United Kingdom. Products manufactured by\nthe Company outside of the United States include faucets and accessory products, bath and shower enclosures, kitchen and bath cabinets, furniture, decorative accessories, door locks and related hardware, ventilating fans and equipment and submersible water pumps.\nThe Company's foreign operations are subject to political, monetary, economic and other risks attendant generally to international businesses. These risks generally vary from country to country.\nFinancial information concerning the Company's foreign and domestic operations, including the amounts of net sales, operating profit and assets employed which are attributable to the Company's operations in the United States and in foreign countries, as of and for the three years ended December 31, 1994, is set forth in Item 8 of this Report in the Note to the Company's Consolidated Financial Statements captioned \"Segment Information.\" From 1992 through 1994, the Company's annual net export sales from the United States to other countries, as a percentage of consolidated annual net sales, approximated three percent.\nEQUITY INVESTMENTS\nMascoTech, Inc.\nIn 1984, Masco transferred its industrial businesses to a newly formed subsidiary, MascoTech, Inc. (formerly Masco Industries, Inc.), which became a separate public company in July, 1984 when Masco distributed to its stockholders shares of MascoTech common stock as a special dividend. Masco currently owns approximately 44 percent of the outstanding common stock of MascoTech.\nMascoTech is a supplier of powertrain and chassis components, technical engineering and related services and automotive aftermarket products and a manufacturer of architectural products and other specialty products primarily for the defense industry. In 1994, MascoTech had sales of $1.7 billion.\nMascoTech has adopted a long term strategic plan to focus on certain core operating capabilities and divest certain other businesses. In late 1993, MascoTech adopted a plan to divest the businesses in its energy segment, which has since been completed. MascoTech's financial statements have been reclassified to present the operating results of the energy segment as discontinued operations. These businesses manufactured specialized tools, equipment and other products for energy-related industries. In late 1994, MascoTech adopted a plan to dispose of its architectural products, defense and certain of its transportation-related businesses. The disposition of these businesses, which have annual sales of approximately $700 million, is expected to occur primarily in 1995 with the cash portion of the proceeds applied to reduce MascoTech's indebtedness and to provide capital to invest in its core businesses. The disposition of these businesses does not meet the criteria for discontinued operations treatment for accounting purposes; accordingly, the sales and results of operations of these businesses will be included in the results of continuing operations through the date of disposition. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" included in Item 7 of this Report regarding the effect of these actions on the Company.\nMascoTech's core transportation-related businesses manufacture powertrain, chassis and aftermarket products and provide technical engineering and other related services. Powertrain and chassis products include semi-finished transmission shafts, drive gears, engine connecting rods, wheel spindles, front wheel drive and exhaust system components, control arms and heavy stampings and related assemblies for suspension and chassis applications. MascoTech's technical engineering and related services businesses supply engineering and engineering services to support the vehicle development processes of automotive original equipment manufacturers as well as specialty vehicle, marketing, training, visual and other related professional services. Aftermarket products include fuel and emission systems components, windshield wiper blades, constant-velocity joints, brake hardware repair kits and automotive accessories. MascoTech's transportation-related businesses held for disposition manufacture products for vehicle body related applications including automotive trim, luggage racks and accessories and light, medium and specialty metal stampings. These businesses also supply specialty coatings and truck cab body and passenger car convertible assemblies. MascoTech's products\nare manufactured using various metalworking technologies, including cold, warm and hot forming, powdered metal forming and stamping. During 1994, sales to various divisions and subsidiaries of Ford Motor Company, Chrysler Corporation and General Motors Corporation accounted for approximately 19 percent, 13 percent and 12 percent, respectively, of MascoTech's net sales (including both core businesses and businesses held for disposition).\nSpecialty products manufactured by MascoTech include a variety of architectural products for commercial, institutional and residential markets. Products include steel doors and frames; stainable and low maintenance steel doors; wood windows and aluminum-clad wood windows; leaded, etched and beveled glass for decorative windows and entryways; residential entry systems; garage doors; sectional and rolling doors; security grilles; and modular metal partitions. MascoTech's sales of architectural products in 1994 were $277 million. MascoTech's other specialty products consist primarily of defense products, including large diameter cold formed cartridge cases, projectiles and casings for rocket motors and missiles for the United States government and its suppliers. MascoTech also markets waste-water treatment services to other industrial companies principally in southern California. MascoTech's sales in 1994 of these other specialty products were $93 million.\nTriMas Corporation\nThe Company and MascoTech currently own approximately 5 percent and 41 percent, respectively, of the outstanding common stock of TriMas Corporation. TriMas is a diversified proprietary products company with leadership positions in commercial, industrial and consumer niche markets, including industrial container closures, pressurized gas cylinders, specialty industrial gaskets, towing systems products, specialty fasteners, tapes and products for fiberglass insulation, and precision cutting tools.\nHans Grohe\nThe Company has a partnership interest in Hans Grohe GmbH & Co. KG, a German manufacturer of faucets, handheld showers, shower heads and other shower accessories.\nPATENTS AND TRADEMARKS\nThe Company holds a number of United States and foreign patents covering various design features and valve constructions used in certain of its faucets, and also holds a number of other patents and patent applications, licenses, trademarks and trade names. As a manufacturer of brand-name consumer products, the Company views its trademarks as important, but does not believe that there is any reasonable likelihood of a loss of such rights which would have a material adverse effect on the Company's industry segments or its present business as a whole.\nCOMPETITION\nThe major domestic and foreign markets for the Company's products in its industry segments are highly competitive. Competition is based primarily on performance, quality, style, service and price, with the relative importance of such factors varying among products. A number of companies of varying size compete with one or more of the Company's product lines.\nEMPLOYEES\nAt December 31, 1994, the Company employed approximately 51,300 people. Satisfactory relations have generally prevailed between the Company and its employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe following list includes the Company's principal manufacturing facilities by location and the industry segments utilizing such facilities:\nNote: Multiple footnotes within the same parenthesis indicate the facility is engaged in activities relating to both segments. Multiple footnotes to the same municipality denote separate facilities in that location. Industry segments in the preceding table are identified as follows: (1) Home Improvement and Building Products Segment, and (2) Home Furnishings Products Segment.\nThe home furnishings products manufacturing facilities are located primarily in North Carolina, with principal facilities ranging in size from 710,000 to 1,108,000 square feet. The two principal faucet manufacturing plants are located in Greensburg, Indiana and Chickasha, Oklahoma and a new 394,000 square foot faucet manufacturing plant is under construction in Jackson, Tennessee. The faucet manufacturing plants and the majority of the Company's other facilities range from approximately 20,000 to 700,000 square feet. The Company owns most of its manufacturing facilities and none of the properties is subject to significant encumbrances. The Company also maintains approximately 1.5 million square feet of designer and trade showroom space at various locations throughout the United States where it coordinates the display and sale of its home furnishings products and owns 725,000 square feet of showroom space in High Point, North Carolina utilized for furniture industry trade shows. In addition, the Company maintains 357,000 square feet of designer and trade showroom space at various foreign locations. The Company's corporate headquarters are located in Taylor, Michigan and are owned by the Company. An additional building near its corporate headquarters is used by the Company's corporate research and development department.\nThe Company's buildings, machinery and equipment have been generally well maintained, are in good operating condition, and are adequate for current production requirements.\nThe following list identifies the location of the principal manufacturing facilities of MascoTech and the industry segments utilizing such facilities:\nNote: Multiple footnotes within the same parenthesis indicate the facility is engaged in significant activities relating to more than one segment. Multiple footnotes to the same municipality denote separate facilities in that location. Industry segments in the preceding table are identified as follows: (1) transportation-related products; (2) specialty products - architectural and (3) specialty products - other.\nMascoTech's largest manufacturing facility is located in Vernon, California and is a multi-plant facility of approximately 920,000 square feet. MascoTech owns the largest plant, comprising approximately 540,000 square feet, and operates the remaining portions of this facility under leases, the earliest of which expires at the end of 1996. Except for the foregoing facility and an additional manufacturing facility covering approximately 605,000 square feet, MascoTech's manufacturing facilities range in size from approximately 10,000 to 325,000 square feet, are owned by MascoTech or leased and are not subject to significant encumbrances. MascoTech's executive offices are located in Taylor, Michigan, and are provided by the Company to MascoTech under a corporate services agreement.\nMascoTech's buildings, machinery and equipment have been generally well maintained, are in good operating condition, and are adequate for current production requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nCivil suits were filed in December 1992 in a California state court by the California Attorney General, the Natural Resources Defense Counsel and the Environmental Law Foundation against a subsidiary of the Company and approximately 15 other manufacturers or distributors of faucets sold in that state. The suits principally allege that brass faucets unlawfully leach lead into tap water and that the defendants have failed to provide clear and reasonable warnings in violation of California law. The plaintiffs have requested, among other things, that the defendants be enjoined from selling products in California that leach lead into tap water, be ordered to offer restitution to California purchasers of defendants' products, and pay unspecified compensatory and punitive damages. Based upon the Company's present knowledge and subject to future legal and factual developments, the Company does not believe that these suits will result in any material adverse effect on the Company's financial position.\nThe Company is subject to other claims and litigation in the ordinary course of business, but does not believe that any such claim or litigation will 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.\nNot applicable.\nSUPPLEMENTARY ITEM. EXECUTIVE OFFICERS OF REGISTRANT (PURSUANT TO INSTRUCTION 3 TO ITEM 401(B) OF REGULATION S-K).\nExecutive officers who are elected by the Board of Directors serve for a term of one year or less. Each elected executive officer has been employed in a managerial capacity with the Company for over five years except for Mr. Gargaro. Mr. Gargaro joined the Company as its Vice President and Secretary on October 1, 1993. Prior to joining the Company, Mr. Gargaro was a partner at the Detroit law firm of Dykema Gossett PLLC. Mr. Gargaro has served as a director and Secretary of MascoTech, Inc., since 1984 and a director and Secretary of TriMas Corporation since 1989. Richard A. Manoogian, the Chairman of the Board and Chief Executive Officer of the Company, is the son of its Chairman Emeritus, Alex Manoogian.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe New York Stock Exchange is the principal market on which the Company's Common Stock is traded. The following table indicates the high and low sales prices of the Company's Common Stock as reported on the New York Stock Exchange Composite Tape and the cash dividends declared per share for the periods indicated:\nOn March 15, 1995, there were approximately 6,680 holders of record of the Company's Common Stock.\nThe Company expects that its practice of paying quarterly dividends on its Common Stock will continue, although future dividends will continue to depend upon the Company's earnings, capital requirements, financial condition and other factors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table sets forth summary consolidated financial information of the Company, for the years and dates indicated:\n(1) After the $79 million after-tax ($.50 per share) non-cash equity investment charge in 1994.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCORPORATE DEVELOPMENT\nAcquisitions have historically contributed significantly to Masco's long-term growth, even though generally the initial impact on earnings is minimal after deducting acquisition-related costs such as interest and added depreciation and amortization. The important earnings benefit to Masco arises from subsequent growth of acquired companies, since incremental sales are not handicapped by these expenses.\nIn early 1994, the Company acquired for common stock, Melard Corporation and Zenith Products Corporation, manufacturers of plumbing specialties and bath accessories, and Berkline Corporation, a manufacturer of popularly priced recliners and motion upholstered furniture, all of which were accounted for as poolings of interests.\nIn December 1994, the Company acquired Alma Kuchen Aloys Meyer GmbH and Co., a German manufacturer of kitchen cabinets, and NewTeam Group, a United Kingdom manufacturer of handheld showers and other bath accessories, both of which were accounted for as purchase transactions.\nThe above pooled and purchased companies had annual net sales in 1993 of approximately $320 million.\nIn January 1995, the Company received approximately $70 million upon the sale of its investment in Formica Corporation. The Company anticipates that the gain from this transaction, however, will be largely offset by charges and reserves for profit improvement programs and asset disposals that should enhance the Company's future performance.\nPROFIT MARGINS\nNet income and earnings per share for 1994, prior to an unusual non-cash fourth quarter equity investment charge, were $273 million and $1.72, representing increases of 23 percent and 19 percent from $221 million and $1.45 in 1993, respectively. Including the unusual charge of approximately $.50 per share, net income was $194 million, with earnings per share of $1.22. The unusual charge is the Company's equity share of its affiliate MascoTech, Inc.'s $315 million non-cash after-tax charge which results from MascoTech's strategic decision to focus on its core transportation-related business and divest non-core businesses. MascoTech believes that this strategy should strengthen its balance sheet and profitability, which in turn should enhance the value of the Company's investment in MascoTech.\nAfter-tax profit margin on sales and after-tax profit return on shareholders' equity in 1994, before the effect of the above-mentioned unusual equity charge, increased to 6.1 percent and 13.7 percent, respectively, as compared with 5.7 percent and 11.7 percent, respectively, in 1993, and 5.2 percent and 10.2 percent, respectively, in 1992, primarily due to increased product sales resulting from improved market shares and the expanded economy. Including the effect of the equity charge, after-tax profit margin as a percent of net sales and after-tax profit return on shareholders' equity were 4.3 percent and 9.7 percent, respectively, in 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nOver the years, the Company has largely funded its growth through cash provided by a combination of operations and long-term bank and other borrowings.\nAt year-end 1994, current assets were approximately 3.1 times current liabilities.\nDuring 1994, cash of $311 million was provided by operating activities and by $134 million from a net increase in debt; cash decreased by $191 million for the purchase of property and equipment, by $127 million for the acquisition of companies, by $62 million for the repurchase of Company Common Stock, by $109 million for cash dividends and by $15 million for other cash outflows. The aggregate of the preceding items represents a net cash outflow of $59 million in 1994. Cash provided by operating\nactivities totalled $311 million, $261 million and $204 million in 1994, 1993 and 1992, respectively; the Company has generally reinvested a majority of these funds in its operations.\nIn late 1994, the Company's Board of Directors authorized the repurchase of up to 10 million shares of its common stock in open-market transactions or otherwise. Pursuant to this authorization, approximately 2.8 million common shares were repurchased in the fourth quarter of 1994.\nThe Company's anticipated internal cash flow is expected to provide sufficient liquidity to fund its near-term working capital and other investment needs. The Company believes that its longer-term working capital and other general corporate requirements will be satisfied through its internal cash flow and to the extent necessary in the financial markets.\nRECEIVABLES AND INVENTORIES\nDuring 1994, the Company's receivables increased by $135 million. This increase is primarily comprised of receivables from existing operations, which increased by $53 million, principally as a result of increased sales in the fourth quarter of 1994 compared with the same period in 1993, and receivables of acquired companies.\nDuring 1994, the Company's inventories increased by $125 million. This increase is primarily comprised of a $75 million increase in inventories from existing operations which had increased sales, and inventories of acquired companies.\nAs compared with the average manufacturing company, the Company maintains a higher investment in inventories, which relates to the Company's business strategies of providing better customer service, establishing efficient production scheduling and benefitting from larger, more cost-effective purchasing.\nCAPITAL EXPENDITURES AND DEPRECIATION\nCapital expenditures totalled $191 million in 1994, compared with $167 million in 1993. These amounts primarily pertain to expenditures for additional facilities related to increased demand for existing products as well as for new Masco products.\nThe Company continues to invest in automating its manufacturing operations and increasing its productivity, in order to be a more efficient producer and improve customer service and response time.\nDepreciation expense and amortization expense were $88.1 million and $32.5 million, respectively, in 1994, compared with $82.1 million and $33.9 million, respectively, in 1993. The major portion of amortization expense, from the excess of cost over net assets acquired, relates to companies acquired in previous years. These companies have been successful for many years in established markets not subject to rapid technological changes. At each balance sheet date, management assesses whether there has been an impairment in the carrying value of excess of cost over net assets of acquired companies, primarily by comparing current and projected sales, operating income and annual cash flows with the related annual amortization expense as well as considering the equity of such companies.\nEQUITY AND OTHER INVESTMENTS IN AFFILIATES\nEquity losses from affiliates were $101.3 million in 1994, compared with equity earnings of $18.7 million in 1993 and $17.3 million in 1992.\nIn December 1994, MascoTech, an equity affiliate of the Company, announced and recorded a non-cash after-tax charge of $315 million in anticipation of losses associated with the planned disposition of its non-core businesses. As a result, the Company recorded $138 million pre-tax ($79 million after-tax) as its equity share of this non-cash charge.\nCASH DIVIDENDS\nDuring 1994, the Company increased its dividend rate six percent to $.18 per share quarterly. This marks the 36th consecutive year in which dividends have been increased. Dividend payments over this period have increased at an 18 percent average annual rate. Although the Company is aware of the greater interest in yield by many investors and has maintained an increased dividend payout in recent years, the Company continues to believe that its shareholders' long-term interests are best served by investing a significant portion of its earnings in the future growth of the Company.\nRECENTLY ISSUED PROFESSIONAL ACCOUNTING STANDARDS\nThe American Institute of Certified Public Accountants' Statement of Position 93-7, Reporting on Advertising Costs, becomes effective in 1995. This statement provides guidance on the accounting treatment and reporting of advertising costs and should not have a material effect on the Company's financial statements.\nGENERAL FINANCIAL ANALYSIS\n1994 VERSUS 1993\nNet sales in 1994, aided by acquisitions, increased 15 percent to $4,468 million; excluding acquisitions, net sales increased 7 percent. Sales in 1994 of the Company's Home Improvement and Building Products and Home Furnishings Products each increased 15 percent to $2,523 million and $1,945 million, respectively; excluding acquisitions, sales of Home Improvement and Building Products and Home Furnishings Products increased 8 percent and 6 percent, respectively.\nCost of sales as a percentage of sales decreased modestly to 67.2 percent in 1994 from 67.5 percent in 1993. Selling, general and administrative expenses as a percentage of sales decreased to 21.4 percent in 1994 from 22.1 percent in 1993. Operating profit, after general corporate expense, increased 26 percent to $510 million in 1994, primarily due to increased sales and profit improvement programs.\nOperating profit of the Company's Home Improvement and Building Products segment, before general corporate expense, increased 22 percent to $504 million. Operating profit of the Company's Home Furnishings Products segment, before general corporate expense, increased 29 percent to $89 million.\nIncluded in other income and expense for 1994 are equity losses from MascoTech of $106 million, which reflect the Company's $138 million pre-tax equity share of MascoTech's unusual non-cash fourth quarter charge, as compared with $13.2 million of equity earnings from MascoTech in 1993. MascoTech reported a loss from continuing operations and a net loss, after preferred stock dividends, of $234.4 million and $233.1 million, respectively, in 1994, as compared with income from continuing operations and net income, after preferred stock dividends, of $70.9 million and $32.7 million, respectively, in 1993.\nNet income and earnings per common share, for 1994 prior to the above-mentioned MascoTech charge, were $273 million and $1.72, representing increases of 23 percent and 19 percent from $221 million and $1.45 in 1993, respectively. Including the above-mentioned charge of approximately $.50 per share, net income was $194 million, with earnings per share of $1.22.\n1993 VERSUS 1992\nNet sales in 1993 increased 10 percent to $3,886 million. The sales increase was primarily due to increased shipments of kitchen, bath and home furnishings products. Cost of sales as a percentage of sales was 67.5 percent in both 1993 and 1992. Selling, general and administrative expenses as a percentage of sales decreased modestly to 22.1 percent in 1993 from 22.3 percent in 1992. Operating profit increased 13 percent in 1993 from 1992.\nThe Company's Home Improvement and Building Products sales in 1993 increased 10 percent to $2,188 million while operating profit increased 12 percent to $412 million.\nSales in 1993 of the Company's Home Furnishings Products increased 11 percent to $1,698 million and operating profit increased 15 percent to $69 million.\nIncluded in other income and expense for 1993 are equity earnings from MascoTech, Inc. of $23.2 million, prior to an approximate $10 million after-tax fourth quarter charge which reflects the Company's equity share of MascoTech's loss provision for the disposition of its energy-related businesses and extraordinary loss on the early extinguishment of debt, as compared with $12.6 million of equity earnings in 1992. MascoTech reported income from continuing operations of $70.9 million and $39.0 million in 1993 and 1992, respectively, and net income, after preferred stock dividends, of $32.7 million for 1993 and $29.1 million for 1992. The 1993 results of MascoTech were favorably impacted by internal cost reductions and from increased demand in its transportation industries, which more than offset its fourth quarter special charges of approximately $26 million after-tax.\nIncluded in the fourth quarter of 1993 is a $28.3 million pre-tax gain (approximately $18 million after-tax) on the redemption of MascoTech's 10% exchangeable preferred stock. This gain was principally offset by the Company's approximate $10 million after-tax equity share of MascoTech's above-mentioned fourth quarter special charges, as well as by charges related to certain restructurings of Company operations which should result in future cost savings.\nThe Company reported increases in net income and earnings per share of 21 percent and 20 percent, respectively, in 1993 as compared with 1992.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Masco Corporation:\nWe have audited the accompanying consolidated balance sheet of Masco Corporation and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income and cash flows for each of the three years in the period ended December 31, 1994, and the financial statement schedule as listed in Item 14(a)(2)(i) of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\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 Masco Corporation and subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nDetroit, Michigan February 17, 1995\nMASCO CORPORATION\nCONSOLIDATED BALANCE SHEET\nDECEMBER 31, 1994 AND 1993\nASSETS\nSee notes to consolidated financial statements.\nMASCO CORPORATION\nCONSOLIDATED STATEMENT OF INCOME\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee notes to consolidated financial statements.\nMASCO CORPORATION\nCONSOLIDATED STATEMENT OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee notes to consolidated financial statements.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nACCOUNTING POLICIES\nPrinciples of Consolidation. The consolidated financial statements include the accounts of Masco Corporation and all majority-owned subsidiaries. All significant intercompany transactions have been eliminated. Certain prior period amounts have been reclassified to conform with the current-year presentation.\nAverage Shares Outstanding. The average number of common shares outstanding in 1994, 1993 and 1992 approximated 158.8 million, 152.7 million and 151.7 million, respectively.\nCash and Cash Investments. The Company considers all highly liquid investments with an original maturity of three months or less to be cash and cash investments.\nReceivables. Accounts and notes receivable are presented net of allowances for doubtful accounts of $20.1 million at December 31, 1994 and $19.1 million at December 31, 1993.\nProperty and Equipment. Property and equipment, including significant betterments to existing facilities, are recorded at cost. Upon retirement or disposal, the cost and accumulated depreciation are removed from the accounts and any gain or loss is included in income. Maintenance and repair costs are charged to expense as incurred.\nDepreciation and Amortization. Depreciation is computed principally using the straight-line method over the estimated useful lives of the assets. Annual depreciation rates are as follows: buildings and land improvements, 2 to 10 percent, and machinery and equipment, 5 to 33 percent. Depreciation was $88.1 million, $82.1 million and $79.4 million in 1994, 1993 and 1992, respectively.\nThe excess of cost over net assets of acquired companies is being amortized using the straight-line method over periods not exceeding 40 years; at December 31, 1994 and 1993, such accumulated amortization totalled $147.3 million and $127.2 million, respectively. At each balance sheet date, management assesses whether there has been an impairment in the carrying value of excess of cost over net assets of acquired companies, primarily by comparing current and projected sales, operating income and annual cash flows with the related annual amortization expense as well as considering the equity of such companies. Purchase costs of patents are being amortized using the straight-line method over the legal lives of the patents, not to exceed 17 years. Amortization of intangible assets was $32.5 million, $33.9 million and $35.1 million in 1994, 1993 and 1992, respectively.\nFair Value of Financial Instruments. The carrying value of financial instruments reported in the balance sheet for current assets and current liabilities approximates fair value. The fair value of financial instruments that are carried as long-term investments (other than those accounted for by the equity method) was based principally on quoted market prices for those or similar investments or by discounting future cash flows using a discount rate that approximates the risk of the investments. The fair value of the Company's long-term debt instruments was based principally on quoted market prices for the same or similar issues or the current rates available to the Company for debt with similar terms and remaining maturities. The aggregate market value of the Company's long-term investments and long-term debt at December 31, 1994 was approximately $187 million and $1,483 million, as compared with the Company's carrying value of $152 million and $1,593 million, respectively. The aggregate market value of the Company's long-term investments and long-term debt at December 31, 1993 was approximately $230 million and $1,471 million, as compared with the Company's carrying value of $200 million and $1,418 million, respectively.\nStatement of Financial Accounting Standards No. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments, became effective in 1994. This Standard defines\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nACCOUNTING POLICIES -- (CONTINUED) the disclosure requirements for derivative financial instruments, of which the Company has no material holdings.\nRecently Issued Professional Accounting Standards. The American Institute of Certified Public Accountants' Statement of Position 93-7, Reporting on Advertising Costs, becomes effective in 1995. This statement provides guidance on the accounting treatment and reporting of advertising costs and should not have a material effect on the Company's financial statements.\nACQUISITIONS\nPOOLING ACQUISITIONS:\nDuring 1994, the Company issued approximately 6.5 million of its common shares for the acquisitions of Melard Manufacturing Corporation, Zenith Products Corporation and Berkline Corporation. Each of these acquisitions was accounted for as a pooling of interests. Melard and Zenith are manufacturers of plumbing specialties and bath accessories, and Berkline is a manufacturer of recliners and motion upholstered furniture. Prior year financial statements were not restated due to immateriality.\nPURCHASE ACQUISITIONS:\nIn December 1994, the Company acquired Alma Kuchen Aloys Meyer GmbH and Co., a German manufacturer of kitchen cabinets, and NewTeam Group, a United Kingdom manufacturer of handheld showers and other bath accessories, for approximately $100 million.\nThe Company also acquired several other companies in 1994 for approximately $25 million.\nThe above pooled and purchased companies had combined net sales in 1993 of approximately $320 million.\nINVENTORIES\nInventories are stated at the lower of cost or net realizable value, with cost determined principally by use of the first-in, first-out method.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEQUITY INVESTMENTS IN AFFILIATES\nEquity investments in affiliates consist primarily of the following common equity and partnership interests:\nMascoTech, Inc. presently has voting preferred shares outstanding, which are to be converted into common shares no later then mid-1997. On an assumed converted basis and utilizing the minimum number of common shares to be so issued, the Company's equity investment in MascoTech would be 38 percent at December 31, 1994 (which equals the Company's voting interest at that date).\nExcluding the partnership interest in Hans Grohe, for which there is no quoted market value, the aggregate market value of the Company's equity investments at December 31, 1994 (which may differ from the amounts that could then have been realized upon disposition), based upon quoted market prices at that date, was $431 million, as compared with the Company's related aggregate carrying value of $205 million.\nThe Company's carrying value of its equity investments in MascoTech exceeds its equity in the underlying net book value by approximately $73 million at December 31, 1994. This excess, which principally resulted from repurchases by MascoTech of its common stock, is being amortized over a period not to exceed 40 years. The Company's carrying value of its other equity investments at December 31, 1994 approximates the Company's equity in the underlying net book value in these affiliates.\nIn March 1993, the Company and MascoTech partially restructured their affiliate relationships through transactions that reduced the Company's common equity interest in MascoTech from 47 percent to approximately 35 percent and resulted in MascoTech's acquisition of the Company's investments in Emco Limited, a Canadian company. The Company received $87.5 million in cash, $100 million of 10% exchangeable preferred stock and seven-year warrants to purchase 10 million common shares of MascoTech at $13 per share. MascoTech received 10 million of its common shares, all $77.5 million of its 12% exchangeable preferred stock, the Company's investments in Emco Limited and a modified option expiring in early 1997 to require the Company to purchase up to $200 million aggregate amount of debt securities in MascoTech.\nIn November 1993, MascoTech redeemed for cash its $100 million of 10% exchangeable preferred stock issued in March 1993. As a result of this redemption, the Company realized a $28.3 million pre-tax gain.\nIn December 1993, following MascoTech's call for redemption, the Company converted $130 million of MascoTech's 6% debentures due 2011 into MascoTech common stock, thereby increasing the Company's common equity interest in MascoTech from approximately 35 percent to 42 percent.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEQUITY INVESTMENTS IN AFFILIATES -- (CONTINUED) Approximate combined condensed financial data of the above-listed affiliates are summarized in U.S. dollars as follows, in thousands:\nIn December 1994, MascoTech announced and recorded a non-cash after-tax charge of $315 million in anticipation of losses associated with the planned disposition of its non-core businesses. As a result, the Company recorded $138 million pre-tax as its equity share of this non-cash charge.\nEquity in undistributed earnings of affiliates of $24 million at December 31, 1994, $132 million at December 31, 1993 and $118 million at December 31, 1992 are included in consolidated retained earnings.\nPROPERTY AND EQUIPMENT\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nACCRUED LIABILITIES\nLONG-TERM DEBT\nAt December 31, 1994, all of the outstanding notes other than notes payable to banks are nonredeemable.\nThe Company intends to refinance the 6.25% notes due June 15, 1995 through borrowings under its bank revolving-credit agreement.\nIn August 1993, the Company issued $200 million of 7.125% notes due August 15, 2013. In September 1993, the Company issued $200 million of 6.125% notes due September 15, 2003. The proceeds from these financings were used to eliminate floating-rate borrowings under the Company's bank revolving-credit agreement.\nThe 5.25% subordinated debentures due February 15, 2012 are convertible into common stock at $42.28 per share.\nThe notes payable to banks at December 31, 1994 relate to a $750 million revolving-credit agreement, with any outstanding balance due and payable in May 1998. Interest is payable on borrowings under this agreement based upon various floating rates as selected by the Company.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nLONG-TERM DEBT -- (CONTINUED) Certain debt agreements contain limitations on additional borrowings and restrictions on cash dividend payments and common share repurchases. At December 31, 1994, the amount of retained earnings available for cash dividends and common share repurchases approximated $199 million under the most restrictive of these provisions.\nAt December 31, 1994, the maturities of long-term debt during each of the next five years were approximately as follows: 1995-$214.6 million; 1996-$257.2 million; 1997-$2.6 million; 1998-$105.8 million; and 1999-$200.9 million.\nIn October 1994, the Company amended its shelf registration statements, on file with the Securities and Exchange Commission, for the purpose of converting these statements to an unallocated shelf registration, which allows for the issuance of up to a combined $800 million of debt and equity securities.\nInterest paid was approximately $103 million, $104 million and $121 million in 1994, 1993 and 1992, respectively.\nSHAREHOLDERS' EQUITY\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSHAREHOLDERS' EQUITY -- (CONTINUED) On the basis of amounts paid (declared), cash dividends per share were $.69 ($.70) in 1994, $.65 ($.66) in 1993 and $.61 ($.62) in 1992.\nIn 1994, the Company's Board of Directors authorized the repurchase of up to 10 million shares of its common stock in open-market transactions or otherwise. Pursuant to this authorization, approximately 2.8 million common shares were repurchased in the fourth quarter of 1994 at an aggregate cost of approximately $62 million.\nSTOCK OPTIONS AND AWARDS\nFor the three years ended December 31, 1994, stock option data pertaining to stock option plans for key employees of the Company and affiliated companies are as follows:\nPursuant to restricted stock incentive award plans, the Company granted long-term incentive awards, net, for 598,000, 100,000 and 267,000 shares of Company Common Stock during 1994, 1993 and 1992, respectively, to key employees of the Company and affiliated companies. The unamortized costs of unvested awards under these plans, aggregating approximately $55.3 million at December 31, 1994, are being amortized over the ten-year vesting periods.\nAt December 31, 1994, a combined total of 10,680,000 shares of Company Common Stock was available for the granting of stock options and incentive awards under the above plans.\nPursuant to the 1984 Restricted Stock (MascoTech) Incentive Plan, the Company may award to key employees of the Company and affiliated companies, shares of common stock of MascoTech, Inc. held by the Company. No such awards were granted in 1994, 1993 or 1992. At December 31, 1994, there were 4,695,000 of such shares available for granting future awards under this plan.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEMPLOYEE RETIREMENT PLANS\nThe Company sponsors defined-benefit pension plans for most of its employees. In addition, substantially all salaried employees participate in noncontributory profit-sharing plans, to which payments are determined annually by the Directors. Aggregate charges to income under the pension and profit-sharing plans were $23.3 million in 1994, $19.2 million in 1993 and $16.9 million in 1992.\nNet periodic pension cost for the Company's pension plans includes the following components:\nMajor assumptions used in accounting for the Company's pension plans are as follows:\nThe funded status of the Company's pension plans is summarized as follows, in thousands, at December 31:\nThe Company sponsors certain postretirement benefit plans that provide medical, dental and life insurance coverage for eligible retirees and dependents in the United States based on age and length of service. At December 31, 1994, the aggregate present value of the accumulated postretirement benefit obligation approximated $6 million pre-tax and is being amortized over 20 years.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSEGMENT INFORMATION\nThe Company's operations in the industry segments detailed below consisted of the manufacture and sale principally of the following products:\nHome improvement and building -- faucets; plumbing fittings; kitchen and bath cabinets; shower tubs, whirlpools and spas; bath accessories; kitchen appliances; builders' hardware; venting and ventilating equipment; and water pumps.\nHome furnishings products -- quality furniture, fabrics and other home furnishings products.\nCorporate assets consisted primarily of real property and other investments.\nPursuant to a corporate services agreement to provide MascoTech, Inc. with certain corporate staff and administrative services, the Company charges a fee approximating .8 percent of MascoTech net sales. This fee approximated $11 million in each of 1994, 1993 and 1992 and is included as a reduction of general corporate expense.\n(1) Income before income taxes and net income from foreign operations for 1994, 1993 and 1992 were $114 million and $76 million, $92 million and $55 million, and $88 million and $54 million, respectively.\n(2) Property additions include assets of acquired companies.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOTHER INCOME (EXPENSE), NET\nEquity earnings from MascoTech for 1994 were $32 million, prior to the Company's $138 million pre-tax equity share of MascoTech's non-cash fourth quarter charge.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nINCOME TAXES\nNet deferred tax liability at December 31, 1994 and 1993 consists of net short-term deferred tax assets of $44.5 million and $32.1 million, respectively, and net long-term deferred tax liabilities of $66.3 million and $129.0 million, respectively.\nThe effective tax rate differs from the United States federal statutory rate principally due to: foreign income tax (-1 percent in 1993 and -2 percent in 1992), amortization in excess of tax, net (-2 percent in 1994, -1 percent in 1993 and -2 percent in 1992), dividends-received deduction (2 percent in 1994 and 1 percent in 1993 and 1992), state income tax (-4 percent in 1994, -2 percent in 1993 and -3 percent in 1992) and other (-1 percent in 1994 and 1993).\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nINCOME TAXES -- (CONTINUED) Income taxes paid were approximately $175 million, $135 million and $97 million in 1994, 1993 and 1992, respectively.\nStatement of Financial Accounting Standards No. 109, Accounting for Income Taxes, which requires the use of an asset and liability method of accounting for income taxes, became effective in January 1993. Deferred income taxes result from temporary differences between the tax basis of assets and liabilities and the related basis reported in the consolidated financial statements. Prior to 1993, the Company followed the requirements of Statement of Financial Accounting Standards No. 96, Accounting for Income Taxes.\nProvision has not been made for U.S. or additional foreign taxes on approximately $75 million of remaining undistributed earnings of foreign subsidiaries, as those earnings are intended to be permanently reinvested. Generally, such earnings become taxable upon the remittance of dividends and under certain other circumstances. It is not practicable to estimate the amount of deferred tax liability on foreign undistributed earnings which are intended to be permanently reinvested.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCOMBINED FINANCIAL STATEMENTS (UNAUDITED)\nThe following presents the combined financial statements of the Company, MascoTech, Inc. and TriMas Corporation as one entity, with Masco Corporation as the parent company. Intercompany transactions have been eliminated. Amounts, except earnings per share, are in thousands.\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCOMBINED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCOMBINED FINANCIAL STATEMENTS (UNAUDITED) -- (CONTINUED)\nMASCO CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED)\nINTERIM FINANCIAL INFORMATION (UNAUDITED)\nFourth quarter 1994 net loss and loss per share reflect the Company's $138 million pre-tax equity share of MascoTech's non-cash fourth quarter charge associated with the planned disposition of its non-core businesses.\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 regarding executive officers required by this Item is set forth as a Supplementary Item at the end of Part I hereof (pursuant to Instruction 3 to Item 401(b) of Regulation S-K). Other information required by this Item will be contained in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders, to be filed on or before April 28, 1995, and such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation required by this Item will be contained in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders, to be filed on or before April 28, 1995, and such information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation required by this Item will be contained in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders, to be filed on or before April 28, 1995, and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation required by this Item will be contained in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders, to be filed on or before April 28, 1995, and such 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) LISTING OF DOCUMENTS.\n(1) Financial Statements. The Company's Consolidated Financial Statements included in Item 8 hereof, as required at December 31, 1994 and 1993, and for the years ended December 31, 1994, 1993 and 1992, consist of the following:\nConsolidated Balance Sheet\nConsolidated Statement of Income\nConsolidated Statement of Cash Flows\nNotes to Consolidated Financial Statements\n(2) Financial Statement Schedules.\n(i) Financial Statement Schedule of the Company appended hereto, as required for the years ended December 31, 1994, 1993 and 1992, consists of the following:\nII. Valuation and Qualifying Accounts\n(ii) (A) MascoTech, Inc. and Subsidiaries Consolidated Financial Statements appended hereto, as required at December 31, 1994 and 1993, and for the years ended December 31, 1994, 1993 and 1992, consist of the following:\nConsolidated Balance Sheet\nConsolidated Statement of Operations\nConsolidated Statement of Cash Flows\nNotes to Consolidated Financial Statements\n(ii) (B) MascoTech, Inc. and Subsidiaries Financial Statement Schedule appended hereto, as required for the years ended December 31, 1994, 1993 and 1992, consists of the following:\nII. Valuation and Qualifying Accounts\n(3) Exhibits.\n- --------------- (1) Incorporated by reference to the Exhibits filed with Masco Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.\n(2) Incorporated by reference to the Exhibits filed with Masco Corporation's Annual Report on Form 10-K for the year ended December 31, 1993.\n(3) Incorporated by reference to the Exhibits filed with Masco Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n(4) Incorporated by reference to the Exhibits filed with Masco Corporation's Annual Report on Form 10-K for the year ended December 31, 1992.\n(5) Incorporated by reference to the Exhibits filed with Masco Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1991.\n(6) Incorporated by reference to the Exhibits filed with Masco Corporation's Annual Report on Form 10-K for the year ended December 31, 1991.\n(7) Incorporated by reference to the Exhibits filed with Masco Corporation's Annual Report on Form 10-K for the year ended December 31, 1990.\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.\nMASCO CORPORATION\nBy \/s\/ RICHARD G. MOSTELLER ------------------------------------ RICHARD G. MOSTELLER Senior Vice President -- Finance\nMarch 28, 1995\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.\nMASCO CORPORATION\nFINANCIAL STATEMENT SCHEDULES\nPURSUANT TO ITEM 14(A)(2) OF FORM 10-K\nANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION\nSchedules, as required, for the years ended December 31, 1994, 1993 and 1992:\nMASCO CORPORATION\nSCHEDULE II. VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nNotes:\n(A) Allowance of companies acquired and companies disposed of, net.\n(B) Deductions, representing uncollectible accounts written off, less recoveries of accounts written off in prior years.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of MascoTech, Inc.:\nWe have audited the accompanying consolidated balance sheet of MascoTech, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations and cash flows for each of the three years in the period ended December 31, 1994, and the financial statement schedule as listed in Item 14(a)(2)(ii) of this Form 10-K. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the 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 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 MascoTech, Inc. and subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nDetroit, Michigan February 17, 1995\nMASCOTECH, INC.\nCONSOLIDATED BALANCE SHEET\nDECEMBER 31, 1994 AND 1993\nASSETS\nThe accompanying notes are an integral part of the consolidated financial statements.\nMASCOTECH, INC.\nCONSOLIDATED STATEMENT OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n* Anti-dilutive\nThe accompanying notes are an integral part of the consolidated financial statements.\nMASCOTECH, INC.\nCONSOLIDATED STATEMENT OF CASH FLOWS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nThe accompanying notes are an integral part of the consolidated financial statements.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nACCOUNTING POLICIES:\nPrinciples of Consolidation. The consolidated financial statements include the accounts of the Company and all majority-owned subsidiaries. All significant intercompany transactions have been eliminated. Corporations that are 20 to 50 percent owned are accounted for by the equity method of accounting. Capital transactions by equity affiliates, which reduce the Company's ownership interest at amounts differing from the Company's carrying amount, are reflected in other income or expense and equity and other investments in affiliates.\nCertain amounts for the years ended December 31, 1993 and 1992 have been reclassified to conform to the presentation adopted in 1994. The balance sheet at December 31, 1994 reflects the segregation of net current and net non-current assets related to the plan, adopted in late 1994, to dispose of certain businesses. The financial statements and related notes have been reclassified to present the energy segment as discontinued operations (see \"Dispositions of Operations\" note).\nThe Company has a corporate services agreement with Masco Corporation, which at December 31, 1994 owned approximately 44 percent of the Company's Common Stock. Under the terms of the agreement, the Company pays fees to Masco Corporation for various corporate staff support and administrative services, research and development and facilities. Such fees, which are determined principally as a percentage of net sales, including net sales related to businesses held for disposition, aggregated approximately $11 million in each of 1994, 1993 and 1992.\nCash and Cash Investments. The Company considers all highly liquid debt instruments with an initial maturity of three months or less to be cash and cash investments. The carrying amount reported in the balance sheet for cash and cash investments approximates fair value.\nMarketable Securities. The Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", in 1994. At December 31, 1994 marketable equity securities have been categorized as trading securities, and, as a result, are stated at fair value. At December 31, 1993 marketable equity securities were stated at the lower of cost or market. Derivative financial instruments, consisting principally of S&P 500 futures contracts, are held for purposes other than trading and are carried at market value. Changes in market value of outstanding futures contracts are recognized as incurred.\nReceivables. Receivables are presented net of allowances for doubtful accounts of approximately $1.6 million and $5.1 million at December 31, 1994 and 1993, respectively.\nInventories. Inventories are stated at the lower of cost or net realizable value, with cost determined principally by use of the first-in, first-out method.\nProperty and Equipment, Net. Property and equipment additions, including significant betterments, are recorded at cost. Upon retirement or disposal of property and equipment, the cost and accumulated depreciation are removed from the accounts, and any gain or loss is included in income. Repair and maintenance costs are charged to expense as incurred.\nDepreciation and Amortization. Depreciation is computed principally using the straight-line method over the estimated useful lives of the assets. Annual depreciation rates are as follows: buildings and land improvements, 2 1\/2 to 10 percent, and machinery and equipment, 6 2\/3 to 33 1\/3 percent. Deferred financing costs are amortized over the lives of the related debt securities. The excess of cost over net assets of acquired companies is amortized using the straight-line method over the period estimated to be benefitted, not exceeding 40 years. At each balance sheet date, management assesses whether there has been a permanent impairment of the excess of cost over net assets of acquired companies by comparing anticipated undiscounted future cash flows from operating activities with the carrying amount of the excess of cost over net assets of acquired companies. The factors considered by\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nmanagement in performing this assessment include current operating results, business prospects, market trends, potential product obsolescence, competitive activities and other economic factors. Based on this assessment there was no permanent impairment related to the excess of cost over net assets of acquired companies not held for disposition at December 31, 1994.\nAt December 31, 1994 and 1993, accumulated amortization of the excess of cost over net assets of acquired companies and patents was $34.5 million and $86.5 million, respectively. Amortization expense was $22.9 million, $22.2 million and $22.8 million in 1994, 1993 and 1992, respectively, including amortization expense of approximately $1.6 million in both 1993 and 1992 related to discontinued operations.\nIncome Taxes. In January 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (\"SFAS No. 109\"), \"Accounting for Income Taxes.\" SFAS No. 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, SFAS No. 109 generally allows consideration of all expected future events other than enactments of changes in the tax law or tax rates. There was no income statement impact from the adoption of SFAS No. 109. Provision has not been made for U.S. or additional foreign taxes on approximately $28 million of undistributed earnings of foreign subsidiaries as those earnings are intended to be permanently reinvested. Generally, such earnings become taxable upon the remittance of dividends and under certain other circumstances. It is not practicable to estimate the amount of deferred tax liability on such undistributed earnings.\nEarnings (Loss) Per Common Share. Primary loss per common share in 1994 is based on 58.9 million weighted average shares of common stock outstanding. The effect of stock options and warrants in 1994 would be anti-dilutive. Primary earnings per common share are based on weighted average shares of common stock and common stock equivalents outstanding (including the dilutive effect of stock options and warrants, utilizing the treasury stock method) of 57.4 million and 60.9 million in 1993 and 1992, respectively. Primary earnings (loss) per common share are calculated on earnings (loss) after deducting preferred stock dividends of $13.0 million, $14.9 million and $9.3 million in 1994, 1993 and 1992, respectively.\nFully diluted earnings (loss) per common share are only presented when the assumed conversion of convertible securities is dilutive. Fully diluted earnings per common share in 1993 was calculated based on 68.8 million weighted average common shares outstanding. Convertible securities did not have a dilutive effect on earnings (loss) per common share in 1994 or 1992.\nIn late 1993, approximately 10.4 million common shares were issued as a result of the conversion of the 6% Convertible Subordinated Debentures (see \"Shareholders' Equity\" note). If such conversion had taken place at the beginning of 1993, the primary earnings per common and common equivalent share amounts would have approximated the amounts presented for earnings per common and common equivalent share, assuming full dilution, in 1993.\nAdoption of Statements of Financial Accounting Standards. The Company expects that the adoption of Statement of Financial Accounting Standards No. 114, \"Accounting by Creditors for Impairment of a Loan\", will not have a material impact on the financial position or the results of operations of the Company when adopted in 1995.\nSUPPLEMENTARY CASH FLOWS INFORMATION:\nSignificant transactions not affecting cash were: in 1993: in addition to the payment by the Company of $87.5 million, the non-cash portion of the issuance of Company Preferred Stock and warrants in exchange for Company Common Stock, Company Preferred Stock and Masco\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nCorporation's holdings of Emco Limited common stock and convertible debentures (see \"Shareholders' Equity\" note); conversion of $187 million of convertible debentures into Company Common Stock (see \"Shareholders' Equity\" note); and conversion of the Company's TriMas Corporation (\"TriMas\") convertible preferred stock holdings into TriMas common stock (see \"Equity and Other Investments in Affiliates\" note).\nIncome taxes paid were $28 million, $32 million and $23 million in 1994, 1993 and 1992, respectively. Interest paid was $61 million, $82 million and $91 million in 1994, 1993 and 1992, respectively.\nDISPOSITIONS OF OPERATIONS:\nIn late 1994, the Company adopted a plan to dispose, by sale or liquidation, a number of businesses, including its Architectural Products, Defense and certain of its Transportation-Related Products businesses, as part of its long-term strategic plan to increase the focus on its core operating capabilities. The disposition of these businesses is expected to primarily occur in 1995 with the cash portion of the proceeds applied to reduce the Company's indebtedness and to provide capital to invest in its core businesses. The disposition of these businesses does not meet the criteria for discontinued operations treatment for accounting purposes; accordingly, the sales and results of operations of these businesses will be included in continuing operations until disposition. The businesses to be disposed had annual sales of $675 million, $715 million and $675 million in 1994, 1993 and 1992, respectively, and operating profit (loss), before the charge recorded in 1994, of $(2) million, $22 million and $30 million in 1994, 1993 and 1992, respectively.\nThe expected proceeds from the sale or liquidation of the businesses to be disposed was estimated by the Company's management based on a variety of factors including: historical and projected operating performance, competitive market position, perceived strategic value to potential acquirors, tangible asset values and other relevant factors. In addition, management's estimate of the expected proceeds included input from independent parties familiar with business valuations of this nature. The Company's carrying value of a number of the businesses to be disposed exceeded the estimated proceeds expected from such dispositions. To reflect the estimated loss on the disposition of these businesses, the Company recorded a non-cash charge aggregating $400 million pre-tax (approximately $315 million after-tax or $5.35 per common share) for those businesses for which a loss is anticipated. The approximate components of the charge are as follows (in thousands):\nFuture periods will include the operating results of the businesses to be sold and any additional anticipated costs to be incurred in connection with the sale or liquidation of the remaining businesses which cannot be accrued at December 31, 1994, as well as the result of differences between estimated and actual proceeds. In addition, management expects that certain of the businesses to be disposed may be sold for gains; such gains will be recognized when realized.\nIn late 1993, the Company adopted a plan to divest the business units in its energy segment. This plan met the criteria for discontinued operations accounting treatment; accordingly, the financial statements and related notes present the Company's energy segment as discontinued operations.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDuring 1993, two such business units were sold for approximately $93 million, including the sale of one business unit to the Company's equity affiliate, TriMas, for $60 million cash. The expected loss from the disposition of the Company's energy segment resulted in a fourth quarter 1993 pre-tax charge of approximately $41 million (approximately $22 million after-tax), including a provision for the businesses not sold in 1993 and the deferral of a portion of the gain (approximately $6 million after-tax) related to the sale of the business to TriMas. Certain of the remaining business units were sold at prices greater than those used in estimating the loss on disposition in 1993, resulting in a reversal in 1994 of approximately $18 million pre-tax ($11.7 million after-tax) relating to the charge established in 1993.\nSelected financial information for the Company's discontinued energy segment is as follows for the period up to the decision to discontinue in 1993, and for the year ended December 31, 1992:\nThe unusual relationship of income taxes to pre-tax income in 1992 results principally from foreign losses for which no tax benefit was recorded.\nAmounts included in the consolidated balance sheet for net assets of businesses held for disposition consist of the following at December 31, 1994 and 1993, after reflecting the anticipated loss on disposition:\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nINVENTORIES:\nEQUITY AND OTHER INVESTMENTS IN AFFILIATES:\nEquity and other investments in affiliates consist primarily of the following common stock interests in publicly traded affiliates:\nThe carrying amount of investments in affiliates at December 31, 1994 and 1993 and quoted market values at December 31, 1994 for publicly traded affiliates (which may differ from the amounts that could have been realized upon disposition) are as follows:\nIn 1988, the Company transferred several businesses to TriMas, a publicly traded, diversified manufacturer of commercial, industrial and consumer products. In exchange, the Company received $128 million principal amount of 14% Subordinated Debentures (which were subsequently redeemed resulting in prepayment premium income to the Company of $9 million pre-tax in 1992), $70 million (liquidation value) of 10% Convertible Participating Preferred Stock and 9.3 million shares of TriMas common stock.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDuring the second quarter of 1992, TriMas sold 9.2 million shares of newly issued common stock at $9.75 per share in a public offering, which reduced the Company's common equity ownership interest in TriMas to 28 percent from 41 percent. As a result, the Company recognized a pre-tax gain of $16.7 million from the change in the Company's common equity ownership interest in TriMas. In late 1993, the TriMas 10% Convertible Participating Preferred Stock held by the Company was converted at a conversion price of $9 per share into 7.8 million shares of TriMas common stock, increasing the Company's common equity ownership interest in TriMas to 43 percent. During 1994, the Company sold a portion of its common stock holdings in TriMas, decreasing the Company's common equity ownership interest in TriMas to 41 percent, and resulting in a pre-tax gain of $17.9 million.\nThe Company's holdings in Emco Limited (\"Emco\") were acquired from Masco Corporation in 1993 (see \"Shareholders' Equity\" note). Emco is a major, publicly traded, Canadian-based manufacturer and distributor of building and other industrial products with annual sales of approximately $800 million.\nAt December 31, 1992, the Company had an approximate 47 percent common equity ownership interest in Titan Wheel International, Inc. (\"Titan\"), a manufacturer of wheels, tires and other products for agricultural, construction and other off-highway equipment markets. In May 1993, Titan completed an initial public offering of three million shares of common stock at $15 per share (including 292,000 shares held by the Company), reducing the Company's common equity ownership interest in Titan to 24 percent. The Company's ownership interest was further reduced in late 1993 to 21 percent as a result of the issuance of additional common shares by Titan in connection with an acquisition by Titan. These transactions resulted in 1993 gains aggregating approximately $12.8 million pre-tax (principally in the second quarter) as a result of the sale of shares held by the Company and from the change in the Company's common equity ownership interest in Titan.\nIn addition to its equity and other investments in publicly traded affiliates, the Company has equity and other investment interests in privately held manufacturers of automotive components, including the Company's common equity ownership interest in Delco Remy America, Inc. (\"Delco Remy\"), a manufacturer of automotive electric motors and other components in which the Company acquired an interest in mid-1994.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nApproximate combined condensed financial data of the Company's equity affiliates, including Delco Remy and Emco subsequent to the Company's investment in these affiliates, are as follows:\nEquity and interest income from affiliates consists of the following:\nPROPERTY AND EQUIPMENT, NET:\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDepreciation expense totalled $44 million, $48 million and $46 million in 1994, 1993 and 1992, respectively. These amounts include depreciation expense of approximately $8 million in each of 1993 and 1992 related to the discontinued energy segment.\nACCRUED LIABILITIES:\nLONG-TERM DEBT:\nIn 1993, the Company entered into a new $675 million revolving credit agreement with a group of banks, replacing its prior bank credit agreement. During 1994, the Company amended this agreement, resulting in an extension of the due date to July 1998 from January 1997. The interest rates applicable to the revolving credit agreement are principally at alternative floating rates provided for in the agreement (approximately six percent at December 31, 1994).\nThe revolving credit agreement contains restrictions including limitations on intangible assets, ratio of senior debt to earnings and the ratio of debt to equity. At December 31, 1994, the unused portion of the revolving credit agreement was principally available to refinance the 10% Senior Subordinated Notes and other indebtedness. Cash dividends and any acquisition of Company Common Stock and Convertible Preferred Stock could be accomplished with future internal cash flows and through future reductions of cash investments and marketable securities.\nIn January 1994, the Company issued, in a public offering, $345 million of 4 1\/2% Convertible Subordinated Debentures due December 15, 2003. These debentures are convertible into Company Common Stock at $31 per share. The net proceeds of approximately $337 million were used to redeem the $250 million of 10 1\/4% Senior Subordinated Notes on February 1, 1994 and to reduce other indebtedness. In the fourth quarter of 1993, the Company recognized a $5.8 million pre-tax\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nextraordinary charge ($3.7 million after-tax) related to the call premium (1.25%) and unamortized prepaid debenture expense associated with the early extinguishment of the $250 million of 10 1\/4% Senior Subordinated Notes. The 10% Senior Subordinated Notes are due March 15, 1995 but are classified as non-current at December 31, 1994 as the Company has the intent and the ability to maintain these borrowings on a long-term basis (due to available borrowings under the Company's revolving credit agreement). During 1994, the Company recognized extraordinary income of $4.4 million pre-tax ($2.6 million after-tax) related to the early extinguishment of a portion of the 4 1\/2% Convertible Subordinated Debentures.\nThe maturities of debt during the next five years are as follows (in millions): 1995 -- $237; 1996 -- $1; 1997 -- $0; 1998 -- $316; and 1999 -- $0.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSHAREHOLDERS' EQUITY:\nOn March 31, 1993, the Company acquired from Masco Corporation 10 million shares of Company Common Stock, recorded at $100 million, $77.5 million of the Company's previously outstanding 12% Exchangeable Preferred Stock, and Masco Corporation's holdings of Emco Limited common stock and convertible debentures, recorded at $80.8 million. In exchange, Masco Corporation received $100 million (liquidation value) of the Company's 10% Exchangeable Preferred Stock, seven-year warrants to purchase 10 million shares of Company Common Stock at $13 per share, recorded at $70.8 million, and $87.5 million in cash. The transferable warrants are not exercisable by Masco Corporation if an exercise would increase Masco Corporation's common equity ownership interest in the Company above 35 percent. The cash portion of this transaction is included in the accompanying statement of cash flows as cash used for investing activities of $87.5 million. As part of this transaction, as modified in late 1993, Masco Corporation agreed to purchase from the Company, at the Company's option through March 1997, up to $200 million of subordinated debentures. In late 1993, the Company redeemed the 10% Exchangeable Preferred Stock for its $100 million liquidation value.\nIn July 1993, the Company issued 10.8 million shares of 6% Dividend Enhanced Convertible Stock (DECS, classified as Convertible Preferred Stock) at $20 per share ($216 million aggregate liquidation amount) in a public offering. The net proceeds from this issuance were used to reduce the Company's indebtedness. On July 1, 1997, each of the then outstanding shares of the DECS will convert into one\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nshare of Company Common Stock, if not previously redeemed by the Company or converted at the option of the holder, in both cases for Company Common Stock.\nEach share of the DECS is convertible at the option of the holder anytime prior to July 1, 1997 into .806 of a share of Company Common Stock, equivalent to a conversion price of $24.81 per share of Company Common Stock. Dividends are cumulative and each share of the DECS has 4\/5 of a vote, voting together as one class with holders of Company Common Stock.\nBeginning July 1, 1996, the Company, at its option, may redeem the DECS at a call price payable in shares of Company Common Stock principally determined by a formula based on the then current market price of Company Common Stock. Redemption by the Company, as a practical matter, will generally not result in a call price that exceeds one share of Company Common Stock or is less than .806 of a share of Company Common Stock (resulting from the holder's conversion option).\nThe Company's 6% Convertible Subordinated Debentures were called for redemption in late 1993. Substantially all holders, including Masco Corporation, exercised their right to convert these debentures into Company Common Stock (at a conversion price of $18 per share), resulting in the issuance of approximately 10.4 million shares of Company Common Stock.\nDuring 1994, the Company repurchased and retired approximately four million shares of its common stock in open-market purchases, pursuant to a Board of Directors' authorized repurchase program. At December 31, 1994, the Company may repurchase approximately six million additional shares of Company Common Stock and Convertible Preferred Stock pursuant to this repurchase authorization.\nThe Company commenced paying cash dividends on its Common Stock in August 1993. On the basis of amounts paid (declared), cash dividends per Common Share were $.10 ($.11) in 1994 and $.04 ($.06) in 1993.\nSTOCK OPTIONS AND AWARDS:\nFor the three years ended December 31, 1994, stock option data pertaining to stock option plans for key employees of the Company and affiliated companies are as follows:\nAt December 31, 1994, options have been granted and are outstanding with exercise prices ranging from $4 1\/2 to $26 per share, the fair market value at the dates of grant.\nPursuant to restricted stock incentive plans, the Company granted long-term incentive awards, net, for 213,000, 202,000 and 251,000 shares of Company Common Stock during 1994, 1993 and 1992, respectively, to key employees of the Company and affiliated companies. The unamortized costs of\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nincentive awards, aggregating approximately $22 million at December 31, 1994, are being amortized over the ten-year vesting periods.\nAt December 31, 1994 and 1993, a combined total of 5,773,000 and 5,631,000 shares, respectively, of Company Common Stock were available for the granting of options and incentive awards under the above plans.\nEMPLOYEE BENEFIT PLANS:\nPension and Profit-Sharing Benefits. The Company sponsors defined-benefit pension plans for most of its employees. In addition, substantially all salaried employees participate in noncontributory profit-sharing plans, to which payments are approved annually by the Directors. Aggregate charges to income under these plans were $9.8 million in 1994, $10.9 million in 1993 and $10.3 million in 1992, including approximately $.9 million in each of 1993 and 1992 related to the discontinued energy segment.\nNet periodic pension cost for the Company's defined-benefit pension plans includes the following components for the three years ended December 31, 1994:\nMajor assumptions used in accounting for the Company's defined-benefit pension plans are as follows:\nIn 1995, the Company changed its assumption for the expected long-term rate of return on plan assets to 11 percent.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe funded status of the Company's defined-benefit pension plans at December 31, 1994 and 1993 is as follows (at December 31, 1994, no plans had assets which exceeded accumulated benefits):\nPostretirement Benefits. The Company provides postretirement medical and life insurance benefits for certain of its active and retired employees.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106 (\"SFAS 106\"), \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", for its postretirement benefit plans. This statement requires the accrual method of accounting for postretirement health care and life insurance based on actuarially determined costs 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. In conjunction with the adoption of SFAS 106, the Company elected to recognize the transition obligation on a prospective basis and accordingly, the net transition obligation is being amortized over 20 years. Net periodic postretirement benefit cost includes the following components for the years ended December 31, 1994 and 1993:\nThe incremental cost in 1994 and 1993 of accounting for postretirement health care and life insurance benefits under SFAS 106, as compared to 1992, amounted to approximately $2 million in each year.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nPostretirement benefit obligations, none of which is funded, are summarized as follows at December 31, 1994 and 1993:\nThe discount rates used in determining the accumulated postretirement benefit obligation were 8.5 percent and 7.0 percent in 1994 and 1993, respectively. The assumed health care cost trend rate in 1994 was 12 percent, decreasing to an ultimate rate in the year 2000 of seven percent. If the assumed medical cost trend rates were increased by one percent, the accumulated postretirement benefit obligation would increase by $2.1 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost would increase by $.3 million. Included in the Company's 1994 charge for the disposition of certain businesses are curtailment costs for postretirement benefit obligations relating to these businesses of approximately $3.7 million.\nSEGMENT INFORMATION:\nThe Company's business segments involve the production and sale of the following:\nTransportation-Related Products:\nPrecision products, generally produced using advanced metalworking technologies with significant proprietary content, and aftermarket products for the transportation industry.\nSpecialty Products:\nArchitectural -- Doors, windows, security grilles and office panels and partitions for commercial and residential markets.\nOther -- Products manufactured principally for the defense industry.\nCorporate assets consist primarily of cash and cash investments, marketable securities, equity and other investments in affiliates, notes receivable and net assets of the discontinued energy segment.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n(A) Included within this segment are sales to one customer of $322 million, $324 million and $268 million in 1994, 1993 and 1992, respectively; sales to another customer of $225 million, $186 million and $184 million in 1994, 1993 and 1992, respectively; and sales to a third customer of $212 million, $222 million and $216 million in 1994, 1993 and 1992, respectively.\n(B) Other income (expense), net in 1992, includes approximately $15 million to reflect disposition costs related to idle facilities and other long-term assets.\n(C) Operating profit in 1994 includes the impact of a pre-tax charge in the amount of $400 million for the disposition of businesses. The charge impacts the Company's business segments as follows: Transportation-Related Products -- $196 million; Architectural -- $116 million; and Other Specialty Products -- $75 million. The remaining $13 million of the charge is included in General Corporate Expense.\n(D) Assets employed at December 31, 1994 include net assets related to the disposition of certain operations (see \"Dispositions of Operations\" note).\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOTHER INCOME (EXPENSE), NET:\nGains and losses realized from sales of marketable securities and gains from sales of common stock of equity affiliates are determined on a specific identification basis at the time of sale.\nINCOME TAXES:\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe components of deferred taxes at December 31, 1994 and 1993 are as follows:\nNet current and net non-current assets of businesses held for disposition at December 31, 1994 include approximately $60 million of net deferred tax assets, including an expected net capital loss carryforward benefit of approximately $20 million. This capital loss is expected to be realized through the sale of common stock of equity affiliates that result in capital gains, or through the sale of businesses at a gain.\nThe following is a reconciliation of tax computed at the U.S. federal statutory rate to the provision for income taxes (credit) allocated to income (loss) from continuing operations before extraordinary income (loss):\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFAIR VALUE OF FINANCIAL INSTRUMENTS:\nIn accordance with Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" the following methods were used to estimate the fair value of each class of financial instruments:\nMARKETABLE SECURITIES, NOTES RECEIVABLE AND OTHER ASSETS\nFair values of financial instruments included in marketable securities, notes receivable and other assets were estimated using various methods including quoted market prices and discounted future cash flows based on the incremental borrowing rates for similar types of investments. In addition, for variable-rate notes receivable that fluctuate with the prime rate, the carrying amounts approximate fair value.\nLONG-TERM DEBT\nThe carrying amount of bank debt and certain other long-term debt instruments approximate fair value as the floating rates inherent in this debt reflect changes in overall market interest rates. The fair values of the Company's subordinated debt instruments are based on quoted market prices. The fair values of certain other debt instruments are estimated by discounting future cash flows based on the Company's incremental borrowing rate for similar types of debt instruments.\nThe carrying amounts and fair values of the Company's financial instruments at December 31, 1994 and 1993 are as follows:\nDERIVATIVES\nThe Company has limited involvement with derivative financial instruments, and does not use derivatives for trading purposes. The derivatives, principally consisting of S&P 500 futures contracts, are intended to reduce the market risk associated with the Company's marketable equity securities portfolio. The Company's investment in futures contracts increases in value as a result of decreases in the underlying index and decreases in value when the underlying index increases. The contracts are financial instruments (with off balance sheet market risk), as they are required to be settled in cash. At December 31, 1994 the notional amount of the derivatives was $33.2 million. The notional amounts do not represent the amounts exchanged by the parties, and thus are not a measure of the exposure of the Company through its use of derivatives. The Company's market risk is subject to the price differential between the contract market value and contract cost.\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nFutures contracts trade on organized exchanges, and as a result, settlement of such contracts has little credit risk. Initial margin requirements are met in cash or other instruments, and changes in the contract values are settled periodically. Initial margin requirements are recorded as cash investments in the balance sheet. Futures contracts are short-term in nature, usually less than six months. Related gains and losses are reported as income or loss in other income (expense) as part of marketable securities gain or loss. At December 31, 1994, based upon the current index, the Company's obligation amounted to $.3 million and is included in marketable securities.\nINTERIM AND OTHER SUPPLEMENTAL FINANCIAL DATA (UNAUDITED):\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nResults for the fourth quarter of 1994 include a non-cash pre-tax charge of $400 million ($315 million after-tax or $5.56 per common share in the fourth quarter of 1994) reflecting the anticipated loss on the disposition of certain businesses (see \"Dispositions of Operations\" note).\nNet income (loss) for the fourth quarter of 1994 also includes income aggregating approximately $18 million pre-tax ($11.7 million after-tax or $.21 per common share) relating to the reversal of the charge established in the fourth quarter of 1993 for the disposition of the Company's energy segment (see \"Dispositions of Operations\" note).\nNet income (loss) for the third quarter of 1994 includes $4.4 million pre-tax of extraordinary income ($2.6 million after-tax or $.04 per common share) related to the early extinguishment of convertible debt.\nResults for the first, second and third quarters of 1994 include pre-tax gains of approximately $9.8 million, $7.1 million and $1.0 million, respectively, from the sale by the Company of a portion of its common stock holdings of an equity affiliate.\nThe 1994 income (loss) per common share amounts for the quarters do not total to the full year amounts due to the purchase and retirement of shares throughout the year and a lower dilutive effect from outstanding options and warrants on the year-to-date calculation.\nResults for the second quarter of 1993 include pre-tax income of approximately $9 million as a result of gains associated with the sale of common stock through public offerings by equity affiliates. This income was largely offset by costs and expenses related to cost reduction initiatives, the restructuring of certain operations and product lines, adjustments to the carrying value of certain long-term assets, and other costs and expenses.\nResults for the third quarter of 1993 were reduced by a charge of approximately $.04 per common share reflecting the increased 1993 federal corporate income tax rate.\nThe fourth quarter of 1993 net loss includes the effect of a $5.8 million pre-tax extraordinary loss ($3.7 million after-tax or $.06 per common share) related to the early extinguishment of subordinated debt (see \"Long-Term Debt\" note). The fourth quarter of 1993 net loss also includes an after-tax charge of approximately $22 million ($.38 per common share) related to the disposition of a segment of the Company's business (see \"Dispositions of Operations\" note).\nThe 1993 results include the benefit of approximately $11.5 million pre-tax income ($6.7 million after-tax or $.12 per common share), primarily in the third and fourth quarters, resulting from net gains from sales of marketable securities.\nThe 1993 income (loss) per common share amounts for the quarters do not total to the full year amounts due to the changes in the number of common shares outstanding during the year and the dilutive effect of first, second and third quarter 1993 results.\nThe calculation of earnings per common and common equivalent share for the fourth quarter of 1993 results in dilution for income from continuing operations, assuming full dilution. Therefore, the fully diluted earnings per share computation is used for all computations, even though the result is anti-dilutive for one of the per share amounts.\nThe following supplemental unaudited financial data combine the Company with TriMas and have been presented for analytical purposes. The Company had a common equity ownership interest in TriMas of approximately 41 percent at December 31, 1994 and 43 percent at December 31, 1993. The\nMASCOTECH, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONCLUDED)\ninterests of the other common shareholders are reflected below as \"Equity of other shareholders of TriMas.\" All significant intercompany transactions have been eliminated.\nFINANCIAL STATEMENT SCHEDULE\nPURSUANT TO ITEM 14(A)(2)(II)(B) OF FORM 10-K\nANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSION\nFOR THE YEAR ENDED DECEMBER 31, 1994\nSchedules, as required for the years ended December 31, 1994, 1993 and 1992:\nMASCOTECH, INC.\nSCHEDULE II. VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nNOTES:\n(A) Allowance of companies reclassified for businesses held for disposition in 1994, and for discontinuance of Energy-related segment in 1993.\n(B) Deductions, representing uncollectible accounts written off, less recoveries of accounts written off in prior years.\nEXHIBIT INDEX","section_15":""}
{"filename":"6720_1994.txt","cik":"6720","year":"1994","section_1":"ITEM 1. BUSINESS:\nSUMMARY DESCRIPTION AND CHARACTERISTICS\nAnthony Industries, Inc. (\"Anthony\" or the \"Company\") is a diversified manufacturer and distributor of brand name sporting goods, specialty active apparel, and other recreational products. In addition, the Company manufactures and distributes selected industrial products. For financial information and a geographic breakdown regarding the recreational and industrial segments, see Note 11 of Notes to Consolidated Financial Statements, \"Segment Data,\" in Part II, Item 8 of this Form 10K.\nThe Company, headquartered in Los Angeles, California, was founded in 1946 as Anthony Pools, Inc. The Company's common stock was first offered to the public in 1959 and is currently traded on the New York and Pacific Stock Exchanges (symbol: ANT). Set forth below is a description of the recreational and industrial businesses of the Company.\nRECREATIONAL PRODUCTS\nAnthony's Recreational Products segment consists of three product classes: outdoor sporting goods, active & sporting apparel and home recreational products. Total sales for the segment were $332.1 million, $285.5 million and $266.6 million for the years 1994, 1993 and 1992, respectively.\nOUTDOOR SPORTING GOODS. Anthony's outdoor sporting goods are used in a wide variety of sports and sporting activities and are marketed under the following brand names:\nSales of outdoor sporting goods accounted for $224.6 million, $192.7 million and $170.8 million during 1994, 1993 and 1992, respectively.\nSkis, snowboards and in-line skates. The Company manufactures its alpine skis in the United States and Norway for sale in North America, Europe and Japan under the K2 and Olin names. K2 snowboards, introduced in 1987, are manufactured by the Company in the United States for sale in the United States, Europe and Japan. K2 in-line skates, introduced in 1994, are manufactured to Company specifications by a vendor in Korea, although certain components, such as wheels, are made in the United States. In-line skates are sold by the Company in the United States, Europe and Japan. The Company manufactures cross- country skis under the name Madshus for a retailer\/distributor which owns the name and sells the skis principally in Europe. K2 products are sold by independent sales representatives in the United States, and through independent distributors and\/or Company-owned distributors in Europe, to specialty retail shops and to sporting goods chains.\nFishing Tackle. The Company sells fishing rods, reels, fishing line and fishing kits and combos worldwide through the fishing tackle division of its subsidiary Shakespeare Company (\"Shakespeare\"). Shakespeare fishing tackle is manufactured principally in the People's Republic of China, although rod components, including blanks for the Ugly Stick fishing rods, are made by the Company in the United States. Certain other products are manufactured to the Company's specifications by vendors in Asia. Shakespeare products are distributed through an in-house marketing staff and through independent sales representatives to mass merchandisers, single-store retailers, and chain stores.\nWater Safety Products. Stearns manufactures and sells flotation vests, jackets and suits (\"personal flotation devices\"), cold water immersion products, neoprene wetsuits, rainwear and snorkeling equipment, to the recreational industries, the off-shore oil industry, commercial fishermen and other commercial users, both domestically and internationally. Other than rainwear, neoprene wetsuits and snorkeling equipment, which it purchases from suppliers mainly in Asia, Stearns' products are manufactured by it in the U.S. and distributed throughout the world by an in-house marketing staff and independent sales representatives. The laws of the U.S. and most states require that occupants of boats either wear or have available to them personal flotation devices meeting Coast Guard standards. Stearns' personal flotation devices are manufactured to those standards and are subject to rigorous testing for certification by Underwriters Laboratories. International regulations require merchant marine operators and commercial fishermen to equip their fleets with cold water immersion suits, where appropriate. The Company believes that Stearns is the largest manufacturer of personal flotation devices in the United States.\nMountain Bikes. Girvin, acquired in 1993, designs and distributes full- suspension mountain bikes and components under the Girvin(R), Girvin Flexstem(R), Vector(R), and ProFlex(R) brand names in the United States, Western Europe and Asia. Certain components, particularly front forks, are manufactured by Girvin in the U.S. The mountain bikes are assembled to Girvin's specifications by a vendor in Asia. Girvin distributes its products through an in-house marketing staff and through independent sales representatives to independent bicycle dealers in the U.S., and through distributors internationally.\nOutdoor products. Dana Design and Wilderness Experience (\"Wilderness\") were acquired by the Company in February 1995 and December 1994, respectively, and their operations have been combined. Dana Design and Wilderness design manufacture and distribute backpacks and specialized outdoor apparel under the Dana Design(R), Wilderness Experience(R) and Wild X(R) brand names domestically. The products are distributed through independent sales representatives to outdoor specialty dealers in the U.S.\nACTIVE AND SPORTING APPAREL. The Company's Active and Sporting Apparel product class consists of Hilton active wear and K2 ski apparel. Sales of Active and Sporting Apparel accounted for $40.1 million, $34.9 million and $35.3 million during 1994, 1993 and 1992, respectively.\nThe Hilton Active Apparel division manufactures and distributes jackets, shirts, fleece tops and other activewear, primarily for use in the screen print and advertising specialty markets which supplies imprinted items (including garments) primarily to corporate buyers. These garments are sold under the Hilton(R) and USA(R) trademarks to advertising specialty customers, embroiderers and screen printers throughout the United States. Hilton sales are generated largely from Hilton Active Apparel's catalogs, through a direct sales force and independent sales representatives. K2 ski apparel is manufactured to K2's specifications by various suppliers, located in Europe and Asia. These garments are sold under the K2 trademark mainly to European dealers and distributors.\nHOME RECREATIONAL PRODUCTS. The Company's Home Recreational Products consist of Anthony pools, pool equipment and Poolsaver swimming pool covers. Sales of Home Recreational Products accounted for $67.4 million, $57.9 million and $60.5 million during 1994, 1993 and 1992, respectively.\nAnthony Pools constructs and remodels residential gunite swimming pools sold directly to consumers, or indirectly through home builders, in five regions in or near major cities in California, Texas, and the eastern seaboard. The division also distributes swimming pool equipment, such as filters and heaters, which are installed on swimming pools built by Anthony or sold to gunite or concrete pool builders under an authorized dealership program in markets not served by Anthony. Replacement parts and equipment are sold by authorized service centers. The Company believes that Anthony Pools is one of the two largest builders of residential gunite swimming pools in the United States. Poolsaver manufactures and installs motorized and hand-operated swimming pool covers sold directly to consumers and pool builders. Sales are made through branches in or near major cities in California and the eastern seaboard and through distributors and dealers in markets in which Poolsaver does not have offices. Poolsaver additionally provides service on existing pool covers through its service organization.\nSeveral of the trademarks used by the Company's recreational products segment are believed to be recognizable by the consumer and therefore important to facilitating the sales of these products. Such trademarks include Ugly Stik(R) fishing rods, K2(R) skis, snowboards and in-line skates, Olin(R) skis, Stearns(R) flotation devices, Anthony Pools(R), Poolsaver(R) pool covers, Girvin Flexstems(R) and Proflex(R) mountain bikes, Hilton(R) active apparel, and Dana Design(R) and Wilderness Experience(R) backpacks and apparel.\nINDUSTRIAL PRODUCTS\nThe Company's Industrial Products segment consists principally of extruded thermoplastic monofilaments, fiberglass antennas and light poles and laminated and coated paperboard products. Extruded thermoplastic monofilaments are used by the paperweaving industry and for weed trimmer line applications. Paperboard products are used in residential and commercial construction and industrial packaging. Sales of Industrial Products accounted for $170.3 million, $146.1 million and $135.4 million during 1994, 1993 and 1992, respectively.\nThrough the Monofilament division of Shakespeare, the Company manufactures single strand extruded nylon or polymer monofilament in a variety of diameters, tensile strengths and softnesses for use in various applications. Specialized monofilament line is marketed to weavers who manufacture woven \"mats\" for use by the paper industry in the United States, Europe and South America. The European market is supplied primarily from its manufacturing facility in the U.K. The Monofilament division also supplies weed trimmer line to retailers and original equipment manufacturers in the lawn care market. Fishing line is manufactured by Monofilament and is marketed by Fishing Tackle throughout the United States to retailers and mass merchandisers.\nThe Electronics & Fiberglass division of Shakespeare manufactures fiberglass products primarily for the United States market, consisting mainly of utility and decorative light poles and radio antennas for citizen band, marine and military applications. The Company also distributes marine radios and other marine electronics under the Shakespeare brand which are manufactured in Asia to the Company's specifications.\nThe Simplex Products division manufactures a wide range of laminated, coated and reinforced paperboard products, which include insulative sheathing marketed under the trademark Thermo-ply(R), container components for fibre drums and flexible packaging paperboard products. These products are sold to the residential and manufactured housing, container and industrial packaging industries. Simplex also sells building products, such as Barricade(R) building wrap principally to residential construction and Finestone(R) coatings principally to the commercial construction industries. Simplex also operates a paper recycling mill which produces chip paperboard primarily used in the manufacture of Thermo-ply and secondarily sold to others in nonconstruction related markets. Most Simplex products must meet rigid performance specifications imposed by regulatory agencies and customers. Insulative sheathing additionally requires national and local building code approvals.\nSales of industrial products are generally made either directly or through distributors or sales representatives. Except for sales of fibre drum container components and paperweaving monofilaments, sales of industrial products are made to a large number of customers.\nCOMPETITION\nAnthony believes that it has the leading market share in the United States market for alpine skis, personal flotation devices, paperweaving monofilament, weed trimmer line, fiberglass light poles, laminated and coated paperboard insulative sheathing, marine antennas and full-suspension mountain bikes, motorized pool covers and has one of the two largest market shares for domestic residential gunite swimming pools. The Company also believes that it has one of the leading market shares in fishing tackle in the United Kingdom and Holland and has one of the top five market shares for skis in Germany and Japan. Fewer than ten ski manufacturers and personal flotation device manufacturers account for the majority of shipments worldwide. Six fishing tackle manufacturers account for the majority of the domestic shipments of fishing tackle. A large number of companies compete within the ad specialty market, while five mountain bike manufacturers account for the majority of sales to the independent bike dealers domestically.\nThe sporting goods markets are generally highly competitive, with competition mainly centering on product performance, price and rapid delivery. The ski market is also dependent on weather conditions in various geographic regions in the United States, Europe and Japan and on the amount of discretionary income available in the economy.\nThe Company's swimming pool business competes with many privately owned and small franchised pool building operations. The swimming pool market is dependent to a large extent on the amount of discretionary income available in the economy, the level of consumer confidence, the availability of consumer credit at reasonable interest rates and on the existence of favorable weather during the pool building season. The pool cover business competes with five manufacturers of pool covers and substitute products in competing industries.\nThe Company's industrial products are, in most instances, subject to price competition, ranging from moderate in the marine antenna and monofilament lines to intense for the commodity-type products. Sales growth and stability are dependent to varying degrees upon favorable economic conditions in the domestic housing, container and paper industries. Insulative sheathing products and fiberglass light poles compete with substitute products used for similar purposes.\nRAW MATERIALS AND FOREIGN SOURCING\nThe recreational products segment has not experienced any substantial difficulty in obtaining raw materials, parts or finished goods inventory. Certain components and finished goods, however, are manufactured or assembled abroad and therefore could be subject to interruption as a result of domestic unrest, local economic changes or other conditions in those countries and as a result of increased tariffs and trade difficulties between those countries and other countries in which Company products are manufactured or sold. A major portion of the Company's fishing rods, including its Ugly Stik line, and reels are currently manufactured in the People's Republic of China which trades with the United States under a Most Favored Nation (\"MFN\") trade status. While the Company believes that alternative sources for its fishing tackle produced in China could be found, maintaining its existing costs of such fishing tackle will depend on these products continuing to be treated under MFN tariff rates, which the U.S. from time to time has threatened to rescind. Early in 1995, the United States threatened trade sanctions against certain products made in China, including fishing rods. Shortly before such sanctions were to have become effective, however, the U.S. agreed not to impose them based on certain representations made by China relating to its future enforcement of intellectual property laws.\nThe industrial product segment has not experienced any substantial difficulty in obtaining raw materials, although recycled corrugated scrap paper, a raw material used in the production of insulative sheathing, has become materially more expensive, a trend which the Company expects could continue. At some level this increasing cost could have a material impact on the profitability of this line.\nSEASONALITY\nThe recreational products segment generally sells to highly seasonal markets. Alpine ski and snowboard sales and sales of active apparel to the advertising specialty markets are strongest in the third and fourth quarters. Sales of personal flotation devices occur primarily in the first and second quarters, whereas those of fishing tackle occur primarily in the first, second and fourth quarters. Mountain bike sales occur primarily in the fourth and first quarters and swimming pool sales occur primarily in the second and third quarters. In fishing tackle, skiing, personal flotation devices and active apparel, the rapid delivery requirements of customers and the seasonality of the business require an investment in significant amounts of inventory in anticipation of and through the selling seasons. Progress payments collected from customers during the construction of swimming pools help avoid utilizing substantial amounts of the Company's cash during the pool construction period. Extended payment terms offered in the fishing tackle, ski, snowboard and personal flotation device industries create seasonally large accounts receivable balances.\nThe Company has observed an evolving change in the buying patterns of mass merchant and other sporting goods customers, who are becoming more cautious about pre-season inventories, preferring to accept delivery closer to their retail selling seasons.\nThe Company's industrial products segment is mildly seasonal. Sales to the domestic housing, lawn care and marine antenna markets occur more heavily in the first two quarters of the year.\nMAJOR CUSTOMERS\nNo one customer of the Company accounts for ten percent or more of its consolidated annual net sales. While the Company believes that its customer relationships are excellent, it has two large customers, and the loss of either could have a material impact on the Company's sporting goods business.\nRESEARCH AND DEVELOPMENT\nThe Company maintains at several of its manufacturing centers decentralized research and development departments which are engaged in development of new products and processes, new uses of raw materials and improvement of products presently being manufactured. Expenditures for Company-sponsored research and development activities at all locations amounted to approximately $6.3 million in 1994, $4.3 million in 1993 and $3.5 million in 1992.\nENVIRONMENTAL FACTORS\nThe Company is among several potentially responsible parties named in certain EPA matters involving discharge of hazardous materials at an old waste disposal site. This action seeks primarily cleanup costs. The potential costs related to such matters are not expected to have a material impact on the capital expenditures, equity, earnings or the competitive position of the Company.\nEMPLOYEES\nAt December 31, 1994 and 1993 the Company and its subsidiaries had approximately 3,700 employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate headquarters of the Company is located in 15,000 square feet of leased office space in Los Angeles, California. The table below provides information with respect to the principal production and distribution facilities utilized by the Company as of December 31, 1994.\nThe terms of the leases range from one to eight years, and many are renewable for additional periods. The termination of any of the short-term leases would not have a material adverse effect on the Company's operations.\nThe Company believes that, in general, its plants and equipment are adequately maintained, in good operating condition and adequate for the Company's present needs. The Company regularly upgrades and modernizes its facilities and equipment and expands its facilities to meet customer requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nCertain of the Company's products are used in relatively high risk recreational settings and from time to time the Company is named as a defendant in lawsuits asserting product liability claims relating to its sporting goods and recreational products and, in particular, its swimming pools. To date none of these lawsuits has had a material effect on the Company, and the Company does not believe that any lawsuit now pending could reasonably be expected to have such an effect. While the Company maintains product libility insurance coverage, no assurances can be given that such insurance will continue to be available at acceptable prices or that a significant product liability judgment would be covered by such insurance or that such judgment would not exceed the policy limits.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nEXECUTIVE OFFICERS OF THE COMPANY\nMr. Forester has been Chairman of the Board and Chief Executive Officer for more than the past five years.\nMr. Rodstein has been President and Chief Operating Officer of the Company for more than the past five years.\nMr. Doyle has been a Senior Vice President of the Company and president of Simplex Products for more than the past five years.\nMr. Rangel, a CPA, has been Senior Vice President--Finance for more than the past five years.\nMr. Chow has been a Vice President of the Company for more than the past five years.\nMr. Cook has been a Vice President of the Company and president of Stearns for more than the past five years.\nMr. Greene has been Vice President--Quality and Process Improvement of the Company since January 1, 1993 and Director of Quality and Process Improvement of the Company from May 1991 to December 1992. For more than one year previous to that, Mr. Greene was employed by QualPro, Inc., a quality and process improvement consulting firm.\nMr. Herzberg has been a Vice President of the Company and president of Shakespeare Monofilament for more than the past five years.\nMrs. Lane has been Vice President and Treasurer for more than the past five years.\nMr. Leibow has been a Vice President of the Company since January 1, 1993 and president of Hilton Active Apparel since October 1989.\nMr. Shealy has been a Vice President of the Company since January 1991 and president of Shakespeare Electronics & Fiberglass since August 1989.\nMrs. McConnell, a California attorney, has been Secretary of the Company and administrative assistant to the Chief Executive Officer for more than the past five years.\nOfficers of the Company are elected for one year by the directors at their first meeting after the annual meeting of shareholders and hold office until their successors are elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nPRINCIPAL MARKETS\nThe Common Stock of the Company is traded on the New York and Pacific Stock Exchanges (symbol: ANT). At March 15, 1995 there were 1,893 holders of record of Common Stock of the Company.\nCOMMON STOCK PRICES\nThe following table sets forth the high and low sales prices of the Common Stock during the Company's two most recent fiscal years:\n-------- Prices and per share figures have been adjusted for stock dividends.\nDIVIDENDS\nQuarterly dividends of $.11 were declared on each share of Common Stock during the two most recent years. A 5% stock dividend was declared in the fourth quarter of each of the previous two years and the cash dividend was subsequently paid on the higher number of shares outstanding. The Company is subject to credit agreements which limit its ability to pay cash dividends. As of December 31, 1994, $7.9 million was available for such payments. See Note 5 of Notes to Financial Statements in Part II, item 8 of this Form 10-K for further description of the Company's credit facilities.\nTrust Agent, Registrar and Dividend Disbursing Agent for Common Stock\nHarris Trust Company of California 601 South Figueroa Street, Ste. 4900 Los Angeles, California 90017\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA RELEVANT DATA HAS BEEN RETROACTIVELY ADJUSTED FOR STOCK DIVIDENDS AND STOCK SPLITS\n-------- (a) Reflects a restructuring charge of $1.8 million.\n(b) Reflects the write-off of unamortized original issue discount, net of tax benefit, relating to the redemption of convertible subordinated debentures.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nREVIEW OF OPERATIONS: COMPARISON OF 1994 TO 1993\nNet income for 1994 rose 17% to $13.0 million, or $1.09 per share, from $11.1 million, or $.94 per share, in the prior year. Sales advanced 16% to $502.4 million from $431.6 million in 1993.\nIn the recreational products group, sales rose $46.6 million, or 16%, to $332.1 million. Fifty percent of the improvement was attributable to the successful introduction of K2's brand of Exotech in-line skates, increased demand worldwide for the K2 snowboard line and inclusion for the full year of the rapidly growing Proflex mountain bike business acquired in October 1993. Growth was also achieved from product extensions and higher overall activity in the swimming pool industry. Of particular significance were fifty-four styles of Hilton jackets, activewear and accessories for the advertising specialty market and new models of Stearns rainwear and wetsuits, all introduced within the prior 24 months, along with several new models of Shakespeare fishing reels, kit and combo series, which were introduced within the last 12 months in the U.S. market. Unit sales of Anthony swimming pools in 1994 increased for the first time since 1988, reflecting higher overall activity within the industry. Sales also benefited from increases in swimming pool remodels. Partially offsetting these gains were lower sales of skis to the economically depressed European and Japanese markets.\nIn the industrial products group, sales increased $24.2 million, or 17% to $170.3 million. Over half of the improvement was attributable to the Simplex products business, which benefited from increased sales of Finestone commercial coatings, expanded models of vapor barriers and from improved housing starts and\nshipments into the Japanese market which drove sales of insulative sheathing to a record level. Improved sales, particularly of fiberglass light poles and composite products and paperweaving monofilaments in the United Kingdom, generated the majority of the sales gains in the other two businesses of the group.\nCosts of goods sold, as a percent of sales, declined in 1994 as compared with the prior year. The resulting improvement in gross profit margin was driven by product mix and gains in efficiency from further applications of the Anthony Improvement Process, particularly at Stearns, Hilton, Shakespeare Monofilament and Simplex. Overall gross profit in dollars also improved despite the significant cost of completing the conversion to cap skis and subsequent lower margins realized in the sale of these higher-cost skis. Margin and gross profit were also unfavorably impacted by the dramatic increase in the cost of recycled corrugated scrap paper, a raw material used in the manufacture of insulative sheathing by Simplex.\nSelling expense increased $8.8 million although as a percent of sales it was comparable to the year-ago period. The increase in selling expense resulted primarily from volume-related increases in the pool business, by the inclusion of the mountain bike business for a full year and increased spending in support of new products in the in-line skate, mountain bike, snowboard and apparel businesses.\nGeneral and administrative expenses increased $7.7 million from the prior year. The increase reflects expenditures for new product development (particularly at K2), a continuation of further investments in systems and personnel to support the growth of the Company, and the inclusion of the mountain bike business for a full year.\nInterest expense increased $1.7 million in 1994. Domestic interest rates accounted for $532,000 of the increase, and a $17.4 million higher level of average borrowings, incurred to acquire and finance the mountain bike business and support the working capital needs of several product lines which exhibited growth in sales, accounted for the remainder.\nCombined operating profit (before interest, corporate expenses and taxes) increased $6.5 million over 1993. In the recreation products group, operating profit rose $3.8 million, or 31%, to $16.0 million. The group benefited from Shakespeare Fishing Tackle's introduction of several new fishing rods, reels and kit and combo series in the U.S. which, combined with lower manufacturing costs abroad, helped to produce record worldwide earnings for the fishing tackle business for the second consecutive year. Sales-related earnings gains also contributed to the group's improvement, particularly from the K2 snowboards and successful introduction of the previously described products of Stearns and Hilton. Partially offsetting these profit gains were a loss incurred by the swimming pool business and the impact of costs incurred in converting the ski plant to the manufacture of cap skis, the resulting increased cost to manufacture the cap skis and the impact of declining sales in the European and Japanese ski markets.\nIn the industrial products group, operating profit rose $2.7 million, or 19%, to $16.7 million. The improvement was mainly due to sales-related earnings and efficiency gains at Shakespeare Monofilament and Simplex.\nIncome tax expense in 1994 included $600,000 relating to a reclassification of state tax previously recorded as selling and general and administrative expense (See Note 4 of Notes to Consolidated Financial Statements).\nREVIEW OF OPERATIONS: COMPARISON OF 1993 TO 1992\nNet income for 1993 rose 31%, to $11.1 million, or $.94 per share, from $8.5 million, or $.73 per share, in the prior year. Sales in 1993 increased 7%, to a record $431.6 million, from the $402.0 million reported in 1992.\nSales of the recreational products group increased $18.9 million, to $285.5 million for the 1993 year. Favorable weather conditions in the United States and an improvement in the economy in certain regions of the country provided a boost to sales of K2 skis. The popularity of K2 snowboards pushed sales of this product up to nearly double prior years' levels. Sales of Shakespeare fishing tackle in the United States benefited from an increased distribution of Ugly Stik fishing rods, a growing acceptance of the new series of fishing reels introduced and an increase in shipments of fishing line. Several new products introduced by Stearns and Hilton in recent years have gained acceptance by their customers. These include Stearns wetsuits and rainwear and new styles of Hilton jackets and activewear for the ad specialty markets. A focused marketing effort in the pool remodeling business produced attractive gains in this segment of the swimming pool business. The Group also benefited from sales reported by an October 1993 acquisition, Girvin, which distributes and designs full suspension mountain bikes under the ProFlex brand name. Offsetting these gains was the lingering impact of the recession in the Northeast and California, which resulted in lower new pool and pool cover sales, and the European recession and an oversupplied Japanese market, which unfavorably impacted sales of fishing tackle and alpine skis in those markets.\nSales of the industrial products group increased to $146.1 million, from $135.4 million in the prior year. Increased housing starts and a wider distribution of building products sales in the United States and Japan produced sales gains in Thermo-ply, Finestone and other building products. Sales of fiberglass light poles and ornamental poles increased over the prior year as a result of new product introductions, broader distribution in the marketplace and improved product quality. Sales of monofilaments also contributed to the Group's sales increase.\nGross profits as a percent of sales declined in 1993, from 26.4% to 25.6%, largely because of the impact of significant costs incurred in the conversion of virtually the entire K2 plant in Washington to cap ski production. These costs are expected to continue into early 1994, until manufacturing efficiencies improve and the converted plant is brought up to capacity production levels. The gross profit percentage decline also reflects the development cost of the K2 in-line skate which, along with the cap ski, is scheduled for initial shipments in early 1994. Other factors affecting the gross profit percentage were largely offsetting: significant cost reductions attained through manufacturing process improvements at Simplex, Monofilament and Electronics and Fiberglass, from which continued benefits are expected to be derived, were offset by higher costs at our distribution businesses in Europe, which arose from the devaluation of European currencies in 1993.\nSelling expense as a percent of sales also declined from the prior year. This resulted largely from the recession-related contraction of sales for fishing tackle and skis in the European market. Partially offsetting this was spending increases at the Hilton activewear business to increase its penetration in new markets and better serve its customers.\nGeneral and administrative expenses increased $1.3 million from 1992. The increase reflects performance-based compensation and the Company's investments in personnel, training and systems for improving the quality of products and services.\nInterest expense declined by a net amount of $1.0 million in 1993. Lower worldwide interest rates produced a benefit of $1.7 million, which was partially offset by $700,000 of higher interest incurred domestically on a $12 million increase in average bank debt arising from higher sales of recreational products.\nCombined operating profit (before interest, corporate expenses and taxes) increased $3.6 million from the prior year. The recreational products group, which reported operating profit of $12.2 million, accounted for a $600,000 increase. Higher domestic sales of fishing tackle and continuing foreign manufacturing cost economies produced record worldwide fishing tackle earnings. Gains were also achieved at Anthony Pools, which significantly narrowed its losses due to a robust aftermarket in remodeling and its ongoing quality and process improvement program, and at Hilton Active Apparel, which benefited from higher overall sales.\nLargely offsetting these gains were lower ski earnings resulting from costs incurred in the conversion of the U. S. plant to cap ski production and the development cost of the in-line skate program.\nThe industrial products group reported an improvement of $3.0 million in operating profit to $14.0 million for the current year. Earnings of the building products and light pole businesses improved due to increased volume and cost reductions from improvements made in the manufacturing processes. Paperweaving and cutting line earnings improved largely as a result of increased volume.\nLIQUIDITY AND SOURCES OF CAPITAL\nThe Company's operating activities used $15.7 million of cash during the current year as compared with cash provided of $10.3 million in the prior year. The decrease in cash was due primarily to financing higher levels of accounts receivable and inventories arising from the growth in sales of in-line skates, snowboards, rainwear, wetsuits, fishing tackle and full suspension mountain bikes. In the industrial products group, cash was also used to purchase additional inventories in anticipation of further raw material cost increases.\nNet cash used for investment activities in 1994 decreased to $8.7 million from $12.5 million in 1993. No material commitments for capital expenditures existed at yearend.\nThe Company's principal long-term borrowing facility is a $70 million unsecured bank revolving credit line due June 28, 1997. At December 31, 1994, $68.0 million was outstanding under this line. Additionally, the Company had several foreign and domestic short-term lines of credit totaling $40.7 million, of which $18.3 million was outstanding at yearend. Under the long-term facility, the Company is subject to a loan agreement which, among other things, restricts amounts available for payment of cash dividends by the Company. As of December 31, 1994, retained earnings of $7.9 million were free of such restrictions. The Company also has $40 million of 8.39% unsecured senior notes due in 2004, payable in nine equal annual principal payments beginning in 1996. The notes are subject to agreements which are generally less restrictive than the $70 million bank revolving credit line. For information regarding the Company's interest rate swap agreements, see Note 5 of the Notes to Consolidated Financial Statements.\nThe Company anticipates its cash needs in 1995 will be provided from operations, existing credit lines, new borrowings or other public or private market sources.\nIMPACT OF INFLATION AND CHANGING PRICES\nThe inflation rate, as measured by the Consumer Price Index, has been relatively low in the last few years, and therefore pricing decisions by the Company have largely been influenced by competitive market conditions. The Company uses the LIFO method of inventory pricing for 46% of its inventories, which results in the most recent costs of LIFO-priced inventory being reflected in the income statement. Current costs of the Company's inventories priced on a FIFO basis are also reflected in the income statement because of the relatively high turnover of these inventories.\nDepreciation expense is based on the historical cost to the Company of its fixed assets and therefore is considerably less than it would be if it were based on current replacement cost. While buildings, machinery and equipment acquired in prior years will ultimately have to be replaced at significantly higher prices, it is expected that this will be a gradual process over many years.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSTATEMENTS OF CONSOLIDATED INCOME\nSee notes to consolidated financial statements\nANTHONY INDUSTRIES, INC.\nCONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements\nANTHONY INDUSTRIES, INC.\nSTATEMENTS OF CONSOLIDATED CASH FLOWS\nSee notes to consolidated financial statements\nANTHONY INDUSTRIES, INC.\nSTATEMENTS OF CONSOLIDATED SHAREHOLDERS' EQUITY\nSee notes to consolidated financial statements\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Shakespeare Company, K2 Corporation, Stearns Manufacturing Company and Girvin Inc.\nCash Equivalents\nShort-term investments (including any debt securities) that are part of the Company's cash management portfolio are classified as cash equivalents and are carried at amortized costs. These investments are highly liquid, are of limited credit risk and have original maturities of three months or less. The carrying amount of cash equivalents approximates market.\nAccounts Receivable and Allowances\nAccounts receivable are the result of the Company's worldwide sales activities. Although the Company's credit risk is spread across a large number of customers within a wide geographic area, periodic concentrations within a specific industry occur due to the seasonality of its businesses. As of December 31, 1994, the Company's receivables from the ski and snowboard industry amounted to 46% of total receivables. The Company performs periodic credit evaluations to manage its credit risk. Allowances include reserves for volume-related discounts of $3,018,000 and $2,712,000 as of December 31, 1994 and 1993, respectively.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined on the LIFO method with respect to approximately 46% and 49% of total inventories at December 31, 1994 and 1993, respectively, Cost was determined on the FIFO method for all other inventories.\nIncome Taxes\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" As permitted by Statement No. 109, the Company has elected not to restate the financial statements of any prior years. The cumulative effect of the change on the Company's financial statements was not material. Income taxes have been provided using the liability method. For years prior to 1993, the Company accounted for income taxes in accordance with Accounting Principles Board Opinion No. 11, \"Accounting for Income Taxes,\" which provided for income taxes using the income statement approach.\nProperty, Plant and Equipment\nProperty, plant and equipment is recorded at costs. Depreciation is provided on the straight-line method based upon the estimated useful lives of the assets.\nIntangibles\nGoodwill arising from acquisitions is amortized on a straight-line basis over a period up to 40 years. Other intangibles are amortized on a straight-line basis over 3 to 15 years. Accumulated amortization of intangibles as of December 31, 1994 and 1993 amounted to $6,004,000 and $5,143,000, respectively. The Company periodically reviews intangibles for impairment of value.\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 1--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)\nForeign Currency Translation\nThe functional currency for most foreign operations is the local currency. Foreign currency financial statements are converted into United States dollars by translating balance sheet accounts at the current exchange rate at yearend and income statement items at the average exchange rate for the year, with the resulting translation adjustment made to a separate component of shareholders' equity. Transaction gains or losses, other than those related to items deemed to be of a long-term nature, are included in net income in the period in which they occur.\nAdvertising Costs\nAdvertising costs are generally expensed as incurred. Advertising costs for the years ended December 31, 1994, 1993 and 1992 amounted to $12,943,000, $11,050,000 and $11,263,000, respectively.\nResearch and Development\nResearch and development costs are charged to expense as incurred. Research and development costs for the years ended December 31, 1994, 1993 and 1992 amounted to $6,298,000, $4,290,000 and $3,538,000, respectively.\nPer Share Data\nEarnings and cash dividends per share data have been retroactively adjusted for stock dividends. Earnings per share were determined by dividing net income by the average outstanding shares, including common stock equivalents and ESOP shares, using the treasury stock method. Common stock equivalents include stock options. Primary earnings per share approximate earnings per share on a fully diluted basis.\nNOTE 2--ACQUISITION OF BUSINESSES\nOn October 14, 1993, the Company purchased certain assets of Ocean State International, Inc. (\"Girvin\"). Girvin is a distributor and manufacturer of Proflex full-suspension mountain bikes and Girvin accessories for sale in the U.S. and Europe. On February 4, 1995, the Company purchased Dana Design Ltd., a small manufacturer and distributor of backpacks primarily in the U.S.\nNOTE 3--INVENTORIES\nInventories at December 31 are:\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--INCOME TAXES\nPretax income for the years ended December 31 was taxed under the following jurisdictions:\nComponents of the income tax provision for the three years ended December 31 are:\nThe principal elements accounting for the difference between the statutory federal income tax rate and the effective tax rates for the three years ended December 31 are:\nDeferred tax assets and liabilities are comprised of the following at December 31:\nIncome taxes paid, net of refunds, in the years ended December 31, 1994, 1993 and 1992 were $6.7 million, $5.3 million and $2.2 million, respectively.\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 4--INCOME TAXES--(CONTINUED)\nThe income tax provision for the year ended December 31, 1994 includes $600,000 relating to a reclassification of the provision for certain state taxes which have historically been included in selling and general and administrative expense. The Company has elected not to restate the financial statements of any prior years, as such amounts were not material.\nNo provision for United States income taxes has been made on undistributed earnings of foreign subsidiaries, since a substantial portion of these earnings has been permanently reinvested. At December 31, 1994, the foreign subsidiaries had unused operating loss carryforwards of approximately $7.5 million, of which approximately $1.8 million expires in 2001 and the remainder carries forward indefinitely. Since the use of these operating loss carryforwards is limited to future taxable earnings of the related foreign subsidiaries, a valuation allowance has been recognized to offset the deferred tax asset arising from such carryforwards.\nNOTE 5--BORROWINGS AND OTHER FINANCIAL INSTRUMENTS\nAt December 31, 1994, the Company had several foreign and domestic short-term lines of credit totaling up to $40.7 million. The foreign subsidiaries' lines of credit generally have no termination date but are reviewed annually for renewal and are denominated in the subsidiaries' local currencies. At December 31, 1994, amounts outstanding under such short-term lines of credit (bank loans) were $18.3 million at interest rates ranging from 5.75% to 11.2%. The weighted average interest rates on short-term lines of credit as of December 31, 1994 and 1993 were 6.5% and 7.1%, respectively.\nThe principal components of long-term debt at December 31 are:\nThe principal amount of long-term debt maturing in each of the four years following 1995 is:\nInterest paid on short- and long-term debt for the years ended December 31, 1994, 1993 and 1992 was $7.5 million, $5.8 million and $6.8 million, respectively.\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 5--BORROWINGS AND OTHER FINANCIAL INSTRUMENTS--(CONTINUED)\nThe $70 million revolving credit line is subject to an agreement which, among other things, restricts amounts available for payment of cash dividends by the Company. As of December 31, 1994, retained earnings of $7.9 million were free of such restrictions. Interest rates on the revolving line at December 31, 1994 ranged from 6.375% to 7.125%.\nThe Company had $14.5 million of letters of credit outstanding as of December 31, 1994.\nThe Company has entered into interest rate swap agreements to manage its interest rate exposure on the $40 million 8.39% notes payable. During 1993, the Company converted the fixed rate to a variable rate by entering into an interest rate swap with a maturity in 1996. The Company subsequently entered into an offsetting swap effectively returning the debt to a fixed rate which also matures in 1996. The remaining gain of $66,000 is being recognized over the remaining life of the interest rate swap agreements. In 1994, the Company also entered into an interest rate swap agreement effectively converting the interest rate exposure on the $4.7 million bank loan described above to a fixed rate of 6.97%. The interest rate swap agreement matures at the time the related loan matures. The Company is exposed to credit loss in the event of nonperformance by the banks, who are parties to these agreements. However, in view of the substantial size and financial strength of these banks, the Company believes that non-performance is remote.\nThe Company enters into forward exchange contracts to hedge certain anticipated and firm sales and purchases commitments which are denominated in foreign currencies. The purpose of the Company's foreign currency hedging activities is to reduce the Company's risk to fluctuating exchange rates. At December 31, 1994, the Company had foreign exchange contracts with maturities of generally less than one year in the aggregate amount of $5.0 million, and with unrealized losses of $205,000. The unrealized losses will be recognized in earnings when realized and when the underlying transaction occurs. At December 31, 1994, the Company had no deferred realized gains or losses from forward exchange contracts.\nThe carrying amounts for the short-term lines of credit and the long-term bank revolving credit line approximate their fair value since floating interest rates are charged which approximate market rates. The fair value of the $40 million 8.39% notes payable, based on quoted market prices, is $37.7 million as compared to a carrying amount of $40.0 million, and the fair value of the $4.7 million note payable is $4.2 million as compared to a carrying amount of $4.7 million.\nNOTE 6--COMMITMENTS AND CONTINGENCIES\nFuture minimum payments under noncancelable operating leases as of December 31, 1994, are as follows:\nLeases are primarily for rental of facilities, and about one-half of these contain renewal rights to extend the terms from one to ten years.\nNet rental expense, including those rents payable under noncancelable leases and month-to-month tenancies, amounted to $3,837,000, $3,609,000 and $3,770,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6--COMMITMENTS AND CONTINGENCIES--(CONTINUED)\nThe Company is subject to various legal actions and proceedings in the normal course of business. While the ultimate outcome of these matters cannot be predicted with certainty, and to the extent not previously provided, management does not believe these matters will have a material adverse effect on the Company's financial statements.\nThe Company is among several potentially responsible parties named in a cleanup of a chemical waste disposal site in South Carolina under the Comprehensive Environmental Response, Compensation and Liability Act. The ultimate outcome of this matter cannot be predicted with certainty, however, to the extent to which not previously provided, management does not believe this matter will have a material adverse effect on the Company's financial statements.\nNOTE 7--PENSION PLANS AND OTHER BENEFIT PLANS\nThe Company sponsors several trusteed noncontributory defined benefit pension plans covering most of its employees. Benefits are generally based on years of service and the employee's highest compensation for five consecutive years during the years of credited service. Contributions are intended to provide for benefits attributable to service to date and service expected to be provided in the future. The Company funds these plans in accordance with the Employee Retirement Income Security Act of 1974 (ERISA).\nThe Company also sponsors defined contribution pension plans covering certain domestic employees who are not covered by a defined benefit pension plan and substantially all Stearns employees. Contributions by the Company are determined as a percent of the amounts contributed by the respective employees.\nThe following table sets forth the defined benefit plans' funded status and amounts recognized in the Company's consolidated balance sheet at December 31:\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 7--PENSION PLANS AND OTHER BENEFIT PLANS--(CONTINUED)\nNet pension cost consisted of the following at December 31:\nOn January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pension.\" The adoption of Statement No. 106 had an immaterial effect on the Company's financial statements.\nIn November 1992, the FASB issued Statement No. 112, \"Employers' Accounting for Postemployment Benefits,\" that requires accrual accounting for postemployment benefits instead of recognizing an expense for those benefits when paid. The Company has complied with the new rules beginning in 1994. The adoption of the new standard has not had a material effect on the Company's financial statements.\nNOTE 8--QUARTERLY OPERATING DATA (UNAUDITED)\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 9--STOCK OPTIONS\nUnder the Company's 1994 Incentive Stock Option Plan (\"1994 Plan\"), options may be granted to eligible directors and key employees of the Company and its subsidiaries at not less than 100% of the market value of the shares on the dates of grant. No further options may be granted under the Company's 1988 Incentive Stock Option Plan (\"1988 Plan\").\nThe 1994 Plan permits the granting of options for terms not to exceed ten years from date of grant. The options are exercisable on such terms as may be established by the Compensation Committee of the Board of Directors at the dates of grant.\nThe Company is authorized, at the discretion of the Compensation Committee, to provide loans to key employees in connection with the exercise of stock options under both the 1994 Plan and the 1988 Plan. The loans are collateralized by the underlying shares of stock issued and bear interest at the applicable rates published by the IRS. At December 31, 1994 and 1993, there was a total of $2,440,000 and $2,167,000, respectively, of loans and accrued interest outstanding which are due on various dates through December 1999. The loan amounts have been deducted from shareholders' equity.\nFurther information regarding the Plans is shown below. The data has been adjusted to reflect the 5% stock dividend in December 1994.\nDuring 1994, options for 182,800 shares were granted at $15.00 to $17.25 per share, and options for 21,286 shares at $8.85 to $14.52 per share were cancelled or expired. At December 31, 1994, 1,449,935 shares of common stock were reserved for issuance under the Plans.\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 10--SHAREHOLDERS' EQUITY\nPreferred Stock\nShares are issuable in one or more series, and the Board of Directors has authority to fix the terms and conditions of each series.\nEmployee Stock Ownership Plan\nThe Company has an Employee Stock Ownership Plan (ESOP) which covers substantially all of its domestic non-union employees with at least one year of service. As of December 31, 1994, the trust was indebted to the Company in the aggregate amount of $944,000 in connection with stock purchases made from 1982 through 1984 of which 260,415 shares with an aggregate market value of $4,167,000 as of December 31, 1994 remained unallocated to participants. These loans are repayable over the next eight to ten years with interest at prime plus 1\/2 %, not to exceed 18% and the unallocated shares will be released to participants proportionately as these loans are repaid. Of the total dividends received by the ESOP on its investment in the Company's common stock, dividends on unallocated shares in the amount of $157,000 and $147,000 in 1994 and 1993, respectively, were used to service these loans. Additionally, the trust was indebted to the Company in the amount of $400,000 in connection with distributions made to terminees. The loan carries no interest and is due June 30, 1995. It is anticipated the loan will be repaid through the sale of unallocated shares.\nShareholders' equity has been reduced by the amount of the loans and any payments made by the Company on behalf of the trust. The payments, which at December 31, 1994 totaled $153,000, are being amortized to expense over the lives of the loans.\nThe amount of the Company's annual contribution to the ESOP is at the discretion of the Company's Board of Directors. For the three years 1994, 1993 and 1992 contributions were limited to amounts in excess of annual dividends, net of debt service, of the ESOP necessary to fund obligations arising in each of those years to retired and terminated employees. These amounts were $1,016,000, $1,260,000 and $1,150,000, respectively. ESOP expense, including amortization of the foregoing payments, was $1,014,000, $1,012,000 and $1,321,000 in 1994, 1993 and 1992, respectively. Allocated shares as of December 31, 1994 totaled 2,109,907 shares.\nPreferred Stock Rights\nRights are outstanding which entitle the holder of each share of Common Stock of the Company to buy one one-hundredth of a share of Series A preferred stock at an exercise price of $51.712 per one one-hundredth of a share, subject to adjustment. The rights are not separately tradable or exercisable until a party either acquires, or makes a tender offer that would result in ownership of, at least 20% of the Company's common shares. If a person becomes the owner of at least 20% of the Company's outstanding common shares (an \"Acquiring Person\"), each holder of a right other than such Acquiring Person and its affiliates is entitled, upon payment of the then current exercise price per right (the \"Exercise Price\"), to receive shares of Common Stock (or Common Stock equivalents) having a market value of twice the Exercise Price. If the Company subsequently engages in certain mergers, business combinations or asset sales with the Acquiring Person, each holder of a right other than the Acquiring Person and its affiliates is thereafter entitled, upon payment of the Exercise Price, to receive stock of the Acquiring Person having a market value of twice the Exercise Price. At any time after any party becomes an Acquiring Person, the Board of Directors may exchange the rights (except those held by the Acquiring Person) at an exchange ratio of one common share per right. Prior to a person becoming an Acquiring Person, the rights may be redeemed at a redemption price of one cent per right, subject to adjustment. The rights are subject to amendment by the Board.\nANTHONY INDUSTRIES, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 11--SEGMENT DATA\nThe Company and its subsidiaries are organized into the recreational products and industrial products segments. The recreational products segment is composed of the following lines of business: manufacture and sale of skis and snowboards; sale of in-line skates; manufacture and sale of athletic jackets, imprintable shirts and bowling shirts; manufacture and sale of personal flotation devices; construction of residential concrete swimming pools; manufacture and installation of swimming pool covers; manufacture and sale of full-suspension mountain bikes and accessories; and manufacture and sale of rods, reels and other fishing tackle items. The industrial products segment consists of the manufacture and sale of extruded monofilament used by the paperweaving industry and for cutting line, fishing line and sewing thread; fiberglass marine antennas, communication and navigation equipment and light poles; and laminated and coated paperboard products.\nThe following segment data is presented for the three years ended December 31, 1994. \"Identifiable Assets\" are as of December 31.\nANTHONY INDUSTRIES, INC.\nREPORT OF INDEPENDENT AUDITORS\nTo the Board of Directors and Shareholders Anthony Industries, Inc.\nWe have audited the accompanying consolidated balance sheets of Anthony Industries, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related statements of consolidated income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 Anthony Industries, Inc. and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nErnst & Young LLP Los Angeles, California February 14, 1995\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\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\nExcept as noted in the following paragraph the information called for by Items 10, 11, 12 and 13 have been omitted because on or before April 29, 1995, Registrant will file with the Commission pursuant to Regulation 14A a definitive proxy statement. The information called for by these items set forth in that proxy statement is incorporated herein by reference.\nThe information called for by Item 10 with respect to executive officers of the Registrant appears following Item 4 under Part I of this Report.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nThe following documents are filed as part of this report:\n(a-1) Financial Statements (for the three years ended December 31, 1994 unless otherwise stated):\nAll other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes.\n(a-3)Exhibits\n(3) (a) Restated Certificate of Incorporation dated May 4, 1989, filed as Exhibit (3)(a) to Form 10-K for the year ended December 31, 1989 and incorporated herein by reference\n(b) By-Laws of Anthony Industries, Inc., as amended\n(4) (a) Rights Agreement dated August 10, 1989 between the Company and Harris Trust Company, filed as Item 6, Exhibit (a) to Form 10-Q for the quarter ended September 30, 1989 and incorporated herein by reference\n(10)Material contracts\n(a) Credit Agreement dated as of June 28, 1993 among Anthony Industries, Inc., the Banks party thereto and Bank of America National Trust and Savings Association, as agent filed as Item 6, Exhibit (a)(10)(i) to Form 10-Q for the quarter ended June 30, 1993 and incorporated herein by reference\n(i) First Amendment to the Credit Agreement dated as of June 28, 1993 between Anthony Industries, Inc., the Banks, and Bank of America National Trust and Savings Association as a Bank and as Agent for the banks filed as Item 6, Exhibit (a)10(i) to Form 10-Q for the quarter ended June 30, 1994 and incorporated herein by reference\n(b) Note Agreement Re: $40,000,000 8.39% Senior Notes due November 30, 2004 dated as of October 15, 1992, filed as Exhibit (10)(b) to Form 10-K for the year ended December 31, 1992 and incorporated herein by reference\n(c) Executive compensation plans and arrangements\n(1)(i) Amended and restated employment agreement dated as of December 31, 1991 between the Company and B. I. Forester, filed as Exhibit (10)(a) to Form 10-K for the year ended December 31, 1991 and incorporated herein by reference\n(ii) Amendment dated October 20, 1994 to amended and related employment agreement dated as of December 1991 between the Company and B.I. Forester, filed as Item 6, Exhibit (a)10(i) to Form 10-Q for the quarter ended September 30, 1994 and incorporated herein by reference\n(2)(i) Special Supplemental Benefit Agreement between the Company and Bernard I. Forester dated December 9, 1986, filed as Exhibit (10)(g) to Form 10-K for the year ended December 31, 1986 and incorporated herein by reference\n(ii) Amendment dated July 27, 1990 to Special Supplemental Benefit Agreement between the Company and Bernard I. Forester dated December 9, 1986, filed as Exhibit (10)(f)(2) to Form 10-K for the year ended December 31, 1990 and incorporated herein by reference\n(3) 1988 Incentive Stock Option Plan, filed as Exhibit A to the Proxy Statement for the Annual Meeting of Shareholders held on May 5, 1988 and incorporated herein by reference\n(4) Anthony Industries, Inc. Non-Employee Directors' Benefit Plan effective May 1, 1992, filed as Item 6, Exhibit (a)(28) of Form 10-Q for the quarter ended March 31, 1992 and incorporated herein by reference\n(5) Anthony Industries, Inc. Corporate Officers' Medical Expense Reimbursement Plan, as amended through October 22, 1993, effective August 15, 1974, filed as Exhibit (10)(c)(5) to Form 10-K for the year ended December 31, 1993 and incorporated herein by reference\n(6) Anthony Industries, Inc. Directors' Medical Expense Reimbursement Plan, as amended through October 22, 1993, effective January 1, 1983, filed as Exhibit (10)(c)(6) to Form 10-K for the year ended December 31, 1993 and incorporated herein by reference\n(7) Anthony Industries, Inc. Executive Officers' Incentive Compensation Plan adopted August 5, 1993 filed as Item 6, Exhibit (a)10(ii) to Form 10-Q for the the quarter ended June 30, 1993 and incorporated herein by reference\n(8) 1994 Incentive Stock Option Plan, filed as Exhibit A to the Proxy Statement for the Annual Meeting of Shareholders held on May 5, 1994 and incorporated herein by reference\n(11)Computation of earnings per share for three years ended December 31, 1994\n(21)Subsidiaries\n(23)Consent of Independent Auditors\n(27)Financial Data Schedule\n(b)REPORTS ON FORM 8-K\nNot applicable\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.\nANTHONY INDUSTRIES, INC. (Registrant)\nBy \/s\/ B. I. Forester _____________________________________ (B. I. Forester) Chairman and Chief Executive Officer\nDate March 29, 1995 _____________________________________\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-------- *A majority of the directors of the registrant.\nANTHONY INDUSTRIES, INC.\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\n(THOUSANDS)","section_15":""}
{"filename":"723188_1994.txt","cik":"723188","year":"1994","section_1":"Item 1. Business\nGeneral Community Bank System, Inc. (\"Company\") was incorporated on April 15, 1983, under the Delaware General Corporation Law. Its principal office is located at 5790 Widewaters Parkway, DeWitt, New York 13214 and its telephone number is (315) 445-2282. The Company became a bank holding company in 1984 with the acquisition of The St. Lawrence National Bank (\"St. Lawrence Bank\") on February 3, 1984 and the First National Bank of Ovid (renamed Horizon Bank, N.A or \"Horizon Bank\") on March 2, 1984. Also in 1984 the Company obtained a national bank charter for its third wholly-owned subsidiary bank, The Exchange National Bank (\"Exchange Bank\"), and on July 1, 1984 Exchange Bank acquired the deposits and certain of the assets of three branches of the Bank of New York located in southwestern New York. On September 30, 1987, the Company acquired The Nichols National Bank (\"Nichols Bank\") located in Nichols, New York. On September 30, 1988, the Company acquired ComuniCorp, Inc., a one-bank holding company located in Addison, New York, the parent company to Community National Bank (\"Community Bank\"). On March 26, 1990, Community Bank opened the Corning Market Street branch from the Company's acquisition of deposits and certain assets from Key Bank of Central New York. On January 1, 1992, the Company's five banking affiliates consolidated into a single, wholly-owned national banking subsidiary, known as Community Bank, N.A. (\"Bank\"). On March 31, 1993, the Bank's marketing representative office in Ottawa, Canada was closed. On June 3, 1994, the Company acquired three branch offices in Canandaigua, Corning and Wellsville, New York from the Resolution Trust Corporation. On October 28, 1994, the Company acquired the Cato, New York branch of The Chase Manhattan Bank, N.A. The Company had a wholly-owned data processing subsidiary, Northeastern Computer Services, Inc. (\"Northeastern\"). Northeastern was acquired by the Company from the St. Lawrence Bank on May 31, 1984 pursuant to a corporate reorganization. Northeastern had previously been a wholly-owned subsidiary of the St. Lawrence Bank and was the survivor of a merger with Lawban Computer Systems, Inc., another wholly-owned subsidiary of the St. Lawrence Bank. Northeastern's office was located at 6464 Ridings Road, Syracuse, New York. In December 1991, the Company entered into a five year agreement with Mellon Bank, N.A. to provide data processing services. On June 30, 1992, Northeastern ceased operations and was dissolved. The Company also had a wholly-owned mortgage banking subsidiary, Community Financial Services, Inc. (CFSI), which was established in June 1986; it commenced operation in January 1987. In July 1988, CFSI purchased Salt City Mortgage Corp., a Syracuse-based mortgage broker. CFSI was dissolved in 1990. The Company provides banking services through its two regional offices at 45-49 Court Street, Canton, New York and 201 North Union Street, Olean, New York, as well as through 36 banking offices in the counties of St. Lawrence, Jefferson, Lewis, Cayuga, Seneca, Ontario, Oswego, Allegheny, Cattaraugus, Tioga, and Steuben. The administrative office is located at 5790 Widewaters Parkway, DeWitt, New York, in Onondaga County. The Bank is a community retail bank committed to the philosophy of serving the financial needs of customers in local communities. The Bank's branches are generally located in small cities and villages within its geographic market areas. The Company believes that the local character of business, knowledge of the customer and customer needs, and comprehensive retail and small business products, together with rapid decision-making at the branch and regional level, enable the Bank to compete effectively.\nThe Bank is a member of the Federal Reserve System and the Federal Home Loan Bank of New York (\"FHLB\"), and its deposits are insured by the FDIC up to applicable limits. Banking Services The Bank offers a range of commercial and retail banking services in each of its market areas to business, individual, agricultural and government customers.\nAccount Services. The Bank's account services include checking accounts, negotiable orders of withdrawal (\"NOW\") and savings accounts, time deposit accounts and individual retirement accounts.\nLending Activities. The Bank's lending activities include the making of residential and farm loans, business lines of credit, working capital facilities, inventory and dealer floor plans, as well as installment, commercial, term and student loans.\nThe Company believes that its predominant focus on the retail borrower enables its loan portfolio to be highly diversified. Over 70% of loans outstanding are made to consumers borrowing on an installment and mortgage loan basis. In addition, the typical loan to the Company's commercial business borrowers is under $50,000, with less than 15% of the commercial portfolio being in loans in excess of $500,000.\nOther Services. The Bank offers a range of trust services, including investment management, financial planning and custodial services. The Bank also offers safe deposit boxes, travelers checks, money orders, wire transfers, collections, foreign exchange, drive-in facilities and twenty-four hour depositories. Through an accounts receivable management program, the Bank provides a service to qualifying businesses by purchasing accounts receivable on a discounted basis. In addition, through an affiliation with Prime Vest, Inc., the Bank offers non-bank financial products including fixed- and variable-rate annuities, mutual funds, and stock investments.\nCompetition\nThe Company, through the Bank, competes in three distinct banking markets in the Northern (\"Northern Market\"), Finger Lakes (\"Finger Lakes Market\"), and Southern Tier (\"Southern Tier Market\") regions of New York State. The Bank considers its primary market areas in these regions to be the counties in which it has banking facilities. Major competitors in these markets include local branches of regional affiliates of banks based in New York City, Albany or Buffalo, New York, as well as local independent banking and thrift institutions and federal credit unions. Other competitors for deposits and loans within the Bank's market areas include insurance companies, money market funds, consumer finance companies and financing affiliates of consumer durable goods manufacturers. Lastly, personal and corporate trust and investment counseling services in competition with the Bank are offered by insurance companies, investment counseling firms and other financial service firms and individuals.\nThe Bank is predominantly a retail bank committed to the philosophy of serving the financial needs of customers in local communities. The Bank's branches are generally located in small cities and villages within its geographic market areas. The Company believes that the local character of business, the Bank's knowledge of the customer and customer needs, and its comprehensive retail and small business products, together with rapid decision-making at the branch and regional level, enable the Bank to compete effectively.\nNorthern Market. Branches in the Northern Market compete for loans and deposits in the three county primary market area of St. Lawrence, Jefferson and Lewis Counties in Northern New York State. Within this market area, the Bank maintains a market share(1) of 14.2% including commercial banks, credit unions, savings and loan associations and savings banks. The Northern Region operates 18 office locations, and the Bank is ranked either first or second in market share in 13 of the 14 towns where these offices are located. The Bank's Northern Region also competes for loans where it has no banking facilities; this secondary market area includes Franklin County.\nFinger Lakes Market. In the Finger Lakes Market, the Bank operates seven office locations competing for loans and deposits in the four-county primary market area of Seneca, Oswego, Ontario and Cayuga Counties. Within the Finger Lakes Market area, the Bank maintains a market share(1) of 1.3% including commercial banks, credit unions, savings and loan associations and savings banks. The Bank is ranked either first or second in market share in five of the seven Finger Lakes Market area towns where its offices are located.\nSouthern Tier Market. The Bank's Southern Tier Market consists of two sub-markets, the Olean submarket and the Corning submarket.\nOlean Submarket. The Olean Submarket competes for loans and deposits in the primary market area of Cattaraugus and Allegany Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share(1) of 13.1% including commercial banks credit unions, savings and loan associations and savings banks. The Olean Submarket operates four office locations, and the Bank is ranked either first or second in market share in three of the four towns where these offices are located. The Bank also competes for loans where it has no banking facilities; this secondary market area includes Chautauqua County.\nCorning Submarket. The Corning Submarket competes for loans and deposits in the primary market area of Steuben and Tioga Counties in the Southern Tier of New York State. Within this area, the Bank maintains a market share(1) of 6.7% including commercial banks, credit unions, savings and loan associations and savings banks. The Corning Submarket operates seven office locations, and the Bank is ranked either first or second in market share in four of the five towns where these offices are located. The Bank also competes for loans where it has no banking facilities; this secondary market area includes Chemung and Schuyler Counties in New York State, and Tioga County in Pennsylvania.\n(1) Deposit market share data as of June 30, 1994, as calculated by Sheshunoff Information Services, Inc.\nEmployees\nAs of December 31, 1994, the Bank employed approximately 440 full-time equivalent employees. The Bank provides a variety of employment benefits and considers its relationship with its employees to be good. Upon consummation of the Acquisition the Bank will retain approximately 117 full-time equivalent employees currently employed by Chase at the Chase Branches and add approximately 36 additional full-time equivalent employees. Neither the Company nor the Bank is a party to any collective bargaining agreement. See \"Pending Acquisition\".\nCERTAIN REGULATORY CONSIDERATIONS\nBank holding companies and national banks are regulated by state and federal law. The following is a summary of certain laws and regulations that govern the Company and the Bank. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the actual statutes and regulations thereunder.\nBank Holding Company Supervision\nThe Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (the \"BHCA\") and as such is subject to regulation by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"). As a bank holding company, the Company's activities and those of its subsidiary are limited to the business of banking and activities closely related or incidental to banking. Under Federal Reserve Board policy, a bank holding company is expected to act as a source of financial strength to its subsidiary banks and to make capital contributions to a troubled bank subsidiary. The Federal Reserve Board may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. A required capital injection may be called for at a time when the Company does not have the resources to provide it. Any capital loans by the Company to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks.\nThe BHCA requires the prior approval of the Federal Reserve Board in any case where a bank holding company proposes to acquire direct or indirect ownership or control of more than 5% of any class of the voting shares of, or substantially all of the assets of, any bank (unless it owns a majority of such bank's voting shares) or otherwise to control a bank or to merge or consolidate with any other bank holding company. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank. The BHCA would prohibit the Federal Reserve Board from approving an application from the Company to acquire shares of a bank located outside of New York, unless such an acquisition is specifically authorized by statute of the state in which the bank whose shares are to be acquired is located.\nHowever, the Riegal-Neal Interstate Banking and Efficiency Act of 1994 (enacted on September 29, 1994) provides that, among other things, substantially all state law barriers to the acquisition of banks by out-of- state bank holding companies will be eliminated effective September 29, 1995. The law will also permit interstate branching by banks effective as of June 1, 1997, subject to the ability of states to opt-out completely or to set an earlier effective date. The Company anticipates that the effect of the new law may be to increase competition within the market in which the Company operates, although the Company cannot predict the effect to which competition will increase in such markets or the timing of such increase.\nOCC Supervision\nThe Bank is supervised and regularly examined by the OCC. The various laws and regulations administered by the OCC affect corporate practices such as payment of dividends, incurring debt and acquisition of financial institutions and other companies, and affect business practices, such as payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices. There are no regulatory orders or outstanding issues resulting from regulatory examinations of the Bank.\nLimits on Dividends and Other Revenue Sources\nThe Company's ability to pay dividends to its shareholders is largely dependent on the Bank's ability to pay dividends to the Company. In addition to state law requirements and the capital requirements discussed below, the circumstances under which the Bank may pay dividends are limited by federal statutes, regulations and policies. For example, as a national bank, the Bank must obtain the approval of the OCC for the payment of dividends if the total of all dividends declared in any calendar year would exceed the total of the Bank's net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. Furthermore, the Bank may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations. At December 31, 1994, the Bank had $18.0 million in undivided profits legally available for the payment of dividends.\nIn addition, the Federal Reserve Board and the OCC are authorized to determine under certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of dividends that deplete a bank's capital base could be deemed to constitute such an unsafe or an unsound practice. The Federal Reserve Board has indicated that banking organizations should generally pay dividends only out of current operating earnings.\nThere are also statutory limits on the transfer of funds to the Company by its banking subsidiary whether in the form of loans or other extensions of credit, investments or asset purchases. Such transfers by the Bank to the Company generally are limited in amount to 10% of the Bank's capital and surplus, or 20% in the aggregate. Furthermore, such loans and extensions of credit are required to be collateralized in specified amounts.\nCapital Requirements\nThe Federal Reserve Board has established risk-based capital guidelines which are applicable to bank holding companies. The guidelines established a framework intended to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and take off-balance sheet exposures into explicit account in assessing capital adequacy. The Federal Reserve Board guidelines define the components of capital, categorize assets into different risk classes and include certain off-balance sheet items in the calculation of risk-weighted assets. At least half of the total capital must be comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, less goodwill (\"Tier I capital\"). Banking organizations that are subject to the guidelines are required to maintain a ratio of Tier I capital to risk-weighted assets of at least 4.00% and a ratio of total capital to risk-weighted assets of at least 8.00%. The appropriate regulatory authority may set higher capital requirements when an organization's particular circumstances warrant. The remainder (\"Tier 2 capital\") may consist of a limited amount of subordinated debt, limited- life preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The sum of Tier I capital and Tier 2 capital is \"total risk-based capital.\" The Company's Tier I and total risk-based capital ratios as of December 31, 1994 were 12.43% and 13.68%, respectively.\nIn addition, the Federal Reserve Board has established a minimum leverage ratio of Tier I capital to quarterly average assets less goodwill (\"Tier I leverage ratio\") of 3.00% for bank holding companies that meet certain specified criteria, including that they have the highest regulatory rating. All other bank holding companies are required to maintain a Tier I leverage ratio of 3.00% plus an additional cushion of at least 100 to 200 basis points. The Company's Tier I leverage ratio as of December 31, 1994 was 6.83%, which exceeded its regulatory requirement of 4.00%. The guidelines also provide that banking organizations 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. The Company is subject to the same OCC capital requirements as those that apply to the Bank.\nIn February 1994, the federal banking agencies proposed amendments to their respective risk-based capital requirements that would explicitly identify concentration of credit risk and certain risks arising from nontraditional activities, and the management of such risks, as important factors to consider in assessing an institution's overall capital adequacy. The proposed amendments do not, however, mandate any specific adjustments to the risk-based capital calculations as a result of such factors. On August 24, 1994, the Federal Reserve Board issued proposed amendments to its risk-based capital standards that would increase the amount of capital required under such standards for long-dated interest rate and exchange rate contracts and for derivative contracts based on equity securities and indexes, precious metals (other than gold) and other commodities. The proposed amendments would also permit banking institutions to recognize the effect of bilateral netting arrangements in calculating their exposure to derivative contracts for risk-based capital purposes. The Company and the Bank do not expect that these proposals, if adopted in their current form, would have a material effect on its financial condition or results of operations.\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 revised the bank regulatory and funding provisions of the Federal Deposit Insurance Act and made significant revisions to several other federal banking statutes. FDICIA provides for, among other things, (i) a recapitalization of the Bank Insurance Fund of the FDIC (the \"BIF\") by increasing the FDIC's borrowing authority and providing for adjustments in its assessment rates; (ii) annual on-site examinations of federally-insured depository institutions by banking regulators; (iii) publicly available annual financial condition and management reports for financial institutions, including audits by independent accountants; (iv) the establishment of uniform accounting standards by federal banking agencies; (v) the establishment of a \"prompt corrective action\" system of regulatory supervision and intervention, based on capitalization levels, with more scrutiny and restrictions placed on depository institutions with lower levels of capital; (vi) additional grounds for the appointment of a conservator or receiver; (vii) a requirement that the FDIC use the least- cost method of resolving cases of troubled institutions in order to keep the costs to insurance funds at a minimum; (viii) more comprehensive regulation and examination of foreign banks; (ix) consumer protection provisions including a Truth-in-Savings Act; (x) a requirement that the FDIC establish a risk-based deposit insurance assessment system; (xi) restrictions or prohibitions on accepting brokered deposits, except for institutions which significantly exceed minimum capital requirements; and (xii) certain additional limits on deposit insurance coverage.\nFDICIA also provides for increased funding of the FDIC insurance fund through a risk-related premium schedule for insured depository institutions. Under this schedule, premiums range from 0.23% for the best capitalized, healthiest institutions, to 0.31% for the weakest institutions. The Bank's premium for the semi-annual assessment period beginning January 1, 1995, will be 0.23% of insured deposits. Following the proposed acquisition of 15 branches from The Chase Manhattan Bank, N.A. (See \"Pending Acquisition\"), it is anticipated that the Bank's premium will increase to 0.26%.\nFDICIA requires federal banking agencies to take \"prompt corrective action\" with respect to banks that do not meet minimum capital requirements. FDICIA establishes five capital tiers: \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized,\" and \"critically undercapitalized.\" The following table sets forth the minimum capital ratios that a bank must satisfy in order to be considered \"well capitalized\" or \"adequately capitalized\" under Federal Reserve Board regulations:\nAdequately Capitalized Well Capitalized Total Risk-Based Capital Ratio 8% 10% Tier I Risk-Based Capital Ratio 4% 6% Tier I Leverage Ratio 4% 5%\nIf a bank does not meet all of the minimum capital ratios necessary to be considered \"adequately capitalized,\" it will be considered \"undercapitalized,\" \"significantly undercapitalized,\" or \"critically undercapitalized,\" depending upon the amount of the shortfall in its capital. As of December 31, 1994, the Bank's total risk-based capital ratio and Tier I risk - based capital ratio were 13.68% and 12.43%, respectively, and its Tier I leverage ratio as of such date was 6.83%. As a result of the Acquisition and the infusion of additional capital from the Offerings, it is anticipated that the Bank will be classified as \"adequately capitalized.\" See \"Pending Acquisition--Regulatory Conditions\/Capital Plan.\"\nNotwithstanding the foregoing, if its principal federal regulator determines that an \"adequately capitalized\" institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice, it may require the institution to submit a corrective action plan, restrict its asset growth and prohibit branching, new acquisitions and new lines of business. Among other things, an institution's principal federal regulator may deem the institution to be engaging in an unsafe or unsound practice if it receives a less than satisfactory rating for asset quality, management, earnings or liquidity in its most recent examination.\nPossible sanctions for undercapitalized depository institutions include a prohibition on the payment of dividends and a requirement that an institution submit a capital restoration plan to its principal federal regulator. The capital restoration plan of an undercapitalized bank will not be approved unless any holding company that controls the bank guarantees the bank's performance. The obligation of a controlling bank holding company to fund a capital restoration plan is limited to the lesser of five percent (5%) of an undercapitalized subsidiary's assets or the amount required to meet regulatory capital requirements. If an undercapitalized depository institution fails to submit or implement an acceptable capital restoration plan, it can be subjected to more severe sanctions, including an order to sell sufficient voting stock to become adequately capitalized. Critically undercapitalized institutions are subject to the appointment of a receiver or conservator.\nIn addition, FDICIA requires regulators to impose new non-capital measures of bank safety, such as loan underwriting standards and minimum earnings levels. Regulators are also required to perform annual on-site bank examinations, place limits on real estate lending by banks and tighten auditing requirements.\nMany of the provisions of FDICIA will be implemented through the adoption of regulations by the various federal banking agencies. Although the precise effect of the legislation on the Company and the Bank therefore cannot be assessed at this time, the Company does not anticipate that such regulations will materially affect its operating results, financial condition or liquidity.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company leases its administrative offices at 5790 Widewaters Parkway, DeWitt, New York. The Bank owns its regional offices in Olean, New York and Canton, New York. Of the Bank's 36 branch offices, 32 are owned by the Bank, and four are located on long-term leased premises.\nReal property and related banking facilities owned by the Company at December 31, 1994 had a net book value of $10.6 million and none of the properties was subject to any encumbrances. For the year ended December 31, 1994, rental fees of $502,312 were paid on facilities leased by the Bank for its operations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn March 28, 1995 the Company received papers in connection with a lawsuit filed by three shareholders in the Supreme Court of the State of New York, Albany County, against the Company, the Bank, and its directors. The complaint alleges that the Company's and the Bank's directors failed to exercise due care and breached their fiduciary duties in connection with entering into the Purchase and Assumption Agreement (\"Agreement\") with The Chase Manhattan Bank, N.A. on December 6, 1994 for the acquisition of certain assets and assumption of certain liabilities by the Bank related to 15 Chase branch offices (\"Acquisition\"). The action seeks to enjoin the consummation of the Agreement, offering of stock in connection with the Acquisition, or performing any acts in furtherance of the consummation of any stock offerings.\nThe three defendants bring the action individually and derivatively on behalf of the Company. The Company and the directors have retained legal counsel and expect to vigorously defend against the action. The Company intends to defend and indemnify the directors in accordance with the Company's Bylaws and Delaware law.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders Not applicable\nExecutive Officers of the Registrant The following table sets forth certain information about the principal executive officers of the Company and the Bank, each of whom is elected by the Board of Directors and each of whom holds office at the discretion of the Board of Directors.\nName and Age Position\nSanford A. Belden President and Chief Age 52 Executive Officer of the Company and the Bank\nDavid G. Wallace Treasurer of the Company Age 50 and Senior Vice President and Chief Financial Officer of the Bank\nJames A. Wears Regional President, Age 45 Northern Region of the Bank\nMichael A. Patton Regional President, Age 49 Southern Region of the Bank\nSanford A. Belden (Director; President and Chief Executive Officer of the Company and the Bank). Mr. Belden has been President and Chief Executive Officer of the Company and the Bank since October 1, 1992. Mr. Belden was formerly Manager, Eastern Region, Rabobank Nederland, New York, New York from 1990 to 1992 and prior thereto served as President, Community Banking for First Bank System, Minneapolis, Minnesota, a multi- state bank holding company.\nMichael A. Patton (Regional President, Southern Region of the Bank). Mr. Patton was the President and Chief Executive Officer of The Exchange National Bank, a former subsidiary of the Company, from 1984 until January 1992, when, in connection with the consolidation of the Company's five subsidiary banks into the Bank, he was named to his current position as Regional President for the Southern Region of the Bank.\nDavid G. Wallace (Treasurer of the Company; Senior Vice President and Chief Financial Officer of the Bank). Mr. Wallace became Vice President and Chief Financial Officer in November 1988, and has been Senior Vice President and Chief Financial Officer since August 1991.\nJames A. Wears (Regional President, Northern Region of the Bank). Mr. Wears served as Senior Vice President of The St. Lawrence National Bank, a former subsidiary of the Company, from 1988 through January 1991, and as its President and Chief Executive Officer from January 1991 until January 1992. Following the January 1992 consolidation of the Company's five subsidiary banks into the Bank, Mr. Wears was named to his current position as Regional President for the Northern Region of the Bank.\nPart II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThe Common Stock has been traded over-the-counter on the Nasdaq National Market under the symbol \"CBSI\" since September 16, 1986. The following table sets forth the high and low bid quotations for the Common Stock, and the cash dividends declared with respect thereto, for the periods indicated. The quotations represent bid prices between dealers, do not include retail mark-ups, mark-downs or commissions, and do not necessarily represent actual transactions. There were 2,788,150 shares of Common Stock outstanding on March 10, 1995 held by approximately 1,720 shareholders of record.\nPrice Range Cash Dividend ---------------------- Declared Per High Low Share -------------\n1994:\nFirst Quarter $30.75 $28.50 $0.27 Second Quarter 30.50 28.50 0.27 Third Quarter 31.75 29.00 0.30 Fourth Quarter 31.75 25.75 0.30\n1.14\n1993:\nFirst Quarter $30.50 $27.88 $0.25 Second Quarter 30.00 26.00 0.25 Third Quarter 30.00 25.00 0.27 Fourth Quarter 30.75 23.00 0.27\n1.04\nThe Company has historically paid regular quarterly cash dividends on its Common Stock, and declared a cash dividend of $0.30 per share for the first quarter of 1995. The Board of Directors of the Company presently intends to continue the payment of regular quarterly cash dividends on the Common Stock, as well as to make payment of regularly scheduled dividends on the Preferred Stock as and when due, subject to the Company's need for those funds. However, because substantially all of the funds available for the payment of dividends by the Company are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition, its need for funds and applicable governmental policies and regulations. See \"Supervision and Regulation -- Limits On Dividends and Other Payments.\"\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following table sets forth selected consolidated historical financial data of the Company as of and for each of the years in the five year period ended December 31, 1994. The historical \"Income Statement Data\" and historical \"Statement of Condition Data\" are derived from financial statements which have been audited by Coopers & Lybrand L.L.P., independent public accountants. The \"Per Share Data\", \"Selected Ratios\" and \"Other Data\" for all periods are unaudited. All financial information in this table should be read in conjunction with the information contained in \"Capitalization,\" \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and with the Consolidated Financial Statements and the related notes thereto included elsewhere in this Prospectus. See also \"Pending Acquisition -- Impact of the Acquisition on Operating Performance\" for a discussion of the impact of the Acquisition on certain of the Selected Consolidated Financial Information.\nItem 7.","section_7":"Item 7. Management Discussion and Analysis of Financial Condition and Results of Operations\nThe following discussion is intended to facilitate an understanding and assessment of significant changes in trends related to the financial condition of the Company and the results of its operations. The following discussion and analysis should be read in conjunction with the Selected Consolidated Financial Data and the Company's Consolidated Financial Statements and related notes thereto appearing elsewhere in this Prospectus. All references in the discussion to financial condition and results of operations are to the consolidated position and results of the Company and its subsidiaries taken as a whole.\nResults of Operations\nIn 1994, the Company's net income increased 5.6% from $9.6 million in 1993 to $10.1 million, a record level for the Company. In 1994, earnings per share reached $3.59, up 4.7% over the $3.43 reported in 1993. 1992's net income was $7.5 million or $2.76 per share. The Company's earnings growth in 1994 was influenced by the following factors:\n* Net interest income on a fully tax-equivalent basis increased 6.3% over 1993, reflecting earning asset growth of 18.1%, which more than offset the impact of a 59 basis point decline in the Company's net interest margin from its historical annual high in 1993.\n* Non-interest income was up 7.5% over 1993 due largely to continued strength in fiduciary services income, the first-year impact of new investment product sales, and growth in general service charges, commissions and fees; excluding net losses on the sale of investment securities and other assets, non-interest income rose 17.6% over 1993.\n* Non-interest expense increased 6.7% over 1993, reflecting increased staff related to four branches acquired by the Bank in 1994, certain related conversion costs, and amortization of deposit intangibles associated with these branch purchases.\n* Loan loss provision expense rose 13.0%, generally consistent with record loan growth of 15.6%; net charge-offs were $1.1 million, or 0.25% of average loans, with the provision covering net charge-offs by 1.5 times.\nThese results reflect the fourth consecutive year of increased earnings since the Company consolidated its five commercial bank subsidiaries into a single-bank entity and ceased operations of unprofitable nonbank subsidiaries. No further expenses relating to this consolidation were incurred in 1994. In 1993, one-time expenditures related to the consolidation amounted to $164,000, due primarily to costs associated with closing the Bank's marketing representative office in Ottawa, Canada. In 1992, consolidation-related costs were a substantially greater $812,000.\nThe Company's return on average stockholders' equity was 15.79% in 1994, as compared to 16.71% in 1993 and 14.69% in 1992. The return on average total assets for 1994 was 1.25%, as compared to 1.40% for 1993 and 1.15% for 1992.\nNet Interest Income\nNet interest income, the largest single component of the Company's earnings, represents the difference between income earned on loans and other earning assets and interest expense paid on deposits and borrowing. Net interest margin is the difference between the gross yield on interest-earning assets and the cost of interest-bearing funds as a percent of average interest-earning assets.\nThe Company's net interest income is affected by the change in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as a \"volume change.\" It is also affected by changes in yields earned on assets and rates paid on deposits and other borrowed funds, referred to as a \"rate change.\"\nThe following table sets forth certain information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and resultant yield information in the table is on a fully tax-equivalent basis for the three-year period ended December 31, 1994 using marginal federal income tax rates of 22%, 34% and 34%, respectively. Averages are computed on daily average balances for each month in the period divided by the number of days in the period. Yields and amounts earned include loan fees. Non-accrual loans have been included in interest-earning assets for purposes of these computations.\nThe Company's net interest income, on a fully tax-equivalent basis, was $40.1 million in 1994. This represented a $2.4 million or 6.3% increase from 1993 and resulted primarily from growth in interest-earning assets. Net interest income grew $2.8 million or 8.0% in 1993 over 1992. Over $600,000 of 1993's growth reflects premiums received on $12.9 million in investment securities called for redemption.\nAverage interest-earning assets grew by $116.8 million in 1994, after increasing by $38.4 million in 1993 and $25.3 million in 1992. Slightly less than half of 1994's growth was made possible by an expanded deposit base, with branch acquisitions contributing approximately 60% of that deposit increase. Greater short-term borrowing from the FHLB provided the balance of funding needed to support 1994 interest-earning asset growth. In 1994, average loans increased $63.5 million or 16.6% over 1993, while average investments increased $55.1 million or 21.6% over 1993. The components of 1993's growth were a 9.0% increase in average loans over 1992 and a 5.5% rise in average investments.\nAverage net interest margin decreased 59 basis points to 5.31% in 1994, as compared to 5.90% in 1993 and 5.82% in 1992. For the fourth quarter of 1994, the average net interest margin was 5.11%. This most recent level reflects a decline from the peak achieved in the fourth quarter of 1992 of 6.16%. During 1993, rates on interest-bearing liabilities fell more slowly than the decline in interest-earning asset yields. In 1994, interest-earning asset yields continued to decrease through early spring before turning up with a lag in response to the rising prime and other financial market rates. As such, yields ended the year slightly higher than they began. On the other hand, the average rate paid on interest-bearing liabilities increased in the first quarter of 1994, coincident with the rise in the Federal Funds rate, and ended the year almost three quarters of a point higher than where it started.\nThe above rate patterns reflect the changing financial market environment and the structure of the Bank's balance sheet. More specifically, the Company's deposits have a shorter maturity or are subject to repricing more frequently than its loans and investments, both of which are more fixed-rate in nature but with a high degree of cash flow. As a result, with the exception of prime rate-based loans, the Bank's overall yield on interest-earning assets adjusts more slowly than rates paid on certificates of deposit; moderating this latter impact is the typical lag of rate changes on regular savings and money market accounts behind certificates of deposit repricing. Rates on the Bank's FHLB borrowing, the majority of which are overnight or mature within 30 days, mirror the rise in the Federal Funds rate.\nNet interest income may also be analyzed by segregating the volume and rate components of interest income and interest expense. The following table sets forth for the periods indicated a summary of the changes in net interest income for each major category of interest-earning assets and interest-bearing liabilities resulting from volume changes and rate changes:\n(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of change in each.\n(2) Changes due to volume and rate are computed from the respective changes in average balances and rates of the totals; they are not a summation of the changes of the components.\nAs a result of narrower margins, all of the increase in the Company's net interest income in 1994 was due to interest-earning asset growth. More specifically, approximately $6.4 million of 1994's growth in net interest income was due to higher volume offset by $4.0 million from narrower margins. This mix is in contrast to 1993's improvement in net interest income of $2.8 million of which wider margins contributed approximately $500,000.\nNon-Interest Income\nNon-interest income is comprised principally of fees from banking operations and revenues from one-time events, such as net gains\/losses from the sale of investments, loans, and miscellaneous assets. Management's focus is to build recurring fee-based income sources and to take advantage of one-time events when they support a specific business objective.\nIn 1994, non-interest income was $5.1 million as compared to $4.8 million in 1993 and $5.1 million in 1992. All subcategories of recurring non-interest income showed an increase in 1994 but were partially offset by non-recurring investment security losses. The following table sets forth information by category of non- interest income for the Company for the years indicated:\nYears ended December 31, -------------------------------------------- 1994 1993 1992 --------- --------- -------- (In thousands)\nFiduciary and investment services $1,380 $1,113 $ 898 Service charges on deposits 1,621 1,478 1,419 Overdraft fees 971 901 847 Other service charges and fees 1,519 1,186 1,455 Other operating income 131 101 279 Investment security gains (losses) (502) (15) 184 --------- --------- -------- Total $5,120 $4,764 $5,082\nTotal non-interest income (excluding investment security gains (losses) as a percentage of average assets) 0.69% 0.70% 0.75%\nIncome from fiduciary services increased $267,000, or 24.0% from 1993, to approximately $1.4 million in 1994, primarily attributable to increased business development efforts. Service charges and overdraft fees grew to approximately $2.6 million, a 9.0% increase due to a higher deposit base and the Company's commitment to reduce fee waivers. Investment services (selling mutual funds and annuities through the Bank's branch network and financial service representatives in selected geographic markets) was a new product offered in 1994. Income generated from this product in 1994 was $148,000, and is included in other service charges and fees.\nInvestment security losses of $502,000 in 1994 were caused by the sale of approximately $27.2 million in investment securities. Investment security losses in 1993 were $15,000, while investment security gains in 1992 were $184,000. The $318,000 decline in non-interest income from 1992 to 1993 was due to this difference in investment security gains and the absence of fees associated with the Company's non-bank computer subsidiary, which was closed in late 1992.\nNon-Interest Expense\nThe following table sets forth information by category of non- interest expenses of the Company for the years indicated:\nYears ended December 31, --------------------------------------------- 1994 1993 1992 --------- --------- --------- (In thousands)\nSalary expense $10,486 $9,631 $9,932 Payroll taxes and benefits 2,612 2,321 2,010 Net occupancy expense 2,043 1,814 1,849 Equipment expense 1,697 1,642 2,327 Professional fees 1,282 1,528 1,417 Data processing expense 2,573 2,193 1,805 Amortization 355 166 348 Stationary and supplies 739 696 898 Deposit insurance premiums 1,390 1,317 1,308 Other 3,321 3,519 4,553 --------- --------- --------- Total $26,498 $24,827 $26,447\nTotal operating expenses as a percentage of average assets 3.28% 3.63% 4.06%\nEfficiency ratio (1) 57.94% 58.45% 65.48%\n(1)Non-interest expense to recurring operating income\nNon-interest expenses increased $1.7 million, or 6.7%, to $26.5 million in 1994, compared to a decline of $1.6 million, or 6.1%, from 1992 to 1993. Salary expenses comprised the largest share of non-interest expense, increasing 8.9% from 1993 to 1994 after decreasing 3.0% from 1992 to 1993. The increase in 1994 is a result of 34 additional full-time employees hired largely to support four new branches and business development efforts. The decrease from 1992 to 1993 was due to the closing of a non-bank subsidiary late in 1992.\nAmortization, supplies, data processing, net occupancy, and FDIC insurance premiums increased in 1994 in comparison to 1993 as a result of the Bank's acquisition of three Columbia Savings FSA branches from the Resolution Trust Company in June 1994 and the Bank's acquisition of Chase's Cato, New York branch in October 1994.\nIncome Tax Expense\nTotal income tax expense of the Company was approximately $6.3 million, $5.8 million and $3.1 million in 1994, 1993, and 1992, respectively. The Company's effective income tax rate for the years 1994, 1993 and 1992 was 38.2%, 37.6%, and 29.5%, respectively. Year-to-year increases are the result of higher taxable operating revenues and a higher effective tax rate.\nEffective January 1993, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes\", which requires an asset-liability approach to recognizing the tax effects of temporary differences between tax and financial reporting. In prior years, the Company accounted for the tax effects of timing differences between tax and financial reporting using Accounting Principle Board Opinion Number 11. This change had no significant effect on the 1993 consolidated financial statements.\nAsset\/Liability Management\nAsset\/liability management involves the maintenance of an appropriate balance between interest sensitive assets and interest sensitive liabilities to reduce interest rate exposure while also providing liquidity to satisfy the cash flow requirements of operations and to meet customers' fluctuating demands for funds, either in terms of loan requests or deposit withdrawals.\nThe Company's management has placed an increased emphasis on interest rate sensitivity management. Interest-earning assets and interest-bearing liabilities are those which have yields or rates which are subject to change within a future time period due to maturity of the instrument or changes in the rate environment. Gap refers to the difference between interest-earning assets and interest-bearing liabilities repricing within given time frames. As a result, major fluctuations in net interest income and net earnings could occur due to imbalances between the amounts of interest-earning assets and interest-bearing liabilities, as well as different repricing characteristics. Asset\/liability management seeks to protect earnings by maintaining an appropriate balance between interest- earning assets and interest-bearing liabilities in order to minimize fluctuations in the net interest margin and net earnings in periods of volatile interest rates.\nA tool known as a gap maturity matrix is used to isolate interest rate sensitivity or repricing mismatches between assets and liabilities. The diagonal band on the matrix indicates basic matching of asset\/liability repricing and maturity opportunities. Outstandings shown above the band are assets subject to repricing more quickly than their supporting liabilities (asset sensitivity). Outstandings shown below the band are liabilities subject to repricing more quickly than the assets which they support (liability sensitivity).\nThe following is the Company's gap maturity matrix as of December 31, 1994:\nNote: IPC = Accounts of individuals, partnerships, and corporations. Public = Accounts of U.S. government, state, and local municipalities. 85% of IPC Savings are treated as core (> 60 months). 100% of Public Fund Savings are treated as 181 - 360 days. 95% of IPC Money Markets are treated as core (91 - 180 days). 100% of Public Fund Money Markets are treated as 181-360 days. 15% of IPC Savings are spread over 24 months, and 5% of IPC Money Markets are in 181 to 360 days. Totals may not foot due to rounding.\nThe following table sets forth information concerning interest rate sensitivity of the Company's consolidated assets and liabilities as of December 31, 1994:\nAs of December 31, 1994, the Bank was structurally liability sensitive in both its short-term (under one year) strategic planning horizon and in its long-term (over one year) horizon. Much of this sensitivity was the result of funding longer-term fourth quarter investment purchases with shorter-term borrowing. Such a funding mismatch was carried out with the intention that such borrowing would be temporary in nature. These short-term borrowings are expected to be replaced with lower cost core deposit liabilities assumed in the Acquisition. See \"Pending Acquisition.\"\nLiquidity and Borrowing\nThe primary objective of liquidity management is to maintain a balance between sources and uses of funds in order that the cash flow needs of the Bank are met in the most economical and expedient manner. The liquidity needs of a financial institution require the availability of cash to meet the withdrawal demands of depositors and the credit commitments of borrowers. Due to the potential for unexpected fluctuation in deposits and loans, active management of the Bank's liquidity is critical. In order to respond to these circumstances, sources of both on- and off-balance sheet funding are in place.\nTraditionally, the Bank has relied on such sources as cash on hand, loan and investment maturities, and large certificates of deposit to fund liquidity needs. The Bank has chosen to expand its sources to include lines of credit with the FHLB and other correspondent banks, as well as securities repurchase agreements with a number of brokerage firms. Excess short-term borrowing capacity available for use as of December 31, 1994 amounted to approximately $116.9 million, compared to $84.4 million as of December 31, 1993. This increase was largely due to the increased size of the investment portfolio, which provided additional borrowing capacity under securities repurchase agreements.\nThe Bank's primary approach to measuring liquidity is known as the Basic Surplus\/Deficit model. It is used to calculate liquidity over two time periods: first, the relationship within 30 days between liquid assets and short term liabilities which are vulnerable to non-replacement; and second, a projection of subsequent cash flow funding needs over an additional 60 days. The Bank's minimum policy level of liquidity under the Basic Surplus\/Deficit model is 7.5% of total assets for both the 30- and 90-day time horizons. At December 31, 1994, this ratio was 12.8% and 13.3%, respectively.\nAs of December 31, 1994, borrowing amounted to $162.9 million as compared to $59.6 million at December 31, 1993. Although this increase is attributable in part to seasonal deposit fluctuations and greater than expected fourth quarter loan demand, the majority of new funding was to support management's investment portfolio objectives during 1994. Average borrowing for the year totaled $87.3 million versus $23.0 million in the prior year. The Chase Deposits are expected to be used to repay the Bank's currently outstanding short-term borrowing. See \"Pending Acquisition.\"\nCapital Resources\nThe Company's Tier I capital to risk-weighted assets ratio at December 31, 1994 was 12.43%, compared to 14.87% at December 31, 1993 and 13.13% at December 31, 1992. These ratios exceed the regulatory Tier I capital requirement of 4.00%. The Company's total risk-based capital to risk- weighted assets ratio at December 31, 1994 was 13.68% as compared to 16.12% at December 31, 1993 and 14.37% at December 31, 1992. These ratios exceeded the regulatory total risk-based capital requirement of 8.00%. The Company's Tier I leverage ratio at December 31, 1994 was 6.83%, compared to 8.46% at December 31, 1993 and 7.90 at December 31, 1992. These ratios exceeded the regulatory Tier I leverage ratio requirement of 4.00%.\nLoan Portfolio\nNet loans grew 15.7% from $412.2 million in 1993 to $476.8 million in 1994. This increase was achieved in most loan categories and was attributable to business development efforts by the Bank's lending personnel. The largest volume gain was realized in installment loans to individuals.\nThe amounts of the Bank's loans outstanding (net of deferred loan fees or costs) at the dates indicated are shown in the following table according to type of loan:\nReal Estate Mortgages. Real estate mortgages increased 10.3% in 1994, as compared to 22.2% in 1993 and 27.3% in 1992. Significant increases in residential real estate mortgages reflected the nationwide surge in refinancing, but slowed in 1994 due to increasing interest rates. Outstandings of the Bank's home equity loan product have continued to grow in recent years in response to its tax-deductible nature and the Bank's marketing efforts.\nCommercial, Financial, and Agricultural. Growth in this category of 16.4% in 1994 and 37.8% in 1993 was due to increased business development efforts as a result of adding commercial lenders to marketplaces in the Southern Region and an agricultural lender in the Bank's Northern Region. The economic recession which began in mid-1990 caused the decrease in volumes from 1990 to 1992. Approximately 90% of the Bank's commercial customers borrow less than $100,000, which as a group constitute half of commercial loans outstanding.\nInstallment Loans to Individuals. The 21.6% increase in this category in 1994 reflects a reversal of the declining trend reflected for 1990 through 1993. This reversal resulted from increased demand for installment debt indirectly originated through automobile, marine and mobile home dealers. This type of lending has been strong in the Bank's Northern Region for a number of years, while the commitment to indirect lending in the Southern Region was re-emphasized in late 1993 with continued growth in 1994. The declining trend from 1990 through 1993 resulted from the 1990-91 national recession and the lag in economic rebound in the rural New York State markets in which the Bank does business.\nMaturities and Sensitivities of Loans to Changes in Interest Rates\nThe following table shows the amount of loans outstanding as of December 31, 1994 which, based on remaining scheduled repayments of principal, are due in the periods indicated:\nThe following table sets forth the sensitivity of the amounts due after one year to changes in interest rates:\nNon-Performing Assets\nThe following table presents information concerning the aggregate amount of non-performing assets:\nAt December 31, --------------------------------------------- 1994 1993 1992 1991 1990 ---- ---- ---- ---- ---- (Dolloars in thousands)\nLoans accounted for on a non-accrual basis 2,396 1,738 881 1,369 2,064 Accruing loans which are contractually past due 90 days or more as to principal or interest payments 862 653 726 957 1,138 --------------------------------------------- Total non-performing loans 3,258 2,391 1,607 2,326 3,202\nLoans which are \"troubled debt restructurings\" as defined in Statement of Financial Accounting Standards No. 15 \"Accounting by Debtors and Creditors for Troubled Debt Restructurings\" 15 243 356 1,720 1,423\nOther real estate 223 433 459 1,426 430 --------------------------------------------- Total non-performing assets 3,496 3,067 2,422 5,472 5,055 =============================================\nRatio of allowance for loan losses to period-end loans 1.30% 1.37% 1.37% 1.24% 0.99%\nRatio of allowance for loan losses to period-end non-performing loans 192.79% 238.67% 310.05% 185.40% 112.64%\nRatio of allowance for loan losses to period-end non-performing assets 179.67% 186.06% 205.72% 78.81% 71.35%\nRatio of non-performing assets to period-end total loans and other real estate owned 0.72% 0.73% 0.67% 1.56% 1.38%\nThe impact of interest not recognized on non-accrual loans, and interest income that would have been recorded if the restructured loans had been current in accordance with their original terms, was immaterial. CBSI's policy is to place a loan on a non-accrual status and recognize income on a cash basis when it is more than ninety days past due, except when in the opinion of management it is well secured and in the process of collection.\nNon-performing loans, defined as non-accrual loans plus accruing loans 90 days or more past due, totaled $3.3 million at December 31, 1994. This level is approximately $870,000 higher than at year-end 1993, largely due to a construction loan where recent cost overruns delayed permanent financing by the Farmers' Home Administration. At year-end 1993, a more critical view of certain commercial credits was taken by the Company's then new chief executive officer and lending personnel added as a result of organizational turnover; the result was an increase in non-performing loans of about $780,000 to $2.4 million.\nTotal delinquencies, defined as all loans over 30 days past due, decreased 2.7% in 1994 to $6.8 million. The general reduction in delinquencies reflects the consolidation of the Southern Region collection department, heavy emphasis on taking prompt corrective action, and adherence to a strict and timely charge-off policy. Other real estate owned totaled approximately $223,000, or 0.02% of total assets.\nDuring 1993, the Financial Accounting Standards Board issued Statement No. 114, \"Accounting By Creditors for Impairment of a Loan.\" This pronouncement, effective for fiscal years beginning 1995, is not expected to have a material effect on the Company's financial statements.\nSummary of Loan Loss Experience\nThe following table summarizes loan balances at the end of each period indicated and the daily average amount of loans. Also summarized are changes in the allowance for possible loan losses arising from loans charged off and recoveries on loans previously charged off and additions to the allowance which have been charged to expenses.\n(1) The additions to the allowance during 1990 through 1994 were determined using actual loan loss experience and future projected loan losses and other factors affecting the estimate of possible loan losses.\nLoans charged off in 1994 totalled $1.6 million as compared to $1.4 million in 1993 and $2.6 million in 1992. Net loans charged off totaled $1.1 million in 1994, $782,000 in 1993, and $2.1 million in 1992.\nThe allowance for possible loan losses has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at the dates indicated:\nInvestment Portfolio\nAs of December 31, 1994, the carrying value of the Company's total investment portfolio was $378.5 million, up $125.1 million from the prior year. Approximately 77.2% of the carrying value of the Company's total investment portfolio is designated \"held-to-maturity\" and the balance is designated held \"available-for-sale.\"\nThe following table sets forth the amortized cost and market value for the Company's held-to-maturity investment securities portfolio:\nThe following table sets forth the amortized cost and market value for the Company's available-for-sale investment portfolio:\n(1) Includes $13,805, $13,805, $4,396 and $4,396 of FHLB common stock at December 31, 1994 and 1993, respectively.\nThe following table sets forth the amortized cost and market value as of December 31, 1992:\nAmortized Market Cost Value --------------------------- U.S. Treasury securities and obligations of U.S. government corporations and agencies $ 106,797 $ 112,679\nObligations of states and political subdivisions 27,940 29,207\nCorporate securities 5,182 5,254\nMortgage-backed securities 117,931 120,936\nEquity securities 4,448 4,459\nFederal Reserve Bank common stock 500 500\n- -------------------------------------------------------------------- TOTALS $ 262,798 $ 273,035 ====================================================================\nThe 49.3% increase between 1993 and 1994 in the carrying value of the Company's investment portfolio is largely attributed to an unusually low starting balance at the beginning of 1994 as well as by investment of the net proceeds from $75.2 million in deposits assumed in 1994 through the acquisition of four branches. In late 1993, the Company allowed the portfolio to mature rather than aggressively purchase new securities during a time of historically low interest rates. This decision continued into the first quarter of 1994 until February, when the initial increase in overnight rates by the Federal Reserve Bank occurred. In addition to the funds provided by the branch acquisitions, growth in the investment portfolio was supported by $85.8 million in increased FHLB borrowing during the last nine months of 1994.\nAs interest rates began their rise in the first quarter of 1994, the Company began to pursue a strategy that focused on purchasing securities with high cash flow characteristics. Bonds purchased during this period included premium 15-year and balloon mortgage-backed securities. The average duration of these instruments ranged from 1.5 to 3.4 years.\nAs the movement in longer-term rates began to stabilize further in 1994, the Company's investment securities objective moved away from cash flow production to call protection. Bonds purchased during this period included ten-year agency debentures with three-and five-year embedded call options. Depending on whether the embedded call options are exercised at a future date, the average duration of these instruments ranged between 2.5 and 6.6 years.\nFinally, as the yield curve flattened late in the fourth quarter, purchases were largely confined to slightly discounted, intermediate-term mortgage- backed securities. The average duration of these instruments ranged between 4.0 and 5.0 years while providing a modest level of cash flow for reinvestment purposes.\nDuring 1994, the composition of the Company's investment portfolio continued to shift away from the municipal, corporate and private sectors to U.S. Government agency bonds and agency mortgage-backed obligations. As of December 31, 1994, the latter two security types represented approximately 90% of total portfolio investments, up from a level of 88% at year-end 1993. The portfolio's weighting under risk-based capital requirements at December 31, 1994 was 18.1%, up slightly from 16.6% as of December 31, 1993.\nThe average life of the portfolio, including the exercise of embedded call options, extended to 3.5 years as of December 31, 1994. As of December 31, 1993, the average life of the portfolio stood at 2.3 years. The investment strategies pursued during 1994 were largely responsible for this extension.\nAverage investment yields for 1994 declined to 6.95% from 7.24% for 1993 (adjusted for a one-time benefit in 1993 of approximately $600,000 in option-adjusted premiums received from agency debentures called prior to maturity). This decrease is attributed to lower investment yields on securities purchased in the latter half of 1993 and early 1994.\nDuring the fourth quarter of 1994, the Company chose to sell $27.2 million in securities from its available-for-sale portfolio, replacing lower yielding investments with higher yielding investments. Although these sales produced a net pre-tax loss of approximately $502,000 for the quarter, the loss is expected to be recaptured in 1995 through the higher yields earned from reinvestment of the sales proceeds. In addition, the reinvestment will produce a higher level of future earnings, net of the pre-tax loss, over the average term-to-maturity of the investments sold.\nThe following table sets forth as of December 31, 1994, the maturities of investment securities and the weighted-average yields of such securities, which have been calculated on the basis of the cost, weighted for scheduled maturity of each security, and adjusted to a fully tax-equivalent basis:\n(1) Weighted-average yields on the tax-exempt obligations have been computed on a fully tax-equivalent basis assuming a marginal federal tax rate of 34%. These yields are an arithmetic computation of accrued income divided by average balance; they may differ from the yield to maturity, which considers the time value of money.\nDeposits\nThe Bank offers a variety of deposit instruments typical of most commercial banks. Total deposits averaged $651.5 million in 1994, $598.9 million in 1993 and $585.6 million in 1992. The deposit growth of 8.8% in 1994 was almost four times the growth rate in 1993. This rate is attributed largely to the Bank's three branch purchases in the middle of 1994 and one in the fourth quarter of 1994. The growth rate in 1992 was 3.4%.\nWith the exception of 1994, the Bank's level of stable core deposits has climbed at a faster rate than total deposits; the 1990-1994 average core deposit growth rate was 6.3% versus 4.7% for all deposits. The difference represents the Company's objective to reduce certificates of deposit of $100,000 or more when a satisfactory margin cannot be earned over the prevailing large deposit market rate or when other more cost effective forms of temporary borrowing can be obtained. In 1994 certificates of deposit increased over the prior year because rates in certain maturities were competitive with FHLB borrowings.\nDeposits of local municipalities accounted for $81.2 million or 13.2% of average core deposits in 1994. The average daily amount of deposits and the average rate paid on each of the following deposit categories is summarized below for the years indicated:\nThe remaining maturities af time deposits in amoints of $100,000 or more outstanding at December 31, 1994 and 1993 are summarized below:\nAt December 31, (Dollars in Thousands)\n1994 1993 --------- --------- Less than three months $29,963 $12,410\nThree months to six months 9,983 7,869\nSix months to one year 4,248 1,881\nOver one year 3,589 85 --------- ---------\n$47,783 $22,245 ========= =========\nBorrowing\nThe following table summarizes the outstanding balances of short-term borrowing of the Company for the years indicated:\nYear-end 1994 total short-term borrowing amounted to $162.3 million as compared to $57.0 million at year-end 1993. While a portion of this borrowing was attributable to seasonal deposit fluctuations and greater than expected fourth quarter loan demand, the majority of new funding was to support the Company's investment portfolio objectives during 1994. Average borrowing for the year totaled $87.3 million versus $23.0 million in 1993. The Chase Deposits are expected to be used in part to repay the Bank's currently outstanding short-term borrowings. See \"The Acquisition.\"\nReturn on Assets and Equity\nReturn on average assets, return on average equity, dividend payout and equity to asset ratios for the years indicated are as follows:\nYear ended December 31, ------------------------------------- 1994 1993 1992 ---- ---- ----\nPercentage of net income to: average total assets 1.25% 1.40% 1.15%\nPercentage of net income to 15.79 16.71 14.69 average shareholders equity\nPercentage of dividends 31.24 29.67 32.26 declared per common share to net income per common share\nPercentage of average 7.92 8.37 7.85 shareholder's equity to average total assets\nEffects of Inflation\nThe financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles which 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.\nVirtually all of the assets and liabilities of the Company are monetary in nature. As a result, interest rate changes have a more significant impact on the Company's performance than the effects of general levels of inflation.\nPENDING ACQUISITION\nThe Bank and the Company have entered into a Purchase and Assumption Agreement (the \"Agreement\") with The Chase Manhattan Bank, N.A. (\"Chase\") for the acquisition of certain assets and the assumption of certain liabilities (the \"Acquisition\") relating to 15 Chase branch offices located in Norwich, Watertown (two), Boonville, New Hartford, Utica, Skaneateles, Geneva, Pulaski, Seneca Falls, Hammondsport, Canton, Newark (two) and Penn Yan, New York (the \"Chase Branches\"). Subject to the terms of the Agreement, on the closing date the Bank will assume deposits booked at the Chase Branches (the \"Chase Deposits\") and pay Chase a premium of 8.25% on the Chase Deposits. As of December 31, 1994, the Chase Deposits totaled $459.1 million, which amount is subject to change due to run-off or growth of deposits occurring prior to the closing date. As of February 28, 1995, the Chase Deposits totaled $451.7 million. In addition, the Bank will acquire certain assets related to the Chase Branches including certain small business and consumer loans (the \"Chase Loans\"), which totaled approximately $25.2 million as of December 31, 1994, at face value, and branch facilities and fixed operating assets associated with the Chase Branches (the \"Chase Assets\") at a purchase price of approximately $5.1 million.\nIt is anticipated that the Acquisition will close during the third quarter of 1995. The closing is contingent upon, among other things, receipt by the parties of all necessary regulatory approvals. In the event that the Bank is unable to proceed to closing due to a lack of regulatory approval or the Company's inability to raise sufficient capital, the Bank is obligated to pay Chase a \"break-up fee\" of up to $1.85 million.\nThe Company and the Bank view the Acquisition as a unique opportunity to augment the Bank's branch network in existing market areas, as well as to expand the Bank's network into contiguous markets in Central and Northern New York State. The acquisition of the Chase Branches provides the opportunity for the Bank to increase its business substantially and improve the quality of its services to existing market areas, without significantly increasing overhead or operating costs.\nReasons for Acquisition\nThe following summarizes the Company's major objectives of the Acquisition and the benefits the Company expects will accrue to the operations of the Bank from the Acquisition:\n* The Chase Branches consolidate and extend the Bank's branch network into contiguous markets, resulting in the Bank having assets in excess of $1.2 billion (after repayment of short-term borrowings) and 50 locations (net of the planned closing of one of the Canton facilities and prior to any potential dispositions). The Chase Branches will link the Bank's existing Northern New York and Finger Lakes\/Southern Tier distribution network.\n* The Chase Branches are located in markets with which the Bank is already familiar, either because it is servicing them to some degree already without a branch facility, or because they are similar to the Bank's existing markets, being comprised of small towns and villages outside of metropolitan trade centers. Of the 13 towns in which the Chase Branches are located, the Chase Branches are ranked either first, second or third in deposit market share as of June 30, 1994 in 10 of the towns, which, when coupled with the Bank's present branches, will result in the Bank being ranked either first, second or third in 36 of the 41 towns in which the Bank will operate branches.\n* Although the Acquisition includes only a relatively small amount of loans outstanding, the depositor base of the Chase Branches includes approximately 300 small business customers and 30,000 consumer households. Because of Chase's centralized style of underwriting and servicing, the Company believes that these markets offer significant future growth opportunities. Based on the Bank's locally responsive approach to loan decision-making, personalized service, and knowledge of these markets, the Bank believes the achievement of a 40.0% loan to deposit ratio in the Chase Branches (compared to a 4.7% level as of the closing date of the Acquisition) to be reasonable within five years. The Bank's loan to deposit ratio for its present branch network is approximately 71.0% as of year-end 1994.\n* The Company believes that the Chase Deposits are largely stable, relatively low cost core deposit funds, similar to the Bank's existing deposit base. The Chase Deposits will be used to replace the Bank's presently higher cost Federal Home Loan Bank of New York (\"FHLB\") borrowings, thus lowering overall funding costs and improving the Bank's liquidity. After providing for purchased loans, branch facilities and equipment, and the deposit premium, approximately $220 million of cash received (net of repayment of short-term borrowings) will be temporarily placed in the Bank's investment portfolio, increasing its size by nearly 60%. It is the Company's intention to invest these funds in a mix of securities intended to produce a high, relatively stable level of interest income and provide on-going cash flow to help fund expected loan growth and\/or be subsequently reinvested in other investment securities.\n* The Acquisition leverages the Company's existing infrastructure. The Chase Branches will be administratively managed from either the Bank's Northern or Southern Region by existing senior management personnel. The Northern and Southern regional service centers will process the added loan and deposit volumes, with incremental overhead limited to volume-sensitive staff and equipment. Similarly, a limited number of audit, loan review, and accounting personnel will be added. A total of approximately 36 full-time employees are expected to be added to the Bank upon consummation of the Acquisition. The personnel acquired from Chase include only branch-related personnel, including approximately 14 small business lending and support staff and three residential mortgage origination personnel, for a total of approximately 117 full-time equivalent employees. To assist with the integration of the Chase Branches into its existing branch network, the Bank has engaged an outside consultant to focus on customer sales and service training, operations center planning and upgrading; a full-time internal project coordinator has also been retained.\nRegulatory Conditions\/Capital Plan\nThe Acquisition is contingent upon obtaining necessary regulatory approvals and maintaining certain regulatory the capital ratios. In order to maintain required regulatory capital ratios, the Company and the Bank must raise additional capital prior to consummation of the Acquisition.\nIn conjunction with the Acquisition, the Company anticipates raising approximately $26.7 million (net of issuance costs) in additional capital through the Offerings to offset the reduction in regulatory capital ratios associated with the Acquisition. The Company will contribute the additional capital to the Bank as capital surplus with the objective of maintaining the Bank's Tier I leverage ratio following consummation of the Acquisition in the \"adequately capitalized\" range which is defined by the FDIC as between 4.0% and 5.0%. Approximately $10.0 million of the additional capital will be raised through the Preferred Stock Offering. The balance of the additional capital, approximately $16.7 million, is being raised through the Common Stock Offering.\nPotential Disposition\nSubject to general market conditions and the Company's ongoing assessment of business objectives, the Bank intends to divest up to $125 million in deposits through a combination of selling certain branch locations and related deposits and reducing public funds from the Bank's balance sheet. The purpose of any such divestitures would be to mitigate any potential adverse impact of the Acquisition on the Company's earnings per share and tangible book value, reduce the Company's exposure to interest rate risk, and strengthen the Bank's capital ratios. Any such divestitures would occur subsequent to the consummation of the Acquisition, would be structured to maximize the Bank's business objectives at that time, and would help facilitate the Bank's return to a Tier I leverage ratio in the \"well capitalized\" range. There can be no assurance of the size or impact of any divestiture, or that a divestiture will actually occur.\nImpact of the Acquisition on Operating Performance\nThe following discussion represents the Company's current assessment of the impact of the Acquisition on the operating performance of the Company. Numerous factors, including factors outside the Company's control (such as the general level of interest rates and both national and regional economic conditions) may significantly alter the effects described below. As such, there can be no assurance that the effects of the Acquisition will meet the Company's expectations.\nNet Interest Income\nWhen the Acquisition is consummated and prior to any expected deposit run-offs and divestitures, the Bank is expected to assume deposit liabilities which totaled $459.1 million as of December 31, 1994 and receive approximately $25.2 million in loans and $391.5 million in cash. An additional $26.7 million in cash is expected to be received from the net proceeds of the Offerings. The cash will be used to fund investment security purchases, repay short-term borrowings of the Bank, and fund additional growth. The impact of the Acquisition on net interest income is expected, therefore, to include (i) interest income from investment securities purchased, (ii) interest income from the Chase Loans, (iii) interest income from new loans originated through the Chase Branches, and (iv) interest expense of the Chase Deposits, including the benefit of the lower interest expense on the Chase Deposits which will replace higher cost FHLB borrowings.\nThe Company currently estimates that the Bank could make net new loans in an amount equal to at least 40.0% of the deposits outstanding within five years after consummation of the Acquisition, although there can be no assurance that the Bank will be able to do so. New loans are expected to be similar to the Bank's current loan distribution with respect to types and pricing characteristics, subject to market conditions.\nSince a large portion of the funds received in the Acquisition and the Offerings will initially be invested in securities, the Company, assisted by an asset\/liability consultant, has undertaken analyses to determine a strategy for the optimal deployment of these funds. In order to determine this investment strategy, the Company has conducted an analysis of the impact of the Acquisition on the Bank's overall asset\/liability risk position. A variety of interest rate simulations was considered, including, but not limited to, a flat rate environment, a rising rate environment with rates increasing 200 basis points, and a falling rate environment with rates decreasing 200 basis points. The Company continues to utilize and update its analysis as conditions warrant.\nThe analysis combined the Bank's year-end 1994 asset\/liability profile with that of the Chase Branches. A number of investment strategies was then examined, focusing on the goal of enhancing the profitability of the Bank while limiting the volatility of earnings under a variety of interest rate environments. Such an investment strategy could be accomplished with a variety of approaches, including maturity laddering of bonds (with and without call features), purchasing mortgage-backed securities whose average life characteristics meet the investment objective, or a combination of these or similar securities. The Company has determined that the strategy which it currently expects will best achieve its goals is investing two- thirds of the net funds received in the Acquisition and the Offerings in seasoned 15-year mortgage-backed securities with an average duration of two to four years and one-third of the net funds in U.S. Treasury and agency securities with an average maturity of one year.\nSince the interest rate environment could change substantially before all the funds from the Acquisition are invested, however, it is impossible to predict with certainty which investment combination will ultimately be pursued by the Bank. It is the Bank's intention that the mix of securities selected will provide continuing cash flows to help fund expected loan growth and\/or to subsequently invest in other securities.\nGiven the Company's current expectations for loan growth, the intended investment strategy, the repayment of the Bank's short-term borrowings and the acquired deposit liabilities, the Company and its asset\/liability consultant have analyzed potential results for the Company under a variety of interest rate scenarios. The analysis showed that the Acquisition could add between $12.0 million and $16.5 million to net interest income in the first full year of operations. While interest rates will continue to have a substantial impact on future earnings levels and therefore no assurance can be given, anticipated loan growth could increase these levels of net interest income in future years.\nLoan Loss Provision\nThe Chase Loans and any new loans originated by the Bank through the Chase Branches will meet the underwriting standards of the Bank. As the loan portfolio grows, the Bank expects to add annually to its allowance for loan losses by approximately 0.30% to 0.35% (net of charge- offs) of average loans, building to a loan loss reserve of 1.30% of period- end loans within approximately four years. Actual loan loss reserves will be based on numerous factors and may be higher or lower than the Bank's current expectations.\nNon-Interest Income\nThe Company expects to earn additional non-interest income through deposit service charges and by selling trust and investment products to the customers of the Chase Branches. The Bank has historically earned approximately 70 basis points on average assets in non-interest income. While actual results will be based on numerous factors, many of which are not in the Company's control, and, therefore, no assurance can be given, the Company believes that a rate of 50 to 70 basis points of the Chase Deposits is a reasonable approximation of the level of non-interest income it could earn after the Acquisition. This could result in additional non-interest income of $2.3 million to $3.2 million on an annualized basis.\nNon-Interest Expense\nThe Company has estimated the cost of operating the Chase Branches within the Bank's existing infrastructure. The following is a breakdown of the additional annual expenses anticipated over the first full year of operations: Amount ------ (In millions) Salary and employee benefits $ 3.6 Occupancy expense 1.1 Amortization of intangible assets 3.1 Other expense 3.6 ----- Total incremental non-interest expense $11.4 =====\nSalary and employee benefits include approximately 117 full-time equivalent employees currently at the Chase Branches and approximately 36 full-time equivalent employees expected to be added, primarily in the Bank's operations centers to service the Chase Deposits, Chase Loans, and expected loan growth. Occupancy expense includes estimated costs of refurbishment and other capital expenditures that the Bank is expected to incur after completion of the Acquisition.\nFor income tax purposes, the intangible assets created from the 8.25% deposit premium paid in the Acquisition are fully tax-deductible and amortizable on a straight-line basis over a 15 year period under current law. For financial statement proposes, generally accepted accounting principles as currently in effect require that a portion of the premium be attributed to the expected life of the deposits (the \"Core Deposit Value\"), amortizable over that expected life in a manner approximating the decay rate of the deposits. The balance of the premium is attributable to the cost of entering the new banking markets represented by the Chase Branches, and is amortizable on a straight-line basis over a 25 year period.\nThe Core Deposit Value is expected to be $19.1 million, amortizable over a 10-year period. For the first full year, amortization of the Core Deposit Value and other intangibles is expected to be approximately $3.1 million, declining to $2.8 million and $2.6 million in the second and third years, respectively.\nOther expenses include conversion costs and data processing expenses estimated for the Acquisition as well as the other support costs needed to operate the Chase Branches, including the impact of increased FDIC deposit insurance premiums to the Bank of approximately $210,000 (assuming that the Bank remains in the \"adequately capitalized\" designation for one year following the Acquisition). $275,000 of other expenses are one-time charges (mostly anticipated to be incurred in 1995) necessary in order to effect the Acquisition. In addition, the Company expects to incur $1.9 million in related incremental capital expenditures.\nImpact of the Acquisition on Operating Performance Assuming Intended Potential Disposition\nSubsequent to the Acquisition, the Bank intends to divest up to $125 million in deposits through a combination of selling certain branch locations and related deposits and reducing public funds from the Bank's balance sheet. See \"Pending Acquisition - Potential Disposition.\" These divestitures, if and when completed, should have the effect of returning the Company's Tier I leverage ratio to the \"well capitalized\" level and should reduce potential variances in earnings levels. If the Bank were to divest $125 million in deposits, the following are the Company's estimates of the impact to its operations:\nNet Interest Income\nUsing the same analysis described above, the reduction in the Bank's size could result in additional net interest income of $8.1 million to $12.2 million rather than $12.0 million to $16.5 million.\nProvision for Loan Losses\nThe only direct effect of divestitures on the Bank's provision level would be due to lower loan volumes as a result of fewer branch locations to originate new loans.\nNon-Interest Income\nThe reduction in deposits could reduce the expected additional income by $0.6 million to $0.9 million which could result in additional non-interest income to the Bank of $1.7 million to $2.3 million, rather than $2.3 million to $3.2 million.\nNon-Interest Expense\nDivesting $125 million of deposits and branches would result in reduced expenses. The extent of such reductions would be largely dependent upon the number and identity of branches sold. The Company estimates the savings to be approximately $1.5 million in the first full year of operations. This could cause the net impact from the Acquisition on non-interest expense to be reduced from $11.4 million to approximately $9.9 million.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements and auditor's reports of Community Bank System, Inc. and subsidiaries are contained on pages 45 through 61 of this item.\n- - Consolidated Statements of Condition -- December, 31, 1994 and 1993\n- - Consolidated Statements of Income -- Years ended December 31, 1994, 1993, and 1992\n- - Consolidated Statements of Changes in Stockholders' Equity -- Years ended December 31, 1994, 1993, and 1992\n- - Consolidated Statement of Cash Flows -- Years ended December 31, 1994, 1993, and 1992\n- - Notes to Consolidated Financial Statements -- December 31, 1994\n- - Auditors' report\nQuarterly Selected Data (Unaudited) are contained on page 62.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY COMMUNITY BANK SYSTEM, INC. AND SUBSIDIARIES Years ended December 31, 1992, 1993 and 1994\nThe accompanying notes are an integral part of the consolidated financial statements.\nCOMMUNITY BANK SYSTEM, INC. CONSOLIDATED STATEMENT OF CASH FLOWS\nSUPPLEMENTAL DISCLOSURE OF NONCASH AND OTHER INVESTING ACTIVITIES:\nGross change in unrealized net gains and (losses) on available for sale securities ($5,426,535) $2,164,046\nProceeds from maturities of investment securities for 1994 included $27,695,203 from available for sale and $36.579,872 from held to maturity securities.\nPurchases of investment securities for 1994 included $22,055,530 of available for sale and $201,943,283 of held to maturity securities.\nAll proceeds from sale of investment securities in 1994 related to available for sale securities.\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, which include Community Bank, N.A. and a currently inactive nonbanking subsidiary. Northeastern Computer Services, Inc., established in 1981, provided computer servicing activities for the Company, its subsidiaries, thrift institutions, and credit unions, until it was dissolved in June 1992. All intercompany accounts and transactions have been eliminated in consolidation.\nCash and Cash Equivalents\nFor purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are sold for one-day periods.\nThe carrying amounts reported in the balance sheet for cash and cash equivalents approximate those assets' fair values.\nInvestment Securities\nEffective December 31, 1993 the Company adopted statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" As required by this pronouncement, the Company has classified its investments in debt and equity securities as held to maturity or available for sale. Held to maturity securities are those for which the Company has the positive intent and ability to hold to maturity, and are reported at cost, adjusted for amortization of premiums and accretion of discounts. Debt securities not classified as held to maturity are classified as available for sale and are reported at fair market value with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of applicable income taxes. None of the Company's investment securities has been classified as trading securities.\nThe average cost method is used in determining the realized gains and losses on sales of investment securities, which are reported under other income -- investment security gains (losses).\nFair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.\nLoans\nFor variable rate loans that reprice frequently and with no significant credit risk, fair values are based on carrying values. Fair values for fixed rate loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximates its fair value.\nNOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nInterest on Loans and Reserve for Possible Loan Losses\nInterest on commercial loans and mortgages is accrued and credited to operations based upon the principal amount outstanding. Unearned discount on installment loans is recognized as income over the term of the loan, principally by the actuarial method. Nonrefundable loan fees and related direct costs are deferred and amortized over the life of the loan as an adjustment to loan yield using the effective interest method.\nThe Company's banking subsidiary places a loan on nonaccrual status and recognizes income on a cash basis when it is more than ninety days past due (or sooner, if management concludes collection of interest is doubtful), except when in the opinion of management, it is well-collateralized and in the process of collection.\nThe reserve for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The reserve is increased by provisions charged to expense and reduced by net charge-offs. The level of the reserve is based on management's evaluation of potential losses in the loan portfolio, as well as prevailing economic conditions.\nDuring 1993, the Financial Accounting Standards Board issued Statement No. 114, \"Accounting By Creditors for Impairment of a Loan\". This pronouncement, effective for fiscal years beginning 1995, is not expected to have a material effect on the Company's financial statements.\nPremises and Equipment\nPremises and equipment are stated at cost less accumulated depreciation. The annual provision for depreciation is computed using the straight-line method in amounts sufficient to recognize the cost of depreciable assets over their estimated useful lives. Maintenance and repairs are charged to expense as incurred.\nOther Real Estate\nProperties acquired through foreclosure, or by deed in lieu of foreclosure, are recorded at the lower of the unpaid loan balance plus settlement costs, or fair value. The carrying value of individual properties is subsequently adjusted to the extent that it exceeds estimated fair value.\nIntangible Assets\nIntangible assets represent core deposit intangibles and goodwill arising from various acquisitions. Core deposit intangibles are being amortized on a straight-line basis over five to eight years. Goodwill is being amortized on a straight-line basis over ten to fifteen years.\nDeposits\nThe fair values disclosed for demand and savings deposits are equal to the carrying amounts at the reporting date. The carrying amounts for variable rate money market accounts and certificates of deposit approximate their fair values at the reporting date. 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 on time deposits. The carrying value of accrued interest approximates fair value.\nTerm borrowings\nThe carrying amounts of federal funds purchased, short-term and long-term borrowings approximate their fair values.\nEarnings Per Share\nEarnings per share are computed on the basis of weighted average common and common-equivalent shares outstanding throughout each year (2,814,710 in 1994; 2,788,330 in 1993; and 2,722,093 in 1992).\nFair Values of Financial Instruments\nFASB Statement No. 107, \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of fair value information on 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. Statement 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 Company.\nReclassification\nCertain amounts from 1993 and 1992 have been reclassified to conform to the current year's presentation.\nNOTE B:INVESTMENT SECURITIES\nThe amortized cost and estimated market values of investments in securities as of December 31 are as follows:\nThe amortized cost and estimated market value of debt securities at December 31, 1994 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nProceeds from sales of investments in debt securities during 1994, 1993 and 1992 were approximately $29,241,000, $3,000,000 and $20,298,000, respectively. Gross gains of approximately $258,000 and $215,000 for 1994 and 1992 and gross losses of $761,000, $15,000 and $31,000 were realized on those sales in 1994, 1993 ,and 1992, respectively.\nInvestment securities with a carrying value of $199,032,705 and $132,506,000 at December 31, 1994 and 1993, respectively, were pledged to collateralize deposits and for other purposes required by law.\nNOTE C: LOANS\nMajor classifications of loans at December 31 are summarized as follows:\n- ------------------------------------------------------------------------------ 1994 1993 - ------------------------------------------------------------------------------ Real estate mortgages: Residential $196,547,718 $177,058,875 Commercial 35,603,929 32,914,622 Farm 7,624,577 7,420,575 Agricultural loans 13,295,398 11,564,058 Commercial loans 67,975,882 58,251,529 Installment loans to individuals 188,209,205 154,813,023 Other loans 1,482,066 1,578,387 ------------- ------------- 510,738,775 443,601,069 Less: Unearned discount (27,659,684) (25,729,899) Reserve for possible loan losses (6,281,109) (5,706,609) ------------- ------------- Net loans $476,797,982 $412,164,561 ==============================================================================\nThe estimated fair values of loans receivable net of unearned discount at December 31, 1994 and 1993 were $473,655,000 and $420,878,000, respectively.\nChanges in the reserve for possible loan losses for the years ended December 31 are summarized below:\nThe Company grants real estate, consumer, and commercial loans to customers throughout New York State.\nNOTE D: PREMISES AND EQUIPMENT\nPremises and equipment consist of the following at December 31:\n- ---------------------------------------------------------------------------- 1994 1993 - ----------------------------------------------------------------------------\nLand and land improvements $2,253,625 $2,089,927 Bank premises owned 11,998,034 11,140,847 Equipment 7,923,757 10,071,301 ------------- ------------- Premises and equipment, gross 22,175,416 23,302,075 Less: Allowance for depreciation 11,583,906 13,256,293 ------------- ------------- Premises and equipment, net $10,591,510 $10,045,782 =============================================================================\nNOTE E: INTANGIBLE ASSETS\nIntangible assets consist of the following at December 31:\n- ----------------------------------------------------------------------------- 1994 1993 - -----------------------------------------------------------------------------\nCore deposit intangible $573,400 $573,400 Goodwill and other intangibles 6,593,203 1,112,340 ------------- ------------- Intangible assets, gross 7,166,603 1,685,740 Less: Accumulated amortization 1,059,995 1,233,476 ------------- ------------- Intangible assets, net $6,106,608 $452,264\n=============================================================================\nNOTE F: DEPOSITS\nDeposits by type at December 31 are as follows:\n- ------------------------------------------------------------------- 1994 1993 - -------------------------------------------------------------------\nDemand $103,006,969 $88,644,788 Savings 306,023,336 308,629,692 Time 270,607,319 191,040,763 ------------- ------------- Total deposits $679,637,624 $588,315,243 ===================================================================\nThe estimated fair values of deposits at December 31, 1994 and 1993 were approximately $677,087,000 and $589,795,000, respectively.\nAt December 31, 1994 and 1993, time certificates of deposit in denominations of $100,000 and greater totaled $47,783,000 and $22,245,000, respectively.\nNOTE G: TERM BORROWINGS\nAt December 31, 1994 and 1993, outstanding borrowings were as follows:\n- -------------------------------------------------------------------- 1994 1993 - -------------------------------------------------------------------- Federal funds purchased $57,300,000 $57,000,000 Short-term borrowings 105,000,000 Long-term borrowings 550,000 550,000 ------------- ------------- $162,850,000 $57,550,000 ====================================================================\nAll short and long term borrowings above represent Federal Home Loan Bank advances. These advances are secured by a blanket lien on the Company's residential real estate loan portfolio.\nBorrowings are classified as short-term if their maturity is one year or less. As of year end 1994 all short-term borrowings were scheduled to mature within 53 days. Long-term borrowings mature in 1996. The Interest rate on this borrowing is 4.5%.\nNOTE H: INCOME TAXES\nEffective January 1, 1993 the Company adopted the provisions of SFAS No. 109 \"Accounting for Income Taxes\", which requires an asset-liability approach to recognizing the tax effects of temporary differences between tax and financial reporting. In prior years, the Company accounted for the tax effects of timing differences between tax and financial reporting using Accounting Principle Board Opinion Number 11. This change had no significant effect on the 1993 consolidated financial statements.\nThe provision (benefit) for income taxes for the years ended December 31 is as follows:\n- --------------------------------------------------------------------------- 1994 1993 1992 - ---------------------------------------------------------------------------\nCurrent: Federal $4,993,505 $4,542,509 $2,024,798 State 1,717,768 1,631,979 967,446 Deferred: Federal (341,226) (305,383) 60,600 State (113,742) (103,698) 86,395 ------------ ------------ ------------ Total income taxes $6,256,305 $5,765,407 $3,139,239 ==============================================================================\nThe components of the net deferred tax asset, included in other assets, as of December 31 are as follows:\n- ----------------------------------------------------------------------- 1994 1993 - -----------------------------------------------------------------------\nAllowance for loan losses $2,555,480 $1,945,137 Deferred loan fees 294,470 326,758 Medical insurance and other reserves 176,197 267,184 Pension and postretirement benefits 354,562 157,091 Investment securities 388,683 ------------ ------------ Total deferred tax asset $3,769,392 $2,696,170 ------------ ------------\nInvestment securities $1,576,164 Depreciation 66,238 87,474 ------------ ------------ Total deferred tax liability $66,238 $1,663,638 ------------ ------------\nNet deferred tax asset $3,703,154 $1,032,532 =======================================================================\nNote H: Income Taxes (Continued)\nThe deferred income taxes in 1992 result from timing differences in the recognition of income and expense for tax and financial statement purposes. The principal timing differences in 1992 were the loan loss provision, accretion on investments and corporate restructuring, which resulted in a deferred tax expense of $146,995 in 1992.\nA reconciliation of the differences between the federal statutory income tax rate and the effective tax rate for the years ended December 31 is shown in the following table:\n- ------------------------------------------------------------------------------ 1994 1993 1992 - ------------------------------------------------------------------------------\nFederal statutory income tax rate 35.0% 35.0% 34.0% Increase (reduction) in taxes resulting from: Tax-exempt interest (2.8) (3.8) (5.7) State income taxes, net of federal benefit 6.4 6.5 6.5 Alternative minimum tax (5.6) Other (0.4) (0.1) 0.3 ------------ ------------ ------------ Effective income tax rate 38.2% 37.6% 29.5% ==============================================================================\nNOTE I: PENSION PLAN\nThe Company has a noncontributory defined benefit pension plan for all eligible employees. The plan is administered by the Trust Department of Community Bank, N.A. under the direction of an appointed retirement board. The policy of the company is to fund the plan to the extent of its maxium tax deductibility.\nThe net periodic pension cost and assumptions used in the accounting for the years ended December 31 were as follows:\nThe entire amount of unrecognized gains and losses is amortized over the average remaining service lives of the participants on a straight-line basis.\nThe following table presents a reconciliation of the plan's funded status at December 31: - ------------------------------------------------------------------------------- 1994 1993 - ------------------------------------------------------------------------------- Actuarial present value of benefit obligations: Vested $5,924,223 $6,185,662 Nonvested 28,389 37,241 ------------ ----------- Accumulated benefit obligation $5,952,612 $6,222,903 ===============================================================================\nNOTE I: PENSION PLAN (Continued)\n- ------------------------------------------------------------------------------- 1994 1993 - -------------------------------------------------------------------------------\nProjected benefit obligation ($6,888,795) ($7,317,594) Plan assets at fair value 6,996,892 7,623,102 ------------ ------------ Plan assets in excess of projected benefit obligation 108,097 305,508\nUnrecognized net loss (gain) from past experience different from that assumed and effects of changes in assumptions 1,049,638 952,249\nUnrecognized prior service cost, being recognized over 17 years (324,317) (339,507)\nUnrecognized net asset at date of adoption, being recognized over 17 years (203,517) (225,760) ------------ ------------ Prepaid pension cost included in other assets $629,901 $692,490 ===============================================================================\nThe increase in the discount rate from 7% to 8% decreased the projected benefit obligation at December 31, 1994 by $1,007,272.\nPlan assets consist primarily of listed stocks, governmental securities and cash equivalents. The plan is authorized to invest up to 10% of the fair value of its total assets in common stock of Community Bank System, Inc. At December 31, 1994 and 1993, the plan holds 1,160 and 10,660 shares, respectively, of the sponsor company common stock.\nThe Company also has an Employee Savings and Retirement Plan, which is administered by the Trust Department of Community Bank, N.A. The Employee Savings and Retirement Plan includes Section 401(k) and Thrift provisions as defined under the Internal Revenue Code. The provisions permit employees to contribute up to 15% of their total compensation on a pre-tax or post-tax basis. The Company's match amounts to 50% on the first 6% contributed. Company contributions to the trust amounted to $460,459, $361,827 and $370,170 in 1994, 1993 and 1992, respectively.\nNOTE J. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company provides health and life insurance benefits for eligible retired employees and their dependents. An employee becomes eligible for these benefits by satisfying plan provisions which include certain age and\/or service requirements. Medical benefits are based on years of service at retirement, with forty years of service being required in order to be fully eligible for benefits. The medical plans pay a stated percentage of medical expenses reduced by deductibles and other coverages. The Medicare supplement policy provides for a $100,000 maximum lifetime benefit. Generally, life insurance benefits are equal to $5,000.\nEffective January 1, 1993 the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". This statement requires that the cost of postretirement benefits be accrued for during the service lives of employees. The Company elected the prospective transition approach and is amortizing the transition obligation over a 20 year period.\nA plan amendment effective January 1, 1994 limits the Company's expense to a maximum of $2,500 per person per year for medical coverage. This has decreased the APBO at January 1, 1994 by approximately $779,000, reducing the remaining unrecognized transition obligation and decreasing the annual expense by approximately $41,000.\nNet periodic postretirement benefit cost at December 31 includes the following components: - ------------------------------------------------------------------------------ 1994 1993 - ------------------------------------------------------------------------------ Service Cost $73,200 $89,900\nAmortization of transition obligation over 20.1 years 61,200 102,000\nAmortization of unrecognized net loss over 19.5 years 21,800\nInterest on APBO less interest on expected benefit payments 156,300 180,500 ------------ ------------ Net periodic postretirement benefit cost $312,500 $372,400 ==============================================================================\nA 10.5 percent annual rate of increase in the per capita costs of covered health care benefits was assumed for 1994, gradually decreasing to 5.5 percent by the year 2051. Increasing the assumed health care cost trend rates by one percentage point would increase the accumulated postretirement benefit obligation as of December 31, 1994 by $255,000 and increase the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for 1994 by $26,000. A discount rate of 8% was used to determine the accumulated postretirement benefit obligation.\nThe following sets forth the funded status of the plan as of December 31: - ------------------------------------------------------------------------------ 1994 1993 - ------------------------------------------------------------------------------ Accumulated Postretirement Benefit Obligation (APBO): Retirees $1,047,500 $1,117,600 Fully eligible active plan participants 97,400 59,700 Other active plan participants 885,800 1,509,500 ------------ ------------ Total APBO 2,030,700 2,686,800\nPlan assets at fair value 0 0 ------------ ------------ Accumulated postretirement benefits obligation in excess of plan assets (2,030,700) (2,686,800)\nUnrecognized portion of net obligation at transition 1,108,100 1,948,700\nUnrecognized net loss 458,500 483,300 ------------ ------------ Accrued postretirement benefit cost ($464,100) ($254,800) ==============================================================================\nNOTE K. INCENTIVE COMPENSATION\nThe Company has long-term incentive compensation programs for officers and key employees including incentive stock options (ISO's), restricted stock awards, nonqualified stock options (NQSO's) and warrants, and retroactive stock appreciation rights.\nIncentive stock options and warrants are granted at a price which is not less than market value at the time of the grant and are exercisable within ten years, but no earlier than one year from the date of the grant at dates specified by the Board of Directors of the Company. Retroactive stock appreciation rights may be granted with respect to both ISO's and NQSO's.\nInformation with respect to stock options and warrants under the above plans is as follows:\n- ------------------------------------------------------------------------------ Number Number Option Price of Shares of Shares Per Share Exercisable - ------------------------------------------------------------------------------ Outstanding at December 31, 1991 167,790 11.74-21.50 159,143 Granted 59,000 13.00-25.00 Exercised (6,300) 11.74-16.00 Cancelled (1,000) 17.50 Outstanding at December 31, 1992 219,490 11.74-25.00 159,990 Granted 1,000 29.00-30.25 Exercised (66,800) 11.74-18.25 Outstanding at December 31, 1993 153,690 11.74-30.25 105,540 Granted 14,150 28.50 Exercised (42,800) 15.50-16.63 Outstanding at December 31, 1994 125,040 15.5-30.25 74,840 ==============================================================================\nThe program also provides for issuance of stock under a restricted stock award plan subject to forfeiture terms as designated by the Board of Directors of the Company. Stock issued under this plan is subject to restrictions as to continuous employment and\/or acheivement of pre-established financial objectives during the forfeiture period. Restricted stockholders have dividend and voting rights during the forfeiture period. Restricted stock awarded in 1993 amounted to 200 shares. Total expense is determined based on the market value of the stock at the date of grant and is being accrued over the period the restrictions lapse. Expense in 1994, 1993, and 1992 was $2,185, $2,186 and $9,574, respectively.\nThere were 130,000 and 46,909 shares available for future grants or awards under the various programs described above at December 31, 1994 and 1993, respectively.\nNOTE L: COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS\nThe Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit, which involve, to varying degrees, elements of credit risk in excess of the amount recognized in the statement of condition. The contract amount of those commitments to extend credit reflects the extent of involvement the Company has in this particular class of financial instrument. The Company's exposure to credit loss in the event of nonperfomance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of the instrument. The Company uses the same credit policies in making commitments as it does for on-balance-sheet instruments. - ------------------------------------------------------------------------------- 1994 1993 - ------------------------------------------------------------------------------- Financial instruments whose contract amounts represent credit risk at December 31: Letters of credit $ 507,000 $ 847,000 Commitments to make or purchase loans or to extend credit on lines of credit 61,525,000 61,296,000 ------------ -----------\nTotal $ 62,032,000 $ 62,143,000 =============================================================================== The fair value of these instuments is insignificant.\nCommitments to extend credit are agreements to lend to a customer 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. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include residential real estate, income-producing commercial properties, and personal property.\nThe Company had unused lines of credit totaling $62,031,000 and $64,452,000 at December 31, 1994 and 1993, respectively.\nThe approval of bank regulatory authorities is required before dividends paid by the bank subsidiary during the year can exceed certain prescribed limits. Approximately $17,955,000 is free of limitations at December 31, 1994.\nThe Company is required to maintain a reserve balance, as established by the Federal Reserve Bank of New York. The required average total reserve for the 14-day maintenance period ended December 31, 1994 was $11,498,000 of which $3,397,000 was required to be on deposit with the Federal Reserve Bank of New York. The remainder, $8,101,000, was represented by cash on hand.\nThe Company is currently being examined by the Internal Revenue Service in connection with tax years 1990 to 1993, and has received certain notices of proposed adjustments. The Company intends to vigorously defend its position with respect to these proposed adjustments and believes the ultimate resolution will not have a material effect on the financial statements.\nNOTE M: LEASES\nRental expense included in operating expenses amounted to $502,312, $474,863, and $735,940 in 1994, 1993 and 1992, respectively.\nThe future minimum rental commitments as of December 31, 1994 for all noncancelable operating leases are as follows: - -------------------------------------------------------- Years ending December 31: Building Equipment Total - --------------------------------------------------------\n1995 $331,971 $24,828 $356,799 1996 281,451 20,124 301,575 1997 177,051 20,124 197,175 1998 172,252 18,447 190,699 1999 119,318 119,318 Thereafter 869,232 869,232 ========================================================\nNOTE N: BRANCH ACQUISITIONS\nOn December 6, 1994 the Company and the Bank signed a purchase and assumption agreement with The Chase Manhattan Bank, N.A. (\"Chase\"), a wholly owned subsidiary of The Chase Manhattan Corporation, for the acquisition of certain assets and the assumption of certain liabilities by the Bank relating to 15 Chase branch offices located in the Northern, Central, and Finger Lakes region of New York State. These locations include Norwich, Watertown (2), Boonville, New Hartford, Utica, Skaneateles, Geneva, Pulaski, Seneca Falls, Hammondsport, Canton, Newark (2), and Penn Yan, New York. Pursuant to the Agreement, the Bank would assume certain deposit liabilities estimated to be approximately $458 million, purchase certain loans estimated to be approximately $25 million and purchase at various prices certain real property, furniture and equipment related to the branches having a book value of approximately $3.2 million. The Bank will receive approximately $392 million in cash as consideration for the net deposit liabilities, reflecting a deposit premium of 8.25%, or approximately $38 million. The sale is subject to regulatory approvals and financing arrangements, and is expected to close during the third quarter of 1995. Subject to certain events and conditions, the Agreement requires the Bank to pay Chase between $1,000,000 and $1,850,000 in the event the transaction is not consummated. In conjunction with this acquisition, the Company is expected to effect a public offering in the second or third quarter of 1995 of additional common and preferred stock, principally to offset the resulting dilution of regulatory capital ratios. Results of operations on a proforma basis are not presented since historical financial information for the branches acquired is not available.\nOn June 6, 1994, the Company completed the purchase of three branches from the Resolution Trust Corporation and on October 28, 1994 the Company acquired a branch from The Chase Manhattan Bank, N.A. These acquisitions have been accounted for as purchases and their results of operations are included in the consolidated financial statements from their respective dates of acquisition. In total the Company received $68 million in cash, consisting of approximately $75 million for the assumption of deposit liabilities less approximately $1 million in assets received and a deposit premium of approximately $6 million. The premium is being amortized on a straight line basis over 15 years.\nNOTE O: SUBSEQUENT EVENT\nOn February 21, 1995 the Company adopted a Stockholders Protection Rights Plan and declared a dividend of one right for each outstanding share of common stock. The right can only be exercised when an individual or group has acquired or attempts to acquire 15% or more of the Company's common stock, if such action the Board of Directors believes is not in the best interest of stockholders. Each right then entitles the holder to acquire common stock having a market value equivalent to two times the stated exercise price. The rights expire in February 2005 and may be redeemed by the Company in whole at a price of $.01 per right.\nNote P: Parent Company Statements\nCommunity Bank System, Inc. (the parent company) contributed to its wholly-owned subsidiary, Community Bank, N.A., substantially all of its assets and liabilities as of January 1, 1992. During 1992, all operating expenses related to these assets and liabilities were recorded by the subsidiary bank.\nThe following are the condensed balance sheets, statements of income and statements of cash flows for the Parent Company:\nThe accompanying notes are an integral part of the consolidated financial statements.\nCoopers & Lybrand Certified Public Accountants\nBoard of Directors and Shareholders Community Bank System, Inc.\nWe have audited the accompanying consolidated statements of condition of Community Bank system, Inc. and Subsidiaries as of Demcember 31, 1994 and 1993 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 principle 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 of our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial condition of Community Bank System, Inc. and Subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs futher discussed in the notes to the consolidated financial statements, the Company changed its method of accounting for post retirement benefits other than pensions, income taxes, and investments in 1993.\n\/s\/ Coopers & Lybrand L.L.P.\nSyracuse, New York January 27, 1995, except for Note O as to which the date is February 21, 1995\nItem 9.","section_9":"Item 9. Disagreements 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 This item is incorporated by reference from the registrant's definitive Proxy Statement. Information concerning executive officers is included in Part I after Item 4 of this Form 10-K Annual Report.\nItem 11.","section_11":"Item 11. Executive Compensation This item is incorporated by reference from the registrant's definitive Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management This item is incorporated by reference from the registrant's definitive Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions This item is incorporated by reference from the registrant's definitive Proxy Statement.\nPart IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a) Documents Filed\n1. The following consolidated financial statements of Community Bank System, Inc. and subsidiaries are included in Item 8:\n- - Consolidated Statements of Condition -- December, 31, 1994 and 1993\n- - Consolidated Statements of Income -- Years ended December 31, 1994, 1993, and 1992\n- - Consolidated Statements of Changes in Stockholders' Equity -- Years ended December 31, 1994, 1993, and 1992\n- - Consolidated Statement of Cash Flows -- Years ended December 31, 1994, 1993, and 1992\n- - Notes to Consolidated Financial Statements -- December 31, 1994\n- - Auditors' report\n- - Quarterly selected data -- Years ended December 31, 1994 and 1993 (unaudited)\n2. Schedules are omitted since the required information is either not applicable or shown elsewhere in the financial statements.\n3. Listing of Exhibits\n(11) Statement re: Computation of earnings per share\n(22) Subsidiaries of the registrant - Community Bank, National Association, State of New York - Northeastern Computer Services, Inc., State of New York - Community Financial Services, Inc., State of New York\n(b) Reports on Form 8-K - Report filed June 3, 1994 item #5 Other Events. - Report filed December 6, 1994 item #5 Other Events.\n(c) See Exhibit 14(a)(3) above.\n(d) See Exhibit 14(a)(2) above\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.\nCOMMUNITY BANK SYSTEM, INC.\nBy: \/s\/ Sanford A. Belden Sanford A. Belden President, Chief Executive Officer and Director March 15, 1995\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 indicated on the 15th day of March 1995.\nName Title Chairman of the Board of Directors \/s\/ Dr. Earl W. MacArthur and Director Dr. Earl W. MacArthur\n\/s\/ David G. Wallace Treasurer David G. Wallace\nDirectors:\n\/s\/ John M. Burgess \/s\/ Richard C. Cummings John M. Burgess, Director Richard C. Cummings, Director\n\/s\/ William M. Dempsey William M. Dempsey, Director\n\/s\/ Benjamin Franklin \/s\/ James A. Gabriel Franklin, Director James A. Gabriel, Director\n\/s\/ Lee T. Hirschey \/s\/ David C. Patterson Lee T. Hirschey, Director David C. Patterson, Director\n\/s\/ William N. Sloan \/s\/ William D. Stalder William N. Sloan, Director William D. Stalder, Director\n\/s\/ Hugh G. Zimmer Hugh G. Zimmer, Director\nCommunity Bank System, Inc. Statement re Earnings Per Share Computation\nExhibit 11\nThree Months Ended Year Ended December 31, December 31, 1994 1993 1994 1993 Primary Earnings Per Share\nNet Income 2,347,347 2,301,661 10,109,218 9,574,774 Dividends on preferred shares --------- --------- --------- --------- Income applicable to common stock 2,347,347 2,301,661 10,109,218 9,574,774 ========= ========= ========= =========\nWeighted average number of common shares 2,778,824 2,746,842 2,764,454 2,724,428 Add: Shares issuable from assumed exercise of incentive stock options 41,976 59,323 50,256 63,902 --------- --------- --------- --------- Weighted average number of common shares - adjusted 2,820,800 2,806,165 2,814,710 2,788,330 ========= ========= ========= =========\nPrimary earnings per share $0.84 $0.82 $3.59 $3.43 ===== ===== ===== =====\nFully Diluted Earnings Per Share\nNet Income 2,347,347 2,301,661 10,109,218 9,574,774 ========= ========= ========= =========\nWeighted average number of common shares - adjusted 2,820,800 2,806,165 2,814,710 2,791,659 Add: Equivalent number of common shares assuming conversion of preferred --------- --------- --------- --------- Weighted average number of common shares - adjusted 2,820,800 2,806,165 2,814,710 2,791,659 ========= ========= ========= =========\nFully diluted earnings per share $0.84 $0.82 $3.59 $3.43 ===== ===== ===== =====","section_15":""}
{"filename":"215466_1994.txt","cik":"215466","year":"1994","section_1":"ITEM 1. BUSINESS\nCoeur d'Alene Mines Corporation (\"Coeur\" or the \"Company\") is principally engaged in the exploration, development, operation and\/or ownership of gold and silver mining properties located within the United States in Nevada, Idaho and Alaska and abroad in New Zealand and Chile. The Company's most significant properties are: (i) the Rochester Mine, a silver and gold surface mining operation located in northwestern Nevada, which is owned and operated by Coeur and which is believed to be one of the largest and lowest cost of production primary silver mines in the United States and is a significant gold producer as well; (ii) the Golden Cross Mine, an underground and surface gold mining operation located near Waihi, New Zealand, which is operated by Coeur and in which it has an 80% operating interest acquired on April 30, 1993; (iii) the Galena Mine and the Coeur Mine, underground silver mines in the Coeur d'Alene Mining District in Northern Idaho at which mining operations were suspended in July 1992 and April 1991, respectively, due to then prevailing silver prices, and in which the Company has an indirect 50% ownership interest through its ownership of 50% of the capital stock of Silver Valley Resources Corporation, a Delaware corporation formed by the Company and ASARCO Incorporated (\"Asarco\") in January 1995; (iv) the Kensington Property, located north of Juneau, Alaska, which was acquired in 1987 and is being developed as an underground gold mine jointly by Coeur and its 50% joint venture partner; (v) the Fachinal Property, located in southern Chile, South America, which Coeur acquired in 1990, at which construction commenced on an open pit and underground mine and processing plant in November 1994, with completion scheduled for the fourth quarter of 1995; and (vi) the El Bronce Mine, a Chilean gold mine of which the Company acquired operating control in October 1994. In addition, in September 1994, the Company entered into an agreement under which it has the right to acquire up to a 51% operating interest in another Chilean gold mine, the Faride Mine. Coeur also has interests in other properties which are the subject of silver or gold exploration activities and on which no commercially mineable ore bodies have been identified.\nThrough The Flexaust Company (\"Flexaust\") division of the Company's wholly-owned subsidiary Callahan Mining Corporation (\"Callahan\"), Coeur is also engaged in the manufacture and sale of lightweight flexible hose and duct and metal tubing. Flexaust's products are used in a wide variety of industrial and commercial applications for conveying air, dust, fumes and materials.\nThe Rochester Mine, the Golden Cross Mine and the El Bronce Mine, which are operated by the Company, currently constitute the Company's sources of mining revenues. The Rochester Mine accounted for approximately 67.9%, 56.2% and 50.4% of the Company's total revenues in 1992, 1993 and 1994, respectively. The Golden Cross Mine accounted for 23.9% of the Company's total revenues for 1993, 35.3% of total revenues for the eight-month period subsequent to its acquisition on April 30, 1993 and 26.2% of total revenues in 1994. Flexaust revenues accounted\nfor approximately 17.9%, 12.2% and 11.0% of the Company's total revenues in 1992, 1993 and 1994, respectively. The El Bronce Mine accounted for approximately 1% of the Company's total revenues in 1994 and 4% of total revenues for the three-month period subsequent to its acquisition on October 3, 1994. The balance of revenues was attributable to interest, dividend and other income.\nThe following sets forth definitions of certain important mining terms used in this report. \"Ore reserve\" means that part of a mineral deposit which could be economically and legally extracted or produced at the time of the reserve determination. \"Proven reserves\" means reserves for which (a) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; grade and\/or quality are computed from the results of detailed sampling and (b) the sites for inspections, sampling and measurement are spaced so closely and the geologic character is so well defined that size, shape, depth and mineral content of reserves are well-established. \"Probable reserves\" means reserves for which quantity and grade and\/or quality are computed from information similar to that used for proven reserves, but the sites for inspection, sampling and measurement are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven reserves, is high enough to assume continuity between points of observation. References herein to \"silver\" mean an alloy with a minimum fineness of 999 parts per 1000 pure silver; references to \"gold\" mean an alloy with a minimum fineness of 995 parts per 1000 pure gold; and references to an \"ounce\" mean a troy ounce, which is 31.10348 grams. References to \"dore\" mean a bullion produced by smelting, containing gold, silver and minor amounts of impurities. \"Mineralized material\" is a mineralized underground body which has been intersected by sufficient closely spaced drill holes and\/or underground sampling to support sufficient tonnage and average grade of metal(s) to warrant further exploration-development work. Such material does not qualify as an \"ore reserve\" until a final and comprehensive economic, technical and legal feasibility study based upon the test results is concluded. References to a \"ton\" mean a short ton, which is 2,000 pounds.\nROCHESTER MINE\nThe Rochester Mine is a silver-gold, surface mine located in Pershing County, Nevada, approximately 25 road miles northeast of Lovelock. The Rochester orebody consists of disseminated precious-metals mineralization hosted in Triassic volcanic rocks. The mine, which is accessible by road, utilizes the heap-leaching process to extract both silver and gold from ore mined using open-pit methods. The property consists of 16 patented and 552 unpatented contiguous mining claims and 74 mill-site claims totaling approximately 10,000 acres. The Company owns 100% of the Rochester Mine by virtue of its 100% ownership of its subsidiary, Coeur Rochester, Inc. Asarco, the prior lessee, has a net smelter royalty interest which varies from 0 to 5% provided the market price of silver equals or exceeds $17.00 per ounce.\nBased on the reserve-review report dated January 1995, of Independent Mining Consultants, Inc., and accounting for production through December 31, 1994, in-place, proven and probable ore reserves, as of January 1, 1995, total approximately 80.7 million tons averaging 1.259 ounces per ton silver and 0.0108 ounces per ton gold. The reserve estimate is based on a 1.20 ounce per ton silver-equivalent, breakeven-design cutoff grade and a silver and gold price of $5.50 and $385, respectively. The average grades do not reflect losses in the recovery process nor any allowance for extractive dilution during the mining process. The amount of proven and probable reserves will vary depending on the relative price of silver and gold. A reserve estimate calculated at various silver and gold prices are outlined as follows:\nBased upon its experience and certain metallurgical testing, the Company estimates recovery rates at 55% for silver and 85% for gold. Although, as shown in the preceding table, the average strip ratio for the remaining life of the mine will vary based primarily on future gold and silver prices. The actual strip ratio may vary significantly from year-to-year during the remaining life of the mine. The realization of the Company's production estimates is subject to actual rates of recovery, continuity of ore grades, mining rates, the levels of silver and gold prices and other uncertainties inherent in any mining and processing operation.\nThe following table sets forth information for the periods indicated relating to Rochester Mine production. Production may decrease during the winter due to slower solution flow from the heaps. Such conditions are not expected to effect annual production levels since mining, crushing and heap construction are expected to continue during those months at normal rates, resulting in increased dore' production during warmer weather. Also, production will vary from time to time depending upon the area being mined.\nThe following table sets forth the costs of production per ounce of silver and goldon a silver equivalent basis during the periods indicated at the Rochester Mine. Such costs include mining, processing and direct administration costs, financing costs, royalties and exploration expenses. To obtain the silver equivalent, each ounce of gold produced is multiplied by the same ratio as the then current ratio of the price of gold to the price of silver. This silver equivalent gold production is then added to actual silver production to determine total silver equivalent production.\nA new life-of-mine leach pad and conveyor system commenced operations in September, 1994. Initially, the new pad is expected to permit faster metals recovery than the previous pad. The leach cycle at the Rochester Mine requires approximately five years from the point ore is mined until all recoverable metal is recovered. The above costs are based upon actual operating experience at the mine. There can be no assurance that these costs will remain at the same level for future operations.\nGOLDEN CROSS MINE\nEffective April 30, 1993, a wholly-owned subsidiary of the Company acquired from a wholly-owned subsidiary of Cyprus Minerals Company all of the outstanding capital stock of Cyprus Gold New Zealand Limited (\"Cyprus NZ\"), the name of which was changed by the Company to Coeur Gold New Zealand Limited (\"Coeur NZ\"). The principal asset of Coeur NZ is its undivided 80% participating joint venture interest in the Golden Cross Mine located near Waihi on the North Island of New Zealand, approximately 100 miles southeastof Auckland, and certain other exploration properties in New Zealand. The remaining undivided 20% joint venture interest is owned by a subsidiary of The Todd Company Limited, a New Zealand corporation.\nIn addition to all the capital stock of Cyprus NZ, the Company also acquired from the former parent of Cyprus NZ a term loan receivable from Cyprus NZ in the principal amount of approximately $53.2 million which was owed by Cyprus NZ to its former parent and is now owed by Coeur NZ to the Company. A cash purchase price of approximately $54 million was paid by the Company for the Cyprus NZ capital stock and term loan. The Company accounted for the acquisition as a purchase transaction.\nThe Golden Cross Mining License covers an area of approximately 961 acres of which 274 acres are occupied by the current Golden Cross Mine operation. The mine property includes the open-pit and underground mine facilities, process plant, tailings pond, water treatment plant and mine\noffices which are all accessible by road from the town of Waihi. Construction of the Golden Cross Mine began in April, 1990, and commercial production commenced in December, 1991. Ore is mined from an extensive precious-metals bearing, epithermal vein system hosted in Tertiary volcanic rocks.\nBased upon reserve reports dated September 1, 1994 (open-pit reserve) and December, 1994, (underground reserve) by Snowden Associates Pty Ltd, an independent consulting firm, in-place, open-pit and underground, proven and probable ore reserves less actual production through December 31, 1994, total 7.565 million tons averaging 0.079 ounces per ton gold. The open-pit reserve estimate, totaling 6.642 million tons averaging 0.065 ounces per ton gold, is based on a 0.029 ounce per ton gold cutoff, $400 per ounce gold price and a currency exchange rate of US$ = 0.58 NZ$. The underground-reserve estimate, totaling 924,000 tons averaging 0.182 ounces per ton gold, is based on a 0.117 ounce per ton cutoff, gold and silver prices of $385 and $5.50, respectively and a currency exchange rate of $US = 0.61 NZ$. The reserve estimate reflects an allowance for extractive dilution during the mining process, but does not reflect losses during the recovery process. In addition, the reserve estimate has identified 404,000 tons of mineralized material averaging 0.05 ounce per ton gold which is insufficiently defined to be included in the reserve, but may be mineable given additional definition or changes in economic parameters.\nSilver reserves are empirically estimated using past production\/recovery ratios for silver:gold. Open pit and underground silver:gold ratios have historically averaged 4:1 and 5:1, respectively. Total contained silver ounces are estimated at 2,572,000 ounces, with an average grade of 0.34 ounces of silver per ton, for open pit and underground proven\/probable reserves. No mineralized material grades for silver were estimated.\nThe following table sets forth Golden Cross Mine production data. Information relating to production prior to April 30, 1993 was obtained from the former owner of Cyprus NZ. Because the Company's acquisition of Cyprus NZ was accounted for as a purchase, results of its operations prior to April 30, 1993 are not included in the Company's reported results of operations. The following data reflects the amount of production attributable to Cyprus NZ's 80% interest in the mine:\nThe following table sets forth the costs of production per ounce of gold and silver on a gold equivalent basis during the periods indicated at the Golden Cross Mine. Such costs include mining, processing and direct administration costs, royalties and exploration expenses, but do not include financing costs associated with the term loan formerly owed by Coeur Gold NZ to its parent. The production costs per ounce of gold for any period is computed on a gold equivalent basis. Each ounce of silver produced is multiplied by the same ratio as the then current silver-to-gold price ratio. This gold equivalent silver production is then added to actual gold production to determine the total gold equivalent production.\nThe above-reported Golden Cross Mine production and cost data relating to operations subsequent to the commencement of commercial production in December 1991 reflect an initial under-utilization of the mine's productive capacity associated with commencement of operations as well as other start-up costs expected to be nonrecurring in nature. The 1994 increase in the cash costs of production per ounce of gold was primarily attributable to the presence of a harder grinding ore in the open pit requiring more milling and chemicals in the processing and a lower grade of ore being provided from the underground portion of the mine. The increase in ore reserves during 1994 enabled the Company to lower the depletion at the mine, which had the effect of reducing non-cash costs per ounce.\nThe Company estimates the current waste-to-ore strip ratio to be approximately 4.32 to 1. Approximately 1550 tons per day of ore is currently being mined at the open pit operation. The underground mine is a trackless operation with a declining access from the surface, currently mining approximately 700 to 850 tons per day of ore and utilizing mechanized cut and fill and long hole benching methods. A 2,000 ton per day mill processes ore from both the open pit and underground operations and Coeur NZ estimates that approximately 89% of the gold and 60% of the silver contained in the ore mined is recovered. The production of gold and silver is subject to the risks of actual rates of recovery, continuity of ore grades, mining rates, the levels of gold and silver prices and other uncertainties inherent in any mining and processing operation. Tailings are treated by a proprietary process that removes and recycles cyanide used in the milling process.\nThe Company obtained favorable variances to the Golden Cross Mine's effluent discharge permit by a decision from the Waikato Regional Council issued in August 1993. While this decision has been appealed to the Planning Tribunal by environmental organizations, and while the environmental organizations filed a petition for enforcement of the permit in November 1993 with the Planning Tribunal which raises issues related to the permit, the Company nevertheless believes that environmental issues will not hamper operations of the Golden Cross Mine and that the appeal and petition will be resolved favorably to the Company.\nCoeur NZ expended approximately $579,313 during 1994 to explore properties adjacent to the Golden Cross Mine and various other properties in the eastern portion of the North Island of New Zealand. Such exploratory activities included drilling, sampling and assaying. Coeur NZ plans during 1995 to expend approximately $1.4 million to explore Waihi East, Waitekauri and three other New Zealand licenses on the north island.\nIn addition to significantly increasing the Company's total gold production capability, the acquisition of Coeur NZ geographically diversified the Company's operations, may contribute to further expansion in the Pacific Rim and may widen the Company's potential investor base.\nCOEUR D'ALENE MINING DISTRICT - SILVER VALLEY RESOURCES CORPORATION\nIn late 1994, the Company, Callahan and Asarco formed Silver Valley Resources Corporation, a Delaware corporation (\"Silver Valley\"), and effective January 1, 1995, the Company, Callahan and Asarco transferred certain assets, including their interests in the Coeur Mine and the Galena Mine in the Coeur d'Alene Mining District of northern Idaho, to Silver Valley. Specifically, Asarco contributed to Silver Valley Asarco's (i) ownership interest in the Joint Venture Agreement, dated August 31, 1964, related to the Coeur Mine property; (ii) interest in the lease, dated January 15, 1947, relating to the Galena Mine property; (iii) ownership interest in the Osburn tailings pond; (iv) 75% interest in the royalty deficit related to the Galena Mine property; and (v) ownership interest in certain other assets located in the Coeur d'Alene Mining District. Coeur and Callahan contributed to Silver Valley Coeur's or Callahan's (i) ownership and lease interest in the Coeur Mine property; (ii) ownership and lease interest in the Galena Mine property; (iii) ownership interest in the Caladay operating agreement; (iv) ownership interest in certain properties surrounding the above properties; and (v) 25% interest in the royalty deficit related to the Galena Mine property.\nThe Board of Directors of Silver Valley consists of six directors, three of whom, including the Chairman of the Board, are appointed by Asarco and three of whom, including the President, are appointed by Coeur. Pursuant to a Shareholders' Agreement between the parties, certain specified corporate actions may not be taken without the approval of at least 80% of the members of Silver Valley's Board of Directors. Such actions include certain major capital expenditures and\nasset sales, the commencement of mining operations and approvals of certain operating plans and budgets, substantial borrowings, issuances of capital stock and other specified significant actions. Certain other specified matters require approval by a majority of the members of the Board. As to matters requiring a majority vote, if the voting results in a tie at any Board Meeting, the Chairman of the Board of Silver Valley, who also is the Chairman of the Board of Asarco, will decide the issue. The President of Coeur also is the President of Silver Valley and serves on its Executive Committee. Certain other officers of Silver Valley are officers of Coeur or Asarco, which companies may provide management and other services to Silver Valley upon the request of its Board of Directors. Asarco and Coeur furnish certain management and other services to Silver Valley pursuant to a Management Services Agreement between them and Silver Valley.\nIt is expected that under a two-year plan of development, improving infrastructure and diamond drilling to extend reserves and mine life, Silver Valley will invest approximately $25 million in the further development and exploration at its properties. The reopening of the Galena and Coeur Mines is dependent upon the favorable action of the Board of Directors of Silver Valley, which will base its decision on several factors, including silver prices.\nGALENA MINE\nCallahan, which became a wholly-owned subsidiary of the Company on December 31, 1991, owned the Galena Mine located in the Coeur d'Alene Mining District of northern Idaho, prior to the transfer of such ownership to Silver Valley, effective January 1, 1995. The Galena Mine property consists of approximately 1,100 acres lying immediately west of the City of Wallace, Shoshone County, Idaho adjoining the Coeur Mine's eastern boundary. The property consists of 52 patented mining claims in which Callahan owns a fee title, and 25 unpatented mining claims, paramount title to which is vested in the United States. The Galena Mine is an underground silver-copper mine which is served by two vertical shafts.\nOn July 26, 1992, Asarco, which was the Galena Mine operator, suspended operations at the Galena Mine due to then prevailing silver prices and placed the property on a care and maintenance basis to conserve ore reserves. Silver Valley has the power to make a decision as to the resumption of production at the mine. Coeur cannot predict whether or when operations will resume there.\nOperating losses were incurred at the Galena Mine throughout 1990, 1991 and 1992. As a result, Callahan's revenues from the Galena Mine were limited to minimum royalty payments of $87,000 in 1990, $91,418 in 1991 and $45,809 in 1992.\nBased on the ore-reserve estimate, dated July 1, 1992, of Asarco, proven and probable ore reserves at the Galena Mine total 951,000 tons averaging 15.07 ounces per ton silver, 8.80% lead and 0.49% copper. The Asarco reserve estimate is based on a minimum diluted mining width of 5.0\nfeet for most silver-copper and silver-lead veins and 5.5 feet for lead-zone veins. Cutoff grade is based on the cost of breaking and producing ore from a stope, but do not include development costs and administrative overhead. The cutoff grade varies from area-to-area within the mine due to changing silver-copper ratios of the ore.\nThe reserve estimate has also identified an additional 856,000 tons of mineralized material which has not been included in the reserve, but given additional definition drilling or more favorable silver prices, may become mineable. This material averages 8.84 ounce per ton silver, 5.73% lead and 0.43% copper.\nThe following table sets forth information, for the periods indicated, relating to total Galena Mine production:\nThe Company's previous ownership interest in the above production, giving retroactive effect to Coeur's acquisition of Callahan on December 31, 1991, amounted to 50% through June 11, 1992, and 62.5% thereafter until such ownership was transferred to Silver Valley effective January 1, 1995.\nThe total cost of production per ounce of silver (net of credit for copper byproduct), including mining, processing, direct administrative costs and exploration expenses, but not including financing costs, royalties and smelter charges, amounted to $4.50 in 1988, $4.35 in 1989, $4.19 in 1990, $3.94 in 1991 and $4.23 in 1992 prior to the temporary discontinuation of operations at the Galena Mine on July 26, 1992. Such costs are not necessarily indicative of actual costs that would be incurred if and when mining operations resume at the mine.\nCOEUR MINE\nThe Coeur Mine is an underground silver mine located in the Coeur d'Alene Mining District of Shoshone County in northern Idaho, and consists of approximately 868 acres comprised of 38 patented mining claims, and four unpatented mining claims paramount title to which is vested in the United States. Commercial production began in 1976, and total pre-production expenditures of approximately $20 million were recovered by April 1979, at which time the Company commenced receiving revenues from its non-operating joint venture interest in the mine. Asarco is the operator of the Coeur Mine pursuant to a joint venture agreement with the Company, Callahan and, prior to November 30, 1990, Hecla. Until November 30, 1990, the Company owned 40% of the ores\nproduced from the Coeur Mine and was obligated to pay 40% of the costs. On November 30, 1990, the Company purchased Hecla's 5% interest thereby increasing the Company's interest to 45%. Effective December 31, 1991, Coeur increased its non-operating joint venture interest in the mine to 50% as a result of Coeur's acquisition of Callahan, which had acquired a 5% interest in the mine in March,1968. Effective January 1, 1995, Coeur and Asarco transferred their interests in the Coeur Mine to Silver Valley.\nAsarco suspended operations at the Coeur mine on April 3, 1991 due to then prevailing silver prices and placed the property on a care and maintenance basis to conserve ore reserves. Silver Valley has the power to make a decision as to the resumption of production at the mine. Coeur cannot predict whether or when operations will resume there.\nThe following table sets forth information, for the periods indicated, relating to total Coeur Mine production:\nThe Company's ownership interest in the above production, giving retroactive effect to Coeur's acquisition of Callahan's 5% interest on December 31, 1991, amounted to 45% prior to November 30, 1990 and 50% thereafter until such ownership was transferred to Silver Valley Resources effective January 1, 1995.\nThe total cost of production per ounce of silver (net of credit for copper byproduct), including mining, processing, direct administration costs and exploration expenses, but not including financing costs, royalties and smelter charges, amounted to $4.71 in 1988, $4.36 in 1989, $4.68 in 1990 and $5.38 in 1991 prior to the suspension of operations at the Coeur Mine on April 3, 1991. Such costs are not necessarily indicative of actual costs that would be incurred if and when mining operations resume at the mine.\nBased on the ore-reserve estimate, dated January 1, 1991, of Asarco, proven and probable ore reserves in the Coeur Mine total 377,000 tons averaging 17.33 ounces per ton silver and 0.80% copper. The Asarco reserve estimate is based on a minimum mining width of 4.5 to 5.0 feet with a minimum dilution of 1.0 foot from each margin of the vein. Cutoff grades used in the reserve estimate are estimated from costs based on the unit superintendent's forecast for 1991. The reserve estimate has also identified an additional 172,000 tons of mineralized material which has not been included in the reserve, but given additional definition drilling or more favorable precious silver prices, may become mineable. This material averages 14.21 ounce per ton silver and 0.64% copper.\nKENSINGTON PROPERTY JOINT VENTURE\nOn August 5, 1987, Coeur purchased certain patented and unpatented claims located approximately 50 miles north of Juneau, Alaska known as the Kensington gold property (the \"Kensington Property\") from Placid Oil Company of Dallas, Texas (\"Placid\"). The purchase price paid to Placid for the Kensington Property was $20 million, of which $10 million was paid by Coeur and the $10 million balance was paid by Echo Bay Mines, Ltd., a Canadian corporation (\"Echo Bay Parent\"). On the same date, Coeur conveyed an undivided 50% interest in the Kensington Property to Echo Bay Exploration, Inc., a Delaware corporation (\"Echo Bay\") that is a wholly-owned subsidiary of Echo Bay Parent, and the remaining undivided 50% interest in the Kensington Property to Coeur-Alaska, Inc., a Delaware corporation (\"Coeur-Alaska\") that is a wholly-owned subsidiary of the Company.\nCoeur-Alaska and Echo Bay entered into a joint venture agreement pursuant to which the companies agreed to participate in the exploration, evaluation, development and mining of the Kensington Property. Echo Bay is the operator of the Kensington Property under programs that must be approved by a management committee composed of an equal number of members from both Echo Bay and Coeur-Alaska. The joint venture agreement permits either party, under certain circumstances, to increase its ownership interest in the venture by paying the other party's appropriate share of exploration and development costs in the event the other party declines or is unable to fund its share.\nThe Kensington orebody consists of an extensive, precious-metals bearing, mesothermal, quartz-stockwork vein system hosted in Cretaceous intrusive rocks. Based on Echo Bay's ore-reserve study, as audited during January 1995, by Woollett Consulting Ltd., independent consulting geologists, Kensington Property proven and probable ore reserves, as of December 31, 1994, are estimated to be 13.641 million tons averaging 0.143 ounce of gold per ton totaling 1.946 million ounces of gold. An additional 3.188 million tons of mineralized material averaging 0.147 ounce per ton gold has been identified, but is insufficiently defined to be included in the reserve. The Kensington ore zone has not been fully defined and several peripheral veins remain to be explored. The reserve estimate reflects the effects of extractive dilution during the mining process, but not losses during the recovery process. A gold price of $375 per ounce was used in calculating the reserve estimate. Based upon metallurgical testing work, the Company expects that 92% of the gold contained in ores milled will be recovered. The joint venture has completed metallurgical testing primarily consisting of bench-scale test work, including grinding, flotation, cyanide leaching, carbon recovery and other tests, and a subsequent pilot scale test conducted on a bulk ore sample to simulate full-scale plant operations and to confirm selected operating parameters.\nDuring 1994, the activities at Kensington were directed toward the permitting process. As of December 31, 1994, the Company had invested a total of $52,139,488 (including capitalized interest of $11,796,897) in the Kensington Property.\nBased on a comprehensive feasibility study prepared by an independent engineering firm engaged to perform detailed design and engineering at the Kensington Property, Coeur estimates that in the event it is decided to proceed with the construction of the Kensington facility, approximately $180 million (in addition to monies previously expended), 50% of which will be the responsibility of Coeur, will be required in order to place the property into commercial production. That estimate is based upon the engineering firm's completion of 30% of the engineering upon the project to date.\nFurther development of the Kensington Property is contingent upon several factors, including gold prices and the ability of the joint venture to obtain valid permits. The Kensington feasibility study contemplates a gold price of $400 per ounce and it is unlikely that the project facility will be constructed unless the venturers are able to satisfy themselves that this gold price is reasonably achievable. The construction of the project cannot commence until all necessary permits are obtained. The major permits necessary for the construction and operation of the facility have been obtained with the exception of two, the Army Corps of Engineers Section 404 Permit and the Environmental Protection Agency National Pollutant Discharge Elimination System Permit. Kensington is intensively regulated under various local laws and regulations. Numerous permits are required by government agencies which authorize construction and operations.\nThe United States Forest Service (\"USFS\") approved the environmental impact statement (\"EIS\") in February 1992. Thereafter, administrative appeals were filed by parties opposed to the project. The appeals alleged that the EIS did not satisfy the requirements of the National Environmental Policy Act due to, among other alleged reasons, inadequacy of baseline data used to analyze environmental impacts and failure to adequately consider alternative methods of mining and waste disposal. The appellants sought to prevent USFS approval of an operating plan for the project pending completion of EIS meeting all legal requirements. On July 7, 1992, the USFS approved the Company's proposed Plan of Operations for the project. On July 28, 1992, the USFS ruled against the appellants upon their appeal. While Coeur believes a court would uphold the USFS determination in the event it were to be further appealed, no assurance can be given as to the outcome of any such appeal if filed. On September 16, 1992, parties opposed to the project requested that the USFS withdraw its decision to approve the operating plan on the grounds that the plan was not complete at the time it was approved. The USFS decided not to withdraw the July 7, 1992 approval of the Plan of Operations on November 10, 1992.\nIn addition to the USFS decision to permit operation, other key permits are required by the U.S. Environmental Protection Agency (the \"EPA\"), the U.S. Army Corps of Engineers, the State of Alaska and the City and Borough of Juneau. In November 1992, the project's Large Mine Permit was approved bythe City and Borough of Juneau. On April 30, 1993, a group opposed to the project filed an appeal in state court to that approval, which has been denied. The motion is now pending before\nthe Alaska Supreme Court. Additional permitting requirements include the EPA National Pollutant Discharge Elimination System (\"NPDES\") permit for discharge of effluent from the tailings impoundment and the U.S. Army Corps of Engineers \"fill\" permit.\nIn November 1994, the EPA issued a draft of its Technical Assistance Report (\"TAR\") calling for the redesign of portions of the project and certain additional data and recommending that certain specific actions should be taken in order for the Kensington project to meet environmental requirements and comply with the Clean Water Act. These actions include providing additional waste water treatment, a redesign to address peak flow information, further analysis of avalanche hazard, a movement of the outfall into deeper water to assure adequate mixing, additional testing for potential acid generation and the performance of additional analysis on ore samples to project effluent quality. Compliance with the TAR should enable the U.S. Army Corps of Engineers to complete its work for issuance of a federal permit for construction of a water treatment facility at the Kensington property pursuant to Section 404 of the Clean Water Act. If, in the final TAR, the EPA adheres to the recommendations in the draft, the Company believes it is feasible to make design changes and furnish necessary data. It is anticipated that a final TAR will be furnished by the EPA to the Army Corps of Engineers in the second quarter of 1995. However, no assurance can be given as to when or whether the required federal permit will be issued.\nDecember 20, 1993, a coalition of environmental and citizen groups, including the National Wildlife Federation and the Sierra Club, filed a complaint in the Federal District Court of Alaska against the EPA and the U.S. Army Corps of Engineers challenging the two federal agencies' interpretation of the Clean Water Act regulations as they relate to the Kensington Property and another mining project near Juneau, Alaska. Under that interpretation, announced in October 1992, NPDES permits would not be required for discharge of tailings from process facilities into proposed tailings impoundment ponds constructed in \"waters of the United States.\" The suit was dismissed by the court on July 15, 1994, on the grounds that it was not ripe for decision.\nOn July 15, 1993, the Company acquired a 66 2\/3% interest, and in August, 1994 the Company acquired the remaining 33 1\/3% interest in the Jualin property, an exploratory property located adjacent to the Kensington Property, and an exploratory property in Mexico. The Jualin property consists of approximately 9,400 acres, of which approximately 345 acres of patented claims. The Company's initial 66 2\/3% interest in the Jualin property was acquired in connection with the Company's purchase of 26% of its capital stock of International Curator Resources, Ltd.(ICR), a Canadian corporation. The 33 1\/3% interest in the property was acquired by the Company from ICR in connection with the Company's sale of ICR shares between August 1994 and February 1995.\nFACHINAL PROPERTY\nIn January 1990, the Company acquired, through its wholly-owned subsidiary, CDE Chilean Mining Corporation, ownership of the Fachinal\ngold and silver project (the \"Fachinal Property\") and six exploration projects located in Chile. Coeur acquired these properties for $5 million by purchasing a wholly-owned subsidiary of Freeport Minerals Company, which held the exploitation and exploration concessions for this area of known mineralization.\nThe Fachinal property covers about 90 square miles and is located south of Coihaique, the capital of Region XI in southern Chile, and approximately 10 miles west of the town of Chile Chico. The project lies on the east side of the Andes at an elevation from 600 to 4,500 feet and is serviced by a gravel road from Chile Chico. The Fachinal property is believed to contain at least 67 veins containing gold and silver and at least five zones of mineralization. The Company has been granted exploitation concessions (the Chilean equivalent to a patented claim except that the owner does not have title to the surface which must be separately acquired from the surface owner) covering the mineralized areas of Fachinal property as well as the necessary surface rights to permit mining there.\nAs of December 31, 1994, the Company had expended a total of $35,945,229 (including capitalized interest of $4,596,960) on the Fachinal Property. Currently, three mineral systems are the primary development targets, namely Laguna Verde, Temer, and Guanaco. To date, the work program at the Fachinal Property has included diamond drilling, underground drifting and cross-cutting at Laguna Verde, Temer and Guanaco, initiation of metallurgical testing, mine modeling, mine planning and cost estimating.\nFollowing the completion by an independent engineering firm of a final feasibility study, the Company announced in July 1994 its decision to proceed with the construction of mining facilities on the Fachinal property. The Company expects that the new mining facilities will be completed in the fourth quarter of 1995 and will include both underground and open pit mining operations, with an estimated 1,650 per ton day throughput. The milling facility will use conventional crush\/grind\/floatation methods to produce a gold\/silver concentrate, which will then be shipped to off site smelters for processing. The total project construction cost is expected to approximate $41.8 million. When completed, the Fachinal Mine will be one of the southern most mining operations in the world, employing approximately 225 workers near the town of Chile Chico, located 800 miles south Santiago at an elevation of approximately 1,200 feet. The Company estimates that the Fachinal Mine will produce approximately 41,000 ounces of gold and 2.6 million ounces of silver during its first full year of production.\nEconomic, precious metals bearing mineralization at Fachinal occurs in an extensive epithermal, quartz-veins system hosted in Jurassic volcanic rocks. Based on a reserve-review report dated April 1994, by Micon International Limited, total, in-place, open-pit and underground, proven and probable reserves at the Fachinal property are approximately 4.547 million tons averaging 0.07 ounces per ton gold and 3.219 ounces per ton silver. The Fachinal open-pit reserve estimate, totaling 3.562 million tons averaging 0.057 ounces per ton gold and 2.55 ounces per ton\nsilver, is based on an internal cutoff grade of 0.04 ounces per ton equivalent gold. The underground reserve is based on internal cutoff grades ranging form 0.088 to 0.102 ounces per ton equivalent gold. Both reserve estimates are based on gold and silver prices of $375 per ounce and $5.00 per ounce, respectively. Average grades reflect extractive dilution, but not losses during the recovery process. The Company estimates, based upon thorough metallurgical testing, recovery rates between 86.8 - 94.6% for gold and 82.2 - 92.3% for silver. The open-pit reserve estimate has also identified 872,000 tons of mineralized material, averaging 0.05 ounce per ton gold and 1.14 ounce per ton silver. Likewise, the underground resource estimate has identified an additional 656,000 tons of mineralized material averaging 0.11 ounce per ton gold and 6.01 ounces per ton silver. Confidence in these additional tonnages is insufficient for them to be included in the Fachinal reserve. Numerous other attractive exploration targets with known precious-metals mineralization remain to be evaluated.\nAlthough the government and economy of Chile has been relatively stable in recent years, the ownership of property in a foreign country is always subject to the risk of expropriation or nationalization with inadequate compensation. Any foreign operation or investment may also be adversely affected by exchange controls, currency fluctuations, taxation and laws or policies of particular countries as well as laws and policies of the United States affecting foreign trade, investment and taxation.\nEL BRONCE MINE\nIn July 1994, the Company entered into an agreement with Compania Minera El Bronce de Petorca, a Chilean corporation (\"CMEB\"), pursuant to which the Company acquired an option exercisable through July 1997 to purchase from CMEB a 51% equity interest in the producing El Bronce Mine. The El Bronce Mine is an underground, gold-silver mine located on approximately 33,000 acres in the Andean foothills about 90 miles north of Santiago, Chile and is accessible by road. The property consists of 64 exploitation concessions and 10 exploration concessions. Surface rights to permit mining on the property are leased from private owners. Ore is produced from an extensive, precious-metals bearing, epithermal, quartz-vein system hosted in Cretaceous volcanic rocks. Pursuant to the agreement, the Company made an initial payment to CMEB of $750,000 on July 25, 1994, an option payment of $4,050,000 on October 14, 1994 and expended $1.2 million during the balance of 1994 for exploration and mine development activities. In order to exercise its option to acquire a 51% equity interest in the mine, the Company will be required to invest an additional $20.4 million and also to invest at least $5 million (including 1994 s expenditures) prior to July 1996 for exploratory and developmental activities designed to increase ore reserves and increased annual gold production to 65,000 ounces from the present level of 40,000 ounces of gold.\nIn October 1994, the Company assumed operating control of the El Bronce Mine, in which the Company has 51% interest in any operating profits. The Company plans to maintain the 500 to 600 ton per day milling rate at the mine, improve the mining method to increase ore\nreserves and to restructure the work force. The mill currently has a 1,200 ton per day capacity. In addition, the Company has commenced exploratory activities at three main exploration sites within the 17,800 acre area surrounding the mine.\nBased on a reserve-report review dated January, 1995 by Compania Minera CDE El Bronce, in-place, proven and probable ore reserves on the El Bronce property total 393,000 tons averaging 0.172 ounces per ton gold. An additional 627,000 tons of mineralized material, averaging 0.18 ounce per ton gold, has been identified, but is currently insufficiently defined to be included in the reserve. The reserve is based on an internal cutoff of 0.058 ounce per ton gold. The Company estimates, based on past experience and metallurgical testing, mill recovery rates are 91.5% for gold and 90% for silver. The mineralized system remains geologically open both along strike and down-dip.\nThe following table sets forth El Bronce Mine production data subsequent to its acquisition on October 3, 1994. As stated above, the Company has a 51% interest in any operating profits from the mine. The Company's 5l% interest in the mine's operating profits from October 3, 1994 through December 31, 1994 amounted to $1,023,537.\nThe following sets forth the costs of production per ounce of gold and silver on a gold equivalent basis during the period subsequent to October 3, 1994 at the El Bronce Mine. Such costs include mining, processing and direct administration costs, royalties and exploration expenses. The production costs per ounce of gold for the period is computed on a gold equivalent basis. Each ounce of silver produced is multiplied by the same ratio as the then current silver-to-gold price ratio. This gold equivalent silver production is then added to actual gold production to determine the total gold equivalent production.\nThe Company plans to spend expend approximately $3.9 million during 1995 on exploratory anddevelopmental activities at the El Bronce Mine and surrounding areas.\nTHE FARIDE MINE\nIn September 1994, the Company entered into an agreement with Minera Cerro Dominador, a Chilean corporation (\"MCD\") pursuant to which the Company acquired an option, exercisable through January 15, 1998, to purchase from MCD a 51% operating interest in the fully-developed Faride Mine. The Faride property is located in northern Chile approximately 800 miles north of Santiago in the Andean foot-hills of Region II and is accessible by road. It consists of 36 exploitation concessions covering approximately 7,000 acres. Surface rights to permit mining are under lease from the Chilean government. Mineralization at Faride occurs in an extensive, precious and base-metal bearing, epithermal, quartz-vein system hosted in Tertiary granitic-intrusive rocks.\nThe Company can acquire its 51% operating interest by paying MCD $4 million over a four-year period and investing $3.5 million in exploration. Upon exercise of that option, the Company also has the right to purchase 51% of the crushing and milling facility at the mine for an additional $8 million.\nThe Faride property includes the fully-developed, underground Faride Mine, which was built to produce 660 tons of ore per day, and a 46,200 ton per month floatation mill, which is undergoing expansion to 77,000 tons per month capacity. The mine has not been operational since 1988.\nThe Company expended approximately $542,873 during 1994 to conduct surface and underground drilling in order to define reserves and to increase the resource base at the mine.\nBased on a reserve-review report dated July 1990 by Minera Cerro Dominador, in-place, proven and probable ore reserves on the Faride property total approximately 1.075 million tons averaging 0.078 ounce per ton gold, 3.82 ounce per ton silver and 0.88% copper. An additional 566,000 tons of mineralized material, averaging 0.04 ounce per ton gold and 4.5 ounces per ton silver, has been identified during the reserve estimation. This material is insufficiently defined to be included in the reserve. The reserve estimate is based on gold, silver and copper prices of $400 per ounce, $6.20 per ounce and $0.80 per pound, respectively. Average grades reported in the reserve estimate do not reflect losses during the recovery process nor allowance for extractive dilution. Estimated recovery rates based on using a traditional milling process are approximately 80% gold, 75% silver and 25% copper. The vein system remains geologically open both down-dip and along strike.\nThe mill currently processes copper slag from Chuquicamata on a contract that is expected to terminate between 1996 and 1998. During\nlate 1994, the Company conducted extensive sampling and completed approximately 3,000 meters of surface and underground drilling to develop and define sufficient reserves.\nThe Company s work program consists of additional drilling to further delineate the ore body to enable the commencement of a feasibility study late in 1995.\nSILVER AND GOLD PRICES\nThe Company's operating results are substantially dependent upon the world market prices of silver and gold. The Company has no control over silver and gold prices, which can fluctuate widely. The volatility of such prices is illustrated by the following table, which sets forth the high and low prices of silver (as reported by Handy and Harman) and gold (London final) per ounce during the periods indicated:\nMARKETING\nCoeur has historically sold its gold and silver from its mines both pursuant to forward contracts and at spot prices prevailing at the time of sale to various precious metals firms. As of December 31, 1994, the Company has entered into forward contracts to deliver a total of 115,000 ounces of gold at an average price of $416.20 per ounce through 1996.\nEXPLORATORY MINING PROPERTIES\nCoeur, either directly or through its wholly-owned subsidiaries, owns, leases and has interests in certain exploration-stage mining properties located in the United States, Mexico, Chile, and New Zealand. Giving retroactive effect to the Company's acquisition of Callahan, exploration expenses of approximately $2.3 million, $2.5 million and $3.9 million were incurred by the Company in connection with exploration activities in 1992, 1993 and 1994, respectively.\nMANUFACTURING -- THE FLEXAUST COMPANY\nFlexaust manufactures several lines of lightweight flexible hose and duct and metal tubing at plants located in Warsaw, Indiana and Ontario, California. In September 1992, the manufacturing operations previously located in Amesbury, Massachusetts were consolidated at the Flexaust facilities located in Warsaw, Indiana and Ontario, California in order to achieve efficiencies and economies of scale. Flexaust's\nmajor product line consists of Flexaust close-pitch hose for low pressure and suction use as well as severe flexing conditions. A second line consists of Springflex wide-pitch retractable duct. Both lines are made primarily of neoprene-coated synthetic fabrics, wire-reinforced and are approximately one-third the weight of metal duct work of comparable load-carrying capacity. They are used in a wide variety of industrial and commercial applications for conveying air, dust, fumes and other materials.\nFlexaust also produces Genesis , which is plastic hose used in industrial markets as well as commercial cleaning and vacuum applications; and Bendway duct, a line of metal tubing made of aluminum or stainless steel which also has a wide variety of industrial applications.\nIn addition, Flexaust participates in two joint ventures: Flexadux, Incorporated, a 50%-owned U.S. company, formed in partnership with a European producer, which makes and sells plastic industrial hose in the United States and Canada; and Flexaust GmbH, also 50%-owned, located in West Germany, which produces and markets Flexaust's regular line of wire-reinforced neoprene-coated fabric hose in Europe. In both joint ventures, Flexaust and its partner share equally in costs and profits. Each of the joint ventures has an exclusive license to produce and market the respective joint venture's products. These licenses are terminable upon one year's prior notice.\nFlexaust's products are sold principally for industrial use through distributors, dealers and Flexaust's own sales force. Approximately 850 stocking distributors and dealers market Flexaust's products, and sales to distributors and dealers have averaged approximately 80% of total sales in the last three years. There are no continuing contracts for the sale of products. Approximately 80% of the products sold are standard while the remaining 20% are made to order or contain variations from standard. U.S. government sales and foreign sales are not material. There are no seasonal aspects to Flexaust's operations. Pre-tax income contributed by Flexaust in 1992, 1993 and 1994 amounted to approximately $1.1 million, $1.1 million and $1.2 million, respectively.\nGOVERNMENT REGULATION AND LEGAL PROCEEDINGS\nThe Company's mining and mineral processing operations and property exploration and development activities are subject to extensive federal, state and local laws governing the protection of the environment, prospecting, development, production, taxes, labor standards, occupational health, mine safety, toxic substances and other matters. Coeur believes it is in substantial compliance with all applicable laws and regulations.\nFor the years ended December 31, 1992, 1993 and 1994, the Company expended $1,050,015, $2,404,698 and $2,974,438 respectively, in connection with environmental compliance activities at its operating\nproperties. Furthermore, as discussed under \"Bunker Hill Superfund Site\" below, the Company agreed in October 1993 to settle an environmental matter for $1,230,000. In addition, as of December 31, 1994, the Company had expended approximately $4.6 million on environmental and permitting activities at the Kensington Property, which expenditures have been capitalized as part of its development cost. Future environmental expenditures will be determined by governmental regulations and the overall scope of the Company's operating and development activities.\nFederal Environmental Laws\nAmong the numerous federal environmental laws to which the Company is subject is the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (\"Superfund\" or \"CERCLA\"), which is the most important federal program for remediating environmental dangers caused by hazardous substances. CERCLA provides for the possible imposition of joint and several liability upon potentially responsible parties (\"PRPs\"), including current and past owners and operators at the site involved, persons who generated or otherwise arranged for the disposal of hazardous substances released at the site, and persons who were involved in the transport, treatment or disposal of hazardous substances released at the site. The Resource Conservation and Recovery Act of 1976 (\"RCRA\") established a comprehensive regulatory framework for the management of hazardous waste at active facilities, complementing the Superfund Program which more often addresses inactive waste sites. RCRA sets up a system for the management of hazardous wastes (including leach spoil waste containing cyanide such as the waste generated by the Rochester Mine), imposing requirements for performance, testing and record keeping upon parties who generate, transport, treat, store or dispose of waste.\nThe Company's commitment to environmental responsibility has been recognized in eight awards received since 1987, which included the Dupont\/Conoco Environmental Leadership Award, awarded to the Company on October 1, 1991 by a judging panel that included representatives from environmental organizations and the federal government and the \"Star\" award granted on June 23, 1993 by the National Environmental Development Association. The receipt of such awards does not relieve the Company of its obligations to comply with all applicable environmental laws.\nBunker Hill Superfund Site.\nThe Company knows of no material environmental liabilities to which it currently is subject. During October 1993, the Company and Callahan negotiated a tentative settlement agreement with the U.S. Environmental Protection Agency (the \"EPA\") and a group of other companies that are potentially responsible parties (\"PRPs\") in connection with the Bunker Hill Superfund site. The Company and Callahan were notified in February 1990 by the EPA that they were PRPs in connection with that site, where the EPA claims there is a need for cleanup action under CERCLA. The negotiated settlement agreement called for the Company and\nCallahan to pay a total of $1,230,000 to a group of other PRPs in order to remove the Company and Callahan from any additional cleanup liability relating to the site. Accordingly, the Company recorded a non-recurring environmental settlement expense of $1,230,000 during the third quarter of 1993. An order approving the settlement was issued by the Unites States District Court for the District of Idaho on November 17, 1994 and the settlement amount was paid on December 16, 1994.\nMining Act of 1872.\nLegislation is presently pending in the U.S. Congress to change the Mining Law of 1872 (the \"Mining Act\") under which the Company holds mining claims on public lands. It is considered possible that the Mining Act will be amended or be replaced by stricter legislation in 1995. Some of the legislation being discussed contains strict new environmental standards and conditions, additional reclamation requirements and extensive new procedural steps which would likely result in delays in permitting. The legislation may also impose an 8% gross royalty on the value of minerals mined on public lands, payable to the U.S. Government. Whether changes will be enacted or the extent of any changes is not presently known and the potential impact on the Company's United States activities is difficult to predict.\nNew Zealand and Chile Government Regulations\nThe mining properties located in New Zealand and Chile are subject to various government laws and regulations pertaining to the protection of the air, surface water, ground water and the environment in general, as well as the health of the work force, labor standards and the socioeconomic impacts of mining facilities upon the communities. The Company believes it is in substantial compliance with all applicable laws and regulations in both Chile and New Zealand, and believes that it can comply with the laws in Chile which will govern operations at Fachinal.\nEMPLOYEES\nAt March 1, 1995, the Company employed a total of 1,007 full-time employees, of which 46 are located at the Company's executive offices in Coeur d'Alene, Idaho, 307 are employed at the Rochester Mine, 169 are employed at the Golden Cross Mine in New Zealand, 82 are employed by Flexaust, 400 are employed in Chile and 3 are employed in other various activities. The Company maintains labor agreements under country statutes in New Zealand at the Coeur Golden Cross Mine and in Chile at the El Bronce Mine. Both agreements are for three years and currently are being proactively administered. In the opinion of the Company, its labor relations have been satisfactory. The personnel developing the Kensington property are employees of Echo Bay Mines Alaska, Inc. and the employees of Silver Valley Resources are employees of that company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nInformation regarding the Company's properties is set forth under Item 1 above.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nPromissory Note Suit\nOn September 22, 1994, a judgment was entered against the Company in the United States District Court for the District of Idaho in a case entitled Goldberg v. Coeur d'Alene Mines Corporation in the amount of $725,688. The action involves an alleged claim by the plaintiff to recover on four promissory notes made by a predecessor of the Company. The notes are claimed to be the obligation of the Company by virtue of successive mergers which occurred in 1974 and 1988. The plaintiff filed with the court a cost bill in the approximate amount of $225,000. The claim was settled on January 11, 1995 by the payout of $800,000.\nInternal Revenue Service Audit\nIn December 1993, the IRS completed an audit of the Company for the years 1990 and 1991. In November 1994, the IRS also initiated their audit of the Company for the years 1992 and 1993. For all such years, the IRS has advised the Company that three material issues remain unresolved. All issues involve the deductibility of costs previously claimed by the Company.\nOn February 7, 1995, the IRS issued its thirty-day letter assessing tax deficiencies of $738,806. If resolved in favor of the IRS, the Company would be subject to the deficiency, net operating loss carryforwards would be decreased by $28.2 million, and approximately $2 million of pending tax refunds would be forfeited. The Company believes it has treated each issue in question in a manner that is consistent with applicable law and prevailing industry practice and is in the process of filing a petition with the United States Tax Court to contest the assessment.\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 certain information regarding the Company's current executive officers:\nMessrs. Wheeler, Sabala and Angelos have been principally employed by the Company for more than the past five years. Prior to his employment with the Company in October 1992, Mr. Clark had served as the Executive Vice President and Chief Operating Officer of Pegasus Gold, Inc. since 1990 and as the Vice President-Operations and Chief Operating Officer of that company since 1986. Mr. Boyd was a partner in the law firm of Evans, Keane, Koontz, Boyd, Simko & Ripley for more than five years prior to his employment with the Company in April 1990. Mr. Alan L. Wilder was Process Plant Superintendent at Coeur Rochester in 1986, Project Manager for Newmont Mining Corporation until 1989, a consultant in 1990 and 1991, and Manager of Engineering and Construction for the Company in 1991 until his appointment as an executive officer effective January 1, 1992.\nPart II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS.\nThe Company's Common Stock is listed on the New York Stock Exchange (\"NYSE\") and the Pacific Coast Exchange. The following table sets forth, for the periods indicated, the high and low closing sales prices of the Common Stock as reported by the NYSE:\nThe Company paid per share cash dividends of $.15, $.15, $.15, $.12, $.11, and $.11 on its Common Stock on April 15, 1994, April 16, 1993, April 15, 1992, April 12, 1991, April 20, 1990 and April 21, 1989 respectively. Future dividends on the Common Stock, if any, will be determined by the Company's Board of Directors and will depend upon the Company's results of operations, financial conditions, capital requirements and other factors.\nAt March 21, 1995, there were 8,859 record holders of the Company's outstanding Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table summarizes certain selected consolidated financial data with respect to the Company and its subsidiaries and should be read in conjunction with the Consolidated Financial Statements and Notes thereto appearing elsewhere in this report. The information has been restated to give effect to a business combination with Callahan Mining Corporation. (See Note C to the consolidated financial statements.)\n(1) Effective January 1, 1993, the Company changed its method of accounting for income taxes by adopting Statement of Financial Accounting Standards (FAS) 109, \"Accounting for Income Taxes.\" FAS 109 requires an asset and liability approach to accounting for income taxes and establishes criteria for recognizing deferred tax assets. Accordingly, the Company adjusted its existing deferred income tax assets and liabilities to reflect current statutory income tax rates and previously unrecognized tax benefits related to federal and certain state net operating loss carryforwards. FAS 109 also contains new requirements regarding balance sheet classification and prior business combinations. Hence, the Company adjusted the carrying values of an incremental interest in the Rochester Property acquired in 1988 and CDE Chilean Mining Corp. acquired in 1990 to reflect the gross purchase value previously reported net-of-tax. The cumulative effect of the accounting change on prior years at January 1, 1993 is a nonrecurring gain of $5,181,188, or $.34 per share, and is included in the Consolidated Statement of Operations for the year ended December 31, 1993. Other than the cumulative effect, the accounting change had no material effect on the results of operations for the year ended December 31, 1993.\nAs of January 1, 1993, after giving effect to the implementation of FAS 109, the significant components of the Company's net deferred tax liability were as follows:\nAs permitted by FAS 109, prior year financial statements have not been restated to reflect the change in accounting method.\n(2) Earnings per share are calculated based on the weighted average number of common shares outstanding and those Common Stock equivalents that are deemed to be dilutive. The 6% Convertible Subordinated Debentures Due 2002 are considered to be Common Stock equivalents. Accordingly, such debentures are assumed to be converted, and interest expense on such debentures, net of tax expense, has been considered in the computation of earnings per share, except in those instances where the effects of conversion would be antidilutive.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nGENERAL\nThe results of the Company's operations are significantly affected by the market prices of gold and silver which may fluctuate widely and are affected by many factors beyond the Company's control, including interest rates, expectations regarding inflation, currency values, governmental decisions regarding the disposal of precious metals stockpiles, global and regional political and economic conditions, and other factors. The Company's currently operating mines are the Rochester Mine in Nevada, which it wholly owns and operates; the Golden Cross Mine in New Zealand, in which the Company has an 80% operating interest; and the El Bronce Mine, a Chilean gold mine of which the Company acquired operating control in October 1994. In addition, in September 1994, the Company entered into an agreement under which it has the right to acquire up to a 51% operating interest in another Chilean gold mine, the Faride Mine.\nEffective January 1, 1995, the Company, Callahan and Asarco contributed to Silver Valley their interests in and relating to the Galena and Coeur Mines in Idaho, at which mining activities were suspended in July 1992 and April 1991, respectively, due to then prevailing silver prices, and the adjoining Caladay property, a silver exploration property. It is contemplated that Silver Valley, of which Asarco owns 50% and the Company and Callahan own 50%, will invest approximately $25 million in development and exploration at the properties under a two-year plan of lengthening the existing workings, improving infrastructure and diamond drilling to increase reserves and mine life. The reopening of the Galena and Coeur Mines is dependent upon the favorable action of the Board of Directors of Silver Valley, which will base its decision upon several factors, including silver prices.\nThe Company has an option until July 1997 to increase its ownership interest in the El Bronce Mine to 51% if it invests $20.4 million and also invests a minimum of $5 million over a two-year period for exploration and mine development designed to expand ore reserves and increase annual gold production above the current level of 40,000 ounces per year. The Company also has an option until January 15, 1998 to acquire up to a 51% operating interest in the Faride Mine by paying the current owner $4 million over a four-year period and investing $3.5 million in exploratory activities.\nIn July 1994, the Company's Board of Director's approved construction of the Fachinal Project. Construction of the new mine is expected to be completed in the fourth quarter of 1995 at a total estimated cost of approximately $41.8 million. The mine presently is expected to produce approximately 41,000 ounces of gold and 2.6 million ounces of silver in its first year.\nA production decision at the Kensington Property is subject to the approval by the Company and its joint venture partner, a market price of gold of at least $400 per ounce and the receipt of certain required permits. The market price of gold (London final) on March 9, 1995 was $381.50 per ounce. With respect to the permits, the Company is unable to\ncontrol the timing of their issuance. On November 8, 1994 EPA issued a draft of its Technical Assistance Report which calls for the Kensington venture to redesign portions of its project and furnish additional data, in order to satisfy certain environmental requirements. If, in its final report, the EPA adheres to the recommendations in the draft, the Company believes it is feasible to make design changes and furnish necessary data. It is anticipated that a final EPA Technical Assistance Report will be furnished by the EPA to the Army Corps of Engineers in the second quarter of 1995, which should lead to the issuance by the Corps of its Section 404 permit in due course. However, the Company is not able to control the timing of such regulatory issues.\nThe Company's business plan is to continue to acquire mining properties and\/or businesses that are operational or expected to become operational in the near future so that they can reasonably be expected to contribute to the Company's near-term cash flow from operations and expand the Company's gold and\/or silver production.\nRESULTS OF OPERATIONS\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nSALES AND GROSS PROFITS\nSales of concentrates and dore' in 1994 increased by $11,616,272, or 17%, over 1993. The increase is primarily attributable to an increase in gold production and increases in metal prices. Silver and gold prices averaged $5.28 and $384.01 per ounce, respectively, in 1994 compared to $4.30 and $359.77 per ounce, respectively, in 1993. During 1994, the Company produced 6,180,215 ounces of silver and 129,239 ounces of gold compared to 6,119,219 ounces of silver and 123,310 ounces of gold in 1993. The increase in gold production is due to the Company's acquisition of an 80% interest in the Golden Cross Mine effective April 30, 1993. The Company's 80% interest in Golden Cross production in 1994 amounted to 67,400 ounces of gold and 222,246 ounces of silver compared to 56,898 ounces of gold and 175,325 ounces of silver in 1993.\nThe cost of mine operations in 1994 increased by $7,998,962, or 13%, over 1993. Gross profit from mine operations increased by $3,617,310, or 44%, over 1993. Mine operations gross profit as a percent of sales increased to 15% in 1994 compared to 12% in 1993. The increase was primarily attributable to the increases in silver and gold prices in 1994 over the prior year.\nThe cash costs of production per ounce of gold at the Golden Cross Mine amounted to $277 per ounce in 1994, compared to $245 per ounce during the four months ended April 30, 1993 and $220 per ounce during the eight months ended December 31, 1993. The increase was primarily attributable to the presence of a harder grinding ore in the open pit requiring more milling and chemicals in the processing and lower grade of ore being provided from the underground portion of the mine. The cash costs of production per ounce of silver on a silver equivalent basis at the Rochester Mine amounted to $3.57 per ounce in 1994, compared to $3.55 per ounce in 1993.\nSales of industrial products in 1994 increased by $1,224,646, or 12%, compared to 1993. Cost of manufacturing increased by $1,175,157, or 13%, in 1994 compared to 1993. As a result, gross profit from manufacturing in 1994 increased by $49,489, or 4%, compared to 1993.\nOTHER INCOME\nInterest and other income in 1994 increased by $7,320,550, or 132%, over 1993. The increase is primarily due to an increase in the level of the Company's cash and securities portfolio and a gain of $2.7 million arising from the sale by the Company of common shares of International Curator in the third quarter of 1994.\nEXPENSES\nTotal expenses in 1994 decreased by $2,054,213, or 7%, from 1993. The decrease is primarily due to the non-recurring write-offs of $9,374,000, or $.61 per share, effected in the third quarter of 1993. Those write-offs are discussed below and included one-time provisions for litigation settlement of $5,875,000, environmental settlement of $1,230,000 and the write-off of uncollectible notes receivable of $2,268,564. A non-recurring write-off of $800,000 was recorded in 1994 as a result of an adverse judgment in a lawsuit described below relating to four promissory notes made by a predecessor of the Company.\nOn September 22, 1994, a judgment was entered against the Company in the United States District Court for the District of Idaho in a case entitled Goldberg v. Coeur d'Alene Mines Corporation in the amount of $725,688 plus attorney fees. The action involves an alleged claim by the plaintiff to recover on four promissory notes made by a predecessor of the Company. The notes are claimed to be the obligation of the Company by virtue of successive mergers which occurred in 1974 and in 1988. Plaintiff filed with the court a cost bill in the approximate amount of $225,000. The claim was settled on January 11, 1995 by payout of $800,000.\nOn November 12, 1993, the Company's Board of Directors approved the proposed settlement of Kassover v. Coeur d'Alene Mines Corporation, the class action originally filed in November 1990 and amended in March 1991 alleging violations of the federal securities laws and common law primarily in connection with the Company's public offering of Common Stock in September 1990. The proposed settlement called for the Company to (i) issue to the class members Common Stock of the Company having a fair market value of $4 million based on the average closing sale price of the Common Stock on the New York Stock Exchange during the five trading days immediately preceding the court hearing to be held in connection with the settlement and (ii) pay $1,875,000 in cash. On June 24, 1994, the U.S. District Court for the District of Idaho approved the settlement and prior to the end of 1994, a total of 220,083 shares of Common Stock were issued in connection with the settlement. The Board's decision reflected its desire to avoid the continuing substantial costs and expenses associated with the lawsuit and the inherent uncertainties\nof litigation. The Company recorded a litigation settlement expense of $5,875,000 in the third quarter of 1993.\nDuring October 1993, the Company and Callahan negotiated a tentative settlement agreement with the U.S. Environmental Protection Agency (the \"EPA\") and a group of other companies that are potentially responsible parties (\"PRPs\") in connection with the Bunker Hill Superfund site. The Company and Callahan had been notified in February 1990 by the EPA that they were PRPs in connection with that site, where the EPA claimed there was a need for cleanup action under the Comprehensive Environmental Response Compensation and Liability Act of 1980. The negotiated settlement agreement called for the Company and Callahan to pay a total of $1,230,000 to a group of other PRPs in order to remove the Company and Callahan from any additional cleanup liability relating to the site. Accordingly, the Company recorded a non-recurring environmental settlement expense of $1,230,000 during the third quarter of 1993. An order approving the settlement was issued by the United States District Court for the District of Idaho on November 17, 1994, and the settlement amount was paid on December 16, 1994.\nDuring September 1993, the Company commenced foreclosure proceedings upon the collateral underlying two delinquent collateralized promissory notes, the recorded principal and accrued interest on which amounted to $2,268,564. The notes originally were acquired by a corporation that merged with the Company in 1988. Demand for payment had been made without satisfaction and the Company discontinued accruing interest on the notes in October 1991. As a result of the institution of the foreclosure proceedings and the Company's inability to ascertain what amounts, if any, could be realized therefrom, the Company effected a non-recurring write-off of uncollectible notes receivable of $2,268,564 in the third quarter of 1993.\nThe above-described decrease in non-recurring expenses in 1994 from 1993 was partially offset by an increase in interest expense of approximately $6.0 million in 1994, which was related to the issuance of $100 million principal amount of 6-3\/8% Convertible Subordinated Debentures in the first quarter of 1994, and increases in administrative expenses of approximately $.2 million and mining exploration of approximately $1.3 million.\nINCOME (LOSS) BEFORE TAXES AND ACCOUNTING CHANGE\nAs a result of the above, the Company's loss before income taxes and the cumulative effect of a change in accounting amounted to $3,679,258 in 1994 compared to $16,720,820 in 1993. The provision for income taxes amounted to $263,306 in 1994, compared to a benefit of $3,430,760 in 1993. As a result, the Company reported a net loss before the cumulative effect of a change in accounting of $3,942,564, or $ .26 per share, in 1994, compared to a net loss of $13,290,060, or $.87 per share, in 1993.\nCHANGE IN ACCOUNTING\nEffective January 1, 1993, the Company changed its method of accounting for income taxes by adopting the mandatory Statement of Financial Accounting Standards (FAS) 109, \"Accounting for Income Taxes.\" FAS 109 requires an asset and liability approach to accounting for income taxes and establishes criteria for recognizing deferred tax assets. Accordingly, the Company adjusted its existing deferred income tax assets and liabilities to reflect current statutory income tax rates and previously unrecognized tax benefits related to federal and certain state net operating loss carry forwards. The cumulative effect of the accounting change on prior years at January 1, 1993, resulted in a non-recurring gain of $5,181,188, or $.34 per share, and is included in the results of operations for 1993.\nNET INCOME (LOSS)\nAs a result of the above, the Company reported a net loss of $3,942,564, or $.26 per share, in 1994, compared to a net loss of $8,108,872, or $.53 per share, in 1993.\nRESULTS OF OPERATIONS - 1993 COMPARED TO 1992\nSALES AND GROSS PROFIT\nSales of concentrates and dore in 1993 increased by $26,575,500, or 64%, over 1992. The increase is primarily attributable to an increase in gold production and increases in metal prices. Silver and gold prices averaged $4.30 and $359.77 per ounce, respectively, in 1993 compared to $3.94 and $343.73 per ounce, respectively, in 1992. During 1993, the Company produced 6,119,219 ounces of silver and 123,310 ounces of gold compared to 6,254,273 ounces of silver and 56,638 ounces of gold in 1992. The decrease in silver production is due to the temporary closure of the Galena Mine in July 1992. The Galena Mine contributed 822,904 ounces of silver production during 1992. The increase in gold production is due to the Company's acquisition of an 80% interest in the Golden Cross Mine effective April 30, 1993. The Company's 80% interest in Golden Cross Mine production in 1993 amounted to 56,898 ounces of gold and 175,325 ounces of silver.\nThe cost of mine operations in 1993 increased by $21,974,182, or 58%, over 1992 and is primarily due to the acquisition of the Golden Cross Mine in 1993. Gross profit from mine operations increased by $4,601,318, or 128%, in 1993 from 1992. Mine operations gross profit as a percent of sales increased to 12.0% in 1993 compared to 8.7% in 1992. The increase was primarily attributable to the increases in silver and gold prices in 1993 from the prior year.\nSales of industrial products in 1993 increased by $84,116, or .8%, compared to 1992. Cost of manufacturing increased by $101,134, or 1.1%, in 1993, compared to the prior year. As a result, gross profit from manufacturing for 1993 decreased by $17,018, or 1.5%, compared to 1992.\nEXPENSES\nTotal expenses in 1993 increased by $17,429,334, or 123%, over the prior year. The increase is primarily due to non-recurring write-offs of $9,373,564, or $.61 per share ($.49 per share net of taxes), effected in the third quarter of 1993. The write-offs include a one time provision for litigation settlement of $5,875,000, resolution of an environmental matter of $1,230,000 and the write-off of uncollectible notes receivable of $2,268,564. The increase is also attributable to an increase in interest expense of $4,267,802, which is related to the issuance of $75 million principal amount of 7% Convertible Subordinated Debentures in December 1992, and increases in accounting and legal expenses of $1,641,235, idle facilities expense of $769,902, corporate expenses of $617,067 and administrative expenses of $485,501.\nNON-RECURRING CHARGES\nAs described above, non-recurring expenses recorded by the Company during 1993 included (i) a litigation settlement expense of $5,875,000 in connection with the settlement of the Kassover class action lawsuit, (ii) an environmental expense of $1,230,000 in connection with the settlement relating to the Bunker Hill Superfund site and (iii) a write-off of uncollectible notes receivable of $2,268,564.\nINCOME (LOSS) BEFORE TAXES AND ACCOUNTING CHANGE\nAs a result of the above, the Company's loss before income taxes and the cumulative effect of a change in accounting amounted to $16,720,820 in 1993, compared to $4,506,391 in 1992. The benefit for income taxes amounted to $3,430,760 in 1993, compared to $3,747,136 in 1992. The Company reported a net loss before the cumulative effect of a change in accounting of $13,290,060, or $.87 per share, in 1993, compared to $759,255, or $.05 per share, in 1992.\nCHANGE IN ACCOUNTING\nEffective January 1, 1993, the Company changed its method of accounting for income taxes by adopting the mandatory Statement of Financial Accounting Standards (FAS) 109, \"Accounting for Income Taxes.\" FAS 109 requires an asset and liability approach to accounting for income taxes and establishes criteria for recognizing deferred tax assets. Accordingly, the Company adjusted its existing deferred income tax assets and liabilities to reflect current statutory income tax rates and previously unrecognized tax benefits related to federal and certain state net operating loss carry forwards. The cumulative effect of the\naccounting change on prior years at January 1, 1993, results in a non-recurring gain of $5,181,188, or $.34 per share, and is included in the results of operations for 1993.\nNET INCOME (LOSS)\nThe Company reported a net loss of $8,108,872, or $.53 per share, in 1993, compared to a net loss of $759,255, or $.05 per share, in 1992.\nLIQUIDITY AND CAPITAL RESOURCES\nWorking Capital; Cash and Cash Equivalents\nThe Company's working capital at December 31, 1994 was approximately $173.5 million compared to $107.6 million at December 31, 1993. The ratio of current assets to current liabilities was 10.4 to one at December 31, 1994 compared to 6.0 to one at December 31, 1993.\nThe increase in the Company's working capital at December 31, 1994 compared to December 31, 1993 is primarily attributable to the Company's sale in January and February 1994 of an aggregate of $100,000,000 principal amount of 6-3\/8% Convertible Subordinated Debentures Due 2004 (the \"6 3\/8% Debentures\"). The 6 3\/8% Debentures were sold by the Company to Kidder, Peabody & Co. Incorporated (\"Kidder\") pursuant to a Purchase Agreement, dated January 18, 1994, at a price equal to 96.75% of the principal amount sold and were issued by the Company in connection with an offering to \"qualified institutional buyers\" as defined in Rule 144A under the Securities Act and to certain non-U.S. persons in reliance upon Regulation S under the Securities Act of 1933 (the \"Securities Act\"). The 6 3\/8% Debentures were issued pursuant to an Indenture, dated as of January 26, 1994 (the \"Indenture\"), between the Company and Bankers Trust Company, as trustee. The 6 3\/8% Debentures are convertible into shares of Common Stock on or before January 31, 2004, unless previously redeemed, at a conversion price of $26.20 per share, subject to adjustment in certain events. The 6 3\/8% Debentures are redeemable, in whole or in part, at any time on or after January 31, 1997, at redemption prices declining from 103.643% of the principal amount during the year beginning January 31, 1997, to 100% of the principal amount during the year beginning January 31, 2001 and thereafter. The 6 3\/8% Debentures are required to be repurchased at the option of the holder if a Designated Event (as defined in the Indenture) occurs, at 100% of the principal amount thereof plus accrued interest. The Debentures are unsecured and subordinate in right of payment to all Senior Debt (as defined in the Indenture). The Indenture, Purchase Agreement and Registration Rights Agreement are filed as exhibits to this Report.\nPursuant to a Registration Rights Agreement, dated January 26, 1994, (\"Registration Rights Agreement\") between the Company and Kidder, the Company filed a shelf registration statement under the Securities Act in April 1994 for the purpose of registering the 6 3\/8% Debentures and underlying shares of Common Stock issuable upon the conversion thereof under the Securities Act. The Company plans to use the approximately $95.5 million net proceeds from such offering for general corporate purposes, including the possible acquisition of, or investment in,\nadditional precious metals mines, properties or businesses, and for possible developmental activities on new or existing mining properties. The Company's acquisition efforts are primarily focused upon operating precious metals mines and precious metals properties or businesses that are expected to become operational in the near future. The Company currently is engaged in the review and investigation of opportunities for expansion of its business through acquisitions, investments or other transactions. While preliminary agreements have been entered into with respect to certain proposed acquisitions, the consummation of such acquisitions is subject to significant contingencies. The Company invested the proceeds of the above offering in interest-bearing marketable securities and money market obligations, and plans to continue such investments pending the use of the proceeds of that offering as discussed above.\nNet cash provided by operating activities in 1994 was $6,403,007 compared to $4,202,377 in 1993. Net cash used in investing activities in 1994 was $97,244,073 compared to $119,558,375 in 1993. Net cash provided by financing activities in 1994 was $91,310,877 compared to$4,072,853 net cash used in financing activities in 1993. As a result of the above, cash and cash equivalents increased by $469,811 in 1994 compared to a $119,428,851 decrease in 1993.\nConstruction of Fachinal Mine\nIn July 1994, following completion by an independent engineering firm of a detailed feasibility study regarding the Company's Fachinal property, the Company's Board of Directors approved the construction of the project. Based on that study, the Company estimates that the cost to complete the Fachinal mining facilities will be approximately $41.8 million. The Company is funding that construction on a project financing basis. The Company expects to enter into a financing agreement with N.M. Rothschild and Sons, Ltd. under which the bank will provide $24 million for project development. The agreement requires Coeur d Alene Mines to guarantee repayment of the facility until the project reaches a defined completion after which the project alone is liable for repayment. The agreement has numerous financial covenants. The interest rate prior to completion is equal to LIBOR plus 1.5% and increases to LIBOR plus 2.75% after completion. The facility is repayable in eight equal semiannual installments after project completion.\nEnvironmental Compliance Expenditures\nFor the years ended December 31, 1994, 1993 and 1992, the Company expended $2,974,438, $2,404,698, and $1,050,015, respectively, in connection with environmental compliance activities at its operating properties. At December 31, 1994, the Company had expended a total of approximately $4.6 million on environmental and permitting activities at the Kensington Property, which expenditures have been capitalized as part of its development cost.\nThe Company estimates that its environmental compliance expenditures at its operating properties during 1995 will approximate $2,071,000. Such activities at the Rochester and Golden Cross Mines include monitoring, bonding, earth moving, water treatment and revegetation activities. The Company estimates that environmental compliance expenditures at its Kensington and Fachinal developmental properties during 1995 will approximate $542,904 and relate to activities associated with obtaining permits required for construction. Such expenditures would significantly increase in the event a decision is made to proceed with the construction of production facilities at the Kensington property. The Company established a $585,000 reserve in 1991 for future costs relating to the closure of the Ropes Mine previously owned by Callahan; the Company is currently reviewing the adequacy of that reserve to cover expenditures required to comply with environmental regulations. Future environmental expenditures will be determined by governmental regulations and the overall scope of the Company's operating and development activities. The Company places a very high priority on its compliance with environmental regulations.\nExploration and Development Expenditures\nDuring 1994, the Company expended approximately $2.2 million (excluding capitalized interest) for its share of the developmental costs at the Kensington Property, approximately $5.8 million for leach pad construction at the Rochester Mine, $7.5 million (excluding capitalized interest) for the development of the Fachinal Property, $4.8 million representing investment in the El Bronce Mine and $1.2 million to continue its planned development exploration programs. During 1995, the Company presently plans to expend approximately $1.7 million (excluding capitalized interest) for its share of Kensington Property development costs, approximately $38.3 million (excluding capitalized interest) for development at the Fachinal Property, and $3.9 million for developmental and exploration activities at the El Bronce Mine. Construction of the new Fachinal mining facilities is expected to be completed in the fourth quarter of 1995. No decision has been made as to when or whether the Kensington Property will be placed into commercial production.\nInternal Revenue Service Audit\nIn December 1993, the IRS completed an audit of the Company for the years 1990 and 1991. The IRS has advised the Company that two issues remain unresolved, and that the IRS will issue a proposed assessment. One issue involves the alternative minimum tax, which, if resolved in favor of the IRS, would require payment by the Company of approximately $1.2 million. The other issue involves the deductibility of costs previously claimed by the Company. If resolved in favor of the IRS, the Company's net operating loss carryforward would be decreased by $8.2 million. The Company believes it has treated both issues in a manner that is consistent with applicable law and prevailing industry practice and will contest any such assessment.\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item regarding directors is hereby incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. Information regarding the Company's executive officers is set forth above under Item 4A of this Form 10-K.\nITEM 11. EXECUTIVE COMPENSATION\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nPart IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) Financial Statements and Financial Statement Schedules:\n(1) The following consolidated financial statements of Coeur d'Alene Mines Corporation and subsidiaries are included in Item 8.","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"103575_1994.txt","cik":"103575","year":"1994","section_1":"Item 1. BUSINESS\n\t\t General Development of Business\nThe Company is the result of the merger in 1988 of the former Sunstates Corporation, a real estate and insurance conglomerate, with Acton Corporation, an owner and operator of cable television systems. The merger was accounted for as a reverse acquisition: the surviving legal entity having the name and corporate attributes of Acton Corporation but the financial accounting and tax attributes of Sunstates Corporation. Appropriate changes in the capital structure were made to accommodate the various classes of stock of both corporations. With the disposition of the last cable television system (see discussion below), none of the assets of the former cable television operation remain. At the Company's Annual Shareholders' Meeting on December 13, 1993, the shareholders approved the changing of the Company's name to Sunstates Corporation, effective January 1, 1994, in recognition of the fact that the name of Acton Corporation was associated with its cable television operations.\nSunstates Corporation (herein referred to as \"Sunstates\" or the \"Company\", which reference shall include subsidiaries) is a majority-owned subsidiary of Wisconsin Real Estate Investment Trust (\"WREIT\") and WREIT in turn is a direct and indirect majority-owned subsidiary of the following companies: Hickory Furniture Company (\"Hickory\"), Telco Capital Corporation (\"Telco\") and RDIS Corporation (\"RDIS\"), formerly Libco Corporation.\nOn January 17, 1989, Sunstates acquired from Hickory, for a cash payment of $2,000,000, a 99% ownership interest in Sew Simple Systems, Inc. (\"Sew Simple\"), a designer and manufacturer of automated textile machinery located in Fountain Inn, South Carolina. The results of operations of Sew Simple since January 1, 1989 are included in the Consolidated Statement of Operations. The Stock Purchase Agreement provided that if Hickory should find a buyer for Sew Simple prior to the expiration of the Agreement, then Hickory would be entitled to additional amounts based upon the excess, if any, of the sales price over an escalating amount specified in the contract, which, as of April 13, 1992, was approximately $3.4 million (the Rights). On April 13, 1992, Sunstates acquired from Hickory its remaining 1% ownership and its Rights under the Stock Purchase Agreement for approximately $13.6 million (see Note 1 of the Notes to Consolidated Financial Statements). The consideration given by Sunstates included the assignment of approximately $12 million previously due to Sunstates from Hickory and other affiliates plus a note payable for approximately $1.6 million.\nOn June 21, 1990, Hickory White Company (\"Hickory White\"), a wholly-owned subsidiary of Sunstates, completed the purchase of Hickory's furniture manufacturing assets for $44,500,000 plus the assumption of related operating liabilities and transaction costs. The consideration given by Hickory White was composed of cash of $25,315,740 (of which $20,623,807 was borrowed from a major bank pursuant to a Credit Agreement), the assignment of amounts previously due from Hickory totalling $11,257,935 and the assignment of $7,926,325 in Increasing Rate Notes, including accrued interest, due from Hickory Furniture Group, Inc., a wholly-owned subsidiary of Hickory. The operating results of Hickory White are included in the Consolidated Statement of Operations from the date of acquisition.\nAlba-Waldensian, Inc. (\"Alba\"), a manufacturer of women's hosiery and pantyhose, women's casual hosiery products, women's intimate apparel, men's hosiery, medical specialty products and warp knit products located in Valdese, N. C., had been an investee of the Company accounted for utilizing the equity method of accounting since May, 1987. Effective June 30, 1993, Alba became a 50.1% owned subsidiary of the Company's insurance subsidiary, and accordingly, the financial statements of Alba have been consolidated in the accompanying financial statements since that date. Prior to June 30, 1993, the Company's share of Alba's earnings, which averaged 49.9% during the six months ended June 30, 1993, and the year ended December 31, 1992, was reported as equity in earnings of affiliates in the Consolidated Statement of Operations.\nOn December 30, 1993, the Company sold its sole remaining cable television system comprised of approximately 44,000 subscribers located in Anne Arundel County, Maryland resulting in after-tax net income of $46,565,847. With the sale of its sole remaining cable television system, the Company is no longer engaged in the cable television business. Accordingly, the Company has presented its cable television segment as a discontinued operation in the financial statements presented in Item #8 of this Report. Prior year's statements have been reclassified to remove the operations of the cable television segment from income from continuing operations and the net assets and liabilities have been presented on a single line in the prior years' balance sheets.\n\t Financial Information About Industry Segments\nSunstates operates in four principal industries; insurance, manufacturing, real estate and, prior to December 30, 1993, cable television. See Note 14 of Notes to Consolidated Financial Statements contained in Item 8 of this report for information regarding Sunstates' operations in these industry segments.\n\t\tNarrative Description of Business\nSunstates has been engaged in the development, sale and management of real estate and in the property and casualty insurance business for each of the last five years. It has also been engaged in the cable television business from May 4, 1988 through December 30, 1993, in the manufacture of automated textile machinery since January 17, 1989, in the manufacture of furniture since June 21, 1990, in the manufacture of military footwear since September 30, 1990, and the manufacture of textile apparel since June 30, 1993. Sunstates conducts its business primarily through the following subsidiaries:\nNormandy Insurance Agency, Inc., an Illinois corporation engaged in property and casualty insurance through its wholly-owned subsidiaries, principally, Coronet Insurance Company (\"Coronet\"). Hickory White Company, a North Carolina corporation engaged in the manufacture of high end home furnishing products encompassing a broad selection of traditional and transitional wood and upholstered lines with five production facilities located in Hickory and High Point, North Carolina.\nAlba-Waldensian, Inc., a Delaware corporation engaged in the manufacture of women's hosiery and pantyhose, women's casual hosiery products, women's intimate apparel, men's hosiery, medical specialty products and warp knit products located in Valdese, N. C.\nWellco Enterprises, Inc., a North Carolina corporation engaged in the manufacturing of military footwear in Waynesville, N. C. with additional production facilities in Puerto Rico.\nSew Simple Systems, Inc., a South Carolina corporation engaged in the design and manufacture of automated textile machinery.\nSunstates Realty Group, Inc., Sunstates Equities, Inc., and Pensacola Holding Corp., Florida corporations engaged in the development of income-producing properties for sale to others. Their primary activities are in the states of North Carolina, Virginia and Florida.\nNational Development Company, Inc., a Texas corporation engaged in the development and sale of recreational and second home resort lots, primarily in the states of Missouri, Tennessee and Oklahoma.\nThe Springs, Inc., a Wisconsin corporation, engaged in the operation of a luxury hotel and golf resort and the development of residential lots and multi-family units in Spring Green, Wisconsin.\n\t\t\tInsurance Operations\nOperations in the insurance segment include the providing of property and casualty insurance, primarily confined to the writing of full coverage non-standard automobile insurance. During 1994, Coronet's gross writings were 75% classified as auto liability, and 25% as auto physical damage. Illinois premiums account for 48% of the business; Arizona, 22%; Tennessee, 7%; Ohio 6%; Nevada, 8%; and all others, 9%.\nCoronet generally writes minimum statutory limits of liability coverage under policies with terms up to one year. Coronet's customers are typically located in large urban areas and are drivers with a record of accidents or violations thereby making it difficult for them to obtain coverage from insurance companies not specializing in the non-standard automobile business. Types of coverage provided include both physical damage (collision and comprehensive), which has a relatively short payout pattern, as well as liability (bodily injury and property damage) which customarily has a longer payout pattern. Coverage written in excess of amounts which management deems reasonable to retain in relation to surplus are reinsured with other insurance companies.\nNormandy and Coronet were both incorporated in Illinois in December, 1962 and commenced business on April 5, 1963 under the Illinois Insurance Code. Coronet is licensed to transact business in Alabama, Arizona, Arkansas, Colorado, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kentucky, Minnesota, Mississippi, Missouri, Montana, Nevada, New Mexico, Ohio, Oklahoma, Oregon, South Dakota, Tennessee, Texas, Utah, Virginia, West Virginia, Wisconsin and Wyoming.\nCoronet Insurance Company operates three wholly-owned full line property and casualty insurance subsidiaries; National Assurance Indemnity Company (\"NAIC\"), Casualty Insurance Company of Florida (\"CIC Florida\") and Crown Casualty Company (\"Crown\"). NAIC was incorporated in Illinois on April 19, 1988, commenced business on June 21, 1988, and is licensed only in the State of Illinois. During 1992, NAIC began writing non-standard auto insurance at rates different than Coronet. CIC Florida was incorporated in Florida on April 3, 1990, commenced business on April 26, 1990 and is licensed only in the State of Florida. CIC Florida began writing business in February, 1994. Crown, a wholly-owned subsidiary of NAIC, was incorporated in the State of Illinois on March 23, 1990, commenced business on January 11, 1991, and is licensed only in the State of Illinois. On November 30, 1992, Coronet ceded 100% of the unearned premiums on its auto business lines as of that date to NAIC (75%) and Crown(25%). A reinsurance agreement provides that effective December 1, 1992, Coronet will cede 27% of its new auto business on the programs existing at that time to NAIC (20%) and Crown (7%). On December 31, 1994, Casualty Insurance Company of Georgia, formerly a wholly owned subsidiary of NAIC, was merged into Coronet Insurance Company.\nCoronet operates in Illinois through numerous independent agencies who in turn deal with the retail customer. Liability and physical damage claims are adjusted by the home office staff. Written premiums in Illinois were $23,426,000 in 1994 compared to $19,515,000 in 1993, and $ 25,690,411, in 1992. The decrease in 1993 was primarily the result of program changes instituted by new management during 1993 that were not well received by certain major Illinois producers. During the latter part of 1993 and throughout 1994, Coronet has addressed the issues raised by the producers so as to regain the lost volume. In addition, Coronet has signed up additional producers, and developed new marketing programs in 1994.\nFlorida, Georgia, Tennessee, Arizona and Nevada business is obtained through managing general agency agreements. Subject to rules, regulations and rates promulgated by the Company, the agents are responsible for the production and issuance of policies. Claims have been handled by the same agents subject to separate agreements until late December 1993, at which time the Georgia claims were transferred to Coronet's Tampa claims office. Coronet personnel have conducted regular underwriting and claims audits in the offices of the agents.\nAs of October 1, 1991, laws materially affecting automobile insurance changed in Georgia. These changes have resulted in lower penetration of the marketplace and a decision was made to stop accepting new business in August 1993. As a result of these matters, premium volume declined to $61,769, $2,928,068 and $6,804,681, for the years of 1994, 1993 and 1992, respectively, as compared $13,717,709 in 1991.\nBased on a review of the Arizona marketplace and rates, a rate increase of 21.7% was made in April 1993, which resulted in volume decreasing to $10,693,777 in 1994 as compared to $12,454,787 in 1993 and to $33,092,807 in 1992.\nDuring 1993 and 1992, certain unprofitable programs were terminated. They include the termination in December 1993 of the Camelback reinsurance program which had written premiums of $4,800,000 in 1993 and $10,650,000 in 1992. Other programs which were terminated in late 1992 or early 1993 include the Kansas, Iowa, Kentucky and West Virginia programs, which had combined written premiums of $7,300,000 in 1992.\nThrough the end of 1993, substantially all of the premiums produced in the states of Missouri and Ohio were produced under Managing General Agency agreements similar to the agreements used to procure the Georgia, Tennessee and Arizona business. All underwriting for these programs were done by the Managing General Agents. Substantially all of the claims handling function for these programs were transferred from the agents to Coronet's Chicago or Tampa claims offices during 1993. Coronet personnel have conducted regular underwriting and claims audits, if appropriate, in the offices of the agent.\nAs the result of the factors and circumstances described above, Coronet has experienced a decline in written premiums from $131 million in 1991 to $119 million in 1992 to $57 million in 1993 and $48 million in 1994.\nPrior to December 30, 1994, Normandy owned 72% of Greater Heritage Corporation (\"Heritage\") which in turn owned Florida No-Fault Insurance Agency, Inc. (\"Agency\"), an insurance agency business in the State of Florida. The Agency was sold in August, 1989 at a price of $2,250,000 with an initial payment of $250,000 and a note of $2,000,000. The note carries an interest rate of prime plus 1%, with principal payments being amortized over a twelve year period and a balloon payment due August 1, 1997. The sale resulted in a gain of $1,121,674, which is being recognized as the payments under the note are received. Heritage has no other ongoing operations. The note which was acquired by Coronet at December 31, 1992, has a remaining balance of $1,291,491. On December 30, 1994, GHC was merged into a wholly-owned subsidiary of Normandy.\nCompetition\nThe insurance industry is highly competitive and Coronet competes not only with other stock companies, many of which have substantially larger capital, but with mutual companies (which may have a competitive advantage because all profits accrue to policyholders), and with underwriters operating under insurance exchanges. Many other companies offer the lines of insurance which Coronet writes now or may write in the future. Many of these companies have been in business for long periods of time, have a much larger volume of business, offer more diversified lines of coverage and have far greater financial resources than Coronet.\nCoronet obtains its underwriting business in three ways: (i) through insurance agencies who in turn deal with the retail customer, (ii) through managing general agents who in turn deal with smaller insurance agencies, and (iii) through reinsurance assumed agreements with other insurance companies. Assumed reinsurance business accounts for less than 10% of Coronet's business. Coronet does not directly market to retail customers. Primary competitive factors in particular markets are the premium rates for insurance coverage, commission rates offered to producers of underwriting business and the quality and responsiveness of services.\nInvestments\nCoronet may invest in numerous different types of investments as allowed under applicable insurance regulations (see \"Regulation\" below): including U. S. Government securities; bonds and other corporate debt instruments; stocks and stock market options; income-producing real estate and real estate mortgages; and, through ownership of certain Sunstates subsidiaries, other non-insurance operations of Sunstates. Under Coronet's investment policy, investments may be made in high yield, unrated or less than investment grade corporate debt securities when it is perceived that such an investment could produce yields sufficiently greater than those generated by investment grade securities. Investments in high yield, unrated or less than investment grade corporate debt securities have different risks than other investments in corporate debt securities rated investment grade and held by Coronet. Risk of loss upon default by the borrower is significantly greater with respect to such corporate debt securities than with other corporate debt securities because 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. Coronet may from time to time utilize both market as well as issuer-specific call or put options for various investment reasons including reducing its portfolio's exposure to stock market volatility.\nRegulation of Insurance Operations\n1. General. Coronet, NAIC and Crown are subject to statutory regulation and supervision by the Illinois Department of Insurance (\"IDI\") pursuant to the Illinois Insurance Code (\"Insurance Code\"). The IDI possesses broad administrative powers relating to such matters as licensing of insurance companies and their agents, approving policy forms, prescribing the nature of and limitations on investments, requiring the establishment of reserves, regulating trade practices, establishing the form and content of financial statements and reports, and reviewing the rates for insurance, among other matters. Coronet, NAIC and Crown are required to file detailed annual statements with IDI and its business and accounts are subject to periodic examination by IDI.\nCIC Florida is subject to statutory regulation and supervision by the Florida Department of Insurance which possess powers similar to those possessed by the Illinois Department of Insurance.\n2. Holding Company System Regulation. The Insurance Code requires registration and periodic reporting by insurance companies that are licensed in Illinois and that are part of an insurance holding company system. An \"insurance holding company system\" means two or more affiliated persons, as defined by the Insurance Code, one or more of whom is an insurer. Since Coronet is an indirect subsidiary of Sunstates, Coronet is subject to these regulations. Generally, Coronet is required to register with the Director of the IDI as a member of an insurance holding company system and to file an annual statement and make its books and records available for examination. Material transactions between Coronet and any other affiliate of Coronet, which includes RDIS, Telco, Hickory, WREIT and Sunstates are subject to disclosure and such transactions must be on terms that are fair and reasonable.\n3. Dividends. The Insurance Code permits the declaration and payment of dividends only out of earned, as distinguished from contributed, surplus, provided further that the remaining surplus is not less than the minimum original surplus required for it to transact business after payment of the dividend. The provisions of the Insurance Code pertaining to insurance company holding systems further restrict payment of any extraordinary dividend. Pursuant to this provision, Coronet will not be permitted to pay any extraordinary dividend or distribution unless the Director of IDI has received thirty days prior notice of the declaration and does not disapprove of such payment within that thirty day period. An extraordinary dividend or distribution is defined as one whose fair market value, together with other dividends within the preceding twelve months, exceeds the greater of (i) ten percent of surplus as regards policyholders as of the preceding December 31, or (ii) the net income from operations, as adjusted, for the twelve months ending on the preceding December 31.\n4. Acquisition of Control. The Insurance Code restricts the ability of any person to acquire control of Coronet or of any company that directly or indirectly controls Coronet (which includes RDIS, Telco, Hickory, WREIT and Sunstates) without prior regulatory approval. Pursuant to the Insurance Code, ownership, control or holding shareholders' proxies representing ten percent or more of the voting securities of Coronet, RDIS, Telco, Hickory, WREIT or Sunstates, will be presumed to constitute control unless rebutted by a showing made in the manner as the Director of IDI may provide by rule.\n5. Restrictions on Investments. The Insurance Code restricts investments of Coronet to those set forth in the Insurance Code. The Insurance Code requires any investment of Coronet to be authorized or ratified by the Board of Directors or by a committee thereof charged with the duty of supervising investments and loans. Among the type of investments permitted are obligations of the United States, states or political subdivisions of a state; revenue obligations of states or municipal public utilities; obligations of business corporations; obligations of not-for-profit corporations; non-demand obligations of financial institutions; common stock; preferred or guaranteed stock; equity or index put and call options (other than uncovered call options); savings and loan association deposits; income producing real estate; collateral loans; mortgages on real estate and mortgage pass-through securities as well as other permitted investments. The Insurance Code provides limitations for each category of investment as to the percentage of admitted assets or as to the percentage of surplus of Coronet which may be invested in each category. In addition, the Insurance Code provides limitations as to the percentage of admitted assets which may be invested in any one particular obligation or investment.\n6. Restriction on Rates. The Insurance Code, and similar statutes which govern Coronet in each jurisdiction in which it does business, sets forth standards with regard to the making and use of rates. The statutes require generally that the rates not be excessive or inadequate, nor can they be discriminatory. A rate will not be held to be excessive unless it is unreasonably high for the insurance provided and a reasonable degree of competition does not exist in the area with respect to the classification to which the rate is applicable. A rate will not be held inadequate unless it is unreasonably low for the insurance provided and continued use of the rate would endanger the solvency of Coronet. The statutes generally permit consideration to be given to past and prospective loss experience, to a reasonable margin for underwriting profit and contingencies and to past and prospective expenses.\nEvery insurance company writing certain lines of insurance must file its rates and rating schedules with the appropriate governmental regulators. The filing must be made as often as the rates are changed or amended.\nThe consolidated financial statements include the estimated liability for unpaid losses and loss adjustment expenses (\"LAE\") of Coronet. The liabilities for losses and LAE are determined using case-basis evaluations and statistical projections, including independent actuarial reviews, and represent estimates of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. In estimating the ultimate net cost of unpaid claims and LAE the impact of inflation is implicitly considered. Coronet reduces its reserves for any estimated salvage or subrogation recoveries which may be realized in connection with settling unpaid claims. These estimates are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as necessary. Such adjustments, if any, are reflected in current operations.\nThe accompanying tables present an analysis of losses and LAE. The following table provides a reconciliation of beginning and ending liability balances for 1994, 1993 and 1992. The tabular Analysis of Loss Adjustment and Loss Expense Development shows the development of the estimated liability for the ten years prior to 1994.\nThe increase (decrease) in estimated losses and loss adjustment expenses for claims occurring in prior years, as shown in the preceding table, is due to settling case-basis reserves established in prior years at amounts other than originally expected.\nThe anticipated effect of inflation is implicitly considered when estimating present liabilities for losses and LAE. Anticipated cost increases due to inflation are considered in estimating the ultimate claim costs. Average claim costs (severities) are projected based on historical trends adjusted for changes in underwriting standards, policy provisions and general economic trends. These trends are monitored based on actual development and are modified if necessary.\nThe limits on risks retained by Coronet vary by type of policy. Risks in excess of the retention limits are reinsured.\nThe following table presents the development of balance sheet liabilities for 1984 through 1994. The top line of the table shows the estimated liability for unpaid losses and LAE recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amounts of losses and LAE for claims arising in all prior years that are unpaid at the balance sheet date, including losses that had been incurred but not yet reported to Coronet. The upper portion of the table shows the reestimated amount of the previously recorded liability based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about each individual claim.\nThe \"cumulative redundancy (deficiency)\" represents the aggregate change in the estimates over all prior years. For example, the 1984 liability has developed a $662,000 deficiency over ten years. That amount has been reflected in income over the ten years and did not have a significant effect on income of any one year.\nThe lower section of the table shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year. For example, in connection with the accident year of 1985, Coronet had paid as of December 31, 1994, $23,491,000 of the currently estimated $23,660,000 of losses and LAE that had been incurred; thus, an estimated $169,000, net of salvage and subrogation receivable, remains to be paid as of the current financial statement date.\nIn evaluating this information, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, the amount of redundancy related to losses settled in 1989, but incurred in 1983, will be included in the cumulative redundancy (or deficiency) amount for years 1984 through 1989. This table does not present accident or policy year development data, which readers may be more accustomed to analyzing. Conditions and trends that have affected development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table.\n\t\t Furniture Manufacturing\nHickory White Company, through its four divisions, manufactures and retails wood furniture (also known as \"casegoods\") consisting of bedroom, dining room, and occasional pieces as well as upholstered furniture. Hickory White's furniture generally follows certain period styles from America, England, France, Italy and the Orient and is offered in numerous finishes. Recent introductions have also included contemporary and transitional designs. Designs are acquired from various independent designers on a retainer or royalty basis under agreements generally lasting five years.\nCasegoods are manufactured at the Company's residential manufacturing complex in Hickory, NC. Pricing generally falls in the upper-middle to upper price ranges, either as individual pieces or as a suite of furniture.\nThe upholstery division also targets pricing in the upper-middle to upper price ranges, with products manufactured at the Company's upholstery plant in High Point, NC. Wood frame parts are made in an adjacent frame plant. Some frames are imported from Spain and Italy, and are finished and upholstered at the Company's plant.\nThe Chaircraft Division, located in Bethlehem, NC, manufactures and markets occasional chairs and lounge seating which are sold to the contract, hospitality and health care markets. Their products are generally priced in the medium price ranges.\nThe Retail Division consists of two factory outlet stores in Statesville and Burlington, North Carolina. These stores sell factory seconds, returns, showroom samples, discontinued lines, etc. to the general public.\nThe following table shows the percentage of Hickory White's total sales (including periods prior to acquisition on June 21, 1990) from operations attributable to the sale of casegoods, upholstered furniture and occasional chairs\\lounges during each of the periods set forth.\nManufacturing Process, Raw Materials and Supplies\nHickory White manufactures furniture by combining skilled craftsmanship with mechanized techniques. The blending of modern technology and skilled craftsmanship results in volume production without sacrificing quality. Prices of furniture pieces vary according to type and quality of wood used in the piece of furniture, detailed matching of veneers, quality of fabric (if upholstered), amount of hand work performed by the skilled craftsmen and time devoted to hand assembling and finishing the product.\nMaterials and supplies used in the manufacture of Hickory White's product consists primarily of lumber, veneers, fabrics, finishing material and various types of hardware. With a few exceptions, such as mahogany lumber, these items are provided by domestic sources and are offered by a number of competing suppliers. Hickory White devotes significant attention to its production scheduling, adequacy of inventories of materials, and the orderly procurement of a steady flow of materials and supplies. This stability has been achieved without the necessity of entering into long-term purchase commitments. Consequently, while the furniture industry has occasionally experienced temporary shortages and increased costs of some of its raw materials, such occurrences have not had any significant effect on the preponderance of Hickory White's diversified line of products and management does not expect any significant effect in the future.\nMarketing, Sales and Distribution\nHickory White sells its products primarily to furniture retailers, showrooms and department stores. Furniture is also sold on a contract basis to customers other than furniture retailers such as hotels, motels, restaurants, offices, and retirement homes. Hickory White's products are principally sold in the United States, however, both the European Common Market and the Japanese Market have produced some sales to date. Although not currently significant, the volume in both of these markets is expected to increase in the future.\nResidential products are sold through 21 exclusive commissioned sales agents. In addition, 25 commissioned sales agents sell Hickory White's products to the contract market and these representatives also sell the products of other companies.\nHickory White maintains approximately 2,200 active customer accounts. No single customer accounted for more than 3% of consolidated net sales during the 1994 fiscal year.\nThe percentages of consolidated net sales attributable to certain categories of purchasers during each of the last five years (including periods prior to acquisition) are as follows:\nBacklog\nHickory White's unfilled customer orders (backlog) for furniture was approximately $7,339,000, $9,084,000 and $7,431,000 as of December 31, 1994, 1993 and 1992, respectively. Backlog is generally filled within three months.\nEnvironmental and Other Regulation\nHickory White believes it has complied with all federal, state and local environmental and regulatory requirements and in cooperation with its insurance carriers, conducts safety programs and makes capital improvements to reduce risks of injury to employees, loss of property and the correction of environmental problems.\nHickory White is aware of the vast amount of activity pending on the federal, state and local levels which would require the expenditure of unknown amounts should the proposals be adopted. Proposals which have been advocated include but are not limited to: (a) further restrictions concerning the amount of wood dust particles in the work place, (b) increased control of permissible emissions such as smoke and finishing fumes into the environment, (c) further restrictions on flammability of upholstered furniture, (d) further restrictions on above ground and underground storage tanks and (e) bans on use of toxic substances.\nThe furniture industry is working with various regulatory bodies in an effort to see that adequate protection can be provided to employees, communities and consumers without prohibitive costs to manufacturers. In the past, the voluntary efforts of the industry, (including Hickory White) and the cooperative efforts of the industry and regulatory agencies, have produced reasonable regulation, the cost of which has not been prohibitive.\nCompetition and Housing Industry Factors\nThe furniture industry is highly competitive, with more than 2,000 manufacturers engaged in various phases of the industry. Although furniture manufactured by Hickory White is marketed primarily in the upper-middle to high price ranges, such furniture competes with other manufacturers' furniture in all price ranges. Many other competing furniture manufacturers have greater resources than Hickory White. Reputation, price, design and service constitute the principal methods of competition in the industry.\nImports have become an increasing factor in the furniture market, primarily in wood furniture. The primary sources of imports include Taiwan, Korea, Canada and Europe. Imports from Europe are generally in the upper price range (above Hickory White) and are less competitive at the lower price points. Hickory White has been affected in a small way by imports from the Pacific rim.\nCompetitive factors require that Hickory White and other industry members carry significant amounts of inventory in order to meet rapid delivery requirements of customers. Hickory White does not normally grant extended payment terms to customers, and it follows the normal practice in the industry of not permitting its customers to return merchandise unless the return is authorized.\nThe furniture industry has traditionally benefitted from new housing construction. Although interest rates have increased during the past year, they are still within reach of most new homeowners. However, such increases have resulted in a decline in new housing starts.\nManufacturing Consolidation\nIn early 1993 the Company closed its casegoods manufacturing operation in Mebane, NC which was the old White Furniture Company acquired in 1985. The shutdown was attributed to sagging demand for upper-end wood furniture, and to the Company's excess production capacity. Product lines previously manufactured in Mebane were transferred to the Hickory plant, and service to customers continued uninterrupted. (See \"Management Discussion and Analysis\" in Item 7. of Part II of this Annual Report for further information regarding this consolidation.)\n\t\t\t Textile Apparel\nAlba manufactures and markets a variety of knitted apparel and health care products through four divisions, the Consumer Products Division, the Health Products Division, the Alba Direct Division and the Byford Apparel Division. In addition, Alba has created the AWI retail division to market products directly to the consumer.\nConsumer Products Division\nProducts manufactured and sold by this division include women's intimate apparel and women's hosiery products. Intimate apparel includes stretch bikinis, briefs and bodywear, as well as specially designed briefs for maternity wear. Women's hosiery products include sheer stockings, pantyhose, and trouser socks, primarily for large-size women and the maternity market.\nAlba has developed a process which makes it possible to knit bras, tank tops and body suits in seamless knitting equipment. This design technology, which has a patent pending, has allowed the company to significantly broaden its product offerings.\nAlba uses state of the art computer-controlled circular-knitting technology. In addition, a significant portion of Alba's consumer products, including its women's intimate apparel, are produced on fine gauge full-fashion knitting equipment. Such equipment produces apparel that management believes is better fitting, therefore more comfortable. Management believes that, due to the limited availability of such equipment, few companies have the ability to produce a significant volume of these full-fashioned products.\nHealth Products Division\nProducts manufactured and sold by this division are designed to assist in healthcare. They include anti-emobolism stockings and pulsitate anti-embolism systems, an intermittent pneumatic compression device, both designed to improve circulation and reduce the incidence of deep vein thrombosis; sterile wound dressings such as presaturated gauze, petrolatum and xeroform gauze, non-adhering dressings and gauze strips; XX-Span dressing retainers, an extensible net tubing designed to hold dressing in place without the use of adhesive tape. All dressing products are used in wound care therapy, particularly the treatment of burns.\nKnitted stockinette is manufactured in a variety of sizes and used under fracture casts, and sterile packaged for use as a supplemental drape in surgical procedures. Heel and elbow pads are XX-Span(R) sleeves with an inner soft foam pad used to reduce pressure and the incidence of decubitus ulcers.\nSlip-resistant patient treads are knitted, soft patient footwear with slip-resistant soles to help prevent patient falls while keeping feet warm even while in bed. Knitted arm sleeves provide protection to the skin of patients with poor circulation. Blood filter sleeves are a component used in blood filtering systems manufactured by others. Mesh panties are inexpensive stretch pants used to hold maternity pads or incontinent pads in place.\nByford Apparel Division\nByford imports and markets a broad range of better men's hosiery and sweaters. For the most part, Byford's socks are imported from the Byford mill in Leicester, England. The men's hosiery incorporates fully reciprocated and reinforced heels and toes. Sourcing for Byford sweaters is more broadly based , with products coming from Coats Viyella mills in the UK, mills in the Far East, and domestic sweater producers.\nAlba Direct Division\nAlba Direct distributes products from the Consumer Products Division, Byford Apparel Division, and Health Products Division to the independent specialty retail class of trade via telemarketing. It is also the primary group responsible for building Alba's export business.\nAWI Retail Division\nAlba Direct also has responsibility for an outlet store in Branson, Missouri, thereby providing entry into one of the fastest growing channels of distribution.\nMethods of Distribution\nThe Consumer Products Division markets its products directly to chain store organizations, which sell them under their own labels, and to several companies that market nationally advertised brands. Alba's products are sold throughout the United States through salaried and commissioned salesmen. Byford products are marketed primarily through men's specialty stores, both chain and independents. Products of the Health Products Division for use in hospitals are marketed to major distributors supported by Alba's commissioned sales representatives. These products are sold both under private label and under Alba's own Life Span(R)label. Alba Direct distributes branded Consumer Products and Health Products to the independent retail trade through telemarketing. Sales offices are located in Valdese, N.C. and in New York. Total expense for marketing and selling of all products from Alba's continuing operations was 10.0% of sales in 1994, compared to 12.0% in 1993. The decrease from 1993 was mainly due to better cost control and the absence of incurred costs associated with a repackaging project and expenses related to the Leslie Fay(R) line.\nManufacturing\nFrom the 1920's to the 1940's, women's silk stockings were knitted to the shape of the leg on fine gauge full-fashion machines and were seamed up the back (because silk is an inelastic yarn). The introduction of stretch nylon yarn in the early 1950's made it feasible to knit seamless stockings and, later, pantyhose on tubular knitting machines. When this occurred, the industry considered fine gauge full-fashion knitting equipment obsolete and production of this equipment here and in Europe ceased. Much existing equipment was destroyed and none has been manufactured since. In the mid-1950's Alba developed a technique for producing stretch, one-size panty products for women on this full-fashion knitting equipment. After some years of marketing development, the stretch panty product became quite successful, and, subsequently, Alba began using the same equipment to produce children's leotards and, later, men's underwear. During 1989 and 1990, men's underwear, the remainder of the children's leotards and tights were discontinued. In past years, Alba sought and acquired significant number of fine gauge full-fashion knitting machines and also developed a substantial stock of spare parts. As a result, management believes that Alba now owns more fine gauge full-fashion knitting machines than any other manufacturer. Company technicians have developed the capability of rebuilding and refurbishing the equipment to meet new equipment efficiency and quality standards. Alba, through its training programs, has developed a corps of professional mechanics and knitters to continue efficient operation of these machines. Alba's present complement of equipment is more than sufficient to produce the volume of its present sales, and it can produce or has produced any machine parts required for continuing operation of these machines. The balance of Alba's products is manufactured on equipment generally available to the industry (even though some equipment is modified by Alba). Alba anticipates that capital expenditures for 1995 will be approximately $2,100,000 for the renovation of existing plant and equipment and for the purchase of new, more efficient knitting equipment.\nFinancial Information About Classes of Similar Products\nAlba is in a single line of business: manufacturing, processing and selling knitted products, consisting of several classes. The table below illustrates sales as a percentage of net dollar volume from continuing operations for each product class for each of Alba's last five years:\nDiscontinued products are eliminated for the purpose of this table. The remaining sales percentages of each class were restated after this elimination to represent sales of each class as a percentage of net dollar volume from continuing product lines.\nNew Products or Segments\nAlba maintains an active research and development department that continually evaluates new products and processes. Management also evaluates new products, business opportunities, and acquisitions on an on-going basis and could encounter a profitable situation which would require substantial investment in the future. Such an investment occurred in 1994 with the purchase of the pulsitate anti-embolism system from Baxter Healthcare Systems.\nOn March 6, 1995, the Company's textile apparel manufacturing subsidiary (Alba) purchased the Balfour Health Care Division and manufacturing facility in Rockwood, Tennessee from Kayser-Roth Corporation for approximately $14.5 million, subject to post-closing adjustments. The acquisition of Balfour will add approximately $15 million in annual sales to Alba. Alba financed 100% of the acquisition price with a revolving loan agreement provided by a major bank.\nSources and Availability of Raw Materials\nThe principal raw materials used by Alba in its manufacturing processes include various types of yarn, chemicals for dyeing and finishing and for impregnating medical products and packaging materials for all products. Alba acquires these materials from a number of sources and is not dependent on any one source for a significant amount of its raw materials. Alba anticipates no material change in either the availability or the cost of its raw materials.\nPatents and Licenses\nThe only material patents held by Alba are (1) for pantyhose with a terry crotch insert, which expired in 1992; (2) for a device used to warm wet dressings; and (3) for a process covering the manufacture of dressings. The latter two expire in 2002. Alba or its subsidiary, Pilot Research Corporation, holds numerous other patents that, because of obsolescence or other reasons, are not material to Alba's current operations. Alba licensed the No-Nonsense(R) trade mark in 1990 for an initial term of 3 years and seven months with renewal options after the expiration date. Management decided to terminate the license agreement at the end of 1993.\nWorking Capital\nDifferences resulting from seasonal fluctuations have not been sufficient to materially affect Alba's working capital requirements. Alba sells merchandise on consignment only on a limited basis. Returns are permitted when the quality of merchandise sold is below acceptable standards or when an error in completing an order occurs. The number and amounts of returns during Fiscal 1994 did not have a material effect on working capital of Alba. Due to the various approaches to manufacturing and distribution used by the industry, Alba is not aware of any industry-wide norms relating to sale and delivery requirements. During Fiscal 1994 working capital was adversely affected by the purchase of inventory related to the pulsitate anti-embloism system from Baxter Healthcare. This purchase was financed through short term borrowings on a line of credit which will be converted to a long term note in 1995 with an amortization schedule of 5 years.\nSignificant Customers\nMajor customers for Alba's products and their respective volume of sales for 1994, 1993 and 1992 are as follows:\n\t\t\t 1994 1993 1992\nBaxter Health Products Corporation $12,902,722 $13,610,937 $11,074,280\nWhile the loss of Baxter Health Products Corporation would have a material adverse effect on the business of Alba, management believes that because of the number of departments within this company to which it sells, the loss of a material amount of sales is unlikely.\nBacklog\nAlba's backlog of firm orders at December 31, 1994 was $2,173,893. A majority of Alba's orders are for delivery within 30 to 60 days. The backlog figures, therefore, are not normally indicative of orders for the remainder of the year.\nCompetition\nIn addition to meeting the demands of the normal hosiery and intimate apparel markets, Alba specializes in producing garments for the hard-to-fit woman. Consumer products are sold on a private label basis through the nation's retail chains and national brands. Health care products for use in hospitals are marketed under private label to major distributors, supported by commissioned sales representatives. In addition, health care products for use in the home have been introduced under private label and under Alba's own Life Span(R)label. Byford products are primarily marketed under the Byford name. Alba encounters severe competition in the sale of its products from numerous competitors, a few of which are known to have larger sales and capital resources than Alba. Management is unable to estimate the number of Alba's competitors or its relative position among them. Alba believes that the principal methods of competition in the markets in which it competes include price, delivery, performance, service and the ability to bring to the market innovative products. Management believes that Alba is competitive with respect to these factors but is unable to identify specific positive and negative aspects of Alba's business pertaining to such factors.\nResearch and Development\nAlba reported that it spent $376,008, $340,663 and $187,000 for the years ended December 31, 1994, 1993 and 1992, respectively, in company-sponsored research and development projects through its wholly-owned subsidiary, Pilot Research Corporation and through Alba's Quality Control and Research and Development Department.\nEnvironmental Regulations\nIn the opinion of management, Alba and its subsidiaries are in substantial compliance with present federal, state and local regulations regarding the discharge of materials into the environment. Capital expenditures required to be made in order to achieve such compliance have had no material effect upon the earnings or competitive position of Alba or its subsidiaries. Management believes that continued compliance will require no material expenditures.\nGovernment Regulation\nAlba is subject to various regulations relating to the maintenance of safe working conditions and manufacturing practices. In addition, certain of the products manufactured by the Health Products Division are subject to the requirements of the Food and Drug Administration with respect to environmentally controlled facilities. Alba believes that it is currently in compliance with all such regulations.\n\t\t\tMilitary Footwear\nA majority of Wellco's operations relate to military footwear, which involve the following activities:\nCombat Boot Manufacturing\nWellco's largest activity involves the manufacture and sale of military combat boots under firm fixed price contracts with the United States government. Boot products are the general issue all-leather boot, the hot weather boot and the desert boot, all manufactured using the government specified Direct Molded Sole (\"DMS\") process.\n\t Military combat boot manufacturing activities in 1994 consisted of production and shipments against a three year contract awarded in 1993. When this contract was initially awarded, it was projected that shipments would be spread equally over three years, with the second and third years being from the award of contract options. However, actual consumption of combat boots during 1994 (first year) was less than projected, and resulted in the government's award in August, 1994 of the first option with a delivery time of sixteen months, one-third longer than the first year. This reduced the pairs of combat boots shipped in 1994, but the negative effect of this was somewhat offset by increased sales of equipment to non-military boot manufacturing customers and foreign military sales. The government has expressed their intent to also extend over sixteen months deliveries under the second option of this contract, at the end of which they are projecting the completion of their inventory reduction program.\nMilitary Equipment and Technology\nThrough a subsidiary (Ro-Search, Inc.) Wellco supplies certain equipment and technology under long-term agreements to U.S. combat boot manufacturers. The boot makers receive equipment, technology and service, and Wellco earns fees based on pairs produced. Equipment is either sold or leased to these customers.\nForeign Military Sales\nRo-Search provides military footwear technology, technical assistance, training, equipment and materials to other countries. This may be through private companies who contract with their government, as is the practice in the U.S., or directly to the military who run their own factories. This activity can vary from year to year with the needs and financial resources of these customers. 1994 developments included the sale of additional equipment and materials to a long-term customer, the military of El Salvador.\nResearch and Development\nA significant research and development effort is required in order to maintain Ro-Search's leading position in military footwear technology. Ro-Search's own resources committed to such research and development are supplemented by contracts with various agencies of the Department of Defense. In 1994, Ro-Search completed development work for the U. S. Army's Research and Development Laboratories on improvements to the hot weather boot, which will soon be incorporated into boot production contracts. Wellco estimates that the cost of research and development varies from $50,000 to $300,000 per year, depending on the number of research projects and the specific needs of its customers.\nNon-Military Footwear Activity\nAlthough much smaller than military activity, non-military footwear is also an important part of Wellco's business, which involve the following activities:\nRo-Search provides, primarily under long-term licensing agreements, technical assistance for manufacturing commercial footwear to customers in the United States and abroad. Under these agreements licensees receive technology, services and assistance, and Ro-Search earns fees based primarily on the licensees' sales volume. In 1994, Ro-Search provided one of its oldest customers with a significant amount of new equipment, and sold equipment and started the installation process for one new customer.\nRo-Search also has an ongoing business in the supply of European-made metal hardware for boots, such as hooks and speed lace loops and D-rings, and the related automated machinery for applying such hardware, to North American manufacturers of rugged footwear. The recent popularity of boots has significantly increased the sales of these items.\nGovernment Military Boot Contracting Environment\nBidding on contracts is open to any qualified U.S. manufacturer. In addition to meeting very stringent manufacturing and quality specifications, contractors are required to comply with precise delivery schedules and a significant investment in specialized equipment is required.\nWellco usually competes on U. S. government contracts with three other companies, no one of which dominates the industry. Many factors affect the government's demand for combat boots and the quantity purchased can vary from year to year. Contractors cannot influence the government's combat boot needs. Price, quality and manufacturing efficiency are the areas emphasized by Wellco that strengthen its competitive position. Combat boots contract awards are presently based on negotiated-price directed awards.\nGovernment contracts are subject to partial or complete termination under the following circumstances:\n1. Convenience of the Government. The government's contracting officer has the authority to partially or completely terminate a contract for the convenience of the government only when it is in the government's interest to terminate. The contracting officer is responsible for negotiating a settlement with the contractor.\n2. Default of the Contractor. The government's contracting officer has the authority to partially or completely terminate a contract because of the contractor's actual or anticipated failure to perform his contractual obligations.\nUnder certain circumstances occasioned by the egregious conduct of a contractor, contracts may be terminated and a contractor may be prohibited for a certain period of time from receiving government contracts. Wellco has never had a contract either partially or completely terminated.\nOther Information\nBecause domestic commercial footwear manufacturers are adversely affected by imports from low labor cost countries, Wellco targets its marketing of technology and assistance to military footwear manufacturers. Wellco competes against several other footwear construction methods commonly used for heavy-duty footwear with leather uppers. These methods include the Goodyear Welt construction, as well as boots bottomed by injection molding. These methods are used in work shoes, safety shoes, and hiking boots manufactured both in the U.S. and abroad for the commercial market. The Goodyear Welt method is also used for certain types of military boots, although not for the models manufactured by Wellco which are made only in the government specified Direct Molded Sole construction. Quality, service and reasonable manufacturing costs are the most important features used to market Wellco's technology, assistance and services.\nThe backlog of all sales, not including license fees and rentals, as of December 31, 1994 was approximately $4,179,000 compared to $5,000,000 last year. This decrease is reflective of the U. S. government's awarding of the first option under the three year combat boot contract in two equal amounts, with the second half of that option not being awarded until the 1995 year. Substantially all of the current year backlog will be shipped by the end of 1995.\nCompliance with various existing governmental provisions relating to protection of the environment has not had a material effect on Wellco's capital expenditures, earnings or competitive position.\nMost of the raw materials used by Wellco can be obtained from at least two sources and are readily available. Because all materials in combat boots must meet rigid government specifications and because quality is the first priority, Wellco purchases most of its raw materials from vendors who provide the best materials at a reasonable cost. The loss of some vendors would cause some difficulty for the entire industry, but Wellco believes a suitable replacement could be found in a reasonably short period of time. Major raw materials include leathers, fabrics and chemicals, and by government regulation all are from manufacturers in the United States.\n\t\t Textile Equipment Manufacturing\nOn January 17, 1989, Sunstates acquired from Hickory, for a cash payment of $2,000,000, a 99% ownership interest in Sew Simple Systems, Inc. (\"Sew Simple\"), a designer and manufacturer of automated textile machinery located in Fountain Inn, South Carolina. The results of operations of Sew Simple since January 1, 1989 are included in the Consolidated Statements of Operations. The Stock Purchase Agreement provided that if Hickory should find a buyer for Sew Simple prior to the expiration of the Agreement, then Hickory would be entitled to additional amounts based upon the excess, if any, of the sales price over an escalating amount specified in the contract, which, as of April 13, 1992, was approximately $3.4 million (the Rights). On April 13, 1992, Sunstates acquired from Hickory its remaining 1% ownership and its Rights under the Stock Purchase Agreement for approximately $13.6 million (see Note 1 of the Notes to Consolidated Financial Statements). The consideration given by Sunstates included the assignment of approximately $12 million previously due to Sunstates from Hickory and other affiliates plus a note payable for approximately $1.6 million.\nManufacturing operations began in 1968 with the development of a cloth cutting and hemming system known as an \"Auto Casting System\", which takes rolled material, measures, cuts, sews two ends with an overcast or purl stitch, trims, labels and stacks the finished product. Following later was the introduction of other machinery systems that automated folding hems on dishcloth materials, and for sewing cross hems and mitering corners of small towels.\nThe success of these products led to the incorporation in South Carolina in 1972 of Sew Simple Systems, Inc. to address the growing need for automation of various textile product fabricating processes with a broader and more comprehensive product line. Sew Simple has developed and introduced a broad range of fully automatic machine systems for fabricating various textile products such as sheets, pillowcases, towels, washcloths, blankets, drapes, tablecloths, napkins, etc.\nMachines are built to meet a specific customer order and working capital is partially provided through the product's sales terms. Normally, 50% of the sales price is paid at the time of the order, 40% at the time the production of the machine is completed, with the final 10% paid upon installation in the customer's facility.\nSew Simple has a product line of over 20 different machines used in the production of various textile products. During 1994, various quantities of seven different machine products were manufactured and shipped. The product mix in any year, however, is directly related to the product line expansion activities of the customers in that particular year and is not necessarily indicative of future product mix. Order backlog approximated five months at current production levels as of December 31, 1994, and four months as of December 31, 1993.\nSew Simple's customers are primarily large domestic producers of finished textile products. Although 100.0% of machinery sales for 1994 were to eight customers, there is no dependence from year to year on any one customer. Due to the sales value of certain of Sew Simple's most popular machines ($475,000 to $675,000 each) a significant portion of annual sales volume may be to differing individual customers.\nDuring the past three years, overseas sales have, on a cumulative basis, represented less than 1% of total revenues. Sew Simple has focused its efforts on developing the domestic market for its newer machines, and in expanding its customer base for both existing and new machine products.\nCompetition in the domestic marketplace exists in a limited number of Sew Simple's machine systems and even in those instances the competitors are principally foreign manufacturers who have difficulty effectively competing on price, quality, productivity and service.\nMost raw materials are readily available from numerous sources at competitive prices. Although certain more technologically advanced parts used in the production process are obtained from one or two primary suppliers, the success of Sew Simple's operations are not dependent upon those suppliers. Sew Simple believes that alternative sources for obtaining such parts are available with only minor design modifications being necessary to accommodate such alternative parts.\nMost of Sew Simple's machine systems incorporate the application and use of patented inventions. Current expiration dates of existing patents range from 1996 through 2009, with additional patents pending.\nResearch and development activities are continually underway in connection with current product line and the development of new products. Sew Simple is currently dependent upon one individual, who has been employed by Sew Simple since 1976 and whose employment agreement continues until 1999, for the invention and development of new machines. Although the long-term prospects for continued success are dependent upon the development of new products, operations would not be materially impacted for a period of three to five years by the loss of this individual and Sew Simple believes that it could seek and obtain comparable research and developmental skills within that time frame. Total research and development expenditures during the three years ended December 31, 1994, were $218,045, $232,540, and $248,559, respectively.\n\t\t Real Estate Operations\nHistorically, the Company's real estate operations primarily reflected the development for resale of income producing properties located in the southeastern United States. Sunstates is also actively involved in the sale of recreational and second home resort lots and continues its efforts to sell other real estate assets no longer under active development.\nSunstates' primary real estate activity has been the development of income-producing properties with a view to selling these properties upon completion and lease-up. Projects are generally located in the southeastern United States with an emphasis on shopping centers and apartments.\nSunstates has substantially completed the construction phase of all of its major commercial and multi-family projects. Presently, Sunstates has five shopping centers which are presently either in various stages of lease-up or are currently being marketed. Based upon current market conditions, Sunstates presently does not anticipate that it will continue to actively seek locations for the development of new shopping centers or apartment projects.\nOn August 25, 1992, a subsidiary of Sunstates purchased 100% of the common stock of The SPRINGS, Inc. (\"Springs\") for $7,273,183 in cash (see Note 1 of Notes to Consolidated Financial Statements). The Springs is an 1,800 acre resort development project located in Spring Green, Wisconsin encompassing an 80 suite hotel, 27 hole golf course, ski slopes and trails, condominiums, single family home sites and other amenities. The hotel and golf course are substantially complete and real estate development and sales operations should begin in 1995. On February 23, 1993, the Company acquired from its Chairman approximately 1,137 additional acres of land near the Springs. This additional land, which presently contains 9 residential units and one vacation rental house, will provide for complementary development with the Springs project. (See Item #13 of this Report for additional information regarding this transaction.)\nIn the past, Sunstates has also engaged in the development of three interval ownership (timeshare) projects for sale in the Sarasota, Orlando and St. Augustine, Florida areas. In the first quarter of 1986, Sunstates elected to limit any future involvement in interval ownership (timeshare) development and during 1993 the Company disposed of substantially all of its remaining assets related to timeshare.\nThere are a number of risks inherent in Sunstates' real estate activities. The availability of short-term and long-term financing, the demand for space by tenants and the demand for real estate projects by purchasers are perhaps the major risks. Changes in federal and state tax laws can have a short-term impact upon the demand and market for income-producing properties. Additionally, the development of real estate projects involves substantial time between inception and completion. Success in real estate development is dependent upon accurate assessment of these risks. In certain instances, the risks may be minimized by obtaining financing, leasing or pre-sale commitments prior to construction. In other instances, management may deem it prudent not to make any commitments other than for construction financing prior to commencing construction of a project in order to take advantage of perceived favorable trends in given markets or the availability of long-term financing.\nAlthough it has always been Sunstates' intention to obtain long-term financing or to sell its projects prior to the maturity of any construction loans, current conditions in the banking and other financial markets have made it difficult to obtain reasonable financing for either sales or refinancings. Banks and other financial institutions are restricting the availability of credit to the real estate and other industries. This inability to obtain financing has adversely affected Sunstates' current real estate operations and could restrict Sunstates' ability to sell its real estate projects.\nIn its present activities of developing, financing and marketing real estate, Sunstates is subject to competition from various types of entities including banks, real estate investment trusts, real estate developers, governmental agencies and other owners of income-producing properties.\nA number of jurisdictions have adopted laws and regulations relating to environmental controls on the development of real estate. Such laws and regulations affect properties currently owned by Sunstates and will have an effect on the cost and type of development allowed on the properties. Although the application of such laws and regulations has not, to date, materially affected operations, the effect on future operations cannot be predicted.\nIn October 1993, the Company acquired Bell's Apple Orchard, a 32 acre apple orchard with 12 additional acres of production, retail and administrative facilities located in Lake Zurich, Illinois. The orchard is engaged in the growing, manufacture and retail marketing of apples and apple related products and employs 15 to 20 full time employees with approximately 45 to 50 seasonal employees during the harvest season. A portion of the retail facility is leased to tenants.\n\t\t\tOther Investments\nSunstates makes investments in the outstanding common stock of numerous corporations (sometimes in excess of 5% of the outstanding common stock of such corporations). When appropriate, Sunstates accounts for certain of the investments in common stock utilizing the equity method of accounting. Sunstates continually evaluates the corporations in which it has made investments and may, subject to such factors as price of shares, availability of shares and business prospects, increase or decrease its positions in those corporations. Factors considered in such analysis include, but are not limited to, economic prospects of the businesses, availability of investment opportunities and the potential for a satisfactory return on amounts invested.\nRocky Mountain Chocolate Factory, Inc. (\"Rocky Mountain\"), located in Durango, Colorado, manufactures, from its own recipes, a line of gourmet chocolates and other premium confectionery products for sale at company-owned and franchised stores. On December 31, 1989, Sunstates became the owner of 35.12% of the common stock of Rocky Mountain through the conversion of a note which was held in its investment portfolio. As of December 31, 1994, Sunstates' owned 55% of the common stock of Rocky Mountain and also holds additional notes which are secured by the common stock of Rocky Mountain. Although Sunstates' present ownership of Rocky Mountain is over 50%, the financial statements of Rocky Mountain have not been consolidated with Sunstates' due to immateriality. Sunstates is represented on the Board of Directors of Rocky Mountain.\nLerner Communications, Inc. (\"Lerner\"), a publisher of several neighborhood newspapers in the Chicago area, was acquired on October 13, 1992. Lerner solicits advertising and publishes the newspapers but subcontracts the printing of the papers with other newspaper printers. The purchase price of the net assets acquired totalled $1,078,626 consisting of $475,000 cash at closing and a short-term note payable of $602,431 paid in early 1993 plus other assumed liabilities of $1,195. The operations of Lerner are included in the Sunstates' consolidated financial statements since the date of acquisition.\nThe Company also invests in oriental artwork, antique jewelry and books and other collectibles which are purchased and sold through dealers and at public auctions.\n\t\t\t Seasonality\nSunstates' insurance, manufacturing, and commercial property operations are generally not subject to significant seasonal fluctuations. However, sales of resort and recreational lots are subject to seasonal effects. The peak selling seasons for these products are during the spring and summer with declining sales activities during the fall and winter. Sales activities at Sunstates' recreational and resort lot projects are generally shut down during the months of November through February.\n\t\t\tForeign Operations\nSunstates has no material continuing foreign operations. See \"Furniture Manufacturing, Military Footwear, Textile Apparel and Textile Equipment Manufacturing\" for information regarding foreign sales.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe following table presents a description of the real estate owned by Sunstates at December 31, 1994. The net book value represents the historical cost of the property, net of accumulated depreciation, if any, and is not presented net of any related recourse or non-recourse financing on the property.\nProperty Name & Location Description Net Book Value\nReal Estate Held for Development and Sale\nShopping Centers:\nMoratok Shopping Center, 47,870 s.f. $ 1,389,660 Plymouth, NC \t\t\t Mariner Crossing Shopping Ctr., 74,236 s.f. plus two 4,783,869 Spring Hill, FL outparcels\nPatriot's Square Shopping Ctr., 47,231 s.f. plus three York County, VA outparcels 3,525,699\nOcean Village Square 60,631 s.f. Shopping Ctr., plus three New Smyrna Beach FL outparcels 4,990,619\nThe Market Place at West Melbourne 52,045 s.f. 1,532,751 Melbourne, FL\nOffice Buildings:\nAnderson Plaza Raleigh, NC 29,727 s.f 1,104,059 \t\t\t\t\t\t\t\t\t\n\t\nRecreational and Second Home Lots:\nWoodland Lakes, Sullivan, MO 1,388 lots 398,488\nHidden Valley Lake, Dixon, TN 314 lots 212,488 \t\t\t\nPiney Creek OK 271 lots 85,299 Pittsburgh County, OK\nTwin Oaks Harbor 367 lots 308,916 Lowry City, MO\nInactive subdivisions 9 inactive subdivisions 25,351\nLand:\nThe Springs 985 acres, primarily suitable Spring Green, WI for residential lots 2,145,633\nHacienda Hills 128 acres primarily suitable 108,034 New Port Richey, FL for residential lots\nCreekside Office Plaza, 5.5 acres suitable for office Jacksonville, FL building 440,000\nSomerset Port 22.5 acres suitable for 313,200 Orange, FL apartments\nMayport Road 13 acres suitable for Mayport, FL apartments 100,000\nSouthern Pines 50% undivided interest Southern Pines, NC in 20 acres 190,523\nWestshore 50% undivided interest St.Petersburg, FL in 23 acres 100,000\nDenver, CO 5.98 acres 1,000\nGreen Meadows Subdivision 91 developed residential lots 91 Omaha, NE \t\t\t\t\t\t\t\t\t\nBerryhill Subdivision 8 developed residential lots and Carrboro, NC acreage suitable for 60 \t\t\t\t additional lots 1,561,405\nSparrows Walk 3 acres 50,000 Coral Springs, FL\nGastonia Commercial 50% undivided interest in Gastonia, NC approximately 3 acres 8,843\nChapel Hill Lots 4 developed residential lots 106,031 Chapel Hill, NC\nInvestment in Partnerships:\nMaryland Trade Center 50% general partnership interest Greenbelt, MD in 208-room hotel (470,861)\nInlet Investors, Ltd., 28.31% Limited partnership Ponte Vedra Beach, FL interest in hotel and beach \t\t\t\t club development 725,848 \t\t\t\t\nAmli-Will Ltd. Partnership, 5.5% Limited partnership Will County, IL interest in 2,505 acres held \t\t\t\t for development 730,285\nOther Real Estate:\nThe Springs 6 condominiums and 1 single- Spring Green, WI family home 719,399\nThe Springs Winter ski slope held Spring Green, WI for sale 918,139\nLand Lease 84 year lease of land underlying Boca Raton, FL the recreational amenities of a \t\t\t\t condominium project 63,355\nMagic Tree Resort 3 timeshare weeks available Kissimmee, FL for sale 3\nEpernay Property 1,137 acres held for Spring Green, WI development 999,057\nBell's Apple Orchard 32 acre apple orchard plus Lake Zurich, IL production, retail and \t\t\t\t administrative facilities 1,373,441\nCoach Horse Property leased to a Chicago, IL coach horse livery operation \t\t\t\t In downtown Chicago 883,350\nProperty, Plant and Equipment\nOperating Properties\nThe Springs 80 unit hotel and amenities 4,928,224 Spring Green, WI\nThe Springs 27 hole Robert Trent Jones\/ Spring Green, WI Andy North golf course 2,110,400\nManufacturing Facilities\nThe following table sets forth information regarding production and showroom facilities of the Company's manufacturing subsidiaries.\n\t\t Approximate Approximate Lease Primary Use Facility Name Floor Area Site Size Expiration or Products Location (Sq. Ft.) (Acres) (Annual Rent) Manufactured\nProduction Facilities: Hickory Manufacturing 479,000 29.6 (1) Owned Medium and higher Hickory, NC priced quality case goods\nHickory Manufacturing 124,000 6.5 11\/15\/95 Portion used for Hickory , NC ($34,400) rough mill, \t\t\t\t\t\tTwo 5 year balance to be \t\t\t\t\t\tOptions used for future \t\t\t\t\t\tThrough expansion \t\t\t\t\t\t11\/15\/05\n\t\t\t\t\t Chaircraft 230,000 25.65 Owned Lower-medium , Bethlehem NC priced quality \t\t\t\t\t\t\t wood chairs and \t\t\t\t\t\t\t upholstered \t\t\t\t\t\t\t furniture\nKayLyn 129,000 2.3 2\/1\/96 Medium and High Point, NC ($179,000) higher priced quality \t\t\t\t\t\t\t upholstered \t\t\t\t\t\t\t Furniture\nAdministrative Office 77,000 3.6 Owned Office and Oak Street Plant warehouse High Point, NC\nPendleton Frame 52,000 3.8 1\/31\/1996 Wood furniture Building High Point, NC ($69,800) frames\nChair Building 50,400 N\/A 10\/31\/97 Vacant; sublet Mebane NC ($18,200) in March 1994\nOutlet Store 25,000 N\/A 1\/31\/2000 Retail space in Burlington, NC ($136,800) shopping center \t\t\t\t \t\t\t Outlet Store 15,000 N\/A 12\/31\/98 Retail space in Statesville, NC ($74,000) shopping center\nSew Simple 30,000 7 Owned Textile Fountain Inn, SC machinery\nWellco and Ro-Search 90,000 3 Owned Manufacturing, Hazelwood, NC warehousing \t\t\t\t\t\t\t and office \t\t\t\t\t\t\t facilities\nWellco 22,700 1 6\/30\/97 Military boot Aguadilla, Puerto Rico ($54,000) manufacturing \t\nAlba 157,000 8.37 Owned Knitting, yarn Valdese, NC processing and \t\t\t\t\t\t\t finishing\nKnitting 18,000 1.22 Owned Knitting Valdese, NC (intimate \t\t\t\t\t\t apparel)\nJohn Louis 178,300 7.57 Owned Finishing Valdese, NC\nPineburr 81,000 19.8 Owned Knitting Valdese, NC (hosiery & \t\t\t\t\t\t\t health care \t\t\t\t\t\t\t products)\nOffices 3,000 N\/A 1998 Sales offices New York City, NY ($120,000)\nMain Office 52,000 3.5 Owned Corporate Valdese, NC Headquarters\nMain Street 69,000 1.4 Owned Knitting and Valdese, NC Finishing\nOutlet Store 1,760 N\/A 1999 Retail space in Branson, MO ($26,400) shopping center\nShowroom and other Facilities:\nFurniture Market 34,000 N\/A 8\/31\/97 Furniture Showroom ($248,000) showroom High Point, NC\nWorld Trade Center 12,906 N\/A annually, Furniture showroom Dallas, TX renewable thru \t\t\t\t\t\t6\/30\/96 \t\t\t \t\t\t($63,000) \t\t\t\n(1) The Hickory Manufacturing North Carolina production site includes approximately 13.6 acres of unimproved land, suitable for plant expansion if and when necessary or desirable.\nAs a result of Hickory White closing its facility in Mebane, N. C. early in 1993 and transferring the production requirements to its plant in Hickory, N. C., Hickory White returned to 90% of capacity. Hickory White estimates that an increase in production of approximately 15% of normal capacity could be achieved with only modest capital expenditures for plant expansion. However, based upon present economic conditions, there is no anticipated need for such increased capacity and there are no significant capital expenditures planned in 1995.\nIn 1994, both Wellco's Hazelwood and Aguadilla facilities were used at less than normal capacity. Both facilities have the capability to significantly increase their production output within a short period of time.\nManagement believes all its plants, warehouses and offices are in good condition and are reasonably suited for the purposes for which they are presently used. Although there are no current plans for major expansion, current properties provide ample opportunity for future growth and there is an adequate and stable work force in all of Sunstates's manufacturing locations.\nNewspaper Publishing:\nSunstates' newspaper publishing business operates out of approximately 10,000 square feet of leased office space in Chicago, Illinois. The lease calls for annual lease payments of $130,086 and expires on January 31, 1998. The printing of the newspapers is sub-contracted and Sunstates maintains no printing or other facilities with respect to its newspaper publishing operations.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nIn April of 1988, two essentially similar civil actions styled Jeremiah P. O'Connor, Sarah M. O'Connor, and Leonore Ballan v. Acton Corporation, et al., and VR Associates and PJE Associates v. Acton Corporation, et al., were filed in the Court of Chancery for the State of Delaware in and for New Castle County. Also named in these actions are Sunstates Corporation and the directors of Acton prior to the merger with Sunstates. These actions, along with another subsequently filed action styled Harry Lewis v. Clyde W. Engle, et al., have been consolidated into one action entitled In Re Acton Corporation Shareholders Litigation. All plaintiffs allege to be holders of common stock of Acton and seek to have the action designated a class action on behalf of all parties owning common stock of Acton. The action challenges the merger of Sunstates Corporation with and into Acton, alleges fraud and breach of fiduciary duty and seeks unspecified damages plus costs and expenses including attorney's fees. Acton intends to defend this action vigorously. The suit is still in the preliminary stages and management is unable to predict the outcome of the litigation; however, management is of the opinion that the outcome of the litigation is unlikely to have a material adverse effect on Sunstates' financial position.\nOn June 4, 1990, VR Associates and Sonem Partners, L.P. filed a shareholder derivative action in the Court of Chancery for the State of Delaware in New Castle County against the directors of Acton and Hickory. The action alleges that certain transactions entered into and investments made by Acton constituted waste or a breach of fiduciary duty by the Board of Directors of Acton. In particular, the action alleges that Acton's purchase of the furniture operations of Hickory was not in the best interests of Acton and seeks various relief, including rescission of the purchase, unspecified damages and costs. The action also sought to obtain a temporary restraining order to prevent consummation of the purchase transaction. The request for a restraining order was denied by the Court on June 8, 1990. An essentially similar action was filed in the State of Delaware on June 12, 1990 by PJE Associates. These suits are still in the preliminary stages and management is unable to predict the outcome of the litigation; however, Sunstates intends to defend these actions vigorously and does not believe that the outcome of the litigation is likely to have a material adverse effect on Sunstates' financial position.\nOn June 14, 1991, a jury in a District Court of Dallas County, Texas awarded $3.5 million in actual damages and $5 million in punitive damages to the plaintiffs of a lawsuit filed against Acton Corporation. This dispute relates to the amount of additional purchase consideration due plaintiffs under an agreement made in 1983 whereby the Company purchased National Development Company, a real estate company based in Dallas. The Company has appealed the verdict based, in part, on the exclusion by the court of evidence crucial to the Company's defense. On November 7, 1991, the Company filed a Supersedeas Bond in the amount of the judgment, plus costs and interest for one year, with the Clerk of the District Court, signed by the Company as principal and by National Development Company, Inc., an affiliate of the Company, as surety. The effect of the filing of the supersedeas bond is to stay any execution of the judgment against assets of the Company, pending the results on appeal or any further orders of the District Court regarding the supersedeas. The plaintiffs have filed a cross-appeal, alleging that the trial court should have awarded an additional $5 million in exemplary damages, based upon the jury verdict. The Company believes that the damages awarded are contrary to the law and facts in this matter and is vigorously pursuing its rights on appeal. However, at this time management is not able to predict the Company's ultimate liability, if any, in this matter and accordingly, no provision for any such liability has been made in the Company's financial statements. Should the Company be required to pay all or a significant portion of this judgment, it could have a material adverse effect on the financial position and results of operations of the Company.\nOn December 6, 1991, California Federal Bank filed a suit against Acton in the Circuit Court, Duval County, Florida alleging breach of a Contract of Guaranty of a $5,100,000 note executed by Jacksonville Apartment Associates, Ltd. and secured by a mortgage on an apartment project in Jacksonville, Florida. During 1994 the suit was settled with the Company making a payment of $230,000.\nOn December 8, 1993, Richard N. Frank filed a purported derivative and class action in the Court of Chancery for the State of Delaware in New Castle County against the directors of Acton, Hickory and Telco. The action alleges that certain transactions entered into and investments made by Acton constituted waste or a breach of fiduciary duty by the Board of Directors of Acton. The complaint also alleges that the Company and its insurance subsidiary repurchased shares of the Company's common stock and $3.75 Cumulative Preferred Stock in violation of the Company's certificate of incorporation. Finally, the complaint alleges that the proxy statement disseminated in connection with the Company's December 13, 1993, annual meeting was materially misleading. This suit is in the preliminary stages and management is unable to predict the outcome of the litigation; however, Sunstates intends to defend these actions vigorously and does not believe that the outcome of the litigation is likely to have a material adverse effect on Sunstates' financial position.\nOn January 10, 1994, Robert A. Lee, et al. filed a punitive derivative action in the Court of Chancery for the State of Delaware in New Castle County against the directors of Acton, Hickory, Telco, WREIT, RDIS Corporation and nominally against the Company itself. The complaint alleges that certain transactions entered into and investments made by Acton constituted waste or a breach of fiduciary duty. This suit is in the preliminary stages and management is unable to predict the outcome of the litigation; however, Sunstates intends to defend these actions vigorously and does not believe that the outcome of the litigation is likely to have a material adverse effect on Sunstates' financial position.\nAt December 31, 1994, Sunstates and its subsidiaries also were, and currently are, defendants in other legal proceedings incidental to their business. Sunstates intends to defend such proceedings vigorously and, in the opinion of the management, Sunstates' ultimate liability, if any, in these proceedings will not have a material adverse effect on the consolidated financial position of Sunstates.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted to the vote of security holders during the quarter ended December 31, 1994.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMarket Information\nPrior to May 3, 1994, both Sunstates' Common Stock, and $3.75 Cumulative Preferred Stock (\"$3.75 Preferred Stock\") were traded on the American Stock Exchange (AMEX) under the symbols \"ATN\" and \"ATNP\", respectively. On May 3, 1994, both Sunstates' Common Stock, and $3.75 Cumulative Preferred Stock (\"$3.75 Preferred Stock\") began trading on the Nasdaq Stock Market (NASDAQ\/NMS) under the symbols \"SUST\" and \"SUSTP\", respectively.\nThe Sunstates' Class B Accumulating Convertible Stock (\"Class B Stock\") is traded through brokers who have registered with the National Association of Securities Dealers, Inc. to make a market in these shares. Currently, Mesirow Financial is the only broker who has registered to buy and sell Sunstates' Class B Stock. There is no significant trading market for Sunstates' Class E Preferred Stock, Series I and II.\nThe following table sets forth for the periods indicated the high and low closing prices for the Sunstates' Common Stock and $3.75 Preferred Stock, respectively, as reported by the AMEX and NASDAQ\/NMS, as appropriate.\nThe following table sets forth for the periods indicated the range of high and low bid prices for Sunstates' Class B Stock as reported by the primary market maker, Mesirow Financial. These quotations do not reflect retail mark-ups, mark-downs or commissions and do not represent actual transactions.\nThe approximate numbers of holders of record for the respective classes of Sunstates' equity securities at March 6, 1995, were as follows:\nCommon Stock 2,718 Class B Stock 104 $3.75 Preferred Stock 1,434 Class E Preferred Stock, Series I & II 58\nDividends\nNo dividends were paid to holders of Sunstates' Common Stock and Class B Stock during 1994, 1993 or 1992 nor does the Company currently anticipate the payment of such dividends in the foreseeable future. Under the terms of Sunstates' $3.75 Preferred Stock, dividends may not be paid on common shares while preferred stock dividends remain in arrears. At March 14, 1995, nine semi-annual dividend payments aggregating $4,795,588 ($16.875 per share) were in arrears on Sunstates' $3.75 Preferred Stock.\nThe above financial information has been retroactively restated to reflect the effect of the Company's change in its method of valuing its furniture manufacturing inventories from the last-in, first-out method to the first-in, first-out method (see Note 2 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form). The effect of this retroactive restatement upon previously reported balances is as follows:\nItem 7.","section_6":"","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLitigation\nSee Note 9 of Notes to Consolidated Financial Statements contained in Item 8","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe response to Item 8 is submitted as a separate section of this report.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING \t AND FINANCIAL DISCLOSURE\nThere have been no changes in and disagreements with accountants on accounting and financial disclosure.\n\t\t\t PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n\t\t Year Shares and \t\t First Class of Positions with Sunstates; Became Equity Principal occupations Director Securities Name\t\t During Past Five Years; other of Beneficially (Age)\t\t Directorships Sunstates owned (1)(2)\nWilliam D. Principal (since January, 1989) Schubert of Advanced Management Concepts, 1991 -O- (71)\t\t a management consulting firm to \t\t the textile and apparel \t\t industries; Director (from 1973 \t\t to May, 1991), Chairman of the \t\t Board of Directors (from \t\t December, 1985 to December, \t\t 1988) and President and Chief \t\t Executive Officer (from April, \t\t 1974 to July, 1988) of Alba- \t\t Waldensian, Inc., a manufacturer \t\t of textile apparel and medical \t\t specialty products; Director \t\t (since November, 199O) of Wellco \t\t Enterprises, Inc.\nRobert J. Spiller Director (from 1981 to May, (64) 1988) of Sunstates Corporation; 1988 148 shares \t\t retired Chairman and Chief of Class B \t\t Executive Officer (197O - 199O) Stock; 3,607 \t\t of The Boston Five Bancorp. shares of \t\t\t\t\t\t\t\t Common Stock \t\t\t\t\t\t\t \t issuable upon \t\t\t\t\t\t\t\t conversion of \t\t\t\t\t\t\t \t Class B Stock\nClyde Wm. Chairman of the Board (since 1985 See \"Security Engle(3) December, 1985) and Chief ownership of (52) Executive Officer (since Certain \t\t December, 199O); President and Beneficial \t\t Chief Executive Officer (from Owners,\". \t\t December, 1985 to May, 1988) of \t\t Acton; Director (from 1981 to \t\t May, 1988) of Sunstates \t\t Corporation. Other than as \t\t noted below, during the past 5 \t\t years Mr. Engle has served as: \t\t Chairman of the Board and Chief \t\t Executive Officer of Telco \t\t Capital Corporation (a \t\t diversified financial services \t\t and manufacturing company and an \t\t indirect parent of Sunstates); \t\t General Partner of Sierra \t\t Associates, itself the general \t\t partner of Sierra-Capital Group \t\t (an investment partnership); \t\t Chairman of the Board and Chief \t\t Executive Officer of GSC \t\t Enterprises, Inc. (a one-bank \t\t holding company), and Chairman \t\t of the Board of its subsidiary, \t\t Bank of Lincolnwood; Chairman of \t\t the Board and President of RDIS \t\t Corporation (a diversified \t\t financial services and \t\t manufacturing company), Director \t\t and since 199O, Chairman of the \t\t Board, President and Chief \t\t Executive Officer of Hickory \t\t Furniture Company; Director and \t\t Chairman of the Board of NRG, \t\t Inc.; Trustee and Chairman of \t\t the Board of Wisconsin Real \t\t Estate Investment Trust; \t\t Director of Wellco Enterprises, \t\t Inc.; Director and Chairman \t\t (since May, 1991) of Alba- \t\t Waldensian, Inc.; Director of \t\t Indiana Financial Investors, \t\t Inc.; Director (since November, \t\t 1987) of Rocky Mountain \t\t Chocolate Factory, Inc.\nHoward Friedman Partner (since 1971) in the law 1986 50O shares of (55) firm of Altheimer & Gray, Common Stock \t\t Chicago, Illinois; Director \t\t (since 1984) of Bank of \t\t Lincolnwood.\nLee N. Mortenson President (since May, 1988), 1988 5OO shares of (59) Chief Operating Officer (since Common Stock, \t\t December, 199O) and Chief 8OO shares of \t\t Executive Officer (May, 1988 to $3.75 December, 199O) of Sunstates; Preferred President and Chief Executive Stock \t\t Officer (from July, 1984 to May, \t\t 1988) and Director (from \t\t February, 1985 to May, 1988) of \t\t Sunstates Corporation; \t\t President, Chief Operating \t\t Officer and Director of Telco \t\t Capital Corporation (since \t\t January, 1984); Director (since \t\t April, 1984) of Alba-Waldensian, \t\t Inc.; Director (since March, \t\t 1987) of NRG, Inc.; Director \t\t (January, 1988 to October, 1992) \t\t of Sun Electric Corporation; \t\t Director (since November, 1987) \t\t of Rocky Mountain Chocolate \t\t Factory, Inc.; Director of \t\t Wellco Enterprises, Inc. (since \t\t December 1993).\nHarold Sampson Director (from 1982 to May, 1988 -O- (76) 1988) of Sunstates Corporation; \t\tChairman of the Board (since \t\t1981) of Sampson Investments (a \t\treal estate holding company); \t\tTrustee (since 198O) of \t\tWisconsin Real Estate Investment \t\tTrust; Director (since 1986) of \t\tIndiana Financial Investors, \t\tInc; Chairman of the Board of \t\tDiginet Communications, Inc. \t\t(since 1985); Director of Mt. \t\tSinai Hospital (since 196O).\n(1) All stock information is as of March 3, 1995. Unless otherwise noted, all shares are owned directly, with sole voting and dispositive power.\n(2) Unless otherwise noted, the shares of equity securities owned by each director represents less than 1% of the class so owned.\n(3) The following information is provided voluntarily by Mr. Engle although it is not deemed material information as that term is used in Item 401 of Regulation S-K. Mr. Engle is the subject of a Cease and Desist Order dated October 7, 1993, issued by the Securities and Exchange Commission (the Commission) requiring Mr. Engle and certain of his affiliated companies to permanently cease and desist from committing any further violations of Section 16(a) of the Securities Exchange Act of 1934 as amended and the rules promulgated thereunder, which requires monthly and other periodic reports of transactions in certain securities. The Commission found some of the reports of such transactions to have been filed delinquently although many of these transactions were between affiliated entities or had been publicly reported in other reports filed with the Commission or had been otherwise publicly announced.\nExecutive Officers\nName Age Positions and Offices Business Experience During \t\t\t with Company Last Five Years\nClyde Wm. Engle 52 Chairman of the See \"DIRECTORS\" above \t\t\t Board and Chief \t\t\t Executive Officer\nLee N. Mortenson 59 Director, See \"DIRECTORS\" above \t\t\t President and \t\t\t Chief Operating \t\t\t Officer\nGlenn J. Kennedy 43 Vice President, Vice President (since July \t\t\t Treasurer and 1988) and Treasurer and Chief \t\t\t Chief Financial Financial Officer (since May \t\t\t Officer \t\t 1988) of the company, \t\t\t\t\t\t Treasurer and Chief Financial \t\t\t\t\t\t Officer of Sunstates \t\t\t\t\t\t Corporation (from September \t\t\t\t\t\t 1986 to May 1988); Chief \t\t\t\t\t\t Financial Officer of Simms \t\t\t\t\t\t Investment Company (May 1984 \t\t\t\t\t\t to August 1986); Senior Audit \t\t\t\t\t\t Manager, Price Waterhouse \t\t\t\t\t\t (1978 to May 1984)\nRichard A. Leonard 48 Vice President and Vice President (since July 1988) \t\t\t Secretary and Secretary (since May 1988) \t\t\t\t\t\tof the Company; Vice President \t\t\t\t\t\t(from April 1986 to May 1988) \t\t\t\t\t\tand Secretary (from September \t\t\t\t\t\t1986 to May 1988) of Sunstates \t\t\t\t\t\tCorporation; Administrative \t\t\t\t\t\tVice President and Counsel \t\t\t\t\t\t(from June 1984 to April 1986) \t\t\t\t\t\tof Sunstates Properties, Inc., \t\t\t\t\t\ta wholly-owned subsidiary of \t\t\t\t\t\tSunstates Corporation; President \t\t\t\t\t\tand Counsel of AMIC Title \t\t\t\t\t\tInsurance Company (January 1982 \t\t\t\t\t\tto June 1984)\nFor information on security ownership of the Company's executive officers, see above sections captioned \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\". Mr. Kennedy and Mr. Leonard do not own any securities of Sunstates.\nCOMPLIANCE WITH SECTION 16(a) OF SECURITIES EXCHANGE ACT OF 1934\nBased solely upon a review of Forms 3 and 4 and amendments thereto furnished to the Company during the fiscal year ended December 31, 1994, and Forms 5 and amendments thereto furnished to the Company with respect to the fiscal year ended December 31, 1994, and any written representations from a reporting person that no Form 5 is required, to the best of the Company's knowledge, no person who was a director, officer or beneficial owner of more than ten percent of any class of equity securities of the Company (a reporting person) failed to file on a timely basis, as disclosed in the above Forms, reports required by Section 16(a) of the Securities Exchange Act of 1934 during the most recent fiscal year. However, Mr. Engle has not furnished the Company with copies of any Form 5 or written representation with respect to reporting during the fiscal year ended December 31, 1994.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nCOMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY\nDirectors\nThe following summarizes the director compensation paid by the Company during the year ended December 31, 1994.\nEach director other than Messrs. Engle and Mortenson is paid $5,000 per quarter for serving in such capacity. In addition, directors other than Messrs. Engle and Mortenson, receive $1,500 for each Board meeting attended ($1,000 prior to June 1994) and $600 for each standing committee meeting attended which is not held on the day of a regularly scheduled Board of Directors meeting. Directors are also compensated from time to time for special assignments, including serving on special committees, at the rate of $200 per hour ($1,600 per day maximum) plus expenses. Each director is reimbursed for his actual expenses in attending meetings of the Board or any of its committees.\nEmployment Agreements\nMr. Engle has entered into an employment agreement effective January 1, 1991, and initially extending through 1995, whereby Mr. Engle received a base salary of $500,000. Such amount will increase in each subsequent year by at least the increase in the Chicago Consumer Price Index. In addition, under the terms of the employment agreement, Mr. Engle received a bonus in the amount of $2,470,000 (3.25% of the gross sales price) in connection with the sale of the cable television system. There are no other employment agreements between the Company and any of its other executive officers.\nThe following table sets forth a summary of the compensation earned by the Company's executive officers during 1994, 1993 and 1992:\n(c) Salary: Total base salary paid by the Company during the calendar year. Mr. Engle became an employee of the Company on September 16, 1991 under an employment agreement extending initially through 1995 and providing for an initial annual salary of $500,000 retroactive to January 1, 1991. Prior to 1991, Mr. Engle served the Company as its Chairman and Chief Executive Officer without compensation. Mr. Engle and Mr. Mortenson are also employees of the Company's parent, Hickory, and receive compensation from Hickory for services rendered to the Company. The Company pays Hickory an annual management fee and the compensation received by Mr. Engle and Mr. Mortenson from Hickory attributable to services rendered to the Company is included in Other Annual Compensation (column \"e\").\n(d) Bonus: With respect to Mr. Kennedy and Mr. Leonard, represents annual incentive compensation awarded on a discretionary basis for results achieved during the calendar year under a plan approved by the Board of Directors. Up to one-half of the bonus amount is paid when awarded and the remainder is paid over the succeeding five years on a prorata basis. Should the officer voluntarily leave the Company during that five-year period, he will forfeit all rights to any unpaid balance. The award for 1994 has not yet been determined. With respect to Mr. Mortenson, the 1994 bonus was a special cash bonus awarded by the Compensation Committee of the Board of Directors for services rendered during 1993 and 1994. With respect to Mr. Engle, the bonus in 1993 represents amounts payable to Mr. Engle under the terms of his employment agreement as the result of the sale of the cable television system.\n(e) Other Annual Compensation: All additional forms of cash and non-cash compensation paid, awarded or earned. The amounts shown for Mr. Engle and Mr. Mortenson represent salary paid by the Company's parent, Telco, attributable to services rendered to the Company (see \"a\" above). The value of all other personal benefits and perquisites received by the Company's executive officers in 1992 and 1993 was less than the required reporting threshold.\n(i) All Other Compensation: All other compensation that does not fall under any of the aforementioned categories. The amounts shown in this column for 1994 comprise the following payments made by the Company: (i) Mr. Mortenson: $2,914 - matching contribution to 401(k) plan and $916 - premium for term life insurance policy; (ii) Mr. Kennedy: $2,254 - matching contribution to 401(k) plan and $1,197 - premium for term life insurance policy; and (iii) Mr. Leonard: $2,464 - matching contribution to 401(k) plan and $1,199 - premium for term life insurance policy.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table shows the name, address and beneficial ownership, as of March 14, 1995, of each person known to the Company to be the beneficial owner of more than 5% of any class of its outstanding securities entitled to vote. Information presented in this table and related notes has been obtained from the Company's shareholder lists, the beneficial owner or from reports filed by the beneficial owner with the Securities and Exchange Commission pursuant to Section 13 of the Securities Exchange Act of 1934 as amended, (the \"Exchange Act\").\n\t\t\t\t\t\t\t\t Percent Name and Address of Amount and Class of Equity Percent of of Voting Beneficial owner Securities Beneficially Class (1) Power(3) owned (8)\nCOMMON AND CLASS B COMBINED (3):\nA group consisting of: Wisconsin Real Estate 63,O43 Shares of Class B 9O.4% 79.9% Investment Trust Stock (2) (\"WREIT\") 55 East Monroe P. O. Box 17 Chicago, Illinois 6O6O3 (7)\nand and\nHickory Furniture 91,3O1 Shares of Common 11.67% 1.36% Company (\"Hickory\") Stock (2) 55 East Monroe P. O. Box 17 Chicago, Illinois 6O6O3 (8)\nand or\nIndiana Financial 1,627,974 Shares of Common 7O.2% 56.3% Investors, Inc. Stock issuable upon (\"Indiana\") conversion of Class B Stock 55 East Monroe (4) P. O. Box 17 Chicago, Illinois 6O6O3\nand\nTelco Capital Corporation (\"Telco\") 55 East Monroe P. O. Box 17 Chicago, Illinois 6O6O3\nand\nRDIS Corporation (\"RDIS\") 55 East Monroe P. O. Box 17 Chicago, Illinois 6O6O3 (6)\nand\nGSC Enterprises 55 East Monroe P. O. Box 17 Chicago, Illinois 6O6O3 (5)\nand\nClyde Wm. Engle 55 East Monroe P. O. Box 17 Chicago, Illinois 6O6O3 (5)\nDimensional Fund 52,5O4 Shares of Common 6.71% O.78% Advisors, Inc. Stock 1299 Ocean Avenue Santa Monica, California 9O4O1 (9)\n$3.75 PREFERRED STOCK (3):\nJohn D. Weil 84,668 Shares of $3.75 29.8% 29.8% 5O9 Olive St Preferred Stock Suite 7O5 St. Louis, Mo 631O1\nThe Employees' 17,8OO Shares of $3.75 6.26% 6.26% Retirement Plan of Preferred Stock Consolidated Electrical Disributors, Inc. 1516 Pontius Avenue Los Angeles, California 9OO25\n(1) At March 14, 1995, there were 782,422 shares of Common Stock outstanding, net of 1,046,966 shares held by subsidiaries and therefore deemed to be treasury shares, 69,471 shares of Class B Stock outstanding, net of 12,453 shares held by subsidiaries and therefore deemed to be treasury shares, and 284,183 shares of $3.75 Preferred Stock outstanding, net of 178,795 shares held by subsidiaries and therefore deemed to be treasury shares.\n(2) Hickory owns directly 31,913 shares of Common Stock, Indiana owns directly 1,340 shares of Class B Stock and 43,988 shares of Common Stock, WREIT owns directly 61,703 shares of Class B Stock, and GSC owns directly 15,400 shares of Common Stock.\n(3) Holders of Common Stock are entitled to one vote per share and holders of Class B Stock are entitled to 85.3125 votes per share, voting together as a single class. Percentages indicated are based upon the combined total number of votes available to holders of Common Stock and Class B Stock, a total of 6,732,201 on March 14, 1995. Common Stock and $3.75 Preferred Stock are each entitled to one vote per share when voting as a separate class.\n(4) Each share of Class B Stock is convertible immediately into 24.375 shares of Common Stock. Were only Hickory, Indiana and WREIT to immediately convert their shares of Class B Stock into Common Stock, the group would then hold 56.3% of the voting power of the outstanding securities regularly entitled to vote.\n(5) Mr. Engle may be deemed the beneficial owner of the shares of Class B Stock beneficially owned by Hickory, Indiana and WREIT by virtue of his ownership of RDIS. According to information filed with the Commission, Mr. Engle, Chairman of the Board of Directors of RDIS, possesses beneficial ownership in excess of 50% of the outstanding shares of common stock of RDIS. RDIS owns 100% of the outstanding common stock of Telco; Telco owns approximately 92.9% of the outstanding common stock of Hickory; and Hickory owns approximately 76.6% of the outstanding shares of beneficial interest of WREIT and approximately 70.6% of the outstanding common stock of Indiana. Mr. Engle may be deemed the beneficial owner of the shares of Common Stock owned by GSC Enterprises, a one bank holding company, of which Mr. Engle is the majority owner.\n(6) Although RDIS is not in the business of making loans, at the request of Mr. Engle, RDIS has made a loan to Mr. Engle on a non-preferential basis secured by a lien on the shares of RDIS owned by Mr. Engle. In addition, all of the shares of common stock of Hickory owned by Telco have been pledged to an unaffiliated bank in Chicago to secure a loan to Telco by that bank.\n(7) WREIT has pledged its 61,703 shares of Sunstates' Class B Stock to secure a loan from Hickory.\n(8) The amounts included do not include 14,300 shares of Sunstates Common Stock held directly by or in trust for members of Mr. Engle's immediate family. Mr. Engle specifically disavows beneficial ownership of such shares.\n(9) Dimensional Fund Advisors Inc. (\"Dimensional\"), a registered investment advisor, is deemed to have beneficial ownership of 52,504 shares of Sunstates Corporation common stock as of December 31, 1994, all of which shares are held in portfolios of DFA Investment Dimensions Group Inc., a registered open-end investment company, the DFA Investment Trust Company and the DFA Participating Group Trust, investment vehicles for qualified employee benefit plans, all of which Dimensional Fund Advisors Inc. serves as investment manager. Dimensional disclaims beneficial ownership of such shares.\nAs of March 14, 1995, all officers and directors of the Company as a group, a total of 8 persons, owned beneficially 92,301 shares of Common Stock, or 11.8% of the total shares of Common Stock outstanding, 63,191 shares of Class B Stock, or 90.61% of the total shares of Class B Stock outstanding, 800 shares of $3.75 Preferred Stock or 0.28% of the total shares of $3.75 Preferred Stock outstanding and 49,000 shares of Class E Preferred Stock or 8.55% of the total shares of Class E Preferred Stock outstanding. If the group were to presently convert its Class B Stock into Common Stock, they would receive an additional 1,540,281 shares of Common Stock for a total ownership of 1,632,582 shares of Common Stock, or 70.29% of the total shares of Common Stock outstanding. Each share of Class B Stock is entitled to 85.3125 votes and votes together with the Common Stock as a single class, with respect to all matters to be voted upon by shareholders except with respect to the election of one director to be elected solely by the holders of Common Stock, voting as a separate class, and as otherwise provided by law. Officers and directors as a group are currently the beneficial owners of 81.45% of the voting power of all Common Stock and Class B Stock presently outstanding when these shares vote as a single class. (See Item 10 of this Report for information as to securities ownership of individual directors and officers.)\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nMessrs. Engle and Sampson serve as trustees and Mr. Engle is also Chairman of the Board of Trustees of WREIT. Messrs. Engle and Sampson serve as directors of Indiana Financial Investors, Inc. Messrs. Engle and Mortenson serve as directors, and Mr. Engle is Chairman of the Board of Directors, President and Chief Executive Officer, of Hickory Furniture Company. Mr. Engle is Chairman of the Board and Chief Executive Officer and Mr. Mortenson is a director, President and Chief Operating Officer of Telco Capital Corporation. Please see \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\" for additional information regarding the relationship of the Company and management to these entities.\nThe law firm of Altheimer & Gray, of which Mr. Friedman is a member, has rendered legal services to the Company during 1994 (approximately $308,000) and the current fiscal year (approximately $78,000).\nSee Note 12 to Consolidated Financial Statements contained in Part IV, Item 14","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) List of documents filed as part of this report\n1. Financial Statements\nThe response to this portion of Item 14 is submitted as a separate section of this report.\n2. Financial Statement Schedules\nThe response to this portion of Item 14 is submitted as a separate section of this report.\n3. Exhibits\nThe response to this portion of Item 14 is submitted as a separate section of this report.\n(b) Reports on Form 8-K\nThere we no filings on Form 8-K during the quarter ended December 31, 1994.\n(c) Exhibits\nThe response to this portion of Item 14 is submitted as a separate section of this report.\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 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.\nMarch 31, 1995 Sunstates Corporation\nby \/s\/ Clyde Wm. Engle 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\/ Clyde Wm. Engle Director March 31, 1995 Clyde Wm. Engle (Chairman of the Board and Chief Executive Officer)\n\/s\/ Lee N. Mortenson President and Director March 31, 1995 Lee N. Mortenson (Chief Operating Officer)\n\/s\/ Glenn J. Kennedy Vice President and Treasurer March 31, 1995 Glenn J. Kennedy (Chief Financial Officer)\n\/s\/ Dean F. Shaver Controller March 31, 1995 Dean F. Shaver\n\/s\/ Howard Friedman Director March 31, 1995 Howard Friedman\n\/s\/ Harold Sampson Director March 31, 1995 Harold Sampson\n\/s\/ William D. Schubert Director March 31, 1995 William D. Schubert\n\/s\/ Robert J. Spiller Director March 31, 1995 Robert J. Spiller\nANNUAL REPORT ON FORM 10-K\nITEM 8, ITEM 14(a)(1) AND (2), (c) AND (d)\nFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nCERTAIN EXHIBITS\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1994\nSUNSTATES CORPORATION AND SUBSIDIARIES\nRALEIGH, NORTH CAROLINA\nForm 10-K - Item 8, Item 14(a)(1) and (2) and Item 14(d) Sunstates Corporation and Subsidiaries LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Sunstates Corporation and Subsidiaries are included in Item 8:\nConsolidated Balance Sheets, December 31, 1994 and 1993\nConsolidated Statements of Operations for the Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the Years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nIndependent Auditors' Reports\nThe following consolidated financial statement schedules of Sunstates Corporation and Subsidiaries are included in Item 14(d):\nSchedule I - Condensed Financial Information of Registrant - December 31, 1994 and 1993 and for the Years Ended December 31, 1994, 1993, and 1992\nSchedule II - Valuation and Qualifying Accounts - For the Years Ended December 31, 1994, 1993 and 1992\nSchedule III - Real Estate Held for Development and Sale and Accumulated Depreciation - December 31, 1994\nSchedule V - Supplemental Information Concerning Property\/Casualty Insurance Operations - For the Years Ended December 31, 1994, 1993 and 1992\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Organization\nOn December 13, 1993, the shareholders voted to change the name of the Company from Acton Corporation to Sunstates Corporation, effective January 1, 1994.\nParent Company\nSunstates Corporation (\"Sunstates\" and\/or the \"Company\") is a majority-owned subsidiary of Wisconsin Real Estate Investment Trust (\"WREIT\") and WREIT in turn is a direct and indirect majority-owned subsidiary of the following companies: Hickory Furniture Company (\"Hickory\"), Telco Capital Corporation (\"Telco\") and RDIS Corporation (\"RDIS\").\nSale of Cable Television System\nOn December 30, 1993, Sunstates Corporation completed the sale of its sole remaining cable television system comprised of approximately 44,000 subscribers located in Anne Arundel County, Maryland to InterMedia Partners of San Francisco, California. The $76 million sale price produced after-tax net income of $46.5 million or $18.45 per share on a primary basis and $15.22 per share on a fully diluted basis.\nThe $76 million consideration consisted of $26.5 million in cash, the assumption of approximately $32.1 million of debt (without recourse to the Company) which was outstanding against the system and a $17.4 million secured note initially bearing interest at LIBOR plus 3% and paid in June 1994.\nWith the sale of its sole remaining cable television system, the Company is no longer engaged in the cable television business and accordingly the Company has presented its cable television segment as a discontinued operation in the accompanying financial statements. Prior years' statements have been reclassified to remove the operations of the cable television segment from income from continuing operations and to present the segment's net assets and liabilities on a single line in the balance sheet. Revenues from the operations of the cable television system totalled $17,189,152 and $16,385,939 for the years ended December 31, 1993 and 1992, respectively.\nAlba-Waldensian Consolidation\nAlba-Waldensian, Inc. (\"Alba\"), a manufacturer of women's hosiery and pantyhose, women's casual hosiery products, women's intimate apparel, men's hosiery, medical specialty products and warp knit products located in Valdese, N. C., has been an investee of the Company accounted for utilizing the equity method of accounting since May, 1987. Effective June 30, 1993, Alba became a 50.1% owned subsidiary of the Company's insurance subsidiary, and accordingly, the accounts of Alba have been consolidated in the accompanying financial statements as of that date.\nThe following table presents the Company's investment as allocated utilizing the purchase method of accounting to the individual assets and liabilities of Alba as of June 30, 1993 (amounts in thousands):\nProperty, plant and equipment $9,682 Restricted cash 77 Accounts receivable 7,703 Inventories 11,354 Prepaid expenses 1,463 Notes payable (1,291) Mortgage notes payable (150) Accounts payable (1,554) Accrued expenses (1,553) Other liabilities (1,845) Minority interest in net assets (13,112) ------\nConsolidated net assets $ 10,774 ======\nPrior to June 30, 1993, the Company's investment in Alba was presented in the Balance Sheet as an investment in affiliates and the Company's share of Alba's earnings, which averaged 49.9% during the six months ended June 30, 1993, and the years ended December 31, 1992 and 1991, was reported as equity in earnings of affiliates in the Statement of Operations. Accordingly, there would be no material change to reported net income or earnings per share had the acquisition been consummated at the beginning of either 1993 or 1992. Commencing July 1, 1993, the operating revenues and expenses of Alba are included in the Company's Consolidated Statements of Operations and contributed $26,798,277 of revenues and $1,004,407 of pre-tax income before minority interests of $287,878 during the year.\nSew Simple Systems, Inc.\nOn January 17, 1989, Sunstates acquired from Hickory, for a cash payment of $2,000,000, a 99% ownership interest in Sew Simple Systems, Inc. (\"Sew Simple\"), a designer and manufacturer of automated textile machinery located in Fountain Inn, South Carolina. Accordingly, Sew Simple has been included in Sunstates' consolidated financial statements since that date. The Stock Purchase Agreement provided that if Hickory should find a buyer for Sew Simple prior to the expiration of the Agreement, then Hickory would be entitled to additional amounts based upon the excess, if any, of the sales price over an escalating amount specified in the contract, which, as of April 13, 1992, was approximately $3.4 million (the Rights).\nOn April 13, 1992, Sunstates acquired from Hickory its remaining 1% ownership and its Rights under the Stock Purchase Agreement for approximately $13.6 million. The consideration given by Sunstates included the assignment of approximately $12 million previously due to Sunstates from Hickory and other affiliates plus a note payable for the remaining $1.6 million.\nAt April 13, 1992, Hickory beneficially owned approximately 52% of the common equity interests of Sunstates (61% on a fully diluted basis) and controlled approximately 79% of its voting interests. Generally accepted accounting principles applicable to purchases of businesses in transactions between entities under common voting control require that the assets acquired be recorded at their historical cost basis as previously reflected on the books of the seller. Accordingly, approximately $11 million, representing the excess of the fair market value paid for Hickory's remaining interest in Sew Simple over Hickory's historical cost basis, was reflected as a reduction to Sunstates' capital in excess of par value as of the date of the transaction. Future reported results of operations will be favorably impacted as the result of the elimination of Hickory's Rights under the Stock Purchase Agreement.\nSubsequent Event - Balfour Acquisition\nOn March 6, 1995, the Company's textile apparel manufacturing subsidiary (Alba) purchased the Balfour Health Care Division and manufacturing facility in Rockwood, Tennessee from Kayser-Roth Corporation for approximately $14.5 million, subject to post-closing adjustments. The acquisition of Balfour will add approximately $15 million in annual sales to Alba. Alba financed 100% of the acquisition price with a revolving loan agreement provided by a major bank.\n2. Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Sunstates and all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nHickory White is included based on its 52\/53 week fiscal year which ended on January 2, 1993, January 1, 1994 and December 31, 1994. Wellco is included based upon its four fiscal quarters ended January 2, 1993, January 1, 1994 and December 31, 1994. The accounts of Hickory White and Wellco have been included in the accompanying consolidated financial statements as of those dates. There were no material transactions during the periods from those dates to December 31st of each year.\nThe accounts of Sunstates' insurance subsidiaries are included based upon generally accepted accounting principles which differ from statutory accounting practices required by regulatory authorities.\nProperty, Plant and Equipment\nProperty, plant and equipment consists of investment in productive facilities and equipment, including (prior to December 30, 1993) the cost of acquired cable television franchises. Such assets are stated at cost and are depreciated and amortized over their estimated useful lives (ranging from 3 to 40 years, 15 years for cable television) primarily on a straight-line basis.\nCertain shoe-making machinery is leased to licensees under cancelable operating leases. Such activity is accounted for by the operating method whereby leased assets are capitalized and depreciated over their estimated useful lives (5 to 20 years) and rentals, based primarily on the volume of shoes produced or shipped by the lessees, are recorded during the period earned.\nReal Estate Held for Development and Sale\nReal estate held for development and sale is recorded at the lower of cost or net realizable value. Depreciation, where appropriate, is provided using the straight-line method over the estimated useful lives of the assets (not exceeding forty years).\nDuring the construction and development phase of real estate development certain costs are capitalized, including the cost of land, land improvements, construction, amenities, and certain indirect costs such as interest and real estate taxes. Construction and development costs are allocated to cost of sales using specific identification or other methods, as appropriate. During the sell-out or rent-up period, which is limited to a period no longer than one year after construction completion, the net results of incidental operations are reflected as an adjustment to the construction cost of the project.\nInvestments\nOn December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115 (\"Accounting for Certain Investments in Debt and Equity Securities\"). Under this Statement the Company began reporting its investment in debt securities, which are all classified as available for sale, at fair value, with unrealized gains or losses (other than permanent declines in value) excluded from earnings and reported in a separate component of stockholders' equity. Prior to December 31, 1993, the Company accounted for investments in debt securities at original cost, adjusted for amortization of premium or discount and permanent declines in value. Furthermore, under Statement No. 115, the Company began reporting marketable equity securities available for sale which are owned by other than its insurance subsidiary at their fair value, with unrealized gains or losses (other than permanent declines in value) reported in a separate component of stockholders' equity. Prior to December 31, 1993, marketable equity securities not owned by Sunstates' insurance subsidiaries were carried at the lower of aggregate cost or market value, whereas marketable equity securities owned by its insurance subsidiary have always been reported at fair value in a manner similar to that now required under Statement No. 115.\nA summary of the Company's accounting policies for investments are as follows:\nShort-term investments are carried at cost, which approximates market, and represent the temporary investment of excess cash balances within the insurance investment portfolio. These investments are composed of interest-bearing deposits and other investments in short-term financial instruments.\nFixed maturities investments representing debt securities are available for sale and are reported at their fair value. In addition to debt securities as described above, fixed maturity investments include certain collateralized notes receivable which are accounted for at original cost, as adjusted for amortization of premium or discount and permanent declines in value.\nEquity securities are available for sale and are carried at current market value.\nInvestments in affiliates represent investments which are accounted for utilizing the equity method of accounting and the common stocks of certain of Sunstates' direct and indirect parent companies which are carried at cost.\nRealized gains and losses on the sale of investments are recognized in net income on the specific identification basis. Changes in market values of debt and equity securities available for sale are reflected as unrealized gains (losses) directly in stockholders' equity and accordingly have no effect on net income. Unrealized losses which are deemed to be other than temporary are charged to operations. The Company may also invest in equity or index put or call options which are carried at their current market values with any change in such values being immediately recognized in the income statement.\nCash\nSunstates may invest cash in excess of operating requirements in income producing investments including certificates of deposit and money market accounts which have original maturities of three months or less. Such short-term investments, other than those which are a part of the insurance investment portfolio, are included in the cash balances reported in the accompanying financial statements. The carrying amount approximates fair value because of the short maturity of those instruments.\nRestricted Cash\nRestricted cash primarily represents cash of the insurance subsidiaries, whose ability to transfer cash to Sunstates is restricted by regulatory authorities. Restricted cash also represents cash of other subsidiaries which is restricted by law or by contract to specific purposes and is generally not available for other discretionary use. The carrying amount approximates fair value because of the short maturity of those instruments.\nReceivables\nAccounts receivable result primarily from the Company's furniture, textile apparel and military footwear manufacturing businesses and represent amounts receivable under normal trade terms. No single customer accounted for more than 3% of sales in 1994 except for the Company's textile apparel manufacturing division's sales to Baxter Health Care Corporation which totalled $12,902,722, $13,610,937 and $11,074,280 for the years ended December 31, 1994, 1993 and 1992, respectively. Military footwear sales are primarily to the U. S. government. Accounts receivable are net of a reserve for possible uncollectible amounts of $804,047 and $737,036 at December 31, 1994 and 1993, respectively.\nThe Company conducts its insurance business in certain states through managing general agents who issue the Company's policies to and collect premiums from other agents and retail customers. These managing general agents are given normal trade credit terms of between 45 to 60 days and at December 31, 1994, the Company had $2,027,270 of premium receivables from 5 different managing general agents, the largest of which totalled $1,640,955. Premiums receivable are net of a reserve for possible uncollectible amounts of $500,000 at both December 31, 1994 and 1993.\nInventories\nTextile apparel manufacturing inventories are stated at the lower of cost as determined by the first-in, first-out (FIFO) method or market.\nRaw materials and supplies of the military footwear manufacturing subsidiary are valued at the lower of first-in, first-out cost or market. Finished goods and work in progress of this subsidiary are valued at the lower of actual cost, determined on a specific basis, or market. Such inventories have been reduced by progress payments received on United States government contracts since title to all inventories related to these contracts vests in the U. S. government.\nDuring 1994, the Company changed its method of inventory valuation for its furniture manufacturing inventories from the last-in, first-out (LIFO) method to the first-in, first-out (FIFO) method because the FIFO method of reporting inventories and cost of sales represents a preferable method. The change is reported in the accompanying financial statements by restating all prior years to reflect the new method of accounting. The change is preferable, in part, because under the current economic environment of low inflation, the Company believes that the FIFO method will result in a better measurement of operating results. Also, as a result of the recent operating losses and demands upon its liquidity, the Company believes its financial position is the primary concern of the readers of its financial statements and that the accounting change will reflect inventories in the balance sheet at a value that more closely represents current costs.\nRestatement of operating results due to the change decreased cost of manufacturing sales and the net loss by $731,197 ($.29 per primary and fully diluted share) in 1994, increased cost of manufacturing sales and decreased net income by $284,361 ($.11 per primary share and $.09 per fully diluted share) in 1993 and decreased cost of manufacturing sales and the net loss by $44,280 ($.02 per primary and fully diluted share) in 1992. The cumulative effect of the change of $7,589,886 represents the reversal of the LIFO reserve as of January 1, 1992. Of this amount, $6,245,669 represented the LIFO reserve originally recorded in connection with the acquisition of the furniture assets from the Company's controlling shareholder in June of 1990. The original accounting for this acquisition resulted in a charge to paid in capital to reflect the excess of the purchase price paid over the seller's historical cost basis of the assets acquired. Accordingly, $6,245,669 has been reflected in the accompanying financial statements as a retroactive adjustment to paid in capital. The remaining balance of $1,344,217 has been reported as an adjustment to the accumulated deficit as of January 1, 1992. The aggregate effect of the change was to increase stockholders' equity by $8,081,002 as of December 31, 1994.\nOther inventories, consisting mainly of raw materials and work in process related to the textile equipment manufacturing business are stated at the lower of cost (determined on a first-in, first-out method) or market.\nPolicy Acquisition Costs\nCommissions and other variable costs related to the production of profitable new insurance underwriting business are deferred at the time of policy issuance. The Company may reduce such deferred costs when necessary to ensure that when combined with estimated costs of future claims and claims adjustment expenses, such costs do not exceed the amount of unearned premiums relating to the new business. Policy acquisition costs are amortized against income over the term of the related insurance policy and amortization totalled $1,670,889, $4,314,649, and $6,060,029 for the years ended December 31, 1994, 1993, and 1992, respectively.\nOther Assets\nThe Company also invests in oriental artwork, antique jewelry and books and other collectibles which are purchased and sold through dealers and at public auctions. Such collectible investments are carried at cost (which does not exceed market) and are saleable. At December 31, 1994, other assets included $2,256,909 of such collectible investments.\nCosts in Excess of Assets Acquired\nCosts in excess of net assets acquired represents the excess of the purchase price over the fair value of net assets acquired in connection with the acquisition of the insurance, manufacturing and newspaper publishing businesses. The Company evaluates the continued recoverability of its tangible assets, including cost in excess of assets acquired, whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. Factors which would trigger such an evaluation would include, but not limited to a significant decrease in the market value of an asset or operation, a significant change in the extent or manner in which an asset is being used, a significant change in legal factors or business climate and an expectation of continuing future losses. The Company evaluates the realizability of goodwill based upon expectations of nondiscounted cash flows and operating income for each subsidiary having a material amount of goodwill recorded.\nThese costs are being amortized on a straight-line basis over a 20 and 10-year period, respectively, except with respect to $3,706,258 related to furniture acquisitions prior to 1970 which is not being amortized since, in the opinion of management, there has not been any diminution in its value. Cumulative amortization totalled $1,883,409 and $1,649,004 at December 31, 1994 and 1993, respectively.\nInsurance Reserves\nReserve for losses represents the estimated liability on all claims outstanding plus a reserve for losses incurred but not yet reported. An amount for both future overhead and external expenses expected to be incurred in processing and settling such claims is also estimated and added to the reserves for claims. Case-basis evaluations and other statistical and judgmental methods, including independent actuarial reviews, are used to establish and continually evaluate the adequacy of the reserves. The ultimate amount of losses and loss adjustment expenses paid may differ from previously recorded reserves and any adjustments which may thereby be determined to be necessary are reflected in current operations at the time such differences are identified.\nUnearned Premiums\nPremium revenue is recognized in income on a pro-rata basis over the terms of the related insurance policies.\nReinsurance\nSunstates is involved in both the cession and assumption of reinsurance with other insurance companies. Reinsurance is assumed primarily on a quota share, or dollar for dollar sharing basis, on business which is essentially the same type of business which is written directly. Reinsurance premiums, commissions, claim processing expense reimbursements, and reserves related to reinsurance business are accounted for on bases consistent with those used in accounting for the original policies issued and the terms of the reinsurance contracts. Earned premiums related to assumed reinsurance totalled $481,841, $5,655,727, and $19,402,040 for the years ended December 31, 1994, 1993 and 1992, respectively.\nTo the extent that a portion of the Company's liabilities under its insurance policies have been ceded to other insurance companies, these policy risks are treated as though they are risks for which the Company is not liable. A contingent liability exists with respect to such reinsurance in the event the reinsurer is unable to meet its obligations. At December 31, 1994, reinsured unpaid losses and unearned premiums totalled $1,261,774.\nManufacturing Revenue\nSales of furniture, textile apparel and automated textile machinery are recorded at the time the inventory is shipped. Military footwear is sold primarily under contracts with the United States government and revenue is recognized at the time the goods are inspected and accepted by the United States government.\nReal Estate Revenue\nProfits on sales of real estate are recorded under the full accrual method or other generally accepted methods, as appropriate.\nInterest, rent and other operating income is recorded when earned, except that interest is not accrued on loans which are in excess of sixty days past due and other income is not recognized if collectability is doubtful.\nPensions\nCertain of Sunstates' manufacturing operations maintain defined benefit pension plans covering substantially all of their employees. The benefits under these plans are based upon years of service and employee compensation. Sunstates' policy is to fund the minimum amount required by the Employee Retirement Income Security Act.\nIncome Taxes\nSunstates and its eligible United States subsidiaries file consolidated federal income tax returns. Income earned by its Puerto Rican subsidiary is not subject to United States federal income tax and is 90% exempt from Puerto Rican income taxes through the year 2000.\nIncome taxes for both federal and state tax purposes are provided based on both income reported for financial statement purposes and the applicable tax laws and rates in effect for the years presented. Significant net operating loss carryforwards for federal income tax purposes are available which may be utilized to eliminate, except for alternative minimum tax, substantially all federal income taxes.\nThe Company adopted prospectively Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", effective January 1, 1993. This Statement affects methods of accounting for deferred tax assets and liabilities, recognizing benefits of existing net operating loss carryforwards, and the accounting for income tax effects of business combinations accounted for under the purchase method. The utilization of net operating loss carryforwards is no longer reported as an extraordinary item in the statement of operations but instead the current provision for income tax expense is presented net of any benefit recognized from the utilization of existing net operating loss carryforwards. The Statement also requires the use of the asset and liability method of accounting for income taxes wherein deferred income taxes are recognized for the tax consequences of \"temporary differences\" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. A valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. In establishing such an allowance, the Company considers all available information, including but not limited to, its historical taxable income record, the likelihood of future taxable income, the availability of tax planning strategies and the existence of taxable temporary differences which will reverse during periods in which the Company's net operating loss carryforwards will be available to offset such taxable items.\nFinancial 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:\nMortgage Loans - estimated by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit risks and for the same remaining maturities.\nLand Contracts Receivable - by discounting future cash flows using the current rates at which the Company is now making such loans (12%).\nShort-term Investments - the carrying amount approximates fair value because of the short-term maturity of those instruments.\nFixed Maturity Investments - marketable debt securities are valued at their quoted market prices or dealer quotes. Other debt securities are valued by discounting future cash flows using the current rates at which similar loans would be made to borrowers with similar credit risks and for the same remaining maturities.\nEquity Security Investments - valued at their quoted market prices or dealer quotes.\nInvestments in Affiliates - valued at their quoted market prices or dealer quotes.\nReceivables from Affiliates - due to their related party nature and terms of the receivables from affiliates, the Company cannot estimate the fair market value of such financial instruments.\nNotes Payable - these notes substantially bear interest at a floating rate of interest based upon the lending institution's prime lending rate. Accordingly, the fair value approximates their reported carrying amount at December 31, 1994.\nMortgage Notes - estimated based upon current market borrowing rates for loans with similar terms and maturities.\nReclassifications\nCertain amounts in the financial statements for prior years have been reclassified to conform to current year presentation. Such reclassifications had no effect on previously reported net income or stockholders' equity.\n3. Real Estate\nProperty, Plant and Equipment\nProperty, plant and equipment is shown net of accumulated depreciation and amortization of $41,084,496 and $37,616,828 at December 31, 1994 and 1993, respectively. Included therein is $1,374,609 and $1,303,521 of accumulated depreciation related to machinery leased to licensees at December 31, 1994 and 1993, respectively. Rental revenue on such leased machinery, substantially all of which vary with lessee's production or shipments, totalled $132,355, $139,083 and $127,845 for the years ended December 31, 1994, 1993 and 1992, respectively.\nProperty, plant and equipment totalling $27,413,700 is pledged as collateral under various notes and mortgages outstanding at December 31, 1994 (see Note 6).\nReal Estate Held For Development and Sale\nCertain of the assets shown above are stated at their fair values as established in connection with a 1985 merger. The adjustment to historical cost represents the difference between such fair values and the cost which was allocated to those assets in connection with the merger.\nApproximately $17,721,000 of the real estate was pledged to secure various mortgage notes payable at December 31, 1994 (see Note 6).\nInterest capitalized on the above assets during the years ended December 31, 1994, 1993 and 1992 totalled $6,096, $9,907, and $316,506, respectively.\nReal estate presented above is net of accumulated depreciation of $2,516,956 and $2,621,464 at December 31, 1994 and 1993, respectively.\nMortgage Loans\nCertain mortgage loans are stated at their fair values as established in connection with a 1985 merger. An adjustment to historical cost was established representing the difference between such fair values and the cost allocated to those mortgage loans in connection with the merger. At December 31, 1994 and 1993 the remaining balance of this adjustment to historical cost was $21,292 and $43,308 respectively.\nMortgage loans at December 31, 1994 and 1993 are net of unamortized discount of $272,824 and $332,747 and allowances for possible losses of $165,036 and $153,092, respectively. The effective interest rates used to discount these loans range from 8.25% to 20%. The weighted average interest rates on the mortgage loan portfolio were 11.13% and 9.8% for the years ended December 31, 1994 and 1993, respectively.\nEstimated collections of principal on mortgage loans at December 31, 1994 are as follows:\nYears Ending Principal December 31, Collections 1995 $ 937,117 1996 318,486 1997 1,406,850 1998 1,625,811 1999 110,273 2000 and thereafter 1,369,554 \t\t\t\t\t\t\t --------- Total gross receivables 5,768,091 Less: Unamortized interest discounts (272,824) Allowance for possible losses (165,036) \t\t\t\t\t\t\t --------- 5,330,231 Adjustment to historical cost (21,292) \t\t\t\t\t\t\t --------- $ 5,308,939 \t\t\t\t\t\t\t =========\nLand Contracts Receivable\nNDC typically finances its sales of recreational and second home resort lots, after a 10% down payment, over a period of three to seven years with an interest rate of 12%. Estimated collections of principal on land contracts receivable at December 31, 1994 are as follows:\nYears Ending Principal December 31, Collections\n1995 $3,088,140 1996 1,280,822 1997 1,083,409 1998 825,140 1999 527,223 2000 and thereafter 138,415 \t\t\t\t\t\t\t--------- Total gross receivables 6,943,149 Less: Unamortized interest discounts (246,004) Allowance for cancellation and uncollectible accounts (1,580,425) \t\t\t\t\t\t\t--------- $ 5,116,720 \t\t\t\t\t\t=========\nLand contracts receivable are discounted to reflect market rates of interest prevailing at the date of sale, primarily 12-15%. The discounts are amortized to operations using the interest method over the term of the respective notes.\n4. Investments\nFixed Maturities\nIn addition to marketable debt securities available for sale, fixed maturity investments include certain collateralized notes receivable which are accounted for at original cost, as adjusted for amortization of premium or discount and permanent declines in value (\"carrying amount\"). In 1993, the Company adopted Statement of Financial Accounting Standards No. 114 (\"Accounting by Creditors for Impairment of a Loan\"). Under this Statement an impaired loan is valued at the lower of its carrying amount or its net realizable value, including interest to be collected. Any changes in its estimated net realizable value, up to but not exceeding the loan's carrying amount, are reported as an adjustment to bad debt expense for the period. At December 31, 1994 and 1993, the Company had one collateralized note receivable which had previously been impaired. During 1993, the estimated net realizable value of the loan increased as the result of bankruptcy court's approval for the sale of the debtor's business, which was completed in February 1994. The following presents the activity in the allowance for credit losses during 1993 and 1994:\nBalance, January 1, 1993 $575,803 Reduction to bad debt expense 575,803 \t\t\t\t\t\t\t ------- Balance, December 31, 1993 and 1994 $ -- \t\t\t\t\t\t\t =======\nIncluded in fixed maturity investments at December 31, 1994, are certain one and two-year U. S. Treasury securities yielding 7.22% to 7.67% with an original cost of $25,522,655 (approximates market) which were acquired under agreements to resell on various dates through April 3,1995. Due to the short-term nature of the agreements, the Company did not take possession of the securities which were instead held in custody by the Company's brokerage firms. Additionally, the Company borrowed $25,343,045 from these brokerage firms against such securities with interest rates ranging from 5.25% to 6.375% and maturing on various dates through April 3, 1995 (see Note 6).\nThe amortized cost and estimated market value of debt securities at December 31, 1994, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nEstimated Amortized Market Cost Value Due in one year or less $ 23,358,463 23,425,184 Due after one year through five years 13,852,877 13,675,012 Due after five years through ten years 1,619,823 1,763,570 Due after ten years 71,837 71,837 \t\t\t\t\t ---------- ---------- 38,903,000 38,935,603 Collateralized notes receivable (due in 1995) 378,532 378,532 \t\t\t\t\t ---------- ---------- $ 39,281,532 39,314,135 ========== ==========\nAt December 31, 1994, investments in high yield, unrated or non-investment grade securities and notes totalled $1,946,506 with an aggregate market value of $1,946,506. Included in this category at December 31, 1994, is a receivable of $378,532 remaining from a bankruptcy filed during 1993. During 1993 the bankruptcy court approved the sale of the debtor's assets (which closed in 1994) wherein the Company received distributions totalling $5,923,320, which were sufficient to realize all but $378,532 of the carrying value of the note at December 31, 1993. The Company anticipates receiving additional distributions from the bankruptcy which will exceed the carrying value of the receivable at December 31, 1994.\nAs required by law, bonds and certificates of deposit carried at $6,433,045 and $4,244,606 at December 31, 1994 and 1993, respectively, were on deposit with the various states in which the insurance subsidiaries are doing business.\nEquity Securities\nThe cost of marketable equity securities available for sale totalled $16,382,784 and $14,266,424 at December 31, 1994, and 1993, respectively.\nAt December 31, 1994, the net pre-tax unrealized gains on marketable equity securities of $4,407,933 included in stockholders' equity was comprised of $5,313,461 of unrealized gains and $905,528 of unrealized losses.\nNet realized gains related to sales of equity securities which are included in investment income in the accompanying financial statements totalled $12,528,332, $15,434,405, and $2,338,276 for the three years ended December 31, 1994. In addition, writedowns to reflect what the Company believed to be other than temporary declines in the market value of equity securities totalled $913,590 and $1,394,322 during the years ended December 31, 1994 and 1992, respectively.\nInvestments in Affiliates\nDuring the period from 1987 through 1991, Normandy acquired from Hickory and on the open market a 49.94% interest in Alba-Waldensian, Inc. (\"Alba\"), a manufacturer of knitted apparel and health care products. Accordingly, Alba has been an investee of the Company accounted for utilizing the equity method of accounting since May, 1987. Effective June 30, 1993, Alba became a 50.1% owned subsidiary of the Company's insurance subsidiary, and accordingly, the accounts of Alba have been consolidated in the accompanying financial statements since that date (see Note 1).\nRocky Mountain Chocolate Factory, Inc. (\"Rocky Mountain\"), located in Durango, Colorado, manufactures, from its own recipes, a line of gourmet chocolates and other premium confectionery products for sale at company-owned and franchised stores. On December 31, 1989, Sunstates became the owner of 35.12% of the common stock of Rocky Mountain through the conversion of a note which was held in its investment portfolio and thereby commenced equity accounting for its investment at that date. In addition to the $2,678,715 carrying value of Sunstates' investment in 55% of the common stock of Rocky Mountain indicated below (which represents an equity in the underlying net assets of Rocky Mountain totalling $3,041,000), Sunstates also holds additional notes with a carrying value of $1,124,996, which are secured by the common stock of Rocky Mountain. Although Sunstates' present ownership of Rocky Mountain is over 50%, the financial statements of Rocky Mountain have not been consolidated with Sunstates' due to immateriality. At December 31, 1994, the Company's investment in Rocky Mountain stock, which has a carrying value of $2,678,715 and a market value of $19,537,970, was pledged to secure a note payable to a bank (see Note 6).\nThe following is a summary of the equity in earnings of equity investees recognized by the Company during the three years ended December 31, 1994:\nRocky Year Alba Mountain\n1992 $ 1,274 101 1993 435 382 1994 -- 891\nThe difference between the cost of the investments and the underlying net assets of investees is allocated to the property, plant and equipment of the investee and amortized over the depreciable life of the assets. At December 31, 1994, consolidated stockholders' equity included $1,566,221 of cumulative undistributed earnings of equity investees.\nAlso included in investment in affiliates on the accompanying Consolidated Balance Sheet at December 31, 1994, is the common stock of certain of Sunstates' direct and indirect parent companies which was purchased on the open market at an aggregate cost of $954,995. (See Note 12 regarding the writeoff at December 31, 1994, of the Company's investment in WREIT.)\n5. Inventories\nThe principal classifications of inventories are:\nDecember 31, 1994 1993 Furniture manufacturing - Materials and supplies $ 2,807,511 2,718,289 Work in process 6,535,222 6,452,802 Finished goods 12,041,195 8,838,599 \t\t\t\t ---------- ---------- 21,383,928 18,009,690 \t\t\t\t ---------- ---------- Textile apparel manufacturing - Materials and supplies 3,296,755 2,548,836 Work in progress 5,803,012 5,870,073 Finished goods 8,164,413 5,729,717 \t\t\t\t ---------- ---------- 17,264,180 14,148,626 \t\t\t\t ---------- ---------- Bootwear manufacturing - Materials and supplies 882,022 1,314,587 Work in progress 1,501,282 1,608,896 Finished goods 542,876 146,647 \t\t\t\t --------- --------- 2,926,180 3,070,130 \t\t\t\t --------- ---------\nTextile equipment manufacturing 883,086 1,254,300 Resort development 164,036 124,834 Other 287,521 118,519 \t\t\t\t ---------- ---------- $42,908,931 36,726,099 \t\t\t\t ========== ==========\n(See Note 2 for information regarding a change in method of valuing the furniture subsidiary's inventories.)\n6. Debt\nNotes Payable\nThe following table summarizes notes payable: December 31, 1994 1993\nNotes payable to bank $10,000,000 6,000,000\nInvestment financing 25,343,045 --\nRevolving credit line 11,860,195 10,706,789\nEquipment loan 1,500,000 2,000,000\nCapitalized lease obligations 715,186 802,597\nShort-term borrowings 3,248,062 20,000\nOther 10,026 -- \t\t\t\t\t ---------- ---------- $ 52,676,514 19,529,386 \t\t\t\t\t ========== ==========\nThe Company's note payable to a bank matures December 29, 1995, bears interest at Prime + 1% and is secured by the Company's investment in its textile apparel, military footwear manufacturing subsidiaries and its investment in Rocky Mountain (see Note 4). Additionally, the Company has pledged substantially all of the assets of its hotel and golf resort and its automated textile equipment manufacturing operations as collateral under this note.\nOn October 27, 1993, the Company's insurance subsidiary entered into a $10,000,000 loan agreement with a bank bearing interest at Prime plus 0.5% and due on January 26, 1994. The outstanding balance of $6,000,000 at December 31, 1993, was secured by the Company's investment in its textile apparel and military footwear manufacturing subsidiaries and its investment in Rocky Mountain (see Note 4) and was repaid on January 3, 1994, with a portion of the proceeds from the sale of the cable television system.\nDuring December 1994, the insurance subsidiary borrowed $25,343,045 from various brokerage firms at rates varying from 5.25% to 6.375%, with maturities through April 3, 1995. These borrowings were secured by certain one and two-year U. S. Treasury securities with an original cost of $25,522,655 (approximates market) yielding 7.22% to 7.67% which were acquired under agreements to resell on various dates through April 3,1995.\nThe furniture subsidiary's revolving credit agreement with a major bank provides for borrowings of up to $12.5 million based upon the levels of eligible (as defined) accounts receivable and inventories. The credit agreement carries interest at the lender's \"alternative base rate\", as defined, plus 2% (10.5% at December 31, 1994). At December 31, 1994, borrowings under the revolving credit agreement were $11,860,195 and there was approximately $640,000 available under the agreement. Borrowings pursuant to the credit agreement are secured by substantially all of the assets of Hickory White and the loan is guaranteed by Hickory Furniture Company, Sunstates' parent. However, Sunstates is not obligated under the credit agreement. At December 31, 1994, the net worth of Hickory Furniture Company, Sunstates' parent, did not meet the minimum requirement under the loan covenants. The furniture subsidiary requested and obtained from the bank a waiver of the violation.\nThe credit agreement has previously matured and has been extended through January 3, 1996, to allow the Company additional time to obtain refinancing. However, the Company cannot state with certainty that it will be able to find alternative financing at terms acceptable to the Company prior to the extended maturity date of the loan. The credit agreement contains various covenants by Hickory White, the more restrictive of which include: (i) maintenance of; (a) minimum earnings, (b) tangible net worth levels and, (c) minimum ratios of earnings to fixed charges, all as defined, (ii) limitation of cash dividends on the common stock of Hickory White, (iii) prohibition on investments in and advances to other companies and affiliates and (iv) limitations on indebtedness of Hickory White.\nThe Company's textile apparel manufacturing subsidiary has a $2,000,000 term loan agreement with a bank that provides for equipment purchases of $250,000 up to $2,000,000, collateralized by the equipment purchased. Interest on the loan is 6.3% and as of December 31, 1994, there was $1,500,000 outstanding under this loan agreement.\nThe Company has leased certain computer, golf course and telephone equipment at its various operations under capital leases at inherent interest rates varying from 8% to 13.75% under varying terms extending through April 1999.\nShort-term borrowings primarily represent balances owed under various seasonal and annually renewable bank lines of credit. The textile apparel manufacturing subsidiary has a $3,000,000 seasonal line of credit under which $1,821,938 was available at December 31, 1994. This line of credit bears interest at prime and is secured by liens on equipment and accounts receivable and contains covenants which relate to the maintenance of working capital and net worth, the purchase of fixed assets and the payment of dividends. At December 31, 1994, the military footwear manufacturing subsidiary had borrowed $2,050,000 at the bank's prime rate of interest which was secured by marketable securities and repaid in January 1995. The military footwear manufacturing subsidiary also has a $1,500,000 unsecured bank line of credit which bears interest at the bank's prime rate and expires December 30, 1995, but can be renewed annually at the bank's discretion. At December 31, 1994, $1,480,000 was available under this line.\nAt December 31, 1994, the prime rate of interest was 8.5%. Effective weighted average interest rates for notes payable was 8.44%, 9.01%, and 8.43% for the years ended December 31, 1994, 1993 and 1992, respectively.\nMortgage Notes\nThe above mortgage notes are collateralized by approximately $17,721,000 of real estate (see Note 3).\nAt December 31, 1994, the prime rate of interest was 8.5%. Effective weighted average interest rates for mortgage notes payable approximated 8.75%, 7.9%, 7.93% for the years ended December 31, 1994, 1993 and 1992, respectively.\nFive Year Maturity Schedule\nThe following table reflects the required principal payments on debt, including notes payable and mortgage notes which would be made if the debt outstanding at December 31, 1994, was held to maturity:\nYears Ending Principal December 31, Payments\n1995 $57,542,677 1996 7,606,592 1997 773,100 1998 2,747,710 1999 99,693 2000 and thereafter 182,644 \t\t\t\t\t\t\t\t---------- 68,952,416 Unamortized discounts (164,465) \t\t\t\t\t\t\t\t --------- Net carrying value $ 68,787,951 \t\t\t\t\t\t\t\t ==========\nWith respect to the notes maturing in 1995, Sunstates is continuing to search for satisfactory alternative financing for these properties. However, the availability of real estate financing has been severely curtailed as the result of problems in both the banking and real estate industries. Accordingly, Sunstates cannot state with certainty that it will be successful in obtaining such refinancing.\nInterest paid for the years ended December 31, 1994, 1993 and 1992 totalled $3,954,096, $7,755,005 and, $6,309,934, respectively.\n7. Minority Interest in Subsidiaries\nIncluded in the minority interest in subsidiaries is the minority stockholders' proportionate share of Alba's net assets (49.6% and 49.9% at December 31, 1994 and 1993, respectively), and Wellco's net assets (41.4% and 43% at December 31, 1994 and 1993, respectively).\n8. Stockholders' Equity\nPreferred Stocks\nSunstates has the following issues of preferred stock:\nDecember 31, 1994 1993\n$3.75 Cumulative Preferred Stock $ 7,198,975 9,008,675\nClass E Preferred Stock 57,300 57,300 \t\t\t\t\t --------- -------- Total Preferred Stock $ 7,256,275 9,065,975 \t\t\t\t\t ========= =========\nClass B Preferred Stock - $1.00 par value; preference in liquidation $100; authorized and issued one share at December 31, 1994 and 1993. The one share issued is held by a 100% owned subsidiary of Sunstates and is thereby deemed to be treasury stock and not outstanding. If the Class B Preferred were outstanding, it would have a voting equivalency of 400,000 shares and vote with the common stock as a single class.\n$3.75 Cumulative Preferred Stock - $25 par value per share, 471,100 shares authorized; 287,959 and 360,347 issued and outstanding at December 31, 1994 and 1993, respectively. The $3.75 Cumulative Preferred Stock has no conversion, exchange, mandatory redemption, preemptive or other subscription rights or sinking fund provisions and is currently callable at $25 per share, in whole or in part, at the option of Sunstates. Dividends are cumulative and payable semi-annually, when and as declared. The $3.75 Cumulative Preferred Stock has no voting rights, except if two semi-annual dividend payments are unpaid and in arrears at the date of the Company's annual meeting the holders of the $3.75 Cumulative Preferred Stock have the right to elect fifty percent of the members of the Company's Board of Directors. At December 31, 1994, Sunstates was eight semi-annual dividends in arrears on its $3.75 Cumulative Preferred Stock.\nDuring the three years ended December 31, 1994, Sunstates' insurance subsidiary purchased 15,000, 20,600 and 72,319 shares, respectively, of $3.75 Cumulative Preferred Stock at a cost of $329,618, $455,432 and $2,020,629, respectively. These shares are deemed to be treasury shares on a consolidated basis and deducted from outstanding shares in the accompanying financial statements.\nClass E Preferred Stock, Series I and II - $.10 par value per share; 589,000 shares authorized; 573,000 issued and outstanding at December 31, 1994 and 1993, with a $1.00 per share liquidation preference. Class E Preferred Stock has no conversion, exchange, mandatory redemption, preemptive or general voting rights and may be redeemed in whole or in part by action of Sunstates' Board of Directors. Non-cumulative dividends are payable on the Class E Preferred Stock at the annual rate of $.08 per share, when and as declared. There were no dividends declared during the three years ended December 31, 1994.\nCommon Stock - $.33 1\/3 par value per share; 5,000,000 shares authorized; 1,829,388 shares issued as of December 31, 1994 (1,826,347 shares at December 31, 1993) of which 1,032,372 and 792,775 shares were held in treasury at December 31, 1994 and 1993, respectively. During the three years ended December 31, 1994, Sunstates' insurance subsidiaries purchased 160,775, 69,100 and 239,597 shares, respectively, of its Common Stock at a cost of $943,485, $333,184 and $1,791,015, respectively. These shares are deemed to be treasury shares on a consolidated basis and deducted from outstanding shares in the accompanying financial statements.\nClass B Accumulating Convertible Stock (\"Class B Stock\") $.10 par value, 84,800 shares authorized. Class B Stock has the same rights as Common Stock other than with respect to voting rights and conversion privileges. Each share of Class B Stock has 85.3125 votes per share on each matter submitted to a vote of Sunstates' stockholders. Holders of Class B Stock also have the right, at their option, to convert Class B Stock into Common Stock at a rate of 21.125 shares of Common Stock per share of Class B Stock at December 31, 1994. The conversion rate increases annually to a maximum conversion rate in 1995 of 24.375 shares of Common Stock per share of Class B Stock. During 1994 and 1993, 140 and 222 shares of Class B Stock were converted into 3,041 and 3,968 shares of Common Stock, respectively. During the year ended December 31, 1994, Sunstates' insurance subsidiaries purchased 8,613 shares of its Class B Stock at a cost of $1,559,392.\nDividends\nUnder the terms of Sunstates' $3.75 Preferred Stock, dividends may not be paid on common shares while preferred stock dividends remain in arrears. At December 31, 1994, Sunstates was in arrears eight semi-annual dividends on its $3.75 Cumulative Preferred Stock aggregating $4,319,385 ($15 per share).\nOptions and Warrants\nIn May 1982 shareholders approved the adoption of an Incentive Stock Option Plan pursuant to which options to purchase the common stock of Sunstates may be granted to key employees at a price not less than fair market value at date of grant, up to a maximum of 32,994 additional shares of Sunstates' common stock. Options under this Plan were issued in 1982 through 1984 and became exercisable at the rate of 25% per year beginning one year from the date of grant and expired in ten years. No charges were made to income with respect to these options. During the three years ended December 31, 1994, there were no exercises of outstanding options and all previously outstanding options have now expired. The Company has no plans to issue any new options under the Incentive Stock Option Plan.\nAll previously issued warrants under Sunstates' 1979 compensatory warrant plan have expired unexercised.\n9. Commitments and Contingencies\nLitigation\nIn April of 1988, two essentially similar civil actions styled Jeremiah P. O'Connor, Sarah M. O'Connor, and Leonore Ballan v. Acton Corporation, et al., and VR Associates and PJE Associates v. Acton Corporation, et al., were filed in the Court of Chancery for the State of Delaware in and for New Castle County. Also named in these actions are Sunstates Corporation and the directors of Acton prior to the merger with Sunstates. These actions, along with another subsequently filed action styled Harry Lewis v. Clyde W. Engle, et al., have been consolidated into one action entitled In Re Acton Corporation Shareholders Litigation. All plaintiffs allege to be holders of common stock of Acton and seek to have the action designated a class action on behalf of all parties owning common stock of Acton. The action challenges the merger of Sunstates Corporation with and into Acton, alleges fraud and breach of fiduciary duty and seeks unspecified damages plus costs and expenses including attorney's fees. Acton intends to defend this action vigorously. The suit is still in the preliminary stages and management is unable to predict the outcome of the litigation; however, management is of the opinion that the outcome of the litigation is unlikely to have a material adverse effect on Sunstates' financial position.\nOn June 4, 1990, VR Associates and Sonem Partners, L.P. filed a shareholder derivative action in the Court of Chancery for the State of Delaware in New Castle County against the directors of Acton and Hickory. The action alleges that certain transactions entered into and investments made by Acton constituted waste or a breach of fiduciary duty by the Board of Directors of Acton. In particular, the action alleges that Acton's purchase of the furniture operations of Hickory was not in the best interests of Acton and seeks various relief, including rescission of the purchase, unspecified damages and costs. The action also sought to obtain a temporary restraining order to prevent consummation of the purchase transaction. The request for a restraining order was denied by the Court on June 8, 1990. An essentially similar action was filed in the State of Delaware on June 12, 1990 by PJE Associates. These suits are still in the preliminary stages and management is unable to predict the outcome of the litigation; however, Sunstates intends to defend these actions vigorously and does not believe that the outcome of the litigation is likely to have a material adverse effect on Sunstates' financial position.\nOn June 14, 1991, a jury in a District Court of Dallas County, Texas awarded $3.5 million in actual damages and $5 million in punitive damages to the plaintiffs of a lawsuit filed against Acton Corporation. This dispute relates to the amount of additional purchase consideration due plaintiffs under an agreement made in 1983 whereby the Company purchased National Development Company, a real estate company based in Dallas. The Company has appealed the verdict based, in part, on the exclusion by the court of evidence crucial to the Company's defense. On November 7, 1991, the Company filed a Supersedeas Bond in the amount of the judgment, plus costs and interest for one year, with the Clerk of the District Court, signed by the Company as principal and by National Development Company, Inc., an affiliate of the Company, as surety. The effect of the filing of the supersedeas bond is to stay any execution of the judgment against assets of the Company, pending the results on appeal or any further orders of the District Court regarding the supersedeas. The plaintiffs have filed a cross-appeal, alleging that the trial court should have awarded an additional $5 million in exemplary damages, based upon the jury verdict. The Company believes that the damages awarded are contrary to the law and facts in this matter and is vigorously pursuing its rights on appeal. However, at this time management is not able to predict the Company's ultimate liability, if any, in this matter and accordingly, no provision for any such liability has been made in the Company's financial statements. Should the Company be required to pay all or a significant portion of this judgment, it could have a material adverse effect on the financial position and results of operations of the Company.\nOn December 6, 1991, California Federal Bank filed a suit against Acton in the Circuit Court, Duval County, Florida alleging breach of a Contract of Guaranty of a $5,100,000 note executed by Jacksonville Apartment Associates, Ltd. and secured by a mortgage on an apartment project in Jacksonville, Florida. During 1994 the suit was settled with the Company making a payment of $230,000.\nOn December 8, 1993, Richard N. Frank filed a purported derivative and class action in the Court of Chancery for the State of Delaware in New Castle County against the directors of Acton, Hickory and Telco. The action alleges that certain transactions entered into and investments made by Acton constituted waste or a breach of fiduciary duty by the Board of Directors of Acton. The complaint also alleges that the Company and its insurance subsidiary repurchased shares of the Company's common stock and $3.75 Cumulative Preferred Stock in violation of the Company's certificate of incorporation. Finally, the complaint alleges that the proxy statement disseminated in connection with the Company's December 13, 1993, annual meeting was materially misleading. This suit is in the preliminary stages and management is unable to predict the outcome of the litigation; however, Sunstates intends to defend these actions vigorously and does not believe that the outcome of the litigation is likely to have a material adverse effect on Sunstates' financial position.\nOn January 10, 1994, Robert A. Lee, et al. filed a punitive derivative action in the Court of Chancery for the State of Delaware in New Castle County against the directors of Acton, Hickory, Telco, WREIT, RDIS Corporation and nominally against the Company itself. The complaint alleges that certain transactions entered into and investments made by Acton constituted waste or a breach of fiduciary duty. This suit is in the preliminary stages and management is unable to predict the outcome of the litigation; however, Sunstates intends to defend these actions vigorously and does not believe that the outcome of the litigation is likely to have a material adverse effect on Sunstates' financial position.\nAt December 31, 1994, Sunstates and its subsidiaries also were, and currently are, defendants in other legal proceedings incidental to their business. Sunstates intends to defend such proceedings vigorously and, in the opinion of the management, Sunstates' ultimate liability, if any, in these proceedings will not have a material adverse effect on the consolidated financial position of Sunstates.\nInsurance Matters\nDuring the past three years, the Company's insurance subsidiary experienced significant declines in premium volume as the result of the discontinuation of certain general liability reinsurance programs and several unprofitable direct automotive insurance programs combined with the effect of price increases having been implemented in other markets which were producing unsatisfactory results. The combination of the above has resulted in the written premium volume declining to approximately $47,944,000 in 1994 as compared to $57,063,000 in 1993 and $118,830,000 in 1992. The decline in writings accelerated in the latter half of 1993 with writings in the fourth quarter totalling approximately $10,493,000 as compared to $20,711,000 for the same period in 1992. The decline in premium volume stabilized during the early part of 1994 and showed modest increases during the last half of the year as new programs already established and other planned actions to increase volume started to become effective resulting in fourth quarter 1994 writings totalling $12,910,000.\nThe short-term impact of the drop in written volume was that the company experienced a period of negative cash flow from underwriting activities resulting from relatively immediate declines in collected premiums while claim payouts, relating primarily to previously written policies, continue at disproportionately higher levels. The Company's negative cash flow from underwriting has begun to decline as premium volume has stabilized. Negative cash flow from investment income and underwriting activities of the insurance segment for 1994 was $29,162,720 (declining to only $5,551,737 in the fourth quarter) compared to $54,819,238 for 1993 and $12,859,008 for 1992. Accordingly, the Company believes that any required liquidations of the investment portfolio in order to meet operating cash flow requirements during 1995 will be greatly reduced.\nThe level of liquid assets, as defined by the National Association of Insurance Commissioners (\"NAIC\"), of the Company's insurance subsidiaries was $90,109,196 at December 31, 1994, as compared to $77,678,160 at December 31, 1993. Included in NAIC-defined liquid assets are U. S. Treasury securities with approximately $25,500,000 which were acquired under agreements to resell (see Note 4) as well as certain securities with a reported value of $6,932,590 at December 31, 1994, which are not publically traded as well as approximately $8,333,000 of securities and certificates of deposit which were on deposit pursuant to state laws and various reinsurance agreements. In addition, $33,954,320 ($36,446,728 at December 31, 1993) of investments in publicly traded equity securities of other companies, valued at their quoted market prices on December 31, 1994, do not meet the NAIC definition of liquid assets solely because of the level of ownership of such securities.\nIn August 1992, the Company agreed with the Illinois Department of Insurance to decrease Coronet's ratio of liabilities to liquid assets, as defined by the NAIC, to 105% over a five year period. At December 31, 1994, Coronet's ratio was 134.6%, as compared to the agreed upon ratio of 155%. The ratio required to be met by December 31, 1995, is 130%. The Company expects to achieve this objective without any material adverse consequences; however, such compliance is dependent upon a combination of future premium volumes, underwriting and investment results, various restructurings and asset transfers, potential regulatory examination adjustments, if any, and other factors beyond the Company's control.\nIn September 1993, the Arizona Department of Insurance notified the Company that it would be performing a limited examination of the Company's reported statutory surplus, however, to date no such examination has commenced. The Illinois Department is currently conducting a financial examination of Coronet as of December 31, 1993, although the examination has not been completed, at this time no matters have been brought to the Company's attention which would have a material adverse impact on the Company.\nThe National Association of Insurance Commissioners (\"NAIC\") recently adopted risk-based capital guidelines for property\/casualty insurance companies whereby defined risk-based capital would be based, in part, upon a formulated risk assessment of the type of assets held in an insurance company's investment portfolio, asset concentrations and underwriting risks. Such proposed regulations are anticipated to become effective in 1995, however, a computation of the Company's risk-based capital was required to be prepared for informational purposes only as of December 31, 1994. Based upon this computation, as filed under the NAIC's reporting requirements, the Company's risk-based capital far exceeds proposed minimum requirements.\nThe consolidated financial statements include the estimated liability for unpaid losses and loss adjustment expenses (\"LAE\") of Coronet. The liabilities for losses and LAE are determined using case-basis evaluations and statistical projections, including independent actuarial reviews, and represent estimates of the ultimate net cost of all unpaid losses and LAE incurred through December 31 of each year. In estimating the ultimate net cost of unpaid claims and LAE the impact of inflation is implicitly considered. Coronet reduces its reserves for any estimated salvage or subrogation recoveries which may be realized in connection with settling unpaid claims. These estimates are continually reviewed and, as experience develops and new information becomes known, the liability is adjusted as necessary. Such adjustments, if any, are reflected in current operations.\nThe increase (decrease) in estimated losses and loss adjustment expenses for claims occurring in prior years, as shown in the preceding table, is due to settling case-basis reserves established in prior years at amounts other than originally expected and no additional premiums have been accrued as a result of these prior-year effects.\nLiquidity\nAs the result of negative cash flow from insurance underwriting (see discussion above), operating losses in certain other segments of the Company's operations (see Note 14), and maturing debt obligations (see Note 6), the Company will be facing various demands upon its liquidity in 1995. Although, the Company believes that it can meet such demands through selective liquidations of securities in its investment portfolio, sales or refinancings of various real estate and other assets and the refinancing of its furniture business, it cannot predict with certainty the outcomes of such actions.\n10. Income Taxes\nThe provision for income taxes includes the following (amounts in thousands):\n1994 1993 1992\nCurrent - Federal $150 (322) 268 - State 123 212 614 \t\t\t\t\t --- --- --- 273 (110) 882\nProvision by majority-owned subsidiaries 1,766 838 777 \t\t\t\t\t ----- --- ---\nTotal provision $ 2,039 728 1,659 \t\t\t\t\t ===== === =====\nIn 1993 the provision for federal taxes reflects a benefit attributable to current operating losses which were utilized to reduce the amount of alternative minimum tax which would have otherwise been payable on the taxable income generated in connection with the sale of the cable television system (see Note 1). Income from discontinued operations is presented net of income taxes totalling $35,173 and $256,990 which have been allocated to the operations of the cable television system for the years ended December 31, 1993 and 1992, respectively. The amount of income taxes allocated to income from discontinued operations in 1993 is net of a benefit of $282,495 from the utilization of the Company's net operating loss carryforwards. Income from the sale of the cable television system in 1993 is presented net of $1,015,446 of income taxes which reflects a benefit of $12,196,279 from the utilization of the Company's net operating loss carryforwards.\nA valuation allowance has been provided to reduce the deferred tax assets to a level which management estimates will more likely than not be realized, primarily through the reversal of taxable temporary differences within the net operating loss carryforward periods. Certain subsidiaries do not file consolidated tax returns with the Company and thereby the Company's net operating loss carryforwards are not available to offset future deferred tax liabilities of these subsidiaries. As of December 31, 1994 and 1993, these subsidiaries had net deferred tax liabilities of $852,000 and $298,000, respectively, which are included in the Company's consolidated balance sheet.\nNet operating loss carryforwards of approximately $57,000,000 are available to offset future taxable income which, if not used, will expire in 1995 through 2009. The tax returns for the years during which these operating losses were generated have not been examined by the Internal Revenue Service and such returns could be examined at the time the loss carryforwards are utilized. Additionally, approximately $26,700,000 of these tax loss carryforwards were generated by subsidiaries prior to their acquisition and are thereby restricted to offsetting only future taxable income of the subsidiaries which generated the losses. Any future utilization of these pre-acquisition loss carryforwards may be treated for financial reporting purposes as a retroactive adjustment to the original purchase cost assigned to certain assets of such subsidiaries.\nState and federal income taxes paid for the years ended December 31, 1994, 1993 and 1992 totalled $924,035, $1,403,205 and $1,542,830, respectively.\n11. Per Share Amounts\nPer share amounts are computed based upon the weighted average number of common and common equivalent shares outstanding. Common equivalent shares consist of the assumed conversion of the Class B stock (21.125 to 1 in 1994; 17.875 to 1 in 1993 and 15.4375 to 1 in 1992) and any dilutive effect of stock options and warrants.\nPrimary per share amounts for 1994, 1993 and 1992 have been computed based on weighted average common and common equivalent shares of 2,564,584, 2,523,962, and 2,488,466, respectively. Fully diluted earnings per share for 1994, 1993 and 1992 have been computed based on the weighted average number of common and common equivalent shares of 2,564,584, 3,060,359, and 2,488,466, respectively.\nThe effect of stock options and warrants were not included in the computation of fully diluted per share amounts in 1993 or 1992 because their inclusion would have been anti-dilutive. At December 31, 1994, all such stock options and warrants had expired and were no longer outstanding. The maximum conversion of Class B Stock was not included in the computation of fully diluted per share amounts in 1994 and 1992 because its inclusion would have been anti-dilutive.\nNet income applicable to common stock reflects the dividend requirements applicable to preferred stocks totalling $1,125,686, $1,397,141, and $1,476,176 for the years ended December 31, 1994, 1993 and 1992, respectively.\n12. Related Party Transactions\nFollowing is a summary of the amounts receivable from (payable to) affiliates:\nDecember 31, 1994 1993\nTelco $ 2,304,404 1,917,995 Hickory 777,584 710,779 WREIT -- 2,086,014 Chairman 152,764 2,456,086 \t ---------\t \t --------- $ 3,234,752 7,170,874 \t\t\t ========= \t\t =========\nDuring 1993, the Company advanced $40,720 to Telco on an unsecured basis which, along with all amounts previously advanced, is due on demand and bears interest at prime plus two percent.\nOn April 13, 1992, Sunstates acquired Hickory's remaining interest in Sew Simple in a transaction whereby approximately $12 million of balances due from Hickory and Telco were satisfied (see Note 1), including all amounts due under the Intercompany Credit Agreement which expired simultaneously with the transaction. The transaction also created an unsecured note payable at prime +2% to Hickory in the amount of $1,637,323. Subsequent to the transaction, Sunstates made payments to Hickory such that the entire balance due under the note was paid off in 1992.\nDuring the years ended December 31, 1993 and 1992, the Company loaned Hickory $108,161 and $895,000, respectively, which amounts were due on demand and provide for interest at a rate of Prime + 2%. No additional amounts were loaned during the year ending December 31, 1994. All of the amounts advanced prior to 1993 were either assigned to Hickory in conjunction with the acquisition on June 21, 1990, of Hickory's furniture manufacturing business or were satisfied in the Sew Simple acquisition transaction referred to above (see Note 1).\nDuring 1992, the Company purchased $108,700 (par value) of 12% Debentures of Hickory Furniture Company at a cost of $103,736. At December 31, 1994, the Company held a total of $474,900 par value (with a carrying value of $651,350, including interest) of these debentures which were due in January 1992 and remain in default.\nSubsequent to December 31, 1994, the Company determined that due to a decline in the value of the Company's Class B Stock owned by WREIT and the fact that substantially all of WREIT's assets were pledged to secure other obligations, the repayment of amounts owed to the Company by WREIT is doubtful. Accordingly, as of December 31, 1994, the Company has written off its receivable from and its investment in the shares of beneficial interest of WREIT in the amounts of $2,287,750 and $669,395, respectively.\nThe advances to Sunstates' Chairman as of December 31, 1994, are unsecured, non-interest bearing and due on demand. During 1993, $1,150,000 was advanced to the Chairman under similar terms. These advances to the Chairman were in connection with a transaction as to which negotiations were completed on February 26, 1993, whereby Sunstates' Board of Directors approved the purchase from the Chairman of Epernay Properties, Inc., which owns approximately 1,137 acres of improved and unimproved land located near the Company's resort development in Spring Green, Wisconsin, at a price of $1,700,000. Generally accepted accounting principles applicable to purchases of businesses in transactions between entities under common voting control require that the assets acquired be recorded at their historical cost basis as previously reflected on the books of the seller. Accordingly, $676,000, representing the excess of the fair market value paid over the Chairman's historical cost basis of Epernay Properties, Inc. was reflected as a reduction to Sunstates' capital in excess of par value as of the date of the transaction.\nAdditionally, during 1993 amounts totalling $2,456,086 were advanced to the Company's Chairman against commissions due upon the sale of the cable television system totalling $2,470,000 (see Note 1). During 1994 such commissions were paid and the receivable from the Chairman was reduced by $2,470,000.\nDuring early 1994 amounts totalling $309,008 were paid to the Company's Chairman in full satisfaction of salary due for the year of 1994. Subsequent to December 31, 1994, $432,210 was paid to the Chairman in full satisfaction of salary due for the year of 1995. Both amounts reflect a discount of 10%.\nOn March 4, 1994, the Company purchased from its parent, RDIS, an automobile for $109,404. Although the purchase price did not exceed the fair market value of the automobile, the depreciated carrying value of the car on the books of RDIS was zero on the date of the transaction. Generally accepted accounting principles applicable to transactions between entities under common voting control require that the assets acquired be recorded at their historical cost basis as previously reflected on the books of the seller. Accordingly the $109,404, representing the excess of the amount paid for the automobile over RDIS's historical cost basis, was reflected as a reduction to Sunstates' capital in excess of par value as of the date of the transaction.\nSince January 1, 1990, the Company has purchased on the open market, 84,842 shares of beneficial interest of WREIT, representing 5.5% on the outstanding shares of beneficial interest of WREIT, for a total cost of $669,395 (see discussion above where this amount has been written off as of December 31, 1994). Also, since January 1, 1990, the Company purchased on the open market 9,330 shares of common stock of Hickory, representing 1.2% of the outstanding shares of Hickory, at a total cost of $166,113. Since January 1, 1990, the Company has purchased on the open market 134,445 shares of common stock of Indiana Financial Investors, Inc. (\"IFII\"), representing 16.2% of the issued shares of IFII, at a total cost of $788,882. Subsequent to December 31, 1994, the Company purchased 2,255 shares of common stock of IFII at a cost of $7,329.\nDuring 1994, subsidiaries of the insurance company purchased, from brokers and other non-affiliated owners, 8,613 shares of Class B Stock of Sunstates (at a total cost of $1,559,392) which had been owned by the Company's parent prior to their acquisition by the Company. Subsequent to December 31, 1994, subsidiaries of the insurance company purchased, from non-affiliated owners, an additional 3,840 shares of Class B Stock of Sunstates (at a total cost of $503,140) which had been owned by the Company's parent prior to their acquisition by the Company.\nDuring the years ended December 31, 1994, 1993 and 1992 Sunstates earned interest income from affiliates of $359,453, $295,787, and $495,926, respectively.\nDuring 1994, 1993 and 1992, Telco invoiced Sunstates $1,856,000, $1,945,000, and $2,069,000, respectively for various professional services primarily related to the insurance operations and to various corporate activities. As of December 31, 1994, the Company had advanced Telco $1,255,250 on an unsecured, non-interest bearing basis as a prepayment of fees for such professional services to be rendered in 1995. On February 4, 1994, the Company's insurance subsidiary entered into a ten year lease agreement for office space to be occupied largely by employees of Hickory. The lease calls for initial monthly payments of $4,096, which will be offset against amounts billed to the Company for professional services discussed above.\nThe above financial information has been retroactively restated to reflect the effect of the Company's change in its method of valuing its furniture manufacturing inventories from the last-in, first-out method to the first-in, first-out method (see Note 2). The effect of this change was to increase net income by $94,000 ($.04 per primary and fully diluted share), $294,000 ($.11 per primary and fully diluted share), $206,000 ($.08 per primary and fully diluted share) and $137,000 ($.06 per primary and fully diluted share) in the first through fourth quarters of 1994, respectively. For 1993, the effect of this change was to increase net income by $94,000 ($.04 per primary and fully diluted share), $10,000 ($.01 per primary and fully diluted share), and $17,000 ($.01 per primary and fully diluted share) in the first three quarters, respectively, while decreasing net income by $405,000 ($.16 per primary and $.13 per fully diluted share) during the fourth quarter.\n(a) See Note 1 for information regarding the sale of the cable television business.\n(b) See Note 2 for information regarding the adoption of Statement No. 109 \"Accounting for Income Taxes\".\n(c) Includes net gains of approximately $6,182,000 realized from the insurance subsidiary's equity security investment portfolio. Also includes $3,930,000 of underwriting loss emanating from programs which had been previously discontinued due to their unsatisfactory results.\n(d) Includes net gains of approximately $3,926,000 realized from the insurance subsidiary's equity security investment portfolio. Also includes $2,442,000 of underwriting loss related to prior accident years, primarily on the Company's continuing programs.\n(e) Includes $2,166,000 of underwriting loss related to prior accident years, primarily on the Company's continuing programs. Also includes $3,296,000 of gains realized from the insurance subsidiary's equity security investment portfolio.\n(f) Includes bad debt writeoff of $556,205 relating to textile apparel manufacturing customer which filed for bankruptcy as well as $428,652 of costs incurred in connection with investigation of a potential acquisition.\n(g) Includes $2,728,693 of profit from the sale of an apartment project.\n(h) Writedowns totalling $571,800 were recorded to reflect what Sunstates believes to be other than temporary declines in the value of securities in its investment portfolio. Also, see Note 12 regarding the writeoff at December 31, 1994, of the Company's receivables from and investments in WREIT.\n14. Industry Segments\nSunstates operates in four industry segments: insurance, manufacturing, real estate development and, prior to December 30, 1993, cable television (see Note 1).\nOperations of the insurance segment include the providing of property and casualty insurance, primarily confined to the writing of full coverage non-standard automobile insurance in Arizona, Illinois, Nevada, Ohio and Tennessee and several other states, and the financing of premiums on policies issued by the Company.\nManufacturing represents operations in the furniture, textile apparel, military footwear and textile equipment manufacturing businesses. The furniture operations encompass the manufacture of high end home furnishing products covering a broad selection of traditional and transitional wood and upholstered lines which are marketed to furniture retailers throughout the country. The Company's textile apparel manufacturing subsidiary produces and sells an extensive line of men's and women's hosiery and knitted intimate apparel products as well as a variety of surgical products for the health care industry. Military footwear operations include the manufacture and sale of military combat boots under fixed price contracts, primarily to the United States government. Automated textile machinery is designed and produced in South Carolina and is marketed to large textile producers located primarily in the United States.\nReal estate operations primarily reflect the development for resale of income producing properties located in the southeastern United States. The Company is also actively involved in the development of a resort in Spring Green, Wisconsin and in the development and sale of recreational and second home resort lots and continues its efforts to sell other real estate assets no longer under active development.\nCable represents the Company's involvement in the development, management and operation of a cable television system in Maryland (which was sold on December 30, 1993).\nEquity investees represent less than 50% investments in Alba (until June 30, 1993) and Rocky Mountain.\nIncluded in corporate and other is the Company's newspaper production operation which was acquired in October 1992. The assets and results of operations of the newspaper operation are not significant.\nDuring 1994, 1993 and 1992, insurance premium production from one broker approximated 29%, 44% and 46% respectively, of direct written premiums and 29%, 43% and 39%, respectively, of total written premiums.\nThe reported statutory net worth of Coronet at December 31, 1994 and 1993 was $59,483,697 and $58,605,217, respectively. Statutory net income (loss) for the three years ended December 31, 1994, totalled $2,843,245, $(5,975,327) and $7,256,796, respectively. The maximum amount of dividends which can be paid by the insurance subsidiary without prior approval of the Insurance Commissioner of the State of Illinois is subject to restrictions. The maximum dividend payment which may be made without prior approval is subject to the availability of earned surplus from which it can be paid and further limited to the greater of statutory net income, as adjusted, for the twelve months last ended or 10% of the subsidiary's statutory surplus. At December 31, 1994, there was no earned surplus from which dividends can be paid.\nThe financial statements of Normandy Insurance Agency, Inc. and its subsidiaries are included in the consolidated financial statements pursuant to FASB Statement No. 94 \"Consolidation of All Majority-Owned Subsidiaries\"; prior to 1988, such financial statements were not consolidated. Subsequent to 1987, Normandy has invested in manufacturing and other segments of Sunstates' operations. As a result, the current Normandy financial statements are no longer comparable to those formerly not consolidated. Management believes that the disaggregated information provided in this segment note and elsewhere in the consolidated financial statements presents the most meaningful information.\nInformation about operations in different industry segments for the three years ending December 31 is as follows (amounts in thousands):\n1994 1993 1992\nRevenues Insurance $ 49,054 88,678 138,314 Manufacturing 130,495 96,454 67,740 Real Estate 24,301 17,362 8,546 Equity Investees 1,496 1,256 1,565 Corporate and Other 3,808 3,444 227 \t\t\t\t\t ------- ------- ------- $209,154 207,194 216,392 \t\t\t\t\t ======= ======= =======\nOperating Income (Loss) Insurance $ (6,792) (3,555) (14,302) Manufacturing 7,929 4,292 1,994 Real Estate 1,377 1,534 (435) Equity Investees 1,496 1,256 1,565 Corporate and Other (4,826) (4,404) (3,416) Interest (3,129) (3,700) (2,708) \t\t\t\t\t ----- ----- ------ $ (3,945) (4,577) (17,302) \t\t\t\t\t ===== ===== ======\nIdentifiable Assets Insurance $100,396 102,773 120,142 Manufacturing 100,694 95,481 65,942 Real Estate 47,430 59,700 63,722 Equity Investees 3,804 2,902 12,869 Corporate and Other 3,108 6,701 1,873 Eliminations ( 8,857) (18,277) (13,897) \t\t\t\t\t ------- ------- ------- $246,575 249,280 250,651 \t\t\t\t\t ======= ======= =======\nDepreciation and Amortization Insurance $ 842 685 491 Manufacturing 3,119 2,592 1,900 Real Estate 1,320 1,071 817 Corporate and Other 51 59 43 \t\t\t\t\t ----- ----- ----- $ 5,332 4,407 3,251 \t\t\t\t\t ===== ===== =====\nCapital Expenditures Insurance $ 523 1,328 312 Manufacturing 3,135 2,580 637 Real Estate 1,986 1,406 178 Corporate and Other 89 41 56 \t\t\t\t\t ----- ----- ----- $ 5,733 5,355 1,183 \t\t\t\t\t ===== ===== =====\nReport of Independent Certified Public Accountants\nStockholders and Board of Directors Sunstates Corporation\nWe have audited the consolidated balance sheets of Sunstates Corporation and subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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. We did not audit the financial statements of Wellco Enterprises, Inc., a 58.6% owned subsidiary, which statements reflect total assets of $24,788,000 and $20,058,000 as of December 31, 1994 and 1993 and total revenues of $20,790,000, $20,644,000 and $18,434,000 for each of the three years in the period ended December 31, 1994. We also did not audit the 1993 and 1992 financial statements of Alba-Waldensian, Inc. a 50.4% owned subsidiary in which Sunstates' statements reflect total assets of $33,141,000 as of December 31, 1993 and total revenues of $26,798,000 for the year then ended. In 1992, Sunstates' statements reflected an investment in Alba-Waldensian, Inc. of $10,279,000 at December 31, 1992 and equity in $1,274,000 for the year then ended. Those statements were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to amounts included for Wellco Enterprises, Inc. and Alba-Waldensian, Inc. is based solely on the reports of the other auditors.\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 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 that our audits and the reports of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of Sunstates Corporation and subsidiaries at December 31, 1994 and 1993 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with general accepted accounting principles.\nAlso, in our opinion, the schedules present fairly, in all material respects, the information set forth therein.\nAs discussed in Note 2 to the consolidated financial statements, the Company changed its method of inventory valuation for its furniture manufacturing inventories.\nAs discussed in Note 9 to the consolidated financial statements, the Company is involved in various lawsuits, including a lawsuit which is being appealed where a jury has awarded $8,500,000 in actual and punitive damages against the Company, and the Company's insurance subsidiary is involved in certain regulatory matters, including a requirement to further reduce its ratio of liabilities to liquid assets over the next two years. While the Company cannot predict the outcome of the lawsuit which is being appealed, it believes that the other lawsuits and the regulatory matters will not have a material adverse impact on the consolidated financial statements or on its ability to continue to write new insurance at anticipated 1995 levels. Accordingly, no provision for any liability or other adjustments which may result, if any, have been recorded in the accompanying consolidated financial statements.\nBDO SEIDMAN\nGreensboro, North Carolina March 30, 1995\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Wellco Enterprises, Inc. Waynesville, North Carolina\nWe have audited the accompanying consolidated balance sheets of Wellco Enterprises, Inc. and subsidiaries as of July 2, 1994 and July 3, 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended July 2, 1994. 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 consolidated financial statements present fairly, in all material respects, the financial position of Wellco Enterprises, Inc. and subsidiaries as of July 2, 1994 and July 3, 1993, and the results of their operations and their cash flows for each of the three years in the period ended July 2, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 12 to the consolidated financial statements, the Company changed its method of accounting for income taxes during fiscal year 1993 to conform with Statement of Financial Accounting Standards No. 109.\nDELOITTE & TOUCHE LLP\nCharlotte, North Carolina August 31, 1994\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors Alba-Waldensian, Inc. Valdese, North Carolina\nWe have audited the accompanying consolidated balance sheet of Alba-Waldensian, Inc. and subsidiaries as of December 31, 1993, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the two 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, such consolidated financial statements present fairly, in all material respects, the financial position of Alba-Waldensian, Inc. and subsidiaries as of December 31, 1993, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nAs discussed in Notes 1 and 8 to the consolidated financial statements, in 1992 the Company changed its method of accounting for income taxes effective January 1, 1992 to conform with Statement of Financial Accounting Standards No. 109.\nDELOITTE & TOUCHE LLP\nHickory, North Carolina February 11, 1994\nThe statements presented on Schedule I include the accounts of the Company and its unrestricted subsidiaries. This statement does not include the individual accounts of Normandy Insurance Agency, Inc., (including Sew Simple Systems, Inc., Wellco Enterprises, Inc. and Alba Waldensian, Inc.), Hickory White Company, nor, prior to December 30, 1993, Acton Cable Partnership inasmuch as the ability of those entities to transfer assets to Sunstates is restricted by governmental regulation with respect to Normandy and by contract otherwise. The Company's investment in these entities is reflected utilizing the equity method of accounting and presented as an investment in affiliates.\n3. Depreciation of operating properties is computed on the straight-line method over the remaining useful lives of the properties, which are generally thirty-one and one-half to forty years for buildings and five to twelve years for furniture and equipment.\n4. Aggregate cost as of December 31, 1994 for federal income tax purposes has not yet been determined.\nEXHIBIT INDEX\nSunstates Corporation Form 10-K Annual Report For the Year Ended December 31, 1994\nAll Exhibits except Exhibits 3.1, 3.2, 3.3, 3.4, 4.1, 4.2, \t4.3, 4.4, 4.5,10.1, 10.2, 10.3, 10.4, 10.5, 10.6, 10.7, 10.8, \t10.9, 10.10, and 10.11 are filed herewith and included in Item \t14. Exhibit 10.1 is incorporated by reference to Acton's \tQuarterly Report on Form 10-Q for the quarter ended September 30, \t1990. Exhibits 4.1 and 10.4 are incorporated by reference to \tActon's Current Report on Form 8-K dated July 5, 1990. Exhibits \t3.1 and 10.2 are incorporated by reference to Acton's Form 10-K \tfor the year ended December 31, 1989. Exhibits 3.2, and 10.3 \tare incorporated by reference to Acton's Form 10-K for the year \tended December 31, 1990. Exhibit 4.2 is incorporated by reference to \tActon's Form 10-Q for the quarter ended March 31, 1991. Exhibits \t4.3, 4.4, 10.5, 10.6, 10.7 and 10.8 are incorporated by \treference to Acton's Form 10-K for the year ended December 31, \t1991. Exhibits 4.4 and 10.8 are incorporated by reference to \tActon's Form 10-K for the year ended December 31, 1992. Exhibits 3.3, \t3.4, 4.5, 10.9 and 10.10 are incorporated by reference to \tSunstates Corporation's Form 10-K for the year ended December \t31, 1993. Exhibit 10.11 is incorporated by reference to \tSunstates Corporation's Form 8-K dated March 6, 1995.\n(3) Amended and Restated Certificate of Incorporation and By-Laws\n(3.1) Restated Certificate of Incorporation\n(3.2) Certificate of Amendment of Restated Certificate of \t Incorporation\n(3.3) Certificate of Amendment to Restated Certificate of \t\tIncorporation dated December 28, 1993\n(3.4) Amended and Restated By-Laws of Sunstates Corporation\n(4) Instruments Defining the Rights of Security Holders, Including \tDebentures\n(4.1) Credit Agreement dated June 15, 1990 by and between Hickory White Company and Citicorp North America, Inc.\n(4.2) First Amendment to Credit Agreement dated April 1, 1991, by and between Hickory White Company and Citicorp North America, Inc.\n(4.3) Second Amendment to Credit Agreement dated January 30, 1992, by and between Hickory White Company and Citicorp North America, Inc.\n(4.4) Third Amendment to Credit agreement dated January 31, 1993, by and between Hickory White Company and Citicorp North America, Inc.\n(4.5) Fourth Amendment to Credit Agreement dated November \t 30, 1993, by and between Hickory White Company and \t Citicorp North America, Inc.\n(4.6) Fifth Amendment to Credit Agreement dated December 21, 1994, by \t and between Hickory White Company and Citicorp North \t America, Inc.\n(10) Material Contracts\n(10.1) Form of Indemnification Agreement between Acton Corporation and each officer and director, respectively.\n(10.2) Stock Purchase Agreement dated January 17, 1989, both by and between Normandy Insurance Agency, Inc. and Hickory Furniture Company.\n(10.3) Asset Purchase Agreement dated June 15, 1990, by and between Hickory White Company and Hickory Furniture Company et. al.\n(10.4) Extension Agreement dated February 28, 1992, both by and between Normandy Insurance Agency, Inc. and Hickory Furniture Company.\n(10.5) Executive Employment Agreement dated September 16, 1991, by and between Acton Corporation and Clyde Wm. Engle.\n(10.6) Corporate Officers Discretionary Bonus Plan.\n(10.7) Purchase of Stock and Assignment of Contract Rights dated April 13, 1992, by and between Normandy Insurance Agency, Inc. and Hickory Furniture Company.\n(10.8) Stock Purchase Agreement dated July, 28, 1992, by and between Coronet Insurance Company and Euroactividade Corporation, et. al., covering the acquisition of all of the outstanding capital stock of Euroactividade Spring Green, Inc.\n(10.9) Amended and Restated Purchase and Sale Agreement \t dated as of December 30, 1993, by and between Acton \t Corporation and Acton Cable Investors, N.V. as sellers and \t InterMedia Partners of Maryland, L.P. and InterMedia \t Partners, III, L.P. as buyers\n(10.10) Note payable to Acton Corporation and Acton Cable Investors, \t N.V. in the amount of $17,366,614 dated December 30, 1993, \t by InterMedia Partners of Maryland, L.P. and InterMedia \t Partners III, L.P.\n(10.11) Asset Purchase Agreement dated as of March 6, 1995, by and \t between Alba-Waldensian, Inc. and Kayser-Roth Corporation \t for the purchase of the Balfour Healthcare Division.\n(11) Statement re Computation of Per Share Earnings\n(11.1) Primary\n(11.2) Fully diluted\n(18) Letter re Change in Accounting Principle\n(21) Subsidiaries of the Company\n(27) Financial Data Schedules\n(28P) Information from Reports Furnished to State Regulatory Authorities. Schedules P of the 1994 Annual Statement of Coronet Insurance Company of Chicago to the Insurance Department of the State of Illinois.","section_15":""}
{"filename":"752302_1994.txt","cik":"752302","year":"1994","section_1":"ITEM 1. BUSINESS\nOrganization\nGuaranteed Mortgage Corporation III (the \"Company\") was incorporated under the laws of the State of Michigan on October 18, 1982, as a wholly-owned limited purpose financing subsidiary of Pulte Financial Companies, Inc. (\"PFCI\"), a wholly-owned subsidiary of Pulte Corporation, a publicly-owned holding company listed on the New York Stock Exchange.\nIssuance of Collateralized Mortgage Bonds\nThe Company was organized to facilitate the financing of long-term mortgage loans on single-family residential homes, including homes built by Pulte Home Corporation (\"PHC\"), through the issuance and sale of bonds secured by mortgage-backed securities (\"Certificates\") or by funding agreements with various limited-purpose financing companies (\"Funding Companies\") and the notes issued thereunder that are secured by Certificates (\"Funding Notes\"), or by a combination thereof. Such Certificates consist of Guaranteed Mortgage Pass-Through Certificates (\"FNMA Certificates\"), issued and guaranteed as to the full and timely payment of principal and interest by the Federal National Mortgage Association, Fully Modified Pass-Through mortgage-backed certificates (\"GNMA Certificates\"), guaranteed as to the full and timely payment of principal and interest by the Government National Mortgage Association, Mortgage Participation Certificates (\"FHLMC Certificates\"), issued and guaranteed as to the full and timely payment of interest and as to the ultimate payment of principal by the Federal Home Loan Mortgage Corporation, or a combination of such Certificates. To accomplish its purpose, the Company issued collateralized mortgage bonds in series and used the net proceeds of such sales to purchase Certificates backed by mortgage loans, some of which were originated by ICM Mortgage Corporation, a wholly-owned subsidiary of PHC, and are secured by homes, some of which were built by PHC. Alternatively, the Company remitted a portion of the net proceeds of such sales of collateralized mortgage bonds in series to a Funding Company that, in turn, pledged to the Company certain Funding Notes, which, together with certain other collateral, serve as security for the obligations of that Funding Company to the Company.\nThe Company, although incorporated in October, 1982 and capitalized in August, 1984, did not commence operations until it issued its first series of bonds on October 24, 1984. Prior to 1994, the Company issued fifteen series of bonds, all of which were offered and sold to the public pursuant to a registration statement filed with the Securities and Exchange Commission. The bonds had an aggregate original principal amount of $1,208,697,000, with stated annual interest rates ranging from 7.0% to 12.5%. The Company did not issue any additional series of bonds in 1994. At December 31, 1994, the Company had $189,715,500 in aggregate principal amount of bonds outstanding, with stated annual interest rates ranging from 8.50% to 9.00%. This aggregate principal amount includes $21,860,006 in outstanding aggregate principal amount of the Company's Series H Bonds, secured by Funding Notes, and $53,024,658 in outstanding aggregate principal amount of the Company's Series L and Series M Bonds, all of which are non-recourse obligations and do not represent a liability of the Company.\nEach series of the Company's bonds is secured by a separate collateral package consisting, in part, of the Certificates purchased in connection with the issuance of a bond series, or Funding Notes or a combination thereof, additional pledged GNMA certificates and cash. The collateral package for a series is pledged to NBD Bank, N.A., as trustee on behalf of the holders of the bonds of such series. Funds held by the trustee with respect to the bonds are restricted so as to assure the payment of principal and interest on the bonds to the extent of such funds.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nUnder the Company's articles of incorporation and the terms of the indenture governing the issuance of the Company's collateralized mortgage bonds, the Company may only issue collateralized mortgage bonds rated in the highest category by Standard & Poor's Corporation.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company has no material physical properties. Its primary asset is ownership of the various Certificates, and the mortgage loans underlying such Certificates, pledged to NBD Bank, N.A., as trustee, to secure the Company's collateralized mortgage bonds.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nInformation in response to this item is omitted pursuant to General Instruction J(2).\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company is a wholly-owned subsidiary of PFCI. (See \"Business - Organization\" in Item 1 of this Report.) Thus, there is no market for its common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation in response to this item is omitted pursuant to General Instruction J(2).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nThe Company's mortgage-backed securities (Certificates) or finance companies' notes secured by Certificates (Funding Notes) are used as collateral for associated bonds payable. Mortgage-backed securities were acquired from affiliates. Any difference between the acquisition price and the principal balance of the securities at their date of acquisition (mortgage discounts\/premiums) was amortized into operations as an adjustment of mortgage yield.\nThe Company's pretax income (loss) before extraordinary item was $(7,204,441) for 1994 as compared to pretax income (loss) before extraordinary item of $(794,434) and $4,905,355 for 1993 and 1992, respectively. Earnings decreased during 1994 as compared to 1993 primarily due to increased amortization of mortgage discounts, bond discounts and bond issue costs as a result of GMC III changing its accounting\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nestimate of amortization speeds in December, 1994 due to greater than expected prepayment experience.\nEarnings decreased during 1993 from 1992 primarily due to reduced net interest carry as a result of volume declines resulting from accelerated mortgage prepayments related to heavy refinancing activity in 1993.\nPretax extraordinary losses from the bond extinguishments during 1993 and 1992 were $2,028,327 and $1,872,795, respectively. These losses resulted from the write-off of unamortized bond discounts and issue costs. There was no similar activity in 1994.\nFinancial Condition\nThe Company will have no additional capital or liquidity requirements, assuming the mortgage-backed securities continue to pay principal and interest in accordance with their terms.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nBALANCE SHEETS DECEMBER 31, 1994 AND 1993\nSee accompanying notes.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nSTATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee accompanying notes.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nSTATEMENTS OF SHAREHOLDER'S EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee accompanying notes.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee accompanying notes.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nNOTES TO FINANCIAL STATEMENTS\n1. BASIS OF PRESENTATION, RELATED PARTY TRANSACTIONS AND SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nGuaranteed Mortgage Corporation III (GMC III) is a wholly-owned financing subsidiary of Pulte Financial Companies, Inc. (PFCI), which is a wholly-owned financing subsidiary of Pulte Corporation.\nGMC III acquired mortgage-backed securities from affiliates and entered into funding agreements with various limited purpose financing companies (funding companies), the notes (funding notes) issued thereunder being secured by mortgage-backed securities. GMC III then issued bonds collateralized by such securities or funding notes. The mortgage-backed securities are guaranteed by the Government National Mortgage Association, the Federal National Mortgage Association or the Federal Home Loan Mortgage Corporation.\nRELATED PARTY TRANSACTIONS\nTransactions and arrangements between GMC III and PFCI, Pulte Corporation, and\/or Pulte Home Corporation (PHC), an indirect wholly-owned subsidiary of Pulte Corporation, are summarized as follows:\n- GMC III has periodic interest-free cash and non-cash advances from certain affiliates, the net payable balances of which were $86,479 and $249,956 at December 31, 1994 and 1993, respectively. Average month-end balances due these affiliates were $171,485 and $4,784,151 during the years ended December 31, 1994 and 1993, respectively. Advances payable by GMC III to affiliates relate principally to the acquisition of mortgage-backed securities.\n- GMC III's taxable income is included in the consolidated tax returns of Pulte Corporation. Pursuant to PFCI's tax sharing agreement with Pulte Corporation, no federal income taxes were provided in 1992, because the consolidated group did not incur federal income tax expense. Effective January 1, 1993, GMC III implemented the new method of accounting for income taxes (FAS No. 109) that requires income taxes to be provided by subsidiaries based on their own results of operations. In 1994 and 1993, GMC III provided for income taxes on a stand alone basis at statutory rates. The related income tax benefit was settled by a dividend to the parent corporation and did not represent a cash transaction.\n- Certain of GMC III's corporate officers are also officers of PFCI, Pulte Corporation, PHC, ICM, and\/or other affiliates of GMC III.\n- PFCI incurs certain administrative expenses on behalf of GMC III, for which GMC III reimburses PFCI.\n- During the years ended December 31, 1994, 1993 and 1992, GMC III paid $33,303, $45,917 and $71,233, respectively, to PFCI for management fees related to the issuance and administration of non-recourse bonds (see Note 3).\n- During the years ended December 31, 1994, 1993 and 1992, GMC III paid dividends to PFCI of $2,809,732, $1,100,877 and $334,500, respectively. Dividends during 1994 and 1993 related entirely to income tax benefits that did not represent cash transactions.\nSIGNIFICANT ACCOUNTING POLICIES\n- Mortgage-backed securities are classified as held-to-maturity based upon the Company's positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost and are adjusted for amortization of premiums and accretion of discounts over the estimated life of the security. Such amortization, along with interest and dividends are included in interest income.\n- Unamortized net mortgage discounts\/premiums, bond discounts and issue costs had been amortized using the interest method over the estimated lives of the mortgage-backed securities and bonds, respectively. The rates previously used to amortize these into operations were based on management's estimates of the remaining lives of the mortgage-backed securities and bonds. These estimates had been periodically reviewed and adjusted, as necessary.\n- In December 1994, due to higher than anticipated collateral prepayment experience, GMC III changed its accounting estimate of required amortization and expensed all remaining mortgage discounts, bond discounts and issue costs amounting to $5,812,061. Unamortized net mortgage premiums were $2,164,399 at December 31, 1993.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nNOTES TO FINANCIAL STATEMENTS, CONTINUED\n2. MORTGAGE-BACKED SECURITIES\nAt December 31, 1994, mortgage-backed securities (GNMA certificates) had an estimated fair market value of $115,620,712 which included gross unrealized gains of $1,605,605 on securities with an amortized cost of $114,015,107. At December 31, 1993, these securities had an estimated fair market value of $163,612,379, which included gross unrealized gains of $9,079,734 on securities with an amortized cost of $154,532,645. Actual maturities of these mortgage-backed securities may differ from contractual maturities because the issuers of the securities may have the right to prepay obligations without penalties.\nDuring the year ended December 31, 1993, GMC III extinguished $79,295,473 of its long-term debt prior to scheduled maturity. Due to this redemption, GMC III transferred the related outstanding collateral of $77,044,581 and the unamortized discount of $1,740,318 associated with this collateral, to its affiliate, Pulte Financial Holding Company.\n3. BONDS PAYABLE\nBonds payable at December 31, 1994 and 1993 consisted of two bond issues with stated interest rates ranging from 8.50% to 9.00%. Weighted average stated interest rates were 8.88% and 8.82% at December 31, 1994 and 1993, respectively. Both of the bond issues have classes of bonds with serial maturities. Each series of the bonds is secured by separate pools of mortgage-backed securities. Timing of bond retirements is dependent upon payments received on mortgage loans. The bonds are further collateralized by additional pledged GNMA certificates in the aggregate amount of $1,060,400.\nBonds payable are stated net of unamortized bond discounts of $4,279,765 at December 31, 1993 ($0 at December 31, 1994).\nThe estimated fair market values of the outstanding bonds payable at December 31, 1994 and 1993 were $115,084,000 and $162,725,000, respectively. This was estimated using December secondary market activity for comparable securities. Secondary market activity for these specific securities is limited.\nUnder provisions of the bond indenture, funds held by trustee are restricted so as to assure the payment of principal and interest on the bonds to the extent of such funds.\nAs of December 31, 1994, $74,884,664 was outstanding for three series of non-recourse bonds issued by GMC III in the initial aggregate principal amount of $527,300,000, which are secured by funding notes or mortgage-backed securities in which GMC III has nominal or no ownership interest. In accordance with generally accepted accounting principles, these series of bonds are not treated as borrowings and, accordingly, such bonds and related collateral are not included on the balance sheet.\n4. EXTRAORDINARY ITEM\nDuring the year ended December 31, 1993, GMC III extinguished $79,295,473 of its long-term debt prior to scheduled maturity, resulting in an extraordinary pretax loss of $2,028,327 due to the write-off of unamortized bond discounts and issue costs.\nDuring the year ended December 31, 1992, GMC III extinguished or notified the trustee of its intent to extinguish $51,370,603 of its long-term debt prior to scheduled maturity, resulting in an extraordinary loss of $1,872,795 due to the write-off of unamortized bond discounts and issue costs. The funds for these extinguishments were obtained from the sale of the mortgage-backed securities which collateralized the bonds.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nREPORT OF ERNST & YOUNG LLP\nINDEPENDENT AUDITORS\nTHE BOARD OF DIRECTORS AND SHAREHOLDER GUARANTEED MORTGAGE CORPORATION III\nWe have audited the accompanying balance sheets of Guaranteed Mortgage Corporation III as of December 31, 1994 and 1993, and the related statements of income, shareholder's equity and cash flows for each of the three years in the period ended December 31, 1994. 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.\nAs more fully described in Note 1, Guaranteed Mortgage Corporation III is a wholly-owned financing subsidiary of Pulte Financial Companies, Inc., which in turn is a wholly-owned financing subsidiary of Pulte Corporation. Guaranteed Mortgage Corporation III has certain transactions with affiliates.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Guaranteed Mortgage Corporation III at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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 1 of the Notes to the Financial Statements, Guaranteed Mortgage III changed its method of accounting for income taxes in 1993.\nERNST & YOUNG LLP Detroit, Michigan January 31, 1995\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThis item is not applicable.\nPART III\nInformation in response to this part 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\nThe following documents are filed as a part of this Annual Report on Form 10-K:\n(a) (1) Financial Statements\nGUARANTEED MORTGAGE CORPORATION III Balance Sheets at December 31, 1994 and 1993 Statements of Operations for the years ended December 31, 1994, 1993 and 1992 Statements of Shareholder's Equity for the years ended December 31, 1994, 1993 and 1992 Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 Notes to Financial Statements Report of Ernst & Young LLP, Independent Auditors\n(a) (2) Financial Statement Schedules\nGUARANTEED MORTGAGE CORPORATION III\nIV - Indebtedness of and to Related Parties - Not Current\nAll other schedules have been omitted since the required information is not present, is not present in amounts sufficient to require submission of the schedule or because the required information is included in the financial statements or notes thereto.\n(a) (3) Exhibits\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\n(b) Reports on Form 8-K\nNo reports on Form 8-K have been filed during the last quarter of the fiscal year covered by this Report.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nSCHEDULE IV - INDEBTEDNESS OF AND TO RELATED PARTIES - NOT CURRENT ($000's omitted)\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\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 21, 1995.\nGUARANTEED MORTGAGE CORPORATION III\nBy \/s\/JAMES A. WEISSENBORN -------------------------------- James A. Weissenborn, 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.\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nINDEX TO EXHIBITS ------------------\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94\nYear Ended FORM 10-K GUARANTEED MORTGAGE CORPORATION III 12\/31\/94","section_15":""}
{"filename":"819539_1994.txt","cik":"819539","year":"1994","section_1":"Item 1. BUSINESS\nGeneral\nThe Neiman Marcus Group, Inc. (together with its operating divisions and subsidiaries, the \"Company\") is a Delaware corporation which commenced operations in August 1987. Harcourt General, Inc. (\"Harcourt General\"), a Delaware corporation based in Chestnut Hill, Massachusetts, owns approximately 65% of the fully converted equity of the Company; two of its directors and nearly all of its officers and corporate staff employees occupy similar positions with the Company. For more information about the relationship between the Company and Harcourt General, see Items 12 and 13 below and Notes 5 and 6 to the Company's Consolidated Financial Statements incorporated herein by reference. Harcourt General is a public company subject to the reporting requirements of the Securities Exchange Act of 1934. For further information about Harcourt General, reference may be made to the reports filed by Harcourt General from time to time with the Securities and Exchange Commission.\nDescription of Operations\nNeiman Marcus\nNeiman Marcus, based in Dallas, Texas, is a high fashion, specialty retailer which offers high quality women's and men's apparel, fashion accessories, precious jewelry, decorative home accessories, fine china, crystal and silver, and epicurean products. A relatively small portion of Neiman Marcus' customers accounts for a significant percentage of its retail sales. In addition, Neiman Marcus operates a state-of-the-art direct marketing business, NM Direct, which distributes the catalogues of Neiman Marcus, Horchow and Pastille.\nNeiman Marcus' 27 stores are located in Arizona (Scottsdale); California (five stores: Beverly Hills, Newport Beach, Palo Alto, San Diego and San Francisco); Colorado (Denver); the District of Columbia; Florida (two stores: Fort Lauderdale and Bal Harbour); Georgia (Atlanta); Illinois (three stores: Chicago, Northbrook and Oak Brook); Missouri (St. Louis); Massachusetts (Boston); Minnesota (Minneapolis); Michigan (Troy); Nevada (Las Vegas); New York (Westchester); Texas (six stores: three in Dallas, one in Fort Worth and two in Houston); and Virginia (McLean). The average size of the Neiman Marcus stores is 142,000 gross square feet, and the stores range in size from 90,000 gross square feet to 269,000 gross square feet. Neiman Marcus plans to open a new store in Short Hills, New Jersey, in calendar 1995 and new stores in King of Prussia, Pennsylvania, and Paramus, New Jersey, in calendar 1996.\nBergdorf Goodman\nBergdorf Goodman is a high fashion, exclusive retailer of high quality women's and men's apparel, fashion accessories, precious jewelry, decorative home accessories, fine china, crystal and silver. It operates two leased stores at Fifth Avenue and 58th Street in New York City. The original store, consisting of 250,000 gross square feet, is dedicated to women's apparel and accessories, home furnishings and gifts. Bergdorf Goodman Men, which opened in August 1990, consists of 66,000 gross square feet and is dedicated to men's apparel and accessories. A relatively small portion of Bergdorf Goodman's customers accounts for a significant percentage of its retail sales. In addition, Bergdorf Goodman operates an important direct marketing business. The distribution and fulfillment operations of the Bergdorf Goodman direct marketing business were consolidated with those of NM Direct in June 1993.\nContempo Casuals\nContempo Casuals, based in Los Angeles, operates a chain of retail stores which sells quality fashion apparel and accessories primarily for young women between the ages of 15 and 21 at moderate prices. Almost all apparel sold in the Contempo Casuals stores carries the Contempo Casuals label.\nIn April 1994, the Company implemented a plan to restructure the Contempo Casuals division (including its chain of retail stores operated under the name Pastille) as a result of its continued poor operating performance. The restructuring included the closing of 40 underperforming Contempo Casuals stores, the closing of the Hong Kong buying office and the closing of the Pastille chain of 39 stores in 15 states. In June 1994, the Pastille direct marketing operations were consolidated with NM Direct. For additional information concerning the restructuring of Contempo Casuals, see Item 7 below and Note 2 to the Company's Consolidated Financial Statements incorporated herein by reference.\nThe Contempo Casuals chain includes 247 stores in 33 states and Puerto Rico with an average store size of approximately 4,000 gross square feet. All of the stores are located in leased facilities, primarily in regional shopping malls.\nCompetition\nThe Company's specialty store operations compete with numerous specialty retail stores and department stores for both customers and merchandise. The Company believes that the principal competitive factors for specialty store operations are customer service, quality of merchandise, merchandise assortment, store ambience and price. The Company's direct marketing operations compete with numerous other retail and direct marketing operations for both customers and merchandise. The Company believes that the principal competitive factors for its direct marketing operations are customer service, price, merchandise quality and assortment and catalogue presentation.\nEmployees\nAt July 30, 1994, Neiman Marcus had approximately 11,000 employees, of whom approximately 3,300 were part-time; Bergdorf Goodman had approximately 1,200 employees, of whom approximately 35 were part-time; and Contempo Casuals had approximately 3,200 employees, of whom approximately 1,750 were part-time. None of the employees of Neiman Marcus or Contempo Casuals are subject to collective bargaining agreements. Approximately 12% of the Bergdorf Goodman employees are subject to collective bargaining agreements. The Company believes that its relations with its employees are generally good.\nCapital Expenditures; Seasonality; Liquidity\nFor information on capital expenditures, seasonality, liquidity and other financial information, reference is made to the \"Management's Discussion and Analysis\" section on pages 17 through 20 of the Annual Report to Stockholders for the fiscal year ended July 30, 1994 (the \"1994 Annual Report\"), which is incorporated herein by reference.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company's corporate headquarters are located at Harcourt General's leased facility in Chestnut Hill, Massachusetts. The operating headquarters for Neiman Marcus, Bergdorf Goodman and Contempo Casuals are located in Dallas, New York City and Los Angeles, respectively.\nAt July 30, 1994, the square footage used in the Company's specialty store operations was approximately as follows:\nLeases for Neiman Marcus stores, including renewal options, range from 30 to 99 years. Leases for Contempo Casuals stores are generally for 10 to 15 years, with no renewal options. The lease on the Bergdorf Goodman main store expires in 2050, and the lease on the Bergdorf Goodman Men's store expires in 2010, with two 10-year renewal options. Leases are generally at fixed rentals, except that certain leases provide for additional rentals based on sales in excess of predetermined levels. The Company also owns approximately 50 acres of land in Las Colinas, Texas where its direct marketing operations and computer facility are located. For further information on the Company's properties, see \"Leases\" in Note 8 of the Notes to the Company's Consolidated Financial Statements on page 30 of the Annual Report.\nNM Direct and Bergdorf Goodman's direct marketing operations are located at Neiman Marcus' 520,000 square foot facility in Las Colinas, Texas.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is involved in various suits and claims in the ordinary course of business. The Company does not believe that the disposition of any such suits or claims will have a material adverse effect upon the continuing operations or financial condition 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 STOCKHOLDER MATTERS\nThe following information contained in the 1994 Annual Report is incorporated herein by reference:\n(i) \"Stock Information\" and \"Shares Outstanding\" on page 36 of the Annual Report;\n(ii) \"Dividends\" in Note 10 of the Notes to the Consolidated Financial Statements on page 33 of the Annual Report; and\n(iii) The fourth and fifth sentences of paragraph (a) of Note 4 of the Notes to the Consolidated Financial Statements (relating to restrictions on the Company's ability to pay dividends) on page 27 of the Annual Report.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe response to this Item is contained in the 1994 Annual Report under the caption \"Selected Financial Data\" on page 35 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 response to this Item is contained in the 1994 Annual Report under the caption \"Management's Discussion and Analysis\" on pages 17 through 20 and is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements and supplementary data referred to in Item 14 are 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\nA. Directors\nBelow are the name, age and principal occupations for the last five years of each director of the Company.\nClass I Directors - Terms expire at 1995 Annual Meeting\nRichard A. Smith - 69 Director since 1987 Chairman of the Board of the Company and of Harcourt General; Chairman of the Board, President and Chief Executive Officer of GC Companies, Inc. since December 1993; Chief Executive Officer of the Company and of Harcourt General until November 26, 1991; Director of Harcourt General, GC Companies, Inc., Liberty Mutual Insurance Company, Liberty Mutual Fire Insurance Company, Bank of Boston Corporation and its principal subsidiary, The First National Bank of Boston. Mr. Smith is the father of Robert A. Smith, an executive officer of the Company.\nRobert J. Tarr, Jr. - 50 Director since 1987 President, Chief Executive Officer (since November 26, 1991) and Chief Operating Officer of the Company and of Harcourt General; Director of Harcourt General and GC Companies, Inc.\nClass II Directors - Terms expire at 1996 Annual Meeting\nWalter J. Salmon - 63 Director since 1987 Stanley Roth, Sr. Professor of Retailing and Senior Associate Dean, External Relations, Graduate School of Business Administration, Harvard University; Director of Hannaford Bros. Co., The Quaker Oats Company, Circuit City Stores, Inc., Luby's Cafeterias, Inc., Promus Companies, Incorporated and Telxon Corporation.\nMatina S. Horner - 55 Director since 1993 Executive Vice President of the Teachers Insurance and Annuity Association-College Retirement Equities Fund (TIAA-CREF) and President Emerita of Radcliffe College since 1989; President of Radcliffe College for 17 years prior thereto. Director of Boston Edison Company.\nClass III Directors - Terms expire at 1997 Annual Meeting\nGary L. Countryman - 55 Director since 1987 Chairman (since April 1991) and Chief Executive Officer of Liberty Mutual Insurance Company and Liberty Mutual Fire Insurance Company; President of said companies through March 1992; Director of Boston Edison Company, Bank of Boston Corporation and its principal subsidiary, The First National Bank of Boston.\nJean Head Sisco - 69 Director since 1987 Partner in Sisco Associates, international management consultants; Director of Textron, Inc., Santa Fe Pacific Corporation, Sante Fe Pacific Gold Corp., Washington Mutual Investors Fund, Chiquita Brands International, Inc., The American Funds Tax-Exempt Series I, K-Tron International, Inc. and McArthur\/Glen Realty Corp.\nB. Executive Officers Who Are Not Directors\nBelow are the name, age and principal occupations for the last five years of each executive officer of the Company who is not also a director of the Company. All such persons have been elected to serve until the next annual election of officers and their successors are elected or until their earlier resignation or removal.\nJohn R. Cook - 53 Senior Vice President and Chief Financial Officer of the Company and of Harcourt General since September 1992; Senior Vice President - Finance and Administration and Chief Financial Officer of NACCO Industries prior thereto.\nStephen C. Elkin - 51 Chairman and Chief Executive Officer of Bergdorf Goodman since May 1994; President and Chief Operating Officer of Bergdorf Goodman from December 1990 to May 1994; Vice Chairman and Chief Operating Officer of Bergdorf Goodman prior thereto.\nBernie Feiwus - 46 President and Chief Executive Officer of NM Direct since October 1991; Executive Vice President of Neiman Marcus - Horchow Mail Order Division from March 1991 to October 1991; Senior Vice President - Sales Promotion Director of Neiman Marcus prior thereto.\nEric P. Geller - 47 Senior Vice President and General Counsel of the Company and of Harcourt General since May 1992; Secretary of the Company since January 1992 and of Harcourt General since December 1991; Vice President, Associate General Counsel and Assistant Secretary of the Company and of Harcourt General prior thereto.\nPaul F. Gibbons - 43 Vice President and Treasurer of the Company and of Harcourt General since August 1992; Vice President and Treasurer of GC Companies, Inc. since March 1994; Vice President - Taxation of the Company and of Harcourt General prior to August 1992.\nDawn Mello - 63 President of Bergdorf Goodman since May 1994 and from 1983 to 1989; Executive Vice President and Creative Director Worldwide of Guccio Gucci SpA from October 1989 to May 1994.\nStephen C. Richards - 39 Vice President and Controller of the Company and of Harcourt General since June 1993; Vice President and Controller of GC Companies, Inc. since January 1994; Partner, Deloitte & Touche from June 1990 to May 1993; Senior Manager, Deloitte & Touche prior thereto.\nGerald A. Sampson - 53 President and Chief Operating Officer of Neiman Marcus Stores since April 1993; Chairman of May Company California, a division of May Department Stores Company, from 1991 to January 1993; Chairman of Kaufmann's, a division of May Department Stores Company, prior thereto.\nCraig B. Sawin - 38 Vice President - Planning and Analysis of the Company and of Harcourt General since 1990; Director of Planning and Analysis and Director of Administration of the Company and of Harcourt General prior thereto.\nRobert A. Smith - 35 Group Vice President of the Company since January 1992 and of Harcourt General since December 1991; Vice President - Corporate Development of the Company from March 1989 to January 1992; Vice President - Corporate Development of Harcourt General from December 1988 to December 1991; Director of Harcourt General. Mr. Smith is the son of Richard A. Smith, the Chairman of the Company.\nBurton M. Tansky - 56 Chairman and Chief Executive Officer of Neiman Marcus Stores since May 1994; Chairman and Chief Executive Officer of Bergdorf Goodman from February 1992 to May 1994; Vice Chairman of Bergdorf Goodman from February 1991 to February 1992; President of Saks Fifth Avenue prior thereto.\nC. Section 16 Reports\nSection 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's directors and executive officers and persons who own more than 10% of the Company's Common Stock to file initial reports of ownership and reports of changes in ownership with the Securities and Exchange Commission and the New York Stock Exchange. The Company believes that all filing requirements applicable to its insiders were complied with during fiscal 1994.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\n(1) Under the Intercompany Services Agreement between the Company and Harcourt General, Harcourt General provides certain management, accounting, financial, legal, tax, personnel and other corporate services to the Company, including the services of certain senior officers of Harcourt General who are also senior officers of the Company, in consideration of a fee based on Harcourt General's direct and indirect costs of providing the corporate services. The level of services and fees are subject to the approval of the Special Review Committee of the Board of Directors of the Company. During fiscal 1994, 1993 and 1992, the Company paid or accrued approximately $6.9 million, $7.2 million and $6.4 million, respectively, to Harcourt General for all of its services under the Intercompany Services Agreement. With the exception of Mr. Tarr, the senior officers of Harcourt General, who derive all of their compensation directly from Harcourt General, are not included in this table. Mr. Tarr is also the President and Chief Executive Officer of Harcourt General. All of Mr. Tarr's cash and non-cash compensation is paid by Harcourt General pursuant to Mr. Tarr's Employment Agreement with Harcourt General effective November 26, 1991. Of the amounts paid by the Company to Harcourt General under the Intercompany Services Agreement for fiscal 1994, 1993 and 1992, approximately $2.3 million, $2.1 million and $1.7 million, respectively, were attributable to Mr. Tarr's services. These amounts include costs related to Mr. Tarr's base compensation, bonuses, benefits and amounts necessary to fund his retirement benefits, all of which are direct obligations of Harcourt General.\n(2) The Company does not have a long-term compensation program that includes long-term incentive payouts. No stock appreciation rights were granted to any of the named executive officers during the years reported in the table.\n(3) Bonus payments are reported with respect to the year in which the related services were performed.\n(4) Calculated by multiplying the closing price of the Company's Common Stock on the New York Stock Exchange on the date of grant by the number of shares awarded. Twenty percent of an award of restricted Common Stock are freed from the restrictions on transfer each year, commencing one year after the date of grant, provided that the recipient continues to be employed by the Company on the anniversary date of the grant. Dividends are paid to holders of restricted stock, who are also entitled to vote their restricted shares. In the event of termination of employment for any reason, other than death or permanent disability, restricted shares are forfeited by the holder and revert to the Company. At the end of fiscal 1994, the named executive officers' restricted stock holdings and market values (based on the New York Stock Exchange closing price of $15.25 for the Company's Common Stock at fiscal year end) were as follows: Mr. Elkin - 3,000 shares ($45,750) and Mr. Feiwus - 1,200 shares ($18,300). The closing price of the Company's Common Stock on the New York Stock Exchange on October 14, 1994 was $14.625. All of the restricted shares reported in this column were granted to the executive officers in fiscal 1992. Mr. Lundgren forfeited his 4,500 shares of restricted stock upon his resignation from the Company in April 1994.\n(5) The items accounted for in this column include the cost to the Company of matching contributions under (a) the Company's Key Employee Deferred Compensation Plan or the Savings and Investment Plan (401(k) Plan) and (b) group life insurance premiums. For fiscal 1994, such amounts for each of the named executive officers were, respectively, as follows: Mr. Tansky - $4,875 and $5,772; Mr. Sampson - $2,110 and $4,311; Mr. Elkin - $3,550 and $6,100; Mr. Feiwus - $2,310 and $3,573 and Mr. Lundgren - $2,250 and $4,329. See Note 6 below for information regarding additional compensation of Mr. Tansky reported in this column.\n(6) Mr. Tansky received a $140,000 bonus in fiscal 1992 pursuant to his employment agreement with the Company, which is included under \"All Other Compensation.\" Prior to becoming the Chairman and Chief Executive Officer of Neiman Marcus Stores in May 1994, Mr. Tansky was the Chairman and Chief Executive Officer of Bergdorf Goodman. Pursuant to his employment agreement, Mr. Tansky's fiscal 1994 bonus was determined based on the performance of Bergdorf Goodman during fiscal 1994.\n(7) Mr. Sampson's employment with the Company commenced on April 1, 1993.\n(8) Mr. Lundgren resigned from the Company effective April 12, 1994.\n(1) No stock appreciation rights were granted to any named executive officer during fiscal 1994.\n(2) These potential realizable values are based on assumed rates of appreciation required by applicable regulations of the Securities and Exchange Commission.\n(3) All option grants are non-qualified stock options having a term of 10 years and one day. They become exercisable at the rate of 20% on each of the first five anniversary dates of the grant.\n(4) None of the executive officers of Harcourt General who are also officers of the Company, including Mr. Tarr, participate in the Company's 1987 Stock Incentive Plan.\n(5) All of these options terminated upon Mr. Lundgren's resignation from the Company effective April 12, 1994.\n(1) The value of unexercised in-the-money options is calculated by multiplying the number of underlying shares by the difference between the closing price of the Company's Common Stock on the New York Stock Exchange at fiscal year end ($15.25) and the option exercise price for those shares. These values have not been realized. The closing price of the Company's Common Stock on the New York Stock Exchange on October 14, 1994 was $14.625.\n(2) None of the executive officers of Harcourt General who are also officers of the Company, including Mr. Tarr, participate in the Company's 1987 Stock Incentive Plan.\n(3) Mr. Lundgren resigned from the Company effective April 12, 1994. The Company paid Mr. Lundgren $54,000 with respect to options held by him to purchase an aggregate of 22,750 shares of Common Stock of the Company at various exercise prices. The $54,000 payment was calculated based on the difference between the closing price of the Company's Common Stock on the New York Stock Exchange on the date Mr. Lundgren elected to receive this payment (February 25, 1994) and the option exercise prices. All unexercisable options held by Mr. Lundgren terminated upon his resignation from the Company.\nDirectors Compensation\nDirectors who are not affiliated with the Company or Harcourt General each receive an annual retainer of $20,000 and a fee of $1,500 per Board of Directors meeting attended, plus travel and incidental expenses (an aggregate of $4,134 in fiscal 1994) incurred in attending meetings and carrying out their duties as directors. They also receive a fee of $500 (the Chairmen receive $1,000) for each committee meeting attended. If a director is unable to attend a meeting in person but participates by telephone, he or she receives one-half of the fee that would otherwise be payable.\nMr. Countryman receives his director fees on a deferred basis. The Company maintains an account to record the accrual of Mr. Countryman's deferred fees and accrued interest, which accrues at a rate equal to that paid on 90-day certificates of deposit issued by The First National Bank of Boston from time to time.\nPension Plans\nThe Company maintains a funded, qualified pension plan known as The Neiman Marcus Group, Inc. Retirement Plan (the \"Retirement Plan\"). Most non-union employees who have completed one year of service with 1,000 or more hours participate in the Retirement Plan, which pays benefits upon retirement or termination of employment by reason of disability. The Retirement Plan is a \"career-average\" plan, under which a participant earns each year a retirement annuity equal to 1% of his or her compensation for the year up to the Social Security wage base and 1.5% of his or her compensation for the year in excess of such wage base. Benefits under the Retirement Plan become fully vested after five years of service with the Company.\nThe Company also maintains a Supplemental Executive Retirement Plan (the \"SERP\"). The SERP is an unfunded, non- qualified plan under which benefits are paid from the Company's general assets to supplement Retirement Plan benefits and Social Security. Executive, administrative and professional employees (other than those employed as salespersons) with an annual base salary at least equal to a self-adjusting minimum ($99,000 as of December 31, 1993) are eligible to participate. At normal retirement age (age 65), a participant with 25 or more years of service is entitled to payments under the SERP sufficient to bring his or her combined annual benefit from the Retirement Plan and SERP, computed as a straight life annuity, up to 50% of the participant's highest consecutive 60 month average of pensionable earnings, less 60% of his or her estimated primary Social Security benefit. If the participant has fewer than 25 years of service, the combined benefit is proportionately reduced. In computing the combined benefit, \"pensionable earnings\" means base salary, including any salary which may have been deferred. Benefits under the SERP become fully vested after five years of service with the Company.\nThe following table shows the estimated annual pension benefits payable to employees in various compensation and years of service categories. The estimated benefits apply to an employee retiring at age 65 in 1994 who elects to receive his or her benefit in the form of a straight life annuity. These benefits include amounts attributable to both the Retirement Plan and the SERP and are in addition to any retirement benefits that might be received from Social Security.\n(1) The amounts actually payable will be somewhat lower than the amounts shown above, since the above amounts will be reduced by 60% of the participant's estimated primary Social Security benefit.\nThe following table shows the pensionable earnings and credited years of service for the executive officers named in the Summary Compensation Table as of July 30, 1994 and years of service creditable at age 65. Credited service may not exceed 25 years for purpose of calculating retirement benefits under any of the Company's retirement plans.\n(1) Mr. Tarr does not participate in the Company's Retirement Plan or SERP.\n(2) Under Mr. Tansky's employment agreement with the Company, for purposes of determining his retirement benefits under the SERP, Mr. Tansky will be credited with 5\/3 times his years of service with the Company provided he remains continuously employed by the Company until his 65th birthday; otherwise, Mr. Tansky's accrued service at age 65 under the SERP will be calculated in the normal manner. Mr. Tansky is 56 years old.\n(3) For purposes of determining Mr. Sampson's retirement benefits under the SERP, Mr. Sampson will be credited with 20\/13 times his years of service with the Company provided he remains continuously employed by the Company until his 65th birthday; otherwise, Mr. Sampson's accrued service at age 65 under the SERP will be calculated in the normal manner. Mr. Sampson is 53 years old.\n(4) Mr. Lundgren resigned from the Company effective April 12, 1994.\nEmployment and Severance Agreements\nBurton Tansky\nIn connection with Mr. Tansky's appointment as Chairman and Chief Executive Officer of Neiman Marcus Stores in May 1994, the Company and Mr. Tansky entered into a new employment agreement which provides for Mr. Tansky's employment as Chairman and Chief Executive Officer of Neiman Marcus Stores through January 31, 1997. Pursuant to the agreement, Mr. Tansky will receive an annual base salary of $600,000, subject to adjustment by the Compensation Committee. In the event Mr. Tansky is terminated without cause within 24 months of a change of control of the Company, or if within 24 months of such a change of control Mr. Tansky resigns because he is not permitted to continue in a position comparable in duties and responsibilities to that which he held prior to the change of control, Mr. Tansky will be entitled to receive his then-current base compensation through July 31, 1998, which amount will be reduced by any amounts earned by him between August 1, 1997 and July 31, 1998 from other employment. If the Company terminates Mr. Tansky's employment during the term of the Employment Agreement for any reason other than for cause or other than because of his total disability or death, Mr. Tansky will continue to receive his base compensation and benefits until January 31, 1997 or for 18 months following termination, whichever is greater. If the Company determines not to extend Mr. Tansky's employment beyond January 31, 1997, the Company will pay to Mr. Tansky his then-current base compensation through July 31, 1998, which amount will be reduced by any amounts earned by him between August 1, 1997 and July 31, 1998 from other employment.\nGerald A. Sampson\nPursuant to an agreement between Mr. Sampson and the Company, effective April 1, 1993, Mr. Sampson is entitled to receive severance payments in the event the Company terminates his employment other than for cause or other than due to his total disability or death prior to March 31, 1995. In such event he will receive an amount equal to his then-current base salary, which amount will be paid to him in 12 monthly installments following such termination but will be reduced by any amounts received by him from other employment during the payment period.\nStephen C. Elkin\nPursuant to an agreement between Mr. Elkin and Bergdorf Goodman, effective September 1993, Mr. Elkin is entitled to receive severance payments in the event his employment with Bergdorf Goodman is terminated in certain situations. If the Company terminates Mr. Elkin's employment other than for cause or other than due to his total disability or death, he will receive an amount equal to one and one half times his then-current base salary, which amount will be paid to him in 18 monthly installments following such termination but will be reduced by any amounts received by him from other employment during the period beginning six months following his termination and ending at the end of the 18 month period. Mr. Elkin will also be entitled to receive such payments in the event his employment is terminated without cause within 24 months of a change of control of either Bergdorf Goodman or the Company, or in the event he resigns within 24 months of a change of control because he is not permitted to continue in a position comparable in duties and responsibilities to that which he held before the change of control.\nDawn Mello\nPursuant to an agreement between Ms. Mello and Bergdorf Goodman, effective May 1994, Ms. Mello is entitled to receive severance payments in the event her employment with Bergdorf Goodman is terminated in certain situations. If the Company terminates Ms. Mello's employment other than for cause or other than due to her total disability or death, she will receive an amount equal to her then-current annual salary, which amount will be paid in 12 monthly installments following such termination but will be reduced by any amounts received by her from other employment during the period beginning six months following such termination. Ms. Mello will also be entitled to receive such payments in the event her employment is terminated without cause before November 1, 1996 and within 24 months of a change of control of either Bergdorf Goodman or the Company, or in the event she resigns before November 1, 1996 and within 24 months of a change of control because she is not permitted to continue in a position comparable in duties and responsibilities to that which she held before the change of control.\nCompensation Committee Interlocks and Insider Participation\nDuring fiscal 1994, Richard A. Smith, Chairman of the Board of Directors of the Company, served on the Boards of Directors of Liberty Mutual Insurance Company and Liberty Mutual Fire Insurance Company (collectively, \"Liberty Mutual\"). Gary L. Countryman, a director of the Company and the Chairman of the Company's Compensation Committee, is the Chairman and Chief Executive Officer of Liberty Mutual. Liberty Mutual underwrites most of the Company's insurance policies. These insurance policies contain terms which, in the judgment of management, are no less favorable than could be obtained from other insurance companies. During fiscal 1994, the Company paid to Liberty Mutual an aggregate of $3.3 million in premiums and administrative fees.\n_________________\nNotwithstanding anything to the contrary set forth in any of the Company's previous filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, each as amended, that might incorporate future filings, including this Form 10-K, in whole or in part, the following Compensation Committee Report on Executive Compensation and Stock Performance Graph shall not be deemed to be incorporated by reference into any such filings, nor shall such sections of this Report be deemed to be incorporated into any future filings made by the Company under the Securities Act of 1933 or the Securities Exchange Act of 1934.\nCompensation Committee Report on Executive Compensation\nThe Compensation Committee is composed of Gary L. Countryman (Chairman), Matina S. Horner, Walter J. Salmon and Jean Head Sisco. The members of the Compensation Committee are all independent directors.\nThe principal responsibility of the Committee is to review the performance of, and determine the compensation for, the executive officers of the Company who are not also executive officers of Harcourt General. The individuals in this group include Messrs. Tansky, Sampson, Elkin and Feiwus, all of whom are named executive officers in the Summary Compensation Table, as well as Dawn Mello, President of Bergdorf Goodman, and Robert Kelleher, President and Chief Operating Officer of Contempo Casuals. The compensation of Harcourt General's executive officers, most of whom are also executive officers of the Company, is determined by Harcourt General's Compensation Committee.\nCompensation Policies\nThe principal objectives of the Company's executive compensation program are to reward competitively its executive officers in order to attract and retain excellent management and to provide incentives that will most sharply focus the attention of those individuals on the goal of increasing the profitability of the Company and its operating divisions over both the short and long terms.\nEarly in each fiscal year, the Committee considers the recommendations of the Chief Executive Officer, which are supported by data generated by the Company's Human Resources Department, for each component of compensation of the Company's executive officers. The Committee approves those recommendations with such modifications as it deems appropriate.\nThe principal components of the Company's compensation program are:\nBase Salary:\nThis is determined with reference both to salary survey information from recognized compensation consulting firms and to each executive officer's level of responsibility, experience and performance. The salary survey data is used to establish benchmark amounts for both base salary and total cash compensation for each executive position. Comparisons are made to a range of retail companies or to divisions within such companies, with the principal selection criteria for comparisons being similar revenues to the division within the Company. While there are no hard and fast rules which bind the Committee, the Company generally sets its salary and total cash compensation benchmarks (assuming that maximum bonuses are achieved) for executive officers at the 75th percentile of the comparison group of companies in order to compete for and retain the best management talent available. Because the Company competes for executive talent with a broad range of U.S. retail companies, the Committee does not limit its comparison information for compensation purposes to the three companies included in the peer group in the Stock Performance Graph.\nThe Committee reviews in detail the base salary levels for each of the principal executive officers of the Company. While the Committee uses the benchmarks as a reference point, a particular individual's base salary may vary from the benchmark depending upon his or her salary history, experience, individual performance and contractual obligations of the Company.\nAnnual Incentive Plan:\nThe determination of annual bonuses is based principally on the achievement of performance objectives by the operating division for which the executive is responsible and the individual executive's own performance. For some executive officers, a small component of their bonus eligibility depends on the Company's overall performance.\nShortly after the beginning of each fiscal year, the Compensation Committee considers the recommendations of the Chief Executive Officer for the Company's and each division's performance goals for the current year, the executive officers who should participate in the annual incentive plan for that year, and the maximum bonus values attainable by them. The Committee approves those recommendations with such modifications as it deems appropriate.\nIn addition, each of the Company's executive officers prepares and reaches agreement with the Chief Executive Officer on individual performance goals which must be achieved in addition to the performance targets in order for an executive to receive his or her full bonus. Individual performance goals typically include achievement of specific tasks.\nFor fiscal 1994, the plan provided for maximum bonuses ranging from 35% to 45% of base salary. Eligibility for the divisional performance component of the bonus was determined based on a weighting of several factors, the most important of which was operating earnings before corporate expenses. Other factors included return on net assets and working capital as a percentage of sales. Similar factors will be used by the Committee in determining bonuses for fiscal 1995. The bonuses actually awarded to the executive officers for fiscal 1994 were determined by an assessment of all of these factors, as well as certain subjective factors.\nAbsent extraordinary circumstances, if the financial performance targets are exceeded, bonus awards are not increased over the maximum bonus values established by the Committee. If the performance targets are not met, bonus awards are generally reduced at the discretion of the Committee. If the Company and\/or the relevant division falls sufficiently short of its performance target, there is a presumption that bonuses would not be paid absent special circumstances. For example, no bonuses were awarded to executives at Contempo Casuals for fiscal 1994. If corporate and\/or division performance targets are met, but an individual falls short of his or her performance goals, the individual's bonus could be reduced or eliminated in the discretion of the Committee.\nThe bonus program is intended to put substantial amounts of total cash compensation at risk with the intent of focusing the attention of the executives on achieving both the Company's and their division's performance goals and their individual goals, thereby contributing to profitability and building shareholder value.\nStock Incentives:\nThe Committee's purpose in awarding equity based incentives, principally in the form of stock options which vest over a five year period and terminate ten years from the date of grant, is to achieve as much as possible an identity of interest between the executives and the long term interest of the stockholders. The principal factors considered in determining which executive officers (including the named executive officers) were awarded equity based compensation in the 1994 fiscal year, and in determining the types and amounts of such awards, were salary levels, equity awards granted to executives at competing retail companies, special circumstances such as promotions as well as the performance, experience and level of responsibility of each executive.\nCompensation of the Chief Executive Officer\nMr. Tarr is also the Chief Executive Officer of Harcourt General, which owns approximately 65% of the fully converted equity of the Company. All of Mr. Tarr's cash and non-cash compensation is paid directly by Harcourt General to Mr. Tarr pursuant to an employment agreement between Mr. Tarr and Harcourt General which was approved by the Harcourt General Compensation Committee and became effective in November, 1991. Mr. Tarr receives no compensation directly from the Company. However, pursuant to the Intercompany Services Agreement between the Company and Harcourt General, Harcourt General provides certain management and other corporate services to the Company, including Mr. Tarr's services as Chief Executive Officer. During fiscal 1994, the Company paid or accrued approximately $6.9 million to Harcourt General for all of its services under the Intercompany Services Agreement, of which approximately $2.3 million was attributable to Mr. Tarr's services. While the Special Review Committee of the Company reviews each year the appropriateness of the charges by Harcourt General to the Company under the Intercompany Services Agreement, neither this Committee nor the Special Review Committee plays any role in determining the compensation that Mr. Tarr, or any other executive officer of Harcourt General, receives from Harcourt General.\nCompliance with Internal Revenue Code Section 162(m)\nAmendments to Section 162(m) of the Internal Revenue Code which were enacted in 1993 generally disallow a tax deduction to public companies for compensation in excess of $1 million per year paid to each of the executive officers named in the Summary Compensation Table. The Company does not anticipate that any of its executive officers will receive cash compensation in excess of this deductibility limit in fiscal 1995. Under transition provisions in the regulations under Section 162(m), compensation resulting from awards under the Company's Incentive Stock Option Plan is not subject to the deductibility limit at this time. The Committee will continue to monitor the requirements of Section 162(m) and to determine what actions should be taken by the Company in order to preserve the tax deduction for executive compensation to the maximum extent, consistent with the Company's continuing goals of providing the executives of the Company with appropriate incentives and rewards for their performance.\nCOMPENSATION COMMITTEE\nGary L. Countryman, Chairman Matina S. Horner Walter J. Salmon Jean Head Sisco\nStock Performance Graph\nThe graph below compares the cumulative total shareholder return on the Common Stock of the Company against the cumulative total return of the Standard & Poor's 500 Stock Index and a Peer Index during the five fiscal years ended July 30, 1994. The graph assumes a $100 investment in the Company's Common Stock and in each index at July 29, 1989 and that all dividends were reinvested.\nThe Company's Peer Index is made up of three companies in the specialty retail industry: The Limited, Inc., Nordstrom, Inc. and Tiffany & Co. The common stocks of the companies in the Peer Index have been weighted annually to reflect relative stock market capitalization. The comparisons provided in this graph are not intended to be indicative of possible future performance of the Company's Common Stock.\n[STOCK PERFORMANCE GRAPH TO BE INSERTED HERE]\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth information, as of October 14, 1994, with respect to the beneficial ownership of the Common Stock of the Company by (i) each person known to the Company to own beneficially more than 5% of the outstanding shares of Common Stock; (ii) each executive officer named in the Summary Compensation Table, (iii) each director of the Company; and (iv) all directors and current executive officers of the Company as a group. Harcourt General beneficially owns all of the outstanding shares of the 6% Cumulative Convertible Preferred Stock, $1.00 par value (the \"Preferred Stock\"), of the Company.\nNumber Percent Name and Address of Shares of Common of Beneficial Owner Owned(1) Stock\nHarcourt General, Inc.(2) 21,440,960 56.5% 27 Boylston Street Chestnut Hill, MA 02167\nGabelli Funds, Inc.(3) 4,951,700 13.0% 655 Third Avenue New York, NY 10017\nFMR Corp.(4) 3,000,000 7.9% 88 Devonshire Street Boston, MA 02109\nBurton M. Tansky(5) 23,300 * Gerald A. Sampson(6) 3,000 * Stephen Elkin(7)(8) 57,759 * Bernie Feiwus(8)(9) 14,156 * Terry Lundgren(10) - * Gary L. Countryman - * Matina S. Horner - * Walter J. Salmon 8,942 * Jean Head Sisco 1,126 * Richard A. Smith(11) - * Robert J. Tarr, Jr.(11) - * All current executive officers and directors as a group (17 persons)(12) 108,283 * _____________________ * Less than 1%.\n(1) Unless otherwise indicated in the following footnotes, each stockholder referred to above has sole voting and investment power with respect to the shares listed.\n(2) Harcourt General's holdings of Common Stock and Preferred Stock comprise approximately 65% of the fully converted equity and voting power of the Company. Each share of Preferred Stock is convertible into 8.99 shares of Common Stock at a price of $41.70 per share of Common Stock. The closing price of the Common Stock on the New York Stock Exchange on October 14, 1994 was $14.625 per share.\nRichard A. Smith, Chairman of the Board of Directors of the Company and of Harcourt General, his sister, Nancy L. Marks, and certain members of their families may be regarded as controlling persons of Harcourt General, and therefore of the Company. The shares of Harcourt General Class B Stock and Harcourt General Common Stock beneficially owned by or for the benefit of the Smith family constitute approximately 28% of the aggregate number of outstanding equity securities of Harcourt General. Each share of Harcourt General voting stock entitles the holder thereof to one vote on all matters submitted to Harcourt General's stockholders, except that each share of Harcourt General Class B Stock (virtually all of which is owned by the Smith family) entitles the holder thereof to ten votes on the election of directors at any Harcourt General stockholders' meeting under certain circumstances. Accordingly, as to any elections in which the Harcourt General Class B Stock would carry ten votes per share at a Harcourt General stockholders' meeting, the Smith family would have approximately 80% of the combined voting power of the Harcourt General voting securities.\nUnder the definition of \"beneficial ownership\" in Rule 13d-3 of the Rules and Regulations promulgated under the Securities Exchange Act of 1934, as amended, the Smith family and the members of Harcourt General's Board of Directors may be deemed to be the beneficial owners of the securities of the Company beneficially owned by Harcourt General in that they may be deemed to share with Harcourt General the power to direct the voting and\/or disposition of such securities. However, this information should not be deemed to constitute an admission that any such person or group of persons is the beneficial owner of such securities.\n(3) The information reported is based on information provided to the Company by Gabelli Funds, Inc. in October 1994. The Gabelli Funds have sole voting power with respect to 4,711,300 shares and sole dispositive power with respect to all of the shares shown in the table.\n(4) The information reported is based on information provided to the Company by FMR Corp., an affiliate of Fidelity Management & Research Company, in October 1994. FMR Corp. has no voting power but has sole dispositive power with respect to all of the shares shown in the table.\n(5) Represents 23,300 shares of Common Stock which are subject to outstanding options exercisable within 60 days of October 14, 1994.\n(6) Includes 2,000 shares of Common Stock which are subject to outstanding options exercisable within 60 days of October 14, 1994.\n(7) Includes 42,305 shares of Common Stock which are subject to outstanding options exercisable within 60 days of October 14, 1994.\n(8) Includes shares of restricted stock over which the individual has voting but not dispositive power. For the number of shares of restricted stock owned, see Note 4 to the Summary Compensation Table.\n(9) Includes 11,711 shares of Common Stock which are subject to outstanding options exercisable within 60 days of October 14, 1994.\n(10) Mr. Lundgren was the Chairman and Chief Executive Officer of Neiman Marcus Stores until his resignation in April 1994.\n(11) The members of the Board of Directors of Harcourt General, including Messrs. Smith and Tarr, may be deemed to be the beneficial owners of the securities of the Company owned by Harcourt General. However, this information should not be deemed to be an admission that any such person or group is the beneficial owner of such securities.\n(12) Excludes the beneficial ownership of securities of the Company which may be deemed to be attributed to Messrs. Smith and Tarr (see Note 11 above). Includes 79,316 shares of Common Stock which are subject to outstanding options exercisable within 60 days of October 14, 1994.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nTransactions with Principal Stockholder - Intercompany Services Agreement\nSee Note 1 to the Summary Compensation Table in Item 11 above.\nTransactions with Directors\nSee \"Compensation Committee Interlocks and Insider Participation\" in Item 11 above.\nTransactions with Officers\nIn July 1994, the Company made an interest free bridge loan in the amount of $240,000 to Mr. Tansky to assist him in purchasing a new home in the Dallas area in connection with his new position as Chairman and Chief Executive Officer of Neiman Marcus Stores. Mr. Tansky repaid the loan in August 1994.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n14(a)(1) Financial Statements\nThe documents listed below are incorporated by reference to the Company's 1994 Annual Report to Shareholders and are incorporated by reference into Item 8 hereof:\nConsolidated Balance Sheets at July 30, 1994 and July 31, 1993.\nConsolidated Statements of Operations for the fiscal years ended July 30, 1994, July 31, 1993 and August 1, 1992.\nConsolidated Statements of Cash Flows for the fiscal years ended July 30, 1994, July 31, 1993 and August 1, 1992.\nConsolidated Statements of Common Shareholders' Equity for the fiscal years ended July 30, 1994, July 31, 1993 and August 1, 1992.\nNotes to Consolidated Financial Statements.\nIndependent Auditors' Report.\n14(a)(2) Consolidated Financial Statement Schedules\nThe documents and schedules listed below are filed as part of this Form 10-K:\nPage in Form 10-K\nIndependent Auditors' Report on Consolidated Financial Statement Schedules Schedule II - Accounts Receivable from Related Parties and Underwriters, Promoters and Employees other than Related Parties Schedule V - Property, Plant and Equipment Schedule VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment Schedule VIII - Valuation and Qualifying Accounts and Reserves Schedule IX - Short-Term Borrowings Schedule X - Supplementary Income Statement Information\nAll other schedules for which provision is made in the applicable regulations of the Securities and Exchange Commission have been omitted because the information is disclosed in the Consolidated Financial Statements or because such schedules are not required or are not applicable.\n14(a)(3) Exhibits\nThe exhibits filed as part of this Annual Report are listed in the Exhibit Index immediately preceding the exhibits. The Registrant has identified with an asterisk in the Exhibit Index each management contract and compensation plan filed as an exhibit to this Form 10-K in response to Item 14(c) of Form 10-K.\n14(b) Reports on Form 8-K\nThe Company did not file any reports on Form 8-K during the quarter ended July 30, 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.\nTHE NEIMAN MARCUS GROUP, INC.\nBY: s\/Robert J. Tarr, Jr. Robert J. Tarr, Jr., President, Chief Executive Officer and Chief Operating Officer Dated: October 26, 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 following capacities and on the dates indicated.\nSignature Title Date\nPrincipal Executive Officer:\ns\/Robert J. Tarr, Jr. President, Chief Executive October 26, 1994 Robert J. Tarr, Jr. Officer, Chief Operating Officer and Director\nPrincipal Financial Officer:\ns\/John R. Cook Senior Vice President and October 26, 1994 John R. Cook Chief Financial Officer\nPrincipal Accounting Officer:\ns\/Stephen C. Richards Vice President and Controller October 26, 1994 Stephen C. Richards\nDirectors: Date\ns\/Richard A. Smith October 24, 1994 Richard A. Smith\ns\/Gary L. Countryman October 27, 1994 Gary L. Countryman\ns\/Matina S. Horner October 21, 1994 Matina S. Horner\ns\/Walter J. Salmon October 21, 1994 Walter J. Salmon\ns\/Jean Head Sisco October 13, 1994 Jean Head Sisco\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of The Neiman Marcus Group, Inc. and Subsidiaries\nWe have audited the consolidated financial statements of The Neiman Marcus Group, Inc. and subsidiaries as of July 30, 1994 and July 31, 1993, and for each of the three years in the peirod ended July 30, 1994, and have issued our report thereon dated September 19, 1994; such financial statements and report are included in your 1994 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedules of The Neiman Marcus Group, Inc. 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 financial statements taken as a whole, present fairly in all material respects the information set forth therein.\nDeloitte & Touche LLP Boston, Massachusetts September 19, 1994\nSCHEDULE II\nTHE NEIMAN MARCUS GROUP, INC.\nACCOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES\n(A) Loan represents notes receivable under The Neiman Marcus Group, Inc. Key Executive Stock Purchase Loan Plan. Interest payable quarterly at 6% per annum; the balance was paid in full on August 31, 1993.\n(B) Loan represents an interest free bridge loan secured by a mortgage. The loan was paid in full during August, 1994.\nSCHEDULE V\nTHE NEIMAN MARCUS GROUP, INC.\nPROPERTY, PLANT AND EQUIPMENT\nYEARS ENDED JULY 30, 1994, JULY 31, 1993 AND AUGUST 1, 1992 (Dollar amounts in thousands)\n(A) Represents primarily fully depreciated assets and write-downs associated with the Contempo Causals restructuring in 1994.\n(B) Represents asset reclassifications.\nEstimated useful lives used by the Company at July 30, 1994 for computing depreciation (straight-line method) are as follows:\nClassification Years\nBuildings and improvements 15 - 30 Fixtures and equipment 3 - 15 Leasehold improvements Lesser of the estimated useful life of the asset or the lease term.\nSCHEDULE VI\nTHE NEIMAN MARCUS GROUP, INC.\nACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nYEARS ENDED JULY 30, 1994, JULY 31, 1993 AND AUGUST 1, 1992 (Dollar amounts in thousands)\n(A) Represents primarily fully depreciated assets.\nSCHEDULE VIII\n(A) Write-off of uncollectible accounts net of recoveries.\nSCHEDULE IX\nTHE NEIMAN MARCUS GROUP, INC. SHORT-TERM BORROWINGS\nYEARS ENDED JULY 30, 1994, JULY 31, 1993 AND AUGUST 1, 1992 (Dollar amounts in thousands)\n(A) Interest and principal are payable in full at the due date (see Note 4 to the Consolidated Financial Statements).\n(B) Based on amounts outstanding at month-end.\n(C) Based on daily averages.\nSCHEDULE X\nEXHIBIT INDEX\nPage No.\n3.1(a) Restated Certificate of Incorporation of the Company, incorporated herein by reference to the Company's Report on Form 10-K for the twenty-six week period ended August 1, 1987.\n3.1(b) Certificate of Designation and Terms of 9-1\/4% Cumulative Redeemable Preferred Stock, incorporated herein by reference to the Company's Report on Form 10-K for the fiscal year ended August 3, 1991.\n3.2 By-Laws of the Company, as amended, incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended August 1, 1992.\n*10.1 Intercompany Services Agreement, dated as of July 24, 1987, between Harcourt General and the Company, incorporated herein by reference to the Company's Report on Form 10-K for the twenty-six week period ended August 1, 1987.\n*10.2 1987 Stock Incentive Plan, incorporated herein by reference to the Company's Report on Form 10-K for the twenty-six week period ended August 1, 1987.\n*10.3 Key Executive Stock Purchase Loan Plan, as amended.\n*10.4 Supplemental Executive Retirement Plan, incorporated herein by reference to the Company's Report on Form 10-K for the fiscal year ended July 30, 1988.\n*10.5 Employment Agreement between the Company and Burton M. Tansky dated May 1, 1994.\n10.6 Stock Purchase Agreement between the Company and Harcourt General, dated October 14, 1991 and effective as of August 2, 1991, incorporated herein by reference to the Company's Report on Form 10-K for the fiscal year ended August 3, 1991.\n*10.7 Description of the Company's Executive Life Insurance Plan, incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended August 1, 1992.\n*10.8 Supplementary Executive Medical Plan, incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1993.\n*10.9 Termination Agreement between Bergdorf Goodman, Inc. and Stephen C. Elkin, effective September 1993, incorporated herein by reference to the Company's Annual Report on Form 10-K for the fiscal year ended July 31, 1993.\n*10.10 Termination Agreement between the Company and Gerald Sampson, effective April 1, 1993.\n*10.11 Termination Agreement between Bergdorf Goodman, Inc. and Dawn Mello, effective May 1994.\n*10.12 Key Employee Deferred Compensation Plan, as amended.\n*10.13 Deferred Compensation Agreement between the Company and Gary L. Countryman, dated August 27, 1987.\n11.1 Computation of Average Number of Shares Outstanding Used in Determining Primary and Fully-Diluted Earnings Per Share.\n13.1 1994 Annual Report to Stockholders (which is not deemed to be filed except to the extent that portions thereof are expressly incorporated by reference in this Annual Report on Form 10-K).\n22.1 Subsidiaries of the Company.\n24.1 Consent of Deloitte & Touche LLP.\n27.1 Financial Data Schedule.\n28.1 Dividend Reinvestment and Common Stock Purchase Plan, incorporated herein by reference to the Company's Registration Statement on Form S-3 dated September 17, 1990 (File No. 33-36419).\n________________ *Exhibits filed pursuant to Item 14(c) of Form 10-K","section_15":""}
{"filename":"2024_1994.txt","cik":"2024","year":"1994","section_1":"Item 1. Business\nAce Hardware Corporation was formally organized as a Delaware corporation in 1964. In 1973, by means of a corporate merger, it succeeded to the business of Ace Hardware Corporation, an Illinois corporation organized in 1928. Until 1973, the business now being engaged in by the Company had been conducted by the Illinois corporation. The Company's principal executive offices are located at 2200 Kensington Court, Oak Brook, Illinois 60521. Its telephone number is (708) 990-6600.\nThe Company functions as a wholesaler of hardware and related products, and manufactures paint products. Sales of the products distributed by it are presently made primarily to individuals, partnerships or corporations who are engaged in business as retail dealers of hardware or related items and who have entered into Membership Agreements with the Company entitling them to purchase merchandise and services from the Company and to use the Company's marks as provided therein.\nThe Company operates on a cooperative basis and distributes patronage dividends to its eligible member dealers each year in proportion to the amount of their annual purchases of merchandise from it. (See the subheading \"Distribution of Patronage Dividends.\")\nAt December 31, 1994 there were 4,940 retail business outlets with respect to which such Membership Agreements had been entered into. Those States having the largest concentration of member outlets are California (approximately 10%), Texas (approximately 6%), Illinois and Florida (approximately 5% each), Michigan (approximately 4%) and Georgia (approximately 3%). States into which were shipped the largest percentages of the merchandise sold by the Company in 1994 are California (approximately 11%), Illinois (approximately 9%), Florida and Texas (approximately 6% each) and Michigan and Georgia (approximately 4% each). Less than 4% of the Company's sales are made to outlets located outside of the United States or its territories.\nInformation as to the number of the Company's member outlets during each of the past three calendar years is set forth in the following table:\n1994 1993 1992 Member outlets at beginning of period 4,921 4,986 5,111 New member outlets 198 158 183 Member outlets terminated 179 223 308\nMember outlets at end of period 4,940 4,921 4,986\nDealers having one or more member outlets at end of period 4,054 4,045 4,134\nThe Company services its dealers by purchasing merchandise in quantity lots, primarily from manufacturers, by warehousing substantial quantities of said merchandise and by selling the same in smaller lots to the dealers. Most of the products that the Company distributes to its dealers from its regional warehouses are sold at a 10% markup. In 1994 warehouse sales accounted for 62% of total sales and bulletin sales accounted for 2% of total sales with the balance of 36% representing direct shipment, including lumber and building material sales.\nThe proportions in which the Company's total warehouse sales were divided among the various classes of merchandise sold by it during each of the past three calendar years are as follows:\nClass of Merchandise 1994 1993 1992\nPaint, cleaning and related supplies 19% 19% 18% Hand and power tools 14% 14% 15% Electrical supplies 12% 12% 13% Plumbing and heating supplies 16% 15% 15% General hardware 13% 12% 12% Housewares and appliances 6% 7% 7% Garden, rural equipment and related supplies 11% 12% 11% Sundry 9% 9% 9%\nThe Company sponsors two major conventions annually (one in the Spring and one in the Autumn) at various locations. Dealers and vendors are invited to attend, and dealers generally place orders for delivery during the period prior to the next convention. During the convention regular merchandise, new merchandise and seasonal merchandise for the coming season are displayed to attending dealers. Lawn and garden supplies, building materials and exterior paints are seasonal merchandise in many parts of the country, as are certain sundries such as holiday decorations.\nWarehouse sales involve the purchase of merchandise from the Company that is maintained in inventory by the Company at its warehouses. Direct shipment sales involve the purchase of merchandise from the Company with shipment directly from the vendors. Bulletin sales involve the purchase of merchandise from the Company pursuant to special bulletin offers by the Company.\nDirect shipment sales are orders placed by dealers directly with vendors, using special purchase orders. Such vendors bill the Company for such orders, which are shipped directly to dealers. The Company, in turn, bills the ordering dealers at a markup. The markup on this category of sales varies with invoice amounts in accordance with the following schedule and is exclusive of sales under the LTL Plus program discussed below.\nInvoice Amount Handling Charge (Markup)\n0.00 to $ 999.99 2.00% or $1.00 whichever is greater $1,000.00 to $1,999.99 1.75% $2,000.00 to $2,999.00 1.50% $3,000.00 to $3,999.00 1.25% $4,000.00 to $4,999.00 1.00% $5,000.00 to $5,999.00 .75% $6,000.00 to $6,999.00 .50% $7,000.00 to $7,999.00 .25% $8,000.00 and over .00%\nBulletin sales are made based upon notification from dealers of their participation in special bulletins offered by the Company. Generally, the Company will give notice to all members of its intention to purchase certain products for bulletin shipment and then purchases only so many of such products as the members order. When the bulletin shipment arrives at the Company, it is not warehoused, but is broken up into appropriate quantities and delivered to members who placed orders. A 6% markup is generally applied to this category of sales.\nAn additional markup of 3% is applied on the various categories of sales of merchandise exported to certain dealers located outside of the United States and its territories and possessions. Effective April 1995, a\nflat 2% markup is applied to all direct shipment sales placed by all dealers located outside of the United States and its territories and possessions.\nThe Company maintains inventories to meet only normal resupply orders. Resupply orders are orders from members for merchandise to keep inventories at normal levels. Generally, such orders are filled within one week of receipt. Bulletin orders (which are in the nature of resupply orders) may be for future delivery. The Company does not backlog normal resupply orders and, accordingly, no significant backlog exists at any point in time.\nThe Company also has established special sales programs for lumber and building materials products and for products assigned from time to time to an \"extreme competitive price sales\" classification and for products purchased from specified vendors for delivery to certain of the Company's dealers on a direct shipment basis (LTL Plus Program). Under its lumber and building materials (\"LBM\") program, the Company imposes no handling charge, markup or national advertising assessment on direct shipment orders for such products. The LBM program also enables the Company's dealers to purchase these products at net invoice prices which pass on to them important cost savings resulting from the Company's closely monitored lumber and building materials purchasing procedures. Additionally, the LBM program offers dealers the opportunity to order less than truckload quantities of many lumber and building materials products at economical prices under the LTL warehouse redistribution procedure which the Company has established with certain major vendors.\nThe Store Traffic Opportunity Program (\"STOP\") established by the Company is a program under which certain stockkeeping units of specific products assigned to an \"extreme competitive price sales\" classification are offered for sale to its dealers for delivery from designated Company retail support centers. Sales under this program are made without the addition of freight charges and with such handling charge or markup (if any) of not more than 5% as shall be specified for each item. The Company's officers have authority to add items to, and to withdraw items from, the STOP program from time to time and to establish reasonable minimum or multiple item purchase requirements for the items offered under the program. No allocations or distributions of patronage dividends are made with respect to sales under the STOP program. Purchases under the STOP program are, however, deemed to be warehouse purchases or bulletin purchases, as the case may be, for purposes of calculating the forms of patronage dividend distributions. (See the subheading under this Item 1 entitled \"Forms of Patronage Dividend Distributions.\")\nThe LTL Plus Program established by the Company is a program under which full or partial truckloads of products are purchased by the Company's dealers from specified vendors for delivery to such dealers on a direct shipment basis. No markup, handling charge or national advertising assessment is imposed by the Company on sales under the LTL Plus Program, and the maximum amount of patronage dividends allocated or distributed to the Company's dealers with respect to their purchases of products in the LTL Plus category is .5% of such sales. (See the subheading under this Item 1 entitled \"Patronage Dividend Determinations and Allocations.\")\nThe Company, in addition to conducting semi-annual and other conventions and product exhibits for its dealers, also provides them with numerous special services (on a voluntary basis and at a cost to cover its related expenses), such as inventory control systems, price and bin ticketing, and an electronic ordering system. In order for them to have on hand current pricing and other information concerning the merchandise obtainable from the Company, the Company further provides to each of its dealers either a catalogue checklist service or a microfiche film service (whichever the dealer selects), for either of which services the dealer must pay a monthly charge. The Company also provides on a full-participation basis videotapes and related materials for educational and training programs for which dealers must pay an established monthly charge. (See the subheading under this Item 1 entitled \"Special Charges and Assessments.\")\nThrough its wholly-owned subsidiary, Ace Insurance Agency, Inc., the Company makes available to its dealers a Group Dealer Insurance Program under which they can purchase a package of insurance coverages, including \"all risk\" property insurance and business interruption, crime, liability and workers'compensation coverages, as well as medical insurance coverage for their employees. AHC Realty Corporation, another wholly-owned subsidiary of the Company, provides the services of a broker to those dealers who desire to sell or seek a new location for a presently owned store or to acquire an additional store. Loss Prevention Services, Inc. a third wholly-owned subsidiary provides security training and services for all dealers desiring security assistance. In addition, the Company offers to its dealers retail computer systems consisting of computer equipment, maintenance service and certain software programs and services. These are marketed by the Company under its registered service mark \"PACE\".\nThe Company manufactures paint and related products at a facility owned by it in Matteson, Illinois and will begin manufacturing paint and related products at a Chicago Heights, Illinois facility in mid 1995. These facilities now constitute the primary source of such products offered for sale by the Company to its dealers. It is operated as a separate Division of the Company for accounting purposes. All raw materials used by the Company to manufacture paint are purchased from outside sources. The Company has had adequate sources of raw materials, and no shortages of any materials which would materially impact operations are currently anticipated. The manufacturing of paint is seasonal to the extent that greater paint sales are found in the months of April through September. Historically, compliance 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 have not had any material impact.\nThe Company's business, either in hardware wholesaling or paint manufacturing activities is not dependent on any major suppliers and the Company feels that any seasonal fluctuations do not have a significant impact upon operations. For further discussion of the Company's business, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", in Item 7 hereof.\nSpecial Charges and Assessments\nThe Company sponsors a national advertising program for which its dealers are currently assessed an amount equal to 1.25% of their purchases (exclusive of lumber, building materials, purchases of PACE computer systems (hardware and software), less than truckload lumber and building material program purchases and LTL Plus Program purchases as described above in this Item 1) from the Company during each bi-weekly period, with the current minimum annual assessment being $975.00 and with the maximum annual assessment being $4,750 for each business location of any one dealer which has become a member of the Company. The total annual amount of advertising assessments payable by any one dealer is also subject to a further maximum limit which is determined by multiplying the number of such dealer's member retail store outlets serving the general public by $4,750. In the case of a dealer whose place of business is located outside the contiguous States of the United States, the Company's management has authority to determine the extent, if any, to which such dealer shall be required to pay the annual national advertising assessment based upon its evaluation of the amount and nature of the television broadcasts received in the dealer's area. The percentage of bi-weekly purchases to be assessed for the Company's national advertising program and the amount of the maximum annual assessment for such program are both subject to being changed from time to time by action of the Board of Directors of the Company. The Company also has the authority, effective January 1, 1993 to impose a regional advertising assessment (for select geographic regions) not to exceed 2% of annual purchases with the same minimum and maximum assessments imposed by the National Advertising assessment.\nEach dealer must pay a low volume service charge if the dealer's purchases during the calendar year are less than the minimum purchase levels described below. Minimum purchase levels and the amount of the low volume service charge are subject to change from time to time by the Company's Board of Directors. Presently, the low volume service charge is $30.00 and applies beginning one (1) year after the granting of the membership, if the dealer's purchases from the Company (exclusive of\ncarload lumber purchases) are less than $4,000.00 per bi-weekly billing period. If the dealer's purchases from the Company reach $104,000 during the calendar year, then the dealer receives credit on its next bi-weekly billing statement for all low volume service charges imposed on that account earlier in the same calendar year, and the account is not subject to any further low volume service charges for the rest of the calendar year. The low volume service charge is not billed on a bi-monthly basis to those accounts whose previous year's sales volume exceeded the minimum purchases level for the previous year, but the full annual low volume service charge will be billed at year end to those accounts if the minimum purchase level to avoid imposition of the charge has not been met for the current year. For the calendar year in which the first anniversary of the store's membership occurs, the $104,000 purchase requirement is pro-rated from the first billing statement after that anniversary through December 31, if less than a full calendar year. An Ace store that falls below minimum purchase levels may also be subject to termination.\nA late payment service charge is added on any past due balance owing by a dealer to the Company for purchases of merchandise and services or for the purchase price of the capital stock of the Company subscribed for by the dealer. The late payment service charge currently in effect is an amount equal to .77% per bi-weekly statement period, except in Texas where the charge is .384% and Georgia where the charge is .692%. A past due balance is created whenever payment of the amounts shown as due on any such statement is not received by the Company within 10 days following the date of the statement. The percentage for determining the amount of the late payment service charge may be changed from time to time by the Company.\nSubscriptions to a retail training program consisting of video tapes and related course materials (the \"S.T.A.R. Program\") are mandatory for all stores located in the United States and U.S. Territories. The initial monthly assessment imposed on such stores for such subscriptions is $14.50 for each single store or parent store and $10.00 for each branch store. A single store or parent store is an initial retail outlet for which a dealer owns, or has subscribed for, one (1) share of Class A stock and forty (40) shares of Class C stock of the Company. A branch store is an additional retail outlet for which a dealer owns, or has subscribed for, fifty (50) shares of Class C stock of the Company. (See Article XXV, Section 2 of the By-laws.) Branch stores may, upon request, be granted an exemption from the monthly subscription fee.\nSubscriptions to a Material Safety Data Sheet information service are also mandatory for all stores located in the United States. The initial annual assessment imposed on such stores for such subscriptions is $30.00 for each single store or parent store and $15.00 for each branch store.\nTrademark and Service Mark Registrations\nThe names \"ACE HARDWARE\" and \"ACE\" are used extensively by the Company and by its member-dealers in connection with the promotion, advertising and marketing of products and services sold by the Company. The Company holds the following Trademark and Service Mark Registrations issued by the U.S. Patent and Trademark Office for the marks used by it:\nCurrently, the Company has applications pending before the U.S. Patent and Trademark Office for Registration of \"ACE RENTAL PLACE\" in stylized lettering design for use in connection with the rental of equipment,\nmerchandise and supplies; \"THE NEW AGE OF ACE\" with design for business consulting and retail store services; \"CELEBRATIONS\" for Christmas lights and light fixtures and \"GREAT FINISHES\" for paints, paint-like coatings, primers, lacquers, stains and varnishes. In addition, the Company also has service mark applications pending for \"ACE HOME CENTER,\" \"HELPFUL HARDWARE FOLKS,\" Repeating \"A\" in stylized lettering design and Repeating \"A\" in stylized lettering design with \"ACE\" in stylized lettering design for retail store services.\nCompetition\nThe competitive conditions in the wholesale hardware industry can be characterized as intensive due to the fact that independent retailers are required to remain competitive with discount stores and chain stores such as Wal-Mart, Home Depot, Menard's and Sears and with other mass merchandisers. The gradual shift of retail operations to high rent shopping center locations and the trend toward longer store hours have also intensified pressures to obtain low cost wholesale supply sources. The Company directly competes in several U.S. markets with Cotter & Company, Servistar Corporation, Hardware Wholesalers, Inc., Our Own Hardware Company, and United Hardware Distributing Co., all of which companies are also dealer-owned wholesalers. Of the aforementioned companies, only Cotter & Company, headquartered in Chicago, Illinois, has a larger sales volume than the Company.\nEmployees\nThe Company employs 3,664 full-time employees, of which 1,083 are salaried employees. Collective bargaining agreements covering one truck drivers' bargaining unit and four warehouse bargaining units are currently in effect at certain of the Company's distribution warehouses. The Company's employee relations with both union and non-union employees are considered to be good, and the Company has experienced no significant employee-related work stoppage in the past five years. All employees are covered either by negotiated or non-negotiated employee benefit plans which include hospitalization, death benefits and, with few exceptions, retirement benefits.\nLimitations on Ownership of Stock\nAll of the issued and outstanding shares of capital stock of the Company are owned by its dealers. Only approved retail and other dealers in hardware and related products having Membership Agreements with the Company are eligible to own or purchase shares of any class of the Company's stock.\nNo dealer, regardless of the number of member business outlets owned or controlled by him, shall be entitled to own more than 1 share of Class A Stock, which is the only class of voting stock which can be issued by the Company. This ensures that each stockholder-dealer will have an equal voice in the management of the Company. An unincorporated person or partnership shall be deemed to be controlled by another person, partnership or corporation if 50% or more of the assets or profit shares therein are owned (i) by such other person, partnership or corporation or (ii) by the owner or owners of 50% or more of the assets or profit shares of another unincorporated business firm or (iii) by the owner or owners of 50% or more of the capital stock of an incorporated business firm. A corporation shall be deemed to be controlled by another person, partnership or corporation if 50% or more of the capital stock of said corporation is owned (i) by such person, partnership or corporation or (ii) by the owner or owners of 50% or more of the capital stock of another incorporated business firm or (iii) by the owner or owners of 50% or more of the assets or profit shares of an unincorporated business firm.\nDistribution of Patronage Dividends\nThe Company operates on a cooperative basis with respect to purchases of merchandise made from it by those of its dealers who have become \"members\" of the Company as described below and in the Company's By-laws. In addition, the Company operates on a cooperative basis with respect to all dealers who have subscribed for shares but who have not as yet become\n\"members\" by reason of the fact that the payments made by them on account of the purchase price of their shares have not yet reached an amount equal to the $1,000 purchase price of 1 share of Class A Voting Stock. All member dealers falling into either of the foregoing classifications are entitled to receive patronage dividend distributions once each year from the Company in proportion to the amount of their annual purchases of merchandise from it.\nThe patronage dividends distributed on wholesale warehouse, bulletin and direct shipment sales made by the Company and on total sales of products manufactured by the Paint Division represented the following percentages of each of said categories of sales during each of the past three calendar years:\n1994 1993 1992\nWarehouse Sales 4.64117% 4.94434% 5.26838% Bulletin Sales 2.0% 2.0% 2.0% Direct Shipment Sales 1.0% 1.0% 1.0% Paint Sales 8.2205% 7.9389% 8.9440%\nIn addition to the dividends described above, patronage dividends are calculated separately and distributed on sales of lumber products, building material products and less-than-truckload (LTL) sales of lumber and building material products. Patronage dividends equal to .4073%, .1763% and .1260% of the total sales of these products (calculated separately by each of these three sales categories) were distributed to the Company's dealers who purchased those products in 1994, 1993 and 1992, respectively. Under the LTL Plus Program, patronage dividends are also calculated separately on sales of full or partial truckloads of products purchased by eligible dealers from specified vendors (see discussion of LTL Plus Program set forth above in this Item 1). The maximum amount of patronage dividends allocable to LTL Plus sales is .5% of such sales. The LTL Plus Program dividend was .5% of such sales for 1994, 1993 and 1992.\nPatronage Dividend Determinations and Allocations\nThe amounts distributed by the Company as patronage dividends consist of its gross profits on business done with dealers who qualify for patronage dividend distributions after deducting from said gross profits a proportionate share of the Company's expenses for administration and operations. Such gross profits consist of the difference between the price at which merchandise is sold to such dealers and the cost of such merchandise to the Company. All income and expenses associated with activities not directly related to patronage transactions are excluded from the computation of patronage dividends. Generally these include profits on business done with dealers who do not qualify for patronage dividend distributions and any income (loss) realized by the Company from the disposition of property and equipment (except that, to the extent that depreciation on such assets has been deducted as an expense during the time that the Company has been operating on a cooperative basis and is recaptured in connection with such a disposition, the income derived from such recapture would be included in computing patronage dividends).\nThe By-laws of the Company provide that, by virtue of a dealer being a \"member\" of the Company (that is, by virtue of his ownership of 1 share of Class A Voting Stock), he will be deemed to have consented to include in his gross income for federal income tax purposes for the dealer's taxable year in which they are received by him all patronage dividends distributed to him by the Company in connection with his purchases of merchandise from the Company. A dealer who has not yet paid an amount which at least equals the $1,000 purchase price of the 1 share of Class A Voting Stock subscribed for by him will also be required to include all patronage dividends distributed to him by the Company in his gross income for federal income tax purposes in the year in which they are received by him. This is required by virtue of a provision in the Subscription Agreement executed by him under which he expressly consents to take all such patronage dividends into his gross income for such purposes. The amount of the patronage dividends which must be included in a dealer's gross income includes both the portion of such patronage dividends received by him in cash or applied against indebtedness owing by him to the Company in\naccordance with Section 7 of Article XXIV of the Company's By-laws and the portion or portions thereof which he receives in shares of Class C Nonvoting Stock of the Company or in patronage refund certificates.\nPatronage dividends on each of the Company's three basic categories of sales (warehouse sales, bulletin sales and direct shipment sales) are allocated separately, as are patronage dividends under the LTL Plus Program. However, the maximum amount of patronage dividends allocable to LTL Plus Program sales is an amount no greater than .5% of such sales, the maximum amount of patronage dividends allocable to direct shipment sales exclusive of LTL Plus Program sales is an amount equal to 1% of such sales and the maximum amount of patronage dividends allocable to bulletin sales is an amount equal to 2% of that category of sales. All remaining patronage dividends resulting from sales made under these programs are allocated by the Company to warehouse sales. The Company feels that this allocation procedure provides a practical and understandable method for the distribution of these patronage dividends in a fair and equitable manner.\nSales of lumber and building materials products are not included as part of warehouse sales, bulletin sales, or direct shipment sales for patronage dividend purposes. Patronage dividends are calculated separately and distributed to the Company's dealers with respect to their purchases within each of three sales categories involving these types of products. These three categories are (a) lumber products (other than less-than-truckload sales); (b) building materials products (other than less-than-truckload sales); and (c) less-than-truckload (\"LTL\") sales of lumber and building material products. Patronage dividends are also calculated separately and distributed to the Company's dealers for full and partial truckloads of products purchased under the LTL Plus Program. (See the discussion of the LTL Plus Program set forth above in this Item 1 and under the subheading \"Forms of Patronage Dividend Distributions,\" subparagraphs 2(a)-(b) below).\nAny manufacturing profit realized on intracompany sales of the products manufactured by the Company's Paint Division is allocated among and distributed as patronage dividends to those member dealers who are eligible to receive patronage dividends from the Company in proportion to their respective annual dollar purchases of paint and related products manufactured by said Division. The earnings realized by the Company on wholesale sales of such products made by it to its member dealers are distributed as patronage dividends to all of its dealers who are eligible to receive patronage dividends from it as part of the patronage dividends which they receive each year with respect to the basic patronage dividend categories established for warehouse sales, bulletin sales, and direct shipment sales. Under Section 8 of Article XXIV of the Company's By-laws, if the Paint Division's manufacturing operations for any year result in a net loss, rather than a profit, to the Paint Division, such loss would be netted against the earnings realized by the Company from its other activities during the year, with the result that the earnings available from such other activities for distribution as patronage dividends for such year would be correspondingly reduced.\nForms of Patronage Dividend Distributions\nPatronage dividend distributions will be made to the eligible and qualified member dealers of the Company in cash, shares of the Company's Class C stock and patronage refund certificates in accordance with the following plan which has been adopted by the Company's Board of Directors with respect to purchases of merchandise made by such dealers from the Company on or after January 1, 1995, and which will continue to be in effect until such time as the Board of Directors, in the exercise of their authority and discretion based upon business conditions from time to time and the requirements of the Company, shall determine that such plan should be altered or amended:\n1. With respect to each store owned or controlled by each eligible and qualifying dealer, such dealer shall receive a minimum cash distribution determined as follows:\n(a) an amount equal to 20% of the first $5,000 of the total patronage dividends allocated for distribution each year to such dealer in connection with the purchases made for such store;\n(b) an amount equal to 25% of the portion of the total patronage dividends allocated for distribution each year to such dealer for such store which exceeds $5,000 but does not exceed $7,500;\n(c) an amount equal to 30% of the portion of the total patronage dividends allocated for distribution each year to such dealer for such store which exceeds $7,500 but does not exceed $10,000;\n(d) an amount equal to 35% of the portion of the total patronage dividends allocated for distribution each year to such dealer for such store which exceeds $10,000 but does not exceed $12,500;\n(e) an amount equal to 40% of the portion of the total patronage dividends allocated for distribution each year to such dealer for such store which exceeds $12,500;\n2. The portion of the total annual distribution allocated to any such dealer for each store owned or controlled by such dealer in excess of the amount to be distributed to such dealer for such store in cash shall be distributed each year in the form of shares of Class C Non-voting Stock of Ace Hardware Corporation (par value $100 per share), valued at the par value thereof, until the total par value of all shares of all classes of capital stock of the corporation held by such dealer with respect to such store equals the greater of:\n(a) $20,000; or\n(b) a sum equal to the total of the following categories of purchases made by such dealer for such store during the most recent calendar year;\n(i) 15% of the volume of warehouse (including STOP and excluding Ace manufactured paint and related products) and bulletin purchases, plus\n(ii) 15% of the volume of Ace manufactured paint and related products purchases, plus\n(iii) 3% of the volume of drop-shipment or direct purchases (excluding Ace manufactured paint and related products), plus\n(iv) 4% of the volume of lumber and building material (excluding LTL) purchases, plus\n(v) 4% of the volume of LTL Plus purchases;\nprovided, however, that no fractional shares of Class C Non-voting Stock shall be issued to any dealer and that any amount which would have otherwise been distributable as a fractional share of such stock shall instead be distributed to such dealer in cash.\n3. The portion of the total patronage dividends allocated each year to any such dealer for each store owned or controlled by such dealer which exceeds the sum of (a) the amount to be distributed to such dealer for such store in cash pursuant to Paragraph 1., above and (b) any amount to be distributed to him in the form of shares of Class C Non-voting Stock of Ace Hardware Corporation (par value $100 per share) pursuant to Paragraph 2., above shall be distributed to such dealer in cash; provided, however, that in no event shall the total amount distributed under this plan to any such dealer for any such store in cash exceed 45% of the total patronage dividends allocated for such store for such year, and to the extent that any distribution to be made to any such dealer for any store pursuant to this Paragraph 3., would otherwise cause the total cash distribution to such dealer for such store to exceed 45% of the total patronage dividends allocated for such store for such year, the distribution to be made under this Paragraph 3., shall instead be made in the form of a non-negotiable patronage refund certificate having such a maturity date and bearing interest at such an annual rate as shall be determined by the Board of Directors prior to the issuance thereof.\nPatronage dividend distributions will be made to the eligible and qualified member dealers of the Company in cash, shares of the Company's Class C stock and patronage refund certificates in accordance with the following plan which has been adopted by the Company's Board of Directors\nwith respect to purchases of merchandise made by such dealers from the Company on or after January 1, 1993, through and including December 31, 1994.\n1. With respect to each store owned or controlled by each eligible and qualifying dealer, such dealer shall receive a minimum cash distribution determined as follows:\n(a) an amount equal to 20% of the first $5,000 of the total patronage dividends allocated for distribution each year to such dealer in connection with the purchases made for such store;\n(b) an amount equal to 25% of the portion of the total patronage dividends allocated for distribution each year to such dealer for such store which exceeds $5,000 but does not exceed $7,500;\n(c) an amount equal to 30% of the portion of the total patronage dividends allocated for distribution each year to such dealer for such store which exceeds $7,500 but does not exceed $10,000;\n(d) an amount equal to 35% of the portion of the total patronage dividends allocated for distribution each year to such dealer for such store which exceeds $10,000 but does not exceed $12,500;\n(e) an amount equal to 40% of the portion of the total patronage dividends allocated for distribution each year to such dealer for such store which exceeds $12,500;\n2. The portion of the total annual distribution allocated to any such dealer for each store owned or controlled by such dealer in excess of the amount to be distributed to such dealer for such store in cash shall be distributed to him each year in the form of shares of Class C Non-voting Stock of Ace Hardware Corporation (par value $100 per share), valued at the par value thereof, until the total par value of all shares of all classes of capital stock of the corporation held by such dealer with respect to such store equals the greater of:\n(a) $20,000; or\n(b) a sum equal to the total of the following categories of purchases made by such dealer for such store during the most recent calendar year;\n(i) 13% of the volume of warehouse (including STOP and excluding Ace manufactured paint and related products) and bulletin purchases, plus\n(ii) 10% of the volume of Ace manufactured paint and related products purchases, plus\n(iii) 3% of the volume of drop-shipment or direct purchases (excluding Ace manufactured paint and related products), plus\n(iv) 4% of the volume of lumber and building material (excluding LTL) purchases, plus\n(v) 4% of the volume of LTL Plus purchases;\nprovided, however, that no fractional shares of Class C Non-voting Stock shall be issued to any dealer and that any amount which would have otherwise been distributable as a fractional share of such stock shall instead be distributed to such dealer in cash.\n3. The portion of the total patronage dividends allocated each year to any such dealer for each store owned or controlled by such dealer which exceeds the sum of (a) the amount to be distributed to such dealer for such store in cash pursuant to Paragraph 1., above and (b) any amount to be distributed to him in the form of shares of Class C Non-voting Stock of Ace Hardware Corporation (par value $100 per share) pursuant to Paragraph 2., above shall be distributed to such dealer in cash; provided, however, that in no event shall the total amount distributed under this plan to any such dealer for any such store in cash exceed 49.9% of the total patronage dividends allocated for such store for such year, and to the extent that any distribution to be made to any such dealer for any store pursuant to this Paragraph 3., would otherwise cause the total cash distribution to such dealer for such store to exceed 49.9% of the\ntotal patronage dividends allocated for such store for such year, the distribution to be made under this Paragraph 3., shall instead be made in the form of a non-negotiable patronage refund certificate having such a maturity date and bearing interest at such an annual rate as shall be determined by the Board of Directors prior to the issuance thereof.\nWith certain modifications, the above Plans are applied separately in determining the form in which patronage dividends accrued with respect to sales of lumber and building materials products are distributed. In this connection the combined patronage dividends allocated annually to a store from (a) sales of lumber products (other than LTL sales) to the store, (b) sales of building materials (other than LTL sales) to the store, and (c) LTL sales to the store are used in determining the minimum cash distribution percentages to be applied under Paragraph 1 of the above Plans. A store's patronage dividends from any other sales category with respect to which patronage dividends are distributed by the Company are not taken into account in determining either the minimum portion or any additional portion of the store's patronage dividends derived from its purchases of lumber and building materials products which is to be distributed in cash. Also, Paragraphs 2 and 3 of the above Plans are applied separately to patronage dividends on lumber and building materials sales and the requirements of Paragraph 2 of the Plans shall not be deemed to have been complied with in the cases of (a) purchases of lumber products (other than LTL purchases) or (b) purchases of building materials products (other than LTL purchases) until the store's holdings of Class C Non-voting Stock of the Company resulting from patronage dividends on the Company's sales to it within the particular one of those two sales categories for which a patronage dividend distribution is to be made equal 4% of the volume of the store's purchases within such category during the most recent calendar year. However, no such special Class C Stock requirement applies to patronage dividends accrued on LTL purchases.\nNotwithstanding the provisions of the above-described Plans, however, under Section 7 of Article XXIV of the Company's By-laws the portion of any patronage dividends which would otherwise be distributable in cash with respect to a retail dealer outlet which is a member of the Company will instead be applied against any indebtedness owing by the dealer to the Company to the extent of such indebtedness in any case where the membership for such outlet is cancelled or terminated prior to the distribution of such patronage dividends except that an amount equal to 20% of the dealer's total annual patronage dividends for such outlet will be paid in cash if a timely request for the payment of such amount in cash is submitted to the Company by the dealer.\nBecause of the requirement of the U.S. Internal Revenue Code that the Company withhold 30% of the annual patronage dividends distributed to member dealers of the Company whose places of business are located in foreign countries or Puerto Rico (except in the case of unincorporated Puerto Rico dealers owned by individuals who are U.S. citizens and certain dealers incorporated in Guam, American Samoa, the Northern Mariana Islands, or the U.S. Virgin Islands, if less than 25% of its stock is owned by foreign persons, and at least 65% of the Corporation's gross income for the last three years has been effectively connected with the conduct of a trade or business in such possession or in the United States), the cash portion of the annual patronage dividends of such dealers shall in no event be less than 30%.\nIt is anticipated that the terms of any patronage refund certificates issued pursuant to Paragraph 3. of the foregoing Plans would include provisions giving the Company a first lien thereon for the amount of any indebtedness owing to it at any time by the owner of any such certificate and provisions subordinating the certificates to all the rights and claims of secured, general and bank creditors against the Company. It is further anticipated that all such patronage refund certificates will have maturity dates which will be no later than five years from the dates of issuance thereof.\nIn order to aid the Company's dealers in acquiring and installing standardized exterior signs identifying the retail stores operated by them as member outlets supplied by the Company, the Board of Directors of the Company has authorized a program under which a dealer may borrow from the Company within a range of $100 to $20,000 the funds required for such\npurpose. A dealer who obtains a loan under this program may either repay the loan in twelve substantially equal payments billed on such dealer's regular by-weekly billing statement, or may execute a direction to have the portion of the dealer's annual patronage dividends which would otherwise be distributed under the above plan in a form other than cash from no more than the next three annual distributions of such dividends applied toward payment of the principal and interest on the loan.\nIn order to aid the Company's dealers in acquiring and installing PACE and PAINTMAKER computer systems purchased from the Company, the Board of Directors of the Company has also authorized programs under which the Company will finance, for qualified dealers, (but not to exceed 80% of the cost of any system) in the case of a PAINTMAKER computer, within the range of $1,000 to $15,000 repayable over a period of three (3) years, and in the case of a PACE computer, within the range of $5,000 to $50,000 repayable over a period of five (5) years for such purpose. Dealers who obtain financing from the Company for these purposes direct the Company, during the financing term, to first apply toward the principal and interest due on such loans, the patronage dividends which would otherwise be payable in the form of patronage refund certificates for each year, and then to apply the patronage dividends which would otherwise be payable for the same year in the form of the Company's Class C stock.\nThe aforementioned signage and computer financing programs may be revised or discontinued by the Board at any time.\nFederal Income Tax Treatment of Patronage Dividends\nBoth the shares of Class C Non-voting Stock and the patronage refund certificates used by the Company to pay patronage dividends that accrue to its eligible and qualifying dealers constitute \"qualified written notices of allocation\" within the meaning of that term as used in Sections 1381 through 1388 of the U.S. Internal Revenue Code, which specifically provide for the income tax treatment of cooperatives and their patrons and which have been in effect since 1963. The stated dollar amounts of such qualified written notices of allocation must be taken into the gross income of each of the recipients thereof for the taxable years in which they are received, not withstanding the fact that stated dollar amounts may not be received in such taxable years.\nIn order for the Company to receive a deduction from its gross income for federal income tax purposes for the amount of any patronage dividends paid by it to a patron (that is, to one of its eligible and qualifying dealers) in the form of qualified written notices of allocation, it is necessary that the Company pay (or apply against indebtedness owing to the Company by such patron in accordance with Section 7 of Article XXIV of the Company's By-laws) not less than 20% of the total patronage dividends distributable to such patron in cash and that the patron consent to having the written notices of allocation, at their stated dollar amounts, included in his gross income for the taxable year in which they are received by him. It is also required under the Code that any patronage dividend distributions deducted by the Company on its federal income tax return with respect to business done by it with patrons during the year for which such deduction is taken must be made to the Company's patrons within 8 months after the end of such year.\nDealers who have become \"members\" of the Company by owning 1 share of Class A Voting Stock are deemed under the U.S. Internal Revenue Code to have consented to take any written notices of allocation distributed to them into their gross income by their act of obtaining or retaining membership in the Company and by having received from the Company a written notification of the By-law provision providing that membership in the Company constitutes such consent. In accordance with another provision in the Internal Revenue Code, nonmember dealers who have subscribed for shares of the Company's stock will also be deemed to have consented, by virtue of the consent provisions included in their Subscription Agreements, to take any written notices of allocation distributed to them into their gross income.\nA dealer receiving a patronage refund certificate as part of the dealer's patronage dividends in accordance with the last clause of Paragraph 3 of the patronage dividend distribution plans previously described under the subheading \"Forms of Patronage Dividend Distributions\" in this Item 1, may be deemed to have received interest income in the form of an original issue discount to the extent of any excess of the face amount of the certificate over the present value of the stated principal and interest payments to be made by the Company under the terms of the certificate. Such income would be taxable to the dealer ratably over the term of the certificate under Section 7872(b) (2) of the U.S. Internal Revenue Code. The present value for this purpose is to be determined by using a discount rate equal to the applicable Federal rate in effect as of the day of issuance of the certificate, compounded semi-annually.\nThe Company will be required to withhold federal income tax on the patronage dividend distribution which is made to a payee who has not furnished his taxpayer identification number to the Company or as to whom the Company has notice of the fact that the number furnished to it is incorrect. A cooperative organization may also be required to withhold on the cash portion of each patronage dividend distribution made to a payee who becomes a member of the cooperative if the payee fails to certify to the cooperative that he is not subject to backup withholding. It is the opinion of counsel for the Company that this provision is not applicable to any patronage dividend distribution to a payee unless 50% or more of the total distribution is made in cash. Since all of the Company's patronage dividends for a given year are distributed at the same time and the Company's currently effective patronage dividend plan does not permit any store which is a member of the Company to receive more than 49.9% of its patronage dividends for the year in the form of cash, it is said counsel's further opinion that such a certification failure would ordinarily have no effect on the Company or any of its dealers.\nPatronage dividends distributed by a cooperative organization to its patrons who are located in foreign countries or certain U.S. possessions have been held to constitute fixed or determinable annual or periodic income on which such patrons are required to pay a tax of 30% of the amount received in accordance with the provisions of Sections 871(a)(1)(A) and 881(a) (1) of the Internal Revenue Code, as do patronage dividends distributed to patrons which are incorporated in Puerto Rico or who reside in Puerto Rico but have not become citizens of the United States. With respect to its dealers who are subject to such 30% tax, the Company is also obligated to withhold from their patronage dividends and pay over to the U.S. Internal Revenue Service an amount equal to the tax. The foregoing provisions do not apply to a corporation organized in Guam, American Samoa, the Northern Mariana Islands, or the U.S. Virgin Islands if less than 25% of its stock is owned by foreign persons and at least 65% of its gross income for the last three years has been effectively connected with the conduct of a trade or business in such possession or in the United States.\nThe 20% minimum portion of the patronage dividends to be paid in cash to a patron with respect to whom the Company is neither required to withhold 30% of his total patronage dividend distribution nor permitted to apply such minimum portion against indebtedness owing to it by him may be insufficient depending upon the income tax bracket of each individual patron, to provide funds for the full payment of the federal income tax for which such patron will be liable as a result of the receipt of the total patronage dividends distributed to him during the year, including cash, patronage refund certificates and\/or Class C Non-voting Stock.\nIn the opinion of the Company's management, payment in cash of not less than 20% of the total patronage dividends distributable each year to the Company's eligible and qualifying dealers will not have a material adverse effect on the operations of the Company or its ability to obtain adequate working capital for the normal requirements of its business.\nMembership Agreement\nIn addition to signing a Subscription Agreement for the purchase of shares of the Company's stock, each retail dealer who applies to become an\nAce dealer (excluding the firms which are \"International Retail Merchants\" as discussed below under the subheading \"International Retail Merchants\" in this Item 1) must sign the Company's customary Membership Agreement. A payment of $400 must accompany the signed Membership Agreement to defray the Company's estimated costs of processing the membership application. If the application is accepted, copies of both the Membership Agreement and the Stock Subscription Agreement, signed on behalf of the Company to evidence its acceptance, are forwarded to the dealer. No royalties are payable at any time by a dealer for an outlet which the Company accepts for affiliation into its dealer network. Membership may be terminated upon various notice periods and for various reasons (including voluntary termination by either party) as prescribed in the membership agreement, except to the extent that special laws or regulations applicable to specific locations may limit the Company's right to terminate memberships, or may prescribe greater periods of notice under particular circumstances.\nInternational Retail Merchants\nIn 1989, the Company's Board of Directors authorized the Company to affiliate International Retail Merchants, who operate retail businesses outside the United States, its territories and possessions. International Retail Merchants do not sign the Company's Regular Membership Agreement, but may, depending on the circumstances, be granted a license to use certain of the Company's trademarks and service marks. They do not sign stock subscription agreements or become shareholders of the Company, nor do they receive distributions of patronage dividends. As of December 31, 1994, 1993 and 1992 International Retail Merchant volume with the Company accounts for less than 4% of the Company's total sales in each such year.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's general offices are located at 2200 Kensington Court, Oak Brook, Illinois 60521. Information with respect to the Company's principal properties follows:\n(1) Includes 35,254 square feet leased to tenant until July 31, 1996. The subject property is adjacent to the Company's general offices. (2) This facility was leased by the Company in October, 1994, for use as a bulk merchandise redistribution center. (3) This facility was leased by the Company in June, 1994 for use as a freight consolidation center. (4) This facility was purchased by the Company in December, 1994 and is currently being remodeled. The Company anticipates that production will commence the second quarter of 1995. (5) This land is adjacent to the Company's LaCrosse, Wisconsin warehouse.\nThe Company also leases a fleet of transportation equipment for the primary purpose of delivering merchandise from the Company's warehouses to its dealers.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThere are no material pending legal proceedings which either individually or in the aggregate involve claims for damages that exceed 10% of the current assets of the Company and its subsidiaries on a consolidated basis.\nItem 4.","section_4":"Item 4. Submission 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\nThere is no existing market for the stock of the Company and there is no expectation that any market will develop. The Company is organized and operates as a cooperative corporation, and its stock is owned exclusively by retailers of hardware and related merchandise who are members of the Company.\nThe number of holders of record as of February 28, 1995 of each class of stock of the Company is as follows:\nTitle of Class Number of Record Holders\nClass A stock, $1,000 par value 3,901 Class B stock, $1,000 par value 803 Class C stock, $100 par value 4,770\nDividends, other than patronage dividends are prohibited by the Company's Articles of Incorporation and By-laws. See the discussion of patronage dividends under Item 1. Business.\nItem 6.","section_6":"Item 6. Selected Financial Data\n(A) The Company operates as a cooperative organization, and pays patronage dividends to member dealers on earnings derived from business done with such dealers. It is the practice of the Company to distribute substantially all patronage sourced earnings in the form of patronage dividends.\n(B) The form in which patronage dividends are to be distributed can only be determined at the end of each year when the amount distributable to each of the member dealers is known. For the five years ended December 31, 1994, patronage dividends were payable as follows:\n(C) Numbered notes refer to Notes to Financial Statements, beginning on page.\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\nLiquidity and Capital Resources\nThe Company's ability to generate cash adequate to meet its needs (\"liquidity\") results from internally generated funds, short-term lines of credit and long-term financings (see Notes 3 and 4 to the financial statements). These sources have been sufficient to finance the Company's seasonal and other working capital requirements and its capital expenditure programs.\nIn the second quarter of 1994, the Company established an unsecured revolving credit facility with a group of banks. The Company had unused unsecured lines of credit of $120.0 million at December 31, 1994. Any borrowings under these lines of credit would bear interest at the prime rate or less. Long-term financings are arranged as determined necessary to meet the Company's capital or other requirements, with principal amount, timing and form dependent on prevailing debt markets and general economic conditions.\nCapital expenditures for new and improved facilities were $28.3, $16.3 and $34.6 million in 1994, 1993 and 1992, respectively. During 1994, the Company financed the $28.3 million of capital expenditures out of current and accumulated internally generated funds, and short-term borrowings. 1995 capital expenditures are anticipated to be approximately $44.3 million primarily for a new distribution facility and improvements to existing facilities.\nAs a cooperative, the Company distributes substantially all of its patronage source earnings to its members in the form of patronage dividends, which are deductible for income tax purposes (see headings \"Patronage Dividend Determinations And Allocations\" and \"Federal Tax Treatment of Patronage Dividends\").\nThe Company expects that existing and new internally generated funds, along with established lines of credit and long-term financings, will continue to be sufficient to finance the Company's patronage dividend and capital expenditure programs.\nOperations-1994 Compared to 1993\nNet sales increased 15.3% in 1994 primarily due to increases in volume from existing dealers and increased International sales. Sales of basic hardware and paint merchandise (including warehouse, bulletin, and direct shipments) increased 13.5%. Increased advertising activity fueled strong 1994 promotional increases, particularly in the warehouse sales categories. Lumber and building material sales experienced higher percentage increases in 1994 as sales efforts were accelerated. Net dealer outlets increased in 1994 as set forth on page 1 partially reversing previous year declines. Targeted sales efforts on new store development and conversions to the Ace program and increased emphasis on dealer retail success resulted in positive 1994 dealer growth.\nGross profit increased $16.8 million or 11.2% vs. 1993 due primarily to the strong sales results in the basic sales categories and strong manufacturing profits. As a percent of sales, however, gross profit declined due to continued growth of competitively priced and promotional items within the overall sales mix. Upfront rebates through reduced handling charges and low upfront pricing programs and discounts have accelerated and reduced gross profit as a percent of sales.\nWarehouse and distribution expenses decreased by $2.3 million or 7.2%, and as a percent of sales due to increased traffic revenues and reduced building and operating costs due to the replacement of a facility in early 1993.\nSelling, general, and administration expenses increased by $9.1 million or 16.8% and as a percent of sales due to reduced net advertising income, increased personnel costs for field retail support and increased marketing costs. Increases within these expense categories are directly related to retail support of Ace dealers.\nInterest expense increased $2.2 million in 1994 due to increased borrowing levels to fund the sales growth and increased interest rates. The use of both short-term borrowings and long-term financing is expected to continue to fund planned capital expenditures (see liquidity and capital resources and Notes 3 and 4 to the financial statements).\nOther income increased $807,000 or 27.7% in 1994 due to increased interest income related to dealer financing programs and 1993 losses on asset disposals at a replaced facility which did not re-occur in 1994.\nOperations-1993 Compared to 1992\nNet sales increased 7.9% in 1993 primarily due to increases in volume from existing dealers. Sales of basic hardware and paint merchandise (including warehouse, bulletin, and direct shipments) increased 6.8%. Lumber and building material sales experienced a higher percentage increase in 1993. Net dealer outlets decreased as set forth on page 1 as a result of increased sales and marketing efforts with existing dealers and increased competition.\nGross profit increased $2.8 million or 1.9% vs. 1992 due primarily to higher net merchandise discounts and allowances. Gross profit decreased as a percent of sales, however, due to reduced handling charges on competitively priced items and shifts in the Company's sales mix.\nWarehouse and distribution expenses decreased by $641,000 or 2.0% due to decreased building rental and facility costs and increased levels of warehousing costs absorbed into cost of sales, partially offset by increased personnel and equipment costs and traffic freight subsidies.\nSelling, general, and administration expenses increased by $5.9 million or 12.2% due to higher personnel costs and marketing expenses partially offset by higher advertising and retail support income.\nInterest expense increased $1.4 million in 1993 despite lower interest rates due to increased borrowing levels resulting from the financing of planned capital expenditures and increased inventory levels.\nInflation and Changes in Prices\nThe Company's business is not generally governed by contracts that establish prices substantially in advance of the receipt of goods or services. As vendors increase their prices for merchandise supplied to the Company, the Company increases the price to its dealers in an equal amount plus the normal handling charge on such amounts. In the past, these increases have provided adequate gross profit to offset the impact of inflation on operating expenses.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements And Supplementary Data\nFinancial statements and financial statement schedules covered by the report of the Company's certified public accountants are listed on Page.\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 Company\nThe directors and the executive officers of the Company are:\nPosition(s) Held Name Age and Business Experience\nJennifer C. Anderson 44 Director since June 6, 1994; term expires 1997; President of Davis Lumber and Ace Hardware, Inc., Davis, California.\nMichael C. Bodzewski 45 Vice President-Merchandising since June, 1990; General Merchandise Manager since April, 1988.\nLawrence R. Bowman 48 Director since February 4, 1991; term expires 1995; Vice President of Owenhouse Hardware Co., Inc., Bozeman, Montana.\nDavid F. Hodnik 47 President and Chief Operating Officer since January 1, 1995; Executive Vice President and Chief Operating Officer since January, 1994; Executive Vice President and Treasurer since January, 1991; Senior Vice President and Treasurer since January, 1988; Vice President-Finance and Management Information Systems and Treasurer since September, 1986; Vice President-Finance and Treasurer from December, 1982.\nPaul M. Ingevaldson 49 Vice President-Corporate Strategy and International Business since September, 1992; Vice President- Retail Support Services since August, 1989; Vice President- Western Region since September 1, 1988; Vice President-Distribution since September, 1986; Vice President-Management Information Systems from October, 1985; Director of Data Processing from October, 1982.\nMark Jeronimus 46 Director since June 3, 1991; term expires 1997; President of Duluth Hardware, Inc., Duluth, Minnesota.\nHoward J. Jung 47 Director since June 1, 1987; term expires 1996; Vice President of Ace Hardware & Home Center, Inc., Raleigh, North Carolina.\nRita D. Kahle 38 Vice President-Finance since January, 1994; Vice President- Controller since January, 1992; Controller from July, 1988.\nJohn E. Kingrey 51 Director since May 17, 1992; term expires 1996; President of WK&K Corp., Wimberley, Texas.\nRichard E. Laskowski 53 Chairman of the Board since February 18, 1992 and Director since June 1, 1987; term expires 1995; President of Ace Hardware Home Center of Round Lake, Inc., Round Lake, Illinois.\nDavid W. League 55 Vice President-General Counsel and Secretary since June, 1990; General Counsel and Secretary since January, 1990; General Counsel since January, 1989.\nPosition(s) Held Name Age and Business Experience\nWilliam A. Loftus 56 Senior Vice President-Retail Operations and Marketing since October, 1994; Senior Vice President-Marketing and Advertising since September, 1992; Senior Vice President since January 1, 1991; Vice President-Retail Support Operations since August, 1989; Vice President-Eastern Region since September 1, 1988; Vice President- Sales since October, 1983; National Sales Manager from October, 1976.\nDavid F. Myer 49 Vice President-Retail Support and New Business since October, 1994; Vice President-Retail Support since August, 1992; Vice President- Distribution since July, 1989.\nFred J. Neer 55 Vice President-Human Resources since April, 1989; Director of Human Resources from April, 1986.\nRay W. Osborne 58 Director since June 6, 1988; term expires 1997; President of Cook & Sons Ace Hardware Company, Inc., Albertville, Alabama.\nRoger E. Peterson 57 Chief Executive Officer (CEO) since January 1, 1995; President and Chief Executive Officer (CEO) since December, 1989; President since August, 1986; Executive Vice President from March, 1985; Vice President-Operations from December, 1982.\nDonald L. Schuman 56 Vice President-Information Systems since June, 1990; Director- Information Systems since January, 1987.\nJon R. Weiss 59 Director since June 4, 1990; term expires 1996; President of John W. Weiss Hardware Company, Glenview, Illinois.\nDon S. Williams 53 Director since June 6, 1988; term expires 1997; President of Williams Lumber, Inc., Rhinebeck, New York.\nJames R. Williams 47 Director since June 5, 1989; term expires 1995; Vice President of Williams Ace Hardware, Inc., Wichita, Kansas.\nThe By-laws of the Company provide that its Board of Directors shall be comprised of such number of persons, not less than 9 and not greater than 12, as shall be fixed from time to time by the Board of Directors. A minimum of 9 of the directors shall be dealer directors. A maximum of two of the directors may be non-dealer directors. A person shall be eligible for election or appointment as a non-dealer director without regard to whether or not such person is the owner of a retail business organization which is a stockholder of Ace Hardware Corporation, or an executive officer, general partner or general manager of such a retail business organization. The By-laws also provide for three classes of directors who are to be elected for staggered 3-year terms.\nThe By-laws provide that no person is eligible to serve as a dealer director unless such person is either the owner of a retail business organization holding stock in the Company or an executive officer, general partner or general manager of such a retail business organization. Regional dealer directors are elected from geographic regions of the United States established by the Board. If the Board determines that all regions have representation by regional dealer directors and the maximum number of directors would not thereby be exceeded, then dealer directors at large may also be elected.\nIn accordance with the applicable procedure established by the By-laws, the following directors have been selected as nominees for reelection at the annual stockholders meeting to be held on June 5, 1995, as directors of the classes, from the regions, and for terms as indicated below:\nNominee Class Region Term\nRichard E. Laskowski Third 4 3 years James R. Williams Third 5 3 years Lawrence R. Bowman Third 7 3 years\nThe person named below has been selected as the nominee for election to the Board for the first time at the 1995 annual meeting as a non-dealer director of the class, and for the term indicated.\nNominee Age Class Region Term\nRoger E. Peterson 57 Third None 3 years\nReference should be made to Article IV of the By-laws for information concerning the qualifications required for membership on the Board of Directors, the terms of directors, the limitations on the total period of time for which a director may hold office, the procedure established for the designation of Nominating Committees to select certain persons as nominees for election to the Board of Directors, and the procedure for filling vacancies on the Board for the remaining portion of unexpired terms.\nNone of the events described under Item 401(f) of Regulation S-K occurred during the past 5 years with respect to any director of the Registrant, any nominee for membership on the Board of Directors of the Registrant or any executive or staff officer of the Registrant.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe following information is set forth with respect to the cash compensation paid by the Company to each of the five highest paid executive officers of the Company whose cash compensation exceeded $100,000, for services rendered by them in all capacities to the Company and its subsidiaries during the fiscal year ended December 31, 1994 and the two previous fiscal years:\n(1) The Incentive Compensation Plan covers each of the executive officers (except Mr. Peterson). The bonus amounts awarded to participants in the Plan are determined in accordance with achievement of individual performance based objectives and achievement of corporate goals. For 1991 to 1993, the maximum short-term incentive award for Messrs. Hodnik, Loftus and Ingevaldson was 18% of their respective annual salaries and for other executive officers was 15% of their annual salary. For 1994, and after, the maximum short-term incentive award for each executive officer is 20% of their respective salary. The short-term bonus award becomes payable to each participant as early as practicable at or after the end of the fiscal year. The bonus amounts for Mr. Peterson were special awards as described in the Compensation Committee Report.\n(2) The Company provides automobiles and prior to 1993 provided club memberships to certain of its executive officers. The Company requires them to maintain records with respect to any business automobile use. Such officers pay, both directly and by reimbursement to the Company, personal automobile expenses and personal charges at clubs. The compensation table set forth above includes the value of these items and such value for any officer did not exceed the lesser of $25,000 or 10% of the compensation reported for each in said table.\n(3) Includes the long-term incentive award under the Incentive Compensation Plan paid in 1994. The long-term executive award is based on corporate performance over a three year time frame (beginning with the period 1990 to 1992). For the 1993 Plan, payable in 1994, the maximum long-term incentive award for Messrs. Hodnik, Loftus, Ingevaldson, and Myer and other executive officers was 8.7% of their respective average 3 year annual salaries. The long term incentive award is determined and becomes payable to each participant as early as practicable each year if the participant is still employed by the Company on the preceding 31st of December.\nIn 1994, the incentive plan was revised and a new long term Officer Incentive Plan was adopted. The 1994 value added long-term Officer incentive plan is based upon corporate performance over a three year period with emphasis on total shareholder return through maximizing both year-end patronage dividends and upfront dividends (throughout the year) through pricing programs and discounts. This plan maintains the commitment to long-term performance and shareholder return in a cooperative environment. One third of the total long-term incentive award is subject to a one year vesting provision. Total awards granted for 1994, payable in 1995, were $105,870, $80,204, $71,221 and $48,684 for Messrs. Hodnik, Loftus, Ingevaldson and Myer, respectively.\nEffective January 1, 1995, a Long Term Incentive Compensation Deferral Option Plan was adopted. Executive officers may elect to defer a portion (20% to 100%, in 20% increments) of the annual award granted. Participants' compensation deferrals are credited with a specified rate of interest to provide a means to accumulate supplemental retirement benefits. Deferred benefits are payable over a period of 5 to 20 years. Annual elections are required for the upcoming deferral year by December of the preceding year. Of the total 1994 awards, amounts deferred were $84,696, $64,163, $71,221 and $32,456 for Messrs. Hodnik, Loftus, Ingevaldson and Myer, respectively.\n(4) Includes compensation for the Executive Supplemental Benefit Plan (ESBP), contributions to the Company's Profit Sharing Plan which has been in existence since January 1, 1953, and contributions to the Company's Retirement Benefits Replacement Plan.\nThe Board of Directors adopted the Executive Supplemental Benefit Plan (ESBP) in 1991. ESBP provides supplemental life insurance through a universal life insurance policy, supplemental long-term disability and supplemental retirement benefits to the executive officers. Under the supplemental retirement benefits portion of ESBP a formula equal to .02 of 1% of the total corporate annual Patronage Dividend times the number of executive officers participating determines the total annual supplemental retirement benefits under ESBP. This total sum for all executive officers allocated to the supplemental retirement benefits portion of ESBP cannot exceed $200,000 in any year. The sum is allocated to the executive officers and placed in the cash value portion of each participant's variable annuity insurance policy as soon as practicable in each subsequent year. During the year 1994, total contributions were $13,414 for Messrs. Peterson, Hodnik, Loftus and Ingevaldson and $10,731 for Mr. Myer.\nIn 1994, the supplemental retirement benefits portion of the ESBP was replaced with the Long Term Incentive Compensation and Deferral Option Plan, as described above. The Company funds only the base premium to keep the supplemental universal life insurance policy in force but does not contribute to supplemental retirement benefits through this vehicle. Participants may elect to deposit a portion (up to one third) of the long term incentive award into the variable annuity insurance policy in their name or may elect to defer this portion under the Deferral Option Plan.\nAll active employees are eligible to participate in the Company's profit sharing plan after one year of service. Those active employees covered by a collective bargaining agreement regarding retirement benefits, which were the subject of good faith bargaining, are not eligible if such agreement does not include them in the plan. For the year 1994, the Company contributed 10.9% of each participant's eligible compensation to the Plan. During the year 1994, $16,350 was expensed by the Company pursuant to the Plan for Messrs. Peterson, Hodnik, Loftus, Ingevaldson and Myer.\nThe Company has also established a Retirement Benefits Replacement Plan coveringall executive officers of the Company. This is an unfunded Plan under which the participants therein are eligible to receive retirement benefits equal to the amounts by which the benefits they would otherwise have been entitled to receive under the Company's Profit Sharing Plan may be reduced by reason of the limitations on contributions and benefits imposed by any current or future provisions of the U.S. Internal Revenue Code or other federal legislation. During the year 1994, amounts expensed by the Company pursuant to the Plan were $113,078 for Mr. Peterson, $42,535 for Mr. Hodnik, $26,074 for Mr. Loftus, $25,380 for Mr. Ingevaldson and $9,465 for Mr. Myer.\n(5) As a cooperative whereby all stockholders are member dealers, the Company does not grant or issue stock awards of any kind.\nMessrs. Hodnik, Loftus, and Ingevaldson are employed under contracts, each dated October, 1994 for respective terms of two years, terminating December 31, 1996. Mr Myer is employed under a contract dated December 15, 1993 for a two year term terminating December 31, 1995. The contracts provide for annual compensation effective January 1, 1995 of $450,000, $275,000, $247,000, and $187,000 respectively or such increased amount, if any, as shall be approved by the Board of Directors.\nThe Company also maintains a Pension Plan which has been in existence since December 31, 1970. All active employees are eligible to participate in this Plan on the first January 1 that they are working for the Company. Those active employees covered by a collective bargaining agreement regarding retirement benefits, which were the subject of good faith bargaining are not eligible if such agreement does not include them in the plan. The Plan provides benefits at retirement at or after age 65 determined under a formula which takes into account 60% of a participant's average base pay (including overtime) during the 5 highest consecutive calendar years of employment and years of service prior to age 65, and under which an offset is applied for the straight life annuity equivalent of the vested portion of the participant in the amount of benefits provided for them by the Company under the Profit Sharing Plan.\nExamples of yearly benefits provided by the Pension Plan (prior to reduction by the Profit Sharing Plan offset) are as follows:\nYears of Service Remuneration 10 15 20 25 30 or more\n$200,000 $40,000 $60,000 $80,000 $90,000 $90,000 $150,000 30,000 45,000 60,000 75,000 90,000 $100,000 20,000 30,000 40,000 50,000 60,000 $ 50,000 10,000 15,000 20,000 25,000 30,000\nThe amounts shown above represent straight life annuity amounts. Maximum benefits from the Pension Plan are attained after 30 years of service and attainment of age 65. The compensation covered by the Pension Plan consists of base compensation (exclusive of bonuses and non-recurring salary or wage payments) and shall not exceed $150,000 of such total remuneration paid to a participant during any plan year. Remuneration and yearly benefits under the Plan are limited, and subject to adjustment, under Sections 415(d) and 401(a)17 of the U.S. Internal Revenue Code. The present credited years of service under the Pension Plan for the currently employed executive officers named in the compensation table are as follows:\nRoger E. Peterson-18 years; David F. Hodnik-22 years; William A. Loftus-18 years; Paul M. Ingevaldson-15 years; David F. Myer-13 years.\nCompensation Committee Report\nThe corporation's Executive Compensation philosophy is one that supports the Company's fundamental business strategies. We stress long term measured results, focus on teamwork, accepting prudent risks, and are strongly committed to fulfilling dealer\/consumer needs.\nOur compensation program reflects a policy of competitive performance based pay. Our competitors for Human Resources include publicly owned for profit retail corporations, privately owned for profit retail enterprises, and other national cooperatives. Each of these comparative groupings has quite a different compensation practice\/philosophy. An annual review is performed of executive cash compensation at competitor enterprises. Our orientation is to be cognizant of their respective practices and pay levels, but to give greater emphasis to that which supports the needs of our dealer network.\nIn 1994, the Compensation Committee changed the compensation mix to one which stresses the provision of more significant performance based incentives, particularly long term. 1994 salary increases for executive officers, excluding Mr. Peterson, averaged 8.8% per eligible executive. Annual and long term incentive opportunities were increased beginning in 1994, with substantive changes in long term performance criteria. Individual, isolated criteria to achieve results have been eliminated due to their emphasis on short-term decisions. Long-term performance is evaluated heavily on a measurement of total shareholder return including both year-end patronage dividends and upfront dividends through low-upfront pricing programs and discounts. This criteria maximizes total return to our membership.\nAs it relates to the President\/CEO compensation, the Committee in the past relied on providing the President\/CEO with a base salary without either annual or long term incentives. The primary rationale for this was to allow the President\/CEO to make objective recommendations pertaining to incentive eligible officers without the incumbrance of a personal stake associated with the same performance criteria. In connection with the pending retirement of the CEO in May, 1995 and the election of a new President effective January 1, 1995, this has changed so as to ensure the commitment of the President position to the longer term interest of our dealer network. Effective in 1995, the President's compensation includes a base salary and a long-term incentive award only (no short-term award) so as to maintain the commitment to long-term performance and shareholder return.\nFor 1994 and 1993, special incentive awards of $125,000 and $100,000 were granted to the CEO. This was warranted due to his exclusion from all previous incentive awards, exceptional Company results during these years and Mr. Peterson's long-term contribution to the success of Ace and its retailers.\nThe Committee reviews the executive benefits provided all senior executives. Country club memberships previously granted to some officers have been eliminated, except for the President.\nCompensation of Directors\nEffective January 1, 1995, and January 1, 1994, each member of the Board of Directors receives a monthly fee of $2,650 and $2,500, respectively, for their services. Effective as of the foregoing dates, Mr. Laskowski is paid a total annual fee of $110,000 and $100,000 per year, respectively, in his capacity as Chairman of the Board.\nIn 1994, the previous Deferred Director Fee Plan was amended, restated and retitled the Directors' Deferral Option Plan. Like the Officers' Long Term Incentive Compensation Deferral Option Plan, under this Directors' Plan, directors may elect to defer a portion (5% to 100%, in 5% increments)\nof their annual director's fee. Deferred benefits are payable over a period of 5 to 20 years, as elected. Annual elections are required for the upcoming deferral year by December of the preceding year.\nEach member of the Board is also reimbursed for the amount of travel and lodging expenses incurred in attending meetings of the Board and of the Committees of the Board. The expenses incurred by them in attending the semi-annual conventions and exhibits which the Company sponsors are also paid by the Company. Each member of the Board is also paid $200.00 per diem compensation for special committee meetings and nominating committee regional trips attended.\nItem 12.","section_12":"Item 12. Security Ownership Of Certain Beneficial Owners And Management\nWith the exception of Mr. Laskowski, no shares of the Company's stock were held by any of its officers. No person owns of record or is known by the Company to own beneficially more than five percent of the outstanding voting securities of the Company.\nThe following table sets forth the shares of Class B Stock and Class C Stock of the Company held beneficially, directly or indirectly, by each director owning such shares, individually itemized, and by all officers and directors as a group, as of February 15, 1995:\nThere are no known contractual arrangements nor any pledge of securities of the Company which may at a subsequent date result in a change in control of the Company.\nItem 13.","section_13":"Item 13. Certain Relationships And Related Transactions\nNo director, executive officer, security holder who is known to the Registrant to own of record or beneficially more than five percent of any class of the Registrant's voting securities, or any member of the immediate family of any of the foregoing persons, had during the last fiscal year or is currently proposed to have any material interest, direct or indirect, in any transaction in which the amount involved exceeds $60,000 and to which the Registrant was or is to be a party, except that each of the directors purchased merchandise and services from the Registrant in the ordinary course of business on behalf of the retail hardware businesses in which they have ownership interests. None of such persons received benefits not shared by other hardware retailers supplied by the Registrant.\nNo director has had any business relationship which is required to be disclosed pursuant to Item 404(b) of Regulation S-K of the Securities and Exchange Commission, during the Registrant's last fiscal year. Mr. Peterson, who is a director nominee, and has announced his retirement as CEO of the Company effective May 31, 1995 is subject to an agreement through May 31, 2000 providing for non competition within the industry, participation in designated Company functions and total renumeration of $150,000 per year over the 5 year term.\nNo director, director nominee, executive officer, any member of the immediate family of any of the foregoing, or any corporation or organization of which any of the foregoing is an executive officer, partner, or, directly or indirectly, the beneficial owner of ten percent or more of any class of equity securities, or any trust or other estate in which any of the foregoing has a substantial beneficial interest or as to which such person serves as a trustee or in a similar capacity, has been indebted to the Registrant or its subsidiaries at any time since the beginning of the Registrant's last fiscal year in an amount in excess of $60,000, except for indebtedness incurred in connection with purchases of merchandise and services made from the Registrant in the ordinary course of business by the retail hardware businesses in which the directors have ownership interest.\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 in the accompanying index (page) to the financial statements are filed as part of this annual report.\n2. Financial Statement Schedules\nThe financial statement schedules listed in the accompanying index (page) to the financial statements are filed as part of this annual report.\n3. Exhibits\nThe exhibits listed on the accompanying index to exhibits (pages E-1 through E-6) are filed as part of this annual report.\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 Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nACE HARDWARE CORPORATION\nBy RICHARD E. LASKOWSKI Richard E. Laskowski Chairman of the Board and Director\nDATED: March 23, 1995\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.\nSignature Title Date\nRICHARD E. LASKOWSKI Chairman of the Board March 23, 1995 Richard E. Laskowski and Director\nROGER E. PETERSON Chief Executive Officer March 23, 1995 Roger E. Peterson\nDAVID F. HODNIK President and March 23, 1995 David F. Hodnik Chief Operating Officer\nRITA D. KAHLE Vice President-Finance March 23, 1995 Rita D. Kahle (Principal Financial Officer)\nJennifer C. Anderson, Directors Lawrence R. Bowman, Mark Jeronimus, Howard J. Jung, John E. Kingrey, Ray W. Osborne, Don S. Williams, Jon R. Weiss and James R. Williams\n*By DAVID F. HODNIK David F. Hodnik\n*By RITA D. KAHLE Rita D. Kahle\n*Attorneys-in-fact March 23, 1995\nItem 14(a). Index To Financial Statements And Financial Statement Schedules\nPage(s)\nIndependent Auditors' Report\nBalance Sheets at December 31, 1994 and 1993\nStatements of Earnings for each of the three years in the period ended December 31, 1994\nStatements of Member Dealers' Equity for each of the three years in the period ended December 31, 1994\nStatements of Cash Flows for each of the three years in the period ended December 31, 1994\nNotes to Financial Statements\nFinancial Statement Schedule for each of the three years in the period ended December 31, 1994:\nII-Valuation and qualifying accounts - Allowance for doubtful accounts\nAll other schedules have been omitted because the required information is not present or is not present in amounts sufficient to require submission of the schedule or the required information is included in the financial statements or the notes thereto.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Ace Hardware Corporation:\nWe have audited the balance sheets of Ace Hardware Corporation as of December 31, 1994 and 1993, and the related statements of earnings, member dealers' equity, and cash flows for each of the years in the three-year period ended December 31, 1994. In connection with our audits of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\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 Ace Hardware Corporation at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1994 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.\nKPMG PEAT MARWICK LLP\nChicago, Illinois January 31, 1995\n(Table Continued on following page)\nACE HARDWARE CORPORATION\nNOTES TO FINANCIAL STATEMENTS\n(1) Summary of Significant Accounting Policies\n(a) The Company and Its Business The Company operates as a wholesaler of hardware and related products, and manufactures paint products. As a dealer-owned cooperative, the Company distributes substantially all of its patronage sourced earnings in the form of patronage dividends to its member dealers based on their volume of merchandise purchases.\n(b) Cash Equivalents The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents.\n(c) Receivables Receivables from dealers include amounts due from the sale of merchandise and special equipment used in the operations of dealers' businesses. Other receivables are principally amounts due from suppliers for promotional and advertising allowances.\n(d) Inventories Inventories are valued at the lower of cost or net realizable value. Cost is determined using the last-in, first-out method on substantially all inventories.\n(e) Property and Equipment Property and equipment are stated at cost less accumulated depreciation and amortization. Expenditures for maintenance, repairs and renewals of relatively minor items generally are charged to earnings. Significant improvements or renewals are capitalized.\nDepreciation expense is computed on both straight-line and accelerated methods based on estimated useful lives as follows:\nUseful Life Principal Years Depreciation Method\nBuildings and improvements 10-40 Straight line Warehouse equipment 5-10 Sum of years Office equipment 3-10 Various Manufacturing equipment 3-20 Straight line Transportation equipment 3-7 Straight line\nLeasehold improvements are generally amortized on a straight-line basis over the term of the respective leases.\n(f) Retirement Plans The Company has retirement plans covering substantially all non-union employees. Costs with respect to the noncontributory pension plans are determined actuarially and consist of current costs and amounts to amortize prior service costs and unrecognized gains and losses. The Company contribution under the profit sharing plan is determined annually by the Board of Directors.\n(g) Reclassifications Certain financial statement reclassifications have been made to prior year amounts to conform to comparable classifications followed in 1994.\nACE HARDWARE CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(Continued)\n(2) Inventories Inventories consist primarily of merchandise inventories. Substantially all of the Company's inventory is valued on the last-in, first-out (LIFO) method; the excess of replacement cost over the LIFO value of inventory was approximately $65,052,000 and $63,615,000 at December 31, 1994 and 1993, respectively. Indirect costs, consisting primarily of warehousing costs, are absorbed as inventory costs rather than period costs.\n(3) Short-Term Borrowings Short-term borrowings were utilized during 1994 and 1993. The maximum amount outstanding at any month-end during the period was $115,500,000 in 1994 and $91,000,000 in 1993. The interest rate effective as of December 31, 1994 and 1993 was 6.5% and 3.6%, respectively. Short term borrowings outstanding as of December 31, 1994 and 1993 were $30,000,000 and $38,500,000, respectively. At December 31, 1994 the Company has available a revolving credit facility with a group of banks providing for $100 million in committed lines and $50 million in uncommitted lines. The aggregate unused line of credit available at December 31, 1994 and 1993 was $120,000,000 and $69,000,000, respectively. At December 31, 1994, the Company had no compensating balance requirements. Aggregate compensating balances (not legally restricted) at December 31, 1993 were $600,000.\n(4) Long-Term Debt Long-term debt is comprised of the following:\nACE HARDWARE CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(Continued)\nPrime interest rates in effect ranged from 6.0% to 8.5% in 1994 and were 6.0% in 1993.\nAggregate maturities of long-term debt are $7,369,000, $7,060,000, $6,131,000, $6,064,000 and $5,972,000 in 1995 through 1999, respectively.\nThe fair value of the Company's debt based upon discounting of future cash flows does not materially vary from the carrying value of such debt as of December 31, 1994.\n(5) Patronage Dividends and Refund Certificates Payable The Company operates as a cooperative organization and has paid or will pay patronage dividends to member dealers on the portion of earnings derived from business done with such dealers. Patronage dividends are allocated in proportion to the volume of purchases by member dealers during the period. The amount of patronage dividends to be remitted in cash depends upon the level of dividends earned by each member outlet, varying from 20% on the total dividends under $5,000 and increasing by 5% on total dividends for each subsequent $2,500 earned to a maximum of 40% on total dividends exceeding $12,500. All amounts exceeding the cash portions will be distributed in the form of Class C $100 par value stock, to a maximum based upon the current year's purchase volume or $20,000 whichever is greater, and thereafter in a combination of additional cash and patronage refund certificates having maturity dates and bearing interest as determined by the Board of Directors. A portion of the dealer's annual patronage dividends distributed under the above plan in a form other than cash can be applied toward payment of principal and interest on any balances outstanding for approved exterior signage and computer equipment financing.\nThe patronage dividend composition for 1994, 1993 and 1992 follows:\nPatronage dividends are allocated on a calendar year basis with issuance in the following year.\nThe patronage refund certificates outstanding at December 31, 1994 are payable as follows:\nACE HARDWARE CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(Continued)\nOn January 1, 1994 the Company prepaid a portion of the patronage refund certificates payable on January 1, 1995 and accordingly, these certificates are classified as current liabilities in the December 31, 1993 balance sheet. The remaining patronage refund certificates payable on January 1, 1995 will be paid in January 1995.\n(6) Retirement Plans The Company has defined benefit pension plans covering substantially all non-union employees. Benefits are based on years of service, highest average compensation (as defined) and the related profit sharing and primary social security benefit. Contributions to the plan are based on the Entry Age Normal, Frozen Initial Liability actuarial funding method and are limited to amounts that are currently deductible for tax reporting purposes. As of December 31, 1994, plan assets were held primarily in group annuity and guaranteed interest contracts, equities and mutual funds.\nPension income for the years 1994, 1993 and 1992 included the following components:\nThe following table sets forth the funded status of the plans and amounts recognized in the Company's Balance Sheet at December 31, 1994 and 1993 (September 30th measurement date):\nACE HARDWARE CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(Continued)\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 7.0% in 1994 and 7.5% in 1993. The related expected long-term rate of return was 8.0% in 1994 and 8.5% in 1993. The rate of increase in future compensation was projected using actuarial salary tables plus 1% in 1994 and using a rate of 6% in 1993.\nThe Company also participates in several multi-employer plans covering union employees. Amounts charged to expense and contributed to the plans totaled approximately $282,000, $275,000, and $426,000 in 1994, 1993 and 1992, respectively.\nThe Company's profit sharing plan contribution for the years ended 1994, 1993, and 1992 was approximately $9,381,000, $8,690,000 and $7,374,000, respectively.\nThe Company has no significant post-retirement benefit liabilities as defined under Financial Accounting Standard No. 106.\n(7) Income Taxes As a cooperative, the Company distributes substantially all of its patronage sourced earnings to its members in the form of patronage dividends. The 1994, 1993 and 1992 provisions for federal income taxes were $924,000, $141,000 and $162,000, respectively, and for state income taxes were $560,000, $287,000 and $409,000, respectively.\nThe Company made tax payments of $1,428,000, $357,000, and $728,000 during 1994, 1993 and 1992, respectively.\n(8) Member Dealers' Equity The Company's founders for many years contemplated that the ownership of the Company would eventually be with the Company's member dealers. Prior to November 30, 1976, dealers deposited monies to the Ace Dealer's Perpetuation Fund for the purpose of accumulating funds for the purchase of stock when such ownership became available. The Company registered its stock with the Securities and Exchange Commission on October 1, 1976 and existing dealers who subscribed for stock applied their deposits toward payment of such shares. The small number of dealers who did not subscribe for shares had their respective deposits refunded during 1977.\nACE HARDWARE CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(Continued)\nThe Company's classes of stock are described below:\nAt December 31, 1994 and 1993 there were no common shares reserved for options, warrants, conversions or other rights; nor were any options granted or exercised during the two years then ended.\nMember dealers may subscribe for the Company's stock in various prescribed combinations. Only one share of Class A Stock may be owned by a dealer with respect to the first member retail outlet controlled by such dealer. Only four shares of Class B Stock may be owned by a dealer with respect to each retail outlet controlled by such dealer, but only if such outlet was a member of the Company on or before February 20, 1974. An appropriate number of shares of Class C Stock must be included in any subscription by a dealer in an amount to provide that such dealer has a par value of all shares subscribed for equal to $5,000 for each retail outlet. Unregistered shares of Class C Stock are also issued to dealers in connection with patronage dividends. No dividends can be declared on any shares of any class of the Company's Stock.\nUpon termination of the Company's membership agreement with any retail outlet, all shares of stock of the Company, held by the dealer owning or controlling such outlet, must be sold back to the Company, unless a transfer of such shares is made to another party accepted by the Company as a member dealer with respect to the same outlet.\nA Class A share is issued to a member dealer only when the share subscribed has been fully paid. Class B and Class C shares are only issued when all such shares subscribed with respect to a retail outlet have been fully paid. Additional Stock Subscribed in the accompanying statements represents the par value of shares subscribed, reduced by the unpaid portion.\nACE HARDWARE CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(Continued)\nAll shares of stock are currently issued and repurchased at par value, except for Class B Stock which is repurchased at twice its par value, or $2,000 per share. Upon retirement of Class B shares held in treasury, the excess of redemption price over par is allocated equally between contributed capital and retained earnings.\nTransactions during 1993 and 1994 affecting treasury shares follow:\n(9) Commitments Leased property under capital leases is included under \"Property and Equipment\" in the balance sheets as follows:\nACE HARDWARE CORPORATION\nNOTES TO FINANCIAL STATEMENTS-(Continued)\nThe Company rents buildings and warehouse, office and certain other equipment under operating and capital leases. At December 31, 1994 annual minimum rental commitments under leases that have initial or remaining noncancelable terms in excess of one year were as follows:\nYear Ending Capital Operating December 31, Leases Leases (000's omitted)\n1995 $502 $ 9,421 1996 271 7,746 1997 -- 5,768 1998 -- 4,502 1999 -- 3,448 Thereafter -- 24,780\nTotal minimum lease payments $773 $55,665\nLess amount representing interest 47\nPresent value of total minimum lease payments $726\nAll leases expire prior to 2010. Under certain leases, the Company pays real estate taxes, insurance and maintenance expenses in addition to rental expense. Management expects that in the normal course of business, leases that expire will be renewed or replaced by other leases. Rent expense was approximately $21,814,000, $21,444,000 and $21,073,000 in 1994, 1993 and 1992, respectively. Rent expense includes $4,382,000, $4,282,000 and $3,706,000 in contingent rentals paid in 1994, 1993 and 1992, respectively, primarily for transportation equipment mileage.\n(10) Supplementary Income Statement Information Gross media expense, prior to income offsets from dealers and suppliers, amounting to $52,185,000, $48,293,000 and $47,813,000 were charged to operations in 1994, 1993, and 1992, respectively.\n(11) Interest Expense and Other Income, Net Capitalized interest totaled $213,000, $29,000 and $836,000 in 1994, 1993 and 1992, respectively. Interest paid was $13,518,000, $10,670,000 and $9,149,000 in 1994, 1993 and 1992, respectively.\nINDEX TO EXHIBITS\nExhibits Enclosed Description\n21 Subsidiaries of the Registrant. 24 Powers of Attorney.\nExhibits Incorporated by Reference\n2 Not Applicable\n3-A Restated Certificate of Incorporation of the Registrant dated September 18, 1974 filed as Exhibit 3-A to the Registrant's Form S-1 Registration Statement (Registra- tion No. 2-55860) on March 30, 1976 and incorporated herein by reference.\n3-B By-laws of the Registrant as amended on September 20, 1994 included as Appendix A to the Prospectus constitut- ing a part of the Registrant's Form S-2 Registration Statement filed on or about March 23, 1995 and incorporated herein by reference.\n3-C Certificate of Amendment to the restated Certificate of Incorporation of the Registrant dated May 19, 1976 filed as Exhibit 3-D to Amendment No. 1 to the Registrant's Form S-1 Registration Statement (Registration No. 2-55860) on June 10, 1976 and incorporated herein by reference.\n3-D Certificate of Amendment to the restated Certificate of Incorporation of the Registrant dated May 21, 1979 filed as Exhibit 3-F to Amendment No. 1 to the Registrant's Form S-1 Registration Statement (Registration No. 2-63880) on May 23, 1979 and incorporated herein by reference.\n3-E Certificate of Amendment to the restated Certificate of Incorporation of the Registrant dated June 7, 1982 filed as Exhibit 3-G to the Registrant's Form S-1 Registration Statement (Registration No. 2-82460) on March 16, 1983 and incorporated herein by reference.\n3-F Certificate of Amendment to the restated Certificate of Incorporation of the Registrant dated June 5, 1987 filed as Exhibit 3-F to the Registrant's Form S-1 Registration Statement (Registration No. 33-4299) on March 29, 1988 and incorporated by reference.\n3-G Certificate of Amendment to the restated Certificate of Incorporation of the Registrant dated June 16, 1989 filed as Exhibit 4-G to Post Effective Amendment No. 1 to the Registrant's S-2 Registration Statement filed on or about March 20, 1990 and incorporated by reference.\n4-A Specimen copy of Class B stock certificate as revised as of November, 1984, filed as Exhibit 4-A to Post-Effective Amendment No. 2 to the Registrant's Form S-1 Registration Statement (Registration No. 2-82460) on March 15, 1985 and incorporated herein by reference.\n4-B Specimen copy of Patronage Refund Certificate as revised in 1988 filed as Exhibit 4-B to Post-Effective Amendment No. 2 to the Registrant's Form S-1 Registration Statement (Registration No. 33-4299) on March 29, 1988 and incorporated herein by reference.\nE-1\nExhibits Incorporated by Reference\n4-C Specimen copy of Class A stock certificate as revised in 1987 filed as Exhibit 4-C to Post-Effective Amendment No. 2 to the Registrant's Form S-1 Registration Statement (Registration No. 33-4299) on March 29, 1988 and incorporated herein by reference.\n4-D Specimen copy of Class C stock certificate filed as Exhibit 4-I to the Registrant's Form S-1 Registration Statement (Registration No. 2-82460) on March 16, 1983 and incorporated herein by reference.\n4-E Copy of current standard form of Subscription for Capital Stock Agreement to be used for dealers to subscribe for shares of the Registrant's stock in conjunction with new membership agreements submitted to the Registrant filed as Exhibit 4-L to Post-Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorporated herein by reference.\n4-F Copy of plan for the distribution of patronage dividends with respect to purchases of merchandise made from the Registrant on or after January 1, 1995 adopted by the Board of Directors of the Registrant on July 26, 1994 filed as Exhibit 4-M to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n4-G Copy of plan for the distribution of patronage dividends with respect to purchases of merchandise made from the Registrant on or after January 1, 1993 through December 31, 1994, adopted by the Board of Directors of the Registrant on December 8, 1992, filed as Exhibit 4-M to Post-Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorpoated herein by reference.\n9 No Exhibit\n10-A Copy of Retirement Benefits Replacement Plan of the Registrant, restated as of January 1, 1989, filed as Exhibit 10-A to Post-Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorporated herein by reference.\n10-B Copy of resolutions amending the 1990 Incentive Compensation Plans for Executives and establishing the Executive Supplemental Benefit Plans of the Registrant adopted by its Board of Directors on December 11, 1990 and filed as Exhibit 10-G to Post Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-27790) on March 20, 1991 and incorporated herein by reference.\n10-C Copy of amendment to the Executive Supplemental Benefits Plan of the Registrant adopted by its Board of Directors on July 30, 1991 filed as Exhibit 10-E to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 23, 1992 and incorporated herein by reference.\n10-D Copy of amendment to the Executive Supplemental Benefits Plan of the Registrant adopted by its Board of Directors on December 9, 1991 filed as Exhibit 10-F to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 23, 1992 and incorporated herein by reference.\nE-2\nExhibits Incorporated by Reference\n10-E Copy of the \"Ace Hardware Corporation Officer's (sic) Incentive Compensation Plan\" as amended and restated effective January 1, 1994, filed as Exhibit 10-G to Post-Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorporated herein by reference.\n10-F Copy of Employment Agreement dated October 4, 1994 between Ace Hardware Corporation and Paul M. Ingevaldson filed as Exhibit 10-F to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-G Copy of Employment Agreement dated October 4, 1994 between Ace Hardware Corporation and David F. Hodnik filed as Exhibit 10-G to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-H Copy of Employment Agreement dated October 12, 1994 between Ace Hardware Corporation and William A. Loftus filed as Exhibit 10-H to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-I Copy of Employment Agreement effective January 1, 1993 between Ace Hardware Corporation and Roger E. Peterson filed as Exhibit 10-K to Post Effective Amendment No. 1 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 22, 1993 and incorporated herein by reference.\n10-J Copy of Employment Agreement effective January 1, 1993 between Ace Hardware Corporation and Paul Ingevaldson filed as Exhibit 10-I to Post Effective Amendment No. 1 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 22, 1993 and incorporated herein by reference.\n10-K Copy of Employment Agreement effective January 1, 1993 between Ace Hardware Corporation and David F. Hodnik filed as Exhibit 10-J to Post Effective Amendment No. 1 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 22, 1993 and incorporated herein by reference.\n10-L Copy of Employment Agreement effective January 1, 1993 between Ace Hardware Corporation and William A. Loftus filed as Exhibit 10-L to Post Effective Amendment No. 1 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on or about March 22, 1993 and incorporated herein by reference.\n10-M Copy of Loan Agreement with Anne Arundel County, Maryland dated December 1, 1981 securing 15-year floating rate industrial development revenue bonds in the principal sum of $9 million held by The Northern Trust Company, Chicago, Illinois, for itself and other participating lenders filed as Exhibit 10-A-k to Post-Effective Amendment No. 3 to the Registrant's Form S-1 Registration Statement (Registration No. 2-63880) on March 9, 1982 and incorporated herein by reference.\n10-N Copy of Note Purchase and Private Shelf Agreement with the Prudential Insurance Company of America dated September 27, 1991 securing 8.74% Senior Series A Notes in the principal sum of $20,000,000.00 with a maturity date of July 1, 2003 filed as Exhibit 10-A-q to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 23, 1992 and incorporated herein by reference.\nE-3\nExhibits Incorporated by Reference\n10-O Copy of Standard Form of Ace Hardware International Retail Merchant Agreement adopted in 1990, filed as Exhibit 10-A-q to Post Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-27790) on March 20, 1991 and incorporated herein by reference.\n10-P Copy of current standard form of Ace Hardware Membership Agreement filed as Exhibit 10-P to Post-Effective Amendment No. 2 to the Registrant's form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorporated herein by reference.\n10-Q Copy of 6.89% Senior Series B notes in the aggregate principal sum of $20,000,000 issued July 29, 1992 with a maturity date of January 1, 2000 pursuant to Note Purchase and Private Shelf Agreement with the Prudential Insurance Company of America dated September 27, 1991 and filed as Exhibit 10-A-r to Post Effective Amendment No. 1 to the Registrant's Form S-2 Registration Statement on March 22, 1993 and incorporated herein by reference.\n10-R Copy of 6.47% Senior Series A notes in the aggregate principal amount of $30,000,000 issued September 22, 1993 with a maturity date of June 22, 2008, and $20,000,000 Private Shelf Facility, pursuant to Note Purchase and Private Shelf Agreement with the Prudential Insurance Company of America dated as of September 22, 1993, filed as Exhibit 10-R to Post-Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorporated herein by reference.\n10-S Assignment and Assumption dated October 22, 1992 of Lease dated August 31, 1992 with MTI Vacations, Inc. filed as Exhibit 10-A-s to Post Effective Amendment No. 1 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 22, 1993 and incorporated herein by reference.\n10-T Copy of Amendment to the Executive Supplemental Benefit Plans of the Registrant adopted by its Board of Directors on March 17, 1992 and filed as Exhibit 10-A-t to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 22, 1993 and incorporated herein by reference.\n10-U Copy of Lease dated September 30, 1992 for general offices of the Registrant in Oak Brook, Illinois filed as Exhibit 10-A-u to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on March 22, 1993 and incorporated herein by reference.\n10-V Copy of Fourth Amendment to Executive Supplemental Benefit Plans effective January 1, 1994 filed as Exhibit 10-V to Post-Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorporated herein by reference.\n10-W Copy of Ace Hardware Corporation Deferred Director Fee Plan as amended on June 8, 1993, filed as Exhibit 10-W to Post-Effective Amendment No. 2 to the Registrant's Form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorporated herein by reference.\n10-X Copy of Ace Hardware Corporation Deferred Compensation Plan effective January 1, 1994, filed as Exhibit 10-X to Post-Effective Amendment No. 2 to the Registrants Form S-2 Registration Statement (Registration No. 33-46449) on or about March 23, 1994 and incorporated herein by reference.\nE-4\nExhibits Incorporated by Reference\n10-Y Copy of Lease dated September 22, 1994 for bulk merchandise redistribution center of the Registrant in Carol Stream, Illinois filed as Exhibit 10-Y to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-Z Copy of Lease dated May 4, 1994 for freight consolidation center of the Registrant in Chicago, Illinois filed as Exhibit 10-Z to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-1 Copy of Long-Term Incentive Compensation Deferral Option Plan of the Registrant effective January 1, 1995 adopted by its Board of Directors on December 6, 1994 filed as Exhibit 10-a-1 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-2 Copy of Directors' Deferral Option Plan of the Registrant effective January 1, 1995 adopted by its Board of Directors on December 6, 1994 filed as Exhibit 10-a-2 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-3 Copy of Employment Agreement dated March 22, 1994 between Ace Hardware Corporation and Fred J. Neer filed as Exhibit 10-a-3 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-4 Copy of Employment Agreement dated March 22, 1994 between Ace Hardware Corporation and Donald L. Schuman filed as Exhibit 10-a-4 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-5 Copy of Employment Agreement dated December 13, 1993 between Ace Hardware Corporation and David W. League filed as Exhibit 10-a-5 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-6 Copy of Employment Agreement dated December 15, 1993 between Ace Hardware Corporation and David F. Myer filed as Exhibit 10-a-6 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-7 Copy of Employment Agreement dated March 24, 1994 between Ace Hardware Corporation and Michael C. Bodzewski filed as Exhibit 10-a-7 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-8 Copy of Employment Agrement dated December 15, 1993 between Ace Hardware Corporation and Rita D. Kahle filed as Exhibit 10-a-8 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n10-a-9 Copy of Agreement dated January 6, 1995 between Ace Hardware Corporation and Roger E. Peterson filed as Exhibit 10-a-9 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\nE-5\nExhibits Incorporated by Reference\n10-a-10 Copy of Ace Hardware Corporation Officer Incentive Plan for Fiscal Year 1994 filed as Exhibit 10-a-10 to the Registrant's Form S-2 Registration Statement on or about March 23, 1995 and incorporated herein by reference.\n11 No Exhibit.\n12 No Exhibit.\n13 No Exhibit.\n16 Not Applicable.\n18 No Exhibit.\n22 Not Applicable.\n23 Auditors' Consent, dated March 23, 1995, filed as Exhibit 23(a) to the Registrant's Form S-2 Registration Statement filed on or about March 23, 1995 and incorporated herein by reference.\n27 No Exhibit.\n28 Not Applicable.\nSupplemental Information to be Furnished with Reports Filed Pursuant to Section 15(d) of the Act by Registrants which have not Registered Securities Pursuant to Section 12 of the Act.\nAs of the date of the foregoing Report, no annual report for the Registrant's year ended December 31, 1994, nor any proxy soliciting materials for the Registrant's 1995 annual meeting have been sent to security holders. Copies of such Annual Report and proxy soliciting materials will subsequently be sent to security holders and furnished to the Securities and Exchange Commission.\nE-6","section_15":""}
{"filename":"9984_1994.txt","cik":"9984","year":"1994","section_1":"Item 1. Business. --------- The Company is in three businesses: Bowman Distri- bution, a distributor of consumable repair and replacement products for industrial, heavy equipment, and transportation maintenance markets; Associated Spring, a manufacturer and distributor of custom-made springs and other close-tolerance engineered metal components; and Barnes Aerospace, a manufacturer of precision machined and fabricated assemblies for the aircraft and aerospace industries and a refurbisher of jet engine components.*\nBowman Distribution. Bowman Distribution is engaged in ------------------- distributing in the United States, Canada, the United Kingdom and France a variety of replacement parts and other products, including fasteners and special purpose hardware, automotive parts, automotive specialties and accessories, general purpose electric and gas welding supplies, industrial maintenance supplies, and industrial aerosols such as adhesives, lubricants, and sealants.\nThe products sold by Bowman Distribution are, for the most part, not manufactured by the Company, but are obtained from a number of outside suppliers. The vast majority of the products are repackaged and sold under Bowman's labels.\nSales by Bowman Distribution in the United States and Canada are primarily to industrial plants, chemical and petro- chemical process industries, contractors, new car dealers, garages, service stations, operators of vehicle fleets, and airline ground maintenance facilities.\nIn 1992, the Company sold substantially all of the assets of the Pioneer division of Bowman.\nAssociated Spring. Associated Spring manufactures and ----------------- distributes a wide variety of custom metal parts for mechanical purposes. It is equipped to produce practically every type of spring requiring precision engineering, as well as an extensive variety of precision metal components and assemblies. Its\n----------------------- *As used in this annual report, \"Company\" refers to the registrant and its consolidated subsidiaries except where the context requires otherwise, and \"Associated Spring,\" \"Barnes Aerospace,\" and \"Bowman Distribution\" refer to the above-defined businesses, but not to separate corporate entities.\n- 1 -\nproducts range in size from fine hairsprings for instruments to large springs for heavy machinery, and its output of a given metal part may vary in amount from a few units to several million. Associated Spring does not produce leaf springs or bed springs.\nAssociated Spring's custom metal parts are sold in the United States and through the Company's foreign subsidiaries to manufacturers in many industries, chiefly for use as components in their own products. Custom metal parts are sold primarily through Associated Spring's sales employees. In view of the diversity of functions which Associated Spring's custom metal parts perform, Associated Spring's output is characterized by little standardization, with the major portion being manufactured to customer specifications.\nThe automotive and automotive parts industries constitute Associated Spring's largest single custom metal parts market. Other important outlets include manufacturers of industrial and textile machinery, motors, generators, meters and other electrical and electronic equipment, aircraft, diesel and other internal combustion engines, household appliances and fixtures, hardware, office equipment, agricultural equipment, railroad equipment, general machinery, firearms, and scientific instruments.\nThe Associated Spring Distribution division is engaged in the distribution of industrial products to the tool and die market, of which die springs manufactured by Associated Spring are the principal item. It also distributes certain standard parts manufactured by Associated Spring consisting primarily of stock wire and flat springs which are sold under the Company's SPEC registered trademark. The Company has an exclusive marketing agreement with Stroemsholmens Mekaniska Verkstad AB to market Kaller nitrogen gas springs and systems in North America and other specified countries.\nAssociated Spring also has manufacturing operations in Brazil, Canada, Mexico, and Singapore, and distribution operations in the United Kingdom and France. In 1992, the Company closed its spring manufacturing plant in Dayton, Ohio. In 1993, the Company closed its spring manufacturing plant in Memphis, Tennessee and transferred the warehouse operations conducted in Corry, Pennsylvania to a new warehouse facility located in Ypsilanti, Michigan. In 1994, it closed its spring manufacturing plants in Gardena, California, and Monterrey, Mexico. The Company has retained a minority interest of 15% in its former subsidiary in Argentina.\nThe Company is a partner in a joint venture corporation in the United States with NHK Spring Co., Ltd. of Japan. The joint venture corporation, NHK-Associated Spring Suspension Components\n- 2 -\nInc. (\"NASCO\"), has a manufacturing facility in Bowling Green, Kentucky. It manufactures and sells hot-wound coil springs for automotive suspension systems and counterbalance torque bars for trunk lids. Barnes Group owns a minority interest of 45% in NASCO.\nBarnes Aerospace. Barnes Aerospace is engaged in the ---------------- advanced fabrication and precision machining of components for jet engines and airframes as well as the repair and overhaul of jet engine components. Windsor Manufacturing, Windsor Airmotive, and Advanced Fabrications constitute the Barnes Aerospace Group.\nWindsor Manufacturing manufactures machined and fabricated parts as well as assemblies. It specializes in the machining of difficult-to-process aircraft engine superalloys. Manufacturing processes include computer numerically controlled machining, electrical discharge machining, laser drilling, creep-feed grinding, and automated deburring. Customers include gas turbine engine manufacturers for commercial and military jets as well as land-based turbines. In 1993, the operations of the Company's Central Metal Products plant were consolidated with Windsor Manufacturing.\nWindsor Airmotive specializes in refurbishing jet engine components. Electron beam welding and plasma spray are two of the major processes used in this division, and customers include approximately 30 airlines world-wide and the military. Windsor Airmotive also has a facility in Singapore.\nAdvanced Fabrications, through its Jet Die and Flameco plants, specializes in hot forming and fabricating titanium and other high-temperature alloys such as hastelloy and inconel for use in precision details and assemblies for aircraft engine and airframe applications. It utilizes advanced manufacturing processes including superplastic forming and diffusion bonding.\nSegment Analysis.The analysis of the Company's revenue ----------------- from sales to unaffiliated customers, operating income, and identifiable assets by industry segments and geographic areas appearing on pages 26 and 27 of the Company's 1994 Annual Report to Stockholders, included as Exhibit 13 to this report, is incorporated by reference.\nCompetition. The Company competes with many other ----------- companies, large and small, engaged in the manufacture and sale of custom metal parts (including aerospace components). The Company believes Associated Spring is the largest domestic manufacturer of precision springs used for mechanical purposes. The Company also faces active competition in the products sold by Bowman\n- 3 -\nDistribution. The principal methods of competition for the Company's three businesses include service, quality, price, reliability of supply, and also, in the case of Associated Spring and Barnes Aerospace, technology and design.\nBacklog. The backlog of the Company's orders believed to ------- be firm amounted to $108,143,000 at the end of 1994, as compared with $102,596,000 at the end of 1993. Of the 1994 year-end backlog, $53,622,000 is attributable to the Barnes Aerospace Group and all of the balance is attributable to the Associated Spring Group. $16,067,000 of Barnes Aerospace's backlog is not expected to be shipped in 1995. Substantially all of the remainder of the Company's backlog is expected to be shipped during 1995.\nRaw Materials and Customers. None of the Company's --------------------------- divisions or groups are dependent upon any single source for any of their principal raw materials or products for resale, and all such materials and products are readily available. No one customer accounted for more than 10% of total sales in 1994. Automotive manufacturers continue to be important customers of Associated Spring. Sales by Barnes Aerospace to two domestic jet engine manufacturers accounted for approximately 50% of its business. Bowman Distribution is not dependent on any one or a few customers for a significant portion of its sales.\nResearch and Development. Although most of the products ------------------------ manufactured by the Company are custom parts made to the customers' specifications, the Company is engaged in continuing efforts aimed at discovering and implementing new knowledge that is useful in developing new products or services or improving significantly an existing product or service. The Company spent approximately $2,640,000 on its research and development activities in 1994, as compared to expenditures of approximately $1,846,000 in 1993 and $1,145,000 in 1992. There were no significant customer-sponsored research and development activities in 1994. Barnes Aerospace divisions spent approximately $495,000 in 1993 on customer-sponsored research and development activities compared to expenditures of approximately $6,882,000 in 1992.\nPatents and Trademarks. Patents, licenses, franchises ---------------------- and concessions are not material to any of the Company's businesses.\nEmployees. As of the date of this report, the Company --------- employs approximately 4,200 persons.\nEnvironmental Laws. Compliance with federal, state, and ------------------ local laws 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 and is not expected to have a material effect upon the capital expenditures, earnings, or competitive position of the Company.\n- 4 -\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ---------- The Company and its Canadian subsidiary operate 12 manufacturing plants and 15 warehouses at various locations throughout the United States and Canada, of which all of the plants and 6 of the warehouses are owned in fee, and the others are leased. Of the properties which are owned, none is subject to any encumbrance. The Company's other foreign subsidiaries own or lease plant or warehouse facilities in the countries where their operations are conducted. The listing of the facility locations of each of the Company's businesses contained in the Directory of Operations on the inside back cover of the 1994 Annual Report to Stockholders, included as Exhibit 13 to this report, is incorporated by reference.\nThe Company believes that its owned and leased properties have been adequately maintained, are in satisfactory operating condition, are suitable and adequate for the business activities conducted therein, and have productive capacities sufficient to meet current needs.\nItem 3.","section_3":"Item 3. Legal Proceedings. ----------------- There are no material pending legal proceedings 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. --------------------------------------------------- No matter was submitted during the fourth quarter of 1994 to a vote of security holders.\nThe following information is included in accordance with the provisions of Item 401(b) of Regulation S-K:\n- 5 -\nExcept for Messrs. Barnes, Fadel, and Martin, each of the Company's executive officers has been employed by the Company or its subsidiaries in an executive or managerial capacity for at least the past five years. Each officer holds office until his or her successor is chosen and qualified, or otherwise as provided in the By-Laws. No family relationships exist among the executive officers of the Company.\nMr. Barnes was elected Senior Vice President- Administration effective December 16, 1993. From 1982 to 1993, Mr. Barnes was employed by The Olson Brothers Company as Executive Vice President and President, which position he held since 1983. Prior to joining Olson Brothers, Mr. Barnes held a variety of management positions with The Connecticut Bank and Trust Company, The S. Carpenter Construction Company, and the Company's Bowman Distribution division.\nMr. Fadel was elected Vice President of Barnes Group Inc. and President, Associated Spring effective January 21, 1994. Mr. Fadel joined the Company in 1991 as Group Director of Advanced Engineering and Technology for Associated Spring. In addition, Mr. Fadel served as Division Manager at the Associated Spring plant in Saline, Michigan from 1992 to 1994. From 1989 to to 1991, Mr. Fadel\n- 6 -\nwas employed by Herman Miller, Inc. as Manager of Chemical Engineering and Senior Project Manager. Prior to joining Herman Miller, he held industrial and manufacturing engineering positions at Chrysler Corp., General Dynamics Corp. and the former Burroughs Corporation.\nMr. Martin was elected Executive Vice President- Operations effective December 16, 1993. He joined the Company on October 1, 1990 as Group Vice President, Associated Spring. In December, 1991, his title was changed to President and Chief Operating Officer of Associated Spring. Mr. Martin was previously Corporate Vice President of Manufacturing for Herman Miller, Inc. Prior to joining Herman Miller, he worked for Bendix Corporation from 1981 to 1988 as Vice President of Planning of its Industrial Group, Vice President and General Manager of the Electronics Division, Vice President and General Manager of the Filtration Systems Group and most recently served as President of Bendix's Fram Canada business. Prior to 1981, Mr. Martin held a variety of management positions with the General Electric Company and was a senior consultant with Arthur D. Little.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related ---------------------------------------------------- Stockholder Matters. ------------------- The information regarding the Company's common stock contained on pages 23 and 29 of the Company's 1994 Annual Report to Stockholders is incorporated by reference. As of February 7, 1995, the Company's common stock was held by 3,583 stockholders of record. The Company's common stock is traded on the New York Stock Exchange.\nItem 6.","section_6":"Item 6. Selected Financial Data. ----------------------- The selected financial data for the last five years contained on pages 30 and 31 of the Company's 1994 Annual Report to Stockholders is incorporated by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial ------------------------------------------------- Condition and Results of Operations. ----------------------------------- The financial review and management's analysis thereof appearing on pages 11 through 13 of the Company's 1994 Annual Report to Stockholders are incorporated by reference.\n- 7 -\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. ------------------------------------------- The financial statements and report of independent accountants appearing on pages 14 through 28 of the Company's 1994 Annual Report to Stockholders are incorporated by reference. See also the reports of independent accountants included on pages 13 and 14 below pursuant to Item 302(a) of Regulation S-K. The material under \"Quarterly Data\" on page 29 of the Company's 1994 Annual Report to Stockholders is also incorporated by reference.\nItem 9.","section_9":"Item 9. Changes and Disagreements with Accountants on ------------------------------------------------------- Accounting and Financial Disclosure. ----------------------------------- The material under \"Approval of Selection of Independent Accountants\" on pages 13 and 14 of the Company's Proxy Statement dated March 3, 1995 is incorporated by reference.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Company. ----------------------------------------------- The material under \"Election of Directors\" on pages 1 through 5 of the Company's Proxy Statement dated March 3, 1995 is incorporated by reference. See also \"Executive Officers of the Company,\" included above pursuant to Item 401(b) of Regulation S-K.\nItem 11.","section_11":"Item 11. Executive Compensation. ---------------------- The material under \"Compensation of Directors\" appearing on page 6, the material under \"Stock Plan for Non- Employee Directors\" appearing on page 7, and the information appearing on pages 8 through 12 of the Company's Proxy Statement dated March 3, 1995 is incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and --------------------------------------------------- Management. ----------\nThe information concerning this item appearing on pages 6 through 8 of the Company's Proxy Statement dated March 3, 1995 is incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions. ---------------------------------------------- The information concerning this item appearing on page 6 of the Company's Proxy Statement dated March 3, 1995 is incorporated by reference.\n- 8 -\nPART IV\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 notes thereto.\n- 9 -\nThe consolidated financial statements listed in the above index which are included in the Annual Report to Stock- holders of Barnes Group Inc. for the year ended December 31, 1994 are hereby incorporated by reference. With the exception of the pages listed in the above index and in Items 1, 2, 5, 6, 7, and 8, the 1994 Annual Report to Stockholders is not to be deemed filed as part of this report.\n(b) No reports on Form 8-K were filed during the last quarter of the period covered by this report.\n(c) The Exhibits required by Item 601 of Regulation S-K are filed as Exhibits to this Annual Report and indexed at pages 16 through 18 of this report.\n- 10 -\nSIGNATURES ----------\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.\nDate: February 17, 1995\nBARNES GROUP INC.\nBy \/s\/ A. Stanton Wells ----------------------------- A. Stanton Wells President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below as of the above date by the following persons on behalf of the Company in the capacities indicated.\n\/s\/ A. Stanton Wells --------------------------- A. Stanton Wells President and Chief Executive Officer (the principal executive officer) and Director\n\/s\/ John E. Besser --------------------------- John E. Besser Senior Vice President-Finance and Law (the principal financial officer)\n\/s\/ Francis C. Boyle, Jr. --------------------------- Francis C. Boyle, Jr. Assistant Controller (the principal accounting officer)\n\/s\/ Thomas O. Barnes --------------------------- Thomas 0. Barnes Director\n\/s\/ Wallace Barnes -------------------------- Wallace Barnes Director\n- 11 -\n\/s\/ Gary G. Benanav --------------------------- Gary G. Benanav Director\n\/s\/ William S. Bristow, Jr. --------------------------- William S. Bristow, Jr. Director\n\/s\/ Robert J. Callander -------------------------- Robert J. Callander Director\n\/s\/ George T. Carpenter --------------------------- George T. Carpenter Director\n\/s\/ Donna R. Ecton --------------------------- Donna R. Ecton Director\n\/s\/ Marcel P. Joseph --------------------------- Marcel P. Joseph Director\n\/s\/ Theodore E. Martin ---------------------- Theodore E. Martin Director\n\/s\/ Juan M. Steta --------------------------- Juan M. Steta Director\n\/s\/ K. Grahame Walker --------------------------- K. Grahame Walker Director\n- 12 -\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of Barnes Group Inc.\nOur audit of the consolidated financial statements referred to in our report dated January 23, 1995 appearing on page 28 of the 1994 Annual Report to Stockholders of Barnes Group 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 Schedule for the year ended December 31, 1994 listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\n\/s\/ PRICE WATERHOUSE LLP PRICE WATERHOUSE LLP\nHartford, Connecticut January 23, 1995\n- 13 -\nREPORT OF INDEPENDENT AUDITORS\nStockholders and Board of Directors Barnes Group Inc.\nWe have audited the consolidated balance sheet of Barnes Group Inc. as of December 31, 1993 and the related consolidated statements of income, stockholders' equity and cash flows for each of the two years in the period ended December 31, 1993. Our audits also included the financial statement schedule listed in the Index at Item 14(a) for each of the two years in the period ended December 31, 1993. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Barnes Group Inc. at December 31, 1993 and the consolidated results of its operations and its cash flows for each of the two 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 1 to the consolidated financial statements, the Company changed its methods of accounting for income taxes and for certain postretirement and postemployment benefits in the year ended December 31, 1992.\n\/s\/ Ernst & Young LLP Ernst & Young LLP\nHartford, Connecticut January 28, 1994\n- 14 -\nBARNES GROUP INC.\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nYears ended December 31, 1994, 1993 and 1992 (in thousands)\n- 15 -\nEXHIBIT INDEX ------------- Barnes Group Inc.\nAnnual Report on Form 10-K for year ended December 31, 1994 --------------------------------\n- 16 -\n- 17 -\nThe Company agrees to furnish to the Commission, upon request, a copy of each instrument with respect to which there are outstanding issues of unregistered long-term debt of the Company and its subsidiaries the authorized principal amount of which does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis.\nExcept for Exhibit 13, which will be furnished free of charge, and Exhibits 22, 23.1 and 23.2, which are included herein, copies of exhibits referred to above will be furnished at a cost of twenty cents per page to security holders who make written request therefor to The Secretary, Barnes Group Inc., Executive Office, 123 Main Street, P.O. Box 489, Bristol, Connecticut 06011-0489.\n- 18 -","section_14":"","section_15":""}
{"filename":"731336_1994.txt","cik":"731336","year":"1994","section_1":"ITEM 1. Business.\nGenetics Institute, Inc. (\"Genetics Institute\" or the \"Company\") was organized in December 1980 as a Delaware corporation. The Company is principally engaged in the discovery, development and commercialization of protein-based therapeutic products, using recombinant DNA and other technologies, for the treatment of a wide range of diseases and conditions, including anemia, hemophilia, cancer, tissue damage, infectious disease, cardiovascular disease and autoimmune diseases.\nUnless otherwise indicated, all references in this Annual Report on Form 10-K to Genetics Institute or the Company include the Company and its wholly owned subsidiaries, Genetics Institute, Inc. of Japan, Genetics Institute of Europe, Inc., Genetics Institute of Europe B.V., GI Europe, Inc., GI JJV, Inc., GI Japan, Inc., GI Manufacturing, Inc. and GI Drug Design, Inc.\nTransaction with American Home Products Corporation ---------------------------------------------------\nOn January 16, 1992, the Company's Common Stock shareholders approved the Agreement and Plan of Merger, dated as of September 19, 1991 and amended as of December 9, 1991 (the \"Merger Agreement\"), among the Company, American Home Products Corporation (\"AHP\"), and certain AHP subsidiaries, pursuant to which, among other things, (i) each share of Common Stock then outstanding was converted into the right to receive $20.00 in cash and six-tenths of a depositary share (a \"Depositary Share\"), each Depositary Share representing one share of Common Stock subject to an AHP call option (the \"Call Option\") and evidenced by a depositary receipt (a \"Depositary Receipt\"), (ii) AHP acquired 40% of the Company's then outstanding Common Stock and (iii) AHP purchased 9,466,709 shares of newly issued Common Stock (the \"Additional Shares\") from the Company for $300 million in cash. As a result of the foregoing transactions, subsequent open market purchases by AHP, and conversion of the Company's Convertible Exchangeable Preferred Stock, effective July 15, 1993, AHP owned, at February 22, 1995, approximately 64% of the outstanding shares of Common Stock.\nIndependent of its right to call the Depository Shares, AHP may acquire additional shares of Genetics Institute stock, provided that its aggregate holdings do not exceed 75% of the Company's stock outstanding, subject to certain exceptions. Under the terms of the Call Option, AHP has the right, but not the obligation, to purchase the shares of Common Stock represented by the Depositary Shares and held by The First National Bank of Boston, as depositary, in whole but not in part at any time on or prior to December 31, 1996, at per share call prices increasing by approximately $1.84 per share per quarter from $72.11 per share for the period from January 1, 1995 through March 31, 1995 to $85.00 per share for the period from October 1, 1996 through December 31, 1996. In the event that AHP elects to call any shares of Common Stock, AHP must purchase all of the shares that it does not already own. Accordingly, if the Call Option is exercised, AHP will own 100% of the outstanding shares of Common Stock of the Company, and all other stockholders of the Company will cease to have any equity interest in the Company.\nFor information relating to certain governance provisions contained in the Governance Agreement among the Company, AHP and its subsidiaries, see Item 13 in this Report.\nOverview --------\nOver the past fourteen years, Genetics Institute has financed its business through collaborative research and development revenues from licensees, royalties on product sales by certain licensees, product sales (since December 1992), interest income and use of equity capital. This has enabled the Company to undertake a broad range of research and development programs and to build an approximate 1000-person organization with over 600,000 square feet of corporate office, research, development and manufacturing facilities.\nIn recent years, the Company has dedicated a larger proportion of its resources to the development of self-funded proprietary products. The Company also has entered into joint ventures, development collaborations, partnerships and other commercial arrangements for certain of its proprietary products, which enable the Company to retain significant development, manufacturing and marketing rights for such products.\nCertain of the Company's corporate licensees have brought to market in various territories four products developed by the Company: recombinant human antihemophilic factor (\"rhAHF\"), erythropoietin (\"rhEPO\"), granulocyte-macrophage colony stimulating factor (\"rhGM-CSF\"), and tissue plasminogen activator (\"rhtPA\"). The Company receives royalties on commercial sales by its licensees of these products and, in the case of rhAHF, receives additional revenue from its manufacture of bulk concentrated drug substance.\nThe Company retains substantial manufacturing and marketing rights for several product candidates which are in various stages of development, including: a second recombinant coagulation factor (\"rhFIX\"), a platelet factor (\"rhIL-11\"), several bone morphogenetic proteins (\"rhBMP-2\" and others), and an immune system modulator (\"rhIL-12\").\nPrincipal Product Candidates, Discovery Research Areas and Licensed ------------------------------------------------------------------- Products --------\nThe following describes the Company's principal product candidates, its discovery research areas and licensed products.\nPrincipal Product Candidates ----------------------------\nRecombinant human Factor IX (\"rhFIX\") -------------------------------------\nRecombinant human Factor IX (\"rhFIX\") is being developed as a potential treatment for Hemophilia B, or Christmas Disease, which affects approximately 10,000 individuals in North America, Europe and Japan. Similar to Hemophilia A, but less prevalent, Hemophilia B is a coagulation disorder that can result in severe, often life threatening, and uncontrollable bleeding and crippling joint destruction.\nCurrently, people with Hemophilia B rely on clotting products derived from human blood to treat or prevent bleeding episodes. The Company believes that the current plasma-derived market for Factor IX is approximately $150 million worldwide. The supply of Factor IX from this source is limited by blood and plasma donations. Patients who rely on these plasma-derived products may also risk exposure to human blood-borne viruses. A recombinant human Factor IX product may provide a significant improvement over current plasma-derived clotting factor products by eliminating the risk of human viral contamination associated with such products and providing a means to manufacture large quantities of clotting factor without the supply limitations faced by the plasma-derived products. A recombinant Factor IX product may also have the\npotential to lower thrombogenic risk due to the absence of other clotting factors that remain in some plasma-derived Factor IX products.\nPhase I\/II clinical studies of rhFIX commenced in the first quarter of 1995. If these studies proceed as planned, the Company may be able to commence pivotal studies of rhFIX in 1995 or early 1996. GI currently has retained worldwide development and commercialization rights to rhFIX.\nIn September 1994, the U.S. Patent and Trademark Office (\"USPTO\") initiated a patent interference proceeding involving one of the Company's issued U.S. patents relating to rhFIX and patent applications of three other companies. See ITEM 3. LEGAL PROCEEDINGS at page 25 for additional information about this interference.\nIn January 1993, Genetics Institute licensed patent rights from British Technology Group, Limited to produce rhFIX protein from cell culture.\nNeumegaTM Recombinant Human Interleukin-Eleven (\"rhIL-11\") ----------------------------------------------------------\nRecombinant human interleukin-eleven (\"rhIL-11\") is a differentiation cytokine which has been shown in preclinical studies, among other activities, to stimulate the growth and proliferation of megakaryocytes, the cells which produce platelets. Platelets, a critical component of the body's normal ability to form blood clots and repair damaged tissues, are often severely depleted during cancer treatments involving chemotherapy alone or with bone marrow or peripheral blood progenitor cell transplantation, leaving some patients with bleeding complications. Platelet depletion is expected to continue to grow as a problem in cancer treatment as bone marrow and peripheral blood progenitor cell transplantation become more common and other growth factors enable oncologists to use higher doses of chemotherapy. rhIL-11 may be useful in accelerating the body's ability to return platelets to a normal level following chemotherapy alone or with bone marrow or peripheral blood progenitor cell transplant procedures.\nThe only therapy currently available to patients suffering from decreased platelet counts caused by cancer chemotherapy alone or with bone marrow or peripheral blood progenitor cell transplantation is platelet transfusion, the infusion of platelets which are taken from one or more blood donors. This therapy is relatively expensive and exposes patients to blood components that can introduce infectious complications. It also has the potential to decrease in efficacy over time if the patient develops an immune reaction to the transfused platelets. By stimulating the body's natural production of platelets, rhIL-11 could potentially provide a safe and effective alternative or supplement to the use of platelet transfusions.\nThree phase II clinical studies and one phase I\/II study of NeumegaTM rhIL-11 are presently underway in the United States. The three phase II studies involve treatment of: (1) patients who previously required a platelet transfusion as a result of their cancer chemotherapy treatment; (2) breast cancer patients undergoing moderately high-dose chemotherapy; and (3) patients undergoing extremely high-dose chemotherapy supported with bone marrow and progenitor cells harvested from peripheral blood. The phase I\/II study involves pediatric patients undergoing moderately high-dose cancer chemotherapy. Two phase I\/II studies in adult cancer patients were completed in the United States. Platelet effects were observed in both of the phase I\/II studies. Pharmacokinetic studies in healthy volunteers have been completed in the U.S. and Japan using a range of well-tolerated doses. Phase II studies in Japan are underway.\nTo date, over 200 patients and healthy volunteers have received NeumegaTM rhIL-11 in various phase I and II studies conducted in the U.S. and Japan.\nApart from NeumegaTM rhIL-11's potential effects on platelets, rhIL-11 also appears in preclinical research to have useful effects on mucosal surfaces of the gastro-intestinal tract. This latter effect (i.e. maintaining mucosal integrity) was first observed serendipitously by a researcher conducting a platelet restoration experiment of NeumegaTM rhIL-11, and has now been extended to preclinical models of inflammatory colitis. The Company plans to initiate a phase I clinical study of NeumegaTM rhIL-11 in a gastro-intestinal indication in 1995 to explore this new potential use for the cytokine.\nIn 1991, the Company and Essex Chemie A.G., an affiliate of Schering-Plough Corporation (\"Schering-Plough\") formed an alliance under which Schering-Plough will register and market rhIL-11 in Europe, Africa and Latin America. Under the terms of its agreement with Schering-Plough, the Company has received initial and milestone payments and is entitled to receive subsequent milestone payments and royalties based on further development activities, clinical results and eventual product sales of NeumegaTM rhIL-11 in the licensed territories. The Company will manufacture and supply all of Schering-Plough's requirements for bulk rhIL-11 protein.\nIn 1992, the Company granted GI-Yamanouchi, Inc. (the \"GYJ\"), a 50\/50 joint venture with Yamanouchi Pharmaceutical Co., Ltd. (\"Yamanouchi\"), rights to develop and market rhIL-11 in Japan, pursuant to a license agreement providing for milestone payments, the payment of royalties to the Company on product sales and the purchase of bulk rhIL-11 manufactured by the Company. Two phase I normal volunteer studies were completed in Japan, and two early phase II studies are underway in Japan in cancer patients receiving moderate dose chemotherapy and in patients with hematological disorders.\nIn 1993, the Company granted Wyeth-Ayerst International Inc., an affiliate of AHP, rights to develop and market rhIL-11 in the Pacific Basin (excluding Japan), Australia and New Zealand pursuant to a license agreement providing for milestone payments, the payment of royalties to the Company on product sales and the purchase of bulk NeumegaTM rhIL-11 manufactured by the Company.\nGI has retained development and commercialization rights for rhIL-11 in the United States.\nThe Company has four United States patents, and has filed additional patent applications covering rhIL-11 in the United States and in other territories. Regardless of whether the Company is successful in obtaining patent protection for NeumegaTM rhIL-11, the field of platelet restoration is expected to be highly competitive. A number of other cytokines are being developed for this use, including ones previously discovered by the Company and licensed to Sandoz Pharmaceutical Co., Ltd. (rhIL- 3 and rhIL-6). In addition, Immunex Corporation is in phase III clinical trials with PIXY 321, and Amgen Inc., Zymogenetics, Inc. and Genentech, Inc. have reported that they are engaged in preclinical research involving thrombopoietin (\"TPO\"), each of which is a potential platelet growth factor.\nRecombinant Human BMP-Two (\"rhBMP-2\") and Other Bone ---------------------------------------------------- Morphogenetic Proteins ----------------------\nIn humans and animals, bone normally undergoes constant resorption and reformation (the natural process of breaking down and rebuilding existing bone). This process is believed to play\nan important role during fracture healing. The Company, in conjunction with certain collaborative partners, is conducting a program to develop products based on certain protein factors which it believes regulate these processes. The Company has cloned and produced a number of novel recombinant human bone morphogenetic proteins. In several preclinical models, these proteins have been shown to induce formation of new cartilage and bone.\nOne of these proteins, recombinant human bone morphogenetic protein-two (\"rhBMP-2\") is a manufactured version of a human protein naturally present in very small quantities in the body. Genetics Institute believes it was first to clone the human gene for the human BMP-2 protein and is currently manufacturing rhBMP-2 protein for clinical evaluation.\nBecause rhBMP-2 protein causes cells to differentiate and form cartilage and bone, it has been termed \"osteoinductive\". The Company is currently developing this protein for uses in bone repair, such as healing fractures and bony defects.\nCurrent methods to stimulate bone growth and healing have some disadvantages. For example, autogenous bone (autograft) is occasionally used to facilitate bone repair. This material must be harvested from a bony site in the patient and grafted at the repair site. Such a harvest procedure can cause considerable pain and morbidity to a patient. rhBMP-2 may have the potential to provide more reliable and convenient methods to facilitate, accelerate and help assure bony healing, while avoiding the pain, morbidity and other disadvantages associated with other approaches.\nA lead product candidate containing rhBMP-2 is currently in pilot stage human clinical testing for several indications, including orthopedic trauma, maxillofacial repair and avascular necrosis of the hip. Additional clinical trials are expected to begin in 1995. In the United States rhBMP-2 is being regulated as a combination product (device and biologic) under the jurisdiction of the device branch of the U.S. Food and Drug Administration. rhBMP-2 is expected to be regulated either as a biologic or a drug outside the U.S.\nThe Company and its licensees are designing and implementing a global clinical trial program to test multiple indications in pilot studies initially in different geographic territories. Results will be shared among the Company and its licensees, and if preliminary data are positive, approvals will be pursued worldwide. To date, the Company's clinical studies have evaluated, or are evaluating, the safety and clinical feasibility of a surgically-implanted device that contains the rhBMP-2 protein in two matrix delivery systems in orthopedic trauma and maxillofacial repair.\nIn 1993, the Company completed patient enrollment in one orthopedic trauma study in the United States. This study had a two-year evaluation endpoint and is ongoing. In 1994, Genetics Institute initiated two additional pilot studies in the United States, one in orthopedic trauma (tibia fractures) and one in maxillofacial repair. The Company also initiated and completed a second pilot study through the GYJ in Japan in the area of maxillofacial repair and completed enrollment in a second iliac crest defect study. In Europe, the Company through the GI- Yamanouchi European Partnership (the \"GYEP\") initiated and completed patient enrollment in a study of rhBMP-2 use in patients suffering avascular necrosis of the femoral head. More studies are planned for 1995.\nThe Company holds several significant U.S. patents for rhBMP- 2 and other members of the BMP family. These patents cover the DNA sequences and recombinant production of BMP-1, BMP-2, BMP-3, BMP-4, BMP-5, BMP-6 and BMP-7. The Company believes it has discovered many of the known members of the BMP family.\nThe Company is aware that a potential competitor has been issued several patents in the field of bone-inducing proteins. Although no assurance can be given, the Company believes that its commercialization of rhBMP-2 protein will not infringe any valid patent issued to any third party. However, no assurance can be given that third parties will not obtain patents containing claims which would materially interfere with the Company's commercialization of rhBMP-2 or other bone morphogenetic proteins.\nIn 1990, the Company formed a United States partnership (the \"GPDC\") with Yamanouchi to fund a substantial portion of the development of bone morphogenetic proteins prior to phase III or pivotal clinical trials worldwide. Capital contributions, profits and losses of the GPDC generally are divided 25% and 75% between the Company and Yamanouchi, respectively, prior to the first commercial sale in specified countries. After the first commercial sale, each partner's capital contribution and share of profits or losses of the GPDC will become 50%.\nIn 1990, the Company also entered into the GYJ joint venture with Yamanouchi for the commercialization and marketing in Japan of the Company's bone morphogenetic proteins and other potential future products. The GYJ is responsible for clinical development, registration and marketing of bone-inducing protein products in Japan. The ownership and profits and losses of the GYJ are divided equally between the Company and Yamanouchi.\nIn 1993, the Company and Yamanouchi formed the GI-Yamanouchi European Partnership (the \"GYEP\") for the commercialization of the GPDC's bone morphogenetic proteins in Europe. The GYEP contracted with the Company to manage the clinical development, registration and the core marketing activities of the initial products in the field of localized bone repair. The GYEP has entered into distribution agreements with Yamanouchi Europe B.V. (formerly Brocades Pharma B.V.) and Wyeth-Ayerst International Inc., affiliates of Yamanouchi and AHP, respectively, in return for distribution fees and milestone payments. These distributors will assist in obtaining local country approvals and market the products in their respective territories. The Company believes this relationship will afford it the opportunity to develop a European commercialization infrastructure with the cooperation and support of its partners.\nIn 1994, the GPDC decided to focus GPDC resources on the development of certain then-existing BMPs, and to discontinue funding of further research activities at the Company directed toward discovery of additional members of the BMP family. The Company, however, plans to continue its discovery research activities in this area, alone and in collaboration with third parties, and discoveries of additional bone morphogenetic proteins after November 30, 1994 will not be licensed to the GPDC.\nThe GPDC holds exclusive worldwide marketing rights for bone morphogenetic proteins discovered by the Company prior to December 1, 1994 and has exclusively sublicensed these rights to the Company in North America, to the GYJ in Japan, and to the GYEP in Europe, as noted above. These bone morphogenetic protein commercialization rights for the rest of the world will be retained by the GPDC and may be sublicensed in the future to third parties or to the Company, Yamanouchi or their respective affiliates. The Company has retained manufacturing rights to BMPs worldwide and rights to its future discoveries of new factors in this field.\nIn February 1995, the Company and Sofamor Danek Group, Inc. (\"Danek\") announced their agreement to enter into an exclusive license to develop and commercialize rhBMP-2 products for use in certain surgical procedures involving the spine in North America. Under the agreement,\nDanek will have the exclusive right in North America to develop and commercialize these products for spinal applications and Danek will pay GI license fees of up to $50 million over the next four years. The two companies will share the profits resulting from sales of these products upon a predetermined formula. The Company retains the exclusive right to manufacture rhBMP-2 for supply to Danek. Effectiveness of the agreement is subject to regulatory clearance under the Hart Scott Rodino Act, as amended.\nRecombinant Human Interleukin-12 (\"rhIL-12\") --------------------------------------------\nNatural IL-12 is an immune system modulating protein whose activity was first discovered at the Wistar Institute of Anatomy and Biology (\"Wistar\") and later cloned at Genetics Institute. It was originally named natural killer cell stimulatory factor (\"NKSF\"). The Company believes Hoffmann-La Roche Inc. (\"Roche\") independently cloned rhIL-12 at about the same time as the Company and Wistar.\nGenetics Institute and Roche completed a preclinical development collaboration on rhIL-12 in 1993. Roche and the Company decided to pursue commercialization of rhIL-12 independently; however, in connection with their agreement to collaborate on preclinical research, the Company and Roche have agreed to a patent cross-license to eliminate their existing potential patent conflicts.\nIL-12 is a complex protein that is believed to link \"natural immunity\" with \"adaptive\" or \"acquired\" immunity. Natural immunity is mediated by specialized white blood cells that, in healthy people, perform surveillance and kill invading bacteria, parasites, and viruses and may eliminate the growth of tumor cells. IL-12 is believed to activate, and in some cases cause the proliferation of, certain of these white blood cells, potentially enhancing the immune system's killing ability. IL-12 also may trigger the production of other immune system regulatory proteins that not only reinforce this natural immune response but also may initiate an \"adaptive\" immune response.\nWhereas natural immunity provides for an immediate immune response to invading pathogens, adaptive immunity involves T and B cell \"memory\" that can provide a sustained response against infectious agents and protect the body against future challenges by these same agents. IL-12 is also believed to stimulate the part of the immune system that is active in fighting cancer and intra-cellular pathogens. Examples of diseases caused by intra- cellular pathogens are tuberculosis, viral hepatitis, and HIV disease.\nGiven the biologic activities of IL-12, Genetics Institute launched an effort to explore recombinant human interleukin-twelve (\"rhIL-12\") as a therapeutic for certain infectious diseases by augmenting or replacing natural IL-12 with a recombinant version of the protein. In test tube experiments, rhIL-12 enhanced or augmented normal immune function in blood cells taken from HIV- infected persons. Also, recent work has shown that cells from HIV-infected persons are not able to make IL-12 in the same quantities as non-infected persons. This suggests that rhIL-12 may have the potential to correct a deficiency in the immune system of HIV-infected persons. Patient accrual for initial phase I clinical safety trials for HIV-infected persons was completed in early 1995, and biological activity was observed over a range of well-tolerated doses. Other infectious diseases may be explored in the future.\nIn preclinical models of a variety of cancers including melanoma, lung cancer, kidney cancer, lymphoma and colon cancer, rhIL-12 (or its recombinant murine analog, \"rmIL-12\") has\nshown positive effects by either shrinking or entirely eliminating tumors. In a mouse model of kidney cancer, rmIL-12 appears to trigger a memory response, since new tumors would not grow in animals that had been previously administered rmIL-12 to treat their tumors. Phase I clinical safety trials of rhIL-12 for cancer patients began in May of 1994. Other studies of rhIL-12 for cancer are planned for 1995.\nIn July 1994, the Company and Wyeth-Ayerst Laboratories, the pharmaceutical division of AHP, agreed to form a 50\/50 joint venture (\"IL-12 Partners\") to develop and commercialize rhIL-12 on a worldwide basis, except for Japan. IL-12 Partners has a joint project team and steering committee to oversee current and future clinical trials and other development activities. These activities will be funded equally by the partners. The arrangement also provides for certain payments to the Company. In 1994, reimbursement for rhIL-12 research and development expenses by IL- 12 Partners and initial milestone payments by AHP to the Company were approximately $23.1 million. Future milestone payments will become due upon achievement of certain clinical outcomes and submission or approval of specific regulatory filings -- the exact value of such payments is contingent upon rhIL-12's success in various therapeutic areas. The Company has the right to supply rhIL-12 to the joint venture and will receive royalties based on the joint venture's sales of rhIL-12. The Company will have marketing rights in North America; Wyeth-Ayerst International will have marketing rights outside North America and Japan.\nIn July 1994, the Company granted the GYJ rights to develop and market rhIL-12 in Japan pursuant to a license agreement providing for milestone payments, the payment of royalties to the Company on product sales and the purchase of bulk rhIL-12 manufactured by the Company.\nMacstimTM Recombinant Human Macrophage Colony Stimulating Factor ---------------------------------------------------------------- (\"rhM-CSF\") -----------\nThe Company has cloned the human gene for rhM-CSF and is producing MacstimTM rhM-CSF for preclinical and clinical evaluation. rhM-CSF is a blood cell growth factor that acts predominantly on monocytes and macrophages, which constitute a particular class of white blood cell. In 1991, the Company entered into an arrangement with SciGenics, Inc. relating to the research, development, use, manufacture and sale of MacstimTM rhM-CSF in North America. See \"SciGenics.\"\nrhM-CSF was initially believed to have potential for treating cancer and infectious disease as a result of its biologic effects on monocytes and macrophages. In November 1994, SciGenics,the Company's North American licensee, and the Company decided to cease exploration of the potential uses of rhM-CSF in the treatment of cancer based on results in over 200 patients. In 1993, SciGenics and Genetics Institute announced the decision to discontinue testing of rhM-CSF for the treatment of infectious disease based on results in a broad series of evaluations in preclinical models of infectious diseases.\nIn studies of rhM-CSF in cancer, rhM-CSF was observed to lower cholesterol levels in cancer patients whose cholesterol levels were considered to be normal. Subsequent studies have also shown that rhM-CSF treatment is associated with lower cholesterol levels in normal volunteers. In 1993, the Company commenced a phase I safety study for rhM-CSF in patients with extremely high cholesterol. The patients in this study suffer from a hereditary disorder known as familial hypercholesterolemia (\"FH\"). In its severest form, homozygous FH, in which a person has inherited a defective gene from both parents, cholesterol levels may be so high as to be acutely life-threatening. Existing pharmacological therapies have limited effectiveness in the\ntreatment of homozygous FH patients. At least one potentially competitive gene therapy approach to treat hereditary high cholesterol, however, is being tested in an experimental clinical protocol.\nPreliminary data collected from the first seven homozygous FH patients were presented at a scientific meeting in October 1994. The data presented showed that there was some cholesterol reduction in these patients and that the drug was well tolerated in this population. SciGenics and the Company presently are accruing additional patients to the study, and there can be no assurance that the final data from the study will be consistent with the preliminary data from the study.\nWhile the Company is initially testing rhM-CSF in the homozygous FH population, the Company does not believe that this narrow indication will itself be commercially viable. In order to develop a commercially viable product suitable for a broader population (e.g., all FH patients and\/or other patients with significantly elevated cholesterol), significant additional clinical and other development activities would be required to demonstrate that the product would be competitive with current therapies that include orally active agents. Furthermore, cholesterol reduction in itself may not be a sufficient basis for FDA licensure of rhM-CSF. Other endpoints such as arterial plaque reduction or a reduction in the incidence of coronary events are likely to be required. To establish such endpoints may require very large clinical trials over several years. In addition, before initiating further studies in a broader population (e.g., heterozygous FH or atherosclerosis), the safety of long-term or chronic dosing with rhM-CSF would need to be evaluated in a second phase I safety study.\nIn order to determine what effect, if any, rhM-CSF may have on sustained cholesterol reduction and arterial plaque reduction, the Company is conducting a preclinical chronic dosing study. If this preclinical study provides positive data, it may support initiation of a second phase I study to test the safety of chronic dosing of rhM-CSF in humans. However, no assurances can be given as to the likely results of either study with respect to either safety or efficacy. There are also significant regulatory requirements which must be satisfied in order to expand clinical testing into a broader population with a less severe medical need. The Company will continue to evaluate the rhM-CSF Program on an on-going basis to decide whether to continue funding the rhM-CSF Program throughout 1995.\nIn 1991, the Company and Schering-Plough formed an alliance under which Schering-Plough will register and market rhM-CSF in Europe, Africa and Latin America. Under the terms of the agreement, the Company received an initial payment and is entitled to receive subsequent milestone payments and royalties on product sales of rhM-CSF in the licensed territories. The Company also has the right to manufacture and supply all of Schering-Plough's requirements for bulk protein. Schering-Plough is not obligated to proceed with development in its territory until the Company has shown rhM-CSF to have a commercially meaningful indication in a phase II study, and the Company cannot predict when or whether this condition precedent can be satisfied.\nThe Company has granted an exclusive license to Morinaga Milk Industry Company, Ltd. (\"Morinaga\") to market and, subject to certain conditions, to manufacture the Company's rhM-CSF product in Japan and certain other Far Eastern countries. Morinaga is obligated to pay the Company royalties on commercial sales of rhM-CSF and to purchase its initial commercial requirements of rhM-CSF from the Company until Morinaga develops its own manufacturing capability for rhM-CSF. Commercial sales, however, will be dependent on developing a commercially viable indication for rhM-CSF.\nIn 1990, the Company and Cetus Corp. (which was acquired by Chiron Corporation in 1991) agreed to cross-license each other on a royalty-free basis under patent rights in Europe and\nthe United States and under any orphan drug designations they receive from the United States Food and Drug Administration (\"FDA\") for rhM-CSF.\nDiscovery Research Areas ------------------------\nHematopoiesis and Immunology ----------------------------\nThe Company is devoting a substantial portion of its discovery research resources to the fields of immunology and hematopoiesis (blood cell growth factors). This area has historically been a source of important therapeutic candidates and our efforts are continuing in this field. Attention has been focused specifically on factors that regulate stem cell and lymphocyte development as well as on factors which can modulate the immune response including both immune-stimulators and immunosuppressive agents. Discoveries in this field may lead to promising new anti-cancer and anti-infective therapies as well as factors potentially useful for the treatment of autoimmune diseases including rheumatoid arthritis, systemic lupus erythematosus and multiple sclerosis as well as organ transplant rejection.\nBone and Connective Tissue Biology ----------------------------------\nThe Company is continuing its discovery research efforts in the field of bone and connective tissue biology. Company scientists are continuing to identify novel factors which may play an important role in the formation, growth and repair of bone, cartilage and other connective tissues. In 1994, one of these novel factors, rhBMP-12, was seen to potentially play a role in inducing the repair of tendons and ligaments.\nSoft Tissue Repair and Organ Regeneration -----------------------------------------\nResearch continues in the study of the effects of growth factors on tissue development and repair with the aim of developing therapies useful for the treatment of human tissues damaged by injury or disease. The Company has also continued its work in the embryonic growth and regulatory protein (EGRP) program under its agreement with SciGenics, studying the effects of specific gene expression and cellular interactions on the development of insulin-expressing cells in the pancreas. It is believed that this work has the potential to lead to the development of assays to identify potentially useful EGRP factors. SciGenics will own any EGRP factors and certain related technology which are discovered by the Company under its agreement with SciGenics.\nSmall Molecule Drug Discovery (\"SMDD\") --------------------------------------\nThe Company's research efforts have produced expertise in molecular and structural biology, and in high throughput screening that is relevant to the identification and utilization of novel human proteins as targets for the discovery of small molecule based pharmaceuticals.\nIn recent years the Company's SMDD research has focused on: (i) cellular adhesion proteins, molecules that play a critical role in the movement of white blood cells into damaged or diseased tissues; and (ii) inhibitors to cPLA2, an enzyme believed to play a key role in the production of inflammatory mediators. By identifying the molecules that block the action of these proteins, the Company hopes to develop new treatments for asthma, rheumatoid arthritis, organ transplant rejection, and cancer metastasis. During 1994, the Company continued its program to screen compounds that could potentially become lead candidates as possible new drugs. Several potential leads have been identified, and preclinical research is in progress.\nDuring 1992, the Company entered into two agreements with Wyeth-Ayerst. The first agreement centers on the discovery of novel target areas for developing new small molecule based drugs. This agreement provided Wyeth-Ayerst with the option to enter into a collaboration agreement for each selected target area. Pursuant to this option agreement, the Company signed a second agreement with Wyeth-Ayerst to collaborate in the target area of cellular adhesion. Wyeth-Ayerst presently contributes significantly to the funding of this collaborative program. The option agreement expired at the end of fiscal 1993, and collaborative funding is committed through mid-1995.\nLicensed Products -----------------\nRecombinant Human Antihemophilic Factor (\"rhAHF\") -------------------------------------------------\nRecombinant human antihemophilic factor (\"rhAHF\", or recombinant human Factor VIII) is a manufactured version of a naturally occurring protein that helps regulate activation of the body's coagulation pathway -- the system that controls the formation of blood clots and prevents bleeding. Hemophilia A, a condition affecting approximately one in 10,000 men (or approximately 20,000 persons in the U.S.) is caused by deficient levels of Factor VIII. Symptoms of hemophilia include uncontrolled bleeding into soft tissues, muscles and weight-bearing joints.\nFor the past 20 years, people with hemophilia have had to rely on Factor VIII products derived from human blood to treat or prevent bleeding episodes. The supply of Factor VIII from this source is limited by blood and plasma donations. Patients who rely on this product may also risk exposure to blood-borne viruses, such as hepatitis and the AIDS virus.\nGenetics Institute's development of a genetically engineered human Factor VIII product is one of the most significant technical achievements by the biotechnology industry. Recombinant Factor VIII is the largest protein ever produced using genetic engineering technology.\nIn 1992, the FDA licensed the Company's concentrated rhAHF product and its licensee's (Baxter Healthcare Corporation, Hyland Division (\"Baxter\")) finished product, RecombinateTM Antihemophilic Factor (Recombinant), for the treatment of hemophilia A. RecombinateTM Antihemophilic Factor (Recombinant) brand Factor VIII is currently marketed in the U.S. and Europe by the Hyland division of Baxter Healthcare Corporation, under the terms of a worldwide license, and by Rhone-Poulenc Rorer Inc. (\"RPR\"), a Hyland distributor. Applications for regulatory approval have been filed by Baxter in Japan and other countries throughout the world.\nThe production of concentrated rhAHF by recombinant DNA technology rather than from human blood eliminates the risk of transmitting human viruses associated with plasma-derived Factor VIII products. In addition, it makes possible a supply of Factor VIII which is not limited by the blood donor system. These advantages should ultimately enable persons with hemophilia to use rhAHF to prevent episodes of bleeding, and thereby improve the quality of their lives.\nBaxter is the Company's worldwide exclusive licensee of concentrated rhAHF. The Company has retained substantial worldwide manufacturing rights and will supply product concentrate to Baxter. Baxter further processes the concentrated rhAHF and sells finished product. Genetics Institute has the right to manufacture fifty percent of Baxter's requirements until December 2002, and thirty percent of Baxter's requirements until December 2009. Currently, the Company manufactures one hundred percent of Baxter's requirements for product concentrate. Baxter has initiated activities to develop its own capacity to manufacture product concentrate, and the Company expects Baxter to begin supplying a portion of its worldwide commercial\nrequirements beginning as early as 1997. The Company earns manufacturing revenue on the supply of concentrated rhAHF material, and a royalty on Baxter's sales of finished rhAHF product.\nRecombinant Human Erythropoietin (\"rhEPO\") ------------------------------------------\nNatural EPO is a protein that stimulates the production of red blood cells. Inadequate production of EPO by the kidneys results in decreased red blood cell production and anemia. Pharmaceutical compositions containing EPO are used by kidney dialysis patients as an alternative to whole blood or red cell transfusions. Such transfusions are the only other current treatments for this form of anemia and may expose the patient to various side effects and the risk of contracting blood-borne diseases.\nGenetics Institute's rhEPO products are being sold in Japan, Europe and certain other countries outside the United States by its licensees, Chugai Pharmaceutical Co., Ltd. (\"Chugai\") and Boehringer Mannheim GmbH (\"Boehringer Mannheim\"), respectively. Chugai has an exclusive, royalty-bearing license from the Company to manufacture and market rhEPO in the Far East (except for China), Australia, New Zealand, Canada and Mexico. The Company has granted Boehringer Mannheim an exclusive, royalty-bearing license to manufacture and market rhEPO in Europe, China, South America, Africa and the Middle East. The Company is currently receiving royalties based on licensee sales of rhEPO in these territories.\nDue to blocking patents held by Amgen Inc. (\"Amgen\") in the United States, the Company does not expect to receive any revenue from the sale of its rhEPO products by licensees or by its own manufacturing or marketing efforts in the United States.\nIn 1993, a long-standing EPO patent infringement dispute between the Company and Amgen was settled. As part of the settlement, the Company paid Amgen $14.0 million. An additional $2.0 million may become payable contingent upon the outcome of certain future events. Ortho Pharmaceutical Corporation's (\"Ortho\") infringement claims against the Company were dismissed. An appeal by Ortho of the dismissal of its infringement claims is pending. See ITEM 3. LEGAL PROCEEDINGS at page 25.\nEPO patent litigation is proceeding in Europe on a country- by-country basis; and, absent settlement, is expected to continue for a number of years. However, injunctive relief sought by Ortho or its affiliates could at any time result in a loss of royalties in the country or countries where issued. Royalties in fiscal 1994 totalled approximately $11.3 million for rhEPO sales in Europe. See ITEM 3. LEGAL PROCEEDINGS at page 25.\nIn June 1994, the U.S. Patent and Trademark Office granted the Company a new patent on homogeneous EPO compositions which the Company believes is infringed by the making, using and selling of rhEPO in the United States by Ortho and Amgen. The Company is engaged in legal proceedings with Ortho and Amgen concerning this new patent and can provide no assurance as to their outcome. See ITEM 3. LEGAL PROCEEDINGS at page 25.\nRecombinant Novel Plasminogen Activater (\"rNPA\") ------------------------------------------------\nRecombinant novel plasminogen activator (\"rNPA\") is a form of thrombolytic (clot-dissolving) agent which may be useful in the treatment of heart attacks and other conditions which may benefit from the dissolution of blood clots.\nHeart attacks can result from blockage of the coronary arteries which supply oxygen-rich blood to the cardiac muscle. Frequently, the final blockage of a diseased (atherosclerotic), partially-obstructed artery results from the formation of blood clots, or thrombi, which block the supply of blood to the heart muscle. The degree of permanent damage to the heart depends on the severity and duration of the blockage of the coronary artery. rNPA is being evaluated in phase II clinical studies in Japan for its utility in dissolving these blood clots.\nGenetics Institute granted Suntory, Ltd. of Japan a license to develop and commercialize rNPA for the Japanese market. The Company has commercial rights to rNPA in the rest of the world, including the United States.\nrNPA may have improved qualities over existing thrombolytic therapy. Preclinical data and early clinical data suggest that rNPA's period of activity in the body (its \"half-life\") is approximately ten times that of tPA. As a result, unlike tPA, an existing thrombolytic agent which is administered by infusion over several hours, rNPA is being developed and tested by Suntory for administration as a single injection. If the clinical tests are successful, rNPA could potentially be administered earlier and more easily than tPA.\nIn June 1994, the United States Court of Appeals for the Federal Circuit (\"CAFC\") reversed a 1991 lower court decision and found in favor of Genetics Institute that rNPA does not infringe any of Genentech, Inc.'s United States tPA patents. The CAFC's decision recognized a significant distinction between rNPA and tPA. As a result of this decision and Suntory's preliminary clinical data, the Company is currently exploring commercialization options for rNPA in territories outside of Japan.\nrhGM-CSF, rhIL-3, and rhIL-6 ----------------------------\nGM-CSF is a blood cell growth factor which is produced by cells of the body as part of the natural defense against infections. GM-CSF stimulates the intermediate to late stages of development of several different blood cell lineages, and is particularly effective in stimulating growth of cells in the granulocyte and macrophage lineages.\nThe Company developed rhGM-CSF under a Research Agreement with Sandoz, Ltd. (\"Sandoz\") and assigned its rhGM-CSF patent rights to Sandoz in return for royalties on product sales. Schering-Plough also independently developed a rhGM-CSF product. In 1988, Sandoz entered into an agreement with Schering-Plough concerning worldwide co-development and co-promotion of rhGM-CSF and Sandoz and Schering-Plough have received approval to sell rhGM-CSF in Europe and certain other countries outside the United States. As a result of this agreement, the Company receives royalties under Sandoz rhGM-CSF patent rights on the combined worldwide sales of rhGM-CSF by Sandoz and Schering-Plough at the same royalty rate due under the Company's agreement with Sandoz.\nrhIL-3 is a blood cell growth factor that is produced by cells of the immune system as part of the body's natural defense against infections. The Company believes that rhIL-3 acts earlier in the pathway of blood cell production than certain other colony stimulating factors and stimulates a broader range of cell types, including white blood cells, red blood cells and platelets.\nrhIL-6 is a blood cell growth factor that also is produced by cells of the immune system as part of the body's natural defense against infections. The Company believes that rhIL-6, like rhIL-3, acts early in the pathway of blood cell production stimulating a broad range of cell types, including white blood cells, red blood cells and platelets.\nThe Company licensed to Sandoz the exclusive worldwide right to manufacture and market rhIL-3 and rhIL-6 and is entitled to receive royalties on commercial sales of both products. Both of the products are currently in clinical development.\nDevelopment and License Agreements ----------------------------------\nThe Company has entered into agreements with a number of licensees to conduct collaborative research and development programs, and to supply bulk drug substance. While the terms of each agreement differ, the agreements generally provide that the Company will perform research on specific products or in a specific field and will use commercially reasonable and diligent efforts to develop a specified product or group of products. Under most of these agreements, the Company is reimbursed for a portion of its research and development costs and\/or is paid fixed fees for attaining specified technical or product development benchmarks by the Company and\/or the licensee. In general, such agreements can be canceled on relatively short notice if certain objectives are not met or, in some cases, for reasons unrelated to the Company's research and development progress.\nGenerally, upon the completion of the Company's research and development efforts, the licensee agrees to use its best or commercially reasonable diligent efforts, subject to certain conditions, to conduct clinical testing and obtain regulatory approvals, to market and, in some cases, manufacture the developed product. Under most of the agreements, the licensee acquires the exclusive right to exploit the developed technology in specified geographic territories for specified products or within specified fields of use, and the Company retains the right to use such technology for other products or outside such fields of use or such territories. The Company is generally entitled to receive royalties based on sales of products derived from the technology developed by the Company. Royalty rates for patented products in some cases are higher than those for unpatented products, and royalty periods for patented products sometimes extend for longer periods of time. The Company has retained the right, subject to certain conditions, to manufacture commercial quantities of products for certain of its licensees, including Baxter (relating to rhAHF), Schering-Plough (relating to rhM-CSF and rhIL-11), the GPDC (relating to bone morphogenetic proteins), the GYJ (relating to rhIL-11 and rhIL-12), Wyeth-Ayerst International (relating to rhIL-11), and IL-12 partners (relating to rhIL-12).\nThe Company's licensees that have contributed 10% or more of the Company's revenues during one or more of the past three years are Baxter, AHP, Chugai, Yamanouchi, SciGenics and Boehringer Mannheim. Baxter provided approximately 12%, 44% and 38% of the Company's revenues in fiscal 1992, 1993 and 1994, respectively. AHP provided 12% and 22% of the Company's revenue in fiscal 1993 and 1994 respectively. Chugai provided approximately 21%, 16% and 17% of the Company's revenues in fiscal 1992, 1993 and 1994, respectively. Yamanouchi provided approximately 24%, 13% and 10% of the Company's revenues in fiscal 1992, 1993 and 1994, respectively. SciGenics provided approximately 12% of the Company's revenues in fiscal 1992. Boehringer Mannheim provided approximately 10% of the Company's revenues in fiscal 1992. Chugai and AHP are shareholders of the Company.\nThe Company's research and development expenses were $89.6 million, $99.0 million and $108.2 million in fiscal 1992, 1993 and 1994, respectively. Under collaborative research and development agreements with corporate sponsors and development partners, the Company recognized $60.4 million, $34.3 million and $44.8 million of collaborative research and development revenue in fiscal 1992, 1993 and 1994, respectively.\nSciGenics ---------\nIn May 1991, the Company and SciGenics, Inc. (\"SciGenics\") completed a public offering of 2,090,909 units (the \"Offering\"), each unit consisting of one share of SciGenics Callable Common Stock and one warrant to purchase one share of Common Stock of Genetics Institute, which resulted in gross proceeds to SciGenics of approximately $42.0 million. In connection with the Offering, the Company entered into various agreements with SciGenics.\nThe Company has entered into a technology license agreement and a research and development agreement with SciGenics. Under the terms of the technology license agreement, SciGenics has obtained exclusive licenses to the Company's technology to develop and commercialize rhM-CSF in North America and to develop and commercialize embryonic growth and regulatory proteins (\"EGRP Factors\") throughout the world for all purposes other than for the inducement, formation, growth, repair, regeneration or treatment of human or animal bone or cartilage. Under the terms of the research and development agreement, SciGenics has engaged the Company to continue the development of rhM-CSF and to conduct early stage research and development of EGRP Factors. Pursuant to the technology license agreement, SciGenics paid the Company a non-refundable payment of $2.5 million. Pursuant to the research and development agreement, SciGenics is obligated to pay to the Company approximately $39.0 million (together with the non-refundable payment, substantially all of the net proceeds raised by it in the Offering) for research and development services. The Company has committed to match funds expended by SciGenics toward continued development efforts of rhM-CSF up to $20.0 million of SciGenics rhM-CSF funding. Such obligation (along with the Company's continuing obligation to conduct rhM-CSF research and development) is terminable by the Company, provided that if it elects to so terminate such obligation, the Company's program purchase and stock purchase options described below will terminate. Under the terms of the technology license agreement and the research and development agreement, SciGenics will own worldwide rights to all EGRP Factors (and related technology discovered on behalf of SciGenics) during the term of the research and development agreement.\nThe Company has been granted an option to purchase all (but not less than all) of the shares of Callable Common Stock of SciGenics. Except as noted below, the option provides for escalating exercise prices per share ranging from $54.04 (if exercised on or before May 31, 1995) to $69.83 (if exercised from June 1, 1995 to May 31, 1996). The option will terminate no later than May 31, 1996 and may terminate earlier upon the occurrence of certain events.\nThe Company also has been granted options to acquire all technology and related rights of SciGenics under either or both of the rhM-CSF and EGRP programs. If the Company exercises a program purchase option for either the rhM-CSF or EGRP program, the program purchase option for the remaining program will terminate. In such event, the Company's call option on the outstanding SciGenic's Callable Common Stock will remain in effect, however, the call option price will be reduced by the per share equivalent price paid for the exercise of a program purchase option. Such options will terminate no later than May 31, 1996 and may terminate earlier upon the occurrence of certain events. The exercise periods and the program purchase option exercise price for each program are as follows:\nIf the Company exercises the program purchase option for the EGRP program, it will be required to pay to SciGenics, in addition to the applicable amount set forth above, $4.0 million (a \"Benchmark Payment\") for each EGRP Factor that is identified by it prior to November 30, 1996 and that enters phase I clinical trials prior to November 30, 2001, subject to certain limitations and conditions.\nPatents and Proprietary Rights ------------------------------\nAs of February 1, 1995, 87 United States patents and a total of 282 patents worldwide have been issued to the Company. There can be no assurance as to how many patents will issue to the Company or whether any issued patents will provide the Company and its corporate sponsors with significant protection against competitors.\nUnited States patent office interference proceedings have been declared or are likely with respect to a number of the Company's United States patent applications, and the costs of such proceedings may be significant. Moreover, there can be no assurance that any patents issued to the Company will not be infringed upon or designed around by others. See \"Legal Proceedings.\"\nThe patent position of biotechnology firms generally is highly uncertain and involves complex legal and factual questions. Competitors have filed applications for, or have been issued, patents and may obtain additional patents relating to products or processes which are similar to or improve upon many of the products or processes being developed by the Company. The Company is unable to predict how the courts will resolve issues relating to the validity and scope of such patents. Companies that have or obtain patents relating to such products or processes could bring, and, in some cases, have brought, legal actions against the Company or its licensees claiming damages and seeking to enjoin them from manufacturing, marketing or clinically testing the affected product. The costs of such litigation are significant. If any such action were successful, in addition to any potential liability for damages, in the case of an action against the Company, or a reduction in royalties, in the case of an action against a licensee, the Company or its licensees would be required to obtain a license in order to continue to manufacture or market the affected product. No assurance can be given that the Company or its licensees would be able to prevail in any such action or could obtain on acceptable terms any license required under any such patent. See \"Legal Proceedings.\"\nExisting patents, including several owned by competitors of the Company, claim basic aspects of genetic engineering technology. A number of pending patent applications filed by competitors make similar claims. It is unclear whether patents will issue from these applications, or whether the broad claims made in such applications will be allowed. If broad claims of existing or future patents are upheld as valid by courts, certain companies whose business consists of genetic engineering, such as the Company, would be required to obtain licenses. There can be no assurance that such licenses will be available on acceptable terms or that the total royalties payable under such licenses would not adversely affect the Company's operating results. If the Company's licensees are required to pay royalties or make similar payments to a third party in order to obtain\nany such licenses which are required to market and sell the products developed by the Company for such licensees, such licensees are generally entitled to deduct a portion of such payments from royalties otherwise payable to the Company. In a few cases, the Company is required to indemnify the licensees against certain costs or liabilities incurred by the licensees as the result of any patent infringement or similar claim asserted by a third party with respect to technology or products developed by the Company.\nThe Company intends to continue to apply for patent protection in appropriate cases. The Company also intends to rely on its unpatented proprietary know-how. There can be no assurance that competitors will not develop or acquire equivalent proprietary information. All key employees, consultants and licensees of the Company have agreed to maintain the confidentiality of the Company's proprietary information. The Company's licensees may be competitors of the Company with respect to products other than those covered by their development and license agreements with the Company, and many of the Company's consultants may be engaged in research projects outside the scope of their consulting agreements with the Company.\nThe Company engages in research collaborations and enters into preclinical and clinical testing agreements with academic institutions and U.S. government agencies, such as the National Institutes of Health (\"NIH\"), in order to benefit from their technical expertise and staff and to gain access to clinical testing models, patients and related technology. Consistent with biopharmaceutical industry and academic standards, and the rules and regulations under the Federal Technology Transfer Act of 1986, these agreements may provide that results will be freely published, that information or materials supplied by the Company or developed under the agreement will not be treated as confidential, and that the Company will receive either joint ownership in or the right to negotiate a royalty-bearing license to such results.\nThe Company has entered into, and may in the future enter into, agreements with certain companies and institutions under which the Company obtains royalty-bearing licenses to use certain products, patent rights and processes in the manufacture of the Company's products.\nManufacturing -------------\nProteins produced by recombinant DNA technology are manufactured by growing large quantities of genetically engineered cells, purifying the desired protein from the cells or culture medium and characterizing in detail the protein's chemical and biological properties. Development groups within the Company have expertise in engineering bacterial (e.g., E coli) and mammalian cells (e.g. chinese hamster ovary cells) to produce recombinant proteins and in characterizing the resulting products. The optimal cell type for the production of a particular protein product depends on the individual properties of that protein and the quantities required for commercial use. The achievement and maintenance of an optimal environment for the production of a protein becomes more difficult as the scale of production increases and may require extensive development efforts and expenditures.\nThe Company owns and operates a 220,000 square foot product development and manufacturing facility in Andover, Massachusetts. The manufacturing portion of this facility contains four independent production suites. Two of the four suites are currently licensed by the FDA for the commercial production of rhAHF. The Company also has a production suite at its facilities in Cambridge, Massachusetts. These facilities are designed to be adequate to address clinical and early commercial-scale production requirements of the Company and its licensees, as applicable, for the next several years.\nThe Company presently does not have its own fill and finish capabilities for producing and labelling final drug products from bulk drug substance or bulk proteins. The Company has agreements with its licensees, such as Baxter with respect to rhAHF, to perform such services, and contracts with suppliers for its own proprietary products currently in clinical development to perform fill and finish services. In 1994, the Company relied substantially on Wyeth-Ayerst Laboratories, the pharmaceutical division of AHP, and one other third party for the fill and finish of products used in clinical testing.\nCurrently, 100% of the Company's product sales are dependent upon the manufacture of rhAHF concentrate. Raw materials used in the manufacture of rhAHF are supplied by vendors qualified by the Company and conform to specifications set by the Company that meet regulatory requirements. In the event a qualified vendor cannot provide sufficient raw materials to meet rhAHF production requirements, no assurance can be given that an alternate vendor can be qualified by the Company, and make up any shortfall of raw materials in a timely fashion.\nBoth the Cambridge and Andover production facilities have been inspected by the FDA and are designed to meet applicable standards for \"Good Manufacturing Practices\" or GMPs established by the FDA and other applicable government standards. The Company anticipates that these facilities will be subject to ongoing inspections by the FDA and international regulatory authorities in connection with their reviews of the Company's products. GMPs require that all manufacturing processes be monitored and controlled, and prohibit the release of any products which fail to comply with applicable product and process specifications. Because the manufacture of proteins is complex, the Company cannot guarantee that in the event of a failure or series of failures in the production of a protein resulting in GMP non-compliance, that it will have adequate manufacturing capacity to meet all of the Company's clinical and commercial manufacturing requirements.\nGovernment Regulation ---------------------\nThe production and marketing of the Company's products and its ongoing research and development activities are subject to regulation by numerous governmental authorities in the United States and other countries.\nFDA Approval. Pharmaceutical products or devices intended for preventative, therapeutic or diagnostic use in humans are governed by FDA regulations in the United States. The process of completing clinical testing and obtaining FDA approvals for a new drug, device or biological product is likely to take a number of years and requires the expenditure of substantial resources. No product is assured of ultimately receiving such approvals.\nThe steps required before a new human pharmaceutical product or device can be marketed in the United States typically include preclinical testing, filing an Investigational New Drug (\"IND\") application or an Investigational Device Exemption (\"IDE\"), conducting clinical trials and filing with and approval by the FDA of a marketing application, either a New Drug Application for drugs, a Product License Application for biologics or a Premarket Approval Application for devices. Preclinical studies are conducted in the laboratory and in animal model systems to gain preliminary information on the investigational product's efficacy and to identify significant safety problems. The results of these studies are submitted to the FDA for review as part of the IND or IDE application before a company can commence testing in humans.\nThe human clinical testing program is conducted in phases, is designed to collect data relating to the dosing, safety, side effects and efficacy of a product candidate, and may include a comparison with any currently accepted therapy. Phase I clinical trials are usually conducted with a small number of individuals and are designed to determine the metabolic and pharmacologic activities of the pharmaceutical product and to assess its safety. Pilot studies, in the case of devices, are similarly designed to test the general biocompatibility of the device and its safety in humans. While phase I and pilot study results have received increasing attention in the biotechnology industry, it is important to recognize that phase I and pilot study results only represent the first step in the clinical testing of a product and are important insofar as they provide the safety data and the initial clinical evidence needed to proceed to phase II and pivotal trials in which efficacy is ultimately measured.\nPhase II clinical trials generally involve studies in a limited patient population to provide preliminary evidence of efficacy of the product for specific targeted indications and to determine optimal dosage. Phase II studies generally do not involve enough patients to demonstrate efficacy in support of regulatory approval, and the Company cautions investors that positive phase II results alone do not assure that a product candidate will ultimately demonstrate efficacy in larger-scale phase III or pivotal trials. Phase III or pivotal clinical trials will be required to further evaluate clinical efficacy, to test for safety within an expanded patient population and to support registration of the product.\nUpon completion of clinical testing demonstrating that the new product is safe and effective for a specific indication, a marketing application may be filed with the FDA, and no assurance can be given that an application will be approved based on the data collected. This marketing application includes details of the manufacturing and testing processes, preclinical studies and clinical trials. The FDA must approve the application before the applicant may market the new product.\nOnce an FDA license has been obtained or the FDA approves a marketing application, further studies may be required to provide additional data on safety or to gain approval for the promotion of a product as a treatment for clinical indications other than those for which the product was initially tested. Also, the FDA may require post-approval testing for certain products and also requires surveillance programs to monitor a product's longer-term effects. Side effects resulting from the use of pharmaceutical products may prevent or limit the further marketing of the products.\nIn addition to product licensing or product marketing approval, a company producing biological products must obtain an establishment license from the FDA covering the company's manufacturing facilities before a biological product manufactured by the company can be marketed in the United States. Prior to granting such a license, the FDA will review the company's manufacturing procedures and inspect its facilities and equipment for compliance with applicable rules and regulations. Since any establishment license which may be granted by the FDA is both site and process specific, any material change by a company in its manufacturing process, equipment or location would necessitate additional FDA review and approval. In 1992, the Company received an Establishment License from the FDA for the manufacture of concentrated rhAHF for sale to Baxter which will further process and resell the rhAHF.\nHealth Care Reform. The debate regarding health care reform has raised the level of risk associated with biopharmaceutical development. The Company cannot predict with certainty what impact health care reform or the continuing competitive pricing pressures in the pharmaceutical\nmarkets, particularly from large buyers, managed care organizations and government purchasers, might have on the Company's products.\nOther Regulation. The federal government regulates certain recombinant DNA research activity through the NIH guidelines for research involving recombinant DNA molecules (the \"NIH Guidelines\"). The Company complies with the NIH Guidelines which, among other things, restrict or prohibit certain recombinant DNA experiments and establish levels of biological and physical containment of recombinant DNA molecules that must be met for various types of research.\nGenetics Institute is also subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Federal Insecticide, Fungicide and Rodenticide Act, the Research Conservation and Recovery Act, national restrictions on technology transfer, federal regulations on the protection of human subjects in clinical studies, the protection of animal welfare in preclinical studies, import, export and customs regulations and other present or possible future local, state or federal regulation. From time to time Congressional Committees and federal agencies have indicated an interest in implementing further regulation of biotechnology and its applications.\nOrphan Drug Act. The Orphan Drug Act is intended to provide incentives to manufacturers to develop and market drugs for rare diseases or conditions affecting fewer than 200,000 persons in the United States at the time of application for orphan drug designation. Historically, both drugs (filed under NDAs) and biologicals (filed under PLAs) have been eligible for orphan drug designation.\nA product that receives orphan drug designation and is the first product to receive an FDA license for its product claim is entitled to a seven-year exclusive marketing period in the United States for that product claim. However, a product that is considered by the FDA to be different than a particular orphan drug is not barred from sale in the United States during such seven-year exclusive marketing period even if it receives marketing approval for the same product claim.\nForeign Regulatory Approval. Whether or not FDA approval has been obtained, approval of a pharmaceutical product by comparable governmental regulatory authorities in foreign countries must be obtained prior to the commencement of clinical trials and subsequent marketing of such product in such countries. The approval procedure varies from country to country, and the time required may be longer or shorter than that required for FDA approval. Although there are now procedures for unified filing in Western Europe for the fifteen members of the European Union, many member countries require pricing reviews and approvals prior to marketing.\nAt present, pharmaceutical products generally may not be exported from the United States for other than research purposes until the FDA has approved the product for marketing in the United States. However, a company may apply to the FDA for permission to export finished products or partially processed biologics to a limited number of countries prior to obtaining FDA marketing approval for the United States.\nCompetition -----------\nThe Company believes that it is likely to encounter significant competition with respect to its principal products. Companies that are able to complete clinical trials, obtain required regulatory approvals and commence commercial sales of their products before their competitors may achieve a significant competitive advantage. Research in biotechnology is also being carried\nout in universities and other nonprofit research organizations. These entities have become increasingly active in seeking patent protection and licensing revenues for their research results. Moreover, these institutions continue to compete with the Company in recruiting skilled scientific personnel.\nAmgen and its licensees are marketing rhEPO in the United States, Europe and Japan. Cutter Biologicals, Inc. (\"Cutter\"), a division of Miles Laboratories, Inc. (a subsidiary of Bayer AG), has developed a recombinant antihemophilic factor which competes directly with the Company and Baxter's jointly-developed rhAHF product in the United States and certain other countries excluding Japan. rhAHF also competes throughout the world with plasma- derived Factor VIII, which is marketed worldwide by several major healthcare companies, including Baxter, RPR, Pharmacia A.B., Behringwerke Gmbh, Alpha Therapeutics, Inc. and its parent The Green Cross Corporation, Immuno A.G., the American Red Cross and similar Red Cross organizations. There is also potential for competition from second generation recombinant Factor VIII molecules. Pharmacia A.B. is conducting clinical trials with a second generation molecule and the Company has also discovered a second generation molecule which it may consider for development. The Company believes that its patent rights in second generation recombinant Factor VIII molecules will protect against competition from Pharmacia A.B. However, no assurance can be given as to the strength and breadth of such patent rights.\nIn connection with the settlement of the Factor VIII patent litigation (see \"Legal Proceedings\"), Baxter agreed to sell rhAHF to Rhone-Poulenc Rorer, Inc. (\"RPR\") as a distributor under RPR's own name. The Company believes RPR is seeking regulatory approvals in the United States and abroad, and Rorer will compete with Baxter upon entering such market. The Company may earn additional manufacturing revenue if RPR purchases rhAHF from Baxter. However, RPR's sales of rhAHF may reduce the manufacturing profit or royalties received from sales of rhAHF by Baxter.\nSignificant potential competition exists with respect to the Company's principal proprietary product candidates: rhFIX, rhIL- 11, rhBMP-2, and rhIL-12. Plasma derived Factor IX is currently marketed and sold worldwide by RPR, Pharmacia A.B., Alpha Therapeutics, Inc. and its parent the Green Cross Corporation, Red Cross organizations, Bayer AG, Behringwerke AG, Immuno AG, Armour Pharmaceutical Company, and is expected to compete with rhFIX. Pharmaceutical Proteins Ltd. is developing a recombinant Factor IX product which it produces in transgenic sheep. Roche, with whom the Company has a cross-license with respect to rhIL-12, is actively developing a competitive rhIL-12 product.\nImmunex Corporation is developing PIXY-321, which is in phase III clinical trials, as a agent to restore platelets, and if successful, it could compete with NeumegaTM rhIL-11. Genentech, Inc., Zymogetics, Inc. and Amgen, Inc. are each testing TPO in preclinical models, to determine if it has potential as a platelet restoration agent, and Sandoz is testing both rhIL-3 and rhIL-6 in the clinic in that indication as well. The Company believes that NeumegaTM rhIL-11 has the potential to compete favorably with each of these molecules; however, without final clinical data, and regulatory approval, it is not possible to provide any assurances as to the relative labelling and efficacy of these various product candidates.\nCreative BioMolecules, Inc. and Stryker Corporation are developing a bone morphogenic protein which could potentially compete with rhBMP-2. Other companies are developing bovine- derived bone growth factors, as well as other growth factors for the repair of bone and cartilage tissue.\nCompetitors have also commenced clinical trials on, filed for marketing approval for, or received marketing approval for products that will compete with rhM-CSF, rNPA, rhGM-CSF, rhIL-3, and rhIL-6.\nThe field of biotechnology is expected to continue to undergo rapid and significant technological change and to involve significant competition. One example is the emerging field of gene therapy in which the gene for a protein is inserted in the patient to enable the patient to manufacture the protein that he or she lacks. In the future, gene therapy could reduce much of the need for rhAHF or rhFIX, and other protein therapeutics. As a result, the Company has entered into research collaborations with gene therapy companies with respect to the rhAHF and rhFIX genes, and is evaluating the desirability of entering into similar collaborations with respect to its other proprietary genes.\nGenetics Institute believes that its ability to compete effectively in the biotechnology industry will be based on a number of factors. These factors include the Company's ability to create and maintain scientifically advanced discovery, development and manufacturing technology, develop proprietary products or processes, attract and retain qualified personnel, raise capital, obtain patent or other protection for its products or processes, obtain required government approvals on a timely basis, select and pursue product candidates with significant market potential, manufacture its products on a cost-effective basis and successfully commercialize its products. Many of the Company's competitors have substantially greater financial resources, experience and sales and marketing organizations than Genetics Institute.\nHuman Resources ---------------\nAs of December 31, 1994, the Company had 941 full-time regular employees, of which 741 were engaged in research, product development, manufacturing, clinical development and regulatory affairs, 116 in operations support and 84 in general administration. Of the Company's employees, 161 have Ph.D. or M.D. degrees and another 133 hold other advanced degrees.\nNone of the Company's employees is covered by a collective bargaining agreement. Genetics Institute considers its relations with its employees to be excellent.\nThe Company's ability to maintain its competitive position will depend, in part, upon its continued ability to attract and retain qualified scientific and managerial personnel. Competition for such personnel is intense.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties. - ------ ----------\nThe Company's executive, administrative and research offices as well as a small-scale production facility and research and development laboratories, all comprising approximately 220,000 square feet, are located in four buildings in Cambridge, Massachusetts. The Company owns one building, and leases the remaining three buildings. The lease terms for the Company's two principal Cambridge facilities extend through 1999 and 2009, respectively. In addition, the Company leases approximately 5,000 square feet of office space in Tokyo, Japan, and Paris, France.\nThe Company also owns an approximately 220,000 square foot process development and manufacturing facility in Andover, Massachusetts. This facility contains four independent production suites. See \"Manufacturing.\" The Company recently added a 40,000 square foot central utility plant and a new 130,000 square foot preclinical biology and product development facility at its Andover campus. In addition, the Company leases 18,000 square feet of warehouse space in an adjacent Andover building.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings. - ------ -----------------\nThe Company has been engaged in legal proceedings relating to the amount of damages payable by the Company as a result of the holding of the U.S. Court of Appeals for the Federal Circuit (\"CAFC\") that the Company infringed a U.S. patent of Amgen Inc. (\"Amgen\") relating to recombinant erythropoietin (\"EPO\"). On May 11, 1993, the Company and Amgen agreed to settle all then outstanding claims of Amgen against the Company in the United States relating to recombinant EPO.\nIn August 1991, Ortho Pharmaceutical Corporation and its affiliates (\"Ortho\"), a licensee of Kirin-Amgen, Inc.'s recombinant EPO patents, initiated infringement proceedings against the Company in the U.S. District Court in Massachusetts. Ortho moved to consolidate the case with the infringement suit brought by Amgen. Upon motion by the Company and Amgen, Ortho's claims were dismissed and Ortho has appealed the District Court's decision. A decision on the Ortho appeal is pending. The Company and Amgen also jointly moved to dismiss similar claims brought by Ortho against the Company in the U.S. District Court in California in 1989, and the court granted the motion in March 1994.\nIn June 1994, the Company sued Ortho in the U.S. District Court in Delaware. The Company's suit claimed that Ortho's manufacture, use and sale of EPO in the U.S. infringes a patent covering pharmaceutical compositions containing homogeneous EPO that was issued to the Company by the U.S. Patent and Trademark Office on June 21, 1994 (the '837 patent). In September 1994, Amgen sued the Company in U.S. District Court in Massachusetts. Amgen's suit asked the court to declare that the Company's '837 patent is invalid and not infringed by Amgen and to declare that any dispute over the patent was resolved by the prior litigation. The Company has filed counterclaims against Amgen for infringement of the '837 patent. Ortho intervened in the Amgen suit in Massachusetts, and the action against Ortho in Delaware was stayed. In February 1995, the Massachusetts court granted a motion by Amgen for summary judgment. The court ruled that the CAFC decision in the prior litigation invalidating an earlier U.S. EPO patent of the Company precluded the assertion of the '837 patent. The Company plans to appeal. The Company can provide no assurances as to the outcome of these disputes with Ortho and Amgen.\nThe Company and its licensees are engaged in various patent litigation proceedings in Europe related to EPO. Beginning in 1991, Ortho and certain Ortho affiliates initiated patent infringement litigation in Europe against Boehringer Mannheim, the Company's European EPO licensee, based on a European recombinant EPO patent issued to Kirin-Amgen, Inc. (\"Kirin-Amgen\"), its licensor. The suits have included requests for damages and\/or injunctive relief. Boehringer Mannheim filed suits against Ortho and\/or certain of its affiliates in Europe claiming infringement of the Company's European EPO patents. This litigation has expanded into many of the European Community countries in Boehringer Mannheim's territory. In some countries, where the patentee is a legally necessary party to a suit to enforce a patent, the Company has joined as a plaintiff. The Company is also a defendant in suits in the United Kingdom, Germany, Italy and the\nNetherlands brought by an Ortho affiliate seeking to invalidate and revoke the Company's EPO patents in the United Kingdom, the former East Germany, Italy and the Netherlands, respectively. The revocation suit in Germany was dismissed in May 1994. However, it is subject to appeal.\nIn June 1994, a claim in the Company's European patent covering homogeneous EPO compositions (the '539 patent) was upheld by the Opposition Division of the European Patent Office. This decision has been appealed. In September 1994, an appellate hearing was held before the Board of Technical Appeals (the \"Board\") of the European Patent Office relating to the oppositions to Kirin-Amgen's European recombinant EPO patent. The Board ruled that a modified version of certain of Kirin-Amgen's original claims in the patent filing was valid.\nThe Company can provide no assurance as to the outcome of these European proceedings. If the courts ultimately rule in Ortho's favor in these European proceedings, including issuing an injunction against the future manufacture or sale of recombinant EPO by Boehringer Mannheim, or if this litigation is otherwise concluded in a manner adverse to Boehringer Mannheim or the Company, future royalty income from EPO in Europe, which totaled $11.3 million in fiscal 1994, could be reduced or eliminated.\nThe Company is engaged in a patent interference proceeding among the Company, Genentech, Inc. and Chiron Corporation concerning the Factor VIII U.S. patent rights which are cross- licensed between Baxter (the Company's licensee) and Genentech, Inc. While the Company believes it or Genentech should prevail in the interference, no assurance can be given as to the outcome of this interference. Any disposition of this proceeding in a manner unfavorable to the Company or its licensee could have a material adverse effect on the Company's future consolidated results of operations.\nIn September 1994, the Company's U.S. patent directed to the use of vitamin K as a culture medium supplement in the manufacture of recombinant Factor IX was put into a patent interference proceeding among the Company, Transgene, Inc., Zymogenetics, Inc. and British Technology Group, Ltd. (\"BTG\"). BTG has licensed its Factor IX patent rights to the Company. In addition, in late October 1994, one of the Company's U.S. patents covering recombinant BMP-2 was put into a patent interference proceeding between the Company and Stryker Corporation, the assignee of Creative BioMolecules, Inc. The Company can provide no assurance as to the outcome of these proceedings.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to Vote of Security Holders. - ------ -------------------------------------------------\nNot applicable.\nExecutive Officers of the Registrant ------------------------------------\nThe following table sets forth the names and ages of, and the positions and offices with the Company as of February 1, 1995 held by, all executive officers of the Company under Section 16 of the Securities and Exchange Act:\nBusiness Experience\nMr. Schmergel has been President, Chief Executive Officer and a director of the Company since April 1981.\nDr. Gage joined the Company in November 1989 as Senior Vice President-Scientific Affairs, was subsequently promoted to Executive Vice President in January 1990 and then was promoted to Chief Operating Officer in November 1993. From 1971 to October 1989, Dr. Gage held various scientific and management positions at Hoffmann-La Roche Inc., most recently as Vice President, Director of Exploratory Research.\nMr. Bohlin joined the Company in December 1983 as Director of Finance and Treasurer and was subsequently promoted to Vice President-Finance and then to Senior Vice President-Finance and Administration. He has been serving as Executive Vice President and Chief Financial Officer since January 1990.\nMr. Ha-Ngoc joined the Company in May 1984 as Marketing Manager and was subsequently promoted to Director of Marketing, then to Vice President-Marketing and Business Development and then to Senior Vice President-Pharmaceutical Business. He has been serving as Executive Vice President since January 1990.\nDr. Clark joined the Company in March 1981 as one of the founding Senior Scientists and was subsequently promoted to Director of Hematopoiesis Research in September 1986. He was promoted to Vice President-Research and Development in April 1989, and then to Senior Vice President-Discovery Research in November 1993.\nMr. Stein joined the Company in November 1992 as Senior Vice President and General Counsel. From 1976 to November 1992, he was an attorney with the law firm of Arnold & Porter, where he became a partner in 1984.\nMr. Grimm joined the Company in July 1986 as Director of Finance. He has been serving as Treasurer since December 1987 and was promoted to Vice President-Finance in January 1992.\nMr. Morgan joined the Company as Director, Corporate Development in April 1991 and has been serving as Vice President- Corporate Development since November 1993. Prior to joining the Company, he spent 12 years at Baxter Healthcare Corporation where, among other responsibilities, he was Vice President of Corporate Planning.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related - ---------------------------------------------------------- Stockholder Matters - -------------------\nSTOCK PROFILE\nGenetics Institute's Common Stock (now represented by Depositary Shares) and Warrants are traded on the National Market System of NASDAQ under the symbols GENIZ and GENIW, respectively. At January 31, 1995, shareholders of record of the Company's Depositary Shares totaled approximately 1,600. The Company has not paid cash dividends on its Common Stock since its inception. The following table sets forth the high and low sale prices per share of the Common Stock on the NASDAQ National Market System since December 1, 1992.\nPRICE RANGE OF COMMON STOCK\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 Genetics Institute, Inc. and subsidiaries (the \"Company\") are principally engaged in discovering, developing and commercializing protein-based therapeutic products using recombinant DNA and related technologies.\nSignificant volatility has been associated with the business and operations of biopharmaceutical companies. Announcements by the Company or its competitors concerning technological innovations, new commercial products, results of clinical trials, developments concerning patents, proprietary rights and related infringement disputes, results of litigation, and the expense and time associated with obtaining requisite government approvals may have a significant impact on the Company's business.\nThe Company's consolidated results of operations have fluctuated from period to period and may continue to fluctuate in the near- term as a result of: the timing of production and shipment of bulk protein products; changes in the timing and composition of funding under its collaborative research and development agreements; the ability to consummate new collaborative agreements; royalty income (and the impact of infringement litigation on royalty income); investment income; and the amount of expenditures committed to research and development programs.\nAs of December 31, 1994, four of the Company's proprietary product candidates were in phase I or phase II human clinical trials. Phase I and phase II data are preliminary measurements of a product's safety and efficacy and do not assure positive phase III data or ultimate regulatory approval for commercial sale. The Company's market valuation could be subject to volatility as investors interpret the results of the Company's current and future clinical trials.\nThe Company and American Home Products Corporation (\"AHP\") entered into a transaction (the \"AHP Transaction\") through which AHP acquired a majority interest in the Company effective January 16, 1992 (see Note 2 of Notes to Consolidated Financial Statements).\nThe Company changed its fiscal year to a calendar year effective January 1, 1994. Results for the month of December 1993 are included in the accompanying financial statements as a transition period.\nRESULTS OF OPERATIONS\nThe Company reported a net loss of $18.9 million for fiscal 1994, an increase of $2.0 million from the loss of $16.9 million in fiscal 1993. The fiscal 1994 loss reflects the ongoing expansion of product development activities in the United States, as well as in Japan through a joint venture. In fiscal 1994, revenue increases from the prior year were more than offset by increases in operating and other expenses and by a decrease in investment income.\nThe net loss for the December 1993 transition period was $4.4 million. This loss exceeded the average monthly net loss recorded in fiscal 1993 and 1994 primarily due to lower than average collaborative research and development revenues.\nThe net loss of $37.0 million reported for fiscal 1992 included special charges of $32.0 million, primarily relating to the AHP Transaction. The increase in the net loss from fiscal 1992 (exclusive of the special charges) to fiscal 1993 was primarily due to significant expansion of the Company's product development activities and discovery research programs during fiscal 1993.\nThe Company's revenues include product sales from the supply of recombinant human antihemophilic factor concentrate (\"rhAHF\") to Baxter Healthcare Corporation (\"Baxter\"), royalties on sales of products by marketing partners, and collaborative research and development revenue for activities conducted under the Company's agreements with its various collaborative partners. Revenues increased 28% or $28.8 million in fiscal 1994. In fiscal 1994, product sales increased 5% to $43.5 million, royalties increased 61% to $42.6 million and collaborative research and development revenues, including $23.1 million recognized in connection with a joint venture with AHP discussed below, increased 31% to $44.8 million. Revenues for fiscal 1993 increased 16% from fiscal 1992 primarily in relation to the Company's first year of commercial product sales, partly offset by a decrease in collaborative research and development revenues.\nProduct sales increased 5% or $2.2 million in fiscal 1994. Product sales in fiscal 1993 included $5.8 million of manufacturing profit relating to shipments of rhAHF to Baxter made prior to the December 1992 commercial approval date. Pre- commercial shipments of rhAHF were originally billed to Baxter at cost and were included in collaborative research and development revenues prior to fiscal 1993. Excluding this $5.8 million of one-time manufacturing profit recognized in fiscal 1993, product sales increased 22% or $8.0 million in fiscal 1994, due to an increase in the volume of rhAHF shipped to Baxter.\nRoyalties increased 61% or $16.1 million in fiscal 1994 primarily due to increases in the volume of recombinant erythropoietin (\"EPO\") sold by the Company's marketing partners. Royalties also include $2.2 million recognized in fiscal 1994 representing a payment of EPO royalties earned prior to 1994. Such royalties were initially withheld in escrow by the Company's licensee, Boehringer Mannheim GmbH (\"Boehringer Mannheim\"), to fund the Company's share of the cost of EPO patent suits filed against Ortho Pharmaceutical Co., Ltd. and its affiliates (\"Ortho\") in Europe. Pursuant to an agreement between the Company and Boehringer Mannheim which specifies the terms for such cost sharing, $2.2 million was released from escrow in the third quarter of fiscal 1994. In addition, a significant increase in the volume of finished rhAHF product sold by Baxter also contributed to the increase in royalty revenue in fiscal 1994. Royalty revenues decreased 3% in fiscal 1993 despite increases in the volume of finished drug product sold by the Company's marketing partners. The decrease was due to a reduced royalty rate on sales of EPO in Japan as a result of the settlement of a potential patent infringement dispute, and due to royalties withheld to fund the Company's contribution to the cost of EPO patent litigation in Europe as discussed above.\nCollaborative research and development revenues increased 31% or $10.5 million in fiscal 1994, principally due to $23.1 million recognized in fiscal 1994 in connection with a joint venture formed by the Company and AHP to develop and commercialize recombinant human interleukin-twelve (\"rhIL-12\"), a cellular immune system activator, worldwide (except Japan). The amount recognized included $20.0 million in initial milestone and signature payments. The Company also recognized $3.0 million in milestone and signature payments in connection with an agreement between the Company and GI-Yamanouchi, Inc., a joint venture between the Company and Yamanouchi Pharmaceutical Co., Ltd. (\"Yamanouchi\"), to develop and commercialize rhIL-12 in Japan. The increases in collaborative research and development revenues relating to the rhIL-12 program were offset by decreases in reimbursable activities and a lower level of benchmark payments from collaborative partners in other development programs. Collaborative research and development revenues decreased 43% from fiscal 1992 to fiscal 1993 principally due to the absence in fiscal 1993 of pre-commercial sales of rhAHF at cost and to a higher level of benchmark payments recognized in fiscal 1992 under collaborative agreements. Collaborative research and development revenues include $28.9 million, $11.8 million and $8.7 million for fiscal years 1994, 1993 and 1992, respectively, relating to collaborations with AHP.\nCost of sales includes royalties payable to third parties upon the receipt of certain royalty revenues from collaborative partners. Such third party royalties totaled $3.8 million and $1.6 million in fiscal 1994 and 1993, respectively. Cost of sales excluding third party royalties, as a percentage of product sales (and also excluding the $5.8 million of one-time manufacturing profit recognized in fiscal 1993 as discussed above) was 56% and 58% for fiscal 1994 and 1993, respectively. The decrease in fiscal 1994 was due to lower unit manufacturing costs.\nResearch and development expense increased 9% to $108.2 million in fiscal 1994 and increased 11% to $99.0 million in fiscal 1993. The increase in fiscal 1994 was primarily attributable to higher staffing levels in the research and product development areas of the Company and expansion of clinical development activities and outside research collaborations. The increase in fiscal 1993 was primarily due to expansion of the Company's research programs and product development activities.\nGeneral and administrative expenses decreased 10% in fiscal 1994 and increased 15% in fiscal 1993, primarily due to higher litigation-related costs in fiscal 1993.\nInvestment income decreased 32% in fiscal 1994 and increased 22% in fiscal 1993. The increase in fiscal 1993 reflected the higher average balance of cash and marketable securities in fiscal 1993 resulting from the issuance of common stock in January 1992 to AHP in the AHP Transaction. The decrease in fiscal 1994 was due to a lower average balance of cash and marketable securities and net realized losses recorded on sales of certain marketable securities as cash was used during the year, primarily to fund capital expenditures. The Company expects the level of investment income to continue to decrease in fiscal 1995 as cash is used for ongoing capital expenditures and working capital requirements.\nIncome (loss) of affiliates, net, was $5.3 million of net expense in fiscal 1994, $3.3 million of net income in fiscal 1993 and $0.4 million of net expense in fiscal 1992. In fiscal 1993 the Company recorded $5.0 million of equity income relating to distribution agreements entered into by the GI-Yamanouchi European Partnership (the \"GYEP\"), which was formed by the Company and Yamanouchi for the commercialization of bone morphogenetic proteins in Europe. The GYEP entered into distribution agreements with AHP and Yamanouchi in return for distribution fees and milestone payments. Excluding the $5.0 million of equity income relating to the GYEP\ndistribution agreements, the increases in loss of affiliates, net, in fiscal 1994 and 1993 were due primarily to increases in the Company's equity in the net losses of GI-Yamanouchi, Inc., relating to expansion of product development activities in Japan.\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\"). Implementation of SFAS No. 115 had no impact on the Company's fiscal 1994 results of operations because the Company's marketable securities, which consist of debt securities, are classified as available-for-sale. Under SFAS No. 115, the net unrealized gain or loss on an available-for-sale portfolio of debt securities is recorded in shareholders' equity. The net unrealized gain on the Company's marketable securities recorded in shareholders' equity at January 1, 1994 was $2.6 million. A net unrealized loss of $11.2 million was reflected in shareholders' equity at December 31, 1994.\nLEGAL PROCEEDINGS\nThe Company has been engaged in legal proceedings relating to the amount of damages payable by the Company as a result of the holding of the U.S. Court of Appeals for the Federal Circuit (\"CAFC\") that the Company infringed a U.S. patent of Amgen Inc. (\"Amgen\") relating to recombinant EPO. On May 11, 1993, the Company and Amgen agreed to settle all then outstanding claims of Amgen against the Company in the United States relating to recombinant EPO.\nIn August 1991, Ortho, a licensee of Kirin-Amgen, Inc.'s (\"Kirin- Amgen\") recombinant EPO patents, initiated infringement proceedings against the Company in the U.S. District Court in Massachusetts. Ortho moved to consolidate the case with the infringement suit brought by Amgen. Upon motion by the Company and Amgen, Ortho's claims were dismissed and Ortho has appealed the District Court's decision. A decision on the Ortho appeal is pending. The Company and Amgen also jointly moved to dismiss similar claims brought by Ortho against the Company in the U.S. District Court in California in 1989, and the court granted the motion in March 1994.\nIn June 1994, the Company sued Ortho in the U.S. District Court in Delaware. The Company's suit claimed that Ortho's manufacture, use and sale of EPO in the U.S. infringes a patent covering pharmaceutical compositions containing homogeneous EPO that was issued to the Company by the U.S. Patent and Trademark Office on June 21, 1994 (the '837 patent). In September 1994, Amgen sued the Company in U.S. District Court in Massachusetts. Amgen's suit asked the court to declare that the Company's '837 patent is invalid and not infringed by Amgen and to declare that any dispute over the patent was resolved by the prior litigation. Ortho intervened in the Amgen suit in Massachusetts and the action against Ortho in Delaware was stayed. In February 1995, the Massachusetts court granted a motion by Amgen for summary judgment. The court ruled that the CAFC decision in the prior litigation invalidating an earlier U.S. EPO patent of the Company precluded the assertion of the '837 patent. The Company plans to appeal. The Company can provide no assurances as to the outcome of these disputes with Ortho and Amgen.\nThe Company and its licensees are engaged in various patent litigation proceedings in Europe related to EPO. Beginning in 1991, Ortho and certain Ortho affiliates initiated patent infringement litigation in Europe against Boehringer Mannheim, based on a European recombinant EPO patent issued to Kirin-Amgen, its licensor. The suits have included requests for damages and\/or injunctive relief. Boehringer Mannheim filed suits against Ortho and\/or certain of its affiliates in\nEurope claiming infringement of the Company's European EPO patents. This litigation has expanded into many of the European Community countries in Boehringer Mannheim's territory. In some countries, where the patentee is a legally necessary party to a suit to enforce a patent, the Company has joined as a plaintiff. The Company is also a defendant in suits in the United Kingdom, Germany, Italy and the Netherlands brought by an Ortho affiliate seeking to invalidate and revoke the Company's EPO patents in the United Kingdom, the former East Germany, Italy and the Netherlands, respectively. The revocation suit in Germany was dismissed in May 1994. However, it is subject to appeal.\nIn June 1994, a claim in the Company's European patent covering homogeneous EPO compositions (the '539 patent) was upheld by the Opposition Division of the European Patent Office. This decision has been appealed. In September 1994, an appellate hearing was held before the Board of Technical Appeals of the European Patent Office relating to oppositions to Kirin-Amgen's European recombinant EPO patent. The Board ruled that a modified version of certain of Kirin-Amgen's original claims in the patent filing was valid.\nThe Company can provide no assurance as to the outcome of these European proceedings. If the courts ultimately rule in Ortho's favor in these European proceedings, including issuing an injunction against the future manufacture or sale of recombinant EPO by Boehringer Mannheim, or if this litigation is otherwise concluded in a manner adverse to Boehringer Mannheim or the Company, future royalty income from EPO in Europe, which totaled $11.3 million in fiscal 1994, could be reduced or eliminated.\nThe Company is engaged in a patent interference proceeding among the Company, Genentech, Inc. and Chiron Corporation concerning the Factor VIII U.S. patent rights which are cross-licensed between Baxter (the Company's licensee) and Genentech, Inc. While the Company believes it or Genentech should prevail in the interference, no assurance can be given as to the outcome of this interference. Any disposition of this proceeding in a manner unfavorable to the Company or its licensee could have a material adverse effect on the Company's future consolidated results of operations.\nThe Company is engaged in a patent interference proceeding among the Company, Transgene, Inc., Zymogenetics, Inc. and British Technology Group, Ltd. (\"BTG\") concerning U.S. patent rights directed to the use of vitamin K as a culture medium supplement in the manufacture of recombinant Factor IX. BTG has licensed its Factor IX patent rights to the Company. In addition, the Company is engaged in a patent interference proceeding with Stryker Corporation, the assignee of Creative BioMolecules, Inc., concerning one of the Company's U.S. patents covering recombinant BMP-2. Both Factor IX and BMP-2 are currently in the clinical development stage. The Company can provide no assurance as to the outcome of these proceedings.\nLIQUIDITY AND CAPITAL RESOURCES\nCash and marketable securities totaled $269.8 million at December 31, 1994, a decrease of $21.7 million from November 30, 1993. This decrease included a non-cash net unrealized loss on marketable securities of $11.2 million and a net use of cash and marketable securities of $10.5 million for the thirteen-month period which includes the transition period of December 1993 and the year ended December 31, 1994. For the thirteen-month period: operating activities generated $3.0 million of cash; stock issuances under stock option and employee stock purchase plans generated $9.0 million of cash; equipment sale-leaseback transactions generated cash proceeds of $26.6 million; and cash was used for capital expenditures totaling $49.0 million and other net investments of $0.2 million.\nCash flow in 1995 will be affected by a change in the contractual terms for the payment of rhAHF product revenue to the Company by Baxter. The change in payment terms is expected to increase average accounts receivable from Baxter by up to $20.0 million during 1995.\nThe Company expects that its available cash and marketable securities, together with investment income, operating revenues and lease and debt financing arrangements, will be sufficient to finance its working capital and capital requirements for the foreseeable future. Over the next several years, the Company's working capital and capital requirements will be subject to change depending upon numerous factors including the level of capital expenditures, changes in the amount of expenditures committed to self-funded research and development programs, results of research and development activities, competitive and technological developments, the levels of resources which the Company devotes to the expansion of its clinical testing, manufacturing and marketing activities and the timing and cost of obtaining required regulatory approvals for new products.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data. - ------ -------------------------------------------\nAll financial statements and schedules required to be filed hereunder are filed as exhibits hereto, are listed under Item 14 (a), and are incorporated herein by reference.\nPART III\nITEM 10.","section_9":"","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 the section captioned \"Election of Directors\" in the Company's Proxy Statement with respect to the Annual Meeting of Stockholders to be held on May 16, 1995.\n(b) Executive Officers. The information with respect to executive officers required under this item is incorporated herein by reference to 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 the sections entitled \"Election of Directors -- Compensation for Directors,\" \"-- Compensation of Executive Officers,\" \"-- Compensation Arrangements and Employment Agreements,\" \"-- Report of the Compensation Committee,\" \"-- Stock Performance Chart,\" in the Company's Proxy Statement with respect to the Annual Meeting of Stockholders to be held on May 16, 1995.\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 the section entitled \"Principal Stockholders\" in the Company's Proxy Statement with respect to the Annual Meeting of Stockholders to be held on May 16, 1995.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions. - ------- ----------------------------------------------\nThe information required under this item is incorporated herein by reference to the sections entitled \"Election of Directors -- Compensation Arrangements and Employment Agreements\" and \"-- Certain Transactions\" in the Company's Proxy Statement with respect to the Annual Meeting of Stockholders to be held on May 16, 1995.\nThe Company, AHP and its affiliate, AHP Biotech Holdings, Inc. (\"Holdings\") have entered into a Governance Agreement (the \"Governance Agreement\") providing, among other things, for (i) the inclusion of nominees designated by Holdings on, and the change in composition on January 1, 1997 of, an expanded Board of Directors of the Company, (ii) the establishment of committees of the Board of Directors addressing compensation, scientific affairs and intellectual property rights and the membership of the directors designated by Holdings on such new as well as existing committees, (iii) approval rights on the part of the directors designated by Holdings with respect to material acquisitions by the Company, dispositions of all or any substantial portion of its business or assets, issuances and repurchases of equity securities, amendments to the Certificate of Incorporation or By-Laws of the Company and any action otherwise within the purview of the Intellectual Property Committee, Scientific Affairs Committee or Compensation Committee of the Board of Directors established pursuant to the Governance Agreement which is presented to the full Board for action, (iv) certain rights of first refusal granted to AHP with respect to material licensing and marketing arrangements with third parties, including an obligation to first offer to AHP marketing rights to products before offering them to third parties, (v) certain restrictions on acquisitions and dispositions of New Shares by AHP and its affiliates and (vi) certain agreements as to Holdings' voting of its Common Stock with respect to elections of directors and amendments to the terms of the Depositary Shares.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statements Schedules, Supplementary - ------- -------------------------------------------------------- Data and Reports on Form 8-K. ----------------------------\nAll 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.\n(a)(3) Index to Exhibits.\nThe Exhibits filed as part of this Form 10-K are listed on the Exhibit Index immediately preceding such Exhibits, which Exhibit Index is incorporated herein by reference.\n(b) Reports on Form 8-K.\nThe Company filed no reports on Form 8-K during the quarter ended December 31, 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.\nGENETICS INSTITUTE, INC.\nMarch 15, 1995 By: \/s\/Gabriel Schmergel -------------------------- 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.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and the Shareholders of Genetics Institute, Inc.:\nWe have audited the accompanying consolidated balance sheets of Genetics Institute, Inc., and subsidiaries as of December 31, 1994 and November 30, 1993 and the related consolidated statements of operations, cash flows and stockholders' equity for the years then ended and the month 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 Genetics Institute, Inc. and subsidiaries as of December 31, 1994 and November 30, 1993 and the results of their operations and their cash flows for the years then ended and the month ended December 31, 1993 in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of the financial statements is presented for the purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states 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 LLP\nBoston, Massachusetts January 18, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Genetics Institute, Inc.:\nWe have audited the accompanying consolidated statements of operations, cash flows, and changes in shareholders' equity for Genetics Institute, Inc. and subsidiaries for the year ended November 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 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 disclosure 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 Genetics Institute, Inc. and subsidiaries for the year ended November 30, 1992 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 schedule listed in the index of the financial statements is presented for the purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nCoopers & Lybrand L.L.P.\nBoston, Massachusetts December 29, 1992\nCONSOLIDATED BALANCE SHEETS GENETICS INSTITUTE, INC. AND SUBSIDIARIES\n(In thousands except share data)\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED STATEMENTS OF OPERATIONS GENETICS INSTITUTE, INC. AND SUBSIDIARIES\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY GENETICS INSTITUTE, INC. AND SUBSIDIARIES\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS GENETICS INSTITUTE, INC. AND SUBSIDIARIES\n1. Summary of Significant Accounting Policies\nBusiness: Genetics Institute, Inc. and subsidiaries (the \"Company\") are principally engaged in discovering, developing and commercializing therapeutic products using recombinant DNA and related technologies.\nBasis of Presentation: The consolidated financial statements include all accounts of Genetics Institute, Inc. and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. Certain amounts in the prior year financial statements have been reclassified to conform to the current year presentation.\nChange in Fiscal Year: The Company changed its fiscal year-end from November 30 to December 31, effective January 1, 1994. Financial information for the preceding fiscal year has not been restated because the information is reasonably comparable with the current year. The one-month transition period ended December 31, 1993 is presented separately in the financial statements. Comparative unaudited condensed statement of operations data for the one-month period ended December 31, 1992 is as follows: revenue $9.5 million; operating income $0.7 million; net income $1.9 million; and net income per common share $.06.\nRevenue Recognition: Product sales revenue is recognized upon shipment of commercial product and represents commercial sales of recombinant human antihemophilic factor concentrate (\"rhAHF\") under a supply contract with Baxter Healthcare Corporation (\"Baxter\") for Baxter's final product manufacturing and distribution. Shipments of rhAHF and other products at cost for periods prior to commercial approval are included in collaborative research and development revenue. The Company has entered into agreements with a number of collaborative partners to conduct collaborative research and development programs. In some cases, these programs are conducted through development partnerships. Revenue under these arrangements is included in collaborative research and development revenue and is generally recognized as the related costs are incurred by the Company, as benchmarks are achieved or as pre-commercial product is shipped, as applicable. Collaborative research and development revenue from development partnerships is recorded net of amounts funded to the partnerships by the Company. Royalty revenue is recognized in the period that commercial product is sold by the licensee.\nResearch and Development costs, including those incurred in relation to the Company's collaborative research and development programs, are expensed in the period incurred.\nCash Equivalents, for purposes of reporting cash flows, include highly liquid instruments purchased with a maturity of three months or less. The Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS No. 115\") effective January 1, 1994. Under SFAS No. 115, the Company's cash equivalents are classified as held-to-maturity (recorded at amortized cost).\nMarketable Securities consist of debt securities which are classified under SFAS No. 115 as available-for-sale (recorded at fair value). At January 1, 1994, the cumulative effect of implementing SFAS No. 115 was to record a net unrealized gain of $2.6 million on available-for-sale securities. Under SFAS No. 115, such net unrealized holding gains or losses are recorded in shareholders' equity. For periods prior to fiscal 1994, marketable securities are recorded at cost which approximates market. In computing realized gains or losses, the cost of securities sold is\nbased on average cost. The estimated fair value of marketable securities is based primarily on market quotations.\nInventories are valued at the lower of cost or market. Cost is determined on the first-in, first-out method.\nProperty, Plant and Equipment is carried at cost. Depreciation is provided, using the straight-line method, over the assets' estimated useful lives, or for leasehold improvements and leased equipment, over the lesser of the lease term or the useful life, as follows (in years): buildings and building improvements, 10- 30; machinery and equipment, 3-10; and leasehold improvements, 3-15.\nForeign Currency Transactions: The Company enters into foreign exchange forward and option contracts to hedge royalties on sales in foreign currencies by marketing partners. The purpose of this hedging activity is to protect the Company from the risk that dollar cash flows from such royalties will be adversely affected by changes in exchange rates. Gains and losses on forward and option contracts that are hedges of firm commitments are deferred and recognized in revenue in the same period as the hedged transactions. Contracts that hedge anticipated royalty transactions are marked to market and unrealized gains and losses are recorded in income for the period. The net loss on such contracts was $0.6 million in fiscal 1994 and was not material in fiscal 1993. At December 31, 1994, the Company had forward exchange contracts, all having maturities of less than one year, to sell Japanese yen in the amount of $20.0 million and German deutschmarks in the amount of $5.5 million.\nFinancial Instruments consist of cash equivalents, marketable securities, foreign currency contracts and accounts receivable. The estimated fair value of these financial instruments approximates their carrying value and, except for accounts receivable, is based primarily on market quotes. The Company's cash equivalents and marketable securities are generally obligations of the federal government or investment grade corporate or municipal issuers. The Company, by policy, limits the amount of credit exposure to any one financial institution. The counter parties to foreign currency contracts are major financial institutions. The Company does not anticipate any losses from non-performance on such contracts.\nNet Loss Per Common Share is computed based on the weighted average number of common shares outstanding during the period. Common share equivalents have not been included in the calculations because their effect would be antidilutive. For periods prior to July 1993, the net loss applicable to common shares consists of the reported net loss plus dividends declared on the Company's then outstanding Convertible Exchangeable Preferred Stock (the \"Preferred Stock\").\n2. Transactions with American Home Products Corporation\nThe Company and American Home Products Corporation (\"AHP\") entered into a transaction (the \"AHP Transaction\") through which AHP acquired a majority interest in the Company effective January 16, 1992. In connection with the AHP Transaction, the Company issued 9,466,709 new shares of Genetics Institute, Inc. Common Stock (the \"Common Stock\") to AHP for an aggregate purchase price of $300.0 million and, for shares of Common Stock owned, the Company's shareholders received from AHP a combination of cash and Depositary Shares subject to a call option (the \"Depositary Shares\"). Under the terms of the call option, AHP has the right, but not the obligation, to purchase the outstanding Depositary Shares that it does not own, in whole but not in part, at any time until December 31, 1996, at a call price of $72.11 per share for the period January 1, 1995 to March 31, 1995 and increasing by approximately $1.84 on a quarterly basis to $85.00 per share for the quarter ending December 31, 1996. The Company incurred a special charge of $30.0 million in AHP Transaction-related expenses in fiscal 1992.\nIndependent of its right to call the Depositary Shares, AHP is permitted by the terms of the agreements with the Company to acquire additional Depositary Shares through open market purchases or privately negotiated purchases, provided that its aggregate holdings do not exceed 75% of the Company's outstanding equity, subject to certain exceptions. As of December 31, 1994, AHP had purchased 947,000 additional Depositary Shares through such purchases . In addition, in connection with the call for redemption of the Company's Preferred Stock in July 1993, holders of Preferred Stock elected to convert 1,136,815 shares, or approximately 99% of the outstanding shares of such stock, into 1,624,021 shares of Common Stock which, pursuant to the AHP Transaction, were exchanged for the same combination of cash and Depositary Shares received by shareholders in the AHP Transaction. Pursuant to agreements with AHP, the Company issued to AHP 14,864 shares of Common Stock, the proceeds of which funded the cash required for the redemption of the 8,490 shares of Preferred Stock not converted. As of December 31, 1994, such transactions have brought AHP's total ownership position in the Company to approximately 64%.\nEffective July 8, 1994, the Company and AHP entered into an agreement to form a joint venture to develop and commercialize recombinant human interleukin-twelve (rhIL-12), an immune system modulatory protein, on a worldwide basis except for Japan. In connection with this agreement, the Company recognized $23.1 million of collaborative research and development revenue in fiscal 1994 of which $20.0 million represented initial milestone and signature payments and $3.1 million represented funding of product development costs. Collaborative research and development revenue also includes $5.8 million, $11.8 million and $8.7 million, for fiscal years ended 1994, 1993 and 1992, respectively, relating to collaborations with AHP in the area of cell adhesion technology and the potential commercialization of recombinant human interleukin-eleven (rhIL-11), a blood cell growth factor, in certain Pacific Basin territories.\n3. Investments in Debt Securities\nThe Company's investment portfolio of debt securities consists of cash equivalents classified as held-to-maturity and marketable securities classified as available-for-sale. The fair value of cash equivalents approximated the amortized cost of $21.4 million at December 31, 1994. Aggregate fair value, amortized cost and average maturity for marketable securities held at December 31, 1994 are presented below. The average maturities presented below include estimates of the effective life for certain securities whose actual maturities will differ from contractual maturities because the borrowers have the right to call or prepay the obligations without call or prepayment penalties.\nGross realized gains and losses on sales of marketable securities in fiscal 1994 were $0.8 million and $2.4 million, respectively. Approximately $5.5 million in debt securities at December 31, 1994 has been pledged as collateral pursuant to obligations under operating leases (Note 9).\n4. Inventories\nInventories include $14.3 million and $11.6 million of rhAHF at December 31, 1994 and November 30, 1993, respectively, and consisted of:\n5. Property, Plant and Equipment, Net\nProperty, plant and equipment consisted of:\nMachinery and equipment with an aggregate cost of $16.7 million and $9.9 million were sold and leased-back in fiscal 1994 and in the month ended December 31, 1993, respectively, as discussed in Note 9.\n6. Income Taxes\nAs of December 31, 1994, the Company had, for federal income tax purposes, carryforwards of net operating losses (NOL) and research and development credits (R&D) available as an offset against future taxable income and income taxes payable as follows (in thousands):\nThe Company utilized approximately $13.1 million of NOLs in 1994 due to revenue recognized for tax purposes in connection with the rhIL-12 joint venture discussed in Note 2. Based on the Internal Revenue Code and the change in ownership of the Company resulting from the AHP Transaction discussed in Note 2, utilization of the NOL may be subject to an annual limitation.\nThe Company's NOLs, tax credits and other temporary differences ($51.8 million) represent a deferred tax asset of $74.3 million. Because the level of future taxable income is uncertain, the Company has recorded a valuation allowance equal to the total tax asset.\n7. Special Items\nSpecial items in fiscal 1992 include a charge of $30.0 million in AHP Transaction-related expenses as discussed in Note 2 and a charge of $2.0 million to recognize a loss on the sale of the Company's interest in a manufacturing partnership.\n8. SciGenics, Inc.\nIn May 1991 SciGenics, Inc. and the Company completed an initial public offering of 2,090,909 units, each unit consisting of one share of callable common stock of SciGenics, and one warrant to purchase one share of the Company's Common Stock at an exercise price of $35.92 per share, exercisable at any time from December 1, 1992 through May 31, 1996 (\"the Warrants\"). SciGenics received net proceeds of $42.0 million from the unit offering. These funds are being used to engage the Company to conduct research and development on recombinant human macrophage colony stimulating factor (\"rhM-CSF\") for North America and embryonic growth and regulatory proteins worldwide in accordance with a development contract. The Company has the option to reacquire the rights for either program or to acquire all of the shares of SciGenics callable common stock, in each case for predetermined amounts during specified future periods. The Company committed, commencing December 1, 1991, to match SciGenics funds expended toward development and clinical trials conducted in the rhM-CSF program up to a maximum of $20.0 million. Through December 31, 1994, $14.2 million had been expended under this commitment. The Company may terminate this commitment, in which event, the program purchase option with respect to the rhM-CSF program and the stock purchase option will terminate. The value of the Warrants ($8.3 million), representing an incentive to enter into the development contract, is included in Other Assets and is being amortized as a charge to operating expenses on the basis of revenues received by the Company from SciGenics each period to projected total revenues to be received. Amortization expense, included in general and administrative expenses, was $0.5 million, $1.1 million and $2.0 million in fiscal 1994, 1993 and 1992, respectively. Accumulated amortization was $6.4 million and $5.9 million at December 31, 1994 and November 30, 1993, respectively.\nIn September 1991 the units separated into their two components. As noted above, the units were to have separated on December 1, 1992. However, the separation date was advanced due to the Company's announcement of a merger agreement with AHP as discussed in Note 2. The expiration date of the Warrants is unaffected by the merger and remains May 31, 1996. From and after the AHP Transaction, the Warrants are exercisable for the same consideration received by shareholders in the AHP Transaction.\n9. Commitments and Contingencies\nLitigation: The Company has been engaged in legal proceedings relating to the amount of damages payable by the Company as a result of the holding of the U.S. Court of Appeals for the Federal Circuit (\"CAFC\") that the Company infringed a U.S. patent of Amgen Inc. (\"Amgen\") relating to recombinant EPO. On May 11, 1993, the Company and Amgen agreed to settle all then outstanding claims of Amgen against the Company in the United States relating to recombinant EPO.\nIn August 1991, Ortho Pharmaceutical Co., Ltd. and its affiliates (\"Ortho\"), a licensee of Kirin-Amgen, Inc.'s (\"Kirin-Amgen\") recombinant EPO patents, initiated infringement proceedings against the Company in the U.S. District Court in Massachusetts. Ortho moved to consolidate the\ncase with the infringement suit brought by Amgen. Upon motion by the Company and Amgen, Ortho's claims were dismissed and Ortho has appealed the District Court's decision. A decision on the Ortho appeal is pending. The Company and Amgen also jointly moved to dismiss similar claims brought by Ortho against the Company in the U.S. District Court in California in 1989, and the court granted the motion in March 1994.\nIn June 1994, the Company sued Ortho in the U.S. District Court in Delaware. The Company's suit claimed that Ortho's manufacture, use and sale of EPO in the U.S. infringes a patent covering pharmaceutical compositions containing homogeneous EPO that was issued to the Company by the U.S. Patent and Trademark Office on June 21, 1994 (the '837 patent). In September 1994, Amgen sued the Company in U.S. District Court in Massachusetts. Amgen's suit asked the court to declare that the Company's '837 patent is invalid and not infringed by Amgen and to declare that any dispute over the patent was resolved by the prior litigation. The Company has filed counterclaims against Amgen for infringement of the '837 patent. Ortho intervened in the Amgen suit in Massachusetts and the action against Ortho in Delaware was stayed. In February 1995, the Massachusetts court granted a motion by Amgen for summary judgment. The court ruled that the CAFC decision in the prior litigation invalidating an earlier U.S. EPO patent of the Company precluded the assertion of the '837 patent. The Company plans to appeal. The Company can provide no assurances as to the outcome of these disputes with Ortho and Amgen.\nThe Company and its licensees are engaged in various patent litigation proceedings in Europe related to EPO. Beginning in 1991, Ortho and certain Ortho affiliates initiated patent infringement litigation in Europe against Boehringer Mannheim, the Company's European EPO licensee, based on a European recombinant EPO patent issued to Kirin-Amgen, its licensor. The suits have included requests for damages and\/or injunctive relief. Boehringer Mannheim filed suits against Ortho and\/or certain of its affiliates in Europe claiming infringement of the Company's European EPO patents. This litigation has expanded into many of the European Community countries in Boehringer Mannheim's territory. In some countries, where the patentee is a legally necessary party to a suit to enforce a patent, the Company has joined as a plaintiff. The Company is also a defendant in suits in the United Kingdom, Germany, Italy and the Netherlands brought by an Ortho affiliate seeking to invalidate and revoke the Company's EPO patents in the United Kingdom, the former East Germany, Italy and the Netherlands, respectively. The revocation suit in Germany was dismissed in May 1994. However, it is subject to appeal.\nIn June 1994, a claim in the Company's European patent covering homogeneous EPO compositions (the '539 patent) was upheld by the Opposition Division of the European Patent Office. This decision has been appealed. In September 1994, an appellate hearing was held before the Board of Technical Appeals of the European Patent Office relating to the oppositions to Kirin-Amgen's European recombinant EPO patent. The Board ruled that a modified version of certain of Kirin-Amgen's original claims in the patent filing was valid.\nThe Company can provide no assurance as to the outcome of these European proceedings. If the courts ultimately rule in Ortho's favor in these European proceedings, including issuing an injunction against the future manufacture or sale of recombinant EPO by Boehringer Mannheim, or if this litigation is otherwise concluded in a manner adverse to Boehringer Mannheim or the Company, future royalty income from EPO in Europe, which totaled $11.3 million in fiscal 1994, could be reduced or eliminated.\nThe Company is engaged in a patent interference proceeding among the Company, Genentech, Inc. and Chiron Corporation concerning the Factor VIII U.S. patent rights which are cross-licensed\nbetween Baxter (the Company's licensee) and Genentech, Inc. While the Company believes it or Genentech should prevail in the interference, no assurance can be given as to the outcome of this interference. Any disposition of this proceeding in a manner unfavorable to the Company or its licensee could have a material adverse effect on the Company's future consolidated results of operations.\nThe Company is engaged in a patent interference proceeding among the Company, Transgene, Inc., Zymogenetics, Inc. and British Technology Group, Ltd. (\"BTG\") concerning U.S. patent rights directed to the use of vitamin K as a culture medium supplement in the manufacture of recombinant Factor IX. BTG has licensed its Factor IX patent rights to the Company. In addition, the Company is engaged in a patent interference proceeding with Stryker Corporation, the assignee of Creative BioMolecules, Inc. concerning one of the Company's U.S. patents covering recombinant BMP-2. The Company can provide no assurance as to the outcome of these proceedings.\nLeases: The Company has entered into operating leases for various facilities and equipment. The most significant of these arrangements relates to the Company's headquarters facility which was sold at cost in 1984 and then leased back. The terms of this 20-year lease provide for rental adjustments and purchase options at the end of every fifth year of the lease. In addition, the Company has pledged certain of its marketable securities as collateral pursuant to obligations under the lease (Note 3) and the lease agreement requires that the Company maintain certain levels of net worth and working capital, as defined, throughout the term of the lease. In December 1993 and fiscal 1994, the Company entered into several operating leases involving the sale-leaseback of certain machinery and equipment. The Company is responsible for taxes, insurance and maintenance under all of its facility and equipment leasing arrangements.\nFuture minimum rental payments under operating leases at December 31, 1994 are as follows (in thousands):\nRent expense under operating leases was $11.2 million, $9.1 million and $9.3 million in fiscal 1994, 1993 and 1992, respectively.\nCommitments: In connection with facilities expansion and improvement projects, the Company had commitments for capital expenditures of approximately $11.5 million at December 31, 1994.\n10. Other Income, Net\nOther, net items included in Other Income, Net for the three years ended December 31, 1994, November 30, 1993 and 1992 are as follows:\n11. Capital Stock\nThere were 26,589,948 shares and 26,253,505 shares of Common Stock issued and outstanding at December 31, 1994 and November 30, 1993, respectively. In July 1993, the Company elected to call for redemption all of the outstanding shares of its Preferred Stock at a redemption price of $52.40 per share, as discussed in Note 2.\n12. Incentive and Benefit Plans\nStock Option Plans: The Company has reserved 3,800,000 shares of Common Stock under 1982 incentive and non-qualified stock option plans and 4,400,000 shares under the 1991 incentive and non-qualified stock option plan. These plans were implemented to enable the Company to attract and retain key employees and consultants. In addition, the Company reserved 100,000 shares of Common Stock in both fiscal 1990 and 1993 to establish non-qualified stock option plans for non-employee directors of the Company. Shares under option, which are granted at fair market value, generally vest ratably over a five-year period. The Company reserves the right to cancel those options not vested at termination of the related stock option agreements. Activity under these plans for the fiscal years ended November 30, 1992 and 1993, the month ended December 31, 1993 and the year ended December 31, 1994 is summarized as follows:\n==========\nPursuant to the AHP Transaction, each holder of an employee stock option had an opportunity to make a cash-out election with respect to up to 40% of all vested options held. Further, at the time of the approval of the AHP Transaction by the shareholders of the Company, each outstanding employee stock option that was not then vested became vested with respect to 50% of the unvested portion in addition to the portion that already was vested.\nOn January 16, 1992, the effective date of the AHP Transaction, 733,045 vested employee stock option shares that were subject to a cash-out election and were not exercised, were canceled and, immediately after the effective date, the Company paid the holder an amount in cash of $50.00 less the applicable exercise price for each option. Also, immediately after the effective date, the remaining portion of those options was canceled and exchanged for substitute options to purchase, at a per share price equal to the per share price of the canceled options, an equal number of callable Depositary Shares. The substitute options are subject to the same terms and conditions as the options for which they were exchanged, including the terms related to vesting and the conditions relating to exercise.\nDirectors of the Company who are not employees of the Company were not entitled to make a cash-out election. However, all unvested stock options for such non-employee directors became fully vested in connection with the AHP Transaction. All such options that were not exercised prior to the AHP Transaction were canceled at the effective date and exchanged for substitute options to purchase, at a per share price equal to the per share price of such canceled options and subject to the same terms and conditions as such canceled options, an equal number of callable Depositary Shares.\nPursuant to the AHP Transaction, if AHP exercises the call option discussed in Note 2, all outstanding options granted under the 1982 and the 1991 option plans will automatically accelerate and become fully vested and exercisable.\nEffective April 14, 1992, the Company provided stock option exchange offers to certain non-officer option holders allowing for the surrender of options granted at prices above $28.50 in exchange for new options granted at the then fair market value of $28.50 per share. The old options were exercisable at prices ranging from $30.00 to $42.50 per share. Options to purchase 827,835 shares were exchanged in the offering. The new options were vested to the same extent as the old options and continue to vest under the same terms as the old options.\nRestricted Stock Plan: Under the Company's 1991 restricted stock plan, which was approved by shareholders on January 16, 1992, the Company is authorized to award up to 300,000 restricted Depositary Shares to a limited number of key employees for nominal consideration. Awards totaling 150,000 shares were granted under the plan during fiscal 1992. At December 31, 1994, 67,500 shares had vested under the plan.\nStock Purchase Plans: In 1992, the Company established an employee stock purchase plan which allows substantially all employees to purchase Depositary Shares upon exercise of options granted. The options are exercisable at the lower of 85% of the fair market value of the Depositary Shares at either the date of grant or of exercise. Purchases under this plan are subject to certain limitations and may not exceed 480,000 shares during the term of the plan which expires in May 1997. During fiscal 1994, 1993 and 1992, 70,721, 57,779 and 38,418 shares, respectively, were issued under this plan at prices ranging from $25.39 to $36.97.\nSavings Plan: The Company has a voluntary 401(k) savings plan for all employees. In fiscal 1992, the Company began matching 100% of employee contributions of up to 3% of base salary and 50% of employee contributions from 3% to 6% of base salary. Company contributions to the savings plan in fiscal 1994, 1993 and 1992 were approximately, $1,934,000, $1,542,000 and $918,000, respectively.\n13. Major Customers and Related Party Transactions\nThe percentage of total revenues for customers who contributed 10% or more of total revenue, and revenues from foreign customers for the three years ending December 31, 1994, November 30, 1993 and 1992 are as follows:\nAccounts receivable in the accompanying consolidated balance sheets include $13.3 million and $14.7 million at December 31, 1994 and November 30, 1993, respectively, from major customers. At December 31, 1994, AHP and Chugai Pharmaceutical Co., Ltd. were holders of the Company's Common Stock or Depositary Shares.\nRevenues from Yamanouchi Pharmaceutical Co., Ltd. (\"Yamanouchi\") include collaborative revenue from development partnerships formed by the Company and Yamanouchi to direct licensing activities and oversee commercial development of certain products in Japan and Europe. The partnerships have entered into agreements with the Company and with Yamanouchi to perform research and development on their behalf. Under the partnership agreements, until product commercialization, Yamanouchi is committed to share in the partnerships' losses, which principally represent research and development costs billed by the Company and by Yamanouchi to the partnerships. In connection with such partnerships, reimbursement for research and development costs and benchmark payments from Yamanouchi are included in collaborative research and development revenue and totaled $12.6 million, $13.3 million and $21.1 million in fiscal 1994, 1993 and 1992, respectively.\nThe GI-Yamanouchi European Partnership (the \"GYEP\") was formed in fiscal 1993 by the Company and Yamanouchi for the commercialization of bone morphogenetic proteins in Europe. The GYEP entered into distribution agreements with AHP and Yamanouchi in return for distribution fees totaling $10.0 million and future milestone payments. The Company recorded equity income of $5.0 million in fiscal 1993 relating to these distribution agreements.\n14. Quarterly Financial Information (Unaudited - in thousands except for per share amounts)\nSCHEDULE II-VALUATION, QUALIFYING AND RESERVE ACCOUNTS GENETICS INSTITUTE, INC. AND SUBSIDIARIES\nEXHIBIT INDEX\nExhibit No. Description Page Number ----------- ----------- -----------\n3.1 Restated Certificate of Incorporation, as amended, of Genetics Institute, Inc. (the \"Company\").(12)\n3.2 Restated By-Laws of the Company.(2)\n4.1 Depositary Agreement among Genetics Institute, Inc., American Home Products Corporation (\"AHP\"), AHP Biotech Holdings, Inc. (\"Holdings\") and The First National Bank of Boston, as Depositary.(12)\n10.1 1982 Incentive Stock Option Plan, as amended.(3)\n10.2 1982 Non-Qualified Stock Option Plan, as amended.(3)\n10.3 Amendment to 1982 Incentive Stock Option Plan dated December 16, 1986.(4)\n10.4 Amendment to 1982 Incentive Stock Option Plan dated September 19, 1991.(12)\n10.5 Amendment to 1982 Non-Qualified Stock Option Plan dated September 19, 1991.(12)\n10.6 1991 Stock Option Plan.(12)\n10.7 1987 Employee Stock Purchase Plan.(5)\n10.8 Amendment to 1987 Employee Stock Purchase Plan.(8)\n10.9 1991 Employee Stock Purchase Plan, as amended.(12)\n10.10 1990 Outside Director Stock Option Plan.(9)\n10.11 Amendment to 1990 Outside Director Stock Option Plan.(12)\n10.12 1991 Restricted Stock Plan, as amended.(12)\n10.13 Research Agreement between the Company and Sandoz Ltd., dated as of June 9, 1982, as amended.(3)(19)\n10.14 Agreement between the Company and Chugai Pharmaceutical Co., Ltd., as amended.(3)(19)\n10.15 Agreement between the Company and Chugai Pharmaceutical Co., Ltd. dated as of November 27, 1985.(3)(19)\n10.16 Development and License Agreement between the Company and Boehringer Mannheim GmbH dated as of October 8, 1985.(3)(19)\n10.17 Lease between the Company and Fleet Real Estate, Inc. dated as of November 29, 1984.(3)\n10.18 Lease between the Company and Cambridge I Associates dated as of December 1, 1983, as amended.(3)\n10.19 Indenture of Lease between the Company and Judith Ann Spinelli dated as of August 27, 1984.(3)\n10.20 Extension and Fourth Amendment of Lease dated as of November 20, 1992 between the Company and Cambridge I Associates.(14)(19)\n10.21 Amendment dated as of October 9, 1986 to Research Agreement between the Company and Sandoz Ltd. dated as of June 9, 1982.(4)(19)\n10.22 Development and License Agreement between the Company and Morinaga Milk Industry Co., Ltd. dated as of March 30, 1987.(2)(19)\n10.23 Agreement between the Company and Boehringer Mannheim GmbH dated as of May 5, 1988.(7)(19)\n10.24 Agreement between the Company and Morinaga Milk Industry Co., Ltd. dated as of May 30, 1988.(8)(19)\n10.25 License Agreement between the Company and Suntory Limited dated as of November 24, 1988.(7)(19)\n10.26 Agreement between the Company and Boehringer Mannheim GmbH dated as of January 11, 1989.(8)(19)\n10.27 Supply Agreement between the Company and Baxter Healthcare Corporation dated as of July 31, 1989.(8)(19)\n10.28 Partnership Agreement of GPDC Partnership dated as of May 30, 1990 by and between GI Japan, Inc., and Yamanouchi Pharmaceutical Co., Ltd. (10)(19)\n10.29 Organizational Agreement of GI-Yamanouchi, Inc., dated as of June 30, 1990 among Genetics Institute, Inc., GI JJV, Inc. and Yamanouchi Pharmaceutical Co., Ltd.(10)(19)\n10.30 Research and Development Agreement dated as of May 30, 1990, between the Company and GPDC Partnership.(10)(19)\n10.31 License Agreement dated as of May 30, 1990 between Genetics Institute, Inc. and GI Japan, Inc.(10)(19)\n10.32 GI Sublicense Agreement dated as of May 30, 1990 between GPDC Partnership and Genetics Institute, Inc.(10)(19)\n10.33 JJV Sublicense Agreement dated as of September 20, 1990 between GPDC Partnership and GI-Yamanouchi, Inc. (10)(19)\n10.34 Agreement between Genetics Institute, Inc. and Cetus Corporation dated as of May 1, 1990 and related Agreement between the Company and EuroCetus International, N.V. dated as of May 1, 1990.(10)(19)\n10.35 Strategic Alliance Agreement between the Company and Essex Chemie A.G. dated June 26, 1991.(12)(19)\n10.36 Option Agreement dated as of February 28, 1992 between the Company and AHP.(14)(19)\n10.37 Cellular Adhesion Strategic Alliance Agreement dated as of May 15, 1992 between the Company and AHP.(14)(19)\n10.38 Agreement and Plan of Merger dated as of September 19, 1991 and amended as of December 9, 1991 among the Company, AHP, Holdings and AHP Merger Subsidiary Corporation.(11)\n10.39 Governance Agreement among the Company, AHP and Holdings.(12)\n10.40 Research and Development Agreement, dated as of May 22, 1991, between the Company and SciGenics, Inc. (\"SciGenics\").(13)\n10.41 Technology License Agreement, dated as of May 22, 1991, between the Company and SciGenics.(13)\n10.42 Stock Purchase Option Agreement, dated as of May 23, 1991, among the Company and the Underwriters (as defined therein).(13)\n10.43 Services Agreement, dated as of May 22, 1991, between the Company and SciGenics.(13)\n10.44 Program Purchase Option Agreement, dated as of May 22, 1991, between the Company and SciGenics.(13)\n10.45 Administrative Agreement, dated as of May 22, 1991, between the Company and SciGenics.(13)\n10.46 Class A Note dated as of May 22, 1991.(13)\n10.47 Employment Agreement entered into between the Company and Patrick Gage dated January 14, 1992.(12)\n10.48 Employment Agreement entered into between the Company and Lawrence V. Stein dated November 9, 1992.(14)\n10.49 Letter dated April 11, 1991 from the Company to Dr. Thomas Maniatis regarding certain consulting arrangements and a related memorandum dated July 1, 1991.(14)\n10.50 Partnership Agreement of GI-Yamanouchi European Partnership dated as of May 19, 1993 between GI Europe, Inc. and Yamanouchi B.V. (15)(19)\n10.51 European Partnership Sublicense Agreement dated as of May 19, 1993 between GPDC Partnership and GI-Yamanouchi European Partnership.(15)(19)\n10.52 Participation Agreement Number 1 dated as of May 19, 1993 between GI Netherlands B.V. and Yamanouchi B.V.(15)(19)\n10.53 Product Management Agreement Number 1 dated as of May 19, 1993 between GI Netherlands B.V. and GI-Yamanouchi European Partnership (15)(19)\n10.54 Parent Company Agreement dated as of May 19, 1993 between Genetics Institute, Inc. and Yamanouchi Pharmaceutical Co., Ltd. (15)\n10.55 License Agreement dated as of August 11, 1993 between Genetics Institute, Inc. and American Home Products Corporation. (16)(19)\n10.56 Sales and Distribution Agreement between GI-Yamanouchi European Partnership and Wyeth-Ayerst International Inc. (17)(19)\n10.57 Sales and Distribution Agreement between GI-Yamanouchi European Partnership and Brocades Pharma B.V. (17)(19)\n10.58 Master Lease Agreement, dated as of December 22, 1993, between the Company and BancBoston Leasing, Inc. (17)\n10.59 Master Equipment Lease Agreement, dated as of December 27, 1993, between the Company and Fleet Credit Corporation.(17)\n10.60 Amended and Restated Addendum to Master Equipment Lease Agreement between the Company and Fleet Credit Corporation dated December 20, 1994. (l)\n10.61 Equipment Lease Agreement, dated as of December 28, 1987, between Maryland Nationalease Corporation and the Company. (1)\n10.62 Amendment to Equipment Lease Agreement, dated as of December 28, 1993, by and between the Company and General Electric Capital Corporation.(17)\n10.63 Agreement among the Company, Hoffmann- LaRoche Inc. and F. Hoffmann-LaRoche Ltd. dated July 7, 1994. (18)(19)\n10.64 IL-12 Joint Development Agreement and License Agreement between the Company and GI-Yamanouchi, Inc. dated August 4, 1994. (18)(19)\n10.65 License Agreement between British Technology Group Limited and the Company dated December 23, 1992.(1)(20)\n10.66 Partnership Agreement of IL-12 Partners between AHP IL-12 Corporation and GI Drug Design, Inc. effective July 1, 1994. (l)(20)\n10.67 License Agreement between the Company and GI Drug Design, Inc. effective July 1, 1994. (1)(20)\n10.68 Assignment and Assumption Agreement among GI Drug Design, Inc., IL-12 Partners and the Company effective July 1, 1994. (1)(20)\n10.69 Sale, Assignment and Assumption Agreement between AHP IL-12 Corporation and GI Drug Design, Inc. effective July 1, 1994. (1)(20)\n10.70 Parent Company Agreement among the Company, American Home Products Corporation and AHP Biotech Holdings, Inc. effective July 1, 1994.(1)\n10.71 GI Research and Development Agreement between IL-12 Partners and the Company effective July 1, 1994. (1)(20)\n10.72 Wyeth Research and Development Agreement between IL-12 Partners and American Home Products Corporation effective July 1, 1994.(1)\n21 Subsidiaries of the Company.(12)\n23.1 Consent of Arthur Andersen LLP(1)\n23.2 Consent of Coopers & Lybrand L.L.P.(1)\n_______________\n(1) Filed as an exhibit to this Annual Report on Form 10-K.\n(2) Filed as an exhibit to the Company's Registration Statement on Form S-1 (Registration No. 33-14013) on May 5, 1987 and incorporated herein by reference.\n(3) Filed as an exhibit to the Company's Registration Statement on Form S-1 (Registration No. 33-4746) on April 11, 1986 and incorporated herein by reference.\n(4) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended November 30, 1986 (File No. 0-14587) on February 27, 1987 and incorporated herein by reference.\n(5) Filed as an exhibit to the Company's Registration Statement on Form S-8 (Registration No. 33-13528) on April 16, 1987 and incorporated herein by reference.\n(6) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended November 30, 1987 (File No. 0-14587) on February 26, 1988 and incorporated herein by reference.\n(7) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended November 30, 1988 (File No. 0-14587) on February 27, 1989 and incorporated herein by reference.\n(8) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended November 30, 1989 (File No. 0-14587) on February 27, 1990 and incorporated herein by reference.\n(9) Filed as an exhibit to the Company's Registration Statement on Form S-8 (Registration No. 33-34629) on April 30, 1990 and incorporated herein by reference.\n(10) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended November 30, 1990 (File No. 0-14587) on February 28, 1991 and incorporated herein by reference.\n(11) Filed as an exhibit to the Company's Registration Statement on Form S-4 (Registration No. 33-44418) on December 9, 1991 and incorporated herein by reference.\n(12) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended November 30, 1991 (File No. 0-14587) on February 28, 1992 and incorporated herein by reference.\n(13) Filed as an exhibit to the Annual Report on Form 10-K of SciGenics, Inc. (Commission File No. 0-19088) for the year ended November 30, 1991 filed on February 28, 1992 and incorporated herein by reference.\n(14) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended November 30, 1992 (File No. 0-14587) on February 28, 1993 and incorporated herein by reference.\n(15) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended May 31, 1993 (File No. 0-14587) on July 1, 1993 and incorporated herein by reference.\n(16) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended August 31, 1993 (File No. 0-14587) on September 29, 1993 and incorporated herein by reference.\n(17) Filed as an exhibit to the Company's Annual Report on Form 10-K for the year ended November 30, 1993 (File No. 0-14587) on February 28, 1994 and incorporated herein by reference.\n(18) Filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (File No. 0-14587) on November 10, 1994 and incorporated herein by reference.\n(19) Confidential treatment granted as to certain portions.\n(20) Confidential treatment requested as to certain portions which are indicated by an asterisk and filed separately with the Securities and Exchange Commission with an Application for Confidential Treatment pursuant to Rule 24b-2 promulgated under the Securities Exchange Act of 1934, as amended.","section_15":""}
{"filename":"701288_1994.txt","cik":"701288","year":"1994","section_1":"ITEM 1 - BUSINESS\nGENERAL\nAlaTenn Resources, Inc. (AlaTenn or the Company) was incorporated in the state of Alabama in 1982 in connection with a reorganization of Alabama-Tennessee Natural Gas Company (Alabama-Tennessee) which was founded in 1944 and which has been in operation since 1950. AlaTenn is a diversified holding company which is engaged in two lines of business: (1) energy - natural gas transmission and marketing, primarily through the provision of natural gas service in the lower Tennessee Valley area and (2) the manufacture of products for the health care industry. During 1994, the Company was the sole owner of five natural gas transmission companies, a natural gas marketing company, two natural gas distribution companies and one company which was engaged in oil and gas exploration through its participation in a limited partnership. Also, in 1994 the Company, through RIC Acquisition Corporation, a wholly-owned subsidiary of the Company formed to effect the acquisition, purchased the business of Ryder International Corporation, a manufacturer of health care products.\nThe Company's principal pipeline subsidiary, Alabama-Tennessee, is an interstate natural gas pipeline company engaged in the transportation of natural gas in the Tennessee Valley. Its main pipeline extends from Selmer, Tennessee approximately 130 miles across northern Mississippi and Alabama to Huntsville, Alabama. This system includes approximately 288 miles of pipeline and two compressor stations.\nBecause it is engaged in the transportation of natural gas in interstate commerce, Alabama-Tennessee is a \"natural gas company\" as defined in the Natural Gas Act of 1938. As such, it is subject to the jurisdiction of the Federal Energy Regulatory Commission (FERC), which jurisdiction includes the power to regulate Alabama-Tennessee's rates on the transportation of natural gas for its customers, as well as the power to authorize the construction and operation of certain new facilities.\n- 1 -\nTennessee River Intrastate Gas Company, Inc. (TRIGAS), one of the Company's intrastate pipeline subsidiaries, completed construction in 1990 of a 38-mile, 10-inch pipeline that extends from Barton, Alabama to Courtland, Alabama. In 1990, TRIGAS entered into a long-term agreement to transport natural gas to an industrial customer in the Courtland, Alabama area. In 1993, this customer increased its existing contract for a three-year period by approximately 70%.\nAlaTenn Energy Marketing Company, Inc. (ATEMCO) is the Company's natural gas marketing subsidiary. ATEMCO buys natural gas primarily on the spot market and sells that natural gas to customers on the Company's interstate and intrastate pipelines, as well as to off-system customers. As part of its services, ATEMCO evaluates customers' supply requirements, locates natural gas supplies and negotiates and manages contracts for those customers. ATEMCO also can arrange for the use of its customers' excess gas storage and transportation rights by others, generating savings for its customers.\nTwo of the Company's subsidiaries, Central Gas Company (Central) and Tennessee River Development Company (Tennessee River), operated natural gas distribution systems in Alabama prior to May 3, 1991, when both subsidiaries sold substantially all their distribution assets to the City of Florence, Alabama. Since that time, both subsidiaries have transported or sold natural gas to the City of Florence for resale to its customers.\nHardin County Gas Company, an AlaTenn distribution subsidiary, serves approximately 140 customers in Hardin County, Tennessee. In 1994, North Mississippi Natural Gas Corporation, which is also an AlaTenn distribution subsidiary sold substantially all of its distribution assets to a former customer and is not active at the current time.\nVulcan Oil and Gas Company (Vulcan) is a wholly owned subsidiary of AlaTenn engaged in oil and natural gas exploration through its participation as a limited partner in Lima Resources Associates (Lima). Vulcan did not make any additional investments in Lima during 1994, its thirteenth year as a limited partner. As of December 31, 1992, the total investment in Lima had been written off by the Company, and Vulcan is under no obligation to invest any additional funds in the limited\n- 2 -\npartnership. The Company does not anticipate any significant income in the future from Lima's operations.\nIn recent years, changes in the nature of Alabama-Tennessee's business attributable in large part to significant regulatory changes in the natural gas industry contributed to the emergence of ATEMCO as the Company's primary marketer of natural gas. For the past several years, ATEMCO has been the primary seller of natural gas for the Company. Sales by ATEMCO constituted 72%, 68% and 74% of the Company's total revenues for the years 1994, 1993 and 1992, respectively. However, due to the relatively small margins on such sales, ATEMCO's contribution to the Company's net income was significantly less than its percentage of the Company's total revenues for each of the three years.\nAlso, as a result of these regulatory changes, Alabama-Tennessee's customers have increasingly utilized Alabama-Tennessee to provide transportation services rather than sales services and have utilized other companies, including ATEMCO, for the purchase of their natural gas supplies. While this change in the nature of its business has had an adverse impact on Alabama-Tennessee, ATEMCO has benefitted from the open-access status of Alabama-Tennessee and other pipelines and has made significant contributions to the Company's revenues and net income during the last three years. Also, TRIGAS contributed materially to the Company's earnings in 1994, 1993 and 1992 as a result of deliveries through its pipeline.\nOn April 19, 1994, the Company through RIC Acquisition Corporation, a wholly-owned subsidiary of the Company formed to effect the acquisition, purchased the business of Ryder International Corporation by acquiring its assets, excluding cash and receivables, and assuming substantially all of its liabilities. The Company paid to Ryder International Corporation, including post-closing adjustments, $11.1 million in cash, issued a promissory note in the principal amount of $1.0 million and assumed liabilities totaling $2.2 million, for a total purchase price of $14.3 million. Following the closing, RIC Acquisition Corporation's name was changed to Ryder International Corporation (Ryder). Ryder is principally engaged in the design, development, manufacture and sale of proprietary products for the health care industry, including disposable or semi-disposable soft contact lens storage and disinfection\n- 3 -\nsystems and diagnostic products sold primarily by major health care companies.\nIn 1994, the Company formed AlaTenn Pipeline Company Inc., which has agreed in principle with an industrial gas producer to construct and operate a 23-mile, 8-5\/8\" high pressure steel pipeline to transport gaseous oxygen to a large industrial customer in North Alabama.\nBeginning in 1994, with the acquisition of Ryder, the Company classifies its continuing operations into two industry segments, energy and health care products. Unless the context otherwise requires, references in this report to AlaTenn or the Company mean AlaTenn Resources, Inc. and its subsidiaries.\nAdditional information respecting certain of the above matters is contained in Management's Discussion and Analysis of Financial Condition and Results of Operations and in the Notes to Consolidated Financial Statements in the Company's 1994 Annual Report to shareholders incorporated herein by reference.\nREVENUES\nDuring 1994, 1993 and 1992, Alabama-Tennessee accounted for 14%, 30% and 24% of total revenues, respectively. ATEMCO accounted for 72%, 68% and 74% of revenues during these same periods. The table below summarizes total revenue and delivered volumes for the Company's pipelines as well as for its natural gas marketing and other subsidiaries.\n- 4 -\nDuring 1994, gas marketing sales by ATEMCO totaled 22.5 million MMBtu of natural gas, a decrease of 11.9 million MMBtu from the 1993 volume of 34.4 million MMBtu. Related revenues decreased to $51.5 million in 1994, a reduction of $30.0 million from 1993. These decreases in volumes and revenues were due to the loss of certain ATEMCO customers in late 1993, as described below, three of which have since returned to ATEMCO for sales services. The decreases in revenues and volume between years were partially offset by an increase of approximately 1.8 million MMBtu and $2.1 million in revenues from off-system sales. The decrease in revenues was also attributable to a decrease in the price of natural gas purchased and sold. Natural gas prices decreased by approximately 14% in 1994 compared with 1993. Gas marketing sales in 1993 totaled 34.4 million MMBtu of natural gas, a decrease of 11.3 million MMBtu from the 1992 volume of 46.3 million MMBtu. Related revenues decreased to $81.5 million in 1993, a reduction of $9.4 million from 1992. Approximately 7.1 million MMBtu and $13.5 million in revenues of such decreases between years are attributable to a reduction in off-system sales. This decrease in revenues from 1992 was partially offset by an increase in the price of natural gas purchased and sold. For a description of recent changes in ATEMCO's contractual relationship with certain of its municipal customers, see \"Competition\" below.\nAlabama-Tennessee receives a fee for transportation services to its customers which is set by the FERC. However, the transportation fee is much lower than the total consideration Alabama-Tennessee otherwise received in prior periods when it provided a bundled sales and transportation service because the cost of natural gas is not included when only transportation service is provided. During 1994, 1993 and 1992, almost all volumes delivered through Alabama-Tennessee's pipeline were transportation volumes. In 1993, as a result of changes in the natural gas industry brought about by FERC Order 636, Alabama-Tennessee's sales customers converted their firm sales service on Alabama-Tennessee to firm transportation service, and also acquired Alabama-Tennessee's firm capacity on Tennessee Gas Pipeline Company (TGP), an upstream pipeline. The conversion of sales service to transportation service along with the upstream assignments resulted in decreased revenues by Alabama-Tennessee because (1) transportation service does not include a gas cost component as does a bundled sales and transportation\n- 5 -\nservice and (2) the assignment of upstream capacity on TGP required those customers to pay TGP directly, thereby removing those revenues from Alabama-Tennessee.\nDuring 1994, 1993 and 1992, ATEMCO sold approximately 50%, 74% and 92%, respectively, of the natural gas delivered on the Company's pipelines, enabling the Company in 1993 and 1992 to maintain sales levels on its pipelines comparable to those prior to the implementation of open-access transportation service (see Regulation). However, on November 1, 1993, ATEMCO's contract with the municipal customers on the Company's pipeline system terminated and some of those customers chose to make other arrangements for gas supply, using a marketing company other than ATEMCO. Three of those customers, however, have since begun using ATEMCO again. Those customers formerly contracting with ATEMCO for their gas supply which are now utilizing different marketing companies accounted for 29% of the Company's revenues, but only $0.1 million of the Company's net income, for the twelve-month period ended October 31, 1993. Also, as a result of increased deliveries to an industrial customer which could not obtain alternate fuels due to the flooding on the Mississippi River, Alabama-Tennessee was able to increase its deliveries in 1993 above prior year levels. Increased deliveries to an industrial customer on the TRIGAS pipeline also resulted in a substantial increase in deliveries in 1993 through that pipeline.\nIn 1994, two industrial customers, Champion International Corporation and Amoco Chemicals Corporation, accounted for approximately 32% and 12%, respectively, of the Company's operating revenues. For information regarding recent developments related to the City of Decatur, see \"Competition\" below.\nApproximately 59% of Alabama-Tennessee's natural gas throughput in 1994 was delivered to 17 municipal customers serving 28 communities, including several industrial customers located within those communities. Alabama-Tennessee serves most of the communities extending from Selmer, Tennessee to Huntsville, Alabama, including portions of northeast Mississippi, the Muscle Shoals area of northwest Alabama, and Athens, Decatur and Huntsville, Alabama. The remaining 41% of Alabama- Tennessee's throughput was delivered directly to 6 industrial users. Approximately 99% of TRIGAS's throughput was delivered to one\n- 6 -\nindustrial customer while the remaining 1% was delivered to a single resale customer.\nAlabama-Tennessee's business is seasonal in nature and is strongly influenced by weather conditions. Natural gas deliveries on Alabama-Tennessee's pipeline system tend to be higher in the winter months due to increased consumption for residential heating. Natural gas deliveries during the summer months decline as a result of lower residential usage. Sales by ATEMCO to municipal customers on the Company's pipelines also tend to be seasonal in nature, while sales to industrial users are not normally impacted by weather changes. TRIGAS, the Company's intrastate pipeline, is less subject to such seasonal fluctuations because the majority of its deliveries are to two industrial users whose usage does not change as a result of weather conditions.\nRyder, the Company's health care products subsidiary, is engaged in the design, development , manufacture and sale of proprietary products used in the health care industry. Ryder's products are generally manufactured through an injection molding process, using state-of-the-art equipment. These products include disposable and semi-disposable soft contact lens storage and disinfection systems which are marketed to major health care companies worldwide in conjunction with their name-brand products. Ryder also produces a range of diagnostic devices, including products used in blood analysis, tissue biopsies and microbiological testing which major health care companies market and distribute to hospitals, clinics, surgical centers, physicians and other health care providers. Ryder develops working models or prototypes that allow its customers to test products in their own markets. As a result of its development of various products and engineering solutions, Ryder currently holds more than 100 design and use patents. Ryder relies on patents and contracts to protect its proprietary technology. Ryder generally enters into confidentiality agreements with its employees, consultants and customers and limits access to and distribution of its documentation and other proprietary information. In 1994, Ryder spent approximately $.5 million for research and development of new products or improvements to existing product lines. Typically, Ryder bears the expense of the product-development phase and then enters into long-term contracts with its customers which allow Ryder to retain exclusive world-wide manufacturing rights to the products it has\n- 7 -\ndeveloped. Ryder employs a limited number of sales persons who make direct contact with potential customers who may have need of Ryder's services. Currently, more than 20% of Ryder's products are shipped to international markets.\nFor additional financial information regarding each operating segment, see Note 12 of Notes to Consolidated Financial Statements contained in the Company's 1994 Annual Report to shareholders incorporated herein by reference.\nAVAILABILITY OF NATURAL GAS SUPPLY AND RAW MATERIALS\nAlabama-Tennessee's historical supplier of natural gas under firm contract until the implementation of FERC Order 636 (See Regulation) was TGP, a subsidiary of Tenneco, Inc. In November 1993, Alabama-Tennessee assigned all of its firm transportation and storage entitlement on the TGP system to its resale customers. By so doing, Alabama-Tennessee gave those customers the ability to obtain gas supplies from various suppliers and to transport such supply on a firm basis on the TGP system to Alabama-Tennessee for ultimate delivery to the resale customers' facilities.\nOn September 1, 1993, Alabama-Tennessee converted the balance of its capacity on TGP to firm transportation service as a result of regulatory changes requiring the implementation by TGP of FERC Order 636, which resulted in the \"unbundling\" of sales and transportation service on regulated pipelines. Effective September 1, 1993, Alabama-Tennessee also implemented Order 636 allowing its customers to convert firm sales capacity on Alabama-Tennessee to firm transportation service. Alabama-Tennessee, as required by Order 636, assigned to its customers the firm transportation service which it held on TGP, giving its customers firm transportation service on both Alabama-Tennessee and its upstream pipeline. The assignment of these firm transportation and storage rights enhanced these customers' flexibility in acquiring and maintaining gas supplies by allowing them to benefit from recent changes in the natural gas industry (see Regulation).\nDuring 1994, transportation services by Alabama-Tennessee constituted 100% of its throughput. As a result of FERC Order 636, as noted above, Alabama-Tennessee will have no future obligation to provide a sales service to its customers.\n- 8 -\nATEMCO, the Company's marketing subsidiary, generally purchases natural gas on the spot market, but has contracted for longer-term supplies as required to meet its commitments to its customers. In all cases in which ATEMCO contracts for long-term supplies, matching long-term sales contracts are also obtained that allow ATEMCO to serve as a conduit between the producer and the end-user of the natural gas without incurring the risk of shortfalls in either the demand or supply. These spot market and long-term arrangements should provide ATEMCO with an adequate supply of natural gas in 1995.\nIn 1990, ATEMCO entered into a 15-year contract with a producer to purchase up to 20,000 MMBtu of natural gas per day. ATEMCO obtained this supply to meet a matching sales obligation with an industrial customer. During 1993, this industrial customer increased its supply requirements by 9,000 MMBtu per day. At that time, ATEMCO entered into new agreements with a natural gas producer to secure a source of supply to meet this increased obligation (see Revenues).\nRyder purchases high-grade resin and other minor components for its manufacturing process from various suppliers. The resin is a readily available material and, while Ryder is selective in its choice of suppliers, it believes that there are no significant restrictions or limitations on supply.\nCOMPETITION\nExcept for natural gas deliveries to four municipal customers and one industrial customer from other intrastate pipelines, Alabama-Tennessee's and TRIGAS's pipelines currently are the only pipelines utilized by their customers to access upstream pipelines and supplies of natural gas. The principal competitive fuels for industrial and commercial purposes are coal and fuel oil. Electricity is the main competition for residential uses.\nIn the past, Alabama-Tennessee's profitability was a function of its ability to sell natural gas as a merchant. As a result of changes adopted by the FERC which required pipelines to offer equal access to their pipelines to all customers, Alabama- Tennessee was under pressure to reduce sales margins on sales to industrial customers in 1987 and 1988 and to provide lower-margin transportation services for industrial customers which chose to buy natural gas directly from third parties. Also, as\n- 9 -\na result of FERC Order 636, Alabama-Tennessee was required to substitute firm transportation service for its firm sales service to its industrial customers, effective September 1, 1993. These substitutions have resulted in reductions in margins on Alabama-Tennessee as these customers will pay only FERC regulated transportation rates. As these customers have converted their firm sales entitlement to firm transportation service, ATEMCO has generally been able to negotiate contracts with certain of these customers to maintain a portion of the sales margins previously earned by Alabama- Tennessee.\nATEMCO buys and resells natural gas primarily on the spot market, resulting in a gross margin equal to the difference between the purchase price and the resale price of such gas. ATEMCO has a long-term agreement to supply natural gas for a plant expansion on the TRIGAS pipeline. Almost all of ATEMCO's other contracts are shorter-term agreements. Through its knowledge of the industry and contacts with industry personnel, ATEMCO identifies potential natural gas markets, contracts for the sale of natural gas to these markets, contracts for the purchase of natural gas from suppliers and arranges for the transportation of the natural gas over one or more pipeline systems. ATEMCO's success is highly dependent upon its ability to find and market competitively-priced natural gas.\nRegulatory changes culminating with FERC Order 636 have given customers on Alabama-Tennessee's pipeline system increased flexibility over the past few years in contracting directly with producers and marketing companies for their natural gas supplies. ATEMCO's service contracts with its municipal customers on Alabama-Tennessee's pipeline system terminated as of October 31, 1993 and on November 1, 1993, ATEMCO entered into new two-year contracts with several of these municipal customers. Of those municipal customers who opted to contract with other natural gas suppliers, three have since returned to ATEMCO. Regulatory changes have enabled ATEMCO to provide certain new services, the income from which should more than offset the decline in net income attributable to the loss of some of its customers.\nThe City of Decatur, which accounted for approximately 16% of Alabama-Tennessee's pipeline throughput in 1994, received authorization from the FERC in 1994 to connect directly to TGP via a proposed 37-mile pipeline to be constructed and operated\n- 10 -\nby Decatur, and thereby bypass Alabama-Tennessee's facilities. Should Decatur construct the pipeline and by-pass Alabama- Tennessee's pipeline system, Alabama-Tennessee would attempt to resell Decatur's capacity to other customers and would be permitted by the FERC to seek from Alabama-Tennessee's remaining customers the revenues lost as a result of this by-pass. The FERC has also granted authorization for three of Decatur's major industrial customers to obtain natural gas service directly from Alabama-Tennessee, thus bypassing Decatur. As of the end of 1994, one of these customers, Monsanto Company, had already begun to receive service directly from the Company. This bypass of Decatur, and similar bypasses, would have the effect of reducing or eliminating the adverse impact of the municipality's by-pass of Alabama-Tennessee's pipeline system.\nRyder, the Company's health care products subsidiary, manufactures products for certain major health care companies and is dependent on several customers for the majority of its sales. The loss of one or more of these customers would have a material adverse impact on the health care products segment of the Company. Also, the fact that Ryder's products are somewhat limited in number and normally are only a component of the ultimate product sold by Ryder's customers, requires Ryder to be continually attentive to the need to manufacture such products at competitive prices and in compliance with strict manufacturing standards. Depending on the product and the nature of the project, Ryder competes on the basis of its ability to provide engineering and design expertise as well as on the basis of product and price. Ryder believes that its expertise and reputation for quality products have allowed it to compete favorably with respect to each such factor and to maintain long-term relationships with these customers.\nTo the extent that each Ryder product is sold to a single customer, Ryder is dependent on the ability of that customer to sell its products, of which Ryder's products are a component. Therefore, Ryder seeks to choose highly successful companies with which to do business. This risk is somewhat minimized by Ryder's ability to obtain long-term exclusive manufacturing rights while its customers have long-term marketing rights.\n- 11 -\nREGULATION\nAlabama-Tennessee is subject to the Natural Gas Pipeline Safety Act of 1968, as amended, which regulates pipeline safety requirements, and to the National Environmental Policy Act and other environmental legislation. Alabama-Tennessee has a continuing program of inspection designed to keep all of its facilities in compliance with environmental and pipeline safety requirements.\nAlso, as an interstate natural gas pipeline company, Alabama-Tennessee is subject to the jurisdiction of the FERC (under the Natural Gas Act of 1938 and other federal legislation) with respect to interstate sales and transportation of natural gas, certain rates and charges, construction of new facilities, extension or abandonment of services and facilities, accounts and records, depreciation and amortization policies and certain other related matters. Alabama-Tennessee holds certificates of public convenience and necessity issued by the FERC authorizing it to construct and operate all pipelines, facilities and properties which it now operates, and to transport natural gas in interstate commerce in instances where such certificates are required. As necessary, Alabama-Tennessee files with the FERC applications for changes in its transportation rates and charges which are designed to allow it to recover its costs of providing such services to its customers, as well as a reasonable return on its investment. These rates are normally allowed to become effective, subject to refund, until such time as the FERC determines the just and reasonable rates.\nOn April 1, 1993, Alabama-Tennessee increased its jurisdictional rates from rates that had been in effect since April 1, 1990. This rate increase was agreed to in an uncontested settlement with Alabama-Tennessee's customers which the FERC has approved. As a result of this settlement, Alabama-Tennessee realized an increase in its jurisdictional revenue of approximately $400,000 per year which was offset by the lower recovery of certain demand charges, resulting in a net decrease of approximately $350,000 per year compared with actual jurisdictional revenues realized in the 12 months ended May 31, 1992, the base period used in the rate filing.\n- 12 -\nDuring the past few years, the FERC has issued a series of orders which have resulted in significant changes in the natural gas industry. The primary thrust of these new orders has been to bring increased competition to the transportation and sale of natural gas in interstate commerce. Among other things, the regulations promulgated by the FERC: (1) require interstate pipelines that provide self-implementing transportation to do so for all other shippers on a nondiscriminatory basis (\"open-access transportation\"); (2) require open-access pipelines to establish rates which remove incentives favoring the pipeline's merchant function; (3) permit the customers of open-access pipelines to convert firm sales entitlement to firm transportation service; and (4) make available to pipelines an optional expedited certificate process to institute new services and to construct and operate facilities relating to those new services, provided that the pipelines file for and accept a blanket transportation certificate to perform open-access transportation and that the pipeline assume certain market risks.\nDuring 1992, the FERC issued Order Nos. 636, 636-A and 636-B, (collectively referred to as the \"Restructuring Rule\"). Under the Restructuring Rule, which is pending review by certain federal appellate courts, all interstate natural gas pipelines were required to make a number of changes in the structure of the services which they provide prior to the end of 1993. Among other things, the Restructuring Rule required interstate pipelines to revise their tariffs to reflect a separating or \"unbundling\" of their sales services from their transportation services and the provision of all transportation services on a basis that is equal in quality for all natural gas supplies, whether purchased from the pipeline or from any other natural gas supplier. The Restructuring Rule also provides that pipelines would be allowed to collect from their customers the prudently incurred \"transition costs\" associated with the changes required by these orders, including gas supply realignment costs.\nAlabama-Tennessee implemented restructured services on its system as of September 1, 1993 in compliance with the FERC's orders under the Restructuring Rule.\nFrom 1988 through 1992, Alabama-Tennessee's firm supplier of natural gas, TGP, passed on to its customers certain take-or-pay costs paid to its producers. During the same period, Alabama-Tennessee sought to recover from its customers the take-or-pay\n- 13 -\ncosts passed through to it by TGP. In accordance with the allocation method required by the FERC at the time, the Company recorded a provision of $6.4 million, net of income taxes, in 1989 for its estimate of the nonrecoverable portion of its take-or-pay obligation. However, changes in the allocation methodology employed by the FERC and agreements with customers in 1991 resulted in a favorable after-tax adjustment of $3.4 million in the estimate for non-recoverable take-or-pay expense. Based on this favorable adjustment and a favorable settlement with the Internal Revenue Service in 1993 concerning the Company's treatment of take-or-pay payments and collections in certain tax returns, the Company recorded income in 1993 of $3.6 million, reduced by income taxes of $1.3 million.\nAs a result of the payments made by Alabama-Tennessee to TGP since 1988, Alabama-Tennessee has reduced its ultimate take-or-pay obligation to TGP by $22.3 million through December 31, 1994. As of that date, Alabama-Tennessee had an unpaid balance owed to TGP, under the settlement, of $0.7 million, including interest.\nFor more information on take-or-pay matters, see Note 4 of Notes to Consolidated Financial Statements contained in the Company's 1994 Annual Report to shareholders incorporated herein by reference.\nThe facilities of Ryder, the Company's health care products subsidiary, are registered with the Food and Drug Administration (FDA). All of Ryder's medical products are manufactured in accordance with Good Manufacturing Practices as set forth in the Food, Drug and Cosmetic Act of 1938. The FDA does not establish or regulate price levels for products manufactured by Ryder.\nTRIGAS, the Company's intrastate pipeline subsidiary, is subject to the jurisdiction of the Alabama Public Service Commission (APSC), as are Central Gas Company and Tennessee River Development Company.\nHardin County Gas Company and North Mississippi Natural Gas Corporation are subject to the jurisdiction of the Tennessee Public Service Commission and the Mississippi Public Service\n- 14 -\nCommission, respectively. There are no material proceedings before these state commissions involving these companies.\nAdditional regulatory information is contained in Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 3 of Notes to Consolidated Financial Statements in the Company's 1994 Annual Report to shareholders incorporated herein by reference.\nPEOPLE\nAt December 31, 1994, the Company had 159 full-time employees, 40 of which are employed by Alabama-Tennessee. AlaTenn and its energy related subsidiaries of the Company are managed and operated by Alabama-Tennessee's employees and have no employees of their own. Ryder employs 119 full time employees in the health care products segment.\nEmployee relations are good and there has not been any work stoppage due to labor disagreements. None of the Company's employees is represented by any labor union.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES\nThe headquarters of the Company and its subsidiaries are located in a Company-owned office building in Sheffield, Alabama.\nAlabama-Tennessee has approximately 288 miles of transmission pipeline and two compressor stations. Its primary transmission pipeline extends from an interconnection with TGP's pipeline near Selmer, Tennessee approximately 130 miles eastward across northern Mississippi and Alabama to Huntsville, Alabama. The system interconnects with TGP's Kinder- Portland line near Corinth, Mississippi and its Delta-Portland line near Barton, Alabama. The system also interconnects with the Columbia Gulf Transmission Pipeline near Corinth and with the Texas Eastern Transmission Pipeline near Barton. Pipe sizes range from 2-inch to 16-inch, including 74 miles of 12-inch, 97 miles of 10-inch, 48 miles of 8-inch, 51 miles of 6-inch and 18 miles of various other diameters. These transmission pipelines are located primarily on rights-of-way held under easement, license or permit\n- 15 -\non lands owned by others. None of Alabama-Tennessee's properties is subject to any liens. Alabama-Tennessee's pipeline system is certificated by the FERC to deliver approximately 133,000 MMBtu per day of natural gas to its customers.\nTRIGAS has 38 miles of 10-inch pipeline, extending from Barton, Alabama to Courtland, Alabama.\nRyder's manufacturing facilities are located on a 67-acre campus in Arab, Alabama. Ryder has three office buildings which house administrative, engineering and design operations and which jointly contain approximately 27,000 square feet of work space. The manufacturing facility, situated on the same location, contains approximately 112,000 square feet of manufacturing space.\nDuring 1991, two of the Company's distribution subsidiaries, Central Gas Company and Tennessee River Development Company, sold substantially all of their distribution pipeline service lines to the City of Florence, Alabama. The Company's two remaining natural gas distribution subsidiaries have 11 miles of distribution pipeline. The Company's investment in these systems at original cost is approximately $300,000.\nFor further information on Properties, see System Map included herewith as Exhibit 99.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nFor information concerning regulatory proceedings, see Item 1 above under the caption \"Regulation\" and see Note 3 of the Notes to Consolidated Financial Statements in the Company's 1994 Annual Report to shareholders incorporated herein by reference.\nThere were no other material pending legal proceedings to which the Company or any of its subsidiaries was a party, or of which any of their property was the subject, as of December 31, 1994.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\n- 16 -\nEXECUTIVE OFFICERS OF THE COMPANY\nThe persons who are identified as executive officers of the Company currently serve as officers of the Company or of Alabama-Tennessee, Ryder International Corporation or of AlaTenn Energy Marketing Company, Inc. or of both the Company and Alabama-Tennessee. The officers of the Company and Ryder International Corporation, Alabama-Tennessee and AlaTenn Energy Marketing Company are elected annually by the respective Boards of Directors of the Company and its subsidiaries at the first meeting of such Boards of Directors held after the annual meetings of shareholders of such entities. Accordingly, the\n- 17 -\nterms of office of the current officers of the Company and of Alabama-Tennessee are due to expire on May 1, 1995 when such meetings of the Boards of Directors of the Company and of Alabama-Tennessee are scheduled to be held or when their successors are elected.\nThere are no arrangements or understandings between any officer and any other person pursuant to which the officer was elected. There are no family relationships between any of the executive officers or directors.\nThere 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 officers during the past five years.\nBRIEF ACCOUNT OF THE BUSINESS EXPERIENCE DURING THE PAST FIVE YEARS\nExcept as noted below, the above listed executive officers have served in the positions indicated above for more than the past five years.\nMr. Howard has served as Chairman of the Board, President and Chief Executive Officer of the Company and of Alabama- Tennessee and Chairman of the Board and President of all other subsidiaries, except for AlaTenn Energy Marketing Company, Inc. for more than five years, except for his position as Chairman of the Board of the Company, which position became effective in January 1991. Mr. Howard also serves as Chairman of the Board for AlaTenn Energy Marketing Company, Inc. and served as its President and Chief Executive Officer until May, 1992. Mr. Howard has also served as Chairman of the Board of Ryder International Corporation since April, 1994.\nMr. Strickland has served as Vice President-Corporate Development since May 1992 and as Assistant Secretary and Assistant Treasurer of the Company since May 1990. Mr. Strickland served as Director of Planning of the Company from December 1988 until May 1992. Mr. Strickland has served as Vice President-Planning of Alabama-Tennessee since May 1992 and as Director of Planning of Alabama-Tennessee prior to May 1992.\n- 18 -\nMr. Magrini has served as President and Secretary of AlaTenn Energy Marketing Company, Inc. since May, 1993. From May, 1992 until May, 1993, Mr. Magrini served as Vice-President-Customer Relations of Alabama-Tennessee. Prior to that time, Mr Magrini served as Vice President-Sales and Supply of Alabama-Tennessee since December 1989.\nMr. Rabenau has served as President and Secretary of Ryder International Corporation since April 19, 1994, when the assets of Ryder were acquired by RIC Acquisition Corporation, a Company subsidiary formed to effect the acquisition, after which RIC Acquisition Corporation was renamed Ryder International Corporation. From April 1, 1990 until April 19, 1994, Mr. Rabenau served as President of the predecessor company, also named Ryder International Corporation prior to the purchase of its assets by the Company.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe information for this item is set forth on page 28 of the Company's 1994 Annual Report to shareholders (Exhibit 13) under the heading \"Stock Information\" and is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe information for this item is set forth in the section entitled \"Selected Financial Data\" on page 22 of the Company's 1994 Annual Report to shareholders (Exhibit 13) 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 for this item is set forth in the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 23 through 26 of the Company's 1994 Annual Report to shareholders (Exhibit 13) and is incorporated herein by reference.\n- 19 -\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information for this item is set forth on pages 11 through 21 of the Company's 1994 Annual Report to shareholders (Exhibit 13) 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\nDIRECTORS -\nThe information for this item relating to directors and nominees of the Company and to the filing of reports under Section 16(a) of the Securities Exchange Act of 1934 is set forth in the section entitled \"Election of Directors\" in the Company's Proxy Statement related to the annual meeting of shareholders to be held on May 1, 1995, which section is incorporated herein by reference.\nEXECUTIVE OFFICERS -\nThe information for this item relating to executive officers of the Company is set forth on pages 16 through 18 of this report.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION\nThe information for this item is set forth in the section entitled \"Executive Compensation\" in the Company's Proxy Statement related to the annual meeting of shareholders to be held on May 1, 1995, which section (except for the portions thereof entitled \"Compensation Committee Report on Executive Compensation\" and \"Performance of Common Shares\") is incorporated herein by reference.\n- 20 -\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS -\nThe information for this item is set forth in the section entitled \"Information Regarding Certain Beneficial Owners of Common Shares\" in the Company's Proxy Statement related to the annual meeting of shareholders to be held on May 1, 1995, which section is incorporated herein by reference.\nSECURITY OWNERSHIP OF MANAGEMENT -\nThe information for this item is set forth in the section entitled \"Securities Ownership of Management\" in the Company's Proxy Statement related to the annual meeting of shareholders to be held on May 1, 1995, which section is incorporated herein by reference.\nCHANGES IN CONTROL -\nThe Company knows of no arrangements which may at a subsequent date result in a change in control of the Company.\nITEM 13","section_13":"ITEM 13 - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information for this item is set forth in the section entitled \"Certain Transactions\" in the Company's Proxy Statement related to the annual meeting of shareholders to be held on May 1, 1995, which section is incorporated herein by reference.\n- 21 -\nPART IV\nITEM 14","section_14":"ITEM 14 - EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nFINANCIAL STATEMENT SCHEDULES\nAll financial statement schedules have been omitted since the required information is included in the consolidated financial statements or the notes thereto, or is not applicable or required.\nEXHIBITS (NUMBERED IN ACCORDANCE WITH ITEM 601 OF REGULATION S-K)\nThe following exhibits are filed as part of this 1994 Form 10-K Report. Those exhibits previously filed and incorporated herein by\n- 22 -\nreference are identified below by a note reference to the previous filing.\n- 23 -\n- 24 -\n- 25 -\n- 26 -\n* Management Contract or Compensatory Plan or Arrangement\nREPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during the last quarter of the year ended December 31, 1994.\n- 27 -\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.\nAlaTenn Resources, Inc.\nBy: \/s\/Jerry A. Howard ------------------------- Jerry A. Howard Chairman of the Board, President and Chief Executive Officer\nDated: March 30, 1995\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- 28 -\n- 30 -\nALATENN RESOURCES, INC.\nINDEX OF EXHIBITS\nThe following exhibits are filed as part of this 1994 Form 10-K Report. Those exhibits previously filed and incorporated herein by reference are identified below by a note reference to the previous filing.\n* Management Contract or Compensatory Plan or Arrangement","section_15":""}
{"filename":"74208_1994.txt","cik":"74208","year":"1994","section_1":"Item 1. Business\nUnited Dominion Realty Trust, Inc. (the \"Trust\"), a Virginia corporation, is a self-administered equity real estate investment trust (\"REIT\"), formed in 1972, whose business is devoted to one industry segment, the ownership and operation of income-producing real estate, primarily apartment communities in the Southeast. The Trust is a fully integrated real estate company with acquisition, construction and management capabilities. The Trust acquires, upgrades and operates its properties with the goals of maximizing its funds from operations (\"FFO\") (defined as income before gains [losses] on investments and extraordinary items adjusted for certain non-cash items, primarily real estate depreciation) and quarterly distributions to shareholders, while building equity primarily through real estate appreciation. Prior to 1991, the Trust's investment policy was to emphasize the acquisition of under-leased, under-managed, and\/or under-maintained properties that could be physically or otherwise upgraded and could be acquired at significant discounts from replacement costs. At the beginning of 1991, changed economic conditions and the Trust's financial strength enabled it to embark on a major expansion of its apartment portfolio by taking advantage of unique buying opportunities resulting from the real estate credit crisis. This has enabled the Trust to (i) acquire more stable apartment properties having high occupancy levels and not requiring substantial renovation, and (ii) enter into new markets including the Baltimore\/Washington area, central and south Florida, and Nashville and Memphis, Tennessee. During 1994, the Trust also made acquisitions for the first time in Delaware and Alabama. The properties have been acquired generally at significant discounts from replacement cost and at current yields believed to be attractive. The sellers have included financially distressed real estate limited partnerships, the RTC, the FDIC, lenders who had foreclosed and insurance companies seeking to reduce their real estate exposure. During the three years prior to 1994, the Trust purchased 36 apartment communities with 9,237 units for approximately $250 million. In 1994, the Trust purchased 47 apartment communities with 11,433 units for approximately $404 million. This includes 26 apartment communities with 5,318 units acquired in a portfolio purchase for $171 million, including closing costs. One of the portfolio properties containing 65 units at a cost of $1.6 million was subsequently resold. As of March 28, 1995, the Trust's portfolio of income-producing real estate consisted of 138 properties including 121 apartment complexes, 13 shopping centers, and 4 other properties. (See Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties (continued) December 31, 1994\n(1) Two anchor tenants occupying more than 60,000 square feet at this center filed for bankruptcy in 1993. Subsequently, 56,000 square feet has been leased.\n(2) An achor tenant occupying more than 53,000 square feet at this center filed for bankruptcy in 1993.\n(3) An anchor tenant occupying more than 34,800 square feet vacated in May 1992. This property was sold in February 1995.\n(4) The Trust has experienced vacancies at this property over the past several years and has not leased the vacant space.\n(5) Building was vacated by anchor tenant on 1993.\nItem 3.","section_3":"Item 3. Legal proceedings\nNone\nItem 4.","section_4":"Item 4. Submission of matters to a vote of security holders\nNo matters were submitted to a vote of the Trust's shareholders during the last quarter of its fiscal year ended December 31, 1994.\nExecutive Officers of the Registrant\nThe executive officers of the Trust, listed below, serve in their respective capacities for approximate one year terms and are subject to re-election annually by the Board of Directors, normally in May of each year.\nMr. McCann, a Director, has been the Trust's managing officer since 1974, serving as its President since 1979, its Secretary from 1974 to 1980, and its Treasurer from 1982 to 1985.\nMr. Dolphin, a Director, was first employed by the Trust in May, 1979 as Controller and served as Corporate Secretary from 1980 to January, 1994. He was elected Vice President of Finance in 1985 and Senior Vice President in 1987. Prior to joining the Trust, Mr. Dolphin was employed by Arthur Young and Company, Certified Public Accountants.\nMr. Kornblau, a Director, joined the Trust in 1991 as Senior Vice President and Director of Apartment Operations. From 1985 through 1990, he was President and Chief Executive Officer of Summit Realty Group, Inc. which managed the Trust's apartment properties during that period. He is a licensed real estate broker and a C.P.M.\nMr. Chess joined the Trust in October, 1987 as Director of Acquisitions. He was elected Assistant Vice President in 1988 and Vice President in 1989. From 1984 to 1987 he was employed by Manufacturers Life Insurance Company as Senior Analyst - Real Estate Syndications. He previously served in the Pennsylvania General Assembly and is admitted to the practice of law in Virginia and Pennsylvania.\nMr. Giannotti joined the Trust as Director of Development and Construction in September, 1985. He was elected Assistant Vice President in 1988 and Vice President in 1989. Prior to joining the Trust he was employed as Project Manager by Vaughan Associates, Architects and by Beckstoffer and Associates, Architects, both of Richmond, Virginia. He is a registered architect.\nMs. Surface joined the Trust in 1992 as Assistant Vice President and Legal Counsel and in 1994 was elected General Counsel, Corporate Secretary and Vice President. From 1986 to 1992, she was an attorney with the law firm of Hunton and Williams, the Trust's outside counsel.\nMr. Davis joined the Trust in March, 1989 as Controller and was subsequently elected Assistant Secretary. In 1991 he was elected Vice President. From 1986 to 1989, he was employed by Crestar Bank, Richmond, Virginia, as an officer and financial analyst. He was previously employed by Arthur Young & Company, Certified Public Accountants, Richmond, Virginia. He is a certified public accountant.\nPart II\nItem 5.","section_5":"Item 5. Market for registrant's common equity and related stockholder matters\nIncorporated herein by reference from the captions \"Common Stock Price\" and \"Shareholders\" appearing on the inside back cover of the Trust's 1994 Annual Report to Shareholders. Information regarding the Trust's dividend policy is included in Item 7.\nItem 6.","section_6":"Item 6. Selected financial data\nIncorporated herein by reference from the caption \"Selected Financial Information\" appearing on page 21 of the Trust's 1994 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 the caption \"Management's Discussion of Financial Condition and Operations\" appearing on pages 22 through 24 of the Trust's 1994 Annual Report to Shareholders, exclusive of graphs and related captions appearing therein.\nItem 8.","section_7A":"","section_8":"Item 8. Financial statements and supplementary data\nThe Trust's consolidated financial statements at December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994, and the independent auditor's report thereon and the Trust's unaudited quarterly financial data for the two-year period ended December 31, 1994 are incorporated herein by reference from pages 25 through 36 of the Trust's 1994 Annual Report to Shareholders.\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\nIncorporated herein by reference from the Trust's definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders to be held on May 2, 1995.\nInformation required by this item regarding the executive officers of the Trust is included in Part I of this Form 10-K in the section entitled \"Executive Officers of the Registrant\".\nItem 11.","section_11":"Item 11. Executive compensation\nIncorporated herein by reference from the Trust's definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders to be held on May 2, 1995.\nItem 12.","section_12":"Item 12. Security ownership of certain beneficial owners and management\nIncorporated herein by reference from the Trust's definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders to be held on May 2, 1995.\nItem 13.","section_13":"Item 13. Certain relationships and related transactions\nIncorporated herein by reference from the Trust's definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders to be held on May 2, 1995.\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 and are hereby incorporated by reference:\n2. Financial Statement Schedules\nSchedule II - Valuation and Qualifying Accounts 22\nSchedule III - Summary of Real Estate Owned 23 - 25\nAll other schedules are 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.\n3. Exhibits\nThe exhibits listed on the accompanying exhibit index are filed as part of this annual report. See pages 18 - 20.\n(b) Reports on Form 8-K\n(i) A Form 8-K dated October 14, 1994 was filed with the Securities and Exchange Commission on October 31, 1994 and amended by a Form 8-K\/A dated December 29, 1994. The filing reported the acquisition of certain properties which in the aggregate were deemed to be significant. The financial statements filed as a part of this report are statements of rental operations of Copperfield Apartments, Mediterranean Village Apartments, Briar Club Apartments, Covington Crossing Apartments and Hunters Trace Apartments.\nUNITED DOMINION REALTY TRUST, INC.\nEXHIBIT INDEX\nItem 14 (a)\nReferences to pages under the caption \"Location\" are to sequentially numbered pages of the manually signed original of this Form 10-K, and references to exhibits, forms, or other filings indicate that the form or other filing has been filed, that the indexed exhibit and the exhibit referred to are the same and that the exhibit referred to is incorporated by reference.\nExhibit Description Location\nThe Trust agrees to furnish to the Commission on request a copy of any instrument with respect to long-term debt of the Trust or its subsidiary the total amount of securities authorized under which does not exceed 10% of the total assets of the Trust.\n23 Consent of Independent Page 44 Auditors\nITEM 14(a)(1) and (2), (c) and (d)\nFINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nCERTAIN EXHIBITS\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1994\nUNITED DOMINION REALTY TRUST, INC.\nRICHMOND, VIRGINIA\nSchedule II\nUNITED DOMINION REALTY TRUST, INC. VALUATION AND QUALIFYING ACCOUNTS For the years ended December 31, 1994 and 1993\n(1) The balance is netted against the cost of real estate owned on the balance sheet\nSCHEDULE III. Summary of Real Estate Owned\nSCHEDULE III. Summary of Real Estate Owned (continued)\nSCHEDULE III. Summary of Real Estate Owned (continued)\n(a) The aggregate cost for federal income tax purposes was approximately $987 million at December 31, 1994 and $563 million at 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 Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUnited Dominion Realty Trust, Inc. (registrant)\nBy \/s\/ James Dolphin James Dolphin Senior Vice President, and Chief Financial Officer March 30, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on March 30, 1995 by the following persons on behalf of the registrant and in the capacities indicated.\n\/s\/ John P. McCann \/s\/ R. Toms Dalton, Jr. John P. McCann R. Toms Dalton, Jr. Director, President and Chief Director Executive Officer\n\/s\/ James Dolphin \/s\/ Jeff C. Bane James Dolphin Jeff C. Bane Director, Senior Vice President, Director Secretary and Chief Financial Officer\n\/s\/ Jerry A. Davis \/s\/ John C. Lanford Jerry A. Davis John C. Lanford Vice President, Controller-Corporate Accounting Director and Chief Accounting Officer\n\/s\/ C. Harmon Williams, Jr. \/s\/ H. Franklin Minor C. Harmon Williams, Jr. H. Franklin Minor Chairman of the Board of Directors Director\n\/s\/ Barry M. Kornblau \/s\/ Robert P. Buford Barry M. Kornblau Robert P. Buford Director, Senior Vice President and Director Director of Apartments","section_15":""}
{"filename":"726927_1994.txt","cik":"726927","year":"1994","section_1":"Item 1. Business - ----------------\nBalcor Realty Investors-84 (the \"Registrant\") is a limited partnership formed in 1982 under the laws of the State of Illinois. The Registrant raised $140,000,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of real property, and all information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire twenty-three real property investments and a minority joint venture interest in one additional property. The Registrant has since disposed of ten of these properties, including the Pinebrook Apartments which was sold in February 1995 and the property in which the Registrant had a minority joint venture interest. As of December 31, 1994, the Registrant owned the fifteen properties described under \"Properties\" (Item 2). The Partnership Agreement provides that the proceeds of any sale or refinancing of the Registrant's properties will not be reinvested in new acquisitions.\nDuring 1994, institutionally owned and managed multi-family residential properties in many markets continued to experience favorable operating conditions combined with relatively low levels of new construction. These favorable operating conditions were supported by the strong pattern of national economic growth which contributed to job growth and rising income levels in most local economies. However, some rental markets continue to remain extremely competitive; therefore, the General Partner's goals are to maintain high occupancy levels, while increasing rents where possible, and to monitor and control operating expenses and capital improvement requirements at the properties. As discussed in Item 7. Liquidity and Capital Resources, of the Registrant's fifteen remaining properties, during 1994, nine generated positive cash flow while six generated marginal cash flow deficits.\nHistorically, real estate investments have experienced the same cyclical characteristics affecting most other types of long-term investments. While real estate values have generally risen over time, the cyclical character of real estate investments, together with local, regional and national market conditions, has resulted in periodic devaluations of real estate in particular markets, as has been experienced in the last few years. As a result of these factors, it has become necessary for the Registrant to retain ownership of many of its properties for longer than the holding period for the assets originally described in the prospectus. The General Partner examines the operations of each property and each local market in conjunction with the Registrant's long term dissolution strategy when determining the optimal time to sell each of the Registrant's properties.\nDuring 1994, the Registrant completed refinancings or modifications of three mortgage notes payable. See Item 7. Liquidity and Capital Resources for additional information.\nThe Registrant sold two properties during 1994. See Item 7. Liquidity and Capital Resources for additional information.\nThe Registrant, by virtue of its ownership of real estate, is subject to federal and state laws and regulations covering various environmental issues. Management of the Registrant utilizes the services of environmental consultants to assess a wide range of environmental issues and to conduct tests for environmental contamination as appropriate. The General Partner is not aware of any potential liability due to environmental issues or conditions that would be material to the Registrant.\nThe officers and employees of Balcor Partners-XV, the General Partner of the Registrant, and its affiliates perform services for the Registrant. The Registrant currently has no employees engaged in its operations.\nOther Information - -----------------\nPinebrook Apartments - --------------------\nIn 1984, Pinebrook Apartments was acquired by Pinebrook Investors, a joint venture consisting of the Registrant and an affiliate. The Registrant and the affiliate hold participating percentages in the joint venture of 51.57% and 48.43%, respectively. Pinebrook Investors utilized $2,959,230 towards the purchase of the property, including $1,400,000 from the Registrant. The remainder of the purchase price was payable in the form of a $5,185,000 purchase money note (the \"Note\") collateralized by a wrap-around mortgage on the property. The Note wrapped around four subordinate mortgage loans held by unaffiliated parties and was collateralized by the property. In 1992, Pinebrook Limited Partnership, another joint venture consisting of the Registrant and the affiliate, purchased one of the subordinate loans at a discount for $220,000, of which $113,454 was the Registrant's share.\nIn November 1992, Pinebrook Investors suspended debt service payments on the Note, and subsequently, in December 1992, filed for protection under Chapter 11 of the U.S. Bankruptcy Code. In May 1994, the Pinebrook Investor's plan of reorganization became effective. Pursuant to the plan of reorganization, Pinebrook Investors was required to sell the property within two years.\nOn February 2, 1995, Pinebrook Investors sold the property to TGM Pinebrook Inc., a Delaware corporation, for a sale price of $6,140,000. From the proceeds of the sale, Pinebrook Investors paid approximately $5,058,226 to the third party mortgage holders in full satisfaction of the outstanding amount of the loans. Additionally, Pinebrook Investors paid approximately $716,729 to Pinebrook Limited Partnership in full satisfaction of the outstanding amount of its loan, of which the Registrant's share is $369,617. Pinebrook Investors paid $184,200 as a brokerage commission to an unaffiliated party and approximately $25,975 representing closing and other costs. Pinebrook Investors received the remaining $13,316, of which the Registrant's share is $6,867. Neither the General Partner nor its affiliates will receive a commission in connection with the sale of the property.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1994, the Registrant owned the 15 properties described below:\nLocation Description of Property - -------- -----------------------\nJacksonville, Florida Antlers Apartments: a 400-unit apartment complex located on approximately 43 acres.\nChandler, Arizona Briarwood Place Apartments: a 268-unit apartment complex located on approximately 15 acres.\nPhoenix, Arizona Canyon Sands Village Apartments: a 412-unit apartment complex located on approximately 20 acres.\nHarris County, Texas Chesapeake Apartments: a 320-unit apartment complex located on approximately 11 acres.\nFort Worth, Texas Chestnut Ridge Apartments (Phase II): a 160-unit apartment complex located on approximately 6 acres.\nColorado Springs, Colorado Chimney Ridge Apartments: a 280-unit apartment complex located on approximately 9 acres.\nDade County, Florida Courtyards of Kendall Apartments: a 300-unit apartment complex located on approximately 20 acres.\nTulsa, Oklahoma Creekwood Apartments (Phase I): a 276-unit apartment complex located on approximately 13 acres.\nCharleston County, South Carolina Drayton Quarter Apartments: a 206-unit apartment complex located on approximately 17 acres.\nLexington, Kentucky * Pinebrook Apartments: a 208-unit apartment complex located on approximately 11 acres.\nOklahoma City, Oklahoma Quail Lakes Apartments: a 384-unit apartment complex located on approximately 19 acres.\nDallas, Texas Ridgetree Apartments (Phase I): a 444-unit apartment complex located on approximately 11 acres.\nLas Vegas, Nevada Somerset Pointe Apartments: a 452-unit apartment complex located on approximately 26 acres.\nOverland Park, Kansas Sunnyoak Village Apartments: a 548-unit apartment complex located on approximately 33 acres.\nIrving, Texas Woodland Hills Apartments: a 250-unit apartment complex located on approximately 10 acres.\n* This property was owned by the Registrant through a joint venture with an affiliate and was sold during 1995. See Item 1. Business and Note 12 of Notes to Financial Statements for additional information.\nEach of the above properties is held subject to various forms of financing.\nIn the opinion of the General Partner, the Registrant has provided for adequate insurance coverage for its real estate investment properties.\nSee Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - -------------------------\nThe Registrant is not subject to any material pending legal proceedings, nor were any such proceedings terminated during the fourth quarter of 1994.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - -----------------------------------------------------------\nNo matters were submitted to a vote of the Limited Partners of the Registrant during 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder - ------------------------------------------------------------------------- Matters - -------\nThere has not been an established public market for Limited Partnership Interests and it is not anticipated that one will develop; therefore, the market value of the Limited Partnership Interests cannot reasonably be determined. For information regarding distributions, see Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\nAs of December 31, 1994, the number of record holders of Limited Partnership Interests of the Registrant was 13,453.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ----------\nTotal income $30,392,509 $30,159,179 $30,525,777 $31,274,909 $32,505,457 Loss before gains on sale of assets and extraordinary items (2,814,657) (3,588,955) (5,092,181) (6,901,927) (7,890,602) Net income (loss) 5,572,852 2,809,966 (5,092,181) (3,093,431) (7,890,602) Net income (loss) per Limited Partnership Interest 39.41 19.87 (36.01) (21.88) (55.80) Total assets 98,385,353 117,468,061 128,763,485 132,982,864 169,019,865 Mortgage notes payable 114,779,433 136,404,898 149,910,843 150,663,629 182,960,724\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nSummary of Operations - ---------------------\nThe Ridgepoint Hill and Ridgepoint View apartment complexes were sold in 1994 and certain of the related loans were repaid at a discount. During 1993, the Ridgetree Phase I first mortgage loan was purchased at a discount and title to the Highland Glen apartment complex was relinquished through foreclosure. As a result of these transactions and the timing of their related gains, Balcor Realty Investors-84 (the \"Partnership\") generated increased net income during 1994 as compared to 1993 and generated net income during 1993 as compared to a net loss during 1992. Further discussion of the Partnership's operations is summarized below.\nOperations - ----------\n1994 Compared to 1993 - ---------------------\nIn August 1994, the Partnership sold the Ridgepoint Hill and Ridgepoint View apartment complexes and repaid the first mortgage loans to a third party. In addition, sales proceeds were used to repay the second mortgage loans and unsecured third mortgage loan from an affiliate of the General Partner at a\ndiscount. As a result, the Partnership recognized gains on the sales of the properties and extraordinary gains on forgiveness of debt during 1994. During May 1993, title to the Highland Glen apartment complex was relinquished to the mortgage holder through foreclosure. As a result, the Partnership recognized an extraordinary gain on foreclosure. The 1994 property sales and the 1993 foreclosure resulted in decreases in rental and service income, interest expense on mortgage notes payable, depreciation, property operating expenses, maintenance and repair expense, real estate taxes and property management fees during 1994 as compared to 1993. These decreases were partially or, in certain cases, fully offset by the events described below.\nTwelve of the Partnership's remaining properties experienced improved occupancy and\/or higher rental rates in 1994, resulting in increased rental and service income and property management fees during 1994 as compared to 1993, which fully offset the decreases from the property sales and foreclosure.\nDue to higher average cash balances and higher market interest rates on short- term interest bearing instruments, interest income on short-term investments increased during 1994 as compared to 1993.\nIn accordance with the loan agreements, the interest rates on the Briarwood, Canyon Sands, Somerset Pointe and Sunnyoak Village mortgage notes decreased in 1993 based on lower market rates and resulted in a decrease in interest expense on these loans. In addition, during 1994 and 1993, the Chestnut Ridge Phase II mortgage note and the Ridgetree Phase I and Woodland Hills mortgage notes were refinanced at lower interest rates and reduced total principal balances. These decreases in interest expense, as well as the decreases discussed above, were partially offset during 1994 by interest expense recognized on the Chesapeake mortgage note, which was obtained during June 1993, and on the Quail Lakes loan, which had principal-only payments until June 1993 at which time the payments increased to principal and interest. In addition, the Partnership recognized extraordinary gains on forgiveness of debt during 1993 in connection with the refinancings of the Ridgetree Phase I and Chimney Ridge mortgage loans.\nDue to increases in the short-term loan balance payable to an affiliate and interest rates during 1994, interest expense on short-term loans increased during 1994 as compared to 1993.\nHigher costs for insurance premiums, payroll expenses and contract services at many of the Partnership's properties resulted in increased property operating expense during 1994 as compared to 1993. This increase fully offset the decrease from the property sales and foreclosure.\nDue to higher repair and maintenance expenditures, which included roof and pavement repairs, landscaping and replacement of floor coverings at many of the Partnership's properties, maintenance and repair expense increased during 1994 as compared to 1993, which fully offset the decrease from the property sales and foreclosure.\nDue primarily to a higher tax assessment for the Ridgetree Phase I apartment complex, real estate taxes increased during 1994 as compared to 1993, which fully offset the decrease from the property sales and foreclosure.\nPrimarily as a result of increased legal fees relating to the Pinebrook bankruptcy settlement and increased portfolio management and data processing expenses, administrative expenses increased during 1994 as compared to 1993. This increase was partially offset by a decrease in accounting fees during 1994 as compared to 1993.\nThe Pinebrook apartment complex was owned by a joint venture consisting of the Partnership and an affiliate. The joint venture recognized other income during 1993 in connection with the purchase of a note investment related to the property. During 1994, default interest expense was recognized on the fourth mortgage loan in connection with the bankruptcy plan of reorganization. These transactions, as well as higher property operating and repairs and maintenance\nexpenditures at the property which had been deferred due to the bankruptcy, resulted in an increase in affiliate's participation in loss from joint venture during 1994 as compared to 1993.\n1993 Compared to 1992 - ---------------------\nAfter the Partnership suspended debt service payments on the Highland Glen apartment complex and the lender filed foreclosure proceedings, a receiver was appointed and took possession of the property in September 1992. This caused decreases in rental and service income, interest expense on mortgage notes payable, depreciation expense, property operating expenses, maintenance and repair expenses, real estate taxes and property management fees during 1993 as compared to 1992. These decreases were partially or, in certain cases, fully offset by the events described below. During May 1993, title to the Highland Glen apartment complex was relinquished to the mortgage holder through foreclosure. As a result, the Partnership recognized an extraordinary gain on foreclosure during 1993.\nFourteen of the Partnership's remaining properties experienced improved occupancy levels and\/or higher rental rates in 1993, partially offsetting the previously discussed decreases in rental and service income and property management fees during 1993 as compared to 1992.\nThe Partnership reached a settlement with the seller of the Ridgetree Phase I apartment complex in June 1992. Prorations due from the seller pursuant to the terms of the original management and guarantee agreement on this property were previously written off due to uncertain collectibility. Pursuant to the settlement agreement, the parties have released all claims and causes of action against one another, and the Partnership received cash of $208,000 and was relieved of certain other liabilities by the seller. Other income of $259,174 was recognized in connection with this transaction and resulted in a decrease in other income during 1993 as compared to 1992.\nThe interest rate on the previous Creekwood Phase I mortgage note adjusted monthly based on a market rate while the interest rates on the Briarwood, Canyon Sands, Somerset Pointe and Sunnyoak Village mortgage notes were adjusted in 1993 based on market rates. Lower interest rates during 1993 resulted in a decrease in interest expense on these loans. In April 1993, the Ridgetree Phase I mortgage note was refinanced and the original loan was repaid at a discount. As a result of a lower principal balance and interest rate on the new loan, interest expense decreased for this property. In May 1993, the Woodland Hills first mortgage note was refinanced and the second mortgage was partially repaid. As a result of the reduced total principal balances and a lower interest rate on the new first mortgage loan, interest expense decreased for this property. These items contributed to the decrease in interest expense on mortgage notes payable during 1993 as compared to 1992. The decreases in interest expense discussed above were partially offset during 1993 by interest expense recognized on the Chesapeake mortgage note, which was obtained during June 1993, and on the Quail Lakes apartment complex loan, which had principal- only payments until June 1993.\nAs a result of the full amortization of the deferred expenses related to prior mortgages on the Highland Glen apartment complex, which was foreclosed in 1993, and the Woodland Hills, Chesapeake and Chimney Ridge apartment complexes, which were refinanced in 1993, amortization of deferred expenses increased during 1993 as compared to 1992.\nSlightly higher property operating expenses at most of the remaining properties resulted in an increase in property operating expenses during 1993 as compared to 1992.\nDuring 1993, the Partnership recognized extraordinary gains on forgiveness of debt in connection with the refinancings of the Ridgetree Phase I and Chimney Ridge mortgage loans.\nLiquidity and Capital Resources - -------------------------------\nThe cash position of the Partnership increased as of December 31, 1994 as compared to December 31, 1993. The Partnership received cash from its operating activities which consisted primarily of cash flow generated from property operations which were partially offset by the payment of administrative expenses and short-term interest expense. The Partnership also received cash from its investing activities relating to the sale of the Ridgepoint Hill and Ridgepoint View apartment complexes, all of which was used in its financing activities to repay the related mortgage notes. The Partnership also used cash to fund its other financing activities which consisted primarily of a net repayment to the General Partner and the refinancing of the Chestnut Ridge Phase II and Creekwood Phase I mortgage notes, as well as principal payments on mortgage notes payable.\nThe Partnership has loans from the General Partner and owes approximately $12,153,000 to the General Partner at December 31, 1994 in connection with the funding of operating deficits and borrowings needed for loan refinancings. These loans are expected to be repaid from available cash flow from future property operations, and from proceeds received from the disposition or refinancing of the Partnership's real estate investments, prior to any distributions to Limited Partners.\nAlthough an affiliate of the General Partner has, in certain circumstances, provided mortgage loans for certain properties to the Partnership, there can be no assurance that loans of this type will be available from either an affiliate or the General Partner in the future. The General Partner may also continue to provide additional short-term loans to the Partnership or to fund working capital needs or property operating deficits, although there is no assurance that such loans will be available. Should such short-term loans not be available, the General Partner will seek alternative third party sources of financing working capital. However, the current economic environment and its impact on the real estate industry make it unlikely that the Partnership would be able to secure financing from third parties to fund working capital needs or operating deficits. Should additional borrowings be needed and not be available either through the General Partner or third parties, the Partnership may be required to dispose of some of its properties to satisfy these obligations.\nIn instances where the General Partner concludes that the Partnership's investment objectives cannot be met by continuing to own a particular property and fund operating deficits, the Partnership has suspended and may in the future suspend debt service payments or sell the property at a price less than its original cost. Suspension of debt service payments may lead to a renegotiation of terms with lenders which would permit the Partnership to continue to own properties or may lead to foreclosure or other action by lenders which would result in the relinquishment of title to properties in satisfaction of the outstanding mortgage loan balances. In the case of each property, the General Partner will pursue modification of underlying debt, consider suspending debt service payments and\/or deferring non-critical repair and maintenance costs and analyze present and projected market conditions and projections for operations prior to determining the disposition of a property.\nThe Partnership classifies the cash flow performance of its properties as either positive, a marginal deficit or a significant deficit, each after consideration of debt service payments unless otherwise indicated. A deficit is considered to be significant if it exceeds $250,000 annually or 20% of the property's rental and service income. The Partnership defines cash flow generated from its properties as an amount equal to the property's revenue receipts less property related expenditures, which include debt service payments. For 1994, nine of the fifteen remaining properties owned by the Partnership generated positive cash flow and six generated marginal cash flow deficits. For 1993, of these fifteen properties, ten generated positive cash flow and five generated marginal cash flow deficits.\nThe Canyon Sands apartment complex, which had generated marginal deficits\nduring 1993, generated positive cash flow during 1994 due to higher rental income and slightly lower debt service payments. The following two properties that had generated positive cash flow during 1993 generated marginal cash flow deficits during 1994. The Pinebrook apartment complex experienced higher insurance premiums and increased repairs and maintenance expense which had been deferred during the bankruptcy proceedings while the Drayton Quarter apartment complex experienced slightly higher real estate taxes and slightly lower rental income during 1994.\nWhile the cash flow of certain of the Partnership's properties has improved, the General Partner continues to pursue a number of actions aimed at improving the cash flow of the Partnership's properties including refinancing of mortgage loans, improving property operating performance, and seeking rent increases where market conditions allow. As of December 31, 1994, the occupancy rates of all of the Partnership's properties ranged from 92% to 97% except for Ridgetree Apartments Phase I which had an occupancy rate of 89%. Despite improvements during 1993 and 1994 in the local economies and rental markets where certain of the Partnership's properties are located, the General Partner believes that continued ownership of many of the properties is in the best interests of the Partnership in order to maximize potential returns to Limited Partners. As a result, the Partnership will continue to own these properties for longer than the holding period for the assets originally described in the prospectus.\nEach of the Partnership's properties is owned through the use of third-party mortgage loan financing and, therefore, the Partnership is subject to the financial obligations required by such loans. See Note 3 of Notes to Financial Statements for information concerning outstanding balances, maturity dates, interest rates, and other terms related to each of these mortgage loans. During 1995 and 1996, the Partnership has only one loan maturing, a mortgage loan of approximately $4,765,000 collateralized by the Drayton Quarter apartment complex. The General Partner has decided to sell the property and negotiations are currently in progress to accomplish this prior to the maturity of the loan.\nThe Pinebrook apartment complex was owned by Pinebrook Investors, a joint venture consisting of the Partnership and an affiliate, and was financed with a $5,185,000 wrap-around mortgage payable, which matured in July 1993. In December 1992, Pinebrook Investors filed for protection under the U.S. Bankruptcy Code and in 1994, a plan of reorganization was approved by the Bankruptcy Court. Pursuant to the plan, Pinebrook Investors was required to sell the property within two years. Consequently, in February 1995, Pinebrook Investors sold the property in an all cash sale for $6,140,000. From the proceeds, Pinebrook Investors paid $5,058,226 to the third party mortgage holders in full satisfaction of the first, second and fourth mortgage loans. Additionally, Pinebrook Investors paid approximately $716,729 in full satisfaction of the third mortgage note payable to Pinebrook Limited Partnership, a separate joint venture consisting of the Partnership and the affiliate. See Notes 3, 10 and 12 of Notes to Financial Statements for additional information.\nDuring 1994, the Chestnut Ridge Phase II mortgage loans, the Creekwood Phase I first mortgage loan, and the Quail Lakes first mortgage loan were refinanced or modified. See Note 3 of Notes to Financial Statements for additional information.\nDuring 1994, the Partnership sold the Ridgepoint Hill and Ridgepoint View apartment complexes in an all cash sale for $18,659,285. From the proceeds, the Partnership paid $12,658,037 in full satisfaction of the first mortgage loans and $5,381,539 to an affiliate of the General Partner in full satisfaction of the second mortgage loans and an unsecured third mortgage loan which represented a discount of $2,791,215. The Partnership did not receive any proceeds from the sale of the properties. See Notes 8 and 11 of Notes to Financial Statements for additional information.\nWoodland Hills Apartments is located near the Dallas\/Ft. Worth Airport. A proposed expansion plan provides for the construction of two additional runways on airport property. A plan proposed by the Dallas\/Fort Worth International\nAirport Board provides for varying levels of compensation to single family homeowners; however, no similar compensation is planned for the majority of apartment complex owners, including the property. In July 1993, the Partnership and other affected multi-family property owners filed a lawsuit seeking to obtain compensation. As a result of the court's decisions, the Partnership is not entitled to receive any compensation due to the airport expansion. The plaintiffs have decided not to appeal the decision due to the costs of continuing the litigation, but intend to continue to monitor the situation. Woodland Hills Apartments, however, may be entitled to be reimbursed for the costs of sound proofing under the Final Environmental Impact Statement approved by the Federal Aviation Administration. However, a final determination will not be made until the runways are completed and actual noise studies are analyzed. The General Partner does not anticipate that the proposed expansion plan will have a significant impact to the value of the property.\nThe Briarwood apartment complex is located in the path of a planned expansion of Price Road, which is adjacent to the property. Discussions for this expansion have been ongoing, and the General Partner has been attending the public hearings due to its opposition to this expansion. If the current plans are approved, approximately 68 of the complex's 268 units would be condemned, which would have a significant impact on the property's value. Currently it is unclear whether the future approvals and funding for the project will be obtained and, if obtained, what compensation the Partnership would receive for the units or when the work would begin.\nAlthough investors have received certain tax benefits, the Partnership has not commenced distributions. Future distributions to investors will depend on improved cash flow from the Partnership's remaining properties and proceeds from future property sales, as to both of which there can be no assurances. In light of results to date and current market conditions, the General Partner does not anticipate that investors will recover a substantial portion of their original investment.\nThe General Partner has recently completed the outsourcing of the financial reporting and accounting services, transfer agent and investor records services, and computer operations and systems development functions that provided services to the Partnership. All of these functions are now being provided by independent third parties. Additionally, Allegiance Realty Group, Inc., which has provided property management services to all of the Partnership's properties, was sold to a third party. Each of these transactions occurred after extensive due diligence and competitive bidding processes. The General Partner does not believe that the cost of providing these services to the Partnership, in the aggregate, will be materially different to the Partnership during 1995 when compared to 1994.\nInflation has several types of potentially conflicting impacts on real estate investments. Short-term inflation can increase real estate operating costs which may or may not be recovered through increased rents depending on general or local economic conditions. In the long-term, inflation will increase operating costs and replacement costs and may lead to increased rental revenues and real estate values.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------\nSee Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\nThe supplemental financial information specified by Item 302 of Regulation S-K is not applicable.\nThe net effect of the differences between the financial statements and the tax returns is summarized as follows:\nDecember 31, 1994 December 31, 1993 ------------------------- -------------------------\nFinancial Tax Financial Tax Statements Returns Statements Returns ---------- --------- ---------- ---------\nTotal assets $98,385,353 $67,625,335 $117,468,061 $86,235,405 Partners' capital accounts (deficit): General Partner (1,545,395)(11,230,881) (1,601,123) (18,854,592) Limited Partners (29,002,420)(49,329,122) (34,519,544) (50,849,212) Net income (loss): General Partner 55,728 7,623,711 28,100 (3,584,849) Limited Partners 5,517,124 1,520,090 2,781,866 6,627,854 Per Limited Part- nership Interest 39.41 10.86 19.87 47.34\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 any matter of accounting principles, practices or financial statement disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - -----------------------------------------------------------\n(a) Neither the Registrant nor Balcor Partners-XV, its General Partner, has a Board of Directors.\n(b, c & e) The names, ages and business experience of the executive officers and significant employees of the General Partner of the Registrant are as follows:\nTITLE OFFICERS ----- --------\nChairman, President and Chief Thomas E. Meador Executive Officer Executive Vice President, Allan Wood Chief Financial Officer and Chief Accounting Officer Senior Vice President Alexander J. Darragh First Vice President Daniel A. Duhig First Vice President Josette V. Goldberg First Vice President Alan G. Lieberman First Vice President Brian D. Parker and Assistant Secretary First Vice President John K. Powell, Jr. First Vice President Reid A. Reynolds First Vice President Thomas G. Selby\nThomas E. Meador (July 1947) joined Balcor in July 1979. He is Chairman, President and Chief Executive Officer and has responsibility for all ongoing day-to-day activities at Balcor. He is a Director of The Balcor Company. Prior to joining Balcor, Mr. Meador was employed at the Harris Trust and Savings Bank in the commercial real estate division where he was involved in various lending activities. Mr. Meador received his M.B.A. degree from the Indiana University Graduate School of Business.\nAllan Wood (January 1949) joined Balcor in August 1983 and, as Balcor's Chief Financial Officer and Chief Accounting Officer, is responsible for the financial and administrative functions. He is also a Director of The Balcor Company. Mr. Wood is a Certified Public Accountant. Prior to joining Balcor, he was employed by Price Waterhouse where he was involved in auditing public and private companies.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and has primary responsibility for the Portfolio Advisory Group. He is responsible for due diligence analysis and real estate advisory services in support of asset management, institutional advisory and capital markets functions. Mr. Darragh has supervisory responsibility of Balcor's Investor Services, Investment Administration, Fund Management and Land Management departments. Mr. Darragh received masters' degrees in Urban Geography from Queens's University and in Urban Planning from Northwestern University.\nDaniel A. Duhig (October 1956) joined Balcor in November 1986 and is responsible for the Asset Management Department relating to real estate investments made by Balcor and its affiliated partnerships, including negotiations for modifications or refinancings of real estate mortgage investments and the disposition of real estate investments.\nJosette V. Goldberg (April 1957) joined Balcor in January 1985 and has primary responsibility for all human resources matters. In addition, she has supervisory responsibility for Balcor's administrative and MIS departments. Ms. Goldberg has been designated as a Senior Human Resources Professional\n(SHRP).\nAlan G. Lieberman (June 1959) joined Balcor in May 1983 and is responsible for the Property Sales and Capital Markets Groups. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and is responsible for Balcor's corporate and property accounting, treasury and budget activities. Mr. Parker is a Certified Public Accountant and holds an M.S. degree in Accountancy from DePaul University.\nJohn K. Powell, Jr. (June 1950) joined Balcor in September 1985 and is responsible for the administration of the investment portfolios of Balcor's partnerships and for Balcor's risk management functions. Mr. Powell received a Master of Planning degree from the University of Virginia. He has been designated a Certified Real Estate Financier by the National Society for Real Estate Finance and is a full member of the Urban Land Institute.\nReid A. Reynolds (April 1950) joined Balcor in March 1981 and is involved with the asset management of residential properties for Balcor. Mr. Reynolds is a licensed Real Estate Broker in the State of Illinois.\nThomas G. Selby (July 1955) joined Balcor in February 1984 and has responsibility for various Asset Management functions, including oversight of the residential portfolio. From January 1986 through September 1994, Mr. Selby was Regional Vice President and then Senior Vice President of Allegiance Realty Group, Inc., an affiliate of Balcor providing property management services. Mr. Selby was responsible for supervising the management of residential properties in the western United States.\n(d) There is no family relationship between any of the foregoing officers.\n(f) None of the foregoing officers or employees are currently involved in any material legal proceedings nor were any such proceedings terminated during the fourth quarter of 1994.\nItem 11.","section_11":"Item 11. Executive Compensation - -------------------------------\nThe Registrant has not paid and does not propose to pay any remuneration to the executive officers and directors of the General Partner. Certain of these officers receive compensation from The Balcor Company (but not from the Registrant) for services performed for various affiliated entities, which may include services performed for the Registrant. However, the General Partner believes that any such compensation attributable to services performed for the Registrant is immaterial to the Registrant. See Note 7 of Notes to Financial Statements for the information relating to transactions with affiliates.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - -----------------------------------------------------------------------\n(a) No person owns of record or is known by the Registrant to own beneficially more than 5% of the outstanding Limited Partnership Interests of the Registrant.\n(b) Balcor Partners-XV and its officers and partners own as a group the following Limited Partnership Interests of the Registrant:\nAmount Beneficially Title of Class Owned Percent of Class -------------- ------------- ----------------\nLimited Partnership Interests 116 Interests Less than 1%\nRelatives and affiliates of the officers and partners of the General Partner own an additional 80 Interests.\n(c) The Registrant is not aware of any arrangements, the operation of which may result in a change of control of the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------\n(a & b) See Note 2 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\nSee Note 7 of Notes to Financial Statements for information relating to transactions with affiliates.\n(c) No management person is indebted to the Registrant.\n(d) The Registrant has no outstanding agreements with any promoters.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------------------------------------------------------------------------\n(a) (1 & 2) See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\n(3) Exhibits:\n(3) The Amended and Restated Agreement of Limited Partnership and Amended and Restated Certificate of Limited Partnership, previously filed as Exhibits 3 and 4.1 to Amendment No. 1 to the Registrant's Registration Statement on Form S-11 dated December 16, 1983 (Registration No. 2-86317) are incorporated herein by reference.\n(4) Form of Confirmation regarding Interests in the Registrant set forth as Exhibit 4.2 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1992 (Commission File No. 0-13349) are incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1994 is attached hereto.\n(99) Agreement of Sale relating to the sale of Pinebrook Apartments, Lexington, Kentucky is attached hereto.\n(b) Reports on Form 8-K: No Reports on Form 8-K were filed during the quarter ended December 31, 1994.\n(c) Exhibits: See Item 14(a)(3) above.\n(d) Financial Statement Schedules: See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of l934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALCOR REALTY INVESTORS-84\nBy: \/s\/Allan Wood ---------------------- Allan Wood Executive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XV, the General Partner\nDate: March 27, 1995 ------------------\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 - ---------------------- ------------------------------- ------------ President and Chief Executive Officer (Principal Executive Officer) of Balcor Partners-XV, \/s\/Thomas E. Meador the General Partner March 27, 1995 - ---------------------- -------------- Thomas E. Meador\nExecutive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XV, \/s\/Allan Wood the General Partner March 27, 1995 - ---------------------- -------------- Allan Wood\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1994 and 1993\nStatements of Partners' Deficit, for the years ended December 31, 1994, 1993 and 1992\nStatements of Income and Expenses, for the years ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows, for the years ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements\nFinancial Statement Schedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1994\nFinancial Statement Schedules, other than that listed, are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Balcor Realty Investors-84:\nWe have audited the financial statements and the financial statement schedule of Balcor Realty Investors-84 (An Illinois Limited Partnership) as listed in the index of this Form 10-K. These financial statements and financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these 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 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 Balcor Realty Investors-84 at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois March 10, 1995\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1994 and 1993\nASSETS\n1994 1993 ------------- ------------- Cash and cash equivalents $ 1,311,019 $ 736,429 Certificate of deposit - restricted 700,000 700,000 Net investment in note receivable 914,040 Escrow deposits 2,501,015 3,052,027 Accounts and accrued interest receivable 914,727 1,615,965 Deferred expenses, net of accumulated amortization of $1,061,641 in 1994 and $1,128,672 in 1993 1,353,111 1,570,886 ------------- ------------- 6,779,872 8,589,347 ------------- ------------- Investment in real estate: Land 18,397,507 22,657,624 Buildings and improvements 130,982,523 145,783,613 ------------- ------------- 149,380,030 168,441,237 Less accumulated depreciation 57,774,549 59,562,523 ------------- ------------- Investment in real estate, net of accumulated depreciation 91,605,481 108,878,714 ------------- ------------- $ 98,385,353 $117,468,061 ============= =============\nLIABILITIES AND PARTNERS' DEFICIT\nLoans payable - affiliate $ 12,153,202 $ 11,166,206 Accounts payable 328,647 1,040,208 Due to affiliates 197,822 207,444 Accrued liabilities, principally interest and real estate taxes 1,201,714 4,229,868 Security deposits 582,347 599,835 Mortgage notes payable 112,812,222 126,356,211 Mortgage notes payable - affiliate 1,967,211 10,048,687 ------------- ------------- Total liabilities 129,243,165 153,648,459\nAffiliate's participation in joint venture (309,997) (59,731)\nPartners' deficit (140,000 Limited Partnership Interests issued and outstanding) (30,547,815) (36,120,667) ------------- ------------- $ 98,385,353 $117,468,061 ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' DEFICIT for the years ended December 31, 1994, 1993 and 1992\nPartners' Deficit Accounts -------------------------------------------- General Limited Total Partner Partners(A) -------------- ------------- -------------\nBalance at December 31, 1991 $ (33,838,452) $ (1,578,301) $(32,260,151)\nNet loss for the year ended December 31, 1992 (5,092,181) (50,922) (5,041,259) -------------- ------------- ------------- Balance at December 31, 1992 (38,930,633) (1,629,223) (37,301,410)\nNet income for the year ended December 31, 1993 2,809,966 28,100 2,781,866 -------------- ------------- ------------- Balance at December 31, 1993 (36,120,667) (1,601,123) (34,519,544)\nNet income for the year ended December 31, 1994 5,572,852 55,728 5,517,124 -------------- ------------- ------------- Balance at December 31, 1994 $ (30,547,815) $ (1,545,395) $(29,002,420) ============== ============= =============\n(A) Includes a $110,000 investment by the General Partner, which is treated on the same basis as the other Limited Partnership Interests.\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1994, 1993 and 1992\n1994 1993 1992 ------------- ------------- ------------- Income: Rental and service $ 30,283,700 $ 29,915,125 $ 30,010,121 Interest on short-term investments 108,809 76,829 81,558 Other income 167,225 434,098 ------------- ------------- ------------- Total income 30,392,509 30,159,179 30,525,777 ------------- ------------- -------------\nExpenses: Interest on mortgage notes payable 10,764,902 12,047,956 13,816,050 Interest on short-term loans 635,617 484,932 494,403 Depreciation 4,461,058 4,617,794 4,884,047 Amortization of deferred expenses 455,911 471,567 229,473 Property operating 8,770,470 8,085,076 7,892,370 Maintenance and repairs 3,264,328 3,207,875 3,353,405 Real estate taxes 2,535,394 2,492,324 2,502,189 Property management fees 1,502,309 1,481,954 1,493,809 Administrative 1,049,594 923,660 1,021,753 ------------- ------------- ------------- Total expenses 33,439,583 33,813,138 35,687,499 ------------- ------------- -------------\nLoss before gains on sales of properties, affiliate's participation in loss from joint venture and extraordinary items (3,047,074) (3,653,959) (5,161,722)\nGains on sales of properties 5,596,294 Affiliate's participation in loss from joint venture 232,417 65,004 69,541 ------------- ------------- ------------- Income (loss) before extraordinary items 2,781,637 (3,588,955) (5,092,181) ------------- ------------- ------------- Extraordinary items: Gains on forgiveness of debt 2,791,215 2,058,078 Gain on foreclosure of property 4,340,843 ------------- ------------- Total extraordinary items 2,791,215 6,398,921 ------------- ------------- ------------- Net income (loss) $ 5,572,852 $ 2,809,966 $ (5,092,181) ============= ============= ============= Income (loss) before extraordinary items allocated to General Partner $ 27,816 $ (35,890) $ (50,922) ============= ============= ============= Income (loss) before extraordinary items\nallocated to Limited Partners $ 2,753,821 $ (3,553,065) $ (5,041,259) ============= ============= ============= Income (loss) before extraordinary items per Limited Partnership Interest (140,000 issued and outstanding) $ 19.67 $ (25.38) $ (36.01) ============= ============= =============\nExtraordinary items allocated to General Partner $ 27,912 $ 63,989 None ============= ============= ============= Extraordinary items allocated to Limited Partners $ 2,763,303 $ 6,334,932 None ============= ============= ============= Extraordinary items per Limited Partnership Interest (140,000 issued and outstanding) $ 19.74 $ 45.25 None ============= ============= ============= Net income (loss) allocated to General Partner $ 55,728 $ 28,100 $ (50,922) ============= ============= ============= Net income (loss) allocated to Limited Partners $ 5,517,124 $ 2,781,866 $ (5,041,259) ============= ============= ============= Net income (loss) per Limited Partnership Interest (140,000 issued and outstanding) $ 39.41 $ 19.87 $ (36.01) ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1994, 1993 and 1992 (Continued)\n1994 1993 1992 ------------- ------------- ------------- Operating activities: Net income (loss) $ 5,572,852 $ 2,809,966 $ (5,092,181) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Extraordinary items: Gains on forgiveness of debt (2,791,215) (2,058,078) Gain on foreclosure of property (4,340,843) Gains on sales of properties (5,596,294) Affiliate's participation in loss from joint venture (232,417) (65,004) (69,541) Depreciation of properties 4,461,058 4,617,794 4,884,047 Amortization of deferred expenses 455,911 471,567 229,473 Amortization of discount on note receivable (112,816) (117,185) Deferred interest on note receivable (131,475) (424,168) (39,871) Deferred interest expense 806,802 Net change in: Escrow deposits 295,653 (1,083,694) (426,432) Accounts and accrued interest receivable 701,238 (926,249) (243,519) Accounts payable (711,561) 72,914 355,743 Due to affiliates (9,622) (10,263) 4,383 Accrued liabilities (241,377) 1,365,981 607,755 Security deposits (17,488) (13,309) 2,631 ------------- ------------- ------------- Net cash provided by operating activities 1,755,263 303,798 902,105 ------------- ------------- ------------- Investing activities: Proceeds from redemption of restricted investments 100,000 610,000 Purchase of investment in note (220,000) Additions to properties (48,774) (33,750) Proceeds from sales of properties 18,659,285 Payment of selling costs (250,816) ------------- ------------- ------------- Net cash provided by investing activities 18,408,469 51,226 356,250 ------------- ------------- ------------- Financing activities: Capital contributions by joint venture partner - affiliate 4,953 133,342 Distributions to joint venture partner -\naffiliate (22,802) (23,780) (7,537) Proceeds from loan payable - affiliate 764,128 5,918,837 1,478,387 Repayment of loan payable - affiliate (1,218,432) (7,164,610) (302,178) Proceeds from issuance of mortgage notes payable 8,828,700 27,532,897 2,863,800 Repayment of mortgage notes payable (20,626,168) (21,205,963) Repayment of mortgage notes payable - affiliate (5,668,638) (1,912,948) (2,863,800) Principal payments on mortgage notes payable (1,574,407) (1,579,971) (2,093,148) Principal payments on mortgage notes payable - affiliate (133,699) (7,675) (43,837) Payment of deferred expenses (198,136) (967,631) (203,029) Payment of financing escrows (113,250) (896,083) (111,245) Release of financing escrows 368,609 32,228 ------------- ------------- ------------- Net cash used in financing activities (19,589,142) (274,699) (1,149,245) ------------- ------------- -------------\nNet change in cash and cash equivalents 574,590 80,325 109,110 Cash and cash equivalents at beginning of year 736,429 656,104 546,994 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 1,311,019 $ 736,429 $ 656,104 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Accounting Policies:\n(a) Depreciation expense is computed using straight-line and accelerated methods. Rates used in the determination of depreciation are based upon the following estimated useful lives:\nYears -----\nBuildings and improvements 20 to 30 Furniture and fixtures 5 to 7\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nInterest incurred while properties were under construction was capitalized.\nThe Partnership records its investments in real estate at cost, and periodically assesses possible impairment to the value of its properties. In the event that the General Partner determines that a permanent impairment in value has occurred, the carrying basis of the property is reduced to its estimated fair value.\n(b) Deferred expenses consist of financing fees which are amortized over the terms of the respective agreements.\n(c) Cash equivalents include all unrestricted highly liquid investments with an original maturity of three months or less.\n(d) The Partnership is not liable for Federal income taxes and each partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(e) Reclassifications have been made to the previously reported 1993 and 1992 statements in order to provide comparability with the 1994 statements. These reclassifications have not changed the 1993 or 1992 results.\n2. Partnership Agreement:\nThe Partnership was organized in September 1982. The Partnership Agreement provides for Balcor Partners-XV to be the General Partner and for the admission of Limited Partners through the sale of up to 150,000 Limited Partnership Interests at $1,000 per Interest, 140,000 of which were sold on or prior to June 27, 1984, the termination date of the offering.\nThe Partnership Agreement provides that the General Partner generally will be allocated 1% of the profits and losses. One hundred percent of \"Net Cash Receipts\" available for distribution shall be distributed to the holders of Interests in proportion to their participating percentages as of the record date for such distributions. In addition, there shall be accrued for the benefit of the General Partner as its distributive share from operations an amount equivalent to approximately 1% of the total Net Cash Receipts being distributed, which will be paid only out of Net Cash Proceeds.\nUnder certain circumstances, the General Partner may also participate in the Net Cash Proceeds of the sale or refinancing of Partnership properties. When and as the Partnership sells or refinances its properties, the Net Cash Proceeds resulting therefrom, which are available for distribution, will be distributed only to holders of Interests until such time as holders of Interests have received an amount equal to their Original Capital plus certain\nlevels of return as specified by the Partnership Agreement. Only after such returns are made to the Limited Partners will the General Partner receive 15% of further distributed Net Cash Proceeds, which will include the accrued distributive share of Net Cash Receipts, subject to increase by an amount equal to certain acquisition fees the General Partner would otherwise have been entitled to pursuant to the Partnership Agreement.\n3. Mortgage Notes Payable:\nMortgage notes payable at December 31, 1994 and 1993 consisted of the following:\nCarrying Carrying Current Final Property Amount of Amount of Inter- Matur- Current Estimated Pledged as Notes at Notes at est ity Monthly Balloon Collateral 12\/31\/94 12\/31\/93 Rate Date Payment Payment - --------------- ---------- ---------- ------ ------ -------- ----------\nMortgage Notes Payable - Nonaffiliates:\nApartment Complexes: Antlers (A) $10,309,549 $10,446,268 8.25% 1998 $82,787 $9,731,000 Briarwood Place 6,137,179 6,261,495 6.498% 1998 43,961 5,606,000 Canyon Sands Village 9,265,525 9,447,725 6.498% 1998 66,130 8,460,000 Chesapeake (B) 5,140,624 5,170,785 7.875% 2028 36,357 None Chimney Ridge (C) 7,321,840 7,389,254 7.625% 2003 52,377 6,452,000 Chestnut Ridge (Phase II) (D) 3,112,914 2,843,547 9.02% 2001 25,219 2,934,000 Courtyards of Kendall (E) 9,137,019 9,461,431 9.50% 1997 83,906 9,014,000 Creekwood (F) 5,677,152 5,335,504 8.88% 1999 45,372 5,465,000 Drayton Quarter 4,796,013 4,833,492 11.00% 1995 47,276 4,765,000 Pinebrook (G) 5,068,603 5,185,000 Quail Lakes (H) 6,801,164 6,847,000 8.25% 2001 51,295 6,350,000 Ridgepoint Hill (I) 6,186,000 Ridgepoint View (I) 6,352,000 Ridgetree (Phase I) (J) 9,569,351 9,626,164 10.05% 2000 85,139 9,157,000 Somerset Pointe 11,473,744 11,690,016 6.498% 1998 80,531 10,501,000 Sunnyoak Village 14,008,532 14,247,685 7.33% 2015 106,091 None Woodland Hills (K) 4,993,013 5,032,845 8.54% 1998 39,009 4,828,000 ----------- -----------\nSubtotal 112,812,222 126,356,211 ----------- -----------\nMortgage Notes Payable - Affiliates:\nApartment Complexes: Chestnut Ridge (L) 1,515,739 2,829,241 10.50% 2002 (L) 1,516,000 Ridgepoint Hill (I) 3,288,870 Ridgepoint View (I) 3,345,405 Woodland Hills (M) 451,472 585,171 10.50% 1999 (M) 451,000 ----------- -----------\nSubtotal 1,967,211 10,048,687 ----------- ----------- Total $114,779,433$136,404,898 ============ ===========\n(A) In July 1993, this loan was modified. The loan balance was increased by $232,334 to $10,500,000, the interest rate decreased from 9% to 8.25%, the maturity date was extended from January 1994 to August 1998 and the monthly payments decreased from $87,745 to $82,787.\n(B) In June 1993, the Partnership obtained this first mortgage loan. It replaced the bonds collateralized by the property, which the Partnership had purchased in 1991.\n(C) In October 1993, this loan was refinanced. The interest rate decreased from 10.00% to 7.625%, the maturity date was extended from July 2002 to November 2003 and the monthly payments decreased from $53,285 to $52,377. Proceeds from the new $7,400,000 first mortgage loan were used to repay the existing first mortgage loan of $6,023,757, which represented a discount to the Partnership of $180,599.\n(D) In March 1994, this loan was refinanced. The interest rate decreased from 9.75% to 9.02%, the maturity date was changed from January 2002 to April 2001 and the monthly payments increased from $24,073 to $25,219. Proceeds from the new $3,128,700 first mortgage loan were used to repay the existing $2,841,601 first mortgage loan as well as $287,099 of the Balcor Real Estate Holdings, Inc. (\"BREHI\") loan.\n(E) The Partnership is obligated to pay the lender (upon the earlier of maturity or the sale or refinancing of the property) additional interest equal to the lesser of: (i) 25% of the amount by which the agreed upon value of the property at maturity or upon sale or refinancing exceeds $10,100,000, or (ii) interest which would have accrued on the loan from June 1, 1992 through the earlier of maturity or the sale or refinancing of the property at a rate of 15% per annum.\n(F) In May 1994, this loan was refinanced. The interest rate changed from a floating rate to a fixed rate of 8.88%, the maturity date was extended from September 1994 to June 1999, and the monthly payments decreased from $49,953 to $45,372. Proceeds from the new $5,700,000 first mortgage loan were used to repay the existing first mortgage loan of $5,246,568.\n(G) In December 1992, Pinebrook Investors, the joint venture which owns the property filed for protection under the U.S. Bankruptcy Code. In 1994, a plan of reorganization was approved by the Bankruptcy Court. Under the plan, the wrap-around features of the various mortgage notes were eliminated and the notes became first, second, third and fourth mortgage notes upon which the joint venture made monthly payments totaling $40,761, a portion of which might have been deferred based on availability of cash flow, at interest rates ranging from 8.875% to 10%. Under the plan of reorganization, the new first, second and fourth mortgage loan balances were $2,294,722, $1,712,135 and $1,006,029, respectively. The third mortgage note payable was eliminated, along with its monthly payments, through consolidation of the financial statements. In February 1995, Pinebrook Investors sold the property. The mortgage maturity amount is included in the 1995 maturity schedule amount below. See Notes 10 and 12 of Notes to Financial Statements for additional information.\n(H) In March 1994, this loan was modified. Effective February 1994, the interest rate increased from 6.745% to 8.25%, the maturity date was extended from March 1995 to March 2001 and the monthly payments increased from $44,612 to $51,295.\n(I) In August 1994, the Partnership sold this property. See Note 8 of Notes to Financial Statements for additional information.\n(J) In April 1993, this loan was refinanced. The interest rate decreased from 11.00% to 10.05%, the maturity date was extended from September 1996 to May 2000 and the monthly payments decreased from $102,889 to $85,139. Proceeds from the $9,467,780 first mortgage loan and the $193,220 second mortgage loan, along with a principal payment of $760,190, were used to repay the existing $12,298,669 first mortgage loan which represents a discount of $1,877,479.\n(K) In May 1993, this loan was refinanced. The interest rate decreased from 10.00% to 8.54%, the maturity date was extended from September 1993 to June 1998 and the monthly payments decreased from $44,405 to $39,009. Proceeds from the new $5,054,563 first mortgage loan were used to repay the existing first\nmortgage loan of $4,941,615 as well as $112,948 of the BREHI loan.\n(L) This note represents a subordinate non-recourse loan of $1,315,739 payable to BREHI and a preferred limited partnership interest of $200,000 in the subsidiary partnership which holds title to the property. During 1994, $287,099 of the proceeds from the new first mortgage loan were used to repay a portion of the $414,897 deferred interest on the previous junior loans from affiliates. In addition, as a requirement of the first mortgage loan, of the remaining balances of the junior loans and deferred interest, $1,441,300 was retired and replaced with a General Partner loan and the remainder was retired and replaced with the current notes and preferred limited partnership interest. The contract rate on the BREHI loan remains unchanged at 10.5%, which is the rate of return earned on the preferred limited partnership interest as well. The interest pay rate on the BREHI loan is the lower of the contract rate or the net cash flow from the property. Any deferred interest on the BREHI loan will be payable at maturity. The Limited Partners' position is unaffected by this conversion of a portion of the junior loans to an equity position as Limited Partners' equity is subordinate to the preferred interest just as it was subordinate to the junior loans prior to the recharacterization.\n(M) This note represents a second mortgage loan payable to BREHI. During 1993, the balance of the BREHI loan of $2,498,119, including accrued interest, was reduced to $585,171 as a requirement of the first mortgage loan. The partial repayment was conditioned upon BREHI agreeing to subordinate repayment of the remaining portion of the BREHI loan to a payment to the Partnership from sale or refinancing proceeds from this property of $1,800,000. The interest pay rate is the lower of the contract rate or the net cash flow from the property, after payment of interest on the first mortgage loan, limited to a maximum annual deficit of $62,500. Deferred interest on the second mortgage loan is accumulated and bears interest at the contract rate.\nThe Partnership's mortgage loans to non-affiliates described above require current monthly payments of principal and interest. During the years ended December 31, 1994, 1993 and 1992, the Partnership incurred interest expense on mortgage notes payable to non-affiliates of $10,132,223, $10,882,258 and $12,561,221, respectively. The Partnership paid interest expense of $10,140,419 in 1994, $10,655,057 in 1993 and $11,830,225 in 1992. See Note 8 of Notes to Financial Statements for interest paid and incurred on loans payable to affiliates.\nMaturities of the mortgage notes payable - nonaffiliates and mortgage note payable - affiliates in each of the next five years are approximately as follows:\n1995 $12,031,000 1996 1,564,000 1997 10,339,000 1998 40,443,000 1999 6,644,000\n4. Management Agreements:\nAs of December 31, 1994, all of the properties owned by the Partnership are under management agreements with a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts.\n5. Affiliate's Participation in Joint Venture:\nThe Pinebrook apartment complex was purchased by Pinebrook Investors, a joint venture between the Partnership and an affiliate. All assets, liabilities, income and expenses of the joint venture are included in the financial statements of the Partnership with the appropriate deduction from income or loss for the affiliate's participation in the joint venture. Profits and losses are allocated 51.57% to the Partnership and 48.43% to the affiliate.\n6. Tax Accounting:\nThe Partnership keeps its books in accordance with the Internal Revenue Code, rules and regulations promulgated thereunder and existing interpretations thereof. The accompanying financial statements which are prepared in accordance with generally accepted accounting principles will differ from the tax basis method of accounting due to the different treatment of various items as specified in the Internal Revenue Code. The net effect of these accounting differences is that the net income for 1994 in the financial statements is $3,570,949 less than the tax income of the Partnership for the same period.\n7. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/94 12\/31\/93 12\/31\/92 ------------------ ------------------ ------------------ Paid Payable Paid Payable Paid Payable -------- ------- -------- ------- -------- -------\nProperty manage- ment fees $1,401,854 None $1,477,069 $135,884 $1,483,559 $130,999 Reimbursement of expenses to General Partner at cost: Accounting 119,390 $39,870 64,346 5,325 24,802 1,840 Data processing 102,770 20,814 57,699 10,401 63,566 5,255 Investor communications 12,677 4,234 10,210 845 10,201 757 Legal 35,233 11,767 27,006 2,235 40,765 3,025 Other 43,319 14,467 32,012 2,649 35,905 2,664 Portfolio mgmt. 127,397 38,107 118,754 9,356 78,260 5,377\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all of the Partnership's properties until the affiliate was sold to a third-party in November 1994.\nDuring 1994, $1,441,300 of an unsecured affiliate loan relating to the Chestnut Ridge Phase II Apartments was retired and replaced with a General Partner loan as a result of the March 1994 refinancing of that property. In addition, the Partnership borrowed an additional $764,128 to meet working capital requirements. The Partnership repaid $1,218,432 of these loans from the General Partner during 1994. As of December 31, 1994, the Partnership had outstanding short-term loans totaling $12,153,202 from the General Partner with accrued interest payable on these loans totaling $68,563. During 1994, 1993 and 1992, the Partnership incurred interest expense of $635,617, $484,932 and $494,403 and paid interest expense of $607,803, $511,973 and $480,680 on these loans, respectively. Interest expense is computed at the American Express Company cost of funds rate plus a spread to cover administrative costs. As of December 31, 1994, this rate was 6.56%.\nIn March 1994, the Partnership refinanced the Chestnut Ridge Phase II mortgage loans payable, including a second mortgage loan previously outstanding to BREHI, an affiliate of the General Partner, and the unsecured loan described above. See Note 3 of Notes to Financial Statements for additional information.\nIn August 1994, the Partnership repaid the Ridgepoint Hill and Ridgepoint View BREHI loans at a discount in connection with the sale of these properties. See Note 8 of Notes to Financial Statements for additional information.\nAs of December 31, 1994, the Partnership had junior loans outstanding from BREHI relating to the Chestnut Ridge Phase II and Woodland Hills apartment complexes in the aggregate amount of $1,967,211 with accrued interest payable on these loans totaling $29,623. See Note 3 of Notes to Financial Statements\nfor additional information. During 1994, 1993 and 1992, the Partnership incurred interest expense of $632,679, $1,165,698 and $1,254,829 and paid interest expense of $913,199, $770,479 and $974,726 on these affiliated mortgage loans, respectively.\nThe General Partner may continue to provide additional short-term loans to the Partnership to fund future working capital needs or operating deficits, although there is no assurance that such loans will be available. Should such short-term loans not be available, the General Partner will seek alternative third party sources of financing working capital. However, the current economic environment and its impact on the real estate industry make it unlikely that the Partnership would be able to secure financing from third parties to fund working capital needs or operating deficits. Should additional borrowings be needed and not be available either through the General Partner or third parties, the Partnership may be required to dispose of some of its properties to satisfy these obligations.\nThe Partnership participates in an insurance deductible program with other affiliated partnerships in which the program pays claims up to the amount of the deductible under the master insurance policies for its properties. The program is administered by an affiliate of the General Partner who receives no fee for administering the program. The Partnership's premiums to the deductible insurance program were $310,984, $208,938 and $207,395 for 1994, 1993 and 1992, respectively. The Partnership had receivables from the insurance deductible program totaling $159,351 at December 31, 1994.\n8. Property Sales:\nIn August 1994, the Partnership sold the Ridgepoint Hill and Ridgepoint View apartment complexes in an all cash sale for $18,659,285. From the proceeds of the sale, the Partnership paid $12,658,037, which included accrued interest, in full satisfaction of the first mortgage loans, as well as brokerage commissions and other closing costs. The bases of these properties were $12,812,175, net of accumulated depreciation of $6,249,032. For financial statement purposes, the Partnership recognized a gain of $5,596,294 from the sale of these properties. The remaining $5,381,539 of sales proceeds were paid to an affiliate of the General Partner in full satisfaction of the second mortgage loans and an unsecured third mortgage loan. This represents a discount of $2,791,215 from the outstanding balance of the affiliate loans and accrued interest. The Partnership did not receive any proceeds from the sale of the properties.\n9. Restricted Investments:\nAs of December 31, 1992, the Partnership had pledged cash of $800,000 as additional collateral related to the Woodland Hills and Canyon Sands mortgage loans. In connection with the May 1993 Woodland Hills refinancing, cash collateral of $100,000 was released. As of December 31, 1994, $700,000 remained pledged related to the Canyon Sands mortgage loan. This amount was invested in short-term instruments pursuant to the terms of the agreement with the lending institution. Interest earned on the collateral accumulates to the benefit of the Partnership.\nIn addition, an affiliate of the General Partner had been providing a guarantee against a letter of credit in the amount of $250,000 posted as additional collateral for the funding of capital improvements on the Courtyards of Kendall apartment complex. During 1994, the letter of credit was cashed and applied to the principal balance of the underlying mortgage loan.\n10. Net Investment in Note Receivable:\nThe Pinebrook apartment complex was owned by Pinebrook Investors, a joint venture consisting of the Partnership and an affiliate, and was financed with a $5,185,000 wrap-around mortgage note payable to Lexington Associates, the seller of the property (\"Lexington\"), which wrapped two underlying mortgage notes payable to Pinebrook Limited Partnership, a separate joint venture consisting of the Partnership and the affiliate. These notes in turn wrapped a\nmortgage note payable to Tates Creek Place (\"Tates Creek\"). As of December 31, 1993, the Partnership's net investment in the notes was $914,040, consisting of the wrap-around notes receivable from Lexington of $4,885,918, offset by the mortgage note payable to Tates Creek of $3,971,878. In December 1992, Pinebrook Investors filed for protection under the U.S. Bankruptcy Code and a plan of reorganization was approved by the Bankruptcy Court and made effective in May 1994. Under the plan of reorganization, the wrap-around features of the various mortgage notes were eliminated and the mortgage notes payable by Pinebrook Investors to third parties became first, second and fourth mortgage notes. The net investment of $914,040 described above was recharacterized as a third mortgage note payable by Pinebrook Investors to Pinebrook Limited Partnership. The operations of these joint ventures have been consolidated within the Partnership's financial statements, and the related intercompany mortgage notes transactions have been eliminated. In February 1995, the Partnership sold the Pinebrook apartment complex. See Notes 3 and 12 of Notes to Financial Statements for additional information.\n11. Extraordinary Items:\n(a) During 1994, the Ridgepoint Hill and Ridgepoint View apartment complexes were sold. In connection with the sale, the Partnership repaid the second mortgage loans and an unsecured third mortgage loan due to an affiliate of the General Partner at a discount. This transaction resulted in an extraordinary gain on forgiveness of debt of $2,791,215 during 1994 for financial statement purposes. See Note 8 of Notes to Financial Statements for additional information.\n(b) During 1993, the Ridgetree Phase I and the Chimney Ridge mortgage notes were refinanced. The mortgage notes which had outstanding balances totaling $18,322,426, including accrued interest, were repaid for $16,264,348. These transactions resulted in extraordinary gains on forgiveness of debt totaling $2,058,078 during 1993 for financial statement purposes.\n(c) During 1993, title to the Highland Glen Apartments was relinquished through foreclosure. The Partnership wrote-off the property basis of $10,613,575, net of accumulated depreciation of $4,252,309, a mortgage loan balance of $14,918,362 and accrued real estate taxes of $36,056. The Partnership recognized an extraordinary gain on foreclosure of property of $4,340,843 during 1993 for financial statement purposes.\n12. Contingency:\nThe Briarwood apartment complex is located in the path of a planned expansion of Price Road, which is adjacent to the property. Discussions for this expansion have been ongoing, and the General Partner has been attending the public hearings due to its opposition to this expansion. If the current plans are approved, approximately 68 of the complex's 268 units would be condemned, which would have a significant impact on the property's value. Currently it is unclear whether the future approvals and funding for the project will be obtained and, if obtained, what compensation the Partnership would receive for the units or when the work would begin.\n13. Subsequent Event:\nIn February 1995, the Partnership sold the Pinebrook Apartments in an all cash sale for $6,140,000. From the proceeds of the sale, the Partnership paid $5,058,226 to the third party mortgage holders in full satisfaction of the first, second and fourth mortgage loans, as well as a brokerage commission and other closing costs. The basis of the property was $4,114,855, net of accumulated depreciation of $3,364,699. The Partnership will recognize a gain of $1,814,970 in its 1995 financial statements.\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS-84 (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III (a) See description of mortgage notes payable in Note 3 of Notes to Financial Statements.\n(b) Consists of legal fees, appraisal fees, title costs, other related professional fees and capitalized construction period interest.\n(c) Guaranteed income earned on properties under the terms of certain management and guarantee agreements was recorded by the Partnership as a reduction of the basis of the property to which the guaranteed income related.\n(d) A reduction of basis was made to write down the property to its December 31, 1988 mortgage liability balance.\n(e) The aggregate cost of land for Federal income tax purposes is $19,534,465 and the aggregate cost of buildings and improvements for Federal income tax purposes is $124,960,899. The total of these is $144,495,364.\n(f) Reconciliation of Real Estate ----------------------------- 1994 1993 1992 ---------- ---------- ----------\nBalance at beginning of year $168,441,237 $183,258,347 $183,224,597\nAdditions during year: Improvements 48,774 33,750\nDeductions during year Foreclosure of investment properties None (14,865,884) None Cost of real estate sold (19,061,207) None None ------------ ------------ ------------ Balance at close of year $149,380,030 $168,441,237 $183,258,347 ============ ============ ============\nReconciliation of Accumulated Depreciation ------------------------------------------ 1994 1993 1992 ---------- ---------- ----------\nBalance at beginning of year $ 59,562,523 $ 59,197,038 $ 54,312,991\nDepreciation expense for the year 4,461,058 4,617,794 4,884,047 Accumulated depreciation of foreclosed investment properties None (4,252,309) None Accumulated depreciation of real estate sold (6,249,032) None None ------------ ------------ ------------ Balance at close of year $ 57,774,549 $ 59,562,523 $ 59,197,038 ============ ============ ============\n(g) Depreciation expense is computed based upon the following estimated useful lives: Years -----\nBuildings and improvements 20 to 30 Furniture and fixtures 5 to 7","section_15":""}
{"filename":"68412_1994.txt","cik":"68412","year":"1994","section_1":"ITEM 1. BUSINESS.\nNATURE OF THE BUSINESS\nMosinee Paper Corporation was incorporated in Wisconsin in 1910. The company and its subsidiaries (collectively, the \"company\") operate in the pulp and paper industry. The company's Pulp and Paper Division (\"Pulp and Paper\") produces and sells specialty papers and its Mosinee Converted Products Division (\"Converted Products\") produces and sells wax laminated and converted papers. Bay West Paper Corporation (\"Bay West\") produces, converts and sells towel and tissue paper products and The Sorg Paper Company (\"Sorg Paper\"), produces and sells specialty papers. Additional wholly-owned subsidiaries are: Mosinee Paper International Inc., which administers export sales for the company and acts as a foreign sales corporation (FSC); and Mosinee Holdings, Inc., which operates a power plant in Middletown, Ohio to provide steam and electricity to Sorg Paper and Bay West's towel and tissue paper mill located there.\nSEGMENT INFORMATION\nThe manufacture and sale of paper is the company's only line of business.\nPRINCIPAL PRODUCTS AND SERVICES\nThe principal product groups of the company are specialty papers, laminated and converted papers and towel and tissue products.\nSPECIALTY PAPERS\nSpecialty paper products are produced and sold by Pulp and Paper and Sorg Paper. Principal products of Pulp and Paper include industrial crepe, masking, gumming, converting and wax laminating, foil laminating, flame resistant, interleaver, cable wrap, electrical insulation, pressure sensitive backing, toweling, water base and film coating and packaging papers. Sorg Paper produces decorative laminate, deep-color and facial tissue, filter, construction, parchtex, saturating, soapboard and soapwrap and latex label papers. All products of the company's specialty paper operations are sold to other manufactures or converters for further processing and ultimate sale to end users. These manufacturers and converters are in many industries including housing, steel, aluminum and other metal producers, automotive, consumer packaging, food processing, home appliance, consumer goods and printing.\nTOWEL AND TISSUE PRODUCTS\nThe towel and tissue products produced and sold by Bay West are primarily for the commercial and institutional wash room products markets that include recreation, health care, food service, manufacturing, education, automotive and dairy. The products include roll and folded towels, tissue products, soaps, windshield towels, dairy towels, household roll towels and glass cleaner. Bay\nWest products are sold through independent distributors to end users both domestically and internationally.\nCONVERTED PRODUCTS\nWax-laminated and converted papers produced by Converted Products include roll, ream and skid wrap paper, can body stock, impregnated paper and coated papers. These products are sold to manufacturers and converters in the paper, can and corrugated container industries.\nEXPORT SALES\nMosinee Paper International, Inc. acts as a commissioned sales agent for the export sales of the company and has elected to be treated as a foreign sales corporation, or FSC, for federal income tax purposes. During 1994, export sales of the company's products amounted to nearly $26 million.\nRAW MATERIALS\nFor paper making operations, fiber represents approximately half of the cost of paper. The company satisfies its fiber requirements using virgin fiber from pulpwood and chips, purchased bleached pulp and both pre- and post-consumer waste or recyclable papers. The types of paper being made and their intended uses determine the type or quality of the fiber used.\nDuring 1994, Pulp and Paper required 36,000 tons, or 29% of total fiber requirements, of bleached pulp which it purchased on the open market. The balance, representing unbleached pulp, was produced at its kraft pulp mill. Sorg Paper is a non-integrated paper manufacturer and must purchase all required fiber on the open market. During the year it used 37,000 tons of bleached pulp, or 99% of its fiber requirements. Pulp prices have risen dramatically from an average $400\/ton at the start of 1994 to slightly over $700\/ton in March, 1995. The balance of purchased fiber represented waste papers, generally pre-consumer, available from printers and other paper converters.\nBay West produces all its fiber requirements from its deink and direct entry systems. The fiber source for these systems is low grade recyclable waste papers. During the year demand for most grades of waste papers increased as new deinking facilities were started in the industry. Increased export of waste papers also increased demand. Bay West was able to purchase its requirements although spot shortages did occur. The cost of waste papers used by Bay West rose dramatically in response to the demand pressures in the market. As an example, the price of file stock (which is post-consumer waste paper) rose from a beginning of the year cost of $90\/ton to $235\/ton at year-end. It continued to rise to $280\/ton by March, 1995. News (#8) waste paper is the most plentiful and rose from $38\/ton in 1994 to the March, 1995 level of $210\/ton. Bay West consumed over 137,000 tons of pre- and post-consumer waste papers during the year.\nWood for Pulp and Paper's pulp mill is produced at its Mosinee Industrial Forest in northwestern Wisconsin and purchased from private landowners, public forests, and from other forest product\nmanufacturers. During 1994, Pulp and Paper consumed 29,000 cords of pulpwood, or 20% of its total wood requirements, from its own forests. The balance was available on the open market. During 1994 the demand on pulpwood and woodchips increased resulting in both lower availability and higher costs. Costs rose from $63\/cord to $67\/cord. While some other paper mills experienced shortages of supply, Mosinee's Pulp and Paper Division did not and also was not subject to price volatility that exceed the range mentioned above. The availability of wood has improved in 1995 and prices are expected to remain stable for the year.\nConverted Products utilizes linerboard and various waxes to produce its laminated papers. Linerboard, purchased from large paper mills in the United States, was subject to high demand in 1994 that continued on into 1995. As a result, linerboard producers raised prices significantly during the year, resulting in an increase of $81\/ton to $423\/ton by the end of 1994. Since year-end, additional price increases totaling $100-$110\/ton have been implemented or announced. The increased demand also tightened availability reaching a peak in February of 1995, with slight easing since then. Converted Products has been able to procure adequate supplies and temporarily supplemented supplies with inventory reduction which is now in the gradual process of being restored.\nAll other chemicals, dyes and sundry raw materials have remained readily available with no anticipated shortages seen during 1995. The company has recovered a portion of raw material cost increases through higher selling prices for its own products. See \"Competitive Conditions\".\nENERGY\nThe company's paper mills require large amounts of steam and electricity for production. Both Pulp and Paper and the Sorg Paper\/Bay West Middletown, Ohio complex have their own steam and electricity generating facilities. Additionally, Pulp and Paper operates a hydro-electric generating facility that produces a portion of its electricity requirements. Both facilities have the capability to purchase electricity from area utilities. The primary fuel used at the Middletown complex is coal while Pulp and Paper utilizes a mixture of coal, bark and sludge and also operates a recovery boiler that recovers inorganic chemicals from its pulping process.\nPATENTS AND TRADEMARKS\nThe company obtains and files trademarks and patents as appropriate for newly developed products. The company does not own or hold material licenses, franchises or concessions.\nSEASONAL NATURE OF BUSINESS\nNone of the products manufactured and sold by the company are seasonal in nature. Bay West unit shipments, however, are moderately higher during the summer and early fall months.\nWORKING CAPITAL\nAs is customary in the paper industry, the company carries adequate amounts of raw materials and finished goods inventory to facilitate the manufacture and rapid delivery of paper products to its customers.\nMAJOR CUSTOMERS\nNo single customer accounted for 10% or more of consolidated net sales during 1994.\nBACKLOG\nThe sales backlog in dollars climbed to over $21 million, up $6 million from the level at 1993 year-end. The backlog was nearly $16 million at specialty paper operations. Backlogs at converting facilities, where customer orders are serviced from inventories, generally represent orders being prepared for shipment. Backlogs at all operations existing at year-end are expected to be shipped during 1995.\nCOMPETITIVE CONDITIONS\nCompetition in the paper industry in general has been strong as capacity in excess of demand for many grades of paper has heightened pricing pressure. The tissue portion of the industry saw previous years' capacity additions being absorbed by higher demand resulting from the strong economy that existed through the year and into 1995.\nSpecialty paper operations at Sorg Paper and Pulp and Paper compete in many different niche markets. The highly technical nature of specialty paper limits competition since not all paper mills can produce the required papers. The competition is generally based more upon quality and service to the customer than price. However, as quality and service are improving at most paper manufacturers and becoming expected attributes of the product, price competition has begun to intensify among competitors in specialty grades. The less technical specialty grades of paper encounter more price competition since more paper mills have the capability to produce them. Additionally, as demand for commodity grade papers declines, producers of these commodity grades temporarily may venture into the less technical specialty grades to maintain production volumes, thereby increasing price competition. Mosinee's specialty paper operations were partially successful in raising selling prices to recover the rapid rise in purchased pulp cost. Additional purchased pulp cost increases during 1995 are expected to be recovered through higher selling prices.\nCompetition in the commercial and institutional tissue markets, which includes toweling, is among several large paper companies. Bay West, although growing, is one of the smaller competitors in this market. The improved economy and less announced capacity increases provided reductions to the severe price competition among tissue producers during 1994. With most competitors in this market feeling the effect of the high waste paper costs, the recovery of most of such increases has been possible, beginning primarily in the later part of 1994 and continuing into 1995.\nWax-laminated and converted products compete with several similar sized producers. Competition is primarily focused on price. Additionally, wax-laminated roll wrap, for paper products sold in roll form by paper mills, competes with polywrap as an alternative roll wrap material.\nRESEARCH AND DEVELOPMENT\nThe company is involved in research and development activities at all locations. Generally, research at specialty paper operations occurs in both the laboratory and actual paper machines in the form of trial runs. Research at converting facilities is limited to development, often in conjunction with suppliers, on new laminating compounds. Tissue operations perform trial run research in both deinking and paper production to improve product capability and quality. Additionally, research is conducted to improve existing, and develop the next generation of, product dispensers. The amounts spent on research activities are not material in relation to total operating expenses.\nENVIRONMENT\nThe paper industry is subject to stringent environmental laws and regulations which govern the discharge of materials into the air and ground and surface waters. Environmental regulations have become more restrictive in the past and additional changes can be anticipated in the future. The company is committed to full compliance with all rules designed to protect the environment and compliance with current rules is not expected to have a material adverse effect on the company's earnings or competitive position. There are no proposed regulatory changes of which the company is now aware which are expected to have a material effect on the business or financial condition of the company, but it can be anticipated that future environmental regulations will likely increase the company's capital expenditures and operating costs.\nAdditional information concerning the company's status as a potentially responsible party (\"PRP\") and other environmental matters can be found in the first paragraph of Note 12 of the Notes to Consolidated Financial Statements, page 41. As noted therein, the company is of the opinion that any costs associated with its status as a PRP will not have a material adverse effect on the business and financial condition of the company.\nEMPLOYEES\nThe company had 1,295 employees at the end of 1994. Hourly employees at the company's paper making operations are covered under collective bargaining agreements. During 1993 negotiations were conducted which led to a four-year agreement at Sorg Paper signed in 1994. During 1994 the company negotiated with the Union Bargaining Committee at Bay West's Middletown, Ohio mill and signed a five-year labor agreement. The company considers its relationship with its employees to be excellent. Eligible employees participate in retirement plans and group life, disability and medical insurance programs.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following information relates to Executive Officers of the Company as of March 24, 1995:\nSAN W. ORR, JR., 53\nChairman of the Board since 1987 Director since 1972 Also Attorney, Estates of A.P. Woodson & Family and Chairman of the Board and Chief Executive Officer of Wausau Paper Mills Previously, Vice Chairman of the Board (1978-1987)\nRICHARD L. RADT, 63\nVice Chairman of the Board since August, 1993 Director since 1988 Previously, President and Chief Executive Officer (1988-1993) and President and Chief Executive Officer of Wausau Paper Mills Company (1977-1987)\nDANIEL R. OLVEY, 46\nPresident and Chief Executive Officer since August, 1993, Director since August, 1993 Previously, Executive Vice President and Chief Operating Officer (1992-1993), Group Vice President-Specialty Paper (1991-1992), Vice President-Finance; Secretary and Treasurer (1989-1991); Vice President Finance, Secretary and Treasurer, Wausau Paper Mills Company (1983-1989)\nGARY P. PETERSON, 46\nSr. Vice President-Finance, Secretary and Treasurer since August, 1993 Previously, Vice President-Finance (1991-1993); partner, Wipfli Ullrich Bertelson CPAs (1981-1991)\nSTUART R. CARLSON, 48\nSr. Vice President-Administration since August, 1993 Previously, Vice President-Human Resources (1991-1993); Director of Human Resources, Georgia Pacific, Inc. (1990-1991) and Corporate Director of Industrial Relations, Great Northern Nekoosa Corporation (1989-1990)\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe company's corporate headquarters are located in Mosinee, Wisconsin. The building, which is owned by the company, was constructed in 1985, and consists of approximately 38,000 square feet. Executive officers and a corporate staff of approximately 16 persons who perform corporate accounting and financial, human resource and MIS services are located in the corporate headquarters.\nThe following paragraphs provide information on the location and general character of the company's facilities, including their productive capacity and extent of utilization.\nMOSINEE INDUSTRIAL FOREST\nLOCATION AND CAPACITY\nSolon Springs, WI 1994 production: 31,520 cords 1994 acreage: 87,145 acres\n*\"Practical capacity\" is the amount of product a mill can produce with existing equipment and workforce and usually approximates maximum, or theoretical, capacity. At the company's converting operations it reflects the approximate maximum amount of product that can be made on existing equipment, but would require additional days and\/or shifts of operation to achieve.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe company, along with other paper companies, is part of a civil investigation by the U.S. Department of Justice to determine whether any violation of U.S. antitrust laws has occurred in the commercial and industrial market for sanitary paper products. The company believes it has not violated any antitrust laws.\nIn the ordinary course of conducting business, the company also becomes involved in environmental issues, investigations, administrative proceedings and litigation. While any proceeding or litigation has an element of uncertainty, the company believes that the outcome of any pending or threatened claim or lawsuit will not have a material adverse effect on the business and financial condition of the company.\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 in the fourth quarter.\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 Nasdaq National Market System under the symbol MOSI. The number of shareholders of record as of March 1, 1995 was 1,841. In addition, the company has received identification of 1,356 non-objecting beneficial owners who own stock in \"street name\" or who are institutional owners. The company also believes that it has approximately 1,322 beneficial owners who either did not reply or who object to being disclosed. The total estimated number of shareholders as of March 24, 1995 is 4,519. Information related to high and low closing prices and dividends is set forth in Note 16 of Notes to Consolidated Financial Statements, page 44. A description of certain dividend restrictions under the company's credit agreement is set forth in Note 7 of the Notes to Consolidated Financial Statements, page 34.\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 OPERATION.\nSales increased $22 million, or 9%, over the prior year. All business units experienced increased sales revenue and volume of product sold. In the aggregate, tons sold increased to 255,000 tons, over 7%, or 17,000 tons, over the prior year. The majority of gain, in tons sold, was registered at Bay West, accounting for over 80% of the total increase. Foreign sales also experienced an increase to nearly $26 million and now account for nearly 10% of total net sales. Exports of towel and tissue products increased to $13 million and specialty paper product sales, which also registered increases over the prior year, contributed the other $13 million.\nDuring the year, the strong economy increased demand in most areas of the paper industry and absorbed prior years' excess capacity. This helped to restore margins that had eroded over the past several years and to recover raw material price increases which occurred with unprecedented frequency during much of the year. With higher demands for paper, the mix of product sold was improved by replacing papers that provide minimal profit in favor of higher margin products. In summary, strong volume increases added nearly $20 million and a more optimal product mix added $4 million of additional sales. These increases were partially offset by unfavorable pricing effects of over $1.5 million.\nDuring 1993, sales increased $19 million, or 9%, over the prior year. Strong price competition in all areas resulting from reduced demand and capacity additions led to reduced selling prices. Tons shipped increased to 238,000 tons, an improvement of over 10%. Strong volume gains, particularly at Bay West which accounted for 41% of the increased tons shipped, added $33 million in sales. Unfavorable selling prices of over $9 million and less optimal mix of products of $4 million offset some of the benefit of additional volume.\nSales increased in 1992 on sales volume which rose to 216,000 tons, or 18% over the prior year. Bay West accounted for 42% of the change. Pricing for all operations was difficult during 1992 reflecting the general economic slowness that persisted throughout the year. Highly competitive pricing continued during the year in the tissue area of our business as it had during 1991. Capacity increases in excess of existing demand caused serious price discounting among all tissue producers. Strong volume increases\nadded approximately $36 million in sales and was partially offset by unfavorable pricing effects of over $8 million.\nGross profit of over $49 million rose 13% over the $44 million reported last year. Gross profit margin remained at 18%. Increased raw material costs that could not always be timely recovered by higher selling prices reduced gross profit margins at all locations. Bay West however, reduced costs substantially, more than overcoming the unfavorable effect of lower selling prices. Increased productivity at Bay West's facilities and higher volumes brought cost structures more in line with expectations. In 1994, production of towel and tissue paper at the Bay West mill increased 9%, or 7 thousand tons, helping to absorb fixed production costs. Higher volumes and an improved mix of product sold at all other units contributed to the increase in gross profit. Aggressive cost reduction programs at all operations also aided in offsetting lower selling prices. Increase in the raw material prices for purchased pulp, waste paper and linerboard occurred at an unprecedented rate during the year.\nFiber represents approximately half of the cost of paper. The company satisfies its fiber requirements using virgin fiber from pulpwood and chips, purchased bleached pulp and both pre- and post-consumer waste or recyclable papers. The types of paper being made and their intended uses determine the type and quality of the fiber used. During the year the Pulp and Paper Division purchased 36,000 tons of bleached pulp, or 29% of its fiber needs, which were purchased on the open market. The balance, representing unbleached pulp, was produced at its kraft pulp mill. The pulpwood used to produce pulp consumed 29,000 cords from Mosinee's Industrial Forest, or 20% of wood requirements. The balance was available from the open market. Sorg Paper is a non-integrated paper manufacturer and must purchase all required fiber on the open market. During the year it used 37,000 tons of virgin fiber, or 99% of its total fiber requirements. The balance of purchased fiber represented waste papers, generally pre-consumer wastes from printers or paper converters. Bay West's towel and tissue mill produces all its pulp requirements from its deink or direct entry systems. The fiber requirements for these systems is low grade recyclable waste papers that have been subject to sharp increases in cost resulting from strong demand from new deinking facilities, increased exports and higher industry operating rates. Bay West consumed over 137,000 tons of waste paper during the year.\nDuring 1993, gross profit of nearly $44 million rose 43% over the $30 million reported in the prior year and gross profit margin\nimproved to 18%. The improvement in gross profit primarily resulted from productivity improvements at the Bay West towel and tissue mill during the year. Gross profit also increased at all other operating units during the year. Strong volume increases combined with aggressive cost reduction programs offset lower selling prices at all units. Raw material prices remained stable until near the end of the year when price increases were announced.\nDuring 1992, gross profit of $30 million declined slightly from the $31 million reported in the prior year and gross profit margin declined to 14% from the 1991 level of 16%. Gross profit margins declined at all operating units. The unfavorable gross profit and gross profit margin comparisons primarily resulted from weak selling prices. The Bay West towel and tissue mill experienced excessive operating costs during its first full year of operation. Higher deink pulp cost from low yields and high raw material cost also unfavorably effected gross profit.\nGross profit at specialty paper operations remained nearly constant as additional sales volume, a better product mix, higher efficiencies and cost reduction programs offset temporary pulp price increases and lower selling prices.\nOperating expenses declined nearly $2 million, or 8%, from the prior year level of $25 million. As a percent of net sales, operating expenses declined to 9% reflecting the higher dollar amount of sales and lower costs.\nSelling and advertising expenses increased $0.6 million from the prior year. Increased selling incentive compensation and higher advertising and promotional expenses, primarily at Bay West offset reductions in other costs. General inflation increased salaries and wages and contributed to the increase in selling expenses.\nAdministrative expenses declined $2.5 million, or 16%, from the year earlier level. Included in administrative expenses are charges or credits for the company's Stock Appreciation Rights Plans (SAR) further described in Note 11 to the financial statements. During 1994, the market price of the company's stock declined, resulting in a credit of $1 million compared to a charge of $1.7 million in 1993, due to increased market price. Adjusting total administrative expenses for these affects, result in $14.3 million in 1994 compared to $14.3 million reported in the prior year, or no increase. Salaried employment reductions offset general inflationary increases. Higher profitability increased the company's contribution to its 401-k plans, a part of the retirement benefit package offered to employees. Cost reduction program savings offset other inflation oriented increases in normal administrative expenses.\nDuring 1993, The costs associated with some promotion programs were classified as reductions of selling prices and accounted for the majority of the change in the selling and advertising expenses in comparison to 1992. This reduction was partially offset by nominal inflation cost increases, primarily in salaries and related benefits at all operating units.\nThe nearly $3 million increase in 1993 for administrative expenses was generally attributable to the SAR plan. The SAR programs resulted in a charge of $1.7 million due to a 22% increase in the stock price in 1993 compared to a $1 million credit to expense in 1992 when the company's stock price had fallen at year-end. Cost reduction programs helped to offset modest inflationary increases in salary and benefit expenses incurred at all operating units.\nSelling and advertising expenses of $10 million in 1992 reflected the major promotion and advertising programs at Bay West and Sorg. Administrative expenses of $13 million reflected a $1 million credit from SAR programs which partially offset inflationary increases in most other costs.\nRecord income from operations climbed to nearly $26 million, 41% ahead of last year's $18 million. As a percent of net sales, income from operations improved to nearly 10%, the highest level reached since 1983. Strong sales volumes and some needed relief in pricing, necessitated by increased raw material costs, combined with aggressive cost reduction programs in all facets of the business led to the record level.\nDuring 1993, selling prices for paper, particularly in the tissue market, remained below the prior year which had also been adversely affected by depressed prices. Lower operating costs and higher sales volumes at all facilities, especially the Bay West towel and tissue mill during the year, more than offset the lower selling prices and resulted in the strong improvement.\nDuring 1992, high operating costs at the Bay West towel and tissue mill along with the depressed tissue selling prices offset\nprogress at other facilities and accounted for the modest improvement over 1991.\nInterest income was received on various state and federal income tax refunds from prior periods and a minimal amount from overnight investments of excess cash. Interest expense on commercial paper and other long-term debt totaled $5 million in 1994 compared to $5.7 million incurred in 1993 before immaterial amounts of capitalized interest were deducted in each year. During 1992, interest expense reached $7.7 million on short-term debt, commercial paper and long-term bank notes.\nThe average debt level for 1994 of $95 million compared favorably to $99 million during the prior year. This reduction, combined with the expiration of the interest rate protection agreement, accounts for the decrease in interest expense.\nIn early 1993, the U.S. Court of Appeals for the Federal Circuit upheld the District Court judgement awarded the company. The District Court found that James River Corporation had infringed upon certain washroom towel cabinet roll transfer mechanisms patented by Bay West Paper Corporation, a subsidiary of the company. The company received $5.5 million, including interest, which is included in income before taxes.\nThe $7.7 million in interest expense recorded in 1992 resulted from the high debt level following completion of the expansion program and higher interest rates in effect.\nThe income tax provision varies with reported income and federal, state and local tax rates. The 1994 provision for income taxes increased due to continued improvement in earnings. The tax\nprovision of $8.5 million in 1994 results in an effective tax rate of 39.5%.\nThe 1993 provision for income taxes reflected increased earnings and increased federal tax rates. The tax provision of nearly $8 million in 1993 results in an effective tax rate of 44.6%. This rate reflects the enactment of Revenue Reconciliation Act of 1993, which increased the marginal corporate tax rate, requiring a charge to earnings of nearly $1 million to recognize the adjustment of current and deferred taxes.\nDuring 1992, the effective tax rate of 37.3% closely reflected the statutory rates in effect for the year. Also, in 1992, the adoption of the Statement of Financial Accounting Standards No. 109 (SFAS No. 109), Accounting for Income Taxes, allowed the recognition of deferred tax assets, subject to a valuation allowance, for the tax benefit of state income tax loss carryforwards. The ability to recognize a portion of this asset minimizes the impact of the company not being able to offset consolidated income with subsidiary losses, compared to the 1991 effective tax rate.\nReflecting the above, record net income of $12.3 million, or $1.71 per share, rose $2.7 million over the prior year level of $9.6 million, or $1.34 per share.\nStatement of Financial Accounting Standards (SFAS) No. 112, Employers' Accounting for Postemployment Benefits, requires that employers accrue a liability for compensation for future absences of former or inactive employees and their beneficiaries and covered dependents. SFAS No. 112 was adopted January 1, 1994, the required adoption date, by recognizing a cumulative effect expense of $750,000, net of income taxes of $400,000. The company does not anticipate routine accrual expenses, but, will record expenses in accordance with SFAS No. 112 when events occur that require such accrual.\nNet income for 1993 of $9.6 million, or $1.34 per share, increased over the prior year's loss of $8.5 million, or $1.21 per share. Strong sales volumes and lowered operating costs at all operations, especially Bay West, combined to offset lower selling prices and produce stronger earnings.\nNet income for 1992 was adversely affected by the adoption of Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions. This\nadoption required the company to charge income with the cost of such benefits earned through December 31, 1991 by current employees and retirees. The charge to record the entire liability at January 1, 1992 was $13.3 million which generated a deferred tax benefit of $4.8 million resulting in a net cumulative effect of $8.5 million, or $1.20 per share.\nNet cash provided by operating activities decreased slightly to nearly $26 million, just below last year's record level. Improved sales of $22 million combined with improved productivity and cost reduction efforts led to an improved gross profit of $6 million providing additional cash from operations. Adjusting net income for non-cash items, cash available in 1994 reached $33 million compared to $30 million last year. The $3 million increase was accounted for by $3.6 million in higher accounts receivable relative to the increase experienced during 1993. Strong control over inventory growth resulted in $1.7 million less of an increase compared to the prior year when higher inventory was needed to facilitate the increased volume of business. During 1993 the company received additional cash of $2 million from income tax refunds whereas in 1994 no material amounts were received. The net effect of these items lowered cash from operations by $1 million when compared to last year's record level.\nGross trade receivables of the company increased over $5 million, or 24% over the prior year. Accounts receivable allowances increased by $0.6 million in 1994 principally to provide for potential losses on Mexican accounts resulting from devaluation of the Mexican peso.\nThe company invested $19 million, below the planned level, in plant and equipment additions in 1994. The major projects included the spending of $5.2 million on Pulp and Paper's recovery boiler rebuild and upgrade, and $2.3 million on their automated roll wrap system. Bay West's mill in Ohio installed new flotation cells during the year spending $2.3 million. The balance of capital spending was limited to replacement of equipment required in normal operations. The strong cash flow and control of capital projects allowed for sufficient cash to reduce the outstanding debt by nearly $5 million and return $2.6 million in cash dividends to shareholders. The effect of all operating, investing\nand financing activities for 1994 was to maintain cash and cash equivalents of $1.5 million at the end of the year.\nWorking capital increased 24% to $26 million from the $21 million reported last year, mainly due to an increase of $5 million in receivables due to increased sales volume which was partially offset by increases in accounts payable and other liabilities. The current ratio, current assets divided by current liabilities, increased to 1.7:1 from the 1.6:1 reported last year.\nWhile the company's financing arrangements do not require scheduled repayments of its long-term debt, the company repaid $5 million of the long-term debt outstanding during the year. The reduction in long-term debt to $91 million, however, did not meet the planned debt level. Higher raw material costs not recovered in increased selling prices held cash generation below planned levels. The ratio of long-term debt to total capitalization of 51% improved from the prior year reflecting an increase in stockholders' equity due to stronger earnings and a lower level of debt.\nEarly in the year, the company refinanced a portion of its existing debt by entering into a $20 million unsecured five-year loan with a fixed rate of 7.83%. Its unsecured credit facility of $110 million was reduced to $90 million near the end of the year. The company currently utilizes $50 million of this credit agreement to support its participation in the commercial paper markets. At year-end, approximately $46 million of commercial paper was outstanding and classified as long-term debt.\nManagement believes that with prior years' major expansions running close to designed levels, proper staffing now in place and a continued strong economy that allows for selling price improvements, cash flow from operations will adequately allow for partial repayments of existing debt and allow for planned capital expenditures for property and equipment of $18 million next year.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nManagement's Responsibility For Financial Reporting. . . . . . 21\nReport of Independent Accountants. . . . . . . . . . . . . . . 22\nConsolidated Balance Sheets. . . . . . . . . . . . . . . . . . 23\nConsolidated Statements of Stockholders' Equity. . . . . . . . 24\nConsolidated Statements of Income. . . . . . . . . . . . . . . 25\nConsolidated Statements of Cash Flows. . . . . . . . . . . . . 26\nNotes to Consolidated Financial Statements . . . . . . . . . . 27\nSchedules. . . . . . . . . . . . . . . . . . . . . . . . . . . 45\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of Mosinee Paper Corporation is responsible for the integrity and objectivity of the consolidated financial statements. Such financial statements were prepared in conformity with generally accepted accounting principles. Some of the amounts included in these financial statements are estimates based upon management's best judgement of current conditions and circumstances. Management is also responsible for preparing other financial information included in this annual report.\nThe company's management depends on the company's system of internal accounting controls to assure itself of the reliability of the financial statements. The internal control system is designed to provide reasonable assurance, at appropriate cost, that assets are safeguarded and transactions are executed in accordance with management's authorizations and recorded properly to permit the preparation of financial statements in accordance with generally accepted accounting principles. Periodic reviews of internal controls are made by management and the internal audit function and corrective action is taken if needed.\nThe Audit Committee of the Board of Directors, consisting of outside directors, provides oversight of financial reporting. The company's internal audit function and independent public accountants meet with the Audit Committee to discuss financial reporting and internal control issues and have full and free access to the Audit Committee.\nThe consolidated financial statements have been audited by the company's independent auditors and their report is presented below. The independent auditors are approved each year at the annual shareholders' meeting based on a recommendation by the Audit Committee and the Board of Directors.\nDANIEL R. OLVEY GARY P. PETERSON President and Sr. Vice President - Finance Chief Executive Officer and Secretary and Treasurer\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Board of Directors Mosinee Paper Corporation Mosinee, Wisconsin\nWe have audited the accompanying consolidated balance sheets of MOSINEE PAPER CORPORATION and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of stockholders' equity, income and cash flows for each of the years in the three- year period ended December 31, 1994 and the supporting schedule appearing on page 45. These financial statements and supporting schedules are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and supporting 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 supporting 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 supporting schedules. 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 23-44 present fairly, in all material respects, the financial position of MOSINEE PAPER CORPORATION and subsidiaries at December 31, 1994 and 1993, and the results of their operations and cash flows for each of the years in the three-year period ended December 31, 1994, and the supporting schedule appearing on page 45 present fairly the information required to be set forth therein, all in conformity with generally accepted accounting principles.\nAs discussed in Note 3 to the consolidated financial statements, the company changed its method of accounting for postemployment benefits in 1994 and its methods of accounting for postretirement benefits other than pensions and income taxes in 1992.\nWe hereby consent to the incorporation by reference of this report in the Registration Statement on Form S-8 filed with the Securities and Exchange Commission by Mosinee Paper Corporation on April 19, 1991.\nWIPFLI ULLRICH BERTELSON February 2, 1995 Wipfli Ullrich Bertelson Wausau, Wisconsin Certified Public Accountants\nMOSINEE PAPER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation - The consolidated financial statements include the accounts of Mosinee Paper Corporation and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.\nCash Equivalents - The company considers all highly liquid debt instruments with an original maturity of three months or less to be cash equivalents.\nInventories - Substantially all inventories are stated at the lower of cost, determined on the last-in, first-out method (LIFO), or market. Inventories not on the LIFO method, primarily supply items, are stated at cost (principally average cost) or market, whichever is lower. Allocation of the LIFO reserve among the components of inventories is impractical.\nProperty, Plant and Equipment - Depreciable property is stated at cost less accumulated depreciation. Land, water power rights, and construction in progress are stated at cost and timberlands are stated at net depleted value. Facilities financed by leases, which are essentially equivalent to installment purchases, are recorded as assets and the related obligation as a long-term liability.\nWhen property units are retired, or otherwise disposed of, the applicable cost and accumulated depreciation thereon are removed from the accounts. The resulting gain or loss, if any, is reflected in income.\nDepreciation is computed on the straight-line method for financial statement purposes over 20 to 45 years for buildings and 3 to 20 years for machinery and equipment. Depletion on timberlands is computed on the unit-of-production method. Depreciation expense includes amortization on capitalized leases. Maintenance and repair costs are charged to expense when incurred. Improvements which extend the useful lives of the assets are added to the plant and equipment accounts.\nRevenue Recognition - Revenue is recognized upon shipment of goods and transfer of title to the customer. Concentrations of credit risk with respect to trade accounts receivable are generally diversified due to the large number of entities comprising the company's customer base and their dispersion across many different industries and geographies.\nTaxes - Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities, as measured by the enacted tax rates which will be in effect when these differences are expected to reverse. Deferred tax expense is the result of changes in the deferred tax asset and liability. The principal sources giving rise to such differences are identified in Note 10. See Note 3 for change in accounting policy for 1992.\nPer Share Data - Income per share is computed by dividing net income less Sorg Paper preferred stock dividends by the weighted average number of shares of common stock outstanding.\n2 - SEGMENT INFORMATION\nThe company operates predominantly in the paper and allied products industry. The company formed Mosinee Paper International, Inc., a wholly-owned subsidiary located and domiciled in the U.S. Virgin Islands, to administer the export sales made by the company.\n3 - CHANGES IN ACCOUNTING POLICIES\nOn January 1, 1994, the company adopted Statement of Financial Accounting Standards (SFAS) No. 112 \"Employers' Accounting for Postemployment Benefits\" which requires the company to accrue for the estimated cost of benefits provided by an employer to former or inactive employees after employment but before retirement. Previously, the cost of these benefits were expensed as they were incurred. The cumulative effect of $750,000 is shown net of income taxes of $400,000 and represents the entire liability for such benefits earned through 1993. The impact of this accounting change on 1994 operating results is not material.\nDuring 1992, the company adopted the provisions of SFAS No. 106 \"Employers' Accounting for Postretirement Benefits Other than Pensions\" and SFAS No. 109 \"Accounting for Income Taxes.\"\nIn December 1992, the company adopted SFAS No. 106 which requires the estimated cost of retiree benefit payments, primarily health and life insurance, to be accrued during the employees' active service period. Previously, the cost of these benefits was expensed as incurred. The company elected to immediately recognize the accumulated liability as of January 1, 1992, which resulted in a one-time non-cash charge against earnings of $13,287,000 before taxes and $8,537,000 after taxes, or $1.20 per share. The effect of this change on 1992 operating results was to recognize an additional pre-tax expense of $967,000 and after-tax expense of $585,000, or $.07 per share. Previously reported quarterly earnings for 1992, as presented in Note 15, have been restated for the effect of this change as if it had been adopted on January 1, 1992. Additional information on retirement benefits can be found in Note 6.\nThe company also adopted SFAS No. 109 during the first quarter of 1992. The cumulative effect of the accounting change at the time of adoption and the current year effect on net income was immaterial as the company had previously been on the liability method of accounting for deferred taxes.\n4 - SUPPLEMENTAL BALANCE SHEET INFORMATION\n5 - LEASES\nThe company has various operating leases for machinery and equipment, automobiles, office equipment and warehouse space.\nRent expense for all operating leases of plant and equipment was $2,834,000 in 1994, $3,081,000 in 1993 and $2,698,000 in 1992.\n6 - RETIREMENT PLANS\nPENSIONS\nSubstantially all employees of the company are covered under various pension plans. The defined benefit pension plan benefits are based on the participants' years of service and either compensation earned over certain final years of employment or fixed benefit amounts for each year of service. The plans are funded in accordance with federal laws and regulations.\nThe projected benefit obligations at September 30, were determined using an assumed discount rate of 8% and 7.25% for 1994 and 1993, respectively, and assumed compensation increases of 5% in 1994 and 1993. The assumed long-term rate of return on plan assets was 9%. Plan assets consist principally of fixed income and equity securities and includes Mosinee Paper Corporation common stock of $2,511,000 and $1,905,000 in 1994 and 1993 respectively.\nThe company's defined contribution pension plans, covering various salaried employees, provide for company contributions based on various formulas. The cost of such plans totaled $2,100,000 in 1994, $1,823,000 in 1993, and $1,324,000 in 1992.\nThe company has deferred compensation or supplemental retirement agreements with certain present and past key officers, directors and employees. The principal cost of such plans is being or has been accrued over the period of active employment to the full eligibility date. Certain payments, insignificant in amount, are charged to expense when paid. Costs charged to operations under such agreements approximated $161,000, $89,000, and $78,000 for 1994, 1993, and 1992, respectively.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nIn addition to providing pension benefits, the company provides certain health care and nominal term life insurance benefits for retired employees. Substantially all of the company's employees may become eligible for those benefits if they reach normal retirement age while working for the company.\nCost-sharing provisions, benefits and eligibility for various employee groups vary by location and union agreements. Generally, eligibility is attained after reaching age 55 or 62 with minimum service requirements. Upon reaching age 65, the benefits become coordinated with Medicare. The plans are unfunded and the company funds the benefit costs on a current basis.\nThe 1994 assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 11%, declining by 1% annually for six years to an ultimate rate of 5%. The weighted average discount rate used was 8%. For 1993, the obligation was calculated using a health care cost trend rate of 12%, declining by 1% annually for 6 years to an ultimate rate of 6%. The weighted average discount rate was 7.25%.\nThe effect of a 1% increase in the health care cost trend rate would increase the APBO by $1,610,000 or 11.1% and $1,714,000 or 10.4%, at December 31, 1994 and 1993, respectively. The effect of this change would increase the aggregate of the service cost and interest cost by $262,000 or 16.5% in 1994, and $243,000 or 15.7% in 1993.\n7 - LONG-TERM DEBT\nThe company has a commercial paper placement agreement to issue up to $50 million of unsecured debt obligations. The weighted average\ninterest rate on commercial paper outstanding at December 31, 1994 was 6.3% compared to 3.6% at December 31, 1993. The amounts have been classified as long-term as the company intends, and has the ability to refinance the obligations under the revolving credit agreement.\nA credit agreement with one bank as agent and certain financial institutions as lenders was established April 16, 1993 to issue up to $130 million of unsecured borrowings less the amount of commercial paper outstanding. This agreement was amended December 28, 1994 to reduce the issue amount to $90 million. The term of this agreement is five years requiring no payments until March 31, 1998, at which time, all outstanding amounts become due. The company may, however, reduce the commitment amount prior to that date without penalty. The weighted average interest rate at December 31, 1994 was 6.3% and at December 31, 1993 was 3.7%. The agreement provides for various restrictive covenants, which includes maintaining minimum net worth, interest coverage and debt to equity ratios and limits dividend and other restricted payments to approximately $16 million.\nThe credit agreement provides for commitment and facility fees during the revolving loan period. Commitment fees are 0.1875% per annum of the unused portions of the commitment, payable quarterly. Facility fees are 0.125% per annum of the total commitment, payable quarterly.\nThe company entered into an unsecured five-year fixed rate debt arrangement for $20 million on September 30, 1994 with one financial institution to secure an interest rate of 7.83%. Interest is paid monthly but the principal is not due until September 1999. The arrangement provides for various restrictive covenants, which includes maintaining a minimum net worth, interest coverage and debt to capital ratios.\nThe difference between the book value and the fair market value of long-term debt is not material.\nThe company maintained an interest rate protection agreement which expired November 6, 1993 for the revolving credit agreement. This agreement provided for interest rate protection on $60 million the first year, $85 million the second year and $50 million in the third year. Under terms of the agreement, the company received compensation when the 90 day LIBOR (London Interbank Offered Rate) exceeds 9.5% in the first year, 10.5% in the second year and 11% in the third year. The company paid compensation when LIBOR was less than 7.5% in the first year, 7% the second year and 6.5% the third year. Amounts paid or received were recognized as interest rates deviated beyond the stated amounts and were included in interest expense.\nThe annual maturities on the revolving credit agreement included in the above schedule are based on the amount outstanding at December 31, 1994. Annual maturities will be affected by future borrowings under the agreement.\n9 - PREFERRED SHARE PURCHASE RIGHTS PLAN\nUnder the Rights Agreement dated June 26, 1986, amended February 21, 1991, each share of the company's common stock entitles its holder to one nonvoting preferred share purchase right (\"Right\"). Rights become exercisable 10 days after a person or group acquires 20% or more of the company's outstanding common stock (an \"Acquiring Person\"). The Board may reduce this threshold amount to 10%. The Right will entitle the holder to purchase from the company .01 share of Series A Junior Participating Preferred Stock at a price of $60. If the company is acquired in a merger or other business combination, the holder may exercise the Right and receive common stock of the acquiring company having a market value equal to two times the exercise price of the Right. If a person becomes an \"Acquiring Person\" the holder may exercise the Right and receive common stock of the company having a market value equal to two times the exercise price of the Right. Rights are subject to redemption by the company for $.05 per Right until a person or group becomes an Acquiring Person. After a person or group becomes an Acquiring Person, but before the Acquiring Person acquires 50% of the company's common stock, the company may exchange one share of common stock for each Right. Rights expire on July 10, 1996. The company has reserved 100,000 shares of Series A Junior Participating Preferred Stock.\n10 - INCOME TAXES\nAt the end of 1994, $41,500,000 of unused state operating loss carryovers existed which may be used to offset future state taxable income in various amounts through the year 2009. Because separate state tax returns are filed, the company is not able to offset consolidated income with the subsidiaries' losses. Under the provisions of SFAS No. 109, the benefits of state tax losses are recognized as a deferred tax asset, subject to appropriate valuation allowances. At December 31, 1994, the company has unused alternative minimum tax credit carryforward of approximately $7,853,000 which can be used to offset future regular tax liabilities.\nA valuation allowance has been recognized for a subsidiary's state tax loss carryforward as cumulative losses create uncertainty about the realization of the tax benefits in future years.\n11 - STOCK OPTIONS AND APPRECIATION RIGHTS\nThe company has adopted two Executive Stock Option Plans. The 1994 plan, which needs shareholder approval at the April 1995 annual meeting, provides for the granting of either qualified incentive stock options (ISO) or non-qualified options. Under the 1994 plan, options to purchase 100,000 shares of common stock may be issued to key employees of the company. Options must be granted at an option price which is not less than fair market value at the time of the grant. Qualified options can be exercised no sooner than six months or no later than ten years from the date of the grant (twenty years from date of grant for non-qualified options). The 1985 plan is a non-qualified stock option plan under which options to purchase 135,000 common shares have been issued to key executive employees of the company or subsidiaries. The plan provides for the granting of options at a price which is not less than market value at the time of the grant. Options can be exercised no sooner than six months or no later than twenty years from the date of the grant. No accounting recognition is given until the stock options are exercised.\nTwo stock appreciation rights plans are maintained by the company. The 1988 Stock Appreciation Rights Plan gives certain officers and key employees the right to receive cash equal to the sum of the appreciation in value of the stock and the value of reinvested hypothetical cash dividends which would have been paid on the stock covered by the grant. The 1988 Management Incentive Plan gives certain management employees the right to receive similar cash payments. The stock appreciation rights granted under the plans may be exercised in whole or in installments and will vest at such times as specified in the grant. In all instances, the rights lapse if not exercised within 20 years of the grant date. Compensation expense is recorded with respect to the rights, based upon quoted market value of the shares and the exercise provisions. The provision (credit) for incentive compensation plans based upon the company's stock price, principally stock appreciation rights, was ($933,000) in 1994, $1,668,000 in 1993, and ($1,155,000) in 1992.\n12 - CONTINGENCIES, LITIGATION, COMMITMENTS, AND RELATED TRANSACTIONS\nThe company has been informed by the Wisconsin Department of Natural Resources (\"DNR\") that a landfill, for which the company may be a potentially responsible party, was nominated by the DNR for inclusion by the Environmental Protection Agency (\"EPA\") on the National Priorities List (\"NPL\"). The EPA has not placed the landfill on the NPL nor has any other action been taken by the DNR or the EPA. The company has contributed its allocated portion of the cost of remediation of a second landfill pursuant to a cost sharing agreement. The company cannot predict what, if any, additional costs will be borne by the company. Based on the information available, the company does not believe that any additional cost associated with these landfills will have a material adverse effect on the business and financial condition of the company.\nThe company, along with other paper companies, is part of a civil investigation by the U. S. Department of Justice to determine whether any violation of U. S. antitrust laws has occurred in the commercial and industrial market for sanitary paper products. The company believes it has not violated any antitrust laws.\nIn the ordinary course of conducting business, the company also becomes involved in other environmental issues, investigations, administrative proceedings and litigation. While any proceeding or litigation has an element of uncertainty, the company believes that the outcome of any pending or threatened claim or lawsuit will not have a material adverse effect on the business and financial condition of the company.\nThrough the year 2006, the company is to pay a municipality a minimum annual usage fee of approximately $150,000 paid on a quarterly basis, to discharge industrial waste into the municipality's wastewater treatment facility. The aggregate amount of such required future minimum payments at December 31, 1994 was $1,687,000. In addition, the company is to pay monthly contingent usage fees to the municipality based on the amount of industrial waste discharged. Minimum and contingent usage fees incurred totaled $630,000, $611,000 and $531,000 in 1994, 1993, and 1992 respectively.\nDuring 1992, the company sold 79,100 shares of its treasury stock for $2,195,000 to various pension plans it maintains. The sale price per share was determined using the trading price at the time of the sale as reflected on Nasdaq.\n13 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION\nIn 1992, the company exchanged two airplanes with a total book value of $5,028,000 for an airplane with an estimated value of $5,200,000. The new equipment is recorded at $5,028,000, which represents the book value of the items traded.\n14 - PATENT INFRINGEMENT AWARD\nOn February 8, 1993, the U.S. Court of Appeals for the Federal Circuit upheld the District Court judgement awarded Mosinee Paper\nagainst James River Corporation. The District Court found that James River had infringed upon certain washroom towel cabinet roll transfer mechanisms patented by the Bay West Paper Corporation, a subsidiary. Mosinee Paper's judgement of approximately $5.5 million, including interest, is included in the 1993 statement of income.\n16 - MARKET PRICES FOR COMMON SHARES (UNAUDITED)\nPrices reflect high and low closing price quotations on the Nasdaq National Market System and do not reflect mark-ups, mark-downs or commissions and may not represent actual transactions.\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 relating to directors of the company is incorporated into this Form 10-K by this reference to the material set forth under the caption \"Election of Directors\", pages 3 and 4, in the company's proxy statement dated March 17, 1995 (the \"1995 Proxy Statement\"). Information relating to executive officers of the company is set forth in Part I, page 6.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation relating to director compensation is incorporated into this Form 10-K by this reference to the material set forth under the subcaption \"Director Compensation\", pages 4 and 5, in the 1995 Proxy Statement. Information relating to the compensation of executive officers is incorporated into this Form 10-K by this reference to (1) the material set forth under the caption \"Executive Officer Compensation\", pages 8 through 10 and (2) the material set forth under the subcaption \"Compensation Committee Interlocks and Insider Participation\", page 15, in the 1995 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation relating to security ownership of certain beneficial owners is incorporated into this Form 10-K by this reference to the material set forth under the caption \"Beneficial Ownership of Common Stock\", page 6, through the material immediately preceding final two paragraphs, page 7, in the 1995 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. (a) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES. Filed as part of this report and required by Item 14(d), are set forth on pages 22 to 49 herein.\n(b) REPORTS ON FORM 8-K. No reports on Form 8-K were filed by the company during the fourth quarter of fiscal 1994.\n(c) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K.\nThe following exhibits are filed with the Securities and Exchange Commission as part of this report.\nEXHIBIT 3 - ARTICLES OF INCORPORATION AND BYLAWS\n(a) Restated Articles of Incorporation, as amended. . . . . . . . . . 12-53(1)\n(b) Restated Bylaws, as last amended April 16, 1992 . . . . . . . . . . . 54-89(1)\nEXHIBIT 4 - INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS\n(a) Preferred Share Rights Agreement dated June 26, 1986 as amended . . . . . . . 54-147(4)\n(b) Restated Articles of Incorporation and Restated Bylaws (see Exhibit 3(a) and (b))\nEXHIBIT 10 - MATERIAL CONTRACTS\n*(a) Deferred Compensation Plan for Directors as amended and restated June 17, 1993. . . . 148-164(4)\n*(b) 1985 Executive Stock Option Plan dated June 27, 1985 . . . . . . . . . . 83-95(5)\n*(c) Mosinee Paper Corporation 1988 Stock Appreciation Rights Plan, as amended 4\/18\/91. . . . . . . . . . . . . . . . . . . 41-50(2)\n*(d) 1993 and 1994 Incentive Compensation Plan for Corporate Executive Officers. . . . 165-169(4)\n*(e) Supplemental Retirement Benefit Plan dated October 17, 1991. . . . . . . . . 63-71(2)\n*(f) Supplemental Retirement Benefit Agreement dated November 15, 1991. . . . . . . . . . . 72-76(2)\n*(g) 1994 Executive Stock Option Plan . . . . . . 50\n*(h) Mosinee Supplemental Retirement Plan . . . . 68\n* Denotes Executive Compensation Plans and Arrangements.\nEXHIBIT 11 - COMPUTATION OF PER SHARE EARNINGS. . 84\nEXHIBIT 22 - SUBSIDIARIES OF REGISTRANT . . . . . 167(1)\nPage numbers set forth herein correspond to the page numbers using the sequential numbering system, where such exhibit can be found in the following Annual Reports on Form 10-K:\n(1) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992; Commission File Number 0-1732.\n(2) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1991; Commission File Number 0-1732.\n(3) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990; Commission File Number 0-1732.\n(4) Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1993; Commission File Number 0-1732.\n(5) Exhibit 4(e) Form S-8 filed on April 19, 1991.\nThe above exhibits are available upon request in writing from the Secretary, Mosinee Paper Corporation, 1244 Kronenwetter Drive, Mosinee, Wisconsin 54455-9099.\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.\nMOSINEE PAPER CORPORATION\nDate March 27, 1995 GARY P. PETERSON ------------------------------------ Gary P. Peterson Senior Vice-President, Finance, Secretary and Treasurer (Principal Financial Officer)\nPursuant to the requirement 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.\nSAN W. ORR, JR. RICHARD L. RADT ------------------------------ ------------------------------- San W. Orr, Jr. Richard L. Radt Chairman of the Board Vice Chairman of the Board March 27, 1995 March 27, 1995\nDANIEL R. OLVEY STANLEY F. STAPLES, JR. ------------------------------ ------------------------------- Daniel R. Olvey Stanley F. Staples, Jr. President and CEO Director (Principal Executive Officer) March 27, 1995 March 27, 1995\nRICHARD G. JACOBUS WALTER ALEXANDER ------------------------------ ------------------------------- Richard G. Jacobus Walter Alexander Director Director March 27, 1995 March 27, 1995\nDONALD E. JANIS ------------------------------ Donald E. Janis Corporate Controller March 27, 1995 (Principal Accounting Officer)","section_15":""}
{"filename":"833053_1994.txt","cik":"833053","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nASBESTOS-RELATED PERSONAL INJURY CLAIMS\nAt December 31, 1994, Fibreboard was a defendant in approximately 41,900 personal injury claims. Approximately 15,600 of these claims were filed on or after August 27, 1993 and will be covered by the Global Settlement discussed below, if approved. Additional claims are anticipated in the future. These claims typically allege injury or death from asbestos exposure. Fibreboard is generally only one of several defendants. These claims seek compensatory, and in many cases, punitive damages in varying amounts depending on injury severity. Claims are pending in federal and state courts throughout the United States.\nDuring 1993 Fibreboard reached settlement agreements (the Global Settlement and Insurance Settlement) with its insurers and plaintiff representatives which, if approved by the courts, should resolve Fibreboard's existing and future asbestos-related personal injury liabilities within insurance resources and existing corporate reserves. These settlements require court approval. The Global Settlement action is titled Gerald Ahearn, James Dennis and Charles W. Jeep, on Behalf of Themselves and Others Similarly Situated, Plaintiffs, v.\nFibreboard Corporation, Defendant, Continental Casualty Company and Pacific Indemnity Company, Intervenors, Civil Action No. 6:93cv526, U.S. District Court for the Eastern District of Texas, Tyler Division. The Insurance Settlement action is titled Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company and Pacific Indemnity Company, Plaintiffs, v. Daniel Herman Rudd, Jr., Beverly White and John Hansel, on Behalf of Themselves and Others Similarly Situated, and Owens-Illinois, Inc., on Behalf of Itself and Others Similarly Situated, and Penn Mutual Life Insurance Company, Defendants, Civil Action No. 6:94cv458, U.S. District Court for the Eastern District of Texas, Tyler Division.\nAdditional information concerning personal injury claims can be found in Note 14 to Fibreboard's consolidated financial statements, \"Asbestos-Related Litigation,\" which begins on page 37.\nASBESTOS-IN-BUILDINGS CLAIMS\nAt December 31, 1994, Fibreboard was a defendant in 14 asbestos-in- buildings claims pending in federal and state courts throughout the United States. Fibreboard is typically only one of several defendants. These claims involve many thousands of buildings and seek hundreds of millions of dollars in compensatory damages for expenses incurred for locating, testing and monitoring or removing asbestos-containing materials. Some claims also seek punitive damages.\nAdditional information concerning Fibreboard's asbestos-in-buildings claims can be found in Note 14 to Fibreboard's consolidated financial statements, \"Asbestos-Related Litigation,\" which begins on page 37.\nINSURANCE COVERAGE FOR PERSONAL INJURY CLAIMS\nFibreboard is litigating with two insurers, Continental Casualty Company and Pacific Indemnity Company, to determine the amount of insurance available to Fibreboard under policies issued by these companies (In Re Asbestos Insurance Coverage Cases, Judicial Council Coordination Proceeding No. 107). The litigation has been completed at the trial court level, with judgments favoring Fibreboard on all issues. These judgments were appealed to the California Court of Appeal by the insurers. In November 1993, the Court of Appeal issued its ruling on the trigger and scope of coverage issues which upheld the favorable trial court judgments in these areas, except the court held the period for coverage would begin at the time of exposure to Fibreboard's asbestos products rather than at the time of exposure to any company's asbestos product, with the presumption that those periods are the same. The insurers have filed petitions for review with the California Supreme Court, which has granted review but not yet scheduled any further activity.\nAt the request of Fibreboard, Continental and Pacific Indemnity, the Court of Appeal withheld its ruling on certain issues which were unique between Fibreboard and its insurers while the parties seek approval of the Global and Insurance Settlements.\nIf the Global and\/or Insurance Settlements are ultimately approved, Fibreboard and its insurers will seek to dismiss the insurance coverage litigation.\nFurther information concerning this litigation can be found in Note 14 to Fibreboard's consolidated financial statements, \"Asbestos-Related Litigation,\" which begins on page 37.\nINSURANCE COVERAGE FOR ASBESTOS-IN-BUILDINGS CLAIMS\nFibreboard believes the total limits of insurance policies in effect from 1932 to 1985 which may provide coverage for the asbestos-in-buildings claims aggregated approximately $390 million (approximately $295 million of which has been confirmed through settlements during 1994 and 1993), which is in addition to the personal injury insurance coverage and does not include additional policies which contain no aggregate limit. The remaining insurers dispute coverage. Fibreboard is pursuing an insurance coverage suit (Fibreboard vs. Continental Casualty, et al; Superior Court of the State of California for the City and County of San Francisco). Trial in this action has been continued. During the continuance, Fibreboard and its insurers are attempting to settle their disputes.\nAdditional information concerning this litigation can be found in Note 14 to Fibreboard's consolidated financial statements, \"Asbestos-Related Litigation,\" which begins on page 37.\nOther Litigation\nFibreboard has been named as a potentially responsible party in two California landfill clean ups, the Operating Industries Inc. site in Monterey Park and the GBF landfill in Pittsburg, and has been named as a defendant in a private lawsuit related to the Acme landfill in Martinez, CA. Additional information concerning Fibreboard's involvement can be found in Note 15 to Fibreboard's consolidated financial statements, \"Other Litigation and Contingencies,\" on page 43.\nIn March 1994, two purported class action lawsuits were filed in Delaware Chancery Court naming the Company and its directors as defendants (Sonem Partners LTD., et al. v. Roach, et al., Civil Action No. 13411; Vogel v. Roach, et al., Civil Action No. 13421). Both lawsuits alleged substantially similar causes of actions for breach of fiduciary duty relating to the 1994 amendment of Fibreboard's stockholder rights plan and Fibreboard's rejection of a March 1994 unsolicited proposal of a merger with or an acquisition of Fibreboard. These lawsuits were dismissed without prejudice in February 1995 at no cost to Fibreboard.\nFibreboard is involved in a number of additional disputes arising from its operations. Fibreboard believes resolution of these disputes will not have a material adverse impact on its financial condition 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\nInformation with respect to executive officers of Fibreboard follows:\nOfficers serve at the discretion of the board of directors.\nMr. Roach was elected Chairman, President and Chief Executive Officer of Fibreboard on July 2, 1991. Prior to his election, Mr. Roach was Executive Vice President of Manville Corporation, where he served as President of its Mining and Minerals Group and President of Celite Corporation, a wholly-owned Manville subsidiary. In addition, Mr. Roach served as President of Manville Sales Corporation, now known as Schuller International, from 1988 to 1989, and as Chief Financial Officer of Manville Corporation from 1987 to 1988. Prior to Manville, Mr. Roach was a strategy consultant and Vice Chairman of Braxton Associates; Vice President and Managing Director of the Strategic Management Practice for Booz, Allen, Hamilton; and Vice President and Director of The Boston Consulting Group. Previous experience at Northrop Corporation included Director of strategic planning, economic analysis, accounting, management information systems and co-manager of a venture capital subsidiary.\nMr. Donohue was elected Senior Vice President, Finance and Administration and Chief Financial Officer in October 1991. Prior to joining Fibreboard, he was an Executive Vice President of Continental Bank in Chicago where he held a wide variety of senior management positions during his 25 years with the bank.\nMr. Douglas became General Counsel to Fibreboard in September 1987 and was elected Secretary in November 1990. He was elected Vice President in August 1991 and Senior Vice President in October 1993. From March 1986 to September 1987 he was employed by the Asbestos Claims Facility, of which Fibreboard was a member, as Senior Legal Counsel and then as Director of Law-West Coast Region. From 1982 to 1986 he was an attorney in the asbestos litigation group of Jim Walter Corporation.\nMr. Costello has been Vice President, Wood Products Operations since December 1988. He previously was employed by Snider Lumber Products Co., Inc. from December 1983 until December 1988. Prior to December 1983, he was employed by Fibreboard for 14 years. Mr. Costello rejoined Fibreboard with the acquisition of Snider in October 1988, at which time he was president of Snider. Mr. Costello is First Vice Chairman of Western Wood Products Association, an industry group.\nMr. DeMaria joined Fibreboard in May 1989 as Director-Corporate Communications and Investor Relations and was elected Vice President, Corporate Relations in August 1991. Prior to joining Fibreboard, he was Executive Vice President of the California Forest Protective Association, an industry trade association representing the interests of industrial timberland owners before the California legislature and regulatory agencies.\nMr. Elliott was appointed General Manager of Pabco in October 1991 and was elected Vice President, Industrial Insulation Products in February 1992. Prior to joining Fibreboard, Mr. Elliott was a partner in Management Resource Partners, a professional management firm advising corporations on financial and operating matters and functioned as CEO, CFO or a director of companies with sales from $5-$50 million. Mr. Elliott has been CFO of Consolidated Fibers and Itel Corporation, Vice President Corporate Development of Alexander and Baldwin and a consultant for A.T. Kearney.\nMr. Jensen joined Fibreboard in October 1991 as General Manager of Northstar-at-Tahoe and was elected Vice President in June 1993. From 1989 to 1991, Mr. Jensen was Vice President of Marketing and Sales for Sunday River Ski Resort in Bethel, Maine. From 1986 to 1989, Mr. Jensen was Vice President, Tracked Vehicles for Kassbohrer of North America, a manufacturer of ski resort snow grooming vehicles and equipment.\nMr. Johnston joined Fibreboard with the acquisition of Norandex Inc. on August 31, 1994 at which time he was elected Vice President. Mr. Johnston has been employed with Norandex Inc. for 19 years and has held the office of President since 1985. He was formerly Vice President of Sales and Branch Operations for Norandex. Mr. Johnston was previously employed by Kaiser Aluminum Corporation and Reynolds Metals Company.\nMr. Swan has been Controller of Fibreboard since October 1988, and was elected Vice President in October 1991. He previously was an Audit and Financial Consulting Manager in the Portland, Oregon office of Arthur Andersen LLP.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAs of March 17, 1994, there were 11,788 holders of record of Fibreboard common stock. Fibreboard's common stock is traded on the American Stock Exchange under the symbol FBD. Information with respect to the quarterly high and low market sales prices for Fibreboard's common stock for 1994 and 1993, based upon sales transactions reported by the American Stock Exchange, is provided below.\nMarket Prices of Fibreboard Common Stock\nThe closing price of Fibreboard's common stock on March 17, 1995 was $31 1\/2.\nSince its spin-off from Louisiana-Pacific Corporation on June 6, 1988, Fibreboard has not paid cash dividends. Fibreboard's Structured Settlement Program contains restrictions on the amount of dividends or distributions to shareholders. At December 31, 1994, $12.9 million was available for the payment of dividends, share repurchases or other distributions.\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\n1994 VS. 1993\nNet sales increased 37%. Of the increase, $85.6 million, or 87% of the total, was due to the addition of Norandex Inc. on August 31, 1994. The remaining increase resulted from increases in industrial insulation products and resort operations, reduced by a decline in wood product sales. Income from continuing operations was $27.0 million compared to\n$11.7 million in 1993. The 1994 amount includes a pre-tax gain of $18.9 million ($11.2 million after tax) from the sale of surplus timberlands in the third quarter. Norandex contributed pre-tax operating income of $8.1 million for the last four months of the year. Operating income increased for industrial insulation products and resort operations, while wood products experienced a decline.\nBUILDING PRODUCTS\nWood products sales declined 5%. The majority of the decrease was due to the early 1994 sale of the agricultural container business, which in 1993 generated sales of approximately $9.7 million. For 1994, lumber sales were higher (increased volume reduced by slightly lower average product sales prices) while decreases were experienced in plywood sales (lower shipment volume) and moulding and millwork (lower volume and sales prices).\nWood products operating income declined from $18.5 million to $12.7 million driven by higher log costs in 1994 and slightly lower product sales prices compared to 1993. Higher log costs were caused by a 1993 decision to purchase available open market logs, ensuring a raw material supply for 1994. However, the incremental logs were purchased at high prices which drove up average log cost for 1994. As a higher percentage of logs to be consumed in 1995 will come from company owned lands, Fibreboard expects its average log cost in 1995 will be significantly lower than in 1994.\nFibreboard believes it has adequate raw material on hand, under contract or expected to become available through open market log purchases to operate its primary converting facilities at scheduled production levels through 1995 and into 1996. However, future timber supply remains a strategic concern. Competition for the reduced timber available from the USFS has resulted in higher prices for those contracts where Fibreboard has been the successful bidder. Interim harvest rules announced in early 1993 for USFS timber in California and the possible implementation of the DEIS recommended forest management alternative could further reduce the quantity of timber available for harvest. Fibreboard has responded to these concerns by pursuing non-traditional sources of raw materials, such as imported logs from New Zealand and Chile and the acquisition of timber cutting rights on 4,800 acres in northern New Mexico. Fibreboard expects to continue pursuing alternative timber sources in the future. In addition, Fibreboard has evaluated various operating configurations available to respond most profitably to raw material constraints, and has committed $6.7 million in 1995 to install additional sawmill optimization technology which is expected to improve manufacturing yield and grade recovery.\nIn the past, timber supply concerns have resulted in increased sales prices for Fibreboard's wood products. While there can be no assurance, Fibreboard believes sales prices for its products may increase should timber supply be further constrained. Continuing supply constraints should also enhance the value of Fibreboard's fee-owned timberlands.\nFrom its acquisition on August 31, 1994 through the end of the year, Norandex generated sales of $85.6 million and operating income of $8.1 million. Norandex sales activity is seasonal, and is driven by the weather and construction activity in its primary market areas. Construction activity is typically at a peak in June-October. Mild early winter weather in Norandex's market areas extended the building season into December and increased Norandex generated profits beyond expectations. Due to the seasonality of the business, the results of the last four months of 1994 should not be considered indicative of the results that would be achieved for a full year of Norandex operations.\nIndustrial insulation products sales increased 15% due principally to increased shipments and higher sales prices of metal products with some improvement in molded industrial insulation sales.\nOperating income increased to $6.5 million from $5.4 million in 1993. Metal products profitability increased as average sales prices increased in advance of corresponding raw material cost increases. However, this improvement was offset somewhat by lower profits from molded insulation due to higher material costs.\nRESORT OPERATIONS\nResort revenues increased from $25.5 million to $41.4 million on a 100% increase in skier visits. The increase in skier visits was a result of the addition of Sierra-at-Tahoe (which operated only 23 days subsequent to its acquisition in 1993), a heavy early season snow fall in the fourth quarter of 1994 and the inclusion of two high-volume Christmas to New Years weeks in 1994, one as the first and one as the last week of the year, versus only one such week in 1993's results.\nOperating income improved from $2.3 million to $8.0 million driven primarily by the revenue increase as well as aggressive cost controls. Fibreboard believes Northstar's and Sierra's marketing campaigns have increased their market share among Lake Tahoe ski resorts.\nNorthstar anticipates beginning development of a new subdivision of 158 single family home sites which will be offered for sale on a phased basis over several years starting in 1995. Northstar believes this additional real estate activity will add operating profit of $1.5 to $2.0 million per year.\nGENERAL CORPORATE EXPENSES\nUnallocated costs declined from $8.3 million to $7.4 million, reflecting the 1994 resolution of a contingent liability related to post-retirement benefits which resulted in a gain of $1.0 million.\nASBESTOS-RELATED COSTS\nThe 1994 and 1993 results of operations do not include any asbestos-related costs. During 1994, $2.2 million of unreimbursed costs related to the asbestos litigation were incurred and charged against the reserve established in prior years.\nAs more fully discussed in Note 14 to the consolidated financial statements, at December 31, 1991, Fibreboard estimated its potential liability for asbestos-related personal injury claims to be received through the end of the decade at $1,610 million and that it would ultimately receive insurance proceeds of $1,584 million related to those claims. Although Fibreboard, its insurers and plaintiffs' representatives entered into the Insurance and Global Settlements discussed elsewhere, Fibreboard does not believe these settlements impact its estimate of liability through the end of the decade, and no additional events have transpired which indicate these estimates should be changed. Consequently, no adjustment has been made to the estimated liability for personal injury claims through the end of the decade or anticipated insurance proceeds. Fibreboard will periodically evaluate its estimates and make adjustments as circumstances and future developments dictate.\nOTHER ITEMS\nInterest expense increased from $3.6 million to $4.9 million, as Fibreboard had higher average borrowings (due to the Norandex purchase on August 31, 1994) offset by lower rates under its new revolving credit facility.\nInterest and other income increased to $22.6 million from $5.6 million. Other income included gains from the sales of surplus real estate of $20.5 million in 1994 and $3.8 million in 1993. Interest income increased to $2.1 million from $1.8 million as additional amounts were available for investment than in 1993.\nFibreboard's effective tax rate was 41% in 1994 and 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nFibreboard generated cash flows from operations (including gains on the sale of assets) of $70.2 million in 1994, compared to a use of $1.4 million in 1993. The investment in working capital was reduced $31.4 million in 1994, compared to an increased investment of $28.5 million in 1993. Fibreboard had an abnormally high level of log inventories on hand at December 31, 1993, which was reduced to a more normal level at year end 1994. Fibreboard believes it will continue to generate substantial cash flows from operations in the future.\nFibreboard has a $175 million revolving credit facility which expires September 30, 1997. At December 31, 1994, borrowings were $86.0 million and $82.9 million remained available. Borrowings may be used for general corporate purposes and acquisitions. Maximum availability decreases to $150 million at September 30, 1995 and to $125 million at September 30, 1996. In addition, Fibreboard's resort operations have two revolving credit facilities, a $5 million operating credit line which expires May 31, 1995 and a $8.1 million reducing revolving line which expires May 31, 1998 and under which maximum availability is reduced by $1.4 million in April of each year. Fibreboard is negotiating with a bank to replace Resort Operations' two revolving credit facilities and a $4.5 million term loan with a new $30 million revolving facility. This new facility is expected to be in place by early in the second quarter of 1995. Fibreboard believes these facilities, combined with cash generated from on-going operations, will be adequate to fund existing operating cash needs and acquisition activities.\nIn addition to working capital needs, Fibreboard anticipates primarily discretionary capital expenditures of approximately $19 million to $20 million during 1995. Major anticipated projects include $6.7 million to install additional optimization equipment in two sawmills, $1.2 million to expand the Norandex vinyl siding manufacturing plant capacity by 22% and infrastructure development costs of approximately $3 million to support the lot sales program at Northstar, as well as replacements and improvements of machinery and equipment and additional ski area amenities. Capital expenditures will be funded from operating cash flow and borrowings under Fibreboard's credit facilities as needed.\nFibreboard has scheduled principal reductions of long-term debt due in 1995 of $2.0 million. Of this amount, Fibreboard will receive $1.0 million from notes receivable which have interest and payment terms identical to a like amount of Fibreboard's revenue bonds.\nIn addition to cash needs related to continuing operations, Fibreboard must fund its modest on-going asbestos-related costs. To date, substantially all such costs, other than the cost of litigating insurance coverage issues, have been funded from insurance resources. At December 31, 1994, Fibreboard had $1.9 million in cash on hand restricted for asbestos-related uses.\nFibreboard and Continental have entered into an interim agreement under which Continental agreed to make certain funds available for defense and indemnity costs associated with asbestos-related personal injury claims during the period pending final approval of the Global and\/or Insurance Settlements discussed below, or if neither are approved, through the final conclusion of the insurance coverage litigation, however long that may take. Fibreboard believes the amounts to be paid by Continental under this interim agreement and amounts available under settlements with asbestos-in-buildings insurers will be adequate to satisfy its asbestos-related cash requirements as they come due.\nDuring 1993, Fibreboard and its insurers entered into the Insurance Settlement Agreement, and Fibreboard, its insurers and plaintiffs representatives entered into the Global Settlement Agreement. These agreements are interrelated. Final court approval of these agreements is required. Fibreboard believes trial court approval will occur in the first half of 1995, but if appealed, it may be 1996 or later before final court approval could be obtained.\nIf both the Global and Insurance Settlement Agreements are approved, Fibreboard believes its existing and future personal injury asbestos liabilities will be resolved through insurance resources and existing corporate reserves. If the Insurance Settlement is approved but the Global Settlement is not approved, the insurers will provide Fibreboard with up to $2 billion to resolve claims pending as of August 27, 1993 and all future claims, and will pay claims settled but not yet paid as of August 27, 1993.\nFibreboard believes it is probable its insurance coverage for personal injury claims will ultimately be confirmed on appeal or the settlements discussed above will be approved by the court. However, if neither the Global Settlement nor Insurance Settlement is approved and if the trial court decisions in the insurance coverage litigation are subsequently overturned or substantially modified on appeal, Fibreboard would not have adequate resources to fund its asbestos personal injury liabilities.\n1993 VS. 1992\nNet sales increased 11%, reflecting increased wood products sales and resort operations revenues while sales of industrial insulation products were flat. Income from continuing operations was $11.7 million compared to $9.4 million in 1992. Operating profit increased in wood products and resort operations, but declined slightly in insulation products.\nBUILDING PRODUCTS\nWood products sales increased 12%, due principally to increased selling prices in all three major product lines while shipment volumes declined in lumber and plywood. Mill closures and manufacturing operations consolidations accounted for the majority of the lumber volume decline while softer demand impacted plywood shipments. Selling prices for many products reached record highs during the second quarter, before falling during the third quarter.\nWood products operating income increased from $17.3 million to $18.5 million. This improvement was due to price increases and manufacturing improvements offset by increased log costs and volume decreases. Price increases during the year were largely in response to timber and finished product shortage concerns, as timber supply continued to be more restricted and additional industry production capacity reductions were made during the year.\nIndustrial insulation products sales were nearly unchanged between years. A lack of significant construction and maintenance activity in the petrochemical and power generation industries was offset by a modest increase in export sales activity.\nIndustrial insulation products operating income decreased to $5.4 million from $6.1 million in 1992. The decrease was caused by reduced average sales prices for molded insulation products, which were partially offset by continuing manufacturing improvements and tighter margins on sales of metal products.\nRESORT OPERATIONS\nResort revenues increased from $20.4 million to $25.5 million on a 16% increase in skier visits. The increase in skier visits was a result of improved snowfall in the Sierra during the first quarter of 1993 compared to 1992. Northstar set records during 1993 in a number of areas, including skier days, meals served and lodging room nights.\nOperating income improved from $1.6 million to $2.3 million. This increase understates the significant improvements achieved at Northstar-at-Tahoe during the year, as the business unit operating income includes anticipated start-up and operating expenses at Sierra since its July 1993 acquisition in excess of revenues of approximately $1 million. The Northstar improvement was due to the increase in skier visits, lower snowmaking costs due to increased snowfall, aggressive marketing and cost controls.\nGENERAL CORPORATE EXPENSES\nUnallocated costs declined from $11.9 million to $8.3 million, reflecting improvements resulting from the organizational restructuring completed during 1992 and reversal of certain contingency accruals no longer considered necessary, offset by higher incentive compensation tied to stock performance. In addition, 1992 costs include $1.0 million to increase the reserve for future landfill cleanup costs.\nASBESTOS-RELATED COSTS\nThe 1993 and 1992 results of operations do not include any asbestos-related costs. During 1993, $1.8 million of unreimbursed costs related to the asbestos litigation were incurred and charged against the reserve established in prior years.\nOTHER ITEMS\nInterest expense declined from $4.2 million to $3.6 million, due to lower rates on variable rate debt and lower aggregate borrowings.\nInterest and other income decreased from $7.7 million to $5.6 million. Other income included $2.4 million in 1992 resulting from the freezing of a defined benefit pension plan\nand gains from the sales of surplus real estate of $3.0 million in 1992 and $3.8 million in 1993. Interest income declined as lower amounts were available for investment at lower rates than in prior years.\nOn July 1, 1993, Fibreboard adjusted the depreciable lives of its assets to more closely approximate their economic useful lives, resulting in a reduction of depreciation expense of $1.4 million during 1993. This expense reduction is included in the segment results discussed above.\nFibreboard's effective tax rate was 41% in 1993 and 44% in 1992. Fibreboard adopted Statement of Financial Accounting Standards No. 109, ACCOUNTING FOR INCOME TAXES (SFAS 109) on January 1, 1993. SFAS 109 requires an asset and liability approach for financial accounting and reporting for income taxes, and requires the recognition of the tax impact of certain items for which no income tax impact would have been provided in the past. Fibreboard recorded no adjustment of its tax accounts as a result of adopting SFAS 109.\nIMPACT OF INFLATION\nInflation has not had any significant impact on Fibreboard's operations during the three years ended December 31, 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndex to Financial Statements and Supplementary Data\nPAGE\nConsolidated Statements of Income for 21 each of the three years in the period ended December 31, 1994\nConsolidated Balance Sheets as of December 31, 22 1994 and 1993\nConsolidated Statements of Cash Flows for each 24 of the three years in the period ended December 31, 1994\nConsolidated Statements of Stockholders' Equity 26 for each of the three years in the period ended December 31, 1994\nNotes to Consolidated Financial Statements 27\nReport of Independent Public Accountants 44\nReport of Management 45\nSupplementary Data (unaudited) - Selected Quarterly Financial Data for each of the 46 two years in the period ended December 31, 1994\nFIBREBOARD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME\nSee attached notes to financial statements\nFIBREBOARD CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nSee attached notes to financial statements\nFIBREBOARD CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nSee attached notes to financial statements\nFIBREBOARD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\n(continued)\nFIBREBOARD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nSee attached notes to financial statements\nFIBREBOARD CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee attached notes to financial statements\nFIBREBOARD CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollar amounts in thousands)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF PRESENTATION\nThe consolidated financial statements include the accounts of Fibreboard Corporation, a Delaware Corporation, and all its wholly-owned subsidiaries (collectively Fibreboard) after elimination of intercompany balances and transactions.\nCertain reclassifications of prior year amounts have been made to conform with the current presentation.\nEARNINGS PER SHARE\nEarnings per common and common equivalent share are calculated using the weighted average number of common shares outstanding during the year plus the net additional number of shares which would be issuable upon the exercise of stock options, assuming Fibreboard used the proceeds received to purchase additional shares at market value. The effect of common stock equivalents was not material in 1992.\nCASH AND CASH EQUIVALENTS\nFibreboard utilizes a centralized cash management system to minimize the amount of cash on deposit with banks and maximize interest income from amounts not required for immediate disbursement. Cash includes cash on hand or in banks available for immediate disbursal. Cash equivalents are short-term investments that have an original maturity date of less than 90 days.\nINVENTORY VALUATION\nInventories are valued at the lower of cost (first-in, first-out) or market. Inventory costs include material, labor and operating overhead. Operating supplies are priced at average cost. Inventories are valued as follows:\nTIMBER\nFibreboard follows an overall policy on fee timber that amortizes timber costs over the total fiber available during the estimated growth cycle. Timber carrying costs are expensed as incurred.\nPROPERTY, PLANT AND EQUIPMENT\nFibreboard uses the units of production method of depreciation for some of its machinery and equipment which depreciates cost over the estimated number of units that the equipment will be able to produce during its useful life.\nProvisions for depreciation of buildings and the remaining machinery and equipment have been computed using straight-line rates based upon the estimated service lives (4-30 years).\nFibreboard capitalizes interest on borrowed funds incurred during construction periods. Capitalized interest is amortized over the lives of the related assets. Interest capitalized in 1994, 1993 and 1992 was $0, $183 and $142.\nFibreboard capitalizes logging road construction costs as part of \"Land and Improvements.\" These costs are amortized as the timber volume adjacent to the road system is harvested.\nOn July 1, 1993, Fibreboard adjusted the depreciable lives of its assets to more closely approximate their useful lives, resulting in a reduction of depreciation expense of $1,437 in 1993.\nINCOME TAX POLICIES\nThe income tax provision includes the following:\nThe following table summarizes the differences between the statutory federal and effective tax rate:\nIn 1993, the Omnibus Budget Reconciliation Act of 1993 was signed into law increasing the federal tax rate from 34% to 35%.\nEffective January 1, 1993, the Company implemented the provisions of Statement of Accounting Standards No. 109, Accounting for Income Taxes (SFAS 109). SFAS 109 utilizes the liability method and deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax bases of assets and liabilities given the provisions of the enacted tax laws. The adoption of SFAS 109 had no effect on reported net income.\nThe tax effect of significant temporary differences representing deferred tax assets and liabilities are as follows:\nPrior to the implementation of SFAS 109, the Company accounted for income taxes using Accounting Principles Board Opinion No. 11, Accounting for Income Taxes (APB 11). The following table summarizes the major components of the provision for deferred taxes under APB 11 which resulted from timing differences in the recognition of income and expense for financial reporting and tax purposes:\n2. RECEIVABLES\n3. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nFibreboard is self-insured for the majority of its workers compensation benefits. Workers compensation expense was $2,356, $1,074 and $1,836 in 1994, 1993 and 1992 based on actual and estimated claims incurred.\n4. NOTES PAYABLE\nAt December 31, 1993, Fibreboard had a $40,000 operating line of credit facility, secured by a substantial majority of Fibreboard's receivables, inventories and machinery and equipment. This facility was replaced during 1994 with the revolving credit facility described in Note 5.\nFibreboard has a $5,000 operating line of credit dedicated for the seasonal cash needs of its resort operations. Borrowings under the facility carry interest at the prime rate plus 1\/4% (8-3\/4% at December 31, 1994). The facility expires May 31, 1995. At December 31, 1994, no amounts were outstanding; however, $1,428 of availability under the facility was utilized to secure standby letters of credit.\n5. LONG-TERM DEBT\nFibreboard's long-term debt not associated with asbestos consists of the following:\nRequired repayment of long-term debt is as follows:\nFibreboard has notes receivable with terms and payment dates which are substantially identical to $5,905 of revenue bonds included in the above table. Payments under these notes are as follows:\nFibreboard obtained a $175,000 revolving credit facility during 1994. Initial borrowings were used to replace the credit facility described in Note 4, repay the 11.8% term loans and fund a portion of the purchase of Norandex Inc. (see Note 13). The maximum amount available reduces to $150,000 on September 30, 1995 and to $125,000 on September 30, 1996 with the balance due September 30, 1997, unless the maturity date is extended by Fibreboard and its lenders. Proceeds of borrowings may be used for general corporate purposes and acquisitions. Additional amounts available aggregated $82,904 at December 31, 1994.\nFibreboard's loan agreements contain various financial covenants, the most restrictive of which impose limitations on dividends and other distributions to stockholders, require the maintenance of minimum levels of net worth, limit the ratio of consolidated funded debt to net worth and require maintenance of certain coverage ratios. At December 31, 1994, these covenants were met.\nFibreboard has entered into an interest rate swap to fix the interest rate on $50,000 of borrowings under the revolving credit facility. Through October 1995, Fibreboard will pay the intermediary interest at 6.41% and will receive interest at LIBOR. In addition, Fibreboard has entered into an agreement under which it will receive an interest payment on $50,000 to the extent LIBOR exceeds 7.5% for the period November 1995 through October 1996. The cost of this transaction will be recognized during 1996.\nFibreboard's asbestos related long-term debt consists of the following and is due upon conclusion of the asbestos personal injury insurance coverage litigation. In the event Fibreboard prevails in the insurance coverage litigation, the amounts will be repaid from insurance proceeds.\n6. 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 SHORT-TERM INVESTMENTS\nCarrying amount approximates fair value because of the short maturity of these investments.\nNOTES RECEIVABLE\nFair value of notes receivable is estimated by discounting future cash flows using current rates at which similar loans would be made.\nNOTES PAYABLE TO BANKS\nCarrying amount approximates fair value based on current rates offered to the corporation for similar debt.\nLONG-TERM DEBT\nFair market value is estimated by discounting the future cash flows using the current rates at which similar debt could be placed.\nINTEREST RATE INSTRUMENTS\nFair market value is based on market rates at the end of the period for similar instruments.\nThe estimated fair values of financial instruments are as follows:\nFibreboard's consolidated balance sheets include financial instruments resulting from the asbestos-related litigation, asbestos costs to be reimbursed, asbestos claims settlement obligations and asbestos-related long-term debt. These are unique financial instruments. Consequently, these instruments are not traded nor is it likely a willing buyer could be found. Therefore, it is not practicable to estimate a market value. The balance sheets as of December 31, 1994 and 1993 reflects asbestos costs to be reimbursed of $810,454 and $968,309, asbestos claims settlements of $795,365 and $952,928 and asbestos-related long- term debt of $22,360 and $21,361.\n7. PENSION PLANS\nFibreboard has pension plans covering substantially all employees. Contributions to defined benefit plans are based on actuarial calculations of amounts necessary to cover current cost and amortization of prior service costs. Benefits for employees of the acquired Norandex operation continue to vest while all other plan participants' benefits have vested and been frozen. Contributions to defined contribution plans are nondiscretionary and based on varying percentages of eligible compensation for the year.\nThe status of Fibreboard's defined benefit pension plan at December 31, 1994 and 1993 is as follows:\nOf the accrued expense, $4,518 and $1,058 is included in accounts payable and accrued liabilities (Note 3).\nThe actuarial assumptions used to determine accrued pension expense and the funded status of the plans for 1994 were: 7.5% discount rate (net pension expense), 8.25% discount rate (funded status), 8% expected long-term rate of return on plan assets and a 5% salary increase for active participants. The assets of the plan at December 31, 1994 and 1993 consist of bonds, both corporate and government, stocks, cash and cash equivalents.\nAs required by Statement of Accounting Standards No. 87, Employers' Accounting for Pensions, Fibreboard has recognized a minimum pension liability associated with its frozen defined benefit plan. As a result, Fibreboard recorded an after tax reduction in equity of $4,571 at December 31, 1994 and $2,427 at December 31, 1993.\nPension expense included the following components:\nOn December 31, 1992, a defined benefit pension plan with assets in excess of obligations was frozen, resulting in a curtailment gain of $2,353. The assets of the plan were merged with Fibreboard's other defined benefit pension plan. The curtailment gain is reflected as a component of interest and other income in the Consolidated Statements of Income.\n8. NON-PENSION POST-RETIREMENT BENEFITS\nThrough 1992, Fibreboard provided post-retirement benefits to employees who met certain requirements until they reached age 65. The benefits provided were mainly health care and dental. This benefit was discontinued for employees who retired after December 31, 1992. However, post-retirement benefits are available to certain collective bargaining units of facilities which have been sold.\nThe status of Fibreboard's non-pension post retirement benefits at December 31, 1994 and 1993 are as follows:\nAmounts recorded as net other includes a gain of $1,164 from the resolution of a post-retirement benefit obligation of facilities sold in 1988.\nA 16% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1994. The cost trend rate was assumed to decrease to 9% in 1995 and slightly thereafter until 2001 at which time the rate was assumed to stabilize at 6%. Increasing the assumed health care cost trend rates by 1% in each year would increase the accumulated post retirement benefit obligation as of December 31, 1994 by $45 and the aggregate of the service and interest cost components of net periodic post retirement cost for the year then ended by $4. The weighted average discount rate used in determining the accumulated post retirement benefits was 8.25% while 7.5% was used to determine the 1994 post-retirement benefit cost.\n9. STOCK OPTION AND STOCK PURCHASE PLANS\nFibreboard has a stock option and rights plan for certain officers, directors and key employees. The plan provides for granting stock options, stock appreciation rights, limited stock appreciation rights and restricted stock awards. Awards under the plan are determined by the compensation committee of the Board of Directors. The maximum number of shares available for award under the plan is 800,000. Option prices are set by the committee. Option prices for grants must be at least 85% of the fair market value on the date of grant. The time limit within which options may be exercised and other exercise terms are fixed by the committee.\nWhen stock options are exercised, the proceeds (including any tax benefits to Fibreboard resulting from the exercise) are credited to the appropriate common stock and additional paid-in capital accounts. Compensation related to restricted stock awards and certain option grants (measured at the grant date) is recognized as expense over the term of the related award.\nAt December 31, 1994, options to purchase 503,650 shares at prices from $2.83 to $25.38 were outstanding. Options exercised in 1994 were 4,750. At December 31, 1994, options to purchase 491,650 shares were immediately exercisable. Options becoming exercisable in 1995 are 12,000. Option awards for 54,000 shares include limited stock appreciation rights for a like number of shares. Each limited stock appreciation right entitles the holder, in certain limited circumstances, to surrender the underlying option in exchange for cash equal to the difference between fair market value at the date of surrender and the option price for such shares.\nAt December 31, 1994, restricted stock awards of 35,000 shares were outstanding. The shares awarded will be issued, 7,000 shares in 1995, 15,000 in 1996 and 13,000 in 1997 provided the grantee is employed continuously through the issue date.\nIn addition, Fibreboard had an employee stock purchase plan which was suspended in 1992. The plan allowed employees to purchase Fibreboard stock with an aggregate purchase price of up to 15% of the employee's base salary at the beginning of each purchase period. The purchase price was the lesser of 85% of fair market value at the beginning of each purchase period or 85% of fair market value at the actual purchase date. The maximum number of shares issuable under the plan was 250,000. During 1994, 1993 and 1992, 0, 0 and 17,360 shares of Fibreboard stock were sold to employees under this plan.\nFibreboard has a long-term equity incentive plan, which provides for awards of phantom stock units. Each phantom stock unit entitles the grantee to a cash payment equal to the fair market value of one share of Fibreboard common stock at the maturity date less the fair market value on the grant date. At December 31, 1994, 235,400 phantom stock units had been awarded at fair market value on the grant date from $27.50 to $30.00. These phantom stock units mature 47,400 units in 1995, 79,000 units in 1996, and 109,000 units in 1997.\nCompensation expense recognized for these plans was $129, $1,039 and $517 in 1994, 1993 and 1992.\n10. PREFERRED STOCK PURCHASE RIGHTS\nIn 1988, Fibreboard implemented a stockholder rights plan and distributed to stockholders one preferred share purchase right for each share of Fibreboard common stock then outstanding. Under the rights plan, as amended in 1994, each right entitles the registered holder to purchase from Fibreboard 1\/100th of a share of Series A Junior Participating Preferred Stock at an exercise price of $106 per 1\/100th share, subject to adjustment. The rights will not be exercisable until a party acquires beneficial ownership of 15% or more of Fibreboard's then outstanding common shares. The rights, which do not have voting rights, expire in February 2004 and may be redeemed in whole by Fibreboard, at its option, at a price of $.01 per right prior to the expiration or exercise of the rights.\nIn the event Fibreboard is acquired in an unsolicited merger or other business combination transaction, each right will entitle the holder to receive, upon exercise of the right, common stock of the acquiring company having a market value of two times the then current exercise price of the right. In the event a party acquires 15% or more of Fibreboard's outstanding common shares, each right will entitle the holder to receive upon exercise Fibreboard common shares having a market value of two times the exercise price of the right.\n11. COMMITMENTS\nFibreboard is obligated to purchase timber under cutting contracts with the U.S. Forest Service, which extend to 1996. The table below presents Fibreboard's best estimate of its commitment under timber cutting contracts by year of contract expiration:\nFibreboard leases certain office and warehouse space and machinery and equipment under operating leases which expire within six years. Minimum lease payments and subleases for the next five years are as follows:\nIn addition, the Company leases property from the U.S. Forest Service for one of its resort operations. Lease payment terms are based on a percentage of revenues. Total rent expense for all operating leases amounted to $4,979, $2,194 and $1,753 in 1994, 1993 and 1992.\n12. INDUSTRY SEGMENT INFORMATION\nInformation about Fibreboard's industry segments is set forth below.\n13. ACQUISITIONS AND DISPOSITIONS\nIn July 1993, Fibreboard acquired the net assets of Sierra Ski Ranch, a ski facility located in California, for $13,054. The acquisition was accounted for as a purchase of assets. The ski area was subsequently renamed Sierra-at-Tahoe.\nOn August 31, 1994, Fibreboard acquired the stock of Norandex Inc., a manufacturer and distributor of residential exterior building products, for $119,894 in cash including acquisition costs. The acquisition, which was accounted for as a purchase, resulted in $65,332 of goodwill which will be amortized over 30 years. Norandex operating earnings have been included in Fibreboard's consolidated statement of income since the date of acquisition. The following unaudited table presents the pro forma combined results of Fibreboard and Norandex assuming the transaction took place at January 1, 1994 or 1993.\nThe pro forma results include only adjustments necessary to 1) reflect the allocation of the purchase price resulting in changes in depreciation and amortization; 2) recognize the interest cost associated with the purchase; and 3) recognize the income tax effects of these adjustments.\nBecause the pro forma results include only the adjustments indicated above, they should not be considered indicative of the results that would have occurred if the combination had been in effect on the dates indicated or which may be obtained in the future. No attempt has been made to quantify in the pro forma results additional costs which may be incurred as a result of the combination, even though certain costs are expected to increase. Furthermore, the pro forma results include the effects of gains on asset sales and restructuring costs which occurred during the periods and which may not reoccur.\nIn February 1994, Fibreboard sold its agricultural container manufacturing facilities located in Fresno, CA in order to concentrate its resources on the primary wood products and remanufacturing businesses. In July 1994, 8,900 acres of non-essential timberlands were sold for $21,500 and an $18,858 pre-tax gain was recognized in interest and other income.\n14. ASBESTOS-RELATED LITIGATION\nCONTINGENT LIABILITY FOR ASBESTOS-RELATED CLAIMS\nOverview:\nFibreboard's ability to continue to operate in the normal course of business is dependent upon its ongoing capability to fund asbestos-related defense and indemnity costs. Prior to 1972, Fibreboard manufactured insulation products containing asbestos. Fibreboard has since been named as a defendant in many thousands of personal injury claims for injuries allegedly caused by asbestos exposure and in asbestos-in-buildings actions involving many thousands of buildings.\nFibreboard believes it has unique insurance coverage for personal injury claims, as the trial court has held (with the issue on appeal) that claims with initial exposure to asbestos prior to 1959 are covered by two no-aggregate-limit policies.\nDuring 1993, Fibreboard and its insurers entered into the Insurance Settlement Agreement, and Fibreboard, its insurers and plaintiffs representatives entered into the Global Settlement Agreement. These agreements are interrelated. Final court approval of these agreements is required. Fibreboard believes trial court approval could occur during the first half of 1995, but if appealed, it may be 1996 or later before final court approval could be obtained.\nIf both the Global and Insurance Settlement Agreements are approved, Fibreboard believes its existing and future personal injury asbestos liabilities will be resolved through insurance resources and existing corporate reserves. If the Insurance Settlement is approved but the Global Settlement is not approved, the insurers will provide Fibreboard with up to $2,000,000 to resolve claims pending as of August 27, 1993 and all future claims, and will pay claims settled but not yet paid as of August 27, 1993.\nClaims Activity:\nFibreboard has already resolved 147,400 personal injury claims for approximately $1,654,400, not including legal defense costs. Substantially all of the settlements have been achieved through 1) payments by Fibreboard's insurers; 2) assignments of Fibreboard's rights to insurance payments, most of which have been converted to three-party agreements among Fibreboard, its insurer and plaintiffs; or 3) deferring payments pending resolution of the personal injury insurance coverage litigation discussed below. An additional 26,800 claims have been disposed of at no cost to Fibreboard other than legal defense costs. At December 31, 1994, Fibreboard estimates that approximately 41,900 claims have been filed against it which remain unresolved. Approximately 15,600 of these claims were initially filed against Fibreboard on or after August 27, 1993 and will be covered by the Global Settlement, if approved. Fibreboard is unable to determine the exact number of claims that may be filed in the future, although the number is expected to be substantial.\nFibreboard has achieved excellent results in resolving asbestos-in- buildings actions. At December 31, 1994, of the 152 actions served against it, Fibreboard has been dismissed from 134 (31 of which joined the National Schools class action), settled or agreed to settle five for $2,020, tried one to a defense verdict and remains a defendant in 14 actions. In one of the remaining actions, Fibreboard won a defense verdict on product identification and cost of abatement issues, although further proceedings are scheduled.\nThe following tables illustrate asbestos-related claims activity for the last three years:\n--------------------------------------------------------------------------------\nInsurance Coverage for Personal Injury Claims:\nDuring 1993, Fibreboard entered into a settlement agreement with Continental Casualty Company (Continental) and Pacific Indemnity Company (Pacific) (the Insurance Settlement). In addition, Fibreboard, Continental, Pacific and plaintiffs' representatives entered into a settlement agreement (the Global Settlement). These agreements are interrelated. Final court approval of the agreements is required. Fibreboard believes trial court approval could occur during the first half of 1995, but if appealed, it may be 1996 or later before final court approval could be obtained.\nIf both the Global Settlement and Insurance Settlement are approved, Fibreboard believes its existing and future personal injury asbestos liabilities will be resolved through insurance resources and existing corporate reserves. Fibreboard will contribute $10,000 toward a $1,535,000 settlement trust, which it will obtain from other remaining insurance sources and existing reserves. The Home Insurance company paid $9,892 into the escrow account after December 31, 1994 on behalf of Fibreboard, in satisfaction of an earlier settlement agreement. Fibreboard is obligated to pay $245, which includes interest from the settlement date to December 31, 1994, into the escrow account if the Global Settlement is approved. The remainder of the trust will be funded by Continental and Pacific. The insurers have placed $1,525,000 in an escrow account pending court approval of the settlements. The balance of the escrow account was $1,560,633 at December 31, 1994 after payment of interim expenses associated with the Global Settlement. The trust will be used to compensate \"future\" plaintiffs, defined as those plaintiffs who had not filed a claim against Fibreboard before August 27, 1993. Such future plaintiffs only source of compensation will be the trust, as an injunction will be entered prohibiting future claims against Fibreboard or the insurers.\nIf the Global Settlement is not approved, but the Insurance Settlement is approved, the insurers will instead provide Fibreboard with up to $2,000,000 to resolve pending and future claims and will pay the deferred payment portion of existing settled claims.\nWhile Fibreboard is optimistic, there is no assurance final court approval of either the Global Settlement or the Insurance Settlement can be obtained. If neither the Global Settlement nor the Insurance Settlement is approved, the parties will be bound by the outcome of the insurance coverage litigation and prior settlements with Continental and Pacific, unless other settlements are reached. All insurance proceeds due from other insurers under previous settlements have been received.\nIn the event the settlements discussed above are not approved, Fibreboard believes it has substantial insurance coverage for asbestos-related defense and indemnity costs. Fibreboard's disputes with Continental and Pacific have been the subject of litigation which began in 1979. Trial court judgments rendered in 1990 give Fibreboard virtually unlimited insurance coverage for asbestos- related personal injury claims where the initial exposure to asbestos occurred prior to March 1959. Under the judgments, these insurers can be required to pay up to $500 for each occurrence (defined as each individual claim) with no limitation on the aggregate number of occurrences.\nThe insurers appealed to the California Court of Appeal. Among other issues, Continental disputed the definition of an occurrence under its policy as well as the trigger and scope of coverage as determined by the trial court, while Pacific argued that its policy contained an aggregate limit as well as disputing the trigger and scope of coverage issues. In November 1993, the Court of Appeal issued its ruling on the trigger and scope of coverage issues, confirming the favorable trial court judgments, except the court held the period for coverage would begin at the time of exposure to Fibreboard's asbestos products rather than at the time of exposure to any company's asbestos product, with the presumption that these periods are the same. The insurers have filed petitions for review with the California Supreme Court, which has granted review but not yet scheduled any further activity. At the request of Fibreboard, Continental and Pacific, the Court of Appeal withheld its ruling on the remaining\nissues while the parties seek approval of the Global and Insurance Settlements. If the Global and\/or Insurance Settlements are ultimately approved, Fibreboard and its insurers will seek to dismiss the insurance coverage litigation.\nFibreboard has entered into an interim agreement with Continental under which Continental agreed to provide a full defense to Fibreboard on pre-1959 claims and make certain funds available as needed to pay currently due Structured Settlement Obligations and other personal injury defense costs for which Fibreboard does not otherwise have insurance available during the period pending final approval of the Global and\/or Insurance Settlement, or if neither is approved, through the ultimate conclusion of the insurance coverage appeal, however long that may take. In exchange for the benefits provided under this agreement, Fibreboard agreed not to settle additional pre-1959 personal injury claims without Continental's consent.\nIf neither the Global Settlement nor the Insurance Settlement are approved and Fibreboard prevails in the appeal of the insurance coverage litigation, Continental has agreed to provide Fibreboard with $315,000 to $425,000 to resolve personal injury claims alleging first exposure to asbestos after March 1959, less any amounts Fibreboard recovers from the Pacific settlement described below. Continental would also continue to have responsibility for all pre-1959 personal injury claims against Fibreboard up to $500 per claim.\nIn March 1992, Fibreboard and Pacific entered into a settlement agreement (the Pacific Agreement). If the Global Settlement or Insurance Settlement is approved, the Pacific Agreement will be of no effect. If neither of the settlements is approved, the Pacific Agreement establishes amounts payable to Fibreboard if the trial court judgments are upheld. Fibreboard received $10,000 upon signing the agreement and received an additional $10,000 during 1993. In addition, if the judgments are affirmed on appeal, Fibreboard will receive from $80,000 to $105,000 to be used for claims costs for which it does not otherwise have insurance.\nIn the event the trigger and scope of coverage judgments are reversed on appeal, Pacific will owe Fibreboard nothing and will have a right to repayment of interim funds previously advanced.\nFibreboard believes amounts available under the settlements discussed above will be adequate to fund defense and indemnity costs until the insurance coverage appeal is concluded, whether as a result of the final approval of the Global and\/or Insurance Settlements or the final resolution of the insurance coverage litigation.\nLiability Quantification:\nAt the end of 1991, Fibreboard attempted to quantify its liability for asbestos-related personal injury claims then pending as well as anticipated to be received through the end of the decade. There are many opportunities for error in such an exercise. Assumptions concerning the number of claims to be received, the disease mix of pending and future claims and projections of defense and indemnity costs may or may not prove correct. Fibreboard's assumptions are based on its historical experience, modified as appropriate for anticipated demographic changes or changes in the litigation environment.\nNotwithstanding the inherent risk of significant error in such a calculation, Fibreboard estimated that the amount necessary to defend and dispose of asbestos-related personal injury claims pending at December 31, 1991 and anticipated through the end of the decade plus the costs of prosecuting its insurance coverage litigation would aggregate $1,610,000. Because of the dynamic nature of this litigation, it is more difficult to estimate how many personal injury claims will be received after 1999 as well as the costs of defending and disposing of those future claims. Consequently, Fibreboard's estimated liability contains no amounts for personal injury claims received after the end of the decade, although it is likely additional claims will be received thereafter.\nFibreboard determined it was probable that it would ultimately receive insurance proceeds of $1,584,000 for the defense and disposition of the claims quantified above. Fibreboard's opinion was based on its understanding of the disputed issues, the financial strength of the insurers and the opinion of outside legal counsel regarding the outcome of the insurance coverage litigation.\nAs a result, Fibreboard recorded a liability, net of anticipated insurance proceeds, of $26,000 at December 31, 1991, representing its best estimate of the unreimbursed cost of resolving personal injury claims then pending and anticipated through the remainder of the decade as well as the costs of prosecuting the insurance coverage litigation. Although there likely will be claims filed beyond the end of the decade, these have not been estimated. During 1994, 1993 and 1992, unreimbursed costs of $2,211, $1,802 and $4,729 were charged against this reserve.\nFibreboard continues to believe it is probable that it will ultimately receive insurance proceeds of $1,584,000 for the defense and disposition of the asbestos-related personal injury claims quantified above. Although Fibreboard, its insurers and plaintiffs' representatives entered into the Insurance and Global Settlements discussed above, Fibreboard does not believe these settlements impact its estimate of liability through the end of the decade, and no additional events have transpired during 1994 which indicate the potential liability and insurance proceeds estimates should be changed. Consequently, no adjustment has been made to the estimated liability for personal injury claims through the end of the decade or anticipated insurance proceeds. Fibreboard will continue to reevaluate its estimates and will make adjustments to the effect dictated by changes in the personal injury litigation.\nAsbestos-in-Buildings Liabilities:\nFibreboard does not believe it is presently possible to reasonably estimate potential liabilities for asbestos-in-buildings claims, if any. Fibreboard believes that its asbestos-containing products, properly used, cause no damage to buildings. Further, Fibreboard can frequently identify its asbestos- containing products and aggressively pursues dismissals of claims where its products are not identified. To date, Fibreboard has been very successful in obtaining dismissals, and has won the only trial which went to verdict and won a defense verdict on product identification and cost of abatement issues in another trial in which further proceedings are scheduled.\nFibreboard has settled five asbestos-in-buildings claims, including settlement agreements in the National Schools class action and another class action, for $2,020. The class action settlements are subject to court approval. Further, although personal injury claims have similar characteristics, the same cannot be said for asbestos-in-buildings claims. Each claim can involve from one to several thousand buildings, each of which may vary as to age, ability to identify various producers products contained in the building as well as the extent of a producer's product present, building use, difficulty of abatement (if required) and so on. Thus, while extrapolation of personal injury claims disposition experience may provide useful information for estimating future personal injury liability, such an analysis cannot be applied to asbestos-in- buildings claims.\nTrials in some of the pending asbestos-in-buildings claims are likely to occur over the next few years. To date Fibreboard has successfully defended these claims, or settled the claims for nominal amounts compared to the damages sought. Based on its experience to date, Fibreboard believes the ultimate resolution of asbestos-in-buildings claims will not have a material adverse effect on its financial condition.\nInsurance for Asbestos-in-Buildings Claims:\nFibreboard has reached final settlements with four of its primary insurers and several of its excess level insurers. The settlements confirm more than $295,000 of insurance as needed to defend and dispose of asbestos-in-buildings claims, of which $6,400 has been used through December 31, 1994.\nFibreboard is also litigating with its remaining insurance carriers and believes the total limits of insurance policies in effect from 1932 to 1985 which may provide coverage for asbestos-in-buildings claims, aggregate approximately $390,000 (including the $295,000 referred to in the prior paragraph), which is in addition to the personal injury insurance coverage and does not include additional policies which contain no aggregate limit. The remaining insurers dispute coverage. To date substantially all of Fibreboard's costs of defending asbestos-in-buildings claims have been paid by insurance.\nFibreboard is seeking a declaration that the underlying asbestos-in- building claims are covered under various insurance policies. Barring settlement, final resolution of the insurance available for asbestos-\nin-buildings claims may not be known for some time as an appeal of the trial court decision is likely. The trial has been continued. No date has been set for the trial to recommence. Fibreboard is continuing settlement discussions with the remaining insurers.\nEVENTS IMPACTING ASBESTOS-RELATED LIABILITIES\nA number of events could impact Fibreboard's ability to continue to manage its asbestos-related liabilities within available resources. The potential impact of the personal injury issues which follow are largely dependent on whether the Global and\/or Insurance Settlements are approved.\nInsurance Assignment Program:\nDuring 1991, Fibreboard introduced its Insurance Assignment Program as a settlement vehicle for large groups of claims. Under this program, the plaintiffs accept an assignment of Fibreboard's right to insurance monies from Continental as complete settlement of their claims against Fibreboard. Consequently, these settlements involve no cash payments by Fibreboard. This contrasts with settlements under Fibreboard's Structured Settlement Program, in existence since 1988, wherein partial payments are made by Fibreboard using insurance funds with the remainder of the settlement deferred pending resolution of insurance coverage.\nThe settlement agreements entered into to date under the Insurance Assignment Program do not require Fibreboard to pay cash unless insurance proceeds are ultimately not available. Additional provisions of certain settlement agreements provide that Fibreboard and the plaintiffs return to the \"status quo\" existing prior to settlement if certain specified court actions are not obtained. The plaintiffs have a right to return to the status quo should Continental declare bankruptcy prior to the final resolution of the personal injury insurance coverage litigation.\nDuring 1992, Fibreboard obtained widespread acceptance of this program to resolve large numbers of pending and not yet filed claims. Most of the assignment agreements have subsequently been converted to three-party agreements among Fibreboard, Continental and the plaintiffs. A 1992 judicial determination in California state court supporting the right of Fibreboard to settle claims via the Insurance Assignment Program was reversed by the appellate court in 1994. Fibreboard does not believe this reversal will have an adverse impact on the resolution of its asbestos-related personal injury liabilities.\nInsurance Assignment Program and three-party settlements are recorded as a liability when the settlement is executed. A corresponding asset for anticipated insurance proceeds is also recorded. This accounting treatment differs from the handling of unresolved claims, where no gross liability is recorded until such time as the claim is settled.\nStructured Settlement Program:\nBeginning in 1988, Fibreboard has used its Structured Settlement Program (SSP) to settle personal injury claims. Under the SSP, Fibreboard and the plaintiff agree to a settlement amount. Fibreboard agrees to pay 40% of the settlement amount of pre-1959 claims in cash, and the remainder is deferred until September 1, 1996 or upon approval of the Global and\/or Insurance Settlements. Settlements of post-1959 claims result in deferring 100% of the settlement amount.\nAs a consequence of the insurance settlements with Continental and Pacific in 1993, the SSP now has been superseded by three-party agreements among Continental, Fibreboard and the plaintiffs, whereby Continental or Fibreboard agrees to pay certain amounts depending upon the resolution of the insurance coverage case or the final approval or disapproval of the Global and Insurance Settlements. These three-party agreements typically provide a partial cash payment from Continental on pre-1959 claims.\nOher Issues (Asbestos-in-Buildings Claims):\nMany asbestos-in-buildings claims allege a conspiracy and\/or concert of action theory which assert, among other things, that the asbestos producers withheld information regarding the potential danger of asbestos. If this theory prevails at trial, it could eliminate the requirement that the plaintiff positively identify Fibreboard's products as present in buildings in trials where the conspiracy theory is alleged. The conspiracy theory has not yet been tested in trial against Fibreboard, although Fibreboard believes it has meritorious defenses.\nOther Issues (Punitive Damage Claims):\nMost of the personal injury claims and many of the asbestos-in-buildings actions also seek punitive damages. Fibreboard has not paid any punitive damages judgments except when funded by insurance. It is uncertain whether punitive damages would be covered by insurance as the law in this area varies from state to state. During 1991, Fibreboard received a ruling by the 9th Circuit Court of Appeal that punitive damages awarded by the Cimino jury in Texas and by a West Virginia jury in a consolidated trial similar to Cimino were covered by insurance. However, this ruling may have limited applicability in view of the varying state rules regarding punitive damage awards.\nRESOURCES AVAILABLE FOR ASBESTOS-RELATED COSTS\nUnder the terms of the interim agreement, Continental will provide a full defense to Fibreboard on pre-1959 claims and make certain funds available as needed to pay currently due Structured Settlement obligations and other personal injury defense costs for which Fibreboard does not have insurance available during the period pending final approval of the Global and\/or Insurance Settlement, or if neither is approved, through the ultimate conclusion of the insurance coverage appeal, however long that may take. At December 31, 1994, Fibreboard had $1,062 in cash on hand restricted for asbestos-in-buildings- related expenditures. At December 31, 1994, $6,878 was due in 1995 to asbestos claimants who had accepted Structured Settlement Program obligations and will be paid by Continental under the interim agreement. Fibreboard believes restricted cash on hand, amounts available under the interim agreement with Continental and amounts available under settlement agreements with Fibreboard's asbestos-in- buildings insurers will be adequate to fund defense and indemnity costs of personal injury and asbestos-in-buildings claims plus any amounts due under current and future Structured Settlement Program settlements.\n15. OTHER LITIGATION AND CONTINGENCIES\nFibreboard has been named as a potentially responsible party in two separate landfill clean-ups in the state of California, the Operating Industries, Inc. landfill in Monterey Park and the GBF landfill in Pittsburg. In addition, Fibreboard has been named as a defendant in a private party lawsuit seeking to recover costs of clean-up and remediation of the Acme landfill in Martinez, California. In all cases, Fibreboard's former container products division was responsible for materials deposited at the landfills. Fibreboard is working with the steering committees of each site to determine Fibreboard's allocable share of investigation and remediation costs. Fibreboard has established a reserve against which the costs of study and cleanup, as well as ongoing legal and steering committee administrative costs, will be charged. The amount of the reserve was increased by $986 in 1992 to account for the addition of the Acme landfill contingency and to reflect more current remediation cost estimates for the GBF landfill. As of December 31, 1994, the reserve had a remaining balance of $1,627. Fibreboard believes its litigation reserves will be adequate to cover its remaining costs associated with these landfill sites.\nFibreboard is involved in a number of additional disputes arising from its operations. Fibreboard believes resolution of these disputes will not have a material adverse impact on its financial condition or results of operations.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders of Fibreboard Corporation:\nWe have audited the accompanying consolidated balance sheets of Fibreboard Corporation (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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 Fibreboard Corporation and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in more detail in Note 14 to the accompanying financial statements, Fibreboard has been subject to significant asbestos-related litigation and claims allegedly caused by products that the Company manufactured prior to 1972. The amounts involved are substantial. During 1993, Fibreboard, its insurance carriers, and counsel for personal injury claimants entered into agreements which, if finally approved by the court, would resolve the Company's asbestos-related personal injury liabilities within available insurance and existing reserves. However, if these agreements are not approved by the court, the ultimate resolution of these claims and litigation could be materially adverse to Fibreboard causing a substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements have been prepared assuming that Fibreboard will continue as a going concern and do not include any adjustments that might result from the final resolution of these asbestos-related uncertainties.\nArthur Andersen LLP\nSan Francisco, California, February 1, 1995.\nREPORT OF MANAGEMENT\nThe objectivity and integrity of the consolidated financial statements are the responsibility of Fibreboard Corporation management. To discharge this responsibility, management maintains a system of internal controls designed to provide reasonable assurance that assets are safeguarded and that accounting records are reliable. Management supports an internal audit program to provide assurance that the system of internal controls is operating effectively. The consolidated financial statements and notes thereto and other financial information included in this annual financial report have been prepared by management in accordance with generally accepted accounting principles, and by necessity include some items determined using management's best judgment, tempered by materiality.\nThe Board of Directors discharges its responsibility for reported financial information through its Audit Committee. This Committee, composed of all outside directors, meets periodically with management, the internal audit department and Arthur Andersen LLP to review the activities of each.\nJohn D. Roach James P. Donohue Chairman, President and Senior Vice President, Chief Executive Officer Finance and Administration\nGarold E. Swan Vice President and Controller\nFIBREBOARD CORPORATION AND SUBSIDIARIES SELECTED QUARTERLY FINANCIAL DATA (DOLLAR AMOUNTS IN THOUSANDS EXCEPT PER SHARE) (UNAUDITED)\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 with respect to the Directors of Fibreboard is incorporated herein by reference from \"Election of Directors\" and \"Directors Not Standing for Election\" of Fibreboard Corporation's Proxy Statement to be filed pursuant to Regulation 14A not later than April 30, 1995. See also \"Executive Officers of the Registrant\" in Part I of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to Executive Compensation is incorporated herein by reference from \"Compensation of Directors\" and \"Executive Compensation\" of Fibreboard's Proxy Statement to be filed pursuant to Regulation 14A not later than April 30, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to Security Ownership of Certain Beneficial Owners and Management is incorporated herein by reference from \"Security Ownership of Management and Principal Stockholders\" of Fibreboard's Proxy Statement to be filed pursuant to Regulation 14A not later than April 30, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nNot applicable.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K\n(a) FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES AND EXHIBITS FILED IN THIS REPORT.\n1. Index to Financial Statements and Supplementary Data. See page 20. 2. Index to Financial Statement Schedules. See page 51. 3. The following exhibits are filed as part of this Form 10-K:\nEXHIBIT NUMBER EXHIBIT DESCRIPTION ------- ---------------------------------------------\n3.1 Fibreboard's Restated Certificate of Incorporation (incorporated herein by reference from Fibreboard Corporation's Registration Statement on Form 10 dated May 23, 1988, as amended on June 28, 1988).\n3.2 Fibreboard's Restated Bylaws as amended June 8, 1993 (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993).\n4.1 Specimen Common Stock Certificate, $.01 par value (incorporated herein by reference from Fibreboard Corporation's Registration Statement on Form 10 dated May 23, 1988, as amended on June 28, 1988).\n4.2 Rights Agreement dated as of August 25, 1988 between Fibreboard Corporation and Bank of America, N.T.&S.A. as Rights Agent (incorporated herein by reference from Fibreboard Corporation's Current Report on Form 8-K dated August 25, 1988).\n4.2.1 Amendment No. 1 to Rights Agreement, dated as of February 11, 1994, between Fibreboard Corporation and The First National Bank of Boston (incorporated herein by reference from Fibreboard Corporation's Form 8-A\/A dated February 15, 1994).\n10.1* Form of Indemnification Agreement between Fibreboard Corporation and each director and officer of Fibreboard Corporation (incorporated herein by reference from Fibreboard Corporation's Registration Statement on Form 10 dated May 23, 1988, as amended on June 28, 1988).\n10.2 Asset Purchase Agreement dated February 22, 1988, between Fibreboard Corporation and Gaylord Container Corporation (incorporated herein by reference from Fibreboard Corporation's Registration Statement on Form 10 dated May 23, 1988, as amended on June 28, 1988).\n10.3 Fibreboard Corporation Restated 1988 Employee Stock Option and Rights Plan (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the quarter ended June 30, 1992).\n10.3.1 Amendment No. 1 to Fibreboard Corporation Restated 1988 Employee Stock Option and Rights Plan (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the quarter ended March 31, 1994).\n10.4 Form of Fibreboard Corporation Profit Sharing 401(k) Plan (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.5 Fibreboard Corporation 1988 Employee Stock Purchase Plan (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1988).\n10.5.1 Prospectus Supplement (Appendix) to Registration Statement on Form S-8 No. 33-26449 for Shares issuable under the Fibreboard Corporation 1988 Employee Stock Purchase Plan (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.6 Agreement of Compromise, Settlement and Release dated May 27, 1987, between Fibreboard Corporation and The Home Insurance Company (incorporated herein by reference from Fibreboard Corporation's Registration Statement on Form 10 dated May 23, 1988, as amended on June 28, 1988).\n10.6.1 Agreement dated February 6, 1995 between Fibreboard Corporation and The Home Insurance Company.\n10.7 Fibreboard Corporation Structured Settlement Program Description dated November 8, 1988 (incorporated herein by reference from Fibreboard's Current Report on Form 8-K dated November 8, 1988).\n10.8 Form of Structured Settlement Agreement (incorporated herein by reference from Fibreboard's Current Report on Form 8-K dated November 8, 1988).\n10.9 Form of Stipulation Regarding Settlement Negotiations and Right to Alternative Dispute Resolution (incorporated herein by reference from Fibreboard's Current Report on Form 8-K dated November 8, 1988).\n10.10 Amended and Restated Trust Agreement dated September 29, 1989 by and among Fibreboard Corporation, the Trustees and the Directors and Officers of Fibreboard (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.11 Consulting\/Sales Representation Agreement dated February 20, 1989 between Distribution International and Pabco Metals Corporation, a wholly-owned subsidiary of Fibreboard Corporation (incorporated herein by reference from Fibreboard Corporation's Current Report on Form 8-K dated February 20, 1989).\n10.12* Summary description of Fibreboard Corporation incentive compensation arrangements (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.13* Amended and Restated Employment Agreement dated January 1, 1995 between Fibreboard Corporation and John D. Roach.\n10.14 Amended and Restated Credit Agreement dated September 29, 1994 among Fibreboard Corporation, as Borrower, Certain Commercial Lending Institutions and Bank of America National Trust and Savings Association, as Administrative Co-Agent and Collateral Co-Agent (incorporated herein by\nreference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994).\n10.14.1 First Amendment to Amended and Restated Credit Agreement, dated as of March 10, 1995, among Fibreboard Corporation, Bank of America National Trust and Savings Association, as administrative co-agent for the Lenders and as collateral co-agent for the Lenders, and the several financial institutions party to the Credit Agreement.\n10.15 Stock Purchase Agreement among Noranda Aluminum, Inc., Norandex Inc. and Fibreboard Corporation dated as of August 31, 1994 (incorporated herein by reference from Fibreboard Corporation's Current Report on Form 8-K dated August 31, 1994).\n10.16* Form of Severance Agreement dated January 1, 1992 between Fibreboard Corporation and Messrs. Donohue, Costello, Douglas, DeMaria, Elliott and Swan (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.17 Agreement and related documents dated March 27, 1992 between Fibreboard Corporation and Pacific Indemnity Company (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.18 Rescission of Insurance Policies dated March 27, 1992 between Fibreboard Corporation and Pacific Indemnity Company (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.19* Amended and Restated Fibreboard Corporation Supplemental Retirement Plan.\n10.20 Settlement Agreement dated January 1, 1993 between Fibreboard Corporation and Continental Casualty Company (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.21 Settlement Agreement dated January 1, 1993 between Fibreboard Corporation and Fireman's Fund Insurance Company, Insurance Company of North America and Royal Insurance Company (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.22 Settlement Agreement between Fibreboard Corporation and American Home Assurance Company, et al (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.23 Agreement of Purchase and Sale between Fibreboard Corporation and Sierra Ski Ranch, Inc. dated as of June 11, 1993 (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the period ended June 30, 1993).\n10.24 Settlement Agreement among Fibreboard Corporation, Continental Casualty Company and Ness, Motley, Loadholt, Richardson & Poole and certain affiliated law firms dated as of August 5, 1993 (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the period ended June 30, 1993).\n10.25 Agreement between Fibreboard Corporation and Continental Casualty Company dated April 9, 1993 (incorporated herein by reference from Fibreboard Corporation's Current Report on Form 8-K dated April 9, 1993).\n10.26 Loan Agreement dated May 3, 1993 between First Interstate Bank of Nevada, N.A. and Trimont Land Company (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the period ended September 30, 1993).\n10.27 Loan Agreement dated September 17, 1993 between First Interstate Bank of Nevada, N.A. and Sierra-at-Tahoe and Trimont Land Company (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the period ended September 30, 1993).\n10.28 Settlement Agreement dated October 12, 1993 among Fibreboard Corporation, Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company and Pacific Indemnity Company (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the period ended September 30, 1993).\n10.29 Supplemental Agreement dated October 12, 1993 between Fibreboard Corporation and Continental Casualty Company (pursuant to Rule 24b- 2 promulgated under the Securities Exchange Act of 1934, as amended, confidential treatment has been requested for this exhibit. This agreement has been placed under court seal.)\n10.30 Global Settlement Agreement among Fibreboard Corporation, Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company, Pacific Indemnity Company and The Settlement Class, together with Exhibits A-E (incorporated herein by reference from Fibreboard Corporation's Current Report on Form 8-K dated December 23, 1993).\n10.30.1 Amendment No. 1 to the Global Settlement Agreement, dated December 15, 1994, by and among The Settlement Class, Fibreboard Corporation, Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company, Pacific Indemnity Company and the Trustees of the Fibreboard Asbestos Compensation Trust.\n10.30.2 Amendment No. 2 to the Global Settlement Agreement, dated February 6, 1995, by and among the Settlement Class, Fibreboard Corporation, Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company and Pacific Indemnity Company.\n10.30.3 Amendment No. 1 to the Escrow Agreement, dated February 6, 1995, by and among Continental Casualty Company, Pacific Indemnity Company, Fibreboard Corporation and The First National Bank of Chicago.\n10.31 Agreement dated March 1994 among Representative Plaintiffs, Fibreboard Corporation, Continental Casualty Company, CNA Casualty Company of California, Columbia Casualty Company and Pacific Indemnity Company (incorporated herein by reference from Fibreboard Corporation's Quarterly Report on Form 10-Q for the period ended June 30, 19943).\n10.32 Settlement Agreement dated October 28, 1994 between Fibreboard Corporation, CIGNA Specialty Insurance Company, Central National Insurance Company of Omaha, Century Indemnity Company, CIGNA Property and Casualty Insurance Company and Insurance Company of North America (pursuant to Rule 24b-2 promulgated under the Securities Exchange Act of 1934, as amended, confidential treatment has been requested for this exhibit).\n10.33* Fibreboard Corporation Long-Term Equity Incentive Plan (incorporated herein by reference from Fibreboard Corporation's Annual Report on Form 10-K for the year ended December 31, 1993).\n21. Fibreboard Corporation Subsidiaries.\n23. Consent of Arthur Andersen LLP\n* Denotes management contract or compensation plan identified pursuant to Item 14(a)(3) of Form 10-K.\n(b) REPORTS ON FORM 8-K\nNo Current Reports on Form 8-K were filed during the period October 1, 1994 to December 31, 1994.\nINDEX TO FINANCIAL STATEMENT SCHEDULES TO FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1994\nSchedule Page -------- ----\nIII Valuation and qualifying accounts for each 52 of the three years in the period ended December 31, 1993\nReport of independent public accountants on 53 financial statement schedules.\nFIBREBOARD CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31 (000'S Omitted)\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULES\nTo the Stockholders of Fibreboard Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Fibreboard Corporation included in this Form 10-K, and have issued our report thereon dated February 1, 1995. Our report on the consolidated financial statements includes an explanatory paragraph with respect to the significant uncertainty surrounding the asbestos claims that have been filed against the Company as discussed in Note 14 to the financial statements. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. Schedule II, Valuation and Qualifying Accounts, is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has 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 LLP\nSan Francisco, California February 1, 1995.\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.\nFIBREBOARD CORPORATION ---------------------- (Registrant)\nDated: March 24, 1995 By: \/s\/ John D. Roach -------------------- John D. Roach 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 in the capacities and on the dates indicated:\nName Title Date ------------------------- ----------------- -----------\n\/s\/ John D. Roach Chairman, President, March 24, 1995 ------------------------- Chief Executive Officer John D. Roach and Director (Principal Executive Officer)\n\/s\/ James P. Donohue Senior Vice President, March 24, 1995 ------------------------- Finance and Adminis- James P. Donohue tration and Chief Financial Officer (Principal Financial Officer)\n\/s\/ Garold E. Swan Vice President and March 24, 1995 ------------------------- Controller (Principal Garold E. Swan Accounting Officer)\n\/s\/ Philip R. Bogue Director March 24, 1995 ------------------------- Philip R. Bogue\nName Title Date ------------------------- ----------------- -----------\n\/s\/ William D. Eberle Director March 24, 1995 ------------------------- William D. Eberle\n\/s\/ G. Robert Evans Director March 24, 1995 ------------------------- G. Robert Evans\n\/s\/ George B. James Director March 24, 1995 ------------------------- George B. James\n\/s\/ John W. Koeberer Director March 24, 1995 ------------------------- John W. Koeberer\n\/s\/ James F. Miller Director March 24, 1995 ------------------------- James F. Miller","section_15":""}
{"filename":"789895_1994.txt","cik":"789895","year":"1994","section_1":"Item 1. Business\nThe principal objectives of Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership) are to purchase and lease used commercial jet aircraft in order to provide quarterly distributions of cash from operations, to maximize the residual values of aircraft upon sale and to protect Partnership capital through experienced management and diversification. PAIF-II was organized as a California limited partnership on June 27, 1984 and will terminate no later than December 2010.\nPAIF-II has many competitors in the aircraft leasing market, including airlines, aircraft leasing companies, other limited partnerships, banks and several other types of financial institutions. This market is highly competitive and there is no single competitor who has a significant influence on the industry. In addition to other competitors, the general partner, Polaris Investment Management Corporation (PIMC), and its affiliates, including GE Capital Aviation Services, Inc. (GECAS), Polaris Aircraft Leasing Corporation (PALC), Polaris Holding Company (PHC) and General Electric Capital Corporation (GE Capital), acquire, lease, finance and sell aircraft for their own accounts and for existing aircraft leasing programs sponsored by them. Further, GECAS provides a significant range of management services to GPA Group plc, a public limited company organized in Ireland, together with its consolidated subsidiaries (GPA), which acquires, leases and sells aircraft. Accordingly, in seeking to re-lease and sell its aircraft, the Partnership may be in competition with the general partner and its affiliates and GPA.\nA brief description of the aircraft owned by the Partnership is set forth in Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. The following table describes certain material terms of the Partnership's leases to Northwest Territorial Airways, Ltd. (NWT), Trans World Airlines, Inc. (TWA), Viscount Air Services, Inc. (Viscount) and Continental Micronesia, Inc. (Continental Micronesia) and Continental Airlines, Inc. (Continental) as of December 31, 1994:\nNumber of Lease Lessee Aircraft Type Aircraft Expiration Renewal Options (1) ------ ------------- -------- ---------- -------------------\nNWT Boeing 737-200 Combi 1 10\/95 (2) 18 months\nTWA McDonnell Douglas DC-9-30 16 2\/98 (3) none McDonnell Douglas DC-9-40 1 11\/98 (3) none McDonnell Douglas DC-9-30 1 11\/98 (3) none\nViscount Boeing 737-200 1 11\/97 (4) none\nContinental Boeing 727-200 Advanced 1 4\/98 (5) none\nContinental Micronesia Boeing 727-200 Advanced 2 4\/98 (6) none\n(1) The rental rate during the renewal term remains the same as the current rate unless otherwise noted.\n(2) This aircraft was previously on lease to Air Zaire, Inc. (Air Zaire). The aircraft was re-leased to NWT at approximately 45% of the prior rental rate through February 1993, then extended through December 1993 at 80% of the previous rental rate, and again extended through March 1994 at the same rental rate. The Partnership negotiated a new lease with NWT for 16 months commencing in June 1994 at approximately 108% of NWT's prior rental rate.\n(3) TWA may specify a lease expiration date for each aircraft up to six months before the date shown, provided the average date for the 16 aircraft is February 1998, and the average expiration date for the remaining two aircraft is November 1998.\nThe TWA leases were modified in 1991. The leases for the 16 aircraft were extended for an aggregate of 75 months beyond the initial lease expiration date in November 1991 at approximately 46% of the original lease rates. The leases for the remaining two aircraft were extended for 72 months beyond the initial lease expiration dates in November 1992 at approximately 42% of the original lease rates. The Partnership also agreed to share in the costs of certain Airworthiness Directives (ADs). If such costs are incurred by TWA, they will be credited against rental payments, subject to annual limitations with a maximum of $500,000 per aircraft over the lease terms. On January 31, 1992, TWA commenced reorganization proceedings under Chapter 11 of the Federal Bankruptcy Code as discussed further in Note 6 to the financial statements (Item 8). TWA emerged from bankruptcy protection in November 1993 and affirmed all of the Partnership's aircraft leases.\nAs discussed in Item 7, in October 1994, TWA notified its creditors, including the Partnership, of a proposed restructuring of its debt. Subsequently, GECAS (which as discussed in Part III, Item 10 now provides certain management services to PIMC and PALC) negotiated a proposed standstill agreement with TWA which was approved on behalf of the Partnership by PIMC. That agreement provides for a moratorium of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995, with the deferred rents, which aggregate $3.6 million, plus interest being repaid in monthly installments beginning in May 1995 through December 1995. The Partnership received as consideration for the agreement $218,071 and warrants for such amount of TWA Common Stock as would have a value on December 31, 1997, on a fully diluted basis, equal to the total amount of rent deferred (Item 7).\n(4) This aircraft was previously on lease to SABA Airlines, S.A. (SABA). The lease rate to Viscount is approximately 56% of the prior lease rate. As discussed in Item 7, the Partnership has negotiated an agreement with Viscount to defer certain rents due the Partnership and to provide financing to Viscount for maintenance expenses relating to the Partnership's aircraft.\n(5) This aircraft, previously on lease to Alaska Airlines, Inc. (Alaska), was leased to Continental in April 1993. The lease rate is approximately 55% of the prior lease rate. The lease stipulates that Continental may assign the lease to its affiliate Continental Micronesia under certain conditions. The lease also stipulates that the Partnership will reimburse costs for cockpit modifications up to $600,000, C-check labor costs up to $300,000 and the actual cost of C-check parts for the aircraft. In addition, the Partnership will provide financing up to $815,000 for new image modifications to be repaid with interest over the lease term. In accordance with the cost sharing agreement, in January 1994, the\nPartnership reimbursed Continental $600,000 for cockpit modifications and $338,189 for C-check labor and parts. In addition, the Partnership financed $719,784 for new image modifications, which is being repaid with interest over the lease term of the aircraft. The lease also stipulates that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time.\n(6) These two aircraft, previously on lease to Alaska, were leased to Continental Micronesia in May and June 1993. The lease rates are approximately 55% of the prior lease rates. The leases stipulate that the Partnership will reimburse costs for cockpit modifications up to $600,000 per aircraft, C-check labor costs up to $300,000 for one of the aircraft and the actual cost of C-check parts for one of the aircraft. In addition, the Partnership will provide financing up to $815,000 for new image modifications to be repaid with interest over the lease term for each aircraft. In accordance with the cost sharing agreement, in January 1994, the Partnership reimbursed Continental (on behalf of its affiliate Continental Micronesia) $1.2 million for cockpit modifications and $404,136 for C-check labor and parts. In addition, the Partnership financed $1,457,749 for new image modifications, which is being repaid with interest over the lease terms of the aircraft. The leases also stipulate that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time.\nThe Partnership transferred six Boeing 727-200 aircraft, formerly leased to Pan American World Airways, Inc. (Pan Am), to aircraft inventory in 1992. These aircraft were disassembled for sale of their component parts as discussed in Item 7. The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit (described below), formerly leased to Delta Airlines, Inc. (Delta), to American International Airways, Inc. (AIA) in February 1995 as discussed in Item 7.\nApproximately 600 commercial aircraft are currently available for sale or lease, approximately 100 less than a year ago. The current surplus has negatively affected market lease rates and fair market values of both new and used aircraft. Current depressed demand for air travel has limited airline expansion plans, with new aircraft orders and scheduled delivery being cancelled or substantially deferred. As profitability has declined, many airlines have taken action to downsize or liquidate assets and many airlines have filed for bankruptcy protection. The Partnership has been forced to adjust its estimates of the residual values realizable from its aircraft and aircraft inventory, which resulted in an increase in depreciation expense in 1994, 1993 and 1992, as discussed in Item 7. A discussion of the current market condition for the type of aircraft owned by the Partnership follows:\nBoeing 727-200 Advanced - The Boeing 727 was the first tri-jet introduced into commercial service. The Boeing 727 is a short- to medium-range jet used for trips of up to 1,500 nautical miles. In 1972, Boeing introduced the Boeing 727-200 Advanced model, a higher gross weight version with increased fuel capacity. Noise suppression hardware, commonly known as a \"hushkit,\" has been developed which, when installed on the aircraft, bring the Boeing 727-200 Advanced into compliance with Federal Aviation Administration (FAA) Stage 3 noise restrictions. The cost of the hushkit is approximately $2.5 million for the Boeing 727-200 Advanced aircraft. Hushkits may not be cost effective on all aircraft due to the age of some of the aircraft and the time required to fully amortize the additional investment. Certain ADs applicable to all models of the Boeing 727 have been issued to prevent fatigue cracks and control corrosion. The market for this type of aircraft, as for all Stage 2 narrowbody aircraft, remains very soft.\nBoeing 737-200 - The Boeing 737-200 aircraft was introduced in 1967 and 150 were delivered from 1967 through 1971. This two-engine, two-pilot aircraft provides operators with 107 to 130 seats, meeting their requirements for economical lift in the 1,100 nautical mile range. Hushkits, that bring Boeing 737-200 aircraft into compliance with FAA Stage 3 noise restrictions, are now available at a cost of approximately $1.7 million for lighter weight aircraft and up to $3.0 million for aircraft with heavier takeoff weights. Hushkits may not be cost effective on all aircraft due to the age of some of the aircraft and the time required to fully amortize the additional investment. Certain ADs applicable to all models of the Boeing 737 have been issued to prevent fatigue cracks and control corrosion. The market for this type of aircraft, as for all Stage 2 narrowbody aircraft, remains very soft.\nMcDonnell Douglas DC-9-30\/40 - The McDonnell Douglas DC-9-30\/40 is a short- to medium-range twin-engine jet that was introduced in 1967. Providing reliable, inexpensive lift, these aircraft fill thin niche markets, mostly in the United States. Hushkits are available to bring these aircraft into compliance with Stage 3 requirements at a cost of approximately $1.6 million per aircraft. Hushkits may not be cost effective on all aircraft due to the age of some of the aircraft and the time required to fully amortize the additional investment. The market for this type of aircraft, as for all Stage 2 narrowbody aircraft, remains very soft. It is expected that the FAA will continue to propose and adopt ADs for the McDonnell Douglas DC-9 aircraft similar to those discussed above for the Boeing 737s and Boeing 727s, which will require modifications at some point in the future to prevent fatigue cracks and control corrosion. The demand for and the value of these aircraft may be diminished to the extent that the costs of bringing McDonnell Douglas DC-9 aircraft into compliance with any ADs reduces the economic efficiency of operating these aircraft.\nThe general partner believes that in addition to the factors cited above, the current soft market for the Partnership's aircraft reflects the airline industry's reaction to the significant expenditures potentially necessary to bring these aircraft into compliance with certain ADs issued by the FAA relating to aging aircraft, corrosion prevention and control and structural inspection and modification, as discussed in the Industry Update section of Item 7.\nItem 2. Properties\nPAIF-II owns one Boeing 737-200 Combi aircraft leased to NWT, 17 McDonnell Douglas DC-9-30 and one McDonnell Douglas DC-9-40 aircraft leased to TWA, one Boeing 737-200 aircraft leased to Viscount, one Boeing 727-200 Advanced aircraft leased to Continental and two Boeing 727-200 Advanced aircraft leased to Continental Micronesia. All leases are operating leases. The Partnership transferred six Boeing 727-200 aircraft, previously leased to Pan Am, to aircraft inventory in 1992. These aircraft, which are not included in the following table, have been disassembled for sale of their component parts. The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit to AIA in February 1995.\nThe following table describes the Partnership's current aircraft portfolio in greater detail:\nYear of Cycles Aircraft Type Serial Number Manufacture As of 9\/30\/94 (1) ------------- ------------- ----------- -----------------\nBoeing 727-200 Advanced 21426 1977 29,691 Boeing 727-200 Advanced 21427 1977 28,331 Boeing 727-200 Advanced 21947 1979 24,947 Boeing 737-200 19609 1968 62,323 Boeing 737-200 Combi 19743 1969 63,674 McDonnell Douglas DC-9-30 47082 1967 71,904 McDonnell Douglas DC-9-30 47096 1967 72,506 McDonnell Douglas DC-9-30 47135 1968 73,198 McDonnell Douglas DC-9-30 47137 1968 72,571 McDonnell Douglas DC-9-30 47249 1968 78,499 McDonnell Douglas DC-9-30 47251 1968 76,793 McDonnell Douglas DC-9-30 47343 1969 75,679 McDonnell Douglas DC-9-30 47345 1969 73,838 McDonnell Douglas DC-9-30 47411 1969 71,231 McDonnell Douglas DC-9-30 47412 1969 71,222 McDonnell Douglas DC-9-30 47027 1967 77,358 McDonnell Douglas DC-9-30 47107 1968 77,081 McDonnell Douglas DC-9-30 47108 1968 73,836 McDonnell Douglas DC-9-30 47174 1968 74,623 McDonnell Douglas DC-9-30 47324 1969 71,249 McDonnell Douglas DC-9-30 47357 1969 70,635 McDonnell Douglas DC-9-30 47734 1977 41,767 McDonnell Douglas DC-9-40 47617 1975 40,310\n(1) Cycle information as of 12\/31\/94 is not yet available.\nItem 3.","section_3":"Item 3. Legal Proceedings\nBraniff, Inc. (Braniff) Bankruptcy - In September 1989, Braniff filed a petition under Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court for the Middle District of Florida, Orlando Division. On September 26, 1990 the Partnership filed a proof of claim to recover unpaid rent and other damages, and on November 27, 1990, the Partnership filed a proof of administrative claim to recover damages for detention of aircraft, non- compliance with court orders and post-petition use of engines as well as liquidated damages. On July 27, 1992, the Bankruptcy Court approved a stipulation embodying a settlement among the Partnership, the Braniff creditor committees and Braniff in which it was agreed that the Partnership would be allowed an administrative claim in the bankruptcy proceeding of approximately $230,769. The Partnership has received a check from the bankruptcy estate in full payment of the allowed administrative claim, subject, however, to the requirement of the stipulation that 25% of such proceeds be held in a separate, interest-bearing account pending notification by Braniff that all the allowed administrative claims have been satisfied. The Partnership recognized 75% of the total claim as other revenue in the statement of operations in 1992 (Item 8). In the third quarter of 1994, the Partnership was authorized to release one-half of the 25% portion of the Partnership's administrative claim segregated pursuant to the stipulation approved in 1992. At the end of 1994, the Partnership was advised that the remaining one-half balance of the 25% segregated portion of the administrative claim payment could be released. As the final disposition of the Partnership's claim in the Bankruptcy proceedings, the Partnership was permitted by the Bankruptcy Court to exchange a portion of its unsecured claim for Braniff's right (commonly referred to as a \"Stage 2 Base Level right\") under the FAA noise regulations to operate one Stage 2 aircraft and has been allowed a net remaining unsecured claim of $769,231 in the proceedings.\nKepford, et al. v. Prudential Securities, et al. - On April 13, 1994, an action entitled Kepford, et al. v. Prudential Securities, Inc. was filed in the District Court of Harris County, Texas. The complaint names Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, General Electric Capital Corporation, Prudential Securities, Inc., Prudential Insurance Company of America and James J. Darr, as defendants. Certain defendants were served with a summons and original petition on or about May 2, 1994. Plaintiffs' original petition alleges that defendants violated the Texas Securities Act, the Texas Deceptive Trade Practices Act, sections 11 and 12 of the Securities Act of 1933 and committed common law fraud, fraud in the inducement, negligent misrepresentation, negligence, breach of fiduciary duty and civil conspiracy by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an award of compensatory damages in an unspecified amount plus interest thereon, and double and treble damages under the Texas Deceptive Trade Practices Act.\nCertain defendants, including Polaris Investment Management Corporation and the Partnership, filed a general denial on June 29, 1994 and a motion for summary judgment on June 17, 1994 on the basis that the statute of limitations has expired. On June 29, 1994 and July 14, 1994, respectively, plaintiffs filed their first amended original petition and second amended original petition, both of which added plaintiffs. On July 18, 1994, plaintiffs filed their response and opposition to defendants' motion for partial summary judgment and also moved for a continuance on the motion for partial summary judgment. On\nAugust 11, 1994, after plaintiffs again amended their petition to add numerous plaintiffs, the defendants withdrew their summary judgment motion and motion to stay discovery, without prejudice to refiling these motions at a later date.\nRiskind, et al. v. Prudential Securities, Inc., et al. - An action entitled Riskind, et al. v. Prudential Securities, Inc., et al. has been filed in the District Court of the 165 Judicial District, Maverick County, Texas. This action is on behalf of over 3,000 individual investors who purchased units in \"various Polaris Aircraft Income Funds,\" including the Partnership. Polaris Aircraft Income Fund I and Polaris Investment Management Corporation received service of plaintiffs' second amended original petition and, on June 13, 1994, filed an original answer containing a general denial.\nThe second amended original petition names Polaris Aircraft Income Fund I, Polaris Investment Management Corporation, Prudential Securities, Inc. and others as defendants and alleges that these defendants violated the Texas Securities Act and the Texas Deceptive Trade Practices Act and committed common law fraud, fraud in the inducement, negligent misrepresentation, negligent breach of fiduciary duty and civil conspiracy by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an award of compensatory damages in an unspecified amount plus interest thereon, and double and treble damages under the Texas Deceptive Trade Practices Act.\nOn April 29, 1994 and June 30, 1994, plaintiffs filed third and fourth amended original petitions which added additional plaintiffs. On April 24, 1994, plaintiffs filed motions for (i) joinder and consolidation of cases in arbitration, (ii) joinder and consolidation of cases not subject to arbitration, and (iii) a pre-trial scheduling order. These motions were amended on June 29, 1994 and, on August 22, 1994, plaintiffs filed a renewed motion for consolidation and motion to set for jury. On August 31, 1994, plaintiffs filed their fifth amended original petition which added additional plaintiffs and also filed their second plea in intervention adding nearly 2,000 intervenors. On September 7, 1994, the court denied plaintiffs' motion to consolidate and motion to set for jury, but determined to sever from the primary lawsuit four plaintiffs and set the action for trial on November 7, 1994. On October 4, 1994, plaintiffs filed their sixth amended petition adding as defendants: the Partnership, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, Polaris Holding Company, Polaris Aircraft Leasing Corporation, Polaris Securities Corporation, General Electric Capital Corporation, General Electric Financial Services, Inc., and General Electric Company.\nOn October 14, 1994, defendants filed motions for summary judgment on the grounds of, inter alia, statute of limitations and failure to state a claim. The motions have been fully briefed and the parties are waiting for a decision by the Texas trial court. On October 20, 1994, certain Polaris and General Electric entities filed a motion to transfer venue, plea in abatement and motion to dismiss the claims of non-Texas residents on the basis of forum non conveniens. On November 1, 1994 and November 7, 1994, plaintiffs filed their seventh and eighth amended original petitions. On November 4, 1994, plaintiffs filed a motion for summary judgment, motion for collateral estoppel, and motion for summary judgment on the issue of fraudulent concealment. On November 7, 1994, plaintiffs filed a second motion for summary judgment. These motions were supplemented on November 10, 1994. Defendants filed responses to these motions on November 23, 1994.\nOn November 7, 1994, the Partnership and other Polaris and General Electric entities filed in the Court of Appeals for the 4th Judicial District San\nAntonio, Texas: (1) an emergency motion to stay trial court proceedings, and (2) a motion for leave to file petition for writ of mandamus, together with relator's petition for writ of mandamus, supporting brief and record. These motions, which concern trial court rulings regarding venue, discovery, and trial settings, were denied by the Court of Appeals on November 9, 1994. On November 14, 1994, the Partnership and other Polaris and General Electric entities filed in the Texas Supreme Court motions (a) for emergency stay of trial court proceedings, and (b) for leave to file petition for writ of mandamus, together with relators' petition and writ of mandamus, supporting brief and record. On November 15, 1994, the Supreme Court granted the emergency motion to stay trial court proceedings pending determination of relators' motion for leave to file petition for writ of mandamus, which concerns trial court rulings regarding venue, discovery, and trial settings. On November 16, 1994, plaintiffs filed an emergency motion to lift the stay. On February 16, 1995, the Texas Supreme Court denied leave to file the petition and writ of mandamus and the stay of trial court proceedings was lifted. On February 21, 1995, defendants filed a motion for a continuance of the case.\nHowland, et al. v. Polaris Holding Company, et al. - On or about February 4, 1994, a purported class action entitled Howland, et al. v. Polaris Holding Company, et al. was filed in the United States District Court for the District of Arizona on behalf of investors in Polaris Aircraft Income Funds I-VI. The complaint names each of Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Holding Company, Polaris Aircraft Leasing Corporation, the Partnership, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund III, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V, Polaris Aircraft Income Fund VI, General Electric Capital Corporation, Prudential Securities, Inc., Prudential Securities Group, Inc., Prudential Insurance Company of America, George W. Ball, Robert J. Sherman, James J. Darr, Paul J. Proscia, Frank W. Giordano, William A. Pittman, Joseph H. Quinn, Joe W. Defur, James M. Kelso and Brian J. Martin, as defendants. The complaint alleges that defendants violated federal RICO statutes, committed negligent misrepresentations, and breached their fiduciary duties by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, an accounting of all monies invested by plaintiffs and the class and the uses made thereof by defendants, an award of compensatory, punitive and treble damages in unspecified amounts plus interest thereon, rescission, attorneys' fees and costs. On August 3, 1994, the action was transferred to the multi-district litigation in the Southern District of New York entitled In re Prudential Securities Limited Partnerships Litigation, discussed in Part III, Item 10 below.\nOther Proceedings - Part III, Item 10 discusses certain other actions which have been filed against the general partner in connection with certain public offerings, including that of the Partnership. With the exception of Novak, et al v. Polaris Holding Company, et al, where the Partnership is named as a nominal defendant, the Partnership is not a party to these actions.\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\na) Polaris Aircraft Income Fund II's (PAIF-II or the Partnership) limited partnership interests (Units) are not publicly traded. Currently there is no market for PAIF-II's Units and it is unlikely that any market will develop.\nb) Number of Security Holders:\nNumber of Record Holders Title of Class as of December 31, 1994 ---------------------------- -------------------------\nLimited Partnership Interest: 16,920\nGeneral Partnership Interest: 1\nc) Dividends:\nThe Partnership distributed cash to partners on a quarterly basis beginning in July 1986. Cash distributions to limited partners during 1994 and 1993 totaled $12,499,925 and $9,999,940, respectively. Cash distributions per limited partnership unit were $25.00 and $20.00 in 1994 and 1993, respectively.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe Partnership owns a portfolio of 23 used commercial jet aircraft and certain inventoried aircraft parts out of its original portfolio of 30 aircraft. The portfolio consists of one Boeing 737-200 Combi aircraft leased to Northwest Territorial Airways, Ltd. (NWT), 17 McDonnell Douglas DC-9-30 aircraft and one McDonnell Douglas DC-9-40 aircraft leased to Trans World Airlines, Inc. (TWA), one Boeing 737-200 aircraft leased to Viscount Air Services, Inc. (Viscount), two Boeing 727-200 Advanced aircraft leased to Continental Micronesia, Inc. (Continental Micronesia) and one Boeing 727-200 Advanced aircraft leased to Continental Airlines, Inc. (Continental). One engine owned by Polaris Aircraft Income Fund I is leased to Viscount through a joint venture with the Partnership. The Partnership transferred six Boeing 727-200 aircraft, previously leased to Pan American World Airways, Inc. (Pan Am), to aircraft inventory in 1992. These aircraft have been disassembled for sale of their component parts as discussed below. The Partnership sold one Boeing 727-200 aircraft, formerly leased to Delta Airlines, Inc. (Delta), in February 1995 as discussed below.\nPartnership Operations\nThe Partnership recorded a net loss of $3,217,172, or $8.87 per limited partnership unit, for the year ended December 31, 1994, compared to net income of $48,114, or an allocated net loss of $1.91 per limited partnership unit, for the year ended December 31, 1993 and a net loss of $1,709,007, or $5.88 per limited partnership unit, for the year ended December 31, 1992. The net loss in 1994 resulted primarily from a decrease in rental revenue recognized from the leases with TWA combined with maintenance expenses incurred from the Partnership's leases to TWA. Further impacting the decline in operating results in 1994 as compared to 1993, depreciation expense was substantially increased in 1994 for declines in the estimated realizable values of the Partnership's aircraft and aircraft inventory, as discussed later in the Industry Update section. The Partnership recognized depreciation adjustments of approximately $1.68 million in 1994, compared to adjustments of $300,000 and $5.8 million in 1993 and 1992, respectively.\nRental revenues, net of related management fees, continued to decline in 1994 as compared to 1993 and 1992, primarily as a result of a decrease in rental revenue recognized in 1994 on the Partnership's leases with TWA. In October 1994, TWA proposed to its creditors, including the Partnership, a restructuring of its debt. As discussed later in Item 7, in December 1994, GE Capital Aviation Services, Inc. (or \"GECAS\" which, as discussed in Part III, Item 10 now provides certain management services to Polaris Investment Management Corporation (PIMC) and Polaris Aircraft Leasing Corporation) negotiated a proposed standstill agreement with TWA which was approved on behalf of the Partnership by PIMC. That agreement provides for a moratorium of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995, with the deferred rents, which aggregate $3.6 million plus interest, being repaid by TWA in monthly installments between May 1995 through December 1995. The Partnership will not recognize the rental amount deferred in 1994 of $1.575 million as rental revenue until it is received. The Partnership received as consideration for the agreement $218,071 and warrants for such amount of TWA Common Stock as would have a value (as described later) on December 31, 1997, on a fully diluted basis, equal to the total amount of rent deferred.\nAs part of the TWA lease extension as discussed in Note 6 to the financial statements (Item 8), the Partnership agreed to share the cost of meeting\ncertain Airworthiness Directives (ADs) after TWA successfully reorganized in 1993. The agreement stipulates that such costs incurred by TWA may be credited against monthly rentals, subject to annual limitations and a maximum of $500,000 per aircraft through the end of the leases. In accordance with the cost sharing agreement, the Partnership recognized as operating expense $3.6 million and $2.7 million of these AD expenses during 1994 and 1993, respectively.\nLiquidity and Cash Distributions\nLiquidity - The Partnership has received all lease payments due from NWT, Continental, Continental Micronesia and Viscount, with the exception of certain maintenance reserve payments due from Viscount. However, to assist Viscount with the funding of costs associated with Federal Aviation Regulation compliance relating to the Partnership's aircraft, the Partnership has entered into an agreement with Viscount under which it agreed to defer certain rents due the Partnership on one aircraft. These deferred rents are being repaid by Viscount with interest over the remaining term of the lease. The agreement with Viscount also stipulates that the Partnership will advance Viscount $127,000, primarily for maintenance expenses incurred by Viscount relating to the Partnership's aircraft. In accordance with the agreement, the Partnership advanced Viscount $127,000 in 1994 which is being repaid by Viscount with interest over a 30-month period beginning in January 1995 as discussed later.\nThe Partnership receives maintenance reserve payments from certain of its lessees that may be reimbursed to the lessee or applied against certain costs incurred by the Partnership for maintenance work performed on the Partnership's aircraft, as specified in the leases. Maintenance reserve balances remaining at the termination of the lease may be used by the Partnership to offset future maintenance expenses. The net maintenance reserves payments aggregate $722,690 as of December 31, 1994.\nAs previously discussed, the Partnership and TWA agreed to defer certain rents due the Partnership totaling $3.6 million, to be repaid by TWA, with interest beginning in May 1995 through December 1995. Until the deferred rents are repaid by TWA in full, the negative impact on the Partnership's cash reserves will be significant.\nAs discussed above, during 1994 TWA offset $3.6 million against rental payments due the Partnership for expenses TWA incurred for certain ADs on the Partnership's aircraft. TWA may offset rental payments due the Partnership for the ADs up to an additional $2.7 million, subject to annual limitations, over the lease terms.\nAs specified in the Partnership's leases with Continental Micronesia and Continental, in January 1994, the Partnership reimbursed Continental (partially on behalf of its affiliate Continental Micronesia) an aggregate of $1.8 million for cockpit modifications and $742,325 for C-check labor and parts for the three aircraft. In addition, in January 1994, the Partnership financed an aggregate of $2,177,533 for new image modifications, which is being repaid with interest over the terms of the aircraft leases. The leases with Continental and Continental Micronesia also stipulate that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time.\nThe Partnership sold one Boeing 727-200 aircraft equipped with a hushkit to American International Airways, Inc. (AIA) in February 1995 as discussed below. The agreement specifies payment of the sales price in 36 monthly installments of $55,000 beginning in March 1995.\nPayments of $323,448 have been received during 1994 from the sale of inventoried parts from the six disassembled aircraft. The Partnership's cash reserves are being retained to meet obligations under the TWA and Continental and Continental Micronesia lease agreements.\nCash Distributions - Cash distributions to limited partners were $12,499,925, $9,999,940 and $12,499,925 in 1994, 1993 and 1992, respectively. Cash distributions per limited partnership unit were $25.00, $20.00 and $25.00 per limited partnership unit in 1994, 1993 and 1992, respectively. The timing and amount of future cash distributions will depend upon the Partnership's future cash requirements; the receipt of rental payments from NWT, TWA, Viscount, Continental and Continental Micronesia; the receipt of the deferred rental payments from TWA; the receipt of the deferred rental payments and financing payments from Viscount; the receipt of modification financing payments from Continental and Continental Micronesia; the receipt of sales proceeds from AIA; and, the receipt of payments generated from the aircraft disassembly process.\nRemarketing Update\nSale of Aircraft to AIA - The Partnership sold one Boeing 727-200 aircraft equipped with a hushkit, formerly leased to Delta, to AIA in February 1995 for a sales price of approximately $1.77 million. The Partnership agreed to accept payment of the sales price in 36 monthly installments of $55,000, with interest at a rate of 7.5% per annum, beginning in March 1995.\nDisassembly of Aircraft\nIn an attempt to maximize the economic return from the remaining six aircraft formerly leased to Pan Am, the Partnership entered into an agreement with Soundair, Inc. (Soundair) in October 1992 for the disassembly and sale of certain of the Partnership's aircraft. It is anticipated that the disassembly and sales process will take at least three years. The Partnership has borne the cost of disassembly and will receive the proceeds from the sale of such parts, net of overhaul expenses if necessary, and commissions paid to Soundair. Disassembly of the six aircraft has been completed. During 1993 and 1992, the Partnership paid $327,750 and $135,750, respectively, for aircraft disassembly costs. The Partnership has received net proceeds from the sale of aircraft inventory of $323,448, $1,169,483 and $32,460 during 1994, 1993 and 1992, respectively.\nThe six aircraft were recorded as aircraft inventory in the amount of $3.0 million in 1992. During 1994 and 1993, the Partnership recorded downward adjustments to the inventory value of $72,000 and $300,000, respectively, to reflect the then-current estimate of net realizable aircraft inventory value. These adjustments are reflected as increased depreciation expense in the corresponding years' statements of operations (Item 8).\nTWA Restructuring\nIn October 1994, TWA notified its creditors, including the Partnership, of a proposed restructuring of its debt. Such restructuring was to include a six- month moratorium on its lease payments to TWA's lessors commencing November 1994. TWA initially proposed that lease payments for a portion of that period be forgiven in exchange for shares of TWA common stock to be issued in conjunction with the restructuring and the remainder repaid over the remaining lease term. TWA stated that if it were unable to obtain approvals from its\ncreditors (including the Partnership) for the proposed restructuring, it would have to file for protection under Chapter 11 of the Federal Bankruptcy Code.\nSubsequently, GECAS negotiated a proposed standstill agreement with TWA for the 46 aircraft that are managed by GECAS. That agreement, which was subject to the approval of the owners of these aircraft, was subsequently approved by PIMC. The agreement provides for a moratorium of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995, with the deferred rents, which aggregate $3.6 million plus interest, being repaid in monthly installments beginning in May 1995 through December 1995. The Partnership will not recognize the rental amount deferred in 1994 of $1.575 million as rental revenue until it is received. In consideration for that partial moratorium, TWA agreed to make an initial payment to the TWA lessors for whom GECAS provides management services and who agreed to the proposed standstill agreement, including the Partnership. The Partnership received as consideration for the agreement $218,071 in January 1995. In addition, TWA issued warrants to the Partnership for such amount of TWA Common Stock as would have a value (based on the projected balance sheet provided by TWA in connection with the restructuring) on December 31, 1997, on a fully diluted basis, equal to the total amount of rent deferred. TWA has not concluded agreements with all of its creditors regarding its proposed debt restructuring. Thus, it remains uncertain whether TWA will file for protection under Chapter 11 of the Federal Bankruptcy Code.\nViscount Restructuring Agreement\nRent Deferral - To assist Viscount with the funding of costs associated with Federal Aviation Regulation compliance relating to the Partnership's aircraft, the Partnership has entered into an agreement with Viscount to defer certain rents due the Partnership on one aircraft for a period of six months. The deferred rents, which aggregate $196,800, are being repaid by Viscount with interest at a rate of 6% per annum, beginning in October 1994, over the remaining lease term.\nMaintenance Advance - The Partnership has also agreed to extend a line of credit to Viscount for $127,000 to be used primarily for maintenance expenses relating to the Partnership's aircraft. In accordance with the agreement, the Partnership advanced Viscount $127,000 during 1994. Payments of interest at variable rates ranging from 8.75% to 9.18% per annum were paid by Viscount beginning in September 1994. Beginning in January 1995, level payments to amortize the advance over a 30-month period, with interest at a rate of 11.53% per annum, are being paid in arrears.\nOption - The Partnership has the option to acquire approximately 0.6% of the issued and outstanding shares of Viscount stock as of July 26, 1994 for an option price of approximately $91,000. The option may be exercised at any time during the option period, which expires on July 20, 1999. This option is carried at zero value in the balance sheet as of December 31, 1994 (Item 8) due to the uncertainty of its realizability.\nClaims Related to Lessee Defaults\nBraniff, Inc. (Braniff) Bankruptcy Claim - As discussed in Item 3, in 1992, the Partnership received full payment of the Braniff administrative claim, subject, however, to the requirement that 25% of total proceeds be held by PIMC in a separate, interest-bearing account pending notification by Braniff that all of the allowed administrative claims have been satisfied. During 1994, the Partnership was advised that the 25% portion of the administrative claim proceeds with interest could be released by PIMC to the Partnership. As a result, the Partnership recognized $67,958 as other revenue in the 1994 statement of operations (Item 8).\nContinental Restructuring\nOn January 26, 1995, Continental announced a number of actual and proposed changes in its operations and financial situation. In connection with those changes, Continental indicated that it was discussing with certain of its major lenders modifications to existing debt amortization schedules to enhance the airline's capital structure. Continental stated that during those discussions it would not be making payments to such lenders and lessors otherwise required under the current contracts. The Partnership is not engaged in any such discussions with Continental at the present time, and Continental has made all payments due to the Partnership on a current basis to date.\nReconciliation of Book Loss to Taxable Loss\nThe following is a reconciliation between net loss per limited partnership unit reflected in the accompanying financial statements (Item 8) and the information provided to limited partners for federal income tax purposes:\n1994 book net loss per limited partnership unit $(8.87) Adjustments for tax purposes: TWA rental revenue recognized for tax purposes and deferred for book purposes 5.76 Management fee recognized for tax purposes and deferred for book purposes (0.27) Recognition of revenue from increase in maintenance reserves 2.67 Additional expense from disbursement of maintenance reserves (3.25) Reversal of book other revenue previously recognized for tax (1.18) Tax depreciation in excess of book depreciation (2.76) Net tax loss on sale of inventory and writedown of inventory (0.39) Items capitalized for tax and expensed for book 7.13 ------\n1994 taxable loss per limited partnership unit $(1.16) ======\nThe difference between net loss for book purposes and net loss for tax purposes result from timing differences of certain revenue and deductions. As previously discussed, the Partnership has deferred certain 1994 TWA rents until 1995, when they are to be paid with interest. For book purposes, the Partnership will not recognize the rental amount deferred in 1994 as revenue until it is received. This deferral has been reversed for tax purposes and the rental revenue and associated management fee expense has been recognized. During 1994, TWA incurred maintenance costs related to the Partnership's aircraft. Under the lease agreement, these costs will offset future rental payments owed by TWA. For tax purposes, the payment of these costs by TWA is treated as prepaid rent and recognized as rental revenue in 1994.\nCertain increases in the Partnership's book maintenance reserve liability were recognized as revenue for tax purposes. Certain disbursements from the Partnership book maintenance reserves are capitalized or expensed for tax purposes, as appropriate. During 1994, certain maintenance reserve liability balances remaining at the end of the lease term were recognized as revenue for book purposes. Since this revenue had been previously recognized for tax purposes, it was reversed for tax purposes.\nThe Partnership computes depreciation using the straight-line method for financial reporting purposes and generally an accelerated method for tax purposes. As a result, the current year tax depreciation expense is greater than the book depreciation expense. Certain aircraft have been disassembled and held in inventory until their component parts can be sold. A net tax loss\nresulted from the sale of these component parts along with a writedown to tax basis inventory value. For book purposes, such assets are reflected at estimated net realizable value. Finally, certain costs were capitalized for tax purposes and expensed for book purposes.\nIndustry Update\nMaintenance of Aging Aircraft - The process of aircraft maintenance begins at the aircraft design stage. For aircraft operating under Federal Aviation Administration (FAA) regulations, a review board consisting of representatives of the manufacturer, FAA representatives and operating airline representatives is responsible for specifying the aircraft's initial maintenance program. The general partner understands that this program is constantly reviewed and modified throughout the aircraft's operational life.\nSince 1988, the FAA, working with the aircraft manufacturers and operators, has issued a series of ADs which mandate that operators conduct more intensive inspections, primarily of the aircraft fuselages. The results of these mandatory inspections may uncover the need for repairs or structural modifications that may not have been required under pre-existing maintenance programs.\nIn addition, an AD adopted in 1990 requires replacement or modification of certain structural items on a specific timetable. These structural items were formerly subject to periodic inspection, with replacement when necessary. The FAA estimates the cost of compliance with this AD to be approximately $1.0 million and $900,000 per Boeing 727 and Boeing 737 aircraft, respectively, if none of the required work had been done previously. The FAA also issued several ADs in 1993 updating inspection and modification requirements for Boeing 737 aircraft. The FAA estimates the cost of these requirements to be approximately $90,000 per aircraft. In general, the new maintenance requirements must be completed by the later of March 1994, or 75,000 and 60,000 cycles for each Boeing 737 and 727, respectively. A similar AD was adopted on September 24, 1990, applicable to McDonnell Douglas aircraft. The AD requires specific work to be performed at various cycle thresholds between 50,000 and 100,000 cycles, and on specific date or age thresholds. The estimated cost of compliance with all of the components of this AD is approximately $850,000 per aircraft.\nIn December 1990, the FAA adopted another AD intended to mitigate corrosion of structural components, which would require repeated inspections from 5 years of age throughout the life of an aircraft, with replacement of corroded components as needed. Integration of the new inspections into each aircraft operator's maintenance program was required by December 31, 1991 on Boeing aircraft.\nThe Partnership's existing leases require the lessees to maintain the Partnership's aircraft in accordance with an FAA-approved maintenance program during the lease term. At the end of the leases, each lessee is generally required to return the aircraft in airworthy condition including compliance with all ADs for which action is mandated by the FAA during the lease term. The Partnership has agreed to bear a portion of the costs of compliance with certain ADs with respect to the aircraft leased to TWA, Continental and Continental Micronesia, as described in Item 1. In negotiating subsequent leases, market conditions currently generally require that the Partnership bear some or all of the costs of compliance with future ADs or ADs that have been issued, but which did not require action during the previous lease term. The ultimate effect on the Partnership of compliance with the FAA maintenance standards is not determinable at this time and will depend on a variety of factors, including the state of the commercial aircraft industry, the timing of\nthe issuance of ADs, and the status of compliance therewith at the expiration of the current leases.\nAircraft Noise - Another issue which has affected the airline industry is that of aircraft noise levels. The FAA has categorized aircraft according to their noise levels. Stage 1 aircraft, which have the highest noise level, are, with few exceptions, no longer allowed to operate from civil airports in the United States. Stage 2 aircraft meet current FAA requirements, subject to the phase- out rules discussed below. Stage 3 aircraft are the most quiet and Stage 3 is the standard for all new aircraft.\nOn September 24, 1991, the FAA issued final rules on the phase-out of Stage 2 aircraft by the end of this decade. The current U.S. fleet is comprised of approximately 57% Stage 3 aircraft and 43% Stage 2 aircraft. The key features of the rule include:\n- Compliance can be accomplished through a gradual process of phase-in or phase-out (see below) on each of three interim compliance dates: December 31, 1994, 1996, and 1998. All Stage 2 aircraft must be phased out of operations in the contiguous United States by December 31, 1999, with waivers available in certain specific cases to December 31, 2003.\n- All operators have the option of achieving compliance through a gradual phase-out of Stage 2 aircraft (i.e., eliminate 25% of its Stage 2 fleet on each of the compliance dates noted above), or a gradual phase-in of Stage 3 aircraft (i.e., 55%, 65% and 75% of an operator's fleet must consist of Stage 3 aircraft by the respective interim compliance dates noted above).\n- Carryforward credits will be awarded to operators for early additions of Stage 3 aircraft to their fleets. These credits may be used to reduce either the number of Stage 2 aircraft it must phase-out or the number of Stage 3 aircraft it must phase-in by the next interim compliance date. The credits must be used by that operator, however, and cannot be transferred or sold to another operator.\nThe federal rule does not prohibit local airports from issuing more stringent phase-out rules. In fact, several local airports have adopted more stringent noise requirements which restrict the operation of Stage 2 and certain Stage 3 aircraft.\nOther countries have also adopted noise policies. The European Union (EU) adopted a non-addition rule in 1989, which directed each member country to pass the necessary legislation to prohibit airlines from adding Stage 2 aircraft to their fleets after November 1, 1990. The rule has specific exceptions for leased aircraft and does allow the continued use of Stage 2 aircraft which were in operation before November 1, 1990, although adoption of rules requiring the eventual phase-out of Stage 2 aircraft is anticipated. The International Civil Aviation Organization has also endorsed the phase-out of Stage 2 aircraft on a world-wide basis by the year 2002.\nExcept for one Boeing 727-200 aircraft with a hushkit, which was sold in February 1995 as previously discussed, the Partnership's entire fleet consists of Stage 2 aircraft. Hushkit modifications, which allow Stage 2 aircraft to meet Stage 3 requirements, are currently available for the Partnership's aircraft. However, while technically feasible, hushkits may not be cost effective on all models due to the age of some of the aircraft and the time required to fully amortize the additional investment. The general partner will evaluate, as appropriate, the potential benefits of hushkitting some or all of\nthe Partnership's aircraft. It is unlikely, however, that the Partnership will incur such costs unless they can be substantially recovered through a lease.\nImplementation of the Stage 3 standards has adversely affected the value of Stage 2 aircraft, as these aircraft will require eventual modification to be operated in the U.S. or other countries with Stage 3 standards after the applicable dates.\nDemand for Aircraft - Approximately 600 commercial aircraft are currently available for sale or lease, approximately 100 less than a year ago. The current surplus has negatively affected market lease rates and fair market values of both new and used aircraft. Current depressed demand for air travel has limited airline expansion plans, with new aircraft orders and scheduled delivery being cancelled or substantially deferred. As profitability has declined, many airlines have taken action to downsize or liquidate assets and many airlines have filed for bankruptcy protection.\nEffects on the Partnership's Aircraft - To ensure that the carrying value of each asset equals its estimated residual value at the end of its expected holding period, where appropriate the Partnership made downward adjustments to the residual value during 1994, 1993 and 1992 for certain of its on-lease aircraft. In addition, during 1994, 1993 and 1992, the Partnership recognized downward adjustments totaling approximately $1.68 million, $300,000 and $5.8 million, respectively, to the book value for certain of its off-lease and on- lease aircraft, and with respect to 1994 and 1993, the adjustments also included adjustments to aircraft inventory as previously discussed. These adjustments are included in depreciation expense in the statements of operations (Item 8).\nThe Partnership's leases expire between October 1995 and November 1998. To the extent that the Partnership's Boeing and McDonnell Douglas aircraft continue to be adversely affected by industry events, the Partnership will evaluate each aircraft as it comes off lease to determine whether a re-lease or a sale at the then-current market rates would be most beneficial for unit holders.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership\nFINANCIAL STATEMENTS AS OF DECEMBER 31, 1994 AND 1993\nTOGETHER WITH\nAUDITORS' REPORT\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Polaris Aircraft Income Fund II, A California Limited Partnership:\nWe have audited the accompanying balance sheets of Polaris Aircraft Income Fund II, A California Limited Partnership as of December 31, 1994 and 1993, and the related statements of operations, changes in partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the general partner. 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 the general partner, 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 Polaris Aircraft Income Fund II, A California Limited Partnership as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nSan Francisco, California, January 24, 1995 (except with respect to the matter discussed in Note 11, as to which the date is February 9, 1995)\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership\nBALANCE SHEETS\nDECEMBER 31, 1994 AND 1993\n1994 1993 ASSETS: ---- ----\nCASH AND CASH EQUIVALENTS $ 14,662,147 $ 97,473\nSHORT-TERM INVESTMENTS, at cost which approximates market value - 22,347,610 ------------ -----------\nTotal Cash and Cash Equivalents and Short-Term Investments 14,662,147 22,445,083\nRENT AND OTHER RECEIVABLES 292,061 37,733\nNOTES RECEIVABLE 2,781,432 1,022,308\nAIRCRAFT at cost, net of accumulated depreciation of $90,004,933 in 1994 and $77,031,695 in 1993 91,954,354 104,927,592\nAIRCRAFT INVENTORY 848,613 1,244,061\nOTHER ASSETS, net of accumulated amortization of $459,928 in 1994 and 1993 29,770 29,770 ------------ ------------\n$110,568,377 $129,706,547 ============ ============\nLIABILITIES AND PARTNERS' CAPITAL (DEFICIT):\nPAYABLE TO AFFILIATES $ 702,841 $ 52,274\nACCOUNTS PAYABLE AND ACCRUED LIABILITIES 38,663 2,556,325\nLESSEE SECURITY DEPOSITS 171,140 189,564\nMAINTENANCE RESERVES 722,690 869,363\nDEFERRED INCOME 642,742 642,742 ------------ ------------\nTotal Liabilities 2,278,076 4,310,268 ------------ ------------\nPARTNERS' CAPITAL (DEFICIT): General Partner (1,119,868) (948,683) Limited Partners, 499,997 units issued and outstanding 109,410,169 126,344,962 ------------ ------------\nTotal Partners' Capital 108,290,301 125,396,279 ------------ ------------\n$110,568,377 $129,706,547 ============ ============\nThe accompanying notes are an integral part of these statements.\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership\nSTATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1994 1993 1992 ---- ---- ---- REVENUES: Rent from operating leases $12,933,795 $ 14,397,683 $ 17,170,434 Net loss on sale of equipment - (513,395) - Interest and other 1,510,107 1,674,578 819,762 ----------- ------------ ------------\nTotal Revenues 14,443,902 15,558,866 17,990,196 ----------- ------------ ------------\nEXPENSES: Depreciation and amortization 13,045,238 11,114,846 16,556,938 Management and advisory fees 615,940 685,950 805,411 Operating 3,738,938 3,445,325 2,001,445 Interest - - 63,057 Administration and other 260,958 264,631 272,352 ----------- ----------- ------------\nTotal Expenses 17,661,074 15,510,752 19,699,203 ----------- ------------ ------------\nNET INCOME (LOSS) $(3,217,172) $ 48,114 $ (1,709,007) =========== ============ ============\nNET INCOME ALLOCATED TO THE GENERAL PARTNER $ 1,217,696 $ 1,000,375 $ 1,232,778 =========== ============ ============\nNET LOSS ALLOCATED TO LIMITED PARTNERS $(4,434,868) $ (952,261) $ (2,941,785) =========== ============ ============\nNET LOSS PER LIMITED PARTNERSHIP UNIT $ (8.87) $ (1.91) $ (5.88) =========== ============ ============\nThe accompanying notes are an integral part of these statements.\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership\nSTATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT)\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nGeneral Limited Partner Partners Total ------- -------- -----\nBalance, December 31, 1991 $ (681,851) $ 152,738,873 $ 152,057,022\nNet income (loss) 1,232,778 (2,941,785) (1,709,007)\nCash distributions to partners (1,388,881) (12,499,925) (13,888,806) ------------ ------------- -------------\nBalance, December 31, 1992 (837,954) 137,297,163 136,459,209\nNet income (loss) 1,000,375 (952,261) 48,114\nCash distributions to partners (1,111,104) (9,999,940) (11,111,044) ------------ ------------- ------------\nBalance, December 31, 1993 (948,683) 126,344,962 125,396,279\nNet income (loss) 1,217,696 (4,434,868) (3,217,172)\nCash distributions to partners (1,388,881) (12,499,925) (13,888,806) ------------ ------------- -------------\nBalance, December 31, 1994 $ (1,119,868) $ 109,410,169 $ 108,290,301 ============ ============= =============\nThe accompanying notes are an integral part of these statements.\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership\nNOTES TO FINANCIAL STATEMENTS\nDECEMBER 31, 1994\n1. Accounting Principles and Policies\nAccounting Method - Polaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership), maintains its accounting records, prepares financial statements and files its tax returns on the accrual basis of accounting.\nCash and Cash Equivalents - This includes deposits at banks and investments in money market funds.\nShort-Term Investments - The Partnership classifies all liquid investments with original maturities of three months or less as short-term investments.\nAircraft and Depreciation - The aircraft are recorded at cost, which includes acquisition costs. Depreciation to an estimated residual value is computed using the straight-line method over the estimated economic life of the aircraft which was originally estimated to be 30 years from the date of manufacture. Depreciation in the year of acquisition is calculated based upon the number of days that the aircraft are in service.\nThe Partnership periodically reviews the estimated realizability of the residual values at the end of each aircraft's economic life. For any downward adjustment in estimated residual, or decrease in the estimated remaining economic life, the depreciation expense over the remaining life of the aircraft is increased. If the expected net income generated from the lease (rental revenue, net of management fees, less adjusted depreciation and an allocation of estimated administrative expense) results in a net loss, that loss will be recognized currently. Off-lease aircraft are carried at the lower of depreciated cost or estimated net realizable value. A further adjustment is made for those aircraft, if any, that require substantial maintenance work.\nCapitalized Costs - Aircraft modification and maintenance costs which are determined to increase the value or extend the useful life of the aircraft are capitalized and amortized using the straight-line method over the appropriate period. These costs are also subject to the periodic evaluation discussed above.\nAircraft Inventory - Aircraft held in inventory for sale are reflected at the lower of depreciated cost or estimated net realizable value. Proceeds from sales are applied against inventory until book value is fully recovered.\nOther Assets - Lease acquisition costs are capitalized as other assets and amortized using the straight-line method over the term of the lease.\nOperating Leases - The aircraft leases are accounted for as operating leases. Lease revenues are recognized in equal installments over the terms of the leases.\nOperating Expenses - Operating expenses include costs incurred to maintain, insure, lease and sell the Partnership's aircraft, including costs related to lessee defaults and costs of disassembling aircraft inventory.\nNet Income (Loss) Per Limited Partnership Unit - Net income (loss) per limited partnership unit is based on the limited partners' share of net income or loss and the number of units outstanding for the years ended December 31, 1994, 1993 and 1992.\nIncome Taxes - The Partnership files federal and state information income tax returns only. Taxable income or loss is reportable by the individual partners.\nReclassification - Certain 1993 and 1992 balances have been reclassified to conform to the 1994 presentation.\nFinancial Accounting Pronouncements - SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" and the related SFAS No. 118, which together require that certain impaired loans be measured based on the present value of expected cash flows discounted at the loan's effective interest rate; or, alternatively, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. This statement has been adopted as of January 1, 1995. The Partnership does not expect the adoption of this statement to have a significant impact on its financial position or results of operations.\n2. Organization and the Partnership\nThe Partnership was formed on June 27, 1984 for the purpose of acquiring and leasing aircraft. The Partnership will terminate no later than December 2010. Upon organization, both the general partner and the initial limited partner contributed $500. The Partnership recognized no profits or losses during the periods ended December 31, 1985 and 1984. The offering of limited partnership units terminated on December 31, 1986, at which time the Partnership had sold 499,997 units of $500, representing $249,998,500. All partners were admitted to the Partnership on or before December 1, 1986.\nPolaris Investment Management Corporation (PIMC), the sole general partner of the Partnership, supervises the day-to-day operations of the Partnership. PIMC is a wholly-owned subsidiary of Polaris Aircraft Leasing Corporation (PALC). Polaris Holding Company (PHC) is the parent company of PALC. General Electric Capital Corporation (GE Capital), an affiliate of General Electric Company, owns 100% of PHC's outstanding common stock. PIMC has entered into a services agreement dated as of July 1, 1994 with GE Capital Aviation Services, Inc. (GECAS). Allocations to affiliates are described in Note 9.\n3. Aircraft\nThe Partnership owns 24 aircraft and certain inventoried aircraft parts from its original portfolio of 30 used commercial jet aircraft, which were acquired and leased as discussed below, including one aircraft which was sold in February 1995 (Note 11). All aircraft acquired from an affiliate were purchased within one year of the affiliate's acquisition at the affiliate's original price paid. The aircraft leases are net leases, requiring the lessees to pay all operating expenses associated with the aircraft during the lease term. While the leases require the lessees to comply with Airworthiness Directives (ADs) which have been or may be issued by the Federal Aviation Administration (FAA) and require compliance during the lease term, in certain of the leases the Partnership has agreed to share in the cost of compliance with ADs. In addition to basic rent, certain lessees are required to pay supplemental amounts based on flight hours or cycles into a maintenance reserve account, to be used for heavy maintenance of the engines or airframe. The leases generally state a minimum acceptable return condition for which the\nlessee is liable under the terms of the lease agreement. Certain leases also provide that, if the aircraft are returned at a level above the minimum acceptable level, the Partnership must reimburse the lessee for the related excess, subject to certain limitations. The related liability to these lessees, if any, cannot currently be estimated and therefore is not reflected in the financial statements.\nOne Boeing 737-200 - This aircraft was acquired for $6,766,166 in 1986 and leased to various lessees until 1989, when Braniff, Inc. (Braniff) defaulted on its lease. The aircraft remained off lease until March 1991. The aircraft was then leased to SABA Airlines, S.A. (SABA) at approximately 70% of the prior rate until February 1992, when the aircraft was repossessed by the Partnership after SABA defaulted under its lease. In November 1992, the aircraft was re-leased for five years to Viscount Air Services, Inc. (Viscount) at approximately 56% of the prior lease rate. Viscount, a charter carrier based in Arizona, has the option to purchase the aircraft for the then-current fair market value at the end of the lease term. An engine for the aircraft has been leased from an affiliate (Note 9) following the return of an inoperable engine from SABA as discussed in Note 4. The Partnership has negotiated an agreement with Viscount to defer certain rents due the Partnership and to provide financing to Viscount for maintenance expenses relating to the Partnership's aircraft (Note 7).\nSeven Boeing 727-200 - These aircraft were acquired for $38,986,145 during 1986 and leased to Pan American World Airways, Inc. (Pan Am) until 1991, when the lease was terminated due to Pan Am's bankruptcy filing, as discussed in the Partnership's 1993 Annual Report to the Securities and Exchange Commission on Form 10-K. The Partnership has transferred six of these aircraft to aircraft inventory and has disassembled them for sale of the component parts (Note 5). One hushkit set from the aircraft was sold in January 1993 and two additional hushkit sets from the aircraft were sold in September 1993 (Note 4).\nThe remaining aircraft was leased to Delta Airlines, Inc. (Delta) in September 1991. Delta returned the aircraft at the end of September 1993, following several month-by-month lease extensions since the original lease termination date in April 1993. The Partnership has adjusted the book value of this aircraft to the estimated net realizable value as discussed in Note 1 by increasing depreciation expense approximately $1.03 million in 1994. The aircraft was sold in February 1995 as discussed in Note 11.\nOne Boeing 737-200 Combi - This aircraft was acquired for $7,582,572 in 1986 and leased to Presidential Airways, Inc. (Presidential), until Presidential's default in 1989. The aircraft remained off lease until June 1990, when it was leased to Air Zaire, Inc. (Air Zaire). The lease required that Air Zaire maintain the aircraft in accordance with FAA requirements. However, Air Zaire was unable to obtain FAA approval for its proposed maintenance program, thus prompting the early termination of the lease in 1991. Air Zaire provided a $610,000 letter of credit, the proceeds of which the Partnership applied to outstanding rent, reserves and interest due in 1991. Air Zaire paid additional amounts in 1993 and 1992 as a result of legal action commenced by the Partnership (Note 8).\nIn August 1992, the Partnership leased the aircraft to Northwest Territorial Airways, Ltd. (NWT) through March 1993 at approximately 45% of the prior rental rate then extended the lease through March 1994 at approximately 80% of the previous rental rate. An engine for the aircraft was leased from an affiliate through April 1994 (Note 9). The aircraft was returned to the Partnership in April 1994 and NWT subsequently paid to the Partnership approximately $860,000 in lieu of meeting return conditions as specified in the lease. The Partnership negotiated a new lease with NWT for 16 months commencing in June\n1994. The new lease rate is approximately 108% of NWT's prior rental rate. During the off-lease period, the Partnership performed certain maintenance and modification work on the aircraft, which was offset by the approximately $860,000 paid to the Partnership by NWT.\n17 McDonnell Douglas DC-9-30 and One McDonnell Douglas DC-9-40 - These aircraft were acquired for $122,222,040 during 1986 and leased to Ozark Air Lines, Inc. (Ozark). In 1987, Trans World Airlines, Inc. (TWA) merged with Ozark and assumed the leases. The leases were modified and extended prior to TWA's bankruptcy filing as discussed in Note 6.\nThree Boeing 727-200 Advanced - These aircraft were acquired for $36,364,929 during 1987 and leased to Alaska Airlines, Inc. (Alaska) until September 1992. Upon return of the aircraft, an additional amount of $509,000 was received from Alaska for deferred maintenance and applied in 1993 as an offset to maintenance expenses incurred on the aircraft. One of the aircraft was re-leased to Continental Airlines, Inc. (Continental) from April 1993 until April 1998. The remaining two aircraft were re-leased to Continental Micronesia, Inc. (Continental Micronesia), an affiliate of Continental, from May and June 1993 until April 1998. All three of the aircraft are leased at approximately 55% of the prior lease rates. The three leases stipulate that the Partnership will reimburse costs for cockpit modifications up to $600,000 per aircraft, C-check labor costs up to $300,000 per aircraft for two of the aircraft and the actual cost of C-check parts for these two aircraft. In addition, the Partnership will provide financing of up to $815,000 for new image modifications, to be repaid with interest over the lease term for each aircraft. In accordance with the cost sharing agreement, in January 1994, the Partnership reimbursed Continental (partially on behalf of its affiliate Continental Micronesia) $1.8 million for cockpit modifications, which is included in aircraft cost in the December 31, 1993 balance sheet, and $742,325 for C-check labor and parts, which was included in operating expense in the statement of operations for the year ended December 31, 1993. In addition, the Partnership financed $2,177,533 for new image modifications, which is being repaid with interest over the lease terms of the aircraft, beginning in February 1994. The Partnership has received all scheduled principal and interest payments due from Continental and Continental Micronesia through December 31, 1994. The aggregate note receivable balance as of December 31, 1994 was $1,764,167. The leases with Continental and Continental Micronesia also stipulate that the Partnership share in the cost of meeting certain ADs, which cannot be estimated at this time.\nThe following is a schedule by year of future minimum rental revenue under the existing leases:\nYear Amount\n1995 $14,596,500 1996 14,074,000 1997 14,041,000 1998 3,410,000 1999 and thereafter - -----------\nTotal $46,121,500 ===========\nFuture minimum rental payments may be offset or reduced by future costs as described above and in Note 6.\nTo ensure that the carrying value of each asset equals its estimated residual value at the end of its expected holding period, where appropriate the\nPartnership made downward adjustments to the residual value during 1994, 1993 and 1992 for certain of its on-lease aircraft (Note 1). In addition, during 1994, 1993 and 1992, the Partnership recognized downward adjustments totaling approximately $1.68 million, $300,000 and $5.8 million, respectively, to the book value for certain of its off-lease and on-lease aircraft, and with respect to 1994 and 1993, the adjustments also included adjustments to aircraft inventory as described in Note 5. These adjustments are included in depreciation expense in the accompanying statements of operations.\n4. Sale of Equipment\nOne hushkit set from the aircraft formerly leased to Pan Am (Note 3) was sold in January 1993 to ALG, Inc. (ALG) for $1,750,000, which resulted in a $259,809 gain in 1993. ALG paid cash for a portion of the sale price and issued an 11% interest-bearing promissory note for the balance of $1,132,363, which specifies 23 equal monthly payments and a balloon payment due in January 1995. The Partnership has received all payments due under the note through December 31, 1994. The note receivable balances as of December 31, 1994 and 1993 were $890,265 and $1,022,308, respectively. ALG paid to the Partnership only a portion of the balloon payment due in January 1995, originating an event of default under the note. The Partnership and ALG have subsequently restructured the terms of the promissory note as discussed in Note 11.\nIn September 1993, two additional hushkit sets from the disassembled Pan Am aircraft were sold to Emery Worldwide Airlines for $1,250,000 each, which resulted in a $398,192 loss. The decline in sales price from the previous hushkit sale in January 1993 reflected a softening market for this equipment.\nThe Partnership sold one used engine to International Aircraft Support, L.P. in July 1993 for $85,000, which resulted in a $375,012 loss. The engine, along with its airframe, was repossessed from the former lessee, SABA in February 1992. At the time of its default, SABA had not maintained the aircraft as required under the lease agreement, rendering the engine inoperable. The Partnership determined the costs to repair the engine were excessive in comparison to amounts recoverable from sale or lease. As a result, the engine was sold for its component parts.\n5. Disassembly of aircraft\nIn an attempt to maximize the economic return from the remaining six aircraft formerly leased to Pan Am, the Partnership entered into an agreement with Soundair, Inc. (Soundair) in October 1992, for the disassembly and sale of certain of the Partnership's aircraft. It is anticipated that the disassembly and sales process will take at least three years. The Partnership has borne the cost of disassembly and will receive the proceeds from the sale of such parts, net of overhaul expenses if necessary, and commissions paid to Soundair. Disassembly of the six aircraft has been completed. During 1993 and 1992, the Partnership paid $327,750 and $135,750, respectively, for aircraft disassembly costs. The Partnership has received net proceeds from the sale of aircraft inventory of $323,448, $1,169,483 and $32,460 during 1994, 1993 and 1992, respectively.\nThe six aircraft were recorded as aircraft inventory in the amount of $3.0 million in 1992 as discussed in Note 3. During 1994 and 1993, the Partnership recorded downward adjustments to the inventory value of $72,000 and $300,000, respectively, to reflect the then current estimate of net realizable aircraft inventory value. These adjustments are reflected as increased depreciation expense in the accompanying statements of operations.\n6. TWA Reorganization\nDuring 1991, TWA defaulted under its leases with the Partnership when it failed to pay its March lease payments. On March 28, 1991, TWA and the Partnership entered into lease amendments which specified (i) renegotiated lease rates equal to approximately 70% of the original rates; (ii) payment of the March and April lease payments at the renegotiated rates on March 27, 1991; and (iii) an advance lump-sum security deposit payment on March 29, 1991 representing the present value of the remaining lease payments due through the end of the leases at the renegotiated rate. The Partnership recorded the lump sum payment from TWA as deferred income, and recognized the rental revenue as it was earned over the lease term. The Partnership also recognized interest expense equal to the difference between the cash received and the rental revenue earned over the lease term. The 16 leases that expired in November 1991 were extended for three months at 57% of the original rates.\nIn December 1991, the leases for all 18 aircraft were amended further, with extensions into various dates in 1998. The renegotiated lease rates represent approximately 46% of the initial lease rates. In addition, the Partnership agreed to share in the costs of certain ADs after TWA successfully reorganized. The agreement with TWA stipulates that such costs incurred by TWA may be credited against monthly rentals due to the Partnership, subject to annual limitations and a maximum of $500,000 per aircraft over the term of the leases.\nIn January 1992, TWA commenced reorganization proceedings under Chapter 11 of the Federal Bankruptcy Code. TWA received court approval to emerge from bankruptcy protection effective November 3, 1993. TWA notified the Partnership of its intention to affirm its leases for all 18 DC-9 aircraft. In addition, while the court had originally granted TWA an additional 90-day period subsequent to its emergence from bankruptcy during which it could exercise its right to reject the Partnerships's leases, TWA elected to waive that right with respect to the Partnership's aircraft. As previously agreed with TWA, August and September 1993 rentals were drawn from the security deposit held by the Partnership, which had been posted for this purpose by TWA prior to its bankruptcy filing.\nIn accordance with the cost sharing arrangement described above, TWA submitted to the Partnership invoices for expenses paid by TWA to meet the ADs. Expenses totaling $2.7 million were offset against rental payments during 1993 and are included in operating expense in the 1993 statement of operations. Additional expenses totaling $3.6 million, which are included in operating expense in the 1994 statement of operations, were offset against rental payments that were due to the Partnership in the first four months of 1994. TWA may offset an additional $2.7 million against rental payments, subject to annual limitations, over the lease terms.\nIn October 1994, TWA notified its creditors, including the Partnership, of a proposed restructuring of its debt. Such restructuring was to include a six- month moratorium on its lease payments to TWA's lessors commencing November 1994. TWA initially proposed that lease payments for a portion of that period would be forgiven in exchange for shares of TWA common stock to be issued in conjunction with the restructuring and the remainder repaid over the remaining lease term. TWA stated that if it were unable to obtain approvals from its creditors (including the Partnership) for the proposed restructuring, it would have to file for protection under Chapter 11 of the Federal Bankruptcy Code.\nSubsequently, GECAS (which now provides certain management services to PIMC and PALC) negotiated a proposed standstill agreement with TWA for the 46 aircraft that are managed by GECAS. That agreement, which was subject to the approval of the owners of these aircraft, was subsequently approved by PIMC. The\nagreement provides for a moratorium of the rent due the Partnership in November 1994 and 75% of the rents due the Partnership from December 1994 through March 1995, with the deferred rents, which aggregate $3.6 million plus interest, being repaid in monthly installments beginning in May 1995 through December 1995. The Partnership will not recognize the rental amount deferred in 1994 of $1.575 million as rental revenue until it is received. In consideration for that partial moratorium, TWA agreed to make an initial payment to the TWA lessors for whom GECAS provides management services and who agreed to the proposed standstill agreement, including the Partnership. The Partnership received as consideration for the agreement $218,071 in January 1995. In addition, TWA issued warrants to the Partnership for such amount of TWA Common Stock as would have a value (based on the projected balance sheet provided by TWA in connection with the restructuring) on December 31, 1997, on a fully diluted basis, equal to the total amount of rent deferred. TWA has not concluded agreements with all of its creditors regarding its proposed debt restructuring. Thus, it remains uncertain whether TWA will file for protection under Chapter 11 of the Federal Bankruptcy Code.\n7. Viscount Restructuring Agreement\nRent Deferral - To assist Viscount with the funding of costs associated with Federal Aviation Regulation compliance relating to the Partnership's aircraft, the Partnership has entered into an agreement with Viscount to defer certain rents due the Partnership on one aircraft for a period of six months. The deferred rents, which aggregate $196,800, are being repaid by Viscount with interest at a rate of 6% per annum, beginning in October 1994, over the remaining lease term.\nMaintenance Advance - The Partnership has also agreed to extend a line of credit to Viscount for $127,000 to be used primarily for maintenance expenses relating to the Partnership's aircraft. In accordance with the agreement, the Partnership advanced Viscount $127,000 during 1994. Payments of interest at variable rates ranging from 8.75% to 9.18% per annum were paid by Viscount beginning in September 1994. Beginning in January 1995, level payments to amortize the advance over a 30-month period, with interest at a rate of 11.53% per annum, will be due in arrears.\nOption - The Partnership has the option to acquire approximately 0.6% of the issued and outstanding shares of Viscount stock as of July 26, 1994 for an option price of approximately $91,000. The option may be exercised at any time during the option period, which expires on July 20, 1999. This option is carried at zero value in the accompanying balance sheet as of December 31, 1994 due to the uncertainty of its realizability.\n8. Claims Related to Lessee Defaults\nBraniff Bankruptcy Claim - In July 1992, the Bankruptcy Court approved a stipulation embodying a settlement among PIMC, on behalf of the Partnership, the Braniff Creditor committees and Braniff in which it was agreed that First Security Bank of Utah, National Association, acting as trustee for the Partnership, would be allowed an administrative claim in the bankruptcy proceeding of approximately $230,769. In 1992, the Partnership received full payment of the claim, subject, however, to the requirement that 25% of total proceeds be held by PIMC in a separate, interest-bearing account pending notification by Braniff that all of the allowed administrative claims have been satisfied. The Partnership recognized 75% of the total claim as other revenue in the accompanying 1992 statement of operations. During 1994, the Partnership was advised that the 25% portion of the administrative claim proceeds with\ninterest could be released by PIMC to the Partnership. As a result, the Partnership recognized $67,958 as other revenue in the 1994 statement of operations.\nAir Zaire - As a result of legal action commenced by the general partner, a final settlement was reached with Air Zaire. Air Zaire paid to the Partnership approximately $2,885,000, of which approximately $1,570,000 has been applied to legal and maintenance expenses related to the default. The final expenses were paid in 1993 and approximately $915,000 was reflected as other income in the 1993 statement of operations. The remaining amount of $400,000, which was included in maintenance reserves in the December 31, 1993 balance sheet, was recognized as other revenue in 1994.\n9. Related Parties\nUnder the Limited Partnership Agreement (Partnership Agreement), the Partnership paid or agreed to pay the following amounts to PIMC and\/or its affiliates in connection with services rendered:\na. An aircraft management fee equal to 5% of gross rental revenues with respect to operating leases or 2% of gross rental revenues with respect to full payout leases of the Partnership, payable upon receipt of the rent. In 1994, 1993 and 1992, the Partnership paid management fees to PIMC of $604,551, $681,241 and $896,143, respectively. Management fees payable to PIMC at December 31, 1994 were $11,389. No payable was outstanding as of December 31, 1993.\nb. Reimbursement of certain out-of-pocket expenses incurred in connection with the management of the Partnership and supervision of its assets. In 1994, 1993 and 1992, $228,357, $407,582 and $275,312, respectively, were reimbursed by the Partnership for administrative expenses. Administrative reimbursements of $101,277 and $46,910 were payable at December 31, 1994 and 1993, respectively. Reimbursements for maintenance and remarketing costs of $305,200, $2,608,523 and $2,040,505 were paid by the Partnership in 1994, 1993 and 1992, respectively. Maintenance and remarketing reimbursements of $590,175 and $5,364 were payable at December 31, 1994 and 1993, respectively.\nc. A 10% interest in all cash distributions and sales proceeds, gross income in an amount equal to 9.09% of distributed cash available from operations and 1% of net income or loss and taxable income or loss, as such terms are defined in the Partnership Agreement.\nd. A subordinated sales commission of 3% of the gross sales price of each aircraft for services performed upon disposition and reimbursement of out-of-pocket and other disposition expenses. Subordinated sales commissions shall be paid only after limited partners have received distributions in an aggregate amount equal to their capital contributions plus a cumulative non-compounded 8% per annum return on their adjusted capital contributions, as defined in the Partnership Agreement. The Partnership did not pay or accrue a sales commission on any aircraft sales to date as the above subordination threshold has not been met.\ne. One engine owned by Polaris Aircraft Income Fund I (PAIF-I) is leased to Viscount beginning in April 1993 through a joint venture with the Partnership. The rental payments of $146,000 and $98,000 were offset against rent from operating leases in the 1994 and 1993 statement of operations, respectively.\nf. One engine was leased from PHC from September 1993 through April 1994 for use on the aircraft leased to NWT. The rental payments of $38,400 and $42,000 were offset against rent from operating leases in the 1994 and 1993 statement of operations, respectively.\n10. Income Taxes\nFederal and state income tax regulations provide that taxes on the income or loss of the Partnership are reportable by the partners in their individual income tax returns. Accordingly, no provision for such taxes has been made in the accompanying financial statements.\nThe net differences between the tax basis and the reported amounts of the Partnership's assets and liabilities at December 31, 1994 and 1993 are as follows:\nReported Amounts Tax Basis Net Difference\n1994: Assets $ 110,568,377 $ 108,560,932 $ 2,007,445 Liabilities 2,278,076 1,049,849 1,228,227\n1993: Assets $ 129,706,547 $ 120,984,013 $ 8,722,534 Liabilities 4,310,268 255,838 4,054,430\n11. Subsequent Events\nPromissory Note from ALG - As discussed in Note 4, the promissory note from ALG required a balloon payment of $897,932 due in January 1995. ALG paid $19,138 of this balloon payment in January 1995 which originated an event of default under the note. The Partnership and ALG subsequently restructured the terms of the promissory note. The renegotiated terms specify payment by ALG of the note balance with interest at a rate of 13% per annum with one lump sum payment in January 1995 of $254,733, eleven monthly payments of $25,600 beginning in February 1995, and a balloon payment in January 1996 of $416,631. ALG is current on the renegotiated payments.\nSale of Aircraft to American International Airways, Inc. (AIA) - The Partnership sold one Boeing 727-200 aircraft and hushkit, formerly leased to Delta, to AIA in February 1995 for a sales price of approximately $1.77 million. The Partnership agreed to accept payment of the sales price in 36 monthly installments of $55,000, with interest at a rate of 7.5% per annum, beginning in March 1995.\nContinental Restructuring - On January 26, 1995, Continental announced a number of actual and proposed changes in its operations and financial situation. In connection with those changes, Continental indicated that it was discussing with certain of its major lenders modifications to existing debt amortization schedules to enhance the airline's capital structure. Continental stated that during those discussions it would not be making payments to such lenders and lessors otherwise required under the current contracts. The Partnership is not engaged in any such discussions with Continental at the present time, and Continental has made all payments due to the Partnership on a current basis to date.\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\nPolaris Aircraft Income Fund II, A California Limited Partnership (PAIF-II or the Partnership) has no directors or officers. Polaris Holding Company (PHC) and its subsidiaries, including Polaris Aircraft Leasing Corporation (PALC) and Polaris Investment Management Corporation (PIMC), the general partner of the Partnership (collectively Polaris), have recently restructured their operations and businesses (the Polaris Restructuring). In connection therewith, PIMC has entered into a services agreement dated as of July 1, 1994 (the Services Agreement) with GE Capital Aviation Services, Inc. (the Servicer or GECAS), a Delaware corporation which is a wholly owned subsidiary of General Electric Capital Corporation, a New York corporation (GE Capital). GE Capital has been PHC's parent company since 1986. As subsidiaries of GE Capital, the Servicer and PIMC are affiliates.\nThe GE Capital Restructuring - GE Capital has recently completed a restructuring (the GE Capital Restructuring) of its commercial aviation operations, and as a result the owned and managed aircraft portfolios of certain of its affiliates, including its Polaris affiliates, are now managed by GECAS, subject in the case of Polaris investment programs to overall management and supervision by PIMC. The business of GECAS has combined commercial aviation activities formerly conducted by GE Capital's Polaris affiliates and its Transportation and Industrial Funding Corporation division (the T&I Division). In addition, GECAS will provide a significant range of aircraft management services to GPA Group plc, a public limited company organized in Ireland, together with its consolidated subsidiaries.\nThe Polaris Restructuring - In connection with the GE Capital Restructuring, the Servicer hired many of the employees who had performed the functions for Polaris and its investment programs (including the Partnership) that are now performed by the Servicer for PHC owned aircraft and for Polaris investment programs under the Services Agreement and under similar services agreements entered into by PIMC and\/or PALC with the Servicer relating to other Polaris investment programs.\nIn order to allow it to continue to be able to discharge its responsibilities as general partner of the Partnership, PIMC has retained certain of its employees. As of December 31, 1994, PIMC had seven full-time employees. In addition, certain employees of GECAS will serve as officers and directors of PIMC. The following management personnel will serve in the capacities shown opposite their names:\nName PIMC Title\nHoward L. Feinsand President; Director Richard J. Adams Vice President; Director Rodney Sirmons Director James W. Linnan Vice President John E. Flynn Vice President Robert W. Dillon Vice President; Assistant Secretary James F. Walsh Chief Financial Officer William C. Bowers Secretary\nSubstantially all of these management personnel will devote only such portion of their time to the business and affairs of PIMC as deemed necessary or appropriate.\nMr. Feinsand, 47, Senior Vice President and Manager, Capital Markets, Pricing and Investor Programs of GECAS, joined PIMC and PALC as Vice President, General Counsel and Assistant Secretary in April 1989. Effective July 1989, Mr. Feinsand assumed the position of Senior Vice President, and served as General Counsel and Secretary from July 1989 to August 1992. Mr. Feinsand, an attorney, was a partner in the New York law firm of Golenbock and Barell from 1987 through 1989. In his previous capacities, Mr. Feinsand served as counsel to PIMC and PALC. Mr. Feinsand also serves as a director on the board of Duke Realty Investments, Inc. Effective July 1, 1994, Mr. Feinsand held the positions of President and Director of PIMC.\nMr. Adams, 61, Senior Vice President, Aircraft Marketing - North America, served as Senior Vice President - Aircraft Sales and Leasing of PIMC and PALC effective August 1992, having previously served as Vice President - Aircraft Sales & Leasing, Vice President - North America, and Vice President - Corporate Aircraft since he joined PALC in August 1986. Effective July 1, 1994, Mr. Adams held the positions of Vice President and Director of PIMC.\nMr. Sirmons, 48, is Vice President, Portfolio and Risk Management for GECAS. During the last twenty-one years, he has held a variety of credit, underwriting and financial positions with several businesses within GE Capital and its predecessor. Effective July 1, 1994, Mr. Sirmons held the position of Director of PIMC.\nMr. Linnan, 53, became Vice President - Financial Management of PIMC and PALC effective April 1991, having previously served as Vice President - Investor Marketing of PIMC and PALC since July 1986. Effective July 1, 1994, Mr. Linnan held the position of Vice President of PIMC.\nMr. Flynn, 54, Senior Vice President and Manager, Task Force Marketing and General Manager, Cargo, of GECAS, served as Senior Vice President, Aircraft Marketing for PIMC and PALC effective April 1991, having previously served as Vice President, North America of PIMC and PALC effective July 1989. Mr. Flynn joined PALC in March 1989 as Vice President, Cargo. For the two years prior to joining PALC, Mr. Flynn was a transportation consultant. Effective July 1, 1994, Mr. Flynn held the position of Vice President of PIMC.\nMr. Dillon, 53, became Vice President - Aviation Legal and Insurance Affairs effective April 1989. Previously, he served as General Counsel of PIMC and PALC effective January 1986. Effective July 1, 1994, Mr. Dillon held the positions of Vice President and Assistant Secretary of PIMC.\nMr. Walsh, 45, Senior Vice President and Chief Financial Officer of GECAS, joined PIMC and PALC in March 1987. He served as Senior Vice President and Chief Financial Officer, having previously served as Vice President and Chief Financial Officer. Effective October, 1993, Mr. Walsh resigned as Senior Vice President and Chief Financial Officer of PIMC to assume new responsibilities at GE Capital. Effective July 1, 1994, Mr. Walsh held the position of Chief Financial Officer of PIMC.\nMr. Bowers, 48, Senior Vice President and Associate General Counsel of GECAS, joined that company in November, 1993. Prior to joining GECAS, Mr. Bowers, an attorney, was General Counsel of GPA Capital, the capital markets division of GPA Group plc, from June, 1990 to October, 1993. Prior to joining GECAS, Mr. Bowers was a partner in the New York office of Paul, Hastings, Janofsky & Walker from January, 1988 until June, 1990, having joined that firm as an Of Counsel in October, 1985. Effective November 18, 1994, Mr. Bowers held the position of Secretary of PIMC.\nThrough the personnel it has retained, PIMC will oversee the services to be performed by the Servicer under the Services Agreement, make decisions as to\nmatters that are effectively reserved to PIMC for decision by the Services Agreement, receive and analyze reports received from the Servicer, and otherwise discharge its responsibilities as general partner of the Partnership (See \"The Services Agreement\"). In addition, PIMC will continue to perform investor relations services for the Partnership and will continue to supervise ReSource\/Phoenix, a division of Phoenix Leasing Incorporated which, since August 1993, has been performing substantially all of the accounting and financial reporting services previously performed by PIMC, pursuant to a Program Accounting and Financial Reporting Administration Agreement. Since July 1994, ReSource\/Phoenix has also provided database time-share services, data processing services and investor transfer services pursuant to a Time- Share and Transfer Services Agreement.\nGECAS - GECAS is a global commercial aviation financial services company that (i) offers a broad range of financial products to airlines and aircraft operators, aircraft owners, lenders and investors, including financing leases, operating leases, tax-advantaged and other incentive-based financing and debt and equity financing, and (ii) provides management, marketing and technical support services to aircraft owners, lenders and investors, including GE Capital, its affiliates, and certain third parties.\nGECAS is the world's largest manager of commercial aircraft. From time to time, GE Capital and its affiliates are likely to acquire additional new and used aircraft which are expected to be included in the portfolio to be managed by GECAS. GECAS's managed portfolio includes other aircraft of the same type as those owned by the Partnership. Accordingly, the Servicer may have certain conflicts of interest in performing its duties under the Services Agreement. (See \"The Services Agreement\", herein.)\nThe Servicer has represented to PIMC that during the term of the Services Agreement the Servicer's net worth will be greater than $25,000,000, and has agreed during such term not to pay or make any dividends or distributions to its shareholder(s) which would have the effect of reducing the Servicer's net worth below that amount.\nThe Services Agreement - Under the Services Agreement, PIMC has engaged the Servicer to perform, or arrange for the performance of, aircraft management services, aircraft leasing and sales services, and certain portfolio management services. These services will include, inter alia, managing the Partnership's portfolio of aircraft, arranging for the re-leasing and sale of aircraft, preparing certain reports for the Partnership, employing persons to perform services for the Partnership, and otherwise performing various portfolio and partnership management functions. PIMC will continue to serve as general partner of the Partnership and will retain all of its rights, powers and interests as general partner. In its capacity as general partner, PIMC will exercise supervisory control over the Servicer's rendering of services in connection with the Partnership and will continue to have control and overall management of all matters relating to the Partnership's ongoing business and operations. The Servicer is not becoming a general partner of the Partnership and is not assuming any fiduciary duty that PIMC, as general partner, has had or will have.\nAs compensation for services provided by the Servicer, PIMC will pay to the Servicer (i) a portion of the aircraft management fees, cash available from operations and cash available from sales proceeds received by PIMC under the Partnership Agreement, and (ii) all sales commissions received by PIMC under the Partnership Agreement with respect to sales of Partnership aircraft arranged by the Servicer. The Servicer will also receive an amount equal to the reimbursement for Partnership expenses which PIMC receives from the Partnership on account of expenses incurred by the Servicer in performing\nservices pursuant to the Services Agreement. The expense reimbursement limitations in the Partnership Agreement will not be affected by the Services Agreement.\nThe Services Agreement recognizes that the Servicer will be providing services with respect to the separate aircraft of GE Capital and its affiliates as well as with respect to the aircraft of third parties, and that conflicts of interest may arise as a result. The Servicer is required to perform services under the Services Agreement in good faith and, to the extent that a particular Partnership aircraft and other aircraft then in the Servicer's managed portfolio are substantially similar in terms of relevant objectively identifiable characteristics, the Servicer must not discriminate between such aircraft on the basis of ownership, fees payable to the Servicer, or on an unreasonable basis. The Services Agreement also requires the Servicer to perform services in accordance with all applicable laws, in a manner consistent with all applicable provisions of the Partnership Agreement, and with such care and in accordance with such standards of performance as would have been applied to PIMC had PIMC performed the services directly.\nThe Services Agreement requires the Servicer to take any actions relating to the Services Agreement that PIMC may direct so long as such actions are reasonably deemed by PIMC to be necessary or appropriate in order to permit PIMC to fulfill its fiduciary duties as general partner of the Partnership or otherwise to be in the best interest of the Partnership or its limited partners. Furthermore, certain actions with respect to the Partnership may not be taken by the Servicer without the prior approval of PIMC. Such actions include, among others: (i) selling or otherwise disposing of one or more aircraft by the Partnership (including the sale or other disposition of an aircraft as parts or scrap); (ii) entering into any new lease (or any renewal or extension of an existing lease) with respect to any aircraft; (iii) terminating or modifying any lease with respect to any aircraft; (iv) financing or refinancing one or more aircraft by the Partnership; (v) making material capital, maintenance or inspection expenditures for the Partnership; (vi) hiring any broker to sell or lease any aircraft; (vii) entering into any contract (including any contract of sale), agreement or instrument other than a contract, agreement or instrument entered into in the ordinary course of business that has a term of less than one year and that does not contemplate payments which will exceed, over the term of the contract, agreement or instrument, $100,000 in the aggregate; (viii) changing in any material respect the type or amount of insurance coverage in place for the Partnership; and (ix) incurring any Partnership expenses for which the Servicer will seek reimbursement pursuant to the Services Agreement which exceed in the aggregate, for any calendar month, the sum of $10,000. Absent PIMC authorization, it is contemplated that the Servicer will not enter into contracts, agreements or instruments on behalf of the Partnership.\nAbsent earlier termination based on certain events (including the withdrawal, removal or replacement of PIMC as general partner of the Partnership), the Services Agreement will terminate upon the completion of the winding up and liquidation of the Partnership and the distribution of all of its assets.\nCertain Legal Proceedings:\nAs reported in the Partnership's 1990 Form 10-K, on June 8, 1990, a purported class action entitled Harner, et al., v. Prudential Bache Securities, Inc. et al., (to which the Partnership was not a party) was filed by certain purchasers of units in a 1983 and 1984 public offering in several corporate aircraft public partnerships. Polaris Aircraft Leasing Corporation and Polaris Investment Management Corporation were named as two of the defendants in this action. On September 24, 1991, the court entered an order in favor of Polaris Aircraft Leasing Corporation and Polaris Investment Management Corporation granting their motion for summary judgment and dismissing the plaintiffs' complaint with prejudice. On March 13, 1992, plaintiff filed a notice of appeal to the United States Court of Appeals for the Sixth Circuit. On August 21, 1992, the Sixth Circuit ordered consolidation of the appellants' causes for the purposes of briefing and submission. On September 9, 1994, the Sixth Circuit affirmed the lower court's decision dismissing the action.\nOn October 27, 1992, a class action complaint entitled Weisl, Jr. et al., v. Polaris Holding Company, et al. was filed in the Supreme Court of the State of New York for the County of New York. The complaint sets forth various causes of action which include allegations against certain or all of the defendants (i) for alleged fraud in connection with certain public offerings, including that of the Partnership, on the basis of alleged misrepresentation and alleged omissions contained in the written offering materials and all presentations allegedly made to investors; (ii) for alleged negligent misrepresentation in connection with such offerings; (iii) for alleged breach of fiduciary duties; (iv) for alleged breach of third party beneficiary contracts; (v) for alleged violations of the NASD Rules of Fair Practice by certain registered broker dealers; and (vi) for alleged breach of implied covenants in the customer agreements by certain registered brokers. The complaint seeks an award of compensatory and other damages and remedies. On January 19, 1993, plaintiffs filed a motion for class certification. On March 1, 1993, defendants filed motions to dismiss the complaint on numerous grounds, including failure to state a cause of action and statute of limitations. On July 20, 1994, the court entered an order dismissing almost all of the claims in the complaint and amended complaint. Certain claims, however, remain pending. Plaintiffs filed a notice of appeal on September 2, 1994. The Partnership is not named as a defendant in this action.\nOn or around February 17, 1993, a civil action entitled Einhorn, et al. v. Polaris Public Income Funds, et al., was filed in the Circuit Court of the 11th Judicial Circuit in and for Dade County, Florida against, among others, Polaris Investment Management Corporation and Polaris Depositary Company. Plaintiffs seek class action certification on behalf of a class of investors in Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and Polaris Aircraft Income Fund VI who purchased their interests while residing in Florida. Plaintiffs allege the violation of Section 517.301, Florida Statutes, in connection with the offering and sale of units in such Polaris Aircraft Income Funds. Among other things, plaintiffs assert that the defendants sold interests in such Polaris Aircraft Income Funds while \"omitting and failing to disclose the material facts questioning the economic efficacy of\" such Polaris Aircraft Income Funds. Plaintiffs seek rescission or damages, in addition to interest, costs, and attorneys' fees. On April 5, 1993, defendants filed a motion to stay this action pending the final determination of a prior filed action in the Supreme Court for the State of New York entitled Weisl v. Polaris Holding Company. On that date, defendants also filed a motion to dismiss the complaint on the grounds of failure to attach necessary documents, failure to plead fraud with particularity and failure to plead reasonable reliance. On April 13, 1993, the court denied the defendants' motion to stay. On May 7, 1993, the court stayed the action pending an appeal of the denial of the motion\nto stay. Defendants subsequently filed with the Third District Court of Appeal a petition for writ of certiorari to review the lower court's order denying the motion to stay. On October 19, 1993, the Court of Appeal granted the writ of certiorari, quashed the order, and remanded the action with instruction to grant the stay. The Partnership is not named as a defendant in this action.\nOn or around May 14, 1993, a purported class action entitled Moross, et al., v. Polaris Holding Company, et al., was filed in the United States District Court for the District of Arizona. This purported class action was filed on behalf of investors in Polaris Aircraft Income Funds I - VI by nine investors in such Polaris Aircraft Income Funds. The complaint alleges that defendants violated Arizona state securities statues and committed negligent misrepresentation and breach of fiduciary duty by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the above- named funds. An amended complaint was filed on September 17, 1993, but has not been served upon defendants. On or around October 4, 1993, defendants filed a notice of removal to the United States District Court for the District of Arizona. Defendants also filed a motion to stay the action pending the final determination of a prior filed action in the Supreme Court for the State of New York entitled Weisl v. Polaris Holding Company (\"Weisl\") and to defendants' time to respond to the complaint until 20 days after disposition of the motion to action pending resolution of the motions for class certification and motions to dismiss pending in Weisl. On January 20, 1994, the court stayed the action and required defendants to file status reports every sixty days setting forth the status of the motions in Weisl. The Partnership is not named as a defendant in this action.\nOn September 21, 1993, a purported derivative action entitled Novak, et al., v. Polaris Holding Company, et al., was filed in the Supreme Court of the State of New York, County of New York. This action was brought on behalf of the Partnership, Polaris Aircraft Income Fund I and Polaris Aircraft Income Fund III. The complaint names as defendants Polaris Holding Company, its affiliates and others. Each of the Partnership, Polaris Aircraft Income Fund I and Polaris Aircraft Income Fund III is named as a nominal defendant. The complaint alleges, among other things, that defendants mismanaged the Partnership and the other Polaris Aircraft Income Funds, engaged in self- dealing transactions that were detrimental to the Partnership and the other Polaris Aircraft Income Funds and failed to make required disclosure in connection with the sale of the units in the Partnership and the other Polaris Aircraft Income Funds. The complaint alleges claims of breach of fiduciary duty and constructive fraud and seeks, among other things an award of compensatory and punitive damages in an unspecified amount, re-judgment interest, and attorneys' fees and costs. On January 13, 1994, certain of the defendants, including Polaris Holding Company, filed motions to dismiss the complaint on the grounds of, among others, failure to state a cause of action and failure to plead the alleged wrong in detail. On August 11, 1994, the court denied in part and granted in part defendants' motions to dismiss. Specifically, the court denied the motions as to the claims for breach of fiduciary duty, but dismissed plaintiffs' claim for constructive fraud with leave to replead. On October 7, 1994, defendants filed a notice of appeal. On November 15, 1994, defendants submitted an answer to the remaining causes of action.\nOn or around March 13, 1993, a purported class action entitled Kahn v. Polaris Holding Company, et al., was filed in the Supreme Court of the State of New York, County of New York. This purported class action on behalf of investors in Polaris Aircraft Income Fund V (\"PAIF V\") was filed by one investor in PAIF V. The complaint names as defendants Polaris Investment Management Corporation, Polaris Holding Company, its affiliates and others. The complaint charges defendants with common law fraud, negligent misrepresentation and\nbreach of fiduciary duty in connection with certain misrepresentations and omissions allegedly made in connection with the sale of interest in PAIF V. Plaintiffs seek compensatory and consequential damages in an unspecified amount, plus interest, disgorgement and restitution of all earnings, profits and other benefits received by defendants as a result of their alleged practices, and attorneys' fees and costs. Defendants' time to move, answer or otherwise plead with respect to the complaint was extended by stipulation up to and including April 24, 1995. The Partnership is not named as a defendant in this action.\nOn June 8, 1994, a consolidated complaint captioned In re Prudential Securities Inc. Limited Partnerships Litigation was filed in the United States District Court for the Southern District of New York, purportedly consolidating cases that had been transferred from other federal courts by the Judicial Panel on Multi-District Litigation. The consolidated complaint names as defendants Prudential entities and various other sponsors of limited partnerships sold by Prudential, including Polaris Holding Company, one of its former officers, Polaris Aircraft Leasing Corporation, Polaris Investment Management Corporation and Polaris Securities Corporation. The complaint alleges that the Prudential defendants created a scheme for the sale of approximately $8-billion of limited partnership interests in 700 assertedly high-risk limited partnerships, including the Partnership, to approximately 350,000 investors by means of false and misleading offering materials; that the sponsoring organizations (including the Polaris entities) participated with the Prudential defendants with respect to, among other things, the partnerships that each sponsored; and that all of the defendants conspired to engage in a nationwide pattern of fraudulent conduct in the marketing of all limited partnerships sold by Prudential. The complaint alleges violations of the federal Racketeer Influenced and Corrupt Organizations Act and the New Jersey counterpart thereof, fraud, negligent misrepresentation, breach of fiduciary duty and breach of contract. The complaint seeks rescission, unspecified compensatory damages, treble damages, disgorgement of profits derived from the alleged acts, costs and attorneys fees. On October 31, 1994, Polaris Investment Management Corporation and other Polaris entities filed a motion to dismiss the consolidated complaint on the grounds of, inter alia, statute of limitations and failure to state a claim. The Partnership is not named as a defendant in this action.\nA further litigation captioned Romano v. Ball et. al, an action by Prudential Insurance Company policyholders against many of the same defendants (including Polaris Investment Management Corporation and Polaris Aircraft Leasing Corporation), has also been commenced by policy holders of the Prudential Insurance Company as a purported derivative action on behalf of the Prudential Insurance Company. The complaint alleges claims under the federal Racketeer Influenced and Corrupt Organizations Act, as well as claims for waste, mismanagement and intentional and negligent misrepresentation, and seeks unspecified compensatory, treble and punitive damages. The case is being coordinated with In re Prudential.\nOn or about February 6, 1995, a class action complaint entitled Cohen, et al. v. J.B. Hanauer & Company, et al. was filed in the Circuit Court of the Fifteenth Judicial Circuit in and for Palm Beach County, Florida. The complaint names J.B. Hanauer & Company, General Electric Capital Corporation, General Electric Financial Services, Inc., and General Electric Company as defendants. The action purports to be on behalf of \"approximately 5,000 persons throughout the United States\" who purchased units in Polaris Aircraft Income Funds I through VI. The complaint sets forth various causes of action which include allegations against certain or all of the defendants (i) for violation of Section 12(2) of the Securities Act of 1933, as amended, by a registered broker dealer and for violation of Section 15 of such act by all defendants in connection with certain public offerings, including that of the\nPartnership, on the basis of alleged misrepresentation and alleged omissions contained in the written offering materials and all presentations allegedly made to investors; (ii) for alleged fraud in connection with such offerings; (iii) for alleged negligent misrepresentation in connection with such offerings; (iv) for alleged breach of fiduciary duties; (v) for alleged breach of third party beneficiary contracts; (vi) for alleged violations of the NASD Rules of Fair Practice by a registered broker dealer; and (vii) for alleged breach of implied covenants in the customer agreements by a registered broker dealer. The complaint seeks an award of compensatory and punitive damages and other remedies. The Partnership is not named as a defendant in this action.\nOn or about January 12, 1995, a class action complaint entitled Cohen, et al. v. Kidder Peabody & Company, Inc., et al. was filed in the Circuit Court of the Fifteenth Judicial Circuit in and for Palm Beach County, Florida. The complaint names Kidder Peabody & Company, Inc., General Electric Capital Corporation, General Electric Financial Services, Inc., and General Electric Company as defendants. The action purports to be on behalf of \"approximately 20,000 persons throughout the United States\" who purchased units in Polaris Aircraft Income Funds III through VI. The complaint sets forth various causes of action which include allegations against certain or all of the defendants (i) for violation of Section 12(2) of the Securities Act of 1933, as amended, by a registered broker dealer and for violation of Section 15 of such act by all defendants in connection with certain public offerings on the basis of alleged misrepresentation and alleged omissions contained in the written offering materials and all presentations allegedly made to investors; (ii) for alleged fraud in connection with such offerings; (iii) for alleged negligent misrepresentation in connection with such offerings; (iv) for alleged breach of fiduciary duties; (v) for alleged breach of third party beneficiary contracts; (vi) for alleged violations of the NASD Rules of Fair Practice by a registered broker dealer; and (vii) for alleged breach of implied covenants in the customer agreements by a registered broker dealer. The complaint seeks an award of compensatory and punitive damages and other remedies. The Partnership is not named as a defendant in this action.\nOn or about February 13, 1995, an action entitled Adams, et al. v. Prudential Securities, Inc. et al. was filed in the Court of Common Pleas, Stark County, Ohio. The action names Prudential Securities, Inc., Prudential Insurance Company of America, Polaris Investment Management Corporation, Polaris Securities Corporation, Polaris Aircraft Leasing Corporation, Polaris Holding Company, General Electric Capital Corporation, Polaris Aircraft Income Fund I, Polaris Aircraft Income Fund IV, Polaris Aircraft Income Fund V and James Darr as defendants. The complaint alleges that defendants committed common law fraud, fraud in the inducement, negligent misrepresentation, negligence, breach of fiduciary duty and civil conspiracy by misrepresenting and failing to disclose material facts in connection with the sale of limited partnership units in the Partnership and the other Polaris Aircraft Income Funds. Plaintiffs seek, among other things, rescission of their investments in the Partnership and the other Polaris Aircraft Income Funds, an award of compensatory damages in an unspecified amount plus interest thereon, and punitive damages in an unspecified amount. On or about March 15, 1995, defendants filed a Notice of Removal to the United States District Court for the Northern District of Ohio, Eastern Division. The Partnership is not named as a defendant in this action.\nOther Proceedings - Part I, Item 3 discusses certain other actions arising out of certain public offerings, including that of the Partnership, to which both the Partnership and its general partner are parties.\nDisclosure pursuant to Section 16, Item 405 of Regulation S-K:\nBased solely on its review of the copies of such forms received or written representations from certain reporting persons that no Forms 3, 4, or 5 were required for those persons, the Partnership believes that, during 1994 all filing requirements applicable to its officers, directors and greater than ten percent beneficial owners were met.\nItem 11.","section_11":"Item 11. Executive Compensation\nPAIF-II has no directors or officers. PAIF-II is managed by PIMC, the General Partner. In connection with management services provided, management and advisory fees of $604,551 were paid to PIMC in 1994.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\na) No person owns of record, or is known by PAIF-II to own beneficially, more than five percent of any class of voting securities of PAIF-II.\nb) The General Partner of PAIF-II owns the equity securities of PAIF-II as set forth in the following table:\n(1) (2) (3) (4) Title Name of Amount and Nature of Percent of Class Beneficial Owner Beneficial Ownership of Class\nGeneral Polaris Investment Represents a 10.0% interest 100% Partner Management of all cash distributions, Interest Corporation gross income in an amount equal to 9.09% of distributed cash available from operations, and a 1% interest in net income or loss\nc) There are no arrangements known to PAIF-II, including any pledge by any person of securities of PAIF-II, the operation of which may at a subsequent date result in a change in control of PAIF-II.\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\n1. Financial Statements.\nThe following are included in Part II of this report: Page No.\nReport of Independent Public Accountants 20 Balance Sheets 21 Statements of Operations 22 Statements of Changes in Partners' Capital (Deficit) 23 Statements of Cash Flows 24 Notes to Financial Statements 25\n2. Reports on Form 8-K.\nNone.\n3. Exhibits required to be filed by Item 601 of Regulation S-K.\n10. Material Contracts.\na. Services Agreement.\n27. Financial Data Schedules (Filed electronically only).\n4. Financial Statement Schedules.\nAll financial statement schedules are omitted because they are not applicable, not required or because the required information is included in the financial statements or 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.\nPOLARIS AIRCRAFT INCOME FUND II, A California Limited Partnership (REGISTRANT) By: Polaris Investment Management Corporation General Partner\nMarch 23, 1995 By: \/S\/ Howard L. Feinsand --------------------- -------------------------------- Date Howard L. Feinsand, 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\/Howard L. Feinsand Chairman of the Board and March 23, 1995 --------------------- President of Polaris -------------- (Howard L. Feinsand) Investment Management Corporation, General Partner of the Registrant\n\/S\/Richard J. Adams Vice President and Director of March 23, 1995 ------------------- Polaris Investment Management -------------- (Richard J. Adams) Corporation, General Partner of the Registrant\n\/S\/James F. Walsh Chief Financial Officer of March 23, 1995 ----------------- Polaris Investment Management -------------- (James F. Walsh) Corporation, General Partner of the Registrant","section_15":""}
{"filename":"730409_1994.txt","cik":"730409","year":"1994","section_1":"Item 1. BUSINESS\nGeneral Development of the Business\nThe Claridge Hotel and Casino Corporation (the \"Corporation\"), a New York corporation was formed on August 26, 1983, and qualified to engage in business in New Jersey as a foreign corporation in September 1983. The Corporation holds all of the shares of capital stock of The Claridge at Park Place, Incorporated, a New Jersey corporation (\"New Claridge\"), which was formed on August 29, 1983. On October 31, 1983, New Claridge acquired certain assets of The Claridge Hotel and Casino (\"Claridge\"), including gaming equipment (\"Casino Assets\"), from Del E. Webb New Jersey, Inc. (\"DEWNJ\") a wholly-owned subsidiary of Del Webb Corporation (\"Webb\"); leased certain other of the Claridge's assets, including the buildings, parking facility and non-gaming, depreciable, tangible property of the Claridge (\"Hotel Assets\"), from Atlantic City Boardwalk Associates, L.P., a New Jersey limited partnership (\"Partnership\"); subleased the land on which the Claridge is located from the Partnership; assumed certain liabilities related to the acquired assets; and undertook to carry on the business of the Claridge.\nThese transactions were entered into in connection with the private placement of equity interests in the Corporation and the Partnership. The offering was structured to furnish the investors with certain tax benefits available under the federal tax law then in effect. Following the 1983 transactions, Webb and its affiliates retained significant interests in the Claridge. The common stock of the Corporation and the limited partnership interests of the Partnership were sold together in the private placement as units, and because there has been relatively little trading in the stock or Partnership interests, there is a substantial similarity between the equity ownership of the Corporation and the Partnership. Although the Corporation and the Partnership are independent entities, approximately 93% of the Corporation's common stock is owned by persons who also own limited partnership interests in the Partnership. The Partnership does not currently engage in any significant business activities other than those relating to the Claridge.\nIn October 1988, the Corporation and New Claridge entered into an agreement to restructure the financial obligations of the Corporation and New Claridge (the \"Restructuring Agreement\"). The restructuring, which was consummated in June 1989, resulted in (i) a reorganization of the ownership interests in the Claridge; (ii) modifications of the rights and obligations of certain lenders; (iii) satisfaction and termination of the obligations and commitments of Webb and DEWNJ under the original structure; (iv) modifications of the lease agreements between New Claridge and the Partnership; and (v) the forgiveness by Webb of substantial indebtedness (see Item 1. Business - \"1989 Restructuring\").\nIn October 1983, the Partnership granted to New Claridge the Expandable Wraparound Mortgage which was inclusive of and subordinate to an $80 million first mortgage (the \"First Mortgage\") granted by the Partnership to a group of banks and a $47 million purchase money second mortgage (the \"Purchase Money Second Mortgage\") granted by the Partnership to DEWNJ. The Purchase Money Second Mortgage was subsequently cancelled upon satisfaction of certain conditions agreed to in the Restructuring Agreement. (see Item 1. Business -\"1989 Restructuring\" and \"Certain Transactions and Agreements\").\nThe Casino Assets are owned by New Claridge. The Hotel Assets and underlying land are owned by the Partnership and leased by the Partnership to New Claridge. The lease obligations are set forth in a lease (the \"Operating Lease\"), originally entered into on October 31, 1983, and an expansion operating lease (the \"Expansion Operating Lease\"), covering additions to the Claridge made in 1986. Pursuant to the Restructuring Agreement, the Operating Lease and Expansion Operating Lease were amended to provide for the deferral by the Partnership of $15.1 million of rental payments and the abatement by the Partnership of $38.8 million of basic rent payable through 1998 (see Item 1. Business - \"Certain Transaction and Agreements\").\nThe Corporation maintains its executive and administrative offices at Indiana Avenue and the Boardwalk, Atlantic City, New Jersey 08401, telephone number (609) 340-3400.\nRecent Business Developments\nOn January 31, 1994, the Corporation completed an offering of $85 million of First Mortgage Notes (the \"Notes\") due 2002, bearing interest at 11 3\/4%. The Notes are secured by (i) a non-recourse mortgage granted by the Partnership representing a first lien on the Hotel Assets, (ii) a pledge granted by the Corporation of all outstanding shares of capital stock of New Claridge, and (iii) a guarantee by New Claridge. New Claridge's guarantee of the Notes is secured by a collateral assignment of the second lien Expandable Wraparound Mortgage, and by a lien on the Claridge's gaming and other assets, which lien will be subordinated to liens that may be placed on those gaming and other assets to secure any future revolving credit line arrangement. Interest on the Notes is payable semiannually on February 1 and August 1 of each year, commencing August 1, 1994.\nA portion of the net proceeds of $82.2 million was used as follows:\n(i) to repay in full the Corporation's outstanding debt under the Revolving Credit and Term Loan Agreement (the \"Loan Agreement\"), including the outstanding balance of the Corporation's revolving credit line, which was secured by the First Mortgage. In conjunction with the full satisfaction of the Loan Agreement, the Corporation's revolving credit line arrangement was terminated. The Corporation is currently seeking to obtain a new line of credit arrangement;\n(ii) to fund the cost of a 12,000 square foot expansion of New Claridge's casino capacity, the addition of approximately 500 slot machines, and the relocation of two restaurants and their related kitchen areas. The total cost of this expansion, which became fully operational on June 30, 1994, was approximately $12.7 million; and\n(iii) the acquisition of an adjacent parcel of land, to be used for the construction of a self-parking facility. In March 1994, New Claridge acquired options to purchase for $7,500,000 two parcels of property adjacent to its existing valet-parking facility. On June 6, 1994, New Claridge exercised these options, and deposited $400,000 with the Title Company of Jersey, to be held in escrow until settlement. In an effort to ensure that site preparation and construction of the self- parking facility could commence as soon as possible, New Claridge purchased an assignment of National Westminster Bank NJ's first mortgage interest in the property on November 3, 1994 for $2,040,000. These acquisitions gave New Claridge control of the property as of November 16, 1994. The first mortgage interest was satisfied by the mortgagor at settlement, which occurred on January 5, 1995.\nThe balance of the net proceeds from the offering of the Notes are expected to be used as follows:\n(i) the construction of the self-parking facility;\n(ii) the possible purchase of the Contingent Payment (see Item 1. Business-\"1989 Restructuring\") granted in 1989 and now held in a trust for the benefit of the United Way of Arizona. The Corporation is currently negotiating to purchase the Contingent Payment, for substantially less than face value, from the trustee for the United Way of Arizona. The Corporation previously offered to purchase the Contingent Payment for $10 million, but that offer was not accepted. Negotiations between the trustee for the United Way of Arizona and the Corporation are continuing; and\n(iii) the potential expansion of the Corporation's activities into emerging gaming markets. On March 16, 1994, Claridge Gaming Incorporated (\"CGI\") was formed as a wholly-owned subsidiary of the Corporation for the purpose of developing gaming opportunities in other jurisdictions.\nOn November 8, 1994, a casino management agreement (the \"Casino Management Agreement\") was executed between CGI and St. Petersburg Kennel Club, Inc. (\"SPKC\"), which owns a greyhound racetrack located in St. Petersburg, Florida. Pursuant to the Casino Management Agreement, which expires on December 31, 1997, CGI would receive fees for managing any casino entertainment facility authorized at SPKC's site. In November 1994, Florida voters rejected a ballot question which would have authorized up to 47 casinos in the state of Florida, including one at SPKC's St. Petersburg greyhound race track.\nThe Claridge\nThe Claridge, located in the Boardwalk casino section of Atlantic City, New Jersey, is a 26-story building that contains the Corporation's casino and hotel facilities. Built in 1929 as a hotel, the Claridge was remodeled at a cost of approximately $138 million prior to its reopening as a casino hotel in 1981. The Claridge was renovated and expanded in 1986 at a cost of approximately $20 million, which provided approximately 10,000 additional square feet of casino space, together with a 3,600 square foot lounge (\"Expansion Improvements\"). In 1994, approximately $12.7 million was expended to expand the Claridge's casino square footage by approximately 12,000 feet. Since 1991, the Claridge's exterior, lobby, and other public areas have been refurbished. The Claridge is currently in the process of redecorating all of its guest rooms, and has completed the redecoration of approximately 250 rooms, with the remainder scheduled for completion by the end of 1995.\nThe Claridge's casino consists of approximately 56,000 square feet of casino space on three main levels with various adjacent mezzanine levels. The casino currently contains approximately 1,890 slot machines and seventy-six table games, including forty-five blackjack tables, ten craps tables, eight poker tables, six roulette tables, two Caribbean stud poker tables, one mini-baccarat table, one big six wheel, one red dog table, one sic bo table, and one pai gow poker table, as well as a keno operation. The hotel with related amenities consists of 501 guest rooms (including 66 two- and three-room suites, 26 specialty suites and four tower penthouse suites), four restaurants, a buffet area, three lounges, a private players club, a 600-seat theater, limited meeting rooms, a gift shop, a beauty salon, and a health club with an indoor swimming pool.\nNew Claridge experiences a seasonal fluctuation in demand, which is typical of casino-hotel operations in Atlantic City. Historically, peak demand has occurred during the summer season. New Claridge's principal market is the Mid-Atlantic area of the United States. Casino gaming in Atlantic City is\nhighly competitive and is strictly regulated under the New Jersey Casino Control Act (the \"Act\") and regulations thereunder which affect virtually all aspects of casino operations. (See Item 1. Business - \"Competition\" and \"Gaming Regulation and Licensing\").\n1989 Restructuring\nOn October 27, 1988, the parties with an economic interest in the Corporation and New Claridge, including the banks holding the First Mortgage (the \"First Mortgage Lenders\"), executed the Restructuring Agreement with respect to the restructuring of the financial obligations of the Corporation and New Claridge. Had the Corporation not entered into the Restructuring Agreement, New Claridge probably would not have been relicensed by the New Jersey Casino Control Commission (the \"Commission\") for the license period beginning October 31, 1988 and ending October 31, 1989, and would have had to consider filing for bankruptcy protection. The Restructuring Agreement by its terms was subject to approval by at least two-thirds in interest of the limited partners of the Partnership and the holders of at least two-thirds of the Class A Stock of the Corporation. These approvals were received, and the restructuring was consummated in June 1989. The restructuring resulted in (i) a reorganization of the ownership interest in the Corporation; (ii) modifications of the rights and obligations of certain lenders; (iii) satisfaction and termination of the obligations and commitments of Webb and DEWNJ under the original structure; (iv) modifications of the lease agreements between New Claridge and the Partnership; and (v) the forgiveness by Webb of substantial indebtedness. As a result of the restructuring, an aggregate of $132 million of indebtedness was forgiven. The principal amount secured by the First Mortgage was reduced by approximately $15 million to approximately $74.5 million outstanding at June 16, 1989, and the Purchase Money Second Mortgage was subsequently cancelled upon satisfaction of certain conditions agreed to in the Restructuring Agreement.\nDEWNJ assigned to the First Mortgage Lenders all right, title and interest of DEWNJ in, to and under the Purchase Money Second Mortgage previously executed and delivered by the Partnership. New Claridge retained the right to require the First Mortgage Lenders to cancel and release the Purchase Money Second Mortgage and the obligations secured thereunder upon the occurrence of one or more specified conditions. New Claridge met one of these conditions, and accordingly, the First Mortgage Lenders cancelled the Purchase Money Second Mortgage, including interest which accrued at 14%, and released the obligations secured thereunder.\nAt the closing of the restructuring on June 16, 1989, Webb transferred all of its right, title, and interest to its Claridge land, easements, and air rights to the Partnership, which had the effect of eliminating the land lease between Webb and the Partnership and of subjecting that land to a direct lease (rather than a sublease) from the Partnership to New Claridge.\nPursuant to amendments to the Operating Lease and Expansion Operating Lease, the Partnership agreed to deferrals and abatement of basic rent (see Item 1. Business - \"Certain Transactions and Agreements\").\nIn addition, the Partnership loaned $3.6 million to New Claridge. That amount represented substantially all the cash and cash equivalents remaining in the Partnership as of June 16, 1989 other than funds needed to pay expenses incurred through the closing of the restructuring. The Partnership paid to New Claridge $100,000 for the cancellation of an option agreement relating to the land underlying the Claridge.\nThe Restructuring Agreement provided that Webb would retain an interest equal to $20 million plus interest from December 1, 1988 at the rate of 15% per annum compounded quarterly (the \"Contingent Payment\") in any proceeds ultimately recovered from the operations and\/or the sale or refinancing of the Claridge facility in excess of the first mortgage loan and other liabilities. To give effect to this Contingent Payment, the Corporation and the Partnership agreed not to make any distributions to the holders of their equity securities, whether derived from operations or from sale or refinancing proceeds, until Webb had received the Contingent Payment.\nIn connection with the restructuring, Webb agreed to grant those investors in the Corporation and the Partnership (\"Releasing Investors\") from whom Webb had received written releases from all liabilities rights (\"Contingent Payment Rights\") to receive certain amounts to the extent available for application to the Contingent Payment. Approximately 81% in interest of the investors provided releases and became Releasing Investors. Payments to Releasing Investors are to be made in accordance with the following schedule of priorities:\n(i) Releasing Investors would receive 81% of the first $10 million of any net proceeds from operations or a sale or a refinancing of the Claridge facility pursuant to an agreement executed within five years (\"Five-Year Payments\") after the restructuring (i.e., the sum obtained by multiplying the lesser of $10 million of, or the total of, any Five-Year Payments by 81%, with the balance of any such funds to be applied against the Contingent Payment), and\n(ii) All distributions of funds other than Five-Year Payments, or of Five-Year Payments in excess of the $10 million, would be shared by Webb and Releasing Investors in the following proportions: Releasing Investors will receive 40.5% (one-half of 81%) of any such excess proceeds, with the balance of any such funds to be applied against the Contingent Payment, until the Contingent Payment is paid in full ($20 million plus accrued interest.)\nOn April 2, 1990, Webb transferred its interest in the Contingent Payment to an irrevocable trust for the benefit of the United Way of Arizona, and upon such transfer Webb was no longer required to be qualified or licensed by the Commission.\nAs previously noted, the Corporation is continuing its negotiations with the Trustee for the United Way of Arizona in an attempt to purchase the Contingent Payment. (See Item 1. Business - \"Recent Business Developments\").\nCertain Transactions and Agreements\nOn October 31, 1983, the Corporation and\/or New Claridge completed the following transactions and entered into the following agreements. On March 17, 1986, certain of these agreements were amended and certain new agreements were entered into relating to the construction and financing of the Expansion Improvements. On June 16, 1989, with the closing of the restructuring, certain of these agreements were further amended.\na. Closing of Offering of Class A Stock. The Corporation sold 4,500,000 shares of Class A Stock through a private offering, with net proceeds to the Corporation after payment of selling commissions and fees (but before payment of other expenses of the offering) of $5,051,000.\nb. Asset Purchase Agreement. Pursuant to an asset purchase agreement (the \"Asset Purchase Agreement\"), New Claridge purchased the Casino Assets from DEWNJ, as successor to Claridge Limited (\"Old Claridge\") and assumed related\nliabilities and paid approximately $5 million. New Claridge assumed the collective bargaining contracts and employment contracts of employees of Old Claridge employed in connection with the operation of the Claridge other than those providing maintenance and engineering services, which employees were employed by DEWNJ.\nc. Operating Lease\/Expansion Operating Lease. New Claridge leased from the Partnership the Hotel Assets and subleased from the Partnership the land on which the Claridge is located for an initial term of 15 years with three 10-year renewal options. Basic annual rent payable during the initial term of the Operating Lease in equal monthly installments was $36,055,000 in 1992, $37,080,000 in 1993, $38,055,000 in 1994 and escalates yearly thereafter up to $41,775,000 in 1997 and $32,531,000 for the nine month period ending September 30, 1998. If New Claridge exercises its option to extend the term of the Operating Lease, basic rent during the renewal term will be calculated pursuant to a formula, with such rent not to be more than $29,500,000 nor less than $24,000,000 for the lease year commencing October 1, 1998 through September 30, 1999, and, subsequently, not to be greater than 10% more than the basic rent for the immediately preceding lease year in each lease year thereafter. New Claridge is also required to pay as additional rent amounts including certain taxes, insurance and other charges relating to the occupancy of the land and Hotel Assets, certain expenses and debt service relating to furniture, fixture and equipment replacements and building improvements (collectively, \"FF&E Replacements\") and the general and administrative costs of the Partnership. The Partnership will be required during the entire term of the Operating Lease to provide FF&E Replacements to New Claridge and until September 30, 1998 will be required to provide facility maintenance and engineering services to New Claridge.\nUnder the Operating Lease, New Claridge is required to lend the Partnership any amounts (\"FF&E Loans\") necessary to fund the cost of FF&E Replacements, and if the Partnership's cash flow, after allowance for certain distributions, is insufficient to provide the facility maintenance and engineering services required of it, New Claridge is also required to lend the Partnership the funds required to provide those services. Any advances by New Claridge for either of the foregoing will be secured. Under the terms of the Operating Lease, New Claridge has an option to purchase, on September 30, 1998 and, if it renews the Operating Lease, on September 30, 2003, the Hotel Assets and the underlying land for their fair market value at the time the option is exercised.\nOn March 17, 1986, New Claridge entered into the Expansion Operating Lease Agreement with the Partnership under which New Claridge leased the Expansion Improvements for an initial term beginning March 17, 1986 and ending on September 30, 1998 with three 10-year renewal options. Basic annual rent payable during the initial term of the Expansion Operating Lease was $3,870,000 in 1986 (prorated based on the day that the Expansion Improvements opened to the public) and determined based on the cost of the construction of the Expansion Improvements. Annually thereafter the rental amount will be adjusted based on the Consumer Price Index with any increase not to exceed two percent per annum. Basic annual rent for 1994 was $4,534,000. If New Claridge exercises its option to extend the term of the Expansion Operating Lease, basic rent during the renewal term will be calculated pursuant to a formula, with annual basic rent not to be more than $3 million nor less than $2.5 million and, subsequently, not to be greater than 10% more than the basic annual rent for the immediately preceding lease year in each lease year thereafter.\nNew Claridge also is required under the Expansion Operating Lease to pay as additional rent amounts equal to certain expenses and the debt service relating to furniture, fixture and equipment replacements and building improvements (collectively \"Expansion FF&E Replacements\") for the Expansion Improvements. The Partnership will be required during the entire term of the Expansion Operating Lease to provide New Claridge with Expansion FF&E\nReplacements and until September 30, 1998, will be required to provide facility maintenance and engineering services to New Claridge. New Claridge will be obligated to lend the Partnership any amounts necessary to fund the cost of Expansion FF&E Replacements. Any advances by New Claridge for the foregoing will be secured under the Expandable Wraparound Mortgage.\nEffective with the consummation of the restructuring in June 1989, the Operating Lease and the Expansion Operating Lease were amended to provide for the deferral of up to $15.1 million of rental payments during the period July 1, 1988 through the beginning of 1992, and to provide for the abatement of $38.8 million of basic rent through 1998, thereby reducing the Partnership's cash flow to an amount estimated to be necessary only to meet the Partnership's cash requirements. During the third quarter of 1991, the maximum deferral of rent was reached. On August 1, 1991, the Operating Lease and Expansion Operating Lease were amended further to revise the abatement provisions so that, commencing January 1, 1991, for each calendar year through 1998, the lease abatements may not exceed $10 million in any one calendar year, and $38,820,000 in the aggregate.\nIf the Partnership should fail to make any payment due under the Expandable Wraparound Mortgage, New Claridge may exercise a right of offset against rent or other payments due under the Operating Lease and Expansion Operating Lease to the extent of any such deficiency.\nd. Expandable Wraparound Mortgage. On October 31, 1983, the Partnership executed and delivered to New Claridge the Expandable Wraparound Mortgage, which was subordinate to the First Mortgage and the Purchase Money Second Mortgage. The Purchase Money Second Mortgage, which was due on September 30, 2000, was cancelled upon satisfaction of certain conditions set forth in an agreement entered into at the time of the restructuring. In conjunction with the offering of $85 million of Notes on January 31, 1994, the outstanding debt under the Loan Agreement, which included the First Mortgage and the revolving credit line, was satisfied in full (see Item 1. Business- \"Recent Business Developments\"). By its terms, the Expandable Wraparound Mortgage may secure up to $25 million of additional borrowings by the Partnership from New Claridge to finance FF&E Replacements and facility maintenance and engineering shortfalls. The Expandable Wraparound Mortgage provides that, so long as the Partnership is not in default on its obligations under the Expandable Wraparound Mortgage, New Claridge is obligated to make payments required under any senior mortgage indebtedness. The indebtedness secured by the Expandable Wraparound Mortgage, which will mature on September 30, 2000, bears interest at an annual rate equal to 14% with certain interest installments that accrued in 1983 through 1988 totalling $20 million being deferred until maturity. In addition, the Partnership is required under the Expandable Wraparound Mortgage to make payments of principal and interest in respect of any loans made to finance FF&E Replacements or facility maintenance or engineering costs as described above. To the extent those borrowings exceed $25 million in the aggregate outstanding at any time, they will be secured under separate security agreements and not by the lien of the Expandable Wraparound Mortgage.\nOn March 17, 1986, the First Mortgage was amended and assumed by New Claridge. The amount of the amended and assumed First Mortgage was increased to secure up to $96.5 million to provide financing for the Expansion Improvements. Indebtedness secured by the Expandable Wraparound Mortgage was increased by an amount up to $17 million to provide the Partnership with the necessary funding.\nEffective August 28, 1986, the Partnership commenced making level monthly payments of principal and interest so as to repay on September 30, 1998, in full, the principal balance of this $17 million increase in the Expandable\nWraparound Mortgage. The Expandable Wraparound Mortgage was amended to require that the $127 million aggregate principal amount secured by it would be repayable in installments during the years 1988 through 1998 in escalating amounts totalling $80 million, with a balloon payment of $47 million and the $20 million of deferred interest due on September 30, 2000.\nIn connection with the offering of $85 million of the Notes on January 31, 1994, the Corporation agreed to use not less than $8 million from the net proceeds of the offering to finance certain internal improvements to the Claridge which were funded through additional FF&E Loans. In connection therewith, the Expandable Wraparound Mortgage Loan agreement as well as the Operating Lease, and the Expansion Operating Lease were amended to provide that the principal on these additional FF&E Loans will be payable at final maturity of the Expandable Wraparound Mortgage.\nCompetition\nCompetition in the Atlantic City casino-hotel market is intense. At the present time, twelve casino-hotels are operating in Atlantic City. The most recent property to open in Atlantic City was the Taj Mahal Casino Hotel, which opened April 2, 1990 with a 120,000 square foot casino, the largest in the Atlantic City marketplace. The opening of the Taj Mahal, together with various casino expansions which have opened in the last two years, further heightened the intense competition for casino patrons. For the years ended December 31, 1994 and 1993, citywide gaming revenues, as reported, increased 3.9% and 2.7%, respectively, over prior year levels.\nThe primary markets for Atlantic City casino patrons are Philadelphia, New Jersey and New York City, together with the secondary markets of central Pennsylvania, Delaware, Baltimore and Washington, D.C. Casinos offer cash incentives, in the form of coins to play slot machines, to their drive-in customers based on their casino play. In recent years competition for, and incentives offered to, drive-in customers have increased significantly. Although New Claridge offers similar promotional coin incentives to attract drive-in customers, it is at a distinct disadvantage since it remains the only casino without a public self-parking facility. Many Atlantic City casino patrons also arrive by bus and stay for approximately six hours. Competitive factors in Atlantic City require the payment of cash incentives and coupons for use toward the price of meals to patrons arriving under bus programs sponsored by the casino operators. During 1994, 8.0 million casino patrons arrived in Atlantic City by bus, a 4.4% decrease from 1993 figures.\nAll casinos in Atlantic City are part of hotels which offer dining, entertainment and other guest facilities. Competition among casino facilities is based primarily on such factors as promotional allowances and incentives; the attractiveness of the casino area; advertising; service, quality and price of rooms, food and beverage; restaurant, parking and convention facilities; and entertainment. The Atlantic City business is seasonal with the highest level of activity occurring during the summer months and the lowest level of activity during the winter months.\nThe Claridge has positioned itself as the \"smaller, friendlier\" alternative to the other Atlantic City casinos. This strategy, implemented in 1989, is designed to capitalize on the Claridge's unique physical facility, which the Corporation believes retains an atmosphere of Atlantic City's former grandeur, and on the Claridge's size relative to the larger Atlantic City casinos. By emphasizing an environment that is intimate, friendly and service-oriented, the Claridge targets a market niche different than that of a majority of its competitors. The Claridge seeks to attract and retain as customers the player whose wagering, while significant, is below the high-wagering of patrons targeted by several of the other larger Atlantic City casinos. The Claridge's typical patron wagers less on credit and warrants fewer\ncomplimentaries than the higher wagering player. The majority of the Claridge's casino revenue is generated by slot machine play. In 1994, 75% of the Claridge's casino revenue came from slot play as compared to 67% reported for all Atlantic City properties.\nThe Claridge's positioning statement \"Because Smaller is Friendlier\" conveys its operating and marketing strategy. All Claridge employees are required to attend extensive in-house training programs, which emphasize courteous, customized service.\nIn common with other Atlantic City casinos, the Claridge operates a direct marketing program. Through this program, customer loyalty is encouraged with incentives including gifts, coupons for coins and services, and complimentaries. A sophisticated computer database marketing system is utilized to track customers who meet the Corporation's target profile, analyze the effectiveness of promotional activities, and identify prospective customers. Information for this database is compiled through a customer's use of a Compcard Gold rating card provided by the Claridge. All Claridge customers are encouraged to request a Compcard Gold rating card and to use it when playing at table games and slot machines. Use of the Compcard Gold rating card provides the Claridge with data on the level, style and duration of casino play of its customers.\nThe database derived from use of the Compcard Gold rating card furnishes the Corporation with a powerful marketing tool. This database allows the Claridge to target identified players with incentives. Incentives are tailored to the identified player's potential for future play, thus assuring that direct marketing expenditures are effective. Additionally, through analysis of demographic and other information contained in the Compcard Gold database, the value of customers with certain characteristics can be assessed and used as a basis for identifying prospective customers.\nThe Claridge, as do all other Atlantic City casinos, maintains a bus program. Customers arriving by bus generally stay in Atlantic City six to eight hours before returning home. Bus customers are given coupons for coins and\/or other services. The Corporation continually monitors the incentives offered to bus customers by other Atlantic City casinos to assure that the Claridge's offerings are attractive.\nCompetition in Atlantic City also extends to the employment market. The Commission has promulgated regulations which require staffing levels at Atlantic City casinos which are sharply higher than those for casino-hotels in Nevada. In addition, although the January 1995 amendments to the Act (see Item 1. Business - \"Gaming Regulation and Licensing\") have eased the licensing requirements for some employees, all of New Claridge's casino employees must be licensed. Prior to these amendments, casino employees applying for a license had to meet applicable standards pertaining to such matters as financial responsibility, good character, ability, casino training and experience; as a result of these amendments, the Commission will focus their investigation on the integrity of the person. Partly as a result of the licensing requirements, there has been intense competition for experienced casino employees in Atlantic City. Difficulties in hiring personnel licensed by the Commission have elevated labor costs, and licensed personnel frequently leave their current positions for higher paying jobs in other casinos. In addition, the expansion of casino gaming into other jurisdictions has increased the competition for experienced casino management personnel.\nBeginning in the fall of 1988, three events occurred that accelerated the presence of casino gaming in the United States: (i) a statewide ballot issue in South Dakota approved limited-stakes gaming in Deadwood; (ii) the state legislature approved riverboat gaming in Iowa in early 1989; and (iii) Congress passed the Indian Gaming Regulatory Act of 1988, which permits unrestricted gaming on Indian land in any state that already allows similar gaming (for\nexample, if the state allows charitable gaming for non-profit organizations, then Indians can run similar operations on their land for profit). Since these events occurred, the gaming industry rapidly expanded, and casino gaming of some form is now available in approximately twenty-two states. Indian gaming is currently authorized in twenty-one states including New York, Michigan, Minnesota, California, and most notably, Connecticut. In February 1992, the Foxwoods High Stakes Casino and Bingo Hall (\"Foxwoods\"), operated by the Mashantucket Pequot Indian tribe in Ledyard, Connecticut commenced operations, offering the table games found in Atlantic City as well as bingo rooms. In January 1993, approval was granted by the Connecticut government for Foxwoods to offer slot machines; as of December 31, 1994, over 3,800 slot machines were reported to be operational at Foxwoods.\nUntil recently, it was believed that the legalization of casino gaming in at least limited forms in Philadelphia and other areas of Pennsylvania was a significant possibility. Currently, a bill for riverboat gaming is awaiting action in the Pennsylvania House Finance Committee. However, newly- elected Governor, Tom Ridge, has indicated that he will require a statewide vote on gaming, as well as local referendum; the requirement for a statewide vote would make the legalization of casino gaming in Pennsylvania a more difficult and expensive possibility than previously anticipated. Management believes that, should casino gaming be legalized in the future in Philadelphia, the effects on Atlantic City casinos and on the Claridge would depend upon the form and scope of such gaming. The continued expansion of casino gaming, lotteries, including video lottery terminals (VLT's), and offtrack betting in other nearby states could also have a negative effect on the Atlantic City market.\nGaming Regulation and Licensing\na. The New Jersey Casino Control Commission and Division of Gaming Enforcement. The ownership and operation of casino-hotel facilities in Atlantic City are subject to extensive state regulation under the Act. No casino-hotel may operate in Atlantic City unless necessary corporate and individual officer, director and employee licenses are obtained from the Commission. The Commission is authorized under the Act to adopt regulations covering a broad spectrum of gaming-related activities.\nThe Act also establishes a Division of Gaming Enforcement (the \"Division\") to investigate all applications for licenses, enforce the provisions of the Act and the regulations thereunder, and prosecute before the Commission all proceedings for violations of the Act or any regulations thereunder. The Division conducts audits and continually reviews casino operations, maintains information with respect to any changes in ownership of the casino-hotel and conducts investigations of casino owners and investors when appropriate.\nIn January 1995, significant amendments to the Act were signed into law, which are intended to reduce regulation of the Atlantic City casino industry. These amendments include changes regarding (i) the authority and responsibilities of the Commission and the Division; (ii) the licensing requirements of employees, casinos, and employees of industries which service the casinos; (iii) the operation of the casinos; and (iv) the operation of the Casino Reinvestment Development Authority (the \"CRDA\"). The most significant changes resulting from these amendments include:\n(i) The elimination of the requirement for hotel employees to register with the Commission, and the creation of a new classification of employee, the \"Casino Service Employee\", broadly defined as an employee who performs duties in the casino but is not categorized as a casino employee, a casino key employee, or casino security employee; the Casino Service Employee will not have to hold a casino license, but will merely have to register with the Commission. In addition, the Commission will\nno longer have the responsibility for determining whether an applicant for a casino license or casino key license has sufficient business ability and experience, but rather will focus the license investigation on the integrity of the applicant;\n(ii) The standardization of the renewal period of all casino licenses for periods of four years, at a fee of $200,000 for a four year license;\n(iii) The elimination of the limitation that prohibited entities from holding more than three casino licenses, provided that the granting of additional licenses would not create undue economic concentration in Atlantic City casino operations, as determined by the Commission;\n(iv) An increase in the amount of casino space permitted, to 60,000 square feet, for a casino hotel with 500 hotel rooms (from the previous maximum allowed of 50,000 square feet);\n(v) The elimination or easing of requirements for Commission or Division approvals needed to implement or change individual casino's internal operating procedures; and\n(vi) The creation of a fund, known as the \"Atlantic City Fund\", which will provide for the reinvestment of savings expected to be realized by the reduction in regulation created by these amendments, as well as a reallocation of CRDA funds which would have gone to North Jersey over the next five years, in Atlantic City. This Atlantic City Fund will be administered by the CRDA.\nb. Licensing Requirements. The Act provides that various categories of persons or entities must hold casino licenses. The Act also provides that each officer, director and person who directly or indirectly holds any beneficial interest or ownership in a casino licensee; or any person who, in the opinion of the Commission, has the ability to control a casino licensee or elect a majority of the board of directors; or each principal employee or any other employee of a casino licensee (and any lender to or underwriter, agent or employee of the licensee) whom the Commission may consider appropriate for approval or qualification, be qualified for approval pursuant to the provisions of the Act. In addition, all contracts and leases entered into by the licensee may, upon request of the Commission, have to be submitted to the Commission, are subject to its review, and, if found unacceptable, are voidable. All enterprises which provide gaming-related services to the licensee must be licensed. All other enterprises dealing with the licensee must register with the Commission, which may require that they be licensed if they do $75,000 or more per year in business with a single licensee, and $225,000 or more per year if with more than one licensee.\nNew Claridge holds a casino license because it carries on the casino business of the Claridge and owns the Casino Assets. As a result, New Claridge's officers and directors are subject to Commission qualification. The Corporation, as the sole owner of the stock of New Claridge, is also required to be qualified. As a part of its determination of the Corporation's qualification, the Commission will require the qualification of each officer, each director, and each person who directly or indirectly holds any beneficial interest or ownership in the Corporation, and who the Commission requires to be qualified, or any person who, in the opinion of the Commission, has the ability to control the Corporation or elect a majority of its Board of Directors; or each principal employee or any other employee whom the Commission may consider appropriate for approval or qualification. The Commission has determined that no stockholder of the Corporation owning less than 5% of its stock will be required to be qualified unless the Commission determines that such stockholder has the ability to control the Corporation or elect a majority of its Board of Directors. Prior to June 16, 1989, Webb was the only stockholder in this category. The names and\naddresses of all stockholders have been supplied to the Commission and any changes are reported when they occur.\nc. Licensing Status. The Commission issues casino licenses, which, prior to the January 1995 amendments to the Act, were renewable every two years, subject to a series of requirements including a requirement of demonstrating financial viability. In 1989, and again in 1991, the First Mortgage Lenders agreed to modify the schedule of principal payments under the Loan Agreement, in order in part to allow New Claridge to demonstrate financial viability to the Commission. In connection with the 1993 relicensing, for the period ending in 1995, the First Mortgage Lenders agreed for the first time to modify the schedule of principal payments required under the Loan Agreement to beyond the two-year licensing period. On September 22, 1993, New Claridge was issued a two year casino license by the Commission for the period commencing September 30, 1993. The relicensing approval was based in part on the execution of this amendment to the Loan Agreement.\nd. Investigations and Disqualifications. The Commission may find any holder of any amount of securities of the Corporation not qualified to own securities of the Corporation. Further, as required by New Jersey, the charter and the by-laws of the Corporation and New Claridge provide that securities of the Corporation and New Claridge are held subject to the condition that if a holder is found to be disqualified by the Commission the holder must dispose of the securities of the Corporation or New Claridge, as the case may be. The Corporation will periodically report the names and addresses of owners of record of Class A Stock to the Commission as is required for all publicly traded holding companies that have wholly-owned subsidiaries holding casino licenses.\ne. Casino Fees and Taxes. The Act provides for a casino license issue fee of not less than $200,000, based upon the cost of the investigation and consideration of the license application, and renewal fee of not less than $200,000, as amended in January 1995, based upon the cost of maintaining control and regulatory activities. In addition, a licensee is subject to (i) a tax of eight percent (8%) of gaming revenues, less the provision for uncollectible accounts, (ii) an annual license fee of $500 on each slot machine, and (iii) an alcoholic beverage fee computed on the basis of the cost of investigatory time spent monitoring each beverage outlet.\nThe Act as amended in December 1984 further provides for the imposition of an investment obligation pursuant to criteria set forth in the Act or the payment of an alternative tax. The investment obligation is 1.25% of the total gaming revenues for each calendar year. Gaming revenues are the total revenues derived from gaming operations less the provision for uncollectible accounts. If the casino licensee opts not to make an investment, it is assessed an alternative tax of 2.5% of total gaming revenues less the provision for uncollectible accounts. The licensee has two options in satisfying its investment obligation; it can make a direct investment in a project approved by the CRDA, which is the agency responsible for administering this portion of the Act, or it can buy bonds issued by the CRDA which will, if tax exempt, bear interest at the rate of 66 and 2\/3% of the average rate of the Bond Buyer Weekly 25 Revenue Bond Index for the 26 weeks preceding the issue of the bonds. If the bonds are not tax exempt they will bear interest at the rate of 66 and 2\/3% of the average rate of Moody's A Rated Utility Index for the 26 weeks preceding the issue of the CRDA bonds. The investment obligation must be paid on the 15th day of the first, fourth, seventh, and tenth months of each year based on the estimated gaming revenues for the three month period immediately preceding the first day of those months. The alternative tax must be paid not later than April 30 of the following year.\nNew laws and regulations as well as amendments to existing laws and regulations relating to gaming activities in Atlantic City are periodically\nadopted. Effective July 1, 1993, the New Jersey state legislature passed a law requiring the payment of parking fees by casinos in New Jersey in the amount of $2.00 per day for each motor vehicle parked in a casino parking space. In 1992 the New Jersey state legislature passed a law requiring the payment of a tourism marketing fee of $2.00 per occupied room by casino hotels in Atlantic City. While the Corporation believes that these fees have not had a significant impact on its operations, there is no assurance that future laws or changes in existing laws will not have an adverse effect.\nEmployees\nAs of December 31, 1994, New Claridge employed approximately 2,500 persons, of whom approximately 800 are represented by labor unions. Approximately 700 of the 800 are represented by the Hotel, Restaurant Employees and Bartender International Union, AFL-CIO, Local 54. In September 1994, the Corporation's collective bargaining agreement covering the employees represented by Local 54 was renewed, together with the collective bargaining agreements of all Atlantic City casinos with respect to Local 54, for a period of five years. During the past two years, local unions have been active in their efforts to organize non-union employees in Atlantic City.\nThe management of the Claridge believes that its employee relations are generally satisfactory. All of the employees represented by labor unions are covered by collective bargaining agreements which prohibit work stoppages during their terms.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Claridge hotel was constructed in 1929 at the northeastern end of Absecon Island, on which Atlantic City is located. After remodeling, modernization and expansion at a cost of approximately $138 million, the Claridge opened as a casino-hotel in July 1981. Located in the Boardwalk Casino section of Atlantic City on Brighton Park, approximately 550 feet north of the Boardwalk, the Claridge occupies three parcels of property.\nThe casino-hotel, situated on the main parcel (41,408 square feet with 138 feet fronting the park and 300 feet deep), is a concrete steel frame structure, 26 stories high at its highest point. The garage, situated on an adjacent parcel of land (21,840 square feet) west of the casino-hotel site, is an eight-level reinforced concrete ramp structure, built in 1981. Including the bus drive-through area, a bus patron waiting room and an electrical room, it totals an area of 197,100 square feet and provides parking for approximately 475 automobiles. The office building, situated on an adjacent parcel of land (7,766 square feet), is a two-story reinforced concrete and brick structure with a flat roof. Constructed about 50 years ago, its interior has been modernized. The building is utilized as an administration facility, and totals an area of 14,020 square feet. All of these facilities are owned by the Partnership and are leased to New Claridge under the Operating Lease and the Expansion Operating Lease.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Corporation and its subsidiaries are not parties to any material litigation other than ordinary routine litigation which is incidental to its business.\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 issued and outstanding shares of the Corporation have been offered and sold in reliance on exemptions from the registration requirements of the Securities Act of 1933 as amended (the \"Securities Act\"). Therefore, there is no established trading market for any class of shares of the Corporation. In October 1983, 562,500 shares of Class A Stock were sold to Oppenheimer Holdings, Inc., and certain officers and employees of Oppenheimer & Co., Inc., (placement agent for the Partnership and the Corporation) at their par value, $.001 per share, and 4,500,000 shares of Class A Stock were privately offered and sold at $1.2336306 per share. At the same time, 562,500 shares of Class B Stock were sold to Webb at their par value, $.001 per share. On March 24, 1989, Oppenheimer Holdings, Inc. returned to the Corporation all of its shares (273,938) of the Corporation's Class A Stock. On June 16, 1989, all of the outstanding shares of the Corporation's Class B Stock, all of which was owned by Webb, was returned to the Corporation and cancelled. As of March 1, 1995, there were approximately 450 holders of record of the Class A Stock. The Contingent Payment Rights (see Item 1. Business - \"1989 Restructuring\") received by Releasing Investors may or may not be securities. The Corporation, the Partnership and Webb filed a registration statement under the Securities Act with respect to the Contingent Payment Rights as if they were securities and each of the Corporation, the Partnership and Webb were an issuer of such securities. However, by such action none of the Corporation, the Partnership or Webb admitted that the Contingent Payment Rights are securities or that any of them is the issuer of any such securities. There is no market for the Contingent Payment Rights.\nThe indenture governing the Notes (the \"Indenture\") restricts the declaration or payment of dividends or distributions on redemptions of capital stock by the Corporation and its subsidiaries, other than (i) dividends or distributions payable in equity interests of the Corporation or such subsidiaries, (ii) dividends or distributions payable to the Corporation or any wholly-owned subsidiary, or (iii) dividends by a subsidiary on its common stock if such dividends are paid pro-rata to all holders of such common stock.\nIn addition, the Corporation and the Partnership have agreed not to make any distributions to the holders of their equity securities, whether derived from operations or from sale or refinancing proceeds, until the Contingent Payment has been satisfied (see Item 1. Business - \"1989 Restructuring\").\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nThe following table summarizes certain selected consolidated financial data for the years ended December 31, 1994, 1993, 1992, 1991 and 1990.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations for the Year Ended December 31, 1994\nThe Corporation had a net loss of $6,901,000 for the year ended December 31, 1994, as compared to net income of $5,132,000 for the year ended December 31, 1993.\nFor the year ended December 31, 1994, the Corporation's \"Adjusted EBITDA\" was $11,224,000, compared to $20,131,000 for the year ended December 31, 1993. \"EBITDA\" represents earnings before interest expense, income taxes, depreciation, amortization, and other non-cash items. \"Adjusted EBITDA\" is equal to EBITDA plus rent expense to the Partnership less interest income from the Partnership less \"Net Partnership Payments,\" which represent the Corporation's net cash outflow to the Partnership, and is used by the Corporation to evaluate its financial performance in comparison to other gaming companies with more traditional financial structures. Adjusted EBITDA may be used as one measure of the Corporation's historical ability to service its debt, but should not be considered as an alternative to, or more meaningful than, operating income or cash flow. The decrease in Adjusted EBITDA from 1993 was primarily due to (i) the decline in business volume in the first quarter of 1994 due to the severe snow and ice storms throughout the Northeastern United States, (ii) a reduction in volume in the second quarter of 1994 as a result of business disruption due to the construction of the Claridge's expanded casino facility (which opened in late June 1994, and resulted in the addition of approximately 500 slot machines), and (iii) increased marketing expenditures to promote the opening of the expanded facility.\nCasino revenue, which is the difference between amounts wagered by and paid to casino patrons, was $156,159,000 (including poker, simulcasting, and keno revenue) for the year ended December 31, 1994, a 1.0% increase over 1993 casino revenue of $154,615,000, and 6.7% higher than 1992 casino revenue of $146,357,000. Casino revenue earned by all Atlantic City casinos for 1994, as reported, including poker, simulcasting, and keno revenue, increased 3.9% over 1993 revenue. Although all Atlantic City casinos experienced a decline in business volume in the first quarter of 1994 as a result of the severe weather conditions, New Claridge experienced a greater decline in business as compared to other Atlantic City casinos due to its dependency on customers arriving by bus, its focus on the New York and Northern New Jersey markets, and its lack of a covered self-parking facility.\nTable games revenue (including poker revenue) earned by New Claridge during the year ended December 31, 1994 was $38,824,000, a 5.2% decrease from 1993 table games revenue of $40,959,000. The decrease in table games revenue resulted from a 1.9% decline in table games drop (the amount of gaming chips purchased by patrons), combined with a decline in the hold percentage (the ratio of win to drop) to 14.0% in 1994, compared to 14.7% in 1993. Citywide table games drop and revenue for 1994, as reported, increased 0.3% and 1.7%, respectively, over 1993 levels.\nClaridge slot machine revenue for the year ended December 31, 1994 was $116,909,000, a 2.9% increase over 1993 slot machine revenue. Citywide slot machine revenue as reported for 1994 increased 3.7% over 1993 revenue. The expansion in June 1994 of the Claridge's casino floor space and the addition of approximately 500 slot machines resulted in a 20.7% increase in Claridge's average number of slot machines during 1994 as compared to 1993. Expansions at several other Atlantic City casinos during 1994 contributed to the 8.4% increase reported in the average number of slot machines at all Atlantic City properties during 1994 as compared to 1993.\nNew Claridge offers promotional incentives through its direct marketing program to its customers based on their casino play, as well as to prospective\ncustomers based on demographic models. During the year ended December 31, 1994, cash incentives offered through this program totalled $11,595,000, compared to $10,912,000 for the year ended December 31, 1993. In addition, New Claridge offers coin incentives to patrons arriving by bus; during 1994, $9,179,000 in coin incentives were issued to 835,000 bus passengers arriving at the Claridge, compared to $7,772,000 of coin incentives issued to 829,000 bus passengers in 1993. The increase in coin incentives per passenger in 1994 as compared to 1993 resulted from efforts to maintain a competitive position with other Atlantic City casino operators, which, starting in the second quarter of 1994, increased the incentives offered in order to increase business levels which had been depressed due to the severe weather experienced during the first quarter of 1994.\nHotel revenues for the year ended December 31, 1994 of $10,962,000 were 4.0% lower than 1993 revenues of $11,416,000 due to a slightly lower occupancy rate (92% in 1994 compared to 93% in 1993), combined with a lower average room rate ($67 in 1994 compared to $68 in 1993). Food and beverage revenues earned in 1994 totalled $18,346,000, a slight decline from revenues earned in 1993 of $18,597,000; this decrease was due primarily to a decline in the number of covers (meals served), to 1,715,000 in 1994 from 1,724,000 in 1993. Other revenues for the year ended December 31, 1994 of $2,547,000 were lower than 1993 revenues of $2,913,000, primarily resulting from the contracting out of the Claridge gift shop operation commencing in October 1994.\nTotal costs and expenses for the year ended December 31, 1994 were $200,049,000, an increase of 10.5% over 1993 expenses of $181,118,000, resulting in part from increased interest expense due to the completion of the offering of $85 million of First Mortgage Notes on January 31, 1994. Casino and general and administrative expenses were higher in 1994 as compared to 1993, resulting from marketing and advertising efforts to increase business volume, promote the opening of the expanded casino, and remain competitive with other Atlantic City casino operators, as well as increased payroll costs due to higher staffing levels necessary as a result of the increased casino floor space. In addition, New Claridge recorded $1,972,000 of expense during 1994 relating to its investment obligation to the CRDA, as compared to $665,000 of expense recorded in 1993. This increase in expense resulted from the donation of funds, totalling approximately $3.8 million, representing amounts previously deposited with the CRDA, during the third quarter of 1994. In exchange for the donations, New Claridge received credits equal to fifty-one percent of the donations, to be applied to its obligations commencing after the dates of the donations. New Claridge recorded expense during 1994 to write-down the book value of the donated amounts to the amount of the credits received.\nThe Corporation recorded an income tax benefit of $2,393,000 for the year ended December 31, 1994 which represents the tax refund expected from the carryback of Federal net operating losses net of increased deferred tax credits. The Corporation recorded income tax expense of $3,422,000 as a result of the income earned during the year ended December 31, 1993.\nResults of Operations for the Year Ended December 31, 1993\nThe Corporation had net income of $5,132,000 for the year ended December 31, 1993, as compared to net income of $6,048,000 for the year ended December 31, 1992. Net income in 1992 was favorably impacted by the reversal of progressive slot liability of $2,437,000, as further discussed below.\nCasino revenue was $154,615,000 for the year ended December 31, 1993, a 5.6% increase over 1992 casino revenue of $146,357,000, and a 14.2% increase over 1991 casino revenues of $135,406,000. Citywide casino revenue, as reported for 1993, increased 2.7% over 1992 revenues. These favorable comparisons can be attributed to the first full year of unlimited twenty-four hour gaming in 1993, as well as, improved economic conditions in the Northeastern United States. In\naddition, the passage of live poker and simulcast wagering in 1993 and other Commission policy changes (i.e. extended hours of operation) have had a positive impact on casino revenues. Citywide casino revenues in early 1993 were adversely affected by poor weather conditions, most notably the March 13, 1993 storm, which covered portions of the Northeastern United States with over a foot of snow.\nFor the year ended December 31, 1993, Claridge table games revenue was $40,959,000, a slight increase over 1992 table games revenue of $40,758,000. Table games drop for 1993 increased 1.0% over 1992 levels. The 1993 hold percentage was 14.7%, compared to a hold percentage of 14.8% in 1992. Citywide table games revenue and drop, as reported, decreased 1.4% and 3.1%, respectively, as compared to 1992 figures. This decrease is attributed in part to the industry's continued shift in focus from table games to slots. During 1993, citywide slot machine units reportedly increased 10.4% over 1992, while citywide table game units, excluding the addition of poker games, decreased 6.1% from 1992.\nClaridge slot machine revenue for the year ended December 31, 1993 was $113,656,000, a 7.6% increase over 1992 slot machine revenue. Citywide slot machine revenue reportedly increased 4.8% over 1992 revenue. Coin incentives issued through New Claridge's direct marketing programs totalled $10,912,000 and $6,959,000 for the years ended December 31, 1993 and 1992, respectively. In addition during 1993, 829,000 bus passengers were brought to the Claridge, and were issued $7,772,000 in coin incentives; in 1992, $8,816,000 in coin incentives was issued to 854,000 bus passengers. The increase in direct marketing coin incentive costs over 1992 reflects an increased focus on attracting the more profitable drive-in patrons.\nHotel, food and beverage revenues for the year ended December 31, 1993 were $30,013,000, a slight decrease from 1992 revenues of $30,092,000. Net of promotional allowances, hotel, food and beverage revenues in 1993 increased 3.1% over 1992 net revenues. Promotional allowances for the year ended December 31, 1993 decreased as a result of eliminating food coupons from the bus program incentive packages. The total number of covers served in 1993 were 1,724,000, a 15.2% increase over the number of covers in 1992 as a result of offering a $4.75 buffet in 1993 compared to a $9.95 buffet in 1992. Hotel occupancy for the years ended December 31, 1993 and 1992 was 93% and 87%, respectively, while the average room rate was $68 in 1993 compared to $71 in 1992. Other revenues for the year ended December 31, 1993 decreased from the prior year due primarily to revisions to New Claridge's entertainment policy, from the presentation of daily Broadway-style shows in 1992 to a headliner performance approximately one weekend per month in 1993.\nTotal costs and expenses for the year ended December 31, 1993 were $181,118,000, a 5.3% increase over 1992 expenses of $172,081,000. The increase is primarily evident in the casino operating expenses, due to the reversal of progressive slot liability in 1992 of $2,437,000, resulting from the removal of certain progressive slot machines as approved by the Commission, as well as higher labor costs resulting from increased levels of business and the extended gaming hours, and higher coin redemption and other marketing costs. In addition, general and administrative expenses increased as a result of higher payroll costs. Other costs decreased as a result of the reduced entertainment schedule as previously discussed.\nAs a result of the income earned for the year ended December 31, 1993, income tax expense of $3,422,000 was recorded.\nLiquidity and Capital Resources\nOn January 31, 1994, the Corporation completed an offering of $85 million of Notes (see Item 1. \"Recent Business Developments\"). The Notes are\nsecured by (i) a non-recourse mortgage granted by the Partnership representing a first lien on the Hotel Assets, (ii) a pledge granted by the Corporation of all outstanding shares of capital stock of New Claridge, and (iii) a guarantee by New Claridge. New Claridge's guarantee of the Notes is secured by a collateral assignment of the second lien Expandable Wraparound Mortgage, and by a lien on the Claridge's gaming and other assets, which lien will be subordinated to liens that may be placed on those gaming and other assets to secure any future revolving credit line arrangement. Interest on the Notes is payable semiannually on February 1 and August 1 of each year, commencing August 1, 1994.\nA portion of the net proceeds of $82.2 million was used as follows:\n(i) to repay in full the Corporation's outstanding debt under the Revolving Credit and Term Loan Agreement (the \"Loan Agreement\"), including the outstanding balance of the Corporation's revolving credit line, which was secured by the First Mortgage. In conjunction with the full satisfaction of the Loan Agreement, the Corporation's revolving credit line arrangement was terminated. The Corporation is currently seeking to obtain a new line of credit arrangement;\n(ii) to fund the cost of a 12,000 square foot expansion of New Claridge's casino capacity, the addition of approximately 500 slot machines, and the relocation of two restaurants and their related kitchen areas. The total cost of this expansion, which became fully operational on June 30, 1994, was approximately $12.7 million; and\n(iii) the acquisition of an adjacent parcel of land, to be used for the construction of a self-parking facility. In March 1994, New Claridge acquired options to purchase for $7,500,000 two parcels of property adjacent to its existing valet-parking facility. On June 6, 1994, New Claridge exercised these options, and deposited $400,000 with the Title Company of Jersey, to be held in escrow until settlement. In an effort to ensure that site preparation and construction of the self-parking facility could commence as soon as possible, New Claridge purchased an assignment of National Westminster Bank NJ's first mortgage interest in the property on November 3, 1994 for $2,040,000. These acquisitions gave New Claridge control of the property as of November 16, 1994. The first mortgage interest was satisfied by the mortgagor at settlement, which occurred on January 5, 1995.\nThe balance of the net proceeds from the offering of the Notes are expected to be used as follows:\n(i) the construction of the self-parking facility;\n(ii) the possible purchase of the Contingent Payment (see Item 1. Business-\"1989 Restructuring\") granted in 1989 and now held in a trust for the benefit of the United Way of Arizona. The Corporation is currently negotiating to purchase the Contingent Payment, for substantially less than face value, from the trustee for the United Way of Arizona. The Corporation previously offered to purchase the Contingent Payment for $10 million, but that offer was not accepted. Negotiations between the trustee for the United Way of Arizona and the Corporation are continuing; and\n(iii) the potential expansion of the Corporation's activities into emerging gaming markets. On March 16, 1994, CGI was formed as a wholly-owned subsidiary of the Corporation for the purpose of developing gaming opportunities in other jurisdictions.\nBeginning in 1995, and annually thereafter, the Corporation will be required to make an offer (\"Excess Cash Offer\") to all holders of Notes, to purchase at 100% of par (plus accrued and unpaid interest, if any, to the\npurchase date), the maximum amount of Notes that may be purchased with 50% of the Corporation's \"Excess Cash\" (as defined in the Indenture), from the preceding year. If less than $5 million is available to make such payments (i.e. if Excess Cash is less than $10 million), no such offer needs to be made. The commencement date of any required Excess Cash Offer must be not later than 30 days after the publication of the Corporation's audited financial statements for the immediately preceding fiscal year. For the year ended December 31, 1994, the Corporation's Excess Cash was less than $10 million, and therefore the Corporation is not required to make an Excess Cash Offer in 1995.\nIn addition, if construction for the self-parking garage or equivalent facility has not commenced by December 31, 1995, the Corporation is required under the terms of the Indenture to make an offer, (the \"Parking Garage Funds Offer\") within 30 days of such date, to all holders of Notes to purchase the maximum principal amount of Notes that may be purchased with $24 million, at an offer price in cash equal to 101% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase. Pursuant to the terms of the Indenture, construction shall be deemed to have commenced when (i) all necessary approvals to commence the construction have been obtained, and (ii) demolition or other physical work below street grade for the project shall have commenced. In March 1995, the Corporation received final site approval for the proposed garage from the Atlantic City Zoning Board; no other approvals are required to complete the garage project. In addition, demolition of the structure previously located on the site is substantially complete. As a result, the Corporation believes it will not be required to make an offer to purchase Notes pursuant to the Parking Garage Funds Offer.\nAt December 31, 1994, the Corporation had working capital of $25,278,000, as compared to a working capital deficiency of $11,534,000 at December 31, 1993. The increase in working capital is principally attributable to increases in cash and cash equivalents of $32,051,000, in receivables of $3,549,000, in prepaid expenses and other current assets of $4,044,000, decreases in accrued payroll and related benefits of $620,000 and other current liabilities of $1,258,000, offset by increases in interest payable of $4,593,000. The increase in cash and cash equivalents is attributable to the net proceeds from the offering of Notes on January 31, 1994, a portion of which was used to repay the Corporation's outstanding debt under the Loan Agreement. Current liabilities at December 31, 1994 and 1993 included deferred rental payments of $15,078,000, and the $3.6 million loan from the Partnership plus accrued interest thereon of $2,394,000 and $1,962,000 at December 31, 1994 and 1993, respectively. The deferred rental payments and $3.6 million loan will only be payable upon (i) a sale or refinancing of the Claridge; (ii) full or partial satisfaction of the Expandable Wraparound Mortgage; and (iii) full satisfaction of any first mortgage then in place. If these amounts were not included in current liabilities, the Corporation's working capital at December 31, 1994 and 1993 would have been $46,350,000 and $9,106,000, respectively.\nNew Claridge is obligated under the Operating Lease to lend the Partnership, at an annual interest rate of 14%, any amounts necessary to fund the cost of furniture, fixtures and equipment replacements. The Expandable Wraparound Mortgage, granted by the Partnership to New Claridge, by its terms may secure up to $25 million of additional borrowings by the Partnership from New Claridge to finance the replacements of furniture, fixtures and equipment, facility maintenance, and engineering shortfalls. The advances to the Partnership are in the form of FF&E Loans and are secured by the Hotel Assets. One half of the principal is due on the 48th month following advance, with the remaining balance due on the 60th month following the date of issuance. In connection with the offering of $85 million of First Mortgage Notes on January 31, 1994, the Corporation agreed to use not less than $8 million from the net proceeds of the offering to finance internal improvements to the Claridge, which were funded through additional FF&E Loans. In connection therewith, the Expandable Wraparound Mortgage Loan agreement as well as the Operating Lease, and the Expansion Operating Lease were amended to provide that the principal on these additional FF&E Loans will be payable at final maturity of the Expandable Wraparound Mortgage. New Claridge is obligated to pay as additional rent to the Partnership the debt service on the FF&E Loans.\nThe Expandable Wraparound Mortgage requires monthly principal payments to be made by the Partnership to New Claridge, commencing in the year 1988 and continuing through the year 1998, in escalating amounts totalling $80 million. The Expandable Wraparound Mortgage, which will mature on September 30, 2000, bears interest at an annual rate equal to 14% with the deferral until maturity of $20 million of certain interest payments which accrued between 1983 and 1988. In addition, in 1986 the principal amount secured by the Expandable Wraparound Mortgage was increased to provide the Partnership with funding for the construction of an expansion improvement, which resulted in approximately 10,000 square feet of additional casino space and a 3,600 square foot lounge. Effective August 28, 1986, the Partnership commenced making level monthly payments of principal and interest calculated to provide for the repayment in full of the principal balance of this increase in the Expandable Wraparound Mortgage by September 30, 1998. Under the terms of the Expandable Wraparound Mortgage, New Claridge is not permitted to foreclose on the Expandable Wraparound Mortgage and take ownership of the Hotel Assets so long as a senior mortgage is outstanding. The face amount outstanding of the Expandable Wraparound Mortgage at December 31, 1994 (including the outstanding FF&E Loans and the $20 million of deferred interest) was $137.4 million.\nThe Hotel Assets are owned by the Partnership and leased by the Partnership to New Claridge under the terms of the Operating Lease originally entered into on October 31, 1983, and the Expansion Operating Lease, which covered the expansion improvements made to the Claridge in 1986. The initial terms of both leases are scheduled to expire on September 30, 1998 and each lease provides for three 10-year renewal options at the election of New Claridge. The Operating Lease requires basic rental payments to be made in equal monthly installments escalating annually up to $41,775,000 in 1997, and $32,531,000 for the remainder of the initial lease term. Prior to the Corporation's 1989 restructuring, basic rent expense (recognized on a leveled basis in accordance with Statement of Financial Accounting Standards No. 13), was $31,902,000 per year. Therefore, in the early years of the lease term, required cash payments under the Operating Lease (not including the Expansion Operating Lease) were significantly lower than the related expense recognized for financial reporting purposes. Rental payments under the Expansion Operating Lease are adjusted annually based on a Consumer Price Index with any increase not to exceed two percent per year. Pursuant to the Restructuring Agreement, the Operating Lease and the Expansion Operating Lease were amended to provide for the abatement of $38.8 million of basic rent payable through 1998 and the deferral of $15.1 million of rental payments, thereby reducing the Partnership's cash flow to an amount estimated to be necessary only to meet the Partnership's cash requirements. Effective on completion of the 1989 restructuring, lease expense recognized on a level basis was reduced prospectively, based on a revised schedule of rent leveling based on the agreed rental abatements. At December 31, 1994, the Corporation had accrued the maximum amount of $15.1 million of deferred rent liability under the lease arrangements. The deferred rent liability will become payable (i) upon a sale or refinancing of the Claridge; (ii) upon full or partial satisfaction of the Expandable Wraparound Mortgage; and (iii) upon full satisfaction of any first mortgage then in place. Also as of December 31, 1994, $20.9 million of basic rent had been abated. The remaining $17.9 million of available abatement is expected to be fully utilized by the first quarter of 1997. Because the initial term of the Operating Lease continues through September 30, 1998, rental payments after the $38.8 million abatement is fully utilized will increase substantially to approximately $40.1 million in 1997, as compared to $31.4 million (net of projected abatement) in 1996. However, if New Claridge exercises its option to extend the term of the Operating Lease, basic rent during the renewal term will be calculated pursuant to a formula with annual basic rent not to be more than $29.5 million or less than $24 million for the twelve months commencing October 1, 1998, and subsequently, not to be greater than 10% more than the basic rent for the immediately preceding lease year in each lease year thereafter. If New Claridge exercises its option to extend the term of the Expansion Operating Lease, basic rent also will be calculated pursuant to a formula with annual basic rent not\nto be more than $3 million or less than $2.5 million for the twelve months commencing October 1, 1998, and subsequently, not to be greater than 10% more than the basic rent for the immediately preceding lease year in each lease year thereafter. If the term of both leases is extended under their renewal options, the aggregate basic rent payable during the initial years of the renewal term will be significantly below the 1997 level.\nIf the Partnership should fail to make any payment due under the Expandable Wraparound Mortgage, New Claridge may exercise a right of offset against rent or other payments due under the Operating Lease and Expansion Operating Lease to the extent of any such deficiency.\nIn February 1992, the Financial Accounting Standards Board issued Statement No. 109, \"Accounting for Income Taxes\". Statement No. 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 estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.\nEffective January 1, 1993, the Corporation adopted Statement No. 109 on a prospective basis. There was no effect on the Corporation's statement of operations for the year ended December 31, 1993 as a result of the adoption of Statement No. 109.\nA valuation allowance of $422,000 has been provided against deferred tax assets as of December 31, 1994. No valuation allowance was provided on deferred tax assets as of December 31, 1993 since management believed that it was more likely than not that such assets would be realized through the reversal of existing deferred tax liabilities and future taxable income.\nThe effective tax rate decreased from 40% for the year ended December 31, 1993 to (26%) for the year ended December 31, 1994. The decrease in the benefit recognized is due to (i) a change in tax laws which resulted in an increase in non-deductible expenses, (ii) other nondeductible expenses which were incurred in 1994 which were not incurred in 1993, and (iii) the establishment of a valuation reserve. The components of income tax expense did not change significantly from the prior year except for the nondeductible items discussed in the change in the effective tax rate.\nFactors Which May Influence the Corporation's Future Operating Results\nThe continued expansion of casino gaming, lotteries, including video lottery terminals (VLT's), and offtrack betting in other nearby states, particularly Pennsylvania, Delaware, Maryland, or New York, could have an adverse effect on the Atlantic City market and on the Corporation's future operating results. Until recently, it was believed that the legalization of casino gaming in at least limited forms in Philadelphia and other areas of Pennsylvania was a significant possibility. Currently, a bill for riverboat gaming is awaiting action in the Pennsylvania House Finance Committee. However, newly-elected Governor, Tom Ridge, has indicated that he will require a statewide vote on gaming, as well as local referendum; the requirement for a statewide vote would make the legalization of casino gaming in Pennsylvania a more difficult and expensive possibility than previously anticipated. Management believes that, should casino gaming be legalized in the future in Philadelphia, the effects on Atlantic City casinos and on the Claridge would depend upon the form and scope of such gaming. In addition, in July 1994, Delaware enacted legislation authorizing the installation of VLT's at horse tracks. Although regulations governing the use of VLT's in Delaware are currently being finalized, the machines could be operational by the summer of 1995.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Financial Statements and Financial Statement Schedules are set forth at pages to of the report.\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 THIS REGISTRANT\nName Office Age ---- ------ --- David W. Brenner Chairman, Director 59 Robert M. Renneisen President, Director 48 James W. O'Brien Executive Vice President, Director 59 A. Bruce Crawley Director 49 Mark H. Sayers Director 45 Shannon L. Bybee Director 57 James M. Montgomery Director 55 Jean I. Abbott Vice President 39 Gloria E. Soto Vice President, Assistant Secretary 46 Raymond A. Spera Executive Vice President, Treasurer 38 Albert T. Britton Executive Vice President 38 Peter F. Tiano Executive Vice President 59 Glenn S. Lillie Vice President 46 Frank A. Bellis, Jr Senior Vice President, Secretary 41\nBusiness Experience\nMr. Brenner has served as a member of the Board of Directors of the Corporation since February 1991, and became Chairman of the Board of Directors in August 1993. He served as President of the Philadelphia Sports Congress from January 1987 through June 1994. Mr. Brenner served as Chairman of the Hospital and Higher Education Facilities Authority of Philadelphia from January 1986 to June 1992, and as Director of Commerce of the City of Philadelphia from January 1984 to September 1986. He was with the accounting firm of Arthur Young & Company from 1957 to September 1983. He was managing partner of the Philadelphia office of Arthur Young from November 1969 until March 1980.\nMr. Renneisen has served as President of the Corporation since June 1992, as Chief Executive Officer of the Corporation and New Claridge since July 1993, and as Vice Chairman of New Claridge since June 1994. Mr. Renneisen was Executive Vice President of the Corporation from June 1991 to June 1992. He has served as President of New Claridge since January 1991. He was Chief Operating Officer of New Claridge from January 1991 to July 1993. Mr. Renneisen was Executive Vice President of New Claridge, responsible for marketing and later casino operations from February 1988 to January 1991. Prior to joining New Claridge, Mr. Renneisen served from January 1987 to December 1987 as Vice President of Marketing of Treasure Island Hotel and Casino in St. Maarten. From June 1986 to May 1987, he served as President of Renneisen, Kincade & Associates, Inc. of Las Vegas, Nevada, a marketing consulting firm. He was Senior Vice President of Marketing of the Tropicana Hotel and Casino in Atlantic City from May 1982 to August 1984.\nMr. O'Brien has served as a member of the Board of Directors of the Corporation since June 1988, and as Executive Vice President of the Corporation since June 1994. Mr. O'Brien has also served as President and Chief Operating Officer of New Claridge since June 1994. Mr. O'Brien was the Corporation's Acting Chairman of the Board from October 20, 1988 to November 22, 1988. Mr. O'Brien served as Vice President of Human Resources of Genesco, Inc. of Nashville, Tennessee from July 1987 to August 1993. He was Vice President of\nHuman Resources of Southwest Forest Industries of Phoenix, Arizona from February 1986 to May 1987. He was President of Del E. Webb Hotel Group from April 1982 to January 1986 and as Chief Executive Officer and a Director of the Corporation from October 1983 to January 1986.\nMr. Crawley has served as a member of the Board of Directors of the Corporation since February 1995. He currently serves as President and Director of Public Relations and Marketing Services for Crawley, Haskins & Rodgers, a Philadelphia based public relations and advertising firm. Prior to establishing his own firm in May 1989, Mr. Crawley was employed at First Pennsylvania Bank and First Pennsylvania Corporation, where he served as Senior Vice President and Director of Public and Investor Relations. He also served, from 1976 to 1979, as Vice President and Director of Advertising for First Pennsylvania Bank and First Pennsylvania Corporation.\nMr. Sayers has served as a member of the Board of Directors of the Corporation since February 1990. Mr. Sayers has served as Vice President of EMES Management Corporation, a real estate management and development company, of New York, New York, since February 1976.\nMr. Bybee has served as a member of the Board of Directors of the Corporation since July 1988. He currently is Associate Professor for Gaming Management, Law & Regulation, at University of Nevada Las Vegas, where he occupies the Michael D. Rose Distinguished Chair in Gaming, a position he has held since August 1994. From July 1993 to August 1994 Mr. Bybee served as President and Chief Operating Officer for United Gaming, Inc. Mr. Bybee was the Corporation's Chairman of the Board from November 1988 to July 1993, and from August 1988 to October 1988. In June 1989, Mr. Bybee was appointed to serve as the Chief Executive Officer of the Corporation and New Claridge, a position he held through July 1993. From 1983 to 1987, he was Senior Vice President of Golden Nugget, Incorporated which operated the Golden Nugget Casino Hotel in Atlantic City. From 1981 to 1983, Mr. Bybee was President of GNAC Corporation, which operated the Golden Nugget Casino Hotel in Atlantic City.\nMr. Montgomery has served as a member of the Board of Directors of the Corporation since March 1995. Since 1978, he has served as President of Houze, Shourds, and Montgomery, Inc., a management consulting firm located in Long Beach, California. Prior to 1978, Mr. Montgomery held various managerial positions with Rohr Industries, Inc. and Rockwell International.\nMs. Abbott served as a member of the Board of Directors of the Corporation from August 1989 to June 1994, and served as a consultant to the Corporation until March 26, 1994, at which time she became a Vice President of New Claridge. From October 1992 to July 1993, Ms. Abbott was Finance Director for the United Way of Atlantic County. She was Assistant Professor at Stockton State College from September 1989 to June 1991. She served as Senior Vice President, Treasurer of the Corporation and Senior Vice President, Controller of New Claridge from May 1987 to September 1989. She was Vice President, Controller of New Claridge from October 1985 to May 1987 and she was Director of Finance of New Claridge from April 1984 to October 1985. From October 1980 through April 1984, Ms. Abbott held various executive positions with New Claridge and Old Claridge.\nMs. Soto has served as Vice President of the Corporation since February 1987, and as Assistant Secretary of the Corporation since August 1993. She served as Secretary of the Corporation from February 1987 to August 1993. Ms. Soto has served as Vice President, Legal and Governmental Affairs of New Claridge since December 1991. She was Vice President of Compliance and Legal Affairs from November 1986 to December 1991 and Director of Regulatory Affairs from August 1985 to November 1986. Prior to joining New Claridge, Ms. Soto served as Associate General Counsel for Harrah's in Atlantic City. In 1980, former Governor Byrne appointed Ms. Soto to the New Jersey State Parole Board, where she served as a member until 1983.\nMr. Spera has served as Executive Vice President of the Corporation since August 1993. He served as Vice President of the Corporation from December 1989 to August 1993, and as Assistant Secretary of the Corporation since December 1991. He also has served as Executive Vice President of Finance and Corporate Development of New Claridge since December 1992. Mr. Spera was Senior Vice President of Finance and Corporate Development of New Claridge from December 1991 to December 1992 and Vice President of Finance of New Claridge from December 1989 to December 1991. From April 1982 through November 1989, Mr. Spera has held various accounting positions with New Claridge and Old Claridge. Prior to joining New Claridge, he spent three years with the accounting firm of KPMG Peat Marwick LLP.\nMr. Britton has served as Executive Vice President of the Corporation since June 1994, and as Executive Vice President and General Manager of New Claridge since February 1994. He served as a Vice President of the Corporation from June 1992 to June 1994, and as Executive Vice President of Operations of New Claridge from December 1992 to February 1994. He was Senior Vice President of Operations of New Claridge from December 1991 to December 1992, and Vice President of Casino Operations from June 1990 to November 1991. From July 1981 through June 1990, Mr. Britton has held various positions in both accounting and casino operations with New Claridge and Old Claridge.\nMr. Tiano has served as Executive Vice President of the Corporation since June 1994, and as Executive Vice President of Operations of New Claridge since February 1994. He served as a Vice President of the Corporation from June 1992 to June 1994. Mr. Tiano was Executive Vice President of Administration of New Claridge from December 1992 to February 1994, Senior Vice President of Administration of New Claridge from December 1991 to December 1992, Vice President of Administration from September 1986 to December 1991, and Director of Human Resources from June 1984 to September 1986. Prior to joining New Claridge, he was Assistant Director of Human Resources for the Institute of Scientific Information of Philadelphia, Pennsylvania from 1972 to 1984.\nMr. Lillie has served as Vice President of the Corporation since June 1992, and as Vice President of Public Affairs of New Claridge since February 1990. He was Vice President of Marketing Communications of New Claridge from April 1985 to February 1990, Director of Public Relations from March 1982 to January 1983, and Training Manager from November 1980 to February 1982. From February 1983 to April 1985, Mr. Lillie was employed as the Director of Public Relations of the Tropicana Hotel and Casino in Atlantic City.\nMr. Bellis has served as Vice President, General Counsel and Secretary to the Corporation since August 1993. He also has served as Senior Vice President and General Counsel of New Claridge since February 1994, as Vice President and General Counsel of New Claridge from September 1992 to February 1994, and as Secretary of New Claridge since August 1993. Previously, from May 1985 to August 1992, Mr. Bellis was Corporate Counsel and Secretary to Inductotherm Industries, Inc., Rancocas, New Jersey. During 1984 and 1985, Mr. Bellis was Associate General Counsel for New Claridge. Prior to joining New Claridge, he was a Deputy Attorney General in the New Jersey Division of Criminal Justice in the State Attorney General's office.\nFurther information regarding the directors and certain executive officers of the Corporation and\/or New Claridge is incorporated by reference to the information contained under the caption \"Voting\" in the Corporation's Proxy Statement for the Annual Meeting of Shareholders to be held on June 5, 1995.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nInformation contained under the caption \"Executive Compensation\" in the Corporation's Proxy Statement for the Annual Meeting of Shareholders to be held on June 5, 1995 is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOn March 24, 1989, Oppenheimer Holdings, Inc. returned to the Corporation all of its shares (273,938) of the Corporation's Class A Common Stock.\nOn June 16, 1989, in accordance with the terms of the Restructuring Agreement, all of the outstanding shares of the Corporation's Class B Stock, all of which was owned by Webb, was returned to the Corporation and cancelled.\nAs of December 31, 1994 there were no beneficial owners of more than 5% of the Corporation's Class A Stock.\nOn February 12, 1992, the Corporation's Board of Directors approved a Long Term Incentive Plan which provided for the grant to certain key officers of the Corporation and\/or New Claridge of the 273,938 shares which were held as treasury shares by the Corporation. These shares were issued to the key employees upon approval by the Commission on April 15, 1992, and upon receipt the transfer of, and right to continue to hold the shares, are subject to certain vesting restrictions.\nOn July 25, 1993, Shannon Bybee, resigned his position as Chairman and Chief Executive Officer of the Corporation, resulting in the return to the Corporation of 73,963 shares of the Corporation's Class A stock, which had previously been awarded under the Plan. Mr. Bybee continues to serve as a member of the Board of Directors of the Corporation. On April 16, 1994, the shares of Class A Stock and Equity Units which had been returned by Mr. Bybee were awarded to certain officers of the Corporation and\/or New Claridge.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Partnership has a direct material interest in the Expandable Wraparound Mortgage Loan Agreement, the Operating Lease and the Expansion Operating Lease together with amendments thereto. See Item 1. Business - \"1989 Restructuring\" and \"Certain Transactions and Agreements.\"\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a)(1) and (2): The response to this portion of Item 14 is submitted as a separate section of this report beginning on page. All other schedules have been omitted as inapplicable, or not required, or because the required information is included in the Consolidated Financial Statements or notes thereto.\n(a)(3) Exhibits. The exhibits required to be filed as part of this annual report on Form 10-K are listed in the attached Index to Exhibits.\n(b) Reports on Form 8-K. The Corporation filed no reports on Form 8-K during the last quarter of the period covered by this report.\n(c) Index to Exhibits and Exhibits filed as a part of this report.\n3(a) Copy of Certificate of Incorporation of the Corporation. Incorporated by reference to Exhibit 3.1 to Form 8 Amendment No. 1 to Form 10 dated February 21, 1984.\n3(b) Copy of By-Laws of the Corporation as amended. Incorporated by reference to Exhibit 3(b) to Form 10-K for the period August 26, 1983 to December 31, 1983.\n3(c) Copy of Certificate of Amendment of The Certificate of Incorporation of the Corporation dated June 15, 1989, incorporated by reference to Exhibit 3(c) to Form 10-K for the year ended December 31, 1990.\n3(d) Copy of Certificate of Amendment of The Certificate of Incorporation dated June 26, 1991. Incorporated by reference to Exhibit 3(d) to Form 10-K for the year ended December 31, 1991.\n4(a) Form of Indenture (including the Guarantee of The Claridge at Park Place, Incorporated). Incorporated by reference to Exhibit 4.1 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n4(b) Form of 11 3\/4% First Mortgage Note due 2002 certificate. Incorporated by reference to Exhibit 4.2 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(a) Copy of Operating Lease Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P. Incorporated by reference to Exhibit 2.2 to Form 8 Amendment No. 1 to Form 10 dated February 21, 1984.\n10(b) Copy of Expandable Wraparound Mortgage and Security Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P. Incorporated by reference to Exhibit 10(b) to Form 10-K for the period August 26, 1983 to December 31, 1983.\n10(c) Copy of Expandable Wraparound Mortgage Loan Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P. Incorporated by reference to Exhibit 10(c) for Form 10-K for the period August 26, 1983 to December 31, 1983.\n10(h) Copy of Expansion Operating Lease Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P. Incorporated by reference to Exhibit 10(h) to Form 10-K for the year ended December 31, 1985.\n10(i) Copy of First Supplemental Amendment to Expandable Wraparound Mortgage and Security Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P. Incorporated by reference to Exhibit 10(i) to Form 10-K for the year ended December 31, 1985.\n10(j) Copy of First Supplemental Amendment to Expandable Wraparound Mortgage Loan Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P. Incorporated by reference to Exhibit 10(j) to Form 10-K for the year ended December 31, 1985.\n10(n) Copy of the Restructuring Agreement, among The Claridge Hotel and Casino Corporation, The Claridge at Park Place, Incorporated, Del Webb Corporation, Del E. Webb New Jersey, Inc., Atlantic City Boardwalk Associates, L.P. and First Fidelity Bank, National Association, New Jersey, dated October 27, 1988. Incorporated by reference to Exhibit 10(n) to Form 10-Q for the quarter ended September 30, 1988.\n10(x) Copy of Long Term Management Incentive Plan of The Claridge Hotel and Casino Corporation effective January 1, 1992. Incorporated by reference to Exhibit 10(x) to Form 10-K for the year ended December 31, 1991.\n10(ab) Amendment to Operating Lease Agreement and Expansion Operating Lease Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P., dated June 15, 1989. Incorporated by reference to Exhibit 10.5 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n10(ac) Second Amendment to Operating Lease Agreement and Expansion Operating Lease Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P., dated March 27, 1990. Incorporated by reference to Exhibit 10.6 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n10(ad) Third Amendment to Operating Lease Agreement and Expansion Operating Lease Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P., dated August 1, 1991. Incorporated by reference to Exhibit 10.7 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n10(ae) First Amendment to Expandable Wraparound Mortgage Loan Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P., dated March 17, 1986. Incorporated by reference to Exhibit 10.8 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n10(af) Second Amendment to Expandable Wraparound Mortgage Loan Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P., dated June 15, 1989. Incorporated by reference to Exhibit 10.9 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n10(ag) Second Amendment to Expandable Wraparound Mortgage and Security Agreement between New Claridge and Atlantic City Boardwalk Associates, L.P., dated June 15, 1989. Incorporated by reference to Exhibit 10.11 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n10(ah) The 1992 Claridge Management Incentive Plan. Incorporated by reference to Exhibit 10.18 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n10(ai) The 1993 Claridge Management Incentive Plan. Incorporated by reference to Exhibit 10.19 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n10(aj) Form of Mortgage, Assignment of Leases and Rents, Security Agreement and Financing Statement. Incorporated by reference to Exhibit 4.3 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(ak) Form of Collateral Trust Agreement among the Corporation, New Claridge, the Partnership and the Collateral Trustee. Incorporated by reference to Exhibit 4.4 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33- 71550) dated January 18, 1994.\n10(al) Form of Corporation Pledge Agreement between the Corporation and the Collateral Trustee. Incorporated by reference to Exhibit 4.5 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(am) Form of New Claridge Pledge Agreement between New Claridge and the Collateral Trustee. Incorporated by reference to Exhibit 4.6 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(an) Form of New Claridge Cash Collateral Pledge Agreement between New Claridge and the Collateral Trustee. Incorporated by reference to Exhibit 4.7 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(ao) Form of New Claridge Security Agreement between New Claridge and the Collateral Trustee. Incorporated by reference to Exhibit 4.8 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(ap) Form of New Claridge Trademark Security Agreement between New Claridge and the Collateral Trustee. Incorporated by reference to Exhibit 4.9 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(aq) Form of Collateral Assignment of Expandable Wraparound Mortgage and Security Agreement. Incorporated by reference to Exhibit 4.10 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(ar) Form of Collateral Assignment of Lessor's Interest in Operating Leases. Incorporated by reference to Exhibit 4.13 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(as) Form of Subordination Agreement among the Partnership, New Claridge and the Collateral Trustee. Incorporated by reference to Exhibit 4.14 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(at) Form of Assignment of Leases and Rents and Other Contract Rights. Incorporated by reference to Exhibit 4.15 to Pre-Effective Amendment No. 2 to Form S-1 Registration Statement (file number 33-71550) dated January 18, 1994.\n10(au) Copy of Land Option Agreement between The Claridge at Park Place, Incorporated and Robert Schiff dated March 21, 1994. Incorporated by reference to Exhibit 10(au) to Form 10-Q for the quarter ended March 31, 1994.\n10(av) Copy of Land Option Agreement between The Claridge at Park Place, Incorporated and Abraham Schiff and Robert Schiff, t\/a Schiff Enterprises dated March 21, 1994. Incorporated by reference to Exhibit 10(av) to Form 10-Q for the quarter ended March 31, 1994.\n10(aw) Copy of Employment Agreement between James W. O'Brien and The Claridge at Park Place, Incorporated dated June 27, 1994. Incorporated by reference to Exhibit 10(aw) to Form 10-Q for the quarter ended June 30, 1994.\n10(ax) Copy of Amended Employment Agreement between Robert M. Renneisen and The Claridge at Park Place, Incorporated dated February 6, 1995.\n10(ay) Copy of Amended Employment Agreement between Albert T. Britton and The Claridge at Park Place, Incorporated dated February 6, 1995.\n10(az) Copy of Amended Employment Agreement between Peter F. Tiano and The Claridge at Park Place, Incorporated dated February 6, 1995.\n10(ba) Copy of Amended Employment Agreement between Raymond A. Spera and The Claridge at Park Place, Incorporated dated February 6, 1995.\n10(bb) Copy of Supplemental Executive Retirement Plan of The Claridge at Park Place, Incorporated effective January 1, 1994.\n12(a) Statement of Computation of Ratio of Earnings to Fixed Charges. Incorporated by reference to Exhibit 12.1 to Form S-1 Registration Statement (file number 33-71550) dated November 12, 1993.\n22(a) Subsidiaries of the Corporation. Incorporated by reference to Exhibit 22.1 Form 8 Amendment No. 1 to Form 10 dated February 21, 1984.\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.\nCLARIDGE HOTEL AND CASINO CORPORATION\nDated: March 28, 1995 By:\/s\/ ROBERT M. RENNEISEN ---------------------- -------------------------- Robert M. Renneisen 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.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nPage Reference In Report on Form 10-K ------------- Independent Auditors' Report .................................\nConsolidated Balance Sheets at December 31, 1994 and 1993 ....\nConsolidated Statements of Operations and Accumulated Earnings (Deficit) for the Years Ended December 31, 1994, 1993 and 1992 .......................................................\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 ...........................\nNotes to Consolidated Financial Statements ...................\nFinancial Statement Schedule:\nSchedule VIII - Valuation and Qualifying Accounts ...\nAll other schedules for which provision is made in the applicable accounting regulations promulgated by the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted.\nIndependent Auditors' Report\nThe Board of Directors and Stockholders The Claridge Hotel and Casino Corporation:\nWe have audited the consolidated financial statements of The Claridge Hotel and Casino Corporation and subsidiaries 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 Corporation'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 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 The Claridge Hotel and Casino Corporation and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, 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 LLP Short Hills, New Jersey March 3, 1995\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1994 and 1993 (dollars in thousands)\nSee accompanying notes to consolidated financial statements.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Consolidated Statements of Operations and Accumulated Earnings (Deficit) For the Years Ended December 31, 1994, 1993 and 1992 (in thousands except per share data)\nSee accompanying notes to consolidated financial statements.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended December 31, 1994, 1993 and 1992 (in thousands)\nSee accompanying notes to consolidated financial statements. Continued\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Consolidated Statements of Cash Flows (Cont'd.) For the Years Ended December 31, 1994, 1993 and 1992 (in thousands)\nSee accompanying notes to consolidated financial statements.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements\n1. THE CORPORATION\na) Organization\nThe Claridge Hotel and Casino Corporation (the \"Corporation\"), was formed on August 26, 1983 to hold all of the shares of capital stock of The Claridge at Park Place, Incorporated (\"New Claridge\"), which was formed on August 29, 1983. On October 31, 1983, New Claridge acquired certain assets of The Claridge Hotel and Casino (the \"Claridge\"), including gaming equipment (the \"Casino Assets\"), from Del E. Webb New Jersey, Inc. (\"DEWNJ\"), a wholly-owned subsidiary of Del Webb Corporation (\"Webb\"); leased certain other of the Claridge's assets, including the buildings, parking facility and non-gaming, depreciable, tangible property of the Claridge (the \"Hotel Assets\"), from Atlantic City Boardwalk Associates, L.P. (the \"Partnership\"); subleased the land on which the Claridge is located from the Partnership; assumed certain liabilities related to the acquired assets; and undertook to carry on the business of the Claridge Casino Hotel, a facility operating in Atlantic City, New Jersey.\nb) Recent Business Developments\nOn January 31, 1994, the Corporation completed an offering of $85 million of First Mortgage Notes (the \"Notes\") due 2002, bearing interest at 11 3\/4%. The Notes are secured by (i) a non-recourse mortgage granted by the Partnership representing a first lien on the Hotel Assets, (ii) a pledge granted by the Corporation of all outstanding shares of capital stock of New Claridge, and (iii) a guarantee by New Claridge. New Claridge's guarantee of the Notes is secured by a collateral assignment of the second lien Expandable Wraparound Mortgage, and by a lien on the Claridge's gaming and other assets, which lien will be subordinated to liens that may be placed on those gaming and other assets to secure any future revolving credit line arrangement. Interest on the Notes is payable semiannually on February 1 and August 1 of each year, commencing August 1, 1994.\nA portion of the net proceeds of $82.2 million was used as follows:\n(i) to repay in full the Corporation's outstanding debt under the Revolving Credit and Term Loan Agreement (the \"Loan Agreement\"), including the outstanding balance of the Corporation's revolving credit line, which was secured by the First Mortgage. In conjunction with the full satisfaction of the Loan Agreement, the Corporation's revolving credit line arrangement was terminated. The Corporation is currently seeking to obtain a new line of credit arrangement;\n(ii) to fund the cost of a 12,000 square foot expansion of New Claridge's casino capacity, the addition of approximately 500 slot machines, and the relocation of two restaurants and their related kitchen areas. The total cost of this expansion, which became fully operational on June 30, 1994, was approximately $12.7 million; and\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\nb) Recent Business Developments (cont'd)\n(iii) the acquisition of an adjacent parcel of land, to be used for the construction of a self- parking facility. In March 1994, New Claridge acquired options to purchase for $7,500,000 two parcels of property adjacent to its existing valet-parking facility. On June 6, 1994, New Claridge exercised these options, and deposited $400,000 with the Title Company of Jersey, to be held in escrow until settlement. In an effort to ensure that site preparation and construction of the self-parking facility could commence as soon as possible, New Claridge purchased an assignment of National Westminster Bank NJ's first mortgage interest in the property on November 3, 1994 for $2,040,000, which is included in other receivables at December 31, 1994. These acquisitions gave New Claridge control of the property as of November 16, 1994. The first mortgage interest was satisfied by the Mortgagor at settlement, which occurred on January 5, 1995.\nThe balance of the net proceeds from the offering of the Notes are expected to be used as follows:\n(i) the construction of the self-parking facility;\n(ii) the possible purchase of the Contingent Payment (see Note 9, Other Non-Current Liabilities) granted in 1989 and now held in a trust for the benefit of the United Way of Arizona. The Corporation is currently negotiating to purchase the Contingent Payment, for substantially less than face value, from the trustee for the United Way of Arizona. The Corporation previously offered to purchase the Contingent Payment for $10 million, but that offer was not accepted. Negotiations between the trustee for the United Way of Arizona and the Corporation are continuing; and\n(iii) the potential expansion of the Corporation's activities into emerging gaming markets. On March 16, 1994, Claridge Gaming Incorporated (\"CGI\") was formed as a wholly-owned subsidiary of the Corporation for the purpose of developing gaming opportunities in other jurisdictions.\nc) 1989 Restructuring\nOn October 27, 1988, the parties with an economic interest in the Corporation and New Claridge, including the banks holding the First Mortgage (the \"First Mortgage Lenders\"), entered into an agreement to restructure the financial obligations of the Corporation and New Claridge (the \"Restructuring Agreement\"). Had the Corporation not entered into the Restructuring Agreement, New Claridge probably would not have been relicensed by the New Jersey Casino Control Commission (the \"Commission\") for the license period beginning October 31, 1988 and ending October 31, 1989, and would have had to consider filing for bankruptcy protection. The Restructuring Agreement by its terms was subject to approval by at least two-thirds in interest of the limited partners of the Partnership and the holders of at least two-thirds of the Class A Stock of the Corporation. These approvals were received, and the restructuring was consummated in June 1989. The restructuring resulted in (i) a reorganization of the ownership interest in the\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\nc) 1989 Restructuring (cont'd.)\nCorporation; (ii) modifications of the rights and obligations of certain lenders; (iii) satisfaction and termination of the obligations and commitments of Webb and DEWNJ under the original structure; (iv) modifications of the lease agreements between New Claridge and the Partnership; and (v) the forgiveness by Webb of substantial indebtedness.\nAt the closing of the restructuring on June 16, 1989, Webb transferred all of its right, title, and interest to its Claridge land, easements, and air rights to the Partnership, which had the effect of eliminating the land lease between Webb and the Partnership and of subjecting that land to a direct lease (rather than a sublease) from the Partnership to New Claridge.\nPursuant to amendments to the Operating Lease and Expansion Operating Lease, the Partnership agreed to deferrals of basic rent (see Note 12, \"Operating Lease\").\nIn addition, the Partnership loaned $3.6 million to New Claridge. That amount represented substantially all the cash and cash equivalents remaining in the Partnership as of June 16, 1989 other than funds needed to pay expenses incurred through the closing of the restructuring. The Partnership paid to New Claridge $100,000 for the cancellation of an option agreement relating to the land underlying the Claridge.\nThe Restructuring Agreement provided that Webb would retain an interest equal to $20 million plus interest from December 1, 1988 at the rate of 15% per annum compounded quarterly (the \"Contingent Payment\") in any proceeds ultimately recovered from the operations and\/or the sale or refinancing of the Claridge facility in excess of the first mortgage loan and other liabilities. To give effect to this Contingent Payment, the Corporation and the Partnership agreed not to make any distributions to the holders of their equity securities, whether derived from operations or from sale or refinancing proceeds, until Webb had received the Contingent Payment.\nIn connection with the restructuring, Webb agreed to grant those investors in the Corporation and the Partnership (\"Releasing Investors\") from whom Webb had received written releases from all liabilities rights (\"Contingent Payment Rights\") to receive certain amounts to the extent available for application to the Contingent Payment. Approximately 81% in interest of the investors provided releases and became Releasing Investors. Payments to Releasing Investors are to be made in accordance with the following schedule of priorities:\n(i) Releasing Investors would receive 81% of the first $10 million of any net proceeds from operations or a sale or a refinancing of the Claridge facility pursuant to an agreement executed within five years (\"Five-Year Payments\") after the restructuring (i.e., the sum obtained by multiplying the lesser of $10 million of, or the total of, any Five-Year Payments by 81%, with the balance of any such funds to be applied against the Contingent Payment), and\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\nc) 1989 Restructuring (cont'd)\n(ii) All distributions of funds other than Five-Year Payments, or of Five-Year Payments in excess of the $10 million, will be shared by Webb and Releasing Investors in the following proportions: Releasing Investors will receive 40.5% (one-half of 81%) of any such excess proceeds, with the balance of any such funds to be applied against the Contingent Payment, until the Contingent Payment is paid in full ($20 million plus accrued interest.)\nOn April 2, 1990, Webb transferred its interest in the Contingent Payment to an irrevocable trust for the benefit of the United Way of Arizona, and upon such transfer Webb was no longer required to be qualified or licensed by the Commission.\nThe Corporation has recently offered to purchase the Contingent Payment from the United Way of Arizona for the amount of $10 million; this offer was not accepted. The Corporation is continuing its negotiations with the Trustee for the United Way of Arizona in an attempt to purchase the Contingent Payment. (See Note 1(b) \"Recent Business Developments\").\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\na) Basis of Presentation\nThe consolidated financial statements are prepared in accordance with generally accepted accounting principles. The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiaries, New Claridge and CGI. All material intercompany accounts and transactions have been eliminated in consolidation.\nThe separate financial statements of New Claridge, which is a guarantor of the Notes, are not included because the aggregate assets, liabilities, earnings and equity of New Claridge are substantially equivalent to the assets, liabilities, earnings and equity of the Corporation on a consolidated basis, and because the separate financial statements and other disclosures concerning New Claridge are not deemed material to holders of Notes. There are no separate financial statements for CGI, which is the only other subsidiary of the Corporation and is not a guarantor of the Notes.\nb) Cash and Cash Equivalents\nCash and cash equivalents includes investments in interest bearing repurchase agreements in government securities with maturities of three months or less when purchased. Interest income is recorded as earned.\nc) Casino Receivables and Revenues\nCredit is issued to certain casino customers and the Corporation records all unpaid credit as casino receivables on the date the\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (cont'd.)\ncredit was issued. Allowances for estimated uncollectible casino receivables are provided to reduce these receivables to amounts anticipated to be collected. The Corporation recognizes as casino revenue, the net win (which is the difference between amounts wagered and amounts paid to winning patrons) from gaming activity.\nd) Inventories\nInventories are stated at the lower of cost or market, cost being determined principally on a first-in, first-out basis.\ne) Gaming Equipment\nGaming equipment is stated at cost. Depreciation is provided over the estimated useful lives (5 years) of the respective assets using the straight line method.\nf) Deferred Charges\nDeferred charges primarily relate to the January 31, 1994 issuance of the Notes. These charges, which totalled approximately $3.7 million, are being amortized over the term of the Notes. Accumulated amortization of these charges as of December 31, 1994 was $428,000.\ng) Income Taxes\nDeferred income taxes are provided for temporary differences between financial statement reporting and income tax reporting for rent levelling provisions, asset basis differences, and various other expenses recorded for financial statement purposes.\nh) Earnings Per Share\nEarnings per share is calculated based on the weighted average shares outstanding (5,035,819 for the year ended December 31, 1994, 5,030,078 for the year ended December 31, 1993, and 4,983,696 for the year ended December 31, 1992).\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n3. RECEIVABLES\nReceivables at December 31, 1994 and 1993 consist of the following:\nAt December 31, 1994, other receivables includes approximately $2.5 million representing the escrow deposit and first mortgage interest in the adjacent parcel of land which will be used to construct a self-parking facility (see Note 1 (b), \"Recent Business Developments\").\nThe Expandable Wraparound Mortgage Loan Agreement (\"Expandable Wraparound Mortgage\") was executed and delivered by the Partnership to New Claridge and is secured by all property of the Partnership. As part of the agreement, New Claridge will service the\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n3. RECEIVABLES (cont'd.)\nFirst Mortgage and the Partnership's debt under the Purchase Money Second Mortgage indebtedness (note 8). $20 million in interest was deferred between 1983 and 1988 and will be due upon maturity. Principal payments required under the Expandable Wraparound Mortgage commenced in 1988.\nThe Expandable Wraparound Mortgage also includes a provision whereby New Claridge will loan the Partnership up to $25 million in the form of FF&E promissory notes, secured under the Expandable Wraparound Mortgage, for the purchase of property and equipment. One half of the principal is due in 48 months and the remaining balance is due 60 months from the date of the respective FF&E promissory note. During the year ended December 31, 1995, $1,251,000 of principal payments will become due. In connection with the offering of $85 million of Notes on January 31, 1994, the Corporation agreed to use not less than $8 million from the net proceeds of the offering to finance certain internal improvements to the Claridge which were funded through additional FF&E Loans. In connection therewith, the Expandable Wraparound Mortgage Loan agreement as well as the Operating Lease, and the Expansion Operating Lease were amended to provide that the principal on these additional FF&E Loans will be payable at final maturity of the Expandable Wraparound Mortgage.\nIn 1986, the Expandable Wraparound Mortgage was increased up to $17 million to provide the Partnership with funding for the construction of an expansion. Effective on the date that the expansion opened to the public (August 28, 1986), the Partnership commenced making level monthly payments of principal and interest so as to repay on September 30, 1998, in full, the principal balance of this increase in the Expandable Wraparound Mortgage. The Expandable Wraparound Mortgage was amended to require, in addition to the above, principal payments (in equal monthly installments) due during the years 1988 through 1998 in escalating amounts totalling $80 million and on September 30, 2000 a balloon payment of $67 million which includes $20 million of deferred interest.\n4. OTHER ASSETS\nThe Casino Control Act (the \"Act\") provides for the imposition of an investment obligation, calculated at 1.25% of the total revenues from gaming operations, less the provision for uncollectible accounts. If a casino licensee opts not to make the investment as required, it is assessed an alternative tax of 2.5% of total gaming revenues less the provision for uncollectible accounts. The licensee can satisfy its obligation by making a direct investment in a project approved by the Casino Reinvestment Development Authority (\"CRDA\"), the agency responsible for administering this portion of the Act, or it can buy bonds issued by the CRDA. These bonds bear interest at two-thirds of market rates, as set forth in the Act.\nNew Claridge has opted to deposit its reinvestment obligation funds with the State Treasurer. Through December 31, 1994, the Corporation has deposited $13,920,000 of which $2,277,000 has been used to purchase bonds issued by the CRDA. Since interest on these\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n4. OTHER ASSETS (cont'd.)\nbonds and funds deposited is paid at a discounted rate, New Claridge records a valuation allowance of approximately one-third of the reinvestment obligation. In addition, in January 1990, it was determined that certain bonds issued by the CRDA had become impaired, and that the payment of principal and interest was uncertain. As a result, New Claridge has recorded a valuation allowance for the full amount of its investment in these bonds, totalling $1,654,000.\nIn the third quarter of 1994, New Claridge made donations to the CRDA of funds, totalling $3,831,000 which had previously been deposited with the State Treasurer. In exchange for these donations, New Claridge received credits from the CRDA equal to 51% of the donations, to be applied to satisfy portions of the reinvestment obligations commencing after the date of the donations. As of December 31, 1994, $915,000 of these credits remained available, and are included in other current assets.\n5. WORKING CAPITAL LOANS\nOn January 31, 1994, the Corporation completed an offering of $85 million of Notes due 2002, bearing interest at 11 3\/4%. A portion of the net proceeds of $82.2 million, after deducting fees and expenses, was used to repay in full the Corporation's outstanding debt under the Loan Agreement, including the outstanding balance of the Corporation's revolving credit line, which was secured by the first mortgage. In conjunction with the full satisfaction of the Loan Agreement, the Corporation's revolving credit line arrangement was terminated.\nPursuant to the terms of the Loan Agreement, First Fidelity Bank, N.A., New Jersey (\"Bank\") established a revolving working capital facility, which as of December 31, 1993 was in the amount of $7.5 million. Interest on the working capital facility borrowings, which was payable monthly in arrears, accrued at a rate equal to the prime rate plus four percent, as amended effective April 1, 1993 (see Note 8, Long-Term Debt). New Claridge was also required to pay quarterly a commitment fee equal to .5% per annum of the unused portion of the revolving working capital facility.\nNew Claridge's outstanding borrowings on the revolving working capital facility at December 31, 1993 were $1,700,000. The amount outstanding on the revolving working capital facility at December 31, 1993 has been classified as long-term debt, due to the repayment in full on January 31, 1994, in conjunction with the full satisfaction of the Loan Agreement.\n6. LOAN FROM THE PARTNERSHIP\nIn accordance with the terms of the Restructuring Agreement, on June 16, 1989 the Partnership loaned to New Claridge $3.6 million, which represented substantially all cash and cash equivalents remaining in the Partnership other than funds needed to pay expenses\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n6. LOAN FROM THE PARTNERSHIP (cont'd.)\nincurred through the closing of the Restructuring. This loan is evidenced by an unsecured promissory note and is not due and payable until such time as the full or partial satisfaction of the Expandable Wraparound Mortgage and the First Mortgage has been made in connection with a refinancing or sale of all or a partial interest in the Claridge.\nInterest which accrues at 12% per annum is payable in full upon maturity. As of December 31, 1994, such interest, which is included in other current liabilities, amounted to $2,394,000.\n7. OTHER CURRENT LIABILITIES\nOther current liabilities at December 31, 1994 and 1993 consist of the following:\nThe amount of deferred rent as of December 31, 1994 of $15,078,000 represents the maximum deferral allowed in accordance with the Operating Lease Agreement and Expansion Operating Lease Agreement, as amended. The deferred rent liability will become payable (i) upon a sale or refinancing of the Claridge; (ii) upon full or partial satisfaction of the Expandable Wraparound Mortgage; and (iii) upon full satisfaction of any first mortgage then in place.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n8. LONG-TERM DEBT\nLong-term debt at December 31, 1994 and 1993 consists of the following:\n1994 1993 ---- ---- (in thousands)\n11 3\/4% Notes, due 2002 $85,000 -0- First Mortgage Note, prime plus 4%, effective April 1, 1993 -0- 33,559 Revolving line of credit -0- 1,700 ------- ------ $85,000 35,259 ======= ======\nOn January 31, 1994, the Corporation completed an offering of $85 million of Notes due 2002, bearing interest at 11 3\/4%. The Notes are secured by (i) a non-recourse mortgage granted by the Partnership representing a first lien on the Hotel Assets, (ii) a pledge granted by the Corporation of all outstanding shares of capital stock of New Claridge, and (iii) a guarantee by New Claridge. New Claridge's guarantee of the Notes is secured by a collateral assignment of the second lien Expandable Wraparound Mortgage, and by a lien on the Claridge's gaming and other assets, which lien will be subordinated to liens that may be placed on those gaming and other assets to secure any future revolving credit line arrangement. Interest on the Notes is payable semiannually on February 1 and August 1 of each year, commencing August 1, 1994. A portion of the net proceeds of $82.2 million was used to repay in full the Corporation's outstanding debt under the Loan Agreement, including the outstanding balance of the Corporation's revolving credit line, which was secured by the First Mortgage. In conjunction with the full satisfaction of the Loan Agreement, the Corporation's revolving credit line arrangement was terminated.\nBeginning in 1995, and annually thereafter, the Corporation will be required to make an offer (\"Excess Cash Offer\"), to all holders of Notes, to purchase at 100% of par (plus accrued and unpaid interest, if any, to the purchase date), the maximum amount of Notes that may be purchased with 50% of the Corporation's \"Excess Cash\" (as defined in the indenture governing the Notes (the \"Indenture\")), from the preceding year. If less than $5 million is available to make such purchases (i.e., if Excess Cash is less than $10 million), no such offer needs to be made. The commencement date of any required Excess Cash Offer must be not later than 30 days after the publication of the Corporation's audited financial statements for the immediately preceding fiscal year. For the year ended December 31, 1994, the Corporation's Excess Cash was less than $10 million, and therefore the Corporation is not required to make an Excess Cash Offer in 1995.\nIn addition, if construction for the self-parking garage or equivalent facility has not commenced by December 31, 1995, the Corporation is required under the terms of the Indenture to make an offer (the \"Parking Garage Funds Offer\") within 30 days of such date to all holders of Notes to purchase the maximum principal amount of Notes that\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n8. LONG-TERM DEBT (cont'd.)\nmay be purchased with $24 million, at an offer price in cash equal to 101% of the principal amount thereof plus accrued and unpaid interest, if any, to the date of purchase. Pursuant to the terms of the Indenture, construction shall be deemed to have commenced when (i) all necessary approvals to commence the construction have been obtained, and (ii) demolition or other physical work below street grade for the project shall have commenced. In March 1995, the Corporation received final site approval for the proposed garage from the Atlantic City Zoning Board; no other approvals are required to complete the garage project. In addition, demolition of the structure previously located on the site is substantially complete. As a result, the Corporation believes it will not be required to make an offer to purchase Notes pursuant to the Parking Garage Funds Offer.\nOn October 7, 1991, New Claridge was issued a two year license by the Commission for the period commencing October 31, 1991. The relicensing approval was based in part on the execution of the second amendment to the Loan Agreement on April 23, 1991. In addition, New Claridge was required to submit to the Commission by April 30, 1993 a plan to satisfy the balloon payment due on the term loan on January 1, 1994, pursuant to the terms of the Loan Agreement, with implementation of the plan by June 30, 1993. The third amendment to the Loan Agreement was executed, effective April 1, 1993. The modifications resulting from this amendment included (i) the extension of the maturity date of the first mortgage loan from January 1, 1994 to December 31, 1996; (ii) an increase in the interest rate to the prime rate of Marine Midland Bank, N.A. plus four percent (from the previous prime rate plus one and one-half percent); (iii) an increase in the mandatory principal payments from $1.2 million to $3 million annually, payable in equal monthly installments; (iv) an increase in the maximum annual capital expenditure limitation from $3.5 million per year to $5 million per year; and (v) an increase in the co-agent's fee to $70,000 per year. Prior to this amendment, New Claridge was required to pay a co-agent's fee equal to one-fortieth of one percent of the average daily outstanding balance of the first mortgage loan. In addition, New Claridge paid an extension fee of $200,000 upon the execution of this amendment to the Loan Agreement.\nIn addition to the mandatory principal payments, New Claridge was also required to pay quarterly, to the Bank, for permanent application to the outstanding principal balance of the first mortgage loan, any excess cash flow as defined in the Loan Agreement.\nThe total principal balance outstanding on the first mortgage loan at December 31, 1993 has been classified as long-term debt, due to the repayment in full of the first mortgage on January 31, 1994, in conjunction with the full satisfaction of the Loan Agreement.\n9. OTHER NONCURRENT LIABILITIES\nPursuant to the Restructuring Agreement, Webb retained an interest, which was assigned to the United Way of Arizona on April 2, 1990, equal to $20 million plus interest at a rate of 15% per annum, compounded quarterly, commencing December 1, 1988, in any proceeds\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n9. OTHER NONCURRENT LIABILITIES (cont'd.)\nultimately recovered from operations and\/or the sale or refinancing of the Claridge facility in excess of the first mortgage loan (\"Contingent Payment\"), which amount is payable under certain circumstances. Consequently, New Claridge has deferred the recognition of $20 million of forgiveness income with respect to the Contingent Payment obligation. Interest on the Contingent Payment has not been recorded in the accompanying consolidated financial statements since the likelihood of paying such amount is not considered probable at this time. As of December 31, 1994, accrued interest would have amounted to approximately $29 million.\n10. PROMOTIONAL ALLOWANCES\nThe retail value of complimentary rooms, food and beverages and other complimentaries furnished to patrons is included in gross revenue and then deducted as promotional allowances. The estimated cost of providing such promotional allowances for the years ended December 31, 1994, 1993 and 1992 has been allocated to casino expenses as follows (in thousands):\n11. INCOME TAXES\nIn February 1992, the Financial Accounting Standards Board issued Statement No. 109, \"Accounting for Income Taxes\". Statement No. 109 requires a change from the deferred method of accounting for income taxes to the asset and liability method of accounting for income taxes.\nUnder the asset and liability method, 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 basis.\nEffective January 1, 1993, the Corporation adopted Statement No. 109 on a prospective basis. There was no effect on the Corporation's statement of operations for the year ended December 31, 1993 as a result of the adoption of Statement No. 109.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n11. INCOME TAXES (cont'd.)\nThe provision for income taxes is comprised of the following (in thousands):\nThe provision for income taxes differs from the amount computed at the statutory rate as follows (in thousands):\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n11. INCOME TAXES (cont'd.)\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993 are presented below (in thousands):\nThe net change in the valuation allowance for the year ended December 31, 1994 was an increase of $422,000. No valuation allowance was provided on deferred tax assets as of December 31, 1993 since management believed that it was more likely than not that such assets would be realized through the reversal of existing deferred tax liabilities and future taxable income.\nThe Corporation recorded an income tax benefit of $2,393,000 for the year ended December 31, 1994 which represents the tax refund expected from the carryback of Federal net operating losses net of increased deferred tax credits. As of December 31, 1994, the current portion of the income tax benefit of approximately $4.2 million is included in other current assets.\nThe principal items comprising the deferred tax provision in 1994 included rent levelling of $1,280,000, Expandable Wraparound Mortgage discount expense of $460,000, bad debt expense of ($80,000) and depreciation expense of $200,000.\nThe principal items comprising the deferred tax provision in 1993 included rent levelling of $1,270,000, Expandable Wraparound Mortgage\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n11. INCOME TAXES (cont'd.)\ndiscount expense of $402,000, bad debt expense of $42,000, and income related to debt forgiveness of ($520,000).\nThe principal items comprising the deferred tax provision in 1992 included rent levelling of $1,150,000, Expandable Wraparound Mortgage discount expense of $350,000, reversal of progressive jackpot liability of $615,000, bad debt expense of ($66,000), and income related to debt forgiveness of ($678,000).\nAs a result of the restructuring in 1989, the amount of debt forgiven resulted in the loss or reduction of various tax attributes including tax operating loss carryforwards of $30,400,000, unused tax credits of $1,041,000 and reduction in tax basis of assets by $89,178,000. As a result of the reduction in tax basis of assets, cash payments for income taxes will significantly exceed income tax expense for financial statement purposes in future years. The above amounts have been adjusted to reflect settlements of the Internal Revenue Service (\"IRS\") audits of the years 1983 through 1987. The IRS is currently conducting an audit of the Corporation's federal income tax returns for the years 1990 and 1991. The Corporation believes the results of the audit will not have a material adverse effect on the consolidated financial statements.\n12. OPERATING LEASE\nNew Claridge leases the Hotel Assets and the land on which the Claridge is located from the Partnership under an Operating Lease for an initial lease term of 15 years with three 10- year renewal options. If New Claridge exercises its option to extend the term of the Operating Lease, basic rent during the renewal term will be calculated pursuant to a formula, with such rent not to be more than $29,500,000 nor less than $24,000,000 for the lease year commencing October 1, 1998 through September 30, 1999 and, subsequently, not to be greater than 10% more than the basic rent for the immediately preceding lease year in each lease year thereafter. New Claridge is also required to pay as additional rent amounts including certain taxes, insurance and other charges relating to the occupancy of the land and Hotel Assets, certain expenses and debt service relating to furniture, fixture and equipment replacements and building improvements, and the general and administrative costs of the Partnership. Under the terms of the Operating Lease, New Claridge has an option to purchase, on September 30, 1998 and, if it renews the Operating Lease, on September 30, 2003, the Hotel Assets and the underlying land for their fair market value at the time the option is exercised.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n12. OPERATING LEASE (cont'd.)\nMinimum future basic lease payments under the initial term of the Operating Lease, as amended, as of December 31, 1994 (net of expected abatements, as discussed below) are as follows (in thousands):\n1995 $ 31,693 1996 31,420 1997 40,077 1998 32,531 --------- Total Minimum $135,721 =========\nAlso, additional rent payments are required based upon fixed assets purchased by the Partnership (the FF&E Replacements, Note 3) and then leased to New Claridge. For the years ended December 31, 1994, 1993 and 1992, expense resulting from the Operating Lease amounted to $36,219,000, $34,580,000 and $34,658,000, respectively, of which ($3,209,000), ($3,183,000) and ($2,884,000) of rental expense is attributable to the requirement under Statement of Financial Accounting Standards No. 13 to provide a level rent expense for those leases with escalating payments. Under terms of the Operating Lease, the Partnership is responsible for taxes, assessments, insurance, maintenance and repairs and other costs related to use and occupancy of the Hotel Assets.\nNew Claridge entered into an Expansion Operating Lease Agreement with the Partnership whereby New Claridge leased the expansion facility for an initial term beginning March 17, 1986 and ending on September 30, 1998 with three 10-year renewal options. Basic annual rent payable during the initial term of the Expansion Operating Lease was $3,870,000 in 1986 (prorated based on the day that the Expansion Improvements opened to the public) and determined based on the cost of the construction of the Expansion Improvements. Annually thereafter the rental amount is adjusted based on the Consumer Price Index but any increase may not exceed two percent per annum. Basic annual rent for 1994, 1993, and 1992 amounted to $4,534,000, $4,445,000, and $4,358,000, respectively. If the term of the Expansion Operating Lease is extended, basic annual rent will be calculated pursuant to a formula, with such rent not to be more than $3,000,000 nor less than $2,500,000 and not to be greater than 10% more than the basic annual rent for the immediately preceding lease year in each lease year thereafter.\nNew Claridge is also required to pay as additional rent certain expenses and the debt service relating to Furniture, Fixture and Equipment Replacements and building improvements (collectively \"Expansion FF&E Replacements\") for the expanded facility. The Partnership will be required during the entire term of the Expansion Operating Lease to provide New Claridge with Expansion FF&E Replacements and until September 30, 1998, will be required to provide facility maintenance and engineering services to New Claridge. New Claridge will be obligated to lend the Partnership any amounts necessary to fund the cost of Expansion FF&E Replacements. Any advances by New Claridge for the foregoing will be secured under the Expandable\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n12. OPERATING LEASE (cont'd.)\nWraparound Mortgage. New Claridge will have the option to purchase, on September 30, 1998 and, if it renews the Expansion Operating Lease, on September 30, 2003, the expansion facility (including air rights) for their fair market value at the time the option is exercised.\nEffective with the consummation of the restructuring in June 1989, the Operating Lease Agreement and the Expansion Operating Lease Agreement were amended to provide for the deferral of $15,078,000 of rental payments during the period July 1, 1988 through the beginning of 1992, and to provide for the abatement of $38.8 million of basic rent payable through 1998, thereby reducing the Partnership's cash flow to an amount estimated to be necessary to meet the Partnership's cash requirements. During the third quarter of 1991, the maximum deferral of basic rent allowable under the Operating Lease of $15,078,000 was reached. On August 1, 1991, the Operating Lease Agreement and Expansion Operating Lease Agreement were further amended to revise the abatement provisions so that, commencing January 1, 1991, for each calendar year through 1998, the lease abatements not exceed $10 million in any one calendar year, and $38,820,000 in the aggregate. As of December 31, 1994, $20.9 million of basic rent had been abated.\nEffective with the closing of the Restructuring on June 16, 1989, lease expense recognized on a level basis is reduced prospectively, from the use of a revised schedule of rent levelling relative to the abatement of certain rents beginning in 1992.\nIf the Partnership should fail to make any payment due under the Expandable Wraparound Mortgage, New Claridge may exercise a right of offset against rent or other payments due under the Operating Lease and Expansion Operating Lease to the extent of any such deficiency.\nNew Claridge also leases supplemental office, warehouse, and surface parking spaces in nearby lots. For the years ended December 31, 1994, 1993, and 1992, operating lease expense for these facilities amounted to $1,531,000, $1,645,000 and $1,776,000, respectively. The minimum future lease payments due under these leases total $1,297,000 in 1995, $784,000 in 1996, $756,000 in 1997, $736,000 in 1998, and $739,000 in 1999.\nOn March 8, 1991, New Claridge entered into an operating lease agreement to lease certain computer equipment. For the years ended December 31, 1994, 1993 and 1992, operating lease expense for the computer equipment amounted to $77,000, $308,000, and $308,000, respectively. New Claridge had an option to acquire the equipment at the end of the lease term at the then fair market value of the equipment. This option was exercised on February 28, 1994.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n13. CONTINGENCIES\na) Licensing\nOn September 22, 1993, New Claridge was issued a two-year casino license by the Commission for the period commencing September 30, 1993. The relicensing approval was based in part on the execution of the third amendment to the Loan Agreement on April 1, 1993 (as discussed in Note 8, Long-Term Debt).\nb) Legal Proceedings\nThe Corporation and New Claridge are defendants in various legal proceedings arising in the normal course of business. In the opinion of management, it is not reasonably likely that any such matters individually or collectively would result in an outcome having a material adverse effect on the consolidated financial statements.\n14. OTHER EVENTS\nOn November 8, 1994, a casino management agreement (the \"Casino Management Agreement\") was executed between CGI and St. Petersburg Kennel Club, Inc. (\"SPKC\"), which owns a greyhound racetrack located in St. Petersburg, Florida. Pursuant to the Casino Management Agreement, which expires on December 31, 1997, CGI would receive fees for managing any casino entertainment facility authorized at SPKC's site. In November 1994, Florida voters rejected a ballot question which would have authorized up to 47 casinos in the state of Florida, including one at SPKC's St. Petersburg greyhound race track.\n15. RELATED PARTY TRANSACTIONS\na. The Restructuring Agreement provided for Webb to retain an interest, which was assigned to the United Way of Arizona on April 2, 1990, equal to $20 million plus interest at a rate of 15% per annum, compounded quarterly, commencing December 1, 1988, in any proceeds ultimately recovered from operations and\/or in the sale or refinancing of the Claridge facility in excess of the first mortgage loan. Webb was also entitled to retain a seat on the Board of Directors of the Corporation and New Claridge (a right it subsequently relinquished). Effective with the closing of the Restructuring on June 16, 1989, all or substantially all of the financial, contractual, ownership, guarantee and other relationships of the Corporation and New Claridge with Webb were terminated.\nb. The Partnership has a direct material interest in the Expandable Wraparound Mortgage Loan Agreement, the Operating Lease and the Expansion Operating Lease together with the amendments thereto as described in the preceding notes. The\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n15. RELATED PARTY TRANSACTIONS (cont'd.)\nownership interests in the Partnership which have a relationship to the Corporation are currently as follows:\n- Limited Partners representing approximately 98% interest in the Partnership own approximately 4,500,000 shares of the Corporation's Class A Stock; and\n- Special Limited Partners (Oppenheimer Holdings, Inc. and certain officers and employees of Oppenheimer & Co., Inc.) represent approximately 1% interest in the Partnership and prior to March 24, 1989 owned the remaining 562,500 shares of Class A Stock. On March 24, 1989, Oppenheimer Holdings, Inc. returned to the Corporation all of its shares (273,938) of the Corporation's Class A Stock.\nSee footnote 1.c, \"1989 Restructuring\", for a summary of the transactions consummated pursuant to the terms of the Restructuring Agreement.\nc. In February 1992, the Corporation's Board of Directors adopted a Long-Term Incentive Plan (the \"Plan\") in which certain key employees of the Corporation and\/or New Claridge participate. The Plan provides for the grant of the 273,938 shares of the Corporation's Class A stock, which were held as treasury shares of the Corporation, and for the issuance of 100 Equity Units. The aggregate value of the 100 Equity Units is equal to 5.41 percent of certain amounts as further defined in the Plan. Specified portions of the awarded treasury shares and Equity Units held by participants vest upon the attainment of specific goals as described in the Plan. The treasury shares and Equity Units fully vest upon a further restructuring or a change in control as defined in the Plan. Payment with respect to the Equity Units will only be made (a) upon the occurrence of a transaction in which substantially all of the assets and business operations of the Claridge entities are transferred to one or more entities in a merger, sale of assets or other acquisition-type transaction, (b) upon termination of employment of any participant in the Plan within one year after any change in control of the Corporation occurs, as defined in the Plan, or (c) if the Corporation pays dividends to its stockholders, if the Partnership makes distributions to its partners, or if the Corporation or the Partnership makes certain distributions under the Restructuring Agreement. On April 15, 1992, the Commission approved the Plan and the treasury shares were delivered to the participants. Upon the issuance of the Notes and the repayment in full of the Corporation's outstanding debt under the Loan Agreement, 25% of the shares and Equity Units awarded under the Plan vested. A participant is entitled to vote all awarded treasury shares whether or not vested in such shares.\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements (Cont'd.)\n15. RELATED PARTY TRANSACTIONS (cont'd.)\nOn July 25, 1993, Shannon Bybee, resigned his position as Chairman and Chief Executive Officer of the Corporation, resulting in the return to the Corporation of 73,963 shares of the Corporation's Class A stock, which had previously been awarded under the Plan. In addition, the Equity Units held by Mr. Bybee were returned to the Corporation upon his resignation. Mr. Bybee continues to serve as a member of the Board of Directors of the Corporation. On April 16, 1994, the shares of Class A Stock and Equity Units which had been returned by Mr. Bybee were awarded to certain officers of the Corporation and\/or New Claridge.\n16. PARENT COMPANY INFORMATION\nThe Corporation owns all of the outstanding common stock of New Claridge, which it purchased for $5,000,000. The balance sheet accounts of the Corporation as of December 31, 1994 and 1993 include the following:\n1994 1993 ---- ---- (in thousands)\nCash $ 2 -0- Investment in New Claridge 87,206 5,000 Other assets 7,219 457 -------- --------\nTotal assets $ 94,427 5,457 ======== ========\nLong-term debt $ 85,000 -0- Other liabilities 17,517 6,030 Stockholders' deficiency (8,090) (573) -------- -------- Total liabilities and stockholders' deficiency $ 94,427 5,457 ======== ========\nThe Corporation's expenses for the years ended December 31, 1994, 1993 and 1992 amounted to $7,518,000, $599,000, and $611,000, respectively, including income tax benefit of $3,908,000, $-0-, and $-0-, respectively. These amounts represent the net loss of the Corporation for the respective periods before equity in the results of New Claridge. For the year ended December 31, 1994, New Claridge had net income of $617,000, as compared to net income of $5,731,000 and $6,659,000 for the years ended December 31, 1993 and 1992, respectively.\nSCHEDULE VIII\nTHE CLARIDGE HOTEL AND CASINO CORPORATION AND SUBSIDIARIES Valuation and Qualifying Accounts Years Ended December 31, 1994, 1993 and 1992 (in thousands)\n(a) Accounts written-off.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"71222_1994.txt","cik":"71222","year":"1994","section_1":"Item 1. Business\nGeneral\nCommonwealth Electric Company (the Company) is engaged in the generation, transmission, distribution and sale of electricity at retail to approximately 312,200 customers (including 48,600 seasonal) in 40 communities located in southeastern Massachusetts, including Cape Cod and the island of Martha's Vineyard, having an approximate year-round population of 549,000 and a large influx of summer residents. The results of the 1990 federal census taken in the Company's service area indicated a population increase of 18.1% since 1980. Also, the Company sells power to the New England Power Pool (NEPOOL) and is actively marketing sales of certain available capacity to other utilities in and outside the New England region.\nThe Company, which was organized on April 4, 1850 pursuant to a special act of the legislature of the Commonwealth of Massachusetts, operates under the jurisdiction of the Massachusetts Department of Public Utilities (DPU), which regulates retail rates, accounting, issuance of securities and other matters. In addition, the Company files its wholesale rates with the Federal Energy Regulatory Commission (FERC). Since the date of its organization, the Company has from time to time acquired or disposed of the property and franchises of or merged with various gas or electric companies. The Company is a wholly-owned subsidiary of Commonwealth Energy System (System), which, together with its subsidiaries, is collectively referred to as \"the system.\"\nBy virtue of its charter, which is unlimited in time, the Company distrib- utes electricity without direct competition in kind from any privately or municipally-owned utilities. Alternate sources of energy are available to customers within the service territory, but competition from these sources to date has not been a significant factor affecting the Company. However, this past year the Company continued to develop and implement strategies to deal with the increasingly competitive environment. For further details, refer to the \"Competition\" section that follows in this Item 1. Of the Company's 1994 retail electric unit sales (73.8% of its total sales), 48.8% was sold to residential customers, 32.1% to commercial customers, 10.2% to industrial and 8.9% to municipal and other customers.\nElectric Power Supply\nThe Company relies almost entirely on purchased power to meet its electric energy requirements. The Company owns generating facilities with a total capacity of 13.8 megawatts (MW), which are principally used for emergency and peaking purposes. The Company also has a joint-ownership interest of 8.9 MW in Central Maine Power Company's oil-fired Wyman Unit 4.\nPower purchases for the Company and Cambridge Electric Light Company (Cambridge Electric), the other wholly-owned electric distribution subsidiary of the System, are arranged in accordance with their requirements. These arrangements include purchases from Canal Electric Company (Canal), another wholly-owned subsidiary of the System. Canal is a wholesale electric generat- ing company located in Sandwich, Massachusetts and an important source of purchased power for the Company and Cambridge Electric. Under long-term con- tracts, system entitlements include one-quarter (140 MW) of the capacity and\nCOMMONWEALTH ELECTRIC COMPANY\nenergy of Canal Unit 1 and one-half (292 MW) of the capacity and energy of Canal Unit 2. The Company's entitlements in these units are 112.5 MW and 141.9 MW, respectively.\nPursuant to a Capacity Acquisition and Disposition Agreement (CADA), Canal seeks to secure bulk electric power on a single system basis to provide cost savings for the customers of the Company and Cambridge Electric. The CADA has been accepted for filing as an amendment to Canal's FERC rate schedule and allows Canal to act on behalf of the Company and Cambridge Electric in the procurement of additional capacity for one or both companies, or, to sell capacity and\/or energy from each company's entitlements. The CADA is in effect for Seabrook 1, Phases I and II of Hydro-Quebec, New England Power Company (Bear Swamp Units), Northeast Utilities and Central Vermont Public Service Corp. (Vermont Yankee and Merrimack 2 Unit). Exchange agreements are in place with several of these utilities whereby, in certain circumstances, it is possible to exchange capacity so that the mix of power improves the pricing for dispatch for both the seller and the purchaser. Power contracts are in place whereby Canal bills or credits the Company and Cambridge Electric for the costs or revenues associated with these facilities. The Company and Cambridge Electric, in turn, have billed or are billing these charges (net of revenues from sales) to their customers through rates subject to DPU approval.\nThe Company has other long-term contracts for the purchase of electricity from various sources including a 73.5 MW entitlement from a nuclear unit in Plymouth, Massachusetts (Pilgrim) under a life-of-the-unit contract with Boston Edison Company. Also, through Canal's equity ownership in Hydro-Quebec Phase II and its 3.52% interest in the Seabrook nuclear power plant, the Company has entitlements of 48.2 MW and 32.4 MW, respectively.\nSeveral independent power producer (IPP) sources provided a substantial portion of the Company's requirements in 1994 as follows:\nCompany Entitlement (MW) Natural gas fired units - Lowell Cogeneration Company, L.P. (a) 23.0 Pepperell Power Associates, L.P. (a) 38.0 Northeast Energy Associates 46.0 Masspower 59.9 Altresco Pittsfield, L.P. 27.5 Dartmouth Power Associates 67.2 261.6 Waste-to-Energy fired units (b) - SEMASS 70.2\nHydro sources (5) 29.9\n(a) For further information on these units, refer to the \"Power Contract Negotiations\" section that follows in this Item 1. (b) Includes an expansion unit that became operational in May 1993.\nThere were no new sources of system generation or purchased power in 1994. In 1993, the Company extended a commitment to April 1997 to exchange 50 MW of Canal Electric's oil-fired generation with 50 MW of pumped storage energy capacity from non-affiliate New England Power Company's Bear Swamp Units (an initial, smaller exchange of 25 MW began in 1992). In 1991, Canal Electric\nCOMMONWEALTH ELECTRIC COMPANY\narranged for a long-term exchange of power with Central Vermont Public Service Company (CVPS) whereby 50 MW from Canal Electric's oil-fired Unit 2 was exchanged for 25 MW from CVPS's Vermont Yankee nuclear unit and 25 MW from its Merrimack Unit 2 coal-fired facility. This agreement expires in October 1995. The Canal Electric\/Bear Swamp transaction alone will save the Company's customers $2.7 million over a four-year period that began in June 1993. In 1995, it is expected that these exchanges, combined with a reduction in the capacity from purchased power contracts with natural gas-fired IPPs, will necessitate increased purchases from the oil-fired Canal Electric units.\nThe Company expects to provide for future peak load plus reserve require- ments through existing system generation, including purchasing available capacity from neighboring utilities and\/or IPP generators. These and other bulk electric power purchases are necessary in order to fulfill the system's NEPOOL obligation and for Canal to acquire and deliver sufficient electric generating capacity to meet the Company's and Cambridge Electric's capacity requirements.\nIn addition to power purchases, the Company is actively pursuing the marketing of certain capacity at competitive terms and rates to utilities in and outside the New England region at a higher price (thus saving the Com- pany's customers the difference) than if it were to sell to NEPOOL. This situation is a result of several utilities in New England (the Company included) having excess capacity and lowered prospects for sales growth. This competitive business developed for the Company in the early 1990s when it began to formally request proposals to supply short-term energy and associated capacity to other utilities on the open market to fulfill their power require- ments. Increased emphasis on the marketing of this capacity yielded approxi- mate savings of $1,039,000, $429,000 and $451,000 in 1994, 1993 and 1992, respectively.\nNew England Power Pool\nThe Company, together with other electric utility companies in the New England area, is a member of NEPOOL, which was formed in 1971 to provide for the joint planning and operation of electric systems throughout New England.\nNEPOOL operates a centralized dispatching facility to ensure reliability of service and to dispatch the most economically available generating units of member companies to fulfill the region's energy requirements. This concept is accomplished through the use of computers to monitor and forecast load requirements.\nThe Company and the System's other electric subsidiaries are also members of the Northeast Power Coordinating Council (NPCC), an advisory organization that includes the major power systems in New England and New York plus the provinces of Ontario and New Brunswick in Canada. NPCC establishes criteria and standards for reliability and serves as a vehicle for coordination in the planning and operation of these systems.\nThe reserve requirements used by the NEPOOL participants in planning future additions are determined by NEPOOL to meet the reliability criteria recommended by NPCC. The system estimates that, during the next ten years, reserve requirements so determined will be in the range of 16% to 25% of peak load.\nCOMMONWEALTH ELECTRIC COMPANY\nEnergy Mix\nThe Company's energy mix, including purchased power, is shown below:\nActual 1994 1993 1992 Natural gas 42% 35% 24% Oil 22 27 39 Nuclear 18 20 22 Waste-to-energy 12 11 9 Hydro 3 4 3 Coal 3 3 3 Total 100% 100% 100%\nThe Company's energy mix has shifted during the last several years from oil to natural gas and other fuels due to the requirement to purchase capacity from IPP facilities and, to a lesser extent, the exchange agreements noted in the \"Electric Power Supply\" section above.\nRates and Regulatory Matters\n(a) Retail Rate Proceeding\nThe Company operates under the jurisdiction of the DPU which requires historical test-year information to support changes in rates. The Company's most recent general rate proceeding approved by the DPU was as follows: Return on Effective Common Total Date Requested Authorized Equity Return (Dollars in Millions) July 1, 1991 $17.3 $10.9 12% 10.49%\n(b) Cost Recovery\nRate Schedule The Company files a Fuel Charge (FC) rate schedule, which provides for the current recovery, from retail customers, of fuel used in electric generation and a substantial portion of purchased power, demand and transmission costs. This schedule requires the quarterly computation and DPU approval of a FC decimal based on forecasts of fuel, electricity purchased for resale and transmission costs and billed unit sales for each period. To the extent that collections under the rate schedule do not match actual costs for that period, an appropriate adjustment is reflected in the calculation of the decimal for the next calendar quarter.\nPurchased Power The Company has long-term contracts for the purchase of electricity from various sources. Generally, these contracts are for fixed periods and require that the Company pay a demand charge for its capacity entitlement and an energy charge to cover the cost of fuel. The DPU ordered the Company, effective July 1, 1991, to collect its capacity-related costs associated with certain long-term power arrangements through base rates. Prior to that date, the Company was recovering these costs through its FC. The current recovery mechanism uses a per kilowatthour (KWH) factor that is calculated using historical (test-period) capacity costs and unit sales. This factor is then applied to current monthly KWH sales. When current period capacity costs and\/or unit sales vary from test-period levels, the Company\nCOMMONWEALTH ELECTRIC COMPANY\nexperiences a revenue excess or shortfall which can have a significant impact on net income. All other capacity and energy-related electricity purchased for resale costs are recovered dollar-for-dollar through the FC. The Company and Cambridge Electric made a filing in late 1992 with the DPU seeking an alternative method of recovery. This request was denied in a letter order issued on October 6, 1993. However, the Company and Cambridge Electric were encouraged by the DPU's acknowledgement that the issues presented warrant further consideration. The DPU encouraged each company to continue to work with other interested parties, including the Attorney General of Massachu- setts, to reach a consensus solution on the issue for future consideration. The Company and Cambridge Electric have been involved in settlement discus- sions with interested parties in an effort to resolve this issue in a positive fashion and hope to reach an agreement in the near future.\nConservation and Load Management Programs The Company has implemented a variety of cost-effective conservation and load management (C&LM) programs for its customers which are designed to reduce future energy use. On June 30, 1993, the DPU issued an order in Phase I of a C&LM cost recovery filing made by the Company and Cambridge Electric which allows the recovery of \"lost base revenues\" from electric customers. The recovery of lost base revenues is employed by the DPU to encourage effective implementation of C&LM programs.\nThe KWH savings that are realized as a result of the successful implemen- tation of C&LM programs serve as the basis for determining lost base revenues. The Company recovered approximately $3.5 million based on estimated KWH savings for the eighteen-month period that began January 1, 1993 beginning July 1, 1993 over a twelve-month period. On June 30, 1994, the DPU issued an order that further allows the Company to recover approximately $3.7 million in additional lost base revenues for a one-year period that commenced July 1, 1994. Through December 31, 1994, the combined recovery was approximately $5.6 million, $2.3 million of which was collected in 1993.\nSeabrook Costs The FERC, in a final order issued on August 4, 1992, approved full recovery of Canal's investment in the Seabrook nuclear power plant. The Company and Cambridge Electric had been billing, subject to refund, Seabrook 1 charges to their retail customers since August 1, 1990 through FC decimals approved by the DPU. In its June 1, 1993 rate decision, the DPU allowed Cambridge Electric to recover its Seabrook 1 costs in base rates. However, the Company continues to recover these costs through the FC.\nThe Company and Cambridge Electric collect, through their respective base rates, amounts being billed to them by Canal for costs associated with Sea- brook 2 (over a ten-year period ending in 1997) pursuant to a Capacity Acqui- sition Agreement the terms of which were approved by both FERC and the DPU.\nPotential Impact of Regulatory Restructuring Based on the current regulatory framework, the Company 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.\" Under SFAS No. 71, a utility is allowed to defer costs that would otherwise be expensed in recognition of the ability to recover them in future rates. As a result, the Company has accumulated $54.2 million (approximately 11% of total assets) of regulatory assets as of December 31, 1994. Management believes that the current regulatory framework provides for the continued recovery of these assets.\nCOMMONWEALTH ELECTRIC COMPANY\nIn the event that recovery of specific costs through rates becomes uncertain or unlikely in the future either as a result of the expanding effects of competition or specific regulatory actions, the Company could be required to move away from cost-of-service ratemaking and, therefore, SFAS No. 71 would no longer apply. Discontinuation of SFAS No. 71 could lead to the write-off of various regulatory assets, which would have an adverse impact on the Company's financial position and results of operations. At this time, management believes that it is unlikely that regulatory action would lead to the discontinuation of SFAS No. 71 in the near future.\nCompetition\nThis past year, the Company continued to develop and implement strategies to deal with the increasingly competitive environment in its electric busi- nesses. The inherently high cost of providing energy services in the North- east has placed the region at a competitive disadvantage as more customers begin to explore alternative supply options. Many state and federal govern- ment agencies are considering implementing programs under which utility and non-utility generators can sell electricity to customers of other utilities without regard to previously closed franchise service areas. In 1994, the DPU began an inquiry into incentive ratemaking and in February 1995 opened an investigation into electric industry restructuring.\nThe Company's actions in response to the new competitive challenges have been well received by regulators, business groups and customers. The Company has developed and will continue to develop innovative pricing mechanisms designed to retain existing customers, add new retail and wholesale customers and expand beyond current markets.\nThe Company recently revised its Economic Development Rate which will benefit a number of high-use industrial customers and contribute to economic development in the area. Another new rate will provide incentive for business to expand into previously vacant space and its Rate Stabilization Plan, approved in 1994, continues to hold the line on costs passed on to customers while aggressively pursuing other cost reduction measures. Recently completed contract negotiations are expected to save customers approximately $42 million through 1999 as the Company continues to explore opportunities to reduce purchased power costs. The Company recently signed an agreement with another New England utility to purchase peaking-unit capacity at rates lower than that available from NEPOOL or other regional utilities.\nThe Company continues to be aggressive in its cost containment efforts. For example, through work force reductions and attrition the Company has reduced its work force approximately 26.5% since 1989. Also, the introduction of advanced technologies in the workplace continues to improve customer service and the Company's competitive position. The Company has yet to be significantly impacted by the increase in competition, and absent a major shift in regulation at the state level, believes its current business strategy will have a positive impact in the near-term.\nSome of the more specific details of the innovative measures taken in response to competition include the following:\nRate Stabilization Plan The Company implemented a FC rate settlement on April 1, 1994 that stabilizes its quarterly FC rate during the years 1994\nCOMMONWEALTH ELECTRIC COMPANY\nthrough 1996 at 6.5 cents per KWH and no greater than 6.7 cents per KWH during 1997. The settlement results in billings at a lower rate than would have otherwise been in effect and could save customers between 1.75% and 5% on their annual electric bills through 1997. This rate stabilization is achieved through the use of a cost deferral mechanism that was sponsored jointly by the Company and the Massachusetts Attorney General and approved by the DPU. The deferred costs are reflected as a regulatory asset to be recovered, with carrying charges, over the subsequent six-year period beginning in 1998 pursuant to a recovery schedule yet to be determined and subject to DPU approval. The deferred amount, excluding carrying charges, is restricted to a maximum of $40 million during the deferral period (1994 through 1997) and is further limited to an annual amount of $16 million. The Company deferred $15,964,000 in 1994. In view of recent contract renegotiations, the Company does not expect deferred amounts to exceed $20 million through 1997.\nThe rate stabilization mechanism is part of a long-term plan to control the Company's retail rates and will help to eliminate the disincentive for economic development resulting from a volatile and unpredictable FC rate. Further, the stabilized FC rate will enable current and prospective customers to better plan their business and personal finances in a more efficient and effective manner. In addition to the Massachusetts Attorney General, this proposal has been widely supported by various business and customer groups and other political interests.\nPower Contract Negotiations The Company concluded the negotiation of a restructured Power Sale Agreement (PSA), effective January 1, 1995, with Lowell Cogeneration Company Limited Partnership (23 MW). The restructured PSA will allow the Company to defer the purchase of capacity and energy for a maximum of six years and, when called back into service, power will be dispatched only when needed at the discretion of the Company. In addition, the Company terminated a PSA with Pepperell Power Associates Limited Partner- ship (38 MW), effective January 27, 1995, through a buy-out arrangement that is subject to final FERC approval. In 1994, the power purchased from these units cost the Company 6 cents per kilowatthour as compared to costs at the Canal units of 3.5 cents. It is expected that the resolution of these contracts will enhance the Company's competitiveness by lowering costs and saving customers approximately $42 million through 1999.\nEconomic Development Realizing a healthy regional economy benefits not only businesses but all area residents, the Company actively encourages economic growth by working in partnership with communities and businesses, providing resources and incentives to drive the region's economy.\nIn an effort to foster industrial development in its service area, the Company began offering an Economic Development Rate (EDR) in October 1991 to new or existing industrial customers who have demand of 500 kilowatts or more and meet specific financial and other criteria. As of December 31, 1994, twenty-three commercial and industrial customers were benefitting from this special rate which is available for a six-year term. In 1993, the DPU conducted a generic investigation into EDRs and rendered a decision on September 1, 1993 that established rate design guidelines and minimum customer eligibility requirements. The Company refiled its EDRs to comply with the ruling. The new EDR is available to both commercial and industrial customers with loads greater than 500 kilowatts. Revenues were lower by $1.7 million, $1.5 million and $1.3 million in 1994, 1993 and 1992, respectively. These\nCOMMONWEALTH ELECTRIC COMPANY\namounts represent the difference between what these customers would have paid prior to the availability of this rate. The Company also received approval for a Vacant Space Rate that is available to qualifying small commercial and industrial customers who establish loads in previously unoccupied building space.\nPower Contract Arbitrations\nOn May 2, 1994, the Company and Cambridge Electric gave notice of termina- tion of power purchase agreements with Eastern Energy Corporation, the developer of a proposed 300 MW coal-fired plant, based upon the developer's failure to meet its contractual obligations. In June 1989, the Company and Cambridge Electric agreed to buy 27% (50 MW and 33 MW, respectively) of the power to be produced by the proposed plant, originally scheduled to begin operation in January 1992. The developer did not meet the permitting, construction or operation milestones established by the contracts, and has not yet obtained the required permits, commenced construction or sold any addi- tional power from the proposed plant. Efforts to reshape the power purchase agreements to provide a satisfactory arrangement were unsuccessful. In a letter dated June 30, 1994, the developer objected to the notices of termina- tion and invoked arbitration, which is pending. A decision by the arbitrators on the legality of the Company's and Cambridge Electric's termination is expected in 1995.\nThe Company has initiated an arbitration proceeding with Dartmouth Power Associates, an IPP, seeking approximately $5 million for recovery of excess fuel charges billed to the Company for power purchases in 1992. A decision is expected from the arbitrators in 1995.\nConstruction and Financing\nInformation concerning the Company's financing and construction programs is contained in Note 2(a) of Notes to Financial Statements filed under Item 8 of this report.\nEmployees\nThe total number of full-time employees for the Company declined 12.4% to 913 in 1994 from 1,042 employees at year-end 1992 due to a second quarter 1993 work force reduction. 592 employees (64.6%) are represented by the Brother- hood of Utility Workers of New England, Inc. under three separate collective bargaining units with agreements expiring September 30, 1996, October 31, 1997 and April 30, 1998. Employee relations have generally been satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal properties of the Company consist of an integrated system of transmission and distribution lines, substations, an office building in the Town of Wareham, Massachusetts and other structures such as garages and service buildings. In addition, the Company owns and operates, for standby and emergency purposes only, two diesel plants with a combined capability of 13.8 MW located on the island of Martha's Vineyard. The Company also has a 1.4% joint-ownership interest in Central Maine Power Company's Wyman Unit 4 with an entitlement of 8.9 MW.\nCOMMONWEALTH ELECTRIC COMPANY\nAt December 31, 1994, the electric transmission and distribution system consisted of 5,697 pole miles of overhead lines, 3,511 cable miles of under- ground line, 138 substations and 329,051 active customer meters.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company is subject to legal claims and matters arising from its course of business, including its participation in power contract arbitrations as discussed in Item 1 above.\nCOMMONWEALTH ELECTRIC COMPANY\nPART II.\nItem 5.","section_4":"","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\n(a) Principal Market\nNot applicable. The Company is a wholly-owned subsidiary of Common- wealth Energy System.\n(b) Number of Shareholders at December 31, 1994\nOne\n(c) Frequency and Amount of Dividends Declared in 1994 and 1993\n1994 1993 Per Share Per Share Declaration Date Amount Declaration Date Amount\nJanuary 21, 1994 $1.60 January 28, 1993 $1.90 April 25, 1994 1.90 April 26, 1993 1.10 July 18, 1994 1.00 October 18, 1993 3.20 October 24, 1994 3.25 $6.20 $7.75\nOn January 28, 1993, dividends were declared on the 1,606,472 outstanding shares of common stock of the Company. Beginning on April 26, 1993, dividends were declared on the 2,043,972 outstanding shares of common stock of the Company.\nReference is made to Note 6 of the Notes to Financial Statements filed under Item 8 of this report for the restriction against the payment of cash dividends.\n(d) Future dividends may vary depending upon the Company's earnings and capital requirements as well as financial and other conditions existing at that time.\nCOMMONWEALTH ELECTRIC COMPANY\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations\nThe following is a discussion of certain significant factors which have affected operating revenues, expenses and net income during the periods included in the accompanying statements of income and is presented to facili- tate an understanding of the results of operations. This discussion should be read in conjunction with Item 1 of this report and the Notes to Financial Statements filed under Item 8","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Company's financial statements required by this item are filed here- with on pages 20 through 39 of this report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure\nNone.\nCOMMONWEALTH ELECTRIC COMPANY\nItem 8. Financial Statements and Supplementary Data\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Commonwealth Electric Company:\nWe have audited the accompanying balance sheets of COMMONWEALTH ELECTRIC COMPANY (a Massachusetts corporation and wholly-owned subsidiary of Common- wealth Energy System) as of December 31, 1994 and 1993, and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. 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 upon 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 Commonwealth Electric Company as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended Decem- ber 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 4 to the financial statements, effective January 1, 1993, the Company changed its method of accounting for costs associated with 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 schedules listed in the index to financial statements and 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 LLP Arthur Andersen LLP\nBoston, Massachusetts February 21, 1995\nCOMMONWEALTH ELECTRIC COMPANY INDEX TO FINANCIAL STATEMENTS AND SCHEDULES PART II.\nFINANCIAL STATEMENTS\nBalance Sheets at December 31, 1994 and 1993\nStatements of Income for the Years Ended December 31, 1994, 1993 and 1992\nStatements of Retained Earnings for the Years Ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows for the Years Ended December 31, 1994, 1993 and\nNotes to Financial Statements\nPART IV.\nSCHEDULES\nI Investments in, Equity in Earnings of, and Dividends Received from Related Parties - Years Ended December 31, 1994, 1993 and 1992\nII Valuation and Qualifying Accounts - Years Ended December 31, 1994, 1993 and 1992\nSCHEDULES OMITTED\nAll other schedules are not submitted because they are not applicable or not required or because the required information is included in the financial statements or notes thereto.\nFinancial statements of 50% or less owned companies accounted for by the equity method have been omitted because they do not, considered individually, constitute a significant subsidiary.\nCOMMONWEALTH ELECTRIC COMPANY BALANCE SHEETS DECEMBER 31, 1994 AND 1993 ASSETS\n1994 1993 (Dollars in Thousands)\nPROPERTY, PLANT AND EQUIPMENT, at original cost $496 166 $475 348 Less - Accumulated depreciation 143 877 133 349 352 289 341 999 Add - Construction work in progress 5 216 5 478 357 505 347 477\nINVESTMENTS Equity in nuclear electric power company 654 601 Other 14 14 668 615\nCURRENT ASSETS Cash 1 637 2 794 Advances to affiliates - 4 485 Accounts receivable - Affiliates 3 713 2 413 Customers, less reserves of $2,841,000 in 1994 and $3,268,000 in 1993 37 862 38 743 Unbilled revenues 8 899 9 332 Inventories, at average cost - Materials and supplies 4 152 4 658 Electric production fuel oil 149 202 Prepaid property taxes 2 739 2 538 Other 1 731 1 927 60 882 67 092\nDEFERRED CHARGES 57 831 34 619\n$476 886 $449 803\nCOMMONWEALTH ELECTRIC COMPANY BALANCE SHEETS DECEMBER 31, 1994 AND 1993 CAPITALIZATION AND LIABILITIES\n1994 1993 (Dollars in Thousands)\nCAPITALIZATION Common Equity - Common stock, $25 par value - Authorized and outstanding - 2,043,972 shares wholly-owned by Commonwealth Energy System (Parent) $ 51 099 $ 51 099 Amounts paid in excess of par value 97 112 97 112 Retained earnings 15 350 15 118 163 561 163 329 Long-term debt, less current sinking fund requirements 157 817 158 858 321 378 322 187\nCURRENT LIABILITIES Interim Financing - Notes payable to banks 6 400 - Advances from affiliates 200 - 6 600 -\nOther Current Liabilities - Current sinking fund requirements 1 053 1 053 Accounts payable - Affiliates 7 716 10 088 Other 31 911 22 044 Accrued taxes - Local property and other 3 721 3 017 Income 8 049 2 337 Accrued interest 3 966 4 027 Other 9 725 9 098 66 141 51 664 72 741 51 664\nDEFERRED CREDITS Accumulated deferred income taxes 42 074 39 396 Unamortized investment tax credits 7 994 8 430 Other 32 699 28 126 82 767 75 952 COMMITMENTS AND CONTINGENCIES $476 886 $449 803\nThe accompanying notes are an integral part of these financial statements.\nCOMMONWEALTH ELECTRIC COMPANY STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1994 1993 1992 (Dollars in Thousands)\nELECTRIC OPERATING REVENUES $437 950 $430 484 $409 493\nOPERATING EXPENSES Electricity purchased for resale and fuel 287 632 284 980 254 316 Transmission 4 734 4 836 5 240 Other operation 70 581 72 962 87 898 Maintenance 10 053 10 714 12 143 Depreciation 15 619 15 032 15 012 Taxes - Income 9 670 7 158 3 556 Local property 5 275 5 023 4 694 Payroll and other 2 735 3 066 3 046 406 299 403 771 385 905\nOPERATING INCOME 31 651 26 713 23 588\nOTHER INCOME (EXPENSE) Allowance for equity funds used during construction 325 - - Other, net (1 293) 249 253 (968) 249 253\nINCOME BEFORE INTEREST CHARGES 30 683 26 962 23 841\nINTEREST CHARGES Long-term debt 14 183 13 252 10 891 Other interest charges 703 1 738 4 248 Allowance for borrowed funds used during construction (276) (106) (302) 14 610 14 884 14 837\nNET INCOME $ 16 073 $ 12 078 $ 9 004\nThe accompanying notes are an integral part of these financial statements.\nCOMMONWEALTH ELECTRIC COMPANY STATEMENTS OF RETAINED EARNINGS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1994 1993 1992 (Dollars in Thousands)\nBalance at beginning of year $15 118 $14 882 $14 151\nAdd (Deduct): Net income 16 073 12 078 9 004 Cash dividends on common stock (15 841) (11 842) (8 273)\nBalance at end of year $15 350 $15 118 $14 882\nThe accompanying notes are an integral part of these financial statements.\nCOMMONWEALTH ELECTRIC COMPANY STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1994 1993 1992 (Dollars in Thousands) OPERATING ACTIVITIES Net income $ 16 073 $ 12 078 $ 9 004 Effects of noncash items - Depreciation and amortization 17 723 16 447 19 666 Deferred income taxes 8 672 4 407 (5 176) Investment tax credits (436) (446) (452) Allowance for equity funds used during construction (325) - - Change in working capital, exclusive of cash, advances to affiliates and interim financing - Accounts receivable and unbilled revenues 14 5 228 7 119 Income taxes, net 5 712 1 727 (3 705) Local property and other taxes, net 503 222 (25) Accounts payable and other 8 816 8 935 (2 159) Fuel charge stabilization deferral (15 964) - - Deferred postretirement benefit and pension costs (4 609) (5 189) (1 418) All other operating items (8 398) (4 488) 8 923\nNet cash provided by operating activities 27 781 38 921 31 777\nINVESTING ACTIVITIES Additions to property, plant and equipment (exclusive of AFUDC) (22 865) (18 631) (20 821) Allowance for borrowed funds used during construction (276) (106) (302) Payment from (advances to) affiliates 4 485 (4 485) -\nNet cash used for investing activities (18 656) (23 222) (21 123)\nFINANCING ACTIVITIES Long-term debt issues - 65 000 - Sale of common stock to Parent - 35 000 - Payment of dividends (15 841) (11 842) (8 273) Proceeds from (payment of) short-term borrowings 6 400 (67 275) 3 975 Advances from (payment to) affiliates 200 (11 840) 2 290 Long-term debt issues refunded - (21 300) (7 522) Retirement of long-term debt through sinking funds (1 041) (1 155) (631)\nNet cash used for financing activities (10 282) (13 412) (10 161)\nNet increase (decrease) in cash (1 157) 2 287 493 Cash at beginning of period 2 794 507 14 Cash at end of period $ 1 637 $ 2 794 $ 507\nThe accompanying notes are an integral part of these financial statements.\nCOMMONWEALTH ELECTRIC COMPANY NOTES TO FINANCIAL STATEMENTS\n(1) Significant Accounting Policies\n(a) General and Regulatory\nCommonwealth Electric Company (the Company) is a wholly-owned subsidiary of Commonwealth Energy System. The parent company is referred to in this report as the \"System\" and, together with its subsidiaries, is collectively referred to as \"the system.\" The Company is regulated as to rates, accounting and other matters by various authorities including the Federal Energy Regula- tory Commission (FERC) and the Massachusetts Department of Public Utilities (DPU). The System is an exempt holding company under the provisions of the Public Utility Holding Company Act of 1935 and, in addition to its investment in the Company, has interests in other utility companies and several nonregu- lated companies.\nThe Company has established various regulatory assets in cases where the DPU and\/or the FERC have permitted or are expected to permit recovery of specific costs over time. Similarly, certain regulatory liabilities estab- lished by the Company are required to be refunded to its customers over time. The principal regulatory assets included in deferred charges at December 31, 1994 and 1993 were as follows:\n1994 1993 (Dollars in Thousands)\nFuel charge stabilization $16 638 $ - Postretirement benefit costs including pensions 11 215 6 607 Yankee Atomic unrecovered plant and decommissioning costs 10 204 8 625 Pilgrim nuclear plant litigation costs 7 001 7 358 Cannon Street generating plant abandonment, net 4 400 4 391 Conservation and load management 3 659 3 611 Other 1 049 1 361 Total regulatory assets $54 166 $31 953\nRegulatory assets as a percent of total assets 11.4% 7.1%\nThe principal regulatory liabilities, reflected in deferred credits - other and relating to income taxes, were $3.7 million and $4 million at December 31, 1994 and 1993, respectively.\n(b) Reclassifications\nCertain prior year amounts are reclassified from time to time to conform with the presentation used in the current year's financial statements.\n(c) Transactions with Affiliates\nTransactions between the Company and other system companies include purchases and sales of electricity, including purchases from Canal Electric Company (Canal), an affiliate wholesale electric generating company. Other Canal transactions include costs relating to the abandonment of Seabrook 2 and the recovery of a portion of Seabrook 1 pre-commercial operation costs. In\nCOMMONWEALTH ELECTRIC COMPANY\naddition, payments for management, accounting, data processing and other services are made to an affiliate, COM\/Energy Services Company. Transactions with other system companies are subject to review by the DPU.\nThe Company's operating expenses include the following major intercompany transactions for the periods indicated: Purchased Power Purchased Power and Transmission Period Ended Purchased Power and Transmission From Canal December 31, Canal Units Seabrook 1 as Agent (Dollars in Thousands)\n1994 $34 256 $34 617 $21 508 1993 40 537 36 702 20 881 1992 46 844 37 691 22 992\nThe costs for the Canal and Seabrook 1 units are included in the long-term obligation table listed in Note 2(b). The Company sold electricity to other affiliates, primarily station service for Canal, totaling $1,401,000, $2,973,000 and $2,733,000 in 1994, 1993 and 1992, respectively, and the Company also purchased natural gas from an affiliate Commonwealth Gas Company, totaling $106,000 in 1992 (there were no purchases in 1994 and 1993).\n(d) Operating Revenues\nThe Company is generally permitted to bill customers currently for fuel used in electric production, purchased power and transmission costs, and conservation and load management (C&LM) costs through adjustment clauses. Amounts recoverable under these clauses are subject to review and adjustment by the DPU. Customers are billed for their use of electricity on a cycle basis throughout the month. To reflect revenues in the proper period, the estimated amount of unbilled sales revenue is recorded each month. The Company collects a portion of capacity-related purchased power costs associat- ed with certain long-term power arrangements through base rates. The amount of such fuel and energy costs incurred but not yet reflected in customers' bills, which totaled $3,056,000 in 1993, is recorded as unbilled revenues. There were no unbilled amounts in 1994. The Company also has implemented a Fuel Charge (FC) rate settlement that stabilizes its quarterly FC rate for the years 1994 through 1997 by utilizing a cost deferral mechanism approved by the DPU. The deferral, which will ultimately be recovered in revenues beginning in 1998, is limited to $16 million annually (excluding carrying charges) and is further restricted to a maximum of $40 million during the settlement period.\n(e) Depreciation\nDepreciation is provided using the straight-line method at rates intended to amortize the original cost and the estimated cost of removal less salvage of properties over their estimated economic lives. The average composite depreciation rates were 3.31% in 1994 and 1993 and 3.39% in 1992.\n(f) Maintenance\nExpenditures for repairs of property and replacement and renewal of items\nCOMMONWEALTH ELECTRIC COMPANY\ndetermined to be less than units of property are charged to maintenance expense. Additions, replacements and renewals of property considered to be units of property are charged to the appropriate plant accounts. Upon retirement, accumulated depreciation is charged with the original cost of property units and the cost of removal less salvage.\n(g) Allowance for Funds Used During Construction\nUnder applicable rate-making practices, the Company is permitted to include an allowance for funds used during construction (AFUDC) as an element of its depreciable property costs. This allowance is based on the amount of construction work in progress that is not included in the rate base on which the Company earns a return. An amount equal to the AFUDC capitalized in the current period is reflected in the accompanying statements of income.\nWhile AFUDC does not provide funds currently, these amounts are recover- able in revenues over the service life of the constructed property. The amount of AFUDC recorded was at a weighted average rate of 10% in 1994, 4% in 1993 and 4.5% in 1992.\n(2) Commitments and Contingencies\n(a) Financing and Construction Programs\nThe Company is engaged in a continuous construction program presently estimated at $141 million for the five-year period 1995 through 1999. Of that amount, $27.1 million is estimated for 1995. The program is subject to periodic review and revision because of factors such as changes in business conditions, rates of customer growth, effects of inflation, maintenance of reliable and safe service, equipment delivery schedules, licensing delays, availability and cost of capital and environmental factors. The Company expects to finance these expenditures on an interim basis with internally generated funds and short-term borrowings which are ultimately expected to be repaid with the proceeds from sales of long-term debt and equity securities.\n(b) Long-Term Power Contracts\nThe Company has long-term contracts for the purchase of electricity from various sources. Generally, these contracts are for fixed periods and require payment of a demand charge for the capacity entitlement and an energy charge to cover the cost of fuel. In addition, the Company pays its share of decom- missioning expense to nonaffiliated Boston Edison Company, the operator of the Pilgrim nuclear facility, as a cost of electricity purchased for resale.\nCOMMONWEALTH ELECTRIC COMPANY\nThe Company also has long-term contracts to purchase capacity from other generating facilities. Information relative to the Company's power contracts is as follows:\nRange of Contract Expiration Entitlement 1994 1993 1992 Dates % MW Cost Cost Cost (Dollars in Thousands) Type of Unit Cogenerating 2008-2017 (a) 261.6 $122 496 $ 99 620 $ 69 742 Oil 2002-2009 (b) 254.4 34 256 40 537 46 844 Nuclear 2012-2026 (c) 105.9 76 092 77 280 75 207 Waste-to-energy 2015 100 70.2 38 107 34 189 27 206 Hydro 2008-2014 100 29.9 7 521 8 904 10 941 Total 722.0 $278 472 $260 530 $229 940\n(a) Includes contracts to purchase power from various cogenerating units with capacity entitlements ranging from 11.1% to 100%. (b) Includes entitlements in Canal Unit 1 (20%) and Canal Unit 2 (40%). (c) Includes entitlements in Seabrook 1 (2.8%) and Pilgrim (11%).\nCosts pursuant to these contracts are included in electricity purchased for resale in the accompanying statements of income and are recoverable in revenues through either the Fuel Charge or in base rates.\nThe estimated aggregate capacity obligations under the life-of-the-unit contracts, including the Canal and Seabrook 1 units, and from other long-term purchased power contracts, in effect for the five years subsequent to 1994 is as follows: Long-Term Purchased Power (Dollars in Thousands)\n1995 $267 183 1996 281 118 1997 296 183 1998 319 824 1999 319 288\nThe Company successfully negotiated a restructured Power Sale Agreement (PSA), effective January 1, 1995, with an independent power producer (IPP), that defers purchases for a maximum of six years and requires the facility to provide power on a dispatchable basis at the discretion of the Company. In addition, the Company terminated a PSA with another IPP, effective January 27, 1995, through a buyout arrangement, the cost of which will be recorded as a regulatory asset in 1995 pending final FERC approval.\n(c) Yankee Atomic Nuclear Power Plant\nIn February 1992, the Board of Directors of Yankee Atomic Electric Company (Yankee Atomic) agreed to permanently discontinue power operation and decom- mission the Yankee Nuclear Power Station (the Plant). At December 31, 1994, the Company's 2.5% investment in Yankee Atomic was $654,000. The Company's\nCOMMONWEALTH ELECTRIC COMPANY\nestimated decommissioning costs include its unrecovered share of all costs associated with the shutdown of the Plant, recovery of its plant investment, and the decommissioning and closing of the Plant. The most recent cost estimate to permanently shut down the plant is approximately $408.2 million. The Company's share of this liability is $10.2 million and is currently reflected in the accompanying balance sheets as a liability and corresponding regulatory asset. The market value of the Company's share of assets in the plant's decommissioning fund at December 31, 1994 is approximately $2.7 million.\n(d) Environmental Matters\nThe Company is subject to laws and regulations administered by federal, state and local authorities relating to the quality of the environment. These laws and regulations affect, among other things, the siting and operation of electric generating and transmission facilities and can require the installa- tion of expensive air and water pollution control equipment. These regula- tions have had an impact on the Company's operations in the past and will continue to have an impact on future operations, capital costs and construc- tion schedules of major facilities.\n(3) Income Taxes\nFor financial reporting purposes, the Company provides federal and state income taxes on a separate-return basis. However, for federal income tax purposes, the Company's taxable income and deductions are included in the consolidated income tax return of the System and it makes tax payments or receives refunds on the basis of its tax attributes in the tax return in accordance with applicable regulations.\nThe following is a summary of the Company's provisions for income taxes for the years ended December 31, 1994, 1993 and 1992.\n1994 1993 1992 (Dollars in Thousands) Federal Current $ 1 133 $ 2 627 $ (15) Deferred 7 242 3 705 (4 548) Investment tax credits (437) (446) (452) 7 938 5 886 (5 015) State Current 302 570 (34) Deferred 1 315 749 348 1 617 1 319 314 9 555 7 205 (4 701) Amortization of regulatory liability relating to deferred income taxes 115 (47) (976) $ 9 670 $ 7 158 $(5 677) Federal and state income taxes charged to: Operating expense $ 9 670 $ 7 158 $ 3 556 Other expense - - (9 233) $ 9 670 $ 7 158 $(5 677)\nEffective January 1, 1992, the Company adopted the provisions of Statement\nCOMMONWEALTH ELECTRIC COMPANY\nof Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109). SFAS No. 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 basis and tax bases of assets and liabilities using enacted tax rates in effect in the year in which the differences are expected to reverse.\nAccumulated deferred income taxes consisted of the following in 1994 and 1993: 1994 1993 (Dollars in Thousands) Liabilities Property-related $47 233 $44 837 Fuel charge stabilization 6 526 - Litigation costs 2 746 2 886 Postretirement benefits plan 2 857 2 222 All other 1 702 1 918 61 064 51 863 Assets Investment tax credit 5 159 5 441 Pension plan 1 496 1 384 Uncollectible accounts 1 118 1 282 All other 3 118 2 463 10 891 10 570 Accumulated deferred income taxes,net $50 173 $41 293\nThe net year-end deferred income tax liability above includes current deferred tax liabilities of $8,099,000 and $1,897,000 in 1994 and 1993, respectively, which are included in accrued income taxes in the accompanying balance sheets.\nThe total income tax provision set forth above represents 38% in 1994, 37% in 1993 and (171)% in 1992 of income before such taxes. The following table reconciles the statutory federal income tax rate to these percentages:\n1994 1993 1992 (Dollars in Thousands) Federal statutory rate 35% 35% 34%\nFederal income tax expense at statutory levels $9,010 $6,733 $1,131 Increase (Decrease) from statutory levels: Amortization of regulatory liability relating to deferred income taxes - - (5 768) State tax, net of federal tax benefit 1,051 858 228 Tax versus book depreciation 109 117 111 Amortization of investment tax credits (436) (446) (452) Reversals of capitalized expenses (67) (68) - Amortization of excess deferred reserves 115 (47) (920) Equity AFUDC (114) - - Other 2 11 (7) $9,670 $7,158 $(5,677)\nEffective federal income tax rate 38% 37% (171)%\nCOMMONWEALTH ELECTRIC COMPANY\nOn April 22, 1992, the DPU approved a settlement agreement among the Company, the Attorney General of Massachusetts and a consumer group, which resulted in the issuance of an accounting order authorizing the Company's retention of $5.7 million in excess deferred taxes subject to obtaining a favorable ruling from the Internal Revenue Service which was received on November 30, 1992.\nIn accordance with the above settlement agreement, the Company wrote off in 1992 storm damage costs of $9.2 million ($5.7 million net of tax). The balance of the excess reserves was removed from the deferred tax reserve account and, after adjustment to its pretax amount as required by SFAS 109, was credited to a liability account. The excess reserves\/regulatory liability that the Company would retain pursuant to the settlement agreement was also removed from this liability account and credited to other income, together with the related income taxes. These amounts were classified as income tax expense and were used in the reconciliation of the income tax rate.\nAs a result of the Revenue Reconciliation Act of 1993, the Company's federal income tax rate increased to 35% effective January 1, 1993.\n(4) Employee Benefit Plans\n(a) Pension\nThe Company has a noncontributory pension plan covering substantially all regular employees who have attained the age of 21 and have completed a year of service. Pension benefits are based on an employee's years of service and compensation. The Company makes monthly contributions to the plan consistent with the funding requirements of the Employee Retirement Income Security Act of 1974.\nComponents of pension expense and related assumptions to develop pension expense were as follows:\n1994 1993 1992 (Dollars in Thousands)\nService cost $ 3 196 $ 2 630 $ 2 728 Interest cost 9 793 9 283 8 506 Return on plan assets - (gain)\/loss 2 043 (16 412) (10 992) Net amortization and deferral (10 046) 9 130 4 235 Total pension expense 4 986 4 631 4 477 Transfers to affiliated companies, net 74 (465) (609) Less: Amounts capitalized and deferred 1 921 1 379 2 127 Net pension expense $ 3 139 $ 2 787 $ 1 741\nDiscount rate 7.25% 8.50% 8.50% Assumed rate of return 8.50 8.50 8.50 Rate of increase in future compensation 4.50 5.50 5.50\nPension expense reflects the use of the projected unit credit method, which is also the actuarial cost method used in determining future funding of the plan. The Company, in accordance with current ratemaking, is deferring the difference between pension contribution, which is allowed currently in base rates, and pension expense, recognized pursuant to Statement of\nCOMMONWEALTH ELECTRIC COMPANY\nFinancial Accounting Standards No. 87, \"Employers' Accounting for Pensions.\" The funded status of the Company's pension plan (using a measurement date of December 31) is as follows: 1994 1993 (Dollars in Thousands) Accumulated benefit obligation: Vested $ (91 450) $ (95 433) Nonvested (10 490) (13 030) $(101 940) $(108 463)\nProjected benefit obligation $(125 534) $(131 066) Plan assets at fair market value 114 876 120 685 Projected benefit obligation greater than plan assets (10 658) (10 381) Unamortized transition obligation 4 503 5 146 Unrecognized prior service cost 6 283 5 520 Unrecognized gain (6 086) (5 095) Accrued pension liability $ (5 958) $ (4 810)\nThe following actuarial assumptions were used in determining the plan's year-end funded status: 1994 1993\nDiscount rate 8.50% 7.25% Rate of increase in future compensation 5.00 4.50\nPlan assets consist primarily of fixed income and equity securities. Fluctuations in the fair market value of plan assets will affect pension expense in future years.\n(b) Other Postretirement Benefits\nThrough December 31, 1992, the Company provided postretirement health care and life insurance benefits to eligible retired employees. Employees became eligible for these benefits if their age plus years of service at retirement equaled 75 or more, provided, however, that such service was performed for the Company or another subsidiary of the System. As of January 1, 1993, the Company eliminated postretirement health care benefits for those nonbargaining employees who were less than 40 years of age or had less than 12 years of service at that date. Under certain circumstances, eligible employees are now required to make contributions for postretirement benefits.\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postre- tirement Benefits Other Than Pensions\" (SFAS No. 106). This new standard requires the accrual of the expected cost of such benefits during the employ- ees' years of service and the recognition of an actuarially determined postre- tirement benefit obligation earned by existing retirees. The assumptions and calculations involved in determining the accrual and the accumulated postre- tirement benefit obligation (APBO) closely parallel pension accounting requirements. The cumulative effect of implementation of SFAS No. 106 as of January 1, 1993 was approximately $48.3 million, which is being amortized over 20 years. Prior to 1993, the cost of postretirement benefits was recognized as the benefits were paid. The cost of retiree medical care and life\nCOMMONWEALTH ELECTRIC COMPANY\ninsurance benefits totaled $1,915,000 during 1992.\nIn 1993, the Company began making contributions to various voluntary employees' beneficiary association (VEBA) trusts that were established pursuant to section 501(c)9 of the Internal Revenue Code (the Code). The Company also makes contributions to a sub-account of its pension plan pursuant to section 401(h) of the Code to satisfy a portion of its postretirement benefit obligation. The Company contributed approximately $6,677,000 and $5,964,000 to these trusts during 1994 and 1993, respectively.\nThe net periodic postretirement benefit cost for the years ended December 31, 1994 and 1993 include the following components and related assumptions:\n1994 1993 (Dollars in Thousands)\nService cost $1 127 $1 093 Interest cost 3 799 4 103 Return on plan assets (95) (292) Amortization of transition obligation over 20 years 2 417 2 417 Net amortization and deferral (547) 3 Total postretirement benefit cost 6 701 7 324 Transfer from affiliated companies, net (465) (316) Less: Amounts capitalized and deferred 4 268 5 144 Net postretirement benefit cost $1 968 $1 864\nDiscount rate 7.25% 8.50% Assumed rate of return 8.50 8.50 Rate of increase in future compensation 4.50 4.50\nThe funded status of the Company's postretirement benefit plan using a measurement date of December 31, 1994 and 1993 is as follows:\n1994 1993 (Dollars in Thousands)\nAccumulated postretirement benefit obligation: Retirees $(27 808) $ (27 520) Fully eligible active plan participants (3 681) (3 756) Other active plan participants (19 598) (19 277) (51 087) (50 553) Plan assets at fair market value 9 797 5 308 Accumulated postretirement benefit obligation greater than plan assets (41 290) (45 245) Unamortized transition obligation 43 500 45 917 Unrecognized gain (2 210) (672) $ - $ -\nCOMMONWEALTH ELECTRIC COMPANY\nThe following actuarial assumptions were used in determining the plan's year-end funded status: 1994 1993\nDiscount rate 8.50% 7.25% Rate of increase in future compensation 5.00 4.50\nIn determining its estimated APBO and the funded status of the plan for 1994 and 1993, the Company assumed health care trend rates as follows:\n1994 1993\nMedicare Part B premiums 12.3% 14.9% Medical care 8.5 9.0 Dental care 5.0 5.0\nThe above rates, with the exception of the dental rate, which remains constant, decrease to five percent in the year 2007 and remain at that level thereafter. A one percent change in the medical trend rate would have a $769,000 impact on the Company's annual expense (interest component - $503,000; service cost - $266,000) and would change the transition obligation by approximately $6.6 million.\nPlan assets consist primarily of fixed-income and equity securities. Fluctuations in the fair market value of plan assets will affect postretire- ment benefit expense in future years.\nThe DPU's policy on postretirement benefits is to allow in rates the maximum tax deductible contributions made to trusts that have been established specifically to pay postretirement benefits. The Company intends to seek regulatory approval to recover these costs and, while the outcome cannot be predicted, it is likely that the DPU will authorize similar rate treatment as was provided to Cambridge Electric and other Massachusetts electric and gas companies. A deferral representing the difference between what is being collected in rates and the SFAS No. 106 accrual amounted to approximately $7.3 million in 1994 and $4.1 million in 1993.\n(c) Savings Plan\nThe Company has an Employees Savings Plan that provides for Company contributions equal to contributions by eligible employees of up to four percent of each employee's compensation rate. Effective January 1, 1993, the rate was increased to five percent for those employees no longer eligible for postretirement health benefits. The Company's contribution was $1,746,000 in 1994, $1,700,000 in 1993 and $1,808,000 in 1992.\n(5) Interim Financing and Long-Term Debt\n(a) Notes Payable to Banks\nThe Company and other system companies maintain both committed and uncommitted lines of credit for the short-term financing of their construction programs and other corporate purposes. As of December 31, 1994, system companies had $90 million of committed lines that will expire at varying intervals in 1995. These lines are normally renewed upon expiration and\nCOMMONWEALTH ELECTRIC COMPANY\nrequire annual fees of up to .1875% of the individual line. At December 31, 1994, the uncommitted lines of credit totaled $90 million. Interest rates on the outstanding borrowings generally are at an adjusted money market rate and averaged 4.9% and 3.4% in 1994 and 1993, respectively. Notes payable to banks totaled $6.4 million at December 31, 1994. The Company had no notes payable to banks at December 31, 1993.\n(b) Advances from Affiliates\nNotes payable to the System totaled $200,000 at December 31, 1994. The Company had no notes payable to the System at December 31, 1993. These notes are written for a term of up to 11 months and 29 days. Interest is at the prime rate and is adjusted for changes in that rate during the term of the notes. The rate averaged 7.3% and 6% in 1994 and 1993, respectively.\nThe Company is a member of the COM\/Energy Money Pool (the Pool), an arrangement among the subsidiaries of the System, whereby short-term cash surpluses are used to help meet the short-term borrowing needs of the utility subsidiaries. In general, lenders to the Pool receive a higher rate of return than they otherwise would on such investments, while borrowers pay a lower interest rate than those available from banks. Interest rates on the out- standing borrowings are based on the monthly average rate the Company would otherwise have to pay banks, less one-half the difference between that rate and the monthly average U.S. Treasury Bill weekly auction rate. The borrow- ings are for a period of less than one year and are payable upon demand. Rates on these borrowings averaged 4.3% and 3.2% in 1994 and 1993, respective- ly. The Company had no notes payable to the Pool at December 31, 1994 and had $4,485,000 invested in the Pool at December 31, 1993.\n(c) Long-Term Debt Maturities and Retirements\nLong-term debt outstanding, exclusive of current maturities, current sinking fund requirements and related premiums, is as follows:\nOriginal Balance December 31, Issue 1994 1993 (Dollars in Thousands)\n15-Year Term Loan, 9.30%, due 2002 $30 000 $30 000 $30 000 25-Year Term Loan, 9.37%, due 2012 20 000 17 895 18 947 10-Year Notes, 7.43%, due 2003 15 000 15 000 15 000 15-Year Notes, 9.50%, due 2004 15 000 15 000 15 000 15-Year Notes, 7.70%, due 2008 10 000 10 000 10 000 18-Year Notes, 9.55%, due 2007 10 000 10 000 10 000 20-Year Notes, 7.98%, due 2013 25 000 25 000 25 000 25-Year Notes, 9.53%, due 2014 10 000 10 000 10 000 30-Year Notes, 9.60%, due 2019 10 000 10 000 10 000 30-Year Notes, 8.47%, due 2023 15 000 15 000 15 000 $157 895 $158 947\nThe Company, under favorable conditions, may purchase its outstanding notes in advance; however, an early payment premium may be incurred. Certain of these agreements require the Company to make periodic sinking fund payments\nCOMMONWEALTH ELECTRIC COMPANY\nfor retirement of outstanding long-term debt. The required sinking fund payments for the five years subsequent to December 31, 1994 are as follows:\nYear Sinking Funds (Dollars in Thousands)\n1995 $1 053 1996 3 553 1997 3 553 1998 3 553 1999 3 553\n(d) Disclosures about Fair Value of Financial Instruments\nThe fair value of certain financial instruments included in the accompany- ing balance sheets as of December 31, 1994 and 1993 are as follows:\n1994 1993 (Dollars in Thousands)\nCarrying Fair Carrying Fair Value Value Value Value\nLong-Term Debt $158 870 $157 762 $159 911 $184 180\nThe carrying amount of cash, notes payable to banks and advances to\/from affiliates approximates the fair value because of the short maturity of these financial instruments.\nThe estimated fair value of long-term debt is based on quoted market prices of the same or similar issues or on the current rates offered for debt with the same remaining maturity. The fair values shown above do not purport to represent the amounts at which those obligations would be settled.\n(6) Dividend Restriction\nAt December 31, 1994, approximately $10,659,000 of retained earnings was restricted against the payment of cash dividends by terms of term loans and note agreements securing long-term debt.\n(7) Lease Obligations\nThe Company leases equipment and office space under arrangements that are classified as operating leases. These lease agreements are for terms of one year or longer. Leases currently in effect contain no provisions that prohibit the Company from entering into future lease agreements or obliga- tions.\nCOMMONWEALTH ELECTRIC COMPANY\nFuture minimum lease payments, by period and in the aggregate, of noncanc- elable operating leases consisted of the following at December 31, 1994:\nOperating Leases (Dollars in Thousands)\n1995 $ 2 809 1996 2 117 1997 842 1998 388 1999 261 Beyond 1999 1 036 Total future minimum lease payments $ 7 453\nTotal rent expense for all operating leases, except those with terms of a month or less, amounted to $3,491,000 in 1994 and 1993 and $3,669,000 in 1992. There were no contingent rentals and no sublease rentals for the years 1994, 1993 and 1992.\n(8) Supplemental Disclosures of Cash Flow Information\nThe Company's supplemental information concerning cash flow activities is as follows:\n1994 1993 1992 (Dollars in Thousands) Cash paid during the periods for: Interest (net of capitalized amounts) $ 13 908 $ 13 074 $ 14 084 Income taxes 2 301 2 438 1 491\nCOMMONWEALTH ELECTRIC COMPANY PART 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) 1. Index to Financial Statements\nFinancial statements and notes thereto of the Company together with the Report of Independent Public Accountants, are filed under Item 8 of this report and listed on the Index to Financial Statements and Schedules (page 21).\n(a) 2. Index to Financial Statement Schedules\nFiled herewith at page(s) indicated -\nSchedule I - Investments in, Equity in Earnings of, and Dividends Received from Related Parties - Years Ended December 31, 1992, 1993 and 1994 (page 51).\nSchedule II - Valuation and Qualifying Accounts - Years Ended December 31, 1994, 1993 and 1992 (page 52).\n(a) 3. Exhibits: Notes to Exhibits -\na. Unless otherwise designated, the exhibits listed below are incorporat- ed by reference to the appropriate exhibit numbers and the Securities and Exchange Commission file numbers indicated in parentheses.\nb. During 1981, the Company sold its gas business and properties to Commonwealth Gas and changed its corporate name from New Bedford Gas and Edison Light Company to Commonwealth Electric Company.\nc. The following is a glossary of Commonwealth Energy System and subsid- iary companies' acronyms that are used throughout the following Exhibit Index:\nCES ...................... Commonwealth Energy System CEL ...................... Cambridge Electric Light Company CEC ...................... Canal Electric Company CG ....................... Commonwealth Gas Company NBGEL .................... New Bedford Gas and Edison Light Co.\nExhibit Index:\nExhibit 3. Articles of incorporation and by-laws\n3.1.1 By-laws of the Company as amended, (Refiled as Exhibit 1 to the CE 1991 Form 10-K, File No. 2-7749).\n3.1.2 Articles of Incorporation, as amended, of NBGEL, including certif- ication of name change to Commonwealth Electric Company as filed with the Massachusetts Secretary of State on March 1, 1981 (Re- filed as Exhibit 1 to the CE 1990 Form 10-K, File No. 2-7749).\nCOMMONWEALTH ELECTRIC COMPANY\nExhibit 10. Material Contracts.\n10.1 Power contracts.\n10.1.1 Power contracts between CEC (Unit 1) and NBGEL and CEL dated December 1, 1965 (Exhibit 13(a)(1-4) to the CEC Form S-1, File No. 2-30057).\n10.1.2 Power contract between Yankee Atomic Electric Company (YAEC) and NBGEL dated June 30, 1959, as amended April 1, 1975 (Refiled as Exhibit 2 to the CE 1991 Form 10-K, File No. 2-7749).\n10.1.2.1 Second, Third and Fourth Amendments to 10.1.2 as amended October 1, 1980, April 1, 1985 and May 6, 1988, respectively (Exhibit 1 to the CE Form 10-Q (June 1988), File No. 2-7749).\n10.1.2.2 Fifth and Sixth Amendments to 10.1.2 as amended June 26, 1989 and July 1, 1989, respectively (Exhibit 3 to the CE Form 10-Q (Septem- ber 1989), File No. 2-7749).\n10.1.3 Agreement between NBGEL and Boston Edison Company (BECO) for the purchase of electricity from BECO's Pilgrim Unit No. 1 dated Aug- ust 1, 1972 (Exhibit 7 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.3.1 Service Agreement between NBGEL and BECO for purchase of stand-by power for BECO's Pilgrim Station dated August 16, 1978 (Exhibit 1 to the CE 1988 Form 10-K, File No. 2-7749).\n10.1.3.2 System Power Sales Agreement by and between CE and BECO dated July 12, 1984 (Exhibit 1 to the CE Form 10-Q (September 1984), File No. 2-7749).\n10.1.3.3 Power Exchange Agreement by and between BECO and CE dated December 1, 1984 (Exhibit 16 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.4 Agreement for Joint-Ownership, Construction and Operation of New Hampshire Nuclear Units (Seabrook) dated May 1, 1973 (Exhibit 13(N) to the NBGEL Form S-1 dated October 1973, File No. 2-49013), and as amended below:\n10.1.4.1 First through Fifth Amendments to 10.1.4 as amended May 24, 1974, June 21, 1974, September 25, 1974, October 25, 1974 and January 31, 1975, respectively (Exhibit 13(m) to the NBGEL Form S-1 (No- vember 7, 1975), File No. 2-54995).\n10.1.4.2 Sixth through Eleventh Amendments to 10.1.4 as amended April 18, 1979, April 25, 1979, June 8, 1979, October 11, 1979 and December 15, 1979, respectively (Refiled as Exhibit 1 to the CEC 1989 Form 10-K, File No. 2-30057).\n10.1.4.3 Twelfth through Fourteenth Amendments to 10.1.4 as amended May 16, 1980, December 31, 1980 and June 1, 1982, respectively (Refiled as Exhibits 1, 2, and 3 to the CE 1992 Form 10-K, File No.2-7749).\nCOMMONWEALTH ELECTRIC COMPANY\n10.1.4.4 Fifteenth and Sixteenth Amendments to 10.1.4 as amended April 27, 1984 and June 15, 1984, respectively (Exhibit 1 to the CEC Form 10-Q (June 1984), File No. 2-30057).\n10.1.4.5 Seventeenth Amendment to 10.1.4 as amended March 8, 1985 (Exhibit 1 to the CEC Form 10-Q (March 1985), File No. 2-30057).\n10.1.4.6 Eighteenth Amendment to 10.1.4 as amended March 14, 1986 (Exhibit 1 to the CEC Form 10-Q (March 1986), File No. 2-30057).\n10.1.4.7 Nineteenth Amendment to 10.1.4 as amended May 1, 1986 (Exhibit 1 to the CEC Form 10-Q (June 1986), File No. 2-30057).\n10.1.4.8 Twentieth Amendment to 10.1.4 as amended September 19, 1986 (Ex- hibit 1 to the CEC 1986 Form 10-K, File No. 2-30057).\n10.1.4.9 Twenty-First Amendment to 10.1.4 as amended November 12, 1987 (Exhibit 1 to the CEC 1987 Form 10-K, File No. 2-30057).\n10.1.4.10 Settlement Agreement and Twenty-Second Amendment to 10.1.4, both dated January 13, 1989 (Exhibit 4 to the CEC 1988 Form 10-K, File No. 2-30057).\n10.1.5 Interim Agreement to Preserve and Protect the Assets of and In- vestment in the New Hampshire Nuclear Units dated April 27, 1984 (Exhibit 2 to the CEC Form 10-Q (June 1984), File No. 2-30057).\n10.1.6 Resolutions proposed by Merrill Lynch Capital Markets and adopted by the Joint-Owners of the Seabrook Nuclear Project regarding Project financing, dated May 14, 1984 (Exhibit 1 to the CEC Form 10-Q (March 1984), File No. 2-30057).\n10.1.7 Agreement for Seabrook Project Disbursing Agent establishing YAEC as the disbursing agent under the Joint-Ownership Agreement, dated May 23, 1984 (Exhibit 4 to the CEC Form 10-Q (June 1984), File No. 2-30057).\n10.1.7.1 First Amendment to 10.1.7 as amended March 8, 1985 (Exhibit 2 to the CEC Form 10-Q (March 1985), File No. 2-30057).\n10.1.7.2 Second through Fifth Amendments to 10.1.7 as amended May 20, 1985, June 18, 1985, January 2, 1986 and November 12, 1987, respectively (Exhibit 4 to the CEC 1987 Form 10-K, File No. 2-30057).\n10.1.8 Purchase and Sale Agreement together with an implementing Addendum dated December 31, 1981, between CE and CEC, for the purchase and sale of the CE 3.52% joint-ownership interest in the Seabrook units, dated January 2, 1981 (Refiled as Exhibit 4 to the CE 1992 Form 10-K, File No. 2-7749).\n10.1.8.1 Agreement to transfer ownership, construction and operational interest in the Seabrook Units 1 and 2 from CE to CEC dated Janu- ary 2, 1981 (Refiled as Exhibit 3 to the CE 1991 Form 10-K, File No. 2-7749).\nCOMMONWEALTH ELECTRIC COMPANY\n10.1.9 Termination Supplement between CEC, CE and CEL for Seabrook Unit 2, dated December 8, 1986 (Exhibit 3 to the CEC 1986 Form 10-K, File No. 2-30057).\n10.1.10 Power Contract, as amended to February 28, 1990, superseding the Power Contract dated September 1, 1986 and amendment dated June 1, 1988, between CEC (seller) and CE and CEL (purchasers) for sell- er's entire share of the Net Unit Capability of Seabrook 1 and related energy (Exhibit 1 to the CEC Form 10-Q (March 1990), File No. 2-30057).\n10.1.11 Agreement between NBGEL and Central Maine Power Company (CMP), for the joint-ownership, construction and operation of William F. Wyman Unit No. 4 dated November 1, 1974 together with Amendment No. 1 dated June 30, 1975 (Exhibit 13(N) to the NBGEL Form S-1, File No. 2-54955).\n10.1.11.1 Amendments No. 2 and 3 to 10.1.11 as amended August 16, 1976 and December 31, 1978 (Exhibit 5(a) 14 to the System's Form S-16 (June 1979), File No. 2-64731).\n10.1.12 Contract between CEC and NBGEL and CEL, affiliated companies, for the sale of specified amounts of electricity from Canal Unit 2 dated January 12, 1976 (Exhibit 7 to the System's 1985 Form 10-K, File No. 1-7316).\n10.1.13 Capacity Acquisition Agreement between CEC,CEL and CE dated Sep- tember 25, 1980 (Exhibit 1 to the CEC 1991 Form 10-K, File No. 2- 30057).\n10.1.13.1 Supplement to 10.1.13 consisting of three Capacity Acquisition Commitments each dated May 7, 1987, concerning Phases I and II of the Hydro-Quebec Project and electricity acquired from Connecticut Light and Power Company CL&P) (Exhibit 1 to the CEC Form 10-Q (September 1987), File No. 2-30057).\n10.1.13.2 Amendment to 10.1.13 as amended and restated June 1, 1993, hence- forth referred to as the Capacity Acquisition and Disposition Agreement, whereby CEC, as agent, in addition to acquiring power may also sell bulk electric power which CEL and\/or the Company owns or otherwise has the right to sell (Exhibit 1 to the CEC Form 10-Q (September 1993), File No. 2-30057).\n10.1.14 Phase 1 Vermont Transmission Line Support Agreement and Amendment No. 1 thereto between Vermont Electric Transmission Company, Inc. and certain other New England utilities, dated December 1, 1981 and June 1, 1982, respectively (Refiled as Exhibits 5 and 6 to the 1992 CE Form 10-K, File No. 2-7749).\n10.1.14.1 Amendment No. 2 to 10.1.14 as amended November 1, 1982 (Exhibit 5 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.14.2 Amendment No. 3 to 10.1.14 as amended January 1, 1986 (Exhibit 2 to the CE 1986 Form 10-K, File No. 2-7749).\nCOMMONWEALTH ELECTRIC COMPANY\n10.1.15 Participation Agreement between MEPCO and CEL and\/or NBGEL dated June 20, 1969 for construction of a 345 KV transmission line between Wiscasset, Maine and Mactaquac, New Brunswick, Canada and for the purchase of base and peaking capacity from the NBEPC (Exhibit 13 to the CES 1984 Form 10-K, File No. 1-7316).\n10.1.15.1 Supplement Amending 10.1.15 as amended June 24, 1970 (Exhibit 8 to the CES Form S-7, Amendment No. 1, File No. 2-38372).\n10.1.16 Power Purchase Agreement (Revised) between Weweantic Hydro Associ- ates and the Company for the purchase of available hydro-electric energy produced by a facility located in Wareham, MA, originally dated December 13, 1982, revised and dated March 12, 1993 (Filed as Exhibit 1 to the CE Form 10-Q (June 1993), File No. 2-7749).\n10.1.17 Power Purchase Agreement between Pioneer Hydropower, Inc. and CE for the purchase of available hydro-electric energy produced by a facility located in Ware, Massachusetts, dated September 1, 1983 (Refiled as Exhibit 1 to the CE 1993 Form 10-K, File No. 2-7749).\n10.1.18 Power Purchase Agreement between Corporation Investments, Inc. (CI), and CE for the purchase of available hydro-electric energy produced by a facility located in Lowell, Massachusetts, dated January 10, 1983 (Refiled as Exhibit 2 to the CE 1993 Form 10-K, File No. 2-7749).\n10.1.18.1 Amendment to 10.1.18 between CI and Boott Hydropower, Inc., an assignee therefrom, and CE, as amended March 6, 1985 (Exhibit 8 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.19 Phase 1 Terminal Facility Support Agreement dated December 1, 1981, Amendment No. 1 dated June 1, 1982 and Amendment No. 2 dated November 1, 1982, between New England Electric Transmission Corpo- ration (NEET), other New England utilities and CE (Exhibit 1 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.19.1 Amendment No. 3 to 10.1.19 (Exhibit 2 to the CE Form 10-Q (June 1986), File No. 2-7749).\n10.1.20 Preliminary Quebec Interconnection Support Agreement dated May 1, 1981, Amendment No. 1 dated September 1, 1981, Amendment No. 2 dated June 1, 1982, Amendment No. 3 dated November 1, 1982, Amend- ment No. 4 dated March 1, 1983 and Amendment No. 5 dated June 1, 1983 among certain New England Power Pool (NEPOOL) utilities (Exhibit 2 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.21 Agreement with Respect to Use of Quebec Interconnection dated December 1, 1981, Amendment No. 1 dated May 1, 1982 and Amendment No. 2 dated November 1, 1982 among certain NEPOOL utilities (Ex- hibit 3 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.21.1 Amendatory Agreement No. 3 to 10.1.21 as amended June 1, 1990, among certain NEPOOL utilities (Exhibit 1 to the CEC Form 10-Q (September 1990), File No. 2-30057).\nCOMMONWEALTH ELECTRIC COMPANY\n10.1.22 Phase I New Hampshire Transmission Line Support Agreement between NEET and certain other New England Utilities dated December 1, 1981 (Exhibit 4 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.23 Agreement, dated September 1, 1985, with Respect To Amendment of Agreement With Respect To Use Of Quebec Interconnection, dated December 1, 1981, among certain NEPOOL utilities to include Phase II facilities in the definition of \"Project\" (Exhibit 1 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.24 Preliminary Quebec Interconnection Support Agreement - Phase II among certain New England electric utilities dated June 1, 1984 (Exhibit 6 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.24.1 First, Second and Third Amendments to 10.1.24 as amended March 1, 1985, January 1, 1986 and March 1, 1987, respectively (Exhibit 1 to the CEC Form 10-Q (March 1987), File No. 2-30057).\n10.1.24.2 Fifth, Sixth and Seventh Amendments to 10.1.24 as amended October 15, 1987, December 15, 1987 and March 1, 1988, respectively (Ex- hibit 1 to the CEC Form 10-Q (June 1988), File No. 2-30057).\n10.1.24.3 Fourth and Eighth Amendments to 10.1.24 as amended July 1, 1987 and August 1, 1988, respectively (Exhibit 3 to the CEC Form 10-Q (September 1988), File No. 2-30057).\n10.1.24.4 Ninth and Tenth Amendments to 10.1.24 as amended November 1, 1988 and January 15, 1989, respectively (Exhibit 2 to the CEC 1988 Form 10-K, File No. 2-30057).\n10.1.24.5 Eleventh Amendment to 10.1.24 as amended November 1, 1989 (Exhibit 4 to the CEC 1989 Form 10-K, File No. 2-30057).\n10.1.24.6 Twelfth Amendment to 10.1.24 as amended April 1, 1990 (Exhibit 1 to the CEC Form 10-Q (June 1990), File No. 2-30057).\n10.1.25 Phase II Equity Funding Agreement for New England Hydro-Transmis- sion Electric Company, Inc. (New England Hydro) (Massachusetts), dated June 1, 1985, between New England Hydro and certain NEPOOL utilities (Exhibit 2 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.26 Phase II Massachusetts Transmission Facilities Support Agreement dated June 1, 1985, refiled as a single agreement incorporating Amendments 1 through 7 dated May 1, 1986 through January 1, 1989, respectively, between New England Hydro and certain NEPOOL utili- ties (Exhibit 2 to the CEC Form 10-Q (September 1990), File No. 2- 30057).\n10.1.27 Phase II New Hampshire Transmission Facilities Support Agreement dated June 1, 1985, refiled as a single agreement incorporating Amendments 1 through 8 dated May 1, 1986 through January 1, 1990, respectively, between New England Hydro-Transmission Corporation (New Hampshire Hydro) and certain NEPOOL utilities (Exhibit 3 to the CEC Form 10-Q (September 1990), File No. 2-30057).\nCOMMONWEALTH ELECTRIC COMPANY\n10.1.28 Phase II Equity Funding Agreement for New Hampshire Hydro, dated June 1, 1985, between New Hampshire Hydro and certain NEPOOL util- ities (Ex. 3 to the CEC Form 10-Q (Sept. 1985), File No. 2-30057).\n10.1.28.1 Amendment No. 1 to 10.1.28 dated May 1, 1986 (Exhibit 6 to the CEC Form 10-Q (March 1987), File No. 2-30057).\n10.1.28.2 Amendment No. 2 to 10.1.28 as amended September 1, 1987 (Exhibit 3 to the CEC Form 10-Q (September 1987), File No. 2-30057).\n10.1.29 Phase II New England Power AC Facilities Support Agreement, dated June 1, 1985, between NEP and certain NEPOOL utilities (Exhibit 6 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.29.1 Amendments Nos. 1 and 2 to 10.1.29 as amended May 1, 1986 and February 1, 1987, respectively (Exhibit 5 to the CEC Form 10-Q (March 1987), File No. 2-30057).\n10.1.29.2 Amendments Nos. 3 and 4 to 10.1.29 as amended June 1, 1987 and September 1, 1987, respectively (Exhibit 5 to the CEC Form 10-Q (September 1987), File No. 2-30057).\n10.1.30 Phase II Boston Edison AC Facilities Support Agreement, dated June 1, 1985, between BECO and certain NEPOOL utilities (Exhibit 7 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.30.1 Amendments Nos. 1 and 2 to 10.1.30 as amended May 1, 1986 and February 1, 1987, respectively (Exhibit 2 to the CEC Form 10-Q (March 1987), File No. 2-30057).\n10.1.30.2 Amendments Nos. 3 and 4 to 10.1.30 as amended June 1, 1987 and September 1, 1987, respectively (Exhibit 4 to the CEC Form 10-Q (September 1987), File No. 2-30057).\n10.1.31 Agreement Authorizing Execution of Phase II Firm Energy Contract, dated September 1, 1985, among certain NEPOOL utilities in regard to participation in the purchase of power from Hydro-Quebec (Ex- hibit 8 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.32 System Power Sales Agreement by and between CE, as seller, and Central Vermont Public Service Corporation (CVPS), as buyer, dated September 15, 1984 (Exhibit 2 to the CE Form 10-Q (September 1984), File No. 2-7749).\n10.1.32.1 System Sales Agreement by CVPS, as seller, and CE, as buyer, dated September 15, 1984 (Exhibit 9 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.32.2 System Sales and Exchange Agreement by and between CVPS and CE on energy transactions, dated September 15, 1984 (Exhibit 10 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.32.3 System Exchange Agreement by and between CE and CVPS for the exchange of capacity and associated energy, dated September 3, 1985 (Exhibit 1 to the CE 1985 Form 10-K, File No. 2-7749).\nCOMMONWEALTH ELECTRIC COMPANY\n10.1.32.4 Purchase Agreement by and between CEC and CVPS for the purchase of capacity from CEC for the term March 1, 1991 to October 31, 1995, dated March 1, 1991 (Exhibit 1 to CEC Form 10-Q (June 1991), File No. 2-30057).\n10.1.32.5 Power Sale Agreement by and between CEC and CVPS for the purchase of 50 MW of capacity from CVPS's units (25 MW from Vermont Yankee and 25 MW from Merrimack 2) for the term of March 1, 1991 to October 31, 1995, dated March 1, 1991 (Exhibit 2 to CEC Form 10-Q (June 1991), File No. 2-30057).\n10.1.33 Agreements by and between Swift River Company and CE for the purchase of available hydro-electric energy to be produced by units located in Chicopee and North Willbraham, Massachusetts, both dated September 1, 1983 (Exhibits 11 and 12 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.33.1 Transmission Service Agreement between Northeast Utilities' compa- nies (NU) - The Connecticut Light and Power Company (CL&P) and Western Massachusetts Electric Company (WMECO), and CE for NU companies to transmit power purchased from Swift River Company's Chicopee Units to CE, dated October 1, 1984 (Exhibit 14 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.33.2 Transformation Agreement between WMECO and CE whereby WMECO is to transform power to CE from the Chicopee Units, dated December 1, 1984 (Exhibit 15 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.34 System Power Sales Agreement by and between CL&P and WMECO, as buyers, and CE, as seller, dated January 13, 1984 (Exhibit 13 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.35 System Power Sales Agreement by and between CL&P, WMECO, as sell- ers, and CEL, as buyer, of power in excess of firm power customer requirements from the electric systems of the NU Companies, dated June 1, 1984, as effective October 25, 1985 (Exhibit 1 to CEL 1985 Form 10-K, File No. 2-7909).\n10.1.36 Power Purchase Agreement with Respect to South Meadow Unit Nos. 11, 12, 13, and 14 of the NU system company of CL&P (seller) and CE (buyer), dated November 1, 1985 (Exhibit 1 to the CE Form 10-Q (June 1986), File No. 2-7749).\n10.1.37 Power Purchase Agreement by and between SEMASS Partnership, as seller, to construct, operate and own a solid waste disposal facility at its site in Rochester, Massachusetts and CE, as buyer of electric energy and capacity, dated September 8, 1981 (Exhibit 17 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.37.1 Power Sales Agreement to 10.1.37 for all capacity and related energy produced, dated October 31, 1985 (Exhibit 2 to the CE 1985 Form 10-K, File No. 2-7749).\nCOMMONWEALTH ELECTRIC COMPANY\n10.1.37.2 Amendment to 10.1.37 for all additional electric capacity and related energy to be produced by an addition to the Original Unit, dated March 14, 1990 (Exhibit 1 to the CE Form 10-Q (June 1990), File No. 2-7749).\n10.1.37.3 Second Amendment to 10.1.37.2 for all additional electric capacity and related energy to be produced by an addition to the Original Unit, dated May 24, 1991 (Exhibit 1 to the CE Form 10-Q (June 1991), File No. 2-7749).\n10.1.38 System Power Sales Agreement by and between CE (seller) and NEP (buyer), dated January 6, 1984 (Exhibit 1 to the CE Form 10-Q (June 1985), File No. 2-7749).\n10.1.39 Service Agreement by and between CE and NEP dated March 24, 1984, whereas CE agrees to purchase short-term power applicable to NEP'S FERC Electric Tariff Number 5 (Exhibit 1 to the CE Form 10-Q (June 1987), File No. 2-7749).\n10.1.40 Power Sale Agreement by and between CE (buyer) and Northeast Energy Associates, Ltd. (NEA) (seller) of electric energy and capacity, dated November 26, 1986 (Exhibit 1 to the CE Form 10-Q (March 1987), File No. 2-7749).\n10.1.40.1 First Amendment to 10.1.40 as amended August 15, 1988 (Exhibit 1 to the CE Form 10-Q (September 1988), File No. 2-7749).\n10.1.40.2 Second Amendment to 10.1.40 as amended January 1, 1989 (Exhibit 2 to the CE 1988 Form 10-K, File No. 2-7749).\n10.1.40.3 Power Sale Agreement dated August 15, 1988 between NEA and CE for the purchase of 21 MW of electricity (Exhibit 2 to the CE Form 10-Q (September 1988), File No. 2-7749).\n10.1.40.4 Amendment to 10.1.40.3 as amended January 1, 1989 (Exhibit 3 to the CE 1988 Form 10-K, File No. 2-7749).\n10.1.41 Power Sale Agreement by and between CE (buyer) and Pepperell Power Associates Limited Partnership (seller) of all electricity pro- duced from a 38 KW generating unit, dated April 13, 1987 (Exhibit 3 to the CE Form 10-Q (March 1987), File No. 2-7749).\n10.1.42 Exchange of Power Agreement between Montaup Electric Company and CE dated January 17, 1991 (Exhibit 2 to the CE Form 10-Q (Septem- ber 1991), File No. 2-7749).\n10.1.42.1 First Amendment, dated November 24, 1992, to Exchange of Power Agreement between Montaup Electric Company and the Company dated January 17, 1991 (Exhibit 1 to the CE Form 10-Q (March 1993), File No. 2-7749).\n10.1.43 System Power Exchange Agreement by and between CE and New England Power Company dated January 16, 1992 (Exhibit 1 to the CE Form 10-Q March 1992), File No. 2-7749).\nCOMMONWEALTH ELECTRIC COMPANY\n10.1.43.1 First Amendment, dated September 8, 1992, to 10.1.43, dated January 16, 1992 (Exhibit 1 to the CE Form 10-Q (Sept. 1992), File No. 2-7749).\n10.1.43.2 Second Amendment, dated March 2, 1993, to System Power Exchange Agreement by and between the Company and New England Power Company dated January 16, 1992 (Exhibit 2 to the CE Form 10-Q (March 1993), File No. 2-7749).\n10.1.44 Power Purchase Agreement and First Amendment, dated September 5, 1989 and August 3, 1990, respectively, by and between CE (buyer) and Dartmouth Power Associates Limited Partnership (seller), whereby buyer will purchase all of the energy (67.6 MW) produced by a single gas turbine unit (Exhibit 1 to the CE Form 10-Q (June 1992), File No. 2-7749).\n10.1.45 Power Purchase Agreement by and between Masspower (seller) and the Company (buyer) for a 11.11% entitlement to the electric capacity and related energy of a 240 MW gas-fired cogeneration facility, dated February 14, 1992 (Exhibit 1 to the CE Form 10-Q (September 1993), File No. 2-7749).\n10.1.46 Power Sale Agreement by and between Altresco Pittsfield, L.P. (seller) and the Company (buyer) for a 17.2% entitlement to the electric capacity and related energy of a 160 MW gas-fired cogen- eration facility, dated February 20, 1992 (Exhibit 2 to the CE Form 10-Q (September 1993), File No. 2-7749).\n10.1.46.1 System Exchange Agreement by and among Altresco Pittsfield, L.P., CEL, the Company and New England Power Company, dated July 2, 1993 (Exhibit 3 to the CE Form 10-Q (September 1993), File No. 2-7749).\n10.2 Other agreements.\n10.2.1 Pension Plan for Employees of Commonwealth Energy System and Subsidiary Companies as amended and restated January 1, 1993 (Exhibit 1 to the CES Form 10-Q (Sept. 1993), File No. 1-7316).\n10.2.2 Employees Savings Plan of Commonwealth Energy System and Subsid- iary Companies as amended and restated as of January 1, 1993 (Ex- hibit 2 to the CES Form 10-Q (September 1993), File No. 1-7316).\n10.2.2.1 First Amendment to the Employees Savings Plan of Commonwealth Energy System and Subsidiary Companies, as amended and restated as of January 1, 1993, effective October 1, 1994. (Exhibit 1 to CES Form S-8 (January 1995), File No. 1-7316).\n10.2.3 New England Power Pool Agreement (NEPOOL) dated September 1, 1971 as amended through August 1, 1977, between NEGEA Service Corpora- tion, as agent for CEL, CEC, NBGEL, and various other electric utilities operating in New England together with amendments dated August 15, 1978, January 31, 1979 and February 1, 1980 (Exhibit 5(c)13 to New England Gas and Electric Association's Form S-16 (April 1980), File No. 2-64731).\nCOMMONWEALTH ELECTRIC COMPANY\n10.2.3.1 Thirteenth Amendment to 10.2.3 as amended September 1, 1981 (Re- filed as Exhibit 3 to the CES 1991 Form 10-K, File No. 1-7316).\n10.2.3.2 Fourteenth through Twentieth Amendments to 10.2.3 as amended December 1, 1981, June 1, 1982, June 15, 1983, October 1, 1983, August 1, 1985, August 15, 1985 and September 1, 1985, respective- ly (Exhibit 4 to the CES Form 10-Q (Sept. 1985), File No. 1-7316).\n10.2.3.3 Twenty-first Amendment to 10.2.3 as amended to January 1, 1986 (Exhibit 1 to the CES Form 10-Q (March 1986), File No. 1-7316).\n10.2.3.4 Twenty-second Amendment to 10.2.3 as amended to September 1, 1986 (Exhibit 1 to the CES Form 10-Q (Sept. 1986), File No. 1-7316).\n10.2.3.5 Twenty-third Amendment to 10.2.3 as amended to April 30, 1987 (Exhibit 1 to the CES Form 10-Q (June 1987), File No. 1-7316).\n10.2.3.6 Twenty-fourth Amendment to 10.2.3 as amended March 1, 1988 (Exhib- it 1 to the CES Form 10-Q (March 1989), File No. 1-7316).\n10.2.3.7 Twenty-fifth Amendment to 10.2.3. as amended to May 1, 1988 (Ex- hibit 1 to the CES Form 10-Q (March 1988), File No. 1-7316).\n10.2.3.8 Twenty-sixth Agreement to 10.2.3 as amended March 15, 1989 (Exhib- it 1 to the CES Form 10-Q (March 1989), File No. 1-7316).\n10.2.3.9 Twenty-seventh Agreement to 10.2.3 as amended October 1, 1990 (Exhibit 3 to the CES 1990 Form 10-K, File No. 1-7316).\n10.2.3.10 Twenty-eighth Agreement to 10.2.3 as amended September 15, 1992 (Exhibit 1 to the CES Form 10-Q (September 1994), File No. 1- 7316).\n10.2.3.11 Twenty-ninth Agreement to 10.2.3 as amended May 1, 1993 (Exhibit 2 to the CES Form 10-Q (September 1994), File No. 1-7316).\nExhibit 27. Financial Data Schedule\nFiled herewith as Exhibit 1 is the Financial Data Schedule for the twelve months ended December 31, 1994.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the three months ended December 31, 1994.\nSCHEDULE I\nCOMMONWEALTH ELECTRIC COMPANY INVESTMENTS IN, EQUITY IN EARNINGS OF, AND DIVIDENDS RECEIVED FROM RELATED PARTIES\nFOR THE YEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(Dollars in Thousands)\nName of Issuer and Description of Investment\nCommon Stock - Yankee Atomic Electric Company\nBalance, December 31, 1991\nNumber of Shares: 3 835\nAmount $526\nAdd: Equity in Earnings 75\nLess: Dividends Received -\nBalance, December 31, 1992 601\nAdd: Equity in Earnings -\nLess: Dividends Received -\nBalance, December 31, 1993 601\nAdd: Equity in Earnings 53\nLess: Dividends Received -\nBalance, December 31, 1994 $654\nThere were no changes in the number of shares held during the years 1992, 1993 or 1994.\nUnder terms of the capital funds agreements and power contracts, no stock may be sold or transferred except to another stockholder; however, no market exists for these securities.\nSee Note 2(c) of the Notes to Financial Statements included in Item 8 of this report for a discussion of the permanent closing of the nuclear plant owned by Yankee Atomic Electric Company.\nSCHEDULE II\nCOMMONWEALTH ELECTRIC COMPANY VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 and 1992\n(Dollars in Thousands)\nAdditions Balance Provision Deductions Balance Beginning Charged to Accounts at End Description of Year Operations Recoveries Written Off of Year\nAllowance for Doubtful Accounts Year Ended December 31, 1994\n$3 268 $2 362 $641 $3 430 $2 841\nYear Ended December 31, 1993\n$3 131 $3 173 $783 $3 819 $3 268\nYear Ended December 31, 1992\n$2 653 $5 216 $854 $5 592 $3 131\nCOMMONWEALTH ELECTRIC COMPANY FORM 10-K DECEMBER 31, 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.\nCOMMONWEALTH ELECTRIC COMPANY (Registrant)\nBy: WILLIAM G. POIST William G. Poist, 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.\nPrincipal Executive Officers:\nWILLIAM G. POIST March 29, 1995 William G. Poist, Chairman of the Board and Chief Executive Officer\nR. D. WRIGHT March 29, 1995 Russell D. Wright, President and Chief Operating Officer\nPrincipal Financial Officer:\nJAMES D. RAPPOLI March 29, 1995 James D. Rappoli, Financial Vice President and Treasurer\nPrincipal Accounting Officer:\nJOHN A. WHALEN March 29, 1995 John A. Whalen, Comptroller\nA majority of the Board of Directors:\nWILLIAM G. POIST March 29, 1995 William G. Poist, Director\nR. D. WRIGHT March 29, 1995 Russell D. Wright, Director\nJAMES D. RAPPOLI March 29, 1995 James D. Rappoli, Director","section_15":""}
{"filename":"806072_1994.txt","cik":"806072","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nC.I.S. Technologies, Inc. (\"the Company\") develops and markets computer-based healthcare reimbursement management programs and (ii) offers professional consulting and reimbursement assistance services to over 900 healthcare clients (primarily acute-care 100+ bed hospitals and physician practices) across the country. The Company's services are designed to improve the cash flows and reduce the administrative costs of its healthcare clients.\nRECENT DEVELOPMENTS\nAcquisition of AMSC, Inc. In November, 1994 the Company completed the - - ------------------------- acquisition of 100% of the outstanding capital stock of AMSC, Inc. for a total consideration of $5 million, which consisted of a combination of cash, notes and the Company's common stock. AMSC is the nation's leading reseller of The Medical Manager(R) physician practice management software and provides complete automated business office solutions for medical service organizations (MSOs) and physician-hospital organizations (PHOs), as well as individual physicians and small practices. The Company believes that this acquisition positions it to take advantage of the untapped potential in the physician market, and assist in the building of integrated delivery systems. Unlike the hospital market, relatively few physician claims are currently billed electronically and, with AMSC, the Company has potential access to approximately 800,000 additional claims per month. There is also an opportunity for the Company to enter the physician market with not only claims automation solutions, but also professional services, decision support services and financial services.\nRelationship with GE Capital. In late October, 1994, the Company entered into - - ---------------------------- several agreements with General Electric Capital Corporation (\"GE Capital\"). GE Capital acquired 840,336 newly issued common shares of the Company's stock for $2 million. GE Capital also provided a $2 million three-year term loan, which funds were used in acquiring AMSC, Inc. (see above discussion), as well as a $5 million, three-year revolving credit facility to be used for working capital and acquisitions. The two companies also have entered into a strategic alliance to provide accounts receivable funding to the healthcare industry through a newly formed and equally-owned business entity. Precision Funding(SM) is the name of the service under which the funding product will be marketed.\nRelationship with Bankers Trust. In late November, 1994 the Company entered - - ------------------------------- into an agreement with a subsidiary of Bankers Trust New York Corporation (\"Bankers Trust\") in connection with a strategic alliance to pursue opportunities in cash management and data services in the healthcare industry. Pursuant to the agreement, Bankers Trust acquired 2,384,182 shares, and warrants to acquire an additional 500,000 shares, of newly issued convertible preferred stock and 1,615,818 shares of newly issued common stock for $10 million. By utilizing Bankers Trust's decision support services and the Company's database and market segment expertise, the two companies will look for opportunities to meet the growing need in the healthcare industry for relative performance on costs as well as treasury functions including cash management, lock box operation and cash reconciliation.\nPRODUCTS AND SERVICES\nThe focus of reimbursement management is the accurate and efficient billing of third-party insurance payers and the efficient operation of the hospital's billing office. The Company has developed services which will assist hospitals in reducing administrative costs and improving cash flows. A brief description of each of the Company's services follows:\nElectronic Data Interchange (\"EDI\") Services. EDI is the automated transfer of - - --------------------------------------------- business data between two or more parties, using electronic technology to speed the exchange of data and reduce paperwork, human error and administrative costs. Approximately 52% of total revenue in 1994 was derived from electronic data interchange, of which 87% is considered to be recurring. The Company has several products and services which are part of the EDI Services offering that are described in more detail below.\nPREMIS(R) or Electronic Claims Management. The foundation of the Company's business is its proprietary electronic claims management software. The software is PC-based and resides at the hospital billing office. Claim information from the hospital's central computer is downloaded into the PC, where the software edits (based upon approximately 10,000 payer specific edit requirements) and formats the data. The software isolates claims with errors and then assists the billing clerk in correcting the claims. \"Clean\" or error-free claims are then transmitted via modem to the Company's clearinghouse computer in Tulsa, where the information is re-formatted and transmitted to the various insurance payers. The Company's claims management system provides transmission security and comprehensive accounting reports, and is capable of processing a variety of health insurance claims (e.g. Medicare, Medicaid, commercial, managed care), amounting to an \"all-payer\" approach. Use of the Company's electronic claims management system reduces its clients' claims rejection rate to less than 1%, resulting in more timely payment of claims and improved operating efficiency, thereby decreasing days in accounts receivable and administrative costs. During 1994, the Company processed over 24 million claims worth $45 billion, which positions it as the largest independent claims clearinghouse in the United States.\nThe Company generally charges its clients fees for initial licensing, training and installation. After the claims management system is operational, clients are charged a monthly claims processing fee, based upon either the number of patient beds or the number of claims processed during the month, as well as a monthly fee for ongoing software maintenance and an annual software license renewal fee. Revenue from PREMIS or electronic claims management is generally considered to be recurring because client retention is high and services are typically provided over a long period of time.\nThe Company completed a significant revision of its PREMIS software and released PREMIS 2.0 in July, 1994. PREMIS 2.0 includes additional functionality that enhances the value that clients receive from use of the software. PREMIS replaces the previous electronic claims management system as the Company's core product and current users of the previous electronic claims management system will be converted to PREMIS over the next few years.\nPOSTPRO(TM) or Electronic Remittance Posting. For every claim a hospital submits, the insurance payer responds with documentation called a remittance advice. The remittance advice contains valuable data about the claim, whether it was accepted or rejected, when payment should be received by the hospital and what the payment will be. Information on these remittance advices must be manually entered into the hospital's mainframe computer, and painstakingly re- entered and maintained in the various reports required by Medicare, Medicaid and other payers. POSTPRO eliminates the need for rekeying remittance information by uploading an electronic remittance file from the insurance payer into the hospital's information system. POSTPRO automatically reconciles cash deposits with remittance data, calculates and posts contractuals and\/or adjustments for managed care contracts, facilitates secondary billing, and generates meaningful reports for managing reimbursement. A major revision of POSTPRO, POSTPRO Version 2, was released in late 1994, creating a standard format that will allow for faster installations and more consistent applications to all clients.\nEligibility Services. Through strategic alliances with other companies, the Company began offering eligibility services to clients during 1994. Eligibility services gives hospitals direct access to payer computer files that can instantly verify patient insurance eligibility, benefits coverage and exceptions. This not only supplies the information needed upfront to reduce re- submissions of claims due to missing or inaccurate data, but also\nhelps determine, before patients are discharged from the hospital, secondary coverage and what out-of-pocket expenses the patients will need to pay (such as a deductible or remaining balance).\nReimbursement Services. One of the roadblocks to efficiency and cash flow in - - ----------------------- the hospital business office is the lack of accuracy in billing. While the Company's claims management programs specialize in moving information efficiently between hospitals and insurance payers, the Company's Reimbursement Services Division (formerly Hospital Billing Analysis, Inc., \"HBA\") provides several services that help ensure that hospitals capture all appropriate charges. Charge recovery services are performed at the hospital by the Company's skilled revenue auditors. These auditors compare insurance claims to patient files, verifying that all chargeable items and services have been accurately billed. The auditors also perform rebilling, follow-up and collections services for the claims they identify. This service, which also identifies charges which were erroneously included in such claims, has historically identified net undercharges amounting to 3%-5% of the value of the claims examined. The Company is paid a percentage of the net undercharges identified and collected.\nReimbursement Services also include: a Defense Audit program which provides hospitals with specially trained medical auditors to act on their behalf when dealing with insurance carriers; Patient Audit Request Services, which provides hospitals with third-party intervention to respond to patient questions or disputes in regard to billing issues; a Concurrent Audit program, whereby the Company's auditors review claims as they are generated by the hospital's billing office to help ensure that hospital charges are accurate upon initial submission of claims to insurance companies; and Supplemental Audit Support Services, designed to assist hospitals in evaluating, training and supplementing their existing internal auditing staffs.\nRevenue from Reimbursement Services is considered to be recurring because client retention is high and services are typically provided over a long period of time. Approximately 35% of total revenue in 1994 was derived from Reimbursement Services.\nProfessional Services. Hospitals often have a shortage of trained billing - - --------------------- office personnel and a backlog of claims to be processed. Other times, hospitals require assistance with converting from one hospital information system to another. Through its variety of comprehensive professional services, the Company provides experienced and highly trained personnel to work on-site, in conjunction with the Company's electronic claims management system, providing assistance through temporary situations which otherwise would disrupt the normal billing process.\nMany hospitals have found that subcontracting, or \"outsourcing\", with outside vendors for food service, emergency room, linen service, waste disposal and laboratory work can be more cost effective than if the hospital were to itself provide such services. The Company has found that a number of hospitals can also benefit from subcontracting all or certain specific functions of their business office. Acting as a strategic partner with a hospital, the Company's Professional Services staff can perform all hospital business office functions related to the reimbursement cycle, from the initial verification of insurance coverage through the final resolution and payment of the insurance claim. The Company's Professional Services provide several immediate and measurable benefits to the hospital business office: needed programs and changes can be implemented in less time; overhead and operating budgets can be reduced; necessary expertise to accomplish an objective is readily available; and new technology is accessible without the usual heavy investment.\nCharges for Professional Services are based upon negotiated fees, which can be a percentage of the claim value submitted through the electronic claims management system, a percentage of cash collected or a fixed fee, depending on the length of the project and the level of service provided. Revenue from Professional Services is generally considered to be non-recurring because the services provided are under special circumstances that rarely last longer than a few months. Approximately 8% of total revenue during 1994 was derived from Professional Services.\nPhysician Services. Through its newly acquired subsidiary, AMSC, Inc., the - - ------------------ Company plans to expand its services to the physician and emerging integrated delivery systems markets. AMSC is the nation's leading reseller of The Medical Manager physician practice management software and provides complete automated business office solutions for medical service organizations and physician- hospital organizations, as well as individual physicians. During 1994, approximately 5% of the Company's revenue was derived from Physician Services.\nDecision Support Services. The Company's electronic claims management system - - ------------------------- processes approximately $4 billion of healthcare claims per month. As a result, the Company has established one of the largest data bases of current healthcare information available. As part of the strategic alliance with Bankers Trust (see above), the Company plans to market this statistical and tactical information in an aggregate format to hospitals, hospital associations, state and federal agencies and other entities.\nMARKETING AND CUSTOMERS\nThe Company markets its reimbursement management services to acute-care hospitals with greater than 100 beds, of which there are approximately 2,500 in the United States. The Company markets its physician services to physician practices across the country. Currently, the Company's EDI, Audit, Professional and Physician Services are utilized by over 900 clients in 38 states. The Company's services are marketed by direct sales and account service personnel on a decentralized basis. Regional offices are maintained in Atlanta, Georgia; Chicago, Illinois; Dallas, Texas; Orlando, Florida; Palm Springs, California and Philadelphia, Pennsylvania.\nDuring 1995, the Company's marketing activities will consist primarily of selling its reimbursement management services to both new and existing clients, and focusing on the newly emerging integrated delivery systems. Cross-selling opportunities between the Company's clients will continue to be explored.\nDuring 1994, the Company did not have any customers accounting for more than 10% of total revenue.\nSOFTWARE MAINTENANCE AND DEVELOPMENT\nSoftware Maintenance. To ensure the continuous flow of information, the - - -------------------- Company's electronic claims management software must be updated to reflect changes in the rules, regulations and requirements of third-party insurance payers. To accomplish the updates, the Company regularly obtains current claims specifications from each insurance payer. Company personnel then translate each set of specifications to a format that can be used for programming purposes. Once the specifications are programmed and approved by the Company, the Company's electronic claims software is then updated and distributed to clients. Because the requirements of third-party insurance payers change so frequently, the Company releases updated software to clients on a monthly basis. The Company's other software products, such as eligibility verification and remittance posting, generally do not require continuous updates.\nSoftware Development for New States. Currently, the Company offers its - - ----------------------------------- electronic claims management services in 32 states. Because of its all-payer approach to claims management, the Company limits its claims management to those states in which it has first met the requirements for processing Medicare and Medicaid claims, in addition to commercial claims (the Company currently has the ability to manage commercial claims in all 50 states). Thus, before the Company begins managing claims in a new state, the complex and varied requirements of Medicare and Medicaid fiscal intermediaries must be obtained, translated, programmed and approved in a process similar to that of software maintenance. Once claims management has begun, the software will require continuous updating (see \"Software Maintenance\" above).\nPATENTS, TRADEMARKS AND COPYRIGHTS\nThe Company has obtained or has applied for all such copyright, trademark and product and service tradename protection as it deems appropriate for its software, documentation and product and service tradenames. The Company also relies upon secrecy and non-disclosure agreements with its employees and consultants and upon provisions of trade secret and unfair competition laws to protect its proprietary interests.\nThe Company has no patents or patent applications pending and does not currently intend to seek such patent protection. All currently available software underlying the Company's EDI Services are only usable by its own clients. The Company's claims editing and transmission software must be constantly maintained due to changing requirements of the insurance carriers and other payers and cannot be used independent of the Company's host computer system located in Tulsa, Oklahoma.\nSEASONAL EFFECTS\nThere are no material seasonal effects on the business of the Company.\nCOMPETITIVE CONDITIONS\nHealthcare reimbursement management has emerged within the last 10 years as an industry comprised mainly of smaller, privately-owned firms. These firms are primarily regional or local and, because of their smaller size, tend to specialize in only one or two areas of reimbursement management (such as claims processing, follow-up and collections or charge recovery). There are larger firms, such as Blue Cross\/Blue Shield (\"BCBS\"), which have developed electronic claims processing programs, but are limited to processing BCBS claims generally and Medicaid claims only in those states where BCBS is the fiscal intermediary. There are other electronic claims clearinghouses that have the ability to, and in some instances do, compete with the Company for claims processing at competitive rates. Some hospitals have attempted to develop claims processing capabilities, with limited success.\nThe Company is aware of approximately twelve firms which claim to be \"all-payer\" in their claims processing capabilities. Based upon contacts with representatives of health insurance companies, trade publications and associations, the Health Care Financing Administration and its client base, the Company believes that of these twelve firms, the Company is the only firm whose reimbursement management services include electronic payer specific editing; a large number of insurance carriers accepting electronic claims; installation, training and support services; and the ability to offer comprehensive on-site reimbursement management services. In addition, the Company is developing and presently offers healthcare providers a variety of technology-based, electronic reimbursement management services that are unavailable from any other single source.\nEven though barriers to entry are currently believed to be high due to the time and expense related to system development and maintenance, there can be no assurance that well-capitalized competitors, potentially including affiliates of health insurance companies themselves, will not develop claims management and related services which are directly competitive with, or even superior to, those of the Company. In addition, the industry trend towards transmission and format standards could reduce these barriers to entry.\nThe Company is aware of approximately eight national or regional firms, all of which are privately owned, which offer Reimbursement Services. The Company also competes in any given geographic location with any number of local providers of such services. Some hospitals also perform charge recovery and audit services in-house. Although the Company is not aware of any charge recovery and audit firm which competes with the Company on a national level or offers the Company's variety of reimbursement management programs, competition by local and regional firms is often intense.\nAdditionally, the current administration in Washington, D.C., as well as various governmental agencies, continue to discuss healthcare reform, which will likely include mandatory electronic processing of all healthcare transactions. The Company continues to stay informed of decisions being made on a national level, but is unable to predict the effect on its competitive environment at this time.\nEMPLOYEES\nAs of March 30, 1995, the Company had 411 full-time, 30 part-time and 4 temporary employees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate offices are comprised of 43,424 square feet in a high- rise office building in Tulsa, Oklahoma. The Tulsa offices are leased for a period ending July 31, 1999.\nThe Company's Reimbursement Services Division leases office space in Palm Springs, California (see \"Item 13. Certain Relationships and Related Transactions\").\nThe Company also leases office space in Albany, New York; Atlanta, Georgia; Chicago, Illinois; Dallas, Texas; Los Angeles, California; North Bergen, New Jersey; Orlando, Florida; Philadelphia, Pennsylvania and San Francisco, California.\nThe Company considers that its properties are generally suitable and adequate for its current needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs of March 30, 1995, there were no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of its property is subject.\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 the fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nIncorporated by reference herein from page 34 of the Company's 1994 Annual Report to Shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated by reference herein from page 16 of the Company's 1994 Annual Report to Shareholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS\nIncorporated by reference herein from pages 17 and 18 of the Company's 1994 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated by reference herein from pages 19 through 32 of the Company's 1994 Annual Report to Shareholders.\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\nIncorporated by reference herein from pages 3, 11, 12 and 21 of the Company's Proxy Statement dated March 27, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference herein from pages 13 through 18 of the Company's Proxy Statement dated March 27, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference herein from page 2 of the Company's Proxy Statement dated March 27, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference herein from page 20 of the Company's Proxy Statement dated March 27, 1995.\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 financial statements contained in the Company's 1994 Annual Report to Shareholders are incorporated in other parts of this Report by reference:\nAll other schedules have been omitted since they are not required, are not applicable, or because the information required is included in the financial statement and notes thereto.\n3. EXHIBITS --------\n* Incorporated herein by reference\n(b) REPORTS ON FORM 8-K\nDuring the fourth quarter of 1994, specifically on November 17, 1994, one Report on Form 8-K was filed reporting the acquisition of AMSC, 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.\nC.I.S. TECHNOLOGIES, INC.\nDate: April 14, 1995 By \/s\/ Philip D. Kurtz -------------------- ------------------------------------- PHILIP D. KURTZ, Chief Executive Officer (Principal Executive Officer)\nDate: April 14, 1995 By \/s\/ Richard A. Evans ------------------- ------------------------------------- RICHARD A. EVANS, Treasurer and Chief Financial Officer (Principal Financial Officer and 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.\nDate: April 14, 1995 By \/s\/ James L. Hersma ------------------- ------------------------------------- JAMES L. HERSMA, Director\nDate: April 14, 1995 By \/s\/ Philip D. Kurtz ------------------- ------------------------------------- PHILIP D. KURTZ, Director\nDate: April 14, 1995 By \/s\/ Nathan H. Peck, Jr. ------------------- ------------------------------------- NATHAN H. PECK, JR., Director\nDate: April 14, 1995 By \/s\/ John D. Platt ------------------- ------------------------------------- JOHN D. PLATT, Director\nDate: April 14, 1995 By \/s\/ Dennis D. Pointer ------------------- ------------------------------------- DENNIS D. POINTER, Director\nDate: April 14, 1995 By \/s\/ Robert J. Simmons ------------------- ----------------------------------- ROBERT J. SIMMONS, Director\nDate: April 14, 1995 By \/s\/ N. Thomas Suitt ------------------- ----------------------------------- N. THOMAS SUITT, Director\nREPORT OF INDEPENDENT ACCOUNTANTS\nOur report on the consolidated financial statements of C.I.S. Technologies, Inc. and Subsidiaries has been incorporated by reference in this Form 10-K from page 19 of the 1994 Annual Report to Shareholders of C.I.S. Technologies, Inc. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 11 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nTulsa, Oklahoma February 7, 1995\nR-1\nC.I.S. TECHNOLOGIES, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFor the Years Ended December 31, 1994, 1993 and 1992\n* Represents initial valuation allowance recorded at date of adoption of Statement of Financial Accounting Standards No. 109.\nS-1","section_15":""}
{"filename":"822426_1994.txt","cik":"822426","year":"1994","section_1":"ITEM 1. BUSINESS -----------------\nPIMCO Advisors L.P. (the \"Partnership\" or \"PA\"), formerly known as Thomson Advisory Group L.P., is one of the nation's largest publicly traded investment management firms, with as of December 31, 1994, approximately $72.2 billion of assets under management. The Partnership offers a broad range of investment management services and styles to institutional and retail investors, combining the substantial fixed income-oriented institutional investment management operations of Pacific Investment Management Company and four smaller affiliated domestic and international equity investment management firms with the equity-oriented investment management and retail mutual fund operations of Thomson Advisory Group L.P., including the operations of its former Columbus Circle Investors division. The Partnership provides investment management services (i) to large institutional clients through separate accounts, (ii) to medium and smaller-sized institutional clients through the PIMCO Advisors Institutional Funds (formerly known as the PFAMCo Funds) and the PIMCO Funds and (iii) to retail investors through the PIMCO Advisors Funds (formerly known as the Thomson Fund Group), which are sold principally through the broker-dealer community.\nThe Partnership's strategy is to pursue growth by capitalizing on the investment management expertise, performance record and reputation of its six institutional investment management firms (the \"Investment Management Firms\") by (i) continuing to provide quality investment performance and service to institutional clients through separate account and pooled fund management of assets, (ii) offering an expanded family of retail mutual funds utilizing the proprietary portfolio management techniques developed for the Partnership's institutional clients by the Investment Management Firms and (iii) marketing its family of institutional mutual funds to the defined contribution pension market, principally 401(k) plans. The Investment Management Firms are five Delaware partnerships: Pacific Investment Management Company (\"PIMCO\"), Columbus Circle Investors (\"CCI\"), Cadence Capital Management (\"Cadence\"), NFJ Investment Group (\"NFJ\") and Parametric Portfolio Associates (\"Parametric\"); and one United Kingdom limited partnership, Blairlogie Capital Management (\"Blairlogie\").\nThe Partnership's six Investment Management Firms are structured as separate and largely autonomous subpartnerships. The Partnership believes this decentralized structure enables the Investment Management Firms to implement their own distinct investment strategies and philosophies, providing financial and other incentives for the managers of each of the firms to render superior performance and client service. The Managing Directors of the Investment Management Firms have a significant profits interest in their respective Investment Management Firms, as well as substantial economic interests in the Partnership. These economic interests relate primarily to Class B Units, distributions on which currently are subordinated to the annual $1.88 per Unit priority distribution on the Class A Units as described below.\nRECENT EVENTS -------------\nThe scope of the Partnership's business and the ownership of the Partnership changed significantly in 1994 as a result of the consolidation (the \"Consolidation\") of the business of Thomson Advisory Group L.P. with certain of the investment advisory businesses of Pacific Financial Asset Management Corporation (\"PFAMCo\"), an indirect subsidiary of Pacific Mutual Life Insurance Company (\"Pacific Mutual\"), in November 1994 and a concurrent public offering (the \"Offering\").\nPrior to the Consolidation, the Partnership conducted its investment advisory business under the name of Thomson Advisory Group L.P. and its affiliate, Thomson Investor Services Inc., now named PIMCO Advisors Distribution Company (\"PADCo\" or the \"Distributor\"), served as the distributor for the Partnership's mutual funds. On November 15, 1994, these businesses were combined with the investment management and related businesses of PFAMCo. Subsequent to the Consolidation, PIMCO Partners, G.P., a newly-organized California general partnership (\"PIMCO GP\"), was admitted as the general partner of the Partnership and the prior general partner, Thomson Advisory Group Inc. (\"TAG Inc.\") withdrew. PIMCO GP has two general partners: (i) PIMCO Partners, LLC (\"PPLLC\"), a newly-formed California limited liability company, all of the interests of which are held directly by the Managing Directors of PIMCO and (ii) Pacific Investment Management Company, a California corporation (\"PIMCO Inc.\"), an indirect wholly owned subsidiary of Pacific Mutual. In connection with the Consolidation:\n. the Partnership declared a 106% Unit distribution effective October 9, 1994, payable to holders of its then outstanding limited and general partner Units;\n. the Partnership adopted the Amended and Restated Partnership Agreement (the \"Partnership Agreement\") providing, among other things, for (i) the establishment of two classes of limited partner interest, Class A Units and Class B Units, (ii) the reclassification of 8,798,764 outstanding limited partner units held by public Unitholders as Class A Units, (iii) the conversion of the 412,000 General Partner Units (\"GP Units\") and 11,389,180 LP Units held by TAG Inc. prior to the Consolidation into 800,000 GP Units, 5,100,590 Class A Units and 8,260,826 Class B Units, (iv) a new management structure vesting Partnership management authority in the Operating Board, its Operating Committee and the Equity Board and (v) the grant of discretionary powers to the general partner to restructure (the \"Restructuring\") the Partnership in anticipation of taxation of the Partnership as a corporation, expected to occur no later than January 1, 1998;\n. PIMCO Inc. (through PIMCO GP) transferred the PIMCO investment advisory business to the Partnership, and PIMCO Inc. and PPLLC contributed cash in the amount necessary for such assets to meet a minimum net worth requirement, in exchange for the issuance to PIMCO GP and its partners, PIMCO Inc. and PPLLC, of an aggregate of 21,875,000 Class A Units and 21,875,000 Class B Units.\n. PFAMCo contributed its businesses and the businesses of Cadence, Parametric, NFJ and Blairlogie to the Partnership in exchange for the issuance to PFAMCo, certain of its subsidiaries and certain newly formed limited partnerships owned by those subsidiaries and the Managing Directors of Cadence, NFJ and Parametric of an aggregate of 2,700,000 Class A Units and 2,700,000 Class B Units;\n. 5,297,000 options to purchase Class B Units were issued pursuant to the 1994 Option Plan as hereinafter described, and amendments were made to existing options for 2,442,130 Class A Units granted under the Partnership's 1993 Option Plan;\n. PIMCO GP borrowed approximately $130 million, approximately $119.3 million of which was loaned and contributed by PIMCO GP to TAG Inc., primarily to finance TAG Inc.'s purchase of approximately 61% of its outstanding common stock for approximately $116.3 million, and approximately $8.7 million of which was used by PIMCO GP to purchase approximately 5% of TAG Inc.'s outstanding common stock;\n. TAG Inc. transferred the ownership of PADCo to the Partnership in exchange for 218,801 Class A Units of limited partner interest; and\n. concurrently with such stock purchases, the remaining 34% of the outstanding common stock of TAG Inc. was exchanged by its holders for an aggregate of 2,028,386 shares of non-voting Series A Preferred Stock of TAG Inc. and 2,839,742 shares of Series B Preferred Stock of TAG Inc. Until the earlier of December 31, 1997 or a Restructuring, the holders of the Series B Preferred Stock are entitled to one vote per share and vote as a single class with the holders of the outstanding shares of common stock of TAG Inc. (approximately 2,145 shares) on all matters, including the election of directors, except amendments to the charter which would adversely affect the Series B Preferred Stock. As a result of the voting rights of the Series B Preferred Stock, PIMCO GP will not have control over TAG Inc. until the earlier of December 31, 1997 or a Restructuring, when the Series B Preferred Stock will become non-voting (except under limited circumstances).\nSubsequent to the Consolidation, when PIMCO GP was admitted as general partner of the Partnership and TAG Inc. withdrew as general partner, the 800,000 of the Class A Units held by PIMCO GP were reclassified as GP Units and the 800,000 GP Units held by TAG Inc. were reclassified as Class A Units.\nIn the Offering in November 1994, the Partnership sold 1,200,000 Class A Units and certain selling Unitholders sold an aggregate of 3,400,000 Class A Units. At the closing of the Offering, the holders of approximately 1.17 million shares of Series A Preferred Stock of TAG Inc. exchanged those shares with PIMCO Inc. pursuant to a contractual exchange arrangement for approximately 1.09 million Class A Units, which were included among the Class A Units sold by selling Unitholders in the Offering.\nGENERAL -------\nThe table below sets forth the assets under management of the Partnership and its six Investment Management Firms at the dates indicated:\n1 Includes assets under management not advised or subadvised by the Investment Management Firms.\n2 Includes assets invested in Cash Accumulation Trust (a money market fund) under a contractual relationship which expired September 30, 1994. In November 1994, Columbus Circle Investors was appointed as the subadvisor for Cash Accumulation Trust.\nThe revenues of the Partnership and its six Investment Management Firms consist principally of management fees based on the value of assets under management and in some cases the performance of the advisor. The table below sets forth management fees for the Partnership and its six Investment Management Firms for the periods indicated:\n1 Includes revenues not directly allocable to the investment management services of the Investment Management Firms, the management fees of the Cash Accumulation Trust and intercompany eliminations.\nGRAPHICS APPENDIX LIST\n-------------------------------------------------------------------------------- PAGE WHERE DESCRIPTION OF GRAPHIC OR CROSS-REFERENCE GRAPHIC APPEARS -------------------------------------------------------------------------------- 7 On this page is a chart which illustrates the structure of the -------------------------------------------------------------------------------- Partnership and its Investment Management Firms and mutual -------------------------------------------------------------------------------- funds. In the center of the chart is a box for PIMCO Advisors -------------------------------------------------------------------------------- L.P. (formerly Thomson Advisory Group L.P.) Connected to the top -------------------------------------------------------------------------------- of such box are three additional boxes representing the owners -------------------------------------------------------------------------------- of PIMCO Advisors L.P.: the public, PIMCO G.P. (the general -------------------------------------------------------------------------------- partner) and the non-public partners. To the left of the PIMCO -------------------------------------------------------------------------------- Advisors L.P. box attached by a broken line is a box for PIMCO -------------------------------------------------------------------------------- Advisors Institutional Funds (formerly PFAMCo Funds)- -------------------------------------------------------------------------------- institutional funds managed by the firms listed below. To the -------------------------------------------------------------------------------- right of the PIMCO Advisors L.P. box, attached by a broken line, -------------------------------------------------------------------------------- is a box for PIMCO Advisors Funds (formerly Thomson Funds), -------------------------------------------------------------------------------- retail funds managed by the firms listed below. Connected to the -------------------------------------------------------------------------------- bottom of the PIMCO Advisors L.P. box are seven additional -------------------------------------------------------------------------------- boxes; one each for PIMCO Advisors Distribution Company -------------------------------------------------------------------------------- (formerly Thomson Investor Services Inc.), mutual fund -------------------------------------------------------------------------------- distributor for Funds; Pacific Investment Management Company, -------------------------------------------------------------------------------- Newport Beach, CA-primarily Fixed Income; Columbus Circle -------------------------------------------------------------------------------- Investors, Stamford, CT, Equity - momentum surprise; Parametric -------------------------------------------------------------------------------- Portfolio Associates; Seattle, Washington, Equity - -------------------------------------------------------------------------------- Quantitative; Cadence Capital Management, Boston, MA, Equity - -------------------------------------------------------------------------------- Growth; NFJ Investment Group, Dallas, TX, Equity - Value; and -------------------------------------------------------------------------------- Blairlogie Capital Management, Edinburgh, Scotland, Equity - -------------------------------------------------------------------------------- International. Finally, connected by a broken line to the bottom -------------------------------------------------------------------------------- of the Pacific Investment Management Company box is a box for -------------------------------------------------------------------------------- PIMCO Funds, fixed income institutional funds managed by Pacific -------------------------------------------------------------------------------- Investment Management Company. --------------------------------------------------------------------------------\nGRAPHIC REQUIREMENTS FOR EDGAR FILINGS\nIf a submission contains graphic material that cannot be reproduced electronically, the filer must provide a complete fair and accurate description of the omitted graphic in Appendix List at the end of the document. If a description of the graphic appears in the text surrounding it, the filer need only cross-reference the graphic in the Appendix List. It is necessary to describe corporate logos, differences in pagination, color, or type size and style.\nRR DONNELLEY DISCLAIMER\nBecause our clients receive comments back from the SEC about graphic material contained in their documents. RR Donnelley cannot write the descriptions of omitted graphic materials at the risk of being held liable.\nA principal component of the Partnership's marketing strategy is the historical performance of its investment management activities relative to selected benchmarks over long periods of time. For example, PIMCO stresses its record in equaling or exceeding client-selected performance benchmarks over a long period through a measured risk taking approach that emphasizes preservation of capital. Over the last 10 years, PIMCO's Total Return composite (of full discretion accounts), representing approximately 56% of PIMCO's total assets under management at December 31, 1994, outperformed the Lehman Brothers Aggregate Bond Index by approximately 120 basis points (11.2% compared to 10.0%) annually on a compound basis after adjusting for the fees paid to PIMCO. Similarly, CCI uses in its marketing the record of the PIMCO Advisors Growth Fund, which has been the twentieth ranked growth stock mutual fund within a universe of 132 such funds over the last ten years by Lipper Analytical Services, Inc., and the PIMCO Advisors Opportunity Fund, which has been the first ranked growth fund within a universe of 46 such funds over the last ten years by the same source.\nPRIMARY MARKETS AND STRATEGY FOR GROWTH\nThe two primary markets for the investment management services offered by the Partnership's Investment Management Firms are the institutional market and the retail mutual fund market. Several of the Investment Management Firms also accept individually managed private accounts over a certain threshold size for high net worth individuals.\nINSTITUTIONS. The institutional market for investment management services includes corporate, government and labor union pension plans, charitable endowments and foundations, and corporations purchasing investment management services for their own account. Each of the Investment Management Firms serves the institutional market and conducts its own institutional marketing activities through client service representatives as well as through direct marketing contact by investment principals. In general, the Investment Management Firms' marketing approach targets Fortune 1,000 companies and other large institutional investors primarily through independent consultants who analyze the performance of investment advisors. The Investment Management Firms seek to develop client relationships through investment management performance and focused and responsive client service. Their business strategies also involve increasing assets under management for non-U.S. clients, expanding the array of fixed income and equity products offered to clients, seeking to expand market share with medium and smaller institutional investors by offering pooled investment vehicles such as the PIMCO Funds and the PIMCO Advisors Institutional Funds, and otherwise seeking to diversify and expand their businesses by asset class, method of delivery and markets.\nThe Partnership's business strategy divides the institutional market into two primary segments: defined benefit pension plan accounts and defined contribution pension plan accounts.\nDefined Benefit. The defined benefit market is composed primarily of corporate, government and labor union pension plans. The defined benefit market has grown substantially in recent years.\nThe Partnership serves the defined benefit market primarily through separate accounts and its institutional mutual funds. The PIMCO Funds and the PIMCO Advisors Institutional Funds provide medium and smaller sized institutional investors in this market access to the Investment Management Firms' expertise.\nDefined Contribution. The defined contribution market has also grown rapidly in recent years, primarily as a result of 401(k) plans. According to Bernstein Research's The Future of Money Management in America 1994 Edition, defined contribution plans now constitute a larger market than defined benefit plans in terms of the number of plan participants, with approximately 12 million people becoming defined contribution plan participants since 1983.\nThe Partnership believes that the combination of Investment Management Firms resulting from the Consolidation provides a potentially significant source of growth for the Partnership in providing services to the defined contribution plan market. The Partnership offers the PIMCO Advisors Institutional Funds, which allow 401(k) plan sponsors and institutional investors to choose from a broad array of equity and fixed income investment funds managed by one or more of the Partnership's six Investment Management Firms. In addition, the Partnership plans to \"bundle\" its investment services with a full range of plan administrative and supplementary services offered by third parties, including record keeping capabilities and relationships with custodians, thereby offering plan sponsors a fully integrated product.\nOther. The Partnership also serves other institutional investors, consisting primarily of endowments and foundations.\nRETAIL MUTUAL FUNDS. Like the institutional market for investment management services, the mutual fund market has expanded rapidly in recent years.\nThe mutual fund industry is highly competitive and is characterized by a high degree of fragmentation and a large and rapidly increasing number of product offerings. The mutual fund industry has become a consumer product business where marketing strategies, product development, business development, sales expertise and servicing are increasingly important. The traditional channel for the distribution of mutual funds (other than money market funds) is through brokerage firms that are not affiliated with the funds' sponsor organization and that are compensated primarily through front-end sales loads deducted from the purchaser's investment at the time of the sale. More recently, a number of other distribution arrangements and channels have become important. These include \"no-load\" or \"low-load\" funds, sold primarily through direct marketing efforts or captive sales forces affiliated with the sponsor organization; \"private label\" and \"proprietary\" funds managed by and offered primarily through, or to customers of, a financial organization such as a brokerage firm, insurance company or bank; and \"back-end load\" or \"level load\" funds offered through brokerage and other third-party channels, but with compensation to the selling brokers being funded through commission advances from the funds' sponsor which are recovered through ongoing charges against fund assets assessed under Rule 12b-1 under the Investment Company Act, contingent deferred sales charges assessed against shareholders at the time they redeem their investments, or a combination of such sources.\nThe Partnership's retail strategy centers on the PIMCO Advisors Funds, a family of 13 predominantly equity-based retail mutual funds. The addition of PIMCO and four other Investment Management Firms in the Consolidation is expected to enable the Partnership to develop new products to offer to the retail investor. In particular, the Partnership's new fixed income expertise provides the opportunity to expand the breadth of its mutual funds beyond their recent historical emphasis on equities. In addition, the Partnership sells the PIMCO Funds through aggregators such as Charles S. Schwab and Jack White to retail clients.\nThe Partnership's strategy is to build a \"brand name\" awareness of the fund group both at the broker-dealer level and the retail investor level, creating a valuable, long-term franchise. Leveraging off the depth and expertise of the six Investment Management Firms, the Partnership is currently developing new funds to fill gaps in its product line in terms of investment objectives and styles. After the Consolidation, PIMCO Advisors Funds commenced offering two new funds: (i) total return fixed income managed by PIMCO and (ii) innovation\/technology equity managed by CCI. Possible new PIMCO Advisors Fund offerings also under consideration include funds based on (i) value equity managed by NFJ, (ii) global fixed income managed by PIMCO, (iii) emerging markets equity managed by Blairlogie and (iv) \"growth at a reasonable price\" (GARP) equity managed by Cadence. In addition, through its increased capabilities, the Partnership also intends to upgrade its 401(k) products for smaller plans, offer a family of variable annuity products, and ultimately develop a series of \"lifestyle portfolios\" that would invest in a combination of existing PIMCO Advisors Funds.\nThe Partnership currently distributes its retail mutual funds on a \"front-end\" and \"level load\" basis. The Partnership is considering the introduction of \"back-end load\" shares for the PIMCO Advisors Funds and is contemplating a variety of financing opportunities in connection therewith.\nINVESTMENT MANAGEMENT FIRMS\nPACIFIC INVESTMENT MANAGEMENT COMPANY (PIMCO)\nGeneral. Pacific Investment Management Company had aggregate assets under management at December 31, 1994 and December 31, 1993 of $56.9 billion and $53.0 billion, respectively, of which 91.7% and 91.8%, respectively, consisted of fixed income accounts and 8.3% and 8.2%, respectively, consisted of equity- related accounts. PIMCO's clients principally include large and medium-sized corporate pension and profit sharing plans, public pension plans, multi-employer (Taft-Hartley) pension plans and foundations and endowment funds. Its client list includes many of the nation's largest pension funds, foundations and endowments and other institutional investors; in this regard, an independent survey recently indicated that 28% of the nation's 200 largest pension funds are PIMCO clients.\nInvestment Strategy. PIMCO believes that its strength in the management of fixed income assets is derived from its investment philosophy, which stresses active management, measured risk-taking and the application of strong analytical capabilities across all fixed income market sectors. Under PIMCO's investment philosophy, longer term macro-economic trends (rather than short-term market movements) determine portfolio strategy and moderate portfolio duration ranges are favored to reduce volatility in return relative to client- specified benchmarks. PIMCO's investment strategy process begins with a \"top- down\" approach utilizing an intensive review of long-term and cyclical trends to anticipate interest rates, volatility, yield curve shape and credit trends. These forecasts become the basis for the major portfolio strategies. PIMCO then uses a \"bottom up\" process to select specific portfolio investments.\nIn managing fixed income investment advisory accounts, PIMCO uses investment grade and below-investment grade securities, as well as derivatives (which use dates back to 1980) in seeking to manage portfolio risk and exploit market inefficiencies. PIMCO's use of derivatives has generally been confined to futures, options and mainstream mortgage derivatives (such as collateralized mortgage obligations, or CMOs); however, PIMCO at times has also held positions in client portfolios in interest-only and principal-only strips (IOs and POs) and, in special situations, structured notes and swaps. Although certain of these derivative securities can have higher degrees of interest rate risk, illiquidity and counterparty credit risk, PIMCO approaches derivatives much as it does other complex fixed income instruments-as potential investments to be analyzed, monitored and used when appropriate to enhance a portfolio's return or manage its risk. PIMCO has developed and employs, in the case of derivatives as well as other securities, various risk controls at the portfolio and individual security levels in an effort to evaluate and monitor interest rate, liquidity and credit quality risk. PIMCO believes its use of derivatives has contributed positively to portfolio returns and PIMCO has not suffered any material claims or made any material payments to clients related to its use of derivatives.\nPIMCO relies on internally developed, proprietary computer software programs in managing its clients' assets rather than using analytical models purchased from outside sources. PIMCO believes that its proprietary computer technology provides it with an important competitive advantage.\nPIMCO has sought to expand its client base beyond the traditional defined benefit pension market, and has increased its presence in the defined contribution pension market with $3.3 billion of such assets under management at December 31, 1994. PIMCO's strategy also involves focusing on \"aggregators\" of retail assets such as unaffiliated sponsors of mutual funds and other registered investment advisors (including fee-based financial planners) who recommend the use of \"no-load\" mutual funds such as the PIMCO Funds to their clients. In addition, PIMCO seeks to increase both institutional and retail assets under management for non-U.S. investors, for which it does not currently have a well- established presence.\nInvestment Products. PIMCO offers a range of investment services for both fixed income and equity assets.\nFixed Income Portfolios. PIMCO offers a variety of strategies for ----------------------- clients with fixed income portfolios, with the adoption of a particular strategy reflecting the particular client's investment objective.\n. Total Return Portfolios--PIMCO structures total return portfolios with the objective of realizing maximum total return, consistent with the preservation of capital and prudent investment management across the spectrum of fixed income securities. This strategy generally results in a portfolio duration of three to six years. The total return strategy is PIMCO's flagship investment management service; portfolios utilizing this strategy represented approximately 60% of PIMCO's total assets under management at December 31, 1994.\n. Low Duration Portfolios--PIMCO has actively managed low duration accounts since 1979. The objectives in the low duration portfolios are to preserve principal through investment in low- volatility instruments, while seeking to achieve superior risk- adjusted returns.\n. Other Duration Specific or Sector Specific Portfolios-PIMCO also offers clients active management of portfolios based upon specific duration targets (e.g., long duration portfolios or Guaranteed Investment Contract alternative products which are designed to mimic Guaranteed Investment Contracts) or sector emphases (e.g., international, high-yield, or mortgages).\nEquity Portfolios. PIMCO offers two equity strategies, StocksPLUS(R) ----------------- and a growth style portfolio. StocksPLUS(R) represents a proprietary technique developed by PIMCO that combines the active management of stock index futures (to provide a proxy for equity market returns) with active management of a short-term fixed income portfolio using much of the same technology as is used by PIMCO in its fixed income portfolios. PIMCO's growth style equity strategy utilizes quantitative and fundamental equity analysis to identify stocks that it believes to have above-average market appreciation potential over a full market cycle.\nPIMCO Funds. Founded in 1987, the PIMCO Funds, a series of no-load ----------- mutual funds (with a minimum investment of $1 million), enable medium and smaller U.S. institutional investors and high net worth individuals who do not satisfy PIMCO's minimum investment requirement for separate account management services ($75 million at December 31, 1994) to obtain PIMCO's investment management services on a commingled basis. The PIMCO Funds are also sold to retail clients through \"aggregators.\" The PIMCO Funds include 12 separate funded portfolios, principally in the fixed income area. PIMCO's investment strategies in managing these portfolios in large measure reflect the investment strategies used by PIMCO for its separately managed accounts. At December 31, 1994, the PIMCO Funds had $9.9 billion of assets under management (excluding separate account assets invested in PIMCO Funds portfolios), with $6.7 billion invested in total return portfolios, $2.4 billion in low duration portfolios, $365 million in foreign portfolios and $528 million in other strategies.\nInternational and Other Portfolios. PIMCO, as investment advisor to a ---------------------------------- series of offshore funds, provides fixed income investment advice to non-U.S. investors. Assets under management for these funds totaled $132.6 million and $145.7 million at December 31, 1994 and December 31, 1993, respectively. PIMCO also serves as subadvisor for a series of trusts investing in mortgage related securities that are marketed to Japanese investors. These trusts had assets of $2.3 billion and $2.1 billion at December 31, 1994 and December 31, 1993, respectively. PIMCO also serves as subadvisor for nine families of U.S. mutual funds sponsored by other mutual fund complexes. Total assets under management for these nonaffiliated funds at December 31, 1994 and December 31, 1993 were $1.2 billion and $967 million, respectively.\nSet forth below is a table showing PIMCO's assets under management and number of portfolios by investment strategy at the dates indicated:\n(1) Includes the managed assets of the PIMCO Funds.\nPerformance Based Fees. PIMCO's fee schedules are typically computed as a percentage of assets under management. PIMCO's StocksPLUS(R) product, which accounted for $4.6 billion of assets under management at December 31, 1994, generally is subject to a performance-based fee schedule in which under- performance relative to the S&P 500 index over a particular time period results in no fees being paid by clients and superior performance results in incentive fees that are not subject to a cap. The StocksPLUS(R) fee arrangement can materially affect PIMCO's total revenues from period to period.\nIn addition to the StocksPLUS(R) accounts, several large fixed income accounts also have performance-based fee arrangements. For these accounts, PIMCO must outperform a specified fixed income benchmark over a particular time period in order to receive a performance-based fee, but generally is entitled to a base fee determined with reference to the value of assets under management. Such arrangements can significantly affect PIMCO's revenues, but also provide an opportunity to earn higher fees than could be obtained under fee arrangements based solely on a percentage of assets under management.\nEmployees. PIMCO's ten Managing Directors have an average of 19 years of industry experience. Of the ten Managing Directors, three (William H. Gross, William F. Podlich, III and James F. Muzzy) have been associated with PIMCO since its founding and the other seven have been with PIMCO for an average of nine years. At December 31, 1994, the firm-wide staff of 232 included 35 investment professionals, of whom 12 are Chartered Financial Analysts. PIMCO's portfolio managers, including the fixed income staff (14 professionals) and equity staff (three professionals), are responsible for research and trading. Account managers (18 professionals) are primarily responsible for client relationship management and\/or marketing.\nCOLUMBUS CIRCLE INVESTORS (CCI)\nGeneral. CCI, based in Stamford, Connecticut and established in 1975, manages discretionary accounts for entities such as corporate, government and union pension and profit sharing plans, foundations and educational institutions, as well as accounts for \"high net worth\" individuals. In addition, CCI has a private collective investment program for accredited investors. The assets under management and revenues of CCI have increased significantly in recent years. As of December 31, 1994, assets under management by CCI, exclusive of the approximately $3.5 billion of assets of the PIMCO Advisors Funds and the Cash Accumulation Trust under CCI management, were approximately $6.8 billion for 158 clients.\nCCI's principal equity product consists of its \"core\" portfolios, which accounted for approximately $6.8 billion (or 66%) of its assets under management at December 31, 1994. CCI uses its \"positive momentum & positive surprise\" style for these portfolios, which principally consist of \"large cap\" U.S. equity securities. CCI also applies its \"positive momentum & positive surprise\" style to manage \"small cap\" portfolios aggregating approximately $1.4 billion (or 14%) of its assets under management at December 31, 1994; \"mid cap\" portfolios aggregating approximately $853 million (or 8%) of its assets under management at December 31, 1994; and \"equity income\" portfolios aggregating approximately $185 million (or 2%) of its assets under management at December 31, 1994. CCI also manages relatively small fixed income, balanced and specialized equity portfolios.\nInvestment Strategy. CCI's investment strategy has remained essentially unchanged since 1975. CCI's investment philosophy is based on the premise that companies producing results which exceed the expectations of investors and Wall Street equity research analysts will have rising stock prices, while companies with disappointing results will experience stock price decline. CCI's investment discipline focuses on the potential for \"positive momentum & positive surprise.\" CCI monitors numerous factors, including political and economic developments, secular trends and industry and group dynamics, in addition to company-specific events, to determine which companies are best-positioned to achieve revenue and earnings acceleration. In addition to meeting the criteria for potential \"positive momentum & positive surprise,\" thorough fundamental analysis is completed prior to making an investment decision. Depending upon market conditions, CCI seeks to enhance investment performance by writing \"covered\" call and stock index options on securities held in equity accounts.\nThe equity funds of the PIMCO Advisors Funds (plus the Tax Exempt Fund and the Money Market Fund) currently are managed by the same individuals who manage CCI's individual and institutional private accounts. Accordingly, the CCI investment philosophy and techniques described above are also applied to such equity and fixed income funds. CCI's policy is to accept only new accounts of $10 million or more (except in its accredited investors program).\nEmployees. Two of CCI's five Managing Directors, Irwin F. Smith and Donald A. Chiboucas, have been with CCI since its founding in 1975. Mr. Smith also served as Chairman of the Partnership from March 1993 until the Consolidation. At December 31, 1994, CCI had 66 employees, of whom 25 were investment professionals.\nCADENCE CAPITAL MANAGEMENT (CADENCE)\nGeneral. Cadence, based in Boston, Massachusetts and established in 1988, specializes in disciplined, growth-oriented management of equity securities. At December 31, 1994, Cadence had $1.8 billion of assets under management, managed separate account portfolios for 53 clients and subadvised four portfolios within the PIMCO Advisors Institutional Funds.\nInvestment Strategy. Cadence is a \"growth at a reasonable price\" equity manager. Cadence's philosophy is to participate in the long-term growth of the equity markets by constructing fully invested portfolios of stocks selling at reasonable valuations in relation to the fundamental prospects of the underlying companies. Cadence uses a disciplined, \"bottom-up\" investment process which utilizes quantitative screening for favorable fundamental and valuation attributes, followed by \"hands-on\" qualitative research to confirm the apparent business trends. Cadence structures its portfolios to be broadly based, typically including 80 to 100 issues.\nCadence's investment strategy involves the application of a proprietary investment management process to different universes of equity securities which are usually differentiated by market capitalization into four categories: large cap (the top 1,000 market cap issues), mid cap (market cap of over $500 million excluding the largest 200 issues), small cap ($50 million to $500 million) and micro cap (up to $100 million). Through this strategy, Cadence is able to differentiate its investment products while remaining focused on a single investment style.\nEmployees. The Managing Directors of Cadence include David B. Breed, a founder of the firm who serves on the Operating Board of the Partnership, and William Bannick, who joined Cadence in 1992. Mr. Breed is the Chief Executive Officer and Chief Investment Officer of Cadence and is responsible for the original development and ongoing maintenance of the investment process. Mr. Bannick is responsible for investment management and client service. Cadence had a total of 21 employees at December 31, 1994, including five portfolio managers in addition to Messrs. Breed and Bannick.\nPARAMETRIC PORTFOLIO ASSOCIATES (PARAMETRIC)\nGeneral. Parametric, based in Seattle, Washington and established in 1987, specializes in the use of highly quantitative techniques to manage U.S. and international equity portfolios for large U.S. corporate and public pension plans. Parametric's objective is to provide superior returns relative to a specified benchmark such as the S&P 500, the Russell 1000, EAFE or other customized indices. For pension plans, Parametric's strategy is to target those larger plans having passive index programs. In the mutual fund area, Parametric's strategy involves customizing its investment management product to a specified benchmark of the fund. Parametric focuses its institutional marketing efforts on pension consultants for large pension funds, which tend to be current users of index products. Parametric also seeks to develop client relationships with family trusts. At December 31, 1994, Parametric had assets under management of $1.5 billion, managed separate accounts for 18 clients and served as subadvisor for three PIMCO Advisors Institutional Funds and two unaffiliated families of funds.\nInvestment Strategy. Parametric structures its clients' portfolios to meet specific risk return objectives. Parametric believes that portfolios which track generally accepted performance benchmarks, such as the S&P 500, are not the most efficient portfolios because the benchmark simply represents the aggregate of current investor holdings. Parametric seeks to improve portfolio efficiency by changing the relative weightings of securities in its clients' portfolios relative to the selected benchmark, using rigorous and highly quantitative analysis of the historical return pattern of the selected benchmark and of securities within that benchmark.\nParametric uses a proprietary computer model to analyze the return pattern of the thousands of portfolios that can be constructed from securities in a given benchmark. In structuring its clients' portfolios, Parametric seeks to meet all of the following criteria simultaneously: higher returns than the benchmark in both favorable and unfavorable markets; total volatility no greater than that of the selected benchmark; and limited underperformance both in magnitude and in the number of underperforming periods. Parametric's typical U.S. benchmark-managed portfolios contain 200 to 225 stocks, while its international portfolios average 200 to 250 stocks.\nEmployees. At December 31, 1994, Parametric's staff included Mark England-Markun and William Cornelius as Managing Directors and 12 other employees.\nNFJ INVESTMENT GROUP (NFJ)\nGeneral. NFJ, based in Dallas, Texas and established in 1989, is a disciplined, value-oriented manager of equity securities. NFJ's specialty is investing in a combination of low P\/E stocks with high dividends selected through a proprietary screening model. NFJ's business strategy involves targeting the U.S. pension and mutual fund markets with specific attention to the pension consultants which dominate the pension market. NFJ believes that its value niche and conservative investment style is attractive to prospective clients because it naturally complements the styles of other growth or core equity managers. At December 31, 1994, NFJ had assets under management of $1.1 billion, managed separate account portfolios for 27 clients and also served as manager for three PIMCO Advisors Institutional Funds and four unaffiliated families of funds.\nInvestment Strategy. NFJ's investment philosophy is based on research showing that portfolios with a combination of low P\/E stocks and high dividends consistently outperform market indices. The low P\/E bias is based on the belief that \"out of favor\" stocks are not normally subjected to significant negative earnings surprises because their low P\/E ratios already incorporate the market's negative expectations. The high dividend component offers an \"income cushion\" to protect returns when market conditions are unfavorable. Another important concept is NFJ's belief that diversification across industries is an important criterion for adding value. To avoid portfolios heavily concentrated in particular industries, NFJ has divided its 2,000-stock universe into numerous industry groups and selects its 50-stock portfolios from that universe.\nNFJ has developed a structured process with a systematic buy\/sell discipline based on fundamental research and computer modeling. NFJ analyzes all buy candidates to verify the low multiple of all stocks, based on trailing operating earnings, positive forward earnings, and acceptable relative price momentum.\nEmployees. At December 31, 1994, NFJ had a staff of 11, including Managing Directors Christopher Najork, Ben Fischer and John Johnson. Prior to joining NFJ in January 1989, these three individuals worked as a group for over 15 years at NCNB Texas (successor organization to First Republic Bank), and as a group they have over 75 years of investment experience.\nBLAIRLOGIE CAPITAL MANAGEMENT (BLAIRLOGIE)\nGeneral. Blairlogie, based in Edinburgh, Scotland and founded in late 1992, specializes in international equity investments. Blairlogie provides an international investment product that combines the country selection strategies with the systematic application of an investment process more typically used by U.S. investment firms. Blairlogie focuses its marketing efforts in the U.S. and seeks to capitalize on increased demand for international investment products by U.S. pension funds and retail-oriented U.S. mutual funds. Blairlogie's future business strategy may also include the development of investment management relationships in the United Kingdom and other parts of Europe.\nBlairlogie is a newly organized firm and has operated at a loss since its inception. PFAMCo accordingly has agreed to reimburse Blairlogie for future operating losses, if any, through 1996, subject to 50% recoupment out of operating profits. At December 31, 1994, Blairlogie had approximately $500 million of assets under management including PIMCO Advisors International Fund, which had assets of approximately $280 million as of December 31, 1994.\nInvestment Strategy. Blairlogie's investment strategy involves the application of fundamental valuation criteria to country allocations and then to stock selection in order to enhance client returns over time, while seeking a relatively low level of overall portfolio risk. Blairlogie applies this strategy to all countries and stocks, regardless of whether they are developed or emerging or are large or small capitalization stocks. Blairlogie's investment process is a disciplined screening process that is based on active management at both the country selection and stock selection levels. Country allocation is generally the major single influence in Blairlogie's risk\/reward decision, both in its global and emerging market models.\nEmployees. At December 31, 1994, Blairlogie had a staff of 18, including Managing Directors and firm founders Gavin R. Dobson, James G.S. Smith and Robert Stephens, with 17, 13 and 21 years of investment experience, respectively.\nPARTNERSHIP MUTUAL FUNDS\nIn addition to the PIMCO Funds, which are offered and managed by PIMCO, the Partnership offers and manages two families of mutual funds, the PIMCO Advisors Funds for retail investors and the PIMCO Advisors Institutional Funds for institutional investors. The Partnership provides investment management and advisory services to these funds under investment advisory agreements with each of the funds.\nRetail Mutual Funds. The PIMCO Advisors Funds are a family of 13 retail mutual funds (two of which commenced operations in December 1994) sold to retail investors principally through the broker-dealer community. The Partnership determines the investment policy and manages and supervises the administrative affairs of each fund. An Investment Management Firm acts as subadvisor and manages the day-to-day investments of these funds, except for the Precious Metals Fund. In the case of the Precious Metals Fund, an independent party acts as subadvisor. The following table presents the net assets of the retail funds at the dates indicated (excluding the Money Market Fund):\n______ (1) Currently closed to new investors.\nMarketing and Distribution. Marketing and distribution activities of certain of PIMCO Advisors Funds is conducted by the Distributor, a wholly owned subsidiary of the Partnership. The Partnership uses the Distributor to distribute the PIMCO Advisors Funds through a large, diversified network of unaffiliated retail broker-dealers, including most leading full-service broker- dealers. Since October 1990, the Distributor has entered into selling agreements with over 700 broker-dealers and banks. The sales and marketing personnel develop and support sales and marketing strategies between the Partnership and the different retail broker-dealers. Additionally, the relationships fostered by this group allow the Distributor's wholesalers to have access to the branch offices and sales representatives of the retail broker-dealers.\nAs a captive sales, marketing and distribution company of the Partnership, the Distributor has in the past operated on essentially a break- even basis or at a loss. Revenues consist of payments made to it by the mutual funds as distribution, administrative and servicing fees pursuant to plans adopted under Rule 12b-1 under the Investment Company Act, contingent deferred sales charges (\"CDSCs\") or \"back-end loads,\" reimbursement of distribution expenses and net commissions on the sale of front-end load funds. The mutual fund distribution contracts and Rule 12b-1 plans must be renewed annually by the trustees of the mutual funds, including a majority of the trustees considered \"disinterested.\" The Distributor incurs expenses in marketing and promoting the PIMCO Advisors Funds, with the largest expense being the commissions which are paid to broker-dealers and their salesmen for the sale of the PIMCO Advisors Funds.\nInstitutional Mutual Funds. The PIMCO Advisors Institutional Funds are a series of 18 institutional mutual funds, each with its own investment objective and policies. The Partnership provides the administrative, advisory and certain marketing services to these funds and the Investment Management Firms act as subadvisor and manage the day-to-day investments of 16 of these funds. The PIMCO Advisors Institutional Funds are designed primarily to provide pension and profit sharing plans, employee benefit trusts, foundations and endowment funds, corporations, other institutions and high net worth individuals with access to the professional investment management services of the Investment Management Firms. Each is an \"open-end\" fund which continuously offers to sell and redeem its shares at prices based on the net asset value of the fund's portfolios. Shares of these Funds are offered in both an institutional class and an administrative class. At December 31, 1994, the PIMCO Advisors Institutional Funds collectively had approximately 465 shareholders and $1.2 billion of assets under management.\nThe following table sets forth the assets under management of the institutional mutual funds:\nREGULATION\nVirtually all aspects of the investment management business of the Partnership are subject to various federal and state laws and regulations. The Partnership and its Investment Management Firms are registered with the Securities and Exchange Commission (the \"Commission\") under the Investment Advisers Act of 1940, as amended (the \"Advisers Act\"), and are registered under applicable state securities laws. The Advisers Act imposes numerous obligations on registered investment advisors including fiduciary, recordkeeping, operational and disclosure obligations. Blairlogie is also a member of the Investment Management Regulatory Organization in the United Kingdom. PIMCO and Parametric are registered with the Commodity Futures Trading Commission as Commodity Trading Advisors and are members of the National Futures Association. PIMCO and its subsidiary are also registered as Commodity Pool Operators. The funds are registered with the Commission under the Investment Company Act of 1940, as amended, shares of these funds are registered with the Commission under the Securities Act of 1933, as amended, and the shares of each such fund are qualified for sale (or are exempt) under applicable state securities laws in all states in the United States and the District of Columbia in which shares are sold.\nThe Partnership and its Investment Management Firms are subject to the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"), and to regulations promulgated thereunder, insofar as they are \"fiduciaries\" under ERISA with respect to many of their clients.\nThe foregoing laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict any of the Investment Management Firms from conducting their business in the event that they fail to comply with such laws and regulations. Possible sanctions that may be imposed in the event of such noncompliance include the suspension of individual employees, limitations on the Investment Management Firm's business activities for specified periods of time, revocation of the Investment Management Firm's registration as an investment advisor, and other censures and fines. Changes in these laws or regulations could have a material adverse impact on the profitability and mode of operations of the Partnership and its Investment Management Firms.\nThe officers, directors and employees of the Partnership and its Investment Management Firms may from time to time own securities which are also owned by one or more of their clients. Each firm has internal policies with respect to individual investments and requires reports of securities transactions and restricts certain transactions so as to minimize possible conflicts of interest.\nThe Distributor is registered as a broker-dealer under the Securities Exchange Act of 1934, as amended, and is subject to regulation by the Commission, the National Association of Securities Dealers, Inc. and other federal and state agencies. As a registered broker-dealer, it is subject to the Commission's net capital rule and certain state securities laws designed to enforce minimum standards regarding the general financial condition and liquidity of a broker-dealer. Under certain circumstances, these rules limit the ability of the Distributor's parent to make withdrawals of capital and receive dividends from such broker-dealer. The securities industry is one of the most highly regulated in the United States, and failure to comply with related laws and regulations can result in the revocation of broker-dealer licenses, the imposition of censures or fines and the suspension or expulsion from the securities business of a firm, its officers or employees.\nCOMPETITION\nThe investment management business is highly competitive. The Partnership and its Investment Management Firms compete with a large number of other domestic and foreign investment management firms, commercial banks, insurance companies, broker-dealers and others, although as a practical matter the Investment Management Firms typically compete with other firms offering comparable investment services and having comparable performance records. Some of the financial services companies with which the firms compete have greater resources and assets under management and administration than the Partnership and the Investment Management Firms and offer a broader array of investment products and services.\nThe Partnership believes that the most important factors affecting its competition for clients are the range of products offered, the abilities, performance records and reputations of its investment managers, management fees and the development of new investment strategies and marketing, although the importance of these factors can vary depending on the type of investment management service involved. Client service is also an important competitive factor. The Partnership's ability to increase and retain client assets could be adversely affected if client accounts underperform the market or if key investment managers leave the firms. The ability of the Partnership and the Investment Management Firms to compete with other investment management firms is also dependent, in part, on the relative attractiveness of their investment philosophies and methods under prevailing market conditions. There are relatively few barriers to entry by new investment management firms in the institutional managed accounts business, which increases competitive pressure.\nSelection of advisors by institutional investors often is subject to a competitive review process relying heavily upon historical performance. As a result, new firms such as Blairlogie typically require a three to five year start-up period during which they experience losses and require subsidies.\nA large number of mutual funds are sold to the public by investment management firms, broker-dealers, insurance companies and banks in competition with mutual funds sponsored by the Partnership. Many competitors apply substantial resources to advertising and marketing their mutual funds which may adversely affect the ability of Partnership-sponsored funds to attract new clients and to retain assets under management. The ability to attract and retain mutual fund assets in the load mutual funds which the Partnership offers is dependent to a significant degree on the ability to attract, retain and motivate retail brokerage salespersons.\nPOSSIBLE CONSTRAINTS ON GROWTH AND OPERATIONS\nDistributions. Cash that is used to pay distributions on the Partnership's Class A Units, GP Units and Class B Units will not be available for other Partnership uses, including investments in new business opportunities. Because distributions on Class B Units are currently subordinated to the first-priority distributions on Class A and GP Units and since members of the Partnership's Operating and Equity Boards (which determine the amounts to be distributed to Unitholders) have an economic interest in a substantial number of Class B Units, there is a risk that the Partnership may distribute cash that could otherwise be used for other Partnership purposes. Also, there is a risk that the Operating and Equity Boards could cause the Partnership in certain circumstances to defer or forego the possibility of making an acquisition of a business venture in the best interest of the Partnership which could be made through the issuance of additional Class A Units because such an acquisition could result in a diminution in distributions paid to the holders of the Class B Units.\nEffect of Covenants and Restrictions in Certain Debt Obligation of General Partner. The operations of the Partnership and the Investment Management Firms may be affected by the terms of a note agreement PIMCO GP entered into concurrently with the closing of the Consolidation, pursuant to which PIMCO GP issued notes in the principal amount of $130 million. Although this indebtedness will not constitute an obligation of the Partnership or any of the Investment Management Firms and the documents governing the indebtedness will not be binding on the Partnership or any of the Investment Management Firms, it is anticipated that the businesses of the Partnership and the Investment Management Firms will be conducted in compliance with the operating restrictions in the documents governing the indebtedness in order to avoid a default thereunder, even though contrary courses of action may be in the best interests of the Partnership or the Investment Management Firms. The operating restrictions under the note agreement, among other things, include restrictions on incurrence of indebtedness and liens, investments, asset sales, mergers and consolidations, affiliate transactions, issuance of additional Units and amendment of the Partnership Agreement. In addition, the note agreement includes cash flow and interest coverage requirements; these financial covenants could have the effect of inhibiting the Partnership's use of cash for any purpose other than for distributions. The operating restrictions in the note agreement will remain in effect until the debt matures in 2001 unless prepaid. The note agreement indebtedness will be non-recourse to PIMCO GP and will be secured by, among other things, a pledge of certain Units owned by PIMCO GP and indirectly by a pledge of certain of the Units held by TAG Inc. In the event of a default under this indebtedness, the lenders could foreclose upon and cause a sale of the pledged Units, which would reduce the economic interests in the Partnership of the General Partner and its beneficial owners, including Managing Directors of PIMCO, and which could adversely affect the market price of the Units.\n19a\nDERIVATIVES\nThe use of derivatives by investment managers has recently received national attention because of losses suffered on investments in derivatives. As a result of such losses, some of those investment managers have been sued for using or inadequately disclosing their use of derivatives or have made payments to clients to compensate for losses. As part of its investment philosophy, PIMCO has used deriviatives since 1980 in various ways in seeking to manage portfolio risk and exploit market inefficiencies. Its use of derivatives has generally been confined to futures, options and mainstream mortgage derivatives (such as collateralized mortgage obligations); however, PIMCO has at times also held positions in client portfolios in interest-only and principal-only strips (IOs and POs) and, in a few special situations, structured notes and swaps. Although certain of these derivative securities can have relatively higher degrees of interest rate risk, illiquidity and counterparty credit risk, PIMCO approaches derivatives much as it does other complex fixed income instruments -- as potential investments to be analyzed, monitored and used, when appropriate, to enhance a portfolio's return or manage its risk. PIMCO has developed and employs, in the case of derivatives as well as other securities, various risk controls at the portfolio and individual security levels in an effort to evaluate and monitor interest rate, liquidity and credit quality risk. PIMCO believes its use of derivatives has contributed positively to portfolio returns and PIMCO has not suffered any material claims or made any material payments to clients related to its use of derivatives.\nRELIANCE ON KEY PERSONNEL AND PROFIT-SHARING PAYMENTS\nThe ability of the Partnership and the Investment Managment Firms to attract and retain clients is dependent to a large extent on their ability to attract and retain key employees, including skilled portfolio managers. Certain of these employees are responsible for significant client relationships. In particular, the Partnership will depend to a signficant extent on the services of William H. Gross of PIMCO, Irwin F. Smith and Donald A. Chiboucas of CCI, and David B. Breed of Cadence. Mr. Gross is one of the best known fixed income portfolio managers in the United States, and the loss of his services could have a material adverse effect on the Partnership. In order to help retain these and other key personnel, each of the six Investment Management Firms has a policy of reserving a substantial percentage of its adjusted net book income for profit-sharing payments (45% in the case of PIMCO and CCI and in the case of the other Investment Management Firms, 15% of the first $3 million of such income, 25% of the next $2 million of such income, 40% of the next $5 million of such income and 45% of such income in excess of $10 million). These profit-sharing payments will signficantly reduce the amount of the Investment Management Firms' profits that will be distributed to the Partnership and become available for distribution to Unitholders. There can be no assurance that key personnel will be retained.\n19b\nFACTORS AFFECTING FEE REVENUES\nGeneral Considerations. Investment management agreements between investment management firms and their clients typically provide for fees based on a percentage of the assets under management, determined at least quarterly and valued at current market levels. The percentage of the fee applicable to a particular classification of assets under management is a function of several factors, including that investments which have higher degree of risk and uncertainty command a higher percentage fee. Therefore, significant fluctuations in securities prices or in the investment patterns of clients that result in shifts in assets under management can have a material effect on the Partnership's consolidated revenues and profitability. Such fluctuations in asset valuations and client investment patterns may be affected by overall economic conditions and other factors influencing the capital markets and the net sales of mutual fund shares generally, including interest rate fluctuations.\nVirtually all of the Partnership's revenues are derived from investment management agreements with clients that are terminable at any time or upon 30 to 60 days' notice, as is the case generally in the investment management industry. Any termination of agreements representing a significant portion of assets under management could have an adverse impact on the Partnership's results of operations.\nThe investment management business is highly competitive and fees vary among investment managers. Some of the Investment Management Firms' fees are higher than those of many investment managers relative to the average size of accounts under management. Each Investment Management Firm's ability to maintain its fee structure in the competitive environment is dependent to a large extent on the ability of its investment managers to provide clients with service and investment returns that will cause clients to be willing to pay those fees. There can be no assurance that the Investment Management Firms will be able to retain their clients or sustain their fee structures in the future.\nReliance on Performance-Based Fees. On a pro forma combined basis, approximately 3.4% and 10.5% of the Partnership's revenues for the year ended December 31, 1994 and the year ended December 31, 1993, respectively, were derived from performance-based fees. Most of these revenues are attributable to PIMCO's operations. To earn a performance-based fee with respect to an account, the relevant Investment Management Firm must generally outperform a specific benchmark over a particular period. Performance-based fee arrangements can have a significant effect on revenues, but also provide an opportunity to earn higher fees than could be obtained under fee arrangements based solely on a percentage of assets under management. PIMCO's StocksPLUS (R) product, which accounted for $4.6 billion of assets under management at December 31, 1994, is subject to a performance-based fee schedule in which under-performance relative to the S&P 500 over a particular time period results in no fees being paid by clients, while superior performance results in incentive fees that are not subject to a cap. In addition to the Stocks PLUS (R) accounts, several large fixed income accounts also have performance-based fee arrangements. PIMCO's performance-based fee arrangements, including the StocksPLUS (R) fee arrangement, can materially affect PIMCO's revenues, and thus those of the Partnership, from period to period.\n19c\nFEDERAL INCOME TAX CONSIDERATIONS; ANTICIPATED FUTURE RESTRUCTURING\nPartnership Tax Considerations. In general, under the Internal Revenue Code of 1986, as amended (the \"Code\"), entities classified as partnerships are not subject to federal income tax. Instead, all holders of partnership interests are taxable on their allocable share of a partnership's income or gain for tax purposes, whether or not such income or gain is distributed. The Partnership has been advised that the Partnership should be classified as a partnership for federal income tax purposes and the Investment Management Firms should not be treated as associations taxable as corporations for federal income tax purposes.\nLoss of Partnership Tax Status. Under current law, the Partnership will cease being classified as a partnership for federal income tax purposes, and will be treated as a corporation, immediately after December 31, 1997 (or sooner if the Partnership adds a substantial new line of business or otherwise fails to satisfy certain requirements) unless the Partnership's limited partner interests cease to be publicly traded prior to such time. As a corporation, the Partnership would be subject to tax on its income and its shareholders would be subject to tax on dividends.\nAnticipated Future Restructuring of the Partnership. In an effort to preserve partnership tax treatment after December 31, 1997 for nonpublic Unitholders, the Partnership Agreement confers on the General Partner broad authority to effect a Restructuring of the Partnership in connection with, or in anticipation of, such a change in tax status. While the precise form of a Restructuring cannot now be determined and will depend upon the facts and circumstances existing at the time a Restructuring is implemented, it is generally expected that, following a Restructuring, public Unitholders will hold their equity participation in the business of the Partnership through publicly traded stock issued by an entity treated as a corporation for federal income tax purposes, allowing the nonpublic Unitholders to continue to hold their equity participation in the Partnership directly or through some other entity treated as a partnership for federal income tax purposes. The Partnership does not currently expect to change its distribution policy following a Restructuring, and it is anticipated that the corporate entity generally would distribute all cash received by it from the Partnership other than cash needed for payment of taxes and operational expenses. Because of federal, state and other income taxes on such entity's income, cash available for dividends to the holders of the corporate entity's publicly traded securities would be substantially less than the cash distributed to the corporate entity by the Partnership.\nThe Partnership Agreement limits the liability of the General Partner with respect to a restructuring as described in Item 13 of this Report.\nInternal Revenue Code Section 754 Election ------------------------------------------\nThe Partnership has made the election to adjust the basis of Partnership property as provided in Internal Revenue Code Section 754. The effect of this election, in conjunction with Internal Revenue Code Section 197, is generally to allow partners acquiring Units after April 30, 1992 to amortize and receive deductions for the amortization of the portion (if any) of their purchase price allocable to goodwill or intangibles. Amortization must occur over a fifteen year period, on a straight-line basis. Deductions for amortization reduce a partner's basis in his interest and must be recaptured as ordinary income upon the disposition of that interest.\nWith respect to options granted under the Unit Option Plans described in Item 11 below, the Partnership has been advised that: (i) upon the exercise of an option, the option holder will recognize ordinary compensation income for federal income tax purposes equal to the excess of the fair market value of the option Unit acquired over the exercise price of the option; and (ii) the Partnership will have an ordinary compensation deduction for federal income tax purposes equal to the amount of compensation income described in (i) and this deduction should be allocated among the units of partner interest in the Partnership outstanding immediately prior to exercise and should not be shared by the option Units.\nThe compensation deduction would be allocated among units of partner interest in the Partnership for tax purposes only if it were incurred in a taxable year of the Partnership beginning before January 1, 1998 (or any later year in which the Partnership has retained its status as a partnership as a result of a Restructuring or otherwise). Under current law, for taxable years of the Partnership beginning after December 31, 1997, the Partnership will be treated as a corporation for federal income tax purposes unless a Restructuring is effected to prevent that outcome.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES -------------------\nThe Partnership's principal offices are currently located at 840 Newport Center Drive, Newport Beach, CA where it occupies approximately 4,200 square feet of space under a sub-lease with PIMCO expiring on December 31, 1996 and at 2187 Atlantic Street where it and PADCo occupy approximately 17,200 square feet of space under a sub-lease expiring on July 31, 2002. Each location is a modern office building and the demised space is adequate for the Partnership's current operations, but more space may be necessary should the Partnership's business expand.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS --------------------------\nNone.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS ----------------------------------------------------------\nOn October 31, 1994, the holders of Units of limited partner interest consented to the following actions:\n(i) the Agreement and Plan of Consolidation for PIMCO Advisors L.P. was approved -- For 4,695,320; Against 70,329; Abstaining 110,436; (ii) the PIMCO Advisors L.P. 1994 Class B Unit Option Plan was approved -- For 16,035,641; Against 114, 824; Abstaining 111,709; and (iii) the amendments to the existing option agreements under the Partnership's 1993 Unit Option Plan were approved -- For 16,036,053; Against 115,236; Abstaining 111,709.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ------------------------------------------------------------------------------\nPrior to the Consolidation, the Partnership's limited partner units were listed on the New York Stock Exchange (the \"NYSE\") under the symbol \"TAG\" and after the Consolidation, the Class A Units have been listed on the NYSE under the symbol \"PA.\" The following table sets forth, for the periods indicated, the high and low closing prices for each limited partner unit or Class A Unit, as the case may be, as reported on the NYSE and the total cash distributions paid per limited partner Unit or Class A Unit, as the case may be, and GP Unit, as adjusted for the distribution of 1.06 Units per Unit effective October 9, 1994.\nOn March 23, 1995, the closing price of the Partnership's Class A Units as reported on the NYSE was $17.50 per unit. On March 15, 1995, there were approximately 721 holders of record of the Partnership's Class A Units.\nThe Partnership Agreement provides that the General Partner shall cause the Partnership to distribute to Unitholders on a quarterly basis cash in an amount equal to Operating Profit Available for Distribution less any amount the General Partner deems may be required for capital expenditures, reserves or otherwise in the business of the Partnership. The Partnership Agreement defines Operating Profit Available for Distribution as the sum of (i) the net income of the Partnership for such quarter determined in accordance with generally accepted accounting principles and (ii) certain non-cash charges resulting from the amortization of goodwill and certain other intangible assets and non-cash compensation expenses related to options and restricted Units. The General Partner believes that the amounts withheld for capital expenditures, reserves or otherwise will not be substantial and intends to cause the Partnership to distribute cash to Unitholders in an amount which represents substantially all of the Partnership's Operating Profit Available for Distribution.\nFor each quarter commencing with the quarter ended December 31, 1994 and ending with the quarter ending December 31, 1997 (the \"Interim Period\"), distributions will be made first to holders of Class A Units and GP Units until such holders have received $0.47 per Unit per calendar quarter (aggregating to $1.88 per Unit per year) since the date of the Consolidation, second to holders of Class B Units until such holders have received $0.47 per Unit per calendar quarter on a cumulative basis within a calendar year but not carried over from year to year and third to all holders of Units pro rata. Distributions with respect to Class A and GP Units will be made within 45 days of the end of each calendar quarter in the Interim Period and thereafter within 60 days after the end of the calendar quarter, and with respect to Class B Units will be made within 60 days of the end of the calendar quarter, in all cases to holders of record on the 30th day after the end of the quarter.\nAfter December 31, 1997, or earlier upon the occurrence of an Adverse Tax Event, as defined in the Partnership Agreement, the priority distributions will cease, distributions thereafter will be made on a pro rata basis among all Units then outstanding and any remaining cumulative shortfalls in the quarterly priority amounts will not be carried over. If, immediately prior to that time, the Class B Unit distribution were less than the Class A Unit distribution, upon termination of the subordination feature of the Class B Units, distributions to holders of Class A Units would decrease. Although not currently anticipated, a change in current law or the addition of a substantial new line of business may result in the occurrence of an Adverse Tax Event. If a Restructuring occurs prior to December 31, 1997, the General Partner will make (i) a final quarterly distribution for the quarter preceding the Restructuring in the priorities stated above and (ii) a cash distribution in an amount which the General Partner, in its good faith discretion, determines will not be required for expenses, for capital expenditures, as reserves or otherwise in the business of ongoing restructured entity in the priorities stated above. If an Adverse Tax Event has not occurred prior to the Restructuring, the first-priority distributions to the holders of Class A Units and GP Units will continue until the earlier of December 31, 1997 or the occurrence of an Adverse Tax Event.\nNo assurances can be given as to the Partnership's future earnings levels. Distributions made by the Partnership will depend on the Partnership's profitability and the profitability of the Investment Management Firms, which in turn, will be affected in part by overall economic conditions and other factors affecting capital markets generally, which are beyond the Partnership's control. In addition, the General Partner may, in determining the amount of distributions, deduct from Operating Profit Available for Distribution any amount the General Partner deems may be required for capital expenditures, reserves or otherwise in the business of the Partnership. To the extent the Partnership retains profits in any year, Unitholders may have taxable income from the Partnership that exceeds their cash distributions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ---------------------------------\n__________ (1) Net income per unit and Operating Profit Available for Distribution are computed on earnings following the Consolidation.\n(2) Upon completion of the Consolidation of PFAMCo Group and Thomson Advisory Group L.P., approximately $284.9 million of intangible assets were created. See Note 3 in the Notes to the Consolidated Financial Statements.\nNote: The information above should be read in connection with Management's Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and related notes appearing elsewhere in this document.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ================================================================================ OF OPERATIONS =============\nGENERAL\nPIMCO Advisors L.P. and subsidiaries (\"PA\") was formed on November 15, 1994 (\"Date of Consolidation\"), when Pacific Financial Asset Management Group (\"PFAMCo Group\") merged (the \"Consolidation\") certain of its investment management businesses and substantially all of its assets into Thomson Advisory Group L.P. (\"TAG\"). The PFAMCo Group comprised the operations of Pacific Financial Asset Management Corporation (\"PFAMCo\"), an indirect wholly-owned subsidiary of Pacific Mutual Life Insurance Company (\"Pacific Mutual\"), and certain of its wholly-owned investment management subsidiaries. The businesses of PFAMCo Group contributed to PA were then contributed to the following newly formed subsidiaries:\n. Pacific Investment Management Company (\"Pacific Investment Management\") and its wholly-owned subsidiary, StocksPLUS Management, Inc. (\"StocksPLUS\"), managing primarily Fixed Income, with approximately $56.9 billion in assets under management; . Cadence Capital Management (\"Cadence\") managing Equities, with approximately $1.8 billion in assets under management; . Parametric Portfolio Associates (\"Parametric\"), managing Equities, with approximately $1.5 billion in assets under management; . NFJ Investment Group (\"NFJ\"), managing Equities, with approximately $1.1 billion in assets under management; . Blairlogie Capital Management (\"Blairlogie\"), managing Equities, with approximately $500 million in assets under management.\nAs a result of the Consolidation, the PFAMCo Group businesses described above and Columbus Circle Investors (\"CCI\"), formerly a division of TAG, managing primarily Equities, with approximately $10.3 billion in assets under management, were organized and now conduct their businesses as separate, autonomous subsidiaries of PA. The subsidiaries are each a registered investment advisor and collectively they provide a broad array of investment management and advisory services for clients using distinctive investment management styles.\nIn addition to the investment management subsidiaries, PA sponsors three mutual fund families: PIMCO Funds (12 funds for institutions); PIMCO Advisors Funds (13 retail funds and Cash Accumulation Trust); and PIMCO Advisors Institutional Funds (18 funds for institutional and 401(k)\/defined contribution investors).\nUnder generally accepted accounting principles, the Consolidation is accounted for as an acquisition of TAG by PFAMCo Group, even though the legal form was the reverse. Therefore, the historical financial statements include the operations of PFAMCo Group, in its corporate form, prior to the Consolidation and the combined results of PA, in its partnership form, for the period since the Consolidation.\nDue to the different bases of presentation and resulting difficulties in analyzing comparative historical financial information as a result of the required accounting presentation, management has included below certain pro forma financial information as if the Consolidation occurred at the beginning of 1993. Pro forma results eliminate the significant comparative differences in the historical results of operations arising primarily from different taxation of corporations and partnerships, from the inclusion of the former TAG's results of operations in the pro forma results from the beginning of 1993 (as opposed to only from the date of Consolidation reflected in the historical financial statements), and from certain transactions and restructuring effected by the Consolidation, principally related to the creation and amortization of intangibles and revised profit sharing arrangements.\nPRO FORMA FINANCIAL INFORMATION\nThe following table summarizes the unaudited condensed pro forma results of operations as if the Consolidation discussed above had occurred on January 1, 1993. The pro forma operating results give effect to:\n(i) The Consolidation of PFAMCo Group and TAG; (ii) The amendment of existing options under TAG's 1993 Unit Option Plan; (iii)The adoption of the Class B Limited Partnership Unit Option Plan; (iv) The contribution of PIMCO Advisors Distribution Company (\"PADCO\") to PA in exchange for Class A Limited Partnership Units; and (v) Certain transactions effected by PFAMCo Group and TAG in connection with the consolidation, primarily related to intangible amortization and profit sharing .\nThe pro forma information given above is not intended to reflect the results that actually would have been obtained if the operations were consolidated during the periods presented.\nPRO FORMA FINANCIAL INFORMATION RESULTS OF OPERATIONS FOR 1994 COMPARED TO 1993\nPA derives substantially all its revenues and net income from advisory fees for investment management services provided to its institutional and individual clients and advisory, distribution and servicing fees for services provided to its proprietary families of mutual funds (\"Proprietary Funds\").\nGenerally, such fees are determined based upon a percentage of client assets under management and are billed quarterly to institutional clients, either in advance or arrears, depending on the agreement with the client, and monthly in arrears to Proprietary Funds. Revenues, therefore, are determined in large part based upon the level of assets under management which are dependent upon market conditions, client decisions to add or withdraw assets from PA's management and from PA's ability to attract new clients, among other factors. In addition, PA has certain accounts which are subject to performance based fee schedules wherein performance relative to the S&P 500 Index or other benchmarks over a particular time period can result in additional fees. Such performance based fees can have a significant effect on revenues, but also provide an opportunity to earn higher fees than could be obtained under fee arrangements based solely on a percentage of assets under management.\nPA's consolidated pro forma 1994 revenues, including those of its wholly- owned distributor PADCO, were $269.1 million compared to $255.5 million in 1993, up $13.6 million. Advisory revenues were $231.5 million in 1994 compared to $222.4 million in 1993, up $9.1 million. PADCO's revenues were $37.6 million in 1994 compared to $33.1 million in 1993, up $4.5 million. Revenue increases resulted from the commitment of new assets by institutional clients and to a lesser extent from favorable investment performance and increases in mutual fund assets under management. These increases were partially offset by a decline in performance based fees which were 3.4% of revenues in 1994, versus 10.5% of revenues in 1993. The decline in performance based fees occurred primarily from under performance in a product line that seeks to outperform the S&P 500 Index.\nPro forma revenues by operating entity were as follows:\n\/(1)\/ Includes PA's Institutional Services (formerly PFAMCo) and Mutual Funds divisions and Blairlogie.\nCompensation and benefits expenses in 1994 of $119.0 million were $5.4 million higher than 1993 reflecting additional staffing, primarily in Pacific Investment Management's client support and administration areas, offset by lower profit sharing expenses which are based on profits of each of the investment advisor subsidiaries.\nCommission expenses increased by $2.9 million to $23.1 million in 1994. Commission expenses are incurred by PADCO and are paid primarily to broker- dealers and their sales people for the sale of PA's retail oriented mutual funds. Commissions include amounts paid at the time of sale of the mutual funds (\"up-front\" commissions) and \"trail\" commissions for the maintenance of assets in the mutual funds and servicing fees for services provided to mutual fund shareholders. The level of commission expense will vary according to the level of assets in the mutual funds (on which trail and service fee commissions are determined) and sales of mutual funds (on which up-front commissions are paid at the time of sale). Trail and service fee commissions are generally paid quarterly beginning one year after sale of the mutual funds. Therefore, at any given time, trail and service fee commissions will be paid on only the mutual fund assets that qualify for such payments. In 1994, trail and service fee commissions increased to $16.3 million from $9.1 million in 1993 as a result of an increase in the amount of qualifying assets. Up-front commissions decreased by $4.3 million to $6.8 million in 1994 as a result of lower current levels of retail mutual fund sales.\nOther expenses increased $6.1 million to $33.4 million. This resulted from increases in occupancy costs, commensurate with increases in personnel described above, marketing and promotional expenses for the Proprietary Funds and the increased use of outside professional services.\nOther income includes interest and dividend income and pro forma expense reimbursements under agreements with Pacific Mutual. Other income in 1993 included approximately $2.0 million of expense reimbursement related to the operations of PA's Institutional Services division which is the maximum amount that can be received under the agreement. In actuality, this reimbursement agreement became effective on the date of Consolidation and reimbursement will be realized subsequent to the date of Consolidation.\nIntangible assets of approximately $284.9 million created by the Consolidation represent the excess of the purchase price over the fair value of net tangible assets of TAG deemed acquired by PFAMCo Group. Approximately $80.7 million of the intangible assets represents the value assigned to PA's Master Limited Partnership (\"MLP\") structure. Under current tax law, an MLP is exempt from Federal and most state and local income taxes through December 31, 1997. The value attributed to the MLP structure is being amortized through the period ended December 31, 1997. The remainder is being amortized over its estimated life of twenty years.\nNet income per unit is computed under the two-class method which allocates net income to Class A and Class B Limited Partnership units in proportion to the Operating Profit Available for Distribution for each class. Operating Profit Available for Distribution is defined by PA's partnership agreement and is computed as the sum of net income plus non-cash charges from the amortization of intangible assets and non-cash compensation expenses arising from option and restricted unit plans. Since Class A Limited Partnership and General Partner units are entitled to a priority distribution, the amount of Operating Profit Available for Distribution allocated to such units is greater than the amount for Class B Limited Partnership units. As a result, the net income per Class A Limited Partnership and General Partner unit is greater than the net income per Class B Limited Partnership unit. Due to the priority distribution, any dilution to net income per unit from the assumed exercise of unit options is currently applied entirely to Class B Limited Partnership units.\nThe General Partner and Class A Limited Partnership units are entitled to a priority distribution of $1.88 per unit per year. Actual unit distributions in February 1995 were 23.9 cents for the General Partner and Class A Limited Partnership units and in March 1995 were 7.7 cents for the Class B Limited Partnership units. These amounts reflect Operating Profit Available for Distribution for the 46 day period from the date of Consolidation through December 31, 1994.\nHISTORICAL FINANCIAL STATEMENTS\nThe historical financial statements reflect the results of PFAMCo Group during 1992 and 1993. The results for 1994 include PFAMCo Group, in its corporate form for the period January 1, 1994 to November 15, 1994 and PA's post-Consolidation combined results in its partnership form from November 16, 1994 to December 31, 1994. This accounting treatment, known as \"reverse acquisition\" accounting, is required under generally accepted accounting principles.\nTherefore, many of the comparative differences in the results of operations between 1994 and 1993 are due to the reorganization of PFAMCo Group into partnership form, the inclusion of the former TAG operations in combination with PFAMCo Group's operations from November 16, 1994 to December 31, 1994, and from transactions and restructuring which occurred in the Consolidation. The 1994 results also include certain first-time non-cash expenses related to the amortization of intangible assets created by the Consolidation and from expenses related to option and restricted unit plans.\nRESULTS OF OPERATIONS FOR 1994 COMPARED TO 1993\nPA's 1994 revenues, including PADCO, were $180.3 million compared to $165.9 million in 1993, up $14.4 million. The increase in revenues results primarily from the inclusion of the former TAG in the results of PA's operations since the Consolidation.\nCompensation and benefits which primarily includes salaries, employee benefits and incentive compensation is PA's largest expense category. Incentive compensation consists of profit-sharing and other incentive awards which are primarily formula driven and based upon profitability of the investment management subsidiaries. Incentive compensation also includes discretionary bonus amounts. Prior to the Consolidation, profit-sharing awards ranged from 40% to 80% of the profits, as defined, of the operating subsidiaries of PFAMCo Group. Awards range from 15% to 45% of such profits after the Consolidation.\nCommission expenses include the up-front, trail and service fee commissions from PADCO's operations. Restricted Unit and Option Plan expense results from grants to key employees of restricted units and options to purchase units at substantially reduced prices. Such plans have 5-year vesting provisions and other restrictions and the associated expense is being amortized over the 5-year period. There were no similar items in the 1993 results of operations for commissions and Restricted Unit and Option Plan expenses.\nGeneral and administrative expenses are primarily comprised of supplies, telephone, printing, books and periodicals, and electronic research fees.\nMarketing and promotional includes sales literature, marketing fees, sales promotion, travel and entertainment, and public relations costs. The increase in 1994 over 1993 results from the inclusion of $1.4 million of TAG's costs, primarily related to PADCO, since the Consolidation and from promotional spending for the marketing of the PIMCO Funds.\nOccupancy and equipment includes $0.9 million of TAG's costs and increased over 1993 due to facility expansion primarily at Pacific Investment Management.\nProfessional fees include costs of outside services for legal, accounting, audit and consultants. The expense for 1994 includes approximately $0.4 million from TAG's operations. The increase in total professional fees over 1993 is largely due to professional services rendered in connection with the Consolidation.\nEquity in income of partnerships represents earnings from Pacific Investment Management's investment in a limited partnership, StocksPLUS, L.P., a pooled investment vehicle whose investment objective is to create returns for clients above the S & P 500 index. The amount earned by Pacific Investment Management will vary from year-to-year and will depend on the relative investment performance of StocksPLUS, L.P.\nIncome tax expense represents the current and deferred provision for Federal and state income taxes. Following the Consolidation, PA is organized as a partnership whose income is generally not subject to tax at the partnership entity level. PA does, however, have two corporate subsidiaries that may be subject to Federal and state income taxes.\nRESULTS OF OPERATIONS FOR 1993 COMPARED TO 1992\nNo revenue or expense of the former TAG operations are included in this comparison.\nRevenues for the year ended December 31, 1993 increased 38% as compared to the year ended December 31, 1992, primarily from assets under management increasing 30.8%. Performance based fees increased from $14 million for the year ended December 31, 1992 to $26.8 million for the year ended December 31, 1993. This increase in performance based fee revenue is directly related to the performance of these accounts exceeding their benchmarks in 1993 as compared to 1992 as well as an increase in the number of performance based accounts.\nOperating expenses increased 41.3% for the year ended December 31, 1993 as compared to the year ended December 31, 1992, primarily from increased employee compensation and benefits resulting from certain profit sharing programs tied to profitability and the addition of staff to support an increased client base and assets under management. Employees increased to 276 at December 31, 1993 from 204 at December 31, 1992. Overall, expenses increased to 79.3% of revenues in 1993 as compared to 77.4% of revenues for the year ended December 31, 1992.\nIncome before income tax expense increased 24.8% for the year ended December 31, 1993 as compared to the year ended December 31, 1992 primarily as a result of the factors noted above. The effective tax rate for the year ended 1993 was slightly higher than the expected rate due to the foreign operations of Blairlogie not being included as part of the tax provision calculation.\nCAPITAL RESOURCES AND LIQUIDITY\nPA's and its predecessor entities' combined business has not historically been capital intensive. Prior to the Consolidation, working capital requirements have been satisfied out of operating cash flow or short-term borrowings. PA will make quarterly profit-sharing payments and distributions to its unitholders. PA may need to finance profit sharing payments using short-term borrowings.\nPA had approximately $55.0 million of cash and cash equivalents at December 31, 1994 compared to approximately $9.3 million at December 31, 1993. The increase in cash was due primarily to the receipt of approximately $20 million of net proceeds raised in a public offering of primary units shortly after the Consolidation and approximately $14.6 million derived from the consolidation of the former TAG businesses acquired. PA's liquidity will be used for general corporate purposes including profit-sharing payments and brokers' commissions on sales of mutual fund shares distributed without a front-end sales load. PA believes that the level of such commissions may increase in the future due to the introduction of new products and mutual fund pricing structures which may require an internal financing source; however, PA has made no formal decision as to the source or necessity of such financing.\nPA currently has no long-term debt. The Partnership does expect to obtain a $25 million four-year revolving line of credit for working capital purposes.\nECONOMIC FACTORS\nThe general economy including interest rates, inflation and client responses to economic factors will affect, to some degree, the operations of PA. As a significant portion of assets under management are fixed income funds, fluctuations in interest rates could have a material impact on the operations of PA. PA's advisory business is generally not capital intensive and therefore any effect of inflation, other than on interest rates, is not expected to have a significant impact on its operations or financial condition. Client responses to the economy, including decisions as to the amount of assets deposited may also impact the operations of PA. These fluctuations may or may not be recoverable in the pricing of services offered by PA.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA --------------------------------------------------------------------------------\nIndex to Financial Statements:\nPage(s) ------- PIMCO Advisors L.P.\nIndependent Auditors' Report 33\nConsolidated Statements of Financial Condition - as of December 31, 1994 and 1993 34\nConsolidated Statements of Operations - for each of the years in the three years ended December 31, 1994 35\nConsolidated Statements of Changes in Owners' Equity - for each of the years in the three years ended December 31, 1994 36-37\nConsolidated Statements of Cash Flows - for each of the years in the three years ended December 31, 1994 38-39\nNotes to Consolidated Financial Statements 40-50\nPIMCO ADVISORS L.P. AND SUBSIDIARIES\nConsolidated Statements of Financial Condition as of December 31, 1994 and 1993 and Consolidated Statements of Operations, Changes in Owners' Equity and Cash Flows for Each of the Three Years Ended December 31, 1994 and Independent Auditors' Report\nINDEPENDENT AUDITORS' REPORT ----------------------------\nPIMCO Advisors L.P. and Subsidiaries:\nWe have audited the accompanying consolidated statements of financial condition of PIMCO Advisors L.P. and subsidiaries (the \"Partnership\") as of December 31, 1994 and 1993, and the related consolidated statements of operations, changes in owners' equity, and cash flows for each of the three years ended December 31, 1994. 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 consolidated financial statements present fairly, in all material respects, the financial condition of the Partnership as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years ended December 31, 1994, in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nNew York, New York February 17, 1995\nThe accompanying notes are an integral part of these consolidated financial statements.\nThe accompanying notes are an integral part of these consolidated financial statements.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN OWNERS' EQUITY ================================================================================\nContinued\nPIMCO ADVISORS L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN OWNERS' EQUITY, CONTINUED\nThe accompanying notes are an integral part of these consolidated financial statements.\nContinued\nThe accompanying notes are an integral part of these consolidated financial statements.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n1. ORGANIZATION AND BUSINESS\nPIMCO Advisors L.P. (\"PA\") is a registered investment advisor that provides a broad array of investment management and advisory services to institutional and retail mutual funds and to separate accounts of institutional clients.\nPA was formed on November 15, 1994, when Pacific Financial Asset Management Group (\"PFAMCo Group\") merged (the \"Consolidation\") certain of its investment management businesses and substantially all of its assets into Thomson Advisory Group L.P. (\"TAG\"). The PFAMCo Group comprised Pacific Financial Asset Management Corporation (\"PFAMCo\"), a wholly-owned subsidiary of Pacific Mutual Life Insurance Company (\"Pacific Mutual\"), and certain of PFAMCo's wholly-owned investment management subsidiaries. The businesses of PFAMCo Group contributed to PA were then contributed to newly formed subsidiaries of PA.\nFor the period after the Consolidation, the accompanying consolidated financial statements include the accounts of PA and its subsidiaries. The investment advisor subsidiaries included in these consolidated financial statements are as follows:\n. Pacific Investment Management Company (\"Pacific Investment Management\") manages a variety of predominantly fixed income portfolios primarily for institutions and mutual funds;\n. Columbus Circle Investors (\"CCI\") manages primarily equity securities using a positive momentum\/positive surprise approach, principally for institutions and mutual funds;\n. Cadence Capital Management (\"Cadence\") specializes in disciplined, growth-oriented management of equity securities primarily for institutions and mutual funds;\n. Parametric Portfolio Associates (\"Parametric\") specializes in highly quantitative management of domestic and international equity portfolios primarily for institutions and mutual funds;\n. NFJ Investment Group (\"NFJ\") is a value-oriented manager of equity securities primarily for institutions and mutual funds; and\n. Blairlogie Capital Management (\"Blairlogie\") specializes in international equity securities from its office in Edinburgh, Scotland primarily for institutions and mutual funds.\nThe investment advisor subsidiaries are supported by additional incorporated subsidiaries:\n. PIMCO Advisors Distribution Company (\"PADCO\") serves as the distributor of institutional and retail mutual funds (the \"Proprietary Funds\") for which PA and the investment advisor subsidiaries provide investment management and administrative services; and\n. StocksPLUS Management, Inc. (\"StocksPLUS\"), a wholly-owned subsidiary of Pacific Investment Management, owns approximately 0.2 percent interest in, and is the general partner of StocksPLUS, L.P. (Note 13).\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nPacific Investment Management, CCI, Cadence, Parametric, NFJ and Blairlogie are registered investment advisors. PADCO is a registered broker\/dealer with the Securities and Exchange Commission and a member of the National Association of Securities Dealers, Inc.\nInstitutional mutual funds managed consist of the PIMCO Funds (the \"PIMCO Funds\") and the PIMCO Advisors Institutional Funds, formerly the PFAMCo Funds, both of which are open-end investment management companies. The PIMCO Funds include 12 predominantly fixed income funds. The PIMCO Advisors Institutional Funds are a series of 18 equity and fixed income funds. The retail mutual funds managed consist of 14 funds included within two open-end investment management companies, the PIMCO Advisors Funds (\"PAF\"), formerly the Thomson Funds, and the Cash Accumulation Trust (\"CAT\").\nThe accompanying financial statements for the period prior to the Consolidation include the accounts of PFAMCo and its wholly-owned subsidiaries, reflected on a combined basis.\n2. SIGNIFICANT ACCOUNTING POLICIES\na. Cash and Short-Term Investments - PA invests certain cash balances in money market funds. At December 31, 1994, this investment was approximately $41,000,000, of which approximately $32,000,000 is invested in the National Money Market Fund of CAT. At December 31, 1993, approximately $2,514,000 was invested in money market funds. Management considers investments in money market funds to be cash equivalents for purposes of the Consolidated Statements of Cash Flows. These investments are carried at cost, which approximates market.\nb. Investment Advisory Fees - PA records investment advisory fees on an accrual basis. Investment advisory fees receivable for private and separate accounts consist primarily of accounts billed on a quarterly basis. Private accounts may also generate a fee based on investment performance, which is recorded as income when earned and not subject to forfeiture. Investment advisory fees for the Proprietary Funds are received monthly.\nc. Depreciation and Amortization - Office equipment, furniture and fixtures are depreciated on a straight-line basis over their estimated useful lives, generally five years. Automobiles are depreciated on a straight-line basis over their estimated lives, generally three years. Leasehold improvements are amortized on a straight-line basis over the remaining terms of the related leases or the useful lives of such improvements, whichever is shorter.\nd. Income Taxes - Subsequent to the Consolidation, PA and its subsidiaries are predominantly partnerships and, as a result, are generally not subject to Federal or state income taxes. PA is subject to an unincorporated business tax in a certain jurisdiction in which it operates. All partners of PA are responsible for taxes, if any, on their proportionate share of PA's taxable income.\nPADCO and StocksPLUS are subject to Federal and state income taxes and file separate tax returns and account for income taxes under Statement of Financial Accounting Standards No. 109.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\ne. Investments - The investments in Proprietary Funds as of December 31, 1994 represent primarily investments in PAF and CAT. The investments are carried at market value in accordance with SFAS No. 115. The investments in Proprietary Funds as of December 31, 1993 are primarily invested in the PIMCO Funds with a short-term duration objective and are carried primarily at the lower of cost or market value. Cost approximated market value as of December 31, 1993.\nf. Foreign Currency Translation - The assets and liabilities of Blairlogie, PFAMCo UK Limited and Blairlogie's predecessor Company have been translated into U.S. dollars at the current rate of exchange existing at year-end. Revenues and expenses were translated at the average of the monthly exchange rates then in effect.\ng. Net Income Allocation - Net income is allocated in accordance with the Amended and Restated Agreement of Limited Partnership of PA. Net income is allocated among unit holders in the same proportions as cash distributions. PA's cash distribution policy provides for a first priority distribution to General Partner and Class A Limited Partnership units followed by a second priority distribution to Class B Limited Partnership units. During the period from the Consolidation through December 31, 1994, the second priority distribution was less than the first priority distribution.\nh. Earnings per Unit - Earnings per unit are computed based on the weighted average number of units outstanding, assuming the exercise of dilutive unit options. Proceeds from the exercise of such unit options are assumed to be used to repurchase outstanding Limited Partnership units under the treasury stock method.\nThe weighted average number of units used to compute earnings per unit was as follows:\nGeneral Partner and Class A Limited Partnership Units 41,802,420 Class B Limited Partnership Units 32,960,826\ni. Other - Certain items have been reclassified to conform with the current year presentation. All significant intercompany items have been eliminated in the accompanying consolidated financial statements.\n3. INTANGIBLE ASSETS\nFor accounting purposes, the Consolidation between PFAMCo Group and TAG is treated as a purchase and recapitalization of TAG by PFAMCo Group, or a \"reverse acquisition.\" Intangible assets of approximately $284.9 million represent the excess of the purchase price over the fair value of the net tangible assets of TAG deemed acquired in the Consolidation. A portion of the intangible assets represents the value assigned to PA's Master Limited Partnership (\"MLP\") structure. Under current Internal Revenue Code guidelines, an MLP is exempt from Federal and most state and local income taxes through December 31, 1997. The value attributed to the MLP structure will be amortized over the period ending December 31, 1997. The remainder will be amortized on a straight-line basis over its estimated life of twenty years. During the year ended December 31, 1994, approximately $5.0 million of amortization has been charged to expense.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n4. PRO FORMA RESULTS (UNAUDITED) The following represents the unaudited pro forma results of operations as if the Consolidation discussed in Note 1 had occurred on January 1, 1993, except for the period from November 15, 1994 through December 31, 1994 which reflects actual results. The pro forma operating results give effect to:\n(a) The Consolidation of PFAMCo Group and TAG; (b) The amendment of existing options under TAG's 1993 Unit Option Plan; (c) The adoption of the Class B Limited Partnership Unit Option Plan; (d) The contribution of PADCO to PA in exchange for Class A Limited Partnership Units; and (e) Certain transactions effected by PFAMCo Group and TAG in connection with the Consolidation, primarily related to the intangible amortization and profit sharing.\nThe pro forma information above is not intended to reflect the results that actually would have been obtained if the operations were consolidated during the periods presented.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n5. NOTES RECEIVABLE\nPacific Investment Management has granted loans to certain employees as part of programs designed to ensure the long-term retention of those employees. These loans are primarily non-interest bearing and are generally due within one year of issuance.\n6. FIXED ASSETS\nThe major classifications of fixed assets are as follows:\nFixed assets of certain of the subsidiaries were revalued at their estimated fair market values in connection with the Consolidation.\n7. INCOME TAXES\nPrior to the Consolidation, PFAMCo's operations and those of its domestic subsidiaries were included in the combined domestic Federal income tax returns of Pacific Mutual. PFAMCo's operations and its domestic subsidiaries were included in the combined California franchise tax return of Pacific Financial Holding Company (\"PFHC\"), the parent of PFAMCo. Certain subsidiaries filed separate state income or franchise tax returns. PFAMCo and its domestic subsidiaries were allocated an expense or a benefit based principally on the effect of including their operations in the combined provision as if the companies filed a separate return in accordance with a tax sharing agreement between PFAMCo and PFHC.\nIncluded on the accompanying Consolidated Statements of Financial Condition as \"other assets\" are deferred tax assets (liabilities) as of December 31, 1993 related to the following components:\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nThe provision for income taxes prior to the Consolidation was as follows:\nReconciliations of the statutory federal income tax rates to the effective income tax rates prior to the Consolidation are as follows:\nAfter the Consolidation, PA incurred a tax liability of $19,250 principally related to the activities of a corporate subsidiary.\n8. RELATED-PARTY TRANSACTIONS\nAs of December 31, 1994, the payable to affiliates includes cash received by PA and several of the subsidiaries for advisory fees which pre-dated the Consolidation. This amount is payable to affiliates of Pacific Mutual.\nPrior to the Consolidation, PFAMCo and a subsidiary had credit agreements with PFHC, which provided for borrowings up to $40,000,000. The outstanding balance incurred a rate of interest as defined in the agreement. As of December 31, 1993, the applicable interest rate averaged 3.5% on outstanding borrowings of $18,000,000 which were included in payable to affiliates in the accompanying Consolidated Statements of Financial Condition.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nPacific Mutual provided certain support services to PFAMCo Group prior to the Consolidation. Services for certain of PFAMCo Group's employees include participation in a pension plan maintained by Pacific Mutual (Note 9f). Charges for support services, including pension plan participation, amounted to approximately $2,335,000, $2,272,000 and $2,158,000 for the period ended November 15, 1994 and the years ended December 31, 1993 and 1992, respectively.\nDividends declared of $7,258,012 for the year ended December 31, 1993 were satisfied through a reduction in intercompany accounts.\n9. BENEFIT PLANS\na. Profit Sharing and Incentive Programs - PA and its subsidiaries have several profit sharing and incentive programs that compensate participants on the basis of profitability and discretionary bonuses. Compensation under these programs was approximately $10,091,000 for the period from the Consolidation through December 31, 1994.\nPrior to the Consolidation, PFAMCo Group had nonqualified profit sharing plans (the \"Profit Sharing Plans\") covering certain key employees and other employees. The Profit Sharing Plans provided for awards based on the profitability of the respective subsidiary. Such profitability was primarily based on income before income taxes and before profit sharing. The awards ranged from 40% to 80% of such amounts depending on the level of profitability. Profit sharing awards were fully vested at the date of the Consolidation. Profit sharing expense relating to the Profit Sharing Plans of approximately $68,387,000, $86,286,000 and $60,711,900 are included in compensation and benefits in the accompanying Consolidated Statements of Operations for the period ended November 15, 1994 and the years ended December 31, 1993 and 1992, respectively.\nb. Long-Term Compensation - Long-term compensation includes amounts payable to certain officers of a subsidiary in connection with the discretionary bonuses discussed above. The amounts payable will be paid on specified dates and are subject to cancellation upon the occurrence of certain events.\nIn addition, certain key employees of the PFAMCo subsidiaries participated in Long-Term Incentive Plans that provided compensation under the Profit Sharing Plans for a specified period of time subsequent to their termination of employment. These plans were terminated as of the Consolidation.\nc. Savings and Investment Plans - PA and its subsidiaries have several defined contribution employee benefit plans covering substantially all employees. PA and Pacific Investment Management are the sponsors of certain defined contribution employee savings and investment plans. The plans qualify under Section 401(k) of the Internal Revenue Code and allow eligible employees of PA and certain of its subsidiaries, to contribute up to ten percent of their annual compensation as defined, and subject to a maximum dollar amount determined from time to time by the Internal Revenue Service. Employees are generally eligible following the later of attainment of age 21 or the completion of one year of credited service. For 1994, PA and certain of its subsidiaries, matched and contributed an amount equal to one half of the first six percent of annual compensation, subject to Internal Revenue Service limits, contributed by the employees. In addition, PA and certain of its subsidiaries, elected to make a discretionary contribution to all participants. Contributions fully vest to employees after five years of credited service. For 1994, the amount contributed by PA and certain of its subsidiaries was approximately $50,000.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nPacific Investment Management has several defined contribution employee benefit plans covering substantially all of its employees and made contributions to the plans ranging from five percent to eleven percent of covered individuals' base compensation.\nd. Restricted Unit Plan - PA adopted a restricted unit plan for the benefit of certain key employees. A total of 125,000 Class A Limited Partnership Units and 125,000 Class B Limited Partnership Units have been awarded under the plan. The units vest over a five- year period. There are no additional units available for grants under the plan. The expense under this plan was approximately $101,000 during 1994.\ne. Unit Option Plans - PA has two unit option plans which grant options to key employees of PA and its subsidiaries. The unit option plans are administered by the Unit Incentive Committee of the Equity Board of PA, which determines the key employees and the terms of the options to be granted. The outstanding options vest over a period of not more than five years and are generally exercisable after January 1, 1998.\nA Summary of Unit Option activity is as follows:\nAt December 31, 1994, 303,000 Class B Limited Partnership unit options were available for future grants. The expense under the option plans was approximately $1,061,000 during 1994.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nf. Other Benefit Plans - Certain of PFAMCo Group's eligible employees were included in a Pacific Mutual sponsored defined benefit pension plan, and healthcare and life insurance plans that provide post- retirement benefits. PFAMCo Group was charged an immaterial amount by Pacific Mutual for these plans prior to the Consolidation. Upon completion of the Consolidation, PA will not bear any expense associated with these plans.\n10. COMMITMENTS\na. Lease Agreements - PA and its subsidiaries lease office space and certain office equipment under noncancelable leases with terms in excess of one year. Future minimum payments are as follows:\nRent expense in connection with these agreements was approximately $2,379,000, $1,476,000 and $1,261,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\nb. Letter of Credit - PA is contingently liable for a letter of credit in the amount of $738,548 related to PA's membership in a captive insurance program.\n11. SEGMENT INFORMATION\nPA operates in one industry segment, that of investment management services.\n12. NET CAPITAL\nPADCO is subject to the Uniform Net Capital Rule (Rule 15c3-1) under the Securities and Exchange Act of 1934, which requires the maintenance of minimum net capital and requires that the ratio of aggregate indebtedness to net capital, both as defined, shall not exceed 15 to 1. At December 31, 1994, PADCO had net capital of $1,736,811, which was $1,156,876 in excess of its required net capital of $579,935. PADCO's net capital ratio was 5.01 to 1.\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n13. INVESTMENT IN STOCKSPLUS, L.P.\nStocksPLUS accounts for its investment in StocksPLUS, L.P. under the equity method because StocksPLUS is the general partner in, and exercises significant influence over the operating and financial policies of StocksPLUS, L.P. (Note 1). The underlying investments of StocksPLUS, L.P. are carried at market value. The effect of such accounting does not have a material effect on PA's consolidated financial statements. StocksPLUS, L.P. has made its investments with the intent to have its performance equivalent to the S&P 500 Index.\nStocksPLUS has mitigated the effects of its pro rata investment in StocksPLUS, L.P.'s investments through the use of short futures positions. Gains and losses related to these positions are settled daily. Included in \"other assets - current\" in the accompanying Consolidated Statements of Financial Condition are securities which are used as necessary for deposits made in connection with the futures positions and are recorded at market value. The notional amounts of the contracts do not necessarily represent future cash requirements, as the contracts are intended to be closed prior to their expiration. As of December 31, 1994 and 1993, the notional amounts of futures contracts approximated $2,076,000 and $5,370,000, respectively.\nCondensed financial information for StocksPLUS, L.P. is as follows:\nPIMCO ADVISORS L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n14. CONSOLIDATED QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nThe quarterly results for the periods indicated were as follows:\n* Information is for the period following the Consolidation.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND ------------------------------------------------------------------------- FINANCIAL DISCLOSURE --------------------\nOn December 15, 1994, the Operating Committee of the Operating Board of the Partnership, with the consent of the Audit Committee of the Equity Board of the Partnership, appointed the firm of Deloitte & Touche LLP as the Partnership's auditor, to replace the firm of Coopers & Lybrand L.L.P., which served in that position until it was dismissed in connection with the appointment of Deloitte & Touche LLP.\nThe change in auditors was made by the Partnership as a result of the Consolidation, which occurred November 15, 1994. As reported above, in the Consolidation, the businesses of the Partnership were consolidated with the principal businesses of PFAMCo and certain of its subsidiaries. The firm of Deloitte & Touche LLP had served as auditors of the PFAMCo businesses, which after the Consolidation comprised the majority of the Partnership's operations. Accordingly, the Partnership believed it to be appropriate that Deloitte & Touche LLP serve as auditor for the Partnership.\nThe change in auditors did not arise from any disagreement during the Partnership's two most recent fiscal years and the subsequent interim period up to December 15, 1994 with Coopers & Lybrand L.L.P. on any matters of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which, if not resolved to the satisfaction of Coopers & Lybrand L.L.P., would have caused it to make reference to the subject matter of the disagreement in any of its reports. The financial statements prepared by Coopers & Lybrand L.L.P. for 1992 and 1993 have not contained an adverse opinion or a disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT -------------------------------------------------------------\nMANAGEMENT\nGENERAL\nThe Partnership carries on its combined businesses (i) directly through the Partnership with respect to the Partnership's administrative, accounting and legal functions, its retail mutual fund business and certain mutual fund businesses and distribution activities of the PIMCO Advisors Institutional Funds and (ii) through six largely autonomous Investment Management Firms which carry on the respective businesses of PIMCO, CCI, Cadence, Parametric, NFJ and Blairlogie.\nPARTNERSHIP\nPursuant to the terms of the Partnership Agreement, the General Partner has delegated substantially all of the management and control of the Partnership to two management boards, the Operating Board and the Equity Board. For Partnership governance purposes, the Operating Board and the Equity Board are intended to function comparably to a board of directors of the Partnership. Under the terms of the Partnership Agreement, governance matters are allocated generally to the Operating Board, which has, in turn, delegated the authority to manage day-to-day operations and policies of the Partnership to the Operating Committee. Accordingly, the members of the Operating Committee, together with certain other officers of the Partnership, fulfill the functions of executive officers of the Partnership.\nThe members of the Operating Board and the Operating Committee are as set forth below:\n_____________\n(1) Member of Operating Committee.\nUntil the earlier of December 31, 1997 or a Restructuring, the Operating Board is required to be composed of the Chief Executive Officer of PIMCO, six other persons designated by the Managing Directors of PIMCO, three persons designated by the Managing Directors of CCI, one person selected by the vote of the Managing Directors of Cadence, NFJ, Parametric and Blairlogie weighted by the contribution of Cadence, NFJ, Parametric and Blairlogie to the income of the Partnership, and the Chief Executive Officer of the Partnership, who serves ex officio. Thereafter, the Operating Board will consist of at least 11 members designated by the Investment Management Firms in accordance with their relative contributions to the income of the Partnership and may include additional members.\nThe Operating Committee, which is appointed by the Operating Board, is required to be composed of no fewer than three members, including the Chief Executive Officer of the Partnership and one member who is a Managing Director of an Investment Management Firm other than PIMCO. The management board of an Investment Management Firm may appeal any decision made by the Operating Committee which may have a material adverse effect on such Investment Management Firm to the full Operating Board which, after any such appeal, will have the sole power and authority (subject to the referral to the Equity Board in certain circumstances) with respect to the resolution of such matter.\nThe authority of the Operating Board and the Operating Committee to take certain specified actions is subject to the approval of an Equity Board. The Equity Board has jurisdiction over any decision of the Operating Board with which three members of the Operating Board disagree and which is expected to have a material adverse effect on an Investment Management Firm. In addition, the Equity Board's approval is required for certain material transactions, including amendment of the Partnership Agreement or the partnership agreement of an Investment Management Firm, incurring large amounts of debt or making significant investments, making certain material changes in the business of the Partnership or of an Investment Management Firm or material acquisitions or dispositions by the Partnership or an Investment Management Firm, the authorization of additional Units, the selection of the Chief Executive Officer of the Partnership, the removal of any Managing Director of an Investment Management Firm (to the extent such approval is required by the Investment Management Firm), declaring distributions on Units, material transactions with affiliates, any increase in the compensation of a Managing Director of an Investment Management Firm, and the adoption of any policy or any action by one Investment Management Firm that materially burdens another.\nThe members of the Equity Board are as set forth below:\nUntil the earlier of December 31, 1997 or a Restructuring, the Equity Board is required to be composed of twelve members: the Chairperson of the Operating Board, the Chief Executive Officer of the Partnership, three persons designated by PFAMCo, two persons designated by PPLLC, two persons designated by the Series B Preferred stockholders of TAG Inc. and three independent members designated by the other nine members of the Equity Board. Thereafter, the then serving Equity Board will appoint an Equity Board consisting of 13 members who shall consist of the Chairperson of the Operating Board, the Chief Executive Officer of the Partnership and 11 other members, including at least three independent directors, allocated in a manner reasonably determined by the Equity Board to represent most effectively the interests of the direct or indirect beneficial owners of Units, including the public Unitholders.\nOther individuals who serve as executive officers of the Partnership include Steven T. Bailey, Executive Vice President and Chief Financial Officer; Robert A. Prindiville, Executive Vice President; John O. Leasure, Senior Vice President; Newton B. Schott, Jr., Senior Vice President; Robert M. Fitzgerald, Vice President and Principal Accounting Officer; Kenneth M. Poovey, General Counsel; and Brian J. Girvan, Senior Vice President.\nIn addition, the Partnership has an Audit Committee, a Compensation Committee and a Unit Incentive Committee of the Equity Board, each composed of the three independent Members of the Equity Board.\nSet forth below is certain background information with respect to the persons who are the members of the Operating and Equity Boards or certain executive officers of the Partnership:\nWalter E. Auch, Sr. Mr. Auch serves on the Equity Board as an independent Member and as a member of the Constructive Termination Committee. He currently is a management consultant. Mr. Auch was a Director of TAG Inc. from October 1990 until November 1994. He was a director of Thomson McKinnon Asset Management Inc. (\"TMAMI\"), a former general partner of the Partnership, from October 1987 until October 1990. He was previously the Chairman and Chief Executive Officer of the Chicago Board Options Exchange from 1979 to 1986. He is also a director of Geotek Industries, Inc., Fort Dearborn Fund, Shearson VIP Fund, Shearson Advisors Fund, Shearson TRAK Fund, Banyan Strategic Land Trust, Banyan Strategic Land Fund II, Banyan Mortgage Investment Fund, Express American Holding Corporation and Nicholas\/Applegate Funds.\nSteven T. Bailey. Mr. Bailey serves as an Executive Vice President and Chief Financial Officer of the Partnership. Mr. Bailey was the Managing Director of PFAMCo from 1989 until November 1994. Mr. Bailey was also a director of certain of the predecessors to the Investment Management Firms.\nDavid B. Breed. Mr. Breed is Chief Executive Officer, Chief Investment Officer and a Managing Director of Cadence. From February 1985 to July 1993, he was a Managing Director and Director of Cadence Capital Management Corporation and he was Chief Executive Officer and Chief Investment Officer thereof until November 1994.\nDonald A. Chiboucas. Mr. Chiboucas is a member of the Operating Board of the Partnership and the President and a Managing Director of CCI. Mr. Chiboucas was Senior Executive Vice President of TAG Inc. and the Partnership, a member of the Partnership's Executive Operating Committee and President of the CCI division from October 1990 until November 1994. He was a Senior Vice President of the Partnership from November 1987 until October 1990.\nWilliam D. Cvengros. Mr. Cvengros is President and CEO of the Partnership, a member of its Equity and Operating Boards and Chairperson of its Operating Committee. In February 1986, Mr. Cvengros became both Chairman of the Board and Director of PIMCO Inc. He was associated with Pacific Mutual from July 1972 until November 1994. He was promoted to Executive Vice President, Investment Operations of Pacific Mutual in April 1986, and became a Director in January 1988. Mr. Cvengros became Vice Chairman and Chief Investment Officer of Pacific Mutual in January 1990. Mr. Cvengros also served as a director of Pacific Equities Network, Mutual Services Corporation, PFAMCo, PFAMCo UK Limited, Blairlogie, Parametric, NFJ, Cadence and PM Realty Advisors, Inc.\nRobert M. Fitzgerald. Mr. Fitzgerald is Vice President and Principal Accounting Officer of the Partnership. He joined the Partnership in February 1995. From April 1994 through January 1995, he served as a consultant to various companies, including PIMCO. From October 1991 until April 1994, he served in various senior executive positions, including President, at Mechanics National Bank. Prior to October 1991, he was a partner with Price Waterhouse. He is a Certified Public Accountant.\nWalter B. Gerken. Mr. Gerken is the Chairperson of the Equity Board. Mr. Gerken has served as Chairman of the Executive Committee of Pacific Mutual since September 1987 and as one of its directors since 1970. Mr. Gerken is the former Chairman of the Board and CEO of Pacific Mutual.\nBrian J. Girvan. Mr. Girvan is a Senior Vice President and was Chief Financial Officer and Treasurer of the Partnership until March 1, 1995. It is anticipated that he will resign his position in the third quarter of 1995. Mr. Girvan was Senior Vice President, Chief Financial Officer and Treasurer of TAG Inc. from October 1990 until November 1994. He currently is a Senior Vice President and the Chief Financial Officer and Treasurer and a Director of PADCo. He is a Certified Public Accountant.\nWilliam H. Gross. Mr. Gross is a member of the Equity and Operating Boards. Mr. Gross is a Managing Director of PIMCO. Mr. Gross joined PIMCO Inc. in June 1971 and became a Managing Director in February 1982. He serves as a director and vice president of StocksPLUS(R) and as a Senior Vice President of PIMCO Funds.\nBrent R. Harris. Mr. Harris serves on the Operating Board and as a Managing Director of PIMCO. Mr. Harris was a Managing Director of PIMCO Inc. until November 1994. He joined PIMCO Inc. as an Account Manager in June 1985, and became a Vice President in February 1987, a Senior Vice President in February 1990, a Principal in April 1991 and a Managing Director in April 1993. Mr. Harris serves on the boards of PIMCO Commercial Mortgage Securities Trust, Inc. and StocksPLUS(R). He also serves as a trustee and chairman of the PIMCO Funds and the PIMCO Commercial Mortgage Securities Trust, Inc.\nDonald R. Kurtz. Mr. Kurtz serves on the Equity Board as an independent Member and as a member of the Constructive Termination Committee of the Partnership. Mr. Kurtz was a Director of TAG Inc. from May 1992 until November 1994. Since December 1994, he has been acting Managing Director of Domestic Equity Investments at General Motors Investment Management Corp. Prior thereto, he served as Vice President or Director, Internal Asset Management at General Motors Investment Management Corp. from January 1990 and at General Motors Corp. from February 1987 until December 1989.\nJohn O. Leasure. Mr. Leasure is a Senior Vice President of the Partnership and President and a Director of PADCo. Mr. Leasure was an Executive Vice President of the Partnership from November 1987 until November 1994 and was a member of the Partnership's Executive Operating Committee from October 1990 until November 1994. He was an Executive Vice President and Chief Operating Officer of PADCo from May 1990 to October 1990. He was a Director of TMAMI and Chief Operating Officer of the Partnership from November 1987 until October 1990. He was a Senior Vice President and a Director of Thomson McKinnon Securities Inc. (\"TMSI\") from July 1987 until January 1990. In 1990, TMSI filed for protection under Chapter 11 of the Bankruptcy Act.\nJames F. McIntosh. Mr. McIntosh serves on the Equity Board as an independent Director. He is currently the Executive Director of Allen, Matkins, Leck, Gamble & Mallory, a law firm, which position he has held from October 1994. From January 1981 to October 1994, he was Executive Director of Paul, Hastings, Janofsky & Walker, a law firm.\nDean S. Meiling. Mr. Meiling serves as a member of the Operating Board and as a Managing Director of PIMCO. Mr. Meiling was a Managing Director of PIMCO Inc. until November 1994. Mr. Meiling joined PIMCO Inc. in October 1977 and became a Senior Vice President in February 1982, a Principal in February 1984, and a Managing Director in May 1987. Mr. Meiling serves as a director and Vice President of StocksPLUS(R).\nDonald K. Miller. Mr. Miller serves as a member of the Equity Board, as an Assistant to the Chief Executive Officer of the Partnership and is President, Chief Executive Officer and the sole director of TAG Inc. Mr. Miller was Vice Chairman of the Partnership, Vice Chairman and a Director of TAG Inc. and a member of the Partnership's Executive Operating Committee until November 1994. From October 1990 until March 1993, he was Chairman, Chief Executive Officer and a Director of TAG Inc. and the Chairman and Chief Executive Officer of the Partnership and Chairman of its Executive Operating Committee. He was a Director of PADCo from May 1992 until November 1994. Mr. Miller is the Chairman of Greylock Financial Inc. and currently serves as Chairman of Christensen Boyles Corporation and as a Director of Huffy Corporation and RPM, Inc.\nJames F. Muzzy. Mr. Muzzy serves as a member of the Operating Board and as a Managing Director of PIMCO. Mr. Muzzy was a Managing Director of PIMCO Inc. until November 1994. Mr. Muzzy joined PIMCO Inc. in September 1971 and became a Director in February 1978 and a Managing Director in February 1982. Mr. Muzzy serves as a director of StocksPLUS(R).\nDaniel S. Pickett. Mr. Pickett serves as a member of the Operating Board and as a Managing Director of CCI. Mr. Pickett was a Senior Vice President and Director of Research for Columbus Circle Investors division of the Partnership until November 1994. He had been employed by the Partnership in similar capacities since 1988.\nWilliam F. Podlich, III. Mr. Podlich serves as a member of the Equity and Operating Boards and as a Managing Director of PIMCO. Mr. Podlich was a Managing Director of PIMCO Inc. until November 1994. Mr. Podlich joined PIMCO Inc. as a Director in August 1969 and became a Managing Director in February 1982. Mr. Podlich serves as a director of StocksPLUS(R).\nKenneth M. Poovey. Mr. Poovey is General Counsel of the Partnership, which position he has held since November 1994. He is currently a partner with the law firm of Latham & Watkins with which he has been affiliated since 1980.\nWilliam C. Powers. Mr. Powers serves as a member of the Operating Board and as a Managing Director of PIMCO. Mr. Powers was a Managing Director of PIMCO Inc. until November 1994 Mr. Powers joined PIMCO Inc. as a Vice President in January 1991 and became an Executive Vice President in April 1991 and a Managing Director in April 1993. Mr. Powers was a Senior Managing Director with Bear, Stearns & Company, an investment banking firm, from February 1988 to December 1990.\nRobert A. Prindiville. Mr. Prindiville is an Executive Vice President of the Partnership. Mr. Prindiville was President and a Director of TAG Inc. from October 1990 until November 1994. He was President of the Partnership until November 1994. He serves as President and a Trustee of Cash Accumulation Trust and of PIMCO Advisors Funds. He is Chairman and a Director of PADCo and has been a senior officer thereof since May 1990. Until October 31, 1990, he was a Director of TMAMI, which position he had held since January 1985. He was an Executive Vice President and a Director of TMSI from June 1987 to January 1990. He was a Director of Thomson McKinnon Inc. (\"TMI\") from December 1984 until January 1990. In 1990, each of TMI and TMSI filed for protection under Chapter 11 of the Bankruptcy Act.\nGlenn S. Schafer. Mr. Schafer serves as a member of the Equity Board. Mr. Schafer was the Executive Vice President and Chief Financial Officer of Pacific Mutual from April 1988 until he became President thereof in January 1995. Mr. Schafer also serves as a director and President of PFAMCo and as the CFO for StocksPLUS(R). He is a director and Chairman of United Planners Group, Inc.\nNewton B. Schott, Jr. Mr. Schott serves as Senior Vice President-Legal and Secretary of the Partnership. Mr. Schott was an Executive Vice President, Secretary and General Counsel of TAG Inc. from October 1990 to November 1994 and of the Partnership from September 1989 to November 1994. He currently is a Senior Vice President, Secretary and a Director of PADCo and has held senior positions with PADCo since May 1990. He was a Director of TMAMI from January 1985 until October 1990. He was Executive Vice President, Secretary, General Counsel and a Director of TMI from December 1984 until August 1992, Senior Executive Vice President, Secretary and Special Counsel of TMSI from December 1984 until January 1990, and a Director of TMSI from November 1980 to January 1990.\nIrwin F. Smith. Mr. Smith serves as a member of the Operating and Equity Boards and the Operating Committee of the Partnership and the Chairman, Chief Executive Officer and Chief Investment Officer of CCI. Mr. Smith was Chairman and Chief Executive Officer of the Partnership, Chairman of its Executive Operating Committee, Chairman, Chief Executive Officer and Chief Investment Officer of the CCI division, and Chairman, Chief Executive Officer and a Director of TAG Inc. from March 1993 until November 1994. From October 1990 until March 1993, he was Vice Chairman and a Director of TAG Inc. and Vice Chairman of the Partnership and a member of its Executive Operating Committee. He was a Senior Vice President of the Partnership from November 1987 until October 1990.\nThomas C. Sutton. Mr. Sutton serves as a member of the Equity Board. Mr. Sutton has been the Chairman and Chief Executive Officer of Pacific Mutual since January 1990 and a Director of Pacific Mutual since 1987. He also serves as a director of PIMCO Inc. and PFAMCo. He has been associated with Pacific Mutual since June 1965 and became its President in September 1987. Mr. Sutton is also a director of Pacific Equities Network, Mutual Service Corporation, Pacific Financial Holding Company and PM Realty Advisors, Inc.\nWilliam S. Thompson, Jr. Mr. Thompson serves as Chairperson of the Operating Board, as a member of the Equity Board and the Operating Committee, and as Chief Executive Officer and a Managing Director of PIMCO. Mr. Thompson was a Managing Director and the Chief Executive Officer of PIMCO Inc. until November 1994. Mr. Thompson joined PIMCO Inc. in April 1993. From February 1975 until April 1993, he was with Salomon Brothers Inc., an investment banking firm serving as a Managing Director starting in 1981.\nMr. Miller was a trustee of the PIMCO Advisors Funds and Cash Accumulation Trust from October 1990 until November 1994. Messrs. Leasure and Schott were trustees of such Funds prior to October 1990. Messrs. Prindiville and Schott were directors of TMI and Messrs. Prindiville, Leasure and Schott were directors of TMSI; in 1990 each of TMI and TMSI filed a petition in bankruptcy.\nTo the Partnership's knowledge, based solely on a review of the copies of reports furnished to the Partnership and written representations that no other reports were required, during the two fiscal years ended December 31, 1994 and 1993, there has been compliance with all filing requirements under Section 16(a) of the Securities Exchange Act of 1934, as amended, applicable to its officers, directors and greater than ten-percent beneficial owners.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ----------------------------------\nExecutive Cash Compensation ---------------------------\nThe following table sets forth the cash compensation paid or allocated with respect to the three years ended December 31, 1994 for services rendered to the Partnership (and its affiliates) in all capacities to the Chief Executive Officer and each of the Partnership's four most highly compensated executive officers:\n---------- (1) Amounts shown include amounts paid by PADCo.\n(2) Except for Mr. Cvengros, salary includes amounts deferred in the Partnership's 401(k) Savings and Investment Plan of $9,240 for 1994, $8,994 for 1993 and $8,728 for 1992.\n(3) Except for Mr. Cvengros, amounts shown are premiums on term life insurance ($750,000 face amount) and long-term disability purchased for person indicated and the amount of the Partnership's and\/or PADCo's discretionary and matching contributions to the Partnership's 401(k) Savings and Investment Plan. Mr. Cvengros' amount includes discretionary 401(k) contribution only.\n(4) Amount shown is the amount credited to Mr. Smith's Deferred Compensation Account pursuant to a plan which was cancelled in connection with the Consolidation. Mr. Smith relinquished his rights to $2,259,000 of deferred compensation which he would otherwise have been able to use to fund exercises of options.\n(5) Mr. Cvengros was awarded 100,000 Class A Limited Partnership Units and 100,000 Class B Limited Partnership Units in connection with the Consolidation. The units vest over a five-year period, pay distributions quarterly and had an aggregate value of $2,871,000 at December 31, 1994.\n(6) Options for the persons indicated were granted in 1993 and were amended in connection with the Consolidation to options on Class A Limited Partnership Units. In addition, Mr. Smith's options and 50% of the options granted to Messrs. Leasure, Schott, Girvan and Celentano were amended to reflect a fixed exercise price of $2.425 per unit. Except for Mr. Smith and Mr. Girvan, the options vest in the following percentages on December 31 of the years 1993 through 1998: 10%, 15%, 15%, 20%, 20% and 20%.\nMr. Smith's options were 50% vested on the date of the Consolidation and the remainder vests in equal semi-annual installments through December 31, 1998, subject to certain conditions relating to the terms of his employment. Mr. Girvan's options vest according to his Severance Agreement as more fully described elsewhere in this document.\nAll amounts have been restated to reflect the Partnership's 106% unit distribution in 1994.\nCompensation to key employees who are not executive officers may exceed the compensation paid to executive officers in any given year.\n----------\n(1) These options vest 20% per year on each December 31 through 1998.\n(2) Based on the twenty day average closing prices of LP Units on the New York Stock Exchange and discounted by 28.6% due to the subordinated distribution rights and limited liquidity of Class B Units.\n(3) Option values reflect Black-Scholes model output for options. The assumptions used in the model were expected volatility of 30% (based upon daily LP Unit price data for the twelve months ended November 15, 1994), risk-free rate of return of between 7.38% and 7.54%, the fixed exercise price and exercise date no later than the end of the vesting schedule.\n----------\n* Class B Unit options had no In-The-Money value as of December 31, 1994. (1) Options under the 1994 Unit Option Plan. (2) Options (Class I and Class II) under the 1993 Unit Option Plan.\n----------\n(1) Adjusted for the distribution of 1.06 Units per Unit effective October 1, 1994.\n(2) All such repricings were approved by Unitholder vote in connection with the Consolidation. All such options were formerly declining exercise price options and were amended to fixed exercise price options in the repricing.\nCOMPENSATION OF DIRECTORS -------------------------\nThe Partnership will pay members of the Equity Board (who are not employees of the Partnership or of an Investment Management Firm) a $20,000 annual retainer plus $750 per in-person meeting ($250 per conference call meeting) of the Equity Board attended and for each meeting of a committee of the Equity Board; the Partnership also paid $7,932 for 1994 for medical benefits for Mr. and Mrs. Auch. Members who are employees of the Partnership or any Investment Management Firm are not entitled to any additional compensation from or the Partnership for their services as Board members.\nCOMPENSATION OF GENERAL PARTNER -------------------------------\nThe General Partner does not receive any compensation from the Partnership for services rendered to the Partnership as General Partner. Rather, the General Partner's interest in profits and losses of the Partnership is based on the number of Units it holds. Upon liquidation, the liquidating distributions to the General Partner will be based on the number of Units it holds.\nThe Partnership pays for substantially all expenses incurred by PIMCO GP in performing its activities as general partner , including the cost of directors' and officers' liability insurance.\nCOMPENSATION PURSUANT TO CONTRACT ---------------------------------\nWilliam D. Cvengros, Chief Executive Officer and President of the Partnership, has entered into a four-year Employment Agreement with the Partnership under which he will receive an annual base salary of $500,000 and a guaranteed annual bonus of $500,000. Mr. Cvengros is also eligible to receive a discretionary bonus in the target range of $200,000 to $500,000 (which amount may be increased or decreased at the recommendation of the Operating Board and upon the approval of the Equity Board). The Partnership granted Mr. Cvengros options to purchase up to 400,000 Class B Units under the 1994 Unit Option Plan, described below. Mr. Cvengros has also been granted Units under the Restricted Unit Plan described below. Mr. Cvengros' contract provides certain benefits in connection with certain terminations by the Partnership. If his contract is terminated on December 31, 1996, he receives $500,000, plus all accrued but unpaid salary and guaranteed bonus plus any discretionary bonus which may be declared. If his contract is terminated without cause prior to December 31, 1996, he receives accrued but unpaid salary and guaranteed bonus plus pro-rata guaranteed bonus to date of termination plus any discretionary bonus that may be declared plus a severance payment of the greater of (i) $500,000 or (ii) a continuation until December 31, 1996 of his salary and guaranteed bonus. If his contract is terminated without cause between December 31, 1996 and December 31, 1998, he shall be entitled to the same payments described in the prior sentence except that the amount of the severance payment shall be fixed at $500,000. In the event of any such terminations, all his options and Restricted Units which have not vested shall automatically vest.\nIrwin F. Smith, a member of the Operating Committee, Operating Board and Equity Board, as well as Chief Executive Officer of CCI, entered into an Employment Agreement with CCI through December 31, 1998, under which he will receive an annual base salary of $350,000, which will increase to $400,000 on January 1, 1997. During the term of his Employment Agreement, Mr. Smith will be prohibited from diverting or taking away funds with respect to which CCI is performing investment management services or from competing with the investment management services offered by the Partnership or any of the Investment Management Firms. Upon a voluntary termination or a termination for cause, until January 1, 1999, Mr. Smith will not engage in certain prohibited competition activities and until December 31, 2000, Mr. Smith will also be prohibited from soliciting clients or soliciting or working with professional employees of CCI. Mr. Smith's existing option agreement was amended in certain respects. Mr. Smith is also eligible to participate in the profit sharing plan adopted by CCI.\nWilliam S. Thompson, Jr., a member of the Operating Committee, Operating Board and Equity Board, entered into an Employment Agreement with PIMCO under which he will receive an annual base salary (including taxable fringe benefits) of $236,000. In addition, Mr. Thompson will be eligible to participate in the profit sharing plan adopted by PIMCO. Mr. Thompson's Employment Agreement provides that, during his term of employment with PIMCO, he will be prohibited from diverting or taking away funds with respect to which PIMCO is performing investment management services and from competing with the investment management services offered by the Partnership or any of the Investment Management Firms. The Partnership also granted Mr. Thompson options to purchase up to 230,000 Class B Units under the 1994 Unit Option Plan.\nJohn O. Leasure, a Senior Vice President of the Partnership and President and a Director of PADCO, entered into an Employment Agreement with the Partnership through December 31, 1996 under which he will receive an annual base salary of $275,000 and an annual bonus of at least 50% of such amount (with such bonus expected to be within the range of 50% to 150% of such salary). In the event of an Involuntary Termination (as defined) 100% of his options under the 1993 Unit Option Plan (described below) and at least 60% of his options under the 1994 Unit Option Plan (described below) will vest.\nKenneth M. Poovey, General Counsel of the Partnership, will act in such capacity in return for a monthly payment of $25,000 (plus travel expenses) to his law firm, Latham & Watkins. This arrangement will be reviewed quarterly and adjusted if appropriate. In addition, his firm will also bill the Partnership for the fees and expenses of other professionals employed by such firm who render services to the Partnership at the firm's usual rates.\nBrian J. Girvan, a Senior Vice President of the Partnership, has entered into a Severance Agreement with the Partnership which provides that, until his termination date (currently anticipated to be August 31, 1995), he will be paid a salary at his 1995 rate and a bonus (pro-rata based upon his 1994 regular bonus) payable in July and the remainder at termination. He will also be paid a retention bonus pro rata for time worked in 1995 based upon his 1995 base salary, a transition bonus in the range of $50,000 to $100,000 and a severance payment equal to four weeks salary for each year worked starting in 1983. With respect to his options under the 1993 Unit Option Plan, the Class II options with an exercise price of $4.855 vested and are exercisable as of January 20, 1995 and the Class I options with an exercise price of $2.425 vest and become exercisable on June 30, 1995. With respect to his options under the 1994 Unit Option Plan, 50% of his options vest on his termination date.\nRESTRICTED UNIT GRANTS TO MANAGEMENT ------------------------------------\nThe Partnership has a Restricted Unit Plan for the benefit of certain key employees of the Partnership pursuant to which 100,000 Class A Units and 100,000 Class B Units were awarded to William D. Cvengros and 25,000 Class A Units and 25,000 Class B Units were awarded to Steven T. Bailey. No additional Units are available for award under the Restricted Unit Plan. Such Class A Units or Class B Units are forfeited to the General Partner in the event of certain terminations of employment with the Partnership prior to vesting; this arrangement was agreed upon because Class A Units and Class B Units that otherwise would have been issued to the General Partner in the Consolidation were allocated to the Restricted Unit Plan.\nOPTION PLANS ------------\nThe Partnership adopted the 1994 Class B LP Unit Option Plan (the \"Option Plan\") to provide incentives and rewards to certain key employees of the Partnership and\/or the Investment Management Firms. The Option Plan is administered by the Unit Incentive Committee of the Equity Board of the Partnership. Currently there are outstanding options to purchase an aggregate of 5,223,000 Class B Units most of which were issued at an exercise price equal to 71.4% of the average trading price of the Partnership's limited partner units for the 20 trading day period prior to the closing of the Consolidation to officers of the Partnership, Managing Directors of the Investment Management Firms and certain other employees. These options generally will vest in five equal annual installments beginning December 31, 1994 and generally are not exercisable until January 1, 1998. Options to purchase an additional 377,000 Class B Units are available under the Option Plan at exercise prices to be determined by the Unit Incentive Committee, which consists of members of the Equity Board who are not eligible to receive grants of options under the Option Plan. As part of the Consolidation, the Chief Executive Officer and two of the Investment Management Firms have the right to recommend to the Unit Incentive Committee the persons to whom an aggregate of 127,000 of such 377,000 remaining options shall be granted.\nIn addition, 2,442,130 options are outstanding under the Partnership's 1993 Unit Option Plan for the purchase of Class A Units at prices ranging from $2.425 to $4.855 per Class A Unit. It is not expected that any further options will be granted under the 1993 Unit Option Plan.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -------------------------------------------------------------------------\nThe following table sets forth information regarding beneficial ownership of the Partnership's GP Units, Class A Units and Class B Units after giving effect to the Consolidation and the Offering by each person who, to the Partnership's knowledge, is the beneficial owner of more than 5% of a class of Units and of all Units as a single class, each person who may be deemed to be a director of the Partnership, the CEO of the Partnership and the Partnership's four most highly compensated executive officers and all officers and persons who may be deemed to be directors of the Partnership as a group. Except as indicated, the address of each person or entity listed below is 840 Newport Center Drive, Newport Beach, California.\n____________\n* Less than 1%\n(1) Each of the persons and entities listed disclaims beneficial ownership of any Units except to the extent that it has a pecuniary interest in such items.\n(2) Includes (i) 16,735,322 Class A Units held of record by PIMCO GP; (ii) 800,000 Class A Units which may be acquired by PIMCO GP pursuant to the Partnership Agreement upon conversion of the 800,000 GP Units of the Partnership held by PIMCO GP should PIMCO GP cease to be the general partner of the Partnership; and (iii) 6,119,391 Class A Units held of record by TAG Inc., all of the common stock of which (0 of the voting securities) is owned by PIMCO GP. Excludes 1,252,000 Class A Units originally issued to PIMCO GP in connection with the Consolidation which were distributed to PIMCO Inc. in accordance with its capital account. Includes (i) 21,875,000 Class B Units held of record by PIMCO GP and (ii) 8,260,826 Class B Units held of record by TAG Inc.\n(3) Includes 800,000 GP Units, 27,294,391 Class A Units and 32,835,826 Class B Units beneficially owned by PFHC which may be deemed to be beneficially owned by Pacific Mutual because PFHC is a wholly owned subsidiary of Pacific Mutual. Address: 700 Newport Center Drive, Newport Beach, CA 92660.\n(4) Includes (i) the 800,000 GP Units, 26,503,916 Class A Units and 32,835,826 Class B Units beneficially owned by PFAMCo which may be deemed to be beneficially owned by PFHC because PFAMCo is a wholly owned subsidiary of PFHC; and (ii) 790,475 Class A Units held of record by PFHC over which PFHC holds sole voting and disposition power. Address: 700 Newport Center Drive, Newport Beach, CA 92660.\n(5) Includes (i) the 800,000 GP Units, 28,819,747 Class A Units and 30,135,826 Class B Units beneficially owned by PFAMCO Inc. which may be deemed to be beneficially owned by PIMCO Inc. because PIMCO Inc. is a wholly owned subsidiary of PFAMCo; (ii) 200,000 Class A Units held of record by PFAMCo and issued to PFAMCo in exchange for the contribution to the Partnership of the operating business of PFAMCo and the capital stock of Blairlogie Ltd., over which PFAMCo holds sole voting and disposition power; and (iii) an aggregate of 2,341,689 Class A Units issued as follows: Cadence Inc. (32,652 Class A Units), Cadence LP (1,275,000 Class A Units), NFJ Inc. (18,404 Class A Units), NFJ LP (506,211 Class A Units), Parametric Inc. (18,562 Class A Units), and Parametric LP (490,860 Class A Units) in exchange for the contribution to the Partnership of the operating business of Cadence Inc., NFJ Inc., and Parametric Inc. as part of the Consolidation which may be deemed beneficially owned by PFAMCo because Cadence Inc., NFJ Inc., and Parametric Inc., are wholly owned subsidiaries of PFAMCo and Cadence Inc., NFJ Inc., Parametric Inc., in turn are the general partners of Cadence LP, NFJ LP, and Parametric LP, respectively. Also includes 2,700,000 Class B Units owned by the foregoing. As general partners, Cadence Inc., NFJ Inc., and Parametric Inc., have shared investment and disposition powers with respect to Units held by Cadence LP, NFJ LP, and Parametric LP, respectively. Address: 700 Newport Center Drive, Newport Beach, CA 92660.\n(6) Includes (i) 800,000 GP Units, 23,654,713 Class A Units beneficially owned by PIMCO GP; and (ii) 165,034 Class A Units of the 1,252,000 Class A Units distributed by PIMCO GP to PIMCO Inc. and not exchanged with certain selling Unitholders in the Offering for Series A Preferred Stock of TAG Inc., over which PIMCO Inc., holds sole voting and disposition power. PIMCO Inc. is a general partner of PIMCO GP and shares investment and voting power over the Class A Units owned directly by PIMCO GP with PIMCO Partners, LLC (\"PIMCO LLC\"), PIMCO GP's managing general partner, and as a result may be deemed to own beneficially the Class A Units owned directly by PIMCO GP. In connection with the Offering, PIMCO Inc. exchanged 1,086,966 Class A Units for 1,168,780 shares of Series A Preferred Stock of TAG Inc., thereby acquiring an indirect beneficial ownership interest in 1,168,787 Class A Units held by TAG Inc. and attributable to such Series A Preferred Stock. Such 1,168,787 Class A Units are included in the 6,119,391 Class A Units deemed beneficially owned by PIMCO GP. Class A Units\n(originally issued to PIMCO GP, distributed to PIMCO Inc., and exchanged by PIMCO Inc. in accordance with an exchange agreement for Series A Preferred Stock of TAG Inc.) were issued in connection with the Consolidation to certain selling Unitholders in the Offering, and subsequently sold by such selling Unitholders in the Offering. Also excludes 2,313,034 Class A Units originally issued to PIMCO GP and in connection with the Consolidation and sold in the Offering. Includes 30,135,826 Class B Units beneficially owned by PIMCO GP. Address: 700 Newport Center Drive, Newport Beach, CA 92660.\n(7) Includes (i) 142,480 Class A Units held of record by PIMCO LLC; and (ii) 800,000 GP Units, 23,654,713 Class A Units and 30,135,826 Class B Units which may be considered to be beneficially owned by PIMCO GP, and which may be deemed to be beneficially owned by PIMCO LLC, which is a general partner of PIMCO GP.\n(8) Member of Equity Board.\n(9) Member of Operating Board.\n(10) Includes Class A Units which may be acquired upon exchange of Series A Preferred Stock of TAG Inc. based on a variable conversion rate (initially .93 Class A Units per share of Series A Preferred Stock during 1994). Includes Class B Units that may be acquired in limited circumstances upon exchange of Series B Preferred Stock of TAG Inc. on a one-for-one basis. The individual disclaims beneficial ownership of any Class B Units.\n(11) Mr. Cvengros is Chief Executive Officer of the Partnership, a member of the Equity Board and the Operating Board and the Chairperson of the Operating Committee.\n(12) Mr. Gerken is the Chairperson of the Equity Board.\n(13) Includes (i) 70,000 shares held in trusts of which the individual is trustee and as to which he has sole voting and disposition power, (ii) 142,480 Class A Units held of record by PIMCO LLC, which may be deemed to be beneficially owned by the individual, who is a member of PIMCO LLC; and (iii) 800,000 GP Units, 23,654,713 Class A Units and 30,135,826 Class B Units which may be considered to be beneficially owned by PIMCO GP, of which PIMCO LLC is a general partner.\n(14) Includes (i) 142,480 Class A Units held of record by PIMCO LLC, which may be deemed to be beneficially owned by the individual, who is a member of PIMCO LLC; and (ii) 800,000 GP Units, 23,654,713 Class A Units and 30,135,826 Class B Units which may be considered to be beneficially owned by PIMCO GP, of which PIMCO LLC is a general partner.\n(15) Includes 572,222 Class A Units which may be acquired upon exercise of options within 60 days. Mr. Smith is a member of the Operating Committee.\n(16) Includes (i) 3,000 shares held in trusts of which the individual is trustee and as to which he has sole voting and disposition power, (ii) 142,480 Class A Units held of record by PIMCO LLC, which may be deemed to be beneficially owned by the individual, who is a member of PIMCO LLC; and (iii) 800,000 GP Units, 23,654,713 Class A Units and 30,135,826 Class B Units which may be considered to be beneficially owned by PIMCO GP, of which PIMCO LLC is a general partner. Mr. Thompson is the Chairperson of the Operating Board and a member of the Equity Board and the Operating Committee.\n(17) Mr. Prindiville is an Executive Vice President of the Partnership.\n(18) Represents aggregate Units issued pursuant to the Partnership's Restricted Unit Plan. These Units vest in 5 equal annual installments on December 31, 1994, 1995, 1996, 1997 and 1998. The officer is entitled to distributions and voting rights with respect to such Units prior to vesting. Such Units could be forfeited to the General Partner of the Partnership in the event of certain terminations of employment with the Partnership prior to vesting.\n(19) Includes 51,500 Class A Units which may be acquired upon exercise of options.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS --------------------------------------------------------\nANTICIPATED FUTURE RESTRUCTURING OF THE PARTNERSHIP\nGeneral. Under current law, the Partnership will cease being classified as a partnership for federal income tax purposes, and will be treated as a corporation, immediately after December 31, 1997 (or sooner if the Partnership adds a substantial new line of business or otherwise fails to satisfy certain requirements) unless the Partnership's limited partner interests cease to be publicly traded prior to such time. As a corporation, the Partnership would be subject to tax on its income and its shareholders would be subject to tax on distributions. In an effort to preserve partnership tax treatment after December 31, 1997 for the nonpublic Unitholders, the Partnership Agreement confers on the General Partner broad authority to effect one or more Restructurings of the Partnership in connection with, or in anticipation of, such a change in tax status.\nWhile the precise form of a Restructuring cannot now be determined and will depend on the facts and circumstances existing at the time a Restructuring is implemented, it is generally expected that, following a Restructuring, public Unitholders will hold their equity participation in the business of the Partnership through publicly traded stock issued by an entity treated as a corporation for federal income tax purposes, allowing the nonpublic Unitholders to continue to hold their equity participation in the Partnership directly or through some other entity treated as a partnership for federal income tax purposes. The Partnership does not currently expect to change its distribution policy following a Restructuring, and it is anticipated that the corporate entity generally would distribute all cash received by it from the Partnership other than cash needed for payment of taxes and operational expenses. Because of federal, state, and other taxes on such entity's income, cash available for dividends to the holders of the corporate entity's publicly traded securities would be substantially less than the cash distributed to the corporate entity by the Partnership. If the Restructuring were carried out in the manner currently anticipated, under current law the amount of such taxes imposed on such entity would be reduced by the entity's carrying over the balance of the amortizable Section 197 Intangibles associated with the publicly traded Class A Units immediately prior to the Restructuring and claiming amortization deductions with respect to such amount. No assurance can be given, however, that the Restructuring will take a form that will allow this result.\nWhile the Partnership Agreement provides that the General Partner may impose restrictions on the transfer of Units as part of a Restructuring (which could have the effect of preserving the Partnership's status as a partnership), the General Partner currently believes that trading restrictions will not be necessary to accomplish the Restructuring absent legal or other developments. It is anticipated that the holders of interests in a partnership entity will have the right from time to time to exchange the partnership interests for equity interests in the corporate entity in order to achieve liquidity.\nThe Restructuring in the form currently anticipated could result in the publicly traded corporation being classified as an \"investment company\" under the Investment Company Act. If the corporation is so classified, the corporation would be required to comply with the terms of the Investment Company Act which, among other things, could entail additional expenditures and restrictions on transactions with affiliates. In order to avoid such status, the General Partner could cause the corporation to become a general partner of the Partnership, in which case the corporation would be jointly and severally liable with the General Partner for obligations of the Partnership.\nThe federal income tax consequences of a Restructuring will depend upon the final form of the Restructuring and therefore it is not possible to predict the tax consequences of a Restructuring. However, assuming the public Unitholders hold their interest in an entity treated as a corporation for federal income tax purposes, whether as a result of a Restructuring or by operation of law on January 1, 1998, it is generally expected that the exchange or conversion pursuant to which public Unitholders become treated as shareholders in a corporation for federal income tax purposes will be treated as a tax-free transaction under Code Section 351, provided that certain requirements, some of which are beyond the control of the Partnership and the General Partner, are satisfied. In general if the transaction qualifies under Code Section 351, (i) the holding periods for the shares received by the public Unitholders will include the holding periods for their Class A Units, (ii) the public Unitholders will have an\ninitial tax basis in their shares equal to their adjusted tax basis in their Class A Units immediately prior to the exchange or conversion (reduced by their share, if any, of Partnership liabilities immediately prior to such exchange or conversion) and (iii) gain (or loss) on disposition of shares of any such corporate entity will be capital gain or loss (long-term or short-term as the case may be).\nRestructuring Authority. Because of possible changes in tax law or regulations and other factors, it cannot now be predicted with certainty what actions the General Partner may take in connection with a Restructuring, if any. Section XVIII of the Partnership Agreement confers on the General Partner broad power and authority to take all such actions it may deem necessary or appropriate in connection with, in anticipation of or to effect a Restructuring, without consent of or other action on the part of any other Unitholder and whether or not such actions or omissions may treat public Unitholders differently than nonpublic Unitholders and result in different and more favorable treatment of the nonpublic Unitholders. The Partnership Agreement imposes no obligations on the General Partner to effect any Restructuring and gives the General Partner authority to choose the timing (subject to certain limitations) of a Restructuring. The Partnership Agreement provides no appraisal or similar rights to any Unitholder with respect to any Restructuring, nor does it require that the General Partner obtain an opinion as to the fairness of any Restructuring to the public Unitholders. The General Partner has advised the Partnership that it does not currently contemplate that any such opinion will be delivered to Unitholders at the time of a Restructuring.\nThe Partnership Agreement provides that, in effecting a Restructuring, the General Partner may not subject any holder of a Unit to liability to Partnership creditors without such holder's consent.\nLimited Duty to Unitholders Related to Restructuring. In order to assure that it is clear that the General Partner may effect the anticipated Restructuring in a form which will preserve partnership taxation for the nonpublic Unitholders even though the public Unitholders will be subject to corporate level tax, the Partnership Agreement releases the General Partner and its directors, officers, employees and affiliates from any liability based upon actions taken or omitted to be taken by the General Partner with respect to any Restructuring, to the extent that such actions or omissions may treat public Unitholders differently and less favorably than nonpublic Unitholders. Section 6.13(a) provides that the General Partner shall not be liable for errors in judgment or for breach of fiduciary duty unless it is proved by clear and convincing evidence 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 or was undertaken with reckless disregard for the best interests of the Partnership.\nThe Partnership is organized under the Delaware Revised Uniform Limited Partnership Act (the \"Delaware Act\"). Section 17-1101(d) of the Delaware Act expressly provides that, to the extent that at law or in equity, a partner has duties (including fiduciary duties) and liabilities relating thereto to a limited partnership or to another partner, the partner's duties and liabilities may be expanded or restricted by provisions in the partnership agreement. General partners of a Delaware limited partnership have been held in court cases to owe duties of ordinary care and of utmost good faith, fairness and loyalty to the partnership and to the other partners. The effect of Section 6.13 is to substitute the requirement that the General Partner act in good faith for the more comprehensive duties and liabilities that the General Partner would otherwise owe to the Partnership and to any other partner with respect to any Restructuring.\nLOSS REIMBURSEMENT AGREEMENTS\nAs part of the Consolidation, PFAMCo transferred to the Partnership certain assets and liabilities of PFAMCo (excluding the businesses of the Investment Management Firms) (the \"PFAMCo Operation\"). Until December 31, 1996, PFAMCo has agreed to reimburse the Partnership for losses up to an aggregate of $2 million incurred by the PFAMCo Operation.\nIn addition, from the date of the Consolidation until the end of 1996, if the Subpartnership conducting the business of Blairlogie (the \"Blairlogie Subpartnership\") incurs net losses as a result of ordinary business operations, PFAMCo has agreed to pay the amount of such net losses to the Blairlogie Subpartnership. If the Blairlogie Subpartnership subsequently earns net profits as a result of ordinary business operations, 50% of these profits will be paid to PFAMCo until the amount of any loss reimbursement, plus accured interest, has been repaid. The Partnership has retained the right to dispose of or liquidate the Blairlogie Subpartnership without recourse for such advances by PFAMCo after December 31, 1996.\nINDEBTEDNESS OF MANAGEMENT\nBrent R. Harris and William C. Powers, each a Managing Director of PIMCO and Member of the Operating Board, are indebted to PIMCO for short-term, interest-bearing loans amounting to $88,650 and $91,550, respectively.\nOTHER CONFLICTS\nWithdrawal and Removal of General Partner. The general partner has agreed that it may withdraw as general partner of the Partnership only if such withdrawal is approved by holders of a majority of the LP Units (other than the general partner and its Affiliates) and if counsel renders an opinion that the limited partners do not lose their limited liability pursuant to Delaware law or the Partnership Agreement (a \"Limited Liability Determination\"), and provides certain other opinions relating to the status of the Partnership as a partnership for federal income tax purposes (a \"Tax Determination\") and the continuation of the Partnership's advisory agreements (an \"Assignment Determination\"). The general partner may be removed by a vote of Unitholders holding 80% or more of all outstanding Units if a successor general partner is appointed, counsel makes a Limited Liability Determination, a Tax Determination and an Assignment Determination and such removal is approved by the successor general partner. However, by virtue of PIMCO GP's ownership of Units, PIMCO GP can veto any such removal. Also, interests in the general partner may be sold or transferred without any prior approval or consent of the holders of Class A Units.\nIn the event of withdrawal or removal of the general partner, the general partner will have the option to require a successor general partner (if any) to acquire all of the general partner's GP units for a cash payment equal to their fair value as of the effective date of the general partner's departure. Such value will be determined by agreement between the general partner and the successor general partner or, if no agreement is reached, by an independent investment banking firm or other independent expert selected by the general partner and the successor general partner (or if no expert can be agreed upon, by the expert chosen by agreement of each of the experts selected by each such general partner). If the option is not exercised by the general partner, the GP Units of the general partner will be converted into an equal number of Class A Units.\nThe general partner, TAG Inc., certain affiliates of PIMCO GP and Pacific Mutual and certain individuals have registration rights as to Units that they own or have the right to acquire.\nIndemnification. The Partnership Agreement provides that the Partnership will indemnify the general partner or any general partner which has withdrawn or been removed (a \"Departing Partner\"), any Person (as defined) who is or was an Affiliate of the general partner or any Departing Partner each shareholder of the general partner or of the parent company of the general partner, shareholder or the general partner or of any departing general partner and any member of the Equity Board, Operating Board or Operating Committee, any officer of the Partnership or any of its Investment Management Firms or divisions. The Partnership may also enter into indemnification agreements with certain other Persons.\nThe Partnership Agreement also provides that neither general partner nor any indemnitee will be liable to the Partnership or the Unitholders for errors in judgment or for breach of fiduciary duty (including breach of any duty of care or any duty of loyalty) unless it is proved by clear and convincing evidence 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 or was undertaken with reckless disregard for the best interests of the Partnership.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K -------- ----------------------------------------------------------------\n(a) (1) Financial Statements. --------------------- Financial Statements of the Registrant are listed in \"Index to Financial Statements\" on page 31 and are filed as part of this Report.\n(2) Financial Statement Schedules. ------------------------------ There are no Financial Statement Schedules of the Registrant filed as part of this Report.\n(3) Exhibits: ---------\n2.1 Amended and Restated Agreement and Plan of Consolidation of PIMCO Advisors L.P. dated effective as of July 11, 1994.\/1\/\/ -\n3.1 Amended and Restated Certificate of Limited Partnership of Registrant.\n3.2 Amended and Restated Agreement of General Partnership of PIMCO Partners, G.P. (\"PIMCO GP\").\/1\/\/ -\n4.1 Amended and Restated Agreement of Limited Partnership of Registrant dated October 31, 1994.\/1\/\/ -\n4.2 Specimen Class A LP Unit Certificate.\/2\/\/\n4.3 Specimen Class B LP Unit Certificate.\/2\/\/\n4.4 9.01% Secured Nonrecourse Note Agreement, dated as of November 14, 1994, by and between PIMCO GP and Thomson Advisory Group Inc. (\"TAG Inc.\").\/1\/\/ -\n4.5 PIMCO Pledge and Security Agreement, dated as of November 14, 1994, by and between PIMCO GP and Citibank, N.A.\/1\/\/ -\n4.6 TAG Pledge and Security Agreement, dated as of November 14, 1994, by and among TAG Inc., PIMCO GP and Citibank, N.A.\/1\/\/ -\n4.7 Collateral Agency Agreement, dated as of November 14, 1994, by and among Purchasers identified therein, PIMCO GP and Citibank, N.A.\/1\/\/ -\n4.8 Registration Rights Agreement, dated as of November 15, 1994, by and among the Funds, PFAMCo Parties and Individuals, as such terms are defined therein.\/1\/\/ -\n4.9 Exchange Agreement, dated November 14, 1994, by and among PIMCO GP, TAG Inc. and the Registrant.\/1\/\/ -\n4.10 Custodial Account Agreement, dated as of November 15, 1994, by and among PIMCO GP and Citibank, N.A.\/1\/\/ -\n4.11 Form of 9.01% Secured Nonrecourse Note due December 15, 2001.\/1\/\/ -\n4.12 Form of Intercompany Note Secured Nonrecourse Demand Note.\/1\/\/ -\n4.13 PFAMCo Stock Exchange Agreement dated November 15, 1994.\/1\/\/ -\n4.14 Amended and Restated Certificate of Incorporation of TAG Inc.\/1\/\/ -\n10.1 Cvengros Employment Agreement.\/2\/\/\n10.2 Smith Employment Agreement.\/2\/\/\n10.3 Chiboucas Employment Agreement.\/2\/\/\n10.4 Form of Manager Employer Agreement.\/2\/\/\n10.5 Profit Sharing Plan for Pacific Investment Management Company.\n10.6 Profit Sharing Plan for Columbus Circle Investors.\/2\/\/\n10.7 Form of Profit Sharing Plan for Investment Management Firms.\/2\/\/\n10.8 PFAMCo Loss Reimbursement Agreement.\/2\/\/\n10.9 Blairlogie Loss Reimbursement and Recapture Agreement.\/2\/\/\n10.10 Thomson Advisory Group L.P. 1993 Unit Option Plan (as amended through April 20, 1993).\/3\/\/\n10.11 Award of Options dated March 10, 1993 to Irwin F. Smith.\/4\/\/ -\n10.12 Smith Option Amendment Agreement.\/2\/\/\n10.13 Form of Class I Option Amendment Agreement.\/2\/\/\n10.14 Form of Class II Option Amendment Agreement.\/2\/\/\n10.15 Form of PIMCO Advisors L.P. 1994 Class B LP Unit Option Plan.\/5\/\/ -\n10.16 Form of Option Agreement for Item 10.15. \/5\/\/ -\n10.17 PIMCO Advisors L.P. Restricted Unit Plan.\/2\/\/\n10.18 (a) Thomson Advisory Group 401(k) Savings and Investment Plan.\/6\/\/ - (b) First Amendment to the Thomson Advisory Group 401(k) Savings and Investment Plan.\/7\/\/ - (c) Thomson Advisory Group 401(k) Savings and Investment Plan Volume Submitter Amendment.\/7\/\/ - (d) Consolidation Transaction Amendment. (e) Third Amendment to the Thomson Advisory Group 401(k) Savings and Investment Plan. (f) Fourth Amendment to the PIMCO Advisors 401(k) Savings and Investment Plan.\n10.19 TAG Fund\/Administrative Incentive Bonus Plan.\/8\/\/ -\n10.20 Form of Indemnification Agreement executed by certain officers of the Registrant and certain directors of Thomson McKinnon Asset Management Inc.\/9\/\/ -\n10.21 Form of Indemnification Agreement executed by certain directors and\/or officers of TAG Inc.\/10\/\/ --\n10.22 Form of Amendment No. 1 to Indemnification Agreement (Exhibit 10.20 hereto).\/11\/\/ --\n10.23 Employment Agreement between PIMCO Advisors L.P. and John O. Leasure.\n10.24 Severance Agreement with Brian J. Girvan.\n23.1 Consent of Deloitte & Touche LLP.\n__________ 1\/ Filed as an Exhibit to Schedule 13D of PIMCO Partners, G.P. filed November - 25, 1994 and incorporated herein by reference. 2\/ Filed as an Exhibit to the Registrant's Report on Form 8-K dated July 11, - 1994 and incorporated herein by reference. 3\/ Filed as an Exhibit to Registrant's Report on Form 10-Q for the quarter - ended March 31, 1993 and incorporated herein by reference. 4\/ Filed as an Exhibit to Registrant's Report on Form 10-K for the year ended - December 31, 1992 and incorporated herein by reference. 5\/ Filed as an Exhibit to Registrant's Registration Statement on Form S-4 (File - No. 33-84914) and incorporated herein by reference. 6\/ Filed as an Exhibit to Registrant's Report on Form 10-K for the year ended - December 31, 1991 and incorporated herein by reference. 7\/ Filed as an Exhibit to Registrant's Report on Form 10-K for the year ended - December 31, 1993 and incorporated herein by reference. 8\/ Filed as an Exhibit to Registrant's Report on Form 10-K for the year ended - December 31, 1990 and incorporated herein by reference. 9\/ Filed as an Exhibit to Registrant's Report on Form 10-Q for the quarter - ended June 30, 1990 and incorporated herein by reference. 10\/ Filed as an Exhibit to Registrant's Report on Form 10-Q for the quarter -- ended September 30, 1990 and incorporated herein by reference. 11\/ Filed as an Exhibit to Registrant's Report on Form 10-Q for the quarter -- ended March 31, 1991 and incorporated herein by reference.\n(b) Reports on Form 8-K. The Registrant filed the following -------------------- reports on Form 8-K during the fourth quarter of 1994:\n(i) a report dated November 15, 1994 indicating that the Consolidation had been consummated; describing the funding source for the TAG Inc. recapitalization; and providing information concerning the beneficial ownership of the Partnership's securities after the Consolidation and the Offering; and\n(ii) a report dated December 15, 1994 indicating that Deloitte & Touche LLP had been appointed as the Partnership's auditors to replace Coopers & Lybrand L.L.P.\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.\nPIMCO ADVISORS L.P.\nBy: \/S\/ William D. Cvengros ---------------------------------- William D. Cvengros, President and Chief Executive Officer\nDate: March 29, 1995\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.\nTHOMSON ADVISORY GROUP L.P. FORM 10-K EXHIBIT INDEX","section_15":""}
{"filename":"791348_1994.txt","cik":"791348","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nLone Star Technologies, Inc.'s (\"LST\") operating subsidiary, Lone Star Steel Company (\"Steel\"), serves two business segments: oilfield products and services, comprised of casing, tubing, and line pipe, are manufactured and marketed globally to the oil and gas drilling industry; and, industrial products consist of specialty tubing and flat rolled steel which are manufactured and provided to general industrial markets.\nLST, a management and holding company, was incorporated in Delaware in 1986 and became the holding company of Steel, pursuant to Steel's merger with a wholly owned subsidiary of LST. In 1991, Steel emerged from bankruptcy, having operated as debtor in possession under Chapter 11 of the U.S. Bankruptcy Code since 1989. Under the Plan of Reorganization, a major creditor group received 19.5 percent of the common equity of Steel. LST's consolidated balance sheets reflect this reduction of equity ownership in Steel by including \"minority interest in Steel\" in the liability section, and LST's consolidated statements of earnings are adjusted by the minority interest participation in Steel's earnings or losses.\nIn August, 1988, LST acquired, for $48 million, the stock of American Federal Bank, F.S.B. (\"AFB\"), a newly created, federally chartered savings bank. In November, 1993, LST sold the stock of AFB to Guaranty Federal Bank, F.S.B. (\"GFB\") for $155.7 million, of which LST received $135.7 million in cash on the sale date and $5.0 million in November, 1994. Fifteen million dollars remain in escrow to provide for payment of certain claims that could be filed by GFB under the terms of the sale agreement. The accompanying consolidated financial statements reflect AFB as a discontinued operation.\nLINES OF BUSINESS INFORMATION\nIn the last three years, segment revenues were as follows:\nAdditional segment information is included in Note B to the consolidated financial statements.\nOILFIELD PRODUCTS AND SERVICES. Steel manufactures, markets, stores, and transports oil country tubular goods (\"OCTG\") and line pipe.\nOCTG manufactured by Steel includes a wide size and chemistry range of electric resistance welded (\"ERW\") high-quality casing and tubing for oil and gas drilling and production. Casing, about 75 percent of all OCTG tonnage sold by Steel, is the structural retainer for the walls of oil and gas wells. It also serves to prevent pollution of nearby water reservoirs and to prevent contamination of a well's production. Casing is generally not removed after it has been installed. Production tubing is installed within the casing to convey oil and gas to the surface.\nDemand for OCTG is affected by drilling activity which is driven by customers' expectations of future oil and gas prices and political factors such as energy and trade policies. Domestic drilling activity was essentially unchanged in 1994 from the prior year, according to the average number of rigs operating in this country as measured by Baker Hughes. Steel's open orders for OCTG at December 31, 1994, were unchanged from the year-ago level. Steel continued its efforts to penetrate global markets, and 7 percent of its shipments in 1994 were used outside the lower 48 United States. Removal of trade barriers, specifically the North American Free Trade Agreement, should create positive market opportunities for Steel, although the near-term impact is expected to be minor.\nLINE PIPE manufactured by Steel ranges in diameter from 2 3\/8\" to 16\" and is used to gather and transport oil and gas from the well site to storage or refining facilities. Approximately 3 percent of Steel's line pipe shipments were exported in 1994.\nOTHER SERVICES. Transportation, storage, and other services are provided by Steel's subsidiaries.\nSALES AND DISTRIBUTION. The domestic OCTG sales distribution network consists of 13 non-exclusive distributors who maintain product inventory and provide delivery to major and independent oil and gas companies that explore for oil and natural gas. Line pipe is also sold through distributors. Internationally, OCTG is sold through distribution channels as well as directly to end users. The largest single customer and the ten largest customers of Steel's OCTG in 1994 accounted for 9 percent and 40 percent of total shipments, respectively. About 74 percent of the oil and gas wells drilled in the United States in 1994 were located in Texas, Oklahoma, Kansas, Louisiana, and New Mexico, all within 750 miles of Steel's mill in Lone Star, Texas, and the majority of Steel's oilfield products were sold for use in these states.\nRAW MATERIALS AND INVENTORIES. OCTG and line pipe are generally produced to fill specific orders and, accordingly, Steel maintains the majority of its inventory in the form of raw materials, work in process, or finished goods earmarked for specific orders. Steel purchases slabs and steel scrap used in the manufacture of its products. The availability of steel to meet production needs tightened in 1994, and it was often necessary for Steel to commit to purchase steel up to 120 days prior to having orders.\nCOMPETITION. OCTG and line pipe are sold in highly competitive markets, and sales and earnings are affected by price, cost and availability of raw materials, oil and gas drilling activity, and general economic conditions. Steel offers a wide range of sizes and chemistries and, based on shipment data compiled by the American Iron & Steel Institute, Steel believes that it is one of the largest domestic suppliers of OCTG. Users of OCTG base their purchase decisions on four factors: availability, price, quality, and service. Steel believes that it is competitive in all of these areas. LST's revenues are not seasonal.\nTwo distinct markets exist for OCTG, and Steel serves both. Deep critical wells require high-performance OCTG that can sustain enormous pressure as measured by burst strength, collapse strength, and yield strength. The major oil companies and independents who conduct drilling programs of this nature emphasize quality and compliance with specific standards. Steel, with its full-body normalized ERW products which meet American Petroleum Institute Standards, competes with seamless OCTG in this market. Operators who drill shallower wells generally purchase OCTG on the basis of price and availability because those wells require less expensive products without superior performance characteristics. Steel competes in this market, which is served primarily by producers of seam-annealed ERW and seamless OCTG, with its full range of Lone Star-R- products as well as with its Wildcat-TM- brand of OCTG. Several domestic manufactures produce limited lines of OCTG, and a number of foreign manufacturers produce\nOCTG for export to the United States. Imported OCTG represented an estimated one-fourth of the supply available to the domestic OCTG market during the past two years. Members of the domestic steel pipe and tube industry have recently filed trade cases against foreign producers who are believed to be dumping their products into the domestic marketplace. If successful, the impact of these cases could reduce the volume of imports in 1995 and beyond.\nINDUSTRIAL PRODUCTS. Steel manufactures and markets specialty tubing and flat rolled steel.\nSPECIALTY TUBING includes a wide array of high-quality, custom-made steel tubular products which require critical tolerances, precise dimensional control, and special metallurgical properties. Steel's specialty tubing products range in size from 7\/8\" to 15 1\/2\" in outside diameter and are made from a variety of combinations of chemical compositions, thermal treatments, mechanical properties, and surface finishes. The products are used in the manufacture of automotive, construction, and farm equipment and in industrial applications such as hydraulic cylinders, stabilizers and intrusion devices, machine parts, bearing races, downhole pump barrels, and printing rollers. Steel produces most of its specialty tubing by the drawn over mandrel (\"DOM\") process which uses a drawbench to pull tubing through a die and over a mandrel to form tubular products of the desired inside and outside diameter, wall thickness, and surface finish.\nDemand for specialty tubing, sensitive to general economic conditions as evidenced by the variety of industrial markets served, has improved during the past year. Steel's open orders at December 31, 1994, were up 23 percent from the prior year due to expanding markets and increased market share domestically, and Steel continued its pursuit of global opportunities, particularly in the European and Pacific Rim markets.\nFLAT ROLLED STEEL is used by Steel in the manufacture of tubular products, and it is also sold to fabricators of large diameter transmission pipe, storage tanks, rail cars, and a variety of other construction and industrial products.\nSALES AND DISTRIBUTION. Domestically, specialty tubing is marketed and sold through 18 non-exclusive distributors known as steel service centers and, to a lesser extent, directly to end users. Specialty tubing products have detailed design specifications and in some cases long lead times, making annual contracts an efficient mechanism for large purchasers. The largest single user and the ten largest customers of Steel's specialty tubing in 1994 accounted for 3 percent and 17 percent, respectively, of total shipments. Approximately 60 percent of Steel's specialty tubing was sold into the Southern and Midwestern regions of the United States. Internationally, the majority of Steel's specialty tubing is currently sold directly to end users. Exports accounted for approximately 17 percent and 11 percent of Steel's specialty tubing shipments in 1994 and 1993, respectively.\nFlat rolled steel products are sold directly to end users or through distributors, primarily in the Southwestern region of the United States.\nRAW MATERIALS AND INVENTORIES. Raw materials are readily available from multiple sources. Production is generally scheduled to meet specific orders and, accordingly, inventory is managed to minimize the amount of finished goods on hand. Work-in-process inventories are maintained in order to provide flexibility in responding to customer needs.\nCOMPETITION. Based on shipment data compiled by the Steel Tube Institute, Steel believes that it is one of the three largest producers of DOM specialty tubing products. Steel is the only fully\nintegrated DOM producer in the United States. One of Steel's drawbenches, among the largest in the world, enables it to produce DOM products in a greater size range than its competitors. Because these products are made to end-user specification and often require just-in-time delivery, only small quantities are imported into the United States. In contrast to the OCTG market, seamless and ERW specialty tubing products differ in their applications. ERW is preferred for many mechanical tubing applications because its consistent wall thickness requires less machining in the finishing process. Seamless tubes are used primarily in heavy gauge applications such as boiler and pressure tubing.\nFlat rolled steel is sold in highly competitive markets. Sales and earnings are affected by the cost of raw materials, use by Steel in tubular production, demand by outside customers, and general economic conditions. LST's revenues are not seasonal.\nRESEARCH, DEVELOPMENT, AND PATENTS\nSteel conducts limited research and development activities at its metallurgical laboratory in East Texas. Its patents do not significantly affect financial results.\nEMPLOYEES\nAt December 31, 1994, Steel employed 1,592 people, of whom 1,131 were members of two unions represented by three bargaining units. The majority of union workers are represented by the United Steelworkers of America under a contract which expires in June, 1996. Management considers its relationship with the Steelworkers to be good.\nFOREIGN OPERATIONS\nSteel conducts no manufacturing operations outside the United States. Export sales to destinations outside the United States were approximately $25.5 million, $20.6 million, and $26.5 million for the years 1994, 1993, and 1992, respectively.\nENVIRONMENTAL\nSteel's operating activities are governed by numerous environmental laws, which are regulated by state and federal agencies. The three major areas of regulation are air quality, water quality, and solid and hazardous waste management.\nRELATIONSHIP OF FEDERAL AND STATE REGULATION. The United States Environmental Protection Agency (\"EPA\") is responsible for implementing and enforcing federal environmental laws. In Texas, the environmental regulatory agency is the Texas Natural Resource Conservation Commission (\"TNRCC\"). The TNRCC was formed in 1993 pursuant to a merger between the Texas Water Commission, responsible for water quality and solid and hazardous waste management, and the Texas Air Control Board which had exclusive authority over air quality.\nMost federal environmental statutes expressly provide for state assumption of responsibility when it can be demonstrated that the state program is as stringent as the federal program; however, the EPA retains authority to enforce the program if the state fails to do so.\nTexas is authorized to implement the federal hazardous waste program under the Resource Conservation and Recovery Act (\"RCRA\") and the federal air quality program under the Clean Air Act. The Texas air quality program also requires all new or modified facilities that may emit any air contaminant to obtain a permit which imposes limitations on each emission.\nTexas has not yet been delegated authority to implement the federal water quality program under the Clean Water Act. Therefore, dual federal and state water quality programs exist in Texas, requiring companies such as Steel to obtain both a federal permit and a state permit to discharge wastewater into state waters.\nIn addition, Texas has state environmental programs that supplement and operate independently of the federal environmental programs. Texas has established its own program for the regulation of municipal and industrial solid wastes under the Texas Solid Waste Disposal Act. Steel's operations generate wastes that are regulated as industrial solid waste under this program.\nAIR quality is governed by the federal Clean Air Act and the Texas Clean Air Act. The TNRCC has primary responsibility for implementing and enforcing the federal law through the state program. The Texas State Implementation Plan implements, maintains, and enforces the National Ambient Air Quality Standards established by the EPA for particulate matter, sulfur dioxide, carbon monoxide, nitrogen oxide, ozone, and lead, as well as the other federal air quality programs. Emission sources at Steel's facilities are regulated by a combination of individual permit limitations and statewide standards. Sources which existed before the implementation of the state permitting requirements are registered with the TNRCC as \"grandfathered sources\" and are not required to obtain a permit. If, however, a grandfathered source is modified in a manner that increases the amount or changes the character of air contaminants emitted into the atmosphere, it becomes subject to permitting requirements.\nSteel does not believe that the 1990 amendments to the federal Clean Air Act will significantly impact its operations over the next two years. The amendment with the greatest potential to impact the steelmaking industry requires the EPA to establish emission standards for certain hazardous substances based on maximum achievable control technology. However, until the EPA promulgates the regulations for the iron and steel manufacturing source category and the related electric arc furnace (\"EAF\") operation source category, Steel cannot determine the impact of this amendment on its operations. The EPA has set November 15, 1997, as its deadline for promulgating emission standards for these source categories.\nSteel is presently in substantial compliance with the conditions of its permits and applicable standards. Steel recently received approval from the TNRCC for a permit amendment to install a baghouse to serve as an additional air pollution control device for its EAFs. The new facility is now under construction.\nWATER quality is governed by the federal Clean Water Act, implemented by the EPA, and the state Water Code, implemented by the TNRCC. Steel is required to have two separate permits to discharge wastewater from each of its outfalls: a National Pollution Discharge Elimination System permit issued by the EPA and a wastewater discharge permit issued by the TNRCC. The regulatory emphasis on water and wastewater is directed at the control of effluent toxicity.\nWith respect to both the federal and state wastewater discharge permits, Steel and the regulators have been engaged in ongoing discussions regarding the applicability of the state water quality standards for lead. In August, the TNRCC granted Steel a three-year variance to the state water quality standards for lead, issued Steel a renewal state water permit with lead\nlimits based on this variance, and proposed a site-specific standard for lead consistent with the variance. Also, the EPA recently issued Steel a draft renewal federal permit with lead limits based on the state variance. Steel thus believes that it will be possible to achieve substantial compliance with both its state and federal wastewater discharge permits without requiring material expenditures.\nSOLID AND HAZARDOUS WASTE management is governed by the Texas Solid Waste Disposal Act and RCRA. The TNRCC has primary responsibility for implementing and enforcing the federal law through the state program.\nSolid waste, some of which is now classified as hazardous, has been generated by Steel since it began operation. As with similar mills in the industry, Steel's EAF generates dust containing lead, chromium, and cadmium. Until 1988, Steel disposed of the EAF dust and other wastes in on-site management units. Steel does not store hazardous waste and no longer disposes of waste on site. Wastes are now shipped off-site to commercial facilities for disposal or reclamation.\nIn the past, Steel operated solid waste management units for the storage and disposal of non-hazardous and hazardous wastes. These sites include four land-based RCRA waste management units and a fifth site that is not subject to RCRA. Steel has submitted to the TNRCC a closure plan for the site not subject to RCRA, a pond previously used for storing an acidic waste, and Steel is closing it as a non-hazardous facility. Two sites subject to RCRA, the plant's landfill and a site that received air pollution sludge, have been closed in accordance with requirements of RCRA and corresponding state regulations. These sites are subject to post-closure care obligations, including ground-water monitoring, for up to thirty years. The remaining two sites have been closed by removal (\"clean closure\") in accordance with requirements of RCRA and corresponding state regulations. Steel is seeking to limit the duration of future post-closure, ground-water monitoring at these facilities based on the clean closure. The TNRCC will issue Steel a permit for the facilities requiring post-closure care. Steel projects the actual cost during the thirty-year post-closure period for its various facilities to be approximately $1 million.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSteel conducts its operations at facilities on a 2,000-acre site in East Texas. The original facilities, constructed in the 1940's, have been expanded and modernized, and include two EAF's with capacity of approximately 500,000 ingot tons per year; two rolling mills, a \"two-high\" mill that rolls the EAF ingots into slabs and a \"four-high\" single stand reversing Steckel mill that produces flat rolled coils; two pipe welding mills; six drawbenches, including the largest specialty tubing drawbench in the United States; heat treating facilities; numerous types of ultrasonic and electromagnetic testing and inspection equipment; finishing facilities at which tubular goods are threaded and couplings are applied; and, various support facilities including a shortline railroad and other transportation and storage facilities. Steel's and LST's headquarters are located in leased facilities in Dallas, Texas.\nSteel's annual productive capacity approximates 425,000 slab tons, 1,250,000 coil tons, and 1,000,000 pipe tons. In 1994, the EAF and specialty tubing facilities operated at 90 - 100 percent of capacity, while the rolling mills and pipe mills generally operated at 55 percent or less.\nLST and certain minority shareholders of Steel agreed to fund up to $23 million for a capital expenditure program. Steel issues 6 percent cumulative convertible preferred stock to its participating shareholders as funds are advanced. Included in the program is a significant\nexpansion of Steel's capacity to manufacture specialty tubing products. The balance of the expenditures will be used to upgrade Steel's capability to manufacture tubular products for use in the energy sector. This program began in early 1995, is scheduled to be completed in mid-1996, and had no impact on 1994 results.\nUnder current and projected market conditions, Steel believes that the facilities have sufficient capacity to meet production needs for several years.\nIn addition to the manufacturing facilities, Steel owns 20,000 acres in Texas and 3,000 acres in Oklahoma which were purchased primarily for iron ore or coal reserves, and mineral interests on an additional 12,000 acres in Oklahoma and 60,000 acres in Texas. No minerals have been recovered from these properties for many years because their use is no longer required in Steel's operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nSteel filed a Petition for Review with the United States Court of Appeals for the Fifth Circuit in 1992 seeking judicial review of certain conditions in an EPA permit governing Steel's wastewater discharges. The EPA is the only other party to this proceeding which was brought by Steel under statutory provisions that permit private parties to seek judicial review of administrative agency decisions.\nLST and its subsidiaries are parties to a number of lawsuits and controversies which are not discussed in this document. As to the legal proceedings not discussed, it is the opinion of management, based upon analysis of known facts and circumstances and reports from legal counsel, that LST and its subsidiaries are not parties to any legal proceeding, which is material to them taken as a whole, other than ordinary routine litigation incidental to their business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nLST's Common Stock trades on Nasdaq National Market System under the symbol LSST. The following table summarizes the range of trading prices by quarter for the last two years (in $):\nAs of February 15, 1995, LST had approximately 5,300 common shareholders of record. LST has paid no dividends on its Common Stock since becoming a public company and is not expected to declare dividends in the foreseeable future.\nIn 1988, LST sold one million shares of Series A nonvoting convertible cumulative preferred stock, $1.00 par value (\"Series A Preferred stock\"), for $49.6 million in cash. The Series A Preferred stock carried a $50.00 per share liquidation preference, plus any unpaid dividends, and became redeemable in cash at the option of LST after September, 1993. No dividends were declared, accrued, or paid, and cumulative dividends in arrears at January 1, 1994, approximated $18.8 million. In February, 1994, LST redeemed this stock and extinguished all dividend obligations related to it for $51.7 million.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ($ in millions, except share and employee data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nOVERVIEW\nLST's revenues are derived from Steel's two business segments: oilfield products and services and industrial products.\nPRODUCTS AND MARKETS. The oilfield products and services business includes the manufacture and marketing of OCTG, the casing and tubing used in oil and gas well drilling and production, and line pipe which is used to gather and transport oil and gas from the well site to storage or refining facilities. Steel is one of the largest domestic producers and suppliers of OCTG, based on data compiled by the American Iron & Steel Institute. OCTG represents three-fourths of Steel's oilfield products volume as measured in tonnage, and exports have ranged from 6 to 13 percent of this segment's shipments during the last three years.\nDemand for oilfield products is generally affected by customers' expectations of future oil and gas prices and political factors such as energy and trade policies. A key indicator of domestic demand is the average number of drilling rigs operating in the United States which, during the last three years, has been historically low. According to Baker Hughes, the rig average in 1994, 1993, and 1992 was 775, 755, and 717, respectively. Demand is also affected by the amount of oilfield products imported into this country as well as available industry inventories. Imported OCTG has represented approximately one-fourth of the total supply during the past two years, up from 12 percent in 1992, much of which was supplied by manufacturers who dump their products in this country. Trade cases have been filed by domestic producers to curtail this practice. The effect of available inventory, which is believed to be low, has been insignificant in the marketplace in the past three years. Recent volatility of oil and gas prices has created uncertainty with respect to the timing and extent of a recovery in the energy sector. This instability has eroded customer confidence in the longer-term outlook for energy prices and has caused some drilling projects to be deferred. International markets are volatile and have been weakened by the uncertain conditions that exist in the former Soviet Union and China, both major oil producers and users of oilfield pipe.\nSteel's industrial products segment includes two product groups: specialty tubing and flat rolled steel. Specialty tubing consists of a wide array of high-quality, custom-made steel tubular products requiring critical tolerances, precise dimensional control, and special metallurgical properties. These products are used in the further manufacture of automotive, construction, and other industrial equipment such as hydraulic cylinders, stabilizers and intrusion devices, and machine parts.\nSteel's primary emphasis in the industrial products segment is the specialty tubing market. Demand for specialty tubing, sensitive to general economic conditions as evidenced by the variety of industrial markets served, has continued to improve during the past year. Steel is one of the largest domestic producers of specialty tubing, based on shipment data compiled by the Steel Tube Institute. International shipments increased to 17 percent of specialty tubing shipments in 1994 from 11 percent in 1993 and 1992. The recent devaluation of the peso is not expected to impact Steel's business opportunities in Mexico in the near term.\nSteel's participation in the flat rolled steel commodity market is limited to the Southwestern region and is affected by factors such as price, capacity utilization, and raw material costs. Flat rolled steel produced by Steel is either further processed by Steel in the manufacture of tubular products or is shipped to customers for the manufacture of a variety of commercial and industrial products. Flat rolled steel is sold in a highly competitive market, with price and availability primarily determining customer purchase decisions.\nMANUFACTURING. Steel's plant is a capital intensive, integrated facility. As such, its operating costs are sensitive to changes in production volumes, the price of purchased raw materials, and energy costs. Steel attempts to adjust its cost structure to correspond with current production levels while maintaining excess capacity for potential use; however, the cost of purchased materials fluctuates with changing market conditions which are beyond Steel's control. Capacity utilization currently ranges from nearly 100 percent in the EAF and specialty tubing facilities to 55 percent or less in other areas. Purchased steel scrap and slabs, in combination with energy sources, account for nearly half of Steel's overall costs. In 1994, those costs increased approximately 8 percent.\nLST and certain minority shareholders of Steel have agreed to fund up to $23 million for a capital expenditure program during 1995 and early 1996. Included in the program is a significant expansion of Steel's capacity to manufacture specialty tubing products. The balance of the expenditures will be used to upgrade Steel's capability to manufacture tubular products for use in the energy sector.\nRESULTS OF OPERATIONS\nConsolidated revenues reported in the statements of earnings are as follows ($ million):\n1994 COMPARED WITH 1993\nLST's 1994 consolidated net revenues increased 7 percent to $357.0 million from $332.5 million, due to a 2 percent increase in oilfield products to $215.2 million and a 17 percent increase in industrial products to $141.8 million. Volume accounted for the rise in oilfield revenues while the growth in industrial products was attributable to price and product mix.\nOperating losses of $3.4 million in 1994 versus $10.6 million in 1993 reflect an increase of $6.5 million in gross earnings and a decrease of $0.7 million in selling, general, and administrative expense. This improvement plus increased interest and other income resulted in a loss from continuing operations of $3.8 million, or $0.19 per share, reduced from $14.1 million, or $0.69 per share, in 1993.\nNet earnings in 1994 were $1.2 million compared to net losses of $7.2 million in the prior year. The 1994 net results include a $5 million gain on the sale of AFB. Net results in 1993 include earnings from discontinued operations of $16.5 million which relate to AFB prior to its sale in November, 1993, and an extraordinary charge of $9.6 million which represents Steel's obligation to fund medical and death benefits of assigned retirees and eligible dependents of the United Mine Workers of America (\"UMWA\").\nAlso in 1994, Steel increased the discount rate used to calculate the present value of its pension obligation from 7 1\/2 percent to 8 1\/2 percent. This action increased consolidated equity by $3.1 million, net of minority interest.\nPer share earnings in 1994 were adjusted downward by $0.10 to reflect the preferred stock redemption described in the Financial Condition and in Note D. The net loss per share available to common shareholders of $0.04 in 1994 compares to $0.35 in the prior year.\nPrior to the 1993 sale, AFB earned $21.2 million. As a result of recognizing only the $135.7 million in proceeds received at the time of the sale, LST experienced a loss of $4.7 million on the disposition which reduced the reported 1993 earnings from discontinued operations to $16.5 million. The remaining $20 million in sale proceeds was placed in escrow to provide for possible future claims by GFB as permitted under the sale agreement. In 1994, LST received $5 million of those funds, and $15 million remain in escrow.\n1993 COMPARED WITH 1992\nLST's 1993 consolidated revenues were $332.5 million, earnings before an extraordinary item were $2.4 million, or $0.12 per share, and consolidated net losses were $7.2 million, or $0.35 per share. In 1992, consolidated revenues were $277.6 million, earnings before an accounting change were $7.2 million, or $0.36 per share, and net earnings were $0.1 million, or $0.01 per share. Earnings from discontinued operations of $16.5 million in 1993 and $17.6 million in 1992 relate to AFB, which was sold in November, 1993, and are included in the net results.\nThe extraordinary item in 1993 of $9.6 million, net of minority interest in Steel, relates to Steel's future obligation to fund medical and death benefits of assigned retirees and eligible dependents of the UMWA under the Coal Industry Retiree Health Benefit Act of 1992. This government-imposed liability was unexpected as Steel has conducted no mining operations in more than 30 years and it had previously fully funded its obligation.\nIn 1993, Steel decreased the discount rate used to calculate the present value of its pension obligation from 9 percent to 7 1\/2 percent. This action decreased net equity by $6.6 million.\nThe accounting change in 1992 of $7.1 million, net of minority interest, is attributable to Steel's adoption of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires employers to accrue the anticipated cost of retiree health care benefits.\nThe 20 percent increase in Steel's 1993 revenues over the prior year was comprised of a 23 percent increase in oilfield products to $210.8 million and a 14 percent increase in industrial products to $121.7 million. In both segments, the revenue increases were attributable primarily to volume.\nA 28 percent decrease in gross earnings reflects the higher cost of purchased raw materials that could not be absorbed through product pricing. This situation primarily affected the oilfield products segment. Although domestic drilling activity was up 5 percent from the all-time low level of 1992 as evidenced by the number of rigs in operation as measured by Baker Hughes, uncertainties with respect to future oil prices have caused many projects to be deferred or canceled. During the fourth quarter of 1993, the price of West Texas Intermediate crude oil fell more than 25 percent. Confidence in oil and gas prices must be restored throughout the industry before a meaningful improvement in this segment's operations can be expected.\nIn the industrial products segment, the recent performance and outlook are somewhat brighter. A strengthening economy and continuing adaptation of Steel's tubular products to new applications are contributing to the relative success of this segment.\nDespite a 4 percent decrease in selling, general, and administrative expense in 1993 compared to the prior year, operating losses increased 19 percent to $10.6 million. Interest expense increased in 1993, reflecting the higher borrowings necessary to fund Steel's operations and working capital requirements.\nPrior to the sale, AFB earned $21.2 million in 1993, compared to $17.6 million in 1992. As a result of recognizing only the $135.7 million in sale proceeds received at the time of the sale, LST experienced a loss of $4.7 million on the disposition which reduced the reported 1993 earnings from discontinued operations to $16.5 million. The remaining $20 million in sale proceeds was placed in escrow to provide for possible future claims by GFB. Funds released from escrow in the future will be recognized as income in the periods received.\nFINANCIAL CONDITION\nLST has no direct business operations other than Steel or significant sources of cash other than from short-term investments or the sale of securities. Steel is restricted from paying cash dividends under the terms of its revolving credit agreement; however, LST is reimbursed by Steel for a portion of its operating costs as provided under the terms of a cost-sharing agreement.\nIn November, 1993, LST sold AFB for $155.7 million, of which LST received $135.7 million on the date of the sale and $5 million in November, 1994. Fifteen million dollars remain in escrow to provide payment for certain claims that may be filed by the purchaser as permitted under the sale agreement.\nAt December 31, 1994, LST had available cash and short-term investments of $82.8 million.\nIn 1988, LST sold one million shares of Series A Preferred stock for $49.6 million. As of January 1, 1994, the cumulative but undeclared and unaccrued dividends approximated $18.8 million. In February, 1994, LST redeemed all of its Series A Preferred stock and extinguished all related dividend obligations for $51.7 million.\nIn November, 1994, LST and certain minority shareholders of Steel agreed to fund up to $23 million for a capital expenditure program. Steel issues 6 percent cumulative convertible preferred stock to its participating shareholders as funds are advanced to finance the program. LST's participation in the program amounts to 89.753 percent. The program began in January, 1995, is scheduled to be completed in mid-1996, and had no impact on 1994 results.\nThe Steel preferred stock to be issued to LST and the other participating shareholders will have a designated value equal to the amount of the funds advanced, will pay quarterly dividends at the rate of 6 percent per year on that value, and will require its mandatory redemption by Steel, unless earlier redeemed or converted, on January 3, 2002, in cash, at the designated value plus any unpaid dividends. Prior to redemption of the stock, dividends may be paid in cash, although currently prohibited by the terms of the revolving credit agreement, or in additional preferred shares.\nThese preferred shares will be convertible into Steel common stock prior to redemption at the rate of one share of common stock for each $10,000 of designated value (subject to anti-dilution provisions).\nIn addition, as a result of an earlier unrelated transaction, LST holds warrants to purchase 241.5 shares of Steel common stock, and other Steel shareholders hold warrants to purchase 58.5 shares at $33,358 per share (subject to anti-dilution provisions). The warrants are exercisable at any time until December 31, 1998.\nSteel presently has a total of 1,000 shares of common stock outstanding of which LST holds 80.5 percent. Depending upon warrant exercises and preferred share conversions, this percentage could change.\nLST periodically purchases steel slabs which are consigned to Steel to be used in its production of tubular products. Steel pays LST as the slabs are used or within ninety days, whichever occurs first. This program's structure is consistent with those previously established with third parties. During 1994, LST's slab purchases amounted to approximately $38 million.\nIt is currently anticipated that the remainder of the proceeds from the sale of AFB will be used by LST for general corporate purposes, which could include further investment in Steel or such other uses as may reasonably be determined by the Board of Directors to be in the best interest of LST and its shareholders. LST believes it has and will continue to have adequate funds to meet its operating requirements.\nSteel requires capital primarily to fund general working capital needs and capital expenditures. Principal sources of funds include cash generated by operations, borrowings, and equity financing.\nSteel has a revolving credit agreement under which it can borrow the lesser of $55.0 million (increased to $65.0 million for 1995 and beyond) or an amount based upon eligible accounts receivable and inventories which secure the borrowings. At December 31, 1994, borrowings totaled $39.0 million on an available borrowing base of $50.8 million. The interest rate on borrowings is prime plus 1.75 percent which, at year end, was 10.25 percent. Steel also pays a fee of 0.5 percent on the unused portion of the credit facility. The three-year agreement, entered into in March, 1993, contains various restrictive covenants, including requirements to maintain certain financial ratios. Steel's ability to continue to meet the covenants is largely dependent upon a variety of external factors, including market conditions and costs of purchased materials. In March, 1993, Steel also borrowed $4.6 million at 8.08 percent to be repaid in equal monthly installments through March, 1997.\nSteel believes that funds generated by operations, its borrowing capacity under the revolving credit agreement, and capital contributions from its shareholders, will provide the liquidity necessary to fund its cash requirements in 1995. Adequate liquidity in the longer term is dependent on a recovery in the energy sector and\/or Steel's ability to obtain raw material at lower cost which will be necessary for Steel to achieve an improvement in profitability.\nSteel's defined benefit pension plans cover its bargaining unit employees. At December 31, 1994, the projected obligation exceeded the plans' assets by $33.7 million. Steel's annual pension expense, including amortization of the excess obligation, approximates $4.2 million.\nThe Coal Industry Retiree Health Benefit Act of 1992 burdened Steel with an obligation to fund future medical and death benefits of certain UMWA retirees and dependents. An extraordinary charge of $9.6 million, net of minority interest, was recognized in 1993 to reflect future payments which are assessed annually. The 1994 payment amounted to $1.0 million, and the 1995 payment is expected to approximate $0.5 million. Steel is making these payments under protest and has filed suit in Federal District Court to question the validity of the Act.\nSteel's operations are subject to compliance and permitting requirements of various governmental agencies with regard to environmental and other matters, the laws and regulations over which generally are becoming more restrictive. The primary oversight agencies include the TNRCC and the EPA. Steel has entered into specific agreements with these agencies to conduct numerous environmental studies and to develop plans to ensure continuous compliance with applicable laws and regulations. Steel believes that the cost of maintaining compliance with environmental requirements will fall within its contemplated operating and capital expenditure plans, averaging $2 - $3 million annually in the foreseeable future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page ---- INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Public Accountants.................................. 16 Consolidated Statements of Cash Flows, for the years ended December 31, 1994, 1993, and 1992............... 17 Consolidated Statements of Earnings, for the years ended December 31, 1994, 1993, and 1992............... 18 Consolidated Balance Sheets at December 31, 1994 and 1993................. 19 Notes to Consolidated Financial Statements ............................... 20 Schedule III - Condensed Financial Information............................ 31\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Shareholders and Board of Directors of Lone Star Technologies, Inc.:\nWe have audited the accompanying consolidated balance sheets of LST (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, shareholders' equity, and cash flows for the three years ended December 31, 1994. These financial statements and the schedule referred to below are the responsibility of LST'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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of LST and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for the three years ended December 31, 1994, in conformity with generally accepted accounting principles.\nEffective January 1, 1992, LST changed its method of accounting for postretirement health care benefits, as discussed in Note J.\nOur audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in the index to consolidated financial statements is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not a part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in our audits of the basic consolidated financial statements and, in our opinion, fairly states 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 LLP Dallas, Texas, February 6, 1995\nLONE STAR TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In millions)\nLONE STAR TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF EARNINGS (In millions, except share data)\nLONE STAR TECHNOLOGIES, INC. CONSOLIDATED BALANCE SHEETS (In millions)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nLone Star Technologies, Inc. (\"LST\") is a management and holding company whose operating subsidiary Lone Star Steel Company (\"Steel\") manufactures and markets products and services to the oil and gas drilling industry and to the general industrial sector.\nACCOUNTING POLICIES - NOTE A\nPRINCIPLES OF CONSOLIDATION. The consolidated financial statements include the accounts of LST and its subsidiaries, with American Federal Bank, F.S.B. (\"AFB\") presented as a discontinued operation. Intercompany transactions are eliminated in consolidation.\nINVESTMENTS IN DEBT SECURITIES. LST's cash equivalents include U. S. Government debt obligations and corporate debt obligations rated A-1 P-1 or higher with original maturities of less than 90 days. Short-term investments consist of U. S. Government debt obligations with original maturities of up to one year. In 1994, LST adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Under this statement, investments are classified as held-to-maturity and recorded at cost or classified as held for sale or trading securities and recorded at market value. LST's cash equivalents and short-term investments are classified as held-to-maturity because LST has the intent and ability to hold them to maturity. At December 31, 1994, LST's carrying amounts of cash equivalents and short-term investments approximated market value. LST does not invest in or hedge exposures through the use of derivative financial instruments. As a result, the provisions of Statement of Financial Accounting Standards No. 119, \"Disclosure about Derivative Financial Instruments,\" have no impact on LST's financial disclosures. At December 31, 1994, investments in debt securities at amortized cost consisted of $76.6 million in U. S. Government debt obligations and $6.2 million in corporate debt obligations rated A-1 P-1 or higher.\nINVENTORIES of Steel are stated at the lower of cost (principally last-in, first-out \"LIFO\") or market value and include raw materials, labor, and overhead. Inventories at LST are stated at the lower of cost (principally first-in, first out \"FIFO\") or market value and consist of steel slabs.\nPROPERTY, PLANT, AND EQUIPMENT are stated at cost. Depreciation is provided on the straight-line method.\nINCOME TAXES. LST files a consolidated federal income tax return. In 1993, LST adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" (\"SFAS No. 109\") which requires an asset and liability approach for financial accounting and income tax reporting. Deferred tax liabilities or assets are recognized for the estimated future tax effects attributable to temporary differences and carryforwards and are adjusted whenever tax rates or other provisions of income tax statutes change. Prior to 1993, income taxes were recognized in accordance with Accounting Principles Board Opinion No. 11.\nPOSTEMPLOYMENT BENEFITS. Effective January 1, 1994, LST adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" (\"SFAS No. 112\") which requires, under certain conditions, accrual accounting for obligations such as termination and medical benefits for former employees. Because LST has historically accrued for such obligations, the adoption of SFAS No. 112 was not material to the current year operations.\nMINORITY INTEREST. The 19.5 percent minority ownership in Steel is included in the liabilities section of LST's consolidated balance sheets, and results are adjusted in the consolidated statements of earnings to reflect participation of the minority ownership in Steel's earnings or losses.\nRECLASSIFICATION AND RESTATEMENT. The accompanying consolidated financial statements and schedule have been restated to reflect AFB as a discontinued operation, and certain 1993 and 1992 balances have been reclassified to conform to the 1994 presentation.\nLINES OF BUSINESS - NOTE B\nSteel's operations include the oilfield products and services segment which manufactures tubular products and provides technical, warehousing, and other services; and the industrial products segment which manufactures specialty tubing and flat rolled steel. The manufacture of these products uses several common facilities and shares administrative support. Accordingly, certain costs and assets are allocated and may not reflect each line of business as if it were operated separately. ($ in millions; unaudited)\nThe majority of Steel's sales are made through distributors. Sales to the two largest distributors represented 12 percent and 10 percent of 1994 revenues, 12 percent and 11 percent of 1993 revenues, and 12 percent and 11 percent of 1992 revenues. Direct foreign revenues were approximately 7 percent of the total in 1994, 6 percent in 1993, and 10 percent in 1992.\nADDITIONAL BALANCE SHEET INFORMATION - NOTE C ($ in millions)\nAccounts receivable are stated net of allowance for doubtful accounts of $1.9 million and $1.8 million at December 31, 1994 and 1993, respectively. Approximately $78.8 million and $88.5 million of total inventories before the LIFO valuation reserve were accounted for on the LIFO basis at December 31, 1994 and 1993, respectively. Non-LIFO inventories are stated at the lower of cost or market. The amount of total inventories before LIFO valuation reserve approximates inventory replacement cost. During 1994, a reduction in inventory resulted in the depletion of previous LIFO inventory layers, the financial effect of which was not significant to net results.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - NOTE D ($ in millions)\nPREFERRED STOCK. In 1988, LST sold one million shares of Series A nonvoting convertible cumulative preferred stock, $1.00 par value, (\"Series A Preferred stock\") for $49.6 million. No dividends were declared, accrued, or paid and at January 1, 1994, the cumulative dividends in arrears approximated $18.8 million. In February, 1994, LST redeemed the Series A stock and extinguished all dividend obligations related to it, for $51.7 million. Earnings per share in 1994 were adjusted downward by $0.10 to reflect the $2.1 million difference between the amount paid and the carrying amount.\nDEBT - NOTE E ($ in millions)\nThe $50 million, 8 percent convertible subordinated debentures are due in 2002 and may be converted at any time into shares of LST common stock. The conversion price, initially set at $24.25 per share, is subject to antidilution provisions. Fair value of the debentures is estimated based upon quotes from brokers.\nSteel has a revolving credit agreement under which it can borrow the lesser of $55.0 million (increased to $65.0 million) or an amount based upon eligible accounts receivable and inventories which secure the borrowings. At December 31, 1994, borrowings totaled $39.0 million on an available borrowing base of $50.8 million. The interest rate on borrowings was prime plus 1.75 percent which, at year end, was 10.25 percent. Steel also pays a fee of 0.5 percent on the unused portion of the credit facility. The three-year agreement, entered into in March, 1993, contains various restrictive covenants, including requirements to maintain certain financial ratios. Steel's ability to continue to meet the covenants is largely dependent upon a variety of external factors, including market conditions and costs of purchased materials. In March, 1993, Steel also borrowed $4.6 million at 8.08 percent to be repaid in equal monthly installments through March, 1997.\nSteel believes that funds generated by operations, its borrowing capacity under the revolving credit agreement, and temporary advances from its shareholders or other sources, will provide the liquidity necessary to fund operations and certain capital expenditures in the short term. However, adequate liquidity in the longer term is dependent on a recovery in the energy sector and\/or a reduction in raw material costs which will be necessary for Steel to achieve an improvement in profitability.\nAt December 31, 1994, debt maturities are as follows: 1995, 1.2 million; 1996, $40.3 million; 1997, $0.3 million; and thereafter, $50 million.\nCash paid for interest during 1994, 1993, and 1992 was $4.1 million, $2.9 million, and $1.7 million, respectively, by Steel; and $4.0 million in each of the last three years by LST.\nCHANGE IN COMMON SHARES OUTSTANDING - NOTE F\nNET EARNINGS PER SHARE - NOTE G\nThe computation of primary earnings per share is based on the weighted average number of shares of common stock and common stock equivalents, including exercisable stock options, assumed to be outstanding during the year. The numbers of shares used in 1994, 1993, and 1992 were approximately 20.4 million. For all three years, the effect of potentially dilutive shares on fully diluted earnings per share was either antidilutive or not significant. Earnings per share in 1994 were adjusted downward by $0.10 to reflect the redemption of Series A stock, described in Note D.\nINCOME TAXES - NOTE H\nLST adopted SFAS No. 109 effective January 1, 1993, which requires an asset and liability approach for income taxes. Previously, LST reported taxes in accordance with Accounting Principles Board Opinion No. 11. There was no current or deferred income tax expense or benefit for 1994, 1993, or 1992. A reconciliation of computed income taxes to actual income taxes follows ($ in millions):\nThe sources of deferred taxes and the tax effect of each for 1992 ($ in millions):\nThe adoption of SFAS No. 109 resulted in a net deferred tax asset at January 1, 1993, of $85.7 million, less a valuation allowance of the same amount, with no recorded effect on the consolidated statements of earnings. The following table discloses the components of the deferred tax amounts at December 31, 1994 and 1993 ($ in millions):\nAt December 31, 1994, LST had federal tax net operating loss carryforwards (\"NOL's\") of approximately $271 million, a portion of which is related to AFB and subject to regulatory audit. If not utilized, the NOL's will expire between 2000 and 2009, and their future availability may be limited if LST or a member of the consolidated group experiences an ownership change of more than 50 percentage points, as defined by IRS regulations. LST's common stock is publicly traded and management cannot assure that future trading will not result in an ownership change, as defined, which would limit availability of the NOL's.\nEXTRAORDINARY ITEMS - NOTE I\nCOAL INDUSTRY RETIREE HEALTH BENEFIT ACT OF 1992\nThe Coal Industry Retiree Health Benefit Act of 1992 (\"Act\") created a benefit plan fund to provide medical and death benefits to certain United Mine Workers of America (\"UMWA\") retirees and eligible dependents. The legislation was prompted by the occurrence of operating deficits in benefit trusts previously established by agreements between the UMWA and various coal operators represented by the Bituminous Coal Operators' Association, Inc. Steel has not operated coal mines for more than 30 years and had previously fully funded the agreed upon defined contributions to the benefit trusts. However, Steel was notified in 1993 that under the Act it will be liable for additional current and future costs for certain assigned beneficiaries.\nBased on this information and actuarial assumptions, an extraordinary charge of $9.6 million, net of minority interest, was recognized in 1993 to reflect the total estimated future payments related to the Act. Payments are assessed annually and will be made over an extended period for as long as there may be eligible beneficiaries. Steel is making these payments under protest and has filed suit in Federal District Court to question the validity of the Act.\nEMPLOYEE BENEFIT PLANS - NOTE J\nCAPITAL ACCUMULATION PLAN. LST and Steel have defined contribution plans available to substantially all full-time employees. Participants may make voluntary pretax contributions to the plans, and the employer contributes within specified limits. Employer contributions totaled $0.7 million in each of the last three years.\nSTOCK OPTION PLAN. LST has a long-term incentive plan which provides for the issuance of up to 2,700,000 shares of common stock to key employees and outside directors through the granting of incentive and nonqualified stock options, stock appreciation rights, restricted stock grants, and performance unit grants. The option price is not less than the market price on the date of grant. Options are generally exercisable for ten years with one-fourth of the shares becoming exercisable on the first anniversary of the grant date and an additional one-fourth becoming exercisable on each of the next three anniversaries. If a change of control of LST occurs before an option's fourth anniversary, the option may be exercised earlier. Following is a summary of stock option activity during 1994 and 1993:\nAt December 31, 1994, 1,487,778 shares were available for grant and 538,897 shares were exercisable. Pursuant to a separate management contract arranged prior to the spin-off of LST from its former parent, LST's former chief executive officer was granted a separate, nonqualified option with stock appreciation rights for 500,000 shares of common stock at $7.89 per share. During 1993, 80 percent of the option was exercised in the form of stock appreciation rights. The remaining 20 percent is fully exercisable and expires in 1995.\nPOSTRETIREMENT HEALTH CARE PLAN. Steel sponsors an unfunded, defined benefit, postretirement health care plan (\"Health Care Plan\") for most of its bargaining unit employees and a limited number of non-bargaining unit retirees eligible under special early retirement programs. Health Care Plan benefits are provided to eligible retirees until they reach the age of 65, at which time coverage terminates. Steel accrues for the anticipated cost of retirees' health care benefits in accordance with Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pension\" (\"SFAS 106\"). Steel implemented SFAS No. 106 in 1992 and the full transition obligation of $7.1 million, net of minority interest, is included in the 1992 consolidated statement of earnings as the cumulative effect of the change in accounting principle.\nNet retiree health care benefits expense for 1994, 1993, and 1992, included the following components ($ in millions):\nThe annual rate of increase in per capita costs of covered health care benefits was assumed to gradually decrease from 12 percent to an ultimate trend rate of 7 percent by the year 2004. An increase of 1 percent per year in the assumed medical cost trend rate would have resulted in an additional obligation of $1.1 million for accumulated benefits at December 31, 1994, and an additional $0.2 million in the aggregate of the 1994 service cost and interest cost components. Weighted average discount rates of 8.5 percent at December 31, 1994, and 7.5 percent at December 31, 1993, were used to determine the accumulated obligation.\nThe following table sets forth the Health Care Plan's unfunded status and the amounts recognized in the consolidated balance sheets at December 31, 1994 and 1993 ($ in millions):\nPENSION PLAN. Steel has defined benefit pension plans covering its bargaining unit employees. Retirement benefits are based on years of service at progressively increasing flat-rate amounts. A special lump-sum payment equal to 13 weeks of vacation pay is made upon retirement. Steel's policy is to fund the minimum contribution each year as required by applicable regulations. The measurement dates for determining the plans' assets and obligations were November 30, 1994, and December 31, 1993. At December 31, 1994 and 1993, the plans' funded status and amounts recognized in the consolidated balance sheets were as follows ($ in millions):\nIn determining the projected benefit obligation, the weighted average discount rate was assumed to be 8.5 percent at November 30, 1994, and 7.5 percent at December 31, 1993. The expected long-term rate of return on assets was assumed to be 9 percent and the annual increase in compensation rate was assumed to be 5 percent for both years. In accordance with Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions,\" Steel has recorded an adjustment, as shown in the above table, to recognize a minimum pension liability. Offsetting this liability at December 31, 1994, was a noncurrent intangible asset of $6.3 million and a reduction of shareholders' equity of $3.5 million net of minority interest, with no recorded tax benefit assumed. The December 31, 1993, adjustment resulted in an offsetting $7.4 million intangible asset and an $6.6 million net equity reduction. The plans' assets consist primarily of short-term money market investments, government and corporate obligations, real estate, and public market equity securities.\nNet pension expense in 1994, 1993, and 1992 was as follows ($ in millions):\nPROFIT SHARING PLAN. Effective July 1, 1993, Steel implemented a profit sharing plan for substantially all employees. The plan provides for payment of a specified percentage of Steel's quarterly operating earnings. Steel's contribution for 1994 was $0.1 million and there was no contribution for 1993.\nCOMMITMENTS AND CONTINGENCIES - NOTE K\nAs a steel facility, Steel's operations are subject to numerous environmental laws. The three major areas of regulation are air quality, water quality, and solid and hazardous waste management. The primary governmental oversight agencies include the Texas Natural Resource Conservation Commission and the Environmental Protection Agency. Steel has agreements with these agencies to conduct numerous environmental studies and to develop plans to ensure continuous compliance with applicable laws and regulations. Steel is engaged in various ongoing environmental studies, monitoring programs, and capital projects. Estimated expenditures for certain remediation programs are included in accrued liabilities and other noncurrent liabilities as shown in Note C. Steel believes that its environmental expenditures will continue to fall within its contemplated operating and capital plans.\nSteel leases equipment under various operating leases. Rental expense totaled $3.3 million, $3.0 million, and $2.7 million in 1994, 1993, and 1992, respectively. Future minimum lease payments under noncancellable operating leases are as follows: 1995, $1.3 million; 1996, $0.9 million; 1997, $0.5 million; 1998, $0.3 million; 1999, $0.3 million; and, thereafter, $0.1 million.\nLST and its subsidiaries are parties to a number of lawsuits and controversies which are not discussed herein. It is the opinion of management of LST and its operating companies, based upon their analysis of known facts and circumstances and reports from legal counsel, that these matters will have no material effect on the results of operations or financial condition of LST and its subsidiaries, taken as a whole.\nSALE OF AFB - NOTE L\nIn November, 1993, LST sold the stock of AFB, one of its operating subsidiaries, to Guaranty Federal Bank, f.s.b. (\"GFB\"). The accompanying consolidated financial statements have been restated to reflect AFB as a discontinued operation. The sale price was $155.7 million, of which LST received $135.7 million in cash on the date of the sale and $5 million in November, 1994.\nPrior to the sale, AFB earned $21.2 million in 1993 and $17.6 million in 1992. As a result of recognizing only the $135.7 million received at the time of the sale, LST experienced a loss of $4.7 million on the disposition which reduced the reported 1993 earnings from discontinued operations to $16.5 million. Escrowed funds, included in other noncurrent assets, currently amount to $15 million to provide payment for certain claims that may be filed by GFB as permitted under the sale agreement. As these funds are released to LST, they are recognized as income in the periods received.\nQUARTERLY FINANCIAL SUMMARY - NOTE M\n($ in millions, except share amounts; quarterly amounts unaudited):\nRELATED PARTY TRANSACTIONS - NOTE N\nIn November, 1994, LST and certain minority shareholders of Steel agreed to fund up to $23 million for a capital expenditure program. Steel issues 6 percent cumulative convertible preferred stock to its participating shareholders as funds are advanced. Included in the program is a significant expansion of Steel's capacity to manufacture specialty tubing products. The balance of the expenditures will be used to upgrade Steel's capability to manufacture tubular products for use in the energy sector. LST's participation in the program amounts to 89.753 percent. The program began in 1995, is scheduled to be completed in mid-1996, and had no impact on 1994 results.\nThe Steel preferred stock to be issued to LST and the other participating shareholders will have a designated value equal to the amount of the funds advanced, will pay quarterly dividends at the rate of 6 percent per year on that value, and will require its mandatory redemption by Steel, unless earlier redeemed or converted, on January 3, 2002, in cash, at the designated value plus any unpaid dividends. Prior to redemption of the stock, dividends may be paid in cash, although currently prohibited by the terms of the revolving credit agreement, or in additional preferred shares.\nLST periodically purchases steel slabs which are consigned to Steel to be used in its production of tubular products. Steel pays LST as the slabs are used or within ninety days, whichever occurs first. This program's structure is consistent with those previously established with third parties. During 1994, LST's slab purchases amounted to approximately $38 million. Intercompany transactions related to this program are eliminated in consolidation.\nLONE STAR TECHNOLOGIES, INC. AND SUBSIDIARIES Schedule III - Condensed Financial Information of Registrant (Parent Company Only) ($ in millions)\nSee accompanying notes.\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\nInformation required under this item is contained in LST's proxy statement for the 1995 Annual Meeting of Shareholders, and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required under this item is contained in LST's proxy statement for the 1995 Annual Meeting of Shareholders, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required under this item with respect to beneficial owners of more than 5 percent of outstanding common stock and to directors and executive officers is contained in LST's proxy statement for the 1995 Annual Meeting of Shareholders, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required under this item with respect to directors and executive officers is contained in LST's proxy statement for the 1995 Annual Meeting of Shareholders, and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)1 Financial Statements - The following Consolidated Financial Statements are filed as part of this report: - Report of Independent Public Accountants - Consolidated Statements of Cash Flows - for the years ended December 31, 1994, 1993, and 1992 - Consolidated Statements of Earnings - for the years ended December 31, 1994, 1993, and 1992 - Consolidated Balance Sheets at December 31, 1994 and 1993 - Notes to Consolidated Financial Statements\n2 Schedule III - Condensed Financial Information of Registrant\nNote: All schedules not filed herein for which provision is made under rules of Regulation S-X have been omitted as not applicable or not required or the information required has been included in the notes to the consolidated financial statements.\n3 Index to Exhibits\nDESCRIPTION\n3.1 Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 3(a) to Form S-4 Registration Statement of LST as filed on April 4, 1986, File No. 33-4581); Certificate of Amendment to Certificate of Incorporation dated September 30, 1986, (incorporated by reference to Exhibit 3(b) of Form 10-K of LST as filed on April 7, 1989). 3.2 Agreement and Plan of Merger dated March 6, 1986, among Steel, a Texas corporation, LST, a Delaware corporation, and Lone Star Steel Company Merging Corporation, a Delaware corporation (incorporated by reference to Exhibit II to Form S-4 Registration Statement of LST as filed on April 4, 1986, File No. 33-4581). 3.3 By-Laws as adopted March 6, 1986, as amended effective September 30, 1986, (incorporated by reference to Exhibit 3(d) of Form 10-K of LST as filed on April 7, 1989). 4.1 Statement of Resolution establishing Cumulative Preferred Stock, Series A (par value $1 per share), dated September 9, 1988, (incorporated by reference to Exhibit 3(c) of Form 10-K of LST as filed on April 7, 1989). 4.2 LST Indenture with Bankers Trust Company, Trustee, with respect to $50,000,000 8% Convertible Subordinated Debentures Due 2002 (Eurobonds), dated August 26, 1987, (incorporated by reference to Exhibit 4(c) of Form 10-K of LST as filed on April 7, 1989). 10.1 Amended 1985 Long-Term Incentive Plan (incorporated by reference to Exhibit A of Proxy Statement of LST as filed on October 22, 1993). 10.2 LST Corporate Improvement Incentive Program adopted October 9, 1990, (incorporated by reference to Exhibit 10(s) to Form 10-K as filed on March 15, 1991). 10.3 Contingent Severance Policy agreement dated October 23, 1989, between LST and Rhys J. Best, Vice President and Treasurer. 10.4 Contingent Severance Policy agreement dated October 23, 1989, between LST and Judith A. Murrell, Vice President - Corporate Relations (incorporated by reference to Exhibit 10(k) to Form 10-K as filed on April 2, 1990). 10.5 Employment and Contingent Severance Policy agreements dated November 20, 1989, between LST and James T. Dougherty, Vice President and General Counsel (incorporated by reference to Exhibit 10(l) to Form 10-K as filed on April 2, 1990). 10.6 Employment Agreement dated June 2, 1989, between LST and John P. Harbin, Chairman of the Board, President, and Chief Executive Officer (incorporated by reference to Exhibit 10(m) to Form 10-K as filed on April 2, 1990). 10.7 Steel Employee Stock Purchase Plan (incorporated by reference to Exhibit 10(m) of Amendment No. 1 to Form S-1 Registration Statement of Steel as filed on April 15, 1985, File No. 2-95858). 10.8 Financing Agreement dated March 2, 1993, between The CIT Group\/Business Credit, Inc. and Steel (incorporated by reference to Exhibit 10(af) to Form 10-K as filed on March 15, 1993); Amendment agreement dated February 14, 1994, (related to Financing Agreement dated March 2, 1993). 10.9 Loan and Security Agreement dated March 22, 1993 between Steel and the CIT Group Equipment Financing, Inc. 10.10 Amendment Agreement dated December 22, 1994, (related to Financing Agreement dated March 2, 1993, between The CIT Group\/Business Credit, Inc. and Steel incorporated by reference to Exhibit 10(af) to Form 10-K as filed on March 15, 1993). 10.11 Agreement dated November 2, 1994, among Steel, LST, and certain minority holders of Steel regarding participation in the First Capital Project by acquiring convertible preferred stock of Steel. 10.12 Stockholders and Registration Rights Agreement among Steel, LST, and Minority Shareholders of Steel, dated May 16, 1991, (incorporated by reference to Exhibit 10(p) to Form 10-K filed on March 5, 1992).\n10.13 Cost Sharing Agreement between Steel and LST, dated May 16,1991, (incorporated by reference to Exhibit 10(p) to Form 10-K filed on March 5, 1992); Amendment to the Cost Sharing Agreement dated May 16, 1991, between LST and Steel dated March 2, 1993, (incorporated by reference to Exhibit 10(ai) to Form 10-K as filed on March 15, 1993). 10.14 Tax Allocation and Indemnification Agreement dated May 16, 1991, between Steel and LST (incorporated by reference to Exhibit 10(r) to Form 10-K filed on March 5, 1992); Amendment to Tax Allocation and Indemnification Agreement dated May 16, 1991, among LST, Steel, and Steel subsidiaries dated March 2, 1993, (incorporated by reference to Exhibit 10(ah) to Form 10-K as filed on March 15, 1993). 10.15 Asset Purchase Agreement by and among Zink and Affiliates, the Sellers, and Koch Engineering Company, Inc., Buyer, dated September 18, 1989, (incorporated by reference to Exhibit 7(c) of Form 8-K as filed on October 19, 1989). 10.16 Stock Purchase Agreement, Assistance Agreement, Capital Maintenance Agreement, and Subordination Agreement regarding the acquisition by LST of AFB dated August 18, 1988, (incorporated by reference to Form 8 (Amendment No. 3 to Form 8-K) dated January 11, 1989); Amendment No. 1 to the Assistance Agreement of August 18, 1988, dated August 31, 1990, (incorporated by reference to Exhibit 10(q) to Form 10-K as filed on March 15, 1991); Settlement Agreement and Second Amendment to Assistance Agreement dated September 30, 1992, among the FDIC, as Manager, the RTC, AFB, and LSST (incorporated by reference to Exhibit 10(ab) to Form 10-K as filed on March 15, 1993). 10.17 Agreement and Plan of Merger dated March 25, 1992, as amended by First Amendment to Agreement and Plan of Merger dated April 15, 1992, between AFB and Americity (incorporated by reference to Form 8-K dated July 14, 1992). 10.18 Holdback Escrow Agreement dated July 1, 1992, among Americity, AFB, Bank One, Texas, as Agent, and James C. Jarocki, as Shareholder Representative (incorporated by reference to Exhibit 10(x) to Form 10-K as filed on March 15, 1993). 10.19 Letter Agreement dated July 1, 1992, among AFB, Americity, and the FDIC, as Manager, (regarding assignment and assumption of the Termination Agreement and Tax Benefits Cancelation Agreement) (incorporated by reference to Exhibit 10(y) to Form 10-K as filed on March 15, 1993); Termination Agreement dated December 18, 1991, among Americity, the FDIC, as Manager, and the RTC (terminating Assistance Agreement of November 18, 1988, between Americity and the FSLIC) (incorporated by reference to Exhibit 10(z) to Form 10-K as filed on March 15, 1993); Tax Benefits Cancelation Agreement dated December 18, 1991 among Americity, the FDIC, as Manager, and the RTC (incorporated by reference to Exhibit 10(aa) to Form 10-K as filed on March 15, 1993). 10.20 Stock Purchase Agreement and Agreement and Plan of Reorganization by and among Guaranty Federal Bank, f.s.b., Guaranty Holdings, Inc. I, LST, and LSST Financial Services Corporation, dated February 16, 1993, First Amendment to Stock Purchase Agreement and Agreement and Plan of Reorganization, dated April 2, 1993, Second Amendment to Stock Purchase Agreement and Agreement and Plan of Reorganization, dated August 31, 1993, and Third Amendment to Stock Purchase Agreement and Agreement and Plan of Reorganization, dated September 30, 1993, (incorporated by reference to Exhibit B of Proxy Statement of LST as filed October 22, 1993). 10.21 Holdback Escrow Agreement to Stock Purchase Agreement and Agreement and Plan of Reorganization, dated November 12, 1993, (incorporated by reference to Exhibit C of Proxy Statement of LST as filed October 22, 1993).\n22 List of Subsidiaries.\n25 Powers of Attorney.\n27 Financial Data Schedule\n(b) Reports on Form 8-K:\nDATE OF REPORT DATE FILED DESCRIPTION - -------------- ---------- ----------- None.\nITEM 15.","section_15":"ITEM 15. 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.\nLONE STAR TECHNOLOGIES, INC.\nDate: February 15, 1995 By: \/s\/ JUDITH A. MURRELL --------------------- (Judith A. Murrell) Vice President - Corporate Relations, Principal Accounting Officer, and Treasurer\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 date indicated.\nSIGNATURE TITLE DATE - --------- ----- ----\n\/s\/ JOHN P. HARBIN Chairman, Director, and February 15, 1995 - --------------------------, Chief Executive Officer (John P. Harbin)\n\/s\/ CHARLES L. BLACKBURN* Director February 15, 1995 - --------------------------, (Charles L. Blackburn)\n\/s\/ DEAN P. GUERIN* Director February 15, 1995 - --------------------------, (Dean P. Guerin)\n\/s\/ FREDERICK B. HEGI, JR.* Director February 15, 1995 - --------------------------, (Frederick B. Hegi, Jr.)\n\/s\/ WILLIAM C. MCCORD* Director February 15, 1995 - --------------------------, (William C. McCord)\n\/s\/ JAMES E. MCCORMICK* Director February 15, 1995 - --------------------------, (James E. McCormick)\n*By: \/s\/ JUDITH A. MURRELL --------------------- (Judith A. Murrell, Attorney-in-Fact)"}
{"filename":"757790_1994.txt","cik":"757790","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nCupertino National Bancorp (the \"Company\") is a California corporation and bank holding company. Cupertino National Bank (the \"Bank\"), a wholly owned subsidiary of the Company, is a national bank conducting a commercial banking business. The Company was organized in August 1984, and the Bank began operations in May 1985. The Company and the Bank have their principal offices at 20230 Stevens Creek Boulevard, Cupertino CA 95014. The Company's current activities are principally acting as the holding company for the Bank and as the lessee and sublessor to the Bank of the premises on which the Bank is located.\nThe Bank provides a wide range of commercial banking services to small and medium-sized businesses, real estate firms, business executives, professionals and other individuals. Trust services are provided by a separate department of the Bank to support the trust needs of its clients. The Bank's strategy emphasizes acquiring and developing relationships with clients in the Bank's service area. Personal service officers are assigned to each borrowing client to provide continuity to the relationship.\nThe Bank provides commercial loans for working capital and business expansion to small and medium-sized businesses with annual revenues in the range of $1 million to $25 million. Commercial loans typically include revolving lines of credit collateralized by inventory, accounts receivable or leasehold improvements, loans to purchase equipment, and loans for general working capital purposes, collateralized by equipment. The Bank's commercial customers are drawn from a wide variety of manufacturing, wholesale and service businesses, and are not concentrated in any one particular industry. Loans to real estate construction and development companies are primarily for construction of single- family residences in the Bank's primary service area. Such loans typically range between approximately $200,000 and $2,900,000. Loans to professional and other individual clients, whose income typically equals or exceeds the median income for the Bank's service area, cover a full range of consumer services, such as automobile, aircraft, home improvement and home equity loans, and other secured and unsecured lines of credit, including credit cards.\nThe Bank has a Small Business Administration (\"SBA\") department which makes loans to assist smaller clients and those who are starting new businesses in obtaining financing. The loans are generally 65% to 80% guaranteed by the SBA. In 1994, the Bank was named a Preferred Lender by the SBA. Preferred Lender status is awarded by the SBA to lenders who have demonstrated superior ability to generate, underwrite and service loans guaranteed by the SBA, and results in more rapid turn around of loan applications submitted to the SBA for approval.\nIn May 1994, the Bank opened its Emerging Growth Industries (\"EGI\") Venture Lending Group to serve the needs of companies in their start-up and development phase. This unit was developed to meet the needs of clients in the Bank's service area by allowing them to access a banking relationship early in their development. The loans to this target group of clients are generally secured by the accounts receivable, inventory and equipment of the companies. The financial strength of these companies also tends to be bolstered by the presence of venture capital investors among the shareholders.\nThe Bank is a member of the Federal Reserve System and the deposits of the Bank's clients are insured up to $100,000 by the Federal Deposit Insurance Corporation (\"FDIC\"). In 1992, the Bank became a member of the Federal Home Loan Bank of San Francisco (\"FHLB\")in order to enhance its ability to service its loan clients. This membership allows the Bank to enhance its funding sources as the FHLB allows members to borrow funds by pledging mortgage loans as collateral.\nMARKET AREA AND CLIENT BASE\nThe Bank concentrates on providing service to clients in Cupertino, San Jose, Palo Alto and the surrounding communities in Santa Clara County and San Mateo County. Cupertino is located in the center of the geographical area which is referred to as \"Silicon Valley\". The City of Cupertino has a population of approximately 42,000 and its average annual household income exceeds $79,000. Among metropolitan areas, Santa Clara County ranks third in California in median household income.\nThe commercial base of Santa Clara County is diverse and includes computer and semiconductor manufacturing, professional services, printing and publishing, aerospace, defense, real estate construction, and wholesale and retail trade. The Bank has not concentrated on attracting commercial clients from any single industry, although it has in the past emphasized lending to the residential real estate construction industry in its service area.\nThe Bank's headquarters are in Cupertino. In March 1991, the Bank opened its first regional office in downtown San Jose. This office was established to better serve existing clients of the Bank, as well as to gain new relationships from clients based in the growing financial center in the downtown San Jose area. In May 1992, the Bank opened a second regional office in Palo Alto. This office gives the Bank a presence in the financial market in Northern Santa Clara and Southern San Mateo counties. The opening of these regional offices has contributed to the continued growth of the Bank through 1994.\nMany of the directors of the Company and the Bank, and their affiliates, maintain deposit and loan relationships with the Bank. See Note 11 of Notes to Consolidated Financial Statements in the Company's 1994 Annual Report, incorporated herein by reference, for information regarding loans to affiliates and other significant related party transactions.\nSOURCES OF FUNDS\nMost of the Bank's deposits are obtained from small and medium-sized businesses, business executives, professionals and other individuals. At December 31, 1994, the Bank had a total of 4,633 deposit accounts, representing 2,032 non-interest-bearing deposit (checking) accounts with an average balance of approximately $26,700 each, 2,146 interest-bearing demand, money market demand, and savings accounts with an average balance of approximately $41,200 each, and 455 time deposit accounts with an average balance of approximately $99,000 each. Rates paid on deposits vary among the categories of deposits due to different terms, the size of the individual deposit, and rates paid by competitors on similar deposits.\nThe Bank has one large deposit relationship with a title company, in which three of the directors of the Bank serve as directors (one Bank director is also the principal shareholder and Chief Executive Officer of the title company). Deposits from this client ranged between $3.9 million and $12.6 million during 1994; balances related to this client, in both non-interest- bearing demand accounts and money market accounts totaled $4.6 million on December 31, 1994.\nLENDING ACTIVITIES\nThe Bank's loan portfolio is centered in commercial lending to small and medium-sized businesses in the manufacturing and service industries. The Bank has also been an active lender in residential real estate construction. Due to economic declines in the company's business market, the emphasis on residential real estate construction lending has been reduced.\nApproximately 59% of the Bank's portfolio was in commercial loans at December 31, 1994. Real estate construction loans represented approximately 13% of total loans at December 31, 1994, primarily for residential projects. In addition, 9% of the Bank's loans were real estate term loans, which are primarily secured by commercial properties. The balance of the portfolio consists of consumer loans and loans held for sale. The Bank's loan clients are primarily located in Cupertino, San Jose, Palo Alto and the surrounding communities in Santa Clara County and San Mateo County.\nThe majority of loans are collateralized. Generally, real estate loans are secured by real property, and commercial and other loans are secured by bank deposits or business and personal assets. Repayment is generally expected from the sale of the related property for real estate construction loans, and from the cash flow of the borrower for commercial and other loans.\nThe interest rates charged for the loans made by the Bank vary with the degree of risk, size and maturity of the loans. Rates are generally affected by competition, associated factors stemming from the client's deposit relationship with the Bank and the Bank's cost of funds. A majority of the loans in the Bank's portfolio have a floating rate.\nIn its commercial loan portfolio, the Bank provides personalized financial services to the diverse commercial and professional businesses in its market area, but does not concentrate on any particular industry. Commercial loans consist chiefly of short-term loans (normally with a maturity of under one year) for working capital. Significant emphasis is placed on the borrower's earnings history, capitalization, secondary sources of repayment (such as accounts receivable), and in some instances, third party guaranties or highly liquid collateral (e.g., time deposits). Commercial loan pricing is generally at a rate tied to the Prime rate (as quoted in the Wall Street Journal) or the Bank's reference rate.\nWhile the commercial loan portfolio of the Bank is not concentrated in any one industry, the Bank's service area has a concentration of technology companies, and accordingly, the ability of any of the Bank's borrowers to repay loans may be affected by the performance of this sector of the economy. The California economy has been particularly hard hit by the national recession. There has been a significant decline in the California residential real estate market since late 1990, which has persisted through 1994. This has resulted in an increase in the level of non-performing assets in 1993 and 1994, and has resulted in an increase in loans charged-off and the provision for loan losses in 1993 and 1994. The Bank's portfolio may be adversely affected if economic conditions do not improve, which could result in an increase in non-performing loans, charge-offs and the related provision to the allowance for loan losses.\nThe Bank's residential real estate construction loan activity has focused on providing short-term (less than one year maturity) loans to local individuals, partnerships and corporations in the local residential real estate industry for the construction of single family residences. During 1992 through 1993, the Bank concentrated its construction loan activity in the market for owner-occupied custom residences. During 1994 real estate values began to stabilize and the Bank began to cautiously enter the construction loan market for small townhouse and single family home projects.\nResidential real estate construction loans are typically secured by first deeds of trust and require guaranties of the borrower. The economic viability of the project and the borrower's credit-worthiness are primary considerations in the loan underwriting decision. Generally, these loans provide an attractive yield, but may carry a higher than normal risk of loss or delinquency, particularly if general real estate values decline or the loan underwriting process is based upon inaccurate appraisals. The Bank utilizes independent local appraisers and conservative loan-to-value ratios (e.g. loans generally not exceeding 65% to 75% of the appraised value of the property). The Bank monitors projects during the construction phase through regular construction inspections and a disbursement program tied to the percentage of completion of each project. In the absence of rapid declines in residential real estate values, ultimate collectibility of such secured loans is usually better than the average mix of commercial loans. Construction loans are generally made on a floating rate basis.\nThe Bank's consumer loan portfolio is divided between installment loans for the purchase of such items as automobiles and aircraft, and home improvement loans and equity lines of credit which are often secured by residential real estate. Installment loans tend to be fixed rate and longer- term (one to five year maturity), while the equity line type loans are generally floating rate, and are reviewed for renewal on an annual basis. The Bank also has a minimal portfolio of credit card loans, issued as an additional service to its clients.\nLOAN ADMINISTRATION\nThe loan policy of the Bank is approved each year by its Board of Directors and is managed through periodic reviews of such policies in relation to current economic activity and the degree of risk (both credit and interest rate) in the\ncurrent portfolio. The Directors' Loan Committee supervises the lending activities of the Bank. This committee consists of four outside directors, the Chairman\/Chief Executive Officer, the President\/Chief Operating Officer (position currently vacant), the Executive Vice President\/Senior Credit Officer, Senior Vice President Commercial Lending and the Vice President\/Credit Administration. The officers in this group make up the Officers' Loan Committee.\nSole lending authority is granted to officers on a limited basis. Loan requests exceeding individual officer approval limits are submitted to the Officers' Loan Committee, and those which exceed its limit are submitted to the Directors' Loan Committee for final approval. Both of these committees meet on a regular basis in order to provide timely responses to the Bank's clients.\nThe Bank has an active credit administration function which includes, in addition to internal reviews, the regular use of an outside loan review firm to review the quality of the loan portfolio. The Bank has an internal asset review committee (IARC) that meets monthly to review delinquencies, non- performing assets, classified assets and other pertinent information for the purpose of evaluating credit risk within the Bank's loan portfolio and to recommend general reserve percentages and specific reserve allocations. The IARC reports to the Board of Directors on a quarterly basis.\nTRUST DEPARTMENT\nThe Bank's Trust Department commenced operations in July 1988 and offers a full range of fee-based trust services directly to its clients. The Trust Department administers all types of retirement plans, including corporate pension plans, 401(k) plans and individual retirement plans, with an emphasis on the investment management, custodianship and trusteeship of such plans. In addition, the Trust Department acts as executor, administrator, guardian and\/or trustee in the administration of the estates of individuals. Investment and custodial services are provided for corporations, individuals and non-profit organizations. Total assets under management by the Trust Department were approximately $157 million at December 31, 1994, as compared to approximately $118 million at December 31, 1993, and $117 million at December 31, 1992.\nMORTGAGE BANKING DIVISION\nThe Bank opened a Mortgage Banking Division in July 1992. The purpose of this division is to originate residential mortgage loans for sale on the secondary market. The primary revenue of this division is the premium received on the sale of such mortgage loans and their related servicing rights. The Bank funds both loans which are originated directly by a mortgage banking officer and loans purchased through a network of mortgage brokers. The Bank is currently selling both the loans and the related servicing rights through a correspondent. During 1993 the Bank was designated as an approved seller\/servicer by the Federal National Mortgage Association and the Federal Home Loan Corporation, known in the industry as Fannie Mae and Freddie Mac, respectively. During 1994 the increased upward pressure on interest rates caused mortgage refinancing and home purchases to significantly decline. This required the Bank in June 1994 to restructure its mortgage operations and focus all of its efforts on the wholesale mortgage market. This change reduced the operating costs within the mortgage business unit; however, the operating results for the last half of 1994 did not return to acceptable levels of return on investment corresponding to the risks involved. Based on these factors the Bank determined to close its mortgage operations effective March 31, 1995. In connection with this action, the Bank anticipates incurring a $180,000 after tax charge related to this operation in the first quarter of 1995. The Bank will continue to offer mortgage loans to its market area and client base through its regional offices.\nCOMPETITION\nThe banking business in the Bank's service area is highly competitive, as it is throughout California. Many of the major branch banking institutions in California have one or more offices in the Bank's service area. The Bank competes in the marketplace for deposits and loans, principally against these banks, other independent community banks, savings and loan associations, credit unions and other financial institutions.\nThe major advantages that larger branch institutions have over the Bank are their ability to provide wide ranging advertising programs; to allocate their investment assets in areas of higher yields and demands; and, by virtue of their greater total capitalization, to utilize substantially higher lending limits than the Bank. These banks can also offer certain services, such as international banking, which are not offered directly by the Bank. However, the Bank is able to offer most of these services indirectly, through its correspondent institutions. Smaller independent banks, including the Bank, have found a market niche by providing specialized services, and by targeting clients whose credit needs are below levels generally sought by the major branch banks.\nThe Bank defines its service area as the cities of Cupertino, San Jose, Palo Alto, and the surrounding cities in Santa Clara County and San Mateo County. Banks and savings and loan operations in Santa Clara County collectively held approximately $21 billion in deposits as of June 30, 1994 (the latest date as of which complete deposit data was available). Based on this data, the Bank had a market share in Santa Clara County of approximately .93% at June 30, 1994.\nTo compete with the major financial institutions in its service area, the Bank relies upon customized services and direct personal contacts by its officers, directors and staff. For clients whose loan demands exceed the Bank's legal lending limit, the Bank seeks to arrange such loans on a participation basis with other lenders, primarily other community banks in the San Francisco Bay Area.\nEFFECT OF GOVERNMENTAL POLICIES AND LEGISLATION\nBanking is a business in which profitability depends primarily on interest rate differentials. In general, the difference between the interest rates paid by the Bank on its deposits and its other borrowings and the interest rates received by the Bank on loans extended to its customers and on securities held in the Bank's investment portfolio will be the principal factor affecting the Bank's earnings. The interest rates paid and received by the Bank are sensitive to many factors which are beyond the control of the Bank, including the influence of domestic and foreign economic conditions. The earnings and growth of the Bank and the Company will also be affected not only by general economic conditions, including inflation, recession and unemployment, but also by monetary and fiscal policies of the United States and federal agencies, particularly the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\"). The Federal Reserve Board can and does implement national monetary policy, such as seeking to curb inflation and\/or combat recession, by its open market operations in United States Government securities, by its control of the discount rates applicable to borrowing by banks from the Federal Reserve System and by its establishment of reserve requirements for financial institutions subject to its regulation. The actions of the Federal Reserve Board in these areas influence the growth of bank loans, investments and deposits, and also affect the interest rates charged on loans and paid on deposits. Changes in the financial services industry as a result of such governmental policies and regulations have often contributed to increases in the cost of funds of banks and other depository institutions and may continue to affect such cost, and consequently the earnings of such institutions. However, the degree, timing and full extent of the impact of the laws or of possible changes to the laws on banking in general, and the business of the Bank in particular, presently cannot be predicted.\nSUPERVISION AND REGULATION\nThe following information is qualified in its entirety by reference to the statutory and regulatory provisions described, which statutes and regulations are subject to change at any time.\nTHE BANK HOLDING COMPANY\nThe Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"), and is subject to supervision by the Federal Reserve Board. As a bank holding company, the Company is required to file with the Federal Reserve Board an annual report and such other additional information as the Federal Reserve Board may require pursuant to the BHCA. The Federal Reserve Board may also make examinations of the Company and the Bank. Under the BHCA, bank holding companies may not (subject to certain limited exceptions) directly or indirectly acquire the ownership or control of substantially all of the assets or more than 5% of any class of voting shares of any company, including a bank, without the prior written approval of the Federal Reserve Board. The\nBHCA prohibits the Federal Reserve Board from approving the acquisition by a bank holding company of substantially all the assets or more than 5% of any class of voting shares of any bank (or its holding company) located in a state other than the state in which the operations of the bank holding company's bank subsidiaries are principally conducted, unless the statutes of the state in which the acquiree bank is located expressly permit such an acquisition.\nIn addition, subject to certain exceptions, bank holding companies are prohibited under the BHCA from engaging in non-banking activities. One principal exception to this prohibition is for activities found by the Federal Reserve Board to be so closely related to banking as to be properly incident thereto. For each application to engage in non-banking activities, the Federal Reserve Board is required to consider whether the performance of such activities can reasonably be expected to produce benefits to the public such as greater convenience, increased competition, or gains in efficiency, that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices.\nSubsidiary banks of a bank holding company are subject to restrictions imposed by the Federal Reserve Act on any extensions of credit to the bank holding company or any of its subsidiaries, on investments in the stocks or securities thereof, and on the taking of any such stock or securities as collateral for loans to any borrowers. Furthermore, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with extensions of credit, the lease or sale of any property or the furnishing of other banking services.\nThe Company is also a bank holding company within the meaning of Section 3700 of the California Financial Code. As such, the Company and its subsidiaries are subject to examination by, and may be required to file reports with, the Superintendent of Banks of the State of California (the \"Superintendent\").\nCAPITAL ADEQUACY OF THE COMPANY\nThe Federal Reserve Board has adopted risk based capital guidelines for bank holding companies. The minimum guideline for the ratio of total capital to risk weighted assets (including certain off-balance-sheet activities) is 8%. At least half of the total capital is to be composed of common stockholders' equity, minority interests in the equity accounts of consolidated subsidiaries and a limited amount of perpetual preferred stock, less disallowed intangibles including goodwill (\"Tier 1 Capital\"). The remainder of a bank's allowable capital may include subordinated debt, other preferred stock and a limited amount of loan loss reserves (\"Tier 2 Capital\").\nIn addition, the Federal Reserve Board has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum Tier 1 Capital leverage ratio (Tier 1 Capital to total assets, less goodwill) of 3% for bank holding companies that meet certain specified criteria, including having the highest regulatory rating. All other bank holding companies are generally required to maintain a minimum Tier 1 Capital leverage ratio of 3% plus an additional 100 to 200 basis points. The guidelines also provide that bank holding companies 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 (i.e. goodwill, core deposit intangibles and purchased mortgage servicing rights). Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a \"tangible Tier 1 Capital leverage ratio\" (deducting all intangibles) in evaluating proposals for expansion or new activities.\nAt December 31, 1994, the Company had total capital and leverage capital ratios above the minimums required by the Federal Reserve Board.\nTHE BANK\nThe Bank, as a national banking association, is subject to the National Bank Act and to primary supervision, examination and regulation by the Comptroller of the Currency (the \"Comptroller\"). The Comptroller regulates the number and locations of branch offices of a national bank. The Bank is also a member of the Federal Reserve System and is subject to applicable provisions of the Federal Reserve Act and regulations issued pursuant thereto. Each\ndepositor's accounts with the Bank are insured by the Bank Insurance Fund, which is managed by the Federal Deposit Insurance Corporation (\"FDIC\"), to the maximum aggregate amount permitted by law, which is currently $100,000 for all insured deposits of the depositor. For this protection, the Bank pays a semi-annual assessment and is subject to the rules and regulations of the FDIC pertaining to deposit insurance and other matters. The Federal Reserve Board requires banks to maintain non-interest bearing reserves against certain of their transactional accounts (primarily deposit accounts that may be accessed by writing checks) and non-personal time deposits.\nAs a creditor and a financial institution, the Bank is subject to certain regulations promulgated by the Federal Reserve Board including, without limitation, Regulation B (Equal Credit Opportunity Act), Regulation D (Reserves), Regulation E (Electronic Funds Transfers Act) and Regulation F (interbank liabilities), Regulation Z (Truth in Lending Act), Regulation CC (Expedited Funds Availability Act), and Regulation DD (Truth in Savings Act). As creditors on loans secured by real property and as owners of real property, the Bank may be subject to potential liability under various statutes and regulations applicable to property owners including statutes and regulations relating to the environmental condition of the property. The Bank is also subject to applicable provisions of California law, insofar as they do not conflict with or are not preempted by federal banking law. California law exempts banks from the usury laws.\nThe supervision, regulation and examination of the Bank by the bank regulatory agencies are generally intended to protect depositors and are not intended to protect the Company's shareholders.\nINTERSTATE BANKING AND BRANCHING\nOn September 29, 1994, the Reigle\/Neal Interstate Banking and Branching Efficiency Act of 1994 (the \"Interstate Act\") was signed into law. The Interstate Act effectively permits nationwide banking. The Interstate Act provides that one year after enactment, adequately capitalized and adequately managed bank holding companies may acquire banks in any state, even in those jurisdictions that currently bar acquisitions by out-of-state institutions, subject to deposit concentration limits. The deposit concentration limits provide that regulatory approval by the Federal Reserve Board may not be granted for a proposed interstate acquisition if, after the acquisition, the acquirer on a consolidated basis would control more than 10% of the total deposits nationwide or would control more than 30% of deposits in the state where the acquiring institution is located. The deposit concentration state limit does not apply for initial acquisitions in a state and in every case, may be waived by state regulatory authority. Interstate acquisitions are subject to compliance with the Community Reinvestment Act (\"CRA\"). States are permitted to impose age requirements not to exceed five years on target banks for interstate acquisitions. States are not allowed to opt-out of interstate banking.\nBranching between states may be accomplished either by merging separate banks located in different states into one legal entity, or by establishing de novo branches in another state. Consolidation of banks is not permitted until June 1, 1997, provided that the state has not passed legislation \"opting-out\" of interstate branching. If a state opts-out prior to June 1, 1997, then banks located in that state may not participate in interstate branching. A state may opt-in to interstate branching by bank consolidation or by de novo branching by passing appropriate legislation earlier than June 1, 1997. Interstate branching is also subject to a 30% statewide deposit concentration limit on a consolidated basis, and a 10% nationwide deposit concentration limit. The laws of the host state regarding community reinvestment, fair lending, consumer protection (including usury limits) and the establishment of branches shall apply to the interstate branches.\nDe novo branching by an out-of-state bank is not permitted unless the host state expressly permits de novo branching by banks from out-of-state. The establishment of an initial de novo branch in a state is subject to the same conditions as apply to the initial acquisition of a bank in the host state other than deposit concentration limits.\nEffective one year after enactment, the Interstate Act permits bank subsidiaries of a bank holding company to act as agents for affiliated depository institutions in receiving deposits, renewing time deposits, closing loans, servicing loans and receiving payments on loans and other obligations. A bank acting as an agent for an affiliate shall not be considered a branch of the affiliate. Any agency relationship between affiliates must be on terms that are consistent with safe and sound banking practices. The authority for an agency relationship for receiving deposits includes the taking of deposits for an existing account, but is not meant to include the opening or origination of new deposit accounts. Subject to certain\nconditions, insured savings associations which were affiliated with banks as of June 1, 1994, may act as agents for such banks. An affiliate bank or savings association may not conduct any activity as an agent which such institution is prohibited from conducting as a principal.\nIf an interstate bank decides to close a branch located in a low or moderate income area, it must comply with additional branch closing notice requirements. The appropriate regulatory agency is authorized to consult with community organizations to explore options to maintain banking services in the affected community where the branch is to be closed.\nTo ensure that interstate branching does not result in taking deposits without regard to a community's credit needs, the regulatory agencies are directed to implement regulations prohibiting interstate branches from being used as \"deposit production offices\". The regulations to implement its provisions are due by June 1, 1997. The regulations must include a provision to the effect that if loans made by an interstate branch are less than fifty percent of the average of all depository institutions in the state, then the regulator must review the loan portfolio of the branch. If the regulator determines that the branch is not meeting the credit needs of the community, it has the authority to close the branch and to prohibit the bank from opening new branches in that state.\nEffective January 1, 1991, California adopted legislation permitting any out-of-state bank holding company to acquire an existing California bank if its state of principal business provides reciprocal rights to California bank holding companies. The Superintendent has determined that substantial reciprocity exists between California and a variety of states including Arizona, Oregon, Washington, and New York. Although these changes have had the impact of increasing competition among banks and between banks and other financial service providers, the long-term effects of this increased competition on the Bank and on the competition which may arise as a result of the Interstate Act, cannot be determined at this time.\nCAPITAL ADEQUACY OF THE BANK\nIn 1989, the Federal Reserve Board, along with the Comptroller and the FDIC, established an interagency risk-based capital framework that establishes uniform risk-based capital guidelines for certain banking organizations in the United States. Under these guidelines, both assets reported on the balance sheet and certain off-balance sheet items are assigned to certain risk categories. Each category has an assigned risk weight. Capital ratios are then calculated by dividing the capital by a weighted (according to risk) sum of the assets and off-balance sheet items.\nOn February 28, 1991, the FDIC adopted minimum \"leverage ratio\" standards for certain banking organizations. The leverage ratio is a ration of Tier 1 capital to quarterly average total assets. The minimum required leverage ratio is 3.0% Tier 1 capital for banks that meet certain specified criteria, including having the highest regulatory rating. All other banks are generally required to maintain a leverage ratio of between 4.0% and 5.0% Tier 1 capital.\nAt December 31, 1994, the Bank had capital ratios, both risk-adjusted and leverage, which placed it in the \"well capitalized\" category. For an analysis of the capital ratios of the Bank as of December 31, 1994, see \"Management's Discussion and Analysis of Financial Conditions and Results of Operations - Capital Resources\" in the 1994 Annual Report to Shareholders, which is incorporated herein by reference. The Company does not presently expect that compliance with regulatory capital guidelines will have a material adverse effect on the business of the Company or the Bank. The Company anticipates that if significant asset growth continues in the future, such growth may necessitate the addition of capital to comply with regulatory guidelines.\nFINANCIAL INSTITUTIONS REFORM, RECOVERY AND ENFORCEMENT ACT\nThe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") mandated changes that continue to affect the financial institutions industry. FIRREA substantially revised the regulatory structure of the banking, savings and financial services industries. Many of these changes directly affect the Bank and the Company. Deposits at commercial banks such as the Bank are now insured by the Bank Insurance Fund (\"BIF\") of the FDIC.\nFIRREA requires the banking regulatory agencies to make written evaluations after examining a depository institution for compliance with the Community Reinvestment Act (\"CRA\"). The CRA evaluations now include a public section, including the CRA rating agency assigned to the bank, and a confidential section, which is not released to either the public or the institution, except under limited circumstances. The regulatory guidelines now require each institution to place the written evaluation in its CRA public file at its head office and at one designated office in each local community. FIRREA also revised the rating system for CRA compliance.\nFIRREA mandated appraisals by state-certified or state-licensed appraisers for loans made by financial institutions over certain amounts. Effective December 31, 1992, an appraisal by a state-certified appraiser is required for the following types of bank loans secured by real estate: (1) any real estate loan transaction having a value of $1 million or more, or (2) any non-residential real estate transaction or complex residential real estate transaction in the amount of $250,000 or more. In addition, an appraisal by a state-licensed appraiser is required for any real-estate transaction having a value of more than $100,000. The State of California has established a program for the licenser and certification of real estate appraisers in order to meet the requirements of FIRREA.\nFEDERAL DEPOSIT INSURANCE CORPORATION IMPROVEMENT ACT OF 1991\nOn December 19, 1991, the Federal Deposit Insurance Corporation Improvement Act of 1990 (\"FDICIA\") was signed into law. Among other things, FDICIA recapitalized the BIF, implemented deposit insurance reform, and imposed new supervisory standards requiring annual examinations, independent audits, uniform accounting and management standards and prompt corrective action for problem institutions. As a result of FDICIA, depository institutions and their affiliates are subject to federal standards which govern asset growth, interest rate exposure, executive compensation, and many other areas of depository institution operations. Only the most highly capitalized and well-managed institutions are allowed to expand their operations and activities. Undercapitalized institutions are subject to activity limitations and other restrictions.\nBIF Recapitalization. FDICIA provides increased funding for the BIF, primarily by increasing the authority of the FDIC to borrow from the U.S. Treasury Department. A significant portion of any such borrowing will be repaid by insurance premiums assessed on BIF members, including the Bank, sufficient to repay any borrowed funds within 15 years and to provide BIF reserves of $1.25 for each $100 of insured deposits. FDICIA also provides authority for special assessments against insured deposits.\nRisk Based Deposit Insurance Rates. On January 1, 1994, a permanent risk-based deposit premium assessment system became effective under which each depository institution is placed in one of nine assessment categories based on certain capital and supervisory measures. The assessment rates under the system range from 0.23 percent to 0.31 percent of domestic deposits depending on the assessment category into which an insured bank is placed. It is possible that such assessments may be increased or decreased and that there may be additional special assessments in the future. A significant increase in the assessment rate or an additional special assessment could have an adverse impact on the Bank's and the Company's results of operations. Increases in deposit insurance assessment rates add to an insured bank's operating costs. These cost increases can have a measurable effect upon a bank's profitability and capitalization. Increases in deposit insurance assessment expenses do not, however, necessarily lead to equally proportionate declines in bank profits. The Company does not anticipate that an increase or decrease in its deposit insurance assessment rate will significantly impact the Bank's profitability or capitalization.\nBrokered Deposits. Under FDIC regulations governing the receipt of brokered deposits, a bank cannot accept brokered deposits (which term is defined to mean deposits with an interest rate which exceeds significantly prevailing rates in its market) unless (i) it is well capitalized or (ii) it is adequately capitalized and has received a waiver from the FDIC. Except under certain conditions, a bank that cannot accept brokered deposits also cannot offer \"pass- through\" insurance on certain employee benefit accounts. The Bank is considered to be well capitalized for purposes of this regulation and in 1994 began accepting limited amounts of brokered deposits to help manage its liquidity position.\nPrompt Corrective Regulatory Action. FDICIA categorizes banking institutions as well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A bank is subject to corrective action if it is not adequately capitalized. Significantly and critically undercapitalized banks are subject to extensive federal regulatory control, including closure. A bank's capital tier depends upon where its capital levels are in relation to various relevant capital measures, which include a risk-based capital measure and a leverage capital measure, and upon certain other factors. The federal banking authorities adopted regulations effective December 19, 1992, which define the capital measures a bank must meet in order to be considered well capitalized as a ratio of total capital to risk- weighted assets of not less than 10.0%, a ratio of Tier 1 capital to risk- weighted assets of not less than 6.0% and a leverage ratio of Tier 1 capital to average quarterly assets of not less than 5.0%. A bank will be considered adequately capitalized if it has a ratio of total capital to risk-weighted assets of not less than 8.0%, a ratio of Tier 1 capital to risk-weighted assets of not less than 4.0%, and a leverage ratio of Tier 1 capital to average quarterly assets of not less than 4.0%. The capital levels for the undercapitalized category are defined as any level under 8.0% for the total risk-based capital ratio, under 4.0% for the Tier 1 risk-based capital ratio, or under 4.0% for the Tier 1 leverage ratio. A bank will be considered significantly undercapitalized if it has a ratio of total capital to risk- weighted assets that is less than 6.0%, a ratio of Tier 1 capital to risk- weighted assets that is less than 3.0%, or a Tier 1 leverage ratio that is less than 3.0%. A bank will be considered critically undercapitalized if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. In addition to FDICIA's capital requirements, a financial institution may be reclassified and subject to corrective action if it receives a less than satisfactory rating in its most recent examination for its assets, management, earnings or liquidity. The Company and the Bank were considered \"well capitalized\" at December 31, 1994.\nFDICIA also requires an insured institution which does not meet any one of the statutory or regulatory capital requirements applicable to it to submit a capital restoration plan for improving its capital. In addition, FDICIA prohibits an insured institution from making a capital distribution if it fails to meet any capital requirements. FDICIA also contains a number of consumer banking provisions, including disclosure requirements and substantive contractual limitations with respect to deposit accounts, and places restrictions on a bank's dealings with \"large customers\" if a principal officer or director of the \"large customer\" is a member of the bank's audit committee.\nReal Estate Lending. As required by FDICIA, on December 19, 1992, the federal banking agencies adopted uniform regulations prescribing standards for real estate lending effective March 19, 1993. The uniform rules require depository institutions to adopt and maintain comprehensive written real estate lending policies that are consistent with safe and sound banking practices, as well as establish loan-to-value limitations on real estate lending by insured depository institutions. The loan-to-value limits do not apply to loans guaranteed by the U.S. Government or backed by the full faith and credit of a state government; loans facilitating the sale of real estate acquired by the lending institution in the ordinary course of collecting a debt previously contracted; loans where real estate is taken as additional collateral solely through an abundance of caution by the lender; loans renewed, refinanced, or restructured by the original lender to the same borrower, without the advancement of new funds; or loans originated prior to the effective date of the regulation. The new regulations also allow lending institutions to make a limited amount of loans that do not conform to the regulations' loan-to-value limitations. The Bank has amended its real estate lending policies to comply with this legislation; such amendments are not expected to adversely affect the Bank's operations or profitability.\nStandards for Safety and Soundness. In September of 1992 the FDIC proposed regulations to require management to establish and maintain an internal control structure and procedures to ensure compliance with laws and regulations concerning bank safety and soundness on matters such as loan underwriting and documentation, asset quality, earnings, internal rate risk exposure and compensation and other employee benefits. The proposals, among other things, establish the maximum ratio of classified assets to total capital at 1.0 and the minimum level of earnings sufficient to absorb losses without impairing capital. The proposals provide that a bank's earnings are sufficient to absorb losses without impairing capital if the bank is in compliance with minimum capital requirements and the bank would, if its net income or loss over the last four quarters continued over the next four quarters, remain in compliance with minimum capital requirements. Any institution which fails to comply with these standards must submit a compliance plan. The failure to submit a plan or to comply with an approved plan will subject the institution to further enforcement action. Finally, independent auditors would be required to attest to or report separately on assertions in management's report, by using audit procedures agreed upon by the FDIC for determining the extent of compliance with laws and regulations\nconcerning bank safety and soundness. In anticipation of the adoption by the FDIC of the proposed regulations, the Bank is in the process of documenting and establishing additional internal control structures and procedures, as necessary, to ensure compliance with new requirements imposed by FDICIA and the regulations thereunder concerning the Bank's safety and soundness. The Bank's audit committee is composed entirely of outside directors.\nPAYMENT OF DIVIDENDS\nThere are statutory and regulatory requirements applicable to the payment of dividends by the Bank to the Company and by the Company to its shareholders.\nBy the Company. The Company began paying cash dividends in December 1994. The Company anticipates continuing to pay cash dividends on a semi-annual basis to the shareholders of the Company, when and as declared by its Board of Directors, out of funds legally available therefor, subject to the restrictions set forth in the California General Corporation Law (the \"Corporation Law\"). The amount of the annual dividend is anticipated to range between 10% to 25% of estimated annual earnings. The Corporation Law provides that a corporation may make a distribution to its shareholders if the corporation's retained earnings equal at least the amount of the proposed distribution. The Corporation Law further provides that, in the event that sufficient retained earnings are not available for the proposed distribution, a corporation may nevertheless make a distribution to its shareholders if it meets the following two generally stated conditions: (i) the corporation's assets equal at least 1.25 times its liabilities, and (ii) the corporation's current assets equal at least its current liabilities or, if the average of the corporation's earnings before taxes on income and interest expense for the two preceding fiscal years was less than the average of the corporation's interest expense for such fiscal years, the corporation's current assets must equal at least 1.25 times it current liabilities. The primary source of funds for payment of dividends by the Company would be obtained from dividends received from the Bank.\nBy the Bank. The board of directors of a national bank may declare the payment of dividends from funds legally available therefore, depending upon the earnings, financial condition and cash needs of the bank and general business conditions. A national bank may not pay dividends from its capital. All dividends must be paid out of net profits then on hand, after deducting losses and bad debts. A national bank is further restricted from declaring a dividend on its shares of common stock until its surplus fund equals the amount of capital stock, or, if the surplus fund does not equal the amount of capital stock, until one-tenth of the bank's net profits of the preceding half year in the case of quarterly or semiannual dividends, or the preceding two consecutive half-year periods in the case of an annual dividend, are transferred to the surplus fund. Furthermore, if the total of all dividends declared by a bank in any calendar year would exceed the total of its retained net profits of that year combined with its net profits of the two preceding years, less any required transfers to surplus or a fund for the retirement of any preferred stock, then the approval of the Comptroller is required for the payment of any dividends.\nGuidelines of the Comptroller set forth factors which are to be considered by a national bank in determining the payment of dividends. A national bank, in assessing the payment of dividends, is to evaluate the bank's capital position, its maintenance of an adequate allowance for loan and lease losses, and the need to revise or develop a comprehensive capital plan, complete with financial projections, budgets and dividend guidelines. The Comptroller has broad authority to prohibit a national bank from engaging in banking practices which it considers to be unsafe and unsound. It is possible, depending upon the financial condition of the national bank in question and other factors, that the Comptroller may assert that the payment of dividends or other payments by a bank is considered an unsafe or unsound banking practice and, therefore, direct the bank to implement corrective action to address such a practice. Accordingly, the future payment of cash dividends by the Bank to the Company will not only depend upon the Bank's earnings during any fiscal period, but also upon the assessment of the Bank's Board of Directors of the capital requirements of the Bank and other factors, including dividend guidelines and the maintenance of an adequate allowance for loan and lease losses.\nPOLICY STATEMENT ON ALLOWANCE FOR LOAN LOSSES\nIn 1993, the Federal banking agencies, through the Federal Financial Institutions Examination Council, issued a uniform policy statement on the adequacy of the reserves for loan and lease losses. The policy statement establishes a\nbenchmark equal to the sum of (a) 100% of assets classified as uncollectible, (b) 50% of assets classified as doubtful, (c) 15 % of assets classified substandard and (d) estimated credit losses on other assets over the upcoming 12 months. Federal bank examiners will measure the reasonableness of a banks' methodology for computing its reserves against this benchmark which is designed to be neither a floor nor a safe harbor.\nCOMMUNITY REINVESTMENT ACT AND FAIR LENDING DEVELOPMENTS\nThe CRA requires banks, as well as other lenders, to identify the communities served by the bank's offices and to identify the types of credit the bank is prepared to extend within such communities. The CRA also requires an assessment of the performance of the bank in meeting the credit needs of its community and to take such assessment into consideration in reviewing applications for mergers, acquisitions, and other transactions. An unsatisfactory CRA rating may be the basis for denying such an application. The Bank is subject to certain fair lending requirements and reporting obligations involving home mortgage lending operations and CRA activities. In addition to substantive penalties and corrective measures that may be required for a violation of certain fair lending laws, the Federal banking agencies may take compliance with such laws and CRA into account when regulating and supervising other activities.\nOn March 8, 1994, the Federal Interagency Task Force on Fair Lending issued a policy statement, which became effective April 15, 1994, on discrimination in lending. The policy statement describes the three methods that Federal agencies will use to prove discrimination: overt evidence of discrimination, evidence of disparate treatment, and evidence of disparate impact.\nIn connection with its assessment of CRA performance, the regulators assign a rating of \"outstanding,\" \"satisfactory,\" needs to improve,\" or \"substantial noncompliance.\" The OCC conducts examinations of a bank's CRA performance as part of its regular examination process.\nPENDING LEGISLATION AND REGULATIONS\nCertain legislative and regulatory proposals which could affect the Company, the Bank and the banking business in general are pending, or may be introduced, before the U.S. Congress, the California State Legislature, and Federal and State government agencies. The U.S. Congress is considering numerous bills that could reform the banking laws substantially, particularly if the current legal barriers between commercial banking and investment banking are eliminated, as is now being proposed.\nIt is not known to what extent, if any, these proposals will be enacted or what effect such legislation would have on the structure, regulation, or competitive relationship of financial institutions. It is likely, however, that many of these proposals would subject the Company and the Bank to increased regulation, disclosure and reporting requirements and would increase competition to the Bank and its cost of doing business.\nIn addition to pending legislative changes, the various banking regulatory agencies frequently propose rules and regulations to implement and enforce already existing legislation. FDICIA requires the regulatory agencies to adopt numerous rules, regulations, standards and guidelines over the next several years. Some of these regulations have been proposed. With respect to others, the agencies have solicited comments from the industry on the form the regulations should take. It cannot be predicted whether or in what form any such legislation or regulations will be enacted or the effect that such legislation may have on the business of the Company and the Bank.\nCOMPETITORS\nCommercial banks, in general, have historically been less restricted in the types of loans they may lawfully make than have been non-bank financial institutions. However, the Depository Institutions Deregulation and Monetary Control Act, enacted in 1980, has increased the ability of non-banking institutions to compete with banks in lending activities. Federally chartered savings and loan associations may now invest up to 10% of their assets in commercial corporate, business or agricultural loans, and may offer credit card services. Federal credit unions have previously been authorized\nby law to offer certain types of consumer loans. Additionally, since December 31, 1980, banks and other financial institutions, nationwide, have been permitted to offer check-like services, such as negotiable order of withdrawal (NOW) accounts, on which interest or dividends may be paid under certain circumstances.\nSELECTED STATISTICAL INFORMATION\nThe following tables present selected financial information regarding the Bank's loans and deposits. This information should be read in conjunction with the company's Consolidated Financial Statements and the notes thereto and Management's Discussion and Analysis of Financial condition and Results of Operations included in the Company's 1994 annual Report to Shareholders, which has been incorporated herein by reference.\nTABLE I - LOAN MATURITIES - The following table details the maturity structure of the Bank's Commercial, SBA, Technology and Real Estate Construction and Land loan portfolio at December 31, 1994.\nTABLE II - COMPOSITION OF LOANS - The following tables details the composition of the Bank's gross loan portfolio at:\nTABLE III - NON-PERFORMING LOANS -The following table details the Bank's non- performing loan portfolio for the last five years.\nTABLE IV - ALLOCATION OF ALLOWANCE FOR LOAN LOSSES - The Bank's allocation of its allowance for loan losses for the past five years is detailed as follows for years ended December 31:\nTABLE V - The following table summarizes the activity in the Bank's allowance for loan losses for the past five years:\nTable VI - MATURITIES OF CERTIFICATES OF DEPOSIT\nThe following table presents the Bank's maturities of certificates of deposit over $100,000 issued by the Bank as of December 31, 1994.\nFor information regarding certain required disclosures of the maturities of investments, refer to Note 2 in the Company's 1994 Annual Report to Shareholders which is incorporated herein by reference.\nEMPLOYEES ---------\nThe Company has no salaried employees, since all officers of the Company are employees of the Bank. At December 31, 1994, the Bank had 111 full time equivalent employees. Management believes that its employee relations are good and that the benefits provided by the Bank to its employees are competitive.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases, from an unaffiliated party, approximately 19,000 square feet of office space, consisting of a portion of the first and second floors of a two-story building at the intersection of Stevens Creek Boulevard and Torre Avenue in Cupertino, California. The lease commenced on October 1, 1992, and has a term of ten years, with two consecutive five-year renewal options. The current minimum monthly rental payments are approximately $42,000, and are subject to annual adjustments depending on the percentage increase in the consumer price index over the prior period. The rent is further subject to adjustment upon exercise of each renewal option, to an amount equal to the then current market rental rate for similar properties. At December 31, 1994, the Company subleased all 19,000 square feet of the leased premises to the Bank for an amount equivalent to the Company's expense related to such premises.\nThe Bank has entered into a lease for 3,900 square feet of office space on the ground floor of Sixty South Market Street, San Jose, CA, effective August 1, 1993. The lease has a term of five years, with an option to extend for an additional five years. The monthly rent is approximately $5,200 and is subject to annual adjustments. The rent is subject to adjustment upon exercise of the renewal option to an amount equal to the then current market rental rate for similar space.\nEffective March 28, 1994, the Bank extended its lease for 5,300 square feet of office space at 3 Palo Alto Square in Palo Alto, CA, which currently accommodates its Palo Alto regional banking office, and its Emerging Growth Industries division. The term is for eight years, with a base rent of $11,125 per month, with scheduled annual increases. The Company has an option to extend the lease for two additional five-year periods.\nEffective June 16, 1994, the Bank leased 2,100 square feet of office space at 3530 Camino Del Rio North, San Diego, CA. This space is currently utilized by the Banks wholesale mortgage origination unit. The term of the lease is approximately 21 months, with a base rent of approximately $2,200 per month.\nThe Company believes that its facilities are well maintained and adequate to meet its current requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLEGAL PROCEEDINGS. On January 25, 1994, Sumitomo Bank (\"Sumitomo\") as ----------------- trustee for the California Dental Guild Real Estate Mortgage Fund II (\"Fund II\"), filed suit against the Bank in the Superior Court of the State of California, Santa Clara County, alleging negligence by the Bank and, by amendment of the complaint, one of its officers, in connection with the administration of a trust account. Sumitomo brought suit in its capacity as successor trustee for Fund II, and currently seeks monetary damages of approximately $2.2 million. Discovery for this litigation is still in process and no trial date has currently been scheduled.\nAfter consultation with its litigation counsel, the Bank believes that it has defenses to the claims made by Sumitomo and will vigorously defend the suit. However, litigation is subject to inherent uncertainties, especially in cases such as this where issues of trustee standards of care may be decided by a lay jury. Accordingly, no assurance can be given that Sumitomo's claims will be decided in favor of the Bank.\nThe Bank believes that, if there were to be an unfavorable outcome of this suit, the Bank's litigation reserves and, based upon advice of litigation counsel, its coverages under a professional liability and director and officer insurance policies, would be adequate to cover any reasonably determined liability for the alleged claims. In any event, the Bank believes that the Sumitomo suit will not have a material adverse effect on the financial statements of the Bank.\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 SHAREHOLDER MATTERS\nThe information required by this Item is incorporated by reference to the section entitled \"Stock Activity\" on page 21 of the Company's 1994 Annual Report to Shareholders.\nAt December 31, 1994 there were approximately 403 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 incorporated herein by reference to the table entitled \"Financial Highlights\" on page 1 of the Company's 1994 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 this Item is incorporated herein by reference to the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 10 through 21 of the Company's 1994 Annual Report to Shareholders.\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 the Company's Consolidated Financial Statements and the notes thereto, and the Independent Auditor's Report thereon, set forth on pages 22 through 38 of the Company's 1994 Annual Report to Shareholders.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nThe information required to be reported on this item has been previously reported in a Form 8-K filed on October 20, 1994.\nPART III\nCertain information required by Part III is omitted from this Report in that the Company intends to file its definitive proxy statement pursuant to Regulation 14A (the \"Proxy Statement\") not later than 120 days after the end of the fiscal year covered by this Report, and certain information therein is incorporated herein by reference.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this Item is incorporated herein by reference to the information relating to the directors of the Company set forth under the captions \"Election of Directors\" and \"Compliance with Section 16)a) of the Securities Exchange Act of 1934\" in the Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated herein by reference to the information relating to executive compensation set forth under captions \"Executive Compensation and Other Matters\" in the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated herein by reference related to ownership of equity securities as set forth under the caption \"General Information - Stock Ownership of Certain Beneficial Owners and Management\" in the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated herein by reference to the information relating to certain relationships and related transactions set forth under the caption \"Compensation Committee Interlocks and Insider Participation\" in the Proxy Statement.\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:\n(1) Financial Statements.\nThe following Consolidated Financial Statements of Cupertino National Bancorp and Independent Auditors' Report are contained in and incorporated by reference herein to the Company's 1994 Annual Report to Shareholders:\nConsolidated Balance Sheets - At December 31, 1994 and 1993 Consolidated Statements of Income - For the years ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Shareholders' Equity -For the years ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Cash Flows - For the years ended December 31, 1994, 1993 and 1992.\nNotes to Consolidated Financial Statements.\nIndependent Auditors' Reports.\nWith the exception of the information incorporated by reference to the Company's 1994 Annual Report to Shareholders in Parts I, II and IV of this Form 10-K, the Company's 1994 Annual Report to Shareholders is not to be deemed filed as part of this Report.\n(2) Financial Statement Schedules.\nAll financial statement schedules are omitted because they are not applicable or not required, or because the required information is included in Management's Discussion and Analysis of Financial Condition and Results of Operations or in the Consolidated Financial Statements and Notes thereto contained in the Company's 1994 Annual Report to Shareholders, which are incorporated herein by reference.\n(3) Exhibits.\nThe exhibits listed on the accompanying Exhibit Index are filed as part of, or are incorporated by reference into, this Report. Exhibit Nos. 10.2, 10.5, 10.7, 10.8, 10.9 and 10.10 are management contracts or are compensatory plans or arrangements covering executive officers or directors of the Company.\n(b) Reports on Form 8-K.\nThe Company filed the following reports on Form 8-K during the fourth quarter of fiscal 1994:\nDate of Report Items Reported -------------- --------------\nSeptember 7, 1994 Pursuant to Item 5, the Company reported the announcement of the resignation of Scott Montgomery as an officer and director of the Company and as a director of the Bank effective September 30, 1994.\nOctober 20, 1994 Pursuant to Item 4, the Company reported changing its independent public accountants from Deloitte & Touche, LLP to Coopers & Lybrand, L.L.P.\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.\nCUPERTINO NATIONAL BANCORP\nBy: \/s\/ C. Donald Allen ------------------------------- C. Donald Allen, Director and Chief Executive Officer\nDated:\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints C. Donald Allen and Steven C. Smith or either of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her, and in his or her name, place and stead, in any and all capacities to sign any and all amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchanges 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 connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or either of them, or their or his substitutes or substitute, may lawfully do or cause to be done by virtue of 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 Registrant in the capacities and on the dates indicated.\nINDEX TO EXHIBITS\n_____ *A management contract or compensatory plan or arrangement required to be filed pursuant to Item 14(c).","section_15":""}
{"filename":"65660_1994.txt","cik":"65660","year":"1994","section_1":"ITEM 1. BUSINESS (CONTINUED)\nINDUSTRY SEGMENTS MNC operates in two industry segments - financial services and residential mortgage banking. Please refer to Note X to the Consolidated Financial Statements for further information.\nThe primary businesses of the financial services segment are retail banking, commercial banking and investment banking. These businesses are operated by MNB. Independence One Bank of California (IOBOC) also operates retail and commercial banking businesses.\nMNB also operates a residential mortgage banking business and offers residential mortgages to customers through MNB's branch network.\nCOMPETITION Michigan is a highly competitive financial services market. Michigan laws allow reciprocal interstate banking with the states of Illinois, Indiana, Minnesota, Ohio and Wisconsin. Federal laws, beginning in 1995, will allow interstate bank acquisitions, further expanding the banking market and heightening competitive forces. MNB competes primarily with other Michigan banks for loans, deposits and trust accounts. Further competition comes from a variety of financial intermediaries including investment companies, savings and loan associations, consumer finance companies, mortgage companies, and credit unions. IOBOC does business in the highly competitive southern California market. Financial institutions compete for deposit accounts, loans and other business on the basis of interest rates, fees, convenience and quality of service.\nMNC's non-bank subsidiaries (included in the financial services industry segment), which are involved in leasing, insurance and investment management, face direct competition from leasing companies, brokerage houses, large retailers and commercial finance and insurance companies.\nSUPERVISION AND REGULATION MNC is subject to supervision and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956, as amended. Since it is a bank holding company, the services provided by the subsidiary banks and the operations of MNC are required to be closely related to the business of banking or related financial services.\nMICHIGAN NATIONAL CORPORATION AND SUBSIDIARIES\nITEM 1. BUSINESS (CONTINUED)\nMNC currently operates one national bank, which is a member of the Federal Reserve System, thereby supervised, regulated and subject to examination by the appropriate federal regulatory agencies. MNC also operates a federally-chartered stock savings bank which is regulated by the Office of Thrift Supervision.\nIn addition, MNC's bank subsidiary and savings bank subsidiary are members of the Federal Deposit Insurance Corporation. The electronic funds transfer services of these subsidiaries are governed by both state and federal laws.\nDuring October 1994, the Central Office of the Comptroller of the Currency terminated the Memorandum of Understanding it entered into with MNB in August 1993.\nPART I ITEM 2.","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":"ITEM 10 (a) DIRECTORS OF THE CORPORATION\n____________________\n(1) Each of the Directors is also a Director of Michigan National Bank, the Corporation's principal banking subsidiary.\n____________________\n(2) Independence One Bank of California, FSB (formerly Beverly Hills Business Bank, FSB), Mission Viejo, CA; and Independence One Investment Services, Corp., Farmington Hills, MI, are wholly- owned subsidiaries of the Corporation. Lockwood Banc Group, Inc., Houston, TX, was a wholly-owned subsidiary of the Corporation until its sale, effective August 4, 1994.\nPART III ITEM 10 (b) EXECUTIVE OFFICERS OF THE CORPORATION\n________________\n(1)Independence One Asset Management Corporation, Irvine, CA; Independence One Bank of California, FSB (formerly Beverly Hills Business Bank, FSB), Mission Viejo, CA; Independence One Holding Company (formerly BancA Corporation), Dallas, TX; Independence One Life Insurance Company, Phoenix, AZ; MNC Leasing Company, Detroit, MI; and MNC Operations and Services, Inc., Farmington Hills, MI, are wholly-owned subsidiaries of the Corporation. First State Bank and Trust Company of Port Lavaca, Port Lavaca, TX, was a wholly-owned subsidiary of the Corporation until its merger into International Bank of Commerce, Loredo, TX, effective September 1, 1994. Lockwood Banc Group, Inc. Houston, TX, was a wholly-owned subsidiary of the Corporation until its sale to Comerica Incorporated, Delaware, effective August 4, 1994.\n(2)Executive Relocation Corporation, Farmington Hills, MI; General Audit Systems, Inc., Farmington Hills, MI; Independence One Brokerage Services, Inc., Farmington Hills, MI; Independence One Financial Services, Inc., Southfield, MI; and MNC Financial Services, Detroit, MI, are wholly-owned subsidiaries of Michigan National Bank. Independence One Mortgage Corporation, Southfield, MI, was a wholly-owned subsidiary of Michigan National Bank until its sale to Norwest Mortgage, Inc., effective October 1, 1994.\n(3)See the section entitled \"Directors of the Corporation\" under Item 10 (a) for a description of Mr. Mylod's and Mr. Ebert's principal positions and offices with the Corporation, business experience, principal occupation and employment during the past five years.\nPART III ITEM 10 (h) EXCHANGE ACT, SECTION 16(a) COMPLIANCE\nSection 16(a) of the Securities Exchange Act of 1934 requires the Corporation's directors and officers, and persons who own more than ten percent of a registered class of the Corporation's equity securities to file reports of ownership and changes in ownership with the Securities and Exchange Commission (\"Commission\") and the National Association of Securities Dealers. Specific due dates for these reports have been established and the Corporation is required to report in this Annual Report on Form 10-K any failure to file by these dates during 1994. All of these filing requirements were satisfied by its officers and directors except that Morton E. Harris, Director and David M. Zarnoch, Senior Vice President(1) each failed to file on a timely basis one required report relating to one transaction involving Common Stock of the Corporation. William F. Pickard, Director, failed to file on a timely basis four required reports relating to four transactions involving Common Stock of the Corporation, all of which occurred in years prior to 1994. In making this statement, the Corporation has relied on the written representations of its incumbent directors and officers and copies of the reports that they have filed with the Commission.\n__________________\n(1) As a result of a reorganization announced on March 10, 1994, Mr. Zarnoch no longer serves as an executive officer of the Corporation.\nPART III ITEM 11(a) AND 11(k)\nCOMPENSATION COMMITTEE REPORT\nThe Compensation Committee of the Board of Directors is composed of outside directors. The Compensation Committee's responsibilities include reviewing and approving recommendations from senior management and, in turn, making recommendations to the Board regarding the base salaries and the policies and procedures that govern the various compensation programs for the Chief Executive Officer and other executive officers of Michigan National Corporation. Specifically, the Compensation Committee recommends and the Board considers and approves: the corporate executive salary program; the corporate bonus plan; the deferred compensation plans; the corporate stock option and performance incentive plan; and all other plans that impact the Chief Executive Officer's and the executive officers' total compensation. The Board, when considering these matters, meets in executive session.\nMichigan National Corporation's executive compensation programs are designed to attract, retain, motivate and reward highly talented executives who are capable of developing and achieving strategic business objectives that will allow the Corporation to remain highly competitive in a very complex and demanding industry.\nOn an annual basis, the Compensation Committee conducts a review of the Corporation's executive compensation programs. This review includes the presentation of salary survey information compiled by the Corporation's Human Resources Department. The Human Resources Department gathers survey data from independent sources it concludes are reliable for positions which are comparable to positions within the Corporation. This allows the Committee to evaluate competitive base salaries, bonuses and total compensation in establishing the compensation of the Corporation's executives. Data from three independent surveys covering regional banks with assets from $6 Billion to $20 Billion was utilized by the Committee in formulating its base salary and bonus recommendations for 1994(1). If survey data is not available for a specific position, the Human Resources Department analyzes the components of the position and makes a salary recommendation to the Committee.\nRobert J. Mylod, Chairman and Chief Executive Officer, Douglas E. Ebert, President and Chief Operating Officer and Joseph J. Whiteside, Executive Vice President and Chief Financial Officer have employment agreements approved by the Compensation Committee establishing a starting salary and providing for participation in all other welfare, deferred benefits, salary, bonus and incentive plans, subject to Compensation Committee review and approval.\nAfter reviewing the above described survey data in the context of the Corporation's profitability, quality of its balance sheet, results of internal and external audits and the position of the Corporation in its markets, the Committee recommended and the Board approved a 1994 base salary of $534,500 for Mr. Mylod(2). The\n- ---------------\n(1) Most of the banks included in the compensation surveys are not included in the Keefe, Bruyette & Woods Bank Stock Index (KBW 50 Index) which is the index to which the Corporation has compared the performance of its common stock against since 1992 when stock performance comparisons became a proxy statement requirement. See Stock Performance Chart under Item 11(l). The KBW 50 Index provides an appropriate index for stock comparison purposes but is less appropriate for compensation comparison purposes. For purposes of making compensation comparisons, the Corporation compares its compensation to the compensation of banks which more closely approximate its asset size.\n(2) Mr. Mylod voluntarily reduced his 1994 base salary to $481,050.\nCommittee recommended and the Board approved 1994 base salaries of $450,000 for Mr. Ebert(3), $275,000 for Mr. Whiteside, $216,900 for Richard C. Webb, Senior Vice President and $194,900 for Lawrence L. Gladchun, Senior Vice President, General Counsel and Secretary.\nMr. Mylod and the other executive officers of the Corporation participate in the Corporation's bonus program. For 1994, the corporate bonus program provided for the payment of bonuses based upon corporate and individual performance. In analyzing the Corporation's performance, the Compensation Committee considered the achievement of predetermined return on asset (ROA) goals. A total of four progressively higher ROA goals were established with commensurately higher bonus potentials. If the Corporation's ROA was below the base level ROA goals, no bonuses would be paid. The bonus potential for the Chief Executive Officer ranged from a minimum of 22% of base salary to a maximum of 80% of base salary. The minimum bonus potential for the other executive officers ranged from 17% to 22% of base salary and the maximum bonus potential ranged from 45% to 70% of base salary. Under the program, 100% of the bonuses for the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer are tied to the Corporation's performance. For the other named executive officers, 75% of their bonus potential is tied to the Corporation's performance and 25% to business unit performance. The Committee and the Board considered numerous factors, including the following: (i) core earnings and ROA grew significantly; (ii) tax issues were resolved and several non-Michigan based businesses were sold, producing one-time profits of $131 million; (iii) the Corporation conceived and began the implementation of Project Streamline, which will produce an $85 million improvement in pre-tax profit when fully implemented; and (iv) the Corporation's stock price grew 30% during 1994. Based on this strong financial performance, and considering the individual contributions to this successful year, the Compensation Committee recommended and the Board awarded bonus payments of $250,000 (47% of base salary) for Mr. Mylod, $225,000 (50% of base salary) for Mr. Ebert, $125,000 (45% of base salary) for Mr. Whiteside, $65,000 (30% of base salary) for Mr. Webb and $78,500 (40% of base salary) for Mr. Gladchun.\nThe 1994 total compensation for Mr. Mylod, including base salary and bonus, is 85% of the average total compensation for chief executive officers indicated by the applicable salary surveys above described. The 1994 total compensation for other named executive officers fall within a range of 95% to 127% of the average total compensation indicated by such salary surveys.\nThe Compensation Committee recommended and the Board of Directors approved a corporate bonus program for 1995 which is similar to the 1994 program. The principal performance criteria will continue to be ROA. The bonus opportunity for the Chief Executive Officer and other named executive officers will be based primarily upon the Corporation's performance, with business unit performance considered as a factor for officers other than the Chief Executive Officer, Chief Operating Officer and Chief Financial Officer. Similar to the 1994 program, no bonuses will be paid if the base level ROA target is not achieved. Once the base level target is achieved, the executive officers' bonus potential will increase with the achievement of each successive ROA goal, up to a maximum of 62.5% of base salary for the Chief Executive Officer and from 44% to 56% of base salary for the other named executive officers.\nIn 1985, the Corporation's shareholders approved the Michigan National Corporation Stock Option and Performance Incentive Plan. Under the Plan, the Corporation provides a report to the Compensation Committee\n- ------------ (3) Mr. Ebert voluntarily reduced his 1994 base salary to $405,000.\nsetting forth its recommendations. Stock options are granted to officers by the Board of Directors upon a recommendation by the Compensation Committee. The stock options are intended to reward officers for diligent performance of their responsibilities and their contributions to the Corporation and to provide incentive for future performance by increasing their ownership interest in the Corporation. Historically, options are granted based upon grade level, typically Vice President and above, with each team member in a respective grade level being granted the same number of shares. Stock options are granted with an exercise price equal to the market value on the date of grant and are vested over a three-year period with a ten-year term. In 1994, the Compensation Committee approved the granting of stock options to Mr. Whiteside, as part of his employment agreement.\nOn an annual basis, the Compensation Committee reviews the qualified benefit plans under which the executive officers are covered participants. This review includes an analysis of any recommended plan amendments and how those amendments and\/or the existing plan provisions impact the total deferred compensation of the executive officers. The plans included in this review are the Michigan National Corporation Employees' Pension Plan and Trust Agreement, the Michigan National Corporation Deferred Compensation Plan and Trust, the Michigan National Corporation Employee Stock Ownership Plan and the Michigan National Corporation Stock Option and Performance Incentive Plan. The Compensation Committee has concluded that, in the aggregate, the total compensation, including deferred compensation, of the named executive officers is appropriate, competitive with the market and meets the Corporation's compensation objectives.\nStanton Kinnie Smith, Jr., Chairman Sidney E. Forbes Gerald B. Mitchell Walter H. Teninga\nPART III ITEM 11","section_11":"ITEM 11 (b) EXECUTIVE COMPENSATION\nThe following table provides summary information concerning compensation paid or accrued by the Corporation and its subsidiaries, to or on behalf of the Corporation's Chief Executive Officer and each of the five other most highly compensated executive officers of the Corporation (determined as of December 31, 1994) for the fiscal years ended December 31, 1992, 1993 and 1994.\nSUMMARY COMPENSATION TABLE\n1 Messrs. Mylod and Ebert voluntarily reduced their 1994 base salary on May 19, 1994 to $481,050 and $405,000, respectively.\n2 The 1994 compensation figures of Messrs. Mylod, Ebert, Whiteside, Webb and Gladchun in the All Other Compensation column are equal to the annual contribution to the Employee Stock Ownership Plan (ESOP) for each executive officer.\n3 The 1993 compensation figures in the All Other Compensation column are equal to the annual contribution to the ESOP for each executive officer.\n4 The 1992 compensation figures of Messrs. Mylod and Booth in the Other Annual Compensation column are equal to the tax gross-up provided to them as a consequence of the Corporation's purchase of single premium annuities for them in 1992. For an explanation of the purchase, see the section entitled \"Pension Plans\" under Item 11 (f).\n5 The 1992 compensation figures of Messrs. Mylod and Booth in the All Other Compensation column are equal to the premium expense of the single premium annuities purchased for them in 1992 (see reference in footnote #4) and the annual contribution to the ESOP for each of them. For Mr. Mylod, the premium expense was $1,232,630 and the ESOP contribution was $5,714. For Mr. Booth, the premium expense was $88,886 and the ESOP contribution was $5,714. The 1992 entries in this column for Messrs. Webb and Gladchun represent the annual ESOP contributions for their accounts.\n6 Mr. Ebert joined the Corporation on December 13, 1993.\n7 The 1994 compensation figures of Messrs. Ebert and Whiteside in the Other Annual Compensation column represent compensation relating to their relocation.\n8 The 1993 compensation figure of Mr. Ebert in the Bonus column represents Mr. Ebert's signing bonus under his employment agreement.\n9 The options of Mr. Ebert in the 1993 Options column were granted to Mr. Ebert pursuant to his employment agreement.\n10 Mr. Whiteside joined the Corporation on March 2, 1994.\n11 The 1994 compensation figure of Mr. Whiteside in the Bonus column represents Mr. Whiteside's $35,000 signing bonus under his employment agreement, plus a $125,000 performance bonus.\n12 The options of Mr. Whiteside in the 1994 Options column were granted to Mr. Whiteside as part of his employment agreement.\n13 As of October 21, 1994, Mr. Booth terminated his employment with the Corporation.\n14 The 1994 compensation figure of Mr. Booth in the Bonus column represents the total of two bonuses paid to Mr. Booth; $135,000 as a stay-to-the-end bonus and $81,000 based on the value realized from the sale of substantially all of the assets of Independence One Mortgage Corporation (IOMC).\n15 The 1994 compensation figure of Mr. Booth in the Other Annual Compensation column is equal to the tax gross-up provided to Mr. Booth as a consequence of the Corporation's purchase of a single premium annuity for him in 1994 as a result of his termination of employment with the Corporation subsequent to the sale of IOMC.\n16 The 1994 compensation figure of Mr. Booth in the All Other Compensation column represents the premium expense of a single premium annuity of $1,186,900, a lump sum settlement payment of $291,500, and an ESOP contribution of $9,194.\nPART III ITEM 11 (c) STOCK OPTION GRANTS\nThe following table provides information, with respect to the named executive officers, concerning the grant of stock options during the last fiscal year.\n- ------------\n(1) The 5% and 10% annual rates of stock price appreciation are hypothetical assumptions. If the transaction contemplated by the Agreement and Plan of Merger described under Item 12","section_12":"Item 12 (c) is consummated, these options will have the following values: $2,187,000 for Mr. Mylod; $5,113,000 for Mr. Ebert; $1,140,625 for Mr. Whiteside; $2,144,066 for Mr. Webb; and $1,730,875 for Mr. Gladchun.\nPART III ITEM 11 (f) PENSION PLANS\nThe Corporation also has a Supplemental Pension Agreement (Mylod Pension Agreement) dated January 16, 1985 with Mr. Mylod, under which he will be entitled to an annual contractual pension benefit equal to the vested portion of 60% of his average annual total compensation (salary plus bonus) for the 36 consecutive months his total compensation was the highest, less (i) the annual amount of any benefits he is then entitled to receive under the Corporation's Pension Plan, (ii) the annual amount of any benefits he is entitled to receive under Social Security, and (iii) the pre-tax equivalent of any annual benefits due him under any single premium deferred annuity contracts purchased by the Corporation on his behalf. Under the vesting schedule of the Pension Agreement, Mr. Mylod is currently 100% vested. Mr. Mylod will first be eligible to receive pension benefits at age 55, but such payment will be reduced by 2% for each year that the commencement of payments precedes his attainment of age 60.\nIf Mr. Mylod retires at age 60 with average annual total compensation of $714,428 and 15 years of service, his estimated annual contractual benefit under the Pension Agreement would be $357,083. In combination with the qualified pension plan and social security, his total estimated annual pension benefits would be $428,657. Pension benefits are paid for Mr.Mylod's life and then to his surviving spouse for life. If Mr. Mylod dies before receiving his benefit, his surviving spouse will receive his lifetime monthly benefit beginning at age 55.\nThe Corporation also has entered into Supplemental Pension Agreements and amendments thereto (Pension Agreements) with, of the other named executive officers, Messrs. Ebert, Whiteside, Webb and Gladchun. The Pension Agreements entitle each executive officer to an annual contractual pension benefit equal to the vested portion of a contractual benefit less (i) the annual amount of any benefits each is entitled to receive under the Corporation's Pension Plan, (ii) the annual amount of any benefit each is entitled to receive under Social Security, and (iii) the pre-tax equivalent of any annual benefits due him under any single premium deferred annuity contracts purchased by the Corporation on his behalf. The contractual benefit for each of the above individuals is as follows: Mr. Ebert (50% of his average total compensation for the 36 consecutive months his total compensation was the highest); Mr. Whiteside (40% of his average total compensation for the 36 consecutive months his total compensation was the highest); Mr. Webb ($100,000); Mr. Gladchun ($100,000); and Mr. Booth ($200,000)1. Messrs. Ebert and Whiteside are presently 0% vested; Mr. Booth is 100% vested; and Messrs. Webb and Gladchun are 40% vested. Messrs. Ebert and Whiteside are 0% vested for the first 3 years of service, 30% vested at the end of the third year, and then an additional 10% vested for each year of service from year 4 through year 10 until they are 100% vested. Messrs. Webb and Gladchun vest an additional 10% each year until they are fully vested. The Pension Agreements for Messrs. Webb and Gladchun will become 100% vested in the event of a change in control of the Corporation. The Pension Agreements for Messrs. Ebert and Whiteside will be 30% vested in the event of a change in control of the Corporation during the first three years of the Agreements, with no accelerated vesting if a change in control occurs thereafter. Generally, the pensions will be paid monthly for each executive officer's life, and then to his surviving spouse for life. If the executive officer dies before receiving his benefit, his surviving spouse will receive his lifetime monthly benefit beginning at or after age 55 or 60, whichever is applicable.\nThe Mylod Pension Agreement and the Pension Agreements allow for purchases of individual non-participating non-qualified deferred annuities to fund a portion of the Corporation's obligations under such agreements. The annuities so purchased are owned by the executive officer. Pursuant to the Mylod Pension Agreement and Mr. Booth's\nPension Agreement, the Corporation purchased single premium annuities for Messrs. Mylod and Booth.(1) There have been no discretionary annuity purchases for any of the other named executives officers.\nThe benefits purchased under the annuity policies will always be less than what the Corporation would have otherwise paid because, unlike supplemental retirement benefits paid directly by the Corporation, payments under the annuity policies will not be fully taxable to the executive officer upon receipt. Thus, the annuities purchased reflect the after-tax equivalent of benefits which would otherwise be paid by the Corporation on a pre-tax basis.\nThe purchase of annuity policies by the Corporation constitutes taxable income to the executive officer in the year of the purchase. The Corporation paid the federal and state taxes resulting both from the purchases and such tax payments.\nThere is an ongoing liability to the Corporation to purchase deferred annuities under the Mylod Pension Agreement and the Pension Agreements. As of December 31, 1994, if all five current executive officers with Supplemental Pension Agreements had terminated on that date, the total expense to purchase annuities, including gross-ups, would have been $6,418,824. This liability will increase on an annual basis as the vesting percentage in the individual pension goals increase.\n- ------------\n(1) As of October 21, 1994, Mr. Booth terminated his employment with the Corporation. Pursuant to Mr. Booth's Pension Agreement, the Corporation bought a single premium annuity for Mr. Booth, as described in footnote #15 to the Summary Compensation Table under Item 11 (b).\nPART III ITEM 11 (g) DIRECTOR COMPENSATION\nIn 1994, the Board of Directors met on eighteen separate occasions. Outside directors of the Corporation received $13,500 as a retainer for their services. For their attendance at each board meeting, outside directors received $900. The retainer and board meeting fees include fees paid to outside directors for their service on the Board of Michigan National Bank. All outside directors who served on a committee were paid $800 for their attendance at each committee meeting. All outside directors who served on the Audit and Credit Committee were paid $2,000 for their attendance at each Audit and Credit Committee meeting, and the Chairman of the Audit and Credit Committee received a $5,000 retainer. These fees paid to outside directors will remain the same in 1995, except that beginning in April 1995, all outside directors will be paid $300 for their participation in any telephonic board meetings.\nPART III ITEM 11 (h) EMPLOYMENT CONTRACTS AND TERMINATION OF EMPLOYMENT ARRANGEMENTS\nThe Corporation has an employment agreement dated January 16, 1985, with Mr. Mylod, under which Mr. Mylod will serve as Chairman of the Board of Directors and Chief Executive Officer of the Corporation. Under the contract, Mr. Mylod's current salary as of December 31, 1994 was $534,500(1). The current term of Mr. Mylod's employment agreement expires January 22, 1999. In addition to participation in all standard employee benefit plans, Mr. Mylod is entitled to other benefits afforded senior officers of the Corporation including participation in the Corporation's bonus plans. If Mr. Mylod's employment as an officer is terminated by the Corporation, other than for cause, as defined in the employment agreement, he will continue to receive his salary and benefits for the remaining term of the agreement. The employment agreement also provides for certain benefits to be paid in the event of disability or death. In addition to the employment agreement, Mr. Mylod has an Executive Change in Control Severance Agreement (Severance Agreement) and a Supplemental Pension Agreement with the Corporation, both of which are described below.\nThe Corporation has an employment agreement dated November 17, 1993 with Mr. Ebert, under which Mr. Ebert will serve as President and Chief Operating Officer of the Corporation. Under the contract, Mr. Ebert's salary as of December 31, 1994 was $450,000(2). The current term of Mr. Ebert's employment agreement expires December 31, 1997. In addition to participation in all standard employee benefit plans, Mr. Ebert is entitled to other benefits afforded senior officers of the Corporation including participation in the Corporation's bonus plans. If Mr. Ebert's employment as an officer is terminated by the Corporation other than for breach of his employment agreement, he will continue to receive his salary for the remaining term of the agreement. In addition to the employment agreement, Mr. Ebert has a Severance Agreement and a Supplemental Pension Agreement with the Corporation, both of which are described below.\nThe Corporation has an employment agreement dated March 2, 1994 with Mr. Whiteside, under which Mr. Whiteside will serve as Executive Vice President and Chief Financial Officer of the Corporation. Under the contract, Mr. Whiteside's salary as of December 31, 1994 was $275,000. The current term of Mr. Whiteside's employment agreement expires March 2, 1998. In addition to participation in all standard employee benefit plans, Mr. Whiteside is entitled to other benefits afforded senior officers of the Corporation including participation in the Corporation's bonus plans. If Mr. Whiteside's employment as an officer is terminated by the Corporation, he will continue to receive his salary for the remaining term of the employment agreement. In addition to the employment agreement, Mr.\n------------\n(1)Mr. Mylod voluntarily reduced his 1994 base salary to $481,050 on May 19, 1994, and it will be restored to $534,500 on April 20, 1995.\n(2)Mr. Ebert voluntarily reduced his 1994 base salary to $405,000 on May 19, 1994, and it will be restored to $455,000 on April 20, 1995.\nWhiteside has a Severance Agreement and a Supplemental Pension Agreement with the Corporation, both of which are described below.\nThe Corporation has entered into Severance Agreements with current executive officers of the Corporation including, of the named executive officers, Messrs. Mylod, Ebert, Whiteside, Webb and Gladchun in order to reinforce and encourage the continued dedication and attention of those executives as members of the Corporation's management without distraction in potentially disturbing circumstances arising from the possibility of a change in control of the Corporation. The Severance Agreements are operative upon the occurrence of a \"change in control\" of the Corporation, which would be deemed to occur (a) upon any person or group of persons other than the Corporation, its subsidiaries or employee benefit plans acquiring the beneficial ownership of 20% or more of the combined voting power of the Corporation's then outstanding voting securities; or (b) if during any two-year period during the term of the Severance Agreement, individuals who at the beginning of such period constitute the Corporation's Board of Directors, cease for any reason to constitute at least a majority thereof; or (c) upon a merger, consolidation or any sale, lease, exchange or other transfer of all or substantially all of the assets of the Corporation, or any other similar business combination or transaction other than any business combination or transaction which (i) would result in the outstanding voting securities of the Corporation immediately prior thereto continuing to represent (either by remaining outstanding or being converted into voting securities of the surviving entity) more than 75% of the combined voting securities immediately after such business combination or transaction or (ii) would be effected to implement a recapitalization of the Corporation in which no person or group of persons acquires 20% or more of the combined voting power of the outstanding voting securities of the Corporation; or (d) upon the adoption of any plan or proposal for the liquidation or dissolution of the Corporation; or (e) upon the occurrence of any other event that requires reporting in response to Item 6(e) of Schedule 14A of Regulation 14A of the Securities Exchange Act of 1934.\nThe Severance Agreements provide that, in the event of certain terminations of the executive's employment with the Corporation within two years of a change of control of the Corporation, the executive will be entitled to receive the following severance benefits: (1) a lump-sum payment equal to three times the greater of (i) the executive's annual salary in effect at the time of the notice of termination; or (ii) the executive's average salary based on the previous 5 calendar years; (2) a lump-sum payment equal to (i) two times the highest annual bonus paid during or with respect to the prior 5 calendar years plus (ii) a pro rata portion of any bonus the executive shall be deemed to have earned for the year termination occurred; (3) in addition to the executive's vested benefits under the Pension Plan, a supplemental cash benefit equal to the excess of (i) benefits payable under the Pension Plan if the executive continued to be employed for the remainder of the period under the Severance Agreement over (ii) the benefits actually payable under any such plan in addition to their fully vested benefits; (4) a payment of $10,000 for outplacement services; (5) an office, secretary and automobile for two years and (6) the continuation of equivalent life, health, hospitalization, disability and other similar benefits that the executive would have received prior to termination for the remainder of the period under the Severance Agreement. Benefits under the Severance Agreement, to the extent that\nthey conflict therewith, are paid in lieu of benefits provided under any other agreement with the executive.\nUnder the Severance Agreement, the executive is not required to mitigate the amount of payments by seeking employment or otherwise; nor shall the amount of any benefit be reduced by any compensation or benefit earned by the executive after termination. In addition, if an executive becomes subject to an excise tax under the Internal Revenue Code as a result of any payments or benefits received on a change in control, the Corporation will make an additional payment to the executive to make him whole after payment of the excise tax and any income taxes on the additional payment.\nThe Severance Agreement is inoperative when the termination of the executive is made (i) by the Corporation due to death, permanent disability or cause, or (ii) by the executive for other than \"good reason\". \"Good reason\" is broadly defined in the Severance Agreements to include any significant adverse alteration in duties or responsibilities of the executive, any reduction in compensation or benefits or involuntary relocation. The Severance Agreements terminate on their anniversary dates in 1997.\nPART III ITEM 11 (l) STOCK PERFORMANCE CHART\nSet forth below is a line-graph presentation comparing cumulative five-year stockholder returns on the Corporation's Common Stock against the cumulative total return of the NASDAQ Stock Market Index(1) and the Keefe, Bruyette & Woods Bank Stock Index (KBW 50 Index)(2) for the five-year period commencing December 31, 1989 and ending December 31, 1994.(3)\nTotal return includes reinvestment of dividends. All data as of full-year-end December 31.\n- ----------------------\n(1) The NASDAQ Stock Market Index, a broad market equity index, is made up of both U.S. and foreign companies listed on the NASDAQ exchange.\n(2) The KBW 50 Index, a market-capitalization-weighted index, is made up of fifty of the nation's most important banking companies, including all money-center and most regional banks.\n(3) Total return includes reinvestment of dividends. All data is as of fiscal year-end December 31.\nPart III Item 12(a) and (b)\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSECURITY OWNERSHIP OF DIRECTORS AND EXECUTIVE OFFICERS\nThe following table sets forth information regarding beneficial ownership, as of February 4, 1995, of Common Stock of the Corporation by directors of the Corporation, the Corporation's five most highly compensated executive officers, and the Corporation's directors and executive officers as a group.\n- ------------ 1 The beneficial ownership of shares shown in this column include currently exercisable Corporation Stock Options exercisable within 60 days of the filing, which were granted to various individuals named in this table, or included in the group, pursuant to the Corporation's Stock Plans. Corporation Stock Options currently exercisable or exercisable within 60 days of the filing, include 34,000 shares for Robert J. Mylod, 100,000 shares for Douglas E. Ebert, 24,500 shares for Lawrence L. Gladchun, 31,333 shares for Richard C. Webb, 25,000 shares for Joseph J. Whiteside and 13,351 shares held by the other executive officers in the group who are not named in the table.\nThe shares shown in this column also include shares allocated to the individual accounts of the named persons and all officers and directors included as a group in the table, which are held by Corporation Stock Plans or the ESOP. MNB is the \"Trustee\" of the Corporation Stock Plans. See \"Other Ownership of the Corporation's Common Stock.\"\nFully vested amounts accrued pursuant to the Deferred Compensation Plan include 15 shares for Robert J. Mylod, 2,024 shares for Lawrence L. Gladchun, 5,291 shares for Richard C. Webb, and 9,840 shares held by the other executive officers in the group who are not named in the table. Fully vested amounts accrued pursuant to the ESOP include 3,007 shares for Robert J. Mylod, 1,082 shares for Lawrence L. Gladchun, 1,116 shares for Richard C. Webb, and 3,268 shares held by the other executive officers in the group who are not named in the table.\n2 Includes 36,325 shares held by Spectrum Associates of which Mr. Harris is managing partner.\n3 Includes 1,916 shares acquired by Mr. Mitchell and 1,985 shares acquired by Mr. Smith pursuant to their elections to defer fees into Common Stock pursuant to the Deferred Compensation Plan.\n4 Includes 445 shares as to which Mr. Williams disclaims beneficial ownership.\n5 For security ownership of Robert J. Mylod, Chairman and Chief Executive Officer, and Douglas E. Ebert, President and Chief Operating Officer, refer to their entries above with the list of directors.\n* Less than 1% of the outstanding shares of Common Stock. OTHER OWNERSHIP OF THE CORPORATION'S COMMON STOCK\nThe following table sets forth information, as of December 31, 1994, concerning persons known to the Corporation to be the beneficial owners of more than 5% of the outstanding shares of Common Stock.\n- ------------ (1)Heine Securities Corporation (\"HSC\") is an investment advisor registered with the SEC. The shares reported herein were beneficially owned by portfolios of Mutual Series Fund Inc., an investment company for whom HSC acts as investment advisor. Pursuant to an advisory contract, HSC had sole investment and voting power with respect to such shares. HSC disclaimed any beneficial ownership over any of the shares reported herein. As of February 7, 1995, Heine Securities ceased to hold or own, beneficially or otherwise, shares of Common Stock.\n(2)Plan shares are held for the benefit of the participants in the Deferred Compensation Plan, and are voted by the Trustee -- Michigan National Bank, Trust Department, 77 Monroe Center, P.O. Box 1707, Grand Rapids, MI 49501.\nThe Deferred Compensation Plan participants have the right to direct the vote of all shares allocated to their accounts in the Defered Compensation Plan whether vested or unvested. Allocated shares (and in some instances certain unallocated shares) for which timely and proper directions are not received by the Trustee will be voted by the Trustee in the same proportion as it votes the shares as to which timely and proper directions are received. Shares allocated to the Payroll Based Stock Option Plan (\"PAYSOP\"), an account in the Deferred Compensation Plan, will not be voted at all unless timely and proper instructions are received by the Trustee. As of February 22, 1995, the total number of shares allocated to such PAYSOP account was 34,662. Participants must approve certain dispositions of the Corporation's stock by the Trustee of the Deferred Compensation Plan. Various officers of the Corporation who are named or included as a group in the section entitled \"Security Ownership of Directors and Officers\" are participants in the Deferred Compensation Plan.\n(3)Trust shares are held for the benefit of the participants in the ESOP and are voted by the Trustee -- Michigan National Bank, Trust Department, 77 Monroe Center, P.O. Box 1707, Grand Rapids, MI 49501.\nParticipants have the right to direct the vote of all shares allocated to their accounts in the ESOP whether vested or unvested. Shares which are not allocated to the account of a particular participant, and allocated shares for which timely and proper directions are not received by the Trustee, will be voted by the Trustee in the same proportion as it votes the shares as to which timely and proper directions are received. Participants also have the right to respond to tender or exchange offers for the Common Stock allocated to their accounts. See \"Security Ownership of Directors and Executive Officers.\"\nAs of the date hereof, the Corporation's management knows of no other beneficial owner of more than 5% of any class of voting security of the Corporation.\nPART III ITEM 13","section_13":"ITEM 13 (a), (b) AND (c) CERTAIN TRANSACTIONS\nDirectors and executive officers of the Corporation, certain beneficial owners of over 5% of the Corporation's Common Stock and members of their immediate families were customers of, and had transactions (including loans and loan commitments) with the Corporation and its subsidiaries during 1994. In the opinion of management, all such loan transactions were made in the ordinary course of business, on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons not affiliated with the Corporation or its subsidiaries, and did not involve more than the normal risk of collectibility or present other unfavorable features.\nDuring 1994, certain subsidiaries of the Corporation made lease payments totalling $2,036,841 to FCN Associates, a general partnership in which Sidney E. Forbes, a Director of the Corporation, has a 15 1\/2% interest.\nDuring 1994, Amway Hotel Corporation (\"Amway Hotel\") received lease payments totalling $76,271 under a lease of a banking facility in the Amway Plaza Hotel, Grand Rapids, Michigan, to a subsidiary bank of the Corporation. Amway Hotel is a wholly-owned subsidiary of Amway Properties Corporation, which is a wholly-owned subsidiary of Amway Corporation. Stephen A. Van Andel, a Director of the Corporation, is Vice President and Chairman of the Executive Committee of Amway Corporation.\nFIRST AMENDMENT TO PENSION AGREEMENT*\nFIRST AMENDMENT dated as of February 4, 1995, to the Pension Agreement (the \"Pension Agreement\") dated as of January 19, 1994, by and between Michigan National Corporation, a Michigan corporation (the \"Corporation\"), and Douglas E. Ebert (the \"Executive\").\nWHEREAS, the Corporation and the Executive are a party to the Pension Agreement; and\nWHEREAS, the Corporation and the Executive desire to provide the Executive with security with respect his retirement benefits in the event of a Change in Control of the Corporation;\nNOW, THEREFORE, in consideration of the premises and the mutual covenants and obligations hereinafter set forth, the parties agree to amend the Pension Agreement as follows:\n1. Section 12 of the Pension Agreement is amended by adding new subsections (c) and (d) to read in their entirety as follows:\n(c) Immediately upon a termination of employment of Employee following a Change in Control (as defined in the Employee's Executive Change in Control Severance Agreement dated January 14, 1994, and amended on March 14, 1994 and February 4, 1995) (\"purchase date\"), the Corporation (or its successor) shall purchase a Single Premium Annuity from an Insurer to fully guarantee the vested benefits accrued to the purchase date under this Agreement as described in sub-section (d) below.\n(d) For purposes of this Section, the amount of the Single Premium Annuity shall be calculated to place the Employee and\/or his Surviving spouse in the same after-tax position had no annuity been purchased, taking into account the fact that a portion of the annuity payment will be non-taxable to Employee (or Surviving Spouse). This will be deemed to occur if, once the actual annuity payment is known, the following formula is satisfied:\nx = After-Tax Benefit -------------------- 1 - [(1 - ER) x ATR]\nwhere:\n- After-Tax Benefit is the annual benefit being purchased under Section 4 of this Agreement multiplied by the result obtained by subtracting the Applicable Tax Rate from one (1).\n- ER is the exclusion ratio calculated under Section 72 of the Internal Revenue Code of 1986 (as amended from time to time) which is based upon Employee's age, the actual annuity payment, and its purchase price.\n- ATR is the Applicable Tax Rate as of the date of purchase, and will not change thereafter.\n- X is the annual amount of the Single Premium Annuity.\n2. Except as expressly provided herein, the Pension Agreement shall remain in full force and effect in all respects.\nIN WITNESS WHEREOF, the Executive has hereunto set his hand and, pursuant to the authorization from its Board of Directors, the Corporation has caused these presents to be executed in its name on its behalf, all as of the day and year first above written.\nMICHIGAN NATIONAL CORPORATION\n\/s\/ By: ______________________________ Robert J. Mylod, Chairman and Chief Executive Officer\nEXECUTIVE\n\/s\/ __________________________________ Douglas E. Ebert\n* The First Amendment To Pension Agreement between Michigan National Corporation and Joseph J. Whiteside is substantially identical in all material respects to this amendment agreement and therefore, is not included as an exhibit.\nSECOND AMENDMENT TO MICHIGAN NATIONAL CORPORATION EXECUTIVE CHANGE IN CONTROL AGREEMENT**\nSECOND AMENDMENT dated as of February 4, 1995 to the Executive Change in Control Severance Agreement (the \"Agreement\") dated as of September 14, 1989, by and between Michigan National Corporation, a Michigan corporation (the \"Corporation\"), and Robert J. Mylod (the \"Executive\").\nWHEREAS, the Corporation and the Executive are a party to the Agreement; and\nWHEREAS, the Corporation and the Executive desire to amend the Agreement to represent more fully the original intent of the parties.\nNOW, THEREFORE, in consideration of the premises and the mutual covenants and obligations hereinafter set forth, the parties agree to amend the Agreement as follows:\n1. Section 5(b) of the Agreement is amended so that it reads in its entirety as follows:\n(b) INCENTIVE AWARDS. The Executive shall receive a cash payment in a single sum, within 10 business days following the Executive's Date of Termination, in an amount equal to (i) 2 times the highest annual bonus paid to the Executive during or with respect to the prior 5 calendar years prior to the year in which the Date of Termination occurs plus (ii) a pro-rata annual bonus for the year in which the Date of Termination occurs pursuant to the terms of the Corporation's annual incentive plan for such year based on actual performance through the date of the Change in Control.\n2. The first sentence of Section 5(i) of the Agreement is amended to read in its entirety as follows:\nIf any payments made to the Executive, whether pursuant to this Agreement or otherwise, are subject to the excise tax imposed by Section 4999 of the Internal Revenue Code of 1986, as amended, the Corporation shall pay to the Executive such additional amounts as are necessary (taking into account all Federal, state, and local income, excise and other taxes payable by the Executive as a result of the payment of such additional amounts) to place the Executive in the same after-tax position he would have been in had no such excise tax (or any interest or penalties thereon) been imposed on any such payments, including those made pursuant to this Section 5(i).\n3. Except as expressly provided herein, the Agreement shall remain in full force and effect in all respects.\nIN WITNESS WHEREOF, the Executive has hereunto set his hand and, pursuant to the authorization from its Board of Directors, the Corporation has caused these presents to be executed in its name on its behalf, all as of the day and year first above written.\nMICHIGAN NATIONAL CORPORATION\n\/s\/ By: __________________________ Lawrence L. Gladchun, Senior Vice President\nEXECUTIVE\n\/s\/ ______________________________ Robert J. Mylod\n** The Second Amendment To Michigan National Corporation Executive Change In Control Agreements between Michigan National Corporation and four current executive officers including, Douglas E. Ebert, Richard C. Webb, Joseph J. Whiteside and Lawrence L. Gladchun are substantially identical in all material respects to this amendment agreement and therefore, are not included as exhibits.\nMICHIGAN NATIONAL CORPORATION AND SUBSIDIARIES\nPART IV ITEM 14","section_14":"","section_15":""}
{"filename":"351825_1994.txt","cik":"351825","year":"1994","section_1":"ITEM 1. BUSINESS\nFirst National Bancorp (Registrant) was incorporated as a Georgia business corporation in 1980. In July 1981, through a plan of reorganization, the Registrant acquired all of the issued and outstanding common stock of The First National Bank of Gainesville (FNBG), Gainesville, Georgia in exchange for Registrant's common stock.\nSince its formation in 1980 through December 31, 1994, the Registrant has acquired sixteen banks in addition to the founding bank, FNBG. Those banks which have been acquired and some information about each is presented in the \"Acquisition Schedule, Properties, and Other Information\" table below.\nBecause of its ownership of all the issued and outstanding shares of common stock of the following banks, Registrant is a \"bank holding company\" as that term is defined under Federal law in the Bank Holding Company Act of 1956, as amended, and under the bank holding company laws of the State of Georgia. As a bank holding company, the Registrant is subject to the applicable provisions of the Federal Reserve System and the Georgia State Department of Banking and Finance. The Registrant's primary business as a bank holding company is to manage the business and affairs of its banking subsidiaries. The Registrant's subsidiary banks provide a full range of banking and mortgage banking services to their customers.\nThe following table lists the Registrant and subsidiaries, disclosing information pertinent to Part I, Item 1 and properties information disclosure as required in Part I, Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nRegistrant's seventeen subsidiary banks operate as autonomously as is possible under a holding company structure within their particular counties and maintain separate banking facilities, which each subsidiary bank owns or leases. In addition, Registrant owns a main office building, used as its corporate offices, and several other offices used to house banking support operations. See Item 1. Business for additional information concerning properties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe nature of the business of Registrant and its subsidiaries ordinarily results in a certain amount of litigation. Accordingly, Registrant and its subsidiaries are parties (both as plaintiff and defendant) to a limited number of lawsuits incidental to their business and, in certain of such suits, claims or counterclaims have been asserted. In the opinion of management and counsel for Registrant, these lawsuits are considered ordinary litigation incidental to the conduct of business and in none of these cases should the ultimate outcome have a material adverse effect on Registrant's financial position.\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 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe market, stock price, and dividend information which appears on page 35 and 36 of Registrant's Management's Discussion and Analysis of Financial Condition and Results of Operations section, included in Registrant's 1994 Annual Report to shareholders, is incorporated by reference in this Form 10-K Annual Report. The discussion of source of dividends and restrictions on dividends, which may be declared by the subsidiary banks, appearing on page 53, Note 14, of Registrant's 1994 Annual Report to shareholders, is incorporated by reference in this Form 10-K Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Selected Financial Data which appears as a part of Management's Discussion and Analysis of Financial Condition and Results of Operations on page 19 of Registrant's 1994 Annual Report to shareholders, is incorporated by reference in this Form 10-K Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following Interest Rate Sensitivity Table is provided:\nAdditional information relating to Management's Discussion and Analysis of Financial Condition and Results of Operations appears on pages 18 through 36 of Registrant's 1994 Annual Report to shareholders, including a discussion of interest rate sensitivity management on page 34, and is incorporated by reference in this Form 10-K Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements and Notes to Consolidated Financial Statements, together with the report thereon of KPMG Peat Marwick LLP, dated January 27, 1995, appearing on pages 37 through 56 of Registrant's 1994 Annual Report to shareholders, are incorporated by reference in this Form 10-K Annual Report.\nConsolidated quarterly financial information appearing on page 56 of the Registrant's 1994 Annual Report to shareholders, is incorporated by reference in this Form 10-K Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nWithin the twenty-four month period prior to the date of Registrant's most recent financial statements, and for the year ended December 31, 1994, Registrant did not change accountants and had no disagreements with its accountants on any matter of accounting principles, practices, or financial statement disclosure.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information concerning directors is presented on pages 2 through 7 of the Proxy Statement for Annual Meeting of Shareholders, to be held April 19, 1995, which information is incorporated by reference in this Form 10-K Annual Report.\nInformation concerning executive officers of Registrant is set forth under the caption \"Executive Officers of the Registrant\" in Item 1. Business, hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nExecutive Compensation is shown under Compensation of Executive Officers on pages 9 through 17 of the Proxy Statement for Annual Meeting of Shareholders, to be held April 19, 1995, which is incorporated by reference in this Form 10-K Annual Report.\nCompensation of Directors is shown under Compensation of Directors on pages 17 and 18 of the Proxy Statement For Annual Meeting of Shareholders, to be held April 19, 1995, which is incorporated by reference in this Form 10-K Annual Report.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPrincipal Shareholders of Registrant which appears on page 8 of the Proxy Statement For Annual Meeting of Shareholders, to be held April 19, 1995, is incorporated by reference in this Form 10-K Annual Report.\nSecurity Ownership of Directors, Nominees, Executive Officers, and Directors and Executive Officers, as a group, which appears on pages 7 and 8 of the Proxy Statement For Annual Meeting of Shareholders, to be held April 19, 1995, is incorporated by reference in this Form 10-K Annual Report.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nTransactions with Management which appears on page 18 of the Proxy Statement For Annual Meeting of Shareholders, to be held April 19, 1995, is incorporated by reference in this Form 10-K Annual 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 Registrant and its subsidiaries and independent auditors' report, incorporated herein by reference from pages 37 through 56 of Registrant's 1994 Annual Report to shareholders, have been filed as Item 8 in Part II of this report:\nIndependent Auditors' Report Consolidated Balance Sheets - December 31, 1994 and 1993 Consolidated Statements of Income - Years ended December 31, 1994, 1993, and 1992 Consolidated Statements of Shareholders' Equity - Years ended December 31, 1994, 1993, and 1992 Consolidated Statements of Cash Flows - Years ended December 31, 1994, 1993, and 1992 Notes to Consolidated Financial Statements\n(a)2. Financial Statement Schedules\nFinancial statement schedules are omitted as the required information is not applicable.\n(a)3. Exhibits List\nSee Exhibit Index included as page 13 of this report, which is incorporated herein by reference.\n(b)Reports on Form 8-K\nCurrent Report on Form 8-K, dated November 22, 1994, was filed on November 23, 1994, pertaining to the signing of an Agreement and Plan of Merger, by and between Registrant and FF Bancorp, whereby Registrant will exchange .825 shares of Registrant's common stock for each share of FF Bancorp stock in a transaction to be accounted for as a pooling-of-interests.\nCurrent Report on Form 8-K, dated October 27, 1994, was filed on October 28, 1994, pertaining to signing of a Letter of Intent, by Registant and FF Bancorp, whereby Registrant will exchange .825 shares of Registrant's common stock for each share of FF Bancorp stock in a transaction to be accounted for as a pooling-of- interests.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, First National Bancorp has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFIRST NATIONAL BANCORP\nBy: \/s\/ Richard A. McNeece ------------------------------------ Richard A. McNeece, Chairman and Chief Executive 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 First National Bancorp and in the capacities and on the dates indicated.\n\/s\/ Richard A. McNeece 3\/29\/95 -------------------------------------- Richard A. McNeece Date Chairman and CEO\n\/s\/ Richard L. Shockley 3\/29\/95 -------------------------------------- Richard L. Shockley Date Vice Chairman\n\/s\/ Jane Wood Banks 3\/29\/95 -------------------------------------- Jane Wood Banks, Director Date\n\/s\/ Paul J. Reeves 3\/29\/95 -------------------------------------- Paul J. Reeves, Director Date\n\/s\/ Thomas S. Cheek 3\/29\/95 -------------------------------------- Thomas S. Cheek, Director Date\n-------------------------------------- A. Roy Roberts, Jr., Director Date\n\/s\/ John A. Ferguson, Jr. 3\/29\/95 -------------------------------------- John A. Ferguson, Jr., Dirctor Date\n\/s\/ Harold L. Smith 3\/29\/95 -------------------------------------- Harold L. Smith, Director Date\n\/s\/ James H. Harris 3\/29\/95 -------------------------------------- James H. Harris, Dirctor Date\n\/s\/ W. Woodrow Stewart 3\/29\/95 -------------------------------------- W. Woodrow Stewart, Director Date\n\/s\/ Ray C. Jones 3\/29\/95 -------------------------------------- Ray C. Jones, Director Date\n\/s\/ Bobby M. Thomas 3\/29\/95 -------------------------------------- Bobby M. Thomas, Director Date\n\/s\/ Arthur J. Kunzer, Jr. 3\/29\/95 -------------------------------------- Arthur J. Kunzer, Jr., Director Date\n-------------------------------------- James A. Walters, Director Date\n-------------------------------------- W. L. Lester, Director Date\n-------------------------------------- Mack G. West, Director Date\n\/s\/ Peter D. Miller 3\/29\/95 -------------------------------------- Peter D. Miller, Director, Date President, CAO and CFO\n-------------------------------------- J. Michael Womble, Director Date\n\/s\/ Joe Wood, Jr. 3\/29\/95 -------------------------------------- Joe Wood, Jr. Date\n-------------------------------------- Loy D. Mullinax, Director Date\n\/s\/ J. Reid Moore 3\/29\/95 -------------------------------------- J. Reid Moore, Group Date Vice President and Controller\n-------------------------------------- J. Kenneth Nix, Sr., Director Date\n-------------------------------------- Edwin C. Poss, Director Date\nEXHIBITS INDEX\nSequential Exhibit Page Number Description Number\n3.1 Articles of Incorporation of First National Bancorp, as amended, (incorporated by reference to such - - document filed as Exhibit 3.1 to Registrant's Registration Statement No. 33-64590 on Form S-4).\n3.2 Bylaws of First National Bancorp currently in effect (incorporated by reference to Exhibit 3.2 - - of Registrant's Registration Statement No. 33-64590 on Form S-4).\n10.1 1988 Employee Stock Option Plan of First National Bancorp (incorporated by reference to such - - document filed as Exhibit 4.1 to Registrant's Registration Statement No. 33-24985 on Form S-8).\n10.2 1990 Employee Stock Option Plan of First National Bancorp and Amendment thereto dated July 17, 1991 - - (incorporated herein by reference to such document filed as Exhibit 10.3 of Registrant's Registration Statement No. 33-64590 on Form S-4).\n10.3 Change of Control Agreement, dated June 23, 1992, between First National Bancorp and Richard A. McNeece - - (incorporated herein by reference to such document filed as Exhibit 10.7 of Registrant's Registration Statement No. 33-50422 on Form S-4).\n10.4 Change of Control Agreement, dated June 16, 1992, between First National Bancorp and Peter D. Miller - - (incorporated herein by reference to such document filed as Exhibit 10.8 of Registrant's Registration Statement No. 33-50422 on Form S-4).\n10.5 Change of Control Agreement, dated June 16, 1992, between First National Bancorp and C. Talmadge Garrison - - (incorporated herein by reference to such document filed as Exhibit 10.9 of Registrant's Registration Statement No. 33-50422 on Form S-4).\n10.6 Change of Control Agreement, dated June 24, 1992, between First National Bancorp and Richard D. White - - (incorporated herein by reference to such document filed as Exhibit 10.10 of Registrant's Registration Statement No. 33-50422 on Form S-4).\n10.7 1993 Employee Stock Option Plan of Registrant dated April 26, 1993 (incorporated herein by reference - - to such document filed as Exhibit 10.11 of Registrant's Registration Statement No. 33-64590 on Form S-4).\n10.8 First National Bancorp Incentive Compensation Plan (incorporated by reference to Exhibit 10.12 of Registrant's - - Registration Statement No. 33-64590 on Form S-4).\n10.9 Change of Control Agreement, dated June 16, 1993, between First National Bancorp and Bryan F. Bell - - (incorporated herein by reference to such document filed in Form 10- K for the year ended December 31, 1993, SEC File No. 0-10657).\nEXHIBITS INDEX (continued) Sequential Exhibit Page Number Description Number\n10.10 Change in Control Agreement, dated July 1, 1992, between First National Bancorp and Stephen M. Rownd - - (incorporated herein by reference to such document filed as Exhibit 10.10 of Registrant's Registration Statement No. 33-57681 on Form S-4).\n10.11 First National Bancorp Performance-Based Restrictive Stock Plan approved by the shareholders on - - April 20, 1994 (incorporated herein to such document filed as Exhibit 10.10 of First National Bancorp's Registration Statement No. 33-53719 on Form S-4.\n11.1 Computation of Net Income per Common Share. 15\n13.1 1994 Annual Report to shareholders for the year ended December 31, 1994, including certain pages of 16 which are incorporated herein by reference.\n21.1 Subsidiaries of the Registrant at December 31, 1994, are incorporated by reference to Acquisition Schedule, - - Properties, and Other Information, provided under Item I. Business of this document.\n23.1 Independent Auditors' Consent to incorporation by reference in Registrant's Registration Statements No. 82 33-32997, No. 33-24985, 33-41878, 33-61586, 33-68770, and 33-56969 on Form S-8, No. 33-57019 on Form S-3.\n27.1 Financial Data Schedule (for SEC use only) 83\n99.1 Proxy Statement For Annual Meeting of Shareholders, to be held April 19, 1995, certain pages of which are 84 incorporated herein by reference.","section_15":""}
{"filename":"215310_1994.txt","cik":"215310","year":"1994","section_1":"ITEM 1. BUSINESS\n(A) GENERAL DEVELOPMENT OF BUSINESS.\nBMC Industries, Inc. is a Minnesota corporation with its executive offices located at Two Appletree Square, Minneapolis, Minnesota 55425; telephone (612) 851-6000. Unless the context otherwise indicates, the terms \"Company\" or \"BMC\" as used herein mean BMC Industries, Inc. and its consolidated subsidiaries.\nBMC was organized in 1907 under the name Buckbee-Mears Company. Over the course of its early history, the Company developed an expertise in photolithography and in the chemical etching of metals. In the 1950's, BMC collaborated in the development of chemically etched aperture masks for color cathode ray tubes. The Company entered the optical business in 1969 with the acquisition of Vision- Ease Lens, a manufacturer of glass multifocal ophthalmic lenses, based in St. Cloud, Minnesota.\nIn the early 1980's, the Company sought accelerated growth through acquisition, acquiring additional optical products operations and operations producing electronic interconnection components and related manufacturing equipment. In 1985, the Company determined that the interest burden from acquisition-related debt and a worsening economy in the electronics industry made it impossible to sustain the growth strategy. Between 1985 and 1987, the Company divested several optical products operations and all of the interconnection component operations. Additionally, a contact lens manufacturing operation and the Company's former European optical products businesses were divested in 1989.\nThe Company presently is composed of two product groups, referred to as Precision Imaged Products and Optical Products. Precision Imaged Products designs, manufactures and markets precision etched metal parts, specialty printed circuits, precision electroformed components and precision etched and filled glass products. Precision Imaged Products includes the only U.S. and the only independent European manufacturers of aperture masks for color cathode ray tubes, an integral component of color television picture tubes and color computer monitors. Precision Imaged Products, through its Peptech division, also is involved in the sale, design, manufacture and installation of aperture mask manufacturing equipment and the licensing of BMC's related proprietary process technology. Optical Products designs, manufactures and markets polycarbonate, glass and hard-resin plastic multifocal and single-vision ophthalmic lenses for the personal eyewear market. As of February 28, 1995, the Company had 1,853 employees.\n(B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nFinancial Information about the Company's business segments for the most recent three fiscal years is contained on pages 33-35 of the 1994 Annual Report, and is incorporated herein by reference.\n(C) NARRATIVE DESCRIPTION OF BUSINESS.\nThe Company's business is divided into two product groups: Precision Imaged Products and Optical Products.\nPRECISION IMAGED PRODUCTS\nPrecision Imaged Products (\"PIP\") includes operations that design, manufacture and market precision etched metal parts, specialty printed circuits, precision electroformed components and precision etched and filled glass products. The group's Peptech division is involved in the sale, design, manufacture and installation of aperture mask manufacturing equipment and the licensing of the Company's related proprietary process technology.\nPRODUCTS AND MARKETING. PIP includes Buckbee-Mears Cortland (Cortland, New York), Buckbee-Mears Europe (Mullheim, Germany) and Buckbee-Mears St. Paul (St. Paul, Minnesota). The Cortland and Mullheim facilities primarily manufacture aperture masks. The St. Paul facility manufactures precision etched metal parts, specialty printed circuits, precision electroformed components and precision etched and filled glass products. Two customers each accounted for more than 10% of PIP's 1994 total revenues, while one accounted for more than 10% of the Company's 1994 total revenues. Thomson, S.A. of France (including its U.S. based operations) accounted for approximately 20% of the Company's 1994 total revenues. Thomson produces televisions in North America and Europe under various trademarks, including RCA and GE.\nAperture masks are photochemically etched fine screen grids essential in the manufacture and operation of color cathode ray tubes used in color televisions and color computer monitors. An aperture mask allows electron beams to activate selectively the red, green or blue phosphors on the inside face plate of the cathode ray tube, producing a color image. Aperture masks are made from cold rolled steel or invar (a nickel alloy). The Company's facilities employ an automated continuous photochemical etching process originally developed by the Company. Aperture masks are sold directly by the Company to color picture tube manufacturers in North America, Western and Eastern Europe, India, and Asia. PIP maintains an in-house sales staff to sell aperture masks directly to its customers.\nDuring the 1980's, the Company expanded its aperture mask production capacity by adding additional aperture mask production lines in 1984 and 1988 at its Cortland, New York facility and in 1986 at its Mullheim, Germany facility. In 1986, the Company also added a specialized production line at Mullheim. The specialized line is designed to manufacture precision etched components other than aperture masks, such as gimbel springs for use in computer disk drives. This line was modified in late 1993 and is now capable of manufacturing certain small-sized aperture masks. At its Cortland operation, the Company also manufactures small quantities of special-purpose, very-high-resolution foil aperture masks for military avionics use.\nThe Company was engaged in research and development efforts in recent prior years aimed at developing the manufacturing and technical expertise necessary to produce aperture masks for high definition television (\"HDTV\") and other large color cathode ray tube applications (\"jumbo masks\"). As a result, the Company has delivered limited quantities of prototype HDTV aperture masks to customers engaged in HDTV research and development. Commercial production deliveries of other jumbo masks, which are manufactured primarily from invar, have increased significantly in the last three years due to a corresponding increase in sales of jumbo televisions, particularly in the United States. In addition, over the past few years, the Company has engaged in research and development efforts aimed at developing the manufacturing and technical expertise necessary to produce aperture masks for high-resolution color computer monitors.\nIn 1993, the Company modified one of the three manufacturing lines at its Cortland, New York facility to permit the production of high-resolution masks for computer monitors. An initial pre-production run of high-resolution masks was completed during the fourth quarter of 1993. During 1994, the Company qualified as a high-resolution computer monitor mask vendor and began its first volume shipments of the product. In February 1994, the Company began steps to upgrade another one of the three manufacturing lines at its Cortland, New York facility. The upgraded line in Cortland will serve the growing demand for large and jumbo masks for high-performance color television tubes, and at the same time allow the Company to dedicate the previously modified manufacturing line to the production of high-resolution computer monitor masks. The Company expects to complete the process upgrades by the fourth quarter of 1995.\nIn February of 1994, the Company initiated construction of a new production line at its Mullheim, Germany facility. The line is expected to be operational in the fourth quarter of 1995, with a ramp into full volume production during 1996. The new production line in the German facility will be dedicated exclusively to the production of high-resolution computer monitor masks.\nIn January 1995, the Company announced its plans to add a new television aperture mask production line in 1997. The Company expects to finalize site selection and break ground on the new television aperture mask line before the end of 1995. This line will add manufacturing capacity for seven to nine million television aperture masks, focused particularly on the growing market for large masks (25-29 inch).\nProducts manufactured at the St. Paul, Minnesota facility include precision etched metal parts; large size, tight tolerances specialty printed circuits up to four by twelve feet in area; precision electroformed components; and, precision etched and filled glass products. These products are sold directly by the Company, both by in-house sales personnel and manufacturers representatives, to manufacturers of military and avionics electronics, microwave antennas, computers and printers, various consumer products, medical electronics and computer aided design\/computer aided manufacturing (\"CAD\/CAM\") equipment.\nPIP's Peptech division was created to coordinate and administer sales of aperture mask manufacturing equipment and licensing of related proprietary process technology and to exercise general oversight over the group's technological resources, development efforts and future equipment sales activities. In 1991, the Company (through its Peptech division) largely completed delivery and installation of aperture mask manufacturing equipment to a Chinese customer; in 1992, acceptance testing of the equipment was completed and the customer commenced commercial production. In 1993, the Company (through Peptech) entered into a 24-month contract to deliver and install aperture mask manufacturing equipment to another Chinese customer. The Company expects that installation and start-up of the mask production equipment covered by this contract will be completed in 1995.\nINTELLECTUAL PROPERTY. The Company has a number of patents which are important to the success of its PIP operations. These patents range in their expiration dates from 1997 to 2012. The loss of any single patent would not have a material adverse effect on the business of the Company as a whole. The Company believes that improvement of existing products and processes and a reliance on trade secrets and unpatented proprietary know-how are as important as patent protection in establishing and maintaining the Company's competitive position. At the same time, the Company continues to seek patent protection for its products and processes on a selective basis. However, there can be no assurance that any patents obtained will provide substantial protection or be of\ncommercial value. The Company generally requires its consultants and employees to agree in writing to maintain the confidentiality of the Company's information and (within certain limits) to assign to the Company any inventions, and any patent or other intellectual property rights, relating to the Company's business.\nCOMPETITION. Competition with respect to the products described above is intense, with no one competitor dominating the market. The principal methods of competition are pricing, product quality and product availability.\nThe Company is one of only five independent aperture mask manufacturers in the world. In addition, several color picture tube manufacturers operate captive aperture mask production facilities. State directed ventures operate in China. The Company believes that it has approximately a 20% share of the total world television aperture mask market held by independent manufacturers. The Company is the only independent aperture mask manufacturer with production facilities in either North America or Western Europe.\nMany producers compete in the market for precision etched metal parts produced by the St. Paul facility; there is no clear market share leader. The Company sells its precision etched metal parts to approximately 350 industrial users. The specialty printed circuit market served by that facility includes producers of a wide variety of end products; its size therefore is difficult to quantify. The Company estimates that there are approximately 100 customers for specialty circuits, primarily military and industrial users.\nSUPPLIES. Each of the PIP operations have available multiple sources of the raw materials needed to manufacture its products. The Cortland operation imports from Japan and Germany all of its steel and invar requirements necessary in the manufacture of its products; the Mullheim operation imports from Japan a portion of its steel and invar requirements. Importation of such steel into the United States is subject to restrictions imposed by U.S. federal trade legislation and regulations, but the Company does not anticipate difficulty in obtaining this or any other raw materials. In 1992, the Company was involved in a successful effort to exclude aperture mask steel from products currently involved in a dumping investigation by the U.S. International Trade Commission.\nBACKLOG. As of December 31, 1994, the backlog of PIP sales orders believed to be firm was $126 million, compared with $121 million as of December 31, 1993. The Company expects that all of the December 31, 1994 backlog orders will be filled within the current fiscal year. Backlog orders are based on the results of annual price\/quantity negotiations with aperture mask customers and purchase orders in hand from other customers. Backlog orders may be changed or cancelled by aperture mask customers without penalty.\nENVIRONMENTAL. Chemically etching metals, which is performed by all PIP operations, requires the Company to utilize chemical substances which must be handled in accordance with applicable laws and regulations. The etching processes also generate wastewater, which is treated using on-site wastewater treatment systems, and wastes, some of which are classified as hazardous under applicable environmental laws and regulations. The Company employs systems for either disposing of such wastes in accordance with applicable laws or regulations or recycling the chemicals it utilizes through the manufacturing process. The wastes and the wastewater treatment systems are monitored by environmental agencies to assure compliance with applicable standards. Generation of waste does entail that the Company maintain responsibility for the waste even after proper disposal. As of March 28, 1995, the Company was involved in a total of eight (8) sites where\nenvironmental investigations are ongoing, of which 5 relate to the PIP division and 3 relate to the Optical Products division. See \"Optical Products -- Environmental\" for a discussion of the sites relating to the Optical Products division.\nDuring 1994, the Company received a request for information from the Environmental Protection Agency (the \"EPA\") regarding the Company's potential involvement at a new site. The EPA also initiated additional investigations at two other sites where the Company had previously been identified as a potentially responsible party (\"PRP\"). These additional three (3) sites bring the total to five (5) potential sites, involving the Company's PIP division, where environmental investigations are still occurring and where final settlement has not been reached. However, it is not currently anticipated that the Company's share of the costs of environmental remediation activities for any of the sites will have a materially adverse effect on the financial condition of the Company as a whole.\nIn addition to the above sites, the Company has been named a defendant in connection with real property located in Irvine, California previously occupied by a discontinued operation of the Company's PIP division. The Company has reached a settlement for this site with the other parties to the lawsuit, which is subject to court approval, and is in the process of obtaining approval for the proposed remediation system from the applicable state regulatory agency. The settlement amount and the cost of the proposed remediation system are both within the amounts previously reserved by the Company for this matter. The Company has also been named as a defendant by parties identified as PRP's for a site in Cortland, New York. The Company is presently committed to a vigorous defense of this case. It is impossible at this time to predict the likely outcome of this matter or the Company's exposure if either case is decided adversely. However, it is not currently anticipated that either case will have a material adverse effect on the financial condition of the Company as a whole.\nPIP estimates that in 1994 and 1993 it incurred approximately $3.4 and $3.5 million, respectively, in expenditures (including capital expenditures) related to efforts to comply with applicable laws and regulations regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. In addition, it estimates that it will make approximately $400 thousand dollars in capital expenditures for environmental control facilities during 1995.\nOptical Products ----------------\nOptical Products, also referred to as Vision-Ease Lens (\"Vision-Ease\"), is a major U.S. manufacturer of ophthalmic lenses, including semi-finished polycarbonate, glass and hard-resin plastic multifocal and single-vision lenses and finished polycarbonate single-vision lenses, with group headquarters located in Brooklyn Park, Minnesota. Vision-Ease includes operations located in Brooklyn Center and St. Cloud, Minnesota and in Ft. Lauderdale, Florida. Vision-Ease also has 10 distribution centers in the U.S. and a sales subsidiary in Canada.\nPRODUCTS AND MARKETING. Ophthalmic lenses are manufactured from three principal materials: polycarbonate (\"poly\"), glass and hard-resin plastic. Hard-resin plastic includes both standard plastic lenses and high-index plastic lenses. Semi-finished lenses are sold to independent wholesale optical laboratories or retail outlets with on-site laboratories, which then finish the lens by grinding and polishing the back side of the lens according to the prescription provided by the optometrist or ophthalmologist. After processing, the lens is edged and inserted into the frame by either the wholesale laboratory or the retail optical dispenser. The Company also factory finishes and sells\nto wholesale and retail laboratories a broad range of standard power prescription poly lenses. These finished lenses are ready to be edged and inserted into the frame without laboratory surfacing. Vision-Ease additionally markets limited quantities of lenses produced by third party manufacturers.\nVision-Ease manufactures finished and semi-finished single-vision and semi- finished multifocal poly lenses, including progressive power multifocal lenses, at its Brooklyn Center facility. Progressive power multifocal lenses provide a gradual transition from distance to near viewing without the visual \"jump\" generally associated with a multifocal lens. Due to the strong market demand, Vision-Ease doubled its polycarbonate manufacturing capacity in 1994. The Company produces semi-finished glass multifocal and single-vision lenses at its St. Cloud facility. The Ft. Lauderdale facility manufactures semi-finished hard-resin plastic multifocal (including high-index) and single-vision lenses, including plastic progressive power multifocal lenses, and glass progressive power multifocal lenses.\nA strategic supply agreement has been reached with a low-cost, off-shore supplier for mid-range power standard hard-resin plastic lenses. Under the terms of the supply agreement, Vision-Ease is committed to purchase approximately $12 million dollars of lens over a four year period. This agreement will allow Vision-Ease to focus manufacturing capabilities on higher-margin products within this segment and to be cost-competitive on mid-range, lower-margin products.\nOver the last three years, the Company has made increasing investments in lens development work, particularly in poly lens development and other higher margin products. The result has been the 1992 introduction of a high-index plastic lens product line and a new poly single-vision lens product line, and the first quarter 1993 introduction of a poly progressive lens product line and other new poly products. The Company has added several new products during 1994: VersaLite Sungrays (a fixed-tint sunglass lens) and the VersaLite 1.0 (the thinnest and lightest single-vision lens). Vision-Ease will continue to make significant investments in poly lens development.\nVision-Ease also markets the Optifacts-TM- computer software system. Optifacts- TM- combines proprietary software and standard major manufacturer computer hardware for use by optical wholesale laboratories. The Optifacts-TM- software assists the laboratory in order entry, inventory tracking and related business functions.\nVision-Ease markets its optical products to more than 1,000 wholesalers and retailers in the U.S. and to more than 200 in international markets. No single customer of Vision-Ease accounted for more than 10% of its or the Company's total revenues in 1994. Vision-Ease utilizes independent sales representatives to market its lens products, and the Company advertises extensively in industry publications. Vision-Ease also maintains an internal sales and marketing department to coordinate all sales and promotional activities and provide customer service.\nINTELLECTUAL PROPERTY. The Company has several patents protecting certain of the products and manufacturing processes of its Vision-Ease operations. These patents have expiration dates ranging from 1998 to 2012. The loss of any single patent would not have a material adverse effect on the business of the Company as a whole. The Company believes that improvement of existing products and processes, the development of new lens products and a reliance on trade secrets and unpatented proprietary know-how are as important as patent protection in establishing and maintaining the Company's competitive position. At the same time, the Company continues to seek patent\nprotection for its products and processes on a selective basis. However, there can be no assurance that any patents obtained will provide substantial protection or be of commercial value. The Company generally requires its consultants and employees to agree in writing to maintain the confidentiality of the Company's information and (within certain limits) to assign to the Company any inventions, and any patent or other intellectual property rights, relating to the Company's business.\nCOMPETITION. Competition in the ophthalmic industry with respect to all of the products described above is intense, with no one firm dominating the industry. The principal methods of competition in the industry are pricing, product quality and customer service, particularly with respect to turnaround time from order to shipment.\nSUPPLIES. Vision-Ease has available multiple sources of the raw materials required to manufacture all of its products, with the exception of a monomer required in the production of standard hard-resin plastic lenses, which is available domestically only through Pittsburgh Plate Glass Industries, Inc. and Akzo Chemie America, a monomer required in the production of high-index plastic lenses, available only from Daiso, a Japanese company, and photochromic glass blanks used in producing photochromic glass lenses, which are available domestically only from Corning Glass and Schott. Although the Company's principal supplier of standard monomer is Akzo Chemie America, the products of both domestic suppliers are qualified for use in the Company's production process. Alternate offshore supplies of both standard monomer and photochromic glass blanks are available in the event of any disruption of supplies from domestic sources.\nBACKLOG. Due to the significance to the ophthalmic industry of rapid turnaround time from order to shipment, the backlog of sales orders is not material. Due to the large number of stock-keeping units required, there is a need to maintain a significant amount of inventory in order to satisfy rapid response time.\nENVIRONMENTAL. As part of its lens manufacturing processes, the Company utilizes hazardous chemical substances, which must be handled in accordance with applicable laws and regulations. The lens manufacturing processes also generate wastewater and wastes, some of which are classified as hazardous under applicable environmental laws and regulations. The Company employs systems for either disposing of such wastes in accordance with applicable laws and regulations, or recycling the chemicals it utilizes through the manufacturing process. The wastes and the wastewater treatment systems are monitored by environmental agencies to assure compliance with applicable standards. The wastes generated by Vision-Ease operations must be managed and disposed of properly and the Company retains responsibility for those wastes even after proper disposal. As of March 28, 1995, the Company was involved in a total of eight (8) sites where environmental investigations are ongoing, of which 5 relate to the PIP division and 3 relate to the Optical Products division. See \"Precision Imaged Products -- Environmental\" for a discussion of the sites relating to the PIP division.\nDuring 1994, the Company received correspondence from a group of private parties regarding the Company's potential involvement at a new site. This additional site brings the total to three (3) potential sites, involving the Company's Optical Products division, where environmental investigations are still occurring and where final settlement has not been reached. However, it is not currently anticipated that the Company's share of the costs of environmental remediation activities for any of the sites will have a materially adverse effect on the financial condition of the Company as a whole.\nThe Company has also continued its site investigations at its Fort Lauderdale facility. At this time, there has been no communication from the state regulatory agency regarding the ultimate resolution of the Fort Lauderdale property. The Company's consultant, however, has indicated that some type of remediation is reasonably probable to occur and has provided the Company an approximate cost range for that remediation. Based on the consultant's estimates, and in accordance with allowable accounting principles, the Company has reserved for potential remediation costs. Because the governmental bodies have not yet identified the full extent of any remedial actions, it is still impossible at this time to predict the likely outcome of the Fort Lauderdale matter as well as the sites discussed above, or the Company's exposure if any of these cases are decided adversely. However, it is not currently anticipated that the Company's share of the costs of environmental remediation activities for any of the sites, including the range provided by the Company's consultant for the Fort Lauderdale facility, will have a materially adverse effect on the financial condition of the Company.\nVision-Ease estimates that in 1994 and 1993 it incurred approximately $580,000 and $319,000, respectively, in expenditures (including capital expenditures) related to efforts to comply with applicable laws and regulations regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. In addition, it estimates that it will make approximately $70,000 in capital expenditures for environmental control facilities during 1995.\n(D) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES.\nFinancial information about the Company's foreign and domestic operations and export sales for the most recent three fiscal years is contained on page 35 of the 1994 Annual Report, and is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe locations of the Company's principal production facilities are as follows:\nApproximate Square Feet of Space Location Principal Use (in thousands) -------- ------------- ------------------\nOwned: St. Cloud, MN Optical Products 94 Mullheim, Germany Precision Imaged Products 170 Cortland, NY Precision Imaged Products 152\nLeased: St. Paul, MN Precision Imaged Products 111 Ft. Lauderdale, FL Optical Products 65 Brooklyn Center, MN Optical Products 37\nThe Company leases approximately 9,500 square feet in Minneapolis, Minnesota for its corporate administrative offices. The Company leases approximately 6,000 square feet in Brooklyn Park, Minnesota for the administrative offices of Vision-Ease.\nThe Company's existing facilities are fully utilized. The Company plans to begin construction of a new aperture mask production facility in 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nWith regard to certain environmental matters, See Item 1(c) \"Narrative Description of Business\" and Item 7 \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nOther than as noted above, there are no material pending or threatened legal, governmental, administrative or other proceedings to which the Company is a party or of which any of its property is subject.\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 the fiscal year covered by this Report.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company, their ages, the year first elected or appointed as an executive officer and the offices held as of March 27, 1995 are as follows:\nDate First Elected or Appointed as an Executive Name (Age) Officer Title ---------- ------------ ----- Paul B. Burke (39) August, 1985 President and Chief Executive Officer\nMichael P. Hawks (42) August, 1985 Treasurer and Secretary\nMerle D. Kerr (48) May, 1983 Vice President Finance and Chief Financial Officer\nTerry R. Nygaard (46) May, 1993 Corporate Controller\nThere are no family relationships between or among any of the executive officers of the Company. Executive officers of the Company are elected by the Board of Directors for one-year terms, commencing with their election at the first meeting of the Board of Directors immediately following the annual meeting of stockholders and continuing until the next such meeting of the Board of Directors.\nExcept as indicated below, there has been no change in the principal occupations or employment of the executive officers of the Company during the past five years.\nMr. Burke is also a director of the Company. Mr. Burke joined the Company as Associate General Counsel in June, 1983, and became Vice President, Secretary and General Counsel in August, 1985. In November, 1987, he was appointed Vice President, Fort Lauderdale Operations of the Company's Vision-Ease Lens Division and in May, 1989, he was appointed President of Vision-Ease Lens. In May, 1991, Mr. Burke was elected President and Chief Operating Officer of the Company, and in July, 1991, he became President and Chief Executive Officer. Mr. Burke has also been appointed Chairman of the Board effective as of the next scheduled board meeting, which will be held following the 1995 Annual Meeting.\nMr. Hawks joined the Company in October, 1983 as Assistant Corporate Controller and became Corporate Controller in August, 1985. In May, 1993, Mr. Hawks became Treasurer and Secretary of the Company.\nMr. Kerr joined the Company in May, 1983 as Corporate Controller and became Vice President Finance and Chief Financial Officer in July, 1985, and Treasurer in August, 1985. In May, 1993, Mr. Kerr relinquished the title of Treasurer.\nMr. Nygaard joined the Company in July, 1984 as Director of Taxes and became Corporate Controller in May, 1993.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nPrice Range of Common Stock on page 36 of the 1994 Annual Report is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nHistorical Financial Summary on pages 16-17 of the 1994 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\nManagement's Discussion and Analysis on pages 18-20 of the 1994 Annual Report is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and related notes on pages 21-36 of the 1994 Annual Report are incorporated herein by reference.\nSelected Quarterly Data (unaudited) on page 37 of the 1994 Annual Report 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 OFFICERS OF THE REGISTRANT\nIn addition to certain information as to executive officers of the Company included in Part I of this Form 10-K, the information contained on pages 2-5 and pages 18-19 of the 1995 Proxy Statement, with respect to directors and executive officers of the Company and Section 16 compliance, is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information contained on pages 7-14 of the 1995 Proxy Statement, with respect to executive compensation and transactions, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information contained on pages 5-7 of the 1995 Proxy Statement, with respect to security ownership of certain beneficial owners and management, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information contained on page 18 of the 1995 Proxy Statement, with respect to certain relationships and related 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 items are incorporated in this Form 10-K by reference to the Registrant's 1994 Annual Report (page numbers refer to pages in such 1994 Annual Report):\nConsolidated Financial Statements: Page: ---------------------------------- ----- Consolidated Statements of Earnings for the Years Ended December 31, 1994, 1993 and 1992 . . . . . . . . . . . . . . . 21\nConsolidated Balance Sheets, December 31, 1994 and 1993. . . . 22\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 . . . . . . . . . . . . . . . 23\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1994, 1993 and 1992 . . . . . . . . . . . . 24\nNotes to Consolidated Financial Statements . . . . . . . . . . 25-35\nReport of Independent Auditors . . . . . . . . . . . . . . . . 36\n2. FINANCIAL STATEMENT SCHEDULE:\nSelected quarterly data (unaudited) is contained on page 37 of the 1994 Annual Report.\nThe following supplemental financial data is included herein and should be read in conjunction with the consolidated financial statements referenced above:\nConsent of Independent Auditors (filed as Exhibit 23.1 to this Form 10-K)\nSupplemental Schedule: Page: ---------------------- ----- II - Valuation and Qualifying Accounts 16\nSchedules other than the one listed above are omitted because of the absence of the conditions under which they are required or because the information required is included in the consolidated financial statements or the notes thereto.\n3. EXHIBITS:\nReference is made to the Exhibit Index hereinafter contained on pages 18-23 of this Form 10-K.\nA copy of any of the exhibits listed or referred to herein will be furnished at a reasonable cost to any person who was a stockholder of the Company as of March 10, 1995, upon receipt from any such person of a written request for any such exhibit. Such request should be sent to Investor Relations Department, BMC Industries, Inc., Two Appletree Square, Minneapolis, Minnesota 55425.\nThe following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c):\na) 1984 Omnibus Stock Program, as amended effective December 19, 1989 (incorporated by reference to Exhibit 10.1 of the Company's Annual Report on Form 10-K for the year ended December 31, 1989 (File No. 1-8467)).\nb) 1994 Management Incentive Bonus Plan Summary (incorporated by reference to Exhibit 10.3 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-8467)).\nc) 1995 Management Incentive Bonus Plan Summary (filed herewith as Exhibit 10.3).\nd) Interest Rate Supplement Program (incorporated by reference to written description thereof on page 10 of the Company's Proxy Statement dated March 22, 1991 (File No. 1-8467)).\ne) Revised Executive Expense Policy (effective as of January 1, 1993) (incorporated by reference to Exhibit 10.7 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 1-8467)).\nf) BMC Industries, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1988 (File No. 1-8467)).\ng) First and Second Declaration of Amendment, effective March 15, 1991 and June 3, 1991, respectively, to BMC Industries, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 1-8467)).\nh) Third Declaration of Amendment, effective as of January 1, 1992, to BMC Industries, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 1-8467)).\ni) Fourth Declaration of Amendment, effective as of June 30, 1992, to BMC Industries, Inc. Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.10 to the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 1-8467)).\nj) BMC Industries, Inc. Profit Sharing Plan 1994 Revision, as amended (filed herewith as Exhibit 10.10).\nk) BMC Industries, Inc. Savings Plan 1994 Revision, as amended (filed herewith as Exhibit 10.11).\nl) Description of directors' fees (incorporated by reference to written description thereof on page 4 of the Company's Proxy Statement dated March 27, 1995 (File No. 1-8467)).\nm) Directors' Deferred Compensation Plan (incorporated by reference to Exhibit 10.16 to the Company's Annual Report on Form 10-K for the year ended December 31, 1984 (File No. 1-8467)).\nn) Form of Change of Control Agreement entered into between the Company and Messrs. Burke, Kerr and Hawks (incorporated by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 1-8467)).\no) 1994 Stock Incentive Plan (incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-8467)).\np) BMC Stock Option Exercise Loan Program, as revised December 14, 1994 (filed herewith as Exhibit 10.15).\nq) BMC Industries, Inc. Benefit Equalization Plan (incorporated by reference to Exhibit 10.14 to the Company's Annual Report on Form 10-K for the year ended December 31, 1993 (File No. 1-8467)).\n(B) REPORTS ON FORM 8-K\nThe Company did not file any reports on Form 8-K during the quarter ended December 31, 1994.\n(C) EXHIBITS\nThe response to this portion of Item 14 is submitted as a separate section of this report.\n(D) FINANCIAL STATEMENT SCHEDULES\nThe response to this portion of Item 14 is submitted as a separate section of this report.\nSchedule II Valuation and Qualifying Accounts Years Ended December 31 (in thousands)\nSIGNATURES\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on March 30, 1995, on its behalf by the undersigned, thereunto duly authorized.\nBMC INDUSTRIES, INC.\nBy \/S\/ Merle D. Kerr -------------------------------------- Merle D. Kerr Vice President Finance and Chief Financial Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below on March 30, 1995, by the following persons on behalf of the Registrant and in the capacities indicated.\nSignature Title\n\/S\/ Paul B. Burke President, Chief Executive Office and ------------------------------ Paul B. Burke Director (Principal Executive Officer)\n\/S\/ Merle D. Kerr Vice President Finance and Chief Financial ------------------------------ Merle D. Kerr Officer (Principal Financial Officer)\n\/S\/ Terry R. Nygaard Corporate Controller (Principal Accounting ------------------------------ Terry R. Nygaard Officer)\n\/S\/ Lyle D. Altman Director ------------------------------ Lyle D. Altman\n\/S\/ John W. Castro Director ------------------------------ John W. Castro\n\/S\/ Joe E. Davis Director ------------------------------ Joe E. Davis\n\/S\/ Norman C. Mears Director ------------------------------ Norman C. Mears\n\/S\/ S. Walter Richey Director ------------------------------ S. Walter Richey\n\/S\/ Richard A. Swalin Director ------------------------------ Richard A. Swalin\nBMC Industries, Inc. Exhibit Index to Annual Report on Form 10-K For the Year Ended December 31, 1994","section_15":""}
{"filename":"83047_1994.txt","cik":"83047","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nReliance Financial Services Corporation ('Reliance Financial', 'Company' or 'Registrant') owns all of the common stock of Reliance Insurance Company ('Reliance Insurance Company'). Reliance Insurance Company and its property and casualty insurance subsidiaries (such subsidiaries, together with Reliance Insurance Company, the 'Reliance Property and Casualty Companies') and its title insurance subsidiaries (collectively, the 'Reliance Insurance Group') underwrite a broad range of commercial lines of property and casualty insurance, as well as title insurance. Reliance Insurance Company has conducted business since 1817, making it one of the oldest property and casualty insurance companies in the United States.\nThe Reliance Property and Casualty Companies consist of four principal operations: Reliance National, Reliance Insurance, Reliance Reinsurance and Reliance Surety. Established in 1987, Reliance National offers, through national and regional brokers, a broad range of commercial property and casualty insurance products and services for large companies and specialty line customers. Reliance National selects market segments where it can provide specialized coverages and services, and it conducts business nationwide and in certain international markets. In 1994, Reliance National accounted for 50% of the net premiums written by the Reliance Property and Casualty Companies. Reliance Insurance offers commercial property and casualty insurance coverages for mid-sized companies throughout the United States. Reliance Insurance also offers traditional and specialized coverages for more complex risks as well as insurance programs for groups with common insurance needs. Reliance Reinsurance primarily provides property and casualty treaty reinsurance for small to medium sized regional and specialty insurance companies located in the United States. Reliance Surety is a leading writer of surety bonds and fidelity bonds in the United States. The Reliance Property and Casualty Companies accounted for $1,777.3 million (67%) of the Reliance Insurance Group's 1994 net premiums earned.\nThe Reliance Insurance Group's title insurance business consists of Commonwealth Land Title Insurance Company ('Commonwealth') and Transamerica Title Insurance Company ('Transamerica Title', together with Commonwealth and their respective subsidiaries, 'Commonwealth\/Transamerica Title'). Commonwealth\/Transamerica Title is the third largest title insurance operation in the United States, in terms of 1993 total premiums and fees. Commonwealth\/Transamerica Title accounted for $856.8 million (33%) of the Reliance Insurance Group's 1994 net premiums earned.\nBusiness segment information for the years ended December 31, 1994, 1993 and 1992 is set forth in Note 18 to the Company's consolidated financial statements (the 'Consolidated Financial Statements'), which segment information is included in the Company's 1994 Annual Report and incorporated herein by reference. All financial information in this Annual Report on Form 10-K is presented in accordance with generally accepted accounting principles ('GAAP') unless otherwise specified.\nThe common stock of Reliance Insurance Company, which represents approximately 98% of the combined voting power of all Reliance Insurance Company stockholders, has been pledged by the Company to secure certain indebtedness. See Note 8 to the Company's consolidated financial statements. The Company is a wholly-owned subsidiary of Reliance Group Holdings, Inc. ('Reliance Group Holdings'). Approximately 47% of the common stock of Reliance Group Holdings, the only class of voting securities outstanding, is owned by Saul P. Steinberg, members of his family and affiliated trusts.\nOPERATING UNITS\nProperty and Casualty Insurance. The Reliance Property and Casualty Companies consist of four principal operations: Reliance National, Reliance Insurance, Reliance Reinsurance and Reliance Surety. The following table sets forth the amount of net premiums written in each line of business by Reliance National, Reliance Insurance, Reliance Reinsurance and Reliance Surety for the years ended December 31, 1994, 1993 and 1992.\nThe following table sets forth underwriting results for the Reliance Property and Casualty Companies for the years ended December 31, 1994, 1993 and 1992.\n------------------ (1) Includes catastrophe losses (net of reinsurance) for the years ended December 31, 1994, 1993 and 1992 of $50.1 million, $39.3 million and $61.1 million, respectively.\nThe following table sets forth certain financial information of the Reliance Property and Casualty Companies based upon statutory accounting practices and common shareholder's equity of Reliance Insurance Company based upon GAAP, in thousands:\n------------------ * Includes Reliance Insurance Company's investment in title insurance operations of $180.8 million at December 31, 1994.\nThe Reliance Property and Casualty Companies write insurance in every state of the United States, the District of Columbia, Puerto Rico, Guam and The Virgin Islands. The Reliance Property and Casualty Companies also write insurance in the European Community through offices in the United Kingdom, the Netherlands and Spain, and in the Americas through offices in Canada, Mexico and Argentina. In 1994, California, New York, Texas, Pennsylvania and Florida accounted for approximately 18%, 9%, 7%, 6% and 5%, respectively, of direct premiums written. No other state accounted for more than 5% of direct premiums written by the Reliance Property and Casualty Companies. The Reliance Property and Casualty Companies write insurance through independent agents, program agents and brokers. No single insurance agent or broker accounts for 10% or more of the direct premiums written by the Reliance Property and Casualty Companies.\nThe Reliance Property and Casualty Companies ranked 32nd among property and casualty insurance companies and groups in terms of net premiums written during 1993, according to Best's Insurance Management Reports. A. M. Best & Company, Inc. ('Best'), publisher of Best's Insurance Reports, Property-Casualty, has assigned an A- (Excellent) rating to the Reliance Property and Casualty Companies. Best's ratings are based on an analysis of the financial condition and operations of an insurance company as they relate to the industry in general. An A- (Excellent) rating is assigned to those companies which have demonstrated excellent overall performance when compared to the norms of the property and casualty industry. Standard & Poor's ('S&P') rates the claims-paying ability of the Reliance Property and Casualty Companies A. S&P's ratings are based on quantitative and qualitative analysis including consideration of ownership and support factors, if applicable. An A rating is assigned to those companies which have good financial security, but capacity to meet policyholder obligations is somewhat susceptible to adverse economic and underwriting conditions. Best's ratings are not designed for the protection of investors and do not constitute recommendations to buy, sell or hold any security. Although the Best and S&P ratings of the Reliance Property and Casualty Companies are lower than those of many of the insurance companies with which the Reliance Property and Casualty Companies compete, management believes that the current ratings are adequate to enable the Reliance Property and Casualty Companies to compete successfully.\nReliance National. Established in 1987, Reliance National offers a broad range of commercial insurance products and services to selected segments of the property and casualty market which do not lend themselves to traditional insurance products and services. Reliance National selects market segments where it can provide specialized coverages and services. In 1994, Reliance National accounted for 50% of the net premiums written by the Reliance Property and Casualty Companies. Reliance National, which conducts business nationwide, is headquartered in New York City and has regional offices in seven states. Reliance National also conducts business in the European Community through offices located in the United Kingdom, the Netherlands and Spain and in the Americas through offices in Canada, Mexico and Argentina. In 1994, Reliance National completed its acquisition of a Mexican insurance company and purchased an Argentinean insurance company. Reliance National distributes its products primarily through national insurance brokers. Reliance National maintains an underwriting staff in the United States, the United Kingdom, Canada and Mexico, an actuarial staff in the United States and makes extensive use of third party administrators and technical consultants for certain claims and loss control services. Net premiums written by Reliance National were $889.7 million, $872.2 million and $828.6 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nReliance National is organized into eight major divisions. Each division is comprised of individual departments, each focusing on a particular type of business, program or market segment. Each department makes use of underwriters, actuaries and other professionals to market, structure and price its products. Reliance National's eight major divisions are:\no Risk Management Services, Reliance National's largest division, targets Fortune 1,000 companies and multinationals with a broad array of coverages and services. Its use of risk financing techniques such as retrospectively rated policies, self-insured retentions, deductibles, captives, alternative risk funding and fronting arrangements all help clients to reduce costs and\/or manage cash flow more efficiently. It provides workers' compensation, commercial automobile, general liability and pollution coverages. In 1994, this division had net premiums written of $290.8 million.\no Special Operations provides coverages for construction, transportation and ocean marine risks and offers non-standard personal automobile insurance for drivers unable to obtain insurance in the standard market. In 1994, this division had net premiums written of $181.4 million.\no Excess and Surplus Lines provides professional liability insurance to architects and engineers, lawyers, healthcare providers and other professions, and markets excess and umbrella coverages. It also provides employment practices liability insurance and develops and provides insurance products to certain markets requiring specialized underwriting, such as the entertainment industry market. In 1994, this division had net premiums written of $121.6 million.\no International writes predominantly commercial property and casualty\ninsurance products, including specialized coverages such as excess casualty, directors and officers liability, and fidelity insurance, in the European Community, Canada, Mexico and Argentina. It also provides certain risk management services for foreign subsidiaries of United States multinational corporations. In 1994, this division had net premiums written of $86.4 million.\no Financial Products provides directors and officers liability insurance and, for financial institutions, errors and omissions insurance. In 1994, this division had net premiums written of $70.7 million.\no Financial Specialty Coverages provides aviation and space satellite risk coverages on an assumed and direct basis, and also underwrites complex non-traditional insurance and reinsurance products, including finite risk transactions. In 1994, this division had net written premiums of $53.9 million.\no Accident and Health provides high limit disability, group accident, blanket special risk and medical excess of loss programs. In 1994, this division had net premiums written of $48.1 million.\no Property provides commercial property coverage focusing on excess and specialty commercial property. In 1994, this division had net premiums written of $23.0 million.\nReliance National attempts to limit its exposure to losses through the use of certain methods such as claims-made policies, retrospectively rated policies, high deductible policies and reinsurance. Approximately 23% of Reliance National's net premiums written during 1994 were written on a 'claims-made' basis which provides\ncoverage only for claims reported during the policy period or within an established reporting period, as opposed to 'occurrence' basis policies which provide coverage for events during the policy period without regard for when the claim is reported. Claims-made policies mitigate the 'long tail' nature of the risks insured.\nApproximately 13% of Reliance National's net premiums written during 1994 were written on a retrospectively rated or loss sensitive basis, whereby the insured effectively pays for a large portion or, in many cases, all of its losses. Approximately 6% of Reliance National's net premiums written during 1994 were written on a high deductible basis, whereby the insured pays for all of its losses up to the deductible amount. The use of high deductible policies results in lower premiums and losses for Reliance National as loss payments made by an insured under a high deductible policy are not considered premium or losses to an insurer. With retrospectively rated and high deductible policies Reliance National provides insurance and loss control management services, while reducing its underwriting risk. Reliance National assumes a credit risk in connection with retrospectively rated and high deductible policies and, therefore, accounts with such policies undergo extensive credit analysis by a\ncentralized credit department. Collateral in the form of bank letters of credit, trust accounts or cash collateral is generally provided by the insured to cover a significant portion of Reliance National's credit exposure.\nTo further limit exposures, approximately 91% of Reliance National's net premiums written during 1994 were for policies with net retentions equal to or lower than $1.5 million per risk. By reinsuring a large proportion of its business, Reliance National seeks to limit its exposure to losses on each line of business it writes. Its largest single exposure, net of reinsurance, at December 31, 1994, was $2.3 million per occurrence.\nReliance Insurance. Reliance Insurance offers commercial lines property and casualty insurance products, primarily focusing on the diverse needs of mid-sized companies nationwide. Reliance Insurance distributes its products through approximately 2,800 independent agents, program agents and brokers. Reliance Insurance's customers are primarily closely held companies with 25 to 1,000 employees and annual sales of $5 million to $300 million. Reliance Insurance underwrites a variety of commercial insurance coverages, including property, general liability, commercial automobile and workers' compensation (the majority of which is written on a loss sensitive or retrospectively rated basis). Reliance Insurance is headquartered in Philadelphia and operates in 50 states and the District of Columbia. Net written premiums by Reliance Insurance were $631.0 million (including $20.7 million of personal lines premiums), $668.2 million (including $45.4 million of personal lines premiums) and $510.8 million (including $8.8 million of personal lines premiums) for the years ended December 31, 1994, 1993 and 1992, respectively.\nReliance Insurance is organized into the Commercial Insurance Division, comprised of the Standard Commercial department and the Large Accounts department, and the Custom Underwriting Facility, comprised of the Special Risk department and the Program department. The Commercial Insurance Division provides its products and services through a decentralized network of regional and branch offices. This organization allows it to place major responsibility and accountability for underwriting, sales, claims, and customer service close to the insured. The Custom Underwriting Facility's Special Risk department has three regional offices and the Program department has one central office.\nThe Commercial Insurance Division's Standard Commercial department focuses on accounts with annual premiums of up to $1 million. This department offers a broad range of traditional commercial coverages, primarily written on a guaranteed cost basis. The Standard Commercial department had net written premiums of $312.8 million in 1994. The Commercial Insurance Division's Large Accounts department focuses on casualty exposures of accounts with annual premiums in excess of $1 million, where it is able to offer more flexible coverages through the use of retrospectively rated and high deductible policies. The Large Accounts department primarily provides workers' compensation insurance and approximately 85% of its business was written on a loss sensitive basis. Accounts with retrospectively rated and high deductible policies undergo extensive credit analysis by a centralized credit department and collateral is generally provided by the insured to cover a significant portion of Reliance Insurance's credit exposure. The Large Accounts department wrote $115.7 million of net premiums in 1994.\nThe Custom Underwriting Facility's Special Risk department provides underwriting of excess and surplus coverages (generally with lower net retentions than for other commercial lines written by Reliance Insurance) for risks with unique exposures. The Special Risk department had net written premiums of $109.5 million in 1994. The Custom Underwriting Facility's Program department provides property and liability insurance programs,\ntargeting homogeneous groups of insureds with particular insurance needs, such as auto rental companies, day care centers and municipalities. These programs are administered by independent program agents, with Reliance Insurance retaining authority for all underwriting and pricing decisions. Program agents market the programs, gather the initial underwriting data and, if authorized by Reliance Insurance, issue the policies. All claims and other services are handled by Reliance Insurance. The Program department had net written premiums of $73.4 million in 1994.\nReliance Insurance has substantially withdrawn from personal lines, where it has had unfavorable experience and does not perceive a potential for long-term profitability. The Reliance Property and Casualty Companies derived 1.2% of their net premiums written from personal lines in 1994, compared with 2.6% in 1993.\nReliance Reinsurance. Reliance Reinsurance provides property reinsurance on a treaty basis and casualty reinsurance on a treaty and facultative basis. All treaty business is marketed through reinsurance brokers who negotiate contracts of reinsurance on behalf of the primary insurer or ceding reinsurer, while facultative business is produced both directly and through reinsurance brokers. While Reliance Reinsurance's treaty clients include all types and sizes of insurers, Reliance Reinsurance typically targets treaty reinsurance for small to medium sized regional and specialty insurance companies, as well as captives, risk retention groups and other alternative markets, providing both pro rata and excess of loss coverage. Reliance Reinsurance believes that this market is subject to less competition and provides Reliance Reinsurance an opportunity to develop and market innovative programs where pricing is not the key competitive factor. Reliance Reinsurance typically avoids participating in large capacity reinsurance treaties where price is the predominant competitive factor. It generally writes reinsurance in the 'lower layers,' the first $1 million of primary coverage, where losses are more predictable and quantifiable. The assumed reinsurance business of the Reliance Property and Casualty Companies is conducted nationwide and is headquartered in Philadelphia. Net written premiums by Reliance Reinsurance were $125.6 million, $123.6 million and $107.9 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nReliance Surety. Reliance Surety is a leading writer of surety bonds and fidelity bonds in the United States. Reliance Surety concentrates on writing performance and payment bonds for contractors of public works projects, commercial real estate and multi-family housing. It also writes financial institution and commercial fidelity bonds. Reliance Surety performs extensive credit analysis on its clients, and actively manages the claims function to\nminimize losses and maximize recoveries. Reliance Surety has enjoyed long relationships with the major contractors it has insured. Reliance Surety has established an operation targeting smaller contractors, an area traditionally less fully serviced by national surety companies and one providing potential growth for Reliance Surety. Reliance Surety is headquartered in Philadelphia and conducts business nationwide through 43 branch offices and approximately 3,200 independent agents and brokers. Net written premiums by Reliance Surety were $118.0 million, $106.7 million and $94.3 million for the years 1994, 1993 and 1992, respectively.\nSurety bonds guarantee the payment or performance of one party (called the principal) to another party (called the obligee). This guarantee is typically evidenced by a written agreement by the surety (e.g., Reliance Insurance Company) to discharge the payment or performance obligations of the principal pursuant to the underlying contract between the obligee and the principal. Fidelity bonds insure against losses arising from employee dishonesty. Financial institution fidelity bonds insure against losses arising from employee dishonesty and other specifically named theft and fraud perils.\nTitle Insurance. Through Commonwealth\/Transamerica Title, the Company writes title insurance for residential and commercial real estate nationwide and provides escrow and settlement services in connection with real estate closings. The National Title Services division of Commonwealth\/Transamerica Title provides title services for large and multi-state commercial transactions. Through the Commonwealth OneStop(Trademark) program, Commonwealth\/Transamerica Title provides national lenders with a full range of residential closing services, including title insurance through its National Residential Title Services division, appraisal management through its CLT Appraisal Services, Inc. subsidiary, and other real estate related services. Commonwealth\/Transamerica Title is the third largest title insurance operation in the United States, based on 1993 total premiums and fees. Commonwealth\/Transamerica Title had premiums and fees (excluding Commonwealth Mortgage Assurance\nCorporation, its mortgage insurance subsidiary which was sold in the fourth quarter of 1992) of $856.8 million, $893.4 million and $770.5 million for the years 1994, 1993 and 1992, respectively.\nCommonwealth\/Transamerica Title is organized into six regions with more than 325 offices covering all 50 states, as well as Puerto Rico and the Virgin Islands. In 1994, Texas, California, Florida, Pennsylvania, New York, Washington and Michigan accounted for approximately 11%, 10%, 10%, 8%, 7%, 6% and 6%, respectively, of revenues for premiums and services related to title insurance. No other state accounted for more than 5% of such revenues. Commonwealth\/Transamerica Title is committed to increasing its market share through a carefully developed plan of expanding its direct and agency operations, including selective acquisitions.\nA title insurance policy protects the insured party and certain successors in interest against losses resulting from title defects, liens and encumbrances existing as of the date of the policy and not specifically excepted from the policy's provisions. Generally, a title policy is obtained by the buyer, the\nmortgage lender or both at the time real property is transferred or refinanced. The policy is written for an indefinite term for a single premium which is due in full upon issuance of the policy. The face amount of the policy is usually either the purchase price of the property or the amount of the loan secured by the property. Title policies issued to lenders insure the priority position of the lender's lien. Many lenders require title insurance as a condition to making loans secured by real estate. Title insurers, unlike other types of insurers, seek to eliminate future losses through the title examination process and the closing process, and a substantial portion of the expenses of a title insurer relate to those functions.\nConsulting and Technical Services. RCG International, Inc. ('RCG'), a subsidiary of the Reliance Insurance Group, and its subsidiaries provide consulting and technical services to industry, government and nonprofit organizations, principally in the United States and Europe, and also in Canada, Asia, South America, Africa and Australia. The services provided by RCG include consulting in two principal areas: information technology, which provides computer-related professional services to large corporate clients, and energy\/environmental services. RCG and its subsidiaries had revenues of $141.6 million, $116.8 million and $109.1 million for 1994, 1993 and 1992, respectively.\nSALE OF NON-CORE OPERATIONS\nThe Company has realigned its operations to emphasize commercial property and casualty insurance, particularly specialized insurance products and complex risks of larger accounts, and title insurance. In July 1993, the Company completed the sale of its life insurance subsidiary, United Pacific Life Insurance Company ('UPL'). In the fourth quarter of 1992, the Company sold substantially all of the operating assets and insurance brokerage, employee benefits consulting and related services businesses of its insurance brokerage subsidiary, Frank B. Hall & Co. Inc. ('Hall'). Also in the fourth quarter of 1992, the Company sold its mortgage insurance subsidiary, Commonwealth Mortgage Assurance Corporation ('CMAC'), through a public offering of 100% of the common stock of CMAC Investment Corporation ('CMAC Investment'). For a further description of the above referenced transactions, see Notes 13 and 16 to the Consolidated Financial Statements.\nINSURANCE CEDED\nAll of the Reliance Insurance Group's insurance operations purchase reinsurance to limit the Company's exposure to losses. Although the ceding of insurance does not discharge an insurer from its primary legal liability to a policyholder, the reinsuring company assumes a related liability and, accordingly, it is the practice of the industry, as permitted by statutory regulations, to treat properly reinsured exposures as if they were not exposures for which the primary insurer is liable. The Reliance Insurance Group enters into reinsurance arrangements that are both facultative (individual risks) and treaty (blocks of risk). Limits and retentions are based on a number of factors, including the previous loss history of the operating unit, policy limits and exposure data, industry studies as to potential severity, and market terms, conditions and capacity, and may change over time. Reliance National and Reliance Insurance limit their exposure to individual risks by purchasing excess of loss and quota share reinsurance, with treaty structures and net retentions\nvarying with the specific requirements of the line of business or program being reinsured. In many cases, Reliance National and Reliance Insurance purchase additional facultative reinsurance to further reduce their retentions below the treaty levels.\nDuring 1994, the highest net retention per occurrence for casualty risk was $2.2 million for Reliance National and $3.0 million for Reliance Insurance. In addition, both Reliance National and Reliance Insurance purchase 'casualty clash' coverage to provide protection in the event of losses incurred by multiple coverages on one occurrence.\nDuring 1994, the highest net retention per occurrence for property risk was $2.3 million for Reliance National and $3.2 million for Reliance Insurance. In addition, during 1994, Reliance National and Reliance Insurance together had reinsurance for 95% of net retained property catastrophe losses in excess of $15 million and up to $107 million. Thus, for all net retained losses attributable to a single catastrophe of $107 million, Reliance National and Reliance Insurance together retained a maximum exposure of $19.6 million. Any net retained loss from a single catastrophe beyond $107 million is not reinsured and is retained by Reliance National and Reliance Insurance together. Renewal of catastrophe coverage during the term of the treaty is provided by a provision for one automatic reinstatement of the original coverage at a contractually determined premium. The Company believes that the limit of $107 million of net retained losses per occurrence is sufficient to cover its probable maximum loss in the event of a catastrophe.\nCatastrophe losses, including losses incurred by Reliance Reinsurance on insurance assumed, were $50.1 million in 1994 ($134.0 million before insurance ceded), which included $44.9 million ($127.0 million before insurance ceded) arising from the January 1994 California earthquake, compared to $39.3 million in 1993 ($88.5 million before insurance ceded). Catastrophe losses, including losses incurred by Reliance Reinsurance on insurance assumed, were $61.1 million in 1992 ($119.2 million before insurance ceded), which included $45.6 million ($94.1 million before insurance ceded) arising from Hurricane Andrew.\nA catastrophic event can cause losses in lines of insurance other than property. Both Reliance National and Reliance Insurance purchase workers' compensation reinsurance coverage up to $200 million to provide protection against losses under workers' compensation policies which might be caused by catastrophes. Such workers' compensation reinsurance applies after retentions by Reliance National of up to $500,000 and Reliance Insurance of up to $1 million. For Reliance Insurance, any such losses over $200 million would be covered by the property catastrophe treaty to the extent of available capacity. For Reliance National, any such losses over $200 million and up to $255 million would be covered by Reliance National's casualty clash coverage.\nReliance National and Reliance Insurance have also purchased reinsurance to cover aggregate retained catastrophe losses in the event of multiple catastrophes in any one year. This reinsurance agreement provides coverage for up to 93% of aggregate catastrophe losses between $12.5 million and $31.0 million, after applying a deductible of $3.8 million per catastrophe.\nReliance Surety retains 100% of surety bond limits up to $2 million. For surety bonds in excess of $2 million, up to $40 million, Reliance Surety obtains 50% quota share reinsurance. For surety bonds between $40 million and $50 million, Reliance Surety obtains 60% quota share reinsurance. In addition, Reliance Surety has excess of loss protection, with a net retention of up to $4.3 million, for losses up to $30 million on any one principal insured. For fidelity business, Reliance Surety retains 100% of each loss up to $1.5 million. Reliance Surety has obtained reinsurance above that retention up to a maximum of $8.5 million on each loss.\nReliance Reinsurance writes treaty property and casualty reinsurance and facultative casualty reinsurance with limits of $1.5 million per program. Facultative property reinsurance, which was discontinued in February 1994, was written with limits of $10 million per risk, of which the Company retained $500,000 after the purchase of reinsurance. Reliance Reinsurance purchases catastrophe protection for its property treaty and facultative insurance assumed of $5.0 million in excess of a $2.5 million per occurrence retention, with a contractual provision for a reinstatement. In 1994, Reliance Reinsurance also wrote a specific catastrophe book of business with an aggregate limit of $17.7 million for any one event, not subject to the above protection. In 1994, losses and expenses of $12.5 million incurred under this specific catastrophe program were offset by premiums of $11.0 million. As of December 31, 1994, Reliance Reinsurance no longer writes a specific catastrophe book of business.\nCommonwealth\/Transamerica Title generally retains no more than $60 million on any one risk, although it often retains significantly less than this amount, with reinsurance placed with other title companies. Commonwealth\/Transamerica Title also purchases reinsurance from Lloyd's of London which provides coverage\nfor 80% of losses between $20 million and $60 million, on any one risk. The largest net loss paid by Commonwealth or, since its acquisition, Transamerica Title on any one risk was approximately $5 million.\nPremiums ceded by the Reliance Insurance Group to reinsurers were $1.2 billion and $1.1 billion in 1994 and 1993, respectively. The Reliance Insurance Group is subject to credit risk with respect to its reinsurers, as the ceding of risk to reinsurers does not relieve the Reliance Insurance Group of its liability to insureds. At December 31, 1994, the Reliance Insurance Group had reinsurance recoverables of $2.9 billion, representing estimated amounts recoverable from reinsurers pertaining to paid claims, unpaid claims, claims incurred but not reported and unearned premiums. In order to minimize losses from uncollectible reinsurance, the Reliance Insurance Group places its reinsurance with a number of different reinsurers, and utilizes a security committee or a credit department to approve in advance the reinsurers which meet its standards of financial strength and are acceptable for use by Reliance Insurance Group. The Reliance Insurance Group holds substantial amounts of collateral, consisting of letters of credit, trust accounts and cash collateral, to secure recoverables from unauthorized reinsurers. The Company had $8.2 million reserved for potentially unrecoverable reinsurance at December 31, 1994. The Company is not aware of any impairment of the creditworthiness of any of the Reliance Insurance Group's significant reinsurers. While the Company is aware of\nfinancial difficulties experienced by certain Lloyd's of London syndicates, the Company has not experienced deterioration of payments from the Lloyd's of London syndicates from which it has reinsurance. The Company has no reason to believe that the Lloyd's of London syndicates from which it has reinsurance will be unable to satisfy claims that may arise with respect to ceded losses.\nIn 1994, the Reliance Property and Casualty Companies did not cede more than 5.1% of direct premiums to any one reinsurer and no one reinsurer accounted for more than 10.9% of total ceded premiums. The Reliance Insurance Group's ten largest reinsurers, based on 1994 ceded premiums, are as follows:\n------------------ (1) Individual Lloyd's of London syndicates are not rated by Best. (2) An unrated captive reinsurer that is not affiliated with the Company. Recoverables from such reinsurer are fully collateralized. (3) Assigned a Best's Rating of NA-3 (Insufficient Operating Experience) as the reinsurer has not accumulated five years of representative operating experience. (4) Reinsurer is not rated by Best. The S&P Rating for such reinsurer is A.\nThe Reliance Insurance Group maintains no 'Funded Cover' reinsurance agreements. 'Funded Cover' reinsurance agreements are multi-year retrospectively rated reinsurance agreements which may not meet relevant accounting standards for risk transfer and under which the reinsured must pay additional premiums in subsequent years if losses in the current year exceed levels specified in the reinsurance agreement.\nPROPERTY AND CASUALTY LOSS RESERVES\nAs of March 15, 1995, the Reliance Insurance Group maintains a staff of 101 actuaries, of whom 17 are fellows of the Casualty Actuarial Society and one is a fellow of the Society of Actuaries. This staff regularly performs comprehensive analyses of reserves and reviews the pricing and reserving methodologies of the\nReliance Insurance Group. Although the Company believes, in light of present facts and current legal interpretations, that the Reliance Insurance Group's overall property and casualty reserve levels are adequate to\nmeet its obligations under existing policies, due to the inherent uncertainty and complexity of the reserving process, the ultimate liability may be more or less than such reserves.\nThe following tables present information relating to the liability for unpaid claims and related expenses ('loss reserves') for the Reliance Property and Casualty Companies. The table below provides a reconciliation of beginning and ending liability balances for the years ended December 31, 1994, 1993 and 1992.\n------------------ * Loss reserves exclude the loss reserves of title operations of $228.1 million, $204.7 million and $173.3 million at December 31, 1994, 1993 and 1992, respectively.\nPolicy claims and settlement expenses includes a provision for insured events of prior years of $22.4 million, $40.2 million and $31.5 million for the years 1994, 1993 and 1992, respectively. The 1994 provision includes $17.0 million of adverse development related to prior year asbestos-related and environmental pollution claims. Development in asbestos-related and environmental pollution claims primarily affects general liability and multiple peril lines of business. The 1994 provision also includes $14.7 million of adverse development from other general liability lines. This development was partially offset by $13.3 million of favorable development in workers' compensation. The 1993 provision includes $21.1 million of adverse development from workers' compensation reinsurance pools and $35.2 million of adverse development related to prior-year asbestos-related and environmental pollution claims. This development was partially offset by favorable development in other lines of business, including other general liability lines. The 1992 provision includes $55.6 million of adverse development from workers' compensation and automobile reinsurance pools. This development was partially offset by favorable development of $11.9 million from two general liability claims and favorable development of $10.7 million related to unallocated loss adjustment expenses.\nThe table below summarizes the development of the estimated liability for loss reserves (net of reinsurance recoverables) as of December 31 of each of the prior ten years. The amounts shown on the top line of the table represent the estimated liability for loss reserves (net of reinsurance recoverables) for claims that are unpaid at the particular balance sheet date, including losses that had been incurred but not reported to the Reliance Property and Casualty Companies. The upper portion of the table indicates the loss reserves as they are reestimated in subsequent periods as a percentage of the originally recorded reserves. These estimates change as losses are paid and more accurate information becomes available about remaining loss reserves. A redundancy exists when the original loss reserve estimate is greater, and a deficiency exists when the original loss reserve estimate is less, than the reestimated loss reserve at December 31, 1994. A redundancy or deficiency indicates the cumulative percentage change, as of December 31, 1994, of originally recorded loss reserves. The lower portion of the table indicates the cumulative amounts paid as of successive periods as a percentage of the original loss reserve liability. In calculating the percentage of cumulative paid losses to the loss reserve liability in each year, unpaid losses of General Casualty Company of Wisconsin, a former wholly-owned subsidiary, and its subsidiaries ('General Casualty') at April 30, 1990 (the date of sale of General Casualty), relating to 1984 to 1989, were deducted from the original liability in each year. Each amount in the following table includes the effects of all changes in amounts for prior periods. The table does not present accident or policy year development data. For the years 1984 through 1993, the Company has experienced deficiencies in its estimated liability for loss reserves. Included in these deficiencies were provisions of $156.0 million in 1991 and $100.0 million in 1986 specifically made to strengthen prior-years' loss reserves. The Company's loss reserves\nduring this period have been adversely affected by a number of factors beyond the Company's control as follows: (i) significant increases in claim settlements reflecting, among other things, inflation in medical costs; (ii) increases in the costs of settling claims, particularly legal expenses; (iii) more frequent resort to litigation in connection with claims; and (iv) a widening interpretation of what constitutes a covered claim.\n------------------ (1) The gross liability for unpaid claims and related expenses was $5.6 billion at December 31, 1994. The gross liability for unpaid claims and related expenses for years 1993 and prior was redundant by $144.4 million at December 31, 1994.\nThe difference between the property and casualty liability for loss reserves at December 31, 1994 and 1993 reported in the Company's consolidated financial statements (net of reinsurance recoverables) and the liability which would be reported in accordance with statutory accounting practices is as follows:\nThe difference between the property and casualty liability for loss reserves at December 31, 1994 and 1993 reported in the Company's consolidated financial statements and the liability which would be reported in accordance with statutory accounting practices is as follows:\nProperty and casualty loss reserves are based on an evaluation of reported claims, in addition to statistical projections of claims incurred but not reported and loss adjustment expenses. Estimates of salvage and subrogation are deducted from the liability for unpaid claims. Also considered are other factors such as the promptness with which claims are reported, the history of the ultimate liability for such claims compared with initial and intermediate estimates, the type of insurance coverage involved, the experience of the property and casualty industry and other economic indicators, when applicable.\nThe establishment of loss reserves requires an estimate of the ultimate liability based primarily on past experience. The Reliance Property and Casualty Companies apply a variety of generally accepted actuarial techniques to determine the estimates of ultimate liability. The techniques recognize, among other factors, the Reliance Insurance Group's and the industry's experience with similar business, historical trends in reserving patterns and loss payments, pending level of unpaid claims, the cost of claim settlements, the Reliance Insurance Group's product mix, the economic environment in which property and casualty companies operate and the trend toward increasing claims and awards.\nEstimates are continually reviewed and adjustments of the probable ultimate liability based on subsequent developments and new data are included in operating results for the periods in which they are made. In general, reserves are initially established based upon the actuarial and underwriting data utilized to set pricing levels, and are reviewed as additional information, including claims experience, becomes available. The Reliance Property and Casualty Companies regularly analyze their reserves and review their pricing and reserving methodologies, using Reliance Insurance Group actuaries, so that future adjustments to prior year reserves can be minimized. From time to time, the Reliance Property and Casualty Companies consult with independent actuarial firms concerning reserving practices and levels. The Reliance Property and Casualty Companies are required by state insurance regulators to file, along with their statutory reports, a statement of actuarial reserve opinion setting forth an actuary's assessment of their reserve status and, in 1994, the Reliance Property and Casualty Companies used an independent actuarial firm to meet such requirements. However, given the complexity of this process, reserves require continual updates. The process of estimating claims is a complex task and the ultimate liability may be more or less than such estimates indicate.\nSince 1989, the Reliance Property and Casualty Companies have increased their premium writings in long tail lines of business. Estimation of loss reserves for these lines of business is more difficult than for short tail lines because claims may not become apparent for a number of years, and a relatively higher proportion of ultimate losses are considered incurred but not reported. As a result, variations in loss development are more likely in these lines of business. The Reliance Property and Casualty Companies attempt to reduce these variations in certain of its long tail lines, primarily directors and officers liability, professional liability and general liability, by writing policies on a claims-made basis, which mitigates the long tail nature of the risks. The Reliance Property and Casualty Companies also seek to limit the loss from a single event through the use of reinsurance.\nIn calculating the liability for loss reserves, the Reliance Property and Casualty Companies discount workers' compensation pension claims which are expected to have regular, periodic payment patterns. These claims are discounted for mortality and for interest using statutory annual rates ranging from 3.5% to 6%. In addition, the reserves for claims assumed through the participation of the Reliance Property and Casualty Companies in workers' compensation reinsurance pools are discounted. The discounting of all claims (net of reinsurance recoverables) resulted in a decrease in the liability for loss reserves of $245.7 million, $284.7 million and $289.5 million at December 31, 1994, 1993 and 1992, respectively. The discount in 1994 was reduced by $27.3 million plus discount amortization of $11.7 million, resulting in a reduction in pre-tax income of $39.0 million. The discount in 1993 was increased by $7.9 million, which was more than offset by discount amortization resulting in a decrease in pre-tax income of $4.8 million. The discount in 1992 was increased by $54.1 million which was partially offset by discount amortization, resulting in an increase in pre-tax income of $45.7 million.\nThe liability for loss reserves includes provisions for inflation in several ways, depending on how the reserve is established. An explicit provision for inflation is used where estimates of ultimate loss are based on pricing. A\nprovision for inflation is also included for certain discounted workers' compensation claims. In these cases, the provision for inflation is based on factors supplied by the respective workers' compensation rating bureaus which have jurisdiction for states which provide for cost-of-living increases in indemnity benefits. In other reserves, the analysis reflects the effect of inflationary trends as part of the overall effect on claim costs, as well as changes in marketing, underwriting, reporting and processing systems, claims settlement and coverages purchased.\nIncluded in the liability for loss reserves at December 31, 1994 are $182.2 million ($130.1 million net of reinsurance recoverables) of loss reserves pertaining to asbestos-related and environmental pollution claims. The following table presents information relating to the liability for unpaid claims and related expenses pertaining to asbestos-related and environmental pollution claims (such information is for the years 1994 and 1993 only as certain 1992 information is not available):\nIncluded in the December 31, 1994 net liability for unpaid claims and related expenses for asbestos-related and environmental pollution claims are $36.5 million of loss costs for claims incurred but not reported, $49.4 million of loss costs for reported claims and $44.2 million of related expenses. The Company continues to receive claims asserting injuries from hazardous materials and alleged damages to cover various clean-up costs. Asbestos-related and environmental pollution claims primarily result from the Company's general liability and multiple peril lines of business. Loss and loss expense reserves for asbestos-related and environmental pollution claims are established using standard actuarial techniques as well as management's judgment. Coverage and claim settlement issues, related to policies written in prior years, such as the determination that coverage exists and the definition of an occurrence, may cause the actual loss development for asbestos-related and environmental pollution claims to exhibit more variation than the remainder of the Company's book of business.\nThe Company's net paid losses and related expenses for asbestos-related and environmental pollution claims have not been material in relation to the\nCompany's total net paid losses and related expenses. Net paid losses and related expenses relating to these claims were $20.2 million (including $7.9 million of related expenses), $24.8 million (including $8.1 million of related expenses) and $16.1 million (including $6.2 million of related expenses) for the years ended December 31, 1994, 1993 and 1992, respectively. Related expenses consist primarily of legal costs. Total payments for all property and casualty insurance policy claims and related expenses were $1.1 billion, $1.0 billion and $961.1 million for the years ended December 31, 1994, 1993 and 1992, respectively. The following table presents information related to the number of insureds with asbestos-related and environmental pollution claims outstanding:\nThe average net paid loss per insured for asbestos-related and environmental pollution claims was $34,200 and $28,200 for the years 1994 and 1993, respectively. As of December 31, 1994, the Company was involved in approximately 45 coverage disputes (where a motion for declaratory judgment had been filed, the resolution of which will require a judicial interpretation of an insurance policy) related to asbestos or environmental pollution claims. The Company is not aware of any pending litigation or pending claim which will result in significant contingent liabilities in these areas. The Company believes it has made reasonable provisions for these claims, although the ultimate liability may be more or less than such reserves. The Company believes that future losses associated with these claims will not have a material adverse effect on its financial position, although there is no assurance that such losses will not materially affect the Company's results of operations for any period.\nAlthough the Company believes, in light of present facts and current legal interpretations, that the overall loss reserves of the Reliance Property and Casualty Companies are adequate to meet their obligations under existing policies, due to the inherent uncertainty and complexity of the reserving process, the ultimate liability may be more or less than such reserves.\nPORTFOLIO INVESTMENTS\nInvestment activities are an integral part of the business of the Reliance Insurance Group. The Reliance Insurance Group believes that the investment objectives of safety and liquidity, while seeking the best available return, can be achieved by active portfolio management and intensive monitoring of\ninvestments. Reference is made to 'Financial Review--Investment Portfolio' on page 30 of the Company's 1994 Annual Report, which section is incorporated herein by reference, and Note 2 to the Consolidated Financial Statements.\nAt December 31, 1994, the Company's investment portfolio was $3.8 billion (at cost) with 87.4% in fixed maturities and short-term securities (including redeemable preferred stock) and 12.6% in equity securities, approximately half of which were convertible preferred stock. The following table details the distribution of the Company's investments at December 31, 1994:\n------------------ (1) Does not include investment in Zenith National Insurance Corp. which is accounted for by the equity method and which, as of December 31, 1994, had a carrying value of $147.5 million and a market value of $149.6 million. See '--Investee Company.' (2) In the Company's Consolidated Financial Statements, mortgage loans are included in other accounts and notes receivable.\nThe Company seeks to maintain a diversified and balanced fixed maturity portfolio representing a broad spectrum of industries and types of securities. The Company holds virtually no investments in commercial real estate mortgages and has no exposure to derivative securities (other than through its ownership of any option, warrant or convertible security with an exercise or conversion price related to an equity security). Purchases of fixed maturity securities are researched individually based on in-depth analysis and objective predetermined investment criteria and are managed to achieve a proper balance of safety, liquidity and investment yields. The\nReliance Insurance Group primarily invests in investment grade securities (those rated 'BBB' or better by S&P), and, to a lesser extent, non-investment grade and non-rated securities.\nAt December 31, 1994, the aggregate carrying value and market value of fixed maturities (other than short-term investments and cash) that either have been rated by S&P in the following categories or are non-rated were as follows:\nSubstantially all of the non-investment grade fixed maturities are classified as 'available for sale' and, accordingly, are carried at quoted market value. All publicly traded investment grade securities are priced using the Merrill Lynch Matrix Pricing model, which model is one of the standard methods of pricing such securities in the industry. All publicly traded non-investment grade securities, except as indicated below, are priced from broker-dealers who make markets in these and other similar securities. For fixed maturities not publicly traded, prices are estimated based on values obtained from independent third parties or quoted market prices of comparable instruments. Upon sale, such prices may not be realized when the size of a particular investment in an issue is significant in relation to the total size of such issue. Non-investment grade securities that are thinly traded are priced using internally developed calculations. Such securities represent less than 1% of the Reliance Insurance Group's fixed maturities portfolio.\nEquity investments are made after in-depth analysis of individual companies' fundamentals by the Reliance Insurance Group's staff of investment professionals. They seek to identify equities of large capitalization companies with strong growth prospects and equities that appear to be undervalued relative to the issuer's business fundamentals, such as earnings, cash flows, balance sheet and future prospects. Subsequent to purchase, the business fundamentals of each equity investment are carefully monitored.\nAs of March 15, 1995, the Reliance Insurance Group owned 3,568,634 shares of common stock of Symbol Technologies, Inc. ('Symbol'), representing 13.9% of the then outstanding common stock of Symbol. Symbol is the nation's largest manufacturer of bar code-based data capture systems. As of March 15, 1995, the market value of the Reliance Insurance Group's investment in Symbol was $105,274,703 (based upon the closing price on such date as reported by the NYSE), with a cost basis of $26,890,000.\nAt December 31, 1994, the Company's real estate holdings had a carrying value of $289.5 million, which includes 11 shopping centers with an aggregate carrying value of $138.0 million, office buildings and other commercial properties with an aggregate carrying value of $90.7 million, and undeveloped land with a carrying value of $60.8 million.\nThe following table presents the investment results of the Reliance\nInsurance Group's investment portfolio for each of the years ended December 31, 1994, 1993, and 1992:\n------------------ (1) The average is computed by dividing the total market value of investments at the beginning of the period plus the individual quarter-end balances by five for the years ended December 31, 1994, 1993 and 1992. (2) Does not include investment in Zenith National Insurance Corp. See '--Investee Company.' (3) The impact on the overall rate of return of a one percent increase or decrease in the December 31, 1994 fixed maturity portfolio market value would be approximately 0.77%.\nThe carrying value and market value at December 31, 1994 of fixed maturities for which interest is payable on a deferred basis was $114.0 million.\nINVESTEE COMPANY\nAs of March 15, 1995, the Reliance Insurance Group owned 6,574,445 shares of common stock of Zenith National Insurance Corp. ('Zenith'), representing 34.7% of the outstanding common stock of Zenith, a California-based insurance company with significant workers' compensation and standard commercial and personal lines business. As of March 15, 1995 the market value of the Reliance Insurance Group's investment in Zenith was $129,023,483 (based upon the closing price on such date as reported by the NYSE), with a carrying value of $147,513,000.\nThe board of directors of Zenith includes certain executive officers of the Company. The Company's investment in Zenith is accounted for by the equity method. See Note 3 to the Consolidated Financial Statements.\nREGULATION\nThe businesses of the Reliance Insurance Group, in common with those of other insurance companies, are subject to comprehensive, detailed regulation in the jurisdictions in which they do business. Such regulation is primarily for the protection of policyholders rather than for the benefit of investors. Although their scope varies from place to place, insurance laws in general grant broad powers to supervisory agencies or officials to examine companies and to enforce rules or exercise discretion touching almost every significant aspect of the conduct of the insurance business. These include the licensing of companies and agents to transact business, the imposition of monetary penalties for rules violations, varying degrees of control over premium rates (particularly for property and casualty companies), the forms of policies offered to customers, financial statements, periodic reporting, permissible investments and adherence to financial standards relating to surplus, dividends and other criteria of solvency intended to assure the satisfaction of obligations to policyholders. Other legislation obliges the Reliance Property and Casualty Companies to offer policies or assume risks in various markets which they would not seek if they were acting solely in their own interest. While such regulation and legislation is sometimes burdensome, inasmuch as all insurance companies similarly situated are subject to such controls, the Company does not believe that the competitive position of the Reliance Insurance Group is adversely affected.\nState holding company acts also regulate changes of control in insurance holding companies and transactions and dividends between an insurance company and its parent or affiliates. Although the specific provisions vary, the holding company acts generally prohibit a person from acquiring a controlling interest in an insurer incorporated in the state promulgating the act or in any other controlling person of such insurer unless the insurance authority has approved the proposed acquisition in accordance with the applicable regulations. In many states, including Pennsylvania, where Reliance Insurance Company is domiciled, 'control' is presumed to exist if 10% or more of the voting securities of the insurer are owned or controlled by a party, although the insurance authority may find that 'control' in fact does or does not exist where a person owns or controls either a lesser or a greater amount of securities. The holding company acts also impose standards on certain transactions with related companies, which generally include, among other requirements, that all transactions be fair and\nreasonable and that certain types of transactions receive prior regulatory approval either in all instances or when certain regulatory thresholds have been exceeded.\nOther states, in addition to an insurance company's state of domicile, may regulate affiliated transactions and the acquisition of control of licensed insurers. The State of California, for example, presently treats certain insurance subsidiaries of the Company which are not domiciled in California as though they were domestic insurers for insurance holding company purposes and such subsidiaries are required to comply with the holding company provisions of the California Insurance Code, certain of which provisions are more restrictive than the comparable laws of the states of domicile of such subsidiaries.\nThe Insurance Law of Pennsylvania, where Reliance Insurance Company is domiciled, limits the maximum amount of dividends which may be paid without approval by the Pennsylvania Insurance Department. Under such law, Reliance Insurance Company may pay dividends during the year equal to the greater of (a) 10% of the preceding year-end policyholders' surplus or (b) the preceding year's statutory net income, but in no event to exceed the amount of unassigned funds, which are defined as 'undistributed, accumulated surplus including net income and unrealized gains since the organization of the insurer.' In addition, the Pennsylvania law specifies factors to be considered by the Pennsylvania Insurance Department to allow it to determine that statutory surplus after the payment of dividends is reasonable in relation to an insurance company's outstanding liabilities and adequate for its financial needs. Such factors include the size of the company, the extent to which its business is diversified among several lines of insurance, the number and size of risks insured, the nature and extent of the company's reinsurance, and the adequacy of the company's reserves. The maximum dividend permitted by law is not indicative of an insurer's actual ability to pay dividends, which may be constrained by business and regulatory considerations, such as the impact of dividends on surplus, which could affect an insurer's ratings, competitive position, the amount of premiums that can be written and the ability to pay future dividends. Furthermore, the Pennsylvania Insurance Department has broad discretion to limit the payment of dividends by insurance companies.\nIn addition, under California Insurance law, Reliance Insurance Company is deemed to be a 'commercially domiciled' California insurer and therefore subject to the dividend payment laws of California. The California\nlaws that limit the maximum amount of dividends which may be paid without approval by the California Insurance Department and specify the factors to be considered by the California Insurance Department to determine if the payment of the dividend is reasonable in relation to an insurance company's outstanding liabilities and financial needs are substantially the same as the laws of Pennsylvania. As in Pennsylvania, the California Insurance Department has broad discretion to limit the payment of dividends by insurance companies.\nTotal common and preferred stock dividends paid by Reliance Insurance Company during 1994, 1993 and 1992 were, $114.1 million ($111.5 million for common stock), $133.7 million ($130.6 million for common stock) and $143.7 million ($140.4 million for common stock), respectively. During 1995, $124.5\nmillion would be available for dividend payments by Reliance Insurance Company under Pennsylvania and California law. The Company believes such amount will be sufficient to meet its cash needs.\nThere is no assurance that Reliance Insurance Company will meet the tests in effect from time to time under Pennsylvania or California law for the payment of dividends without prior Insurance Department approvals or that any requested approvals will be obtained. However, Reliance Insurance Company has been advised by the California Insurance Department that any required prior approval will be based on the financial stability of the Company. Reliance Insurance Company has also been advised by the Pennsylvania Insurance Department that any required prior approval will be based upon a solvency standard and will not be unreasonably withheld. Any significant limitation of Reliance Insurance Company's dividends would adversely affect the Company's ability to service its debt and to pay dividends on its Common Stock.\nThe National Association of Insurance Commissioners (the 'NAIC') has adopted a 'risk-based capital' requirement for the property and casualty insurance industry which became effective in 1995 based on annual statements as of December 31, 1994. 'Risk-based capital' refers to the determination of the amount of statutory capital required for an insurer based on the risks assumed by the insurer (including, for example, investment risks, credit risks relating to reinsurance recoverables and underwriting risks) rather than just the amount of net premiums written by the insurer. A formula that applies prescribed factors to the various risk elements in an insurer's business is used to determine the minimum statutory capital requirement for the insurer. An insurer having less statutory capital than the formula calculates would be subject to varying degrees of regulatory intervention, depending on the level of capital inadequacy. All of the Company's statutory insurance companies have policyholders' surplus in excess of the minimum required risk-based capital. Management cannot predict the ultimate impact of risk-based capital requirements on the Company's competitive position.\nMaintaining appropriate levels of statutory surplus is considered important by the Company's management, state insurance regulatory authorities, and the agencies that rate insurers' claims-paying abilities and financial strength. Failure to maintain certain levels of statutory capital and surplus could result in increased scrutiny or, in some cases, action taken by state regulatory authorities and\/or downgrades in an insurer's ratings.\nThe Company's principal property and casualty insurance subsidiary, Reliance Insurance Company, has operated outside of the NAIC financial ratio range concerning liabilities to liquid assets (the 'NAIC liquidity test'). This ratio is intended only as a guideline for an insurance company to follow. The Company believes that it has sufficient marketable assets on hand to make timely payment of claims and other operating requirements.\nOn November 8, 1988, voters in California approved Proposition 103, which requires a rollback of rates for property and casualty insurance policies issued or renewed after November 8, 1988 of 20% from November 1987 levels and freezes rates at such lower levels until November 1989. Proposition 103 also requires that subsequent rate changes be justified to, and approved by, an elected\ninsurance commissioner.\nIn 1989, the California Department of Insurance directed to United Pacific Insurance Company, one of the Company's California subsidiaries which writes business in California, a notice to reduce its current rates and make refunds to its policyholders by approximately $10.0 million. In January 1991, the regulations which formed the basis of the notice were repealed by the newly elected Insurance Commissioner. Subsequently, there were several administrative hearings on rate rollback and several different sets of regulations were issued. The regulations were subject to ongoing administrative and legal challenges. In February 1993, a Los Angeles Superior Court issued a decision declaring several sections of the regulations invalid and enjoined the enforcement of the regulations. On August 18, 1994, the California Supreme Court issued a decision reversing the Superior Court and upholding the validity of the regulations issued by the Insurance Commissioner. A\npetition filed with the United States Supreme Court seeking review of the California Supreme Court decision was denied on February 21, 1995. On November 28, 1994, Reliance Insurance Company and several of its affiliates received an order from the outgoing Insurance Commissioner ordering refunds totaling $44.8 million plus interest of $27.5 million. The Company believes that the refund order is based on incomplete and erroneous data. Furthermore, the Company believes that it did not earn a fair rate of return on its California business during the year at issue, 1989. Consequently, it intends to contest the order vigorously. The Company is entitled to a hearing to present evidence to establish what it believes to be an appropriate rollback or refund amount, if any. In the fourth quarter of 1994, the Company recorded a pre-tax charge of $11.6 million related to Proposition 103. While this charge reflects the Company's assessment of the impact of potential refunds to policyholders under Proposition 103, the Company nevertheless intends to contest the imposition of any refund on the basis of the matters set forth above. The Company does not believe that it is probable that it will be subject to a refund in an amount which will have a material adverse effect on the Consolidated Financial Statements.\nFrom time to time, other states have considered adopting legislation or regulations which could adversely affect the manner in which the Company sets rates for policies of insurance, particularly as they relate to personal lines. No assurance can be given as to what effect the adoption of any such legislation or regulation would have on the ability of the Company to raise its rates. However, since the Company is transferring or running off its personal lines business and, as a result, has substantially withdrawn from personal lines, the Company believes that these initiatives will not have a material adverse effect on its on-going business.\nCOMPETITION\nAll of the Company's businesses are highly competitive. The property and casualty insurance business is fragmented and no single company dominates any of the markets in which the Company operates. The Reliance Property and Casualty Companies compete with individual companies and with groups of affiliated\ncompanies with greater financial resources, larger sales forces and more widespread agency and broker relationships. Competition in the property and casualty insurance industry is based primarily on price, product design and service. In addition, because the Reliance Property and Casualty Companies sell policies through independent agents and insurance brokers who are not obligated to choose the policies of the Reliance Property and Casualty Companies over those of another insurer, the Reliance Property and Casualty Companies must compete for agents and brokers and for the business they control. Such competition is based upon price, product design, policyholder service, commissions and service to agents and brokers.\nCommonwealth\/Transamerica Title compete with large national title insurance companies and with smaller, locally established businesses which may possess distinct competitive advantages. Competition in the title insurance business is based primarily on the quality and timeliness of service. In some market areas, abstracts and title opinions issued by attorneys are used as an alternative to title insurance and other services provided by title companies. In addition, certain jurisdictions have title registration systems which can lessen the demand for title insurance.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company and its consolidated subsidiaries own and lease offices in various locations primarily in the United States. None of these properties is material to the Company's business. At December 31, 1994, the Company and its consolidated subsidiaries employed approximately 9,075 persons in approximately 440 offices.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company and its subsidiaries are involved in certain litigation arising in the course of their businesses, some of which involve claims of substantial amounts. Although the ultimate outcome of these matters cannot be ascertained at this time, and the results of legal proceedings cannot be predicted with certainty, the Company is contesting the allegations of the complaints in each pending action and believes, based on current knowledge and after consultation with counsel, that the resolution of these matters will not have a material adverse effect on the Consolidated Financial Statements. In addition, the Company is subject to the litigation set forth below.\nIn June 1989, Hall, the predecessor corporation of Prometheus Funding Corp., a subsidiary of the Company ('Prometheus'), entered into a settlement agreement, which is subject to court approval, with the Superintendent of Insurance of the State of New York (the 'Superintendent'), arising out of the insolvency of Union Indemnity Insurance Company of New York, Inc. ('Union Indemnity'). The settlement agreement was submitted to the court for approval in October 1989 and objections were filed by various parties. In March 1994, the Superintendent informed Prometheus that he did not intend to pursue court approval of the settlement until the resolution of appellate proceedings in a pending litigation between the Superintendent and certain of Union Indemnity's\nreinsurers. Prometheus has advised the Superintendent that this position is in breach of the settlement agreement's requirement that the parties diligently make every effort to obtain court approval of the settlement, and Prometheus has reserved all of its rights with respect thereto. There is no assurance that such approval will be obtained. The settlement agreement will not become effective until final approval by the court.\nThirty-one employers doing business in Texas have brought two actions in the District Court of Dallas County, Texas, against, among others, approximately 200 individual insurance companies, including Reliance Insurance Company and several of its subsidiaries. The plaintiffs in the actions, which were commenced against the Reliance parties in April 1992 and February 1995 respectively (and the second of which has been stayed in light of the pendency of the first), assert that they were overcharged for workers' compensation insurance and multiple line retrospectively rated casualty insurance between 1987 and 1992. In August 1994, the plaintiffs in the first action moved for certification of a purported plaintiff class consisting of all employers who purchased Texas workers' compensation insurance from the insurance company defendants during the years in question. Plaintiffs seek monetary damages, with interest and attorneys' fees, against all defendants jointly and severally, together with a release of all purported class members from liability for payment of unlawful premiums, and injunctive relief. The Company has filed answers denying the allegations and is contesting the actions vigorously. The Company does not believe that it is probable that its liability, if any, in excess of what the Company has provided for in respect of this matter will have a material adverse effect on the Consolidated Financial Statements.\nSee Note 16 to the Consolidated Financial Statements for additional information concerning the above referenced legal proceedings affecting the Company and its subsidiaries.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nItem 4 is not required pursuant to the reduced disclosure requirements applicable to this Form 10-K.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAs of March 15, 1995, all 1,000 outstanding shares of Reliance Financial's common stock are held of record by Reliance Group Holdings and are not publicly traded. See the information in 'Market and Dividend Information for Common Stock' on page 32 of the Reliance Financial 1994 Annual Report, which information is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nItem 6 is not required pursuant to the reduced disclosure requirements applicable to this Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nSee the information in 'Reliance Financial Services Corporation and Subsidiaries Financial Review' on pages 27 through 32 of the Reliance Financial 1994 Annual Report, which information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements of the Company and its consolidated subsidiaries, included on pages 1 through 25 of the Reliance Financial 1994 Annual Report, which information is incorporated herein by reference, are listed in Item 14 below.\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, which comprise Part III, are not required pursuant to the reduced disclosure requirements applicable to this Form 10-K.\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) 1. FINANCIAL STATEMENTS.\nThe consolidated financial statements of Reliance Financial Services Corporation and Subsidiaries, which appear on pages 1 through 25 of the Reliance\nFinancial 1994 Annual Report, are incorporated herein by reference.\nPursuant to Rule 1-02(v) of Regulation S-X, Reliance Insurance Group's investment in Zenith National Insurance Corp. meets the definition of a 'significant subsidiary.' Zenith National Insurance Corp. files financial statements with the Securities and Exchange Commission which should be referred to for additional information.\n3. EXHIBITS\n------------------ * Neither Reliance Financial nor its subsidiaries is a party to any instrument relating to long-term debt under which the securities authorized exceed 10% of the total consolidated assets of Reliance Financial and its subsidiaries. Copies of instruments relating to long-term debt of lesser amounts will be provided to the Securities and Exchange Commission upon request.\n------------------ + Schedule P from the statutory reports of Zenith National Insurance Corp., 34.7% of the outstanding common stock of which is owned by the Reliance Insurance Group, is omitted herefrom as such Schedule P is filed directly with the Securities and Exchange Commission.\n** To be filed by Amendment.\n(B) REPORTS ON FORM 8-K\nDuring the last quarter of the period for which this report is filed, the Company filed a Report on Form 8-K, dated (date of earliest event reported) November 28, 1994, reporting an Item 5 matter regarding an order of the insurance commissioner of California.\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 30TH DAY OF MARCH, 1995.\nRELIANCE FINANCIAL SERVICES COPORPORATION\nBy: SAUL P. STEINBERG ---------------------------------- SAUL P. STEINBERG\nCHAIRMAN 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.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholder Reliance Financial Services Corporation New York, New York\nWe have audited the consolidated financial statements of Reliance Financial Services Corporation (a subsidiary of Reliance Group Holdings, Inc.) and subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 22, 1995 (which report includes an explanatory paragraph concerning the adoption of Statement of Financial Accounting Standards No. 109); such financial statements and report are included in your 1994 Annual Report and are incorporated herein by reference. Our audits also included the financial statement schedules of Reliance Financial Services Corporation, 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.\n\/s\/ DELOITTE & TOUCHE LLP New York, New York February 22, 1995\nA-1\nSCHEDULE I ITEM 14(A)2 RELIANCE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1994\n(1) In the consolidated financial statements, mortgage loans are included in other accounts and notes receivable.\nA-2\nSCHEDULE II ITEM 14(A)2 RELIANCE FINANCIAL SERVICES CORPORATION (PARENT COMPANY)\nSTATEMENT OF INCOME\nA-3\nSCHEDULE II ITEM 14(A)2 RELIANCE FINANCIAL SERVICES CORPORATION (PARENT COMPANY)\nBALANCE SHEET\nA-4\nSCHEDULE II ITEM 14(A)2 RELIANCE FINANCIAL SERVICES CORPORATION (PARENT COMPANY)\nSTATEMENT OF CASH FLOWS\nSUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:\nIn 1994 and 1993, non-cash dividends of $24,813,000 and $99,936,000 were recorded as a reduction in notes receivable from parent company.\nA-5\nSCHEDULE III ITEM 14(A)2 RELIANCE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES\nSUPPLEMENTARY INSURANCE INFORMATION\nA-6\nSCHEDULE IV ITEM 14(A)2 RELIANCE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES REINSURANCE\nA-7\nSCHEDULE VI ITEM 14(A)2\nRELIANCE FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES SUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS\n(a) Liabilities for unpaid claims and related expenses for short-duration contracts which are expected to have fixed, periodic payment patterns are discounted to present values using statutory annual rates ranging from 3 1\/2% to 6% in 1994 and 3% to 6% in 1993 and 1992.\nA-8\nEXHIBITS TO FORM 10-K\nANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED COMMISSION FILE NUMBER DECEMBER 31, 1994 1-7080\nRELIANCE FINANCIAL SERVICES CORPORATION (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)\nRELIANCE FINANCIAL SERVICES CORPORATION EXHIBIT INDEX\n------------------ * Neither Reliance Financial nor its subsidiaries is a party to any instrument relating to long-term debt under which the securities authorized exceed 10%\nof the total consolidated assets of Reliance Financial and its subsidiaries. Copies of instruments relating to long-term debt of lesser amounts will be provided to the Securities and Exchange Commission upon request.\n------------------ + Schedule P from the statutory reports of Zenith National Insurance Corp., 34.7% of the outstanding common stock of which is owned by the Reliance Insurance Group, is omitted herefrom as such Schedule P is filed directly with the Securities and Exchange Commission. ** To be filed by Amendment.","section_15":""}
{"filename":"714560_1994.txt","cik":"714560","year":"1994","section_1":"Item 1. Business\nUSAir Group, Inc. (\"USAir Group\" or the \"Company\") is a corporation organized under the laws of the State of Delaware. The Company's executive offices are located at 2345 Crystal Drive, Arlington, Virginia 22227 (telephone number (703) 418-5306). USAir Group's primary business activity is ownership of all the common stock of USAir, Inc. (\"USAir\"), Allegheny Airlines, Inc. (which was formerly Pennsylvania Commuter Airlines, Inc.) (\"Allegheny\"), Piedmont Airlines, Inc. (\"Piedmont\") (formerly Henson Aviation, Inc.), Jetstream International Airlines, Inc. (\"Jetstream\"), USAir Fuel Corporation (\"USAir Fuel\"), USAir Leasing and Services, Inc. (\"USAir Leasing and Services\") and Material Services Company, Inc. In May 1987, the Company acquired Pacific Southwest Airlines, which merged into USAir on April 9, 1988. In November 1987, the Company completed its acquisition of Piedmont Aviation, Inc., which merged into USAir on August 5, 1989. On July 15, 1992, the Company sold three wholly-owned subsidiaries, Piedmont Aviation Services, Inc., Air Service, Inc. and Aviation Supply Corporation. The former subsidiaries were engaged in fixed base operations and the sale and repair of aircraft and aircraft components. During the third quarter of 1992, the Company merged one wholly-owned subsidiary, Allegheny Commuter Airlines, Inc., into another, Pennsylvania Commuter Airlines, Inc. (now Allegheny Airlines, Inc.).\nUSAir, a certificated air carrier engaged primarily in the business of transporting passengers, property and mail, is the Company's principal operating subsidiary, accounting for approxi- mately 93% of USAir Group's operating revenues in 1994. USAir is one of nine passenger carriers classified as \"major\" airlines (those with annual revenues greater than $1 billion) by the U.S. Department of Transportation (\"DOT\"). USAir enplaned more than 59.8 million passengers in 1994, and is the sixth largest United States air carrier ranked by revenue passenger miles (\"RPMs\") flown.\nAt January 4, 1995, USAir provided regularly scheduled jet service through 119 airports to more than 152 cities in the continental United States, Canada, the Bahamas, Bermuda, the Cayman Islands, Jamaica, Puerto Rico, Germany, France, Mexico and the Virgin Islands. USAir ceased scheduled service to the United Kingdom in January 1994. See \"British Airways Investment Agree- ment\" below. USAir's executive offices are located at 2345 Crystal Drive, Arlington, Virginia 22227 (telephone number (703) 418-7000), and its primary connecting hubs are located at the Pittsburgh, Charlotte\/Douglas, Philadelphia and Baltimore\/Washington Interna- tional (\"BWI\") Airports. As discussed below in \"Significant Impact of Low Cost, Low Fare Competition,\" a substantial portion of USAir's RPMs is flown within or to and from the eastern United States.\nUSAir Group and USAir have incurred substantial operating and net losses since 1989. As discussed in greater detail below, USAir is actively seeking to reduce its annual operating costs by $1 billion through a combination of labor and other cost reductions.\nUSAir began negotiating with the unions representing certain of its employees in March 1994. As described below in \"Agreement in Principle with Pilots Union,\" USAir signed an agreement in principle on March 29, 1995 with the negotiating committee of the Air Line Pilots Association (\"ALPA\") Master Executive Council for substantial concessions. ALPA represents USAir's pilots and the Master Executive Council is ALPA's governing body. This agreement in principle is subject to many significant conditions, as described below. It is uncertain whether USAir will be successful in reaching agreements with its other unions and whether or when any transactions with any of the unions will be consummated. As discussed below in \"Major Airline Operations,\" in March 1995, USAir announced that it would cut capacity throughout its system by five percent by July 1995 as part of its efforts to forge a profitable airline built on the strengths of its hubs and other major east coast urban centers. In addition, the Company is evaluating and considering the risks associated with various strategic options, including further downsizing.\nThe Company ended the first quarter of 1995 with approximately $400 million in cash and short-term investments, substantially higher than previously expected primarily due to the timing of certain working capital activity. However, market, economic and other factors discussed below could adversely affect the Company's future liquidity position. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nAgreement in Principle with Pilots' Union\nOn March 29, 1995, USAir and the negotiating committee of the ALPA Master Executive Council signed an agreement in principle on wage and other concessions in exchange for financial returns and governance participation for USAir's organized labor groups and other employees. The agreement in principle is subject to many significant conditions, including, without limitation, approval by the USAir pilot Master Executive Council, ratification by the pilots, negotiation and ratification of acceptable agreements between USAir and its three other organized labor groups, either the restructuring of the terms of USAir Group's publicly held $437.50 Series B Cumulative Convertible Preferred Stock, without par value (the \"Series B Preferred Stock\"), or the continued deferral of dividends on this stock, approval of the boards of directors of the Company and USAir and of the shareholders of the Company and the execution of definitive documentation.\nThe board of directors of USAir Group (the \"Board\") held a special meeting on April 5, 1995 to review the agreement in principle with ALPA. It did not take any action with respect to the proposed agreement. The Company plans to hold one or more additional special Board meetings to consider developments in USAir's ongoing negotiations with its unions and to analyze and consider further the agreement in principle or any other agreement reached with ALPA and any other agreements that may be reached with USAir's other labor unions. Various parties who would be affected\nby the agreement in principle have expressed their unwillingness to accept, or reservations about, certain terms of the tentative agreement currently under discussion. Negotiations with respect to this agreement are continuing. In addition, USAir continues to negotiate with representatives of its other unions, but it is uncertain whether any agreements will be reached.\nNo assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. If a transaction with one or more unions is consummated, it would affect materially the disclosure contained herein. The terms of any proposed transaction would be described in a proxy statement to the Company's stockholders.\nSignificant Impact of Low Cost, Low Fare Competition\nMost of USAir's operations are in competitive markets. USAir and its regional affiliates experience competition in varying degrees with other air carriers and with all forms of surface transportation. USAir competes with at least one major airline on most of its routes between major cities. Vigorous price competi- tion exists in the airline industry, and competitors have frequent- ly offered sharply reduced discount fares in many of these markets. Airlines use discount fares and other promotions to stimulate traffic during normally slack travel periods, to generate cash flow and to increase relative market share in selected markets. Discount and promotional fares are often subject to various restrictions such as minimum stay requirements, advance ticketing, limited seating and refund penalties. USAir has often elected to match those discount or promotional fares. To the extent that low fares continue and their depressive effect on revenues is not offset by stimulation of additional traffic or by reduced costs, USAir's and the Company's earnings and liquidity will continue to be materially and adversely affected.\nThe dramatic expansion of low fare competitive service in many of USAir's markets in the eastern U.S. during 1994 and USAir's competitive response of reducing its fares up to 70% in certain affected primary and secondary markets in order to preserve its market share contributed to greater losses in 1994 than in 1993. The growth of the operations of low cost, low fare carriers in USAir's markets in the eastern U.S. continues to represent an intense competitive challenge for USAir, which has higher operating costs than its competitors. USAir believes that it must reduce its operating costs substantially if it is to survive in this low fare competitive environment.\nIn September 1993, Southwest Airlines, Inc. (\"Southwest\"), a low cost, low fare, \"no frills\" air carrier which had not previous- ly provided service to or in the eastern U.S., inaugurated service to Chicago and Cleveland from BWI at fares substantially below those previously offered by USAir and other airlines in the same markets. BWI is one of USAir's hub airports. USAir responded by matching most of Southwest's fares and increasing the frequency of service in related markets. In late spring and early summer 1994,\nSouthwest expanded service between BWI and Chicago and initiated its low fare service between BWI and St. Louis and between BWI and Birmingham, Alabama and Louisville, Kentucky. In response, USAir matched most of Southwest's reduced prices where significant traffic diversion was expected.\nUSAir believes that Southwest and other low cost carriers with a significant cost advantage over USAir likely will expand their operations to additional markets. For example, in December 1993, Southwest completed its acquisition of Morris Air, a regional air carrier with operations concentrated in the western U.S. This acquisition will enable Southwest to divert resources to expand its operations in the eastern U.S. Furthermore, in June 1994, Southwest entered into a long-term agreement for the use of four additional gates at BWI, where it currently operates from two gates. Southwest will likely commence its use of those gates in the third quarter of 1995. In addition, Southwest has reportedly ordered approximately 25 airplanes scheduled for delivery in 1995. Southwest could deploy those aircraft in markets served by USAir. Finally, as discussed below, Southwest recently reached an agreement with its pilots that provides for no wage increases for five years. USAir views Southwest, which has one of the lowest cost structures in the industry, as a serious competitive threat. Any escalation by Southwest of low fare competition in USAir's markets could have a material and adverse effect on USAir's revenues, cash flow and liquidity.\nIn October 1993, Continental Airlines (\"Continental\"), which had reorganized under bankruptcy proceedings earlier in 1993, inaugurated low fare service on certain routes in the eastern U.S. USAir is a competitor in most of the markets served by these routes. Continental's operating costs are substantially lower than those of USAir. Under its new program, Continental linked certain cities independently of its hubs while continuing to provide many of the same services that are available on its hub flights, including advance seat assignment, frequent traveler mileage credits and interline connections. At that time, USAir made a measured response by matching most of the low fares offered by Continental where the carriers were directly competitive.\nDuring 1994, Continental increased its competitive threat by substantially expanding the low fare program in additional markets also served by USAir. In February 1994, to avoid a loss of market share in the eastern U.S., USAir began to substantially lower its fares in primary and secondary markets affected by the expansion of Continental's low cost, low fare service branded \"Continental Lite.\" In late June 1994, Continental again expanded its service in the eastern U.S. after reducing its Denver, Colorado operation. By July 1994, markets from which USAir had historically generated approximately 40% of its passenger revenue had the reduced fares in place, reflecting fare reductions in certain markets of up to 70% from previous levels. In September 1994, Continental escalated competition by further reducing service at its Denver hub and establishing a flight crew base at Greensboro, North Carolina. These measures enabled Continental to expand further its high\nfrequency, low fare service described above in additional short- haul markets served by USAir. By late 1994, USAir competed with Continental in primary and secondary markets from which USAir then generated approximately 46% of its passenger revenue. Continental could continue to redeploy its assets and offer other low fare service in additional markets served by USAir, although, as discussed below, Continental has recently begun to reduce its Continental Lite service. See \"Industry Restructuring.\"\nIn addition, other low cost carriers may enter other USAir markets. For example, America West Airlines (\"America West\") commenced service in April 1994 between Columbus, Ohio, where it operates a hub, and Philadelphia, where USAir has a hub operation. Other carriers, including some of the larger carriers, have also developed or indicated their intent to develop similar low fare short-haul service, such as United Air Lines' (\"United\") low cost, low fare operation in the western United States discussed below. New low cost airlines, including but not limited to ValuJet Airlines (\"ValuJet\"), Carnival Air Lines, Inc. (\"Carnival\"), Kiwi International Air Lines, Inc. (\"Kiwi\"), Air South, Inc. (\"Air South\"), Eastwind Airlines (\"Eastwind\") and Nations Air Express (\"Nations Air\") have initiated or announced plans to initiate service in some of USAir's markets. Nations Air initiated service between Philadelphia and both Boston and Pittsburgh in March 1995 at fares substantially below those previously offered by USAir in those markets. USAir immediately matched the fares offered by Nations Air. Eastwind has indicated its intention to fly initially from Trenton, New Jersey to Boston and thereafter possibly to add service to Washington, D.C., Pittsburgh, Chicago and Florida.\nBy the end of February 1995, fare levels within the primary and secondary Continental Lite market network had increased from their dramatically lower levels in 1994. However, USAir, which suffered a 9.6% decline in yield (passenger revenue per RPM) in 1994 from 1993, does not expect yields to return to their mid-1993 levels. While USAir believes it has benefitted from some of Continental's and other airlines' schedule reductions discussed below in \"Industry Restructuring,\" these carriers continue to represent competitive threats to USAir. USAir does not believe that there has been a change in the public demand for generally lower air fares. Regardless of recent capacity and fare changes in the east coast markets, improved financial performance at USAir will depend largely on whether its efforts to cut costs, as described below, are successful.\nFactors beyond the Company's control, such as a downturn in the economy, a dramatic increase in fuel prices or intensified industry fare wars, could have a material adverse effect on the Company's and USAir's prospects, liquidity and financial condition. Because the Company and USAir are highly leveraged and currently do not have access to bank credit and receivables facilities which had supplied a substantial portion of their liquidity, or to public debt and equity markets because of their financial condition and current financial outlook, they are more vulnerable to these factors than are financially stronger competitors. In addition,\ndespite the fact that a recent independent audit concluded that USAir is being operated safely and in compliance with regulations of the Federal Aviation Administration (the \"FAA\"), due to the two aircraft accidents involving USAir in 1994 and the negative publicity associated with these accidents, USAir may be particu- larly susceptible to adverse passenger reactions should any other aircraft accident or incident involving USAir occur in the future. See \"Major Airline Operations\" for a discussion of the safety audit and the Company's other recent safety initiatives. USAir is currently engaged in discussions to arrange a replacement receiv- ables facility. There can be no assurance that USAir will be successful in reaching a new agreement to sell its receivables. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nIndustry Restructuring\nMajor carriers that compete with USAir have implemented, or are in the process of implementing, measures to reduce their operating costs. For example, United has substantially reduced its personnel costs as part of a recapitalization transaction completed in July 1994. The resulting lower operating costs will give United a competitive advantage over carriers with higher costs. United initiated its low cost, low fare operation in the western U.S. in October 1994. As described below under \"Major Airline Operations,\" USAir reduced its service between San Francisco and Los Angeles in November 1994 and plans to close its crew base in San Francisco in the first half of 1995. United could initiate additional low cost, low fare service in other markets served by USAir. Delta Air Lines, Inc. (\"Delta\") is currently engaged in a restructuring initiative announced in April 1994 that is intended to reduce substantially its operating costs through measures which include the elimination of up to 15,000 positions, or approximately 20% of its work force. Delta is currently in discussions with certain of its employees regarding concessions. American Airlines (\"Ameri- can\") has announced a restructuring of its non-union workforce and that it is seeking $750 million in concessions and productivity gains from its unionized workers. Trans World Airlines, Inc. (\"TWA\") has negotiated productivity improvements with its unionized employees and has proposed a restructuring transaction in which, among other things, certain creditors would swap debt for equity. As discussed below, Continental announced plans in January 1995 to eliminate up to 4,000 jobs. In January 1995, Southwest announced that its pilots had ratified a 10-year labor contract that provides for no wage increases in the first five years, providing for grants of stock options to the pilots instead. USAir expects that the implementation of this labor contract will further enhance Southwest's low cost advantage over USAir and other carriers. The announcements by Delta, American, TWA, Continental and Southwest illustrate the trend among the major U.S. airlines to restructure in order to reduce their operating costs and enable them to compete in a low fare environment. See \"Major Airline Operations\" below for a discussion of USAir's cost reduction initiatives.\nIn its negotiations with its unions, USAir has offered an ownership stake in the Company. There are recent examples of companies in the airline industry which have obtained employee concessions in agreements also resulting in the recapitalization of the companies, including employee ownership stakes and employee participation in corporate governance. Most recently, in July 1994, UAL Corporation, parent of United, consummated a recapital- ization which resulted in majority ownership and board membership for certain employee groups in exchange for concessions. In other cases, airlines have filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code, and some airlines have ceased operation altogether when their operating costs remained excessive in relation to their revenues, and their liquidity became insufficient to sustain their operations.\nIn early 1995, various carriers announced planned cutbacks in service in the eastern U.S. The \"intra-east coast\" area represents 67% of USAir's departures and slightly greater than half of its seat capacity. In March 1995, USAir announced that it will cut capacity throughout its system by five percent by July 1995. See \"Major Airline Operations.\" In January 1995, Continental announced plans to reduce capacity by at least 10% and to eliminate 4,000 jobs nationwide as part of an effort to eliminate unprofitable routes. Continental began cutting many of its Continental Lite flights and stated that it intends to reduce Continental Lite capacity by 40% by late summer 1995. Continental also announced plans to delay or reschedule deliveries of jets from The Boeing Company (\"Boeing\"). American has reduced its operations at Raleigh\/Durham (\"RDU\"). In January 1995, American and Chicago- based Midway Airlines (\"Midway\") announced that American agreed to lease seven airport gates at RDU to Midway. Midway stated that it plans to move its operations headquarters to RDU and to operate at least 60 flights from there by the end of the year. Northwest Airlines, Inc. (\"Northwest\") has significantly reduced its activi- ties in Washington, D.C. and Boston. By May 1995, TWA's daily departures in the intra-east coast area will have decreased by almost 75% from their peak in March 1994. United, which drastical- ly cut the number of its daily departures in the intra-east coast area from January 1993 to May 1994, has announced plans for further reductions of almost 40% by May 1995. The result of these cutbacks is that the older, established carriers will have decreased service in the area by approximately 14% from May 1994 to May 1995. However, several smaller carriers, including but not limited to ValuJet, Carnival, Kiwi, Air South, Eastwind and Nations Air, have increased the number of departures in this region during the same time period or have announced plans to introduce or increase service in this region.\nIn April 1994, Delta and Virgin Atlantic Airways (\"Virgin Atlantic\") announced that they had reached a code share marketing agreement that would enable Delta to feed traffic to Virgin Atlantic for travel between the U.S. and Heathrow Airport in London. This arrangement was approved by the U.K. government in 1994 and by the DOT in February 1995. The Company believes that the Delta\/Virgin Atlantic arrangement will compete with the code\nshare service discussed below in \"British Airways Investment Agreement - Code Sharing\" offered by USAir and British Airways Plc (\"BA\") between certain U.S. cities and London. United and Lufthansa German Airlines (\"Lufthansa\") have implemented a code share arrangement which includes transatlantic service from certain U.S. cities to Europe and beyond. United and Lufthansa implemented the first phase of their service in June 1994. The resulting impact of these code share arrangements on the Company's results of operations and financial condition cannot be predicted at this time, but is not expected to be material.\nIn February 1995, several major carriers, including Delta, American, Northwest, United, TWA and USAir, imposed limits on the commissions they pay travel agents for domestic air fares. Formerly, most major airlines paid a fixed commission of approxi- mately 10% on the price of a ticket for the distribution of all domestic tickets. The new cap limits commission payments to $50 for a round-trip domestic ticket with a base fare above $500 and $25 for a one-way domestic ticket with a base fare above $250. The new limits on commissions are designed to reduce one of airlines' largest expenses. USAir believes that it will experience cost savings through its implementation of a limit on the commissions it pays travel agents for domestic air fares. As a result of the new limits on commissions, some travel agents have announced plans to charge some customers a fee for writing tickets. Other travel agents have filed lawsuits against the airlines that imposed commission caps, including USAir, claiming that the airlines violated antitrust laws. See Item 3. \"Legal Proceedings.\"\nVarious U.S. carriers have begun to implement electronic ticketing or \"paperless travel\" in an attempt to cut their operating costs and to increase travelers' convenience. Elec- tronic ticketing eliminates the need to issue a paper ticket to the passenger. USAir is evaluating electronic ticketing alternatives and hopes to offer this product later in 1995. Electronic ticketing is expected to reduce airline distribution costs, but at this early stage in the evolution of electronic ticketing, the magnitude and extent of distribution cost savings cannot be predicted. Some airlines, including USAir, are also exploring the use of self-ticketing machines in airports, which could also eventually reduce distribution costs.\nGeneral Industry Conditions\nDemand for air transportation historically has tended to mirror general economic conditions. During the most recent economic recession in the United States, the change in industry capacity failed to mirror the reduction in demand for domestic air transportation due primarily to continued delivery of new aircraft and, secondarily, to the operation of certain major U.S. carriers under the protection of Chapter 11 of the Bankruptcy Code for extended periods. While industry capacity has leveled off and the general economy has improved, the Company expects that the airline industry will remain extremely competitive for the foreseeable future, primarily due to the dramatic change which has occurred in\nindustry pricing and which has resulted in generally lower fares. See \"Significant Impact of Low Cost, Low Fare Competition\" above. In 1994, the U.S. airline industry had its best year since the recession began in July 1990, with several airlines posting profits, although the major carriers continue to be burdened with large amounts of debt. However, unlike the results of some of its competitors, the Company's results did not improve in 1994. The Company believes that for the foreseeable future the demand for higher yield \"business fares\" will remain essentially flat and relatively inelastic while the lower yield \"leisure\" market will continue to grow with the general economy. This trend will make it more difficult for the domestic airlines, including USAir, to sustain meaningful yield increases in the future. Therefore, the Company believes it must reduce its cost structure substantially in order to survive.\nHistorically, the Company's airline operations have been subject to seasonal variations in demand. First quarter results have often been adversely affected by winter weather and, with certain exceptions, reduced travel demand. Typically, the industry's performance has been the best in the third quarter, while the Company's results have been the best in the second quarter. The restructuring of USAir's route system in recent years to emphasize its strengths in the northeastern U.S. and to capitalize in the first, second and fourth quarters on passenger traffic to Florida may result in changes in historic seasonality.\nOf the eleven airlines classified as \"major\" carriers by the DOT in January 1991, two have ceased operations and three filed for bankruptcy protection, reorganized and emerged from bankruptcy in 1993 and 1994. Airlines operating under Chapter 11 often engage in discount pricing to generate the cash flow necessary for their survival. In addition, when these airlines emerge from bankruptcy they may have substantially reduced their debt and lease obliga- tions and other operating costs, as was the case when Continental, TWA and America West emerged. These reduced costs may permit the reorganized carriers to enter new markets and offer discount fares, which may be intended to generate cash flow, preserve and enhance market share and rehabilitate the carriers' image in the market- place. Since its reorganization, Continental has entered many of USAir's markets in the eastern U.S. and offered fares that were substantially lower than those that were previously available, although it has recently begun to reduce its Continental Lite service. See \"Significant Impact of Low Cost, Low Fare Competi- tion\" and \"Industry Restructuring\" above. The availability of the assets of bankrupt carriers enabled certain financially stronger participants in the market, including, to a lesser extent, USAir, to purchase routes, aircraft, takeoff and landing slots and other assets. While capacity has been removed in certain domestic markets, these bankruptcies and failures and the substantial debt burden of many carriers illustrate the difficulties that the airline industry continues to face today.\nBritish Airways Announcement Regarding Additional Investment in the Company\nAs described in greater detail in \"British Airways Investment Agreement\" below, on January 21, 1993, the Company and BA entered into an Investment Agreement (as subsequently amended, the \"Investment Agreement\"). Pursuant to the Investment Agreement, BA has to date invested approximately $400 million in certain preferred stock of the Company. The Company has deferred quarterly dividend payments on all outstanding series of preferred stock beginning with payments due September 30, 1994. Further, as of December 31, 1994, the Company was unable to pay dividends on any outstanding shares of its common stock, par value $1.00 per share (\"Common Stock\") or preferred stock due to limitations under Delaware law. See \"Deferral of Dividends\" below and Item 8A. Note 8(a) to the Company's consolidated financial statements. The Company benefitted from the additional equity provided by BA and also from the resulting enhancement of the Company's image in the marketplace and in the investment community. However, on March 7, 1994, BA announced that because of the Company's continued substantial losses it would make no additional investments in the Company until the outcome of the Company's efforts to reduce its costs is known. See \"Significant Impact of Low Cost, Low Fare Competition\" above and Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\" At the same time, BA indicated it would continue to cooperate with USAir on the code sharing arrangements discussed below.\nDeferral of Dividends\nBecause of the Company's poor financial results, on Septem- ber 29, 1994, the Company announced that it was deferring the quarterly dividend payment due September 30, 1994 on the 358,000 shares of the Company's 9 1\/4% Series A Cumulative Convertible Redeemable Preferred Stock (\"Series A Preferred Stock\"). The Series A Preferred Stock is owned by affiliates of Berkshire Hathaway Inc. On March 13, 1995, Berkshire Hathaway Inc. announced that it had recorded a pre-tax charge of $268.5 million to recognize a decline in the value of its investment in the Series A Preferred Stock that had an original cost of $358 million.\nThe Company has also deferred quarterly dividend payments on all its other outstanding series of preferred stock, including the Series F Cumulative Convertible Senior Preferred Stock, without par value (the \"Series F Preferred Stock\"), and Series T Cumulative Convertible Exchangeable Senior Preferred Stock, without par value (the \"Series T Preferred Stock\"), both of which are owned by BA, as well as on the publicly held Series B Preferred Stock. For a description of the effects of the deferral of dividends, see Item 8A. Note 8 to the Company's consolidated financial statements.\nThe Company, organized under the laws of the State of Delaware, is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware\nlaw. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends on all outstanding common and preferred stock issuances. See Item 5A. \"Market for USAir Group's Common Equity and Related Stockholder Matters.\" The Company has not paid a dividend on its Common Stock since the second quarter of 1990. Even if the Company is successful in restructuring its costs, there can be no assurance when or if preferred dividend payments will resume.\nRating Agencies' Downgrade of the Company's and USAir's Securities\nThe Company's and USAir's debt and equity securities are presently rated below investment grade by Standard and Poor's Corporation (\"S&P\") and Moody's Investors Service, Inc. (\"Moody's\"). In February 1994, as a result of USAir's low fare initiative in certain markets and its high cost structure, S&P and Moody's placed the securities of the Company and USAir on watch with negative implications. On March 24, 1994, S&P downgraded the Company's and USAir's securities. On September 29, 1994, following the Company's announcement that it had deferred payment of preferred dividends, Moody's and S&P further downgraded their ratings of the Company's and USAir's securities. S&P continues to keep the securities of the Company and USAir on watch with negative implications. The ratings of the Company's and USAir's debt and equity securities make it more difficult for the Company and USAir to effect additional financing. On January 19, 1995, Moody's announced that it is revising its ratings practice on airline equipment trust and pass through obligations and would consider assigning higher ratings to certain of these securities. At the same time Moody's placed under review all existing airline equipment trust certificates and pass through obligations (includ- ing those of USAir) for possible upgrade. At this time, USAir does not believe that an upgrade by Moody's would have any material positive or negative effect on its ability to effect additional financings. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\"\nMajor Airline Operations\nAs discussed above, USAir is the Company's principal operating subsidiary, accounting for approximately 93% of USAir Group's operating revenues in 1994. USAir Group and USAir have incurred substantial losses since 1989.\nYields at USAir started to erode in the fourth quarter of 1993 and declined versus the comparable quarter of 1992 due to the proliferation of discount and promotional fares which were designed to stimulate passenger traffic. Yields were even weaker in 1994 due primarily to USAir's action to reduce fares to remain competi- tive with low cost, low fare carriers in many of USAir's markets in the eastern U.S. During 1993, systemwide traffic was relatively weak. In 1994, USAir's traffic was stronger than in 1993, although the Company estimates that USAir's two aircraft accidents during\nthe third quarter of 1994 resulted in reduced passenger traffic that produced a revenue shortfall of approximately $150 million for the year. By early 1995, traffic at USAir had recovered from the effects of the accidents and approached a level normally associated with USAir's capacity in the marketplace.\nUSAir implemented several operational changes during 1991 through 1994 in efforts to return to profitability, as discussed in detail below, and it has announced plans for additional changes in 1995.\nIn March 1995, USAir disclosed plans to cut capacity through- out its system by five percent as part of its efforts to return to profitability. It intends to emphasize the strengths of its hubs in Pittsburgh, Charlotte, Philadelphia and Baltimore, as well as other major east coast urban centers. USAir expects that this downsizing will produce over $100 million in annual financial benefits. As a result of USAir's new capacity plan, by July 1995, point-to-point flights will comprise less than 10% of the USAir system. Approximately 240 flights will be eliminated and about 70 flights will be added. The additional service will include flights to Frankfurt from Philadelphia and Boston, as discussed below, and more flights to the west coast from Charlotte. USAir plans to use regional aircraft in markets where passenger loads have been consistently too low to sustain continued jet service. See \"Regional Airline Operations.\" These changes will be phased in during April, May and June.\nUSAir, whose operating costs are the highest among the major U.S. airlines, is actively pursuing several initiatives in an effort to enhance revenues and to reduce its costs significantly in order to survive in the current low fare competitive environment. The Company's goal is to achieve a pre-tax margin of 3.0% in the next one to two years and a 7.5% pre-tax margin longer term. USAir implemented certain revenue enhancement and cost reduction programs in 1994 and expects to continue and expand these programs and initiate others in 1995, as discussed below. The Company believes that it must reduce USAir's annual operating expenses by approxi- mately $1 billion in order to achieve its margin goals.\nThe Company is seeking to realize half, or approximately $500 million, of the $1 billion of annual savings through reductions in personnel costs, which are the largest single component of USAir's operating costs (approximately 39%). USAir is engaged in discus- sions with the leadership of its unionized employees regarding the $500 million annual savings in personnel costs it desires to achieve through wage and benefit reductions, improved productivity and other cost savings. In August 1994, USAir received a proposal regarding cost savings from ALPA, which represents USAir's pilot employees, and shortly thereafter the Company announced that the terms of ALPA's proposal were largely unacceptable. Although discussions between the Company and ALPA continued, ALPA ceased negotiations in early October following USAir's announcement of its plan, described below, to dispose of its Boeing 767 fleet and certain other aircraft. On October 25, 1994, Gerald L. Baliles,\nformer Governor of Virginia, was appointed by Secretary of Transportation Federico Pena as facilitator in the negotiations. Former Governor Baliles also served in 1993 as chairman of the National Commission to Ensure a Strong Competitive Airline Industry. Discussions with the facilitator began on October 28, 1994. On February 6, 1995, USAir received a proposal from ALPA, the International Association of Machinists (\"IAM\") and the Transport Workers Union (the \"TWU\"). On February 22, 1995, the Company responded with a counterproposal to these unions. On March 29, 1995, USAir reached an agreement in principle with ALPA. The agreement in principle is subject to many significant condi- tions. See \"Agreement in Principle with Pilots' Union\" above. USAir is continuing to negotiate with the labor unions representing certain of its other employees. The timing and outcome of USAir's discussions with its other labor unions are uncertain. No assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. Even if the savings described above are achieved, it remains uncertain whether they will be adequate in light of the Company's financial condition and competitive position. As a result of these uncertainties, several key management personnel have recently left USAir, and more may follow unless the Company's financial outlook improves.\nThe Company plans to achieve the majority of the remaining $500 million in annual cost savings through a combination of organizational and structural changes, reengineering and other initiatives including:\n* centralization of its purchasing functions;\n* customer service realignment, including the transfer of commuter handling to USAir Express operators;\n* improvements in operations performance to increase crew productivity;\n* cargo, catering and communications outsourcing;\n* maintenance operations organizational changes;\n* a reengineering of its maintenance operations, reservations, information services and operations research area; and\n* rationalization of its jet fleet which will include the elimination of certain fleet types, as described below.\nCertain of the above initiatives are part of the Company's \"Management Action Plan.\" The Company expects to achieve at least $250 million to $300 million of these savings in 1995. There can be no assurance that these savings will be fully realized.\nIn addition to the above cost-cutting initiatives, the Company is focusing on other significant Management Action Plan items designed to enhance revenues or further reduce costs. These include:\n* \"quick turn\" service (discussed below);\n* a new inventory management system that allows USAir to better allocate seats within various fare levels to produce a traffic mix that maximizes revenues;\n* synergies through the BA alliance (code sharing, frequent flyer programs and joint sales promotions, ground handling and purchasing); and\n* a premium \"Business Select\" service (discussed below).\nIn February 1994, USAir inaugurated its quick turn, point-to- point service mentioned above in 18 city-pair markets using 22 aircraft in a move intended to increase the utilization of its existing aircraft, facilities and personnel and thereby reduce its unit costs on those flights. The trial program consisting of 22 aircraft was shown to produce the desired results and in July 1994, USAir expanded the quick turn service to approximately 165 markets using approximately 100 aircraft. Currently, USAir is using quick turn as an operating standard system-wide to increase aircraft utilization and to improve schedules wherever expedient. Although the expanded quick turn program is producing the intended results with regard to aircraft utilization, there can be no assurance that the quick turn service will generate sufficient additional revenue to offset the increased costs associated with this service.\nIn addition, USAir hopes to attract additional higher yield business passenger revenue through its implementation of a convertible passenger cabin which allows USAir to offer a premium service branded \"Business Select\" to these passengers, as referred to above. USAir initiated the Business Select service in certain markets on January 4, 1995. As of March 1995, Business Select was available on 30 aircraft. USAir expects to determine whether to expand Business Select later in 1995. At least one other major U.S. airline, American, has announced plans to implement similar service.\nThe Company is also evaluating other strategic options, including further downsizing, which may be available to address the difficult financial and competitive factors facing USAir.\nFrom 1991 through the present, USAir has taken various steps to reduce its operating costs and to augment or enhance its service and, in addition or related to the initiatives described above, it plans to make other efforts to achieve these goals. These histori- cal and future efforts are described below.\nOn May 2, 1991, USAir ceased operating its fleet of British Aerospace BAe 146-200 (\"BAe-146\") aircraft, ceased serving eight airports in California, Oregon and Washington, and eliminated some flights at BWI and Cleveland Hopkins International Airports. Although other service was added to partially offset these reductions, the net effect was a decrease of approximately three percent in USAir's system available seat miles (\"ASMs\"), and a net reduction in scheduled departures of ten percent from January 1991 service levels. In connection with this restructuring, USAir closed four flight crew bases, two heavy maintenance facilities and one reservations office (these measures are collectively referred to as the \"May 1991 Restructuring\"). (In April 1993, USAir reintroduced long-haul service at John Wayne Airport in Orange County, California, one of the airports that USAir ceased serving in the May 1991 Restructuring). USAir has not resumed operation of its BAe-146 aircraft. USAir owns one and leases seventeen of these aircraft. USAir has continued to pay rent, insure the BAe-146 aircraft and perform its other obligations under the BAe-146 leases, except that USAir has not performed mandatory airworthiness directives on these aircraft or engines as required by the leases. USAir is storing the aircraft and related spare engines in accordance with FAA-approved procedures and manufacturer guide- lines. Maintenance reserves for the cost of airworthiness directives compliance and lease return requirements have been accrued by the Company. In the fourth quarter of 1994 the Company recorded a non-recurring charge of approximately $132.8 million for such non-operating aircraft. USAir continues, however, to pursue remarketing opportunities for the BAe-146 aircraft.\nIn 1992, USAir purchased 62 jet take-off and landing slots and 46 commuter slots at LaGuardia Airport (\"LaGuardia\") and six jet slots at Washington National Airport from Continental for $61 million. USAir also assumed Continental's leasehold obligations associated with the East End Terminal at LaGuardia, which commenced operations in September 1992, and a flight kitchen at LaGuardia. As a result of the acquisition, USAir expanded its operations at LaGuardia, including the initiation of non-stop service to nine additional cities, five of which are in Florida. USAir Express carriers used the commuter slots to expand service primarily to cities in the northeastern United States. USAir sold substantially all the assets associated with the flight kitchen operation in October 1992.\nUSAir Group reached an agreement during 1992 with the creditors of the Trump Shuttle to manage and operate the Shuttle under the name \"USAir Shuttle\" for a period of up to ten years. Under the agreement, USAir Group has an option to purchase the shuttle operation on or after October 10, 1996. The USAir Shuttle commenced operations in April 1992 between New York City, Boston and Washington D.C.\nDuring 1993 and 1994 USAir and BA implemented code sharing arrangements pursuant to the Investment Agreement. As of Decem- ber 31, 1994, USAir and BA had implemented code sharing to 52 of the 65 airports currently authorized by the DOT. See \"British Airways Investment Agreement\" below.\nIn early 1994, USAir implemented certain measures previously announced in 1993 to reduce its operating costs. These measures included a workforce reduction of approximately 2,500 full time positions and revision of USAir's vacation, holiday and sick leave policy for non-union employees. The workforce reduction, which was completed by the end of the first quarter of 1994, was comprised primarily of the elimination of approximately 1,800 customer service, 200 flight attendant and 200 maintenance positions. USAir recorded a non-recurring charge of approximately $68.8 million primarily in the third quarter of 1993 for severance, early retirement and other personnel-related expenses in connection with the workforce reduction.\nIn March 1994, USAir (i) purchased from United certain takeoff and landing slots at Washington National Airport and LaGuardia; (ii) purchased from United certain gates and related space at Orlando International Airport and (iii) granted to United options to purchase certain gates and related space, and a right of first refusal to purchase certain takeoff and landing slots, at Chicago O'Hare International Airport. In December 1993, USAir had reached an agreement with United to negotiate a code sharing agreement with United regarding USAir's flights to and from Miami and United's flights between Miami and Latin America. Consummation of this agreement was subject to a number of conditions. For a variety of reasons, including rapidly changing market conditions and other priorities within both companies, neither USAir nor United actively pursued the negotiation of a code sharing agreement. At this time, it appears unlikely the parties will consummate a code sharing agreement.\nIn May 1994, USAir announced plans to subcontract air freight and mail operations at 35 cities, which has affected approximately 600 of the fleet service employees. The United Steel Workers of America (\"USWA\") and several individual employees subsequently sought an injunction in a U.S. district court against the implemen- tation of those plans. On July 14, 1994, the court denied the plaintiffs' request for a preliminary injunction based on its finding that the plaintiffs did not have legal standing to represent USAir employees and had failed to demonstrate that they would suffer irreparable harm as a result of the subcontracting. In early 1995, USAir announced plans to subcontract air freight and mail operations at four additional cities.\nIn November 1994, USAir reduced substantially the frequency of its service between Los Angeles and San Francisco. It plans to close its crew base in San Francisco in the first half of 1995. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for information regarding a $25.9 million charge recorded as a result of this action.\nIn February 1995, USAir reduced the number of departures at Newark International Airport from 51 to 35 and further decreased the number to 18 effective March 5. These moves are part of USAir's strategy to use assets where they can be the most produc- tive. The changes will result in lower staffing levels in customer service and maintenance.\nIn response to the entry of certain low cost, low fare competitors at BWI and as part of USAir's measures to reduce the cost and increase the efficiency of its short haul service, USAir substantially expanded its operations at BWI in 1994. Also in 1994, USAir added several new destinations to its flight schedule, including Mexico City; St. Maarten; Jamaica; and Portland, Oregon. In February 1995, USAir announced plans to realign its Frankfurt service. It intends to increase the number of weekly flights from 14 to 21 in June 1995 for the summer season and will introduce non- stop service from Philadelphia and Boston. It will continue to offer non-stop service from Pittsburgh, and its Charlotte-Frankfurt service will include a stop in Boston. The realignments are designed to allow USAir to maximize its transatlantic performance and to take advantage of the large population bases in Philadelphia and Boston.\nIn order to reduce aircraft ownership costs and to reduce its fleet size, USAir has been pursuing the sale or lease of jet aircraft and has not been renewing certain aircraft leases upon their expiration. USAir currently plans to reduce its operating fleet by 21 jet aircraft in 1995 from December 31, 1994 levels through sales, leases, lease returns and groundings. USAir plans to retire or dispose of, at various times, 15 Boeing 737-300, five Boeing 767-200ER, two Boeing 737-200 and six Boeing 727-200 aircraft. These plans are subject to change if a labor deal is consummated, but the Company cannot predict at this time the potential impact of a labor deal on its fleet reduction plans. USAir had previously announced that its entire fleet of 12 767- 200ER aircraft was on the market. As part of its fleet reduction plan, on February 22, 1995, USAir entered into an agreement with General Electric Capital Corporation (\"GE Capital\") to sell 11 B- 737-300 aircraft during 1995, two of which were sold during the first quarter. USAir has also entered into an agreement in principle with a leasing company to sell two additional Boeing 737- 300 aircraft during 1995. USAir will record a slight financial statement loss from the sales of these 737-300 aircraft to GE Capital and the leasing company but cannot estimate the financial statement impact of other potential transactions at this time. Moreover, in furtherance of its fleet reduction, USAir will explore opportunities to sell, lease or terminate leases for additional aircraft, with the exception of Boeing 757-200 aircraft. USAir has taken delivery of four Boeing 757-200 aircraft in the first quarter of 1995 and intends to purchase the remaining three scheduled to be delivered in 1995, for which financing commitments have been obtained. If any of USAir's five Boeing 767-200ER aircraft currently on the market were sold, they would be phased out of the fleet in the following order: U.S. domestic service first and the\nBA wet lease service (described below in \"British Airways Invest- ment Agreement - U.S.-U.K. Routes\") second. The timing of the disposal of the Boeing 767-200ER aircraft is dependent on economi- cally feasible sale or lease opportunities. Excluding any Boeing 767-200ER dispositions, USAir's capacity, as measured by ASMs, is expected to decrease approximately 2.5% in 1995 compared with 1994. Pursuant to resolutions of the Company's Board and the board of directors of USAir, USAir is required to use the net proceeds of any sales of assets, after payment of any associated lease and mortgage obligations, to repurchase, defease or redeem outstanding debt.\nPreviously, on May 12, 1994, USAir reached an agreement with Boeing to reschedule the delivery of 40 737-series aircraft from the 1997-2000 time period to the years 2003-2005. As part of the same agreement, USAir relinquished all of its options to purchase 737-series, 757-series and 767-series aircraft during the 1996-2000 time period. In early 1995, USAir reached agreements in principle with Boeing and Rolls-Royce plc to reschedule the delivery dates for eight 757-200 aircraft from 1996 to 1998. As a result of these recent agreements, the Company's capital commitments have been substantially reduced for the 1995 to 2000 time period. See Note 4(d) to the Company's consolidated financial statements for the future aircraft commitments schedule reflecting these agreements with Boeing and Rolls-Royce plc. USAir is using the Boeing 757-200 aircraft, which seats 182 passengers, on long haul routes, in high demand markets where potential passenger traffic may not currently be accommodated on smaller aircraft at peak travel times and in replacement of certain 737-300 long range aircraft that are to be sold to GE Capital. USAir considers the 757-200 aircraft to be more suitable for these missions than the Boeing 767-200ER and Boeing 737 aircraft types.\nUSAir has recently implemented several additional safety initiatives. In November 1994, USAir elected a former general in the United States Air Force, General Robert C. Oaks, to the new position of Vice President-Corporate Safety and Regulatory Compliance, reporting directly to the Chairman and Chief Executive Officer. The Company and USAir have each established a new committee of their boards of directors, the Safety Committees, which have oversight of all corporate safety matters. In addition, USAir retained an aviation consulting firm, PRC Aviation, to conduct a full audit of USAir's safety operations. The audit was completed in early 1995. In the opinion of the safety auditors, USAir is being operated safely in compliance with FAA regulations. PRC Aviation identified and recommended opportunities for safety enhancements. USAir has established an Audit Response Council that is addressing the recommendations made in the audit report.\nIn summary, since 1989, USAir Group and USAir have incurred substantial losses. Their results of operations have been adversely affected by the growth of low cost, low fare competition, particularly in 1994. Therefore, in order for USAir to remain competitive, it has attempted to reduce costs, enhance service and become more efficient by engaging in historical and current\ninitiatives and by formulating plans for the future discussed above in this description of \"Major Airline Operations.\"\nUSAir's operating statistics during the years 1990 through 1994 are set forth in the following table (1):\n* Scheduled service only (excludes charter flights). ** All service. c = cents\n(1) Statistics include free frequent travelers and the related miles flown. (2) Passenger load factor is the percentage of aircraft seating capacity that is actually utilized (RPMs\/ASMs). (3) Breakeven load factor represents the percentage of aircraft seating capacity that must be utilized, based on fares in effect during the period, for USAir to break even at the pre- tax income level, adjusted to exclude non-recurring and unusual items. (4) Adjusted to exclude non-recurring and unusual items. (5) Financial statistics for 1994 and 1993 exclude revenue and expense generated under the BA wet lease arrangement. (6) Certain statistics have been recalculated to reflect expense reclassifications.\nFor a discussion of USAir's frequent traveler program, see Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Frequent Traveler Program.\"\nRegional Airline Operations\nMost regional airlines in the United States are affiliated with a major or smaller jet carrier. USAir provides reservations and, at certain stations, ground support services, in return for service fees, to ten regional carriers (including Allegheny, Piedmont and Jetstream) which operate under the name \"USAir Express.\" These airlines share USAir's two-letter designator code and feed connecting traffic into USAir's route system at several points, including its major hub operations at Pittsburgh, Char- lotte, Philadelphia and BWI. At January 4, 1995, USAir Express carriers served 185 airports in the United States, Canada and the Bahamas, including 90 also served by USAir. During 1994, USAir Express' combined operations enplaned approximately 9.2 million passengers.\nPiedmont's collective bargaining agreement with ALPA, which represents its pilot employees, became amendable on December 1, 1992. On February 22, 1994, the National Mediation Board (the \"NMB\"), which had assigned a mediator to the negotiations between Piedmont and ALPA on a new agreement, declared these negotiations at an impasse and commenced a thirty-day \"cooling-off\" period. On March 27, 1994, two days following the expiration of this period at midnight on March 25, 1994, Piedmont reached agreement on a new collective bargaining agreement that becomes amendable on March 31, 1998. The new agreement was ratified by Piedmont's pilot employees on May 2, 1994 and provides for increases in salary and benefits for the term of the agreement in exchange for productivity improvements.\nIn July 1992, Allegheny Commuter Airlines, Inc. merged into Pennsylvania Commuter Airlines, Inc. (now Allegheny Airlines, Inc.). The pilots of each of these companies were represented by ALPA and were covered by collective bargaining agreements. Interim agreements were reached with both pilot groups on July 1, 1992. Negotiations on a unified collective bargaining agreement covering all pilots of the merged company began in September 1992 and continued through September 1, 1994. Allegheny reached agreement with the pilots on September 1, 1994. The contract expires on August 31, 1998. The flight attendants of each of these companies, represented by the Association of Flight Attendants (the \"AFA\"), were also covered by collective bargaining agreements. Negotia- tions on a unified collective bargaining agreement covering all flight attendants of the merged company began in April 1992. Two tentative agreements were reached but were not ratified by the combined membership. On December 19, 1994, a third tentative agreement was reached which was ratified by the membership on January 30, 1995. The new Allegheny flight attendant agreement became effective February 1, 1995 and becomes amendable on January 31, 2000. Both the pilot and flight attendant agreements with Allegheny provide for increases in salary and benefits for the term of the agreements in exchange for productivity improvements.\nUSAir's reduction in jet aircraft and its continuing efforts to reduce costs and enhance revenue by eliminating less profitable routes has resulted in the cessation of or reduction in jet flying between certain city pairs. In some cases, subject to possible changes should a labor deal be consummated, existing or former jet routes may be turned over to USAir Express with the goal of maintaining portions of the revenue base (particularly the hub connecting traffic) with lower cost operations. The change from jet routes to regional airline service and the operating expenses of operating smaller turboprop aircraft have resulted in the Company pursuing the 30-seat and larger market for its owned regional operations. Over time, the Company intends to upgrade routes operated by smaller turboprops to aircraft of 30 seats or larger or to have those routes flown by non-owned USAir Express carriers. In August 1994, USAir, Allegheny and USAir Leasing and Services sold to Mesa Air Group, Inc. (formerly Mesa Airlines, Inc.) (\"Mesa\") the Beechcraft 1900 and Shorts 360 regional operations previously operated by Allegheny, certain spare parts, station and ground equipment and a maintenance facility in Reading, Pennsylvania. The transaction resulted in the divestiture of 22 aircraft by Allegheny in 1994 and the consolidation of Allegheny's operations to one fleet type, the de Havilland Dash 8-100. Connecting traffic has not been materially affected because connecting feed formerly provided by Allegheny is now provided by Mesa or other USAir Express carriers.\nPiedmont and Allegheny intend to enlarge their Dash 8 fleets in 1995 by pursuing operating leases for those aircraft when such aircraft are available upon economically feasible terms. In 1994, Piedmont added four new Dash 8s and Allegheny added six new Dash 8s by entering into operating leases with an affiliate of the aircraft manufacturer. In 1995, Allegheny has added three Dash 8s through operating leases and has an agreement in principle to lease five additional used aircraft from an affiliate of the aircraft manufacturer. One of Piedmont's lessors has advised, however, that it will not renew leases for four used Dash 8s that expire in 1995. In addition, as discussed below in Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nFlight Equipment\nAt December 31, 1994, USAir operated the following jet aircraft:\n(1) Of the owned aircraft, 115 were pledged as collateral for various secured financing obligations aggregating $2.2 billion at December 31, 1994. (2) The terms of the leases expire between 1995 and 2015. Includes two 737-300 aircraft that were returned to the lessor in April 1995. (3) The above table excludes one owned and two leased Boeing 767- 200ER which USAir leased to BA under a wet lease arrangement at December 31, 1994. See \"British Airways Investment Agreement - U.S.-U.K. Routes.\" (4) Includes aircraft that USAir has agreed to sell. See Item 1. \"Business - Major Airline Operations.\" The average age of these aircraft is 8.9 years.\nAt December 31, 1994, USAir Group's three regional airline subsidiaries operated the following propeller-driven aircraft:\n(1) Of the owned aircraft, 13 were pledged as collateral for various secured financing obligations aggregating $50.3 million at December 31, 1994, five were owned by USAir Leasing and Services, and four were owned by USAir. (2) The terms of the leases expire between 1995 and 2010.\nUSAir is a party to purchase agreements that provide for the future acquisition of new jet aircraft. Jetstream is party to an agreement with Dornier LuftFahrt Gmbh which provides for the firm acquisition by operating lease of 20 Dornier 328-100 series aircraft by December 1995 and 20 options to acquire such aircraft. Allegheny and Piedmont have agreements to acquire additional Dash 8 aircraft. USAir Leasing and Services has a commitment to sell its five owned J-31s in 1995. Jetstream intends to return the 28-seat Embraer Brasilia to a lessor in 1995 and to sublease the 30-seat Brasilia to another air carrier. See Note 4(d) to the Company's consolidated financial statements for outstanding commitments and options for the purchase of flight equipment. The Company's subsidiary airlines maintain inventories of spare engines, spare parts, accessories and other maintenance supplies sufficient to meet their operating requirements.\nUSAir owns one and leases 17 BAe 146-200 aircraft, leases two Boeing 727-200, owns six Boeing 737-200, and owns seven Fokker- 1000 aircraft that were parked in storage facilities and not in its operational fleet at December 31, 1994. USAir recorded substantial charges during 1994 to recognize costs associated with repair parts, inventory and future lease payments for certain parked aircraft. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" In addition, certain of the Company's subsidiaries lease ten owned Fokker- 1000 aircraft and nine owned Boeing 737-200 aircraft to outside parties.\nUSAir is a participant in the Civil Reserve Air Fleet (\"CRAF\"), a voluntary program administered by the Air Mobility Command (the \"AMC\"). The General Services Administration of the United States government also requires that airlines participate in CRAF in order to receive United States government business. The United States government is the largest customer of USAir. USAir's commitment under CRAF is to provide three Boeing 767 aircraft in support of military operations, probably for aeromedical missions, as specified by the AMC. To date, the AMC has not requested USAir to activate any of its aircraft under CRAF.\nGround Facilities\nUSAir leases the majority of its ground facilities, including executive and administrative offices in Arlington, Virginia adjacent to Washington National Airport; its principal operating, overhaul and maintenance bases at the Pittsburgh and Charlotte\/ Douglas International Airports; major training facilities in Pittsburgh and Charlotte; central reservations offices in several cities; and line maintenance bases and local ticket, cargo and administrative offices throughout its system. USAir owns property\nin Fairfax, Virginia, a training facility in Winston-Salem, North Carolina, a reservations and training facility in San Diego, California, and a reservations facility in Orlando, Florida. USAir's property in Fairfax, Virginia is leased to the U.S. government and is currently for sale. Allegheny owns its principal ground facilities in Middletown, Pennsylvania. Jetstream leases its principal ground facilities in Dayton, Ohio. Piedmont leases its principal ground facilities in Salisbury, Maryland, Norfolk, Virginia and Jacksonville, Florida.\nThe Company's airline subsidiaries utilize public airports for their flight operations under lease arrangements with the govern- ment entities that own or control these airports. Airport authorities frequently require airlines to execute long-term leases to assist in obtaining financing for terminal and facility construction. Any future requirements for new or improved airport facilities and passenger terminals will require additional expenditures and long-term commitments. Several significant projects which affect large airports on USAir's route system are discussed below.\nThe new terminal at Pittsburgh International Airport commenced operation in October 1992. The construction cost of the new terminal, approximately $800 million, was financed largely through the issuance of airport revenue bonds. As the principal tenant of the new facility, USAir pays a portion of the cost of the new terminal through rents and other charges pursuant to a use agreement which expires in 2018. USAir's terminal rental expense at Pittsburgh was approximately $46 million annually in 1994. The new facility has provided additional gate capacity for USAir and has enhanced the efficiency and quality of its hub services at Pittsburgh. In addition to the annual terminal rental expense, USAir is recognizing approximately $13 million annual rental expense for property and equipment typically owned by USAir at other airports. The annual terminal rental expense is subject to adjustment, depending on the actual airport operating costs, among other factors. These rents are reflected in Note 4(b), \"Lease Commitments\", to the Company's and USAir's respective consolidated financial statements.\nThe East End Terminal at LaGuardia, which cost approximately $177 million to construct, opened in the third quarter of 1992. USAir, USAir Express and the USAir Shuttle operations at LaGuardia are conducted from this new terminal and the adjoining USAir Shuttle terminal. The East End Terminal has 12 jet gates. USAir recognizes approximately $32 million in annual rental expense for the new terminal and is responsible for all maintenance and operating costs.\nIn 1993, USAir and the City of Philadelphia reached an agreement to proceed with certain capital improvements at Philadel- phia International Airport, where USAir has its third largest hub. The improvements include approximately $85 million in various terminal renovations and a new $220 million commuter airline runway expansion project, exclusive of financing costs. Depending on the\ntiming of certain federal environmental reviews, USAir expects construction on the terminal project will begin in 1995 and will be completed in 1996 or 1997. The runway expansion project may begin in 1995 and is not expected to be completed until 1999 or 2000. The Company expects that its annual costs of operations at Philadelphia International Airport will increase by approximately $14 million once construction is complete, representing more than a 40% increase.\nThe Washington National Airport Authority, which operates Washington National Airport, is currently undertaking a $1 billion capital development project at Washington National Airport, which includes construction of a new terminal currently expected to commence operation in the first quarter of 1997. Based on current projections, the Company estimates that its annual operating expenses at Washington National Airport will more than double, increasing by approximately $10 million to $15 million.\nIn January 1995, USAir announced plans to dispose of its hangar at Indianapolis. The closing of this facility is expected to save approximately $2.4 million per year in rental payments. Initial costs associated with the closing are estimated to be $4.5 million for employee relocation.\nUSAir intends to divest six of nine gates it holds at Newark International Airport. It is currently negotiating with another carrier with respect to the disposition of those gates. USAir anticipates that the divestiture will result in an annual rent reduction of approximately $4 million.\nDuring 1990, Congress enacted legislation to permit airport authorities, with prior approval from the DOT, to impose passenger facility charges (\"PFCs\") as a means of funding local airport projects. These charges, which are collected by the airlines from their passengers, are limited to $3.00 per enplanement, and to no more than $12.00 per round trip. The legislation provides that the airlines will be reimbursed for the cost of collecting these charges and remitting the funds to the airport authorities. To date, more than 230 airports, including airports in Boston, Baltimore, Washington, Newark, New York City, Philadelphia, Orlando and Tampa (which are major markets served by USAir), have imposed PFCs. These airports receive more than $1 billion annually in PFCs. As a result of downward competitive pressure on fares, USAir and other airlines have been unable in many instances to pass on the cost of the PFCs to passengers.\nWith respect to the magnitude of airport rent and landing and other user fees generally, federal law prohibits States and their subdivisions from collecting these fees, other than reasonable rental charges, landing fees and other service charges, from aircraft operators for the use of airport facilities. Controver- sies have arisen in recent years concerning the allocation of airport costs among the airlines, general aviation and concession- aires operating at the airport. In addition, during 1993 and 1994, the controversy surrounding the diversion by airport and other\ngovernmental authorities of airport revenues continued to grow. Airport revenues typically consist primarily of rents and landing and other user fees paid by the airlines operating at the airport. Under federal law, federal transportation funds could be denied to certain airports that engage in diversion of these revenues. In August 1994, Congress enacted legislation which strengthens prohibitions on revenue diversion. The DOT recently established procedures for the resolution of disputed charges imposed by airports. It is too early to tell how the DOT will resolve disputes between airport operators and the carriers under these new procedures.\nItem 3.","section_3":"Item 3. Legal Proceedings\nUSAir has been named as party to, or may be affected by, legal proceedings brought by owners and residents of property located in the vicinity of certain commercial airports. The plaintiffs generally seek to enjoin certain aircraft operations at those airports or to obtain awards of damages on the defendant airport operators and air carriers as a result of alleged aircraft noise or air pollution. The relative rights and liabilities among property owners, airport operators, air carriers and Federal, state and local governments are the subject of ongoing interpretation by the courts. Any liability imposed on airport operators or air carriers, or the granting of any injunctive relief against them, could result in higher costs to air carriers, including the Company's airline subsidiaries.\nThe Equal Employment Opportunity Commission and various state and local fair employment practices agencies are investigating charges by certain job applicants, employees and former employees of the Company's subsidiaries involving allegations of employment discrimination in violation of Federal and state laws. The plaintiffs in these cases generally seek declaratory and injunctive relief and monetary damages, including back pay. In some instances they also seek classification adjustment, compensatory damages and punitive damages.\nThe above proceedings are in various stages of litigation and investigation, and the outcome of these proceedings is difficult to predict. In the Company's opinion, however, the disposition of these matters is not likely to have a material adverse effect on its financial condition or results of operations.\nUSAir is involved in legal proceedings arising out of its two aircraft accidents that occurred in July and September 1994 near Charlotte, North Carolina and Pittsburgh, Pennsylvania, respective- ly. The NTSB held hearings beginning in September 1994 relating to the July accident and January 1995 relating to the September accident. In April 1995, the NTSB issued its finding of probable causes with respect to the accident near Charlotte. It assigned as probable causes flight crew errors and the failure of air traffic control to convey weather and windshear hazard information. The NTSB has not yet issued its final accident investigation report for the accident near Pittsburgh. USAir expects that it will be at\nleast two to three years before the accident litigation and related settlements will be concluded. USAir believes that it is fully insured with respect to this litigation and has recovered its claims related to the loss of the two aircraft. Therefore, the Company believes that the litigation will not have a material adverse effect on the Company's financial condition or results of operations. However, due to these two aircraft accidents, it is probable that the Company's insurance costs will increase upon renewals of various policies in 1995. See Item 1. \"Business - Insurance.\"\nIn 1989 and 1990, a number of U.S. air carriers, including USAir, received two Civil Investigative Demands (\"CIDs\") from the DOJ (a CID is a request for information in the course of an antitrust investigation and does not constitute the institution of a civil or criminal action) related to investigations of price fixing in the domestic airline industry.\nThe investigations by the DOJ culminated in the filing of a lawsuit against Airline Tariff Publishing Company (\"ATPCo\") and eight major air carriers, including USAir, alleging that the defendants had agreed to fix prices in violation of Section 1 of the Sherman Act through the methods used to disseminate fare data to ATPCo, an airline-owned fare publishing service. To avoid the costs associated with protracted litigation and an uncertain outcome, USAir and another carrier decided to settle the lawsuit by entering into a consent decree to modify their fare-filing practices in certain respects and to implement compliance programs that would include education of employees regarding the carrier's responsibilities under the consent decree. Accordingly, the consent decree and the U.S. Government's complaint were filed contemporaneously in the U.S. District Court for the District of Columbia in December 1992. On November 1, 1993, after it had reviewed comments filed regarding the consent decree, the Court entered the decree. In March 1994, the remaining six air carrier defendants agreed to the entry of a separate consent decree to settle the lawsuit. USAir petitioned the Court to have its consent decree amended to conform with the other settlement and the Court entered an amended consent decree on September 21, 1994.\nOn March 19, 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit. The class action suit, which was filed in July 1990, alleged that the airlines used ATPCo to signal and communicate carrier pricing intentions and otherwise limit price competition for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers paid $45 million in cash and issued $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. USAir's share of the cash portion of the settlement, $5 million, was recorded in results of operations for the second quarter of 1992. The certificates, mailed to approximately 4.1 million claimants between December 15 and 31, 1994, provide a dollar-for- dollar discount against the cost of a ticket generally of up to a\nmaximum of 10 percent per ticket, depending on the cost of the ticket. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certifi- cates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates, and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on further passenger revenue and cash flows. USAir has employed the incremental cost method to estimate a range of costs attributable to the exercise of the certificates, based on the assumption that the estimated maximum number of certificates to be redeemed for travel on USAir will be related to USAir's market share relative to the total market share of the six carriers involved in the settlement. USAir's estimated percentage of such market share is less than nine percent. Incremental costs include unit costs for passenger food, beverages and supplies, fuel, reservations, communications, liability insurance, and denied boarding compensation expenses expected to be incurred on a per passenger basis. USAir has estimated that its incremental cost will not be material based on the equivalent free trips associated with the settlement.\nOn October 11, 1994, USAir and seven other carriers entered into a settlement agreement with a group of State Attorneys General resolving similar issues with the states. The settlement entitles passengers traveling within the United States on state government business to a 10% discount off the published fares of each of the settling carriers and will be available for 18 months or until the combined discount amount reaches $40 million. Following a notice and public comment period, the reviewing judge will conduct a hearing to determine whether this settlement is a fair one. The hearing is scheduled for May 10, 1995. The Company does not expect that this settlement will have a material adverse effect on its financial condition or results of operations. As was the case with the settlement of the private antitrust litigation, it is difficult to predict the amount of discounted state travel that will occur on USAir. Thus, a dollar impact of the settlement cannot be estimat- ed.\nIn February and March 1995, several class action lawsuits were filed in various federal district courts by travel agencies and a travel agency trade association alleging that most of the major U.S. airlines, including USAir, violated the antitrust laws when they individually capped travel agent commissions at $50 for round- trip domestic tickets with base fares above $500 and at $25 for one-way domestic tickets with base fares above $250. USAir intends to vigorously defend itself against the allegations made in these lawsuits. The plaintiffs are seeking unspecified treble damages for restraint of trade and an injunction to prevent the airlines from implementing or maintaining the cap on commissions. Because the lawsuits are in the first stages of litigation, USAir is unable to predict at this time their ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn March 1995, a number of U.S. carriers, including USAir, received a CID from the DOJ related to an investigation of incentives paid to travel agents over and above the base commission payments, which are the subject matter of the suits recently brought by travel agencies, as discussed above. USAir responded to an earlier CID on this topic during 1994. USAir is required to produce documents and respond to interrogatories in connection with this CID. USAir intends to comply with the requirements of the CID. Because this matter is in the investigatory stage, USAir is unable to predict at this time its ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn February 1995, two members of USAir's frequent traveler program filed a class action lawsuit in Pennsylvania state court against USAir after it raised the required minimum level of miles necessary to earn a free ticket. The plaintiffs allege breach of contract and seek unspecified damages and specific performance of the contract allegedly breached. USAir denies the allegations. The ultimate resolution of this lawsuit and its potential impact on the Company's financial condition and results of operations cannot be predicted at this time.\nUSAir and certain of the Company's other subsidiaries have received notices from the U.S. Environmental Protection Agency and various state agencies that it is a potentially responsible party with respect to the remediation of existing sites of environmental concern. Only two of these sites have been included on the Superfund National Priorities List. USAir and the other subsidiar- ies continue to negotiate with various governmental agencies concerning known and possible cleanup sites. These companies have made financial contributions for the performance of remedial investigations and feasibility studies at sites in Moira, New York; Escondido, California; Newberry Township, Pennsylvania; Elkton, Maryland; and Salisbury, Maryland.\nBecause of changing environmental laws and regulations, the large number of other potentially responsible parties and certain pending legal proceedings, it is not possible to reasonably estimate the amount or timing of future expenditures related to environmental matters. The Company provides for costs related to environmental contingencies when a loss is probable and the amount is reasonably estimable. Although management believes adequate reserves have been provided for all known contingencies, it is possible that additional reserves could be required in the future which could have a material effect on results of operations. However, the Company believes that the ultimate resolution of known environmental contingencies should not have a material adverse effect on the Company's financial position or results of operations based on the Company's experience with similar environmental sites.\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 1994.\nPart II\nItem 5A. Market for USAir Group's Common Equity and Related Stockholder Matters\nStock Exchange Listings\nThe Common Stock of the Company is traded on the New York Stock Exchange (Symbol U). On February 28, 1995, there were approximately 61,856,000 shares of Common Stock of the Company outstanding. The stock was held by 36,857 stockholders of record. The holders reside throughout the United States and abroad.\nMarket Prices of Common Stock\nPresented below are the high and low sale prices of the Common Stock of the Company as reported on the New York Stock Exchange Composite Tape during 1994 and 1993:\nHolders of the Common Stock are entitled to receive such dividends as may be lawfully declared by the Board of Directors of the Company. A Common Stock dividend of $.03 per share was paid in every quarter from the second quarter of 1980 through the second quarter of 1990. In September 1990, however, the Company suspended the payment of dividends on Common Stock for an indefinite period. The Company is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends until its capital surplus becomes positive. Surplus is the remainder of (i) net assets (total assets less total liabilities), less (ii) total capital (that amount of preferred and common equity designated as capital by a company's board of directors). At December 31, 1994, the Company's capital deficit was approximately $199.3 million. The Company's net assets were in a deficit balance of approximately $138.2 million, and its total capital was approximately $61.1 million (the $61.1 million is all attributable to the Company's Common Stock; capital for all of the Company's preferred stock issuances is a nominal amount of one cent per share). In order for the Company to return to a capital\nsurplus position, it must realize substantial profits or increase its equity through other measures, such as the sale of additional common or preferred stock. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Item 8A. Notes 8 and 9 to the Company's consolidated financial statements.\nForeign Ownership Restrictions\nIn connection with BA's 1993 investment in the Company, the Company's stockholders approved an amendment to its restated certificate of incorporation (\"Charter\") at the 1993 annual meeting that is designed to prevent the loss of USAir's operating certifi- cates due to foreign ownership or control of the Company's voting securities exceeding the level permitted by relevant Federal law. Under current law, foreign citizens cannot own or control more than 25% of the Company's voting securities.\nThe Charter provides that: (i) transfers of the Company's voting securities to non-U.S. citizens (\"Aliens\") on or after May 27, 1993 are prohibited; (ii) Aliens that acquire beneficial ownership of the Company's voting securities on or after May 27, 1993 have no voting rights; (iii) the Company can compel these Aliens to sell their securities to U.S. citizens; (iv) the Company can redeem or exchange the voting securities beneficially owned by these Aliens; and (v) the independent directors of the Company, who are those directors other than those employed by or affiliated with BA or the Company, have broad powers to construe and apply these provisions of the Charter, including the determination as to whether Aliens have become the beneficial owners of the Company's voting securities.\nItem 5B. Market for USAir's Common Equity and Related Stockholder Matters\nThere is no established public trading market for USAir's Common Stock, which is all owned by USAir Group. No dividends were paid in 1994 or 1993. USAir is subject to statutory restrictions on the payment of dividends according to capital surplus require- ments of Delaware law. At December 31, 1994, USAir's capital surplus was exhausted and therefore, under Delaware law, USAir is legally restricted from paying dividends until its capital surplus becomes positive. Surplus is the remainder of (i) net assets (total assets less total liabilities), less (ii) total capital (that amount of preferred and common equity designated as capital by a company's board of directors). At December 31, 1994, USAir's capital deficit was approximately $273.2 million. USAir's net assets were in a deficit balance of approximately $273.2 million, and its total capital was a nominal amount. In order for USAir to return to a capital surplus position, it must realize substantial profits or increase its equity through other measures, such as the sale of additional common or preferred stock. See Item 7. \"Manage- ment's Discussion and Analysis of Financial Condition and Results of Operations\" and Item 8B. Note 7 to USAir's consolidated financial statements.\nCovenants related to USAir's 10% and 9 5\/8% senior unsecured notes currently do not permit the payment of dividends by USAir to USAir Group. However, these covenants do not restrict USAir from loaning or advancing funds to USAir Group.\nItem 6.","section_5":"","section_6":"Item 6. Selected Financial Data\nSelected financial data for USAir Group is presented below:\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condi- tion and Results of Operations\nThe following discussion relates to the financial results and condition of USAir Group, Inc. (the \"Company\"). USAir, Inc. (\"USAir\") is the Company's principal subsidiary and accounts for approximately 93% of its operating revenue. Therefore, the following discussion is based primarily upon USAir's results of operations and prospects.\nThe primary factor that currently influences the Company's financial results and its future prospects is USAir's high cost structure amid the low cost, low fare environment which character- izes the U.S. airline industry. The Company has recorded net losses in excess of $3 billion on revenues of approximately $40 billion since 1988, which was its most recent profitable year.\nThe U.S. airline industry has undergone dramatic and permanent changes in recent years, generally resulting in lower operating costs and fares. As discussed in more detail below, the current competitive environment is the result of several factors including the emergence and expansion of low cost, low fare carriers, the protection and cost restructuring opportunities afforded to certain carriers while operating under Chapter 11 of the Bankruptcy Code, and other cost restructuring initiatives among major airlines, including employee concessions in exchange for equity ownership. USAir believes that it must reduce its operating costs substantial- ly if it is to survive in this low cost, low fare competitive environment.\nUSAir began negotiating with the unions representing certain of its employees in 1994 and, as described in Item 1. \"Business - Agreement in Principle with Pilots' Union,\" signed an agreement in principle on March 29, 1995 with the negotiating committee of the Air Line Pilots Association (\"ALPA\") Master Executive Council. ALPA represents USAir's pilots and the Master Executive Council is ALPA's governing body. The agreement in principle is subject to many significant conditions. It is uncertain whether USAir will be successful in reaching agreements with its other unions and whether or when any transactions with one or more of the unions will be consummated. As discussed below, the Company has taken various steps to reduce its non-labor costs including a five percent reduction in capacity to be phased in during April to June 1995. In addition, the Company is evaluating and considering the risks associated with various strategic options, including further downsizing.\nLow Cost, Low Fare Environment\nThe growth and expansion of low cost, low fare carriers into USAir's markets in the eastern U.S. and the improved competitive position of other major airlines which have substantially reduced their operating costs together represent an urgent competitive\nchallenge for USAir, which has higher operating costs than its competitors. Unless USAir is able to reduce its operating costs, competition from lower cost airlines in USAir's markets will continue to have a material adverse impact on USAir's cash position and therefore, its ability to sustain operations. See \"Liquidity and Capital Resources\" below.\nIn October 1993, Continental Airlines (\"Continental) inaugu- rated its low cost, low fare \"Continental Lite\" service on certain routes in the eastern U.S. also served by USAir. During 1994, Continental substantially expanded the Continental Lite service into additional markets also served by USAir. Continental has operating costs that are substantially lower than those of USAir. In February 1994, to avoid a loss of market share in the eastern U.S., USAir began to substantially lower its fares in primary and secondary markets affected by the expansion of Continental's low cost, low fare service. By late 1994, USAir competed with Continental in primary and secondary markets from which USAir then generated approximately 46% of its passenger revenue and offered fares in these markets up to 70% lower than the beginning of 1994. In January 1995, Continental announced its intention to reduce its capacity, to eliminate 4,000 jobs, and to reduce its Continental Lite service by 40% during 1995. This action has affected markets in which USAir and Continental compete. However, any impact on the Company's results of operations or financial position cannot be estimated at this time. See Item 1. \"Business - Significant Impact of Low Cost, Low Fare Competition\" and \"Industry Restructuring.\"\nIn September 1993, Southwest Airlines, Inc. (\"Southwest\"), a low cost, low fare air carrier which had not previously provided service to or in the eastern U.S., inaugurated service from Baltimore\/Washington International Airport (\"BWI\") at fares substantially below those previously offered by USAir and other airlines in the same markets. BWI is one of USAir's hub airports. USAir responded by matching most of Southwest's fares and increas- ing the frequency of service in related markets. Southwest further expanded its service from BWI during 1994 and USAir reduced its fares to avoid the loss of traffic. USAir believes that Southwest and other low cost carriers likely will expand their operations to additional markets also served by USAir. See Item 1. \"Business - Significant Impact of Low Cost, Low Fare Competition.\"\nIn 1993, Northwest Airlines, Inc. (\"Northwest\") and Trans World Airlines, Inc. (\"TWA\") sought and obtained from unionized employees substantial concessions and productivity improvements. In exchange, these employees have received ownership interests in those companies. In 1994, United Airlines, Inc. (\"United\") completed a transaction which traded employee concessions for a substantial ownership stake. The stated intent and purpose of these labor concessions are to enable these carriers to lower their operating costs. United initiated a low cost, low fare operation in the western U.S. in October 1994. USAir substantially reduced the frequency of its service between San Francisco and Los Angeles in November 1994 and will close its crew base in San Francisco in the first half of 1995. See the discussion in \"Results of\nOperations\" below for information regarding a $25.9 million charge recorded as a result of this action. United could initiate additional low cost, low fare service in other markets served by USAir.\nDelta Air Lines (\"Delta\") is currently engaged in a restruc- turing initiative, announced in April 1994, that is intended to reduce its operating costs through measures which include the elimination of up to 15,000 positions, or approximately 20% of its work force. Delta is currently in discussion with certain of its employees regarding concessions. American Airlines (\"American\") has announced a restructuring of its non-union workforce and that it is seeking $750 million in concessions and productivity gains from its unionized workers. TWA has negotiated further productivi- ty improvements with its unionized employees and has proposed another restructuring transaction in which, among other things, certain creditors would swap debt for equity. As discussed above, Continental plans to reduce its workforce by 4,000 and reduce service levels. Southwest has agreed with its pilots on a new ten year contract that provides for no wage increases in the first five years, providing for grants of stock options to the pilots instead. The announcements by Delta, American, TWA, Continental and Southwest further illustrate the trend among the major U.S. airlines to restructure in order to reduce operating and other costs and enable them to compete in a low fare environment. See Item 1. \"Business - Industry Restructuring.\"\nThe Company is actively pursuing several initiatives in an effort to enhance its revenues and to reduce USAir's costs. The Company's goal is to achieve a pre-tax margin of 3.0% in the next one to two years and a 7.5% pre-tax margin longer term. The Company believes that it must reduce USAir's annual operating expenses by approximately $1 billion in order to achieve its margin goals.\nThe Company is seeking to realize half, or approximately $500 million, of the $1 billion of annual savings through reductions in personnel costs, which are the largest single component of USAir's operating costs. USAir is engaged in discussions with the leadership of its unionized employees regarding the $500 million annual savings in personnel costs it desires to achieve through wage and benefit reductions, improved productivity, and other cost savings and has reached an agreement in principle with ALPA. The agreement in principle is subject to many significant conditions. See Item 1. \"Business - Agreement in Principle with Pilots' Union.\" The timing and outcome of USAir's discussions with its other labor unions are uncertain. No assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. Even if the savings described above are achieved, it remains uncertain whether they will be adequate in light of the Company's financial condition and competitive position. See Item 1. \"Business - Major Airline Operations.\"\nThe Company plans to achieve the remaining $500 million in annual cost savings through a combination of initiatives including: organizational and process re-engineering; rationalization of USAir's jet fleet; centralization of USAir's purchasing function; operations research initiatives intended to improve operational efficiency and maximize passenger revenue generation; and the outsourcing of certain cargo, catering, and communications positions. The Company currently expects to realize at least $250 million to $300 million savings from these initiatives during 1995 and will continue to pursue additional savings. However, there can be no assurance that these savings will be fully realized. See Item 1. \"Business - Major Airline Operations\" for additional discussion about the various initiatives.\nUSAir has implemented several programs intended to enhance its results of operations. These include USAir's quick turn program which results in increased utilization of aircraft, facilities, and personnel. In January 1995, USAir introduced a convertible passenger cabin in certain markets which will allow USAir to offer a premium service, branded \"Business Select,\" to higher yield business passengers. USAir expects to determine whether to expand the Business Select service later in 1995. This modification involves substantial one-time implementation costs and there can be no assurance that other airlines will not implement similar service. At least one other major U.S. airline has announced plans to initiate service which USAir believes is similar to Business Select. See Item 1. \"Business - Major Airline Operations\" for additional information about these programs.\nIn March 1995, USAir announced plans to cut capacity through- out its system by five percent as part of its efforts to return to profitability. It intends to emphasize the strengths of its hubs in Pittsburgh, Charlotte, Philadelphia and Baltimore, as well as other major east coast urban centers. USAir expects that this downsizing will produce over $100 million in annual financial benefits. See Item 1. \"Business - Major Airline Operations.\" In addition, the Company is evaluating and considering other strategic options, including further downsizing, which may be available to address the difficult financial and competitive factors facing USAir.\nIn order to reduce aircraft ownership costs and to reduce its fleet size, USAir has been pursuing the sale and lease of jet aircraft and has not renewed certain aircraft leases upon their expiration. USAir currently plans to reduce its operating fleet by 21 jet aircraft in 1995 from December 31, 1994 levels. USAir has taken delivery of four Boeing 757-200 aircraft in the first quarter of 1995 and intends to purchase the remaining three Boeing 757-200 aircraft scheduled to be delivered in the remainder of 1995, for which financing commitments have been obtained. It plans to retire or dispose of, at various times, 15 Boeing 737-300, five Boeing 767-200ER, two Boeing 737-200 and six Boeing 727-200 aircraft. These plans are subject to change if a labor deal is consummated, but the Company cannot predict at this time the potential impact of a labor deal on its fleet reduction plans. USAir has entered into\nan agreement with General Electric Capital Corporation (\"GE Capital\") to sell 11 Boeing 737-300 aircraft during 1995, two of which were sold in the first quarter of 1995. USAir has also reached an agreement in principle to sell two Boeing 737-300 aircraft to a leasing company during 1995. USAir believes that it will recognize a slight financial statement loss as a result of the sales of the Boeing 737-300 aircraft and cannot estimate the financial statement impact of other potential transactions at this time. Pursuant to resolutions of the boards of directors of the Company and USAir, USAir is required to use the net proceeds from contemplated aircraft sales to repay debt. Excluding any Boeing 767-200ER dispositions, USAir's capacity, as measured by available seat miles (\"ASMs\"), is expected to decrease approximately 2.5% in 1995 compared with 1994. See Item 1. \"Business - Major Airline Operations.\"\nIn its negotiations with its unions, USAir has offered an ownership stake in the Company. There are recent examples of companies in the airline industry which have obtained employee concessions in agreements also resulting in the recapitalization of the companies, including employee ownership stakes and employee participation in corporate governance. In other cases, airlines have filed for bankruptcy protection under Chapter 11 of the Bankruptcy Code, and some airlines have ceased operation altogether when their operating costs remained excessive in relation to their revenues, and their liquidity became insufficient to sustain their operations. In addition, other factors beyond the Company's control, such as a downturn in the economy, a dramatic increase in fuel prices or intensified industry fare wars, could have a material adverse effect on the Company's and USAir's prospects, liquidity and financial condition. Because the Company and USAir are highly leveraged and currently do not have access to bank credit and receivables facilities which had supplied a substantial portion of their liquidity, or to public debt and equity markets because of their financial condition and current financial outlook, they are more vulnerable to these factors than their financially stronger competitors. See Item 1. \"Business - Significant Impact of Low Cost, Low Fare Competition\" and \"Liquidity and Capital Resources.\"\nBecause of the Company's poor financial results, it began to defer quarterly dividend payments on all series of its preferred stock in September 1994. Furthermore, the Company is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. Capital surplus is the amount of net assets which remain after deducting the capital portion of preferred and common equity. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends on all outstanding common and preferred stock issuances until its capital surplus becomes positive. Even if the Company is successful in restructuring its costs, there can be no assurance when or if preferred dividend payments will resume. See Notes 8 and 9 to the Company's consolidated financial statements.\nFrequent Traveler Program\nEach major airline has developed a frequent traveler program that offers its passengers incentives to maximize travel on that particular carrier. Participants in such programs typically earn \"mileage credits\" for every trip they fly that can be redeemed for airline travel or, in some cases, for other benefits. Under USAir's Frequent Traveler Program (\"FTP\"), participants generally receive mileage credits equal to the greater of actual miles flown or 750 miles (500 miles effective May 1, 1995) for each paid flight on USAir or USAir Express, or actual miles flown on one of USAir's FTP airline partners. Participants generally receive a minimum of 1,000 mileage credits for each paid flight on USAir Shuttle (500 miles effective May 1, 1995). Participants flying on first or business class tickets receive additional credits. Participants may also earn mileage credits by utilizing certain credit cards, staying at participating hotels or by renting cars from participat- ing car rental companies.\nMileage credits can be redeemed for certificates for various travel awards, including fare discounts, first class upgrades and tickets on USAir or other airlines participating in USAir's FTP. Certain awards also include hotel and car rental awards. Award certificates may not be brokered, bartered or sold, and have no cash value. USAir and its airline partners limit the number of seats allocated per flight for award recipients. The number of seats varies depending upon flight, day, season and destination. Award travel for all but USAir's most frequent travelers generally is not permitted on blackout dates, which correspond to certain holiday periods in the United States or peak travel dates to foreign destinations. Hotel and car awards are valid at partici- pating locations, subject to availability, and are not available for use on specified blackout dates. USAir reserves the right to terminate the FTP or portions of the program at any time, and the FTP's official rules, partners, special offers, blackout dates, awards and mileage levels are subject to change with or without prior notice.\nUSAir accounts for its FTP under the incremental cost method, whereby travel awards are valued at the incremental cost of carrying one additional passenger. Such costs are accrued when FTP participants accumulate sufficient miles to be entitled to claim award certificates. Incremental costs include unit costs for passenger food, beverages and supplies, fuel, reservations, communications, liability insurance and denied boarding compensa- tion expenses expected to be incurred on a per passenger basis. No profit or overhead margin is included in the accrual for incremen- tal costs. No liability is recorded for airline, hotel or car rental award certificates that are to be honored by other parties because there is no cost to USAir for these awards.\nEffective January 1, 1995, USAir increased the minimum mileage level required for a free domestic flight from 20,000 to 25,000. FTP participants had accumulated mileage credits for approximately 3,697,000 awards (using the new 25,000 mile level) at December 31,\n1994. The accumulated awards at the previous 20,000 mile level would have been 4,596,000 at December 31, 1994, compared with 3,896,000 awards at December 31, 1993 (also at the 20,000 mile level). Because USAir expects that some award certificates will never be redeemed, the calculations of the accrued liability for incremental costs at December 31, 1994 and 1993 were based on approximately 86% and 88%, respectively, of the accumulated credits. Mileage for FTP participants who have accumulated less than the minimum number of mileage credits necessary to claim an award is excluded from the calculation of the accrual. Most participants belong to more than one frequent traveler program and it is not possible to project when or if participants will accrue additional mileage credits required to earn an award. Incremental changes in the liability resulting from additional mileage credits are recorded as part of the regular review process.\nUSAir's customers redeemed approximately 927,000, 841,000 and 626,000 awards for free travel on USAir in 1994, 1993 and 1992, respectively, representing approximately 7.0%, 8.0% and 4.9% of USAir's revenue passenger miles (\"RPMs\") in those years, respec- tively. The number of award redemptions in 1994 may have been stimulated by the impending increase in the minimum mileage level required for a free domestic flight and could also be related to customers' fear about USAir's poor financial performance and future prospects. During 1993, two \"free ticket for segments flown\" promotions were completed which increased the number of awards used for free travel on USAir. These promotions were offered in response to similar promotions offered by USAir's competitors. USAir does not believe that usage of FTP awards results in any significant displacement of revenue passengers. USAir has the ability, through its inventory management system, to identify markets and flights expected to have high load factors and, through capacity controls, to maximize use of FTP awards on flights with lower demand and available seats. Also, blackout dates forestall the usage of awards on peak travel days. Furthermore, USAir's exposure to the displacement of revenue passengers is not signifi- cant, as the number of USAir flights that depart 100% full is minimal. In the third quarter of 1994, when the highest number of free frequent traveler miles were flown, for example, fewer than 4.0% of USAir's flights departed 100% full. During this same quarterly period, approximately 3.1% of USAir's flights departed 100% full and also had one or more passengers on board who were traveling on FTP award tickets.\nAirlines often use other competitive promotions, such as offering extra credits or reduced award thresholds under certain conditions, as incentives to stimulate travel. To the extent these promotions are determined to be an integral part of the FTP, they are accounted for in the same manner as free travel earned through mileage credits.\nA recent decision by the U.S. Supreme Court involving American held that members of frequent traveler programs may file contract claims against airlines in state courts. In February 1995, members of USAir's frequent traveler program filed a class action lawsuit\nagainst USAir after it raised the required minimum level of miles necessary to earn a free ticket. See Item 3. \"Legal Proceedings.\" It is possible that additional lawsuits, including class action suits, could be brought against carriers, including USAir, by members of frequent traveler programs. In addition, the DOT has expressed concern about potential consumer fraud relating to frequent traveler programs and their restrictions on the use of awards. It is uncertain whether USAir will be named party in any further litigation or if the DOT will take any action with respect to frequent traveler programs. The Company cannot determine the potential effect, if any, of the existing or potential class action lawsuits or possible DOT actions on its results of operations and financial condition.\nIndustry Globalization and Regulation\nThe trend toward globalization of the airline industry has accelerated in recent years as certain U.S. and foreign carriers have formed marketing alliances. Certain foreign carriers have made substantial investments in U.S. carriers which have frequently been tied to marketing alliances or, less frequently, reciprocal investments by the U.S. carrier in its foreign partner. Foreign investment in U.S. air carriers is restricted by statute and may be subject to review by the U.S. Department of Transportation (\"DOT\") and, on antitrust grounds, by the U.S. Department of Justice (\"DOJ\").\nOn January 21, 1993, USAir Group and BA entered into an Investment Agreement (\"Investment Agreement\") under which a wholly- owned subsidiary of BA has to date purchased certain preferred stock of the Company for $400.7 million. On March 7, 1994, BA announced that it would not make any additional investments in the Company until results of its efforts to reduce its costs are known. Under the Investment Agreement, USAir and BA have entered into a code sharing arrangement under which certain domestic USAir flights, connecting to certain BA transatlantic flights, may be listed on computerized reservation systems either under USAir's or BA's two letter designation code, subject to authorization by the DOT. As of March 1, 1995, USAir and BA offered code share service to and from 52 of the 65 airports authorized by the DOT. On January 13, 1995, USAir and BA filed applications to renew for another one year term the existing authorizations which were granted on March 17, 1994. The DOT has taken no action with respect to the renewal applications. Therefore, the existing authorizations have been extended automatically until final action is taken by the DOT. In January 1994, USAir and BA filed applica- tions with the DOT to code share to 65 additional domestic and seven additional foreign destinations. The DOT has not yet acted on these applications. See Item 1. \"Business - British Airways Investment Agreement\".\nUSAir believes that the code sharing arrangement provides greater access to international traffic and that its and BA's customers benefit from better on-line connections as well as coordinated check-in and baggage checking procedures. The DOT may\ncontinue to link further renewals of the code share authorization to the United Kingdom's (\"U.K.\") liberalization of U.S. air carrier access to the U.K. markets. However, the code sharing arrangement is expressly permitted under the bilateral air services agreement between the U.S. and U.K. USAir expects that the authorization will be renewed in the future; however, there can be no assurance that this will occur. USAir does not believe that the DOT's failure to renew the code share authorization or grant the pending application would result in a material adverse change in its financial condition. However, further investment in the Company by BA, as contemplated in the Investment Agreement, may be less likely. See Item 1. \"Business - British Airways Announcement Regarding Additional Investments in the Company\" and \"- British Airways Investment Agreement.\"\nAs part of its initiative in the transportation industry, the Clinton Administration had indicated that the DOT would conduct a comprehensive examination of the \"high density rule\" which limits airline operations at Chicago O'Hare, New York's LaGuardia (\"LaGuardia\") and John F. Kennedy International, and Washington National (\"National\") Airports by restricting the number of takeoff and landing slots. As part of its study, the DOT will determine whether the operating limitations imposed by the rule can be elimi- nated or modified to better utilize available capacity at these airports. The DOT has not yet released the results of its study. USAir holds a substantial number of slots at LaGuardia and National, including slots purchased from Continental in 1992 and those assigned a value when the Company acquired Piedmont Aviation, Inc. in 1987. Any DOT action which would eliminate those slots or compel USAir to transfer those slots could have a material adverse effect on USAir's operations and financial position. Revision of the high density rule at National, however, would require legisla- tion by Congress.\nResults of Operations\n1994 Compared with 1993\nAdverse weather during the first quarter, the two aircraft accidents which occurred during the third quarter, the intense competitive environment characterized by the growth of low cost, low fare airlines in USAir's markets, widespread industry fare discounting, and USAir's cost structure are factors that had a negative effect on the Company's results of operations during 1994. To the extent that certain of these factors continue to be present, particularly USAir's higher cost structure relative to its competitors, the Company's results of operations and financial condition will continue to be materially and adversely affected.\nThe Company recorded a net loss of $684.9 million on revenue of $7.0 billion for 1994, compared with a net loss of $393.1 million on revenue of $7.1 billion for 1993. The Company estimates that severe winter weather in the first quarter of 1994 negatively affected its results of operations by approximately $50 million and that the effect of the two aircraft accidents during the third and\nfourth quarters of 1994 produced a revenue shortfall of approxi- mately $150 million from forecast amounts.\nThe financial results for 1994 include: (i) a $172.9 million charge related to USAir's grounded BAe-146 fleet and to USAir's decision to cease operations of its remaining Boeing 727 aircraft in 1995; (ii) a $54.0 million charge for obsolete inventory and rotables to reflect market values; (iii) a $25.9 million charge related to USAir's decision to reduce substantially service between Los Angeles and San Francisco in November 1994; (iv) a $28.3 million gain resulting from the sale of certain aircraft and assets to Mesa Air Group, Inc. (formerly Mesa Airlines, Inc.) (\"Mesa\") and the accounting treatment of the hull insurance recovery on the aircraft destroyed in the September accident; and (v) a $1.7 million charge related to the sale of assets to Mesa. The following table indicates where these items appear in the Company's consolidated statement of operations which is found in Part II, Item 8A. of this report ($ millions, brackets denote expense):\nIn addition to the above charges, USAir recorded a $50 million addition to passenger transportation revenue in the fourth quarter of 1994 to adjust estimates made during the first three quarters of 1994.\nThe financial results for 1993 included: (i) a $43.7 million charge for the cumulative effect of an accounting change, as required by Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits;\" (ii) a $68.8 million charge for severance, early retirement, and other person- nel-related expenses for a workforce reduction of approximately 2,500 full-time positions; (iii) a $36.8 million charge based on a projection of the repayment of certain employee pay reductions; (iv) a $13.5 million charge for certain airport facilities at locations where USAir has, among other things, discontinued or reduced its service; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership, which operates a computerized reservations system; and (vi) an $18.4 million credit related to non-operating aircraft. The following table indicates where these items (excluding the accounting change) appear in the Company's statement of operations which is found in Part II, Item 8A. of this report ($ millions, brackets denote expense):\nOperating Revenue - Increases in traffic which were stimulated by the lower fares during 1994 were not sufficient to offset USAir's lower yields (revenue per RPM) experienced during 1994. The Company expects that capacity, as measured by ASMs, will decrease by approximately 2.5% in 1995 compared with 1994, and yields will be relatively unchanged for the entire year 1995 compared with 1994. The Company believes that for the foreseeable future the demand for higher yield \"business fares\" will remain essentially flat and relatively inelastic while the lower yield \"leisure\" market will continue to grow with the general economy. This trend will make it more difficult for the domestic airlines, including USAir, to achieve meaningful yield increases in the future.\nAs discussed above, severe winter weather in the first quarter of 1994 had a material adverse effect on the Company's operations and financial results. Passenger transportation revenue increased during the second quarter compared with 1993 because increases in passenger traffic more than offset the dilutive effect of the lower fares. However, this trend did not continue in the third and fourth quarters primarily due to the reduced number of passengers following the two aircraft accidents. By early 1995, USAir's traffic had recovered from the effects of the accidents and approached a level normally associated with USAir's capacity in the marketplace.\nThe Company's Passenger Transportation Revenue decreased $197.4 million (3.0%) in 1994 compared with 1993, $159.6 million of which is attributable to USAir and the remainder to the Company's wholly-owned regional airlines. Despite the negative effect of the adverse weather during the first quarter and the two accidents during the third quarter, USAir's scheduled traffic as measured by RPMs increased by 7.7% during 1994 on 2.6% of additional capacity, as measured by ASMs, resulting in a 3.0 percentage point increase in passenger load factor, a measure of capacity utilization. However, USAir's yield decreased by 9.6% in 1994 compared with 1993 due to several factors including lower fares resulting from increased competition from low cost, low fare carriers in USAir's markets and industry fare discounting promotions. USAir expects that its yield for the year 1995 will be relatively unchanged compared with 1994. The Company expects that the low fares offered in response to low cost, low fare competition will generally remain in place and, even if traffic is stimulated, will continue to materially and adversely affect its results of operations unless USAir is successful in reducing its operating costs.\nIn March 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit, which alleged that the airlines used the Airline Tariff Publishing Company to signal and communi- cate carrier pricing intentions and otherwise limit price competi- tion for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers have issued $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates, and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir has estimated that any incremental cost associated with the settlement will not be material based on the nominal equivalent free trips associated with the settlement. The travel certificates were mailed to claimants in December 1994 and may be applied towards travel purchased between January 1995 and December 1998.\nOn October 11, 1994, USAir and seven other carriers entered into a settlement agreement with a group of State Attorneys General resolving similar issues with the states. The settlement entitles passengers traveling within the United States on state government business to a 10% discount off the published fares of each of the settling carriers and will be available for 18 months or until the combined discount amount reaches $40 million. Following a notice and public comment period, the reviewing judge will conduct a hearing to determine whether this settlement is a fair one. The hearing is scheduled for May 10, 1995. The Company does not expect that this settlement will have a material adverse effect on its financial condition or results of operations. As was the case with the settlement of the private antitrust litigation, it is difficult to predict the amount of discounted state travel that will occur on USAir. Thus, a dollar impact of the settlement cannot be estima- ted.\nThe Company's Cargo and Freight revenue decreased $10.2 million (5.9%) due to USAir's $10.1 million (5.9%) decrease caused by overall lower volumes and lower mail yields during 1994. The $121.6 million (34.3%) increase in the Company's Other Revenue ($125.2 million or 33.8% for USAir) is the result of several factors including the wet lease arrangement between USAir and BA, increased volume and rate for cancellation and rebooking fees, and fees from companies which participate in USAir's frequent traveler program. These increases are largely offset by increases in other operating expenses. The duration of the British Airways wet lease revenue is expected to be no more than a three year period for each of the three aircraft involved. One each of the three aircraft began the wet lease service in the months of June 1993, October\n1993, and January 1994. The Company expects that the increased levels in the other categories will continue.\nExpense - The Company's Personnel Costs increased $48.4 million (1.7%) primarily due to USAir's $55.2 million (2.0%) increase in personnel costs. Excluding the effect of the unusual charges discussed and presented in the tables above, USAir's personnel costs increased $157.3 million (6.1%) in 1994 compared with 1993 due to the expiration during 1993 of employee wage reductions, subsequent contractual and general salary increases, and a lower discount rate used during 1994 in the calculation of pension and postretirement benefit expense. These increases more than offset any expense reductions realized as a result of the workforce reduction during 1994. Aviation Fuel expense decreased $38.2 million (5.4%), primarily because of USAir's $35.6 million (5.2%) decrease, which is the result of an 8.8% reduction in the cost of fuel partially offset by a 3.8% increase in consumption compared with 1993. Fuel prices are expected to increase during 1995. Further, a 4.3 cent per gallon tax on transportation fuels is scheduled to become effective within the airline industry on October 1, 1995. This tax increase would result in over $50 million of additional annual expense for the Company. However, in early 1995 legislation was introduced to repeal the tax on transportation fuels scheduled to become effective October 1, 1995 in the airline industry. There can be no assurance if or when this legislation will be passed. See Item 1. \"Business - Jet Fuel\" and Note 2 to the Company's consolidated financial statements. The Company's Commissions expense decreased $13.6 million (2.3%) and $10.6 million (1.9%) at USAir as a result of decreased passenger revenue. In early 1995, several large carriers, including USAir, announced limits on the amount of travel agent commissions they will pay. See Item 1. \"Business - General Industry Conditions\" and Note 4 to the Company's consolidated financial statements. The Company's Other Rent and Landing Fees expense decreased $9.3 million (2.1%) and $9.4 million (2.2%) at USAir primarily due to lower operating costs at certain airport facilities. See Item 2. \"Properties.\" The Company's Aircraft Rent increased $91.0 million (19.2%) primarily due to USAir's $89.8 million (20.8%) increase. Excluding the effect of the unusual charges discussed and presented in the tables above, USAir's aircraft rent decreased $25.7 million (6.0%) in 1994 compared with 1993 due to the expiration or renegotiation of several aircraft leases and additional wet lease service over 1993 levels. The Company's Aircraft Maintenance increased $18.1 million (4.8%) primarily because of USAir's $26.9 million (8.7%) increase which resulted from the $18.4 million credit in 1993 (see above table) and initial repairs on certain of USAir's newer aircraft in 1994. The Company's Depreciation and Amortization expense increased $55.2 million (15.7%) due to USAir's $61.0 million (18.8%) increase. Excluding the effect of\nthe unusual charges discussed and presented in the tables above, USAir's depreciation and amortization expense increased $16.6 million (5.3%) in 1994 compared with 1993 primarily due to the delivery of new Boeing 757-200 aircraft. The $158.0 million (11.4%) increase in the Company's Other Expenses, Net is due to USAir's $146.0 million (10.9%) increase. Excluding the effect of the unusual charges discussed and presented in the tables above, USAir's other expenses, net increased $65.0 million (4.9%) in 1994 compared with 1993 largely due to increases in several passenger volume-related expense categories and expenses related to the increase in USAir's other revenue category discussed above.\nThe Company's Interest Income improved by $14.5 million as a result of higher cash levels and more favorable interest rates in 1994. USAir's results include intercompany transactions which are eliminated from the Company's results. The Company's Interest Expense increased $34.1 million (13.7%) primarily as a result of interest incurred on certain aircraft-secured and unsecured financings completed during 1993 and 1994. Interest Capitalized decreased $4.0 million (22.5%) because average deposits for future aircraft deliveries were lower during 1994 compared with 1993. Other, Net reflects an $83.7 million improvement primarily due to the $28.3 million gain discussed above and improved equity results from USAir's 11% ownership investment in the Galileo International Partnership, which owns and operates the Galileo Computerized Reservation System (\"CRS\"), and USAir's 21% ownership investment in the Apollo Travel Services Partnership, which markets the Galileo CRS in the U.S. and Mexico.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). The adoption of FAS 109 resulted in no cumulative adjustment. Results for 1994 and 1993 do not include any income tax credit due to the FAS 109 limitations in recognizing a current benefit for net operating losses. See Note 6 to the Company's consolidated financial statements for additional information.\n1993 Compared with 1992\nThe Company recorded a net loss of $393.1 million on revenue of $7.1 billion in 1993 compared with the 1992 net loss of $1.2 billion on revenue of $6.7 billion. Several unusual items, which include the cumulative effect of accounting changes, make it diffi- cult to compare these results. After excluding the effect of the unusual items discussed below, which amount to $153.2 million and $759.3 million in 1993 and 1992, respectively, the net loss would have been $239.9 million in 1993 ($5.69 per common share after preferred dividend requirement) compared with a loss of $469.6 million in 1992 ($11.09 per common share after preferred dividend requirement).\nThe Company's 1993 financial results contain $153.2 million of unusual items discussed above. The Company's 1992 financial results contain $759.3 million of unusual items, including (i) a $628.1 million charge for the cumulative effect of an accounting change, as required by Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"); (ii) a $107.4 million charge related to aircraft which have been withdrawn from service; (iii) a $34.1 million loss related to the sale of ten McDonnell Douglas 82 (\"MD-\n82\") aircraft which USAir had on order but eliminated from its fleet plan; and (iv) a $10.3 million gain resulting from the sale of three of the Company's subsidiaries during 1992. The following table indicates where these items (excluding the accounting change) appear in the Company's consolidated statement of operations which is found in Part II, Item 8A. of this report ($ millions, brackets denote expense):\nOperating Revenue - The Company's Passenger Transportation Revenue increased by $356.5 million (5.8%) in 1993 compared with 1992, primarily due to the $296.0 million (5.1%) increase at USAir. USAir's RPMs increased by 0.4% during 1993 on 0.3% less capacity, as measured by ASMs, resulting in a 0.4 percentage point increase in passenger load factor, a measure of capacity utilization. USAir's yield increased by 4.7% in 1993 compared with 1992 due to the lower level of fare discounting in 1993 versus 1992. Several factors during 1992 led to an industry-wide 50%-off sale for summer travel that year.\nThe Company's Other Revenue increased by $38.8 million (12.3%) in 1993. USAir's increase of $90.5 million (32.3%) was partially offset at the Company level by a decrease in non-airline subsidiary revenue resulting from the sale of three wholly-owned subsidiaries in July 1992. USAir's 32.3% improvement was the result of several factors including the wet lease arrangement between USAir and BA, increased volume and rate for cancellation and rebooking fees, contract services performed for USAir Shuttle under a management agreement, and fees from companies which participate in USAir's frequent traveler program. These increases were largely offset by increases in operating expenses. The USAir Shuttle service revenue is related to USAir's agreement to manage the USAir Shuttle which began in 1992 and will continue for up to ten years from that date.\nExpense - The Company's total operating expenses increased $146.3 million (2.1%) in 1993 compared with 1992. The Company's Personnel Costs increased by $217.7 million (8.3%), $205.6 million of which is attributable to USAir. Without the effect of the unusual charges discussed above, USAir experienced an increase in employee salaries of $91.4 million (4.7%) and an increase in employee benefits of $11.8 million (2.1%). The increase in employee salaries is generally due to contractual and general salary increases which occurred during 1993. The amount saved as a result of USAir's 12-month salary reduction program was approxi- mately the same in 1993 and 1992. The $11.8 million increase in employee benefits is the result of increased pension expense,\noffset partially by a decrease in other postretirement benefit expense. The increased pension expense in 1993 resulted from the establishment of a defined contribution pension plan for USAir's non-contract employees on January 1, 1993. The defined benefit plan for these employees was frozen at December 31, 1991.\nThe Company's Aviation Fuel Expense decreased $43.2 million (5.7%) due to USAir's $42.8 million (5.9%) decrease which resulted from a lower cost per gallon and decreased consumption. The Company's Commissions increased by $27.2 million (4.8%), reflecting USAir's $22.1 million (4.1%) increase which resulted from the increase in Passenger Transportation Revenue. The Company's Other Rent and Landing Fees increased $56.9 million (14.6%) due to USAir's $57.3 million (15.3%) increase which was primarily the result of increased facility rental expense following the opening of the new terminal at Pittsburgh in October 1992. The Company's Aircraft Rent expense decreased $57.4 million (10.8%) due to USAir's $64.4 million (13.0%) decrease. Without the unusual charges discussed above, USAir's aircraft rent expense increased $8.0 million (1.9%) due to the addition of new leased aircraft in 1993. Excluding the effect of the unusual items discussed above, the Company's and USAir's Aircraft Maintenance expense increased by $37.6 million (10.6%) and $33.3 million (11.3%), respectively, resulting from USAir's timing of aircraft maintenance cycles. The Company's Other Operating Expense decreased by $57.4 million (4.0%), reflecting a $24.4 million (1.8%) decrease at USAir and a $58.4 million decrease which resulted from the sale of three wholly-owned subsidiaries in July 1992, offset by increases at the Company's other wholly-owned subsidiaries.\nThe Company's Interest Capitalized decreased $10.0 million (36.1%) as the level of outstanding purchase deposits decreased with the delivery of new aircraft and changes in delivery sched- ules. The $9.5 million (21.8%) improvement in the Company's Other Non-operating Expense, net is driven by the unusual gains and losses described above.\nEffective January 1, 1993, the Company adopted FAS 109. The adoption of FAS 109 resulted in no cumulative adjustment. Results for 1993 do not include any income tax credit due to the FAS 109 limitations in recognizing a current benefit for net operating losses. See Note 6 to the Company's consolidated financial statements for additional information.\nInflation and Changing Prices\nInflation and changing prices do not have a significant effect on the Company's operating revenues and expenses (other than depreciation and amortization) because such revenues and expenses generally reflect current price levels.\nDepreciation and amortization expense is based on historical cost. For assets acquired through the purchase of Pacific Southwest Airlines, USAir's historical cost is based on fair market value of the assets on May 29, 1987. In the case of Piedmont\nAviation, Inc., USAir's historical cost is based on the fair market value of the assets on November 5, 1987, reduced by the tax effect of that portion of fair market value not deductible for tax purposes in the form of depreciation and amortization. Therefore, aggregate depreciation and amortization is lower than if this expense reflected today's replacement costs for existing productive assets. In evaluating how inflation would increase depreciation expense, however, consideration should also be given to the reduction in other operating expenses, such as aircraft maintenance and aviation fuel, that would be achieved from the operating efficiencies of newer, more technologically advanced productive assets.\nLiquidity and Capital Resources\nCash provided by operations was approximately $1 million in 1994. At December 31, 1994, cash and cash equivalents totaled approximately $429.5 million and short-term investments totaled approximately $22.1 million. These amounts exclude approximately $161.1 million which was deposited in trust accounts to collateral- ize letters of credit or workers compensation policies and classified as \"Other Assets.\" Due to the coincidence of certain semiannual, quarterly and monthly debt and lease payments, substantial scheduled payments of more than $170 million were due and paid in the month of January 1995. The Company ended the first quarter of 1995 with approximately $400 million in cash and short- term investments, substantially higher than previously expected primarily due to the timing of certain working capital activity. However, market, economic and other factors discussed below could adversely affect the Company's future liquidity position.\nThe Company and USAir are highly leveraged. In order to meet debt service, lease and other obligations and to finance daily operations, the Company and USAir require substantial liquidity and working capital. In view of the Company's limited liquidity in relation to the size of USAir's operations and its associated obligations, developments may occur that are beyond the control of the Company and USAir which could have a material adverse effect on the Company's prospects, liquidity and financial condition, including intensified fare wars, substantial increases in jet fuel prices, adverse weather conditions, negative public perception regarding safety, and further incursion by low cost, low fare carriers into USAir's markets. USAir is seeking in discussions with the leadership of its unionized employees substantial wage reductions, improved productivity and other cost savings and has reached an agreement in principle with ALPA that is subject to various significant conditions. See Item 1. \"Business - Agreement in Principle with Pilots' Union.\" However, if unforeseen adverse developments occur, if the Company and USAir are unable to finance unencumbered assets, or if timely agreements with the unions are not finalized and consummated, the Company and USAir may pursue other restructuring alternatives. See Item 1. \"Business - Signifi- cant Impact of Low Cost, Low Fare Competition\" and \"Low Cost, Low Fare Competition\" above.\nThe Company has deferred the dividend payments on all series of its preferred stock. The aggregate annual dividend requirements related to all series of the Company's preferred stock total approximately $80 million. Furthermore, the Company is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends on all outstanding common and preferred stock issuances until its capital surplus becomes positive. Even if the Company is successful in restructuring its costs, there can be no assurance when or if dividend payments will resume. See Notes 8 and 9 to the Company's consolidated financial statements for additional information.\nThe Company currently is not party to a revolving credit facility. The Company has historically utilized such a facility to supplement its liquidity from time to time. On April 26, 1994, the Company terminated its revolving credit facility with a group of banks (\"Credit Agreement\"). As a result, 66 jet and turboprop aircraft and certain spare engines with a net book value of approximately $260 million at that time were released from a mortgage related to the Credit Agreement. Certain of the Boeing 737-300 aircraft which USAir has agreed to sell are among the 66 unencumbered aircraft. Pursuant to resolutions of the boards of directors of the Company and USAir, USAir is required to use any proceeds from the contemplated aircraft sales to repay certain debt. USAir has notified one of its creditors that it intends to prepay approximately $60 million in aircraft-secured debt in May 1995 and will use proceeds from asset sales to make the payment.\nUSAir's revolving accounts receivable sale program (\"Receiv- ables Agreement\") expired in December 1994. USAir was unable to sell receivables under the agreement during 1994 because of failure to comply with financial covenants required to be maintained in connection with that agreement. USAir is currently engaged in discussions with the financial institution that was party to the Receivables Agreement regarding a new agreement. There can be no assurance that USAir will be successful in reaching a new agreement to sell its receivables.\nOn May 12, 1994, USAir reached an agreement with Boeing to reschedule the delivery of 40 737-series aircraft from the 1997- 2000 time period to the years 2003-2005. In addition, as part of the same agreement, USAir relinquished all of its options to purchase aircraft during the 1996-2000 time period. In early 1995, USAir reached an agreement in principle with Boeing and Rolls-Royce plc to reschedule the delivery dates for eight 757-200 aircraft from 1996 to 1998. As a result of these recent agreements, the Company's capital commitments have been substantially reduced for the 1995-2000 time period. See Note 4 to the Company's consolidat- ed financial statements for the future aircraft commitments schedule reflecting these agreements with Boeing and for future expenditures required to comply with Stage 3 noise level require- ments of the FAA. During 1993 to the present time, USAir's\nagreements with Boeing to defer and reschedule certain Boeing 737- series and 757-200 deliveries reduced USAir's capital expenditures by over $1 billion between 1993 and 1996 from previously planned amounts.\nThe Company's and USAir's debt and equity securities are presently rated below investment grade by Standard and Poor's Corporation (\"S&P\") and Moody's Investors Service, Inc. (\"Moody's\"). In February 1994, as a result of USAir's low fare initiative in certain markets and its high cost structure, S&P and Moody's placed the securities of the Company and USAir on watch with negative implications. On March 24, 1994, S&P downgraded the Company's and USAir's securities. On September 29, 1994, following the Company's announcement that it had deferred payment of preferred dividends, Moody's and S&P further downgraded their ratings of the Company's and USAir's securities. S&P continues to keep the securities of the Company and USAir on watch with negative implications. The ratings of the Company's and USAir's debt and equity securities make it more difficult for the Company and USAir to effect additional financing. On January 19, 1995, Moody's announced that it is revising its rating practice on airline equipment trust and pass through obligations and would consider assigning higher ratings to certain of these securities. At the same time, Moody's placed under review all existing airline equipment trust certificates and pass through obligations (including those of USAir) for possible upgrade. At this time, USAir does not believe that an upgrade by Moody's would have any material positive or negative effect on USAir's ability to effect additional financings.\nUSAir and the Company have filed with the Securities and Exchange Commission a shelf registration for various debt and equity securities. Approximately $187 million of securities remain available for sale on the shelf registration and may be sold from time to time depending on market conditions. The Company will continue to evaluate opportunities in the financial markets. However, the Company believes that the availability of those opportunities will be directly related to USAir's success in restructuring its costs and its resulting financial prospects.\nThe Company and USAir are party to certain financial contracts to reduce exposure to fluctuations in the price of jet fuel and interest rates. Under the jet fuel arrangements, USAir pays a fixed rate per notional gallon of fuel and receives in return a floating rate per notional gallon based on the market rate during the month of settlement. Under the interest rate agreements, the Company pays a fixed rate on a notional principal amount and receives a floating rate on the notional principal in return. Decreases in the market cost of jet fuel and market interest rates below the rates specified in the contracts require the Company and USAir to make cash payments. However, the Company and USAir believe these contracts do not present a material risk to the Company's financial position or liquidity due to the relatively simple terms of the agreements, their purpose, and their short\nremaining duration. See Note 2 to the Company's consolidated financial statements for additional information.\nUSAir and certain of the Company's other subsidiaries have received notices from the U.S. Environmental Protection Agency and various state agencies that they are potentially responsible parties with respect to the remediation of existing sites of environmental concern. The Company believes that the ultimate resolution of known environmental contingencies should not have a material adverse effect on its liquidity or financial position based on the Company's experience with similar environmental sites. See Note 4 to the Company's consolidated financial statements.\nDuring 1994, the Company's investment in new aircraft acquisi- tions and purchase deposits totaled $270.6 million (which includes $224.6 million presented as \"non-cash\" on the Company's consolidat- ed statement of cash flows since debt was incurred upon delivery of aircraft or to satisfy equipment deposit progress payments). USAir took delivery of five new Boeing 757-200 aircraft during 1994. The Company invested $134.1 million in non-aircraft property during 1994 (e.g., ground support equipment, computer equipment, software, aircraft rotables and hushkits, and take-off and landing slots), partly offset by $75.1 million in proceeds from disposition of assets which includes the sale of certain aircraft and assets to Mesa and insurance proceeds related to a jet aircraft involved in the September 1994 accident. Net cash provided by financing activities was $183.4 million, which includes (i) $172.2 million net proceeds received by USAir upon the sale of $175 million principal amount of 9 5\/8% Senior Notes due 2001 through an underwritten public offering and (ii) $136.7 million of new debt issued which is secured by aircraft delivered before 1994, offset by $87.1 million of scheduled debt payments and $49.7 million of preferred dividend payments. In addition, as discussed above, the Company incurred $270.6 million of debt upon delivery of five Boeing 757-200 aircraft and to satisfy equipment deposit progress payments. USAir has committed financing for its 1995 scheduled aircraft deliveries.\nDuring 1993, the Company's investment in new aircraft acquisi- tions and purchase deposits totaled $545.3 million (which includes $343.2 million presented as \"non-cash\" on the Company's consolidat- ed statement of cash flows since debt was incurred upon delivery of aircraft or to satisfy equipment deposit progress payments). USAir took delivery of 11 Boeing 757-200, one Boeing 767-200, and six MD- 82 aircraft during the year. The MD-82s were immediately sold to a third party. In addition, USAir sold two other MD-82 aircraft which had been delivered in the fourth quarter of 1992. Proceeds from the sale of the MD-82s approximated $168 million. The Company completed financing arrangements for, including the $337.7 million issue of Pass Through Certificates (\"Certificates\") which USAir sold through an underwritten public offering on November 1, 1993, or internally funded, all of its 1993 aircraft expenditures. The Company invested $159.0 million in non-aircraft property during 1993 (e.g., ground support equipment, computer equipment, software, aircraft rotables and hush kits, take-off and landing slots).\nOn January 21, 1993, a wholly-owned subsidiary of BA purchased 30,000 shares of the 7% Series F Cumulative Convertible Senior Preferred Stock (\"Series F Preferred Stock\"), for $300 million. Substantially all of the $300 million received by the Company from the sale of the Series F Preferred Stock was used to pay down debt under the Company's Credit Agreement. The Series F Preferred Stock is subject to mandatory redemption on January 15, 2008.\nOn May 4, 1993, the Company sold 11.5 million shares of $1 par value Common Stock at $20.75 per share which netted proceeds of approximately $231 million. BA partially exercised its preemptive right to maintain its proportionate ownership percentage by purchasing, on June 10, 1993, 9,919.8 shares of redeemable Series T-2 Cumulative Exchangeable Senior Preferred Stock (\"Series T-2 Preferred Stock\") for approximately $99.2 million. For additional information, see Note 8 to the Company's consolidated financial statements. On March 7, 1994, BA announced that it would not make any additional investments in the Company until the outcome of measures by the Company to reduce costs and improve its financial results is known.\nOn July 8, 1993, USAir sold $300 million principal amount of 10% Senior Notes due 2003 (\"10% Notes\") through an underwritten public offering. The offering netted proceeds of approximately $294 million. The 10% Notes are unconditionally guaranteed by the Company.\nAll net proceeds received by USAir or the Company from the Common Stock offering, the sale to BA of the Series T-2 Preferred Stock, the sale of the 10% Notes and 9 5\/8% Notes were added to the working capital of the Company for general corporate purposes.\nIn 1992, the Company's investment in new aircraft acquisitions and purchase deposits, net of deposits refunded, totaled $458.7 million (which includes $219.6 million presented as \"non-cash\" on the Company's consolidated statement of cash flows since debt was incurred upon delivery of aircraft or to satisfy equipment deposit progress payments). The Company purchased eight Fokker and four de Havilland Dash 8 aircraft during 1992. The acquisition of these aircraft was financed through a combination of secured debt financings and interim debt financings. In addition, USAir took delivery of four MD-82s, two of which were immediately sold to a third party. The remaining two aircraft delivered in 1992 were sold to a third party in early 1993. Cash outflows for other property during the period totaled $277.2 million, which includes $61 million paid to Continental for landing and take-off slots at LaGuardia and National Airports and $50 million paid to TWA for London routes from BWI and Philadelphia International Airports. See Item 1. \"Business - British Airways Investment Agreement - U.S.-U.K. Routes.\" Proceeds from disposition of assets of $429.5 million were realized during the year, primarily from sale- leaseback transactions, the sale of the two MD-82 aircraft, and the sale of three wholly-owned subsidiaries.\nAt December 31, 1994, USAir Group's ratio of current assets to current liabilities was .49 to 1 and the debt component of USAir Group's capitalization structure was greater than 100% (also greater than 100% if the three series of redeemable preferred stock are considered to be debt) due to the existence of a net capital deficiency.\n(this space intentionally left blank)\nItem 8A. Financial Statements and Supplementary Information USAir Group, Inc.\nIndependent Auditors' Report\nThe Stockholders and Board of Directors USAir Group, Inc.:\nWe have audited the consolidated balance sheets of USAir Group, Inc. and subsidiaries (\"Group\") as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows, and changes in stockholders' equity (deficit) for each of the years in the three-year period ended December 31, 1994. These consoli- dated financial statements are the responsibility of Group'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 USAir Group, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for the three-year period ended December 31, 1994 in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that Group will continue as a going concern. As discussed in Note 4(a) to the consolidated financial statements, Group has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 4(a). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nAs discussed in Note 11 to the consolidated financial statements, effective January 1, 1993, Group changed its method of accounting for postemployment benefits and effective January 1, 1992, Group changed its method of accounting for postretirement benefits other than pensions.\nKPMG Peat Marwick LLP Washington, D. C. February 22, 1995, except as to Notes 4(a) and 4(c) which are as of April 10, 1995\nUSAir Group, Inc. Notes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies\n(a) Basis of Presentation\nThe accompanying consolidated financial statements include the accounts of USAir Group, Inc. (\"USAir Group\" or the \"Company\") and its wholly-owned subsidiaries USAir, Inc. (\"USAir\"), Piedmont Airlines, Inc. (\"Piedmont\"), Jetstream International Airlines, Inc. (\"Jetstream\"), Allegheny Airlines, Inc. (\"Allegheny\") (formerly Pennsylvania Commuter Airlines, Inc. (\"PCA\")), USAir Leasing and Services, Inc. (\"Leasing\"), USAir Fuel Corporation and Material Services Company, Inc. All significant intercompany accounts and transactions have been eliminated.\nAt December 31, 1992, USAM Corp. (\"USAM\"), a subsidiary of USAir, owned 11% of the Covia Partnership (\"Covia\") which owned and operated a computerized reservation system (\"CRS\"). In September 1993, Covia purchased the assets of the corporation that owned and operated the Galileo CRS which provided CRS services to travel agent subscribers in Europe. Covia was immediately separated into three new entities and, as a result, USAM owns 11% of the Galileo International Partnership which owns and operates the Galileo CRS, approximately 11% of the Galileo Japan Partnership which markets the Galileo CRS in Japan, and approximately 21% of the Apollo Travel Services Partnership which markets the Galileo CRS in the U.S. and Mexico. USAM accounts for these investments using the equity method because it is represented on the board of directors of each of the partnerships and therefore participates in policy making processes.\nOn August 1, 1992, two wholly-owned USAir Group regional airline subsidiaries, Allegheny Commuter Airlines, Inc. and PCA, merged. The combined entity is now called Allegheny Airlines, Inc.\nOn July 15, 1992, USAir Group completed the sale of three of its wholly-owned subsidiaries: Piedmont Aviation Services, Inc., Air Service, Inc. and Aviation Supply Corporation. The Company realized a gain of $10.3 million as a result of the sale. The three former subsidiaries engaged in fixed base operations and the sale and repair of aircraft and aircraft components. These subsidiaries were included in the accounts until their sale.\nUSAir Group's principal operating subsidiary, USAir, and three regional airline subsidiaries, Piedmont, Jetstream and Allegheny, operate within one industry (air transportation); therefore, no segment information is provided.\nCertain 1993 and 1992 amounts have been reclassified to conform with 1994 classifications.\n(b) Cash and Cash Equivalents and Short-Term Investments\nFor financial statement purposes, the Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates market value. Short-term investments consist of certificates of deposit and commercial paper with original maturities greater than three months but less than one year. Short-term investments are stated at cost plus accrued interest, which approximates market value.\n(c) Materials and Supplies\nInventories of materials and supplies are valued at average cost and are charged to operations as consumed. An allowance for obsolescence is provided for flight equipment expendable parts.\n(d) 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. Maintenance and repairs, including the overhaul of aircraft components, are charged to operating expense as incurred and costs of major improvements are capitalized for both owned and leased assets. Interest related to deposits on aircraft purchase contracts and facility and equipment construction projects is capitalized as additional cost of the asset or as leasehold improvement if the asset is leased. Depreciation and amortization for principal asset classifications is provided on a straight-line basis to estimated residual values over estimated depreciable lives as follows:\nProperty acquired under capital lease is amortized on a straight-line basis over the term of the lease and charged to Depreciation and Amortization Expense.\n(e) Goodwill, Other Intangibles and Other Assets\nGoodwill, the cost in excess of fair value of identified net assets acquired, is being amortized on a straight-line basis over 40 years. The $629 million goodwill resulting from the acquisition of Pacific Southwest Airlines (\"PSA\") and Piedmont Aviation, Inc. (\"Piedmont Aviation\"), both in 1987, is being amortized as Depreciation and Amortization Expense. Accumulated amortization at December 31, 1994 and 1993 related to the PSA and Piedmont acquisitions was $113 million and $97 million, respectively. The $11 million goodwill resulting from USAM's CRS investments is being amortized as other non-operating expense, consistent with the classification of income or loss on the investments. USAM's associated accumulated amortization at December 31, 1994 and 1993 was $2 million and $1 million, respectively. USAir evaluates whether or not goodwill is impaired by comparing the goodwill balances with estimated future undiscounted cash flows which, in USAir's judgment, are attributable to the goodwill. This analysis is performed separately for the goodwill which resulted from each acquisition.\nIntangible assets consist mainly of purchased operating rights at various airports, purchased route authorities, capitalized software costs and the intangible assets associated with the underfunded amounts of certain pension plans. The operating rights, valued at purchase cost or appraised value if acquired from PSA or Piedmont Aviation, are being amortized over periods ranging from ten to 25 years as Depreciation and Amortization Expense. The purchased route authorities are being amortized over periods of 25 years as Depreciation and Amortization Expense. Capitalized software costs are being amortized as Depreciation and Amortization Expense over five years, the expected period of benefit. Accumu- lated amortization related to intangible assets at December 31, 1994 and 1993 was $80 million and $72 million, respectively.\nBased on the most recent analyses, USAir believes that goodwill and other intangible assets were not impaired at Decem- ber 31, 1994.\nThe increase in Other Assets, net in 1994 is primarily attributable to changes in non-current pension assets. USAir's Other Assets balance includes a $47 million receivable from British Airways Plc related to the relinquishment of two U.S. to London routes.\n(f) Restricted Cash and Investments\nRestricted cash and investments consist primarily of deposits in trust accounts to collateralize letters of credit or workers compensation policies. These amounts are classified as Other Assets on the accompanying balance sheets.\n(g) Deferred Gains on Sale and Leaseback Transactions\nGains on aircraft sale and leaseback transactions are deferred and amortized over the term of the leases as a reduction of rental expense.\n(h) Passenger Revenue Recognition\nPassenger ticket sales are recognized as revenue when the transportation service is rendered. At the time of sale, a liability is established (Traffic Balances Payable and Unused Tickets) and subsequently eliminated either through carriage of the passenger, through billing from another carrier which renders the service or by refund to the passenger.\n(i) Frequent Traveler Awards\nUSAir accrues the estimated incremental cost of providing outstanding travel awards earned by participants in its Frequent Traveler Program when such award levels are reached.\n(j) Investment Tax Credit\nInvestment tax credit benefits have been recorded using the \"flow-through\" method as a reduction of the Federal income tax provision.\n(k) Advertising Costs\nAdvertising costs are expensed when incurred as other operat- ing expense. Advertising expense for 1994, 1993 and 1992 was $63 million $59 million and $84 million, respectively.\n(l) Income (Loss) Per Common Share\nIncome (loss) per common share is computed by dividing net income (loss), after deducting preferred stock dividend require- ments, by the weighted average number of shares of Common Stock outstanding, net of treasury stock. The Company has deferred quarterly dividend payments on all series of its preferred stock beginning September 30, 1994. However, the accumulated unpaid dividends and interest on unpaid dividends continue to be deducted from net income or loss in order to calculate income or loss per common share (see Notes 8 and 9). The 1994 preferred dividend requirement includes dividends deferred (including interest) of $32.8 million, or $0.55 per common share. USAir Group's outstand- ing redeemable Series A Cumulative Convertible Preferred Stock (\"Series A Preferred Stock\"), Series B Cumulative Convertible Preferred Stock (\"Series B Preferred Stock\"), redeemable Series F Cumulative Senior Preferred Stock (\"Series F Preferred Stock\"), redeemable Series T Cumulative Convertible Exchangeable Senior Preferred Stock (\"Series T Preferred Stock\") and Common Stock equivalents are anti-dilutive. See Note 10 regarding Common Stock held in trust by an ESOP.\n(2) Financial Instruments\n(a) Terms of Certain Financial Instruments\nUSAir has entered into hedging arrangements to reduce its exposure to fluctuations in the price of jet fuel. Net settlements are recorded as adjustments to aviation fuel expense. The total notional number of gallons under these arrangements was 86 million and 194 million at December 31, 1994 and 1993, respectively. Under these arrangements, the Company will pay $0.496 to $0.521 per notional gallon in 1995 and receive a floating rate per notional gallon based on current market prices. In 1994, the Company paid $0.481 to $0.594 per notional gallon and received a floating rate per notional gallon based on current market prices. Decreases in the market price of fuel to levels below the fixed prices require cash payments by the Company and cause an increase in the Company's aviation fuel expense. The hedging arrangements represent approxi- mately 7% and 16% of USAir's expected 1995 and actual 1994 fuel consumption, respectively. USAir is party to such hedging arrangements with several entities. Although the agreements, which expire in 1995, expose the Company to credit loss in the event of nonperformance by the other parties to the agreements, the Company does not anticipate such nonperformance because of the favorable creditworthiness status of the other parties. The Company may continue to enter into such arrangements, depending on market conditions.\nThe Company has entered into interest rate swap transactions to manage interest rate exposure. Net settlements are recorded as an adjustment to interest expense. The Company is party to such interest rate swap agreements with banks and other financial institutions. The notional principal amount of these agreements was $150 million at December 31, 1994 and 1993. Under these swap agreements, the Company pays interest at fixed rates averaging 9.8% at December 31, 1994 and 1993, and receives floating rate interest payments based on three-month LIBOR. Although the agreements, which expire in 1995, expose the Company to credit loss in the event of non-performance by the other parties to the agreements, the Company does not anticipate such non-performance because of the favorable creditworthiness status of the other parties.\nAn aggregate of $32 million of future principal payments of USAir's long-term debt due 1998 through 2000 is payable in Japanese Yen. This foreign currency exposure has been hedged to maturity by USAir's participation in foreign currency contracts. Although the Company is exposed to credit loss in the event of non-performance by the counterparty to the contracts, the Company does not anticipate such non-performance because of the favorable credit- worthiness status of the other party.\n(b) Fair Value of Financial Instruments\nUnless a quoted market price indicates otherwise, the fair values of cash and investments generally approximate carrying values because of the short maturity of these instruments. The\nCompany has estimated the fair value of long-term debt based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of similar remaining maturities. The estimated fair values of the Series A Preferred Stock, the Series F Preferred Stock and the Series T Preferred Stock are obtained by consulting with an independent external valuation source. The fair values of interest rate swap agree- ments, energy swap agreements and foreign currency contracts are obtained from dealer quotes whereby these values represent the estimated amount the Company would receive or pay to terminate such agreements.\nThe estimated fair values of the Company's financial instru- ments, none of which are held for trading purposes, are summarized as follows (brackets denote liability):\n* Amounts included in Other Assets on the Company's consolidated balance sheets.\n(3) Long-Term Debt\nDetails of long-term debt are as follows:\nMaturities of long-term debt and debt under capital leases for the next five years are as follows:\n(in thousands) 1995 $ 85,538 1996 84,765 1997 96,005 1998 165,535 1999 89,635 Thereafter 2,459,438\nInterest rates on $529 million principal amount of long-term debt at December 31, 1994 are subject to adjustment to reflect prime rate and other rate changes.\nOn April 26, 1994, the Company terminated its credit agreement dated March 30, 1987, as amended, with a group of banks (\"Credit Agreement\"). During 1994, there were no borrowings under the Credit Agreement. As a result of the termination, 66 jet and turboprop aircraft and certain spare engines with a net book value of approximately $260 million at that time were released from a\nmortgage related to the Credit Agreement. The Company had been in violation of certain covenants at March 31, 1994. The Credit Agreement was scheduled by its terms to expire on September 30, 1994.\nDuring 1993 and 1992, the maximum amount of Credit Agreement borrowings outstanding at any month end was $250 million and $450 million, respectively. All outstanding Credit Agreement borrowings were paid off in May 1993 and no other funds were borrowed during the remainder of 1993. The average amount of Credit Agreement borrowings outstanding and the weighted average interest rate for 1993 were $37 million and 5.8%, respectively. The average amount of Credit Agreement borrowings outstanding and the weighted average interest rate for 1992 were $174 million and 6.2%, respectively.\nEquipment financings totaling $2.2 billion were collateralized by aircraft and engines with a net book value of $2.3 billion at December 31, 1994.\n(4) Commitments and Contingencies\n(a) Operating Environment\nThe U.S. airline industry has undergone dramatic and permanent changes in recent years, generally resulting in lower operating costs and fares. The current competitive environment is the result of several factors including the emergence and expansion of low cost, low fare carriers, the protection and cost restructuring opportunities afforded to certain carriers while operating under Chapter 11 of the Bankruptcy Code, and other cost restructuring initiatives among major airlines, including employee concessions in exchange for equity ownership. The Company has incurred annual operating losses for every year since 1990 and has a net capital deficiency at December 31, 1994. The Company is currently in negotiations with employee labor groups in an effort to obtain employee concessions that will substantially reduce operating costs. On March 29, 1995, USAir and the negotiating committee of the Air Line Pilots Association (\"ALPA\") Master Executive Council, which represents USAir's pilots, signed an agreement in principle on wage and other concessions in exchange for financial returns and governance participation for USAir pilots. The agreement in principle is subject to many significant conditions, including approval of the boards of directors of the Company and USAir and of the shareholders of the Company and the execution of definitive documentation. USAir continues to negotiate with representatives of its other unions but it is uncertain whether any final agree- ments will be reached. No assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. In addition, the Company is evaluating other strategic decisions that could be implemented to improve the operating results of the airline. The Company believes that it must reduce its operating costs substan- tially if it is to survive in this low cost, low fare competitive environment.\n(b) Lease Commitments\nThe Company's airline subsidiaries lease certain aircraft, engines, computer and ground equipment, in addition to the majority of their ground facilities. Ground facilities include executive offices, overhaul and maintenance bases and ticket and administra- tive offices. Public airports are utilized for flight operations under lease arrangements with the municipalities or agencies owning or controlling such airports. Substantially all leases provide that the lessee shall pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased property. Most leases also include renewal options and some aircraft leases include purchase options.\nThe following amounts applicable to capital leases are included in property and equipment:\nAt December 31, 1994, obligations under capital and noncancel- able operating leases for future minimum lease payments were as follows:\nJetstream has the option to lease an additional 20 aircraft. If the options for aircraft leases are exercised, deliveries could begin as early as 1996 and the projected lease payments presented above would increase.\nRental expense under operating leases for 1994, 1993 and 1992 was $748 million, $781 million and $707 million, respectively. The $748 million rental expense for 1994 excludes charges of $103 million related to USAir's grounded BAe-146 fleet and $13 million primarily related to USAir's decision to cease operations of its remaining Boeing 727-200 aircraft in 1995. The $707 million rental expense for 1992 excludes a charge of $72 million related to USAir's grounded BAe-146 fleet.\n(c) Legal Proceedings\nThe Company and various subsidiaries have been named as defendants in various suits and proceedings which involve, among other things, environmental concerns and employment matters. These suits and proceedings are in various stages of litigation, and the status of the law with respect to several of the issues involved is unsettled. For these reasons the outcome of these suits and proceedings is difficult to predict. In the Company's opinion, however, the disposition of these matters is not likely to have a material adverse effect on its financial condition or results of operations.\nUSAir is involved in legal proceedings arising out of its two aircraft accidents that occurred in July and September 1994 near Charlotte, North Carolina and Pittsburgh, Pennsylvania, respec- tively. The National Transportation Safety Board (the \"NTSB\") held hearings beginning in September 1994 relating to the July accident and January 1995 relating to the September accident. In April 1995, the NTSB issued its finding of probable causes with respect to the accident near Charlotte. It assigned as probable causes flight crew errors and the failure of air traffic control to convey weather and windshear hazard information. The NTSB has not yet issued its final accident investigation report for the accident near Pittsburgh. USAir expects that it will be at least two to three years before the accident litigation and related settlements will be concluded. USAir believes that it is fully insured with respect to this litigation and has recovered its hull claims related to the loss of the two aircraft. Therefore, the Company believes that the litigation will not have a material adverse effect on the Company's results of operations or financial condition. However, due to these two aircraft accidents, it is probable that the Company's insurance costs will increase upon renewals of various policies in 1995.\nUSAir and certain of the Company's other subsidiaries have received notices from the U.S. Environmental Protection Agency and various state agencies that it is a potentially responsible party with respect to the remediation of existing sites of environmental concern. Only two of these sites have been included on the Superfund National Priorities List. USAir and the other subsidiar-\nies continue to negotiate with various governmental agencies concerning known and possible cleanup sites. These companies have made financial contributions for the performance of remedial investigations and feasibility studies at sites in Moira, New York; Escondido, California; Newberry Township, Pennsylvania; Elkton, Maryland; and Salisbury, Maryland.\nBecause of changing environmental laws and regulations, the large number of other potentially responsible parties and certain pending legal proceedings, it is not possible to reasonably estimate the amount or timing of future expenditures related to environmental matters. The Company provides for costs related to environmental contingencies when a loss is probable and the amount is reasonably estimable. Although management believes adequate reserves have been provided for all known contingencies, it is possible that additional reserves could be required in the future which could have a material effect on results of operations. However, the Company believes that the ultimate resolution of known environmental contingencies should not have a material adverse effect on the Company's financial position or results of operations based on the Company's experience with similar environmental sites.\nIn March 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit, which alleged that the airlines used the Airline Tariff Publishing Company to signal and communi- cate carrier pricing intentions and otherwise limit price competi- tion for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers have issued $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir estimates that any incremental cost associated with the settlement will not be material based on the nominal equivalent free trips associated with the settlement. The travel certificates were mailed to claimants in December 1994 and may be applied towards travel purchased between January 1995 and December 1998.\nOn October 11, 1994, USAir and seven other carriers entered into a settlement agreement with a group of State Attorneys General resolving similar issues with the states. The settlement entitles passengers traveling within the United States on state government business to a 10% discount off the published fares of each of the settling carriers and will be available for 18 months or until the combined discount amount reaches $40 million. Following a notice and public comment period, the reviewing judge will conduct a hearing to determine whether this settlement is a fair one. The\nhearing is scheduled for May 10, 1995. The Company does not expect that this settlement will have a material adverse effect on its financial condition. As was the case with the settlement of the private antitrust litigation, it is difficult to predict the amount of discounted state travel that will occur on USAir. Thus, a dollar impact of the settlement cannot be estimated.\nIn February and March 1995, several class action lawsuits were filed in various Federal district courts by travel agencies and a travel agency trade association alleging that most of the major U.S. airlines, including USAir, violated the antitrust laws when they individually capped travel agent commissions at $50 for round- trip domestic tickets with base fares above $500 and at $25 for one-way domestic tickets with base fares above $250. USAir intends to vigorously defend itself against the allegations made in these lawsuits. The plaintiffs are seeking unspecified treble damages for restraint of trade and an injunction to prevent the airlines from implementing or maintaining the cap or commission. Because the lawsuits are in the first stages of litigation, USAir is unable to predict at this time their ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn March 1995, a number of U.S. carriers, including USAir, received a Civil Investigative Demand (\"CID\") from the Department of Justice related to an investigation of incentives paid to travel agents over and above the base commission payments, which are the subject matter of the suits recently brought by travel agencies as discussed above. USAir responded to an earlier CID on this topic during 1994. USAir is required to produce documents and respond to interrogatories in connection with this CID. USAir intends to comply with the requirements of the CID. Because this matter is in the investigatory stage, USAir is unable to predict at this time its ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn February 1995, two members of USAir's frequent traveler program filed a class action lawsuit in Pennsylvania state court against USAir after it raised the required minimum level of miles necessary to earn a free ticket. The plaintiffs allege breach of contract and seek unspecified damages and specific performance of the contract allegedly breached. USAir denies the allegations. The ultimate resolution of this lawsuit and its potential impact on the Company's financial condition and results of operations cannot be predicted at this time.\n(d) Aircraft Commitments\nUSAir and The Boeing Company (\"Boeing\") reached an agreement in principle in early 1995 regarding the deferral of eight 757-200 aircraft from 1996 to 1998.\nThe following schedule of USAir's new aircraft deliveries and scheduled payments at December 31, 1994 (including progress payments, payments at delivery, buyer furnished equipment, spares, and capitalized interest) reflects USAir's agreement in principle with Boeing discussed above:\nIn addition, USAir has a commitment to purchase hushkits for certain of its McDonnell Douglas DC-9-30 aircraft and a substantial portion of its Boeing 737-200 aircraft. The installation of these hushkits will bring the aircraft into compliance with Federal Aviation Administration (\"FAA\") Stage 3 noise level requirements. The projected payments associated with the purchase of the hushkits are: $10.5 million - 1995; $44.3 million - 1996; $45.5 million - 1997; $45.2 million - 1998; and $25.0 million - 1999.\n(e) Concentration of Credit Risk\nUSAir Group does not believe it is subject to any significant concentration of credit risk. At December 31, 1994, most of the Company's receivables related to tickets sold to individual passengers through the use of major credit cards (45%) or to tickets sold by other airlines (17%) and used by passengers on USAir or the regional airline subsidiaries. These receivables are short-term, generally being settled shortly after sale. Bad debt losses, which have been minimal in the past, have been considered in establishing allowances for doubtful accounts.\n(f) Guarantees\nAt December 31, 1994, USAir guaranteed payments of certain debt obligations of the Galileo International Partnership amounting to approximately $9 million.\n(5) Sale of Receivables\nThe revolving receivables sales facility (\"Receivables Agreement\") to which USAir had been a party expired on December 21, 1994. USAir was unable to sell receivables under the Receivables Agreement during 1994 because it was in violation of certain financial covenants. USAir had no outstanding amounts due under the Receivables Agreement at December 31, 1993. The average dollar amount of outstanding sales during 1993 and 1992 was $255 million and $100 million, respectively. USAir is currently engaged in discussions to arrange a replacement facility. There can be no assurance that USAir will be successful in reaching a new agreement to sell its receivables.\n(6) Income Taxes\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). FAS 109 required a change from the deferred method under Accounting Principles Board Opinion No. 11 to the asset and liability method of accounting for income taxes. No cumulative adjustment at January 1, 1993, and no income tax credit for the years ended December 31, 1994 and 1993, were recognized due to the FAS 109 limitation in recognizing benefits for net operating losses.\nThe Company files a consolidated Federal income tax return with its wholly-owned subsidiaries.\nThe components of the provision (credit) for income taxes are as follows:\nThe significant components of deferred income tax expense\/ (benefit) for the years ended December 31, 1994 and 1993, are as follows:\nFor the year ended December 31, 1992 deferred income taxes result from differences in the recognition of revenue and expenses and investment tax credits for tax and financial reporting purposes. The major items resulting in these differences and the related tax effects are shown in the following chart: ---- (in thousands)\nEquipment depreciation and amortization $ 70,441 Gain on sale and leaseback transactions (55,238) Net operating loss carryforward 53,753 Employee benefits (36,015) Tax benefits purchased\/sold 6,752 Investment tax credits (2,372) Leasing transactions (33,296) Frequent traveler program (2,815) Other (1,210) -------- Total deferred provision (credit) $ 0 ========\nA reconciliation of taxes computed at the statutory Federal tax rate on earnings before income taxes to the provision (credit) for income taxes is as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993 are presented below:\nThe valuation allowance for deferred tax assets as of January 1, 1993, was $420 million. The valuation allowance increased $145 million in 1993 and $240 million in 1994.\nAt December 31, 1994, the Company had unused net operating losses of $1.9 billion for Federal tax purposes, which expire in the years 2005-2009. The Company also has available, to reduce future taxes payable, $775 million alternative minimum tax net operating losses expiring in 2007 to 2009, $50 million of invest- ment tax credits expiring in 2002 and 2003, and $21 million of\nminimum tax credits which do not expire. The Federal income tax returns of the Company through 1986 have been examined and settled with the Internal Revenue Service.\n(7) British Airways Plc Investment\nOn January 21, 1993, USAir Group and BA entered into an investment agreement (the \"Investment Agreement\") under which a wholly-owned subsidiary of BA purchased certain series of convert- ible preferred stock during 1993 (see Note 8 - Redeemable Preferred Stock) and BA entered into code sharing and wet lease arrangements with USAir contemplated by the Investment Agreement. On March 7, 1994, BA announced that it would not make any additional invest- ments in the Company until the outcome of measures by the Company to reduce its costs and improve its financial results is known.\nAt December 31, 1994, the preferred stock held by BA con- stituted approximately 21.5% of the total voting interest in the Company. To the extent permitted by foreign ownership restrictions which are applicable by statute regulations or interpretation by regulatory authorities, including the U.S. Department of Transpor- tation (\"DOT\") (\"Foreign Ownership Restrictions\"), the preferred stock owned by BA votes on all matters presented to the Company's stockholders for a vote and has voting power equal to the underly- ing shares of Common Stock. Pursuant to the Investment Agreement, on January 21, 1993, BA designated three of its officers to serve on the Company's and USAir's boards of directors.\nIn addition to BA's holdings of the Company's preferred stock at December 31, 1994, BA has the option, which it has announced it will not exercise under current circumstances, to purchase, at a minimum, an additional $450 million of the Company's preferred stock. Under certain circumstances, BA is entitled, at its option, to purchase, on or prior to January 21, 1996, 50,000 shares of Series C Cumulative Convertible Senior Preferred Stock (\"Series C Preferred Stock\") resulting in an additional cash investment in the Company of $200 million, and, on or prior to January 21, 1998, 25,000 shares of Series E Cumulative Convertible Senior Preferred Stock (\"Series E Preferred Stock\") resulting in an additional cash investment in the Company of $250 million. If the DOT approves all the transactions and acts contemplated by the Investment Agreement, at the election of either BA or the Company on or prior to January 21, 1998, BA's purchase of the Series C Preferred Stock (unless previously consummated) and BA's purchase of the Series E Preferred Stock must be consummated under certain circumstances.\nOn March 15, 1993, the DOT issued an order (\"DOT Order\") stating, among other things, that BA's initial investment does not impair USAir's citizenship under current U.S. Foreign Ownership Restrictions. However, the DOT instituted a proceeding to consider whether USAir will remain a U.S. citizen if the transactions and acts contemplated by the Investment Agreement, including the possible sale of Series C Preferred Stock and Series E Preferred Stock, to BA, are consummated. The DOT has indefinitely suspended the period for comments from interested parties pending its\nresolution of requests by other airlines for production of additional documents from USAir. The DOT Order states that the DOT expects and advises USAir and BA not to proceed with the closing of the purchase of the Series C Preferred Stock or the Series E Preferred Stock until the DOT has completed its review of USAir's citizenship. In any event, on March 7, 1994, BA announced it would not make any additional investments in the Company under current circumstances. The Company cannot predict the outcome of the proceedings or if further transactions contemplated under the Investment Agreement, including the sale of Series C and Series E Preferred Stock to BA, will be consummated. The sale of additional preferred stock to BA on June 10, 1993 (see Note 8(c)) did not result in BA's ownership of voting stock in the Company exceeding applicable Foreign Ownership Restrictions and therefore does not affect the Company's U.S. citizenship under those restrictions.\n(8) Redeemable Preferred Stock and Dividend Restrictions\n(a) Series A Preferred Stock and Dividend Restrictions\nAt December 31, 1994, the Company had 358,000 shares of its 9 1\/4% Series A Cumulative Convertible Redeemable Preferred Stock (\"Series A Preferred Stock\"), without par value, outstanding which were convertible into 9,239,944 shares of the Company's Common Stock at a conversion price of approximately $38.74 per share. The Series A Preferred Stock ranks pari passu with the Series F Cumulative Convertible Senior Preferred Stock (\"Series F Preferred Stock\"), without par value, and Series T-_ Cumulative Convertible Exchangeable Senior Preferred Stock (\"Series T Preferred Stock\"), without par value, and senior to the Series B Cumulative Convert- ible Preferred Stock (\"Series B Preferred Stock\"), without par value, Junior Participating Preferred Stock, Series D (\"Series D Preferred Stock\"), without par value, and the Common Stock, with respect to dividend payments and the distribution of assets. At December 31, 1994, the Series A Preferred Stock is entitled to approximately 25.8099 votes per share, or a total of 9,239,944 votes, and votes together with the Series F Preferred Stock, the Series T Preferred Stock and the Common Stock, on all matters submitted to a vote of stockholders of the Company.\nThe Series A Preferred Stock is redeemable on August 7, 1999 at $1,000 per share. The Company has the right to redeem the stock at a 10% premium until that time. The agreement relating to the sale of the Series A Preferred Stock imposes certain restrictions on the purchaser's ability to increase its ownership of, and to transfer, its stock in USAir Group. The Series A Preferred Stock is owned by affiliates of Berkshire Hathaway Inc. (\"Berkshire\"). There have been no changes in the balance sheet value of the Series A Preferred Stock since its issuance in 1989.\nThe Company has deferred quarterly dividend payments on all outstanding series of preferred stock. The annual dividends on the Series A Preferred Stock amount to approximately $33.1 million. So long as preferred dividends are deferred, the Series A Preferred Stock will continue to cumulate dividends at its stated dividend\nrate of 9.25% plus additional dividends (interest) on the balance of the deferred dividends at the higher of the stated dividend rate or the prime rate plus five percentage points. Accordingly, the redemption value of the Series A Preferred Stock at December 31, 1994 is $374.8 million (the face amount of the issuance of $358.0 million plus unpaid dividends and interest of $16.8 million).\nUnder the terms of the Series A Preferred Stock, Berkshire has the right to elect two additional directors to the Board of the Company after a scheduled dividend payment has not been paid for thirty days. Berkshire has informed the Company that it does not intend to exercise this right at this time. Further, Berkshire's Chairman Warren E. Buffet and Vice Chairman Charles T. Munger serve as directors on the Company's and USAir's Boards of Directors. Messrs. Buffet and Munger have advised the Company that they will not stand for re-election to the Company's and USAir's Boards in 1995. Under the terms of the Series B Preferred Stock, the holders of that security would have the right to elect two additional directors to the Board if six quarterly dividends are not paid. That right will become effective on February 15, 1996 if dividends are not resumed prior to that time. If Berkshire were to exercise its right or the holders of the Series B Preferred Stock were to exercise their right to nominate additional directors, BA would have the right to designate additional nominees for election as directors to the Board pursuant to its Investment Agreement with the Company.\nThe Company, organized under the laws of the State of Delaware, is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. At December 31, 1994, the Company's capital surplus was exhausted and therefore, under Delaware law, the Company is legally restricted from paying dividends on all outstanding common and preferred stock issuances. Surplus is the remainder of (i) net assets (total assets less total liabilities), less (ii) total capital (that amount of preferred and common equity designated as capital by a company's board of directors). At December 31, 1994, the Company's capital deficit was approximately $199.3 million. The Company's net assets were in a deficit balance of approximately $138.2 million, and its total capital was approximately $61.1 million (the $61.1 million is all attributable to the Company's common stock; capital for all of the Company's preferred stock issuances is a nominal amount of one cent per share). In order for the Company to return to a capital surplus position, it must realize substantial profits or increase its equity through other measures, such as the sale of additional common or preferred stock. Even if the Company is successful in restructuring its costs, there can be no assurance when or if preferred dividend payments will resume.\n(b) Series F Preferred Stock\nAt December 31, 1994, the Company had outstanding 30,000 shares of its 7% Series F Preferred Stock which was convertible into 15,458,851 shares of the Company's Common Stock at a conver-\nsion price of approximately $19.41 per share. The Series F Preferred Stock ranks pari passu with the Series A Preferred Stock and Series T Preferred Stock and senior to the Series B Preferred Stock, Series D Preferred Stock, and the Common Stock, with respect to dividend payments and the distribution of assets. At Decem- ber 31, 1994, each share of Series F Preferred Stock was entitled to 515.295 votes per share to the extent permitted by the existing Foreign Ownership Restrictions and votes with the Company's Series A Preferred Stock, the Series T Preferred Stock and the Company's Common Stock as a single class. Under Foreign Ownership Restric- tions, no more than 25% of the Company's voting interest may be held by persons other than U.S. citizens. In accordance with the terms of any preferred stock held by BA, conversion rights and voting rights may not be exercised to the extent that doing so would result in a loss of the Company's or any of its subsidiaries' operating certificates and authorities under Foreign Ownership Restrictions, and it is assumed for this purpose that Series F Preferred Stock will be fully converted before any other preferred stock held by BA.\nThe Series F Preferred Stock is convertible at any time on or after January 21, 1997 to the extent that such conversion would not violate U.S. Foreign Ownership Restrictions. Series F Preferred Stock may be converted at the option of the Company at any time after January 21, 1998 if the average composite closing market price of Common Stock during any 30-day calendar period is at least 133% of the conversion price. The Series F Preferred Stock is mandatorily redeemable on January 21, 2008. If BA has not purchased the Series C Preferred Stock by January 21, 1996, then the Company may at its option redeem, in whole or in part, Series F Preferred Stock at the higher of market value or the price of $10,000 per share, plus accrued dividends. The Series F Certifi- cate provides that if on any one occasion on or prior to Janu- ary 21, 1996, any court or regulatory authority issues a final order that any material part of the Investment Agreement is unenforceable (except pursuant to bankruptcy or like event), then the conversion price of Series F Preferred Stock shall be reduced by 10.2564%. There have been no changes in the balance sheet value of the Series F Preferred Stock since its issuance in 1993.\nThe Company deferred quarterly dividend payments on all outstanding series of preferred stock beginning with payments due September 30, 1994. The annual dividends on the Series F Preferred Stock amount to approximately $21.0 million. So long as preferred dividends are deferred, the Series F Preferred Stock will continue to cumulate dividends at its stated dividend rate of 7.0% plus additional dividends (interest) on the balance of the deferred dividends at the stated dividend rate. Accordingly, the redemption value of the Series F Preferred Stock at December 31, 1994 is $307.0 million (the face amount of the issuance of $300.0 million plus unpaid dividends and interest of $7.0 million). The Company is currently unable to pay dividends due to limitations under Delaware law. See discussion above in Note 8(a).\n(c) Series T Preferred Stock\nUnder the Investment Agreement, BA has preemptive and optional purchase rights to maintain its proportionate ownership of the Company's Common Stock and convertible securities, measured in terms of the BA percentage (\"BA Percentage\") which approximates BA's fully diluted ownership percentage based on BA's current and potential holdings in the Company. The BA Percentage is calculated without regard to Foreign Ownership Restrictions at the time of the calculation. BA may exercise such preemptive or optional purchase rights by purchasing, from time to time, a series of Series T Preferred Stock.\nAt December 31, 1994, the Company had two series of the Series T Preferred Stock outstanding. On June 10, 1993, BA exercised its preemptive purchase right by purchasing 9,919.8 shares of a series of the Series T Preferred Stock (\"Series T-2 Preferred Stock\") for approximately $99.2 million and exercised its optional purchase right by purchasing 152.1 shares of a series of Series T Preferred Stock (\"T-1 Preferred Stock\") for approximately $1.5 million. BA's preemptive right was triggered by the issuance of Common Stock, as described in Note 9 - Stockholders' Equity, and BA's optional purchase rights were triggered by the Company's issuance of additional shares of Common Stock through the exercise of options under various employee stock option plans and through the sale of shares to certain defined contribution plans during the period from January 21, 1993 to March 31, 1993. BA has advised the Company that it will not exercise its optional purchase rights to buy additional series of Series T Preferred Stock triggered by the Company's issuance of Common Stock pursuant to certain employee benefit plans during the second, third and fourth quarters of 1993 and during 1994.\nThere have been no changes in the balance sheet value of the Series T-1 Preferred Stock and Series T-2 Preferred Stock since their issuance in 1993.\nThe terms of all series of the Series T Preferred Stock are substantially similar to those of the Series F Preferred Stock except as noted. Each share of Series T-2 Preferred Stock carries a conversion price of $26.40 and is convertible into approximately 378.7879 shares of Common Stock or Non-Voting Class ET stock. Each share of Series T-1 Preferred Stock has a conversion price of $20.50 and is convertible into approximately 487.8049 shares of Common Stock or Non-Voting Class ET stock. With respect to the Series T Preferred Stock, dividends are payable quarterly in arrears, at 50 basis points over the three month LIBOR rate. Any shares of the Series T Preferred Stock held by any person other than BA or its subsidiaries may be redeemed for cash at any time at the option of the Company at $10,000 plus accrued dividends plus a redemption premium equal to $700 from the date of issue until the first anniversary thereof and reduced by $46.67 on each anniversary thereafter.\nThe Series T Preferred Stock is exchangeable, at the option of the Company, for that principal amount of floating rate convertible subordinated notes of the Company (the \"T Notes\") equal to the liquidation preference of the shares to be exchanged and bearing interest at the dividend rate. Any accrued dividends on the Series T Preferred Stock to be exchanged will be treated as accrued interest on the T Notes. Each $10,000 aggregate principal amount of such T Notes will be entitled to a number of votes equal to the number of votes to which each share of Series T Preferred Stock was entitled at the time of its exchange for T Notes, subject to adjustment. If issued, T Notes will have terms otherwise consis- tent with the terms of the Series T Preferred Stock.\nThe Company has deferred quarterly dividend payments on all outstanding series of preferred stock beginning with payments due September 30, 1994. The annual dividends on the Series T Preferred Stock amount to approximately $6.6 million. So long as preferred dividends are deferred, the Series T Preferred Stock will continue to cumulate dividends at its dividend rate of the three-month LIBOR rate plus one-half of a percentage point plus additional dividends (interest) on the balance of the deferred dividends at the dividend rate. Accordingly, the redemption value of the Series T Preferred Stock at December 31, 1994 is $102.7 million (the face amount of the issuance of $100.7 million plus unpaid dividends and interest of $2.0 million). The Company is currently unable to pay dividends due to limitations under Delaware law. See discussion above in Note 8(a).\n(9) Stockholders' Equity\n(a) Common Stock\nThe Company had 150,000,000 authorized shares of Common Stock, par value $1, at December 31, 1994 and 1993. If BA purchases the Series C Preferred Stock (see Note 7 - British Airways Plc Investment), the number of authorized shares of various classes of Common Stock will increase to 300,000,000. BA has indicated, however, that it will not make any additional investments in the Company under current circumstances. At December 31, 1994, approximately 51,781,000 shares were reserved for issuance upon the conversion of preferred stock and for offerings under employee stock purchase, stock option, stock incentive and retirement plans. The Company is currently unable to pay dividends due to limitations under Delaware law. See discussion above in Note 8(a).\nOn May 4, 1993, the Company sold 11.5 million shares of previously unissued Common Stock at $20.75 per share through a public, underwritten offering. The offering netted proceeds of approximately $231 million.\n(b) Preferred Stock and Senior Preferred Stock\nAt December 31, 1994, the Company had 5,000,000 authorized shares of preferred stock, without nominal or par value, of which 358,000 shares were issued as Series A Preferred Stock, approxi-\nmately 43,000 shares were issued as Series B Preferred Stock and 1,035,000 shares were reserved as Series D Preferred Stock. Also, at December 31, 1994, the Company had 3,000,000 authorized shares of Senior Preferred Stock, without nominal or par value, of which 30,000 shares were issued as Series F Preferred Stock and approxi- mately 10,000 were issued as Series T Preferred Stock.\n(c) Series B Preferred Stock\nAt December 31, 1994, the Company had 4,263,050 Depositary Shares, representing 42,630.5 shares of its $437.50 Series B Preferred Stock outstanding. Each Depositary Share represents 1\/100 of a share of the Series B Preferred Stock. The Series B Preferred Stock is convertible at any time, at the option of the holder, at the rate of 249.25 shares of Common Stock of the Company per preferred share, or 2.4925 shares of Common Stock per Deposi- tary Share. The Series B Preferred Stock ranks junior to the Company's Series A Preferred Stock, the Series F Preferred Stock and the Series T Preferred Stock and senior to the Series D Preferred Stock and the Common Stock with respect to dividend payments and the distribution of assets, whether upon liquidation or otherwise. Except under certain circumstances, the holders of Series B Preferred Stock have no voting rights.\nThe Series B Preferred Stock is redeemable, at the option of the Company and with consent of the holders of Series F Preferred Stock, (i) in whole but not in part, only in certain circumstances, for so long as any shares of Series A Preferred Stock are outstand- ing; and (ii) in whole or in part if no shares of Series A Preferred Stock are outstanding, in each case initially at a redemption price of approximately $53.06 per 1\/100 of a share and thereafter at prices declining to $50 per 1\/100 of a share (equivalent to $5,000 per share of Series B Preferred Stock) on or after May 15, 2001, plus dividends accrued and accumulated but unpaid to the redemption date.\nThe Company has deferred quarterly dividend payments on all outstanding series of preferred stock beginning with payments due September 30, 1994. The annual dividends on the Series B Preferred Stock amount to approximately $18.7 million. So long as preferred dividends are deferred, the Series B Preferred Stock will continue to cumulate dividends at its stated dividend rate of 8.75% but is not subject to additional dividends (interest) on the balance of the deferred dividends. Accordingly, the liquidation preference of the Series B Preferred Stock at December 31, 1994 is $220.1 (the face amount of the issuance of $213.2 million plus unpaid dividends of $6.9 million). The Company is currently unable to pay dividends due to limitations under Delaware law. See discussion above in Note 8(a).\n(d) Preferred Stock Purchase Rights\nEach outstanding share of Common Stock is accompanied by one Preferred Share Purchase Right (\"Right\") and each outstanding share of Series A Preferred Stock, Series F Preferred Stock and Series T\nPreferred Stock is accompanied by a Right for each share into which it is convertible. Each Right entitles the holder to buy 1\/100th of a share of Series D Preferred Stock at an exercise price of $175 per Right. The Rights expire on June 29, 1996. As long as the Rights remain outstanding, the Company will issue one Right with each new share of Common Stock issued upon the conversion of any preferred stock into, or the exercise of any options for, Common Stock, as long as such preferred stock or options were outstanding prior to the Rights becoming exercisable.\nGenerally, the Rights become exercisable only if a party other than, under certain circumstances, BA acquires 20% or more of the Company's Common Stock or announces a tender offer for 20% or more of the Common Stock. The Rights are redeemable at $.03 per Right at any time before 20% or more of the Company's Common Stock has been acquired. If at any time after the Rights become exercisable and before they have been redeemed the Company is involved in a merger or other business combination transaction, the Rights will automatically entitle a holder, other than a holder of 20% or more of the Company's Common Stock, to receive, upon exercise of each Right, a number of shares of Common Stock, or a number of common shares of the acquiring company, as the case may be, having a market value of two times the exercise price of each Right. In addition, at any time after the acquisition of 30% or more of the Common Stock by any person and prior to the acquisition by such person of 50% or more of the Common Stock, the Board of the Company may exchange the Rights (other than Rights owned by such person which have become void), in whole or in part, at an exchange ratio of one share of Common Stock, or 1\/100th of a share of Series D Preferred Stock, per Right.\nUntil the first to occur of the redemption or expiration of the Rights, the Company will issue one Right with each new share of Common Stock issued upon the conversion of any securities into, or the exercise of any options or warrants for, Common Stock if such securities, options or warrants were outstanding prior to when Rights became exercisable.\n(e) Treasury Stock\nIn 1989, the Company's Board authorized the repurchase from time to time of up to 9.4 million shares of its Common Stock in open market transactions. In 1989, approximately 2.1 million shares were repurchased in addition to 635,000 that it held in treasury prior to that time. The Company sold approximately 1,864,000 shares, 500,000 shares, and 390,000 shares of its treasury stock during 1994, 1993, and 1992, respectively. As of December 31, 1994, there were no shares of Common Stock held in treasury. Due to the capital surplus requirements of Delaware law, the Company is currently unable to repurchase shares of its Common Stock.\n(f) Employee Stock Option and Purchase Plans\nAt December 31, 1994, approximately 5.0 million shares of Common Stock were reserved for the possible exercise of options under the 1992 Stock Option Plan (\"1992 Plan\"). Under the 1992 Plan, employees whose pay was reduced, generally during a 12 month period in 1992 and 1993, received options to purchase 50 shares of Common Stock at a price of $15 per share for each $1,000 of salary reduction. Participating employees have five years from the grant date to exercise such options. All outstanding options under the 1992 plan were fully vested at December 31, 1994.\nAt December 31, 1994, 5.3 million shares of Common Stock were reserved for the granting of stock options or restricted stock under the Company's 1984 Stock Option and Stock Appreciation Rights (\"SARs\") Plan and 1988 Stock Incentive Plan. These plans provide that options may be granted as either nonqualified or incentive stock options. Options awarded under the two plans prior to 1992, except for those that reverted, have vested. Options awarded during 1992, 1993 and 1994 become exercisable generally within three years from date of grant. Optionees may also receive SARs which permit them to receive, in lieu of the right to exercise the stock option, an amount equivalent to the difference between the stock option price and the fair market value of the Common Stock on the date of exercising the right. This amount may be paid in stock, in cash, or in any combination of the two. Also, restricted stock award grants for 15,800 shares and 57,000 shares were outstanding at December 31, 1994 and 1993, respectively. Deferred compensation related to the restricted stock, which vests over periods of up to five years, amounted to $16 thousand and $0.3 million at December 31, 1994 and 1993, respectively.\nAs of December 31, 1994, options to acquire approximately 9 million shares under all three plans, including 76,200 options with tandem SARs, were outstanding at a weighted average exercise price of $18.14. Of those outstanding, approximately 8.3 million options were exercisable at December 31, 1994. Options were exercised to purchase approximately 5,000 shares and 33,500 shares of Common Stock at average exercise prices of $9.63 and $17.24 during 1994 and 1993, respectively.\n(10) Employee Stock Ownership Plan\nIn August 1989, USAir established an Employee Stock Ownership Plan (\"ESOP\"). The Company sold 2,200,000 shares of Common Stock to an Employee Stock Ownership Trust to hold on behalf of USAir's employees, exclusive of officers, in accordance with the terms of the Trust and the ESOP. Financing of approximately $111.4 million for the Trust's purchase of the shares was provided by USAir through a 9 3\/4% loan to the Trust, and an additional $2.2 million was contributed to the Trust by USAir. The loan is being repaid with contributions made by USAir. The contributions are made in amounts equal to the periodic loan payments as they come due, less dividends available for loan payment. As the loan is repaid over time, participating employees receive allocations of the Common\nStock purchased by the Trust. The initial maturity of the loan is 30 years. However, the ESOP provides that if USAir's profitability as measured by return on sales exceeds certain goals during the life of the ESOP, USAir's contributions and the repayment of the loan will be accelerated. Annual contributions made by USAir and therefore loan repayments made by the Trust were $11.4 million in each of 1994, 1993 and 1992. The interest portion of these contributions was $10.5 million in 1994, $10.5 million in 1993 and $10.6 million in 1992. Approximately 438,000 shares of Common Stock have been allocated to employees. USAir recognized approxi- mately $4 million of compensation expense related to the ESOP in each of 1994, 1993 and 1992 based on shares allocated to employees (the \"shares allocated\" method). Deferred compensation related to the ESOP amounted to approximately $91 million, $95 million and $98 million at December 31, 1994, 1993 and 1992, respectively. Shares held by the ESOP trust are included in shares outstanding for the Company's income (loss) per share calculation.\n(11) Employee Benefit Plans\n(a) Pension Plans\nThe Company's subsidiaries have several pension plans in effect covering substantially all employees. One qualified defined benefit plan covers USAir maintenance employees and provides benefits of stated amounts for specified periods of service. Qualified defined benefit plans for substantially all other employees provide benefits based on years of service and compensa- tion. The qualified defined benefit plans are funded, on a current basis, to meet requirements of the Employee Retirement Income Security Act of 1974.\nThe defined benefit pension plan for USAir non-contract employees was frozen at the end of 1991 for all non-contract participants, resulting in a one-time book gain of approximately $107 million in 1991. All non-contract plan participants became 100% vested at the time of the freeze. As a result of this plan curtailment, the accrual of service costs related to defined benefits for USAir non-contract and certain other employees ceased at the end of 1991. USAir implemented a defined contribution pension plan for non-contract employees in January 1993.\n(this space intentionally left blank)\nThe funded status of the qualified defined benefit plans at December 31, 1994 and 1993 was as follows:\nUnrecognized transition assets are being amortized over periods up to 27 years. The weighted average discount rate used to determine the actuarial present value of the projected benefit obligation was 9.0% and 7.6% as of December 31, 1994 and 1993, respectively. The expected long-term rate of return on plan assets used in 1994 and 1993 was 9.5%. Rates of 3% to 6% were used to estimate future salary levels. At December 31, 1994, plan assets consisted of approximately 8% in cash equivalents and short-term debt investments, 27% in equity investments, and 65% in fixed income and other investments. At December 31, 1993, plan assets consisted of approximately 8% in cash equivalents and short-term debt investments, 37% in equity investments, and 55% in fixed income and other investments.\nThe following items are the components of the net periodic pension cost for the qualified defined benefit plans:\nNet pension cost for 1993 presented above excludes a settle- ment charge of approximately $33.9 million, related to \"early-out\" incentive programs offered to a limited number of USAir employees during the years. No such charges were incurred in 1994 or 1992.\nNon-qualified supplemental pension plans are established for certain employee groups, which provide incremental pension payments from the Company's funds so that total pension payments equal amounts that would have been payable from the Company's principal pension plans if it were not for limitations imposed by income tax regulations.\n(this space intentionally left blank)\nThe following table sets forth the non-qualified plans' status at December 31, 1994 and 1993:\nNet periodic supplementary pension cost for the non-qualified supplemental pension plans included the following components:\nThe discount rate used to determine the actuarial present value of the projected benefit obligation was 9.0% and 7.5% as of December 31, 1994 and 1993, respectively. Rates of 3% to 5% were used to estimate future salary levels.\nIn addition to the qualified and non-qualified defined benefit plans described above, USAir also contributes to certain defined contribution plans primarily for employees not covered under a collective bargaining agreement. Company contributions are based on a formula which considers the age and pre-tax earnings of each employee and the amount of employee contributions. The Company's contribution expense was $43 million and $42 million for 1994 and 1993, respectively. The Company recognized no such expense in 1992 because the plans became effective January 1, 1993.\n(b) Postretirement Benefits Other Than Pensions\nUSAir offers medical and life insurance benefits to employees hired prior to March 29, 1993 who retire from USAir and their eligible dependents. The medical benefits provided by USAir are coordinated with Medicare benefits. Retirees generally contribute amounts towards the cost of their medical expenses based on years of service with the Company. USAir provides uninsured death benefit payments to survivors of retired employees for stated dollar amounts, or in the case of retired pilot employees, death benefit payments determined by age and level of pension benefit. The plans for postretirement medical and death benefits are funded on the pay-as-you-go basis.\nUSAir adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"), during 1992 and elected to record the January 1, 1992 Accumulated Postretirement Benefit Obligation (\"APBO\") using the immediate recognition approach. The cumulative effect of adopting FAS 106 was $745.7 million ($628.1 million net of tax benefit).\nThe following table sets forth the financial status of the plans as of December 31, 1994 and 1993:\nThe components of net periodic postretirement benefit cost are as follows:\nThe postretirement benefit expense for 1993 presented above excludes a charge of approximately $15.5 million related to \"early- out\" programs offered to a limited number of employees during the year. No such charges were incurred in 1994 or 1992.\nThe discount rate used to determine the APBO was 9.0%, 7.75% and 8.75% at December 31, 1994, 1993 and 1992, respectively. The assumed health care cost trend rate used in measuring the APBO was 9.5% in 1994, declining by 1% per year after 1994 to an ultimate rate of 4.5%. If the assumed health care cost trend rate were increased by one percentage point, the APBO at December 31, 1994 would be increased by 11% and 1994 periodic postretirement benefit cost would increase 13%.\n(c) Postemployment Benefits\nUSAir adopted Statement of Financial Accounting Standards No. 112, \"Employer's Accounting for Postemployment Benefits\" (\"FAS 112\"), during 1993. FAS 112 requires the use of an accrual method to recognize postemployment benefits such as disability-related benefits. The cumulative effect at January 1, 1993 of adopting FAS 112 was $43.7 million.\n(12) Supplemental Balance Sheet Information\nThe components of certain accounts in the accompanying balance sheets are as follows:\n(13) Non-Recurring and Unusual Items\n(a) 1994\nThe Company's results for 1994 include (i) a $132.8 million charge related to USAir's grounded BAe-146 fleet, recorded in the fourth quarter of 1994; (ii) a $54.0 million charge for obsolete inventory and rotables to reflect market value, recorded in the fourth quarter of 1994; (iii) a $50 million addition to passenger transportation revenue in the fourth quarter of 1994 to adjust estimates made during the first three quarters of 1994; (iv) a $40.1 million charge primarily related to USAir's decision to cease operations of its remaining Boeing 727 aircraft in 1995, recorded in the third quarter of 1994; (v) a $25.9 million charge related to USAir's decision to substantially reduce service between Los Angeles and San Francisco and close its San Francisco crew base, recorded in the third quarter of 1994; (vi) a $28.3 million gain resulting from the sale of certain aircraft and assets to Mesa Air Group, Inc. (formerly Mesa Airlines, Inc.) (\"Mesa\") and the accounting treatment of the hull insurance recovery on the aircraft destroyed in the September accident, recorded in the third quarter of 1994; and (vii) a $1.7 million charge related to the sale of assets to Mesa, recorded in the third quarter of 1994.\n(b) 1993\nThe Company's results for 1993 include non-recurring charges of (i) $43.7 million for the cumulative effect of an accounting change, as required by FAS 112 which was adopted during the third quarter of 1993, retroactive to January 1, 1993; (ii) $68.8 million for severance, early retirement and other personnel-related expenses recorded primarily during the third quarter of 1993 in connection with a workforce reduction of approximately 2,500 full- time positions between November 1993 and the first quarter of 1994;\n(iii) $36.8 million based on a projection of the repayment of certain employee pay reductions, recorded in the fourth quarter of 1993; (iv) $13.5 million for certain airport facilities at locations where USAir has, among other things, discontinued or reduced its service, recorded in the fourth quarter of 1993; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership which operates a computerized reserva- tions system, recorded in the fourth quarter of 1993; and (vi) $18.4 million credit related to non-operating aircraft recorded in the second quarter of 1993.\n(c) 1992\nThe Company's results for 1992 include (i) a charge of $628.1 million for the cumulative effect of an accounting change as required by FAS 106, effective January 1, 1992; (ii) a $107.4 million charge related to certain aircraft which have been withdrawn from service, recorded in the fourth quarter of 1992; (iii) a $34.1 million non-operating loss related to the sale of ten MD-82 aircraft which USAir eliminated from its fleet plan, recorded in the fourth quarter of 1992; and (iv) a $10.3 million gain on the sale of three wholly-owned subsidiaries, recorded in the third quarter of 1992 (see Note 1).\n(14) Selected Quarterly Financial Data (Unaudited)\nThe following table presents selected quarterly financial data for 1994 and 1993:\nSee Note 13 - Non-Recurring and Unusual Items.\nNote: The sum of the four quarters may not equal yearly totals due to rounding of quarterly results.\nCertain 1993 amounts have been reclassified to conform with 1994 classifications.\n(this space intentionally left blank)\nItem 8B. Financial Statements and Supplementary Information USAir, Inc.\nIndependent Auditors' Report\nThe Stockholder and Board of Directors USAir, Inc.:\nWe have audited the consolidated balance sheets of USAir, Inc. and subsidiary (\"USAir\") as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows, and changes in stockholder's equity (deficit) for each of the years in the three-year period ended December 31, 1994. These consolidated financial statements are the responsibility of USAir'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 USAir, Inc. and subsidiary as of December 31, 1994 and 1993, and the results of their operations and their cash flows for the three-year period ended December 31, 1994 in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that USAir will continue as a going concern. As discussed in Note 4(a) to the consolidated financial statements, USAir has suffered recurring losses from operations and has a net capital deficiency that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in Note 4(a). The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nAs discussed in Note 9 to the consolidated financial statements, effective January 1, 1993, USAir changed its method of accounting for postemployment benefits and effective January 1, 1992, USAir changed its method of accounting for postretirement benefits other than pensions.\nKPMG Peat Marwick LLP Washington, D. C. February 22, 1995, except as to Notes 4(a) and 4(c) which are as of April 10, 1995\nUSAir, Inc. Notes to Consolidated Financial Statements\n(1) Summary of Significant Accounting Policies\n(a) Basis of Presentation\nThe accompanying consolidated financial statements include the accounts of USAir, Inc. (\"USAir\") and its wholly-owned subsidiary USAM Corp. (\"USAM\"). USAir is a wholly-owned subsidiary of USAir Group, Inc. (\"USAir Group\" or \"the Company\"). All significant intercompany accounts and transactions have been eliminated.\nAt December 31, 1992, USAM owned 11% of the Covia Partnership (\"Covia\") which owned and operated a computerized reservation system (\"CRS\"). In September 1993, Covia purchased the assets of the corporation that owned and operated the Galileo CRS which provided services to travel agent subscribers in Europe. Covia was immediately separated into three new entities and, as a result, USAM owns 11% of the Galileo International Partnership which owns and operates the Galileo CRS, approximately 11% of the Galileo Japan Partnership which markets the Galileo CRS in Japan and approximately 21% of the Apollo Travel Services Partnership which markets the Galileo CRS in the U.S. and Mexico. USAM accounts for these investments using the equity method because it is represented on the board of directors of each of the partnership and therefore participates in policy making processes.\nCertain 1993 and 1992 amounts have been reclassified to conform with 1994 classifications.\n(b) Cash and Cash Equivalents and Short-Term Investments\nFor financial statement purposes, USAir considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents. Cash and cash equivalents are stated at cost, which approximates market value. Short-term investments consist of certificates of deposit and commercial paper with original maturities greater than three months but less than one year. Short-term investments are stated at cost plus accrued interest, which approximates market value.\n(c) Materials and Supplies\nInventories of materials and supplies are valued at average cost and are charged to operations as consumed. An allowance for obsolescence is provided for flight equipment expendable parts.\n(d) 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.\nMaintenance and repairs, including the overhaul of aircraft components, are charged to operating expense as incurred and costs of major improvements are capitalized for both owned and leased assets. Interest related to deposits on aircraft purchase contracts and facility and equipment construction projects is capitalized as additional cost of the asset or as leasehold improvement if the asset is leased. Depreciation and amortization for principal asset classifications is provided on a straight-line basis to estimated residual values over estimated depreciable lives as follows:\nProperty acquired under capital lease is amortized on a straight-line basis over the term of the lease and charged to Depreciation and Amortization Expense.\n(e) Goodwill, Other Intangibles and Other Assets\nGoodwill, the cost in excess of fair value of identified net assets acquired, is being amortized on a straight-line basis over 40 years. The $629 million goodwill resulting from the acquisition of Pacific Southwest Airlines (\"PSA\") and Piedmont Aviation, Inc. (\"Piedmont Aviation\"), both in 1987, is being amortized as Depreciation and Amortization Expense. Accumulated amortization at December 31, 1994 and 1993 related to the PSA and Piedmont acquisitions was $113 million and $97 million, respectively. The $11 million goodwill resulting from USAM's CRS investments is being amortized as other non-operating expense, consistent with the classification of income or loss on the investments. USAM's associated accumulated amortization at December 31, 1994 and 1993 was $2 million and $1 million, respectively. USAir evaluates whether or not goodwill is impaired by comparing the goodwill balances with estimated future undiscounted cash flows which, in USAir's judgment, are attributable to the goodwill. This analysis is performed separately for the goodwill which resulted from each acquisition.\nIntangible assets consist mainly of purchased operating rights at various airports, purchased route authorities, capitalized software costs and the intangible assets associated with the underfunded amounts of certain pension plans. The operating rights, valued at purchase cost or appraised value if acquired from PSA or Piedmont Aviation, are being amortized over periods ranging from ten to 25 years as Depreciation and Amortization Expense. The purchased route authorities are being amortized over periods of 25 years as Depreciation and Amortization Expense. Capitalized software costs are being amortized as Depreciation and Amortization Expense over five years, the expected period of benefit. Accumu- lated amortization related to intangible assets at December 31, 1994 and 1993 was $80 million and $72 million, respectively.\nBased on the most recent analyses, USAir believes that goodwill and other intangible assets were not impaired at Decem- ber 31, 1994.\nThe increase in Other Assets, net in 1994 is primarily attributable to changes in non-current pension assets. USAir's Other Assets balance includes a $47 million receivable from British Airways Plc related to the relinquishment of two U.S. to London routes.\n(f) Restricted Cash and Investments\nRestricted cash and investments consist primarily of deposits in trust accounts to collateralize letters of credit or workers compensation policies. These amounts are classified as Other Assets on the accompanying balance sheets.\n(g) Deferred Gains on Sale and Leaseback Transactions\nGains on aircraft sale and leaseback transactions are deferred and amortized over the term of the leases as a reduction of rental expense.\n(h) Passenger Revenue Recognition\nPassenger ticket sales are recognized as revenue when the transportation service is rendered. At the time of sale, a liability is established (Traffic Balances Payable and Unused Tickets) and subsequently eliminated either through carriage of the passenger, through billing from another carrier which renders the service or by refund to the passenger. Approximately $23 million and $29 million of amounts owed to wholly-owned subsidiaries of USAir Group for passenger transportation revenue are included in Traffic Balances Payable and Unused Tickets at December 31, 1994 and 1993, respectively.\n(i) Frequent Traveler Awards\nUSAir accrues the estimated incremental cost of providing outstanding travel awards earned by participants in its Frequent Traveler Program when such award levels are reached.\n(j) Investment Tax Credit\nInvestment tax credit benefits have been recorded using the \"flow-through\" method as a reduction of the Federal income tax provision.\n(k) Advertising Costs\nAdvertising costs are expensed when incurred as other operating expense. Advertising expense for 1994, 1993 and 1992 was $63 million, $59 million and $83 million, respectively.\n(2) Financial Instruments\n(a) Terms of Certain Financial Instruments\nUSAir has entered into hedging arrangements to reduce its exposure to fluctuations in the price of jet fuel. Net settlements are recorded as adjustments to aviation fuel expense. The total notional number of gallons under these agreements was 86 million and 194 million at December 31, 1994 and 1993, respectively. Under these arrangements, USAir will pay $0.496 to $0.521 per notional gallon in 1995 and receive a floating rate per notional gallon based on current market prices. In 1994 USAir paid $0.481 to $0.594 per notional gallon and received a floating rate per notional gallon based on current market prices. Decreases in the market price of fuel to levels below the fixed prices require cash payments by USAir and cause an increase in USAir's aviation fuel expense. The hedging arrangements represent approximately 7% and 16% of USAir's expected 1995 and actual 1994 fuel consumption, respectively. USAir is party to such hedging arrangements with several entities. Although the agreements, which expire in 1995, expose USAir to credit loss in the event of nonperformance by the other parties to the agreements, USAir does not anticipate such nonperformance because of the favorable creditworthiness status of the other parties. USAir may continue to enter into such arrange- ments, depending on market conditions.\nAn aggregate of $32 million of future principal payments of the Equipment Financing Agreements due 1998 through 2000 are payable in Japanese Yen. This foreign currency exposure has been hedged to maturity by participation in foreign currency contracts. Although USAir is exposed to credit loss in the event of non- performance by the counterparty to the contracts, USAir does not anticipate such non-performance because of the favorable credit- worthiness status of the other party.\n(b) Fair Value of Financial Instruments\nUnless a quoted market price indicates otherwise, the fair values of cash and investments generally approximate carrying values because of the short maturity of these instruments. USAir has estimated the fair value of long-term debt based on quoted market prices for the same or similar issues or on the current rates offered to the Company for debt of similar remaining\nmaturities. The fair values of energy swap agreements and foreign currency contracts are obtained from dealer quotes whereby these values represent the estimated amount USAir would receive or pay to terminate such agreements.\nThe estimated fair values of USAir's financial instruments, none of which are held for trading purposes, are summarized as follows (brackets denote liability):\n* Amounts are included in Other Assets on USAir's consolidated balance sheets.\n(this space intentionally left blank)\n(3) Long-Term Debt\nDetails of long-term debt are as follows:\nMaturities of long-term debt and debt under capital leases for the next five years are as follows:\n(in thousands) 1995 $ 80,714 1996 80,536 1997 91,630 1998 160,616 1999 84,105 Thereafter 2,432,601\nInterest rates on $480 million principal amount of long-term debt at December 31, 1994 are subject to adjustment to reflect prime rate and other rate changes.\nEquipment financings totaling $2.2 billion were collateralized by aircraft and engines with a net book value of $2.2 billion at December 31, 1994.\n(4) Commitments and Contingencies\n(a) Operating Environment\nThe U.S. airline industry has undergone dramatic and permanent changes in the last several years, generally resulting in lower operating costs and fares. The current competitive environment is the result of several factors including the emergence and expansion of low cost, low fare carriers, the protection and cost restructur- ing opportunities afforded to certain carriers while operating under Chapter 11 of the bankruptcy code, and other cost restructur- ing initiatives among major airlines, including employee conces- sions in exchange for equity ownership. USAir has incurred annual operating losses for every year since 1990 and has a net capital deficiency at December 31, 1994. USAir is currently in negotia- tions with employee labor groups in an effort to obtain employee concessions that will substantially reduce operating costs. On March 29, 1995, USAir and the negotiating committee of the Air Line Pilots Association (\"ALPA\") Master Executive Council, which represents USAir's pilots, signed an agreement in principle on wage and other concessions in exchange for financial returns and governance participation for USAir pilots. The agreement in principle is subject to many significant conditions, including approval of the boards of directors of the Company and USAir and of the shareholders of the Company and the execution of definitive documentation. USAir continues to negotiate with representatives of its other unions but it is uncertain whether any final agree- ments will be reached. No assurance can be given whether or when any transactions with any of the unions will be consummated or what the terms of any such transactions might be. In addition, USAir is evaluating other strategic decisions that could be implemented to improve the operating results of the airline. USAir believes that it must reduce its operating costs substantially if it is to survive in this low cost, low fare competitive environment.\n(b) Lease Commitments\nUSAir leases certain aircraft, engines, computer and ground equipment, in addition to the majority of its ground facilities. Ground facilities include executive offices, overhaul and mainte- nance bases and ticket and administrative offices. Public airports are utilized for flight operations under lease arrangements with the municipalities or agencies owning or controlling such airports. Substantially all leases provide that the lessee shall pay taxes, maintenance, insurance and certain other operating expenses applicable to the leased property. Most leases also include renewal options and some aircraft leases include purchase options.\nThe following amounts applicable to capital leases are included in property and equipment:\nAt December 31, 1994, obligations under capital and noncancel- able operating leases for future minimum lease payments were as follows:\nThe above table excludes $107 million future sublease rental revenues related to equipment under operating leases. Rental expense under operating leases for 1994, 1993 and 1992 was $703 million, $739 million and $678 million, respectively. The $703 million rental expense for 1994 excludes charges of $103 million related to USAir's grounded BAe-146 fleet and $13 million primarily related to USAir's decision to cease operations of its remaining Boeing 727 aircraft in 1995. The $678 million rental expense for 1992 excludes a charge of $72 million related to USAir's grounded BAe-146 fleet.\n(c) Legal Proceedings\nUSAir has been named as defendant in various suits and proceedings which involve, among other things, environmental concerns and employment matters. These suits and proceedings are in various stages of litigation, and the status of the law with respect to several of the issues involved is unsettled. For these reasons the outcome of these suits and proceedings is difficult to predict. In USAir's opinion, however, the disposition of these matters is not likely to have a material adverse effect on its financial condition or results of operations.\nUSAir is involved in legal proceedings arising out of its two aircraft accidents that occurred in July and September 1994 near Charlotte, North Carolina and Pittsburgh, Pennsylvania, respective- ly. The National Transportation Safety Board (the \"NTSB\") held hearings beginning in September 1994 relating to the July accident and January 1995 relating to the September accident. In April 1995, the NTSB issued its finding of probable causes with respect to the accident near Charlotte. It assigned as probable causes flight crew errors and the failure of air traffic control to convey weather and windshear hazard information. The NTSB has not yet issued its final accident investigation report for the accident near Pittsburgh. USAir expects that it will be at least two to three years before the accident litigation and related settlements will be concluded. USAir believes that it is fully insured with respect to this litigation and has recovered its hull claims related to the loss of the two aircraft. Therefore, USAir believes that the litigation will not have a material adverse effect on USAir's results of operations or financial condition. However, due to these two aircraft accidents, it is probable that USAir's insurance costs will increase upon renewals of various policies in 1995.\nUSAir and certain of the Company's other subsidiaries have received notices from the U.S. Environmental Protection Agency and various state agencies that it is a potentially responsible party with respect to the remediation of existing sites of environmental concern. Only two of these sites have been included on the Superfund National Priorities List. USAir and the other subsidiar- ies continue to negotiate with various governmental agencies concerning known and possible cleanup sites. These companies have made financial contributions for the performance of remedial investigations and feasibility studies at sites in Moira, New York; Escondido, California; Newberry Township, Pennsylvania; Elkton, Maryland; and Salisbury, Maryland.\nBecause of changing environmental laws and regulations, the large number of other potentially responsible parties and certain pending legal proceedings, it is not possible to reasonably estimate the amount or timing of future expenditures related to environmental matters. USAir provides for costs related to environmental contingencies when a loss is probable and the amount is reasonably estimable. Although management believes adequate reserves have been provided for all known contingencies, it is\npossible that additional reserves could be required in the future which could have a material effect on results of operations. However, USAir believes that the ultimate resolution of known environmental contingencies should not have a material adverse effect on USAir's financial position based on USAir's experience with similar environmental sites.\nIn March 1993, the U.S. District Court in Atlanta, Georgia entered a settlement involving USAir and five other U.S. air carrier defendants in the Domestic Air Transportation Antitrust Litigation class action lawsuit, which alleged that the airlines used the Airline Tariff Publishing Company to signal and communi- cate carrier pricing intentions and otherwise limit price competi- tion for travel to and from numerous hub airports. Under the terms of the settlement, the six air carriers have issued $396.5 million in certificates valid for purchase of domestic air travel on any of the six airlines. It is possible that this settlement could have a dilutive effect on USAir's passenger transportation revenue and associated cash flow. However, due to the interchangeability of the certificates among the six carriers involved in the settlement, the possibility that carriers not party to the settlement will honor the certificates and the potential stimulative effect on travel created by the certificates, USAir cannot reasonably estimate the impact of this settlement on future passenger revenue and cash flows. USAir estimates that any incremental cost associated with the settlement will not be material based on the nominal equivalent free trips associated with the settlement. The travel certificates were mailed to claimants in December 1994 and may be applied towards travel purchased between January 1995 and December 1998.\nOn October 11, 1994, USAir and seven other carriers entered into a settlement agreement with a group of State Attorneys General resolving similar issues with the states. The settlement entitles passengers traveling within the United States on state government business to a 10% discount off the published fares of each of the settling carriers and will be available for 18 months or until the combined discount amount reaches $40 million. Following a notice and public comment period, the reviewing judge will conduct a hearing to determine whether this settlement is a fair one. The hearing is scheduled for May 10, 1995. USAir does not expect that this settlement will have a material adverse effect on its financial condition. As was the case with the settlement of the private antitrust litigation, it is difficult to predict the amount of discounted state travel that will occur on USAir. Thus, a dollar impact of the settlement cannot be estimated.\nIn February and March 1995, several class action lawsuits were filed in various Federal district courts by travel agencies and a travel agency trade association alleging that most of the major U.S. airlines, including USAir, violated the antitrust laws when they individually capped travel agent commissions at $50 for round- trip domestic tickets with base fares above $500 and at $25 for one-way domestic tickets with base fares above $250. USAir intends to vigorously defend itself against the allegations made in these\nlawsuits. The plaintiffs are seeking unspecified treble damages for restraint of trade and an injunction to prevent the airlines from implementing or maintaining the cap on commissions. Because the lawsuits are in the first stages of litigation, USAir is unable to predict at this time their ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn March 1995, a number of U.S. carriers, including USAir, received a Civil Investigative Demand (\"CID\") from the Department of Justice related to an investigation of incentives paid to travel agents over and above the base commission payments, which are the subject matter of the suits recently brought by travel agencies as discussed above. USAir responded to an earlier CID on this topic during 1994. USAir is required to produce documents and respond to interrogatories in connection with this CID. USAir intends to comply with the requirements of the CID. Because this matter is in the investigatory stage, USAir is unable to predict at this time its ultimate resolution or potential impact on the Company's financial condition and results of operations.\nIn February 1995, two members of USAir's frequent traveler program filed a class action lawsuit in Pennsylvania state court against USAir after it raised the required minimum level of miles necessary to earn a free ticket. The plaintiffs allege breach of contract and seek unspecified damages and specific performance of the contract allegedly breached. USAir denies the allegations. The ultimate resolution of this lawsuit and its potential impact on the Company's financial condition and results of operations cannot be predicted at this time.\n(d) Aircraft Commitments\nUSAir and The Boeing Company (\"Boeing\") reached an agreement in principle in early 1995 regarding the deferral of eight 757-200 aircraft from 1996 to 1998.\nThe following schedule of USAir's new aircraft deliveries and schedule payments at December 31, 1994 (including progress payments, payments at delivery, buyer furnished equipment, spares and capitalized interest) reflects USAir's agreement in principle with Boeing discussed above:\nIn addition, USAir has a commitment to purchase hushkits for certain of its McDonnell Douglas DC-9-30 aircraft and a substantial portion of its Boeing 737-200 aircraft. The installation of these hushkits will bring the aircraft into compliance with Federal Aviation Administration (\"FAA\") Stage 3 noise level requirements. The projected payments associated with the purchase of the hushkits are: $10.5 million - 1995; $44.3 million - 1996; $45.5 million - 1997; $45.2 million - 1998; and $25.0 million - 1999.\n(e) Concentration of Credit Risk\nUSAir does not believe it is subject to any significant concentration of credit risk. At December 31, 1994, most of USAir's receivables related to tickets sold to individual passen- gers through the use of major credit cards (45%) or to tickets sold by other airlines (17%) and used by passengers on USAir or USAir Group's regional airline subsidiaries. These receivables are short-term, generally being settled shortly after sale. Bad debt losses, which have been minimal in the past, have been considered in establishing allowances for doubtful accounts.\n(f) Guarantees\nAt December 31, 1994, USAir guaranteed payments of certain debt obligations of the Galileo International Partnership amounting to approximately $9 million. In addition, at December 31, 1994, USAir guaranteed payments of debt and lease obligations of Piedmont Airlines, Inc. and Jetstream International Airlines, Inc., wholly- owned subsidiaries of USAir Group, amounting to $123 million.\n(5) Sale of Receivables\nThe revolving receivables sales facility (\"Receivables Agreement\"), to which USAir had been a party, expired on Decem- ber 21, 1994. USAir was unable to sell receivables under the Receivables Agreement during 1994 because it was in violation of certain financial covenants. USAir had no outstanding amounts due under the Receivables Agreement at December 31, 1994. The average dollar amount of outstanding receivable sales during 1993 and 1992 was $255 million and $100 million, respectively. USAir is currently engaged in discussions to arrange a replacement facility. There can be no assurance that USAir will be successful in reaching a new agreement to sell its receivables.\n(6) Income Taxes\nEffective January 1, 1993, USAir adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). FAS 109 required a change from the deferred method under Accounting Principles Board Opinion No. 11 to the asset and liability method of accounting for income taxes. No cumulative adjustment at January 1, 1993, and no income tax credit for the years ended December 31, 1994 and 1993, were recognized due to the FAS 109 limitation in recognizing benefits for net operating\nlosses. USAir files a consolidated Federal income tax return with its parent USAir Group pursuant to a tax allocation agreement.\nThe components of the provision (credit) for income taxes are as follows:\nThe significant components of deferred income tax expense\/ (benefit) for the years ended December 31, 1994 and 1993, are as follows:\n(this space intentionally left blank)\nFor the year ended December 31, 1992, deferred income taxes result from differences in the recognition of revenue and expenses and investment tax credits for tax and financial reporting purposes. The major items resulting in these differences and the related tax effects are shown in the following chart: ---- (in thousands)\nEquipment depreciation and amortization $ 67,582 Gain on sale and leaseback transactions (55,514) Net operating loss carryforward 55,671 Employee benefits (35,737) Tax benefits purchased\/sold 7,464 Investment tax credits (2,372) Leasing transactions (33,527) Frequent traveler program (2,815) Other (752) ------- Total deferred provision (credit) $ 0 =======\nA reconciliation of taxes computed at the statutory Federal tax rate on earnings before income taxes to the provision (credit) for income taxes is as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1994 and 1993 are presented below:\n(continued on next page)\nThe valuation allowance for deferred tax assets as of January 1, 1993, was $438 million. The valuation allowance increased $131 million in 1993 and $234 million in 1994.\nAt December 31, 1994, USAir had unused net operating losses of $1.8 billion for Federal tax purposes, which expire in the years 2005-2009. USAir also has available, to reduce future taxes payable, $740 million alternative minimum tax net operating losses expiring in 2007 to 2009, $48 million of investment tax credits expiring in 2002 and 2003, and $21 million of minimum tax credits which do not expire. The Federal income tax returns of the Company through 1986 have been examined and settled with the Internal Revenue Service.\n(7) Stockholder's Equity and Dividend Restrictions\nUSAir Group owns all of the outstanding Common Stock of USAir. USAir, organized under the Laws of the State of Delaware, is subject to statutory restrictions on the payment of dividends according to capital surplus requirements of Delaware law. At December 31, 1994, USAir's capital surplus was exhausted and therefore, under Delaware law, USAir is legally restricted from paying dividends to USAir Group. Surplus is the remainder of (i) net assets (total assets less total liabilities), less (ii) total capital (that amount of preferred and common equity designated as\ncapital by a company's board of directors). At December 31, 1994, USAir's capital deficit was approximately $273.2 million. USAir's net assets were in a deficit balance of approximately $273.2 million, and its total capital was a nominal amount. In order for USAir to return to a capital surplus position, it must realize substantial profits or increase its equity through other measures, such as the sale of additional common or preferred stock.\nCovenants related to USAir 10% and 9 5\/8% Senior Unsecured Notes currently do not permit the payment of dividends by USAir to USAir Group.\n(8) Employee Stock Ownership Plan\nIn August 1989, USAir established an Employee Stock Ownership Plan (\"ESOP\"). USAir Group sold 2,200,000 shares of its Common Stock to an Employee Stock Ownership Trust to hold on behalf of USAir's employees, exclusive of officers, in accordance with the terms of the Trust and the ESOP. Financing of approximately $111.4 million for the Trust's purchase of the shares was provided by USAir through a 9 3\/4% loan to the Trust, and an additional $2.2 million was contributed to the Trust by USAir. The loan is being repaid with contributions made by USAir. The contributions are made in amounts equal to the periodic loan payments as they come due, less dividends available for loan payment. As the loan is repaid over time, participating employees receive allocations of the Common Stock purchased by the Trust. The initial maturity of the loan is 30 years. However, the ESOP provides that if USAir's profitability as measured by return on sales exceeds certain goals during the life of the ESOP, USAir's contributions and the repayment of the loan will be accelerated. Annual contributions made by USAir and therefore loan repayments made by the Trust were $11.4 million in each of 1994, 1993 and 1992. The interest portion of these contributions was $10.5 million in 1994, $10.5 million in 1993 and $10.6 million in 1992. Approximately 438,000 shares of Common Stock have been allocated to employees. USAir recognized approximately $4 million of compensation expense related to the ESOP in each of 1994, 1993 and 1992 based on shares allocated to employees (the \"shares allocated\" method). Deferred compensation related to the ESOP amounted to approximately $91 million, $95 million and $98 million at December 31, 1994, 1993 and 1992, respectively.\n(9) Employee Benefit Plans\n(a) Pension Plans\nUSAir has several pension plans in effect covering substan- tially all employees. One qualified defined benefit plan covers USAir maintenance employees and provides benefits of stated amounts for specified periods of service. Qualified defined benefit plans for substantially all other employees provide benefits based on years of service and compensation. The qualified defined benefit plans are funded, on a current basis, to meet requirements of the Employee Retirement Income Security Act of 1974.\nThe defined benefit pension plan for USAir non-contract employees was frozen at the end of 1991 for all non-contract participants, resulting in a one-time book gain of approximately $107 million in 1991. All non-contract plan participants became 100% vested at the time of the freeze. As a result of this plan curtailment, the accrual of service costs related to defined benefits for USAir non-contract and certain other employees ceased at the end of 1991. USAir implemented a defined contribution pension plan for non-contract employees in January 1993.\nThe funded status of the qualified defined benefit plans at December 31, 1994 and 1993 was as follows:\nUnrecognized transition assets are being amortized over periods up to 27 years. The weighted average discount rate used to determine the actuarial present value of the projected benefit obligation was 9.0% and 7.6% as of December 31, 1994 and 1993, respectively. The expected long-term rate of return on plan assets used in 1994 and 1993 was 9.5%. Rates of 3% to 6% were used to estimate future salary levels. At December 31, 1994, plan assets consisted of approximately 8% in cash equivalents and short-term debt investments, 27% in equity investments, and 65% in fixed income and other investments. At December 31, 1993, plan assets consisted of approximately 8% in cash equivalents and short-term debt investments, 37% in equity investments, and 55% in fixed income and other investments.\nThe following items are the components of the net periodic pension cost for the qualified defined benefit plans:\nNet pension cost for 1993 presented above excludes a charge of approximately $33.9 million related to \"early-out\" incentive programs offered to a limited number of USAir employees during the years. No such charges were incurred in 1994 or 1992.\nNon-qualified supplemental pension plans are established for certain employee groups, which provide incremental pension payments from USAir's funds so that total pension payments equal amounts that would have been payable from USAir's principal pension plans if it were not for limitations imposed by income tax regulations.\nThe following table sets forth the non-qualified plans' status at December 31, 1994 and 1993:\nNet periodic supplementary pension cost for the non-qualified supplemental pension plans included the following components:\nThe discount rate used to determine the actuarial present value of the projected benefit obligation was 9.0% and 7.5% as of December 31, 1994 and 1993, respectively. A rate of 3% was used to estimate future salary levels.\nIn addition to the qualified and non-qualified defined benefit plans described above, USAir also contributes to certain defined contribution plans primarily for employees not covered under a collective bargaining agreement. USAir contributions are based on a formula which considers the age and pre-tax earnings of each employee and the amount of employee contributions. USAir's contribution expense was $43 million and $42 million for 1994 and 1993, respectively. USAir recognized no such expense in 1992 because the plans became effective January 1, 1993.\n(b) Postretirement Benefits Other Than Pensions\nUSAir offers medical and life insurance benefits to employees hired prior to March 29, 1993 who retire from the Company and their eligible dependents. The medical benefits provided by USAir are coordinated with Medicare benefits. Retirees generally contribute amounts towards the cost of their medical expenses based on years of service with USAir. USAir provides uninsured death benefit payments to survivors of retired employees for stated dollar amounts, or in the case of retired pilot employees, death benefit payments determined by age and level of pension benefit. The plans for postretirement medical and death benefits are funded on the pay-as-you-go basis.\nUSAir adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"), during 1992 and elected to record the January 1, 1992 Accumulated Postretirement Benefit Obligation (\"APBO\") using the immediate recognition approach. The cumulative effect of adopting FAS 106 was $745.5 million ($638.8 million net of tax benefit).\nThe following table sets forth the financial status of the plans as of December 31, 1994 and 1993:\nThe components of net periodic postretirement benefit cost are as follows:\nThe postretirement benefit expense for 1993 presented above excludes a charge of approximately $15.5 million related to \"early- out\" programs offered to a limited number of employees during the year. No such charges were incurred in 1994 or 1992.\nThe discount rate used to determine the APBO was 9.0%, 7.75% and 8.75% at December 31, 1994, 1993 and 1992, respectively. The assumed health care cost trend rate used in measuring the APBO was 9.5% in 1994, declining by 1% per year after 1994 to an ultimate rate of 4.5%. If the assumed health care cost trend rate were increased by 1 percentage point, the APBO at December 31, 1994 would be increased by 11% and 1994 periodic postretirement benefit cost would increase 13%.\n(c) Postemployment Benefits\nUSAir adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"FAS 112\"), during 1993. FAS 112 requires the use of an accrual method to recognize postemployment benefits such as disability-related benefits. The cumulative effect at January 1, 1993 of adopting FAS 112 was $43.7 million.\n(10) Supplemental Balance Sheet Information\nThe components of certain accounts in the accompanying balance sheets are as follows:\n(11) Non-Recurring and Unusual Items\n(a) 1994\nUSAir's results for 1994 include (i) a $132.8 million charge related to its grounded BAe-146 fleet, recorded in the fourth quarter of 1994; (ii) a $54.0 million charge for obsolete inventory and rotables to reflect market value, recorded in the fourth quarter of 1994; (iii) a $50 million addition to passenger transportation revenue in the fourth quarter of 1994 to adjust estimates made during the first three quarters of 1994; (iv) a $40.1 million charge primarily related to USAir's decision to cease operations of its remaining Boeing 727 aircraft in 1995, recorded in the third quarter of 1994; (v) a $25.9 million charge related to USAir's decision to substantially reduce service between Los Angeles and San Francisco and close its San Francisco crew base, recorded in the third quarter of 1994; and (vi) an $18.6 million gain resulting from the accounting treatment of the hull insurance recovery on the aircraft destroyed in the September accident, recorded in the third quarter of 1994.\n(b) 1993\nUSAir's results for 1993 include non-recurring charges of (i) $43.7 million for the cumulative effect of an accounting change, as required by FAS 112 which was adopted during the third quarter of 1993, retroactive to January 1, 1993; (ii) $68.8 million for severance, early retirement and other personnel-related expenses recorded primarily during the third quarter of 1993 in connection with a workforce reduction of approximately 2,500 full-time positions between November 1993 and the first quarter of 1994; (iii) $36.8 million based on a projection of the repayment of certain employee pay reductions, recorded in the fourth quarter of 1993; (iv) $13.5 million for certain airport facilities at locations where USAir has, among other things, discontinued or\nreduced its service, recorded in the fourth quarter of 1993; (v) $8.8 million for a loss on USAir's investment in the Galileo International Partnership, which operates a computerized reserva- tion system, recorded in the fourth quarter of 1993; and (vi) $18.4 million credit related to non-operating aircraft, recorded in the second quarter of 1993.\n(c) 1992\nUSAir's results for 1992 include (i) a charge of $628.1 million for the cumulative effect of an accounting change as required by FAS 106, effective January 1, 1992; (ii) a $107.4 million charge related to certain aircraft which have been withdrawn from service, recorded in the fourth quarter of 1992; and (iii) a $34.1 million non-operating loss related to the sale of ten MD-82 aircraft which USAir eliminated from its fleet plan, recorded in the fourth quarter of 1992.\n(12) Selected Quarterly Financial Data (Unaudited)\nThe following table presents selected quarterly financial data for 1994 and 1993:\nSee Note 11 - Non-Recurring and Unusual Items.\nNote: The sum of the four quarters may not equal yearly totals due to rounding of quarterly results.\nCertain 1993 amounts have been reclassified to conform with 1994 classifications.\nItem 9.","section_7A":"","section_8":"","section_9":"Item 9. Changes in and Disagreements with Accountants on Account- ing and Financial Disclosure\nNone\nPart III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of USAir Group, Inc.\nEach of the persons listed below is currently a director of the Company and was elected in 1994 by the stockholders of the Company. Each director of the Company is also a director of USAir. Except as noted otherwise, the following biographies disclose the age and describe the business experience of each director for at least the past five years. As required by the Investment Agree- ment, the Board amended the Company's By-Laws on January 21, 1993 to increase the authorized number of directors by three and immediately thereafter elected Messrs. Marshall, Maynard and Stevens to fill the new directorships. Under the Investment Agreement, the Company is required to use its best efforts to ensure that the slate of persons nominated by the Company for election as directors of the Company includes that number of persons designated by BA that is the percentage of the total then authorized number of directors, which is currently 16, of the Company that is nearest to but not greater than the percentage (but in no event greater than 25%) of the aggregate voting power of the securities that vote with the Common Stock as a single class for the election of directors of the Company then held by BA and its wholly-owned subsidiaries. Under this provision of the Investment Agreement, BA is entitled to designate three directors to the Board and has accordingly designated Messrs. Marshall, Maynard and Stevens. Messrs. Buffet and Munger have advised the Company that they will not stand for re-election as directors of the Company and of USAir at the 1995 annual meeting. They had previously announced that their continued service as directors of the Company and of USAir was dependent upon USAir successfully reaching a timely agreement with its organized labor groups that, in the opinion of Messrs. Buffett and Munger, provided USAir with sufficient labor cost savings which, when combined with other cost reduction programs being implemented by USAir, would afford USAir a reason- able opportunity to achieve profitability in a low fare competitive environment. On March 13, 1995, in announcing the decision of Messrs. Buffett and Munger not to stand for re-election, Berkshire Hathaway Inc. stated, \"To date, USAir has not been successful in achieving necessary labor cost savings.\"\nServed as Director since -------- Warren E. Buffett, 64 ................................. 1993\nMr. Buffett has been Chairman and Chief Executive Officer of Berkshire Hathaway Inc. (insurance, candy, retailing, manufacturing and publishing) since 1970. He is also a Director of Capital- Cities\/ABC, Inc., The Coca-Cola Company, The Gil- lette Company and Salomon Inc. Mr. Buffett is a member of the Finance and Planning Committee of the Board.\nEdwin I. Colodny, 68 ................................. 1975\nMr. Colodny is of counsel to the law firm of Paul, Hastings, Janofsky & Walker. He retired as Chair- man of the Company and of USAir in July 1992. He served as Chief Executive Officer of USAir from 1975 until retiring as an employee of USAir in June 1991. Mr. Colodny is a Director of Martin Marietta Corporation, Comsat Corporation and Esterline Technologies, Inc., and is a member of the Board of Trustees of the University of Rochester. He is a member of the Finance and Planning and Nominating Committees of the Board.\nMathias J. DeVito, 64 ................................. 1981\nMr. DeVito is Chairman of the Board of The Rouse Company (real estate development and management). He also serves as a Director of First Maryland Bancorp and subsidiaries of The Rouse Company. He is a member of the Board of the Business Committee for the Arts, Chairman of the Board of Empower Baltimore Management Corporation and former Chair- man of the Greater Baltimore Committee. Mr. DeVito is Chairman of the Compensation and Benefits Com- mittee and a member of the Finance and Planning Committee of the Board.\nGeorge J. W. Goodman, 64 .............................. 1978\nMr. Goodman is President of Continental Fidelity, Inc. which provides editorial and investment ser- vices. He is the author of a number of books and articles on finance and economics under the pen name \"Adam Smith\" and is the host of a television series of that name seen on public broadcasting stations in the U.S. and on other networks abroad. He is a Director of Cambrex Corporation. Mr. Goodman also serves as a member of the Advisory Committee of the Center for International Relations\nat Princeton University, and is a Trustee of the Urban Institute. He is a member of the Compensa- tion and Benefits and Finance and Planning Commit- tees of the Board.\nJohn W. Harris, 48 .................................... 1991\nMr. Harris is President of The Harris Group (real- estate development). From 1972 through 1991, he was President of The Bissell Companies, Inc. (real- estate development). He is a Director of Southern Bell Telephone and Telegraph Company. Mr. Harris is former Chairman of the Greater Charlotte Chamber of Commerce and a member of the Board of Trustees of the University of North Carolina and serves on the boards of several community service organiza- tions. He is a member of the Audit and Compensa- tion and Benefits Committees of the Board.\nEdward A. Horrigan, Jr., 65 ........................... 1987\nMr. Horrigan is the former Chairman of the Board of Directors of Liggett Group Inc. (consumer prod- ucts), a position he had held from May 1993 until his retirement in December 1994. He is also the retired Vice Chairman of the Board of RJR Nabisco, Inc. and retired Chairman and Chief Executive Officer of R. J. Reynolds Tobacco Company, Winston- Salem, North Carolina (consumer products). He is a Director of the Haggai Foundation. Mr. Horrigan is a member of the Audit and Nominating Committees of the Board.\nRobert LeBuhn, 62 ..................................... 1966\nMr. LeBuhn was the Chairman of Investor Interna- tional (U.S.), Inc. (investments) until his retire- ment in January 1995. He is now a private investor and is a Director of Acceptance Insurance Compa- nies, Amdura Corp., Lomas Financial Corp., Cambrex Corporation and Enzon, Inc. He is Trustee and President of the Geraldine R. Dodge Foundation, Morristown, New Jersey and is a member of the New York Society of Security Analysts. He is Chairman of the Finance and Planning Committee and a member of the Nominating Committee of the Board.\nSir Colin Marshall, 61 ................................ 1993\nSir Colin was elected Chairman of BA in February 1993. Previously, he had been Chief Executive of BA and a member of BA's Board of Directors since 1983. Sir Colin is a Director of HSBC Holdings Plc, IBM, United Kingdom Holdings Limited and Qantas Airways Limited. He is a member of the\nFinance and Planning Committee of the Board.\nRoger P. Maynard, 52 .................................. 1993\nMr. Maynard has been Director of Corporate Strategy of BA since 1991. Previously, from 1987, he had held various positions at BA, including Director of Investor Relations & Marketplace Performance and Executive Vice President North America. Mr. Maynard is a member of the Nominating and Compensation and Benefits Committees of the Board.\nJohn G. Medlin, Jr., 61 ............................... 1987\nMr. Medlin is Chairman of the Board and, until December 31, 1993, was Chief Executive Officer of Wachovia Corporation (bank holding company). Mr. Medlin also serves as a Director of BellSouth Company, Burlington Industries, Inc., Media Gener- al, Inc., National Services Industries, Inc., RJR Nabisco, Inc. and Nabisco Holdings Corporation. He is Chairman of the Nominating Committee and a member of the Compensation and Benefits Committee of the Board.\nHanne M. Merriman, 53 ................................. 1985\nMrs. Merriman is the Principal in Hanne Merriman Associates (retail business consultants). Previ- ously, she served as President of Nan Duskin, Inc. (retailing), President and Chief Executive Officer of Honeybee, Inc., a division of Spiegel, Inc., and President of Garfinckel's, a division of Allied Stores Corporation. Mrs. Merriman is a Director of CIPSCO, Inc. Central Public Service Company, State Farm Mutual Automobile Insurance Company, The Rouse Company, Ann Taylor Stores Corporation and T. Rowe Price Mutual Funds. She is a member of the Nation- al Women's Forum and a Trustee of The American- Scandinavian Foundation. She was a member of the Board of Directors of the Federal Reserve Bank of Richmond, Virginia from 1984-1990 and served as Chairman in 1989-1990. Mrs. Merriman is Chairman of the Audit Committee and is a member of the Nominating Committee of the Board.\nCharles T. Munger, 71 ................................. 1993\nMr. Munger is Vice Chairman of Berkshire Hathaway Inc. (insurance, candy, retailing, manufacturing and publishing) of which he has been an officer and Director since 1975. He is Chairman of Daily Journal Corporation and is a Director of Salomon Inc. and Wesco Financial Corporation. Mr. Munger\nis a member of the Audit Committee of the Board.\nFrank L. Salizzoni, 56 ................................ 1994\nMr. Salizzoni was elected President and Chief Operating Officer of the Company and USAir, effec- tive April 1, 1994, and was elected to the Board on May 25, 1994. Previously, Mr. Salizzoni was Vice Chairman and Chief Financial Officer of Trans World Airlines and Trans World Corporation until 1987, when he became Vice Chairman and Chief Financial Officer of TW Services, Inc. (food service). He was Chairman and Chief Executive Officer of TW Services from April 1987 until August 1989, just before that company went private. Mr. Salizzoni was associated with Mancusco and Co. (investments) from August 1989 until he was elected Executive Vice President-Finance of the Company and of USAir in November 1990. Mr. Salizzoni is a Director of H&R Block, Inc., and SKF USA, Inc.\nSeth E. Schofield, 55 ................................. 1989\nMr. Schofield was elected Chairman of the Board of the Company and USAir in June 1992. In June 1991 he was elected President and Chief Executive Offi- cer of the Company and of USAir. In June 1990 he was elected President and Chief Operating Officer of USAir. He had served as Executive Vice Presi- dent-Operations of USAir since 1981. Mr. Schofield joined USAir in 1957 and has held various corporate staff positions. Mr. Schofield is a Director of the Erie Insurance Group, the PNC Bank, N.A., USX Corp., the Greater Washington Board of Trade, the Flight Safety Foundation and the Greater Pittsburgh Council of the Boy Scouts of America. Mr. Scho- field is Chairman of the Board of Directors of the Greater Pittsburgh Chamber of Commerce, and a Board Member of the Pennsylvania Business Roundtable, Penn's Southwest Association, the Virginia Business Council and a member of the Desai Capital Manage- ment Advisory Board. He is also a member of the Allegheny Conference on Community Development and the Federal City Council and serves on the Board of Trustees of the University of Pittsburgh and West- minster College.\nRaymond W. Smith, 57 .................................. 1990\nMr. Smith is Chairman of the Board and Chief Execu- tive Officer of Bell Atlantic Company, which is engaged principally in the telecommunications business and is one of the seven regional companies formed as a result of the divestiture of the Bell System. Previously, Mr. Smith had served as Vice\nChairman and President of Bell Atlantic and Chair- man of The Bell Telephone Company of Pennsylvania. He is a member of the Board of Directors of Core- States Financial Company, a trustee of the Univer- sity of Pittsburgh and is active in many civic and cultural organizations. He is a member of the Compensation and Benefits and Nominating Committees of the Board.\nDerek M. Stevens, 56 .................................. 1993\nMr. Stevens has been Chief Financial Officer of and a Director of BA since 1989. Previously, from 1981, he was Finance Director of TSB Group plc (financial institution). Mr. Stevens is a member of the Audit Committee of the Board.\nThe law firm of Paul, Hastings, Janofsky and Walker, with which Mr. Colodny is affiliated on an Of Counsel basis, provided legal services to USAir during 1994 and is expected to provide such services during 1995.\nThe following persons are executive officers of the Company.\nFor purposes of Rule 405 under the Securities Act of 1933, as amended, Messrs. Lagow, Long, Aubin, Fornaro, Frestel, Harper and Ms. Risque Rohrbach are deemed to be executive officers of the Company.\nThere are no family relationships among any of the officers listed above. No officer was selected pursuant to any arrangement between him or her and any other person. Officers are elected annually to serve for the following year or until the election and qualification of their successors. All the executive officers except Ms. Risque Rohrbach and Messrs. Lagow, Salizzoni, Aubin, Fornaro and Harper have been actively engaged in the business and affairs of the Company and USAir during the past five years. The business experience of the officers listed above since at least January 1, 1990 is as follows:\nMr. Schofield was elected Executive Vice President of the Company in July 1989. At that time he was also elected Vice Chairman of the Board of the Company and of USAir. Mr. Schofield served as Executive Vice President-Operations of USAir until his election as President and Chief Operating Officer of USAir in June 1990. Effective on July 1, 1991, Mr. Schofield was elected President and Chief Executive Officer of both the Company and USAir. Effective on July 1, 1992, Mr. Schofield was elected Chairman of the Board of both the Company and USAir.\nMr. Salizzoni was Vice Chairman and Chief Financial Officer of Trans World Airlines and Trans World Corporation until 1987, when he became Vice Chairman and Chief Financial Officer of TW Services, Inc. He was Chairman and Chief Executive Officer of TW Services\nfrom April 1987 until August 1989, just before that company went private. Mr. Salizzoni was associated with Mancusco and Co. from August 1989 until he was elected Executive Vice President-Finance of the Company and of USAir in November 1990. Mr. Salizzoni was elected President and Chief Operating Officer of the Company and USAir in 1994.\nMr. Lagow was Senior Vice President-Market Planning of Northwest Airlines until February 1988, when he became Senior Vice President-Planning of United Airlines. Mr. Lagow held that position until he was elected Executive Vice President-Marketing of USAir in February 1992.\nMr. Lloyd engaged in the private practice of law in Washing- ton, D.C. from 1967 until his election as Vice President, General Counsel and Secretary of the Company and as Senior Vice President and General Counsel of USAir in 1987. He served in those capaci- ties until his election as Executive Vice President, Secretary and General Counsel of the Company and Executive Vice President and General Counsel of USAir in January 1991.\nMr. Long served as Senior Vice President-Administration of USAir until his election as Senior Vice President-Customer Operations of USAir in June 1989. He served in that capacity until his election as Senior Vice President-Customer Services in March 1991. Mr. Long served as Senior Vice President-Customer Services until his election as Executive Vice President-Customer Services in May 1992.\nMr. Aubin was Executive Advisor to the Vice Chairman, President and Chief Executive Officer of Air Canada prior to joining USAir and, prior to that position, he served as Senior Vice President Technical Operations and Chief Technical Officer of Air Canada. He was elected Senior Vice President-Maintenance Opera- tions of USAir in January 1994.\nMr. Fornaro was Vice President-Research of Jesup & Lamont Securities until February 1988, when he became Senior Vice President-Marketing of Braniff, Inc. In August 1988, Mr. Fornaro became Senior Vice President-Market Planning of Northwest Airlines, the position he held until February 1992. He was elected Senior Vice President-Planning of USAir in March 1992.\nMr. Frestel was associated with The Atchison, Topeka & Santa Fe Railway for 22 years prior to joining USAir, most recently as Vice President-Personnel and Labor Relations, and was a Director of that company from June 1988 until his election as Senior Vice President-Human Resources of USAir in January 1989.\nMr. Harper was Senior Vice President-Marketing and Information Systems at Axe-Houghton Management (investment management) until his election as Vice President and Controller of the Company and USAir in December 1991. He served in that position until his election as Senior Vice President-Information Systems of USAir in October 1992. Mr. Harper was elected Senior Vice President -\nFinance and Chief Financial Officer of the Company and USAir in 1994.\nMs. Risque Rohrbach served as a member of the White House legislative liaison team (1981-1986) and as Assistant to the President and Secretary to the Cabinet (1987-1988). In 1989 and 1990, she was a resident fellow at Harvard University's Institute of Politics and a consultant to the Department of Energy. She was Assistant Secretary of Labor for Policy at the U.S. Department of Labor during 1991-1992 and a public policy and communications consultant during 1993. Ms. Risque Rohrbach was elected Vice President-Public and Community Relations of the Company and Senior Vice President-Public and Community Relations of USAir in January 1994.\nItem 11.","section_11":"Item 11. Executive Compensation\nCompensation of Directors\nIn 1994, each incumbent director, except Messrs. Schofield and Salizzoni, was paid a retainer fee of $18,000 per year for service on the Board of the Company and a fee of $600 per Board meeting or committee meeting attended. Consistent with a comprehensive cost reduction program at USAir, the retainer fee was reduced by 20% to $14,400 for an eighteen-month period commencing January 1, 1992 and ending on June 30, 1993. As of January 1, 1995, the retainer fee has been reduced to $14,000 per year. Mr. LeBuhn, Chairman of the Finance and Planning Committee, Mr. DeVito, Chairman of the Compensation Committee, and Mrs. Merriman, Chairman of the Audit Committee, each receives an additional fee of $2,000 per year for serving in those respective capacities. Mr. Medlin, Chairman of the Nominating Committee, receives an additional fee of $1,000 per year for serving in that capacity. Each of Messrs. Schofield and Salizzoni receives a salary in his capacity as an officer of USAir and receives no additional compensation as a director of the Company and USAir.\nIn 1987 the Company established a retirement plan for directors who are not also employees of the Company and its subsidiaries. The plan provides that such directors shall be eligible to receive retirement benefits thereunder if they have attained seventy years of age and served at least five consecutive years on the Board or, if they have not attained age seventy, have served for at least ten consecutive years on the Board. Eligible directors receive an annual retirement benefit equal to the highest annual retainer in effect for active directors during the five years prior to retirement. If the annual retainer for active directors is increased, the annual retirement benefit paid to retired directors is increased by an amount equal to 50% of the increase in retainer paid to active directors. If a director dies prior to retirement and had served for at least five consecutive years on the Board, the deceased director's surviving spouse is eligible under the plan to receive, for a period of five years following such death, an annual death benefit equal to 50% of the annual retainer paid to such director at the time of his or her\ndeath. If a retired eligible director dies, the director's surviving spouse is eligible under the plan to receive, for a period of five years following such death, 50% of the annual retirement benefit payable to the director at the time of his or her death. The plan is administered by the Compensation and Benefits Committee.\nCompensation of Executive Officers\nThe Summary Compensation Table below sets forth the compensa- tion paid during the years indicated to each of the Chief Executive Officers and the four remaining most highly compensated executive officers of the Company (including its subsidiaries).\nSummary Compensation Table\n(a) Mr. Salizzoni was named President and Chief Operating Officer of the Company and USAir effective April 1, 1994. (b) Mr. Lagow's employment with USAir commenced on February 7, 1992. (c) Amounts disclosed reflect reductions in salary during (i) 1993 of $24,365, $12,250, $14,942, $10,904 and $8,750, and (ii) 1992 of $87,019, $43,750, $49,272, $38,942 and $31,250 for Messrs. Schofield, Salizzoni, Lagow, Lloyd and Frestel, respectively, which were implemented for all USAir officers for a fifteen-month period commencing on January 1, 1992 and ending on March 29, 1993 pursuant to a comprehensive cost reduction program at USAir.\n(d) Paid to Mr. Lagow in the form of a \"sign-on bonus.\" (e) Amounts disclosed include for (i) 1994, $108,633, $10,391, $18,705, and $30,518, (ii) 1993, $271,288, $33,259, $73,215, and $48,805 and (iii) 1992, $171,410, $22,523, $47,974 and $31,717, received by Messrs. Schofield, Salizzoni, Lloyd and Frestel, respectively, to cover incremental tax liability resulting from income derived from the lapsing of restrictions on the disposition of Restricted Stock. Restricted Stock is Common Stock subject to certain restrictions on disposition. Any amounts disclosed in the column that are in excess of the amounts disclosed in the preceding sentence represent income derived from personal travel on USAir. (f) At December 31, 1994, Messrs. Schofield, Salizzoni, Lloyd and Frestel owned 10,000, 3,000, 1,000 and 1,000 shares of Restricted Stock, respectively. At the fair market value of the Common Stock on that date, these holdings of Restricted Stock were valued at $42,500, $12,750, $4,250 and $4,250, respectively. Restricted Stock is eligible to receive divi- dends; however, the Company has not paid dividends on its Common Stock since the second quarter of 1990. (g) Non-qualified stock option grant on April 1, 1994, the date Mr. Salizzoni was named President and Chief Operating Officer of the Company and USAir. (h) Under USAir's split dollar life insurance plan, described under \"Additional Benefits\" below, individual life insurance coverage is available to the named officers. During 1992, each officer paid the amount of the premium associated with the term life component of the coverage. In 1993, USAir commenced paying the premium associated with this coverage. In 1992, 1993 and 1994, USAir paid the remainder of the premium associated with the whole life component of the coverage. If all assumptions as to life expectancy and other factors occur in accordance with projections, USAir expects to recover the premiums it pays with respect to the whole life component of the coverage. The following amounts reflect the value of the benefits accrued during the years indicated, calculated on an actuarial basis, ascribed to the insurance policies purchased on the lives of the named officers (plus, with respect to 1993 and 1994, the dollar value of premiums paid by USAir with respect to term life insurance): 1994--Mr. Schofield--$31,194; Mr. Salizzoni--$27,722; Mr. Lagow--$10,225; Mr. Lloyd--$18,424 and Mr. Frestel--$21,188; 1993--Mr. Schofield--$29,328, Mr. Salizzoni--$26,010, Mr. Lagow--$9,716, Mr. Lloyd--$17,291 and Mr. Frestel--$18,661; 1992--Mr. Schofield--$38,495; Mr. Salizzoni--$34,382; Mr. Lagow--$12,902; Mr. Lloyd--$21,382 and Mr. Frestel--$19,821. During 1994 and 1993, USAir made contributions to the accounts of Messrs. Schofield, Salizzoni, Lagow, Lloyd and Frestel in certain defined contribution pension plans in the following amounts: 1994--$43,627, $38,192, $26,000, $22,000 and $24,678, respectively, and 1993--$34,974, $26,212, $22,805, $18,897 and $18,702, respec- tively. (i) Amount disclosed also reflects $101,246 for reimbursement of relocation expenses.\n(j) Upon the commencement of his employment, USAir agreed to pay Mr. Lagow $1 million over four years, which amount was intended to compensate him for restricted stock and stock options which he forfeited when he left his former employer. The amount disclosed includes the second installment, $250,000, of the total payment. (k) Amount disclosed includes the first installment, $250,000, of the total payment referred to in footnote (j). (l) Amount disclosed also reflects $4,715 for reimbursement of relocation expenses.\nOption\/SAR Grants in Last Fiscal Year\nThe following table provides information on option grants in fiscal year 1994 to the named executive officers. No option grants were made to Messrs. Schofield, Lagow, Lloyd or Frestel.\n(a) These options were granted as of April 1, 1994. Twenty-five percent of these options will vest on the first anniversary of their grant (April 1, 1995), an additional 25% will vest on the second anniversary of their grant (April 1, 1996), and the remaining 50% will vest on the third anniversary of their grant (April 1, 1997). None of these options is accompanied by stock appreciation rights. (b) Based on total grants of options to purchase 321,000 shares of Common Stock awarded during 1994. (c) The exercise price and tax withholding obligation related to exercise may be paid by delivery of previously-owned shares or by offset of the underlying shares, subject to certain conditions. (d) Represents the increase in aggregate market value of all shares of Common Stock outstanding as of April 1, 1994, from that date to May 1, 2004 at the assumed rate of stock price appreciation specified.\nAggregated Option\/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option\/SAR Values\nThe following table provides information on the number of options held by the named executive officers at fiscal year-end 1994. None of the officers exercised any options during 1994 and\nnone of the unexercised options held by these officers was in-the-money based on the fair market value of the Common Stock on December 31, 1994 ($4.25 per share).\nRetirement Benefits\nPrior to 1993, USAir's Retirement Plan (the \"Retirement Plan\") for its salaried employees was comprised of two qualified plans. The Retirement Plan was designed so that the two plans, when aggregated, would provide noncontributory benefits based upon both years of service and the employee's highest three-year average annual compensation during the last ten calendar years of service. The primary plan is a defined benefit plan which provides a benefit based on the factors mentioned above. The primary plan is integrated with the Social Security program so that the benefits provided thereunder are reduced by a portion of the employee's benefits from Social Security. USAir's contributions to the primary plan are not allocated to the account of any particular employee. The primary plan was frozen on December 31, 1991, and accordingly, retirement benefits payable under the plan were determinable on that date.\nThe secondary plan is a target benefit defined contribution plan. The secondary plan was established in 1983 as a result of changes to the Internal Revenue Code (the \"Code\"), which lowered the maximum benefit payable from a defined benefit plan. In the event that the benefit produced under the primary plan formula cannot be accrued for any employee covered by such plan because of the limit on benefits payable under defined benefit plans, contributions will be made on behalf of such employee to the secondary plan. Such contributions will be calculated to provide the benefit produced under the formula in the primary plan in excess of such limit, to the extent permitted under the Code's limitation on the contributions to defined contribution plans. USAir's contributions to the secondary plan are allocated to individual employees' accounts. During 1994, no contributions were made to any executive officer's account. The secondary plan was also frozen on December 31, 1991.\nUnder the Retirement Plan, benefits usually begin at the normal retirement age of 65. The Retirement Plan also provides benefits for employees electing early retirement from ages 55 through 64. If such an election is made, the benefits may be reduced to reflect the longer interval over which the benefits will\nbe paid. Executive officers participate in the Retirement Plan on the same basis as other employees of USAir.\nContributions to and benefits payable under the Retirement Plan must be in compliance with the applicable guidelines or maximums established by the Code. USAir has adopted an unfunded supplemental plan which will provide those benefits which would otherwise be payable to officers under the Retirement Plan, but which, under the Code, are not permitted to be funded or paid through the qualified plans maintained by USAir. Benefit accruals under the supplemental plan also ceased upon the freezing of the Retirement Plan on December 31, 1991. Such supplemental plan provides that any benefits under the unfunded supplemental plan will be paid in the form of a single, lump sum payment. Such supplemental plans are specifically provided for under applicable law and have been adopted by many corporations under similar circumstances. Messrs. Schofield, Salizzoni, Lloyd and Frestel are currently entitled to receive retirement benefits in excess of the limitations established by the Code.\nThe following table presents the noncontributory benefits payable per year for life to employees under the Retirement Plan and the unfunded supplemental plan described above, assuming normal retirement in the current year. The table also assumes the retiree would be entitled to the maximum Social Security benefit in addition to the amounts shown.\nThe values reflected in the above chart represent the applica- tion of the Retirement Plan formula to the specified amounts of compensation and years of service. The compensation covered by the\nRetirement Plan is salary and bonus, as reported in the Summary Compensation Table. The credited years of service under the Retirement Plan for each of the individuals included in the Summary Compensation Table are as follows: Mr. Schofield-30 years, Mr. Salizzoni-1 year, Mr. Lagow-none, Mr. Lloyd-5 years and Mr. Frestel-3 years.\nUSAir has entered into agreements with Messrs. Lagow, Salizzoni, Lloyd and Frestel which provide for a supplement to their retirement benefits under the Retirement Plan. This supplement is designed to provide such persons with those benefits they would have received had they been employed by USAir for the minimum number of years to be entitled to full retirement benefits under the Retirement Plan.\nUSAir adopted, effective January 1, 1993, a defined contribu- tion retirement program for its eligible non-contract employees (the \"Retirement Savings Plan\") as a replacement for the Retirement Plan described above. Under the Retirement Savings Plan, eligible employees may elect to contribute on a tax-deferred basis up to 13% of their pre-tax compensation, subject to a maximum annual contribution of $9,240 in 1994. USAir will also contribute to each employee's account in the Retirement Savings Plan (i) a matching contribution equal to 50% of each employee's contribution, subject to a maximum of 2% of the employee's annual pre-tax compensation; (ii) a basic contribution which ranges, depending on the employee's age, from 2% to 8% of the employee's annual pre-tax compensation; and (iii) if USAir's pre-tax profit margin, as defined, exceeds certain thresholds, a profit sharing contribution up to a maximum of 7.5% of an employee's annual pre-tax compensation. USAir made no contributions under the profit sharing component of the Retirement Savings Plan in 1994. Pre-tax compensation is defined for purposes of the Retirement Savings Plan as base pay plus bonus, plus an employee's tax deferred contributions under such Plan up to a maximum of $150,000 in 1994. USAir also established a non-qual- ified supplemental defined contribution plan (the \"Supplemental Savings Plan\") in 1993, which credits amounts to accounts of certain officers who participate in the Retirement Savings Plan but who are adversely affected by the maximum benefit limitations under qualified plans imposed by the Code. Amounts obligated to be paid by USAir under the Supplemental Savings Plan will be deposited in a trust established for the benefit of the participants. See the \"All Other Compensation\" column of the Summary Compensation Table for the amounts contributed or allocated in 1994 to Messrs. Schofield, Salizzoni, Lagow, Lloyd and Frestel under the Retirement Savings Plan and the Supplemental Savings Plan.\nUnder the Retirement Savings Plan and the Supplemental Savings Plan, participants may direct the investment of their contributions and USAir's contributions to their accounts among certain invest- ment funds. Participants' contributions are fully vested when made. USAir's contributions vest when the participant has been employed by USAir for at least two years.\nAdditional Benefits\nUSAir has in effect an Officers' Supplemental Benefit Plan, which provides certain benefits to a current or retired officer's spouse and children under age 19 following the officer's death. These benefits include: (i) dependent survivors' monthly income benefit and (ii) dependent survivors' health care insurance.\nA dependent survivors' monthly income benefit is payable to the eligible spouse or children of a deceased officer or retired officer in an amount equal to 20% of the monthly basic rate of salary payable to the officer the day prior to death or, in the case of a deceased retired officer, the day prior to retirement. Monthly income benefits will be reduced by the amount of any spouse protection benefit payable from Retirement Plan funds, and are subject to cessation upon the occurrence of certain specified events. In no case are monthly income benefits payable for more than 19 years following the date of death.\nThe eligible surviving spouse or children of a deceased officer or retired officer are also entitled to receive dependent survivors' health care insurance, which provides the medical, major medical and dental insurance benefits generally available to dependents of salaried employees of USAir. Eligibility for this coverage ceases upon the occurrence of certain specified events.\nUSAir also maintains a split-dollar life insurance plan under which individual term life insurance is available to its officers in the amount of three times base salary. The plan also provides for accrual of a cash value component for each officer who holds a policy. Under the plan, during 1994, USAir paid the premiums on the term and whole life insurance components of the policy. The premium attributable to the term life insurance of the policy is treated as income to the participant. At death, prior to transfer of the policy to the participant, the beneficiary receives the amount of the coverage less any amount necessary to reimburse the employer for its investment, and the beneficiary is entitled to any additional proceeds. Upon transfer of the policy to the partici- pant, the participant is entitled to the cash surrender value of the policy in excess of the amount payable to the employer for recovery of its investment. See the \"All Other Compensation\" column of the Summary Compensation Table for information concerning compensation with respect to Messrs. Schofield, Salizzoni, Lagow, Lloyd and Frestel that was attributable to the split dollar life insurance plan.\nArrangements Concerning Termination of Employment and Change of Control\nUSAir currently has employment contracts (the \"Employment Contracts\") with the executive officers (the \"Executives\") named in the Summary Compensation Table. The terms of the Employment Contracts extend until the earlier of the fourth anniversary thereof or the Executive's normal retirement date and are subject to automatic one-year annual extensions on each anniversary date\n(to the fourth anniversary of such anniversary date) unless advance written notice is given by USAir. In exchange for each Executive's commitment to devote his or her full business efforts to USAir, the agreements provide that each Executive will be re-elected to a responsible executive position with duties substantially similar to those in effect during the prior year and will receive (1) an annual base salary at a rate not less than that in effect during the previous year; (2) incentive compensation as provided in the contract; and (3) insurance, disability, medical and other benefits generally granted to other officers. In the event of a change of control, as defined in each Employment Contract, the term of each Employment Contract is automatically extended until the earlier of the fourth anniversary of the change of control date or the Executive's normal retirement date. As a result of amendments to the Employment Contracts entered into in June 1992, the acquisition of 20% or more of the outstanding securities of the Company under circumstances in which the acquiror would obtain the power to elect 20% or more of the members of the Board was added to the definition of a change of control under the Employment Contracts. To the extent permitted by Foreign Ownership Restrictions and assuming the consummation of the Second Purchase (the \"Second Closing\") results in BA's electing at least 20% of the Board, the Second Closing would be treated as a change of control and would result in extension of the term of each Employment Contract until the earlier of the fourth anniversary of the Second Closing or the Executive's normal retirement date. On March 7, 1994, BA announced that it would not make any additional investments in the Company until the outcome of the measures to reduce the Company's costs and improve its financial results is known. See Item 1. \"Business - British Airways Announcement Regarding Additional Investments in the Company; Code Sharing.\"\nThe Employment Contracts provide that, should USAir or any successor fail to re-elect the Executive to his or her position, assign the Executive to inappropriate duties which result in a diminution in the Executive's position, authority or responsibili- ties, fail to compensate the Executive as provided in the Employ- ment Contract, transfer the Executive in violation of the Employ- ment Contract, fail to require any successor to USAir to comply with the Employment Contract or otherwise terminate the Executive's employment in violation of the Employment Contract, the Executive may elect to treat such failure as a breach of the Employment Contract if the Executive then terminates employment. As liquidat- ed damages as the result of an event not following a change of control that is deemed to be a breach of the Employment Contracts, USAir or its successor would be required to pay the Executive an amount equal to his or her annual base salary for the then remaining term of the Employment Contract, and to continue granting certain employee benefits for the then remaining term of the Executive's Employment Contract. If the breach follows a change of control, the Executive would be entitled to receive (i) an amount equal to the product of three times the sum of the Executive's annual base salary plus an annual bonus; (ii) a lump sum equal to the actuarial equivalent of the pension benefits which the Executive would have received had he or she remained employed by\nUSAir until the end of the term of the Employment Contract, (iii) medical benefits until such time as the Executive qualifies for group medical benefits from another employer; (iv) travel benefits for the Executive's life; (v) reimbursement of reductions in salary sustained by the Executive as a result of a comprehensive cost reduction program initiated by USAir in October 1991; and (vi) continuation of certain other benefits during the remainder of the term of the Employment Contract. In addition, except under the circumstances described in the immediately following paragraph, during the 30-day period immediately following the first anniversa- ry of a change of control any Executive could elect to terminate his or her Employment Contract for any reason and receive the liquidated damages described in the immediately preceding sentence. Each Employment Contract provides that if USAir breaches the Employment Contract, as described above, each Executive shall be entitled to recover from USAir reasonable attorney's fees in connection with enforcement of such Executive's rights under the Employment Contract. Each Employment Contract also provides that any payments the Executive receives in the event of a termination shall be increased, if necessary, such that, after taking into account all taxes he or she would incur as a result of such payments, the Executive would receive the same after-tax amount he or she would have received had no excise tax been imposed under Section 4999 of the Code.\nIn order to facilitate consummation of the acts and transac- tions contemplated by the Investment Agreement, the Executives agreed in January 1993 to an amendment to their Employment Contracts that will become effective upon the Second Closing (i) to eliminate their right to elect to terminate their Employment Contracts without any reason during the 30-day period immediately following the first anniversary of the Second Closing; (ii) that USAir may transfer the Executive's employment to any location that meets certain criteria in the Employment Contracts without such relocation constituting a breach of the Employment Contracts; (iii) that consummation of the Second Closing would be treated as the only change of control with respect to BA; and (iv) that following the Second Closing, USAir may make certain changes in benefit plans affecting the Executives that are not material, as that term is defined in the Employment Contracts, provided that the changes apply to all eligible officers of USAir and are approved by a majority of the directors of the Company not elected by BA. As discussed above, BA announced on March 7, 1994 that it will not make any additional investments in the Company under current circumstances.\nCurrently, under the Company's 1984 Stock Option and Stock Appreciation Rights Plan (the \"1984 Plan\") and 1988 Stock Incentive Plan (the \"1988 Plan,\" and together with the 1984 Plan, the \"Plans\"), pursuant to which employees of the Company and its subsidiaries have been awarded stock options and stock appreciation rights with respect to Common Stock and, in the case of the 1988 Plan, shares of Restricted Stock, occurrence of a change of control, as defined, would make all granted options immediately exercisable without regard to the vesting provisions thereof. In\naddition, grantees would be able, during the 60-day period immediately following a change of control, to surrender all unexercised stock options not issued in tandem with stock apprecia- tion rights under the Plans to the Company for a cash payment equal to the excess, if any, of the fair market value of the Common Stock over the exercise prices of such stock options or the positive value of any stock appreciation rights. As described above, in June 1992, the Company amended the definition of a change of control in the Plans with the result that, to the extent permitted by Foreign Ownership Restrictions and assuming the Second Closing results in BA's electing at least 20% of the Board, the Second Closing would be treated as a change of control thereunder. As of March 1, 1995, there were unexercised stock options to purchase 473,795 shares of Common Stock (of which 73,400 had tandem stock appreciation rights) under the 1984 Plan and unexercised stock options to purchase 3,396,500 shares of Common Stock (none of which had tandem stock appreciation rights) under the 1988 Plan. (As of March 1, 1995, 2,980,500 of the 3,396,500 options outstanding under the 1988 Plan and 315,795 of the 473,795 options outstanding under the 1984 Plan were exercisable pursuant to their normal vesting schedule.) As of March 1, 1995, the weighted average exercise price of all these outstanding stock options was approximately $22.06. On March 1, 1995, the closing price of a share of Common Stock on the NYSE was $6.00. See the \"Aggregated Option\/SAR Exercises in Last Fiscal Year and Fiscal Year-End Option\/SAR Values\" table for information regarding stock options held by the Executives named in that table.\nCurrently, 15,000 shares of Restricted Stock previously granted to the Executives may (i) become free of transfer restric- tions upon their normal vesting schedule or (ii) be subject to accelerated vesting upon a termination of employment which triggers the payment of liquidated damages under the Employment Contracts, as discussed above, regardless of whether the termination occurred following a change of control as defined in the Employment Contracts. See \"Beneficial Security Ownership\" for information regarding Restricted Stock owned by the Executives.\nWith respect to Mr. Lagow, in order to induce him to accept its offer of employment in 1992, USAir agreed, among other things, to pay Mr. Lagow $1 million in four equal installments, each installment being due and payable on the first four anniversaries of the commencement of his employment by USAir, provided Mr. Lagow remains employed by USAir. This payment was intended to compensate Mr. Lagow for stock options and restricted stock which he forfeited when he left his former employer. In the event of a change of control under his Employment Contract or wrongful termination thereunder, USAir has also agreed to pay Mr. Lagow in a lump sum any unpaid balance of this obligation.\nNotwithstanding anything to the contrary set forth in any of the Company's or USAir's filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that incorporates by reference this Annual Report, in whole or in\npart, the following Report and Performance Graph shall not be incorporated by reference into any such filings.\nReport of the Compensation and Benefits Committee of the Board of Directors\nThe policies of the Compensation and Benefits Committee of the Board (the \"Compensation Committee\") with respect to compensation of the Company's executive officers are to:\n* attract and retain talented and experienced senior management by offering compensation that is competitive with respect to other major U.S. airlines and other U.S. companies of compara- ble size; and\n* motivate senior management to provide a high-quality product to consumers with the ultimate goal of maximizing profitabili- ty and stockholder returns by offering incentive and long-term compensation that is linked to return on sales and the market value of the Common Stock.\nThe compensation package for executive officers of the Company is comprised of three elements - base salary, annual cash incentive compensation, and long-term incentive compensation. The Compensa- tion Committee plays an active role in the oversight and review of all compensation paid to executive officers of the Company. Ordinarily, the Compensation Committee and the full Board, in consultation with the Senior Vice President-Human Resources of USAir and, if warranted, an independent compensation consultant, annually review the total compensation package of the Company's executive officers, including the Chairman and Chief Executive Officer and the four other officers named in the Summary Compensa- tion Table. This review did not occur during the last fiscal year. Because of the Company's continued financial losses, no salary increases were contemplated for executive officers in 1994 and hence a competitive salary review was deemed unnecessary. In past years when a salary review was undertaken, the Compensation Committee reviewed the market rate for peer-level positions of the other major domestic passenger airlines, including, but not limited to, Delta, United and American. Delta, United and American (or their parent companies) are included in the S&P Airline Index, which has been used in prior years' Performance Graphs. Based primarily on this comparison, the Compensation Committee estab- lished the base salary for the Chief Executive Officer and other executive officers.\nWhile the Compensation Committee reviews the salaries of the other major airlines to establish a market rate, the Committee does not necessarily \"target\" any specific range, such as the lower end, median or upper end of the comparison range, when setting the Chief Executive Officer's base salary. As discussed below, in 1992, after an independent compensation consultant conducted a study of comparable airline officers' salaries, the Compensation Committee recommended an increase in the Chief Executive Officer's base salary to the median level of the comparison range reflected in the\nstudy, but Mr. Schofield declined to accept an increase. According to publicly available information, the current base salary of the Company's Chief Executive Officer is lower than the base salaries for the chief executive officers of Delta, United, American and Southwest. Mr. Schofield does not participate in Compensation Committee or Board deliberations or decision-making regarding any aspect of his compensation.\nThe Chief Executive Officer has an employment agreement with the Company which guarantees a certain level of base salary. Mr. Schofield's employment agreement provides that he will receive base salary at least equal to the highest base salary paid during the preceding twelve-month period. In the event that the Company violates this provision of the agreement, Mr. Schofield may terminate his employment for \"good reason\" under the agreement and receive a payout of compensation and benefits for the remainder of the four-year employment period protected by the agreement. The four other executive officers named in the Summary Compensation Table have similar employment agreements which also guarantee a certain level of base salary.\nThe principal elements of the Company's compensation paid to the executive officers in the last completed fiscal year are discussed below.\nBase Salary. As reported by the Compensation Committee in prior reports, the Compensation Committee had reduced the salaries of the executive and other officers for a fifteen-month period commencing on January 1, 1992 and ending on March 29, 1993. This salary reduction was part of a comprehensive Company-wide salary reduction program. Each of the executive officers of the Company agreed to the reductions in salary, waiving the base salary guarantees in their employment agreements, where applicable.\nHistorically, the Compensation Committee has awarded merit increases based on measuring individual performance against objectives. However, due to the Company's poor financial perfor- mance since 1989, the Compensation Committee had not awarded merit increases in executive officer base salaries since 1989. From 1989 to 1993, salaries were increased only as a result of a promotion or an increase in responsibilities.\nIn 1992, after the commencement of the salary reduction program, the Company commissioned an independent compensation consultant to conduct a comprehensive study of the salaries of comparable airline officers. The study disclosed that the base salaries of the Company's executive officers (prior to reduction under the salary reduction program) were substantially below those salaries for analogous positions at major competitors. After reviewing the results of the study and considering its desire to motivate and retain the Company's key executive officers, and the officers' individual performance and experience, the Compensation Committee established new base salaries for executive officers (other than the Chief Executive Officer) at the conclusion of the salary reduction period in 1993, targeting the median of the\ncomparative range reflected in the study. Based on the salary review, the Compensation Committee proposed a new base salary for the Chief Executive Officer of $590,000. However, because of the Company's poor financial performance, Mr. Schofield declined to accept an increase in base salary and his salary was restored to its pre-reduction level of $500,000. The new base salaries for the other four executive officers named in the Summary Compensation Table became effective in April 1993. As stated above, as a result of the Company's continuing financial losses, no salary increases were considered by the Compensation Committee during 1994. Except as set forth below, the base salaries established by the Compensa- tion Committee in 1993 remained effective throughout 1994 and remain in effect today.\nOn April 1, 1994, Mr. Salizzoni was promoted from Executive Vice President-Finance to the position of President and Chief Operating Officer. At the time of his promotion, the Compensation Committee approved an increase in his base salary commensurate with his increased responsibilities.\nCommencing in March 1994, the Company has been engaged in negotiations with its labor unions to effectuate a comprehensive expense reduction program which includes a proposal to permanently reduce employee salaries. This expense reduction program is designed to return the Company to profitability. In light of this initiative, Messrs. Schofield and Salizzoni requested a reduction in their base salaries as a demonstration of leadership. In November 1994, the Compensation Committee approved a reduction in the base salaries of the Chief Executive Officer and the President and Chief Operating Officer. Effective in December 1994, their base salaries were reduced in accordance with the following schedule:\n* 10% of the amount of salary between $5,000 and $20,000; * 15% of the amount of salary between $20,000 and $50,000; * 20% of the amount of salary between $50,000 and $100,000; and * 25% of the amount of salary over $100,000.\nBoth executive officers signed waivers of the applicable provisions of their employment agreements guaranteeing a higher level of base salary.\nAnnual Cash Incentive Compensation. The Compensation Committee adopted the Executive Incentive Compensation Plan effective on January 1, 1988. The plan is administered by the Compensation Committee. All officers, including the executive officers, of the Company are eligible to participate in the plan.\nThe Compensation Committee is authorized to grant awards under this plan only if the Company achieves a two percent or greater return on sales (\"ROS\") for a fiscal year. The target level of performance is four percent ROS. The maximum level of performance recognized under the plan is a six percent ROS. Additionally, for each officer of the Company, the Compensation Committee has previously set an incentive compensation target percentage and a\nmaximum percentage. If the Company achieves the target performance of four percent ROS, the full target percentage set by the Committee for the individual officer is applied to the individual's base salary for the year to determine the cash bonus award (the \"Target Award\") for the individual. Target Awards for executive officers range from 30% to 50% of base salary.\nThe Compensation Committee is authorized to approve awards under the plan for performance which is less than or greater than the target performance of four percent ROS. If the Company achieves the minimum performance level of two percent ROS, the executive would be paid only half of the Target Award. For performance levels greater than two percent ROS but less than four percent ROS, a proportionate percentage of the Target Award would be paid. In the event that the Company's performance level exceeds the target performance of four percent ROS, the Company would pay amounts greater than the Target Award. If the Company achieves the maximum target performance of six percent ROS, the executive would receive the maximum percentage which is twice the Target Award. The maximum awards for executive officers, set by the Compensation Committee pursuant to the plan, range from 60% to 100% of base salary. For performance levels greater than four percent ROS but less than six percent ROS, a proportionate percentage of the Target Award would be paid. The plan also provides that the Compensation Committee may adjust awards to executive officers based on individual performance; however, in no event may the award exceed 250% of the Target Award for such individual. The Compensation Committee has never made any such adjustments.\nThe Compensation Committee last approved payments to executive officers under this plan for the fiscal year ended December 31, 1988. The Company has failed to achieve the minimum two percent ROS performance level in any fiscal year since 1988 and, therefore, the Compensation Committee has not made any awards under the plan since then. The Compensation Committee will continue to review the effectiveness of the plan and, if the Compensation Committee deems appropriate, could recommend changes to the plan in the future.\nLong Term Incentive Programs\nStock Options. The executive officers of the Company partici- pate in the Company's 1984 Stock Option and Stock Appreciation Rights Plan (the \"1984 Plan\") and the 1988 Stock Incentive Plan (the \"1988 Plan\"). Both the 1984 Plan and the 1988 Plan are administered by the Compensation Committee. The Compensation Committee is authorized to grant options under these plans only at an exercise price equal to the fair market value of a share of Common Stock on the effective date of the grant.\nThe Compensation Committee determines the size of any option grant under the plans based upon (i) the Compensation Committee's perceived value of the grant to motivate and retain the individual executive; (ii) a comparison of long-term incentive practices within the commercial airline industry; (iii) a comparison of awards provided to peer executives within the Company; and (iv) the\nnumber of outstanding options held by the grantee and the exercise prices of these options. Although the Compensation Committee supports and encourages stock ownership in the Company by its executive officers, it has not promulgated any standards regarding levels of ownership by executive officers.\nDuring 1994, the only executive officers to be granted options were newly hired executive officers and executive officers who received promotions. As stated above, on April 1, 1994, Mr. Salizzoni was promoted to the position of President and Chief Operating Officer. At the time of his promotion, the Compensation Committee awarded Mr. Salizzoni the option to purchase 100,000 shares of Common Stock, under the terms of the 1988 Plan. The stock option awards made in 1994 were non-qualified options and were subject to a vesting schedule under which 25% of the options vested on the first anniversary of the award, 25% of the options will vest on the second anniversary of the award, and the remaining 50% of the options will vest on the third anniversary of the award.\nIn connection with the company-wide salary reduction program in 1992 and 1993, the Company established the 1992 Stock Option Plan (the \"1992 Plan\"). The 1992 Plan is also administered by the Compensation Committee. Under the 1992 Plan, the Compensation Committee granted every employee of the Company who participated in the salary reduction program non-qualified options to purchase 50 shares of Common Stock at $15 per share for each $1,000 of salary foregone during the reduction period. The Compensation Committee granted executive officers options under the 1992 Plan in accord- ance with the same formula applicable to all other employees of the Company.\nRestricted Stock. Under the terms of the 1988 Plan, the Compensation Committee is authorized to grant awards of Restricted Stock. From 1988-1990, the Compensation Committee granted Restricted Stock to a total of nine executive officers, some of whom are no longer employed by USAir. These awards were all subject to a five year vesting schedule, with restrictions lapsing on a percentage of the award on each anniversary of the award. No awards of Restricted Stock have been granted by the Compensation Committee since 1990.\nDuring 1994, the restrictions expired on a total of 20,000 shares of Restricted Stock held by the Chief Executive Officer, which shares were originally granted in 1989 and 1990. Restric- tions also expired during 1994 on 10,000 shares of Restricted Stock held by Messrs. Salizzoni, Lloyd and Frestel, which shares were originally granted in 1989 and 1990.\nThe Omnibus Budget Reconciliation Act of 1993 added Section 162(m) to the Internal Revenue Code. Section 162(m) provides that companies will not be entitled to a tax deduction for certain compensation paid to any executive officer to the extent that the compensation exceeds $1 million in a taxable year. In December 1994, the Securities and Exchange Commission issued amendments to\nthe proposed regulations under Section 162(m). The Compensation Committee is studying Section 162(m) and the proposed regulations thereunder and is in the process of determining whether to recommend that the Company take the necessary measures to conform its compensation to Section 162(m).\nThe Compensation Committee will continue to review all executive compensation and benefits matters presented to it and will act based on the best information available in the best interests of the Company, its shareholders and employees.\nMathias J. DeVito, Chairman George J. W. Goodman John W. Harris Roger P. Maynard John G. Medlin, Jr. Raymond W. Smith\nPerformance Graph\nThe above graph compares the performance of the Company's Common Stock during the period January 1, 1990 to December 31, 1994 with the S&P 500 Index and a peer issuer index (the \"Peer Issuer Index\"). It also depicts the S&P Airline Index during the relevant time period, which was the index used in previous performance graphs of the Company. The graph depicts the results of investing $100 in the Company's Common Stock, the S&P 500 Index and the Peer Issuer Index, as well as the S&P Airline Index, at closing prices on December 29, 1989. The stock price performance shown on the graph above is not necessarily indicative of future price perfor- mance. The Peer Issuer Index consists of AMR Corporation, Delta, Southwest and the Company. The S&P Airline Index consists of AMR Corporation, Delta, UAL Corporation and the Company.\nThe Company has selected the Peer Issuer Index for use in the above and future performance graphs in lieu of the S&P Airline Index because one of the companies in the S&P Airline Index, UAL Corporation, underwent a complex recapitalization in 1994 which makes it difficult to compare the return over time on an initial investment in UAL Corporation to the return on similar investments in the other corporations contained in that index. This is due in part to the fact that holders of common stock of UAL Corporation prior to the recapitalization received a combination of cash and various securities in exchange for their common stock pursuant to the recapitalization. To determine the December 31, 1994 value of the UAL Corporation component of the S&P Airline Index, the Company used its good faith efforts to value at December 31, 1994 each element of the combination of cash and securities received by common stockholders of UAL Corporation in 1994 as a result of the recapitalization. The replacement index, the Peer Issuer Index, is identical to the S&P Airline Index except for the deletion of UAL Corporation and the addition of Southwest Airlines, Inc. The Company believes that the substitution of Southwest Airlines, Inc. makes the Peer Issuer Index a more accurate benchmark against which to compare the stock price performance of the Company over time.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following information pertains to Common Stock, Series A Preferred Stock, Series F Preferred Stock, Series T Preferred Stock and Depositary Shares (\"Depositary Shares\"), each representing 1\/100 of a share of Series B Preferred Stock, beneficially owned by all directors and executive officers of the Company as of March 1, 1995. Unless indicated otherwise, the information refers to ownership of Common Stock. Unless indicated otherwise by footnote, the owner exercises sole voting and investment power over the securities (other than unissued securities, the ownership of which has been imputed to such owner).\n(continued on next page)\n(1) The persons listed also own a number of Preferred Share Purchase Rights (the \"Rights\") equal to their Common Stock holdings, or, in the case of the Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock, Common Stock receivable upon conversion. In addition, such Rights are issuable on a one-for-one basis with respect to shares of Common Stock receivable upon exercise of stock options or conversion of Depositary Shares. (2) Percentages are shown only where they exceed one percent of the number of shares outstanding and, in the case of Common Stock holdings are based on shares of Common Stock outstanding on March 1, 1995. (3) Various affiliates of Berkshire Hathaway Inc. (\"Berkshire\") are recordholders of 358,000 or 100% of the outstanding shares of Series A Preferred Stock. Messrs. Buffett and Munger are Chairman and Chief Executive Officer and Vice Chairman, respectively, of Berkshire and may be deemed to control that company. Messrs. Buffett and Munger each disclaims beneficial ownership of Series A Preferred Stock. Series A Preferred Stock is currently convertible into 9,239,944 shares of Common Stock, which represent approximately 10.2% of the total voting\ninterest represented by Common Stock, Series F Preferred Stock, Series T Preferred Stock and Series A Preferred Stock at March 1, 1995. (4) The listing of Mr. Colodny's holding includes 58,000 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options. (5) Mr. Goodman's holdings of Depositary Shares are convertible into 498.5 shares of Common Stock. (6) A wholly-owned subsidiary of BA is recordholder of 30,000 or 100% of the outstanding shares of Series F Preferred Stock, 152.1 or 100% of the outstanding shares of the Series T-1 Preferred Stock and 9,919.8 or 100% of the outstanding shares of the Series T-2 Preferred Stock pursuant to the Investment Agreement. Messrs. Marshall, Maynard and Stevens are Chair- man, Director of Corporate Strategy and Chief Financial Offic- er, respectively, of BA and have been designated by BA to act as directors of the Company pursuant to the Investment Agreement. Messrs. Marshall, Maynard and Stevens each dis- claims beneficial ownership of Series F Preferred Stock and Series T Preferred Stock. (7) The listing of Mr. Salizzoni's holding includes 177,800 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options and 3,000 shares of Restricted Stock. (8) The listing of Mr. Schofield's holding includes 395,069 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options, and 10,000 shares of Restricted Stock. (9) Mr. Schofield's holding of Depositary Shares is convertible into 185,442 shares of Common Stock. (10) The listing of Mr. Lagow's holding reflects shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options. (11) The listing of Mr. Lloyd's holding includes 163,992 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options and 1,000 shares of Restricted Stock. (12) The listing of Mr. Frestel's holding includes 102,000 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options and 1,000 shares of Restricted Stock. (13) The listing of all directors' and officers' holdings includes, in the case of Depositary Shares, the number of shares of Common Stock into which the Depositary Shares are convertible, and also includes 1,312,591 shares of Common Stock issuable within 60 days of March 1, 1995 upon exercise of stock options and 15,800 shares of Restricted Stock.\nThe only persons known to the Company (from Company records and reports on Schedules 13D and 13G filed with the Securities and Exchange Commission) which owned, as of March 1, 1995, more than 5% of its Common Stock, Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock are listed below:\n(1) Represents percent of class of stock outstanding on March 1, 1995. (2) Number of shares as to which such person has shared voting power-358,000; shared dispositive power-358,000. (3) These shares of Series A Preferred Stock are owned directly by affiliates of Berkshire, are convertible, under certain circumstances and subject to certain antidilution adjustments, into 9,239,944 shares of Common Stock and represent approxi- mately 10.2% of the combined voting power of the outstanding Common Stock, Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock, voting as a single class, at March 1, 1995. A number of Rights, equal to the number of shares of Common Stock into which the Series A Preferred Stock is convertible, is also owned by this person. As disclosed above, two directors of the Company, Messrs. Buffett and Munger, may be deemed to control Berkshire and disclaim beneficial ownership of Series A Preferred Stock. (4) Number of shares as to which BA has sole voting power and sole dispositive power-30,000.\n(5) BritAir Acquisition Corp. Inc. is a wholly-owned subsidiary of BA and owns Series F Preferred Stock and Series T Preferred Stock pursuant to the Investment Agreement. Series F Preferred Stock and Series T Preferred Stock are convertible, under certain circumstances on or after January 21, 1997 and subject to certain antidilution adjustments and Foreign Ownership Restrictions, into a total of 15,458,851 and 3,831,695 shares of Common Stock, respectively. Together, the Series F Pre- ferred Stock and Series T Preferred Stock represent approxi- mately 21.3% of the combined voting power of the outstanding Common Stock, Series A Preferred Stock, Series F Preferred Stock and Series T Preferred Stock, voting as a single class, at March 1, 1995. A number of Rights, equal to the number of shares of Common Stock into which the Series F Preferred Stock and Series T Preferred Stock are convertible, is owned by this person. As disclosed above, three directors of the Company, Messrs. Marshall, Maynard and Stevens, have been designated by BA to act as directors of the Company pursuant to the Invest- ment Agreement and disclaim beneficial ownership of Series F Preferred Stock and Series T Preferred Stock. (6) Reflects 152.1 or 100% of the outstanding shares of Series T-1 Preferred Stock and 9,919.8 or 100% of the outstanding shares of Series T-2 Preferred Stock. BA has sole voting power and sole dispositive power as to all these outstanding shares of Series T Preferred Stock. (7) The Schedule 13G dated February 8, 1995 disclosing this ownership declares that the filing of the Schedule 13G should not be construed as an admission that Franklin Resources, Inc. is the beneficial owner of any securities covered by the Schedule 13G. Franklin Resources, Inc. is an investment company registered under Section 8 of the Investment Company Act of 1940 and an investment adviser registered under Section 203 of the Investment Advisers Act of 1940. Its Schedule 13G states that it was making the filing on a voluntary basis as if all the shares were beneficially owned by Franklin Resourc- es, Inc., its subsidiaries, and investment companies advised by those subsidiaries with respect to the exercise of invest- ment discretion. Number of shares as to which reporting person has sole voting power - 4,830,665 shares; shared voting power: 21,500 shares; shared dispositive power: 4,852,165 shares. (8) Of these shares, 2,166,414 are held by such person under the USAir, Inc. Employee Stock Ownership Plan (shared voting power and shared dispositive power - 2,166,414 shares), 941,923 are held by such person as trustee under various collective investment funds for employee benefit plans and other index accounts (sole voting power - 327,177 shares and sole disposi- tive power - 941,923 shares) and 38 are held by such person as trustee\/co-trustee under various personal trust accounts (shared voting power - 38 shares).\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\n(i) The following consolidated financial statements of USAir Group are included in Part II, Item 8A of this report:\n- Consolidated Statements of Operations for each of the Three Years Ended December 31, 1994 - Consolidated Balance Sheets at December 31, 1994 and 1993 - Consolidated Statements of Cash Flows for each of the Three Years Ended December 31, 1994 - Consolidated Statements of Changes in Stockholders' Equity (Deficit) for each of the Three Years Ended December 31, 1994 - Notes to Consolidated Financial Statements\n(ii) The following consolidated financial statements of USAir are included in Part II, Item 8B of this report:\n- Consolidated Statements of Operations for each of the Three Years Ended December 31, 1994 - Consolidated Balance Sheets at December 31, 1994 and 1993 - Consolidated Statements of Cash Flows for each of the Three Years Ended December 31, 1994 - Consolidated Statements of Changes in Stockholder's Equity (Deficit) for each of the Three Years Ended December 31, 1994 - Notes to Consolidated Financial Statements\n2. Financial Statement Schedules\n(i) Independent Auditors' Report on the Consolidated Financial Statement Schedule of USAir Group.\n- Consolidated Financial Statement Schedule - Three Years Ended December 31, 1994:\nVIII - Valuation and Qualifying Accounts and Re- serves\n(ii) Independent Auditors' Report on the Consolidated Financial Statement Schedule of USAir.\n- Consolidated Financial Statement Schedule - Three Years Ended December 31, 1994:\nVIII - Valuation and Qualifying Accounts and Re- serves\nAll other schedules are omitted because they are not appli- cable or not required, or because the required information is either incorporated herein by reference or included in the financial statements or notes thereto included in this report.\n(b) Reports on Form 8-K\nDuring the quarter ended December 31, 1994, the Company and USAir filed a Current Report dated November 18 on Form 8-K regarding USAir's plans to use the net proceeds of any sales of assets to repurchase, defease or redeem its outstanding debt. The Company and USAir filed a Current Report dated January 27, 1995 on Form 8-K regarding the press release dated January 27, 1995 of USAir Group, Inc. and USAir, Inc., with unaudited consolidated statements of operations for each company.\n3. Exhibits\nDesignation Description\n3.1 Restated Certificate of Incorporation of USAir Group (incorporated by reference to Exhibit 3.1 to USAir Group's Registration Statement on Form 8-B dated January 27, 1983), including the Certificate of Amend- ment dated May 13, 1987 (incorporated by reference to Exhibit 3.1 to USAir Group's and USAir's Quarterly Report on Form 10-Q for the quarter ended March 31, 1987), the Certificate of Increase dated June 30, 1987 (incorporated by reference to Exhibit 3 to USAir Group's and USAir's Quarterly Report on Form 10-Q for the quarter ended June 30, 1987), the Certificate of Increase dated October 16, 1987 (incorporated by reference to Exhibit 3.1 to USAir Group's and USAir's Quarterly Report on Form 10-Q for the quarter ended September 30, 1987), the Certificate of Increase dated August 7, 1989 (incorporated by reference to Exhibit 3.1 to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989), the Certificate of Increase dated April 9, 1992 (incorporated by reference to Exhibit 3.1 to USAir Group's and USAir's Annual Report on Form 10-K for the year ended December 31, 1992), the Certificate of Increase dated January 21, 1993 (incorporated by reference to USAir Group's and\nUSAir's Annual Report on Form 10-K for the year ended December 31, 1992), and the Certificate of Amendment dated May 26, 1993 (incorporated by reference to Appendix II to USAir Group's Proxy Statement dated April 26, 1993).\n3.2 By-Laws of USAir Group.\n3.3 Rights Agreement, dated as of July 29, 1989, as amended and restated as of January 21, 1993, between USAir Group and Chemical Bank, as Rights Agent (incorporated by reference to Exhibit 28.4 to USAir Group's Current Report on Form 8-K dated January 21, 1993).\n3.4 Restated Certificate of Incorporation of USAir (in- corporated by reference to Exhibit 3.1 to USAir's Registration Statement on Form 8-B dated January 27, 1983).\n3.5 By-Laws of USAir.\n4.1 Amended Certificate of Designation, Preferences, and Rights of the Series D of Junior Preferred Stock of USAir Group (incorporated by reference to Exhibit 4(c) to USAir Group's Current Report on Form 8-K dated August 11, 1989).\n4.2 Certificate of Designation of Series A Cumulative Convertible Preferred Stock of USAir Group (incorpo- rated by reference to Exhibit 4(b) to USAir Group's Current Report on Form 8-K dated August 11, 1989).\n4.3 Certificate of Designation of Series B Cumulative Convertible Preferred Stock of USAir Group (incorpo- rated by reference to Exhibit 3.3 to Amendment No. 4 to USAir Group's Registration Statement on Form S-3 (Registration No. 33-39540) dated May 17, 1991).\n4.4 Agreement between USAir Group and Berkshire Hathaway Inc. dated August 7, 1989 (incorporated by reference to Exhibit 4(a) to USAir Group's Current Report on Form 8- K dated August 11, 1989).\n4.5 Certificate of Designation of Series F Cumulative Convertible Senior Preferred Stock of USAir Group (incorporated by reference to Exhibit 28.2 to USAir Group's Current Report on Form 8-K dated January 21, 1993).\n4.6 Form of Certificate of Designation of Series T-_ Cumulative Exchangeable Convertible Senior Preferred Stock of USAir Group (incorporated by reference to Appendix VII to USAir Group's Proxy Statement dated April 26, 1993). Neither USAir Group nor USAir is\nfiling any instrument (with the exception of holders of exhibits 10.1(a-c)) defining the rights of holders of long-term debt because the total amount of securities authorized under each such instrument does not exceed ten percent of the total assets of USAir. Copies of such instruments will be furnished to the Securities and Exchange Commission upon request.\n10.1(a) Supplemental Agreement No. 16, dated July 19, 1990, to Purchase Agreement No. 1102 between USAir and The Boeing Company (incorporated by reference to Exhibit 10.2(a) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1990).\n10.1(b) Supplemental Agreement No. 17, dated November 28, 1990, to Purchase Agreement No. 1102 between USAir and The Boeing Company (incorporated by reference to Exhibit 10.2(b) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1990).\n10.1(c) Supplemental Agreement No. 18, dated December 23, 1991, to Purchase Agreement No. 1102 between USAir and The Boeing Company (incorporated by reference to Exhibit 10.2(c) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.2 Purchase Agreement No. 1725 dated December 23, 1991 between USAir and The Boeing Company (incorporated by reference to Exhibit 10.3 to USAir Group's and USAir's Annual Report on Form 10-K for the year ended Decem- ber 31, 1991).\n10.3 USAir, Inc. Executive Incentive Compensation Plan (incorporated by reference to Exhibit 10.3 to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.4 USAir, Inc. Officers' Supplemental Benefit Plan (incor- porated by reference to Exhibit 10.5 to USAir's Annual Report on Form 10-K for the year ended December 31, 1980).\n10.5 USAir, Inc. Supplementary Retirement Benefit Plan (incorporated by reference to Exhibit 10.5 to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.6 USAir, Inc. Supplemental Executive Defined Contribution Plan.\n10.7 USAir Group's 1984 Stock Option and Stock Appreciation Rights Plan (incorporated by reference to Exhibit A to USAir Group's Proxy Statement dated March 30, 1984).\n10.8 USAir Group's 1988 Stock Incentive Plan (incorporated by reference to Exhibit 10.15 to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1987).\n10.9 USAir Group's 1992 Stock Option Plan (incorporated by reference to Exhibit A to USAir Group's Proxy Statement dated March 30, 1992).\n10.10 Employment Agreement between USAir and its Chief Executive Officer.\n10.11 Employment Agreement between USAir and its President and Chief Operating Officer.\n10.12 Employment Agreement between USAir and its Executive Vice President-Marketing.\n10.13 Employment Agreement between USAir and its Executive Vice President and General Counsel.\n10.14 Employment Agreement between USAir and its Senior Vice President-Human Resources.\n10.15(a) Agreement between USAir and its President and Chief Operating Officer providing supplemental retirement benefits.\n10.15(b) Agreement between USAir and its Executive Vice Presi- dent-Marketing providing supplemental retirement benefits.\n10.15(c) Agreement between USAir and its Executive Vice Presi- dent and General Counsel providing supplemental retire- ment benefits.\n10.15(d) Agreement between USAir and its Senior Vice President- Human Resources providing supplemental retirement benefits.\n10.16(a) Trust Agreement dated as of August 1, 1989 between USAir Group and Wachovia Bank and Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 10.10(a) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.16(b) Trust Agreement dated as of August 1, 1989 between USAir and Wachovia Bank and Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 10.10(b) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.17 Investment Agreement dated as of January 21, 1993 between USAir Group and British Airways Plc (incor- porated by reference to Exhibit 28.1 to USAir Group's\nand USAir's Current Report on Form 8-K filed on Janu- ary 28, 1993, as amended by Amendment No. 1 on Form 8 filed on April 13, 1993).\n10.17(a) Amendment dated as of February 21, 1994 to the Invest- ment Agreement dated as of January 21, 1993 between USAir Group and British Airways Plc (incorporated by reference to Exhibit 10.13(a) to USAir Group's Annual Report on Form 10-K for the year ended December 31, 1993).\n11 Computation of primary and fully diluted earnings per share of USAir Group for the five years ended Decem- ber 31, 1994.\n21 Subsidiaries of USAir Group and USAir.\n23.1 Consent of the Auditors of USAir Group to the incorpo- ration of their report concerning certain financial statements contained in this report in certain regis- tration statements.\n23.2 Consent of the Auditors of USAir to the incorporation of their report concerning certain financial statements contained in this report in certain registration statements.\n24.1 Powers of Attorney signed by the directors of USAir Group, authorizing their signatures on this report.\n24.2 Powers of Attorney signed by the directors of USAir, authorizing their signatures on this report.\n27 Financial Data Schedule\n(this space intentionally left blank)\nSignatures\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, USAir Group, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUSAir Group, Inc.\nBy: \/s\/Seth E. Schofield --------------------------------- Seth E. Schofield Chairman and Chief Executive Officer (Principal Executive Officer)\nDate: April 12, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of USAir Group, Inc. and in the capacities and on the dates indicated.\nApril 12, 1995 By: \/s\/Seth E. Schofield --------------------------------- Seth E. Schofield Chairman and Chief Executive Officer (Principal Executive Officer)\nApril 12, 1995 By: \/s\/John W. Harper --------------------------------- John W. Harper Senior Vice President-Finance (Principal Financial Officer)\nApril 12, 1995 By: \/s\/Ann Greer-Rector --------------------------------- Ann Greer-Rector Vice President & Controller (Principal Accounting Officer)\nApril 12, 1995 By: * -------------------------------- Warren E. Buffett Director\nApril 12, 1995 By: * --------------------------------- Edwin I. Colodny Director\nApril 12, 1995 By: * -------------------------------- Mathias J. DeVito Director\nApril 12, 1995 By: * -------------------------------- George J. W. Goodman Director\nApril 12, 1995 By: * --------------------------------- John W. Harris Director\nApril 12, 1995 By: * --------------------------------- Edward A. Horrigan, Jr. Director\nApril 12, 1995 By: * --------------------------------- Robert LeBuhn Director\nApril 12, 1995 By: * --------------------------------- Sir Colin Marshall Director\nApril 12, 1995 By: * --------------------------------- Roger P. Maynard Director\nApril 12, 1995 By: * --------------------------------- John G. Medlin, Jr. Director\nApril 12, 1995 By: * --------------------------------- Hanne M. Merriman Director\nApril 12, 1995 By: * -------------------------------- Charles T. Munger Director\nApril 12, 1995 By: * --------------------------------- Frank L. Salizzoni Director\nApril 12, 1995 By: * --------------------------------- Raymond W. Smith Director\nApril 12, 1995 By: * -------------------------------- Derek M. Stevens Director\nBy: \/s\/John W. Harper ------------------------------ John W. Harper Attorney-In-Fact\nSignatures\nPursuant to the requirements of Section 13 of 15(d) of the Securities Exchange Act of 1934, USAir, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUSAir, Inc.\nBy: \/s\/Seth E. Schofield --------------------------------- Seth E. Schofield Chairman and Chief Executive Officer (Principal Executive Officer)\nDate: April 12, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of USAir, Inc. and in the capacities and on the dates indicated.\nApril 12, 1995 By: \/s\/Seth E. Schofield --------------------------------- Seth E. Schofield Chairman and Chief Executive Officer (Principal Executive Officer)\nApril 12, 1995 By: \/s\/John W. Harper --------------------------------- John W. Harper Senior Vice President-Finance (Principal Financial Officer)\nApril 12, 1995 By: \/s\/Ann Greer-Rector --------------------------------- Ann Greer-Rector Vice President & Controller (Principal Accounting Officer)\nApril 12, 1995 By: * -------------------------------- Warren E. Buffett Director\nApril 12, 1995 By: * --------------------------------- Edwin I. Colodny Director\nApril 12, 1995 By: * -------------------------------- Mathias J. DeVito Director\nApril 12, 1995 By: * -------------------------------- George J. W. Goodman Director\nApril 12, 1995 By: * --------------------------------- John W. Harris Director\nApril 12, 1995 By: * --------------------------------- Edward A. Horrigan, Jr. Director\nApril 12, 1995 By: * --------------------------------- Robert LeBuhn Director\nApril 12, 1995 By: * --------------------------------- Sir Colin Marshall Director\nApril 12, 1995 By: * --------------------------------- Roger P. Maynard Director\nApril 12, 1995 By: * --------------------------------- John G. Medlin, Jr. Director\nApril 12, 1995 By: * --------------------------------- Hanne M. Merriman Director\nApril 12, 1995 By: * -------------------------------- Charles T. Munger Director\nApril 12, 1995 By: * --------------------------------- Frank L. Salizzoni Director\nApril 12, 1995 By: * --------------------------------- Raymond W. Smith Director\nApril 12, 1995 By: * -------------------------------- Derek M. Stevens Director\nBy: \/s\/John W. Harper ------------------------------ John W. Harper Attorney-In-Fact\nIndependent Auditors' Report On Consolidated Financial Statement Schedule - USAir Group, Inc.\nThe Stockholders and Board of Directors USAir Group, Inc.\nUnder date of February 22, 1995, except as to notes 4(a) and 4(c) which are as of April 10, 1995, we reported on the consolidated balance sheets of USAir Group, Inc. and subsidiaries (\"Group\") as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows, and changes in stockholders' equity (deficit) for each of the years in the three-year period ended December 31, 1994, included in Item 14(a)1(i) in this annual report on Form 10-K for the year 1994. In connection with our audits of the aforementioned consolidated financial statements, we also audited the consolidated financial statement schedule as listed in Item 14(a)2(i). This consolidated financial statement schedule is the responsibility of Group's management. Our responsi- bility is to express an opinion on the consolidated financial statement schedule based on our audits.\nIn our opinion, this consolidated 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.\nThe audit report on the consolidated financial statements of USAir Group, Inc. and subsidiaries referred to above contains an explanatory paragraph that states that Group's recurring losses from operations and net capital deficiency raise substantial doubt about its ability to continue as a going concern. The consolidated financial statement schedule in Item 14(a)2(i) in this annual report on Form 10-K for the year does not include any adjustments that might result from the outcome of this uncertainty.\nKPMG Peat Marwick LLP\nWashington, D. C. February 22, 1995, except as to notes 4(a) and 4(c) of the consoli- dated financial statements which are as of April 10, 1995\nUSAir Group, Inc. Schedule VIII Valuation and Qualifying Accounts and Reserves\n(in thousands)","section_15":""}
{"filename":"92487_1994.txt","cik":"92487","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL CSW, CPL, PSO, SWEPCO and WTU CSW, incorporated under the laws of Delaware in 1925, is a registered holding company under the Holding Company Act and owns all of the outstanding shares of common stock of the Operating Companies, CSWS, CSW Credit, CSWE, CSWI and CSW Communications. In addition, CSW owns 80% of the outstanding shares of common stock of CSW Leasing. The corporate predecessors of CSW and the Electric Operating Companies date back to the 19th century.\nThe Electric Operating Companies are public utility companies engaged in generating, purchasing, transmitting, distributing and selling electricity. The Electric Operating Companies were incorporated as follows:\nState of Registrant Incorporation Year\nCPL Texas 1945 PSO Oklahoma 1913 SWEPCO Delaware 1912 WTU Texas 1927\nCPL and WTU operate in portions of south and central west Texas, respectively. PSO operates in portions of eastern and southwestern Oklahoma, and SWEPCO operates in portions of northeastern Texas, northwestern Louisiana and western Arkansas. Transok is an intrastate natural gas gathering, transmission, processing, storage and marketing company which transports for and sells natural gas to the Electric Operating Companies, principally PSO, as well as processing, transporting and selling natural gas to and for non- affiliates. CSWS performs, at cost, various accounting, engineering, tax, legal, financial, electronic data processing, centralized economic dispatching of electric power and other services for the CSW System. CSW Credit purchases accounts receivable of the Operating Companies and unaffiliated electric and gas utilities. CSWE and CSWI pursue cogeneration projects and other energy ventures within the United States and internationally. CSW Communications provides communication services to the Operating Companies and non-affiliates. CSW Leasing invests in leveraged leases.\nCPL The economic base of the service territory served by CPL includes manufacturing, metal refining, petroleum products, agriculture and tourism. In 1994, industrial customers accounted for approximately 22% of CPL'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.\nPSO The economic base of the territory served by PSO includes mining, petroleum products, manufacturing and agriculture, which provides a balanced economy. The principal industries in the territory include natural gas and oil production, oil refining, steel processing, maintenance of aircraft, the manufacture of paper and timber products, glass, chemicals, cement and aircraft components.\n1-8 SWEPCO The economic base of the service territory served by SWEPCO includes chemical processing, petroleum refining and oil and gas extraction. The primary metals and paper processing industries add balance to SWEPCO's industrial base.\nWTU The economic base of the territory served by WTU is predominantly agricultural, producing cattle, sheep, goats, cotton, wool, mohair and feed crops. Significant gains have been made in economic diversification through value added processing of these products. The natural resources of the territory include oil, natural gas, sulfur, gypsum and ceramic clays. Important manufacturing and processing plants served by WTU produce cotton seed products, oil products, electronic equipment, precision and consumer metal products, meat products and gypsum products. The territory also includes several military installations and state correctional institutions.\nCertain information relating to service provided by the Electric Operating Companies at December 31, 1994 follows:\nSERVICE AREA ESTIMATED APPROXIMATE RETAIL RURAL ELECTRIC REGISTRANT POPULATION SQUARE MILES CUSTOMERS MUNICIPALITIES COOPERATIVES CPL 1,969,000 44,000 603,000 1 5 PSO 1,021,000 30,000 470,000 2 1 SWEPCO 887,000 25,000 403,000 2 8 WTU 410,000 53,000 185,000 2 12 CSW SYSTEM 4,287,000 152,000 1,661,000 7 26\nThe largest cities served by the Electric Operating Companies at retail are shown below:\nCITY CPL PSO SWEPCO WTU\nCorpus Christi, Texas 265,000 Laredo, Texas 133,000 McAllen, Texas 88,000\nTulsa, Oklahoma 557,000 Lawton, Oklahoma 89,000 Bartlesville, Oklahoma 44,000\nShreveport\/Bossier City, Louisiana 278,000 Longview, Texas 79,000 Texarkana, Texas and Arkansas 63,000\nAbilene, Texas 112,000 San Angelo, Texas 88,000\nIn 1994, the CSW System companies contributed the following percentages to aggregate operating revenues, operating income and net income for common stock. TOTAL CPL PSO SWEPCO WTU ELECTRIC TOK OTHER TOTAL OPERATING REVENUES 34% 20% 22% 9% 85% 14% 1% 100% OPERATING INCOME 48% 15% 22% 8% 93% 7% --% 100% NET INCOME FOR COMMON STOCK 49% 17% 26% 9% 101% 6% (7)% 100%\n1-9 The relative contributions of the CSW System companies to the aggregate operating revenues, operating income and net income for common stock differ from year to year due to variations in weather, fuel costs reflected in charges to customers, timing and amount of rate changes and other factors, including changes in business conditions and the results of non-utility businesses. In 1994, approximately 62% of the CSW System's electric revenues were earned in Texas, 24% in Oklahoma, 8% in Louisiana and 6% in Arkansas.\nRestructuring In November 1993, CSW undertook a restructuring designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The restructuring is a response to two major factors, (i) a reduction in the rate of growth in the use of electricity and (ii) increasing competition among suppliers of electricity as a result of the Energy Policy Act. As a result of these changes, CSW believes that the electric utility industry faces changes in the way all electric utilities do business. The underlying goal of the restructuring is to enable the Electric Operating Companies to focus on and be accountable for serving the customer.\nIn general, the restructuring is designed to consolidate and centralize in CSWS certain functions which had been performed separately by CSW's Electric Operating Companies. In part, the restructuring shifts certain management functions relating to the operation of power plants, certain engineering activities and certain administrative and support functions from the Electric Operating Companies to CSWS, thereby reducing costs and freeing the Electric Operating Companies to focus on customer service, marketing and economic development. The restructuring is intended to standardize certain practices throughout the CSW System and to streamline management.\nTo delineate lines more clearly at the holding company level, the restructuring aligns CSW management into two principal units, CSW Electric, covering the CSW System's electric utility operations, and CSW Enterprises, covering CSW's other businesses, including Transok, CSWE, CSWI, CSW Communications, and the mergers and acquisitions and strategic planning departments. CSW Electric and CSW Enterprises are functional business designations only, not new subsidiaries.\nCSW expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies have been, and are expected to continue to be, realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs and thereby reduce the need for future rate increases.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Restructuring for further discussion about the restructuring.\nNew Business Opportunities CSW CSW continues to consider new business opportunities to expand and enhance its core electric utility business, and to expand its non- utility business. CSW's investment strategy with respect to non- utility businesses is to invest in businesses that are related to the expertise utilized in the core electric utility business. CSW's principal non-utility businesses are Transok and CSWE. During 1994, CSW formed a new corporation, CSWI, to pursue independent power initiatives abroad. In addition, CSW is considering investments in telecommunications, environmental and energy services. During 1994, CSW formed CSW Communications to provide a communications network for the CSW System as well as third-parties. CSW expects to make additional investments in non-regulated business during 1995. For additional information, see NON-UTILITY OPERATIONS below.\n1-10 Proposed Acquisition of El Paso CSW In May 1993, CSW entered into a Merger Agreement pursuant to which El Paso would emerge from bankruptcy as a wholly-owned subsidiary of CSW. El Paso is an electric utility company headquartered in El Paso, Texas, engaged principally in the generation and distribution of electricity to approximately 262,000 retail customers in west Texas and southern New Mexico. El Paso also sells electricity under contract to wholesale customers in a number of locations including southern California and Mexico. El Paso had filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code on January 8, 1992.\nOn July 30, 1993, El Paso filed the Modified Plan and a related proposed form of Disclosure Statement providing for the acquisition of El Paso by CSW. On November 15, 1993, all voting classes of creditors and shareholders of El Paso voted to approve the Modified Plan. On December 8, 1993, the Bankruptcy Court confirmed the Modified Plan.\nUnder the Modified Plan, the total value of CSW's offer to acquire El Paso is approximately $2.2 billion. The Modified Plan generally provides for El Paso creditors and shareholders to receive shares of CSW Common, cash and\/or securities of El Paso, or to have their claims cured and reinstated. The Modified Plan also provides for claims of secured creditors generally to be paid in full with debt securities of reorganized El Paso, and for unsecured creditors to receive a combination of debt securities of reorganized El Paso and CSW Common equal to 95.5 percent of their claims, and for small trade creditors to be paid in full with cash. The Modified Plan provides for El Paso's preferred shareholders to receive preferred shares of reorganized El Paso, or cash, and for options to purchase El Paso Common to be converted into options to purchase a proportionate number of shares of CSW Common. In addition, the Modified Plan provides for certain creditor classes of El Paso to accrue interest on their claims and to receive periodic interim distributions of such interest through the Effective Date or the withdrawal or revocation of the Modified Plan, subject to certain conditions and limitations set forth in the Modified Plan. To date, all such accrued interest payments to creditors have been made by El Paso on a timely basis. If, under certain circumstances, the Merger is not consummated, the Merger Agreement provides for CSW to pay El Paso for a portion of such interim interest payments paid or accrued prior to the termination of the Merger Agreement. The Merger Agreement also provides for CSW to pay for a portion of fees and expenses, including legal expenses of certain El Paso creditors under such circumstances. CSW's potential exposure as of December 31, 1994, is estimated to be approximately $17.5 million; however, the actual amount, if any, that CSW may be required to pay pursuant to these provisions depends on a number of contingencies and cannot presently be predicted.\nThe Merger is subject to numerous conditions set forth in the Merger Agreement, including but not limited to (i) the receipt of final orders with respect to all required regulatory approvals on terms that would not cause a regulatory material adverse effect as defined in the Merger Agreement, (ii) the receipt of all third party consents, (iii) the absence of a material adverse effect or facts or circumstances that could reasonably be expected to result in a material adverse effect on El Paso or the business prospects of El Paso, (iv) transfer to El Paso of good and marketable title to El Paso's share of Palo Verde, (v) performance by El Paso, CSW and CSW's acquisition subsidiary, CSW Sub, Inc., in all material respects of all covenants contained in the Merger Agreement and (vi) the occurrence of the Effective Date under the Modified Plan. Required regulatory approvals and filings in connection with the Merger include approvals of the FERC, the SEC, the Texas Commission, the New Mexico Commission, the NRC, and filings with the Department of Justice and the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.\nSee ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, NOTE 11 for CSW, Commitments and Contingent Liabilities, for a discussion of regulatory approval process relating to El Paso.\nCSW continues to use its best efforts to consummate the Merger. At the same time, however, CSW continues to monitor contingencies which may preclude the consummation of the Merger, including without\n1-11 limitation the potential loss of significant portions of El Paso's service area and significant El Paso customers, including Las Cruces and two military installations, Holloman Air Force Base and White Sands Missile Range, regulatory risks principally related to approval of the Merger and El Paso's request for a rate increase in Texas as well as the effects of the conditions imposed by federal or state regulatory agencies on the approval of the Merger and operating risks associated with the ownership of an interest in Palo Verde.\nBased upon El Paso's written response to the concerns identified in a September 12 letter from CSW to El Paso and the failure of El Paso to resolve the contingencies set forth above, CSW cannot predict whether, or if so when, the Merger will be consummated. In the event that the proposed Merger is not consummated, there may be ensuing litigation between El Paso and CSW or among other parties to El Paso's bankruptcy proceedings and either or both of El Paso and CSW.\nSee CSW's ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Proposed Acquisition of El Paso, and CSW's ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 11, Commitments and Contingent Liabilities, for additional information related to the proposed El Paso merger.\nCompetition CSW, CPL, PSO, SWEPCO and WTU Competitive forces at work in the electric utility industry are impacting the CSW System and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail levels in the future. As competition in the industry increases, the Electric Operating Companies will have the opportunity to seek out new customers and at the same time be at risk of losing customers to competitors. The Electric Operating Companies believe that their prices for electricity and the quality and reliability of their service currently place them in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act for EWGs and permits utilities, including registered holding companies and non-utilities, to form EWGs. EWGs are a new category of non-utility wholesale power producers that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While CSW believes that the Energy Policy Act will continue to make the wholesale markets more competitive, CSW is unable to predict the extent to which the Energy Policy Act will impact CSW System operations.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. The Electric Operating Companies compete in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nCSW is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or the CSW System. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\n1-12 CSW, CPL, SWEPCO and WTU PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. CSW is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted.\nIn Texas, electric service areas are approved by the Texas Commission. A given tract in a utility's overall service area may be singly certificated to a utility, to one of several competing electric cooperatives or to one of the competing municipal electric systems or, it may be dually or triply certificated to these entities. These certificated areas have changed only slightly since the formation of the Texas Commission in 1976.\nCSW and CPL CPL is generally singly certificated to serve inside most municipalities, and cooperatives are singly certificated to serve much of the rural areas. The suburban areas are mostly dually certificated. Since 1990, in dually certificated areas, CPL's rates have been higher than some competitors for some customers, especially small commercial and industrial customers. However, most business has been retained and some new business acquired, primarily because of service reliability and other customer service advantages. The availability of low cost natural gas and other alternative fuels, including those used in cogeneration facilities, have resulted in some losses of sales. Although there have been some losses, electricity is still the fuel of choice for most air conditioning installations. Renewable energy such as solar and wind is not now a feasible economic choice for customers of CPL in most instances. CPL believes that its rates, the quality and reliability of its service and the relatively inelastic demand for electricity for certain end uses should allow it to continue to compete in current retail markets.\nSee each of the registrants' ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Recent Developments and Trends for a discussion of competitive issues facing the utility industry.\nREGULATION AND RATES\nRegulation CSW, CPL, PSO, SWEPCO and WTU The CSW System is subject to the jurisdiction of the SEC under the Holding Company Act with respect to the issuance, acquisition and sale of securities, the acquisition and sale of certain assets or any interest in any business and accounting practices and other matters. The Holding Company Act generally limits the operations of a registered holding company to a single integrated public utility system, plus such additional businesses as are functionally related to such system.\nThe Electric Operating Companies have been classified as public utilities under the Federal Power Act and accordingly the FERC has jurisdiction in certain respects over their electric utility facilities and operations, wholesale rates, and in certain other matters.\nThe Electric Operating Companies are subject to the jurisdiction of various state commissions as to rates, accounting matters, standards of service and, in some cases, issuance of securities, certification of facilities and extensions and division of service territory.\n1-13 CPL, SWEPCO and WTU The Texas Commission has jurisdiction over accounts, certification of utility service territory, sales 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.\nCPL Ownership of an interest in a nuclear generating unit exposes CPL and indirectly CSW to regulation not common to a fossil generating unit. Under the Atomic Energy Act of 1954 and the 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 shut down a unit until compliance is achieved, depending upon its assessment of the severity of the situation.\nFor a discussion of NRC regulation and other considerations arising from the ownership of nuclear assets, see NUCLEAR-STP, below.\nOther See ENVIRONMENTAL MATTERS below, for information relating to environmental regulation.\nRates CSW, CPL, PSO, SWEPCO and WTU The retail rates of the Electric Operating Companies are subject to regulation by the state utility commissions in the states in which they operate.\nCPL, SWEPCO and WTU The Texas Commission has original jurisdiction over retail rates in the unincorporated areas of Texas. The governing bodies of incorporated municipalities have original 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.\nPSO PSO is subject to the jurisdiction of the Oklahoma Commission with respect to retail prices, accounts, issuance of certain securities and certain other matters.\nPursuant to authority granted under RESCTA, the Oklahoma Commission established service territorial boundary maps in all unincorporated areas for all regulated retail electric suppliers serving Oklahoma. In accordance with RESCTA, a retail electric supplier may not extend retail electric service into the certified territory of another supplier, except to serve its own facilities or to serve a new customer with an initial full load of 1,000 KW or more. RESCTA provides that when any territory certified to a retail electric supplier or suppliers is annexed and becomes part of an incorporated city or town, the certification becomes null and void. However, once established in the annexed territory, a supplier may generally continue to serve within the annexed area.\nSWEPCO In Arkansas, SWEPCO is subject to the jurisdiction of the Arkansas Commission as to rates, accounts, standards of service, sale or acquisition of certain utility property and issuance of securities by liens on property located in that state. In Louisiana, SWEPCO is subject to the jurisdiction of the Louisiana Commission as to rates, accounts and standards of service, but not as to the issuance of securities. In Oklahoma, SWEPCO is subject to the jurisdiction of the Oklahoma Commission only as to the issuance of evidences of indebtedness secured by liens on property located in that state.\n1-14 SWEPCO has agreements, which have been approved by the FERC, with all of its wholesale customers under which rates are based upon an agreed cost of service formula. These rates are adjusted periodically to reflect the actual cost of providing service. All of SWEPCO's contracts with its wholesale customers contain FERC approved fuel-adjustment provisions that permit it to pass actual fuel costs through to its customers.\nFuel Recovery in Texas CSW, CPL, SWEPCO and WTU Electric utilities in Texas, including CPL, SWEPCO and WTU, 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 that became effective on May 1, 1993, subject to certain transition rules, whereby each utility under its jurisdiction may petition to revise its fuel factor every six months according to a specified schedule. Fuel factors may also be revised in the case of emergencies 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. To date, the new fuel rule has not significantly changed the manner in which the Electric Operating Companies recover retail fuel costs in Texas. Fuel factors are in the nature of temporary rates and the utility's collection of revenues by such factors is subject to adjustments at the time of a fuel reconciliation. Under the procedures, at the utility's semi- annual adjustment date, a utility will be 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. 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. Final reconciliation of fuel costs is 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 that are determined unreasonably incurred in a reconciliation proceeding are not recoverable from retail customers.\nFuel Recovery in Oklahoma CSW and PSO All KWH sales to PSO's retail customers for 1994 were made under rates which include a fuel cost adjustment clause. Oklahoma law requires that an examination of PSO's retail fuel cost adjustment clause be performed annually by the Oklahoma Commission. The fuel cost adjustment is computed for each month on the basis of the average cost of fuel consumed in the month. The amount of any difference in such cost over or under a base rate is applied on a KWH basis and reflected in adjustments to customers' bills during the second month subsequent to the month in which the difference occurred.\nThe FUSER program for qualified commercial and industrial customers and the CSF program, for qualified wholesale customers, were developed to allow program participants to purchase natural gas directly from suppliers, at negotiated prices, to be delivered to and burned in PSO's gas-fired power plants, resulting in reduced prices because of the low cost spot gas fuel provided. Under these programs participants could deliver sufficient quantities of natural gas to meet 70% of their generation requirements with the remaining 30% met with PSO-supplied coal. The FUSER and CSF programs resulted in lower electric costs to all classes of PSO's customers. The FUSER program was canceled effective October 1, 1993 because changing market and supply conditions eliminated the economic viability of the program. The CSF program remains in place although no customers participated in the program during 1994.\n1-15 Fuel Recovery in Louisiana and Arkansas CSW and SWEPCO SWEPCO's retail rates currently in effect in Louisiana are adjusted based on SWEPCO's cost of fuel in accordance with a fuel cost adjustment which is applied to each billing month based on the second previous month's average cost of fuel. Provision for any over- or under-recovery of fuel costs is allowed under an automatic fuel clause.\nUnder SWEPCO's fuel adjustment rider currently in effect in Arkansas, the fuel cost adjustment is applied for each billing month on a basis which permits SWEPCO to recover the level of fuel cost experienced two months earlier.\nFuel Recovery from Wholesale Customers CSW, CPL, PSO, SWEPCO and WTU All of the Electric Operating Companies' contracts with their wholesale customers contain FERC approved fuel-adjustment provisions for recovery of fuel costs.\nOther CSW, CPL, PSO, SWEPCO and WTU In the event that the Electric Operating Companies do not recover all of their fuel costs under the procedures described above, such event could have a material adverse effect on the companies' results of operations and financial condition.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for CSW, CPL, PSO, SWEPCO and WTU, and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 10, for CSW, NOTE 9 for CPL, SWEPCO, and WTU and NOTE 8 for PSO, Litigation and Regulatory Proceedings, for further information with respect to rate proceedings including CPL's rate case and fuel reconciliation proceedings, PSO's rate proceedings, SWEPCO's fuel reconciliation proceedings, WTU's rate matters and fuel reconciliation and CPL's and WTU's deferred accounting matters.\nNUCLEAR - STP CSW and CPL CPL owns 25.2% of STP, a two-unit nuclear power plant which is located near Bay City, Texas. In addition, 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 Outage From February 1993 until May 1994 STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL.\nNuclear Decommissioning At the end of STP's service life, decommissioning is expected to be accomplished using the decontamination method, which is one of the techniques acceptable to the NRC. Using this method the decontamination activities occur as soon as possible after the end of plant operations. Contaminated equipment is cleaned or removed to a permanent disposal location and the site is generally returned to its pre-plant state.\nCPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning and is net of expected earnings on the trust fund.\n1-16 Deferred Accounting CPL was granted deferred accounting for STP Unit 1 and 2 costs by Texas Commission orders. These orders allowed CPL 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.\nSee CSW's and CPL's ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 10 for CSW and NOTE 9 for CPL, Litigation and Regulatory Proceedings, for further information with respect to CPL's rate case and fuel reconciliation proceedings, nuclear decommissioning and deferred accounting.\nOther See ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 11 for CSW and NOTE 10 for CPL, Commitments and Contingent Liabilities for further information related to nuclear insurance for STP.\n1-17 UTILITY OPERATIONS\nFacilities At December 31, 1994, the Electric Operating Companies owned electric generating plants, or portions thereof in the case of jointly-owned plants, with the following net dependable summer rating capabilities, substantially all of which were steam electric and which were located in the cities indicated:\nNet Dependable Capability Plant Name and Location Principal Fuel (MW) (b) Source (a) CSW and CPL\nBarney M. Davis, Corpus Christi, Gas 679 Texas Coleto Creek, Goliad, Texas Coal 604 Lon C. Hill, Corpus Christi, Texas Gas 549 Nueces Bay, Corpus Christi, Texas Gas 512 (c) Victoria, Victoria, Texas Gas 258 (c) La Palma, San Benito, Texas Gas 203 (c) E.S. Joslin, Point Comfort, Texas Gas 252 J. L. Bates, Mission, Texas Gas 182 Laredo, Laredo, Texas Gas 172 Eagle Pass, Eagle Pass, Texas Hydro 6 Oklaunion, Vernon, Texas (b) Coal 53 (d) STP, Bay City, Texas (b) Nuclear 630 (e)\nCPL Total 4,100 (c)\nCSW and PSO\nComanche, Lawton, Oklahoma Gas 258 Oil 4\nNortheastern, Oologah, Oklahoma Gas 632 Coal 924 Oil 4\nRiverside, Jenks, Oklahoma Gas 922 Oil 3\nSouthwestern, Washita, Oklahoma Gas 475 Oil 2\nTulsa, Tulsa, Oklahoma Gas 162 (c) Oil 8\nWeleetka, Weleetka, Oklahoma Gas 151 Oil 4\nOklaunion, Vernon, Texas (b) Coal 106 (d)\nPSO Total 3,655 (c)\n1-18 (Continued) Net Dependable Capability Plant Name and Location Principal Fuel (MW) (b) Source (a)\nCSW and SWEPCO\nArsenal Hill, Shreveport, Gas 113 Louisiana Lieberman, Mooringsport, Louisiana Gas 276 Knox Lee, Cherokee Lake, Texas Gas 501 Lone Star, Daingerfield, Texas Gas 50 Wilkes, Jefferson, Texas Gas 879 Welsh, Cason, Texas Coal 1,584 Flint Creek, Gentry, Arkansas (b) Coal 240 Henry W. Pirkey, Hallsville, Texas (b) Lignite 559 Dolet Hills, Mansfield, Texas (b) Lignite 262\nSWEPCO Total 4,464\nCSW and WTU\nAbilene, Abilene, Texas Gas 18 Paint Creek, Haskell, Texas Gas 237 Lake Pauline, Quanah, Texas Gas 46 Oak Creek, Bronte, Texas Gas 87 San Angelo, San Angelo, Texas Gas 125 Rio Pecos, Girvin, Texas Gas 140 Fort Phantom, Abilene, Texas Gas (f) 362 Presidio, Presidio, Texas Oil 2 Ft. Stockton, Ft. Stockton, Texas Gas 5 Vernon, Vernon, Texas Oil 9 Oklaunion, Vernon, Texas (b) Coal 370 (d)\nWTU Total 1,401\nCSW 13,620 Plant in storage 557 CSW Total 14,177\nFacilities Notes CSW, CPL, PSO, SWEPCO and WTU (a)Some plants have the capability of burning oil in combination with gas. Use of oil in facilities primarily designed to burn gas results in increased maintenance expense and a reduction of approximately from 5% to 15% in capability. PSO and WTU have 25 MW and 11 MW, respectively, of facilities primarily designed to burn oil. (b)Data reflects only CSW System's portion of plants which are jointly owned with non-affiliates. (c)Excludes units in storage - 34 MW at Nueces Bay, 228 MW at Victoria, 48 MW at La Palma for CPL and 247 MW at Tulsa for PSO. (d)CPL owns 7.81%, PSO owns 15.62% and WTU owns 54.69% of the 676 MW unit. The plant is operated by WTU. (e)CPL owns 25.2% of the two 1,250 MW units operated by HLP. (f)Although both Fort Phantom units burn primarily gas, Unit 1 is designed to burn fuel oil for extended periods of time before maintenance is required and Unit 2 is designed to burn fuel oil on a continuous basis.\n1-19 Plants and Properties CSW, CPL, PSO, SWEPCO and WTU All of the generating plants described above are located on land owned by the Electric Operating Companies or jointly with other participants in the case of jointly owned plants. The Electric Operating Companies' electric transmission and distribution facilities are mostly located over or under highways, streets and other public places or property owned by others, for which permits, grants, easements or licenses (which the Electric Operating Companies believe to be satisfactory, but without examination of underlying land titles) have been obtained. The principal plants and properties of the Electric Operating Companies are subject to the liens of the first mortgage indentures under which the Electric Operating Companies' bonds are issued.\nPeak Loads and System Capabilities of the Electric Operating Companies CSW, CPL, PSO, SWEPCO and WTU The following tables set forth for the last three years (i) the net system capability, including the net amounts of contracted purchases and contracted sales, at the time of peak demand, (ii) the maximum coincident system demand on a one-hour integrated basis, exclusive of sales to other electric utilities, and (iii) the respective amounts and percentages of peak demand generated by the Electric Operating Companies and net purchases and sales:\nCSW 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 13,549(3) 13,163(1)(2)(3) 13,230(1)(3) MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 11,434 11,464 10,606 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD (0.3)% 8.1% 3.9% GENERATION AT TIME OF PEAK (MW) 11,353 10,624 10,426 PERCENT OF PEAK DEMAND GENERATED 99.3% 92.7% 98.3% NET PURCHASES (SALES) AT TIME OF PEAK (MW) 81 840 180 PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK .7% 7.3% 1.7% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND JUNE 27 AUGUST 18 AUGUST 10\n(1) CSW's 1993 net system capability at the time of peak demand was less than 1992 net system capability due to unit outages. (2) Does not include 630 MW of STP capability that was not available at the 1993 peak due to the outage described in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 10 for CSW, Litigation and Regulatory Proceedings and NUCLEAR - STP, in ITEM 1.\n1-20 (3) Does not include 881 MW of system capability for 1994, 719 MW of system capability for 1993 and 1992.\nCPL 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 3,969(2) 3,850(1)(2) 4,165(2) MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 3,732 3,518 3,347 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD 6.1% 5.1% 1.7% GENERATION AT TIME OF PEAK (MW) 3,074 2,943 3,003 PERCENT OF PEAK DEMAND GENERATED 82.4% 83.7% 89.7% NET PURCHASES (SALES) AT TIME OF PEAK (MW) 658 575 344 PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK 17.6% 16.3% 10.3% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND AUGUST 18 AUGUST 25 AUGUST 11\n(1) Does not include 630 MW of STP capability that was not available at the 1993 peak due to the outage described in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 9 for CPL, Litigation and Regulatory Proceedings and NUCLEAR - STP, in ITEM 1. (2) Does not include 310 MW of system capability in storage as described above under the heading UTILITY OPERATIONS - Facilities.\nPSO 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 3,664(1) 3,649(1) 3,721(1) MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 3,167 3,147 3,010 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD 0.6% 4.6% (2.3)% GENERATION AT TIME OF PEAK (MW) 2,645 2,609 2,788 PERCENT OF PEAK DEMAND GENERATED 83.5% 82.9% 92.6% NET PURCHASES (SALES) AT TIME OF PEAK (MW) 522 538 222 PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK 16.5% 17.1% 7.4% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND JUNE 27 AUGUST 18 AUGUST 10\n(1) Does not include 247 MW of system capability for 1994, and 409 MW of system capability for 1993 and 1992 in storage, as described above under the heading UTILITY OPERATIONS - Facilities.\nSWEPCO 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 4,464(1) 4,436 3,959 MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 3,526 3,651 3,237 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD (3.4%) 12.8% 1.2% GENERATION AT TIME OF PEAK (MW) 3,987 3,559 3,292 PERCENT OF PEAK DEMAND GENERATED 113.1% 97.5% 101.7% NET PURCHASES (SALES) AT TIME OF PEAK (MW) (461) 92 (55) PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK (13.1%) 2.5% (1.7)% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND JUNE 27 AUGUST 18 AUGUST 10\n(1) Does not include 324 MW of capability that was not available at the 1994 peak.\nWTU 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 1,459 1,384 1,404 MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 1,262 1,201 1,118 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD 5.1% 7.4% 1.9% GENERATION AT TIME OF PEAK (MW) 1,401 1,223 1,151 PERCENT OF PEAK DEMAND GENERATED 111.0% 101.8% 102.9% NET PURCHASES (SALES) AT TIME OF PEAK (MW) (139) (22) (33) PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK (11.0%) (1.8%) (2.9)% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND JUNE 27 AUGUST 11 JULY 1\nPower Purchases and Sales CSW, CPL, PSO, SWEPCO and WTU Various municipalities, electric cooperatives and public power authorities are served by the Electric Operating Companies. The Electric Operating Companies exchange power on an emergency or economy basis with various neighboring systems and engage in economy interchanges with each other. In addition, they contract with certain suppliers for the purchase or sale of power on a unit capacity basis.\nCSW and SWEPCO As part of the negotiations to acquire BREMCO, SWEPCO entered into a long-term purchased power contract with Cajun, BREMCO's previous full-requirements wholesale supplier. The contract covered the purchase of energy at a fixed price for 1993 and 1994, and the purchase of capacity and energy in subsequent years. SWEPCO is a member of the Southwest Power Pool and the Western Systems Power Pool.\n1-21 CSW, SWEPCO and WTU On April 4, 1994, the FERC issued an order pursuant to Section 211 of the Federal Power Act forcing a regional utility to transmit power to Tex-La on behalf of WTU. The order was one of the first issued by FERC under that provision, which was added by the Energy Policy Act to increase competition in wholesale power markets. On December 1, 1994, the FERC issued an order requiring a regional utility to provide this transmission service at a cost which was acceptable to Tex-La. The FERC also ordered the same regional utility to enter into an interconnection and remote control area load agreement with WTU within 30 days. This agreement was executed on January 3, 1995. On January 5, 1995, WTU began selling 92 MW of power and energy to Tex-La. Tex-La has a peak requirement of approximately 120 MWs. WTU will serve Tex-La until facilities are completed to connect Tex-La to SWEPCO, at which time SWEPCO will provide 85 MW and WTU will retain 35 MW of the Tex-La electric load.\nCSW and PSO In 1989, PSO entered into certain long-term contracts with MCPC, a cogeneration development company located in northeastern Oklahoma. These contracts include (i) an Interconnection and Interchange Agreement providing terms and conditions under which MCPC can connect its electric generating facilities to PSO's transmission system and providing for future transmission by PSO of specified amounts of MCPC's power to an unaffiliated utility, (ii) a Stock\/Asset Purchase Agreement which allows PSO under certain conditions to acquire the stock or assets of MCPC, and (iii) an Energy Conversion Agreement which requires PSO to deliver natural gas to MCPC for conversion to electrical energy to be delivered by MCPC to PSO. Under the Energy Conversion Agreement, MCPC is required to deliver at least 394,200 MWH per year of firm energy to PSO. PSO also has the right to dispatch up to 60 MWH per hour of quick-start capability.\nPSO and MCPC filed a joint application with the Oklahoma Commission seeking approval of a September 1992 Letter Agreement between PSO and MCPC which provided for MCPC granting two-year extensions to the Interconnection and Interchange Agreement and the Energy Conversion Agreement in exchange for PSO not requiring payment by MCPC of certain debt and charges related to the Energy Conversion Agreement. The Oklahoma Commission Staff subsequently filed its own application seeking a review and evaluation of the current value to PSO of the Energy Conversion Agreement. MCPC also filed an application with the Oklahoma Commission requesting additional relief through the modification of the existing Energy Conversion Agreement. An emergency order was issued under MCPC's application which increased the payment made by PSO to MCPC for energy purchases and decreased the amount of firm energy MCPC is required to deliver to PSO. The emergency order is subject to a permanent ruling. The application filed by the Oklahoma Commission Staff was subsequently withdrawn. In December 1993, PSO filed an application with an ALJ to dismiss the case filed by MCPC based on a recent ruling from the Oklahoma Supreme Court. PSO's application to dismiss was denied by the ALJ and was appealed to the Oklahoma Commission. PSO's appeal was subsequently denied. The joint application and MCPC's application are expected to be heard by the second quarter of 1995.\nIn July 1993, PSO commenced a lawsuit in the District Court of Tulsa County, Oklahoma, seeking a declaratory judgment that PSO is entitled to terminate the Energy Conversion Agreement as of August 1, 1993, because of a default committed by MCPC. In November 1993, the Court granted judgment in favor of MCPC on grounds that the Oklahoma Commission had exclusive jurisdiction of the case and also that PSO had contractually waived its cause of action. PSO has appealed the Court's ruling to the Oklahoma Supreme Court, where the case is pending.\nSWEPCO SWEPCO furnishes energy at wholesale to two municipalities and also supplies electric energy at wholesale to eight electric cooperatives operating in its territory through NTEC, Tex-La and Rayburn Country. SWEPCO also sells power to AECC and Cajun on an as- available basis.\n1-22 WTU WTU provides wholesale electricity to four electric cooperatives and one municipality for all their electric energy requirements. WTU also provides wholesale power to eight other electric cooperatives, one other municipal customer and one investor owned electric utility company. WTU's contractual obligations with thirteen of its wholesale customers require a five year notice of termination, while one wholesale customer has a three year notice period and another has a fifteen year obligation.\nSystem Interconnections CSW, CPL, PSO, SWEPCO and WTU The CSW System operates on an interstate basis to facilitate exchanges of power. PSO and WTU are interconnected through the 200 MW North HVdc Tie. In August 1992, SWEPCO and CPL entered into an agreement with HLP and TU to construct and operate an East Texas HVdc transmission interconnection which will facilitate exchanges of power for the CSW System. This interconnection will consist of a back-to- back HVdc converter station and 16 miles of 345 KV transmission line connecting transmission substations at SWEPCO's Welsh Power Plant and TU's Monticello Power Plant. In March 1993, an application for a Certificate of Convenience and Necessity for the transmission interconnection was approved by the Texas Commission. This 600 MW project is scheduled to be completed in mid-1995.\nCPL and WTU are members of ERCOT, which also includes TU, HLP, Texas Municipal Power Agency, Texas Municipal Power Pool, Lower Colorado River Authority, the municipal systems of San Antonio, Austin and Brownsville, the South Texas and Medina Electric Cooperatives, and several other interconnected systems and cooperatives. The ERCOT members interchange power and energy on a firm, economy and emergency basis.\nSeasonality CSW, CPL, PSO, SWEPCO and WTU Sales of electricity by the Electric Operating Companies tend to increase during warmer summer months and, to a lesser extent, cooler winter months, because of higher demand for power for cooling and heating purposes.\nFranchises CSW, CPL, PSO, SWEPCO and WTU The Electric Operating Companies hold franchises to provide electric service in various municipalities in their service areas. These franchises have varying provisions and expiration dates including, in some cases, termination and buy-out provisions. CSW considers the Electric Operating Companies' franchises to be adequate for the conduct of their business.\nEmployees CSW, CPL, PSO, SWEPCO and WTU At December 31, 1994, CSW had 8,055 employees, as follows:\nCSWS 1,070 CPL 1,933 PSO 1,552 SWEPCO 1,777 WTU 1,090 TRANSOK 554 CSWE 79 8,055\n1-23 Approximately 600 employees at PSO and 700 employees at SWEPCO are covered under collective bargaining agreements with the IBEW. CSW implemented a restructuring plan in 1994 which resulted in a reduction of approximately 7% of the CSW System work force.\nExecutive Officers of the Registrant The following information is included in Part I pursuant to Regulation S-K, Item 401(b), Instruction 3.\nCSW Age Name at March 16, Present Position\nE. R. Brooks 57 Chairman, President and CEO, Director\nHarry D. Mattison 58 Executive Vice President of CSW and President and CEO of Central and South West Electric, Director\nT. V. Shockley, III 50 Executive Vice President of CSW and President and CEO of Central and South West Enterprises, Director\nFerd. C. Meyer, Jr. 55 Senior Vice President and General Counsel\nGlenn D. Rosilier 47 Senior Vice President and CFO\nFrederic L. Frawley 52 Corporate Secretary and Senior Attorney\nStephen J. McDonnell 44 Treasurer\nWendy G. Hargus 37 Controller\nEach of the executive officers of CSW is elected to hold office until the first meeting of the CSW's Board of Directors after the next annual meeting of stockholders. CSW's next annual meeting of stockholders is scheduled to be held April 20, 1995. Each of the executive officers listed in the table above has been employed by CSW or an affiliate of CSW in an executive or managerial capacity for more than the last five years.\n1-24 OPERATING STATISTICS CSW CENTRAL AND SOUTH WEST CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED ELECTRIC OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 16,368 15,903 14,593 COMMERCIAL 13,463 12,966 12,370 INDUSTRIAL 18,869 18,205 17,257 OTHER RETAIL 1,501 1,434 1,363 SALES TO RETAIL CUSTOMERS 50,201 48,508 45,583 SALES FOR RESALE 7,133 5,852 6,262 TOTAL 57,334 54,360 51,845\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD (THOUSANDS) RESIDENTIAL 1,417 1,396 1,366 COMMERCIAL 205 201 196 INDUSTRIAL 24 24 25 OTHER 15 12 12 TOTAL 1,661 1,633 1,599\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 11,665 11,541 10,786 REVENUE PER CUSTOMER(a) $824 $842 $773 REVENUE PER KWH(a)(cents) 7.06 7.29 7.17\nREVENUE PER KWH ON TOTAL SALES (a)(cents) 5.35 5.62 5.38\nFUEL COST DATA (a) AVERAGE Btu PER NET KWH 10,344 10,391 10,482 COST PER MILLION Btu $1.82 $2.11 $1.92 COST PER KWH GENERATED (cents) 1.88 2.19 2.01 COST AS A PERCENTAGE OF REVENUE 37.9% 39.6% 37.1%\n(a) These statistics reflect the outage at STP in 1993 and early 1994 as well as FUSER and CSF in 1993 and 1992.\n1-25 CPL CENTRAL POWER AND LIGHT COMPANY OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 5,954 5,612 5,408 COMMERCIAL 4,523 4,278 4,181 INDUSTRIAL 6,910 6,406 5,800 OTHER RETAIL 457 435 414 SALES TO RETAIL CUSTOMERS 17,844 16,731 15,803 SALES FOR RESALE 1,286 913 1,370 TOTAL 19,130 17,644 17,173\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD RESIDENTIAL 516,355 504,893 493,772 COMMERCIAL 76,739 74,767 73,200 INDUSTRIAL (a) 5,864 6,156 6,307 OTHER 3,577 3,538 3,561 TOTAL 602,535 589,354 576,840\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 11,729 11,298 11,133 REVENUE PER CUSTOMER (b) $935 $955 $890 REVENUE PER KWH (b) (cents) 7.97 8.45 7.99\nREVENUE PER KWH ON TOTAL SALES (b)(cents) 6.37 6.93 6.48\nFUEL COST DATA (b) AVERAGE Btu PER NET KWH 10,289 10,296 10,404 COST PER MILLION Btu $1.75 $2.17 $1.70 COST PER KWH GENERATED (cents) 1.80 2.23 1.77 COST AS A PERCENTAGE OF REVENUE 27.0% 28.6% 27.6%\n(a) The customer decrease in 1994 was due primarily to the combining of multiple customer accounts into single accounts and a decline in customers due to economic and competitive conditions. The customer decrease in 1993 was largely due to the combining of multiple customer accounts into single accounts.\n(b) These statistics reflect the outage at STP in 1993 and early 1994.\n1-26 PSO PUBLIC SERVICE COMPANY OF OKLAHOMA OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 4,749 4,714 4,139 COMMERCIAL 4,434 4,352 4,092 INDUSTRIAL 4,360 4,445 4,420 OTHER RETAIL 89 87 85 SALES TO RETAIL CUSTOMERS 13,632 13,598 12,736 SALES FOR RESALE 1,509 563 665 TOTAL 15,141 14,161 13,401\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD RESIDENTIAL 409,675 406,847 404,170 COMMERCIAL 53,454 53,166 52,215 INDUSTRIAL 5,156 5,087 5,163 OTHER 1,287 1,008 1,009 TOTAL 469,572 466,108 462,557\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 11,640 11,637 10,297 REVENUE PER CUSTOMER $726 $731 $642 REVENUE PER KWH (cents) 6.24 6.28 6.24\nREVENUE PER KWH ON TOTAL SALES (a)(cents) 4.89 5.00 4.64\nFUEL COST DATA (a) AVERAGE Btu PER NET KWH 10,231 10,220 10,305 COST PER MILLION Btu $1.96 $2.38 $2.34 COST PER KWH GENERATED(cents) 2.00 2.43 2.41 COST AS A PERCENTAGE OF REVENUE 39.5% 43.7% 40.3%\n(a) These statistics reflect FUSER and CSF in 1993 and 1992. See REGULATION AND RATES and FUEL SUPPLY.\n1-27 SWEPCO SOUTHWESTERN ELECTRIC POWER COMPANY OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 4,157 4,114 3,702 COMMERCIAL 3,378 3,249 3,039 INDUSTRIAL 6,357 6,122 5,862 OTHER RETAIL 400 390 373 SALES TO RETAIL CUSTOMERS 14,292 13,875 12,976 SALES FOR RESALE 5,189 4,508 3,854 TOTAL 19,481 18,383 16,830\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD RESIDENTIAL 346,227 340,379 325,301 COMMERCIAL 48,153 46,728 45,185 INDUSTRIAL 5,747 5,809 5,687 OTHER 2,609 2,605 2,636 TOTAL 402,736 395,521 378,809\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 12,107 12,357 11,445 REVENUE PER CUSTOMER $776 $822 $770 REVENUE PER KWH (cents) 6.41 6.65 6.73\nREVENUE PER KWH ON TOTAL SALES (cents) 4.24 4.60 4.62\nFUEL COST DATA AVERAGE Btu PER NET KWH 10,489 10,582 10,717 COST PER MILLION Btu $1.75 $1.94 $1.93 COST PER KWH GENERATED (cents) 1.84 2.05 2.07 COST AS A PERCENTAGE OF REVENUE 40.6% 42.5% 43.0%\n1-28 WTU WEST TEXAS UTILITIES COMPANY OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 1,508 1,464 1,344 COMMERCIAL 1,128 1,087 1,057 INDUSTRIAL 1,241 1,231 1,175 OTHER RETAIL 556 522 491 SALES TO RETAIL CUSTOMERS 4,433 4,304 4,067 SALES FOR RESALE 2,051 2,288 1,951 TOTAL 6,484 6,592 6,018\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD RESIDENTIAL 144,966 143,453 142,270 COMMERCIAL 26,618 26,001 25,714 INDUSTRIAL 7,392 7,453 7,384 OTHER 5,533 5,361 5,254 TOTAL 184,509 182,268 180,622\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 10,449 10,241 9,485 REVENUE PER CUSTOMER $822 $811 $752 REVENUE PER KWH (cents) 7.86 7.92 7.93\nREVENUE PER KWH ON TOTAL SALES (cents) 5.29 5.24 5.24\nFUEL COST DATA AVERAGE Btu PER NET KWH 10,424 10,491 10,445 COST PER MILLION Btu $1.88 $1.91 $1.82 COST PER KWH GENERATED (cents) 1.96 2.00 1.91 COST AS A PERCENTAGE OF REVENUE 38.3% 39.1% 38.0%\n1-29 CONSTRUCTION AND FINANCING\nCSW, CPL, PSO, SWEPCO and WTU The CSW System maintains a continuing construction program, the nature and extent of which is based upon current and estimated future loads of the system. The estimated total capital expenditures, including AFUDC, of the CSW System for the years 1995-1997 are as follows:\nCSW CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $ 47 $ 37 $ 43 $ 127 TRANSMISSION 35 85 59 179 DISTRIBUTION 146 138 131 415 FUEL 4 21 12 37 TRANSOK 63 40 40 143 OTHER 90 61 73 224 TOTAL $385 $382 $358 $1,125\nCPL CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $ 23 $ 20 $ 19 $ 62 TRANSMISSION 16 28 11 55 DISTRIBUTION 45 59 57 161 FUEL 4 21 12 37 OTHER 23 8 11 42 TOTAL $111 $136 $110 $357\nPSO CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $11 $ 9 $18 $ 38 TRANSMISSION 6 20 13 39 DISTRIBUTION 35 29 29 93 OTHER 19 13 11 43 TOTAL $71 $71 $71 $213\nSWEPCO CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $12 $ 7 $ 5 $ 24 TRANSMISSION 10 34 28 72 DISTRIBUTION 48 31 27 106 OTHER 26 22 34 82 TOTAL $96 $94 $94 $284\nWTU CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $ 1 $ 1 $ 1 $ 3 TRANSMISSION 3 3 7 13 DISTRIBUTION 18 19 18 55 OTHER 15 13 11 39 TOTAL $37 $36 $37 $110\nInformation in the foregoing tables is subject to change as a result of change in the underlying assumptions from numerous factors, including the rate of load growth, escalation of construction costs, changes in lead times in manufacturing, inflation, the availability and pricing of alternatives to construction, and nuclear, environmental and other regulation, delays from regulatory hearings, the adequacy of rate relief and the\n1-30 availability of necessary external capital. Changes in these and other factors could cause each respective Electric Operating Company to defer or accelerate construction or to sell or buy more power, which would affect its cash position, revenues and income to an extent that cannot now be reliably predicted.\nIn addition, increasing competition in the electric utility industry may have an impact on the construction programs of the Electric Operating Companies. Traditionally, the Electric Operating Companies have made investments in their utility systems, filed a rate case to seek recovery of their operating and other costs and sought to earn a rate of return on their assets in rate base. Competition in the utility industry, however, is likely to lead to an increasing need to stabilize or reduce rates. At the same time, the retail regulatory environment is beginning to shift from traditional rate base regulation to incentive and performance-based regulation which are intended to encourage efficiency and increased productivity in lieu of traditional ratemaking formulas. In light of the trend toward competition and away from traditional ratemaking, the CSW System will periodically reevaluate its capital spending policies and generally seek to fund only those construction projects and investments that management believes will offer satisfactory returns in the current environment. Consistent with this strategy, the CSW System is likely to continue to make additional investments in non-utility businesses.\nCSW continues to study ways to reduce or meet future increases in customer demand, including demand-side management programs, new and efficient electric technologies, construction of various types and sizes of generation facilities, increasing the availability or efficiency of existing generation facilities, reducing transmission and distribution losses, and where feasible and economical, acquisition of reliable long-term capacity from other suppliers. The public utility commissions in some of the jurisdictions served by the Electric Operating Companies may consider on a case-by-case basis mechanisms to permit recovery of costs of demand-side management programs and a return on the related investment from ratepayers.\nThe CSW System facilities plan indicates that CSW will not require substantial additions of generating capacity until the year 2001 or beyond.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources, Capital Expenditures for each registrant, for additional information with respect to construction expenditures and financing.\nFUEL SUPPLY\nGeneral The CSW System's present net dependable summer rating power generation capabilities and the type of fuel used are set forth in UTILITY OPERATIONS - Facilities above. Additional fuel supply data is set forth in the tables presented below.\nCSW SYSTEM AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 8,246 NATURAL GAS 47% COAL AND LIGNITE 4,702 COAL AND LIGNITE 47% NUCLEAR 630 NUCLEAR 6% HYDRO and OIL 42 TOTAL 100% SUB TOTAL 13,620 PLANT IN STORAGE 557 TOTAL 14,177\n1-31 CPL AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 2,807 NATURAL GAS 56% COAL 657 COAL 24% NUCLEAR 630 NUCLEAR 20% HYDRO 6 TOTAL 100% SUB TOTAL 4,100 PLANT IN STORAGE 310 TOTAL 4,410\nPSO AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 2,600 NATURAL GAS 58% COAL 1,030 COAL 42% OIL 25 TOTAL 100% SUB TOTAL 3,655 PLANT IN STORAGE 247 TOTAL 3,902\nSWEPCO AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 1,819 NATURAL GAS 23% COAL 1,824 COAL 48% LIGNITE 821 LIGNITE 29% TOTAL 4,464 TOTAL 100%\nWTU AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 1,020 NATURAL GAS 59% COAL 370 COAL 41% OIL 11 TOTAL 100% TOTAL 1,401\nNatural Gas CSW The Electric Operating Companies purchase their gas from a number of suppliers operating in and around their service territories. In 1994, approximately 48% of the Electric Operating Companies' total gas purchases were made under long-term contracts and approximately 52% came from short-term contracts and spot purchases.\nCSW and CPL CPL's eight gas-fired electric generating plants are supplied by a portfolio of long-term and short-term natural gas purchase agreements through multiple natural gas pipeline systems. Approximately 68% of CPL's total gas requirements in 1994 were purchased under long-term arrangements representing both purchase obligations and discretionary purchases, with the balance of CPL's requirements being acquired under short-term arrangements from the spot market. CPL's principal gas supplies for 1994 were provided\n1-32 under agreements with Corpus Christi Gas Marketing, L.P., Onyx Pipeline Company, Enron Corporation, or their affiliates. They supplied approximately 25%, 13% and 10%, respectively, of CPL's total natural gas purchases.\nCSW and PSO PSO engages in a program to maintain adequate gas supplies necessary for operation. Natural gas for generation is provided by purchases under a number of long-term and spot market contracts. Approximately 60% of PSO's natural gas requirements were provided for under firm contracts. Transok acts as an administrator with respect to purchases of natural gas supplies. Gas is transported by Transok to PSO facilities under agreements pursuant to which PSO pays Transok for actual costs incurred in providing the services as determined on an allocated cost of service basis, including a rate of return on equity applicable between affiliates as specified by the Oklahoma Commission in PSO's most recent Oklahoma price review. See ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CSW's NOTE 10 and PSO's NOTE 8, Litigation and Regulatory Proceedings, for further information with respect to such agreements between PSO and Transok.\nCSW and SWEPCO In 1994, SWEPCO purchased approximately 99.5% of its gas requirements pursuant to spot purchase contracts with no take-or-pay obligations. The remaining 0.5% of SWEPCO's 1994 gas requirements came from a long-term take-or-pay contract which was terminated in January 1994. SWEPCO plans to continue to enter into short-term contracts with various suppliers to provide gas for peaking purposes.\nCSW and WTU WTU has gas purchase contracts with several suppliers. The largest long-term contract, which is with Lone Star, provided approximately 13% of WTU's total gas requirements in 1994. Lone Star is obligated, except during curtailments, to have gas available for 125% of the estimated annual fuel requirements of each plant served, provided the total of all plants does not exceed 110% of the estimated annual fuel requirement. The Lone Star contract, which expires in 2000, allows WTU considerable flexibility to purchase gas from other sources. Utilizing this flexibility in 1994, WTU purchased approximately 68% of its gas requirements on the spot market from many different suppliers. The remaining 19% of WTU's 1994 gas requirements came from supplemental firm contracts with several suppliers. The contracts with suppliers vary in their terms, but generally provide for periodic or other price adjustments.\nCoal and Lignite CSW The Electric Operating Companies purchase coal from a number of suppliers. In 1994, approximately 82% of the Electric Operating Companies' total coal purchases were supplied under long-term contract with the balance procured on the spot market. The coal for the CSW System plants comes primarily from Wyoming or Colorado mines which are located between 1,000 and 1,500 rail miles from the generating plants.\nProposed Railroad Merger CSW, CPL, PSO, SWEPCO and WTU In October 1994, Burlington Northern Railroad Company and the Atchison, Topeka and Santa Fe Railway Company filed an application with the Interstate Commerce Commission to merge the two railroads. These railroads currently compete for a portion of the coal transportation traffic to CPL's Coleto Creek power plant. Because of the potential elimination of such competition and other factors, CPL and the other Electric Operating Companies may be adversely affected by this merger, if approved, unless conditions mitigating the impact are included in the merger.\nOklaunion CSW, CPL, PSO and WTU The jointly-owned Oklaunion plant is supplied coal under a coal supply contract with Exxon expiring in 2006. This contract was amended and restated in December 1993 as part of a settlement of litigation with Exxon. In November 1994, Caballo Coal Company, an\n1-33 affiliate of Peabody Holding Company, Inc., purchased Exxon's Rawhide and Caballo mines in Wyoming, the sources of the Exxon coal. The long-term coal supply contract has subsequently been transferred from Exxon to Caballo Coal Company.\nApproximately 67% of the total 1994 Oklaunion coal requirements for CPL, 70% for PSO and 71% for WTU were supplied under the Exxon contract with the balance procured on the spot market.\nCPL's share of the year-end 1994 coal inventory at Oklaunion was approximately 46,000 tons, representing approximately 60 days supply. PSO's share was approximately 95,000 tons, representing approximately 21 days supply. WTU's share was approximately 250,000 tons, representing approximately 55 days supply.\nAll coal used at the Oklaunion plant is transported approximately 1,100 miles to the plant by the Burlington Northern Railroad Company pursuant to a coal transportation contract which is projected to expire during late 1995. The coal is transported under this contract in Burlington Northern supplied rail cars. WTU has instituted a rate proceeding at the Interstate Commerce Commission requesting a reasonable rate for rail transportation of coal to the Oklaunion plant, pursuant to filed tariffs, after expiration of the Burlington Northern contract.\nColeto Creek CSW and CPL At Coleto Creek, the long-term agreement expiring in 1999 with Colowyo Coal Company provided approximately 60% of the coal requirements of the plant for 1994. CPL's purchase obligation set forth in the Colowyo agreement for 1995 and through 1999 is for approximately 25% of Coleto Creek's requirements. The coal is mined in northwestern Colorado and is transported approximately 1,400 miles under long-term rail agreements with Denver & Rio Grande Western Railroad Company, the Burlington Northern Railroad Company and the Southern Pacific Transportation Company. Southern Pacific Transportation Company is currently the only rail carrier with access to the Coleto Creek plant. The balance of the Coleto Creek requirements are currently being procured on the spot market. CPL owns sufficient railcars for operation of three unit trains and has negotiated contracts with the rail carriers involved which have been filed with the Interstate Commerce Commission. CPL's rail transportation contracts for Coleto Creek expire December 31, 1995. CPL has instituted a proceeding at the Interstate Commerce Commission requesting a reasonable rate for the 16 mile movement from Coleto Creek to Victoria, Texas, a destination served by Missouri Pacific Railroad Company. After 1995, CPL intends to utilize coal from the Powder River Basin of Wyoming for a portion of the Coleto Creek plant requirements and intends to negotiate rail transportation agreements for such coal. At year-end 1994, CPL had approximately 290,000 tons of coal in inventory at Coleto Creek, representing approximately 43 days supply.\nNortheastern Station CSW and PSO PSO has a contract with Kerr-McGee Coal Corporation, which substantially covers the coal supply for PSO's Northeastern Station coal units through at least 2007, with approximately 11% of the 1994 requirements purchased on the spot market. Coal delivery is by unit trains from mines located in the Gillette, Wyoming vicinity, a distance of about 1,100 rail miles from Northeastern Station. PSO owns sufficient rail cars and spares for operation of six unit trains. Coal is transported to Northeastern Station pursuant to long- term contracts with Burlington Northern and the Missouri Pacific Railroad Company which have been filed with the Interstate Commerce Commission. In some years, including 1994, a portion of the coal has been transported pursuant to short-term contracts with other carriers. Burlington Northern has disputed PSO's right to transport coal at Northeastern Station utilizing other carriers. This dispute is the subject of pending litigation. See ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CSW NOTE 10 and PSO NOTE 8,\n1-34 Litigation and Regulatory Proceedings for further discussion. At year-end 1994, PSO had approximately 529,000 tons of coal in inventory at Northeastern representing approximately 50 days supply.\nCSW and SWEPCO The long-term supply for SWEPCO's Welsh plant and its 50 percent- owned Flint Creek plant is provided under a contract with AMAX. The current contract, executed in December 1993, replaced a prior contract between the parties as part of a settlement of litigation concerning the prior contract. The settlement has resulted in lower fuel costs to the Welsh and Flint Creek plants. Approximately 99% of the total 1994 Flint Creek coal requirements and 94% of the total 1994 Welsh coal requirements were supplied under the AMAX contract with the balance purchased on the spot market.\nCoal under the AMAX contract is mined near Gillette, Wyoming, a distance of about 1,500 and 1,100 miles, respectively, from the Welsh and Flint Creek plants. This coal is delivered to the plants under rail transportation contracts with Burlington Northern and the Kansas City Southern Railroad Company. These contracts will expire between 2001 and 2007. SWEPCO owns or leases under long-term leases sufficient cars and spares for operation of twelve unit trains. SWEPCO has supplemented its railcar fleet from time to time with short-term leases. At December 31, 1994, SWEPCO had coal inventories of 1,199,000 tons at Welsh representing 53 days supply and 552,000 tons at Flint Creek representing 80 days supply.\nSWEPCO has acquired lignite leases covering an aggregate of about 27,000 acres near the Henry W. Pirkey power plant. Sabine Mining Company is the contract miner of these reserves. At December 31, 1994, 322,000 tons of lignite were in inventory at the plant representing 33 days supply.\nAnother 25,000 acres are jointly leased in equal portions by SWEPCO and CLECO in the Dolet Hills area of Louisiana near Dolet Hills Power Plant. The Dolet Hills Mining Venture is the contract miner for these reserves. At December 31, 1994, SWEPCO had 240,000 tons of lignite in inventory at the plant representing 58 days supply.\nIn the opinion of the management of SWEPCO, the acreage under lease in these areas contains sufficient reserves to cover the anticipated lignite requirements for the estimated useful lives of the lignite-fired plants.\nNuclear Fuel CSW and CPL The supply of fuel for STP involves a complex process. This process includes the acquisition of uranium concentrate, the conversion of uranium concentrate to uranium hexafluoride, the enrichment of uranium hexafluoride in the isotope U235 and the fabrication of the enriched uranium into fuel rods and incorporation of fuel rods into fuel assemblies. The fuel assemblies are the final product loaded into the reactor core. The time associated with this process requires fuel decisions be made years in advance of the actual need to refuel the reactor. Fuel requirements for STP are being handled by the STP Management Committee, comprised of representatives of all participants in STP.\nOutages are necessary approximately every 18 months for refueling. Because STP's fuel costs are significantly lower than any of the other CPL units, CPL's average fuel costs are expected to be higher whenever an STP unit is down for refueling or maintenance.\nCPL and the other STP participants have entered into contracts with suppliers for uranium concentrate and conversion service sufficient for the operation of both STP units through 1996. Also, flexible uranium concentrate and uranium hexafluoride contracts are in place to provide approximately 50% of the uranium needed for STP from 1997 to 2000. Enrichment contracts have been secured for a 30- year period from the initial operation of each unit with the exception of the period from October of 2000 to September of 2002. The STP participants canceled the enrichment requirements for such period under a ten year no cost termination provision in the\n1-35 enrichment contract. The STP participants believe that other, lower- cost options will be available in the future. Also, fuel fabrication services have been contracted for operation through 2005 for Unit 1 and 2006 for Unit 2. Although CPL and the other STP owners cannot predict the availability of uranium and related services, CPL and the other STP owners do not currently expect to have difficulty obtaining uranium and related services required for the remaining years of STP operations.\nThe Energy Policy Act has provisions for the recovery of a portion of the costs associated with the decommissioning and decontamination of the gaseous diffusion plants used in the enrichment process. These costs are being recovered on the basis of enrichment services purchased by utilities from the DOE prior to October of 1992. The total annual assessment for all domestic utilities is limited to $150 million per federal fiscal year and assessable for 15 years. The STP assessment will be approximately $2.0 million each year with CPL's share being 25.2% of the annual STP assessment.\nThe Nuclear Waste Policy Act of 1982, as amended, requires the DOE to develop a permanent high level waste disposal facility for the storage of spent nuclear fuel by 1998. The DOE recently announced that the permanent facility will not be available until 2010. The DOE will be taking possession of all spent fuel generated at STP as a result of a contract CPL and other STP participants have entered into with the DOE. STP has on-site storage facilities with the capability to store all the spent nuclear fuel generated by the STP units over their life. Therefore, the DOE delay in providing the disposal facility will not impact the operation of the STP units. Under provisions of the Nuclear Waste Policy Act of 1992, a one-mill per KWH assessment on electricity generated and sold from nuclear reactors funds the DOE waste disposal program.\nRisks of substantial liability could arise from the operation of STP and from the use, handling, disposal and possible radioactive emissions associated with nuclear fuel. While CPL carries insurance, the availability, amount and coverage thereof is limited and may become more limited in the future. The available insurance may not cover all types or amounts of loss or expense which may be experienced in connection with the ownership of STP.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Fuel and Purchased Power for information relating to coal contract litigation.\nGovernmental Regulation CSW, CPL, PSO, SWEPCO and WTU The price and availability of each of the foregoing fuel types are significantly affected by governmental regulation. Any inability in the future to obtain adequate fuel supplies or adoption of additional regulatory measures restricting the use of such fuels for the generation of electricity might affect the CSW System's ability to economically meet the needs of its customers and could require the Electric Operating Companies to supplement or replace, prior to normal retirement, existing generating capability with units using other fuels. This would be impossible to accomplish quickly, would require substantial additional expenditures for construction and could have a significant adverse effect on CSW's and\/or the Electric Operating Companies' financial condition and results of operations.\n1-36 Fuel Costs and Consumption CSW, CPL, PSO, SWEPCO and WTU Additional fuel cost data for the CSW System appears under OPERATING STATISTICS. Average fuel costs and consumption by fuel type follow:\nAVERAGE COST PER FUEL TYPE MILLION Btu\nCSW NATURAL GAS $2.18 COAL 1.71 LIGNITE 1.34 NUCLEAR .51 FUEL TYPE 1994 CONSUMPTION (MILLIONS) All fuel types 1.82 Tons Mcfs Btus\nCPL CPL NATURAL GAS $2.10 NATURAL GAS 105 107 COAL 1.98 COAL 2 43 NUCLEAR .51 NUCLEAR * * 37 All fuel types 1.75\nPSO PSO NATURAL GAS $2.38 NATURAL GAS 83 86 COAL 1.38 COAL 4 63 All fuel types 1.96\nSWEPCO SWEPCO NATURAL GAS $1.98 NATURAL GAS 43 43 COAL 1.90 COAL and 10 148 LIGNITE LIGNITE 1.34 All fuel types 1.75\nWTU WTU NATURAL GAS $2.18 NATURAL GAS 42 42 COAL 1.42 COAL 2 28 All fuel types 1.88 * Not measured\n1-37 Future Cost of Fuel CSW, CPL, PSO, SWEPCO and WTU The registrants are unable to predict the future cost of fuel.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Rates and Regulatory Matters for each registrant, for further information concerning fuel costs.\nENVIRONMENTAL MATTERS CSW, CPL, PSO, SWEPCO and WTU The Operating Companies and CSWE are subject to regulation with respect to air and water quality and solid waste standards and other environmental matters by various federal, state and local authorities. These authorities have continuing jurisdiction in most cases to require modifications in the Electric Operating Companies' facilities and operations. Changes in environmental statutes or regulations could require substantial additional expenditures to modify the Electric Operating Companies' facilities and operations and could have a significant adverse effect on CSW's and each Electric Operating Companies' results of operations and financial condition. Violations of environmental statutes or regulations can result in fines and other costs.\nAir Quality Clean Air Act Amendments CSW, CPL, PSO, SWEPCO and WTU Air quality standards and emission limitations are subject to the jurisdiction of state regulatory authorities in each state in which the CSW System operates, with oversight by the EPA. In accordance with regulations of these state authorities, permits are required for all generating units on which construction is commenced or which are substantially modified after the effective date of the applicable regulations. None of the Electric Operating Companies has received notice from any federal or state government agency alleging that it currently is subject to an enforcement action for a material violation of existing federal or state air quality and emission regulations.\nIn November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, the Electric Operating Companies will be required to hold allowances in order to emit sulfur dioxide. The EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, CSW believes that the Electric Operating Companies' allowances are adequate to meet their needs at least through 2008. Public and private markets are developing for trading of excess allowances. CSW and the Electric Operating Companies presently have no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\nThe Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and require government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations, and the air toxics study, will have on CSW and the Electric Operating Companies cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, CSW expects to spend $4 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\n1-38 CSW, CPL and WTU Air quality standards and emission limitations are subject to the jurisdiction of the TNRCC, with oversight by the EPA. In accordance with regulations of the TNRCC, permits are required for all generating units on which construction is commenced or which are substantially modified after the effective date of the applicable regulations. CPL and WTU have not received notice from any federal or state government agency alleging that they currently are subject to an enforcement action for a material violation of existing federal or state air quality and emission regulations.\nCSW and CPL As a result of requirements imposed by the Clean Air Act, CPL expects to spend approximately $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nCSW and PSO Air quality standards and emission limitations are subject to the jurisdiction of ODEQ, with oversight by the EPA. In accordance with regulations of ODEQ, permits are required for all generating units on which construction is commenced or which are substantially modified after the effective date of the applicable regulations. PSO has not received notice from any federal or state government agency alleging that it currently is subject to an enforcement action for a material violation of existing federal or state air quality and emission regulations. As a result of requirements imposed by the Clean Air Act, PSO expects to spend approximately $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nCSW and SWEPCO Air quality standards and emission limitations are subject to the jurisdiction of the ADPCE in Arkansas, the LDEQ in Louisiana and the TNRCC in Texas, with oversight by the EPA. In accordance with regulations of the ADPCE, LDEQ and TNRCC, permits are required for all generating units on which construction is commenced or which are substantially modified after the effective date of the applicable regulations. SWEPCO has not received notice from any federal or state government agency alleging that it currently is subject to an enforcement action for a material violation of existing federal or state air quality and emission regulations. As a result of requirements imposed by the Clean Air Act, SWEPCO expects to spend approximately $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nCSW and WTU As a result of requirements imposed by the Clean Air Act, WTU expects to spend approximately $0.5 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nTransok Transok's compressor engines and other emission sources are subject to air permit requirements, including monitoring. As a result of new requirements under the Clean Air Act, seven of Transok's facilities will be subject to additional permit requirements. The Clean Air Act may also impose additional enhanced monitoring requirements on these seven facilities.\nWater Quality CSW, CPL, PSO, SWEPCO and WTU The ADPCE, LDEQ, ODEQ, TNRCC and the EPA have jurisdiction over all wastewater discharges into state waters. These authorities have jurisdiction for establishing water quality standards and issuing waste control permits covering discharges which might affect the quality of state waters. The EPA has jurisdiction over point source discharges through the National Pollutant Discharge Elimination System provisions of the Clean Water Act. CPL, PSO, SWEPCO and WTU\n1-39 have not received notice from any federal or state government agency alleging that they currently are subject to an enforcement action for a material violation of existing federal or state wastewater discharge regulations.\nRCRA, CERCLA and Related Matters RCRA CSW, CPL, PSO, SWEPCO and WTU The RCRA and the Arkansas, Louisiana, Oklahoma and Texas solid waste rules provide for comprehensive control of all solid wastes from generation to final disposal. The appropriate state regulatory authorities in the states in which the CSW System operates have received authorization from the EPA to administer the RCRA solid waste control program for their respective states. None of the Electric Operating Companies has received notice from any federal or state government agency alleging that it currently is subject to an enforcement action for a material violation of existing federal or state solid waste regulations.\nCERCLA The operations of the CSW System, like those of other utility systems, generally involve the use and disposal of substances subject to environmental laws. CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nCSW's subsidiaries incur significant costs for the handling, transportation, storage and disposal of hazardous and non-hazardous waste materials. Unit costs for waste classified as hazardous exceed by a substantial margin unit costs for waste classified as non- hazardous waste.\nThe Electric Operating Companies are also subject to various pending claims alleging that they are PRPs under federal or state remedial laws for investigating and cleaning up contaminated property. CSW anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on CSW's consolidated results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites are the volume and\/or type of waste allegedly contributed by the Electric Operating Company, the estimated amount of costs allocated to the Electric Operating Company and the participation of other parties.\nThe Electric Operating Companies, like other electric utilities, produce combustion and other generation by-products, such as sludge, slag, low-level radioactive waste and spent nuclear fuel. The Electric Operating Companies own distribution poles treated with creosote or related substances. The EPA currently exempts coal combustion by-products from regulation as hazardous wastes. Distribution poles treated with creosote or similar substances are not expected to exhibit characteristics that would cause them to be hazardous waste. In connection with their operations, the Electric Operating Companies also have used asbestos, PCBs and materials classified as hazardous waste. If additional by-products or other materials generated or used by companies in the CSW System were reclassified as hazardous wastes, or other new laws or regulations concerning hazardous wastes or other materials were put in effect, CSW System disposal and remedial costs could increase materially. The EPA is expected to issue new regulations stating whether certain other materials will be classified as hazardous.\nSol Lynn Superfund Site CSW and CPL The Sol Lynn salvage yard was declared a Superfund site by the EPA after it was found to contain a number of contaminants including PCBs. Gulf States Utilities Company remediated the site for approximately $2 million and is trying to recover a portion of the remediation costs from alleged PRPs, including CPL. CPL believes its\n1-40 liability, if any, would be as a deminimus party. CPL is negotiating with Gulf States Utilities Company to determine its share, if any, of remediation costs.\nIndustrial Road and Industrial Metals Site CSW and CPL Several lawsuits relating to the industrial road and industrial metal site in Corpus Christi, Texas, naming CPL as a defendant, are currently pending in federal and state court in Texas. Plaintiffs' claims allege property damage and clean-up activities. Although management cannot predict the outcome of these proceedings, based on the defenses that management believes are available to CPL, management believes that the ultimate resolution of these matters will not have a material adverse effect on CSW's or CPL's results of operations or financial condition.\nRose Chemical Site CSW, SWEPCO and WTU SWEPCO and WTU were named PRPs in the clean-up of the Rose Chemical Site, in Missouri, along with 750 other companies. A clean- up fund was established through payments by PRPs who agreed to a \"buyout settlement,\" and the site remediation was undertaken. The site buildings were removed and the grounds cleaned to standards acceptable to the EPA. The site remediation is virtually completed and the court settlement became final in July 1994. Remaining costs are expected to be covered by the previously collected funds and there should be no further costs to either SWEPCO or WTU.\nB&B Salvage Site CSW, SWEPCO and WTU SWEPCO and WTU are also PRPs at the B&B Salvage site. This site, located in Missouri, received scrap metal from the Rose Chemical firm. The B&B site has been remediated and SWEPCO's and WTU's share of cleaning up this site and the Rose Chemical site is not expected to have a material effect on CSW's, SWEPCO's, or WTU's results of operations or financial condition.\nPCB Litigation CSW and PSO PSO has been named a defendant in complaints filed in federal and state courts of Oklahoma in 1984, 1985, 1986 and 1993. The complaints allege, among other things, that some of the plaintiffs and the property of other plaintiffs were contaminated with PCBs and other toxic by-products following certain incidents, including transformer malfunctions in April 1982, December 1983 and May 1984. To date, complaints representing approximately $736 million of claims, including compensatory and punitive damages, have been dismissed, certain of which resulted from settlements among the parties. The settlements did not have a significant effect on CSW's or PSO's consolidated results of operations. Remaining complaints currently total approximately $395 million, of which approximately one-third is for punitive damages. Discovery with regard to the remaining complaints continues. Management cannot predict the outcome of these proceedings. However, management believes that PSO has defenses to these complaints and intends to pursue them vigorously. Moreover, management has reason to believe that PSO's insurance may cover some of the claims. Management also believes that the ultimate resolution of the remaining complaints will not have a material adverse effect on CSW's or PSO's consolidated results of operations or financial condition.\nPCB Storage Facilities CSW and PSO PSO investigated and identified PCB contamination at one of its PCB storage facilities in Sand Springs, Oklahoma. PSO made proper notification to the EPA of the contamination that was caused by spills prior to PCB spill regulations. PSO negotiated a remediation plan with the EPA. Remediation began in November 1994, and the remediation costs are estimated to be $210,000. As part of the remediation plan, the EPA has requested PSO to sample the land surrounding the PCB storage building site. The land will include an active PSO substation and an industrial area that is privately owned.\n1-41 The extent of any PCB contamination has not been determined on either site.\nCompass Industries Superfund Site CSW and PSO PSO has received notice from the EPA that it is a PRP under CERCLA and may be required to share in the reimbursement of cleanup costs for the Compass Industries Superfund site which has been remediated. PSO has been named defendant in a lawsuit filed in Federal District Court in Tulsa, Oklahoma on August 29, 1994, for reimbursement of the clean-up cost. The range of PSO's degree of responsibility, if any, as a de minimis party appears to be insignificant. Management believes the ultimate resolution of this matter will not have a material adverse effect on CSW's or PSO's consolidated results of operations or financial condition.\nAlleged Coal Gasification Plant in McAlester, Oklahoma CSW and PSO PSO has been notified by the EPA of the identification of a coal gasification plant in McAlester, Oklahoma. The EPA requested PSO to identify all properties owned by PSO currently and formerly in McAlester that had been once owned by a non-affiliated company. PSO has submitted the information to the EPA. PSO has not been able to locate the alleged coal gasification plant in McAlester, Oklahoma. PSO has had no further contact with the EPA regarding this issue.\nUSI Site CSW and PSO PSO has been identified by the ADPCE as a PRP at the USI site in Pine Bluff, Arkansas. In 1993, the ADPCE asked PSO to provide it with information regarding any transactions between USI and PSO since 1973 that involved hazardous substances. Based on a review of its records, PSO's environmentally related transactions with USI were limited to USI's provision of oil recycling services to PSO at property owned by PSO, not at the USI site. As a result, PSO's degree of responsibility, if any, at the USI site appears to be insignificant.\nCoal Mine Reclamation CSW and PSO In August 1994, PSO received approval from the Wyoming Department of Environmental Quality to begin reclamation of a coal mine in Sheridan, Wyoming owned by Ash Creek Mining Company, a wholly-owned subsidiary of PSO. Ash Creek Mining Company recorded a $3 million liability in 1993 for the estimated reclamation costs. Actual reclamation work is expected to commence in mid-1995, with completion estimated in late 1996. Surveillance monitoring will continue for ten years after final reclamation. Management believes the ultimate resolution of this matter will not have a material adverse effect on CSW's or PSO's consolidated results of operations or financial condition.\nSuspected MGP Site in Marshall, Texas CSW and SWEPCO SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\n1-42 Suspected MGP Sites in Texarkana, Texas and Arkansas and Shreveport, Louisiana CSW and SWEPCO SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\nSuspected Biloxi, Mississippi MGP Site CSW and SWEPCO SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nRochester Substation Spill CSW and WTU In September 1992, an automobile crashed into WTU's 69 KV substation in Rochester, Texas, and struck a transformer containing 1,500 gallons of 25 parts per million PCB oil. WTU responded and coordinated clean-up efforts with state officials. In December 1993, WTU contracted with a consulting firm to ascertain the impact of the spill on the area ground water and to help determine WTU's effectiveness in the clean-up effort. Total costs to date have been approximately $400,000. The consultant's report, dated June 30, 1994, concluded that the spill cleanup procedures were effective. WTU forwarded the report to the TNRCC on July 12, 1994 and requested the agency close the matter. Management believes the ultimate resolution of this matter will not have a material adverse effect on CSW's or WTU's results of operations or financial condition.\nToxic Substances Control Act of 1976 Under the TSCA, the storage, use and disposal, among other things, of PCBs are regulated. Violations of TSCA may lead to fines and penalties.\nCSW and CPL In an inspection of CPL by the EPA, the EPA alleged that CPL failed to comply with the regulations governing the reporting of leakage of PCBs from some of its equipment. The EPA has proposed a penalty of $91,000. CPL met with EPA to negotiate a reduction in the penalty. EPA responded on January 26, 1995, with a proposed potential reduced penalty of $61,000 dependent upon filing additional information with the EPA. Based on the information currently available to it, CPL expects the final penalty to be between $61,000 and $91,000.\nSee ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, CSW NOTE 10, and PSO NOTE 8, Litigation and Regulatory Proceedings for additional information related to PCB matters.\nOther Environmental CSW, CPL, PSO, SWEPCO and WTU From time to time the registrants are made aware of various other environmental issues or are named as a party to various other legal claims, actions, complaints or other proceedings related to environmental matters. Management does not expect disposition of any such pending environmental proceedings to have a material adverse effect on the registrants' results of operations or financial condition.\n1-43 See ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Environmental for each registrant and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, CSW NOTE 10 and PSO NOTE 8, Litigation and Regulatory Proceedings and CSW NOTE 11 and SWEPCO NOTE 10, Commitments and Contingent Liabilities, for additional information relating to environmental matters.\nNON-UTILITY OPERATIONS\nCSW Transok Transok, a wholly-owned subsidiary of CSW, is an intrastate natural gas gathering, transmission, processing, storage and marketing company. Transok, incorporated in Oklahoma in 1955, was acquired by CSW in 1961 to supply natural gas to PSO's power stations. While Transok's operations in recent years have included the marketing and transportation of natural gas for third parties, it functions within the CSW System to insure reliable and economic natural gas service to the Electric Operating Companies and CSWE.\nTransok provides a variety of services to the Electric Operating Companies including acquiring and transporting natural gas to meet certain of their power generation needs. Transok's largest customer is PSO. The contract between PSO and Transok provides (i) for the transportation of PSO's natural gas fuel supply through Transok's pipeline system and (ii) for Transok to act as PSO's supply administrator in acquiring natural gas and negotiating and administering supply contracts. PSO pays Transok for such services at cost, including a return on equity applicable between affiliates as specified by the Oklahoma Commission in PSO's most recent Oklahoma price review. The contract expires on January 1, 2003, but continues for consecutive five-year terms thereafter unless either party provides two years' notice of cancellation. Under the contract, PSO has the right to require delivery of up to 546 MMcf\/d of natural gas through Transok's pipeline system. Effective January 1, 1998, PSO may adjust the transportation capacity available to it under the contract based on its projected needs. Delivery of natural gas to PSO is currently about 86 Bcf annually and is projected to increase.\nNatural Gas Transportation and Gathering Transok provides natural gas suppliers and shippers with pipeline interconnects for access to the Electric Operating Companies and other end-users throughout the United States. At December 31, 1994, Transok's pipeline system consisted of approximately 6,436 miles of gathering and transmission lines which include approximately 3,973 miles of gathering lines in Oklahoma, 275 miles in Louisiana and 214 miles in Texas. At December 31, 1994, Transok's pipeline system consisted of 200 compressors with 197,900 horsepower to provide both gathering and transmission line compression. Transok's pipeline facilities are located in the major natural gas producing basins in Oklahoma, including the Anadarko and Arkoma basins, and in the major Louisiana corridor of pipelines transporting natural gas to the northeast from the Gulf Coast and mid-continent areas. The Transok pipeline system has numerous connections with major interstate pipelines through which natural gas is transported to markets throughout the United States. In 1994, the Transok pipeline system had a throughput of 506 Bcf of natural gas.\nTransok transported more than 86 Bcf per year of natural gas for PSO in 1994 and provided administrative services to PSO to manage its supply of natural gas. Transok has been active in the development of joint gas purchase arrangements with its other CSW affiliates as well. Transok's access to diverse natural gas markets combined with the natural gas fuel needs of the Electric Operating Companies allow for natural gas opportunities at high load factors, reducing the cost of natural gas fuel for the CSW System.\nNatural Gas Processing Transok also owns and operates seven natural gas processing plants for the production of natural gas liquids. The plants have an aggregate capacity of 444 MMcf\/d. Transok is the second largest natural gas processor in Oklahoma and ranks seventeenth among natural gas liquids producers nationwide. In 1994, Transok's plants produced\n1-44 399.4 million gallons of natural gas liquids while revenue from the sale of natural gas liquids amounted to $117.9 million for the year.\nNatural Gas Storage Transok owns and operates an underground natural gas storage reservoir in Oklahoma with an aggregate storage capacity of approximately 26 billion cubic feet. Operational capabilities include injection into storage at a rate of 130 MMcf\/d and a withdrawal rate in excess of 210 MMcf\/d. In 1993, the FERC issued an order approving market-based storage rates for Transok which enables it to sell storage services to interstate customers at negotiated fees based on the value of those services in the competitive marketplace. Transok's gas storage field also allows Transok to offer peaking services, accommodate volume swings on its pipeline system, and support the natural gas requirements of the Electric Operating Companies.\nNatural Gas Marketing In 1989, Transok began its natural gas marketing program and sold 26 Bcf to a variety of customers including local distribution companies, end-users and other pipelines. In 1994, Transok's natural gas sales volumes were 257 Bcf with a sales revenue of $484.4 million. Off-system sales of natural gas accounted for 111 Bcf of the natural gas sold in 1994. This increase was the result of pipeline acquisition and construction activities combined with new customers. Transok aggregates natural gas supply into various supply pools, which provide Transok with reliable sources of natural gas at market sensitive prices, allowing Transok to meet its natural gas supply needs. Transok offers various gas supply services to provide customers with peaking and balancing alternatives utilizing Transok's gas supplies and facilities. In addition, Transok's customers have the opportunity to select various pricing options including (i) fixed or variable pricing, (ii) indexed to New York Mercantile Exchange pricing or (iii) cash quotes.\nTransok uses natural gas futures, options and basis swaps to reduce its price risk exposure arising from the purchase and sale of natural gas. Natural gas futures and options allow Transok to protect against volatility in supply costs in fulfilling fixed price contracts, meeting storage requirements and purchasing natural gas for processing operations. Natural gas futures and options are also used to protect Transok against price exposure on sales of natural gas from storage or anticipated purchases. In addition, basis swaps protect Transok against volatility in price differentials between geographic areas in matching anticipated supply and demand prices.\nIn 1992, FERC Order 636 went into effect to deregulate the natural gas industry and increase competition. Although Transok operations were not directly affected by Order 636, Transok has developed tariff services, flexible contracts and other natural gas related services in order to meet customers' needs and take advantage of new competitive opportunities.\nServices for CSWE Transok provides natural gas fuel planning and management services for CSWE. Transok assists CSWE in developing natural gas supply and transportation strategies for CSWE's non-utility electric generation projects.\nRegulation As a subsidiary of CSW, Transok is subject to regulation under the Holding Company Act. The Holding Company Act, among other things, requires that regulated companies seek prior SEC approval before entering into certain transactions including the acquisition or issuance of securities.\nTransok's pipelines are considered gathering systems or intrastate pipelines. Transok is therefore exempt from regulation by the FERC under the Natural Gas Act. However, Transok's rates for transporting gas in interstate commerce are subject to FERC regulation under the Natural Gas Policy Act of 1978. The FERC approves Transok's rates for transportation of gas in interstate commerce through Transok's pipelines in Oklahoma and Louisiana and the Texas Railroad Commission approves the rates for such transportation through pipelines in Texas. The FERC also has given\n1-45 Transok approval to charge market-based rates for storage of gas using Transok's storage facility in Oklahoma.\nWhile Transok is not subject to direct regulation by any state public utility commission, the costs that result from transactions with its affiliated Electric Operating Companies are subject to review by the state commissions regulating such affiliates and are required to meet standards for affiliate transactions to be recoverable by the Electric Operating Companies.\nCSWE CSWE, a wholly-owned subsidiary of CSW, is authorized to develop various independent power and cogeneration facilities and to own and operate such non-utility projects, subject to further regulatory approvals. CSWE has an approximate 50% interest in the Brush, Fort Lupton and Mulberry facilities which achieved commercial operation in 1994.\nBrush The 68 MW Brush project, located in Brush, Colorado, achieved commercial operation in January 1994 and provides steam and hot water to a 15-acre greenhouse and sells electricity to Public Service Company of Colorado.\nFt. Lupton The Ft. Lupton project provides steam and hot water to a 20- acre greenhouse and also sells electricity to Public Service Company of Colorado. Phase I of the Ft. Lupton project, representing 122 MWs, achieved commercial operation in June 1994. Phase II of the project commenced operations in July 1994 bringing total on-line capacity of the project to 272 MWs.\nMulberry The Mulberry facility, a 117 MW gas-fired cogeneration plant in Polk County, Florida achieved commercial operation in August 1994 and provides steam to a combined distilled water and ethanol facility and sells electricity to Florida Power Corporation and Tampa Electric Company. CSWS is providing engineering, procurement and construction management services for the Mulberry project. CSWE's operating and maintenance division is operating the plant. On December 30, 1994, the borrower, Polk Power Partners, L.P., in which CSWE is indirectly a 50% owner, was notified it was in technical default under the third party financing documents since substantial completion of the Mulberry Ethanol facility had not occurred by December 30, 1994. CSWE is in the process of discussing with the lender means of curing the technical default. Management does not expect this matter to have a material effect on CSW's consolidated results of operations or financial condition.\nOrange Cogen The Orange Cogen facility, in which CSWE holds a 50% interest, is expected to commence operation in June 1995. The 103 MW, gas fired plant in Florida will provide thermal energy to an orange juice processor and will sell electricity to Florida Power Corporation and Tampa Electric Company. CSWE's O&M division plans to operate the plant.\nOildale In November 1994, CSWE transferred its 50% interest in the 40 MW Oildale cogeneration facility to two non-affiliated third parties, Oildale Holdings, Inc. and Oildale Holdings II, Inc. The Oildale project, which was financed with third-party non-recourse project financing, had been in default of certain provisions of its loan agreement since December 1993. Under the terms of the project transfer, CSWE contributed $3 million in equity in exchange for the return of a letter of credit in the same amount in favor of a third party lender. CSWE had reserved for this liability in 1993, therefore, this transaction has no material adverse effect on CSW's or CSWE's 1994 results of operations or financial condition.\n1-46 Other Projects In addition to these projects, CSWE has another 19 projects totaling more than 5,000 MW in various stages of development, mostly in affiliation with other developers. CSWE can provide no assurances that these projects, which are subject to further negotiations and regulatory approvals, will be commenced or completed and, if they are completed, that they will provide the anticipated return on investment.\nAs a result of its participation in these projects, CSWE has contractual commitments to provide certain services and support. These commitments provide that the potential maximum liability of CSWE will be limited to $215 million. Management believes the likelihood of material liabilities under these contracts is remote.\nThe following table sets forth information about cogeneration projects CSWE is currently operating or bringing to operation:\nCSWI In November 1994, CSWI, a wholly-owned subsidiary of CSW, was formed to engage in international activities including developing, acquiring, financing and owning the securities of exempt wholesale generators and foreign utility companies.\nIn 1994, CSWI continued the Mexico initiative that CSW began in 1992. CSWI's goal is to participate in providing for Mexico's future electric power needs. The geographical location of the CSW System offers opportunities to provide bulk power sales to Mexico. The Mexico City office of CSW allows CSWI greater access to key Mexican markets, permitting CSWI to more readily evaluate opportunities as they become available. However, the recent devaluation of the Mexican peso will slow previously projected power demand for the near-term.\nCSWI is also evaluating energy-related projects in other international markets.\nCSW Communications In July 1994, CSW Communications, a wholly-owned subsidiary of CSW, was formed to provide communication services to the Operating Companies and non-affiliates. One important goal of CSW Communications is to enhance services to CSW System customers through fiber optics and other telecommunications technologies. CSW Communications will consolidate the future design, construction, maintenance and ownership of the CSW System's telecommunications networks. In 1994, CSW announced a $9 million project in Laredo, Texas, to install fiber optic lines and coaxial cable to CPL residential customers who have volunteered to take part in this pilot program. This project involving CSW Communications and CPL will demonstrate the energy efficiency and cost savings that result from giving customers greater choice and control over their electric service. These energy-efficiency services will use only a portion of the capacity of the telecommunications lines CSW Communications is installing. In the future, CSW Communications may, subject to any required regulatory approvals, seek to lease or otherwise use the remaining capacity for other services including possibly telephone service, cable television and home security systems.\n1-47 ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. CSW, CPL, PSO, SWEPCO and WTU See ITEM 1. BUSINESS - UTILITY OPERATIONS - Facilities for a description of properties used in utility operations.\nSee ITEM 1. BUSINESS - Transok and CSWE for a description of properties used in non-utility operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. CSW, CPL, PSO, SWEPCO and WTU The registrants are 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 registrants' results of operations or financial condition.\nSee ITEM 1. BUSINESS - REGULATION AND RATES, ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CSW NOTE 10, CPL NOTE 9, PSO NOTE 8, SWEPCO NOTE 9, and WTU NOTE 9, Litigation and Regulatory Proceedings, for information relating to legal and regulatory proceedings.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for each of the registrants, for information related to fuel settlements.\nSee ITEM 1. BUSINESS - ENVIRONMENTAL MATTERS and ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Recent Developments and Trends for each of the registrants, for information relating to environmental proceedings.\nCSW and CPL See ITEM 1. BUSINESS - NUCLEAR - STP, ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CSW NOTE 10 and CPL NOTE 9, Litigation and Regulatory Proceedings, for information as to pending legal proceedings relating to STP.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. CSW, CPL, PSO, SWEPCO and WTU None.\n2-1 PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. CSW Common Stock Price Range and Dividends Paid per Share 1994 1993 Market Price Dividends Market Price Dividends High Low Paid High Low Paid (cents) (cents) First Quarter $30 7\/8 $24 1\/8 42.5 $33 1\/4 $28 5\/8 40.5 Second Quarter 26 1\/4 20 1\/8 42.5 34 1\/4 28 3\/4 40.5 Third Quarter 23 1\/4 20 7\/8 42.5 33 7\/8 32 1\/4 40.5 Fourth Quarter 23 3\/4 20 1\/8 42.5 33 28 1\/4 40.5\nCommon Stock Listing CSW's common stock is traded under the ticker symbol CSR and listed on the New York Stock Exchange, Inc. and Chicago Stock Exchange, Inc.\nCommon Stock Dividends Dividends of 42.5 cents a share were paid in each quarter of 1994. All dividends paid by CSW represent taxable income to stockholders for federal income tax purposes.\nIn January 1995, CSW's board of directors increased the quarterly dividend to 43 cents per share, payable on February 28, 1995, to stockholders of record on February 8, 1995. Traditionally, the CSW board of directors has declared dividends to be payable on the last business day of February, May, August, and November. CSW has stated that it is committed to achieving a 75% payout ratio in the long-term as a key component of its corporate strategy to maximize stockholder value.\nStockholders There were approximately 74,000 record holders of CSW's common stock as of December 31, 1994.\nCPL, PSO, SWEPCO and WTU All of the outstanding shares of common stock of CPL, PSO, SWEPCO and WTU are owned by CSW.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nReference is made to the page numbers noted in the following table for the location of ITEM 6. SELECTED FINANCIAL DATA, which is included in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPage Number CSW CPL PSO SWEPCO WTU Selected Financial Data 2-6 2-70 2-106 2-132 2-160\n2-2 ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nReference is made to the page numbers noted in the following table for the location of ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS which is included in ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPage Number CSW CPL PSO SWEPCO WTU Management's Discussion and Analysis of Financial Condition 2-7 2-71 2-107 2-133 2-161\n2-3 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Page CSW Central and South West Corporation 2-5 Selected Financial Data 2-6 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-7 Consolidated Statements of Income 2-26 Consolidated Statements of Retained Earnings 2-27 Consolidated Balance Sheets 2-28 Consolidated Statements of Cash Flows 2-30 Notes to Consolidated Financial Statements 2-31 Report of Independent Public Accountants 2-67 Report of Management 2-68\nCPL Central Power and Light Company 2-69 Selected Financial Data 2-70 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-71 Statements of Income 2-81 Statements of Retained Earnings 2-82 Balance Sheets 2-83 Statements of Cash Flows 2-85 Statements of Capitalization 2-86 Notes to Financial Statements 2-87 Report of Independent Public Accountants 2-103 Report of Management 2-104\nPSO Public Service Company of Oklahoma 2-105 Selected Financial Data 2-106 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-107 Consolidated Statements of Income 2-113 Consolidated Statements of Retained Earnings 2-114 Consolidated Balance Sheets 2-115 Consolidated Statements of Cash Flows 2-117 Consolidated Statements of Capitalization 2-118 Notes to Consolidated Financial Statements 2-119 Report of Independent Public Accountants 2-129 Report of Management 2-130\n2-4 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. (continued)\nSWEPCO Southwestern Electric Power Company 2-131 Selected Financial Data 2-132 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-133 Statements of Income 2-141 Statements of Retained Earnings 2-142 Balance Sheets 2-143 Statements of Cash Flows 2-145 Statements of Capitalization 2-146 Notes to Financial Statements 2-147 Report of Independent Public Accountants 2-157 Report of Management 2-158\nWTU West Texas Utilities Company 2-159 Selected Financial Data 2-160 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-161 Statements of Income 2-169 Statements of Retained Earnings 2-170 Balance Sheets 2-171 Statements of Cash Flows 2-173 Statements of Capitalization 2-174 Notes to Financial Statements 2-175 Report of Independent Public Accountants 2-186 Report of Management 2-187\n2-5\nCSW\nCENTRAL AND SOUTH WEST CORPORATION\n2-6 Selected Financial Data CSW The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for CSW.\n1994 1993 1992 1991 1990 (millions, except per share amounts and ratios) Operating Revenues $ 3,623 $ 3,687 $ 3,289 $ 3,047 $2,744 Income Before Cumulative Effect of Changes in Accounting Principles 412 281 404 401 386 Cumulative Effect of Changes in Accounting Principlies (1) -- 46 -- -- -- Net Income 412 327 404 401 386 Preferred Stock Dividends 18 19 22 26 30 Dividends Net Income for Common Stock 394 308 382 375 356\nTotal Assets (2) 10,909 10,604 9,829 9,396 9,074\nCommon Stock Equity 3,052 2,930 2,927 2,834 2,743 Preferred Stock Not Subject to Mandatory Redemption 292 292 292 292 291 Subject to Mandatory Redemption 35 58 75 97 103 Long-term Debt 2,940 2,749 2,647 2,518 2,513\nCapitalization Ratios Common Stock Equity 48.3% 48.6% 49.3% 49.4% 48.5% Preferred Stock 5.2 5.8 6.2 6.8 7.0 Long-term Debt 46.5 45.6 44.5 43.8 44.5 Earnings per Share of Common Stock $2.08 $1.63 $2.03 $1.99 $1.89 Dividends Paid per Share of Common Stock $1.70 $1.62 $1.54 $1.46 $1.38\n(1) The 1993 cumulative effect relates to the changes in accounting for unbilled revenues and adoption of SFAS No. 112, Employer's Accounting for Postemployment Benefits and the adoption of SFAS No. 109, Accounting for Income Taxes. See NOTE 1. Summary of Significant Accounting Policies.\n(2) The 1992 - 1990 total assets have been reclassified to reflect the effects of the adoption in 1993 of SFAS No. 109, Accounting for Income Taxes. See NOTE 2. Federal Income Taxes.\nAll common stock data have been adjusted to reflect the two-for-one common stock split, effected by a 100% stock dividend paid on March 6, 1992, to stockholders of record on February 10, 1992.\nCSW changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore have not been restated.\n2-7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCENTRAL AND SOUTH WEST CORPORATION\nReference is made to CSW's Consolidated Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential in understanding, the following discussion and analysis.\nOverview The electric utility industry is changing rapidly and becoming more competitive. Several years ago, in anticipation of increasing competition and fundamental changes in the industry, CSW's management developed a four-part strategic plan. This plan is designed to help position CSW to be competitive in the rapidly changing environment that the CSW System currently faces. The four-part strategy is:\nEnhance CSW's core electric utility business.\nExpand CSW's core electric utility business.\nExpand CSW's non-utility business.\nPursue financial initiatives.\nSince the introduction of CSW's strategic plan in 1990, CSW has undertaken initiatives in each of these areas that are important steps in the implementation of the overall strategy. These initiatives were marked by the efforts in the proposed acquisition of El Paso and the continued restructuring of CSW's core business. In addition, CSW has faced some operational challenges during the past two years with the outage and 1994 restart of STP. These events are discussed below and elsewhere in this report.\nCSW and the Electric Operating Companies believe that, compared to other electric utilities, the CSW System is well positioned to meet future competition. The CSW System benefits from economies of scale and scope by virtue of its size and is a relatively low-cost producer of electric power. Moreover, CSW is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nProposed Acquisition of El Paso El Paso filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code on January 8, 1992. In May 1993, CSW entered into a Merger Agreement pursuant to which El Paso would emerge from bankruptcy as a wholly-owned subsidiary of CSW. El Paso is an electric utility company headquartered in El Paso, Texas, engaged principally in the generation and distribution of electricity to approximately 262,000 retail customers in west Texas and southern New Mexico. El Paso also sells electricity under contract to wholesale customers in a number of locations including southern California and Mexico.\nOn July 30, 1993, El Paso filed the Modified Plan and a related proposed form of disclosure statement providing for the acquisition of El Paso by CSW. On November 15, 1993, all voting classes of creditors and shareholders of El Paso voted to approve the Modified Plan. On December 8, 1993, the Bankruptcy Court confirmed the Modified Plan.\nUnder the Modified Plan, the total value of CSW's offer to acquire El Paso is approximately $2.2 billion. The Modified Plan generally provides for El Paso creditors and shareholders to receive shares of CSW Common, cash and\/or securities of El Paso, or to have\n2-8 their claims cured and reinstated. The Modified Plan also provides for claims of secured creditors generally to be paid in full with debt securities of reorganized El Paso, and for unsecured creditors to receive a combination of debt securities of reorganized El Paso and CSW Common equal to 95.5 percent of their claims, and for small trade creditors to be paid in full with cash. The Modified Plan provides for El Paso's preferred shareholders to receive preferred shares of reorganized El Paso, or cash, and for options to purchase El Paso Common to be converted into options to purchase a proportionate number of shares of CSW Common.\nBased on information provided by El Paso, 35,544,330 shares of El Paso Common were outstanding as of the Confirmation Date. The Modified Plan provides for El Paso's common shareholders to receive between $3.00 and $4.50, plus dividends, per share of El Paso Common to be paid in CSW Common as described below. The Merger Agreement provides for each share of El Paso Common to be converted on the Effective Date into the number of shares of CSW Common with a value (based on a value of $29.4583 per share of CSW Common) equal to the sum of (i) $3.00 per share of El Paso Common outstanding on the Confirmation Date, (ii) any proceeds received by El Paso prior to the Effective Date from certain contingent claims based on a value of CSW Common equal to the closing price on the New York Stock Exchange on the day such proceeds are received by El Paso, and (iii) the dividends that would be deemed to have been paid on the amounts described in items (i) and (ii) above from the Confirmation Date, or the date upon which such contingent claims are converted into cash, as the case may be, through and including the Effective Date, as well as dividends that would have been paid on such dividends under (iii) above; provided, however, that the sum of (i) and (ii) above will not exceed $4.50 multiplied by the number of shares of El Paso Common outstanding on the Confirmation Date. If $4.50 per share of El Paso Common has not been realized under items (i) and (ii) above and any of the contingent claims are remaining on the Effective Date, the Modified Plan and Merger Agreement provide for a liquidation trust to be established pursuant to the Modified Plan and for El Paso's rights in those contingent claims to be assigned to the trust. The Modified Plan provides for proceeds resulting from disposition of the assets in the liquidation trust, if any, to be distributed pro rata to the holders of El Paso Common up to $4.50 per share under items (i) and (ii) above, with any net proceeds thereafter to be returned to El Paso. El Paso has stated publicly that it has realized sufficient proceeds from the contingent claims referred to in item (ii) above so that no liquidation trust would be required.\nThe aggregate number of shares of CSW Common that would be issued in connection with the Merger cannot be determined at this time due to certain contingencies, including the future price of CSW Common, future dividend rates on CSW Common and the occurrence and timing of the Effective Date of the Merger. CSW has estimated the value of the shares to be issued to El Paso stakeholders at approximately $569 million based on an assumed Effective Date in the first half of 1995. In addition, CSW expects to make payments in cash of approximately $335 million in connection with the consummation of the Merger, a portion of which would be funded by cash in the El Paso estate and an estimated $200 million of which would be funded from other internal or external sources which may include a new issuance of CSW Common or debt securities. Depending on the number of shares issued and the outcome of other matters discussed below, existing holders of CSW Common could experience short-term dilution in earnings if the Merger is consummated. As of December 31, 1994, the price per share of CSW Common had declined by approximately 31% since May 3, 1993, the date of the Merger Agreement. Because the number of shares of CSW Common and the interest rates of the debt securities that would be issued to the creditor groups in connection with the Merger are to be set on or about the Effective Date, changes in the price of CSW Common and the level of interest rates would affect the economic impact of the proposed acquisition to CSW.\nThe Merger is subject to numerous conditions set forth in the Merger Agreement, including but not limited to (i) the receipt of final orders with respect to all required regulatory approvals on terms that would not cause a regulatory material adverse effect as defined in the Merger Agreement, (ii) the receipt of all third party consents, (iii) the absence of a material adverse effect or facts or circumstances that could reasonably be expected to result in a material adverse effect on El Paso or the business prospects of El Paso, (iv) transfer to El Paso of good and marketable title to the leased portion of El Paso's share of Palo Verde, (v) performance by\n2-9 El Paso, CSW and CSW's acquisition subsidiary, CSW Sub, Inc., in all material respects of all covenants contained in the Merger Agreement and (vi) the occurrence of the Effective Date under the Modified Plan. Required regulatory approvals and filings in connection with the Merger include approvals of the FERC, the SEC, the Texas Commission, the New Mexico Commission, the NRC, and filings with the Department of Justice and the Federal Trade Commission under the Hart- Scott-Rodino Antitrust Improvements Act of 1976.\nThe Merger Agreement also provides that CSW and El Paso have the right to terminate the Merger Agreement under specified circumstances including without limitation, (i) the filing of a stand-alone rate plan by El Paso, (ii) the failure of the Effective Date to occur within 18 months after the Confirmation Date (i.e., by June 8, 1995), or , if extended by mutual consent of CSW and El Paso, within 24 months of the Confirmation Date (i.e., by December 8, 1995), or (iii) the entering of any order denying any of the required regulatory approvals. In the event the Merger Agreement is terminated, a termination fee is payable in limited circumstances. El Paso is required to pay a termination fee of $50 million to CSW if El Paso terminates the Merger Agreement under certain circumstances and subsequently consummates a merger with another party. CSW and El Paso would be required to pay a $25 million termination fee to the other party in the case of termination based upon a material breach of the Merger Agreement or failure to approve an extension of time permitted to consummate the Merger under specified circumstances. If the Merger Agreement is terminated, whether or not any termination fee is payable, CSW could be required, in most cases, to recognize as an expense deferred costs associated with the Merger, which amounted to approximately $36 million at December 31, 1994. Additionally, under certain circumstances, if the Merger is not consummated, the Merger Agreement provides for CSW to pay El Paso a portion of certain interest costs and certain fees and expenses. CSW's potential exposure as of December 31, 1994 is estimated to be approximately $17.5 million; however, the actual amount, if any, that CSW may be required to pay pursuant to these provisions depends on a number of contingencies and cannot presently be predicted.\nCSW continues to use its best efforts to consummate the Merger. At the same time, however, CSW continues to monitor contingencies which may preclude the consummation of the Merger, including without limitation the potential loss of significant portions of El Paso's service area and significant El Paso customers, including Las Cruces and two military installations, Holloman Air Force Base and White Sands Missile Range, regulatory risks principally related to approval of the Merger and El Paso's request for a rate increase in Texas as well as the effects of the conditions imposed by federal or state regulatory agencies on the approval of the Merger, and operating risks associated with the ownership of an interest in Palo Verde.\nBased upon El Paso's written response to the concerns identified in a September 12 letter from CSW to El Paso and the failure of El Paso to resolve the contingencies set forth above, CSW cannot predict whether, or if so when, the Merger will be consummated. In the event that the proposed Merger is not consummated, there may be ensuing litigation between El Paso and CSW or among other parties to El Paso's bankruptcy proceedings and either or both of El Paso and CSW.\nManagement is unable to predict the ultimate outcome of the proposed Merger. In the event that recognition of any or all of these expenses is required, it could have a material adverse impact on CSW's consolidated results of operations in the period they are recognized, but would not be expected to have a material adverse impact on CSW's consolidated results of operations or financial condition.\nSee NOTE 11, Commitments and Contingent Liabilities - Proposed Acquisition of El Paso, for additional information related to the proposed El Paso merger.\nRestructuring As previously reported, the CSW System has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the\n2-10 restructuring is to enable the Electric Operating Companies to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $97 million and were expensed in 1993. The final costs of the restructuring were approximately $88 million. Approximately $84 million of the restructuring expenditures were incurred during 1994, with the remaining $4 million expected to be incurred during 1995. Approximately $12 million of the restructuring expenses relate to employee termination benefits, $45 million relate to enhanced benefit costs and $31 million relate to employees that will not be terminated. Approximately $60 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $28 million represents the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nCSW expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. All restructuring costs are expected to be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nSTP Introduction CPL owns 25.2% of STP, a two-unit nuclear power plant which is located near Bay City, Texas. In addition to CPL, 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.\nFrom February 1993 until May 1994, STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL. These matters, including a base rate case and fuel reconciliation proceedings, are discussed immediately below.\nSTP Outage In February 1993, Units 1 and 2 of STP were shut down by HLP in an unscheduled outage resulting from mechanical problems. HLP determined that the units would not be restarted until the equipment failures had been corrected and the NRC was briefed on the causes of these failures and the corrective actions that were taken. The NRC formalized that commitment in a confirmatory action letter that it supplemented to identify additional issues to be resolved and verified by the NRC before STP could be restarted.\nDuring the outage, the necessary improvements were 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 agreed with HLP's recommendation that Unit 1 was ready to restart. Unit 1 restarted on February 25, 1994 and reached 100% power on April 8, 1994. Subsequently, the issues with respect to Unit 2 were resolved and the NRC on May 17, 1994 agreed with HLP's recommendation to restart Unit 2. Unit 2 resumed operation on May 30, 1994 and reached 100% power on June 16, 1994. During 1994, Unit 1 and Unit 2 achieved annual net capacity factors of 75.3% and 54.7%, respectively. During the last six months of 1994, the STP units operated at capacity factors of 98.6% for Unit 1 and 99.2% for Unit 2.\nIn June 1993, the NRC placed STP on its \"watch list\" of plants with \"weaknesses that warrant increased NRC attention.\" The decision to place STP on the watch list followed the June 1993 issuance of a report by an NRC Diagnostic Evaluation Team which conducted a review of STP operations.\nOn February 3, 1995, the NRC removed STP from the \"watch list\". The NRC noted that the four key areas for their decision were sustained improvement throughout 1994, high standards of performance exhibited by the plant, effective maintenance and engineering support\n2-11 resulting in reduced equipment repair backlogs and improved plant reliability, and the open and positive employee climate at the plant. With the NRC reviewing the \"watch list\" status every 6 months and with Unit 2 achieving 100% power in June of 1994, the February review was the first realistic opportunity for STP to be considered for a change in status. On average, plants previously placed on the \"watch list\" have stayed on the list for 29 months.\nRates and Regulatory Matters CPL Rate Inquiry Several Cities, the Texas Commission General Counsel and others initiated actions in late 1993 and early 1994 which, if approved by the Texas Commission, would lower CPL's base rates. The requests for a review of CPL's rates arose out of the unscheduled outage at STP which began in February 1993. The STP outage did not affect CPL's ability to meet customer demand because of existing capacity and CPL's purchase of additional energy.\nCPL submitted a filing package on July 1, 1994, to the Texas Commission justifying its current base rate structure. Parties to CPL's base rate case have filed testimony with the Texas Commission recommending reductions in CPL's retail base rates of up to $147 million annually, resulting from a combination of proposed rate base and cost of service reductions, as well as a rate base disallowance of up to $400 million.\nThe Texas Commission held hearings in November and December 1994, and all parties have filed briefs in the case. The ALJ is expected to issue a recommended order for consideration by the Texas Commission in April 1995 with a final order from the Texas Commission expected in May 1995. Testimony filed by parties to the rate case, including the Staff, is not binding on either the ALJ or the Texas Commission.\nCPL continues to maintain that its rates are reasonable and that its earnings are within established regulatory guidelines. In addition, CPL strongly believes that 100 percent of its investment in both units of STP belongs in rate base. This belief is based on, among other factors, Units 1 and 2 providing output at high capacity factors since April and June 1994, respectively. In addition, the long-term benefits nuclear generation provides to customers further support their inclusion in rate base. Furthermore, there are no Texas Commission precedents addressing the removal of a nuclear plant from rate base as a performance disallowance. Assuming both units of STP are included in rate base, CPL believes it is not collecting excessive revenues, notwithstanding that market rates of return on common equity are generally lower today than they were in 1990 and 1991, when CPL's base rates were last set.\nCPL Fuel Pursuant to the substantive rules of the Texas Commission, CPL generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and CPL'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 from revenues, with a corresponding entry to unrecovered fuel costs 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.\nCPL is currently involved in two proceedings before the Texas Commission relating to the recovery of fuel and purchased power costs. CPL originally filed Docket No. 12154 seeking approval of a customer surcharge to recover fuel and purchased power costs, including those resulting from the STP outage. In Docket No. 13126, the Texas Commission General Counsel and others are reviewing the prudence of management activities at STP. In November 1994, CPL filed a fuel reconciliation case in Docket No. 13650 with the Texas Commission seeking to reconcile fuel costs since March 1, 1990, including the period during which CPL's fuel and purchased power costs were increased due to the STP outage. At December 31, 1994, CPL's under-recovered fuel balance was $54.1 million, exclusive of interest, which was due primarily to the STP outage. If a\n2-12 significant portion of the fuel costs were disallowed by the Texas Commission, CSW could experience a material adverse effect on its consolidated results of operations in the year of disallowance but not on its financial condition. Finally, in Docket No. 13126, the Texas Commission General Counsel is reviewing the prudence of management activities at STP. On January 4, 1995, Docket No. 12154 was consolidated into Docket No. 13650. The results of the prudence inquiry in Docket No. 13126 are expected to be incorporated into the fuel reconciliation proceedings in Docket No. 13650.\nCPL continues to negotiate with the intervening parties to resolve these matters through settlement. However, no settlement has been reached to date.\nManagement cannot predict the ultimate outcome of these regulatory proceedings. However, management believes that the ultimate resolution of the various issues will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nSee NOTE 10, Litigation and Regulatory Proceedings - CPL, STP, for a discussion of regulatory proceedings arising out of the STP outage and background on STP rate orders and deferred accounting.\nNuclear Decommissioning CPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning and is net of expected earnings on the trust fund.\nThe staff of the SEC has questioned certain of the current accounting practices of the electric utility industry regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations. In response to these questions, FASB has agreed to review the accounting for removal costs, including decommissioning. If current electric utility industry accounting practices for such decommissioning are changed, (i) annual provisions for decommissioning could increase, (ii) the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation, and (iii) trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense.\nSee NOTE 1, Summary of Significant Accounting Policies - Nuclear Decommissioning, for further information regarding CPL's decommissioning of STP.\nSee NOTE 10, Litigation and Regulatory Proceedings, for information regarding other rate and regulatory matters, including the PSO rate case, the SWEPCO fuel reconciliation, and WTU's fuel and rate proceedings.\nNew Accounting Standards SFAS No. 115, was effective for fiscal years beginning after December 15, 1993. CSW adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on CSW's consolidated results of operations or financial condition.\nIn June 1993 the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by CSW for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on CSW's consolidated results of operations or financial condition.\n2-13 SFAS No. 119 was effective for fiscal years ending after December 15, 1994. Transok, which is the only subsidiary of CSW currently using derivative financial instruments, uses derivatives to manage price and market risks for gas purchases and sales. The Electric Operating Companies may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on CSW's consolidated results of operations or financial condition.\nLiquidity and Capital Resources Overview The historical capital requirements of the CSW System have been primarily for the construction of electric utility plant. Large capital expenditures for the construction of new generating capacity are not planned through the end of this decade. Accordingly, internally generated funds should meet most of the capital requirements of the Electric Operating Companies. However, CSW's strategic initiatives, including expanding CSW's core electric utility and non-utility businesses, may require additional capital. Primary sources of capital are long-term debt and preferred stock issued by the Electric Operating Companies, common stock issued by CSW and internally generated funds. In addition, CSWE uses various forms of non-recourse project financing. CSW, in order to strengthen its capital structure and support growth from time to time, may issue additional shares of its common stock.\nProductive investment of net funds from operations in excess of capital expenditures and dividend payments are necessary to enhance the long-term value of CSW for its investors. CSW is continually evaluating the best use of these funds. CSW is required to obtain authorization from various regulators in order to invest in any additional business activities.\nCapital Expenditures Construction expenditures for the CSW System totaled $578 million in 1994. Based on projections of growth in peak demand, the CSW System will not require significant additional generating capability through the end of this decade. Planned construction expenditures for the Electric Operating Companies for the next three years are primarily to improve and expand distribution facilities. These improvements will be required to meet the needs of new customers and the growth in the requirements of existing customers. Construction expenditures, excluding capital required for acquisitions by CSW or its subsidiaries, if any, are expected to be approximately $385 million, $382 million and $358 million during 1995, 1996, and 1997, respectively. Not included in the 1995 amount is approximately $61 million of equity investments by CSWE.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in the Electric Operating Companies' service areas, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected coal and lignite-fired generating plants for which the CSW System has invested approximately $140 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, CSW would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of CSW were: common stock equity 48%, preferred stock 5% and long-term debt 47%. The CSW System's embedded cost of long-term debt was 7.7% at the end of 1994. The CSW System continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. The CSW System continues to be committed to maintaining financial flexibility by maintaining a strong capital structure and favorable securities ratings which should allow funds to be obtained from the capital markets when required.\n2-14 The CSW System's significant long-term financing activity for 1994 and 1995 to date is summarized as follows:\nSecurity Issued Security Reacquired Security Amount Rate Maturity Security Amount Rate Maturity (millions) (millions) CPL FMB(1) $100.0 7-1\/2% 1999 PFDs $22.4 10.05% -- FMB 0.6 9-3\/8% 2019\nSWEPCO Term Term Loan 50.0 Floating 2000 Loan 50.0 Floating 1997 FMB 5.8 9-1\/8% 2019\nWTU FMB(2) 40.0 6-1\/8% 2004 FMB 12.0 7-1\/4% 1999 FMB(3) 40.0 7-1\/2% 2000 FMB 7.8 9-1\/4% 2019 PFDs 4.7 7-1\/4% -- CSWS Term(4) Loan 60.0 Floating 2001\n(1) Net proceeds were used to repay a portion of CPL's short-term borrowings.\n(2) Net proceeds were used to reimburse WTU's treasury for (i) $12 million aggregate principal amount of 7-1\/4% FMBs, Series G, due January 1, 1999, redeemed on January 1, 1994, and (ii) $23 million aggregate principal amount of 7-7\/8% FMBs, Series H, due July 1, 2003, redeemed on December 30, 1993. The balance of the proceeds were used to repay outstanding short-term borrowings.\n(3) Issuance occurred in 1995 and is not reflected in the 1994 financial statements. Net proceeds were used to repay a portion of WTU's short-term debt, to provide working capital and for other general corporate purposes.\n(4) Proceeds were used to repay short-term debt, which had been previously used to finance certain assets, including the CSW headquarters building in Dallas, Texas.\nShelf Registration Statements The Electric Operating Companies expect to obtain a majority of their 1995 capital requirements from internal sources, but may issue additional securities subject to market conditions and other factors. CPL and WTU have filed shelf registration statements with the SEC for the sale of securities. The amount available for issuance by company and the date filed with the SEC follow:\nFirst Mortgage Bonds Preferred Stock Amount Date Filed Amount Date Filed Available Available (millions) (millions) CPL $260 1993 $75 1994\nWTU $20 1993\nThe Operating Companies may issue additional debt securities subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost FMBs, to lower the embedded cost of debt, to repay short-term debt, to provide working capital and for other general corporate purposes.\n2-15 The Electric Operating Companies may issue additional preferred stock subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost preferred stock and to repay short-term debt.\nShort-Term Financing The Electric Operating Companies utilize short-term debt to meet fluctuations in working capital requirements due to the seasonal nature of electric sales. The CSW System has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million to back up the CSW commercial paper program.\nThe maximum amount of consolidated short-term debt outstanding in 1994 was $1,618 million in September 1994, which represented 26% of the total capitalization at December 31, 1994. The average amount of short-term debt during 1994 was $1,455 million, of which $694 million was attributable to CSW Credit. The weighted average cost of short- term debt was 4.5% in 1994. Short-term debt outstanding increased due to continued expenditures for corporate initiatives, including investments in CSWE.\nAcquisitions To meet its strategic goals, CSW will continue to search for electric utility companies or other electric utility properties to acquire and will continue evaluating opportunities to pursue energy related non-utility businesses. For any major acquisition, additional funds from the capital markets, including the issuance of CSW Common in underwritten public offerings, in the acquisition transaction itself, or otherwise, may be required.\nFor a discussion of circumstances under which CSW may issue additional shares of common stock in connection with the proposed acquisition of El Paso, see Proposed Acquisition of El Paso, above.\nDividend Reinvestment Plan The PowerShare dividend reinvestment plan is available to all CSW stockholders, employees, eligible retirees, utility customers and other residents of the four states where the Electric Operating Companies operate. Plan participants are able to make optional cash payments and reinvest all or any portion of their dividends in CSW Common. During 1994 CSW raised approximately $50 million in new equity through the PowerShare plan.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. The Electric Operating Companies utilize short-term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. Information concerning internally generated funds follows:\n1994 1993 1992 (millions) Internally Generated Funds $424 $369 $374\nCapital expenditures, Acquisitions, CSWE Equity Investments Provided by Internally Generated Funds 63% 58% 82%\nCSWE and CSWI At December 31, 1994, CSW had loaned $221 million to CSWE on an interim basis for the purpose of developing and constructing independent power and cogeneration facilities. Repayment of these amounts to CSW is expected to be made through funds obtained from third party non-recourse project financing. In late February 1994, CSWE closed permanent project financing for its 50% owned Mulberry facility, which is described below, and repaid $94 million of the interim financing provided by CSW. In March 1995, CSWE closed permanent project financing for its Ft. Lupton facility, which is described below, and repaid $102 million of the interim financing provided by CSW. In addition to the amounts already expended in 1994 for the development of projects, CSWE and CSWI have general authority from the SEC to expend up to $242 million and $399 million, respectively, on future projects.\nCSW Credit CSW Credit purchases, without recourse, the accounts receivable of the Operating Companies and certain non-affiliated electric companies. CSW Credit's capital structure contains greater leverage than that of the Operating Companies, consequently lowering CSW's cost of capital.\nCSW Credit issues commercial paper, secured by the assignment of its receivables, to meet its financing needs. CSW Credit maintains a secured revolving credit agreement which aggregated $900 million at December 31, 1994 to back up its commercial paper program.\nThe sale of these accounts receivables provides the Operating Companies with cash immediately, thereby reducing working capital needs and revenue requirements.\nRecent Developments and Trends\nCompetition and Industry Challenges Competitive forces at work in the electric utility industry are impacting the CSW System and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, the Electric Operating Companies will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. The Electric Operating Companies believe that their prices for electricity and the quality and reliability of their service currently place them in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While CSW believes that the Energy Policy Act will continue to make the wholesale markets more competitive, CSW is unable to predict the extent to which the Energy Policy Act will impact CSW System operations.\nIncreasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nThe Electric Operating Companies also compete with suppliers of alternative forms of energy, such as natural gas, fuel oil and coal, some of which may be cheaper than electricity. The Electric Operating Companies believe that their prices and the quality and reliability of\n2-17 their service currently places them in a position to compete effectively in the marketplace.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. The Electric Operating Companies compete in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities, but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers. In 1993, PSO and SWEPCO filed with the FERC tariffs under which they make available firm and non-firm transmission services for other electric utilities on the combined PSO and SWEPCO transmission systems in the Southwest Power Pool. The FERC accepted the tariffs for filing on November 9, 1993. In the event the FERC approves the Merger between CSW and El Paso and denies CSW's request for rehearing wherein CSW asked FERC to reconsider the imposition of a comparable service requirement, these tariffs could be superseded by a set of compliance tariffs which offer point-to-point and network transmission service on terms and conditions comparable to CSW's and El Paso's use of their own transmission systems. As discussed, compliance tariffs could expose the merged CSW System to additional risks of loss of load from current requirements wholesale customers purchasing power from alternative suppliers or reduced revenue resulting from competition with alternative suppliers of electric power.\nCSW and the Electric Operating Companies believe that, compared to other electric utilities, the CSW System is well positioned to meet future competition. The CSW System benefits from economies of scale and scope by virtue of its size and is a relatively low-cost producer of electric power. Moreover, CSW is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nCSW is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or the CSW System. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\nPublic Utility Regulatory Act PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. CSW is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted. If, however, the Texas Legislature passes legislation permitting any form of retail wheeling, such legislation could have an adverse impact on CPL and CPL's sales to its retail customers.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, the Electric Operating Companies have recognized significant regulatory assets and liabilities. Management believes that the Electric Operating Companies will continue to meet the criteria for following SFAS No. 71. However, in the event the Electric Operating Companies no longer meet the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE\n2-18 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nHolding Company Act The Holding Company Act generally has been construed to limit the operations of a registered holding company to a single integrated public utility system, plus such additional businesses as are functionally related to such system. Among other things, the Holding Company Act requires CSW and its subsidiaries to seek prior SEC approval before effecting mergers and acquisitions or pursuing other types of non-utility initiatives. Pervasive regulation under the Holding Company Act may impede or delay CSW's efforts to achieve its strategic and operating objectives, including its pursuit of non- utility initiatives. CSW is continuing its efforts to repeal or modify the Holding Company Act in order to provide the flexibility to compete within the changing environment.\nConsolidated Taxes The Texas Commission before 1992 allowed income taxes to be recovered in rates based on the federal income tax incurred by a utility as if it were a stand-alone company. This stand-alone approach treated the regulated activities of a utility as a separate entity and considered only those revenues and expenses that are included in the utility's cost of service to calculate the federal income tax liability for ratemaking purposes.\nBeginning in 1992, the Texas Commission changed its method of calculating the federal income tax component of rates to the \"actual tax approach.\" The actual tax approach is an evolving concept but generally seeks to reflect in rates the actual tax liability of the utility irrespective of its relationship to the utility's cost of service. The approach reduces rates by the tax benefits of deductions which are not considered for or included in setting rates for the utility.\nThe Texas Commission is expected to use the actual tax approach for calculating the recovery of federal income tax in the pending rate cases for CPL and WTU. The impact of the actual tax approach on the prospective rates for CPL and WTU cannot be determined since the application of the concept is unsettled.\nCSW believes that the recovery of federal income taxes in rates should be determined on the stand-alone approach for ratemaking purposes, but there is no assurance this approach will be adopted in the pending CPL or WTU rate cases or the pending El Paso rate and Merger cases.\nEnvironmental Matters CERCLA and Related Matters The operations of the CSW System, like those of other utility systems, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nThe Electric Operating Companies are subject to various pending claims alleging that they are PRPs under federal or state remedial laws for investigating and cleaning up contaminated property. CSW anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on CSW's consolidated results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by the Electric Operating Company, the estimated amount of costs allocated to the Electric Operating Company and the participation of other parties.\n2-19 MGPs Contaminated former MGPs are a type of site which utilities, and others, may have to remediate in the future under Superfund or other federal or state remedial programs. Gas was manufactured at MGPs from the mid-1800s to the mid-1900s. In some cases, utilities and others have faced potential liability for MGPs because they, or their alleged predecessors, owned or operated the plants. In other cases, utilities or others may have been subjected to such liability for MGPs because they acquired MGP sites after gas production ceased.\nSuspected MGP Site in Marshall, Texas SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO has accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\nSuspected MGP Site in Texarkana, Texas and Arkansas and Shreveport, Louisiana SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\nBiloxi, Mississippi MGP Site SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nManagement does not expect these matters to have a material effect on CSW's consolidated results of operations or financial condition.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, the Electric Operating Companies will be required to hold allowances in order to emit sulfur dioxide. EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, CSW believes that the Electric Operating Companies' allowances will be adequate to meet their needs at least through 2008. Public and private markets are developing for trading of excess allowances. CSW presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states. CSW estimates that it and the Electric Operating Companies will incur approximately $500,000 to prepare permit applications for the program.\n2-20 The Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on CSW cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, CSW expects to spend an additional $4 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects or damage to the environment. Although a few of the studies to date have suggested certain associations between EMFs and some types of adverse health effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. CSW cannot predict the impact on the CSW System or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nSee NOTE 10, Litigation and Regulatory Proceedings, for additional discussion of environmental issues.\nNon-Utility Initiatives As indicated above, one component of CSW's four-part strategy to meet the increasing competition and fundamental changes in the electric utility industry is to expand CSW's non-utility business. CSW continues to consider new business opportunities to expand its energy related business. CSW's principal non-utility businesses are Transok and CSWE. As discussed below, CSW recently formed CSWI to seek opportunities internationally for investment in non-utility generation. CSW Communications was formed to provide a communications network for the CSW System as well as third parties. While CSW believes that non-utility initiatives are necessary to maintain its competitiveness and to grow in the future, there can be no assurance as to the level of success that will be attained in these initiatives.\nTransok Transok is an intrastate natural gas gathering, transmission, marketing and processing company that provides natural gas services to CSW System companies, predominately PSO, and to non-affiliated gas customers throughout the United States. Transok's natural gas facilities are located in Oklahoma, Louisiana and Texas. It operates gas processing plants and markets natural gas liquids produced from those plants to various markets.\nCSWE CSWE, a wholly-owned subsidiary of CSW, is authorized to develop various independent power and cogeneration facilities and to own and operate such non-utility projects, subject to further regulatory approvals. CSWE has an approximate 50% interest in the Brush, Ft. Lupton and Mulberry facilities which achieved commercial operation in 1994.\nBrush The 68 MW Brush project, located in Brush, Colorado, achieved commercial operation in January 1994, and provides steam and hot water to a 15-acre greenhouse and sells electricity to Public Service Company of Colorado.\nFt. Lupton The Ft. Lupton project, located in Colorado, provides steam and hot water to a 20-acre greenhouse and also sells electricity to Public Service Company of Colorado. Phase I of the Ft. Lupton project, representing 122 MWs, achieved commercial operation in June 1994. Phase II of the project commenced operations in July 1994 bringing total on-line capacity of the project to 272 MWs.\n2-21 Mulberry The Mulberry facility, a 117 MW gas-fired cogeneration plant in Polk County, Florida achieved commercial operation in August 1994 and provides steam to a combined distilled water and ethanol facility and sells electricity to Florida Power Corporation and Tampa Electric Company.\nOrange Cogen The Orange Cogen facility, in which CSWE holds a 50% interest, is expected to commence operation in June 1995. The 103 MW, gas-fired plant in Florida will provide thermal energy to an orange juice processor and will sell electricity to Florida Power Corporation and Tampa Electric Company. CSWE's O&M division plans to operate the plant.\nOther Projects In addition to these projects, CSWE has 19 other projects totaling more than 5,000 MW in various stages of development, mostly in affiliation with other developers. CSWE can provide no assurances that these projects, which are subject to further negotiations and regulatory approvals, will be commenced or completed and, if they are completed, that they will provide the anticipated return on investment.\nCSWI In November 1994, CSWI, a wholly-owned subsidiary of CSW, was formed to engage in international activities including developing, acquiring, financing and owning the securities of exempt wholesale generators and foreign utility companies.\nIn 1994, CSWI continued with the Mexico initiative that began in 1992. CSWI's goal is to participate in providing Mexico's future electricity needs. The geographical location of the CSW System offers opportunities to provide bulk power sales to Mexico. The Mexico City office of CSW, opened in 1993, allows CSWI greater access to key Mexican markets, permitting CSWI to more readily evaluate opportunities as they become available. However, the recent devaluation of the Mexican peso will slow previously projected power demand for the near-term.\nCSW Communications In July 1994, CSW Communications, a wholly-owned subsidiary, of CSW, was formed to provide communication services to the CSW System and non-affiliates. One important goal of CSW Communications is to enhance services to CSW System customers through fiber optics and other telecommunications technologies. CSW Communications will consolidate the future design, construction, maintenance and ownership of the CSW System's telecommunications networks. In 1994, CSW announced a $9 million project in Laredo, Texas, to install fiber optic lines and coaxial cable to CPL residential customers who have volunteered to take part in this pilot program. This project involving CSW Communications and CPL will demonstrate the energy efficiency and cost savings that result from giving customers greater choice and control over their electric service. These energy- efficiency services will use only a portion of the capacity of the telecommunications lines CSW Communications is installing. In the future, CSW Communications may, subject to any required regulatory approvals, seek to lease the remaining capacity for other services including possibly telephone service, cable television and home security systems.\nResults of Operations\nOverview Of Results CSW's earnings increased to $394 million or $2.08 per share in 1994 as compared to $308 million or $1.63 per share in 1993 and $382 million or $2.03 per share in 1992. The return on average common stock equity was 13.4% in 1994 compared to 10.6% in 1993 and 13.5% in 1992. Electric operations contributed approximately 100% of total earnings in 1994 and 1993, and 95% in 1992. In 1994, earnings at Transok, CSWE, and CSW Credit totaling $34 million, were offset by corporate expenditures including merger and acquisition activities and the formation of two new subsidiaries.\n2-22 Earnings increased in 1994 compared to 1993 due primarily to higher KWH sales and natural gas operations and decreased costs associated with the end of the outage at STP. In addition, CSWE, which had three projects become operational during 1994, contributed $2 million to earnings. These items were partially offset by increased interest and depreciation and amortization expense. Earnings in 1993 were significantly affected by several items described below:\n(millions,after-tax) Restructuring charges $(63) Recognition of unbilled revenues 49 Early adoption of SFAS No. 112 (9) Adoption of SFAS No. 109 6 Establishment of reserves for fuel and other properties (11) Prior year tax adjustments (18)\nIn addition to the aforementioned items, earnings in 1993 were below 1992 levels due to additional costs primarily associated with the outage at STP, higher benefit costs as a result of the adoption of SFAS No. 106, higher taxes other than income as a result of school funding tax increases in Texas, and the increase in the federal income tax rate from 34% to 35%. These items were partially offset by higher KWH sales in 1993 due primarily to more normal weather than was experienced in 1992.\nOperating Revenues Revenues decreased 2% in 1994, after increasing 12% in 1993 and 8% in 1992 from the previous years due to the following items:\nRevenue Increase (Decrease) From Prior Year 1994 1993 1992 (millions) Base rate changes $ 7 $ 8 $ -- Fuel costs (49) 168 -- KWH sales 61 93 (25) Natural gas (85) 107 255 Other electric and 2 22 12 diversified $(64) $398 $242\nElectric Revenues Electric revenues increased $10 million in 1994 compared to 1993. Total KWH sales increased approximately 6%, with increases in sales among all customer classes. During 1994, the average number of customers increased approximately 2%. In addition to customer growth, there was slightly more favorable weather during 1994 as compared to 1993. However, offsetting much of the increases in revenue due to KWH sales, fuel revenues were down substantially during 1994 compared to 1993. Fuel costs incurred in the generation of electricity are typically passed through to the customers, so decreases in fuel costs will cause a corresponding decrease in fuel revenues. Fuel costs, which decreased during 1994, are more fully discussed below under Fuel and Purchased Power. Fuel revenues increased in 1993 compared to 1992 due to higher per unit costs of fuel and purchased power.\n2-23 Base rates increased slightly at PSO because of changes in retail customers' rates, and decreased due to a 3.2% interim rate reduction at WTU implemented during the fourth quarter of 1994. Because PSO's increased base rates, finalized in December 1993, were not significantly higher than the interim rates that had been in effect throughout the year, base rates had little overall change from 1993. As part of a stipulated agreement reflecting its rate increase, PSO agreed that it will not file for an increase in base rates until after June 30, 1995. During late 1993 and early 1994, several parties initiated actions, which, if approved, would lower CPL's base rates. The review of CPL's rates arose out of the unscheduled outage at STP as discussed above under the heading Rates and Regulatory Matters, CPL Rate Inquiry.\nFor additional information on these proceedings and others, see NOTE 10, Litigation and Regulatory Proceedings.\nThe percentage changes in KWH sales for the three years were as follows:\nKWH Sales Increase (Decrease) From Prior Year 1994 1993 1992 Residential 2.9% 9.0% (4.2)% Commercial 3.8 4.8 (1.1) Industrial 3.6 5.5 3.1 Sales for resale 21.9 (6.6) 5.4 Total sales 5.5 4.9 0.1\nKWH sales to retail customers increased in 1994 and 1993 as a result of more favorable weather and increased residential customers. In addition, KWH sales grew in all of the other customer classes. SWEPCO acquired BREMCO in July 1993, and accordingly, there were twelve months of KWH sales to these customers in 1994 compared to only six months in 1993. Weather was more favorable in 1994 than in 1993, while extremely mild weather was experienced in 1992. The continued increases in industrial sales over the last three years reflect the increased marketing efforts by the Electric Operating Companies and the continued improvement in the economy throughout their service areas. Sales for resale increased in 1994 because STP was operational for most of the year, whereas in 1993, plants in the CSW System were producing power to replace the power normally produced at STP.\nThe Electric Operating Companies have maintained competitive rates in an increasingly competitive marketplace. Efforts have increased at each of the Electric Operating Companies to attract new customers while efficiently serving all customers. Economic conditions in the service areas of the Electric Operating Companies are expected to continue to improve in 1995.\nNatural Gas Revenues Revenues from natural gas decreased 14% in 1994 due primarily to a decrease in the price of gas, even though total natural gas volumes increased 4% from 1994 to 1993. However, lower gas sales prices were mitigated by lower gas purchase prices, which are described below under Gas Purchased for Resale. The lower gas sales revenues were partially offset by both increased gathering and transportation revenues and increased natural gas liquids processing revenues. Gathering and transportation sales volumes increased 12% primarily as a result of a pipeline extension completed during 1994, and gas liquids processing volumes increased 12% during 1994. Revenues from natural gas increased 22% in 1993 from 1992 due primarily to an increase in sales volumes and to a lesser extent an increase in sales prices. A portion of this increase is attributable to the acquisition of the NGC Anadarko Gathering System in 1993. Revenue increases in 1993 from natural gas liquids are due to increased sales volumes combined with slightly higher prices.\n2-24 Other Diversified Revenues Other diversified revenues increased 38% from 1994 as compared to 1993 due to the reclassification of CSWE's operating revenues more fully discussed below under Other Income and Deductions. Other diversified revenues increased substantially in 1993 as compared to 1992 because CSW Credit began factoring the receivables of a significant non-affiliated utility in January 1993.\nFuel and Purchased Power Expense During 1994, the Electric Operating Companies generated approximately 95% of their electric energy requirements. During 1993 and 1992, they generated 92% and 94%, respectively. Total fuel and purchased power expenses decreased 4% during 1994 due to a decrease in fossil fuel costs and increased usage of lower cost nuclear fuel. The average unit cost of fuel was $1.82 during 1994, compared to $2.11 and $1.92 for 1993 and 1992, respectively. Several contracts with major fuel suppliers and carriers have been recently renegotiated. These settlements have contributed to the lower cost of fuel. In addition, because STP restarted and Units 1 and 2 reached 100% capacity in April and June of 1994, respectively, lower cost nuclear fuel was utilized, whereas the 1993 outage required higher cost energy purchases to replace STP's nuclear power. The increase in fuel and purchased power expense in 1993 compared to 1992 is attributable to higher natural gas costs as well as the cost of STP replacement power.\nGas Purchased for Resale\/Gas Extraction and Marketing Gas purchased for resale decreased 30% in 1994 from 1993, while it increased 29% in 1993 from 1992. Lower gas prices caused the decrease in 1994, including a significant portion attributable to sales made on natural gas drawn from storage. Increased natural gas prices and increased pipeline capacity from Transok's recent acquisitions caused the 1993 increase. Gas extraction and marketing expenses increased 14% in 1994 from 1993 and 19% in 1993 from 1992 due to higher input costs associated with higher natural gas liquids processing volumes.\nOther Operating and Maintenance Expenses and Taxes Other operating and maintenance expenses decreased 8% in 1994 compared to 1993, due primarily to the absence of expenses that were incurred during the 1993 STP outages. In 1993, in addition to $29 million in maintenance costs associated with the STP outage, operating expenses increased compared to 1992 due to expenses associated with the adoption of SFAS 106, reserves taken on lignite and other property, corporate expenditures, and other administrative and general expenses. Federal income taxes were higher in 1994 than 1993 due to higher pre-tax income. Federal income taxes were lower in 1993 than 1992 due to lower pre-tax income offset in part by tax adjustments and the increase in the corporate tax rate from 34% to 35%, which was effective retroactive to January 1, 1993. Taxes other than federal income remained comparable in 1994 from 1993, while they increased in 1993 compared to 1992 due to school funding tax increases in Texas.\nRestructuring Charges In 1994, the original restructuring accrual of $97 million that had been recorded in 1993 was reduced by $9 million. Accordingly, the final costs associated with the CSW System's restructuring totaled $88 million over the two year period. For additional information on CSW's restructuring, see Restructuring, above.\nDepreciation and Amortization Depreciation and amortization expense increased in 1994 compared to 1993 and also 1993 compared to 1992 as a result of increases in depreciable plant.\nInflation Annual inflation rates, as measured by the national Consumer Price Index, have averaged about 2.7% during the three years ended December 31, 1994. Management believes that inflation, at these levels, does not materially affect CSW's consolidated results of operations or financial position. However, under existing regulatory practice, only the historical cost of plant is recoverable from\n2-25 customers. As a result, cash flows designed to provide recovery of historical plant costs may not be adequate to replace plant in future years.\nOther Income and Deductions Other income and deductions increased $18 million or 19% in 1994 compared to 1993, as a result of the reclassification of CSWE's operating activities offset partially by decreased Mirror CWIP liability amortization and the absence of adjustments recorded in 1993 associated with Transok's 1991 acquisition of TEX\/CON. Prior to 1994, CSWE was in the developmental stage of its business, so its operating activities were classified in CSW's Other Income and Deductions. However, in conjunction with the completion of three projects in 1994, CSWE's revenues and expenses were classified as operating activities in CSW's Other Diversified Revenues and Other Operating Expenses. Both of these components had negative earnings impacts classified in Other Income and Deductions in 1993. Other Income and Deductions increased $11 million or 13% in 1993 from 1992 due in part to Transok's aforementioned TEX\/CON acquisition adjustments and slightly higher Allowance for Equity Funds Used During Construction partially offset by decreased Mirror CWIP liability amortization.\nInterest Expense Interest expense on long-term debt in 1994 was comparable to 1993, whereas 1993 interest expense was substantially lower than 1992 due to long-term debt refinancings, which lowered CSW's embedded cost of long-term debt from 8.3% in 1992 to 7.8% in 1993. CSW's embedded cost of long-term debt decreased slightly to 7.7% in 1994. Short-term interest expense increased in 1994 due primarily to higher short-term interest rates combined with higher general corporate borrowings, and in 1993 because of increased borrowings attributable to the expansion of CSW Credit's business, interim financing of CSWE's projects, and various corporate initiatives.\nCumulative Effect of Changes in Accounting Principles In 1993, CSW implemented SFAS No. 112, SFAS No. 109, and changed the method of accounting for unbilled revenues. These changes had a cumulative effect of increasing net income approximately $46 million.\n2-26 Consolidated Statements of Income Central and South West Corporation For the Years Ended December 31, 1994 1993 1992 Operating Revenues (millions, except per share amounts) Electric Residential $1,156 $1,160 $1,046 Commercial 836 832 773 Industrial 733 736 659 Sales for resale 204 179 177 Other 136 148 135 Total Electric 3,065 3,055 2,790 Gas 518 603 496 Other diversified 40 29 3 3,623 3,687 3,289 Operating Expenses and Taxes Fuel and purchased power 1,161 1,209 1,035 Gas purchased for resale 276 396 306 Gas extraction and marketing 98 86 72 Other operating 596 593 490 Restructuring charges (9) 97 -- Maintenance 176 197 170 Depreciation and amortization 356 330 311 Taxes, other than federal income 196 197 175 Federal income taxes 179 125 142 3,029 3,230 2,701 Operating Income 594 457 588\nOther Income and Deductions Mirror CWIP liability amortization 68 76 83 Other 43 17 (1) 111 93 82 Income Before Interest Charges 705 550 670\nInterest Charges Interest on long-term debt 218 219 230 Interest on short-term debt and other 75 50 36 293 269 266 Income Before Cumulative Effect of Changes in Accounting Principles 412 281 404\nCumulative Effect of Changes in -- 46 -- Accounting Principles\nNet Income 412 327 404 Preferred stock dividends 18 19 22 Net Income for Common Stock $394 $308 $382\nAverage Common Shares Outstanding 189.3 188.4 188.3 Earnings per Share of Common Stock before Cumulative Effect of Changes in Accounting Principles $ 2.08 $ 1.39 $ 2.03 Cumulative Effect of Changes in Accounting Principles -- .24 -- Earnings per Share of Common Stock $ 2.08 $ 1.63 $ 2.03 Dividends Paid per Share of Common Stock $ 1.70 $ 1.62 $ 1.54\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nConsolidated Statements of Retained Earnings Central and South West Corporation For the Years Ended December 31, 1994 1993 1992 (millions)\nRetained Earnings at Beginning of Year $1,753 $1,751 $1,659 Net income for common stock 394 308 382 Deduct: Common stock dividends 323 306 290 Retained Earnings at End of Year $1,824 $1,753 $1,751\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-28 Consolidated Balance Sheets Central and South West Corporation As of December 31, 1994 1993 (millions) ASSETS Plant Electric utility Production $ 5,802 $ 5,775 Transmission 1,377 1,228 Distribution 2,539 2,362 General 764 709 Construction work in progress 412 361 Nuclear fuel 161 160 Total Electric 11,055 10,595 Gas 798 738 Other diversified 15 10 11,868 11,343 Less - Accumulated depreciation 3,870 3,550 7,998 7,793 Current Assets Cash and temporary cash investments 27 62 Special deposits -- 2 Accounts receivable 761 801 Materials and supplies, at average cost 162 149 Electric utility fuel inventory, substantially at average cost 118 102 Gas inventory\/products for resale 23 24 Unrecovered fuel costs 54 70 Prepayments and other 44 44 1,189 1,254 Deferred Charges and Other Assets Deferred plant costs 516 518 Mirror CWIP asset 322 332 Other non-utility investments 394 266 Income tax related regulatory assets, net 216 182 Other 274 259 1,722 1,557 $10,909 $10,604\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-29 Consolidated Balance Sheets Central and South West Corporation As of December 31, 1994 1993 (millions) CAPITALIZATION AND LIABILITIES Capitalization Common stock: $3.50 par value Authorized: 350 million shares Issued and outstanding: 190.6 million shares in 1994 and 188.4 million shares in 1993 $ 667 $ 659 Paid-in capital 561 518 Retained earnings 1,824 1,753 Total Common Stock Equity 3,052 2,930 Preferred stock Not subject to mandatory redemption 292 292 Subject to mandatory redemption 35 58 Long-term debt 2,940 2,749 Total Capitalization 6,319 6,029 Current Liabilities Long-term debt and preferred stock due within twelve months 7 26 Short-term debt 910 769 Short-term debt - CSW Credit 573 641 Accounts payable 286 313 Accrued taxes 111 90 Accrued interest 61 55 Accrued restructuring charges 4 97 Other 155 152 2,107 2,143 Deferred Credits Income taxes 2,048 1,935 Investment tax credits 320 335 Mirror CWIP liability and other 115 162 2,483 2,432 $10,909 $10,604\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-30 Consolidated Statements of Cash Flows Central and South West Corporation For the Years Ended December 31, 1994 1993 1992 (millions) OPERATING ACTIVITIES Net Income $ 412 $ 327 $ 404 Non-cash Items Included in Net Income Depreciation and amortization 402 366 351 Deferred income taxes and investment tax credits 87 94 71 Mirror CWIP liability amortization (68) (76) (83) Restructuring charges (9) 97 -- Cumulative effect of changes in accounting principles -- (46) -- Changes in Assets and Liabilities Accounts receivable 29 (52) (52) Unrecovered fuel costs 16 (63) (4) Accounts payable (27) 34 53 Accrued taxes 21 37 (41) Accrued restructuring charges (57) -- -- Other (42) (24) (13) 764 694 686 INVESTING ACTIVITIES Capital expenditures (578) (508) (422) Acquisitions (21) (106) (27) Non-affiliated accounts receivable collections (purchases), net 11 (314) 11 CSW Energy projects (includes $73, $19 and $8 of equity investments for 1994, 1993 and 1992, respectively) (115) (127) (37) Other (14) (14) (8) (717) (1,069) (483) FINANCING ACTIVITIES Common stock sold 50 1 2 Proceeds from issuance of long-term debt 199 904 1,009 Retirement of long-term debt (4) (50) (4) Reacquisition of long-term debt (27) (987) (652) Special deposits for reacquisition of long-term debt -- 199 (199) Redemption of preferred stock (33) (17) (13) Change in short-term debt 73 602 17 Payment of dividends (340) (325) (312) (82) 327 (152)\nNet Change in Cash and Cash Equivalents (35) (48) 51 Cash and Cash Equivalents at Beginning of Year 62 110 59 Cash and Cash Equivalents at End of Year $ 27 $ 62 $ 110\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 280 $ 260 $ 268 Income taxes paid $ 93 $ 53 $ 108\nThe accompanying notes to consolidated financial statements integral part of these statements.\n2-31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation CSW is subject to regulation by the SEC as a registered holding company under the Holding Company Act. CSW's Operating Companies are also regulated by the SEC under the Holding Company Act. CSW's four Electric Operating Companies, Central Power and Light Company, Public Service Company of Oklahoma, Southwestern Electric Power Company, and West Texas Utilities Company, are subject to regulation by the FERC under the Federal Power Act and follow the Uniform System of Accounts prescribed by the FERC. The Operating Companies are subject to further regulation with regard to rates and other matters by state regulatory commissions.\nCSW Credit CSW Credit, as a wholly-owned subsidiary of CSW, purchases, without recourse, the billed and unbilled accounts receivable of the Operating Companies and certain non-affiliated companies.\nThe more significant accounting policies of CSW and its subsidiaries are summarized below:\nPrinciples of Consolidation The consolidated financial statements include the accounts of CSW and its subsidiary companies. All significant intercompany items and transactions have been eliminated.\nPlant 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. Transok's gas plant acquisitions are stated at fair market value based on the purchase price while other gas plant is stated at original cost of construction, which includes the cost of contracted services, direct labor, materials, overhead items and capitalized interest.\nDepreciation Provisions for depreciation of plant are computed using the straight-line method, generally at individual rates applied to the various classes of depreciable property. The annual average consolidated composite rate was 3.2% for 1994, 1993 and 1992.\nNuclear Decommissioning At the end of STP's service life, decommissioning is expected to be accomplished using the decontamination method, which is one of the techniques acceptable to the NRC. Using this method, the decontamination activities occur as soon as possible after the end of plant operations. Contaminated equipment is cleaned or removed to a permanent disposal location and the site is generally returned to its pre-plant state.\nCPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning, and is net of expected earnings on the trust fund.\nCPL's portion of the costs of decommissioning STP were estimated to be $85 million in 1986 dollars based on a site specific study completed in 1986. CPL is recovering these decommissioning costs through rates based on the service life of STP at a rate of $4.2 million per year. The $4.2 million annual cost of decommissioning is reflected on the income statement in other operating expense. Decommissioning costs are paid to an irrevocable external trust\n2-32 and as such are not reflected on CPL's balance sheet. At December 31, 1994, the trust balance was $19.3 million.\nIn May 1994, CPL received a new decommissioning study updating the cost estimates to decommission STP that indicated that CPL's share of such costs would increase from $85 million, as stated in 1986 dollars, to $251 million, as stated in 1994 dollars. The increase in costs occurred primarily as a result of extended on-site storage of high level waste, much higher estimates of low-level waste disposal costs and increased labor costs since the prior study. These costs are expected to be incurred during the years 2027 through 2062. While this is the best estimate available at this time, these costs may change between now and when the funds are actually expended because of changes in the assumptions used to derive the estimates, including the prices of the goods and services required to accomplish the decommissioning. Additional studies will be completed periodically to update this information.\nBased on this projected cost to decommission STP, CPL estimates that its annual funding level should increase to $10.0 million. CPL has requested this amount as part of its cost of service in its current rate filing. Other parties to the rate proceeding have filed their projections of the annual amount, which have ranged from $4.5 million to $8.1 million. CPL expects to fund at the level ultimately ordered by the Texas Commission although CPL cannot predict what that level will be. Historically, the Texas Commission has allowed full recovery of nuclear decommissioning costs. For further information on CPL's current rate filing, see NOTE 10, Litigation and Regulatory Proceedings - Texas Commission Proceedings, below.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, the Electric Operating Companies changed their method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 net income was pre-tax increase of $75 million, and an after-tax increase of $49 million, included in cumulative effect of changes in accounting principles.\nCPL, SWEPCO and WTU recover fuel costs in Texas as a fixed component of base rates whereby over-recoveries of fuel are payable to customers and under-recoveries may be billed to customers after Texas Commission approval. The cost of fuel is charged to expense as consumed. See NOTE 10, Litigation and Regulatory Proceedings, for further information about fuel recovery.\nPSO recovers fuel costs in Oklahoma and SWEPCO recovers fuel costs in Arkansas and Louisiana through automatic fuel recovery mechanisms. The application of these mechanisms varies by jurisdiction.\nEach of the Electric Operating Companies recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause.\nCPL amortizes the costs of nuclear fuel 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.\nAccounts Receivable Each of the Operating Companies sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities For their regulated activities, each of the Electric Operating Companies follows SFAS No. 71 which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to the company associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities\n2-33 represent probable future refunds to customers. At December 31, 1994 and 1993, the CSW System had recorded the following significant regulatory assets and liabilities:\n1994 1993 (millions) Regulatory Assets Deferred plant costs $516 $518 Mirror CWIP asset 322 332 Income tax related regulatory assets, net 216 182 Unrecovered fuel costs 54 70 Other 33 34\nRegulatory Liabilities Mirror CWIP liability 41 109\nDeferred Plant Costs In accordance with orders of the Texas Commission, WTU and CPL deferred operating, depreciation and tax costs incurred for Oklaunion Power Station Unit 1 and STP, respectively. These deferrals were for the period beginning on the date when the plants began commercial operation until the date the plants were included in rate base. The deferred costs are being amortized and recovered through rates over the lives of the respective plants. See NOTE 10, Litigation and Regulatory Proceedings, for further discussion of WTU's and CPL's deferred accounting proceedings.\nMirror CWIP In accordance with Texas Commission orders, CPL previously recorded a Mirror CWIP asset, which is being amortized over the life of STP. For more information regarding Mirror CWIP, reference is made to NOTE 10, Litigation and Regulatory Proceedings. Statements 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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, the CSW System adopted SFAS No. 106, SFAS No. 112 and SFAS No. 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, the Electric Operating Companies also changed their method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in 1993 operating expenses of $16 million. The adoption of SFAS No. 109, SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\n2-34 Pre-Tax Tax Net Income EPS CSW Effect Effect Effect Effect (millions, except EPS) SFAS No. 109 $ -- $ 6 $ 6 $0.03 SFAS No. 112 (13) 4 (9) (0.05) Unbilled revenues 75 (26) 49 0.26 Total $62 $(16) $46 $0.24\nPro 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 The CSW System adopted the provisions of SFAS No. 109 effective January 1, 1993. The net effect on CSW's earnings was a one-time adjustment to increase net income by $6 million or $0.03 per share. This adjustment was recorded as a cumulative effect of change in accounting principle. The benefit was attributable to the reduction in deferred taxes associated with CSW's non-utility operations previously recorded at rates higher than current rates.\nFor utility operations, there were no material effects of SFAS No. 109 on CSW's earnings. As a result of this change, CSW recognized additional accumulated deferred income taxes from its utility operations and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, the CSW System did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\nCSW files a consolidated federal income tax return and participates in a tax sharing agreement with its subsidiaries. The components of income taxes follow:\n1994 1993 1992 Included in Operating Expenses and Taxes (millions) Current $ 88 $ 28 $ 64 Deferred 105 112 95 Deferred ITC (14) (15) (17) 179 125 142 Included in Other Income and Deductions Current (14) (3) (7) Deferred (4) (5) 7 (18) (8) --\nTax effects of cumulative effect of changes in Accounting Principles -- 14 -- -- 14 -- $161 $131 $142\n2-35 Investment tax credits deferred in prior years are included in income over the lives of the related properties. Total income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow:\n1994 % 1993 % 1992 % (dollars in millions) Tax at statutory rates $201 35 $160 35 $186 34 Differences Amortization of ITC (14) (2) (15) (3) (15) (3) Mirror CWIP (20) (4) (23) (5) (25) (4) Prior period adjustments -- -- 18 4 (10) (2) Cumulative effect of change in method of accounting for income taxes Other -- -- (8) (2) -- -- (6) (1) (1) -- 6 1 $161 28 $131 29 $142 26\nThe significant components of the net deferred income tax liability follow: December 31, December 31, 1994 1993 (millions) Deferred Income Tax Liabilities Depreciable utility plant $ 1,683 $ 1,589 Deferred plant costs 181 181 Mirror CWIP asset 113 116 Income tax related regulatory assets 229 239 Other 262 234 Total Deferred Income Tax Liabilities 2,468 2,359\nDeferred Income Tax Assets Income tax related regulatory liability (155) (177) Unamortized ITC (115) (120) Alternative minimum tax carryforward (96) (68) Other (56) (65) Total Deferred Income Tax Assets (422) (430) Net Accumulated Deferred Income Taxes - Total $ 2,046 $ 1,929\nNet Accumulated Deferred Income Taxes - Noncurrent $ 2,048 $ 1,935 Net Accumulated Deferred Income Taxes - Current (2) (6) Net Accumulated Deferred Income Taxes - Total $ 2,046 $ 1,929\n2-36 3.Long-Term Debt The long-term debt of the Operating Companies outstanding as of the end of the last two years follow: Maturities Interest Rates December 31, From To From To 1994 1993 (millions) First mortgage bonds 1995 1999 5.25% 7.50% $443 $343 2000 2004 5.25% 7.75% 836 796 2005 2009 6.20% 7.75% 247 248 2010 2014 7.50% 7.50% 112 112 2015 2019 9.125% 9.75% 226 240 2020 2024 7.25% 7.50% 295 295 2025 2029 6.875% 6.875% 80 80\nPollution control bonds 2000 2004 6.90% 7.125% 21 21 2005 2009 5.90% 6.00% 83 83 2010 2014 7.875% 10.125% 231 231 2015 2019 7.60% 7.875% 114 114 2025 2029 6.00% 6.00% 120 120\nNotes and lease obligations 1996 2023 6.25% 9.75% 328 273 Unamortized discount (21) (22) Unamortized cost of reacquired debt (175) (185) $2,940 $2,749\nThe mortgage indentures, as amended and supplemented, securing first mortgage bonds issued by the Electric Operating Companies, constitute a direct first mortgage lien on substantially all electric utility plant.\nThe Operating Companies may offer additional first mortgage bonds and medium-term notes subject to market conditions and other factors.\nAnnual Requirements Certain series of outstanding first mortgage bonds have annual sinking fund requirements, which are generally 1% of the amount of each such series issued. These requirements may be, and generally have been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. Certain series of pollution control bonds also have sinking fund requirements. At December 31, 1994, the annual sinking fund requirements and annual maturities for first mortgage bonds and pollution control bonds for the next five years follow:\nSinking Fund Requirements Maturities (millions) 1995 $ 4 $ 9 1996 4 33 1997 4 207 1998 4 34 1999 4 98\n2-37 Dividends The subsidiary companies' mortgage indentures, as amended and supplemented, contain certain restrictions on the use of their retained earnings for cash dividends on their common stock. These restrictions do not limit the ability of CSW to pay dividends to its stockholders. At December 31, 1994, $1,375 million of the subsidiary companies' retained earnings were available for payment of cash dividends to CSW.\nReacquired Long-term Debt During 1994, 1993 and 1992, the Electric Operating Companies reacquired $27 million, $987 million and $652 million of long-term debt, respectively, including reacquisition premiums, prior to maturity. The premiums and related reacquisition costs and discounts are included in long-term debt on the consolidated balance sheets and are being amortized over 5 to 35 years, consistent with its expected ratemaking treatment.\nThe weighted average cost of long-term debt was 7.7% for 1994, 7.8% for 1993 and 8.3% for 1992.\nReference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, Liquidity and Capital Resources, for further information related to long-term debt, including new issues and reacquisition.\n4.Preferred Stock The outstanding preferred stock of the Electric Operating Companies as of the end of the last two years follow:\nCurrent 1994 Dividend Rate December 31, Redemption Prices Shares Outstanding From To 1994 1993 From To (millions) Not subject to mandatory redemption\n592,900 4.00% 5.00% 59 59 102.75 107.00 760,000 7.12% 8.72% 76 76 100.00 101.00 1,600,000 auction 160 160 100.00 100.00\nIssuance expenses and unamortized redemption costs (3) (3) $292 $292\nSubject to mandatory redemption 352,000 6.95% 6.95% $ 35 $ 37 104.64 104.64 -- 10.05% 10.05% -- 22 -- --\nIssuance expenses and unamortized redemption costs -- (1) $ 35 $ 58\nThe outstanding preferred stock not subject to mandatory redemption is redeemable at the option of the Electric Operating Companies upon 30 days notice at the current redemption price per share. CPL's auction preferred stock totaling $160 million also may be redeemed at par on any dividend payment date. The CSW System's authorized number of shares of preferred stock totaled 6.4 million at December 31, 1994 and 1993.\nRedemption prices of certain preferred stock decline at specified intervals in future periods. The preferred stock issues subject to mandatory redemption are refundable at various times during the period 1995 through 1999. The minimum annual sinking fund requirements of the preferred stock are $1.2 million for the years 1995 through 1999. During 1994 and 1993, the Electric Operating Companies redeemed $33 million and $17 million, respectively, of preferred stock, including redemption premiums.\n2-38 CPL The dividends on CPL's $160 million auction and money market preferred stocks are adjusted every 49 days, based on current market rates. The dividend rates averaged 3.5%, 2.7%, and 3.6% during 1994, 1993 and 1992.\nCPL retired its remaining 10.05% preferred stock during August 1994.\nWTU In July 1993, WTU redeemed 100,000 shares of its 7.25% Series, $100 par value, Preferred Stock, for $10 million, in accordance with mandatory and optional sinking fund provisions. The capital required for this transaction was provided by short-term borrowings from the CSW System money pool and internal sources.\nIn July 1994, WTU redeemed the remaining 47,000 shares of its 7.25% Series, $100 par value, Preferred Stock.\n5.Common Stock On March 6, 1992, CSW effected a two-for-one split of CSW's common stock by means of a 100% stock dividend paid to stockholders of record on February 10, 1992. All references to number of shares outstanding, to per share information in the Consolidated Financial Statements, and to the notes thereto have been adjusted to reflect the stock split on a retroactive basis.\nCSW has a restricted stock plan and a stock option plan. Under the stock option plan, 3,833,000 shares of common stock are available for grant and 491,000 shares are reserved for exercise of options which were outstanding at December 31, 1994.\nThe PowerShare dividend reinvestment plan is available to all CSW stockholders, employees, eligible retirees, utility customers and other residents of the four states where the Electric Operating Companies operate. Plan participants are able to make optional cash payments and reinvest all or any portion of their dividends in CSW common shares. During 1994, CSW raised approximately $50 million in common stock equity through PowerShare.\n6.Financial Instruments 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 fair value.\nCash and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nShort-term investments The carrying amount approximates fair value because of the short maturity of those instruments. Short-term investments are classified in accounts receivable on the consolidated balance sheets.\nLong-term debt The fair value of the CSW System'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 CSW for debt of the same remaining maturities.\nPreferred stock subject to mandatory redemption The fair value of the Electric Operating Companies' preferred stock subject to mandatory redemption is estimated based on quoted market prices for the same or similar issues or on the current rates offered to CSW for preferred stock with the same or similar remaining redemption provision.\n2-39 Long-term debt and preferred stock due within 12 months The fair value of current maturities of long-term debt and preferred stock due within 12 months are estimated based on quoted market prices for the same or similar issues or on the current rates offered for long-term debt or preferred stock with the same or similar remaining redemption provisions.\nShort-term debt The carrying amount approximates fair value because of the short maturity of those instruments.\nThe fair value does not affect CSW's liabilities unless the issues are redeemed prior to their maturity dates.\nThe estimated fair values of CSW's financial instruments follow:\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (millions) Cash and temporary cash investments $27 $27 $62 $62 Short-term investments -- -- 13 13 Long-term debt 2,940 2,795 2,749 2,947 Preferred stock subject to mandatory redemption 35 32 58 61 Long-term debt and preferred stock due within 12 months 7 7 26 26 Short-term debt 1,483 1,483 1,410 1,410\n7.Short-Term Financing The CSW System has established a money pool to coordinate short- term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million to back up its commercial paper program.\nCSW Credit, which does not participate in the money pool, issues commercial paper that is secured by the assignment of its receivables. CSW Credit maintains a secured revolving credit agreement which aggregated $900 million at December 31, 1994, to back up its commercial paper program.\n8.Benefit Plans Defined Benefit Pension Plan The CSW System maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited 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 which are deductible for income tax purposes and minimum contributions required by the ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate-term fixed income investments.\nContributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $28 million, $32 million and $29 million, respectively.\nThe approximate maximum number of participants in the plan during 1994 were 8,500 active participants, 3,600 retirees and beneficiaries and 1,000 terminated employees.\n2-40 The components of net periodic pension cost and the assumptions used in accounting for pensions follow:\n1994 1993 1992 (dollars in millions) Net Periodic Pension Cost Service cost $22 $20 $18 Interest cost on projected benefit obligation 62 56 50 Actual return on plan assets (4) (68) (43) Net amortization and deferral (70) -- (20) $10 $ 8 $ 5\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nA reconciliation of the funded status of the plan to the amounts recognized on the balance sheets is shown below:\nDecember 31, 1994 1993 (millions) Plan assets, at fair value $794 $790 Actuarial present value of Accumulated benefit obligation for service rendered to date 685 649 Additional benefit for future salary levels 112 133 Projected benefit obligation 797 782 Plan assets in excess\/(below) the projected benefit obligation (3) 8 Unrecognized net gain 60 62 Unrecognized prior service cost (8) (8) Unrecognized net obligation 15 17 Prepaid pension cost $ 64 $ 79\nThe vested portion of the accumulated benefit obligations at December 31, 1994 and 1993 was $626 million and $586 million, respectively. The unrecognized net obligation is being amortized over the average remaining service life of employees or 16 years. Prepaid pension cost is included in other deferred charges on the consolidated balance sheets.\nIn addition to the amounts shown in the above table, the CSW System has a non-qualified excess benefit plan. This plan is available to all pension plan participants who are entitled to receive a pension benefit from CSW which is in excess of the limitations imposed on benefits by the Internal Revenue Code through the qualified plan. CSW's net periodic cost for this non- qualified plan for the years ended December 31, 1994, 1993 and 1992 was $1.8 million, $1.8 million and $0.5 million, respectively.\nHealth and Welfare Plans The CSW System had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active CSW System employees during 1994. The contributions, recorded on a pay-as-you-go basis, for the years ended December 31, 1994 and 1993 were approximately $17\n2-41 million and $23 million, respectively. Effective January 1993, the CSW System's method of providing health benefits was modified to include such benefits as a health maintenance organization, preferred provider options, managed prescription drug and mail- order program and a mental health and substance abuse program in addition to the self-insured indemnity plans.\nPostretirement Benefits Other Than Pensions The CSW System adopted SFAS No. 106 effective January 1, 1993. The effect on operating expense in 1993 was an increase of $16 million. The transition obligation is being amortized over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\nThe components of net periodic postretirement benefit cost follow:\n1994 1993 (millions) Net Periodic Postretirement Benefit Cost Service cost $ 9 $ 8 Interest cost on APBO 19 17 Actual return on plan assets (1) (1) Amortization of transition obligation 9 9 Net amortization and deferral (4) (2) $32 $31\nA reconciliation of the funded status of the plan to the amounts recognized on the consolidated balance sheets follow:\nDecember 31, 1994 1993 APBO (millions) Retirees $141 $146 Other fully eligible participants 31 30 Other active participants 55 64 Total APBO 227 240 Plan assets at fair value (69) (51) APBO in excess of plant assets 158 189 Unrecognized transition obligation (162) (171) Unrecognized gain or (loss) 4 (18) (Accrued)\/Prepaid Cost $ -- $ --\nThe following assumptions were used in accounting for SFAS No. 106.\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001. Post-65 Participants: 1994 rate of 11.25% grading down .75% per year to an ultimate rate of 6.0% in 2001.\n2-42 Increasing the assumed health care cost trend rates by one percentage point in each year would increase the APBO by $26 million and increase the aggregate of the service and interest costs components by $4 million as of December 31, 1994.\n9.Jointly Owned Electric Utility Plant The Electric Operating Companies are parties to various joint ownership agreements with other non-affiliated entities. Such agreements provide for the joint ownership and operation of generating stations and related facilities, whereby each participant bears its share of the project costs. At December 31, 1994, the companies have undivided interests in five such generating stations and related facilities as shown below:\nCPL SWEPCO SWEPCO SWEPCO CSW South Flint Dolet System Texas Creek Pirkey Hills Oklaunion Nuclear Coal Lignite Lignite Coal Plant Plant Plant Plant Plant (dollars in millions) Plant in service $2,343 $ 79 $ 431 $ 226 $ 397 Accumulated depreciation $ 380 $ 39 $ 135 $ 62 $ 91 Plant capacity-MW 2,500 480 650 650 676 Participation 25.2% 50.0% 85.9% 40.2% 78.1% Share of capacity-MW 630 240 559 262 528\n10. Litigation and Regulatory Proceedings\nCPL STP From February 1993 until May 1994, STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL. These matters, including a base rate case and fuel reconciliation proceedings, are discussed immediately below.\nTexas Commission Proceedings Base Rates Rate Inquiry - Docket No. 12820 Several Cities, the Texas Commission General Counsel and others initiated actions in late 1993 and early 1994 which, if approved by the Texas Commission, would lower CPL's base rates. The requests for a review of CPL's rates arose out of the unscheduled outage at STP which began in February 1993. The STP outage did not affect CPL's ability to meet customer demand because of existing capacity and CPL's purchase of additional energy.\nPursuant to a scheduling and procedural settlement agreement among the parties challenging CPL's rates, which was approved by a Texas Commission ALJ on April 1, 1994, CPL submitted a rate filing package on July 1, 1994 to the Texas Commission justifying its current base rate structure. In that filing, CPL stated that it had a $111 million retail revenue deficiency and would be justified in seeking a base rate increase. However, consistent with the procedural settlement agreement, CPL has not sought to increase base rates as a part of this docket but seeks to maintain its rates at the same levels agreed to in the settlement of its last two rate cases in 1990 and 1991. As part of the 1990 and 1991 settlements, CPL 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. On October 31, 1994, CPL filed rebuttal testimony that revised its retail revenue deficiency to approximately $103 million. CPL continues to maintain that its rates are reasonable and that its earnings are within established regulatory guidelines.\n2-43 Parties to CPL's base rate case have filed testimony with the Texas Commission recommending reductions in CPL's base rates. Among the parties that filed testimony were OPUC which initially recommended an annual $100 million retail rate reduction. After hearings on the rate case, OPUC claimed that CPL did not meet its burden of proof concerning deferred accounting and as a result OPUC changed its proposed reduction to $147 million. The Cities, which are parties to the rate case, have recommended an annual $75 million retail rate reduction and the write-off of $219 million of CPL's Mirror CWIP asset. See Deferred Accounting below.\nThe Staff filed testimony recommending an annual reduction in retail rates of $99.6 million resulting from a combination of proposed rate base and cost of service reductions, which it subsequently revised during the hearings to $83.9 million. In its final brief to the ALJ, the Texas Commission's Staff withdrew its recommendation that short-term debt be included in the calculation of CPL's weighted cost of capital. CPL estimates that this change in the Staff's position will lower its revised proposed retail rate reduction by approximately $6 million. The Staff recommended a rate base disallowance of $407 million, or approximately 17% of CPL's investment in STP, based upon the Staff's calculation of historical performance for STP compared to a peer group of other nuclear facilities. The Staff also recommended that accumulated depreciation and accumulated deferred federal income taxes related to the disallowed portion of STP be adjusted to reflect a net reduction to rate base of $325 million. Additionally, the Staff proposed to disallow depreciation expense related to the recommended STP disallowed plant.\nIn its testimony, the Staff argued that its proposed STP rate base reduction was a historical performance-based disallowance that could be temporary in nature and would not have to result in a permanent disallowance. The Staff indicated that, in the future, CPL could seek recovery in rates of the proposed STP rate base disallowance, subject to the performance of STP.\nThe Texas Commission held hearings in November and December 1994, and all parties have filed briefs in the case. The ALJ is expected to issue a recommended order for consideration by the Texas Commission in April 1995, with a final order from the Texas Commission expected in May 1995. Testimony filed by parties to the rate case, including the Staff, is not binding on either the ALJ or the Texas Commission.\nCPL strongly believes that 100 percent of its investment in both units of STP belong in rate base. This belief is based on, among other factors, Units 1 and 2 providing output at high capacity factors since April and June 1994, respectively. In addition, the long-term benefits nuclear generation provides to customers supports their inclusion in rate base. Furthermore, there are no Texas Commission precedents addressing the removal of a nuclear plant from rate base as a performance-based disallowance. Assuming both units of STP are included in rate base, CPL believes it is not collecting excessive revenues, notwithstanding that market rates of return on common equity are generally lower today than they were in 1990 and 1991, when CPL's base rates were last set.\nFuel Introduction Pursuant to the substantive rules of the Texas Commission, CPL generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and CPL'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 costs 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.\nFuel Surcharge - Docket No. 12154 In July 1993, CPL 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\n2-44 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 CPL's request to postpone consideration of the surcharge. In January and July of 1994, CPL updated its fuel surcharge petition to reflect amounts of under-recovery through November 1993 and May 1994, respectively. Also, CPL further updated its petition in January 1995 to reflect amounts of under-recovery through November 1994. Likewise, CPL requested and was granted postponement of the updated petitions until the STP outage concluded or at the time fuel costs are next reconciled. On January 4, 1995, Docket No. 12154 was consolidated into Docket No. 13650.\nPrudence Inquiry - Docket No. 13126 In April 1994, the Texas Commission's General Counsel and Staff issued a Request for Proposal for an audit of the STP outage, and in July 1994 a consultant was selected to perform the audit. The purpose of the audit is to evaluate the prudence of management activities at STP, including the actions of HLP and the STP management committee, of which CPL is a participant. Such review will include the time from original commercial operation of each unit until they were returned to service from the outage. The findings of this audit are expected to be incorporated into this proceeding. CPL and HLP will pay the costs of the audit but will have no control over the ultimate work product of the consultant.\nIn June 1994, the Texas Commission's General Counsel initiated an inquiry into the operation and management of STP which resulted in the establishment of this proceeding. As part of the inquiry, CPL presented certain information concerning the prudence of management activities at STP relating to the STP outage. Testimony filed by CPL stated that the cause of the STP outage was the result of an accidental equipment failure rather than imprudent management activities at STP. Based on this information, CPL will seek full recovery in its fuel reconciliation case of incremental energy costs related to the STP outage.\nAs a part of this proceeding, CPL was required to reconstruct its production costs assuming STP was available 100% of the time during the actual outage. Testimony filed by CPL stated that it is unrealistic to expect any generating unit to operate all the time. The testimony provided calculations of STP replacement power cost estimates for availability factor scenarios at (i) 100%, (ii) 75% and (iii) 65% average availability. Based on these average availability factors, STP net replacement power costs for the entire outage period were estimated to be (i) $104.5 million at 100%, (ii) $79.0 million at 75% and (iii) $68.2 million at 65% average availability.\nThe results of this prudence inquiry are expected to be used in CPL's pending fuel reconciliation proceeding in Docket No. 13650, as discussed below, and possibly CPL's next base rate proceeding should a return on equity penalty be ordered by the Texas Commission. Such penalty could lower CPL's allowed return on equity in its next base rate case from what it otherwise would be permitted to earn.\nFuel Reconciliation - Docket No. 13650 On November 15, 1994, CPL filed a fuel reconciliation case with the Texas Commission seeking to reconcile approximately $1.2 billion of fuel costs from March 1, 1990 through June 30, 1994. This period includes the STP outage where CPL's fuel and purchased power costs were increased as the power normally generated by STP was replaced through sources with higher costs. At December 31, 1994, CPL's under-recovered fuel balance was $54.1 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. CPL cannot accurately estimate the amount of any future under- or over-recoveries due to the nature of the above factors. CPL cannot predict how the Texas Commission will ultimately resolve the reasonableness of higher replacement energy costs associated with the STP outage. Although the Texas Commission could disallow all or a portion of the STP replacement energy costs, such determination cannot be made until a final order is issued by the Texas Commission in this docket.\n2-45 If a significant portion of the fuel costs were disallowed by the Texas Commission, CSW could experience a material adverse effect on its consolidated results of operations in the year of disallowance but not on its financial condition.\nCPL continues to negotiate with the intervening parties to resolve Docket Nos. 12820, 13126 and the STP portions of Docket No. 13650 through settlement. However, no settlement has been reached.\nManagement cannot predict the ultimate outcome of these regulatory proceedings. However, management believes that the ultimate resolution of the various issues will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nSTP Background Final Orders In October 1990, the Texas Commission issued the 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 the STP Unit 2 Order which fully implemented a stipulated agreement to resolve all issues regarding CPL's investment in STP Unit 2.\nThe STP Unit 1 Order allowed CPL 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 had authorized deferral of STP Unit 1 costs. See Deferred Accounting below. 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 CPL 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. The Mirror CWIP liability is being reduced by the recognition of non-cash income during the period 1991 through 1995. The Mirror CWIP asset is being amortized to expense over the life of the plant.\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 costs of CPL's total investment in STP is included in rate base. As indicated under the heading Texas Commission Proceedings above, however, CPL is currently involved in base rate and fuel proceedings which challenge CPL's right to recover certain costs associated with the STP outage.\nAs part of the stipulated agreement, CPL 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. CPL 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 CPL, the Staff and a majority of intervenors including major cities in CPL's service territory and major industrial customers. These intervenors represent a significant majority of CPL's customers. CPL and the TSA reached agreements, which were subsequently approved by the 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\n2-46 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 CSW could experience a significant adverse effect on its consolidated results of operations and financial condition. 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 economic results. Management believes that the STP Unit 1 and 2 Orders will be upheld.\nDeferred Accounting CPL was granted deferred accounting for STP Unit 1 and 2 costs by Texas Commission orders. These orders allowed CPL 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 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, CPL's retail rates include recovery of 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 CPL'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 CPL 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 CPL from earning a return on such costs.\nAfter the Court of Appeals' denial of each party's motion for rehearing of the decision, CPL 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 Appeals' decision, challenging generally the legality of deferred accounting for rate base treatment of any deferred costs. In May 1993, the Supreme Court of Texas granted CPL's Application for Writ of Error. CPL's case was consolidated with the deferred accounting cases of El Paso and HLP. In June 1994, the Supreme Court of Texas sustained deferred accounting as an appropriate mechanism for the Texas Commission to use in preserving the financial integrity of utilities. The Supreme Court of Texas held that the Texas Commission can authorize utilities to defer those costs that are incurred between the in-service date of a plant and the effectiveness of new rates, which include such costs. On October 6, 1994, the Supreme Court of Texas denied a motion for rehearing CPL's deferred accounting matter filed by the State of Texas. The language of the Supreme Court of Texas opinion suggests that the appropriateness of allowing deferred accounting may need to again be reviewed under a financial integrity standard at the time the costs begin being recovered through rates. For CPL, that would be the STP Unit 1\n2-47 and Unit 2 Orders discussed above. To the extent that additional review is required, it should occur in those dockets.\nIf these deferred accounting matters are not favorably resolved, CSW could experience a material adverse effect on its consolidated results of operations and financial condition. While CPL's management cannot predict the ultimate outcome of these matters, management believes CPL will 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 CSW's consolidated results of operations or financial condition.\nWestinghouse Litigation CPL and other owners of STP are plaintiffs in a lawsuit filed in 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 set for trial in July 1995.\nInspections during the STP outage have detected early signs of stress corrosion cracking in tubes at STP Unit 1. Management believes additional problems would develop gradually and will be monitored by the Project Manager 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. Management believes that the ultimate resolution of this matter will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nCivil Penalties In October 1994, the NRC staff advised HLP that it proposes to fine HLP $100,000 for what the NRC believes was discrimination against a contractor employee at STP who brought complaints of possible safety problems to the NRC's attention. These actions resulted from the findings of a NRC investigation of alleged violations of STP security and work process procedures in 1992. The incident cited by the NRC is the subject of a contested hearing that is scheduled to be held in the spring of 1995 before a United States Department of Labor judge. Until the Department of Labor issues a final decision in this matter, the NRC is not requiring HLP to respond to its notice of violation.\nPSO\nRate Review In December 1993, the Oklahoma Commission issued an order unanimously approving a joint stipulation between PSO, the Oklahoma Commission Staff, and the Office of the Attorney General of the State of Oklahoma, as recommended by the ALJ. The order allowed PSO an increase in retail prices of $14.4 million on an annual basis which represents a $4.3 million increase above those authorized by the March 1993 interim order. In January 1994, the Oklahoma Commission issued an order unanimously approving PSO's price schedules reflecting the $14.4 million price increase. The new prices became effective beginning with the billing month of February 1994.\nThe December 1993 order addresses, among other things, the following issues. PSO will recover $4.5 million annually in expenses associated with OPEBs, which, for PSO, are primarily health care related benefits. Such expenses will be recovered along with amortization of the deferred 1993 OPEBs at a rate of $0.5 million per year for 10 years. PSO will amortize deferred storm expenses associated with both a 1987 ice storm and a 1992 wind storm, amounting to $1.2 million per year for five years. In addition, the order recognizes the increase in federal income tax expenses resulting from the recent increase in the federal corporate income tax rate from 34 percent to 35 percent. PSO will continue to use the depreciation rates previously approved by the\n2-48 Oklahoma Commission. PSO agreed that it will not file another retail price increase application until after June 30, 1995.\nGas Transportation and Fuel Management Fees An order issued by the Oklahoma Commission in 1991 required that the level of gas transportation and fuel management fees, paid to Transok by PSO, permitted for recovery through the fuel adjustment clause be reviewed in the aforementioned price proceeding. This portion of the price review was bifurcated. In February 1995, an agreement was reached which allows PSO to recover approximately $28.4 million of transportation and fuel management fees in base rates using 1991 determinants and approximately $1 million through the fuel adjustment clause. The agreement also requires the phase- in of competitive bidding of natural gas transportation requirements in excess of 165 MMcf\/d per day. An ALJ has recommended approval of the agreement to the Oklahoma Commission. A final order is expected in the first quarter of 1995.\nGas Purchase Contracts PSO has been named defendant in complaints filed in federal and state courts of Oklahoma and Texas in 1984 through February 1995 by gas suppliers alleging claims arising out of certain gas purchase contracts. Cases currently pending seek approximately $29 million in actual damages, together with claims for punitive damages which, in compliance with pleading code requirements, are alleged to be in excess of $10,000. The plaintiffs seek relief through the filing dates as well as attorney fees. As a result of settlements among the parties, certain plaintiffs dismissed their claims with prejudice to further action. The settlements did not have a significant effect on CSW's consolidated results of operations. The remaining suits are in the preliminary stages. Management cannot predict the outcome of these proceedings. However, management believes that PSO has defenses to these complaints and intends to pursue them vigorously. Management also believes that the ultimate resolution of the remaining complaints will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nPCB Cases PSO has been named a defendant in complaints filed in state court in Oklahoma alleging, among other things, that some of the plaintiffs were contaminated with PCBs and other toxic by-products following transformer malfunctions. The complaints currently total approximately $383 million of which approximately one-third represents punitive damages. Some claims have been dismissed, certain of which resulted in settlements among the parties. The settlements did not have a significant effect on CSW's consolidated results of operations. Although management cannot predict the outcome of these proceedings, management believes that PSO has defenses to these claims and intends to pursue them vigorously. Moreover, management has reason to believe that PSO's insurance may cover some of the claims. Management also believes that the ultimate resolution of these cases will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nBurlington Northern Transportation Contract In June 1992, PSO filed suit in Federal District Court in Tulsa, Oklahoma, against Burlington Northern seeking declaratory relief under a long-term contract for the transportation of coal. In July 1992, Burlington Northern asserted counterclaims against PSO alleging that PSO breached the contract. The counterclaims sought damages in an unspecified amount. In December 1993, PSO amended its suit against Burlington Northern seeking damages and declaratory relief under federal and state anti-trust laws. PSO and Burlington Northern filed motions for summary judgment on certain dispositive issues in the litigation. In March 1994, the court issued an order granting PSO's motions for summary judgment and denying Burlington Northern's motion. It was not necessary for the court to decide the federal and state anti-trust claims raised by PSO. Judgment was rendered in favor of PSO by the United States District Court in May 1994. In June 1994, Burlington Northern appealed this judgment to the United States Court of Appeals for the Tenth Circuit. This appeal is now pending.\n2-49 Burlington Northern Arbitration In May 1994, in a related arbitration, an arbitration panel made an award favorable to PSO concerning basic transportation rates under the coal transportation contract described above, and concerning the contract mechanism for adjustment of future transportation rates. These arbitrated issues were not involved in the related lawsuit described above. Burlington Northern filed an action to vacate the arbitrated award in the District Court for Dallas County, Texas. PSO removed this action to the United States District Court for the Northern District of Texas, and filed a motion to either dismiss this action or have it transferred to the United States District Court for the Northern District of Oklahoma. Burlington Northern moved to remand the action to state court. In September 1994, the United States District Court for the Northern District of Texas denied Burlington Northern's motion to remand, and granted PSO's motion to transfer the action to the United States District Court for the Northern District of Oklahoma. Separately, PSO filed an action to confirm the arbitration award in the United States District Court for the Northern District of Oklahoma, and Burlington Northern filed a motion to dismiss this confirmation action. On December 6, 1994, the District Court entered an order denying the Burlington Northern's motion to vacate the arbitration award, and granting PSO's motion to confirm the arbitration award. On December 29, 1994, the District Court entered judgment confirming the arbitration award, including a money judgment in PSO's favor for $16.4 million, with interest at 7.2% per annum compounded annually from December 21, 1994 until paid. On January 6, 1995, Burlington Northern appealed the District Court's judgment to the United States Court of Appeals for the Tenth Circuit. This appeal is now pending.\nSWEPCO Fuel Reconciliation On March 17, 1994, SWEPCO filed a petition with the Texas Commission to reconcile fuel costs for the period November 1989 through December 1993. Total Texas jurisdictional fuel expenses subject to reconciliation for this 50-month period were approximately $559 million. SWEPCO's net under-recovery for the reconciliation period was approximately $0.9 million. SWEPCO and the intervening parties in this proceeding were able to negotiate a stipulated agreement providing a $3.2 million fuel cost disallowance and settling all issues except one. That issue involved the recovery of certain fuel related litigation and settlement negotiation expenses. The Texas Commission, at its Final Order hearing on January 18, 1995, approved the stipulated disallowance and granted SWEPCO recovery of the fuel related litigation expense. The $3.2 million disallowance is included in SWEPCO's 1994 results of operations. SWEPCO recognized the litigation costs as expenses in prior periods.\nBurlington Northern Transportation Contract On January 20, 1995, a state district court in Bowie County, Texas, entered judgment in favor of SWEPCO against Burlington Northern in a lawsuit between the parties regarding rates charged under two rail transportation contracts for delivery of coal to SWEPCO's Welsh and Flint Creek power plants. The court awarded SWEPCO approximately $72 million covering damages for the period from April 27, 1989 through September 26, 1994 and prejudgment interest fees and grant certain declaratory relief requested by SWEPCO.\nKansas City Southern Railway Company Transportation Contracts In March 1994, SWEPCO entered into a settlement with the Kansas City Southern Railway Company of litigation between parties regarding two coal transportation contracts. Pursuant to the settlement, SWEPCO and the Kansas City Southern Railway Company executed a new coal transportation agreement. The settlement is expected to result in a reduction of SWEPCO's coal transportation costs now and in the future. Burlington Northern, another party to the prior contracts and to the litigation, did not participate in the settlement and the litigation is still pending between SWEPCO and Burlington Northern.\n2-50 WTU\nRate Proceeding - Docket No. 13369 On August 25, 1994, WTU filed a petition with the Texas Commission and with cities with original jurisdiction to review WTU's rates, proposed an interim across-the-board base rate reduction of 3.25% or, approximately $5.7 million, effective October 1, 1994, and sought until February 28, 1995, the time to develop and file a RFP. WTU also requested the ability to \"true-up\", back to October 1, 1994, any difference in revenue requirements upon final order of the Texas Commission, and proposed that any increases over the pre-October 1, 1994, base rates be implemented prospectively on the effective date of the final order.\nAs discussed below, WTU's fuel reconciliation was consolidated with this proceeding in September 1994. Reconcilable fuel costs during the reconciliation period were approximately $300 million. At June 30, 1994, the fuel cost under-recovery totaled approximately $5.1 million, including interest. At December 31, 1994, this amount had become an over-recovery of approximately $0.2 million. WTU is not seeking a change in fuel factors.\nOn February 28, 1995, WTU filed with the Texas Commission and cities with original jurisdiction the rate filing package which indicates a revenue deficiency of approximately $14.5 million. However, WTU simultaneously filed with the parties a settlement proposal to reduce overall base rate revenue by 3.25%, effective October 1, 1994, an annual impact in the rate year beginning January 1, 1996 of approximately $5.9 million. The settlement proposal reflects WTU's desire to maintain competitive rates, recognizes the importance of competitive rates in the changing electric service marketplace, and demonstrates WTU's strong commitment to the long-term success of WTU and its customers.\nUnless a settlement accelerates the schedule, WTU anticipates hearings in mid-1995 with a final order in the fourth quarter of 1995. Management cannot predict the outcome of the rate proceeding, the fuel reconciliation, or the settlement proposal, but believes that the ultimate resolution of these matters will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nFuel Reconciliation - Docket No. 13172 On June 30, 1994, WTU filed a petition with the Texas Commission to reconcile fuel costs for the period January 1991 through February 1994. Subsequently, in September 1994, this fuel reconciliation proceeding was consolidated into Docket No. 13369 described above, and the reconciliation period was extended through June 1994.\nRate Case Proceeding - Docket No. 7510 In November 1987, the Texas Commission issued a final order in WTU's retail rate case providing for WTU to receive an annual increase in base retail revenues of $34.9 million. Rates reflecting the final order were implemented in December 1987. WTU, along with certain intervenors in the retail rate proceeding, appealed the Texas Commission's final order to the District Court seeking reversal of various provisions of the final order, including the inclusion of deferred accounting in rate base.\nThe appeals were consolidated and in September 1988, the District Court affirmed the final order of the Texas Commission. In November 1988, certain intervenors filed appeals of the District Court's judgment with the Court of Appeals. In February 1990, the Court of Appeals ruled that an intervenor had improperly been excluded from presenting its appeal to the District Court, reversed the District Court's judgment and remanded the case to the District Court for further proceedings.\nIn October 1992, the District Court heard the remanded appeals of the final order of the Texas Commission and in March 1993 issued an order affirming the Texas Commission's order in all material respects with the single exception of the inclusion of deferred\n2-51 Oklaunion carrying costs in rate base. In its treatment of deferred costs, the District Court followed a then-current opinion of the Court of Appeals which precluded recovery of deferred post- in-service carrying costs. In April 1993, WTU and other parties filed appeals, and oral argument was held on the appeals in December 1993 on the non-deferred accounting issues. With respect to the deferred accounting issues, the parties recognized certain Supreme Court of Texas decisions regarding other deferred accounting cases would be influential in WTU's case.\nIn June 1994, the Supreme Court of Texas issued its opinion in the three other cases involving deferred accounting holding that the Texas Commission has the authority to allow deferred accounting treatment during the deferral period, including deferred post-in- service carrying costs. The Supreme Court of Texas upheld the Court of Appeals in all respects except it reversed the Court of Appeals to the extent it disallowed carrying costs deferrals and remanded to the Court of Appeals for consideration of the unresolved arguments of the improperly excluded intervenor. Motions for rehearing were filed by certain parties which were denied by the Supreme Court of Texas. These rulings influenced the Court of Appeals' decision in WTU's rate case appeals, as described below.\nOn February 15, 1995, the Court of Appeals affirmed all aspects of the District Court judgment relating to the Texas Commission's allowance of non-Oklaunion depreciation rates and the surcharge of rate case expenses, reversed the District Court's judgment relating to the exclusion of deferred Oklaunion carrying costs in rate base, and remanded the cause to the Texas Commission to reexamine the issue of deferred costs in light of the remand of Docket No. 7289, as described above. However, on March 3, 1995, WTU filed a motion for rehearing at the Court of Appeals seeking clarification of certain aspects of its order and arguing that the Court of Appeals erred in remanding the case to the Texas Commission for it to determine to what extent deferred costs are necessary to preserve WTU's financial integrity because the issue has been waived since it was not briefed or argued to the Court of Appeals. WTU expects other parties may also file motions for rehearing.\nWTU's motion for rehearing may, if granted, prevent further review of financial integrity issues with respect to deferred accounting in any remand of Docket No. 7510. If a broader remand is permitted and if the Texas Commission concludes in Docket No. 7289 that deferred accounting was necessary to preserve WTU's financial integrity during the deferral period, the Texas Commission must decide to what extent the deferred Oklaunion costs, including carrying costs, were necessary to preserve WTU's financial integrity. If WTU's deferred accounting treatment is ultimately reversed or is substantially reduced, WTU could experience a material adverse impact on its results of operations. While management can give no assurances as to the outcome of the remanded proceeding or the motion for rehearing, management believes that 100 percent of the Oklaunion deferred costs will be determined by the Texas Commission to have been necessary to preserve WTU's financial integrity during the deferral period so that there will be no material adverse effect on CSW's consolidated results of operations or financial condition.\nDeferred Accounting - Docket No. 7289 WTU received approval from the Texas Commission in September 1987 to defer operating expenses and carrying costs associated with Oklaunion incurred subsequent to its December 1986 commercial operation date until December 1987 (the deferral period) when retail rates including Oklaunion in WTU's rate base became effective. WTU has recorded approximately $32 million of Oklaunion deferred costs, of which $25 million are carrying costs. The deferred costs are being recovered and amortized over the remaining life of the plant. In November 1987, OPUC filed an appeal in the District Court challenging the Texas Commission's final order authorizing WTU to defer the costs associated with Oklaunion. In October 1988, the District Court affirmed the final order of the Texas Commission. In December 1988, OPUC filed an appeal of the District Court judgment in the Court of Appeals. In September 1990, the Court of Appeals upheld the District Court's affirmance of the Texas Commission's final order and in October 1990, OPUC filed a motion for rehearing of the Court of Appeals' decision, which was denied in November 1990. On further appeal,\n2-52 the Supreme Court heard oral argument in September 1993, in WTU's case as well as three other cases involving deferred accounting and in June 1994 issued its opinions in these cases affirming the Texas Commission's authority to allow deferred accounting treatment, but establishing a financial integrity standard rather than the measurable harm standard used by the Texas Commission.\nIn October 1994, the Supreme Court of Texas issued a mandate remanding WTU's deferred accounting case to the Texas Commission. While no schedule has yet been established for the proceedings on remand at the Texas Commission, this remand may be considered in tandem with WTU's pending rate case, Docket No. 13369. In the remanded proceeding, the Texas Commission must make a formal finding that the deferral of Oklaunion costs was necessary to prevent WTU's financial integrity during the deferral period from being jeopardized.\nIf WTU's deferred accounting treatment is ultimately reversed and not favorably resolved, WTU could experience a material adverse impact on its results of operations. While management cannot predict the ultimate outcome of these proceedings, management believes that WTU's deferred accounting will be ultimately sustained by the Texas Commission on the basis of the financial integrity standard set forth by the Supreme Court of Texas, so that there will be no material adverse effect on CSW's consolidated results of operations or financial condition.\nWTU FERC Order On April 4, 1994, the FERC issued an order pursuant to section 211 of the Federal Power Act forcing a regional utility to transmit power to Tex-La on behalf of WTU. The order was one of the first issued by FERC under that provision, which was added by the Energy Policy Act to increase competition in wholesale power markets. WTU began serving Tex-La, which has requirements of approximately 120 MW of electric power. WTU will serve Tex-La until facilities are completed to connect Tex-La to SWEPCO, an affiliated system, at which time SWEPCO will provide 85 MW and WTU will retain 35 MW of the Tex-La electric load.\nOther Cimmaron On January 12, 1994, Cimmaron brought suit against CSW and its wholly-owned subsidiary, CSWE, in the 125th District Court of Houston, Harris County, Texas. Cimmaron alleges that CSW and CSWE breached commitments to participant with Cimmaron in the failed BioTech Cogeneration project located in Colorado. Cimmaron claims breach of contract, fraud and negligent misrepresentation with alleged damages totaling $250 million, punitive damages of an unspecified amount, as well as attorney's fees.\nCSWE filed a counterclaim against Cimmaron and third-party claims against the principals of Cimmaron on December 22, 1994, alleging that they misrepresented and omitted material facts about their experience and background and about the proposed cogeneration project. CSWE seeks damages of $500,000, the earnest money paid when the letter of intent was executed, the costs associated with due diligence and punitive damages. On January 10, 1995, Cimmaron filed a first amended original petition suing CSWE board members at the time, personally.\nPre-trial discovery on the case is presently underway with depositions of the parties being taken during March, 1995. Trial was originally set for the week of April 10, 1995, but the parties have filed a joint motion for continuance which is set for hearing on March 20, 1995. Management of CSW cannot predict the outcome of this litigation, but believes that CSW and CSWE have defenses to these complaints and are pursuing them vigorously and that the ultimate resolution will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\n2-53 General Matters CSW and the Operating Companies are 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 CSW's consolidated results of operations or financial condition.\n11. Commitments and Contingent Liabilities Proposed Acquisition of El Paso Background In May 1993, CSW entered into a Merger Agreement pursuant to which El Paso would emerge from bankruptcy as a wholly-owned subsidiary of CSW. El Paso is an electric utility company headquartered in El Paso, Texas, engaged principally in the generation and distribution of electricity to approximately 262,000 retail customers in west Texas and southern New Mexico. El Paso also sells electricity under contract to wholesale customers in a number of locations including southern California and Mexico. El Paso had filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code on January 8, 1992.\nOn July 30, 1993, El Paso filed the Modified Plan and a related proposed form of Disclosure Statement providing for the acquisition of El Paso by CSW. On November 15, 1993, all voting classes of creditors and shareholders of El Paso voted to approve the Modified Plan. On December 8, 1993, the Bankruptcy Court confirmed the Modified Plan.\nUnder the Modified Plan, the total value of CSW's offer to acquire El Paso is approximately $2.2 billion. The Modified Plan generally provides for El Paso creditors and shareholders to receive shares of CSW Common, cash and\/or securities of El Paso, or to have their claims cured and reinstated. The Modified Plan also provides for claims of secured creditors generally to be paid in full with debt securities of reorganized El Paso, and for unsecured creditors to receive a combination of debt securities of reorganized El Paso and CSW Common equal to 95.5 percent of their claims, and for small trade creditors to be paid in full with cash. The Modified Plan provides for El Paso's preferred shareholders to receive preferred shares of reorganized El Paso, or cash, and for options to purchase El Paso Common to be converted into options to purchase a proportionate number of shares of CSW Common. In addition, the Modified Plan provides for certain creditor classes of El Paso to accrue interest on their claims and to receive periodic interim distributions of such interest through the Effective Date or the withdrawal or revocation of the Modified Plan, subject to certain conditions and limitations set forth in the Modified Plan. To date, all such accrued interest payments to creditors have been made by El Paso on a timely basis. If, under certain circumstances, the Merger is not consummated, the Merger Agreement provides for CSW to pay El Paso for a portion of such interim interest payments paid or accrued prior to the termination of the Merger Agreement. The Merger Agreement also provides for CSW to pay for a portion of fees and expenses, including legal expenses of certain El Paso creditors under such circumstances. CSW's potential exposure as of December 31, 1994 is estimated to be approximately $17.5 million; however, the actual amount, if any, that CSW may be required to pay pursuant to these provisions depends on a number of contingencies and cannot presently be predicted.\nOn June 14, 1994, Las Cruces filed a motion with the Bankruptcy Court to lift the automatic stay imposed by the bankruptcy filing to allow it to (i) commence action against El Paso for failure to pay franchise fees after the expiration of its franchise agreement with Las Cruces in March 1994, (ii) enter El Paso's property to conduct an appraisal of the electric distribution system and any suitability studies, (iii) give notice of intent to file a condemnation action and (iv) commence state court condemnation proceedings against El Paso to condemn El Paso's distribution system within Las Cruces' city limits.\nOn June 29 and July 1, 1994, El Paso and CSW filed responses in the Bankruptcy Court opposing the Las Cruces motion. On August 1, 1994, CSW filed an amended response to the Las Cruces motion which states that the threat or actual commencement of condemnation proceedings by Las Cruces or the elimination of El Paso's service\n2-54 to Las Cruces by condemnation or otherwise may constitute an El Paso material adverse effect, as defined in the Merger Agreement, the absence of which is a condition of CSW's obligation to consummate the Merger. The existence of an El Paso material adverse effect would preclude consummation of the Merger and the Modified Plan, unless CSW waives this condition in writing. CSW's amended response concludes that Las Cruces' intention to file a condemnation proceeding creates a situation that must be favorably resolved before the closing of the Merger.\nBy letter dated August 5, 1994, El Paso protested CSW's filing of the amended response and asserted its disagreement with CSW's position regarding Las Cruces as summarized above. In addition, El Paso asserted that CSW's filing of the amended response over El Paso's objection was contrary to the terms of the Merger Agreement.\nOn August 22, 1994, Las Cruces entered into a wholesale full requirements power contract with SPS to supply power to a municipal utility proposed to be established by Las Cruces. On August 30, 1994, voters in Las Cruces approved by nearly a two-to- one margin a referendum authorizing Las Cruces to proceed with efforts to acquire from El Paso, through negotiated purchase or condemnation proceedings, the electric utility system of El Paso within Las Cruces, including certain distribution, substation and associated transmission facilities.\nOn September 12, 1994, CSW delivered a response to El Paso's August 5 letter. In its September 12 letter, CSW reiterated its position that Las Cruces is a material element of CSW's bargain with El Paso and advised El Paso that the municipalization efforts in Las Cruces and other matters, including (i) the potential loss of other customers in El Paso's service area, including the Holloman Air Force Base and the White Sands Missile Range in New Mexico, (ii) cracking in steam generator tubes at Palo Verde, (iii) intense political and regulatory opposition to the Merger, and (iv) a new \"comparable transmission service\" standard being imposed on the Merger by the FERC, place the completion of the Merger in jeopardy. CSW's September 12 letter further advised El Paso that the foregoing matters, individually and cumulatively, constitute a material adverse effect or failure of other closing conditions under the Merger Agreement which, unless timely resolved in accordance with the Merger Agreement, will preclude closing of the proposed Merger.\nSince CSW's September 12 letter, CSW has exchanged letters with El Paso and others regarding the interpretation of the Merger Agreement and the legal significance of the matters cited by CSW in its September 12 letter. Most of these letters are summarized below.\nOn September 14, 1994, CSW filed a second amended response to Las Cruces' motion to lift the stay in bankruptcy. In its second amended response, CSW stated that the intent and plan of Las Cruces to file a condemnation proceeding creates a situation that must be timely and favorably resolved by El Paso before the consummation of the Merger, whether or not the stay is modified or maintained. Further, CSW supported the maintenance of the stay as a means of avoiding disruption pending resolution of the Las Cruces dispute and because El Paso had taken the position that maintenance of the stay was in the best interests of the Merger and the El Paso estate and put El Paso in a better position to resolve the Las Cruces dispute.\nBy letter dated September 16, 1994, El Paso disagreed with the positions set forth by CSW in its September 12 letter and asserted that CSW's September 12 letter \"had inflicted irreparable harm on El Paso and the Merger process.\"\nOn September 20, 1994, following a hearing on the June 14, 1994 motion of Las Cruces discussed above, the Bankruptcy Court judge indicated orally that, effective January 1, 1995, he would lift the bankruptcy stay on certain actions against El Paso and allow Las Cruces to pursue condemnation proceedings against El Paso with respect to the electric distribution system within Las Cruces under applicable New Mexico law. El Paso filed a motion seeking clarification of this oral ruling as to whether Las Cruces may\n2-55 take immediate possession of the El Paso distribution system under the New Mexico condemnation statutes. On November 22, 1994, the Bankruptcy Court judge orally ruled that Las Cruces can commence condemnation proceedings but can not take possession of the distribution system when the stay is lifted until returning to the Bankruptcy Court and obtaining an order which permits that action.\nBy letter dated September 23, 1994, El Paso requested CSW's consent to meet with the City of Las Cruces to discuss the possibility of a resolution of El Paso's dispute with Las Cruces.\nBy letter dated October 3, 1994, CSW responded to El Paso's September 16 letter and reaffirmed the positions set forth in CSW's September 12 letter. In addition, CSW consented to El Paso's meeting with Las Cruces, but advised El Paso that CSW would not participate directly in negotiations between Las Cruces and El Paso.\nBy letter dated October 5, 1994, counsel to the El Paso Unsecured Creditors Committee, with the concurrence of certain other creditor groups, advised CSW that the committee disagreed with certain positions set forth in CSW's September 12 letter to El Paso. By letter dated October 27, 1994, CSW responded to and stated its disagreement with various statements set forth in the Unsecured Creditors Committee's letter.\nBy letter dated October 5, 1994, El Paso's New Mexico regulatory counsel asserted that CSW's September 12 letter had \"adversely affected proceedings before the New Mexico Commission\" relating to the Merger and that the letter \"is being widely interpreted as a statement from CSW that the Merger will not close.\" By letter dated October 7, 1994, CSW's New Mexico regulatory counsel set forth CSW's disagreement with statements made in El Paso's New Mexico regulatory counsel's October 5 letter. The New Mexico Commission had delayed the New Mexico proceedings prior to September 12, 1994. On October 12, 1994, a New Mexico Commission hearing examiner held a prehearing conference covering scheduling and other matters. On October 14, 1994, CSW filed a Statement of Position and Request for Procedural Schedule in the New Mexico proceeding. El Paso filed a separate position statement in the New Mexico proceeding and advised CSW, by letter dated October 14, 1994, that CSW's statement of position did not \"state a sufficiently clear and strong commitment by CSW to closing the Merger.\" By letter dated October 25, 1994, CSW's New Mexico regulatory counsel stated that the filing by El Paso of a separate position statement \"impairs our ability to obtain necessary regulatory approvals from the New Mexico Commission on a timely basis by implying that there are severe problems in the relationship between El Paso and CSW.\" CSW's October 25 letter also stated that \"the lack of a favorable resolution of Las Cruces municipalization efforts continues to not only prevent the closing of the Merger, but is also hindering our ability to obtain New Mexico regulatory approvals.\"\nBy letter dated October 18, 1994, El Paso reasserted its position that the Merger Agreement does not condition CSW's obligation to consummate the Merger on a favorable resolution of the Las Cruces situation. El Paso asserted it was not clear from CSW's October 3 letter whether CSW consented to El Paso's proposed discussion with Las Cruces and again requested CSW's consent to a meeting between El Paso and Las Cruces.\nBy letter dated October 27, 1994, CSW reaffirmed the positions taken in its September 12 and October 3 letters, and again consented to El Paso's meeting with Las Cruces and reiterated CSW's willingness to discuss with El Paso possible resolutions of the Las Cruces situation.\nOn October 11, 1994, the Bankruptcy Court granted an application by El Paso to employ special litigation counsel to advise El Paso as to ongoing activities with CSW and to assist El Paso as to the best means of preserving its rights. El Paso's application stated that special litigation counsel was needed to evaluate El Paso's rights, remedies and obligations with respect to CSW, the Plan and the Merger Agreement and to advise key officers of El Paso on a course of action to preserve and enforce El Paso's rights and remedies. The application also stated that special litigation\n2-56 counsel \"should also be in a position to conduct any litigation which may be necessary,\" and noted that another law firm then representing El Paso \"would not be in a position to represent the Debtor in litigation against CSW.\" On October 28, 1994, CSW filed a response to El Paso's application, in which CSW stated that while it did not oppose El Paso's motion to employ special litigation counsel, the hiring and future use of litigation counsel may be incongruous with the goal of consummating the Merger. The response also stated that El Paso's Disclosure Statement, pursuant to which it obtained confirmation of its Plan of Reorganization, contained projections that explicitly assume the continuation of service to Las Cruces and two military installations in New Mexico.\nBy letter dated December 21, 1994, El Paso objected to CSW's motion filed with the New Mexico Commission to extend the procedural schedule by two-weeks. CSW responded to El Paso in a letter dated January 11, 1995, that CSW considered the short two week extension to be in the best interest of obtaining favorable and timely regulatory approval in New Mexico. The two weeks were to be used to facilitate efforts to narrow and resolve outstanding issues in the proceedings and thereby expedite the progress of those proceedings. El Paso restated its disagreement to CSW's motion for extension in a letter dated January 16, 1995.\nBy letter dated January 13, 1995, CSW recommended that El Paso object to a request by the Equity Committee to renew its engagement of Salomon Brothers as financial advisor to said committee. CSW stated that the Merger Agreement requires the parties to cooperate in limiting professional fees and that the cost and timing of the reengagement is inappropriate. By letter dated January 20, 1995, El Paso responded to CSW that the Equity Committee's request to reemploy Salomon is a direct consequence of CSW's September 12 letter to El Paso and that it supports the Equity Committee's application. El Paso subsequently filed a statement of support of the Equity Committee's request in the Bankruptcy Court. On February 6, 1995, the Equity Committee of El Paso filed a response in the Bankruptcy Court to objections made by other parties to its rehiring of financial advisors in which the committee accused CSW of taking moves to back out of the Merger Agreement, thereby causing harm to the equity holders.\nOn January 3, 1995, a PFD was issued by the presiding officers in the proceedings pending before the Texas Commission relating to the Merger. On January 17, 1995, CSW and El Paso filed joint exceptions to the proposed decision, stating, among other things, that, \"in CSW's view, the rate relief recommended . . . falls far short of what is necessary for the consummation of the merger.\" That same day, CSW issued a press release describing the filing of the exceptions and repeating CSW's view that the terms of the proposed interim decision failed to provide sufficient revenue and adequate rate-making treatment for CSW to consummate the proposed Merger.\nIn a letter dated January 19, 1995, El Paso objected to the tenor of CSW's January 17 press release and claimed that CSW's press release harmed El Paso, its creditors, and shareholders and poisoned the regulatory approval process. CSW responded in a letter dated January 31 that it is El Paso's actions that have hindered obtaining the regulatory approvals necessary to consummate the Merger and that these actions were contrary to El Paso's obligations under the Merger Agreement. Further, CSW called on El Paso again to detail the steps it proposes to take to solve the problems identified by CSW in its September 12 letter cited in the PFD by the hearing examiners of the Texas Commission, and to desist from further actions which undercut CSW's efforts to obtain the rate relief, asset treatment and required regulatory approvals necessary to consummate the Merger.\nOn February 17, 1995, El Paso responded to CSW's January 31, 1995 letter stating that CSW's assertion that El Paso has breached the Merger Agreement are unfounded. El Paso further accused CSW of searching for a \"viable contractual excuse\" not to close the Merger.\n2-57 On February 20, 1995, El Paso sent a letter to CSW inquiring whether CSW would consent to the sale of the Las Cruces service territory by El Paso and, if so, on what terms and at what price. In addition, the letter inquired whether CSW would consent to a rate reduction in New Mexico and, if so, at what percentage reduction over what period of time. CSW responded in a February 27, 1995 letter that CSW is unwilling to give up any more of the value it bargained for in the Merger Agreement, or to accept the risk of a litigated outcome with Las Cruces. However, CSW encouraged dialogue between El Paso and Las Cruces and stated it continues to support El Paso's efforts to resolve its dispute with Las Cruces. CSW stated it is amenable to considering any alternatives negotiated between Las Cruces and El Paso that would not deprive the Merger of further value and that would enable El Paso to continue to serve the Las Cruces service area or provide El Paso with full compensation for the loss of Las Cruces. CSW looks to El Paso to resolve this situation prior to consummation of the proposed Merger.\nTexas Commission Applications On January 10, 1994, CSW and El Paso filed a joint application with the Texas Commission requesting a determination that the Merger is consistent with the public interest. As a part of the application, CSW proposed a three-step rate settlement plan, contingent upon the Texas Commission's approval of the Merger, that seeks to limit El Paso's proposed $41.4 million initial base rate increase for Texas customers, discussed below, to $25 million. In addition, the settlement rate plan proposed to reduce El Paso's fixed fuel factors by $12.8 million and refund $16.4 million from a one-time fuel reconciliation. As a result of the proposed annual reductions in fuel cost, El Paso's rates would not increase during the first year of the settlement plan. The settlement plan also provided for a three-year freeze on additional base rate increases, a limitation on the frequency of base rate increases following the rate freeze period through 2001 to not more than once every other year (i.e., 1997, 1999, and 2001), and a limitation on the amount of the 1997, 1999 and 2001 base rate increases to an amount not to exceed eight percent of total revenues. No party to the proceedings accepted CSW's rate settlement plan.\nOn January 10, 1994, El Paso separately filed with the Texas Commission for a base rate increase, exclusive of fuel, of approximately $41.4 million. The proposed rate increase represents what El Paso has stated it believes is supported under Texas law and prior Texas Commission orders, adjusted to reflect El Paso's proposed Merger with CSW. If the Texas Commission were to approve El Paso's request, the net effect would be to raise rates significantly higher than those proposed in the settlement plan.\nOn June 23, 1994, the El Paso City Council voted to reduce El Paso's rates $15.7 million following a recommendation from the City of El Paso's Public Utility Regulation Board. The City of El Paso's decision was appealed to the Texas Commission and consolidated with the rate case pending before that commission.\nOn June 24, 1994, the Staff filed testimony in the case before the Texas Commission recommending an increase in base rates of $17.1 million and taking the position that the proposed Merger is not in the public interest because of the possible cost increases to CSW's subsidiaries, which the Staff attributed to increased financial risk associated with the proposed acquisition of El Paso. The Staff's recommendation was revised and increased to a $21.5 million increase in base rates for El Paso in October 1994. In addition, the Staff determined that the proposed purchase price for El Paso is too high by $300 to $500 million and disagreed with the estimates of the Merger-related savings presented by CSW and El Paso in the case. Hearings at the Texas Commission began on July 20, 1994 and were completed in early November 1994.\nEffective July 16, 1994, El Paso implemented under bond, a base rate increase of approximately $25 million annually for its Texas jurisdiction, which is subject to refund depending on the outcome of the rate case. The bonded increase in rates is authorized under PURA. Because of the current uncertainty as to the final outcome of the rate proceeding, El Paso has stated that it is deferring on its books the recognition of the revenues resulting from the increased rates.\n2-58 On January 3, 1995, the Texas Commission presiding officers who heard El Paso's pending rate case and the CSW and El Paso Merger case filed their proposed interim decision with the Texas Commission. The presiding officers proposed an initial base-rate increase for El Paso of $21.2 million. The PFD recommends a determination by the Texas Commission that the Merger and the reacquisition of the leased Paso Verde assets are in the public interest and that the purchase price to be paid to El Paso's creditors and equity holders is fair, subject to satisfactory resolution of the Las Cruces and Palo Verde problems. The presiding officers found Merger related benefits ranging from $309 million to $379.4 million over the first ten years of the Merger which the presiding officers allocated to El Paso's customers under the PFD.\nIn addition to recommending the imposition of conditions in the determination that the Merger is in the public interest, the PFD failed to provide sufficient revenue and adequate rate-making treatment for CSW to consummate the proposed Merger. Specifically, the presiding officers propose to reduce El Paso's rates by allocating to customers certain potential tax benefits related to the payment of lease rejection damages on the leased Palo Verde assets. Reallocation of these tax benefits to customers effectively increases the acquisition cost to CSW by $133 million. The presiding officers attempted to mitigate the economic effect of their allocation of these tax benefits by allowing recovery through rates of an acquisition adjustment over the remaining 33 year life of Palo Verde. However, CSW believes that the proposed recovery through rates of an acquisition adjustment has considerably less economic value than the tax deductions. The presiding officers also recommended a reduction in El Paso's rate moderation plan and disallowance of El Paso's Palo Verde Unit 3 deferred accounting assets. CSW believes that, in recommending these rate treatments, the PFD fails to recognize rate relief to which El Paso is entitled under previous Texas Commission decisions in El Paso rate cases. Additionally, the PFD proposed an 11.5% return on equity rather than a 12.5% return which CSW believes is necessary for El Paso to have the opportunity to earn a reasonable return on its equity. Finally, the presiding officers proposed that the Texas Commission's interim order be conditioned on the successful resolution of the loss of Las Cruces as a customer of El Paso and on the successful resolution of the Palo Verde steam generator problems.\nOn March 3, 1995, the Texas Commission issued an interim order in the El Paso rate case and proposed Merger with CSW. The interim order found the proposed Merger to be in the public interest and provides for a $24.9 million base rate increase for El Paso. The interim order adopted most of the recommendations of the presiding officers. The most significant revision to the presiding officers recommendations was an increase in the allowed return on equity from 11.5% to 12%. The presiding officers' recommendations were adopted in the interim decision for several significant issues even though agreement was not reached by the Texas Commission. The interim decision allows for motions for reconsideration to be filed on these issues. The Texas Commission has indicated that the motions for reconsideration will be granted to allow for a consensus of the Texas Commission to be reached on these issues prior to the effective date of the merger. These issues included conditioning approval of the merger on resolution of the Las Cruces and Palo Verde issues, the rate treatment of the tax effects of lease rejection damages, recovery of any acquisition adjustment and deferred costs associated with the regulatory lag period prior to the rate treatment of Palo Verde Unit 3. Pending resolution of these issues, the Texas Commission allowed El Paso's bonded rates to remain in effect until a subsequent interim decision is issued.\nThe Texas Commission severed fuel related issues from the El Paso rate case and issued a final order which allows for El Paso to lower fixed fuel factors by $14.3 million annually and to refund $13.7 million in fuel costs over a twelve month period.\nNew Mexico Commission Application On March 14, 1994, CSW and El Paso filed an application with the New Mexico Commission seeking approval of the pending Merger, the reacquisition of the leased Palo Verde assets and certain accounting treatments. On February 10, 1995, the New Mexico Commission Staff filed testimony recommending approval of each of\n2-59 these requests. El Paso plans to seek approval for the issuance of securities in connection with the Merger.\nOn October 27, 1994, the hearing examiner assigned to hear CSW and El Paso's Merger application before the New Mexico Commission issued an order amending the procedural schedule to provide for hearings beginning February 13, 1995. On December 21, 1994, the hearing examiner issued an order granting a two week extension to the procedural schedule, resulting in hearings beginning February 27, 1995. Hearings in New Mexico were completed on March 2, 1995. This revised schedule allows for the issuance of a final order by the New Mexico Commission by June 1995. However, CSW cannot predict when a final order may be issued by the New Mexico Commission.\nFERC Applications On November 4, 1993, CSWS, as agent for the Electric Operating Companies and El Paso, filed an application with the FERC under Section 211 of the Federal Power Act seeking an order of the FERC and requiring SPS to provide firm and non-firm transmission services in connection with the transfers of power between PSO and El Paso in connection with the post-Merger coordinated operations of the Electric Operating Companies and El Paso. The intent of the transmission services is to obtain the benefits of integrated operations and thereby meet the requirement of the Holding Company Act that the Electric Operating Companies and El Paso be physically interconnected or capable of physical interconnection and economically operated as a single interconnected and coordinated electric system. SPS subsequently requested that the application be dismissed or, in the alternative, be set for hearing.\nOn January 10, 1994, as supplemented on January 13, 1994, CSWS, on behalf of the Electric Operating Companies and El Paso, filed a joint application with the FERC under Sections 203 and 205 of the Federal Power Act requesting approval by the FERC of the Merger. CSWS and El Paso have requested expedited consideration of the joint application. However, CSW cannot predict at this time when the FERC will issue a final decision on the joint application.\nOn August 1, 1994, the FERC issued orders in two proceedings that relate to the Merger. In an order issued under Section 211 of the Federal Power Act, the FERC preliminarily found that \"a final order requiring SPS to provide the transmission service requested by the Applicants would comply with the statutory standards, once reliability concerns have been met.\" The FERC's order rejects assertions made by SPS that the FERC has no authority under Section 211 to order transmission service where the purpose of the service is to allow coordination of merging utilities' operations. The order directed SPS to perform studies so that the FERC can determine whether provision of the requested transmission service will unreasonably impair reliability. Such studies and supplemental pleadings analyzing the studies were filed with the FERC in early October and November 1994. If, after reviewing the studies and comments filed by SPS, CSWS and El Paso, the FERC concludes that reliability will not be unreasonably impaired, the FERC will issue a further \"proposed order\" requiring El Paso, CSWS and SPS to negotiate the rates, terms and conditions on which the requested transmission service will be provided.\nThe FERC also issued an order under Section 203 of the FPA in which the FERC ruled that it will require merging utilities to offer transmission service to others on a basis that is comparable to their own uses of their transmission systems. On August 10, 1994, CSW and El Paso notified the FERC that they will accept, as a condition to the FERC's approval of CSW's acquisition of El Paso, the requirement to amend their non-ERCOT transmission tariffs to offer \"comparable service.\" On August 31, 1994, CSW and El Paso filed with the FERC a request for rehearing that, among other things, asks the FERC to reconsider the imposition of the comparable service requirement. On August 31, 1994, CSW and El Paso also filed the form of transmission tariffs they would propose to file with the FERC in order to meet the comparable service requirement if the requirement is upheld and the Merger is consummated. In agreeing to accept, as a condition to the Merger, the requirement that comparable service be provided over CSW's and El Paso's non-ERCOT transmission facilities, both CSW and El Paso\n2-60 do not intend to waive or otherwise prejudice any of their rights, including but not limited to the right to seek rehearing of the order or any other order the FERC later enters in these proceedings. In addition, both CSW and El Paso do not intend to waive or otherwise prejudice their right under the FPA to seek judicial review of the order or any subsequent order or orders, if and to the extent CSW and El Paso deem such action necessary or advisable.\nThe FERC has not yet determined what \"comparable service\" is. However, the FERC said it will establish what uses PSO, SWEPCO and El Paso make of their own systems. The FERC will also examine likely costs and benefits of the Merger and determine whether the Merger is consistent with the public interest. The FERC has instructed one of its administrative law judges to issue an initial decision by April 14, 1995. A FERC administrative law judge established a procedural schedule whereby hearings began January 3, 1995. Hearings ended January 25, 1995, and the judge's initial decision is expected to be issued on or before April 5, 1995.\nOn November 15, 1994, the FERC trial staff filed its testimony in the Merger proceeding. The FERC staff determined that the proposed Merger will result in total savings of $414 million, $265 million in net present value for the period 1995 through 2004 of post-Merger operations. This compares to Merger savings projected by CSW for the same period of $420 million, or $280 million in net present value. The staff found $140.7 million in non-fuel O&M expense savings, $109.0 million in financial savings, and $15.3 million in production cost savings.\nThe FERC staff has recommended that approval of the Merger be made subject to two conditions. As required in the FERC's August 1, 1994 order, the merged companies must offer the use of their non- ERCOT transmission system to others under rates, terms and conditions comparable to the rates, terms and conditions under which CSW will use their non-ERCOT transmission system. The FERC staff has also recommended that the Merger be approved, conditioned on the existing CSW Operating Companies not being allocated any transmission costs associated with firm transmission service across SPS's system in excess of $24.6 million, which is the amount CSW projects through 2004.\nThe FERC staff also determined that \"hold harmless conditions\" proposed by various state utility commissions and other intervenors to protect CSW Operating Companies from certain potential effects of the Merger are unnecessary to assure that the Merger is in the public interest. The FERC staff concluded that:\nAs proposed, the Merger is beneficial to El Paso and is roughly neutral with respect to the four present CSW Operating Companies. If enacted as proposed, with the Applicants' voluntary offer to exclude Merger-related transmission expenses of non-affiliates from the transmission customers of CSW's four current Operating Companies, the Merger should not substantially harm any class of wholesale customers.\nSEC Application On January 10, 1994, CSW filed with the SEC an application under the Holding Company Act seeking authorization of (i) the Merger and reacquisition of the Palo Verde leased assets, (ii) the issuance of securities by CSW and El Paso in connection with the Modified Plan and Merger and certain related transactions, and (iii) to engage in certain hedging transactions in connection with the Merger. CSW subsequently amended the application to eliminate the request for authorization to engage in certain hedging transactions, at the request of the SEC staff. CSW has subsequently amended and supplemented the application and has filed a brief in response to intervention petitions. CSW cannot predict what action the SEC will take with respect to the application, or when such action will be taken.\n2-61 NRC Application On January 13, 1994, APS, as operating agent for Palo Verde, joined by El Paso, filed a request with the NRC for (i) consent to the indirect transfer of El Paso's interest in the operating licenses for Palo Verde Units 1, 2, and 3 that will occur as a result of the Merger, and (ii) to amend the operating licenses for Units 2 and 3 to delete provisions of those licenses related to El Paso's sale and leaseback transactions involving those units. The request to the NRC specifies that the proposed amendments to the operating licenses and consent become effective on the Effective Date, but CSW cannot predict at this time whether and, if so, when the approvals and consent will be granted.\nPalo Verde The operating agent of Palo Verde, APS, discovered axial cracking in steam generator tubes in Unit 2 following a tube rupture in March 1993. APS began an ongoing examination and analysis of the tubes in each of the two steam generators in each unit of Palo Verde and, as a result, has identified axial cracking in Unit 3 and another more common type of cracking in the steam generator tubes of all three units. APS has indicated that it believes the axial cracking in Units 2 and 3 is due to the susceptibility of tube materials to a combination of deposits on the tubes and the relatively high temperatures at which all three units at Palo Verde are designed to operate. According to statements by APS and El Paso, the form of the degradation experienced in the steam generators is uncommon in the nuclear industry. APS has stated that it believes it can retard further tube degradation to acceptable levels by remedial actions, which include chemically cleaning the steam generators and performing analyses and adjustments that will allow the units to be operated at lower temperatures without appreciably reducing their power output. These analyses and adjustments have been performed on all three units, with each unit operating at 100% of capability. All remedial actions have been completed on each of the three units, except for chemically cleaning Unit 1 which is scheduled for April 1995. El Paso has stated that it is incurring increased maintenance costs related to the mid-cycle inspections of the steam generator tubes and the remedial actions being undertaken to retard tube degradation. El Paso also incurs additional costs for fuel and\/or purchased power during periods in which one or more units are removed from service every 6 months for inspections. In its September 12, 1994 letter to El Paso, CSW stated that the significance of the tube cracking problems will have to be determined before CSW will close the Merger.\nOther El Paso is subject to the informational requirements of the Securities and Exchange Act of 1934, as amended, and in accordance therewith files reports and other information with the SEC. See El Paso's Quarterly Reports on Form 10-Q, its Current Reports on Form 8-K and its Annual Report on Form 10-K and the documents referenced therein.\nCSW continues to use its best efforts to consummate the Merger. At the same time, however, CSW continues to monitor contingencies which may preclude the consummation of the Merger, including without limitation the potential loss of significant portions of El Paso's service area and significant El Paso customers, including Las Cruces and two military installations, Holloman Air Force Base and White Sands Missile Range, regulatory risks principally related to approval of the Merger and El Paso's request for a rate increase in Texas as well as the effects of the conditions imposed by federal or state regulatory agencies on the approval of the Merger, and operating risks associated with the ownership of an interest in Palo Verde.\nBased upon El Paso's written response to the concerns identified in CSW's September 12 letter and the failure of El Paso to resolve items set forth in the preceding paragraph, CSW cannot predict whether, and if so when, the Merger will be consummated. In the event that the proposed Merger is not consummated, there may be ensuing litigation between El Paso and CSW or among other parties to El Paso's bankruptcy proceedings and either or both of El Paso and CSW.\n2-62 See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Proposed Acquisition of El Paso, for further information.\nOther Commitments and Contingencies\nConstruction It is estimated that the CSW System will spend approximately $385 million in construction expenditures during 1995. Substantial commitments have been made in connection with this construction expenditure program.\nFuel To supply a portion of the fuel requirements of the CSW System, the subsidiary companies have entered into various commitments for the procurement of fuel.\nSWEPCO Henry W. Pirkey Power Plant In connection with the South Hallsville lignite mining contract for its Henry W. Pirkey Power Plant, SWEPCO has agreed, under certain conditions, to assume the obligations of the mining contractor. As of December 31, 1994, the maximum amount SWEPCO would have to assume was $73.7 million. The maximum amount may vary as the mining contractor's need for funds fluctuates. The contractor's actual obligation outstanding at December 31, 1994 was $60.9 million.\nSouth Hallsville Lignite Mine As part of the process to receive a renewal of a Texas Railroad Commission permit for lignite mining at the South Hallsville lignite mine, SWEPCO has agreed to provide bond guarantees on mine reclamation in the amount of $70 million. Since SWEPCO uses self- bonding, the guarantee provides for SWEPCO to commit to use its resources to complete the reclamation in the event the work is not completed by the third party miner. The current estimate of cost to reclaim the mine is estimated to be approximately $25 million.\nCoal Transportation SWEPCO has entered into various financing arrangements primarily with respect to coal transportation and related equipment, which are treated as operating leases for rate-making purposes. At December 31, 1994, leased assets of $46 million, net of accumulated amortization of $30.1 million, were included in electric plant on the balance sheet and at December 31, 1993, leased assets were $46 million, net of accumulated amortization of $26.8 million. Total charges to operating expenses for leases were $6.8 million, $7.1 million, and $6.9 million for the years 1994, 1993, and 1992.\nSuspected MGP Site in Marshall, Texas SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO has accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\nSuspected MGP Site in Texarkana, Texas and Arkansas and Shreveport, Louisiana SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\n2-63 Biloxi, Mississippi MGP Site SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nManagement does not expect these matters to have a material effect on CSW's consolidated results of operations or financial position.\nWTU WTU has a sale\/leaseback agreement with Transok for full capacity use of a natural gas pipeline to WTU's Ft. Phantom generating plant. The lease agreement also provides for full capacity use of Transok's natural gas pipelines serving WTU's San Angelo and Oak Creek generating plants. The initial terms of the agreement are for twelve years with renewable options thereafter.\nCPL Nuclear Insurance In 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 $8.92 billion per incident, effective as of January 1995. 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 $8.72 billion. The maximum amount that each licensee may be assessed under the industry-wide program of self-insurance following a nuclear incident at an insured facility is $75.5 million per reactor, 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. CPL and each of the other STP owners are subject to such assessments, which CPL and other owners have agreed will be allocated 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 $2.75 billion provided by ANI and NEIL. Policies of insurance issued by ANI and NEIL stipulate that policy proceeds must be used first to pay decontamination and clean-up costs before being used to cover direct losses to property. Under project agreements, CPL and the other owners of STP will share the total cost of decontamination liability and property insurance for STP, including premiums and assessments, on a pro rata basis, according to each owner's respective ownership interest in STP.\nCPL purchases, for its own account, a NEIL I Business Interruption and\/or Extra Expense policy. This insurance will reimburse CPL for extra expenses incurred, up to $1.65 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 $111.3 million and for Unit 2 is $111.8 million. CPL is subject to an additional assessment up to $2.1 million for the current policy\n2-64 year in the event that losses as a result of a covered accident at a nuclear facility insured under the NEIL I policy exceeds the accumulated funds available under the policy.\nOn August 28, 1994, CPL filed a claim under the NEIL I policy related to the outage at STP Units 1 and 2. NEIL is currently reviewing the claim. CPL management is unable to predict the ultimate outcome of this matter.\nCSWE CSWE has provided construction services to the Mulberry cogeneration facility through a wholly-owned subsidiary, CSW Development-I, Inc. The project achieved commercial operation in August 1994 and added 117 MWs of on-line capacity of which CSWE owns 50%. CSWE's maximum potential liability under the fixed price contract is $83 million and will decrease to zero over the next two years as contractual standards are met. Additionally, CSW Development-I, Inc. has entered into a fixed price contract to construct the Mulberry thermal host facility. The maximum potential liability under this fixed price contract is $14 million. The thermal host facility is expected to be completed by the first quarter of 1995. CSW has provided additional guarantees to the project totaling approximately $57 million.\nCSWE has entered into a purchase agreement on the Ft. Lupton project to provide $79.5 million of equity upon the occurrence of certain events. As of January 9, 1995, $43 million has been paid. CSWE has provided three letters of credit to the project totaling $14.3 million. During March 1995, CSWE closed permanent project financing on the Ft. Lupton facility in the amount of $208 million.\nCSWE has committed to provide up to $125 million of construction financing to the Orange cogeneration project in which CSWE owns a 50% interest. Of this total, CSWE has provided $62 million at December 31, 1994. CSWE expects to obtain third party permanent financing for this project in 1995.\nIn November 1994, CSWE transferred its 50% interest in the 40 MW Oildale cogeneration facility to two non-affiliated third parties, Oildale Holdings, Inc. and Oildale Holdings II, Inc. The Oildale project, which was financed with third party non-recourse project financing, had been in default of certain provisions of its loan agreement since December 1993. Under the terms of the project transfer, CSWE contributed $3 million in equity in exchange for the return of a letter of credit in the same amount in favor of a third party lender.\nIn addition, CSWE has posted security deposits and other security instruments of approximately $14 million on six additional projects in various stages of development, construction, and operation.\n2-65 12. Business Segments CSW's business segments include electric utility operations (CPL, PSO, SWEPCO, WTU), and gas operations (Transok). Seven non- utility companies are included in corporate items (CSWE, CSWI, CSW Communications, CSW Credit, CSW Leasing, CSWS and CSW). CSW's business segment information follows: 1994 1993 1992 (millions) Operating Revenues Electric $ 3,065 $ 3,055 $ 2,790 Gas 518 603 496 Corporate items and other 40 29 3 $ 3,623 $ 3,687 $ 3,289 Operating Income Electric $ 728 $ 559 $ 694 Gas 49 25 42 Corporate items and other 6 5 1 Total operating income before taxes 783 589 737 Income taxes 189 132 149 $ 594 $ 457 $ 588 Depreciation and Amortization Electric $ 316 $ 296 $ 284 Gas 32 29 22 Corporate items and other 8 5 5 $ 356 $ 330 $ 311 Identifiable Assets Electric $ 9,066 $ 8,927 $ 8,575 Gas 724 684 674 Corporate items and other 1,119 993 580 $10,909 $10,604 $ 9,829 Capital expenditures and acquisitions Electric $ 493 $ 481 $ 325 Gas 65 88 101 Corporate items and other (1) 114 64 31 $ 672 $ 633 $ 457\n(1) Includes CSWE Equity Investments.\n2-66 13. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts. Earnings per Share Operating Operating Net of Common Quarter Ended Revenues Income Income Stock (millions) March 31 $ 850 $ 93 $ 48 $0.23 June 30 908 157 107 0.55 September 30 1,070 239 189 0.97 December 31 795 105 68 0.33 $3,623 $ 594 $ 412 $2.08\nMarch 31 $ 810 $ 97 $ 92 $0.47 June 30 894 144 96 0.48 September 30 1,140 219 181 0.93 December 31 843 (3) (42) (0.25) $3,687 $ 457 $ 327 $1.63\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-67 Report of Independent Public Accountants\nTo the Stockholders and Board of Directors of Central and South West Corporation:\nWe have audited the accompanying consolidated balance sheets of Central and South West Corporation (a Delaware corporation) and subsidiary companies, as of December 31, 1994 and 1993, and the related consolidated statements of income, retained earnings and cash flows, for each of the three years in the period ended December 31, 1994. 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 financial position of Central and South West Corporation and subsidiary companies as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, Central and South West Corporation and subsidiary companies changed their methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states 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 LLP\nDallas, Texas February 13, 1995\n2-68 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the consolidated financial statements of Central and South West Corporation and subsidiary companies as well as other information contained in this Annual Report. The consolidated 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 Annual Report is consistent with that in the consolidated financial statements.\nThe consolidated financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of stockholders, the board of directors and committees of the board. CSW and its subsidiaries believe that representations made to the independent auditors during their audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nCSW, together with its subsidiary companies, maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the consolidated financial statements are prepared in accordance with generally accepted accounting principles and that the assets of CSW and its subsidiaries are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that the companies will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of CSW or its subsidiaries, provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nCSW and its subsidiaries believe that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nE. R. Brooks Glenn D. Rosilier Wendy G. Hargus Chairman, President and Senior Vice President and Controller Chief Executive Officer Chief Financial Officer\n2-70\nCPL\nCENTRAL POWER AND LIGHT COMPANY Selected Financial Data CPL The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for CPL.\n1994 1993 1992 1991 1990 (thousands, except ratios) Electric Operating Revenues $1,217,979 $1,223,528 $1,113,423 $1,098,730 $ 948,520 Income Before Cumulative Effect of Changes in Accounting Principles 205,439 145,130 218,511 217,206 204,870 Cumulative Effect of Changes in Accounting Principles (1) -- 27,295 -- -- -- Net Income 205,439 172,425 218,511 217,206 204,870 Preferred Stock Dividends 13,804 14,003 16,070 19,844 23,528 Net Income for Common Stock 191,635 158,422 202,441 197,362 181,342\nTotal Assets (2) 4,822,699 4,781,745 4,583,660 4,458,063 4,516,375\nCommon Stock Equity 1,431,354 1,424,195 1,437,876 1,428,547 1,449,409 Preferred Stock Not Subject to Mandatory Redemption 250,351 250,351 250,351 250,351 250,351 Subject to Mandatory Redemption -- 22,021 28,393 35,331 40,584 Long-term Debt 1,466,393 1,362,799 1,347,887 1,350,854 1,346,587\nRatio of Earnings to Fixed Charges (SEC Method) Before Cumulative Effect of Changes in Accounting Principles 3.24 2.69 3.23 3.18 3.11\nCapitalization Ratios Common Stock Equity 45.5% 46.6% 46.9% 46.6% 47.0% Preferred Stock 7.9 8.9 9.1 9.3 9.4 Long-term Debt 46.6 44.5 44.0 44.1 43.6\n(1) The 1993 cumulative effect relates to the changes in accounting for unbilled revenues and adoption of SFAS No. 112. See NOTE 1, Summary of Significant Accounting Policies.\n(2) The 1992-1990 total assets have been reclassified to reflect the effects of the adoption in 1993 of SFAS No. 109. See NOTE 2, Federal Income Taxes.\nCPL changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore has not been restated.\n2-71 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCENTRAL POWER AND LIGHT COMPANY\nReference is made to CPL's Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential in understanding, the following discussion and analysis.\nOverview Net income for common stock for 1994 increased 21% to $192 million from $158 million in 1993. The increase was due primarily to an increase in base revenues, a decrease in restructuring costs and a decrease in maintenance expense. Such increases were partially offset by the cumulative effect of changes in accounting principles recorded in 1993.\nRestructuring As previously reported, CPL has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable CPL to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $29 million and were expensed in 1993. The final costs of the restructuring were approximately $29 million. Approximately $28 million of the restructuring expenditures were incurred during 1994, with the remaining $1 million expected to be incurred during 1995. Approximately $4 million of the restructuring expenses relate to employee termination benefits, $15 million relate to enhanced benefit costs and $10 million relate to employees that will not be terminated. Approximately $21 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $8 million represents the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nCPL expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. The CSW System expects that all restructuring costs will be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nSTP Introduction CPL owns 25.2% of STP, a two-unit nuclear power plant which is located near Bay City, Texas. In addition to CPL, 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.\nFrom February 1993 until May 1994, STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL. These matters, including a base rate case and fuel reconciliation proceedings, are discussed immediately below.\nSTP Outage In February 1993, Units 1 and 2 of STP were shut down by HLP in an unscheduled outage resulting from mechanical problems. HLP determined that the units would not be restarted until the equipment failures had been corrected and the NRC was briefed on the causes of\n2-72 these failures and the corrective actions that were taken. The NRC formalized that commitment in a confirmatory action letter that it supplemented to identify additional issues to be resolved and verified by the NRC before STP could be restarted.\nDuring the outage, the necessary improvements were 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 agreed with HLP's recommendation that Unit 1 was ready to restart. Unit 1 restarted on February 25, 1994 and reached 100% power on April 8, 1994. Subsequently, the issues with respect to Unit 2 were resolved and the NRC on May 17, 1994 agreed with HLP's recommendation to restart Unit 2. Unit 2 resumed operation on May 30, 1994 and reached 100% power on June 16, 1994. During 1994, Unit 1 and Unit 2 achieved annual net capacity factors of 75.3% and 54.7%, respectively. During the last six months of 1994, the STP units operated at capacity factors of 98.6% for Unit 1 and 99.2% for Unit 2.\nIn June 1993, the NRC placed STP on its \"watch list\" of plants with \"weaknesses that warrant increased NRC attention.\" The decision to place STP on the watch list followed the June 1993 issuance of a report by an NRC Diagnostic Evaluation Team which conducted a review of STP operations.\nOn February 3, 1995, the NRC removed STP from the \"watch list\". The NRC noted that the four key areas for their decision were sustained improvement throughout 1994, high standards of performance exhibited by the plant, effective maintenance and engineering support resulting in reduced equipment repair backlogs and improved plant reliability, and the open and positive employee climate at the plant. With the NRC reviewing the \"watch list\" status every 6 months and with Unit 2 achieving 100% power in June of 1994, the February review was the first realistic opportunity for STP to be considered for a change in status. On average, plants previously placed on the \"watch list\" have stayed on the list for 29 months.\nRates and Regulatory Matters CPL Rate Inquiry Several Cities, the Texas Commission General Counsel and others initiated actions in late 1993 and early 1994 which, if approved by the Texas Commission, would lower CPL's base rates. The requests for a review of CPL's rates arose out of the unscheduled outage at STP which began in February 1993. The STP outage did not affect CPL's ability to meet customer demand because of existing capacity and CPL's purchase of additional energy.\nCPL submitted an RFP on July 1, 1994, to the Texas Commission justifying its current base rate structure. Parties to CPL's base rate case have filed testimony with the Texas Commission recommending reductions in CPL's retail base rates of up to $147 million annually, resulting from a combination of proposed rate base and cost of service reductions, as well as a rate base disallowance of up to $400 million.\nThe Texas Commission held hearings in November and December 1994, and all parties have filed briefs in the case. The ALJ is expected to issue a recommended order for consideration by the Texas Commission in April 1995 with a final order from the Texas Commission expected in May 1995. Testimony filed by parties to the rate case, including the Staff, is not binding on either the ALJ or the Texas Commission.\nCPL continues to maintain that its rates are reasonable and that its earnings are within established regulatory guidelines. In addition, CPL strongly believes that 100 percent of its investment in both units of STP belongs in rate base. This belief is based on, among other factors, Units 1 and 2 providing output at high capacity factors since April and June 1994, respectively. In addition, the long-term benefits nuclear generation provides to customers further support their inclusion in rate base. Furthermore, there are no Texas Commission precedents addressing the removal of a nuclear plant from rate base as a performance disallowance. Assuming both units of STP are included in rate base, CPL believes it is not collecting excessive revenues, notwithstanding that market rates of return on\n2-73 common equity are generally lower today than they were in 1990 and 1991, when CPL's base rates were last set.\nCPL Fuel Pursuant to the substantive rules of the Texas Commission, CPL generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and CPL'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 from revenues, with a corresponding entry to unrecovered fuel costs 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.\nCPL is currently involved in two proceedings before the Texas Commission relating to the recovery of fuel and purchased power costs. CPL originally filed Docket No. 12154 seeking approval of a customer surcharge to recover fuel and purchased power costs, including those resulting from the STP outage. In Docket No. 13126, the Texas Commission General Counsel and others are reviewing the prudence of management activities at STP. In November 1994, CPL filed a fuel reconciliation case in Docket No. 13650 with the Texas Commission seeking to reconcile fuel costs since March 1, 1990, including the period during which CPL's fuel and purchased power costs were increased due to the STP outage. At December 31, 1994, CPL's under-recovered fuel balance was $54.1 million, exclusive of interest, which was due primarily to the STP outage. If a significant portion of the fuel costs were disallowed by the Texas Commission, CPL could experience a material adverse effect on its results of operations in the year of disallowance but not on its financial condition. Finally, in Docket No. 13126, the Texas Commission General Counsel is reviewing the prudence of management activities at STP. On January 4, 1995, Docket No. 12154 was consolidated into Docket No. 13650. The results of the prudence inquiry in Docket No. 13126 are expected to be incorporated into the fuel reconciliation proceedings in Docket No. 13650.\nCPL continues to negotiate with the intervening parties to resolve these matters through settlement. However, no settlement has been reached to date.\nManagement cannot predict the ultimate outcome of the CPL rate inquiry and CPL fuel regulatory proceedings. However, management believes that the ultimate resolution of the various issues will not have a material adverse effect on CPL's results of operations or financial condition.\nSee NOTE 9, Litigation and Regulatory Proceedings - STP, for a discussion of regulatory proceedings arising out of the STP outage and background on STP rate orders and deferred accounting.\nNuclear Decommissioning CPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning and is net of expected earnings on the trust fund.\nThe staff of the SEC has questioned certain of the current accounting practices of the electric utility industry regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations. In response to these questions, FASB has agreed to review the accounting for removal costs, including decommissioning. If current electric utility industry accounting practices for such decommissioning are changed, (i) annual provisions for decommissioning could increase, (ii) the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation, and (iii) trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense.\n2-74 See NOTE 1, Summary of Significant Accounting Policies - Nuclear Decommissioning, for further information regarding CPL's decommissioning of STP.\nNew Accounting Standards SFAS No. 115 was effective for fiscal years beginning after December 15, 1993. CPL adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on CPL's results of operations or financial condition.\nIn June 1993 the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by CPL for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on CPL's results of operations or financial condition.\nSFAS No. 119 was effective for fiscal years ending after December 15, 1994. CPL does not currently use derivative instruments, but may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on CPL's results of operations or financial condition.\nLiquidity and Capital Resources Overview CPL's need for capital results primarily from its construction of facilities to provide reliable electric service to its customers. Accordingly, internally generated funds should meet most of the capital requirements. However, if internally generated funds are not sufficient, CPL's financial condition should allow it access to the capital markets.\nCapital Expenditures Construction expenditures, including AFUDC, were approximately $178 million in 1994, $180 million in 1993, and $102 million in 1992. It is estimated that construction expenditures, including AFUDC, during the 1995 through 1997 period will aggregate $357 million. Such expenditures primarily will be made to improve and expand distribution facilities. These improvements are expected to meet the needs of new customers and to satisfy changing requirements of existing customers. No new baseload power plants are currently planned until after year 2000.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in CPL's service area, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected coal- and lignite-fired generating plants for which CPL has invested approximately $21 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, CPL would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of CPL were 45% common stock equity, 8% preferred stock and 47% long-term debt. CPL continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. CPL continues to be committed to maintaining financial flexibility by maintaining a strong capital structure and favorable securities ratings which should allow funds to be obtained from the capital markets when required.\n2-75 CPL's long-term financing activity for 1994 is summarized as follows:\nIn May, CPL issued $100 million of 7-1\/2% First Mortgage Bonds, Series JJ, due May 1, 1999. Net proceeds were used to repay a portion of CPL's short-term borrowings.\nIn July and August, CPL reacquired $0.6 million of 9-3\/8% First Mortgage Bonds, Series Z, due December 1, 2019. The funds required for this transaction were provided from internal sources.\nIn August, CPL retired $22.4 million, all remaining shares outstanding, of its 10.05% Series Preferred Stock. The funds required for this transaction were provided from internal sources and short- term borrowings.\nCPL has $260 million remaining for the issuance of first mortgage bonds under a shelf registration statement filed with the SEC in 1993. CPL may offer additional first mortgage bonds subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost first mortgage bonds in order to lower CPL's embedded cost of debt.\nCPL has $75 million available for issuance of preferred stock under a shelf registration statement filed with the SEC in March 1994. CPL may offer preferred stock subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost preferred stock and to repay short-term debt.\nShort-Term Financing CPL, together with other members of CSW System, has established a CSW System money pool to coordinate short-term borrowings. These loans are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs. CPL's short-term borrowing limit from the money pool is $300 million. During 1994, the annual weighted average interest rate was 4.5% and the average amount of short- term month-end borrowings outstanding was $129 million. The maximum amount of short-term borrowings outstanding at any month-end during 1994 was $232 million, which was the amount outstanding at February 28, 1994.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. CPL uses short- term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. CPL anticipates that capital requirements for the period 1995 to 1997 will be met, in large part, from internal sources. CPL also anticipates that some external financing will be required during the period, but the nature, timing and extent have not yet been determined. Information concerning internally generated funds follows:\n1994 1993 1992 (millions) Internally Generated Funds $114 $92 $95\nConstruction Expenditures Provided by Internally Generated Funds 65% 52% 94%\nSales of Accounts Receivable CPL sells its billed and unbilled accounts receivable, without recourse, to CSW Credit. The sales provided CPL with cash immediately, thereby reducing working capital needs and revenue requirements. The average and year end amounts of accounts receivable sold were $121.9 million and $113.5 million in 1994, as compared to $112.3 million and $105.8 million in 1993.\n2-76 Recent Developments and Trends Competition and Industry Challenges Competitive forces at work in the electric utility industry are impacting CPL and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, CPL will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. CPL believes that its prices for electricity and the quality and reliability of its service currently places it in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While CPL believes that the Energy Policy Act will continue to make the wholesale markets more competitive, CPL is unable to predict the extent to which the Energy Policy Act will impact its operations.\nIncreasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. CPL competes in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities, but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers.\nCPL believes that, compared to other electric utilities, it is well positioned to meet future competition. CPL benefits from economies of scale and scope by virtue of its size and its relationship to the CSW System. Moreover, CPL is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nCPL is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or on CPL. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\n2-77 Public Utility Regulatory Act PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. CPL is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted. If, however, the Texas Legislature passes legislation permitting any form of retail wheeling, such legislation could have an adverse impact on CPL and CPL's sales to its retail customers.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, CPL has recognized significant regulatory assets and liabilities. Management believes that CPL will continue to meet the criteria for following SFAS No. 71. However, in the event CPL no longer meets the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nConsolidated Taxes The Texas Commission before 1992 allowed income taxes to be recovered in rates based on the federal income tax incurred by a utility as if it were a stand-alone company. This stand-alone approach treated the regulated activities of a utility as a separate entity and considered only those revenues and expenses that are included in the utility's cost of service to calculate the federal income tax liability for ratemaking purposes.\nBeginning in 1992, the Texas Commission changed its method of calculating the federal income tax component of rates to the \"actual tax approach.\" The actual tax approach is an evolving concept but generally seeks to reflect in rates the actual tax liability of the utility irrespective of its relationship to the utility's cost of service. The approach reduces rates by the tax benefits of deductions which are not considered for or included in setting rates for the utility.\nThe Texas Commission is expected to use the actual tax approach for calculating the recovery of federal income tax in the pending rate case for CPL. The impact of the actual tax approach on the prospective rates for CPL cannot be determined since the application of the concept is unsettled.\nCPL believes that the recovery of federal income taxes in rates should be determined on the stand-alone approach for ratemaking purposes, but there is no assurance this approach will be adopted in the pending CPL rate case.\nEnvironmental Matters CERCLA and Related Matters The operations of CPL, like those of other utilities, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nCPL is subject to various pending claims alleging it is a PRP under federal or state remedial laws for investigating and cleaning up contaminated property. CPL anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on CPL's results of operations or financial condition.\n2-78 Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by CPL, the estimated amount of costs allocated to CPL and the participation of other parties.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, CPL will be required to hold allowances in order to emit sulfur dioxide. The EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, CPL believes that its allowances will be adequate to meet its needs at least through 2008. Public and private markets are developing for trading of excess allowances. CPL presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\nThe Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on CPL cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, CPL expects to spend $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects. Although a few of the studies to date have suggested certain associations between EMFs and some types of effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. CPL cannot predict the impact on CPL or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nResults of Operations Electric Operating Revenues Total revenues decreased $5.5 million in 1994 and increased $110.1 million in 1993. The 1994 decrease reflects lower fuel- related revenues of $41.5 million partially offset by higher base revenues of $35.9 million. Fuel-related revenues declined as a result of lower per unit fuel and purchased power costs, as discussed below.\nTotal KWH sales were up 8%, reflecting growth of 7% in retail sales and 41% in lower margin sales for resale. All of CPL's retail classes showed KWH growth with increases of 6% in both residential and commercial sales. An increase in the number of residential and commercial customers served and warmer spring as well as summer weather also contributed to this growth. Industrial sales were up 8% as a result of higher demand in the petrochemical and petroleum industries, where several companies CPL serves had plant expansions and increased load requirements. The rise in sales for resale is attributable to warmer summer and spring weather and lower cost STP generation.\nThe increase in revenues in 1993 over 1992 reflects higher fuel- related revenues and greater base revenues. Fuel-related revenues were up because of the rise in per unit fuel and purchased power costs, as discussed below, and higher fuel consumption on greater KWH sales.\n2-79 Fuel and Purchased Power Fuel expense decreased $21.8 million or 6% due primarily to a decrease in the average unit cost of fuel from $2.17 in 1993 to $1.75 in 1994 partially offset by a 16% increase in generation. The lower average unit cost of fuel reflects increased usage of lower unit cost nuclear fuel since STP Units 1 and 2 restarted and reached 100 percent output level in April and June of 1994, respectively, and lower unit costs of gas and coal in 1994. STP Units 1 and 2 had not operated at full capacity since February 1993 as discussed in Litigation and Regulatory Proceedings in NOTE 9.\nFuel expense increased in 1993 due primarily to higher fuel consumption in both gas and coal as a result of the STP outage and an increase in the average unit cost of fuel from $1.70 in 1992 to $2.17 in 1993.\nPurchased power decreased $21.7 million during 1994 and increased $46.9 million in 1993 when compared to the prior year due to the outage at STP.\nOther Operating and Maintenance Expenses and Taxes Other operating expenses were relatively stable in 1994 and increased $40.5 million or 22% in 1993 when compared to the prior year.\nThe 1993 increase in other operating expenses was due primarily to the higher costs associated with the STP outage and increased pension and medical costs, which included implementation of SFAS No. 106.\nRestructuring charges reflect the initial estimated cost of $29 million as previously discussed. Such expenses include the estimated costs associated with the early retirement program, severance packages and relocation.\nMaintenance expense decreased $12.8 million during 1994 and increased $20.0 million in 1993 when compared to the prior year due primarily to maintenance activities at STP associated with the outage.\nDepreciation and amortization increased in 1994 and 1993 as a result of increases in depreciable plant. The increase in 1994 is also attributable to a decline in amortization credits related to power plant investment.\nTaxes, other than federal income, decreased in 1994 mainly as a result of a franchise tax refund. The increase in 1993 is largely a result of increased ad valorem taxes.\nFederal income taxes increased $10.2 million in 1994 due to higher pre-tax income. Federal income taxes decreased $12.1 million in 1993 due to lower pre-tax income partially offset by the increase in the statutory tax rate from 34% to 35% effective retroactive to January 1, 1993.\nInflation Annual inflation rates, as measured by the Consumer Price Index, have averaged 2.7% during the three years ended December 31, 1994. CPL believes that inflation, at these levels, does not materially affect its results of operation 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.\nMirror CWIP Liability Amortization CPL is amortizing its Mirror CWIP liability in declining amounts over the years 1991 through 1995. Non-cash earnings of $68 million were recognized in 1994, a decrease from the $75.7 million recognized in 1993. The remaining liability to be amortized for 1995 is $41 million, which will fully amortize the Mirror CWIP liability.\n2-80 Cumulative Effect of Changes in Accounting Principles In 1993, CPL changed its method of accounting for unbilled revenues and implemented SFAS No. 112. These accounting changes had a cumulative effect of increasing net income by $27.3 million.\n2-81 Statements of Income Central Power and Light Company For the Years Ended December 31, 1994 1993 1992 (thousands)\nElectric Operating Revenues Residential $ 474,480 $ 474,426 $ 432,295 Commercial 368,405 369,426 342,201 Industrial 271,738 281,247 240,341 Sales for resale 50,777 45,369 50,342 Other 52,579 53,060 48,244 1,217,979 1,223,528 1,113,423 Operating Expenses and Taxes Fuel 328,460 350,268 306,939 Purchased power 42,342 64,025 17,160 Other operating 224,852 225,034 184,514 Restructuring charges 98 29,365 -- Maintenance 68,537 81,352 61,399 Depreciation and amortization 141,622 131,825 129,131 Taxes, other than federal income 80,461 86,394 70,343 Federal income taxes 75,356 65,186 77,272 961,728 1,033,449 846,758\nOperating Income 256,251 190,079 266,665\nOther Income and Deductions Allowance for equity funds used during construction 1,215 1,074 408 Mirror CWIP liability amortization 68,000 75,702 82,527 Other 1,272 1,663 890 70,487 78,439 83,825\nIncome Before Interest Charges 326,738 268,518 350,490\nInterest Charges Interest on long-term debt 111,408 112,939 125,476 Interest on short-term debt and other 12,365 11,993 7,266 Allowance for borrowed funds used during construction (2,474) (1,544) (763) 121,299 123,388 131,979\nIncome Before Cumulative Effect of Changes in Accounting Principles 205,439 145,130 218,511\nCumulative Effect of Changes in Accounting Principles -- 27,295 --\nNet Income 205,439 172,425 218,511 Preferred stock dividends 13,804 14,003 16,070 Net Income for Common Stock $ 191,635 $ 158,422 $ 202,441\nThe accompanying notes to financial statements are an integral part of these statements.\n2-82 Statements of Retained Earnings Central Power and Light Company For the Years Ended December 31, 1994 1993 1992 (thousands)\nRetained Earnings at Beginning of Year $850,307 $863,988 $854,659 Net income for common stock 191,635 158,422 202,441 Deduct: Common stock dividends 183,000 172,000 193,000 Preferred stock redemption costs 1,476 103 112 Retained Earnings at End of Year $857,466 $850,307 $863,988\nThe accompanying notes to financial statements are an integral part of these statements.\n2-83 Balance Sheets Central Power and Light Company As of December 31, 1994 1993 (thousands) ASSETS Electric Utility Plant Production $3,070,005 $3,061,911 Transmission 451,050 351,584 Distribution 828,350 765,266 General 216,888 209,170 Construction work in progress 142,724 168,421 Nuclear fuel 161,152 160,326 4,870,169 4,716,678 Less - Accumulated depreciation 1,400,343 1,263,372 3,469,826 3,453,306 Current Assets Cash and temporary cash investments 642 2,435 Special deposits 668 1,967 Accounts receivable 29,865 23,850 Materials and supplies, at average cost 66,209 64,359 Fuel inventory, at average cost 22,916 16,934 Accumulated deferred income taxes -- 4,831 Unrecovered fuel costs 54,126 52,959 Prepayments and other 2,316 2,255 176,742 169,590 Deferred Charges and Other Assets Deferred STP costs 488,987 489,773 Mirror CWIP asset 321,825 331,845 Income tax related regulatory assets, net 288,444 266,597 Other 76,875 70,634 1,176,131 1,158,849 $4,822,699 $4,781,745\nThe accompanying notes to financial statements are an integral part of these statements.\n2-84 Balance Sheets Central Power and Light Company As of December 31, 1994 1993 (thousands) CAPITALIZATION AND LIABILITIES Capitalization 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 857,466 850,307 Total Common Stock Equity 1,431,354 1,424,195 Preferred stock Not subject to mandatory redemption 250,351 250,351 Subject to mandatory redemption -- 22,021 Long-term debt 1,466,393 1,362,799 Total Capitalization 3,148,098 3,059,366 Current Liabilities Long-term debt and preferred stock due within twelve months 723 3,928 Advances from affiliates 161,320 171,165 Accounts payable 75,051 79,604 Accrued taxes 59,386 33,769 Accumulated deferred income taxes 13,812 -- Accrued interest 24,681 24,683 Accrued restructuring charges 1,325 29,365 Other 30,151 28,020 366,449 370,534 Deferred Credits Income taxes 1,087,317 1,057,453 Investment tax credits 158,533 164,322 Mirror CWIP liability and other 62,302 130,070 1,308,152 1,351,845 $4,822,699 $4,781,745\nThe accompanying notes to financial statements are an integral part of these statements.\n2-85 Statements of Cash Flows Central Power and Light Company For the Years Ended December 31, 1994 1993 1992 (thousands) OPERATING ACTIVITIES Net Income $205,439 $172,425 $218,511 Non-cash Items Included in Net Income Depreciation and amortization 170,971 140,223 154,716 Deferred income taxes and investment tax credits 20,870 84,714 42,773 Mirror CWIP liability amortization (68,000) (75,702) (82,527) Restructuring charges 98 29,365 -- Allowance for equity funds used during construction (1,215) (1,074) (408) Cumulative effect of changes in accounting principles -- (27,295) -- Changes in Assets and Liabilities Accounts receivable (6,015) (3,554) (6,415) Fuel inventory (5,982) 12,325 (3,137) Accounts payable (4,553) 19,151 6,209 Accrued taxes 25,617 (9,311) (2,165) Unrecovered fuel costs (1,167) (57,386) (1,195) Accrued restructuring charges (20,245) -- -- Other deferred credits 232 (35,242) (4,133) Other (4,575) 29,928 (18,479) 311,475 278,567 303,750 INVESTING ACTIVITIES Construction expenditures (174,993) (177,120) (100,805) Allowance for borrowed funds used during construction (2,474) (1,544) (763) (177,467) (178,664) (101,568) FINANCING ACTIVITIES Proceeds from issuance of long-term debt 99,190 441,131 435,497 Retirement of long-term debt (459) (431) (405) Reacquisition of long-term debt (618) (573,776) (304,650) Retirement of preferred stock (27,021) (6,578) (7,050) Special deposits for reacquisition of long-term debt -- 145,482 (145,482) Change in advances from affiliates (9,845) 79,399 29,618 Payment of dividends (197,048) (186,361) (209,196) (135,801) (101,134) (201,668)\nNet Change in Cash and Cash Equivalents (1,793) (1,231) 514 Cash and Cash Equivalents at Beginning of Year 2,435 3,666 3,152 Cash and Cash Equivalents at End of Year $ 642 $ 2,435 $ 3,666\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $114,980 $116,664 $130,078 Income taxes paid $ 28,166 $ 3,631 $ 45,314\nThe accompanying notes to financial statements are an integral part of these statements.\n2-86 Statements of Capitalization Central Power and Light Company As of December 31, 1994 1993 (thousands)\nCOMMON STOCK EQUITY $1,431,354 $1,424,195\nPREFERRED STOCK Cumulative $100 Par Value, Authorized 3,035,000 shares Number Current of Shares Redemption Series Outstanding Price\nNot 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% 500,000 100.00 50,000 50,000 Auction Money Market 750,000 100.00 75,000 75,000 Auction SeriesA 425,000 100.00 42,500 42,500 Auction SeriesB 425,000 100.00 42,500 42,500 Issuance Expense (3,149) (3,149) 250,351 250,351 Subject to Mandatory Redemption 10.05% -- 25,900 Issuance Expense -- (410) Amount to be Redeemed Within One Year -- (3,469) -- 22,021 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 T, 7 1\/2%, due December 15, 2014 * 111,700 111,700 Series U, 9 3\/4%, due July 1, 2015 * 31,765 31,765 Series Z, 9 3\/8%, due December 1, 2019 139,405 140,000 Series AA, 7 1\/2%, due March 1, 2020 * 50,000 50,000 Series BB, 6%, due October 1, 1997 200,000 200,000 Series CC, 7 1\/4%, due October 1, 2004 100,000 100,000 Series DD, 7 1\/8%, due December 1, 1999 25,000 25,000 Series EE, 7 1\/2%, due December 1, 2002 115,000 115,000 Series FF, 6 7\/8% due February 1, 2003 50,000 50,000 Series GG, 7 1\/8%, due February 1, 2008 75,000 75,000 Series HH, 6%, due April 1, 2000 100,000 100,000 Series II, 7 1\/2%, due April 1, 2023 100,000 100,000 Series JJ, 7 1\/2%, due May 1, 1999 100,000 -- Installment 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 68,870 Series 1986, 7 7\/8%, due December 1, 2016 60,000 60,000 Series 1993, 6%, due July 1, 2028 120,265 120,265 Notes Payable, 6 1\/2%, due December 8, 1995 448 652 Unamortized Discount (11,655) (12,265) Unamortized Costs of Reacquired Debt (81,947) (86,249) Amount to be Redeemed Within One Year (723) (459) 1,466,393 1,362,799 TOTAL CAPITALIZATION $3,148,098 $3,059,366\n*Obligations incurred in connection with the sale by public authorities of tax-exempt PCRBs.\nThe accompanying notes to financial statements are an integral part of these statements.\n2-87 NOTES TO FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation CPL is subject to regulation by the SEC under the Holding Company Act and the FERC under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. CPL is subject to further regulation with regard to rates and other matters by the Texas Commission. CPL, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System.\nThe more significant accounting policies of CPL 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 average consolidated composite rates were 3.0% for 1994, 1993 and 1992.\nNuclear Decommissioning At the end of STP's service life, decommissioning is expected to be accomplished using the decontamination method, which is one of the techniques acceptable to the NRC. Using this method the decontamination activities occur as soon as possible after the end of plant operations. Contaminated equipment is cleaned or removed to a permanent disposal location and the site is generally returned to its pre-plant state.\nCPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning, and is net of expected earnings on the trust fund.\nCPL's portion of the costs of decommissioning STP were estimated to be $85 million in 1986 dollars based on a site specific study completed in 1986. CPL is recovering these decommissioning costs through rates based on the service life of STP at a rate of $4.2 million per year. The $4.2 million annual cost of decommissioning is reflected on the income statement in other operating expense. Decommissioning costs are paid to an irrevocable external trust and as such are not reflected on CPL's balance sheet. At December 31, 1994, the trust balance was $19.3 million.\nIn May 1994, CPL received a new decommissioning study updating the cost estimates to decommission STP that indicated that CPL's share of such costs would increase from $85 million, as stated in 1986 dollars, to $251 million, as stated in 1994 dollars. The increase in costs occurred primarily as a result of extended on-site storage of high level waste, much higher estimates of low-level waste disposal costs and increased labor costs since the prior study. These costs are expected to be incurred during the years 2027 through 2062. While this is the best estimate available at this time, these costs may change between now and when the funds are actually expended because of changes in the assumptions used to derive the estimates, including the prices of the goods and services required to accomplish the decommissioning. Additional studies will be completed periodically to update this information.\n2-88 Based on this projected cost to decommission STP, CPL estimates that its annual funding level should increase to $10.0 million. CPL has requested this amount as part of its cost of service in its current rate filing. Other parties to the rate proceeding have filed their projections of the annual amount, which have ranged from $4.5 million to $8.1 million. CPL expects to fund at the level ultimately ordered by the Texas Commission although CPL cannot predict what that level will be. Historically, the Texas Commission has allowed full recovery of nuclear decommissioning costs. For further information on CPL's current rate filing see NOTE 9, Litigation and Regulatory Proceedings - Texas Commission Proceedings.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, CPL changed its method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 net income was an increase of $29.5 million included in cumulative effect of changes in accounting principles.\nCPL recovers fuel costs in Texas as a fixed component of base rates whereby over-recoveries of fuel are payable to customers and under-recoveries may be billed to customers after Texas Commission approval. The cost of fuel is charged to expense as consumed. See NOTE 9, Litigation and Regulatory Proceedings, for further information about fuel recoveries. CPL recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause. CPL amortizes direct nuclear fuel costs to fuel expense on the basis of a ratio of the estimated energy used in the core to the energy expected to be derived from such fuel assembly over its life in the core. In addition to fuel amortization, CPL also incurs nuclear fuel expense as a result of other items, including spent fuel disposal fees assessed on the basis of net KWHs sold from STP, and DOE special assessment fees for decontamination and decommissioning of the enrichment facilities on the basis of prior usage of enrichment services.\nAccounts Receivable CPL sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities For its regulated activities, CPL follows SFAS No. 71, which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to CPL associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future refunds to customers. At December 31, 1994 and 1993, CPL had recorded the following significant regulatory assets and liabilities:\n1994 1993 (thousands) Regulatory Assets Deferred plant costs $488,987 $489,773 Mirror CWIP asset 321,825 331,845 Income tax related regulatory assets, net 288,444 266,597 Unrecovered fuel costs 54,126 52,959\nRegulatory Liabilities Mirror CWIP liability $ 41,000 $109,000\n2-89 Deferred Plant Costs In accordance with orders of the Texas Commission, CPL deferred operating, depreciation and tax costs incurred for STP. This deferral was for the period beginning on the date when the plant began commercial operation until the date the plant was included in rate base. The deferred costs are being amortized and recovered through rates over the life of the plant. See NOTE 9, Litigation and Regulatory Proceedings, for further discussion of CPL's deferred accounting proceedings.\nMirror CWIP In accordance with Texas Commission orders, CPL previously recorded Mirror CWIP, which is being amortized over the life of STP. For more information regarding Mirror CWIP, reference is made to NOTE 9, Litigation and Regulatory Proceedings. Statements 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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, CPL adopted SFAS Nos. 106, 112 and 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, CPL also changed its method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in 1993 operating expenses of $5.9 million. The adoption of SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect (thousands) SFAS No. 112 $(3,371) $ 1,180 $ (2,191) Unbilled revenues 45,363 (15,877) 29,486 Total $41,992 $(14,697) $27,295\nPro 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 CPL adopted the provisions of SFAS No. 109 effective January 1, 1993. The implementation of SFAS No. 109 had no material effect on CPL's earnings. As a result of this change, CPL recognized additional accumulated deferred income taxes from its utility operations, and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, CPL did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\nCPL, together with other members of the CSW System, files a consolidated federal income tax return and participates in a tax sharing agreement.\nComponents of income taxes follow: 1994 1993 1992 Included in Operating Expenses and Taxes (thousands) Current $54,486 $(19,690) $ 34,336 Deferred 26,659 90,682 48,773 Deferred ITC (5,789) (5,806) (5,831) 75,356 65,186 77,272 Included in Other Income and Deductions Current (3,157) 736 390 Deferred -- (162) (163) (3,157) 574 227 Tax Effects of Cumulative Effect of Changes in Accounting Principles -- 14,697 -- $72,199 $80,457 $77,499\nInvestment tax credits deferred in prior years are included in income over the lives of the related properties.\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow:\n1994 % 1993 % 1992 % (dollars in thousands) Tax at statutory $97,174 35.0 $88,509 35.0 $100,643 34.0 Differences Amortization of ITC (5,789) (2.1) (5,806) (3) (5,789) (2.0) Mirror CWIP (20,293) (7.3) (22,989) (9.1) (24,652) (8.3) Prior period adjustments (1,955) (0.7) 19,101 7.6 -- -- Other 3,062 1.1 1,642 .6 7,297 2.5 $72,199 26.0 $80,457 31.8 $77,499 26.2\n2-91 The significant components of the net deferred income tax liability follow: 1994 1993 (thousands) Deferred Income Tax Liabilities Depreciable utility plant $ 755,437 $ 745,164 Deferred plant costs 171,145 171,421 Mirror CWIP asset 112,639 116,146 Income tax related regulatory asset 169,104 178,984 Other 49,800 37,989 Total Deferred Income Tax Liabilities 1,258,125 1,249,704\nDeferred Income Tax Assets Income tax related regulatory liability (68,149) (85,675) Unamortized ITC (55,486) (57,513) Alternative minimum tax credit - carryforward (26,138) (15,744) Other (7,223) (38,150) Total Deferred Income Tax Assets (156,996) (197,082) Net Accumulated Deferred Income Taxes - Total $1,101,129 $1,052,622\nNet Accumulated Deferred Income Taxes - Noncurrent $1,087,317 $1,057,453 Net Accumulated Deferred Income Taxes - Current 13,812 (4,831) Net Accumulated Deferred Income Taxes - Total $1,101,129 $1,052,622\n3.Long-Term Debt The mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by CPL, constitutes a direct first mortgage lien on substantially all electric utility plant. CPL may offer additional first mortgage bonds subject to market conditions and other factors.\nAnnual Requirements Certain series of outstanding first mortgage bonds have annual sinking fund requirements, which are generally 1% of the amount of each such series issued. These requirements may be, and generally have been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. In addition, one series of CPL's pollution control bonds, has a sinking fund requirement. At December 31, 1994, the annual sinking fund requirements and annual maturities for CPL's first mortgage bonds and pollution control bonds for the next five years follow:\nSinking Fund Requirements Maturities (thousands) 1995 $ 2,840 $ 2,840 1996 2,840 2,840 1997 2,585 202,840 1998 2,560 30,560 1999 2,560 27,560\nDividends CPL's mortgage indenture, as amended and supplemented, contains certain restrictions on the use of their retained earnings for cash dividends on their common stock. These restrictions do not\n2-92 limit the ability of CSW to pay dividends to its stockholders. At December 31, 1994, the amount of retained earnings available for payment of cash dividends to CSW by CPL was $684 million.\nReacquired Long-term Debt Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, Liquidity and Capital Resources, for further information related to long-term debt, including new issues and reacquisitions.\n4.Preferred Stock The dividends on CPL's $160 million auction preferred stocks are adjusted every 49 days, based on current market rates. The dividend rates averaged 3.5%, 2.7%, and 3.6% during 1994, 1993 and 1992.\nCPL retired the remaining shares of its 10.05% Series preferred stock during August 1994.\nEach series of preferred stock, with the exception of the auction preferred stock, is redeemable at the option of CPL upon 30 days notice at the current redemption price per share. Redemption prices of the 8.72% Series decline at specified intervals in future years. CPL's two issues of auction preferred stock and one issue of money market preferred stock may be redeemed at par on any dividend payment date.\n5.Short-Term Financing CPL, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. Money pool balances are shown as advances to or from affiliates on the Balance Sheets. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million 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 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 fair value.\nCash, special deposits and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nAdvances from affiliates The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt The fair value CPL'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 CPL for debt of the same or similar remaining maturities.\nPreferred stock The fair value of CPL's preferred stock subject to mandatory redemption is estimated based on quoted market prices for the same or similar issues or on the current rates offered to CPL for preferred stock with the same or similar remaining redemption provisions.\nLong-term debt and preferred stock due within twelve months The fair values of CPL's current maturities of long-term debt and preferred stock are estimated based on current rates offered to CPL for long-term debt and preferred stock.\n2-93 The estimated fair values of CPL's financial instruments follow:\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 642 $ 642 $ 2,435 $ 2,435 Special Deposits 668 668 1,967 1,967 Advances from affiliates 161,320 161,320 171,165 171,165 Long-term debt 1,466,393 1,395,590 1,362,799 1,456,533 Preferred stock subject to mandatory redemption -- -- 22,021 23,086 Long-term debt and preferred stock due within 12 months 723 725 3,928 4,096\nThe fair value does not affect CPL's liabilities unless the issues are redeemed prior to their maturity dates.\n7.Benefit Plans Defined Benefit Pension Plan CPL, together with the other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited 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 which are deductible for income tax purposes and minimum contributions required by the ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate- term fixed income investments. Contributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $7.1 million, $11.0 million and $11.7 million, respectively.\nThe approximate maximum number of participants in the plan during 1994 were 2,300 active employees, 1,200 retirees and beneficiaries and 300 terminated employees.\nThe components of net periodic pension cost and the assumptions used in accounting for pension follow:\n1994 1993 1992 (thousands) Net Periodic Pension Cost Service cost $ 5,796 $ 5,228 $ 4,834 Interest cost on projected benefit obligation 15,989 14,878 13,686 Actual return on plan assets (1,131) (18,079) (11,750) Net amortization and deferral (17,972) 68 (5,330) $ 2,682 $ 2,095 $ 1,440\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\n2-94 At December 31, 1994, the plan's net assets were approximately equal to the total actuarial present value of the accumulated benefit obligation. At December 31, 1993 the plan's net assets exceeded the total actuarial present value of the accumulated benefit obligation. No reconciliation of the funding status of the plan is presented because such information is unavailable.\nHealth and Welfare Plans CPL had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active CPL employees during 1994. The contributions, recorded on a pay-as-you-go basis, for the years ended December 31, 1994 and 1993 were approximately $4.6 million and $6.1 million, respectively. Effective January 1993, CPL's method of providing health benefits was modified to include such benefits as a health maintenance organization, preferred provider options, managed prescription drug and mail-order program and a mental health and substance abuse program in addition to the self- insured indemnity plans.\nPostretirement Benefits Other Than Pensions CPL adopted SFAS No. 106 effective January 1, 1993. The effect on operating expense in 1993 was $5.9 million. CPL is amortizing the transition obligation over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\nThe components of net periodic postretirement benefit cost follow:\n1994 1993 (thousands) Net Periodic Postretirement Benefit Cost Service cost $ 2,435 $ 2,257 Interest cost on APBO 6,061 5,505 Actual return on plan assets (285) (249) Amortization of transition obligation 2,900 2,900 Net amortization and deferral (913) (703) $10,198 $9,710\nA reconciliation of the funded status of the plan to the amounts recognized on the balance sheets follow:\n1994 1993 APBO (thousands) Retirees $49,852 $50,032 Other fully eligible participants 9,278 9,147 Other active participants 15,017 17,353 Total APBO 74,147 76,353 Plan assets at fair value (21,457) (14,185) APBO in excess of plan assets 52,690 62,347 Unrecognized transition obligation (52,208) (55,108) Unrecognized gain or (loss) 577 (6,180) Accrued\/(Prepaid) Cost $ 1,059 $ 1,059\n2-95 The following assumptions were used in accounting for SFAS No. 106.\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 Rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001. Post-65 Participants: 1994 Rate of 11.25% 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 by $8.0 million as of December 31, 1994 and increase the aggregate of the service and interest costs components on net postretirement benefits by $1.1 million.\n8.Jointly Owned Electric Utility Plant CPL has a joint ownership agreement with other members of the CSW System and other non-affiliated entities. Such agreements provide for the joint ownership and operation of STP and Oklaunion power plants. The statements of income reflect CPL's portion of operating costs associated with jointly owned plants. At December 31, 1994, CPL had interests as shown below: South Texas Oklaunion Nuclear Coal Plant Plant (dollars in millions) Plant in service $2,343 $36 Accumulated depreciation 380 8 Plant capacity-MW 2,500 676 Participation 25.2% 7.8% Share of capacity-MW 630 53\n9.Litigation and Regulatory Proceedings STP From February 1993 until May 1994, STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL. These matters, including a base rate case and fuel reconciliation proceedings, are discussed immediately below.\nTexas Commission Proceedings Base Rates Rate Inquiry - Docket No. 12820 Several Cities, the Texas Commission General Counsel and others initiated actions in late 1993 and early 1994 which, if approved by the Texas Commission, would lower CPL's base rates. The requests for a review of CPL's rates arose out of the unscheduled outage at STP which began in February 1993. The STP outage did not affect CPL's ability to meet customer demand because of existing capacity and CPL's purchase of additional energy.\nPursuant to a scheduling and procedural settlement agreement among the parties challenging CPL's rates, which was approved by a Texas Commission ALJ on April 1, 1994, CPL submitted a rate filing package on July 1, 1994 to the Texas Commission justifying its current base rate structure. In that filing, CPL stated that it\n2-96 had a $111 million retail revenue deficiency and would be justified in seeking a base rate increase. However, consistent with the procedural settlement agreement, CPL has not sought to increase base rates as a part of this docket but seeks to maintain its rates at the same levels agreed to in the settlement of its last two rate cases in 1990 and 1991. As part of the 1990 and 1991 settlements, CPL 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. On October 31, 1994, CPL filed rebuttal testimony that revised its retail revenue deficiency to approximately $103 million. CPL continues to maintain that its rates are reasonable and that its earnings are within established regulatory guidelines.\nParties to CPL's base rate case have filed testimony with the Texas Commission recommending reductions in CPL's base rates. Among the parties that filed testimony were OPUC which initially recommended an annual $100 million retail rate reduction. After hearings on the rate case, OPUC claimed that CPL did not meet its burden of proof concerning deferred accounting and as a result OPUC changed its proposed reduction to $147 million. The Cities, which are parties to the rate case, have recommended an annual $75 million retail rate reduction and the write-off of $219 million of CPL's Mirror CWIP asset. See Deferred Accounting below.\nThe Staff filed testimony recommending an annual reduction in retail rates of $99.6 million resulting from a combination of proposed rate base and cost of service reductions, which it subsequently revised during the hearings to $83.9 million. In its final brief to the ALJ, the Staff withdrew its recommendation that short-term debt be included in the calculation of CPL's weighted cost of capital. CPL estimates that this change in the Staff's position will lower its revised proposed retail rate reduction by approximately $6 million. The Staff recommended a rate base disallowance of $407 million, or approximately 17% of CPL's investment in STP, based upon the Staff's calculation of historical performance for STP compared to a peer group of other nuclear facilities. The Staff also recommended that accumulated depreciation and accumulated deferred federal income taxes related to the disallowed portion of STP be adjusted to reflect a net reduction to rate base of $325 million. Additionally, the Staff proposed to disallow depreciation expense related to the recommended STP disallowed plant.\nIn its testimony, the Staff argued that its proposed STP rate base reduction was a historical performance-based disallowance that could be temporary in nature and would not have to result in a permanent disallowance. The Staff indicated that, in the future, CPL could seek recovery in rates of the proposed STP rate base disallowance, subject to the performance of STP.\nThe Texas Commission held hearings in November and December 1994, and all parties have filed briefs in the case. The ALJ is expected to issue a recommended order for consideration by the Texas Commission in April 1995, with a final order from the Texas Commission expected in May 1995. Testimony filed by parties to the rate case, including the Staff, is not binding on either the ALJ or the Texas Commission.\nCPL strongly believes that 100 percent of its investment in both units of STP belong in rate base. This belief is based on, among other factors, Units 1 and 2 providing output at high capacity factors since April and June 1994, respectively. In addition, the long-term benefits nuclear generation provides to customers supports their inclusion in rate base. Furthermore, there are no Texas Commission precedents addressing the removal of a nuclear plant from rate base as a performance-based disallowance. Assuming both units of STP are included in rate base, CPL believes it is not collecting excessive revenues, notwithstanding that market rates of return on common equity are generally lower today than they were in 1990 and 1991, when CPL's base rates were last set.\n2-97 Fuel Introduction Pursuant to the substantive rules of the Texas Commission, CPL generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and CPL'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 costs 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.\nFuel Surcharge - Docket No. 12154 In July 1993, CPL 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 CPL's request to postpone consideration of the surcharge. In January and July of 1994, CPL updated its fuel surcharge petition to reflect amounts of under-recovery through November 1993 and May 1994, respectively. Also, CPL updated its petition in January 1995 to reflect amounts of under-recovery through November 1994. Likewise, CPL requested and was granted postponement of the updated petitions until the STP outage concluded or at the time fuel costs are next reconciled. On January 4, 1995, Docket No. 12154 was consolidated into Docket No. 13650.\nPrudence Inquiry - Docket No. 13126 In April 1994, the Texas Commission's General Counsel and Staff issued a Request for Proposal for an audit of the STP outage, and in July 1994 a consultant was selected to perform the audit. The purpose of the audit is to evaluate the prudence of management activities at STP, including the actions of HLP and the STP management committee, of which CPL is a participant. Such review will include the time from original commercial operation of each unit until they were returned to service from the outage. The findings of this audit are expected to be incorporated into this proceeding. CPL and HLP will pay the costs of the audit but will have no control over the ultimate work product of the consultant.\nIn June 1994, the Texas Commission's General Counsel initiated an inquiry into the operation and management of STP which resulted in the establishment of this proceeding. As part of the inquiry, CPL presented certain information concerning the prudence of management activities at STP relating to the STP outage. Testimony filed by CPL stated that the cause of the STP outage was the result of an accidental equipment failure rather than imprudent management activities at STP. Based on this information, CPL will seek full recovery in its fuel reconciliation case of incremental energy costs related to the STP outage.\nAs a part of this proceeding, CPL was required to reconstruct its production costs assuming STP was available 100% of the time during the actual outage. Testimony filed by CPL stated that it is unrealistic to expect any generating unit to operate all the time. The testimony provided calculations of STP replacement power cost estimates for availability factor scenarios at (i) 100%, (ii) 75% and (iii) 65% average availability. Based on these average availability factors, STP net replacement power costs for the entire outage period were estimated to be (i) $104.5 million at 100%, (ii) $79.0 million at 75% and (iii) $68.2 million at 65% average availability.\nThe results of this prudence inquiry are expected to be used in CPL's pending fuel reconciliation proceeding in Docket No. 13650, as discussed below, and possibly CPL's next base rate proceeding should a return on equity penalty be ordered by the Texas\n2-98 Commission. Such penalty could lower CPL's allowed return on equity in its next base rate case from what it otherwise would be permitted to earn.\nFuel Reconciliation - Docket No. 13650 On November 15, 1994, CPL filed a fuel reconciliation case with the Texas Commission seeking to reconcile approximately $1.2 billion of fuel costs from March 1, 1990 through June 30, 1994. This period includes the STP outage where CPL's fuel and purchased power costs were increased as the power normally generated by STP was replaced through sources with higher costs. At December 31, 1994, CPL's under-recovered fuel balance was $54.1 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. CPL cannot accurately estimate the amount of any future under- or over-recoveries due to the nature of the above factors. CPL cannot predict how the Texas Commission will ultimately resolve the reasonableness of higher replacement energy costs associated with the STP outage. Although the Texas Commission could disallow all or a portion of the STP replacement energy costs, such determination cannot be made until a final order is issued by the Texas Commission in this docket. If a significant portion of the fuel costs were disallowed by the Texas Commission, CPL could experience a material adverse effect on its results of operations in the year of disallowance but not on its financial condition.\nCPL continues to negotiate with the intervening parties to resolve Docket Nos. 12820, 13126 and the STP portions of Docket No. 13650 through settlement. However, no settlement has been reached.\nManagement cannot predict the ultimate outcome of the CPL rate inquiry and fuel regulatory proceedings. However, management believes that the ultimate resolution of the various issues will not have a material adverse effect on CPL's results of operations or financial condition.\nSTP Background Final Orders In October 1990, the Texas Commission issued the 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 the STP Unit 2 Order which fully implemented a stipulated agreement to resolve all issues regarding CPL's investment in STP Unit 2.\nThe STP Unit 1 Order allowed CPL 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 had authorized deferral of STP Unit 1 costs. See Deferred Accounting below. 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 CPL 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. The Mirror CWIP liability is being reduced by the recognition of non-cash income during the period 1991 through 1995. The Mirror CWIP asset is being amortized to expense over the life of the plant.\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,\n2-99 the original costs of CPL's total investment in STP is included in rate base. As indicated under the heading Texas Commission Proceedings above, however, CPL is currently involved in base rate and fuel proceedings which challenge CPL's right to recover certain costs associated with the STP outage.\nAs part of the stipulated agreement, CPL 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. CPL 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 CPL, the Staff and a majority of intervenors including major cities in CPL's service territory and major industrial customers. These intervenors represent a significant majority of CPL's customers. CPL and the TSA reached agreements, which were subsequently approved by the 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 CPL could experience a significant adverse effect on its results of operations and financial condition. 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 economic results. Management believes that the STP Unit 1 and 2 Orders will be upheld.\nDeferred Accounting CPL was granted deferred accounting for STP Unit 1 and 2 costs by Texas Commission orders. These orders allowed CPL 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 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, CPL's retail rates include recovery of 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 CPL'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 CPL 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 CPL from earning a return on such costs.\nAfter the Court of Appeals' denial of each party's motion for rehearing of the decision, CPL and the Texas Commission in December 1992 filed Applications for Writ of Error petitioning the\n2-100 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 Appeals' decision, challenging generally the legality of deferred accounting for rate base treatment of any deferred costs. In May 1993, the Supreme Court of Texas granted CPL's Application for Writ of Error. CPL's case was consolidated with the deferred accounting cases of El Paso and HLP. In June 1994, the Supreme Court of Texas sustained deferred accounting as an appropriate mechanism for the Texas Commission to use in preserving the financial integrity of utilities. The Supreme Court of Texas held that the Texas Commission can authorize utilities to defer those costs that are incurred between the in-service date of a plant and the effectiveness of new rates, which include such costs. On October 6, 1994, the Supreme Court of Texas denied a motion for rehearing CPL's deferred accounting matter filed by the State of Texas. The language of the Supreme Court of Texas opinion suggests that the appropriateness of allowing deferred accounting may need to again be reviewed under a financial integrity standard at the time the costs begin being recovered through rates. For CPL, that would be the STP Unit 1 and Unit 2 Orders discussed above. To the extent that additional review is required, it should occur in those dockets.\nIf these deferred accounting matters are not favorably resolved, CPL could experience a material adverse effect on its results of operations and financial condition. While CPL's management cannot predict the ultimate outcome of these matters, management believes CPL will 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 CPL's results of operations or financial condition.\nWestinghouse Litigation CPL and other owners of STP are plaintiffs in a lawsuit filed in 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 set for trial in July 1995.\nInspections during the STP outage have detected early signs of stress corrosion cracking in tubes at STP Unit 1. Management believes additional problems would develop gradually and will be monitored by the Project Manager 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. Management believes that the ultimate resolution of this matter will not have a material adverse effect on CPL's results of operations or financial condition.\nIndustrial Road and Industrial Metals Site Several lawsuits relating to the industrial road and industrial metals site in Corpus Christi, Texas, naming CPL as a defendant, are currently pending in federal and state court in Texas. Plaintiffs' claims allege property damage and health impairment as a result of operations on the site and clean-up activities. Although management cannot predict the outcome of these proceedings, based on the defenses that management believes are available to CPL, management believes that the ultimate resolution of these matters will not have a material adverse effect on CPL's results of operations or financial condition.\nCivil Penalties In October 1994, the NRC staff advised HLP that it proposes to fine HLP $100,000 for what the NRC believes was discrimination against a contractor employee at STP who brought complaints of possible safety problems to the NRC's attention. These actions resulted from the findings of a NRC investigation of alleged violations of STP security and work process procedures in 1992. The incident cited by the NRC is the subject of a contested hearing that is scheduled to be held in the spring of 1995 before a United States Department of Labor judge. Until the Department\n2-101 of Labor issues a final decision in this matter, the NRC is not requiring HLP to respond to its notice of violation.\nOther CPL 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 CPL's results of operations or financial condition.\n10. Commitments and Contingent Liabilities It is estimated that CPL will spend approximately $108 million in construction expenditures during 1995. Substantial commitments have been made in connection with this capital expenditure program.\nTo supply a portion of its fuel requirements CPL has entered into various commitments for the procurement of fuel.\nNuclear Insurance In 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 $8.92 billion per incident, effective as of January 1995. 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 $8.72 billion. The maximum amount that each licensee may be assessed under the industry-wide program of self-insurance following a nuclear incident at an insured facility is $75.5 million per reactor, 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. CPL and each of the other STP owners are subject to such assessments, which CPL and other owners have agreed will be allocated 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 $2.75 billion provided by ANI and NEIL. Policies of insurance issued by ANI and NEIL stipulate that policy proceeds must be used first to pay decontamination and clean-up costs before being used to cover direct losses to property. Under project agreements, CPL and the other owners of STP will share the total cost of decontamination liability and property insurance for STP, including premiums and assessments, on a pro rata basis, according to each owner's respective ownership interest in STP.\nCPL purchases, for its own account, a NEIL I Business Interruption and\/or Extra Expense policy. This insurance will reimburse CPL for extra expenses incurred, up to $1.65 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 $111.3 million and for Unit 2 is $111.8 million. CPL is subject to an additional assessment up to $2.1 million for the current policy year in the event that losses as a result of a covered accident at a nuclear facility insured under the NEIL I policy exceeds the accumulated funds available under the policy.\nOn August 28, 1994, CPL filed a claim under the NEIL I policy related to the outage at STP Units 1 and 2. NEIL is currently reviewing the claim. CPL management is unable to predict the ultimate outcome of this matter.\n2-102 11. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts.\nOperating Operating Net Quarter Ended Revenues Income Income 1994 (thousands) March 31 $ 263,229 $ 36,943 $ 24,986 June 30 333,169 75,070 62,470 September 30 364,044 96,062 82,877 December 31 257,537 48,176 35,106 $1,217,979 $ 256,251 $ 205,439\nMarch 31 $ 238,254 $ 39,593 $ 54,560 June 30 316,053 66,745 53,679 September 30 387,190 88,438 77,612 December 31 282,031 (4,697) (13,426) $1,223,528 $ 190,079 $ 172,425\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-103 Report 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 a wholly-owned subsidiary of Central and South West Corporation) as of December 31, 1994 and 1993, and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of CPL'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 Central Power and Light Company as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, CPL changed its methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II 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. This schedule 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 LLP\nDallas, Texas February 13, 1995\n2-104 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the financial statements of Central Power and Light Company as well as other information contained in this Annual 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 Annual Report is consistent with that in the financial statements.\nThe financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. CPL believes that representations made to the independent auditors during its audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nCPL maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial statements are prepared in accordance with generally accepted accounting principles and that the assets of CPL are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that CPL will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of CPL provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nCPL believes that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nRobert R. Carey R. Russell Davis President and CEO - CPL Controller - CPL\n2-105\nPSO\nPUBLIC SERVICE COMPANY OF OKLAHOMA\n2-106 Selected Financial Data PSO The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for PSO.\n1994 1993 1992 1991 1990 (thousands, except ratios) Operating Revenues $740,496 $707,536 $622,092 $650,942 $620,132 Income Before Cumulative Effect of Changes in Accounting Principles 68,266 40,496 45,562 53,229 55,082 Cumulative Effect of Changes in Accounting Principles (1) -- 6,223 -- -- -- Net Income 68,266 46,719 45,562 53,229 55,082 Preferred Stock Dividends 816 816 816 816 816 Net Income for Common Stock 67,450 45,903 44,746 52,413 54,266\nTotal Assets 1,465,114 1,420,379 1,351,201 1,308,075 1,283,915\nCommon Stock Equity 461,499 435,049 429,146 419,400 386,987 Preferred Stock 19,826 19,826 19,826 19,826 19,826 Long-term Debt 402,752 401,255 408,731 368,219 367,727\nRatio of Earnings to Fixed Charges (SEC Method) Before Cumulative Effect of Changes in Accounting Principles 4.03 2.78 2.95 3.33 2.93\nCapitalization Ratios Common Stock Equity 52.2% 50.8% 50.0% 51.9% 50.0% Preferred Stock 2.2 2.3 2.3 2.5 2.5 Long-term Debt 45.6 46.9 47.7 45.6 47.5\n(1)The 1993 cumulative effect relates to the changes in accounting for unbilled revenues, adoption of SFAS Nos. 112 and 109. See NOTE 1, Summary of Significant Accounting Policies.\nPSO changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore have not been restated.\n2-107 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPUBLIC SERVICE COMPANY OF OKLAHOMA\nReference is made to PSO's Consolidated Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential to understanding, the following discussion and analysis.\nOverview Net income for common stock for 1994 was $67 million, a 47% increase from 1993. The increase was due primarily to increased energy sales to retail customers and sales for resale to other electric utilities due to increased market place demand and the 1993 restructuring charges of $25 million.\nRestructuring As previously reported, PSO has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable PSO to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $25 million and were expensed in 1993. The final costs of the restructuring were approximately $25 million. Approximately $24 million of the restructuring expenditures were incurred during 1994, with the remaining $1 million expected to be incurred during 1995. Approximately $4 million of the restructuring expenses relate to employee termination benefits, $12 million relate to enhanced benefit costs and $9 million relate to employees that will not be terminated. Approximately $17 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $8 million represents the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nPSO expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. The CSW System expects that all restructuring costs will be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nRates and Regulatory Matters See NOTE 8, Litigation and Regulatory Proceedings, for information regarding the PSO rate case.\nNew Accounting Standards SFAS No. 115 was effective for fiscal years beginning after December 15, 1993. PSO adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on PSO's consolidated results of operations or financial condition.\nIn June 1993 the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by PSO for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on PSO's consolidated results of operations or financial condition.\n2-108 SFAS No. 119 was effective for fiscal years ending after December 15, 1994. PSO does not currently uses derivative instruments, but may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on PSO's consolidated results of operations or financial condition.\nLiquidity and Capital Resources Overview PSO's need for capital results primarily from the construction of facilities to provide reliable electric service to its customers. Accordingly, internally generated funds should meet most of the capital requirements. However, if internally generated funds are not sufficient, PSO's financial condition should allow it access to the capital markets.\nCapital Expenditures Construction expenditures, including AFUDC, were approximately $131 million in 1994, $95 million in 1993, and $100 million in 1992. It is estimated that construction expenditures, including AFUDC, during the 1995 through 1997 period will aggregate $213 million. Such expenditures primarily will be made to improve and expand distribution facilities. These improvements are expected to meet the needs of new customers and to satisfy changing requirements of existing customers. No new baseload power plants are currently planned until after the year 2000.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in PSO's service area, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected lignite-fired generating plants for which PSO has invested approximately $15 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, PSO would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of PSO were 52% common stock equity, 2% preferred stock and 46% long-term debt. PSO's embedded cost of long-term debt was 7.4% at the end of 1994. PSO continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. PSO continues to be committed to maintaining financial flexibility by maintaining a strong capital structure and favorable securities ratings which should allow funds to be obtained from the capital markets when required.\nShort-Term Financing PSO, together with other members of CSW System, has established a CSW System money pool to coordinate short-term borrowings. These loans are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs. PSO's short-term borrowing limit from the money pool is $100 million. During 1994, the annual weighted average interest rate was 4.5% and the average amount of short-term month-end borrowings outstanding was $42 million. The maximum amount of short-term borrowings outstanding at any month-end during 1994 was $73 million, which was the amount outstanding at May 31, 1994.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. PSO utilizes short-term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. PSO anticipates that capital requirements for the period 1995 to 1997 will be met in large part from internal sources. PSO also anticipates that some external financing will be required during the period, but the nature, timing and extent have not yet been determined. Information concerning internally generated funds follows:\n2-109 1994 1993 1992 (millions) Internally Generated Funds $110 $93 $63\nConstruction Expenditures Provided by Internally Generated Funds 85% 99% 63%\nSales of Accounts Receivable PSO sells its billed and unbilled accounts receivable, without recourse, to CSW Credit. The sales provided PSO with cash immediately, thereby reducing working capital needs and revenue requirements. The average and year end amounts of accounts receivable sold were $88 million and $75 million in 1994, as compared to $85 million and $80 million in 1993.\nRecent Developments and Trends Competition and Industry Challenges Competitive forces at work in the electric utility industry are impacting PSO and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, PSO will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. PSO believes that its prices for electricity and the quality and reliability of its service currently place it in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While PSO believes that the Energy Policy Act will continue to make the wholesale markets more competitive, PSO is unable to predict the extent to which the Energy Policy Act will impact on its operations.\nIncreasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. PSO competes in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities,\n2-110 but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers.\nPSO believes that, compared to other electric utilities, it is well positioned to meet future competition. PSO benefits from economies of scale and scope by virtue of its size and its relationship to the CSW System. PSO is also a relatively low-cost producer of electric power. Moreover, PSO is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nPSO is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or on PSO. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, PSO has recognized significant regulatory assets and liabilities. Management believes that PSO will continue to meet the criteria for following SFAS No. 71. However, in the event PSO no longer meets the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nEnvironmental Matters CERCLA and Related Matters The operations of PSO, like those of other utilities, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nPSO is subject to various pending claims alleging it is a PRP under federal or state remedial laws for investigating and cleaning up contaminated property. PSO anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on PSO's consolidated results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by PSO, the estimated amount of costs allocated to PSO and the participation of other parties.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, PSO will be required to hold allowances in order to emit sulfur dioxide. The EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, PSO believes that its allowances will be adequate to meet its needs at least through 2008. Public and private markets are developing for trading of excess allowances. PSO presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\n2-111 The Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on PSO cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, PSO expects to spend an additional $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects. Although a few of the studies to date have suggested certain associations between EMFs and some types of effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. PSO cannot predict the impact on it or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nSee ITEM 1. BUSINESS - Environmental Matters and NOTE 8, Litigation and Regulatory Proceedings, for additional discussion of environmental issues.\nResults of Operations Electric Operating Revenues Revenues for 1994 increased approximately $33 million or 5% when compared to 1993. Revenues for 1993 increased approximately $85.4 million or 14% when compared to 1992. The increase in 1994 reflected an increase of approximately 8% in KWH sales resulting from increased sales for resale to other electric utilities due to increased marketplace demand, partially offset by lower unit fuel costs as described below. Approximately $7.9 million of the 1993 increase was due to an increase in retail prices. Retail kilowatt-hour sales increased 7% as a result of warmer weather in 1993 compared to the substantially milder than normal weather in 1992. Additionally, 1994 and 1993 were affected by increased fuel recovery as discussed below. The Company recovers its monthly fuel and purchased power expenses currently in its revenues and therefore the increase in these costs resulted in higher revenues.\nFuel and Purchased Power Expenses Fuel expense for 1994 increased approximately $17.6 million or 6% when compared to 1993. During 1993, fuel expense increased approximately $64 million or 27% when compared to 1992. Fuel expense for 1994 and 1993 increased primarily as a result of fewer customers participating in the FUSER Program, which terminated effective October 1993. See ITEM 1. BUSINESS -- REGULATION AND RATES for additional information relating to FUSER. In 1994, fuel expense was also affected by a 17% increase in KWH generation and an over- recovery of fuel costs from customers, which was previously recorded as deferred fuel, offset in part by a reduction in average unit fuel costs. The average unit fuel cost for 1994 was $1.96 per million BTU, a decrease of approximately 18% from the same period last year. The decrease in per unit fuel cost reflects the reversal of prior years accruals for potential liabilities related to coal transportation, as well as lower costs for natural gas and coal. The increase in fuel expense during 1993 was due primarily to an increase in KWH generation and an increase in unit fuel costs. KWH generation increased 10% due primarily to increased weather-related customer usage and unscheduled 1992 power station maintenance which did not recur in 1993. The average unit fuel cost for 1993 was $2.38 per million Btu, an increase of approximately 2% from 1992 of $2.34 per million Btu. The increase in unit fuel costs was primarily due to an accrual for potential liabilities related to coal transportation, partially offset by lower costs of natural gas and coal.\nPurchased power expenses for 1994 increased approximately $2.2 million or 7% as a result of additional economy energy purchases. Purchased power expenses for 1993 decreased approximately $10.4 million or 24% as a result of additional purchases of firm energy in\n2-112 1992 due to unscheduled power station maintenance which did not recur in 1993.\nOperating Expenses and Taxes Changes in operating expenses in 1994 and 1993 were affected by 1993 restructuring charges of approximately $25 million, which includes approximately $18 million for an early retirement and voluntary severance program. Changes in operating expenses for both years were also affected by the 1993 write-off of certain lignite properties of approximately $5 million and accrued mine reclamation expenses of approximately $3 million. Maintenance in 1993 decreased as a result of unscheduled power station maintenance in 1992.\nDepreciation and amortization expense increased approximately $4 million or 7% in 1994 and $3 million or 5% in 1993 due to increases in depreciable property.\nTaxes, other than federal income increased approximately $3.6 million or 13% in 1994 and decreased approximately $.5 million or 2% in 1993 primarily as a result of changes in state income taxes.\nFederal income tax expense increased approximately $11.3 million or 56% in 1994 and $5.2 million or 35% in 1993 primarily as a result of increased pre-tax income. Additionally, 1993 tax expense increased as a result of an increase in the federal statutory rate from 34% in 1992 to 35% in 1993.\nInflation Annual inflation rates, as measured by the national Consumer Price Index, have averaged 2.7% during the three years ended December 31, 1994. PSO believes that inflation, at this level, does not materially affect its consolidated 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.\nInterest Charges Interest charges for 1994 decreased approximately $1.3 million or 4% as a result of the refinancing in 1993 of higher cost debt. This decrease is offset in part by increases in short-term borrowings. In 1993, charges increased approximately $1.3 million or 4% as a result of higher principal amounts of long-term debt outstanding, offset in part by the reacquisition of higher cost debt. In 1993, interest on short-term debt and other was affected by interest accruals associated with the settlement of federal income tax audit issues partially offset by decreased short-term borrowings at lower rates.\nCumulative Effect of Changes in Accounting Principles PSO implemented a number of accounting changes in 1993. These included the adoption of SFAS No. 112 and SFAS No. 109. PSO also changed its method of accounting for unbilled revenues. These accounting changes had a cumulative effect of increasing net income approximately $6 million.\n2-113 Consolidated Statements of Income Public Service Company of Oklahoma For the Years Ended December 31, 1994 1993 1992 (thousands) Electric Operating Revenues Residential $296,159 $296,027 $258,259 Commercial 227,488 222,598 203,176 Industrial 165,200 149,762 122,180 Sales for resale 35,458 18,248 17,782 Other 16,191 20,901 20,695 740,496 707,536 622,092 Operating Expenses and Taxes Fuel 316,470 298,905 234,884 Purchased power 34,906 32,711 43,134 Other operating 120,233 125,830 117,450 Restructuring charges (197) 24,995 -- Maintenance 44,847 45,777 49,027 Depreciation and amortization 63,096 59,133 56,103 Taxes, other than federal income 31,637 28,060 28,639 Federal income taxes 31,246 19,969 14,759 642,238 635,380 543,996\nOperating Income 98,258 72,156 78,096\nOther Income and Deductions Allowance for equity funds used during construction 1,094 1,096 349 Other 933 531 (940) 2,027 1,627 (591)\nIncome Before Interest Charges 100,285 73,783 77,505\nInterest Charges Interest on long-term debt 29,594 31,410 30,688 Interest on short-term debt and other 3,844 2,729 1,646 Allowance for borrowed funds used during construction (1,419) (852) (391) 32,019 33,287 31,943\nIncome Before Cumulative Effect of Changes in Accounting Principles 68,266 40,496 45,562\nCumulative Effect of Changes in Accounting Principles -- 6,223 --\nNet Income 68,266 46,719 45,562 Preferred stock dividends 816 816 816 Net Income for Common Stock $ 67,450 $ 45,903 $ 44,746\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-114 Consolidated Statements of Retained Earnings Public Service Company of Oklahoma For the Years Ended December 31, 1994 1993 1992 (thousands)\nRetained Earnings at Beginning of Year $97,819 $91,916 $82,170 Net income for common stock 67,450 45,903 44,746 Deduct: Common stock dividends 41,000 40,000 35,000 Retained Earnings at End of Year $124,269 $97,819 $91,916\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-115 Consolidated Balance Sheets Public Service Company of Oklahoma As of December 31, 1994 1993 (thousands) ASSETS Electric Utility Plant Production $ 902,602 $ 895,315 Transmission 346,433 335,405 Distribution 668,346 626,519 General 150,898 143,834 Construction work in progress 96,133 51,931 2,164,412 2,053,004 Less - Accumulated depreciation 859,894 806,066 1,304,518 1,246,938 Current Assets Cash and temporary cash investments 5,453 2,429 Accounts receivable 21,531 36,612 Materials and supplies, at average cost 39,888 38,212 Fuel inventory, at LIFO cost 17,820 21,273 Accumulated deferred income taxes 6,670 -- Prepayments 7,889 2,755 99,251 101,281\nDeferred Charges and Other Assets 61,345 72,160\n$1,465,114 $1,420,379\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-116 Consolidated Balance Sheets Public Service Company of Oklahoma As of December 31, 1994 1993 (thousands) CAPITALIZATION AND LIABILITIES Capitalization Common stock: $15 par value Authorized: 11,000,000 shares Issued 10,482,000 shares and outstanding 9,013,000 shares $ 157,230 $ 157,230 Paid-in capital 180,000 180,000 Retained earnings 124,269 97,819 Total Common Stock Equity 461,499 435,049 Preferred stock 19,826 19,826 Long-term debt 402,752 401,255 Total Capitalization 884,077 856,130\nCurrent Liabilities\nAdvances from affiliates 55,160 31,744 Payables to affiliates 27,876 18,218 Accounts payable 59,899 55,606 Payables to customers 22,655 13,932 Accrued taxes 17,356 15,191 Accrued interest 8,867 5,382 Accumulated deferred income taxes -- 3,633 Accrued restructuring charges 1,046 24,995 Other 14,111 20,140 206,970 188,841 Deferred Credits Accumulated deferred income taxes 281,139 260,490 Investment tax credits 49,011 51,800 Income tax related regulatory liabilities, net 18,611 21,178 Other 25,306 41,940 374,067 375,408\n$1,465,114 $1,420,379\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-117 Consolidated Statements of Cash Flows Public Service Company of Oklahoma For the Years Ended December 31, 1994 1993 1992 (thousands) OPERATING ACTIVITIES Net Income $ 68,266 $ 46,719 $ 45,562 Non-cash Items Included in Net Income Depreciation and amortization 67,452 65,242 61,821 Restructuring charges (197) 24,995 -- Deferred income taxes and investment tax credits 4,990 6,700 18,446 Cumulative effect of changes in accounting principles -- (6,223) -- Allowance for equity funds used during construction (1,094) (1,096) (349) Changes in Assets and Liabilities Accounts receivable 15,081 (17,299) (8,793) Materials and supplies 1,777 2,872 (5,743) Accounts payable 26,375 10,332 9,540 Accrued taxes 2,165 4,240 (17,195) Accrued restructuring charges (15,626) -- -- Other deferred credits (16,634) (3,712) (13,762) Other (754) 1,322 8,955 151,801 134,092 98,482 INVESTING ACTIVITIES Construction expenditures (128,625) (92,648) (99,079) Allowance for borrowed funds used during construction (1,419) (852) (391) Other (335) (6,125) (2,419) (130,379) (99,625) (101,889) FINANCING ACTIVITIES Proceeds from issuance of long-term debt -- 181,194 113,886 Retirement of long-term debt -- (10,000) -- Reacquisition of long-term debt -- (189,685) (63,933) Change in advances from affiliates 23,416 26,454 (11,575) Payment of dividends (41,814) (40,816) (35,817) (18,398) (32,853) 2,561\nNet Change in Cash and Cash Equivalents 3,024 1,614 (846) Cash and Cash Equivalents at Beginning of Year 2,429 815 1,661 Cash and Cash Equivalents at End of Year $ 5,453 $ 2,429 $ 815\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 31,459 $ 34,844 $ 27,708 Income taxes paid $ 28,910 $ 9,232 $ 8,718\nThe accompanying notes to consolidated financial statements are an integral part of these statements\n2-118 Consolidated Statements of Capitalization Public Service Company of Oklahoma As of December 31, 1994 1993 (thousands)\nCOMMON STOCK EQUITY $461,499 $435,049\nPREFERRED STOCK (Cumulative $100 par value, authorized 700,000 shares, redeemable at the option of PSO upon 30 days notice) Number Current of Shares Redemption Series Outstanding Price\n4.00% 97,900 $105.75 9,790 9,790 4.24% 100,000 103.19 10,000 10,000 Premium 36 36 19,826 19,826\nLONG-TERM DEBT First Mortgage Bonds Series J, 5 1\/4%, due March 1, 1996 25,000 25,000 Series K, 7 1\/4%, due January 1, 1999 25,000 25,000 Series L, 7 3\/8%, due March 1, 2002 30,000 30,000 Series S, 7 1\/4%, due July 1, 2003 65,000 65,000 Series T, 7 3\/8%, due December 1, 2004 50,000 50,000 Series U, 6 1\/4%, due April 1, 2003 35,000 35,000 Series V, 7 3\/8%, due April 1, 2023 100,000 100,000 Series W, 6 1\/2%, due June 1, 2005 50,000 50,000 Installment sales agreement - Pollution Control Bonds Series A, 5.9%, due December 1, 2007 34,700 34,700 Series 1984, 7 7\/8%, due September 15, 2014 12,660 12,660 Unamortized discount (4,756) (5,097) Unamortized costs of reacquired debt (19,852) (21,008) 402,752 401,255 TOTAL CAPITALIZATION $884,077 $856,130\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-119 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation PSO is subject to regulation by the SEC under the Holding Company Act and the FERC under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. PSO is subject to further regulation with regard to rates and other matters by the Oklahoma Commission. PSO, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System.\nThe more significant accounting policies of PSO and its subsidiary are summarized below:\nPrinciples of Consolidation The consolidated financial statements include the accounts of PSO and its wholly-owned subsidiary, Ash Creek Mining Company. All significant intercompany items and transactions have been eliminated.\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 electric utility plant are computed using the straight-line method, generally at individual rates applied to the various classes of depreciable property. The annual average consolidated composite rates were 3.5% in 1994, 1993 and 1992.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, PSO changed its method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 net income was an increase of $8.4 million included in cumulative effect of changes in accounting principles.\nPSO recovers fuel costs in Oklahoma through automatic fuel recovery mechanisms. PSO recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause. Under rules established by the Oklahoma Commission, PSO uses a method of deferred fuel accounting. The difference between fuel revenues billed and fuel expense incurred is recorded as a reduction of or an addition to fuel expense, with a corresponding entry to accounts receivable or payables to customers as appropriate. Deferred fuel costs are applied to the customers' billings as a portion of the fuel adjustment clause the second month subsequent to the month in which the under-recoveries or over-recoveries occurred.\nAccounts Receivable PSO sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities For its regulated activities, PSO follows SFAS No. 71, which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to PSO associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future refunds to customers At December 31, 1994 and 1993, PSO had recorded the following significant regulatory assets and liabilities:\n2-120 1994 1993 (thousands) Regulatory Assets (Included in Deferred Charges and Other Assets on the Balance Sheets) Deferred Storm Costs $ 4,798 $ 5,876 Demand Side Management Costs 5,411 4,198 OPEBs 4,504 5,895 Other 4,945 5,621\nRegulatory Liabilities Income tax related regulatory liabilities, net $18,611 $21,178\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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, PSO adopted SFAS Nos. 106, 112 and 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, PSO also changed their method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in the establishment of a regulatory asset of approximately $5 million. See Note 8, Litigation and Regulatory Proceedings-Rate Review for further information. The adoption of SFAS No. 109, SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect SFAS No. 109 $ -- $ (268) $ (268) SFAS No. 112 (3,173) 1,227 (1,946) Unbilled revenues 13,758 (5,321) 8,437 Total $10,585 $(4,362) $6,223\nPro 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 PSO adopted the provisions of SFAS No. 109 effective January 1, 1993. The implementation of SFAS No. 109 had no material effect on PSO's earnings. As a result of this change, PSO recognized additional accumulated deferred income taxes and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, PSO did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\n2-121 PSO, together with other members of the CSW System, files a consolidated Federal income tax return and participates in a tax sharing agreement.\nComponents of income taxes follow: 1994 1993 1992 Included in Operating Expenses and Taxes (thousands) Current $27,529 $13,165 $ (790) Deferred 6,506 9,595 18,260 Deferred ITC (2,789) (2,791) (2,711) 31,246 19,969 14,759 Included in Other Income and Deductions Current (4,080) (1,977) (314) Deferred 89 (1,082) (149) (3,991) (3,059) (463) Tax Effects of Cumulative Effect of Changes in Accounting Principles -- 3,954 -- $27,255 $20,864 $14,296\nInvestment tax credits deferred in prior years are included in income over the lives of the related properties.\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow: 1994 % 1993 % 1992 % (dollars in thousands) Tax at statutory rates $ 33,432 35.0 $ 23,654 35.0 $ 20,351 34.0 Differences Amortization of ITC (2,789) (2.9) (2,791) (4.1) (2,799) (4.7) Flowback of tax rate differential (1,541) (1.6) (1,629) (2.4) (1,627) (2.7) Tax effect from prior period flow through and permanent differences -- -- 1,167 1.7 1,018 1.7 Prior period adjustments (1,348) (1.4) 486 .7 (3,712) (6.2) Other (499) (0.6) (23) -- 1,065 1.8 $27,255 28.5 $20,864 30.9 $14,296 23.9\n2-122 The significant components of the net deferred income tax liability follow:\n1994 1993 (thousands) Deferred Income Tax Liabilities Depreciable utility plant $292,127 $287,217 Income tax related regulatory assets 15,061 15,885 Other 25,309 19,156 Total Deferred Income Tax Liabilities 332,497 322,258\nDeferred Income Tax Assets Income tax related regulatory liability (22,260) (24,076) Unamortized ITC (18,957) (20,036) Other (16,811) (14,023) Total Deferred Income Tax Assets (58,028) (58,135) Net Accumulated Deferred Income Taxes - Total $274,469 $264,123\nNet Accumulated Deferred Income Taxes - Noncurrent $281,139 $260,490 Net Accumulated Deferred Income Taxes - Current (6,670) 3,633 Net Accumulated Deferred Income Taxes - Total $274,469 $264,123\n3.Long-Term Debt The mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by PSO constitutes a direct first mortgage lien on substantially all electric utility plant. PSO may offer additional first mortgage bonds subject to market conditions and other factors.\nAnnual Requirements Certain series of outstanding first mortgage bonds have annual sinking fund requirements, which are generally 1% of the amount of each such series issued. These requirements may be, and generally have been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. At December 31, 1994, the annual sinking fund requirements and annual maturities for the next five years follow:\nSinking Fund Requirements Maturities (thousands) 1995 $800 $ 800 1996 550 25,550 1997 550 550 1998 550 550 1999 300 25,300\nDividends PSO's mortgage indenture, as amended and supplemented, contains certain restrictions on the payment of common stock dividends. At December 31, 1994, $124 million of retained earnings were available for payment of cash dividends to its parent, CSW.\n4.Financial Instruments 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 fair value.\n2-123 Cash and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt The fair value of PSO'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 PSO for debt of the same or similar remaining maturities.\nAdvances from affiliates The carrying amount approximates fair value because of the short maturity of those instruments.\nThe estimated fair values of PSO's financial instruments follow:\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 5,453 $ 5,453 $ 2,429 $ 2,429 Long-term debt 402,752 364,585 401,255 413,218 Advances from affiliates 55,160 55,160 31,744 31,744\nThe fair value does not affect PSO's liabilities unless the issues are redeemed prior to their maturity dates.\n5.Short Term Financing PSO, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. Money pool balances are shown as advances to or from affiliates on the Consolidated Balance Sheets. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million 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.Benefit Plans Defined Benefit Pension Plan PSO, together with other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited 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 which are deductible for income tax purposes and minimum contributions required by the ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate- term fixed income investments.\nContributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $6.3 million, $6.7 million and $5.9 million, respectively.\nThe approximate maximum number of participants in the plan during 1994, were 2,000 active employees, 1,100 retirees and beneficiaries and 300 terminated employees.\n2-124 The components of net periodic pension cost and the assumptions used in accounting for pensions follows: 1994 1993 1992 (thousands) Net Periodic Pension Cost Service cost $ 5,181 $ 4,642 $ 4,307 Interest cost on projected benefit obligation 14,292 13,209 12,193 Actual return on plan assets (1,011) (16,051) (10,469) Net amortization and deferral (16,064) 60 (4,748) $ 2,398 $ 1,860 $ 1,283\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nAt December 31, 1994, the plan's net assets were approximately equal to the total actuarial present value of the accumulated benefit obligation. At December 31, 1993 the plan's net assets exceeded the total actuarial present value of the accumulated benefit obligation. No reconciliation of the funding status of the plan is presented because such information is unavailable.\nHealth and Welfare Plans PSO had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active PSO employees during 1994. The contributions recorded on a pay-as-you-go basis, for the years ended December 31, 1994 and 1993 were approximately $3.6 million and $5.0 million, respectively. Effective January 1993, the PSO's method of providing health benefits was modified to include such benefits as a health maintenance organization, preferred provider options, managed prescription drug and mail-order program and a mental health and substance abuse program in addition to the self- insured indemnity plans.\nPostretirement Benefits Other Than Pensions PSO adopted SFAS No. 106 January 1, 1993. PSO is amortizing their transition obligation over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\nThe components of net periodic postretirement benefit cost follow:\n1994 1993 (thousands) Net Periodic Postretirement Benefit Cost Service cost $ 2,350 $ 2,175 Interest cost on APBO 5,317 4,811 Actual return on plan assets (495) (264) Amortization of transition obligation 2,528 2,528 Net amortization and deferral (917) (564) $ 8,783 $ 8,686\n2-125 A reconciliation of the funded status of the plan to the amounts recognized on the consolidated balance sheets follow:\nDecember 31, 1994 1993 APBO (thousands) Retirees $ 42,233 $ 41,854 Other fully eligible participants 8,077 7,904 Other active participants 14,372 17,186 Total APBO 64,682 66,944 Plan assets at fair value (21,649) (15,066) APBO in excess of plan 43,033 51,878 Unrecognized transition obligation (45,512) (48,040) Unrecognized gain or (loss) 1,903 (4,414) Accrued\/(Prepaid) Cost $ (576) $ (576)\nThe following assumptions were used in accounting for SFAS No. 106:\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 Rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001.\nPost-65 Participants: 1994 Rate of 11.25% 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, 1994 by $7 million and increase the aggregate of the service and interest costs components on net postretirement benefits by $1 million.\n7.Jointly Owned Electric Plant PSO has a joint ownership agreement with other members of the CSW System and non-affiliated entities. Such agreements provide for the joint ownership and operation of the 676 MW, coal-fired Oklaunion Power Station and its related facilities. Each participant provided financing for its share of the project, which was placed in service in December 1986. The consolidated statements of income reflect PSO's portion of operating costs associated with plant in service. PSO's share is 106 MW or a 15.6% interest in the generating station. PSO's total investment, including allowance for funds used during construction, is $80 million and accumulated depreciation at December 31, 1994 was $24 million.\n8.Litigation and Regulatory Proceedings Rate Review In December 1993, the Oklahoma Commission issued an order unanimously approving a joint stipulation between PSO, the Oklahoma Commission Staff, and the Office of the Attorney General of the State of Oklahoma, as recommended by the ALJ. The order allowed PSO an increase in retail prices of $14.4 million on an annual basis which represents a $4.3 million increase above those authorized by the March 1993 interim order. In January 1994, the Oklahoma Commission issued an order unanimously approving PSO's price schedules reflecting the $14.4 million price increase. The new prices became effective beginning with the billing month of February 1994.\n2-126 The December 1993 order addresses, among other things, the following issues. PSO will recover $4.5 million annually in expenses associated with OPEBs, which, for PSO, are primarily health care related benefits. Such expenses will be recovered along with amortization of the deferred 1993 OPEBs at a rate of $0.5 million per year for 10 years. PSO will amortize deferred storm expenses associated with both a 1987 ice storm and a 1992 wind storm, amounting to $1.2 million per year for five years. In addition, the order recognizes the increase in federal income tax expenses resulting from the recent increase in the federal corporate income tax rate from 34 percent to 35 percent. PSO will continue to use the depreciation rates previously approved by the Oklahoma Commission. PSO agreed that it will not file another retail price increase application until after June 30, 1995.\nGas Transportation and Fuel Management Fees An order issued by the Oklahoma Commission in 1991 required that the level of gas transportation and fuel management fees, paid to Transok by PSO, permitted for recovery through the fuel adjustment clause be reviewed in the aforementioned price proceeding. This portion of the price review was bifurcated. In March 1995, an order was issued by the Oklahoma Commission approving an agreement which allows PSO to recover approximately $28.4 million of transportation and fuel management fees in base rates using 1991 determinants and approximately $1 million through the fuel adjustment clause. The agreement also requires the phase-in of competitive bidding of natural gas transportation requirements in excess of 165 MMcf\/d.\nGas Purchase Contracts PSO has been named defendant in complaints filed in federal and state courts of Oklahoma and Texas in 1984 through February 1995 by gas suppliers alleging claims arising out of certain gas purchase contracts. Cases currently pending seek approximately $29 million in actual damages, together with claims for punitive damages which, in compliance with pleading code requirements, are alleged to be in excess of $10,000. The plaintiffs seek relief through the filing dates as well as attorney fees. As a result of settlements among the parties, certain plaintiffs dismissed their claims with prejudice to further action. The settlements did not have a significant effect on PSO's consolidated results of operations. The remaining suits are in the preliminary stages. Management cannot predict the outcome of these proceedings. However, management believes that PSO has defenses to these complaints and intends to pursue them vigorously. Management also believes that the ultimate resolution of the remaining complaints will not have a material adverse effect on PSO's consolidated results of operations or financial condition.\nPCB Cases PSO has been named defendant in complaints filed in federal and state court in Oklahoma in 1984, 1985, 1986 and 1993. The complaints allege, among other things, that some of the plaintiffs and the property of other plaintiffs were contaminated with PCBs and other toxic by-products following certain incidents, including transformer malfunctions in April 1982, December 1983 and May 1984. To date, complaints represent approximately $736 million, including compensatory and punitive damages of claims have been dismissed, certain of which resulted from settlements among the parties. The settlements did not have a significant effect on PSO's consolidated results of operations. Remaining complaints currently total approximately $395 million, of which approximately one-third is for punitive damages. Discovery with regard to the remaining complaints continues. Management cannot predict the outcome of these proceedings. However, management believes that PSO has defenses to these complaints and intends to pursue them vigorously. Moreover, management has reason to believe that PSO's insurance may cover some of the claims. Management also believes that the ultimate resolution of the remaining complaints will not have a material adverse effect on PSO's consolidated results of operations or financial condition.\nBurlington Northern Transportation Contract In June 1992, PSO filed suit in Federal District Court in Tulsa, Oklahoma, against Burlington Northern seeking declaratory relief under a long-term contract for the transportation of coal. In July 1992, Burlington Northern asserted counterclaims against PSO alleging that PSO breached the contract. The counterclaims sought\n2-127 damages in an unspecified amount. In December 1993, PSO amended its suit against Burlington Northern seeking damages and declaratory relief under federal and state anti-trust laws. PSO and Burlington Northern filed motions for summary judgment on certain dispositive issues in the litigation. In March 1994, the court issued an order granting PSO's motions for summary judgment and denying Burlington Northern's motion. It was not necessary for the court to decide the federal and state anti-trust claims raised by PSO. Judgment was rendered in favor of PSO by the United States District Court in May 1994. In June 1994, Burlington Northern appealed this judgment to the United States Court of Appeals for the Tenth Circuit. This appeal is now pending.\nBurlington Northern Arbitration In May 1994, in a related arbitration, an arbitration panel made an award favorable to PSO concerning basic transportation rates under the coal transportation contract described above, and concerning the contract mechanism for adjustment of future transportation rates. These arbitrated issues were not involved in the related lawsuit described above. Burlington Northern filed an action to vacate the arbitrated award in the District Court for Dallas County, Texas. PSO removed this action to the United States District Court for the Northern District of Texas, and filed a motion to either dismiss this action or have it transferred to the United States District Court for the Northern District of Oklahoma. Burlington Northern moved to remand the action to state court. In September 1994, the United States District Court for the Northern District of Texas denied Burlington Northern's motion to remand, and granted PSO's motion to transfer the action to the United States District Court for the Northern District of Oklahoma. Separately, PSO filed an action to confirm the arbitration award in the United States District Court for the Northern District of Oklahoma, and Burlington Northern filed a motion to dismiss this confirmation action. On December 6, 1994, the District Court entered an order denying Burlington Northern's motion to vacate the arbitration award, and granting PSO's motion to confirm the arbitration award. On December 29, 1994, the District Court entered judgment confirming the arbitration award, including a money judgment in PSO's favor for $16.4 million, with interest at 7.2% per annum compounded annually from December 21, 1994 until paid. On January 6, 1995, Burlington Northern appealed the District Court's judgment to the United States Court of Appeals for the Tenth Circuit. This appeal is now pending.\nCoal Mine Reclamation In August 1994, PSO received approval from the Wyoming Department of Environmental Quality to begin reclamation of a coal mine in Sheridan, Wyoming owned by Ash Creek Mining Company, a wholly- owned subsidiary of PSO. Ash Creek Mining Company recorded a $3 million liability in 1993 for the estimated reclamation costs. Actual reclamation work is expected to commence in mid-1995, with completion estimated in late 1996. Surveillance monitoring will continue for ten years after final reclamation. Management believes the ultimate resolution of this matter will not have a material adverse effect on PSO's consolidated results of operations or financial condition.\nOther PSO 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 PSO's consolidated results of operations or financial condition.\n9. Commitments and Contingent Liabilities It is estimated that PSO will spend approximately $71 million in capital expenditures during 1995. Substantial commitments have been made in connection with the 1995 construction program\nTo supply the fuel requirements of its generating plants, PSO has entered into various commitments for the procurement of fuel.\n2-128 10. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts.\nOperating Operating Net Quarter Ended Revenues Income Income 1994 (thousands) March 31 $ 157,509 $ 12,427 $ 4,307 June 30 174,631 23,808 15,927 September 30 246,378 47,196 40,003 December 31 161,978 14,827 8,029 $ 740,496 $ 98,258 $ 68,266\nMarch 31 $ 145,110 $ 12,312 $ 10,113 June 30 161,237 23,935 15,605 September 30 242,871 46,221 38,641 December 31 158,318 (10,312) (17,640) $ 707,536 $ 72,156 $ 46,719\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-129 Report of Independent Public Accountants\nTo the Stockholders and Board of Directors of Public Service Company of Oklahoma:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of Public Service Company of Oklahoma (an Oklahoma corporation and a wholly-owned subsidiary of Central and South West Corporation) and subsidiary company, as of December 31, 1994 and 1993, and the related consolidated statements of income, retained earnings and cash flows, for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of PSO'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 Public Service Company of Oklahoma and subsidiary company as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, PSO changed its methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II 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. This schedule 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 LLP\nTulsa, Oklahoma February 13, 1995\n2-130 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the consolidated financial statements of Public Service Company of Oklahoma and its subsidiary company as well as other information contained in this Annual Report. The consolidated 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 Annual Report is consistent with that in the consolidated financial statements.\nThe consolidated financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. PSO and its subsidiary believe that representations made to the independent auditors during their audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nPSO, together with its subsidiary company, maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the consolidated financial statements are prepared in accordance with generally accepted accounting principles and that the assets of the companies are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that PSO will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of PSO or its subsidiary, provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nPSO and its subsidiary believe that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nRobert L. Zemanek R. Russell Davis President and CEO - PSO Controller - PSO\n2-131\nSWEPCO\nSOUTHWESTERN ELECTRIC POWER COMPANY Selected Financial Data SWEPCO The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for SWEPCO.\n1994 1993 1992 1991 1990 (thousands, except ratios) Operating Revenues $825,296 $837,192 $778,303 $760,694 $735,217 Income Before Cumulative Effect of Changes in Accounting Principles 105,712 78,471 94,883 96,624 89,713 Cumulative Effect of Changes in Accounting Principles (1) -- 3,405 -- -- -- Net Income 105,712 81,876 94,883 96,624 89,713 Preferred Stock Dividends 3,361 3,362 3,445 3,465 3,528 Net Income for Common Stock 102,351 78,514 91,438 93,159 86,185\nTotal Assets 2,079,207 1,968,285 1,927,320 1,851,108 1,869,340\nCommon Stock Equity 678,122 645,731 647,217 645,780 641,554 Preferred Stock Not Subject to Mandatory Redemption 16,032 16,032 16,032 16,033 14,358 Subject to Mandatory Redemption 34,828 36,028 37,228 38,416 36,422 Long-term Debt 595,833 602,065 532,860 573,626 576,095\nRatio of Earnings to Fixed Charges (SEC Method) Before Cumulative Effect of Changes in Accounting Principles 3.70 3.27 3.39 3.51 3.03\nCapitalization Ratios Common Stock Equity 51.2% 49.7% 52.5% 50.7% 50.6% Preferred Stock 3.8 4.0 4.3 4.3 4.0 Long-term Debt 45.0 46.3 43.2 45.0 45.4\n(1) The 1993 cumulative effect relates to the changes in accounting for unbilled revenues and adoption of SFAS No. 112. See NOTE 1, Summary of Significant Accounting Policies.\nSWEPCO changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore have not been restated.\n2-133 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSOUTHWESTERN ELECTRIC POWER COMPANY\nReference is made to SWEPCO's Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential in understanding, the following discussion and analysis.\nOverview Net income for common stock increased 30% during 1994 to approximately $102.4 million from approximately $78.5 million in 1993, due primarily to the effects of restructuring costs recorded during 1993.\nRestructuring As previously reported, SWEPCO has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable SWEPCO to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $25 million and were expensed in 1993. The final costs of the restructuring were approximately $20 million. Approximately $19 million of the restructuring expenditures were incurred during 1994, with the remaining $1 million expected to be incurred during 1995. Approximately $1 million of the restructuring expenses relate to employee termination benefits, $12 million relate to enhanced benefit costs and $7 million relate to employees that will not be terminated. Approximately $13 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $7 million represents the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nSWEPCO expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. The CSW System expects that all restructuring costs will be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nRates and Regulatory Matters See NOTE 9, Litigation and Regulatory Proceedings, for information regarding the SWEPCO fuel reconciliation proceeding.\nNew Accounting Standards SFAS No. 115 was effective for fiscal years beginning after December 15, 1993. SWEPCO adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on SWEPCO's results of operations or financial condition.\nIn June 1993 the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by SWEPCO for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on SWEPCO's results of operations or financial condition.\n2-134 SFAS No. 119 was effective for fiscal years ending after December 15, 1994. SWEPCO does not currently use derivative financial instruments, but may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on SWEPCO's results of operations or financial condition.\nLiquidity and Capital Resources Overview SWEPCO's need for capital results primarily from its construction of facilities to provide reliable electric service to its customers. Accordingly, internally generated funds should meet most of the capital requirements. However, if internally generated funds are not sufficient, SWEPCO's financial condition should allow it access to the capital markets.\nCapital Expenditures Construction expenditures, including AFUDC, were approximately $153 million in 1994, $176 million in 1993 and $97 million in 1992. Included in the expenditures for 1993 was approximately $35 million for the acquisition of BREMCO, a rural electric cooperative with service territory adjacent to SWEPCO's service territory in Louisiana. Construction expenditures during the period 1995-1997 are estimated at $286 million. These expenditures will consist primarily of expansion and improvements to distribution facilities. No new baseload power plants are currently planned until after the year 2000.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in SWEPCO's service area, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected coal- and lignite-fired generating plants for which SWEPCO has invested approximately $34 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, SWEPCO would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of SWEPCO were 51% common stock equity, 4% preferred stock and 45% long-term debt. SWEPCO's embedded cost of long-term debt was 7.6% at the end of 1994. SWEPCO continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. SWEPCO continues to be committed to maintaining financial flexibility by maintaining a strong capital structure and favorable securities rating which should allow funds to be obtained from the capital markets when required.\nSWEPCO's long-term financing activity for 1994 is summarized below:\nIn June 1994, SWEPCO renegotiated a $50 million term loan due June 1997, changing certain terms, including an extension of the maturity to June 2000.\nIn several transactions during 1994, SWEPCO redeemed $5.8 million, which represented all remaining bonds outstanding of its 9- 1\/8% First Mortgage Bonds, Series U, due November 1, 2019. The funds required for these transactions were provided from short-term borrowings and internal sources. Redemption premiums are included in long-term debt on the balance sheets and are being amortized over 5 to 30 years, in accordance with anticipated regulatory treatment.\nShort-Term Financing SWEPCO, together with other members of CSW System, has established a CSW System money pool to coordinate short-term borrowings. These loans are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs.\n2-135 SWEPCO's short-term borrowing limit from the money pool is $150 million. During 1994, the annual weighted average interest rate was 4.5% and the average amount of short-term borrowings outstanding at month-end was $25 million. The maximum amount of short-term borrowings outstanding at any month-end during 1994 was $82 million, which was the amount outstanding at December 31, 1994.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. SWEPCO utilizes short-term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. SWEPCO anticipates that capital requirements for the period 1995 to 1997 will be met, in large part, from internal sources. SWEPCO also anticipates that some external financing will be required during the period, however the nature, timing and extent have not yet been determined. Information concerning internally generated funds follows:\n1994 1993 1992 (millions) Internally Generated Funds $105 $149 $75\nConstruction Expenditures Provided by Internally Generated Funds 71% 85% 78%\nSales of Accounts Receivable SWEPCO sells its billed and unbilled accounts receivable, without recourse, to CSW Credit. The sales provide SWEPCO with cash immediately, thereby reducing working capital needs and revenue requirements. The average and year end amounts of accounts receivable sold were $69 million and $62 million in 1994, as compared to $64 million and $57 million in 1993.\nRecent Developments and Trends Competition and Industry Challenges Competitive forces at work in the electric utility industry are impacting SWEPCO and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, SWEPCO will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. SWEPCO believes that its prices for electricity and the quality and reliability of its service currently place it in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While SWEPCO believes that the Energy Policy Act will continue to make the wholesale markets more competitive, SWEPCO is unable to predict the extent to which the Energy Policy Act will impact its operations.\n2-136 Increasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. SWEPCO competes in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities, but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers.\nSWEPCO believes that, compared to other electric utilities, it is well positioned to meet future competition. SWEPCO benefits from economies of scale and scope by virtue of its size and its relationship to the CSW System. SWEPCO is also a relatively low-cost producer of electric power. Moreover, SWEPCO is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nSWEPCO is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or on SWEPCO. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\nPublic Utility Regulatory Act PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. SWEPCO is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, SWEPCO has recognized regulatory assets and liabilities. Management believes that SWEPCO will continue to meet the criteria for following SFAS No. 71. However, in the event the SWEPCO no longer meets the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nConsolidated Taxes The Texas Commission before 1992 allowed income taxes to be recovered in rates based on the federal income tax incurred by a utility as if it were a stand-alone company. This stand-alone approach treated the regulated activities of a utility as a separate entity and considered only those revenues and expenses that are included in the utility's cost of service to calculate the federal income tax liability for ratemaking purposes.\n2-137 Beginning in 1992, the Texas Commission changed its method of calculating the federal income tax component of rates to the \"actual tax approach.\" The actual tax approach is an evolving concept but generally seeks to reflect in rates the actual tax liability of the utility irrespective of its relationship to the utility's cost of service. The approach reduces rates by the tax benefits of deductions which are not considered for or included in setting rates for the utility.\nSWEPCO believes that the recovery of federal income taxes in rates should be determined on the stand-alone approach for ratemaking purposes, but there is no assurance this approach will be adopted.\nEnvironmental Matters CERCLA and Related Matters The operations of SWEPCO, like those of other utilities, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nSWEPCO is subject to various pending claims alleging that it is a PRP under federal or state remedial laws for investigating and cleaning up contaminated property. SWEPCO anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on SWEPCO's results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by SWEPCO, the estimated amount of costs allocated to SWEPCO and the participation of other parties.\nMGPs Contaminated former MGPs are a type of site which utilities, and others, may have to remediate in the future under Superfund or other federal or state remedial programs. Gas was manufactured at MGPs from the mid-1800s to the mid-1900s. In some cases, utilities and others have faced potential liability for MGPs because they, or their alleged predecessors, owned or operated the plants. In other cases, utilities or others may have been subjected to such liability for MGPs because they acquired MGP sites after gas production ceased.\nSuspected MGP Site in Marshall, Texas SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO has accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\nSuspected MGP Site in Texarkana, Texas and Arkansas and Shreveport, Louisiana SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\nSuspected Biloxi, Mississippi MGP Site SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power\n2-138 Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nManagement does not expect these matters to have a material effect on SWEPCO's results of operations or financial position.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, SWEPCO will be required to hold allowances in order to emit sulfur dioxide. EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, SWEPCO believes that its allowances will be adequate to meet its needs at least through 2008. Public and private markets are developing for trading of excess allowances. SWEPCO presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\nThe Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on SWEPCO cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, SWEPCO expects to spend an additional $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects. Although a few of the studies to date have suggested certain associations between EMFs and some types of effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. SWEPCO cannot predict the impact on SWEPCO or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nSee ITEM 1. BUSINESS - ENVIRONMENTAL MATTERS and NOTE 10, Commitments and Contingent Liabilities, for additional discussion of environmental issues.\nResults of Operations Electric Operating Revenues Total electric operating revenues decreased $11.9 million or 1% during 1994 due primarily to decreased fuel revenues partially offset by a 3% increase in retail KWH sales due to customer growth and a 15% increase in sales for resale. Sales for resale to non-affiliated electric utilities and rural electric cooperatives increased approximately $9.4 million during the year. Total revenues increased approximately $59 million in 1993 when compared to the prior year. The increase was due primarily to a 6% increase in KWH sales\n2-139 resulting from favorable weather and customer growth due to the acquisition of BREMCO in 1993 as well as increased sales for resale.\nFuel and Purchased Power Expenses Fuel expense decreased approximately $27.2 million or 7% during 1994 and increased approximately $28 million or 8% during 1993. The decrease in 1994 is due primarily to a decrease in unit fuel costs from $1.94 in 1993 to $1.75 in 1994. The decrease in unit fuel costs is primarily due to coal contract settlements and a decrease in the cost of spot market gas. This decrease was partially offset by a 4% increase in generation. The increase in 1993 is attributable to an 8% increase in generation and an increase in unit fuel costs from $1.93 in 1992 to $1.94 in 1993.\nPurchased power costs increased approximately $7.1 million in 1994 and $6.5 million in 1993. The 1994 increase was due primarily to a purchased power contract negotiated as a part of the 1993 purchase of BREMCO. The increase in 1993 was largely due to scheduled and unscheduled maintenance at the Company's generating facilities and the above-mentioned purchased power contract.\nOperating Expenses and Taxes Other operating expenses increased approximately $18.1 million in 1993 due primarily to expensing of reserves for certain lignite properties, outside and legal services, and an increase in employee benefit expenses in 1993 resulting form the adoption of SFAS No. 106.\nRestructuring charges reflect the initial estimated cost of the restructuring of $25.2 million. As the restructuring progressed, this amount was adjusted during 1994 to approximately $20 million.\nMaintenance expense decreased approximately $7.4 million in 1994 and increased approximately $8 million in 1993 when compared to 1992. The changes during both periods are due to increased maintenance of distribution facilities and general plant in 1993.\nTaxes, other than federal income, increased approximately $4.4 million or 10% in 1993 due primarily to a Texas franchise tax refund recognized in 1992.\nFederal income tax expense increased approximately $13.1 million or 48% in 1994 primarily as a result of increased pre-tax income. In 1993, federal income taxes decreased approximately $5.8 million or 18% as a result of lower pre-tax income partially offset by an increase in the federal income tax rate from 34% to 35%.\nInflation Annual inflation rates, as measured by the national Consumer Price Index, have averaged approximately 2.7% for the three-year period ending December 31, 1994. Inflation at these levels does not materially affect SWEPCO's results of operations or financial condition. Under existing regulatory practice, however, 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.\nAllowance for Equity and Debt Funds Used During Construction AFUDC is a function of the amounts of construction on which AFUDC is calculated and the rate used. The increases in 1994 and 1993 were due primarily to increased construction work in process.\nInterest on Long-Term Debt Interest expense on long-term debt increased in 1994 approximately $2.4 million or 6% due primarily to an increase in average balances outstanding. The 1993 decrease of approximately $6.5 million is attributable to the refinancing of higher cost debt with lower cost debt.\n2-140 Interest on Short-Term Debt and Other Interest expense on short-term debt and other increased approximately $2.7 million in 1994 when compared to 1993 due primarily to an interest accrual pursuant to the terms of a settlement agreement approved by the Texas Commission in connection with SWEPCO's fuel reconciliation and increased interest expense associated with short-term debt.\nCumulative Effect of Changes in Accounting Principles Accounting changes in 1993 include the adoption of SFAS 112. SWEPCO also changed its method of accounting for unbilled revenues. These accounting changes had a cumulative effect of increasing net income by $3.4 million.\n2-141 Statements of Income Southwestern Electric Power Company For the Years Ended December 31, 1994 1993 1992 (thousands) Electric Operating Revenues Residential $266,620 $273,707 $249,182 Commercial 173,718 175,059 165,836 Industrial 243,518 250,912 243,508 Sales for resale 102,723 93,337 78,814 Other 38,717 44,177 40,963 825,296 837,192 778,303 Operating Expenses and Taxes Fuel 336,389 363,627 335,594 Purchased power 20,244 13,145 6,620 Other operating 119,277 118,665 100,598 Restructuring charges (4,978) 25,203 -- Maintenance 42,782 50,164 42,191 Depreciation and amortization 79,845 74,385 72,300 Taxes, other than federal income 45,735 46,942 42,502 Federal income taxes 40,080 27,004 32,771 679,374 719,135 632,576\nOperating Income 145,922 118,057 145,727\nOther Income and Deductions Allowance for equity funds used during construction 3,579 1,560 132 Other 4,656 3,658 537 8,235 5,218 669\nIncome Before Interest Charges 154,157 123,275 146,396\nInterest Charges Interest on long-term debt 43,395 40,958 47,490 Interest on short-term debt and other 7,568 4,866 4,073 Allowance for borrowed funds used during construction (2,518) (1,020) (50) 48,445 44,804 51,513 Income Before Cumulative Effect of Changes in Accounting Principles 105,712 78,471 94,883\nCumulative Effect of Changes in Accounting Principles -- 3,405 --\nNet Income 105,712 81,876 94,883 Preferred stock dividends 3,361 3,362 3,445 Net Income for Common Stock $ 102,351 $ 78,514 $ 91,438\nThe accompanying notes to financial statements are an integral part of these statements.\n2-142 Statements of Retained Earnings Southwestern Electric Power Company For the Years Ended December 31, 1994 1993 1992 (thousands) Retained Earnings at Beginning of Year $265,071 $266,557 $265,120 Net income for common stock 102,351 78,514 91,438 Gain on reacquisition of preferred stock 40 -- -- Deduct: Common stock dividends 70,000 80,000 90,000 Preferred stock redemption cost -- -- 1 Retained Earnings at End of Year $297,462 $265,071 $266,557\nThe accompanying notes to financial statements are an integral part of these statements.\n2-143 Balance Sheets Southwestern Electric Power Company As of December 31, 1994 1993 (thousands) ASSETS Electric Utility Plant Production $1,401,418 $1,392,058 Transmission 385,113 350,625 Distribution 733,707 678,788 General 213,563 188,193 Construction work in progress 149,508 126,258 2,883,309 2,735,922 Less - Accumulated depreciation 1,026,751 947,792 1,856,558 1,788,130 Current Assets Cash and temporary cash investments 1,296 6,723 Accounts receivable 54,344 24,363 Materials and supplies, at average cost 28,109 25,218 Fuel inventory, at average cost 61,701 49,487 Accumulated deferred income taxes 6,592 3,912 Prepayments and other 13,071 14,965 165,113 124,668\nDeferred Charges and Other Assets 57,536 55,487 $2,079,207 $1,968,285\nThe accompanying notes to financial statements are an integral part of these statements.\n2-144 Balance Sheets Southwestern Electric Power Company As of December 31, 1994 1993 (thousands) CAPITALIZATION AND LIABILITIES Capitalization Common stock: $18 par value Authorized: 7,600,000 shares Issued and Outstanding: 7,536,640 shares $ 135,660 $ 135,660 Paid-in capital 245,000 245,000 Retained earnings 297,462 265,071 Total Common Stock Equity 678,122 645,731 Preferred stock Not subject to mandatory redemption 16,032 16,032 Subject to mandatory redemption 34,828 36,028 Long-term debt 595,833 602,065 Total Capitalization 1,324,815 1,299,856\nCurrent Liabilities Long-term debt and preferred stock due within twelve months 5,270 5,028 Advances from affiliates 81,868 27,864 Accounts payable 50,138 41,598 Fuel refunds due customers 12,200 2,358 Customer deposits 13,075 14,244 Accrued restructuring charges 1,110 25,203 Accrued taxes 12,495 27,340 Accrued interest 17,175 17,354 Other 29,505 30,499 222,836 191,488 Deferred Credits Income taxes 365,441 332,522 Investment tax credits 81,023 85,301 Income tax related regulatory liabilities, net 44,836 52,828 Other 40,256 6,290 531,556 476,941 $2,079,207 $1,968,285\nThe accompanying notes to financial statements are an integral part of these statements.\n2-145 Statements of Cash Flows Southwestern Electric Power Company For the Years Ended December 31, 1994 1993 1992 (thousands) OPERATING ACTIVITIES Net Income $105,712 $ 81,876 $ 94,883 Non-cash Items Included in Net Income Depreciation and amortization 89,646 93,120 79,051 Restructuring charges (4,978) 25,203 -- Deferred income taxes and investment tax credits 17,970 (4,775) 3,393 Cumulative effect of changes in accounting principles -- (3,405) -- Allowance for equity funds used during construction (3,579) (1,560) (132) Changes in Assets and Liabilities Accounts receivable (29,981) (3,632) (8,067) Fuel inventory (12,214) 21,101 12,722 Accounts payable 8,540 8,612 5,313 Accrued taxes (14,845) 11,561 (5,817) Accrued restructuring charges (11,694) -- -- Unrecovered fuel\/Fuel refund due customers 9,842 1,946 1,274 Other deferred credits 33,966 (9,468) (1,875) Other (10,264) 11,519 (11,892) 178,121 232,098 168,853 INVESTING ACTIVITIES Construction expenditures (146,865) (138,510) (96,676) Acquisition expenditures -- (35,333) -- Allowance for borrowed funds used during construction (2,518) (1,020) (50) Sale of electric utility plant and other (4,980) (4,113) (2,339) (154,363) (178,976) (99,065) FINANCING ACTIVITIES Proceeds from sale of long-term debt -- 221,511 221,067 Reacquisition of long-term debt (5,475) (198,962) (176,474) Redemption of preferred stock (1,160) -- (1,190) Retirement of long-term debt (3,213) (39,835) (3,488) Change in advances from affiliates 54,004 (286) 28,149 Special deposits for reacquisition of long-term debt -- 53,500 (53,500) Payment of dividends (73,341) (83,386) (93,443) (29,185) (47,458) (78,879)\nNet Change in Cash and Cash Equivalents (5,427) 5,664 (9,091) Cash and Cash Equivalents at Beginning of Year 6,723 1,059 10,150 Cash and Cash Equivalents at End of Year $ 1,296 $ 6,723 $ 1,059\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 45,260 $ 42,271 $ 53,129 Income taxes paid $ 36,632 $ 21,112 $ 37,181\nThe accompanying notes to financial statements are an integral part of these statements.\n2-146 Statements of Capitalization Southwestern Electric Power Company As of December 31, 1994 1993 (thousands)\nCOMMON STOCK EQUITY $ 678,122 $ 645,731\nPREFERRED STOCK Cumulative $100 Par Value, Authorized 1,860,000 shares Number Current of Shares Redemption Series Outstanding Price\nNot Subject to Mandatory Redemption 5.00% 75,000 $109.00 7,500 7,500 4.65% 25,000 102.75 2,500 2,500 4.28% 60,000 103.90 6,000 6,000 Premium 32 32 16,032 16,032 Subject to Mandatory Redemption 6.95% 352,000 104.64 36,400 37,600 Issuance Expense (372) (372) Amount to be redeemed within one year (1,200) (1,200) 34,828 36,028 LONG-TERM DEBT First Mortgage Bonds Series U, 9 1\/8%, due November 1, 2019 -- 5,830 Series V, 7 3\/4%, due June 1, 2004 40,000 40,000 Series W, 6 1\/8%, due September 1, 1999 40,000 40,000 Series X, 7%, due September 1, 2007 90,000 90,000 Series Y, 6 5\/8%, due February 1, 2003 55,000 55,000 Series Z, 7 1\/4%, due July 1, 2023 45,000 45,000 Series AA, 5 1\/4%, due April 1, 2000 45,000 45,000 Series BB, 6 7\/8%, due October 1, 2025 80,000 80,000 1976 Series A, 6.20%, due November 1, 2006 * 6,665 6,810 1976 Series B, 6.20%, due November 1, 2006 * 1,000 1,000 Installment Sales Agreements - PCRBs 1978 Series A, 6%, due January 1, 2008 14,420 14,420 Series 1986, 8.2%, due July 1, 2014 81,700 81,700 1991 Series A, 8.2%, due August 1, 2011 17,125 17,125 1991 Series B, 6.9%, due November 1, 2004 12,290 12,290 Series 1992, 7.6%, due January 1, 2019 53,500 53,500 Bank Loan, Variable Rate, due June 15, 2000 50,000 50,000 Railcar lease obligations 17,922 20,635 Unamortized discount and premium (3,745) (4,034) Unamortized costs of reacquired debt (45,974) (48,383) Amount to be redeemed within one year (4,070) (3,828) 595,833 602,065 TOTAL CAPITALIZATION $1,324,815 $1,299,856\n*Obligations incurred in connection with the sale by public authorities of tax-exempt PCRBs.\nThe accompanying notes to financial statements are an integral part of these statements.\n2-147 NOTES TO FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation SWEPCO is subject to regulation by the SEC under the Holding Company Act and the FERC under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. SWEPCO is subject to further regulation with regard to rates and other matters by state regulatory commissions including the Arkansas Commission, Louisiana Commission and the Texas Commission. SWEPCO, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System.\nThe more significant accounting policies of SWEPCO 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 electric utility plant are computed using the straight-line method, generally at individual rates applied to the various classes of depreciable property. The annual average consolidated composite rates were 3.2% in 1994, 1993 and 1992.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, SWEPCO changed its method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 income was an increase of $5.4 million included in cumulative effect of changes in accounting principles.\nSWEPCO recovers fuel costs in Texas as a fixed component of base rates whereby over-recoveries of fuel are payable to customers and under-recoveries may be billed to customers after Texas Commission approval. The cost of fuel is charged to expense as consumed.\nSWEPCO recovers fuel costs in Arkansas and Louisiana through automatic fuel recovery mechanisms. The application of these mechanisms varies by jurisdiction.\nSWEPCO recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause.\nAccounts Receivable SWEPCO sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities For its regulated activities, SWEPCO follows SFAS No. 71, which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to the company associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future refunds to customers. At December 31, 1994 and 1993, SWEPCO had recorded the following significant regulatory assets and liabilities:\n2-148 1994 1993 (thousands) Regulatory Assets (Included in Deferred Charges and Other Assets on the Balance Sheets) SFAS No. 106 Costs $ 1,949 $ 993\nRegulatory Liabilities Fuel refund due customers $12,200 $ 2,358 Income tax related regulatory liabilities, net $44,836 $52,828\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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, SWEPCO adopted SFAS Nos. 106, 112 and 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, SWEPCO also changed its method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in 1993 operating expenses of $3 million. The adoption of SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect\nSFAS No. 112 $(3,047) $ 1,066 $(1,981) Unbilled revenues 8,286 (2,900) 5,386 Total $ 5,239 $(1,834) $ 3,405\nPro 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 SWEPCO adopted the provisions of SFAS No. 109 effective January 1, 1993. The implementation of SFAS No. 109 had no material effect on SWEPCO's earnings. As a result of this change, SWEPCO recognized additional accumulated deferred income taxes and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, SWEPCO did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\nSWEPCO, together with other members of the CSW System, files a consolidated federal income tax return and participates in a tax sharing agreement.\n2-149 Components of income taxes follow: 1994 1993 1992 Included in Operating Expenses and Taxes (thousands) Current $22,110 $31,779 $29,377 Deferred 22,248 418 10,258 Deferred ITC (4,278) (5,193) (6,864) 40,080 27,004 32,771 Included in Other Income and Deductions Current (3,732) (1,916) 278 Deferred -- -- -- (3,732) (1,916) 278 Tax Effects of Cumulative Effect of Changes in Accounting Principles -- 1,834 -- $36,348 $26,922 $33,049\nInvestment tax credits deferred in prior years are included in income over the lives of the related properties.\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow:\n1994 % 1993 % 1992 % (dollars in thousands) Tax at statutory rates $49,721 35.0 $38,079 35.0 $43,497 34.0 Differences Amortization of ITC (4,277) (3.0) (5,193) (4.8) (5,384) (4.2) Prior period adjustments (2,718) (1.9) -- -- (3,218) (2.5) Consolidated savings (2,476) (1.7) (2,575) (2.4) -- -- Other (3,902) (2.8) (3,389) (3.1) (1,846) (1.6) $36,348 25.6 $26,922 24.7 $33,049 25.7\nThe significant components of the net deferred income tax liability follow:\n1994 1993 (thousands) Deferred Income Tax Liabilities Depreciable utility plant $ 389,016 $ 352,629 Income tax related regulatory assets 33,847 33,028 Other 41,150 39,405 Total Deferred Income Tax Liabilities $ 464,013 $ 425,062\nDeferred Income Tax Assets Income tax related regulatory liability (50,162) (52,250) Unamortized ITC (29,482) (31,039) Other (25,520) (13,163) Total Deferred Income Tax Assets (105,164) (96,452) Net Accumulated Deferred Income Taxes - Total $ 358,849 $ 328,610\nNet Accumulated Deferred Income Taxes - Noncurrent $ 365,441 $ 332,522 Net Accumulated Deferred Income Taxes - Current (6,592) (3,912) Net Accumulated Deferred Income Taxes - Total $ 358,849 $ 328,610\n2-150 3.Long-Term Debt The mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by SWEPCO, constitutes a direct first mortgage lien on substantially all electric utility plant. SWEPCO may offer additional first mortgage bonds subject to market conditions and other factors.\nAnnual Requirements Certain series of outstanding first mortgage bonds have annual sinking fund requirements, which are generally 1% of the amount of each such series issued. These requirements may be, and generally have been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. At December 31, 1994, the annual sinking fund requirements and annual maturities for the next five years follow:\nSinking Fund Requirements Maturities (thousands) 1995 $ 145 $ 4,100 1996 145 3,900 1997 145 2,600 1998 145 2,400 1999 595 44,000\nDividends SWEPCO's mortgage indenture, as amended and supplemented, contains certain restrictions on the payment of common dividends. At December 31, 1994, all of SWEPCO's retained earnings were available for the payment of cash dividends to its parent, CSW.\nReacquired Long-term Debt Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, Liquidity and Capital Resources - Long-term Financing, for further information related to long-term debt, including new issues and reacquisitions.\n4.Preferred Stock SWEPCO's 6.95% Series, $100 par value preferred stock required a mandatory sinking fund sufficient to retire 12,000 shares annually.\nThe outstanding preferred stock not subject to mandatory redemption is redeemable at the option of SWEPCO upon 30 days notice at the current redemption price per share.\n5.Financial Instruments 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 fair value.\nCash and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nAdvances from affiliates The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt The fair value of the SWEPCO'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 SWEPCO for debt of the same remaining maturities.\n2-151 Current maturities of long-term debt and preferred stock due within 12 months The fair values of the SWEPCO's current maturities of long-term debt and preferred stock due within 12 months are estimated based on quoted market prices for the same or similar issues or on the current rates offered to SWEPCO for long-term debt or preferred stock with the same or similar remaining redemption provisions.\nPreferred stock The fair value of SWEPCO's preferred stock is estimated based on quoted market prices for the same or similar issues or on the current rates offered to SWEPCO for preferred stock with the same or similar remaining redemption provisions.\nThe estimated fair values of SWEPCO's financial instruments follow: 1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 1,296 $ 1,296 $ 6,723 $ 6,723 Long-term debt and preferred stock due within 12 months 5,270 5,171 -- -- Advances from affiliates 81,868 81,868 32,892 32,892 Long-term debt 595,833 555,659 602,065 631,150 Preferred stock subject to mandatory redemption 34,828 31,968 36,028 38,038\nThe fair value does not affect SWEPCO's liabilities unless the issues are redeemed prior to their maturity dates.\n6.Short-Term Financing SWEPCO, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. Money pool balances are shown as advances to or from affiliates on the Balance Sheets. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million 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.\n7.Benefit Plans Defined Benefit Pension Plan SWEPCO, together with other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited service, age at retirement, and final average annual earnings with an offset for the participants' primary Social Security benefit. The CSW System's funding policy is based on actuarially determined contributions, taking into account amounts which are deductible for income tax purposes and minimum contributions required by ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate- term fixed income investments.\nContributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $5.9 million, $6.1 million and $5.2 million, respectively.\nThe approximate maximum number of participants in the plan during 1994 was 2,000 active employees, 800 retirees and beneficiaries and 100 terminated employees.\n2-152 The components of net periodic pension cost and the assumptions used in accounting for pensions follow: 1994 1993 1992 (thousands) Net Periodic Pension Cost Service cost $ 4,843 $ 4,239 $ 3,857 Interest cost on projected benefit obligation 13,361 12,063 10,920 Actual return on plan assets (945) (14,658) (9,375) Net amortization and deferral (15,018) 55 (4,253) $ 2,341 $ 1,699 $ 1,149\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nAt December 31, 1994, the plan's net assets were approximately equal to the total actuarial present value of the accumulated benefit obligation. At December 31, 1993 and 1992, the plan's net assets exceeded the total actuarial present value of the accumulated benefit obligation. No reconciliation of the funding status of the plan is presented because such information is unavailable.\nHealth and Welfare Plans SWEPCO had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active SWEPCO employees during 1994. The contributions, recorded on a pay-as-you-go basis, for the years ended December 31, 1994 and 1993 were approximately $4.1 million and $5.4 million, respectively. Effective January 1993, SWEPCO's method of providing health benefits was modified to include such benefits as a health maintenance organization, preferred provider options, managed prescription drug and mail-order program and a mental health and substance abuse program in addition to the self- insured indemnity plans.\nPostretirement Benefits Other Than Pensions SWEPCO adopted SFAS No. 106 on January 1, 1993. The effect on operating expense in 1993 was $3 million. SWEPCO is amortizing its transition obligation over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\nThe components of net periodic postretirement benefit cost follow:\n1994 1993 (thousands) Net Periodic Postretirement Benefit Cost Service cost $1,965 $1,813 Interest cost on APBO 4,266 3,782 Actual return on plan assets (464) (230) Amortization of transition obligation 1,967 1,967 Net amortization and deferral (765) (474) $6,969 $6,858\n2-153 A reconciliation of the funded status of the plan to the amounts recognized on the balance sheets follow:\nDecember 31, 1994 1993 APBO (thousands) Retirees $ 32,938 $ 31,883 Other fully eligible participants 7,945 7,505 Other active participants 12,726 14,199 Total APBO 53,609 53,587 Plan assets at fair value (18,775) (13,139) APBO in excess of plan assets 34,834 40,448 Unrecognized transition obligation (35,403) (37,370) Unrecognized gain or (loss) 608 (4,410) Accrued\/(Prepaid) Cost $ 39 $ (1,332)\nThe following assumptions were used in accounting for SFAS No. 106.\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 Rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001.\nPost-65 Participants: 1994 Rate of 11.25% 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, 1994 by $6 million and increase the aggregate of the service and interest costs components on net postretirement benefits by $0.9 million.\n8.Jointly Owned Electric Utility Plant SWEPCO has joint ownership agreements with non-affiliated entities. Such agreements provide for the joint ownership and operation of the Flint Creek, Pirkey and Dolet Hills power plants and related facilities. The statements of income reflect SWEPCO's portion of operating costs associated with jointly owned plants. At December 31, 1994, SWEPCO had interests as shown below: Flint Dolet Creek Pirkey Hills Coal Lignite Lignite Plant Plant Plant (dollars in millions) Plant in service $79 $431 $226 Accumulated depreciation $39 $135 $62 Plant capacity-MW 480 650 650 Participation 50.0% 85.9% 40.2% Share of capacity-MW 240 559 262\n2-154 9.Litigation and Regulatory Proceedings Fuel Reconciliation On March 17, 1994, SWEPCO filed a petition with the Texas Commission to reconcile fuel costs for the period November 1989 through December 1993. Total Texas jurisdictional fuel expenses subject to reconciliation for this 50-month period were approximately $559 million. SWEPCO's net under-recovery for the reconciliation period was approximately $0.9 million. SWEPCO and the intervening parties in this proceeding were able to negotiate a stipulated agreement providing a $3.2 million fuel cost disallowance and settling all issues except one. That issue involved the recovery of certain fuel related litigation and settlement negotiation expenses. The Texas Commission, at its Final Order hearing on January 18, 1995, approved the stipulated disallowance and granted SWEPCO recovery of the fuel related litigation expense. The $3.2 million disallowance is included in SWEPCO's 1994 results of operations. SWEPCO recognized the litigation costs as expenses in prior periods.\nBurlington Northern Transportation Contract On January 20, 1995, a state district court in Bowie County, Texas, entered judgment in favor of SWEPCO against Burlington Northern in a lawsuit between the parties regarding rates charged under two rail transportation contracts for delivery of coal to SWEPCO's Welsh and Flint Creek power plants. The court awarded SWEPCO approximately $72 million covering damages for the period from April 27, 1989 through September 26, 1994 and prejudgment interest fees and granted certain declaratory relief requested by SWEPCO.\nKansas City Southern Railway Company Transportation Contracts In March 1994, SWEPCO entered into a settlement with the Kansas City Southern Railway Company of litigation between parties regarding two coal transportation contracts. Pursuant to the settlement, SWEPCO and the Kansas City Southern Railway Company executed a new coal transportation agreement. The settlement is expected to result in a reduction of SWEPCO's coal transportation costs now and in the future. Burlington Northern, another party to the prior contracts and to the litigation, did not participate in the settlement and the litigation is still pending between SWEPCO and Burlington Northern.\nOther SWEPCO 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 SWEPCO's results of operations or financial condition.\n10. Commitments and Contingent Liabilities It is estimated that SWEPCO will spend approximately $96 million in construction expenditures during 1995. Substantial commitments have been made in connection with this capital expenditure program.\nTo supply a portion of the fuel requirements, SWEPCO has entered into various commitments for procurement of fuel.\nHenry W. Pirkey Power Plant In connection with the South Hallsville lignite mining contract for its Henry W. Pirkey Power Plant, SWEPCO has agreed, under certain conditions, to assume the obligations of the mining contractor. As of December 31, 1994, the maximum amount SWEPCO would have to assume was $73.7 million. The maximum amount may vary as the mining contractor's need for funds fluctuates. The contractor's actual obligation outstanding at December 31, 1994 was $60.9 million.\nSouth Hallsville Lignite Mine As part of the process to receive a renewal of a Texas Railroad Commission permit for lignite mining at the South Hallsville lignite mine, SWEPCO has agreed to provide bond guarantees on mine reclamation in the amount of $70 million. Since SWEPCO uses self-\n2-155 bonding, the guarantee provides for SWEPCO to commit to use its resources to complete the reclamation in the event the work is not completed by the third party miner. The current cost to reclaim the mine is estimated to be approximately $25 million.\nCoal Transportation SWEPCO has entered into various financing arrangements primarily with respect to coal transportation and related equipment, which are treated as operating leases for rate-making purposes. At December 31, 1994, leased assets of $46 million, net of accumulated amortization of $30.1 million, were included in electric plant on the balance sheet and at December 31, 1993, leased assets were $46 million, net of accumulated amortization of $26.8 million. Total charges to operating expenses for leases were $6.8 million, $7.1 million, and $6.9 million for the years 1994, 1993, and 1992.\nSuspected MGP Site in Marshall, Texas SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO has accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\nSuspected MGP Site in Texarkana, Texas and Arkansas and Shreveport, Louisiana SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\nBiloxi, Mississippi MGP Site SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nManagement does not expect these matters to have a material effect on SWEPCO's results of operations or financial position.\n2-156 11. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts. Operating Operating Net Quarter Ended Revenues Income Income 1994 (thousands) March 31 $190,066 $ 24,820 $ 14,537 June 30 211,989 36,699 25,851 September 30 245,331 53,304 41,854 December 31 177,910 31,099 23,470 $825,296 $145,922 $105,712\nMarch 31 $175,601 $ 23,953 $ 16,269 June 30 193,225 31,954 21,363 September 30 276,594 58,639 48,353 December 31 191,772 3,511 (4,109) $837,192 $118,057 $ 81,876\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-157 Report of Independent Public Accountants\nTo the Stockholders and Board of Directors of Southwestern Electric Power Company:\nWe have audited the accompanying balance sheets and statements of capitalization of Southwestern Electric Power Company (a Delaware corporation and a wholly-owned subsidiary of Central and South West Corporation) as of December 31, 1994 and 1993, and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of SWEPCO'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 Southwestern Electric Power Company as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, SWEPCO changed its method of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II 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. This schedule 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 LLP\nDallas, Texas February 13, 1995\n2-158 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the financial statements of Southwestern Electric Power Company as well as other information contained in this Annual 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 Annual Report is consistent with that in the financial statements.\nThe financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. SWEPCO believes that representations made to the independent auditors during its audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nSWEPCO maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial statements are prepared in accordance with generally accepted accounting principles and that the assets of the companies are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that SWEPCO will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of SWEPCO provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nSWEPCO believes that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nRichard H. Bremer R. Russell Davis President and CEO - SWEPCO Controller - SWEPCO\n2-159\nWTU\nWEST TEXAS UTILITIES COMPANY\n2-160 Selected Financial Data WTU The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for WTU.\n1994 1993 1992 1991 1990 (thousands, except ratios) Operating Revenues $342,991 $345,445 $315,370 $318,966 $327,065 Income Before Cumulative Effect of Changes in Accounting Principles 37,366 26,517 35,007 36,368 34,173 Cumulative Effect of Changes in Accounting Principles (1) -- 3,779 -- -- -- Net Income 37,366 30,296 35,007 36,368 34,173 Preferred Stock Dividends 452 967 1,451 1,868 2,077 Net Income for Common Stock 36,914 29,329 33,556 34,500 32,096\nTotal Assets 778,895 754,443 744,829 734,053 735,969\nCommon Stock Equity 271,954 266,092 266,874 259,373 261,466 Preferred Stock Not Subject to Mandatory Redemption 6,291 6,291 6,291 6,291 6,291 Subject to Mandatory Redemption -- -- 9,537 14,482 22,376 Long-term Debt 210,047 176,882 211,610 217,855 216,837\nRatio of Earnings to Fixed Charges (SEC Method) Before Cumulative Effect of Changes in Accounting Principles 3.37 2.79 3.22 3.30 3.05\nCapitalization Ratios Common Stock Equity 55.7% 59.2% 54.0% 52.1% 51.6% Preferred Stock 1.3 1.4 3.2 4.2 5.6 Long-term Debt 43.0 39.4 42.8 43.7 42.8\n(1) The 1993 cumulative effect relates to the changes in accounting for unbilled revenues and adoption of SFAS No. 112. See NOTE 1, Summary of Significant Accounting Policies.\nWTU changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore have not been restated.\n2-161 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nWEST TEXAS UTILITIES COMPANY\nReference is made to WTU's Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential to understanding, the following discussion and analysis.\nOverview Net income for common stock was $37 million in 1994, a 26% increase when compared to 1993. This increase was due primarily to an increase in retail base revenues and other income and a decrease in restructuring charges.\nRestructuring As previously reported, WTU has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable WTU to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $15 million and were expensed in 1993. The final costs of the restructuring were approximately $13 million. Approximately $12 million of the restructuring expenditures were incurred during 1994, with the remaining $1 million expected to be incurred during 1995. Approximately $1 million of the restructuring expenses relate to employee termination benefits, $7 million relate to enhanced benefit costs and $5 million relate to employees that will not be terminated. Approximately $9 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $4 million represent the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nWTU expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. The CSW System expects that all restructuring costs will be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nRates and Regulatory Matters See NOTE 9, Litigation and Regulatory Proceedings, for information regarding the WTU fuel and rate proceedings, and deferred accounting matters.\nNew Accounting Standards SFAS No. 115 was effective for fiscal years beginning after December 15, 1993. WTU adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on WTU's results of operations or financial condition.\nIn June 1993, the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by WTU for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on WTU's results of operations or financial condition.\n2-162 SFAS No. 119 was effective for fiscal years ending after December 15, 1994. WTU currently does not use derivative instruments, but may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on WTU's results of operations or financial condition.\nLiquidity and Capital Resources Overview WTU's need for capital results primarily from the construction of facilities to provide reliable electric service to its customers. Accordingly, internally generated funds should meet most of the capital requirements. However, if internally generated funds are not sufficient, WTU's financial condition and credit rating should allow it access to the capital markets.\nCapital Expenditures Construction expenditures including AFUDC were $42 million, $37 million and $29 million for the years 1994, 1993 and 1992. It is estimated that construction expenditures, including AFUDC, during the 1995 through 1997 period will aggregate $109 million. Such expenditures primarily will be made to improve and expand transmission and distribution facilities. These improvements are expected to meet the needs of new customers and to satisfy changing requirements of existing customers. No new baseload power plants are currently planned until after the year 2000.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in WTU's service area, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected coal- and lignite-fired generating plants for which WTU has invested approximately $15 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, WTU would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of WTU were 56% common stock equity, 1% preferred stock and 43% long-term debt. WTU continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. WTU continues to be committed to maintaining financial flexibility by maintaining its strong capital structure and favorable securities ratings which should allow funds to be obtained from the capital markets when required.\nWTU's long-term financing activity is shown below:\nIn February 1994, WTU issued $40 million of 6-1\/8% FMBs, Series S, due February 1, 2004. Proceeds were used to reimburse WTU's treasury for (i) $12 million aggregate principal amount of 7-1\/4% First Mortgage Bonds, Series G, due January 1, 1999, redeemed on January 1, 1994, and, (ii) $23 million aggregate principal amount of 7- 7\/8% FMBs, Series H, due July 1, 2003, redeemed on December 30, 1993. The balance of the proceeds was used to repay outstanding short-term borrowings.\nIn July 1994, WTU redeemed its remaining $4.7 million outstanding of 7-1\/4% Series Preferred Stock in accordance with mandatory sinking fund provisions. The funds required for this transaction were provided from internal sources and short-term borrowings.\nIn October and November 1994, WTU reacquired $7.8 million aggregate principal amount of its 9-1\/4% FMBs, Series O, due December 1, 2019 in open market transactions. The funds required for these transactions were provided from short-term borrowings and internal sources. The premiums and reacquisition costs of reacquired long-term\n2-163 debt are included in long-term debt on the balance sheets and are being amortized over 10 to 30 years in accordance with the anticipated regulatory treatment.\nIn December 1994, pursuant to sinking fund requirements, WTU elected to redeem at par $650,000 Series O, FMBs.\nIn March 1995, WTU issued $40 million of 7-1\/2% FMBs, Series T, due April 1, 2000. Proceeds were used to repay a portion of WTU's short-term debt, to provide working capital and for other general corporate purposes.\nWTU Shelf Registration WTU expects to obtain a majority of their 1995 capital requirements from internal sources, but may issue additional securities subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost preferred stock and to repay short-term debt. WTU has filed shelf registration statements with the SEC for the sale of securities. As of March 1995, WTU had $20 million remaining for issuance of first mortgage bonds under a shelf registration filed with the SEC in 1993. WTU may issue additional debt securities subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost FMBs, to lower embedded cost of debt, to repay short-term debt, to provide working capital and for other general corporate purposes.\nWTU may issue additional preferred stock subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost preferred stock and to redeem short-term debt.\nShort-Term Financing WTU, together with other members of the CSW System, has established a CSW System money pool to coordinate short-term borrowings. These loans are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs. WTU's short-term borrowing limit from the money pool is $50 million. During 1994, the annual weighted average interest rate was 4.5% and the average amount of short-term month-end borrowings outstanding was $22 million. The maximum amount of short-term borrowings outstanding at any month-end during 1994 was $46 million, which was the amount outstanding at December 31, 1994.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. WTU uses short- term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. During 1993 and 1994, WTU experienced several non-recurring transactions that resulted in negative internally generated funds in 1994, including the refinancing of Series G and Series H FMBs with Series S FMBs which occurred from December 1993 through February 1994. This refinancing caused an abnormally high accounts payable balance at December 31, 1993 which was subsequently reduced by the issuance of Series S in February 1994, resulting in the appearance of a large out flow of cash from operating funds. WTU anticipates that capital requirements for the period 1995 to 1997 will be met, in large part, from internal sources. WTU also expects that some external financings maybe required during the period, but the nature, timing and extent have not yet been determined. Information concerning internally generated funds follows:\n1994 1993 1992 (millions) Internally Generated Funds ($4) $59 $49\nConstruction Expenditures Provided by Internally Generated Funds -- 163% 169%\n2-164 As discussed above, WTU issued $40 million of 7-1\/2% FMBs during the first quarter of 1995, which were used to reduce short-term debt.\nSales of Accounts Receivable WTU sells its billed and unbilled accounts receivable, without recourse, to CSW Credit. The sales provide WTU with cash immediately, thereby reducing working capital needs and revenue requirements. The average and year end amounts of accounts receivable sold were $35 million and $18 million in 1994, as compared to $36 million and $34 million in 1993.\nRecent Developments and Trends Competition and Industry Challenges Competitive forces at work in the electric utility industry are impacting WTU and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, WTU will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. WTU believes that its prices for electricity and the quality and reliability of its service currently place it in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While WTU believes that the Energy Policy Act will continue to make the wholesale markets more competitive, WTU is unable to predict the extent to which the Energy Policy Act will impact its operations.\nIncreasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. WTU competes in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities, but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers.\n2-165 WTU believes that, compared to other electric utilities, it is well positioned to meet future competition. WTU benefits from economies of scale and scope by virtue of its size and its relationship to the CSW System. WTU is also a relatively low-cost producer of electric power. Moreover, WTU is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nWTU is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or on WTU. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\nPublic Utility Regulatory Act PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. WTU is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, WTU has recognized significant regulatory assets and liabilities. Management believes that WTU will continue to meet the criteria for following SFAS No. 71. However, in the event WTU no longer meets the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nConsolidated Taxes The Texas Commission before 1992 allowed income taxes to be recovered in rates based on the federal income tax incurred by a utility as if it were a stand-alone company. This stand-alone approach treated the regulated activities of a utility as a separate entity and considered only those revenues and expenses that are included in the utility's cost of service to calculate the federal income tax liability for ratemaking purposes.\nBeginning in 1992, the Texas Commission changed its method of calculating the federal income tax component of rates to the \"actual tax approach.\" The actual tax approach is an evolving concept but generally seeks to reflect in rates the actual tax liability of the utility irrespective of its relationship to the utility's cost of service. The approach reduces rates by the tax benefits of deductions which are not considered for or included in setting rates for the utility.\nThe Texas Commission is expected to use the actual tax approach for calculating the recovery of federal income tax in the pending rate case for WTU. The impact of the actual tax approach on the prospective rates for WTU cannot be determined since the application of the concept is unsettled.\nWTU believes that the recovery of federal income taxes in rates should be determined on the stand-alone approach for ratemaking purposes, but there is no assurance this approach will be adopted in the pending WTU rate case.\n2-166 Environmental Matters CERCLA and Related Matters The operations of WTU, like those of other utilities, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nWTU is subject to various pending claims alleging it is a PRP under federal or state remedial laws for investigating and cleaning up contaminated property. WTU anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on WTU's results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by WTU, the estimated amount of costs allocated to WTU and the participation of other parties.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, the Electric Operating Companies will be required to hold allowances in order to emit sulfur dioxide. The EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, WTU believes that its allowances will be adequate to meet its needs at least through 2008. Public and private markets are developing for trading of excess allowances. WTU presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\nThe Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on WTU cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, WTU expects to spend $0.5 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects. Although a few of the studies to date have suggested certain associations between EMFs and some types of effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. WTU cannot predict the impact on WTU or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nResults of Operations Electric Operating Revenues Electric operating revenues in 1994 decreased approximately $2.5 million or 1% when compared to 1993. This decrease was due primarily to a reduction in lower margin off-system sales of $8 million resulting from decreased market place demand. This decrease was partially offset by higher on system revenues of $6.5 million attributable to an increase in retail KWH sales of 3% resulting from customer growth and increased usage. Also contributing to the\n2-167 decrease was an interim rate reduction of approximately $5.7 million on an annual basis effective October 1, 1994. Revenues for 1993, when compared to 1992, increased approximately $30.1 million, or 10%. The increase is attributed to a 10% increase in KWH sales and a $9.1 million increase in fuel-related revenues. The increase in KWH sales is attributable to a warmer summer in 1993 and increased sales for resale to an affiliated company.\nFuel and Purchased Power Expenses Fuel expenses decreased approximately $3.8 million or 3% during 1994 when compared to 1993 and increased approximately $15.1 million or 13% when compared to 1992. The decrease in 1994 is primarily attributable to a 2% decrease in average unit fuel costs from $1.91 in 1993 to $1.88 in 1994 and a 2% decrease in generation. The increase in 1993 is due primarily to a 5% increase in average unit fuel cost to $1.91 in 1993 from $1.82 in 1992 and a 7% increase in generation. The change in unit fuel costs during both years is due primarily to changes in the price of natural gas on the spot market.\nPurchased power expenses decreased approximately $2.3 million and increased $4.3 million during 1994 and 1993, respectively, when compared to the prior years. The change during both periods is primarily attributable to increased economy purchases in 1993.\nExpenses and Taxes Other operating expenses increased approximately $4.9 million and $3.8 million during 1994 and 1993, respectively, when compared to prior years. The increase during 1994 reflects a reimbursement in 1993 for the settlement of a dispute relating to a coal supply contract which lowered expenses in 1993. Higher outside services for fuel related issues and other employee related expenses in 1994 also contributed to the increase. The increase during 1993 was due primarily to higher employee pensions and benefits.\nRestructuring charges reflect the original accrual of $15 million in December 1993 which was subsequently adjusted by $2 million in 1994, resulting in total restructuring charges for WTU of $13 million at December 31, 1994.\nMaintenance expense in 1994 increased over 1993 by approximately $1.7 million or 13% due primarily to increased production maintenance of boiler and electric plant. Maintenance increased approximately $1.3 million in 1993 compared with 1992 because of higher production and general expenses resulting from boiler plant maintenance.\nDepreciation and amortization expenses increased approximately $1.2 million and $3.6 million during 1994 and 1993, respectively, when compared to prior years due primarily to increases in depreciable property.\nFederal income taxes increased approximately $4.3 million or 32% in 1994 when compared with 1993 due to higher pre-tax income. The decrease in 1993 compared to 1992 was largely attributable to lower pre-tax income partially offset by an increase in the federal corporate income tax rate to 35% from 34%.\nOther income increased approximately $2.3 million in 1994 resulting from tax benefits received under WTU's tax sharing agreement with CSW.\nInterest on Long-Term Debt Interest on long-term debt decreased approximately $0.7 million in 1994 when compared to the prior year due to WTU's refinancing of higher cost debt with lower cost debt and decreased balances outstanding.\nInflation Annual inflation rates, as measured by the national Consumer Price Index, have averaged approximately 2.7% for the three-year period ending December 31, 1994. WTU believes that inflation, at these levels, does not materially affect its results of operations\n2-168 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.\nCumulative Effect of Changes in Accounting Principles In 1993, WTU changed it method of accounting for unbilled revenue and implemented SFAS No. 112. These accounting changes had a cumulative effect of increasing net income by $3.8 million.\n2-169 Statements of Income West Texas Utilities Company For the Years Ended December 31, 1994 1993 1992 (thousands) Electric Operating Revenues Residential $118,525 $115,932 $106,497 Commercial 66,483 65,085 62,244 Industrial 52,626 53,709 52,651 Sales for resale 67,076 72,252 60,833 Other 38,281 38,467 33,145 342,991 345,445 315,370 Operating Expenses and Taxes Fuel 131,258 135,048 119,983 Purchased power 5,144 7,411 3,086 Other operating 66,290 61,357 57,578 Restructuring charges (2,037) 15,250 -- Maintenance 14,978 13,251 11,959 Depreciation and amortization 31,569 30,405 26,784 Taxes, other than federal income 23,072 22,496 21,970 Federal income taxes 17,954 13,651 16,708 288,228 298,869 258,068\nOperating Income 54,763 46,576 57,302\nOther Income and Deductions Allowance for equity funds used during construction 150 109 51 Other 4,210 1,907 1,114 4,360 2,016 1,165\nIncome Before Interest Charges 59,123 48,592 58,467\nInterest Charges Interest on long-term debt 18,547 19,225 21,368 Interest on short-term debt and other 3,534 2,988 2,197 Allowance for borrowed funds used during construction (324) (138) (105) 21,757 22,075 23,460\nIncome Before Cumulative Effect of Changes in Accounting Principles 37,366 26,517 35,007\nCumulative Effect of Changes in Accounting Principles -- 3,779 --\nNet Income 37,366 30,296 35,007 Preferred stock dividends 452 967 1,451 Net Income for Common Stock $ 36,914 $ 29,329 $ 33,556\nThe accompanying notes to financial statements are an integral part of these statements.\n2-170 Statements of Retained Earnings West Texas Utilities Company For the Years Ended December 31, 1994 1993 1992 (thousands) Retained Earnings at Beginning of Year $126,642 $127,424 $119,923 Net income for common stock 36,914 29,329 33,556 Deduct: Common stock dividends 31,000 30,000 26,000 Preferred stock redemption cost 52 111 55 Retained Earnings at End of Year $132,504 $126,642 $127,424\nThe accompanying notes to financial statements are an integral part of these statements.\n2-171 Balance Sheets West Texas Utilities Company As of December 31, 1994 1993 (thousands) ASSETS Electric Utility Plant Production $427,736 $425,340 Transmission 194,402 190,300 Distribution 308,905 291,509 General 73,938 69,780 Construction work in progress 23,257 14,385 1,028,238 991,314 Less - Accumulated depreciation 364,383 337,888 663,855 653,426 Current Assets Cash 2,501 706 Accounts receivable 23,165 24,497 Materials and supplies, at average cost 16,519 14,451 Fuel inventory, at average cost 9,229 9,150 Coal inventory, at LIFO cost 6,442 5,511 Accumulated deferred income taxes 3,068 1,222 Prepayments and other 1,091 450 62,015 55,987\nDeferred Charges and Other Assets Deferred Oklaunion costs 26,914 27,735 Other 26,111 17,295 53,025 45,030 $778,895 $754,443\nThe accompanying notes to financial statements are an integral part of these statements.\n2-172 Balance Sheets West Texas Utilities Company As of December 31, 1994 1993 (thousands) CAPITALIZATION AND LIABILITIES Capitalization Common stock: $25 par value Authorized: 7,800,000 shares Issued and outstanding: 5,488,560 shares $137,214 $137,214 Paid-in capital 2,236 2,236 Retained earnings 132,504 126,642 Total Common Stock Equity 271,954 266,092 Preferred stock Not subject to mandatory redemption 6,291 6,291 Long-term debt 210,047 176,882 Total Capitalization 488,292 449,265\nCurrent Liabilities Long-term debt and preferred stock due within twelve months 650 17,298 Advances from affiliates 46,315 11,784 Accounts payable 35,407 51,041 Accrued restructuring charges 571 15,250 Accrued taxes 7,452 14,620 Accrued interest 4,394 4,128 Other 3,758 1,979 98,547 116,100 Deferred Credits Accumulated deferred income taxes 146,146 134,595 Investment tax credits 31,882 33,203 Income tax related regulatory liabilities, net 9,217 10,545 Other 4,811 10,735 192,056 189,078 $778,895 $754,443\nThe accompanying notes to financial statements are an integral part of these statements.\n2-173 Statements of Cash Flows West Texas Utilities Company For the Years Ended December 31, 1994 1993 1992 (thousands) OPERATING ACTIVITIES Net Income $ 37,366 $ 30,296 $ 35,007 Non-cash Items Included in Net Income Depreciation and amortization 33,362 31,925 28,354 Restructuring charges (2,037) 15,250 -- Deferred income taxes and investment tax credits 7,056 3,159 4,911 Cumulative effect of changes in accounting principles -- (3,779) -- Allowance for equity funds used during construction (150) (109) (51) Changes in Assets and Liabilities Accounts receivable 1,332 (3,159) (6,804) Fuel inventory (1,010) (6) 141 Accounts payable (15,103) 21,552 13,417 Accrued taxes (7,168) 4,085 1,343 Accrued restructuring charges (8,918) -- -- Other deferred credits (5,924) (6,502) (777) Other (10,802) (2,694) 1,152 28,004 90,018 76,693 INVESTING ACTIVITIES Construction expenditures (41,504) (36,318) (28,902) Allowance for borrowed funds used during construction (324) (138) (105) Disposition of plant (1,315) 3,302 (854) (43,143) (33,154) (29,861) FINANCING ACTIVITIES Proceeds from issuance of long-term debt 39,354 (77) 98,506 Reacquisition of long-term debt (20,731) (24,250) (106,757) Redemption of preferred stock (4,700) (10,000) (5,000) Payment of dividends (31,520) (30,816) (27,874) Change in advances from affiliates 34,531 7,241 (5,714) 16,934 (57,902) (46,839)\nNet Change in Cash and Cash Equivalents 1,795 (1,038) (7) Cash and Cash Equivalents at Beginning of Year 706 1,744 1,751 Cash and Cash Equivalents at End of Year $ 2,501 $ 706 $ 1,744\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 18,128 $ 18,430 $ 21,257 Income taxes paid $ 12,720 $ 325 $ 6,174\nThe accompanying notes to financial statements are an integral part of these statements.\n2-174 Statements of Capitalization West Texas Utilities Company As of December 31, 1994 1993 (thousands)\nCOMMON STOCK EQUITY $271,954 $266,092\nPREFERRED STOCK Cumulative $100 Par Value, Authorized 810,000 shares Number Current of Shares Redemption Series Outstanding Price\nNot Subject to Mandatory Redemption 4.40% 60,000 $107.00 6,000 6,000 Premium 291 291 6,291 6,291 Subject to Mandatory Redemption 7.25% 47,000 $100.91 -- 4,700 Issuance Expense -- (52) Amount to be Redeemed Within One Year -- (4,648) -- -- LONG-TERM DEBT First Mortgage Bonds Series G, 7 1\/4%, due January 1, 1999 -- 12,000 Series O, 9 1\/4%, due December 1, 2019 55,203 63,700 Series P, 7 3\/4%, due June 1, 2007 25,000 25,000 Series Q, 6 7\/8%, due October 1, 2002 35,000 35,000 Series R, 7%, due October 1, 2004 40,000 40,000 Series S, 6 1\/8%, due February 1, 2004 40,000 -- Installment Sales Agreements - PCRBs Series 1984, 7 7\/8%, due September 15, 2014 44,310 44,310 Unamortized discount and premium (1,323) (1,162) Unamortized costs of reacquired debt (27,493) (29,316) Amount to be redeemed within one year (650) (12,650) 210,047 176,882 TOTAL CAPITALIZATION $488,292 $449,265\nThe accompanying notes to financial statements are an integral part of these statements.\n2-175 NOTES TO FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation WTU is subject to regulation by the SEC under the Holding Company Act, and the FERC under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. WTU is subject to further regulation with regard to rates and other matters by the Texas Commission. WTU, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System.\nThe more significant accounting policies of WTU 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 electric utility plant are computed using the straight-line method, generally at individual rates applied to the various classes of depreciable property. The annual average consolidated composite rates were 3.2% in both 1994 and 1993 and 3.1% in 1992.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, WTU changed its method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 net income was an increase of $5.4 million included in cumulative effect of changes in accounting principles.\nWTU recovers fuel costs in Texas as a fixed component of base rates whereby over-recoveries of fuel are payable to customers and under-recoveries of fuel may be billed to customers after Texas Commission approval. The cost of fuel is charged to expense as consumed. WTU recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause.\nAccounts Receivable. WTU sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities. For its regulated activities, WTU follows SFAS No. 71, which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to the company associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future refunds to customers. At December 31, 1994 and 1993, WTU had recorded the following significant regulatory assets and liabilities:\n2-176 1994 1993 (thousands) Regulatory Assets Deferred plant costs $26,914 $27,735\nRegulatory Liabilities Income tax related regulatory liabilities, net $ 9,217 $10,545\nDeferred Plant Costs In accordance with orders of the Texas Commission, WTU deferred operating, depreciation and tax costs incurred for Oklaunion Power Station Unit 1. This deferral was for the period beginning on the date when the plant began commercial operation until the date the plant was included in rate base. The deferred costs are being amortized and recovered through rates over the remaining life of the plant. See NOTE 9, Litigation and Regulatory Proceedings, for further discussion of WTU's deferred accounting.\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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, WTU adopted SFAS Nos. 106, 112 and 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, WTU also changed its method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in 1993 operating expenses of $1.9 million. The adoption of SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect (thousands)\nSFAS No. 112 $(2,534) $ 887 $(1,647) Unbilled revenues 8,347 (2,921) 5,426 Total $ 5,813 $(2,034) $ 3,779\nPro 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 WTU adopted the provisions of SFAS No. 109 effective January 1, 1993. The implementation of SFAS No. 109 had no material effect on WTU's earnings. As a result of this change, WTU recognized additional accumulated deferred income taxes and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, WTU did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\n2-177 WTU, together with other members of the CSW System, files a consolidated federal income tax return and participates in a tax sharing agreement.\nComponents of income taxes follow:\n1994 1993 1992 Included in Operating Expenses and Taxes (thousands) Current $10,898 $11,379 $11,797 Deferred 8,377 3,593 6,426 Deferred ITC (1,321) (1,321) (1,515) 17,954 13,651 16,708 Included in Other Income and Deductions Current (2,998) (510) 590 Deferred -- -- -- (2,998) (510) 590 Tax Effects of Cumulative Effect of Changes in Accounting Principles -- 2,034 -- $14,956 $15,175 $17,298\nInvestment tax credits deferred in prior years are included in income over the lives of the related properties.\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow:\n1994 % 1993 % 1992 % (dollars in thousands) Tax at statutory rates $18,313 35.0 $15,915 35.0 $17,784 34.0 Differences Amortization of ITC (1,321) (2.5) (1,321) (2.9) (1,321) (2.5) Other (2,036) (3.9) 581 1.3 835 1.7 $14,956 28.6 $15,175 33.4 $17,298 33.2\n2-178 The significant components of the net deferred income tax liability follow:\n1994 1993 (thousands) Deferred Income Tax Liabilities Depreciable utility plant $144,501 $120,015 Deferred plant costs 9,420 9,707 Income tax related regulatory liability 10,908 11,074 Other 10,120 18,963 Total Deferred Income Tax Liabilities 174,949 159,759\nDeferred Income Tax Assets Income tax related regulatory liability (14,134) (14,765) Unamortized ITC (11,159) (11,621) Other (6,578) -- Total Deferred Income Tax Assets (31,871) (26,386) Net Accumulated Deferred Income Taxes - Total $143,078 $133,373\nNet Accumulated Deferred Income Taxes - Noncurrent $146,146 $134,595 Net Accumulated Deferred Income Taxes - Current (3,068) (1,222) Net Accumulated Deferred Income Taxes - Total $143,078 $133,373\n3.Long-Term Debt The mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by WTU, constitutes a direct first mortgage lien on substantially all electric utility plant. WTU may offer additional FMBs subject to market conditions and other factors.\nAnnual Requirements Series O FMBs have annual sinking fund requirements, which may be satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements or at WTU's option, the redemption of 1% of the amount originally issued. At December 31, 1994, the annual sinking fund requirements for the next five years, exclusive of maturities, of WTU's first mortgage bonds are $650,000. Pursuant to these sinking fund requirements, WTU elected to redeem at par $650,000 Series O, FMBs in December 1994.\nDividends WTU's mortgage indenture, as amended and supplemented, contains certain restrictions on the payment of common stock dividends. At December 31, 1994, $133 million of retained earnings were available for the payment of cash dividends to its parent, CSW.\nReacquired long-term debt Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources, for further information related to long-term debt, including new issues and reacquisition.\n4.Preferred Stock In July 1993, WTU redeemed 100,000 shares of its 7.25% Series, $100 par value, Preferred Stock, for $10 million, in accordance with mandatory and optional sinking fund provisions. The capital required for this transaction was provided by short-term borrowings from the CSW System money pool and internal sources.\n2-179 In July 1994, WTU redeemed the remaining 47,000 shares of its 7.25% Series, $100 par value, Preferred Stock.\n5.Financial Instruments 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 fair value.\nCash and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nAdvances from affiliates The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt The fair value of the WTU'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 WTU for debt of the same remaining maturities.\nPreferred stock subject to mandatory redemption The fair value of the WTU's preferred stock subject to mandatory redemption is estimated based on quoted market prices for the same or similar issues or on the current rates offered to WTU for preferred stock with the same or similar remaining redemption provisions.\nCurrent maturities of long-term debt The fair value of current maturities is estimated based on quoted market prices for the same or similar issues or the current rates offered for long-term debt.\nThe estimated fair values of WTU's financial instruments follow:\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 2,501 $ 2,501 $ 706 $ 706 Current maturities of long-term debt 650 666 12,650 12,800 Advances from affiliates 46,315 46,315 36,285 36,285 Long-term debt 210,047 228,802 176,882 225,082 Preferred stock -- -- 4,648 4,671\nThe fair value does not affect WTU's liabilities unless the issues are redeemed prior to their maturity dates.\n6.Short-Term Financing WTU, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. Money pool balances are shown as advances to or from affiliates on the Balance Sheets. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million 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.\n2-180 7.Benefit Plans Defined Benefit Pension Plan WTU, together with other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited 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 which are deductible for income tax purposes and minimum contributions required by the ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate- term fixed income investments.\nContributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $3.8 million, $3.9 million and $3.4 million, respectively.\nThe approximate maximum number of participants in the plan during 1994 were 1,300 active employees, 500 retirees and beneficiaries and 100 terminated employees.\nThe components of net periodic pension cost and the assumptions used in accounting for pensions follow:\n1994 1993 1992 (thousands) Net Periodic Pension Cost Service cost $ 3,082 $ 2,732 $ 2,569 Interest cost on projected benefit obligation 8,501 7,776 7,274 Actual return on plan assets (601) (9,448) (6,242) Net amortization and deferral (9,556) 35 (2,836) $ 1,426 $ 1,095 $ 765\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nAt December 31, 1994, the plan's net assets were approximately equal to the total actuarial present value of the accumulated benefit obligation. At December 31, 1993 the plan's net assets exceeded the total actuarial present value of the accumulated benefit obligation. No reconciliation of the funding status of the plan is presented because such information is unavailable.\nHealth and Welfare Plans WTU had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active WTU employees during 1994. The contributions, recorded on a pay-as-you-go basis for the years ended December 31, 1994 and 1993 were approximately $2.7 million and $3.5 million, respectively. Effective January 1993, WTU's method of providing health benefits was modified to include such benefits as preferred provider options, managed prescription drug and mail-order program and a mental health and substance abuse program in addition to the self-insured indemnity plans.\nPostretirement Benefits Other Than Pensions WTU adopted SFAS No. 106 January 1, 1993. The effect on operating expense in 1993 was $1.9 million. WTU is amortizing its transition obligation over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\n2-181 The components of net periodic postretirement benefit cost follow:\n1994 1993 (thousands) Net Periodic Postretirement Benefit Cost Service cost $1,233 $1,157 Interest cost on APBO 2,559 2,316 Actual return on plan assets (113) (104) Amortization of transition obligation 1,225 1,225 Net amortization and deferral (418) (296) $4,486 $4,298\nA reconciliation of the funded status of the plan to the amounts recognized on the consolidated balance sheets follow:\nDecember 31, 1994 1993 APBO (thousands) Retirees $ 19,703 $ 18,722 Other fully eligible participants 4,764 4,624 Other active participants 7,519 8,758 Total APBO 31,986 32,104 Plan assets at fair value (9,636) (6,064) APBO in excess of plan assets 22,350 26,040 Unrecognized transition obligation (22,047) (23,272) Unrecognized gain or (loss) 91 (2,374) Accrued\/(Prepaid) Cost $ 394 $ 394\nThe following assumptions were used in accounting for SFAS No. 106:\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 Rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001.\nPost-65 Participants: 1994 Rate of 11.25% 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, 1994 by $3.5 million and increase the aggregate of the service and interest costs components on net postretirement benefits by $.5 million.\n8.Jointly Owned Electric Utility Plant WTU has a joint ownership agreement with other members of the CSW System and other non-affiliated entities. Such agreements provide for the joint ownership and operation of Oklaunion Power Station. Each participant provided financing for its share of the project, which was placed in service in December 1986. The statements of income reflect WTU's portion of operating costs associated with jointly owned plant in service. WTU's share is 370 MW or a 54.7% interest in the generating station. WTU's total investment, including AFUDC is $280 million and accumulated depreciation at December 31, 1994 is $59 million.\n2-182 9.Litigation and Regulatory Proceedings Rate Proceeding - Docket No. 13369 On August 25, 1994, WTU filed a petition with the Texas Commission and with cities with original jurisdiction to review WTU's rates, proposed an interim across-the-board base rate reduction of 3.25% or, approximately $5.7 million, effective October 1, 1994, and sought until February 28, 1995, the time to develop and file a RFP. WTU also requested the ability to \"true-up\", back to October 1, 1994, any difference in revenue requirements upon final order of the Texas Commission, and proposed that any increases over the pre-October 1, 1994, base rates be implemented prospectively on the effective date of the final order.\nAs discussed below, WTU's fuel reconciliation was consolidated with this proceeding in September 1994. Reconcilable fuel costs during the reconciliation period were approximately $300 million. At June 30, 1994, the fuel cost under-recovery totaled approximately $5.1 million, including interest. At December 31, 1994, this amount had become an over-recovery of approximately $0.2 million. WTU is not seeking a change in fuel factors.\nOn February 28, 1995, WTU filed with the Texas Commission and cities with original jurisdiction the RFP which indicates a revenue deficiency of approximately $14.5 million. However, WTU simultaneously filed with the parties a settlement proposal to reduce overall base rate revenue by 3.25%, effective October 1, 1994, an annual impact in the rate year beginning January 1, 1996 of approximately $5.9 million. The settlement proposal reflects WTU's desire to maintain competitive rates, recognizes the importance of competitive rates in the changing electric service marketplace, and demonstrates WTU's strong commitment to the long- term success of WTU and its customers.\nUnless a settlement accelerates the schedule, WTU anticipates hearings in mid-1995 with a final order in the fourth quarter of 1995. Management cannot predict the outcome of the rate proceeding, the fuel reconciliation, or the settlement proposal, but believes that the ultimate resolution of these matters will not have a material adverse effect on WTU's results of operations or financial condition.\nFuel Reconciliation - Docket No. 13172 On June 30, 1994, WTU filed a petition with the Texas Commission to reconcile fuel costs for the period January 1991 through February 1994. Subsequently, in September 1994, this fuel reconciliation proceeding was consolidated into Docket No. 13369 described above, and the reconciliation period was extended through June 1994.\nRate Case Proceeding - Docket No. 7510 In November 1987, the Texas Commission issued a final order in WTU's retail rate case providing for WTU to receive an annual increase in base retail revenues of $34.9 million. Rates reflecting the final order were implemented in December 1987. WTU, along with certain intervenors in the retail rate proceeding, appealed the Texas Commission's final order to the District Court seeking reversal of various provisions of the final order, including the inclusion of deferred accounting in rate base.\nThe appeals were consolidated and in September 1988, the District Court affirmed the final order of the Texas Commission. In November 1988, certain intervenors filed appeals of the District Court's judgment with the Court of Appeals. In February 1990, the Court of Appeals ruled that an intervenor had improperly been excluded from presenting its appeal to the District Court, reversed the District Court's judgment and remanded the case to the District Court for further proceedings.\nIn October 1992, the District Court heard the remanded appeals of the final order of the Texas Commission and in March 1993 issued an order affirming the Texas Commission's order in all material respects with the single exception of the inclusion of deferred Oklaunion carrying costs in rate base. In its treatment of\n2-183 deferred costs, the District Court followed a then-current opinion of the Court of Appeals which precluded recovery of deferred post- in-service carrying costs. In April 1993, WTU and other parties filed appeals, and oral argument was held on the appeals in December 1993 on the non-deferred accounting issues. With respect to the deferred accounting issues, the parties recognized certain Supreme Court of Texas decisions regarding other deferred accounting cases would be influential in WTU's case.\nIn June 1994, the Supreme Court of Texas issued its opinion in the three other cases involving deferred accounting holding that the Texas Commission has the authority to allow deferred accounting treatment during the deferral period, including deferred post-in- service carrying costs. The Supreme Court of Texas upheld the Court of Appeals in all respects except it reversed the Court of Appeals to the extent it disallowed carrying costs deferrals and remanded to the Court of Appeals for consideration of the unresolved arguments of the improperly excluded intervenor. Motions for rehearing were filed by certain parties which were denied by the Supreme Court of Texas. These rulings influenced the Court of Appeals' decision in WTU's rate case appeals, as described below.\nOn February 15, 1995, the Court of Appeals affirmed all aspects of the District Court judgment relating to the Texas Commission's allowance of non-Oklaunion depreciation rates and the surcharge of rate case expenses, reversed the District Court's judgment relating to the exclusion of deferred Oklaunion carrying costs in rate base, and remanded the cause to the Texas Commission to reexamine the issue of deferred costs in light of the remand of Docket No. 7289, as described below. However, on March 3, 1995, WTU filed a motion for rehearing at the Court of Appeals seeking clarification of certain aspects of its order and arguing that the Court of Appeals erred in remanding the case to the Texas Commission for it to determine to what extent deferred costs are necessary to preserve WTU's financial integrity because the issue has been waived since it was not briefed or argued to the Court of Appeals. WTU expects other parties may also file motions for rehearing.\nWTU's motion for rehearing may, if granted, prevent further review of financial integrity issues with respect to deferred accounting in any remand of Docket No. 7510. If a broader remand is permitted and if the Texas Commission concludes in Docket No. 7289 that deferred accounting was necessary to preserve WTU's financial integrity during the deferral period, the Texas Commission must decide to what extent the deferred Oklaunion costs, including carrying costs, were necessary to preserve WTU's financial integrity. If WTU's deferred accounting treatment is ultimately reversed or is substantially reduced, WTU could experience a material adverse impact on its results of operations. While management can give no assurances as to the outcome of the remanded proceeding or the motion for rehearing, management believes that 100 percent of the Oklaunion deferred costs will be determined by the Texas Commission to have been necessary to preserve WTU's financial integrity during the deferral period so that there will be no material adverse effect on WTU's results of operations or financial condition.\nDeferred Accounting - Docket No. 7289 WTU received approval from the Texas Commission in September 1987 to defer operating expenses and carrying costs associated with Oklaunion incurred subsequent to its December 1986 commercial operation date until December 1987 (the deferral period) when retail rates including Oklaunion in WTU's rate base became effective. WTU has recorded approximately $32 million of Oklaunion deferred costs, of which $25 million are carrying costs. The deferred costs are being recovered and amortized over the remaining life of the plant. In November 1987, OPUC filed an appeal in the District Court challenging the Texas Commission's final order authorizing WTU to defer the costs associated with Oklaunion. In October 1988, the District Court affirmed the final order of the Texas Commission. In December 1988, OPUC filed an appeal of the District Court judgment in the Court of Appeals. In September 1990, the Court of Appeals upheld the District Court's affirmance of the Texas Commission's final order and in October 1990, OPUC filed a motion for rehearing of the Court of Appeals' decision, which was denied in November 1990. On further appeal, the Supreme Court heard oral argument in September 1993, in WTU's case as well as three other cases involving deferred accounting\n2-184 and in June 1994 issued its opinions in these cases affirming the Texas Commission's authority to allow deferred accounting treatment, but establishing a financial integrity standard rather than the measurable harm standard used by the Texas Commission.\nIn October 1994, the Supreme Court of Texas issued a mandate remanding WTU's deferred accounting case to the Texas Commission. While no schedule has yet been established for the proceedings on remand at the Texas Commission, this remand may be considered in tandem with WTU's pending rate case, Docket No. 13369. In the remanded proceeding, the Texas Commission must make a formal finding that the deferral of Oklaunion costs was necessary to prevent WTU's financial integrity during the deferral period from being jeopardized.\nIf WTU's deferred accounting treatment is ultimately reversed and not favorably resolved, WTU could experience a material adverse impact on its results of operations. While management cannot predict the ultimate outcome of these proceedings, management believes that WTU's deferred accounting will be ultimately sustained by the Texas Commission on the basis of the financial integrity standard set forth by the Supreme Court of Texas, so that there will be no material adverse effect on WTU's results of operations or financial condition.\nFERC Order On April 4, 1994, the FERC issued an order pursuant to section 211 of the Federal Power Act forcing a regional utility to transmit power to Tex-La on behalf of WTU. The order was one of the first issued by FERC under that provision, which was added by the Energy Policy Act to increase competition in wholesale power markets. On December 1, 1994, the FERC issued an order requiring a regional utility to provide this transmission service at a cost which was acceptable to Tex-La. The FERC also ordered the same regional utility to enter into an interconnection and remote control area load agreement with WTU within 30 days. This agreement was executed on January 3, 1995. On January 5, 1995, WTU began selling 92 MW of power and energy to Tex-La. Tex-La has a peak requirement of approximately 120 MWs. WTU will serve Tex-La until facilities are completed to connect Tex-La to SWEPCO, at which time SWEPCO will provide 85 MW and WTU will retain 35 MW of the Tex-La electric load.\nOther WTU 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 WTU's results of operations or financial condition.\n10. Commitments and Contingent Liabilities Construction It is estimated that WTU will spend approximately $37 million in construction expenditures during 1995. Substantial commitments have been made in connection with this capital expenditure program.\nFuel To supply a portion of its fuel requirements WTU has entered into various commitments for the procurement of fuel. WTU has a sale\/leaseback agreement with Transok, an affiliated company, for full capacity use of a natural gas pipeline to WTU's Ft. Phantom generating plant. The lease agreement also provides for full capacity use of Transok's natural gas pipelines serving WTU's San Angelo and Oak Creek generating plants. The initial terms of the agreement are for twelve years with renewable options thereafter.\n2-185 11. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts.\nQuarter Ended Operating Operating Net Revenues Income Income 1994 (thousands) March 31 $ 83,319 $ 8,487 $ 3,546 June 30 83,016 12,958 8,192 September 30 109,348 27,987 23,271 December 31 67,308 5,331 2,357 $342,991 $54,763 $37,366\nMarch 31 $ 73,109 $ 9,540 $ 7,898 June 30 86,973 14,060 9,086 September 30 109,897 24,172 19,490 December 31 75,466 (1,196) (6,178) $345,445 $45,576 $30,296\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-186 Report of Independent Public Accountants\nTo the Stockholders and Board of Directors of West Texas Utilities Company:\nWe have audited the accompanying balance sheets and statements of capitalization of West Texas Utilities Company (a Texas corporation and a wholly-owned subsidiary of Central and South West Corporation) as of December 31, 1994 and 1993, and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of WTU'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 West Texas Utilities Company as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, WTU changed its methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II 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. This schedule 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 LLP\nDallas, Texas February 13, 1995\n2-187 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the financial statements of West Texas Utilities Company as well as other information contained in this Annual 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 Annual Report is consistent with that in the financial statements.\nThe financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. WTU believes that representations made to the independent auditors during their audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nWTU maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial statements are prepared in accordance with generally accepted accounting principles and that the assets of the companies are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that WTU will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of WTU provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nWTU believes that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nGlenn Files R. Russell Davis President and CEO - WTU Controller - WTU\n2-188 ITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\n3-1 PART III\nCPL, PSO, SWEPCO and WTU CSW 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 REGISTRANTS. CSW CSW has filed with the SEC its Notice of Annual Meeting of Stockholders and Proxy Statement relating to its 1995 Annual Meeting of Stockholders. The information required by ITEM 10, other than with respect to certain information regarding the executive officers of CSW which is included in ITEM 1. BUSINESS - Executive Officers of the Registrant, is hereby incorporated by reference to pages 3-5 and 8 of such Proxy Statement.\nCPL, PSO, SWEPCO AND WTU (a) The following is a list of directors of each of the Electric Operating Companies, together with certain information with respect to each of them:\nName, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nCPL\nE. R. BROOKS. . . . . . . . . . . . . . . . . . AGE - 57 1991 Chairman, President and CEO of CSW since 1991. President of CSW from 1990 to 1991. President and COO of CSW from January 1990 to September 1990. Director of CSW and each of its subsidiaries. Director of Hubbell, Inc., Orange, Connecticut. Trustee of Baylor University Medical Center, Dallas, Texas and Hardin Simmons University, Abilene, Texas.\nROBERT R. CAREY. . . . . . . . . . . . . . AGE - 57 1989 President and CEO of CPL since 1990. Executive Vice President and COO of CPL from 1989 to 1990. Director of NationsBank, Corpus Christi, Texas.\nRUBEN M. GARCIA. . . . . . . . . . . . . . AGE - 63 1981 President or principal of several firms engaged primarily in construction and land development in the Laredo, Texas area.\nDAVID L. HOOPER. . . . . . . . . . . . . . .AGE - 39 1994 Vice President, Marketing and Business Development of CPL since 1994. Director of Marketing and Business Development of CSWS from 1993 to 1994. Director of Marketing and Business Development of CPL from 1991 to 1993. Area manager of CPL from 1990 to 1991. Director of Corporate Communications of CPL from 1988 to 1990.\nHARRY D. MATTISON. . . . . . . . . . . . AGE - 58 1994 Executive Vice President of CSW since 1990 and CEO of CSWS since 1993. COO of CSW from 1990 to 1993. President and CEO of SWEPCO from 1988 to 1990. Director of CSW and each of CSW's wholly-owned subsidiaries.\n3-2 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nROBERT A. McALLEN. . . . . . . . . . . . AGE - 60 1983 Robert A. McAllen, Insurance Agency, Weslaco, Texas.\nPETE MORALES, JR. . . . . . . . . . . . . .AGE - 54 1990 President and General Manager of Morales Feed Lots, Inc., Devine, Texas. Director of The Bank of Texas, Devine, Texas.\nS. LOYD NEAL, JR. . . . . . . . . . . . . . AGE - 57 1990 President of Hilb, Rogal and Hamilton Company of Corpus Christi, an insurance agency, Corpus Christi, Texas. Director of Bay Area Medical Center, Corpus Christi, Texas.\nJIM L. PETERSON. . . . . . . . . . . . . . .AGE - 59 1989 President and CEO of Whataburger, Inc., Corpus Christi, Texas. President of Peterson Ranch and Cattle Company, Goliad, Texas. President and CEO of Bojangles Restaurants Inc., Charlotte, North Carolina. Director of Mercantile Bank of Corpus Christi and Brownsville, Texas.\nH. LEE RICHARDS. . . . . . . . . . . . . . .AGE - 61 1987 Chairman of the Board of Hygeia Dairy Company, Harlingen, Texas.\nMELANIE J. RICHARDSON. . . . . . . . . AGE - 38 1993 Vice President, Administration of CPL since 1993. Treasurer of CPL from 1992 to 1994. Vice President, Corporate Services of CPL from 1992 to 1993. Director of Internal Audits of CPL from 1991 to 1992. Manager of Personnel Services of CPL from 1986 to 1991.\nJ. GONZALO SANDOVAL. . . . . . . . . . AGE - 46 1992 Vice President, Operations\/Engineering of CPL since 1993. Vice President, Regional Operations of CPL from 1992 to 1993. Vice President, Corporate Services of CPL from 1991 to 1992. General Manager of the Southern Region from 1988 to 1991.\nGERALD E. VAUGHN. . . . . . . . . . . . . AGE - 52 1993 Vice President, Nuclear of CSWS since 1994. Vice President, Nuclear Affairs of CPL since 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.\nEach of the directors and executive officers of CPL is elected to hold office until the first meeting of CPL's Board of Directors after the 1995 Annual Meeting of Stockholders. CPL's 1995 Annual Meeting of Stockholders is presently scheduled to be held on April 13, 1995. All outside directors have engaged in their principal occupations listed above for a period of more than five years, unless otherwise indicated.\n3-3 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nPSO\nE. R. BROOKS. . . . . . . . . . . . . . . . . . AGE - 57 1991 Chairman, President and CEO of CSW since 1991. President of CSW from 1990 to 1991. President and COO of CSW from January 1990 to September 1990. Director of CSW and each of its subsidiaries. Director of Hubbell, Inc., Orange, Connecticut. Trustee of Baylor University Medical Center, Dallas, Texas and Hardin Simmons University, Abilene, Texas.\nHARRY A. CLARKE. . . . . . . . . . . . . . . . . . . . . AGE - 66 1972 HAC Investments, Afton, Oklahoma.\nPAUL K. LACKEY, JR. . . . . . . . . . . . . . . . . . . . AGE - 51 1992 Consultant, Flint Industries, Inc., a construction, electronics manufacturing, and environmental services company, Tulsa, Oklahoma. Advisory Director of Bank IV-Tulsa, Tulsa, Oklahoma.\nPAULA MARSHALL-CHAPMAN . . . . . . . . . . . . . . . . . .AGE - 41 1991 General Partner\/CEO of Bama Pie Ltd., a baked goods produce company, Tulsa, Oklahoma.\nHARRY D. MATTISON. . . . . . . . . . . . .AGE - 58 1994 Executive Vice President of CSW since 1990 and CEO of CSWS since 1993. COO of CSW from 1990 to 1993. President and CEO of SWEPCO from 1988 to 1990. Director of CSW and each of CSW's wholly-owned subsidiaries.\nWILLIAM R. McKAMEY . . . . . . . . . . . . . . . . . . . .AGE - 48 1993 Vice President, Marketing and Business Development of PSO since 1993. Director of Marketing and Business Development of CSW from 1992 to 1993. Director of Marketing of SWEPCO from 1990 to 1992.\nMARY M. POLFER . . . . . . . . . . . . . . . . . . . . . .AGE - 50 1991 Vice President, Administration of PSO since 1993. Vice President, Finance of PSO from 1990 to 1993. Director Corporate Projects from 1987 to 1990, Farmland Industries, Inc., a federated cooperative, Kansas City, Missouri.\nDR. ROBERT B. TAYLOR, JR. . . . . . . . . . . . . . . . . AGE - 66 1975 Dentist, Okmulgee, Oklahoma.\nROBERT L. ZEMANEK . . . . . . . . . . . . . . . . . . . . AGE - 45 1990 President and CEO of PSO since 1992. Executive Vice President of PSO from 1990 to 1992. Vice President, Corporate Services of PSO from 1989 to 1990.\n3-4 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nWALDO J. ZERGER, JR. . . . . . . . . . . . . . . . . . . .AGE - 48 1991 Vice President, Operations and Engineering of PSO since 1994. Vice President of Division Operations of PSO from 1990 to 1994.\nEach of the directors and executive officers of PSO is elected to hold office until the first meeting of PSO's Board of Directors after the 1995 Annual Meeting of Stockholders. PSO's 1995 Annual Meeting of Stockholders is presently scheduled to be held on April 18, 1995. All outside directors have engaged in their principal occupations listed above for a period of more than five years, unless otherwise indicated.\nSWEPCO\nRICHARD H. BREMER . . . . . . . . . . . . . . . . . . . . AGE - 46 1989 President and CEO of SWEPCO since 1990. Vice President, Operations of SWEPCO from 1989 to 1990. Director of Commercial National Bank, Shreveport, Louisiana. Director of Deposit Guaranty Corporation, Jackson, Mississippi.\nE. R. BROOKS. . . . . . . . . . . . . . . . . . AGE - 57 1991 Chairman, President and CEO of CSW since 1991. President of CSW from 1990 to 1991. President and COO of CSW from January 1990 to September 1990. Director of CSW and each of its subsidiaries. Director of Hubbell, Inc., Orange, Connecticut. Trustee of Baylor University Medical Center, Dallas, Texas and Hardin Simmons University, Abilene, Texas.\nJAMES E. DAVISON . . . . . . . . . . . . . AGE - 57 1993 Sole Proprietor of Paul M. Davison Petroleum Products. President and Chief Executive Officer of Davison Transport, Inc. and Davison Terminal Services, Inc. Advisory Board member of Heritage Financial Group. All of the above entities are located in Ruston, Louisiana.\nAL P. EASON, JR. . . . . . . . . . . . . . . . . . . . . .AGE - 69 1975 Retired as Chairman and CEO of the First Federal Savings and Loan Association of Fayetteville, Arkansas in 1990. President, Eason and Company, a general insurance company, Fayetteville, Arkansas.\nW. J. GOOGE, JR. . . . . . . . . . . . . . . . . . . . . .AGE - 52 1990 Vice President, Administration of SWEPCO since 1993. Vice President, Corporate Services of SWEPCO from 1990 to 1993. Vice President, Personnel, Safety and Insurance of SWEPCO from 1984 to 1990.\nDR. FREDERICK E. JOYCE . . . . . . . . . . . . . . . . . .AGE - 60 1990 Physician. President of Chappell-Joyce Pathology Association, P.A., Texarkana, Texas. President of Doctors Diagnostic Laboratory, Inc., Texarkana, Texas. Director of State First National Bank and State First Financial Corporation, Texarkana, Arkansas. Director of First Commercial Corporation, Little Rock, Arkansas.\n3-5 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nMICHAEL H. MADISON . . . . . . . . . . . . . . . . . . . .AGE - 46 1992 Vice President, Operations and Engineering of SWEPCO since 1993. Vice President, Engineering and Production of SWEPCO from 1992 to 1993. Vice President, Corporate Services of WTU from 1990 to 1992. Eastern Division Manager of PSO in 1990.\nHARRY D. MATTISON. . . . . . . . . . . . .AGE - 58 1994 Executive Vice President of CSW since 1990 and CEO of CSWS since 1993. COO of CSW from 1990 to 1993. President and CEO of SWEPCO from 1988 to 1990. Director of CSW and each of CSW's wholly-owned subsidiaries.\nMARVIN R. McGREGOR. . . . . . . . . . . . . . . . . . . . AGE - 48 1990 Vice President, Marketing and Business Development of SWEPCO since 1990.\nWILLIAM C. PEATROSS . . . . . . . . . . . . . . . . . . . AGE - 51 1990 President of Caddo Abstract and Title Co., Inc., Partner-Baucum, Hamilton and Peatross, a law firm; Partner-Kernmass-X Oil Company, Partner-Coastal Land Association, Director of Commercial National Bank. All of the above entities are located in Shreveport, Louisiana.\nJACK L. PHILLIPS . . . . . . . . . . . . . . . . . . . . .AGE - 70 1986 Owner of Jack L. Phillips Oil & Gas Exploration and Production, Gladewater, Texas. Director of Longview National Bank, Longview, Texas.\nEach of the directors and executive officers of SWEPCO is elected to hold office until the first meeting of SWEPCO's Board of Directors after the 1995 Annual Meeting of Stockholders. SWEPCO's 1995 Annual Meeting of Stockholders is presently scheduled to be held on April 12, 1995. All outside directors have engaged in their principal occupations listed above for a period of more than five years, unless otherwise indicated.\nWTU\nRICHARD F. BACON . . . . . . . . . . . . . . . . . . . . .AGE - 68 1980 Retired President and CEO of Merchants, Inc. Companies, a freight common carrier, Abilene, Texas.\nC. HARWELL BARBER . . . . . . . . . . . . . . . . . . . . AGE - 68 1990 Chairman of Rita Barber, Inc., a burial clothing company, Abilene, Texas.\nE. R. BROOKS. . . . . . . . . . . . . . . . . . AGE - 57 1980 Chairman, President and CEO of CSW since 1991. President of CSW from 1990 to 1991. President and COO of CSW from January 1990 to September 1990. Director of CSW and each of its subsidiaries. Director of Hubbell, Inc., Orange, Connecticut. Trustee of Baylor University Medical Center, Dallas, Texas and Hardin Simmons University, Abilene, Texas.\n3-6 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nPAUL J. BROWER . . . . . . . . . . . . . . . . . . . . . AGE - 46 1991 Vice President, Marketing and Business Development of WTU since 1991. Division Manager of PSO from 1990 to 1991 and Corporate Sales Manager of PSO from 1986 to 1990.\nT. D. CHURCHWELL. . . . . . . . . . . . . . . . . . . . .AGE - 50 1994 Executive Vice President of WTU since 1994. Vice President, Corporate Services of CSWS from 1991 to 1993. Central Region Manager of CPL from 1989 to 1991.\nGLENN FILES . . . . . . . . . . . . . . . . . . . . . . .AGE - 47 1991 President and CEO of WTU since 1992. Executive Vice President of WTU from 1991 to 1992. Vice President, Marketing and Business Development of CPL from 1990 to 1991. Director of Corporate Planning of PSO from 1988 to 1990. Director of First National Bank of Abilene, Texas.\nHARRY D. MATTISON. . . . . . . . . . . . AGE - 58 1994 Executive Vice President of CSW since 1990 and CEO of CSWS since 1993. COO of CSW from 1990 to 1993. President and CEO of SWEPCO from 1988 to 1990. Director of CSW and each of CSW's wholly-owned subsidiaries.\nTOMMY MORRIS . . . . . . . . . . . . . . . . . . . . . . AGE - 60 1976 Independent insurance agent, Abilene, Texas.\nDIAN G. OWEN . . . . . . . . . . . . . . . . . . . . . . AGE - 55 1994 Chairman of Owen Healthcare, Inc., hospital services, Abilene, Texas. Director of First National Bank of Abilene, Abilene, Texas. Director of First Financial Bankshares, Inc., Abilene, Texas.\nJAMES M. PARKER . . . . . . . . . . . . . . . . . . . . .AGE - 64 1987 President and CEO of J. M. Parker and Associates, Inc., an investment company, Abilene, Texas. Director of First Financial Bankshares, Inc. and First National Bank of Abilene, Abilene, Texas.\nDENNIS M. SHARKEY . . . . . . . . . . . . . . . . . . . .AGE - 50 1994 Vice President, Administration of WTU since 1994. Vice President, Finance and Director of SWEPCO from 1990 to 1993. Vice President and Corporate Secretary of WTU from 1989 to 1990.\nF. L. STEPHENS . . . . . . . . . . . . . . . . . . . . . AGE - 57 1980 Chairman and CEO of Town & Country Food Stores, Inc., San Angelo, Texas. Director of First National Bank at Lubbock, Lubbock, Texas. Director of Norwest Texas, Lubbock, Texas.\nDONALD A. WELCH . . . . . . . . . . . . . . . . . . . . .AGE - 55 1982 Vice President, Operations and Engineering of WTU since 1993. Vice President, Division Operations of WTU from 1991 to 1992. Vice President, District Operations of WTU from 1990 to 1991.\n3-7 Each of the directors and executive officers of WTU is elected to hold office until the first meeting of WTU's Board of Directors after the 1995 Annual Meeting of Stockholders. WTU's 1995 Annual Meeting of Stockholders is presently scheduled to be held on March 28, 1995. All outside directors have engaged in their 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 registrants, together with certain information with respect to each of them:\nYear First Name, Age, Principal Elected to Occupation, Business Experience Present Position\nCPL, PSO, SWEPCO and WTU SHIRLEY S. BRIONES . . . . . . . . . . . . . . . . . . . AGE - 43 1994 Treasurer of CPL, PSO, SWEPCO, WTU and CSWS since 1994. Manager, Budgets and Accounting Systems of CPL from 1992 to 1994. Supervisor of Accounting of CPL from 1990 to 1992. Supervisor, Financial Planning of CPL from 1988 to 1990.\nR. RUSSELL DAVIS . . . . . . . . . . . . . . . . . . . . AGE - 38 1994 Controller of CPL, WTU, SWEPCO and CSWS since 1994. Controller of PSO since 1993. Assistant Controller of CSW from 1992 to 1993. Assistant Controller of CSWS from 1991 to 1992. Business Improvement Project Manager of WTU in 1991. Manager of Financial Reporting of WTU from 1988 to 1991.\nCPL DAVID P. SARTIN. . . . . . . . . . . . . . . . . . . . . AGE - 38 1991 Director of Planning and Analysis of CPL since 1994. Secretary of CPL since 1991. Controller and Secretary of CPL from 1991 to 1994. Controller of WTU from 1989 to 1991.\nPSO BETSY J. POWERS . . . . . . . . . . . . . . . . . . . . .AGE - 59 1989 Secretary of PSO since 1989.\nSWEPCO ELIZABETH D. STEPHENS . . . . . . . . . . . . . . . . . .AGE - 39 1988 Secretary of SWEPCO since 1988.\nWTU MARTHA MURRAY . . . . . . . . . . . . . . . . . . . . . .AGE - 49 1992 Secretary of WTU since 1992. Previously a senior secretary at WTU.\n3-8 ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. Cash and Other Forms of Compensation\nCSW Information required by ITEM 11 is hereby incorporated by reference to pages 15-19 of CSW's Proxy Statement.\nCPL, PSO, SWEPCO and WTU The following table sets forth the aggregate cash and other compensation for services rendered for the fiscal years of 1994, 1993, and 1992 paid or awarded by each registrant to the CEO and each of the four most highly compensated Executive Officers, other than the CEO, whose salary and bonus exceeds $100,000, and up to two additional individuals, if any, not holding an executive officer position as of year-end but who held such a position at any time during the year, and whose compensation for the year would have placed them among the four most highly compensated executive officers.\n3-12 Option\/SAR Grants\nShown below is information on grants of stock options made in 1994 pursuant to the 1992 LTIP to the Named Executives Officers of each of the Electric Operating Companies. No stock appreciation rights were granted in 1994.\nOption\/SAR Exercises and Year-End Value Table\nShown below is information regarding option\/SAR exercises during 1994 and unexercised options\/SARs at December 31, 1994 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 1994 under cycle III of the LTIP:\n3-15 CPL, PSO, SWEPCO and WTU Payouts of the awards are contingent upon CSW achieving a specified level of total stockholder return, relative to a peer group of utility companies, for the three-year period, or cycle, and exceeding a certain defined minimum threshold. Total stockholder return is calculated by dividing (i) the sum of (a) the cumulative amount of dividends per share for the three-year period, assuming full dividend reinvestment, and (b) the change in share price over the three-year period, by (ii) the share price at the beginning of the three-year period. 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 canceled. The first awards under LTIP were established in 1992 for a three-year cycle through 1994. The Executive Compensation Committee is scheduled to evaluate cycle I performance under the LTIP in March, 1995.\nThe LTIP contains a provision accelerating awards upon a change in control of CSW. If a change in control of CSW occurs, (i) all options and SARs become fully exercisable, (ii) all restrictions, terms and conditions applicable to all restricted stock are deemed lapsed and satisfied and 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 Plan\nCPL, PSO, SWEPCO and WTU PENSION PLAN TABLE Annual Benefits After Specified Years of Credited Service\nAverage Compensation 15 20 25 30 or more\n$100,000 . . . . . .$ 25,050 $ 33,333 $ 41,667 $ 50,000 150,000 . . . . . . 37,575 50,000 62,500 75,000 200,000 . . . . . . 50,100 66,667 83,333 100,000 250,000 . . . . . . 62,625 83,333 104,167 125,000 300,000 . . . . . . 75,150 100,000 125,000 150,000 350,000 . . . . . . 87,675 116,667 145,833 175,000 450,000 . . . . . . 112,725 150,000 187,500 225,000 550,000 . . . . . . 137,775 183,333 229,167 275,000 650,000 . . . . . . 162,825 216,667 270,833 325,000 750,000 . . . . . . 187,875 250,000 312,500 375,000\nExecutive officers are eligible to participate in the tax- qualified CSW Pension Plan like other employees of the registrants. Certain executive officers, including the Named Executive Officers, are also eligible to participate in the 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 62 or later Social Security benefit and (ii) certain other offset benefits.\n\"Average Compensation\" is the covered compensation for the plans and equals the average annual compensation, reported as salary\n3-16 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 benefits, are based on 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, 1994, for the Named Executive Officers are as follows:\nNamed Executive Officer Years of Credited Service Age\nCPL Robert R. Carey 27 57 Melanie J. Richardson 13 38 J. Gonzalo Sandoval 21 45 C. Wayne Stice 30 57 B. W. Teague 30 56\nPSO Robert L. Zemanek 22 45 William R. McKamey 24 48 Mary M. Polfer 4 50 E. Michael Williams 22 46 Waldo J. Zerger, Jr. 24 48\nSWEPCO Richard H. Bremer 17 46 W. Jerry Googe, Jr. 30 52 Michael H. Madison 23 46 Marvin R. McGregor 25 48\nWTU Glenn Files 23 47 Paul J. Brower 18 45 T. D. Churchwell 16 50 Dennis M. Sharkey 16 50 Donald A. Welch 30 55\nMeetings and Compensation\nCPL and PSO The Board of Directors held four regular meetings during 1994. Directors who are not also executive officers and employees of the CPL and PSO or their 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.\n3-17 SWEPCO The Board of Directors held four meetings during 1994. Directors who are not also executive officers and employees of SWEPCO or its affiliates receive annual directors' fees of $6,600 for serving on the board, and a fee of $300 plus expenses for each meeting of the board or committee attended.\nWTU The Board of Directors held five meetings during 1994. Directors who are not also executive officers and employees of WTU 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.\nCPL, SWEPCO and WTU Those directors who are not also officers of CPL, SWEPCO and WTU 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\nCPL, PSO, SWEPCO and WTU No person serving during 1994 as a member of the Executive Compensation Committee of the Board of Directors of CSW served as an officer or employee of each registrant during or prior to 1994. No person serving during 1994 as an executive officer of the Electric Operating Companies serves or has served on the compensation committee or as a director of another company whose executive officers serve or has served as a member of the Executive Compensation Committee of CSW or as a director of one of the Electric Operating Companies.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nCSW The information required by ITEM 12 is hereby incorporated by reference to page 5-6 of CSW's Proxy Statement.\nCPL, PSO, SWEPCO and WTU All outstanding Common Stock shares are owned beneficially and of record by CSW, 1616 Woodall Rodgers Freeway, Dallas, Texas 75202.\nCompany Shares Par Value\nCPL 6,755,535 $25 par value PSO 9,013,000 $15 par value SWEPCO 7,536,640 $18 par value WTU 5,488,560 $25 par value\n3-18 Security Ownership of Management The following table shows securities beneficially owned as of December 31, 1994, by each director, the CEO and the four other most highly compensated executive officers and, as a group, all directors and executive officers of each registrant. Share amounts shown in this table include options exercisable within 60 days after year- end, restricted stock, shares of CSW Common credited to CSW Thrift Plus accounts and all other shares of CSW Common beneficially owned by the listed persons. Each person has sole voting and investment power with respect to all shares listed in the table below, excluding the shares underlying the unexercised options.\nCPL Beneficial Ownership as of December 31, 1994 Name CSW Common Stock Preferred Stock (1)(2) (2)\nE. R. Brooks 81,940 Robert R. Carey 24,260 Ruben M. Garcia -- David L. Hooper 1,775 Harry D. Mattison 33,111 Robert A. McAllen 3,500 Pete Morales, Jr. -- S. Loyd Neal, Jr. 2,950 Jim L. Peterson -- H. Lee Richards 1,700 Melanie J. Richardson 1,356 J. Gonzalo Sandoval 11,328 C. Wayne Stice 5,568 B. W. Teague 3,371 Gerald E. Vaughn 151 All of the above and other executive officers as a group 175,673\n(1)Shares for Messrs., Brooks, Carey, Mattison, Sandoval and CPL directors and executives as a group, include 4,760, 2,851, 3,236, 211 and 11,058 shares of restricted stock, respectively. These individuals currently have voting power, but not investment power, with respect to these shares. The above shares also include 870, 19,062, 9,786, 12,352, 1,942, 1,530, 1,045 and 49,535 shares underlying immediately exercisable options held by Ms. Richardson and Messrs. Brooks, Carey, Mattison, Sandoval, Stice, Teague and CPL directors and executives as a group, respectively.\n(2)Percentages are all less than one percent and therefore are omitted.\n3-19 PSO Beneficial Ownership as of December 31, 1994 Name CSW Common Stock Preferred Stock (1)(2) (2)\nE. R. Brooks 81,940 Harry A. Clarke -- Paul K. Lackey, Jr. -- Paula Marshall-Chapman -- Harry D. Mattison 33,111 William R. McKamey 8,176 Mary M. Polfer 3,378 Jack E. Raulston -- Dr. Robert B. Taylor, Jr. -- Robert L. Zemanek 10,920 Waldo J. Zerger, Jr. 9,635 E. Michael Williams 254 All of the above and other executive officers as a group 154,146\n(1)Shares for Ms. Polfer and Messrs. Brooks, Mattison, Williams, Zemanek, Zerger and PSO directors and executives as a group, include 439, 4,760, 3,236, 254, 1,094, 478 and 10,261 shares of restricted stock, respectively. These individuals currently have voting power, but not investment power, with respect to these shares. The above shares also include 1,942, 19,062, 12,352, 1,322, 7,092, 2,090 and 45,732 shares underlying immediately exercisable options held by Ms. Polfer and Messrs. Brooks, Mattison, McKamey, Zemanek, Zerger, and PSO directors and executives as a group, respectively.\n(2)Percentages are all less than one percent and therefore are omitted.\n3-20 SWEPCO Beneficial Ownership as of December 31, 1994 Name CSW Common Stock Preferred Stock (1)(2) (2)\nRichard H. Bremer 28,578 E. R. Brooks 81,940 James E. Davison -- Al P. Eason, Jr. 2,000 W. J. Googe, Jr. 6,558 Dr. Frederick E. Joyce 2,000 Michael H. Madison 4,241 Harry D. Mattison 33,111 Marvin R. McGregor 3,892 William C. Peatross -- Jack L. Phillips -- All of the above and other executive officers as a group 166,116\n(1)Shares for Messrs. Bremer, Brooks, Googe, Madison, Mattison, McGregor and SWEPCO directors and executives as a group, include 2,609, 4,760, 539, 484, 3,236, 518 and 12,146 shares of restricted stock, respectively. These individuals currently have voting power, but not investment power, with respect to these shares. The above shares also include 8,286, 19,062, 1,942, 2,090, 12,352, 2,090 and 47,011 shares underlying immediately exercisable options held by Messrs. Bremer, Brooks, Googe, Madison, Mattison, McGregor, and SWEPCO directors and executives as a group, respectively.\n(2)Percentages are all less than one percent and therefore are omitted.\nWTU Beneficial Ownership as of December 31, 1994 Name CSW Common Stock Preferred Stock (1)(2) (2)\nRichard F. Bacon 2,643 C. Harwell Barber 12,292 E. R. Brooks 81,940 Paul J. Brower 3,698 T. D. Churchwell 3,131 Glenn Files 9,164 Harry D. Mattison 33,111 Tommy Morris 2,000 Dian G. Owen 50 James M. Parker 6,700 Dennis M. Sharkey 16,205 F. L. Stephens 1,596 Donald A. Welch 7,920 All of the above and other executive officers as a group. 184,360\n(1)Shares for Messrs. Brooks, Brower, Churchwell, Files, Mattison, Sharkey, Welch and WTU directors and executives as a group, include 4,760, 330, 424, 1,071, 3,236, 662, 515 and 10,998 shares of restricted stock, respectively. These individuals currently have voting power, but not investment power, with respect to these shares. The above shares also include 19,062, 2,090, 2,090, 6,596, 12,352, 8,342, 2,090 and 53,558 shares underlying immediately exercisable options held by Messrs. Brooks, Brower, Churchwell, Files, Mattison, Sharkey, Welch and WTU directors and executives as a group, respectively.\n(2)Percentages are all less than one percent and therefore are omitted.\n3-22 ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. CSW The information required by ITEM 13 is hereby incorporated by reference to pages 6-9 of CSW's Proxy Statement.\nCPL, PSO, SWEPCO and WTU None.\n4-1 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: Reports of Independent Public Accountants on the financial statements for CSW and subsidiary companies, CPL, PSO, SWEPCO and WTU are listed under Item 8 herein.\nThe financial statements filed as a part of this report for CSW and subsidiary companies, CPL, PSO, SWEPCO and WTU are listed under Item 8 herein.\n(2) Financial Statement Schedules: Report of Independent Public Accountants as to Schedules for CSW, CPL, PSO, SWEPCO and WTU are included in the Report of Independent Public Accountants for each registrant.\nFinancial Statement Schedules for CSW, CPL, PSO, SWEPCO and WTU are listed in the Index to the Financial Statement Schedules at page 4-15.\n(3) Exhibits Exhibits for CSW, CPL, PSO, SWEPCO and WTU are listed in the Exhibit Index at page 4-21.\n(b) Reports on Form 8-K: CSW and CPL CSW and CPL filed a Current Report on Form 8-K dated October 31, 1994, reporting ITEM 5. \"Other Events\" relating to the CPL rate case.\nPSO and SWEPCO No reports were filed on Form 8-K during the quarter ended December 31, 1994.\nWTU WTU filed a Current Report on Form 8-K dated February 17, 1995 providing unaudited 1994 financial data associated with a debt financing.\n(c) Management Contracts, Compensatory Plans or Arrangements: The management contracts, compensatory plans or arrangements required to be filed as exhibits to this Form 10-K are listed in 10(a)1-10(a)6 in item (d) Exhibits below.\n4-2 CSW 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant and any subsidiaries thereof.\nCENTRAL AND SOUTH WEST CORPORATION\nBy: Wendy G. Hargus 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant and any subsidiaries thereof.\nSignature Title\nE. R. Brooks President and CEO and Director (Principal Executive Officer)\nGlenn D. Rosilier Chief Financial Officer (Principal Financial Officer)\nWendy G. Hargus Controller (Principal Accounting Officer)\n*T. J. Barlow Director *Glenn Biggs Director *Molly Shi Boren Director *Donald M. Carlton Director *Joe H. Foy Director *Robert Lawless Director *Harry D. Mattison Executive Vice President and Director *James L. Powell Director *Arthur E. Rasmussen Director *T. V. Shockley, III Executive Vice President and Director *J. C. Templeton Director *Lloyd D. Ward Director\n*Wendy G. Hargus, 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: Wendy G. Hargus Attorney-in-Fact 4-3 CPL 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant.\nCENTRAL POWER AND LIGHT COMPANY\nBy: R. Russell Davis 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant.\nSignature Title\nRobert R. Carey President and CEO and Director (Principal Executive Officer)\nR. Russell Davis Controller (Principal Accounting and Financial Officer)\n*E. R. Brooks Director *Ruben M. Garcia Director *David L. Hooper 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 *Melanie J. Richardson Director *J. Gonzalo Sandoval Director *Gerald E. Vaughn Director\n*R. Russell Davis, by signing his 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: R. Russell Davis Attorney-in-Fact 4-4 PSO 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant.\nPUBLIC SERVICE COMPANY OF OKLAHOMA\nBy: R. Russell Davis 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant.\nSignature Title\nRobert L. Zemanek President and CEO and Director (Principal Executive Officer)\nR. Russell Davis Controller (Principal Accounting and Financial Officer)\n*E. R. Brooks Director *Harry A. Clark Director *Paul K. Lackey, Jr. Director *Paula Marshall-Chapman Director *Harry D. Mattison Director *William R. McKamey Director *Mary M. Polfer Director *Dr. Robert B. Taylor, Jr. Director *Waldo J. Zerger, Jr. Director\n*R. Russell Davis, by signing his 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: R. Russell Davis Attorney-in-Fact\n4-5 SWEPCO 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant.\nSOUTHWESTERN ELECTRIC POWER COMPANY\nBy: R. Russell Davis 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant.\nSignature Title\nRichard H. Bremer President and CEO and Director (Principal Executive Officer)\nR. Russell Davis Controller (Principal Accounting and Financial Officer)\n*E. R. Brooks Director *James E. Davison Director *Al P. Eason, Jr.. Director *W. J. Googe, Jr. Director *Dr. Frederick E. Joyce Director *Michael H. Madison Director *Harry D. Mattison Director *Marvin R. McGregor Director *William C. Peatross Director *Jack L. Phillips Director\n*R. Russell Davis, by signing his 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: R. Russell Davis Attorney-in-Fact\n4-6 WTU 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant.\nWEST TEXAS UTILITIES COMPANY\nBy: R. Russell Davis 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant.\nSignature Title\nGlenn Files President and CEO and Director (Principal Executive Officer)\nR. Russell Davis Controller (Principal Accounting and Financial Officer)\n*Richard Bacon Director *C. Harwell Barber Director *E. R. Brooks Director *Paul J. Brower Director *T. D. Churchwell Director *Harry D. Mattison Director *Tommy Morris Director *Dian G. Owen Director *James M. Parker Director *F. L. Stephens Director *Dennis M. Sharkey Director *Donald A. Welch Director\n*R. Russell Davis, by signing his 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: R. Russell Davis Attorney-in-Fact 4-7 INDEX TO FINANCIAL STATEMENT SCHEDULES Paper Copy Schedule Page\nII. Valuation and Qualifying Accounts. Central and South West Corporation 4-16 Central Power and Light Company 4-17 Public Service Company of Oklahoma 4-18 Southwestern Electric Power Company 4-19 West Texas Utilities Company 4-20\nCSW, CPL, PSO, SWEPCO and WTU All 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 or related notes to financial statements.\n4-8 CENTRAL AND SOUTH WEST CORPORATION AND SUBSIDIARY COMPANIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts (b) Deductions (c) of Year (millions) Accrued Restructuring Charges $97 $ (9) (a) $(27) $57 $ 4\nAccrued Restructuring Charges $-- $ 97 $ -- $-- $ 97\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(millions) SFAS No. 87 $(31) SFAS No. 112 4 Total $(27)\n(c) Payments of accrued restructuring charges.\n4-9 CENTRAL POWER AND LIGHT COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts(b) Deductions(c) of Year (thousands) Accrued Restructuring Charges $29,365 $ 98 (a) $(7,893) $20,245 $ 1,325\nAccrued Restructuring Charges $ -- $29,365 $ -- $ -- $29,365\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(thousands) SFAS No. 87 $(9,099) SFAS No. 112 1,206 Total $(7,893)\n(c) Payments of accrued restructuring charges.\n4-10 PUBLIC SERVICE COMPANY OF OKLAHOMA\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts(b) Deductions(c) of Year (thousands) Accrued Restructuring Charges $24,995 $ (197) (a) $(8,126) $15,626 $ 1,046\nAccrued Restructuring Charges $ -- $24,995 $ -- $ -- $24,995\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(thousands) SFAS No. 87 $(9,880) SFAS No. 112 1,754 Total $(8,126)\n(c) Payments of accrued restructuring charges.\n4-11 SOUTHWESTERN ELECTRIC POWER COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts(b) Deductions(c) of Year (thousands) Accrued Restructuring Charges $25,203 $ (4,978)(a) $(7,421) $11,694 $ 1,110\nAccrued Restructuring Charges $ -- $ 25,203 $ -- $ -- $25,203\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(thousands) SFAS No. 87 $(8,016) SFAS No. 112 595 Total $(7,421)\n(c) Payments of accrued restructuring charges.\n4-12 WEST TEXAS UTILITIES COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts(b) Deductions(c) of Year (thousands) Accrued Restructuring Charges $15,250 $ (2,037)(a) $(3,724) $8,918 $ 571\nAccrued Restructuring Charges $ -- $ 15,250 $ -- $ -- $15,250\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(thousands) SFAS No. 87 $(3,992) SFAS No. 112 268 Total $(3,724)\n(c) Payments of accrued restructuring charges.\n4-13 (d) Exhibit 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 SEC, respectively, as the exhibits and in the file numbers indicated and are incorporated herein by reference. The exhibits marked with a plus (+) are management contracts or compensatory plans or arrangements required to be filed herewith and required to be identified as such by ITEM 14. of Form 10-K. 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 102 of Regulation S-T of the SEC, immediately precedes the exhibits being physically filed with this Form 10-K.\n(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession\nCSW (a) 1 Agreement and Plan of Merger Among El Paso Electric Company, Central and South West Corporation and CSW Sub, Inc. Dated as of May 3, 1993 as Amended May 18, 1993 (incorporated herein by reference to Exhibit 2.1 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(a) 2 Second Amendment Dated as of August 26, 1993 to Agreement and Plan of Merger Among El Paso Electric Company, Central and South West Corporation and CSW Sub, Inc. Dated as of May 3, 1993 as amended on May 18, 1993 (incorporated herein by reference to Exhibit 2.2 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(a) 3 Third Amendment Dated as of December 1, 1993 to Agreement and Plan of Merger Among El Paso Electric Company, Central and South West Corporation and CSW Sub, Inc. Dated as of May 3, 1993 as amended on May 18, 1993 and August 26, 1993 (incorporated herein by reference to Exhibit 2.3 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(a) 4 Modified Third Amended Plan of Reorganization of El Paso Electric Company Providing for the Acquisition of El Paso Electric Company by Central and South West Corporation as corrected December 6, 1993, and confirmed by the Bankruptcy Court (incorporated herein by reference to Exhibit 2.4 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(a) 5 Order and Judgement Confirming El Paso Electric Company's Third Amended Plan of Reorganization, as Modified, Under Chapter 11 of the United States Bankruptcy Code and Granting Related Relief (incorporated herein by reference to Exhibit 2.5 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(3) Articles of Incorporation and By-laws\nCSW (a) 1 Second Restated Certificate of Incorporation of CSW, as amended (incorporated herein by reference to Exhibit 3 (a) to CSW's 1990 Form 10-K, File No. 1-1443).\n(a) 2 Bylaws of CSW, as amended (incorporated herein by reference to Exhibit 3 (b) to CSW's 1990 Form 10-K, File No. 1-1443).\n4-14 (d) Exhibit Index: (3) Articles of Incorporation and By-laws (continued)\nCPL (b) 1 Restated Articles of Incorporation, as amended, of CPL (incorporated herein by reference to Exhibit 4(a) to CPL'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 CPL's Form 10-Q for the quarterly period ended September 30, 1992, ITEM 6, Exhibit 1).\n* (b) 2 Bylaws of CPL, as amended.\nPSO (c) 1 Restated Certificate of Incorporation of PSO (incorporated herein by reference to Exhibit 3 to PSO's 1987 Form 10-K, File No. 0-343).\n* (c) 2 Bylaws of PSO, as amended.\nSWEPCO (d) 1 Restated Certificate of Incorporation, as amended, of SWEPCO (incorporated herein by reference to Exhibit 3 to SWEPCO's 1980 Form 10-K, File No. 1-3146, Exhibit 2 to Form U-1 File No. 70-6819, Exhibit 3 to Form U-1, File No. 70- 6924 and Exhibit 4 to Form U-1 File No. 70-7360).\n* (d) 2 Bylaws of SWEPCO, as amended.\nWTU * (e) 1 Restated Articles of Incorporation, as amended, of WTU.\n* (e) 2 Bylaws of WTU, as amended.\n(4) Instruments Defining the Rights of Security Holder, Including Indentures\nCPL (a) 1 Indenture of Mortgage or Deed of Trust dated November 1, 1943, executed by CPL to The First National Bank of Chicago and Robert L. Grinnell, as Trustee, as amended through October 1, 1977 (incorporated herein by reference to Exhibit 5.01 in File No. 2-60712), and the Supplemental Indentures of CPL 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, April 1, 1993 and May 1, 1994 (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. 70-7725 and Exhibit 10 (a), 10 (b), 10 (c), 10 (d) and 10(e), respectively, to Form U-1, File No. 70-8053).\n4-15 (d) Exhibit Index: (4) Instruments Defining the Rights of Security Holder, Including Indentures (continued) PSO (b) 1 Indenture dated July 1, 1945, as amended, of PSO (incorporated herein by reference to Exhibit 5.03 in Registration No. 2-60712) and the Supplemental Indenture of PSO dated June 1, 1979 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2-64432), the Supplemental Indenture of PSO dated December 1, 1979 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2-65871), the Supplemental Indenture of PSO dated March 1, 1983 (incorporated herein by reference to Exhibit 2 to Form U-1, File No. 70-6822), the Supplemental Indenture of PSO dated May 1, 1986 (incorporated herein by reference to Exhibit 3 to Form U-1, File No. 70-7234), the Supplemental Indenture of PSO dated July 1, 1992 (incorporated herein by reference to Exhibit 4 (b) to Form S-3, File No. 33-48650), the Supplemental Indenture of PSO dated December 1, 1992 (incorporated herein by reference to to Exhibit 4 (c) to Form S-3, File No. 33-49143), the Supplemental Indenture of PSO dated April 1, 1993 (incorporated herein by reference to Exhibit 4 (b) to Form S-3, File No. 33-49575), and Supplemental Indenture of PSO dated June 1, 1993 (incorporated herein by reference to Exhibit 4 (b) to PSO's 1993 Form 10-K, File No. 0-343). SWEPCO (c) 1 Indenture dated February 1, 1940, as amended through November 1, 1976, of SWEPCO (incorporated herein by reference to Exhibit 5.04 in Registration No. 2-60712), the Supplemental Indenture dated August 1, 1978 incorporated herein by reference to Exhibit 2.02 in Registration No. 2-61943), the Supplemental Indenture dated January 1, 1980 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2-66033), the Supplemental Indenture dated April 1, 1981 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2- 71126), the Supplemental Indenture dated May 1, 1982 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2-77165), the Supplemental Indenture dated August 1, 1985 (incorporated herein by reference to Exhibit 4 to Form U-1, File No. 70-7121), the Supplemental Indenture dated May 1, 1986 (incorporated herein by reference to Exhibit 3 to Form U-1 File No. 70-7233), the Supplemental Indenture dated November 1, 1989 (incorporated herein by reference to Exhibit 3 to Form U-1, File No. 70- 7676), the Supplemental Indenture dated June 1, 1992 (incorporated herein by reference to Exhibit 10 to Form U- 1, File No. 70-7934), the Supplemental Indenture dated September 1, 1992 (incorporated herein by reference to Exhibit 10 (b) to Form U-1, File No.72-8041), the Supplemental Indenture dated July 1, 1993 (incorporated herein by reference to Exhibit 10 (c) to Form U-1, File No. 70-8041) and the Supplemental Indenture dated October 1, 1993 (incorporated herein by reference to Exhibit 10 (a) to Form U-1, File No. 70-8239). WTU (d) 1 Indenture dated August 1, 1943, as amended through July 1, 1973 (incorporated herein by reference to Exhibit 5.05 in File No. 2-60712), Supplemental Indenture dated May 1, 1979 (incorporated herein by reference to Exhibit No. 2.02 in File No. 2- 63931), Supplemental Indenture dated November 15, 1981 (incorporated herein by reference to Exhibit No. 4.02 in File No. 2-74408), Supplemental Indenture dated Nobember 1, 1983 (incorporated herein by reference to Exhibit 12 to Form U-1, File No. 70-6820), Supplemental Indenture dated April 15, 1985 (incorporated herein by reference to Amended Exhibit 13 to Form U-1, File No. 70-6925), Supplemental Indenture dated August 1, 1985 (incorporated herein by reference to Exhibit 4 (b) in File No. 2-98843), Supplemental Indenture dated May 1, 1986 (incorporated herein by reference to Exhibit 4 to Form U-1, File No. 70- 7237), Supplemental Indenture dated December 1, 1989 (incorporated herein by reference to Exhibit 3 to Form U-1, in File No. 70-7719), Supplemental Indenture dated June 1, 1992 (incorporated herein by reference to Exhibit 10 to Form U-1, File No. 70-7936), Supplemental Indenture dated October 1, 1992 (incorporated herein by reference to Exhibit 10 to Form U-1, File No. 70-8057), Supplemental Indenture dated February 1, 1994 (incorporated herein by reference to Exhibit 10-Form U-1, File No. 70-8265) and Supplemental Indenture dated March 1, 1995 (incorporated herein by reference to Exhibit 10(b) to Form U-1, File No. 70-8057).\n4-16 (d) Exhibit Index: (10) Material Contracts\nCSW + (a) 1 Restricted Stock Plan for Central and South West Corporation (incorporated herein by reference to Exhibit 10(a) to CSW's 1990 Form 10-K, File No. 1-1443).\n+ (a) 2 Central and South West System Special Executive Retirement Plan (incorporated herein by reference to Exhibit 10(b) to CSW's 1990 Form 10-K, File No. 1-1443).\n+ (a) 3 Executive Incentive Compensation Plan for Central and South West System (incorporated herein by reference to Exhibit 10(c) to the Corporation's 1990 Form 10-K, File No. 1-1443).\n(a) 4 Central and South West Corporation Stock Option Plan (incorporated herein by reference to Exhibit 10(d) to the Corporation's 1990 Form 10-K, File No. 1-1443).\n(a) 5 Central and South West Corporation Deferred Compensation Plan for Directors (incorporated herein by reference to Exhibit 10(e) to the Corporation's 1990 Form 10-K, File No. 1-1443).\n+ (a) 6 Central and South West Corporation 1992 Long-Term Incentive Plan (incorporated herein by reference to Appendix A to the Central and South West Corporation Notice of 1992 Annual Meeting of Shareholders and Proxy Statement).\n(12) Statements Re Computation of Ratios\nCPL * (a) 1 Statement re computation of Ratio of Earnings to Fixed Charges for the five years ended December 31, 1994.\nPSO * (b) 1 Statement re computation of Ratio of Earnings to Fixed Charges for the five years ended December 31, 1994.\nSWEPCO * (c) 1 Statement re computation of Ratio of Earnings to Fixed Charges for the five years ended December 31, 1994.\nWTU * (d) 1 Statement re computation of Ratio of Earnings to Fixed Charges for the five years ended December 31, 1994.\n(21) Subsidiaries of the registrant\nCSW * (a) 1 Subsidiaries of the registrant.\n(23) Consent of Experts and Counsel\nCSW * (a) 1 Consent of Independent Public Accountants.\n4-17 (d) Exhibit Index: (23) Consent of Experts and Counsel (continued)\nCPL * (b) 1 Consent of Independent Public Accountants.\nWTU * (c) 1 Consent of Independent Public Accountants.\n(24) Power of Attorney\n* CSW (a) 1 Power of Attorney. (a) 2 Power of Attorney. (a) 3 Power of Attorney. (a) 4 Power of Attorney.\n* CPL (b) 1 Power of Attorney. (b) 2 Power of Attorney. (b) 3 Power of Attorney.\n* PSO (c) 1 Power of Attorney. (c) 2 Power of Attorney. (c) 3 Power of Attorney.\n* SWEPCO (d) 1 Power of Attorney. (d) 2 Power of Attorney. (d) 3 Power of Attorney.\n* WTU (e) 1 Power of Attorney. (e) 2 Power of Attorney. (e) 3 Power of Attorney.","section_15":""}
{"filename":"109563_1994.txt","cik":"109563","year":"1994","section_1":"ITEM 1. BUSINESS. --------- BEARINGS, INC., an Ohio corporation, and its wholly-owned operating subsidiaries, BRUENING BEARINGS, INC., a Kentucky corporation, DIXIE BEARINGS, INCORPORATED, a Tennessee corporation, KING BEARING, INC., a California corporation, and MAINLINE INDUSTRIAL DISTRIBUTORS, INC., a Wisconsin corporation, are in the business of selling and distributing bearings, mechanical and electrical drive systems, industrial rubber products, fluid power transmission components and specialty maintenance and repair products manufactured by others. Bearings, Inc. and its wholly-owned operating subsidiaries are hereafter referred to in this Report as the \"Company\", unless the context indicates otherwise. The Company's executive offices are located at 3600 Euclid Avenue, Cleveland, Ohio. The Company and predecessor companies have been engaged in this business since 1923. Bearings, Inc. was incorporated under the laws of Delaware in 1928 and reincorporated from Delaware to Ohio in 1988.\n(a) GENERAL DEVELOPMENT OF BUSINESS. -------------------------------- During fiscal 1994, the Company established a physical presence in strategic geographic markets in the Upper Midwest. In the summer of 1993, the Company opened two branches in the Chicago area, the largest industrial market in the nation. In March 1994, the Company acquired Mainline Industrial Distributors, Inc. of Appleton, Wisconsin in exchange for 196,000 shares of Company Common Stock. The Mainline acquisition added nine branches to the Company's network, including seven in Wisconsin, one in Minneapolis and one in Chicago. All continue to operate under the Mainline name. Four additional Chicago-area branches were acquired by the Company for cash in May 1994.\nAlso in fiscal 1994, the Company's implementation of Total Quality Management (\"TQM\") continued on course. TQM is aimed at maximizing customer satisfaction and improving all aspects of the Company's business, while increasing the understanding, involvement and overall teamwork of the Company's employees at all levels. Virtually all Company branches have undergone quality audits by Company management. Since its adoption of TQM, the Company has been honored with quality-supplier awards from dozens of its customers.\nIn July 1993, John R. Cunin, a Director and former Chairman & Chief Executive Officer of the Company, died after 45 years of service to the Company. Dr. Jerry Sue Thornton, president of Cuyahoga Community College, was elected in January 1994 to fill the vacancy on the Board of Directors. Also in July 1993, Richard C. Shaw, previously Director of Corporate Communications, was appointed to serve as Vice President-Communications & Public Relations.\nFurther information regarding developments in the Company's business can be found in the Bearings, Inc. 1994 Annual Report to shareholders under the caption \"Management's Discussion and Analysis\" on pages 10 and 11, which is incorporated herein by reference.\n(b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS. ---------------------------------------------- The Company considers its business to involve only one industry segment.\n(c) NARRATIVE DESCRIPTION OF BUSINESS. ---------------------------------- PRODUCTS. The Company engages in the distribution and sale of ball, roller, thrust and linear type bearings, mechanical, electrical and fluid power transmission components, industrial rubber products and specialty items used in connection with the foregoing such as seals, lubricants, locking devices, sealing compounds, adhesives and tools for use therewith. Although the Company does not generally manufacture the products that it sells, it does assemble filter carts, fluid power units, speed reducers and electrical panels.\nThe Company is a non-exclusive distributor for numerous manufacturers of the products which it sells. The principal bearing lines distributed by the Company are: American, Barden, Cooper, FAG, INA, Kaydon, MB Bearings, McGill, Rexnord\/PTC, Sealmaster, MRC, SKF, Thomson, Timken and Torrington\/Fafnir. The principal power transmission components distributed by the Company are: Aeroquip, ARO, Baldor, Browning, Dana, Eaton, Falk, FMC, Gates, Goodyear, Jeffrey, Kop-Flex, Lincoln Electric, Lovejoy, Martin, Morse, Reliance\/Dodge, Rexnord\/PTC, Schrader Bellows, and U.S. Electrical Motors. Specialty and other items, including bronze, babbit, nylon, rubber, seals, sealants, \"O\" rings, retaining rings, adhesives, lubricants, maintenance equipment and tools, are purchased from various manufacturers. The principal suppliers of specialty and other items are: CR Industries, Dow Corning, Garlock, Loctite, J.M. Clipper, National\/Federal Mogul, OTC, Parker Hannifin, Rotoclip and Symmco. The Company believes that its relationships with its suppliers are generally good and that the Company can continue to represent these suppliers. The loss of certain of these suppliers could have an adverse effect on the Company's business.\nBased upon the Company's analysis of product dollar sales volume for the fiscal year ended June 30, 1994, bearings (including mounted bearings, which in some contexts are categorized as power transmission components) represented 50%, power transmission components (including certain rubber and fluid power products) represented 38%, and specialty and other items represented 12% of sales. For the year ended June 30, 1993, bearings represented 52%,\npower transmission components represented 32%, and specialty and other items represented 16% of sales. For the year ended June 30, 1992, bearings represented 53%, power transmission components 32%, and specialty and other items 15% of sales.\nThe Company rebuilds precision machine spindles and live centers at its Spindle Lab in Cleveland, Ohio. Mechanical shops located in Cleveland, Ohio; Corona, California; Longview, Washington; Modesto, California; Fort Worth, Texas; Carlisle, Pennsylvania; Butte, Montana; and Florence, Kentucky rebuild and assemble speed reducers, provide custom machining and assemble fluid power systems to customer specifications. Fluid power centers located in Kent, Washington, Corona, California and Worcester, Massachusetts, provide customers with technical expertise. The Company also operates rubber shops in Arlington, Texas; Longview, Washington; Corona, California; Modesto, California; Tucson, Arizona; Atlanta, Georgia; Dayton, New Jersey; and Crestwood, Illinois to modify conveyor belts and provide hose assemblies in accordance with customer requirements.\nSERVICES. The Company's sales personnel advise and assist customers with respect to the selection and application of various bearings, related accessories and power transmission components. The Company considers this advice and assistance to be an integral part of its overall sales efforts. Company sales personnel consist of inside customer service and field account representatives assigned to each branch, in addition to representatives assigned as industry and product specialists. Inside customer service representatives receive, process and expedite customer orders, provide pricing and product information, and provide assistance to field account representatives in servicing customers. Field account representatives make on-site calls to customers and potential customers to provide product and pricing information, make surveys of customer requirements and recommendations, and assist in the implementation of maintenance programs. The Company maintains inventory levels in each branch that are tailored to meet the immediate needs of its customers and maintains back-up inventory in its distribution centers, thereby enabling customers to minimize their own inventories. Such inventories consist of certain standard items stocked at most branches as well as other items related to the specific needs of customers in the particular locale. Due to its high percentage of sales in the maintenance and replacement market, the Company believes that service is more important than price in its sales effort, although price is a competitive factor. As a result, the business of each branch is concentrated largely in the geographic area in which it is located. Special products or products for export may be sold from a number of locations.\nTimely delivery of products to customers is an integral part of the service that the Company provides. Branches and distribution centers utilize the most effective method of transportation available to meet customer needs including both surface and air common carrier and courier services. The Company also maintains a fleet of delivery vehicles to provide for delivery to customers. These transportation services and delivery vehicles are also utilized for movement of products between suppliers, distribution centers and branches to assure availability of merchandise for customer needs.\nThe Company's ability to service its customers is enhanced by its computerized inventory and sales information systems. The Company's point-of-sale OMNEX(TM) 2.0 computer system gives all Company locations on-line access to inventory, sales analysis and data. Inventory and sales information is updated as transactions are entered. The OMNEX(TM) 2.0 system permits direct access for order entry, pricing and price-auditing, order expediting and back order review. The Company's computer system also permits Electronic Data Interchange (EDI) with participating customers. Nine network-integrated computer sites serve all branches, distribution centers and service facilities. Three additional network-integrated computer systems in Cleveland are tied into a mainframe computer for sales analysis, management information and accounting applications.\nThe Company's operations contrast sharply with those of manufacturers whose products it sells in that the manufacturers generally confine their direct sales activities to large-volume transactions with original equipment manufacturers who incorporate the components purchased into the products they make. The manufacturers generally do not sell replacement components directly to the customer but refer the customer to the Company or another nearby distributor, although there is no assurance that this practice will continue.\nPatents, trademarks and licenses do not have a significant effect on the Company's business.\nMARKETS AND METHODS OF DISTRIBUTION. The Company estimates that approximately 85% of its sales are in the maintenance and replacement market, the balance being sales for original equipment. The Company purchases from over 100 major suppliers of bearings, power transmission components and related items and resells to a wide range of customers, which include industrial plants of all kinds, machine shops, mines, paper mills, public utilities, all modes of transportation, defense establishments and other government agencies, garages, textile mills, food processing plants, schools and universities, hospitals, high technology businesses, contractors, agricultural concerns and other enterprises using any form of machine, vehicle or implement that\ncontains bearings, power transmission components or related maintenance items. Its customers range from the largest industrial concerns in the country to the smallest. The Company's business is not significantly dependent upon a single customer or group of customers, the loss of which would have a material adverse effect upon the Company's business as a whole, and no single customer of the Company accounts for more than 2% of the Company's total sales.\nDuring fiscal 1994, 5 branches were closed or consolidated with other branches and 21 branches were newly opened or acquired. On June 30, 1994, the Company had 339 branches in 40 states. The Company has no operations outside the continental United States.\nThe Company's export business during the fiscal year ended June 30, 1994 and prior fiscal years was less than 2% of net sales, and is not concentrated in any one geographic area.\nCOMPETITION. The Company considers its overall business to be highly competitive. The Company's principal competitors are other specialized bearing and power transmission distributors and industrial parts distributors, and, to a lesser extent, mine and mill supply houses. These competitors include single and multiple branch operations, some of which are divisions or subsidiaries of larger organizations that may have greater financial resources than the Company. There is a trend in the industry toward larger multiple branch operations. The Company also competes with the manufacturers of original equipment and their distributors in the sale of maintenance and replacement bearings, power transmission components and related items. Some of these manufacturers may have greater financial resources than the Company. The competitors and the number of competitors vary throughout the geographic areas in which the Company does business. As a distributor, the Company's market continues to be influenced by competitive products of European and Asian manufacturers, which are sold in the United States. The Company continues to develop and implement marketing strategies to maintain a competitive position.\nThe Company is one of the leading distributors of replacement bearings, power transmission components and related items in the United States, but the Company's share of the market for those products is relatively small compared to the portion of that market serviced by original equipment manufacturers and other distributors, including dealers in distressed and surplus merchandise. The Company may not be the largest distributor in each of the geographic areas in which a branch is located.\nBACKLOG AND SEASONALITY. The Company does not have a substantial backlog of orders and backlog is not significant in the business of the Company since prompt delivery of the majority of the Company's products is essential to the Company's business. The Company does not consider its business to be seasonal.\nRAW MATERIALS AND GENERAL BUSINESS CONDITIONS. The Company's operations are dependent upon general industrial activities and economic conditions and would be adversely affected by the unavailability of raw materials to its suppliers or by any prolonged recession or depression that has an adverse effect on American industrial activity generally.\nNUMBER OF EMPLOYEES. On June 30, 1994, the Company had 4056 employees (not including the Company's executive officers). None of the Company's employees are covered by collective bargaining. The Company considers its relationship with its employees to be generally favorable.\nWORKING CAPITAL. The Company's working capital position is disclosed in the financial statements referred to at Item 8 on page 12 of this Report and is discussed in \"Management's Discussion and Analysis\" set forth in the Bearings, Inc. 1994 Annual Report to shareholders on pages 10 and 11.\nThe Company requires substantial working capital related to accounts receivable and inventories. Significant amounts of inventory are required to be carried to meet rapid delivery requirements of customers. The Company generally requires all payments for sales on account within 30 days and generally customers have no right to return merchandise. Returns are not considered to have a material effect on the Company's working capital requirements. The Company believes that such practices are consistent with prevailing industry practices in these areas.\nENVIRONMENTAL LAWS. The Company believes that compliance with federal, state and local provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment will not have a material adverse effect upon capital expenditures, earnings or competitive position of the Company.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND --------------------------------------- DOMESTIC OPERATIONS AND EXPORT SALES. ------------------------------------- The Company has no operations outside the continental United States. The Company's export business during the fiscal year ended June 30, 1994, and prior fiscal years, was less than 2% of net sales, and is not concentrated in any one geographic area.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. ----------- The Company owns or leases the properties in which its offices, branches, distribution centers, shops and corporate facilities are located. As of June 30, 1994, the real properties at 187 locations were owned by the Company, while 164 locations were leased by the Company. Certain property locations may contain multiple operations, such as a branch and a distribution center.\nThe principal real properties owned by the Company (each of which has more than 20,000 square feet of floor space) are: the corporate office building in Cleveland, Ohio; the corporate finance and information services office building in Cleveland, Ohio; the Cleveland East branch in Cleveland, Ohio; the Prospect mechanical shop in Cleveland, Ohio; the Midwest Distribution Center in Florence, Kentucky; the John R. Cunin Distribution Center in Carlisle, Pennsylvania; and the Portland branch and Portland Distribution Center in Portland, Oregon. The principal real properties leased by the Company (each of which has more than 20,000 square feet of floor space) are: the Corona offices and Corona Distribution Center in Corona, California; the Fulton Industrial branch and J. L. Lammers Distribution Center in Atlanta, Georgia; the Fort Worth Distribution Center in Fort Worth, Texas; the Long Beach branch in Long Beach, California; the San Jose branch in San Jose, California; the Worcester branch and fluid power center in Worcester, Massachusetts; the Longview branch and Longview Distribution Center in Longview, Washington; the Appleton offices and branch in Appleton, Wisconsin; and the Milwaukee branch in Milwaukee, Wisconsin.\nThe Company considers the properties owned or leased to be generally sufficient to meet its requirements for office space and inventory stocking. The size of the buildings in which the Company's branches are located is primarily influenced by the amount of inventory required to be carried to meet the needs of the customers of the branch. All of the real properties owned or leased by the Company are being utilized by the Company in its business except for certain properties, which in the aggregate are not material and are either for sale or lease to third parties due to relocation or closing of a facility. Unused portions of buildings may be leased or subleased to others.\nGenerally, when opening a new branch, the Company will lease space for a term not exceeding five years. Then, as the business develops, suitable property may be purchased or leased for relocation of the branch. A new general purpose office-storeroom building may be constructed. However, the Company has no fixed policy in this regard, and in each instance the final decision is made on the basis of availability and cost of suitable property in the local real estate market, whether purchased or leased. The Company does not consider any one of its properties to be material, because it believes that if it becomes necessary or desirable to relocate any of its branches and distribution centers, other suitable properties could be found.\nDuring the fiscal year ended June 30, 1994, the Company opened or acquired 21 new branches and closed or consolidated 5 branches. ITEM 3.","section_3":"ITEM 3. PENDING LEGAL PROCEEDINGS. -------------------------\nIn 1989, Bearings, Inc. was served with a Second Amended Complaint in a case captioned SAMMIE ADKINS, ET AL. V. A. P. GREEN INDUSTRIES, INC., ET AL., Summit County Court of Common Pleas Case No. ACV 88- 7-2398, naming it as an additional defendant, along with over 200 other defendants. Subsequently, 17 additional cases were filed in the same court naming Bearings, Inc. as a defendant and setting forth virtually the same allegations against many of the same defendants on behalf of different plaintiffs. These cases are known generally as the Akron Tireworker Asbestos Cases and allege that the plaintiffs (including spouses in some cases) were injured due to exposure to asbestos while working for various tire and rubber companies in the greater Akron, Ohio area. In each case the employee plaintiff has sued for $500,000 compensatory and $500,000 punitive damages. About 40% of the plaintiffs in the cases are spouses of the employees, and the spouse plaintiffs have each sued for $50,000 compensatory and $50,000 punitive damages.\nPreliminary information made available to the Company indicates that Bearings, Inc. has been named a defendant in these cases only as a supplier of certain products manufactured by others, which products allegedly contained asbestos. Due to the court's case management order, the proceedings as they relate to Bearings, Inc. are in the preliminary stages; the Company believes, however, based upon circumstances presently known that such cases are not material to its business or its financial condition. The Company intends to defend these cases vigorously. Even if liability were assessed, the Company would seek indemnification from its suppliers and its insurance carriers.\nIn 1992, a jury in a case captioned KING BEARING, INC., ET AL. V. CARYL EDMUND ORANGES, ET AL., Superior Court of the State of California, County of Orange, Case No. 53-42-31, awarded a $32.4 million judgment against King Bearing, Inc., a wholly-owned subsidiary of Bearings, Inc.; however, as explained below, the Company believes that this judgment will have no material adverse effect on its business or financial condition. The verdict was based on contractual and other claims asserted by various cross- complainants against King Bearing in a breach of contract and unfair competition case initially filed by King Bearing in 1987. The suit, which involved a former owner of King Bearing, was pending at the time Bearings, Inc. acquired King Bearing in June 1990. All events relative to the judgment occurred prior to the Company's purchase of King Bearing. Although Bearings, Inc. was subsequently named as a party to the lawsuit in 1991, the jury found no liability on the part of Bearings, Inc. Under the 1990 Stock Purchase Agreement relative to the acquisition of King Bearing, both Bearings, Inc. and King Bearing were specifically indemnified by the ultimate parent of the former owner of King Bearing (whose stockholders' equity exceeded $3 billion at June 30,\n1994) for any damages or loss related to the judgment. The judgment is being strongly contested by counsel retained by the indemnitor on behalf of King Bearing, and in September 1992, the trial court granted the motion of King Bearing for a new trial as to all but $219,000 in damages returned by the jury. A notice of appeal was filed by the cross-complainants, and the case is now pending in the California Court of Appeal, Fourth Appellate District.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ---------------------------------------------------- No matters were submitted to a vote of security holders of Bearings, Inc. during the last quarter of the fiscal year ended June 30, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT. ------------------------------------- The Executive Officers are elected for a term of one year, or until their successors are chosen and qualified, at the organizational meeting of the Board of Directors held immediately following the annual meeting of shareholders. The following is a listing of the Executive Officers of Bearings, Inc. and a description of their business experience during the past five years. Except as otherwise stated, the positions and offices indicated are with Bearings, Inc. and the persons were elected to their present positions on October 19, 1993:\nJOHN C. DANNEMILLER. Mr. Dannemiller is Chairman (since January 1992), Chief Executive Officer (since January 1992) and a Director (since 1985). He was President (from January 1990 to January 1992), Chief Operating Officer (from October 1988 to January 1992) and Executive Vice President (from 1988 to January 1990). He is 56 years of age.\nJOHN C. ROBINSON. Mr. Robinson is President (since January 1992), Chief Operating Officer (since January 1992), and a Director (since 1991). He was Vice President (from October 1989 to January 1992) and Executive Vice President & General Manager of the Corporation's wholly-owned subsidiary, King Bearing, Inc. (from June 1990 to October 1991). He was Director of Development & Strategic Planning from 1987 to October 1989. He is 52 years of age.\nMARK O. EISELE. Mr. Eisele is Controller (since October 1992). He was Manager of Internal Audit (from June 1991 to October 1992). Prior to that, Mr. Eisele was a Senior Manager with Deloitte & Touche. He is 37 years of age.\nFRANCIS A. MARTINS. Mr. Martins is Vice President-Marketing (since May 1992). He was Vice President, Industrial Aftermarket Operations for SKF USA Inc., a manufacturer of bearings and related products (from 1985 to May 1992). He is 51 years of age.\nFREDERICK L. MOHR. Mr. Mohr is Vice President-Sales & Marketing (since 1983). He is 64 years of age.\nRICHARD C. SHAW. Mr. Shaw is Vice President-Communications & Public Relations (since July 1993). He was Director of Corporate Communications from 1989 to July 1993. He is 45 years of age.\nROBERT C. STINSON. Mr. Stinson is Vice President-General Counsel (since 1989) and Secretary (since October 1990). He was Assistant Secretary (from 1978 to October 1990). He is 48 years of age.\nJOHN R. WHITTEN. Mr. Whitten is Vice President-Finance & Treasurer (since October 1992). He was Vice President (since 1985) and Controller (from 1981 to October 1992). He is 48 years of age.\nPART II. -------- ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED ------------------------------------------------- STOCKHOLDER MATTERS. -------------------- The Company's Common Stock, without par value, is listed for trading on the New York Stock Exchange. The information concerning the principal market for the Company's Common Stock, the quarterly stock prices and dividends for the fiscal years ended June 30, 1994 and 1993 and the number of shareholders of record as of September 1, 1994 is set forth in the Bearings, Inc. 1994 Annual Report to shareholders on page 25, under the caption \"Quarterly Operating Results and Market Data\", and such information is incorporated here by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. ------------------------ The summary of selected financial data for each of the last five years is set forth in the Bearings, Inc. 1994 Annual Report to shareholders in the table on pages 26 and 27 under the caption \"10 Year Summary\" and is incorporated here by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS. ------------------------------------ The \"Management's Discussion and Analysis\" is set forth in the Bearings, Inc. 1994 Annual Report to shareholders on pages 10 and 11 and is incorporated here by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. -------------------------------------------- The following consolidated financial statements and supplementary data of Bearings, Inc. and subsidiaries for the 1994, 1993 and 1992 fiscal years and the independent auditors' report listed below, which are included in the Bearings, Inc. 1994 Annual Report to shareholders at the pages indicated, are incorporated here by reference and filed herewith:\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 REGISTRANT. --------------------------------------------------- The information required by this Item as to the Directors is set forth in the Bearings, Inc. Proxy Statement dated September 16, 1994 on pages 3 through 5 under the caption \"Election of Directors\" and is incorporated here by reference. The information required by this Item as to the Executive Officers has been furnished in this Report on pages 10 and 11 in Part I, after Item 4, under the caption \"Executive Officers of the Registrant\". The information required by this Item as to Forms 3, 4 and 5 reporting delinquencies is set forth in the Bearings, Inc. Proxy Statement dated September 16, 1994 on page 18 under the caption \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" and is incorporated here by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. ----------------------- The information required by this Item is set forth in the Bearings, Inc. Proxy Statement dated September 16, 1994, under the captions \"Summary Compensation\" on pages 8 and 9, \"Aggregate Option\/SAR Exercises and Fiscal Year-End Option Value Table\" on page 9, \"Estimated Retirement Benefits Under Supplemental Executive Retirement Benefits Plan\" on page 10, \"Compensation of Directors\" on page 14, \"Deferred Compensation Plan for Non-employee Directors\" on page 15, \"G. L. LaMore Consulting Agreement\" on page 16, \"Deferred Compensation Plan\" on page 16, and \"Severance Payment Agreements\" on pages 16 and 17, and is incorporated here by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN ----------------------------- BENEFICIAL OWNERS AND MANAGEMENT. --------------------------------- (a) Information concerning the security ownership of certain beneficial owners is set forth under the caption \"Security Ownership of Certain Beneficial Owners\" on page 6 of the Bearings, Inc. Proxy Statement dated September 16, 1994, and is incorporated here by reference.\n(b) Information concerning security ownership of management is set forth under the caption \"Security Ownership of Management\" on page 7 of the Bearings, Inc. Proxy Statement dated September 16, 1994, and is incorporated here by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. ---------------------------------------------- Not applicable.\nPART IV. --------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL ----------------------------------------- STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. -------------------------------------------- (a)1. FINANCIAL STATEMENTS. --------------------- The following consolidated financial statements of the Company, notes thereto, the independent auditors' report and supplemental data are included in the Bearings, Inc. 1994 Annual Report to shareholders on pages 12 through 23 and page 25, and are incorporated by reference in Item 8 of this Report.\nCaption ------- Statements of Consolidated Income for the Years Ended June 30, 1994, 1993 and 1992\nConsolidated Balance Sheets June 30, 1994 and 1993\nStatements of Consolidated Cash Flows for the Years Ended June 30, 1994, 1993 and 1992\nStatements of Consolidated Shareholders' Equity for the Years Ended June 30, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements for the Years Ended June 30, 1994, 1993 and 1992\nIndependent Auditors' Report\nSupplementary Data: Quarterly Operating Results and Market Data\n(a)2. FINANCIAL STATEMENT SCHEDULES. ------------------------------ The following Report and Schedules are included in this Part IV, and are found in this Report at the pages indicated:\nAll other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission have been omitted because they are not required under the related instructions, are not applicable, or the required information is included in the financial statements and notes thereto.\n(a)3. EXHIBITS. --------- * Asterisk indicates an executive compensation plan or arrangement.\n3(d) Certificate of Amendment of Amended and Restated Articles of Incorporation of Bearings, Inc. filed with the Ohio Secretary of State on October 17, 1990 (filed as Exhibit 4(e) to the Bearings, Inc. Form 10-Q for the quarter ended September 30, 1990, SEC File No. 1-2299, and incorporated here by reference).\n4(a) Certificate of Merger of Bearings, Inc. (Ohio) and Bearings, Inc. (Delaware) filed with the Ohio Secretary of State on October 18, 1988 (filed as Exhibit 4 to the Bearings, Inc. Annual Report on Form 10-K for the fiscal year ended June 30, 1989, SEC File No. 1-2299, and incorporated here by reference).\n4(b) $80,000,000 Maximum Aggregate Principal Amount Note Purchase and Private Shelf Facility dated October 31, 1992 between Bearings, Inc. and The Prudential Insurance Company of America (filed as Exhibit 4(f) to the Bearings, Inc. Form 10-Q for the quarter ended September 30, 1992, SEC File No. 1-2299, and incorporated here by reference).\n*10(a) Form of Executive Severance Agreement between the Company and 7 executive officers (filed as Exhibit 10(b) to the Bearings, Inc. Annual Report on Form 10-K for the fiscal year ended June 30, 1989, SEC File No. 1-2299, and incorporated here by reference), together with schedule pursuant to Instruction 2 of Item 601(a) of Regulation S-K identifying the officers and setting forth the material details in which the agreements differ from the form of agreement that is filed.\n*10(b) Form of amendment dated January 17, 1991 amending the Executive Severance Agreements filed as Exhibit 10(b) to the Bearings, Inc. Annual Report on Form 10-K for the fiscal year ended June 30, 1989 (filed as Exhibit 19(a) to the Bearings, Inc. Form 10-Q for the quarter ended December 31, 1990, SEC File No. 1-2299, and incorporated here by reference). The amendment is applicable to all executive officers named in the schedule filed as part of Exhibit 10(a) of this Report and that schedule is incorporated here by reference.\n*10(c) A written description of the Directors' compensation program is found in the Bearings, Inc. Proxy Statement dated September 16, 1994, SEC File No. 1-2299, on pages 14 and 15 under the caption \"Compensation of Directors\", and is incorporated here by reference.\n*10(d) Deferred Compensation Plan for Non-employee Directors (filed as Exhibit 19 to the Bearings, Inc. Form 10-Q for the quarter ended December 31, 1991, SEC File No. 1- 2299, and incorporated here by reference).\n*10(e) First Amendment to Deferred Compensation Plan for Non-Employee Directors effective July 1, 1993, providing participants with additional flexibility in electing to defer receipt of compensation, and in amending and terminating such elections (filed as Exhibit 10(e) to the Bearings, Inc. Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 1-2299, and incorporated here by reference).\n*10(f) A written description of the Company's Non-Contributory Life and Accidental Death and Dismemberment Insurance for executive officers.\n*10(g) A written description of the Company's Long-Term Disability Insurance for executive officers.\n*10(h) Form of Director and Officer Indemnification Agreement entered into between the Company and its directors and its executive officers (filed as Appendix A to the Bearings, Inc. Proxy Statement dated September 17, 1992, SEC File No. 1-2299, and incorporated here by reference), together with a schedule pursuant to Instruction 2 of Item 601(a) of Regulation S-K identifying the directors and executive officers executing such Agreements.\n*10(i) Bearings, Inc. Supplemental Executive Retirement Benefits Plan (July 1, 1993 Restatement) presently covering 7 executive officers of Bearings, Inc. (as well as certain retired executive officers) (filed as Exhibit 10(j) to the Bearings, Inc. Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 1-2299, and incorporated here by reference).\n*10(j) First Amendment to Bearings, Inc. Supplemental Executive Retirement Benefits Plan (July 1, 1993 Restatement) (filed as Exhibit 10(a) to the Bearings, Inc. Form 10-Q for the quarter ended December 31, 1993, SEC File No. 1-2299, and incorporated here by reference).\n*10(k) Bearings, Inc. Deferred Compensation Plan (filed as Exhibit A to the Bearings, Inc. Proxy Statement dated September 16, 1993, SEC File No. 1-2299, and incorporated here by reference).\n10(l) Stock Purchase Agreement between Bearings, Inc. and MLS Industries, Inc. dated June 12, 1990 (filed as Exhibit 2 to the Bearings, Inc. Form 8-K dated July 12, 1990, SEC File No. 1-2299, and incorporated here by reference).\n10(m) Amendment to Stock Purchase Agreement and Related Guarantee and Agreement among Bearings, Inc., MLS Industries, Inc. and Emerson Electric Co., dated as of June 29, 1990 (filed as Exhibit 2(a) to the Bearings, Inc. Form 8-K dated July 12, 1990, SEC File No. 1-2299, and incorporated here by reference).\n*10(n) Bearings, Inc. 1990 Long-Term Performance Plan adopted by Shareholders on October 16, 1990 (filed as Exhibit 10(t) to the Bearings, Inc. Form 10-K for the fiscal year ended June 30, 1991, SEC File No. 1-2299, and incorporated here by reference).\n*10(o) A written description of the Company's Management Incentive Plan applicable to key executives, including the five most highly compensated executive officers, is found in the Bearings, Inc. Proxy Statement dated September 16, 1994, SEC File No. 1-2299, on pages 11 and 12, in the Report of the Executive Organization & Compensation Committee of the Board of Directors on Executive Compensation, under the subcaption \"Management Incentive Plan\", and is incorporated here by reference.\n*10(p) Consulting Agreement effective January 2, 1992 between the Company and George L. LaMore, Director and former Chairman & Chief Executive\nOfficer of the Company (filed as Exhibit 28 to the Bearings, Inc. Form 10-Q for the quarter ended December 31, 1991, SEC File No. 1-2299, and incorporated here by reference).\n11 Computation of Net Income Per Share.\n13 Bearings, Inc. 1994 Annual Report to shareholders (not deemed \"filed\" as part of this Form 10-K except for those portions that are expressly incorporated by reference).\n21 Subsidiaries of Bearings, Inc. -- This information is set forth at \"Item 1. Business\" on page 2 of this Report and is incorporated here by reference.\n23 Independent Auditors' Consent.\n27 Financial Data Schedule.\nThe Company will furnish a copy of any exhibit described above and not contained herein upon payment of a specified reasonable fee which fee shall be limited to the Company's reasonable expenses in furnishing such exhibit.\n(b) REPORTS ON FORM 8-K. -------------------\nNone during the quarter ended June 30, 1994.\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Directors Bearings, Inc.\nWe have audited the consolidated balance sheets of Bearings, Inc. and its subsidiaries (the \"Company\") as of June 30, 1994 and 1993 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the years in the three year period ended June 30, 1994 and have issued our report thereon dated August 5, 1994; such consolidated financial statements and report are included in your 1994 Annual Report to shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedules of the Company, listed in Item 14(a)2. 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 LLP\nCleveland, Ohio August 5, 1994\nBEARINGS, INC.\nEXHIBIT INDEX TO FORM 10-K FOR THE YEAR ENDED JUNE 30, 1994\nExhibit No. Description Reference - - -------- ----------- ---------\n3(a) Amended and Restated Articles of Incorporation of Bearings, Inc., an Ohio corporation, filed with the Ohio Secretary of State on October 18, 1988. Note (a)\n3(b) Code of Regulations of Bearings, Inc., an Ohio corporation, adopted September 6, 1988. Note (a)\n3(c) Certificate of Amendment of Amended and Restated Articles of Incorporation of Bearings, Inc., an Ohio corporation, filed with the Ohio Secretary of State on October 27, 1988. Note (b)\n3(d) Certificate of Amendment of Amended and Restated Articles of Incorporation of Bearings, Inc., filed with the Ohio Secretary of State on October 17, 1990. Note (c)\n4(a) Certificate of Merger of Bearings, Inc. (Ohio) and Bearings, Inc. (Delaware) filed with the Ohio Secretary of State on October 18, 1988. Note (d)\n4(b) $80,000,000 Maximum Aggregate Principal Amount Note Purchase and Private Shelf Facility dated October 31, 1992 between Bearings, Inc. and The Prudential Insurance Company of America. Note (e)\n10(a) Form of Executive Severance Agreement between the Company and 7 executive officers. Note (d)\nSchedule pursuant to Instruction 2 of Item 601(a) of Regulation S-K identifying the officers and setting forth material details in which the agreements differ from the form of agreement filed. Attached\n10(b) Form of amendment amending the Executive Severance Agreements referenced in Exhibit 10(a) hereto. Note (f) 10(c) A written description of the Directors' compensation program. Note (g)\n10(d) Deferred Compensation Plan for Non- employee Directors. Note (h)\n10(e) First Amendment to Deferred Compensation Plan for Non-employee Directors effective July 1, 1993. Note (i)\n10(f) A written description of the Company's Non-Contributory Life and Accidental Death and Dismemberment Insurance for executive officers. Attached\n10(g) A written description of the Company's Long-Term Disability Insurance for executive officers. Attached\n10(h) Form of Director and Officer Indemnifi- cation Agreement entered into between the Company and its directors and executive officers. Note (j)\nSchedule pursuant to Instruction 2 of Item 601(a) of Regulation S-K identifying the directors and executive officers executing such agreements. Attached\n10(i) Bearings, Inc. Supplemental Executive Retirement Benefits Plan (July 1, 1993 Restatement) presently covering 7 executive officers of Bearings, Inc. Note (i)\n10(j) First Amendment to Bearings, Inc. Supplemental Executive Retirement Benefits Plan (July 1, 1993 Restatement). Note (k)\n10(k) Bearings, Inc. Deferred Compensation Plan. Note (l)\n10(l) Stock Purchase Agreement between Bearings, Inc. and MLS Industries, Inc. dated June 12, 1990. Note (m)\n10(m) Amendment to Stock Purchase Agreement and Related Guarantee and Agreement among Bearings, Inc., MLS Industries, Inc. and Emerson Electric Co., dated as of June 29, 1990. Note (m)\n10(n) Bearings, Inc. 1990 Long-Term Performance Plan adopted by Shareholders on October 16, 1990. Note (n) 10(o) A written description of the Company's Management Incentive Plan applicable to key executives of the Company, including the five most highly compensated executive officers. Note (o)\n10(p) Consulting Agreement effective January 2, 1992 between the Company and George L. LaMore, Director and former Chairman & Chief Executive Officer of the Company. Note (h)\n11 Computation of Net Income Per Share. Attached\n13 Bearings, Inc. 1994 Annual Report to shareholders. Attached\n21 Subsidiaries of Bearings, Inc.--This information is set forth at \"Item 1. Business\" on page 2 of this Report.\n23 Independent Auditors' Consent. Attached\n27 Financial Data Schedule. Attached\nNotes: (a) Incorporated by reference from the Company's Report on Form 8-K dated October 21, 1988, SEC File No. 1-2299.\n(b) Incorporated by reference from the Company's Report on Form 10-Q for the quarter ended September 30, 1988, SEC File No. 1-2299.\n(c) Incorporated by reference from the Company's Report on Form 10-Q for the quarter ended September 30, 1990, SEC File No. 1-2299.\n(d) Incorporated by reference from the Company's Report on Form 10-K for the fiscal year ended June 30, 1989, SEC File No. 1-2299.\n(e) Incorporated by reference from the Company's Report on Form 10-Q for the quarter ended September 30, 1992, SEC File No. 1-2299.\n(f) Incorporated by reference from the Company's Report on Form 10-Q for the quarter ended December 31, 1990, SEC File No. 1-2299. (g) Incorporated by reference from the Company's Proxy Statement dated September 16, 1994, SEC File No. 1-2299, on pages 14 and 15 under the caption \"Compensation of Directors\".\n(h) Incorporated by reference from the Company's Report on Form 10-Q for the quarter ended December 31, 1991, SEC File No. 1-2299.\n(i) Incorporated by reference from the Company's Report on Form 10-K for the fiscal year ended June 30, 1993, SEC File No. 1-2299.\n(j) Incorporated by reference from the Company's Proxy Statement dated September 17, 1992, SEC File No. 1-2299, at Appendix A.\n(k) Incorporated by reference from the Company's Report on Form 10-Q for the quarter ended December 31, 1993, SEC File No. 1-2299.\n(l) Incorporated by reference from the Company's Proxy Statement dated September 16, 1993, SEC File No. 1-2299, at Exhibit A.\n(m) Incorporated by reference from the Company's Report on Form 8-K dated July 12, 1990, SEC File No. 1-2299.\n(n) Incorporated by reference from the Company's Report on Form 10-K for the fiscal year ended June 30, 1991, SEC File No. 1-2299.\n(o) Incorporated by reference from the Company's Proxy Statement dated September 16, 1994, SEC File No. 1-2299, on pages 11 and 12 in the Report of the Executive Organization & Compensation Committee of the Board of Directors on Executive Compensation, under the subcaption \"Management Incentive Plan\".","section_15":""}
{"filename":"930184_1994.txt","cik":"930184","year":"1994","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nOn November 1, 1994, the shareholders of ICN Pharmaceuticals, Inc. (\"ICN\"), SPI Pharmaceuticals, Inc. (\"SPI\"), Viratek, Inc. (\"Viratek\"), and ICN Biomedicals, Inc. (\"Biomedicals\") (collectively, the \"Predecessor Companies\") approved the Merger of the Predecessor Companies, (\"the Merger\"). On November 10, 1994, SPI, ICN and Viratek merged into ICN Merger Corp., and Biomedicals merged into ICN Subsidiary Corp. a wholly-owned subsidiary of ICN Merger Corp. In conjunction with the Merger, ICN Merger Corp. was renamed ICN Pharmaceuticals, Inc. (\"New ICN\" or \"the Company\"). For accounting purposes, SPI is the acquiring company and as a result, the newly merged company will report the historical financial data of SPI in its financial results. Subsequent to the Merger, the results of the newly merged company will include the combined operations of all Predecessor Companies.\nNew ICN is an international pharmaceutical company that develops, manufactures, distributes and sells pharmaceutical and nutritional products, research chemicals and diagnostic products. The Company pursues a strategy of international expansion which includes (i) the research and development of proprietary products with the potential to be significant contributors to the Company's global operations; (ii) the penetration of major pharmaceutical markets by means of targeted acquisitions; and (iii) the expansion in these major markets through the development or acquisition of pharmaceutical products that meet the particular needs of each market.\nThe Company distributes and sells a broad range of prescription and over the counter (\"OTC\") pharmaceutical products in over 60 countries worldwide, primarily in North America, Latin America, Western Europe and Eastern Europe. These pharmaceutical products treat viral and bacterial infections, diseases of the skin, myasthenia gravis, cardiovascular disease, diabetes and psychiatric disorders. The Company's leading product is the broad spectrum antiviral agent ribavirin, which is marketed in the United States, Canada and most of Europe under the name Virazole(R). Virazole(R) is currently approved for commercial sale in over 40 countries for one or more of a variety of viral infections, including respiratory syncytial virus (\"RSV\"), herpes simplex, influenza, chicken pox, hepatitis and HIV. In the United States, Virazole(R) is approved only for use in hospitalized infants and young children with severe lower respiratory infections due to RSV.\nThe Company believes it has substantial opportunities to realize growth from its internally developed compounds. These compounds are the result of significant investments in its research and development activities related to nucleic acids conducted over three decades. During the second quarter 1994, Viratek completed a review of data from Phase III multicenter trials and on June 1, 1994, Viratek submitted a New Drug Application (\"NDA\") to the FDA for Virazole(R) capsules in the treatment of chronic hepatitis C in the United States. In November 1994, the FDA responded to the Company's filing and stated that the data submitted was considered to be inadequate for approval of the NDA. The Company is currently reviewing its options. The Company believes that combination therapy of Virazole(R) with interferon has potential and intends to take all necessary steps to obtain approval of such combination therapy. ICN plans to make a second NDA filing for a combination therapy of Virazole(R) and Interferon in the treatment of chronic hepatitis C. The Company is in discussions with manufacturers of interferon in order to pursue approval of combination therapy. However, there can be no assurance that any such arrangements can be reached.\nApplications for approval to market Virazole(R) as a monotherapy for treatment of chronic hepatitis C were filed in July of 1994 in the European Union and in August of 1994 with the Health Protection Branch (HPB) in Canada. Additional applications have been filed to date in Sweden, Norway, Finland, Australia and New Zealand. There can be no assurance that any of these applications will be approved.\nITEM 1. BUSINESS - CONTINUED\nThe Company believes it is positioned to expand its presence in the pharmaceutical markets in Eastern Europe. In 1991, a 75% interest was acquired in Galenika Pharmaceuticals, a large drug manufacturer and distributor in Yugoslavia. Galenika Pharmaceuticals was subsequently renamed ICN Galenika. This acquisition added new products and significantly expanded the sales volume of the Company. With the investment in Galenika Pharmaceuticals, the Company became one of the first Western pharmaceutical companies to establish a direct investment in Eastern Europe. ICN Galenika continues to be a significant part of the Company's operations although its sales and profitability have been substantially diminished owing principally to the imposition of sanctions on Yugoslavia by the United Nations. See \"Management's Discussion and Analysis of Financial Condition and Results of Operation.\" In pursuing its expansion strategy, the Company acquired a 41% interest in Oktyabr, one of the largest pharmaceutical companies in the Russian Republic, see \"Item 7. Liquidity and Capital Resources, Investment in Russia.\"\nIn addition to its pharmaceutical operations, the Company also develops, manufactures and sells a broad range of research chemical products, biomedical instrumentation, diagnostic reagents and radiation monitoring services. The Company markets these products internationally to major scientific, academic, health care and governmental institutions through catalog and direct mail marketing programs.\nINDUSTRY SEGMENTS\nThe Company operates in two industry segments: pharmaceutical and biomedical. For financial information about industry segments, see Note 10 of Notes to Consolidated Financial Statements.\nPRODUCTS\nANTI-INFECTIVES.\nAnti-infectives: Antibacterial and antiviral drugs treat bacterial and viral infections. The Company sells approximately 65 antibacterial products and sells its antiviral drug, ribavirin, sold under the tradename, Virazole(R), in North America and certain European countries. At the present time, the Company believes that there are fewer than ten antiviral product lines marketed in the world, one of which is Virazole(R), the only antiviral product line currently sold by the Company. Antivirals are rare and difficult to produce relative to antibacterials because of the nature of bacteria compared to viruses. Whereas bacteria live outside of cells, viruses live inside cells. Thus, while antibacterials can focus simply on killing bacteria, antivirals, ideally, must eliminate viruses without killing the host cell or adversely affecting the host organism. An important feature of Virazole(R) is that it inhibits the reproduction of viruses rather than killing viruses.\nAntiviral: Virazole(R) accounted for approximately 13%, 7% and 6% of the Company's consolidated net sales for the years ended December 31, 1994, 1993 and 1992, respectively. The majority of the Virazole(R) sales are in the North American market. 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 the United States and Canada, 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. In the United States, the resulting infection is sufficiently severe to require hospitalization of an estimated 100,000 children annually.\nIn treating RSV, the drug is administered by a small particle aerosolized generator (\"SPAG\"), a system that permits direct delivery of Virazole(R) to the site of the infection. In 1993, the American Academy of Pediatrics issued new treatment guidelines for RSV recommending Virazole(R) for use in all high risk critically ill infants with RSV lung infection, thereby making Virazole(R) the standard of care for this infection. Similar approvals for Virazole(R) for use in the treatment of RSV have been granted by governmental authorities in 22 other countries.\nITEM 1. BUSINESS - CONTINUED\nDuring the second quarter 1994, Viratek completed a review of data from Phase III multicenter trials and on June 1, 1994, Viratek submitted a New Drug Application (\"NDA\") to the FDA for Virazole(R) capsules in the treatment of chronic hepatitis C in the United States. In November 1994, the FDA responded to the Company's filing and stated that the data submitted was considered to be inadequate for approval of the NDA. The Company is currently reviewing its options. The Company believes that combination therapy of Virazole(R) with interferon has potential and intends to take all necessary steps to obtain approval of such combination therapy. ICN plans to make a second NDA filing for a combination therapy of Virazole(R) and interferon in the treatment of chronic hepatitis C. The Company is in discussions with manufacturers of interferon in order to pursue approval of combination therapy, however, there can be no assurance that any such arrangements can be reached.\nApplications for approval to market Virazole(R) as a monotherapy for treatment of chronic hepatitis C were filed in July of 1994 in the European Union and in August of 1994 with the Health Protection Branch (HPB) in Canada. Additional applications have been filed to date in Sweden, Norway, Finland, Australia and New Zealand. There can be no assurance that any of these applications will be approved.\nThe Virazole(R) trademark is used in North America and certain European countries. Ribavirin is sold as Vilona(R) and Virazid(R) in Latin America, and Virazid(R) in Spain, where it is commercially available 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. References to the sale of Virazole(R) in this Form 10-K include sales made under the trademarks Vilona(R) and Virazid(R).\nAntibacterials: Antibacterials accounted for approximately 22%, 24% and 31% of the Company's consolidated net sales for the years ended December 31, 1994, 1993 and 1992, respectively. Most of the antibacterials sold by the Company (excluding ICN Galenika) are proprietary, whereas most of the antibacterial products manufactured and sold by ICN Galenika are licensed from other manufacturers including Roche Holding AG, Bristol-Myers Squibb and Eli Lilly, principally under exclusive licenses for specific geographical areas, primarily Yugoslavia.\nOTHER ETHICALS\nOther ethicals accounted for approximately 41%, 40% and 40% of consolidated net sales for the years ended December 31, 1994, 1993 and 1992, respectively. The Company manufactures and\/or markets a wide variety of other ethical pharmaceuticals, including analgesics, anticholinesterases, antirheumatics, cardiovasculars, dermatologicals, endocrine agents, gastrointestinals, hormonals and psychotropics. The Company manufactures and markets approximately 75 other dermatological products, primarily in North America and Eastern Europe. The Company markets three anticholinesterase product lines in North America under the trade names Mestinon(R), Prostigmin(R) and Tensilon(R). These products, manufactured by and licensed from Roche Holding AG, are used in treating myasthenia gravis, a progressive neuromuscular disorder, and in reversing the effects of certain muscle relaxants. Bensiden(R) is a tranquilizer manufactured by ICN Galenika and is used in the treatment of psychological and emotional disorders. The Company also sells insulin for the treatment of diabetes. Albumina(R) is sold in Spain and Mexico for use in emergency treatment of shock due to burns, trauma, operations and infections, and conditions where the restoration of blood volume is urgent.\nITEM 1. BUSINESS - CONTINUED\nMEDICATED NUTRITIONALS AND VITAMINS.\nMedicated nutritionals and vitamins accounted for 8%, 9% and 8% of consolidated net sales for the years ended December 31, 1994, 1993 and 1992, respectively. The Company manufactures, subcontracts and markets approximately 870 nutritional and vitamin products in Latin America, Western Europe and Eastern Europe. In Mexico, the Company 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. Bedoyecta-Tri(R) is the Company's largest selling vitamin and medicated nutritional. ICN Galenika manufactures and markets Oligovit(R), Beviplex(R) and Bedoxin(R).\nOTHER OVER THE COUNTER PRODUCTS.\nOther OTC products accounted for approximately 10%, 12% and 8% of the Company's consolidated net sales for the years ended December 31, 1994, 1993 and 1992, respectively. Other OTC products encompass a broad range of ancillary products sold through the Company's existing distribution channels. Approximately 90% of these product lines, which include such items as bandages, adhesive tape, candy and instant beverages, are manufactured by ICN Galenika.\nRESEARCH CHEMICALS AND DIAGNOSTIC PRODUCTS.\nDue to the Merger, net sales of research chemicals and diagnostic products are included in the Company's consolidated net sales for the periods subsequent to the effective date of the Merger. On this basis, research chemicals accounted for approximately 3% of the Company's consolidated net sales for the year ended December 31, 1994.\nResearch Chemicals: The Company services biotechnology researchers throughout the world through a catalog sales operation. The Company's catalog lists approximately 55,000 products which are used by medical and scientific researchers involved in molecular biology, cell biology, immunology and biochemistry. A majority of these products are purchased from third party manufacturers and distributed by the Company. Over 3,000 new products were added to the catalog in 1993. Products include biochemicals, immunobiologicals, radiochemicals, tissue culture products and organic and rare and fine chemicals.\nDiagnostic Products: The diagnostic products marketed by the Company are instruments and reagents that are routinely used by physicians and medical laboratories to diagnose accurately and quickly hundreds of patient samples for a variety of disease conditions. The Company manufactures both enzyme and radio-immunoassay kits, which it markets under the ImmuChem(TM) product line. The Company is also a supplier of immunodiagnostic tests for the screening of newborn infants for inherited and other disorders.\nITEM 1. BUSINESS - CONTINUED\nACQUISITIONS\nFor more than ten years, the Company has pursued a strategy of targeted expansion into regional markets which it considers to have significant potential for the sale of pharmaceutical products. This strategy has been implemented in large part through the acquisition of compatible businesses and product lines and the formation of strategic alliances and joint ventures in markets such as Mexico, Spain, Yugoslavia and Germany. The Company intends to continue this strategy and to expand its manufacturing and marketing potential for Virazole(R) through joint ventures.\nGalenika Acquisition: The Company believes it is positioned to expand its presence in the pharmaceutical markets in Eastern Europe. In 1991, a 75% interest was acquired in Galenika Pharmaceuticals, a large drug manufacturer and distributor in Yugoslavia. Galenika Pharmaceuticals was subsequently renamed ICN Galenika. This acquisition added new products and significantly expanded the sales volume of the Company. With the investment in Galenika Pharmaceuticals, the Company became one of the first Western pharmaceutical companies to establish a direct investment in Eastern Europe. ICN Galenika continues to be a significant part of the Company's operations although its sales and profitability have been substantially diminished owing principally to the imposition of sanctions on Yugoslavia by the United Nations. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nUntil the imposition of United Nations sanctions in May 1992, ICN Galenika made a significant contribution to the sales and net income of SPI. Approximately 15% of such sales were exports from Yugoslavia, primarily to republics of the former Soviet Union, the Middle East and certain Balkan nations. The imposition of sanctions, including the prohibition of exports, has had a material adverse effect on the operations and profitability of ICN Galenika. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - ICN Galenika\". The Company believes that if economic stability returns in Yugoslavia, ICN Galenika has the potential to contribute substantially to the Company's results of operations.\nIn September 1994, the United Nations Security Council voted to ease sanctions against Yugoslavia by allowing civilian air traffic to Belgrade and by lifting of the ban on cultural and sports exchanges.\nInvestment in Russia: During 1993 and 1994, the Company acquired a 41% interest in Oktyabr, a Russian pharmaceutical company. The Company intends to increase its ownership interest in Oktyabr to approximately 62% through a government-sponsored investment program. Participation in this program does not require significant expenditure of future funds. Once the Company achieves its ownership goals it will begin a program to construct a new pharmaceutical manufacturing facility in Russia built pursuant to \"good manufacturing practices.\" Although Russia may, in time, evolve into a large, free market oriented economy, because of the present unpredictable political, social and economic factors in Russia, the Company intends to penetrate this market in a gradual manner. There can be no assurance as to when or if the new facility will be constructed or as to its future success.\nFOREIGN OPERATIONS\nThe Company operates in North America, Latin America (principally Mexico), Western Europe and Eastern Europe. For financial information about domestic and foreign operations and export sales, see Note 10 of Notes to Consolidated Financial Statements.\nForeign operations are subject to certain risks inherent in conducting business abroad, including possible nationalization or expropriation, price and exchange controls, limitations on foreign participation in local enterprises, health-care regulation and other restrictive governmental actions. Changes in the relative values of currencies take place from time to time and may materially affect the Company's results of operations. Their effects on the Company's future operations are not predictable. 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\nITEM 1. BUSINESS - CONTINUED\ndevaluations, wage and price controls, potential government action and a rapidly deteriorating economy could have a material effect on the Company's results of operations. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Inflation and Changing Prices.\"\nMARKETING AND CUSTOMERS\nThe Company markets its pharmaceutical products in some of the most developed pharmaceutical markets, including the United States, Canada and Western Europe, as well as developing markets, including Latin America and Eastern Europe. The Company believes its marketing strategy is characterized by flexibility, allowing the Company to successfully market a wide array of pharmaceutical products within diverse regional markets as well as certain drugs, notably Virazole(R), on a worldwide basis.\nThe Company has a marketing and sales staff of approximately 1,510 persons for its pharmaceutical products, 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 for pharmaceuticals, the Company makes direct mailings, advertises in trade and medical periodicals, exhibits products at medical conventions, sponsors medical education symposia and sells through distributors in countries where it does not have its own marketing staff.\nIn the United States, the Company currently sells its pharmaceutical products through drug wholesalers who, in turn, distribute them to drug stores and hospitals. The nutritional product line is sold directly and through distributors to various retail outlets and to certain healthcare professionals. In Mexico, the Company serves pharmacies through a network of distributors and sells directly to pharmacists and hospitals. In Western Europe, the Company markets vision care products in The Netherlands through hospitals and pharmacies and to retail customers through optical shops. The Company's Spanish subsidiary sells pharmaceutical products through its own sales force to hospitals, retail outlets, pharmacies and wholesalers. In Canada, the Company sells directly to hospitals, wholesalers and large drug store chains.\nICN Galenika sells a broad range of pharmaceutical and other products in Yugoslavia through approximately 30 wholesalers, six representative offices and 85 sales representatives. In the event that United Nations sanctions are lifted, it is anticipated that ICN Galenika will resume exporting certain of its product lines to Russia and other Eastern European markets, Africa, the Middle East and the Far East.\nDuring 1994, approximately 88% of ICN Galenika's sales were to entities subsidized by the Yugoslavian government. Future sales by ICN Galenika could be dependent on the ability of the Yugoslavian government to continue to subsidize purchases of pharmaceutical products.\nThe Biomedical group principally sells its products world-wide primarily through its mail order catalog.\nRESEARCH AND DEVELOPMENT\nThe Company's research and development activities utilize the expertise accumulated by the Company and its predecessors in over 30 years of nucleic acids research. In addition, the Company develops innovative products targeted to address the specific needs of the Company's local markets. The Company's predecessors include one of the first firms to engage in broad based nucleic acid research, and the Company's research activities have allowed it to compile a library of over 5,000 nucleoside-based compounds. The Company's long-term research efforts are focused on development of therapeutics and diagnostics for diseases related to DNA and RNA structure such as viral infections, cancer and skin diseases.\nITEM 1. BUSINESS - CONTINUED\nLONG-TERM RESEARCH AND DEVELOPMENT.\nThe Company's long-term research and development activities are targeted on the development of therapeutic and diagnostic agents for use against chronic viral diseases, cancer and diseases of the skin, and, as such, compliment the Company's current product lines and development efforts.\nOne important area of current research has been the use of \"antisense\" technologies. This approach seeks to block genetic material causing diseases such as cancer, viral infections and psoriasis by constructing longer sequences of nucleotides (oligonucleotides) that selectively bond to the disease-causing nucleic acid sequences. In this research, the Company makes use of its extensive library of nucleotide compounds. The Company is using similar technologies to develop diagnostic techniques used to screen for genetic diseases, viral infections and various forms of cancer.\nMEDIUM-TERM RESEARCH AND DEVELOPMENT.\nThe Company's medium-term research and development efforts involve the preclinical and clinical testing of certain nucleotide compounds with broader market applications that have shown the most promise of successful commercialization. These compounds include:\nVirazole(R) (Ribavirin): During the second quarter 1994, Viratek completed a review of data from Phase III multicenter trials and on June 1, 1994, Viratek submitted a New Drug Application (\"NDA\") to the FDA for Virazole(R) capsules in the treatment of chronic hepatitis C in the United States. In November 1994, the FDA responded to the Company's filing and stated that the data submitted was considered to be inadequate for approval of the NDA. The Company is currently reviewing its options. The Company believes that combination therapy of Virazole(R) with interferon has potential and intends to take all necessary steps to obtain approval of such combination therapy. ICN plans to make a second NDA filing for a combination therapy of Virazole(R) and interferon(R) in the treatment of chronic hepatitis C. The Company is in discussions with manufacturers of interferon in order to pursue approval of combination therapy, however, there can be no assurance that any such arrangements can be reached.\nApplications for approval to market Virazole(R) as a monotherapy for treatment of chronic hepatitis C were filed in July of 1994 in the European Union and in August of 1994 with the Health Protection Branch (HPB) in Canada. Additional applications have been filed to date in Sweden, Norway, Finland, Australia and New Zealand. There can be no assurance that any of these applications will be approved.\nClinical studies have also been conducted with Virazole(R) in other pharmaceutical formulations for treatment of several other viral diseases. Among those diseases with respect to which clinical studies have been conducted and for which at least one governmental health regulatory agency in various countries other than the United States has approved commercialization of Virazole(R) are herpes zoster, genital herpes, hemorrhagic fever with renal syndrome, lassa fever, measles, chicken pox, influenza and HIV. The Company has no plans to initiate new clinical studies for any of these indications. The Company intends, where appropriate, to utilize the clinical data from these studies as a basis for future submissions to additional governmental health authorities to expand the use of Virazole(R).\nTiazole(TM) (Tiazofurin(TM)): The Company has maintained an active research program centered on Tiazofurin(R), which the Company is developing under the tradename Tiazole(TM), is a nucleotide that is chemically similar to Virazole(R). Tiazole(TM) has been demonstrated to be an inhibitor of IMP-dehydrogenase, an enzyme whose presence in elevated concentrations is associated with a number of cancers. The Company is in the process of completing Phase II\/III clinical documentation of Tiazole(TM) as a treatment for chronic myelogenous leukemia. The Company is also conducting research into the effectiveness of Tiazole(TM) as an anti-cancer agent when used in conjunction with other basic anti-cancer compounds, such as taxol, in end-stage ovarian carcinoma.\nITEM 1. BUSINESS - CONTINUED\nAdenazole(TM) (8-Cl-c-AMP): This nucleotide, which is in preclinical research, has been shown to control cell proliferation and differentiation in certain cancers. Human trials have been conducted by third parties in Scotland and Italy. The Company is also planning to begin preclinical investigations of the use of the drug against leukemia and is exploring the drug's potential use as a topical treatment for psoriasis based on its ability to inhibit rapid cell proliferation.\nOncozole(TM) (3-Deazaguanine): Research on animals has shown this compound to be active against a range of solid tumors, including breast and colon tumors. The Company is engaged in preclinical research of Oncozole(TM) as a treatment for solid tumors.\nSelenazole(TM) (Selenazofurin): Selenazofurin, an anti-tumor nucleoside licensed from Brigham Young University, is related to tiazofurin. Preclinical studies suggest that selenazofurin combines in treatment protocols with other well known agents against both leukemia and solid tumors.\nGrowth Hormone Releasing Factor (GRF): In November 1994, the Company entered into a license agreement for the rights to develop and commercialize a group of compounds related to and including human GRF for the United States and other major pharmaceutical markets. In connection with this agreement, the Company is obligated to pay, upon reaching certain milestones, an aggregate amount of $2,600,000. In addition, after such milestones are met, the Company is obligated to pay a royalty of 9%, subject to certain adjustments, based upon net sales of the human GRF in certain territories. The testing of these GRF compounds in relieving growth retardation is in Phase III clinical trials.\nSHORT-TERM PRODUCT DEVELOPMENT.\nAt the current time, a majority of the Company's staff of research professionals are located at the Company's facilities in the U.S., Mexico, Spain and Yugoslavia. The Company's research activities are oriented toward the development of products which have been identified by the Company as having particular promise in specific local markets. In general, these products which involve the use of known compounds for new indications, are customized to meet the specific needs or preferences of the targeted local market and can be brought to market in less than 12 months. For example, the Company recently received authorization in Spain to produce and market nasal calcitonin in monodose form. The Company believes that this product, which is administered nasally and used in the treatment of post-menopausal osteoporosis, may prove more popular than alternative treatments now available in the market, certain of which require periodic injections. In Mexico, the Company has been successful in introducing metronidazole(R), a topical antibiotic for the treatment of acne rosacea, a skin infection that affects the nose and face. The Company believes metronidazole(R) is more effective than alternative treatments such as oral tetracyclines. ICN Galenika has developed a wide range of pharmaceuticals, diagnostics, veterinary and over-the-counter drugs and has developed value-added versions of well known therapeutic compounds.\nThere can be no assurance with regard to the results of the Company's research and development efforts or the commercial success of any of its products under development.\nCOMPETITION\nThe Company operates in a highly competitive environment. The Company's competitors, many of whom have substantially greater capital resources and marketing capabilities and larger research and development staffs and facilities than the Company, are actively engaged in marketing products similar to those of the Company and in developing new products similar to those proposed to be developed and sold by the Company. Competitive factors vary by product line and customer and include service, product availability and performance, price and technical capabilities. The Company does business in an industry characterized by extensive and ongoing research efforts. Others may succeed in developing products that are more effective than those presently marketed or proposed for development by the Company. Progress by other researchers in areas similar to those explored by the Company may result in further competitive challenges.\nITEM 1. BUSINESS - CONTINUED\nThe Company is aware of several ongoing research programs which are attempting to develop new prophylactic and therapeutic products for treatment of RSV. Although the Company will follow publicly disclosed developments in this field, on the basis of currently available data it is unable to evaluate whether the technology being developed in these programs poses a threat to its current market position in the treatment of RSV or its revenue streams.\nIn the market segment relating to the treatment of chronic hepatitis C, the Company expects, if Virazole(R) is approved as a combination therapy for that indication, that it will experience intense competition from several pharmaceutical manufacturers who have previously received approval for products containing interferon. Such manufacturers include Schering-Plough Corporation, Roche Holding AG, Wellcome plc and Takeda Chemical Industries Ltd., all of which have substantially greater resources at their disposal than does the Company and all of which have already begun to market their respective brands of interferon products for the treatment of chronic hepatitis C. In addition, the Company believes that research programs are ongoing at a number of laboratories, including government, industry and private, to develop new prophylactic and therapeutic products for chronic hepatitis C.\nCompetitors of the Company's research products group include companies such as Sigma-Aldrich Corporation, Abbott Laboratories, Diagnostic Products Corporation and Amersham in the diagnostic reagents market, Life Technologies, Inc. and Bio Whittaker, Inc.\nORDER BACKLOG\nAs is customary in the pharmaceutical industry, all the Company's products are sold on an \"open order\" basis. Consequently, order backlog is not considered a significant factor.\nRAW MATERIALS\nThe Company manufactures pharmaceuticals at seven facilities. Those facilities are located in Bryan, Ohio; Mexico City, Mexico (at two locations); Montreal, Canada; Zoetermeer, The Netherlands; Barcelona, Spain; and Belgrade, Yugoslavia. The Company believes it has sufficient manufacturing capacity to meet its needs for the foreseeable future. All of these manufacturing facilities, which require GMP approval from the FDA or foreign agencies, have obtained such approval.\nIn Bryan, Ohio, the Company manufactures topical and oral dosages of several pharmaceutical products for the United States market. All of the Company's dermatology products are formulated, packaged and distributed from the Bryan, Ohio, facility. The Bryan, Ohio, facility also packages and distributes Virazole(R) on a worldwide basis.\nAt the two facilities in Mexico City, the Company manufactures a variety of pharmaceuticals in topical, oral and injectable dosage forms to serve the Latin American market. In Montreal, Canada, the Company manufactures Virazole(R) and SPAG units for the administration of Virazole(R) in the treatment of RSV, and other related medical devices. At that facility, the Company manufactures a variety of topical and oral pharmaceuticals including a line of generics to serve the Canadian and United States markets. The Canadian facility also manufactures a full-line of products using the controlled drug substance morphine for the management of pain in cancer and post-surgical states.\nIn The Netherlands, the Company manufactures contact lenses and vision care products. In Spain, the Company manufactures and markets ethical pharmaceuticals principally for distribution in Spain.\nIn Yugoslavia, Galenika manufactures over 450 pharmaceutical, veterinary, dental and other products in topical, oral and injectable forms.\nITEM 1. BUSINESS - CONTINUED\nThe Company subcontracts all of the manufacture of bulk ribavirin to third party suppliers. Most of the finishing and packaging of Virazole(R) is done by the Company and the balance by third party subcontractors. The capacities of these manufacturers are sufficient to meet the current demand for Virazole(R).\nManufacturing of the Company's research chemical products is chiefly carried out in three domestic facilities and one foreign facility: Costa Mesa, California (radioimmunoassay kits and immunobiologic products); Huntsville, Alabama (diagnostic and microplate instrumentation); Irvine, California (radiochemicals) and Eschwege, Germany (chromatography products). Some manufacturing and repackaging is also carried out at the facility in Aurora, Ohio.\nIn general, raw materials used by the Company in the manufacture of all of its products are obtainable from multiple sources in the quantities desired. During 1992 and 1993, the United Nations and the United States government adopted certain resolutions and executive orders that imposed economic sanctions on Yugoslavia. The sanctions require 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. Few licenses have been granted for the import of raw materials. Although licenses for finished goods are relatively easy to obtain, licenses for the importation of raw materials are granted only in exceptional cases. The denial of licenses for raw materials is intended to inhibit the productive capacity of Yugoslavian industry. See Note 12 of Notes to Consolidated Financial Statements. Currently, raw materials in Mexico are available in the quantities required. However, the cost of imported raw materials will increase substantially due to the fall in the relative value of the Mexican Peso.\nLICENSES, PATENTS AND TRADEMARKS\nThe Company may be dependent on the protection afforded by its patents relating to Virazole(R) and no assurance can be given as to the breadth or degree of protection which these patents will afford the Company. The Company has patent rights in the United States expiring in 1999 relating to the use of Virazole(R) to treat specified human viral diseases. While the Company has patents in certain foreign countries covering use of Virazole(R) in the treatment of certain diseases, which coverage and expiration varies and which patents expire at various times between 1995 and 2006. The Company has no, or limited, patent rights with respect to Virazole(R) and\/or its use in certain foreign countries where Virazole(R) is currently, or in the future may be, approved for commercial sale, including France, Germany and Great Britain. The Company has been granted a review classification (Concertation Procedure) for Virazole(R) as a treatment for chronic hepatitis C in all European Union countries (including France, Germany and Great Britain). As a result, approval of the application of Virazole(R) for treatment of chronic hepatitis C (if such approval is granted) would, in the European Union, provide the Company up to ten years of protection from the date of such approval of the application against competitors relying upon the Company's submitted documentation, including the results of clinical trials, to support such competitors' application to manufacture, market or sell generic substitutes of Virazole(R) for treatment of chronic hepatitis C. There can be no assurance that the loss of the Company's patent rights with respect to Virazole(R) upon expiration of the Company's patent rights in the United States, Europe and elsewhere will not result in competition from other drug manufacturers or will not otherwise have a significant adverse effect upon the business and operations of the Company. Marketing approvals in certain foreign countries provide an additional level of protection for products approved for sale in such countries. As a general policy, the Company expects to seek patents, where available, on inventions concerning\nITEM 1. BUSINESS - CONTINUED\nnovel drugs, techniques, processes or other products which it may develop or acquire in the future. However, there can be no assurance that any patents applied for will be granted, or that, if granted, they will have commercial value or as to the breadth or the degree of protection which these patents, if issued, will afford the Company. The Company intends to rely substantially on its unpatented proprietary know-how, but there can be no assurance that others will not develop substantially equivalent proprietary information or otherwise obtain access to the Company's know-how. Patents for pharmaceutical compounds are not available in certain countries in which the Company markets its products.\nICN Galenika manufactures and sells three of its top-selling antibacterial products, Pentrexyl(R), Longaceph(R) and Palitrex(R), under licenses from Bristol-Myers Squibb, Roche Holding AG and Eli Lilly, respectively. See \"Products.\"\nMany of the names of the Company's products are registered trademarks in the United States, Yugoslavia, Mexico, Canada, Spain, The Netherlands and other countries. The Company anticipates that the names of future products will be registered as trademarks in the major markets in which it will operate. Other organizations may in the future apply for and be issued patents or own proprietary rights covering technology which may become useful to the Company's business. The extent to which the Company, at some future date, may need to obtain licenses from others is not known.\nGOVERNMENT REGULATION\nThe Company is subject to licensing and other regulatory control by the FDA, the Nuclear Regulatory Commission, other Federal and state agencies and comparable foreign governmental agencies.\nFDA approval must be obtained in the United States and approval must be obtained from comparable agencies in other countries prior to marketing or manufacturing new pharmaceutical products for use by humans. Obtaining FDA approval for new products and manufacturing processes can take a number of years and involve the expenditure of substantial resources. To obtain FDA approval for the commercial sale of a therapeutic agent, the potential product must undergo testing programs on animals, the data from which is used to file an Investigational New Drug Application with the FDA. In addition, there are three phases of human testing. Phase I: safety tests for human clinical experiments, generally in normal, healthy people; Phase II: expanded safety tests conducted in people who are sick with the particular disease condition that the drug is designed to treat; and Phase III: greatly expanded clinical trials to determine the effectiveness of the drug at a particular dosage level in the affected patient population. The data from these tests is combined with data regarding chemistry, manufacturing and animal toxicology and is then submitted in the form of a NDA to the FDA. The preparation of a NDA requires the expenditure of substantial funds and the commitment of substantial resources. The review by the FDA could take up to several years. If the FDA determines that the drug is safe and effective, the NDA is approved. No assurance can be given that authorization for the commercial sale by the Company 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 in the United States and other regulatory agencies in other countries also periodically inspect manufacturing facilities.\nLITIGATION, GOVERNMENT INVESTIGATIONS AND OTHER MATTERS\nLitigation: The Predecessor Companies were parties to a number of lawsuits. As a result of the Merger, the Company has assumed all of the Predecessor Companies' liabilities with respect to such lawsuits. See Item 3. \"Legal Proceedings.\"\nITEM 1. BUSINESS - CONTINUED\nProduct Liability: The Company could be exposed to possible claims for personal injury resulting from allegedly defective products. The Company generally self-insures against potential product liability exposure with respect to its marketed products, including Virazole(R). While to date no material claim for personal injury resulting from allegedly defective products, including Virazole(R), has been successfully maintained against any of the Predecessor Companies, a substantial claim, if successful, could have a material adverse effect on the Company.\nEnvironmental Matters: The Company has not experienced any material impact on its capital expenditures, earnings or competitive position as a result of compliance with any laws or regulations regarding the protection of the environment. The Company believes it is in compliance in all material respects with applicable laws relating to the protection of the environment.\nEMPLOYEES\nAs of December 31, 1994, the Company employed approximately 5,840 persons, of which approximately 890 were engaged in general and administrative matters, 1,510 in marketing and sales, 330 in research and development and 3,110 in production. Of these employees, approximately 3,880 are employed by ICN Galenika, including 600 engaged in general and administrative matters, 720 in marketing and sales, 250 in research and development and 2,310 in production. All of the employees employed by ICN Galenika, 330 employees of the Company's Mexican subsidiaries and 250 employees of the Company's Spanish subsidiary are covered by collective bargaining agreements. National labor laws in some foreign countries in which the Company has substantial operations, including Yugoslavia and Spain, govern the amount of wages paid to employees and establish restrictions, severance provisions and related requirements that must be satisfied prior to the termination of employees. In Mexico, the terms of the collective bargaining agreements expire in February 1996. The Company has not experienced any work stoppage, slowdown or other serious labor problems which have materially impeded their business operations. In early 1994, there was a minor work stoppage at one of the Company's Mexican subsidiaries, which was satisfactorily resolved. The Company is uncertain as to how the current economic situation, the devaluation of the Peso and wage controls in Mexico may affect future labor relations with the employees in Mexico. The Company currently 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 and its subsidiaries:\nDuring the third quarter of 1994, ICN Galenika commenced a construction and modernization program at its pharmaceutical complex outside Belgrade, Yugoslavia. This program includes the construction of two new pharmaceutical manufacturing plants (one to produce cephalosporins, which are broad spectrum penicillin resistant antibiotics, and the other to produce steroids and hormones), the modernization of the existing facility and the construction of a quality control building and a research institute. It is estimated that this program will have an aggregate cost of $136,000,000. ICN Galenika intends to fund their construction and modernization through funds from local operations and locally funded debt.\nIn the opinion of the Company's management, all facilities occupied by the Company are adequate for present requirements, and the Company's current equipment is considered to be in good condition and suitable for the operations involved.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLITIGATION\nLitigation: The Predecessor Companies were parties to a number of lawsuits. As a result of the Merger, the Company has assumed all of the Predecessor Companies' liabilities with respect to such lawsuits.\nIn February and March 1995, eighteen actions were filed (\"the 1995 Actions\") which named the Company, its Board of Directors, Milan Panic and several other officers of the Company, in various combinations, as defendants (the \"Defendants\"). Eleven of the actions purport to be securities class actions, one is an individual securities action and six purport to be derivative suits. All of the purported securities class actions were filed in the United States District Court for the Central District of California and the individual securities action was filed in the United States District Court for the Eastern District of Tennessee. The derivative suits were filed in the Court of Chancery of the State of Delaware, the United States District Court for the Central District of California and the Superior Court of the State of California.\nIn general, all of the securities class actions allege that the Company made various deceptive and untrue statements of material fact and omitted to state material facts in connection with information it received from the FDA regarding the Company's NDA for the use of Virazole(R) for the treatment of chronic hepatitis C. Plaintiffs also allege that various officers of the Company traded on inside information. The purported securities class actions and the individual securities action assert claims for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, Rule 10b-5 promulgated thereunder, common law fraud, misrepresentation and negligent misrepresentation. They seek unspecified compensatory and punitive damages, attorneys' fees and costs, injunctive and equitable relief, and disgorgement. With respect to the purported securities class actions, plaintiffs seek certification of classes of persons who purchased ICN common stock, ICN debentures, and ICN call options or sold ICN put options. The securities class actions seek certification for differing time periods, the longest alleged time period being June 2, 1994 through February 17, 1995.\nWith respect to the purported derivative suits, plaintiffs assert claims for breach of fiduciary duty, intentional breach of fiduciary duty, negligent breach of fiduciary duty, breach of the fiduciary duty of candor, waste of corporate assets, constructive fraud, disgorgement, gross mismanagement, abuse of control and unjust enrichment. In these actions plaintiffs seek unspecified compensatory and punitive damages, attorneys' fee and costs and injunctive and equitable relief.\nThe Company has had preliminary discussions with the attorneys for plaintiffs who have suggested that an Amended Consolidated Complaint, encompassing the above actions, be filed in the United States District Court for the Central District of California. If this consolidation occurs, as Defendants currently expect, Defendants will have at least 30 days from the filing of the Amended Consolidated Complaint to answer or move. The Defendants intend to vigorously defend these actions.\nFour lawsuits have been filed with respect to the Merger (\"the 1994 Actions\") in the Court of Chancery in the State of Delaware. Three of these lawsuits, entitled Helmut Kling v. Milan Panic, et al., Jallath v. Milan Panic, et al., and Amy Hoffman v. Milan Panic, et al., were filed by stockholders of SPI and, in the Jallath lawsuit, of Viratek, against ICN, SPI, Viratek (in the Jallath lawsuit) and certain directors and officers of ICN, SPI and\/or Viratek (including Milan Panic) and purport to be class actions on behalf of all persons who held shares of SPI common stock and, in the Jallath lawsuit, Viratek common stock. The fourth lawsuit, entitled ~Joice Perry v. Nils O. Johannesson, et. al., was filed by a stockholder of Viratek against ICN, Viratek and certain directors and officers of ICN, SPI and Viratek (including Milan Panic) and purports to be a class action on behalf of all persons who held shares of Viratek common stock. These suits allege that the consideration provided to the public stockholders of SPI and\/or Viratek (as applicable) in the Merger was unfair and inadequate, and that the defendants breached their fiduciary duties in approving the Merger and otherwise. The Company believes that these suits are without merit and intends to defend them vigorously.\nITEM 3. LEGAL PROCEEDINGS (CONTINUED)\nICN, SPI and Viratek and certain of their officers and directors (collectively, the \"ICN Defendants\") were named defendants in certain consolidated class actions pending (\"the 1987 Actions\") 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)). In the Third Amended Consolidated Class Action Complaint, plaintiffs allege that the ICN Defendants made, or aided and abetted Paine Webber, Inc. (\"Paine Webber\") 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 research reports and filings with the Securities and Exchange Commission (the \"Commission\"). The alleged misstatements and omissions primarily concern developments regarding Virazole(R), including the efficacy, safety and market for the drug. The plaintiffs allege that such misrepresentations and omissions violate Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder and constitute common law fraud and misrepresentation. The ICN Defendants filed their Answer, containing affirmative defenses, on February 15, 1993. Fact discovery is complete and expert discovery is virtually complete. Plaintiffs seek the certification of classes of persons who purchased ICN, Viratek or SPI common stock during the period January 7, 1986 through 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. Oral argument on plaintiffs' motion for class certification was held on June 2, 1994. To date, no decision has been rendered. 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. On October 20, 1993, plaintiffs informed the Court that they had reached an agreement to settle with co-defendant Paine Webber and on July 27, 1994, the settlement was approved by the Court. Management believes that, having extensively reviewed the issues in the above referenced matters, there are strong defenses and the Company intends to defend the litigation vigorously. While the ultimate outcome of the 1987 Actions cannot be predicted with certainty, and an unfavorable outcome could have a material adverse effect on the Company, at this time management does not expect these matters will have a material adverse effect on the financial position and results of operations of the Company.\nIn late January 1995 an action was commenced by Deborah Levy against ICN Pharmaceuticals, Inc., SPI Pharmaceuticals, Inc., Viratek, Inc. and Milan Panic. The complaint asserts causes of action for sex discrimination and harassment, and for violations of the California Department of Fair Employment and Housing statute and a provision of the California Government Code. The complaint seeks injunctive relief and unspecified compensatory and punitive damages. Defendants filed their answer, demand for production of documents and request for interrogatories in March 1995. In addition, defendants have taken plaintiff's deposition for two days and intend to continue that deposition. The defendants intend to vigorously defend the suit.\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\"), SPI, and ICN, alleging breach of contract and related claims arising out of a manufacturing contract between Gencon and ICN Canada. ICN and SPI were dismissed from the action in March 1993 based on SPI's agreement to guarantee any judgment against ICN Canada. Following trial in 1993, the judge granted judgment in favor of Gencon for breach of contract in the amount of approximately $2,100,000 plus interest, costs and attorneys' fees (which totals approximately $650,000). ICN Canada timely filed its Notice of Appeal and Gencon filed a Notice of Cross-Appeal, seeking approximately $145,000 in additional claimed costs. Both the appeal and the cross-appeal have been fully briefed. No date has been set for oral argument. The defendants intend to vigorously defend the suit\nITEM 3. LEGAL PROCEEDINGS (CONTINUED)\nOn January 25, 1995, GRC International, Inc. (\"GRC\") filed a motion in the Superior Court of the State of California, County of Orange, to confirm a pre-existing $2,260,807 arbitration award issued against Biomedicals. The dispute centered on the last payment due from Biomedicals to GRC as a result of Biomedical's acquisition of Flow General Inc. in 1989. Biomedicals filed its papers in opposition to the motion to confirm or to vacate the arbitration award on February 28, 1995. On March 23, 1995, GRC's motion to confirm the arbitration award was granted, and a judgment against Biomedicals was entered in the approximate amount of $2,300,000. The Company has accounted for the resolution of this matter upon the effective date of the Merger.\nIn October 1994, an action entitled Engelhardt v. ICN Pharmaceuticals, Inc. (Case No. 94-2-2322) was filed in the United States District Court for the District of Colorado. The action was commenced by Lauri and Kenneth Engelhardt on behalf of themselves and their infant daughter Hannah. It is alleged that Lauri Engelhardt was exposed to Virazole(R) early in her pregnancy, and that as a result of such exposure, Hannah was born with birth defects. Plaintiffs assert causes of action for products liability and negligence and seek unspecified damages. The Company filed a motion on February 28, 1995 to dismiss, asserting that Plaintiffs' claims are barred by the statute of limitations. No decision has been rendered with respect to that motion. The Company believes that the allegations are without merit and intends to vigorously defend this 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 alleged, among other things, 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. ICN and Viratek are seeking compensatory and punitive damages in the amount of $25,000,000. Khan has filed counterclaims, asserting causes of action for slander, interference with economic relations, a shareholders' derivative action for breach of fiduciary duties, violations of the federal securities laws and tortious interference with economic relations, and is seeking compensatory damages, interest and exemplary damages of $29,000,000. On November 4, 1994, ICN and Viratek moved to have a default judgment entered against Khan and to dismiss his counterclaims. Khan submitted his opposition papers on March 15, 1995, and oral argument is currently scheduled for April 21, 1995.\nArbitration: On June 30, 1993, ICN filed a claim in arbitration, ICN v. Labsystems, O.Y., alleging breach of of a certain supplier agreement and requesting repudiation of such agreement. On February 6, 1995, the tribunal awarded Labsystems approximately $5,000,000 including interest and affirming existence of the supplier agreement between the parties requiring ICN to accept $4,500,000 of inventory from Labsystems. The Company has paid and accounted for the resolution of the arbitration as a liability assumed upon the effective date of the Merger.\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\nNew ICN began trading its common stock on the New York Stock Exchange beginning November 14, 1994, the first trading day after the Merger was completed and New ICN common stock was approved for listing on the New York Stock Exchange (Symbol: ICN). Prior to the Merger, SPI common stock was first listed on NASDAQ (National Association of Securities Dealers Automated Quotation System) on October 7, 1983, and was subsequently listed on the American Stock Exchange on July 22, 1988.\nThe following table sets forth, from November 14, 1994, the high and low sales prices of the Company's common stock on the New York Stock Exchange. Prior to November 14, 1994 the table sets forth the high and low sales prices for SPI on the American Stock Exchange. In January 1993, SPI issued a fourth quarter 1992 stock dividend of 2%. During 1993, SPI issued quarterly stock dividends which totaled 6%. During 1994, SPI and the Company issued quarterly stock dividends and distributions which totaled 4.8%. In March 1995, the Company declared a first quarter 1995 stock distribution of 1.7%. The market prices set forth below have been retroactively adjusted for these stock splits, dividends and distributions.\nAs of March 20, 1995, there were 11,647 holders of record of the Company's common stock.\nThe Board of Directors will continue to review the Company's dividend policy. The amount and timing of any future dividends will depend upon the profitability of the Company, the need to retain earnings for use in the development of the Company's 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\") were issued, restrict the ability of the Company to declare cash dividends on, and to repurchase any shares or rights to stock of the Company. Under the most restrictive provisions of the Indentures, the Company may not pay dividends or make distributions on 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 companies 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 of all such dividends, distributions, purchases or 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 of the issuance or sale after July 24, 1986, of any shares of its common stock and capital stock of its subsidiaries or 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\nOn November 1, 1994, the shareholders of ICN, SPI, Viratek and Biomedicals approved the Merger of the Predecessor Companies (\"the Merger\"). On November 10, 1994 (effective November 1, 1994), SPI, ICN and Viratek merged into ICN Merger Corp., and Biomedicals merged into ICN Subsidiary Corp. a wholly-owned subsidiary of ICN Merger Corp. In conjunction with the Merger, ICN Merger Corp. was renamed ICN Pharmaceuticals, Inc. (\"New ICN\" or \"the Company\") . The Merger was accounted for using the purchase method of accounting. Additionally, for accounting purposes, SPI was treated as the acquiring company and as a result, the Company has reported the historic financial data of SPI in its financial results and included the results of ICN, Viratek and Biomedicals from the effective date of the Merger, November 1, 1994.\nThe following table sets forth certain consolidated financial data for the years ended December 31, 1994, 1993, 1992, and 1991, and for the year ended November 30, 1990. The Company's separate results of operations for the month of December 1990 are not reflected in the Statement of Income, but have been charged directly to retained earnings. This information should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and the financial statements included elsewhere in this Form 10-K (amounts in thousands, except per share information).\nSee accompanying notes to Selected Financial Data.\nITEM 6. SELECTED FINANCIAL DATA - CONTINUED\nNOTES TO SELECTED FINANCIAL DATA:\n(1) Financial data for 1991 includes the results of ICN Galenika from the effective date of acquisition, May 1, 1991. For financial statement purposes, the Company's separate results of operations for the month of December 1990 are not reflected in the Statement of Income but have been charged directly to retained earnings.\n(2) ICN Galenika's sales have been adversely affected since the imposition in May, 1992 of United Nations sanctions on Yugoslavia.\n(3) The Merger resulted in $221,000,000 or $9.93 per share being ascribed to purchased research and development and was written-off immediately. This write-off is a one-time, non-cash charge and is not related to the Company's ongoing research and development activities for Virazole(R). The 1994 net loss of $183,581,000 or $8.24 per share, includes a one-time, non-cash write-off of $221,000,000 or $9.93 per share related to purchased research and development due to the Merger. Income, excluding this one-time, non- cash write-off, was $37,419,000 or $1.68 per share in 1994 compared to net income of $21,510,000 or $1.03 per share in 1993, an increase of $15,909,000 or 74%.\n(4) Other, net for 1994, 1993 and 1992 includes research and development costs; translation and exchange losses, net; interest (income) expense, net; other (income) expense, net; and amortization of goodwill.\n(5) In March and July 1991, SPI issued 10% and 15% stock distributions, respectively, which resulted in a 26% stock split. In January 1993, SPI issued a fourth quarter 1992 stock dividend of 2%. During 1993, SPI issued additional stock dividends which totaled 6%. During 1994, SPI and the Company issued additional stock dividends and distributions which totaled 4.8%. In March 1995, the Company declared a first quarter 1995 stock distribution of 1.7%. All share and per share amounts have been restated to reflect these stock splits, dividends and distributions, except for historical dividends issued which are unadjusted for stock splits, dividends and distributions.\n(6) Dividends for 1994 include cash dividends of $.26 on a historical basis and stock dividends and distributions of $.93. Dividends for 1993 include cash dividends of $.25 on a historical basis and stock dividends equivalent to $.87. The dividends in 1992 include cash dividends of $.86 on a historical basis and stock dividend equivalent to $.20 per share. The stock dividends are based upon the market value of SPI's and the Company's common stock at the declaration date. For 1991 and prior years, the dividends were paid in cash.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nINTRODUCTION\nSince 1981 the ICN group of companies included a pharmaceuticals products company, SPI Pharmaceuticals, Inc. (\"SPI\"), a research products company, ICN Biomedicals, Inc. (\"Biomedicals\"), a research and development company, Viratek, Inc. (\"Viratek\"), and the parent company, ICN Pharmaceuticals, Inc. (\"ICN\") (collectively, the \"Predecessor Companies\"). Until November 1, 1994, the effective date of the Merger, ICN maintained a controlling interest in the subsidiary companies.\nOn November 10, 1994, SPI, ICN and Viratek merged into New ICN, and Biomedicals merged into ICN Subsidiary Corp., a wholly-owned subsidiary of New ICN. The Merger was accounted for using the purchase method of accounting. Additionally, for accounting purposes, SPI was treated as the acquiring company and as a result, the Company has reported the historical financial data of SPI in its financial results and the results of ICN, Viratek and Biomedicals have been included with the results of the Company since the effective date of the Merger.\nAs part of the Merger, the Company issued approximately 6,476,770 common shares valued on November 10, 1994 at $20.75 per share, which was the publicly trade price for SPI's common shares at that date. Accordingly, the purchase price, including direct acquisition costs of $3,654,000 has been allocated to the estimated fair value of the net assets, including amounts ascribed to purchased research and development costs of $221,000,000 or $9.93 per share, which was written-off to operations immediately following the consummation of the Merger. The $2,313,000 excess of the fair value of the net assets acquired and amounts allocated to acquired research and development over the purchase price has been proportionately allocated to reduce non-current assets acquired.\nThe purchase price allocation related to the Merger is preliminary, pending resolution of a pre-acquisition contingency associated with certain consolidated class actions entitled In re Paine Weber Securities Litigation; In re ICN\/Viratek Securities Litigation against ICN and Viratek. (See Note 7 of Notes to Consolidated Financial Statements)\nThe Merger resulted in the acquisition of a biomedicals business with annual sales of approximately $58,000,000, direct access to Viratek's research and development resources including its scientific expertise, substantial tax net operating loss carryforwards and the elimination of royalty payments to Viratek on the sales of Virazole(R).\nThe 1994 net loss of $183,581,000 or $8.24 per share, includes a one-time, non-cash write-off of $221,000,000 or $9.93 per share related to purchased research and development due to the Merger. Income, excluding this one-time, non-cash write-off, was $37,419,000 or $1.68 per share in 1994 compared to net income of $21,510,000 or $1.03 per share in 1993, an increase of $15,909,000 or 74%. This improvement is primarily due to improved sales of Virazole(R) in North America and an improved business environment in Yugoslavia. The Company's Yugoslavian subsidiary, ICN Galenika benefited from an overall reduction in operating expenses along with a $15,660,000 decrease in interest expense resulting from reduced levels of inflation in Yugoslavia.\nRESULTS OF OPERATION\nFor financial reporting purposes the Company's operations are divided into two industry segments, the Pharmaceutical segment and the Biomedical segment. Certain financial information for the two industry segments is set forth below.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED\nThis discussion should be read in conjunction with the consolidated financial statements of the Company included elsewhere in this document. For additional financial information by industry segment, see Note 10 of Notes to Consolidated Financial Statements.\nNET SALES. Pharmaceutical segment net sales for 1994 were $357,821,000 compared to $403,957,000 in 1993. This decrease in net sales of $46,136,000, or 11%, is primarily a result of lower sales at ICN Galenika. Net sales at ICN Galenika were $172,124,000 for the year ended December 31, 1994 compared to $239,832,000 for the same period last year. The decline in ICN Galenika dollar sales of $67,708,000, or 28%, is primarily due to differences in exchange rates during 1994 compared to 1993 and the reluctance of the Yugoslavian government to allow sales price increases during 1994. Despite a dollar decline in sales, the number of units sold in ICN Galenika increased 20% over the prior year. In January 1994, the Yugoslavian government initiated an economic stabilization program to control inflation. This program created a more stable business environment that allowed ICN Galenika to increase unit sales, increase production and improve product mix.\nThe decrease in sales at ICN Galenika is partially offset by sales increases of $21,572,000, or 13%, in the Company's operating units excluding ICN Galenika. The sales in these operations increased to $185,697,000 in 1994 compared to $164,125,000 in 1993. This increase is primarily due to increased Virazole(R) sales of $16,782,000, or 57% compared to 1993. Sales and operating results for 1994 were not adversely affected by the devaluation of the Mexican Peso during December 1994. As a result of the Merger, the Company acquired a biomedicals research products business that contributed $9,030,000 of sales to the 1994 operating results since November 1, 1994, and an otherwise insignificant effect on operations.\nNet sales for 1993 declined to $403,957,000 from $476,118,000 for 1992 due to lower sales at the Company's Yugoslavian subsidiary, ICN Galenika. Sales at ICN Galenika were $239,832,000 for 1993 compared to sales of $325,903,000 for 1992. The United Nations sanctions on Yugoslavia and price controls imposed by the Yugoslavian government impacted the sales at ICN Galenika, both in terms of a decrease in unit sales and a change in product mix. Additionally, sales were adversely impacted by inflation and by larger and more frequent devaluations in 1993 as compared to 1992.\nSales in the Company's operating units, excluding ICN Galenika, increased $13,910,000 or 9% in 1993 to $164,125,000 compared to the prior year sales of $150,215,000. The Company's United States operations reported increased sales of $8,906,000, or 17%, for 1993 compared to 1992, primarily due to increased sales of dermatological products. The Company's Mexican subsidiaries recorded an increase in sales of $9,129,000 or 19%, for 1993 compared to 1992, primarily due to increased unit sales and price increases for its injectable vitamin, Bedoyecta, along with increased sales of Virazole(R). The Company's Spanish subsidiary recorded a decrease in sales of $3,153,000, or 12%, primarily due to a 23% devaluation of the Spanish peseta against the U.S. dollar, which was partially offset by increased unit sales.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED\nGROSS PROFIT. Gross profit as a percentage of sales was 50% for 1994 compared to 48% for 1993. The increase in gross profit is primarily due to increased sales of Virazole(R) in the United States. Gross profit margin at ICN Galenika decreased to 29% in 1994 from 35% in 1993 primarily due to the higher cost of inventory and government imposed price controls. During the later part of 1992 and into 1993 the unit cost of inventory had risen due to higher prices resulting from the economic conditions in Yugoslavia existing during this time. This higher priced inventory is reflected in cost of sales for 1994 and has been replaced with inventory having a lower unit cost resulting from an improved economic environment in Yugoslavia and higher production levels. The gross profit margin in the Company's operating units other than ICN Galenika increased to 69% compared to 66% in 1993 due primarily to increased Virazole(R) sales in the United States.\nGross profit as a percentage of sales was 48% for 1993 compared to 56% in 1992. The decrease in the gross profit margin reflects the impact of price controls in Yugoslavia and higher labor costs per unit at ICN Galenika. The decrease in gross margins at ICN Galenika was partially offset by improvements in the aggregate gross profit margins of the Company's subsidiaries outside of Yugoslavia. The combined gross margins of these subsidiaries was 66% for 1993 compared to 62% for 1992.\nAt ICN Galenika, gross profit as a percentage of sales was 35% in 1993 compared to 53% for 1992. The overall rate of inflation in Yugoslavia exceeded the rate at which ICN Galenika could increase selling prices. This was compounded by more frequent currency devaluations, which together resulted in lower revenues and gross profits when stated in U.S. dollars. Additionally, the cost of manufactured inventory increased as a result of declining unit production while maintaining the same work force that existed before sanctions began. United Nations sanctions contributed to shortages of raw materials and a deteriorating business environment, resulting in unit production in 1993 that was significantly less than what was produced in 1992.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses as a percentage of sales were 30% in 1994 compared to 32% in 1993. This decrease was primarily due to expense reductions at ICN Galenika resulting from a lower provision for bad debts, lower wages and the impact of differences in the exchange rates in 1994 compared to 1993.\nSelling, general and administrative expenses as a percentage of sales were 32% for 1993 compared to 36% for 1992. The 1992 results include provisions at ICN Galenika for training employees, redundancy and early retirement costs of $21,065,000. Excluding these provisions, selling, general and administrative costs for the year ended December 31, 1992, were 31% of net sales. The increase in 1993 expenses as a percentage of sales is primarily a result of lower sales at ICN Galenika combined with overall increases in operating expenses due to inflationary pressures in Yugoslavia offset by lower provisions for doubtful accounts.\nIn countries experiencing high inflation, 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. In 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 more frequent devaluations and 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.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED\nROYALTIES TO AFFILIATES, NET. Royalties to Viratek were $7,171,000, $5,903,000 and $5,448,000 for 1994, 1993 and 1992, respectively. These royalties were based on an agreement whereby SPI paid a royalty of 20% on all Virazole(R) sales for all indications. As a result of the Merger, the Company is no longer required to pay future royalties on Virazole(R). The royalties to Viratek in 1994 are based on Virazole(R) sales up to the date of the Merger. In 1994, sales of Virazole(R), for purposes of determining royalties to Viratek in 1994, were $35,855,000. Sales of Virazole(R) were $46,297,000, $29,515,000 and $27,240,000 for 1994, 1993 and 1992, respectively.\nOTHER, NET. A summary of certain other items, including other (income) expense is as follows (in thousands):\nResearch and Development Costs. In 1994, research and development costs decreased $3,826,000 due to lower costs at ICN Galenika of $5,210,000 resulting from wage reductions for research and development personnel and differences in exchange rates. The decrease in research and development expense was partially offset by research and development costs of $1,874,000 resulting from the Merger. In 1993, Viratek reported research and development costs of approximately $5,193,000. The Company intends to continue the research and development efforts that were performed at Viratek. Research and development costs rose in 1993 and 1992 due primarily to higher research and development costs at ICN Galenika.\nTranslation and Exchange Losses (Gains), Net. Foreign exchange losses, net, in 1994 were $191,000 compared to foreign exchange gains, net, of $(3,282,000) in 1993. Foreign exchange losses, net, at ICN Galenika were $1,417,000 in 1994 related to exchange rate fluctuations occurring before the Yugoslavian stabilization program. The losses at ICN Galenika were offset by foreign exchange gains related to certain of the Company's foreign denominated long-term debt. In 1993, the foreign exchange losses, net, decreased compared to 1992, due to foreign exchange gains of $3,143,000 at the Company's Spanish subsidiary and reduced losses at ICN Galenika of $27,790,000 as a result of planned reductions in its net monetary exposure.\nInterest Expense. The decrease in interest expense in 1994 compared to 1993 of $14,433,000 is primarily due to a decrease in interest expense of $15,660,000 at ICN Galenika. The economic stabilization program enacted by the Yugoslavian Government early in the year has resulted in lower interest rates in 1994 compared to 1993. The decrease in interest expense at ICN Galenika is partially offset by increased interest expense in the United States resulting from the assumption of debt in connection with the Merger.\nThe increase in interest expense in 1993 compared to 1992 of $10,685,000 is a result of ICN Galenika's strategy to manage its monetary position by maintaining higher levels of short-term debt compared to the prior year. Approximately $2,000,000 of this dinar denominated short-term debt was outstanding at December 31, 1993. In 1993, ICN Galenika was charged interest at highly inflationary rates. The high level of interest expense in 1993 does not necessarily reflect a high level of debt burden on the Company or a high level of cash paid for interest. From the time that ICN Galenika accrued its liability for its highly inflationary interest expense to the time that it actually paid the interest, significant devaluation in the translation rate occurred. The devaluation resulted in a payment of interest stated in U.S. dollars that was significantly below what was originally accrued. In 1993, ICN Galenika had $16,774,000 of interest expense and interest payments of $7,149,000 resulting in estimated translation gains on accrued interest devaluations of $9,625,000.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED\nOther. In 1993, the Company recorded $988,000 for estimated damages relating to a breach of contract suit and $1,000,000 for costs associated with the layoff of employees in the Company's Spanish subsidiary. These costs did not recur in 1994.\nIncome taxes. The Company's effective income tax rate was 6%, 20% and 17% for 1994, 1993 and 1992 respectively. The Company's effective tax rate of 6% in 1994 was significantly different than the expected U.S. statutory rate of (35%) due to the write-off of purchased research and development related to the Merger for which there is no related tax benefit. The Company's effective rate of 20% in 1993 was significantly less than the U.S. statutory rate primarily due to the utilization of foreign and alternative minimum tax credits and other deferred tax benefits for which a valuation allowance existed at January 1, 1993. The Company's effective tax rate for 1992 was significantly less than the U.S. statutory rate due to an increase in the Company's accumulated foreign earnings which were taxed at relatively low effective foreign rates.\nLIQUIDITY AND CAPITAL RESOURCES\nLiquidity and Capital Resources\nCash provided by operating activities continues to be the Company's primary source of funds to finance operating needs, capital expenditures and dividend payments. In 1994, cash provided by operating activities totaled $42,557,000 which includes increased earnings of the Company before a one-time, non-cash charge to income of $221,000,000 or $9.93 per share, related to purchased research and development due to the Merger. Other net cash flows used in operating activities were primarily attributed to increases in receivables and prepaid expenses and other current assets. The accounts receivable level at ICN Galenika increased $34,670,000 due to the positive effects of the stabilization program and the absence of large and frequent devaluations. Prepaid expenses increased primarily due ICN Galenika prepaying its foreign suppliers of inventory, a trend expected to continue, in order to help mitigate the effects of devaluations. Other net cash flows used in operating activities were partially offset by increases in trade payables and decreases in inventory. The decrease in inventory primarily relates to the higher priced inventory in ICN Galenika which has been charged to cost of sales during 1994 and replaced with inventory having a lower unit cost resulting from an improved economic environment in Yugoslavia and lower unit costs resulting from higher production levels.\nCapital expenditures of $20,205,000 in 1994 primarily relate to the facility expansion and modernization project at ICN Galenika. This project will include two new factories, one of which will manufacture cephalosporins and the other will manufacture steroids and hormones. Additionally, ICN Galenika's existing drug plant will be modernized and upgraded. The total cost of this facility expansion and modernization is expected to be approximately $136,000,000 through 1998. ICN Galenika intends to fund this program through funds generated from local operations and locally funded debt.\nIn November 1994, the Company completed an underwritten public offering in the principal amount of $115,000,000 of 8.5% Subordinated Convertible Notes (the \"Convertible Notes\"), due in November 1999. These notes are convertible at the option of the holder either in whole or in part, at any time prior to maturity, into the Company's common stock at a current conversion price of $22.98 per share, subject to adjustment in certain events. The Convertible Notes are also redeemable, in whole or in part, at the option of the Company at any time on or after November 15, 1997 at specified redemption prices, plus accrued interest. The fair value of the Convertible Notes was approximately $110,975,000 at December 31, 1994.\nThe net proceeds from the Convertible Notes were primarily used by the Company to retire certain high yield debt which included the retirement of $37,000,000 of the Company's 12-7\/8% Sinking Fund Debentures plus accrued interest, $20,238,000 of 12-1\/2% Debentures plus accrued interest, $3,382,000 of Mexican debt and $15,198,000 of Spanish debt. The Company intends to use the remaining proceeds of approximately $32,000,000 for general working capital purposes. The effect on net income from the above debt extinguishments was not material for 1994 but will benefit future years through a reduction of interest expense.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED\nIn an effort to reduce future interest expense, the Company has elected to call $10,000,000 of the 12-7\/8% Sinking Fund Debentures, at par, with payment to be made on April 28, 1995.\nProduct liability: In December 1985, Management discontinued product liability insurance in the United States. 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's liquidity and financial performance. See Note 7 of Notes to Consolidated Financial Statements.\nInvestment in Russia: During 1993 and 1994, the Company acquired a 41% interest in Oktyabr, a Russian pharmaceutical company. The Company intends to increase its ownership interest in Oktyabr to approximately 62% through a government-sponsored investment program. Participation in this program does not require significant expenditure of future funds. Once the Company achieves its ownership goals it will begin a program to construct a new pharmaceutical manufacturing facility in Russia built pursuant to \"good manufacturing practices.\" Although Russia may, in time, evolve into a large, free market oriented economy, because of the present unpredictable political, social and economic factors in Russia, the Company intends to penetrate this market in a gradual manner. There can be no assurance as to when or if the new facility will be constructed or as to its future success.\nDemands on Working Capital: Management believes that funds generated from operations will be sufficient to meet its normal operating requirementsduring the coming year. If these funds prove to be insufficient, or if new opportunities require the Company to raise capital, the Company may seek additional financing or issue additional common stock.\nICN GALENIKA\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 United Nations Security Council (\"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. The sanctions specifically exempt certain medical supplies for humanitarian purposes, a portion of which are distributed by ICN Galenika. ICN Galenika continues to apply for, and has received, licenses under the sanctions, however, the efforts to enforce sanctions create administrative burdens that slow the shipments of licensed raw materials to Yugoslavia. Shipments of imported raw materials in 1994 and 1993 were 60% and 38% of pre-sanction levels, respectively. Additionally, the sanctions have contributed to an overall deteriorating business environment in which ICN Galenika must operate.\nThe sanctions provide for the freezing of bank accounts of Yugoslavian commercial and industrial entities. The implementation of sanctions may create a restriction on ICN Galenika's corporate bond security holdings of approximately $29,155,000 that are maintained in a bank outside of Yugoslavia. Of this amount $8,103,000 serves as collateral for a note payable to the financial institution. Management believes, however, that these funds will be available for drawdowns on lines of credit for shipments specifically licensed under the 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.\nIn September, 1994, the United Nations Security Council voted to ease sanctions against Yugoslavia by allowing air traffic to Belgrade and by lifting the ban on cultural and sports exchanges.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED\nHYPERINFLATION AND PRICE CONTROLS:\nUnder existing Yugoslavian price controls imposed in July of 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. During 1994, ICN Galenika received fewer price increases than in the past, a trend that may continue, applying increased pressure on gross profit margins. 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. U.S. dollar sales in 1994 were below 1993 levels due to exchange rate differences despite an increase in units sold of 20%. This trend of reduced U.S. dollar sales levels could continue as long as sanctions are in place.\nICN Galenika operates in a highly inflationary environment that has, prior to January 1994, experienced high levels of inflation along with large and frequent devaluations. On 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 by exercising restraint in the amount of dinars that it prints, thereby restricting cash in circulation to correspond to hard currency reserves in Yugoslavia. Since the inception of this program the exchange rate of dinars to Deutsche marks has remained stable. The trading of dinars at other than official rates has been virtually eliminated and inflation and interest rates have declined from over 1 billion percent a year to a current annual rate of approximately 5% since early 1994, based on information currently available to the Company. The Company believes that the period of time that the stabilization program has been operating successfully is significant given that past attempts at monetary control by the Yugoslavian government have generally been temporary. In the near term, the positive effects of the stabilization program could reverse and a return to prior levels of high inflation could occur. The success of this stabilization program is dependent upon improvement in the Yugoslavian economy, which is in part dependent upon the lifting of United Nations sanctions.\nAt ICN Galenika the net monetary asset position, consisting primarily of accounts receivable net of trade payables, increased due to a more favorable business environment in Yugoslavia. The stabilization program resulted in lower interest rates, increased availability of hard currency, and a lower risk of devaluation. The reduced risk of holding losses from carrying accounts receivables has resulted in a greater willingness of companies operating in Yugoslavia to extend trade credit. This net monetary asset position is subject to foreign exchange loss if a devaluation of the dinar were to occur, which management is unable to predict with any certainty. The net monetary asset position at ICN Galenika as of December 31, 1994 and February 28, 1995 was approximately $25,442,000 and $34,372,000, respectively, which is subject to fluctuations in the exchange rate of the dinar against the dollar.\nFor additional information and expanded discussion regarding the impact of ICN Galenika, see Note 12 of Notes to Consolidated Financial Statements.\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 restrictive governmental actions. Changes in the relative values of currencies occur from time to time and may, in certain instances, materially affect the Company's results of operations. The effect of these risks remains difficult to predict.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - CONTINUED\nThe Company's subsidiary in Mexico recorded 1994 sales of $56,737,000, cost of sales of $27,997,000 and income before provision for income taxes of $5,115,000. In December 1994, the Mexican peso experienced a 30% devaluation that will result in lower U.S. dollar sales and gross margins in the future. This devaluation resulted in an increase in the foreign currency translation charge included as a component of stockholders' equity of $9,451,000. Also, approximately 30% of the Mexican cost of inventory include materials obtained from outside of Mexico. The devaluation of the peso will make the cost of these foreign materials higher creating added pressure on the gross margins for these products. In addition, inflation continues to increase along with a weakening of the Mexican peso against the U.S. dollar. The Company will endeavor to mitigate these effects by seeking price increases, adjusting its product mix and seeking local sources for materials that had previously been foreign sourced. However, the implementation of these actions may be affected by recently enacted economic restraint plans by the Mexican government, which include stricter price controls.\nThe Company is subject to foreign currency risk on its foreign denominated debt of approximately $31,136,000 at December 31, 1994, which is exposed to currency fluctuations.\nThe effects of inflation are experienced by the Company through increases in the costs of labor, services and raw materials. While the Company attempts to raise selling prices in anticipation of inflation, adverse effects have been experienced in Yugoslavia and are anticipated in Mexico as a result of price controls.\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nFollowing is a summary of quarterly financial data for the years ended December 31, 1994 and 1993 (in thousands, except per share amounts):\n(1) Net income per share has been restated to reflect quarterly stock dividends totaling 6% during 1993, and quarterly stock dividends and distributions totaling 4.8% during 1994 and a 1.7% first quarter 1995 stock distribution declared in March 1995.\n(2) Includes a write-off in 1994 of purchased research and development for which no alternative use exists of $221,000,000 or $9.93 per share as a result of the Merger.\n(3) Includes the results of ICN, Viratek and Biomedicals since the effective date of the Merger, November 1, 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE\nDECEMBER 31, 1994\nThe other schedule has not been submitted because it is not applicable.\nREPORT OF INDEPENDENT AUDITORS\nTo ICN Pharmaceuticals, Inc.:\nWe have audited the consolidated financial statements and the consolidated financial statement schedule of ICN Pharmaceuticals, Inc. (a Delaware corporation, formerly SPI Pharmaceuticals, Inc.) and subsidiaries listed in the index on page 29 of this Form 10-K. These consolidated financial statements and the consolidated financial statement schedule are the responsibility of the Company'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.\nThe Company had certain transactions, through, November 1, 1994, with previously Affiliated Corporations as more fully described in Note 4. 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 ICN Pharmaceuticals, Inc. and subsidiaries as of December 31, 1994 and 1993, the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. In addition, in our opinion, the consolidated financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nThe Company is a defendant in various class action lawsuits (the 1995, 1994 and 1987 Actions), as defined and discussed in Note 7. The ultimate outcome of these lawsuits cannot presently be determined. Accordingly, no provision for any liability that may result has been made in the accompanying consolidated financial statements.\nCOOPERS & LYBRAND L.L.P. Los Angeles, California February 27, 1995\nICN PHARMACEUTICALS, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these consolidated statements.\nICN PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these consolidated statements.\nICN PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these consolidated statements.\nICN PHARMACEUTICALS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated statements.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1994\n1. ORGANIZATION AND BACKGROUND:\nOn November 1, 1994, the shareholders of ICN Pharmaceuticals, Inc. (\"ICN\"), SPI Pharmaceuticals, Inc. (\"SPI\"), Viratek, Inc. (\"Viratek\"), and ICN Biomedicals, Inc. (\"Biomedicals\") (collectively, the \"Predecessor Companies\") approved the Merger of the Predecessor Companies, (\"the Merger\"). On November 10, 1994 (effective November 1, 1994), SPI, ICN and Viratek merged into ICN Merger Corp., and Biomedicals merged into ICN Subsidiary Corp. a wholly-owned subsidiary of ICN Merger Corp. In conjunction with the Merger, ICN Merger Corp. was renamed ICN Pharmaceuticals, Inc. (\"New ICN\" or \"the Company\").\nThe Merger was accounted for using the purchase method of accounting. Additionally, for accounting purposes, SPI was treated as the acquiring company and as a result, the Company has reported the historic financial data of SPI in its financial results and includes the results of ICN, Viratek and Biomedicals since November 1, 1994.\nSPI was incorporated on November 30, 1981, as a wholly-owned subsidiary of ICN and was 39%-owned by ICN prior to the Merger. Viratek and Biomedicals were 63%-owned and 69%-owned by ICN, respectively, prior to the Merger.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPrinciples of Consolidation\nThe accompanying consolidated financial statements for 1994 include the full year financial results of SPI and majority owned subsidiaries, which includes 75% ownership in ICN Galenika (See Note 12), and the financial results of ICN, Viratek, and Biomedicals, from the effective date of the Merger. The consolidated financial statements for 1993 and 1992 reflect the financial results of SPI. Investments in 20% through 50% owned affiliated companies are included under the equity method where the Company exercises significant influence over operating and financial affairs. The accompanying consolidated financial statements reflect the elimination of all significant intercompany account balances and transactions.\nCash and Cash Equivalents\nCash and cash equivalents at December 31, 1994 and 1993, includes $36,124,000 and $1,247,000, respectively, of certificate of deposits 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.\nMarketable Securities\nIn January 1994, the Company adopted SFAS No. 115 (\"Accounting for Certain Investments in Debt and Equity Securities\"). This statement 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 as either held-to-maturity, trading securities, or available-for-sale. The Company has classified its investment in corporate bond securities, with maturities ranging from 1999 to 2003, and its investment in equity\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nsecurities as available-for-sale. The contractual maturity value of these corporate bond securities is approximately $33,700,000. The fair value of the Company's investment in corporate bond securities is approximately $29,155,000. The fair value of these corporate bond securities is determined based on quoted market prices. Gross unrealized holding losses have been calculated on the specific identification method. Changes in market values of equity securities are reflected as unrealized gains or losses directly in stockholders' equity, as required, and accordingly have no effect on the consolidated statements of income. The adoption of SFAS No. 115 did not result in a cumulative effect adjustment in the consolidated statements of income.\nMarketable 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 4-10 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.\nGoodwill and Intangibles\nThe difference between the purchase price and the fair value of net assets acquired 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 and trademarks), 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 by comparing the anticipated undiscounted future operating income of the acquired entity with the carrying value of the goodwill.\nAs a result of the Merger, the Company acquired certain intangible assets (primarily related to patents and customer lists) of $14,000,000 after certain purchase accounting adjustments, which are being amortized over 5 to 10 years, using the straight-line method.\nNotes Payable\nThe Company classifies various borrowings with initial terms of one year or less as notes payable. At December 31, 1994, these notes, which are primarily variable rate notes, had average interest rates of 9% in Spain, 7% in Yugoslavia, 12% in Italy and 16% in the United States on a foreign denominated obligation. The carrying amount of notes payable approximates fair value due to the short-term maturity of these instruments. The weighted average interest rate on short-term borrowings outstanding at December 31, 1994 and 1993 was 9%.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\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 exchange rate fluctuations on subsidiaries operating in highly inflationary economies. The (gains) losses included in operations from foreign exchange translation and transactions for 1994, 1993 and 1992, were $191,000, ($3,282,000), and $25,039,000, respectively.\nIncome Taxes\nIn January 1993, the Company adopted SFAS 109, Accounting for Income Taxes. SFAS 109 requires that 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. The adoption of SFAS 109 in 1993 did not result in a cumulative effect adjustment in the consolidated statements of income.\nPer Share Information\nPer share information is based on the weighted average number of common shares outstanding and the dilutive effect of common share equivalents. Common share equivalents represent shares issuable for outstanding options, on the assumption that the proceeds would be used to repurchase shares in the open market.\nIn January 1993, SPI issued a fourth quarter 1992 stock dividend of 2%. During 1993, SPI issued quarterly stock dividends which totaled 6%. In 1994, SPI and the Company issued quarterly stock dividends and distributions which totaled 4.8%. In March 1995, the Company declared a first quarter 1995 stock distribution of 1.7%. All share and per share amounts used in computing earnings per share have been restated to reflect these stock dividends and distributions.\nReclassifications\nCertain prior year items have been reclassified to conform with the current year presentation.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\n3. ACQUISITION OF THE PREDECESSOR COMPANIES\nOn November 10, 1994, SPI, ICN and Viratek merged into New ICN, and Biomedicals merged into ICN Subsidiary Corp., a wholly-owned subsidiary of New ICN. The Merger was accounted for using the purchase method of accounting. Additionally, for accounting purposes, SPI was treated as the acquiring company and as a result, the Company has reported the historical financial data of SPI in its financial results and the results of ICN, Viratek and Biomedicals have been included with the results of the Company since the effective date of the Merger.\nAs part of the Merger, the Company issued approximately 6,476,770 common shares valued on November 10, 1994 at $20.75 per share, which was the publicly traded price for SPI's common shares at that date. Accordingly, the purchase price, including direct acquisition costs of $3,654,000, has been allocated to the estimated fair value of the net assets, including amounts ascribed to purchased research and development costs which was charged to operations immediately following the consummation of the Merger. The $2,313,000 excess of the fair value of the net assets acquired and amounts allocated to acquired research and development over the purchase price has been proportionately allocated as a reduction of non-current assets acquired.\nThe purchase price allocation related to the Merger is preliminary, pending resolution of a pre-acquisition contingency associated with certain consolidated class actions, the 1987 Actions, entitled In re Paine Weber Securities Litigation; In re ICN\/Viratek Securities Litigation against ICN and Viratek. (See Note 7)\nThe preliminary purchase price allocation, as of the effective date of the Merger, is summarized as follows (in thousands):\nThe Company has obtained independent third party appraisals for the acquired in-process research and development costs and certain other intangible costs, primarily patents and trademarks. The $221,000,000 which represents the valuation of acquired in-process research and development for which no alternative use exists, has been charged to operations immediately upon consummation of the Merger in accordance with generally accepted accounting principles.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nThe following table presents unaudited pro forma combined financial information for the twelve months ended December 31, 1994 and 1993, as though the Merger had been consummated at the beginning of those periods, after including the impact of certain adjustments, such as: decrease of interest expense resulting from the offering of $115,000,000, 8.5% Convertible Notes (See Note 6), the proceeds of which have been used to repay certain long term debt, amortization of intangibles, elimination of related party stock transactions and the related income tax effects. The unaudited pro forma combined financial information does not reflect any non-recurring costs incurred in connection with the Merger (in the aggregate of approximately $223,000,000 of which $221,000,000 was charged to operations immediately following the Merger) (in thousands, except per share data):\nThe pro forma combined financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the Merger been consummated as of the above dates. In addition, the pro forma results are not intended to be a projection of future results and do not reflect any synergies that might be achieved from the combined operations.\n4. RELATED PARTY TRANSACTIONS:\nGeneral\nPrior to the Merger, ICN controlled Biomedicals and Viratek through stock ownership and board representation and was affiliated with SPI. Certain officers of ICN occupied similar positions with SPI, Biomedicals, and Viratek and were affiliated with SPI. Prior to the Merger, ICN, SPI, Biomedicals, and Viratek engaged in certain transactions with each other.\nPrior to the Merger, an Oversight Committee of the Board of Directors of ICN, SPI, Biomedicals and Viratek reviewed transactions between or among the affiliated corporations to determine whether a conflict of interest existed with respect to a particular transaction and the manner in which such a conflict could be resolved. The Oversight Committee had advisory authority only and made recommendations to the Board of Directors of each of the Affiliated Corporations. The Oversight Committee consisted of one non-management director of each Affiliated Corporation and a non-voting chairman. The significant related party transactions were reviewed and recommended for approval by the Oversight Committee and approved by the respective Board of Directors. As a result of the Merger, the Oversight Committee has been eliminated.\nRoyalty Agreements\nEffective December 1, 1990, SPI entered into a royalty agreement with Viratek whereby a royalty of 20% of all sales of Virazole(R) was paid to Viratek. Sales of Virazole(R), for purposes of determining royalties to Viratek, for 1994, 1993 and 1992 were $35,855,000, $29,515,000 and $27,240,000, respectively, which generated royalties to Viratek for 1994, 1993 and 1992 of $7,171,000, $5,903,000 and $5,448,000, respectively. As a result of the Merger, the Company is no longer required to pay future royalties on Virazole(R).\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nBeginning in 1993, under an amended agreement between SPI and the employer of a director of Viratek, SPI was required to pay $20.00 for each new aerosol drug delivery device manufactured. In connection with the Merger, the Company assumed the agreement under the same terms as SPI. Such royalties for 1994 were $16,000. Also, pursuant to this agreement, the Company is required to pay a 2% royalty on all sales of Virazole(R) in aerosolized form. Such royalties for 1994, 1993 and 1992 were $725,000, $422,000 and $430,000, respectively.\nSPI marketed products under license from ICN for the treatment of myasthenia gravis, a disease characterized by muscle weakness and atrophy. ICN charged SPI 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 was recorded in Other Assets and is being amortized using the straight-line method over fifteen years.\nBeginning in December 1986 and prior to the Merger, SPI began selling Brown Pharmaceuticals, Inc. products under license from ICN. ICN charged SPI royalties at the rate of 8-1\/2% of net sales. During 1994, 1993 and 1992, SPI paid ICN $298,000, $218,000 and $65,000, respectively, in royalties under this agreement. As a result of the Merger, the Company is no longer required to pay a royalty to ICN for sales of Brown Pharmaceuticals, Inc. products.\nCost Allocations\nPrior to the Merger, the affiliated corporations occupied ICN's facility in Costa Mesa, California. The accompanying consolidated statements of income include charges for rent from ICN of $230,000 for 1994 and $279,000 for each of years 1993 and 1992. In addition, the costs of common services such as maintenance, purchasing and personnel were incurred by SPI and allocated to ICN, Viratek and Biomedicals based on services utilized. The total of such costs were $2,207,000 for 1994, $2,584,000 in 1993 and $2,556,000 in 1992 of which $1,579,000, $1,733,000 and $1,679,000 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 were reasonable based upon the usage by the respective companies.\nInvestment Policy\nPrior to the Merger, ICN and SPI had 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 was transferred to ICN and, in turn, cash advances were made to ICN's subsidiaries to fund certain transactions. ICN charged or credited interest based on the amounts invested or advanced, current interest rates and the cost of capital. During 1994, 1993 and 1992, SPI was charged interest of $359,000, $800,000 and $1,195,000, respectively.\nDebt and Equity Transactions\nDuring 1993, ICN sold 1,618,200 shares of SPI'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 SPI's common stock for an aggregate sales price of $13,786,000 in open market transactions and privately negotiated sales.\nOn November 15, 1993, SPI 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.\nDuring 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.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nOther\nFollowing is a summary of transactions incurred prior to the Merger, as described above, between SPI and the former affiliated corporations for 1994, 1993 and 1992 (in thousands) :\nThe average balances due to ICN were $6,326,000, $26,439,000 and $29,289,000 for 1994, 1993 and 1992, respectively.\n5. INCOME TAXES:\nIn January 1993, the Company adopted SFAS No. 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 (loss) from continuing operations before minority interest for the years ended December 31, consists of the following (in thousands):\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nThe income tax provisions for the years ended December 31, consist of the following (in thousands):\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 1994, 1993, and 1992, in the amounts of $134,000, $727,000, and $956,000, respectively.\nIn connection with the Merger, the Company acquired approximately $226,000,000 of net operating loss carryforwards (\"NOLs\"). Included in the total acquired net operating loss carryforward is approximately $191,000,000 of domestic NOLs and approximately $35,000,000 of foreign NOLs. The utilization of acquired NOLs is subject to a variety of limitations including an annual limitation under Internal Revenue Code Section 382 on the use of such NOLs to reduce the taxable income of the Company. The Company's NOLs expire beginning 1995 to 2009.\nGenerally, Section 382 imposes an annual limitation on the availability of NOLs that can be used to reduce taxable income after certain substantial ownership changes of a corporation. The Merger resulted in an ownership change with respect to the acquired companies. Consequently, the Company's annual limitation on utilization of the acquired domestic NOLs is approximately $33,000,000 per year.\nIncluded in the total acquired NOL is approximately $9,800,000 of domestic NOLs acquired by Biomedicals from Flow Laboratories (\"Flow\"). Under the terms of the Flow acquisition, 50 percent of the tax benefit from the utilization of these acquired NOLs in excess of $500,000 is payable to the former shareholders of Flow. Under the terms of the Flow acquisition agreement, utilization is determined on a with and without basis.\nIn accordance with SFAS 109, any realization of acquired tax benefits must be used to 1) reduce goodwill, 2) reduce acquired noncurrent intangible assets and 3) reduce income tax expense. Consequently, the Company's post-1994 income tax expense will not reflect the recognition of acquired tax benefits until all acquired intangible assets have been reduced to zero. At December 31, 1994, the balance of acquired noncurrent intangibles was approximately $13,500,000.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nIn addition to the acquired NOLs discussed above, the Company has an NOL carryforward of approximately $3,700,000 which relates to a prior year acquisition. The utilization of this loss carryforward is subject to an annual limitation of $540,000.\nThe primary components of the Company's net deferred tax liability at December 31, 1994 and 1993, are as follows (in thousands):\nThe Company's effective tax rate differs from the applicable U.S. statutory federal income tax rate due to the following:\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nDuring 1994, 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 Pharmaceuticals, since management intends to reinvest those undistributed earnings in the foreign operations. Included in consolidated retained earnings at December 31, 1994, is approximately $61,000,000 of accumulated earnings of foreign operations that would be subject to U.S. income or foreign withholding taxes, if and when repatriated.\nThe Company is under examination by the Internal Revenue Service for the tax years ended November 30, 1991, 1990, 1989, and 1988. Currently, the proposed adjustments, if upheld, would not result in a significant additional tax liability and would not result in a significant reduction in NOLs available to the Company.\n6. DEBT\nLong-term debt consists of the following (in thousands):\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nOn November 17, 1994, the Company completed an underwritten public offering in the principal amount of $115,000,000 of 8.5% Subordinated Convertible Notes (the \"Convertible Notes\"), due in November 1999. These notes are convertible at the option of the holder either in whole or in part, at any time prior to maturity, into the Company's stock at a current conversion price of $22.98 per share, subject to adjustment in certain events. The Convertible Notes are also redeemable, in whole or in part, at the option of the Company at any time on or after November 15, 1997 at the specified redemption prices, plus accrued interest. The fair value of the Convertible Notes was approximately $110,975,000 at December 31, 1994.\nThe net proceeds from the Convertible Notes were primarily used to retire certain high yield debt which included the retirement of $37,000,000 of 12-7\/8% Sinking Fund Debentures (the \"12-7\/8% Debentures\") plus accrued interest, $20,238,000 of 12-1\/2% Debentures plus accrued interest, $3,382,000 of Mexican variable rate debt and $15,198,000 of Spanish debt. The effects on income from the above debt extinguishments was not material.\nIn July 1986, ICN issued $115,000,000 principal amount 12-7\/8% Debentures, due July 15, 1998 in an underwritten public offering of which $33,697,000 remains outstanding at December 31, 1994. The 12-7\/8% Debentures are senior, uncollateralized indebtedness of the Company. The 12-7\/8% Debentures are redeemable, in whole or in part, at the option of the Company at par 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 and (ii) dividends and distributions on, or repurchases and redemptions of common stock of the Company. As mentioned above, the Company utilized the proceeds from the offering of the Convertible Notes to retire $37,000,000 in principal of the 12-7\/8% Debentures plus accrued interest. The fair value of the 12-7\/8% Debentures outstanding at December 31, 1994 was approximately $35,185,000.\nIn October 1986, Xr Capital Holding (\"Xr Capital\"), a trust established by ICN, 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, 1994. At the time of the issuance, the Xr Certificates were 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. Currently, the face value of the outstanding Xr Capital are convertible into 1,444,277 shares of the Company's common stock at the exchange price of $27.74 per share and 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 ICN 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% 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 are funds required for redemption of the Xr Certificates in the event the Company exercises its optional right to redeem). The fair value of the ICN-Swiss Franc Xr. Bonds was approximately $13,277,000 at December 31, 1994.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nIn 1987, Bio Capital Holding (\"Bio Capital\"), a trust established by ICN and Biomedicals, completed a public offering in Switzerland of SFr. 70,000,000 principal amount of 5-1\/2% Swiss Franc Exchangeable Certificates (\"Old Certificates\"). The Bio Capital debt is senior, uncollateralized indebtedness of the Company. At the option of the certificate holder, the Old Certificates are exchangeable into shares of the Company's 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 the Company. Each series of the Zero Coupon Guaranteed Bonds are in an aggregate principal amount of SFr. 3,850,000 maturing February of each year through 2002. The Company has 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. During 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\"). Currently, the face value of the outstanding Bio Capital (SFr. 39,615,000) are convertible into 533,427 shares of the Company's common stock at the exchange prices of $48.99 and $84.44 at fixed exchange rates of Sfr. 1.49 and Sfr. 1.54 for New and Old Certificates, respectively. No repurchases were made in 1994. The fair value of the Zero Coupon Guaranteed Bonds was approximately $8,508,000 at December 31, 1994.\nOn March 25, 1987, ICN 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: (i) entirely into 1,500,000 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); (ii) entirely into 15,000 shares of common stock of Ciba Geigy Ltd. at a conversion price of SFr. 4,000 per share; or (iii) 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. Currently, the outstanding Double Convertible Bonds totaling SFr. 6,136,000 are convertible into 81,538 shares of the Company's common stock at the exchange price of $49.19 per share and at a fixed exchange rate of SFr. 1.53 per $1.00. During 1992, a one to five stock split was declared on Ciba Geigy stock, thereafter, the conversion price for Ciba Geigy shares was adjusted to SFr. 800 per Ciba Geigy share. Meanwhile, the bondholders can convert the Bonds equally into both Ciba Geigy stock and common stock of the Company based on the above exchange price and rate. In connection with this offering, the Company placed in escrow 15,000 shares of Ciba Geigy Ltd. common stock. As of December 31, 1994, 7,670 shares of Ciba Geigy stock were outstanding and are reflected in the Consolidated Balance Sheet as marketable securities. The fair value of these bonds was approximately $4,454,000 at December 31, 1994.\nIn October 1986, Pharma Capital Holdings (\"Pharma Capital\"), a trust established by ICN, 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, 1994. At the time of issuance, the Pharma Certificates were exchangeable into 1,936,000 shares of common stock of ICN at an initial exchange price of $21.14 per share, at a fixed exchange rate of ECU .9775 per $1.00. Currently, the face value of the outstanding Pharma Certificates are convertible into 416,637 shares of the Company's common stock at the exchange price of $39.76 per share and 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 ofDenmark (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\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nKingdom of Denmark Zero Coupon Guaranteed Bonds (except for payment of certain additional amounts in the event 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 the ICN-ECU bonds was approximately $2,293,000 at December 31, 1994.\nThe Company has the optional right to redeem the ICN-ECU Bonds, ICN-Swiss Franc Xr Bonds, Bio Certificates and Double Convertible Bonds in the event that the market price of the Company's common stock meets certain conditions. As mentioned above, due to the Merger, all convertible bonds are now convertible into the Company's common stock at various specified conversion prices, subject to adjustment for subsequent dilutive issues.\nThe Spanish bank credit lines totaling $822,000, which approximates fair value, are collateralized by accounts receivable totaling $3,053,000 and land and a building with a net book value of $10,185,000.\nThe Company has mortgage notes payables totaling $16,963,000, payable in U.S. dollars, Deutsche marks and Dutch guilders, collateralized by certain real property of the Company.\nAnnual aggregate maturities of long-term debt subsequent to December 31, 1994 are as follows (in thousands):\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.\nSubsidiaries of the Company have short and long-term lines of credit aggregating $10,466,000 of which $1,173,000 was outstanding at December 31, 1994.\n7. COMMITMENTS AND CONTINGENCIES:\nOperating Leases\nAt December 31, 1994, the Company was committed under noncancellable operating leases for minimum aggregate lease payments as follows (in thousands):\nRental expense on operating leases was $213,000 in 1994 representing rental expenses on leases assumed in connection with the Merger since November 1, 1994.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nLitigation\nThe Predecessor Companies were parties to a number of lawsuits. As a result of the Merger, the Company has assumed all of the Predecessor Companies' liabilities with respect to such lawsuits.\nIn February and March 1995, eighteen actions were filed which named the Company, its Board of Directors, Milan Panic and several other officers of the Company, in various combinations, as defendants (the \"Defendants\") (\"the 1995 Actions\"). Eleven of the actions purport to be securities class actions, one is an individual securities action and six purport to be derivative suits.\nIn general, all of the securities class actions allege that the Company made various deceptive and untrue statements of material fact and omitted to state material facts in connection with information it received from the FDA regarding the Company's NDA for the use of Virazole(R) for the treatment of chronic hepatitis C. Plaintiffs also allege that various officers of the Company traded on inside information. The purported securities class actions and the individual securities action assert claims for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, Rule 10b-5 promulgated thereunder, common law fraud, misrepresentation and negligent misrepresentation. They seek unspecified compensatory and punitive damages, attorneys' fees and costs, injunctive and equitable relief, and disgorgement. With respect to the purported securities class actions, plaintiffs seek certification of classes of persons who purchased ICN common stock, ICN debentures and ICN call options or sold ICN put options. The securities class actions seek certification for differing time periods, the longest alleged time period being from June 2, 1994 through February 17, 1995.\nWith respect to the purported derivative suits, plaintiffs assert claims for breach of fiduciary duty, intentional breach of fiduciary duty, negligent breach of fiduciary duty, breach of the fiduciary duty of candor, waste of corporate assets, constructive fraud, disgorgement, gross mismanagement, abuse of control and unjust enrichment. In these actions plaintiffs seek unspecified compensatory and punitive damages, attorneys' fee and costs and injunctive and equitable relief.\nThe Company has had preliminary discussions with the attorneys for plaintiffs who have suggested that an Amended Consolidated Complaint, encompassing the 1995 Actions, be filed in the United States District Court for the Central District of California. If this consolidation occurs, as Defendants currently expect, Defendants will have at least 30 days from the filing of the Amended Consolidated Complaint to answer or move. It is not possible at present for the Company to predict the outcome or the range of potential loss, if any, that might result from the 1995 Actions. The Defendants intend to vigorously defend the 1995 Actions.\nIn response to the allegations contained in the 1995 Actions, the Board of Directors established a Special Committee of the Board of Directors in February, 1995 to review the trading of common stock of the Company by executives and issues surrounding the timely disclosure of information received from the FDA regarding the Company's NDA for the use of Virazole in the treatment of chronic hepatitis C. The Committee's investigation is still in progress. It is anticipated that the Committee will finalize its report and present its findings to the Board of Directors in mid-April 1995.\nFour lawsuits have been filed with respect to the Merger in the Court of Chancery in the State of Delaware. Three of these lawsuits, entitled Helmut Kling v. Milan Panic, et al., Jallath v. Milan Panic, et al., and Amy Hoffman v. Milan Panic, et al. (\"the 1994 Actions\"), were filed by stockholders of SPI and, in the Jallath lawsuit, of Viratek, against ICN, SPI, Viratek (in the Jallath lawsuit) and certain directors and officers of ICN, SPI and\/or Viratek (including Milan Panic) and purport to be class actions on behalf of all persons who held shares of SPI common stock and, in the Jallath lawsuit, Viratek common stock. The fourth lawsuit, entitled ~Joice Perry v.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nNils O. Johannesson, et. al., was filed by a stockholder of Viratek against ICN, Viratek and certain directors and officers of ICN, SPI and Viratek (including Milan Panic) and purports to be a class action on behalf of all persons who held shares of Viratek common stock. These suits allege that the consideration provided to the publicstockholders of SPI and\/or Viratek (as applicable) in the Merger was unfair and inadequate, and that the defendants breached their fiduciary duties in approving the Merger and otherwise. The Company believes that the 1994 Actions are without merit and intends to defend them vigorously. It is not possible at present for the Company to predict the outcome or the range of potential loss, if any, that might result from the 1994 Actions.\nICN, SPI and Viratek and certain of their officers and directors (collectively, the \"ICN Defendants\") were named defendants 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)) (collectively \"the 1987 Actions\"). In the Third Amended Consolidated Class Action Complaint, plaintiffs allege that the ICN Defendants made, or aided and abetted Paine Webber, Inc. (\"Paine Webber\") 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 research reports and filings with the Securities and Exchange Commission. The alleged misstatements and omissions primarily concern developments regarding Virazole(R), including the efficacy, safety and market for the drug. The plaintiffs allege that such misrepresentations and omissions violate Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder and constitute common law fraud and misrepresentation. Fact discovery is complete and expert discovery is virtually complete. Plaintiffs seek the certification of classes of persons who purchased ICN, Viratek or SPI common stock during the period January 7, 1986 through April 15, 1987. Oral argument on plaintiffs' motion for class certification was held on June 2, 1994. To date, no decision has been rendered. 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, 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. On May 4, 1994, plaintiffs' counsel agreed to stipulate to the dismissal of the aiding and abetting claim asserted against the ICN Defendants and a formal stipulation will be submitted to the Court in the near future. On October 20, 1993, plaintiffs informed the Court that they had reached an agreement to settle with co-defendant Paine Webber and on July 27, 1994, the settlement was approved by the court. Management believes that, having extensively reviewed the issues in the above referenced matters, there are strong defenses and the Company intends to defend the 1987 Actions vigorously. While the ultimate outcome of the 1987 Actions cannot be predicted with certainty, and an unfavorable outcome could have a material adverse effect on the Company, at this time management does not expect these matters will have a material adverse effect on the financial position and results of operations of the Company.\nIn late January 1995, an action was commenced by Deborah Levy against ICN, SPI, Viratek and Milan Panic. The complaint asserts causes of action for sex discrimination and harassment, and for violations of the California Department of Fair Employment and Housing statute and a provision of the California Government Code. The complaint seeks injunctive relief and unspecified compensatory and punitive damages. Defendants filed their answer, demand for production of documents and request for interrogatories in March 1995. The defendants intend to vigorously defend the suit.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\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\"), SPI, and ICN alleging breach of contract and related claims arising out of a manufacturing contract between Gencon and ICN Canada. ICN and SPI were dismissed from the action in March 1993 based on SPI's agreement to guarantee any judgment against ICN Canada. Following trial in 1993, the judge granted judgment in favor of Gencon for breach of contract in the amount of approximately $2,100,000 plus interest, costs and attorneys' fees (which sums total approximately $650,000). ICN Canada timely filed its Notice of Appeal and Gencon filed a Notice of Cross-Appeal, seeking the award of approximately $145,000 in additional claimed costs. Both the appeal and the cross-appeal have been fully briefed. No date has been set for oral argument. The defendants intend to vigorously defend this action.\nOn January 25, 1995, GRC International, Inc. (\"GRC\") filed a motion in the Superior Court of the State of California, County of Orange, to confirm a $2,260,807 arbitration award issued against Biomedicals. The dispute centered on the last payment due from Biomedicals to GRC as a result of Biomedical's acquisition of Flow General Inc. in 1989. On March 23, 1995, GRC's motion to confirm the arbitration award was granted. The Company has accounted for the resolution of this matter as a liability assumed upon the effective date of the Merger.\nIn October 1994, an action entitled Engelhardt v. ICN Pharmaceuticals, Inc. (Case No. 94-2-2322) was filed in the United States District Court for the District of Colorado. The action was commenced by Lauri and Kenneth Engelhardt on behalf of themselves and their infant daughter Hannah. It is alleged that Lauri Engelhardt was exposed to Virazole(R) early in her pregnancy, and that as a result of such exposure, Hannah was born with birth defects. Plaintiffs assert causes of action for products liability and negligence and seek unspecified damages. The Company filed a motion on February 28, 1995 to dismiss asserting that Plaintiffs' claims are barred by the statute of limitations. No decision has been rendered with respect to that motion. The Company believes that the allegations are without merit and intends to vigorously defend this 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 alleged, among other things, 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, and are seeking compensatory and punitive damages in the amount of $25,000,000. Khan has filed counterclaims on April 12, 1993, asserting causes of action for slander, interference with economic relations, a shareholders' derivative action for breach of fiduciary duties, violations of the federal securities laws and tortious interference with economic relations, and is seeking compensatory damages, interest and exemplary damages of $29,000,000. On November 4, 1994, ICN and Viratek moved to have a default judgment entered against Khan and to dismiss his counterclaims. Khan submitted his opposition papers on March 15, 1995, and an oral argument is currently scheduled for April 21, 1995.\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.\nArbitration: On June 30, 1993, ICN filed a claim in arbitration, ICN v. Labsystems, O.Y., alleging breach of a certain supplier agreement and requesting repudiation of such agreement. On February 6, 1995, the tribunal awarded Labsystems approximately $5,040,000 including interest and affirming existence of the supplier agreement between the parties requiring ICN to accept $4,500,000 of inventory from Labsystems. The Company has accounted for the resolution of the arbitration as a liability assumed upon the effective date of the Merger.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\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.\nLicense Commitment\nIn November 1994, the Company entered into a license agreement for the rights to develop and commercialize a group of compounds related to and including human growth hormone releasing factor (\"GRF\"), for the United States and other major pharmaceutical markets. In connection with this agreement, the Company is obligated to pay, upon meeting certain milestones, an aggregate amount of $2,600,000. In addition, after such milestones are met, the Company is obligated to pay a royalty of 9%, subject to certain adjustments, based upon net sales of GRF in certain territories. The testing of these GRF compounds in relieving growth retardation is in Phase III clinical trials.\nBenefits Plans\nThe Company has a defined contribution plan that provides all U.S. employees the opportunity to defer a portion of their compensation for payout at a subsequent date. The Company can voluntarily make matching contributions on behalf of participating and eligible employees. The Company's expense related to such defined contribution plan was not material in 1994, 1993 and 1992.\nIn connection with the Merger, the Company assumed deferred compensation agreements with certain officers and certain key employees of the Predecessor Companies, with benefits commencing at death or retirement. As of December 31,1994, the present value of the deferred compensation benefits to be paid has been accrued in the amount of $2,270,000. Interest accrues on the outstanding balance at rates ranging from 10.9% to 11.3%. No new contributions are being made, however, interest continues to accrue on the present value of the benefits expected to be paid.\nOther\nPrior to the Merger, the Predecessor Companies had employment agreements with certain executive officers. The Company assumed all such employment agreements upon the effective date of the Merger.\nMilan Panic, the Company's Chairman of the Board, President and Chief Executive Officer, is employed under a contract expiring September 1995 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. Including such cost-of-living adjustments, the annual cost of such consulting services is currently estimated to be in excess of $535,000. 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 Company has Employment Agreements with six key executives which contain \"change in control\" benefits. Upon a \"change in control\" of the Company 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, Mr. Watt, Mr. Phillips and Mr. Sholl.\n8. COMMON STOCK:\nPrior to Merger, each of the Predecessor Companies had their own stock option plans. Upon consummation of the Merger, New ICN assumed all options outstanding under the existing stock option plans. The existing stock option plans were exchanged for shares of New ICN. Each option of ICN common stock, SPI common stock, Viratek common stock and Biomedicals common stock was exchanged for 0.512, 1.0, 0.499 and 0.197 options of New ICN common stock, respectively.\nNew ICN assumed three, two and three Nonqualified Stock Option Plans from Biomedicals, ICN and Viratek, respectively, and two employee Incentive Stock Option Plans from each of Biomedicals, ICN and Viratek, respectively. Prior to the Merger, SPI had three Non Qualified Stock Option Plans, one of these Plans was reserved for certain officers of SPI, and two employee Incentive Stock Option Plans. Under the terms of all Stock Option Plans, the option price may not be less than the fair market value at the date of the grant and may not have a term exceeding 10 years. The options granted are reserved for issuance to officer, directors, key employees, scientific advisors and consultants.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nThe following table sets forth information relating to stock option plans during the years ended December 31, 1994, 1993 and 1992 (in thousands, except per share data):\nIn January 1993, SPI issued a fourth quarter 1992 stock dividend of 2%. During 1993, SPI issued quarterly stock dividends which totaled 6%. In 1994, SPI and the Company issued quarterly stock dividends and distributions which totaled 4.8%. Accordingly, all relevant stock option data and per share data has been restated to reflect these dividends and distributions.\nIn 1994, SPI issued common stock for certain bonuses accrued in 1993. The number of shares issued was based upon the fair value of the shares at the date of issuance and a fixed amount related to the bonuses paid.\nAt December 31, 1994, a total of 5,713,000 shares under options have been granted from the Company's Incentive and Non Qualified Stock Option Plans, with shares available for grant under the Incentive Stock Option Plan of 952,199. Under the Non Qualified Stock Option Plans, a total of 4,253,087 shares were reserved and outstanding and 341,937 shares were not reserved and outstanding 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 stockholders at the next stockholders' meeting.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\n9. DETAIL OF CERTAIN ACCOUNTS (IN THOUSANDS):\nDuring the third quarter of 1994, ICN Galenika commenced a construction and modernization program at its pharmaceutical complex outside Belgrade, Yugoslavia. At December 31, 1994, construction in progress primarily relates to costs incurred to date for these facilities.\nDeferred loan costs incurred in connection with the issuance of the Convertible Notes are amortized using the effective interest method over the life of the related debt.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nThe Company has accrued for certain arbitration settlements of $5,040,000 that were assumed as a result of the Merger. Final arbitration decisions were rendered in February 1995 that fixed the amount of liabilities in these cases. The events that prompted the arbitration awards were preexisting conditions as of the date of the Merger.\nIt is the Company's policy to segregate significant non-operating items and report them separately as Other expense, net, as follows:\nOTHER EXPENSE, NET:\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\n10. INDUSTRY BUSINESS SEGMENTS AND GEOGRAPHIC DATA:\nThe Company operates in two industry segments: pharmaceutical (the \"Pharmaceutical group\") and biomedical (the \"Biomedical group\"). The Pharmaceutical group produces and markets pharmaceutical products in the United States, Mexico, Canada and Europe. The Biomedical group markets research chemical and cell biology products and related services, biomedical instrumentation and immunodiagnostic reagents and instrumentation.\nThe following tables set forth the amount of net sales, income (loss) before interest, provision for taxes and minority interest and identifiable assets of the Company by industry segment and geographical areas for 1994, 1993 and 1992 (in thousands):\nINDUSTRY SEGMENTS\n(1) Includes a write-off of purchased and development for which no alternative use exists of $221,000,000 as a result of the Merger.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994 CAPITAL EXPENDITURES:\n1) Includes a write-off of purchased and development for which no alternative use exists of $221,000,000 or $9.93 per share as a result of the Merger.\nDuring the year ended December 31, 1994, approximately 88% of ICN Galenika's sales were to the Federal Republic of Yugoslavia or government sponsored entities. At December 31, 1994, 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.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\n11. SUPPLEMENTAL CASH FLOWS DISCLOSURES:\nNon-cash Transactions\nIn September 1993, SPI issued 200,000 shares of common stock to ICN in exchange for reducing its debt outstanding to ICN by $3,075,000.\nDuring 1994, 1993, and 1992, the Company issued common stock dividends and distributions of $24,175,000, $20,634,000 and $3,440,000, respectively.\nCash and non-cash financing activities consisted of the following (in thousands):\nMERGER OF PREDECESSOR COMPANIES:\nThe following table sets forth the amounts of interest and income taxes paid during 1994, 1993 and 1992 (in thousands):\n12. ICN GALENIKA:\nThe summary balance sheets of ICN Galenika as of December 31, 1994 and 1993, and the summary income statements for the years ended December 31, 1994, 1993 and 1992, are presented below.\nICN GALENIKA SUMMARY BALANCE SHEETS AS OF DECEMBER 31, 1994 AND 1993 (IN THOUSANDS)\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nICN GALENIKA SUMMARY STATEMENTS OF INCOME BEFORE PROVISION FOR INCOME TAXES AND MINORITY INTEREST FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS)\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 United Nations Security Council (\"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. The sanctions specifically exempt certain medical supplies for humanitarian purposes, a portion of which are distributed by ICN Galenika. ICN Galenika continues to apply for, and has received, licenses under the sanctions, however, the efforts to enforce sanctions create administrative burdens that slow the shipments of licensed raw materials to Yugoslavia. Shipments of imported raw materials in 1994 and 1993 were 60% and 38% of pre-sanction levels, respectively. Additionally, the sanctions have contributed to an overall deteriorating business environment in which ICN Galenika must operate.\nThe sanctions provide for the freezing of bank accounts of Yugoslavian commercial and industrial entities. The implementation of sanctions may create a restriction on ICN Galenika's corporate bond security holdings of approximately $29,155,000 that are maintained in a bank outside of Yugoslavia. Of this amount $8,103,000 serves as collateral for a note payable to this bank. Management believes, however, that these funds will be available for drawdowns on lines of credit for shipments specifically licensed under the 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.\nHYPERINFLATION AND PRICE CONTROLS:\nUnder existing Yugoslavian price controls imposed in July of 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. During 1994, ICN Galenika received fewer price increases than in the past, a trend that is expected to continue, applying increased pressure on gross profit margins. 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. U.S. dollar sales in 1994 were below 1993 levels due to exchange rate differences despite an increase in units sold of 20%. This trend of reduced U.S. dollar sales levels could continue as long as sanctions are in place.\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nICN Galenika operates in a highly inflationary environment that has, prior to January 1994, experienced high levels of inflation along with large and frequent devaluations. This necessitated ICN Galenika to translate the results using daily average exchange rates. On 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 by exercising restraint in the amount of dinars that it prints, thereby restricting cash in circulation to correspond to hard currency reserves in Yugoslavia. Since the inception of this program the exchange rate of dinars to Deutsche marks has remained stable. The trading of dinars at other than official rates has been virtually eliminated and inflation and interest rates have declined from over 1 billion percent a year to a current annual rate of approximately 5% since early 1994, based on information currently available to the Company. The Company believes that the period of time that the stabilization program has been operating successfully is significant given that past attempts at monetary control by the Yugoslavian government have generally been temporary. In the near term, the positive effects of the stabilization program could reverse and a return to prior levels of hyperinflation could occur. The success of this stabilization program is dependent upon improvement in the Yugoslavian economy, which is in part dependent upon the lifting of United Nations sanctions.\nAs a result of the stabilization program and the absence of large and frequent devaluations, the net monetary asset position of ICN Galenika has increased to $25,442,000 as of December 31, 1994, representing the balance sheet increases in accounts receivable and cash from the beginning of the year. This net monetary asset position would be subject to foreign exchange loss if a devaluation of the dinar were to occur.\nAs required by Generally Accepted Accounting Principles (\"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, 1994, ICN Galenika has U.S. $29,155,000 invested in corporate bond securities 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 SPI'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, 1994, and as collateral for $8,103,000 of loans, included in Notes Payable bearing interest at 6.7%, that were issued to pay a 1992 dividend of $10,000,000. 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.\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. Under this law a dividend must be declared and paid immediately after year end. Earnings that are not immediately paid as a dividend can not be used for future dividends. Additionally, ICN Galenika is allowed to pay dividends out of earnings calculated under Yugoslavian Accounting Practices (\"YAP\"), not earnings calculated under GAAP. ICN Galenika dividends are payable in dinars which must be exchanged for dollars before the dividend is repatriated. During high levels of inflation the dinar denominated dividend could devalue substantially by the time the dividend is exchanged for dollars. Future dividends from ICN Galenika will depend\nICN PHARMACEUTICALS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) DECEMBER 31, 1994\nheavily on future earnings and the current level of inflation at the time of the dividend. Under GAAP, ICN Galenika had accumulated earnings, which are not available for distributions, of approximately $71,592,000 at December 31, 1994. 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, plant expansion and reduction of debt.\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 and marketable securities. The Company places its cash and cash equivalents 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, 1994, ICN Galenika had corporate bond securities of $29,155,000 on deposit with this financial institution.\n14. INVESTMENT IN RUSSIA\nDuring 1993 and 1994 the Company acquired a 41% interest in Oktyabr, a Russian pharmaceutical company. The Company intends to increase its ownership interest in Oktyabr to approximately 62% through a government-sponsored investment program. Participation in this program does not require significant expenditure of future funds. Once the Company achieves its ownership goals it will begin a program to construct a new pharmaceutical manufacturing facility in Russia built pursuant to \"good manufacturing practices.\" Although Russia may, in time, evolve into a large, free market oriented economy, because of the present unpredictable political, social and economic factors in Russia, the Company intends to penetrate this market in a gradual manner. There can be no assurance as to when or if the new facility will be constructed or as to its future success.\nSCHEDULE II--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 highly inflationary 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.\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\nINFORMATION CONCERNING DIRECTORS\nOn November 10, 1994, SPI Pharmaceuticals, Inc., ICN Pharmaceuticals, Inc. and Viratek, Inc. merged into ICN Merger Corp., and ICN Biomedicals, Inc. merged into ICN Subsidiary Corp., subsequently renamed ICN Biomedicals, Inc., a wholly-owned subsidiary of ICN Merger Corp. In connection with the Merger, ICN Merger Corp. was renamed ICN Pharmaceuticals, Inc. The current Board of Directors consists of sixteen members: Messrs. Barker, Bayh, Charles, Finch, Guillemin, Jerney, Jolley, Knight, Kurz, Lenagh, Manatt, Moses, Panic, M. Smith, R. Smith and Starr. The names of the sixteen directors are listed below, together with certain personal information, including the present principal occupation and recent business experience of each.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\n(B) Predecessor ICN Biomedicals, Inc. Board Member (I) Predecessor ICN Pharmaceuticals, Inc. Board Member (S) Predecessor SPI Pharmaceuticals, Inc. Board Member (V) Predecessor Viratek, Inc. Board Member\n(a) Member of the Compensation and Benefits Committee (b) Member of the Audit Committee (c) Member of the Finance Committee (d) Member of the Science and Technology Committee (e) Member of the Executive Committee (f) Member of the Special Committee\nNone of the directors are related by blood or marriage to one another or to an executive officer of the Company.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\nCOMMITTEES AND MEETINGS OF THE BOARD OF DIRECTORS\nThe Board of Directors has a standing Executive Committee, Audit Committee, Finance Committee, Science and Technology Committee, Compensation and Benefits Committee and Special Committee, but does not have a standing nominating committee.\nThe members of the Executive Committee are Messrs. Panic, Finch, Moses, and R. Smith. This Committee is empowered to act upon any matter for the Board of Directors, other than matters which may not be delegated under Delaware law. Subsequent to the Merger, the Executive Committee did not meet during the year ended December 31, 1994.\nThe current members of the Audit Committee, which held one meeting during the year ended December 31, 1994, are Messrs. Starr, Lenagh and Finch. Its functions include recommending to the Board of Directors the selection of the Company's independent public accountants and reviewing with such accountants the plan and results of their audit, the scope and results of the Company's internal audit procedures and the adequacy of the Company's systems of internal accounting controls. In addition, the Audit Committee reviews the independence of the independent public accountants and reviews the fees for audit and non-audit services rendered to the Company by its independent public accountants.\nThe Compensation and Benefits Committee recommends to the Board of Directors the compensation and benefits for senior management and directors, including the grant of stock options. The current members of this Committee are Messrs. Barker, Bayh, Charles and Moses. This Committee held two meetings during the year ended December 31, 1994.\nThe Finance Committee oversees investment and commercial banking issues and investment guidelines. The current members of this Committee are Messrs. Barker, Kurz, Manatt and Lenagh. This Committee did not meet during the year ended December 31, 1994.\nThe Science and Technology Committee formulates and oversees the scientific and technology policy of the Company. The current members of this Committee are Messrs. Guillemin, M. Smith, R. Smith, Jolley and Knight. This Committee did not meet during the year ended December 31, 1994.\nA Special Committee (the \"Committee\") was formed in February, 1995 to review certain issues of concern to the Shareholders, including the review of trading by executives of the Company and issues surrounding the timely disclosure of information received from the FDA regarding the Company's NDA for the use of Virazole in the treatment of chronic hepatitis C. The Committee investigation is still in progress. It is anticipated that the Committee will finalize its report and present its findings to the Board of Directors in mid-April 1995. The current members of this Committee are Messrs. Barker, Charles and Moses.\nSubsequent to the Merger, the Board of Directors met one time and all of the Board attended except Messrs. Bayh, Guillemin, Lenagh, Kurz, Manatt, Miscoll, M. Smith and Starr.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company are as follows:\nMr. Panic is employed under an Employment Agreement (which was to be assumed by the Company) which has been extended from its expiring date of November 30, 1994 to September 30, 1995. The Company, through the proposed Compensation and Benefits Committee of its Board of Directors, and Mr. Panic are presently discussing the terms of a new employment agreement to replace the existing agreement. The Company also assumed, from the Predecessor Companies, employment agreements with Messrs. Jerney, Giordani, MacDonald, Phillips, Watt and Sholl. Each of these agreements, which were entered into in March 1993, 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. These agreements also provide for certain payments if, after a change of control (as defined), the employee's employment is terminated under certain circumstances. Executive officers are elected annually.\nMilan Panic, the founder of ICN, has been Chairman of the Board, Chief Executive Officer and President of ICN since its inception in 1960; except for a leave of absence from July 14, 1992 to March 4, 1993 while he was serving as Prime Minister of Yugoslavia and a leave of absence from October 1979 to June 1980. Mr. Panic has also served as Chairman of the Board and Chief Executive Officer of SPI, Viratek and Biomedicals since their respective inceptions (except for such leaves of absence).\nAdam Jerney has served as a director of ICN, SPI, Viratek and Biomedicals since 1992. Prior to the Merger, Mr. Jerney was President and Chief Operating Officer of SPI. He served as Chairman of the Board and Chief Executive Officer of ICN, SPI, Viratek and Biomedicals from July 14, 1992 to March 4, 1993 during Milan Panic's leave of absence (as discussed below). Mr. Jerney joined ICN in 1973 as Director of Marketing Research in Europe and assumed the position of General Manager of ICN Netherlands in 1975. In 1981, he was elected Vice President Operations and in 1987 he assumed his current position. Prior to joining ICN, he spent four years with F. Hoffmann-LaRoche & Company.\nRoberts A. Smith, Ph.D., has served as a director of ICN since 1960 and as a director of Viratek since 1992. Dr. Smith was President of Viratek and Vice President Research and Development of SPI through 1992. Dr. Smith was also a director of the Nucleic Acid Research Institute from 1985 to 1989. For more than eleven years, Dr. Smith was Professor of Chemistry and Biochemistry at the University of California at Los Angeles. Dr. Smith is also a director of PLC Systems.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - CONTINUED\nJohn E. Giordani joined ICN in June 1986 after serving as Vice President and Corporate Controller of Revlon, Inc., in New York, New York since February 1982. Prior to the Merger, Mr. Giordani's primary duties were as Chief Financial Officer of ICN. He devoted substantial time to Biomedicals and Viratek. 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.\nBill A. MacDonald joined ICN in March 1982 as Director of Taxes. In 1983, he became Vice President - Taxes and Corporate Development. In 1987, he was Senior Vice President Tax and Corporate Development, and in 1992 Executive Vice President Tax and Corporate Development. Prior to the Merger in November, 1994, he had been President of Biomedicals since March 18, 1993. 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.\nJohn F. Phillips joined SPI in April 1988 as Senior Vice President and Chief Financial Officer. Prior to the Merger, he was Executive Vice President and Chief Financial Officer of SPI. He managed private assets and was a business consultant from January 1986 to March 1988. From June 1984 through November 1985, he was Senior Vice President and Chief Financial Officer for Playboy Enterprises, Inc. From 1978 through 1984, he was with Max Factor and Company as Senior Vice President and Financial Officer.\nDavid C. Watt joined ICN in March 1988 as Assistant General Counsel and Secretary. He was elected Vice President Law and Secretary in December 1988. In January 1992, Mr. Watt was promoted to Senior Vice President of ICN. On February 1, 1994, Mr. Watt was elected Executive Vice President, General Counsel and Secretary of ICN. 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 Corporation 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.\nJack L. Sholl joined ICN in August 1987 as Vice President, Public Relations. Prior to the Merger, he was promoted to Senior Vice President of SPI. From 1979 to August 1987, he served as Director of Financial and Media Communications with Warner-Lambert Company of Morris Plains, New Jersey, and from 1973 to 1979 as Manager, Department of Communications with Equibank, N.A. of Pittsburgh, Pennsylvania. Prior to that time, he served on the Public Relations staff of the New York Stock Exchange (1971-1973) and in editorial positions with The Associated Press (1986-1971), the last as supervising Business and Financial Editor in New York.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION AND RELATED MATTERS\nSUMMARY COMPENSATION TABLE\nThe following table sets forth the annual and long-term compensation awarded to, earned by, or paid to the Chief Executive Officer and the four most highly paid executive officers of ICN, for services rendered to the Predecessor Companies and ICN in all capacities during the twelve months ended December 31, 1994, 1993 and 1992.\nSUMMARY COMPENSATION TABLE\n(1) Unless otherwise indicated, with respect to any individual named in the above table, the aggregate amount of perquisites and other personal benefits, securities or property was less than either $50,000 or 10% of the total annual salary and bonus reported for the named executive officer.\n(2) Includes grants of options to purchase shares of common stock of ICN (\"ICN common stock\"), common stock of SPI (\"SPI common stock\")(adjusted for stock dividend after the grant date and prior to the Merger), common stock of Viratek (\"Viratek common stock\") and common stock of Biomedicals (\"Biomedicals common stock\") and grants of options to purchase new ICN shares of common stock.\nITEM 11. EXECUTIVE COMPENSATION AND RELATED MATTERS\n(3) Except where otherwise indicated, the amounts in this column represent matching contributions to ICN's 401(K) plan, amounts accrued under an executive deferral plan and medical benefits and medical and life insurance premiums.\n(4) Mr. Panic was granted options to purchase the following shares of ICN common stock, SPI common stock, Viratek common stock and Biomedicals common stock.\n1994 post-merger options equal 465,482 shares of new ICN.\nIn January 1995, the Company advanced Milan Panic $1,406,682, in regards to tax matters relating to the exercise of stock options. The advance, plus accrued interest thereon, was fully paid by March, 1995 with cash of $1,271,013 and common stock of the Company of $135,669.\nIn July 1992, Milan Panic, Chairman of the Board, President and Chief Executive Officer of ICN, with the approval of ICN's Board of Directors, became Prime Minister of Yugoslavia and was granted a paid leave of absence from all duties to ICN while retaining his title as Chairman of the Board. Mr. Panic and ICN entered into a Leave of Absence and Reemployment Agreement which contained mutual obligations, requiring, among other things, that ICN reemploy Mr. Panic and that Mr. Panic return to his previous positions with ICN. 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 ICN.\nIn addition to the salaries of Mr. Panic and certain ICN employees assisting him during his leave of absence, ICN and Mr. Panic incurred certain other expenses in connection with Mr. Panic's transition to and return from his leave of absence. ICN then retained a recently retired member of the California Superior Court to review all such expenses to determine that such expenses represented a valid expense of the Company. The Judge prepared a report for the Audit Committees of ICN and SPI that indicated that these costs represented costs of the Company. Such report was reviewed and approved by these Audit Committees,\nMr. Panic has reimbursed certain withholding taxes due as of December 31, 1992, previously advanced by ICN, in connection with the exercise of stock options, in the amount of $1,351,000. Mr. Panic paid these amounts in 1993, in the form of cash in the amount of $678,000 and Viratek common stock in the amount of $776,000 valued at fair market value.\nOn April 1, 1992, the Board of Directors granted Mr. Panic a bonus of 200,000 shares of SPI common stock for his extraordinary efforts in completing the Galenika transaction. The value of these shares at the date of grant was $5,375,000. Mr. Panic sold the shares during 1993 for a realized value of $4,005,223. Additionally, in 1993, Mr. Panic realized $1,881,250 and $1,853,000 on other sales of shares of ICN common stock and SPI common stock, respectively.\n(5) In 1994, the $70,603 of \"All Other Compensation\" consists of the following: legal $23,835, accounting $34,045, executive medical $6,107 and life insurance $6,616. All other compensaton also includes $70,603, $39,262 and $38,242 for miscellaneous fringe benefits in 1994, 1993 and 1992, respectively. For the three years ended December 31, 1994, Mr. Panic realized $7,498,500, $4,771,220 and $1,461,306 on the exercise of stock options for ICN, SPI, and Viratek common stock, respectively. These stock option gains are not reflected in the \"All Other Compensation\" column.\nITEM 11. EXECUTIVE COMPENSATION AND RELATED MATTERS - CONTINUED\n(6) Mr. Jerney was granted options to purchase the following shares of ICN common stock, SPI common stock (adjusted for stock dividend after the grant date and prior to the Merger), Viratek common stock and Biomedicals common stock:\n1994 post-merger options equal 115,722 shares of new ICN.\n(7) Includes 1991 performance bonus paid in 1992 on the completion of the Galenika transaction and the early payment of the 1992 performance bonus in anticipation of the increase in federal income tax rates (which bonus would have ordinarily been paid 1993).\n(8) In 1994, the $60,741 is further broken out as follows: accounting-tax $27,871, deferred compensation interest $16,928, executive medical $8,523; 401K employee contribution $4,620, tennis club $415, and life insurance $2,384. For the three years ended December 31, 1994, Mr. Jerney realized $372,795 and $894,569 on the exercise of stock option for ICN and SPI common stock, respectively. These stock option gains are not reflected in the \"All Other Compensation\" column.\n(9) Mr. MacDonald was granted options to purchase the following shares of ICN common stock, SPI common stock (adjusted for stock dividend after the grant date and prior to the Merger), Viratek common stock and Biomedicals common stock:\n1994 post-merger options equal 65,552 shares of new ICN.\n(10) Mr. Giordani was granted options to purchase the following shares of ICN common stock, SPI common stock (adjusted for stock dividend after the grant date and prior to the Merger), Viratek common stock and Biomedicals common stock:\n1994 post-merger options equal 22,179 shares of new ICN.\n(11) Mr. Phillips was granted options to purchase the following shares of ICN common stock, SPI common stock (adjusted for stock dividend after the grant date and prior to the Merger), Viratek common stock and Biomedicals common stock:\n1994 post-merger options equal 82,308 shares of new ICN.\nITEM 11. EXECUTIVE COMPENSATION AND RELATED MATTERS - CONTINUED\n(12) Dr. Johannesson has granted options to purchase the following shares of ICN common stock, SPI common stock (adjusted for stock dividend after the grant date and prior to the Merger), Viratek common stock and Biomedicals common stock:\n1994 post-merger options equal 64,613 shares of new ICN.\nOPTION GRANTS\nThe following table sets forth information with respect to options to purchase shares of ICN common stock, SPI common stock, Viratek common stock and Biomedicals common stock granted in 1994 adjusted for stock dividends occurring following grant and prior to November 10, 1994 to the Executive Officers. No executive officer was granted New ICN options following the Merger through December 31, 1994.\nOPTION GRANTS IN LAST FISCAL YEAR\nITEM 11. EXECUTIVE COMPENSATION AND RELATED MATTERS - CONTINUED\n(1) The options granted have ten year terms. The options vest according to the following schedule: 25% on the first anniversary of the date of grant and 25% on each of the next succeeding three anniversary dates of the grant date. The options were granted with an exercise price equal to the fair market value of the underlying shares on the date of grant.\n(2) Based on the Black-Scholes option pricing model adapted for use in valuing executive stock options. 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 arbitrary assumptions as to variables such as interest rates, stock price volatility and future dividend yield.\nITEM 11. EXECUTIVE COMPENSATION AND RELATED MATTERS - CONTINUED\nPOST MERGER CONVERTED OPTION GRANT INFORMATION\nThe following table sets forth information with respect to options to purchase shares described in the Option Grants in Last Fiscal Year table on the preceding page expressed here in shares of new ICN common stock to the Executive Officers, adjusted for a stock dividend occurring after grant through December 31, 1994:\nOPTION GRANTS IN LAST FISCAL YEAR (EXPRESSED IN CONVERTED NEW ICN SHARES)\nITEM 11. EXECUTIVE COMPENSATION AND RELATED MATTERS - CONTINUED\n(1) The options granted have ten year terms. The options vest according to the following schedule: 25% on the first anniversary of the date of grant and 25% on each of the next succeeding three anniversary dates of the grant date. The options were granted with an exercise price equal to the fair market value of the underlying shares on the date of grant.\n(2) Based on the Black-Scholes option pricing model adapted for use in valuing executive stock options. 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 arbitrary assumptions as to variables such as interest rates, stock price volatility and future dividend yield.\nAGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUES\nThe following table sets forth information with respect to each of the Predecessor Companies regarding (i) stock option exercises by the Named Executive Officers during 1994 and (ii) unexercised stock options held by the Named Executive Officers at February 28, 1995:\nAGGREGATED OPTION EXERCISES IN 1994 AND FEBRUARY 28, 1995 OPTION VALUES\n(1) Difference between the fair market value of common stock of the respective Predecessor Company at the date of exercise and the exercise price.\n(2) Difference between the fair market value of the shares of common stock of each of the Predecessor Companies on February 28, 1995 and the exercise price.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPRINCIPAL STOCKHOLDERS\nThe following table sets forth, as of February 28, 1995, certain information regarding the beneficial ownership of New ICN common stock and the percent of shares owned beneficially by each Named Executive Officer and all directors and executive officers of New ICN as a group:\n(1) Except as indicated otherwise in the following notes, shares shown as beneficially owned are those as to which the named persons possess sole voting and investment power. However, under the laws of California and certain other states, personal property owned by a married person may be community property which either spouse may manage and control, and the Company has no information as to whether any shares shown in this table are subject to community property laws.\n(2) Less than 1%\n(3) Includes 29,589 shares of ICN common stock which Mr. Barker has the right to acquire upon the exercise of currently exercisable stock options.\n(4) Includes 18,657 shares of ICN common stock which Mr. Bayh has the right to acquire upon the exercise of currently exercisable stock options.\n(5) Includes 13,922 shares of ICN common stock which Mr. Charles has the right to acquire upon the exercise of currently exercisable stock options.\n(6) Includes 13,219 shares of ICN common stock which Mr. Finch has the right to acquire upon the exercise of currently exercisable stock options.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - CONTINUED\n(7) Includes 42,086 shares of ICN common stock which Dr. Guillemin has the right to acquire upon the exercise of currently exercisable stock options.\n(8) Includes 370,389 shares of ICN common stock which Mr. Jerney has the right to acquire upon the exercise of currently exercisable stock options.\n(9) Includes 136,004 shares of ICN common stock which Dr. Jolley has the right to acquire upon the exercise of currently exercisable stock options.\n(10) Includes 6,686 shares of ICN common stock which Dr. Knight has the right to acquire upon the exercise of currently exercisable stock options.\n(11) Includes 2,714 shares of ICN common stock which Mr. Kurz has the right to acquire upon the exercise of currently exercisable stock options.\n(12) Includes 2,714 shares of ICN common stock which Mr. Lenagh has the right to acquire upon the exercise of currently exercisable stock options.\n(13) Includes 13,922 shares of ICN common stock which Mr. Manatt has the right to acquire upon the exercise of currently exercisable stock options.\n(14) Includes 13,922 shares of ICN common stock which Mr. Miscoll has the right to acquire upon the exercise of currently exercisable stock options.\n(15) Includes 13,922 shares of ICN common stock which Mr. Moses has the right to acquire upon the exercise of currently exercisable stock options.\n(16) Includes 971,658 shares of ICN common stock which Mr. Panic has the right to acquire upon the exercise of currently exercisable stock options.\n(17) Includes 1,306 shares of ICN common stock which Dr. Michael Smith has the right to acquire upon the exercise of currently exercisable stock options.\n(18) Includes 99,476 shares of ICN common stock which Dr. Roberts A. Smith has the right to acquire upon the exercise of currently exercisable stock options.\n(19) Includes 16,986 shares of ICN common stock which Mr. Starr has the right to acquire upon the exercise of currently exercisable stock options.\n(20) Includes 66,335 shares of ICN common stock which Mr. Giordani has the right to acquire upon the exercise of currently exercisable stock options.\n(21) Includes 98,032 shares of ICN common stock which Mr. MacDonald has the right to acquire upon the exercise of currently exercisable stock options.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - CONTINUED\n(22) Includes 72,041 shares of ICN common stock which Mr. Phillips has the right to acquire upon the exercise of currently exercisable stock options.\n(23) Includes 12,524 shares of ICN common stock which Dr. Johannesson has the right to acquire upon the exercise of currently exercisable stock options.\n(24) Includes 2,170,233 shares of ICN common stock which certain directors and officers have the right to acquire upon the exercise of currently exercisable stock options.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS\nCOMPENSATION PURSUANT TO STOCK OPTION PLANS OF THE PREDECESSOR COMPANIES\nICN\nAs of November 10, 1994, under ICN's 1981 Employee Incentive Stock Option Plan (which terminated in 1991) options to acquire 25,378 shares of ICN common stock were outstanding and 25,378 shares were exercisable (at prices ranging from $3.00 to $5.50). There were no options exercised during 1994. There were options to acquire 30,256 shares of ICN common stock exercised during 1993 at $4.65 per share. There were options to acquire 2,250 shares of ICN common stock exercised during 1992 at $3.00.\nPursuant to non-qualified stock option agreements with key employees and officers of ICN, options to acquire 214,363 shares of ICN common stock were outstanding (at prices ranging from $3.00 to $5.75) of which options to acquire 170,363 shares of ICN common stock were exercisable at November 10, 1994. There were options to acquire 250 shares exercised during 1994 at an average price of $5.75. There were options to acquire 153,808 shares exercised during 1993 at an average price of $4.736. There were options to acquire 181,855 shares exercised during 1992 at an average price of $3.55.\nDuring 1992, the stockholders of ICN approved the 1992 ICN Non-Qualified Stock Option Plan (the \"1992 ICN Non-Qualified Plan\") and the 1992 ICN Employee Incentive Stock Plan (the \"1992 ICN Incentive Plan\"), reserving 500,000 shares per plan of ICN common stock for issuance to employees and directors of ICN. ICN has granted options for shares 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.\nAs of November 10, 1994, options to acquire 642,250 shares of ICN common stock were outstanding under the 1992 ICN Non-Qualified Plan (at prices ranging from $6.375 to $22.875) of which 34,500 were exercisable at November 10, 1994. Options to acquire 359,000 shares of ICN common stock were outstanding under the 1992 ICN Incentive Plan (at prices ranging from $6.375 to $9.50) of which 62,500 were exercisable at November 10, 1994. There were no options exercised under either plan during 1994.\nSPI\nAs of November 10, 1994, under SPI's 1982 Incentive Stock Option Plan (the \"1982 ISO Plan\") (which terminated in 1992) options to acquire 1,001 shares of SPI common stock were outstanding and exercisable at a price of $4.71 per share. There were 405 shares exercised in 1994 at $4.71 per share.\nPursuant to the 1982 Non-Qualified Stock Option Plan (the \"1982 SPI Non-Qualified Plan\") as of November 10, 1994, there were options to acquire 826,070 shares of SPI common stock outstanding (at prices ranging from $0.62 to $29.45 per share) of which 659,864 shares were exercisable at November 10, 1994. During 1994, 51,719 options were exercised at an average price of $6.57 per share of SPI common stock.\nAs of November 10, 1994, under SPI's 1992 Incentive Stock Option Plan (the \"1992 SPI Incentive Plan\") options to acquire 541,464 shares of SPI common stock were outstanding (at prices ranging from $9.02 to $24.05 per share) of which 183,112 shares were exercisable. During 1994, there were 416 shares exercised at $24.06 per share.\nAs of November 10, 1994, under SPI's 1992 Non-Qualified Stock Option Plan (the \"1992 SPI Non-Qualified Plan\"), options to acquire 2,204,849 shares of SPI common stock were outstanding (at prices ranging from $9.33 to $29.11 per share) of which 811,396 shares were exercisable. During 1994, there were 5,912 shares exercised at an average of $9.42 per share.\nITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS - CONTINUED\nCOMPENSATION PURSUANT TO STOCK OPTION PLANS OF THE PREDECESSOR COMPANIES\nViratek\nAs of November 10, 1994, under Viratek's 1980 Stock Option Plan and the 1982 Non-Qualified Stock Option Plan (the \"1982 Viratek Non-Qualified Plan\") (which terminated in 1992) options for 331,222 shares were outstanding (at prices ranging from $2.023 to $4.52 per share) of which 325,973 shares were exercisable. During 1994, 7,350 shares were exercised at an average price of $4.29 per share.\nAs of November 10, 1994 under Viratek's 1992 Incentive Stock Option Plan (the \"1992 Viratek ISO Plan\") options to acquire 450,250 shares of Viratek common stock were outstanding (at prices ranging from $7.61 to $21.19 per share) of which 186,376 shares were exercisable. During 1994, there were no exercises.\nAs of November 10, 1994, under Viratek's 1992 Non-Qualified Stock Option Plan (the \"1992 Viratek Non-Qualified Plan\") options to acquire 659,625 shares of Viratek common stock were outstanding (at prices ranging from $6.42 to $13.21 per share) of which 55,784 shares were exercisable. During 1994, there were 10,500 shares exercised at $10.48 per share.\nBiomedicals\nAs of November 10, 1994, under Biomedicals' 1983 Incentive Stock Option Plan (the \"1983 Biomedicals ISO Plan\") (which terminated in 1993) options to acquire 323,260 shares of Biomedicals common stock were outstanding of which 226,760 shares were exercisable (at prices ranging from $3.125 to $10.50 per share). There were no exercises in 1994.\nPursuant to the 1983 Non-Qualified Stock Option Plan (the \"1983 Biomedicals Non-Qualified Plan\"), as of November 10, 1994, there were options to acquire 208,190 shares of Biomedicals common stock outstanding (at prices ranging from $4.38 to $9.27 per share) of which 190,690 options were exercisable. There were no options exercised in 1994.\nAt November 10, 1994, under the Biomedicals 1992 Incentive Stock Option Plan (the \"1992 Biomedicals Incentive Plan\") options to acquire 501,250 shares of Biomedicals common stock were outstanding (at prices ranging from $3.25 to $4.25 per share) of which 84,437 options were exercisable. During 1994, there were 18,000 shares exercised at $3.25 per share.\nAt November 10, 1994 , under the Biomedicals 1992 Non-Qualified Stock Option Plan (the \"1992 Biomedicals Non-Qualified Plan\"), options to acquire 544,265 shares of Biomedicals common stock were outstanding (at prices ranging from $3.25 to $7.00 per share) of which there were 232,500 options exercisable. During 1994, there were no exercises.\nPlan Amendments\nAt each of the Annual Meetings of Stockholders held to consider the Merger Agreement, the stockholders of each of the Predecessor Companies approved amended and restated Stock Option Plans. The amendments, among other things, increased the amount of shares available for grant under the plans. ICN amended its 1992 Non-Qualified Plan to increase the number of shares available for grant thereunder from 500,000 to 1,250,000 and amended its 1992 Incentive Plan to increase the number of shares available for\nITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS - CONTINUED\nCOMPENSATION PURSUANT TO STOCK OPTION PLANS OF THE PREDECESSOR COMPANIES (CONTINUED)\ngrant thereunder from 500,000 to 750,000. SPI amended its 1992 Non-Qualified Plan to increase the number of shares available for grant thereunder from 1,000,000 to 3,000,000 and amended its 1992 Incentive Plan to increase the number of shares available for grant thereunder from 500,000 to 1,000,000. Viratek amended its 1992 Non-Qualified Plan to increase the number of shares available for grant thereunder from 500,000 to 1,000,000 and amended its 1992 ISO Plan to increase the number of shares available for grant thereunder from 500,000 to 1,000,000. Biomedicals amended its 1992 Non-Qualified Plan to increase the number of shares available for grant thereunder from 500,000 to 1,000,000 and amended its 1992 Incentive Plan to increase the number of shares available for grant thereunder from 500,000 to 1,000,000. Upon consummation of the Merger, New ICN will assume all options outstanding under these Stock Option Plans. See \"Principal Stockholders.\"\nCOMPENSATION OF DIRECTORS OF THE PREDECESSOR COMPANIES AND NEW ICN\nMembers of the Board of Directors of ICN, other than employees, were paid an annual fee of $22,000, payable quarterly, plus a fee of $500 for every Board meeting attended and an additional fee of $500 for every committee meeting attended, and were reimbursed for their out-of-pocket expenses in attending meetings. During 1994, Mr. Bayh, or the firm with which he is affiliated, received legal or consulting fees from ICN in the amount of $80,688. Dr. Guillemin received $94,000 from SPI for consulting services rendered. Dr. M. Smith received $28,000 in 1994 from ICN for consulting services rendered. In addition, non-employee directors on the first business day following each annual meeting of stockholders were granted options to purchase 10,000 shares of ICN common stock pursuant to the 1992 ICN Non-Qualified Plan.\nMembers of the Board of Directors of SPI, other than employees, were paid an annual fee of $20,000 in 1994. In addition, all members other than Mr. Panic and Mr. Jerney received fees in the amount of $500 per Board meeting and $500 per committee meeting actually attended, and were reimbursed for their out-of-pocket expenses in attending meetings. In addition, non-employee directors on the first business day following each annual meeting of shareholders were granted options to acquire 10,000 shares of SPI common stock on such date pursuant to the 1992 SPI Non-Qualified Plan.\nMembers of the Board of Directors of Viratek, other than employees, were paid an annual fee of $20,000, payable quarterly, plus a fee of $500 for every Board meeting and $500 for every committee meeting actually attended, and were reimbursed for their out-of-pocket expenses in attending meetings. Dr. Jolley received $1,000 for a Scientific Advisory Committee meeting and Dr. R. Smith received $1,000 for a Scientific Advisory Committee meeting. Dr. Knight is a professor at Baylor. ICN has a royalty agreement with Baylor (see \"Certain transactions\") and SPI paid a royalty of $741,000 in 1994. In addition, non-employee directors on the first business day following each annual meeting of shareholders were granted options to acquire 10,000 shares of Viratek common stock on such date pursuant to the Viratek 1992 Non-Qualified Plan.\nMembers of the Board of Directors of Biomedicals, other than employees, were paid an annual fee of $20,000 in 1994. In addition, all members other than employees received fees in the amount of $500 per Board meeting and $300 per committee meeting actually attended, and were reimbursed for their out-of-pocket expenses. In addition, non-employee directors on the first business day following each annual meeting of shareholders were granted options to acquire 10,000 shares of Biomedicals common stock pursuant to the 1992 Biomedicals Non-Qualified Plan.\nMembers of the Board of Directors of New ICN, other than employees, were paid $500 each for the Board meetings attended. See above Predecessor Company information for a description of any director's compensation beyond board fees paid in 1994.\nITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS - CONTINUED\nCERTAIN EMPLOYMENT AGREEMENTS\nOn March 18, 1993, the Board of Directors of ICN adopted Employment Agreements (\"Employment Agreements\") which contained \"Change in Control\" benefits for six current key senior executive officers of ICN. The executives include Messrs. Jerney, Giordani, MacDonald and Watt, former officers of ICN, and Messrs. Phillips and Sholl, former officers of SPI. The Employment Agreements were assumed by New ICN.\nThe Employment Agreements are intended to retain the services of these executives and provide for continuity of management in the event of any actual or threatened Change in Control. Each agreement has an initial term ending March 30, 1996 and is automatically extended for one year terms each year thereafter unless either the executive or ICN elects not to extend it (provided that any notice by ICN not to extend the agreement cannot cause the agreement to be terminated prior to the expiration of the third anniversary of the date of any Change in Control). These Employment Agreements provide that each executive shall receive severance benefits equal to three times salary and bonus (and certain other benefits) if the executive's employment is terminated without cause, following a Change in Control of ICN or a subsidiary, as the case may be, or if the executive terminates employment for certain enumerated reasons (including a significant reduction in the executive's compensation, duties, title or reporting responsibilities or a change in the executive's job location) or the executive leaves ICN for any reason or without reason during a sixty day period commencing six months after the Change in Control. The executive is under no obligation to mitigate amounts payable under the Employment Agreements.\nFor purposes of the Employment Agreements, a \"Change in Control\" means any of the following events: (i) the acquisition (other than from ICN) by any person, subject to certain exceptions, of beneficial ownership, directly or indirectly, of 20% or more of the combined voting power of ICN's then outstanding voting securities; (ii) the existing Board of Directors cease for any reason to constitute at least two-thirds of the Board, unless the election, or nomination for election by ICN's stockholders, of any new director was approved by a vote of at least two-thirds of the existing Board of Directors; or (iii) approval by stockholders of ICN of (a) a merger or consolidation involving ICN if the stockholders of ICN, immediately before such merger or consolidation, do not, as a result of such merger or consolidation, own, directly or indirectly, more than 80% of the combined voting power of the then outstanding voting securities of the corporation resulting from such merger or consolidation in substantially the same proportion as their ownership of the combined voting power of the voting securities of ICN outstanding immediately before such merger or consolidation, or (b) a complete liquidation or dissolution of ICN or an agreement for the sale or other disposition of all or substantially all of the assets of ICN. Removal of ICN's Board of Directors would also constitute a Change in Control under the Employment Agreements. If the employment of such key senior executives is terminated under any of the circumstances described above following a Change in Control, the executives would be entitled to receive the following amounts (based upon present compensation): Adam Jerney $2,092,623; John Giordani $1,238,277; Bill MacDonald $1,179,486 and John Phillips $1,180,251. In addition, the vesting of certain options granted to the executives would be accelerated. The value of the accelerated options would depend upon the market price of the shares at that time.\nIn connection with the Merger, each of the senior executives has executed an agreement waiving the effect under the Employment Agreements of any Change in Control which may be deemed to arise as a result of the Merger.\nITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS - CONTINUED\nPANIC EMPLOYMENT AGREEMENT\nICN and Milan Panic entered into an Employment Agreement effective October 1, 1988, which, as amended and extended, terminates on September , 1995 (the \"Panic Employment Agreement\"). The base amount of salary for Mr. Panic was determined by the Compensation Committee of the Board of Directors of ICN in 1988. In setting the base amount, the Compensation Committee took into consideration Mr. Panic's then- current base salary, the base salaries of chief executives of companies of similar scope and complexity and the Compensation Committee's desire to retain Mr. Panic's services, given his role as founder of ICN. The Panic Employment Agreement provides for an annual salary, currently $535,000, with an annual 7% increase payable under certain circumstances. The Panic Employment Agreement provides that during the period of his employment, Mr. Panic will not engage in businesses competitive with ICN without the approval of the Board of Directors. Under the Panic Employment Agreement, Mr. Panic agreed to waive and eliminate retirement benefits contained in his prior employment contract with ICN. Instead, Mr. Panic may, at his option, retire upon termination of the Panic Employment Agreement.\nUpon retirement, Mr. Panic has agreed to provide consulting services to ICN for $120,000 per year, which amount is subject to annual cost-of-living adjustments from the base year of 1967 until the date of retirement not to exceed his salary at the date of retirement (currently estimated to be in excess of $535,000 per year, as adjusted). Mr. Panic's agreement to provide consulting services to ICN is a lifetime agreement. The consulting fee shall not at any time exceed the highest annual compensation, as adjusted, paid to Mr. Panic during his employment by ICN. Upon Mr. Panic's retirement, the consulting fee shall not be subject to further cost-of-living adjustments. The Panic Employment Agreement includes a severance compensation provision in the event of a Change in Control of ICN. The Panic Employment Agreement provides that if within two years after a Change in Control of ICN, Mr. Panic's employment with ICN is terminated, except as a result of death, disability or illness, or if Mr. Panic leaves the employ of ICN within such two-year period, then Mr. Panic will receive as severance compensation, five times his annual salary, as adjusted, and Mr. Panic will be deemed to have retired and will receive the same consulting fees to which he would otherwise have been entitled under the Panic Employment Agreement. A Change in Control of ICN would occur, for purposes of the Panic Employment Agreement, if (i) a Change in Control shall occur of a nature which would be required to be reported in response to Item 6(e) of Schedule 14A under the Exchange Act (for purposes of that Item, \"control\" is defined as the power to direct or cause the direction of the management and policies of ICN, whether through the ownership of voting securities, by contract, or otherwise) unless two-thirds of the Existing Board of Directors, as defined below, decide in their discretion that no Change in Control has occurred for purposes of the agreement; (ii) any person is or becomes the beneficial owner, directly or indirectly, of securities of ICN representing 15% or more of the combined voting power of ICN's then outstanding securities; (iii) the persons constituting the Existing Board of Directors, as defined below, cease for any reason to constitute a majority of ICN's Board of Directors; or (iv) shares of ICN common stock cease to be registered under the Exchange Act. \"Existing Board of Directors\" is defined in the Panic Employment Agreement as those persons constituting the Board of Directors at the date of the Panic Employment Agreement, together with each new director whose election or nomination for election by ICN's stockholders was previously approved, or is approved within thirty days of such election or nomination, by a vote of at least two-thirds of the directors in office prior to such person's election as a director. If Mr. Panic's employment is terminated under any of the circumstances described above following such a Change in Control, in addition to the consulting fee as described above, Mr. Panic would be entitled to receive (based upon present compensation) $2,675,000.\nITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS - CONTINUED\nPANIC EMPLOYMENT AGREEMENT - CONTINUED\nIn connection with the Merger, Mr. Panic has executed an agreement waiving the effect under the Panic Employment Agreement of any Change in Control which may be deemed to arise as a result of the Merger. Upon consummation of the Merger, the Panic Employment Agreement will be assumed by New ICN. New ICN through the proposed Compensation and Benefits Committee of its Board of Directors and Mr. Panic are presently discussing the terms of a new employment agreement to replace the existing agreement upon its expiration. No terms of the new agreement have been determined as of the date hereof.\nCOMPENSATION REPORT\nThe Compensation Committee (\"Committee\") is composed of four independent non-employee directors, Messrs. Barker, Bayh, Charles and Moses.\nThe following statement made by the members of the Committee shall not be deemed incorporated by reference into any filing under the Securities Act of 1933 or under the Securities Exchange Act of 1934 and shall not otherwise be deemed filed under such Acts.\nCOMPENSATION PHILOSOPHY\nThe Board of Directors adopts an annual budget and financial plan which incorporates the goals and objectives to be achieved by the Company and the specific operating units. The goals focus on growth in operating income and growth in earnings per share. Each executive is responsible for the performance of their unit in relation to the plan. Specific goals and objectives for each executive are reviewed by the executive and their supervisor. In reviewing the annual performance which will determine the executive's compensation, the supervisor assesses a performance grade based on the pre-set performance objectives. This assessment is used to determine base salary for the following fiscal year. Eligibility for bonus awards was based on the pre-set performance guidelines and growth in operating income and earnings per share. However, bonuses may be paid even when these objective standards are not met if specific contributions by an employee merit a bonus or the reasons for failure to meet the objective standards are beyond the control of the Company and\/or the employee. Stock options are granted based on a program developed for the Company by Towers Perrin, a compensation consulting company. Each individual's base number of options is derived from a formula which ties to their base salary. The Committee may then consider the achievement of individual as well as corporate performance goals in determining the ultimate number of options granted.\nThe compensation of executives consists of salary, a bonus plan to reward performance and a long-term incentive stock option program.\nBASE SALARY\nSalaries are paid within certain grades which are established by the Human Resources Department reviewing data of other like companies in the same industry. The Company reviewed salary surveys prepared by Towers Perrin. These surveys did not state which companies participated in the surveys. The salary levels were in the median of compensation for similar positions. Grades are updated to reflect changes in the marketplace. The salaries of executives are reviewed on an annual basis by supervisory managers and the Committee.\nBONUS PLAN\nThe Company has adopted an Incentive Bonus Plan which is based on target goals of growth in both operating income and earnings per share. Individual performance goals are compared against the target goals established. Recommendations are made by individual supervisors and approved by the Committee.\nITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS - CONTINUED\nLONG-TERM STOCK INCENTIVE PLANS\nStock options are granted as long range incentives to executives. Options vest over a ten year period. Options are granted at fair market value. The amount of options granted is tied to salary and performance and each grant is evaluated. No grant to executives is automatic.\nThe Committee determines the compensation of the Chief Executive Officer based on a number of factors. The goal of the Committee is to grant compensation consistent with compensation granted to other chief executive officers of companies in the same industry. The Chief Executive Officer's compensation is based on a contract comprised of a base salary and based on the Company's performance. Special one-time bonuses will be paid, at the Committee's discretion, based on special contributions made to the Company. Mr. Milan Panic is compensated by ICN pursuant to an employment agreement with ICN (See \"Executive Compensation\"). Substantial bonuses are approved by the Board of Directors.\nCompensation and Benefits Committee Norman Barker Senator Birch Bayh Alan F. Charles Stephen D. Moses\nPERFORMANCE GRAPH\nThe following compares ICN's cumulative total stock return on the shares with the cumulative return on the Standard & Poor's 500 Stock Index and the 5-Stock Custom Composite Index for the five years ended December 31, 1994. The graph assumes that the value of the investment of the ICN Common Stock in each index as $100 at December 31, 1989 and that all dividends were reinvested. The cumulative total return for ICN Pharmaceuticals is based on an initial investment in SPI Pharmaceuticals beginning December 31, 1989 until its merger with ICN Pharmaceuticals on November 11, 1994. The cumulative total return from November 11, 1994 until December 31,1994 is based upon the performance of ICN Pharmaceuticals (New).\nCUMULATIVE TOTAL RETURNS BASED ON REINVESTMENT OF $100 BEGINNING DECEMBER 31, 1988\n[CHART]\nSOURCE: GEORGESON & COMPANY INC.\nThe 5-Stock Custom Composite Index includes Allergan Inc., Carter Wallace Inc., Amgen Inc., Forest Labs Inc.--Class A, and Syntex Corp.\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 the Form 10-K.\n2. FINANCIAL STATEMENT SCHEDULE\nFinancial Statement Schedule of the Registrant is 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\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - CONTINUED\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - CONTINUED\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - CONTINUED\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K - CONTINUED\n(B) REPORTS ON FORM 8-K IN FOURTH QUARTER\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.\nICN PHARMACEUTICALS, INC.\nDate: March 30, 1995\nBy \/s\/ Milan Panic ------------------------------ Milan Panic, 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.\nSIGNATURES - CONTINUED\nEXHIBIT INDEX\nEXHIBIT INDEX (CONTINUED)","section_15":""}
{"filename":"804151_1994.txt","cik":"804151","year":"1994","section_1":"Item\n1. Business. General History Industry Segments Discontinued Operations Restructuring Plan Competition Product Distribution and Customers Backlog Raw Materials Patents, Licenses and Trademarks Research and Development Environmental Matters Employees 2. Properties 3. Legal Proceedings 4. Submission of Matters to a Vote of Security Holders Executive Officers of the Registrant\nPART II\n5. Market for the Registrant's Common Equity and Related Stockholder Matters 6. Selected Financial Data 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 8. Financial Statements and Supplementary Data 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nPART III\n10. Directors and Executive Officers of the Registrant 11. Executive Compensation 12. Security Ownership of Certain Beneficial Owners and Management 13. Certain Relationships and Related Transactions\nPART IV\n14. Exhibits, Financial Statement Schedules and Reports on Form 8-K Exhibit Index Signatures\nPART I\nItem 1. Business.\nGeneral\nImo Industries Inc. (hereinafter with its subsidiaries referred to as the \"Company\") is an integrated multinational industrial manufacturing company that designs, produces and markets proprietary products focused on mechanical and electronic controls and on engineered power products and their support services. The Company operates in the United States, Canada, several European countries and the Pacific Rim. In 1994, the Company announced it accepted an offer to sell its Turbomachinery business segment to Mannesmann Demag of Dusseldorf, Germany. As a result of this acceptance, and the subsequent consummation of the sale, the Company has focused its operations on the remaining two core business segments, as follows:\nThe Morse Controls business segment designs and produces push-pull cable and control systems and automotive products including actuators, window controls, latches and door panels\/assemblies.\nThe Pumps, Power Transmission & Instrumentation business segment designs and produces a broad range of rotary pumps, including a proprietary line of three-screw pumps; electronic adjustable-speed motor drives, gears and speed reducers; and transducers and switches for sensing, measuring and controlling pressure, temperature and liquid level and flow.\nIn addition to the two segments comprising the Company's continuing core operations, the Company has a third business segment entitled Other included in its continuing operations for financial reporting purposes. This segment includes operations previously sold and an operation to be sold as part of the Company's asset divestiture program.\nThe Company's Electro-Optical Systems and Turbomachinery businesses are being accounted for as discontinued operations and, accordingly, have been excluded from the Company's segments. The previously reported financial information has been reclassified to reflect the Turbomachinery business segment as a discontinued operation.\nHistory\nThe Company, founded in 1901 in the United States by Dr. Carl Gustaf Patrick de Laval, a Swedish scientist, was acquired by Transamerica Corporation (\"Transamerica\") in 1963. In 1964, Transamerica merged its existing wholly owned manufacturing subsidiary, General Metals Corporation, into the Company. At the close of business on December 18, 1986, Transamerica distributed all of the issued and outstanding shares of the Company Common Stock to holders of record of Transamerica Common Stock on the basis of one share of Company Common Stock for each ten shares of Transamerica Common Stock held (\"Distribution\"). Following the Distribution, the Company has operated as a publicly traded company.\nIndustry Segments\nA description of the principal products and services offered by each core business segment of the Company, as well as the principal markets for such products and services, are set forth below. Certain information in response to this item with respect to net sales, operating profit, and identifiable assets of each of these segments and by geographic area is contained in Note 11 of the Notes to Consolidated Financial Statements included in Part IV of this Form 10-K Report as indexed at Item 14(a)(1). Information regarding the businesses sold and held for sale and the discontinued operations is provided later in this section and is contained in Note 4 and Notes 2 and 3, respectively, of the Notes to Consolidated Financial Statements.\nMorse Controls\nThe Morse Controls business segment operations, consisting of the Morse Controls and Roltra-Morse businesses, manufacture precision mechanical and electronic control products and systems that are primarily used for automotive, marine, and industrial applications.\nThis segment produces, among other products, push-pull cable and control systems used to control and actuate functions, such as steering and valve adjustment, and as an alternative to electrical systems. Applications include throttle control and steering systems for both off-the-road vehicles and pleasure boats. The segment also manufactures actuators, window controls, latches and door panels\/assemblies for Fiat, and a manual gear shift system that is currently used in Fiat, Lotus, Porsche and other automobiles.\nPumps, Power Transmission & Instrumentation\nThe Pumps, Power Transmission & Instrumentation business segment units produce a wide range of products that control the speed, force and direction of motion in processes and products. Major products in this segment include speed reducers, gears, liquid level indicators, transducers and a range of rotary pumps, including a proprietary line of three-screw pumps. These products are used by a diverse customer base in the marine, elevator, oil and gas and general industrial markets. The IMO AB, IMO Pump, Warren Pumps, Boston Gear\/Delroyd, Fincor Electronics, Gems Sensors and TransInstruments operations of the Company comprise this business segment.\nThe segment's pump operations design and manufacture screw-type fuel, lube oil and hydraulic pumps for use primarily by the marine, process, oil and gas and elevator industries. The segment's three-screw pumps are the leading low-noise-level pumps used in United States Navy vessels and in many commercial vessels. These pumps are also used to power hydraulic elevators, lubricate diesel engines and fuel gas turbines. The segment's two-screw pumps are used by the pulp and paper industry and in other high- viscosity-process applications.\nThe segment's power transmission operations produce speed reducers and loose gearing that are recognized as leading products in their market niches. The speed reducers and gear boxes are used to reduce the output speed and increase the torque of power trains. The operations also produce worm gear sets used as speed reducers by original equipment manufacturers, and by oil and gas and industrial machinery customers.\nIn addition, the power transmission sector manufactures AC and DC adjustable-speed motor controls that are utilized to variably adjust the speed of electric motors. Customized systems for process controls used in such applications as printing, tire and glass production and material handling make up a large portion of the segment's motor controls sales.\nThe instrumentation operations of this segment design and manufacture products that perform a wide variety of critical sensing, measuring, monitoring and control functions.\nTank level indicators, level switches, solid state relays and flow meters are manufactured principally for marine and general industrial applications. These indicators are used in ocean-going tankers, military vessels, petrochemical facilities and industrial and commercial products around the world. Hundreds of varieties of liquid-level monitors, indicators and switches are manufactured for use by more than 30,000 customers. Pressure transducers are used to measure pressure as a continuous function and are sold to a wide segment of the general industrial market.\nDiscontinued Operations\nElectro-Optical Systems\nIn January 1994, pursuant to a plan approved by the Board of Directors, the Company announced its intention to dispose of its Electro-Optical Systems operations which consists of the Company's subsidiaries Varo Inc. and Baird Corporation. On January 3, 1995, the Company completed the sale of its Baird Analytical Instruments Division to Thermo Instruments Systems Inc. for approximately $12.3 million, which was used to repay a portion of the Company's domestic senior debt. On February 8, 1995, the Company announced that it has a letter of intent from Litton Industries for the acquisition of the Optical Systems and Ni-Tec divisions of Varo Inc. and the Optical Systems division of Baird Corporation. These sales will complete a substantial part the Company's planned divestiture of its Electro-Optical Systems business. The Company is continuing discussions with prospective buyers of the remaining Varo division, the Electronic Systems division, and expects to close on this sale in 1995.\nTurbomachinery\nOn July 28, 1994, the Company announced that it had reached an agreement in principle to sell its Delaval Turbine and TurboCare divisions, which comprise substantially all of the Company's Turbomachinery business segment, and its 50% interest in Delaval-Stork, a Dutch joint venture, to Mannesmann Demag of Dusseldorf, Germany. The parties entered into a letter of intent in August 1994 and the sale was approved by the Company's Board of Directors. On January 17, 1995, the Company completed the sale for $124 million. Of this amount, $109 million was received at closing, with the remainder earning interest to the Company and to be received at specified future contract dates. A portion of the proceeds were used by the Company to pay off its domestic senior debt in January 1995, and in March 1995 the Company redeemed $40 million of its 12.25% Senior Subordinated Debentures with the remainder of the proceeds. The transaction, which will be reflected in the Company's first quarter of 1995, will result in an estimated gain of $40 million after tax. Deferred debt expense of $4.2 million, associated with the portions of the domestic senior debt and senior subordinated debentures repaid, was written off as an extraordinary charge in the first quarter of 1995.\nIn accordance with APB Opinion No. 30, the disposals of these business segments have been accounted for as discontinued operations and, accordingly, their operating results have been segregated and reported as Discontinued Operations in the accompanying Consolidated Statements of Income. Prior year financial statements have been reclassified to conform to the current year presentation.\nSee Notes 2 and 3 to the Consolidated Financial Statements located in Part IV of this Form 10-K Report as indexed at Item 14 (a)(1) for additional details regarding the discontinued operations.\nRestructuring Plan\nAsset Divestiture Program\nAs of December 31, 1994, the Company had substantially completed the restructuring plan announced on October 29, 1992, pursuant to which it divested six of its operating units in 1993, and two of its operating units and a portion of its underutilized real estate holdings in 1994. The divestitures included units of its aerospace businesses, units of its instruments and transducer businesses, certain other non-strategic businesses and underutilized real estate holdings. As discussed above, in January 1994, the Company announced its intention to dispose of its Electro-Optical Systems business, and on January 17, 1995 completed the sale of its Delaval Turbine and TurboCare divisions, which comprise substantially all of its Turbomachinery business segment, and its 50% interest in Delaval Stork, a Dutch joint venture. Both of these businesses are being accounted for as discontinued operations.\nDuring 1994, the Company sold its CEC Instruments and Turboflex Ltd. operations, its Corporate headquarters building and other previously identified assets for aggregate proceeds of $13.2 million. The proceeds were used to repay a portion of the Company's domestic senior debt.\nAs of December 31, 1993, the Company had sold its Heim Bearings, Aerospace and Barksdale Controls operations for proceeds of approximately $91 million, and thus had completed a significant portion of the asset divestiture program. These proceeds, net of related expenses, were used to repay senior debt in the amount of $81.9 million in 1993 in accordance with the terms of the restructured credit facilities.\nExcluding the Electro-Optical Systems operations, the remaining assets to be sold in this program consist of one non-strategic business and some remaining underutilized real estate holdings. The Company targets completion of these divestitures over the next 9 to 12 months.\nRestructuring Program\nIn January 1994, the Company announced plans to reduce its cost structure and to improve productivity on a worldwide basis. In the fourth quarter of 1993, the Company recorded a charge to continuing operations of $6.6 million relating to this program. The actions taken under this restructuring plan in 1994, were to implement cost-cutting measures at its core operations to reduce its expense structure and to eliminate duplicative functions. The Company has consolidated certain operations in the European controls and automotive components divisions and has revised operating processes and reduced employment levels at the pumps and other operations. The number of employees in core operations company-wide declined by approximately 210 , or 6 % between mid-1993 and mid-1994. This program was substantially complete as of December 31, 1994, with the remainder expected to be completed by the end of the first quarter of 1995.\nSee Note 4 to the Consolidated Financial Statements located in Part IV of this Form 10-K Report as indexed at Item 14(a)(1) for additional details regarding the asset divestiture and restructuring program.\nCompetition\nThe Company's products and services are marketed on a worldwide basis. Approximately 50% of the Company's products are marketed outside of the United States through wholly owned subsidiaries, sales offices and several joint ventures. Most markets in which the Company operates are highly competitive. The principal elements of competition for the products manufactured in each of the Company's business segments are design features, product quality, customer service and price.\nProduct Distribution and Customers\nThe Company's products are sold primarily through the Company's direct sales forces. During 1994, sales by the Company's direct sales forces accounted for approximately 94%, 67%, and 33% of the Morse Controls, Pumps, Power Transmission & Instrumentation and Other segments, respectively. The Company's remaining sales are made through distributors, dealers and agents.\nThe Morse Controls segment had sales to one commercial customer (Fiat S.p.A. and its subsidiaries) that accounted for 50%, 46% and 54% of segment sales, and 21%, 15% and 18% of consolidated sales in 1994, 1993 and 1992, respectively. None of the other business segments is dependent on any single customer or a few customers, the loss of which would have a material adverse effect on the respective segments, or on the Company as a whole. Total sales to the Department of Defense in the form of prime and subcontracts were approximately 7% of net sales in 1994, 12% of sales in 1993 and 12% of sales in 1992. The level of sales from continuing operations to the United States Department of Defense has been significantly reduced from the 1992 total company-wide level of 22% (in the form of prime and subcontracts) due to the discontinuance of the Electro- Optical Systems and Turbomachinery operations. No customer other than Fiat S.p.A. and its subsidiaries and the United States Department of Defense, accounted for 10% or more of consolidated sales in 1994, 1993 or 1992.\nBacklog\nThe Company's continuing operations' backlog of unfilled orders at February 28, 1995 and 1994 and at December 31, 1994, 1993 and 1992 by business segment was as follows:\nFebruary 28 December 31 1995 1994 1994 1993 1992 (Dollars in millions)\nMorse Controls $ 49.6 $ 45.7 $ 48.7 $ 41.1 $ 42.8 Pumps, Power Transmission & Instrumentation 62.1 62.3 57.6 62.5 75.2 Other 2.3 4.7 1.8 4.6 41.4 $114.0 $112.7 $108.1 $108.3 $159.4\nBacklog is considered significant only to the Warren Pumps operation of the Pumps, Power Transmission & Instrumentation Business segment, which requires long lead times for the manufacture of its products, and to the Roltra-Morse operation of the Morse Controls Business segment, the backlog for which is directly tied to a major customer's production schedule. Of the total backlog from continuing operations at December 31, 1994, the Company believes that all but approximately $2.6 million of its orders will be filled in 1995.\nRaw Materials\nThe Company's operations obtain raw materials, component parts and supplies from a variety of sources, generally from more than one supplier. The sources are based in both the United States and foreign countries. The Company believes that its sources of raw materials are adequate for its needs.\nPatents, Licenses and Trademarks\nThe Company owns numerous unexpired United States patents (currently having a term of 17 years from the date of issuance and expiring at various times in the future), United States design patents and foreign patents (having an initial term that is governed by the law of the country and expiring at various times in the future), including counterparts of certain of its United States patents, in major industrial countries of the world. The Company's products are marketed under various trade names and registered United States and foreign trademarks (having an initial term that is governed by the law of the country and expiring at various times in the future). However, the Company does not consider any one patent or trademark or any group thereof essential to its business as a whole, or to any of its business segments. The Company relies, to an extent, on proprietary product knowledge and manufacturing processes in its operations.\nFollowing the removal of the distinctive modifier \"Transamerica\" from the corporate name prior to the Distribution, the Company changed its name to \"Imo Delaval Inc.\" in 1986 and to \"Imo Industries Inc.\" in 1989. The Company's use of the name \"Delaval\" is restricted as a result of a contract by which the Company's assets were acquired from their former Swedish owner preceding the acquisition of the Company by Transamerica. In January 1995, the Company transferred its rights to use the \"Delaval\" name in connection with certain products of the Turbomachinery segment to Mannesmann Demag as part of the divestiture of its Turbomachinery business.\nResearch and Development\nThe Company's ongoing research and development programs involve the development of new technologies to enhance the performance or lower the cost of manufacturing its products, and the redesign of existing product lines either to increase their efficiency or to lower their manufacturing cost. Expenditures for research and development charged against continuing operations for 1994, 1993 and 1992 by business segment were as follows:\nYear Ended December 31 1994 1993 1992 (Dollars in millions)\nMorse Controls $ 2.8 $ 3.3 $ 3.3 Pumps, Power Transmission & Instrumentation 3.3 3.6 3.9 Other .1 2.3 2.7 $ 6.2 $ 9.2 $ 9.9\nEnvironmental Matters\nThe State of New Jersey Department of Environmental Protection and Energy (the \"DEPE\") has determined that the New Jersey Industrial Site Recovery Act (\"ISRA\") is applicable to three New Jersey \"Industrial Establishments\" owned by the Company at the time of the Distribution. The Company is in the process of selling a portion of one site and leasing another site. The Company will retain responsibility to meet all requirements of ISRA. Under ISRA the Company's three existing New Jersey industrial establishments will undergo a DEPE approved clean-up. All existing adverse environmental conditions and violations are being addressed through this ISRA process. Although the Company will have to correct conditions requiring clean-up under ISRA, the Company does not expect ISRA compliance to have a material adverse effect on its financial condition.\nIn a number of instances the Company has been identified as a Potentially Responsible Party by the United States Environmental Protection Agency, and in one instance the State of Washington, alleging that because various of its divisions had arranged for the disposal of hazardous wastes at a number of facilities that have been targeted for clean-up pursuant to the Comprehensive Environmental Response Compensation and Liability Act (\"CERCLA\") or similar State law. Although CERCLA and corresponding State law liability is joint and several, the Company believes that its liability will not have a material adverse effect on the financial condition of the Company since it believes that it either qualifies as a de minimis or minor contributor at each site. Accordingly, the Company believes that the portion of remediation costs that it will be responsible for will therefore not be material.\nThe Company has operations in numerous locations, some of which require environmental remediation. However, the Company does not know of or believe that any such matters or the cost of any required corrective measure, either individually or in the aggregate, will have a material adverse effect on the financial condition of the Company. However, there can be no guarantee that these matters or other environmental matters not currently known to the Company will not have such a material adverse effect.\nEmployees\nAt December 31, 1994, the Company employed approximately 6,200 persons worldwide of which 3,900 relate to continuing operations. Approximately 4,100 persons were employed in the United States, and approximately 2,100 persons were employed outside of the United States. Approximately 2,000 of the employees associated with continuing operations are located in the United States. There are approximately 1,200 persons worldwide covered by collective bargaining agreements with various unions expiring at various dates in 1995 through 1997. The Company considers its relations with its employees to be satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company's continuing operations have 45 manufacturing facilities in 12 states in the United States, the United Kingdom, Germany, Singapore, Sweden, Switzerland, Italy, France, and Australia of which 26 are owned and 19 are leased. In addition, the Company owns 4 closed manufacturing facilities (approximately 426,000 square feet of building space on 75.4 acres of land) that are being offered for sale. The properties owned by the Company consist of approximately 3.06 million square feet of building space, inclusive of the 426,000 square feet of the closed facilities, on approximately 507.3 acres (including 227.2 acres of undeveloped land). The leases expire over a period of years from 1995 to 2054 with renewal options for varying terms contained in 9 of the leases. The Company's executive office, which is leased by the Company, is located in Lawrenceville, New Jersey and occupies approximately 37,140 square feet.\nThe Company believes that its machinery, plants and offices are in satisfactory operating condition and are adequate for the uses to which they are put. The Company believes that its properties have sufficient capacity to substantially increase their current utilization without incurring significant additional capital expenditures.\nThe manufacturing facilities of the Company by business segment are summarized below: Square Feet of Building Space Number of Plants (In thousands) Owned Leased Owned Leased Morse Controls 6 9 391 415 Pumps, Power Transmission & Instrumentation 11 1 954 120 Other (Including Discontinued Operations) 9 9 1,288 510 26 19 2,633 1,045\nItem 3.","section_3":"Item 3. Legal Proceedings.\nIn August 1985, the Company was named as defendant in a lawsuit filed by Long Island Lighting Company (\"LILCO\"). The action stemmed from the sale of three diesel generators to LILCO for use at its Shoreham Nuclear Power Station. During testing of the diesel generators, the crankshaft of one of the diesel generators severed. The Company's insurers have defended the action under a reservation of rights.\nOn April 10, 1991, a jury, in a trial limited to liability, in the U.S. District Court in the Southern District of New York, found that the warranty was in effect from the time of shipment of the diesel generators until July 1986. On July 22, 1992, the trial court entered a judgment in the amount of $18.3 million which included interest to the judgment date.\nOn September 22, 1993, the Second Circuit Court of Appeals affirmed all lower court decisions in this matter. On October 25, 1993, the judgment against the Company was satisfied by payment to LILCO of approximately $19.3 million by two of the Company's insurers.\nIn late June 1992, the Company filed an action in the United States District Court for the Northern District of California against one of its insurers in an attempt to collect amounts for defense costs paid to counsel retained by the Company in defense of the LILCO litigation. The insurer has refused to reimburse the Company for approximately $8.5 million in defense costs paid by the Company alleging that defense costs above reasonable levels were expended in defending this litigation. Upon motion by the defendant this action has now been transferred to the Southern District of New York and assigned to one of the judges who heard the underlying LILCO trial.\nIn January 1993, the Company was served with a complaint in a case brought in the United States District Court for the Northern District of California by another insurer alleging that the insurer was entitled to recover $10 million in defense costs previously paid in connection with the LILCO matter and $1.2 million of the judgment which was paid on behalf of the Company. The complaint alleges inter alia that the insurer's policies did not cover the matters in question in the LILCO case. In connection with this matter, the Company filed a counterclaim against the insurer seeking payment of $8.5 million in defense costs that the Company previously paid in connection with the LILCO litigation. On January 25, 1995, the Court entered a judgment based on its December 15, 1994 memorandum and order dismissing the Company's counterclaim, denying the Company's Motion for Summary Judgment, and finding sua sponte that there was no coverage under the insurer's policy for the LILCO matter. On February 8, 1995, the Company filed an Application for Leave to File Motion for Reconsideration of the Judgment which was subsequently denied. The Company also filed a Notice of Appeal with the Ninth Circuit Court of Appeals. Subsequent to entry of the District Court Judgment, the insurer moved to have the judgment modified to award the insurer the $10 million defense costs and $1.2 million indemnity payment. The Company has filed a motion in opposition to this motion. Oral arguments relating to this motion were held on February 24, 1995 and the Company is awaiting the District Court's decision.\nThe Company and one of its subsidiaries are two of a large number of defendants in a number of lawsuits brought by approximately 13,500 claimants who allege injury caused by exposure to asbestos. Although the Company and its subsidiary have never been producers or direct suppliers of asbestos, it is alleged that the industrial and marine products sold by the Company and the subsidiary had components which contained asbestos. The allegations state a claim for asbestos exposure when Company-manufactured equipment was maintained or installed. Suits against the Company have been tendered to its insurers who are defending under their stated reservation of rights. The insurers for the subsidiary are being identified and have been and will be provided notice. Should settlements for these claims be reached at levels comparable to those reached by the Company in the past, they would not be expected to have a material effect on the Company.\nThe activities of certain employees of the Ni-Tec Division of the Company's Varo Inc. subsidiary (\"Ni-Tec\"), headquartered in Garland, Texas, are the focus of an ongoing investigation by the Office of the Inspector General of the United States Department of Defense and the Department of Justice (Criminal Division). On July 16, 1992, Ni-Tec received a subpoena for certain records as a part of the investigation, which subpoena has been responded to. Additional subpoenas for additional documents were received in September 1992, February 1993, and March 1994. The Company responded to the September and March subpoenas and the government subsequently withdrew the February subpoena. The investigation appears directed at quality control, testing and documentation activities which began at Ni-Tec while it was a division of Optic-Electronic Corp. Optic-Electronic Corp. was acquired by the Company in November 1990 and subsequently merged with Varo Inc. in 1991. The Company continues to cooperate fully with the investigation.\nThe Securities and Exchange Commission (the \"Commission\") is conducting an inquiry into, among other things, certain accounting practices at Ni-Tec and the 1991 and 1992 fiscal year financial reporting by the Company with respect thereto. The Commission has sought certain information from the Company relating to such inquiry and the Company has cooperated with this request. This inquiry has been dormant since August 1994.\nThe Company was notified in August 1994 that its Electro-Optical operations are being investigated by the United States Attorney for the District of Columbia. The investigation concerns the appropriateness of certifications submitted by Company personnel regarding its contracts with the Arab Republic of Egypt that were funded by the United States Government. In connection with this investigation, the Company has received and has responded to a subpoena issued by the Grand Jury for the District of Columbia.\nRegarding environmental matters, the operations of the Company, like those of other companies engaged in similar businesses, involve the use, disposal and clean-up of substances regulated under environmental protection laws.\nIn a number of instances the Company has been identified as a Potentially Responsible Party by the United States Environmental Protection Agency, and in one instance the State of Washington, alleging that because various of its divisions had arranged for the disposal of hazardous wastes at a number of facilities that have been targeted for clean-up pursuant to the Comprehensive Environmental Response Compensation and Liability Act (\"CERCLA\") or similar State law. Although CERCLA and corresponding State law liability is joint and several, the Company believes that its liability will not have a material adverse effect on the financial condition of the Company since it believes that it either qualifies as a de minimis or minor contributor at each site. Accordingly, the Company believes that the portion of remediation costs that it will be responsible for will therefore not be material.\nThe Company is a defendant in an action filed in the United States District Court for the Middle District of Louisiana brought by Gulf States Utilities Company (\"GSU\"). The complaint alleges that the Company breached its contract for the sale of two emergency diesel generators delivered to GSU's River Bend Nuclear Generating Station in 1981 and 1982. GSU alleges that it has incurred a loss of $8 million and claims additional amounts for the use of money and an equitable adjustment of the purchase price. In July 1992, the District Court for the Middle District of Louisiana granted the Company's motion for Summary Judgment dismissing GSU's claims. In November 1993, the Fifth Circuit Court of Appeals reversed and remanded the case for trial. The ruling eliminated the Company's statute of limitations defense, but preserved all other defenses. In February 1995, a settlement of this matter was tentatively reached requiring a $1.8 million payment by the Company to GSU.\nThe Company also has two other lawsuits pending against it relating to equipment sold by its former diesel engine division and a lawsuit relating to performance shortfalls in products delivered by its former Delaval Turbine Division in a prior year.\nWith respect to the litigation and claims described in the preceding paragraphs, it is management's opinion that the Company either expects to prevail, has adequate insurance coverage or has established appropriate reserves to cover potential liabilities; however, the ultimate outcome of any of these matters is indeterminable at this time.\nIn addition, the Company is involved in various other pending legal proceedings arising out of the Company's business. The adverse outcome of any of these legal proceedings is not expected to have a material adverse effect on the financial condition of the Company. However, if all or substantially all of these legal proceedings were to be determined adversely to the Company, which is viewed by the Company as only a remote possibility, there could be a material adverse effect on the financial condition of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matter was submitted to a vote of the Company's security holders during the fourth quarter of 1994.\nExecutive Officers of the Registrant\nThe following table sets forth information concerning the names, ages and principal occupations of the executive officers of the Company:\nName Age Principal Occupation\nDonald K. Farrar * 56 Chairman, Chief Executive Officer and President Thomas J. Bird, Jr. 51 Executive Vice President, General Counsel and Secretary William M. Brown 52 Executive Vice President and Chief Financial Officer J. Dwayne Attaway 53 Executive Vice President John J. Carr 52 Executive Vice President Brian Lewis 61 Executive Vice President Gary E. Walker 57 Executive Vice President David C. Christensen 61 Senior Vice President, Human Resources Robert A. Derr II 49 Vice President and Corporate Controller Geoffrey M. Dobson 57 Vice President and Treasurer\n* This executive officer is a director of the Company whose current term as a director will expire in 1995.\nDonald K. Farrar joined the Company as Chief Executive Officer and President in September 1993 and was elected Chairman in June 1994. Prior to joining the Company, Mr. Farrar held various positions with Textron, Inc. and Avco Corporation for 24 years. He served as President, Chief Operating Officer and director of Avco until its 1985 acquisition by Textron. Thereafter, he served as Senior Executive Vice President, Operations and a director of Textron, Inc. until December 1989. From January 1990 until joining the Company, Mr. Farrar was a private investor.\nThomas J. Bird, Jr. was promoted to his current position in October 1994. Mr. Bird served as Senior Vice President, General Counsel and Secretary from June 1992 to October 1994, and as Vice President and Associate General Counsel from July 1990 to June 1992. Prior to joining the Company in July 1990, Mr. Bird held various positions with General Electric Company for 18 years, most recently as Group Counsel RCA Aerospace and Defense division from August 1987 to February 1988 and as General Counsel to GE Aerospace of General Electric Company from February 1988 until joining the Company.\nWilliam M. Brown joined the Company in his current position in June 1992. Prior to joining the Company, Mr. Brown held various positions with ITT Corporation for 25 years, most recently as Corporate Assistant Controller and General Auditor from December 1986 to April 1991 and as Corporate Vice President and Assistant Controller from April 1991 until joining the Company.\nJ. Dwayne Attaway joined the Company as Executive Vice President of the Company's Varo Inc. operation in July 1989, and was promoted to his current position in December 1989. Mr. Attaway has overall responsibility for the Company's Electro-Optical Systems business which consists of the Company's Varo and Baird operations. Mr. Attaway served as Corporate Vice President of Business Development at Ranco Inc. from 1987 to 1989, as Vice President and General Manager of the Ranco Inc. Electronics Division from 1982 to 1987, and prior to that was with Varo Inc. for 17 years.\nJohn J. Carr was promoted to his current position in July 1989. From July 1985 to July 1989, Mr. Carr was a Group Vice President of the Company. Mr. Carr is responsible for the Boston Gear\/Delroyd, Fincor Electronics, Gems Sensors, IMO AB, IMO Pump, TransInstruments and Warren Pumps operations of the Company.\nBrian Lewis was promoted to his current position in July 1989. Mr. Lewis was President and Chief Operating Officer of the Controls Group of Incom International Inc. (acquired by the Company in December 1987) from 1985 until January 1988 and was a Group Vice President of the Company from January 1988 to July 1989. Mr. Lewis has responsibility for the Morse Controls and Roltra-Morse operations.\nGary E. Walker was promoted to his current position in February 1993. Mr. Walker served as Group Vice President of the Company from September 1991 to February 1993 and as Vice President and General Manager of the Delaval Turbine operation from September 1988 to September 1991. Prior to joining the Company he served from January 1987 to September 1988 as Vice President and General Manager of Turbonetics Energy Incorporated, a subsidiary of Mechanical Technology Inc. Prior to that, he had held various positions with General Electric for 21 years. Mr. Walker had responsibility for the Company's former Delaval Turbine, Delaval Condenser and TurboCare operations.\nDavid C. Christensen joined the company in his current position in August 1990. Previously, he was Senior Vice President, Human Resources for Pneumo Abex Corporation (and its predecessor Abex Corporation) from 1980 to September 1988. From September 1988 until joining the Company, Mr. Christensen was an independent human resources consultant.\nRobert A. Derr II joined the Company in his current position in 1988. Prior to joining the Company, Mr. Derr held various positions with The Stanley Works for nine years, most recently as Director of Corporate Accounting from 1982 to 1986 and as the Controller of the Vidmar Division of The Stanley Works from 1986 until joining the Company.\nGeoffrey M. Dobson joined the Company in his current position in April 1990. Prior to joining the Company, Mr. Dobson held various positions with Warner-Lambert Company for 21 years, most recently as Corporate Treasurer from August 1983 to January 1988 and as Vice President of Finance for the American Chicle Division from January 1988 until March 1989. From March 1989 until joining the Company Mr. Dobson served as President of Financial Functions Management, a financial consulting firm.\nEach of these executive officers will hold office until his successor is chosen and qualifies or until his earlier resignation or removal. Any officer may be removed at any time by the Board of Directors without prejudice to any contract rights which he may have.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe Company's common stock (the \"Common Stock\") is listed on the New York Stock Exchange (stock symbol IMD). The following table sets forth, for the quarters indicated, the high and low closing price per share for the Common Stock as reported on the New York Stock Exchange Composite Tape and the amount of per share cash dividends declared by the Company during each quarter on its Common Stock.\nDividend Declared High Low Per Share\n1993: 1st Quarter $ 7 1\/2 $ 4 7\/8 -- 2nd Quarter 7 5 7\/8 -- 3rd Quarter 8 6 1\/4 -- 4th Quarter 9 1\/4 6 5\/8 --\n1994: 1st Quarter 10 1\/8 7 -- 2nd Quarter 10 7\/8 9 1\/2 -- 3rd Quarter 12 9 3\/8 -- 4th Quarter 12 1\/4 8 3\/4 --\n1995: 1st Quarter 11 1\/2 6 1\/4 -- (through March 15, 1995)\nThe last sale price for the Company's Common Stock as reported by the New York Stock Exchange on March 15, 1995, was $6 7\/8 per share. As of March 15, 1995, there were approximately 24,289 holders of record of the Company's Common Stock.\nThree of the Company's long-term debt agreements contain, among other provisions, a restriction on retained earnings available for payment of dividends. Under the most restrictive provisions the Company is prohibited from declaring or paying cash dividends through at least July 31, 1997.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nRestructuring Summary\nAs of March 28, 1995, the Company has either completed the sale of, or has received a letter of intent for the sale of, substantially all of the businesses included in the asset divestiture program initially begun in October, 1992. Proceeds from asset sales completed during the first quarter of 1995 have been used to repay all of the Company's outstanding senior domestic bank debt as well as to redeem $40 million of the Company's 12.25% Senior Subordinated Debentures.\nAdditionally, as a result of an approximately $40 million after-tax gain realized on the January 17, 1995 sale of the Turbomachinery business, shareholders' equity will be restored to a positive value in the first quarter of 1995.\nThe remaining businesses included in this program, not currently under contract, are expected to be under contract of sale in the near future and to be sold prior to year-end. Additionally, certain idle facilities remain to be sold and the Company continues to actively pursue the sale of these properties.\nAsset Sales\nThe Company sold its Heim Bearings, Aerospace and Barksdale Controls operations for aggregate proceeds of approximately $91 million in 1993 and its CEC Instruments division, Corporate headquarters building and other previously identified assets for aggregate proceeds of $13.2 million in 1994. Results of these operations to their date of sale as well as an operation remaining to be sold, other than the Electro-Optical and Turbomachinery businesses, are included in continuing operations reported in the consolidated financial statements.\nThe Company sold the Baird Analytical Instruments division of its Electro- Optical Systems business to a subsidiary of Thermo Instruments Systems Inc. on January 3, 1995 for $12.3 million in cash, which was used to reduce its domestic senior debt.\nOn January 17, 1995, the Company completed the sale of its Delaval Turbine and TurboCare divisions, which comprised substantially all of the Company's Turbomachinery business segment, and its 50% interest in Delaval-Stork, a Dutch joint venture, to Mannesmann Demag of Dusseldorf, Germany, for $124 million. At closing, the Company received $109 million in cash, with the balance earning interest until it is received at specified future contract dates subject to adjustment as provided in the agreement. These proceeds were used to complete the repayment of the Company's domestic senior debt and to redeem $40 million of the Company's 12.25% senior subordinated debentures.\nOn February 8, 1995, the Company announced that it has a letter of intent for the acquisition of most of its Electro-Optical Systems business by Litton Industries, for approximately book value. Under the terms of the letter of intent, Litton would acquire all of the assets of the Varo night vision and laser business, other than real estate, and would lease the operations' facilities in Dallas, Texas, for two years with options to extend the leases. The sale is subject to the receipt of certain government approvals. Management believes that this transaction will close in the second quarter of 1995. Not included in the proposed agreement is Varo's Electronic Systems division, which is being marketed to interested parties. Management intends to use the proceeds of these sales to pay down debt.\nOther Restructuring\nIn 1993, the Company recorded a charge to operations for other restructuring activities which benefited 1994 operating results. The Company has implemented cost-cutting measures at its core operations to reduce its expense structure and to eliminate duplicative functions. The Company has also consolidated certain operations in the European controls and automotive components divisions and has revised operating processes and reduced employment levels at the pumps and other operations. The number of employees in core operations company-wide declined by approximately 210, or 6 % between mid-1993 and mid-1994. These organizational restructuring measures have been providing net cash benefits, which for continuing operations, approximated $2 million in 1994 and will approximate $5 million annually thereafter based largely on reduced employment costs. The majority of the restructuring has been completed.\nResults of Operations\nThe net income per share in 1994 was $.23 compared with a net loss per share of $16.02 in 1993 and a net loss per share of $4.90 in 1992.\n1994 1993 1992 Earnings (loss) per share: Continuing operations before extraordinary item and cumulative effect of change in accounting principle $ .22 $ (2.37) $ (1.53) Discontinued operations $ .32 $(12.58) $ (1.73) Extraordinary item $ (.31) $ (1.07) --- Cumulative effect of change in accounting principle --- --- $ (1.64) Net income (loss) $ .23 $(16.02) $ (4.90)\nThe Electro-Optical and Turbomachinery businesses are accounted for as discontinued operations in the accompanying consolidated financial statements. Accordingly, the discussion that follows concerns only the results of continuing operations. The 1993 and 1992 amounts have been reclassified to conform to this presentation. As a result of discontinuing the Electro-Optical Systems and Turbomachinery business segments, the Company has focused its operations on the remaining two core business segments, the Morse Controls segment and the Pumps, Power Transmission & Instrumentation segment.\nThe twelve months ended December 31, 1994 include an extraordinary charge of $5.3 million after-tax ($.31 per share) representing fees and charges related to extinguishment of debt in connection with the restructuring of the Company's senior credit facilities in August 1994.\nThe results of operations for the twelve months ended December 31, 1993 included an extraordinary item of $18.1 million ($1.07 per share) representing fees and expenses related to extinguishment of senior debt of which approximately $4.0 million required immediate cash outlays, approximately $2 million related to the write-off of previously deferred debt expense and $11.9 million was provided as an estimate for make-whole notes (\"Make-Whole Notes\") to be issued to the holders of debt being retired. Through December 31, 1993, Make-Whole Notes of $11.5 million were issued and included in long-term debt. The Make-Whole Notes were repaid in August 1994. Additionally, approximately $4 million of fees related to the 1993 restructuring of the Company's credit facilities were paid in 1993. This amount was being amortized until August 1994, at which time, the balance was recognized as an extraordinary charge in connection with the extinguishment of the restructured credit facilities.\nThe twelve months ended December 31, 1993 include net unusual charges of $15.7 million in loss from continuing operations. These charges include $6.6 million related to the restructuring and consolidation of certain of the Company's operating units ($3.7 million included in the Morse Controls segment, $1.7 million included in the Pumps, Power Transmission & Instrumentation segment and $1.2 million included in Corporate Expense, all principally comprised of severance costs), $10.1 million for an expected net loss overall related to the Company's asset divestiture program (included in the Other segment), and $5 million in debt-related financing fees (included in Corporate Expense). These charges are net of a reversal of a $6.0 million reserve during the third quarter of 1993, as a result of a change in estimate related to legal costs associated with pending litigation (included in the Other segment). Of the $21.7 million of unusual charges, required cash outlays were approximately $7.1 million and $.2 million in 1994 and 1993, respectively. The estimated cash requirement for 1995 is $1.3 million, with the remainder representing non-cash charges.\nAs a result of unanticipated losses in 1993, the Company provided reserves of $13.6 million against previously recorded future tax benefits in loss from continuing operations. These tax benefits may be realized in future years.\nThe twelve months ended December 31, 1992 include unusual charges of $16.7 million in loss from continuing operations principally for the estimated costs associated with pending litigation and certain warranty and claim settlements. Of this amount, $6 million was reversed in the third quarter of 1993 as a result of a change in estimate. No cash outlays are anticipated in the future related to these charges.\nThe twelve months ended December 31, 1992 include a charge of $27.6 million after tax ($1.64 per share) related to the adoption of FASB Statement No. 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions.\" This charge has been reported as a cumulative effect of a change in accounting principle and was retroactively applied as of January 1, 1992.\nThe Company had income from discontinued operations of $5.6 million (net of income tax expense of $.8 million) or $.32 per share in 1994, a loss of $212.4 million (including income tax expense of $1.4 million) or $12.58 per share in 1993, and a loss of $29.2 million (net of an income tax benefit of $13.9 million) or $1.73 per share in 1992. The loss recorded in 1993 includes an estimated loss on disposal of the Company's Electro-Optical Systems business of $168.0 million, most of which represents a non-cash adjustment to reduce the carrying value of assets to estimated realizable value. Of the total estimated loss on disposal, cash outlays are not expected to exceed $11 million, of which approximately $4.6 million was expended in 1994. The results from operations for the discontinued operations include allocations for interest of $17.4 million, $18.0 million and $13.4 million for 1994, 1993 and 1992, respectively.\nThe Company had income from continuing operations of $3.7 million or $.22 per share in 1994. The 1993 loss from continuing operations of $40.1 million or $2.37 per share was primarily as a result of the net unusual charges of $15.7 million and the $13.6 million tax reserve provided against previously recorded future tax benefits. The Company had a loss from continuing operations of $25.8 million or $1.53 per share in 1992 including unusual charges of $16.7 million.\nNet Sales\nNet sales from continuing operations in 1994 were $463.9 million, compared with $494.2 million in 1993. Sales from core operations (excluding operations divested since the beginning of 1993 or pending divestiture) were $452.9 million in 1994 compared with $413.8 million in 1993, an increase of 9.5%. A significant portion of this increase is attributable to the Company's Italian automobile business as the Company continues to be a key supplier to Fiat S.p.A.\nNet sales from continuing operations in 1993 were $494.2 million, a decline of $79.0 million or 13.8% from $573.2 million for 1992. A large part of this decline, $34.7 million, is because six divisions were sold in 1993, therefore contributing for only a part of the year versus a full year for 1992. Excluding the divested divisions, the Company's core businesses had sales of $413.8 million in 1993 versus $458.1 million in 1992, a decline of $44.3 million or 9.7%. Over 80% of this decline, approximately $37 million, was due to unfavorable foreign exchange rate effects. The major portion of the remaining decline was attributable to decreases in volume occurring in the Company's Italian automobile business.\nCosts and Expenses\nSelling, general and administrative expenses declined $21.7 million in 1994 compared with 1993, with most of the decline attributable to businesses sold subsequent to June 30, 1993, to the phase-out of certain postretirement benefit subsidies in 1994, and lower levels of general and administrative staff. Selling, general and administrative expenses as a percent of sales decreased to 18.7% in 1994 compared with 22.0% in 1993. Research and development expenditures were 1.3% of sales in 1994, 1.9% in 1993 and 1.7% in 1992.\nSelling, general and administrative expenses decreased $4.2 million in 1993 from 1992 with the Other segment accountable for $4.6 million of the decrease as a result of six of the divisions having been sold during the year. Selling expenses for the core businesses increased $1.1 million in 1993 primarily because of the consolidation of a joint venture that became wholly-owned in late 1992 offsetting decreases in other core operations. General and administrative expenses decreased slightly on a year-to-year basis. However, because sales decreased while the Company maintained its selling efforts, total selling, general and administrative expenses were 22.0% of sales in 1993 compared with 19.7% for 1992.\nIn March 1994, the Company amended its policy regarding retiree medical and life insurance plans. This amendment, which affects some current retirees and all future retirees, phases out the Company subsidy for retiree medical and life insurance over a three year period ending December 31, 1996. The Company expects to amortize associated reserves to income from continuing operations over the phase out period at approximately $4 million per year. The pre-tax amount amortized to income from continuing operations was $4.4 million in 1994. The Company does not anticipate a significant increase or decrease in cash requirements related to this change in policy during the phase out period.\nAverage borrowings in 1994 were $51 million lower than in 1993. As a result, total interest expense (before allocation to discontinued operations) of $51.7 million in 1994 was $5.5 million less than in 1993. Similarly, because average borrowings in 1993 were $21 million lower than in 1992, interest expense of $57.2 million in 1993 decreased $2.3 million compared with 1992. The interest expense for continuing operations as shown on the Consolidated Statements of Income excludes interest expense incurred by the discontinued operations as well as an interest allocation to the discontinued operations of $17.4 million in 1994, $18.0 million in 1993 and $13.4 million in 1992.\nIncome tax expense from continuing operations for 1994 was $2.4 million and for 1993 was $13.6 million. The 1994 amount represents foreign and state income taxes. The 1993 amount is principally comprised of the provision of a reserve against previously recorded tax benefits. The Company did not record a benefit for the 1993 loss as a valuation allowance has been established in accordance with the provisions of FASB Statement No. 109, \"Accounting for Income Taxes.\" These tax benefits may be realized in future years.\nThe Company has a net operating loss carryforward of approximately $70 million expiring in 2009, foreign tax credit carryforwards of approximately $16 million expiring through 1999 and minimum tax credits of approximately $2.1 million which may be carried forward indefinitely. These carryforwards are available to offset future taxable income and have been reserved in accordance with FASB Statement No. 109. These existing tax loss carryforwards will allow the Company's future earnings to be essentially free from the payment of U.S. taxes for the foreseeable future.\nTaxes have not been provided on the unremitted earnings of foreign subsidiaries, since it is the Company's intention to indefinitely reinvest these earnings. This policy has no impact on the Company's liquidity since the Company does not anticipate paying any U.S. tax on these unremitted earnings. The amount of foreign withholding taxes that would be payable on remittance of these earnings is approximately $1.1 million.\nSegment Operating Results\nThe Morse Controls segment had sales of $197.0 million in 1994, compared with $163.9 million for 1993, a 20.2% increase resulting from a 32.7% increase in sales to the Italian automotive industry and an 8.9% increase in all other sales worldwide. The increased sales level resulted in operating income for the segment of $14.7 million in 1994, compared with $3.1 million in 1993. Operating income in 1993 included unusual charges of $3.7 million related to restructuring and facilities consolidations.\nThe Pumps, Power Transmission & Instrumentation segment had sales of $256.0 million, a 2.4% increase over the $249.9 million in 1993. Sales were up in the power transmission sector, flat in the instrumentation sector and down slightly in the pumps sector. Segment operating income was $29.1 million in 1994, a 41% improvement over 1993, largely as the result of improved volume in the power transmission sector, the phase-out of certain postretirement benefit subsidies, and reduced overhead expenses. Operating income was also adversely impacted in the fourth quarter of 1993 by restructuring charges.\nPower transmission sales and operating profit both improved for the year compared with 1993, benefiting from the upturn in general industrial activity in the U.S. Pump operations sales and operating profit were adversely affected by the continued fall-off in defense business.\nFourth Quarter Results\nNet sales from continuing operations of $116.5 million in the fourth quarter of 1994 were $4.4 million higher than the $112.1 million for the fourth quarter of 1993. However, excluding operations divested since the beginning of 1993 or pending divestiture, fourth quarter sales of core operations were $114.8 million, or 11.0% higher than 1993 fourth quarter sales of $103.4 million. The fourth quarter of 1994 includes income of $1.3 million (pre-tax) related to the phase-out of certain postretirement benefit subsidies. The fourth quarter of 1994 had income from continuing operations of $1.1 million ($.07 per share), compared with a loss from continuing operations of $40.5 million ($2.39 per share) in the same period of 1993. A charge of $21.7 million of unusual items and the provision of a $13.6 million reserve against previously recorded future tax benefits were recorded in the fourth quarter of 1993.\nMorse Controls segment sales for the fourth quarter of 1994, were 22.4% ahead of sales in the fourth quarter of 1993. Roltra-Morse's revenue gained 34%, while worldwide sales elsewhere in the segment were up 11%. Operations for the quarter benefited from increased sales, and from cost- cutting actions taken at the end of 1993; operating income was $3.8 million, compared with a $3.9 million loss in the fourth quarter of 1993 as a result of unusual items related to restructuring and facilities consolidations.\nRoltra-Morse, the segment's automotive components supplier, participated in an increase in Fiat car production as well as a higher market share on certain Fiat models, and a successful entry into production in Poland. Worldwide, there was continued recovery in major sectors served by the segment's other mechanical and electronic controls products, such as pleasure marine, construction, agriculture and truck markets.\nPumps, Power Transmission & Instrumentation segment sales in the fourth quarter were 3.9% ahead of the comparable year-earlier period, and operating profit improved substantially to $6.8 million, compared with $2.9 million in 1993.\nFourth-quarter Pump group sales were flat year-over-year, as the continued decline in Navy business was matched by an increase in commercial business to such markets as pulp and paper, chemical and hydrocarbon processing, crude oil and machinery.\nPower Transmission sales advanced 7.8% year-over-year, primarily into industrial distribution channels, reflecting the stronger general economic environment that has persisted in the U.S. throughout 1994. A wide range of OEMs and end-users are served via this conduit.\nInstrumentation group sales comparisons were favorable by 4.2%, as improvement in Europe and Canada outpaced a moderate decline in U.S. shipments. There was a major shipment of instrumentation to the Navy in the fourth quarter of 1993 that was not repeated in 1994.\nLiquidity and Capital Resources\nThe Company's domestic liquidity requirements are served by a revolving credit facility, while its needs outside the U.S. are covered by short and intermediate term credit facilities from foreign banks.\nEffective August 5, 1994, the Company obtained credit facilities for borrowings up to $150 million from a group of lenders (the \"New Credit Agreement\"), secured by the assets of the Company's domestic operations and all or a portion of the stock of certain of the Company's subsidiaries. The New Credit Agreement provided for a $65 million revolving credit facility through July 31, 1997, a $40 million term loan amortizing to July 1997, and a $45 million bridge loan maturing January 1996. The revolving credit facility is extendible to July 1999 under certain conditions. Proceeds from the New Credit Agreement were used to repay the Company's working capital loans under the former domestic senior credit facilities, its $30 million 12.75% Senior Note and its $12.4 million Make-Whole Note.\nAs a result of the extinguishment of the prior facilities in connection with the New Credit Agreement, the Company incurred a $5.3 million extraordinary charge in the third quarter of 1994, of which $3.7 million represents a prepayment premium paid for the $30 million 12.75% Senior Note.\nThe Company's operating activities provided cash of $16.8 million in 1994, compared with providing cash of $25.1 million in 1993. Net cash used by investing activities was $.3 million in 1994, compared with cash provided of $70.8 million in the 1993 period. The change in net cash provided by investing activities is principally a result of $13.2 million of net proceeds generated from the sale of assets in the 1994 period versus $86.5 million in 1993. Cash and cash equivalents were $26.9 million at December 31, 1994 compared with $22.4 million at December 31, 1993.\nWorking capital at December 31, 1994 was $135.2 million, an increase of $28.1 million from the end of 1993, due principally to the reduction in current debt in 1994. The ratio of current assets to current liabilities was 1.9 at December 31, 1994, compared with 1.6 at December 31, 1993. Principally as a result of the 1993 loss, the Company's total debt as a percent of its total capitalization was 107.5% at December 31, 1994, and 109.7% at December 31, 1993.\nDepreciation for continuing operations decreased $2.6 million to $15.7 million in 1994, from $18.3 million in 1993 which, in turn, decreased $1.6 million from 1992. Amortization of intangibles for continuing operations was $6.3 million in 1994, $4.9 million in 1993, and $4.4 million in 1992. Additions to property, plant and equipment, made primarily to improve productivity, were $9.2 million in 1994. The Company anticipates that capital expenditures in 1995 will increase significantly over the 1994 level to make the necessary investments to maintain and improve competitive advantages at its operations. There were no material outstanding commitments for the acquisition of property, plant and equipment at December 31, 1994.\nAt December 31, 1994, the Company had outstanding $150 million of 12.25% senior subordinated debentures maturing in 1997 and $150 million of 12% senior subordinated debentures maturing in amounts of $37.5 million in 1999, $37.5 million in 2000 and $75.0 million in 2001. In addition, the Company had $36.7 million and $45 million in term and bridge loans, respectively, outstanding under the New Credit Agreement, both of which were repaid with proceeds received in January 1995 from the sales of the Baird Analytical Instruments division and the Turbomachinery business. In March 1995, $40 million of the 12.25% senior subordinated debentures were redeemed with the remainder of these proceeds. Deferred debt expense of $4.2 million, associated with the portions of the domestic senior debt and senior subordinated debentures repaid, was written off as an extraordinary charge in the first quarter of 1995. The Company expects to use proceeds from the remainder of its divestiture program to reduce its 12.25% senior subordinated debentures thereby further reducing the Company's interest expense. As of December 31, 1994, there were no borrowings under the $65 million revolving credit facility; however $35 million of standby letters of credit were outstanding. Letter of credit exposure was reduced to $20.5 million after the Turbomachinery business sale in January 1995. At the same time, and in keeping with the terms of the New Credit Agreement, the $65 million revolving credit facility was reduced to $50 million. The Company also has approximately $30.7 million in foreign short-term credit facilities with approximately $12.8 million outstanding as of December 31, 1994.\nBusiness Environment\nGeneral economic conditions worldwide continue to create business opportunities for the coming year in many of the markets in which the Company operates. Management believes that its multiple niche market strategy helps the Company moderate effects from the cyclical behavior of any particular market segment that it serves.\nApproximately 45% of the Company's property, plant and equipment of continuing operations has been acquired over the past five years and has a remaining useful life ranging from five years to fifteen years for equipment to thirty years for buildings. In addition, property, plant and equipment of the companies acquired by the Company have been adjusted to their fair value at the time of acquisition. Assets acquired in prior years are expected to be replaced at higher costs but this will take place over many years. The newer assets will result in higher depreciation charges but, in many cases, due to technological improvements, there will be operating cost savings as well. The Company considers these matters in establishing its pricing policies.\nTotal sales to the DoD in the form of prime and subcontracts were approximately 7% of net sales from continuing operations in 1994 and 12% in 1993. The level of sales from continuing operations to the United States Department of Defense has been significantly reduced from the 1992 total company-wide level of 22% (in the form of prime and subcontracts) due to the discontinuance of the Electro-Optical Systems and Turbomachinery operations.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe consolidated financial statements and supplementary data required by Part II, Item 8 of Form 10-K are included in Part IV of this Form 10-K Report as indexed at Item 14(a)(1).\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.\nReference is made to the information to be set forth in the section entitled \"Election of Directors\" in the Company's Proxy Statement, for the Annual Meeting of Stockholders which will be held on May 18, 1995 (the \"Proxy Statement\"), which section is incorporated herein by reference. The Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1994, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended.\nThe information under the caption \"Executive Officers of the Company,\" following Item 4 of Part I of this Form 10-K Report, is incorporated herein by reference.\nNone of the executive officers or directors of the Company is related to any of the other executive officers or directors of the Company.\nItem 11.","section_11":"Item 11. Executive Compensation.\nReference is made to the information to be set forth in the section entitled \"Executive Compensation\" in the Proxy Statement, which section (except for its Compensation Committee Report and its Performance Graph) is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nReference is made to the information to be set forth in the section entitled \"Beneficial Ownership of Common Stock\" in the Proxy Statement, which section 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\nThe Financial Statements and Supplementary Data required by Part II, Item 8 of Form 10-K are included in this Part IV of this Form 10-K Report as follows:\nConsolidated Financial Statements Page\nConsolidated Statements of Income for the Years Ended December 31, 1994, 1993 and 1992...................F-1 Consolidated Balance Sheets at December 31, 1994 and 1993.................................................F-2 Consolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992.............F-3 Consolidated Statements of Shareholders' Equity (Deficit) for the Years Ended December 31, 1994, 1993 and 1992.....F-4 Notes to Consolidated Financial Statements.................F-5 Report of Independent Auditors...............................F-6 Quarterly Financial Information..............................F-7\n(2) Financial Statement Schedules\nThe following consolidated financial statement schedule for the year ended December 31, 1994, 1993 and 1992 is filed as part of this Report and should be read in conjunction with the Company's Consolidated Financial Statements.\nSchedule Page\nII Valuation and Qualifying Accounts.................... S-1\nAll other schedules for which provision is made in the applicable regulation of the Securities and Exchange Commission are omitted because they are not required under the related instructions or because the required information is given in the financial statements or notes thereto.\n(3) Exhibits\nThe Exhibits listed in the accompanying Index to Exhibits are filed as part of this Report.\n(b) Reports on Form 8-K The following reports on Form 8-K were filed during the quarter ended December 31, 1994:\nOn December 23, 1994, the Company filed a Report on Form 8-K reporting under Items 5 and 7.\nEXHIBIT INDEX\nExhibit No. Note No. Description\n3(i) (15) The Company's Restated Certificate of Incorporation, as amended March 10, 1989 and November 10, 1992\n3(ii) The Company's Bylaws\n4.1 (A) (11) Indenture agreement dated August 15, 1987 between the Company and IBJ Schroder Bank & Trust Company, Trustee\n(B) (17) First Supplemental Indenture dated as of February 14, 1994 between the Company and IBJ Schroder Bank & Trust Company, Trustee\n4.2 (11) Indenture agreement dated November 1, 1989 between the Company and IBJ Schroder Bank & Trust Company, Trustee\n4.3 (A) (5) Rights Agreement dated as of April 22, 1987 between the Company and Philadelphia National Bank, as Rights Agent\n(B) (15) Amendment dated December 16, 1991 between the Company and First Chicago Trust Company of New York\nManagement Contracts, Compensatory Plans and Arrangements:\n10.1 (A) (3) The Company's Equity Incentive Plan for Key Employees\n(B) (7) Amendment to the Equity Incentive Plan for Key Employees\n10.2 (A) (7) Equity Incentive Plan for Outside Directors\n(B) (12) Amendment effective as of July 2, 1990 to the Equity Incentive Plan for Outside Directors\n10.3 (A) (12) Employment Agreement dated September 1, 1986 by and between the Company and William J. Holcombe, as amended October 1, 1987, as restated and amended May 9, 1989, and as amended March 6, 1991\n(B) Amendment dated January 1, 1993 to the Employment Agreement between the Company and William J. Holcombe, as amended July 19, 1994\n10.4 (15) Change in Control Agreement dated January 9, 1987 between the Company and John J. Carr\n10.5 (15) Change in Control Agreement dated April 8, 1990 between the Company and J. Dwayne Attaway\n10.6 Letter Agreements between the Company and J. Dwayne Attaway dated April 21, 1994 and April 29, 1994, respectively\n10.7 (15) Change in Control Agreement dated December 23, 1988 between the Company and Brian Lewis\n10.8 (15) Change in Control Agreement dated August 5, 1992 between the Company and William M. Brown\n10.9 (15) Change in Control Agreement dated August 13, 1992 between the Company and Thomas J. Bird\n10.10 (17) Change in Control Agreement dated April 19, 1993 between the Company and Gary E. Walker and agreed to by him on May 10, 1993\n10.11 Letter Agreements dated May 19, 1994 between the Company and Gary E. Walker\n10.12 (A) (17) Employment Agreement dated September 13, 1993 between the Company and Donald K. Farrar\n(B) Amendment dated November 17, 1994 to the Employment Agreement between the Company and Donald K. Farrar\n10.13 (17) Change in Control Agreement dated September 13, 1993 between the Company and Donald K. Farrar\nOther Material Contracts:\n10.14 (2) The Company's Retirement Plan for Salaried Employees\n10.15 (A) (8) The Company's Salaried Employees Stock Savings Plan (11) as amended on July 1, 1987 and as amended on June 14, 1988\n(B) (14) Amendment dated March 16, 1989 to the Imo Industries Inc. Employees Stock Savings Plan\n(C) (12) Amendments dated September 6, 1990 and February 14, 1991 to the Imo Industries Inc. Employees Stock Savings Plan\n(D) (13) Amendment dated May 9, 1991 to the Imo Industries Inc. Employees Stock Savings Plan\n(E) (14) Trust Agreement for the Imo Industries Inc. Employees Stock Savings Plan as of January 1, 1992 between the Company and Merrill Lynch Trust Company\n(F) (15) Amendments dated December 30, 1991 and August 3, 1992 to the Imo Industries Inc. Employees Stock Savings Plan\n(G) Trust Agreement for the Imo Industries Inc. Employees Stock Savings Plan as of March 1, 1995 between the Company and Eagle Trust Company\n10.16 (1) Distribution Agreement dated December 18, 1986 between Transamerica Corporation and the Company\n10.17 (1) Tax Agreement between the Company and Transamerica Corporation\n10.18 (A) (9) Revolving Credit Agreement, dated September 16, 1988 (10) by and among the Company, Bankers Trust Company, Barclays Bank PLC, Canadian Imperial Bank of Commerce as amended December 15, 1988, as amended February 28, 1989, as amended May 9, 1989 and as amended September 11, 1989\n(B) (12) Amendment dated as of August 31, 1990 to the agreement dated September 16, 1988 by and among the Company, Bankers Trust Company, Barclays Bank PLC, Canadian Imperial Bank of Commerce, Manufacturers Hanover Trust Company and National City Bank\n(C) (14) Amendment dated as of December 31, 1991 to the agreement dated September 16, 1988 by and among the Company, Bankers Trust Company, Barclays Bank PLC, Manufacturers Hanover Trust Company and National City Bank\n(D)(i) (16) Combined Restated Credit Agreement dated July 15, 1993 among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN-AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, and Istituto Bancario San Paolo Di Torino S.p.A.\n(ii) (17) Amendment No. 1 dated as of November 22, 1993 to the Combined Restated Credit Agreement dated as of July 15, 1993 among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN-AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, and Istituto Bancario San Paolo Di Torino S.p.A.\n(iii) Amended and Restated Combined Restated Credit Agreement dated as of August 19, 1994 among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN-AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, and Istituto Bancario San Paolo Di Torino S.p.A.\n(iv) Consent, Amendment No. 1 and Agreement dated as of January 17, 1995 among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, and National City Bank, Istituto Bancario San Paolo Di Torino S.p.A., Commerzbank AG, New York Branch, ABN-AMRO Bank N.V., New York Branch, The Prudential Insurance Company of America as lenders and Mannesmann Capital Corporation as Assignee\n(E)(i) (16) Credit Agreement dated July 15, 1993 among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN-AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, Istituto Bancario San Paolo Di Torino S.p.A., and The Prudential Insurance Company of America\n(ii) (17) Amendment No. 1 dated as of November 22, 1993 to the Credit Agreement dated as of July 15, 1993 among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN-AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, Istituto Bancario San Paolo Di Torino S.p.A., and The Prudential Insurance Company of America\n(iii) Amended and Restated Credit Agreement dated as of August 19, 1994 among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN-AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, and Istituto Bancario San Paolo Di Torino S.p.A., and The Prudential Insurance Company of America\n(iv) Consent, Amendment No. 1 and Agreement dated as of January 17, 1995 among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, and National City Bank, Istituto Bancario San Paolo Di Torino S.p.A., Commerzbank AG, New York Branch, ABN-AMRO Bank N.V., New York Branch, The Prudential Insurance Company of America as lenders and Mannesmann Capital Corporation as Assignee\n(F) (17) Guarantee Agreement dated July 15, 1993 by certain of the Company's Subsidiaries in favor of Bankers Trust Company as collateral agent (re-executed to reflect certain signatories which are different from those on the version of this Agreement appended as Exhibit 10.16 (F) to the Company's Form 10-K\/A for the fiscal year ended December 31, 1992)\n(G)(i) (16) General Security Agreement dated July 15, 1993 by the Company and certain of its Subsidiaries in favor of Bankers Trust Company as collateral agent\n(ii) (17) Letter Agreement dated December 1, 1993 between the Company's Varo Inc. Subsidiary and Bankers Trust Company as collateral agent, regarding the General Security Agreement identified herein as Exhibit 10.18 (G)(i)\n(H)(i) (16) Securities Pledge Agreement dated July 15, 1993 by the Company and certain of its Subsidiaries in favor of Bankers Trust Company as collateral agent\n(ii) (17) Letter Agreement dated December 1, 1993 between the Company's Varo Inc. Subsidiary and Bankers Trust Company as collateral agent, regarding the Securities Pledge Agreement identified herein as Exhibit 10.18 (H)(i)\n(I)(i) (16) Intellectual Property Pledge Agreement dated July 15, 1993 by the Company and certain of its Subsidiaries in favor of Bankers Trust Company as collateral agent\n(ii) (17) Letter Agreement dated December 1, 1993 between the Company's Varo Inc. Subsidiary and Bankers Trust Company as collateral agent, regarding the Intellectual Property Pledge Agreement identified herein as Exhibit 10.18 (I)(i)\n(J) (16) Collection Deposit and Concentration Account Pledge Agreement dated July 15, 1993 by the Company and certain of its Subsidiaries in favor of Bankers Trust Company as collateral agent\n(K) (16) Intercreditor and Collateral Agency Agreement dated July 15, 1993 among the Company, Bankers Trust Company as lender, issuer, agent and collateral agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN-AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, Istituto Bancario San Paolo Di Torino S.p.A., and The Prudential Insurance Company of America\n(L) (16) Mortgage, Assignment of Rents, Assignment Agreement and Fixture Filing dated July 15, 1993 by the Company in favor of Bankers Trust Company relating to premises in Mercer County, New Jersey\n(M) (16) Schedule of Omitted Mortgages and Deeds of Trust\n(N) (17) Schedule of Additional Omitted Mortgages and Deeds of Trust\n10.19 (A) (4) 12.75% Note Agreement dated December 29, 1982 between the Company and The Prudential Insurance Company of America (\"Prudential\")\n(B) (4) Agreement dated December 22, 1986 between the Company and Prudential amending the 12.75% Note Agreement dated December 29, 1982 between the Company and Prudential\n(C) (11) Amendment dated as of September 16, 1988 to the Agreement dated December 29, 1982 between the Company and Prudential\n(D) (11) Amendment dated as of June 13, 1989 to the Agreement dated December 29, 1982 between the Company and Prudential\n(E) (12) Amendment dated November 27, 1990 to the agreement dated December 29, 1982 between the Company and Prudential\n(F) (14) Amendment dated April 2, 1991, Amendment dated May 14, 1991, Amendment dated November 5, 1991, Amendment dated November 12, 1991 and Amendment dated February 13, 1992 between the Company and Prudential\n(G) (15) Amendment dated August 7, 1992 between the Company and Prudential\n(H) (16) Amendment Agreement dated July 15, 1993 between the Company and The Prudential Insurance Company of America\n(I)(i) (16) Amended and Restated 12.75% Promissory Note Agreement dated July 15, 1993 between the Company and The Prudential Insurance Company of America\n(ii) (17) Amendment No. 1 dated as of December 17, 1993 to the Amended and Restated 12.75% Promissory Note Agreement dated July 15, 1993 between the Company and The Prudential Insurance Company of America\n(J) (16) Warrant dated July 15, 1993 issued by the Company to The Prudential Insurance Company of America\n10.20 (A) (4) 9.60% Note Agreement dated November 5, 1975 between the Company and Prudential\n(B) (4) Agreement dated December 22, 1986 between the Company and Prudential amending the 9.60% Note Agreement dated November 5, 1975 between the Company and Prudential\n10.21 (A) (9) 10.35% Note Agreement dated September 16, 1988 between the Company and Prudential\n(B) (11) Amendment dated as of June 13, 1989 to the Agreement dated September 16, 1988 between the Company and Prudential\n(C) (12) Amendment dated November 27, 1990 to the agreement dated September 16, 1988 between the Company and Prudential\n(D) (14) Amendment dated April 2, 1991, Amendment dated May 14, 1991, Amendment dated November 5, 1991, Amendment dated November 12, 1991 and Amendment dated February 13, 1992 between the Company and Prudential\n(E) (15) Amendment dated August 7, 1992 between the Company and Prudential\n(F) (16) Amendment Agreement dated July 15, 1993 between the Company and The Prudential Insurance Company of America\n(G) (16) Amended and Restated 10.35% Promissory Note Agreement dated July 15, 1993 between the Company and The Prudential Insurance Company of America\n(H) (17) Amendment No. 1 dated as of December 17, 1993 to the Amended and Restated 10.35% Promissory Note Agreement dated July 15, 1993 between the Company and The Prudential Insurance Company of America\n10.22 (A) (17) Amendment No. 2 dated as of December 31, 1993 to the New Credit Agreement, the Combined Restated Credit Agreement and the Prudential Agreements among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN-AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, Istituto Bancario San Paolo Di Torino S.p.A., and The Prudential Insurance Company of America. This Amendment No. 2 Amends: (i) the Combined Restated Credit Agreement identified herein as Exhibit 10.18(D)(i) as amended, (ii) the Credit Agreement identified herein as Exhibit 10.18(E)(i) as amended, (iii) the Amended and Restated 12.75% Promissory Note Agreement identified herein as Exhibit 10.19(I)(i) as amended, and (iv) the Amended and Restated 10.35% Promissory Note Agreement identified herein as Exhibit 10.21(G) as amended.\n(B) (17) Consent and Amendment No. 3 dated as of February 28, 1994 to the New Credit Agreement, the Combined Restated Credit Agreement and the Prudential Agreements among the Company, Bankers Trust Company as lender, issuer and agent, Chemical Bank, CIBC, Inc., Barclays Bank PLC, National City Bank, ABN- AMRO Bank N.V., New York Branch, Commerzbank AG, New York Branch, Istituto Bancario San Paolo Di Torino S.p.A., and The Prudential Insurance Company of America. This Consent and Amendment No. 3 amends: (i) the Combined Restated Credit Agreement identified herein as Exhibit 10.18(D)(i) as amended, (ii) the Credit Agreement identified herein as Exhibit 10.18(E)(i) as amended,(iii) the Amended and Restated 12.75% Promissory Note Agreement identified herein as Exhibit 10.19(I)(i) as amended, and (iv) the Amended and Restated 10.35% Promissory Note Agreement identified herein as Exhibit 10.21(G) as amended.\n10.23 (6) Agreement and Plan of Merger dated July 13, 1987 among the Company, BC Acquisition Corp. and Baird Corporation\n10.24 (4) Stock Purchase Agreement dated November 30, 1987 between the Company and TRIFIN B.V.\n10.25 (9) Agreement and Plan of Merger, dated as of August 21, 1988 by and among the Company, VI Acquisition Corp. and Varo Inc.\n10.26 (9) Stock option agreement, dated as of August 21, 1988, between VI Acquisition Corp. and Varo Inc.\n10.27 (11) Agreement for the purchase of the stock of Warren Pumps Inc. by the Company dated April 3, 1989 among the Company, Warren Pumps Inc. and the holders of all of the issued and outstanding stock of Warren Pumps Inc.\n10.28 (11) Share Purchase Agreement dated April 27, 1989, among Aureoleena Investments Limited, Bushbranch Investments Limited, and Holdings Limited, as vendors, and R. J. Burns, C. P. Burns and J. A. Burns as guarantors, and Morse Controls Limited as purchaser\n10.29 (11) Stock Purchase Agreement dated July 31, 1989 between Immobiliare Marsicana S.R.L. and Ser-Fid Italiana S.p.A.\n10.30 (11) Agreement for sale of assets dated November 30, 1989 among Ferguson Gear Company, Robert E. Lewis and the Company\n10.31 (12) Agreement for sale of assets dated June 15, 1990 among Clifford G. Brockmyre, Robert Healy, Quabbin Industries Inc., Pro Mac Engineering Inc., BHP Associates, Industrial Airpark Associates and the Company\n10.32 (12) Stock Purchase Agreement dated as of May 31, 1990 among United Scientific Holdings PLC, United Scientific Inc. and the Company\n10.33 (17) Asset Sale Agreement dated as of May 10, 1993 between the Company and Roller Bearing Company of America\n10.34 (17) Stock Sale and Asset Transfer Agreement dated as of July 14, 1993 between the Company and Nova Digm Acquisition, Inc.\n10.35 (i) (17) Stock Purchase Agreement dated as of October 28, 1993 among the Company, Imo Industries GmbH, Mark Controls Corporation and Mark Controls GmbH i. Gr.\n(ii) (17) Amendment No. 1 dated as of November 11, 1993 to Stock Purchase Agreement dated as of October 28, 1993, among the Company, Imo Industries GmbH, Mark Controls Corporation and Mark Controls GmbH i. Gr.\n(iii) (17) Amendment No. 2 dated as of December 1, 1993 to Stock Purchase Agreement dated as of October 28, 1993 among the Company, Mark Controls Corporation, Imo Industries GmbH and Mark Controls GmbH i. Gr.\n10.36 (i) (17) German Asset Purchase Agreement among Imo Industries GmbH, Mark Controls GmbH i. Gr., the Company and Mark Controls Corporation\n(ii) (17) Amendment No. 1 dated as of November 23, 1993 to German Asset Purchase Agreement dated as of November 18, 1993 among Imo Industries GmbH, the Company, Mark Controls GmbH i. Gr. and Mark Controls Corporation\n(iii) (17) Amendment No. 2 dated as of December 1, 1993 to the German Asset Purchase Agreement dated as of November 23, 1993 among the Company, Mark Controls Corporation, Imo Industries GmbH and Mark Controls GmbH i. Gr.\n10.37 (A) (18) Credit Agreement dated as of August 5, 1994 among the Company, as Borrower, Baird Corporation, as Guarantor, Warren Pumps Inc., as Guarantor, the Institutions from time to time party thereto as Lenders and as Issuing Banks, and Citibank, N.A., as Agent\n(B) First Amendment dated as of November 18, 1994, Second Amendment dated as of January 11, 1995, and Third Amendment dated as of February 17, 1995 to the Credit Agreement dated as of August 5, 1994 among the Company as Borrower, Baird Corporation, as Guarantor, Warren Pumps Inc., as Guarantor, the Institutions from time to time party thereto as Lenders and as Issuing Banks, and Citibank, N.A., as Agent\n10.38 (A) (18) Asset Purchase Agreement dated as of October 14, 1994 by and among the Company, Varo Inc., Baird Corporation, Optic Electronic International, Inc., TPG Partners, L.P. and Varo Acquisition Corp.\n(B) (18) Amendment dated as of October 28, 1994 to the Asset Purchase Agreement dated as of October 14, 1994 by and among the Company, Varo Inc., Baird Corporation, Optic Electronic International, Inc., TPG Partners, L.P. and Varo Acquisition Corp.\n(C) Letter dated December 20, 1994 issued to the Company by Varo Systems, Inc., (formerly Varo Acquisition Corp.), Varo Holdings Corp. and TPG Partners L.P. terminating the Asset Purchase Agreement dated as of October 14, 1994 by and among the Company, Varo Inc., Baird Corporation, Optic Electronic International Inc., TPG Partners L.P. and Varo Acquisition Corp.\n10.39 (A) (18) Asset Purchase Agreement dated as of November 4, 1994 by and among the Company, Imo Industries International Inc. and Mannesmann Capital Corporation\n(B) Agreement, Amendment and Waiver dated January 17, 1995 by and among the Company and Mannesmann Capital Corporation\n10.40 Asset and Stock Purchase Agreement dated as of January 1, 1995 by and among the Company and Thermo Jarrell Ash Corporation\n20 Proxy Statement for the Company's 1995 Annual Meeting of Stockholders (incorporated by reference to the Company's Proxy Statement to be filed separately with the Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended)\n21 Subsidiaries of the Company\n23 Consent of Ernst & Young LLP dated March 29, 1995\n27 Financial Data Schedule as of December 31, 1994\n_______________________________________________\nNOTES\n(1) Incorporated by reference to the Company's Form 8 Amendment No. 2 filed with the Commission on December 9, 1986 amending the Company's Form 10 as filed with the Commission on October 15, 1986. (2) Incorporated by reference to the Company's Form 10-K filed with the Commission for the fiscal year ended December 31, 1986. (3) Incorporated by reference to the Company's Form S-8 as filed with the Commission on April 10, 1987. (4) Incorporated by reference to the Company's Form 8-K filed with the Commission on February 17, 1987. (5) Incorporated by reference to the Company's Form 8-K filed with the Commission on May 4, 1987. (6) Incorporated by reference to the Company's Schedule 14D-1 as filed with the Commission on July 14, 1987. (7) Incorporated by reference to the Company's Form 10-K filed with the Commission on March 28, 1988. (8) Incorporated by reference to the Imo Industries Inc. Employees Stock Savings Plan Form 11-K filed with the Commission on April 13, 1988. (9) Incorporated by reference to the Company's Form 8-K filed with the Commission on October 14, 1988. (10)Incorporated by reference to the Company's Form S-1 filed with the Commission on October 23, 1989. (11)Incorporated by reference to the Company's Form 10-K filed with the Commission on March 29, 1990. (12)Incorporated by reference to the Company's Form 10-K filed with the Commission on March 28, 1991. (13)Incorporated by reference to the Company's Form S-8 filed with the Commission on June 17, 1991. (14)Incorporated by reference to the Company's Form 10-K filed with the Commission on March 26, 1992. (15)Incorporated by reference to the Company's Form 10-K filed with the Commission on April 19, 1993. (16)Incorporated by reference to the Company's Form 10-K\/A filed with the Commission on August 6, 1993 amending the Company's Form 10-K as filed with the Commission on April 19, 1993. (17)Incorporated by reference to the Company's Form 10-K filed with the Commission on March 31, 1994. (18)Incorporated by reference to the Company's Form 10-Q filed with the Commission on November 14, 1994.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Imo Industries Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 29, 1995 IMO INDUSTRIES INC.\nBy: \/s\/ DONALD K. FARRAR Donald K. Farrar Chairman, Chief Executive Officer, President 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 Imo Industries Inc. and in the capacities and on the dates indicated.\n\/s\/ DONALD K. FARRAR Chairman, Chief Executive Officer, Donald K. Farrar President and Director (principal executive officer) March 29, 1995\n\/s\/ WILLIAM M. BROWN Executive Vice President and William M. Brown Chief Financial Officer (principal financial officer) March 29, 1995\n\/s\/ ROBERT A. DERR II Vice President and Robert A. Derr II Corporate Controller (principal accounting officer) March 29, 1995\n\/s\/ JAMES B. EDWARDS Director March 29, 1995 James B. Edwards\n\/s\/ J. SPENCER GOULD Director March 29, 1995 J. Spencer Gould\n\/s\/ RICHARD J. GROSH Director March 29, 1995 Richard J. Grosh\n\/s\/ CARTER P. THACHER Director March 29, 1995 Carter P. Thacher\n\/s\/ ARTHUR E. VAN LEUVEN Director March 29, 1995 Arthur E. Van Leuven\nImo Industries Inc. and Subsidiaries\nNotes to Consolidated Financial Statements\nNote 1 Significant Accounting Policies\nConsolidation: The consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. Significant intercompany transactions have been eliminated in consolidation. The Company uses the equity method to account for investments in corporations in which it does not own a majority voting interest.\nTranslation of Foreign Currencies: Assets and liabilities of international operations are translated into U.S. dollars at current exchange rates. Income and expense accounts are translated into U.S. dollars at average rates of exchange prevailing during the year. Translation adjustments are reflected as a separate component of shareholders' equity.\nCash Equivalents: Cash equivalents include investments in government securities funds and certificates of deposit. Investment periods are generally less than one month.\nFinancial Instruments: The Company uses forward exchange contracts to hedge certain firm foreign commitments denominated in foreign currencies. Gains or losses on forward contracts are deferred and offset against the foreign exchange gains and losses on the underlying hedged item. The forward exchange contracts are for periods of less than one year, and the amounts outstanding as well as gains or losses on such contracts are not material.\nInventories: Inventories are carried at the lower of cost or market, cost being determined principally on the basis of standards which approximate actual costs on the first-in, first-out method.\nRevenue Recognition: Revenues are recorded generally when the Company's products are shipped.\nDepreciation and Amortization: Depreciation and amortization of plant and equipment are computed principally by the straight-line method.\nInterest Expense: Interest expense incurred during the construction of facilities and equipment is capitalized as part of the cost of those assets. Total interest paid by the Company amounted to $49.5 million in 1994, $56.7 million in 1993 and $58.4 million in 1992. Total interest capitalized was $.2 million in 1994, $.1 million in 1993 and $.9 million in 1992.\nEarnings Per Share: Earnings per share are based upon the weighted average number of shares of common stock outstanding. Common stock equivalents related to stock options are excluded because their effect is not material.\nIntangible Assets: Goodwill of companies acquired is being amortized on the straight-line basis over 40 years. The carrying value of goodwill is reviewed when indicators of impairment are present, by evaluating future cash flows of the associated operations to determine if impairment exists. Goodwill related to continuing operations at December 31, 1994 and 1993 was $68.7 million and $73.6 million, respectively, net of respective accumulated amortization of $14.4 million and $12.9 million. As a result of the decision to sell the Electro-Optical Systems businesses, approximately $104.6 million of associated goodwill was written off at December 31, 1993 in connection with the adjustment of the net investment to estimated net realizable value. Patents are amortized over the shorter of their legal or estimated useful lives.\nRestatements: The Consolidated Financial Statements, and the notes thereto, have been restated to reflect the Company's Electro-Optical Systems business and Turbomachinery business segments as discontinued operations in accordance with Accounting Principles Board Opinion No. 30. Certain prior year amounts have been reclassified to conform to the current year presentation.\nNote 2 Discontinued Operations\nElectro-Optical Systems In January 1994, pursuant to a plan approved by the Board of Directors, the Company announced its intention to dispose of its Electro-Optical Systems operations. On January 3, 1995, the Company completed the sale of its Baird Analytical Instruments Division to Thermo Instruments Systems Inc. for approximately $12.3 million, which was used to repay a portion of the Company's domestic senior debt (See Note 3). On February 8, 1995, the Company announced that it has a letter of intent from Litton Industries for the acquisition of the Optical Systems and Ni-Tec divisions of Varo Inc. and the Optical Systems division of Baird Corporation. These sales will complete a substantial part of the Company's planned divestiture of its Electro-Optical Systems business. The Company is continuing discussions with prospective buyers of the remaining Varo division, the Electronic Systems division, and expects to complete this sale in 1995.\nTurbomachinery On July 28, 1994, the Company announced that it had reached an agreement in principle to sell its Delaval Turbine and TurboCare divisions, which comprise substantially all of the Company's Turbomachinery business segment, and its 50% interest in Delaval-Stork, a Dutch joint venture, to Mannesmann Demag of Dusseldorf, Germany. The parties entered into a letter of intent in August 1994 and the sale was approved by the Company's Board of Directors. On January 17, 1995, the Company completed the sale of its Delaval Turbine and TurboCare divisions and its 50% interest in Delaval- Stork, to Mannesmann Demag for $124 million. Of this amount, $109 million was received at closing, with the remainder earning interest to the Company and to be received at specified future contract dates subject to adjustment as provided in the agreement. A portion of the proceeds have been used by the Company to pay off its domestic senior debt in January 1995 and in March 1995 the Company redeemed $40 million of its 12.25% Senior Subordinated Debentures with the remainder of the proceeds. The transaction, which will be reflected in the Company's first quarter of 1995, will result in an estimated gain of $40 million after tax (See Note 3).\nIn accordance with APB Opinion No. 30, the disposals of these business segments have been accounted for as discontinued operations and, accordingly, their operating results have been segregated and reported as Discontinued Operations in the accompanying Consolidated Statements of Income. Prior year financial statements have been reclassified to conform to the current year presentation. \t Net assets and liabilities of the Discontinued Operations consist of the following:\nDecember 31 (Dollars in thousands) 1994 1993 Current Assets: Receivables $ 57,778 $ 48,122 Inventories 60,280 80,241 Other current assets 2,031 2,068 120,089 130,431\nCurrent Liabilities: Trade accounts payable 21,049 23,637 Other current liabilities 30,343 33,028 51,392 56,665\nNet Current Assets $ 68,697 $ 73,766\nLong-term Assets: Property $ 67,522 $ 72,778 Intangible assets 3,988 4,873 Other long-term assets 9,308 5,195 80,818 82,846\nLong-term Liabilities 4,545 14,901\nNet Long-term Assets $ 76,273 $ 67,945\nNet Assets $144,970 $141,711\nNet assets related to the Electro-Optical Systems business are $85 million as of December 31, 1994 and 1993, and net assets related to the Turbomachinery business are $60 million and $56.7 million as of December 31, 1994 and 1993, respectively.\nA condensed summary of operations for the Discontinued Operations is as follows:\nYear Ended December 31 (Dollars in thousands) 1994 1993 1992\nNet Sales $341,550 $319,074 $355,074\nIncome (loss) from operations before income taxes and minority interest 6,375 (42,587) (43,250)\nIncome taxes (benefit) 800 1,400 (13,875) Minority interest --- 383 (206)\nIncome (loss) from operations $5,575 $(44,370) $(29,169)\nThe income (loss) from operations of the Discontinued Operations for 1994, 1993 and 1992 includes allocated interest expense. Interest expense of $17.4 million, $18.0 million, and $13.4 million, respectively, was allocated based on the ratio of the estimated net assets to be sold in relation to the sum of the Company's shareholders' equity and the aggregate of outstanding debt at each year end.\nElectro-Optical Business\t The Electro-Optical loss from operations was $45.3 million and $32.7 million for 1993 and 1992, respectively. In 1994, losses from the Electro- Optical Systems operations resulted in a net charge of $6.2 million to the Accrued Expenses of Discontinued Operations reserve established as of December 31, 1993. Included in the 1993 loss are unusual charges of $23.3 million. These charges are principally provisions for revised estimates-to- complete on current contracts of $13.9 million, other costs of $5.6 million related to the write-down of assets to net realizable value, $1.9 million of estimated costs associated with settlements of pending litigation and other costs of $1.9 million. Included in the 1992 loss are unusual charges of $27.9 million. These charges include provisions for the estimated costs associated with operational disruptions and restructuring, including revised estimates-to-complete on current contracts, of $22 million, costs associated with pending litigation and certain warranty and claim settlements of $4 million, and other costs of $1.9 million related to the write-down of assets, principally inventories, to net realizable value.\nThe Company also recorded charges of $155.3 million at December 31, 1993, which includes a $104.6 million goodwill write-off (See Note 1) to reduce the carrying amount of the Electro-Optical discontinued operation to estimated realizable value. As of December 31, 1994, the Company has an accrual for anticipated operating losses of $6.4 million (including $4.2 million of allocated interest) through the date of sale, which is expected to occur during the second quarter of 1995.\nTurbomachinery Business The Turbomachinery business income from operations was $5.6 million, $1.0 million and $3.6 million for 1994, 1993 and 1992, respectively. Included in the 1993 income are unusual charges of $2.0 million consisting of restructuring costs. Included in the 1992 income are unusual charges of $7.3 million of which $3.0 million is estimated costs associated with pending litigation and $4.0 million related to estimated warranty and performance claims.\nSee Note 15 for discussion of contingencies related to the Electro-Optical Systems and Turbomachinery businesses.\nNote 3 Subsequent Events\nOn January 3, 1995, the Company completed the sale of the Baird Analytical Instruments division of its Electro-Optical Systems business to Thermo Instrument Systems Inc., a subsidiary of Thermo Electron Corporation, for $12.3 million in cash, which was used to reduce its domestic senior debt. A loss was previously recognized in connection with the net realizable value adjustment on the entire Electro-Optical Systems business recorded in 1993.\nOn January 17, 1995, the Company completed the sale of its Delaval Turbine and TurboCare divisions, which comprise substantially all of the Company's Turbomachinery business segment, and its 50% interest in Delaval-Stork, a Dutch joint venture, to Mannesmann Capital Corporation, a subsidiary of Mannesmann Demag of Dusseldorf, Germany, for $124 million in cash. At closing, the Company received $109 million, with the balance earning interest until it is received at specified future contract dates subject to adjustment as provided in the agreement. A portion of these proceeds were used to complete the repayment of the Company's domestic senior debt in January 1995. In March 1995, $40 million of the 12.25% Senior Subordinated Debentures were redeemed with the remainder of these proceeds. This transaction, which will be reflected in the Company's financial statements in the first quarter of 1995, will result in an estimated after-tax gain of $40 million.\nDeferred debt expense of $4.2 million, associated with the portions of the domestic senior debt and senior subordinated debentures extinguished in connection with the above transactions, was written off as an extraordinary charge in the first quarter of 1995.\nBoth the Electro-Optical Systems and Turbomachinery business segments have been accounted for as discontinued operations, and an interest allocation has been included in the income (loss) from operations of the discontinued operations in each of the three years in the period ended December 31, 1994 (See Note 2).\nPresented below is an unaudited condensed balance sheet which sets forth historical information as adjusted to give effect to the sales of the Company's Baird Analytical Instruments division and its Turbomachinery business including its 50% interest in Delaval-Stork, and the related debt repayments. The adjustments assume that the transactions occurred on the balance sheet date.\nDecember 31, 1994 (Dollars in thousands) Reported Adjustments Adjusted (Unaudited) (Unaudited)\nCash and cash equivalents $ 26,942 $ --- $ 26,942 Other current assets 182,668 5,000 187,668 Noncurrent assets 220,079 5,800 225,879 Net assets of discontinued operations 144,970 (72,870) 72,100 Total Assets $574,659 $ (62,070) $512,589\nNotes payable and current portion of long-term debt $ 29,810 $ (13,333) $ 16,477 Other liabilities 195,855 23,797 219,652 Long-term debt 376,998 (108,334) 268,664 Shareholders' equity (deficit) (28,004) 35,800 7,796 Total Liabilities and Shareholders' Equity (Deficit) $574,659 $ (62,070) $512,589\nNote 4 Restructuring Plan\nAsset Divestiture Program As of December 31, 1994, the Company had substantially completed the restructuring plan announced on October 29, 1992, pursuant to which it divested six of its operating units in 1993, two of its operating units and a portion of its underutilized real estate holdings in 1994. The divestitures included units of its aerospace businesses, units of its instruments and transducer businesses, certain other non-strategic businesses and underutilized real estate holdings. As discussed above, in January 1994, the Company announced its intention to dispose of its Electro-Optical Systems business, and on January 17, 1995 completed the sale of its Delaval Turbine and TurboCare divisions, which comprise substantially all of its Turbomachinery business segment, and its 50% interest in Delaval-Stork, a Dutch joint venture. Both of these businesses are being accounted for as discontinued operations (See Note 2).\nDuring 1994, the Company sold its CEC Instruments and Turboflex Ltd. operations, its Corporate headquarters building and other previously identified assets for aggregate proceeds of $13.2 million. The proceeds were used to repay a portion of the Company's domestic senior debt.\nAs of December 31, 1993, the Company had sold its Heim Bearings, Aerospace and Barksdale Controls operations for proceeds of approximately $91 million, and thus had completed a significant portion of the asset divestiture program. These proceeds, net of related expenses, were used to repay senior debt in the amount of $81.9 million in 1993 in accordance with the terms of the 1993 restructured credit facilities.\nExcluding the Electro-Optical Systems operations, the remaining assets to be sold in this program consist of one non-strategic business and the remainder of its underutilized real estate holdings. The Company targets completion of the divestitures over the next 9 to 12 months.\nThe operating units sold and the remaining assets to be sold as part of the asset divestiture program, except for the Electro-Optical Systems and Turbomachinery businesses, have been grouped as a separate segment entitled Other for segment reporting purposes. See Note 11 for segment operating results for the years ending December 31, 1994, 1993 and 1992. These units in total produced a loss before income taxes of $2 million in 1994 and essentially break-even results before unusual items and income taxes for the years 1993 and 1992. These results are net of $2.2 million , $5.9 million and $8.3 million of interest expense which has been allocated based on net assets for the years 1994, 1993 and 1992, respectively.\nRestructuring Program In January 1994, the Company announced plans to reduce the Company's cost structure and to improve productivity on a worldwide basis. In the fourth quarter of 1993, the Company recorded a charge in continuing operations of $6.6 million relating to this program. The actions taken in 1994, under this restructuring plan, were to implement cost-cutting measures at its core operations to reduce its expense structure and to eliminate duplicative functions. The company has consolidated certain operations in the European controls and automotive components divisions and has revised operating processes and reduced employment levels at the pumps and other operations. The number of employees in core operations declined by approximately 210, or 6% between mid-1993 and mid-1994. This program was substantially complete as of December 31, 1994, with the remainder expected to be completed by the end of the first quarter of 1995.\nIn the fourth quarter of 1993, the Company recorded a charge of $6.6 million ($.39 per share) relating to this program, which amount was classified as an unusual charge in loss from continuing operations (See Note 7). The restructuring charge was principally comprised of severance costs and impacts both the Company's industry segments and the Corporate office (See Note 11). Accrued restructuring costs included in accrued expenses and other liabilities are $1.3 million and $6.4 million at December 31, 1994 and 1993, respectively.\nNote 5 Inventories\nInventories are summarized as follows:\nDecember 31 (Dollars in thousands) 1994 1993\nFinished products $ 35,649 $ 38,476 Work in process 31,990 28,669 Materials and supplies 32,952 36,037 100,591 103,182 Less customers' progress payments 1,635 2,255 Less valuation allowance 12,133 11,821\n$ 86,823 $ 89,106\nNote 6 Accrued Expenses and Other Liabilities\nAccrued expenses and other liabilities consist of the following:\nDecember 31 (Dollars in thousands) 1994 1993\nAccrued contract completion costs $ 556 $ 886 Accrued product warranty costs 5,037 4,050 Accrued litigation and claim costs 4,493 14,312 Payroll and related items 12,773 13,872 Accrued interest payable 10,573 11,590 Accrued restructuring costs 1,321 6,389 Accrued divestiture costs 8,582 4,178 Other 10,341 18,380\n$ 53,676 $ 73,657\nNote 7 Unusual Items\nDuring the twelve months ended December 31, 1993, the Company recognized unusual charges of $15.7 million ($.93 per share) in loss from continuing operations. During the fourth quarter of 1993, the Company recognized charges of $21.7 million that include provisions of $6.6 million related to the restructuring and consolidation of certain of the Company's operating units (See Note 4), $10.1 million expected net loss overall related to the Company's asset divestiture program (See Note 4) and $5.0 million in debt related financing fees associated with obtaining consents from holders of its 12.25% senior subordinated debentures to amend the indenture governing these debentures and obtain waivers from its senior lenders for non- compliance with certain financial covenants as of December 31, 1993, as a result of the fourth quarter net loss. These charges are net of unusual income of $6.0 million recorded in the third quarter of 1993 as a result of a change in estimate related to legal costs associated with pending litigation.\nThe twelve months ended December 31, 1992 include unusual charges of $16.7 million in loss from continuing operations. These charges are principally provisions for the estimated costs associated with pending litigation and certain warranty and claim settlements.\nNote 8 Income Taxes\nThe components of income tax expense (benefit) from continuing operations are:\nYear Ended December 31 (Dollars in thousands) 1994 1993 1992\nCurrent: Federal $ --- $ --- $ --- Foreign 1,973 --- --- State 460 --- --- 2,433 --- --- Deferred: Federal --- 13,000 (7,498) Foreign and State --- 600 (4,513) --- 13,600 (12,011)\n$ 2,433 $ 13,600 $(12,011)\nIncome tax expense (benefit) from discontinued operations, in thousands, is as follows: 1994 - $800; 1993 - $1,400; and 1992 - $(13,875).\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. Significant components of the Company's deferred tax assets and liabilities as of December 31, 1994 and 1993 are as follows:\nDecember 31 (Dollars in thousands) 1994 1993 Current Long-term Current Long-term Deferred tax assets: Postretirement benefit obligation $ 765 $ 11,593 $ 765 $ 14,340 Expenses not currently deductible 19,174 25,879 21,308 32,436 Net operating loss carryover --- 24,673 --- 17,150 Tax credit carryover --- 8,653 --- 1,755 Total deferred tax assets 19,939 70,798 22,073 65,681 Valuation allowance for deferred tax assets (15,140) (53,770) (15,061) (45,154)\nNet deferred tax assets 4,799 17,028 7,012 20,527\nDeferred tax liabilities: Tax over book depreciation --- 14,908 --- 17,708 Difference between book and tax basis of property --- 3,930 --- 8,455 Difference between book and tax basis of income recognition 471 1,230 4,332 4,332 Other --- 4,324 --- 3,976\nTotal deferred tax liabilities 471 24,392 4,332 34,471\nNet deferred tax assets (liabilities) $ 4,328 $ (7,364) $ 2,680 $(13,944)\nAt December 31, 1994, unremitted earnings of foreign subsidiaries were approximately $23.3 million. Since it is the Company's intention to indefinitely reinvest these earnings, no U.S. taxes have been provided. Determination of the amount of unrecognized deferred tax liability on these unremitted earnings is not practicable. The amount of foreign withholding taxes that would be payable upon remittance of those earnings is approximately $1.1 million.\nThe components of income (loss) from continuing operations before income taxes, minority interest, extraordinary item and cumulative effect of change in accounting principle are:\nYear Ended December 31 (Dollars in thousands) 1994 1993 1992\nUnited States $(2,322) $(22,656) $(39,685) Foreign 8,803 (3,667) 2,269\n$ 6,481 $(26,323) $(37,416)\nU.S. income tax expense (benefit) at the statutory tax rate is reconciled below to the overall U.S. and foreign income tax expense (benefit).\nYear Ended December 31 (Dollars in thousands) 1994 1993 1992 Tax at U.S. federal income tax rate $ 2,268 $ (9,213) $(12,721) State taxes, net of federal income tax effect 299 396 (1,092) Impact of foreign tax rates and credits (1,108) --- 141 Impact of foreign sales corporation exempt income --- --- (702) Net U.S. tax on distributions of current foreign earnings 935 --- 175 Goodwill amortization 656 694 1,554 Other\/valuation reserve (617) 21,723 634\nIncome tax expense (benefit) $ 2,433 $ 13,600 $(12,011)\nNet income taxes paid during 1994 and 1992 were $.2 million and $3.7 million, respectively, and net income tax refunds received during 1993 were $7 million.\nThe Company has net operating loss carryforwards of approximately $70 million expiring through 2009, foreign tax credit carryforwards of approximately $16 million expiring through 1999, which, for financial reporting purposes, are reflected as deductible foreign taxes, and minimum tax credits of approximately $2.1 million which may be carried forward indefinitely. These carryforwards are available to offset future taxable income and have been reserved in accordance with FASB Statement No. 109.\nNote 9 Notes Payable and Long-Term Debt\nEffective August 5, 1994, the Company obtained credit facilities for borrowings up to $150 million from a group of lenders (the \"New Credit Agreement\"), secured by the assets of the Company's domestic operations and all or a portion of the stock of certain of the Company's subsidiaries. The New Credit Agreement provided for a $65 million revolving credit facility through July 31, 1997, a $40 million term loan amortizing to July 1997, and a $45 million bridge loan maturing January 1996. Both the revolving credit facility and the term loan are extendible to July 1999 under certain conditions. Proceeds from the New Credit Agreement were used to repay the Company's working capital loans under the former domestic senior credit facilities, its $30 million 12.75% Senior Note and its $12.4 million Make- Whole Notes.\nAt December 31, 1994, the Company had $36.7 million and $45 million in term and bridge loans, respectively, outstanding under the New Credit Agreement, both of which were repaid with proceeds received in January 1995 from the sales of the Baird Analytical Instruments division and the Turbomachinery business (See Note 3). As of December 31, 1994, there were no borrowings under the $65 million revolving credit facility; however $35.1 million in standby letters of credit were outstanding. Letter of credit exposure was reduced to $20.5 million after the Turbomachinery business sale in January 1995. At the same time, and in keeping with the terms of the New Credit Agreement, the $65 million revolving credit facility was reduced to $50 million. The Company currently has approximately $30.7 million in foreign short-term credit facilities with approximately $12.8 million outstanding as of December 31, 1994. Due to the short-term nature of these debt instruments it is the Company's opinion that the carrying amounts approximate the fair value. The weighted average interest rate on short- term notes payable was 8.8% and 8.2% at December 31, 1994 and 1993, respectively.\nLong-term debt of continuing operations consists of the following:\nDecember 31 (Dollars in thousands) 1994 1993\nPromissory note with interest at 12.75%, due March 31, 1995 $ --- $ 30,000 Promissory note with interest at 10.35%, $5 million due annually from 1994 to 2003 --- 4,379 Make-Whole Notes with interest at 2% over the prime rate, due December 31, 1996 --- 11,519 Bridge Loan due January 31, 1996 (1) 45,000 --- Term Loan, $3.3 million due quarterly October 31, 1994 to July 31, 1997 (2) 36,667 --- Senior subordinated debentures with interest at 12.25%, due August 15, 1997 150,000 150,000 Senior subordinated debentures with interest at 12%, due November 1, 1999 to 2001 150,000 150,000 Other 12,370 16,381 394,037 362,279 Less current portion 17,039 8,527\n$376,998 $353,752\n(1) This loan bears interest at a rate equal to the sum of the \"Eurodollar Rate\" calculated in accordance with the New Credit Agreement plus 4.5% for the first six months after the closing date of the New Credit Agreement, and increasing by 0.25% every three months thereafter.\n(2) This loan bears interest at the rate of 2.75% in excess of the \"Eurodollar Rate\" calculated in accordance with the New Credit Agreement. ___________________________________________________________________\nThe aggregate annual maturities of long-term debt from continuing operations, in thousands, for the four years subsequent to 1995 are: 1996 - $60,525; 1997 - $161,381; 1998 - $2,059; and 1999 - $37,533.\nTotal debt of the discontinued operations, in thousands, amounted to $1,654 and $3,277 as of December 31, 1994 and 1993, respectively. Of these amounts, approximately $1,605 and $1,807 represent the long-term portion.\nThe 12.25% senior subordinated debentures are redeemable in whole or in part, at the option of the Company at any time, at 100% of their principal amount, plus accrued interest. Interest is payable semi-annually on February 15 and August 15. The fair value of these instruments at December 31, 1994, based on market bid prices, was $151.1 million. In March 1995, $40 million of the 12.25% senior subordinated debentures were redeemed from the proceeds received from the sale of the Turbomachinery business in January 1995 (See Note 3).\nThe 12% senior subordinated debentures are currently redeemable in whole or in part, at the option of the Company, at 105% of their principal amount, plus accrued interest. The redemption price declines to 102.5% on November 1, 1995 and to 100% on or after November 1, 1996. Interest is payable semi-annually on May 1 and November 1. The fair value of these instruments at December 31, 1994, based on market bid prices, was $151.9 million.\nThe New Credit Agreement requires the Company, among other things, to meet certain objectives with respect to financial ratios and it and the 12.25% and 12% senior subordinated debentures contain provisions which place certain limitations on dividend payments and outside borrowings. Under the most restrictive of such provisions, the Company must maintain certain minimum consolidated net worth levels, interest coverage and fixed charge coverage levels and the Company is prohibited from declaring or paying cash dividends through at least July 31, 1997.\nBank, advisory and legal fees associated with the 1994 refinancing of the New Credit Agreement amounted to approximately $5.6 million payable in 1994. In addition, a $5.3 million ($.31 per share) charge related to the extinguishment of senior debt under the former domestic senior credit facilities was recorded as an extraordinary charge in 1994. The $5.3 million charge is comprised of a $3.7 million premium paid in 1994 on the prepayment of its $30 million 12.75% senior promissory note and the write- off of approximately $1.6 million of previously deferred loan costs.\nBank, advisory and legal fees associated with the 1993 restructuring of the Company's domestic senior credit facilities amounted to approximately $8.0 million payable in 1993. In addition, 200,000 warrants for the Company's common stock, valued at approximately $.4 million, were issued to one senior lender and, as part of the $125 million repayment plan, the Company has recognized a charge in 1993 of approximately $12 million on the prepayment of its senior notes which was partially financed with Make-Whole Notes from one of its senior lenders and the write-off of approximately $2 million of previously deferred loan costs. Approximately $18.1 million ($1.07 per share) of the above amounts relate to the extinguishment of senior debt and were recorded as an extraordinary item in 1993.\nDeferred debt expense of $4.2 million, associated with the portions of the domestic senior debt and the 12.25% senior subordinated debentures repaid in the first quarter of 1995 as discussed in the preceding paragraphs, was written off as an extraordinary charge in the first quarter of 1995 (See Note 3).\nNote 10 Shareholders' Equity\n\tEquity Incentive Plan Under the Company's Equity Incentive Plan, up to 2,200,000 shares of the Company's $1.00 par value common stock can be issued pursuant to the granting of stock options, stock appreciation rights, restricted stock awards and restricted unit awards to key employees. Options can be granted at no less than 100 percent of the fair market value of the stock on the date of grant or on the prospective date fixed by the Board of Directors. None of these options can be exercised for at least a one-year period from the date of grant. After this waiting period, 25 percent of each option, on a cumulative basis, can be exercised in each of the following four years. Additionally, each option shall terminate no later than 10 years from the date of grant.\nOn August 17, 1993, the Board of Directors approved the repricing of certain outstanding non-qualified stock options granted on previous dates under the Plan. This resulted in the replacement of 468,000 non-qualified stock options at various exercise prices ranging from $10.375 to $20.375, by 272,865 non-qualified stock options at an exercise price of $7.375, the fair market value at the date of the replacement grant, subject to the market price of the Company's stock exceeding $10 per share for a period of 30 days. During 1994, the aforementioned criteria was met. Vested dates are based on the original grant dates of the replaced options.\nOn June 20, 1994, certain additional outstanding non-qualified stock options, granted on previous dates under the Plan, were repriced pursuant to the August 17, 1993 Board of Directors approval. This resulted in the replacement of 15,000 non-qualified stock options at various exercise prices ranging from $11.625 to $20.375, by 9,970 non-qualified stock options at an exercise price of $10.25, the fair market value at the date of the replacement grant. Vested dates are based on the original grant dates of the replaced options.\nThe plan permits awards of restricted stock to key employees subject to a restricted period and a purchase price, if any, to be paid by the employee as determined by the Committee of the Equity Incentive Plan. Grants of 40,000 shares and 30,000 shares of restricted stock were made in 1994 and 1993, respectively, all of which were outstanding as of December 31, 1994. Vesting of such awards is subject to a defined vesting period and to the Company's stock achieving certain performance levels during such period.\nStock option activity under the plan was as follows:\nYear Ended December 31 (Shares in thousands) 1994 1993 1992\nOptions: Granted 450 498 197 Exercised (56) --- (14) Canceled (159) (150) (225) Repricing Canceled (15) (468) --- Issued 10 273 --- Outstanding at end of year 1,537 1,307 1,154 Exercisable at end of year 654 652 767 Available for grant at end of year 55 341 524\nOption price range per share: Granted $ 9.75 $7.375 $11.125 -$ 10.25 -$12.00 Exercised $ 7.00 --- $10.375 -$ 7.375\nDuring 1988, the Company adopted the Equity Incentive Plan for Outside Directors. The plan provides for the granting of non-qualified stock options of up to 600,000 shares of the Company's common stock to directors of the Company who are not employees of the Company or any of its affiliates. Pursuant to this plan, options can be granted at no less than 100 percent of the fair market value of the stock on a date five business days after the option is granted and no option granted may be exercised during the first year after its grant. After this waiting period, 25 percent of each option, on a cumulative basis, can be exercised in each of the following four years. In February 1988, 320,000 stock options were granted at $16.19 per share, all of which were exercisable as of December 31, 1994. In December 1990, 40,000 stock options were granted at $10.375 per share, all of which were exercisable as of December 31, 1994.\nPreferred Stock Purchase Rights On April 22, 1987, the Board of Directors declared a distribution of one Preferred Stock Purchase Right for each share of common stock outstanding. Each right will entitle the holder to buy from the Company a unit consisting of 1\/100 of a share of Junior Participating Preferred Stock, Series A, at an exercise price of $70 per unit. The rights become exercisable ten days after public announcement that a person or group has acquired 20 percent or more of the Company's common stock or has commenced a tender offer for 30 percent or more of common stock. The rights may be redeemed prior to becoming exercisable by action of the Board of Directors at a redemption price of $0.025 per right. If more than 35 percent of the Company's common stock becomes held by a beneficial owner, other than pursuant to an offer deemed in the best interest of the shareholders by the Company's independent directors, each right may be exercised for common stock, or other property, of the Company having a value of twice the exercise price of each right. If the Company is acquired by any person after the rights become exercisable, each right will entitle its holder to receive common stock of the acquiring company having a market value of twice the exercise price of each right. The rights expire on May 4, 1997.\nEmployees Stock Savings Plan Up to 600,000 shares of the Company's common stock are reserved for issuance under the Company's Employees Stock Savings Plan. (See Note 12)\nCommon Stock Warrants In July 1993, the Company issued warrants to purchase 200,000 shares of its common stock at $9.02 per share (subject to adjustment in certain events), to one of its senior lenders in connection with the restructuring of its senior credit facilities. The warrants are exercisable on or before December 31, 1998.\nNote 11 Operations by Industry Segment and Geographic Area\nThe Company classifies its continuing operations into two core business segments: Morse Controls and Pumps, Power Transmission & Instrumentation. Detailed information regarding products by segment is contained in the section entitled \"Business\" included in Part I, Item 1 of this Form 10-K Report. A third business segment entitled Other is included in continuing operations for financial reporting purposes, and includes operations previously sold and operations to be sold as part of the Company's asset divestiture program. Certain 1993 and 1992 amounts have been restated to conform to the 1994 presentation reflecting the Turbomachinery business segment as a discontinued operation. Information about the business of the Company by business segment, foreign operations and geographic area is presented below:\nYear Ended December 31 (Dollars in thousands) 1994 1993 1992\nNet Sales Morse Controls $196,955 $163,876 $192,733 Pumps, Power Transmission & Instrumentation 255,962 249,896 265,336 Other 10,974 80,411 115,114 Total net sales $463,891 $494,183 $573,183\nSegment operating income Morse Controls $ 14,677 $ 3,090 $ 6,031 Pumps, Power Transmission & Instrumentation 29,143 20,646 18,263 Other 38 1,117 (8,739) Total segment operating income 43,858 24,853 15,555 Equity in income (loss) of unconsolidated companies --- (231) 983 Unallocated corporate expenses (5,120) (13,160) (10,233) Net interest expense (32,257) (37,785) (43,721) Income (loss) from continuing operations before income taxes, minority interest, extraordinary item and cumulative effect of change in accounting principle $ 6,481 $(26,323) $(37,416)\nA reconciliation of segment operating income to income from operations follows:\nYear Ended December 31 (Dollars in thousands) 1994 1993 1992\nSegment operating income $ 43,858 $ 24,853 $ 15,555 Unallocated corporate expenses (5,120) (13,160) (10,233) Other income (876) (605) (817) Income from operations $ 37,862 $ 11,088 $ 4,505\nSegment operating income for the year ended December 31, 1993, includes $9.5 million of unusual charges, of which $3.7 million, $1.7 million, and $4.1 million relates to the Morse Controls, Pumps, Power Transmission & Instrumentation, and Other segments, respectively. Unallocated corporate expenses include unusual charges of $6.2 million for the year ended December 31, 1993.\nSegment operating income for the year ended December 31, 1992, includes unusual charges of $16.7 million, of which $.3 million, $.4 million, and $16.0 million relates to the Morse Controls, Pumps, Power Transmission & Instrumentation, and Other segments, respectively.\nThe Morse Controls segment had sales to one commercial customer (Fiat S.p.A. and its subsidiaries) that accounted for 21%, 15% and 18% of consolidated sales in 1994, 1993 and 1992, respectively. No other customer accounted for 10% or more of any segment's sales in 1994, 1993 or 1992.\nYear Ended December (Dollars in thousands) 1994 1993 1992\nIdentifiable assets Morse Controls $165,148 $155,745 $167,717 Pumps, Power Transmission & Instrumentation 196,318 196,748 194,408 Other 24,074 46,434 130,599 Corporate 44,149 55,915 91,118 Discontinued Operations: Electro-Optical 85,000 85,000 266,092 Turbomachinery 59,970 56,711 61,894 Total identifiable assets $574,659 $596,553 $911,828\nDepreciation and amortization Morse Controls $ 7,374 $ 6,775 $ 7,737 Pumps, Power Transmission & Instrumentation 9,820 9,449 9,388 Other 826 3,435 4,622 Corporate 3,973 3,516 2,499 Total depreciation and amortization $ 21,993 $ 23,175 $ 24,246\nCapital expenditures Morse Controls $ 4,042 $ 4,907 $ 5,638 Pumps, Power Transmission & Instrumentation 4,586 4,065 5,055 Other 68 1,069 982 Corporate 510 352 3,282 Total capital expenditures $ 9,206 $ 10,393 $ 14,957\nThe continuing operations of the Company on a geographic basis are as follows:\nYear Ended December 31 (Dollars in thousands) 1994 1993 1992\nNet sales United States $246,601 $307,918 $344,808 Foreign (principally Europe) 217,290 186,265 228,375 Total net sales $463,891 $494,183 $573,183\nSegment operating income United States $ 31,679 $ 26,046 $ 8,451 Foreign 12,179 (1,193) 7,104 Total segment operating income $ 43,858 $ 24,853 $ 15,555\nIdentifiable assets Continuing Operations: United States $254,261 $283,614 $408,297 Foreign 175,428 171,228 175,545 Discontinued Operations: United States 141,053 135,585 322,827 Foreign 3,917 6,126 5,159 Total identifiable assets $574,659 $596,553 $911,828\nExport sales Asia $ 2,763 $ 4,362 $ 5,547 Latin America 2,368 1,699 4,202 Canada 3,748 3,132 7,280 Mexico 861 701 530 Europe 2,857 2,750 5,505 Other 3,293 2,596 3,474 Total export sales $ 15,890 $ 15,240 $ 26,538\nNote 12 Pension Plans\nThe Company and its subsidiaries have various pension plans covering substantially all of their employees. Benefits are based on either years of service or years of service and average compensation during the years immediately preceding retirement. Pension expense was $7.9 million in 1994, $8.4 million in 1993 and $8.7 million in 1992, and includes amortization of prior service cost and transition amounts for periods of 6 to 13 years. In 1993 the Company's divestiture program resulted in a decrease in U.S. pension plan participants. The total curtailment and settlement gain, in 1993, of $1.2 million was applied to the reserve for divestitures (See Note 4). The Company included a $1.9 million curtailment loss in its estimated loss on disposal related to the discontinued operation in 1993. It is the general policy of the Company to fund its pension plans in conformity with requirements of applicable laws and regulations. Pension expense (including $5.7 million, $4.5 million and $3.9 million charged to discontinued operations in 1994, 1993 and 1992, respectively) is comprised of the following:\nYear Ended December 31 (Dollars in thousands) 1994 1993 1992\nService cost $ 7,237 $ 7,678 $ 7,526 Interest cost on projected benefit obligation 14,158 13,802 14,271 Actual return on plan assets (449) (22,646) (10,620) Net amortization and deferral (12,963) 9,567 (2,452) Net pension expense $ 7,983 $ 8,401 $ 8,725\nAssumptions used in the accounting for the Company-sponsored defined benefit plans:\nYear Ended December 31 1994 1993 1992\nWeighted average discount rate 8.5% 7.5% 8.0% Rate of increase in compensation levels 5.3% 5.3% 5.3% Expected long-term rate of return on assets 9.0% 9.0% 9.0%\nThe following table sets forth the funded status and amounts recognized in the consolidated balance sheet for the defined benefit pension plans:\nYear Ended December 31 (Dollars in thousands) 1994 1993 Assets Accumulated Assets Accumulated Exceed Benefits Exceed Benefits Accumulated Exceed Accumulated Exceed Benefits Assets Benefits Assets Actuarial present value of benefit obligations: Vested benefit obligation $101,869 $ 60,492 $102,819 $ 62,394 Accumulated benefit obligation $105,020 $ 61,253 $107,089 $ 63,428 Projected benefit obligation $119,886 $ 62,661 $128,485 $ 64,432 Plan assets at fair value 127,850 47,542 135,616 49,326 Plan assets in excess of (less than) projected benefit obligation 7,964 (15,119) 7,131 (15,106) Unrecognized net (gain) or loss (5,897) (175) (1,300) 1,752 Prior service cost not yet recognized in net periodic pension cost 4,066 3,348 4,779 3,524 Unrecognized net (asset) obligation at transition 3,407 821 4,198 1,251 Adjustment required to recognize minimum liability _ (4,165) _ (6,507) Pension asset (liability) recognized in the balance sheet $ 9,540 $ (15,290) $ 14,808 $(15,086)\nPlan assets at December 31, 1994, are invested in fixed dollar guaranteed investment contracts, United States Government obligations, fixed income investments, guaranteed annuity contracts and equity securities whose values are subject to fluctuations of the securities market.\nThe Company maintains a defined contribution (Employees Stock Savings) plan covering substantially all domestic, non-union employees. Eligible employees may generally contribute from 1% to 12% of their compensation on a pretax basis. The Company's historical matching percentage is 50% of the first 6% of each participant's pretax contribution. The employer matching contributions have been temporarily suspended since July 1992. The Company's expense was $1.8 million for 1992.\nNote 13 Postretirement Benefits\nIn addition to providing pension benefits, the Company provides certain health care and life insurance benefits for retired employees. Substantially all of the Company's non-union employees retiring from active service and immediately receiving retirement benefits from one of the Company's pension plans would be eligible to receive such benefits. The Company's unionized retiree benefits are determined by their individually negotiated contracts. The Company's contribution toward the full cost of the benefits is based on the retiree's age and continuous unbroken length of service with the Company. The Company's policy is to pay the cost of medical benefits as claims are incurred. Life insurance costs are paid as insured premiums are due.\nIn December 1990, the FASB issued Statement No. 106, \"Employer's Accounting for Postretirement Benefits Other Than Pensions,\" which requires the accrual method of accounting for postretirement benefits. The accumulated benefit obligation at transition of $44.5 million was recognized as a cumulative effect of a change in accounting principle net of $16.9 million of income taxes calculated in accordance with the FASB's Statement No. 109, \"Accounting for Income Taxes\" (See Note 8), and retroactively applied as of January 1, 1992. In prior years, the cost for life insurance benefits was recognized as premiums were paid and the cost of retiree health care was recognized when claims were paid.\nIn March 1994, the Company amended its policy regarding retiree medical and life insurance. This amendment, which affects some current retirees and all future retirees, phases out the Company subsidy for retiree medical and life insurance over a three year period ending January 1, 1997. The Company expects to amortize associated reserves to income over the phase- out period at approximately $4 million per year. The Company does not anticipate a significant increase or decrease in cash requirements related to this change in policy during the phase-out period. The Company also increased the discount rate in 1994 to 8.5% from 7.5% in 1993 in line with the change in the overall economic environment. This change has an insignificant effect on the net periodic postretirement benefit cost.\nThe following tables set forth the plans' combined status reconciled with the amounts included in the consolidated balance sheet:\nDecember 31 (Dollars in thousands) 1994 Life Medical Insurance Plans Plans Total\nAccumulated postretirement benefit obligation: Retirees $ 16,709 $ 4,826 $ 21,535 Fully eligible active plan participants 1,365 262 1,873 Other active plan participants 1,326 68 1,148 19,400 5,156 24,556 Plan assets --- --- --- Unrecognized prior service cost 7,840 7,376 15,216 Unrecognized net loss (2,423) (2,043) (4,466) Postretirement benefit liability recognized in the balance sheet $ 24,817 $ 10,489 $ 35,306\nDecember 31 (Dollars in thousands) 1993 Life Medical Insurance Plans Plans Total\nAccumulated postretirement benefit obligation: Retirees $ 28,134 $ 8,035 $ 36,169\nFully eligible active plan participants 6,130 1,200 7,330 Other active plan participants 3,750 520 4,270 38,014 9,755 47,769 Plan assets --- --- --- Unrecognized prior service cost --- --- --- Unrecognized net loss (3,693) (920) (4,613) Postretirement benefit liability recognized in the balance sheet $ 34,321 $ 8,835 $ 43,156\nThe 1994 accrued postretirement benefits amount is classified as follows; $2.2 million current liabilities, $30.9 million long-term liabilities, and $2.2 million in net assets of discontinued operations - noncurrent. For 1993, these amounts are $2.2 million, $33.2 million and $7.8 million, respectively.\nAs a result of the divestitures in 1994 and 1993, the Company recognized a $0.3 million gain and a $2.2 million gain, respectively, related to the curtailment of its postretirement benefit plans. These curtailment gains were applied to the reserve for divestitures (See Note 4).\nAs a result of the Company's decision to sell its Electro-Optical Systems operations a curtailment gain of $1.3 million was recognized in 1993. This curtailment gain is a component of the estimated loss on disposal of discontinued operations (See Note 2).\nNet periodic postretirement benefit cost (including $2.3 million credited in 1994 and $1.0 million charged in 1993 to discontinued operations) included the following components:\nYear Ended December 31 (Dollars in thousands) 1994 Life Medical Insurance Plans Plans Total Service cost $ 100 $ 7 $ 107 Interest cost 1,547 289 1,836 Amortization of prior service cost (5,955) (1,967) (7,922) Amortization of loss 543 103 646 Net periodic postretirement benefit cost $ (3,765) $ (1,568) $ (5,333)\nYear Ended December 31 (Dollars in thousands) 1993 Life Medical Insurance Plans Plans Total Service cost $ 372 $ 63 $ 435 Interest cost 2,999 750 3,749 Amortization of prior service cost --- Amortization of loss --- Net periodic postretirement benefit cost $ 3,371 $ 813 $ 4,184\nActual negotiated health care premiums were used in calculating 1994 and 1993 health care costs. It is expected that the annual increase in medical costs will be 13.5% from 1994 to 1995, grading down in future years by .5% per year until it reaches a future general medical inflation level of 6%. Inflation has been capped at 200% for active non-union employees. 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 $1.7 million at beginning of year 1994 and the net periodic cost by $.1 million for the year. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8.5% and 7.5% in 1994 and 1993, respectively.\nNote 14 Leases\nThe Company leases certain manufacturing and office facilities, equipment, and automobiles under long-term leases. Future minimum rental payments required under operating leases of continuing operations that have initial or remaining noncancelable lease terms in excess of one year, as of December 31, 1994, are:\n(Dollars in thousands) 1995 $ 5,100 1996 4,567 1997 3,433 1998 3,081 1999 1,505 Thereafter 3,503\nTotal minimum lease payments $ 21,189\nTotal rental expense under operating leases charged against continuing operations was $8.9 million in 1994, $9.3 million in 1993 and $10.9 million in 1992.\nNote 15 Contingencies\nIn August 1985, the Company was named as defendant in a lawsuit filed by Long Island Lighting Company (\"LILCO\"). The action stemmed from the sale of three diesel generators to LILCO for use at its Shoreham Nuclear Power Station. During testing of the diesel generators, the crankshaft of one of the diesel generators severed. The Company's insurers have defended the action under a reservation of rights.\nOn April 10, 1991, a jury, in a trial limited to liability, in the U.S. District Court in the Southern District of New York, found that the warranty was in effect from the time of shipment of the diesel generators until July 1986. On July 22, 1992, the trial court entered a judgment in the amount of $18.3 million which included interest to the judgment date.\nOn September 22, 1993, the Second Circuit Court of Appeals affirmed all lower court decisions in this matter. On October 25, 1993, the judgment against the Company was satisfied by payment to LILCO of approximately $19.3 million by two of the Company's insurers.\nIn late June 1992, the Company filed an action in the United States District Court for the Northern District of California against one of its insurers in an attempt to collect amounts for defense costs paid to counsel retained by the Company in defense of the LILCO litigation. The insurer has refused to reimburse the Company for approximately $8.5 million in defense costs paid by the Company alleging that defense costs above reasonable levels were expended in defending this litigation. Upon motion by the defendant this action has now been transferred to the Southern District of New York and assigned to one of the judges who heard the underlying LILCO trial.\nIn January 1993, the Company was served with a complaint in a case brought in United States District Court for the Northern District of California by another insurer alleging that the insurer was entitled to recover $10 million in defense costs previously paid in connection with the LILCO matter and $1.2 million of the judgment which was paid on behalf of the Company. The complaint alleges inter alia that the insurer's policies did not cover the matters in question in the LILCO case. In connection with this matter, the Company filed a counterclaim against the insurer seeking payment of $8.5 million in defense costs that the Company previously paid in connection with the LILCO litigation. On January 25, 1995, the Court entered a judgment, based on its December 15, 1994 memorandum and order, dismissing the Company's counterclaim, denying the Company's Motion for Summary Judgment, and finding sua sponte that there was no coverage under the insurer's policy for the LILCO matter. On February 8, 1995, the Company filed an Application for Leave to File Motion for Reconsideration of the Judgment which was subsequently denied. The Company also filed a Notice of Appeal with the Ninth Circuit Court of Appeals. Subsequent to entry of the District Court Judgment, the insurer moved to have the judgment modified to award the insurer the $10 million defense costs and $1.2 million indemnity payment. The Company has filed a motion in opposition to this motion. Oral arguments relating to this motion were held on February 24, 1995 and the Company is awaiting the District Court's decision.\nThe Company and one of its subsidiaries are two of a large number of defendants in a number of lawsuits brought by approximately 13,500 claimants who allege injury caused by exposure to asbestos. Although the Company and its subsidiary have never been producers or direct suppliers of asbestos, it is alleged that the industrial and marine products sold by the Company and the subsidiary had components which contained asbestos. The allegations state a claim for asbestos exposure when Company-manufactured equipment was maintained or installed. Suits against the Company have been tendered to its insurers who are defending under their stated reservation of rights. The insurers for the subsidiary are being identified and have been and will be provided notice. Should settlements for these claims be reached at levels comparable to those reached by the Company in the past, they would not be expected to have a material effect on the Company.\nThe activities of certain employees of the Ni-Tec Division of the Company's Varo Inc. subsidiary (\"Ni-Tec\"), headquartered in Garland, Texas, are the focus of an ongoing investigation by the Office of the Inspector General of the United States Department of Defense and the Department of Justice (Criminal Division). On July 16, 1992, Ni-Tec received a subpoena for certain records as a part of the investigation, which subpoena has been responded to. Additional subpoenas for additional documents were received in September 1992, February 1993, and March 1994. The Company responded to the September and March subpoenas and the government subsequently withdrew the February subpoena. The investigation appears directed at quality control, testing and documentation activities which began at Ni-Tec while it was a division of Optic-Electronic Corp. Optic-Electronic Corp. was acquired by the Company in November 1990 and subsequently merged with Varo Inc. in 1991. The Company continues to cooperate fully with the investigation.\nThe Securities and Exchange Commission (the \"Commission\") is conducting an inquiry into, among other things, certain accounting practices at Ni-Tec and the 1991 and 1992 fiscal year financial reporting by the Company with respect thereto. The Commission has sought certain information from the Company relating to such inquiry and the Company has cooperated with this request. This inquiry has been dormant since August 1994.\nThe Company was notified in August 1994 that its Electro-Optical operations are being investigated by the United States Attorney for the District of Columbia. The investigation concerns the appropriateness of certifications submitted by Company personnel regarding its contracts with the Arab Republic of Egypt that were funded by the United States Government. In connection with this investigation, the Company has received and has responded to a subpoena issued by the Grand Jury for the District of Columbia.\nRegarding environmental matters, the operations of the Company, like those of other companies engaged in similar businesses, involve the use, disposal and clean-up of substances regulated under environmental protection laws.\nIn a number of instances the Company has been identified as a Potentially Responsible Party by the United States Environmental Protection Agency, and in one instance the State of Washington, alleging that because various of its divisions had arranged for the disposal of hazardous wastes at a number of facilities that have been targeted for clean-up pursuant to the Comprehensive Environmental Response Compensation and Liability Act (\"CERCLA\") or similar State law. Although CERCLA and corresponding State law liability is joint and several, the Company believes that its liability will not have a material adverse effect on the financial condition of the Company since it believes that it either qualifies as a de minimis or minor contributor at each site. Accordingly, the Company believes that the portion of remediation costs that it will be responsible for will therefore not be material. For additional information see section entitled Environmental Matters in Part I, Item 1 of this Form 10-K Report.\nThe Company is a defendant in an action filed in the United States District Court for the Middle District of Louisiana brought by Gulf States Utilities Company (\"GSU\"). The complaint alleges that the Company breached its contract for the sale of two emergency diesel generators delivered to GSU's River Bend Nuclear Generating Station in 1981 and 1982. GSU alleges that it has incurred a loss of $8 million and claims additional amounts for the use of money and an equitable adjustment of the purchase price. In July 1992, the District Court for the Middle District of Louisiana granted the Company's motion for Summary Judgment dismissing GSU's claims. In November 1993, the Fifth Circuit Court of Appeals reversed and remanded the case for trial. The ruling eliminated the Company's statute of limitations defense, but preserved all other defenses. In February 1995, a settlement of this matter was tentatively reached requiring a $1.8 million payment by the Company to GSU.\nThe Company also has one other lawsuit pending against it relating to equipment sold by its former diesel engine division and a lawsuit relating to performance shortfalls in products delivered by its Delaval Turbine Division in a prior year.\nWith respect to the litigation and claims described in the preceding paragraphs, it is management's opinion that the Company either expects to prevail, has adequate insurance coverage or has established appropriate reserves to cover potential liabilities; however, the ultimate outcome of any of these matters is indeterminable at this time.\nIn addition, the Company is involved in various other pending legal proceedings arising out of the Company's business. The adverse outcome of any of these legal proceedings is not expected to have a material adverse effect on the financial condition of the Company. However, if all or substantially all of these legal proceedings were to be determined adversely to the Company, which is viewed by the Company as only a remote possibility, there could be a material adverse effect on the financial condition of the Company.\nReported profits from the sale of certain products to the U.S. Government and its agencies are subject to adjustments. In the opinion of management, refunds, if any, will not have a material effect upon the consolidated financial statements.\nThe Company is self-insured for a portion of its product liability and certain other liability exposures. Depending on the nature of the liability claim, and with certain exceptions, the Company's maximum self- insured exposure ranges from $250,000 to $500,000 per claim with certain maximum aggregate policy limits per claim year. With respect to the exceptions, which relate principally to diesel and turbine units sold before 1991, the Company's maximum self-insured exposure is $5 million per claim.\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nBoard of Directors, Imo Industries Inc.\nWe have audited the accompanying consolidated balance sheets of Imo Industries Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, cash flows and shareholders' equity (deficit) for each of the three years in the period ended December 31, 1994. 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 misstatements. An audit also 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 Imo Industries Inc. and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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 as a whole, presents fairly in all material respects the information set forth therein.\nAs discussed in Note 13 to the financial statements, in 1992 the Company changed its method of accounting for postretirement benefits other than pensions.\nERNST & YOUNG LLP Princeton, New Jersey February 15, 1995\nImo Industries Inc. and Subsidiaries Quarterly Financial Information (Unaudited)\nQuarterly financial information for 1994 and 1993 is as follows: (Dollars in thousands except per share amounts) 1st* 2nd* 3rd 4th 1994 (a) Quarter Quarter Quarter Quarter\nNet sales $110,742 $123,230 $113,421 $116,498 Gross profit 31,200 33,799 31,629 34,165 Income (loss) before extraordinary item: Continuing operations 511 (12) 2,051 1,105 Discontinued operations 394 1,764 737 2,680 Extraordinary item --- --- (5,299) --- Net income (loss) 905 1,752 (2,511) 3,785 Earnings (loss) per share: Before extraordinary item: Continuing operations .03 --- .12 .07 Discontinued operations .02 .10 .04 .15 Extraordinary item --- --- (.31) --- Net income (loss) .05 .10 (.15) .22\n1st* 2nd* 3rd* 4th* 1993 (a) Quarter Quarter Quarter Quarter\nNet sales $132,868 $131,643 $117,546 $112,126 Gross profit 37,571 39,557 35,251 32,136 Income (loss) before extraordinary income: Continuing operations (1,807) 1,861 347 (40,488) Discontinued operations (619) (111) (6,584) (205,070) Extraordinary item --- (11,219) (6,876) --- Net income (loss) (2,426) (9,469) (13,113) (245,558) Earnings (loss) per share: Before extraordinary item: Continuing operations (.11) .11 .02 (2.39) Discontinued operations (.03) (.01) (.39) (12.13) Extraordinary item --- (.66) (.41) --- Net income (loss) (.14) (.56) (.78) (14.52)\n(a) The notes to the consolidated financial statements located in Part IV of this Form 10-K Report as indexed at Item 14(a)(1) should be read in conjunction with this summary.\n* Reclassified to conform to 1994 full year presentation.","section_15":""}
{"filename":"24104_1994.txt","cik":"24104","year":"1994","section_1":"Item 1. BUSINESS\nContinental Materials Corporation, Inc. and its subsidiaries (collectively referred to as the \"Company\") operate primarily in two industry segments, the Heating and Air Conditioning segment and the Construction Materials segment. The Heating and Air Conditioning Segment is comprised of Phoenix Manufacturing, Inc. (\"Phoenix\") of Phoenix, Arizona and Williams Furnace Co. (\"Williams\") of Colton, California. The Construction Materials segment is comprised of Castle Concrete Company (\"Castle\") and Transit Mix Concrete Co. (\"Transit Mix\") both of Colorado Springs, Colorado.\nThe Heating and Air Conditioning segment manufactures wall furnaces, console heaters, evaporative air coolers and fan coil\/air handler product lines. Numerous models with differing heating or cooling capacities as well as exterior appearances are offered within each line.\nThe Construction Materials segment is involved in the production and sale of ready mix concrete and other building materials as well as the exploration, extraction and sales of limestone, sand and gravel.\nIn addition to the above operating segments, a General Corporate and Other classification is utilized covering the general expenses of the corporate office which provides treasury, insurance and tax services as well as strategic business planning and general management services.\nThe Company has a 30% interest in Oracle Ridge Mining Partners (\"ORMP\"). ORMP is a general partnership which operates a copper mine near Tucson, Arizona. The Company is not the managing partner of ORMP and thus its operations are accounted for on the equity method with the Company's share of ORMP's operations presented in the other income and expense section of the Company's operating statements.\nFinancial information relating to industry segments appears in Note 12 on page 23 of this Form 10-K. Summary financial information on ORMP appears in Note 4 on page 18 and audited financial statements for ORMP are included in Item 8 of this Form 10-K. See index to item 8 on page 11.\nMARKETING, SALES AND SUPPORT ----------------------------\nMARKETING\nThe Heating and Air Conditioning segment markets its products throughout the United States through plumbing, heating and air conditioning wholesale distributors as well as direct to some major retail home-centers and other retail outlets. Phoenix and Williams utilize independent manufacturers representatives. The Company also employs a small staff of sales personnel. Sales in this segment are predominantly in the United States and are concentrated in the Western and Southwestern states. Sales of Williams' furnaces usually increase in the months of September through January. Sales of Phoenix' evaporative coolers usually increase in the months of February through June. In order to sell wall furnaces and evaporative coolers during the \"off season\", Williams and Phoenix offer extended payment terms to their customers.\nThe Construction Materials segment markets its products primarily through its own direct sales representatives and confines its sales to the Colorado Springs area. Sales are made to government entities, general and sub-contractors and individuals. The businesses of Castle and Transit Mix are affected by the general economic conditions in Colorado Springs (as it relates to construction) and weather conditions. Revenues usually decline in the winter months as the pace of construction slows.\nDuring 1994, no customer accounted for 10% or more of the total sales of either segment.\nCUSTOMER SERVICE AND SUPPORT\nWhile the companies in the Heating and Air Conditioning segment do not perform installation services, they are committed to after-sales service and support of the products. In addition, Williams holds training sessions at its plant for distributors, contractors, utility company employees and other potential customers. The companies in the Construction Materials segment routinely take a leadership role in formulation of the products to meet the strength requirements of their customers.\nBACKLOG\nAt December 31, 1994, Williams' order backlog was approximately $900,000 ($1,100,000 at January 1, 1994) the majority of which represented orders for furnaces.\nAt December 31, 1994, Phoenix had a backlog of approximately $3,000,000 ($1,100,000 at January 1, 1994) representing primarily preseason cooler orders.\nThe above backlogs are all related to the heating and air conditioning segment and are expected to be filled during the first quarter of 1995.\nAt December 31, 1994 Transit Mix and Castle had a backlog of approximately $3,100,000 ($2,600,000 at January 1, 1994) primarily relating to construction contracts awarded and expected to be filled during the first half of 1995.\nManagement does not believe that any of the above backlogs represent a trend but rather are indicative only of the timing of orders received or contracts awarded.\nRESEARCH AND DEVELOPMENT\/PATENTS\nAll companies rely upon, and intend to continue to rely upon, unpatented proprietary technology and information. In addition, recent research and development activities in the Heating and Air Conditioning segment has lead to patent applications related to Phoenix' Power Cleaning System for the evaporative coolers and the configuration of the heat exchanger for Williams' furnaces which has increased efficiency above that previously offered by the industry. The Company believes its interests in its patent applications, as well as its proprietary knowledge are sufficient for its businesses as currently conducted.\nMANUFACTURING\nThe Company conducts its manufacturing operations through a number of facilities as more completely described in Item 2, Properties, below.\nDue to the seasonality of its businesses, Williams and Phoenix build inventory during their \"off seasons\" in order to have adequate wall furnace and evaporative cooler inventory to sell during the \"season\".\nIn general, raw materials required by the Company can be obtained from various sources in the quantities desired. The Company has no long-term supply contracts and does not consider itself dependent on any individual supplier.\nCompliance with environmental protection laws and regulations has not had any material effect upon the Company's capital expenditures, earnings, or competitive position. Castle and Transit Mix have obtained reclamation bonds in the aggregate amount of $860,000 and $1,038,000 respectively to cover the estimated cost of future reclamation on properties currently being mined.\nCOMPETITIVE CONDITIONS\nHEATING AND AIR CONDITIONING - Williams is one of four principal companies producing wall furnaces and holds a significant share of the wall furnace market (excluding units sold to the recreational vehicle industry). The wall furnace market is only a small component of the heating industry. Williams' plant in Colton, California is located close to the major wall furnace markets and it covers the remaining market areas from three warehouse locations situated throughout the country. The sales force consists of Williams' sales personnel and manufacturers' representatives. The entire heating industry is dominated by manufacturers (most of which are substantially larger than the Company) selling diversified lines of heating and air conditioning units directed primarily toward central heating and cooling systems.\nWilliams also manufactures a line of gas fired console heaters. Distribution is similar to wall furnaces with the principal market areas in the South and Southeast. There are five other manufacturers, none of whom is believed to have a dominant share of the market.\nWilliams is a producer of fan coils. Fan coil sales are usually obtained through a competitive bidding process. This market is dominated by International Environmental Corp., a subsidiary of LSB Industries, Inc., a manufacturer of a diversified line of commercial and industrial products. There are also a number of other companies that produce fan coils. All of the producers compete on the basis of price and timeliness of delivery.\nPhoenix produces evaporative air coolers. This market is dominated by Adobe Air. There is one other principal competitor plus a number of other small companies that produce evaporative coolers. All producers of evaporative air coolers compete aggressively on the basis of price.\nCONSTRUCTION MATERIALS - Transit Mix is one of three companies producing ready mix concrete in the Colorado Springs area. Although Transit Mix holds a significant share of the market served, the other two competitors compete aggressively on the basis of price.\nThere are a number of producers of aggregates, sand and gravel in the marketing area served by Transit Mix and Castle who compete aggressively on the basis of price and service.\nMetal doors and door frames, rebar, reinforcement and other construction materials sold in the Colorado Springs metropolitan area are subject to intense competition. Transit Mix competes aggressively with two larger companies and a number of small competitors. However, Transit Mix has a slight competitive advantage in that many of its customers also purchase concrete, sand and aggregates from Transit Mix and Castle whereas our competitors for these particular product lines do not offer concrete, sand or aggregates.\nEMPLOYEES\nThe Company employed 552 persons as of December 31, 1994. Employment varies throughout the year due to the seasonal nature of sales and thus to a lesser extent, production. A breakdown of the prior three years employment at year end by segment was:\nFactory employees at the Colton, California plant are represented by the Amalgamated Industrial Workers Union under a contract that expires in June 1997. Certain drivers, laborers and mechanics at the Colorado Springs facilities are represented by the Western Conference of Teamsters. The contract expired on February 28, 1995 and negotiations are ongoing.\nThe Company considers relations with its employees and with its unions to be good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe heating and air conditioning segment operates out of one owned (Colton, California) and one leased facility (Phoenix, Arizona). Both manufacturing facilities utilized by this segment are, in the opinion of management, in good condition and sufficient for the Company's current needs. Productive capacity exists at the locations such that the Company could exceed the highest volumes achieved in prior years or expected in the foreseeable future and maintain timely delivery.\nThe construction materials segment operates out of two owned facilities in Colorado Springs, Colorado. Additionally, this segment owns four mining properties in four counties in the vicinity of Colorado Springs, Colorado. In the opinion of management, these four properties contain permitted and minable reserves sufficient to service sand, rock and gravel requirements for the foreseeable future.\nThe corporate office operates out of leased facilities in Chicago, Illinois.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nSee Note 6 on page 19 of this Annual Report on Form 10-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 fiscal 1994.\nPART II\nItem 5.","section_5":"Item 5. MARKETING FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nContinental Materials Corporation shares are traded on the American Stock Exchange under the symbol CUO. Market prices for the past two fiscal years are:\nTrading during the two months ended February 28, 1995 ranged from 11 1\/8 to 12 3\/8.\nAt December 31, 1994, the Company had approximately 3,400 shareholders of record.\nThe Company has never paid a dividend. The Company's policy is to reinvest earnings from operations, and the Company expects to follow this policy for the foreseeable future. In addition, the covenants of the Company's unsecured term loan require prior approval of dividends by the lenders. See Note 5 on page 18.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nSELECTED FINANCIAL DATA (Amounts in thousands, except per share amounts)\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n(References to a \"Note\" are to Notes to Consolidated Financial Statements)\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nCash and cash equivalents increased to $2,778,000 at year end compared to $1,067,000 the prior year.\nCash provided from operations in 1994 of $7,191,000 exceeded the $2,727,000 provided in 1993 and the $4,925,000 generated in 1992. The increase in net cash generated by operating activities in 1994 was mainly due to improved sales volume and increased levels of accounts payable and accrued expenses. Accounts payable increased mainly due to the early purchase of raw materials in 1994 for which 1995 price increases had been announced. The increase in accruals was primarily due to the timing of payments with a decrease expected during the first quarter of 1995. The reduction in 1993 from the 1992 level was largely due to working capital changes.\nNet cash used in investing activities was $1,884,000 in 1994 and $3,182,000 in 1992. Net cash of $6,628,000 was provided by investing activities in 1993 primarily as a result of the sale of Imeco, Inc. During 1994, the Company invested $561,000 in Oracle Ridge Mining Partners, comparable to the amount invested during 1992 but approximately half of the investment required in 1993. In addition, during 1993, proceeds of $704,000 were received from the sale of an equity investment.\nCapital expenditures for 1994, 1993 and 1992 were $1,775,000, $3,677,000 and $2,438,000 respectively. There were no significant commitments for capital expenditures at the end of 1994. Budgeted capital expenditures for 1995, exclusive of equipment that may be acquired under operating leases, are approximately $2,756,000 (primarily routine replacements and upgrades), $450,000 more than planned depreciation. The 1995 expenditures will be funded from internal sources and available borrowing capacity.\nIn connection with the sale of Imeco, the Company retained responsibility, if any, on product liability claims involving Imeco equipment occurring prior to the June 30, 1993 sale date. The 1994 results were reduced by $726,000, $426,000 after related tax benefits. This provision is the result of new developments related to these product liability matters. In March 1995, the Company settled the suit brought by ConAgra and their insurance carrier. The amount of the settlement was fully reserved as of December 31, 1994. The remaining Imeco claims are not expected to have a material effect on future earnings. See Note 6.\nDuring 1994, cash of $3,596,000 was used in financing activities. The short- term line of credit was paid off and scheduled long-term debt payments were met. During 1993, cash of $9,914,000 was used in financing activities. The Company used cash from the sale of Imeco, $1,700,000 of borrowings under the line of credit and a portion of the $3,500,000 received from an amendment to the Company's credit agreement with two banks, to repay $12,795,000 of fixed rate long-term debt and the related prepayment penalty of $2,023,000. In addition, the Company acquired 34,000 shares of treasury stock for $296,000 during 1993. Cash of $1,836,000 was used in 1992 to repay scheduled long-term debt payments.\nIn February 1995, the Company amended its credit agreement with two banks to provide $500,000 of additional term debt. The additional debt replaced cash from available funds that was used to pay off an existing mortgage note in November 1994. The $12,000,000 unsecured short-term line of credit remains intact for use in funding seasonal sales programs at Williams Furnace Co. and Phoenix Manufacturing, Inc. The line is also used for stand-by letters of credit to insurance carriers in support of deductible amounts under the Company's insurance program. The interest rates on both the term loan and the short-term line will be reduced to prime during 1995 as certain 1994 profitability goals, set forth in the credit agreement, were met.\nThe Company anticipates the primary source of cash flow in 1995 to be from its operating subsidiaries. This cash flow, supplemented by the line of credit, is sufficient to cover normal and expected future cash needs, including servicing debt and planned capital expenditures.\nOPERATIONS 1994 VS. 1993\nConsolidated net sales from continuing operations increased $12,799,000 (21%). A majority of the increase ($7,698,000) occurred in the construction materials segment. Strong economic conditions and mild weather patterns led to high sales levels throughout the year, including the normally slow winter months. The heating and air-conditioning segment also realized gains of $5,100,000 mainly attributable to hot and dry weather patterns in the areas serviced by Phoenix Manufacturing, Inc.\nThe continued high level of price competition experienced at all of the Company's subsidiaries is expected to continue into 1995. During 1994, the Company experienced some increases in the cost of key raw materials. Selling prices were increased but the Company was unable to recover all of such cost increases.\nCost of sales (exclusive of depreciation and depletion) remained consistent at 76% between years. The 1.7% decline in the heating and air-conditioning segment, due to price competition and the raw material cost increases, was offset by 1.5% improvement in the construction materials segment due mainly to increased volume as a relatively large portion of its operating costs and expenses are fixed in nature.\nSelling and administrative expenses rose $1,297,000 (12%) although they declined as a percentage of net sales from 17% to 16%.\nThe increase in operating income is mainly due to the increase in net sales.\nThe Company recorded a loss of $545,000 related to its investment in Oracle Ridge Mining Partners compared to $1,188,000 in the prior year. The reduction in the loss is attributed to increased production and higher copper prices as well as nonrecurring development costs incurred in the prior year. In 1993, the project was shut down for a three-month period to install equipment and facilities to increase production and improve copper recovery. Copper prices increased throughout 1994, beginning around 74 cents per pound in January and ending at $1.38. Since then, prices have decreased slightly to $1.30 as of the end of February 1995. During 1994, the partnership entered into a one-year agreement beginning September 1994 which fixes the price that the partnership receives for the copper it produces at $1.07 per pound on approximately 50% of ORMP's production. Copper prices have historically been, and are expected to remain volatile.\nDiscussion of the discontinued operation and the prepayment penalty is presented above under the heading Financial Condition, Liquidity and Capital Resources.\nThe Company's effective income tax rate on income from continuing operations (34.2%) reflects federal and state statutory rates adjusted for the effect of non-deductible expenses and other tax items. The current year was favorably impacted by a substantially higher percentage depletion allowance. The 1993 rate was favorably influenced by the reversal of certain income tax contingencies related to matters resolved in favor of the Company. (See Note 10 for the rate reconciliation).\nOPERATIONS 1993 VS. 1992\nConsolidated net sales from continuing operations increased $1,513,000 (2%). The net sales of the heating and air-conditioning segment accounted for virtually all of the gain while the net sales of the construction materials segment remained strong but static compared to the previous year. Sales at Williams Furnace Co. increased 12% due to a strengthening in the markets served and acceptance in the market place of the company's higher efficiency furnaces. Sales at Phoenix Manufacturing, Inc. declined reflecting cool, wet weather last spring in the southwestern states.\nThe Company experienced a high level of price competition at all of its subsidiaries which the Company expects to continue into 1994. During 1993, inflation was not a significant factor at any of the operations.\nCost of sales (exclusive of depreciation and depletion) increased marginally due to higher than normal workers' compensation costs in the construction materials segment.\nSelling and administrative expenses increased $764,000 (8%) due to the increase in sales and additional costs associated with new product development and marketing. As a percentage of sales, selling and administrative expense increased from 16% to 17%.\nThe decrease in the operating income reflects the higher selling and administrative cost as well as the marginal increase in cost of sales.\nThe decrease in interest expense of $98,000 reflects a lower interest rate on term debt during 1993.\nThe Company recorded a loss of $1,188,000 related to its investment in Oracle Ridge Mining Partners. This loss represents the Company's share (30%) of the loss of the partnership for 1993. The Company began accounting for this investment on the equity basis in 1993 (see Note 4). The loss is due to mine development costs, lower than expected mill recoveries and weak copper prices throughout 1993. The project was shut down from August 2 through the end of October to install equipment and facilities to improve copper recovery. Copper prices decreased throughout most of 1993 reaching a low of approximately 72 cents per pound in the fourth quarter. Since then, prices have improved to approximately 90 cents per pound as of the beginning of March 1994. Copper prices have historically been, and are expected to remain volatile.\nThe Company realized a gain of $794,000 from the sale of an equity investment previously held by Transit Mix Concrete Co.\nDiscussion of the discontinued operation and the prepayment penalty is presented above under the heading Financial Condition, Liquidity and Capital Resources.\nThe Company's 1993 effective income tax rate on income from continuing operations was favorably influenced by the reversal of certain income tax contingencies related to matters resolved in favor of the Company (see Note 10 for the rate reconciliation).\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPAGE\nFinancial Statements and Schedules of Continental Materials Corporation and report thereon:\nConsolidated statements of operations and retained earnings for fiscal years 1994, 1993 and 1992 12\nConsolidated statements of cash flows for fiscal years ended 1994, 1993 and 1992 13\nConsolidated balance sheets at December 31, 1994 and January 1, 1994 14\nNotes to consolidated financial statements 15-23\nIndependent Auditors' Report 24\nFinancial Statements and Schedules of Oracle Ridge Mining Partners and report thereon:\nIndependent Auditors' Report 25\nBalance sheet at December 31, 1994 26\nStatement of operations for the fourteen-month period ended December 31, 1994 27\nStatement of partners' deficit for the fourteen- month period ended December 31, 1994 28\nStatement of cash flows for the fourteen-month period ended December 31, 1994 29\nNotes to financial statements 30-33\nCONTINENTAL MATERIALS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS AND RETAINED EARNINGS For Fiscal Years 1994, 1993 and 1992 (Amounts in thousands, except per share data)\n--------------------------------------------------------------------------------\nThe accompanying notes are an integral part of the financial statements.\nCONTINENTAL MATERIALS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS For Fiscal Years 1994, 1993, and 1992 (Amounts in thousands) --------------------------------------------------------------------------------\nSupplemental Schedule of non-cash investing and financing activities: A portion of the proceeds from the sale of equity investment was in the form of preferred stock valued at $90.\nThe accompanying notes are an integral part of the financial statements.\nContinental Materials Corporation Consolidated Balance Sheets December 31 and January 1, 1994 (Amounts in thousands except share data) -------------------------------------------------------------------------------\nThe accompanying notes are an integral part of the financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION The consolidated financial statements include Continental Materials Corporation and all of its subsidiaries (the \"Company\"). Beginning in 1993, the equity method of accounting is used for the Company's 30% interest in Oracle Ridge Mining Partners. Prior to 1993, this investment was accounted for on the cost basis.\nCertain prior years' amounts have been reclassified to conform with the current presentation.\nINVENTORIES Inventories are valued at the lower of cost or market. Cost is determined using the last-in, first-out (LIFO) method for approximately 88% of total inventories at December 31, 1994 (87% at January 1, 1994). The cost of all other inventory is determined by the first-in, first-out (FIFO) method.\nPROPERTY AND DEPRECIATION Property, plant and equipment are carried at cost. Depreciation is provided over the estimated useful lives of the related assets using the straight-line method as follows:\nBuildings . . . . . . . . . 10 to 31 years Leasehold improvements. . . Terms of leases Machinery and equipment . . 3 to 10 years\nThe cost of property sold or retired and the related accumulated depreciation are removed from the accounts and the resulting gain or loss is reflected in other income. Maintenance and repairs are charged to expense as incurred. Major renewals and betterments are capitalized and depreciated over their useful lives.\nRETIREMENT PLANS The Company and certain subsidiaries have various contributory and noncontributory defined contribution profit sharing retirement plans for specific employees. Costs under the plans are charged to operations as incurred. The plans are funded currently with the exception of the executive deferred compensation plan and the supplemental profit sharing plan.\nRESERVE FOR SELF-INSURED LOSSES The Company's risk management program provides for certain levels of loss retention for workers' compensation, automobile liability and general and product liability claims. The provision for self-insured losses is recorded based on the Company's estimate of the liability for claims incurred in accordance with the requirements of Statement of Financial Accounting Standards No. 5, \"Accounting for Contingencies.\"\nCASH AND CASH EQUIVALENTS The Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nINCOME TAXES Income taxes are reported consistent with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Deferred taxes reflect the future tax consequences associated with the differences between financial accounting and tax bases of assets and liabilities.\nCONCENTRATION OF CREDIT RISK Financial instruments, which potentially subject the Company to concentrations of credit risk, consist principally of trade receivables and temporary cash investments. The Company invests its excess cash in commercial paper of companies with strong credit ratings. These securities typically mature within 30 days. The Company has not experienced any losses on these investments.\nThe Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and such losses have been within management's expectations. See Note 12 for a description of the Company's customer base and geographical location by segment.\nFISCAL YEAR END In 1993, the Company changed its fiscal year end from the Friday to the Saturday nearest December 31. The effect of the change on the 1993 financial statements was immaterial. Fiscal 1994, 1993 and 1992 each consist of 52 weeks.\n2. DISCONTINUED OPERATION In June 1993, the Company sold its Imeco, Inc. (\"Imeco\") subsidiary for a cash payment of $10,750,000. Net assets at the sale date consisted primarily of receivables of $1,909,000, inventories of $1,397,000 and payables of $1,380,000 as well as non-current assets of net property, plant and equipment of $3,204,000 and net intangibles of $3,771,000.\nThe sale resulted in a pre-tax gain of $1,050,000 ($825,000 after-tax or $0.71 per share). This gain is net of an accrual, recorded in the fourth quarter of 1993, for management's best estimate of possible costs to be incurred related to product liability suits retained by the Company. During the fourth quarter of 1994, the Company re-evaluated the accrual and, based on updated information, recorded an additional $726,000 ($464,000 after-tax or $0.41 per share). See Note 6.\nThe results of Imeco have been reported separately as a component of discontinued operations in the Consolidated Statements of Operations and Retained Earnings. Net sales of Imeco were $7,513,000 and $18,187,000 for the six months ended June 30, 1993 and fiscal year 1992, respectively.\n3. INVENTORIES Inventories consisted of the following (amounts in thousands):\nIf inventories valued on the LIFO basis were valued at current costs, inventories would be higher as follows: 1994--$2,716,000 1993--$2,456,000; and 1992--$2,643,000.\n4. INVESTMENT IN MINING PARTNERSHIP The Company has a 30% ownership interest in Oracle Ridge Mining Partners. ORMP is a general partnership which operates a copper mine primarily situated in Pima County, Arizona. The Company accounted for its investment in ORMP on the cost basis through the end of 1992. In late 1992, the partners of ORMP purchased the obligations owed by the partnership to a bank that had provided a majority of the funding for the redevelopment and initial operating stages of the project.\nSince the end of 1992, the partners have directly provided all of the financing needs of ORMP. Consequently, beginning in 1993, the Company changed its accounting for the investment in ORMP to the equity method.\nThe Company's share of the losses from ORMP in 1994 and 1993 was $545,000 and $1,188,000, respectively. The Company made cash advances of $561,000 and $1,194,000 to ORMP during 1994 and 1993, respectively.\nThe realization of this investment is contingent upon the successful operation of the Oracle Ridge mine.\nThe Company's interest in the assets, liabilities, and results of operations of Oracle Ridge Mining Partners as of and for the years ended December 31, 1994 and 1993 is summarized as follows (amounts in thousands):\n5. LONG-TERM DEBT Long-term debt consisted of the following (amounts in thousands):\nThe unsecured term loan is payable to two banks in semi-annual installments of $700,000 with final principal payment of all then unpaid principal due on April 20, 1996. The loan bears interest at prime plus 3\/4% (prime was 8.5% at December 31, 1994).\nThe Company is required by the unsecured term loan to maintain certain levels of consolidated tangible net worth, to attain certain levels of cash flow (as defined) on an annual basis, and to maintain certain ratios including consolidated debt to consolidated tangible net worth. Additional borrowing, acquisition of stock of other companies, purchase of treasury shares and payment of cash dividends are either limited or require prior approval by the lenders.\nAggregate long-term debt matures as follows (amounts in thousands):\nDuring 1994, the Company had a $12,000,000 unsecured line of credit ($9,000,000 in 1993) with two banks to be used for short-term cash needs and standby letters of credit. Interest was charged at the rate of prime plus 1\/4% on cash borrowings. The weighted average interest rate was 7.2% for fiscal 1994 and 6.3% for fiscal 1993. There was no outstanding balance at December 31, 1994. The outstanding balance at January 1, 1994 was $1,700,000.\nAt December 31, 1994, the Company had letters of credit outstanding totalling approximately $4,429,000 which primarily guarantee various insurance activities.\nIn February 1995, the Company amended its credit agreement with two banks to provide an additional $500,000 of term debt. Interest rates on both the term debt and the short-term line will be reduced to prime during 1995 as certain 1994 profitability goals, as set forth in the credit agreement, were met.\n6. COMMITMENTS AND CONTINGENCIES As discussed in Note 2, the Company retained the responsibility, if any, related to incidents involving Imeco products occurring prior to June 30, 1993. During 1992 ConAgra, Inc. d\/b\/a Armour Food Company and its insurance carrier, Arkwright Mutual Insurance Company, each filed suit against Imeco and Central Ice Machine Company in the District Court of Douglas County, Nebraska. In March 1995, the Company settled the suit. The amount of the settlement was fully reserved as of December 31, 1994. Imeco was also named as one of the defendants in a product liability matter in which an individual was seriously injured while servicing an evaporative condensor unit manufactured by Imeco. No amount of damages has yet been stated. For the period involved, the Company maintained an aggregate deductible amount of $1,000,000 pertaining to product liability claims and a $10,000,000 umbrella policy for losses in excess of $1,000,000. The Company is vigorously defending the claim. Although this proceeding is not expected to have a material effect on financial condition, a negative resolution of this matter could have a material effect on quarterly or annual operating results.\nThe Company is also involved in other litigation matters related to its business. In the Company's opinion, none of these proceedings, when concluded, will have a material adverse effect on the Company's results of operations or financial position.\n7. SHAREHOLDERS' EQUITY Four hundred thousand shares of preferred stock ($.50 par value) are authorized and unissued.\nThere was no treasury shares activity during either 1994 or 1992. Activity for 1993 was as follows (dollars in thousands):\nA Stock Option Plan (the \"Plan\") provides for grants of options and option prices established by the Compensation Committee of the Board of Directors. Options are exercisable for a period of five years from the date of grant. The Company has reserved 180,000 shares for distribution under the Plan. No options are outstanding as of December 31, 1994.\n8. RENTAL EXPENSE, LEASES AND COMMITMENTS The Company leases certain of its facilities and equipment and is required to pay the related taxes, insurance and certain other expenses. Rental expense was $1,694,000, $1,964,000 and $1,781,000 for 1994, 1993 and 1992, respectively.\nFuture minimum rental commitments under non-cancelable operating leases for 1995 and thereafter are as follows: 1995--$1,459,000; 1996--$1,284,000; 1997-- $788,000; 1998--$737,000; 1999--$617,000; and thereafter--$1,091,000.\nThe Company also receives annual rental income of $145,000 from a building it owns. The related lease expires in January 2003 and contains renewal options.\n9. RETIREMENT PLANS Retirement plan expenses charged to operations were $1,165,000, $745,000 and $947,000 in 1994, 1993 and 1992, respectively.\n10. INCOME TAXES The provision (benefit) for income taxes is summarized as follows (amounts in thousands):\nThe provision (benefit) for income taxes has been allocated as follows:\nThe difference between the tax rate on income from continuing operations for financial statement purposes and the federal statutory tax rate was as follows:\nFor financial statement purposes, deferred tax assets and liabilities are recorded at a blend of the current statutory federal and states' tax rates -- 38%. The principal gross temporary differences that give rise to deferred taxes are as follows (amounts in thousands):\n11. UNAUDITED QUARTERLY FINANCIAL DATA The following table provides summarized unaudited quarterly financial data for 1994 and 1993 (amounts in thousands, except per share amounts):\nEarnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share may not equal the total for the year.\n12. INDUSTRY SEGMENT INFORMATION The Heating and Air Conditioning segment produces and sells heating and cooling equipment which is sold primarily to distributors and retail outlets. Sales are nationwide, but are concentrated in the Southwestern U.S. The Construction Materials segment is involved in the production and sale of concrete and other building materials and the exploration, extraction and sale of limestone, sand and gravel. Sales of this segment are confined to the Colorado Springs area.\nOperating profit is determined by deducting operating expenses from all revenues. In computing operating profit, none of the following has been added or deducted: unallocated corporate expenses, interest, other income, income taxes and unusual items.\nGeneral corporate assets are principally cash, accounts receivable and leasehold improvements.\nNo customer accounts for 10% or more of consolidated sales.\nThe industry segment information for fiscal years 1994, 1993 and 1992 is as follows (amounts in thousands):\nINDEPENDENT AUDITORS' REPORT To the Shareholders and Board of Directors of Continental Materials Corporation\nWe have audited the accompanying consolidated balance sheets of Continental Materials Corporation and Subsidiaries as of December 31 and January 1, 1994, and the related consolidated statements of operations and retained earnings and cash flows for each of the three years in the period ended December 31, 1994. 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 Continental Materials Corporation and Subsidiaries as of December 31 and January 1, 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P. Chicago, Illinois March 10, 1995\nINDEPENDENT AUDITORS' REPORT\nOracle Ridge Mining Partners:\nWe have audited the accompanying balance sheet of Oracle Ridge Mining Partners (the Partnership) as of December 31, 1994, and the related statements of operations, partners' deficit, and cash flows for the fourteen month period then ended. These financial statements are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements based on our 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 financial statements present fairly, in all material respects, the financial position of the Partnership as of December 31, 1994 and the results of its operations and its cash flows for the fourteen month period then ended in conformity with generally accepted accounting principles.\nThe accompanying financial statements have been prepared assuming that the Partnership will continue as a going concern. As discussed in Note 1 to the financial statements, the Partnership's losses from operations and partners' capital deficit raise substantial doubt about the Partnership's ability to continue as a going concern. Management's plans concerning these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nDELOITTE & TOUCHE LLP\nTucson, Arizona March 3, 1995\nORACLE RIDGE MINING PARTNERS\nBALANCE SHEET DECEMBER 31, 1994 -------------------------------------------------------------------------------\nSee notes to financial statements.\nORACLE RIDGE MINING PARTNERS\nSTATEMENT OF OPERATIONS FOR THE FOURTEEN MONTH PERIOD ENDED DECEMBER 31, 1994 -------------------------------------------------------------------------------\nSee notes to financial statements.\nORACLE RIDGE MINING PARTNERS\nSTATEMENT OF PARTNERS' DEFICIT FOR THE FOURTEEN MONTH PERIOD ENDED DECEMBER 31, 1994 -------------------------------------------------------------------------------\nSee notes to financial statements.\nORACLE RIDGE MINING PARTNERS\nSTATEMENT OF CASH FLOWS FOR THE FOURTEEN MONTH PERIOD ENDED DECEMBER 31, 1994 -------------------------------------------------------------------------------\nNON CASH INVESTING AND FINANCING ACTIVITIES:\nThe Partnership acquired $149,000 of equipment by an installment purchase.\nSee notes to financial statements.\nORACLE RIDGE MINING PARTNERS\nNOTES TO FINANCIAL STATEMENTS FOR FOURTEEN MONTH PERIOD ENDED DECEMBER 31, 1994 -------------------------------------------------------------------------------\n1. ORGANIZATION AND BASIS OF PRESENTATION\nORGANIZATION - Oracle Ridge Mining Partners (the Partnership) is a general partnership formed under the Arizona Uniform Partnership Act on May 24, 1977 pursuant to a partnership agreement between Union Copper, Inc. (a Maryland corporation) (Union) and Continental Catalina, Inc. (an Arizona corporation) (Continental).\nUnion is a wholly-owned subsidiary of Santa Catalina Mining Corp. (formerly known as South Atlantic Ventures Ltd.) (a Canadian corporation). Continental is a wholly-owned subsidiary of Continental Copper, Inc. (an Arizona corporation) which in turn is a wholly-owned subsidiary of Continental Materials Corporation (a Delaware corporation).\nThe Partnership has a copper mining property with an underground mine and adjacent crushing and grinding equipment situated in Pima County, Arizona which commenced commercial production in 1991. Smelting is performed by an unrelated third party at another location.\nThe Fifth Amended and Restated Partnership Agreement dated October 1, 1994 provides, among other things, the following:\na. Union shall be the managing partner of the project.\nb. Profits and losses shall generally be allocated 70% to Union and 30% to Continental. Certain types of gains or losses may be subject to an alternative allocation.\nBASIS OF PRESENTATION - The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Partnership has incurred a loss from operations of $2,415,658 for the fourteen month period ended December 31, 1994, and, as of December 31, 1994, has a partners' capital deficit of $7,161,036 and a net working capital deficiency of $764,964 which may indicate that the Partnership will be unable to continue as a going concern for a reasonable period of time. If the Partnership is not able to generate sufficient levels of cash flow from operations, additional financial support will be required from the partners or from other sources to pay its obligations as they come due. Management believes that it can continue to improve the efficiency and the output of the mining property to the extent necessary to attain profitable operations. The ability of the Partnership to ultimately attain profitable operations is also dependent upon the market price for copper. The financial statements do not include any adjustments relating to the recoverability of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Partnership be unable to continue as a going concern.\n2. SIGNIFICANT ACCOUNTING POLICIES\nPLANT, EQUIPMENT AND BUILDINGS are carried at cost less accumulated depreciation. Depreciation is provided on the straight-line basis over estimated useful lives which range from four to fifteen years.\nINVENTORIES - Inventories of concentrate and supplies are stated at the lower of average cost or estimated market value.\nMINERAL PROPERTY AND CLAIMS are carried at cost, reflecting costs incurred in connection with the acquisition of the properties, less depletion and write-downs for recognized impairments in value. The carrying value of the mineral property and claims will be charged to operations of the Partnership over future years by means of depletion charges computed on the basis of actual ore production and estimated recoverable ore reserves.\nDEFERRED DEVELOPMENT COSTS are carried at cost reflecting all mine development costs incurred since the recommencement of development in 1989, including an allocable portion of depreciation, interest and general and administrative expenses. Since the commencement of production in March, 1991, only direct mine development expenditures have been deferred. Such costs will be charged to operations in the same manner as mineral property and claims.\nREVENUE RECOGNITION - Revenue is recognized when product is delivered in satisfaction of sales agreements and title passes to the buyer. Final revenue amounts are adjusted based on the results of the final assays of the copper concentrate approximately 60 to 90 days after shipment.\nINCOME TAXES - Each partner reflects its share of taxable income or loss in its tax return and no income taxes are recorded in the financial statements of the Partnership.\n3. INVENTORIES\nInventories consisted of the following at December 31, 1994:\n4. PROPERTY AND MINERAL INTERESTS\nPlant, equipment and buildings consisted of the following at December 31, 1994:\nDepreciation expense for the fourteen month period ended December 31, 1994 totaled $874,513.\nMineral property and claims and deferred developments costs consisted of the following at December 31, 1994:\nDepletion and amortization expense for the fourteen month period ended December 31, 1994 totaled $337,095.\n5. SENIOR DEBT\nThe Partnership owes Union and Continental $4,760,978 and $2,040,418, respectively, as non-interest bearing senior debt with no defined maturity date. Such debt is collateralized by substantially all of the assets of the Partnership.\n6. UNION DEBT\nAs of December 31, 1994, the Partnership was indebted to Union in the amount of $348,492. The loan bears interest at the prime rate plus 2% and does not carry a defined maturity date. Interest is waived for periods in which the Partnership incurs a net loss before interest expense for this debt. Interest has been waived by Union for the fourteen months ended December 31, 1994. This debt is subordinated to the Senior Debt.\n7. SUBORDINATED DEBT DUE TO PARTNERS\nAs of December 31, 1994, the Partnership had subordinated debt due to the partners of $5,244,011 to Union and $2,247,734 to Continental. The subordinated debt bears interest at the prime rate plus 2%. Interest is waived for periods in which the Partnership incurs a net loss before interest expense for this debt. Interest has been waived by Union and Continental for the fourteen months ended December 31, 1994. The debt is subordinated to the Senior Debt (Note 5) and the Union Debt (Note 6) and does not carry a defined maturity date.\n8. MAJOR CUSTOMER AND FIXED PRICE AGREEMENT\nThe Partnership sells all of its concentrate under a sales agreement to a single unrelated customer. Under the terms of an amendment to the sales agreement, the first 160 metric tons of copper per month are sold at a fixed price of $1.07 per pound. If the Partnership does not deliver 160 metric tons, in a given month, the shortfall is added to the next months base requirement of 160 metric tons on a cumulative basis. Monthly sales in excess of 160 metric tons are sold at a computed average market price. The Partnership sold 3,878 metric tons under this agreement for the fourteen months ended December 31, 1994. The market price per pound of copper was $1.43 at December 31, 1994. The fixed price agreement expires August 30, 1995 and the sales agreement expires December 31, 1995.\n9. COMMITMENT\nUnder an arrangement with the State of Arizona, the Partnership has provided a $45,000 bond to be used for reclamation purposes. In addition, the agreement requires that for each ton of ore mined an additional $0.05 will be provided (up to a total of $99,000) for reclamation. Management believes that the amounts provided under this agreement will be sufficient to pay for all reclamation costs.\n10.INSTALLMENT PURCHASE\nIn 1994, the Partnership entered into agreements to purchase two pieces of equipment on an installment basis. At December 31, 1994, the remaining liability related to the purchases was $148,746, all due in 1995. The installment agreements are collateralized by the related items of equipment.\n11.RELATED PARTY TRANSACTIONS\nRelated party transactions are disclosed throughout the financial statements. Additional related party transactions are as follows for the fourteen month period ended December 31, 1994:\nSanta Catalina Mining Corp. is entitled to a management fee equal to $12,000 per month in connection with the performance of its duties as managing partner of the partnership. However, the managing partner shall not be entitled to such fee in the event net operating income for any given month, calculated on an accrual basis, is less than $15,000.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere has been no Form 8-K filed within the 24 months prior to the date of the most recent financial statements reporting a change of accountants and\/or reporting a disagreement on any matter of accounting principle or financial statement disclosure.\nPART III\nPart III has been omitted from this 10-K Report since Registrant will file, not later than 120 days following the close of its fiscal year ended December 31, 1994, its definitive 1995 proxy statement. The information required by Part III will be included in that proxy statement and such information is hereby incorporated by reference, but excluding the information under the headings \"Compensation Committee Report\" and \"Comparison of Total Shareholders' Return\".\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) 1 Financial statements required by Item 14 are included in Item 8 of Part II.\n(a) 2 The following is a list of financial statement schedules filed as part of this Report:\nReport of Independent Auditors on Schedules.....................\nSchedule II Valuation and Qualifying Accounts & Reserves........ For Years Ended December 31, 1994, January 1, 1994 and January 1, 1993.........................................\nAll other schedules are omitted because they are not applicable or the information is shown in the financial statements or notes thereto.\n(a) 3 The following is a list of all exhibits filed as part of this Report:\nExhibit 3 1975 Restated Certificate of Incorporation dated May 28, 1975 filed as Exhibit 5 to Form 8-K for the month of May 1975, incorporated herein by reference.\nExhibit 3a Registrant's By-laws as amended September 19, 1975 filed as Exhibit 6 to Form 8-K for the month of September 1975, incorporated herein by reference.\nExhibit 3b Registrant's Certificate of Amendment of Certificate of Incorporation dated May 24, 1978 filed as Exhibit 1 to Form 10-Q for quarter ended June 30, 1978, incorporated herein by reference.\nExhibit 3c Registrant's Certificate of Amendment of Certificate of Incorporation dated May 27, 1987 filed as Exhibit 3c to Form 10-K for the year ended January 1, 1988, incorporated herein by reference.\nExhibit 10 Continental Materials Corporation Amended and Restated 1994 Stock Option Plan dated May 25, 1994 filed as Appendix A to the 1994 Proxy Statement, incorporated herein by reference.*\nExhibit 10a Fifth Amendment to Revolving Credit and Term Loan Agreement between The Northern Trust, LaSalle National Bank and Continental Materials Corporation dated as of January 31, 1995 (filed herewith).\nExhibit 10b Form of Supplemental Deferred Compensation Agreement filed as Exhibit 10 to Form 10-Q for the quarter ended July 1, 1983, incorporated herein by reference.*\nExhibit 10c Continental Materials Corporation Employee Profit Sharing Retirement Plan Amended and Restated Generally Effective January 1, 1989 (filed herewith).\nExhibit 11 Statement Regarding Computation of Per Share Earnings (filed herewith).\nExhibit 21 Subsidiaries of Registrant (filed herewith).\nExhibit 23 Consent of Independent Accountants (file herewith).\nExhibit 27 Financial Data Schedule (filed herewith).\nExhibit 28 Continental Materials Corporation Employees Profit Sharing Retirement Plan on Form 11-K for the year ended December 31, 1994 (to be filed by amendment).\n* - Compensatory plan or arrangement\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed during the quarter ended December 31, 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 MATERIALS CORPORATION --------------------------------- Registrant\nBy: \/S\/Joseph J. Sum -------------------------------------- Joseph J. Sum, Vice President, Finance\nDate: March 28, 1995\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 CAPACITY(IES) DATE ------------------------ ------------------------- --------------\n\/S\/ James G. Gidwitz ------------------------ James G. Gidwitz Chief Executive Officer and a Director March 28, 1995\n\/S\/ William A. Ryan ------------------------ William A. Ryan President and a Director March 28, 1995\n\/S\/ Joseph J. Sum ------------------------ Joseph J. Sum Vice President and a Director March 28, 1995\n\/S\/ Mark S. Nichter ------------------------ Mark S. Nichter Secretary and Controller March 28, 1995\n\/S\/ Thomas H. Carmody ------------------------ Thomas H. Carmody Director March 28, 1995\n\/S\/ Joseph L. Gidwitz ------------------------ Joseph L. Gidwitz Director March 28, 1995\n\/S\/ Ralph W. Gidwitz ------------------------ Ralph W. Gidwitz Director March 28, 1995\n\/S\/ Ronald J. Gidwitz ------------------------ Ronald J. Gidwitz Director March 28, 1995\n\/S\/ William G. Shoemaker ------------------------ William G. Shoemaker Director March 28, 1995\n\/S\/ Theodore R. Tetzlaff ------------------------ Theodore R. Tetzlaff Director March 28, 1995\nREPORT OF INDEPENDENT AUDITORS ON SCHEDULES\nOur report on the consolidated financial statements of Continental Materials Corporation and Subsidiaries is included on page 24 of this Annual Report on Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page 34 of this Form 10-K.\nIn our opinion, the financial statement schedule 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 L.L.P.\nChicago, Illinois March 10, 1995\nCONTINENTAL MATERIALS CORPORATION\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (C) (D)\nfor the fiscal years 1994, 1993 and 1992","section_15":""}
{"filename":"311094_1994.txt","cik":"311094","year":"1994","section_1":"Item 1 Business. . . . . . . . . . . . . . . . . . . . . . . . . 3 Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. Descrpition of Property\nBranch Offices and Facilities\nThe Banks are engaged in the banking business through 48 offices in eleven counties in Northern California, including eleven offices in Marin County, nine in Sonoma County, seven in Solano County, seven in Napa County, three in Contra Costa County, four in Lake County, two in Mendocino County, two in Nevada County, one in Sacramento County, one in San Francisco County and one in Placer County. All offices are constructed and equipped to meet prescribed security requirements.\nThe Banks own fifteen banking office locations and three administrative buildings, including the Company's headquarters. Thirty-three banking offices and two support facilities are leased. Substantially all of the leases contain multiple five-year renewal options and provisions for rental increase, principally for changes in the cost of living index, property taxes and maintenance.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Company and its subsidiaries are defendants in various legal actions which, in the opinion of management based on discussions with independent legal counsel, will be resolved with no material effect on the Company's consolidated results of operations or financial position.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nThere were no matters submitted to the shareholders during the fourth quarter of 1994.\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 NASDAQ National Market Exchange (NASDAQ) under the symbol \"WABC\". The following table shows the high and low closing price for the common stock, for each quarter, as reported by NASDAQ, previously reported on the American Stock Exchange.\nPeriod High Low -------------------------------------------------------------- First quarter ........................... $29.25 $25.88 Second quarter ........................... 32.50 27.00 Third quarter ........................... 33.25 29.25 Fourth quarter ........................... 33.25 29.00\n-------------------------------------------------------------- First quarter ........................... $30.25 $22.13 Second quarter ........................... 28.75 23.88 Third quarter ........................... 28.50 25.13 Fourth quarter ........................... 28.50 25.75\nAs of December 31, 1994, there were 5,101 holders of record of the Company's common stock. This number does not include Napa Valley Bancorp. stockholders that as of December 31, 1994 had not yet tendered their shares for conversion to Company Common Stock.\nThe Company has paid cash dividends on its common stock in every quarter since commencing operations on January 1, 1973, and it is currently the intention of the Board of Directors of the Company to continue payment of cash dividends on a quarterly basis. There is no assurance, however, that any dividends will be paid since they are dependent upon the earnings, financial condition and capital requirements of the Company and its subsidiaries. Furthermore, the Company's ability to pay future dividends is subject to contractual restrictions under the terms of the note agreement, as discussed in Note 6 to the Consolidated Financial Statements. Under the most restrictive of these contractual provisions, $24.4 million of retained earnings was available for the payment of dividends at December 31, 1994. Limitations of the Company's ability to pay dividends is discussed in Note 15 to the Consolidated Financial Statements on page 58 of this report.\nAdditional information (required by Item 5) regarding the amount of cash dividends declared on common stock for the two most recent fiscal years is discussed in Note 17 to the consolidated financial statements on page 61 of this report.\nAs discussed in Note 7 of the notes to the consolidated financial statements, in December 1986, the Company declared a dividend distribution of one common share purchase right (a \"Right\") for each outstanding share of common stock. The terms of the Rights were amended and restated on September 28, 1989. On March 23, 1995, the Board of Directors of the Company approved a further amendment and restatement of the Rights. Among other things, the amendments approved on that date included a provision to the effect that, after an acquisition of 15 percent of the Company's common stock without the prior consent of the Company, the Board of Directors will have the power to cause each Right to be exchanged for one share of common stock of the Company.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nFinancial Summary (In thousands, except per share data and number of shareholders)\n[FN] *Fully taxable equivalent\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe following discussion addresses information pertaining to the financial condition and results of operations of Westamerica Bancorporation (the \"Company\") that may not be otherwise apparent from a review of the consolidated financial statements and related footnotes. It should be read in conjunction with those statements and notes found on pages 36 through 62, as well as with the other information presented throughout the report. All data presented for 1992 include the April 15, 1993 acquisition of Napa Valley Bancorp.\nThe Company achieved record earnings of $24.7 million in 1994, representing a 161 percent increase from the $9.5 million earned in 1993 and 62 percent higher than 1992 earnings of $15.2 million. The reduced level of earnings in 1993 was mostly due to $10.5 million in after-tax charges resulting from the April 15, 1993 merger with Napa Valley Bancorp (the \"Merger\"), that were taken in the form of asset write-downs, an additional loan loss provision and other merger-related charges. The asset write-downs and the additional loan loss provision reflect the Company's plan of non-performing asset resolution.\nComponents of Net Income ----------------------------------------------------------------------- (Percent of average earning assets) 1994 1993 1992 ----------------------------------------------------------------------- Net interest income* 5.31% 5.48% 5.50% Provision for loan losses (.32) (.53) (.39) Non-interest income 1.05 1.34 1.33 Non-interest expense (3.84) (5.43) (5.00) Taxes* (.87) (.33) (.59) ----------------------------------------------------------------------- Net income 1.33% .53% .85% ======================================================================= Net income as a percentage of average total assets 1.21% .48% .77% ======================================================================= * Fully taxable equivalent (FTE)\nOn a per share basis, 1994 net income was $3.06, compared to $1.17 and $1.92 in 1993 and 1992, respectively. During 1994, the Company continued to benefit from reductions in cost of funds and expense controls which offset declines in non-interest income. Earnings in 1993 were favorably affected compared to 1992 by reductions in cost of funds, increases in service fees and other non-interest income, and expense controls. However, merger-related costs more than offset those benefits. The Company's return on average total assets was 1.21 percent in 1994, compared to .48 percent and .77 percent in 1993 and 1992, respectively. Return on average equity in 1994 was 15.59 percent, compared to 6.51 percent and 11.16 percent, respectively, in the two previous years. Net Interest Income\nDue to increases in the level of average earning assets and a more favorable composition of deposits represented by increasing volumes of lower-costing demand and savings account balances and a reduction in the volumes of higher costing time deposits, the Company was able to generate higher net interest income (FTE) in 1994 when compared to 1993. However, net interest income (FTE) was still slightly lower than 1992. Continuing decreases in higher-yielding loan volumes and the growth of the lower-yielding investment securities portfolio more than offset the effect of increasing market interest rates and the Company's containment of rates paid on interest-bearing liabilities, resulting in a lower net interest margin for 1994.\nComponents of Net Interest Income -------------------------------------------------------------------- (In millions) 1994 1993 1992 -------------------------------------------------------------------- Interest income $ 134.2 $ 137.0 $ 154.8 Interest expense (41.1) (42.3) (58.9) FTE adjustment 5.3 2.8 2.7 -------------------------------------------------------------------- Net interest income (FTE) $ 98.4 $ 97.5 $ 98.6 ==================================================================== Average earning assets $1,851.9 $1,779.3 $1,793.8 Net interest margin (FTE) 5.31% 5.48% 5.50% ====================================================================\nNet interest income (FTE) in 1994 increased $900,000 from 1993 to $98.4 million. Interest income decreased $2.8 million from 1993, as a result of the combined effect of a 32 basis point decline in earning-asset yields partially offset by a $72.6 million increase in average balances. During 1994, increases in the balance of tax-exempt municipal securities resulted in an FTE adjustment $2.5 million higher than 1993. Interest expense decreased $1.2 million from 1993, the result of a decrease of 11 basis points in rates paid partially offset by an increase of $11.8 million in the average balance of interest-bearing liabilities.\nSummary of Average Balances, Yields\/Rates and Interest Differential\nThe following tables present, for the periods indicated, information regarding the consolidated average assets, liabilities and shareholders' equity, the amounts of interest income from average earning assets and the resulting yields, and the amount of interest expense paid on interest-bearing liabilities. Average loan balances include non-performing loans. Interest income includes proceeds from loans on non-accrual status only to the extent cash payments have been received and applied as interest income. Yields on securities and certain loans have been adjusted upward to reflect the effect of income thereon exempt from federal income taxation at the current statutory tax rate. Amortized loan fees, which are included in interest and fee income on loans were $1.2 million lower in 1994 than in 1993 and $1.5 million lower in 1993 than in 1992.\nDistribution of Average Assets, Liabilities and Shareholders' equity Yield\/Rates and Interest Margin ----------------------------------------------------------------------- (In thousands) 1994 ----------------------------------------------------------------------- Interest Rates Average income\/ earned\/ balance expense paid ----------------------------------------------------------------------- Assets Money market assets and funds sold $ 250 $ -- -- % Trading account securities 37 2 4.24 Investment securities 763,360 45,711 5.99\nLoans: Commercial 593,548 52,777 8.89 Real estate construction 37,968 3,890 10.24 Real estate residential 178,946 12,566 7.02 Consumer 277,780 24,583 8.85 --------------------------------------------------------------- Earning assets 1,851,889 139,529 7.53\nOther assets 187,012 ------------------------------------------------------- Total assets $2,038,901 ======================================================= Liabilities and shareholders' equity Deposits Non-interest bearing demand $ 359,768 $ -- -- % Savings and interest-bearing transaction 970,592 18,785 1.94 Time less than $100,000 282,530 11,034 3.91 Time $100,000 or more 97,928 3,545 3.62 --------------------------------------------------------------- Total interest-bearing deposits 1,351,050 33,364 2.47 Funds purchased 126,225 5,139 4.17 Notes and mortgages payable 29,690 2,612 8.80 --------------------------------------------------------------- Total interest-bearing liabilities 1,506,965 41,115 2.73 Other liabilities 13,887 Shareholders' equity 158,281 ------------------------------------------------------- Total liabilities and shareholders' equity $2,038,901 ======================================================= Net interest spread (1) 4.80 % Net interest income and interest margin (2) $98,414 5.31 % =======================================================================\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.\nDistribution of Average Assets, Liabilities and Shareholders' equity Yield\/Rates and Interest Margin ---------------------------------------------------------------------- (in thousands) 1993 ----------------------------------------------------------------------- Interest Rates Average income\/ earned\/ balance expense paid ----------------------------------------------------------------------- Assets Money market assets and funds sold $ 4,463 $ 170 3.80 % Trading account securities 183 6 3.14 Investment securities 631,700 39,794 6.30\nLoans: Commercial 615,981 53,990 8.76 Real estate construction 55,038 4,745 8.62 Real estate residential 168,379 13,322 7.91 Consumer 303,567 27,726 9.13 --------------------------------------------------------------- Earning assets 1,779,311 139,753 7.85\nOther assets 200,561 ------------------------------------------------------- Total assets $1,979,872 ======================================================= Liabilities and shareholders' equity Deposits Non-interest bearing demand $ 330,867 $ -- -- % Savings and interest-bearing transaction 938,475 19,305 2.06 Time less than $100,000 340,122 14,176 4.17 Time $100,000 or more 135,505 4,837 3.57 --------------------------------------------------------------- Total interest-bearing deposits 1,414,102 38,318 2.71 Funds purchased 57,135 1,937 3.39 Notes and mortgages payable 17,959 2,016 11.22 --------------------------------------------------------------- Total interest-bearing liabilities 1,489,196 42,271 2.84 Other liabilities 14,652 Shareholders' equity 145,157 ------------------------------------------------------- Total liabilities and shareholders' equity $1,979,872 ======================================================= Net interest spread (1) 5.01 % Net interest income and interest margin (2) $97,482 5.48 % =======================================================================\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.\nDistribution of Average Assets, Liabilities and Shareholders' equity Yield\/Rates and Interest Margin ------------------------------------------------------------------------ (in thousands) 1992 ------------------------------------------------------------------------ Interest Rates Average income\/ earned\/ balance expense paid ----------------------------------------------------------------------- Assets Money market assets and funds sold $ 42,964 $ 1,765 -- % Trading account securities 103 4 3.67 Investment securities 534,793 40,332 7.54 Loans: Commercial 646,359 60,050 9.29 Real estate construction 76,173 7,058 9.27 Real estate residential 168,030 15,314 9.11 Consumer 325,393 33,003 10.14 --------------------------------------------------------------- Earning assets 1,793,815 157,526 8.78\nOther assets 175,609 ------------------------------------------------------- Total assets $1,969,424 ======================================================= Liabilities and shareholders' equity Deposits Non-interest bearing demand $ 284,366 $ -- -- % Savings and interest-bearing transaction 903,211 26,518 2.94 Time less than $100,000 406,161 20,948 5.16 Time $100,000 or more 184,799 8,365 4.53 --------------------------------------------------------------- Total interest-bearing deposits 1,494,171 55,831 3.74 Funds purchased 15,729 698 4.44 Notes and mortgages payable 20,439 2,363 11.56 --------------------------------------------------------------- Total interest-bearing liabilities 1,530,339 58,892 3.85 Other liabilities 18,263 Shareholders' equity 136,456 ------------------------------------------------------- Total liabilities and shareholders' equity $1,969,424 ======================================================= Net interest spread (1) 4.93 % Net interest income and interest margin (2) $98,634 5.50 % =======================================================================\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\nThe following table sets forth a summary of the changes in interest income and interest expense from changes in average assets and liability balances (volume) and changes in average interest rates for the periods indicated. Changes not solely attributable to volume or rates have been allocated in proportion to the respective volume and rate components.\n[FN] (1) Amounts calculated on a fully taxable equivalent basis using the current statutory federal tax rate.\nProvision for Loan Losses\nThe level of the provision for loan losses reflects the Company's continuing efforts to improve loan quality by enforcing strict underwriting and administration procedures and aggressively pursuing collection efforts with troubled debtors. The provision for loan losses was $5.9 million for 1994, compared to $9.5 million in 1993 and $7.0 million in 1992. The 1993 provision included a $3.1 million merger-related provision, reflecting an aggressive workout strategy for problem loans and properties acquired in the Merger. For further information regarding net credit losses and the reserve for loan losses, see the \"Asset Quality\" section of this report.\nInvestment Portfolio\nThe Company maintains a securities portfolio consisting of U.S. Treasury, U.S. Government Agencies and Corporations, State and political subdivisions, asset-backed and other securities. Investment securities are held in safekeeping by an independent custodian. 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\"). The statement addresses the accounting and reporting for investments in equity securities that have a readily determinable fair value and for all investments in debt securities. The statement requires that all securities be classified, at acquisition, into one of three categories: held to maturity, available for sale, and trading. In classifying securities as being held to maturity, available for sale or trading, the Banks consider their collateral needs, asset\/liability management strategies, liquidity needs, interest rate sensitivity and other factors that will determine the intent and ability to hold the securities to maturity. SFAS No. 115 was effective for fiscal years beginning after December 15, 1993.\nThe objective of the investment securities held to maturity is to strengthen the portfolio yield, and to provide collateral to pledge for federal, state and local government deposits and other borrowing facilities. The investments held to maturity had an average term to maturity of 43 months at December 31, 1994 and, as of the same date, those investments included $594.8 million in fixed rate and $3.9 million in adjustable rate securities.\nInvestment securities available for sale are typically used to supplement the Banks' liquidity. Unrealized net gains and losses on these securities are recorded as an adjustment to equity net of taxes, and are not reflected in the current earnings of the Company. If the security is sold, any gain or loss is recorded as a charge to earnings and the equity adjustment is reversed. At December 31, 1994, the Banks held $160.6 million classified as investments available for sale. At December 31, 1994, a net unrealized loss of $1.8 million net of taxes of $1.2 million related to these securities was held in stockholders' equity.\nThe Company had no trading securities at December 31, 1994.\nFor more information on investment securities, see Notes 1 and 2 to the consolidated financial statements.\nThe following table shows the amortized cost of the Company's investment securities as of the dates indicated:\n----------------------------------------------------------- December 31, (in thousands) 1994 1993 1992 ----------------------------------------------------------- U.S. Treasury $241,322 $245,586 $126,522 U.S. government agencies and corporations 256,133 254,635 237,753 States and political subdivisions (domestic) 198,135 127,302 87,031 Asset backed securities 37,162 65,433 82,270 Other securities 29,632 28,529 36,660 ----------------------------------------------------------- Total $762,384 $721,485 $570,236 ===========================================================\nThe following table is a summary of the relative maturities and yields of the Company's investment securities as of December 31, 1994. Weighted average yields have been computed by dividing annual interest income, adjusted for amortization of premium and accretion of discount, by the book value of the related securities. Yields on state and political subdivision securities have been calculated on a fully taxable equivalent basis using the federal tax rate of 35 percent.\nMaturities and Sensitivity of Selected Loans to Changes in Interest Rates\nThe following table shows the maturity distribution and interest rate sensitivity of Commercial and Real estate construction loans at December 31, 1994.*\n[FN]\n* Excludes loans to individuals and residential mortgages totaling $471,248. These types of loans are typically paid in monthly installments over a number of years. **Includes demand loans\nCommitments and Lines of Credit\nIt is not the policy of the Company to issue formal commitments on lines of credit except to a limited number of well established and financially responsible local commercial enterprises. Such commitments can be either secured or unsecured and are typically in the form of revolving lines of credit for seasonal working capital needs. Occasionally, such commitments are in the form of Letters of Credit to facilitate the customer's particular business transaction. Commitment fees generally are not charged except where Letters of Credit are involved. Commitments and lines of credit typically mature within one year. See also Note 12 of the consolidated notes to the financial statements.\nAsset Quality\nThe Company closely monitors the markets in which it conducts its lending operations. The Company continues its strategy to control its exposure to loans with higher credit risk and increase diversification of earning assets into less risky investments. Asset reviews are performed using grading standards and criteria similar to those employed by bank regulatory agencies. Assets receiving lesser grades fall under the \"classified assets\" category which includes all non-performing assets and potential problem loans. These lesser grades occur when known information about possible credit problems causes doubts about the ability of such borrowers to comply with loan repayment terms. These loans have varying degrees of uncertainty and may become non-performing assets. Classified assets receive an elevated level of attention by Management to ensure collection. Total classified assets peaked during the second quarter of 1993 as a result of the Merger but declined significantly to $63.6 million by December 31, 1993, mainly due to improvements in the Napa Valley Bank classified asset portfolio. Continuing write-downs, loan collections, real estate liquidations and restructuring reflecting the Company's workout strategy, resulted in classified assets of $46.5 million at December 31, 1994, a decrease of $17.1 million, or 27 percent, from the previous year end.\nNon-Performing Assets\nNon-performing assets include non-accrual loans, loans 90 or more days past due and still accruing, other real estate owned and loans classified as substantively foreclosed. Loans are placed on non-accrual status upon reaching 90 days or more delinquent, unless the loan is well secured and in the process of collection. Interest previously accrued on loans placed on non-accrual status is charged against interest income. Loans secured by real estate with temporarily impaired values and commercial loans to borrowers experiencing financial difficulties are placed on non-accrual status even though the borrowers continue to repay the loans as scheduled. Such loans are classified by Management as \"performing non-accrual\" and are included in total non-performing assets.\nPerforming non-accrual loans are reinstated to accrual status when improvements in credit quality eliminate the doubt as to the full collectibility of both interest and principal and the loan is brought current. When the ability to fully collect non-accrual loan principal is in doubt, cash payments received are applied against the principal balance of the loans until such time as full collection of the remaining recorded balance is expected. Any additional payments received after that point are recorded as interest income on a cash basis.\nPerforming non-accrual loans increased $100,000 to $2.0 million at December 31, 1994 while non-performing non-accrual loans decreased $2.1 million to $5.1 million at December 31, 1994, due to loan collections, write-downs and foreclosure of loan collateral. The amount of gross interest income that would have been recorded for non-accrual loans for the year ended December 31, 1994, if all such loans had been current in accordance with their original terms while outstanding during the period was $814,000. The amount of interest income that was recognized on non-accrual loans from cash payments made during the year ended December 31, 1994 totaled $386,000, representing an annualized yield of 4.39 percent. Cash payments received which were applied against the book balance of performing and non-performing non-accrual loans outstanding at December 31, 1994, totaled $248,000 compared to $534,000 in 1993. Of the $5.4 million loan collateral substantively foreclosed at December 31, 1993, a total of $415,000 was reclassified as non-accrual loans at December 31, 1994 and the rest was either foreclosed or liquidated. The declining OREO balance during 1994 and 1993 is due to asset write-downs and liquidations.\nThe Company's reserve for loan 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, credit loss experience, the amount of past due and non-performing loans, recommendations of regulatory authorities, prevailing economic conditions and other factors. The reserve is allocated to segments of the loan portfolio based in part on quantitative analysis of historical credit loss experience. Criticized and classified loan balances are analyzed using a linear regression model or standard allocation percentages. The results of this analysis are applied to current criticized and classified loan balances to allocate the reserve to the respective segments of the loan portfolio. In addition, loans with similar characteristics not usually criticized using regulatory guidelines due to their small balances and numerous accounts, are analyzed based on the historical rate of net losses and delinquency trends grouped by the number of days the payments on those loans are delinquent. While these factors are essentially judgmental and may not be reduced to a mathematical formula, Management considers the $27.6 million reserve for loan losses, which constituted 2.50 percent of total loans at December 31, 1994, to be adequate as a reserve against inherent losses. Management continues to evaluate the loan portfolio and assess current economic conditions that will dictate future reserve levels.\nThe following table summarizes the loan loss experience of the Company for the periods indicated:\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") issued Statement No. 114, \"Accounting by Creditors for Impairment of a Loan\" (\"SFAS 114\"), which addresses the accounting treatment of certain impaired loans and amends FASB Statements No. 5 and No. 15. In October, 1994, the FASB issued statement No. 118, \"Accounting by Creditors for Impairment of a Loan\" Income Recognition and Disclosures\" (\"SFAS 118\"), which amends the income recognition and disclosure provisions of SFAS 114. SFAS 114 and SFAS 118 are effective January 1, 1995.\nUnder SFAS 114, a loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. Under SFAS 114, impairment may be measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate. Alternatively, impairment may be measured by using the loan's observable market price or the fair value of the collateral if repayment is expected to be provided solely by the underlying collateral. The Company will implement SFAS 114, as amended by SFAS 118, in January, 1995. Management believes that the adoption of this pronouncement will not significantly impact the Company's financial statements.\nThe following tables present the allocation of the loan loss reserve balance on the dates indicated:\nAllocation of the loan loss reserve:\n------------------------------------------------------------ December 31, ----------------------- ----------------------- Allocation Loans as of reserve percent of balance total loans ------- ----------- Type of loan Commercial $2,698 52.5% Real estate construction 4,360 9.5 Real estate residential 29 10.4 Consumer 1,782 27.6 Unallocated portion of the reserve 10,132 - ---------------------------------------------------------- Total $19,001 100.0% ==========================================================\nThe reduced allocation to commercial loans from December 31, 1993 to December 31, 1994 is primarily due to a reduction in the balance of criticized loans. The unallocated component includes Management's judgemental determination of the amounts necessary for concentrations, economic uncertainties and other subjective factors. The changes in the allocation to loan portfolio segments from December 31, 1992 to December 31, 1993 reflect changes in criticized and classified loan balances. The increased allocation to construction loans is attributable to an increase in criticized loans due to the recessionary environment. The decreased allocation to commercial and consumer loans is attributable to a higher level of recoveries.\nAsset and Liability Management\nThe fundamental objective of the Company's management of assets and liabilities is to maximize its economic value while maintaining adequate liquidity and a conservative level of interest-rate risk. The principal sources of asset liquidity are marketable investment and money market securities available for sale. At December 31, 1994, investment securities available for sale totaled $160.6 million. As in previous years, decreased loan balances resulted in an increase in the size of the securities portfolio.\nThe Company generates significant liquidity from its operating activities. The Company's profitability in 1994, 1993 and 1992 generated cash flows provided from operations for such years of $27.7 million, $28.4 million and $33.4 million, respectively.\nAdditional cash flow may be provided by financing activities, primarily the acceptance of customer deposits and short-term borrowings from banks. Over the last three years, deposit balances have either remained flat, as in 1992, or declined, as in 1993 and 1994. The decline in 1993 was mainly due to the sale of its 50 percent interest in Sonoma Valley Bank. During 1994, the Company paid off $9.8 million in principal of its high-rate long-term debt. To compensate for decreases in deposits and long-term debt, the Company increased its short-term borrowings, which grew $64.2 million, $57.0 million and $2.5 million in 1994, 1993 and 1992, respectively. In addition, in December, 1993, Westamerica Bank issued a ten-year, $20.0 million subordinated capital note that qualifies as Tier II Capital, to be used as a source of working capital.\nThe Company uses cash flow from operating and financing activities to make investments in loans, money market assets and investment securities. The Company's strategy to reduce its exposure to high-risk loans is shown in the reduction of loan volumes over the past three years, when balances decreased $11.0 million, $68.1 million and $32.8 million in 1994, 1993 and 1992, respectively. The smaller decline in 1994 reflects efforts of the Company to stabilize loan volume without jeopardizing credit quality. The net repayment of loans resulted in added liquidity for the Company, which increased its investment securities portfolio by $40.9 million, $153.3 million, and $54.7 million in 1994, 1993 and 1992, respectively.\nInterest rate risk is influenced by market forces. However, that risk may be controlled by monitoring and managing the repricing characteristics of interest-bearing assets and liabilities. The primary analytical tool used by Management to gauge interest-rate sensitivity is a simulation model used by many major banks and bank regulators. This industry standard model is used to simulate the effects on net interest income of changes in market interest rates that are up to 2 percent higher or 2 percent lower than current levels. The results of the model indicate that the mix of interest-rate sensitive assets and liabilities at December 31, 1994 would not, in the view of Management, expose the Company to an unacceptable level of interest-rate risk.\nCapital Resources\nThe current and projected capital position of the Company and the impact of capital plans and long-term strategies is reviewed regularly by Management. The Company's capital position represents the level of capital available to support continuing operations and expansion. The Company's primary capital resource is shareholders' equity, which increased $13.8 million or 9 percent from the previous year end and increased $22.5 million from December 31, 1992. During 1994, the Board of Directors approved a 13 percent increase in the cash dividend on the Company's Common Stock, from 15 cents to 17 cents per share. During 1994, the Company recorded common stock dividends of $5.2 million. The ratio of total risk-based capital to risk-adjusted assets increased to 15.32 percent at December 31, 1994, from 14.40 percent at December 31, 1993. Tier I risk-based capital to risk-adjusted assets increased to 12.57 percent at December 31, 1994, from 11.11 percent at year-end 1993.\nCapital to Risk-Adjusted Assets Minimum Regulatory Capital\nMinimum Regulatory Capital At December 31, 1994 1993 Requirements ----------------------------------------------------------------------- Tier I Capital 12.57% 11.11% 4.00% Total Capital 15.32 14.40 8.00 Leverage ratio 8.23 7.42 3.00\nThe risk-based capital ratios improved in 1994 due to a more rapid growth in equity than total assets, in conjunction with the decline in loan volumes and increase in investment securities, which reduced the level of risk-adjusted assets. Capital ratios are reviewed on a regular basis to ensure that capital exceeds the prescribed regulatory minimums and is adequate to meet the Company's future needs. All ratios are in excess of regulatory definitions of \"well capitalized\".\nFinancial Ratios\nThe following table shows key financial ratios for the periods indicated:\n[FN] See accompanying notes to consolidated financial statements.\nWESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF INCOME\n[FN] See accompanying notes to consolidated financial statements.\nWESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\n[FN] See accompanying notes to consolidated financial statements.\nWESTAMERICA BANCORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS\n[FN] See accompanying notes to consolidated financial statements.\nWESTAMERICA BANCORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1: Business and Accounting Policies\nWestamerica Bancorporation, a registered bank holding Company, (the \"Company\"), provides a full range of banking services to individual and corporate customers in Northern California through its subsidiary banks (the \"Banks\"), Westamerica Bank and Subsidiary, Bank of Lake County and Napa Valley Bank. The Banks are subject to competition from other financial institutions and to regulations of certain agencies and undergo periodic examinations by those regulatory authorities.\nSummary of Significant Accounting Policies The consolidated financial statements are prepared in conformity with generally accepted accounting principles and general practices within the banking industry. The following is a summary of significant policies used in the preparation of the accompanying financial statements. In preparing the financial statements, Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the balance sheets and revenues and expenses for the periods indicated.\nPrinciples of Consolidation The financial statements include the accounts of the Company, and all the Company's subsidiaries which include the Banks, Community Banker Services Corporation and Subsidiary and Westcore, a newly formed company which will engage in planning and servicing retirement and employee benefit programs. Significant intercompany transactions have been eliminated in consolidation. All data presented for 1992 has been restated to include the April 15, 1993 acquisition of Napa Valley Bancorp on a pooling-of-interests basis.\nCash Equivalents Cash equivalents include Due From Banks balances and Federal Funds Sold which are both readily convertible to known amounts of cash and are so near their maturity that they present insignificant risk of changes in value because of interest rate volatility.\nSecurities Investment securities consist of U.S. Treasury, federal agencies, state, county and municipal securities, mortgage-backed, corporate debt and equity securities. Under the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", the Company classifies its debt and marketable equity securities in one of three categories: trading, available for sale or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held-to-maturity securities are those securities in which the Company has the ability and intent to hold the security until maturity. All other securities not included in trading or held to maturity are classified as available for sale. Trading and available-for-sale securities are recorded at fair value. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Unrealized gains and losses on trading securities are included in earnings.\nUnrealized gains and losses, net of the related tax effect, on available-for-sale securities are excluded from earnings and are reported as a separate component of shareholders' equity until realized.\nA decline in the market value of any available-for-sale or held-to-maturity security below cost that is deemed other than temporary, results in a charge to earnings and the establishment of a new cost basis for the security.\nPremiums and discounts are amortized or accreted over the life of the related investment security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. Realized gains and losses for securities classified as available for sale are included in earnings and are derived using the specific identification method for determining the cost of securities sold.\nLoans and Reserve for Loan Losses The reserve for loan losses is a combination of specific and general reserves available to absorb estimated future losses throughout the loan portfolio and is maintained at a level considered adequate to provide for such losses. Credit reviews of the loan portfolio, designed to identify problem loans and to monitor these estimates, are conducted continually, taking into consideration market conditions, current and anticipated developments applicable to the borrowers and the economy, and the results of recent examinations by regulatory agencies. Management approves the conclusions resulting from credit reviews. Ultimate losses may vary from current estimates. Adjustments to previous estimates of loan losses are charged to income in the period which they become known.\nUnearned interest on discounted loans is amortized over the life of these loans, using the sum-of-the-months digits formula for which the results are not materially different from those obtained by using the interest method. For all other loans, interest is accrued daily on the outstanding balances. Loans which are more than 90 days delinquent with respect to interest or principal, unless they are well secured and in the process of collection, and other loans on which full recovery of principal or interest is in doubt, are placed on non-accrual status.\nNon-refundable fees and certain costs associated with originating or acquiring loans are deferred and amortized as an adjustment to interest income over the estimated respective loan lives. Loans held for sale are identified upon origination and are reported at the lower of cost or market value on an individual loan basis.\nOther Real Estate Owned and Loan Collateral Substantively Foreclosed Other real estate owned includes property acquired through foreclosure or forgiveness of debt. These properties are transferred at fair value, which becomes the new cost basis of the property. Losses recognized at the time of acquiring property in full or partial satisfaction of loans are charged against the reserve for loan losses. Subsequent losses incurred due to the declines in property values as identified in annual independent property appraisals are recognized as non-interest expense. Routine holding costs, such as property taxes, insurance and maintenance, and losses from sales and dispositions are recognized as non-interest expense. In 1993, the Company had loans classified as \"loan collateral substantially foreclosed\" when the borrower had little or no equity in the collateral, when proceeds for repayment of the loan were expected to come only from the operation or sale of the collateral, and the debtor had either formally or effectively abandoned control of the collateral to the Company or had retained control of the collateral but, because of the current financial condition of the debtor or the economic prospects for the debtor and\/or collateral in the foreseeable future, there were doubts about the ability of the debtor to rebuild equity in the collateral or otherwise repay the loan in the near term. Losses recognized at the time the loans were reclassified as substantive foreclosures were charged against the reserve for loan losses. Subsequent losses incurred due to declines in property values, were recognized as non-interest expense as were other routine holding costs. The Company had no loans classified as substantively foreclosed at December 31, 1994.\nPremises and Equipment Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed substantially on the straight-line method over the estimated useful life of each type of asset. Estimated useful lives of premises and equipment range from 20 to 50 years and from 3 to 20 years, respectively. Leasehold improvements are amortized over the terms of the lease or their estimated useful life, whichever is shorter. Fully depreciated and\/or amortized assets are removed from the Company's balance sheet.\nInterest Rate Swap Agreements The Company uses interest rate swap agreements as an asset\/liability management strategy to reduce interest rate risk. These agreements are exchanges of fixed and variable interest payments based on a notional principal amount. The primary risk associated with swaps is the exposure to movements in interest rates and the ability of the counterparties to meet the terms of the contracts. The Company controls the credit risk of these agreements through credit approvals, limits and monitoring procedures. The Company is not a dealer but an end user of these instruments and does not use them for trading purposes. As a hedging mechanism, the differential to be paid or received on such agreements is recognized as an adjustment to interest income in the period received or paid. Payments made and\/or received in connection with early termination of interest rate swap agreements are recognized over the remaining original term of the swap agreement.\nEarnings Per Share Earnings per share amounts are computed on the basis of the weighted average of common and common equivalent shares outstanding during each of the years.\nIncome Taxes The Company and its subsidiaries file consolidated tax returns. For financial reporting purposes, the income tax effects of transactions are recognized in the year in which they enter into the determination of recorded income, regardless of when they are recognized for income tax purposes. Accordingly, the provisions for income taxes in the consolidated statements of income include charges or credits for deferred income taxes relating to temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements.\nOther Securities and other property held by the Banks in a fiduciary or agency capacity are not included in the consolidated financial statements since such items are not assets of the Company or its subsidiaries. Certain amounts in prior years' financial statements have been reclassified to conform with the current presentation. These reclassification have no effect on previously reported income.\nNote 2: Investment Securities\nAn analysis of available for sale investment securities portfolio as of December 31, 1994 follows:\n[FN] * Includes $46.8 million in Collateralized Mortgage Obligations with the following maturities: 1 to 5 years $10.2 million; over 10 years $36.6 million. The average yield of these securities is 5.91 percent.\nAn analysis of held to maturity investment securities portfolio as of December 31, 1994 follows:\n[FN] * Includes $155.1 million in Collateralized Mortgage Obligations with the following maturities: 1 to 5 years $16.6 million; 5 to 10 years $71.6 million; over 10 years $66.9 million. These securities have a market value of $146.6 million and an average yield of 5.28 percent.\nAn analysis of available for sale investment securities portfolio as of December 31, 1993 follows:\n[FN] * Includes $24.6 million in Collateralized Mortgage Obligations with the following maturities: 1 year or less $9.4 million; 1 to 5 years $15.2 million. The average yield of these securities is 5.56 percent.\nAn analysis of held to maturity investment securities portfolio as of December 31, 1993 follows:\n[FN] * Includes $162.6 million in Collateralized Mortgage Obligations with the following maturities: 1 year or less $9.9 million; 1 to 5 years $9.3 million; 5 to 10 years $71.3 million; over 10 years $72.1 million. These obligations have a market value of $162.4 million and an average yield of 5.45 percent.\nAs of December 31, 1994, $248.1 million of investment securities held to maturity were pledged to secure public deposits.\nNote 3: Loans and Reserve for Loan Losses\nLoans at December 31, consisted of the following:\n---------------------------------------------------------------- (In thousands) 1994 1993 ---------------------------------------------------------------- Commercial $262,518 $266,448 Real estate-commercial 342,727 346,308 Real estate-construction 27,278 40,533 Real estate-residential 193,061 172,245 ---------------------------------------------------------------- Total real estate loans 563,066 559,086 Installment and personal 292,735 304,993 Unearned income (14,548) (15,788) ---------------------------------------------------------------- Gross loans 1,103,771 1,114,739 Loan loss reserve (27,600) (25,587) ---------------------------------------------------------------- Net loans $1,076,171 $1,089,152 ================================================================\nIncluded in real estate-residential at December 31, 1994 and 1993 are loans held for resale of $1.9 million and $5.9 million, respectively, the cost of which approximates market value.\nChanges in the loan loss reserve were: ------------------------------------------------------------------ (In thousands) 1994 1993 1992 ------------------------------------------------------------------ Balance at January 1, $25,587 $24,742 $23,853 Sale of Sonoma Valley Bank - (684) - Provision for loan losses 5,880 9,452 7,005 Credit losses (5,921) (10,091) (8,794) Credit loss recoveries 2,054 2,168 2,678 ------------------------------------------------------------------ Net chargeoffs (3,867) (7,923) (6,116) ------------------------------------------------------------------ Balance at December 31, $27,600 $25,587 $24,742 ==================================================================\nRestructured loans were $4.4 million at December 31, 1994 and at December 31; 1993, they were $319,000 at December 31, 1992.\nThe following is a summary of interest foregone on restructured loans for the years ended December 31: ------------------------------------------------------------------------ (In thousands) 1994 1993 1992 ------------------------------------------------------------------------ Interest income that would have been recognized had the loans performed in accordance with their original terms $380 $472 $135 Less: Interest income recognized on restructured loans (264) (218) - ------------------------------------------------------------------------ Interest foregone on restructured loans $116 $254 $135 ========================================================================\nThere were no commitments to lend additional funds to borrowers whose loans are included above.\nNote 4: Concentrations of Credit Risk\nThe Company's business activity is with customers in Northern California. The loan portfolio is well diversified with no industry comprising greater than ten percent of total loans outstanding as of December 31, 1994.\nThe Company has a significant amount of credit arrangements that are secured by real estate collateral. In addition to real estate loans outstanding as disclosed in Note 3, the Company had loan commitments and stand-by letters of credit related to real estate loans of $11.8 million at December 31, 1994. The Company requires collateral on all real estate loans and generally attempts to maintain loan-to-value ratios no greater than 75 percent on commercial real estate loans and no greater than 80 percent on residential real estate loans.\nNote 5: Premises and Equipment\nA summary as of December 31, follows: ------------------------------------------------------------------------- Accumulated Depreciation and Net (In thousands) Cost Amortization Book Value ------------------------------------------------------------------------- Land $ 3,735 $ - $ 3,735 Buildings and improvements 19,861 (7,286) 12,575 Leasehold improvements 2,276 (1,520) 756 Furniture and equipment 13,737 (7,516) 6,221 ------------------------------------------------------------------------- Total $39,609 $(16,322) $23,287 =========================================================================\nLand $ 3,735 $ - $ 3,735 Buildings and improvements 20,072 (6,876) 13,196 Leasehold improvements 2,537 (1,513) 1,024 Furniture and equipment 14,347 (6,961) 7,386 ------------------------------------------------------------------------- Total $40,691 $(15,350) $25,341 =========================================================================\nDepreciation and amortization included in non-interest expense amount to $3,708,000 in 1994, $3,622,000 in 1993 and $4,198,000 in 1992.\nNote 6: Borrowed Funds\nNotes payable include the unsecured obligations of the Company as of December 31, 1994 and 1993, as follows: ----------------------------------------------------------------------- (In thousands) 1994 1993 ----------------------------------------------------------------------- Unsecured note dated September, 1976, interest payable semiannually at 9 7\/8% and principal payments of $267,000 due annually to September 1, 1996. Note was paid off in September, 1994. $ - $ 196\nUnsecured note dated May, 1984, interest payable quarterly at 12.95% and principal payments of $1,000,000 due annually beginning September 1, 1991 and ending on September 1, 1996. Note was paid off in October, 1994. - 2,100\nEquity contract notes, originated in April, 1986 and maturing on April 1, 1996. Interest payable semiannually at 11 5\/8% and principal payments of $2,500,000 due annually, on April 1, starting in 1993. Notes were paid off in April, 1994. - 7,500\nSenior notes, originated in May, 1988 and maturing on June 30, 1995. Interest payable semiannually at 10.87% and principal payment due at maturity. 5,000 5,000\nSubordinated note, issued by Westamerica Bank, originated in December, 1993 and maturing September 30, 2003. Interest of 6.99% per annum is payable semiannually on March 31 and September 30, with principal due at maturity. 20,000 20,000 ----------------------------------------------------------------------- Total notes payable $25,000 $34,796 =======================================================================\nMortgages payable of $524,000 consist of a note of Westamerica Bank secured by a deed of trust on premises having a net book value of $756,000 at December 31, 1994. The note, which has an effective interest rate of 10 percent, is scheduled to mature in April, 1995.\nAt December 31, 1994, the Company had unused lines of credit amounting to $2.5 million. Compensating balance arrangements are not significant to the operations of the Company.\nAt December 31, 1994, the Banks had $96.6 million in time deposit accounts in excess of $100,000; interest on these accounts in 1994 was $3.5 million.\nNote 7: Shareholders' Equity\nIn April 1982, the Company adopted an Incentive Stock Option Plan and 413,866 shares were reserved for issuance. Under this plan, all options are currently exercisable and terminate 10 years from the grant. At December 31, 1994, 17,340 options were outstanding and exercisable. Under the Stock Option Plan adopted by the Company in 1985, 750,000 shares have been reserved for issuance. Stock appreciation rights, incentive stock options and non-qualified stock options are available under this plan. Options are granted at fair market value and are generally exercisable in equal installments over a three-year period with the first installment exercisable one year after the date of the grant. Each incentive stock option has a maximum ten-year term while non-qualified stock options may have a longer term. The 1985 plan was amended in 1990 to provide for restricted performance shares (\"RPS\") grants. RPS's granted were 33,900, 24,700, and 27,450, for the years ended December 31, 1994, 1993 and 1992, respectively. The related expense for those years was $960,000, $740,000, and $315,000, respectively. An RPS grant becomes fully vested after three years of being awarded, provided that the Company has attained its performance goals for such three-year period. At December 31, 1994, 167,209 options were available for grant under the 1985 Stock Option Plan.\nInformation with respect to options outstanding and options exercised under the plans is summarized in the following table:\n----------------------------------------------------------------------------- Number Option Price of shares $ per share $ Total ----------------------------------------------------------------------------- Shares under option at December 31: 1994 399,741 8.50 - 28.06 8,628,494 1993 313,564 8.50 - 24.50 5,766,400 1992 278,544 6.06 - 22.00 4,249,399 Options exercised during: 1994 31,742 8.88 - 24.50 456,150 1993 51,260 8.88 - 22.00 692,157 1992 168,423 6.06 - 13.29 1,975,000\nAt December 31, 1994, options for 204,104 shares were exercisable.\nShareholders have authorized issuance of two new classes of 1,000,000 shares each, to be denominated \"Class B Common Stock\" and \"Preferred Stock\", respectively, in addition to the 20,000,000 shares of Common Stock presently authorized. At December 31, 1994, no shares of Class B or Preferred Stock had been issued.\nIn December 1986, the Company declared a dividend distribution of one common share purchase right (the \"Right\") for each outstanding share of common stock. The Rights are exercisable only in the event of an acquisition of, or announcement of a tender offer to acquire, 15 percent or more of the Company's stock without the prior consent of the Board of Directors. If the Rights become exercisable, the holder may purchase one share of the Company's common stock for $65. Following an acquisition of 15 percent of the Company's common stock or 50 percent or more of its assets without prior consent of the Company, each right will also entitle the holder to purchase $130 worth of common stock of the Company for $65. Under certain circumstances, the Rights may be redeemed by the Company at a price of $.05 per right prior to becoming exercisable and in certain circumstances thereafter. The Rights expire on December 31, 1999, or earlier, in connection with certain Board-approved transactions.\nNote 8: Income Taxes\nThe Company accounts for income taxes in accordance with the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", (\"SFAS 109\"). Under SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement reported amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. 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.\nThe components of the net deferred tax assets as of December 31 are as follows: ------------------------------------------------------------------------ (In thousands) 1994 1993 ------------------------------------------------------------------------ Deferred tax asset Reserve for loan losses $11,280 $10,321 State franchise taxes 1,318 676 Securities available for sale 1,293 - Deferred compensation 998 534 Real estate owned 2,135 2,742 Other 1,187 1,037 ------------------------------------------------------------------------ 18,211 15,310 Valuation allowance - - ------------------------------------------------------------------------ Total deferred tax asset 18,211 15,310\nDeferred tax liability Net deferred loan costs 452 502 Fixed assets 1,076 1,164 Securities available for sale - 1,864 Other 23 148 ------------------------------------------------------------------------ Total deferred tax liability 1,551 3,678 ------------------------------------------------------------------------ Net deferred tax asset $16,660 $11,632 ========================================================================\nThe Company believes a valuation allowance is not needed to reduce the deferred tax asset because it is more likely than not that the deferred tax asset will be realized through recoverable taxes or future taxable income. The provisions for federal and state income taxes consist of amounts currently payable and amounts deferred which, for the years ended December 31, are as follows:\n----------------------------------------------------------------- (In thousands) 1994 1993 1992 ----------------------------------------------------------------- Current income tax expense: Federal $ 8,693 $2,501 $6,977 State 4,045 2,195 3,130 ----------------------------------------------------------------- Total current 12,738 4,696 10,107 ----------------------------------------------------------------- Deferred income tax benefit: Federal (1,590) (646) (1,758) State (280) (617) (492) ----------------------------------------------------------------- Total deferred (1,870) (1,263) (2,250)\nAdjustment of net deferred tax asset for enacted changes in tax rates: Federal - (304) - State - (90) - ----------------------------------------------------------------- Provision for income taxes $10,868 $3,039 $7,857 =================================================================\nThe provisions for income taxes differ from the provisions computed by applying the statutory federal income tax rate to income before taxes, as follows:\n----------------------------------------------------------------- (In thousands) 1994 1993 1992 ----------------------------------------------------------------- Federal income taxes due at statutory rate $12,433 $4,248 $7,846 (Reductions) increases in income taxes resulting from: Interest not taxable for federal income tax purposes (3,362) (1,895) (1,735) State franchise taxes, net of federal income tax benefit 2,447 982 1,753 Deferred benefit and other (650) (296) (7) ----------------------------------------------------------------- Provision for income taxes $10,868 $3,039 $7,857 =================================================================\nNote 9: Fair Value of Financial Instruments\nThe following fair values of financial instruments do not represent actual amounts that may be realized upon any sale or liquidation of the related assets or liabilities. In addition, these values do not give effect to discounts to fair value which may occur when financial instruments are sold in larger quantities. The fair values presented represent the Company's best estimate of fair value using the methodologies discussed below. The fair value of financial instruments which have a relatively short period of time between their origination and their expected realization was estimated using historical cost. The estimated fair value of such financial instruments at December 31, was:\n--------------------------------------------------------------------------- (In thousands) 1994 1993 --------------------------------------------------------------------------- Cash and cash equivalents $ 112,401 $ 102,618 Money market assets 250 250 Interest and taxes receivable 34,777 28,799 Non-interest bearing and interest-bearing transaction and savings deposits 1,325,941 1,313,908 Funds purchased 133,218 69,064 Interest payable 3,167 2,700\nThe fair value at December 31, of the following financial instruments was estimated using quoted market prices:\n-------------------------------------------------------------------------- (In thousands) 1994 1993 -------------------------------------------------------------------------- Investment securities available for sale $ 160,609 $ 168,819 Investment securities held to maturity 569,684 563,563 Trading account securities - 10\nLoans were separated into two groups for valuation. Variable rate loans, except for those which have reached their maximum contractual rates, which reprice frequently with changes in market rates were valued using historical data. Fixed rate loans were valued by discounting the future cash flows expected to be received from the loans using current interest rates charged on loans with similar characteristics. Additionally, the $27,600,000 reserve for loan losses was applied against the estimated fair value to recognize future defaults of contractual cash flows. The estimated fair value of loans at December 31, was:\n--------------------------------------------------------------------------- (In thousands) 1994 1993 --------------------------------------------------------------------------- Loans $1,054,768 $1,096,164\nThe fair value of time deposits and notes and mortgages payable was estimated by discounting future cash flows related to these financial instruments using current market rates for financial instruments with similar characteristics.\nThe estimated fair values at December 31, were:\n-------------------------------------------------------------------------- (In thousands) 1994 1993 -------------------------------------------------------------------------- Time deposits $ 362,186 $ 420,475 Notes and mortgages payable 22,898 36,014\nThe estimated fair value of the Company's interest rate swaps, which are determined by dealer quotes and generally represent the amount that the Company would pay to terminate its swap contracts were $1,071,000 and $593,000, respectively, at December 31, 1994 and 1993.\nNote 10: Interest Rate Risk Management\nThe Company considers the effects of various factors in implementing interest rate risk management activities, including the utilization of interest-rate swaps. The notional amounts of interest rate swaps outstanding were:\n-------------------------------------------------------------------- (In thousands) 1994 1993 1992 -------------------------------------------------------------------- Balance, January 1, $110,000 $ 50,000 $75,000 Contracts entered - 60,000 50,000 Contracts matured (50,000) - (75,000) -------------------------------------------------------------------- Balance, December 31, $ 60,000 $110,000 $50,000 -------------------------------------------------------------------- Fair value, December 31, $ (1,071) $ (593) $ - ====================================================================\nUnder interest rate swaps, the Company agrees with other parties to exchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated by reference to the notional amounts. For the $60 million of interest rate swaps outstanding at December 31, 1994, comprised of two contracts with notional amounts of $30 million each, the Company pays a floating rate, based on the three-month London Interbank Offering Rate (LIBOR), and receives a weighted average fixed rate of 4.11 percent. The LIBOR rate has averaged 4.43 percent from the date these swaps were entered into through December 31, 1994. The Company is exposed to credit-related losses in the event of non-performance by the counterparty but does not expect this event to occur, as the Company deals only with highly rated counterparties. At December 31, 1994 and 1993, due to the loss position, no credit exposure existed in connection with the interest rate swaps. These swap contracts are scheduled to mature in August, 1995.\nNote 11: Lease Commitments\nFifteen banking offices and three administrative service centers are owned and thirty-three banking offices and two support facilities are leased. Substantially all the leases contain multiple renewal options and provisions for rental increases, principally for cost of living index, property taxes and maintenance. The Company also leases certain pieces of equipment. Minimum future rental payments, net of sublease income, at December 31, 1994, are as follows:\n(In thousands)\nYear Amount -------------------------------------- 1995 $ 3,600 1996 2,933 1997 1,772 1998 1,262 1999 825 Thereafter 2,600 -------------------------------------- Total minimum lease payments $12,992 ======================================\nTotal rentals for premises and equipment net of sublease income included in non-interest expense were $3,129,000 in 1994, $3,862,000 in 1993 and $3,910,000 in 1992.\nNote 12: Commitments and Contingent Liabilities\nLoan commitments are agreements to lend to a customer provided there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future funding requirements. Loan commitments are subject to the Company's normal credit policies and collateral requirements. Unfunded loan commitments were $161.8 million at December 31, 1994.\nStandby letters of credit commit the Company to make payments on behalf of customers when certain specified future events occur. Standby letters of credit are primarily issued to support customers' short-term financing requirements and must meet the Company's normal credit policies and collateral requirements. Standby letters of credit outstanding totaled $6.5 million and $6.4 million at December 31, 1994 and 1993, respectively. The Company, because of the nature of its business, is subject to various threatened or filed legal cases. The Company, based on the advice of the legal counsel, does not expect such cases will have a material, adverse effect on its financial position or results of operations.\nNote 13: Retirement Benefit Plans\nThe Company sponsors a defined benefit Retirement Plan covering substantially all of its salaried employees with one or more years of service. The Company's policy is to expense costs as they accrue as determined by the Projected Unit Cost method. The Company's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes.\nThe following table sets forth the Retirement Plan's funded status as of December 31 and the pension cost for the years ended December 31:\n-------------------------------------------------------------------------- (In thousands) 1994 1993 -------------------------------------------------------------------------- Actuarial present value of benefit obligations: Vested benefit obligation $ (8,870) $(11,245) -------------------------------------------------------------------------- Accumulated benefit obligation $(10,120) $(11,430) -------------------------------------------------------------------------- Projected benefit obligation $(10,331) $(11,612) Plan assets at fair market value 10,430 11,677 -------------------------------------------------------------------------- Funded status - projected benefit obligation less than plan assets $ 99 $ 65 ========================================================================== Comprised of: Prepaid pension cost $ 69 $ 22 Unrecognized net (loss) gain 27 (75) Unrecognized prior service cost 362 529 Unrecognized net obligation, net of amortization (359) (411) -------------------------------------------------------------------------- Total $ 99 $ 65 ========================================================================== -------------------------------------------------------------------------- (In thousands) 1994 1993 -------------------------------------------------------------------------- Net pension costs includes the following components: Service cost during the period $ 372 $ 364 Interest cost on projected benefit obligation 776 744 Actual return on plan assets (68) (1,012) Net amortization and deferral (775) 64 -------------------------------------------------------------------------- Net periodic pension cost $ 305 $ 160 ==========================================================================\nThe 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 percent and 4.50 percent, respectively, at December 31, 1994 and 6.75 percent and 4.50 percent, respectively, at December 31, 1993. The expected long-term rate of return on plan assets in 1994 and 1993 was 7 percent.\nEffective January 1, 1992, the Company adopted a defined contribution Deferred Profit Sharing Plan covering substantially all of its salaried employees with one or more years of service. Participant deferred profit sharing account balances offset benefits accrued under the Retirement Plan which was amended effective January 1, 1992 to coordinate benefits with the Deferred Profit Sharing Plan. The coordination of benefits results in the Retirement Plan benefit formula establishing the minimum value of participant retirement benefits which, if not provided by the Deferred Profit Sharing Plan, are guaranteed by the Retirement Plan.\nThe costs charged to non-interest expense related to benefits provided by the Retirement Plan and the Deferred Profit Sharing Plan were $1,327,000 in 1994, $1,160,000 in 1993 and $1,037,000 in 1992.\nIn addition to the Retirement Plan and the Deferred Profit Sharing Plan, all salaried employees are eligible to participate in the voluntary Tax Deferred Savings\/Retirement Plan (ESOP) upon completion of a 90-day introductory period. This plan allows employees to defer, on a pretax basis, a portion of their salaries as contributions to the plan. Participants may invest in five funds, including Westamerica Bancorporation Common Stock Fund. The matching contributions charged to operating expense were $477,000 in 1994, $482,000 in 1993 and $462,000 in 1992.\nEffective December 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\", (\"SFAS No. 106\"). Adoption of SFAS No. 106 required a change from the cash method to an actuarial based accrual method of accounting for postretirement benefits other than pensions. The Company offers continuation of group insurance coverage to employees electing early retirement, as defined by the Retirement Plan, for the period from the date of early retirement until age sixty five. The Company contributes an amount toward early retirees' insurance premiums which is fixed at the time of early retirement. The Company reimburses Medicare Part B premiums for all retirees over age sixty five, as defined by the Retirement Plan.\nThe following table sets forth the net periodic postretirement benefit cost for the years ended December 31 and the funded status of the plan at December 31:\n---------------------------------------------------------------------- (In thousands) 1994 1993 ---------------------------------------------------------------------- Service cost $ - $ - Interest cost 105 107 Actual return on plan assets - - Amortization of unrecognized transition obligation 61 61 Other, net - - ---------------------------------------------------------------------- Net periodic cost $ 166 $ 168 ---------------------------------------------------------------------- Accumulated postretirement benefit obligation attributable to: Retirees $1,140 $1,130 Fully eligible participants 239 265 Other 188 158 ---------------------------------------------------------------------- Total $1,567 $1,553 ====================================================================== Fair value of plan assets $ - $ -\nAccumulated postretirement benefit obligation in excess of plan assets 1,567 $1,553\nComprised of: Unrecognized prior service cost - - Unrecognized net gain (loss) - - Unrecognized transition obligation 1,407 1,471 Recognized postretirement obligation 160 82 ---------------------------------------------------------------------- Total $1,567 $1,553 ======================================================================\nThe discount rate used in measuring the accumulated postretirement benefit obligation was 7.25 percent at December 31, 1994 and 6.75 percent at December 31, 1993. The assumed health care cost trend rate used to measure the expected cost of benefits covered by the plan was 8 percent for 1995 and declined steadily to an ultimate trend rate of 4 percent beginning in 1999. The effect of a one percentage point increase on the assumed health care cost trend for each future year would increase the aggregate of the service cost components of the 1994 and 1993 net periodic cost by $87,000 and $73,000, respectively, and increase the accumulated postretirement benefit obligation at December 31, 1994 and 1993 by $255,000 and $204,000, respectively.\nNote 14: Related Party Transactions\nCertain directors and executive officers of the Company and\/or its subsidiaries were loan customers of the Banks during 1994 and 1993. All such loans were made in the ordinary course of business on normal credit terms, including interest rate and collateral requirements. No related party loans represent more than normal risk of collection. Such loans were $3,108,000 and $5,238,000 at December 31, 1994 and 1993, respectively.\nNote 15: Restrictions\nPayment of dividends to the Company by Westamerica Bank, the largest subsidiary bank, is limited under regulations for Federal Reserve member banks. The amount that can be paid in any calendar year, without prior approval from regulatory agencies, cannot exceed the net profits (as defined) for that year plus the net profits of the preceding two calendar years less dividends declared. Under this regulation, Westamerica Bank was not restricted as to the payment of $11.4 million in dividends to the Company as of December 31, 1994. During 1992 and 1993, Napa Valley Bank, a banking subsidiary, was operating under a regulatory order which disallowed payment of dividends to the Company unless it reduced the level of problem loans, liquidated or reserved adequately against the real estate investment in its subsidiary company, and strengthened its loan loss reserve. Napa Valley Bank has complied with all conditions of the regulatory order, which was removed by the regulators early in 1994. Napa Valley Bank began to pay dividends to the Company in the fourth quarter of 1994. Bank of Lake County, another subsidiary bank, started to pay dividends to the Company in the third quarter of 1994. Payment of dividends by the Company is also restricted under the terms of the note agreements as discussed in Note 6. Under the most restrictive of these agreements, $24.4 million was available for payment of dividends as of December 31, 1994. The Banks are required to maintain reserves with the Federal Reserve Bank equal to a percentage of its reservable deposits. The Banks' daily average on deposit at the Federal Reserve Bank was $43.0 million in 1994 and $40.4 million in 1993.\nNote 16: Westamerica Bancorporation (Parent Company Only)\nStatements of Income (In thousands) ----------------------------------------------------------------------------- Years ended December 31, 1994 1993 1992 ----------------------------------------------------------------------------- Dividends from subsidiaries $19,680 $16,671 $ 8,630 Interest from subsidiaries 101 315 61 Other income 3,752 2,781 1,158 ----------------------------------------------------------------------------- Total income 23,533 19,767 9,849 ----------------------------------------------------------------------------- Interest on borrowings 1,029 1,958 2,434 Salaries and benefits 5,529 4,526 782 Other non-interest expense 2,927 5,464 3,451 ----------------------------------------------------------------------------- Total expenses 9,485 11,948 6,667 ----------------------------------------------------------------------------- Income before income tax benefit and equity in undistributed income of subsidiaries 14,048 7,819 3,182 Income tax benefit 2,463 3,478 1,890 Equity in undistributed income (loss) of subsidiaries 8,162 (1,842) 10,150 ----------------------------------------------------------------------------- Net income $24,673 $ 9,455 $15,222 =============================================================================\nBalance Sheets (In thousands) ----------------------------------------------------------------------- Years ended December 31, 1994 1993 ----------------------------------------------------------------------- Assets Cash and cash equivalents $ 4,526 $ 4,790 Investment securities held to maturity 6,750 9,250 Loans 148 149 Investment in subsidiaries 158,168 154,257 Premises and equipment 55 29 Accounts receivable from subsidiaries 156 65 Other assets 5,741 2,056 ----------------------------------------------------------------------- Total assets $175,544 $170,596 ======================================================================= Liabilities Long-term debt $ 5,000 $ 14,796 Other liabilities 4,339 3,353 ----------------------------------------------------------------------- Total liabilities 9,339 18,149 Shareholders' equity 166,205 152,447 ----------------------------------------------------------------------- Total liabilities and shareholders' equity $175,544 $170,596 =======================================================================\nStatements of Cash Flows (In thousands) --------------------------------------------------------------------------- Years ended December 31, 1994 1993 1992 --------------------------------------------------------------------------- Operating Activities Net income $ 24,673 $ 9,455 $ 15,222 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 65 108 67 Undistributed earnings (loss) of affiliates (8,162) 607 (10,150) Increase in equity in affiliates - - (1,797) (Increase) decrease in receivables from affiliates (91) 197 1,020 Net change in income taxes (1,740) 60 2,633 (Increase) decrease in other assets (2,295) 1,183 (1,394) Increase in other liabilities 1,448 1,583 301 Gain on sale of Sonoma Valley Bank - (668) - Net gain on sale of land - - 43 --------------------------------------------------------------------------- Net cash provided by operating activities 13,898 12,525 5,945 --------------------------------------------------------------------------- Investing Activities Purchases of premises and equipment (92) - (2,189) Net change in land held for sale - (800) - Net change in loan balances 1 (149) - Investment in subsidiaries (140) (8,639) (485) Purchase of investment securities (4,500) (9,700) (13,991) Proceeds from maturities of investment securities 7,000 14,191 10,500 Proceeds from sale of premises and equipment - 2,369 2,149 Proceeds from sale of Sonoma Valley Bank - 2,733 - --------------------------------------------------------------------------- Net cash provided by (used in) investing activities 2,269 5 (4,016) --------------------------------------------------------------------------- Financing Activities Net decrease in short-term debt - - (656) Principal reductions of long-term debt (9,796) (6,260) (2,611) Proceeds from issuance of note payable to affiliate - - 1,368 Proceeds from exercise of stock options 1,025 1,446 2,139 Retirement of stock (2,488) - - Unrealized loss on marketable equity securities - - 9 Dividends paid (5,172) (4,655) (2,987) --------------------------------------------------------------------------- Net cash used in financing activities (16,431) (9,469) (2,738) --------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (264) 3,061 (809) Cash and cash equivalents at prior year end 4,790 1,729 2,538 --------------------------------------------------------------------------- Cash and cash equivalents at December 31, $ 4,526 $ 4,790 $ 1,729 ===========================================================================\nNote 17: Quarterly Financial Information (Unaudited)","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"831964_1994.txt","cik":"831964","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn February, 1994, the Company settled litigation with Diamond M concerning various matters relating to the sale and bareboat charter of 3 offshore drilling rigs. Legal proceedings were instituted by the Company on August 29, 1991, and were consolidated with related legal proceedings subsequently instituted by Diamond M in the United States District Court, Southern District of Texas, Houston Division. In June, 1993, a partial summary judgment awarded the Company $1.8 million, together with interest and attorneys fees, for notes payable owed by Diamond M to the Company, offset by certain charter hire payments due Diamond M. Following a trial in February, 1994, a judgment was entered in the United States District Court, Southern District of Texas, Houston Division, awarding Diamond M $3.5 million, plus court costs, offset by the partial summary judgment\nof $1.8 million. The Company paid Diamond M $1.7 million in February, 1994 as a final settlement of all disputed issues. See Note 12 of Notes to Consolidated Financial Statements.\nThe Company is also party to a number of lawsuits which are ordinary, routine litigation incidental to the Company's business, the outcome of which, individually, or in the aggregate, is not expected to have a material adverse effect on the Company's financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company did not hold a meeting of stockholders or otherwise submit any matter to a vote of stockholders in the fourth quarter of 1994.\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 Nasdaq Stock Market (\"Nasdaq\") under the symbol \"CLDR.\" The following table sets forth the range of high and low closing sale prices per share of Common Stock as reported by Nasdaq for the periods indicated.\nOn March 1, 1995, the closing sale price of the Company's Common Stock, as reported by Nasdaq, was $12 3\/4 per share. On that date, there were 2,028 holders of record of the Company's Common Stock.\nThe Company has never paid cash dividends on its Common Stock, and it is not anticipated that cash dividends will be paid to holders of Common Stock in the foreseeable future. Under the Company's credit agreement with Internationale Nederlanden (U.S.) Capital Corporation (\"INCC\"), formerly Internationale Nederlanden Bank N.V., the Company is restricted from declaring, making, or paying any cash dividend on any class of capital stock except for the quarterly dividend applicable to the Company's Preferred Stock.\nThe Company's $2.3125 Convertible Exchangeable Preferred Stock (\"Preferred Stock\") is also traded on the Nasdaq under the symbol \"CLDRP.\" The following table sets forth the range of high and low closing sale prices per share of Preferred Stock as reported by Nasdaq for the periods indicated.\nOn February 28, 1995, the closing sale price of the Company's Preferred Stock, as reported by Nasdaq, was $26 13\/64 per share. On that date, there were 33 holders of record of the Company's Preferred Stock.\nHolders of shares of Preferred Stock are entitled to receive, when, as, and if declared by the Board of Directors out of funds of the Company legally available therefor, cash dividends at an annual rate of $2.3125 per share, payable quarterly on March 15, June 15, September 15 and December 15 in each year, except that if any such date is a Saturday, Sunday or legal holiday, such dividend is payable on the next day that is not a Saturday, Sunday or legal holiday. Dividends are cumulative and are payable to holders of record as they appear in the stock books of the Company on such record dates as are fixed by the Board of Directors. Cash dividends paid on each of the quarterly dividend dates in 1994, 1993 and 1992 were $665,000. The Preferred Stock is also convertible into shares of Common Stock at the rate of 1.89394 shares of Common Stock for each share of Preferred Stock and is subject to redemption at the option of the Company at varying prices depending on the date called for redemption. Under the credit agreement with INCC, the Company is restricted from redeeming the Preferred Stock unless such redemption is mandatory.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth certain selected consolidated financial information of the Company. The amounts as of and for each of the five years in the period ended December 31, 1994 have been derived from audited consolidated financial statements of the Company. This information 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 thereto included elsewhere herein. The selected consolidated financial data provided below are not necessarily indicative of the future results of operations or financial performance of the Company.\n- ---------------\n(1) Includes exchange rate losses of $1.2 million in 1994, litigation settlement and expenses of $3.7 million in 1993 and gains on disposition of assets of $5.0 million in 1992.\n(2) The Company has not paid any cash dividends on its Common Stock.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nActivity in the contract drilling industry and related oil service businesses has shown signs of improvement over the last two years due to various market consolidations. Crude oil prices declined significantly during the first quarter of 1994 and have currently returned to higher levels, while natural gas prices have fallen to levels not experienced since 1991. This continued price volatility creates an uncertain domestic market and competition, therefore, remains intense within the contract drilling industry. The financial condition and results of operations of the Company and other drilling contractors are dependent upon the price of oil and natural gas, as demand for their services is primarily dependent upon the level of spending by oil and gas companies for exploration, development and production activities.\nThe Company has endeavored to mitigate the effect of volatile product pricing by diversifying its scope of operations beyond the domestic daywork contract drilling market. To achieve its strategic objective, the Company established separate but related lines of business in turnkey drilling and MOPU operations, and pursued foreign drilling and production opportunities. Each of the Company's business segments will continue to be affected, however, by the unsettled energy markets, which are influenced by a variety of factors, including general economic conditions, the extent of worldwide oil and gas production and demand therefor, government regulations, and environmental concerns.\nRESULTS OF OPERATIONS\nYear 1994 Versus 1993\nThe Company recognized net income, before preferred dividends, of $6.1 million in 1994 compared to net income of $3.6 million in 1993. Operating income increased $.9 million from 1993 to 1994. The improvement in operating income was primarily due to an increase in foreign daywork drilling operating income of $5.3 million, a reduction in domestic daywork drilling operating losses of $2.3 million, an increase in engineering services operating income of $1.9 million, and a reduction in oil and gas operating losses of $.9 million, offset in part by a reduction in MOPU operating income of $9.2 million and an increase in corporate overhead of $.3 million.\nDaywork Drilling\nDomestic daywork drilling results in 1994 reflect the Company's strategy to diversify away from this volatile market. As a result of rig deployments out of the United States, domestic daywork drilling operating losses decreased by $2.3 million from 1993 to 1994. Operating losses incurred in 1993 were due primarily to stacked rig costs associated with the Company's domestic land rigs. One of the Company's land drilling rigs was mobilized to Venezuela during the first quarter of 1994 and began daywork drilling operations for Corpoven for a three-year term. Two of the Company's land drilling rigs, which were stacked during all of 1993, were mobilized to Venezuela during the first quarter of 1994 and are currently drilling turnkey wells for Corpoven.\nForeign daywork drilling revenues increased $11.4 million from 1993 to 1994. Foreign daywork drilling operating income increased $5.3 million during the same period. Foreign daywork drilling operating results reflect increased revenues and operating income primarily due to contributions from one of the Company's jack-up drilling rigs which was mobilized to the Bay of Tampico, Mexico during the first quarter of 1994. This jack-up drilling rig completed operations for CNCTI during the fourth quarter of 1994. The Company has stacked the rig until another contract is awarded. No assurance can be given that the Company will be able to secure a contract for the operation of this unit. Also contributing to the improved results were increased operating income from the Company's 2 jack-up drilling rigs working in Venezuela, primarily due to reduced operating expenses, and contributions from the 3 additional land rigs mobilized to Venezuela during 1994.\nContracts for the Company's 2 jack-up drilling rigs operating in Venezuela were re-negotiated in the first quarter of 1994 and expired in February, 1995. The contract rates were adjusted quarterly based upon fluctuations in oil prices from the base oil price in effect at the contract renewal date. The 2 jack-up rigs will continue drilling operations on a well-to-well basis in Venezuela at reduced dayrates from those received in 1994. The Company is currently marketing the rigs to others for use in Venezuela. No assurance can be given that the Company will be able to secure a contract for the operation of these units. If contracts are not obtained, Maraven is required to demobilize the rigs to the U.S. Gulf of Mexico. Contracts on 2 of the 3 land drilling rigs working in eastern Venezuela on daywork contracts for Corpoven expire in September, 1995, and the other contract expires in February, 1997.\nEngineering Services\nEngineering services revenues increased $19.1 million from 1993 to 1994. Engineering services operating income increased $1.9 million during the same period. Fifteen turnkey contracts were completed in 1994 compared to 6 turnkey contracts completed in 1993. Five of the 15 turnkey wells completed in 1994 and 2 of the 6 turnkey wells completed in 1993 were drilled by CNCTI and recorded under the equity method. One of the 15 turnkey wells completed in 1994 was drilled by CNTI and also recorded under the equity method. See Note 4 of Notes to Consolidated Financial\nStatements. Two of the wells completed in 1994 encountered downhole problems. As a result, the Company recorded losses of $3.2 million in the 1994 results of operations on these contracts. The Company provided well engineering and management services during 1993 and 1994, primarily in Venezuela and Mexico. These activities contributed operating income of $1.0 million and $.1 million in 1994 and 1993, respectively.\nThe Company is currently drilling the fourth and fifth wells included in 2 packages of 3 turnkey wells for Corpoven. The Company expects these 2 wells and the last contracted well to be completed in 1995 with revenues of approximately $18.0 million. The Company mobilized 2 land rigs to Venezuela during the first quarter of 1994 to work on these projects. In addition to the 2 turnkey wells being drilled in Venezuela, the Company is currently in the process of drilling an additional turnkey well in Mexico and one turnkey well in the United States.\nMOPU Operations\nMOPU revenues decreased $5.7 million from 1993 to 1994. MOPU operating income decreased $9.2 million during the same period. The decrease in revenues was primarily due to the expirations in May and September, 1994 of the two-year contracts on the 3 MOPUs which worked in Venezuela. The decreased revenues were offset in part by contributions from Cliffs No. 8, which began operations during the third quarter of 1993. Operating income decreased primarily due to the non-cash deferral of income recognition of $5.2 million on the 2 MOPUs which worked in Venezuela through September, 1994. The expiration of the contracts on the 3 MOPUs which worked in Venezuela also contributed to the decrease in operating income. The 3 MOPUs which worked in Venezuela contributed revenues of $11.9 million and $19.2 million and operating income of $1.6 million and $12.0 million during 1994 and 1993, respectively. The LANGLEY was demobilized back to the United States during the second quarter of 1994 and is currently being marketed. No assurance can be given that the Company will be able to secure a contract for the operation of this unit. The charterer exercised buyout options and purchased the other 2 units which worked in Venezuela for a total of $4.0 million in the fourth quarter of 1994. No gain or loss was recognized upon buyout of the 2 units. See \"Liquidity and Capital Resources.\"\nThe contract for MARLIN NO. 4, which was operating in the Gulf of Mexico, expired at the end of April, 1994. The Company renovated the unit during the third quarter of 1994 and has secured a commitment for a contract for operations which are expected to commence in the second quarter of 1995. The Company secured a bareboat charter for Cliffs No. 11 from a third party for use as a workover rig in the U.S. Gulf of Mexico. Operations commenced on this charter during the second quarter of 1994. The contract option on another of its MOPUs, Cliffs No. 10, was canceled during February, 1995. Renewed marketing efforts have commenced subsequent to the cancellation. No assurance can be given that the Company will be able to secure a contract for the operation of this unit.\nOil and Gas\nOil and gas revenues decreased $2.2 million from 1993 to 1994, primarily due to reduced gas revenues resulting from a net revenue interest reduction upon payout of a significant well. Operating losses in 1994 decreased $.9 million when compared to 1993, primarily because decreased depreciation, depletion and amortization and operating expenses more than offset the revenue decrease.\nCorporate Overhead\nCorporate overhead increased $.3 million from 1993 to 1994. The increase was primarily due to an overall increase in employment costs and other expenses.\nOther Income (Expense)\nThe Company recognized $2.4 million of other expense during 1994 compared to $3.9 million of other expense during 1993. The net decrease in other expense resulted primarily from the litigation settlement and expenses of $3.7 million recorded in 1993, compared to none in 1994, offset in part by decreased gains on disposition of assets and increased exchange rate losses incurred during 1994. Income tax expense for 1994 was consistent with income tax expense for 1993 due primarily to the recognition of a $.4 million net deferred tax asset during the third quarter of 1994. See \"Liquidity and Capital Resources.\"\nYear 1993 Versus 1992\nThe Company recognized net income, before preferred dividends, of $3.6 million in 1993 compared to net income of $3.0 million in 1992. The 1993 results include litigation settlement and expenses of $3.7 million, or $0.82 per share. Excluding this charge in 1993, the Company would have reported net income of $7.3 million, or $1.03 per common share. The 1992 results included a $1.5 million writedown in the carrying value of oil and gas properties and a $4.7 million gain on the disposition of one of the Company's MOPUs due to its constructive total loss in Hurricane Andrew. Excluding these amounts in 1992, the Company would have reported a net loss of $.2 million, or $0.86 per common share. Operating income increased $7.2 million from 1992 to 1993. The improvement in operating income was primarily due to an increase in MOPU operating income of $7.1 million, an increase in foreign daywork drilling operating income of $1.7 million, and a decrease in domestic daywork drilling operating losses of $.4 million, offset in part by a decrease in engineering services operating income of $1.1 million, an increase in oil and gas operating losses of $.5 million, and an increase in corporate overhead of $.4 million.\nDaywork Drilling\nDomestic daywork drilling revenues decreased $4.3 million from $5.5 million in 1992 to $1.2 million in 1993. The decrease was primarily due to the stacking of the majority of the Company's domestic land rigs in 1993 and the sale, effective January 1, 1993, of the Company's 4 inland posted barge drilling rigs together with rights to certain oil and gas production proceeds. Domestic daywork drilling operating losses decreased by $.4 million from $2.8 million in 1992 to $2.4 million in 1993. Cost savings resulting from the sale of the 4 inland posted barge drilling rigs\nwere partially offset by costs associated with stacking the Company's domestic land rigs and the sale, effective January 1, 1993, of rights to certain oil and gas production proceeds. One of the Company's land drilling rigs was mobilized to Venezuela in 1994 and began drilling operations for Corpoven for a three-year term. Two other land drilling rigs began operations in 1994 in Venezuela to drill turnkey wells awarded the Company by Corpoven.\nForeign daywork drilling revenues decreased $.5 million from $21.5 million in 1992 to $21.0 million in 1993. Foreign daywork drilling operating income increased $1.7 million during the same period. The increase in operating income was primarily due to reduced labor costs and repair and maintenance expenses, offset in part by decreased revenues during 1993 when compared to 1992. Foreign operating results reflect decreased revenues primarily due to reduced cost flow-throughs billed to the operators and devaluation of the Venezuelan Bolivar. The contracts for the Company's 2 jack-up drilling rigs operating in Venezuela expired on March 9, 1994 and March 15, 1994, respectively. The Company re-negotiated the contracts through February, 1995. Contracts on the 2 land drilling rigs working in eastern Venezuela on daywork contracts for Corpoven expire in September, 1995.\nEngineering Services\nEngineering services revenues decreased $20.0 million from $37.0 million in 1992 to $17.0 million in 1993. Twelve turnkey contracts were completed during 1992 compared to 6 turnkey contracts completed in 1993, 2 of which related to CNCTI and were accounted for under the equity method in the Company's Consolidated Financial Statements. See Note 4 of Notes to Consolidated Financial Statements. Engineering services operating income decreased $1.1 million in 1993 when compared to 1992, primarily due to fewer completed contracts in 1993.\nThe Company was awarded approximately $50 million in international turnkey contracts to be drilled in 1994 and 1995. The Company was awarded 2 packages with 3 turnkey wells in each package to be drilled for Corpoven with estimated revenues of approximately $36 million. The Company mobilized 2 of its idle domestic land drilling rigs to Venezuela to work on these projects. In addition, CNCTI, a joint venture in which the Company holds a one-third ownership percentage, was awarded 2 drilling packages by PEMEX for the drilling of a total of 4 wells. The Company mobilized an idle jack-up drilling rig to the Bay of Tampico, Mexico in the first quarter of 1994 to drill 2 of the 4 wells. The 2 packages are expected to generate $42 million in revenues to CNCTI.\nMOPU Operations\nMOPU revenues increased $12.5 million from $9.2 million in 1992 to $21.7 million in 1993. MOPU operating income increased $7.1 million in 1993. The Company's MOPUs contributed greater income in 1993 due to 3 MOPU units working in Venezuela during all of 1993 while the 3 units worked only part of 1992. In addition, the Company's mobile offshore supply unit operated in the Bay of Campeche, Mexico during most of 1993 and none in 1992, and a new MOPU began working during the third quarter of 1993. Partially offsetting these increased revenues and operating income was the loss of income from the MARLIN NO. 3, which was destroyed in a hurricane on August 25, 1992. The MARLIN NO. 3 contributed revenues of $.8 million and operating income of $.4 million in 1992. Each of the 3 MOPUs working in Venezuela has an initial contract term of two years, subject to certain buyout options which, if exercised, could have a material adverse effect on the Company's future results of operations. See \"Liquidity and Capital Resources.\"\nOil and Gas\nOil and gas revenues increased $1.0 million from $3.7 million in 1992 to $4.7 million in 1993, primarily due to increased natural gas production and pricing. Operating losses from oil and gas exploration activities increased $.5 million during the same period. Increased depreciation, depletion and amortization more than offset the revenue increases. Average daily natural gas production\nvolumes increased to 4,522 Mcf per day in 1993 from 3,363 Mcf per day in 1992. Oil and condensate production decreased from 163 barrels per day in 1992 to 121 barrels per day in 1993. Average product pricing received in 1993 was $2.31 per Mcf of gas and $18.39 per barrel of oil and condensate compared to $2.08 per Mcf and $18.65 per barrel in 1992.\nCorporate Overhead\nCorporate overhead increased $.4 million from $4.5 million during 1992 to $4.9 million in 1993. The increase was primarily due to higher costs of certain employee benefits.\nOther Income (Expense)\nThe Company recognized $3.9 million of other expense in 1993 compared to $2.7 million of other income in 1992. The $6.6 million decrease was primarily due to a litigation settlement and expenses of $3.7 million in 1993, decreased gains on disposition of assets of $2.9 million and increased income taxes of $.7 million, offset in part by increased interest income of $.7 million. See \"Liquidity and Capital Resources\" for a discussion of the Diamond M litigation settlement and expenses. The net decrease in gains on disposition of assets was primarily related to the $4.7 million gain recorded in 1992 related to the disposition of one of the Company's MOPUs as a result of its constructive total loss in Hurricane Andrew, offset in part by net gains on assets disposed of in 1993. The Company recorded income taxes of $.7 million in 1993 in anticipation of alternative minimum taxes in the United States and certain foreign taxes. The increase in interest income was primarily due to interest on notes receivable issued in connection with the sale of the 4 inland posted barge drilling rigs together with rights to certain oil and gas production proceeds effective January 1, 1993.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's cash and cash equivalents increased $.7 million from $10.6 million at December 31, 1993 to $11.3 million at December 31, 1994. The increase resulted from $23.7 million provided by operating activities, $17.0 million from borrowings, $5.9 million received from the sale of property and equipment, and $1.0 million received from the collection of notes receivable, partially offset by $9.1 million used to fund capital expenditures and $37.8 million used to make payments on borrowings, preferred stock dividends and purchases of Treasury Stock.\nCash provided by operating activities of $23.7 million included $.6 million used for working capital and other requirements, primarily to fund the Company's foreign daywork drilling and engineering services operations. \"Accounts Receivable\" decreased from December 31, 1993 to December 31, 1994 due primarily to the collection of receivables associated with the Company's MOPU operations in Venezuela. \"Inventories\" increased from December 31, 1993 to December 31, 1994 due primarily to the purchase of casing and other supplies for turnkey and daywork drilling operations in Venezuela. The increases in \"Drilling Contracts in Progress\" and \"Accounts Payable\" were due primarily to the Company's expanded turnkey operations. The decrease in \"Property and Equipment\" from December 31, 1993 to December 31, 1994 was due primarily to the sale of 2 MOPUs which worked in Venezuela.\nCash was used during 1994 to fund $9.1 million of capital expenditures, which primarily related to the upgrade of 3 land drilling rigs prior to mobilization to Venezuela, renovation of a jack-up drilling rig, Cliffs No. 12, which was mobilized for drilling operations in Mexico, modifications to Cliffs No. 11 in preparation for workover operations in the U.S. Gulf of Mexico, and drill pipe purchases for the expanded drilling operations in Venezuela.\nIn February, 1995, the Company received a commitment for a contract to drill 2 wells on a daywork basis in Venezuela for Total. The Company intends to purchase, upgrade and mobilize a 3000 HP rig to Venezuela at a cost of approximately $8.6 million to work on this project. Drilling activities are expected to commence in the third quarter of 1995. The Company has plans for other\ncapital expenditures totaling approximately $3.4 million during 1995. The Company intends to fund these capital expenditure requirements with internally-generated cash flow and amounts currently available under its revolving line of credit.\nDuring the fourth quarter of 1992, the Company acquired 5 jack-up drilling rigs at a cost of $6.0 million, with plans to convert them to MOPUs. The first unit, Cliffs No. 8, was converted to a MOPU and commenced operations on July 19, 1993. The second of the 5 rigs acquired was also converted to a MOPU. The Company secured a contract option for this unit, Cliffs No. 10, during 1994. The option on this contract was canceled during February, 1995. Renewed marketing efforts have commenced subsequent to the cancellation. Cliffs No. 14 is currently being used as a mobile offshore supply unit to facilitate the Company's joint venture turnkey drilling operations in Mexico. The Company upgraded and mobilized Cliffs No. 12 into Mexico during the first quarter of 1994 for turnkey drilling operations in the Bay of Tampico. The Company secured a bareboat charter on the final unit, Cliffs No. 11, from a third party for use as a workover rig in the U.S. Gulf of Mexico. The Company refurbished this rig during 1994 at a cost of $1.4 million. Operations commenced during the second quarter of 1994.\nThe LANGLEY, one of 3 MOPUs which worked in Venezuela, ended its two-year contract in May, 1994, and the contract was not extended. The rig was demobilized back to the United States, and the demobilization costs were reimbursed to the Company by the charterer. No assurance can be given that the Company will be able to secure a contract for operation of this unit. Each of the 2 remaining MOPUs which worked in Venezuela had an initial contract term of two years which expired in September, 1994, subject to certain buyout options. The charterer exercised its option to purchase the FRANKLIN and FORRESTAL effective December, 1994 for total proceeds of $4.0 million. The loss of future operating income associated with these units could have a material adverse effect on the Company's future results of operations. Because the Company believed there was a reasonable likelihood that the buyout options on the 2 units would be exercised in 1994 or 1995, the Company deferred income recognition on these 2 units to the extent of losses that would occur upon exercise of the options. As a result, no gain or loss was recognized when the buyout options were exercised.\nApproximately 78% of the Company's revenues and a substantial portion of its operating income were sourced from its Venezuelan and Mexican operations during 1994. See Note 14 of Notes to Consolidated Financial Statements. These operations are subject to customary political and foreign currency risks in addition to operational risks. The Company has attempted to reduce these risks through insurance and the structure of its contracts. Exchange losses increased substantially in 1994 compared to 1993 due to significant devaluation of the Venezuelan Bolivar during the second quarter of 1994. Venezuela instituted currency exchange controls during June, 1994 in response to this devaluation. These exchange controls could impair the Company's ability to convert its Venezuelan cash flow into U.S. dollars in the future. Despite the current economic volatility in Venezuela, the Company believes that the country continues to be a favorable market for its services.\nIn conjunction with the redelivery to Diamond M of 3 offshore drilling rigs under long-term charters, a dispute existed as to whether or not the Company complied with the terms of the charters regarding maintenance and repair of the rigs during the charter period, as well as the condition of the rigs upon redelivery. Following a trial in February, 1994, a judgment was entered in the United States District Court, Southern District of Texas, Houston Division, awarding Diamond M $3.5 million, plus court costs, offset by a partial summary judgment of $1.8 million. The Company reported this litigation settlement and expenses in the Consolidated Statements of Operations during the fourth quarter of 1993. The Company paid Diamond M $1.7 million in February, 1994 as a final settlement of all disputed issues.\nAt December 31, 1993, the Company's credit agreement with INCC provided for a $10.0 million working capital credit facility which had a maturity date of January 1, 1995 and a $30.0 million term\nloan which matured January 1, 1995. The Company executed the Second Restated Credit Agreement with INCC during March, 1994, thereby converting its $10.0 million working capital credit facility to a $20.0 million revolving line of credit subject to certain borrowing base limitations. The revolving line of credit matures on January 1, 1996. As of December 31, 1994, the Company had no outstanding balance on the revolving line of credit with INCC. The $30.0 million term loan was repaid in full during October, 1994.\nThe Company from time to time purchases its Common Stock in the open market. During 1994, the Company purchased 427,000 shares of its Common Stock at an aggregate purchase price of $5.1 million, or approximately $11.93 per share. A total of 5,000 shares, at an aggregate purchase price of $.1 million, or approximately $11.38 per share, was acquired in the fourth quarter of 1993. Management of the Company believes that the Common Stock is trading at prices which do not reflect the value of the Company and has determined that the acquisition of such stock would be in the best interest of the Company and its shareholders. All of the acquired shares are held as Common Stock in treasury, less shares issued under certain benefit plans.\nThe ability of the Company to fund working capital, capital expenditures, debt service and dividends in excess of cash on hand will be dependent upon the success of the Company's domestic and foreign operations. To the extent that internal sources are insufficient to meet those cash requirements, the Company can draw on its available credit facility or seek other debt or equity financing; however, the Company can give no assurance that such other debt or equity financing would be available on terms acceptable to the Company.\nIn any case, the satisfaction of long-term capital requirements will depend upon successful implementation by the Company of its business strategy and future results of operations. Management believes it has successfully implemented the strategy to achieve results of operations commensurate with its immediate and near-term liquidity requirements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and supplementary data of the Company appear on pages 30 through 52 hereof and are incorporated by reference into this Item 8. Selected quarterly financial data is set forth in Note 15 of Notes to Consolidated Financial Statements, which is incorporated herein by reference.\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 the Company's accountants regarding accounting principles or practices for financial statement disclosures.\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 \"Executive Officers\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders, which is to be filed with the Securities and Exchange Commission (the \"Commission\"), describes the directors and executive officers of the Company and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the caption \"Executive Officers -- Compensation\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders, which is to be\nfiled with the Commission, sets forth information regarding management compensation and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth under captions \"Principal Shareholders\" and \"Election of Directors -- Security Ownership of Management\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders, which is to be filed with the Commission, describes the security ownership of certain beneficial owners and management and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information set forth under the caption \"Certain Transactions\" in the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders, which is to be filed with the Commission, sets forth information regarding certain relationships and related transactions 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\n(1) and (2) Financial Statements and Schedules\nSee \"lndex to Consolidated Financial Statements and Schedules\" on Page 28.\n(3) Exhibits. See Exhibit Index on pages 54 to 57.\nThe management contracts and compensatory plans or arrangements required to be filed as Exhibits to this report are as follows:\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.\nMarch 2, 1995 CLIFFS DRILLING COMPANY\nBy: \/s\/ DOUGLAS E. SWANSON --------------------------------- Douglas E. Swanson Chairman of the Board and President\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nFORM 1O-K ITEM 14A (1) AND (2)\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nSchedule: For Each of the Three Years in the Period Ended December 31, 1994:\nAll other schedules for which provision is made in the applicable rules and regulations of the Securities and Exchange Commission have been omitted as the schedules are not required under the related instructions, are not applicable or the information required thereby is set forth in the Consolidated Financial Statements or the Notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nSHAREHOLDERS AND BOARD OF DIRECTORS CLIFFS DRILLING COMPANY\nWe have audited the accompanying consolidated balance sheets of Cliffs Drilling Company and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cliffs Drilling Company and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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.\nERNST & YOUNG LLP\nHouston, Texas February 17, 1995\nCLIFFS DRILLING COMPANY\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee accompanying notes to consolidated financial statements.\nCLIFFS DRILLING COMPANY\nCONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements.\nCLIFFS DRILLING COMPANY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes to consolidated financial statements.\nCLIFFS DRILLING COMPANY\nCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCorporate Structure\nOn June 21, 1988, Cliffs Drilling Company (the \"Company\") became a separate publicly-owned company as a result of the spin-off of the Company to shareholders of Cleveland-Cliffs Inc (\"Cleveland\"). These statements include the activities of the Company's wholly-owned subsidiaries, Cliffs Oil and Gas Company (\"COGC\") and Cliffs Drilling International, Inc. (\"International\") and the Company's Venezuelan activities, which are organized as a foreign branch.\nPrinciples of Consolidation\nThe accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Activities of the Venezuelan branch are also recorded in the accounts of the Company. The Company's one-third ( 1\/3) interest in the operations of Cliffs Neddrill Central Turnkey International (\"CNCTI\"), a joint venture consisting of International, Neddrill Turnkey Drilling B.V. and Perforadora Central, S.A. de C.V., has been accounted for under the equity method. The Company's interest in the operations of Cliffs-Neddrill Turnkey International (\"CNTI\"), a 50\/50 joint venture between the Company and Neddrill Nederland B.V. of the Netherlands (\"Neddrill\") has been accounted for under the equity method. All significant intercompany transactions and balances are eliminated in consolidation.\nCash and Cash Equivalents\nThe Company's policy is to invest cash in short-term investments. Uninvested cash balances are kept at minimum levels. Investments are valued at cost, which approximates market. The Company considers all highly liquid investments with a maturity date of three months or less when purchased to be cash equivalents.\nInventories\nInventories, consisting principally of tubular goods consumed in turnkey drilling operations and spare drilling parts, are carried at cost, specific identification method.\nDrilling Contracts in Progress\nThe Company recognizes revenues and expenses related to its turnkey drilling contracts when all terms and conditions of the contract have been fulfilled. Consequently, the costs related to in-progress turnkey drilling contracts are deferred as drilling contracts in progress until the contract is completed and revenue is realized. The amount of drilling contracts in progress is dependent on the volume of contracts, the duration of the contract at the end of the reporting period and the contract amount. Provision for losses on incomplete contracts is made when such losses are anticipated.\nRevenue Recognition\nThe Company recognizes revenues from its daywork drilling and MOPU operations based upon the contracted daily rate multiplied by the number of operating days in the period. Turnkey drilling contract revenues are recognized when all terms and conditions of the contract have been fulfilled. The Company recognizes oil and gas revenues from its interests in producing wells based upon the sales method.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEach of the 3 MOPUs which worked in Venezuela had an initial contract term of two years expiring in 1994, subject to certain buyout options. The buyout options could have been exercised at any time during the contract term. Because the Company believed there was a reasonable likelihood that the buyout options on 2 of the units would be exercised in 1994, the Company deferred income recognition on these 2 units to the extent of potential losses that could occur upon exercise of the options. The deferral of income recognition is reflected as \"Contract Termination Provision\" in the Consolidated Statements of Operations and was reflected in \"Deferred Income\" in the Consolidated Balance Sheets until the 2 MOPUs were sold during December, 1994.\nProperty and Equipment\nProperty and equipment are carried at original cost or at adjusted net realizable value, as applicable. Certain leases have been capitalized and the leased assets have been included in property and equipment. Major renewals and betterments are capitalized in the property accounts, while the cost of repairs and maintenance is charged to operating expenses in the period incurred.\nThe Company records expenditures made on significant projects as construction in progress (\"CIP\") until the assets are ready for their intended use. No depreciation expense is recorded on amounts included in CIP.\nInterest on funds borrowed for construction of qualifying assets is capitalized during the construction period. Amortization of capitalized interest is included in depreciation, depletion and amortization in the Consolidated Statements of Operations.\nCost and accumulated depreciation, depletion and amortization are removed from the accounts when assets are sold or retired and the resulting gains or losses are included in the Consolidated Statements of Operations.\nDepreciation of property and equipment is provided on the straight-line basis at rates based upon expected useful lives of the various classes of assets. Amortization of capital leases is included in depreciation, depletion and amortization in the Consolidated Statements of Operations.\nCosts related to the exploration and development of oil and gas properties are accounted for under the \"Successful Efforts\" method of accounting. Lease acquisition costs related to oil, gas and mineral properties are capitalized when incurred. The acquisition costs of unproved properties, which are individually significant, are assessed on a property-by-property basis and a loss is recognized by provision of a valuation allowance when the assessment indicates an impairment in value. Exploration costs, excluding exploratory wells, are charged to expense as incurred. Costs of drilling exploratory wells are capitalized pending determination as to whether the wells have proved reserves which justify commercial development. If commercial reserves are not found, the drilling costs are charged to dry hole expense. Tangible and intangible drilling costs applicable to productive exploratory wells and to the development of oil and gas reserves are capitalized.\nThe cost of productive leaseholds is amortized by field on the unit of production basis by applying the ratio of produced oil and gas to estimated proved reserves. Lease and well equipment and other intangible drilling costs associated with productive wells are amortized based on proved developed reserves. The carrying value of proved oil and gas properties is limited to the undiscounted future net revenue from proved reserves, adjusted for income taxes, on a company-wide basis.\nIncome Taxes\nThe Company accounts for income taxes in accordance with Statement of Financial Accounting Standards (SFAS) No. 109 \"Accounting for Income Taxes.\" Deferred income taxes are provided\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\non items recognized in different periods for financial and tax reporting purposes. See Note 6 of Notes to Consolidated Financial Statements.\nEarnings Per Share\nPrimary earnings per share computations are based on net income less dividends on the Company's $2.3125 Convertible Exchangeable Preferred Stock (the \"Preferred Stock\"), divided by the average number of common shares and equivalents outstanding during the respective years. Common stock equivalents include the number of shares issuable upon exercise of stock options, less the number of shares that could have been repurchased with the exercise proceeds using the treasury stock method. The Preferred Stock is not included in the primary earnings per share computation as it is not a common stock equivalent. Fully diluted earnings per common share computations are made after the assumption of conversion of the Preferred Stock when the effect of such conversion is dilutive.\nForeign Currency Translation\nThe U.S. dollar is the functional currency for all of the Company's operations. Foreign currency gains and losses are included in the Consolidated Statements of Operations during the period incurred.\nConcentration of Credit Risk\nThe market for the Company's services is the oil and gas industry, and the Company's customers consist primarily of integrated and government-owned international oil companies and independent oil and gas producers. Financial instruments which potentially subject the Company to concentrations of credit risk consist primarily of trade receivables. The Company has in place insurance to cover certain exposure in its foreign operations and provides allowances for potential credit losses when necessary. Accordingly, management considers such credit risk to be limited.\nChange in Presentation\nCertain financial statement items have been reclassified in prior years to make them conform with the current year presentation.\n2. PROCEEDS-OF-PRODUCTION DRILLING PROGRAM AND NOTES AND OTHER RECEIVABLES -- CURRENT AND LONG-TERM\nThe Company entered into a proceeds-of-production drilling program in 1986 to drill and\/or complete 25 oil and gas wells. The revenues due under this arrangement were paid to the Company through an assignment of the proceeds of production generated from the wells drilled. The revenues and costs associated with the services supplied directly by the Company, including handling fees and interest income, were deferred, resulting in income to be recognized in future periods. Revenues and expenses were recognized in amounts equal to the portion of the cash payments applicable to directly supplied services until all the Company's costs were recovered in the fourth quarter of 1989.\nEffective January 1, 1993, the Company sold its 4 inland posted barge drilling rigs and rights to certain oil and gas production payment proceeds generated from the proceeds-of-production drilling program for an aggregate sales price of $13,500,000, consisting of $5,000,000 in cash and $8,500,000 in notes. The first note has a face amount of $1,000,000, bears interest at the base rate on corporate loans as quoted by the Wall Street Journal, and is due on or before December 31, 1995. Interest is due and payable semi-annually and commenced June 30, 1993. The second note\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nhas a face amount of $7,500,000, bears interest at the base rate on corporate loans as quoted by the Wall Street Journal plus one and one-half percent (1 1\/2%), and matures on January 1, 1998. Principal and interest on the $7,500,000 note is payable on a monthly basis solely from the proceeds of the oil and gas production payment which secures the note. No net gain or loss on the sale was recorded for financial reporting purposes.\n3. PROPERTY AND EQUIPMENT\nBuyout options on 2 MOPUs which previously worked in Venezuela were exercised by the charterer during the fourth quarter of 1994. The Company received total proceeds of $4,000,000 for the 2 units in December, 1994. No net gain or loss on sale was recognized for financial reporting purposes.\nEffective January 1, 1993, the Company sold its 4 inland posted barge drilling rigs and rights to certain oil and gas production payment proceeds for an aggregate sales price of $13,500,000.\nDuring the fourth quarter of 1992, the Company purchased 5 jack-up drilling rigs for $6,000,000 in cash. The Company converted 2 of the 5 rigs to MOPUs, converted one to a mobile offshore supply unit for use in the Bay of Campeche, Mexico, mobilized one unit to the Bay of Tampico, Mexico in February, 1994, to drill turnkey wells during 1994, and bareboat chartered the other unit in 1994 to a third party for use as a workover rig in the U.S. Gulf of Mexico.\nOn October 31, 1991, the Company purchased 3 jack-up drilling rigs from Chiles Offshore Corporation for $15,500,000 in cash. The Company completed the process of refurbishing and converting the rigs for operation as portable compression units in Lake Maracaibo, Venezuela in 1992. The 3 units were contracted to Dresser-Rand Company (\"Dresser-Rand\") and mobilized to Venezuela. Expenditures made in 1991 to acquire and modify the rigs, in addition to the associated financing costs, were included in ClP until the units became operational. No interest was capitalized during the years ended December 31, 1994 and 1993. Total interest capitalized during the year ended December 31, 1992 was $1,278,000. Costs to mobilize the rigs to Venezuela were reimbursed to the Company by Dresser-Rand.\n4. INVESTMENTS IN AND ADVANCES TO UNCONSOLIDATED AFFILIATES\nCNCTI was awarded a contract for one turnkey bid package to drill 4 turnkey wells in the Bay of Campeche, Mexico. Drilling operations commenced in February, 1993. CNCTI was subsequently awarded 2 turnkey bid packages for 2 wells each in the Bay of Campeche and the Bay of Tampico, Mexico. Five and 2 turnkey contracts were completed by CNCTI in 1994 and 1993, respectively, and were recorded under the equity method. The following information summarizes the unaudited Statements of Operations and Balance Sheets of CNCTI:\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n5. NOTES PAYABLE\nIn conjunction with the acquisition of 3 jack-up rigs and the related Dresser-Rand contracts, the Company entered into an interim financing agreement with NMB Postbank Groep N.V., now known as Internationale Nederlanden (U.S.) Capital Corporation (\"INCC\"), on October 31, 1991. The interim financing provided $20,000,000 in available funding for the purchase, construction, modification, mobilization and interest carry on the 3 jack-up rigs (\"Term Loan\") and $10,000,000 in a working capital credit facility. On December 16, 1991, a permanent facility replaced the interim agreement and increased the amount available under the Term Loan to $30,000,000.\nThe Company executed the Second Restated Credit Agreement with INCC during the first quarter of 1994, thereby converting its $10,000,000 working capital credit facility to a $20,000,000 revolving line of credit subject to certain borrowing base limitations.\nFor the $30,000,000 Term Loan, the Company paid a fee equal to two percent (2%) of the facility. The Company paid interest on the advances at either two percent (2%) per annum plus the greater of the prevailing Federal Funds Rate plus one-half percent ( 1\/2%) or INCC's prime rate; or at the adjusted LIBOR rate plus three and three-quarters percent (3 3\/4%) per annum during the period prior to commencement of payments on all three charters from Dresser-Rand, (\"Mobilization Period\") and, thereafter, at one percent (1%) per annum plus the greater of the prevailing Federal Funds Rate plus one-half percent ( 1\/2%) or INCC's prime rate; or at the adjusted LIBOR rate plus two and three-quarters percent (2 3\/4%) per annum. Eighty-five percent (85%) of the cash flow attributable to the contracts for the Company's 3 MOPUs working in Venezuela was dedicated to debt repayment under the contracts and loan agreements relating to such MOPUs. In addition, both notes were secured by an assignment of the revenues due under the contract with Dresser-Rand. The Company paid the outstanding balance under the Term Loan in October, 1994.\nAll advances to the Company from the $20,000,000 revolving line of credit bear interest at three-quarters of one percent ( 3\/4%) per annum plus the greater of the prevailing Federal Funds Rate plus one-half percent ( 1\/2%) or a referenced average prime rate; or at the adjusted LlBOR rate plus two and one-half percent (2 1\/2%) per annum. The foregoing rates are subject to an increase of one-half percent ( 1\/2%) in the event certain financial thresholds are exceeded. The Company is also obligated to pay INCC (i) a commitment fee equal to one-half percent ( 1\/2%) per annum on the average daily unadvanced portion of the commitments and (ii) a letter of credit fee of two percent (2%) per annum on the average daily undrawn and unexpired amount of each letter of credit during the period that sum remains outstanding. The revolving line of credit matures on January 1, 1996. At December 31, 1994, the Company had no outstanding borrowings on the $20,000,000 revolving line of credit.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe revolving line of credit note is secured by accounts receivable, certain oil and gas properties, and a first preferred fleet mortgage on a majority of the Company's rig inventory. Under the Second Restated Credit Agreement with INCC, as amended, the Company is required to comply with various covenants including, but not limited to, the maintenance of various financial ratios, and is restricted from declaring, making, or paying any dividends on the Common Stock.\nInterest payments on all indebtedness amounted to $919,000, $1,536,000 and $2,623,000 for the years ended December 31, 1994, 1993, and 1992, respectively.\n6. INCOME TAXES\nThe Company incurred net operating losses in prior years resulting in tax net operating loss carryforwards. The total carryforward is available to offset taxable income in future years. At December 31, 1994, the net operating loss carryforward is $8,607,000 for regular tax purposes. The Company also has a percentage depletion carryover to 1995 of approximately $1,937,000. The majority of these amounts have been realized in the financial statements as a reduction of deferred taxes. In addition, the Company has $1,394,000 of unused investment tax credit carryforwards and $2,186,000 of foreign tax credit carryforwards at December 31, 1994. These carryforwards are available for use by the Company through the following expiration dates:\n- --------------- (1) The investment tax credits reflect the 35% reduction required by the Tax Reform Act of 1986.\nThe Company provided for $790,000 of income taxes for the year ended December 31, 1994. This amount is comprised of a current provision of $1,190,000 for the taxes paid in foreign jurisdictions and a deferred tax benefit of $400,000 for alternative minimum taxes paid in prior years\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nwhich are available as credits indefinitely against regular tax liabilities. The significant components of deferred tax assets and liabilities are as follows:\nFor financial reporting purposes, income (loss) before income taxes includes the following components:\nSignificant components of the provision for income taxes attributable to continuing operations are as follows:\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe reconciliation of income tax attributable to continuing operations computed at the U.S. statutory tax rates to income tax expense is:\nIncome tax payments amounted to $982,000 and $685,000 for the years ended December 31, 1994 and 1993. No income tax payments were made during the year ended December 31, 1992.\n7. TAX LEASES\nThe Company contracted for the construction of 2 jack-up drilling rigs in the period 1980-1982 at a cost of $65,575,000. For tax purposes, both rigs were sold in 1982 to third parties under lease back terms pursuant to Section 168(f)(8) of the Internal Revenue Code (\"Safe Harbor Lease\"). Cleveland received a payment in the aggregate of $16,685,000 which represented the investment tax credit and depreciable benefits attributable to the rigs. The interest income and principal due the Company from the third parties is equal to the lease payments by the Company to the third parties throughout the lease term. Cleveland guarantees the Company's obligations to indemnify the tax lessors against loss of tax benefits throughout the lease term ending in 1997.\nThe future net tax deductions associated with the Safe Harbor Leases are $3,732,000, $4,644,000 and $5,117,000 for the years 1995, 1996 and 1997, respectively.\n8. DEFINED CONTRIBUTION PLAN\nThe Company has a defined contribution plan (\"401(k) Plan\"). Under the 401(k) Plan, an employee who has reached age 21 and completed 90 days of service is eligible to participate in the plan through contributions that range in one percent multiples up to 16% of salary, with a 1994 dollar maximum of $9,240. In addition, the Company contributes (or \"matches\") on behalf of each participant an amount equal to 100% of the portion of each participant's contribution which does not exceed 6% of the participant's annual salary. Employer contributions for certain highly compensated employees may be further limited through the operation of the non-discrimination requirements found in Sections 401(k) and 401(m) of the Internal Revenue Code.\nEmployee contributions can be invested in any or all of 6 investment options in multiples of 5%. Employer contributions are invested in the Company's Common Stock. Employee contributions are 100% vested and non-forfeitable. Employer contributions are subject to a graded vesting schedule, with participants becoming fully vested upon completion of five years employment service with the Company. Distributions from the 401(k) Plan are made upon retirement, death, disability or separation of service. Participants may borrow up to one-half ( 1\/2) of their vested interest in the\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nplan, limited to a maximum of $50,000. Contributions to the 401(k) Plan and earnings on contributions are not included in a participant's gross income until distributed to the participant. Contributions to the 401(k) Plan by the Company were $302,000, $233,000 and $266,000 for the years 1994, 1993 and 1992, respectively.\n9. LONG-TERM OBLIGATIONS UNDER CAPITAL LEASES\nMaturities of obligations under capital leases at December 31, 1991 were $2,682,000. The final payment under the capital lease obligation was made on January 2, 1992.\n10. CAPITAL STOCK\nOn October 22, 1992, the Company completed a secondary public offering of 1,500,000 shares of common stock at a price to the public of $13.25 per share. The Company received net proceeds of $18,780,000 on October 29, 1992 after deducting underwriting discounts and commissions of $1,095,000, or $0.73 per share. The common stock sold in the public offering has been recorded at par value as Common Stock, with the remainder of the proceeds, after deducting offering costs of $364,000, being recorded as paid-in capital.\nChanges in the number of outstanding shares of the Company's Common Stock are summarized as follows:\nThe Company has an Incentive Equity Plan under which stock options, stock appreciation rights, restricted and deferred stock awards relating to the Company's Common Stock may be awarded to officers, directors and key employees. The Company's Incentive Equity Plan is designed to attract and reward key executive personnel. The stock options granted under this plan expire not more than ten years from the date of grant.\nAt December 31, 1994, the following options were outstanding and exercisable:\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nOptions for 1,500 shares were exercised during 1993 while no options were exercised in 1994 or 1992, respectively.\nThe Company's Board of Directors has awarded restricted stock to the Company's officers and key employees as follows:\nRestrictions on the 1988 award lapsed with respect to 20% of the entire award after one year and after each of the succeeding 4 years. Restrictions lapse with respect to 25% of the entire award after one year and after each of the succeeding 3 years for all other awards. Expense related to amortization of the restricted stock was $46,000, $120,000 and $442,000 for the years 1994, 1993, and 1992, respectively.\nDeferred compensation expense relative to non-vested shares of restricted stock, measured by the market value of the stock on the date of grant, is being amortized on a straight-line basis over the restriction period. The unamortized deferred compensation expense, which has been deducted from equity in the Consolidated Balance Sheets, amounted to $57,000 and $103,000 at December 31, 1994 and 1993, respectively.\nEffective December 31, 1992, the Company's Board of Directors approved the sale of 17,500 shares of restricted Common Stock to certain key executives. The price paid for the restricted stock was $13.25 per share. The Company extended full recourse, interest-bearing loans to the key executives in the aggregate amount of $232,000. The promissory notes bear interest at seven and one-half percent (7 1\/2%) per annum payable quarterly as it accrues on the last day of March, June, September and December until the notes are due on December 31, 1997. Additional shares of deferred stock will be awarded on December 31, 1997 if certain performance criteria are attained by the Company. Compensation expense related to the deferred stock awards will be accrued in future years if it becomes probable the Company performance criteria will be met. No such compensation expense was accrued during the years ended December 31, 1994 and 1993.\n11. REDEEMABLE PREFERRED STOCK\nThe Preferred Stock is redeemable at the option of the Company, in whole or in part, at $25.93 per share if redeemed prior to September 15, 1995, and at prices decreasing ratably annually to $25 per share from and after September 15, 1998, plus accrued and unpaid dividends to the redemption date. Any such non-mandatory redemption would be subject to INCC approval according to the terms of the Second Restated Credit Agreement. Dividends on the Preferred Stock are cumulative from the date of first issuance and are payable quarterly at the rate of $2.3125 per share per annum. Pursuant to the Second Restated Credit Agreement, dividends on Preferred Stock cannot exceed the current dividend rate per share without the consent of INCC.\nIn case of the voluntary or involuntary liquidation, dissolution or winding up of the Company, holders of shares of Preferred Stock are entitled to receive a liquidation preference of $25 per share\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nplus an amount equal to any accrued but unpaid dividends to the payment date. The Preferred Stock is also exchangeable in whole, but not in part, at the option of the Company on any dividend payment date for nine and one-quarter percent (9 1\/4%) Convertible Subordinated Debentures due 2013. The Preferred Stock is convertible into Common Stock of the Company at the initial conversion rate of 1.89394 shares of Common Stock for each share of Preferred Stock, subject to adjustment under certain circumstances. The Preferred Stock has no voting rights except as described below or as required by law.\nThe holders of the Preferred Stock have no voting rights to elect directors except when dividends on the Preferred Stock or on any outstanding shares of parity dividend stock have not been paid in the aggregate amount equal to at least six quarterly dividends on such shares. The holders of the Preferred Stock will then be entitled to elect two additional directors to the Board, at any meeting of the shareholders of the Company at which directors are to be elected held during the period such dividends remain in arrears. The voting rights, as well as the term of office of all directors so elected, shall terminate when all such dividends accrued and in default have been paid in full or set apart for payment.\nIn addition, so long as any Preferred Stock is outstanding, the Company shall not, without the affirmative vote or consent of the holders of sixty-six and two-thirds percent (66 2\/3%) of all outstanding shares of Preferred Stock voting separately as a class, (i) amend, alter or repeal any provision of the Certificate of Incorporation or the By-Laws of the Company so as to adversely affect the relative rights, preferences, qualifications, limitations or restrictions of the Preferred Stock, (ii) authorize, issue or increase the authorized amount of any class or series of stock, or any security convertible into stock of such class or series, ranking senior to the Preferred Stock as to dividends or upon liquidation, dissolution or winding up of the Company or (iii) effect any reclassification of the Preferred Stock.\nThe affirmative vote or consent of the holders of a majority of the Preferred Stock, voting or consenting separately as a class, is required to (a) authorize any sale, lease or conveyance of all or substantially all of the assets of the Company, or (b) approve any merger, consolidation or compulsory share exchange to which the Company is a party, unless (i) the terms of such merger, consolidation or compulsory share exchange do not provide for a change in the terms of the Preferred Stock and (ii) the Preferred Stock is on a parity with or prior to (in respect of dividends and upon liquidation, dissolution or winding up) any other class or series of capital stock authorized by the surviving corporation, other than any class or series of stock of the Company ranking senior to the Preferred Stock either as to dividends or upon liquidation, dissolution or winding up of the Company and previously authorized with the consent of the holders of Preferred Stock.\nIn the event (i) any person becomes the beneficial owner of more than fifty percent (50%) of the Common Stock or the Company is a party to a business combination, including a merger or consolidation or the sale of all or substantially all of its assets, and (ii) either (a) as a result of such acquisition of shares of Common Stock or business combination, the Preferred Stock thereafter is not convertible into Common Stock of the Company or of the ultimate parent of the Company, which Common Stock is traded on the New York Stock Exchange, the American Stock Exchange or the NASDAQ National Market System, or (b) all or substantially all of the consideration paid in such share acquisition or business combination does not consist of Common Stock of the ultimate parent of the Company, which Common Stock is traded on the New York Stock Exchange, the American Stock Exchange or the NASDAQ National Market System, then each holder of Preferred Stock shall have the option to require the Company to redeem all the Preferred Stock owned by such holder at $25 per share plus accrued and unpaid dividends to the redemption date.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n12. COMMITMENTS AND CONTINGENT LIABILITIES\nThe Company leases its headquarters office, office equipment and other items under operating leases expiring at various dates during the next five years. Management expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases. Total rent expense under operating leases was $583,000, $656,000 and $576,000 for the years ended 1994, 1993 and 1992, respectively. Minimum future obligations under non-cancelable operating leases at December 31, 1994 for the following five years are $667,000, $510,000, $515,000, $545,000 and $555,000, respectively, and $693,000 thereafter.\nIn conjunction with the return to Loews San Antonio Hotel Corporation, now known as Diamond Offshore Company (\"Diamond M\"), of 3 offshore drilling rigs under long-term charters, a dispute existed as to whether or not the Company complied with the terms of the charters regarding maintenance and repair of the rigs during the charter period, as well as the condition of the rigs upon redelivery. Diamond M withheld payment of $1,700,000 in notes payable to the Company, representing a part of the purchase price for the subject rigs. Diamond M also claimed additional damages associated with repairs to the drilling rigs. In June, 1993, a partial summary judgment awarded the Company $1,800,000, together with interest and attorneys fees, for the notes payable owed by Diamond M to the Company, offset by certain charter hire payments due Diamond M. Following a trial in February, 1994, a judgment was entered in the United States District Court, Southern District of Texas, Houston Division, awarding Diamond M $3,500,000, plus court costs, offset by the partial summary judgment of $1,800,000. The Company reported this litigation settlement and expenses in the Consolidated Statements of Operations during the fourth quarter of 1993. The Company paid Diamond M $1,700,000 in February, 1994, as a final settlement of all disputed issues.\nThe Company has other contingent liabilities resulting from litigation, claims and commitments incidental to the ordinary course of business. Management believes that the probable resolution of such contingencies will not materially affect the financial position or results of operations of the Company.\n13. BUSINESS SEGMENTS\nDuring the three years ended December 31, 1994, the Company conducted the following business activities:\nDaywork Drilling -- domestic and foreign drilling of oil and gas wells on a dayrate basis for major and independent oil and gas companies on land, inland waters and offshore.\nEngineering Services -- domestic and foreign drilling of oil and gas wells on a turnkey basis for major and independent oil and gas companies on land, inland waters and offshore and foreign well engineering and management services.\nMOPU Operations -- domestic and foreign operation of mobile offshore production units on a dayrate basis for major and independent oil and gas companies.\nOil and Gas -- domestic exploration, development and production of hydrocarbon reserves.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIntersegment sales were $3,357,000, $147,000 and $3,082,000 for the years ended December 31, 1994, 1993 and 1992, respectively. Such intersegment sales were accounted for at prices comparable to unaffiliated customer sales.\nIdentifiable assets by industry segment include assets directly identified with those operations.\nThe Company derived a significant amount of its revenues from a few customers in each of the three years ended December 31, 1994. The following table summarizes information with respect to these major customers.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n14. DISTRIBUTION OF EARNINGS AND ASSETS\nThe following table sets forth financial information with respect to the Company and its subsidiaries on a consolidated basis by geographical area.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n15. QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly operating results for years ended December 31, 1994, 1993 and 1992 are summarized as follows:\n- --------------- (1) Fourth quarter 1993 results include a charge of $3,703,000 related to the Diamond M litigation settlement and expenses.\n(2) Fourth quarter 1992 results include a $1,500,000 writedown in the carrying value of oil and gas properties.\n(3) Net Income (Loss) per Share for the year ended December 31, 1992 differs from the summation of the individual quarters within that year due to the impact of the public offering of Common Stock completed during the fourth quarter of 1992.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n16. SUPPLEMENTAL INFORMATION ON OIL AND GAS OPERATIONS (UNAUDITED)\nCOGC, from time to time, participates as a working interest owner in oil and gas exploration activities when it directly or indirectly results in the award of a drilling contract. The Company's oil and gas operations did not meet applicable disclosure requirements at or for the year ended December 31, 1994.\nA $1,500,000 writedown in the carrying value of oil and gas properties was recorded during the year ended December 31, 1992 due to a decline in estimated future net revenues, caused principally by downward revisions of reserve quantities.\nThe aggregate capitalized costs related to the Company's oil and gas exploration and production activities are summarized in the following table:\nCosts incurred in oil and gas property acquisition, exploration and development activities are summarized as follows:\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe results of operations for oil and gas exploration and production activities are summarized as follows:\n- ---------------\n(1) Includes $63,000 and $158,000 attributable to net profits interests for the years ended December 31, 1993 and 1992, respectively.\nNet quantities of proved reserves, all of which are located in the United States are summarized in the following table:\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe standardized measure of discounted future net cash flows and major components of that calculation relating to proved oil and gas reserves are summarized as follows:\nThe standardized measure of discounted future net cash flows from production of proved reserves was developed as follows:\n1. Estimates were made of quantities of proved reserves and the future periods in which they are expected to be produced based on year-end economic conditions.\n2. The estimated future gross revenues of proved reserves were priced on the basis of year-end prices.\n3. The future gross revenue streams were reduced by estimated future costs to develop and to produce the proved reserves, based on year-end cost estimates. Future income taxes have not been included due to the effect of net operating loss carryforwards.\nThe standardized measure of discounted future net cash flows does not purport to present the fair market value of the Company's oil and gas reserves. A market value determination would include, among other things, anticipated future changes in oil and gas prices and production and development costs; the value of additional estimated reserves, not considered proved at present, which may be recovered as a result of further exploration and development activities; and other business risks.\nCLIFFS DRILLING COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe following are principal sources of changes in the standardized measure of discounted net cash flows:\nSCHEDULE II\nCLIFFS DRILLING COMPANY\nVALUATION AND QUALIFYING ACCOUNTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1994 (IN THOUSANDS) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nEXHIBIT INDEX\n- --------------- * Filed herewith\nAll other exhibits 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.","section_15":""}
{"filename":"799122_1994.txt","cik":"799122","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE PARTNERSHIP. Jones Cable Income Fund 1-B, Ltd. (the \"Partnership\") is a Colorado limited partnership that was formed pursuant to the public offering of limited partnership interests in the Jones Cable Income Fund 1 Limited Partnership Program (the \"Program\"), which was sponsored by Jones Intercable, Inc. (the \"General Partner\"). Jones Cable Income Fund 1-A, Ltd. and Jones Cable Income Fund 1-C, Ltd. (\"Fund 1-C\") are the other partnerships that were formed pursuant to the Program. The Partnership and Fund 1-C formed a general partnership known as Jones Cable Income Fund 1-B\/C Venture (the \"Venture\") in which the Partnership owns a 40 percent interest and Fund 1-C owns a 60 percent interest. The Partnership and the Venture were formed for the purpose of acquiring and operating cable television systems.\nThe Partnership directly owns the cable television system serving the community of Orangeburg, South Carolina (the \"Orangeburg System\"). The Venture owns the cable television systems serving the communities of Brighton and Broomfield and portions of Boulder County, Colorado (the \"Brighton\/Broomfield System\"), Clearlake Oaks, California (the \"Clearlake Oaks System\"), Canyonville, Myrtle Creek, Riddle and Winston, Oregon (the \"Myrtle Creek System\"), South Sioux City, Nebraska (the \"South Sioux City System\") and Three Rivers, Schoolcraft\/Vicksburg, Constantine\/White Pigeon, Dowagiac, Watervliet and Vandalia, Michigan (the \"Southwestern Michigan System\"). The Orangeburg System, Brighton\/Broomfield System, Clearlake Oaks System, Myrtle Creek System, South Sioux City System and the Southwestern Michigan System may hereinafter collectively be referred to as the \"Systems.\"\nOne of the primary objectives of the Partnership is to provide quarterly cash distributions to the partners. Such cash returns are primarily from cash generated through the operating activities of the Partnership and from the distributions made to the Partnership from the Venture. Because the Partnership's credit facility was at the maximum amount available in 1994, the Partnership utilized cash generated from operations to fund capital expenditures. In addition, the Venture's credit facility has a maximum amount available of $45,000,000, of which $42,100,000 was outstanding at December 31, 1994, which limits the amount of borrowings available to the Venture to fund capital expenditures; therefore, the Venture did not declare any distributions in 1994. Due to these conditions, the Partnership did not declare any distributions for 1994. Distributions for the years ended December 31, 1993 and 1992 were $1,735,352 and $1,642,928, respectively. The General Partner has agreed to defer its portion of any cash flow distributions until the Partnership is liquidated. The Venture is not expected to reinstate distributions in the near term. In January 1995, the Partnership completed negotiations for a new revolving credit agreement that will provide liquidity to fund capital expenditures. The Partnership will attempt to provide some level of distributions from cash generated from operations in 1995. No determination has been made regarding the level of future distributions. The level of distributions, if any, will be determined on a quarter-by-quarter basis. A determination of the level of distributions, if any, will be made on a quarter by quarter basis. See Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nCABLE TELEVISION SERVICES. The Systems offer to their subscribers various types of programming, which include basic service, tier service, premium service, pay-per-view programs and packages including several of these services at combined rates.\nBasic cable television service usually consists of signals of all four national television networks, various independent and educational television stations (both VHF and UHF) and certain signals received from satellites. Basic service also usually includes programs originated locally by the system, which may consist of music, news,\nweather reports, stock market and financial information and live or videotaped programs of a public service or entertainment nature. FM radio signals are also frequently distributed to subscribers as part of the basic service.\nThe Systems offer tier services on an optional basis to their subscribers. A tier generally includes most of the cable networks such as Entertainment and Sports Programming Network (ESPN), Cable News Network (CNN), Turner Network Television (TNT), Family Channel, Discovery and others, and the cable television operators buy tier programming from these networks. The Systems also offer a package that includes the basic service channels and the tier services.\nThe Systems also offer premium services to their subscribers, which consist of feature films, sporting events and other special features that are presented without commercial interruption. The cable television operators buy premium programming from suppliers such as HBO, Showtime, Cinemax or others at a cost based on the number of subscribers the cable operator serves. Premium service programming usually is significantly more expensive than the basic service or tier service programming, and consequently cable operators price premium service separately when sold to subscribers.\nThe Systems also offer to subscribers pay-per-view programming. Pay-per-view is a service that allows subscribers to receive single programs, frequently consisting of motion pictures that have recently completed their theatrical exhibitions and major sporting events, and to pay for such service on a program-by-program basis.\nREVENUES. Monthly service fees for basic, tier and premium services constitute the major source of revenue for the Systems. In addition, advertising sales are becoming a significant source of revenue for the Systems. As a result of the adoption by the FCC of new rules under the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), and several rate regulation orders, the Systems' rate structures for cable programming services and equipment have been revised. See Regulation and Legislation. At December 31, 1994, the Systems' monthly basic service rates ranged from $6.72 to $15.96, monthly basic and tier (\"basic plus\") service rates ranged from $17.83 to $22.39 and monthly premium services ranged from $3.40 to $12.95 per premium service. Charges for additional outlets have been eliminated, and charges for remote controls and converters have been \"unbundled\" from the programming service rates. In addition, pay-per-view programs and advertising fees generate revenues. Related charges may include a nonrecurring installation fee that ranges from $4.95 to $45.00; however, from time to time the Systems have followed the common industry practice of reducing or waiving the installation fee during promotional periods. Commercial subscribers such as hotels, motels and hospitals are charged a nonrecurring connection fee that usually covers the cost of installation. Except under the terms of certain contracts with commercial subscribers and residential apartment and condominium complexes, the subscribers are free to discontinue the service at any time without penalty. For the year ended December 31, 1994, of the total fees received by the Systems, basic service and tier service fees accounted for approximately 69% of total revenues, premium service fees accounted for approximately 18% of total revenues, pay-per-view fees were approximately 1% of total revenues, advertising fees were approximately 3% of total revenues and the remaining 9% of total revenues came principally from equipment rentals, installation fees and program guide sales. The Partnership is dependent upon the timely receipt of service fees to provide for maintenance and replacement of plant and equipment, current operating expenses and other costs of the Systems.\nThe Partnership's business consists of providing cable television services to a large number of customers, the loss of any one of which would have no material effect on the Partnership's business. Each of the Systems has had some subscribers who later terminated the service. Terminations occur primarily because people move to another home or to another city. In other cases, people terminate on a seasonal basis or because they no longer can afford or are dissatisfied with the service. The amount of past due accounts in the Systems is not significant. The General Partner's policy with regard to past due accounts is basically one of disconnecting service before a past due account becomes material.\nThe Partnership does not depend to any material extent on the availability of raw materials; it carries no significant amounts of inventory and it has no material backlog of customer orders. The Partnership has no\nemployees because all properties are managed by employees of the General Partner. The General Partner has engaged in research and development activities relating to the provision of new services but the amount of the Partnership's funds expended for such research and development has never been material.\nCompliance with Federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment has had no material effect upon the capital expenditures, earnings or competitive position of the Partnership.\nFRANCHISES. The Systems are constructed and operated under non-exclusive, fixed-term franchises or other types of operating authorities (referred to collectively herein as \"franchises\") granted by local governmental authorities. The Systems' franchises require that franchise fees ranging from $25.00 per year to 7% of gross revenues of the cable system be paid to the governmental authority that granted the franchise, that certain channels be dedicated to municipal use, that municipal facilities, hospitals and schools be provided cable service free of charge and that any new cable plant be substantially constructed within specific periods. (See Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe cable television systems owned by the Partnership and the Venture at December 31, 1994 are described below:\nThe following sets forth (i) the monthly basic plus service rates charged to subscribers, (ii) the number of basic subscribers and pay units and (iii) the range of franchise expiration dates for the Systems. The monthly basic service rates set forth herein represent, with respect to systems with multiple headends, the basic service rate charged to the majority of the subscribers within the system. While the charge for basic plus service may have increased in some cases in 1993 as a result of the FCC's rate regulations, overall revenues may have decreased due to the elimination of charges for additional outlets and certain equipment. In cable television systems, basic subscribers can subscribe to more than one pay TV service. Thus, the total number of pay services subscribed to by basic subscribers are called pay units. As of December 31, 1994, the Partnership's Orangeburg System operated approximately 350 miles of cable plant, passing approximately 17,000 homes, representing an approximate 72% penetration rate, and the Venture's systems operated approximately 2,200 miles of cable plant, passing approximately 132,000 homes, representing an approximate 65% penetration rate. Figures for numbers of subscribers, miles of cable plant and homes passed are compiled from the General Partner's records and may be subject to adjustments.\nFranchise expiration dates range from May 1995 to March 1998. The City of Orangeburg franchise expires in May 1995. The Partnership and the franchising authorities continue to negotiate the terms of a new franchise with a longer term.\nFranchise expiration dates range from October 1997 to February 2008.\nThe franchise expiration dates range from April 1996 to June 2013. There is no franchise expiration date for Brighton.\nFranchise expiration dates range from April 1996 to August 2014.\nFranchise expiration dates range from June 1998 to July 2004.\nFranchise expiration dates range from February 2001 to February 2009.\nPROGRAMMING SERVICES\nProgramming services provided by the Systems include local affiliates of the national broadcast networks, local independent broadcast channels, the traditional satellite services (e.g., American Movie Classics, Arts & Entertainment, Black Entertainment Network, C-SPAN, The Discovery Channel, Lifetime, Entertainment Sports Network, Home Shopping Network, Mind Extension University, Music Television, Nickelodeon, Turner Network Television, The Nashville Network, Video Hits One, and superstations WOR, WGN and TBS. The Partnership's Systems also provide a selection, which varies by system, of premium channel programming (e.g., Cinemax, Encore, Home Box Office, Showtime and The Movie Channel).\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 STOCK AND RELATED SECURITY HOLDER MATTERS\nWhile the Partnership is publicly held, there is no public market for the limited partnership interests, and it is not expected that a market will develop in the future. As of February 15, 1995, the approximate number of equity security holders in the Partnership was 4,470.\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\nJONES CABLE INCOME FUND 1-B\nResults of Operations\n1994 Compared to 1993-\nRevenues of Jones Cable Income Fund 1-B, Ltd. (the \"Partnership\") increased $143,512, or approximately 3 percent, from $4,341,380 in 1993 to $4,484,892 in 1994. The Partnership's Orangeburg, South Carolina cable television system (the \"Orangeburg System\") added 472 basic subscribers during 1994, an increase of 4 percent. Such expansion of the subscriber base was primarily responsible for the increase in revenues. The increase in revenues would have been greater but for the reduction in certain rates charged due to basic rate regulations issued by the FCC in April 1993 with which the Partnership complied effective September 1993. See Item 1. No other factor significantly affected the increase in revenues.\nOperating, general and administrative expenses increased $170,728, or approximately 7 percent, from $2,550,022 in 1993 to $2,720,750 in 1994. Operating, general and administrative expenses represented 59 percent of revenue in 1993, compared to 61 percent in 1994. The increase in operating, general and administrative expenses was due primarily to increases in programming fees. No other factor significantly affected the increase in operating, general and administrative expenses. Management fees and allocated overhead from the General Partner increased $25,921, or approximately 5 percent, from $546,371 in 1993 to $572,292 in 1994. This increase is due to the increase in revenues, upon which such fees and allocations are based, and an increase in expenses allocated from the General Partner. The General Partner has experienced increases in expenses, including personnel costs and reregulation costs, a portion of which are allocable to the Partnership.\nDepreciation and amortization expense decreased $314,234, or approximately 19 percent, from $1,691,043 in 1993 to $1,376,809 in 1994. This decrease is due to a reduction in amortization expense, due to the maturation of the Partnership's intangible asset base and was offset, in part, by an increase in depreciation expense due to capital additions in 1993 and 1994.\nOperating loss decreased $261,097, or approximately 59 percent, from $446,056 in 1993 to $184,959 in 1994. This decrease was due to the increase in revenues and the decrease in depreciation and amortization exceeding the increases in operating, general and administrative expense and management fees and allocated overhead from the General Partner. Operating income before depreciation and amortization decreased $53,137, or approximately 4 percent, from $1,244,987 in 1993 to $1,191,850 in 1994, due to the increase in revenues exceeding the increases in operating, general and administrative expense and management fees and allocated overhead from the General Partner. The decrease in operating income before depreciation and amortization reflects the current operating environment of the cable television industry. The FCC rate regulations under the 1992 Cable Act have caused revenues to increase more slowly than otherwise would have been the case. In turn, this has caused certain expenses which are a function of revenue, such as franchise fees, copyright fees and management fees, to increase more slowly than in prior years. However, other operating costs such as programming fees, salaries and benefits, and marketing costs as well as other costs incurred by the General Partner, which are allocated to the Partnership, continue to increase at historical rates. This situation has led to reductions in operating income before depreciation and amortization as a percent of revenue (\"Operating Margin\"). Such reductions in Operating Margins may continue in the near term as the Partnership and the General Partner incur cost increases due to, among other things, increases in programming fees, compliance costs associated with reregulation and competition, that exceed increases in revenue. The General Partner will attempt to mitigate a portion of these reductions through (a) new service offerings, (b) product re-marketing and re-packaging and (c) marketing efforts targeted at non-subscribers.\nInterest expense increased $15,359, or approximately 4 percent, from $376,224 in 1993 to $391,583 in 1994 due to higher effective rates on interest bearing obligations.\nLoss before equity in net loss of cable television joint venture decreased $227,408, or approximately 26 percent, from $869,795 in 1993 to $642,387 in 1994. This decrease was due to the factors discussed above and are expected to continue.\nIn addition to its wholly owned Orangeburg System, the Partnership owns an approximate 40 percent interest in Jones Cable Income Fund 1-B\/C Venture (the \"Venture\"). The Partnership's share of the Venture's loss increased from $1,753,583 in 1993 to $1,949,794 in 1994. The Venture's operations are significant to the Partnership and should be reviewed in conjunction with this analysis. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations for the Venture for details pertaining to the Venture's operations.\n1993 Compared to 1992-\nRevenues of the Partnership's Orangeburg System increased $177,690, or approximately 4 percent, from $4,163,690 in 1992 to $4,341,380 in 1993. During 1993, the Orangeburg System added 446 basic subscribers, an increase of 4 percent. Such expansion of the subscriber base was primarily responsible for the increase in revenues. The increase in revenue would have been greater but for the reduction in certain rates charged due to basic rate regulations issued by the FCC in April 1993 with which the Partnership complied effective September 1993. No other individual factor significantly affected the increase in revenues.\nOperating, general and administrative expense increased $140,975 or approximately 6 percent, from $2,409,047 in 1992 to $2,550,022 in 1993. Operating, general and administrative expense consumed 59 percent of revenue in 1993 compared to 58 percent in 1992. The increase in operating, general and administrative expense was due primarily to increases in programming fees. Management fees and allocated overhead from the General Partner increased $26,899, or approximately 5 percent, from $519,472 in 1992 to $546,371 in 1993. Such increase was due to the increase in revenue, upon which such fees and allocations are based, and an increase in costs allocated from the General Partner.\nDepreciation and amortization decreased $240,212, or approximately 12 percent, from $1,931,255 in 1992 to $1,691,043 in 1993. This decrease was due to a reduction in amortization expense, due to the maturation of the Partnership's intangible asset base and was offset, in part by an increase in depreciation expense due to capital additions in 1992 and 1993.\nOperating loss decreased $250,028, or approximately 36 percent, from $696,084 in 1992 to $446,056 in 1993. This decrease is due to the increase in revenues and the decreases in depreciation and amortization exceeding the increases in operating, general and administrative expense and management fees and allocated overhead from the General Partner. Operating income before depreciation and amortization increased $9,816, or approximately 1 percent, from $1,235,171 in 1992 to $1,244,987 in 1993, due to the increase in revenues exceeding the increases in operating, general, and administrative expense and management fees and allocated overhead from the General Partner.\nInterest expense decreased $27,908, or approximately 7 percent, from $404,132 in 1992 to $376,224 in 1993 due to lower effective rates on interest bearing obligations. Other expense decreased $244,410, or approximately 84 percent, from $291,925 in 1992 to $47,515 in 1993. This decrease was due to a reduction in costs associated with the potential overbuild in the Orangeburg system.\nLoss before equity in net loss of cable television joint venture decreased $522,345, or approximately 38 percent, from $1,392,141 in 1992 to $869,795 in 1993. This decrease was due to the factors discussed above.\nFinancial Condition\nThe Partnership expended approximately $901,000 for capital additions during 1994. The construction of service drops to subscribers homes accounted for approximately 27 percent of the capital expenditures. Construction of cable television plant extensions accounted for approximately 22 percent of the expenditures. The purchase of converters accounted for approximately 17 percent of the expenditures. The remaining expenditures were for various enhancements in the Orangeburg System. Funding for these expenditures was provided by cash generated from operations and advances from the General Partner. Anticipated capital expenditures for 1995 are approximately $2,216,000. The construction of service drops to subscribers' homes is expected to account for 33 percent of the expenditures. The purchase of converters and advertising equipment are expected to account for approximately 24 percent and 15 percent, respectively, of the expenditures. The remainder of the expenditures is expected to relate to various enhancements in the Orangeburg System.Funding for these expenditures is expected to be provided by cash generated from operations and borrowings under the Partnership's new revolving credit facility as discussed below.\nAs of December 31, 1994, the full amount of the Partnership's $3,500,000 credit facility was outstanding. In January 1995, the General Partner completed negotiations for a new revolving credit facility with a maximum amount available of $8,500,000. The Partnership borrowed $5,800,000 to repay the amounts outstanding under the prior credit facility and to repay the General Partner its advances, leaving $2,700,000 of borrowings available. The revolving credit facility converts to a term loan on December 31, 1997 at which time the then-outstanding loan balance will be due in 20 consecutive quarterly installments beginning March 31, 1998. Interest on the revolving credit facility is at the Partnership's option of the Prime rate plus 1\/4 percent, the CD rate plus 1 3\/8 percent, or the London Interbank Offered Rate plus 1 1\/2 percent.\nSince the balance on the the Partnership's former credit facility was at the maximum available, the General Partner had advanced funds necessary for capital expenditures. Interest on such advances was calculated at the General Partner's weighted average cost of borrowing. At December 31, 1994, such advances totalled $2,162,870. Such advances were repaid in January 1995 with proceeds from borrowings under the new revolving credit facility.\nThe Partnership's approximate 40 percent interest in the Venture is accounted for under the equity method. When compared to the December 31, 1993 balance, the investment has decreased by $1,949,794. This decrease represents the Partnership's share of Venture losses. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations for the Venture for details pertaining to the Venture's financial condition.\nOne of the primary objectives of the Partnership is to provide quarterly cash distributions to the partners. Such cash returns are primarily from cash generated through the operating activities of the Partnership and from the distributions made to the Partnership from the Venture. Because the Partnership's credit facility was at the maximum amount available in 1994, the Partnership utilized cash generated from operations to fund capital expenditures. In addition, the Venture's credit facility has a maximum amount available of $45,000,000, of which $42,100,000 was outstanding at December 31, 1994, which limits the amount of borrowings available to the Venture to fund capital expenditures; therefore, the Venture did not declare any distributions in 1994. Due to these conditions, the Partnership did not declare any distributions for 1994. Distributions for the years ended December 31, 1993 and 1992 were $1,735,352 and $1,642,928, respectively. The General Partner has agreed to defer its portion of the distributions from cash flows until the Partnership is liquidated. The Venture is not expected to reinstate distributions in the near term. In January 1995, the Partnership completed negotiations for a new revolving credit agreement that will provide liquidity to fund capital expenditures. The Partnership will attempt to provide some level of distributions from cash generated from operations in 1995. No determination has been made regarding the level of future distributions. The level of distributions, if any, will be determined on a quarter-by-quarter basis.\nRegulation and Legislation\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The Partnership has filed a cost-of-service showing for its Orangeburg System and therefore anticipates no further reductions in rates. The cost-of-service showing has not yet received final approval from franchising authorities, however, and there can be no assurance that the Partnership's cost-of-service showing will prevent further rate reductions until such final approval is received. See Item 1 for further discussion of the provisions of the 1992 Cable Act and the FCC regulations promulgated thereunder.\nJONES CABLE INCOME FUND 1-B\/C VENTURE\nResults of Operations\n1994 Compared to 1993-\nRevenues of Jones Cable Income Fund 1-B\/C Venture (the \"Venture\") increased $771,011, or approximately 4 percent, from $20,350,776 in 1993 to $21,121,787 in 1994. An increase in subscribers accounted for approximately 41 percent of the increase in revenues. Increases in premium service revenue and advertising sales revenue accounted for approximately 28 percent and 26 percent, respectively, of the increase in revenues. The increase in revenues would have been greater but for the reduction in certain rates charged due to basic rate regulations issued by the FCC in April 1993 with which the Venture complied effective September 1, 1993.\nOperating, general and administrative expenses increased $645,813, or approximately 6 percent, from $11,371,695 in 1993 to $12,017,508 in 1994. Operating, general and administrative expenses represented 56 percent of revenue in 1993 compared to 57 percent in 1994. The increase in operating, general and administrative expense was due to increases in programming fees, personnel related costs, and advertising sales costs. No other individual factor was significant to the increase in operating, general and administrative expenses. Management fees and allocated overhead from Jones Intercable, Inc. increased $125,126, or approximately 5 percent, from $2,589,673 in 1993 to $2,714,799 in 1994, due primarily to the increase in revenues, upon which such fees and allocations are calculated, and an increase in expenses allocated from Jones Intercable, Inc. The General Partner has experienced increases in expenses, including personnel costs and reregulation costs, a portion of which are allocated to the Venture.\nDepreciation and amortization expense decreased $154,759, or approximately 2 percent, from $8,787,240 in 1993 to $8,632,481 in 1994. This decrease is due to the maturation of the Venture's depreciable asset base.\nOperating loss decreased $154,831, or approximately 7 percent, from $2,397,832 in 1993 to $2,243,001 in 1994. This decrease is a result of the increase in revenues and the decrease in depreciation and amortization exceeding the increase in operating, general and administrative expenses, management fees and allocated overhead from Jones Intercable, Inc. Operating income before depreciation and amortization increased less than 1 percent, from $6,389,408 in 1993 to $6,389,480 in 1994.\nInterest expense increased $745,019, or approximately 37 percent, from $2,016,390 in 1993 to $2,761,409 in 1994. This increase was due to higher effective interest rates on interest bearing obligations. Net loss increased $434,366, or approximately 11 percent, from $4,409,310 in 1993 to $4,902,676 in 1994. These losses are due to the factors discussed above and are expected to continue in the future.\n1993 Compared to 1992-\nRevenues of the Venture increased $1,502,431, or approximately 8 percent, from $18,848,345 in 1992 to $20,350,776 in 1993. An increase in subscribers accounted for approximately 36 percent of the increase in revenues and basic rate adjustments accounted for approximately 42 percent of the increase in revenues. Increases in advertising sales revenue accounted for approximately 11 percent of the increase in revenues. The increase in revenue would have been greater but for the reduction in certain rates charged due to new basic rate regulations issued by the FCC in April 1993 with which the Venture complied effective September 1, 1993.\nOperating, general and administrative expenses increased $1,809,113, or approximately 19 percent, from $9,562,582 in 1992 to $11,371,695 in 1993. Operating, general and administrative expenses represented 56 percent of revenue in 1993 compared to 51 percent in 1992. The increase in operating, general and administrative expense was due to increases in programming fees, personnel related costs, and plant related costs. No other individual factor was significant to the increase in operating, general and administrative expenses. Management fees and allocated overhead from Jones Intercable, Inc. increased $218,910, or approximately 9 percent, from $2,370,763 in 1992 to $2,589,673 in 1993, due primarily to the increase in revenues, upon which such fees and allocations are calculated, and an increase in expenses allocated from Jones Intercable, Inc.\nDepreciation and amortization expense decreased $344,202, or approximately 4 percent, from $9,131,442 in 1992 to $8,787,240 in 1993. This decrease was due to the maturation of the Venture's depreciable asset base.\nOperating loss increased $181,390, or approximately 8 percent, from $2,216,442 in 1992 to $2,397,832 in 1993. This increase was a result of the increase in operating, general and administrative expenses, management fees and allocated overhead from Jones Intercable, Inc. exceeding the growth in revenues and the decrease in depreciation and amortization expense.\nInterest expense increased $100,445, or approximately 5 percent, from $1,915,945 in 1992 to $2,016,390 in 1993. This increase was due to higher outstanding balances on interest bearing obligations. Net loss increased $285,918, or approximately 7 percent, from $4,123,392 in 1992 to $4,409,310 in 1993.\nFinancial Condition\nDuring 1994, capital improvements within the Venture's operating systems totaled approximately $4,602,000. Approximately 25 percent were for the construction of service drops to subscribers' homes. Approximately 23 percent of these expenditures were for rebuilds and upgrades in the Venture's cable television systems and approximately 15 percent was for the construction of new cable plant. The remainder of these expenditures related to various system enhancements and improvements in all of the Venture's systems. Funding for these expenditures was provided by borrowings under the Venture's credit facility and cash generated from operations. Anticipated capital expenditures for 1995 are approximately $5,000,000. Construction of service drops to homes and the construction of new cable plant will account for approximately 24 percent and 23 percent, respectively, of the anticipated expenditures. Expenditures for pay security equipment will account for approximately 12 percent, with the remainder of the expenditures relating to other various enhancements in all of the Venture's systems. Funding for these expenditures is expected to come from cash generated from operations and borrowings under the Venture's credit facility.\nIn May 1994, the Venture completed renegotiation of its credit facility to increase the maximum amount available to $45,000,000 and to extend the revolving credit period to June 30, 1997, at which time the outstanding balance is payable in full. At December 31, 1994, $42,100,000 was outstanding on the Venture's credit facility leaving $2,900,000 of available borrowings. Interest on outstanding principal is calculated at the Venture's option of the Prime rate plus 1\/2 percent, or LIBOR plus 1-1\/2 percent.\nOn January 12, 1993, the Venture entered into an interest rate cap agreement covering outstanding debt obligations of $15,000,000. The agreement protects the Venture for LIBOR interest rates that exceed 7 percent for three years from the date of the agreement. The Venture paid a fee of $145,500.\nOne of the primary objectives of the Venture is to provide quarterly cash distributions to the Venture partners. Such cash returns are primarily from cash generated through operating activities of the Venture. The Venture's credit facility has a maximum amount available of $45,000,000, of which $42,100,000 was outstanding on December 31, 1994, which limits the amount of borrowings available to the Venture to fund capital expenditures; therefore, the Venture did not declare any distributions in 1994. During 1993 and 1992, the Venture declared and paid distributions to the Venture partners totaling $4,320,000 and $4,090,000, respectively. Due to the borrowing limitations discussed above, the Venture will need to use cash generated from operations to fund capital expenditures and thus the Venture does not anticipate the resumption of distributions to the Venture partners in the near term.\nThe General Partner believes that the Venture has sufficient sources of capital to meet its presently anticipated needs.\nRegulatory and Legislation\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The Venture has filed cost-of-service showings for its Brighton, Broomfield and Boulder County, Colorado; Myrtle Creek, Oregon; South Sioux City,\nNebraska; and Three Rivers and Watervliet, Michigan systems and thus anticipates no further reductions in rates in these systems. The cost-of-service showings have not yet received final approval from franchising authorities, however, and there can be no assurance that the Venture's cost-of-service showings will prevent further rate reductions until such final approvals are received. The Venture complied with the February 1994 benchmark regulations and further reduced rates in its Clearlake Oaks system effective July 1994. See Item 1 for further discussion of the provisions of the 1992 Cable Act and the FCC regulations promulgated thereunder.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements\nJONES CABLE INCOME FUND 1-B\nFINANCIAL STATEMENTS\nAS OF DECEMBER 31, 1994 AND 1993\nINDEX\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Jones Cable Income Fund 1-B:\nWe have audited the accompanying balance sheets of JONES CABLE INCOME FUND 1-B (a Colorado limited partnership) as of December 31, 1994 and 1993, and the related statements of operations, partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the General Partner'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 Jones Cable Income Fund 1-B as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1995.\nJONES CABLE INCOME FUND 1-B (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nJONES CABLE INCOME FUND 1-B (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nJONES CABLE INCOME FUND 1-B (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES CABLE INCOME FUND 1-B (A Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES CABLE INCOME FUND 1-B (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES CABLE INCOME FUND 1-B (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nJones Cable Income Fund 1-B, Ltd. (the \"Partnership\"), a Colorado limited partnership, was formed on August 14, l986, under a public program sponsored by Jones Intercable, Inc. (\"Intercable\"). The Partnership was formed to acquire, develop and operate cable television systems. Intercable is the \"General Partner\" and manager of the Partnership. The General Partner and its subsidiaries also own and operate cable television systems. In addition, Intercable manages cable television systems for other limited partnerships for which it is general partner and, also, for other affiliated entities.\nContributed Capital\nThe capitalization of the Partnership is set forth in the accompanying statements of partners' capital (deficit). No limited partner is obligated to make any additional contribution to partnership capital.\nThe General Partner purchased its interest in the Partnership by contributing $1,000 to partnership capital.\nAll profits and losses of the Partnership are allocated 99 percent to the limited partners and 1 percent to the General Partner, except for income or gain from the sale or disposition of cable television properties, which will be allocated to the partners based upon the formula set forth in the partnership agreement.\nCable Television System Acquisition\nThe Partnership's acquisition of the cable television system serving the community of Orangeburg, South Carolina (the \"Orangeburg System\") was accounted for as a purchase with the purchase price allocated as follows: first, to the fair value of net tangible assets acquired; second, to the value of a subscriber list, franchise costs and favorable leaseholds; and third to costs in excess of interests in net assets purchased. Brokerage fees paid to a subsidiary of the General Partner were allocated to intangible assets based upon the relative value of these assets at acquisition. Other system acquisition costs were capitalized and included in the cost of distribution systems.\nThe Partnership owns the Orangeburg System and also owns an approximate 40 percent interest in Jones Cable Income Fund 1-B\/C Venture (the \"Venture\"), through a capital contribution made to the Venture in November 1987 of $24,220,000. The Venture acquired cable television systems in Colorado, Oregon and California on December 31, 1987 and in Colorado, Nebraska and Michigan during 1988. The Venture incurred losses of $4,902,676 , $4,409,310 and $4,123,392 in 1994, 1993, and 1992, respectively, of which $1,949,794, $1,753,583 and $1,639,873, respectively, was allocated to the Partnership.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. The Partnership's tax returns are also prepared on the accrual basis.\nInvestment in Cable Television Joint Venture\nThe Partnership's investment in the Venture is accounted for under the equity method. The operations of the Venture are significant to the Partnership and should be reviewed in conjunction with these financial statements. Reference is made to the accompanying financial statements of the Venture on pages 32 to 42.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is provided primarily using the straight-line method over the following estimated service lives:\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nIntangible Assets\nCosts assigned to subscriber lists, favorable leaseholds and costs in excess of interests in net assets purchased are being amortized using the straight-line method over the following remaining estimated useful lives:\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\n(3) TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES\nManagement Fees, Distribution Ratios and Reimbursement\nThe General Partner manages the Partnership and receives a fee for its services equal to 5 percent of the gross revenues of the Partnership, excluding revenues from the sale of cable television systems or franchises. Management fees charged during the years ended December 31, 1994, 1993 and 1992 were $224,245, $217,069 and $208,185, respectively.\nAny partnership distributions made from cash flow (defined as cash receipts derived from routine operations, less debt principal and interest payments and cash expenses) are allocated 99 percent to the limited partners and 1 percent to the General Partner. Distributions resulting from the sale or refinancing of a system or upon dissolution of the Partnership will be made as follows: first, to the limited partners in an amount which together with all prior distributions, other than those made regularly from cash flow, will equal their initial capital contribution; second, payment to the limited partners of a liquidation preference equal to a 10 percent cumulative return on their initial capital contribution, reduced by all prior distributions from cash flow; and the balance, 75 percent to the limited partners and 25 percent to the General Partner.\nThe Partnership reimburses the General Partner for certain allocated overhead and administrative expenses. These expenses represent salaries and benefits paid to corporate personnel, rent, data processing and other corporate facilities costs. Such personnel provide engineering, marketing, administrative accounting, legal, and investor relations services to the Partnership. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner with respect to each partnership managed. Remaining overhead costs are allocated based on\nrevenues and\/or assets managed for the partnership. Effective December 1, 1993 the allocation method was changed to be based only on revenue, which the General Partner believes provides a more accurate method of allocation. Systems owned by the General Partner and all other systems owned by partnerships for which Intercable is the general partner are also allocated a proportionate share of these expenses. The General Partner believes that the methodology used in allocating overhead and administrative expenses is reasonable. Amounts allocated to the Partnership by the General Partner for overhead and administrative expenses during the years ended December 31, 1994, 1993 and 1992 were $348,047, $329,302 and $311,287, respectively.\nThe Partnership was charged interest during 1994 at an average interest rate of 10 percent on the amounts due to the General Partner, which approximated the General Partner's weighted average cost of borrowing. Total interest charged by the General Partner during the years ended December 31, 1994, 1993 and 1992 was $176,867, $217,249 and $214,682, respectively.\nPayments to\/from Affiliates for Programming Services\nThe Partnership receives programming from Product Information Network, Superaudio and The Mind Extension University, affiliates of the General Partner. Payments to Superaudio totaled $7,193, $7,243 and $7,012 in 1994, 1993 and 1992, respectively. Payments to The Mind Extension University totaled $6,517, $4,212 and $4,017 in 1994, 1993 and 1992, respectively. The Partnership receives a commission from Product Information Network based on a percentage of advertising revenues and number of subscribers. Product Information Network, which initiated service in 1994, paid commissions to the Partnership totalling $321 in 1994.\n(4) DISTRIBUTIONS FROM CASH FLOW\nOne of the primary objectives of the Partnership is to provide quarterly cash distributions to the partners. Such cash returns are primarily from cash generated through the operating activities of the Partnership and from the distributions made to the Partnership from the Venture. Because the Partnership's credit facility was at the maximum amount available in 1994, the Partnership utilized cash generated from operations to fund capital expenditures. In addition, the Venture's credit facility has a maximum amount available of $45,000,000, of which $42,100,000 was outstanding at December 31, 1994, which limits the amount of borrowings available to the Venture to fund capital expenditures; therefore, the Venture did not declare any distributions in 1994. Due to these conditions, the Partnership did not declare any distributions for 1994. Distributions for the years ended December 31, 1993 and 1992 were $1,735,352 and $1,642,928, respectively. The General Partner has agreed to defer its portion of the distributions from cash flows until the Partnership is liquidated. The Venture is not expected to reinstate distributions in the near term. In January 1995, the Partnership completed negotiations for a new revolving credit agreement that will provide liquidity to fund capital expenditures. The Partnership will attempt to provide some level of distributions from cash generated from operations in 1995. No determination has been made regarding the level of future distributions. The level of distributions, if any, will be determined on a quarter-by-quarter basis.\n(5) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment as of December 31, 1994 and 1993, consisted of the following:\n(6) DEBT\nAs of December 31, 1994, the full amount of the Partnership's $3,500,000 credit facility was outstanding. In January 1995, the General Partner completed negotiations for a new revolving credit facility with a maximum amount available of $8,500,000. The Partnership borrowed $5,800,000 to repay the amounts outstanding under the prior credit facility and to repay the General Partner its advances, leaving $2,700,000 of borrowings available. The revolving credit facility converts to a term loan on December 31, 1997 at which time the then-outstanding loan balance will be due in 20 consecutive quarterly installments beginning March 31, 1998. Interest on the revolving credit facility is at the Partnership's option of the Prime rate plus 1\/4 percent, the CD rate plus 1 3\/8 percent, or the London Interbank Offered Rate plus 1 1\/2 percent. The effective interest rates on outstanding obligations were 8.63 percent and 4.31 percent, respectively, at December 31, 1994 and 1993.\nInstallments due on debt principal for the five years ending December 31, 1999 and thereafter, respectively, are $13,200, $13,200, $13,200, $167,150, $572,250 and $2,765,000. At December 31, 1994, substantially all of the Partnership assets secured the above indebtedness.\n(7) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because they accrue directly to the partners. The Federal and state income tax returns of the Partnership are prepared and filed by the General Partner.\nThe Partnership's tax returns, the qualification of the Partnership as such for tax purposes, and the amount of distributable partnership income or loss are subject to examination by Federal and state taxing authorities. If such examinations result in changes with respect to the Partnership's qualification as such, or in changes with respect to the Partnership's recorded income or loss, the tax liability of the general and limited partners would likely be changed accordingly.\nTaxable loss reported to the partners is different from that reported in the statements of operations due to the difference in depreciation recognized under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable loss and the net loss reported in the statements of operations.\n(8) COMMITMENTS AND CONTINGENCIES\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The Partnership has filed a cost-of-service showing for its Orangeburg System and therefore anticipates no further reductions in rates. The cost-of-service showing has not yet received final approval from franchising authorities, however, and there can be no assurance that the Partnership's cost-of-service showings will prevent further rate reductions until such final approval is received. See Item 1 for further discussion of the provisions of the 1992 Cable Act and the FCC regulations promulgated thereunder.\nThe Partnership rents office and other facilities under various long-term lease arrangements. Rent paid under such lease agreements totaled $26,875, $27,112, and $27,555, respectively, for the years ended December 31, 1994, 1993 and 1992. Minimum commitments under operating leases for each of the five years in the period ending December 31, 1999, and thereafter are as follows:\n(9) SUPPLEMENTARY PROFIT AND LOSS INFORMATION\nSupplementary profit and loss information for the respective years is presented below:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Jones Cable Income Fund 1-B\/C Venture:\nWe have audited the accompanying balance sheets of JONES CABLE INCOME FUND 1-B\/C Venture (a Colorado general partnership) as of December 31, 1994 and 1993, and the related statements of operations, partners' capital and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the General Partners' 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 Jones Cable Income Fund 1-B\/C Venture as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1995.\nJONES CABLE INCOME FUND 1-B\/C VENTURE (A General Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nJONES CABLE INCOME FUND 1-B\/C VENTURE (A General Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nJONES CABLE INCOME FUND 1-B\/C VENTURE (A General Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES CABLE INCOME FUND 1-B\/C VENTURE (A General Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES CABLE INCOME FUND 1-B\/C VENTURE (A General Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES CABLE INCOME FUND 1-B\/C VENTURE (A General Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nOn October 21, 1987, Jones Cable Income Fund 1-B, Ltd. (\"Fund 1-B\") and Jones Cable Income Fund 1-C, Ltd. (\"Fund 1-C\") formed a Colorado general partnership known as Jones Cable Income Fund 1-B\/C Venture (the \"Venture\") by making capital contributions of $24,220,000 and $36,681,000, respectively (approximately 40 and 60 percent, respectively). The Venture was formed to acquire, develop and operate cable television systems. During 1988 and 1987, the Venture acquired various cable television systems serving the areas in and around Brighton, Broomfield and Boulder County, Colorado; Lake County, California; Myrtle Creek, Oregon; South Sioux City, Nebraska; and Three Rivers and Watervliet, Michigan.\nJones Intercable, Inc. (\"Intercable\"), the general partner of Fund 1-B and Fund 1-C, manages the Venture. Intercable and its subsidiaries also own and operate cable television systems. In addition, Intercable manages cable television systems for other limited partnerships for which it is general partner and, also, for affiliated entities.\nContributed Capital\nThe capitalization of the Venture is set forth in the accompanying statements of partners' capital.\nAll Venture distributions, including those made from cash flow, from the sale or refinancing of Venture property and on dissolution of the Venture, shall be made to Fund 1-B and Fund 1-C in proportion to their interests in the Venture.\nCable Television System Acquisition\nVenture acquisitions were accounted for as purchases with the purchase prices allocated as follows: first, to the fair value of net tangible assets acquired; second, to the value of subscriber lists, franchise costs and a noncompete agreement; and third, to cost in excess of interests in net assets purchased. Brokerage fees paid to a subsidiary of Intercable's parent were allocated to intangible assets based upon the relative value of these assets at acquisition. Other system acquisition costs were capitalized and included in the cost of distribution systems.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. The Venture's tax returns are also prepared on the accrual basis.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is provided primarily using the straight-line method over the following estimated service lives:\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nIntangible Assets\nCosts assigned to franchises, subscriber lists, a noncompete agreement and costs in excess of interests in net assets purchased are amortized using the straight-line method over the following remaining estimated useful lives:\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\nReclassifications\nCertain prior year amounts have been reclassified to conform to the 1994 presentation.\n(3) TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES\nManagement Fees and Reimbursements\nIntercable manages the Venture and receives a fee for its services equal to 5 percent of the gross revenues of the Venture, excluding revenues from the sale of cable television systems or franchises. Management fees paid to Intercable by the Venture during the years ended December 31, 1994, 1993 and 1992 were $1,056,089, $1,017,539 and $942,417, respectively.\nThe Venture reimburses Intercable for certain allocated overhead and administrative expenses. These expenses represent the salaries and related benefits paid for corporate personnel, rent, data processing services and other corporate facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to the Venture. Allocations of personnel costs are based primarily on actual time spent by employees of Intercable with respect to each entity managed. Remaining overhead costs are allocated based on revenue and\/or assets managed for the partnership. Effective December 1, 1993, the allocation method was changed to be based only on revenue, which the General Partner believes provides a more accurate method of allocation. Systems owned by Intercable and all other systems owned by partnerships for which Intercable is the general partner are also allocated a proportionate share of these expenses. Intercable believes that the methodology of allocating overhead and administrative expenses is reasonable. Overhead and administrative expenses allocated to the Venture by Intercable during the years ended December 31, 1994, 1993 and 1992 were $1,658,710, $1,572,134 and $1,428,346, respectively.\nThe Venture was charged interest during 1994 at an average interest rate of 10 percent on the amounts due Intercable, which approximated Intercable's weighted average cost of borrowing. Total interest charged the Venture by Intercable was $180,316, $187,959 and $67,841 during 1994, 1993 and 1992, respectively.\nPayments to\/from Affiliates for Programming Services\nThe Venture receives programming from Product Information Network, Superaudio, The Mind Extension University and Jones Computer Network, affiliates of Intercable. Payments to Superaudio totaled $25,189, $26,541 and $33,913 in 1994, 1993 and 1992, respectively. Payments to The Mind Extension University totaled $33,199, $20,832 and $20,053 in 1994, 1993 and 1992, respectively. Payments to Jones Computer Network, which initiated service in 1994, totaled $13,218 in 1994. The Venture receives a commission from Product Information Network based on a percentage of advertising revenues and number of subscribers. Product Information Network, which initiated service in 1994, paid commissions to the Venture totalling $15,283 in 1994.\n(4) DISTRIBUTIONS FROM CASH FLOW\nOne of the primary objectives of the Venture is to provide quarterly cash distributions to the Venture partners. Such cash returns are primarily from cash generated through operating activities of the Venture. The Venture's credit facility has a maximum amount available of $45,000,000, of which $42,100,000 was outstanding on December 31, 1994, which limits the amount of borrowings available to the Venture to fund capital expenditures; therefore, the Venture did not declare any distributions in 1994. During 1993 and 1992, the Venture declared and paid distributions to the Venture partners totaling $4,320,000 and $4,090,000, respectively. Due to the borrowing limitations discussed above, the Venture will need to use cash generated from operations to fund capital expenditures and thus the Venture does not anticipate the resumption of distributions to the Venture partners in the near term.\n(5) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment as of December 31, 1994 and 1993, consisted of the following:\n(6) DEBT\nIn May 1994, the Venture completed negotiation of its credit facility to increase the maximum amount available to $45,000,000 and to extend the revolving credit period to June 30, 1997, at which time the then-outstanding balance is payable in full. At December 31, 1994, $42,100,000 was outstanding on the Venture's credit facility leaving $2,900,000 of available borrowings. Interest on outstanding principal is calculated at the Venture's option of the Prime rate plus 1\/2 percent, or LIBOR plus 1-1\/2 percent. The effective interest rates on amounts outstanding on the Venture's credit facility as of December 31, 1994 and 1993 were 7.36 percent and 4.67 percent, respectively.\nOn January 12, 1993, the Venture entered into an interest rate cap agreement covering outstanding debt obligations of $15,000,000. The Venture paid a fee of $145,500. The agreement protects the Venture for LIBOR interest rates that exceed 7 percent for three years from the date of the agreement.\nInstallments due on debt principal for each of the five years in the period ending December 31, 1999, respectively, are $85,002, $85,002, $42,185,001, $28,334 and $-0-. As of December 31, 1994, substantially all of the Venture's assets secured the above indebtedness.\n(7) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because they accrue directly to Fund 1-B and Fund 1-C. The Federal and state income tax returns of the Venture are prepared and filed by Intercable.\nThe Venture's tax returns, the qualification of the Venture as such for tax purposes, and the amount of distributable Venture income or loss are subject to examination by Federal and state taxing authorities. If such examinations result in changes with respect to the Venture's qualification as such, or in changes with respect to the Venture's recorded income or loss, the tax liability of Fund 1-B and Fund 1-C would likely be changed accordingly.\nTaxable loss reported to Fund 1-B and Fund 1-C is different from that reported in the statements of operations due to the difference in depreciation recognized under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable income or loss and the net income or loss reported in the statements of operations.\n(8) COMMITMENTS AND CONTINGENCIES\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. In April 1993, the Federal Communications Commission (the \"FCC\") adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The Venture has filed cost-of-service showings for its Brighton, Broomfield and Boulder County, Colorado; Myrtle Creek, Oregon; South Sioux City, Nebraska; and Three Rivers and Watervliet, Michigan systems and thus anticipates no further reductions in rates in these systems. The cost-of-service showings have not yet received final approval from franchising authorities, however, and there can be no assurance that the Venture's cost-of-service showings will prevent further rate reductions until such final approvals are received. The Venture complied with the February 1994 benchmark regulations and further reduced rates in its Clearlake Oaks system effective July 1994.\nThe Venture rents office and other facilities under various long-term lease arrangements. Rent paid under such lease arrangements totaled $82,204 , $78,616 and $88,074, respectively, for the years ended December 31, 1994, 1993 and 1992. Minimum commitments under operating leases for each of the five years in the period ending December 31, 1999, and thereafter are as follows:\n(9) SUPPLEMENTARY PROFIT AND LOSS INFORMATION\nSupplementary profit and loss information for the respective years is presented below:\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 Partnership itself has no officers or directors. Certain information concerning the directors and executive officers of the General Partner is set forth below.\nMr. Glenn R. Jones has served as Chairman of the Board of Directors and Chief Executive Officer of the General Partner since its formation in 1970, and he was President from June 1984 until April 1988. Mr. Jones was elected a member of the Executive Committee of the Board of Directors in April 1985. Mr. Jones is the sole shareholder, President and Chairman of the Board of Directors of Jones International, Ltd. He is also Chairman of the Board of Directors of the subsidiaries of the General Partner and of certain other affiliates of the General Partner. Mr. Jones has been involved in the cable television business in various capacities since 1961, is a past and present member of the Board of Directors of the National Cable Television Association, and is a former member of its Executive Committee. Mr. Jones is a past director and member of the Executive Committee of C-Span. Mr. Jones has been the recipient of several awards including the Grand Tam Award in 1989, the highest award from the Cable Television Administration and Marketing Society; the Chairman's Award from the Investment Partnership Association, which is an association of sponsors of public syndications; the cable television industry's Public Affairs Association President's Award in 1990, the Donald G. McGannon award for the advancement of minorities and women in cable; the STAR Award from American Women in Radio and Television, Inc. for exhibition of a commitment to the issues and concerns of women in television and radio; and the Women in Cable Accolade in 1990 in recognition of support of this organization. Mr. Jones is also a founding member of the James Madison Council of the Library of Congress and is on the Board of Governors of the American Society of Training and Development.\nMr. Derek H. Burney was appointed a Director of the General Partner in December 1994 and Vice Chairman of the Board of Directors in January 1995. He is also a member of the Executive Committee of the Board of Directors. Mr. Burney joined BCE Inc., Canada's largest telecommunications company, in January 1993 as Executive Vice President, International. He has been the Chairman of Bell Canada International Inc., a\nsubsidiary of BCE, since January 1993 and, in addition, has been Chief Executive Officer of BCI since July 1993. Prior to joining BCE, Mr. Burney served as Canada's ambassador to the United States from 1989 to 1992. Mr. Burney also served as chief of staff to the Prime Minister of Canada from March 1987 to January 1989 where he was directly involved with the negotiation of the U.S. - Canada Free Trade Agreement. In July 1993, he was named an Officer of the Order of Canada. Mr. Burney is chairman of Bell Cablemedia plc. He is a director of Mercury Communications Limited, Videotron Holdings plc, Tele-Direct (Publications) Inc., Teleglobe Inc., Bimcor Inc., Maritime Telegraph and Telephone Company, Limited, Moore Corporation Limited and Northbridge Programming Inc.\nMr. James B. O'Brien, the General Partner's President, joined the General Partner in January 1982. Prior to being elected President and a Director of the General Partner in December 1989, Mr. O'Brien served as a Division Manager, Director of Operations Planning\/Assistant to the CEO, Fund Vice President and Group Vice President\/Operations. Mr. O'Brien was appointed to the General Partner's Executive Committee in August 1993. As President, he is responsible for the day-to-day operations of the cable television systems managed and owned by the General Partner. Mr. O'Brien is also President and a Director of Jones Cable Group, Ltd., Jones Global Funds, Inc. and Jones Global Management, Inc., all affiliates of the General Partner. Mr. O'Brien is a board member of Cable Labs, Inc., the research arm of the U.S. cable television industry. He also serves as a director of the Cable Television Administration and Marketing Association and as a director of the Walter Kaitz Foundation, a foundation that places people of any ethnic minority group in positions with cable television systems, networks and vendor companies.\nMs. Ruth E. Warren joined the General Partner in August 1980 and has served in various operational capacities, including system manager and Fund Vice President, since then. Ms. Warren was elected Group Vice President\/Operations of the General Partner in September 1990.\nMr. Kevin P. Coyle joined The Jones Group, Ltd. in July 1981 as Vice President\/Financial Services. In September 1985, he was appointed Senior Vice President\/Financial Services. He was elected Treasurer of the General Partner in August 1987, Vice President\/Treasurer in April 1988 and Group Vice President\/Finance and Chief Financial Officer in October 1990.\nMr. Christopher J. Bowick joined the General Partner in September 1991 as Group Vice President\/Technology and Chief Technical Officer. Previous to joining the General Partner, Mr. Bowick worked for Scientific Atlanta's Transmission Systems Business Division in various technical management capacities since 1981, and as Vice President of Engineering since 1989.\nMr. Timothy J. Burke joined the General Partner in August 1982 as corporate tax manager, was elected Vice President\/Taxation in November 1986 and Group Vice President\/Taxation\/Administration in October 1990.\nMr. Raymond L. Vigil joined the General Partner in June 1993 as Group Vice President\/Human Resources. Previous to joining the General Partner, Mr. Vigil served as Executive Director of Learning with USWest. Prior to USWest, Mr. Vigil worked in various human resources posts over a 14-year term with the IBM Corporation.\nMs. Cynthia A. Winning joined the General Partner as Group Vice President\/Marketing in December 1994. Previous to joining the General Partner, Ms. Winning served since 1994 as the President of PRS Inc., Denver, Colorado, a sports and event marketing company. From 1979 to 1981 and from 1986 to 1994, Ms. Winning served as the Vice President and Director of Marketing for Citicorp Retail Services, Inc., a provider of private-label credit cards for ten national retail department store chains. From 1981 to 1986, Ms. Winning was the Director of Marketing Services for Daniels & Associates cable television operations, as well as the Western Division Marketing Director for Capital Cities Cable. Ms. Winning also serves as a board Member of Cities in Schools, a dropout intervention\/prevention program.\nMs. Elizabeth M. Steele joined the General Partner in August 1987 as Vice President\/General Counsel and Secretary. From August 1980 until joining the General Partner, Ms. Steele was an associate and then a partner at the Denver law firm of Davis, Graham & Stubbs, which serves as counsel to the General Partner.\nMr. Larry Kaschinske joined the General Partner in 1984 as a staff accountant in the General Partner's former Wisconsin Division; was promoted to Assistant Controller in 1990 and named Controller in August 1994.\nMr. James J. Krejci was President of the International Division of International Gaming Technology International headquartered in Reno, Nevada, until March 1995. Prior to joining IGT in May 1994, Mr. Krejci was Group Vice President of Jones International, Ltd. and a Group Vice President of the General Partner. Prior to May 1994, he also served as Group Vice President of Jones Futurex, Inc., an affiliate of the General Partner engaged in manufacturing and marketing data encryption devices, Jones Interactive, Inc., a subsidiary of Jones International, Ltd. providing computer data and billing processing facilities and Jones Lightwave, Ltd., a company owned by Jones International, Ltd. and Mr. Jones, which is engaged in the provision of telecommunications services. Mr. Krejci has been a Director of the General Partner since August 1987.\nMs. Christine Jones Marocco was appointed a Director of the General Partner in December 1994. She is the daughter of Glenn R. Jones. Ms. Marocco is also a director of Jones International, Ltd.\nMr. Daniel E. Somers was appointed a Director of the General Partner in December 1994 and also serves on the General Partner's Audit Committee. From January 1992 to January 1995, Mr. Somers worked as Senior Vice President and Chief Financial Officer of Bell Canada International Inc. and was appointed Executive Vice President and Chief Financial Officer on February 1, 1995. He is also a Director of certain of its affiliates. Prior to joining Bell Canada International Inc. and since January 1989, Mr. Somers was the President and Chief Executive Officer of Radio Atlantic Holdings Limited. Mr. Somers is a member of the North American Society of Corporate Planning, the Financial Executives Institution and the Financial Analysts Federation.\nMr. Robert S. Zinn was appointed a Director of the General Partner in December 1994. Mr. Zinn joined the General Partner in January 1991 and is a member of its Legal Department. He is also Vice President\/Legal Affairs of Jones International, Ltd. Prior to joining the General Partner, Mr. Zinn was in private law practice in Denver, Colorado for over 25 years.\nMr. David K. Zonker was appointed a Director of the General Partner in December 1994. Mr. Zonker has been the President of Jones International Securities, Ltd., a subsidiary of Jones International, Ltd. since January 1984 and he has been its Chief Executive Officer since January 1988. From October 1980 until joining Jones International Securities, Ltd. in January 1984, Mr. Zonker was employed by the General Partner. Mr. Zonker is a member of the Board of Directors of various affiliates of the General Partner, including Jones International Securities, Ltd. Mr. Zonker is licensed by the National Association of Securities Dealers, Inc. and he is a past chairman of the Investment Program Association, a trade organization based in Washington, D.C. that promotes direct investments. He is a member of the Board of Trustees of Graceland College, Lamoni, Iowa; the International Association of Financial Planners and the American and Colorado Institutes of Certified Public Accountants.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no employees; however, various personnel are required to operate the cable television systems owned by the Partnership. Such personnel are employed by the General Partner and, pursuant to the terms of the limited partnership agreement of the Partnership, the cost of such employment is charged by the General Partner to the Partnership as a direct reimbursement item. See Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGERS\nNo person or entity owns more than 5 percent of the limited partnership interests of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe General Partner and its affiliates engage in certain transactions with the Partnership and the Venture as contemplated by the limited partnership agreement of the Partnership. The General Partner believes that the terms of such transactions are generally as favorable as could be obtained by the Partnership and the Venture from unaffiliated parties. This determination has been made by the General Partner in good faith, but none of the terms were or will be negotiated at arm's-length and there can be no assurance that the terms of such transactions have been or will be as favorable as those that could have been obtained by the Partnership or the Venture from unaffiliated parties.\nThe General Partner charges a management fee, and the General Partner is reimbursed the for certain allocated overhead and administrative expenses. These expenses consist primarily of salaries and benefits paid to corporate personnel, rent, data processing services and other facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner. Remaining overhead costs are allocated based on revenues and\/or the costs of assets managed. Systems owned by the General Partner and all other systems owned by partnerships for which Jones Intercable, Inc. is the general partner, are also allocated a proportionate share of these expenses.\nThe General Partner also advances funds and charges interest on the balance payable. The interest rate charged approximates the General Partner's weighted average cost of borrowing.\nThe Systems receive stereo audio programming from Superaudio, a joint venture owned 50% by an affiliate of the General Partner and 50% by an unaffiliated party,educational video programming from Mind Extension University, Inc., an affiliate of the General Partner, and computer video programming from Jones Computer Network, Ltd., an affiliate of the General Partner, for fees based upon the number of subscribers receiving the programming.\nProduct Information Network (\"PIN\"), an affiliate of the General Partner, provides advertising time for third parties on the Systems. In consideration, the revenues generated from the third parties are shared two-thirds and one-third between PIN and the Partnership or the Venture. During the year ended December 31, 1994, the Partnership received revenues from PIN of $321, and the Venture received revenues from PIN of $15,283.\nThe charges to the Partnership and to the Venture for related party transactions are as follows for the periods indicated:\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n-------------------\n(1) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1987.\n(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.\n(3) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.\n(4) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.\n(5) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1988.\n(6) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.\n(7) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1986.\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.\nJONES CABLE INCOME FUND 1-B, LTD. a Colorado limited partnership By: Jones Intercable, Inc.\nBy: \/s\/ Glenn R. Jones --------------------------- Glenn R. Jones Chairman of the Board and Chief Dated: March 27, 1995 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.\nBy: \/s\/ Glenn R. Jones --------------------------- Glenn R. Jones Chairman of the Board and Chief Executive Officer Dated: March 27, 1995 (Principal Executive Officer)\nBy: \/s\/ Kevin P. Coyle --------------------------- Kevin P. Coyle Group Vice President\/Finance Dated: March 27, 1995 (Principal Financial Officer)\nBy: \/s\/ Larry Kaschinske --------------------------- Larry Kaschinske Controller Dated: March 27, 1995 (Principal Accounting Officer)\nBy: \/s\/ James B. O'Brien --------------------------- James B. O'Brien Dated: March 27, 1995 President and Director\nBy: \/s\/ Raymond L. Vigil --------------------------- Raymond L. Vigil Dated: March 27, 1995 Group Vice President and Director\nBy: \/s\/ Robert S. Zinn --------------------------- Robert S. Zinn Dated: March 27, 1995 Director\nBy: \/s\/ David K. Zonker --------------------------- David K. Zonker Dated: March 27, 1995 Director\nBy: --------------------------- Derek H. Burney Dated: Director\nBy: --------------------------- James J. Krejci Dated: Director\nBy: --------------------------- Christine Jones Marocco Dated: Director\nBy: --------------------------- Daniel E. Somers Dated: Director\nEXHIBIT INDEX\n-------------------\n(1) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1987.\n(2) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992.\n(3) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993.\n(4) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990.\n(5) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1988.\n(6) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1989.\n(7) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1986.","section_15":""}
{"filename":"63908_1994.txt","cik":"63908","year":"1994","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 1994, 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, 1994, 1993 and 1992 is included in Part II, item 8, page 42 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, taste 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, 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, 1994, 1993 and 1992 in Part II, item 7, pages 26 through 29, 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 378,000 restaurants generate nearly $224 billion in annual sales. McDonald's accounts for about 2.6% 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 1994, there were no material capital expenditures for environmental control facilities and no such material expenditures are anticipated.\nNumber of employees\nDuring 1994, the Company's average number of employees worldwide was approximately 183,000.\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 42, 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, standardization and by leveraging the Company's global sourcing system. Additional information about the Company's properties is included in 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, 39, 43, 48 and 49, 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. The Company does not believe that any such claims or lawsuits will have a material adverse affect on its financial condition or results of operations.\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\nNone.\nExecutive Officers of the Registrant\nAll of the executive officers of McDonald's Corporation as of March 1, 1995 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 1995 Board of Directors' meeting.\nNumber Number of of years years in Date of with present Name Office Birth Company position --------------------- --------------------- -------- ------- --------\nRobert M. Beavers, Jr. Senior Vice President 01\/27\/44 31 1 James R. Cantalupo President and 11\/14\/43 20 3 Chief Executive Officer-International Michael L. Conley Senior Vice President, 03\/28\/48 21 4 Controller Thomas S. Dentice Executive Vice President 01\/12\/39 29 10 Patrick J. Flynn Executive Vice President 05\/01\/42 33 7 Thomas W. Glasgow, Jr. Executive Vice President, 02\/17\/47 26 3 Chief Operations Officer Jack M. Greenberg Vice Chairman, Chief 09\/28\/42 13 3 Financial Officer Michael R. Quinlan Chairman, Chief 12\/09\/44 31 5 Executive Officer Edward H. Rensi President and Chief 08\/15\/44 29 3 Executive Officer-U.S.A. Paul D. Schrage Senior Executive Vice 02\/25\/35 27 10 President, Chief Marketing Officer Fred L. Turner Senior Chairman 01\/06\/33 38 5\n\/TABLE\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 and Chicago.\nThe following table sets forth the common stock price range on the New York Stock Exchange composite tape and dividends declared per common share. Prices and dividends have been adjusted to reflect the two-for-one common stock split effected in the form of a stock dividend in June, 1994.\n------------------------------------------------------------------------- Quarter 1994 1993 ------------------------------------------------------------------------- Dividend Per Dividend Per High Low Common Share High Low Common Share ------------------------------------------------------------------------- First 31 1\/4 27 1\/4 .0538 27 1\/8 23 3\/8 .0500 Second 31 3\/8 27 5\/8 .0600 26 3\/4 22 3\/4 .0538 Third 29 3\/4 25 5\/8 .0600 27 3\/4 24 1\/8 .0538 Fourth 29 7\/8 25 7\/8 .0600 29 l\/2 25 5\/8 .0538 ------------------------------------------------------------------------- Year 31 3\/8 25 5\/8 .2338 29 1\/2 22 3\/4 .2114 -------------------------------------------------------------------------\nThe approximate number of shareholders of record and beneficial owners of the Company's common stock as of January 31, 1995 was estimated to be 537,000.\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 76 consecutive quarterly dividends on common stock through March 29, 1995, has increased the per share amount 20 times since the first dividend was paid in 1976, and has increased the dividend amount every year. Additional dividend increases will be considered after reviewing returns to shareholders, profitability expectations and financing needs.\nItem 6.","section_6":"Item 6. Selected Financial Data\n11-YEAR SUMMARY\n(Dollars rounded to millions, except per common share data and average restaurant sales)\n1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984\n------------------------------------------------------------------------------------------------------------------------------ Systemwide sales $25,987 23,587 21,885 19,928 18,759 17,333 16,064 14,330 12,432 11,001 10,007\nU.S. $14,941 14,186 13,243 12,519 12,252 12,012 11,380 10,576 9,534 8,843 8,071\nOutside of the U.S. $11,046 9,401 8,642 7,409 6,507 5,321 4,684 3,754 2,898 2,158 1,936\nSystemwide sales by type\nOperated by franchisees $17,146 15,756 14,474 12,959 12,017 11,219 10,424 9,452 8,422 7,612 6,914\nOperated by the Company $ 5,793 5,157 5,103 4,908 5,019 4,601 4,196 3,667 3,106 2,770 2,538\nOperated by affiliates $ 3,048 2,674 2,308 2,061 1,723 1,513 1,444 1,211 904 619 555\nAverage sales by restaurants open at least one year, in thousands $ 1,800 1,768 1,733 1,658 1,649 1,621 1,596 1,502 1,369 1,296 1,264\nRevenues from franchised restaurants $ 2,528 2,251 2,031 1,787 1,621 1,465 1,325 1,186 1,037 924 828\nTotal revenues $ 8,321 7,408 7,133 6,695 6,640 6,066 5,521 4,853 4,143 3,694 3,366\nOperating income $ 2,241 1,984 1,862 1,679 1,596 1,438 1,288 1,160 983 905 812\nIncome before provision for income taxes $ 1,887 1,676 1,448 1,299 1,246 1,157 1,046 959 848 782 707\nNet income $ 1,224 1,083 959 860 802 727 646 549 * 480 433 389\nCash provided by operations $ 1,926 1,680 1,426 1,423 1,301 1,246 1,177 1,051 852 813 701\nFinancial position at year end\nNet property and equipment $11,328 10,081 9,597 9,559 9,047 7,758 6,800 5,820 4,878 4,164 3,521\nTotal assets $13,592 12,035 11,681 11,349 10,668 9,175 8,159 6,982 5,969 5,043 4,230\nLong-term debt $ 2,935 3,489 3,176 4,267 4,429 3,902 3,111 2,685 2,131 1,638 1,268\nTotal shareholders' equity $ 6,885 6,274 5,892 4,835 4,182 3,550 3,413 2,917 2,506 2,245 2,009\nPer common share**\nNet income $ 1.68 1.45 1.30 1.17 1.10 .97 .86 .72 * .62 .55 .49\nDividends declared $ .23 .21 .20 .18 .17 .15 .14 .12 .11 .10 .08\nTotal shareholders' equity at year end $ 9.20 8.12 7.39 6.73 5.82 4.90 4.55 3.86 3.22 2.84 2.47\nMarket price at year end $29 1\/4 28 1\/2 24 3\/8 19 14 1\/2 17 1\/4 12 11 10 1\/8 9 5 3\/4\nSystemwide restaurants at year end 15,205 13,993 13,093 12,418 11,803 11,162 10,513 9,911 9,410 8,901 8,304\nOperated by franchisees 10,458 9,832 9,237 8,735 8,131 7,573 7,110 6,760 6,406 6,150 5,724\nOperated by the Company 3,083 2,699 2,551 2,547 2,643 2,691 2,600 2,399 2,301 2,165 2,053\nOperated by affiliates 1,664 1,462 1,305 1,136 1,029 898 803 752 703 586 527\nU.S. 9,744 9,283 8,959 8,764 8,576 8,270 7,907 7,567 7,272 6,972 6,595\nOutside of the U.S. 5,461 4,710 4,134 3,654 3,227 2,892 2,606 2,344 2,138 1,929 1,709\nNumber of countries at year end 79 70 65 59 53 51 50 47 46 42 36\n* Before the cumulative prior years' benefit from the change in accounting for income taxes. **Restated for two-for-one common stock split in June 1994. \/TABLE\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nCONSOLIDATED OPERATING RESULTS ----------------------------------------------------------------------- INCREASES (DECREASES) IN OPERATING RESULTS OVER PRIOR YEAR ----------------------------------------------------------------------- (Dollars rounded to millions, 1994 1993 except per common share data) Amount % Amount % ----------------------------------------------------------------------- SYSTEMWIDE SALES $2,401 10% $1,702 8% ----------------------------------------------------------------------- REVENUES Sales by Company-operated restaurants $ 636 12 $ 55 1 Revenues from franchised restaurants 277 12 220 11 ----------------------------------------------------------------------- TOTAL REVENUES 913 12 275 4 ----------------------------------------------------------------------- OPERATING COSTS AND EXPENSES Company-operated restaurants 481 12 38 1 Franchised restaurants 55 14 32 9 General, administrative and selling expenses 142 15 81 9 Other operating (income) expense--net (22) 35 2 (3) ----------------------------------------------------------------------- TOTAL OPERATING COSTS AND EXPENSES 656 12 153 3 ----------------------------------------------------------------------- OPERATING INCOME 257 13 122 7 ----------------------------------------------------------------------- Interest expense (10) (3) (58) (15) Nonoperating income (expense)--net (56) NM 48 NM ----------------------------------------------------------------------- INCOME BEFORE PROVISION FOR INCOME TAXES 211 13 228 16 ----------------------------------------------------------------------- Provision for income taxes 69 12 104 21 ----------------------------------------------------------------------- NET INCOME $ 142 13 $ 124 13 ======================================================================= NET INCOME PER COMMON SHARE* $ .23 16 $ .16 12 -----------------------------------------------------------------------\nNM - Not Meaningful * Restated for two-for-one common stock split in June 1994.\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 1994 increase was due to expansion, higher sales at existing restaurants and stronger foreign currencies, negatively affected in part by severe weather conditions worldwide in early 1994. The 1993 increase was due to expansion and higher sales at existing restaurants, offset in part by weaker foreign currencies and one less day in 1993 since 1992 was a leap year. Sales by Company-operated restaurants grew at a faster rate than Systemwide sales in 1994 because Company-operated expansion advanced at a faster rate than Systemwide expansion. Sales by Company- operated restaurants grew at a slower rate than Systemwide sales in 1993 because weaker foreign currencies had a greater impact on sales by Company-operated restaurants than on Systemwide sales, and because of a greater number of franchised restaurants resulting from expansion. Average sales by restaurants open at least one year (excluding satellites) were $1,800,000 in 1994, $32,000 above 1993. Average sales in both the U.S. and outside of the U.S. improved through the emphasis on value and customer satisfaction. Expansion continued at an accelerated pace as 1,212 restaurants (excluding satellites) were added in 1994, compared with 900 in 1993 and 675 in 1992. Restaurants opened during the year (excluding satellites) contributed $799 million to Systemwide sales in 1994, $572 million in 1993 and $478 million in 1992. McDonald's plans to add between 1,200 and 1,500 restaurants (excluding satellites) around the world in 1995 and in each of the next several years. The mix of net additions remains at one-third in the U.S. and two-thirds outside of the U.S. Our global expansion plan also includes satellites -- foodservice facilities that leverage the infrastructure of existing restaurants by using their storage capability and inventory, and by drawing on their management talent and labor pool. During 1994, 575 satellites were added around the world; we expect to open approximately 1,000 satellites in 1995. The consolidated financial statements reflect the operating results of satellites on the same basis as traditional restaurants; the results of satellites operated by the Company are included in sales by and costs of Company-operated restaurants, while those operated by franchisees are included in revenues from and costs of franchised restaurants. Satellites in operation contributed $150 million to Systemwide sales in 1994. The operating results of satellites were immaterial to consolidated operating results.\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 fee is comprised of both a rent and service fee amount at a combined rate of approximately 12.5% of sales for new U.S. franchise arrangements. Prior to 1994 and since 1987, the minimum fee generally was a combined 12.0% for both rent and service fees. 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\nto local business conditions. These fees, together with occupancy and operating rights, are stipulated in franchise arrangements that generally have 20-year terms, and provide a stable, predictable revenue flow to the Company. Revenues grow as locations are added and as sales build in existing locations. Menu price adjustments affect revenues as well as sales; however, due to different pricing structures, new products, promotions, and product mix variations among markets, it is impractical to quantify the impact of menu price adjustments for the System as a whole. The rate of increase in total revenues in 1994 was greater than the rate of increase in Systemwide sales due to strong global operating results and an increase in the Company-operated restaurant base through expansion and changes in ownership. The rate of increase in total revenues in 1993 was lower than the rate of increase in Systemwide sales due to weaker foreign currencies which had a greater impact on revenues than on Systemwide sales, and because of a greater number of franchised restaurants resulting from expansion. Growth rates in sales by Company-operated restaurants and revenues from franchised restaurants varied in 1993 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 1994, about 56% of sales by Company-operated restaurants and 37% of revenues from franchised restaurants were outside of the U.S., compared with 53% and 33%, respectively, in 1993.\nRESTAURANT MARGINS Company-operated margins were 19.8% of sales in 1994, compared with 19.2% in 1993 and 19.1% in 1992. In 1994, as a percent of sales, food and paper, and occupancy and other operating costs declined, while payroll costs increased. In 1993, as a percent of sales, food and paper costs rose, while occupancy, other operating and payroll costs declined. Franchised margins comprised about two-thirds of the combined operating margins. Consolidated franchised margins were 82.8% of applicable revenues in 1994, compared with 83.1% in 1993 and 82.8% in 1992. The 1994 decrease reflected a higher proportion of leased sites resulting from accelerated expansion and satellite development, as financing costs embedded in operating leases were included in rent expense which does not occur if a site is owned. 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, resulting gains compensate the Company for lower margins prior to exercise and are included in other operating (income) expense--net. At year-end 1994, 476 restaurants were operating under such arrangements, compared with 544 and 583 at year-end 1993 and 1992, respectively.\nGENERAL, ADMINISTRATIVE AND SELLING EXPENSES The 1994 increase was primarily due to strategic global investment spending to support expansion and value, and a one-time, noncash $15 million charge related to the early implementation of a new accounting rule regarding the timing of expensing advertising production costs. The 1993 increase was primarily due to higher employee costs associated with expansion and key priorities, partially offset by weaker foreign currencies. These expenses as a percent of Systemwide sales have remained relatively constant over the past five years, and were 4.2% in 1994 and 4.0% in 1993.\nOTHER OPERATING (INCOME) EXPENSE--NET This category is comprised of transactions which relate to franchising and the foodservice business such as gains on sales of restaurant businesses, equity in earnings of unconsolidated affiliates, and net gains or losses from property dispositions. The 1994 income increase reflected higher gains on sales of restaurant businesses and higher income from affiliates, offset in part by higher losses on property dispositions. The 1993 and 1992 amounts were relatively constant, reflecting greater income from affiliates and gains on sales of restaurant businesses in 1993, and 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 resulting gains are integral to franchising and as such, 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 which 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 disposals of excess properties through closings, relocations and other transactions.\nOPERATING INCOME The 1994 and 1993 increases reflected higher combined operating margins, partially offset by higher general, administrative and selling expenses. Additionally, 1994 was positively impacted by higher other operating income and stronger foreign currencies, while 1993 was negatively impacted by weaker foreign currencies.\nINTEREST EXPENSE The 1994 decrease was primarily due to lower average interest rates, partially offset by higher debt levels and stronger foreign currencies. The 1993 decrease was primarily due to lower average debt balances, lower average interest rates and weaker foreign currencies.\nNONOPERATING INCOME (EXPENSE)--NET This category includes interest income, gains and losses related to investments and financings, as well as miscellaneous income and expense. Higher translation losses, principally from Mexico and Brazil, losses on investments and higher minority interest charges impacted 1994. Also contributing to the year-over-year change were gains on debt extinguishments and higher interest income in 1993. The 1993 increase reflected $9 million in gains related to debt extinguishments in 1993 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 was 35.1% in 1994, compared with 35.4% in 1993 and 33.8% in 1992. The 1993 increase was primarily the result of new U.S. tax legislation enacted that year, which negatively impacted the provision by approximately $20 million. Of this amount, nearly $14 million was attributable to a one-time, noncash revaluation of deferred tax liabilities. The Company expects its 1995 effective income tax rate to be between 35.0% and 35.5%. Consolidated net deferred tax liabilities included tax assets of $233 million in 1994, net of valuation allowance, and $148 million in 1993. Substantially all of the tax assets arose in the U.S. and other profitable markets, the majority of which 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 16%, respectively, in 1994. The spreads between the percent increases in net income and net income per common share reflected the impact of share repurchase. Net income and net income per common share increased 13% and 12%, respectively, in 1993. These increases were negatively affected by weaker foreign currencies and new U.S. tax legislation.\nIMPACT OF CHANGING FOREIGN CURRENCIES Changing foreign currencies affect reported results. McDonald's lessens short-term cash exposures principally by purchasing goods and services in local currencies, financing in local currencies and hedging foreign-denominated cash flows. In 1994, stronger foreign currencies positively contributed to operating income, but their impact on interest expense and higher translation losses in Latin America more than offset this benefit, resulting in a reduction in net income. Weaker foreign currencies had a significant negative impact on 1993 results. Further discussion of our management of changing foreign currencies is on pages 26 through 29 in the commentary on financings and total shareholders' equity.\n----------------------------------------------------------------------- (Dollars in millions) As reported As adjusted* ----------------------------------------------------------------------- ----------------------------------------------------------------------- Systemwide sales $25,987 10% $25,715 9% Revenues 8,321 12 8,268 12 Operating income 2,241 13 2,226 12 Net income 1,224 13 1,233 14 ----------------------------------------------------------------------- ----------------------------------------------------------------------- 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 ----------------------------------------------------------------------- *If exchange rates remained constant year-over-year.\n------------------------------------------------------------------------ U.S. OPERATIONS ------------------------------------------------------------------------\nSALES The 1994 and 1993 increases were due to expansion and higher sales at existing restaurants. Positive comparable sales were achieved in 1994 through an emphasis on value and customer satisfaction in the form of Extra Value Meals, Happy Meals and the three-tier value program; as well as through promotions run during the year in the form of the NBA cup highlighting large sandwiches, the Flintstones movie tie-in featuring the McRib Grand Poobah Meal and a set of four Bedrock mugs, the Dream Team II collector cup, the Music Event offering four artist collections with the purchase of a large sandwich or Extra Value Meal, and the Holiday Video offering of four videotapes.\n------------------------------------------------------------------------ Five Ten years years (In millions of dollars) 1994 1993 1992 ago ago ------------------------------------------------------------------------ Operated by franchisees $11,965 $11,435 $10,615 $ 9,077 $6,166 Operated by the Company 2,550 2,420 2,353 2,728 1,856 Operated by affiliates 426 331 275 207 49 ------------------------------------------------------------------------ U.S. sales $14,941 $14,186 $13,243 $12,012 $8,071 ========================================================================\nRESTAURANTS There were 461 restaurants added in the U.S. in 1994, representing 38% of Systemwide additions, compared with 324 and 36% in 1993, and 363 and 56% five years ago. In addition, 494 U.S. satellites were operating at year-end 1994, compared with 114 at year-end 1993. McDonald's expects to maintain the current level of U.S. expansion in 1995 and in each of the next several years by adding between 400 and 500 restaurants each year, exclusive of satellites.\n------------------------------------------------------------------------ Five Ten years years 1994 1993 1992 ago ago ------------------------------------------------------------------------ Operated by franchisees 7,849 7,628 7,375 6,374 5,073 Operated by the Company 1,546 1,433 1,395 1,751 1,481 Operated by affiliates 349 222 189 145 41 ------------------------------------------------------------------------ U.S. restaurants 9,744 9,283 8,959 8,270 6,595 ========================================================================\nRestaurants operated by franchisees and affiliates represented 84% of U.S. restaurants at year-end 1994, compared with 85% at year-end 1993 and 79% five years ago. During the period 1989 through 1991, the Company franchised certain restaurants it previously operated because entrepreneurial owners with an equity stake in the business improved operations, sales and profits as well as consolidated profits. Since 1990, we have continued to make operational improvements and reduce operating and development costs; as a result, over the past several years, our base of restaurants has grown at a faster rate.\nOPERATING RESULTS ------------------------------------------------------------------------ (In millions of dollars) 1994 1993 1992 1991 1990 ------------------------------------------------------------------------ REVENUES Sales by Company- operated restaurants $2,550 $2,420 $2,353 $2,410 $2,655 Revenues from franchised restaurants 1,606 1,511 1,396 1,300 1,216 ------------------------------------------------------------------------ TOTAL REVENUES 4,156 3,931 3,749 3,710 3,871 ------------------------------------------------------------------------ OPERATING COSTS AND EXPENSES Company-operated restaurants 2,066 1,977 1,920 2,000 2,221 Franchised restaurants 270 247 235 217 202 General, administrative and selling expenses 714 638 566 549 511 Other operating (income) expense--net (25) (18) (13) (56) (49) ------------------------------------------------------------------------ TOTAL OPERATING COSTS AND EXPENSES 3,025 2,844 2,708 2,710 2,885 ------------------------------------------------------------------------ U.S. OPERATING INCOME $1,131 $1,087 $1,041 $1,000 $ 986 ========================================================================\nU.S. revenues were positively impacted by strong sales and expansion in 1994 and 1993, and negatively affected in 1992, 1991 and 1990 by the franchising of certain Company-operated restaurant businesses. U.S. Company-operated margins increased $42 million or 9% in 1994, reflecting sales improvement and growth in the number of Company- operated restaurants. These margins were 19.0% of sales in 1994, compared with 18.3% in 1993 and 18.4% in 1992. In 1994, the margin benefited from lower commodity costs and improvements in processing for beef. U.S. franchised margins rose $71 million or 6% in 1994. These margins were 83.2% of applicable revenues in 1994, compared with 83.6% in 1993 and 83.2% in 1992. Franchised margins as a percent of revenues decreased in 1994 because rent expense grew at a faster rate than revenues, resulting from a higher proportion of leased openings. While it is difficult to assess 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 historical range of the past ten years by continuing to build sales and reduce costs.\nU.S. operating income rose $43 million or 4% in 1994, and was 50% of consolidated operating income, compared with 55% in 1993. The 1994 and 1993 increases resulted primarily from higher combined operating margins, partially offset by higher general, administrative and selling expenses in the form of higher employee costs, other expenditures to support our global strategies and a one-time $12 million charge related to the implementation of the new accounting rule for advertising costs in 1994. Without this charge, U.S. operating income would have grown by 5% in 1994. Operating income included $366 million of depreciation and amortization in 1994, compared with $348 million in 1993 and $330 million in 1992. While the U.S. market remains highly competitive, McDonald's is confident of continued growth through a greater emphasis on value and customer satisfaction, and through expansion.\nASSETS AND CAPITAL EXPENDITURES\n------------------------------------------------------------------------- (In millions of dollars) 1994 1993 1992 1991 1990 ------------------------------------------------------------------------- New restaurants $ 472 $ 332 $ 196 $ 214 $ 446 Existing restaurants 125 122 125 151 249 Other properties 113 130 76 45 51 ------------------------------------------------------------------------- U.S. capital expenditures $ 710 $ 584 $ 397 $ 410 $ 746 ========================================================================= U.S. assets $6,683 $6,385 $6,410 $6,154 $6,060 -------------------------------------------------------------------------\nU.S. assets increased $297 million or 5% in 1994, driven by higher expenditures for restaurant property and buildings resulting from expansion. At year-end 1994, 49% of consolidated assets were located in the U.S., compared with 53% at year-end 1993. Capital expenditures rose $126 million or 22% in 1994, and represented 46% of consolidated capital expenditures, compared with 55% five years ago. These amounts excluded expenditures made by franchisees such as their initial investments in equipment, signs, seating and decor, as well as long- term, ongoing reinvestment in their businesses. New restaurant expenditures grew $140 million or 42% because of accelerated expansion, tempered by lower average development costs, and included $41 million related to satellite development. 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 since 1990 reflected cost reduction efforts and 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 $40 million were spent for these investments in 1994, and $249 million over the past five years.\n------------------------------------------------------------------------- (In thousands of dollars) 1994 1993 1992 1991 1990 ------------------------------------------------------------------------- Land $ 317 $ 328 $ 361 $ 433 $ 433 Building 483 482 515 608 720 Equipment 295 317 361 362 403 ------------------------------------------------------------------------- U.S. average development costs $1,095 $1,127 $1,237 $1,403 $1,556 =========================================================================\nAverage development costs have steadily decreased since 1990 due to efforts to optimize building designs and standardize development. Average land costs declined as a result of the increase in low-cost building designs, which utilize smaller land parcels. Average building costs remained relatively flat reflecting the benefits of these building designs and construction efficiencies. Low-cost building designs comprised nearly 83% of 1994 openings compared with 80% in 1993. 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. These lower-cost, lower-volume building designs allow us to profitably expand into more locations. This is consistent with McDonald's goal of increasing market share with greater marketwide presence around the world. The Company continues to emphasize restaurant property ownership, because real estate ownership yields long-term benefits, including the ability to fix occupancy costs. However, most satellites are leased locations. In addition to purchasing new properties, the Company acquires previously leased properties and owned 69% of U.S. sites at year-end 1994, the same as five years ago.\n---------------------------------------------------------------------- OPERATIONS OUTSIDE OF THE U.S. ----------------------------------------------------------------------\nSALES Sales outside of the U.S. rose 18% in 1994 due to expansion, higher sales at existing restaurants as comparable sales on a local currency basis were positive, and stronger foreign currencies. The 1993 increase was negatively impacted by weaker foreign currencies, most notably the European currencies, as well as the Canadian and Australian Dollars. 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) 1994 1993 1992 ago ago ---------------------------------------------------------------------- Operated by franchisees $ 5,182 $4,321 $3,859 $2,142 $ 748 Operated by the Company 3,242 2,737 2,750 1,873 682 Operated by affiliates 2,622 2,343 2,033 1,306 506 ---------------------------------------------------------------------- Sales outside of the U.S. $11,046 $9,401 $8,642 $5,321 $1,936 ======================================================================\nAlthough many European economies were weak over the past 18 months, McDonald's markets generally performed well. Throughout 1994, comparable sales in France and Germany were not as strong as in prior years because of the economy, unusually hot weather in the summer, and World Cup Soccer. Yet, growth and profitability in both markets were very good. Pacific sales were strong with the exception of our joint venture in Japan, which has been affected by a weak economy. Transaction counts and profits were up in Japan, but sales trends had not fundamentally improved. Business in Canada continued to improve, despite a weak economy. Latin American economies have been weak, but our business there has been quite good, particularly in Brazil, since the mid-year economic reforms. Results in Mexico in 1994 were impacted by the continuing sluggish economy and in December, by the devaluation of the Mexican peso. We expect this impact to continue into 1995. In 1994, many markets delivered excellent sales growth on a local currency basis: Argentina, Australia, Austria, Belgium, Brazil, Canada, Denmark, England, Finland, France, Germany, Hong Kong, Hungary, Ireland, Italy, Malaysia, Netherlands, New Zealand, Norway, Panama, Philippines, Puerto Rico, Scotland, Singapore, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey and Wales.\nRESTAURANTS During the past five years, 66% of Systemwide additions have been outside of the U.S. Of the 751 restaurants added in 1994, 51% were in the six largest markets, compared with 54% in 1993 and 57% in 1992. This continued relative decline is indicative of the growing importance of emerging markets. McDonald's expects to boost expansion outside of the U.S. in 1995 and in each of the next several years by adding between 800 and 1,000 restaurants, exclusive of satellites.\n---------------------------------------------------------------------- Five Ten years years 1994 1993 1992 ago ago ---------------------------------------------------------------------- Operated by franchisees 2,609 2,204 1,862 1,199 651 Operated by the Company 1,537 1,266 1,156 940 572 Operated by affiliates 1,315 1,240 1,116 753 486 ---------------------------------------------------------------------- Restaurants outside of the U.S. 5,461 4,710 4,134 2,892 1,709 ====================================================================== About 79% of Company-operated restaurants outside of the U.S. were in England, Canada, Germany, Australia, Taiwan, Hong Kong and France. About 68% of franchised restaurants outside of the U.S. were in Canada, Germany, Australia, France, Japan and the Netherlands. About 65% of the restaurants operated by affiliates were located in Japan.\nOPERATING RESULTS ----------------------------------------------------------------------- (In millions of dollars) 1994 1993 1992 1991 1990 ----------------------------------------------------------------------- REVENUES Sales by Company- operated restaurants $3,242 $2,737 $2,750 $2,499 $2,364 Revenues from franchised restaurants 923 740 634 486 405 ----------------------------------------------------------------------- TOTAL REVENUES 4,165 3,477 3,384 2,985 2,769 ----------------------------------------------------------------------- OPERATING COSTS AND EXPENSES Company-operated restaurants 2,579 2,188 2,206 2,029 1,915 Franchised restaurants 165 133 114 90 77 General, administrative and selling expenses 369 303 295 246 213 Other operating (income) expense--net (59) (44) (51) (58) (46) ----------------------------------------------------------------------- TOTAL OPERATING COSTS AND EXPENSES 3,054 2,580 2,564 2,307 2,159 ----------------------------------------------------------------------- OPERATING INCOME OUTSIDE OF THE U.S. $1,111 $ 897 $ 820 $ 678 $ 610 =======================================================================\nThe 1994 and 1993 revenue and operating income increases reflected expansion and higher combined operating margins, partially offset by higher general, administrative and selling expenses. Changing foreign currencies had a positive effect in 1994 and a negative effect in 1993; higher other operating income helped 1994. Company-operated margins remained strong, increasing $114 million or 21% in 1994. These margins improved to 20.5% of sales in 1994, compared with 20.1% in 1993 and 19.8% in 1992. Franchised margins grew $151 million or 25% in 1994. These margins were 82.1% of applicable revenues in 1994, compared with 82.0% in 1993 and 82.1% in 1992.\nThe 1994 and 1993 increases in general, administrative and selling expenses were primarily due to higher employee costs associated with expansion. The 1994 increase in other operating income was primarily due to gains on sales of restaurant businesses, greater affiliate earnings from Japan and other markets, and gains resulting from property dispositions. 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. Operations outside of the U.S. continued to contribute greater amounts to consolidated results as shown below: --------------------------------------------------------------------- (As a percent of consolidated) 1994 1993 1992 1991 1990 --------------------------------------------------------------------- Systemwide sales 43 40 39 37 35 Total revenues 50 47 47 45 42 Operating income 50 45 44 40 38 Operating margins Company-operated 58 55 56 53 51 Franchised 36 32 31 27 24 Systemwide restaurants 36 34 32 29 27 Assets 51 47 45 46 43 ---------------------------------------------------------------------\nThe Europe\/Africa\/Middle East segment accounted for 63% of revenues and 61% of operating income outside of the U.S. in 1994, growing $369 and $124 million, respectively. Germany, England and France accounted for 82% of this segment's operating income, compared with 85% in 1993. The 1994 increases were primarily due to strong operating results in these countries, as well as many emerging markets. 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 was significantly impacted by the weaker currency. Asia\/Pacific revenues grew $236 million and operating income increased $52 million in 1994; 87% of operating income was contributed by Australia, Japan, Hong Kong and Taiwan. The 1994 and 1993 increases were attributable to expansion and developing economies in many markets, with the exception of our affiliate in Japan which continued to suffer from a weak economy. The change in ownership of Taiwan from an affiliate to a wholly-owned subsidiary was also a benefit in 1994.\nCanadian revenues decreased $12 million in 1994 due to the negative impact of the weaker currency; revenues would have increased $21 million in 1994 if the exchange rate had remained at its 1993 level. Operating income increased $6 million because of lower operating costs and higher gains on sales of restaurant businesses, partially offset by the weaker currency. Latin American revenues grew $95 million, while operating income increased $32 million in 1994. The 1994 increases in revenues and operating income were primarily a function of expansion, as well as a strengthening of the Brazilian market since the mid-year economic reforms. However, operating income in Mexico was down because of the economy and peso devaluation. 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 in 1993. Brazil was also affected by a weak economy in 1993 and 1992.\nASSETS AND CAPITAL EXPENDITURES Assets outside of the U.S. rose $1.3 billion or 22% in 1994 due to expansion and stronger foreign currencies. At year-end 1994, about 51% of consolidated assets were located outside of the U.S.; 60% of these assets were located in England, Germany, France, Australia and Canada.\n----------------------------------------------------------------------- (In millions of dollars) 1994 1993 1992 1991 1990 ----------------------------------------------------------------------- New restaurants $ 723 $ 609 $ 603 $ 612 $ 639 Existing restaurants 87 94 91 94 126 Other properties 34 55 47 39 74 ----------------------------------------------------------------------- Capital expenditures outside of the U.S. $ 844 $ 758 $ 741 $ 745 $ 839 ======================================================================= Assets outside of the U.S. $6,909 $5,650 $5,271 $5,195 $4,608 -----------------------------------------------------------------------\nIn the past five years, nearly $3.9 billion were invested outside of the U.S.; in 1994, capital expenditures rose in all geographic segments. Approximately 70% of capital expenditures outside of the U.S. were invested in Europe -- principally 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. Since 1991, average development costs have decreased due to construction and design efficiencies, standardization, global sourcing and changes in the mix of openings. These lower-cost, lower-volume building designs allow us to profitably expand into more locations. This is consistent with McDonald's goal of increasing market share with greater marketwide presence around the world.\nExpenditures 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. As 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 a viable 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 1994, compared with 35% five years ago. Capital expenditures made by affiliates -- which were not included in consolidated amounts -- were $203 million in 1994, compared with $207 million in 1993. The majority of 1994 expenditures were for development in Japan, Argentina, Sweden and Singapore.\n----------------------------------------------------------------------- FINANCIAL POSITION -----------------------------------------------------------------------\nTOTAL ASSETS AND CAPITAL EXPENDITURES Total assets grew approximately $1.6 billion or 13% in 1994; net property and equipment represented 83% of total assets and rose $1.2 billion. Capital expenditures increased $213 million or 16%, reflecting higher expansion, partially offset by lower average development costs and stronger foreign currencies.\nCASH PROVIDED BY OPERATIONS Cash provided by operations increased $246 million or 15% in 1994. Together with other sources of cash such as borrowings, cash provided by operations was used principally for capital expenditures, debt repayments, share repurchase and dividends. For the fourth 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 .30 at year-end 1994. 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) 1994 1993 1992 1991 1990 ----------------------------------------------------------------------- Cash provided by operations $1,926 $1,680 $1,426 $1,423 $1,301 Cash provided by operations less capital expenditures $ 388 $ 363 $ 339 $ 294 $ (270) Cash provided by operations as a percent of capital expenditures 125 128 131 126 83 Cash provided by operations as a percent of average total debt 48 44 33 31 29 -----------------------------------------------------------------------\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 have been used to effectively convert fixed-rate to floating-rate debt, or vice versa. 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 $4.0 and $3.1 billion at year-end 1994 and 1993, respectively.\n----------------------------------------------------------------------- 1994 1993 1992 1991 1990 ----------------------------------------------------------------------- Fixed-rate debt as a percent of total debt at year end 64 77 75 78 78 Weighted average annual interest rate 8.4 9.1 9.3 9.4 9.4 Foreign-denominated debt as a percent of total debt at year end 92 86 72 61 60 Total debt as a percent of total capitalization (total debt and total shareholders' equity) 39 37 40 49 53 -----------------------------------------------------------------------\nThe Company manages its debt portfolio in order to respond to changes in interest rates and foreign currencies and accordingly, periodically retires, redeems, and repurchases debt; terminates exchange agreements; and uses derivatives. While changing foreign currencies affect reported results, the Company actively hedges seven foreign currencies -- Japanese Yen, Deutsche Mark, French Franc, British Pound Sterling, Australian Dollar, Canadian Dollar and Swiss Franc -- to minimize the cash exposure of royalty and other payments received in the U.S. in local currencies.\nThe Company does not use derivatives with a level of complexity or with a risk higher than the exposures to be hedged and does not hold or issue financial instruments for trading purposes; all exchange agreements are over-the-counter instruments. McDonald's restaurants also 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 exposure is diversified within a basket of currencies, as opposed to one or several. The Company's largest net asset exposures (defined as total assets less foreign-denominated liabilities) by foreign currency were as follows:\n---------------------------------------------------------------------- (In millions of dollars) December 31, 1994 1993 ---------------------------------------------------------------------- British Pounds Sterling $330 $324 Canadian Dollars 311 276 Australian Dollars 212 152 French Francs 99 81 Austrian Schillings 84 63 ----------------------------------------------------------------------\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+. At the present time, these strong ratings are important to us in the context of our global development plans. The Company has not experienced, nor does it expect to experience, difficulty in obtaining financing or in refinancing existing debt. At year-end 1994, the Company and its subsidiaries had $1.7 billion available under line of credit agreements and $585 million under previously filed shelf registrations available 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 40% of U.S. openings (excluding satellites) and 64% of openings outside of the U.S. (excluding satellites). Since 1990, the Company has improved its balance sheet by reducing leverage while simultaneously increasing expansion and repurchasing shares.\nTOTAL SHAREHOLDERS' EQUITY Total shareholders' equity rose $611 million or 10% in 1994, representing 51% of total assets at year-end 1994. One technique used to enhance common shareholder value is to repurchase shares with our excess cash flow or debt capacity, while maintaining a strong equity base for future expansion. At year-end 1994, the market value of shares repurchased and recorded as common stock in treasury was $4.0 billion, compared to their cost of $2.4 billion.\nIn conjunction with efforts to enhance common shareholder value, the Company repurchased about $500 million of its common stock in 1994, representing half of the three-year $1.0 billion program announced in January 1994. In 1993, the Company completed a $700 million common share repurchase program begun in 1992. In 1992, in order to lower the cost of equity capital, the Company issued $500 million of Series E 7.72% Cumulative Preferred Stock; at the same time, the Board of Directors authorized a $500 million common share repurchase program. Subsequently, the Board authorized an additional $200 million expenditure for share repurchase in 1993. Stronger foreign currencies added $77 million to shareholders' equity in 1994. At year-end 1994, foreign-denominated assets not entirely financed with related foreign-denominated debt were principally located in England, Canada, Australia, France and Austria. At year-end 1994, assets in hyperinflationary markets and in Mexico were principally financed in U.S. Dollars.\nRETURNS Return on average assets is computed using operating income. Net income, less preferred stock dividends (net of tax in 1994, 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---------------------------------------------------------------------- 1994 1993 1992 1991 1990 ---------------------------------------------------------------------- Return on average assets 17.6 17.0 16.4 15.7 16.3 Return on average common equity 19.4 19.0 18.2 19.1 20.7 ----------------------------------------------------------------------\nThe improvements in return on average assets since 1991 reflected better global operating results and a slower rate of asset growth. The 1994 and 1993 improvements 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.\nEFFECTS OF CHANGING PRICES--INFLATION McDonald's has demonstrated an ability to manage inflationary cost increases effectively. Rapid inventory turnover, ability to adjust prices, cost controls and substantial property holdings -- many of which are at fixed costs and partially financed by debt made cheaper by inflation -- have enabled McDonald's to mitigate the effects of inflation. In hyperinflationary markets, menu board prices typically are adjusted to keep pace, thereby mitigating the effect on reported results.\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, 1994 33\nConsolidated balance sheet at December 31, 1994 and 1993 34\nConsolidated statement of cash flows for each of the three years in the period ended December 31, 1994 35\nConsolidated statement of shareholders' equity for each of the three years in the period ended December 31, 1994 36\nNotes to consolidated financial statements (Financial comments) 37-54\nQuarterly results (unaudited) 55\nMANAGEMENT'S REPORT\nManagement is responsible for the preparation, integrity and fair presentation 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 judgment and best estimates. Other financial information presented in the annual report is consistent with the financial statements. The Company maintains a system of internal control over financial reporting including safeguarding of assets against unauthorized acquisition, use or disposition, which is designed to provide reasonable assurance to the Company's management and Board of Directors regarding the preparation of reliable published financial statements and such asset safeguarding. The system includes a documented organizational structure and appropriate division of responsibilities; established policies and procedures which are communicated throughout the Company; careful selection, training, and development of our people; 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. There are inherent limitations in the effectiveness of any system of internal control, including the possibility of human error and the circumvention or overriding of controls. Accordingly, even an effective internal control system can provide only reasonable assurance with respect to financial statement preparation and safeguarding of assets. Furthermore, the effectiveness of an internal control system can change with circumstances. The Company believes that at December 31, 1994, it maintained an effective system of internal control over financial reporting and safeguarding of assets against unauthorized acquisition, use or disposition. The consolidated financial statements have been audited by independent auditors, Ernst & Young LLP, who were given unrestricted access to all financial records and related data. The audit report of Ernst & Young LLP is presented herein. The Board of Directors, operating through its Audit Committee composed entirely of outside Directors, provides oversight to the financial reporting process. Ernst & Young LLP has independent 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 26, 1995\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 and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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 and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP Chicago, Illinois January 26, 1995\nMcDONALD'S CORPORATION CONSOLIDATED STATEMENT OF INCOME --------------------------------------------------------------------------\n(In millions of dollars, except per common share data) Years ended December 31, 1994 1993 1992 --------------------------------------------------------------------------\nREVENUES Sales by Company-operated restaurants $5,792.6 $5,157.2 $5,102.5 Revenues from franchised restaurants 2,528.2 2,250.9 2,030.8 -------------------------------------------------------------------------- TOTAL REVENUES 8,320.8 7,408.1 7,133.3 -------------------------------------------------------------------------- OPERATING COSTS AND EXPENSES Company-operated restaurants Food and packaging 1,934.2 1,735.1 1,688.8 Payroll and other employee benefits 1,459.1 1,291.2 1,281.4 Occupancy and other operating expenses 1,251.7 1,138.3 1,156.3 -------------------------------------------------------------------------- 4,645.0 4,164.6 4,126.5 -------------------------------------------------------------------------- Franchised restaurants--occupancy expenses 435.5 380.4 348.6 General, administrative and selling expenses 1,083.0 941.1 860.6 Other operating (income) expense--net (83.9) (62.0) (64.0) -------------------------------------------------------------------------- TOTAL OPERATING COSTS AND EXPENSES 6,079.6 5,424.1 5,271.7 -------------------------------------------------------------------------- OPERATING INCOME 2,241.2 1,984.0 1,861.6 -------------------------------------------------------------------------- Interest expense--net of capitalized interest of $20.6, $20.0 and $19.5 305.7 316.1 373.6 Nonoperating income (expense)--net (48.9) 7.8 (39.9) -------------------------------------------------------------------------- INCOME BEFORE PROVISION FOR INCOME TAXES 1,886.6 1,675.7 1,448.1 -------------------------------------------------------------------------- Provision for income taxes 662.2 593.2 489.5 -------------------------------------------------------------------------- NET INCOME $1,224.4 $1,082.5 $ 958.6 ========================================================================== NET INCOME PER COMMON SHARE $ 1.68 $ 1.45 $ 1.30 -------------------------------------------------------------------------- DIVIDENDS PER COMMON SHARE $ .23 $ .21 $ .20 -------------------------------------------------------------------------- The accompanying Financial Comments are an integral part of the consolidated financial statements. \/TABLE\nMcDONALD'S CORPORATION CONSOLIDATED BALANCE SHEET\n-------------------------------------------------------------------- (In millions of dollars) December 31, 1994 1993 --------------------------------------------------------------------\nASSETS CURRENT ASSETS Cash and equivalents $179.9 $185.8 Accounts receivable 348.1 287.0 Notes receivable 31.2 27.6 Inventories, at cost, not in excess of market 50.5 43.5 Prepaid expenses and other current assets 131.0 118.9 -------------------------------------------------------------------- TOTAL CURRENT ASSETS 740.7 662.8 -------------------------------------------------------------------- OTHER ASSETS AND DEFERRED CHARGES Notes receivable due after one year 80.0 90.0 Investments in and advances to affiliates 579.3 446.7 Miscellaneous 380.4 338.6 -------------------------------------------------------------------- TOTAL OTHER ASSETS AND DEFERRED CHARGES 1,039.7 875.3 -------------------------------------------------------------------- PROPERTY AND EQUIPMENT Property and equipment, at cost 15,184.6 13,459.0 Accumulated depreciation and amortization (3,856.2) (3,377.6) -------------------------------------------------------------------- NET PROPERTY AND EQUIPMENT 11,328.4 10,081.4 -------------------------------------------------------------------- INTANGIBLE ASSETS--NET 483.1 415.7 -------------------------------------------------------------------- TOTAL ASSETS $13,591.9 $12,035.2 ==================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Notes payable $1,046.9 $193.3 Accounts payable 509.4 395.7 Income taxes 25.0 56.0 Other taxes 102.1 90.2 Accrued interest 107.7 132.9 Other accrued liabilities 291.9 203.9 Current maturities of long-term debt 368.3 30.0 -------------------------------------------------------------------- TOTAL CURRENT LIABILITIES 2,451.3 1,102.0 -------------------------------------------------------------------- LONG-TERM DEBT 2,935.4 3,489.4 OTHER LONG-TERM LIABILITIES AND MINORITY INTERESTS 422.8 334.4 DEFERRED INCOME TAXES 840.8 835.3 COMMON EQUITY PUT OPTIONS 56.2 SHAREHOLDERS' EQUITY Preferred stock, no par value; authorized--165.0 million shares; issued--11.2 and 11.4 million 674.2 677.3 Common stock, no par value; authorized--1.25 billion shares; issued--830.3 million 92.3 92.3 Additional paid-in capital 286.0 256.7 Guarantee of ESOP Notes (234.4) (253.6) Retained earnings 8,625.9 7,612.6 Foreign currency translation adjustment (114.9) (192.2) -------------------------------------------------------------------- 9,329.1 8,193.1 -------------------------------------------------------------------- Common stock in treasury, at cost; 136.6 and 123.0 million shares (2,443.7) (1,919.0) -------------------------------------------------------------------- TOTAL SHAREHOLDERS' EQUITY 6,885.4 6,274.1 -------------------------------------------------------------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $13,591.9 $12,035.2 ====================================================================\nThe accompanying Financial Comments are an integral part of the consolidated financial statements. \/TABLE\nMcDONALD'S CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS\n-------------------------------------------------------------------------- (In millions of dollars) Years ended December 31, 1994 1993 1992 --------------------------------------------------------------------------\nOPERATING ACTIVITIES Net income $1,224.4 $1,082.5 $958.6 Adjustments to reconcile to cash provided by operations Depreciation and amortization 628.6 568.4 554.9 Deferred income taxes (5.6) 52.4 22.4 Changes in operating working capital items Accounts receivable increase (51.6) (48.3) (29.1) Inventories, prepaid expenses and other current assets (increase) decrease (15.0) (9.6) 2.2 Accounts payable increase 105.4 45.4 .8 Accrued interest decrease (25.5) (5.1) (27.4) Taxes and other liabilities increase (decrease) 95.2 26.5 (68.2) Other--net (29.7) (32.4) 11.7 -------------------------------------------------------------------------- CASH PROVIDED BY OPERATIONS 1,926.2 1,679.8 1,425.9 -------------------------------------------------------------------------- INVESTING ACTIVITIES Property and equipment expenditures (1,538.6) (1,316.9) (1,086.9) Sales of restaurant businesses 151.5 114.2 124.5 Purchases of restaurant businesses (133.8) (64.2) (64.1) Notes receivable additions (15.1) (33.1) (31.8) Property sales 66.0 61.6 52.2 Notes receivable reductions 56.7 75.7 78.5 Other (92.6) (55.3) (71.1) -------------------------------------------------------------------------- CASH USED FOR INVESTING ACTIVITIES (1,505.9) (1,218.0) (998.7) -------------------------------------------------------------------------- FINANCING ACTIVITIES Net short-term borrowings 521.7 (8.9) 17.0 Long-term financing issuances 260.9 1,241.0 509.5 Long-term financing repayments (536.9) (1,185.9) (1,041.5) Treasury stock purchases (495.6) (620.1) (79.7) Preferred stock issuances 484.9 Common and preferred stock dividends (215.7) (201.2) (160.5) Other 39.4 62.6 59.4 -------------------------------------------------------------------------- CASH USED FOR FINANCING ACTIVITIES (426.2) (712.5) (210.9) -------------------------------------------------------------------------- CASH AND EQUIVALENTS INCREASE (DECREASE) (5.9) (250.7) 216.3 -------------------------------------------------------------------------- Cash and equivalents at beginning of year 185.8 436.5 220.2 -------------------------------------------------------------------------- CASH AND EQUIVALENTS AT END OF YEAR $179.9 $185.8 $436.5 ========================================================================== SUPPLEMENTAL CASH FLOW DISCLOSURES Interest paid $323.9 $312.2 $395.7 Income taxes paid $621.8 $521.7 $531.6 --------------------------------------------------------------------------\nThe accompanying Financial Comments are an integral part of the consolidated financial statements. \/TABLE\nMcDONALD'S CORPORATION CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY\n(Dollars and shares in millions, except per share data) Foreign Preferred Common Additional Guarantee currency Common stock stock issued stock issued paid-in of Retained translation in treasury Shares Amount Shares Amount capital ESOP Notes earnings adjustment Shares Amount\n----------------------------------------------------------------------------------------------------------------------------------\nBalance at December 31, 1991 19.8 $298.2 830.3 $92.3 $155.8 $(286.7) $5,925.2 $32.3 (113.1) $(1,382.0)\n---------------------------------------------------------------------------------------------------------------------------------- Net income 958.6\nCommon stock cash dividends ($.20 per share) (141.8)\nPreferred stock cash dividends ($1.01 for Series B, $1.16 for Series C and $.16 for Series E depositary share), (net of tax benefits of $6.4) (14.7)\nPreferred stock issuance 500.0 (15.1)\nPreferred stock conversion (8.2) (118.0) 22.9 6.4 95.1\nESOP Notes payment 12.6\nTreasury stock acquisitions (3.8) (92.3)\nTranslation adjustments (including taxes of $21.2) (159.7)\nCommon equity put options issuance (91.5)\nStock option exercises and other (including tax benefits of $29.7) 50.5 2.8 7.2 47.9\n----------------------------------------------------------------------------------------------------------------------------------\nBalance at December 31, 1992 11.6 680.2 830.3 92.3 214.1 (271.3) 6,727.3 (127.4) (103.3) (1,422.8)\n----------------------------------------------------------------------------------------------------------------------------------\nNet income 1,082.5\nCommon stock cash dividends ($.21 per share) (150.3)\nPreferred stock cash dividends ($1.01 for Series B, $1.16 for Series C and $1.93 for Series E depositary share), (net of tax benefits of $4.1) (46.9)\nPreferred stock conversion (.2) (2.9) .5 .2 2.4\nESOP Notes payment 15.5\nTreasury stock acquisitions (25.0) (627.7)\nTranslation adjustments (including taxes of $1.6) (64.8)\nCommon equity put options expiration 94.0\nStock option exercises and other (including tax benefits of $23.0) 42.1 2.2 5.1 35.1\n----------------------------------------------------------------------------------------------------------------------------------\nBalance at December 31, 1993 11.4 677.3 830.3 92.3 256.7 (253.6) 7,612.6 (192.2) (123.0) (1,919.0)\n----------------------------------------------------------------------------------------------------------------------------------\nNet income 1,224.4\nCommon stock cash dividends ($.23 per share) (163.9)\nPreferred stock cash dividends ($1.01 for Series B, $1.16 for Series C and $1.93 for Series E depositary share), (net of tax benefits of $3.7) (47.2)\nPreferred stock conversion (.2) (3.1) .5 .2 2.6\nESOP Notes payment 17.5\nTreasury stock acquisitions (17.6) (499.8)\nTranslation adjustments (including taxes of $50.8) 77.3\nCommon equity put options issuance (54.6)\nStock option exercises and other (including tax benefits of $20.3) 28.8 1.7 3.8 27.1\n----------------------------------------------------------------------------------------------------------------------------------\nBALANCE AT DECEMBER 31, 1994 11.2 $674.2 830.3 $92.3 $286.0 $(234.4) $8,625.9 $(114.9) (136.6) $(2,443.7)\n================================================================================================================================== The accompanying Financial Comments are an integral part of the consolidated financial statements. \/TABLE\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. is the respective local currency, except for hyperinflationary countries where it is the U.S. Dollar.\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 30 years.\nADVERTISING COSTS In the fourth quarter of 1994, the Company adopted the American Institute of Certified Public Accountants' Statement of Position 93-7, Reporting on Advertising Costs. Under its provisions, the Company expenses production costs of radio and television ads as of the date the commercials are initially aired. As a result, the Company recorded a one-time, noncash $15.0 million charge to general, administrative and selling expenses in the fourth quarter. Advertising expenses included in costs of Company-operated restaurants and general, administrative and selling expenses were (in millions): 1994--$385.6; 1993--$353.8; 1992--$355.7.\nFINANCIAL INSTRUMENTS The Company utilizes derivatives in managing risk, but not for trading purposes. Non-U.S. Dollar financing transactions generally are effective as hedges of long-term investments or intercompany loans in the corresponding currency. Foreign currency gains and losses on the hedges of long-term investments are recorded as foreign currency translation adjustment included in shareholders' equity. Gains and losses related to hedges of intercompany loans offset the gains and losses on intercompany loans and are recorded in nonoperating income (expense). Interest-rate exchange agreements are designated and effective to modify the Company's interest-rate exposures. Net interest is accrued as either interest receivable or payable with the offset recorded in interest expense. The Company also uses short-term forward foreign exchange contracts to hedge future foreign-denominated royalty cash flows and other payments received in the U.S. from foreign subsidiaries and affiliates. Gains and losses associated with these contracts are deferred and amortized over the twelve-month period being hedged. 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 LOCATIONS IN OPERATION ---------------------------------------------------------------------- December 31, 1994 1993 1992 1991 ---------------------------------------------------------------------- Operated by franchisees 9,982 9,288 8,654 8,151 Operated under business facilities lease arrangements 476 544 583 584 Operated by the Company 3,083 2,699 2,551 2,547 Operated by 50% or less owned affiliates 1,664 1,462 1,305 1,136 ---------------------------------------------------------------------- Systemwide restaurants (excluding satellites) 15,205 13,993 13,093 12,418 ======================================================================\nFranchisees 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. In 1994, due to increased ownership, the Company consolidated affiliates in Taiwan, South Korea, Turkey and China, which increased total assets and liabilities by approximately $205.0 million.\n---------------------------------------------------------------------- December 31, 1994 1993 ---------------------------------------------------------------------- U.S. 494 114 Outside of the U.S. 251 56 ---------------------------------------------------------------------- Systemwide satellites 745 170 ======================================================================\nSatellite foodservice facilities are points of distribution which leverage the infrastructure of existing restaurants by using their storage capability and inventory, and by drawing on their management talent and labor pool.\n---------------------------------------------------------------------- OTHER OPERATING (INCOME) EXPENSE--NET ---------------------------------------------------------------------- (In millions of dollars) 1994 1993 1992 ---------------------------------------------------------------------- Gains on sales of restaurant businesses $(67.1) $(48.2) $(43.1) Equity in earnings of unconsolidated affiliates (47.0) (34.6) (29.5) Net losses from property dispositions 20.0 15.5 18.1 Other--net 10.2 5.3 (9.5) ---------------------------------------------------------------------- Other operating (income) expense--net $(83.9) $(62.0) $(64.0) ======================================================================\nGains 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:\n--------------------------------------------------------------------- (In millions of dollars) 1994 1993 1992 --------------------------------------------------------------------- U.S. $1,046.4 $ 986.0 $ 873.3 Outside of the U.S. 840.2 689.7 574.8 --------------------------------------------------------------------- Income before provision for income taxes $1,886.6 $1,675.7 $1,448.1 ===================================================================== U.S. $ 396.2 $ 391.9 $ 316.8 Outside of the U.S. 266.0 201.3 172.7 --------------------------------------------------------------------- Provision for income taxes $ 662.2 $ 593.2 $ 489.5 =====================================================================\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) 1994 1993 1992 --------------------------------------------------------------------- Current U.S. federal $379.3 $331.6 $256.8 U.S. state 71.1 62.0 56.3 Outside of the U.S. 217.4 147.2 154.0 --------------------------------------------------------------------- 667.8 540.8 467.1 --------------------------------------------------------------------- Deferred U.S. federal (21.2) 21.9 (10.3) U.S. state (3.0) 3.4 4.0 Outside of the U.S. 18.6 27.1 28.7 --------------------------------------------------------------------- (5.6) 52.4 22.4 --------------------------------------------------------------------- Provision for income taxes $662.2 $593.2 $489.5 =====================================================================\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 consisted of:\n------------------------------------------------------------------------- (In millions of dollars) December 31, 1994 1993 ------------------------------------------------------------------------- Property and equipment basis differences $ 852.8 $ 786.1 Other 178.3 175.4 ------------------------------------------------------------------------- Total deferred tax liabilities 1,031.1 961.5 ------------------------------------------------------------------------- Deferred tax assets before valuation allowance (1) (274.7) (192.8) Valuation allowance 41.4 44.5 ------------------------------------------------------------------------- Net deferred tax liabilities (2) $ 797.8 $ 813.2 ========================================================================= (1) Includes loss carryforwards (in millions): 1994--$45.1; 1993-- $46.7. (2) Net of assets recorded in current income taxes (in millions): 1994--$43.0; 1993--$22.1.\nReconciliations of the statutory U.S. federal income tax rates to the effective income tax rates were as follows:\n------------------------------------------------------------------------- 1994 1993 1992 ------------------------------------------------------------------------- Statutory U.S. federal income tax rates 35.0% 35.0% 34.0% State income taxes, net of related federal income tax benefit 2.3 2.5 2.7 Other (2.2) (2.1) (2.9) ------------------------------------------------------------------------- Effective income tax rates 35.1% 35.4% 33.8% =========================================================================\nDeferred U.S. income taxes have not been provided on basis differences related to investments in certain foreign subsidiaries and affiliates. These basis differences were approximately $675.0 million at December 31, 1994, and consisted primarily of undistributed earnings which are considered to be permanently invested in the businesses. 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 (in millions): 1994-- $268.9; 1993--$202.8; 1992--$187.8.\n---------------------------------------------------------------------- (In millions of dollars) 1994 1993 1992 ---------------------------------------------------------------------- U.S. $ 4,155.5 $ 3,931.2 $ 3,749.4 Europe\/Africa\/Middle East 2,604.7 2,235.9 2,187.0 Asia\/Pacific 730.7 494.4 434.6 Canada 546.1 557.8 595.1 Latin America 283.8 188.8 167.2 ---------------------------------------------------------------------- Total revenues $ 8,320.8 $ 7,408.1 $ 7,133.3 ====================================================================== U.S. $ 1,130.5 $ 1,087.1 $ 1,041.6 Europe\/Africa\/Middle East 671.9 547.5 484.0 Asia\/Pacific 242.9 190.6 163.2 Canada 116.8 111.2 113.5 Latin America 79.1 47.6 59.3 ---------------------------------------------------------------------- Operating income $ 2,241.2 $ 1,984.0 $ 1,861.6 ====================================================================== U.S. $ 6,682.7 $ 6,385.4 $ 6,410.6 Europe\/Africa\/Middle East 4,257.5 3,473.2 3,290.9 Asia\/Pacific 1,547.7 1,103.2 980.3 Canada 487.6 562.5 587.4 Latin America 616.4 510.9 412.0 ---------------------------------------------------------------------- Total assets $13,591.9 $12,035.2 $11,681.2 ======================================================================\n------------------------------------------------------------------------ PROPERTY AND EQUIPMENT ------------------------------------------------------------------------ (In millions of dollars) December 31, 1994 1993 ------------------------------------------------------------------------ Land $ 2,950.1 $ 2,587.2 Buildings and improvements on owned land 5,814.7 5,209.4 Buildings and improvements on leased land 4,211.2 3,673.0 Equipment, signs and seating 1,727.8 1,545.4 Other 480.8 444.0 ------------------------------------------------------------------------ 15,184.6 13,459.0 ------------------------------------------------------------------------ Accumulated depreciation and amortization (3,856.2) (3,377.6) ------------------------------------------------------------------------ Net property and equipment $11,328.4 $10,081.4 ========================================================================\nDepreciation and amortization were (in millions): 1994--$550.5; 1993-- $492.8; 1992--$492.9. Contractual obligations for the acquisition and construction of property amounted to $241.2 million at December 31, 1994.\n------------------------------------------------------------------------ DEBT FINANCING ------------------------------------------------------------------------ LINE OF CREDIT AGREEMENTS The Company has a line of credit agreement for $700.0 million, which remained unused at December 31, 1994, and which may be renewed on an annual basis unless the participating banks notify the Company four days prior to the renewal period. Prior to July 20, 1994, the agreement could not be terminated without 18 months notice and supported the classification of certain notes maturing within one year as long-term debt. Each borrowing under the current 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 .07% 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, 1994; these were principally short-term and denominated in various currencies at local market rates of interest. The weighted average interest rates of short-term borrowings, comprised of commercial paper and foreign- denominated bank line borrowings, were 6.8% and 8.1% at December 31, 1994, and 1993, respectively.\nEXCHANGE AGREEMENTS The Company has entered into agreements for the exchange of various currencies, certain of which also provide for the periodic exchange of interest payments. These agreements, as well as additional interest- rate exchange agreements, expire through 2003. The interest-rate exchange agreements had a notional amount with a U.S. Dollar equivalent of $1.3 billion at December 31, 1994, and were denominated primarily in U.S. Dollars, British Pounds Sterling, French Francs, Deutsche Marks and Japanese Yen. The net value of each exchange agreement was classified as an asset or liability based on its carrying amount, and any related interest income was netted against interest expense. The counterparties to these 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 does not have a significant exposure to any individual counterparty, and has entered into master agreements that contain netting arrangements. The Company also had short-term forward foreign exchange contracts outstanding at December 31, 1994, with a U.S. Dollar equivalent of $65.2 million in various currencies, primarily payable in French Francs, Deutsche Marks, British Pounds Sterling and Japanese Yen. The deferred loss related to the short-term hedging program was $1.7 million at December 31, 1994.\nGUARANTEES Included in total debt at December 31, 1994, were $159.5 million of 7.5% ESOP Notes Series A and $83.3 million of 7.2% 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 in 1994 due to refinancing of certain sinking fund payments. The Company has agreed to repurchase the notes upon the occurrence of certain events. The Company also has guaranteed certain foreign affiliate loans totaling $66.9 million at December 31, 1994. The Company also was a general partner in 70 domestic partnerships with total assets of $287.0 million and total liabilities of $141.3 million at December 31, 1994.\nFAIR VALUES ---------------------------------------------------------------------- December 31, 1994 (In millions of dollars) Carrying amount Fair value ---------------------------------------------------------------------- Liabilities Debt $3,116.8 $3,050.9 Notes payable 1,046.9 1,046.9 Foreign currency exchange agreements 186.9 225.5 Interest-rate exchange agreements 35.6 ---------------------------------------------------------------------- Total liabilities 4,350.6 4,358.9 ---------------------------------------------------------------------- Assets Foreign currency exchange agreements 37.5 18.5 ---------------------------------------------------------------------- Net debt $4,313.1 $4,340.4 ======================================================================\nThe carrying amounts for short-term forward foreign exchange contracts approximated fair value at December 31, 1994. The fair value of the debt obligations (excluding capital leases) and of the currency and interest-rate exchange agreements was estimated using quoted market prices, various pricing models or discounted cash flow analyses. The Company has no current plans to retire a significant amount of its debt prior to maturity. Given the market value of its common stock and its significant real estate holdings, the Company believes that the fair value of total assets was higher than their carrying value at December 31, 1994.\nDEBT OBLIGATIONS The Company has incurred debt obligations principally through various public and private offerings and bank loans. The terms of most debt obligations contain restrictions on Company and subsidiary mortgages and long-term debt of certain subsidiaries. Under certain agreements, the Company has the option to retire debt prior to maturity, either at par or at a premium over par. The following table summarizes these debt obligations, including the gross effects of currency and interest-rate exchange agreements:\nDEBT OBLIGATIONS\nInterest rates (1) Amounts outstanding Maturity December 31 December 31 Aggregate maturities by currency for 1994 balances dates 1994 1993 1994 1993 1995 1996 1997 1998 1999 Thereafter\n(In millions of U.S. Dollars) --------------------------------------------------------------------------------------------------------------------------------- Fixed-original issue 8.2% 8.5% $1,647.0 $1,790.6 Fixed-converted via exchange agreements (2) 5.7 5.6 (1,483.6) (1,449.0) Floating 4.5 3.0 167.3 163.2 --------------------------------------------------------------------------------------------------------------------------------- Total U.S. Dollars 1995-2033 330.7 504.8 $644.9 $(363.1) $(72.4) $(400.4) $9.9 $511.8\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 8.3 8.9 527.2 447.1 Floating 6.0 6.7 292.3 168.6 --------------------------------------------------------------------------------------------------------------------------------- Total French Francs 1995-2003 819.5 615.7 150.3 59.6 56.6 93.8 138.6` 320.6\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 6.4 6.3 440.7 423.1 Floating 5.4 6.9 339.5 116.7 --------------------------------------------------------------------------------------------------------------------------------- Total Deutsche Marks 1995-2007 780.2 539.8 168.0 138.5 116.2 259.6 32.3 65.6\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 10.4 9.8 464.9 498.6 Floating 6.1 5.4 197.2 178.0 --------------------------------------------------------------------------------------------------------------------------------- Total British Pounds Sterling 1995-2003 662.1 676.6 32.0 170.7 15.6 77.6 31.3 334.9\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 4.3 4.3 375.8 357.7 Floating 2.0 135.5 --------------------------------------------------------------------------------------------------------------------------------- Total Japanese Yen 1996-2023 511.3 357.7 210.8 100.4 200.1\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 11.1 12.0 113.3 117.3 Floating 7.4 5.0 106.3 61.0 --------------------------------------------------------------------------------------------------------------------------------- Total Australian Dollars 1995-2000 219.6 178.3 84.1 65.9 1.0 67.2 .9 .5\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 6.4 7.7 149.9 71.7 Floating 5.7 6.2 26.6 22.6 --------------------------------------------------------------------------------------------------------------------------------- Total Netherland Guilders 1995-1999 176.5 94.3 49.6 77.8 49.1\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 11.8 11.6 114.5 166.9 Floating 6.0 4.5 39.3 50.3 --------------------------------------------------------------------------------------------------------------------------------- Total Canadian Dollars 1995-2021 153.8 217.2 80.6 71.5 .2 .2 .3 1.0\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 8.1 8.6 97.0 118.4 Floating 6.4 4.1 37.6 21.0 --------------------------------------------------------------------------------------------------------------------------------- Total Hong Kong Dollars 1995-2008 134.6 139.4 44.1 6.5 25.9 12.9 6.4 38.8\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 8.0 41.0 Floating 8.2 69.6 --------------------------------------------------------------------------------------------------------------------------------- Total New Taiwan Dollars (3) 1995-2001 110.6 22.4 26.6 17.0 13.2 8.6 22.8\n--------------------------------------------------------------------------------------------------------------------------------- Fixed 7.5 8.0 289.5 231.6 Floating 12.1 13.6 124.7 48.5 --------------------------------------------------------------------------------------------------------------------------------- Total other currencies 1995-2016 414.2 280.1 135.5 47.6 4.8 99.3 48.5 78.5\n--------------------------------------------------------------------------------------------------------------------------------- Debt obligations including the net effects of currency and interest- rate exchange agreements 4,313.1 3,603.9 1,411.5 434.6 265.3 301.2 325.9 1,574.6\n--------------------------------------------------------------------------------------------------------------------------------- Net asset positions of currency exchange agreements (included in miscellaneous other assets) 37.5 108.8 3.7 12.5 .1 7.1 2.5 11.6\n--------------------------------------------------------------------------------------------------------------------------------- Total debt obligations $4,350.6 $3,712.7 $1,415.2 $447.1 $265.4 $308.3 $328.4 $1,586.2\n=================================================================================================================================\n(1) Weighted average effective rate, computed on a semi-annual basis. (2) A portion of U.S. Dollar fixed-rate debt effectively has been converted into other currencies and\/or into floating-rate debt through the use of exchange agreements. The rates shown reflected the fixed rate on the receivable portion of the exchange agreements. All other obligations in this table reflected the gross effects of these and other exchange agreements. (3) In 1994, due to an increase in ownership, the Company consolidated its Taiwan affiliate. \/TABLE\n------------------------------------------------------------------- OTHER LONG-TERM LIABILITIES AND MINORITY INTERESTS ------------------------------------------------------------------- (In millions of dollars) December 31, 1994 1993 ------------------------------------------------------------------- Security deposits by franchisees $141.2 $121.4 Preferred interests in consolidated subsidiaries 162.4 106.7 Minority interests in consolidated subsidiaries 50.3 38.2 Other 68.9 68.1 ------------------------------------------------------------------- Other long-term liabilities and minority interests $422.8 $334.4 ===================================================================\nA Company subsidiary issued 25 million British Pounds Sterling of 5.42% Series B Preferred Stock in 1994, and 50 million British Pounds Sterling of 5.91% Series A Preferred Stock in 1993. Unless redeemed at the Company's option, each series of preferred stock must be redeemed five years from the date of issuance. These combined preferred interests were valued at U.S. $117.4 million at December 31, 1994. Also, another subsidiary issued additional preferred stock in 1994 and 1993. All of the preferred stock of this subsidiary has a dividend rate adjusted annually (7.5% at December 31, 1994) and is redeemable at the option of the holder at a current redemption price totaling $45.0 million. Each of these issues was 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. This stock, which carries one vote per share, must be redeemed on the occurrence of specified events.\n--------------------------------------------------------------------- LEASING ARRANGEMENTS --------------------------------------------------------------------- At December 31, 1994, the Company was lessee at 2,553 locations under ground leases (the Company leases land and constructs and owns buildings) and at 3,268 locations under improved leases (lessor owns land and buildings). Land and building lease terms for most traditional restaurants 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. Most satellites operate under improved leases which are generally of a shorter term and include primarily percentage rent payments only. For most locations, the Company is obligated for the related occupancy costs which 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, 1994, are:\n--------------------------------------------------------------------- (In millions of dollars) Restaurant Other Total --------------------------------------------------------------------- 1995 $ 335.3 $ 39.8 $ 375.1 1996 330.6 36.5 367.1 1997 318.7 32.9 351.6 1998 301.7 28.6 330.3 1999 283.9 24.3 308.2 Thereafter 2,776.8 171.2 2,948.0 --------------------------------------------------------------------- Total minimum payments $4,347.0 $333.3 $4,680.3 =====================================================================\nRent expense was (in millions): 1994--$394.4; 1993--$339.0; 1992-- $320.2. Included in these amounts were percentage rents based on sales by the related restaurants in excess of minimum rents stipulated in certain lease agreements (in millions): 1994 $40.3; 1993--$29.0; 1992--$26.1.\n---------------------------------------------------------------------- FRANCHISE ARRANGEMENTS ---------------------------------------------------------------------- Franchise arrangements, with franchisees who operate throughout the U.S. and in most countries around the world, 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 which include property taxes, insurance, maintenance and a refundable, noninterest-bearing security deposit. On a limited basis, the Company accepts notes from franchisees, which generally are secured by interests in restaurant equipment and franchises.\n---------------------------------------------------------------------- (In millions of dollars) 1994 1993 1992 ---------------------------------------------------------------------- Minimum rents Owned sites $ 633.4 $ 573.6 $ 538.7 Leased sites 446.0 381.7 353.3 ---------------------------------------------------------------------- 1,079.4 955.3 892.0 ---------------------------------------------------------------------- Percentage fees 1,411.8 1,272.1 1,120.6 Initial fees 37.0 23.5 18.2 ---------------------------------------------------------------------- Revenues from franchised restaurants $2,528.2 $2,250.9 $2,030.8 ======================================================================\nFuture minimum payments to the Company, based on minimum rents specified under franchise arrangements, after December 31, 1994, are:\n---------------------------------------------------------------------- Owned Leased (In millions of dollars) sites sites Total ---------------------------------------------------------------------- 1995 $ 721.7 $ 410.4 $ 1,132.1 1996 708.6 446.5 1,155.1 1997 693.0 444.8 1,137.8 1998 677.0 432.7 1,109.7 1999 662.3 421.0 1,083.3 Thereafter 6,368.1 4,029.9 10,398.0 ---------------------------------------------------------------------- Total minimum payments $9,830.7 $6,185.3 $16,016.0 ======================================================================\nAt December 31, 1994, net property and equipment under franchise arrangements totaled $6.6 billion (including land of $2.0 billion), after deducting accumulated depreciation and amortization of $1.9 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. Profit sharing assets can be invested in McDonald's common stock or among several other investment alternatives. McDESOP allows employees to invest in McDonald's common stock by making contributions which are partially matched by the Company. LESOP is invested in both McDonald's convertible preferred and common stock. Staff, executives and restaurant managers share in profit sharing contributions; shares are released under the LESOP based on participants' compensation. The profit sharing contribution is discretionary, and the amount is determined by the Company each year. The LESOP contribution is based on the loan payments necessary to amortize the debt initially incurred to acquire the convertible preferred stock, some of which has been converted to common stock. Shares held by the LESOP are allocated to participants as the loan is repaid. Dividends on shares held by the LESOP are used to service the debt, and shares are released to participants in order to replace the dividends on shares that have been allocated to them. LESOP costs shown in the following table were based upon the cash paid for loan payments less these dividends.\n------------------------------------------------------------------------- (In millions of dollars) 1994 1993 1992 ------------------------------------------------------------------------- Profit sharing $16.1 $13.5 $14.3 LESOP 26.3 25.5 19.6 McDESOP 10.1 8.1 4.9 ------------------------------------------------------------------------- U.S. program costs $52.5 $47.1 $38.8 =========================================================================\nAssuming conversion of the preferred stock to common stock, at December 31, 1994, 4.4 million and 10.7 million shares would have been allocated and unallocated, respectively; no shares were committed to be released. Certain subsidiaries outside of the U.S. also offer profit sharing, stock purchase or other similar benefit plans. Total plan costs outside of the U.S. were (in millions): 1994--$15.7; 1993--$13.0; 1992--$14.0. 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 expiring ten years from date of grant. At December 31, 1994, 79.0 million shares of common stock were reserved for issuance under both plans.\n------------------------------------------------------------------------- (In millions, except per common share data) 1994 1993 1992 ------------------------------------------------------------------------- Options outstanding at January 1 55.1 50.3 47.4 Options granted 13.6 12.0 11.6 Options exercised (4.1) (5.3) (7.5) Options forfeited (2.3) (1.9) (1.2) ------------------------------------------------------------------------- Options outstanding at December 31 62.3 55.1 50.3 ========================================================================= Options exercisable at December 31 21.4 17.6 15.4 Common shares reserved for future grants at December 31 16.7 28.0 38.2 Option prices per common share Exercised during the year $5 TO $26 $4 to $24 $4 to $22 Outstanding at year end $7 TO $30 $5 to $28 $4 to $24 -------------------------------------------------------------------------\nDuring the past several years, the Financial Accounting Standards Board has been considering the appropriate accounting for stock options, and in December 1994, decided to work towards improving disclosures about stock-based awards. Pending the resolution of this issue, the following table provides additional information regarding the Company's option program. The Company surveyed its institutional investors regarding the appropriate disclosures for stock-based awards, and the content contained herein reflects the information which they considered to be of value. The potential dilution of common shares outstanding upon exercise of stock options represents the number of common shares issuable upon exercise less the number of common shares that could be repurchased with proceeds from the exercise based upon the respective December 31 prices of the Company's common stock. As such, this potential dilution was 1.6%, 1.8% and 1.7% at year-end 1994, 1993 and 1992, respectively. Options outstanding at December 31, 1994, had an average life of 7.4 years if held to their expiration date; options are generally exercised prior to their expiration date.\n------------------------------------------------------------------------- (Shares in millions) 1994 1993 1992 ------------------------------------------------------------------------- Common shares outstanding at year end 693.7 707.3 727.0 Potential dilution of common shares outstanding from option exercises 11.4 12.6 12.2 Average option exercise price $12.14 $11.01 $ 9.68 Average cost of treasury stock issued for option exercises $ 7.05 $ 6.65 $ 6.55 -------------------------------------------------------------------------\nAs shown above, the average option exercise price has consistently exceeded the average cost of treasury stock issued for option exercises because of the Company's practice of prefunding the program through share repurchase. As a result, stock option exercises have generated additional capital, as cash received from employees has exceeded the Company's average acquisition cost of treasury stock. Options granted during each year were 1.9%, 1.7% and 1.6% of average common shares outstanding for 1994, 1993 and 1992, respectively. Stock options were granted to approximately 6,600, 5,800 and 5,700 employees in 1994, 1993 and 1992, respectively. Shares are issued from treasury stock to employees upon exercise of stock options.\n---------------------------------------------------------------------- CAPITAL STOCK ---------------------------------------------------------------------- STOCK SPLITS On May 27, 1994, the Board of Directors approved two-for-one stock splits to be effected in the form of stock dividends to be distributed on June 24, 1994, to common and Series B and C Preferred shareholders of record as of June 7, 1994. All common and Series B and C ESOP Convertible Preferred Stock information appearing in the accompanying consolidated financial statements and Financial Comments has been restated to give retroactive effect to the stock splits, including the transfer of an appropriate amount to common stock from additional paid-in capital.\nPER COMMON SHARE INFORMATION Income used in the computation of per common share information was reduced by preferred stock cash dividends (net of tax) and divided by the weighted average shares of common stock outstanding during each year (in millions): 1994--701.8; 1993--711.8; 1992--726.5. 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 to the LESOP. The LESOP financed the purchase by issuing notes which 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 $14.375 and $16.5625, respectively, and is convertible into a minimum of .7692 and .8 common share (conversion rate), respectively. Upon termination of employment, 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 currently is redeemable at the option of the Company. In 1992, 8.2 million Series B shares were converted into 6.4 million common shares.\nCOMMON EQUITY PUT OPTIONS In June 1994, the Company sold 2.0 million common equity put options which were exercised in November 1994. During November and December 1994, the Company sold an additional 2.0 million common equity put options which expired unexercised in the first quarter of 1995. At December 31, 1994, the $56.2 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, the Company sold 1.0 million common equity put options which expired unexercised in July 1993. In December 1992, the Company sold 2.0 million common equity put options which expired unexercised in April 1993. 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.\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 four-hundredth of a share of Series A Junior Participating Preferred Stock (the economic equivalent of one common share) at an exercise price of $62.50 (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 (which threshold may be reduced by the Board of Directors to as low as 10%), 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 exceeding the threshold. Once the threshold has been exceeded, 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 $.0025, at any time prior to the public announcement that a person or group has exceeded the threshold. At December 31, 1994, 2.1 million shares of the Series A Junior Participating Preferred Stock were reserved for issuance under this plan.\nQUARTERLY RESULTS (UNAUDITED)\n(In millions of dollars, except per common share data) --------------------------------------------------------------------------------------------------------------------------------- Quarters ended December 31 September 30 June 30 March 31 1994 1993 1994 1993 1994 1993 1994 1993 ---------------------------------------------------------------------------------------------------------------------------------\nSYSTEMWIDE SALES $6,964.0 $6,145.7 $6,944.0 $6,247.2 $6,370.2 $5,958.9 $5,709.2 $5,235.1\nREVENUES Sales by Company-operated restaurants $1,586.8 $1,345.2 $1,551.8 $1,351.1 $1,409.3 $1,307.6 $1,244.7 $1,153.3\nRevenues from franchised restaurants 683.3 586.7 673.6 593.2 620.0 570.2 551.3 500.8\n--------------------------------------------------------------------------------------------------------------------------------- TOTAL REVENUES 2,270.1 1,931.9 2,225.4 1,944.3 2,029.3 1,877.8 1,796.0 1,654.1\n--------------------------------------------------------------------------------------------------------------------------------- OPERATING COSTS AND EXPENSES Company-operated restaurants 1,267.7 1,085.3 1,231.3 1,076.9 1,128.6 1,049.5 1,017.4 952.9\nFranchised restaurants 117.8 100.3 111.7 95.7 105.6 93.6 100.4 90.8\nGeneral, administrative and selling expenses 309.4 256.2 277.1 234.6 257.0 232.5 239.5 217.8\nOther operating (income) expense--net (0.6) 3.5 (32.6) (31.1) (30.3) (15.6) (20.4) (18.8)\n--------------------------------------------------------------------------------------------------------------------------------- TOTAL OPERATING COSTS AND EXPENSES 1,694.3 1,445.3 1,587.5 1,376.1 1,460.9 1,360.0 1,336.9 1,242.7\n--------------------------------------------------------------------------------------------------------------------------------- OPERATING INCOME 575.8 486.6 637.9 568.2 568.4 517.8 459.1 411.4\n--------------------------------------------------------------------------------------------------------------------------------- Interest expense 80.1 78.7 80.2 75.7 73.6 82.4 71.8 79.3\nNonoperating income (expense)--net (24.1) (4.9) (16.6) 7.2 1.7 4.3 (9.9) 1.2\n--------------------------------------------------------------------------------------------------------------------------------- INCOME BEFORE PROVISION FOR INCOME TAXES 471.6 403.0 541.1 499.7 496.5 439.7 377.4 333.3\n--------------------------------------------------------------------------------------------------------------------------------- Provision for income taxes 162.7 138.5 191.3 188.8 174.2 150.9 134.0 115.0\n--------------------------------------------------------------------------------------------------------------------------------- NET INCOME $308.9 $264.5 $349.8 $310.9 $322.3 $288.8 $243.4 $218.3 ================================================================================================================================= NET INCOME PER COMMON SHARE $ .43 $ .36 $ .48 $ .42 $ .44 $ .39 $ .33 $ .29\n---------------------------------------------------------------------------------------------------------------------------------\nDIVIDENDS PER COMMON SHARE $ .06 $ .05 3\/8 $ .06 $ .05 3\/8 $ .06 $ .05 3\/8 $ .05 3\/8 $ .05\n--------------------------------------------------------------------------------------------------------------------------------- \/TABLE\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, 1994.\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, 1994.\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, 1994.\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, 1994.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(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.\n2. Financial statement schedules: No additional schedules are required because either 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.\n3. Exhibits: The exhibits listed in the accompanying index are filed as part of this report.\nMcDonald's Corporation Exhibit Index (Item 14)\nExhibit Number Description -------------- -----------\n(3) Restated Certificate of Incorporation and By-Laws, dated as of November 15, 1994, attached hereto as an Exhibit.\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 (U.S. Issue)\/184 days (Euro Issue) 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 (U.S. Issue)\/184 days (Euro Issue) 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.\nExhibit Number Description -------------- -----------\n(10) Material Contracts\n(a) Directors' Stock Plan, as amended and restated, attached hereto as an Exhibit.*\n(b) Profit Sharing Program, as amended and restated, attached hereto as an Exhibit.*\n(c) 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, incorporated herein by reference from Form 10-K for the year ended December 31, 1993.\n(iii)Amendment No. 1 to McDonald's Supplemental Employee Benefit Equalization Plan, incorporated herein by reference from Form 10-K for the year ended December 31, 1993.\n(iv) Amendment No. 2 to McDonald's Supplemental Employee Equalization Plan, incorporated herein by reference from Form 10-K for the year ended December 31, 1993.\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, as amended and restated, attached hereto as an Exhibit.*\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, as amended and restated, attached hereto as an Exhibit.*\nExhibit Number Description -------------- -----------\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(27) Financial Data Schedule\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\nThere were no reports on Form 8-K filed for the last quarter covered by this report, and subsequently up to March 29, 1995.\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 Date March 29, 1995 ----------------------\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 --------- ----- ----\nHall Adams, Jr. ------------------------- Director March 29, 1995 Hall Adams, Jr.\nRobert M. Beavers, Jr. ------------------------- Senior Vice President March 29, 1995 Robert M. Beavers, Jr. and Director\nJames R. Cantalupo ------------------------- President and Chief Executive March 29, 1995 James R. Cantalupo Officer-International and Director\nMichael L. Conley ------------------------- Senior Vice President, March 29, 1995 Michael L. Conley Controller\nGordon C. Gray ------------------------- Director March 29, 1995 Gordon C. Gray\nJack M. Greenberg ------------------------- Vice Chairman, March 29, 1995 Jack M. Greenberg Chief Financial Officer and Director\nSignature Title Date --------- ----- ----\nDonald R. Keough ------------------------- Director March 29, 1995 Donald R. Keough\nDonald G. Lubin ------------------------- Director March 29, 1995 Donald G. Lubin\nAndrew J. McKenna ------------------------- Director March 29, 1995 Andrew J. McKenna\nMichael R. Quinlan ------------------------- Chairman, Chief Executive March 22, 1995 Michael R. Quinlan Officer and Director\nEdward H. Rensi ------------------------- President and Chief Executive March 22, 1995 Edward H. Rensi Officer-U.S.A. and Director\nTerry L. Savage ------------------------- Director March 29, 1995 Terry L. Savage\nPaul D. Schrage ------------------------- Senior Executive Vice March 25, 1995 Paul D. Schrage President, Chief Marketing Officer and Director\nBallard F. Smith ------------------------- Director March 22, 1995 Ballard F. Smith\n------------------------- Director Roger W. Stone\nRobert N. Thurston ------------------------- Director March 29, 1995 Robert N. Thurston\nFred L. Turner ------------------------- Senior Chairman and Director March 29, 1995 Fred L. Turner\nB. Blair Vedder, Jr. ------------------------- Director March 29, 1995 B. Blair Vedder, Jr.","section_15":""}
{"filename":"317745_1994.txt","cik":"317745","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral Re Corporation (the \"Corporation\") was established in 1980 to serve as the parent holding company of General Reinsurance Corporation (\"GRC\", formed in 1921) and its affiliates, together constituting the General Re Group (the \"Group\"). The Corporation operates in three principal businesses: domestic property\/casualty and life reinsurance, international property\/casualty and life reinsurance and financial services. The Group comprises the largest professional property\/casualty reinsurer domiciled in the United States and the third largest in the world.\nDomestic Property\/Casualty\nThe Corporation's largest business (82.2% of 1994 consolidated revenues) is domestic property\/casualty reinsurance. Domestically, the Corporation primarily operates as a treaty and facultative reinsurer, underwriting property and casualty business on a direct basis throughout the United States and Canada. The Corporation predominately writes excess of loss reinsurance across various lines of business. Casualty reinsurance business represented approximately 55 percent of the Corporation's domestic property\/casualty net premiums written in 1994 and property reinsurance business represented approximately 34 percent. The Corporation also writes excess and surplus lines insurance and provides excess insurance to self-insured programs. These lines represented approximately 11 percent of the domestic property\/casualty net premiums in 1994.\nIt is not possible to determine the number of the Corporation's competitors. There are virtually no barriers to entry to the reinsurance industry and competitors may be domestic or foreign, licensed or unlicensed companies. Reinsurers compete on the basis of reliability, financial strength and stability, service, business ethics, price, performance, and almost every aspect of the transaction. Purchasers of reinsurance are themselves insurers and, in some cases, reinsurers.\nU.S. domestic property and casualty insurers, including reinsurers, are subject to regulation by their states of domicile and by those states in which they are licensed. The Corporation's principal subsidiary, GRC, is domiciled in Delaware and licensed in every state but Hawaii. The Corporation's excess and surplus insurers, the General Star companies, are domiciled in Connecticut and Ohio. The Genesis companies, which are the Corporation's direct excess and alternative market insurers, are domiciled in Connecticut and North Dakota.\nIn addition to solvency regulation, licensed primary insurers are typically subject to regulatory approval of insurance policy forms and the rates charged to policyholders; similar approvals are not typically required for either reinsurance contracts or the rates agreed to between ceding insurers and their reinsurers. The insurance regulators of every state participate in the National Association of Insurance Commissioners (the \"NAIC\"). The NAIC adopts forms, instructions and accounting procedures for use by U.S. domestic insurers, including reinsurers, in preparing and filing annual statutory financial statements. These forms, instructions and procedures are collectively known as statutory accounting practices (\"SAP\"). Every state requires use of the NAIC annual statement form, although some states require or permit variations from the NAIC form and SAP.\nIn addition to its activities relating to the annual statement and SAP, the NAIC develops model laws and regulations for use by its members. In 1989, the NAIC adopted its Financial Regulation Standards to guide state legislatures and state regulators in the development of effective insurer solvency regulation. The standards are viewed by the NAIC as minimum requirements for an effective state regulatory scheme.\nIn 1990, the NAIC adopted a formal accreditation program to encourage states to comply with the standards. Each state insurance department may be reviewed by an independent accreditation team to determine whether the state's laws and regulations (including certain NAIC model laws and regulations or their substantially similar equivalents), and the department's administrative practices, comply with the standards. Accredited states may refuse to accept reports of financial examination of insurers issued by non-accredited states; other sanctions may also be imposed, including a refusal to license insurers domiciled in non-accredited states. It is\nlikely that during 1995 the NAIC will reassess the accreditation program, and the sanctions, if any, to be imposed on non-accredited states. As of December 1994, the insurance departments of 44 states were accredited, including the Delaware Insurance Department.\nThe NAIC developed its Financial Regulation Standards and Accreditation Program as an effective national system of solvency regulation to demonstrate that federal involvement in the regulation of the business of insurance is unnecessary. This action was prompted in part by a series of hearings on state regulation of insurance held by the Energy and Commerce Oversight Subcommittee of the U.S. House of Representatives. Legislation mandating a Federal role in the regulation of insurers and reinsurers was introduced in the 102nd and 103rd Congress. No similar legislation has been introduced yet in 1995. It is expected that state regulators and some insurers and reinsurers would vigorously oppose any new legislation, and prospects for passage of such legislation are uncertain. The final form of any legislation is also uncertain.\nThe NAIC has adopted a risk-based capital formula which applies to statutory annual statements of property\/casualty companies beginning with the calendar year 1994 statement (filed by March 1, 1995). The NAIC has also adopted a risk-based capital model law which, if adopted by the domiciliary states of the Corporation's domestic insurance subsidiaries, would supplant current minimum capital and surplus requirements with the risk-based capital requirement. The formula has been made a part of the Financial Regulation Standards; the model law became a part of the standards during 1994, and states must adopt it or a substantially similar law within two years. If enacted, the model law would subject an insurer failing its risk-based capital requirement to various levels of regulatory action. Each of the Corporation's domestic insurance subsidiaries have filed 1994 statutory annual statements reporting risk-based capital well above the threshold for regulatory action.\nThe Corporation is dependent upon the ability of its operating subsidiaries for the transfer of funds in the form of loans, advances or dividends. The insurance holding company laws require the filing of annual reports by the insurance company members of the system and regulate transactions between the holding company and affiliated insurance companies to the extent that such transactions must be fair, reasonable and assure the adequacy of insurance companies' statutory surplus in relation to their liabilities and financial needs.\nThe laws also subject extraordinary dividends and other extraordinary distributions to insurance company stockholders to regulatory approval. Dividends or distributions in a twelve-month period exceeding the greater of 10 percent of an insurance company's surplus as of the prior year end or 100 percent of net income, excluding realized gains, for the previous calendar year are generally considered extraordinary and require such approval. Based on these restrictions, ordinary dividend payments by domestic insurance subsidiaries to the Corporation are limited to $420 million in 1995. Foreign and non-insurance subsidiaries generally are subject to fewer restrictions on the payment of dividends.\nReference is made to Management's Discussion and Analysis -- Financial Condition -- Liabilities for additional discussion of regulatory matters.\nInternational Property\/Casualty\nThe Corporation's international property\/casualty underwriting operations generated revenues of $456 million, or 11.9 percent, of the consolidated total in 1994. The international operations in 1994 were conducted through subsidiaries based in the United Kingdom, Australia, Argentina, Spain, Switzerland and Uruguay. Revenues were also generated in branch offices in certain other countries. The international property\/casualty operations principally wrote treaty reinsurance in 1994. In recent years, the Corporation has expanded its facultative writings in these operations.\nOn December 28, 1994, the Corporation and Colonia Konzern AG (\"Colonia\") formed a new company that acquired 75 percent of the common shares and approximately 30 percent of the preferred shares of Kolnische Ruckversicherungs-Gesellschaft AG (\"Cologne Re\"), which collectively represents a 66.3 percent economic interest in Cologne Re. In exchange for its Cologne Re shares, Colonia, for itself and as trustee for Nordstern Allgemeine Versicherungs AG (collectively the \"CKAG Group\"), received 100 percent of the Class A shares of the new company, General Re-CKAG Reinsurance and Investment S.A.R.L. (\"GR-CK\"). The Corpora-\ntion contributed $884 million (DM 1,377 million) to GR-CK, in exchange for 100 percent of the Class B shares of GR-CK. The Class A shares have 49.9 percent of the votes of GR-CK and are entitled to an annual Class A dividend, while the Class B shares have 50.1 percent of the votes of GR-CK and are entitled to the earnings of GR-CK in excess of the Class A dividend. As a result of the ownership and control structure of GR-CK and Cologne Re, the Corporation has consolidated GR-CK and Cologne Re in its financial statements and recorded as minority interests the share of the CKAG Group in GR-CK and of other stockholders in Cologne Re.\nCologne Re writes both property\/casualty and life reinsurance business throughout the world with its principal operations located in Germany. In 1994, Cologne Re wrote approximately DM 4,123 million (U.S. $2,595 million) of net premiums, of which property\/casualty reinsurance premiums were approximately DM 2,742 million, and life and health reinsurance net written premium was approximately DM 1,381 million. The largest portion of Cologne Re's property\/casualty business is generated from fire and automobile coverages. Cologne Re's life reinsurance is geographically distributed throughout the world with the largest percentage of premiums written in the United States and Germany. The results from Cologne Re's operations did not impact the Corporation in 1994 as the transaction closed at the end of the year. In future years, the Corporation's operating results will include its proportional share of Cologne Re's operations, which will be reported on a quarter lag. Reference is made to Item 7, Management's Discussion and Analysis, and Note 3, \"Reinsurance Ventures\", for additional discussion of this transaction.\nFinancial Services\nThe Corporation's financial services operations include derivative products, insurance brokerage and management, investment management, reinsurance brokerage and real estate management operations. The financial services operations generated $226 million, or 5.9 percent, of the Corporation's 1994 revenues.\nOther Information\nThe business of the operating subsidiaries of the Corporation is developed and served by employees primarily located in the United States, Canada, Argentina, Australia, Denmark, Egypt, Italy, Germany, Japan, New Zealand, Singapore, Switzerland, Spain and the United Kingdom. The addition of Cologne Re to the Corporation added significant operations based in Germany, the United States, the United Kingdom, Australia, South Africa and Austria. The Corporation employed 3,282 persons at December 31, 1994; 2,237 employees in North America and 1,045 employees in international operations, of which 922 are employed by Cologne Re.\nFor further information about the Corporation's business, reference is made to Item 7, Management's Discussion and Analysis, and Note 20, \"Segment Information\" included in this report. Reference is also made to the caption, \"Property\/Casualty Insurance Reserve Disclosures\" on pages 22-25 of this report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Corporation and most of its domestic subsidiaries occupy approximately 75 percent of a six story building in Stamford, Connecticut. This building, consisting of approximately 560,000 square feet of office space and a multiple level parking garage, with approximately eight acres of land on which it is located, was originally owned by Elm Street Corporation, a wholly owned subsidiary of the Corporation. The Corporation has guaranteed the obligations of Elm Street Corporation in connection with this transaction. On November 12, 1984, the land was leased, the improvements were sold and the land and improvements were leased back by the Corporation. Under the terms of the lease, the Corporation has the option to purchase the improvements upon expiration of the 25 year lease or at an earlier date upon the occurrence of certain events.\nGRC Realty Corporation, also a wholly owned subsidiary of the Corporation, has retained title to the Group's former home office site in Greenwich, Connecticut. This site consists of approximately four acres of land and an office building which has about 160,000 square feet of office space that is rented to non-affiliates. The Greenwich site is subject to a mortgage expiring December 31, 1998, which had a remaining balance of $7 million at December 31, 1994.\nCologne Re's German operations are principally based in an office building of approximately 130,000 square feet in Cologne, Germany. The building has an estimated fair value of $40 million and is owned by Cologne Re. The United States operations of Cologne Re are based in an office building in Stamford, Connecticut which had an estimated fair value of $8 million at December 31, 1994.\nIn addition, the Corporation's domestic and international operations have branch and affiliate operations conducted from leased premises in various cities in the United States and foreign countries.\nAt this time, the Corporation believes its facilities are suitable for its purposes, having adequate capacity for the Corporation's present and anticipated needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn September 12, 1994, the Corporation's subsidiary, General Reinsurance Corporation, along with 31 other insurance companies and insurance industry organizations, reached a settlement of civil antitrust actions brought by 20 State Attorneys General and several private plaintiffs.\nThe lawsuit was originally dismissed on motion by the United States District Court for the Northern District of California on September 20, 1989. The United States Court of Appeals for the Ninth Circuit reversed the dismissal and remanded the case to the District Court for further proceedings. On October 5, 1992, the United States Supreme Court granted, in part, defendants' petition for certiorari. On June 28, 1993, the Supreme Court affirmed in part and reversed in part the decision of the Court of Appeals and remanded the Case to the Court of Appeals for further action. On October 6, 1993, the Court of Appeals remanded the case to the District Court for trial in accordance with the opinion of the Supreme Court. There has been no finding of any wrongdoing or illegality by any defendant in this civil action.\nThe settlement involves a restructuring of the insurance industry's largest loss and statistical gathering bureau, the Insurance Services Office, whose board of directors had previously been dominated by insurer representatives, and the funding by the defendants of a national public risk database and a public entity risk services institute to assist risk management efforts. The terms of the settlement, which provide for no admission of wrongdoing, illegality or payment of damages, will be subject to the approval of the District Court. The effect of the settlement was not material to the Corporation's results of operations, financial condition or cash flows.\nThe Corporation and its subsidiaries have been named as defendants in litigation in the ordinary course of conducting insurance business. These lawsuits generally seek to establish liability under insurance or reinsurance contracts issued by the subsidiaries, and occasionally seek punitive or exemplary damages. The Corporation's reinsurance subsidiaries are also indirectly involved in coverage litigation. In those cases, plaintiffs seek coverage for their liabilities under insurance policies from insurance companies reinsured by the Corporation's reinsurance subsidiaries. In the judgment of management, none of these cases, individually or collectively, is likely to result in judgments for amounts which, net of claim and claim expense liabilities previously established and applicable reinsurance, would be material to the financial position, results of operations or cash flow of the Corporation.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF THE CORPORATION.\nThe Executive Officers of the Corporation as of February 28, 1995 are as follows:\nThe Chairman, President, Secretary and Controller are elected by the Board for one-year terms. Vice Presidents are appointed and serve at the pleasure of the Board. Other officers may be appointed by and serve at the pleasure of the Chief Executive Officer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE CORPORATION'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\n(a) The common stock of the Corporation is traded on the New York Stock Exchange. The following table sets forth information as to the closing price of the Corporation's common stock on the Exchange during 1994 and 1993.\n(b) The number of holders of record of the Corporation's common stock at December 31, 1994 was 4,163.\n(c) The following table sets forth information as to the cash dividends paid by the Corporation on shares of its common stock during each of the past two years.\nIt is the intention of the Corporation to declare quarterly dividends to the extent deemed by the Board of Directors to be appropriate. Dividends are paid principally from amounts received by the Corporation as dividends from General Reinsurance Corporation and the other operating subsidiaries. The payment of dividends by General Reinsurance Corporation is subject to certain restrictions. See page 3 within the section, \"Business -- Domestic Property\/Casualty\".\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nELEVEN-YEAR SUMMARY OF SELECTED FINANCIAL DATA\nSee page 10 and notes to consolidated financial statements.\nELEVEN-YEAR SUMMARY OF SELECTED FINANCIAL DATA -- (CONTINUED)\nSee page 10 and notes to consolidated financial statements.\nNOTES TO THE ELEVEN-YEAR SUMMARY OF SELECTED FINANCIAL DATA\nOnly continuing operations are presented. Balance sheet data are as of December 31st.\n(1) Excludes the cumulative effect of accounting changes. The balance sheet data in the table above reflect the adoption of Statement of Financial Accounting Standards No. 115, \"Accounting For Certain Investments in Debt and Equity Securities\" in 1994 and the adoption of Statement of Financial Accounting Standards No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts\" in 1993, with reclassifications made for 1992. Adoption of the Standard did not affect results from operations or common stockholders' equity. In 1993, the Corporation adopted the accounting prescribed by the Emerging Issues Task Force for multiple-year, retrospectively rated reinsurance contracts. The cumulative effect from prior years recorded in 1993 increased net income by $14 million or $.17 per share. In 1992, the Corporation adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\". The cumulative effect from prior years recorded in 1992 increased net income by $61 million or $.71 per share. In 1984, the Corporation adopted the practice of discounting certain workers' compensation claims. The cumulative effect of the change in 1984 was $81 million or $.89 per share.\n(2) Represents compound annual growth rate.\n(3) Return on equity is income from continuing operations excluding after-tax realized gains and cumulative effects of accounting changes divided by average common stockholders' equity at the beginning and end of the year.\n(4) Net of reinsurance.\n(5) Excludes the investments of Cologne Re and GR-CK of $5,301 million as of December 31, 1994.\n(6) The common share price information is based on the Corporation's daily closing price on the New York Stock Exchange.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOPERATING RESULTS\nConsolidated\nComparison of 1994 with 1993\nNet income in 1994 was $665 million or $7.97 per share, a decrease of 3.7 percent over $8.28 per share earned in 1993. These results include after-tax realized gains of $.54 per share in 1994 and $1.10 per share in 1993. Net income in 1993 also included a cumulative benefit of $.17 per share resulting from the adoption of the accounting prescribed by the Emerging Issues Task Force for multiple-year, retrospectively rated reinsurance contracts. Excluding after-tax realized gains and cumulative-effect adjustments, after-tax income for the year ended December 31, 1994 was $7.43 per share, an increase of 6.0 percent over $7.01 per share in 1993.\nConsolidated net premiums written in 1994 were $3,001 million, an increase of $477 million or 18.9 percent from $2,524 million in 1993. Domestic property\/casualty premium volume was $2,581 million in 1994, compared with $2,275 million in 1993, an increase of 13.4 percent. Net premiums written in the international insurance operations were $420 million in 1994, an increase of 69.0 percent over 1993 volume.\nConsolidated net investment income was $749 million in 1994, compared with $755 million in 1993. The level of investment income was adversely affected by the shift in assets from taxable to tax-advantaged securities in response to the Corporation's tax planning strategies, the use of the Corporation's cash flow from operations for stock repurchases, and an increase in lower yielding, short-term securities during the year to fund an investment in Cologne Re. The consolidated pretax investment yield on invested assets, excluding the invested assets of General Re Financial Products Corporation (\"GRFP\"), was 5.9 percent in 1994, compared with 6.5 percent in 1993. Net investment income for the domestic property\/casualty operations was $686 million in 1994, a decrease of 2.7 percent over $705 million earned in 1993. Net investment income for the international property\/casualty operations increased 20.9 percent to $52 million in 1994, compared with $43 million in 1993. The financial services operations had investment income of $11 million in 1994, compared with $7 million in 1993.\nComparison of 1993 with 1992\nNet income in 1993 was $711 million or $8.28 per share, an increase of 9.7 percent over $7.55 per share earned in 1992. These results include after-tax realized gains of $1.10 per share in 1993 and $1.54 per share in 1992. Net income in 1992 also includes a cumulative benefit of $.71 per share resulting from the adoption of SFAS 109. Excluding after-tax realized gains and cumulative-effect adjustments, income for 1993 was $7.01 per share, an increase of 32.3 percent over $5.30 per share in 1992.\nConsolidated net premiums written for 1993 of $2,524 million increased 7.5 percent over $2,349 million in 1992. Domestic property\/casualty premium volume was $2,275 million in 1993, compared with $2,177 million in 1992, an increase of 4.5 percent. The international property\/casualty operations net premiums written were $249 million in 1993, an increase of 44.5 percent from the comparable amount in 1992.\nConsolidated net investment income was $755 million in 1993, unchanged from 1992 levels, as the benefit from increased cash flow from operations available for investment was offset by lower investment portfolio yields. The consolidated pretax investment yield on invested assets (excluding GRFP's invested assets) of 6.5 percent in 1993 declined from 7.0 percent in 1992. Investment income for the domestic property\/casualty operations was $705 million in 1993, a slight increase from the $703 million earned in 1992. Net investment income for the international property\/casualty operations declined 8.5 percent to $43 million in 1993, compared with $47 million in 1992. The financial services operations had investment income of $7 million in 1993, compared with $5 million in 1992.\nDomestic Property\/Casualty\nDomestic property\/casualty income, excluding after-tax realized gains and the cumulative effect of accounting changes, decreased 3.2 percent from 1993's income, principally the result of catastrophe claims arising from the Northridge, California earthquake on January 17, 1994 and reduced investment income, due primarily to lower yields on the portfolio.\nThe statutory combined underwriting ratio is computed based on the relationship of losses and underwriting expenses to premiums. This ratio is the Corporation's principal indicator of underwriting performance, with 100 percent or lower generally indicating a statutory underwriting profit. In 1994, the combined ratio for the domestic property\/casualty segment was 101.3 percent, compared to 101.5 percent in 1993 and 108.4 percent in 1992. The 1994 underwriting result fell short of the Corporation's objective of an underwriting profit primarily due to the Northridge earthquake. Improvement in the 1993 combined ratio over 1992 was largely attributable to lower catastrophe claims in 1993 as Hurricanes Andrew and Iniki adversely impacted 1992's underwriting result. While the 1993 underwriting result did not meet the Corporation's goal of an underwriting profit, the improvement over 1992 was achieved in a difficult environment for both the economy in general, and for insurers and reinsurers, specifically.\nNet premiums written in 1994 for the domestic property\/casualty operations of $2,581 million increased 13.4 percent from $2,275 million in 1993. Premium volume by operating unit expressed as a percentage of total domestic property\/casualty premiums was as follows:\nWhile the domestic primary insurance market grew by about 4 percent, General Reinsurance Corporation's (\"GRC\") premiums grew by 15.0 percent during 1994. The Corporation believes that the growth in its premiums written is due to its marketing efforts, the increase in insurance premiums written by medium and smaller-sized primary companies that generally purchase relatively more reinsurance, increased reinsurance cessions by primary companies seeking to deleverage their capital in response to rating agency concerns and increased demand by primary companies for reinsurance from better capitalized and more credit-worthy reinsurers.\nFor the General Star companies, which write primary and excess specialty insurance on a licensed and surplus lines basis, premium volume grew 23.4 percent in 1994, due to both increased marketing activities and improved rates for coverage containing property exposures. General Star produced a statutory underwriting profit for the tenth consecutive year.\nThe Genesis companies provide direct excess insurance and excess reinsurance to self-insured programs. Underwriting results for the Genesis companies improved during 1994. Premiums increased during the year by 13.0 percent over 1993 levels due principally to growth in casualty premiums.\nNet premiums written for the domestic property\/casualty insurance segment of $2,275 million in 1993 increased 4.5 percent over $2,177 million in 1992. As discussed in Note 3 to the consolidated financial statements, North Star Reinsurance Corporation, a wholly owned subsidiary, was sold to Signet Star Holdings, Inc. in 1993. The disposal affects premium comparisons relative to prior years. During 1992, North Star contributed $157 million to the domestic property\/casualty premium volume. During the first quarter of 1993, North Star had net premiums written of $41 million. After the first quarter of 1993, however, domestic property\/casualty premiums exclude North Star. When North Star's premiums are excluded from the 1993 and 1992 results, domestic property\/casualty premiums increased by 10.6% in 1993, as compared to 1992, due primarily to growth in treaty reinsurance, property facultative and General Star's business. North Star's premiums for 1993 and 1992 are included with GRC in the preceding table.\nInternational Property\/Casualty\nNet income for the international property\/casualty operations of $35 million in 1994 increased 152.9 percent over 1993 levels. Included in these results were after-tax realized gains of $6 million in 1994. Growth in the income for the international property\/casualty operations resulted principally from an underwriting profit of $6 million in 1994, compared to an underwriting loss of $13 million in 1993. Underwriting results improved over 1993 due to stronger pricing and demand in higher margin businesses, particularly in the Corporation's European operations. International premiums written of $420 million in 1994 increased $171 million, or 69.0 percent, over 1993 premiums of $249 million. The premium growth reflects continued expansion of existing client relationships, an increase in reinsurance rates, and development of new reinsurance relationships, particularly in European operations. In 1994, the Corporation combined its subsidiaries located in the United Kingdom and Switzerland to enhance client service and to improve capital efficiency in the European markets. Premium growth in 1994 also resulted from expanded operations in Madrid and the opening of new offices in Cologne, Milan, Paris and Singapore during the past two years.\nNet income for the international property\/casualty operations of $14 million in 1993 decreased from $16 million in 1992. Included in these results were after-tax realized gains of $1 million in 1992. Income for the international property\/casualty operations was adversely affected during 1993 by the strengthening of the U.S. dollar compared to foreign currencies and by nonrecurring charges related to the expansion of operations. The international property\/casualty underwriting results, while still unprofitable, improved by $7 million over 1992 underwriting result, which was adversely affected by catastrophic events. International premiums written of $249 million in 1993 increased 44.5 percent over 1992 premium of $172 million.\nCologne Re\nOn December 28, 1994, the Corporation and Colonia Konzern AG (\"Colonia\") formed a new company that acquired 75 percent of the common shares and approximately 30 percent of the preferred shares of Cologne Re, which collectively represent a 66.3 percent economic interest in Cologne Re. In exchange for its Cologne Re shares, Colonia, for itself and as trustee for Nordstern Allgemeine Versicherungs AG (collectively, the \"CKAG Group\"), received 100 percent of the Class A shares of the new company, General Re-CKAG Reinsurance and Investment S.A.R.L. (\"GR-CK\"). The Corporation initially contributed $884 million (DM 1,377 million) to GR-CK in exchange for 100 percent of the Class B shares of GR-CK. On December 30,\n1994, GR-CK paid $302 million (DM 475 million) to a subsidiary of the Corporation in exchange for notes having a principal amount of DM 475 million. The notes pay interest of 8.0 percent annually to GR-CK and are due on December 30, 2004.\nThe Class A shares have 49.9 percent of the votes of GR-CK and are entitled to an annual Class A dividend, while the Class B shares have 50.1 percent of the votes of GR-CK and are entitled to the earnings of GR-CK in excess of the Class A dividend. The Corporation has an option after seven years to purchase the Class A shares of GR-CK owned by the CKAG Group at a formula price. The option has a minimum exercise price of DM 1,306 million and a maximum of DM 1,509 million, subject to certain warranty adjustments that may reduce the exercise price.\nCKAG Group will receive an annual Class A cash dividend which is based on a formula and is estimated to be approximately DM 36 million. The Corporation will also receive an annual Class B cash dividend of 50.1 percent of GR-CK's distributable income, as defined in the joint venture agreement. It is expected that Cologne Re may increase its capital through an offering of equity securities in the first half of 1995. In connection with this equity offering, GR-CK anticipates it will use approximately DM 300 million of its funds to purchase additional Cologne Re shares. Since the closing occurred at the end of 1994, the transaction did not have a material effect on the Corporation's results from operations. Due to the ownership and control structure of GR-CK and Cologne Re, the Corporation has consolidated GR-CK and Cologne Re in its balance sheet at December 31, 1994.\nFinancial Services\nThe financial services operations include the Corporation's derivative products, insurance brokerage and management, investment management, reinsurance brokerage and real estate management operations. Net income for the financial services operations was $52 million in 1994, an increase of 53.2 percent from $34 million earned in 1993. The increase in 1994 income was principally due to increased profitability of the Corporation's derivative products subsidiary, GRFP, and new revenues from General Re Underwriting Services Limited (\"GRUS\") and General Re Asset Management Corporation (\"GRAM\"). GRUS principally provides underwriting services for Tempest Reinsurance Company Limited, an affiliated Bermuda-based company specializing in excess property catastrophe reinsurance.\nGRFP is engaged as a dealer in derivative financial products, such as interest rate and foreign currency swaps, foreign exchange contracts, options, and swap options. GRFP's gross trading revenue was $135 million in 1994, compared with $142 million in 1993 and $41 million in 1992. During 1994, higher global interest rates reduced capital market activity, thus lowering demand for derivative products. In addition, the Corporation believes concerns regarding the appropriate use of derivative products by certain end users in the United States reduced the overall market demand for derivative products. Despite these limiting factors, GRFP's trading revenue in 1994 only decreased 5.2 percent as compared to 1993.\nGRFP closely monitors its derivatives operations and actively manages its open positions to control its exposures. GRFP hedges its exposure to market risk (which includes foreign exchange, interest rate, swap spread, volatility, and yield curve risks) in connection with its dealer activities by purchasing or selling futures contracts, entering into forward foreign exchange contracts, purchasing or selling government securities or entering into offsetting transactions. Market risk is kept within conservative tolerance limits and is monitored on a daily basis across all swap and option products. In accordance with mark-to-market accounting, GRFP evaluates and records a fair-value adjustment against trading revenue to recognize counterparty credit exposure and future costs associated with administering each contract. The expected credit exposure for each trade is initially established on the trade date and is determined through the use of a proprietary credit exposure model that is based on historical default probabilities, market volatilities and, if applicable, the legal right of set off. These exposures are continually monitored and adjusted due to changes in the credit quality of the counterparty, changes in interest and currency rates or changes in other factors affecting credit exposure. The fair value allowance for counterparty credit exposures and future administrative costs on existing contracts was $55 million and $44 million at December 31, 1994 and 1993, respectively. GRFP has not experienced any counterparty defaults or writeoffs on such contracts.\nThe Corporation's insurance and reinsurance brokerage operations also contributed to the increased profitability of the financial services segment in 1994. In addition, investment management fees increased due to growth in the business of the Corporation's investment management subsidiary, GRAM. The Corporation's investment management clients are other insurance companies, primarily reinsurance clients, that seek the Corporation's expertise in managing insurance company investment portfolios.\nIncome for the financial services operations of $34 million in 1993 increased significantly from $4 million earned in 1992. The increase in 1993 income was principally due to growth in GRFP, which was a startup operation in 1992. The Corporation's reinsurance brokerage operations also contributed to the improved results in 1993, in part due to the reinsurance brokerage operation's improved ability to place catastrophe reinsurance at higher prices.\nFINANCIAL CONDITION\nAssets\nAt December 31, 1994, total assets were $29,597 million, compared with $19,419 million at December 31, 1993. Included in the December 31, 1994 balance sheet was $9,325 million of GR-CK assets related to the Cologne Re joint venture. Excluding the Cologne Re joint venture, total assets increased during 1994 by 7.4 percent, or $1,435 million, to $20,854 million at December 31, 1994. This growth in assets was attributable to an increase of $566 million in the total assets of the domestic property\/casualty operations, $223 million in the international property\/casualty operations and $646 million in the financial services segment.\nThe Corporation's invested assets increased from $14,346 million at December 31, 1993 to $18,898 million at December 31, 1994. Included in the December 31, 1994 balance sheet are GR-CK invested assets of $5,301 million. Excluding the impact of the Cologne Re transaction, invested assets decreased by $167 million as a result of a decrease of $494 million in the financial services operations, which was partially offset by an increase of $158 million in the domestic property\/casualty segment and an increase of $169 million in the international property\/casualty segment. The after-tax unrealized appreciation on the Corporation's total investment portfolio was $453 million and $1,137 million at December 31, 1994 and December 31, 1993, respectively. The decline was principally due to increased market interest rates and reduced equity values.\nEffective January 1, 1994, the Corporation adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Statement addresses accounting for investments in equity and debt securities and requires these investments to be classified into three categories. Debt securities that the Corporation has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and reported at fair value, with unrealized gains and losses included in income. Other debt that is not classified as either held-to-maturity or trading and equity securities not classified as trading are included in available-for-sale securities and reported at fair value, with unrealized gains and losses, net of deferred income taxes, excluded from income and reported in a separate component of common stockholders' equity. The effect of Statement No. 115 decreased the reported fair value of invested assets by $123 million at December 31, 1994. The Statement's adoption had no effect on the Corporation's results from operations.\nThe overall pretax yield on domestic invested assets (excluding GRFP) was 5.9 percent in 1994, compared to 6.4 percent in 1993. The decline in the domestic investment portfolio's pretax yield reflects the shift in assets from taxable to tax-exempt bonds, the decline in market interest rates in recent years and the increased amount of calls of higher coupon investments during this period. The increase in market rates of interest during 1994 had a minimal impact on 1994's investment income.\nIncluded in fixed maturities were mortgage-backed securities (\"MBS\") of $629 million (3.3 percent of consolidated invested assets) and asset-backed securities (\"ABS\") of $244 million (1.3 percent of consolidated invested assets) at December 31, 1994. These securities have interest and principal repayment patterns that differ from typical fixed maturities. MBS issued by quasi-federal agencies, federally supported institutions and corporations can either be direct pass-throughs of cash flows from the underlying mortgages or can be a\ngrouping of underlying mortgages into various principal repayment tranches (\"CMO's\"). The MBS portfolio is comprised of pass-through securities (56 percent) and CMO's (44 percent) based on December 31, 1994 market values. The CMO portfolio is comprised almost entirely of planned amortization class (\"PAC's\") securities which have experienced less volatility in repayment of principal than other types of CMO securities. ABS are usually collateralized by credit card or auto loan receivables which are packaged into debt instruments whose interest and principal payments will vary with the underlying receivable. Almost all of the MBS and ABS portfolios are publicly traded and market values were obtained from an external pricing service.\nThe Corporation continues to place strong emphasis on credit research. Credit considerations are an important part of the Corporation's fixed maturity investment strategy. At December 31, 1994, the Corporation had no bond issues in default. Bonds rated below investment grade represented less than .5 percent of the portfolio. The overall fixed-maturity portfolio continued to average a credit rating of AA. The distribution of the Corporation's domestic fixed-maturity portfolio by credit quality was as follows:\nAt December 31, 1994, investments in domestic equity securities totaled $2,367 million, representing 20.4 percent of the domestic portfolio and 48.7 percent of common stockholders' equity. The domestic equity portfolio is well diversified and primarily consists of companies with large capitalizations that, collectively, have a calculated volatility approximating the Standard & Poor's 500 index.\nA small portion of the domestic investment portfolio was dedicated to non-traditional, private investments. These alternative investments, included in the balance sheet caption, \"other invested assets\", were $325 million (1.7 percent of consolidated invested assets) at December 31, 1994. Most of these investments are interests in limited partnerships run by professional managers. Over time, these investments are expected to provide a higher return than the overall portfolio. This segment, however, also may entail a greater amount of risk both in terms of limited liquidity and greater uncertainty of returns compared to the rest of the Corporation's investment portfolio. The Corporation evaluates the fair value of these alternative investments on a quarterly basis by reviewing available financial information of the investee and by performing other financial analyses in consultation with external advisers. Any changes in the fair value of limited partnerships are included as unrealized appreciation or depreciation in common stockholders' equity, unless a decline in fair value is considered other than temporary, resulting in a charge to income.\nThe Corporation's international property\/casualty subsidiaries held investment portfolios of $6,060 million at December 31, 1994. These portfolios include $4,719 million of Cologne Re's investments, $582 million of GR-CK investments and $759 million in pre-existing international operations. At December 31, 1994, Cologne Re's portfolio was invested approximately 70 percent in fixed maturities, 13 percent in equity securities and 17 percent in short-term and other investments. Cologne Re's investment portfolio is geographically diversified with most fixed maturities having terms of less than five years. Cologne Re's investments are primarily managed by internal investment managers and smaller portfolios are managed by local professional asset managers.\nThe investments held by GR-CK are all denominated in German marks as stipulated by the investment guidelines of the joint venture agreement.\nThe invested assets of the Corporation's pre-existing international subsidiaries were $759 million at December 31, 1994. This portfolio was invested approximately 75 percent in fixed maturities, 15 percent in equities\nand 10 percent in short-term investments. The pretax yield on these investments was 7.6 percent in 1994 and 7.8 percent in 1993. The portfolio of each subsidiary is managed by local professional asset managers who are overseen by a local Board of Directors and the Corporation's investment department based in Stamford.\nLiabilities\nThe Corporation's gross liability for claims and claim expenses, which provides for future obligations arising from current and prior property\/casualty reinsurance and insurance transactions, amounted to $12,158 million at December 31, 1994. Growth in the liability of $3,706 million during 1994 is due to $3,135 million associated with the Cologne Re joint venture and $571 million from pre-existing international operations. In addition to the gross liability for property\/casualty claim and claim expenses, the Corporation, through its interest in Cologne Re, has a gross liability for future policy benefits for life and health contracts of $1,960 million. The asset for reinsurance recoverable on paid and unpaid losses was $2,067 million at December 31, 1994, compared to $1,476 million at December 31, 1993. Growth of $591 million in the asset is due to $373 million associated with Cologne Re ($224 million for property\/casualty business and $149 million related to life and health business) and $218 million from pre-existing operations.\nThe ongoing financial integrity of the Corporation is dependent on reserve adequacy. The gross liability and reinsurance recoverable for claims and claim expenses were based on the Corporation's analysis of reports and individual case estimates received from ceding companies. The liability and related recoverables also include an amount estimated by the Corporation for claims and claim expenses incurred but not reported. The liability and recovery are evaluated continuously by management, annually by the Corporation's independent accountants in conjunction with their audit and periodically by independent consulting actuaries. Any resulting adjustments are included in income currently.\nThe liability for claims and claim expenses for 1993 and prior accident years, net of related reinsurance recoveries, decreased by $36 million in 1994. The decrease, which had a favorable effect on the Corporation's net income in 1994, was principally the result of the net impact of favorable loss development on casualty lines of business, partly offset by reserve strengthening for environmental and latent injury claims. The liability for prior accident years was increased by $140 million and $56 million during 1993 and 1992, respectively, adversely impacting net income in those years. The adverse income impact was the result of reserve strengthening principally for environmental and latent injury claims.\nIncluded in the Corporation's liability for claims and claim expenses were liabilities for environmental and latent injury damage claims. These amounts include provisions for both reported and incurred but not reported (IBNR) claims. The table below presents the three-year development of the balance sheet liability for unpaid environmental and latent injury claims:\nThe Corporation continually estimates its liabilities and related reinsurance recoveries for environmental and latent injury claims and claim expenses. These exposures do not lend themselves to traditional methods of loss development determination and therefore may be considered less reliable than reserves for standard lines of\nbusiness (e.g., automobile). The estimate is composed of four parts: known claims, development on known claims, IBNR and direct excess coverage litigation expenses. Although reliability is constrained by uncertainties, the Corporation has confidence in the reported, known claim liabilities, and based on alternative methods, has projected a fairly reliable estimate of development for these claims. The Corporation has also included an estimate for IBNR which is based on fitted curves of estimated future claim emergence; this estimate is less reliable than the estimated liability for reported claims. The effect of joint and several liability on the severity of claims and a provision for future claims inflation have been included in the loss development estimate.\nThe Corporation has established a liability for litigation costs associated with coverage disputes arising primarily from direct excess insurance policies. The Corporation's subsidiaries were parties in approximately 120 active direct coverage cases at December 31, 1994. Such coverage litigation expenses are estimated using an actuarial forecast of actionable items and their projected costs. The Corporation paid $10 million in such costs during 1994 and as of December 31, 1994 the liability for future litigation costs related to coverage disputes was $174 million (included in the table above). The Corporation has not recorded any reinsurance recoveries for these liabilities.\nAs coverage disputes are tried and verdicts rendered, the Corporation expects that settled case law will result in a downward trend in future coverage litigation expenses. Because reinsurance contracts generally contain arbitration clauses which control disputes between the ceding company and the reinsurer, the Corporation does not expect the future costs associated with reinsurance disputes to be material.\nCeding companies report information about environmental and latent injury claims based upon their individual and differing methodologies for characterizing claims. For example, some ceding companies report one claim for a policyholder with a number of exposure sites, whereas others report each exposure at each site as a separate claim. In addition, a substantial number of latent injury claims, which are often reported to the Corporation on a precautionary basis by ceding companies and insureds prior to reaching the reinsured layer, close without reinsurance payment. Due to these factors, the Corporation is unable to provide meaningful claim count information.\nThe liability for environmental and latent injury claims and claim expenses is management's best estimate of future claim and claim expense payments and recoveries which are expected to develop over the next thirty years. The Corporation continues to monitor evolving case law and its effect on environmental and latent injury claims. Changing government regulations and legislation, newly identified toxins, newly reported claims, new theories of liability, new contract interpretations and other factors could significantly affect future claim development. While the Corporation has recorded its current best estimate of its liabilities for unpaid claims and claim expenses, it is reasonably possible that these estimated liabilities, net of estimated reinsurance recoveries, may increase in the future and that the increase may be material to the Corporation's results from operations, cash flows and financial position. It is not possible to estimate reliably the amount of additional net loss, or the range of net loss, that is reasonably possible.\nThe Corporation discounts certain liabilities associated with workers' compensation claims. A new statutory accounting rule adopted in December 1993 by the NAIC, effective for calendar year 1994 and subsequent statutory annual statements, allows the discounting of \"tabular reserves\", as defined, and allows discounting of non-tabular reserves if permitted by the insurer's state of domicile. As of December 31, 1994, GRC recorded $1,328 million in discount on its loss reserves. Of that amount, $839 million relates to reserves eligible for the tabular reserve discount and $489 million relates to non-tabular reserves for medical costs associated with tabular reserve claims. The Delaware Insurance Department has confirmed that GRC may continue to discount both its tabular reserves and the medical expenses associated with such tabular reserves at 4.5% per year. Accordingly, the adoption of the statutory reserve discount rule during 1994 did not effect the Corporation's results from operations, cash flows and financial condition.\nAssets and Liabilities of the Financial Services Operations\nThe asset and liability positions of the financial services operations fluctuate based on its dealer and related risk-management activities. GRFP manages its market risk through the purchase and sale of government\nsecurities and futures contracts and by entering into offsetting derivative transactions. The purchase of government securities (fixed maturities at fair value), which are financed through collateralized repurchase agreements (securities sold under agreements to repurchase), and the sale of government securities (securities sold but not yet purchased), whose proceeds are invested in reverse repurchase agreements (securities purchased under agreements to resell), contribute to the short-term fluctuation in the operation's total assets and liabilities, while generally not having any material effect on common stockholders' equity. During 1994, invested assets of these operations decreased $494 million to $1,661 million. Securities purchased under agreements to resell (an asset) increased $680 million in 1994 to $813 million. Securities sold under agreements to repurchase (a liability) decreased $628 million in 1994 to $938 million. Securities sold but not yet purchased represent obligations of the Corporation to deliver the specified security at the contracted price, thereby creating a liability to repurchase the security in the market at prevailing prices. Accordingly, the Corporation's ultimate obligation to satisfy the sale of securities sold but not yet purchased may exceed the amount recognized in the balance sheet. The Corporation controls and manages this risk through the use of credit and market risk limits and reviews its market exposure on a daily basis. The liability for securities sold but not yet purchased increased $385 million in 1994 to $927 million at December 31, 1994.\nEffective January 1, 1994, the Corporation adopted FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts. The Interpretation further clarifies the definition of a right of set-off. Effective December 31, 1994, the Corporation adopted FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. The Interpretation modified the accounting in FASB Interpretation No. 39 to permit offsetting in the balance sheet of payables and receivables for repurchase and reverse repurchase agreements when these agreements are with the same counterparty, have the same settlement date, are part of a master netting arrangement, and can be settled for cash on a net basis. The Corporation has reclassified amounts on the December 31, 1993 balance sheet to conform to the new Interpretations. The combined effect of adopting Interpretations Nos. 39 and 41 increased reported assets and liabilities by approximately $950 million at December 31, 1993 and $1,747 million at December 31, 1994. Adoption of these Interpretations had no impact on results from operations, cash flows or stockholders' equity.\nEquity\nCommon stockholders' equity at December 31, 1994 was $4,859 million, an increase of 2.1 percent over $4,761 million at December 31, 1993. The change in common stockholders' equity was primarily due to net income of $665 million less the decline in after-tax unrealized appreciation of $230 million, stock repurchases of $207 million and dividends paid of $168 million. Common stockholders' equity at December 31, 1993 increased 12.6 percent over the $4,227 million at year end 1992.\nThe ratio of claim and claim expense reserves, net of reinsurance, to common stockholders' equity at December 31, 1994 was 2.1 to 1.0, and the ratio of net written premiums to common stockholders' equity was 0.6 to 1.0. These two ratios are conservative by insurance industry averages and indicate the capacity to assume additional reinsurance business.\nGRC, the principal domestic operating subsidiary, has a claims-paying rating of AAA from Standard & Poor's and a financial strength rating of Aaa from Moody's. GRC is also rated A++ by A.M. Best Company, a leading insurance industry rating agency. Each of these ratings represents the highest category for the respective rating agency.\nLIQUIDITY AND CAPITAL RESOURCES\nA summary of the Corporation's cash flow by business segment was as follows:\nThe Corporation's cash flow from operations was $2,410 million in 1994, compared with negative $278 million in 1993, and positive $627 million in 1992. The Corporation's negative operating cash flow in 1993 was not a result of a deterioration in the Corporation's liquidity or profitability. Rather, the negative operating cash flow resulted from the requirement under generally accepted accounting principles to disaggregate GRFP's interrelated cash flows into operating, investing, and financing activities. GRFP hedges its open derivative product positions by the purchase or sale of government securities. These transactions are classified as operating activities in the statement of cash flows. GRFP finances its security purchases through collateralized repurchase agreements which are characterized as financing activities in the cash flow statement. The Corporation invests its short-term cash proceeds in securities purchased under agreements to resell (\"reverse repos\"), which are characterized as investing activities in the cash flow statement. The disaggregation of these interrelated cash flows for financial reporting purposes creates variability in reported operating cash flow of the financial services segment without a corresponding effect on results from operations.\nDomestic and international operating cash flows grew in 1994 and 1993, reflecting growth in the business. Domestic property\/casualty financing cash flows include the Corporation's stock repurchases and dividends to stockholders. As discussed earlier, the Corporation made a net cash investment in 1994 of $582 million in GR-CK, the holding company which owns approximately 66.3 percent of the economic interest of Cologne Re. The funds invested in GR-CK are not available for the Corporation's general business purposes, but are subject to certain restrictions according to the joint venture agreement. The Corporation's domestic cash flow should not be significantly affected by the joint venture structure as interest paid to GR-CK on the intercompany note will be funded by dividends received from GR-CK.\nDividends paid to common and preferred stockholders were $168 million, $170 million and $164 million in 1994, 1993 and 1992, respectively. The Corporation used $207 million, $134 million and $179 million to repurchase 1,912,500 shares, 1,213,600 shares and 2,138,100 shares of its common stock in the years ended December 31, 1994, 1993 and 1992, respectively. Through December 31, 1994, the Corporation has purchased $1,563 million (21,909,300 shares) of its common stock since the inception of the repurchase program in\n1987. In February 1994, the Corporation's Board of Directors authorized an additional repurchase of up to $250 million of common stock. At December 31, 1994, the Corporation had $100 million available under Board authorized repurchase programs and additional standing authority to repurchase shares in anticipation of shares to be issued under various compensation plans. On February 8, 1995, the Board of Directors declared a regular quarterly dividend of $.49 per share on the common stock of the Corporation. This represents an increase of 2.1% over the $.48 per share dividend paid in prior quarters of 1994 and the 19th consecutive year in which the Corporation has had a dividend increase.\nAt December 31, 1994, the Corporation had $150 million of senior debt outstanding, which is rated AAA by Standard and Poor's and Aa1 by Moody's. The Corporation issues short-term commercial paper to provide additional financial flexibility for its operations. Commercial paper offered by the Corporation has been rated A1+ by Standard & Poor's and Prime 1 by Moody's. At December 31, 1994, $31 million of short-term commercial paper was outstanding with an average interest rate of 6.0 percent and a weighted average maturity of 29.8 days. In June 1994, the Corporation increased its lines of credit through a number of participating banks, from $500 million to $1 billion, to provide additional support for commercial paper issuance and to increase its financial flexibility. At December 31, 1994, the Corporation had no outstanding loans under this facility.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nGENERAL RE CORPORATION\nINDEX TO RESERVE DISCLOSURES, FINANCIAL STATEMENTS AND SCHEDULES\nSchedules other than those listed above have been omitted since they are either not required, not applicable or repeat information disclosed in the notes to financial statements.\nPROPERTY\/CASUALTY INSURANCE RESERVE DISCLOSURES\nThe consolidated financial statements include estimated liabilities for unpaid claims and claim expenses of the Corporation's domestic and international property\/casualty reinsurance subsidiaries. The provision for reported but unpaid claims and claim expenses is based on audited client reports and individual case estimates, including anticipated salvage and subrogation recoverable. A provision is included for incurred but not reported (\"IBNR\") claims and claim expenses on the basis of past experience. Historic premium, claim and claim expense data are organized in actuarial formats, analyzed for credibility, and processed through actuarial formulae. Using actuarial judgment, forecasts of IBNR claims and claim expenses are determined and tested for validity. The Corporation strives for accuracy in its reserving structure and monitors its predictions against actual claims and claim expense emergence. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and updated. All adjustments to the reserve structure (which encompasses claims from up to 50 years ago) are included in current operating results.\nThe actuary relied upon by management in forming the basis of its belief as to the adequacy of reserves is Lee R. Steeneck, FCAS, MAAA, a Vice President of GRC. In addition to the ongoing review by management, these liabilities are subject to independent review on a regular basis. The Corporation's independent public accountants use actuaries during their annual financial statement audit to review both current balance sheet liabilities and charges to the income statement. In addition, the Audit Committee of the Board of Directors has periodically engaged the services of an actuarial consulting firm to compare the reserve liabilities established by management with the estimates of an independent consulting actuary.\nThe table below provides a reconciliation of the beginning and ending claim and claim expense liability, net of reinsurance, for 1994, 1993 and 1992.\nTABLE 1\nRECONCILIATION OF LIABILITY FOR CLAIMS AND CLAIM EXPENSES (IN MILLIONS)\nThe Corporation discounts certain domestic workers' compensation loss reserves at an interest rate of 4.5 percent per annum, the same rate used for reporting to state regulatory authorities with respect to the same claim liabilities. These claims are characterized by periodic indemnity payments principally for wage loss and\nmedical\/rehabilitation expenses which are generally fixed or determinable, both in amount and duration. The amortization of the discount is included in current operating results as part of the development of prior years' liabilities. The effect of discounting was to reduce liabilities for claims and claim expenses, net of reinsurance, as follows:\nTABLE 2\nRECONCILIATION OF DISCOUNTING NET LIABILITY FOR CLAIMS AND CLAIM EXPENSES (IN MILLIONS)\nTable 3 reconciles the difference between liabilities for claims and claim expenses, net of reinsurance, reported in the consolidated financial statements under generally accepted accounting principles (\"GAAP\") with that reported in annual statements filed with state insurance regulators in accordance with SAP.\nTABLE 3\nGAAP TO SAP RECONCILIATION OF NET LIABILITY FOR CLAIMS AND CLAIM EXPENSES (IN MILLIONS)\nTable 4 presents the development of net balance sheet liabilities for the Corporation's property\/casualty operations from 1984 through 1994. Table 5 presents the development of the gross balance sheet liability for the Corporation's property\/casualty operations from 1992 through 1994. Reference is made to Exhibit 28, \"Combined Domestic Property\/Casualty Insurance Company Schedule P\" for a more detailed review of SAP liabilities on an accident year basis. Claim and claim expense liabilities associated with the Cologne Re joint venture are included in the Corporation's liabilities in Table 4 and Table 5 at December 31, 1994, although the joint venture had no effect on claim development during 1994 and prior years. The accident-year information required to complete Table 4 and Table 5 for the Corporation's other international subsidiaries was not available in prior years. Although the related amounts were not significant to the consolidated total in prior years, these amounts have been included beginning in 1994. The net liabilities for unpaid claims and claim expenses of these international operations and percentages of the consolidated total were $378 million or 3.7 percent for 1994, $253 million or 3.6 percent for 1993 and $202 million or 3.0 percent for 1992.\nThe first data row shows the estimated net liability for unpaid claims and claim expenses recorded at the balance sheet date for each of the indicated years. This liability represents the estimated amount of claims and claim expenses, including IBNR, that are outstanding as of the balance sheet date.\nThe upper \"triangle\" of data shows the reestimated amount of the previously recorded net liability based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims for individual years.\nThe \"Cumulative (Deficiency) Redundancy\" represents the aggregate change in the initial estimates from the original date through December 31, 1994. Annual changes in the estimates are reflected in current operating results each year as the liabilities are reevaluated. The lower \"triangle\" of data shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year.\nTABLE 4\nANALYSIS OF NET UNPAID CLAIMS AND CLAIM EXPENSES DEVELOPMENT (IN MILLIONS)\nTABLE 5\nANALYSIS OF GROSS UNPAID CLAIMS AND CLAIM EXPENSES DEVELOPMENT (IN MILLIONS)\nA number of major trends occurred within the industry which have significantly affected the development of the Corporation's liabilities for claims and claim expenses displayed in Table 4. Starting in 1980, the Corporation considerably strengthened the liability for claims and claim expenses for latent injury (e.g., asbestos-related) and environmental (e.g., pollution) claims. When originally written, these exposures, some dating back to the 1940s, were not known to cause bodily harm or property damage. Coverage, if any, was provided to policyholders on a very limited basis. Liberal interpretations of very carefully worded insurance policy contract language have, in retrospect, created unanticipated liabilities for the property\/casualty insurance industry. The cumulative deficiency in the Corporation's historical liabilities shown in Table 4 reflects development of environmental and latent injury damage claims. Adjustments to the Corporation's liabilities have been made in each year's current operating results since 1980 to reflect the evolution of case law which has widened the nature and extent of insurance and reinsurance coverage for these exposures.\nBetween 1983 and 1987, the Corporation strengthened its reserves for reinsurance of medical malpractice liability insurance business written on the occurrence form. The crisis in medical malpractice insurance led the Corporation to eliminate occurrence coverage and solely reinsure on a claims made basis. Reinsurance of other classes of professional liability coverage is also generally written on a claims made basis. Patterns of reinsurance liability emergence for claims made coverages differ substantially from such patterns for occurrence coverages.\nBeginning in 1985, the Corporation strengthened its prices and continued to increase its reserves. Significant reserve strengthening on excess liability to qualified self insurers, written on both an excess of specific loss and aggregate basis, has been partially offset by favorable development on reinsurance of liability business written at the higher pricing levels.\nHigh levels of social and economic inflation have had a leveraged effect on liabilities for claims and claim expenses. Implicit within the reserve structure is an increase in both the frequency and severity of claims between years. In recent years, some of the Corporation's clients have increased the amount of their retained risk which partially offsets the effect of social and economic inflation.\nThe Corporation purchases reinsurance, in both the domestic and international markets, which provides protection from large property, liability or workers' compensation claims and allows the Corporation to offer greater capacity to clients for certain lines of business. The Corporation has increased its capacity over time by retaining more risk and by purchasing additional reinsurance protection above its retentions.\nIn evaluating this information, it should be noted that conditions and trends affecting the development of liabilities in the past may not occur in the future. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on these tables. Current actuarial studies indicate that liabilities for claims and claim expense as of December 31, 1994, net and gross of reinsurance, are adequate.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of General Re Corporation Stamford, Connecticut\nWe have audited the consolidated financial statements and schedules of General Re Corporation and subsidiaries listed in the index on page 21 of this Form 10-K. These financial statements and schedules are the responsibility of the Corporation'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 General Re Corporation and subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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 2 to the consolidated financial statements, the Corporation adopted Financial Accounting Standards No. 109, and accordingly, changed its method of accounting for income taxes in 1992.\nCOOPERS & LYBRAND L.L.P.\nNew York, New York February 6, 1995\nGENERAL RE CORPORATION\nCONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN MILLIONS, EXCEPT SHARE DATA)\nIn 1993, the Corporation adopted the accounting prescribed by the Emerging Issues Task Force for multiple-year, retrospectively rated reinsurance contracts. The pro forma effect of adopting the consensus would have resulted in net income of $618 million ($7.10 per share) in 1992.\nThe accompanying notes are an integral part of these consolidated financial statements.\nGENERAL RE CORPORATION\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (IN MILLIONS, EXCEPT SHARE DATA)\nThe accompanying notes are an integral part of these consolidated financial statements.\nGENERAL RE CORPORATION\nCONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN MILLIONS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nGENERAL RE CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN MILLIONS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe following are the significant accounting policies and practices of General Re Corporation and Subsidiaries (the \"Corporation\"):\nBASIS OF PRESENTATION: The Corporation's consolidated financial statements have been prepared on the basis of generally accepted accounting principles. The consolidated financial statements include the Corporation and its subsidiaries. All significant intercompany transactions have been eliminated. Certain international subsidiaries report their results on a quarter lag. This practice has no material effect on the consolidated financial statements.\nOn December 28, 1994, the Corporation and Colonia Konzern AG (\"Colonia\") formed a new company that acquired 75 percent of the common shares and approximately 30 percent of the preferred shares of Kolnische Ruckversicherungs-Gesellschaft AG (\"Cologne Re\"). As a result of its investment in GR-CK at the end of 1994 (see Note 3), the Corporation's operating results were not materially affected by the Cologne Re joint venture. Due to the ownership and control structure of GR-CK and Cologne Re, the Corporation has consolidated the balance sheet of the joint venture in its balance sheet at December 31, 1994.\nCertain reclassifications have been made to 1993 and 1992 balances to conform to the 1994 presentation.\nINVESTMENTS: Effective for 1994, fixed maturity securities that the Corporation has both the ability and intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. Fixed maturity securities that the Corporation may sell prior to maturity in response to changes in market interest rates, changes in liquidity needs, or other factors and equity securities are classified as available-for-sale and carried at fair value, with unrealized gains and losses, net of deferred income taxes, excluded from income and reported in a separate component of common stockholders' equity. Fixed maturity securities that are held for resale are classified as trading and carried at fair value, with unrealized gains and losses included in income. In 1993, fixed maturity securities that the Corporation might have sold prior to maturity in response to changes in market interest rates, changes in liquidity needs or other factors were carried at the lower of aggregate amortized cost or fair value. These securities, which are shown in the balance sheet as comparable to the available-for-sale category utilized in 1994, are carried at fair value commencing in 1994. See Note 2, \"Accounting Changes\", for additional discussion of the Corporation's adoption of Statement of Financial Accounting Standards No. 115.\nRealized gains or losses on sales of investments are primarily determined on the basis of identified cost and include adjustments to the net realizable value of investments for declines in value that are considered to be other than temporary. Realized gains or losses include gains and losses arising from the translation into U.S. dollars of investments held by the domestic operations and denominated in foreign currencies. Investment income is recognized as earned and includes the amortization of bond discount and accretion of bond premium.\nIncluded in other invested assets are investments in reinsurance ventures, limited partnerships and real estate. Reinsurance ventures accounted for under the equity method are carried at initial cost which is adjusted after acquisition for the Corporation's proportionate share of the venture's earnings. The amount of the adjustment is included in income. Limited partnerships are carried at estimated fair value with distributions of income recognized in investment income when received. Real estate is valued at cost and depreciated over its estimated useful life.\nPROPERTY\/CASUALTY OPERATIONS\nPREMIUMS EARNED: Premiums are recognized in income over the contract period in proportion to the amount of insurance or reinsurance provided. Unearned premium liabilities are established to cover the\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nunexpired portion of premiums written. Such liabilities are computed by pro rata methods based on statistical data and reports received from ceding companies. Premium adjustments on contracts and audit premiums are accrued on an estimated basis throughout the contract term. Premiums are net of retrocessions.\nACQUISITION COSTS: Acquisitions costs, consisting principally of commissions and brokerage expenses incurred at contract issuance, are deferred and amortized over the contract period in which the related premiums are earned, generally one year. Deferred acquisition costs are reviewed to determine that they do not exceed recoverable amounts, after considering investment income.\nDEFERRED CHARGES: Deferred charges ($41 million and $48 million at December 31, 1994 and 1993, respectively), which arose from certain reinsurance contracts, are amortized over the periods in which the related investment income is expected to be earned.\nCLAIMS AND CLAIM EXPENSES: The liability for claims and claim expenses is based on reports and individual case estimates received from ceding companies. The liability also includes incurred but not reported losses, which are based on past experience and is reduced by anticipated salvage and subrogation recoverable. The methods of determining such estimates and establishing the related liabilities are regularly reviewed and updated, and any resulting adjustments are currently included in income. Reinsurance recoveries on unpaid claims and claim expenses, net of uncollectible amounts, are recognized as assets at the same time and in a manner consistent with the Corporation's method for establishing the related liability. Workers' compensation liabilities, after deduction of reinsurance recoverable for unpaid losses, were $1,186 million and $1,212 million at December 31, 1994 and 1993, respectively, after being discounted at an interest rate of 4.5 percent.\nLIFE INSURANCE OPERATIONS\nFUTURE POLICY BENEFITS FOR LIFE AND HEALTH CONTRACTS: The liability for future policy benefits for life and health contracts has been computed based upon assumed investment yields and mortality and withdrawal rates anticipated at the time of the Corporation's investment in Cologne Re. These assumptions include a margin for adverse deviation and vary with the characteristics of the reinsurance contract's year of issue, policy duration, country of risk, and other appropriate factors. The interest rate assumptions used vary by country ranging from 3.0 percent to 7.0 percent. There was no participating life business; however, appropriate provisions for profit-sharing commission payments to ceding companies were made.\nPRESENT VALUE OF FUTURE PROFITS: In conjunction with the formation of the Cologne Re joint venture, the Corporation obtained the right to receive future profits from life reinsurance contracts existing at the date of the joint venture's formation. The value of these profits is the actuarially determined present value of the projected profits from the obtained reinsurance contracts. The calculation of the estimated profits includes anticipated future premiums, benefit payments, lapse rates, expenses and related investment income. The present value of future profits was determined using risk adjusted discount rates ranging primarily from 10 percent through 16 percent. The interest rates selected for the valuation were determined based on the applicable interest rates in the country of risk and the risk inherent in the realization of the estimated future profits. The present value of future profits of $132 million will be amortized over the duration of the related life business, approximately 20 years, based upon the assumed underlying profits of the business acquired.\nFUNDS HELD BY REINSURED COMPANIES: Funds held by reinsured companies represent ceded premium retained by the ceding company, for a period, according to contractual terms. The Corporation generally earns investment income on these balances during the period funds are held.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nGOODWILL: The Corporation amortizes on a straight-line basis goodwill recorded in connection with its business combinations. Included in the balance sheet caption \"other assets\", was goodwill of $509 million at December 31, 1994, which is principally related to the Cologne Re joint venture and is being amortized over the expected life of the operations acquired, not exceeding 40 years.\nDEFERRED INCOME TAXES: Deferred income taxes have been provided for all temporary differences between the bases of assets and liabilities used in the financial statements and the Corporation's tax returns. Deferred income taxes are also provided for unrealized appreciation (depreciation) of equity securities and certain fixed maturities, and for foreign currency translation gains or losses by a charge (credit) directly to the applicable component of common stockholders' equity.\nFOREIGN CURRENCY TRANSLATION: Revenues and expenses in foreign currencies are translated at the rate of exchange at the transaction date. Assets and liabilities are translated at the rate of exchange in effect at the close of the period. Gains or losses resulting from translating foreign currency financial statements are accumulated in a separate component of common stockholders' equity. Gains or losses resulting from foreign currency transactions (transactions denominated in a currency other than the entity's functional currency) are included in net income. The net effect of foreign currency transactions on operating results during 1994, 1993 and 1992 was immaterial.\nDEPOSITS: Reinsurance contracts that do not indemnify the ceding company against loss or liability are recorded as deposits. These deposits are treated as financing transactions and are credited or charged with interest income or expense according to contract terms.\nALLOWANCE FOR DOUBTFUL ACCOUNTS: The Corporation establishes an allowance for uncollectible reinsurance recoverables and other doubtful receivables. The allowance was recorded as a valuation account that reduces the corresponding asset. The allowance was $121 million and $79 million at December 31, 1994 and 1993, respectively.\nFINANCIAL SERVICES: Acting as a dealer, the Corporation engages in interest rate and currency swaps, forward rate agreements, forward foreign exchange, option, and synthetic security transactions. These contracts were accounted for as contractual commitments and were carried at estimated fair value based on then current interest, currency rates, and security values. Securities owned, securities sold but not yet purchased and futures contracts were carried at fair value. Realized and unrealized gains or losses from selling or valuing securities and contractual commitments at fair value were included in \"Other revenues\". Purchases of securities under agreements to resell and sales of securities under agreements to repurchase are accounted for as collateralized investing and financing transactions and were recorded at their contractual resale or repurchase amounts, plus accrued interest. Included in the balance sheet caption, trading account assets and liabilities, were the unrealized gains and losses on interest rate and currency swaps, forward currency commitments and option products.\nEARNINGS PER SHARE: Earnings per common share were based on earnings, less preferred dividends, divided by the weighted average common shares outstanding during each year.\n2. ACCOUNTING CHANGES\nEffective January 1, 1994, the Corporation adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. The after-tax impact of Statement No. 115 decreased common stockholders' equity by $81 million at December 31, 1994. The Statement's adoption had no impact on the Corporation's results from operations. See Note 1 for additional details on the resultant changes to the Corporation's investment accounting.\nEffective January 1, 1994, the Corporation adopted FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts. The Interpretation further clarifies the definition of a right of set-off. Effective\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDecember 31, 1994, the Corporation adopted FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. The Interpretation modified the accounting in Interpretation No. 39 to permit offsetting in the balance sheet of payables and receivables for repurchase and reverse repurchase agreements when certain conditions are met. The Corporation has reclassified amounts on the December 31, 1993 balance sheet to conform to the new Interpretations. The combined effect of adopting Interpretations 39 and 41 increased reported assets and liabilities by approximately $950 million at December 31, 1993 and $1,747 million at December 31, 1994. Adoption of these Interpretations had no impact on results from operations or common stockholders' equity.\nIn 1994, the Corporation adopted Statement of Financial Accounting Standards No. 119, Disclosure about Derivatives Financial Instruments and Fair Value of Financial Instruments. The Statement provides new disclosure requirements for derivative financial instruments (see Notes 14 and 15).\nEffective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts. The Statement specifies the accounting for reinsurance of insurance contracts and also applies to retrocessions of reinsurance contracts. Under the Statement, prepaid reinsurance premiums and reinsurance recoveries on unpaid claims and claim expenses are to be reported as assets, rather than as reductions in liabilities. The Statement also establishes the risk transfer requirements that a contract must satisfy in order to be accounted for as reinsurance and prescribes accounting and reporting standards for reinsurance contracts. Contracts that do not both transfer significant insurance risk and result in the reasonable possibility that the reinsurer (or retrocessionaire) may realize a significant loss from the insurance risk assumed are required to be accounted for as deposits. Adoption of the risk transfer components of the new Statement did not have a material impact on the Corporation's financial position or results from operations in 1993.\nOn July 22, 1993, the Emerging Issues Task Force of the Financial Accounting Standards Board reached a consensus on accounting for multiple-year, retrospectively rated reinsurance contracts. The Corporation adopted the EITF's prescribed method of accounting for such contracts during the third quarter of 1993. Accordingly, the Corporation reported a cumulative-effect adjustment of $14 million, or $.17 per share, principally to recognize an asset for the amounts due from retrocessionaires related to favorable contract experience through January 1, 1993.\nEffective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions. See Note 8 for additional details on the adoption of this Statement.\nEffective January 1, 1992, the Corporation adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The Statement requires the use of the liability method of accounting for deferred income taxes. The cumulative effect of the change in accounting increased net income in 1992 by $61 million, or $.71 per common share.\n3. REINSURANCE VENTURES\nCologne Re\nOn December 28, 1994, the Corporation and Colonia formed a new company that acquired 75 percent of the common shares and approximately 30 percent of the preferred shares of Cologne Re, which collectively represents a 66.3 percent economic interest in Cologne Re. In exchange for its Cologne Re shares, Colonia, for itself and as trustee for Nordstern Allgemeine Versicherungs AG (collectively the \"CKAG Group\"), received 100 percent of the Class A shares of the new company, General Re-CKAG Reinsurance and Investment S.A.R.L. (\"GR-CK\"). The Corporation initially contributed $884 million (DM 1,377 million) to GR-CK in exchange for 100 percent of the Class B shares of GR-CK. On December 30, 1994, GR-CK paid $302 million (DM 475 million) to a subsidiary of the Corporation in exchange for notes in the principal amount of DM 475\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nmillion. The notes pay interest of 8.0 percent annually to GR-CK and are due on December 30, 2004. The intercompany note has been eliminated in consolidation.\nThe Class A shares have 49.9 percent of the votes of GR-CK and are entitled to an annual Class A dividend, which is based on a formula and is subject to a minimum of approximately DM 36 million, while the Class B shares have 50.1 percent of the votes of GR-CK and are entitled to the earnings of GR-CK in excess of the Class A dividend. The Corporation has an option after seven years to purchase the Class A shares of GR-CK owned by the CKAG Group at a formula price. The option has a minimum exercise price of DM 1,306 million ($842 million) and a maximum exercise price of DM 1,509 million ($973 million), subject to certain warranty adjustments that may reduce the exercise price.\nThe acquisition of the shares of Cologne Re through GR-CK has been accounted for as a purchase. As a result of the ownership and control structure, the Corporation consolidated GR-CK and Cologne Re in its financial statements and recorded as minority interests the share of the CKAG Group in GR-CK and of the other stockholders in Cologne Re. Since the closing occurred at the end of 1994, the transaction did not have a material effect on the Corporation's results from operations in 1994. In future years, the Corporation's operating results will include its proportional share of Cologne Re's operations, which will be reported on a quarter lag. The cost of the acquisition has been preliminarily allocated on the basis of the estimated fair value of the assets acquired and the liabilities assumed in the transaction. The allocation of the purchase price will be finalized during 1995 with any resulting change adjusting goodwill.\nThe following unaudited, pro forma information was prepared assuming the transaction with Cologne Re had occurred as of the beginning of the periods presented. These results were prepared for informational purposes and do not purport to be the actual results of the entities had they been combined at that time. The pro forma information includes all significant adjustments to the historical results that were directly attributable to the transaction and were expected to have a continuing effect on the Corporation.\nEngineering Insurance Group\nOn December 30, 1994, General Reinsurance Corporation (\"GRC\") exchanged its 50 percent partnership interest in Engineering Insurance Group to EIG Co. (\"EIG\"), a machinery breakdown insurer, for non-voting preferred stock in EIG having a value of $20 million. The preferred stock pays dividends at a rate of 6.5 percent per annum and matures on December 30, 2004.\nSignet Star Holdings\nIn 1993, the Corporation entered into a joint venture with W.R. Berkley Corporation to form Signet Star Holdings, Inc. (\"SSH\"), which acquired the common stock of North Star Reinsurance Corporation (\"North Star\"), a wholly owned subsidiary of the Corporation, and Signet Reinsurance Company, a wholly owned subsidiary of W.R. Berkley Corporation. Under the agreement, the Corporation acquired shares representing 40 percent of the equity interest of SSH, $36 million of 6.96 percent convertible debt due in January 2003 and $40 million of 9.80 percent senior debt due in January 2000. The Corporation accounts for its interest in SSH under the equity method.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nIn November 1993, SSH called the senior debt at par plus accrued interest. The convertible debt is convertible, at the Corporation's discretion, into common stock of SSH between June 30, 1995 and July 15, 1995. If the Corporation converts the debt to equity, it will own a 50 percent equity interest in SSH. The Corporation, through its wholly owned subsidiary, GRC, has retained the net claim and claim expense liability of North Star for all reinsurance contracts underwritten by North Star prior to January 1, 1993. These claim and claim expense liabilities are currently in runoff and did not have a material impact on the Corporation's results from operations or financial position during 1994.\nTempest Reinsurance Company Limited\nIn September 1993, the Corporation acted as sponsor in the formation of Tempest Reinsurance Company Limited (\"Tempest\"), a Bermuda-based reinsurance company specializing in excess property catastrophe reinsurance. The Corporation accounted for its 20.5 percent interest in Tempest of $112 million at December 31, 1994 under the equity method. The Corporation provides underwriting and investment management services for Tempest.\n4. STATUTORY FINANCIAL INFORMATION\nThe Corporation's domestic reinsurance and insurance subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by insurance regulators. Statutory accounting differs from generally accepted accounting principles in the reporting of certain reinsurance contracts, acquisition expenses, furniture and equipment, deferred income taxes and certain other items. Combined statutory surplus at December 31, 1994 and 1993 was $3,770 million and $3,836 million, respectively, and combined statutory net income for the years ended December 31, 1994, 1993 and 1992 was $511 million, $655 million and $547 million, respectively.\nThe Corporation's subsidiaries prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by their domiciliary state's insurance department. Prescribed accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed that have been permitted by the insurance department of the insurer's domiciliary state.\nAs discussed in Note 1, the Corporation discounts certain workers' compensation liabilities at an annual rate of 4.5 percent. Included in the discount recognized for statutory purposes is a benefit of $489 million for certain liabilities which the Corporation has been permitted by the domiciliary insurance department to discount.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n5. INVESTMENTS\nThe cost, fair value and gross unrealized appreciation and depreciation of short-term, fixed maturity, equity and other investments were as follows:\n- --------------- (1) Cost is amortized cost for short-term investments and fixed maturities and original cost for equity securities and other invested assets.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n- --------------- (1) Cost is amortized cost for short-term investments and fixed maturities and original cost for equity securities and other invested assets.\nGross gains of $57 million, $120 million and $140 million and gross losses of $120 million, $22 million and $10 million were realized on sales of available-for-sale fixed maturities in 1994, 1993 and 1992, respectively. The contractual maturities of fixed maturity investments are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay certain obligations.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nRealized gains or losses recognized in income for fixed maturities and equity securities were as follows:\nInvestment income, which consists of interest and dividends from all fixed maturities, equity securities, short-term investments and from other sources, was as follows:\nSecurities with a par value of $549 million at December 31, 1994 were on deposit with various state or governmental departments to comply with insurance laws.\n6. FEDERAL AND FOREIGN INCOME TAXES\nIncome tax expense (benefit) was as follows:\nIncome taxes were established on a consolidated basis for all domestic and foreign subsidiaries of the Corporation. No provision has been made for U.S. income taxes on that portion of cumulative undistributed income of international subsidiaries of $107 million at December 31, 1994, which is considered permanently reinvested.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Corporation's effective income tax rate is less than the U.S. statutory rate due to permanent differences between financial statement income and taxable income. An analysis of the Corporation's effective tax rate as a percentage of pretax income follows:\nIncome taxes paid were $138 million, $142 million and $117 million in 1994, 1993 and 1992, respectively.\nThe components of the net deferred income tax liability were as follows:\n7. NOTES PAYABLE AND COMMERCIAL PAPER\nThe carrying amounts of the Corporation's notes payable were as follows:\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe 9% debenture due in 2009 has a covenant requiring the Corporation not to encumber its common stock holding in General Reinsurance Corporation, the largest subsidiary of the Corporation. The variable rate notes were issued by EIG, which was sold to the Corporation's joint venture partner on December 30, 1994 (see Note 3). The mortgage payable is collateralized by the Corporation's prior home office.\nThe Corporation issues commercial paper for financial flexibility and liquidity purposes. Information on the commercial paper program is as follows:\nThe Corporation has $1,000 million of available lines of credit from banks, all of which were unused at December 31, 1994. The credit agreement with the banks requires the Corporation to maintain a minimum consolidated tangible net worth, as defined, of $2,500 million. Interest expense and interest paid for all loans payable and commercial paper were as follows:\n8. RETIREMENT PLANS\nThe Corporation and its subsidiaries have noncontributory pension plans covering substantially all employees. Pension expense for foreign employees was not material to the Corporation. Plans for United States employees provide pension benefits that are generally computed on the basis of the average earnings during the three consecutive years of highest earnings during the employee's service. The Corporation's funding policy is to contribute sufficient amounts to meet the minimum annual funding required by applicable regulations plus such additional amounts as it may determine to be appropriate from time to time for U.S. plans. Pension plan assets are principally invested in investment-grade fixed maturities and equities. Cologne Re provides pensions benefits to its employees based on years of service and age at retirement.\nThe components of pension expense related to both funded and unfunded plans for United States employees were as follows:\nThe projected benefit obligation for U.S. employees was determined using an assumed discount rate of 8.25% in 1994, 7.25% for 1993 and 8.0% for 1992, and an assumed long-term compensation increase of 6.0% in 1994,\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n5.5% for 1993 and 6.0% for 1992. An assumed long-term rate of return on plan assets of 8.5% was used in determining pension expense in 1994, 1993 and 1992. The projected benefit obligation for Cologne Re employees was determined using an assumed discount rate of 7.0 percent and an assumed long-term compensation increase of 3.5 percent.\nThe Corporation provides pension benefits for certain employees above amounts allowed under tax qualified plans, through unfunded plans. The Corporation also provides postretirement retainers through unfunded plans for members of the Board of Directors.\nThe following table sets forth the plans' funded status and amount recognized in the Corporation's consolidated balance sheet:\nSubstantially all of the Corporation's employees in the United States become eligible for certain health care and group life insurance benefits upon retirement from the Corporation. Effective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The Corporation has funded the benefit cost of current retirees, with the retiree paying a portion of the costs. The retiree's portion of the costs varies depending upon the individual's length of service with Corporation upon retirement. As of December 31, 1994 and 1993 the Corporation had funded $2 million for postretirement health care benefits for current retirees and had an accrued liability of $23 million and $20 million, respectively, for current employees.\n9. EMPLOYEE SAVINGS AND STOCK OWNERSHIP PLAN\nThe Corporation has a leveraged Employee Savings and Stock Ownership Plan (ESSOP) in which substantially all United States employees may participate. The ESSOP borrowed from the Corporation $150 million at 9.25%, payable annually through 2014. The proceeds of this borrowing were used by the ESSOP to purchase 1,754,386 shares of 7.25% ($6.20 dividend per share) cumulative convertible preferred stock of the Corporation. All preferred stock outstanding is held by the ESSOP and is convertible into common stock. The preferred stock is held by the ESSOP trustee as collateral for the loan from the Corporation. The Corporation makes contributions to the ESSOP which, together with the dividend on shares of the preferred stock, are\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nsufficient to make loan interest and principal repayments back to the Corporation. As interest and principal are repaid, a portion of the preferred stock is allocated to participating employees.\nThe following summarizes ESSOP activity:\n10. INCENTIVE PLANS\nThe Corporation has a Long-term Compensation Plan (the \"Plan\") which provides for the granting of incentive and non-qualified stock options to Directors, key executives and managerial employees. The Plan provides that the exercise price of the options granted may not be less than the fair market value of the Corporation's common stock on the date the options are granted. The options are exercisable cumulatively, 20 percent each year, commencing one year from the date of grant and expire ten years from the grant date. In certain circumstances, replacement options may be granted upon exercise of an original option, with the exercise price equal to the current market price and with a term extending to the expiration date of the original option.\nThe Plan also permits the granting of stock appreciation rights (SARs) in connection with options granted under the Plan. SARs permit the grantee to surrender an exercisable option for an amount equal to the excess of the market price of the common stock over the option price when the right is exercised. No SARs have been granted since 1988.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe following summarizes the activity for options and SARs:\nThe Plan also permits the granting of restricted stock awards to key executives and managerial employees. Shares of restricted stock become outstanding when granted, receive dividends and have voting rights identical to other outstanding shares of common stock. Restrictions lapse upon termination of the restriction period or upon death, disability or normal retirement. During 1994, 1993 and 1992, the Corporation made aggregate restricted stock awards of 17,250, 38,250, and 31,000 shares, respectively. The cost of restricted stock awards is based on the market value of the common stock at the date of grant and is recognized as expense over the restriction period. The expense of the restricted stock plan was $2 million in 1994, and $1 million in 1993 and 1992.\n11. LEASES\nThe Corporation and its subsidiaries lease office space and data processing equipment under non-cancelable leases expiring in various years through 2010. Several of the leases have renewal options with various terms and rental rate adjustments. Rental expense was $32 million in 1994 and $33 million in 1993 and 1992. The future minimum annual rental commitments under non-cancelable leases at December 31, 1994 were as follows:\nFuture minimum rental payments have not been reduced by $24 million of anticipated sub-lease rental income on non-cancelable leases.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n12. REINSURANCE\nPremiums written, premiums earned, and claims and claim expenses are reported net of reinsurance in the Corporation's statements of income. Direct, assumed, ceded and net amounts for these items were as follows:\nThe Corporation utilizes reinsurance to reduce its exposure to large claims. These agreements provide for recovery of a portion of certain claims and claim expenses from reinsurers. If the reinsurers are unable to meet their obligations under the agreements, the Corporation would be liable for such defaulted amounts. The Corporation holds partial collateral under these agreements.\n13. DIVIDENDS\nThe Corporation is the ultimate controlling entity in the General Re Group insurance holding company system, which includes domestic insurance companies that are subject to the insurance holding company acts of Delaware and various other states. The Corporation is dependent upon the ability of its operating subsidiaries for the transfer of funds in the form of loans, advances or dividends. The insurance holding company laws require the filing of annual reports by the insurance company members of the system and regulate transactions between the holding company and affiliated insurance companies to the extent that such transactions must be fair, reasonable and assure the adequacy of insurance companies' statutory surplus in relation to their liabilities and financial needs.\nThe laws also subject extraordinary dividends and other extraordinary distributions to insurance company stockholders to regulatory approval. Dividends or distributions in a twelve-month period exceeding the greater of 10 percent of an insurance company's surplus as of the prior year end or 100 percent of net income, excluding realized gains, for the previous calendar year are generally considered extraordinary and require such approval. Based on these restrictions, ordinary dividend payments by domestic insurance subsidiaries to the Corporation are limited to $420 million in 1995. Foreign and non-insurance subsidiaries generally are subject to fewer restrictions on the payment of dividends.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n14. GENERAL RE FINANCIAL PRODUCTS\nGeneral\nGeneral Re Financial Products Corporation (\"GRFP\") is a dealer in derivative financial instruments. GRFP's products include currency and interest rate swaps, interest rate caps and floors, foreign exchange contracts, and options on swaps. These instruments are carried at their current fair value, which is a function of underlying interest rates, currency rates, securities values, volatilities and the credit worthiness of counterparties. Future changes in interest rates, currency rates, security values, and interest rate volatilities or a combination thereof may impact the fair value of these instruments with any resulting adjustment, including amounts in excess of those previously recognized in the financial statements, being included currently in the income statement. In the course of conducting its business, GRFP also engages in a variety of other related transactions to manage its exposure to market and credit risks.\nGRFP reduces exposure to market, currency rate and interest rate risk in connection with its dealer activities by purchasing or selling futures contracts, entering into forward contracts, purchasing or selling government securities, purchasing or selling exchange traded interest rate options, or entering into offsetting transactions. These hedging instruments are carried at fair value and contain elements of market and credit risk associated with the execution, settlement and financing of these instruments similar to the financial instruments described above.\nTrading Revenue\nThe results of GRFP's trading activities are summarized by category of products in the following table. Trading revenue includes any associated gains and losses on hedging instruments. Trading revenue was included in \"other revenues\" in the income statement.\nNature and Terms\nGRFP is a dealer in various types of derivative instruments which are described below.\nInterest rate and currency swaps are agreements between two parties to exchange, at particular intervals, payment streams calculated on a specified notional amount. The parties to a currency swap typically exchange a principal amount in two currencies at inception of the contract, agreeing to reexchange the currencies at a future date and agreed exchange rate.\nInterest rate and currency options grant the purchaser, for a premium payment, the right to either purchase from or sell to the writer a specified financial instrument under agreed terms. Interest rate caps and floors require the writer to pay the purchaser at specified future dates the amount, if any, by which the option's underlying market interest rate exceeds the fixed cap or falls below the fixed floor rate, applied to a notional amount.\nForward rate agreements and futures contracts are commitments either to purchase or sell a financial instrument at a future date for a specified price and are generally settled in cash. Forward rate agreements settle in cash at a specified future date based on the differential between agreed interest rates applied to a notional amount.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nGRFP is party to a variety of foreign exchange spot and forward contracts in its dealer and risk management activities. Foreign exchange contracts generally involve the exchange of two currencies at agreed rates; spot contracts usually require the exchange to occur within two business days of the contract date.\nA summary of contract and notional amounts of interest rate contracts at December 31, 1994, and 1993 is included in the table below. For swap and option transactions, the contract and notional amounts represent the principal volume, which is referenced by the counterparties in computing payments to be exchanged, and are not indicative of GRFP's exposure to market or credit risk, future cash requirements or receipts from such transactions. Approximately 77% of the notional volume outstanding for swap and option contracts at December 31, 1994 have a term of five years or less and substantially all of the instruments have a term of less than ten years.\nFair Value of Trading Instruments\nThe table below discloses the net fair value at the reporting date for each class of derivative financial instrument held or issued by GRFP for dealer or risk management purposes, as well as the average fair value during the year, based on monthly observations. The aggregate fair value of swap and option contracts represents the net unrealized gain or loss on all swap and option contracts of GRFP.\nRisk Management\nGRFP's components of market risk include foreign exchange risk, interest rate risk, swap spread risk, volatility risk and yield curve risk. These are monitored on a daily basis across all swap and option products by\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\ncalculating the profit and loss impact of potential changes in market risks over a one week period. Based on historical market volatility data and informed judgment, GRFP sets market risk limits for each type of risk based on a 95 percent probability that movements in market rates will not exceed the limits. GRFP also monitors its consolidated market risk across all trading books on a weekly basis and has established limits designed to withstand simultaneous losses of two market risk components, each at the 95 percent confidence level. GRFP's aggregate weekly market risk limit across all trading books was $10 million. Since inception, GRFP has not experienced a weekly position change exceeding this aggregate limit. In addition to these daily and weekly assessments of risk, GRFP prepares periodic stress tests to assess its exposure to extreme movements in various market risk factors.\nCredit Risk\nCredit risk arises from the possible inability of counterparties to meet the terms of their contracts. In the event counterparties are unable to fulfill their contractual obligations, future losses due to defaults may exceed amounts currently recognized in the balance sheet. Counterparties to the financial instruments are, in decreasing order of magnitude, foreign and domestic commercial banks, U.S. government-chartered organizations, sovereigns and corporations. GRFP evaluates the creditworthiness of its counterparties by performing formal internal credit analyses and by referring to ratings of widely accepted credit rating services. Counterparty credit limits are determined based on this analysis and counterparty credit exposures are monitored in accordance with these limits. GRFP receives cash and\/or investment grade securities from certain counterparties as collateral to mitigate its credit exposure. GRFP also incorporates into contracts with certain counterparties provisions which allow the unwinding of these transactions in the event of a downgrade in credit rating of either the counterparty or GRFP.\nGRFP assesses credit risk by counterparty based on transactions with each respective counterparty. Assuming 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, 1994, approximated $1,869 million. This value is net of amounts offset pursuant to rights of setoff and qualifying master netting arrangements with various counterparties and is presented in accordance with Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts and FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. The Interpretation further clarifies the definition of a right of set-off. The maximum potential loss will increase or decrease during the life of the transaction as a function of maturity period, accounting values, and interest and currency rates. In the judgment of management, the likelihood that all counterparties would default, resulting in a maximum potential loss, is remote. GRFP has not experienced any counterparty defaults or write-offs on such contracts.\nIn connection with certain purchases and sales of government securities, GRFP enters into collateralized repurchase and reverse repurchase agreements, which may result in credit losses in the event the counterparty to the transaction is unable to fulfill its contractual obligations. Principally all of these transactions are collateralized by government securities. GRFP's exposure to credit risks associated with the non-performance of counterparties in fulfilling these contractual obligations can be directly affected by market fluctuations, which may impair the counterparties' ability to satisfy their obligations. It is GRFP's policy to take possession of securities purchased under agreements to resell. GRFP monitors the market value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral when appropriate. Counterparties to repurchase agreements and futures transactions are commercial banks and securities brokers and dealers.\nGRFP enters into futures contracts for delayed delivery of foreign currencies or securities 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 from the inability of the exchange to meet the terms of the contracts and from counterparties inability to remit additional margin.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nGRFP regularly consults with internal and external legal counsel (in relevant jurisdictions) to determine legality and enforceability of various transactions with different types of counterparties. When there is a perceived risk that a proposed counterparty may lack legal capacity to enter into a transaction, the relevant statutes, regulations, and consents are examined.\n15. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following are the estimated fair values of the Corporation's financial instruments:\nThe Corporation uses various methods and assumptions in estimating the fair value of financial instruments. The following valuation methods and assumptions were utilized by the Corporation in estimating the fair value of financial instruments:\nCash and short-term investments -- The carrying amounts reported in the consolidated balance sheet approximate the fair values for these financial instruments.\nFixed maturities -- Fair values for fixed maturities were generally based on quoted market prices or dealer quotes.\nEquity securities -- Fair values for equity securities were based on quoted market prices.\nOther invested assets -- The fair value of investments in limited partnerships, which were included in other invested assets on the consolidated balance sheet, was determined by reviewing available financial information of the investee and by performing other financial analyses in consultation with external advisors. Fair values for investments in real estate were determined using discounted cash flow analyses for each property. Fair value disclosures for reinsurance ventures were included at the Corporation's proportionate share in the entity's shareholders' equity as the cost of determining fair value exceeds the benefits derived.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nMortgage and loans receivable\/payable -- The fair value of the Corporation's mortgage and notes receivable\/payable was estimated using discounted cash flow analyses, based on the Corporation's current incremental borrowing rates for similar types of arrangements. The fair value of the Corporation's 9.0 percent debenture due 2009 was based on a market quote.\nContract deposit assets\/liabilities -- The fair value of contract deposit assets and liabilities approximate their carrying value.\nSecurities purchased under agreements to resell, securities sold under agreements to repurchase -- The carrying value for these financial instruments approximates their fair value.\nTrading account assets\/liabilities -- The fair value for trading account assets\/liabilities was based on the use of valuation models that utilize, among other factors, current interest and foreign exchange rates and market volatility data.\nSecurities sold but not yet purchased -- The fair value for securities sold but not yet purchased was based on quoted market prices.\n16. LEGAL PROCEEDINGS\nOn September 12, 1994, the Corporation's subsidiary, General Reinsurance Corporation, along with 31 other insurance companies and insurance industry organizations, reached a settlement of civil antitrust actions brought by 20 State Attorneys General and several private plaintiffs.\nThe lawsuit was originally dismissed on motion by the United States District Court for the Northern District of California on September 20, 1989. The United States Court of Appeals for the Ninth Circuit reversed the dismissal and remanded the case to the District Court for further proceedings. On October 5, 1992, the United States Supreme Court granted, in part, defendants' petition for certiorari. On June 28, 1993, the Supreme Court affirmed in part and reversed in part the decision of the Court of Appeals and remanded the Case to the Court of Appeals for further action. On October 6, 1993, the Court of Appeals remanded the case to the District Court for trial in accordance with the opinion of the Supreme Court. There was no finding of any wrongdoing or illegality by any defendant in this civil action.\nThe settlement includes an already completed restructuring of the Insurance Services Office and the proposed funding by the defendants of a national public risk database and a public entity risk services institute to assist risk management efforts. The terms of the settlement, which provide for no admission of wrongdoing, illegality or payment of damages, will be subject to the approval of the United States District Court. The effect of the settlement was not material to the Corporation's results of operations, cash flows or financial condition.\nThe Corporation and its subsidiaries have been named as defendants in litigation in the ordinary course of conducting an insurance business. These lawsuits generally seek to establish liability under insurance or reinsurance contracts issued by the subsidiaries, and occasionally seek punitive or exemplary damages. The Corporation's reinsurance subsidiaries are also indirectly involved in coverage litigation. In those cases, plaintiffs seek coverage for their liabilities under insurance policies from insurance companies reinsured by the Corporation's reinsurance subsidiaries. In the judgment of management, none of these cases, individually or collectively, is likely to result in judgments for amounts which, net of claim and claim expense liabilities previously established and applicable reinsurance, would be material to the financial position, results of operations or cash flow of the Corporation.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n17. CLAIMS AND CLAIM EXPENSES\nThe table below provides a reconciliation of the beginning and ending claim and claim expense liability, net of reinsurance, for 1994, 1993 and 1992.\nThe Corporation continually estimates its liabilities and related reinsurance recoveries for environmental and latent injury claims and claim expenses. These exposures do not lend themselves to traditional methods of loss development determination and, therefore, may be considered less reliable then reserves for standard lines of business (e.g., automobile). The estimate is composed of four parts: known claims, development on known claims, IBNR and direct excess coverage litigation expenses. Although reliability is constrained by uncertainties, the Corporation has confidence in the reported known claim liabilities and, based on alternative methods, has projected a fairly reliable estimate of development for these claims. The Corporation has also included an estimate for IBNR that is based on fitted curves of estimated future claim emergence. This estimate is less reliable than the estimated liability for reported claims. The effect of joint and several liability on the severity of losses and a provision for future claim inflation have been included in the loss development estimate. The Corporation has established a liability for litigation costs associated with coverage disputes arising out of direct excess insurance policies, rather than from reinsurance assumed. Direct excess coverage litigation expenses are estimated using a modified count and amount actuarial study.\nThe gross liability for environmental and latent injury claims and claim expenses and the related reinsurance recoverable were $1,478 million and $382 million, respectively, at December 31, 1994. These amounts are management's best estimate of future claim and claim expense payments and recoveries that are expected to develop over the next thirty years. The Corporation continues to monitor evolving case law and its effect on environmental and latent injury claims. Changing government regulations and legislation, newly identified toxins, newly reported claims, new theories of liability, new contract interpretations, and other factors could significantly affect future claim development. While the Corporation has recorded its current best estimate of its liabilities for unpaid claims and claim expenses, it is reasonably possible that these estimated liabilities, net of estimated reinsurance recoveries, may increase in the future and that the increase may be material to the Corporation's results of operations, cash flows and financial position. It is not possible to estimate reliably the amount of additional net loss, or the range of net loss, that is reasonably possible.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe liability for claims and claims expenses for 1993 and prior accident years, net of related reinsurance recoveries, decreased by $36 million in 1994. The decrease is principally the result of favorable loss development on casualty lines of business partly offset by reserve strengthening for environmental, latent injury and associated litigation costs discussed above.\n18. COMMON AND PREFERRED STOCK\nThe Corporation has the authority to issue 250,000,000 shares of $.50 par value common stock, of which 102,827,344 have been issued. Common stock purchased in the open market is carried at cost and shown as a reduction to common stockholders' equity. When treasury shares are reissued, the treasury stock account is reduced for the cost of the common stock reissued on a first-in, first-out basis. No treasury stock of the Corporation is held by any subsidiary. The number of shares included in treasury stock were as follows:\nThe Corporation also has the authority to issue 20 million shares of preferred stock of which 1,734,717 are issued and outstanding and held by the ESSOP and 1 million (Series A Junior Participating Preferred) are reserved for the Shareholders' Rights Plan. Under the Shareholders' Rights Plan, one right attaches to each outstanding share of common stock. In the event a person or group acquires or commences a tender or exchange offer for 20% or more of the Corporation's common stock, each right entitles common stockholders to purchase Series A Junior Participating Stock, which is convertible to common stock having a value equal to two times the exercise price.\n19. INFORMATION ABOUT THE CORPORATION'S OPERATIONS\nThe Corporation conducts its operations principally through the following business segments:\nPROPERTY\/CASUALTY -- The domestic property\/casualty operations of the Corporation include reinsurance of most property\/casualty lines of business, including general liability, property, workers' compensation and auto liability in the United States and Canada. In addition, the Corporation conducts excess and surplus lines insurance business.\nInternational property\/casualty operations are conducted as of December 31, 1994 through subsidiaries and branch offices located in Argentina, Australia, Barbados, Bermuda, France, Germany, Hong Kong, Italy, Ireland, Latvia, Mexico, Denmark, the Netherlands, New Zealand, Singapore, South Africa, Spain, Switzerland, Sweden, United Kingdom and Venezuela, and include reinsurance of property\/casualty business in those countries and elsewhere outside the United States and Canada. At the end of 1994, the Corporation acquired an ownership interest in Cologne Re. See Note 3 for a further discussion of this transaction. Cologne Re was not included in the Corporation's results from operations during 1994 but was consolidated in the December 31, 1994 balance sheet, and therefore, it has been included in the total asset information under the property\/casualty segment in this note.\nFINANCIAL SERVICES -- The Corporation's financial services operations engage in various financial services for affiliated and non-affiliated companies. Financial services include the Corporation's derivative products, insurance brokerage and management, reinsurance brokerage, investment management and real estate management operations.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe following is a summary of industry segment activity for 1994, 1993 and 1992.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe following table is a summary of the Corporation's business by geographic area. Allocations to geographic area have been made on the basis of subsidiary location.\nGENERAL RE CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n20. UNAUDITED QUARTERLY FINANCIAL DATA\nSummarized quarterly financial data were as follows:\n- --------------- * Closing price, New York Stock Exchange\nEarnings per common share for each quarter are required to be computed independently and, due to purchases of treasury shares, will not equal the total year earnings per common share amounts.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENT 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\nReference is made to the captions \"Board of Directors\" and \"Election of Directors\" in the Proxy Statement. Information with respect to the Corporation's Executive Officers is set forth under the caption \"Executive Officers of the Corporation\" at the end of Part I of this report, which information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is made to the caption \"Executive Compensation\" in the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nReference is made to the caption \"Security Ownership of Certain Beneficial Owners and Management\" in the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is made to the caption \"Transactions with Management and Others\" in the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) FINANCIAL STATEMENTS AND EXHIBITS\n1. The Financial Statements, Reserve Disclosures (unaudited) and Financial Statement Schedules listed in the accompanying index on page 21 are filed as part of this Report.\n- --------------- 1 Filed herewith\n2 Management contracts or compensatory plans filed pursuant to Item 14(c)\n(B) REPORTS ON FORM 8-K\nForm 8-K, dated July 18, 1994, filed on October 11, 1994, consisting of Item 5.\nForm 8-K, dated September 16, 1994, filed on December 22, 1994, consisting of Item 5.\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.\nGENERAL RE CORPORATION (Registrant)\nBy: ELIZABETH A. MONRAD (Elizabeth A. Monrad, Vice President and Treasurer)\nDated: March 9, 1995\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- ---------------\n*By either Charles F. Barr or Robert D. Graham pursuant to a power of attorney.\nGENERAL RE CORPORATION\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- GENERAL RE CORPORATION\nCONDENSED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 (PARENT COMPANY) (IN MILLIONS, EXCEPT SHARE DATA)\nS-1\nGENERAL RE CORPORATION\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (PARENT COMPANY) (IN MILLIONS)\nS-2\nGENERAL RE CORPORATION\nSCHEDULE I--CONDENSED FINANCIAL INFORMATION OF REGISTRANT--(CONTINUED) - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (PARENT COMPANY) (IN MILLIONS)\nS-3\nSCHEDULE V\nGENERAL RE CORPORATION\nSCHEDULE V--SUPPLEMENTARY INSURANCE INFORMATION\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN MILLIONS)\n- -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------\n- --------------- Note: The gross liability for unpaid claims and claim expenses was $12,158 million, $8,452 million and $8,204 million in 1994, 1993 and 1992, respectively. The gross unearned premiums were $1,642 million , $840 million, $836 million in 1994, 1993 and 1992, respectively. The totals shown in the Schedule include only the reinsurance and insurance operations of the Corporation and may not correspond with consolidated amounts.\nS-4\nEXHIBIT INDEX","section_15":""}
{"filename":"804055_1994.txt","cik":"804055","year":"1994","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nCoca-Cola Enterprises Inc. (the \"Company\") is in the liquid nonalcoholic refreshment business and is the world's largest marketer, distributor, and producer of bottled and canned beverage products of The Coca-Cola Company.\nThe Company was incorporated in Delaware in 1944 as a wholly owned subsidiary of The Coca-Cola Company and became a public company in 1986. The Coca-Cola Company owns approximately 44% of the Company's common stock. References in this report to the \"Company\" include the Company and its divisions and subsidiaries.\nThe Company's bottling territories, including those acquired in January 1995 (see \"Acquisitions and Divestitures\" and \"Territories\" below), contain approximately 154 million people. The Company sold approximately 1.7 billion equivalent cases(1) of beverage product throughout its territories in 1994, approximately 90% of which were beverage products of The Coca-Cola Company.\nIn the United States, the Company operates in exclusive and perpetual territories containing approximately 54% of the population and accounting for approximately 55% of all equivalent cases of bottled and canned products of The Coca-Cola Company sold. These territories include the five states with the largest population increases from 1990 to 1994 -- California, Texas, Florida, Georgia, and Washington.\nDomestic Operations\nManagement estimates that the Company's 1994 total case sales of soft drink products in the United States and the Caribbean were approximately 1.6 billion equivalent cases or approximately 18% of the estimated total 1994 case sales of soft drink products by all bottlers and fountain distributors.\nIn 1994, approximately 70% of the equivalent case sales of the Company, excluding products in post-mix (fountain) form, were Coca-Cola Trademark Beverages,(2) approximately 19% were other beverage products of The Coca-Cola Company and approximately 11% were beverage products of companies other than The Coca-Cola Company. The Company's equivalent case sales of products in bottles and cans, including products of companies other than The Coca-Cola Company, constituted approximately 86% of the equivalent case sales of the Company in 1994. The remaining 14% of the Company's equivalent case sales in 1994 were in post-mix form for fountain sales.\nThe Netherlands Operations\nIn 1994, The Company's subsidiary in the Netherlands, Coca-Cola Beverages Nederland B.V. (\"CCB Nederland\"), sold approximately 80 million equivalent cases, approximately 99% of which were beverage products of The Coca-Cola Company.\n- ---------------\n(1) As used in this report, the term \"equivalent case\" refers to 192 ounces of finished beverage product (24 eight-ounce services).\n(2) As used in this report, the term \"Coca-Cola Trademark Beverages\" refers to beverages bearing the trademarks \"Coca-Cola\" or \"Coke\", and \"beverage products of The Coca-Cola Company\" refers collectively to the Coca-Cola Trademark Beverages and all other beverage products of The Coca-Cola Company.\nStrategy\nThe Company expects to accomplish its primary goal -- the enhancement of share-owner value -- through the implementation and execution of operating and financial strategies designed to build the value of the Company.\nThe Company's principal operating goal is to increase long-term operating cash flow through profitable increases in sales volume. The increased complexity of the Company's business drives the Company's strategy of developing and executing innovative marketing programs at the local level. The increased competitiveness of its business dictates the Company's strategy to obtain profitable increases in case sales by balancing volume growth with improved margins and sustainable increases in market share. The realization of short-term profitability at the expense of market share is inconsistent with the Company's strategy. The Company intends to increase volume through profitable business partnerships with its customers and superior marketing to its consumers.\nThe Company's financial strategies are designed to add value through the allocation of funds to projects and activities which generate returns in excess of the Company's cost of capital and which increase share-owner value. One of the Company's primary financial objectives is to achieve an optimal capital structure which provides financial flexibility for internal projects, share repurchases, and appropriately priced acquisitions.\nRELATIONSHIP WITH THE COCA-COLA COMPANY\nThe Coca-Cola Company is the Company's largest share owner. The Chairman of the Board of Directors and three other directors of the Company are executive officers or former executive officers of The Coca-Cola Company.\nThe Company and The Coca-Cola Company are parties to a number of significant transactions and agreements incident to their respective businesses and may enter into additional material transactions and agreements from time to time in the future.\nThe Company conducts its business primarily under contracts with The Coca-Cola Company. These contracts give the Company the exclusive right to market, distribute, and produce beverage products of The Coca-Cola Company in authorized bottles and cans in specified territories and provide The Coca-Cola Company with the ability, in its sole discretion, to establish prices, terms of payment, and other terms and conditions for the purchase of concentrates and syrups from The Coca-Cola Company. See \"Domestic Bottle Contracts\" and \"International Bottler's Agreement\" below. Other significant transactions and agreements relate to, among other things, arrangements for cooperative marketing, advertising expenditures, and purchases of sweeteners.\nSince 1979, The Coca-Cola Company has assisted in the transfer of ownership or financial restructuring of a majority of its United States bottler operations and has assisted in similar transfers of bottlers operating outside the United States. Certain bottlers and interests therein have been acquired by The Coca-Cola Company and certain of those have been sold to bottlers, including the Company, which are believed by management of The Coca-Cola Company to be the best suited to manage and develop these acquired operations. The Coca-Cola Company has advised the Company that it may continue to acquire bottling companies or interests therein and to assist in the sale of acquired bottlers to other bottlers, which may or may not include the Company, viewed as those best suited to promote the interests of The Coca-Cola Company and the Coca-Cola bottler system. In connection with such transactions, The Coca-Cola Company may own all or part of the equity interests of acquired bottlers for varying periods of time. See \"Acquisitions and Divestitures\" below and \"Certain Relationships and Related Transactions -- Agreements and Transactions with The Coca-Cola Company -- Purchase of Coca-Cola Bottlers\" in the Company's Proxy Statement for the Annual Meeting of Share Owners to be held April 17, 1995 (the \"Company's 1995 Proxy Statement\"), which information is incorporated by reference in Item 13 hereof.\nThe Company intends to acquire only bottling businesses offering the Company the ability to produce long-term share-owner value.\nACQUISITIONS AND DIVESTITURES\nDuring 1994, the Company acquired 4% of the outstanding stock of The Coca-Cola Bottling Company of New York, Inc., additional shares of the preferred stock of Southeastern Container, Inc. (a packaging manufacturer), Dr Pepper franchise rights in Yuma, Arizona, and the Coca-Cola Bottling Company of Shelbyville in Shelbyville, Kentucky. For these acquisitions, the Company paid an aggregate cost, including assumed and issued debt, where applicable, of approximately $21 million. In January 1995, the Company purchased The Wichita Coca-Cola Bottling Company, having territories in Kansas, Colorado, Nebraska, and Missouri, for $150 million. The total cost of acquisitions since reorganization in 1986, including assumed and issued debt, where applicable, is approximately $5.6 billion.\nSince reorganization in 1986, the aggregate proceeds to the Company from the sale of bottlers and other businesses have been approximately $456 million; of this amount, bottlers representing sales proceeds of approximately $404 million were reacquired by the Company in 1991 as a result of the acquisition of Johnston Coca-Cola Bottling Group, Inc. (\"Johnston Coca-Cola\"), now a subsidiary of the Company. In 1994, the Company sold assets of an office coffee service in Madison, Wisconsin, vending assets in Jonesboro, Arkansas, and in January 1995, the Company sold its 50% interest in a Mississippi bottler; aggregate proceeds from such sales in 1994 and 1995 were approximately $18 million.\nTERRITORIES\nThe Company's bottling territories in the United States, including territories acquired in January 1995, and the Caribbean, include portions of 38 states, and all of the District of Columbia, the U.S. Virgin Islands, and the islands of Tortola and Grand Cayman. These territories contain approximately 139 million people and include approximately 54% of the United States population. Between 1990 and 1994, population in the territories in the United States in which the Company operates increased by approximately 5.4%, as compared to an increase of 4.4% for the general United States population during the same period.\nThe Company's territory in the Netherlands has a population of approximately 15 million people.\nThe following maps identify the territories in which the Company operates:\nAppearing here are maps of the United States, a portion of the Caribbean and a portion of Western Europe, outlining the Company's territories.\n(MAPS ARE NOT TO SAME SCALE)\nPRODUCTS\nThe Company markets, distributes, and produces beverage products of The Coca-Cola Company; these products include Coca-Cola, Coca-Cola classic, caffeine free Coca-Cola classic, diet Coke, caffeine free diet Coke, Sprite, diet Sprite, Cherry Coke, diet Cherry Coke, Fanta, Fresca, Fruitopia, Hi-C fruit drinks, Mello Yello, Minute Maid, and diet Minute Maid brand carbonated and noncarbonated soft drinks, Mr. PiBB, diet Mr. PiBB, PowerAde, Ramblin' root beer, and TAB. Additionally, the Company markets, distributes, and produces (or obtains from contract packers) Nestea, diet Nestea, and Nestea Cool under license from Coca-Cola Nestle Refreshments Company, USA and various noncola beverage products under the trademarks of companies other than The Coca-Cola Company, including, in some markets, Dr Pepper. Substantially all of the Coca-Cola Trademark Beverages, as well as TAB, Sprite, Minute Maid, and diet Minute Maid carbonated orange beverages, are available throughout the Company's domestic territories. Other products of The Coca-Cola Company and of other companies are available in selected territories. Certain of the Company's locations supply product to other Coca-Cola bottlers and major fountain accounts.\nThe Coca-Cola Company and other companies manufacture concentrates, and in some cases the finished product, for sale to bottlers and to fountain wholesalers. Bottling and canning operations combine the concentrate with sweetener and carbonated water, and package the finished product in authorized bottles, cans, and post-mix containers for sale to retailers. The Company obtains certain products, such as PowerAde, Nestea, and Fruitopia, from contract packers. See \"Marketing\" and \"Raw Materials\" below.\nApproximately 70% of the Company's domestic equivalent case sales in 1994 (excluding post-mix) represented caloric products and the balance represented low-calorie products.\nMARKETING\nThe Company sells its products in a variety of packages authorized by The Coca-Cola Company and other companies. In 1994, domestic and international equivalent case sales of the Company, excluding post-mix syrup sales, were packaged approximately 59% in cans, 36% in nonrefillable packaging, 4% in returnable containers, and 1% in pre-mix containers. Post-mix syrup accounted for approximately 13% of the Company's equivalent case sales in 1994.\nThe Company relies extensively on advertising and sales promotion in the marketing of its products. The Coca-Cola Company and the other beverage companies that supply concentrates, syrups, and finished product to the Company join in making substantial advertising expenditures in all major media to promote sales in the local areas served by the Company. The Company also benefits from national advertising programs conducted by The Coca-Cola Company and other beverage companies. In 1994, the Company's local media advertising expenditures were approximately $34 million, in addition to cooperative media advertising payments by The Coca-Cola Company of approximately $41 million. Certain of the marketing expenditures by The Coca-Cola Company are made pursuant to annual arrangements between The Coca-Cola Company and the Company. Although The Coca-Cola Company has advised the Company that it intends to continue to provide marketing support in 1995, it is not obligated to do so under either the domestic or international bottle contracts between The Coca-Cola Company and the Company. See \"Domestic Bottle Contracts\" and \"International Bottler's Agreement\" below.\nSales of the Company's products are seasonal, with the second and third calendar quarters generally accounting for higher sales volumes than the first and fourth quarters.\nRAW MATERIALS\nIn addition to concentrates, sweeteners, and finished product, the Company purchases carbon dioxide, glass and plastic bottles, cans, closures, post-mix packaging (such as plastic bags in cardboard boxes), and other packaging materials. The Company generally purchases its raw\nmaterials, other than concentrates, syrups, and sweeteners, from multiple suppliers. The bottle contracts with The Coca-Cola Company provide that, with respect to the products of The Coca-Cola Company, all authorized containers, closures, cases, cartons, and other packages and labels must be purchased from manufacturers approved by The Coca-Cola Company.\nHigh fructose corn syrup currently is the principal sweetener of the beverage products, other than low-calorie products, of The Coca-Cola Company. The Company and The Coca-Cola Company have entered into arrangements for the purchase by the Company from The Coca-Cola Company of substantially all of the Company's requirements for sweeteners for 1995. See \"Certain Relationships and Related Transactions -- Agreements and Transactions with The Coca-Cola Company -- Sweetener Requirements Agreement\" in the Company's 1995 Proxy Statement, which information is incorporated by reference in Item 13 hereof. The Company does not separately purchase low-calorie sweeteners because sweeteners for the low-calorie beverage products of The Coca-Cola Company are contained in the concentrate purchased by the Company from The Coca-Cola Company.\nThe Company currently purchases a significant portion of its requirements for plastic bottles from companies jointly owned by it and other Coca-Cola bottlers. Management of the Company believes that ownership interests in certain suppliers and the self-manufacture of certain packages serve to reduce or contain costs.\nThere are no materials or supplies used by the Company which are currently in short supply, although the supply of specific materials could be adversely affected by strikes, weather conditions, governmental controls, or national emergencies.\nDOMESTIC BOTTLE CONTRACTS\nThe Company purchases concentrate and syrup from The Coca-Cola Company and markets, distributes, and produces the principal liquid nonalcoholic refreshment products in its territories within the United States under two basic forms of bottle contracts with The Coca-Cola Company: bottle contracts that cover the Coca-Cola Trademark Beverages (the \"Cola Bottle Contracts\") and bottle contracts that cover other carbonated beverages of The Coca-Cola Company (the \"Allied Bottle Contracts\") (herein referred to collectively as the \"Bottle Contracts\"). See \"Introduction\" and \"Products\" above. The Company and each of its wholly owned bottling company subsidiaries are parties to one or more separate Cola Bottle Contracts and to various Allied Bottle Contracts. In this section, unless the context indicates otherwise, a reference to the Company refers to the legal entity, which may be either the Company or one of its bottling company subsidiaries, which is a party to the Bottle Contracts with The Coca-Cola Company.\nThe Cola Bottle Contracts\nThe Cola Bottle Contracts provide that the Company will purchase its entire requirements of concentrates and syrups for Coca-Cola Trademark Beverages from The Coca-Cola Company at prices, terms of payment, and other terms and conditions of supply, as determined from time to time by The Coca-Cola Company in its sole discretion. The Company has the exclusive right to distribute Coca-Cola Trademark Beverages for sale in its territories in authorized containers. The Coca-Cola Company may determine, from time to time in its sole discretion, what types of containers to authorize for use with products of The Coca-Cola Company.\nPursuant to the Cola Bottle Contracts, The Coca-Cola Company annually establishes the prices charged to the Company for concentrates and syrups for Coca-Cola Trademark Beverages. The Company expects that net prices charged by The Coca-Cola Company in 1995 for syrup and concentrates will increase approximately 2.7% as compared to 1994 prices. The Coca-Cola Company has no rights under the Bottle Contracts to establish the resale prices at which the Company sells its products.\nThe Company is obligated to maintain such plant and equipment, staff, distribution, and vending facilities as are capable of manufacturing, packaging, and distributing Coca-Cola Trademark Beverages in accordance with the Cola Bottle Contracts and in sufficient quantities to satisfy fully the demand for these beverages in its territories; to undertake adequate quality control measures prescribed by The Coca-Cola Company; to develop and stimulate the demand for Coca-Cola Trademark Beverages in those territories; to use all approved means, and spend such funds on advertising and other forms of marketing, as may be reasonably required to satisfy that objective; and to maintain such sound financial capacity as may be reasonably necessary to assure performance by the Company and its affiliates of their obligations to The Coca-Cola Company. The Company is required to meet annually with The Coca-Cola Company to present plans for the following year that set out in reasonable detail its marketing, management, and advertising plans with respect to the Coca-Cola Trademark Beverages for the year, including financial plans showing that the Company and all of its bottler affiliates have the consolidated financial capacity to perform their duties and obligations to The Coca-Cola Company. The Coca-Cola Company may not unreasonably withhold approval of such plans. If the Company carries out its plans in all material respects, it will be deemed to have satisfied its obligations to develop, stimulate, and satisfy fully the demand for the Coca-Cola Trademark Beverages and to maintain the requisite financial capacity. Failure to carry out such plans in all material respects would constitute an event of default that, if not cured or waived by The Coca-Cola Company within 120 days of notice of the failure, would give The Coca-Cola Company the right to terminate the Cola Bottle Contract. If the Company at any time fails to carry out a plan in all material respects in any geographic segment of its territory, and if such failure is not cured within six months after notice of the failure, The Coca-Cola Company may reduce the territory covered by that Cola Bottle Contract by eliminating the portion of the territory with respect to which such failure has occurred.\nThe Coca-Cola Company has no obligation under the Bottle Contracts to participate with the Company in expenditures for advertising and marketing, but it may, in its discretion, contribute to such expenditures and undertake independent advertising and marketing activities, as well as cooperative advertising and sales promotion programs, that would require the cooperation and support of the Company. Although The Coca-Cola Company has advised the Company that it intends to continue to provide various forms of marketing support in 1995 at a comparable level of support as provided in 1994, it is not obligated to do so under the Bottle Contracts.\nIf the Company acquires control, directly or indirectly, of any bottler of Coca-Cola Trademark Beverages in the United States, or any party controlling a bottler of Coca-Cola Trademark Beverages in the United States, the Company must cause the acquired bottler to amend its bottle contract for the Coca-Cola Trademark Beverages to conform to the terms of the Cola Bottle Contract described above.\nThe Cola Bottle Contracts are perpetual, except for the contract covering the U.S. Virgin Islands and the islands of Tortola and Grand Cayman, which has a term of five years, after which the Company may request an additional five-year extension, to be granted at the sole discretion of The Coca-Cola Company. All Cola Bottle Contracts are subject to termination by The Coca-Cola Company in the event of default by the Company. Events of default with respect to each Cola Bottle Contract include: (i) production or sale of any cola product not authorized by The Coca-Cola Company; (ii) insolvency, bankruptcy, dissolution, receivership, or the like; (iii) any disposition by the Company of any voting securities of any bottling company without the consent of The Coca-Cola Company; and (iv) any material breach of any obligation of the Company under the Cola Bottle Contract that remains uncured for 120 days after notice by The Coca-Cola Company. If any Cola Bottle Contract is terminated, The Coca-Cola Company has the right to terminate all other Cola Bottle Contracts held by the bottler which is a party to the terminated contract, as well as the Cola Bottle Contracts of any other entity which such bottler controls.\nIn addition, each Cola Bottle Contract held by the Company provides that The Coca-Cola Company has the right to terminate that Cola Bottle Contract if a person or affiliated group (with\nspecified exceptions) acquires or obtains any contract, option, conversion privilege, or other right to acquire, directly or indirectly, beneficial ownership of more than 10% of any class or series of voting securities of the Company; however, The Coca-Cola Company has agreed with the Company that this provision will not apply with respect to the ownership of any class or series of voting securities of the Company, although it would apply to the voting securities of each bottling company subsidiary.\nThe provisions of the Cola Bottle Contracts of the Company which make it an event of default to dispose of any Cola Bottle Contract or voting securities of any bottling company subsidiary without the consent of The Coca-Cola Company and which prohibit the assignment or transfer of the Cola Bottle Contracts are designed to preclude any person not acceptable to The Coca-Cola Company from obtaining an assignment of a Cola Bottle Contract or from acquiring any voting securities of the Company's bottling subsidiaries. These provisions will prevent the Company from selling or transferring any of its interest in any bottling operations without the consent of The Coca-Cola Company. These provisions may also make it impossible for the Company to benefit from certain transactions, such as mergers or acquisitions, involving any of the bottling operations that might be beneficial to the Company and its share owners but which are not acceptable to The Coca-Cola Company.\nSupplementary Agreement\nIn addition to the Cola Bottle Contracts with The Coca-Cola Company described above, the Company is a party to a supplementary agreement (the \"Supplementary Agreement\") with The Coca-Cola Company regarding the exercise by The Coca-Cola Company of its rights under the Bottle Contracts. Pursuant to the Supplementary Agreement, The Coca-Cola Company has agreed to exercise good faith and fair dealing under the Bottle Contracts; offer marketing support and exercise its rights under the Bottle Contracts in a manner consistent with its dealings with comparable bottlers; offer to the Company any material written amendment to such Bottle Contracts which it offers to any other bottler; and, subject to certain limitations, sell syrups and concentrates to the Company at prices not greater than those charged to other bottlers which are parties to agreements substantially similar to the Bottle Contracts. The Supplementary Agreement provides for a term expiring on March 15, 1999 and may be terminated by The Coca-Cola Company upon 30 days' notice in the event that The Coca-Cola Company should cease to own more than 40% of the Company's outstanding common stock.\nThe Allied Bottle Contracts\nThe Allied Bottle Contracts contain provisions that are similar to those of the Cola Bottle Contracts with respect to pricing, authorized containers, planning, quality control, transfer restrictions, and related matters, and grant similar exclusive rights with respect to the distribution of beverages of The Coca-Cola Company which are neither Coca-Cola Trademark Beverages nor, except for Hi-C fruit drinks, noncarbonated beverages (the \"Allied Beverages\") for sale in authorized containers in specified territories. Under the Allied Bottle Contracts, the Company likewise has advertising, marketing, and promotional obligations, but without restriction as to the marketing of competitive products as long as there is no manufacturing or handling of other products that would imitate, infringe upon, or cause confusion with, the products of The Coca-Cola Company. The Coca-Cola Company has the right to discontinue any or all Allied Beverages, and the Company has a right, but not an obligation, under each of the Allied Bottle Contracts (except under the Allied Bottle Contracts for Hi-C fruit drinks and carbonated Minute Maid beverages) to elect to market any new beverage introduced by The Coca-Cola Company under the trademarks covered by the respective Allied Bottle Contracts. The Allied Bottle Contracts each have a term of ten years and are renewable by the bottler for an additional ten years at the end of each term. The initial term for most of the Company's Allied Bottle Contracts will expire in 1996 and subsequent years. The Allied Bottle Contracts are subject to termination in the event of default by the Company. The Coca-Cola\nCompany may terminate an Allied Bottle Contract in the event of: (i) insolvency, bankruptcy, dissolution, receivership, or the like; (ii) termination of the Cola Bottle Contract of the Company by either party for any reason; or (iii) any material breach of any obligation of the Company under the Allied Bottle Contract that remains uncured for 120 days after notice by The Coca-Cola Company.\nNoncarbonated Beverage Agreements\nThe Company purchases certain noncarbonated beverages such as isotonic, tea, and fruit drinks in finished form from The Coca-Cola Company, or its designees, pursuant to Marketing and Distribution Agreements (\"Noncarbonated Beverage Agreements\"). The Noncarbonated Beverage Agreements have some significant differences from the Cola Bottle Contracts.\nThe Noncarbonated Beverage Agreements each have a term of ten years and are renewable by the Company for an additional ten years at the end of each term. The initial term for most of the Noncarbonated Beverage Agreements for PowerAde will expire in 2004. Unlike the Cola Bottle Contracts, which grant the Company exclusivity in the distribution of the covered beverages in the territory, the Noncarbonated Beverage Agreements permit The Coca-Cola Company to test market noncarbonated beverage products in the territory, subject to the Company's right of first refusal to do so, and to sell noncarbonated beverages to commissaries for delivery to retail outlets in the territory where noncarbonated beverages are consumed on premise, such as restaurants. The Coca-Cola Company shall pay the Company certain fees for lost volume, delivery, and taxes in the event of such commissary sales.\nThe Coca-Cola Company, in its sole discretion, sets the pricing the Company must pay for noncarbonated beverages but has agreed, under certain circumstances, to give the Company the benefit of more favorable pricing if offered to other Coca-Cola bottlers. Under the Noncarbonated Beverage Agreements for PowerAde, the Company may not sell other isotonic beverages.\nIn general, except as set forth above, the Noncarbonated Beverage Agreements contain provisions similar to those in the Bottle Contracts with respect to pricing, planning, quality control, marketing, and promotional obligations.\nPost-Mix Marketing, Fountain Appointments, and Other Similar Arrangements\nThe Company has in the past sold and delivered the post-mix products of The Coca-Cola Company pursuant to one-year post-mix distributorship appointments. In 1994, the Company sold and\/or delivered such post-mix products in most of its major markets. Under the terms of the appointments, the Company is authorized to distribute such syrups to retailers for dispensing to consumers within the United States. The appointments are terminable by either party without cause upon ten days' written notice. Unlike the Bottle Contracts, there is no exclusive territory, and the Company faces competition not only from sellers of other post-mix syrups but from other sellers of post-mix syrups of The Coca-Cola Company (including The Coca-Cola Company). Depending on the market, the Company is involved in the sale, distribution, and marketing of post-mix syrups in differing degrees. In some markets, the Company sells syrup on its own behalf, but the primary responsibility for marketing lies with The Coca-Cola Company. In other territories, the Company is responsible for marketing post-mix syrup to certain segments of the market. See \"Certain Relationships and Related Transactions -- Agreements and Transactions with The Coca-Cola Company -- Agency Billing and Delivery Arrangements\" in the Company's 1995 Proxy Statement, which information is incorporated by reference in Item 13 hereof.\nOther Bottle Agreements\nThe bottle agreements between the Company and other licensors of beverage products and syrups generally give those licensors the unilateral right to change the prices for their products and syrups at any time in their sole discretion. Some of these bottling agreements have limited terms of appointment and, in most instances, prohibit the bottler from dealing in competitive products. Those\nagreements contain restrictions generally similar in effect to those in the Cola Bottle Contracts as to trade names, approved bottles, cans and labels, sale of imitations, and cause for termination.\nINTERNATIONAL BOTTLER'S AGREEMENT\nCCB Nederland operates in the Netherlands under a Bottler's Agreement dated December 14, 1992 (the \"International Bottler's Agreement\") with The Coca-Cola Company; this agreement has some significant differences from the domestic Bottle Contracts.\nThe International Bottler's Agreement expires September 30, 1998, unless terminated earlier as provided therein. If CCB Nederland has fully complied with the agreement during the initial term, is \"capable of the continued promotion, development, and exploitation of the full potential of the business\" and requests an extension of the agreement, an additional ten-year term may be granted at the sole discretion of The Coca-Cola Company. The Coca-Cola Company is given the right to terminate the International Bottler's Agreement before the expiration of the stated term upon the insolvency, bankruptcy, nationalization, or similar condition of CCB Nederland or the occurrence of a default under the International Bottler's Agreement which is not remedied within 60 days of notice of the default being given by The Coca-Cola Company. The International Bottler's Agreement may be terminated by either party in the event foreign exchange is unavailable or local laws prevent performance.\nCCB Nederland has the exclusive right within the Netherlands to sell the beverages covered by the International Bottler's Agreement in refillable glass and PET bottles. The covered beverages include the Coca-Cola Trademark and Allied Beverages. The Coca-Cola Company has retained the rights to produce and sell, or authorize third parties to produce and sell, the beverages in any other manner or form, including cans, within the territory. CCB Nederland has been granted a nonexclusive authorization to purchase finished product in cans from The Coca-Cola Company or its designee and to distribute them within its territory. This authorization is granted in connection with the International Bottler's Agreement and expires on September 30, 1998, with a provision for an extension of five years at the discretion of The Coca-Cola Company. The Coca-Cola Company has granted CCB Nederland a nonexclusive authorization to package and sell post-mix and pre-mix beverages in the territory; this authorization is terminable by either party with 90 days' prior notice.\nCCB Nederland is prohibited from making sales of the beverages outside of its territory, or to anyone intending to resell the beverages outside the territory, without the consent of The Coca-Cola Company, except for sales arising out of an order from a customer in another member state of the European Union or for export to another such member state. The International Bottler's Agreement contemplates that there may be instances in which large or special buyers have operations transcending the boundaries of CCB Nederland's territories, and in furtherance of this, CCB Nederland and The Coca-Cola Company are cooperating in sales to such buyers.\nThe Company believes that the International Bottler's Agreement is substantially similar to other agreements between The Coca-Cola Company and European bottlers of Coca-Cola Trademark and Allied Beverages.\nSimilar to the Bottle Contracts under which the Company and its other subsidiaries operate, the International Bottler's Agreement provides that the sales of beverage base and other goods to CCB Nederland are at prices which are set from time to time by The Coca-Cola Company. The Company expects that net prices charged in 1995 by The Coca-Cola Company for syrup, concentrate, and other goods will increase approximately 4% over 1994 prices.\nThe Coca-Cola Company has no commitment to provide marketing support under the International Bottler's Agreement, but it has done so in the past and has advised CCB Nederland that it intends to continue marketing support to CCB Nederland in 1995 at a similar level as provided in 1994.\nCOMPETITION\nThe liquid nonalcoholic refreshment business is highly competitive. Soft drinks compete with coffee, water, milk, beer, wine, sports drinks, bottled waters, tea, and juices as well as with noncarbonated soft drinks, citrus and noncitrus fruit drinks and other beverages. Competitors in this business include bottlers and distributors of nationally advertised and marketed products, regionally advertised and marketed products, and chain store and private label beverages. The Company estimates that in 1994 the products of The Coca-Cola Company represented approximately 34% of total food store soft drink sales in all domestic territories in which the Company operates, and that those of PepsiCo, Inc. represented approximately 30%. The Company also estimates that in each of its domestic territories, between 50% and 70% of food store soft drink sales are accounted for by the Company and its major competitor, which in most territories is the bottler of the soft drink products of PepsiCo, Inc.\nBrand recognition and pricing are significant factors affecting the Company's competitive position, and the trademarks associated with its products are the most favorable factor for the Company. Other competitive factors among bottlers are marketing, distribution methods, service to the trade and the management of sales promotion activities. Vending machine sales, packaging changes and contracts with fountain customers are also competitive factors.\nThe introduction of new products has been another major competitive element in the liquid nonalcoholic refreshment industry. The Company expects The Coca-Cola Company to introduce an increasing number of new \"alternative\" beverages during 1995. These products include teas, fruit drinks, \"natural\" sodas, and bottled waters.\nEMPLOYEES\nAs of March 1, 1995, the Company had approximately 30,000 employees, about 850 of whom are in the Netherlands. The Company is a party to collective bargaining agreements covering approximately 26% of its employees. These collective bargaining agreements expire at various dates through 1996. The Company has no reason to believe that it will be unable to renegotiate any of these agreements on satisfactory terms. Management of the Company believes that the Company's relations with its employees are generally good.\nGOVERNMENTAL REGULATION\nAnti-litter measures have been enacted in California, Connecticut, Delaware, Iowa, Massachusetts, Michigan, New York, Oregon, and the City of Columbia, Missouri, where some of the Company bottlers operate, prohibiting the sale of certain beverages, whether in refillable or nonrefillable containers, unless a deposit is charged by the retailer for the container. The retailer or redemption center refunds the deposit to the customer upon the return of the container. The containers are then returned to the bottler, which, in most jurisdictions, must pay the refund and, in certain others, must also pay a handling fee. In the past, similar legislation has been proposed but not adopted elsewhere, although the Company anticipates that additional states or local jurisdictions may enact such laws.\nMassachusetts requires the creation of a deposit transaction fund by bottlers and the payment to the state of balances in that fund that exceed three months of deposits received, net of deposits repaid to customers and interest earned. A portion of the Massachusetts law was held unconstitutional by the Massachusetts Supreme Judicial Court as it related to deposits escheated to the state prior to the effective date of the law. Michigan also has a statute, effective January 1, 1990, requiring bottlers to pay to the state unclaimed container deposits. In June 1994 the Michigan Court of Appeals upheld the constitutionality of the Michigan law. The Michigan Soft Drink Association has petitioned the Michigan Supreme Court to accept an appeal of the case, but under Michigan law, an appeal to the Michigan Supreme Court is discretionary with the court.\nExcise taxes on sales of soft drinks have been in place in various states for several years. The states in which the Company operates currently imposing such taxes are Arkansas, Louisiana, North Carolina, Tennessee, and Washington. The Ohio tax on soft drinks was overridden by popular referendum in 1994. In addition, three local jurisdictions in which the Company operates, Baltimore City and Montgomery County, Maryland and Honolulu, Hawaii, have imposed a special tax on nonrefillable soft drink containers. To the knowledge of management of the Company, no similar legislation has been enacted in any other markets served by the Company. Proposals have been introduced in certain states and localities that would impose a special tax on beverages sold in nonrefillable containers as a means of encouraging the use of refillable containers. Management of the Company is unable to predict, however, whether such additional legislation will be adopted.\nThe Company has taken actions to mitigate the adverse effects resulting from legislation concerning deposits, restrictive packaging, and escheat of unclaimed deposits which impose additional costs on the Company. The Company is unable to quantify the impact on current and future operations which may result from such legislation if enacted in the future, but any such legislation could be significant if widely enacted.\nThe domestic production, distribution, and sale of many of the Company's products are subject to the Federal Food, Drug, and Cosmetic Act; the Occupational Safety and Health Act; the Lanham Act; various federal, state, and local environmental statutes and regulations; and various other federal, state, and local statutes regulating the production, packaging, sale, safety, advertising, labeling, and ingredients of such products.\nA California law, enacted in 1986 by ballot initiative, requires that any person who exposes another to a carcinogen or a reproductive toxicant must provide a warning to that effect. Because the law does not define quantitative thresholds below which a warning is not required, virtually all manufacturers of food products are confronted with the possibility of having to provide warnings due to the presence of trace amounts of defined substances. Regulations implementing the law exempt manufacturers from providing the required warning if it can be demonstrated that the defined substances occur naturally in the product or are present in municipal water used to manufacture the product. The Company has assessed the impact of the law and its implementing regulations on the Company's soft drink and other products and has concluded that none of the Company's products currently requires a warning under the law. The Company cannot predict whether or to what extent food industry efforts to minimize the law's impact on food products will succeed, nor can the Company predict what impact, either in terms of direct costs or diminished sales, imposition of the law may have.\nSubstantially all of the facilities of the Company are subject to federal, state, and local provisions regulating above-ground and underground fuel storage tanks and the discharge of materials into the environment. Compliance with these provisions has not had, and the Company does not expect such compliance to have, any material effect upon the capital expenditures, net income, financial condition, or competitive position of the Company. The Company's beverage manufacturing operations do not use or generate a significant amount of toxic or hazardous substances. Management believes that its current practices and procedures for the control and disposition of such wastes comply with applicable federal and state requirements. The Company has been named as a potentially responsible party in connection with certain landfill sites where the Company may have been a de minimis contributor. Under current law, the Company's liability for cleanup costs may be joint and several with other users of such sites, regardless of the extent of the Company's use in relation to other users. However, in the opinion of management of the Company, the potential liability of the Company in connection with such activity is not significant and will not have a material adverse effect on the financial condition or results of operations of the Company.\nSeveral underground fuel storage tanks used by the Company may be found to be in noncompliance with applicable federal and state requirements for the continued maintenance and use of such tanks. The Company has adopted a plan for the testing, removal, replacement, and\nrepair, if necessary, of underground fuel storage tanks at Company bottlers and remediation of their sites, if necessary. The Company spent approximately $25 million pursuant to such plan in 1991, $8 million in 1992, $9 million in 1993 and $12 million in 1994. The Company estimates it will spend approximately $5 million in each of 1995 and 1996 pursuant to this plan. In the opinion of management of the Company, any liabilities associated with such underground fuel storage tanks will not have a material adverse effect on the financial condition or results of operations of the Company.\nThe business of the Company, as the exclusive manufacturer and distributor of bottled and canned beverage products of The Coca-Cola Company and other manufacturers within specified geographic territories, is subject to federal and state antitrust laws of general applicability. Under the federal Soft Drink Interbrand Competition Act, the exercise and enforcement of an exclusive contractual right to manufacture, distribute, and sell a soft drink product in a geographic territory is presumptively lawful if the soft drink product is in substantial and effective interbrand competition with other products of the same class in the market. Management of the Company believes that there is such substantial and effective competition in each of the exclusive geographic territories in which the Company operates.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe executive offices of the Company occupy approximately 28,000 square feet in an office building in Atlanta, Georgia leased from The Coca-Cola Company. See \"Certain Relationships and Related Transactions -- Agreements and Transactions with The Coca-Cola Company -- Lease of Office Space\" in the Company's 1995 Proxy Statement, which information is incorporated by reference in Item 13 hereof.\nThe principal properties of the Company include production facilities, distribution facilities, administrative offices, and service centers. The Company operates 45 beverage production facilities, 17 of which are solely production facilities and 28 of which are combination production\/distribution facilities, and also operates 223 principal distribution facilities. The Company owns 44 of its production facilities, owns 193 of its principal distribution facilities, and leases the others. In the aggregate, the Company's owned and leased facilities cover approximately 22 million square feet. Management of the Company believes that its production and distribution facilities are generally sufficient to meet present operating needs.\nSeventeen of the facilities owned by the Company are subject to liens to secure indebtedness in an aggregate principal amount of approximately $10 million at December 31, 1994. Excluding expenditures for bottler acquisitions, the Company's capital expenditures in 1994 were approximately $366 million.\nThe Company also owns and operates approximately 24,000 vehicles of all types used in the sale, production, and distribution of its products. The Company also owns approximately 860,000 coolers, beverage dispensers, and vending machines.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nImmediately prior to the acquisition of Johnston Coca-Cola by the Company in 1991, a derivative suit (i.e., one which is purportedly brought on behalf of the Company) was filed by Three Bridges Investment Group in the Chancery Court of the State of Delaware against The Coca-Cola Company, Johnston Coca-Cola, and the directors of the Company then in office. The suit is seeking, among other things, a declaration that it is a proper class action, an injunction or rescission of the acquisition of Johnston Coca-Cola, damages, costs, and attorneys' fees. The complaint alleged breaches of fiduciary duties on the part of The Coca-Cola Company and the directors, and asserted a claim against Johnston Coca-Cola for allegedly aiding and abetting the alleged wrongdoing. Johnston Coca-Cola has since been dismissed from the claim, and the remaining defendants have\nfiled answers denying all substantive allegations. The suit is still in the process of discovery. Management of the Company believes this action to be without merit and is defending it vigorously.\nThe Company and several of its bottling subsidiaries or divisions have been named as potentially responsible parties (\"PRPs\") at several federal \"Superfund\" sites. In 1992, the Florida Coca-Cola Bottling Company (\"Florida CCBC\") was named by the Environmental Protection Agency (\"EPA\") as a PRP at the Peak Oil site in Tampa, Florida, formerly the location of a refiner of used motor oil. Other PRPs have claimed that the amount of waste oil contributed by Florida CCBC was such that its ultimate liability for cleanup cost would be from $600,000 to $1.4 million. Florida CCBC has contested the amount of waste oil attributable to it, and it is not known whether Florida CCBC's ultimate liability, if any, will be material. In 1992, another PRP at the West Memphis Landfill site in West Memphis, Arkansas brought The Coca-Cola Bottling Company of Memphis, Tenn. (\"CCBC Memphis\") into the remediation proceedings as an additional PRP with respect to that site, which is alleged to have been used in the 1950s and 1960s as a dump site for the by-products from the reprocessing of used motor oil. The EPA is still investigating the site and has not issued an estimate for the cost of remediation, although the PRP naming CCBC Memphis has estimated the total cost to be as much as $45 million. The involvement of CCBC Memphis has not yet been determined; accordingly, CCBC Memphis does not yet know whether its liability, if any, would be material. In November 1994, the EPA notified the Coca-Cola Bottling Company of Northeast Arkansas (\"CCBC NEARK\"), a bottler acquired by the Company in December 1993, that it was also considered to be a PRP with respect to the West Memphis Landfill site. It is believed that CCBC NEARK had no connection with this site, and in any event the Company has the right of indemnification against the former owners of CCBC NEARK. In April 1994, the Company was notified by a PRP group at the Waste Disposal Engineering site in Andover, Minnesota, that one of its predecessor companies, Midwest Coca-Cola Bottling Company (\"Midwest CCBC\") could be a PRP at such site, a former landfill. The claim against the Company is approximately $100,000; however, if this site is a \"qualified landfill\" under Minnesota law, the entire cost of remediation may be paid by the state without contribution from any PRP. In November 1994, Florida CCBC received notice from a PRP group at the Petroleum Products Corporation site in Pembroke Park, Florida, that it could be a PRP at such site, the former location of a used oil recycling facility. Total cleanup for the site is believed to be as much as $40 million. The PRP group has stated that it is its intention to sue Florida CCBC and approximately 1,000 other PRPs to contribute to the remediation. However, Florida CCBC and the PRP group have entered into a tolling agreement with respect to the statute of limitations, the effect of which is to delay the filing of the suit until Florida CCBC has completed its investigation of its involvement, if any, with the site. In November 1994, Florida CCBC received notice from a PRP group at the Bay Drums site in Tampa, Florida, that it could be a PRP at such site, the former location of a drum recycling facility that operated from 1960 to 1984. Total cleanup for the site is believed to be as much as $20 million. Florida CCBC is currently in the process of investigating its connection, if any, with the site, and it is not known whether Florida CCBC's ultimate liability, if any, will be material. In January 1995, Florida CCBC received notice from a PRP group at the Taylor Road Landfill site in Tampa, Florida that it could be a PRP at such site. Florida CCBC believes that its only connection to this site is to have sent nonhazardous waste (scrap wooden shells) and has asked the PRP group for information as to why it has received such notice. The Company or its bottling subsidiaries have been named PRPs at eight other federal and five state \"Superfund\" sites where management of the Company has concluded either (i) that the Company will have no further liability because there was no responsibility for having deposited hazardous waste; (ii) that payments made to date would be sufficient to satisfy all liability; or (iii) that the Company's ultimate liability, if any, for such site would be less than $100,000.\nThere are various other lawsuits and claims pending against the Company. Included among such litigation are claims for injury to persons or property. Management of the Company believes that such claims are covered by insurance with financially responsible carriers or adequate provisions for losses have been recognized by the Company in its consolidated financial statements.\nIn the opinion of management of the Company, the losses that might result from such litigation will not have a material adverse 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 4(A). EXECUTIVE OFFICERS OF THE COMPANY\nSet forth below is information as of March 5, 1995 regarding the executive officers of the Company:\nSummerfield K. Johnston, Jr. is the father of Summerfield K. Johnston III.\nThe officers of the Company are elected annually by the Board of Directors for terms of one year or until their successors are elected and qualified, 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\nLISTED AND TRADED: New York Stock Exchange\nTRADED: Boston, Cincinnati, Midwest, Pacific, and Philadelphia Exchanges\nShare owners of common stock of record as of March 3, 1995: 8,943\nSTOCK PRICES\nDIVIDENDS\nQuarterly dividends in the amount of $0.0125 per share were paid during the fiscal years 1993 and 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\"Selected Financial Data\" for the years 1986 through 1994, on pages 46 and 47 of the Company's Annual Report to Share Owners for the year ended December 31, 1994, 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 Financial Review\" on pages 18 through 29 of the Company's Annual Report to Share Owners for the year ended December 31, 1994, 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 Registrant and its subsidiaries are incorporated herein by reference to the Company's Annual Report to Share Owners for the year ended December 31, 1994, at the pages indicated:\nConsolidated Statements of Operations -- Years ended December 31, 1994, 1993 and 1992 (page 21)\nConsolidated Statements of Cash Flows -- Years ended December 31, 1994, 1993 and 1992 (page 23)\nConsolidated Balance Sheets -- December 31, 1994 and 1993 (page 25)\nConsolidated Statements of Share-Owners' Equity -- Years ended December 31, 1994, 1993 and 1992 (page 26)\nNotes to Consolidated Financial Statements (pages 30-43)\nReport of Independent Auditors (page 45)\n\"Quarterly Financial Data,\" on page 43 of the Company's Annual Report to Share Owners for the year ended December 31, 1994, is also 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\nInformation relating to the directors of the Company is set forth under the captions \"Election of Directors -- Nominees\" and \"Election of Directors -- Information Concerning Directors\" on page 3 and on pages 4 through 6, respectively, of the Company's 1995 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 at Item 4(A) of this report under the caption \"Executive Officers of the Company.\" Information regarding compliance with the reporting requirements of Section 16(a) of the Securities Exchange Act of 1934, as amended, by the Company's executive officers and directors, persons who own more than ten percent of the Company's common stock and their affiliates who are required to comply with such reporting requirements is set forth in \"Election of Directors -- Compliance with Section 16(a) of the Securities Exchange Act of 1934\" on page 10 of the Company's 1995 Proxy Statement. Such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to executive compensation is set forth under the captions \"Election of Directors -- Compensation of Directors\" and \"Election of Directors -- Executive Compensation\" on pages 7 and 8 and pages 12 through 21, respectively, of the Company's 1995 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 common stock by certain persons is set forth under the captions \"Voting -- Principal Share Owners\" and \"Election of Directors -- Security Ownership of Directors and Officers\" on pages 2 and 3 and pages 8 through 10, respectively, of the Company's 1995 Proxy Statement. Such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation regarding certain transactions between the Company, The Coca-Cola Company and their affiliates and certain other persons is set forth under the caption \"Election of Directors -- Certain Relationships and Related Transactions\" on pages 22 through 26 of the 1995 Proxy Statement. Such 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) (1) Financial Statements. The following consolidated financial statements of the Company and subsidiaries, included in the Company's Annual Report to Share Owners for the year ended December 31, 1994, are incorporated by reference in Part II, Item 8 of this report:\nConsolidated Statements of Operations -- Years ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Cash Flows -- Years ended December 31, 1994, 1993 and 1992.\nConsolidated Balance Sheets -- December 31, 1994 and 1993.\nConsolidated Statements of Share-Owners' Equity -- Years ended December 31, 1994, 1993 and 1992.\nNotes to Consolidated Financial Statements.\nReport of Independent Auditors.\n(2) Financial Statement Schedules. The following financial statement schedule of the Company and its subsidiaries is included in this report on the page indicated:\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission have been omitted either because they are not required under the related instructions or because they are inapplicable.\n(3) Exhibits.\n- ---------------\n* Management contracts and compensatory plans as arrangements required to be filed as an exhibit to this form pursuant to Item 14(c).\n(B) REPORTS ON FORM 8-K.\nOn November 4, 1994, the Company filed a Current Report on Form 8-K, the date of which report was October 18, 1994, regarding the Company's financial results for the third quarter and the first nine months of 1994.\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. COCA-COLA ENTERPRISES INC. (Registrant)\nBy: \/s\/ S. K. JOHNSTON, JR. ------------------------------------ S. K. Johnston, Jr. Vice Chairman and Chief Executive Officer\nDate: March 15, 1995\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.\nINDEX TO FINANCIAL STATEMENT SCHEDULE\nCOCA-COLA ENTERPRISES INC. REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nBoard of Directors Coca-Cola Enterprises Inc.\nWe have audited the consolidated financial statements of Coca-Cola Enterprises Inc. listed in Part IV, Item 14 (a)(1). Our audits also included the financial statement schedule listed in Part IV, Item 14 (a)(2). 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Coca-Cola Enterprises Inc. at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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 the notes to consolidated financial statements, in 1992 the Company changed its methods of accounting for income taxes and postretirement benefits other than pensions.\n\/s\/ ERNST & YOUNG LLP\nAtlanta, Georgia January 30, 1995\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOCA-COLA ENTERPRISES INC.\n- ---------------\n(a) Principally represents allowances for losses on trade accounts of acquired companies at date of acquisition and recoveries of amounts previously charged off. (b) Charge off of uncollectible accounts. (c) Adoption of FAS 109 as of January 1, 1992.","section_15":""}
{"filename":"27409_1994.txt","cik":"27409","year":"1994","section_1":"Item 1. Business. and Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nDayton and Michigan Railroad Company (the \"Company\") is a railroad incorporated in the State of Ohio on March 5, 1851. It owns a line of railroad 141 miles long which lies between Dayton and Toledo, Ohio. Under the terms of a perpetual lease dated May 1, 1863, CSX Transportation, Inc. (\"CSXT\"), as successor by merger, operates the property of the Company, paying rental charges measured principally by the annual dividend requirements of the Company's outstanding shares of capital stock; consisting of two classes, preferred and common. The Company's preferred stock ($50 par value) pays guaranteed dividends of 8%, and its common stock ($50 par value) pays guaranteed dividends of 3-1\/2%. The lease excludes from the measure of the rental charges the dividend requirements on the Company's shares owned by CSXT. As of December 31, 1994, CSXT owned 66.7% of the Company's preferred stock and 80.39% of its common stock.\nIn addition to the rental charges paid by CSXT to the Company for the payment of the Company's dividends, CSXT directly assumes and pays all the operating expenses of and reimburses all taxes assessed against the Company.\nSince the dividends on the Company's preferred and common stock are paid from monies obtained from CSXT pursuant to a lease to CSXT, reference is made to CSXT's Form 10-K for the year ended December 30, 1994, a copy of which is available from Patricia J. Aftoora, Vice President and Corporate Secretary of CSXT, S\/C J-160, 500 Water Street, Jacksonville, FL 32202.\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 Stock and Related Stockholder Matters.\nThe Company's common stock is listed on the Cincinnati Stock Exchange. From a known market maker in the Company's common stock, as of March 10, 1995, a price of $20.25 per share was bid but there were no sales. As of March 10, 1995, there were approximately 73 common shareholders of record.\nThe principal source of quotations, The National Quotation Bureau, Inc. indicates no bid and ask quotations for the Company's common and preferred stocks during the two year period of 1994 and 1993.\nDividends on the Company's preferred and common stocks are guaranteed at 8% on the preferred stock and 3-1\/2% on the common stock pursuant to a perpetual lease agreement dated May 1, 1863, as amended, between the Company and CSXT, more specifically referred to in Items 1 and 2, Business and Properties.\n- 2 -\nItem 6.","section_6":"Item 6. Selected Financial Data. and Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nFive year selected data:\n1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ---------- Income $ 126,706 $ 147,795 $ 114,035 $ 154,661 $ 253,657 Expense --- --- --- --- --- Income Tax Expense 32,850 38,317 28,934 31,344 74,071 ---------- ---------- ---------- ---------- ---------- Net Earnings 93,856 109,478 85,101 123,317 179,586 Dividends on Preferred Stock 32,672 32,672 32,550 33,240 33,240 ---------- ---------- ---------- ---------- ---------- Earnings Available to Common Stock $ 61,184 $ 76,806 $ 52,551 $ 90,077 $ 146,346 ========== ========== ========== ========== ========== Weighted Average Number of Common Shares (a) 9,525 9,525 9,533 9,645 9,645 ========== ========== ========== ========== ========== Earnings Per Common Share (a) $ 6.42 $ 8.06 $ 5.51 $ 9.34 $ 15.17 ========== ========== ========== ========== ========== Dividends Per Common Share (a) $ 1.75 $ 1.75 $ 1.75 $ 1.75 $ 1.75 ========== ========== ========== ========== ==========\nTotal Assets $1,783,088 $1,738,573 $1,678,436 $1,642,571 $1,569,373 ========== ========== ========== ========== ==========\n(a) This does not include shares held by CSX Transportation, Inc. See Note 2 to the Financial Statements.\nNet earnings for 1994 totaled $93,856, a decrease of $15,622 from 1993 and an increase of $8,755 from 1992. The 1994 decrease in net earnings compared to 1993 resulted from higher interest income which was more than offset by decreases in rental income and gains on property sales. The 1993 increase in net earnings compared to 1992 resulted from higher rental income and gains on property sales partially offset by lower interest income.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe financial statements and notes thereto required in response to this item are included herein on pages 11 to 15. (See Index to Financial Statements on page 9).\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone. - 3 -\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Officers of the Registrant.\nDirectors\nThe information concerning directors is incorporated herein by reference to Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission prior to April 30, 1995.\nExecutive Officers\nThe following sets forth certain information relating to the Company's executive officers as of March 10, 1995. Officers are elected annually at the annual meeting of the Board and hold office until the next annual meeting of the Board or until their successors are elected. There are no arrangements or understanding between any director or executive officer and any other person pursuant to which the director or officer was selected. Patricia J. Aftoora and Albert B. Aftoora are married. There are no other family relationships among these officers and directors.\nName, Age, Present Position with the Business Experience during last 5 Years, Company Company Directorships in Public Corporations ------------------ --------------------------------------------\nGERALD L. NICHOLS, 59 President of the Company since March 1, 1995, President and Director and Senior Vice President prior thereto. Mr. Nichols has served in various executive capacities for certain CSXT affiliates during the past five years and is currently Executive Vice President and Chief Operating Officer of CSXT.\nPAUL R. GOODWIN, 52 Executive Vice President of the Company since Executive Vice President March 1990. During the past five years, Mr. and Director Goodwin has served as an executive officer of certain CSXT affiliates and is currently Executive Vice President-Finance and Administration of CSXT.\nP. MICHAEL GIFTOS, 48 Senior Vice President of the Company since Senior Vice President October 1990. During the past five years, Mr. and Director Giftos has served as an officer of CSX Corporation (\"CSX\") and certain CSX affiliates and is currently Senior Vice President and General Counsel of CSXT.\nPATRICIA J. AFTOORA, 55 Vice President of the Company since March 1990 Vice President, and Corporate Secretary of the Company since Corporate Secretary December 1980. Mrs. Aftoora has served and Director as an officer of CSX and certain CSX affiliates during the past five years and is currently Vice President and Corporate Secretary of CSXT.\n- 4 -\nName, Age, Present Position with the Business Experience during last 5 Years, Company Company Directorships in Public Corporations ------------------ -------------------------------------------\nWILLIAM H. COSGROVE, 41 Vice President and Controller of the Company Vice President and Controller since August 8, 1994. During the past five and Director years, Mr. Cosgrove has served as an officer of certain CSXT affiliates and is currently Chief Commercial Officer of C&O Business Unit of CSXT.\nALBERT B. AFTOORA, 55 Assistant Vice President and Treasurer of Assistant Vice President, the Company since October 1990 and Treasurer Treasurer and Director prior thereto. Mr. Aftoora has served as an officer of certain CSXT affiliates during the past five years and is currently Assistant Vice President and Treasurer of CSXT.\nTHOMAS P. SCHMIDT, 47 Vice President of the Company since June Vice President and Director 1992. Mr. Schmidt has served as an officer of certain CSXT affiliates during the past five years and is currently Vice President- Service Design of CSXT.\nBILLIE C. EASON, 46 During the past five years, Mr. Eason has Director served as an officer of certain CSXT affiliates and is currently Vice President- Service Operations of CSXT.\nCARL N. TAYLOR, 55 During the past five years, Mr. Taylor has Director served as an executive officer of certain CSXT affiliates and is currently Senior Vice President-Engineering and Mechanical of CSXT.\nThere have been no events under any bankruptcy act, no criminal proceedings, orders, judgments, decrees or injunctions material to the evaluation of the ability and integrity of any director or executive officer during the past five years.\nItem 11.","section_11":"Item 11. Executive Compensation\nPrior to April 30, 1995, the Registrant will file with the Securities and Exchange Commission, pursuant to Regulation 14A, a definitive proxy statement, and said document is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nPrior to April 30, 1995, the Registrant will file with the Securities and Exchange Commission, pursuant to Regulation 14A, a definitive proxy statement, and said document is incorporated herein by reference.\n- 5 -\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nPrior to April 30, 1995, the Registrant will file with the Securities and Exchange Commission, pursuant to Regulation 14A, a definitive proxy statement, and said document 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\nSee Index to Financial Statements on page 9.\n2. Financial Statement Schedules\nNone.\n3. Exhibits\n(3.1) Articles of Incorporation incorporated herein by reference to Registrant's Form 12 Application for Registration, filed on March 24, 1935.\n(3.2) Code of Regulations incorporated herein by reference to Registrant's report on Form 8-K filed June 3, 1966.\n(10) Material Contracts\nLease Agreement dated May 1, 1863, as amended between the Registrant and CSX Transportation, Inc. (successor to The Cincinnati, Hamilton and Dayton Railroad Company) incorporated herein by reference to Registrant's Form 12 Application for Registration, filed on March 24, 1935.\nSupplemental Agreement modifying original lease agreement dated December 23, 1944, incorporated herein by reference to Registrant's report on Form 8-K filed on July 1, 1954.\n(b) No reports on Form 8-K were filed for the fourth quarter of the year ended December 31, 1994.\n- 6 -\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 30th day of March, 1995.\nDAYTON AND MICHIGAN RAILROAD COMPANY\n\/s\/ GREGORY R. WEBER ------------------------------------ Gregory R. Weber (Principal Accounting Officer)\nMarch 30, 1995\n- 7 -\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\/Gerald L. Nichols President and Director ------------------------ (Principal Executive Officer) Gerald L. Nichols*\n\/s\/Paul R. Goodwin Executive Vice President and Director ------------------------ (Principal Finance Officer) Paul R. Goodwin*\n\/s\/P. Michael Giftos Senior Vice President, General Counsel ------------------------ and Director P. Michael Giftos*\n\/s\/Patricia J. Aftoora Vice President, Corporate Secretary ------------------------ and Director Patricia J. Aftoora*\n\/s\/William H. Cosgrove Vice President, Controller and Director ------------------------ William H. Cosgrove*\n\/s\/Thomas P. Schmidt Vice President and Director ------------------------ Thomas P. Schmidt*\n\/s\/Albert B. Aftoora Assistant Vice President, ------------------------ Treasurer and Director Albert B. Aftoora*\n\/s\/Carl N. Taylor Director ------------------------ Carl N. Taylor*\n\/s\/Billie C. Eason Director ------------------------ Billie C. Eason*\nPatricia J. Aftoora, by signing her name hereto, does hereby sign and execute this report on behalf of each of the above-named officers and directors of Dayton and Michigan Railroad Company pursuant to powers of attorney executed by each of such officers and directors and filed with the Securities and Exchange Commission as an exhibit to this report.\n\/s\/ PATRICIA J. AFTOORA ------------------------ Patricia J. Aftoora March 30, 1995 *(Attorney-in-Fact)\n- 8 -\nDAYTON AND MICHIGAN RAILROAD COMPANY\nPage ---- Report of Ernst & Young LLP, Independent Auditors . . . . . . . . . . 10\nFinancial Statements and Notes to Financial Statements Submitted Herewith:\nStatements of Earnings - Years Ended December 31, 1994, 1993 and 1992. . . . . . . . . . . . . . . . 11\nStatements of Cash Flows - Years Ended December 31, 1994, 1993 and 1992. . . . . . . . . . . . . . . . 12\nStatements of Financial Position - December 31, 1994 and 1993 . . . . . . . . . . . . . . . . . . . . . . . . . 13\nStatements of Retained Earnings (Deficit) - Years Ended December 31, 1994, 1993 and 1992. . . . . . . . . . . . . 14\nNotes to Financial Statements . . . . . . . . . . . . . . . . . . 15\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- 9 -\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Shareholders and Board of Directors Dayton and Michigan Railroad Company\nWe have audited the accompanying statement of financial position of Dayton and Michigan Railroad Company as of December 31, 1994 and 1993, and the related statements of earnings, cash flows, and retained earnings (deficit) for each of the three years in the period ended December 31, 1994. 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 (appearing on pages 11-15) present fairly, in all material respects, the financial position of Dayton and Michigan Railroad Company at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\n\/s\/ ERNST & YOUNG LLP --------------------- Ernst & Young LLP\nRichmond, Virginia January 27, 1995\n- 10 -\nDAYTON AND MICHIGAN RAILROAD COMPANY STATEMENTS OF EARNINGS\nYear Ended ------------------------------- Dec. 31, Dec. 31, Dec. 31, 1994 1993 1992 -------- -------- --------\nINCOME\nRental Income $ 82,191 $ 87,606 $ 78,118 Interest Income 44,515 33,362 35,917 Gain on Disposition of Properties --- 26,827 --- -------- -------- --------\nEARNINGS BEFORE INCOME TAXES 126,706 147,795 114,035\nINCOME TAX EXPENSE 32,850 38,317 28,934 -------- -------- --------\nNET EARNINGS $ 93,856 $109,478 $ 85,101 ======== ======== ========\nEARNINGS PER COMMON SHARE $ 6.42 $ 8.06 $ 5.51 ======== ======== ========\nSee accompanying Notes to Financial Statements.\n- 11 -\nDAYTON AND MICHIGAN RAILROAD COMPANY STATEMENTS OF CASH FLOWS\nYear Ended ------------------------------- Dec. 31, Dec. 31, Dec. 31, 1994 1993 1992 -------- -------- --------\nOPERATING ACTIVITIES\nNet Earnings $ 93,856 $109,478 $ 85,101 Gain on Disposition of Properties --- (26,827) --- -------- -------- -------- Cash Provided by Operating Activities 93,856 82,651 85,101 -------- -------- -------- INVESTING ACTIVITIES\nProceeds from Property Dispositions --- 26,827 --- Advances to CSXT, Net (44,515) (60,137) (35,865) -------- -------- -------- Cash Used by Investing Activities (44,515) (33,310) (35,865) -------- -------- -------- FINANCING ACTIVITIES\nCash Dividends Paid - Preferred (32,672) (32,672) (32,550) - Common (16,669) (16,669) (16,686) -------- -------- -------- Cash Used by Financing Activities (49,341) (49,341) (49,236) -------- -------- -------- CASH AND CASH EQUIVALENTS\nChange in Cash and Cash Equivalents --- --- ---\nCash and Cash Equivalents at Beginning of Year --- --- --- -------- -------- -------- Cash and Cash Equivalents at End of Year $ --- $ --- $ --- ======== ======== ========\nSee accompanying Notes to Financial Statements.\n- 12 -\nDAYTON AND MICHIGAN RAILROAD COMPANY STATEMENTS OF FINANCIAL POSITION\nDec. 31, Dec. 31, 1994 1993 ----------- ----------- ASSETS\nLand and Improvements $ 684,954 $ 688,830\nAdvances to CSXT 1,098,134 1,049,743 ----------- ----------- Total Assets $ 1,783,088 $ 1,738,573 =========== ===========\nSHAREHOLDERS' EQUITY\nPreferred Stock, Non Voting Par Value $50; Authorized 74,000 Shares; Issued and Outstanding 24,225 Shares $ 1,211,250 $ 1,211,250 Common Stock, Par Value $50; Authorized 60,000 Shares; Issued and Outstanding 48,066.18 Shares 2,403,309 2,403,309 Retained Deficit (1,831,471) (1,875,986) ----------- ----------- Total Shareholders' Equity $ 1,783,088 $ 1,738,573 =========== ===========\nSee accompanying Notes to Financial Statements.\n- 13 -\nDAYTON AND MICHIGAN RAILROAD COMPANY STATEMENTS OF RETAINED EARNINGS (DEFICIT)\n1994 1993 1992 --------- --------- ---------\nBeginning Balance $(1,875,986) $(1,936,123) $(1,971,988)\nNet Earnings 93,856 109,478 85,101\nDividends Preferred Stock--$4.00 Per Share (32,672) (32,672) (32,550) Common Stock--$1.75 Per Share (16,669) (16,669) (16,686) ----------- ----------- ----------- Ending Balance $(1,831,471) $(1,875,986) $(1,936,123) =========== =========== ===========\nSee accompanying Notes to Financial Statements.\n- 14 -\nDAYTON AND MICHIGAN RAILROAD COMPANY NOTES TO FINANCIAL STATEMENTS\nNOTE 1. CAPITAL STOCK AND PRINCIPAL SHAREHOLDER.\nCSX Transportation, Inc. (CSXT) owns 66.70% of the Company's preferred stock and 80.39% of its common stock at December 31, 1994. Dividends paid and rental income on the accompanying financial statements exclude amounts related to shares held by CSXT. CSXT is engaged principally in the business of railroad transportation and operates a system comprising 18,759 miles of first main line track in 20 states principally east of the Mississippi River (exclusive of New England), southern Ontario and the District of Columbia.\nNOTE 2. LEASE AGREEMENT.\nThe Company has no operations. Its property is leased in perpetuity to CSXT and is maintained and operated by, for and in the name of CSXT. As rent, CSXT pays the Company's income taxes, administrative expenses and guaranteed dividends on the Company's 3-1\/2% common and 8% preferred stocks on shares held by other than CSXT. All operating expenses of the Company are paid directly by CSXT and are not shown in the accompanying financial statements. Interest income is earned on amounts due from CSXT based on interest rates earned by CSX on its short-term investment portfolio.\nNOTE 3. INCOME TAXES.\nThe income tax provision, reconciled to the tax computed at statutory rates was: 1994 1993 1992 -------- --------- -------- Tax at statutory rate $ 44,347 $ 51,728 $ 38,772 Income tax reimbursement effect (11,497) (13,411) (9,838) -------- -------- -------- Income taxes $ 32,850 $ 38,317 $ 28,934 ======== ======== ======== NOTE 4. EARNINGS PER SHARE.\nEarnings per common share are computed after giving effect to preferred stock dividend requirements and are based on the weighted average number of common shares outstanding, excluding shares held by CSXT.\nNOTE 5. PROPERTIES.\nProperties are carried principally at cost. Additions, retirements and depreciation are charged directly to amounts due from CSXT. There was no significant change in properties during 1994 or 1993. In 1992, there was a $178,925 net change in the detailed property records for abandonment corrections and other adjustments from prior years which were charged to amounts due from CSXT.\nNOTE 6. CASH AND CASH EQUIVALENTS.\nAll of the Company's cash has been advanced to CSXT for investment purposes. Future cash requirements of the Company will be funded by CSXT.\n- 15 -","section_15":""}
{"filename":"904255_1994.txt","cik":"904255","year":"1994","section_1":"ITEM 1. BUSINESS.\nOVERVIEW\nAirTouch Communications, Inc. is one of the world's leading wireless telecommunications companies, with significant cellular interests in the United States, Western Europe and Asia. The Company's worldwide cellular interests represented 99.5 million POPs and more than 1.9 million subscribers on a proportionate basis at December 31, 1994. In the United States, the Company has over 35 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, the Company has 64.1 million POPs and holds significant ownership interests, with board representation and substantial operating influence, in national cellular systems operating in Germany, Japan, Portugal, Sweden and Belgium. In 1994, the Company's consortia were awarded national cellular licenses in Italy, South Korea and Spain. The Company is also the third largest provider of paging services in the United States, based on industry surveys, with approximately 1.5 million units in service at December 31, 1994.\nThe following table sets forth the Company's POPs and proportionate subscribers at December 31, 1994.\n(1) Domestic proportionate subscriber data does not include subscribers to cellular systems over which the Company does not have or share operational control. For a list of such systems, see \"Domestic Cellular.\"\n(2) POPs and proportionate subscribers for the Michigan\/Ohio region reflect both the Company's 50% interest in a partnership with Cellular Communications, Inc. (\"CCI\") and the Company's ownership of approximately 13% of the equity in CCI at December 31, 1994.\n(3) Includes POPs for Italy, South Korea, Spain and the Kyushu and Chugoku regions of Japan, where the systems have not yet commenced operations.\n(4) Includes POPs and proportionate subscribers represented by a 2.25% interest which, under the terms of the cellular license, the Company is under a current obligation to sell to small and medium-sized German businesses.\nINVESTMENT CONSIDERATIONS\nThe following factors, in addition to the other information contained elsewhere herein, should be considered carefully in evaluating the Company and its business.\nCOMPETITION\nThe offering of cellular and paging services in each of the Company's markets is expected to become increasingly competitive. In the United States, where the Company currently has one competitor in each cellular market, the Company in the near future will face up to seven additional competitors following the completion of auctions by the Federal Communications Commission (\"FCC\") of broadband personal communications services (\"PCS\") licenses and the entry of specialized mobile radio (\"SMR\") system operators, which are in the process of constructing digital mobile communications systems on existing SMR frequencies. Depending on voice quality and system reliability, such systems may be competitive with the Company's cellular service. One SMR operator is currently offering digital SMR service in the Los Angeles and San Francisco markets and has announced plans to construct a nationwide system with its partners that would offer service in several of the Company's other cellular markets.\nThere is also significant competition in the Company's international markets. For example, the Company's systems in Germany and Japan face competition from two and five other cellular operators, respectively, and the government-operated cellular systems in those and other countries have recently become increasingly competitive with privately-operated systems. In addition, the pursuit of new international wireless telecommunications opportunities is expected to remain highly competitive. While the Company believes that its technical and operating expertise have been critical in its success in attracting desirable joint venture partners and winning international wireless licenses, there can be no assurance that this such success will continue. In particular, in light of the trend toward the \"auctioning\" of new wireless licenses in international markets, as opposed to merit-based selection criteria, there can be no assurance that the Company will be willing or able to compete as successfully as it has in the past.\nREGULATION\nThe licensing, construction, operation, sale and acquisition of wireless systems, as well as the number of competitors permitted in each market, are regulated in the United States by the FCC and by its counterparts in other countries. In addition, certain aspects of the Company's domestic wireless operations, including the setting of rates, may be subject to public utility regulation in the state in which service is provided. In August 1994, the California Public Utilities Commission (\"CPUC\") issued an interim decision pursuant to which existing cellular carriers such as the Company would be subject to substantially greater regulation than new entrants such as PCS and SMR operators. See \"Regulation-State and Local.\" Although under current federal legislation the CPUC's regulatory power may be preempted by the FCC, the CPUC is seeking to retain such power. In the event the CPUC's authority is not preempted, the Company's operations in California may be subject to a greater regulatory burden than certain of its future competitors. The CPUC is also investigating whether California cellular carriers have complied with rules regarding the filing of applications and permits to locate and construct cell sites. No assurance can be given that the outcome of such investigation, or regulatory changes that may be enacted by federal, state or foreign governmental authorities, will not have an adverse effect on the Company's business.\nIn January 1995, the United States Department of Justice (\"DOJ\") advised the Company of its view that the Company is subject to the Modification of Final Judgment entered in 1982 in United States v. American Telegraph and Telephone Co. (the \"MFJ\"). The Company believes, based on the terms of the MFJ and its underlying policies, that it is not subject to the MFJ, and is seeking a ruling to that effect from the federal court that administers the MJF. In the event the court rules against the Company, the Company believes that it could obtain a stay of the MFJ pending appeal. No assurance can be given in this regard, however, or that the Company's position will be validated by the courts. In the event the Company is re-subjected to the MFJ, unless a waiver on terms and conditions acceptable to the Company\nis negotiated with the DOJ and approved by the court, the Company may be required to cease certain activities in the long-distance and satellite services businesses, as well as its MFJ-prohibited design and development work in wireless technology. See \"Regulation-MFJ.\"\nThe Company's cellular license for the Los Angeles market expired in 1993 and was renewed without difficulty. The Company's licenses for the Sacramento and San Diego markets expired in 1994 and the Company's renewal applications are pending. All of the Company's remaining significant domestic cellular licenses will expire before the end of 1996. While the Company believes that each of the expiring licenses will be renewed, based upon its prior experience with expired licenses and upon FCC rules establishing a presumption in favor of licensees that have complied with their regulatory obligations during the initial license period, there can be no assurance that any license will be renewed. See \"Regulation-Federal.\"\nFUTURE FUNDING REQUIREMENTS\nThe Company expects that its existing domestic cellular operations will require significant amounts of capital in 1995, as will the Company's contribution to the costs of the acquisition of PCS licenses and system build-out. In addition, the construction of cellular systems in international markets where the Company's consortia have recently been awarded licenses will require substantial capital contributions by the Company. In October 1995, the Company has certain obligations to purchase additional equity in CCI. See \"Domestic Cellular-Joint Ventures-New Par.\" While the Company will apply its operating cash flow and the remaining proceeds from its December 1993 initial public offering to the foregoing, these obligations, as well as any additional obligations arising from the Company's pursuit of acquisitions and other new opportunities, will require the Company to seek additional sources of financing in 1995. The Company believes that it will be able to access these sources on terms and in amounts that will be adequate to accomplish its objectives, although there can be no assurance that that will be the case. See Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources.\" The Company has been assigned a BBB+ implied senior debt rating by Standard & Poor's based in part upon that agency's analysis of the expected future financial performance of the Company.\nDILUTION OF OPERATING RESULTS\nIn 1994, the Company's consortia were awarded digital cellular licenses in Italy, South Korea and Spain, and the Company is continuing to pursue new opportunities in international markets. In March 1995, the Company's PCS partnership with Bell Atlantic Corporation, NYNEX Corporation and U S WEST Inc. (\"PCS PrimeCo\") acquired eleven 30 MHz licenses in the FCC's broadband PCS auctions for an investment of approximately $1.1 billion, of which the Company's share is 25%. As a result of costs associated with the foregoing license acquisitions and system build-out, the Company will incur start-up expenses which will, at least in the near term, have a dilutive effect on the Company's earnings.\nANTITRUST PROCEEDINGS\nThe Company believes that its cellular pricing and marketing practices were and are in compliance with the antitrust laws. The Company, however, is a defendant in a number of class action complaints with respect to its Los Angeles, San Francisco or San Diego operations, which allege that the Company conspired to fix retail and wholesale cellular prices. In addition, the California State Attorney General has been investigating the pricing of cellular telephone service in the Los Angeles market in the mid-to late 1980s. The Company does not believe that the investigation will have a material adverse effect on its financial condition. The Company also does not believe that the class actions, if adversely decided, would have a material adverse effect on its financial condition. No assurance can be given as to the foregoing, however, or that any disposition of these proceedings, if adverse to the Company, might not materially adversely affect the Company's results of operations in the year of such disposition. See Item 3, \"Legal Proceedings.\"\nCCI TRANSACTION\nConcurrent with the formation in 1991 of an equally owned joint venture with CCI (\"New Par\"), the Company purchased 5% of the equity in CCI, agreed to purchase additional equity in CCI and obtained\nthe right to acquire all of CCI's remaining equity in stages over the next several years. The Company currently owns approximately 13% of the equity in CCI and has the right to purchase additional equity in CCI in the open market, through privately negotiated transactions or otherwise. Until October 1995, the Company's ownership of CCI's equity may not exceed 27.5% on a fully diluted basis. Pursuant to an agreement between the Company and CCI, the Company is obligated in October 1995 to purchase up to approximately $720 million of stock and stock options in CCI, depending on the number of shares tendered to CCI in a related redemption. The per-share purchase price underlying such obligation is $60. The stock and options that the Company is obligated to purchase represented approximately 25% of CCI's equity on a fully diluted basis at December 31, 1994. The Company also has the right (but not the obligation) during an 18-month period commencing in August 1996 to purchase the remainder of CCI (but excluding any assets and related liabilities other than CCI's interest in New Par unless otherwise agreed by the partners) at a price that reflects appraised private market value of CCI (excluding such assets and related liabilities) at that time. In the event that the Company does not exercise such right, New Par effectively terminates and CCI may be obligated to sell its assets, including those relating to the joint venture, to a third party. If New Par assets (and related liabilities) are sold within a specified period (not to exceed two years) at less than the appraised price, the Company will be obligated to effect certain \"make-whole\" payments to CCI's stockholders based upon the amount of the shortfall. The Company's exercise of its rights to purchase additional equity in CCI will depend upon the Company's evaluation of the market for CCI's stock, CCI's business prospects and financial condition, other investment opportunities available to the Company, prospects for the Company's business, general economic conditions and other factors. No assurance can be given that the Company's investment in CCI will be favorable to the Company or that any sale of the joint venture assets, if required, will be consummated at a price that will eliminate the Company's make-whole obligation. See \"Domestic Cellular-Joint Ventures-New Par.\"\nIMPLICATIONS OF LICENSEE OWNERSHIP STRUCTURE\nThe Company holds most of its domestic cellular properties through partnership interests, a number of which are controlling interests. Upon the contribution of the Company's domestic cellular properties to its joint venture with U S WEST, control over such properties will, to a certain extent, be shared with U S WEST. See \"Domestic Cellular-Joint Ventures-U S WEST.\" In addition, the Company's interests in international wireless licenses are held almost exclusively through foreign corporations in which the Company is a significant, but not controlling, shareholder. Under the governing documents for certain of these partnerships and corporations, the approval of business plans and decisions as to the timing and amount of cash distributions may require a greater percentage vote than that held by the Company. Although the Company has not been materially impeded by the nature of its wireless ownership interests from pursuing its corporate objectives, no assurance can be given that it will not experience difficulty in this regard in the future. The Company may enter into similar arrangements as it participates in consortia to pursue additional wireless opportunities.\nFLUCTUATIONS IN THE VALUE OF WIRELESS LICENSES\nA substantial portion of the Company's assets consists of interests in entities holding cellular licenses, the value of which will depend significantly upon the success of the operations of such entities and the growth and future direction of the cellular industry generally. Values of licenses also have been affected by fluctuations in the level of supply and demand for such licenses. In addition, the infrequency with which licenses are traded or sold may increase the difficulty of establishing values for the Company's license interests. Any transfer of control of an entity holding a domestic license is subject to prior FCC (and possibly state regulatory) approval. Analogous governmental approvals are required for transfers of interests in foreign licenses. Where licenses are held by partnerships or foreign corporations, transfers of interests also are often subject to contractual restrictions.\nThe Company believes that international cellular opportunities in the future will arise primarily through awards by developing countries, where operating risks may be greater and potential returns lower. In addition, investment returns from acquisitions of interests in existing entities holding wireless licenses or from licenses acquired through auctions may be lower than those resulting from the Company's early license awards because of the substantial purchase prices required to acquire such interests.\nEXCHANGE RATE FLUCTUATIONS\nForeign currency exchange rates are increasingly material to the Company's results of operations. The Company evaluates the risk of significant exchange rate volatility and its ability to hedge as part of its decision whether to pursue an international opportunity. A significant weakening against the dollar of the currency of a country where the Company recognizes revenues or earnings may adversely affect the Company's results, while any weakening of the dollar against such currency could have an adverse effect if the Company is obligated to make significant foreign denominated capital investments in such country. The Company attempts to mitigate the effect of foreign currency fluctuations through the use of foreign currency contracts and local banking accounts.\nRADIOFREQUENCY EMISSIONS CONCERNS\nMedia reports have suggested that certain radio frequency (\"RF\") emissions from portable cellular telephones might be linked to cancer. The Company has collected and 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 guidelines 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 telephones, it is anticipated that all cellular telephones currently marketed and in use will comply with those standards. Additional concerns have been expressed about the safety of emissions from cellular facilities which transmit calls to subscriber's telephone handsets. The Company's facilities are licensed by the FCC and comply with the exposure levels set by the FCC. The CPUC has also opened an investigation into the safety of cellular facilities licensed in California. The Company submitted extensive scientific data to the CPUC to support its conclusion that cellular emissions will cause no adverse health effects. A CPUC staff report issued in December 1993 concluded that the CPUC is unlikely to adopt stricter requirements than the FCC absent convincing evidence of risk.\nDOMESTIC CELLULAR\nThe Company 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. The Company's United States cellular interests represented over 35 million POPs and more than 1.5 million proportionate subscribers at December 31, 1994. The Company 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 30 largest cellular markets in the United States. The Company 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 ten other markets, including Dallas\/Fort Worth, Tucson and Las Vegas.\nPrior to the broadband PCS auctions, the FCC licensed only two cellular systems in each market. One license was initially reserved for applicants affiliated with a company engaged in the wireline telephone business (the \"wireline licensee\") and the other was initially reserved for a non-wireline licensee. Through FCC license applications and grants, the Company acquired controlling interests in wireline licensees in San Diego, the greater Los Angeles area, including Oxnard and Ventura, and the greater Sacramento area, including Stockton and Reno. Following the FCC's initial license awards, the Company acquired additional cellular interests throughout the United States. In evaluating acquisition opportunities, the Company considers the attractiveness of the market for cellular services, the Company's ability to control or significantly influence the operations of the system and the opportunity to create regional networks through integration with the Company's existing systems or by acquiring licenses in adjacent markets.\nThe following table sets forth as of December 31, 1994 (i) by region the markets in which the Company owns an interest in a cellular system, (ii) whether each such system is the wireline or non-wireline\nlicensee, (iii) the total population of the market served by such system, (iv) the Company's percentage ownership in the operator of the system, and (v) the Company's POPs based on its percentage ownership.\n- --------------- (1) 1994 Donnelly Marketing Information Service population estimates.\n(2) The Company's ownership percentage and POPs for the Michigan\/Ohio region reflect both the Company's 50% ownership interest in New Par and the Company's ownership of 13.03% of the equity in CCI at December 31,1994.\n(3) Accounted for under the equity method.\n(4) Accounted for under the consolidation method.\n(5) Accounted for under the cost method.\n(6) Operating results are included in the proportionate cellular operating results presented in Item 6, \"Selected Financial Data,\" and in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations-Proportionate Results of Operations.\"\nMARKETING\nThe Company aggressively markets its cellular services under the AirTouch Cellular name through its own sales force and arrangements with independent agents, as well as newspaper and radio advertising and toll-free telephone numbers. In certain markets, the Company's cellular service is sold through resellers who, pursuant to FCC requirements, are allowed to purchase blocks of cellular telephone numbers and access to cellular services at wholesale rates for resale to the public. Agents are independent contractors who solicit customers for the Company's cellular service, and typically include automobile dealers, specialized electronics stores and department stores. The Company generally pays its agents a commission for each subscriber who uses the Company's service for a specified period and makes residual payments to the agent based on the subscriber's ongoing service charges. Recently, the Company has been taking steps to align sales costs with revenues by emphasizing residual payments to agents over upfront commissions and utilizing Company-controlled distribution channels such as direct sales and telemarketing. In the second half of 1994, the Company began targeting the consumer market with special promotions and pricing plans and by expanding into consumer electronics stores and other mass-market distribution channels.\nThe Company's wireline systems are part of an alliance that markets cellular service in the United States and Canada under the MobiLink brand name. The Company's non-wireline systems in the San Francisco Bay Area, Michigan\/Ohio and Kansas market cellular service under the Cellular One brand name. In addition, the Company's Georgia regional network is part of SouthReach, a service offered with three other cellular operators in the southeastern United States.\nTOMCOM, L.P. (\"TOMCOM\"), a joint venture between the Company, U S WEST, Bell Atlantic and NYNEX, will among other things develop a national brand and marketing strategy for the partners' existing cellular operations and the PCS systems to be operated by PCS PrimeCo. See \"Joint Ventures-Bell Atlantic\/NYNEX.\"\nSERVICES\nIn addition to providing high quality wireless telephone service, in most markets the Company makes available to subscribers custom calling services such as voice mail, call forwarding, call waiting, three way calling, no-answer and busy transfer. In 1994, the Company introduced Display Messaging, a new service that allows a cellular phone to receive and store voice-mail messages, short alphanumeric messages and pages even if the handset is in use or switched off. In addition, the Company introduced AirTouch 411 Connect, an enhanced directory assistance service that enables callers to be connected to the party whose number was requested without hanging up and redialing.\nThe Company charges its subscribers for service activation, monthly access, per-minute airtime and custom calling features, and generally offers a variety of pricing options, most of which combine a fixed monthly access fee and per-minute charges. The Company pays the local telephone service company directly for interconnection of cellular telephone calls with the wireline telephone network. Subscribers are billed directly by their selected long distance carrier or by the Company, which provides the billing service for a fee to the long distance carrier. In late 1994, the Company began offering its own long-distance service in its Los Angeles, Sacramento, San Diego and Atlanta markets.\nThe Company maintains a customer service department in each of its cellular markets for billing and service inquiries. Using a toll free telephone number, customers are able to report any problems and obtain up-to-date information with respect to their accounts. In each of its markets, the Company has technicians on call on a 24-hour basis. Through the use of sophisticated monitoring equipment, these technicians are able to check the performance of the cellular network.\nNEW SERVICES\nPersonal Communications Services. Pursuant to the FCC's decision to allocate radio frequency spectrum for broadband PCS licenses, six new licenses will be granted: two 30 MHz licenses (Blocks A and B) in each of the 51 Major Trading Areas (\"MTAs\"), and one 30 MHz license (Block C) and three 10 MHz licenses (Blocks D, E and F) in each of 493 Basic Trading Areas (\"BTAs\"). The two current cellular carriers in each market currently have 25 MHz of spectrum each. The Block C 30 MHz license and Block F 10 MHz license are reserved for \"designated entities,\" including women, minorities and small businesses. The rules adopted by the FCC permit a licensee to acquire up to 40 MHz in a single service area. Cellular licensees (defined as entities owning more than 20% of a cellular system) are not restricted from participating in PCS in areas outside of their cellular service areas, although they are only permitted to obtain a 10 MHz block in their cellular service areas.\nIn the March 1995 Block A and B license auctions, PCS PrimeCo, the Company's partnership with Bell Atlantic Corporation, NYNEX Corporation and U S WEST Inc., was the high bidder for eleven 30 MHz licenses covering the Chicago, Dallas, Tampa, Houston, Miami, New Orleans, Milwaukee, Richmond, San Antonio, Jacksonville and Honolulu markets, with bids totaling approximately $1.1 billion, of which the Company's share is 25%. These licenses complement the partners' existing cellular franchises and will enable them to provide wireless services on a nationwide basis. The remainder of the auctions will take place later in 1995 and are expected to conclude by early 1996. In November, 1994, the Company acquired one nationwide and three regional narrowband PCS licenses in 1994 for use in connection with advanced paging services. See \"Domestic Paging.\"\nAlthough broadband PCS is expected to be similar to current cellular technology in providing \"anytime, anywhere\" voice and data services to mobile users, PCS may offer additional features not available from analog cellular carriers today. The Company intends to use the broadband PCS licenses it acquires in the auctions, its partnerships with U S WEST, Bell Atlantic and NYNEX and other relationships to create a seamless national wireless network and to offer services to customers throughout the United States.\nGlobalstar. The Company holds an 8.3% interest in Globalstar, L.P. (\"Globalstar\"), a joint venture led by Loral Corporation and Qualcomm Incorporated (\"Qualcomm\") that will construct and operate a satellite-based network utilizing code division multiple access (\"CDMA\") technology to offer voice, data, fax, paging and position location services throughout the world. The initial launch is expected to take place in 1997, with service expected to begin in 1998. The Company has exclusive service provider status in the United States, Austria, Belgium, the Caribbean, Indonesia, Japan, The Netherlands, Portugal and Switzerland, and has the right to obtain exclusive service provider status in other areas. Pursuant to a preliminary agreement, the Company will have co-exclusive provider status in Canada and Mexico. The Company made initial investments in Globalstar of $25 million in 1994 and expects to contribute an additional $12.5 million over the next year. The Company may be required to cease its involvement in Globalstar if the MFJ is determined to apply to the Company. See \"Regulation-MFJ.\"\nWireless Data. The Company's wireless data group focuses on data-transmission uses for the Company's cellular network. The Company and three other cellular carriers were the primary developers of the United States' first nationwide cellular data service for United Parcel Service (\"UPS\"). This service allows UPS drivers to send package tracking information over cellular networks throughout the country to UPS' private network and ultimately to UPS' mainframe computers. The Company has also entered into other arrangements to develop wireless data communications software and customer applications.\nThe Company and several other cellular operators have formed a consortium to test wireless packet data transport technology, which is designed to allow short bursts of data to be transmitted more quickly and efficiently than current circuit-switching technology. It is expected that the development of this technology will make it possible for cellular carriers to offer a broad range of cost-effective wireless data services. In October 1994, the Company introduced AirTouch ModemConnect service, which features improved reliability and transmission speed for mobile data customers, in its Atlanta, Los Angeles, Sacramento and San Diego markets.\nTECHNOLOGY\nThe Company is an industry leader in cellular technology. The Company's Los Angeles network was the first to introduce cell site sectorization and overlay\/underlay techniques which simultaneously provide increased coverage in high traffic areas and umbrella coverage of difficult terrain. In 1991, the Company became the first to deploy microcells, which make use of low power antennas located significantly farther from cell sites than permitted by earlier technology, thereby allowing coverage inside buildings, in canyons and tunnels and in other areas that are difficult or impossible to serve with conventional cellular technology. Microcell technology also includes a fast hand-off capability, which is valuable in downtown settings where a greater number of antennas at lower power settings allows the network to handle high traffic densities.\nThe Company also has developed advanced network design and management tools. The Company's proprietary software predicts cell site coverage, which is critical in engineering new cellular networks and in making design improvements to existing systems. Other proprietary software developed by the Company detects and analyzes system problems, allowing the Company to react quickly, often before the problem noticeably affects service quality.\nCurrently, in most markets the radio transmission between the cellular telephone and the cell site is an analog transmission, and both the cellular telephone and the transmitting equipment are designed to send and receive voice signals exclusively in this mode. The Company believes that digital technology will offer many advantages over analog technology, including substantially increased capacity, improved voice quality, greater call privacy, lower operating costs and the opportunity to provide improved data transmissions. Because existing analog cellular telephones will not be able to receive digital transmissions from the cell site, the Company expects that the transition by subscribers who prefer digital service will occur over a number of years. During such transition, cellular systems will maintain transmitting equipment to serve both formats and it is expected that manufacturers will make dual-mode cellular telephones capable of sending and receiving both analog and digital transmissions in order to meet subscriber needs for roaming in areas outside their home systems.\nThe Company was an early proponent of research into CDMA and worked with Qualcomm and others to develop this technology. In September 1994, the Company commenced testing its CDMA network in the Los Angeles market and expects to introduce CDMA service on a commercial basis in portions of its Los Angeles market in the summer of 1995. CMT Partners, the Company's joint venture with McCaw Cellular Communications, Inc., a subsidiary of AT&T, introduced digital cellular service based on time division multiple access (\"TDMA\") technology in the San Francisco Bay Area in October 1993.\nCOMPETITION\nThe cellular services industry in the United States is highly competitive. Cellular systems compete principally on the basis of network quality, customer service, price and coverage area. The Company's chief competition in each market is from the other cellular licensee. In certain markets, the Company also competes at the retail level with resellers. The Company believes that its technological expertise, emphasis on quality and customer service, large coverage areas, and development of new products and services make it a strong competitor.\nThe Company is likely to face greater competition in the future. PCS licensees in the Company's cellular markets are expected to provide significant competition for the Company's existing cellular networks. The FCC has permitted SMR system operators to construct digital mobile communications systems on existing SMR frequencies in many metropolitan areas throughout the United States. When constructed, these multi-site configuration systems will offer interconnected mobile telephone service and, depending on voice quality and system reliability, may compete with the Company's cellular services. One SMR operator is currently offering digital SMR service in the Los Angeles and San Francisco markets and has announced plans to construct a nationwide system with its partners that would offer service in several of the Company's other cellular markets.\nAT&T's acquisition of McCaw may increase the competition that the Company faces in Los Angeles and Sacramento, where its cellular operations compete with McCaw. McCaw is expected to use the AT&T brand name in marketing its cellular services and to utilize AT&T's sales, customer service and distribution channels, as well as the research and development capabilities of AT&T Bell Laboratories. The Company and McCaw jointly operate cellular systems in San Francisco, San Jose, Dallas, Kansas City and certain other markets through CMT Partners. See \"Joint Ventures-CMT Partners.\"\nJOINT VENTURES\nNew Par. In August 1991, the Company and CCI formed New Par, to which CCI contributed its cellular systems, located primarily in Ohio, and the Company contributed its cellular systems in Michigan and Ohio. New Par is equally owned by CCI and the Company and is governed by a four-person committee, with two members appointed by each company.\nThe Company and CCI have entered into an agreement (the \"Merger Agreement\") under which CCI will, in October 1995, offer to redeem up to 10.04 million shares of its redeemable stock at $60 per share and the Company is obligated to purchase from CCI shares or stock options representing in the aggregate approximately 2.4 million shares at a price of $60 per share, less the exercise price in the case of stock options (the \"MRO\"). The Company is obligated to purchase from CCI at $60 per share a number of newly issued shares of stock equal to the number of shares purchased by CCI in the MRO. Pursuant to the Merger Agreement, the Company acquired approximately 5% of CCI and obtained the right to acquire all of CCI's remaining equity in stages over the next several years. The Company currently owns approximately 13% of CCI and has the right to purchase additional equity in CCI in the open market, through privately negotiated purchases or otherwise. Until October 1995, the Company's ownership of CCI's equity may not exceed 27.5% on a fully diluted basis.\nBeginning in August 1996, the Company has the right, by causing CCI to redeem all of its redeemable stock not held by the Company (the \"Redemption\"), to acquire CCI, including its interests in New Par and such other CCI assets and related liabilities as the Company and CCI may agree upon, at a price per\nshare that reflects the appraised private market value of New Par (and such other CCI assets and related liabilities as the Company and CCI agree shall be retained) determined in accordance with an appraisal process set forth in the Merger Agreement. The Company has the opportunity to evaluate up to three different appraisal values during the 18-month period beginning in August 1996, prior to determining whether to cause the Redemption. The Company will finance the Redemption by providing to CCI any necessary funds.\nIn the event that the Company does not exercise its right to cause the Redemption, CCI is obligated to promptly commence a process to sell itself (and, if directed by the Company, the Company's interest in New Par). In the event that the Company does not direct CCI to sell the Company's interest in New Par, such partnership will dissolve and the assets will be returned to the contributing partner. CCI may, in the alternative, purchase the Company's interest in CCI or CCI and New Par, as the case may be, at a price based upon their appraised values determined in accordance with the Merger Agreement. If CCI or its interest in New Par is sold within certain specified time periods not to exceed two years for a price less than the appraised private market value, the Company is obligated to pay to each other CCI stockholder a specified percentage of such shortfall.\nCMT Partners. In September 1993, the Company and McCaw formed CMT Partners, an equally owned partnership that holds interests in cellular systems operating in San Francisco, San Jose, Dallas, Kansas City and certain adjacent suburban areas. CMT Partners is governed by a four-person committee consisting of two members from each company. The Company's contributions to the partnership included its 61.1% interest in Bay Area Cellular Telephone Company (\"BACTC\"), which operates in the San Francisco and San Jose markets, and its 34% interest in the non-wireline licensee operating in the Dallas\/Fort Worth market, as well as certain assets and liabilities of its retail reseller operations in the San Francisco Bay Area. McCaw contributed its 32.9% interest in BACTC, as well as its interests in the nearby Vallejo, Santa Rosa and Salinas\/Monterey systems. McCaw also contributed its interests in Kansas City, Missouri, Lawrence, Kansas and St. Joseph, Missouri. In addition, the Company purchased McCaw's interests in the Wichita and Topeka, Kansas cellular systems for $100 million. Upon dissolution of CMT Partners its assets will be sold unless either the Company or McCaw elects to have the assets distributed in kind. If that election is made, the Dallas\/Fort Worth interest would be distributed to McCaw, the Kansas\/Missouri interests would be distributed to the Company, and the interests in the other systems held by the partnership would be distributed pro rata to both partners.\nU S WEST. In July 1994, the Company and U S WEST announced an agreement to combine their domestic cellular properties. In the initial phase, a partnership known as WMC Partners, L.P. (\"WMC\") was formed in which the Company and U S WEST will initially hold interests of approximately 70 percent and 30 percent, respectively. WMC is governed by an eight-member committee consisting of four representatives of the Company (including the president) and three of U S WEST, with an independent member to cast tie-breaking votes in deadlock situations. Voting in the partnership committee is in proportion to the partners' percentage interests, and supermajority votes are required in connection with certain financial matters, including the approval of business plans.\nThe closing of the initial phase (the \"Closing\") is conditioned on certain federal and state regulatory approvals and is expected to occur in the third quarter of 1995. After the Closing, WMC will provide services to the partners and their domestic cellular properties. During this phase, the cellular properties of the parties will continue to be owned by the individual partners. The parties also formed an equally owned partnership to pursue new PCS opportunities. In conjunction with the PCS PrimeCo, the PCS partnership will construct and operate PCS systems in areas where the partners currently do not have cellular operations. WMC will also provide services to the PCS partnership.\nIn the next phase, the partners will contribute their domestic cellular properties to WMC. This contribution is expected to occur upon the lifting of certain restrictions imposed by the MFJ (or earlier, at the Company's option), but will occur in any event no later than July 25, 1998. The PCS partnership also will be merged into WMC, either at the time the cellular properties are contributed or three years after it acquires its first PCS license, whichever is later.\nU S WEST has the right, which is exercisable after full relief from the MFJ has been obtained but which expires on July 25, 2004, to exchange its interest in WMC for up to 19.9% of the Company's common stock outstanding at the time of the exchange. Any such exchange would be made at a ratio reflecting the appraised private market value of U S WEST's interest in WMC and the appraised public market value of the shares of the Company's common stock to be acquired by U S WEST in the exchange. In the event that the value of U S WEST's interest in WMC determined by such appraisals would result in the issuance of U S WEST of more than 19.9% of the Company's then outstanding common stock, U S WEST is entitled to receive the excess in the form of non-voting preferred stock. The Company has amended its shareholder rights agreement so that U S WEST will not be deemed to be an \"Acquiring Person,\" as defined therein, by reason of its rights in connection with the exchange.\nU S WEST also has the right, exercisable between July 25, 1999, and July 25, 2009, to exchange its interest in WMC for common stock of the company to be held by a trust for purposes of systematic sale to the public. Any such exchange would be made at a ratio reflecting the appraised private market value of U S WEST's interest in WMC and an averaged trading price of the Company's common stock during a period prior to U S WEST's exercise of the right.\nThe Company has the right to cause the exchange to occur either (a) after the later of full MFJ relief and July 25, 2004, if there is a deadlock with U S WEST regarding the management of WMC or (b) at any time after full MFJ relief has been obtained, if at such time U S WEST holds less than 5% interest in WMC.\nUpon the exercise by U S WEST of its right to exchange its interest in WMC for capital stock of the Company, U S WEST will be entitled to certain governance rights (including representation on the Company's board of directors) as well as registration rights. U S WEST is subject to certain standstill restrictions with respect to the Company through July 25, 2004, unless such restrictions are earlier terminated or suspended.\nBell Atlantic\/NYNEX. In October 1994, the Company and U S WEST announced the formation of a consortium between their wireless joint venture (\"ATI\/USW\") and the wireless joint venture announced in June of this year between Bell Atlantic and NYNEX (\"BA\/NYN\"). This consortium consists of two partnerships, each equally owned by ATI\/USW and BA\/NYN. In March 1995, the first partnership, PCS PrimeCo, acquired eleven 30 MHz PCS licenses covering major metropolitan areas, which complement the existing domestic cellular franchises of the Company, U S WEST, BA and NYNEX. See \"NEW SERVICES--Personal Communications Services.\" PCS PrimeCo will construct and operate PCS systems in those areas and any other areas for which PCS PrimeCo wins licenses. This entity will be governed by a board composed of three members from each of ATI\/USW and BA\/NYN.\nThe second partnership, TOMCOM, will provide services to the existing cellular businesses of the four parties and to the PCS properties acquired by the consortium. It will also develop technical and service standards for wireless properties, adopt a national brand and marketing strategy, develop information technology and create a national distribution strategy. The entity will be governed by a board composed of three members from each of ATI\/USW and BA\/NYN, as well as one independent member.\nUnlike the Company's joint venture with U S WEST, the agreements with BA\/NYN do not provide for a merger of cellular properties. Accordingly, each of ATI\/USW and BA\/NYN will continue to hold such properties separately. In addition, either such joint venture after seven years may cause PCS PrimeCo to be dissolved and any PCS properties owned by it to be allocated as equally as possible between them. Bell Atlantic and NYNEX each are subject to certain standstill restrictions with respect to the Company through October 20, 2001, unless such restrictions are earlier terminated or suspended.\nINTERNATIONAL CELLULAR\nThe Company has been highly successful in obtaining significant interests in cellular licenses in some of the world's most attractive markets. The structure of the Company's international cellular interests typically reflect government preferences or requirements that local owners hold at least a majority interest in their telecommunications licenses. However, the Company has board representation and substantial\noperating influence in each of its cellular systems outside of the United States. The Company has the second largest ownership position in Mannesmann Mobilfunk GmbH (\"MMO\") and three of the five Japanese cellular companies in which it has an interest, and currently has the third largest ownership position in Telecel. In Belgium, the Company is the sole private partner in a joint venture with the state-owned telecommunications company. The Company has appointed the director of engineering for the cellular systems in Germany, Japan, Portugal and Belgium, as well as for the networks under construction in South Korea, Italy and Spain. Each of these directors is responsible for network buildout and technical operations.\nGERMANY\nThe Company currently holds a 32.8% interest and is the second largest shareholder of MMO, the joint venture that holds the second of three national digital cellular licenses in Germany. The Company's interest in MMO includes a 2.25% interest which, under the terms of MMO's cellular license, the Company is under an obligation to sell to small or medium-sized German businesses. MMO's network, known as \"D2 Privat,\" was one of the world's first commercial cellular systems to utilize the Global System for Mobile Communications (\"GSM\") technology standard. MMO began commercial operations in June 1992 and had approximately 842,000 subscribers at December 31, 1994. The system presently covers approximately 94% of the population, including all of the major cities and highways.\nThe Company believes that Germany's dense population, high per capita income and attractive workforce profile make it a promising market for cellular services. In addition, the cellular penetration rate in Germany is significantly lower than in the United States. However, there can be no assurance that cellular penetration in Germany will increase to a level comparable to that in the United States.\nThe other shareholders of MMO and their ownership interests are Mannesmann AG (\"Mannesmann\"), a German industrial engineering company and steel manufacturer (62.17%) and Cable and Wireless plc, the British telecommunications company (5.03%). The Company's share of MMO's contributed capital is approximately DM 531 million (US $351 million). MMO expects to fund its future capital needs through operating cash flows and bank loans. MMO has a DM 1.1 billion credit facility, of which DM 720 million (US $465 million) had been drawn down at December 31, 1994.\nOperations. The Company played the lead role in the design and construction of the D2 network. In addition to appointing the director of engineering, the Company provided a large technical staff during the design and construction phase of operations. The Company also has contributed to the development and installation of MMO's customer service and billing system and has assisted with MMO's business planning and marketing, sales and distribution arrangements. The Company continues to influence MMO's operations through its right to appoint two of the six members of the owners' panel, including the deputy chairman, and two of the 12 members of the supervisory board.\nThe Company believes that D2's continued success in attracting customers reflects the significantly improved quality of the digital system, falling equipment prices and D2's customer-oriented service. For example, all D2 subscribers have 24-hour toll-free telephone access to customer service. Demand is expected to increase as hand-held cellular telephones, as well as roaming on the GSM standard within Europe, become more available.\nMMO utilizes three channels of distribution. Resellers have provided the largest portion of D2's subscribers to date. While they receive a discount from the retail rate based on customer longevity, the Company believes that such resellers nonetheless are an efficient means of distribution. D2 also makes use of an increasing number of third-party agents and dealers. Agent commissions generally are paid per new subscriber and are based primarily on the volume of subscribers generated by the dealer. The remainder of D2's customers are acquired through direct sales.\nWhile D2's per-minute charges are relatively high by United States standards, they are comparable to those of the competing state-operated digital cellular system. Unlike in the United States, there is no additional charge for long distance service within Germany. In addition, because D2 is a national\nfranchise, there is no roaming charge within Germany, although a charge is imposed for international roaming. In further contrast to United States systems, the calling party in Germany pays for calls made to cellular subscribers. Accordingly, cellular users in Germany are generally less reluctant than users in the United States to encourage incoming calls to their cellular telephones.\nCompany Rights and Obligations. Under MMO's joint venture agreement, the Company has significant participation in management. The Company's consent is required for such matters as increases in capital contributions, incurrence of certain recourse debt, material transactions with affiliates and any fundamental corporate transactions. In addition, the Company must consent to the adoption of annual budgets and business plans (which cover, among other matters, distributions to the partners, external financing and projected reserves). MMO's senior management group consists of five members, of which the Company has appointed the director of engineering and, jointly with Mannesmann, the director of marketing and sales. In addition, the Company and Mannesmann each appoint one member to a technical committee, which is charged with resolving matters presented by the director of engineering and must do so unanimously. The joint venture agreement provides that any transfer of MMO shares is subject to the other partners' rights of first refusal. Under the terms of the license, any transfer of an ownership interest in MMO must be approved by the German telecommunications ministry. Mannesmann and the Company have committed in principle to maintaining a substantial share of ownership in MMO until certain debt is retired pursuant to agreements with MMO's banks.\nCompetition. Currently, MMO's principal competitor is DeTeMobil, a subsidiary of the state-owned landline telephone company. DeTeMobil operates three mobile telephone networks: \"B-Netz,\" an older system used primarily by government agencies; \"C-Netz,\" an analog cellular system that is reportedly near capacity, with approximately 720,000 subscribers at December 31, 1994; and the \"D1\" network, which operates on the GSM standard. D1 commenced operations in July 1992 and had a reported 870,000 subscribers at December 31, 1994. Although DeTeMobil has high name recognition and a well-developed distribution channel integrated with the landline service, the Company believes that MMO's D2 compares favorably with the state-owned digital system based upon network quality and customer service.\nThe other competitor in the German market is E-Plus Mobilfunk GmbH, whose digital system, known as \"E1,\" commenced operations in May 1994 primarily in Berlin and eastern Germany, where telephone density is much lower. The Company expects E1, which had an estimated 30,000 subscribers at December 31, 1994, to become a significant competitor over time.\nThe German government has stated that no additional licenses will be issued for cellular or cellular-like services through 1996.\nPORTUGAL\nThe Company owns a 23% interest in Telecel, the cellular company that was awarded one of two national GSM licenses by the Portuguese government in October 1991. Telecel began commercial service in October 1992, covering all of Portugal's major cities and highways, and had approximately 88,000 subscribers at December 31, 1994. Telecel currently covers approximately 94% of the population and is required under the terms of its license to cover 99% by October 1996.\nThe Company's equity interest in Telecel will increase by up to an additional 12% if Portugal changes its law to allow non-European Union (\"EU\") entities to own a greater than 25% interest in Portuguese telecommunications licenses. Under an agreement among the shareholders of Telecel, until January 1, 1997 the Company is required to fund Telecel's capital as if it held a 35% equity interest. To the extent that the Company's funding exceeds the amount it would be required to contribute as a 23% shareholder in Telecel, such funding is required to be in the form of five-year interest-free loans. If Portuguese law is amended to permit greater than 25% ownership by non-EU entities, the Company has the assignable obligation to convert its loans into an additional 12% equity interest (or such lesser percentage as is permitted under the new law). In the event that Portugal does not relax its ownership restrictions before October 1996, the Company has agreed to nominate a third party to purchase and convert the loans,\nsubject to the approval of the shareholders of Telecel. Alternatively, the Company can increase its percentage ownership in Telecel through an EU-recognized holding company.\nAs of December 31, 1994, Telecel's contributed capital was approximately ESC 21.5 billion (US $135 million), of which the Company's contribution was approximately ESC 8.4 billion (US $52.6 million). The Company does not expect that it will be required to contribute additional capital to Telecel. Telecel's capital needs are expected to be met through operating cash flow and borrowings. At December 31, 1994, Telecel had approximately ESC 10.5 billion (US $66 million) in short-term commercial paper and other short-term borrowings outstanding.\nTelecel's other shareholders include Espirito Santo Irmaos, SA (37.5%), an affiliate of Espirito Santo-Sociedade de Investimentos, SA, a Lisbon-based international finance and investment company; Amorim, Investimentos e Participacoes SGPS, SA (37.5%), a diversified Portuguese company; and Eurofon of Portugal, Inc. (2%), a subsidiary of LCC Incorporated, a United States software and engineering company.\nOperations. Telecel has a distribution network of exclusive agents that account for a majority of customer activations. These agents, through their own outlets and those of subagents, represent several hundred points of sale in Portugal. Telecel also has a direct sales force which accounts for the balance of the activations. There are no resellers in Portugal.\nCompany Rights and Obligations. The Company played the lead role in the design and implementation of Telecel's network. Under the Telecel shareholders' agreement, the Company appoints the director of network engineering and operations, who occupies one of five positions on the management board, and three of the nine elected members of Telecel's shareholder board. As a greater than 20% shareholder, the Company's consent is necessary for certain fundamental corporate actions such as issuances of stock or debt convertible into stock, as well as for the incurrence of recourse debt, material transactions with affiliates and the approval of business plans and budgets. Telecel's shareholders may not transfer their shares without government approval for five years following the grant of the license. Any transfer, other than in connection with the conversion of the Company's loans to equity or a transfer to a parent or affiliate of the transferring partner, is subject to the other shareholders' rights of first refusal.\nCompetition. Cellular service has been available in Portugal since September 1989 when Telecel's sole competitor, Telecomunicaoes Moveis Nacionais (\"TMN\"), which is operated by Portugal Telecom, the state-owned wireline telephone company, initiated analog cellular service. TMN's analog system utilizes technology similar to that of the German C-Netz system and was estimated to have approximately 29,500 subscribers at December 31, 1994. TMN was awarded a GSM license, and commenced offering GSM service, at approximately the same time as Telecel. TMN's digital system had an estimated 70,500 subscribers at December 31, 1994. Management believes that Telecel compares favorably with TMN based upon coverage, network quality, service offerings, customer service and availability.\nJAPAN\nThe Company is the second largest shareholder in three companies licensed to build and operate digital cellular systems in the Tokyo, Kansai (Western) and Tokai (Central) regions of Japan. The Company has a 15% interest in Tokyo Digital Phone Company (\"TDP\"), and 13% interests in each of Kansai Digital Phone Company (\"KDP\") and Tokai Digital Phone Company (\"CDP\"). The systems utilize the Japan Digital Cellular (\"JDC\") standard and together cover the Tokyo to Osaka corridor, Japan's most densely populated area. The systems became operational in 1994 and together served over 180,000 subscribers by year-end. The Company also holds a 4.5 percent interest in two additional Japanese cellular providers, which plan to offer JDC service in the Kyushu\/Okinawa and Chugoku regions beginning in 1996. The five systems together will eventually cover contiguous areas with a population of approximately 95 million people, or about 75% of the Japanese population.\nThe Company's share of the contributed capital of TDP, KDP and CDP is approximately Y3.6 billion (US $32.2 million), and the Company does not expect to be required to make significant additional capital contributions to these companies. The principal shareholders of each of the three companies include\nJapan Telecom (a long distance carrier in Japan) as lead partner, a regional railway company, Cable and Wireless plc and Toyota Motor Corporation.\nThe Company believes that favorable demographics and a relatively low penetration rate (less than 3%) make Japan an attractive cellular market. Subscriber growth in Japan is a result of the entry of new competitors, including TDP, KDP and CDP; a reduction in subscription fees, monthly fees and usage fees; the implementation of regulations by the Japanese Ministry of Posts and Telecommunications permitting, for the first time, the purchase of cellular handsets; and reductions in handset purchase prices and rental fees.\nOperations. The Company has been integrally involved in the design of each of the systems through its appointment of the director of engineering for each company. The Company also has contributed in other areas, including the implementation of the networks and the preparation of business plans. The Company is working with senior management of each venture to ensure that the networks operate as a single system, with common marketing strategies, pricing policies and equipment offerings.\nCompany Rights and Obligations. The Company has appointed one member to the board of directors of each of the Japanese ventures. To date, such appointees have also functioned as directors of engineering for the ventures.\nCompetition. Cellular competition is substantial in Japan, with four digital and two analog cellular operators in each of the markets served by TDP, KDP and CDP. Up to three additional competitors are expected when Personal Handy Phone service is introduced in 1995.\nSWEDEN\nThe Company holds a controlling interest of 51.1% in NordicTel Holdings AB (\"NordicTel\"), one of three providers of GSM cellular services in Sweden. NordicTel's cellular service, which is marketed under the name \"Europolitan,\" began operations in late 1992 and served approximately 70,000 subscribers at December 31, 1994. The system covers 90% of the population and all of the major cities. Under the terms of the authority granted by the Swedish government, NordicTel will be required to cover all of the major highways and all cities with a population greater than 10,000 by the end of 1995.\nIn 1994, NordicTel sold 21.9% of its common stock in an initial public offering. The remaining principal shareholders of NordicTel are Vodafone Group Plc, with an 18.5% interest, and AB Volvo, with a 7.5% interest. In 1994, the Company made a capital contribution to NordicTel of approximately 282 million Swedish krona (US $32.7 million). At December 31, 1994, NordicTel had drawn approximately 783 million krona ($97.5 million) on its credit facilities.\nCellular penetration in Sweden, which has a population of 8.8 million and approximately 1.3 million cellular subscribers at December 31, 1994, is the highest in the world.\nCompetition. NordicTel competes with two other cellular operators in Sweden. Telia Mobitel AB, a wholly owned subsidiary of the state-owned telephone company, operates one GSM network, with 215,000 subscribers at December 31, 1994, and two analog networks with a combined 860,000 subscribers. Comvik GSM AB operates an analog network and a GSM network, which had a combined 147,000 subscribers at December 31, 1994.\nDenmark Option. Prior to the Company's acquisition, NordicTel held a 20% interest in Dansk Mobiltelefon I\/S (\"DMT\"), one of two GSM cellular licensees in Denmark, through a wholly owned subsidiary, NordicTel Dk (\"Dk\"). Certain of the DMT partners have taken the position that the indirect acquisition by the Company of a controlling interest in Dk would, under the terms of the DMT joint venture agreement, require their approval. NordicTel and the Company oppose that position, and the issue was submitted to arbitration in the summer of 1994. A binding decision is expected in late 1995.\nIn order not to trigger such a transfer, NordicTel sold Dk to the shareholders of NordicTel other than the Company (the \"Dk Shareholders\") immediately prior to the Company's acquisition of its interest in NordicTel. NordicTel also undertook to be responsible to the government of Denmark, jointly with the Dk Shareholders, for fulfillment of DMT's obligations under the terms of its license. The Dk Shareholders have in turn agreed to hold NordicTel harmless for any loss caused by such undertaking. NordicTel concurrently entered into an agreement with the Dk Shareholders under which it has the right to purchase a 100% interest in Dk in the event that the arbitration concludes, among other things, that the approval of the other DMT partners is not required. The Company concurrently entered into an agreement with the Dk Shareholders under which it has the right to purchase a 49% interest in Dk. The Company's right is exercisable only if NordicTel is unable to exercise its right to repurchase Dk in its entirety, and if the arbitration concludes that such a transfer is permissible. Under such agreements, the Dk Shareholders also have the right to sell either a 100% interest in Dk to NordicTel (exercisable only if NordicTel's right to purchase is exercisable) or a 49% interest in Dk to the Company (exercisable only if the Company's right to purchase is not exercisable).\nBELGIUM\nIn July 1993, the Company was chosen by Belgium's state-owned telephone company, Belgacom, from among twenty applicants to provide technical, operating and marketing support for Belgacom's GSM system, which commenced operations on January 1, 1994. Operating under the name \"Proximus,\" the system covers over 80% of Belgium and all of the major cities, including Brussels, Antwerp, Liege and Ghent. The system reported nearly 70,000 digital and 60,000 analog subscribers at year-end 1994.\nIn December 1994, the Company acquired a 25% interest in Belgacom Mobile, a subsidiary of Belgacom that was formed to hold Belgacom's analog and GSM cellular telephone operations.\nCompany Rights and Obligations. Under the Belgacom Mobile shareholders' agreement, the Company is entitled to appoint the chief operating officer and the chief technology officer. In addition, the Company appoints three of the 13 members of the Belgacom Mobile board of directors. As a greater than 20% shareholder, the Company's consent is necessary for certain fundamental corporate actions such as the issuance of stock, approval of or amendment to the business plan, the incurrence of significant debt not contemplated by the business plan, approval of certain contracts with the government and the disposition of a material amount of assets.\nCompetition. In November 1994, the Belgian government announced that a second GSM license would be awarded in 1995.\nITALY\nIn March 1994, the Italian government awarded the second national GSM license to Omnitel-Pronto Italia (\"OPI\"), a consortium in which the Company holds an indirect 10.2% interest. The other principal partners are Ing. C. Olivetti (35.7%), Bell Atlantic (11.6%), Cellular Communications International, Inc. (10.3%), Telia Mobitel AB (6.8%), Lehman Brothers (5.6%) and Mannesmann AG (4.5%). The Company is the lead technical partner and has appointed OPI's director of engineering. OPI expects to begin offering service in 1996, initially covering two-thirds of the population. The license requires that 40% geographic coverage be achieved by May 1996. The Company believes that favorable demographics and business travel patterns make Italy an attractive cellular market.\nCompetition. The state-owned cellular operator, Telecom Italia, operates three cellular networks in Italy: two analog cellular systems and one GSM system, which together served an estimated 2.2 million subscribers at December 31, 1994.\nSOUTH KOREA\nIn May 1994, Shinsegi Telecommunications (\"Shinsegi\"), a consortium in which the Company holds an 11.3% interest and is the lead foreign partner, was awarded the second national cellular license in South\nKorea. The principal Korean partners are Pohang Iron and Steel and the Kolon Group, a textile manufacturer, which hold interests of 15% and 14%, respectively. The Company is entitled to appoint Shinsegi's technical director and one of the eight members of the board of directors.\nShinsegi will construct and operate a nationwide cellular network utilizing CDMA technology. The Company will take the lead role in designing, constructing and operating the network. Service is expected to begin in 1996 in Seoul and expand to Pusan and Taegu, reaching 60% of the country's 44 million people.\nCompetition. Korea Mobile Telecommunication Corp. is currently the sole cellular operator, with approximately 900,000 subscribers at year-end 1994. The cellular penetration rate in Korea, currently 2%, is projected by the government to reach 10% by the year 2000.\nSPAIN\nIn December 1994, the Airtel consortium, in which the Company holds the largest single interest, 15.78%, was awarded the second digital cellular license in Spain. The Company will have primary technical responsibility, including design, construction and operation of the network. Airtel expects to begin service in late 1995 in major cities such as Madrid, Barcelona and Seville, and to cover 65% of Spain's 39 million people by the end of 1995. The Company believes that Spain is an attractive market because of the low cellular penetration rate of approximately 1% and relatively poor landline quality.\nCompetition. Telefonica de Espana, the partially state-owned telephone company, operates two analog systems and was awarded a GSM license at the same time as Airtel. Telefonica's analog networks had approximately 410,000 subscribers at December 31, 1994.\nRUSSIA\nIn December 1994, the Company purchased an $11 million convertible secured note from FGI Wireless, Ltd. (\"FGI\"), the United States company that holds a 45% interest in a Russian cellular company, Vimpel Communications (\"VimpelCom\"). The note is convertible into a minority equity position in FGI. VimpelCom began commercial operations in 1994 in Moscow and holds licenses entitling it to provide cellular services in a corridor from Moscow to south of St. Petersburg with a population of approximately 23 million.\nNEW OPPORTUNITIES\nThe Company plans to continue pursuing new opportunities to acquire interests in wireless systems throughout the world. The Company believes that its proven technical, operating and marketing expertise make it a highly desired participant in consortia formed to pursue new international opportunities. The Company led the design and construction of MMO's and Telecel's nationwide digital cellular systems, and was integrally involved in the design of three of its digital cellular systems in Japan. In addition, the Company successfully supported the launch of digital cellular service in Belgium. The Company believes that the technical expertise it developed in the United States and Germany has been a significant factor in the success of the subsequent license applications by its consortia.\nThe Company measures each international investment against such criteria as demographic factors, the degree of economic, political and regulatory stability, the quality of local partners and the degree to which the Company would control or meaningfully participate in management. The Company's primary focus in pursuing licenses has been Western Europe and Asia because the Company believes that these regions currently provide the highest potential for value creation, although the Company also is considering opportunities in other parts of the world. The Company is currently competing or planning to compete for wireless licenses in Canada and Singapore.\nCanada. Cellular service in Canada is provided by two operators, Rogers Cantel and Bell Mobility (a consortium led by Bell Canada), which together have approximately two million subscribers (representing a penetration rate of 7%). The government is expect to award PCS licenses in late 1995. In February 1995, the Company purchased an 8.5% interest in TeleZone, Inc., a Canadian consortium formed to pursue a 2 GHz PCS license, with the opportunity to acquire an equity interest of 22.5% if TeleZone is successful in acquiring the license.\nSingapore. Singapore Telecom (\"SingTel\"), which operates two analog networks and one GSM network serving approximately 230,000 subscribers, currently is the sole cellular operator in Singapore. SingTel is constructing a 1.8 GHz network that is expected to begin service in late 1996. The Company has a 16% interest in the WyWy consortium, which includes Motorola (18%). WyWy submitted an application for a digital cellular license that is expected to be awarded in mid-1995, for service to begin in April 1997.\nTECHNOLOGY\nGSM. The Company's cellular systems in Europe conform to the GSM digital cellular standard. Developed by a standards body within the European Telecommunications Standards Institute with substantial input from the Company's engineers, the GSM standard is a wide-band TDMA standard substantially different from United States TDMA technology and has been adopted by more than 50 countries worldwide, including all those in the EU and others such as Australia, New Zealand, Singapore, Hong Kong and South Africa. MMO was the first GSM system to offer commercial service.\nThe GSM standard allows users to place and receive calls on any GSM cellular telephone while traveling in all countries utilizing the standard. A subscriber identification module (\"SIM\") card, which contains a microchip identifying the subscriber, is necessary in order to receive GSM cellular service. By inserting the SIM card into any GSM telephone, customers can make calls from the telephone and have the calls billed directly to them. The card also allows the subscriber's home GSM system to locate the subscriber on any GSM network throughout the world. In addition to these conveniences, the SIM card can reduce fraud significantly, because each subscriber has a unique personal identification number that must be used in conjunction with the card.\nJapan Digital Cellular Standard. The technology utilized by TDP, KDP and CDP represents Japan's entry into second-generation cellular communications. The JDC standard uses narrowband Japanese TDMA technology and allows enhanced roaming potential and expanded supplementary services potential. To provide service to subscribers away from their home regions, TDP, KDP and CDP are implementing automatic roaming throughout their combined coverage areas. Subscribers of any of the companies will be able to initiate and receive calls anywhere within the combined coverage area. Two separate digital system frequencies will be utilized throughout Japan: the 800 MHz band and the 1500 MHz band.\nDOMESTIC PAGING\nThe Company offers local, regional, statewide, and nationwide paging services under the AirTouch Paging brand name in over 120 markets in 17 states, including many of the largest metropolitan areas in the United States, such as Atlanta, Dallas\/Fort Worth, Denver, Chicago, Cleveland, Cincinnati, Columbus, Detroit, Houston, Jacksonville, Kansas City, Las Vegas, Los Angeles, Louisville, Miami, Orlando, Phoenix, Portland, Sacramento, Salt Lake City, St. Louis, San Antonio, San Diego, the San Francisco Bay Area, Seattle and Tampa\/St. Petersburg. At December 31, 1994, the Company had over 1.5 million paging units in service and, based upon industry surveys, was the third largest provider of paging services in the United States. The Company's growth strategy is to expand into new markets through start-ups or acquisitions, to increase its share in existing markets by providing superior customer service, to refine its mix of distribution channels, including further expansion of its retail sales and to provide new narrowband PCS services.\nSERVICES\nThe Company currently offers numeric display, alphanumeric, tone-only and tone and voice paging services. More than 90% of the Company's subscribers use numeric display units, which alert the subscriber and then display a short message, usually a telephone number entered by the calling party in a touch tone keypad. The Company's paging revenues consist primarily of monthly charges for paging service and equipment rental.\nThe Company also offers nationwide coverage on its own private carrier paging frequency through an inter-carrier agreement with other paging providers and as a reseller of a nationwide common carrier paging service. In addition, the Company offers voice retrieval service, which allows callers to leave voice messages instead of telephone numbers. The Company offers Page Line News Service, which provides updated news, financial reports, weather and sports information, in Los Angeles, Miami, Detroit, Dallas, Phoenix and Seattle. In 1993, the Company introduced KidTrack, a value-priced service specifically designed for families with young children, in its Arizona markets. KidTrack is now available in San Diego and Las Vegas as well. In 1994, the Company launched the first commercial paging system in North America using FLEX technology, which increases transmission speeds, resulting in greater system capacity and lower costs.\nIn 1994, the Company acquired one nationwide 50\/12.5 KHz narrowband PCS license and three regional 50\/12.5 KHz licenses covering the Northeast, Central and Western regions of the United States. Narrowband PCS may include advanced two-way acknowledgment paging, data messaging, electronic mail, facsimile transmissions and voice paging.\nMARKETING\nThe Company utilizes a decentralized marketing approach, tailored to each market, to promote and sell its paging services. In all of its markets, the Company relies on both direct and indirect sales channels. The Company conducts its direct marketing through its sales, service and customer service representatives, who are located in the Company's local offices in each market. The Company's indirect sales channels generally consist of resellers, who purchase paging services from the Company in bulk quantities at a wholesale monthly rate, and agents and retailers, who sell only pagers and refer purchasers to the Company for service at the Company's rates. The Company typically pays agents and retailers a commission for such referrals. The Company, which was one of the first to offer paging service through retail outlets, has greatly expanded its retail marketing efforts and now has sales arrangements with over 2,000 retail locations nationwide.\nCOMPETITION\nThe Company's paging operations face intense competition from local or regional carriers as well as from carriers with a broad nationwide presence. Paging systems compete primarily on the basis of reliability, geographic coverage, customer service and price. The Company believes that its extensive experience in the paging business and emphasis on cost control and customer service make it an effective paging competitor. Competition is expected to intensify when narrowband PCS offerings become available in the Company's paging markets.\nINTERNATIONAL PAGING\nPORTUGAL\nThrough Telecel, the Company owns a 23% interest in Telechamada-Servico de Chamada de Pessoas, S.A. (\"Telechamada\"), Portugal's first nationwide private paging company. Telechamada offers numeric and alphanumeric paging services and began service in October 1992, on the same date that Telecel's nationwide cellular service became available. At December 31, 1994, Telechamada had approximately 15,000 subscribers. Telechamada estimates that it currently covers 91% of the population.\nSPAIN\nThe Company holds a 17.5% indirect interest in Sistelcom-Telemensaje, S.A., which was awarded a nationwide paging license by the Spanish government in August 1992. By January 1993, the digital paging system was operational in 14 cities, including Madrid, Barcelona and Seville. Sistelcom-Telemensaje offers tone-only, numeric and alphanumeric paging services. At December 31, 1994, Sistelcom-Telemensaje had approximately 40,000 subscribers.\nTHAILAND\nThe Company provides nationwide paging service in Thailand through a 49% interest in PerCom Service Limited (\"PerCom\"), which has served all of Thailand's major population centers since February 1991, and through a wholly owned subsidiary that has provided service in Bangkok since 1987. These companies operate together under the name PacLink and jointly served approximately 111,000 subscribers at December 31, 1994. PerCom is obligated under its license to pay between 25% and 40% of its annual paging revenues to the Communications Authority of Thailand (\"CAT\") during the fifteen-year term of the license, with guaranteed payments of approximately $57 million over such period, of which approximately $6.8 million had been paid as of December 1994. Under the Bangkok paging license, the Company is obligated to pay 33% of its annual paging revenues to CAT, with guaranteed payments of at least $10.6 million required during the remaining term of the license.\nFRANCE\nIn September 1994, Infomobile, in which the Company holds an 18.5% interest, began offering commercial service in Paris. Infomobile is constructing a nationwide digital paging network utilizing the European radio messaging standard, ERMES. The network will be expanded to offer nationwide service by 1998. The Company's principal partners in Infomobile are Bouygues S.A., Societe Generale, Preussen Elektra Telekom GmbH and DeNeufliz-Schlumberger-Mallet Finance.\nOTHER SERVICES\nTELETRAC\nThe Company, through its subsidiary Location Technologies, Inc. (\"LTI\"), has a 51% interest in AirTouch Teletrac, a partnership that offers vehicle location and fleet tracking services (\"Teletrac\"). Teletrac currently has operations in Los Angeles, Detroit, Chicago, Dallas\/Fort Worth, Houston and Miami, and has licenses to operate in more than 100 additional cities. These licenses may be subject to forfeiture if systems are not constructed in such markets by April 1996. See \"Regulation-Federal.\" Teletrac had approximately 41,000 vehicle location units and fleet tracking units in service at December 31, 1994.\nTeletrac reported net losses before taxes of $26.1 million, $41.6 million and $49.1 million in 1994, 1993 and 1992, respectively. The Company does not expect Teletrac's operations, in their current mode, to be profitable for the foreseeable future. In February 1994, the Company reduced Teletrac's staff by 30% to approximately 200 employees. The Company intends to continue cost containment measures to minimize Teletrac's operating losses and does not intend to expand Teletrac's operations significantly unless the Company expects that Teletrac's current or future services will achieve a higher level of commercial acceptance. The Company is evaluating its alternatives, from considering other commercial applications of Teletrac's technology and radio location spectrum to determining Teletrac's fit with the Company's long-term investment objectives.\nNorth American Teletrac (\"NAT\") holds a 49% interest in Teletrac. Prior to March 31, 1995, and if certain conditions have been fulfilled, LTI and NAT may each elect to cause a combination of NAT and LTI. In the combination, the shareholders of LTI and NAT would receive stock in the combined entity in amounts reflecting their indirect interests in Teletrac. The shareholders of NAT may also elect to have the combined entity register its shares in an initial public offering (the \"LTI IPO\"), which must generally occur prior to March 31, 1995. The Company and its affiliates have the right, but not the obligation, to provide capital to Teletrac or the combined entity using convertible notes prior to the earlier of March 31, 1995 or the LTI IPO. If the Company does not provide such funding, capital may be\nsought from other sources (subject to certain restrictions). Convertible securities may only be converted after the earlier of the LTI IPO or March 31, 1995. If converted within two years after that date, the conversion rate will generally be 50% of the price at which stock was sold in the LTI IPO (or, if the LTI IPO did not occur, an appraised price). The Company may not convert during that two-year period to the extent the conversion would result in the Company's having an equity interest of more than 70%. After that time, the conversion rate will equal the LTI IPO price until another limitation, based on a 1:9 relative ownership ratio between the former NAT shareholders and the Company, is reached. Thereafter, the conversion rate will equal the fair market value of the shares. The March 31, 1995 deadlines referred to in the preceding sentences may be extended by the parties.\nINTERNATIONAL LONG DISTANCE\nThe Company presently holds a 10% interest in International Digital Communications (\"IDC\"). IDC provides long-distance telephone service between Japan and over 90 international destinations, including the United States, to business and residential customers. IDC also offers private leased circuit services within Japan. In 1991, IDC began offering service over a 5,200 mile undersea fiber optic cable, the first such cable to connect Japan directly with the U.S. mainland.\nCREDIT CARD VERIFICATION\nIn conjunction with Korea Information and Communications Company, a local service provider in South Korea, the Company sells point-of-sale terminals and provides support service for a nationwide credit card verification system.\nAIR-TO-GROUND\nThe Company also provides air-to-ground telephone services, which allow subscribers to place calls over the public switched telephone network while in an airplane, in Elmira, New York, New York City, Atlanta, Denver, Houston, Phoenix, Seattle and Spokane.\nINVESTMENT IN QUALCOMM\nThe Company owns 400,000 shares of common stock of Qualcomm, a publicly held developer of digital mobile communications technology. The Company also holds warrants to purchase approximately 780,000 additional shares of Qualcomm common stock at an exercise price of $5.50 per share.\nEMPLOYEES\nAt December 31, 1994, the Company had approximately 4,576 employees, none of whom is represented by a labor organization. Management considers its relations with employees to be good.\nREGULATION\nThe Company is subject to extensive federal and state regulation as a provider of cellular, paging and radiolocation services. In addition, the international cellular and paging operations in which the Company has interests are also subject to regulation, although in general the international regulatory schemes are less comprehensive than those in the United States.\nMFJ\nIn general, the MFJ required AT&T to divest the Bell Operating Companies (\"BOCs\") and imposed restrictions on the business activities of the BOCs and their affiliates, successors and assigns. Among other things, the MFJ generally prohibits BOCs and their affiliates from providing voice and data services that cross local access transport areas (\"LATAs\"). The MFJ also precludes BOCs and their affiliates from engaging in the design, development or manufacturing of telecommunications equipment or \"customer\npremises equipment\" such as cellular telephones or the provision of telecommunications equipment such as switches. The stated purpose of the MFJ was to prevent BOCs and their affiliated enterprises from using a BOC's asserted local exchange monopoly to discriminate against companies in other markets in which BOCs or their affiliates compete.\nIn January 1995, the DOJ advised the Company of its view that the Company is subject to the MFJ. The Company believes, based on the terms of the MFJ and its underlying policies, that it is not subject to the MFJ. This conclusion is consistent with the conclusion apparently reached in other transactions in which BOC affiliates or their assets have been sold. Neither the United States District Court for the District of Columbia, which administers the MFJ (the \"Court\"), nor the DOJ has, to the Company's knowledge, taken the position that the purchasers of such affiliates or assets are bound by the MFJ.\nAccordingly, in February 1995, the Company filed with the Court a motion for declaratory judgment that the Company is not subject to the MFJ. Pending the Court's decision on the motion, the DOJ has agreed not to enforce the MFJ against the Company and the Company has agreed not to undertake new business activities prohibited to BOCs under the MFJ without prior notice to the DOJ. In the event the Court rules against the Company, the Company believes that it could obtain a stay of the MFJ pending appeal. No assurance can be given in this regard, however, or that the Company's position will be validated by the Court or an appellate court. In the event the Company is re-subjected to the MFJ, unless a waiver on terms and conditions acceptable to the Company is negotiated with the DOJ and approved by the Court, the Company may be required to cease certain activities in the long-distance and satellite services businesses, as well as its MFJ-prohibited design and development work in wireless technology.\nFEDERAL\nThe construction, operation and transfer of cellular systems in the United States are regulated by the FCC pursuant to the Communications Act of 1934, as amended (\"Communications Act\"). The FCC has promulgated guidelines for construction and operation of cellular systems and licensing and technical standards for the provision of cellular telephone service. For licensing purposes, the United States is divided into separate markets, called Metropolitan Statistical Areas (\"MSAs\") and Rural Service Areas (\"RSAs\"). At present, the frequencies allocated for cellular use in each market are divided into two equal blocks, one of which was initially reserved for entities affiliated with a wireline telephone company such as the Company, while the other was initially reserved for non-wireline entities. Under current FCC rules, any license may be transferred after FCC approval, but no entity may own any interest in both wireline and non-wireline systems in any one MSA or RSA. The FCC may prohibit or impose conditions on sales or transfers of licenses.\nInitial operating licenses are generally granted for terms of 10 years, renewable upon application to the FCC. Licenses may be revoked at any time and license renewal applications may be denied for cause. The Company's cellular license for the Los Angeles market expired in 1993 and was renewed without difficulty. The Company's licenses for the Sacramento and San Diego markets expired in 1994 and the Company's renewal applications are pending. All of the Company's remaining significant domestic cellular licenses will expire before the end of 1996. The FCC has issued a decision confirming that current licensees will be granted a relicensing presumption (renewal expectancy) if they have complied with their obligations under the Communications Act during the initial period. The Company believes that the licenses held by entities controlled by the Company will be renewed upon application for relicensing.\nUnder FCC rules, each cellular licensee was given the exclusive right to construct one of two cellular systems within the licensee's MSA or RSA during the initial five-year period of its authorization. At the end of such five-year period, other persons are permitted to apply to serve areas within the licensed market that are not served by the licensee. Current FCC rules generally provide that competing \"unserved area\" applications are to be resolved through an auction, except for certain long-pending applications such as those filed by several entities with respect to certain portions of the Los Angeles market that were unserved by the Company at the end of 1988. The Company does not expect any material adverse impact on its operations or financial performance in the event that others ultimately acquire rights to such unserved areas.\nThe Company's radio common carrier activities in connection with its paging services also are subject to regulation by the FCC. The FCC allocates radio common carrier frequencies in specific geographic areas and grants licenses for use of an initial frequency only upon a satisfactory demonstration of an applicant's legal and technical qualifications. The FCC allocates frequencies to a number of competitors in each paging market, unlike the current limitation of two cellular licenses in each cellular market. The Company's paging licenses are subject to periodic renewal by the FCC and, as with all such licenses, can be revoked at any time for cause. However, renewal applications are generally granted by the FCC upon a showing of compliance with FCC regulations and the provision of adequate service to the public.\nThe Communications Act prohibits the holding of a common carrier license (such as the Company's cellular licenses) by a corporation of which any officer or director is an alien, or of which more than 20% of the capital stock is owned directly or beneficially by aliens. Where a corporation such as the Company controls another entity that holds an FCC license, such corporation may not have any aliens as officers, may not have more than 25% of its directors as aliens, and may not have more than 25% of its capital stock owned directly or beneficially by aliens, in each case if the FCC finds that the public interest would be served by such prohibitions. Failure to comply with these requirements may result in fines or a denial or revocation of the license.\nThe FCC also regulates the operation and construction of vehicle location systems. In February 1995, the FCC released final regulations governing location and monitoring systems such as those operated by Teletrac. Under the regulations, Teletrac must indicate whether it intends to construct systems in markets for which it holds a license but where there are currently no operations. Such systems must be constructed by April 1996 or the licenses will be forfeited.\nThe Omnibus Budget Reconciliation Act of 1993 includes a provision preempting state regulation of rates or entry for any \"commercial mobile service.\" The FCC has determined that the Company's cellular, paging and air-to-ground services are commercial mobile services, and that the Company's vehicle location services are private services. The FCC has also exercised its authority to forbear from rate and entry regulation, including tariffs, for cellular, paging and air-to-ground services. In August 1994, the CPUC filed a petition with the FCC seeking to retain regulatory authority over cellular service rates in California for 18 months from September 1, 1994. The Company has filed its opposition to the CPUC's petition, contending, among other things, that the CPUC has failed to show that \"market conditions with respect to [commercial mobile] services fail to protect subscribers adequately from unjust and unreasonable rates or rates that are unjustly or unreasonably discriminatory\" or that such conditions exist and commercial mobile service is a \"replacement for land line telephone exchange service for a substantial portion of the telephone land line exchange service within such state.\" The FCC must take final action on the CPUC's petition by August 1995, during which time the CPUC retains regulatory authority over cellular services.\nSTATE AND LOCAL\nIn many states, the Company must obtain approvals and certification from state regulators prior to the commencement of commercial service by a cellular system (or in certain states, prior to construction). In addition, certain state authorities, including the CPUC, regulate the acquisition of control of cellular systems and the prices of services or require the filing of prices, price changes and other terms and conditions of service. The siting and construction of cellular transmitter towers, antennas and equipment shelters are often subject to state or local zoning, land use and other local regulation, which may include zoning and building permit approvals or other state or local certification.\nIn December 1993, the CPUC issued an order instituting investigation (the \"OII\") into mobile telephone service and wireless communications to review the wireless market in light of the entrance of multiple new competitors in 1994 and 1995 such as PCS and SMR. In August 1994, the CPUC issued an interim decision adopting a dominant\/nondominant regulatory framework in which existing cellular carriers are classified as dominant carriers and subject to rate caps and other regulation. The decision also required cellular carriers, upon receipt of a bona fide request from a reseller, to permit such reseller to interconnect\na switch, and to unbundle wholesale network rate elements. This limited measure requires no cost-of-service determination as it continues to allow cellular carriers to charge market rates for these unbundled services, the sum of which cannot exceed the current wholesale rates. The Company does not believe this order will have a material adverse effect on its financial position or results of operations. Nondominant carriers, including PCS and SMR, are subject to minimal regulation involving registration, record inspection and consumer safeguards. In September 1994, the Company filed an application for rehearing, which is still pending. Although under current federal legislation the CPUC's regulatory power may be preempted by the FCC, the CPUC is seeking to retain such power. In the event the CPUC's authority is not preempted, the Company's operations in California may be subject to a greater regulatory burden than certain of its future competitors.\nIn November 1992, the CPUC staff issued an interim report outlining the partial findings of an investigation into compliance with General Order 159 (\"G.O. 159\"), which requires prior CPUC approval of cellular facility additions. In January 1993, the Company responded to the report indicating that it contains significant inaccuracies and goes beyond the scope of the CPUC's authority. In April 1993, the CPUC alleged that the Company failed to obtain five required permits and issued an order requesting that the Company show why a particular cellular facility should not be disapproved. Certain of the Company's markets may have taken steps that the CPUC might consider to be construction of cellular facilities prior to filing advice letters with the CPUC and\/or might be considered by the CPUC to involve the failure to obtain necessary governmental permits for certain cellular facilities. The matter has been stayed with respect to the Company pending the conclusion of proceedings against other carriers. The CPUC is currently holding workshops concerning proposed revisions to G.O. 159. The Company does not believe that sanctions, if any, that may be imposed by the CPUC for any failures to comply with G.O. 159 or to obtain other governmental permits will have a material adverse effect on its financial position.\nIn April 1993, Pacific Bell filed a petition with the CPUC seeking authority to place cellular and paging interconnection service under tariff. In April 1994, the CPUC granted Pacific Bell's request to permit tariffing of interconnection arrangements. Concurrent with the petition, Pacific Bell filed an amended application in a collateral CPUC proceeding setting forth proposed tariff rates. General Telephone, another local exchange carrier, also filed proposed tariff rates in the same proceeding. In September 1994, the Company filed protests against both Pacific Bell's and General Telephone's tariffs. While the tariff proposals remain pending before the CPUC, the Company continues to interconnect under the terms and conditions of negotiated contracts with Pacific Bell and General Telephone. The impact of the Pacific Bell and General Telephone proposals on future operations is uncertain and depends upon the outcome of proceedings before both the CPUC and FCC.\nCertain states also require radio common carriers providing paging services to be certified prior to commencing operations. Certain states in which the Company operates paging activities require the carrier to file notices of its prices or price changes for informational purposes or regulate the acquisition of control of paging systems.\nINTERNATIONAL\nThe Company's international cellular and paging operations provide services pursuant to the terms of licenses granted by the telecommunications agency or similar supervisory authority in the various countries. Such agencies typically also promulgate and enforce regulations regarding the construction and operation of network equipment. For example, MMO's license to provide digital cellular mobile telephone services in the Federal Republic of Germany was issued in accordance with, and is governed by, the applicable provisions of the German Law on Telecommunications Installations. Under such law the right to erect and operate telecommunications facilities is reserved to the government, although the telecommunications ministry is authorized to license such right. The ministry also determines the terms and conditions of any license so granted and, to ensure compliance therewith, issues regulations for the supervision of telecommunications installations erected and\/or operated by a licensee. Other regulations commonly encountered in international markets include legal restrictions on the percentage ownership of telecommunications licensees by foreign entities such as the Company and transfer restrictions, or governmental approval requirements, regarding changes in the ownership of such licensees.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nFor each market served by the Company's cellular operations, the Company maintains at least one sales or administrative office and many transmitter and antenna sites. Some of the facilities are leased, and some are owned. The Company also maintains both owned and leased sales and administrative facilities for its paging services. The Company believes that its facilities are suitable for its current business and that additional facilities will be available for its foreseeable needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is currently involved in legal proceedings that have arisen in the ordinary course of business. While assurances cannot be given as to the outcome of any particular litigation, the Company believes that pending legal proceedings are unlikely to have a material adverse effect on its financial condition. In addition, the Company may be subject to legal challenges and litigation from time to time in connection with matters under the jurisdiction of the FCC and state regulatory authorities. The Company presently is pursuing declaratory relief from the federal court administering the MFJ as to the Company's status under the MFJ. See Item 1, \"Business.\"\nBeginning in November 1993, four class action complaints were filed, three in Orange County Superior Court and one in the United States District Court for the Central District of California, naming, among others, the Company, and alleging that the Company, as general partner of Los Angeles SMSA Limited Partnership, and Los Angeles Cellular Telephone Company (\"LACTC\") conspired to fix the prices of retail and wholesale cellular radio services in the Los Angeles market. The complaints seek damages for the class \"in a sum in excess of $100,000,000.\" In 1994, two class action complaints were filed, one in San Diego County Superior Court and one in the United States District Court for the Southern District of California, alleging that the Company and U S WEST conspired to fix the prices of retail and wholesale cellular radio services in the San Diego market. Discovery is taking place and motions for class certification are pending. In 1994, a class action complaint was filed in San Francisco Superior Court alleging that BACTC and GTE Mobilnet conspired to fix the prices of retail and wholesale cellular radio services in the San Francisco Bay Area market. This action is still in the preliminary pleading phase. The\nCompany intends to defend itself vigorously and does not expect that these proceedings will have a material adverse effect on its financial condition.\nOther Matters. The California State Attorney General has been investigating the pricing of cellular telephone service in the Los Angeles market in the mid-to late 1980s. The Company has had meetings with the Attorney General's office and is cooperating fully in connection with this matter. The Company believes that its pricing and marketing practices were and are in compliance with the antitrust laws. The Company does not believe that the investigation will have a material adverse effect on its 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 quarter ended December 31, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT.\nSet forth below is certain information concerning the persons who serve as executive officers of the Company. The executive officers serve at the pleasure of the Board of Directors and are subject to removal at any time.\nMr. Ginn has been Chairman of the Board and Chief Executive Officer of the Company since December 1993. He was Chairman of the Board, President and Chief Executive Officer of Pacific Telesis Group from 1988 to April 1994 and became a director of Pacific Telesis Group in 1983. He was Chairman of the Board of Pacific Bell from 1988 to April 1994. Mr. Ginn is also a director of Chevron Corporation, Safeway Inc. and Transamerica Corporation.\nMr. Cox was named Vice Chairman of the Board and President Domestic Wireless Businesses in November 1994. He was President and Chief Operating Officer of the Company from December 1993 to November 1994. He was President and Chief Executive Officer of the Company from 1987 to December 1993, was a director of the Company from 1987 to April 1993 and became a director again in January 1994. He was a director and a Group President of Pacific Telesis Group from 1988 to April 1994. Mr. Cox is a director of Cellular Communications, Inc.\nMr. Christensen has been Executive Vice President and Chief Financial Officer of the Company since December 1993. He was Executive Vice President, Chief Financial Officer and Treasurer of Pacific Telesis Group from 1992 to 1993. He was Vice President and Treasurer of Pacific Telesis Group from 1987 to 1992.\nMrs. Gill became Senior Vice President, Legal and External Affairs and Secretary of the Company in January 1994. She had been a partner in the law firm of Pillsbury Madison & Sutro since 1973 and was the head of the firm's Corporate and Securities Group. Mrs. Gill is a director of Consolidated Freightways, Inc.\nMr. Sarin has been Senior Vice President, Corporate Strategy\/Development and International Operations of the Company since November 1994. He was Vice President, Corporate Strategy\/Development and Human Resources of the Company from December 1993 to November 1994. From March 1993 to December 1993, he was Vice President, Strategy of the Company. He was also Vice President, Organization Design of Pacific Telesis Group from March 1993 to April 1994. Mr. Sarin was Vice President and General Manager, Bay Operations for Pacific Bell from 1992 to March 1993, and was Vice President, Chief Financial Officer and Controller of Pacific Bell from 1990 to 1992.\nMr. Gyani became Vice President, Finance and Treasurer of the Company in November 1993. He was Vice President and Treasurer of Pacific Telesis Group from March 1993 to November 1993. From February 1992 to March 1993 he was Vice President and Controller at Pacific Bell. From November 1991 to February 1992 he was Vice President Financial Assurance for Pacific Bell. From April 1989 to November 1991 he was Assistant Treasurer at Pacific Telesis Group.\nMr. Jasmann has been Vice President, Human Resources of the Company since January 1995. He was an international telecommunications consultant from 1993 to 1994. From 1987 to 1992 he was President and Managing Director for AT&T Asia\/Pacific Communications Services, Inc.\nMr. Neels has been President and Chief Executive Officer of AirTouch International since 1987. Mr. Neels joined AirTouch International in 1986 as a Vice President, overseeing the business operations and marketing activities of subsidiaries in Spain, Japan, Korea and Thailand.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nPart of the information required by this Item is set forth in the Company's 1994 Annual Report to Stockholders on page 65, which portions are incorporated herein by reference.\nThe Company currently intends to retain future earnings for the development of its business and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. The Company's future dividend policy will be determined by its Board of Directors on the basis of various factors, including the Company's results of operation, financial condition, capital requirements and investment opportunities.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information required by this Item is set forth in the Company's 1994 Annual Report to Stockholders on pages 10 through 13, which portions are 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 set forth in the Company's 1994 Annual Report to Stockholders on pages 14 through 25, which portions are 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 the Company's 1994 Annual Report to Stockholders on pages 26 through 56, which portions are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNo disagreements with accountants on any accounting or financial disclosure occurred during the Company'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 REGISTRANT.\nThe information required by this Item is set forth under \"Executive Officers of the Registrant\" at the end of Part I of this report and under the headings \"Class I-Nominees for Election\", \"Class II-Directors Continuing in Office Until the 1996 Annual Meeting of Stockholders\" and \"Class III-Directors Continuing in Office Until the 1997 Annual Meeting of Stockholders\" on pages 2 through 4 and \"Compliance with Section 16(a) of the Exchange Act\" on page 17 of the Company's 1995 Proxy Statement, which are incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this Item is set forth on pages 7 through 15 of the Company's 1995 Proxy Statement, which are 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 of the Company's 1995 Proxy Statement, which 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 under the heading \"Certain Relationships and Related Transactions\" on pages 15 and 16 of the Company's 1995 Proxy Statement, which are 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:\n1. Financial Statements:\nAIRTOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES\nThe financial statements required by this Item are set forth in the Company's 1994 Annual Report to Stockholders on pages 26 through 56, which portions are incorporated herein by reference.\nCMT PARTNERS\nReport of Independent Accountants\nConsolidated Balance Sheets - December 31, 1994 and 1993 Consolidated Statements of Income and Changes in Partners' Equity - For the year ended December 31, 1994 and the four-month period from September 1, 1993 (inception) to December 31, 1993 Consolidated Statements of Cash Flows - For the year ended December 31, 1994 and the four-month period from September 1, 1993 (inception) to December 31, 1993 Notes to Financial Statements Financial Statement Schedules Report of Independent Accountants Schedule II - Valuation and Qualifying Accounts and Reserves\nMANNESMANN MOBILFUNK GMBH\nIndependent Auditors' Report Balance Sheets - December 31, 1994 and 1993 Statements of Income - Years ended December 31, 1994, 1993, and 1992 Statements of Capital Subscribers' Equity - Years ended December 31, 1994, 1993, and 1992 Statements of Cash Flows - Years ended December 31, 1994, 1993, and 1992 Notes to Financial Statements\nNEW PAR\nReport of Independent Auditors Consolidated Balance Sheets - December 31, 1994 and 1993 Consolidated Statements of Income - Years ended December 31, 1994, 1993, and 1992 Consolidated Statement of Partners' Capital - Years ended December 31, 1994, 1993, and 1992 Consolidated Statements of Cash Flows - Years ended December 31, 1994, 1993, and 1992 Notes to Consolidated Financial Statements Financial Statement Schedules Schedule II - Valuation and Qualifying Accounts\n2. Financial Statement Schedules:\nAIRTOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES\nSchedule II -- Valuation and Qualifying Accounts and Reserves\nSchedules other than those listed above are omitted because they are either not required or not applicable, or the required information is presented in the Consolidated Financial Statements.\n3. Exhibits:\nExhibits identified in parentheses below, on file with the Commission, are incorporated by reference as exhibits hereto.\n(b) Reports on Form 8-K:\nDate of Report: September 19, 1994 Date of Report: October 20, 1994 Date of Report: December 15, 1994\nSIGNATURES\n---------- 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.\nAIRTOUCH COMMUNICATIONS, INC.\nBy: \/s\/ Mohan S. Gyani - ----------------------------------- Mohan S. Gyani Title: Vice President, Finance and Treasurer\nDate: March 22, 1995\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.\n* By \/s\/ Mohan S. Gyani - --------------------------------- Mohan S. Gyani, Attorney-in-fact Vice President, Finance and Treasurer\nDate: March 22, 1995\nINDEX TO SEPARATE FINANCIAL STATEMENTS OF SIGNIFICANT ENTITIES NOT CONSOLIDATED AND AIRTOUCH COMMUNICATIONS, INC. AND SUBSIDIARIES FINANCIAL STATEMENT SCHEDULES\nS - 1\nCMT PARTNERS\n------------\nCONSOLIDATED FINANCIAL STATEMENTS\nfor the year ended December 31, 1994 and for the four-month period from September 1, 1993 (inception) to December 31, 1993\nS - 2\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of CMT Partners:\nWe have audited the accompanying consolidated balance sheets of CMT Partners (the \"Partnership\") as of December 31, 1994 and 1993 and the related consolidated statements of income and changes in partners' equity and cash flows for the year ended December 31, 1994 and for the four-month period from September 1, 1993 (inception) to 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 audit. We did not audit the financial statements of Kansas Combined Cellular, which statements reflect total assets of 13% and 6% as of December 31, 1994 and 1993, respectively, and total revenues of 12% and 13% for the year ended December 31, 1994 and for the four-month period from September 1, 1993 (inception) to December 31, 1993, respectively. 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 Kansas Combined Cellular, is based solely on the report of other auditors.\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 and the report of the other auditors provides a reasonable basis for our opinion.\nIn our opinion, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of CMT Partners as of December 31, 1994 and 1993 and the results of its operations and its cash flows for the year ended December 31, 1994 and for the four-month period from September 1, 1993 (inception) to December 31, 1993 in conformity with generally accepted accounting principles.\n\/s\/ Coopers and Lybrand L.L.P.\nSan Francisco, California January 30, 1995\nS - 3\nCMT PARTNERS CONSOLIDATED BALANCE SHEETS December 31, 1994 and 1993\n(in thousands)\n------------\nThe accompanying notes are an integral part of these financial statements.\nS - 4\nCMT PARTNERS\nCONSOLIDATED STATEMENTS OF INCOME AND CHANGES IN PARTNERS' EQUITY\nfor the year ended December 31, 1994 and the four-month period from September 1, 1993 (inception) to December 31, 1993\n(in thousands)\n--------------\nThe accompanying notes are an integral part of these financial statements.\nS - 5\nCMT PARTNERS\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nfor the year ended December 31, 1994 and the four-month period from September 1, 1993 (inception) to December 31, 1993\n(in thousands)\n--------------\nSupplemental disclosure of noncash activities: As of December 31, 1993, $12.8 million of the initial contribution from a partner was outstanding. The amount of the contribution was paid by the partner in 1994.\nThe accompanying notes are an integral part of these financial statements.\nS - 6\nCMT PARTNERS\nNOTES TO FINANCIAL STATEMENTS\n---------------------\n1. Organization: ------------- CMT Partners (the Partnership) was formed on September 1, 1993 (inception) pursuant to the Amended and Restated Partnership Agreement dated as of September 1, 1993 between subsidiaries of AirTouch Communications, Inc. (ATI) and subsidiaries of McCaw Cellular Communications, Inc. (MCCI). The Partnership is a Delaware general partnership equally owned by ATI and MCCI through the following contributions:\nThe initial contributions were accounted for at the net book value of the assets and liabilities of the entities. Each of the entities holds a license or licenses from the Federal Communication Commission (FCC) and state authorities to operate cellular telephone systems in Metropolitan Statistical Areas (MSAs) as listed below:\nContinued S - 7\nCMT PARTNERS NOTES TO FINANCIAL STATEMENTS --------\n2. Summary of Significant Accounting Policies: ------------------------------------------- Principles of Consolidations: ----------------------------- The consolidated financial statements of the Partnership include the accounts of all significant ownership interests which include the accounts of BACTC, Combined Suburban Cellular (CSC), and Kansas Combined Cellular (KCC). CSC is comprised of the Cagal, Salinas and Napa cellular markets. KCC is comprised of the Kansas City, St. Joseph, and Lawrence cellular markets.\nRevenue Recognition: -------------------- Cellular air time and access charges are recorded as revenue when earned. Sales of equipment and related services are recorded when the goods and services are delivered.\nCash and Cash Equivalents: -------------------------- Cash and cash equivalents consist of investments with original maturities of less than three months. The carrying amount approximates fair value because of the short maturity of those instruments.\nAllocation of Profits and Losses: --------------------------------- In general, profits and losses incurred by the Partnership are allocated to the partners pro rata in accordance with their partnership ownership percentage.\nProperty and Equipment: ----------------------- Property and equipment are stated at historical cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets.\nDepreciable Life ----------------- Cellular equipment 3 - 7 years Cellular towers\/shelters 5 - 15 years Other 3 - 7 years\nContinued S - 8\nCMT PARTNERS NOTES TO FINANCIAL STATEMENTS --------\n2. Summary of Significant Accounting Policies, continued: ------------------------------------------------------ Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When property and equipment are retired or sold, the cost and accumulated depreciation of dispositions are removed from the accounts, and any gain or loss is reflected in income.\nRepairs and maintenance costs are charged to expense when incurred. Renewals and betterments are capitalized and depreciated over the remaining useful lives of the assets.\nIntangibles: ------------ Intangible assets primarily represent costs incurred in the acquisition and development of the cellular licenses and acquisition of subscriber lists. The costs of the cellular licenses are being amortized over 40 years using the straight-line method. The costs of the subscribers lists are being amortized over three years using the straight-line method.\nIncome Taxes: ------------- The income or loss of CMT Partners and its consolidated subsidiaries are included in the tax returns of the individual partners. Accordingly, no provision has been made for income taxes for these entities in the financial statements.\nMinority Interests: ------------------- Minority interests represent equity interests held by entities other than CMT Partners for the general partnerships serving the St. Joseph, BACTC and Salinas markets and the corporation serving the Cagal market.\nReclassifications: ------------------ Certain items in the financial statements at December 31, 1993 and for the four-month period from September 1, 1993 (inception) to December 31, 1993 have been reclassified to conform to the 1994 presentation. These reclassifications have no effect on previously reported net income or partners' equity.\nContinued S - 9\nCMT PARTNERS NOTES TO FINANCIAL STATEMENTS --------\n3. Property and Equipment: ----------------------- Property and equipment at December 31, 1994 and 1993 consists of the following:\n1994 1993 ---- ---- (in thousands) [S] [C] [C] Land $ 1,454 $ 1,454 Cellular property and equipment 276,259 236,374 Administrative assets 33,511 25,505 --------- --------- 311,224 263,333 Less accumulated depreciation and amortization (150,693) (116,943) --------- --------- 160,531 146,390 Cellular system under construction 29,455 14,243 --------- --------- $ 189,986 $ 160,633 ========= =========\nAdministrative assets primarily consist of office furniture and fixtures, including leasehold improvements.\n4. Accrued Expenses: -------------------------- Accrued expenses consist of the following:\nContinued S - 10\nCMT PARTNERS NOTES TO FINANCIAL STATEMENTS --------\n5. Unconsolidated Investment: -------------------------- The unconsolidated investment represents an investment in D\/FW Signal Partnership which owns approximately 34% of Metroplex, the A Block licensee in Dallas-Fort Worth, Texas. Accordingly, the investment has been accounted for by the equity method of accounting. The purchase price in excess of the Partnership's share of net assets is $71.5 million and is being amortized over 40 years. The financial statements of Metroplex at December 31, 1994 and 1993 and for the year ended December 31, 1994 and the four-month period from September 1, 1993 (inception) to December 31, 1993 are shown below:\n6. Transactions with Related Parties: ---------------------------------- The Partnership and its affiliated companies have entered into several transactions and agreements related to their respective businesses. The following represents the material transactions between the Partnership and its affiliated companies.\nDue from Affiliates: -------------------- Included in the amount due from affiliates at December 31, 1994 and 1993 is $2,958,738 and $2,776,821, which is due from MCCI. This amount is due on demand and no interest is charged on the amount.\nContinued S - 11\nCMT PARTNERS NOTES TO FINANCIAL STATEMENTS --------\n6. Transactions with Related Parties , continued: --------------------------------------------- Acquisition of Cellular Reseller: --------------------------------- In order to comply with a previous California Public Utilities Commission order that ATI divest its resale entity in San Francisco, on September 1, 1993, the date of inception, CMT Partners purchased the net assets and liabilities of ATI's cellular reseller at an agreed upon price of zero. Immediately thereafter, CMT Partners contributed substantially all of the assets and liabilities to BACTC.\nTechnical, Administrative and Marketing Services: ------------------------------------------------- The Partnership entered into a service agreement (the Agreement) with MCCI to provide certain services to CSC and KCC markets. The costs charged pursuant to the Agreement are generally determined using an allocation method. Substantially all of the services under the Agreements were terminated during 1994 and CMT Partners began providing these services to its affiliated markets.\nCellular Equipment Purchases: ----------------------------- On September 19, 1994, MCCI merged with AT&T Corp. (AT&T). The Partnership purchased cellular electronic equipment from AT&T comprising approximately 2% of total capital expenditures for the period from September 19, 1994 through December 31, 1994.\nLong Distance: -------------- Prior to September 1, 1993, CSC, and KCC served as providers for its customers' InterLATA long distance services. Effective with the formation of CMT Partners on September 1, 1993, CSC, KCC, and two interexchange carriers (Interexchange Carriers), both of which are wholly owned subsidiaries of MCCI, entered into Agreements under which the Interexchange Carriers provide InterLATA long distance services for CSC and KCC customers. As CMT Partners is owned in part by a party to the Modified Final Judgment CMT Partners may be restricted from providing InterLATA services.\nContinued S - 12 CMT PARTNERS NOTES TO FINANCIAL STATEMENTS --------\n6. Transactions with Related Parties , continued: ----------------------------------------------\nLong Distance, continued: ------------------------- CSC and KCC provide billing and collection functions on behalf of the Interexchange Carriers at $.42 per customer account. The Interexchange Carriers are responsible for the wholesale cost of the InterLATA long distance services, and any other expense incurred by the Interexchange Carriers in operating their business.\nManagement of Affiliated Markets: --------------------------------- Under the terms of a Management Agreement dated September 1, 1993, between the Partnership and AirTouch Cellular of Kansas (AirTouch Kansas), a wholly-owned subsidiary of ATI, KCC through the Kansas City market manages the markets owned by AirTouch Kansas. This includes the markets providing service in and around Wichita and Topeka, Kansas. AirTouch Kansas must approve capital and operating budgets for these markets. In addition, AirTouch Kansas is obligated to reimburse the Kansas City market for operating expenses. The Kansas City market charges a system operation fee equal to 6% of the AirTouch Kansas system revenues. The Management Agreement waived the fee until March 1994.\nAdditionally, AirTouch Kansas shares the facilities and maintenance of KCC's mobile switching center. The rate per minute of use (MOU) varies with monthly usage and ranges from $.03 to $.04 per MOU.\nInterconnection: ---------------- BACTC has contracted with Pacific Bell, an affiliate of ATI during 1993 and for the first three months of 1994, for interconnection services essential to the operation of its cellular network. The costs pursuant to this contract accounted for 4% and 7% of the total operating costs for the four-month period ended December 31, 1993 and for the first three months of 1994, respectively.\nContinued S - 13\nCMT PARTNERS NOTES TO FINANCIAL STATEMENTS --------\n7. Employee Contribution and Profit Sharing Plan: ---------------------------------------------- Employees of CMT Partners and its subsidiaries participate in a contributory profit-sharing plan referred to as the Cellular One Section 401(k) and Profit Sharing Plan (the Plan), formerly known as the Bay Area Cellular Telephone Company 401(k) and Profit Sharing Plan, which qualifies as a cash or deferred arrangement under Section 401(k) of the Internal Revenue Code. Upon formation of CMT Partners, employees of the markets contributed by MCCI may elect to participate in the Plan at any time. Otherwise, these employees may maintain their contributions in MCCI's 401(k) plan.\nThe Plan allows participating employees to elect to contribute up to 15% of their monthly salaries, to a maximum of $9,240 annually. The Plan sponsor, CMT Partners, contributes to the Plan, on behalf of each participating employee, an amount equal to 50% of the employee's contribution, not to exceed 5% of the participant's salary. Contributions are invested in six different funds. Under the 401(k) Plan, participants are at all times fully vested. Under the profit sharing plan, CMT Partners contributes a discretionary percentage of each eligible employee's salary. Employees vest in the profit sharing plan over five years. CMT Partners recorded a payable and related expense of 5% of eligible salaries. CMT Partners contributed $2,023,757 and $398,000 to the 401(k) and profit sharing plan for 1994 and the four-month period ended December 31, 1993, respectively.\n8. Commitments and Contingencies: ------------------------------ Lease Commitments: ------------------ Future minimum payments, required under operating leases and agreements that have an initial or remaining noncancelable lease term in excess of one year at December 31, 1994 are summarized below:\nContinued S - 14\nCMT PARTNERS NOTES TO FINANCIAL STATEMENTS --------\n8. Commitments and Contingencies, continued: ---------------------------------------- Lease Commitments, Continued: ---------------------------- Rental expense for operating leases was $7,562,000 and $2,047,000 for 1994 and the four-month period ended December 31, 1993, respectively.\nLitigation: ----------- The Partnership is a party to certain litigation in the ordinary course of business and is also a party to routine filings with the FCC, state regulatory authorities and other proceedings which management believes are immaterial to the Partnership.\n9. Line of Credit: --------------- On July 15, 1994, the Partnership entered into a Revolving Line of Credit Note (the \"line of credit\") with Wells Fargo Bank. The line of credit allows for borrowings up to $10,000,000 of which no borrowings were outstanding at December 31, 1994. The terms of the line of credit provide that interest on all advances will accrue at the lesser of a variable rate equal to the Prime Rate or .90% above the LIBOR rate. The line of credit agreement expires June 15, 1995.\nContinued S - 15\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of CMT Partners:\nOur report on the consolidated financial statements of CMT Partners is included as an exhibit to the Form 10-K of AirTouch Communications, Inc. (AirTouch). In connection with our audit of such financial statements, we have audited the related financial statement schedule listed in the index as an exhibit to AirTouch's Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers and Lybrand L.L.P.\nSan Francisco, California January 30, 1995\nS - 16 CMT PARTNERS\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES\n(dollars in thousands)\n(a) Amounts in this column reflect items written off, net of recoveries.\nS - 17\nMANNESMANN MOBILFUNK GMBH\nIndependent Auditors' Report\nBalance Sheets as of December 31, 1994 and 1993\nStatements of Income for the Years ended December 31, 1994, 1993 and 1992\nStatements of Capital Subscribers' Equity for the Years ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows for the Years ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements\nS - 18\nIndependent Auditors' Report ----------------------------\nThe Board of Directors and Capital Subscribers Mannesmann Mobilfunk GmbH\nWe have audited the accompanying balance sheets of Mannesmann Mobilfunk GmbH as of December 31, 1994 and 1993, and the related statements of income, capital subscribers' equity, and cash flows for the years ended December 31, 1994, 1993 and 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 German auditing standards which, in all material respects, are similar to auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Mannesmann Mobilfunk GmbH at December 31, 1994 and 1993, and the results of its operations and its cash flows for the years ended December 31,1994, 1993 and 1992 in conformity with accounting principles generally accepted in the United States.\nAs discussed in notes 1 and 6 to the financial statements, the Company changed its method of accounting for income taxes in 1992 to adopt the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\".\nDusseldorf, Germany, February 27, 1995\nKPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprufungsgesellschaft\n\/s\/ Scheffler \/s\/ Haas Wirtschaftsprufer Wirtschaftsprufer\nS - 19 MANNESMANN MOBILFUNK GMBH\nBalance Sheets\nDecember 31, 1994 and 1993\n(In thousands)\nSee accompanying notes to financial statements.\nS - 20\nMANNESMANN MOBILFUNK GMBH\nBalance Sheets (Continued)\nDecember 31, 1994 and 1993\n(In thousands)\nSee accompanying notes to financial statements.\nS - 21\nMANNESMANN MOBILFUNK GMBH Statements of Income Years ended December 31, 1994, 1993 and 1992 (In thousands)\nSee accompanying notes to financial statements.\nS - 22\nMANNESMANN MOBILFUNK GMBH Statements of Capital Subscribers' Equity Years ended December 31, 1994, 1993 and 1992 (In thousands)\nSee accompanying notes to financial statements.\nS - 23\nMANNESMANN MOBILFUNK GMBH\nStatements of Cash Flows\nYears ended December 31, 1994, 1993 and 1992\n(In thousands)\nS - 24\nMANNESMANN MOBILFUNK GMBH\nStatements of Cash Flows, continued\nYears ended December 31, 1994, 1993 and 1992\n(In thousands)\nThe Company paid interest of DM 48,213, DM 2,301 and DM 150 in 1994, 1993 and 1992 respectively.\nSee accompanying notes to financial statements.\nS - 25 MANNESMANN MOBILFUNK GMBH\nNotes to Financial Statements\nYears ended December 31, 1994, 1993 and 1992\n(All amounts in thousands of Deutschmarks)\n(1) Summary of Significant Accounting Policies ------------------------------------------\n(a) Description of Business\nMannesmann Mobilfunk GmbH was incorporated on September 11, 1989. At December 31, 1994 Mannesmann AG, held a controlling interest of 59.66%, and AirTouch (Netherlands) B.V. held an interest of 30.42%. In addition, a 4.5% interest equally owned by Mannesmann AG and AirTouch (Netherlands) B.V. was held in a trust, which under the terms of the Company's license, must be sold to small or medium sized German businesses.\nThe Company's primary business is the construction, manufacture and operation of a private mobile cellular network (\"D2\") within Germany. It is conducted under a license agreement with the Federal Postal and Telecommunications Ministry expiring at the end of 2009.\nCommercial activities commenced in mid 1992 and by the end of 1994 the Company had almost 850,000 customer subscribers.\n(b) Basis of Presentation\nIn order to conform with accounting principles generally accepted in the United States, certain adjustments are reflected in the financial statements which are not recorded in the German books of account. These adjustments relate primarily to capitalization of own payroll and related costs associated with the design and construction of telecommunications equipment and accounting for income taxes.\n(c) Cash and Cash Equivalents\nThe Company considers all highly liquid monetary instruments with original maturities of three months or less to be cash equivalents.\n(d) Inventories\nInventories are stated at the lower of average cost or market.\nS - 26 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\n(e) Property, Plant and Equipment\nProperty, plant and equipment are stated at cost. Depreciation is calculated on both the straight-line and declining balance methods over the estimated useful lives of the assets as follows:\nTo the extent permissible under tax laws, systematic depreciation is computed according to the declining balance method at a rate of up to 30 percent. Wherever straight-line depreciation results in higher charges, this method is used.\nCertain equipment installed at third party locations for rental periods less than the above useful lives are depreciated over the corresponding terms of the agreements.\n(f) Other Assets\nOther assets are stated at cost. They consist mainly of computer software, patents, rights, concessions and loan commitment fees which are being amortized over periods ranging from three to eight years on a straight-line basis.\nS - 27 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\n(g) Income Taxes\nEffective January 1, 1992, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, and has reported the cumulative effect of the change in the method of accounting for income taxes in the 1992 statement of operations. 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 and operating loss and tax credit carryforwards. 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.\nS - 28 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\n(h) Pension Plans\nThe Company has defined benefit plans limited to its management group and a small minority of its employees transferred with continuing pension rights from other Mannesmann AG group companies. The benefits are based on years of service and recent compensation. The accumulated benefit obligation is determined based on annual actuarial calculations and recorded as a liability in the balance sheet with a corresponding charge to income. The liability is not funded but represented by the Company's assets.\n(i) Financial Statement Translation\nThe financial statements are expressed in Deutschmarks and, solely for the convenience of the reader, have been translated into United States dollars at the rate of DM 1.549 to U.S. $1, the closing rate quotation (New York time - U.S.A.) per Wall Street Journal on December 30,1994.\n(2) Cash and Cash Equivalents ------------------------- This caption includes cash equivalents representing time deposits for amounts maturing within periods of between one day and three months. The balances at December 31, 1994 and 1993 are DM 24,000 and DM 28,000 respectively.\nThe carrying amount of cash and cash equivalents approximates fair value because of the short maturity of the investments.\n(3) Related Party Transactions -------------------------- The Company has significant business transactions with its main capital subscribers, Mannesmann AG and AirTouch Communications, through its group company, AirTouch (Netherlands) B.V., formerly part of the PacTel Corporation group until spin off on March 21, 1994, and their respective group companies. Such transactions are normally concluded within a range of terms similar to those made with non-related parties.\nThe significant balances and transactions with these current and former related parties are shown separately in the balance sheets and statements of operations. In addition, purchases of property, plant and equipment and other assets from related parties during the periods stated are shown below:\nS - 29 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\n(4) Inventories ----------- This caption includes stocks of affiliated products, parts and related supplies. The balances at December 31, 1994 and 1993 are as follows:\n(5) Interest Cost ------------- The Company commenced capitalization of interest cost during 1993 commensurate with the drawdown of its credit facility to finance continuing expansion of the infrastructure for its private mobile cellular network. The following is a summary of interest cost incurred and subject to capitalization during 1994 and 1993:\nInterest capitalized has been included in the telecommunications equipment component of property, plant and equipment.\n(6) Income Taxes ------------ Total income taxes for the years ended December 31, 1994, 1993 and 1992 were allocated as follows:\nS - 30 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\nIncome tax (expense) benefit attributable to income (loss) from continuing operations for the years ended December 31, 1994, 1993 and 1992, relating solely to deferred income taxes, consists of various types of taxes as follows:\nThe respective rates for the above types of taxes and their application for the years ended December 31, 1994, 1993 and 1992 are analyzed as follows:\nThese rates are based on the assumption that future profits will be distributable, otherwise higher rates would apply to retained profits. Since this accords with the future dividend\nS - 31 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\npolicy agreed by the capital subscribers, the adoption of the above lower basis rates is considered appropriate.\nIncome tax (expense) benefit attributable to income (loss) from continuing operations was DM (84,889), DM 66,728 and DM 148,941 for the years ended December 31, 1994, 1993 and 1992 respectively, and differed from the amount computed by applying the above combined German income tax rate of 44.24 per cent for 1994 and 1993 and 47.3 per cent for 1992 to pretax income (loss) from continuing operations as a result of the following:\nThe significant components of the deferred income tax (expense) benefits attributable to the income (loss) from continuing operations for the years ended December 31, 1994, 1993 and 1992 are as follows:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax asset and deferred tax liabilities at December 31,1994, 1993 and 1992 are presented below:\nS - 32 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\nNo valuation allowance for the deferred tax asset at December 31, 1994, 1993 and 1992 has been recognized. In assessing the realizability of the deferred tax asset, management considers whether it is more likely than not that some portion or all of the deferred tax asset will not be realized. The ultimate realization of the deferred tax asset is dependent on the generation of future taxable income. The Company's net operating losses to date have been incurred in the start-up phase of its operations. This covered the period from incorporation in 1989 to the end of 1993, by which the time the Company was almost at a break-even level. Taxable income was generated in 1994 reducing the deferred tax asset. Based on the growth rate in the number of subscribers and projected market penetration, management believes it is more likely than not that the Company will realize the remaining benefits of the net operating loss carryforwards, which are available to reduce future income taxes over an indefinite period.\nDue to its controlling interest of more than 50%, Mannesmann AG has included the income (loss) from continuing operations of the Company for German trade tax purposes in its consolidated tax return under an agreement common to all its majority owned subsidiaries within the German fiscal jurisdiction. Under this agreement Mannesmann AG charges or credits the Company for German trade tax payable or receivable arising from the income (loss) from continuing operations. At the gross rate of 17.7% for German trade tax applicable to each of the years ended December 31, 1994, 1993 and 1992, the respective balances with Mannesmann AG of DM 122,283, DM 158,224 and DM 119,408, representing the realization of the benefits of net operating loss carryforwards, are shown under the balance sheet caption as an amount due from affiliated company. This group arrangement is not applicable to German corporate tax and, from 1995, to German solidarity surcharge tax, which is assessed on an individual legal entity basis without the benefit of group relief.\nAs discussed in note 1, the Company adopted Statement 109 as of January 1, 1992. The cumulative effect of this change in accounting for income taxes of DM 80,083 was\nS - 33 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\ndetermined as of January 1, 1992 and has been reported separately in the statement of income for the year ended December 31, 1992. This amount is due to the recognition of the net benefits attributable mainly to the deferred tax effects of net operating loss carryforwards offset partially by other temporary differences.\n(7) Pension Plans ------------- The Company has two defined benefit pension plans. The first covers all of its 80 member management group (1993 and 1992 - 73 members). The second covers only 40 of its employee group (1993 and 1992 - 45 employees) representing those employees transferred with continuing pension rights from other Mannesmann AG group companies. The remaining employees totaling about 2,400 at the end of 1994 (about 2,100 and 1,500 at the end of 1993 and 1992 respectively) are not presently covered by such plans. It is intended that these employees will eventually be covered by a defined contribution plan funded externally with an insurance company. All personnel are covered by a German state pension scheme under a defined contribution plan funded equally by the employer and the employee.\nThe pension liabilities shown in the balance sheet result directly from independent actuarial calculations based on the situation at the end of each year in accordance with German tax and commercial rules. Due to the relatively insignificant amount of such pension liabilities given the small number of employees covered, together with the short periods of prior service, the Company considers that any potential adjustment or additional disclosures, that would be required had Statement of Financial Accounting Standards No 87, Employers' Accounting for Pensions, been applied, would not be material.\nAs noted above, the pension liabilities shown in the balance sheet represent the actuarial present value of accumulated benefit obligations. Projected benefit obligations and increases in compensation levels are not considered. The pension liabilities under these plans are not funded but considered to be represented by the Company's assets.\nThe pension costs charged to income for 1994, 1993 and 1992 are DM 1,383, DM 1,076 and DM 1,192 respectively.\nThe discount rate assumed in the actuarial valuations for each of the years ended December 31, 1994, 1993 and 1992 is 6%.\n(8) Subscribed Capital ------------------ Subscribed capital is represented by whole sum subscription amounts, issued in the form of participation certificates, on a proportional basis to the various investing parties. The respective amounts of proportional subscriptions directly reflect the percentage of respective ownership and related voting and dividend rights. As discussed below in note 9, the payment of dividends is restricted under the credit facility agreement.\nS - 34 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\n(9) Long-term debt -------------- During 1993 the Company began to utilize its unsecured credit facility negotiated with a banking consortium for an amount ranging from a minimum of DM 990,000 to a maximum of DM 1,100,000. The Company is entitled to draw against the arrangement until December 31, 1995 and is able to draw Domestic and Eurofacilities on roll-over or term bases and to choose up to a maximum of five currencies with fixed and variable interest rates.\nDrawings under this facility, all in Deutschmarks, at December 31, 1994 and 1993 were as follows:\nThis facility also provides for a flexible repayment schedule with final maturity between June 30, 1995 and December 30, 2001. Based on the maximum credit and latest repayment scenario, the maturities of the DM 720,000 long-term debt at December 31, 1994 would be as follows:\nS - 35 MANNESMANN MOBILFUNK GMBH Notes to Financial Statements\nThe carrying amount of the long-term debt at December 31, 1994 is considered to closely approximate fair value to the extent of the combined DM 520,000 for the second, third and fourth drawings as they are being rolled over the year end on a monthly basis at various rates, which did not change significantly during their brief exposure period. For the remaining DM 200,000 for the first drawing being rolled over the year end on an annual basis until June 1995, there is a favorable 17 basis points arising from its prior six months exposure period compared to the weighted average rate for the above monthly basis drawings, and accordingly the fair value of this portion of long-debt is deemed to decrease by DM 170 to DM 199,830.\nIn accordance with the credit facility agreement the Company is also entitled to borrow up to 10% of its capital subscribers' equity on a short term basis. The payment of dividends will be dependent upon the attainment of certain minimum cash flow requirements.\n(10) Commitments ----------- The Company is obligated under various noncancelable operating leases, primarily of a long-term nature, for the main administrative building, base stations and sales offices. The rental expense charged to income during 1994, 1993 and 1992 was DM 51,769, DM 40,739 and DM 25,254 respectively.\nFuture minimum lease payments under noncancelable leases (with initial or remaining lease terms in excess of one year) are:\nS - 36 New Par (A Partnership)\nIndex of Consolidated Financial Statements and Financial Statement Schedules\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.\nS - 37 Report of Independent Auditors\nThe Partnership Committee New Par\nWe have audited the accompanying consolidated balance sheets of New Par as of December 31, 1994 and 1993, and the related consolidated statements of income, partners' capital and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule (Schedule II-Valuation and Qualifying Accounts). 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 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 New Par at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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.\n\/s\/ Ernst & Young LLP\nFebruary 14, 1995\nS - 38\nNew Par (A Partnership) Consolidated Balance Sheets\nSee accompanying notes.\nS - 39\nNew Par (A Partnership) Consolidated Statements of Income\nSee accompanying notes.\nS - 40\nNew Par (A Partnership) Consolidated Statement of Partners' Capital\nSee accompanying notes.\nS - 41\nNew Par (A Partnership) Consolidated Statements of Cash Flows\nS - 42\nNew Par (A Partnership) Consolidated Statements of Cash Flows, continued\nSee accompanying notes.\nS - 43\nNew Par (A Partnership) Notes to Consolidated Financial Statements December 31, 1994 and 1993\n1. Organization\nNew Par was formed on August 1, 1991 pursuant to the Amended and Restated Agreement and Plan of Merger and Joint Venture Organization dated as of December 14, 1990 between AirTouch Communications (\"AirTouch\") (formerly PacTel Corporation), Cellular Communications, Inc. (\"CCI\"), CCI Newco, Inc. and CCI Newco Sub, Inc. (the \"Merger Agreement\"). New Par is a Delaware general partnership equally owned by AirTouch and CCI through the following wholly-owned, indirect corporate subsidiaries:\nS - 44\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n1. Organization (continued)\nEach wholly-owned, indirect corporate subsidiary of AirTouch and CCI initially contributed to New Par its interests in the General Partnerships (see below). The initial contributions were accounted for at the net book value of the assets and liabilities of the General Partnerships. Each of these partnerships, among other assets, holds a license or licenses from the Federal Communications Commission (\"FCC\") and state authorities to operate cellular telephone systems in Cellular Geographic Service Areas as listed below. New Par owns 100% of the partnership interests in each partnership, except as noted.\n(a) New Par is a 38.91% general partner in the Muskegon partnership. AirTouch Cellular of Michigan is a 40.5% general partner. The remaining 20.59% interests are owned by unaffiliated entities.\nS - 45\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n1. Organization (continued)\nEach of the above General Partnerships owns 100% of the FCC license in the Service Area, except for Hamilton\/Middletown and Springfield in which the applicable partnership owns 99.6% and 89.23% of the FCC license, respectively.\nNew Par owns 100% of Cellular One Sales and Service Company, which operates New Par's sales and service center business.\n2. Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of New Par, its wholly-owned partnerships, and partnerships in which New Par's interest is greater than 50%. Significant intercompany accounts and transactions have been eliminated in consolidation.\nCash and Cash Equivalents\nCash and cash equivalents include cash, deposits in interest-bearing accounts and short-term highly liquid investments purchased with a maturity of three months or less.\nTelephone Equipment Inventory\nTelephone equipment inventory, which consists of telephones and accessories, is stated at the lower of cost (first-in, first-out method) or market.\nProperty, Plant and Equipment\nProperty, plant and equipment is stated at cost. Depreciation is computed by the straight-line method over the estimated useful lives of the assets. Estimated useful lives are as follows: building - 25 years, operating plant and equipment - - 7 to 25 years, rental telephones - 3 years and office furniture, computer and other equipment - 3 to 5 years.\nS - 46\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n2. Significant Accounting Policies (continued)\nLicense Acquisition Costs\nDeferred cellular license costs include costs incurred to design cellular telephone systems for specific geographic areas, select and acquire sites to place equipment for such systems, demographic and traffic pattern studies, legal and organization costs, and costs incurred in connection with the preparation and filing of FCC license applications. These costs are amortized by the straight-line method from the commencement of operations over the life of the Partnership's initial license period (ten years).\nIn connection with the purchase of license interests, the excess of purchase price paid over the fair market value of tangible assets acquired is amortized by the straight-line method over 40 years.\nOther Assets\nOther assets includes deferred consulting, legal and interconnection costs, prepaid rent and the long-term portion of financing receivables. The deferred costs are amortized on a straight-line basis over 3, 5 and 15 years. Prepaid rent is charged to expense on a straight-line basis over the life of the various leases.\nRevenue Recognition\nService revenue is recognized at the time the cellular service is rendered. Telephone equipment sales are recorded when the equipment is shipped to the customer. Telephone rental revenue is billed and recognized on a monthly basis.\nIncome Taxes\nNo provision has been made for federal income taxes since such taxes, if any, are the responsibility of the individual partners. Provision has been made for state and local income taxes assessed on partnership income which is a liability of the Partnership.\nAllocation of Income\nPursuant to the New Par Partnership Agreement, income is allocated to the General Partners in proportion to their respective percentage ownership of New Par.\nS - 47\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n2. Significant Accounting Policies (continued)\nFair Value of Financial Instruments\nNew Par's financial instruments consist primarily of cash and cash equivalents, accounts receivable, financing receivables, due from affiliates, accounts payable, accrued expenses, distribution payable to partners, due to affiliates, property and other taxes payable, and commissions payable. The terms and short term nature of these assets and liabilities result in their carrying value approximating fair value.\nReclassifications\nCertain of the 1993 amounts have been reclassified to conform to the 1994 presentation.\n3. License Acquisition Costs\nLicense acquisition costs consist of the following:\nIn 1994, New Par wrote-off $152,000 of fully amortized costs and paid $100,000 in connection with its interim operating authority from the FCC for two Ohio Rural Service Areas.\nIn August 1991, a subsidiary of CCI (\"CCI RSA\") acquired the Mercer, Ohio FCC license. This license was contributed to one of the General Partnerships in accordance with the New Par Partnership Agreement. The contribution was initially recorded at CCI RSA's cost through December 31, 1991 of $1,315,000. During 1993, CCI RSA incurred an additional $19,575,000 upon the receipt of a favorable determination with respect to certain FCC matters. The additional cost was recorded as a contribution in 1993.\nS - 48\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n3. License Acquisition Costs (continued)\nIn 1993, a subsidiary of CCI contributed the Ashtabula, Ohio FCC license and the related assets and liabilities to one of the General Partnerships in accordance with the New Par Partnership Agreement. The contribution was recorded at $10,139,000, of which $8,632,000 was for the FCC license and $1,507,000 was for other assets, net of liabilities.\nIn 1992, New Par purchased the Clinton, Ohio FCC license from CCI RSA for $8,925,000 (CCI RSA's cost).\n4. Property, Plant and Equipment\nProperty, plant and equipment consists of the following:\n5. Financing Receivables\nNew Par provides financing for the purchase of cellular telephones by its customers in the form of noninterest bearing, 12 and 24 month installment contracts. Financing receivables are recorded net of a discount which is calculated based on an imputed interest rate of prime plus 1% at inception. The effective interest rate as of December 31, 1994 was 9.5%.\nS - 49\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n5. Financing Receivables (continued)\nFinancing receivables consists of the following:\n6. Related Party Transactions\nDue from affiliates consists of the following:\nS - 50\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\nDue to affiliates consists of the following:\nPursuant to the New Par Partnership Agreement, the CCI Group is responsible for appointing and employing New Par's chief executive officer and half of the next level executives and the AirTouch Group is responsible for appointing and employing the other half of the next level executives. In addition, the AirTouch Group employed the individuals associated with its former partnerships until July 1, 1992. For the year ended December 31, 1994, New Par was charged $1,215,000 and $1,099,000 for payroll and benefits by AirTouch affiliates and CCI, respectively, of which $228,000 and $2,086,000 are included in operating expenses and selling, general and administrative expenses, respectively. For the year ended December 31, 1993, New Par was charged $779,000 and $816,000 for payroll and benefits by AirTouch affiliates and CCI, respectively, of which $176,000 and $1,419,000 are included in operating expenses and selling, general and administrative expenses, respectively. For the year ended December 31, 1992, New Par was charged $9,364,000 and $836,000 for payroll and benefits by AirTouch affiliates and CCI, respectively, of which $2,154,000 and $8,046,000 are included in operating expenses and selling, general and administrative expenses, respectively.\nIn connection with the Merger Agreement, CCI distributed its wholly-owned subsidiary OCOM Corporation (\"OCOM\") to its shareholders on July 31, 1991. OCOM owns the long distance and microwave operations formerly owned by the partnerships that CCI contributed to New Par. Most of CCI's officers and directors are officers and directors of OCOM. New Par provides billing and collection services to OCOM for the long distance telephone service OCOM sells to certain of New Par's subscribers. OCOM operates the microwave transmission service between the cell sites and switches contributed by CCI. For the years ended December 31, 1994, 1993 and 1992, OCOM charged New Par $4,273,000, $4,043,000, and $4,846,000, respectively, for microwave transmission services which is included in operating expenses.\nS - 51\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n7. Leases\nLeases for office space, sales and service centers and cell sites extend through 2039. Total rent expense for the years ended December 31, 1994, 1993 and 1992 under operating leases was $6,786,000, $5,608,000, and $4,359,000, respectively.\nFuture minimum lease payments under noncancellable operating leases as of December 31, 1994 are as follows:\n8. Deferred Compensation\nIn 1994, New Par granted stock appreciation rights to executives and certain employees entitling them to receive cash in an amount equivalent to any excess of the market value of a stated number of shares of AirTouch and CCI stock over a stated grant price. The rights were granted at $24 per share for the AirTouch shares and $44 per share for the CCI shares. The rights vest based on the increase in the market value over the grant price. Vested rights may be exercised for cash after August 6, 1996.\nAs of December 31, 1994, rights based on 150,300 shares of AirTouch and 150,300 shares of CCI were outstanding. Based on the December 31, 1994 market value of AirTouch and CCI shares, the cash value of the rights in August 1996 would be $906,000. New Par recognized $171,000 of compensation expense in 1994 related to the stock appreciation rights.\nS - 52\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n9. Pension Plan\nNew Par has a defined contribution plan covering all employees who have completed six months of service and worked over 500 hours. New Par's matching and discretionary contributions are determined annually. Participants can make salary deferral contributions of 1% to 16% of annual compensation not to exceed the maximum allowed by law. New Par's expense for the years ended December 31, 1994, 1993 and 1992 was $3,352,000, $3,186,000, and $2,272,000, respectively.\n10. Commitments and Contingent Liabilities\nAs of December 31, 1994, New Par had purchase commitments of approximately $86,000,000 primarily for operating equipment, computer equipment and cellular telephones and accessories.\nIn March 1994, New Par entered into a one year $5,000,000 unsecured revolving credit agreement with a bank for working capital and any other proper business purpose. New Par did not obtain any funds under this agreement during 1994. The terms of the agreement include a commitment fee of .25% per annum.\nThere are various legal proceedings pending against New Par in the ordinary course of business. Management believes the aggregate liabilities, if any, arising from such proceedings would not have a material adverse effect on New Par's consolidated financial position.\n11. AirTouch and CCI Relationship\nA subsidiary of CCI, Cellular Communications of Ohio, Inc., (the parent of the CCI Group) has a loan agreement which places certain restrictions on New Par. These restrictions include the following: (i) New Par's aggregate lease payments may not exceed $8,000,000 for any twelve consecutive months, (ii) New Par's unsecured indebtedness, capital lease obligations and indebtedness for cellular network equipment or cellular telephones and accessories evidenced by a note or subject to a lien may not exceed $5,000,000, (iii) New Par's borrowings secured by real property may not exceed $10,000,000, (iv) New Par may not enter into an agreement that restricts partnership distributions and (v) the aggregate payment obligations outstanding at any time for (ii) and (iii) may not exceed $5,000,000 for any twelve consecutive months.\nS - 53\nNew Par (A Partnership) Notes to Consolidated Financial Statements (continued)\n11. AirTouch and CCI Relationship (continued)\nPursuant to the Merger Agreement, at specified times from August 1996 through January 1998, AirTouch has the right to buy the shares of CCI it does not own at an appraised value, subject to certain adjustments. If AirTouch does not exercise this right, it will determine whether New par should be dissolved or AirTouch's interest in New Par and CCI should be sold as a whole. Upon such determination, CCI must promptly commence a process to sell CCI, although in lieu of any sales to a third party, CCI may purchase AirTouch's CCI shares and, in certain circumstances, its interest in New Par at their appraised values. Any decision by CCI to buy out AirTouch or any irrevocable election by CCI not to effect a sale pursuant to the above sale process would require the approval of CCI stockholders. In the event that either CCI or CCI's interest in New Par is sold to a third party for less than the appraised value of CCI's interest in New Par, AirTouch may be required to pay a \"make-whole\" amount, subject to certain downward adjustments, to the other CCI stockholders.\n12. Partners' Capital\nNew Par is required to make cash distributions of a portion of estimated federal taxable income on a quarterly basis, subject to the amount of cash available including cash borrowable by New Par. Such distributions shall be made to the partners in proportion to their respective ownership percentages. As of December 31, 1994 and 1993, there was approximately $26,133,000 and $22,982,000, respectively, payable to the partners for the estimated federal taxable income distribution. During 1994, 1993 and 1992, New Par distributed $54,297,000, $35,000,000 and $18,241,000, respectively, pursuant to this requirement. New Par must also distribute the amount, if any, that exceeds 120% of the amount required for estimated federal income tax distributions, plus cash reasonably contemplated as being necessary for the cash payment of New Par's operating expenses (net of receipts), debt service, contingencies, budgeted capital expenditures and working capital requirements within 45 days after each quarter. Such distributions are to be made to the partners in proportion to their respective ownership percentages.\nS - 54\nNew Par (A Partnership)\nSchedule II - Valuation and Qualifying Accounts\n(1) Uncollectible accounts written off, net of recoveries.\nS - 55\nREPORT OF INDEPENDENT ACCOUNTANTS\nOur report on the consolidated financial statements of AirTouch Communications, Inc. and Subsidiaries has been incorporated by reference in this Form 10-K from Page 27 of the 1994 Annual Report to Stockholders of AirTouch Communications, Inc. In connection with our audit of such financial statements, we have also audited the related financial statement schedule listed in Item 14(a) 2 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\n\/s\/ Coopers & Lybrand L.L.P.\nSan Francisco, California March 13, 1995\nX - 1\nAirTouch Communications, Inc. and Subsidiaries Schedule II - Valuation and Qualifying Accounts and Reserves (Dollars in millions)\n- -------------------- (a) Amounts in this column reflect items written off, net of recoveries.\nX - 2\nEXHIBIT INDEX","section_15":""}
{"filename":"789863_1994.txt","cik":"789863","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral\nCavalier Homes, Inc. is a Delaware corporation incorporated in 1985, with its executive offices located at Highway 41 North and Cavalier Road, Addison, Alabama. Unless otherwise indicated by the context, references in this report to the \"Company\" or to \"Cavalier\" include the Company, its subsidiaries and their respective predecessors, if any.\nThe Company designs and manufactures a wide range of high quality manufactured homes and markets its homes primarily in the southeastern United States, with a focus on serving the low- to medium-priced manufactured housing market. During 1994, approximately 78% of the Company's revenues were generated from sales in its core markets of Alabama, North Carolina, Mississippi, South Carolina, Texas, Georgia, Louisiana and Tennessee. The Company currently operates nine manufacturing facilities, four of which are located in Alabama, two in North Carolina, one in Georgia, one in Texas and one in Pennsylvania.\nThe Company's homes are sold under the Cavalier, Pacesetter, Brigadier, Knox, Buccaneer, Challenger, Parkwood, Mansion, Olympic, Plantation, Town and Country, Astro and various other brand names. As of December 31, 1994, the Company's homes were sold through approximately 500 independent dealers (including 73 independent exclusive dealers) operating approximately 625 retail sales centers located in 32 states. The Company's homes normally include furniture and appliances and are comprised of one or more floor sections. The Company's single-section homes range in size from 546 to 1,216 square feet and are sold at retail prices ranging from approximately $13,000 to $30,000. Multi-section homes range in size from 880 to 2,394 square feet and are sold at retail prices ranging from approximately $20,000 to $60,000.\nIn 1991, the Company implemented an exclusive dealer program under which participating independent dealers sell only the Company's homes. The Company makes installment sale financing available to the retail customers of its exclusive dealers and provides such dealers with other services and support. The Company believes that its exclusive dealer program has helped to increase the Company's sales.\nThe Company began offering retail installment sale financing in March 1992 through Cavalier Acceptance Corporation (\"CAC\"), the Company's wholly owned finance subsidiary, for homes sold to qualifying retail customers of the Company's independent exclusive dealers. The Company believes that it is the one of the few major manufactured home producers in the United States offering retail consumer financing through independent dealers. The Company intends to continue CAC's financing activities as a means of increasing revenues, providing additional services to its independent exclusive dealers and establishing an additional profit center. For information relating to revenues, operating profit and indentifiable assets attributable to each industry segment of the Company, see Note 11 of \"Notes to Consolidated Financial Statements\" which are included herein.\nManufacturing Operations\nThe Company, through seven wholly owned subsidiaries, operates nine manufacturing facilities engaged in the production of manufactured homes located in Alabama, North Carolina, Georgia, Texas and Pennsylvania. Each of the Company's manufacturing subsidiaries is managed by its own supervisory personnel, who participate in an incentive compensation system based upon each subsidiary's profitability. The management of the Company's facilities typically\nconsists of a general manager, a production manager, a sales manager, a controller, a service manager, a material manager and a quality control manager. These mid-level managers control the operations of the respective operating subsidiaries, with assistance and guidance from the Company's executive officers.\nIn 1992, while operating four manufacturing facilities, the Company's production levels increased significantly from production levels in 1991. In 1993, the Company acquired Homestead Homes, Inc. (\"Homestead\"), opened an additional facility in Addison, Alabama and completed a renovation and expansion of its Hamilton, Alabama plant. During 1994 the Company opened additional manufacturing facilities in Winfield, Alabama and Fort Worth, Texas, expanded and renovated its manufacturing facilities in Cordele, Georgia and Nashville, North Carolina, as well as acquiring Astro Mfg. Co., Inc. located in Shippenville, Pennsylvania (\"Astro\"). These additions and expansions enabled the Company to continue increasing production in 1993 and 1994. The Company currently operates nine manufacturing facilities, ranging in size from 67,000 to 137,000 square feet. The Company's nine manufacturing facilities normally operate on a single shift basis, usually for a five-day week, each with the capacity to produce between 1,500 and 3,500 floor sections per year with an aggregate capacity to produce approximately 22,000 floor sections per year. The following table sets forth certain production information during 1992, 1993 and 1994:\nYear Ended December 31, ---------------------------------------------- 1992 1993 1994 ---------------------------------------------- Number of homes sold: Single section homes 4099 65.1% 5250 62.8% 6309 62.8% Multi-section homes 2202 34.9% 3104 37.2% 3733 37.2% ------- ------ ------- ------ ------ ------ Total homes 6301 100.0% 8354 100.0% 10042 100.0%\nNumber of floors sold 8506 11491 13799\nConstruction of a home begins by welding steel frame members together. The frame is then moved through the plant, stopping at a number of work stations where various components and sub-assemblies are attached. Certain sub-assemblies, such as plumbing, cabinets, ceilings and wall systems, are assembled at off- line work stations. The completed product contains carpeting, cabinets, appliances, wall and window coverings, and heating and plumbing systems, and is ready for connection to customer-supplied water, sewage and electrical systems.\nThe principal raw materials purchased by the Company are steel, lumber, plywood, aluminum, galvanized pipe, insulating materials, electrical supplies and plastics. The Company purchases axles, wheels, tires, kitchen appliances, plumbing fixtures, furniture, carpet, vinyl floor covering, windows and decorator accessories. The Company's Alabama manufacturing facilities currently purchase roof trusses and certain other wood products from a limited partnership in which the Company owns a one-third interest. Prices obtained by the Company for wood products from this entity are competitive with the Company's other sources of supply. Currently, the Company maintains approximately two to three weeks' inventory of raw materials. The Company is not dependent on any single source of supply and believes that the materials and parts necessary for the construction and assembly of its homes are readily available from other sources.\nBecause the cost of transporting a manufactured home is significant, there is a limit to the distance between a manufacturing facility and the dealers it can service. The Company believes that the location of its manufacturing facilities in multiple states allows it to serve more dealers in more markets. The Company generally arranges, at the dealer's expense, for the transportation of finished homes to dealers using independent trucking companies. Dealers or other independent installers are responsible for placing the home on site, making utility connections and providing and installing certain accessory items and appurtenances, such as decks, carports and foundations.\nDuring 1994 the Company, through its wholly owned subsidiary Quality Housing Supply, Inc. (\"Quality\"), acquired a manufacturing facility in Winfield, Alabama for the production of laminated wallboards and distribution of other component products used in the manufactured housing industry. During 1994 the majority of products sold by Quality were to subsidiaries of the Company. The Company currently intends to expand the sales of Quality's products to unaffiliated companies in the manufactured housing industry. For information regarding backlog and seasonality, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Backlog\".\nProducts\nThe Company's homes include both single-section and multi-section models, with the substantial majority of such products being \"HUD Code Homes\", which are manufactured homes that meet the specifications of the U.S. Department of Housing and Urban Development (\"HUD\"). The single-section homes are 14 to 16 feet wide, vary in length from 40 to 80 feet and contain between 546 and 1,216 square feet. The multi-section models are 24 to 42 feet wide, vary in length from 40 to 80 feet and contain between 880 and 2,394 square feet. Multi-section homes are built as two or three floors that are joined at the home site.\nThe Company currently produces over 300 different models of manufactured homes with a variety of decors that are marketed under approximately 30 brand names. The homes typically include a living room, dining area, kitchen, one to four bedrooms and one or two bathrooms. Each home contains a cooking range and oven, refrigerator, hot water heater and central heating. Depending on the customer's preferences, most homes are furnished with complete living room and bedroom furniture, dinette set, carpeting, vinyl flooring, drapes, and window screens. Customers may also choose many available options, including fireplaces, ceiling fans, dishwashers, garbage disposals, microwave ovens, stereos, bay windows, composition shingle roofs, vinyl siding and sliding glass patio doors.\nModular homes, which are homes designed to meet building codes administered by states and local authorities, as opposed to the national HUD guidelines, currently are not a significant part of the Company's product lines. However, three of the Company's manufacturing facilities have the capability to manufacture modular homes meeting applicable regulatory standards. Although the Company has no present plans to increase its production of modular homes, the Company's production facilities could accommodate the further expansion of its product lines into the modular home market without a significant capital outlay.\nThe Company's product development and engineering personnel design homes in consultation with operating management, sales representatives and dealers. They also evaluate new materials and construction techniques and use computer-aided and other design methods in a continuous program of product development, design and enhancement. The Company's product development activities do not require significant capital investments or expenditures.\nIndependent Dealer Network, Sales and Marketing\nAs of December 31, 1994, the Company's homes were sold through approximately 500 independent dealers (including 73 independent exclusive dealers) operating approximately 625 retail sales centers located in 32 states. Approximately 78% of the Company's sales in 1994 were to dealers operating sales centers in the Company's core markets. The Company's percentage of sales to these core markets is as follows: Alabama - 20%, North Carolina - 17%, Mississippi - 8%, South Carolina - 8%, Texas - 7%, Georgia - 6%, Louisiana - 6% and Tennessee - 6%.\nThe Company has written agreements with most of its independent dealers requiring each dealer to maintain qualified service staff to perform day-to-day repair work on the Company's homes sold by the dealer and requiring prompt payment by the dealer for homes purchased. The agreements provide that they may be terminated at any time by either party, with or without cause, after a short notice period, generally 30 days. The Company does not have any control over the operations of, or financial interests in, any of its independent dealers, including any of its independent exclusive dealers; however, the Company owned and operated retail sales centers in Alexandria, Alabama and Douglasville, Georgia. During January 1995, the Company sold its retail sales center in Alexandria, Alabama.The Company is not dependent on any single dealer, and in 1994, the Company's largest dealer accounted for approximately 2.8% of net sales.\nThe Company believes that its independent dealer network enables the Company to achieve broader distribution of its products than if the Company operated its own retail sales centers. To enable dealers to maximize retail market penetration and enhance customer service, and to promote dealer loyalty, typically only one dealer within a given market area distributes a particular product line of the Company. Selling through independent dealers also allows the Company to avoid the substantial investment in management and overhead associated with the operation of company-owned sales centers. In addition, the Company's strategy of selling its homes through independent dealers helps to ensure that the Company's homes are competitive with those of other manufacturers in terms of consumer acceptability, product design, quality and price. Accordingly, a component of the Company's business strategy is to continually strengthen its dealer relations. The Company believes its relations with its independent dealers, including its independent exclusive dealers, are good.\nSince 1991, the Company has been developing an independent exclusive dealer network. The Company's independent exclusive dealers market and sell only homes manufactured by the Company, while the Company's independent non-exclusive dealers typically will choose to offer the products of two to three manufacturers in addition to those of the Company. Historically, sales of the Company's homes to independent dealers operating a single sales center have accounted for a significant portion of the Company's revenues, and the Company has focused its efforts to develop an exclusive dealer network consisting of these operators, as well as certain dealers operating multiple sales centers. The Company makes installment sale financing through CAC available to the retail customers of its exclusive dealers and provides these dealers with other services and support. Beginning with 20 exclusive dealers in 1991, the Company's independent exclusive dealer network grew to 51 in 1992, increased to 60 exclusive dealers in 1993, and as of December 31, 1994, the Company had 73 independent exclusive dealers operating retail sales centers located in 13 states. Sales to the Company's independent exclusive dealers in 1992, 1993 and 1994 represented approximately 28%, 36% and 37%, respectively, of the Company's sales for these periods.\nEach of the Company's plants typically employs a sales manager and from two to eight sales representatives who are compensated on a commission basis. The plant-level sales representatives are charged with the day-to-day servicing of the needs of the Company's independent dealers, including its independent exclusive dealers. The Company provides sales training to its dealers and has instituted a program of bringing more dealers to the plants to view new product designs as they are developed. The Company markets its homes through product promotions, participation in regional manufactured housing shows and advertisements in local media. As of December 31, 1994, the Company maintained a sales force of 43 full-time salesmen and 7 full-time sales managers.\nCavalier Acceptance Corporation; Retail Financing Activities\nThe Company believes that the introduction of retail financing as an additional segment of the Company's operations can facilitate increased sales and earnings. In addition, the Company's goal is for CAC's activities to provide the Company with a source of consistent earnings which may, to a certain extent, be insulated from fluctuating manufactured home sales volumes.\nCAC seeks to provide highly competitive financing terms to customers of the Company's 73 independent exclusive dealers. CAC currently offers four conventional loan programs which require a down-payment ranging from 0% to 20% of the purchase price, in cash, trade-in value of a previously-owned manufactured home and\/or appraised value of equity in any real property pledged as collateral. Repayment terms range from 84 to 240 months, depending upon the amount financed, the amount of the down payment and the customer's creditworthiness. CAC's loans are secured by a purchase money security interest in the manufactured home and, in certain instances, a mortgage on real property pledged as additional collateral. Loans purchased and originated by CAC normally provide a fixed rate of interest with equal monthly payments and are non- recourse to the original dealer. Currently, CAC operates in 13 states and serves all of the Company's exclusive dealers.\nFor those retail customers who meet CAC's lending standards, CAC provides prompt credit approvals and funding of loans. CAC has established a standardized credit scoring system to facilitate such prompt decision-making on loan applications. The most important criteria in the scoring system are the income, employment stability and credit worthiness of the borrower. The system requires a minimum score before CAC will consider funding the installment sale contract.\nCertain operating data relating to CAC are set forth in the following table:\nDecember 31, 1993 1994\nTotal loans Receivable $ 3,058,000 $ 9,825,000 Allowance for credit losses $ 104,000 $ 350,000 Number of loans outstanding 144 415 Number of delinquencies 1 2 Loss ratio .3% .2% Average annual percentage rate 10.9% 11.4%\nCAC presently has 2 part-time and 5 full-time employees, including its president, Jerry F. Wilson, Jr., the son of the Company's President and Chief Executive Officer. Upon graduation from the University of Alabama in 1988 with a degree in finance, Mr. Wilson was employed by Security Pacific Housing Services, Inc., a leading retail lending institution for the manufactured housing industry. After one year of service, Mr. Wilson was promoted to region credit manager in Tampa, Florida, where he was responsible for credit decisions and loan originations for manufactured home retail installment sale contracts in excess of $2 million per month. Mr. Wilson joined the Company in 1990 and served as director of New Business Development for the Company until CAC was incorporated.\nAlthough the level of CAC's future activities cannot presently be determined, the Company expects CAC to utilize internally generated working capital, proceeds from the Company's 1994 stock offering and borrowings under the Company's revolving, warehouse, and term loan agreement with its primary lender (described below under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations, Liquidity and Capital Resources\"), to fund retail installment sale contracts on homes sold by the Company's independent exclusive dealers, and to develop a portfolio of such installment sale contracts. The Company believes that its relationships with its exclusive dealers will assist the development of this portfolio.\nCAC intends in the short-term to act principally as a permanent lender on its conventional loans and to hold such loans as long-term receivables. The Company believes that the term loan component of its revolving, warehouse, and term loan agreement will facilitate the Company's attempts to match liabilities and assets of CAC both as to term and rate, which should reduce loss exposure from interest rate fluctuations. In the future, CAC may \"pool\" certain of the installment sale contracts in its portfolio for sale to institutional or other investors, either on a full-, partial- or non-recourse basis.\nWholesale Dealer Financing and Repurchase Obligations\nIn accordance with manufactured housing industry practice, substantially all of the Company's dealers finance their purchases of manufactured homes through wholesale \"floor plan\" financing arrangements. Under a typical floor plan financing arrangement, a financial institution provides the dealer with a loan for the purchase price of the home and maintains a security interest in the home as collateral. The financial institution which provides financing to the dealer customarily requires the Company to enter into a separate repurchase agreement with the financial institution under which the Company is obligated, upon default by the dealer and under certain circumstances, to repurchase the financed homes at a declining price based upon the Company's original invoice price plus, in specific cases, certain administrative expenses. A portion of purchases by dealers are pre-sold to retail customers and are paid through firm retail financing commitments.\nThe risk of loss under such repurchase agreements is mitigated by the fact that (i) sales of the Company's manufactured homes are spread over a relatively large number of independent dealers, the largest of which accounted for approximately 2.8% of the Company's net sales in 1994, (ii) the repurchase obligation expires on individual homes after a reasonable period of time (generally 12 to 18 months from invoice date) and also declines during such period based on predetermined amounts and (iii) the Company is in many cases able to sell homes repurchased from credit sources in the ordinary course of business without incurring significant losses. As of December 31, 1994, the Company's contingent liability under these repurchase and other similar recourse agreements was an amount estimated to be approximately $54 million. The Company has provided a reserve for possible repurchase losses of $650,000 as of December 3l, 1994, based on prior experience and current market conditions. Management believes its reserve is sufficient to cover any repuchase losses.\nQuality Control, Warranties and Service\nThe Company believes the quality in materials and workmanship, in addition to price and other market factors, is an important element in the market acceptance of manufactured homes. The Company maintains a rigorous quality control inspection program at all production stages at each of its manufacturing facilities. The Company's manufacturing facilities and the plans and specifications of its manufactured homes have been approved by a HUD-designated inspection agency. An independent, HUD-approved third-party inspector checks each of the Company's manufactured homes for compliance during construction. The Company believes that adherence to strict quality standards and continuously refining design and production procedures enhances consumer satisfaction and reduces warranty claims.\nThe Company provides the initial home buyer with a HUD-mandated, one-year limited warranty against manufacturing defects in the home's construction. Warranty services after sale are performed, at the expense of the Company, by local plant personnel, by independent dealers or, in certain cases, local independent contractors. In addition to the warranty by the Company, direct warranties often are provided by the manufacturers of specific components and appliances. The Company maintains a full-time service manager at most of its manufacturing facilities. In addition, the Company has 50 full-time service personnel to provide on-site service and correct production deficiencies that are attributable to the manufacturing process. Warranty service constitutes a significant cost to the Company, and management of the Company has placed emphasis on diagnosing potential problem areas to help minimize costly field repairs. The Company also has focused on reducing response time to customer service requests. At December 31, 1994, the Company had established a reserve for future warranty costs of $4.2 million.\nCompetition\nThe manufactured housing industry is highly competitive, characterized by low barriers to entry and severe price competition. Competition is based on price, product features and quality, reputation for service and quality, depth of field inventory, delivery capabilities, warranty repair service, dealer promotions, merchandising and terms of dealer and retail consumer financing. The Company also competes with other manufacturers, some of which maintain their own retail sales centers, for quality independent dealers. In addition, the Company's manufactured homes compete with other forms of low-cost housing, including site- built, prefabricated, modular homes, apartments, townhouses and condominiums. The selection by retail buyers of a manufactured home rather than an apartment or other alternative is significantly affected by their ability to obtain satisfactory financing. The Company faces direct competition from numerous manufacturers, many of which possess greater financial, manufacturing, distribution and marketing resources.\nAlthough the Company intends to increase substantially the level of retail financing provided through CAC; due to strong competition in the retail finance segment of the industry from companies much larger than CAC combined with the limited operating history of CAC, there can be no assurance that providing this financing will have a positive impact on the Company's ability to compete.\nRegulation\nThe Company's business is subject to a number of federal, state and local laws, regulations and codes. Construction of manufactured housing is governed by the National Manufactured Home Construction and Safety Standards Act of 1974 and regulations issued thereunder by HUD, which have established comprehensive national construction standards. The HUD regulations cover all aspects of manufactured home construction, including structural integrity, fire safety, wind loads, thermal protection and ventilation. Such regulations preempt state and local regulations on such matters. The National Commission on Manufactured Housing has held hearings to develop recommendations relating to the regulation of the manufactured housing industry. This commission is has issued an interim report to Congress which contains a number of recommendations relating to various aspects of manufactured housing regulation, including inspection, warranty and enforcement. The Company cannot presently determine what, if any, legislation may be adopted by Congress or the effect any such legislation may have on the Company or the manufactured housing industry.\nThe Company's manufacturing facilities and the plans and specifications of its manufactured homes have been approved by a HUD-designed inspection agency. Furthermore, an independent, HUD-approved third- party inspector regularly checks the Company's manufactured homes for compliance during construction. Failure to comply with the HUD regulations could expose the Company to a wide variety of sanctions, including closing the Company's plants. The Company believes its manufactured homes meet or surpass all present HUD requirements.\nCertain recently promulgated HUD regulations with respect to structural design relating to wind load capacities of manufactured homes became effective in July 1994. These regulations generally require that homes sold in hurricane-prone areas be designed to withstand wind speeds of up to 110 miles per hour. Such regulations result in an increase in the costs associated with the manufacture of homes sold in the regions affected thereby, particularly hurricane-prone areas. The Company does not believe that the increased costs associated with these rules and regulations will have a material effect on the Company's operations. HUD is also currently reviewing the existing wind load capacity regulations for all other areas of the country, and the Company cannot presently determine if additional regulations will be adopted or the effect any such regulations would have on the Company or the manufactured housing industry as a whole.\nHUD also has adopted energy conservation rules and regulations which became effective in October 1994. The Company does not believe that the increased costs associated with these rules and regulations will have a material effect on the Company's operations. The Federal Trade Commission regulations also require disclosure of a manufactured home's insulation specification.\nCertain components of manufactured and modular homes are subject to regulation by the U.S. Consumer Product Safety Commission (\"CPSC\"), which is empowered to ban the use of component materials believed to be hazardous to health and to require the repair of defective components. The CPSC, the Environmental Protection Agency and other governmental agencies are evaluating the effects of formaldehyde. Manufactured, modular and site-built homes are all built with particle board, paneling and other products that contain formaldehyde resins. Since February 1985, HUD has regulated the allowable concentration of formaldehyde in certain products used in manufactured homes and required manufacturers to warn purchasers concerning formaldehyde associated risks. The Company currently uses materials in its manufactured homes that meet HUD standards for formaldehyde emissions and otherwise comply with HUD regulations in this regard.\nThe Company's manufactured homes are subject to local zoning and housing regulations. A number of states require manufactured home producers to post bonds to ensure the satisfaction of consumer warranty claims. A number of states have adopted procedures governing the installation of manufactured homes. Utility connections are subject to state and local regulation.\nThe Company is subject to the Magnuson-Moss Warranty Federal Trade Commission Improvement Act, which regulates the descriptions of warranties on products. The description and substance of the Company's warranties are also subject to a variety of state laws and regulations.\nThe Company's operations are subject to federal, state and local laws and regulations relating to the generation, storage, handling, emission, transportation and discharge of materials into the environment. Governmental authorities have the power to enforce compliance with their regulations, and violations may result in the payment of fines or the entry of injunctions, or both. The Company currently does not believe it will be required under existing environmental laws and enforcement policies to expend amounts which will have a material adverse effect on its results of operations or financial condition. However, the requirements of such laws and enforcement policies have generally become more strict in recent years. Accordingly, the Company is unable to presently determine the ultimate cost of compliance with environmental laws and enforcement policies.\nA variety of federal laws affect the financing of manufactured homes, including the financing activities conducted by CAC. The Consumer Credit Protection Act (Truth-in-Lending) and Regulation Z promulgated thereunder require substantial disclosures to be made in writing to a consumer with regard to various aspects of the particular transaction, including the amount financed, the annual percentage rate, the total finance charge, itemization of the amount financed and other matters and also sets forth certain substantive limitations on permissible contract terms. The Equal Credit Opportunity Act and Regulation B promulgated thereunder prohibit credit discrimination against any credit applicant based on certain prohibited bases, and also require that certain specified notices be sent to credit applicants whose applications are denied. The Federal Trade Commission has adopted or proposed various trade regulation rules to specify and prohibit certain unfair credit and collection practices and also to preserve consumers' claims and defenses. The Government National Mortgage Association (\"GNMA\") specifies certain credit underwriting requirements in order for installment manufactured home sale contracts to be eligible for inclusion in a GNMA program. HUD also has promulgated substantial disclosure and substantive regulations and requirements in order for a manufactured home installment sale contract to qualify for insurance under the Federal Housing Authority (\"FHA\") program, and the failure to comply with such requirements and procedures can result in loss of the FHA guaranty protection. In addition, the financing activities of CAC may also become subject to the disclosure requirements of the Home Mortgage Disclosure Act. In addition to the extensive federal regulation of consumer credit matters, many states have also adopted consumer credit protection requirements that may impose significant requirements for consumer credit lenders. For example, many states require that a consumer credit finance company such as CAC obtain certain regulatory licenses or permits in order to engage in such business in that state, and many states also set forth a number of substantive contractual limitations regarding provisions that permissibly may be included in a consumer contract, as well as limitations upon the permissible interest rates, fees and other charges that may be imposed upon a consumer. Failure by the Company or CAC to comply with the requirements of federal or state law pertaining to consumer credit could result in the unenforceability of the particular contract for the affected consumer, civil liability to the affected customers, criminal liability and other adverse results.\nEmployees\nAs of December 31, 1994, the Company had 2,259 employees, of whom 2,016 were engaged in manufacturing, 50 in sales, 50 in warranty and service, 136 in general administration and 7 in financial services. At year end only Astro's employees engaged in manufacturing (118 employees) were covered by a collective bargaining agreement. Management considers its relations with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table sets forth information concerning the Company's facilities as of December 31, 1994:\nDate Expiration Approximate Leased or of Lease Square Location Acquired Description Term Feet\nAddison, Alabama 1984 Corporate headquarters 1996 11,500\nAddison, Alabama 1984 Manufacturing facility, 1996 137,000 warehouse and mill building\nAddison, Alabama 1993 Manufacturing facility 1997 108,000\nHamilton, Alabama 1987 Manufacturing facility, (1) 113,500 warehouse and administrative offices\nWinfield, Alabama 1994 Manufacturing facility 1999 71,000\nWinfield, Alabama 1994 Component manufacturing facility 1999 48,000\nCordele, Georgia 1993 Manufacturing facility and (1) 67,000 administrative offices\nNashville, North Carolina 1987 Manufacturing facility, (1) 95,000 warehouse and administrative offices\nRobbins, North Carolina 1987 Manufacturing facility and 1998 89,000 administrative offices\nShippenville, Pennsylvania 1993 Manufacturing facility and (1) 133,000 administrative offices\nFort Worth, Texas 1994 Manufacturing facility and 1999 91,000 administrative offices\nWichita Falls, Texas 1986 Administrative headquarters 1998 1,210\n( 1 ) Company-owned facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are, from time to time, involved in litigation arising in the ordinary course of its business. In the opinion of the Company, none of such litigation is currently expected to have a material adverse effect on 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\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCK HOLDER MATTERS\nOn December 5, 1994 the Company's Common Stock began trading on the New York Stock Exchange under the symbol \"CAV\". Previously the Company's Common Stock was traded on the American Stock Exchange under the symbol of \"CXV\". The following table sets forth, for each of the periods indicated, the reported high and low sale prices per share on each of the respective exchanges referred to above for the Company's Common Stock and the cash dividends paid per share in such periods. The amounts have been adjusted, as appropriate, to reflect a five-for-four stock split which was paid on November 15, 1993:\nSelling Price High Low Dividends Fiscal year ended December 31, 1993: First Quarter $ 14 1\/4 $ 9 3\/4 $ 0.016 Second Quarter 13 1\/2 9 3\/4 0.016 Third Quarter 12 1\/4 8 3\/4 0.016 Fourth Quarter 16 10 1\/8 0.020\nFiscal year ended December 31, 1994: First Quarter 17 12 0.020 Second Quarter 15 1\/2 12 1\/8 0.020 Third Quarter 14 1\/8 12 3\/8 0.020 Fourth Quarter 13 1\/2 9 3\/4 0.020\nAs of March 15, 1995, the Company had approximately 2,400 record and beneficial holders of its Common Stock, based upon information in securities position listings by registered clearing agencies upon request of the Company's transfer agent.\nThe Company intends to continue to pay regular quarterly dividends. However, the payment of dividends on the Company's Common Stock is determined by the Board of Directors of the Company in light of conditions then existing, including the earnings of the Company and its subsidiaries, their funding requirements and financial conditions, certain loan restrictions and applicable laws and governmental regulations. The Company's present loan agreement contains restrictive covenants which, among other things, limit the aggregate dividend payments and purchases of treasury stock to 50% of the Company's aggregate net income for the two most recent fiscal years.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe following table sets forth selected consolidated financial data regarding the Company for the periods indicated. The statement of income data, the balance sheet data, and other data of the Company for each of the five years ended December 31, 1994, have been derived from the consolidated financial statements of the Company. The Company's audited financial statements as of December 31, 1994 and 1993, and for each of the years in the three-year period ended December 31, 1994, including the notes thereto and the related report of Deloitte & Touche LLP, independent auditors, are included elsewhere in this report. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements (including the Notes thereto) and the other financial information contained elsewhere in this report, and with the Company's consolidated financial statements and the notes thereto appearing in the Company's previously filed Annual Reports on Form 10-K.\n(1) As adjusted for two five-for-four stock splits paid in November 1992 and November 1993.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGeneral\nThe principal business of the Company since its inception has been the design and production of manufactured homes. In the first quarter of 1992, the Company, through its wholly owned subsidiary CAC, commenced retail installment sale financing operations. As of the end of 1993, the operations of CAC became significant enough to require segment reporting by the Company.\nThe Company's business is cyclical and seasonal and is influenced by many of the same national and regional economic and demographic factors that affect the United States housing market generally. According to the Manufactured Housing Institute (\"MHI\"), domestic shipments of manufactured homes reached a ten-year low of 170,713 homes in 1991. However, the industry experienced a turnaround during 1992, 1993 and 1994, with shipments increasing approximately 24%, 21% and 20%, respectively, compared to the prior year. The industry recovery has been most heavily concentrated in the southeastern United States, where the Company conducts a substantial portion of its business. According to MHI, shipments of manufactured homes in the Southeast (which MHI designates as the south Atlantic and south central regions) increased approximately 34% in 1992, 25% in 1993 and 21% in 1994, compared to the prior year. The Company attributes the upturn in the manufactured housing industry to increased consumer confidence, a reduction in the availability of alternative housing, increased availability of consumer financing and an improvement in the overall economy.\nAlthough the Company's operations were adversely affected by the overall conditions in the industry through the first quarter of 1991, the Company has enjoyed significant and continued growth in both sales and earnings since that time. The Company believes that the industry turnaround, combined with marketing and other programs instituted by the Company in 1991, including its exclusive dealer program and the retail finance operations of CAC, are the principal reasons for the improvement in the Company's results of operations.\nYear Ended December 31, 1994 Compared to Year Ended December 31, 1993\nNet Sales. For the year ended December 31, 1994, net sales were $206.4 million, representing a 33% increase compared to 1993 net sales of $155.6 million. Net sales for 1994 were the highest in the Company's history. The Company believes that the significant increase in its sales for the year was primarily the result of the continuation of improving industry trends and Company programs discussed above, an escalation in the average selling price of the Company's homes, the acquisition of an additional facility in Pennsylvania, through the Company's acquisition of Astro and the opening a new production facility in each of Winfield, Alabama and Fort Worth, Texas.\nActual shipments of homes during 1994 increased 20% to 10,042 homes, as compared to 8,354 homes in 1993. Differences between the percentage increase in net sales and the percentage increase in shipments are due to differences in selling prices of individual homes sold or product mix in any given year. The average selling price of homes rose from approximately $18,600 to $20,600, primarily due to a change in construction standards mandated by the Deparment of Housing and Urban Development combined with price increases instituted by the Company associated with rising prices in lumber and other raw materials. From October 28, 1994, the date of the acquisition of Astro, through December 31, 1994, Astro had shipments of 140 homes and sales of approximately $3.1 million. Although the acquisition of Astro contributed to the growth in the Company's sales and shipments in 1994, the Company shipped 9,902 homes in 1994, exclusive of shipments by Astro, or an increase of 19% compared to 1993. Sales for 1994, exclusive of Astro, were approximately $203.3 million, or an increase of 31% over 1993.\nGross Profit on Sales. Gross profit on sales is derived by deducting cost of sales from net sales. Gross profit on sales in 1994 increased to $30.4 million, or 14.7% of net sales, as compared to $22.2 million, or 14.2% of net sales, in 1993. The increase in gross profit was primarily attributable to increased sales volume, efficiencies achieved as a result of production level increases and price increases instituted by the Company. Financial Services Revenue. Financial services revenue is derived primarily from interest on installment sale contracts held by CAC. Financial services revenue was approximately $703,000 for 1994, as compared to approximately $230,000 for 1993. The increase in financial services revenue was primarily due to an increase in the Company's loan portfolio to approximately $9.8 million at the end of 1994, up from $3.1 million at the end of 1993.\nSelling, General and Administrative. Selling, general and administrative expenses increased to $23.0 million in 1994 from $17.0 million in 1993. The increase in selling, general and administrative expenses was consistent with the increase in sales and was primarily due to the acquisition of Astro, the opening of a manufacturing facility in each of Winfield, Alabama, and Fort Worth, Texas, the addition of personnel related to the Company's continued growth, an increase in operating expenses of CAC consistent with its growth, increased sales commissions, increased expenses for performance compensation based on profits and other employment-related expenses due to the hiring of additional personnel. As a percentage of total revenues, selling, general and administrative expenses were 11.1% for 1994, compared to 10.9% for 1993.\nOperating Profit. Operating profit is derived by deducting cost of sales and selling, general and administrative expenses from total revenues. Operating profit increased to $8.1 million in 1994, compared to $5.4 million in 1993, consistent with the increase in total revenues. As a percentage of total revenues, operating profit was 3.9% for 1994, compared to 3.4% for 1993.\nOther Income (Expense):\nInterest expense. The Company incurred approximately $76,000 in interest expense in 1994, compared to approximately $35,000 in 1993. Interest expense increased in 1994 primarily due to borrowings by CAC.\nOther, net. Other income or expense is comprised of gain or loss upon sales of assets, interest income (unrelated to financial services) and other investment income, and income or loss on investments recorded under the equity method. Other income was approximately $526,000 for 1994, compared to other income of approximately $237,000 for 1993. The change in the reported item of other income or expense in 1994 was primarily attributable to increased income from an investment recorded under the equity method and an increase in earnings from the investment of proceeds from the Company's 1994 stock offering. (For a further discussion of the 1994 stock offering, see \"Liquidity and Capital Resources\".)\nNet Income. Net income for 1994 increased by $1.8 million to $5.1 million, compared to $3.3 million in 1993. The increase in net income was due primarily to increased sales for the period. As a percentage of total revenues, net income was 2.5% for 1994, compared to 2.1% for 1993.\nYear Ended December 31, 1993 Compared to Year Ended December 31, 1992\nNet Sales. For the year ended December 31, 1993, net sales were $155.6 million, representing a 46% increase compared to 1992 net sales of $106.4 million. The Company believes that the significant increase in its sales for the year was primarily the result of the improving industry trends and Company programs discussed above, an escalation in the average selling price of the Company's homes, the acquisition of an additional facility in Georgia, through the Company's acquisition of Homestead, and the opening of a new production facility in Addison, Alabama.\nActual shipments of homes during 1993 increased 33% to 8,354 homes, as compared to 6,301 homes in 1992. The average selling price of homes rose from approximately $16,900 to $18,600, primarily due to a slight shift in product mix toward multi-section homes combined with rising material costs. From February 26, 1993, the date of the acquisition of Homestead, through December 31, 1993, Homestead had shipments of 723 homes and sales of approximately $17.6 million. Although the acquisition of Homestead contributed to the growth in the Company's sales and shipments in 1993, the Company shipped 7,631 homes in 1993, exclusive of shipments by Homestead, or an increase of 21% compared to 1992. Sales for 1993, exclusive of Homestead, were approximately $138.0 million, or an increase of 30% over 1992.\nGross Profit on Sales. Gross profit on sales in 1993 increased to $22.2 million, or 14.2% of net sales, as compared to $14.5 million, or 13.7% of net sales, in 1992. The increase in gross profit was primarily attributable to increased sales volume, efficiencies achieved as a result of production level increases and price increases made possible by a slight decrease in competitive pressure due to improved industry conditions.\nFinancial Services Revenue. Financial services revenue was approximately $230,000 for 1993, as compared to approximately $60,000 for 1992. The increase in financial services revenue was primarily due to an increase in the Company's loan portfolio to approximately $3.1 million at the end of 1993, up from $600,000 at the end of 1992.\nSelling, General and Administrative. Selling, general and administrative expenses increased to $17.0 million in 1993 from $11.3 million in 1992. The increase in selling, general and administrative expenses was consistent with the increase in sales and was primarily due to the acquisition of Homestead, the opening of a new manufacturing facility in Addison, Alabama, the addition of personnel related to the acquisition and new facility, an increase in operating expenses of CAC consistent with its growth, increased sales commissions, increased expenses for performance compensation based on profits and other employment-related expenses due to the hiring of additional personnel. As a percentage of total revenues, selling, general and administrative expenses were 10.9% for 1993, compared to 10.6% for 1992.\nOperating Profit. Operating profit increased to $5.4 million in 1993, compared to $3.3 million in 1992, consistent with the increase in total revenues. As a percentage of total revenues, operating profit was 3.4% for 1993, compared to 3.1% for 1992.\nOther Income (Expense):\nInterest expense. The Company incurred approximately $35,000 in interest expense in 1993, compared to approximately $20,000 in 1992. Interest expense increased in 1993 primarily due to long-term debt acquired in the acquisition of Homestead and short-term borrowings of CAC.\nOther, net. Other income was approximately $236,000 for 1993, compared to other expense of approximately $500 for 1992. The change in the reported item of other income or expense in 1993 was primarily attributable to income from an investment recorded under the equity method, as opposed to a loss for such investment in 1992.\nNet Income. Net income for 1993 increased by $1.3 million to $3.3 million, compared to $2.0 million in 1992. The increase in net income was due primarily to increased sales for the period. As a percentage of total revenues, net income was 2.1% for 1993, compared to 1.9% for 1992.\nCavalier Acceptance Corporation\nDuring 1992, the Company began the operations of CAC, which was formed to offer retail installment sale financing for manufactured homes sold through the Company's independent exclusive dealer network. In 1992, the Company purchased and originated approximately $600,000 in installment sale contracts and collected principal amounts under such contracts of approximately $22,000, while establishing an allowance for credit losses of approximately $22,000 at December 31, 1992. During 1993, the Company purchased and originated approximately $2.6 million in installment sale contracts, collected approximately $145,000 in principal amounts under such contracts and had established an allowance for credit losses of $104,000 at December 31, 1993. During 1994, the Company purchased and originated approximately $7.3 million in installment sale contracts, collected approximately $542,000 in principal amounts under such contracts and had established an allowance for credit losses of $350,000 at December 31, 1994. The Company expects to continue to expand the operations of CAC during 1995. The Company's current goal is to purchase and originate approximately $10 million to $12 million in retail installment sale contracts during 1995. The Company intends to purchase and originate loans utilizing internally generated working capital, proceeds from its 1994 stock offering, and borrowings under a $13 million revolving, warehouse, and term loan agreement (the \"Credit Facility\") entered into in February 1994 with the Company's primary lender. (For a further discussion of the Credit Facility, see \"Liquidity and Capital Resources\".) Due to strong competition in the retail finance segment of the industry from companies much larger than CAC combined with the limited operating history of CAC, there can be no assurance that the Company will be able to achieve these purchase and origination goals. Numerous factors could affect the availability of various sources of funds, which in turn may change the mix of funds used to purchase and originate loans. As CAC expands, the Company expects that the operations of CAC will have a greater effect upon the Company's consolidated results of operations and financial condition.\nLiquidity and Capital Resources\nAs of December 31, 1994, the Company had working capital of $12.6 million, as compared to $5.5 million and $5.3 million at December 31, 1993 and 1992, respectively. Working capital increased in 1994 primarily due to strong earnings during the period combined with proceeds from the 1994 offering of the Company's Common Stock. Working capital increased marginally in 1993 compared to 1992 despite strong 1993 earnings primarily due to working capital expended for the origination of $2.6 million in installment sales contracts and $2.9 million in capital expenditures during the year combined with costs associated with the acquisition of Homestead.\nThe ratio of current assets to current liabilities was 1.5:1 at December 31, 1994, as compared to 1.4:1 and 1.5:1 at December 31, 1993 and 1992 respectively. Annualized inventory turnover was 22.5 in 1994, compared to 26.5 in 1993 and 24.4 in 1992.\nThe Company began the operations of CAC in March 1992 and purchased and originated approximately $10.5 million in retail installment sale contracts from inception through December 31, 1994, with funds derived from internally generated working capital of the Company, proceeds from the Company's stock offering and borrowings under its Credit Facility. Consistent with the current intention of the Company to expand further the operations of CAC, the Company entered into the Credit Facility to provide additional funds for CAC's growth. As discussed above under the heading \"Cavalier Acceptance Corporation,\" the Company expects to expand the operations of CAC during 1995.\nIn February 1994, the Company entered into the Credit Facility, consisting of a $13 million revolving warehouse and term loan agreement with its primary lender. The Credit Facility contains a revolving line of credit which provides for borrowings (including letters of credit) of up to 80% and 50% of the Company's eligible (as defined) accounts receivable and inventories, respectively, up to a maximum of $5 million. Interest is payable under the revolving line of credit at the bank's prime rate. The warehouse and term loan agreements contained in the Credit Facility provide for borrowings of up to 80% of the Company's eligible (as defined) installment sales contracts, up to a maximum of $8 million. Interest on term notes is fixed for a period of five years from issuance at a rate based on the weekly average yield on five-year treasury securities averaged over the preceding 13 weeks, plus 2.4%, and floats for the remaining two years at a rate (subject to certain limits) equal to the bank's prime rate plus .75%. The warehouse component of the Credit Facility provides for borrowings of up to $2 million with interest payable at the bank's prime rate plus 1%. However in no event may the aggregate borrowings under the warehouse and term loan agreement exceed $8 million.\nOn October 14, 1994 and January 31, 1995 the Company borrowed $3.7 million and $2.0 million respectively under the Credit Facility in order to continue to fund the operations of CAC and to minimize the interest rate risk of the Company's loan portfolio. The Company expects to continue to borrow funds under the Credit Facility to finance the continuing operations of CAC. As the operations of CAC continue to expand the Company anticipates that it will be able to increase its borrowing capacity under the Credit Facility. The term of the Credit Facility, which is renewable annually, was due to expire in February 1995 but has been extended until June 30, 1995. Although the Company intends to renew the Credit Facility and anticipates an increase in the credit available to the Company thereunder, there can be no assurance that the Credit Facility will be renewed or that such additional financing will be available on terms acceptable to the Company.\nOn June 14, 1994, the Company completed the sale of 1,000,000 shares of its common stock in an underwritten public offering. The underwriters exercised their option to purchase an additional 90,000 shares of the over-allotment which closed on July 8, 1994. The net proceeds from the aforementioned sales of the Company's stock was $12,843,619 which the Company has used and intends to continue to use to fund the expansion of the financing operations of CAC, the opening of the Fort Worth and Winfield manufacturing facilities, the expansion and modernization of certain manufacturing facilities of the Company and for other general corporate purposes.\nCapital expenditures were approximately $6.3 million, $2.9 million and $1.1 million for the years ended December 31, 1994, 1993 and 1992, respectively. During 1994 the Company incurred capital expenditures of $6.3 million which included $3.8 million in capital expenditures financed through a portion of the proceeds of the Company's 1994 stock offering. The proceeds were utilized in the opening of two additional manufacturing facilities and the expansion and modernization of certain other manufacturing facilities. The balance of capital expenditures during these periods included normal property, plant and equipment additions and replacements.\nThe Company believes that existing cash and investment balances and funds available under the Credit Facility, together with cash provided by operations, will be adequate to fund the Company's operations and expansion plans for the next twelve months. In order to provide additional funds that may be neccessary for the continued pursuit of the Company's growth strategies and for operations over the longer term, the Company may incur, from time to time, additional short and long-term bank indebtedness and may issue, in public or private transactions, its equity and debt securities, the availability and terms of which will depend upon market and other conditions. There can be no assurance that such additional financing will be available on terms acceptable to the Company.\nImpact of Inflation\nAlthough increases, and particularly sudden increases, in the cost of certain materials can adversely affect the Company's operations, the Company generally has been able to increase its selling prices to offset increased costs, including the costs of raw materials. Price competition, however, can affect the ability of the Company to increase its selling prices to reflect increased costs. In general, the Company believes that the relatively moderate rate of inflation over the past several years has not had a significant impact on its sales or profitability, but can give no assurance that this trend will continue in the future.\nBacklog\nThe Company typically builds a home after receipt of an order from an independent dealer, and accordingly does not generally maintain an inventory of unsold homes. In accordance with industry practice, dealers can cancel orders prior to production without penalty. The Company's backlog of orders for manufactured homes was approximately $16.6 million as of December 31, 1994, compared to approximately $17.2 million as of December 31, 1993. The Company believes that substantially all of its unfilled orders as of December 31, 1994 will be produced by the Company by the end of the Company's first quarter ending March 31, 1995. Backlog volume generally indicates the production levels at which the Company will operate at any given time, but is not indicative of sales for a full year. Historically, sales in the manufactured housing industry have been seasonal in nature, with sales of homes being weaker during the winter months.\nImpact of Accounting Statements\nThe Company has not yet adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 107 regarding disclosures of the fair value of financial instruments. Adoption of this statement is expected in 1995 and will result in only increased disclosure regarding the affected instruments.\nThe Financial Accounting Standards Board has also issued SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which provides guidance on recognition of impairment of a loan as well as methods for measurement of impairment. The statement is effective for fiscal years beginning after December 15, 1994, and management believes its impact would be immaterial to the Company's consolidated financial statements if adopted currently.\nThe Company has adopted SFAS No. 115, Accounting for Certain Investment in Debt and Equity Securities, which provides guidance on classification and accounting treatment of investment in certain markketable securities. SFAS No. 115 was adopted during 1994 when the Company first acquired marketable securities subject to its provisions.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSelected Quarterly Financial Data (Unaudited)\nThe following table sets forth certain unaudited quarterly financial data for the two years ended December 31, 1994 and 1993. The Company believes that the following quarterly financial data includes all adjustments necessary for a fair presentation, in accordance with generally accepted accounting principles. The following quarterly financial data should be read in conjunction with the other financial information contained elsewhere in this report. The operating results for any interim period are not necessarily indicative of results for a complete year or for any future period. The sum of the quarterly amounts may not equal the annual amounts due to rounding.\nFirst Second Third Fourth Quarter Quarter Quarter Quarter (In thousands except per share amounts) Revenues: Net sales $ 46,674 $ 49,641 $ 49,453 $ 60,674 Financial services 109 142 197 255\nTotal revenues 46,783 49,783 49,650 60,929\nGross profit on sales 6,943 6,921 7,378 9,158 Net income 1,029 1,202 1,340 1,508 Net income per share (1) .28 .32 .29 .32\nRevenues: Net sales $ 30,683 $ 41,320 $ 40,122 $ 43,470 Financial services 30 51 66 83\nTotal revenues 30,713 41,371 40,188 43,553\nGross profit on sales 4,110 5,782 5,851 6,429 Net income 478 901 958 996 Net income per share (1) .14 .26 .28 .28\n(1) Adjusted for the five-for-four split paid in November 1993.\nCAVALIER HOMES, INC AND SUBSIDIARIES FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndex to Consolidated Financial Statements and Schedule\nIndependent Auditor's Report 19\nConsolidated Balance Sheets 20 - 21\nConsolidated Statements of Income 22\nConsolidated Statements of Stockholders' Equity 23\nConsolidated Statements of Cash Flows 24\nNotes to Consolidated Financial Statements 25 - 35\nSchedule -\nII - Valuation and Qualifying Accounts 36\nSchedules I, III, IV, and V have been omitted because they are either not required or are inapplicable.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Cavalier Homes, Inc.:\nWe have audited the accompanying consolidated balance sheets of Cavalier Homes, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the index at Item 8. 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 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, such consolidated financial statements present fairly, in all material respects, the financial position of Cavalier Homes, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in 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.\nDELOITTE & TOUCHE LLP\nBirmingham, Alabama March 3, 1995\nCAVALIER HOMES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation - The consolidated financial statements include the accounts of Cavalier Homes, Inc and its wholly owned subsidiaries, (hereinafter collectively referred to as the \"Company\"). The Company's 33% ownership interest in a limited partnership is accounted for using the equity method and is included in other assets in the accompanying consolidated balance sheets. Intercompany profits, transactions and balances have been eliminated in consolidation.\nCash Equivalents - The Company considers all highly liquid investments with original maturities of less than 90 days to be cash equivalents.\nMarketable Securities - The Company accounts for its marketable securities in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 115, Accounting for Certain Investments in Debt and Equity Securities, which requires that marketable securities be classified into three categories - held to maturity, available for sale, and trading, each having a specified accounting method as to carrying value and recognition of unrealized gains and losses. SFAS No. 115 was adopted in 1994 when the Company first acquired marketable securities subject to its provisions.\nHeld to maturity securities are those which the Company has the positive intent and ability to hold to maturity and are reported at cost, adjusted for any premiums and discounts that are recognized as adjustments to interest income using a method which approximates the interest method.\nSecurities available for sale are recorded at their fair value with any unrealized gains and losses, net of deferred income taxes, recorded as a net amount in a separate component of stockholders' equity until realized. Gains and losses on the sale of available for sale securities are determined using the specific identification method. Premiums and discounts are recognized in interest income using a method which approximates the interest method.\nTrading securities are carried at fair value with unrealized gains and losses recognized in the statement of income. The Company has no trading securities and does not plan to engage in such transactions.\nInventories - Inventories consist primarily of raw materials and are stated at the lower of cost (first-in, first-out method) or market. During 1994, 1993 and 1992, the Company purchased raw materials of approximately $7,360,000, $4,960,000, and $2,000,000 respectively, from the partnership referred to above.\nProperty, Plant and Equipment - Property, plant and equipment is stated at cost and depreciated primarily over the estimated useful lives of the related assets using the straight-line method. Maintenance and repairs are expensed as incurred.\nGoodwill - Goodwill is being amortized over 15 years using the straight-line method.\nRevenue Recognition - Sales of manufactured homes to independent dealers are recorded as of the date the home is shipped to the dealer. All sales are final and without recourse except for the contingency described in Note 10.\nInterest income on installment contracts receivable is recognized using the interest method. Loan origination fees and related costs are not material and are recognized in the period earned or incurred. Product Warranties - The Company provides a one-year limited warranty covering defects in material or workmanship in home structure, plumbing and electrical systems. A liability is provided for estimated future warranty costs relating to homes sold, based upon management's assessment of historical experience factors and current industry trends.\nAllowance for Losses on Installment Contracts -The Company has provided an allowance for estimated future losses resulting from retail financing activities of its financial services subsidiary, Cavalier Acceptance Corporation (\"CAC\"), primarily based upon management's current assessment of individual loans in the portfolio and repossession experience in the industry. CAC does not exclusively finance sales for any dealer; all dealers have other financing sources available to offer to their retail customers. Homes financed are subject to repossession by CAC upon default by the borrower.\nInsurance - The Company's workmen's compensation, product liability and general liability insurance coverages are provided under incurred loss, retrospectively rated premium plans. Under these plans, the Company incurs insurance expense based upon various rates applied to current payroll costs and sales. Annually, such insurance expense is adjusted by the carrier for loss experience factors subject to minimum and maximum premium calculations. Since the Company had previously estimated refunds or additional premiums when sufficiently reliable data was available, the application of the consensus in Emerging Issues Task Force Issue No. 93-14, Accounting for Multiple-Year Retrospectively Rated Insurance Contracts by Insurance Enterprises and Other Enterprises, had no impact on the Company's consolidated financial statements.\nIncome Taxes - Effective January 1, 1993, the Company adopted SFAS No. 109, Accounting for Income Taxes. SFAS No. 109 requires that deferred income taxes be determined under an asset and liability method. Under this method, deferred tax assets and liabilities are based on the expected future tax consequences of temporary differences between the book and tax bases of assets and liabilities. Previously, deferred income taxes were determined under Accounting Principles Board Opinion No. 11, Accounting for Income Taxes (\"APB No. 11 \"). Under APB No. 11, deferred income taxes were based on the historical tax effects of timing differences between book and taxable income. The impact of adopting SFAS No. 109 in 1993 was immaterial to the Company's consolidated financial statements.\nNet Income Per Share - Net income per share is based on the weighted average number of shares outstanding during each period including the dilutive effect of stock options.\nAccounting Standards Yet to be Adopted - The Company has not yet adopted the provisions of SFAS No. 107 regarding disclosures of the fair value of financial instruments. Adoption of this statement is expected in 1995 and will result in only increased disclosure regarding the affected instruments.\nThe Financial Accounting Standards Board has also issued SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which provides guidance on recognition of impairment of a loan as well as methods for measurement of impairment. This statement is effective for fiscal years beginning after December 15, 1994 and management believes its impact would be immaterial to the Company's consolidated financial statements if adopted currently.\n2. ACQUISITIONS\nOn October 28, 1994, the Company acquired all of the outstanding stock of Astro Mfg. Co., Inc. (\"Astro\") for $2,923,121 in cash and 160,686 shares of the Company's common stock previously held in treasury. On February 26, 1993, the Company acquired all of the outstanding common stock of Homestead Homes, Inc. (\"Homestead\") in exchange for 186,340 shares of the Company's common stock previously held in treasury.\nThese acquisitions were accounted for using the purchase method and, accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their estimated fair values at the acquisition dates. The excess of consideration paid over the estimated fair value of the net assets acquired was recorded as goodwill. Deferred income taxes were established for the difference in bases between financial and tax reporting of these assets and liabilities at the acquisition dates. The consolidated statements of income include the results of operations of each company acquired from its respective acquisition date forward.\nThe estimated fair value of assets acquired and liabilities assumed in these acquisitions is summarized as follows:\n1994 1993 Astro Homestead\nCash $ 1,959,572 $ 653,477 Other current assets 2,938,886 2,186,504 Property, plant and equipment 1,871,063 900,775 Goodwill 1,382,624 1,126,405 Other assets 84,580 435,986 Current liabilities (2,388,757) (1,824,930) Deferred income taxes (473,337) (206,000) Other liabilities (201,382) (158,072) ------------ ------------ $ 5,173,249 $ 3,114,145 ============ ============\nConsideration consisting of: Cash $ 2,923,121 Fair value of treasury stock reissued 2,088,918 $ 3,028,074 Amounts paid or accrued for acquisition costs 161,210 86,071 ------------ ------------ Total purchase price $ 5,173,249 $ 3,114,145 ============ ============\nThe following unaudited pro forma consolidated results of operations for the years ended December 31, 1994 and 1993 have been prepared as though both acquisitions occurred as of January 1, 1993. The pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations that would have been achieved had the acquisitions taken place as of January 1, 1993 or in the future.\n1994 1993\nNet sales $ 217,212,893 $ 172,657,641 Net income 5,056,124 3,360,782 Net income per share 1.17 .92\n3. MARKETABLE SECURITIES\nMarketable securities have been classified in the consolidated balance sheet at December 31, 1994 according to management's intent. At December 31, 1994, the carrying amount of marketable securities, which approximates fair values, was as follows:\nMarketable securities held to maturity: Due in one year or less: Corporate bonds $ 1,461,569 United States Treasury Notes 494,732 ----------- 1,956,301 ----------- Due in one year to five years: Corporate bonds 1,427,526 United States Treasury Notes 1,000,000 ----------- 2,427,526 ----------- Total held to maturity $ 4,383,827 ===========\nMarketable securites available for sale - Closed end funds $ 1,680,072 ===========\n4. ALLOWANCE FOR LOSSES ON INSTALLMENT CONTRACTS\nIn 1992 CAC began purchasing and originating installment sale contracts made to customers of the Company's exclusive independent dealers. At December 31, 1994, the average term of CAC's loan portfolio was approximately 175 months and the weighted average interest rate was 11.44%.\nActivity in the allowance for losses on installment contracts was as follows:\n1994 1993 1992\nBalance, beginning of year $ 104,000 $ 22,000 Provision for losses 265,000 90,000 $ 22,000 Charge-offs, net (19,000) (8,000) ---------- ----------- ----------- Balance, end of year $ 350,000 $ 104,000 $ 22,000 ========== =========== ===========\n5. CREDIT ARRANGEMENTS\nIn February 1994 the Company executed a $ 13 million revolving, warehouse and term loan agreement (the \"Credit Facility\") with its primary bank, whose president is a director of the Company. The Credit Facility contains a revolving line of credit which provides for borrowings (including letters of credit) of up to 80% and 50% of the Company's eligible (as defined) accounts receivable and inventories, respectively, up to a maximum of $5 million. Interest is payable under the revolving line of credit at the bank's prime rate (8.5% at December 31, 1994).\nThe warehouse and term loan agreements contained in the Credit Facility provide for borrowings of up to 80% of the Company's eligible (as defined) installment sale contracts, up to a maximum of $8 million. Interest on term notes is fixed for a period of five years from issuance at a rate based on the weekly average yield on five year treasury securities averaged over the preceding 13 weeks, plus 2.4%, and floats for the remaining two years at a rate (subject to certain limits) equal to the bank's prime rate plus .75%. The warehouse component of the Credit Facility provides for borrowings of up to $2 million with interest payable at the bank's prime rate plus 1 %. However, in no event may the aggregate outstanding borrowings under the warehouse and term loan agreement exceed $8 million.\nThe Credit Facility contains certain restrictive covenants which limit the aggregate of dividend payments and purchases of treasury stock to 50% of consolidated net income for the two most recent years. Amounts outstanding under the Credit Facility are secured by the accounts receivable and inventories of the Company, loans purchased and originated by CAC and the capital stock of certain of the Company's consolidated subsidiaries.\nAt December 31, 1994, the Company's long-term debt consists of a term loan which bears interest at a fixed rate of 9.4% for the first five years, and floats for the remaining two years as described above.\nPrincipal repayment requirements are as follows:\nYear Ending December 31, Amount\n1995 $ 378,802 1996 418,578 1997 462,531 1998 511,099 1999 564,768 Thereafter 1,250,192 ------------ Total $ 3,585,970 ============\nCash paid for interest during the years ended December 31, 1994, 1993 and 1992 was $61,832, $35,255 and $43,589, respectively.\n6. STOCKHOLDERS' EQUITY\nIn June 1994 the Company completed a secondary public offering of 1,000,000 shares of its common stock at $13 per share.In July 1994, the Company sold an additional 90,000 shares at the same price per share. The Company received net proceeds of $12,843,619 (after offering costs) from these sales.\nOn October 13, 1992 and again on September 7, 1993, the Company's Board of Directors declared five-for-four stock splits on the Company's common stock, which were effected in the form of a 25% stock dividend, distributed on November 16, 1992 and November 15, 1993 to stockholders of record on October 30, 1992 and October 4, 1993, respectively. All applicable share and per share data were restated to give effect to these stock splits.\n7. STOCK OPTION PLANS\na. During 1993, the Company's Board of Directors adopted the Cavalier Homes, Inc. 1993 Amended and Restated Nonqualified Stock Option Plan (the \" 1993 Nonqualified Plan\") and the Cavalier Homes, Inc. 1993 Amended and Restated Nonemployee Directors Stock Option Plan (the \"1993 Nonemployee Directors Plan\"). These plans provide for the issuance of stock options to key employees and nonemployee directors to acquire up to 412,500 and 150,000 shares, respectively, of common stock.\nUnder the 1993 Nonqualified Plan and the 1993 Nonemployee Directors Plan, options generally may be granted at an exercise price of not less than 60% and 100%, respectively, of the fair market value of the underlying shares at the date of grant. Options granted are generally exercisable within six months from the date of grant and must be exercised within ten years from such date, except under certain conditions.\nb. The Company has also adopted the 1988 Nonqualified Stock Option Plan (the \" 1988 Plan\") under which the Company may grant nonqualified stock options to directors, officers, or key employees with respect to an aggregate of 227,518 of its common shares . Options may be granted at an exercise price of not less than 60% of the fair market value of the underlying shares on the date of grant. Options generally are exercisable after six months from the date of grant and must be exercised within ten years, except under certain conditions.\nc. The Company adopted in 1986 the Long Term Incentive Compensation Plan (the \" 1986 Plan\") under which it may grant restricted stock awards, stock appreciation rights, and qualified or nonqualified stock options to key employees with respect to an aggregate of 127,460 of its common shares. Qualilified stock options may be granted at an exercise price of not less than 100% of the fair market value of the underlying shares on the date of grant. Nonqualified options may be granted at an exercise price determined by the Compensation Committee of the Board of Directors. Options generally are exercisable at a cumulative rate of 20% annually after one year and must be exercised within ten years from the date of grant, except under certain conditions.\nAs of December 31, 1994, substantially all available options under the 1988 Plan and the 1986 Plan had been granted.\nThe Company recognized compensation expense of $53,874 (1993) and $12,665 (1992) with respect to options granted at less than fair market value at date of grant under these plans. With respect to options exercised, the income tax benefits resulting from compensation expense allowable under federal income tax regulations in excess of the expense reflected in the Company's financial statements have been credited to additional paid-in-capital. These benefits, which totaled $85,875 (1994), $430,851 (1993), and $411,337 (1992), represent a noncash financing transaction for purposes of the consolidated statements of cash flows.\nInformation regarding these stock option plans is summarized below:\nPrice Range Shares Per Option Shares under option: Outstanding at January 1, 1992 266,600 Options granted 38,950 $1.28 - 1.60 Options exercised (174,925) 1.28 - 1.60 Options terminated (8,500) --------- Outstanding at December 31, 1992 122,125 Options granted 463,078 8.00 - 11.20 Options exercised (95,112) 1.28 - 2.00 --------- Outstanding at December 31, 1993 490,091 Options granted 48,250 10.00 - 16.63 Options exercised (18,999) 1.28 - 8.00 Options terminated (4,375) --------- Outstanding at December 31, 1994 514,967 =========\nStock options exercisable and shares available for future grants at December 31, 1994 were 479,593 and 109,250, respectively, under these plans.\n8. INCOME TAXES\nProvision for income taxes consist of: 1994 1993 1992\nCurrent: Federal $ 3,313,000 $ 2,208,000 $ 1,297,000 State 581,000 390,000 199,000 ----------- ------------ ------------ 3,894,000 2,598,000 1,496,000 ----------- ------------ ------------ Deferred: Federal (333,000) (320,000) (161,000) State (61,000) (57,000) (25,000) ----------- ------------ ------------ (394,000) (377,000) (186,000) ----------- ------------ ------------ Total $ 3,500,000 $ 2,221,000 $ 1,310,000 =========== ============ ============\nTotal income tax expense for 1994, 1993, and 1992 is different from the amount that would be computed by applying the expected federal income tax rates of 35% for 1994 and 1993 and 34% for 1992, to income before income taxes. The reasons for this difference are as follows:\nComponents of the provision for deferred income taxes for the year ended December 31, 1992 were as follows:\nDepreciation $ (6,000) Warranty expense (170,000) Employee benefits (42,000) Inventory capitalization (3,000) Allowance for losses on receivables (27,000) Accrued expenses 42,000 Other 20,000 ---------- $ (186,000) ==========\nThe approximate tax effects of temporary differences at December 31, 1994 and 1993 were as follows:\n1994 1993 ASSETS (LIABILITIES) Current differences: Warranty expense $ 1,309,000 $ 1,013,000 Inventory capitalization 159,000 98,000 Allowance for losses on receivables 390,000 258,000 Accrued expenses 759,000 479,000 Other 32,000 ------------ ------------ $ 2,649,000 $ 1,848,000 ============ ============\nNoncurrent differences: Depreciation and basis differential of acquired assets $ (950,000)$ (292,000) Other 74,000 ------------ ------------ $ (876,000)$ (292,000) ============ ============\nCash paid for income taxes for the years ended December 31, 1994, 1993 and 1992 was $3,519,401, $2,022,253 and $ 1,301,837, respectively.\n9. EMPLOYEE BENEFIT PLAN\nThe Company sponsors an Employee 401 (k) Retirement Plan covering all employees who meet participation requirements. Employee contributions are limited to a percentage of their basic compensation as defined in the Plan. The amount of the Company's matching contribution is discretionary as determined by the Board of Directors. Company contributions amounted to $175,000, $141,000 and $64,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\n10. COMMITMENTS AND CONTINGENCIES\nOperating leases:\nFour of the Company' s manufacturing facilities are leased under separate operating lease agreements (the \"Related Leases\") with partnerships or companies whose owners are certain officers, directors or stockholders of the Company. The Related Leases require monthly payments ranging from $6,000 to $25,000 and provide for lease terms ending from August 1996 to April 1999 as well as renewal option periods. The Related Leases also contain purchase options whereby the Company can purchase the respective manufacturing facility for amounts ranging from $850,000 to $1,750,000 at any time during the lease terms.\nThe Company also leases two other manufacturing facilities under operating leases with unrelated parties. These leases currently require monthly payments of $8,000 and $13,500 through January 1998 and March 1999, respectively, and include renewal option periods. The Company has the option under one of these leases to (i) cancel the lease with a one year notice and (ii) purchase the manufacturing facility for $995,000 at any time during the lease term.\nFuture minimum rents payable under operating leases that have initial or remaining noncancelable lease terms in excess of one year as of December 31, 1994 are as follows:\nYear Ending December 31, Amount\n1995 $ 981,000 1996 881,000 1997 521,000 1998 353,000 1999 102,000 ----------- Total $ 2,838,000 ===========\nTotal rent expense was $832,000, $641,000 and $444,000 for the years ended December 31, 1994, 1993 and 1992, respectively, including rents paid to related parties of $662,000 (1994), $460,000 (1993) and $300,000 (1992).\nContingent Liabilities and Other:\na. It is customary practice for companies in the manufactured housing industry to enter into repurchase and other recourse agreements with lending institutions which have provided wholesale floor plan financing to dealers. Substantially all of the Company's sales are made pursuant to repurchase agreements with dealers located primarily in the Southeastern portion of the United States. These agreements generally provide for repurchase of the Company's products from the lending institutions for the balance due them in the event of repossession upon a dealer's default. Although the Company was contingently liable for an amount estimated to be $54 million under these agreements as of December 31, 1994, such contingency is reduced by the resale value of the homes which are required to be repurchased. The Company has an allowance for losses of $650,000 (1994) and $560,000 (1993) based on prior experience and current market conditions. Management expects no material loss in excess of the allowance.\nb. Under the insurance plans described in Note 1, the Company is contingently liable at December 31, 1994 for future retrospective premium adjustments up to a maximum of approximately $4,900,000 in the event that additional losses are reported related to prior years. The Company recorded an estimated liability of approximately $970,000 (1994) and $590,000 (1993) related to such incurred but not reported claims. Management expects no material loss in excess of the allowance.\nc. The Company and certain of its equity partners have jointly and severally guaranteed certain short-term debt, with a balance of $1,500,000 at December 31, 1994, of the partnership in which the Company owns a 33% interest.\nd. The Company is engaged in various litigation which is routine in nature and, in management's opinion, will have no material adverse effect on the Company's financial statements.\ne. During 1994, the Company entered into split-dollar life insurance agreements with two of its executive officers which provide for payment of the related insurance premiums by the Company and also for reimbursement to the Company of such premiums upon payment of death benefits under the policies.\n11. INDUSTRY SEGMENT INFORMATION\nThe Company's primary activities are the design, production and wholesale sale of manufactured homes to a system of independent dealers. The Company also offers retail financing of its homes through its exclusive independent dealer network. For purposes of segment reporting, corporate assets consist primarily of cash, certain property and equipment and other investments. Operating profit is considered to be income before general corporate expenses, interest and income taxes.\nFinancial information for these segments is summarized in the following table:\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\nFor a description of the Directors and Executive Officers of the Company, see \"Election of Directors\", \"Executive Officers and Principal Stockholders\" and \"Compliance with Section 16(a) of the Exchange Act\" of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on May 10, 1995, which are incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nFor a description of the Company's Executive Compensation, see \"Election of Directors,\" \"Executive Officers and Principal Stockholders\", \"Executive Compensation\" (other than the \"Report of the Compensation Committee\" and the \"Performance Graph\"), \"Compensation Committee Interlocks and Insider Participation\" and \"Certain Relationships and Related Transactions\" of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on May 10, 1995, which sections are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF MANAGEMENT AND CERTAIN BENEFICIAL OWNERS\nFor a description of the Security Ownership of Management and Certain Beneficial Owners, see \"Election of Directors,\" and \"Executive Officers and Principal Stockholders\" of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on May 10, 1995, which are incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nFor a description of Certain Relationships and Related Transactions of the Company, see \"Election of Directors,\" \"Executive Officers and Principal Stockholders,\" \"Compensation Committee Interlocks and Insider Participation,\" and \"Certain Relationships And Related Transactions\" of the Company's Proxy Statement for the Annual Meeting of Stockholders to be held on May 10, 1995, which are 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 financial statements contained in this report and the page on which they may be found are as follows:\nFinancial Statement Description Form 10-K Page No.\nIndependent Auditors' Report 19 Consolidated Balance Sheets as of December 31, 1994 and 1993 20 - 21 Consolidated Statements of Income for the years ended December 31, 1994, 1993 and 1992 22 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992 23 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 24 Notes to Consolidated Financial Statements 25 - 35\n2. The financial statement schedule required to be filed with this report and the page on which it may be found is as follows:\nSchedule Schedule Description Form 10-K Page No.\nII Valuation and Qualifying Accounts 36\n3. The exhibits required to be filed with this report are listed below. The Company will furnish upon request any of the exhibits listed upon the receipt of $15.00 per exhibit, plus $.50 per page, to cover the cost to the Company of providing the exhibit.\n(2)\n* (a) Stock Purchase Agreement, as amended, by and among Astro Mfg. Co., Inc., Shareholders of Astro Mfg. Co., Inc. and Cavalier Homes, Inc. dated as of October 14, 1994, filed as Exhibit 2(a) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, is incorporated herein by reference.\n* (b) Holdback agreement between avalier Homes, Inc. and Raymond A. Peltcs, dated October 28, 1994, filed as Exhibit 2(b) to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, is incorporated herein by reference.\n(3) Articles of Incorporation and By-laws.\n* (a) The Restated Certificate of Incorporation of the Company, as amended, filed as Exhibit 3(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n* (b) The By-laws of the Company, as amended, filed as Exhibit (b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n(4) * (a) Articles four, six, seven, nine and ten of the Company's Restated Certificate of Incorporation, as amended, included in Exhibit 3(a) above. * (b) Article II, Sections 1 through 11; Articles III, Sections 1 and 2; Article IV, Sections 1 and 2; Article VI, Sections 1 through 6; Article VIII, Sections 1 through 3; Article IX, Section 1 of the Company's By-laws, included in Exhibit 3(b) above.\n(10) Material contracts\n* ** (a) Cavalier Homes, Inc. 1988 Nonqualified Stock Option Plan, as amended, filed as Exhibit 10(a) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n* (b) Lease between Cavalier Homes of Alabama, Inc. and Robert L. Burdick, John W Lowe, and Jerry F. Wilson, as tenants in common dated September 1, 1988, as amended, filed as Exhibit 10(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n* (c) Commercial Sub-Lease between Winston County Industrial Development Association and Cavalier Homes of Alabama, Inc., dated March 5, 1993 filed as Exhibit 10(d) to the Company's Registration Statement on Form S-2 (Registration No. 33-59452), is incorporated herein by reference.\n* (d) Agreement and Plan of Merger, dated February 26, 1993, among Homestead Homes, Inc., the Stockholders of Homestead Homes, Inc., Cavalier Acquisition Corporation and Cavalier Homes, Inc. filed as Exhibit 2 to the Company's Current Report on Form 8-K dated February 26, 1993, as amended on Form 8, dated March 12, 1993, is incorporated herein by reference.\n* (e) Revolving, Warehouse and Term Loan Agreement among the Company and First Commercial Bank (Birmingham, Alabama) dated February 17, 1994, filed as Exhibit 10(e) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n* (f) Lease Agreement between Leonard Properties and Cavalier Homes of Texas dated February 17, 1994, filed as Exhibit 10(f) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n* ** (g) Cavalier Homes, Inc. 1993 Amended and Restated Nonqualified Stock Option Plan, filed as Exhibit 10(g) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n* ** (h) Cavalier Homes, Inc. 1993 Amended and Restated Nonemployee Directors Stock Option Plan, filed as Exhibit 10(h) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n* (i) Guaranty Agreement between SouthTrust Bank of Marion County and Cavalier Homes, Inc. dated February 18, 1993, relating to guaranty of payments by Woodperfect, Ltd., filed as Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.\n* (j) Sub-lease Agreement with Option to Purchase between Winfield Industrial Developement Association, Inc and Buccaneer Homes of Alabama, Inc. dated May 9, 1994 filed as Exhibit 10(k) to Amendment No. 1 to the Company's Registration Statement on Form S-2 (Registration No, 33-78644), is incorporated herein by reference.\n* (k) Lease Agreement with Option to Purchase between Marion County Industrial Developement Association, Inc and Quality Housing Supply, Inc. dated May 9, 1994 filed as Exhibit 10(l) to Amendment No. 1 to the Company's Registration Statement on Form S-2 (Registration No, 33-78644), is incorporated herein by reference.\n(11) Statement Re Computation of Per Share Earnings.\n(21) Subsidiaries of the Registrant.\n(23) Consents of Deloitte & Touche LLP.\n* Incorporated by Reference as indicated.\n** Management contract or compensatory plan or arrangement.\n(b) The Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994, which was filed with the Commission on November 10, 1994, contained information otherwise reportable on Form 8-K relating to the Company's acquisition of Astro Mfg. Co., Inc. (\"Astro\"). Also included in such report were financial statements of Astro for the year ended December 31, 1993 and for the nine months ended September 30, 1994, and certain proforma financial information relating to the Company for the same time periods.\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.\nCAVALIER HOMES, INC. Registrant\nBy:\/s\/ JERRY F. WILSON ----------------------------- Date: March 31, 1995\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.\nSignature Title Date\n\/s\/ JERRY F. WILSON Director and Principal Executive March 31, 1995 - - ----------------------------- Officer\n\/s\/ DAVID A. ROBERSON Principal Financial and Accounting March 31, 1995 - - ----------------------------- Officer\n\/s\/ BARRY DONNELL Chairman of the Board and Director March 31, 1995 - - -----------------------------\n\/s\/ THOMAS A. BROUGHTON, III Director March 31, 1995 - - -----------------------------\n\/s\/ JOHN W LOWE Director March 31, 1995 - - -----------------------------\n\/s\/ LEE ROY JORDAN Director March 31, 1995 - - -----------------------------\nINDEX Page in Sequential Exhibit Numbered Number Filing\n(11) Statement Re Computation of Per Share Earnings. 44\n(21) Subsidiaries of the Registrant. 45\n(23) Consents of Deloitte & Touche LLP. 46 - 47\nPART IV Exhibit 11\nCAVALIER HOMES, INC. AND SUBSIDIARIES COMPUTATION OF NET INCOME PER COMMON SHARE\nFor the Years Ended December 31, 1994 1993 1992\nPRIMARY AND FULLY DILUTED\nNet Income $ 5,078,579 $ 3,332,824 $ 2,013,738 ========== =========== =========== Shares* Primary Average common shares outstanding 4,106,314 3,363,916 2,884,554 Dilutive effect if stock options were exercised 90,176 88,828 221,226 ---------- ----------- ----------- Average common shares outstanding as adjusted (primary) 4,196,490 3,452,744 3,105,780 ========== =========== =========== Fully diluted Average common shares outstanding as adjusted (primary) 4,196,490 3,452,744 3,105,780 Addditional dilutive effect if stock options were exercised (fully) - 12,606 19,934 ---------- ----------- ----------- Average common shares outstanding as adjusted (fully diluted) 4,196,490 3,465,350 3,125,714 ========== =========== ===========\nPrimary and Fully Diluted Net Income per common share $ 1.21 $ .97 $ .65 ========== =========== ===========\n* Adjusted for the five-for-four stock split paid in November 1993.\nPART IV Exhibit 21\nCAVALIER HOMES, INC. AND SUBSIDIARIES SUBSIDIARIES OF THE REGISTRANT\nSubsidiary Name\nAstro Mfg. Co., Inc.\nCavalier Acceptance Corporation\nCavalier Insurance Agency, Inc.\nCavalier Town & Country Homes of Texas, Inc.\nCavalier Homes of Alabama, Inc.\nHomestead Homes, Inc.\nQuality Housing Supply, Inc.\nStar Industries, Inc.\nBuccaneer Homes of Alabama, Inc.\nValley Homes, Inc.\nBrigadier Homes of North Carolina, Inc.\nMansion Homes, Inc.\nPART IV Exhibit 23\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in Registration Statements No. 33-63060 and No. 33-86348 of Cavalier Homes, Inc. on Form S-3 of our report dated March 3, 1995, appearing in this Annual Report on Form 10-K of Cavalier Homes, Inc for the year ended December 31, 1994.\nDELOITTE & TOUCHE LLP\nBirmingham, Alabama March 28, 1995\nINDEPENDENT AUDITORS' CONSENT\nWe consent to the incorporation by reference in the Registration Statements (Form S-8) and related Prospectuses pertaining to the Cavalier Homes, Inc. 1993 Amended and Restated Nonqualified Stock Option Plan; 1993 Amended and Restated Nonemployee Directors Stock Option Plan; 1986 Long-Term Incentive Compensation Plan; and the 1988 Nonqualified Stock Plan, of our report dated March 3, 1995, appearing in this Annual Report on Form 1 0-K of Cavalier Homes, Inc. for the year ended December 31, 1994.\nDELOITTE & TOUCHE LLP\nBirmingham, Alabama March 28, 1995","section_15":""}
{"filename":"718244_1994.txt","cik":"718244","year":"1994","section_1":"Item 1. Business\nGENERAL\nWestern Waste Industries (the Company) is the successor to a sole proprietorship that commenced the business of waste collection and disposal in 1955. The Company was incorporated in California in January 1964 as Western Refuse Hauling, Inc. The name later became WRH Industries and then Western Waste Industries.\nWestern Waste Industries is a provider of integrated waste services to commercial, industrial and residential customers. These services consist of the collection, transfer and disposal of solid waste in certain areas of California, Texas, Louisiana, Florida, Colorado and Arkansas. The Company has approximately 90 franchise agreements, 82 of which designate the Company as the exclusive provider of certain waste services within a particular municipality or county. As part of its business, the Company operates six landfills, three transfer stations and four recycling facilities. The Company does not operate hazardous waste landfills and limits its hazardous waste activities to the transportation of such materials for others which accounted for approximately 1% of the Company's revenue during fiscal 1994.\nThe Company has a diversified customer base with no single customer accounting for more than 10% of the Company's revenue in any one of its last three fiscal years. During fiscal 1992, 1993 and 1994, operations in California accounted for approximately 65%, 64% and 68%, respectively, of revenue.\nContribution to Revenue Year Ended June 30, 1992 1993 1994 Collection Services 88% 86% 85%\nLandfill Operations 5 6 7\nTransfer Stations 2 2 3\nOther 5 6 5\n100% 100% 100%\nCOLLECTION SERVICES\nContracts. Substantially all of the Company's residential, and a certain portion of its commercial and industrial collection services are performed under approximately 90 municipal and\nregional authority contracts. These contracts presently represent approximately 46% of the Company's revenue. A contract is an agreement awarded by a municipality or regional authority to provide collection and\/or recycling services to commercial and industrial or residential customers in the jurisdiction.\nThese contracts are normally awarded following competitive bidding, usually have terms of five or more years, and contain renewal options. Payment for residential services is generally received directly from the municipality or authority. Such contracts provide for rate adjustments including, but not limited to, increases in the consumer price index and disposal cost increases.\nMost of the remaining collection revenues are provided under one to three year service agreements.\nThe Company anticipates that more municipalities, in an effort to reduce costs and capital expenditures related to waste services and to deal with their budgetary fiscal constraints, will contract for such services with private sector companies. Such action by municipalities will continue to provide an incremental source of revenue for the Company.\nCommercial and Industrial. The Company provides collection services to more than 63,000 commercial and industrial customer locations, which accounted for approximately 57% of total fiscal 1994 revenue. Commercial and industrial collection services are generally performed under agreements, and fees are determined by such factors as collection frequency, type of equipment and containers furnished, type and volume or weight of the waste collected and the distance to the disposal site. A portion of commercial and industrial services are performed under municipal and regional authority contracts.\nThe Company's commercial and industrial customers utilize containers that range from one to 45 cubic yards in size. The use of containers enables the Company to service most of its commercial and industrial customers with collection vehicles operated by a single employee. Stationary compactors, which reduce the volume of the stored waste prior to collection, are frequently installed by the Company on the premises of large volume customers.\nThe Company has interstate industrial transportation operations servicing primarily customers for the Company's Texas and Arkansas industrial non-hazardous disposal sites. The Company currently holds authority to transport waste in 21 states, mostly in the southern portion of the United States. The Company believes that further development of its industrial transportation capabilities in close coordination with its disposal sites will strengthen its ability to provide fully integrated industrial waste handling services.\nResidential. During fiscal 1994, approximately 28% of total revenue was derived from the curbside collection and transportation of residential refuse to a landfill or transfer station. The Company serviced approximately 677,000 homes and other residential dwelling units. Substantially all of the services for homes and other residential units are performed under exclusive franchise agreements granted by municipalities or regional authorities. Fees are based primarily on market factors, frequency and type of service, distance to processing or disposal facilities and cost of processing or disposal. Residential collection fees are normally paid by the municipalities out of tax revenues or service charges or, in a limited amount of cases, are paid directly by the residents receiving the service.\nHazardous Waste. Hazardous waste hauling activities, included in commercial and industrial services, accounted for approximately 1% of total revenue during fiscal 1994. The Company does not operate any hazardous waste landfills. Its hazardous waste activities are limited to the transportation of non-liquid materials in drums and other containers provided and packaged by its customers. The materials are hauled to licensed hazardous waste landfills owned and operated by others. The transporting of hazardous waste requires state and, for certain hauling, federal licenses. Management believes that the Company has all necessary licenses to carry on its current hazardous waste activities and is in material compliance with applicable regulations. The Company carries separate insurance to cover such activities.\nLANDFILLS\nLandfill disposal continues to be a primary depository for solid waste in North America. With the enactment of the Resource Recovery and Conservation Act Subtitle D regulations, the impact on landfill design, permitting and construction has increased capital resources required to develop additional disposal capacity. At the same time, the Company believes that replacement of existing disposal capacity with more costly, environmentally secure capacity will result generally in an increase in the price of waste disposal.\nThe Company operates disposal sites in California, Texas, Louisiana and Florida. Six facilities are currently operating. Certain of these sites have expansion plans and additional sites are under development or in construction. Of the six operating landfills, four are owned by the Company. None of the landfills are permitted to accept hazardous waste, and the Company's policies and controls are structured to minimize acceptance of such waste. Disposal fees received from third parties generated approximately 7% of fiscal 1994 revenue.\nIn Southern California, the Company owns and operates the El\nSobrante landfill which began receiving waste in July 1986. Solid Waste Disposal Revenue Bonds were issued to finance its development. The El Sobrante landfill operates under a joint development agreement with the County of Riverside for an initial term of 15 years with two successive five year renewal options. At the present waste disposal rate, the site has an estimated remaining life of approximately ten years. Commencing in September 1992, the Company was allowed to import, on a limited basis, solid waste collected outside of Riverside County to the El Sobrante Landfill site. The amount of out-of-county waste cannot exceed 1.8 million tons. In March 1994, the Company received a permit to increase the daily tonnage from 2,000 to 4,000 tons per day.\nThe Company acquired 1,140 acres contiguous to the existing El Sobrante operating site with the intent of expanding landfill operations. The Company has begun the permitting process for this acreage which, if successful, would add 100 million tons of disposal capacity to this site. In April 1991, the Company signed a preliminary memorandum of understanding (MOU) with the County of Riverside regarding this acreage. This MOU included a provision for up to a 10,000 tons per day operation, and increased the amount of out-of-county waste which the site may accept. There is no assurance that the expansion project will be permitted.\nIn Texas, the Company leases and operates a 64-acre disposal site in Conroe for the City of Conroe. The lease term is for the life of the site.\nAdjacent to the Conroe, Texas leased site, the Company operates a special waste (non-hazardous industrial) landfill on a 100-acre tract owned by the Company and repermitted by the Texas Water Commission in April 1992. The Company began receiving waste under this permit in August 1992. Current estimates of the operating life of the facility is in excess of 25 years. The Company acquired an additional 78-acre tract in May 1989 with the intention of utilizing it for future development.\nIn 1990, the Company acquired a 90-acre landfill from the City of New Boston, Texas, located 25 miles west of Texarkana. The permit has been upgraded and the site is currently operating. The life of this facility is estimated to exceed four years. The Company is in the process of developing and submitting a permit modification that will double the existing capacity of the landfill.\nIn Florida, the Company operates a 65-acre site under contract with the County of Nassau. The contract had an initial term of two years through September 1989, and the Company subsequently received a three year extension of the contract. In 1991, the Company negotiated a $14 million contract with the County of Nassau, to construct and operate an additional 140-acre landfill for an initial term of five years with a five year extension option.\nUnder the terms of the agreement, the Company will close the existing 65-acre tract and construct a new disposal site. In 1992, the Company negotiated a modification to the construction contract to provide for an expansion of the site airspace capacity. The construction project is scheduled for completion in fiscal 1995.\nIn Arkansas, the Company owns a 160-acre landfill in Texarkana. The site, which stopped receiving waste in May 1993, is filled to permit capacity and is being closed. The application for a permit covering the 40 acre final phase of this site has been denied and is the subject of an administrative appeal by the Company.\nIn September 1991, the Company contracted to operate, under a closure plan approved by the Louisiana Department of Environmental Quality, a 320-acre landfill located in Jefferson Parish (near New Orleans), Louisiana. The landfill commenced operations in February 1992. Due to changes in law and other unforeseeable circumstances, the Company discontinued its operation of the site October 8, 1993.\nIn September 1990, the Company acquired a 240-acre waste disposal facility in Livonia, Louisiana, approximately 22 miles west of Baton Rouge. This facility, which is permitted to receive municipal solid waste and special waste, is currently under construction with operations expected to commence in fiscal 1995. Included in the facility is a waste disposal facility which can dispose of non-hazardous oilfield waste.\nThe Company has the right to acquire a 648-acre site for the development of a municipal solid waste and special waste landfill approximately five miles east of Lake Charles, Louisiana. The permit application was denied by the Louisiana Department of Environmental Quality and is currently the subject of appeal through a state administrative proceeding.\nThe Company has entered into a joint development arrangement with Gold Fields Mining, a wholly owned subsidiary of Hanson PLC, and SP Environmental, a sister subsidiary of the Southern Pacific Railroad for the purpose of developing a waste-by- rail project called California InteRail. The parties are in the process of permitting a landfill in Imperial County, California, which has an approximate capacity of 600 million tons. As part of this project, existing facilities owned by the Company, SP Environmental, and others could be utilized and new facilities will be developed on an as needed basis. Based upon the current schedule, the landfill could be in operation as early as 1996.\nIn accordance with the Company's overall plan of corporate development, other landfill sites are currently being evaluated both in the Company's existing markets and new markets for joint collection and disposal investment. Sites for certain projects have been selected and preliminary engineering analyses are\ncurrently underway. Normally, the permitting process for landfill sites takes three to five years.\nTRANSFER STATIONS\nThe Company owns or operates three transfer stations. A transfer station is a facility where solid waste is received from collection vehicles and then transferred to and compacted in large, specially constructed trailers for transportation to disposal facilities. This procedure reduces costs by improving utilization of collection personnel and equipment. The services of these facilities are provided to municipalities or counties and in most cases are also used by the Company and other collection companies. Fees are generally based upon such considerations as market factors, the type and volume or weight of the waste transferred, the extent of recycling, the transport distance involved and the cost of disposal.\nThe Company has a transfer station in Carson, California which currently processes approximately 2,300 tons per day. Approximately 86% of the tonnage delivered to this transfer station is provided by the Company's collection operations with the remainder received from municipalities which collect their own residential refuse and from other refuse haulers. The Company has applied for approval to increase the volume of waste processed at the transfer station to 5,000 tons of solid waste per day. This application is pending.\nIn March 1993, the Company was awarded a contract to operate the Sunnyvale Materials Recovery and Transfer Station (SMART). The service area for the station is the cities of Sunnyvale, Mountain View, and Palo Alto, California. The initial term of the contract is for seven years with an option to extend by the City for up to an additional seven years. The operation began on October 1, 1993.\nThe Company operates a transfer station adjacent to the Company's Fresno operations. The transfer station, which includes a commercial materials recycling building, is designed to receive up to 2,500 tons per day of solid waste. The solid waste permit currently allows up to 1,000 tons per day with a green waste storage area.\nRECYCLING\/WASTE DIVERSION\nThe Company operates four recycling facilities in California, one each in Redondo Beach, Chino, Carson, and San Jose. Recycling involves the removal of reusable materials from the waste stream for processing and sale for use in various applications. The Company is assisting certain communities, with which it has\nmunicipal contracts, in implementing recycling programs, and has entered into long-term recycling agreements with several communities in the Company's markets. The Company is also involved in receiving, processing, composting and end-market distribution of green and wood waste material in California and Texas.\nOTHER ACTIVITIES\nWestern Waste is involved in certain other business activities, relating to waste services, including construction support, earth-moving, excavation contracting, and engineering and consulting services. In addition, in fiscal 1992, 1993 and 1994, the Company was involved in the construction of a new landfill for Nassau County, Florida.\nREGULATION\nThe Company is currently subject to extensive and evolving federal, state and local environmental, health, and safety laws and regulations. These regulations are administered by the Environmental Protection Agency (\"EPA\") and various other federal, state and local agencies.\nCollection Services: In the solid waste collection phase, regulation takes such forms as licensing of collection vehicles, vehicle safety requirements, vehicle weight limitation and, in certain localities, limitations on rates, area, time, frequency of collection and transportation of waste to disposal sites. Zoning and land use restrictions are encountered in the solid waste transfer, resource recovery and disposal phases of the Company's business. Air quality and noise pollution regulations may also affect the Company's operations. Governmental authorities have the power to enforce compliance, and violators are subject to injunctions or fines, or both. Private individuals may also have the right to sue to enforce compliance. Safety standards under the Occupational Safety and Health Act are also applicable.\nLandfills: In 1980 the Comprehensive Environmental Response, Compensation and Liability Act (\"Superfund\" or \"CERCLA\") was issued. CERCLA addresses problems created by the release of hazardous substances into the environment. CERCLA imposes strict, joint and several liability on the present or former operators of facilities which release hazardous substances into the environment. Waste generators and transporters are also strictly liable. It is possible that the EPA or others could contend that at least some amounts of hazardous substances exist in the Company's operating and closed disposal facilities. If these sites ever experience environmental problems, there can be no assurance that the Company will not face claims resulting in liability.\nIn 1991, the EPA issued revisions to Subtitle D of the\nResource Conservation and Recovery Act of 1976 (\"RCRA\") which regulates the handling, transportation and disposal of waste and requires states to develop programs to ensure the safe disposal of waste. These revisions affected comprehensive solid waste management regulations, including location standards, facility design and operating criteria, closure and post-closure requirements, financial assurance standards, and groundwater monitoring and corrective action standards which were not previously in place or enforced at landfills. The Company believes that all Company landfills meet or exceed compliance with these regulations. In addition, the Company's planned landfill expansions will be engineered to meet or exceed these requirements.\nThe Company has periodically undertaken, and may in the future undertake or be required to implement and\/or adhere to environmental guidelines at existing facilities, and to add additional monitoring post-closure maintenance or corrective measures at closed waste disposal sites. The Company cannot predict the financial impact, if any, of such matters on the Company's operations.\nDuring the ordinary course of its landfill operations, the Company is, as are others in the industry, subject to governmental enforcement proceedings and resulting fines or other sanctions from such authorities regarding full compliance with applicable environmental or health or safety regulations. The Company believes that based on the results of management's review of its operations, that it has taken appropriate charges and that expense accruals have been provided by the Company for its share of any of these potential liabilities.\nTransportation Services: The Company's transportation of hazardous waste consists of the hauling of solid material in either individual sealed containers or in specially designed, and licensed bins. The State of California licenses the bins and trailers and the tractors are subject to the Southern California Air Quality Management District's regulations in regard to local enforcement of the Clean Air Act. The Clean Air Act provides for the federal, state, and local regulation of the emission of air pollutants. The Company's transporting operation has not been subject to any requirement of the Clean Air Act other than the required posting by the Southern California Air Quality Management District in regard to smog alert requirements, which is in effect for all of the Company's fleet and most other companies in the same geographical area.\nThe Company also engages in the interstate transportation of hazardous and industrial non-hazardous waste. The Company has all of the proper permits to operate in these states.\nSummary: The Company believes that it is currently in substantial compliance with all applicable federal, state and local\nlaws, permits, orders, and regulations. The Company believes that there will probably be increased regulation and legislation related to the waste management industry in the future. The Company attempts to anticipate future regulatory, political and legal developments that might affect its operations and plans accordingly to remain in compliance with the regulatory framework. The Company cannot predict the extent to which any legislation or regulation that may be enacted or enforced in the future may affect its operations particularly in the event that regulations are applied retroactively.\nCORPORATE DEVELOPMENT\nThe Company's corporate development program emphasizes the development of a broad range of waste services. These services include collection, recycling, processing, composting, transfer and disposal. This range enables the Company to compete for business and expand current customer relationships.\nManagement envisions that this program will result in the expansion of its landfill operations, further penetration of its existing collection markets, and acquisitions which either complement its existing operations or allow it to expand into new geographic markets.\nWaste reduction legislation in California, Florida and Louisiana, and contemplated in other states in which the Company operates, is causing municipalities to rethink their waste programs. The Company views recycling and other municipal waste service reduction programs as the catalyst which will enable the Company to expand its services to communities and customers it currently does not serve and further cement relationships with current customers.\nManagement believes that as local governmental budgets face fiscal constraints, an increasing number of municipalities will turn to private sector companies to meet their waste disposal demands. The Company, in an effort to expand its customer base, has therefore focused a significant amount of its marketing efforts on obtaining additional municipal franchises to supplement its existing, approximately 90, franchises.\nThe Company's acquisition activity has been focused on collection companies either within or located near current Western Waste operations. The Company has also acquired companies to expand into new markets. Over the past three years, the Company purchased the routes and certain assets of eleven companies, including one in fiscal 1994. The Company plans to increase acquisition activity in fiscal 1995.\nBONDING AND INSURANCE\nIn order to submit a bid or proposal to a governmental or corporate entity to provide collection, hauling and disposal services, the Company is often required to submit simultaneously a bid bond or a letter of credit and, upon contract award, provide a bond or letter of credit to secure its performance of the contract. Management believes that its current bonding coverage and borrowing capacity are adequate for its present needs.\nThe Company has a risk management program whereby it retains the liability, subject to maximum limits, for auto, general liability, employee health and welfare benefits and workers' compensation. The Company carries insurance coverage which management considers sufficient to protect the assets and operations of the Company, including excess umbrella and special hazardous waste transportation coverage.\nManagement believes the self insured loss reserves of the Company are adequate. The Company establishes reserves to cover its estimated liabilities for unpaid loss and loss adjustment expenses related to claims reported before the balance sheet date, claims incurred but not yet reported, and the expenses of investigating and adjusting all claims incurred prior to the balance sheet date. All estimated liabilities are net of estimated salvage and subrogation recoveries and net of insurance coverage above self insurance retention levels.\nThe Company establishes self insured loss reserves based on estimates of the ultimate cost of claims (including loss adjustment expenses) which have been reported but not fully paid, and of claims which have been incurred but not yet reported. The length of time for which such costs must be estimated varies depending on the coverage involved. Actual claim costs are dependent upon such complex factors as inflation, changes in doctrine of legal liability and size of damage awards. Because of the variables involved, the reserving process results in an estimate rather than an exact calculation of liabilities.\nLiabilities for self insured losses, including loss adjustment expenses, are revalued periodically using a variety of actuarial and statistical techniques for producing current estimates of expected claim costs. Claim frequency and severity and other social and economic factors are considered in the valuation process. A provision for inflation in the calculation of future claim costs is implicit since reliance is placed on both actual historical data which reflect past inflation and on factors which are judged to be appropriate additions to or modifiers of past experience such as industry experience. Adjustments to previously estimated liabilities in connection with establishing self insurance reserves are reflected in current operating results in\nthe period in which they are determined.\nCOMPETITION\nThe waste services industry is very competitive and requires substantial labor and capital resources. The Company encounters competition from national, regional and local companies by locality and by type of service. Some national waste services companies are much larger and have greater resources than the Company. The Company also competes with municipalities and industrial facilities which provide their own waste management services. Competition in the Company's markets is based primarily on service, reliability, and price.\nEMPLOYEES\nThe Company currently employs approximately 1,730 persons, consisting of approximately 90 managers and executives, approximately 1,050 persons employed in collection, transfer, resource recovery and disposal activities, approximately 230 persons employed in equipment repair and maintenance, and approximately 360 persons employed in sales, clerical, data processing and other activities. Approximately 28% of the Company's employees are represented by a union under collective bargaining agreements. The Company did not experience a significant work stoppage in any of the reporting periods covered by this Form 10-K and believes its employee relations are good.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe principal fixed assets of the Company consist of vehicles and equipment which include approximately 1,250 collection, recycling, transfer and support vehicles, an estimated 810,000 storage containers, roll-off boxes and recycling bins, and approximately 230 portable and stationary compactors.\nThe Company owns approximately 2,720 acres of real property, including approximately 2,470 acres used or being developed as landfills. It leases an additional 90 acres of which 64 acres are for landfill. The total space of all buildings utilized by the Company is approximately 500,000 square feet.\nThe Company purchased certain general office facilities in Torrance, California in December 1991. A portion of these facilities is being used for the Company's corporate headquarters. The remaining facilities are currently being leased to outside parties.\nManagement believes that the Company's property and equipment are adequate for its present business needs. The Company intends, however, to continue to invest in additional property and equipment for both expansion and replacement of existing assets.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nOn or about October 13, 1993 the Company was served with a class action lawsuit now entitled In re Western Waste Industries Securities Litigation, Case No. CV-93 6126 KN filed in the United States District Court for the Central District of California. The complaint alleges that the Company violated federal securities laws with regard to certain disclosures and representations made by the Company and certain alleged omissions on the part of the Company in connection with merger negotiations between the Company and Browning-Ferris Industries (\"BFI\"). The plaintiffs allege that they and all other persons or entities that bought the stock of the Company during the period of September 2, 1993 through October 7, 1993 suffered damages as a result of changes in the market price of the Company's common stock. The Company does not believe that it has violated any laws with regard to the BFI matter and intends to vigorously defend the lawsuit.\nOn or about August 9, 1994 a complaint was filed in Rancho Disposal Services, Inc., et al. v. Western Waste Industries, et al., San Bernardino Superior Court Case No. SCB 14473. The Complaint seeks damages and an injunction for the alleged violation of California Business and Professions Code Sections 17047, 17200, and 17500 and for intentional interference with existing and prospective economic relations. The complaint alleges that the Company does not hold a validly issued permit to operate within a certain geographic area in the County of San Bernardino and that the Company has engaged in predatory pricing. The complaint also alleges that the Company has violated a San Bernardino County ordinance by engaging in discriminatory and non-uniform pricing of its refuse hauling services. In addition to the injunction, the complaint prays for three times the actual damages incurred by plaintiffs, punitive and exemplary damages in the amount to be proven at the time of trial, reasonable attorneys' fees and costs of suit. The Company believes it has valid defenses to the allegations and intends to vigorously defend the suit. The Company also intends to file a cross-complaint against the plaintiffs for engaging in improper pricing activities.\nIn July 1994, the Company reached an agreement to settle the claims asserted against it in a lawsuit captioned County of Los Angeles, et al. v. Browning-Ferris Industries, Inc., et al., Case No. 93-1807-WMS filed in the Los Angeles County Superior Court. The complaint sought indemnification on behalf of the County of Los Angeles for alleged damages resulting from hauling waste from\ncounty garbage districts to the Operating Industries Landfill. The settlement was within the range previously accrued. The settlement includes a release by the EPA with regard to the Operating Industries site.\nIn addition to the above-described litigation, there are number of claims and suits pending against the Company for alleged damages to persons and property, alleged violation of certain laws and for alleged liabilities arising out of matters occurring during the normal operation of the waste services business. In the opinion of management, the uninsured liability, if any, under these claims and suits would not materially affect the financial position of the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nDuring the fourth quarter of fiscal 1994, no matter was submitted to a vote of the Company's security holders.\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 under the symbol \"WW\". The following table below sets forth by quarter for the last two years the high and low sales prices of the Company's common stock on the New York Stock Exchange.\n1993 1994\nHigh Low High Low\nQuarter ended September 30 12-1\/4 9-5\/8 22-1\/2 9-5\/8\nQuarter ended December 31 12-3\/4 8-3\/4 19-3\/4 10-3\/8\nQuarter ended March 31 11-5\/8 8-3\/4 16-1\/2 13-3\/8\nQuarter ended June 30 12 9 20-1\/2 13-5\/8\nThe Company is limited with respect to the amount of cash dividends which can be paid, by certain terms of its revolving credit agreement.\nNo cash dividends have been paid to date by the Company. The current policy of the Company is to retain earnings to provide funds for the operation and expansion of its business. The Company does not anticipate paying dividends in the foreseeable future.\nItem 7.","section_6":"","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nRESULTS OF OPERATIONS\nRevenue\nThe increases in revenue over the last three fiscal years have resulted from price increases, obtaining additional franchise agreements, expanding the customer base, acquiring certain assets of other waste management businesses and expanding landfill operations.\nComponents of the increases in revenue are as follows:\nYear Ended June 30, 1992 1993 1994\nPurchased assets . . . . . . . . . 3.7% 2.8% .2% Price and volume changes . . . . . 6.1 2.6 11.0 9.8% 5.4% 11.2%\nThe Company's revenue growth was impacted negatively in fiscal 1993 by (i) the reduction in commercial waste volumes due to the economic recession which affected many of its markets, particularly California, (ii) state and local waste minimization requirements, (iii) the emphasis of many commercial collection customers, as a result of the recession, on controlling and reducing operating costs, which leads to downward pressure on pricing, and (iv) the downward pressure on pricing as a result of increased competition.\nThe principal factor in the decline of revenue growth in fiscal 1993 was the continuation of the nationwide economic recession, particularly in California. Recent evidence indicates that the economy is recovering from the recession, albeit slowly. This improvement in the economy was a ingredient in the revenue growth realized in fiscal 1994, in conjunction with new operations in San Jose and Sunnyvale, California. It is very difficult to predict the future of the economy and as such, no assurances can be given about future operations, but it is anticipated that as the recession abates, revenue and operating results should continue to improve.\nCosts of Operation\nOperating expenses, consisting primarily of wages and benefits for operating personnel, insurance costs, disposal site fees and equipment\noperating costs, were 75.3% of revenue in fiscal 1992, 81.2% in fiscal 1993 and 74.7% in fiscal 1994. Operating costs increased in fiscal 1993, as a percentage of revenue, due primarily to charges of (i) $6,000,000 related to a estimated loss on a municipal contract, and (ii) $4,000,000 related to increases in self-insurance reserves. Operating costs decreased in fiscal 1994, as a percentage of revenue, due principally to (i) charges incurred in fiscal 1993 previously noted (ii) increases in volume at the Companys' landfill operations, including an increase in the volume of out-of-county waste at the Company's El Sobrante California landfill site, which generally have lower operating costs than waste collection operations and (iii) revenue growth resulting from rate increases.\nOn June 30, 1992, the Company entered into an agreement with the City of San Jose, to provide refuse and recycling services, for a term of six years, with service beginning July 1, 1993. During the initial months of the contract, it became apparent that the level of services required for the contract and related costs of operation would be greater than originally envisioned. This occurred, in part, by factors outside of the control of the Company. As a consequence, most of the increased cost could not have been anticipated or estimated prior to the start of the contract. The Company estimated that it would incur a loss of $6,000,000 over the life of the contract, in order to satisfy the service requirements of the contract and accordingly accrued that amount in the fourth quarter of fiscal 1993. The balance of this accrual was approximately $3,000,000 as of June 30, 1994. Based upon facts presently known to it, the Company believes that the balance of this accrual is adequate to cover any future losses related to this contract.\nIn the fourth quarter of fiscal 1993 the Company performed a detailed analysis, considering the trend of increasing development of known claims, along with the pattern shown by payments made in settlement of self-insured losses. As a result of this analysis, the Company increased its reserve for self-insured losses by $4,000,000. The Company performed a similar analysis in fiscal 1994 and determined that the estimated reserve balances remain adequate. The process of estimating loss reserves is a difficult and complex exercise involving many variables, uncertainties, and subjective judgements, and therefore, there is no assurance that the reserve balance will reduce the possibility of adverse reserve developments in subsequent reporting periods.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses, as a percentage of revenue approximated 16.0% in fiscal 1992 and 1993, and 15.0% in 1994. Selling, general and administrative expenses decreased as a percentage of revenue in fiscal 1994 due primarily to the Company's continuing effort to control costs in conjunction with the revenue growth discussed above. In early fiscal 1994, the Company reviewed its\nselling, general and administrative expense levels as compared to the industry and subsequently set a goal to reduce these levels below 15%.\nSpecial Charges\nSpecial charges of $21,043,000 were included in fiscal year 1993's results of operations. The Company re-evaluated its landfill activity in fiscal 1993, focusing on the economic viability of landfill projects under development and closure and post-closure requirements. As a result of revised projections, estimates, and certain regulatory communications on permitting activity in progress, the Company recorded special charges in the third quarter of fiscal 1993 of (i) $10,143,000 related to writeoffs and reserves for certain landfill development projects and (ii) $6,900,000 to establish additional reserves, above those estimated to be required on an ongoing annual basis, for potential future expenditures relating to the long-term requirements for closure\/post closure management of certain Company landfills. Also as a part of the Company's review of facilities and land requirements, the Company recorded a $2,000,000 general reserve for property no longer needed for operations and established a loss reserve of $2,000,000 for other matters. The balance of this accrual was $12,029,000 as of June 30, 1994. Company management believes that the components of this reserve remain adequate as of June 30, 1994.\nInterest Expense\nInterest expense decreased $437,000 or 11.2% in fiscal 1993, and then increased $354,000 or 10.2% in fiscal 1994. The decrease in fiscal 1993 was due to lower borrowing rates, partially offset by increased borrowings. The increase in interest expense in fiscal 1994 was due primarily to higher average debt levels as compared to the prior fiscal year. Total debt in fiscal 1994 averaged approximately $93,000,000 as compared to approximately $87,000,000 in fiscal 1993. The Company capitalized interest costs of $1,753,000, $1,151,000 and $953,000 in fiscal 1992, 1993 and 1994, respectively, related to the development of certain landfill and other construction projects.\nNon-Operating Income (Expense)\nA writedown of $6,600,000 related to G.I. Industries was included in Other non-operating income (expense) in fiscal 1992. In April of 1992, negotiations with G.I. Industries over the proposed acquisition of that company were terminated. As a result, the Company substantially wrote down its investment in GII to reflect the estimated net realizable value. No material changes to this item have occurred since the reserve was established.\nThe Company recorded a gain of $2,800,000 in the third quarter of fiscal 1993 related to the sale of the Company's equity investment in\ncommon stock of Best Pak Disposal. This gain is included in Other non- operating income (expense) in fiscal 1993.\nDuring May of 1992, the Company made the decision to cease operations and sell or otherwise dispose of its truck body manufacturing division, Stagg Equipment Company (Stagg). The decision to dispose of Stagg came after the Company reassessed the division's prospects in light of the continuing economic downturn, which significantly affected anticipated outside demand. In connection with the decision to dispose of Stagg, the Company recorded a fiscal 1992 provision of $4,050,000 to reflect the estimated loss on disposition, including estimated future costs and operating results from Stagg until the completion of the disposal. In November 1993, the Company completed the disposal with the exception of payments to be made on a long-term lease which will expire in November 1995. These payments were provided for in the estimated loss. The balance of the reserve was approximately $1,262,000 as of June 30, 1994.\nIncome Taxes\nThe effective income tax rates for fiscal 1992, 1993, and 1994 were 44%, 30% and 45%, respectively. The effective rates for all years were higher than the statutory federal rate (34% for 1992 and 1993 and 35% for 1994) due primarily to the effect of state income taxes and nondeductible expenses. The effective rate for 1994 reflects a $86,000 reduction related to the recent change in the federal corporate income tax rate from 34% to 35%, retroactive to July 1, 1993 in accordance with the Revenue Reconciliation Act of 1993. In fiscal 1994, the Company recognized a benefit of $414,000 from the adoption of FASB 109. The Company has a net deferred tax asset of $2,372,000 at June 30, 1994, all of which the Company has determined is more likely than not to be realized due to available taxable income in the carryback period.\nFINANCIAL CONDITION\nLiquidity and Capital Resources\nThe solid waste industry is capital intensive. The Company has financed its operations and capital expenditures through cash flow from operations, borrowings and issuances of common stock. Cash provided by operations was $36,242,000 and $35,320,000 in fiscal 1993 and 1994, respectively, while additions to debt provided $13,515,000 and $15,028,000 in those fiscal years, respectively. These funds have been used to purchase property and equipment, to acquire certain assets of other waste services companies, to develop and expand new and existing landfill sites, and to finance the Company's expansion of services.\nThe Company's $100 million revolving line of credit (\"the agreement\"), which currently matures on June 1, 1997, has a $16.5 million quarterly commitment reduction commencing March 1, 1996. On or before the first day of October of each year, the Company has an option\nto request an extension of the revolving period and the termination date with the approval of its banks. The Company has exercised this option and is currently awaiting the approval of its banks. If this option is approved, the termination date shall be extended to June 1, 1999, the quarterly commitment reduction date shall be extended to March 1, 1997, and the quarterly commitment reduction will be reduced from $16.5 million to $10 million. Thereafter, each extension request shall be for a period of one year.\nWorking Capital\nAt June 30, 1993 and 1994, working capital amounted to $13,261,000 and $20,660,000, respectively. The current ratio was 1.6 to 1 at June 30, 1994 as compared to 1.4 to 1 a year earlier. The increase in the current ratio was due primarily to (i) a decrease of $2,661,000 in the current portion of a contract loss accrual recorded as of June 30, 1993 and (ii) an increase of $7,676,000 in cash and short-term investments. The increase in cash and short-term investments was used principally for certain commitments and debt reduction totaling $7,600,000 which were paid at the beginning of fiscal 1995. Trade receivables represent the largest portion of current assets totaling $24,297,000 and $30,244,000 at June 30, 1993 and 1994, respectively. The increase in trade receivables was due primarily to new operations in San Jose and Sunnyvale, California. Days sales in trade receivables were 36 days for fiscal 1993 and 37 days for fiscal 1994. The allowance for doubtful accounts as a percentage of trade receivables was 5.6% and 5.3% at the end of fiscal 1993 and fiscal 1994, respectively.\nCapital Resources\nIn December 1992, the Company renegotiated its revolving line of credit thereby increasing the amount available from $80,000,000 to $100,000,000. At the Company's option, borrowings under the agreement bear interest at the bank's prime rate and\/or at the London Interbank Offered Rate (LIBOR) plus .75 to 2.0 per cent, (1.25 per cent at June 30, 1994), depending upon certain ratios. Outstanding borrowings under the agreement were $82,000,000 at June 30, 1994.\nDuring the year ended June 30, 1994, the Company made capital additions of approximately $35 million. The Company estimates that capital additions for fiscal 1995 will be approximately $30 million. The Company believes that cash provided by operations, cash available under its revolving credit agreement, lease agreements, and cash from other external sources will be sufficient for its financing needs.\nInflation\nInflation has had a minimal impact on the Company's operations for the periods referred to above as most of the Company's collection operations are under contracts that provide for rate adjustments based upon increases in the consumer price index. These contracts reduce the Company's vulnerability to inflation. However, in the case of rapid changes in certain costs, such as fuel and disposal costs, rate increases may lag behind cost increases.\nEnvironmental Matters\nClosure and post-closure costs are accrued and charged to cost of operations over the estimated useful lives of such facilities. These accruals are based on estimates from management reviews performed periodically. The closure and post-closure requirements for the Company's municipal solid waste landfills are established by Subtitle D or the applicable states' adopted and EPA approved Subtitle D implementation plan. In performing the review for each facility, the Company analyzes actual costs incurred versus total estimated costs, updates prior cost estimates to reflect current regulatory requirement, and considers requirements of proposed regulatory changes.\nClosure and post-closure accruals consider final capping of the site, site inspections, ground-water monitoring, leachate management, methane gas control and recovery, and operation and maintenance costs to be incurred during the period after the facility closes.\nThe Company accounts for closure and post-closure accruals by comparing the total estimated closure and post-closure cost with the existing reserve. The difference is accrued and charged to cost of operations as airspace is consumed.\nReport of Independent Auditors\nBoard of Directors and Shareholders Western Waste Industries\nWe have audited the accompanying consolidated balance sheets of Western Waste Industries and subsidiaries as of June 30, 1993 and 1994 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended June 30, 1994. Our audits also included the financial statement schedules listed in the Index at 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.\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 Western Waste Industries and subsidiaries at June 30, 1993 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1994, 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 Note 8 to the consolidated financial statements, in 1994 the Company changed its method of accounting for income taxes.\nERNST & YOUNG LLP\nAugust 26,1994\nWestern Waste Industries Notes to Consolidated Financial Statements\nWestern Waste Industries is a integrated solid waste services company, providing collection, recycling, composting and disposal services for commercial, industrial and residential customers. The Company operates as a single business segment.\nNote 1 Summary of significant accounting policies:\nPrinciples of consolidation-The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts and transactions have been eliminated.\nCash and short term investments-Short term investments generally consist of highly liquid investments with a maturity of three months or less.\nProperty and equipment-Property and equipment are recorded at cost. Landfill sites and site improvements are carried at cost and to the extent this exceeds estimated end use realizable value, such excess is amortized over the remaining estimated useful life of the site. Interest is capitalized in connection with the construction of major facilities. The capitalized interest is recorded as part of the asset to which it relates and is amortized over the asset's useful life. In fiscal 1993 and 1994, respectively, $1,151,000 and $953,000 of interest cost was capitalized. Depreciation and amortization of other property and equipment are provided for by using the straight-line method over their estimated useful lives. Leasehold improvements are amortized over the shorter of the life of the improvement or the term of the lease.\nPurchased routes-Purchased routes are amortized on a straight-line basis over the contract periods or estimated service periods, generally 10 years. Accumulated amortization at June 30, 1993 and 1994 was $15,932,000 and $16,640,000, respectively.\nGoodwill-Consideration paid in excess of the fair market value of net assets acquired is recorded as goodwill and is amortized on a straight- line basis over 40 years. Accumulated amortization at June 30, 1993 and 1994 was $2,088,000 and $2,794,000, respectively.\nDeferred bond issue costs-Expenses related to the issuance of Pollution Control Revenue Bonds and Solid Waste Disposal Revenue Bonds (see Note 7) are included in other assets and are amortized over the life of the bonds using the straight-line method. At June 30, 1993 and 1994, the unamortized portion of deferred bond issue costs amounted to $341,000 and $286,000, respectively.\nClosure and post-closure reserves-The Company will have material financial obligations relating to closure and post-closure costs of landfill facilities it operates or for which it is otherwise\nMarketable Securities-In May 1993, the FASB issued Statement No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\". The Statement would require the Company to report its investment in marketable securities (see Note 5) at fair value, with unrealized gains and losses reported in a separate component of shareholders' equity. The Company is required to adopt this statement in fiscal 1995 and the effect of this adoption is not anticipated to be material to the financial position or results of operations of the Company.\nNote 2 Special Charges\nIn fiscal 1993, the Company incurred special charges in the amount of $21,043,000. These charges included principally (i) writeoffs and reserves of $10,143,000 related to certain landfill development\nprojects (ii) a provision of $6,900,000 for additional reserves for potential future expenditures relating to the long-term requirements for closure\/post closure management of certain of the Company's landfills and (iii) a general reserve of $4,000,000 for property no longer needed for operations and other matters.\nNote 3 Acquisitions\/Divestitures:\nThe Company purchased the routes and certain other assets of six, four and one company(ies) in 1992, 1993 and 1994, respectively. All of the acquisitions have been accounted for by the purchase method. The results of the acquired operations have been included in the Company's operations since the date of acquisition.\nTotal consideration paid for the 1992 acquisitions was $13,676,000, consisting of $4,141,000 cash, $6,252,000 notes payable, $1,075,000 assumed debt and $2,208,000 in capital stock. In exchange for this consideration, the Company allocated $5,538,000 to tangible assets and purchased routes and the remainder of $8,138,000 was recorded as goodwill.\nTotal consideration paid for the 1993 acquisitions was $654,000, consisting of $356,000 cash and of $298,000 notes payable.\nTotal consideration paid for the 1994 acquisition was $35,000, paid in cash.\nThe Company's financial results for the years ended June 30, 1992, 1993, and 1994 would not be materially different if the results of all acquisitions were included as though the acquisitions occurred at the beginning of each period.\nIn October 1990, the Company issued 300,000 shares of its common stock in exchange for all the outstanding capital stock of a waste collection company. This transaction, which was not material to the Company's financial position or results of operations when originally recorded in fiscal 1991, was accounted for as a pooling-of-interests at that time. However, as a result of new information, it was determined in fiscal 1993 that the transaction would have been more properly recorded by using the purchase method. Accordingly, the financial statements for the year ended June 30, 1993 reflect this revision. As the effect was not material, financial statements for prior years were not restated. Total consideration paid for this acquisition was $9,310,000 consisting of 300,000 shares of capital stock at a guaranteed price of $30 per share and $310,000 in assumed debt in excess of assets acquired. In exchange for this consideration, the Company allocated $1,215,000 to purchased routes and $8,095,000 to goodwill. As part of this transaction the Company issued 240,000 shares of common stock in fiscal 1994 as renumeration for a stock price guarantee.\nIn April 1992, the Company sold certain assets and routes in California for $1,949,000. The Company recognized a gain of approximately $537,000, which is included in Nonoperating income (expense) - Other in the Consolidated Statement of Operations.\nIn February 1993, the Company sold its equity investment in the outstanding common stock of Best Pak Disposal resulting in a gain of $2,800,000. As part of this transaction, the Company received 75,000 shares of common stock of USA Waste, the value of which is included in other current assets. The gain of $2,800,000 was included in nonoperating income (expense)-other in the Consolidated Statement of Operations for the year ended June 30, 1993.\nIn April 1992, negotiations with GII over the proposed acquisition of that company were terminated. As a result, the Company substantially wrote-down its investment in GII to reflect the estimated net realizable value. Writedowns related to GII totaled $6,600,000, including investments, advances and certain direct acquisition costs. This writedown was included in nonoperating income (expense) - other, in the Consolidated Statement of Operations for the year ended June 30, 1992. In April 1993, the Company received an Order of the Bankruptcy Court allowing the Company to setoff a debt to a GII Industries\nbank's prime rate and\/or at the London Interbank Offered Rate (LIBOR) plus .75 to 2.0 per cent, (1.25 per cent at June 30, 1994), depending upon certain ratios. The agreement has a $16.5 million quarterly commitment reduction commencing March 1, 1996. On or before the first day of October of each year, the Company has an option to request an extension of the revolving period and the termination date with the approval of its banks. The Company has exercised this option and currently is awaiting the approval of its banks. If this option is approved, the termination date shall be extended to June 1, 1999, the quarterly commitment reduction date shall be extended to March 1, 1997, and the quarterly commitment reduction will be reduced from $16.5 million to $10 million. Thereafter, each extension request shall be for a period of one year. The agreement requires no compensating balances. Under the terms of the agreement, the Company is subject to various debt covenants including maintenance of certain financial ratios, and in addition, it limits the amount of cash dividends.\nAt June 30, 1993, obligations related to capital expenditures in the amount of $8,682,000 were classified as long-term debt. Funds available under the revolving line of credit provided management with the ability to refinance this debt, in early 1994, on a long-term basis. The obligations were classified as long-term debt and included in the notes payable to banks classification above.\nSolid Waste Disposal Revenue Bonds issued by the California Pollution Control Financing Authority are secured by a solid waste landfill facility constructed with bond proceeds. The bonds bear interest at a floating rate set weekly until conversion to a fixed rate, at the option of the Company, for the remaining term of the bonds. As of June 30, 1994, the company has not exercised its option of conversion to a fixed rate. The Company also has an option to redeem the bonds prior to maturity at the redemption price ranging from 100% to 103% depending on the redemption date. At June 30, 1994, the Company established in the trustee's favor an irrevocable letter of credit for the principal amount of $8,200,000 plus 123 days accrued interest on the bonds to guarantee repayment.\nPollution Control Revenue Bonds issued by the California Pollution Control Financing Authority are secured by a solid waste disposal facility constructed with bond proceeds. Revenue from the operation of the solid waste disposal facility is pledged to secure repayment of the bonds. The Company is required to deposit into a Reserve Fund an amount equal to three months' debt service (principal and interest). The Reserve Fund balances at June 30, 1993 and 1994 were $527,000 and $546,000 respectively, and have been deducted from bond principal outstanding. Bond repayment is guaranteed up to a maximum of 80 percent by the Federal Small Business Administration.\nAt June 30, 1994, $10,328,000 of long-term debt was collateralized by land, buildings and equipment with a carrying value of $8,965,000. Interest paid during fiscal years 1992, 1993 and 1994 was $5,217,000, $5,010,000, and $4,652,000, respectively.\nThe fair value of the Company's long term debt calculated using current rates offered to the Company for debt of the same remaining maturities is not materially different from the amounts included in the Consolidated Balance Sheet.\nNote 8 Income taxes:\nEffective July 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109, \"Accounting for Income Taxes\". Under the liability method, deferred tax liabilities and assets are determined based on the difference between financial reporting and tax basis of assets and liabilities, using the enacted tax rates in effect for the year in which the differences are expected to reverse. Taxes previously accrued will be adjusted for changes in tax rates as they become effective as opposed to when the taxes were recorded. The cumulative effect of adopting Statement 109 was a $414,000 benefit to income. As permitted under the new rules, prior year financial statements have not been restated.\nSignificant components of deferred tax assets and liabilities, as of June 30, 1994 were as follows:\nDeferred tax assets:\nSelf insurance $ 4,572,000 Asset valuation reserves 4,305,000 Reserve for landfill related costs 4,094,000 Reserve for loss on municipal contract 1,348,000 Reserve for litigation settlements 1,013,000 Reserve for disposal of a division 581,000 State taxes 595,000 Other, net 1,127,000 Total deferred tax assets 17,635,000\nDeferred tax liabilities: Tax over book depreciation 11,935,000 Deferred gain on sale of asset 1,465,000 Prepaid expenses 490,000 Other 1,373,000 Total deferred tax liabilities 15,263,000\nNet deferred taxes $ 2,372,000\nRental expense approximated $10,951,000, $11,415,000 and $10,156,000 for the fiscal years ended June 30, 1992, 1993 and 1994, respectively. These amounts include rental payments to the President of approximately $167,000, $172,000 and $161,000 for the fiscal years ended June 30, 1992, 1993 and 1994, respectively.\nThe Company has a 401(k) plan which covers all full time salaried and clerical employees not represented by a bargaining agreement. Eligible employees are allowed to contribute up to the maximum allowed by law. At its discretion, the Company can match up to 50% of the amount contributed by employees. The Company's contributions for 1992, 1993, and 1994, represented by issuance of Company common stock, were $504,000 and $506,000, and $566,000, respectively.\nIn May 1992, the Company made the decision to cease operations and sell or otherwise dispose of its truck body manufacturing division, Stagg Equipment Company (Stagg). The decision to dispose of Stagg came after the Company reassessed the division's prospects in light of the continuing economic downturn, which significantly affected anticipated outside demand. In connection with the decision to dispose of Stagg, the Company recorded a fiscal 1992 provision of $4,050,000 to reflect the estimated loss on disposition and the estimated future operating results from Stagg until the completion of its disposal. In November 1993, the Company completed the disposal with the exception of payments to be made on a long-term lease which will expire in November 1995.\nNote 11 Litigation:\nThe Company was served on October 13, 1993 with a class action lawsuit. The complaint alleges that the Company violated federal securities laws with regard to certain disclosures and representations made by the Company and certain alleged omissions on the part of the Company in connection with merger negotiations between the Company and Browning-Ferris Industries (\"BFI\"). The plaintiffs allege that they and all other persons or entities that bought the stock of the Company during the period of September 2, 1993 through October 7, 1993 suffered damages as a result of changes in the market price of the Company's common stock. The Company does not believe that it has violated any laws with regard to the BFI matter and intends to vigorously defend the lawsuit.\nThe Company was served on August 9, 1994 with a complaint filed by certain refuse haulers in San Bernardino County alleging that the Company violated certain California Business and Professions Code Sections and also intentionally interfered with existing and prospective economic relations. The complaint alleges that the Company does not hold a validly issued permit to operate within a certain geographic area in the County of San Bernardino and that the Company has engaged in a course of conduct of predatory pricing. The complaint also alleges that the Company has violated a San Bernardino County ordinance by engaging in discriminatory and non-uniform pricing of its\nrefuse hauling services. In addition to the injunction, the complaint prays for three times the actual damages incurred by plaintiffs, punitive and exemplary damages in the amount to be proven at the time of trial, reasonable attorneys' fees and costs of suit. The Company believes it has valid defenses to the allegations and intends to vigorously defend the suit. The Company also intends to file a cross- complaint against the plaintiffs for engaging in improper pricing activities.\nThe Company was named by the County of Los Angeles in regard to an indemnification action by the County for collection of alleged damages resulting from hauling waste from County garbage districts to the Operating Industries Landfill. The Company and some of its prior subsidiaries hauled waste to the Operating Industries site for certain defendant cities and also hauled waste through two defendant county garbage districts in the County of Los Angeles. In July 1994, the Company reached an agreement to settle the claims for the amount of $3,600,000, and received insurance proceeds of $1,200,000 as of June 30, 1994. This amount fell within the range previously accrued. The settlement includes a release by the EPA with regard to the Operating Industries site.\nIn addition to the above, there are a number of claims and suits pending against the Company for alleged damages to persons and property, alleged violation of certain laws and for alleged liabilities arising out of matters occurring during the normal operation of the waste management business. In the opinion of management, the uninsured liability, if any, under the aforementioned claims and suits would not materially affect the financial position of the Company.\nNote 12 Loss on Municipal Contract:\nOn June 30, 1992, the Company entered into an agreement with the City of San Jose, to provide refuse and recycling services, for a term of six years, with service beginning July 1, 1993. During the initial months of the contract, it became apparent that the level of services required for the contract and related costs of operation would be greater than originally envisioned. This occurred, in part, by factors outside of the control of the Company. As a consequence, most of the increased cost could not have been anticipated or estimated prior to the start of the contract. The Company estimated that it would incur a loss of $6,000,000 over the life of the contract, in order to satisfy the service requirements of the contract and accordingly accrued that amount. The balance of this accrual was approximately $3,000,000 as of June 30, 1994. Based upon facts presently known to it, the Company believes that the balance of this accrual is adequate to cover any future losses related to this contract.\nPART III\nItems 10, 11, 12 and 13 of Part III (except for certain information required with respect to executive officers of the Company which is set forth below) have been omitted from this report, since the Company will file with the Securities and Exchange Commission, not later than 120 days after the close of the fiscal year, a proxy statement, pursuant to Regulation 14A, which involves the election of directors. The information required by Items 10, 11, 12 and 13 of this report which will appear in the definitive proxy statement is incorporated by reference into Part III of this report.\nThe executive officers of the Company are as follows:\nPresent Office Name Age or Position (1)\nKosti Shirvanian (2) (3) 64 Chairman of the Board of Directors and President\nRamsey DiLibero (3) 66 Chief Operating Officer, Director\nSavey Tufenkian (2) (3) 65 Executive Vice President, Secretary and Treasurer; Director\nLawrence F. McQuaide (3) 46 Executive Vice President, Finance\n(1) Officers serve at the discretion of the Board of Directors.\n(2) Kosti Shirvanian is the brother of Savey Tufenkian.\n(3) Member, Management Committee. The Committee, composed of certain officers and outside board members, coordinates Company operations.\nKosti Shirvanian founded the Company in 1955 as a sole proprietorship. He became the Chairman of the Board and President when the Company was incorporated in 1964.\nRamsey DiLibero joined the Company in 1993 as Chief Operating Officer. Prior to joining the Company Mr. DiLibero served as Chief Operating Officer of CECOS International, Inc. and Chief Executive Officer of Browning-Ferris International, both subsidiaries of Browning-Ferris Industries. Mr. DiLibero also served as Chief Operating Officer of Waste Resources Corporation and SCA Services, Inc.\nSavey Tufenkian helped to establish the Company in 1955 and has served as the Secretary and Treasurer of the Company since its incorporation in 1964. In 1988 she was elected as Executive Vice President, Secretary and Treasurer.\nLawrence F. McQuaide, certified public accountant, joined the Company in 1984 as Vice President, Finance. In 1988 he was elected as Executive Vice President, Finance. Prior to joining the Company, Mr. McQuaide was a Senior Manager with Price Waterhouse where he had served for eleven years.\nPART IV\nItem 14.","section_7A":"","section_8":"","section_9":"","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 Statement, Schedules and Exhibits.\n1. Financial Statement (included in Item 8) Reports of Independent Auditors Consolidated Balance Sheet - June 30, 1993 and 1994 Consolidated Statement of Operations for the Three Years Ended June 30, 1994 Consolidated Statement of Shareholders' Equity for the Three Years Ended June 30, 1994 Consolidated Statement of Cash Flows for the Three Years Ended June 30, 1994 Notes to Consolidated Financial Statements\n2. Schedules.\nSchedule II - Amounts Receivable for Related Parties, and Underwriters, Promoters, and Employees Other Than Related Parties\nSchedule V - Property and Equipment\nSchedule VI - Accumulated Depreciation, Depletion and Amortization of Property and Equipment\nSchedule VIII - Valuation and Qualifying Accounts\nSchedule X - Supplementary Income Statement\nAll other schedules have been omitted since the required information is not significant or is included in the financial statements or the notes thereto, or is not applicable.\n3. Exhibits\nThe exhibits to this Report are listed in the Exhibit Index elsewhere herein.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Company during the fourth quarter of the fiscal year ended June 30, 1994\nWESTERN WASTE INDUSTRIES\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nDuring 1992, 1993 and 1994, maintenance and repairs charged to costs and expenses in the Consolidated Statement of Operations were $16,770,000, $18,951,000 and $20,547,000, respectively.\nExhibit Index\nExhibit No. Description of Exhibit\n3.1 Articles of Incorporation of registrant as presently in effect (Exhibit 3.1 to Form S-1 Registration Statement No. 2- 83121 and incorporated herein by reference.)\n3.2 By-laws of registrant as presently in effect (Exhibit 3.2 to Form S-1 Registration Statement No. 2-83121 and incorporated herein by reference.)\n4.1 Specimen of Common Stock Certificate (Exhibit 4.1 to Form S-1 Registration Statement No. 2-8131 and incorporated herein by reference.)\n10.1 Twenty-five Year Lease dated May 1, 1968 between Kosti Shirvanian and Marian Shirvanian as lessors and registrants as lessee, as amended March 24, 1983 (\"the Lease\") (Exhibit 10.1 to Form S-1 Registration Statement No. 2-83121 and incorporated herein by reference.)\n10.2 Second amendment to the Lease.\n10.3 1983 Incentive Stock Option Plan of Western Waste Industries (Exhibit 10.6 to Form S-1 Registration Statement No. 2-83121 and incorporated herein by reference.)\n10.4 Employee Stock Ownership Plan and Employee Stock Ownership Trust Agreement (Exhibit 10.7 to Form S-1 Registration Statement No. 2-83121 and incorporated herein by reference.)\n10.5 1983 Non-Qualified Stock Option Plan (Exhibit 10.10 to Form 10-K Annual Report of Registrant for the fiscal year ended June 30, 1984 and incorporated herein by reference.)\n10.6 Revolving Credit Agreement dated as of November 19, 1992 among Western Waste Industries, as Borrower and Citicorp, USA, Inc., Bank of America National Trust and Savings Association, ABN AMRO\nBank, The Bank of Nova Scotia, The First National Bank of Boston, and BHF- Bank, as Lenders, and Citicorp USA, Inc. as Agent for Lenders (\"the Revolving Credit Agreement\"). (Exhibit 10.1 to Form 10-Q for Quarter Ended December 31, 1992 and incorporated herein by reference.)\n10.7 First Amendment dated as of June 28, 1993 to the Revolving Credit Agreement (Exhibit 10.9 to Form 10-Q for Quarter Ended September 30, 1993 and incorporated herein by reference.)\n10.8 Second Amendment dated as of October 14, 1993 to the Revolving Credit Agreement (Exhibit 10.10 to Form 10-Q for Quarter Ended September 30, 1993 and incorporated herein by reference.)\n10.9 Third Amendment dated as of February 25, 1994 to the Revolving Credit Agreement (Exhibit 10.11 to Form 10-Q for Quarter Ended March 31, 1994 and incorporated herein by reference.)\n10.10 Western Waste Industries 401(k) Savings and Investment Plan. (Exhibit 10.2 to Form 10-Q for Quarter Plan Ended September 30, 1988 and incorporated herein by reference.)\n10.11 1992 Stock Option Plan, as amended\n10.12 Amendment to Stock Option Plan\n21.1 Subsidiaries of registrant (Exhibit 22.1 to Form 10-K for year ended June 30, 1993 and incorporated herein by reference.)\n23.1 Consent of independent auditors.\n99.1 Amendment to 1983 Incentive Stock Option and 1983 Non-qualified Stock Option Plan (undertakings to be incorporated by reference into Form S-8 Registration Statement No. 33-9358.) 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 in the City of Torrance, State of California, on the 27th day of September, 1994.\nWESTERN WASTE INDUSTRIES\nBy: KOSTI SHIRVANIAN Kosti Shirvanian Chairman of the Board and 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.\nSignatures Title Date\nKOSTI SHIRVANIAN Chairman of the Board Kosti Shirvanian of Directors and President (Principal Executive Officer)\nRAMSEY G. DILIBERO Chief Operating Officer and Ramsey G. DiLibero Director\nLAWRENCE F. MCQUAIDE Executive Vice President, Lawrence F. McQuaide Finance (Principal Financial and Accounting Officer)\nSAVEY TUFENKIAN Executive Vice President, Savey Tufenkian Secretary-Treasurer and Director\nJOHN W. SIMMONS Director September 27, 1994 John W. Simmons\nHARRY S. DERBYSHIRE Director Harry S. Derbyshire\nDR. A. N. MOSICH Director Dr. A. N. Mosich\nExhibit 23.1\nConsent of Independent Auditors\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-70492) pertaining to the Western Waste Industries 1992 Stock Option Plan and in the related Prospectus and in the Registration Statement (Form S-8 No. 33-9358) pertaining to the 1983 Incentive Stock Option Plan and the 1983 Non-Qualified Stock Option Plan of Western Waste Industries and in the related Prospectus of our report dated August 26, 1994, with respect to the consolidated financial statements and schedules of Western Waste Industries included in the Annual Report (Form 10-K) for the year ended June 30, 1994.\nERNST & YOUNG LLP\nSeptember 27, 1994","section_15":""}
{"filename":"49648_1994.txt","cik":"49648","year":"1994","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 695,000 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 implementation of a power cost adjustment mechanism (PCA) 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, temperature conditions, and management decisions and less on precipitation and streamflow conditions. As of December 31, 1994, the Company supplied electric energy to 330,308 general business customers and employed 1,703 people in its operations (1,609 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 4,648 miles of high voltage transmission lines; 21 step-up transmission substations located at power plants; 17 transmission substations; 7 transmission switching stations; and 195 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 1,166,900 2005 Swan Falls 27,170 27,170 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 Station) 693,333 678,077 Valmy (Coal-Fired Station) 260,650 260,650 Boardman (Coal-Fired Station) 53,000 53,000\nOn December 31, 1994, the composite average ages of the principal parts of the Company's system, based on dollar investment, were: production plant, 15.8 years; transmission system and substations, 18.0 years; and distribution lines and substations, 13.8 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 vigorously pursued 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 will submit its first applications for license renewal to the FERC in December 1995. These first applications will seek renewal of the Company's licenses for its Bliss, Upper Salmon and Lower Salmon Hydroelectric Projects. The Company cannot anticipate what type of environmental capital investment 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 and PCB\/lead 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 will supersede EPA's \"Interim\" Administrative Order when it is entered by the court.\nOn August 30, 1993, Notice of the Lodging of the Amended Partial 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 Partial 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. Following receipt of the Company's responses, EPA undertook further factual investigations relating to the extent of lead contamination at the site and the nature and extent of lead contributions to the site, including the Company's involvement.\nThe Amended Partial Consent Decree was finally lodged together with EPA's Motion to Enter with the U.S. District Court for the District of Idaho on December 12, 1994. The Amended Partial Consent Decree provides that the Company is protected against any and all claims for contribution by other PRPs, both as to the PCB and lead contamination.\nOn January 24, 1995, the Company was advised that the PRP group associated with lead contamination was objecting to the proposed entry of the Amended Partial Consent Decree on the basis that the Company has not paid its \"fair share\" of the remaining lead clean- up costs which EPA currently estimates at approximately $5 million.\nIt is EPA's position that the Company, as an integral part of its clean-up of the PCB contamination and PCB\/lead contamination, removed approximately 57 percent of the total lead contamination from the entire site, even though the Company contributed only 10.5 percent of the total lead contamination.\nThe Company believes that the objections filed by the PRPs are completely without merit, and both the Company and the EPA are responding to the objections of the PRPs.\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, March 10, 1994, 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 and 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 costs of site remediation, and damages for the insurers' breach of the insurance contracts based on the insurers' failure to pay such costs.\nDue to a case backlog in the Idaho District, the case was assigned to a Federal Judge in the Eastern District of Washington. In the action, the Company seeks reimbursement for approximately $6,125,000 in indemnity and defense costs associated with the remediation, together with prejudgment interest and attorney fees and costs for the action.\nThe Company successfully settled its claim for coverage with the Liquidation Trustee for the first layer insurer (which insurer is now in liquidation) on several of the policies at issue, resulting in a one-time payment of $827,500 to the Company last fall. This sum is not reflected in the damages which the Company seeks in this litigation.\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 Tribe's claim for damages arising from precluding the Tribe's 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.\nOn March 21, 1994, the Federal District Judge issued an order granting the Company's motion for summary judgment on all claims except the Tribe's claim for compensation based on exclusion from its usual and accustomed fishing places, which part of the motion the District Judge denied without prejudice.\nOn September 28, 1994, the Federal District Judge issued an Order rejecting the Second Report and Recommendation of the Magistrate and granting, in its entirety, the Company's motion for summary judgment.\nOn November 8, 1994, the Tribe filed its Notice of Appeal with the Ninth Circuit Court of Appeals. No date for oral argument on the appeal has yet been set.\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, March 10, 1994, and other reports filed with the Commission.\nOn October 6, 1994, the Company brought an action, Idaho Power Company, v. Monsanto Company, et al., in the district court of the fourth judicial district of the State of Idaho, against Monsanto Company, General Electric Company, Westinghouse Electric Corporation, Schlumberger Industries, Inc., McGraw-Edison Company, Asea Brown Boveri, Inc. and Cooper Industries, Inc. The Complaint alleges fraudulent misrepresentation or omission of material facts, and\/or knowing failure to warn Idaho Power Company of the hazards of polychlorinated biphenyls (PCBs), in connection with the sale, service, replacement, maintenance, and\/or removal of electrical equipment utilizing or contaminated with PCBs. The case has been removed to the United States District Court for the District of Idaho and is still in an early stage. Discovery has not yet commenced and no trial date has been set.\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 Name, Age and Position Five (5) Years\nJ. W. Marshall, 56 Appointed August 18, 1989. Chairman of the Board and Chief Executive Officer\nL. R. Gunnoe, 59 Appointed July 12, 1990. Mr. Gunnoe President and Chief was Vice President - Distribution Operating Officer prior to July 12, 1990.\nDaniel K. Bowers, 47 Appointed July 10, 1986. Vice President and Treasurer\nJ. LaMont Keen, 42 Appointed November 14, 1991. Vice President and Mr. Keen was Controller prior to Chief Financial Officer November 14, 1991.\nDouglas H. Jackson, 58 Appointed July 12, 1990. Vice President - Mr. Jackson was Senior Manager of Distribution Corporate Services prior to July 12, 1990.\nPaul L. Jauregui, 53 Appointed June 4, 1988. Vice President - Human Resources\nC. N. Olson, 45 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 and Distribution Engineering and Construction Manager prior to February 1, 1990.\nJ. B. Packwood, 51 Appointed July 13, 1989. Vice President - Power Supply\nRobert W. Stahman, 50 Appointed July 13, 1989. Vice President, General Counsel and Secretary\nHarold J. Hochhalter, 59 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 1992, 1993 and 1994, cash dividends per share of common stock were $1.86. At the July 1994 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 exchanges. For years 1993 and 1994, the following table indicates the reported high and low sales price of the Company's common stock as reported by the Wall Street Journal as composite tape transactions. The Company's number of common stockholders of record at December 31, 1994 was 26,209.\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\n1994 (Quarters) Common Stock, $2.50 par value: 1st 2nd 3rd 4th High $30 5\/8 $27 5\/8 $24 7\/8 $24 1\/8 Low 26 7\/8 21 3\/4 22 1\/2 22 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\nOVERVIEW\nIdaho Power Company's consolidated financial statements represent the Company and its five wholly-owned subsidiaries: Idaho Energy Resources Company (IERCo); Ida-West Energy Company (Ida-West); IDACORP, Inc.; Idaho Utility Products Company (IUPCo); and Stellar Dynamics. This discussion uses the terms Idaho Power and the Company interchangeably to refer to Idaho Power Company and its subsidiaries.\nEARNINGS PER SHARE AND BOOK VALUE\nTwo factors affected earnings per share in 1994. First, drought conditions returned to the Company's service area. These conditions have hampered the Company's hydroelectric operations six of the last eight years. Second, the Company entered into an agreement with a midwest utility regarding a substitution emission allowance exchange. This agreement resulted in a $2.5 million one-time addition to pretax income. Earnings per share of common stock were $1.80 in 1994, down from $2.14 in 1993, a year of improved precipitation and streamflows. However, the 1994 earnings per share are an increase over 1992's drought-affected $1.55. The 1994 earnings equate to a 10.0 percent earned return on year-end common equity, as compared to the 11.8 percent earned in 1993 and the 8.7 percent earned in 1992. At December 31, 1994, the book value per share of common stock was $17.91.\nRESULTS OF OPERATIONS\nEnergy Demand and Customer Growth\nA prolonged period of high temperatures sparked sharp increases in energy demand during the summer of 1994. Southwestern Idaho and southeastern Oregon--the most densely populated area of the Company's service territory--experienced a record 44 consecutive days with temperatures of at least 90 degrees. On June 23, 1994, the Company set a new record for system peak load at 2,392 megawatts (MW).\nThe Company's growth in new customers this year broke a record of its own. By December 31, 1994, Idaho Power had connected 12,536 new general business customers to its system, far outpacing the previous record of 11,563 set in 1978. By customer class, the Company added 10,505 residential customers, 1,548 commercial and industrial customers, and 483 irrigation customers.\nEconomy\nThe Company's service territory posted another outstanding year of economic growth in 1994. Idaho's nonagricultural employment grew by an estimated 4.6 percent, following gains of 5.0 percent in 1993 and 4.6 percent in 1992. Across the entire service territory, nonagricultural employment showed an estimated gain of nearly 4.6 percent for 1994, building on gains of 4.9 percent in 1993 and 3.5 percent in 1992.\nPopulation growth remains strong in the Company's service area. The number of residential customers grew by 3.4 percent in both 1992 and 1993, and by 4.0 percent in 1994. Over the next five years, the Company projects that the number of new households in its service area will grow by an average rate of 3.0 percent per year, while population growth over the same period will exceed 2.2 percent.\nRevenues\nFor the three-year period 1992-1994, the Company received an average 86 percent of its operating revenues from electric sales in Idaho, 5 percent in Oregon, less than 1 percent in Nevada, and 9 percent from the wholesale market. For the same three-year period, the average percentages of total operating revenues by category were as follows: - - 34 percent from residential customers; - - 30 percent from a combination of irrigation customers, street lighting customers, and commercial and industrial customers with less than 750 kW demand; - - 19 percent from commercial and industrial customers with demand of 750 kW or greater; - - 12 percent from sales to other utilities and interchange arrangements; - - 5 percent miscellaneous revenue.\nThe Company's energy sales to general business customers rose 3.0 percent in 1992, fell 1.7 percent in 1993, then increased 6.9 percent in 1994. The sales increases in 1992 and 1994 reflect the strong economic growth in Idaho Power's service territory, increases in new customers served, and varied temperature, streamflow, and energy usage patterns. The decline in 1993 can be traced to two factors: (1) wet spring weather that reduced irrigation kilowatt-hour sales by 28.8 percent; and (2) temporary operational changes made by two of the Company's large industrial customers that lowered energy consumption. FMC Corporation periodically curtailed 1993 operations at its elemental phosphorous production plant in response to market conditions for its product. Also, the Idaho National Engineering Laboratory (INEL) reduced its 1993 electrical usage. Both FMC and INEL returned to a higher level of operation during 1994.\nRecord growth in new customers contributed to the 1994 increase in energy sales. In addition, a long, hot, dry summer boosted the Company's irrigation load by 34.5 percent.\nGeneral business revenues constitute approximately 83 percent of the Company's total operating revenues. For 1992, general business revenues were $431.8 million, for 1993 $428.7 million, and for 1994 $457.4 million. The decrease in 1993 is a result of that year's wet spring, which reduced irrigation revenues by 27.9 percent. The decrease was partially offset by increases in residential revenues (9.3 percent) and small commercial revenues (4.0 percent). The 1994 increase reflects above-normal summer temperatures that increased irrigation revenues by 33.2 percent, or $16.2 million. The number of general business customers served increased by 32,500, or 10.9 percent during the three-year period. Energy usage per average residential customer was 13,856 kilowatt hours (kWh) in 1992, 14,587 kWh in 1993, and 14,159 kWh in 1994.\nTotal operating revenues increased by $14.9 million (3.1 percent) in 1992, $42.3 million (8.5 percent) in 1993, and $3.3 million (0.6 percent) in 1994. Increased opportunity sales to other utilities created the 1993 increase in total operating revenue. Customer growth, coupled with above-normal summer temperatures, accounted for the 1994 increase. However, the increase was offset by a decline in opportunity sales caused by reduced streamflows.\nOff-System Sales\nRevenues from sales to other utilities fell $10.6 million in 1992, rose $44.5 million in 1993, and decreased by $26.6 million in 1994. These are composed of firm sales (long-term contractual agreements) and opportunity sales made on a when-available basis. The volume and price of these sales depend on the Company's firm energy demand, hydroelectric generation conditions in its service territory, and market conditions throughout the West. Revenues from firm sales to other utilities were $37.5 million in 1992, $45.4 million in 1993, and $53.6 million in 1994. Revenues from opportunity sales to other utilities were $4.5 million in 1992, $41.1 million in 1993, and $6.3 million in 1994. Drought conditions reduced opportunity sales in 1992 and 1994, while the return to more normal hydro conditions in 1993 increased the volume of sales and revenue dramatically.\nExpenses\nTotal operating expenses grew $16.4 million in 1992, $5.3 million in 1993, and $15.5 million in 1994. The added expense for 1992 and 1994 are a result of drought conditions that elevated the Company's reliance on thermal generation and purchased power. The 1993 rise in operating expenses reflects the deferral of certain 1992 drought-related net power supply costs to 1993 authorized by the Idaho Public Utilities Commission (IPUC). Maintenance expense also increased in 1993 with that year's return to improved hydroelectric operating conditions.\nPurchased power expenses have been high and fluctuating during the last three years. This situation reflects both necessity purchases from neighboring utilities during drought periods and increased 1993 purchases from cogeneration and small power production (CSPP) projects as a result of improved hydro conditions. The current estimated annualized cost for the 62 CSPP projects on-line at December 31, 1994 is $40.7 million. The Company relies on its thermal generation facilities to operate at high-capacity factors during periods of drought. Increased thermal generation raised fuel expenses by $21.5 million in 1992 and $7.0 million in 1994. In 1993, fuel expenses declined by $8.9 million as a direct result of the increased availability of hydro generation to meet customer demand.\nAll other operation and maintenance expenses fluctuated during the three-year period, with a cumulative increase of $3.1 million. These variations are due, in part, to increases in payroll and benefits, and changes in operation and maintenance due to drought conditions.\nDepreciation expense was up for the three-year period by $2.6 million, or 4.5 percent, due to a greater plant investment base. Taxes other than income taxes grew $2.8 million, or 13.1 percent, as a result of additional property taxes and taxes on the increased generation and sale of hydroelectric power.\nInterest Charges\nInterest charges on long-term debt fluctuated during the three- year period. Ultimately, they were down by $3.2 million, reflecting the maturity, early redemption, and issuance of several series of first mortgage bonds. The Company took advantage of declining interest rates to refinance several higher- cost bond issues. These refinancings reduced the overall cost of debt and annual interest expense by an amount that largely offset the cost of additional financing (see Note 5 of Notes to Consolidated Financial Statements).\nInterest on short-term debt rose due to varying interest rates during the period, as well as to a larger level of short-term borrowings. At December 31, 1994, the Company's short-term borrowings were $55.0 million (see Note 7 of Notes to Consolidated Financial Statements).\nIncome Taxes\nIn August 1993, Congress enacted the Omnibus Budget Reconciliation Act. Among other things, the Act raised 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 higher rate. Also in 1993, the Company settled with the Internal Revenue Service (IRS) federal income tax liabilities for the 1987-1990 tax years and in 1994 the Company settled federal income tax liabilities for the 1991-1992 tax years, except for immaterial amounts relating to a partnership.\nPrecipitation and Streamflows\nAfter experiencing an above-average water year in 1993, Idaho Power's service territory experienced below-normal precipitation and above-normal temperatures throughout much of 1994. Between April and July, the Company recorded 2.75 million acre feet (MAF) of water flowing into Brownlee Reservoir (water source for the three-dam Hells Canyon hydroelectric complex). This figure is 46 percent of 1993's 6.0 MAF, 153 percent of 1992's 1.8 MAF, and 57 percent of the 66-year median of 4.8 MAF.\nThe early indications for l995 are somewhat better. As of February 1, l995, reservoir storage above Brownlee Reservoir was at 37 percent of capacity. However, the average snow water equivalent for the Snake River above Brownlee Reservoir was at 114 percent of the 30-year average, compared to 56 percent of the average at this time last year. Based on current hydrologic conditions and projected meteorological conditions, the Company estimates that approximately 4.5 MAF of water will flow into Brownlee Reservoir between April and July 1995. If the estimate holds true, it would be a 64 percent increase over 1994's streamflow, but still 6 percent below the 66-year median inflow.\nEnergy Requirements\nWith drought conditions returning in 1994, hydroelectric generation accounted for only 40 percent of the Company's total energy requirements. This figure is a substantial decrease from 52 percent in 1993, but higher than 1992's 35 percent. Thermal generation accounted for 46 percent of total energy requirements in 1994, while purchased power and other exchanges supplied 14 percent. Under normal conditions, the Company's hydro system supplies approximately 58 percent of its total energy requirements, with thermal generation accounting for 33 percent and purchased power and other interchanges contributing the remaining 9 percent.\nThe Company expects to meet l995's projected energy loads by using its hydro and coal-fired facilities and strategic geographic location-which presents excellent opportunities to purchase, sell, exchange, and transmit Northwest energy-even if stream flow conditions are below normal.\nRegulatory Issues\nPower Cost Adjustment (PCA)\nSince 1993, the Company's PCA mechanism has allowed it to collect, or to refund, the differences between actual net power supply costs and those allowed in the Company's Idaho base rates. Deviations from forecasted costs are deferred with interest and trued up the following year. The Company filed its 1994 PCA application with the IPUC on April 15, 1994, requesting an increase in base rates for the Idaho jurisdiction. The increase (in effect from May 16, 1994 through May 15, 1995) was approximately $9.8 million, or 2.5 percent including last year's true-up. At December 31, 1994, the Company had recorded $8.6 million of power supply costs above those projected in the 1994 forecast. This cumulative amount will be requested to be included in the 1995 true-up adjustment. With the IPUC's revenue requirement order on February 1, 1995, the PCA mechanism increased to a 90 percent recovery level from its original 60 percent.\nGeneral Revenue Requirement Case\nOn June 30, 1994, the Company filed its application based upon calendar year 1993, using a thirteen month average rate base (annualized for its new Swan Falls production project) and a year end capitalization structure. The IPUC conducted ten days of hearings commencing on October 10 and December 12, 1994. Public hearings were also held in Pocatello, Idaho on December 5 and in Caldwell, Idaho on December 7, 1994. Throughout the proceeding, including the interim rate hearing, documentary and oral evidence was presented by a number of parties.\nOn January 31, 1995, the Company received IPUC Order No. 25880 authorizing $17.2 million in general rate relief from the IPUC representing a 4.2 percent overall increase in Idaho retail rates. The relief is based on an 11.0 percent allowed return on equity with an overall rate of return of 9.199 percent. The Company had requested $37.1 million in general rate relief representing a 9.09 percent increase in rates, a 12.50 percent return on equity, and a 9.88 percent overall rate of return. These increased rates are effective February 1, 1995.\nThe Company is disappointed with the allowed return on common equity granted in the Order and believes it does not adequately reflect today's financial conditions and the returns investors expect to receive on their investment. An allowed return on common equity of 11.0 percent only marginally exceeds the Company's dividend payout ratio of 10.4 percent on year-end book value. This makes it difficult for the Company to meet dividend requirements because of the implied constraint the return allowed places on the Company's earnings potential. The Company has petitioned the IPUC for reconsideration of its decision with regard to the allowed return on common equity seeking an authorized return on common equity which, if earned, would be sufficient to safely cover the current dividend. However, the Company cannot predict the final outcome of this request for reconsideration.\nThe Company will file a general revenue requirement case in Oregon in early l995. This filing will utilize the same information used in the 1994 filing in Idaho.\nCogeneration and Small Power Production Contracts\nIn September 1993, the Company submitted a detailed position paper to its state regulators and other interested parties. This report outlined proposed changes in the Company' s resource acquisition policy. With the potential deregulation of the electric utility industry, and a more competitive power supply marketplace, the Company believes that current resource acquisition policies must be changed to avoid burdening it and its customers with unnecessary future power supply costs. Idaho Power believes that the appropriate criteria for adding future supplies should be power needs at the time of development and that the addition be the least-cost market alternative. Therefore, in December 1993 the Company filed with the IPUC for permission to approve lower published prices for new CSPP contracts. In response to the Company's filing, on January 31, 1995 the IPUC issued an order approving lower published CSPP rates. In the order, the IPUC also determined that negotiated rates for future CSPP projects larger than 1 megawatt should be more closely tied to values determined in the Company's integrated resource planning (IRP) process. In its January 31, l995 order, the IPUC stated, \"There is a widely held expectation that there will be increasing competition within the electric utility industry. In light of that, we believe it is especially important that the QF [Qualified Facilities] industry be able to demonstrate that the energy resources offers are as cost effective as those that a utility would construct.\"\nRosebud Enterprises, Inc. (Rosebud) filed a Complaint against the Company with the IPUC, alleging that the Company refused to sign a contract to purchase the output of a 40 MW petroleum waste- fired generating plant that Rosebud proposes to build near Mountain Home, Idaho. Because this facility, known as the Mountain Home Project, was larger than l0 MW, the IPUC's established rates for small CSPP projects were not available to Rosebud. On September 16, 1994, the IPUC issued an order directing the Company to recalculate and offer avoided cost rates as described in the order. In October 1994, the Company transmitted a purchase offer to Rosebud conforming to the IPUC's final order. Rosebud rejected that purchase offer and has appealed the IPUC's final order to the Idaho Supreme Court.\nOregon Drought Rate Relief\nThe Company's PCA mechanism applies only to its Idaho jurisdiction. As a result of 1994's high power supply costs, the Company also filed for temporary drought rate relief with the Oregon Public Utility Commission (OPUC). The OPUC issued an accounting order that granted the Company permission to defer with interest 60 percent of Oregon's share of the Company's increased power supply costs incurred between May 13, 1994 and December 31, 1994. The amount deferred at December 31, 1994 was $1.3 million. The Company is required to file a request with the OPUC in early 1995 to recover these deferred costs.\nSubsidiaries\nIda-West Energy Company\nThis wholly-owned subsidiary of the Company owns, through various partnerships, 50 percent of five Idaho hydroelectric projects with a total generating capacity of approximately 34 megawatts (MW). Third parties unaffiliated with Ida-West own the remaining 50 percent of these projects, thus satisfying the \"qualifying facility\" status under PURPA guidelines. The partnerships have obtained project financing (non-recourse to the Company) for each of these facilities.\nAs a 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 MW gas-fired cogeneration project to be located near Hermiston, Oregon. On June 4, 1993, BPA selected three projects--including that of the partnership--for participation in the program. The partnership and BPA signed an option development agreement granting BPA an option to acquire energy and capacity from the project any time during a five-year option hold period after all option development period tasks, including permitting, have been completed. The option also entitles the partnership to BPA reimbursement for certain development costs, based on the achievement of certain milestones. This option includes an exclusive right to acquire energy and capacity from a second 233 MW unit at the site during the same five-year option hold period. In March 1994, BPA and the partnership reached an additional agreement on the power purchase contract, setting forth the terms and conditions on which BPA will purchase energy and capacity from the project upon exercise of the option. The partnership expects to complete development period tasks by the end of l995. Project financing for construction costs would be non-recourse to the Company.\nThe Company has invested $20 million in Ida-West. Ida-West continues an active search for new projects.\nStellar Dynamics\nIn 1994, Idaho Power announced the formation of a fifth subsidiary company. Stellar Dynamics will commercialize the Company's extensive expertise in control technology for electric substations and power plants. The Company approved the new venture after receiving a positive recommendation from Newton- Evans Research Company. The recommendation, based on a market survey conducted by Newton-Evans, was backed by strong interest from potential customers. One-third of the companies surveyed, including several large investor-owned utilities, requested product information. The primary opportunity for Stellar Dynamics' design, consulting, installation, and troubleshooting services lies in the U.S. substation controls market. The Company expects to capitalize Stellar Dynamics in early 1995.\nLIQUIDITY AND CAPITAL RESOURCES\nCash Flow\nNet cash generation from operations totaled $377.3 million for the three-year period 1992-1994. After deducting common and preferred dividends of $221.7 million, net cash generation from operations provided approximately $155.6 million for the Company's construction program and other capital requirements.\nInternal cash generation after dividends provided 30 percent of total capital requirements in 1992, 54 percent in 1993, and 41 percent in 1994. Idaho Power expects to continue financing its construction program with both internally generated funds and, to the extent necessary, externally financed capital. Drought conditions hurt the Company's internal cash generation two of the last three years. The Company has first mortgage bond refundings of $20.0 million in 1996 and $30.0 million in 1998. At January 1, 1995, the Company's lines of credit maintained with various banks totaled $70.0 million. The total lines of credit maintained with various banks will increase to $90.0 million at March 1, l995 (see Note 7 of Notes to Consolidated Financial Statements).\nConstruction Program\nThe Company's consolidated cash construction expenditures were $118.0 million in 1992, $122.9 million in 1993, and $110.5 million in 1994. Approximately 42 percent of these expenditures were for generation facilities, 8 percent for transmission facilities, 38 percent for distribution facilities, and 12 percent for general plant and equipment. After completion of the Swan Falls and Twin Falls projects, the Company does not anticipate any new major generation construction projects.\nSwan Falls Project\nIn early spring of 1994, the Company completed testing of the Swan Falls Project and both units were declared available for commercial operation. At December 31, 1994, the Company had spent approximately $55.0 million for construction of the Swan Falls Project, including allowance for funds used during construction. Additional work to preserve the old power plant as an historical site began during the year, while work to establish a museum on the site is scheduled for completion in 1995. In May, crews completed the federally-mandated stabilization of the dam and began the environmental reclamation of approximately 18 acres of land affected by construction activities.\nTwin Falls Project\nExpansion of the Twin Falls Project recently passed the halfway point, with completion estimated for mid-1995. The commitment estimate, including allowance for funds used during construction, is $50.8 million which represents the maximum amount the Company recommends be included in Idaho ratebase. Revised total cash expenditures for the Twin Falls expansion are currently estimated at $38.1 million, with total construction costs at $41.9 million, including an allowance for funds used during construction. At December 31, 1994, the Company had spent approximately $29.4 million on the Twin Falls Project. When completed, it will add 43 MW of new capacity to the Company's generation system.\nSouthwest Intertie Project (SWIP)\nIdaho Power is continuing to study the economic feasibility of constructing the SWIP to capitalize on its strategic location between the Intermountain West and the Pacific Northwest. The SWIP would serve as a major north-south transmission artery for regional transfers of electric power. The Company's SWIP proposal calls for a 500-mile, 500 kV transmission line that would interconnect the Company's system with those of utilities in California and the Southwest. In December 1994, the U.S. Bureau of Land Management issued a favorable record of decision on the Company's environmental impact statement and granted the project a right-of-way across public lands in Idaho, Nevada, and Utah. At present, the Company is conducting financial and contractual discussions with potential partners in the project. Idaho Power intends to retain up to 20 percent of ownership and capacity in the 1,200 MW project. The SWIP may be built in segments as warranted by demand for its transmission services.\nSolar and Solar Photovoltaic Projects\nSolar Two\nIdaho Power is a member of a consortium supporting the upgrade of an existing solar thermal power plant near Barstow, California. The Company has committed $630,500 in direct support to improve the plant's ability to store the sun's heat and use it later to generate electricity. The Electric Power Research Institute (EPRI), of which the Company is also a member, will contribute an additional $630,500, bringing the Company's credited contribution to approximately $1.3 million. Workers have completed over one- third of the retrofitting to date. When finished, Solar Two will use 1,900 mirrors to track the sun and focus its energy on a central receiving tower. The project will use a molten-salt fluid to store and transfer the collected heat. The main benefit the Company will receive by participating in this 10 MW project, is valuable experience and knowledge in solar power plant design, construction, and operation.\nMountain Home Air Force Base\nThe U.S. Air Force retained Idaho Power to design, build, and maintain one of the nation's largest hybrid solar-powered photovoltaic (PV) systems. The $1.2 million project, completed in February 1995, provides electricity to a remote Mountain Home AFB radar training installation near Grasmere, Idaho. Under optimal solar conditions, the PV system produces a peak capacity of 80,000 watts, reducing both the need for combustion generators and the emissions they produce. Under the terms of the contract, the federal government owns the system and pays the Company a monthly maintenance fee.\nInternational Photovoltaics Conference\nThe Company has been selected to host an international conference on the emerging global business opportunities associated with photovoltaic power applications. The Executive Conference on Strategic Photovoltaic Business opportunities for Utilities is scheduled for September 17-20, 1995 in Sun Valley, Idaho. Representatives of the utility and PV industries and government agencies will discuss how they and their organizations can plan for and shape the influence of photovoltaics in developing and changing utility markets.\nPhotovoltaic Service Tariff (PST)\nThe PST offers basic electric service for small loads at remote sites as an alternative to either line extensions for grid service or the use of on-site, fossil-fuel generators. In many cases, PV technology offers a cost-effective solution for both the customer and the Company. Idaho Power benefits by reducing the number of costly line extensions to serve small loads that produce little revenue. Under the PST, the customer pays a monthly fee to receive electric service from a PV system designed, installed, owned, and maintained by Idaho Power. The program, which the Company launched in January 1993, is a pilot offering with a $5,000,000 program limit and a $50,000 limit for individual systems.\nIn 1994, the Company made significant operational and technical improvements to its PST systems based on feedback from early PV customers. Customer comments helped to identify obstacles to customer acceptance of PV systems. To date, seven systems have been installed and are operating as designed.\nFinancing Program\nCapital Structure\nThe Company's capital structure (as illustrated in Selected Financial Data) fluctuated during the three-year period, with common equity growing to 45 percent, preferred rising to 9 percent, and debt falling to 46 percent. The Company's objective is to maintain capitalization ratios of approximately 45 percent common equity, 8-10 percent preferred stock, and the balance in long-term debt. The Company's strategy for achieving this target is through the use of accumulated retained earnings and the issuance of new equity. The Company's pre-tax interest coverage ratios were 2.50 times in 1992, 3.14 times in 1993, and 3.01 times in 1994. The Company has on file a shelf registration statement for the issuance of first mortgage bonds and\/or preferred stock, with an aggregate principal amount not to exceed $200.0 million. The Company's primary financial commitments at year-end 1994 were related to contracts for the Company's facility construction and maintenance program.\nCommon Stock\nDuring the period of January 1992 through May 1994, the Company issued original issue shares of common stock for its Dividend Reinvestment and Stock Purchase Plan and the Employee Savings Plan. During 1992, 1993, and 1994, common shares totaling 959,527; 898,528 and 527,296, respectively, were issued to these plans. The net proceeds from these issues were used for the Company's ongoing construction program.\nPreferred Stock\nOn July 1, 1993, Idaho Power issued $25 million of serial preferred stock. The Company used the net proceeds of this issuance for its ongoing construction program.\nLong-Term Debt\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 of that year, the Company used the net proceeds 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 Company used the net proceeds to retire early first mortgage bonds totaling $30,000,000, plus premiums and accrued interest.\nEnvironmental Issues\nSalmon Recovery Plan\nWork continues on the development of a comprehensive and scientifically credible plan to ensure the long-term survival of anadromous fish runs on the Columbia and Lower Snake Rivers.\nIn mid-August 1994, the federal government changed its designation of the Snake River Fall Chinook Salmon from Threatened to Endangered. The Company does not anticipate that the new designation will have any additional effects on its operations. In September 1991, the Company modified operations at its three-dam Hells Canyon Hydroelectric Complex to protect the Fall Chinook downstream during spawning and juvenile emergence. From its start, the Company's Fall Chinook program has exceeded the protection requirements for threatened species, affording the fish the same high level of protection due an endangered species.\nPending completion of a final recovery plan by the National Marine Fisheries Service (NMFS), the U.S. Army Corps of Engineers and other governmental agencies operating federally-owned dams and reservoirs on the Snake and Columbia Rivers have consulted the NMFS each year regarding federal system operations. On March 28, 1994, Judge Malcolm Marsh of the U.S. District Court for the District of Oregon ordered the federal agencies to reinitiate the consultation completed for 1993 operations of the federal system. Judge Marsh concluded that the consultations and subsequent operations were \"...too heavily geared towards a status quo that has allowed all forms of river activity to proceed...\" at the expense of fish. On September 9, 1994, the Ninth Circuit Court of Appeals echoed Judge Marsh's decision when it found that the 1993 Strategy for Salmon proposed by the Northwest Power Planning Council (NWPPC) was in violation of the 1980 Northwest Power Planning Act. The appeals court ordered the NWPPC to focus on saving young salmon and to defer to the expertise of state, federal and tribal fisheries management agencies in developing its salmon recovery program. Pursuant to the Ninth Circuit's opinion, the NWPPC adopted amendments to its Strategy for Salmon on December 15, 1994. The amended Strategy calls for a substantial increase in water from the Snake River to aid juvenile fish in their downstream migration to the sea. The Plan requires the Bureau of Reclamation to acquire 500,000 acre-feet of additional water by 1996 and another 500,000 acre-feet by 1998 for a total of 1,000,000 acre-feet in addition to the present contribution of 427,000 acre-feet. This water is to be acquired from willing sellers and could have a material impact on the Company's power supply costs. The Plan also calls for an additional 237,000 acre-foot contribution from the Company's Brownlee Reservoir for which the Company is to be reimbursed for by the BPA.\nThe Company expects a draft of the final Salmon Recovery Plan from the NMFS by March 1, 1995. It is possible this recovery plan could also have a material impact on the Company. The Company hopes that anadromous fish runs can be restored without placing undue hardship on either the Company or 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 U.S. District Court for the District of Idaho. The Tribe alleged that the Company's construction, operation, and maintenance of the three-dam Hells Canyon Project prevented anadromous fish from reaching their traditional spawning areas, destroyed certain fish runs, and prevented access to certain of the Tribe's usual and accustomed fishing places. These actions allegedly deprived the Nez Perce Tribe of its treaty rights to take fish from the Columbia and Snake Rivers. The Tribe is seeking compensatory and punitive damages, each in an amount to be proven at trial.\nIdaho Power maintains that the suit is without merit and asked the federal court to issue a summary judgment dismissing the action. The Company believes that the responsibility for concerns expressed by the Nez Perce Tribe lies with the United States. The Hells Canyon Project was licensed by the federal government, was built in accordance with federally approved plans, and is operated subject to federal regulation. The Company has complied with all governmental requirements to mitigate any effects the Project may have had on the fisheries.\nOn January 19, 1993, the Court took the Company's motion for summary judgment under advisement. On July 30, 1993, U.S. Magistrate Judge Larry Boyle issued a Report and Recommendation to the District Judge. Judge Boyle recommended that the District Judge grant that portion of the Company's motion for summary judgment regarding the loss of fish and deny the portion of its motion dealing with the Tribe's claim to compensation for exclusion from its usual and accustomed fishing sites. On March 21, 1994, U.S. District Judge Harold L. Ryan upheld Judge Boyle's recommendation regarding fish losses and took the question of compensation for exclusion from fishing sites under advisement. On September 28, 1994, after reviewing responses and objections on that issue, Judge Ryan rejected the Tribe's claim and granted the final portion of the Company's motion for summary judgment. The Tribe has appealed Judge Ryan's decision to the Ninth Circuit Court of Appeals. No date has been set for oral argument on the appeal.\nSnake River Mollusk\nIn mid-December, 1992, the U.S. Fish and Wildlife Service (USFWS) listed the Snake River Mollusk as a Threatened and Endangered Species. Since that time, the Company has included this possibility in all of its discussions regarding relicensing and new hydro development.\nThe listing specifically mentions the impact that fluctuating water levels related to hydroelectric operations may have on the snails' habitat. While most of the hydro facilities on that reach of the Snake River are baseload facilities, some of them do provide limited load-following capability. At present, there is no certainty as to the impacts, if any, that water fluctuations caused by these facilities may have on the snails. Idaho Power intends to testify to the USFWS that there is little scientific data in this area and that the Company proposes to study these operations. While it is possible that the listing could affect how Idaho Power operates its existing hydroelectric facilities on the middle reach of the Snake River, the Company believes that such changes will be minor and will not present any undue hardship.\nMountaineer\nIn May 1993, the Company was notified that Bridger Coal Company (BCC) was a potential contributor to a Superfund site involving waste motor oil delivered to Mountaineer Refinery in Wyoming. Idaho Energy Resources Company (IERCo), a wholly-owned subsidiary of the Company, owns one-third of BCC. In November 1993, BCC agreed to be included on the list of parties potentially responsible for this site. The current estimated cleanup costs are between $2.6 million and $5.0 million. During the past year, more contributors were added to the list of potentially responsible parties for cleanup of this site. Therefore, BCC's portion of these costs, based on the amount of oil delivered to the site, is estimated now to be approximately 5.0 percent, or between $130,000 and $250,000. IERCo would be liable for one- third of the BCC portion, or between $42,900 and $82,500. In 1994 BCC recorded expenses of $129,450 of which one-third flowed through to the Company's consolidated financials. Of this amount, $42,750 remains on BCC's books as an unfunded liability at December 31, 1994.\nClean Air\nIdaho Power has analyzed the Clean Air Act legislation's effects on the Company and its ratepayers. The Company's coal-fired plants in Oregon and Nevada already meet the federal sulfur dioxide (SO2) emission rate standards. The Company's coal-fired plant in Wyoming meets that state's even more stringent SO2 regulations. Therefore, the Company anticipates no adverse effects on its operations with regard to SO2 emissions.\nThe Company, together with PacifiCorp and Black Hills Corporation, entered into Phase I substitution agreements with Illinois Power Company. The agreements designate Units 1, 2, 3, and 4 of the Company's Jim Bridger thermal facility and facilities owned by PacifiCorp and Black Hills Corporation as substitution units for Baldwin #2, owned by Illinois Power. The substitution agreements will allow the Company to grandfather in less restrictive Phase I nitrous oxide emission requirements at the Jim Bridger units. As part of the agreements, the Company negotiated the sale of a number of its Phase I SO2 emission allowances to Illinois Power.\nElectric and Magnetic Fields (EMF)\nWhile scientific research has yet to establish any conclusive link between EMF and human health, the possibility has caused public concern in the United States and abroad. Electric and magnetic fields are found wherever there is electric current, whether the source is a high-voltage transmission line or the simplest of electrical household appliances. Concerns over possible health effects have prompted regulatory efforts in several states to limit human exposure to EMF. Depending on what researchers ultimately discover and what regulations may be deemed necessary, it is possible that this issue could affect a number of industries, including electric utilities. However, at this time it is difficult to estimate what impacts, if any, the EMF issue could have on the Company and its operations.\nCompetition and Strategic Planning\nCompetition is increasing in the electric utility industry, due to a variety of developments. In response, the Company continues to proceed with a strategic planning process. The goal of this process is to anticipate and fully integrate into Company operations any legislative, regulatory, environmental, competitive, or technological changes. With its low energy production costs, Idaho Power is well-positioned to enter a more competitive environment and is taking action to preserve its low- cost competitive advantage (see Regulatory Issues - Cogeneration and Small Power Production Contracts for a discussion of the Company's revised resource acquisition policy).\nOn June 3, 1994 the IPUC approved the buyout and cancellation of a January 22, 1993 Firm Energy Sales Agreement (FESA) with Meridian Generating Company, L. P. (MGC). The FESA was a 25-year agreement with MGC for a 54 MW natural gas-fired combined cycle cogeneration facility located in Meridian, Idaho. The Company estimates that the revenue requirement savings, including cancellation charges paid to MGC, are between $130 and $170 million.\nOn June 28, 1994, Washington Water Power and Sierra Pacific Resources announced that their respective boards of directors had approved a merger agreement between the two companies. Idaho Power is intervening in the approval process to ensure that the proposed merger has no adverse effects on its operations. In addition, the Company is actively identifying and responding to business opportunities presented by the proposed merger.\nInternally, the Company continues its commitment to refining its business processes to ensure its ability to offer the greatest possible value to its customers and its shareowners. Among these strategic initiatives are:\n- - the examination and refinement of the Company's distribution function, work order, and line extension processes; - - the initiation of a four-year, $3 million project to automate and consolidate the operation of the Company's 17 hydroelectric power plants; - - the formation of a Technical Advisory Panel, composed of representatives from public and private interest groups, to advise the Company on such matters as competition, alternative resources, and conservation. The Company will use the panel's advice as it reviews its IRP, due for publication in mid 1995. - - the implementation of a Restricted Stock Plan and Employee Incentive Plan to focus employees' attention on achieving annual financial and operational goals, to promote and reinforce teamwork, and to encourage employee accountability for business results and the Company's responsiveness to a competitive environment.\nRelicensing of Hydroelectric Projects\nIdaho Power is vigorously pursuing the relicensing of its hydroelectric projects, a process that will continue for the next 10 to 15 years. The Company will submit its first applications for license renewal to the Federal Energy Regulatory Commission in December 1995. These first applications will seek renewal of the Company's licenses for its Bliss, Upper Salmon Falls, and Lower Salmon Falls Hydroelectric Projects. Although various federal requirements and issues must be resolved through the relicensing process, the Company anticipates that its efforts will be successful. At this point, however, the Company cannot predict what type of environmental or operational requirements it may face, nor can it estimate the eventual cost of relicensing.\nBOARD OF DIRECTORS\nOn January 12, 1995, the Company welcomed two new members to its Board of Directors. Jack K. Lemley, 59, was Chief Executive officer of Transmanche-Ling, the Anglo-French construction firm that built the motor and rail transportation tunnel beneath the English Channel. A former senior vice president of Morrison- Knudsen Corporation, Mr. Lemley is currently President of Lemley & Associates, Inc. Peter S. O'Neill, 56, is President of Boise- based O'Neill Enterprises, Inc., a real estate development firm. Mr. O'Neill served as a senior vice president of Boise Cascade Corporation and as President of the Columbia-Willamette Development Co.\nThree directors retired from the board in accordance with the Company's Restated Articles of Incorporation and By-Laws. The articles and by-laws require directors to retire by age 70. Former U.S. Senator James A. McClure and retired plumbing and heating wholesaler Richard T. Norman left the board in December, the same month as their 70th birthdays. Rancher George Coiner retired at the January 12 board meeting. Mr. Coiner turns 70 in February 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAND FINANCIAL STATEMENT SCHEDULES\nPAGE\nManagement's Responsibility for Financial Statements 58\nConsolidated Financial Statements:\nConsolidated Balance Sheets as of December 31, 1994, 1993 and 1992 59-60\nConsolidated Statements of Income for the Years Ended December 31, 1994, 1993 and 1992 61\nConsolidated Statements of Retained Earnings for the Years Ended December 31, 1994, 1993 and 1992 62\nConsolidated Statements of Capitalization as of December 31, 1994, 1993 and 1992 63\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 64\nNotes to Consolidated Financial Statements 65-79\nIndependent Auditors' Report 80\nSupplemental Financial Information (Unaudited) 81\nSupplemental Schedule for the Years Ended December 31, 1994, 1993 and 1992:\nSchedule II- Consolidated Valuation and Qualifying Accounts 90\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 systems of internal accounting controls and related policies and procedures. The systems are designed to provide reasonable assurance that all assets are protected against loss or unauthorized use. Also, the systems provide 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 LLP, 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\nIDAHO POWER COMPANY CONSOLIDATED BALANCE SHEETS ASSETS\nDecember 31, 1994 1993 (Thousands of Dollars)\nELECTRIC PLANT (Notes 1, 5 and 10): In service (at original cost) $2,383,898 $2,249,723 $2,198,747 Less accumulated provision for depreciation 775,033 728,979 683,332\nIn service - Net 1,608,865 1,520,744 1,515,415 Construction work in progress 46,628 92,682 66,997 Held for future use 1,150 2,958 3,083\nElectric plant - Net 1,656,643 1,616,384 1,585,495\nINVESTMENTS AND OTHER PROPERTY 18,034 20,772 11,411\nCURRENT ASSETS: Cash and cash equivalents 7,748 8,228 4,966 Receivables: Customer 31,889 29,741 28,687 Allowance for uncollectible accounts (1,377) (1,377) (1,421) Notes 4,962 5,616 1,669 Employee notes receivable 5,444 5,909 5,970 Other 4,316 1,858 1,695 Accrued unbilled revenues (Note 1) 29,115 25,583 27,210 Materials and supplies (at average cost) 24,141 23,372 25,762 Fuel stock (at average cost) 11,310 11,553 14,282 Prepayments (Note 9) 21,398 20,975 22,171 Regulatory assets associated with income taxes (Note 1) 5,674 4,914 -\nTotal current assets 144,620 136,372 130,991\nDEFERRED DEBITS: American Falls and Milner water rights 32,605 32,755 32,890 Company-owned life insurance (Note 9) 49,510 45,294 40,228 Regulatory assets associated with income taxes (Note 1) 179,311 171,569 - Regulatory assets - other (Note 1) 67,713 35,036 - Other 43,380 39,235 61,292\nTotal deferred debits 372,519 323,889 134,410\nTOTAL $2,191,816 $2,097,417 $1,862,307\nThe accompanying notes are an integral part of these statements.\nIDAHO POWER COMPANY CONSOLIDATED BALANCE SHEETS CAPITALIZATION AND LIABILITIES\nDecember 31, 1994 1993 1992 (Thousands of Dollars) CAPITALIZATION (see Page 63): Common stock equity (Note 3): Common stock - $2.50 par value (shares authorized 50,000,000; shares outstanding 1994 - 37,612,351; 1993 - 37,085,055; 1992 - 36,186,527) $94,031 $92,713 $90,466 Premium on capital stock 363,063 350,882 326,338 Capital stock expense (4,132) (4,128) (3,806) Retained earnings 220,838 222,900 212,404\nTotal common stock equity 673,800 662,367 625,402 Preferred stock (Note 4) 132,456 132,751 107,874 Long-term debt (Note 5) 693,206 693,780 701,948\nTotal capitalization 1,499,462 1,488,898 1,435,224\nCURRENT LIABILITIES: Long-term debt due within one year 517 466 464 Notes payable (Note 7) 55,000 4,000 6,000 Accounts payable 32,063 31,912 34,821 Taxes accrued 16,394 15,452 16,182 Interest accrued 14,755 14,920 18,287 Other 12,574 13,731 12,125\nTotal current liabilities 131,303 80,481 87,879\nDEFERRED CREDITS: Accumulated deferred investment tax credits (Notes 1 and 2) 71,593 72,013 73,651 Accumulated deferred income taxes (Notes 1 and 2) 380,926 358,280 210,435 Regulatory liabilities associated with income taxes (Note 1) 35,090 34,968 - Regulatory liabilities - other (Note 1) 626 4,235 - Other (Note 9) 72,816 58,542 55,118\nTotal deferred credits 561,051 528,038 339,204\nCOMMITMENTS AND CONTINGENT LIABILITIES (Note 8)\nTOTAL $2,191,816 $2,097,417 $1,862,307\nThe accompanying notes are an integral part of these statements.\nIDAHO POWER COMPANY CONSOLIDATED STATEMENTS OF INCOME\nYear Ended December 31, 1994 1993 1992 (Thousands of Dollars)\nREVENUES (Note 1) $543,658 $540,402 $498,092 EXPENSES: Operation: Purchased power (Notes 8 and 10) 60,216 45,361 58,496 Fuel expense (Note 10) 94,888 87,855 96,710 Other 111,252 121,252 101,659 Maintenance 43,490 43,136 35,888 Depreciation (Note 1) 60,202 58,724 59,823 Taxes other than income taxes 23,945 22,129 20,562 Total expenses 393,993 378,457 373,138\nINCOME FROM OPERATIONS 149,665 161,945 124,954\nOTHER INCOME: Allowance for equity funds used during construction (Note 1) 1,680 3,060 2,400 Other - Net (Note 9) 10,480 9,924 8,733 Total other income 12,160 12,984 11,133\nINTEREST CHARGES: Interest on long-term debt 51,172 53,706 53,408 Other interest (Notes 1 and 7) 3,261 2,750 2,050 Total interest charges 54,433 56,456 55,458 Allowance for borrowed funds used during construction (Note 1) (1,781) (2,465) (2,523) Net interest charges 52,652 53,991 52,935\nINCOME BEFORE INCOME TAXES 109,173 120,938 83,152\nINCOME TAXES (Notes 1 and 2) 34,243 36,474 23,162\nNET INCOME 74,930 84,464 59,990 Dividends on preferred stock (Note 4) 7,398 6,009 5,516\nEARNINGS ON COMMON STOCK $ 67,532 $ 78,455 $ 54,474\nAVERAGE COMMON SHARES OUTSTANDING (000) 37,499 36,675 35,116\nEARNINGS PER SHARE OF COMMON STOCK (Note 3) $ 1.80 $ 2.14 $ 1.55\nThe accompanying notes are an integral part of these statements.\nIDAHO POWER COMPANY CONSOLIDATED STATEMENTS OF RETAINED EARNINGS\nYear Ended December 31,\n1994 1993 1992 (Thousands of Dollars) RETAINED EARNINGS Beginning of year $222,900 $212,404 $222,973\nNET INCOME 74,930 84,464 59,990\nTotal 297,830 296,868 282,963\nDIVIDENDS: Preferred stock (Note 4) 7,398 6,009 5,516 Common stock (per share: 1994 - 1992 - $1.86) (Note 3) 69,594 67,959 65,043\nTotal dividends 76,992 73,968 70,559\nRETAINED EARNINGS End of year $220,838 $222,900 $212,404\nThe accompanying notes are an integral part of these statements.\nIDAHO POWER COMPANY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\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., Ida-West Energy Company (Ida-West) and Stellar Dynamics. 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 (FERC) 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 FERC, the Company's weighted average monthly AFDC rates for 1994, 1993 and 1992 were 8.2 percent, 9.6 percent and 8.7 percent, 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 March 29, 1993, the Idaho Public Utilities Commission (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.\nOn January 31, 1994, the Company received an IPUC order authorizing $17.2 million in general rate relief from the IPUC representing a 4.2 percent overall increase in Idaho retail rates. The relief is based on an 11.0 percent allowed return on equity with an overall rate of return of 9.199 percent. The Company had requested $37.1 million in general rate relief representing a 9.09 percent increase in rates, a 12.50 percent return on equity, and a 9.88 percent overall rate of return. These increased rates are effective February 1, 1995.\nIn addition in May 1994, the Company filed for temporary drought rate relief with the Oregon Public Utility Commission (OPUC). The OPUC issued an accounting order that granted the Company permission to defer with interest 60 percent of Oregon's share in the Company's increased power supply costs incurred between May 13, 1994 and December 31, 1994. After the close of 1994, the Company is required to file with the OPUC for an amortization proposal for the $1.3 million deferral.\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 extension 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 2.93 percent in 1994, 2.92 percent in 1993 and 2.91 percent in 1992 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 Statement of Financial Accounting Standards (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 earned on regulated assets are deferred and amortized to income over the estimated service lives of the related properties and credits earned on non-regulated assets or investments are recognized in the year earned.\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.\nREGULATION OF UTILITY OPERATIONS - The Company follows SFAS No 71, \"Accounting for the Effects of Certain Types of Regulation\", and its financial statements reflect the effects of the different ratemaking principles followed by the various jurisdictions regulating the Company. Pursuant to SFAS 71 the Company capitalizes, as deferred regulatory assets, incurred costs which are expected to be recovered in future utility rates. The Company also records as deferred regulatory liabilities the current recovery in utility rates of costs which are expected to be paid in the future.\nThe following is a breakdown of regulatory assets and liabilities for the years 1994 and 1993 (in millions of dollars):\n1994 1993 Millions of Dollars Assets Liabilities Assets Liabilities Income Taxes $185.0 $35.1 $176.5 $35.0 Conservation 29.7 21.2 Postretirement Benefits 5.5 3.5 Postemployment Benefits 4.0 3.9 Other 28.5 0.6 6.4 4.2 Total $252.7 $35.7 $211.5 $39.2\nThe regulatory environment is becoming more complex resulting from the expanding effects of competition. In the event that recovery of cost through rates becomes unlikely or uncertain, this would force the Company away from the cost of service ratemaking and SFAS 71 would no longer apply. If the Company were to discontinue application of SFAS 71 for some or all of its operations then these items would represent stranded investments. Certain regulators are currently reviewing ways to allow the electric utilities to recover these investments in the event the customers are allowed to choose their energy supplier. However, if the Company was not allowed recovery of its stranded investments it would be required to write off the applicable portion of regulatory assets and the financial effects could be significant.\nOTHER ACCOUNTING POLICIES _ Debt discount, expense and premium are being amortized over the terms of the respective debt issues.\n2. INCOME TAXES:\nA reconciliation between the statutory federal income tax rate and the effective rate for the years 1994, 1993 and 1992 is as follows:\n1994 1993 1992 Amount Rates Amount Rates Amount Rates (Thousands of Dollars) Computed income taxes based on statutory federal income tax rate $38,210 35.0% $42,328 35.0% $28,272 34.0% Change in taxes resulting from: AFUDC (1,211) (1.1) (1,798) (1.5) (1,508) (1.8) Investment tax credits (3,351) (3.1) (2,898) (2.4) (3,446) (4.1) Repair allowance (1,575) (1.4) (2,975) (2.5) (2,278) (2.7) Elimination of amounts provided in prior years (2,607) (2.4) (4,686) (3.9) (1,601) (1.9) Current state income taxes 1,496 1.4 2,693 2.2 973 1.2 Depreciation 2,812 2.6 4,116 3.4 1,738 2.1 Other 469 0.4 (306) (0.1) 1,012 1.1\nTotal provision for federal and state income taxes $34,243 31.4% $36,474 30.2% $23,162 27.9%\nThe provision for income taxes consists of the following:\nIncome taxes currently payable: Federal $20,016 $27,199 $16,366 State 1,425 4,168 56 Total 21,441 31,367 16,422 Income taxes deferred - Net of amortization: Federal 12,196 6,621 7,688 State 1,670 69 491 Total 13,866 6,690 8,179 Investment and other tax credits: Deferred 1,643 1,315 2,007 Restored (2,707) (2,898) (3,446) Total (1,064) (1,583) (1,439) Total provision for income taxes $34,243 $36,474 $23,162\nThe provision for deferred income taxes consists of the following:\nDeferred: Excess of tax over book depreciation normalized $12,813 $14,044 $12,474 Other 11,310 6,384 6,743 Total 24,123 20,428 19,217 Restored (10,257) (13,738) (11,038) Total $13,866 $6,690 $8,179\nDuring 1993, the Company settled federal tax liabilities on all open years through the 1990 tax year; in 1994, it settled federal tax liabilities on the 1991 and 1992 tax years and settled Idaho tax liabilities on the 1987-1992 tax years except for immaterial amounts that relate to a partnership.\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, 1994, the Company has recorded regulatory assets of $185.0 million and regulatory liabilities in the amount of $35.1 million which were offset by an equal amount of accumulated deferred income tax. 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.\n3. COMMON STOCK:\nChanges in shares of the common stock of the Company for 1994, 1993 and 1992 were as follows:\nCommon Stock Premium on $2.50 Capital Shares Par Stock Value (Thousands of Dollars)\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\nBalance 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 Gain on reacquired 4% preferred stock (Note 4) - - 126 Stock purchase plans 527,296 1,318 12,055\nBalance at December 31, 1994 37,612,351 $94,031 $363,063\nDuring the period of January 1992 through May 1994, the Company issued original issue shares of common stock for its Dividend Reinvestment and Stock Purchase Plan and the Employee Savings Plan. During 1992, 1993, and 1994 common shares totaling 959,527; 898,528; and 527,296 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, 1994, the Company had 2,791,321 of its authorized but unissued shares of common stock reserved for future issuance under its Dividend Reinvestment and Stock Purchase Plan and Employee Savings 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.\nA restricted stock plan approved by shareholders at the May 1994 Annual Meeting was implemented January 1, 1995 as an equity-based long-term incentive plan.\n4. PREFERRED STOCK:\nThe number of shares of preferred stock outstanding at December 31, 1994, 1993 and 1992 were as follows:\nShares Outstanding at December 31 Call Price 1994 1993 1992 Per Share Preferred stock: Cumulative, $100 par value:\n4% preferred stock (authorized 215,000 shares) 174,556 177,506 178,735 $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) 250,000 250,000 - $103.535 to $100.354\nAuction rate preferred stock, $100,000 stated value, (authorized 500 shares)(c) 500 500 500 $100,000.0\nTotal 825,056 828,006 579,235\n(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, 1994 was 5.16% and ranged between 2.55% and 5.16% during the year.\nDuring 1994, 1993 and 1992 the Company reacquired and retired 2,950; 1,229 and 3,178 shares of 4% preferred stock resulting in a net addition to premium on capital stock of $126,066; $50,151 and $151,891, respectively. As of December 31, 1994 the overall effective cost of all outstanding preferred stock was 6.55 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. 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 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.\nThe only first mortgage bonds maturing during the five-year period ending 1999 are $20,000,000 in 1996 and $30,000,000 in 1998. Sinking fund requirements for the first mortgage bonds outstanding at December 31, 1994 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 1992, 1993 and 1994, $350,000, $400,000, 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 1999 for pollution control bonds outstanding at December 31, 1994 are $450,000 in 1995 and 1996, and $500,000 in 1997, 1998 and in 1999. As of December 31, 1993 and 1994, the overall effective cost of all outstanding first mortgage bonds and pollution control revenue bonds was 8.02 percent and 8.33 percent in 1992.\n6. 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, $762,575,000 for 1993, and $682,647,000 for 1994. The estimated fair values for long-term debt are based upon quoted market prices of the same or similar issues.\n7. NOTES PAYABLE:\nAt January 1, 1995, 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. The total lines of credit maintained with various banks will increase to $90,000,000 at March 1, 1995. Under annual borrowing arrangements with these banks, the Company is required to pay a fee of 1\/10 of 1 percent on the available and committed lines of credit. Commercial paper may be issued in an amount not to exceed 25 percent 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,\n1994 1993 1992 (Thousands of Dollars) Balance at end of year $55,000 $4,000 $6,000 Effective annual interest rate at end of year 6.1% 6.9%(a) 5.9%\n(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%.\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 $9,500,000 at December 31, 1994. The commitments are generally revocable by the Company subject to reimbursement of manufacturers' expenditures incurred and\/or other termination charges.\nThe Company is currently purchasing energy from 62 on-line cogeneration and small power production facilities with contracts ranging from 1 to 33 years. Under these contracts the Company could be required to purchase up to 692,000 (MWH) annually. During the fiscal year ended December 31, 1994, the Company purchased 543,000 (MWH) at a cost of $30.9 million.\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:\nIncentive Plan - The Company implemented two annual incentive plans and a long-term incentive plan effective January 1, 1995. The Executive Annual Incentive Plan and the Employee Incentive Plan tie a portion of each employee's compensation to achieving annual operational and financial goals. The plans share common goals designed to promote safety, control capital expenditures, control operation and maintenance expenses and increase annual earnings per share.\nRestricted Stock Plan - The 1994 Restricted Stock Plan (\"Plan\") approved by shareholders at the May 1994 Annual Meeting was implemented January 1, 1995 as an equity-based long-term incentive plan. The performance-based grant approach and administrative guidelines for the Plan were developed by the Compensation Committee of the Board of Directors (\"Committee\") during 1994. The first grant under the Plan was made to all officers during January 1995. For the first grant, the Committee has selected a three-year restricted period beginning January 1, 1995, through December 31, 1997, with a single financial performance goal of Cumulative Earnings Per Share (\"CEPS\"). To receive a final share award, each officer must be employed by the Company, as an officer, during the entire restricted period, and the Company must achieve the CEPS performance goal established by the Committee.\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 $5.5 million in 1994, $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 supplemental retirement and death benefit payments to the participant and his or her family. The plan is being financed by life insurance policies, of which the Company is the beneficiary, with premiums being paid by the Company. These policies have accumulated cash values of $47.1 million and $42.4 million at December 31, 1994 and 1993, respectively, which do not qualify as plan assets in the actuarial computation of the funded status. Based upon SFAS No. 87, the Company has recorded a liability of $4.6 million as of December 31, 1994.\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 1994 1993 1992 (Thousands of Dollars)\nPension plan: Service cost $ 6,049 $ 4,496 $ 3,762 Interest cost 12,263 11,688 10,926 Actual return on plan assets 312 (23,322) (10,877) Deferred gain (loss) on plan assets (15,584) 9,848 (1,861)\nNet cost $ 3,040 $ 2,710 $ 1,950 Approximate percentage included in operating expenses 67% 66% 64%\nNet deferred compensation plan costs charged to other income (including life insurance and SFAS No. 87 liability accrual)(a) $ 508 $ 1,372 $ 1,276\n(a) These charges to the Income Statement have been reduced by gains from the Company-Owned Life Insurance (COLI) of $2,724,000; $1,638,000; and $1,607,000 for 1994, 1993 and 1992, respectively.\nFunded status and significant assumptions as of December 31:\nDeferred Pension Plan Compensation Plan 1994 1993 1994 1993 (Thousands of Dollars)\nActuarial present value of benefit obligations: Vested benefit obligation $128,162 $134,292 $19,148 $24,024 Accumulated benefit obligation $132,766 $139,270 $19,148 $24,027\nProjected benefit obligation $167,103 $179,895 $19,681 $30,114 Plan assets at fair value 165,839 169,920 - - Plan assets in excess of (or less than) projected benefit obligation (1,264) (9,975) (19,681) (30,114)\nUnrecognized net (gain) loss from past experience different from that assumed 6,040 17,295 2,173 7,295\nUnrecognized prior service cost 6,365 1,460 (3,516) 2,546\nUnrecognized net (asset) obligation existing at date of initial adoption (19.5 year straight-line amortization) (2,756) (3,019) 6,440 7,053 Minimum liability adjustment - - (4,564) (10,807) Net asset (liability) included in the balance sheet $8,385 $5,761 $(19,148) $(24,027) Discount rate to compute projected benefit obligation 8.0% 7.0% 8.0% 7.0% Rate for future compensation increases 4.5 4.5 4.5 4.5 Expected long-term rate of return on plan assets 9.0 9.0 - -\nSupplemental Employee Retirement Plan (SERP) - The Company has a nonqualified SERP that provides benefits in excess of Internal Revenue Service limits (Section 401 (a)(17) of the Internal Revenue Code) for highly paid individuals. The projected benefits obligation of this plan was $857,000 and $525,000 at December 31, 1994 and 1993, respectively, with accrued pension costs of $396,000 and $226,000. The Company's net periodic pension cost of this plan was $125,000 and $36,000 for the same periods.\nSavings Plan _ The Company has an Employee Savings Plan whereby, for each $1 of employee contribution up to 6 percent of their salary the Company will match 100 percent of the first 2 percent employee contribution and 50 percent of the next 4 percent 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 $2,410,200 in 1994, $2,283,200 in 1993 and $2,046,100 in 1992. As of December 31, 1994, a total of 4,214,735 Idaho Power Company common shares were held in this Plan.\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 and was approved by IPUC Order No. 25880.\nThe following tables set forth the amounts to be recognized in the Company's financial statements for year-end 1994 and 1993 and the funded status of the plan in accordance with accounting standard SFAS No. 106 as of December 31, 1993 and 1994.\nDecember 31, 1994 December 31, 1993 (Thousands of Dollars) Postretirement Benefit Cost: Service cost $ 855 $ 750 Interest cost 3,334 3,610 Actual return on plan assets (1,114) (860) Amortization of transition obligation 2,040 2,040 Net amortization and deferral - - Regulatory asset (1,907) (3,548) Net cost (a) $ 3,208 $ 1,992\n(a) Postretirement benefit costs charged to expense in 1992 was $2,622,300\nDecember 31, 1994 December 31, 1993 (Thousands of Dollars) Funded Status: Accumulated postretirement benefit obligation (APBO) $(45,001) $(48,290) Plan assets at fair value 12,116 11,840 APBO in excess of plan assets (32,885) (36,450) Unrecognized gain\/losses 773 4,670 Unrecognized transition obligation 36,720 38,760 Prepaid postretirement benefit cost $ 4,608 $ 6,980\nDiscount rate 8.25% 7.25% Medical and dental inflation rate 7.25 6.75 Long-term plan assets expected 9.0 9.0 return\nA one percent change in the medical inflation rate would change the APBO by 7.3 percent and the postretirement expense for 1994 by 9.0 percent.\nThe Company has a retiree medical benefits funding program which 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 $776,400 in 1994, $632,500 in 1993, $1,733,000 in 1992. The funding to the VEBA was $743,600 in 1994, $2,692,000 in 1993, and $2,977,400 in 1992, 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 OPUC 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 FERC deferral of $545,400 was expensed in 1994. The remaining amount deferred, as a regulatory asset, at December 31, 1994 is $5.5 million. The Company received IPUC Order No. 25880 authorizing the amortization of the $5.5 million over a 10-year period.\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 has recorded a liability and a regulatory asset of $4.0 million which represents the costs associated with postemployment benefits at December 31, 1994. The Company received IPUC Order No. 25880 authorizing the amortization of the regulatory asset over a 10- year period.\n10. ELECTRIC PLANT IN SERVICE AND JOINTLY-OWNED PROJECTS:\nThe following table sets out the major classifications of the Company's electric plant in service and accumulated provision for depreciation for the years 1994, 1993, and 1992.\nElectric Plant in Service 1994 1993 1992 (Thousands of Dollars)\nProduction $1,301,525 $1,199,188 $1,194,148 Transmission 310,102 328,249 324,222 Distribution 625,149 582,604 545,490 General and Other 147,122 139,682 134,887 Total In Service 2,383,898 2,249,723 2,198,747 Less accumulated provision for depreciation 775,033 728,979 683,332\nIn Service - Net $1,608,865 $1,520,744 $1,515,415\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, 1994 are as follows:\nCompany Ownership Electric Accumulated Plant In Provision For Name of Plant Location Service Depreciation % MW (Thousands of Dollars)\nJim Bridger Units 1-4 Rock Springs, WY $376,928 $150,599 33 693 Boardman Boardman, OR 59,488 24,112 10 53 Valmy Units 1 & 2 Winnemucca, NV 299,865 98,030 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 $46,097,000 in 1994, $45,424,000 in 1993 and $42,291,000 in 1992.\nThe Company has contracts to purchase the energy from five PURPA Qualified Facilities which are 50 percent owned by Ida-West. Power purchased from these facilities amounted to $7,139,000 in 1994, $5,975,093 in 1993 and $1,848,904 in 1992.\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 consolidated financial position of Idaho Power Company and subsidiaries at December 31, 1994, 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. 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 LLP\nPortland, Oregon January 31, 1995\nIDAHO POWER COMPANY SUPPLEMENTAL FINANCIAL INFORMATION, UNAUDITED\nQUARTERLY FINANCIAL DATA:\nThe following unaudited information is presented for each quarter of 1994, 1993 and 1992 (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.\nQuarter Ended March 31 June 30 September 30 December 31 Revenues $128,810 $128,541 $151,031 $135,277 Income from operations 37,408 33,984 33,609 44,663 Income taxes 9,406 6,554 8,150 10,133 Net income 18,260 17,030 16,289 23,351 Dividends on preferred stock 1,789 1,819 1,862 1,928 Earnings on common stock 16,471 15,211 14,427 21,423 Earnings per share of common 0.44 0.41 0.38 0.57 stock\nRevenues 140,809 129,471 134,577 135,545 Income from operations 41,479 38,980 34,286 47,201 Income taxes 10,610 9,270 9,108 7,486 Net income 21,347 18,524 16,427 28,166 Dividends on preferred stock 1,345 1,318 1,565 1,781 Earnings on common stock 20,002 17,206 14,862 26,385 Earnings per share of common stock 0.55 0.47 0.40 0.71\nRevenues 114,453 124,656 129,050 129,934 Income from operations 31,024 30,376 29,593 33,962 Income taxes 7,396 6,670 4,353 4,743 Net income 13,378 12,394 15,067 19,152 Dividends on preferred stock 1,424 1,400 1,346 1,347 Earnings on common stock 11,954 10,994 13,721 17,805 Earnings per share of common stock 0.35 0.32 0.38 0.49\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 SCHEDULE 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 schedule.\n(b) Reports on SEC Form 8-K. No reports on Form 8-K were filed during the three months ended December 31, 1994.\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. *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 Number Dated 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 33-65720 4(d)(iii) Thirtieth January 1, 1991 33-65720 4(d)(iv) Thirty-first August 15, 1991 33-65720 4(d)(v) Thirty-second March 15, 1992 33-65720 4(d)(vi) Thirty-third April 16, 1993 1-3198 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.\n10(n)(i)1 The Revised Security Plans for Senior Management Employees and for Directors-a non-qualified, deferred compensation plan effective November 30, 1994.\n10(n)(ii)1 The Executive Annual Incentive Plan for senior management employees effective January 1, 1995.\n10(n)(iii)1 The 1994 Restricted Stock Plan for officers and key executives effective July 1, 1994.\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). ___________________ 1 Compensatory Plan\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. *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.\n27 Financial Data Schedule\nIDAHO POWER COMPANY SCHEDULE II - CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS\nYears Ended December 31, 1994, 1993 and 1992\nColumn C Column A Column B Additions Column D Column E\nBalance Charged Charged Balance At to (Credited) At Classification Beginning Income to Other Deductions End Of Of Period Accounts (1) Period (Thousands of Dollars)\n1994: Reserves Deducted From Applicable Assets: Reserve for uncollectible accounts $1,377 $1,360 $1,018(2) $2,378 $1,377 Other Reserves: Injuries and damages reserve $1,500 $1,804 $ - $1,804 $1,500 Miscellaneous operating reserves $ 748 $ 429 $ (156) $ 81 $ 940\n1993: Reserves Deducted From Applicable Assets: Reserve for uncollectible accounts $1,421 $1,174 $1,001(2) $2,219 $1,377 Other Reserves: Injuries and damages reserve $1,500 $2,820 $ - $2,820 $1,500 Miscellaneous operating reserves $ - $ 870 $ 332 $ 454 $ 748\n1992: Reserves Deducted From Applicable Assets: Reserve for uncollectible accounts $1,300 $1,224 $ 963(2) $2,066 $1,421 Other Reserves: Injuries and damages reserve $1,366 $2,468 $ - $2,334 $1,500\nNOTES: (1) Represents deductions from the reserves for purposes for which the reserves were created. (2) Represents collections of accounts previously written off.\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 9, 1995 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 9, 1995 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\/_ __ By:__\/s\/__Jon H. Miller ________ \" Roger L. Breezley Jon H. Miller Director Director\nBy:__\/s\/_ John B. Carley_______ By:__\/s\/__Peter S. O'Neill ______ \" John B. Carley Peter S. O'Neill Director Director\nBy:__\/s\/__Peter T. Johnson_____ By:__\/s\/__Gene C. Rose _______ \" Peter T. Johnson Gene C. Rose Director Director\nBy:__\/s\/__Jack K. Lemley_____ By:__\/s\/__Phil Soulen _______ \" Jack K. Lemley Phil Soulen Director Director\nEXHIBIT INDEX\nExhibit Page Number Number\n10(n)(i) The Revised Security Plans for Senior 93 Management Employees and for Directors- a non-qualified, deferred compensation plan effective November 30, 1994.\n10(n)(ii) The Executive Annual Incentive Plan for 126 senior management employees effective January 1, 1995.\n10(n)(iii) The 1994 Restricted Stock Plan for 128 officers and key executives effective July 1, 1994.\n12 Statement Re: Computation of Ratio of 133 Earnings to Fixed Charges.\n12(a) Statement Re: Computation of 134 Supplemental Ratio of Earnings to Fixed Charges.\n12(b) Statement Re: Computation of Ratio of 135 Earnings to Combined Fixed Charges and Preferred Dividend Requirements.\n12(c) Statement Re: Computation of 136 Supplemental Ratio of Earnings to Combined Fixed Charges and Preferred Dividend Requirements.\n21 Subsidiaries of Registrant. 137\n23 Independent Auditors' Consent. 138\n27 Financial Data Schedule 139","section_15":""}
{"filename":"37748_1994.txt","cik":"37748","year":"1994","section_1":"ITEM 1. BUSINESS.\nFluor Corporation (\"Fluor\" or the \"Company\") was incorporated in Delaware in 1978 as a successor in interest to a California corporation of the same name that was originally incorporated in 1924. Its executive offices are located at 3333 Michelson Drive, Irvine, California 92730, telephone number (714) 975-2000.\nThrough Fluor Daniel, Inc. and other domestic and foreign subsidiaries, the Company provides engineering, procurement, construction, maintenance and related technical services on a worldwide basis to an extensive range of industrial, commercial, utility, natural resources, energy and governmental clients.\nThe Company maintains investments in coal-related businesses through its ownership of A. T. Massey Coal Company, Inc. (\"Massey\"). In April of 1994, the Company sold its lead business.\nA summary of the Company's operations and activities by business segment and geographic area is set forth below.\nENGINEERING AND CONSTRUCTION\nThe Fluor Daniel group of domestic and foreign companies (\"Fluor Daniel\") provides a full range of engineering, construction and related services to clients in a broad range of markets on a worldwide basis. The types of services provided by Fluor Daniel, directly or through companies or partnerships jointly owned or affiliations with other companies, include: feasibility studies, conceptual design, engineering, procurement, project and construction management, construction, maintenance, plant operations, technical, project finance, quality assurance\/quality control, start-up assistance, site evaluation, licensing, consulting and environmental services.\nFluor Constructors International, Inc. (\"Fluor Constructors\") is organized and operated separately from Fluor Daniel. Fluor Constructors provides construction management, construction and maintenance services in the United States and Canada. Fluor Constructors is the Company's union construction arm.\nThe engineering and construction business is conducted under various types of contractual arrangements, including cost reimbursable (plus fixed or percentage fee), all-inclusive rate, unit price, fixed or maximum price and incentive fee contracts. Contracts are either competitively bid and awarded or individually negotiated. In terms of dollar amount, the majority of contracts are of the cost reimbursable type. In certain instances, the Company has guaranteed facility completion by a scheduled acceptance date and\/or achievement of certain acceptance and performance testing levels. Failure to meet any such schedule or performance requirements could result in additional costs and the amount of such additional costs could exceed project profit margins.\nThe markets served by the business are highly competitive and for the most part require substantial resources, particularly highly skilled and experienced technical personnel. There are a large number of companies competing in the markets served by the business. Competition is primarily centered on performance and the ability to provide the engineering, planning and management skills required to complete complex projects in a timely and cost efficient manner. The engineering and construction business derives its competitive strength from its diversity, reputation for quality, worldwide procurement capability, project management expertise, geographic coverage, ability to meet client requirements by performing construction on either a union or open shop basis, ability to execute projects of varying sizes, strong safety record and lengthy experience with a wide range of services and technologies.\nDesign and engineering services provided by the engineering and construction business involve the continual development of new and improved versions of existing processes, materials or techniques, some of which are patented. However, none of the existing or pending patents held or licensed by the business are considered essential to operations. Generally, the development and improvement of processes, materials and techniques are performed as part of design and engineering services in connection with the projects undertaken for various clients.\nFLUOR DANIEL\nFluor Daniel's operations have been realigned into regional, industry and specialized groups responsible for identifying and capitalizing on opportunities in their market segments. Regional groups include Asia Pacific, the Americas, and Europe, Africa and the Middle East which provide geographic expertise and capability. Industry groups include Process, Industrial, and Power and Government. Specialized groups include Diversified Services and Sales and Marketing. The Sales and Marketing Group includes strategic planning and project finance and provides sales and marketing support and assistance to all of the other groups. The industry and Diversified Services groups are described in further detail below.\nIndividual operating companies within the groups focus on specific clients, industries and markets. The operating companies rely on a network of operations centers and regional offices to provide resources and expertise in support of project execution worldwide.\nWhile the United States will remain an important market for Fluor Daniel's services, increasingly the largest share of opportunities are located outside the United States. Demand for higher living standards is driving strong economic growth in developing economies, particularly in the Asia Pacific and Latin American regions. Expansion of basic industries is increasing fundamental energy requirements and infrastructure needs. Globalization of markets and geopolitical change is also stimulating strategic investments in new production facilities in these emerging markets.\nIn fiscal 1994, the Process, Power and Government, and Diversified Services groups experienced declines in new awards and Industrial Group awards increased. There continue to be a number of megaproject opportunities, particularly outside the United States. The large scale and uncertain timing of these projects can create variability in the Company's new award and backlog pattern.\nThe operations of Fluor Daniel are detailed below by industry group:\nProcess\nServices provided by the Process Group include services provided through the following operating companies: Petroleum and Petrochemicals; Production and Pipelines; and Chemicals, Plastics and Fibers. The Delta business unit, which provided services worldwide to E. I. du Pont de Nemours and Company under an alliance agreement, has been merged into the Chemicals, Plastics and Fibers operating company.\nDuring fiscal 1994, Process Group awards included: engineering, procurement and construction for a grass roots polymer plant in North Carolina; engineering, procurement and construction assistance for a fluid catalytic cracking unit in Korea; engineering, procurement and construction management for a cogeneration project in Kansas, a gas oil hydrotreater in California, a grass roots methanol plant in Norway, gas injection and underground gas storage in the Netherlands, a herbicide facility in Louisiana and capacity expansion at a refinery in Mexico; engineering and procurement for revamp of a reformer unit in Texas and a sour gas plant and sweetening and sulphur recovery facilities, both in Canada; procurement and construction management for a grass roots petrochemical complex in Kuwait; engineering for an organic acid plant expansion in Texas, a refinery upgrade and expansion in Kansas, a liquid petroleum gas plant expansion in Saudi Arabia and oil terminals in Lithuania; construction of an ethoxylation plant in Texas; and inspection services for a gas pipeline and facilities in Florida.\nOngoing projects include: engineering, procurement and construction for a hydrochlorofluorocarbon plant in Kentucky, a grass roots polyethylene facility in Mexico, an aspartame facility expansion in the Netherlands and an ethylene debottlenecking project for a refinery in Texas; engineering, procurement and construction assistance for a reformulated gasoline project in California; engineering, procurement and construction management for a fibers line plant in Luxembourg, a fluid catalytic cracking unit (\"FCCU\") revamp in Illinois, a grass roots refinery in Thailand, a pipeline from Argentina to Chile, a delayed coker in Venezuela, a reformulated gasoline and a clean fuels program, both in California, and a plastics stretch project in Indiana; engineering and procurement for a chlor-alkali\/ethylene expansion of a petrochemical plant in Saudi Arabia, a reformulated fuels project at a refinery in California, an inter-refinery pipeline in Pennsylvania and oil production facilities in Gabon; engineering and construction management for a grass roots nylon facility in\nSpain and a grass roots polymer facility in Singapore; engineering for an aromatics project for a refinery in Pennsylvania, pipeline and pump stations in Alaska, a debottlenecking project in Indonesia and for early production system equipment, oil field production facilities, pipeline development and oil field expansion, all in Columbia; and construction of a chemical plant in Louisiana and a spherilene and ethylene purification facility in Texas.\nProjects completed in fiscal 1994 included: engineering, procurement and construction for fire rehabilitation of a refinery in Mississippi, a bi-component fibers facility and expansion of a fibers facility, both in North Carolina, a turbine generator in South Carolina, modifications to a refinery in California, a plastics stretch project in Alabama and a filter tow facility expansion in the United Kingdom; engineering, procurement, and construction management for a refinery upgrade project in the Netherlands, a hydrotreater upgrade in Canada, a field gathering and oil production system in Gabon, a refinery revamp in Belgium, a refinery expansion in the Philippines, an expansion of crude oil production facilities in Saudi Arabia and a methyl-tertiary butyl ether (\"MTBE\") chemical complex in Saudi Arabia; engineering and procurement for a liquid petroleum gas plant upgrade in the United Arab Emirates, a fibers expansion plant in the Netherlands, an effluent quality upgrade for a refinery in the United Kingdom, a hydrocracker revamp in California, an ethoxylation project in Texas and an ethylene glycol plant in Canada; engineering and construction management for a bulk fibers facility expansion in Canada; engineering for pipeline inspection and right of way services in New York, a natural gas liquids recovery facility in Nigeria, fire rehabilitation of a gas plant in the United Arab Emirates and a tertiary-amyl methyl ether (\"TAME\") unit in Texas; construction in Louisiana of gas reinjection modules for erection in Alaska, a grass roots film facility in Ohio and a chemical fibers plant in North Carolina; and construction management for a polyester fiber facility in South Carolina.\nIndustrial\nServices provided by the Industrial Group include a broad range of services provided through the following operating companies: Mining and Metals; Automotive and General Manufacturing; Pharmaceuticals and Biotechnology; Food and Beverage; Commercial and Institutional Facilities; Electronics; Infrastructure; Telecommunications; and Jaakko Poyry\/Fluor Daniel which serves the pulp and paper industry. An additional operating company is dedicated to serving Fluor Daniel's alliance with Procter & Gamble.\nDuring fiscal 1994, Industrial sector domestic and international contract awards included: engineering, procurement and construction for a food processing plant in Utah and a gold mine in Chile; engineering, procurement and construction management for apparel distribution centers at various locations throughout the United States, a fine chemicals manufacturing plant in Arkansas, a grass roots silicon wafer manufacturing plant in Taiwan, de-inking and paper recycle facilities in the United Kingdom and a copper concentrator expansion and pipeline project in Chile; engineering and construction management for an engine facility in New Jersey; engineering for a synthetic growth hormone facility in Puerto Rico and a vaccine manufacturing plant in North Carolina; construction for a paper mill environmental upgrade in Florida and a personal care product plant in Puerto Rico; construction management for an automotive assembly plant in Alabama, prison projects in Texas and California, a computer disk manufacturing plant in Malaysia and a multi-product personal care facility in the Philippines; project management for a courts\/detention facility in Texas; and general construction for an engine plant expansion in Ohio.\nOngoing projects include: engineering, procurement and construction for a blast furnace coal injection facility in Indiana, personal care and laundry detergent manufacturing facilities in Ohio and an emergency 911 response system for the City of Chicago, Illinois; engineering, procurement and construction management for a grass roots paint shop in Kentucky, a dextrose expansion project in Illinois, a copper mine expansion in Indonesia, a copper smelter modernization in Utah, a copper concentrator expansion in Chile, a sodium cromoglycate facility in the United Kingdom and a paper products plant in Korea; engineering and construction management for a tobacco facility in the Netherlands; engineering and construction for a corn processing plant in Illinois and several consumer products plants in Ohio; condition assessment for facilities at 12 military installations at various locations throughout the United States; construction for an automotive assembly plant in South Carolina and a pulp mill modernization in Ohio; construction management for the renovation of a turbine facility in South Carolina, a correctional facility expansion in California, a county jail\nexpansion in Texas, a tobacco processing plant expansion in North Carolina, a pilot plant for pharmaceutical manufacturing in New Jersey and a grass roots chemical plant in Puerto Rico; maintenance services for automotive facilities in Hungary, Tennessee and Germany; and project management for a convention center in North Carolina, rail stations for the Federal Transportation Administration in New York City, rail transit for the Los Angeles County Metropolitan Transportation Authority and highway construction in Orange County, California.\nProjects completed in fiscal 1994 included: engineering, procurement and construction for food processing plants in Florida, Georgia, South Carolina, Texas and Wisconsin; engineering, procurement and construction management for a building and garage upgrade in Germany, a solvent extraction electrowinning copper processing facility in Chile, a pharmaceutical plant in Canada, a growth factor fermentation plant in California and regional headquarters building in Venezuela; engineering, procurement and validation for a synthetic hemoglobin manufacturing facility in Colorado; engineering and procurement for a copper electrorefinery in Arizona; engineering and construction management for an automotive manufacturing plant expansion in Ohio and a tobacco facility in Turkey; design and construction management for six embassies in Eastern Europe for the United States Department of State; engineering for a nickel reverts handling project in Canada and a process and enzyme system in Missouri; construction for a newsprint mill in Tennessee and a grass roots wastewater facility in Puerto Rico; and construction management for a weave room addition in South Carolina, a dairy plant in Germany, airport expansions in Georgia and Japan, a newsprint recycling plant in Australia and a biotechnology clinical manufacturing plant in Colorado.\nPower and Government\nThe Power and Government Group provides services through the Power Generation, Duke\/Fluor Daniel and Power Services operating companies which serve public utilities and private power companies. The Government Services and FERMCO operating companies serve the United States government.\nDuring fiscal year 1994, Power and Government Group contract awards included: engineering, procurement, construction management and start-up assistance for coal switching modifications to a coal-fired facility in Indiana; engineering, procurement and construction management for a fuel cell pilot plant in California; engineering services for the United States Department of Energy (\"DOE\") National Engineering Laboratories in Idaho; engineering and procurement for a waste-to-energy facility in New York; and maintenance for a 3x1270 megawatt nuclear plant in Arizona.\nOngoing projects include: environmental remediation management for the DOE former uranium processing plant in Ohio (the \"Fernald Project\"); engineering, design and procurement for a 385 megawatt pulverized coal plant in South Carolina; engineering and construction for emission monitoring equipment for various power generating sites of utilities in Arkansas, Louisiana, Mississippi and Texas; engineering and construction management for various radar and weather stations located throughout the United States for the National Oceanic and Atmospheric Administration; engineering for a laboratory facility upgrade in Illinois, a nuclear utility in Illinois, a DOE waste vitrification plant in Washington, the DOE nuclear waste repository program and the reconfiguration of the DOE nuclear weapons program; operation and maintenance for a 130 megawatt cogeneration facility in Virginia; management and operation services for the Naval Petroleum and Oil Shale Reserves program for the DOE in Colorado, Utah and Wyoming; maintenance for fossil and gas generation plants in Texas, Georgia, Louisiana, Arkansas, Mississippi, Australia, Florida and Tennessee; maintenance for nuclear plants in South Carolina, Kansas, Virginia and Texas; and maintenance and outage support at various plant sites for a southeastern power generator in Tennessee and Kentucky.\nProjects completed in fiscal 1994 included: engineering and construction management for the DOE Strategic Petroleum Reserve in Louisiana; and engineering and procurement for a 600 megawatt fossil plant repowering in New Jersey.\nDiversified Services\nThe Diversified Services Group was created in fiscal 1994 to expand existing businesses, to support Fluor Daniel's operating companies and to expand the core competencies of Fluor Daniel beyond the limits of the traditional engineering and construction project cycle into new areas of business.\nExisting businesses in the group include the following operating companies: Facility and Plant Services; TRS International, which provides temporary personnel; American Equipment Company, which sells and leases construction tools and equipment to Fluor Daniel, Fluor Constructors and the construction\/maintenance industry; and Environmental Services. Operating companies and functional areas dedicated primarily to support other Fluor Daniel operating companies include Construction, Project Execution Services, Project of the Future and Continuous Performance Improvement. Operating companies focused on expanding core competencies include Consulting, which will focus on providing solutions to client needs that do not typically fall under traditional engineering and construction services; Technology, which will evaluate investment opportunities in technology; and Acquion, which is dedicated to procurement services.\nDuring fiscal 1994, Diversified Services Group contract awards included: design and installation of a computerized maintenance system for a petroleum company in Indonesia; and training services for pre-start up of an automotive assembly plant in Alabama.\nOngoing projects include: engineering, procurement, construction management and program management for an environmental remediation program for a toxic waste site in Indiana; environmental investigation, feasibility studies and remediation for the United States Army Environmental Center, the United States Army Corps of Engineers and the United States Environmental Protection Agency; environmental investigation, remediation design and implementation services for a chemical waste site in Ohio; environmental investigation and remediation plan services for a toxic waste site in New York; and maintenance for a tire manufacturing facility in Tennessee, a petrochemical plant in Texas, computer manufacturing plants in Florida, Texas and North Carolina and a refinery in Mississippi.\nFLUOR CONSTRUCTORS\nFluor Constructors is organized and operated separately from Fluor Daniel. Fluor Constructors provides unionized construction management, construction and maintenance services in the United States and Canada, both independently and as a subcontractor to Fluor Daniel, and global support to all Fluor Daniel industry and regional groups.\nDuring fiscal 1994, Fluor Constructors awards included: construction and construction management for a hydrocracker revamp for a refinery in Delaware and a waste-to-energy facility in New York; and construction management for a coker shutdown and sulfur dioxide unit, both in Canada.\nOngoing projects include: construction and construction management for an ethylene glycol plant expansion in Canada and a reformulated gasoline project at a refinery in California; construction management for an aromatics project for a refinery and an inter-refinery pipeline, both in Pennsylvania, a blast furnace coal injection facility in Indiana, a potable water supply system in Nevada and an Emergency 911 response system for the City of Chicago, Illinois; maintenance and outage support at various plant sites for a southeastern power generator in Tennessee and Kentucky; and maintenance for nuclear power plants in Missouri and Alabama and fossil power plants in Louisiana, Mississippi and Arkansas.\nProjects completed in fiscal 1994 included: construction management for a copper smelter in Canada; and maintenance for a nuclear power plant in Florida.\nBACKLOG\nDuring fiscal 1994, as part of its ongoing reengineering effort, Fluor Daniel realigned its operating companies into four major industry groups: Process, Industrial, Power and Government, and Diversified\nServices. Backlog balances at October 31, 1993, have been reclassified to conform with the current operating company alignment.\nThe following table sets forth the consolidated backlog of Fluor's engineering and construction segment at October 31, 1994 and 1993 by business group:\nThe following table sets forth the consolidated backlog of Fluor's engineering and construction segment at October 31, 1994 and 1993 by region:\n====\nThe dollar amount of the backlog is not necessarily indicative of the future earnings of Fluor related to the performance of such work. Although backlog represents only business which is considered to be firm, there can be no assurance that cancellations or scope adjustments will not occur. Due to additional factors outside of Fluor's control, such as changes in project schedules, Fluor cannot predict with certainty the portion of its October 31, 1994, backlog to be performed subsequent to fiscal 1995.\nAt October 31, 1994, three significant projects contributed approximately $3.3 billion of backlog to the Process Group. Two of these projects are with companies affiliated with Royal Dutch Shell (the Rayong Refinery project in Thailand and the Pernis Refinery in the Netherlands) and the third project is with a company affiliated with Union Carbide (the Kuwait Petrochemical Refinery). Approximately $1.6 billion of the Power and Government backlog at October 31, 1994, is attributable to the DOE Fernald Project and subject to government funding determined on an annual basis.\nCOAL INVESTMENT\nA. T. Massey Coal Company, Inc., which is headquartered in Richmond, Virginia, and its subsidiaries conduct Massey's coal-related businesses and are collectively referred to herein as the \"Massey Companies.\"\nThe Massey Companies produce, process and sell bituminous, low sulfur coal of steam and metallurgical grades from 16 mining complexes (14 of which include preparation plants) located in West Virginia, Kentucky and Tennessee. At October 31, 1994, two of the mining complexes were still in development and not yet producing coal. A third mining complex is idle pending negotiation of a labor agreement.\nOperations at certain of the facilities are conducted in part through the use of independent contract miners. The Massey Companies also purchase and resell coal produced by unrelated companies. Steam coal is used primarily by utilities as fuel for power plants. Metallurgical coal is used primarily to make coke for use in the manufacture of steel.\nFor each of the three years in the period ended October 31, 1994, the Massey Companies' production (expressed in thousands of short tons) of steam coal and metallurgical coal, respectively, was 17,120 and 7,333 for fiscal 1994, 16,048 and 5,163 for fiscal 1993, and 13,832 and 3,867 for fiscal 1992. Sales (expressed in thousands of short tons) of coal produced by the Massey Companies and others, respectively, were 23,835 and 1,284 for fiscal 1994, 21,192 and 2,302 for fiscal 1993, and 17,538 and 4,402 for fiscal 1992.\nA large portion of the steam coal produced by the Massey Companies is sold to domestic utilities under long-term contracts. Metallurgical coal is sold to both foreign and domestic steel producers. Approximately 53% of the Massey Companies' fiscal 1994 coal production was sold under long-term contracts, 71% of which was steam coal and 29% of which was metallurgical coal. Approximately 8% of the coal tonnage sold by the Massey Companies in fiscal 1994 was sold on the export market.\nMassey is among the five largest marketers of coal in the United States. The coal market is a mature market with many strong competitors. Competition is primarily dependent upon coal price, transportation cost, producer reliability and characteristics of coal available for sale. The management of Massey considers Massey to be generally well-positioned with respect to these factors in comparison to its principal competitors.\nOn October 15, 1994, the Massey Companies acquired certain assets in Boone and Raleigh Counties, West Virginia, from Peabody Coal Company, including two preparation plants, related mining facilities and an estimated 146 million tons of both metallurgical and low sulfur steam coal reserves. The Massey Companies also acquired four metallurgical coal supply agreements serviced from the property, including a long-term supply agreement with a major steel producer.\nRecently passed acid rain legislation is generally anticipated to benefit prices for low sulfur coal. Massey intends to continue to evaluate and pursue, in appropriate circumstances, the acquisition of additional low sulfur coal reserves.\nThe Coal Industry Retiree Health Benefits Act of 1992 (the \"Act\") provides that certain retired coal miners who were members of the United Mine Workers of America, along with their spouses, are guaranteed health care benefits. The Massey Companies' obligation under the Act is currently estimated to aggregate $52 million which will be recognized as expense as payments are assessed. The amount expensed during fiscal 1994 approximated $4 million.\nThe management of the Massey Companies estimates that, as of October 31, 1994, the Massey Companies had total recoverable reserves (expressed in thousands of short tons) of 1,411,265; 569,374 of which are assigned recoverable reserves and 841,891 of which are unassigned recoverable reserves; and 1,053,154 of which are proven recoverable reserves and 358,111 of which are probable recoverable reserves.\nThe management of the Massey Companies estimates that approximately 35% of the total reserves listed above consist of reserves that would be considered primarily metallurgical grade coal. They also estimate that approximately 67% of all reserves contain less than 1% sulfur. A portion of the steam coal reserves could be beneficiated to metallurgical grade by coal preparation plants, and substantially all of the metallurgical coal reserves could be sold as high quality steam coal, if market conditions warrant.\n\"Reserves\" means that part of a coal deposit which could be economically and legally extracted or produced at the time of the reserve determination. \"Recoverable reserves\" means coal which is recoverable by the use of existing equipment and methods under federal and state laws now in effect. \"Assigned recoverable reserves\" means reserves which can reasonably be expected to be mined from existing or planned mines and processed in existing or planned plants. \"Unassigned recoverable reserves\" means reserves for which there are no specific plans for mining and which will require for their recovery substantial capital expenditures for mining and processing facilities. \"Proven recoverable reserves\" refers to deposits of coal which are substantiated by adequate information, including that derived from exploration, current and previous mining operations, outcrop data and knowledge of mining conditions. \"Probable recoverable reserves\" refers to deposits of coal which are based on information of a more preliminary or limited extent or character, but which are considered likely.\nSALE OF LEAD BUSINESS\nIn November 1992, the Company announced its decision to exit its lead business, conducted primarily through The Doe Run Company (\"Doe Run\"). As a result, the Company's lead segment was classified as a discontinued operation in the Company's consolidated financial statements. In April 1994, the lead business was sold to an affiliate of a private investment company for consideration consisting of both cash and deferred payments. Proceeds included $52 million cash on the date of the closing and deferred amounts to be paid in installments over periods ranging from five to eight years.\nOTHER MATTERS\nENVIRONMENTAL, SAFETY AND HEALTH MATTERS\nThe Massey Companies, the Company's coal investment and only remaining natural resource operation, are affected by and comply with federal, state and local laws and regulations relating to environmental protection and plant and mine safety and health, including but not limited to the federal Surface Mining Control and Reclamation Act of 1977; Occupational Safety and Health Act; Mine Safety and Health Act of 1977; Water Pollution Control Act, as amended by the Clean Water Act of 1977; Black Lung Benefits Revenue Act of 1977; and Black Lung Benefits Reform Act of 1977. It is impossible to predict the full impact of future legislative or regulatory developments on such operations, because the standards to be met, as well as the technology and length of time available to meet those standards, continue to develop and change.\nIn fiscal 1994, Fluor expended approximately $5.3 million to comply with environmental, health and safety laws and regulations in connection with its coal investment, none of which were capital expenditures. Fluor anticipates making $12.2 million and $8.3 million in such non-capital expenditures in fiscal 1995 and 1996, respectively. Of these expenditures, $2.6 million, $9.2 million and $5.6 million for fiscal 1994, 1995 and 1996, respectively, are (in the case of fiscal 1994) or are anticipated to be (in the case of fiscal 1995 and 1996) for surface reclamation. Existing reserves are believed to be adequate to cover actual and anticipated surface reclamation expenditures. Other expenditures will be expensed as incurred.\nOther\nIn 1986, the California North Coast Regional Water Quality Control Board for the State of California requested that the Company perform a site investigation of a property in Northern California designated as a hazardous waste site under the California Hazardous Waste Control Act. The Company formerly owned the property. The California Environmental Protection Agency has assumed lead agency status for any required remedial action at the site. The Company signed a Consent Order to perform a remedial investigation\/feasibility study that will determine the extent of contamination for purposes of determining the remedial action required to remedy and\/or remove the contamination.\nThe sale by Fluor of its lead business included St. Joe Minerals Corporation (\"St. Joe\") and its environmental liabilities for several different lead mining, smelting and other lead related environmental sites. As a condition of the St. Joe sale, however, Fluor retained responsibility for certain non-lead related environmental liabilities arising out of St. Joe's former zinc mining and smelting division, but only to the extent that such liabilities are not covered by St. Joe's comprehensive general liability insurance. These liabilities arise out of three zinc facilities located in Bartlesville, Oklahoma; Monaca, Pennsylvania; and Balmat, New York (the \"Zinc Facilities\").\nIn 1987, St. Joe sold its zinc mining and smelting division to Zinc Corporation of America (\"ZCA\"). As part of the sale agreement, St. Joe and Fluor agreed to indemnify ZCA for certain environmental liabilities arising from operations conducted at the Zinc Facilities prior to the sale. During fiscal year 1993, ZCA made claims under this indemnity as well as under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") against St. Joe for past and future environmental expenditures at the Zinc Facilities. In fiscal year 1994, ZCA filed suit against St. Joe and Fluor, among others, seeking compensation for environmental expenditures at the Zinc Facilities. In fiscal year 1994, Fluor and St. Joe, among others, executed a settlement agreement with ZCA which, among other things, cancels the indemnity previously\nprovided to ZCA and limits environmental expenditures at the Zinc Facilities for which St. Joe would be responsible to no more than approximately $10 million. Expenses incurred and payments made under the settlement agreement would be made over the span of at least five years, if not longer.\nFluor and St. Joe, among others, are currently prosecuting cost recovery actions under CERCLA against other potentially responsible parties for the Bartlesville facility. In addition, St. Joe has initiated legal proceedings against certain of its insurance carriers alleging that the investigative and remediation costs, for which St. Joe is or may be responsible, including costs incurred prior to the sale of St. Joe and costs related to the Zinc Facilities, are covered by insurance. A portion of any recoveries received from the insurance carriers would be, pursuant to the St. Joe sale agreement, for the benefit of Fluor. In January 1995, St. Joe executed a settlement agreement with one of its primary insurance carriers that provided coverage for a minor portion of the applicable coverage periods. St. Joe continues to pursue its other primary insurance carrier for additional payments. In as much as the insurance, as well as the cost recovery, proceedings remain in the early stages of litigation, no credit or offset (other than for amounts actually received in settlement), has been taken into account by Fluor in establishing its reserves for future environmental costs.\nThe Company believes, based upon present information available to it, that its reserves with respect to future environmental costs are adequate, and that such future costs will not have a material effect on the Company's consolidated financial condition, results of operations or liquidity. However, the imposition of more stringent requirements under environmental laws or regulations, new developments or changes regarding site cleanup costs or the allocation of such costs among potentially responsible parties, or a determination that the Company is potentially responsible for the release of hazardous substances at sites other than those currently identified, could result in additional expenditures, or the provision of additional reserves in expectation of such expenditures.\nNUMBER OF EMPLOYEES\nThe following table sets forth the number of salaried and craft\/hourly employees of Fluor and its subsidiaries engaged in Fluor's business segments as of October 31, 1994:\nOPERATIONS BY BUSINESS SEGMENT AND GEOGRAPHIC AREA\nThe financial information for business segments and geographic areas is included in the Operations by Business Segment and Geographic Area section of the Notes to Consolidated Financial Statements in Fluor's 1994 Annual Report to stockholders, which section is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nMajor Facilities\nOperations of Fluor and its subsidiaries are conducted in both owned and leased properties. In addition, certain owned or leased properties of Fluor and its subsidiaries are leased or subleased to third party tenants. The following table describes the general character of the major existing facilities, exclusive of mines, coal preparation plants and their adjoining offices:\nCoal Properties\nSee Item 1, Business, of this report for additional information regarding the coal operations and properties of Fluor.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nFluor and its subsidiaries, incident to their business activities, are parties to a number of legal proceedings in various stages of development, including but not limited to those described below. The majority of these proceedings, other than environmental proceedings, involve matters as to which liability, if any, of Fluor or its subsidiaries would be adequately covered by insurance. With respect to litigation outside the scope of applicable insurance coverage and to the extent insured claims may exceed liability limits, it is the opinion of the management of Fluor, based on reports of counsel, that these matters individually and in the aggregate will not have a material adverse effect upon the consolidated financial position or results of operations of Fluor.\nIn July 1987, four lawsuits were filed against R. T. Vanderbilt Company, Inc., Gouverneur Talc Company, Inc., St. Joe and Fluor for personal injury and wrongful death allegedly due to asbestos, talc and silicon exposure in certain New York mines. Subsequent to July 1987, 16 additional lawsuits have been filed. All of these suits (representing a total of 213 plaintiffs) have been filed with the New York Supreme Court, St. Lawrence County, New York. The total damages claimed in these cases, referred to as Bailey, Baker, Beane, et al. v. R. T. Vanderbilt Company, Inc., et al. (the claims have not been consolidated), are $287 million against all defendants. Plaintiffs also seek an unspecified amount of punitive damages against all defendants.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT(1)\nLESLIE G. MCCRAW, age 60\nDirector since 1984; Chairman of Executive Committee and member of Governance Committee. Chairman of the Board since 1991; Chief Executive Officer since 1990; formerly Vice Chairman of the Board from 1990; formerly President from 1988; joined the Company in 1975.\nDENNIS W. BENNER, age 53\nVice President and Chief Information Officer since November, 1994; formerly Vice President and General Manager, Information, and Vice President and General Manager, Target Marketing Services, for TRW from 1992 and 1986, respectively.\nCHARLES J. BRADLEY, Jr., age 59\nVice President, Human Resources and Administration since 1986; joined the Company in 1958.\nJ. MICHAL CONAWAY, age 46\nVice President and Chief Financial Officer since May, 1994; formerly Vice President, Finance, from 1993; formerly Vice President and Chief Financial Officer of National Gypsum Company and its parent, Aancor Holdings, Inc., from 1988.\nJAMES O. ROLLANS, age 52\nChief Administrative Officer since May, 1994; Senior Vice President since 1992; formerly Chief Financial Officer from 1992; formerly Vice President, Corporate Communications, from 1982; joined the Company in 1982.\nP. JOSEPH TRIMBLE, age 64\nCorporate Secretary since 1992; Senior Vice President, Law, since 1984; joined the Company in 1972.\nEXECUTIVE OPERATING OFFICERS(1)\nHUGH K. COBLE, age 60\nDirector since 1984. Vice Chairman since April, 1994; formerly Group President of Fluor Daniel, Inc.(2) from 1986; joined the Company in 1966.\nDENNIS G. BERNHART, age 49\nGroup President, The Americas, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Latin America, Middle East and Africa, of that company from 1993; formerly Vice President, Sales, of that company from 1982; joined the Company in 1968.\nDON L. BLANKENSHIP, age 44\nChairman of the Board and Chief Executive Officer of A. T. Massey Coal Company, Inc.(3) since 1992; formerly President and Chief Operating Officer of that company from 1990; formerly President of Massey Coal Services, Inc.(4) from 1989; joined Rawl Sales & Processing Co.(5) in 1982.\nRICHARD D. CARANO, age 55\nGroup President, Asia\/Pacific, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Asia\/Pacific, of that company from 1993; formerly Vice President, Sales, of that company from 1987; joined the Company in 1970.\nE. DAVID COLE, JR., age 57\nGroup President, Process, of Fluor Daniel, Inc.(2) since May, 1994; formerly Vice President, Petroleum and Petrochemicals, of that company from 1987; joined the Company in 1965.\nCHARLES R. COX, age 52\nGroup President, Industrial, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Operations Centers, of that company from 1989; joined the Company in 1969.\nRICHARD A. FLINTON, age 64\nChairman of the Board of Fluor Constructors International, Inc.(6) since 1989; joined the Company in 1960.\nTHOMAS P. MERRICK, age 57\nVice President, Strategic Planning, of Fluor Daniel, Inc.(2) since May, 1994; formerly Vice President, Technology, of that company from 1993; formerly Vice President, Government Sales, of that company from 1989; joined the Company in 1984.\nCHARLES R. OLIVER, JR., age 51\nGroup President, Sales and Marketing, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Business Units, of that company from 1993; formerly President, Hydrocarbon Sector, of that company from 1986; joined the Company in 1970.\nCAREL J.C. SMEETS, age 55\nGroup President, Europe, Africa and Middle East, of Fluor Daniel, Inc.(2) since May, 1994; formerly Vice President, European Operations, of that company from 1991; formerly Vice President and Managing Director, the Netherlands, of that company from 1985; joined the Company in 1969.\nJAMES C. STEIN, age 51\nGroup President, Diversified Services, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Business Units, of that company from 1993; formerly President, Industrial Sector, of that company from 1986; joined the Company in 1964.\nRICHARD M. TEATER, age 46\nGroup President, Power and Government, of Fluor Daniel, Inc.(2) since May, 1994; formerly President, Power, of that company from 1993; formerly Vice President, Power Marketing, of that company from 1990; formerly Vice President, Industrial Marketing, of that company from 1988; joined the Company in 1980. - ---------------\n(1) Except where otherwise indicated, all references are to positions held with Fluor.\n(2) Fluor Daniel, Inc. is a wholly owned subsidiary of Fluor which provides design, engineering, procurement, construction management and technical services to a wide range of industrial, commercial, utility, natural resources, energy and governmental clients.\n(3) A. T. Massey Coal Company, Inc. is an indirectly wholly-owned subsidiary of Fluor which, along with its subsidiaries, conducts Fluor's coal-related investment.\n(4) Massey Coal Services, Inc. is a wholly owned subsidiary of A. T. Massey Coal Company, Inc.\n(5) Rawl Sales & Processing Co. is a wholly owned subsidiary of A. T. Massey Coal Company, Inc.\n(6) Fluor Constructors International, Inc., a wholly owned subsidiary of Fluor, provides construction and maintenance services to a variety of clients.\nPART II\nInformation for Items 5, 6 and 7 is contained in Fluor's 1994 Annual Report to stockholders, which information is incorporated herein by reference (and except for these sections, and sections incorporated herein by reference in Items 1 and 8 of this report, Fluor's 1994 Annual Report to stockholders is not to be deemed filed as part of this report):\nInformation for Item 8","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","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 concerning Fluor's executive officers is included under the caption \"Executive Officers of the Registrant\" following Part I, Item 4. Other information required by this item is included in the Biographical section of the Election of Directors portion of the definitive proxy statement pursuant to Regulation 14A, involving the election of directors, which is incorporated herein by reference and will be filed with the Securities and Exchange Commission (the \"Commission\") not later than 120 days after the close of Fluor's fiscal year ended October 31, 1994.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nFluor maintains certain employee benefit plans and programs in which its executive officers and directors are participants. Copies of these plans and programs are set forth or incorporated by reference as Exhibits 10.1 through 10.19 inclusive to this report. Certain of these plans and programs provide for payment of benefits or for acceleration of vesting of benefits upon the occurrence of a change of control of Fluor as that term is defined in such plans and programs. The amounts payable thereunder would represent an increased cost to be paid by Fluor (and indirectly by its stockholders) in the event of a change in control of Fluor. This increased cost would be a factor to be taken into account by a prospective purchaser in determining whether, and at what price, it would seek control of the Company and whether it would seek the removal of then existing management.\nIf a change of control were to have occurred on October 31, 1994, the additional amounts payable by Fluor, either in cash or in stock, if each of the five most highly compensated executive officers and all executive officers as a group were thereupon involuntarily terminated without cause would be as follows:\n- ---------------\n(1) Value at October 31, 1994 of previously awarded restricted stock which would vest upon change of control.\n(2) Lump sum entitlement of previously awarded benefits which would vest upon change of control.\n(3) The column formerly reporting cash payments under the Fluor Corporation Change of Control Compensation Plan (\"Plan\") has been deleted because the Company's Board of Directors elected not to renew the agreements under the Plan which expired in fiscal 1994.\nFurther disclosure required by this item is included in the Organization and Compensation Committee Report on Executive Compensation and Executive Compensation and Other Information sections of the definitive proxy statement pursuant to Regulation 14A, involving the election of directors, which is incorporated herein by reference and will be filed not later than 120 days after the close of Fluor's fiscal year ended October 31, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation required by this item is included in the Stock Ownership section of the Election of Directors portion of the definitive proxy statement pursuant to Regulation 14A, involving the election of directors, which is incorporated herein by reference and will be filed not later than 120 days after the close of Fluor's fiscal year ended October 31, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation required by this item is included in the Other Matters section of the Election of Directors portion of the definitive proxy statement pursuant to Regulation 14A, involving the election of directors, which is incorporated herein by reference and will be filed not later than 120 days after the close of Fluor's fiscal year ended October 31, 1994.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. Financial Statements: The financial statements required to be filed hereunder are listed on page 20 hereof. See Part II, Item 8 of this report for information regarding the incorporation by reference herein of such financial statements.\n2. Financial Statement Schedules: All 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 and notes thereto.\n3. Exhibits:\n(b) Reports on Form 8-K:\nNone were 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 Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nFLUOR CORPORATION\nJanuary 27, 1995 By J.M. CONAWAY --------------------------------- J. M. Conaway, Vice President and Chief Financial Officer 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 dates indicated.\nManually signed Powers of Attorney authorizing L. N. Fisher, A. M. Oldham and P. J. Trimble and each of them, to sign the annual report on Form 10-K for the fiscal year ended October 31, 1994 and any amendments thereto as attorneys-in-fact for certain directors and officers of the registrant are included herein as Exhibits 24.1 and 24.2.\nFLUOR CORPORATION\nAND FINANCIAL STATEMENT SCHEDULES\nITEM 14(A)\n1. FINANCIAL STATEMENTS\nThe following financial statements are contained in Fluor's 1994 Annual Report to stockholders:\nConsolidated Balance Sheet at October 31, 1994 and 1993\nConsolidated Statement of Earnings for the years ended October 31, 1994, 1993 and 1992\nConsolidated Statement of Cash Flows for the years ended October 31, 1994, 1993 and 1992\nConsolidated Statement of Shareholders' Equity for the years ended October 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n2. FINANCIAL STATEMENT SCHEDULES\nAll 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 and notes thereto.\nEXHIBIT INDEX","section_15":""}
{"filename":"85149_1994.txt","cik":"85149","year":"1994","section_1":"ITEM 1: BUSINESS (a) General Development of Business\nRose's* was organized in 1915 as a family partnership consisting of Paul H. Rose and his wife, Emma M. Rose, who together opened a \"5-10-25(cent sign)\" store in Henderson, North Carolina. By 1927, when there were 28 stores, the business was incorporated in the state of Delaware under the name of \"Rose's 5, 10 & 25(cent sign) Stores, Inc.\". In 1962, the name was changed to \"Rose's Stores, Inc.\". Over the years, Rose's has opened stores of a larger size. As a result, Registrant's business has evolved from a chain of 5, 10 & 25(cent sign) stores to a chain of general merchandise discount stores.\nOn September 5, 1993, Rose's filed a voluntary petition for Relief under Chapter 11, Title 11 of the United States Bankruptcy Code (the \"Bankruptcy Code\") in the United States Bankruptcy Court for the Eastern District of North Carolina (the \"Bankruptcy Court\"). Rose's is presently operating its business as a debtor-in- possession under Chapter 11 and is subject to the jurisdiction and supervision of the Bankruptcy Court. In the Chapter 11 case, substantially all liabilities as of the date of the filing of the petition for reorganization are subject to settlement under a plan of reorganization to be voted upon by Rose's impaired creditors and stockholders and confirmed by the Bankruptcy Court. As of the date of this report, Rose's has not yet presented its plan of reorganization. Details of the bankruptcy proceedings are discussed in Note 1 of the Consolidated Financial Statements.\n(b) Industry Segments Registrant's business does not include industry segments as defined under the Act.\n(c) Narrative Description of Business\nAt the end of its last fiscal year, Registrant was operating 172 retail stores in a region extending from Delaware to Georgia and westward to the Mississippi Valley. All store buildings are leased. The stores range in size from 24,000 square feet to 76,000 square feet. During the year, Rose's opened no new stores and closed 45 stores. Rose's anticipates closing approximately 58 stores during the 1994 fiscal year and realigning corporate and administrative costs accordingly.\nRegistrant operates one class of stores, known as \"ROSES\". The stores carry a wide range of general merchandise and popularly priced consumer goods such as clothing, shoes, household furnishings, small appliances, toiletries, cosmetics, sporting goods, automobile accessories, food, yard and garden products, electronics and occasional furniture. Registrant operates all of the departments in its stores with the exception of the shoe departments.\nSales are primarily for cash, although credit cards such as MASTER CARD, VISA and DISCOVER are honored. During the past fiscal year, credit card sales amounted to approximately 10% of gross sales. Sales are directly affected by general economic conditions in the southeastern states, consumer spending, and disposable income.\n* Reference in this Annual Report on Form 10-K to \"Rose's\", the \"Registrant\", or \"the Company\" shall mean Rose's Stores, Inc.\nMerchandising Inventories are purchased in two principal ways. Buyers purchase and distribute merchandise to the various stores, and the store managers purchase merchandise for their individual stores from listings and sources approved by buyers. Rose's purchases from a large number of suppliers and sells to a large number of customers and does not believe that the loss of any one customer or supplier would have a materially adverse effect on it. Rose's has registered some trademarks as private label brands. During the past fiscal year, private label merchandise constituted approximately 11% of Rose's gross sales. Rose's does not engage in any material research activities and has no plans for new product lines.\nDistribution Approximately 20% of merchandise is shipped directly to stores from suppliers, and 80% is shipped to stores from Rose's distribution and consolidating facilities located in Henderson, North Carolina. The majority of trailers used in shipping are owned by Roses; the majority of tractors are leased.\nSeasonal Aspects of Operations Rose's business is highly seasonal and directly influenced by general economic conditions in its operating area. The fourth quarter, which includes Christmas, is the period of highest sales volume. During the past fiscal year, a total of approximately 30% of the year's gross sales were made in the fourth quarter, beginning October 31, 1993.\nCompetition Rose's business is intensely competitive. Some of Rose's lines of merchandise compete directly with chains and independent stores including Sears, J. C. Penney, Belk, Leggett's and other similar stores. Other lines compete with chain and independent stores such as Wal-Mart, Kmart, Ames, Hills, Jamesway, Jack Eckerd, Peoples Drug, A&P, Winn-Dixie, Lowe's, Phar-Mor, Marshall's, Office Depot and similar stores. Wal-Mart and Kmart have been opening stores in the area in which Rose's stores are located. In 1993, 15 Company stores faced new competitors' openings, compared to 40 stores in 1992 and 26 stores in 1991. Increasing competition also results from grocery and drug chains expanding merchandise lines to carry goods and products normally identified with general merchandise and variety stores. In addition, other distribution channels, such as telemarketing and catalogs also compete with stores of the Registrant.\nAssociates* Rose's employed, on a full-time or part-time basis, approximately 14,900 persons at fiscal year-end. Rose's considers its relations with its associates to be good.\nITEM 2:","section_1A":"","section_1B":"","section_2":"ITEM 2: PROPERTIES\nThe following table shows the geographical distribution of the 172 Rose's stores in operation on January 29, 1994:\nState Number of Stores North Carolina 79 Virginia 40 South Carolina 10 Georgia 13 Kentucky 9 Tennessee 6 Maryland 4 Delaware 4 Mississippi 4 Alabama 1 West Virginia 2\nTOTAL 172\n* Persons employed by Rose's Stores, Inc.\nDuring the fiscal year which ended January 29, 1994, Rose's opened no new stores and closed 45 stores. Registrant expects to close approximately 58 stores in the coming year. The Registrant occupies approximately 8,864,000 square feet of store space (including office, stockroom, and other non- selling areas). Rose's leases all store space from others under long-term leases which are normally for initial terms of 15 to 20 years with one or more five-year renewal options. (See Leased Assets and Lease Commitments, Note 14, to the Consolidated Financial Statements for additional information about the Registrant's commitments under terms of long-term leases.)\nFollowing is a table of the number of stores opened, closed and remodeled in the last 5 years:\n1993 1992 1991 1990 1989\nNumber of stores at the beginning of year 217 232 256 259 250 Stores opened - - 3 2 15 Stores closed (45) (15) (27) (5) (6) Number of stores at the end of year 172 217 232 256 259\nRemodeled stores 21 7 - 9 3\nMost of the store fixtures are owned by the Registrant. The remaining fixtures are manufacturers' racks that are supplied by vendors. Most of the electronic equipment located in the stores, including point of sale equipment, is leased by Registrant.\nThe Registrant owns its Executive and Buying Offices, its 860,300 square foot central warehouse, an additional consolidating warehouse containing 134,400 square feet, a 31,000 square foot graphic productions building and a 30,000 square foot data center all of which are located in Vance County, North Carolina. Registrant also leases facilities in Henderson, North Carolina for offices (approximately 75,000 square feet) and service facilities (approximately 10,000 square feet) and leases warehouse space in Wilmington, North Carolina (approximately 30,000 square feet). Registrant also owns a 78,000 square foot warehouse in Henderson, North Carolina, which is leased to a third party.\nThe Company has pledged inventories located in approximately 64% of its stores and a collateral pool of $26.5 million consisting of the Distribution Center and, to the extent necessary, its contents, and a secured interest in all other property and equipment to both the short-term and long-term lenders in return for six and one-half year notes and a working capital facility acquired May 29, 1992. Also, the Company pledged approximately $3,000,000 of inventory to a long-term lender to collateralize the lender's deferral of previously scheduled payments.\nThe Company entered into a Debtor-in-Possession Revolving Credit Agreement (the DIP Facility) on September 20, 1993. The DIP Facility gives the lender, G.E. Capital Corporation, a super-priority claim against the property of the Company other than real property.\nITEM 3:","section_3":"ITEM 3: LEGAL PROCEEDINGS\nThe Registrant's business ordinarily results in a number of negligence and tort actions, most of which arise from injuries on store premises, injuries from a product, or false arrest and detainer arising from apprehending suspected shoplifters. General damages are covered by insurance, subject to specified self-retention amounts, and are defended by the Registrant's insurance carrier. The Registrant's liability for uninsured general damages and punitive damages is not considered material. No legal proceedings presently pending by or against the Registrant are described because the Registrant believes that the outcome of such litigation should not have a material adverse effect on the financial position of the Registrant.\nOn September 5, 1993, the Company filed a voluntary petition for Relief under Chapter 11, Title 11 of the United States Code (the \"Bankruptcy Code\") with the United States Bankruptcy Court for the Eastern District of North Carolina (the \"Bankruptcy Court\") Case No. 93-01365-5-ATS (the \"Chapter 11 Case\").\nThe following discussion sets forth certain aspects of the Chapter 11 Case, but is not intended to be an exhaustive summary. For additional information regarding the effect of the Chapter 11 Case on the Company, reference should be made to the Bankruptcy Code.\nChapter 11 Reorganization Under the Bankruptcy Code\nPursuant to Section 362 of the Bankruptcy Code, the commencement of the Chapter 11 Case created an automatic stay, applicable generally to creditors and other parties in interest, of: (i) the commencement or continuation of a judicial administrative or other action or proceeding against the Registrant that was or could have been commenced prior to commencement of the Chapter 11 Case, or to recover for a claim that arose prior to commencement of the Chapter 11 Case; (ii) the enforcement against the Registrant or its property of any judgments obtained prior to commencement of the Chapter 11 Case; (iii) the taking of any action to obtain possession of property of the Registrant or to exercise control over property of the Registrant; (iv) the creation, perfection or enforcement of any lien against the property of the Registrant's bankruptcy estate; (v) any act to create, perfect or enforce against property of the Registrant any lien that secures a claim that arose prior to the commencement of the Chapter 11 Case; (vi) the taking of any action to collect, assess or recover claims against the Registrant that arose before commencement of the Chapter 11 Case; (vii) the setoff of any debt owing to the Registrant that arose prior to commencement of the Chapter 11 Case against any claim against the Registrant or (viii) the commencement or continuation of a proceeding before the United States Tax Court concerning the Registrant. Any entity may apply to the Bankruptcy Court, upon an appropriate showing of cause, for relief from the automatic stay to exercise the foregoing remedies. The Registrant is authorized to operate its business as a debtor-in- possession pursuant to sections 1107 and 1108 of the Bankruptcy Code.\nPlan of Reorganization - Procedures\nUnder Section 1121 of the Bankruptcy Code, for 120 days after the date of the filing of a voluntary petition for relief under Chapter 11, only the debtor-in-possession has the right to propose and file a plan of reorganization with the Bankruptcy Court. If a debtor-in-possession files a plan of reorganization during the 120-day exclusivity period, no other party may file a plan of reorganization until 180 days after the date of filing of the Chapter 11 petition, during which period the debtor-in-possession has the exclusive right to solicit acceptances of the plan. If a debtor-in-possession fails to file a plan during the 120-day exclusivity period or such additional period as may be ordered by the Bankruptcy Court or, after such plan has been filed, fails to obtain acceptance of such plan from impaired classes of creditors and equity security holders during the exclusive solicitation period, any party in interest, including a creditors' committee, an equity security holders' committee, a creditor, an equity security holder, or any indenture trustee may file a plan of reorganization for such debtor. Additionally, if the Bankruptcy Court were to appoint a trustee, the exclusivity period, if not previously terminated, would terminate.\nThe Registrant has not yet filed a plan of reorganization with the Bankruptcy Court and has obtained from its creditors an extension of the exclusivity period to May 31, 1994. The Registrant intends to file a plan of reorganization prior to May 31, 1994.\nAfter a plan of reorganization has been filed with the Bankruptcy Court, it will be sent, together with a disclosure statement approved by the Bankruptcy Court following a hearing, to members of all classes of impaired creditors and equity security holders for acceptance or rejection. Following acceptance or rejection of any plan by impaired classes of creditors and equity security holders, the Bankruptcy Court after notice and a hearing would consider whether to confirm the plan. Among other things, to confirm a plan the Bankruptcy Court is required to find (i) with respect to each impaired class of creditors and equity security holders, that each holder of a claim of interest of such class either (a) will, pursuant to the plan, receive or retain property of a value, as of the effective date of the plan, that is at least as much as such holder would have received in a liquidation on such date of the Registrant, or (b) has accepted the plan, (ii) with respect to each class of claims or equity security holders, that such class has accepted the plan or such class is not impaired under the plan and (iii) confirmation of the plan is not likely to be followed by the liquidation or need for further financial reorganization of the Registrant or any successors unless such liquidation or reorganization is proposed in the plan.\nIf any impaired class of creditors or equity security holders does not accept a plan and assuming that all of the other requirements of section 1129(a) of the Bankruptcy Code are met, the proponent of the plan may invoke the so-called \"cramdown\" provisions of section 1129(b) of the Bankruptcy Code. Under these provisions, the Bankruptcy Court may confirm a plan, notwithstanding the non-acceptance of the plan by an impaired class of creditors or equity security holders, if certain requirements of the Bankruptcy Code are met, including that (i) the plan does not discriminate unfairly and (ii) the plan is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan. As used in the Bankruptcy Code, the phrases \"discriminate unfairly\" and \"fair and equitable\" have narrow and specific meanings unique to bankruptcy law.\nAdversary Proceedings\nOn February 3, 1994, NationsBank as Collateral Agent, for itself and other pre-petition lenders (collectively, the \"Pre-Petition Lenders\") filed a Complaint under 11 U.S.C. Section 506 to determine the validity, enforceability and priority of the Pre-Petition Lenders' liens and security interests in certain assets of the Company described as collateral in various loan documents entered into by the Company and the Pre- Petition Lenders securing promissory notes dated May 29, 1992.\nThe Company, under the provisions of the Bankruptcy Code, commenced an Adversary Proceeding on February 4, 1994 against the Pre-Petition Lenders seeking to reduce the claim of the Pre-Petition Lenders to unsecured status on a variety of theories. The complaint alleged, inter alia, defects in financing statements filed to perfect security interests, defects in the perfection of security interests in after-acquired property and cash proceeds, and defective documentation of collateral in a security instrument.\nMost claims with respect to the secured status of the Pre-Petition Lenders have been resolved by summary judgment dismissing specific challenges or by dismissal of claims by the Company. Discovery has not been completed with respect to the remaining claims.\nITEM 4:","section_4":"ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to stockholders during the fourth quarter of the fiscal year.\nPART II\nITEM 5:","section_5":"ITEM 5: MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nINVESTOR INFORMATION\nCORPORATE DATA\nRose's Stores, Inc. is a Delaware Corporation. Rose's stock is listed on the NASDAQ System for over-the-counter securities; the Voting Common Stock has the symbol \"RSTOQ\" and the Non-Voting Class B Stock has the symbol \"RSTBQ\".\nCOMMON STOCK\nHigh and low prices of Rose's Voting Common Stock and Non-Voting Class B Stock as reported on the NASDAQ are shown below.\n(Dollars in thousands except per share amounts)\nMarket Price Range and Dividends (a)\nDividends Total High Low Per Share Dividends\n1993 7 1\/4 13\/32 - - 1992 7 3 1\/2 - - 1991 7 1\/8 2 1\/8 - - 1990 7 1\/4 2 1\/4 .210 3,991 1989 9 5\/8 5 .210 4,138 1988 12 7 1\/8 .210 4,194 1987 22 1\/2 7 7\/8 .210 4,316 1986 23 1\/8 10 3\/4 .200 4,115 1985 13 1\/2 8 3\/4 .190 3,900 1984 13 1\/2 7 .185 3,798 1983 14 1\/2 3 .135 2,660\n(a) Adjusted to reflect the 2-for-1 stock split effected in 1986, and the 3-for-2 and 3-for-1 stock splits in 1983.\nOn January 24, 1991, the Board of Directors adopted a resolution suspending the payment of dividends until future operating profits warrant reinstatement. Among other things, the Company's DIP financing agreement includes restrictions on the payment of cash dividends and the repurchase of stock. In addition, the Company is precluded from paying dividends while the Chapter 11 case is pending and the Registrant does not believe it is likely that it will pay dividends for the foreseeable future following termination of the Chapter 11 case. At January 29, 1994, such restrictions preclude the payment of dividends or the repurchase of stock. The number of holders of record for the Company's Voting Common Stock was 1,074 and for Non-Voting Class B Stock was 1,537 at April 22, 1994.\nITEM 6:","section_6":"ITEM 6: SELECTED FINANCIAL DATA\n(Dollars in thousands except per share amounts)\n(Not covered by Independent Auditors' Report)\n(a) In 1991, the Company changed its method of accounting for LIFO inventories from the use of the inflation index provided by the Bureau of Labor Statistics to an internally generated price index to measure inflation in the retail prices of its merchandise inventories. This change decreased 1991 cost of sales by $21,428 (or $1.15 per share). Net loss would have been $44,732 in 1991 if the change in accounting method had not been made. The information was not available to determine the cumulative effect of this change nor the impact of any year prior to 1991.\n(b) The provision for future store closings and remerchandising represents the anticipated costs of closing approximately 15 stores during fiscal year 1992 and 27 stores during fiscal 1991. The 1991 provision also includes the costs incurred during fiscal 1992 in the remerchandising of the remaining stores.\n(c) The gain on sale of shoe department fixtures and inventory results from an agreement with a footwear merchandising company to assume total operations of the shoe departments within all Company stores.\n(d) On September 5, 1993, the Company filed a voluntary petition in the United States Bankruptcy Court for the Eastern District of North Carolina seeking to reorganize under Chapter 11 of the Bankruptcy Code. The consolidated financial statements contained herein have been prepared in accordance with generally accepted accounting principles applicable to a going concern and do not purport to reflect or to provide for all the consequences of the ongoing Chapter 11 reorganization.\nIncluded in the reorganization expense is a provision of $39,500 for the costs of closing 43 stores in January 1994, as well as the DIP fee amortization and expenses, professional fees and other reorganization costs. Offsetting these expenses is a reversal of prior reserves for closings due to the anticipated rejection of closed store leases.\n(e) In 1992, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" requiring the Company to accrue health insurance benefits over the period in which associates become eligible for such benefits. The cumulative effect of adopting SFAS 106 was a one-time charge of $5,031.\n(f) Not comparable for 1993, the majority of the amounts comprising this item have been reclassed to liabilities subject to settlement under reorganization proceedings.\nITEM 7:","section_7":"ITEM 7: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS FROM OPERATIONS\n(Dollars in thousands except per share amounts)\nResults of Operations\nThe following table sets forth for the periods indicated the percentage which each item listed bears to net sales:\nAs a Percentage of Net Sales Fiscal Years 1993 1992 1991 Revenue: Gross sales 103.5% 103.1% 103.1% Leased department sales 3.5 3.1 3.1 Net sales 100.0 100.0 100.0 Leased department income 0.7 0.7 0.7 Total revenue 100.7 100.7 100.7 Costs and Expenses: Cost of sales (a) 77.5 81.0 74.6 Selling, general and administrative 23.4 22.1 22.8 Provision for future store closings and remerchandising (b) - - 2.5 Depreciation and amortization 1.0 1.0 1.2 Interest 1.0 1.0 1.0 Total costs and expenses 102.9 105.1 102.1 Loss before reorganization expense, income taxes (benefits), and cumulative effect of accounting change (2.2) (4.4) (1.4) Reorganization expense (c) (3.3) - - Loss before income taxes (benefits) and before cumulative effect of accounting change (5.5) (4.4) (1.4) Income taxes (benefits) - (0.1) 0.3 Loss before cumulative effect of accounting change (5.5) (4.3) (1.7) Cumulative effect of adopting SFAS 106 (d) - (0.4) - Net loss (5.5)% (4.7)% (1.7)%\n(a) In 1991, the Company changed its method of accounting for LIFO inventories from the use of the inflation index provided by the Bureau of Labor Statistics to an internally generated price index to measure inflation in the retail prices of its merchandise inventories. This change decreased 1991 cost of sales by $21,428 (or $1.15 per share). Net loss would have been $44,732 in 1991 if the change in accounting method had not been made.\n(b) The 1991 provision for future store closings and remerchandising represents the anticipated costs of closing approximately 15 stores during fiscal 1992 and the costs incurred during fiscal 1992 in the remerchandising of the remaining stores.\n(c) On September 5, 1993, the Company filed a voluntary petition in the United States Bankruptcy Court for the Eastern District of North Carolina seeking to reorganize under Chapter 11 of the Bankruptcy Code. The consolidated financial statements contained herein have been prepared in accordance with generally accepted accounting principles applicable to a going concern and do not purport to reflect or to provide for all the consequences of the ongoing Chapter 11 reorganization.\nIncluded in the reorganization expense is a provision of $39,500 for the costs of closing 43 stores in January 1994, as well as the DIP fee amortization and expenses, professional fees and other reorganization costs. Offsetting these expenses is a reversal of prior reserves for closings due to the anticipated rejection of closed store leases.\n(d) In 1992, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the Company to accrue health insurance benefits over the period in which associates become eligible for such benefits. The cumulative effect of adopting SFAS 106 was a one-time charge of $5,031.\nChapter 11 Filing\nOn September 5, 1993, the Company filed a voluntary petition for relief under Chapter 11, Title 11 of the United States Code (the \"Bankruptcy Code\") with the United States Bankruptcy Court for the Eastern District of North Carolina (the \"Bankruptcy Court\"). The Company is in possession of its property and is maintaining and operating its property as a debtor-in-possession pursuant to the provisions of Sections 1107 and 1108 of the Bankruptcy Code.\nFor further discussion of the Chapter 11 proceedings, see Footnote 1 in the Consolidated Financial Statements.\nRevenue\nThe Company reported sales in 1993 of $1,245,697, a decrease of $158,605 or 11.3% from 1992. Sales in same stores for 1993, on a comparable week- to-week basis, decreased 7.7% compared to 1992. Prior to its bankruptcy filing, poor sales were caused by out-of-stocks resulting from reduced purchases necessitated by the Company's limited borrowing availability. Also, just prior to and immediately after filing the petition under Chapter 11, many suppliers interrupted their shipments of merchandise causing out-of-stock positions on most seasonal merchandise. It took several months to restore inventory levels to acceptable levels.\nIn 1992, the Company reported sales of $1,404,302, a decrease of $19,043 or 1.3% from fiscal 1991. 1992 same store sales, on a comparable week- to-week basis, increased 2.5% from 1991. Sales in the first half of fiscal 1992 were negatively affected by credit problems related to the Company's bank facility negotiations and by the significant disruptions associated with the remerchandising of all stores. Sales in the second half of 1992 were positively impacted by the sale of clearance merchandise and stronger promotional sales.\nSales have been adversely affected over the last three years as a result of new competition. For the stores open in 1993, 15 faced new competitors, compared to 40 in 1992 and 26 in 1991. In 1994, the Company expects to have 6 stores facing new competition. Also, the Company believes the soft and uncertain economy had a negative impact on the sales results for the sales in 1992 and 1991.\nInflation has had little effect on the Company's operations in the last three years.\nCosts and Expenses\nIn 1993, the cost of sales as a percent of sales decreased 3.5% from the 1992 percent to sales. This was due to (1) decreased markdowns resulting in a decrease in the cost of sales rate of 1.6%, (2) higher markup decreasing the rate by 1.5%, and (3) lower shrinkage resulting in a decrease of the rate by 1.1%. These improvements were offset somewhat by increases in the freight costs. The Company took proactive measures in 1993 to reduce the shrinkage to a normal rate. Some of these measures included strengthening the Company's loss prevention department, implementing systems that automatically calculate markdowns, establishing a shrink incentive program for the stores, and implementing stronger store front-end controls.\nIn 1992, the cost of sales as a percent of sales increased 6.4% over the 1991 percent to sales. This was due primarily to higher clearance markdowns taken during the year to liquidate old and discontinued hardlines inventory and seasonal apparel, resulting in an increase of 2.6% in the cost of sales rate. Lower markup caused an increase to the 1992 cost\nof sales rate of 1.5%. Higher inventory shrinkage increased the cost of sales rate by 1.3% over the 1991 percent to sales. The Company believes that this increase in shrinkage was caused primarily by the disruptions in the stores due to the remerchandising in the first half of 1992 and the large volumes of clearance markdowns taken in the second half of 1992, and by higher internal and external theft. Finally, the cost of sales rate in 1992 increased by .8% due to a higher LIFO charge.\nIn 1991, the Company developed and used internal price indices instead of the inflation index provided by the Bureau of Labor Statistics. The 1991 pre-tax LIFO provision included in cost of sales (a credit of $10,323) would have been a charge of $11,105 if the accounting change had not been made; therefore, the accounting change had the effect of decreasing cost of sales by $21,428. The net loss for 1991 would have been $44,732 if the change in accounting method had not been made. A decrease in mark-up in 1991 resulting from lowering competitive prices was more than offset by a decrease in markdowns as a percent to sales.\nSelling, general and administrative expenses as a percent of sales were 23.4% in 1993, 22.1% in 1992, and 22.8% in 1991. The increase in 1993 is largely attributable to the decline in 1993 sales.\nAs part of its business plan, the Company decided to close 43 stores in January of 1994 and recognized an expense of $39,500 associated with these closings. Additionally, the Company recognized a $13,026 benefit associated with the anticipated rejection of closed store leases on stores already closed. A net reorganization expense of $39,138 before taxes, relating to these closed stores and other bankruptcy costs, was recorded during 1993.\nIn addition, the Company made the decision in the first quarter of 1994 to close approximately 58 stores and realign corporate and administrative costs accordingly. It is expected that a charge of approximately $55,000 relating to these closings will be included in the first quarter of 1994.\nIn 1991, a provision of $24,891 was recorded to provide for the costs of closing 15 stores in 1992. In addition, the Company recorded a charge of $9,000 to provide for payroll costs and inventory reductions that were incurred in 1992 as a result of a significant change in the merchandise mix in the stores.\nInterest expense decreased 13% in 1993 due to a decrease in long-term debt outstanding. Generally, under the Bankruptcy Code, interest on pre- petition claims ceases accruing upon the filing of a petition unless the claims are collateralized by an interest in property with value exceeding the amount of debt. Although no determination has yet been made regarding the value of the property which collateralizes various creditors' claims, the Bankruptcy Court has ordered the Company to make monthly adequate protection payments which have been booked as interest. The Company is disputing the claims to collateral of its pre-petition long-term debtholders. (See Item 3. Legal Proceedings) Interest on the DIP facility and other related DIP fees and expenses were $1,238 in 1993 (0.1% of net sales), and were included in the reorganization costs. In addition, the Company included in the reorganization costs, a write-off of $4,528 related to unamortized costs of pre-petition debt. Interest expense decreased .3% in 1992 due to a decrease in average short-term debt offset by higher rates on renegotiated long-term senior notes. Interest expense decreased 4.9% in 1991 due to a decrease in average short-term debt outstanding.\nOther\nIn February 1992, the Financial Accounting Standards Board (FASB) 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\nincome 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 the first quarter of 1993, the Company adopted Statement 109. The only effect of adopting Statement 109 was the establishment of a $5,760 current deferred tax liability and a $5,760 non-current deferred tax asset. Under the guidelines provided by APB 11, the Company would have no current or non-current deferred tax liability\/asset.\nIn 1992, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the Company to accrue health insurance benefits over the period in which associates become eligible for such benefits. The cumulative effect of adopting SFAS 106 was a one-time charge of $5,031 (or $.27 per share).\nA write-off of deferred tax assets of $8,970 negatively impacted 1991. This write-off was required so that the Company would not have deferred tax assets greater than the tax carrybacks available. If the Company becomes profitable, the reinstatement of these deferred tax assets will be used to reduce tax expense in future years. Additional tax losses were incurred during 1992; thus the remaining deferred tax assets were consumed with the resulting NOL which eliminated the need for an additional write-off.\nThe Internal Revenue Service (IRS) has completed its examinations of the Company's federal income tax returns for the years 1988 through 1991 and has proposed tax adjustments of $2,882 plus interest and penalties. These adjustments pertain to issues including the timing of deductions for inventory shrinkage accruals, depreciation expense and amortization of movie rental assets. The Company's management and tax counsel believe that certain of the IRS's proposed adjustments are without merit and are vigorously contesting these, and that the ultimate resolution of the proposed adjustments will not have a material effect on the Company's financial position.\nLiquidity and Capital Resources\nOn September 2, 1993, the Company received a notice of default for failure to make an interest payment due on August 31, 1993 under its primary line of credit facility under the Amended and Restated Loan Agreement dated May 29, 1992. The notice of default demanded payment in full of the $106,000 of outstanding principal and declined to extend any further credit.\nThe Chapter 11 filing caused a default under many of the agreements to which the Company is a party. Generally, actions to enforce or otherwise effect the repayment of pre-petition liabilities are stayed while the Company is under the protection of Chapter 11 of the Bankruptcy Code. These liabilities will be resolved as a part of the reorganization proceedings. Additional liabilities subject to similar resolution may arise as a result of claims filed by parties related to the rejection of executory contracts, including expired leases, and for the Bankruptcy Court's determination of allowed claims for contingencies and other disputed amounts.\nOn September 6, 1993, the day after the Company filed for Chapter 11, the Company and G. E. Capital Corporation (\"GE Capital\") entered into a commitment letter pursuant to which GE Capital would provide debtor-in-possession post-petition financing to the Company in the form of a two-year revolving credit facility of up to the lesser of (i) 50% of the value of inventory of the Registrant acceptable to GE Capital, less reserves to be established in the discretion of GE Capital or (ii) $125,000. (This two-year credit agreement is hereinafter referred to as the \"DIP Facility\".)\nOn October 14, 1993, the Bankruptcy Court approved the DIP Facility with certain restrictions on the borrowing base pending approval of the Company's 1994 business plan by the secured lenders.\nThe DIP Facility provides for interest to accrue at a lower rate than the Company's primary pre-petition revolving credit facility. As part of the cash collateral order, the Company pays the interest on the pre-petition debt monthly in the form of adequate protection payments.\nWith the approval of the DIP Facility, the Company's short-term liquidity has improved significantly. The cash requirements for the payment of scheduled principal payments, accrued interest, accounts payable and other liabilities incurred prior to the Chapter 11 filing have in most cases been deferred until a Plan of Reorganization is confirmed by the Bankruptcy Court. Pre-petition claims of $207,456 were outstanding as of the end of 1993. In addition, $4,000 of estimated reclamation claims to be paid according to court order are included in current liabilities.\nRose's management expects the Company to realize positive cash flow from its 1994 operations. The filing under Chapter 11 will protect the Company from its pre-petition creditors while a plan of reorganization is being negotiated. Until such a plan is confirmed by the Bankruptcy Court and consummated, payments on pre- petition debt will not be made (except as approved by the Bankruptcy Court) and all existing unexpired contracts and leases will be reviewed to determine whether they should be assumed or rejected (subject to Bankruptcy Court approval). The adequacy of the Company's capital resources and long-term liquidity cannot be determined until a plan of reorganization is developed and confirmed by the Bankruptcy Court.\nThe Company's current ratio for 1993, which includes $4,000 of reclamation claims, is 3.32 compared to 1.87 in 1992 and 2.08 in 1991. In 1993, cash and cash equivalents decreased $7,146 compared to increases of $13,441 in 1992 and $4,416 in 1991. The Company's working capital was $173,640 in 1993, $127,515 in 1992, and $182,723 in 1991. The increase in working capital in 1993 of $46,125 was primarily due to a reclassification of pre-petition current liabilities to liabilities subject to settlement under reorganization proceedings due to the Chapter 11 filing.\nThe fixed charge coverage ratio was 0.00 in 1993, 0.10 in 1992 and 0.80 in 1991. The fixed charge coverage ratio is defined as the sum of net income before taxes, LIFO provision, interest, depreciation, and minimum rent divided by the sum of interest and minimum rent. The ratio, excluding items that are typically non-recurring such as reorganization costs, reserves for store closings and remerchandising, and the adoption of SFAS 106 was 0.74 in 1993, 0.19 in 1992 and 1.37 in 1991.\nIn 1993, $8,373 of cash was provided from operating activities, while $40,071 was provided in 1992 and $16,081 was provided in 1991. Declining sales, as well as an increased investment in inventory and inventory prepayments contributed to the decline in cash.\nInvesting activities used cash of $9,100 in 1993, $9,140 in 1992, and $2,962 in 1991. The Company invested cash in property and equipment totaling $9,109 in 1993, $9,629 in 1992, and $3,102 in 1991. The 1993 expenditures were primarily for store improvements, remodels and new computer software. The Company closed 45 stores in 1993, closed 15 stores in 1992, and opened three stores and closed 27 in 1991.\nFinancing activities used cash of $6,419 in 1993, $17,490 in 1992, and $8,703 in 1991. The Company made $1,127 of payments on long-term debt in 1993, and $12,000 in 1992. In 1991, the Company reduced its short-term debt by $5,000 through a reduction of inventory levels. The Board of Directors has suspended dividend payments until future operating profits warrant reinstatement. The Company's debt agreements include a restriction on the payment of cash dividends and the repurchase of stock.\nITEM 8:","section_7A":"","section_8":"ITEM 8: CONSOLIDATED FINANCIAL STATEMENTS\nSee Consolidated Financial Statements contained elsewhere 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 following is furnished with respect to each of the members of the Board of Directors of the Registrant as of January 29, 1994:\n__________________\n(a) Monica Scott, Inc., which had remained current in payment of liabilities during his tenure as CEO, later filed for protection under the provisions of Chapter 11, U.S. Bankruptcy Code.\nMr. Lucius H. Harvin, III (Chairman of the Board) is the brother of George M. Harvin (a Director); and they are nephews of Marion J. Church (a Director) and John T. Church. Sr. (Chairman of the Board Emeritus and a Director). Mr. and Mrs. Church are husband and wife.\nThe following information is furnished with respect to each of the executive officers of the Registrant as of January 29, 1994:\nOfficers of the Registrant are elected each year at the Annual Meeting of the Board of Directors to serve for the ensuing year and until their successors are elected and qualified.\nSection 16(a) Reporting\nThe Registrant believes that all executive officers and directors of the Registrant and all other persons known by the Registrant to be subject to Section 16 of the Securities Exchange Act of 1934, filed all reports required to be filed during fiscal year 1993 under Section 16(a) of that Act on a timely basis. The Registrant's belief is based solely on its review of Forms 3, 4 and 5 and amendments thereto furnished to the Registrant during, and with respect to, its most recent fiscal year by persons known to be subject to Section 16.\nITEM 11:","section_11":"ITEM 11: EXECUTIVE COMPENSATION\nCash And Other Compensation\nThe following table sets forth all the cash compensation paid or to be paid by the Registrant, as well as certain other compensation paid or accrued, during the fiscal years indicated, to the Chairman of the Board, the Chief Executive Officer, and the three other highest paid executive officers of the Registrant for fiscal year 1993 in all capacities in which they served:\n(1) 1993 Salary represents 52 weeks of base salary. 1992 Salary represents 53 weeks of base salary. 1991 Salary represents 52 weeks of base salary. (2) \"Other Annual Compensation\" consists of tax gross- ups on medical expense reimbursements, and in 1991 also included earnings on LTIP compensation. (3) \"All Other Compensation\" includes payments by the Registrant for the following:\nName Automobile Allowance Profit Sharing Plan Jones $6,198 $1,372 Harvin $6,198 $1,372 Freeman $5,528 $1,372 Anderson $5,528 $1,372 Gruen $5,528 $1,369\n(4) Bonus awards to George L. Jones represent prorated amounts from bonus agreement incident to initial employment with the Registrant and does not represent bonus awards determined during the fiscal year. Amounts shown are not payable until 1994. (5) Bonus awards to Kevin Freeman represent prorated amounts from bonus agreement incident to initial employment with the Registrant and does not represent bonus awards determined during the fiscal year. (6) Messrs. Jones, Freeman, and Gruen joined the Registrant in 1991.\nStock Options Granted During Fiscal Year\nThe following table sets forth information about the stock options granted to the named executive officers of the Registrant during fiscal year 1993. No stock appreciation rights were granted to the named executive officers during fiscal year 1993.\n____________\n(1) Options to purchase the above listed number of shares of the Registrant's Non-Voting Class B Stock for $5.00 a share. Options expiring on April 1, 2003 vest and become receivable on April 1, 1995. Options expiring on June 1, 2003 vest and become receivable on June 1, 1994.\n(2) Options to acquire an aggregate of 256,250 shares of Common Stock of the Registrant were granted to all employees during fiscal year 1993. Options to acquire an additional 50,000 shares of Common Stock were granted to nonemployee directors of the Registrant during fiscal year 1993.\n(3) The potential realizable value of the options reported above was calculated by assuming 5% and 10% annual rates or appreciation of the Common Stock of the Company from the date of grant of the options until the expiration of the options. These assumed annual\nrates of appreciation were used in compliance with the rules of the Securities and Exchange Commission and are not intended to forecast future price appreciation of the Common Stock of the Company. The Company chose not to report the present value of the options because the Company does not believe any formula will determine with reasonable accuracy a present value because of unknown or volatile factors. The actual value realized from the options could be substantially higher or lower than the values reported above, depending upon the future appreciation or depreciation of the Common Stock during the option period and the timing of exercise of the options.\nStock Options Exercised During Fiscal Year and Year End Values of Unexercised Options\nThe following table sets forth information about unexercised stock options and stock appreciation rights by the named executive officers of the Registrant during fiscal year 1993. No stock options or stock appreciation rights were exercised by the named executive officers during fiscal year 1993.\n____________ (1) All options were out of the money at fiscal year end.\nEmployment Contracts, Termination Of Employment And Change-In-Control Arrangements\nThe Registrant has an employment contract with George L. Jones which provides for his active employment for three years, through July 24, 1994. This contract was negotiated with Mr. Jones prior to his initial employment by the Registrant and became effective on July 25, 1991. All sums required to be paid under the contract are shown on a prorated basis per year in the summary compensation table above for the years to date. The bonus amount, shown on a prorated annual basis in column (d) of the summary compensation table, is payable upon the first to occur of (i) the third anniversary of the effective date of the agreement, (ii) the date on which the price of the Registrant's Non-Voting Class B Stock is quoted at a price per share of $15.50 on the NASDAQ system, or (iii) termination of employment by reason of death, permanent disability, discharge without cause, liquidation of substantially all of the assets of the Registrant, resignation resulting from default by the Registrant in its covenants under the agreement, or a change in control of the Registrant as defined in the agreement. In lieu of the bonus, or any part thereof, Mr. Jones has the option under the employment agreement and a Tandem Stock Option Agreement to purchase up to 200,000 shares of the Class B Non-Voting Stock of the Registrant at a price of $3.00 per share exercisable upon the first to occur of the bonus vesting events listed above.\nThe Registrant maintains a severance program authorized by the Bankruptcy Court on April 1, 1994, replacing prior individual agreements with each of Messrs. Freeman, Anderson and Gruen providing for the payment of certain benefits upon the cessation of employment of each such officer. Under this program, these officers would be eligible to receive up to 18 months base salary, up to one-half of such amount being paid in installments which would cease upon re-\nemployment. Each such officer would also be entitled to (i) reimbursement for reasonable expenses incurred to obtain re-employment, not to exceed ten thousand dollars ($10,000) and (ii) continued medical, dental and disability coverage under existing Company plans for a period of three months following cessation of employment. Benefits under the program would be payable for cessation of employment by reason of: elimination of the employee's position unless offered a comparable or better position with the Company, termination of employment other than for misconduct as defined in the program, or constructive or voluntary termination due to a material reduction in salary or due to a material change in job responsibilities, termination on account of permanent disability, or termination due to liquidation of the Company. As of the date hereof no severance programs or agreements have been authorized by the Bankruptcy Court with respect to Messrs. Harvin or Jones.\nOther senior vice presidents of the Company are eligible for the same benefits as those described for Messrs. Freeman, Anderson and Gruen. Other executive officers of the Company are eligible for up to twelve (12) months base salary, a maximum of $7,500 for re-employment expense reimbursement and three months continued coverage under medical, dental and disability plans.\nCompensation of Directors\nDirectors who are officers of the Registrant receive no additional compensation for service on the Board of Directors or committees. Directors who are not officers are paid $8,000.00 per year as retainer, plus $1,000.00 for each meeting of the Directors attended and for each committee meeting held on a day other than the date of a meeting of the Board of Directors, and reimbursement for their actual travel expenses. Directors who are not officers are paid $500.00 a day for each committee meeting held on the same day as a meeting of the Board of Directors and $250.00 for each telephone conference meeting. Committee members are reimbursed for their actual travel expenses. In addition, outside directors receive options to purchase 5,000 shares of the Non-Voting Class B Stock of the Registrant at a purchase price of the greater fair market value on the date of award or $5.00 on award dates occurring every two years up to a maximum of 15,000 shares per outside director.\nCompensation Committee Interlocks and Insider Participation\nThe Compensation Committee of the Registrant during the fiscal year ended January 29, 1994 was composed of Messrs. Busbee (Chairman), Allbright, Maynard, and Montgomery. None of the members of the Compensation Committee were officers or employees of the Registrant during the last fiscal year or in prior fiscal years. Mr. Maynard is Chairman of the Golden Corral Corporation (\"Golden Corral\"). Golden Corral leases certain restaurant facilities from The Rosemyr Corporation and from Emrose Corporation, two corporations affiliated with certain directors and executive officers of the Registrant. See Item 13 \"Certain Relationships and Related Transactions\" below. Golden Corral paid said corporations a total of $234,832 under these leases during the past fiscal year of the Registrant.\nUntil April 16, 1993, Lucius H. Harvin, III, Chairman of the Board of the Registrant, served as a director of Wachovia Corporation of North Carolina and Wachovia Bank of North Carolina, N.A. (collectively \"Wachovia\"). No executive officer of Wachovia served on the Compensation Committee or the Board of Directors of the Registrant during the last fiscal year. Except for Mr. Harvin's service as a director of Wachovia, none of the executive officers of the Registrant served as a member of the board of directors or as a member of the compensation committee of another entity during the last fiscal year. Consequently, there are no interlocking relationships between the Registrant and other entities that might affect the determination of the compensation of the Directors and executive officers of the Registrant.\nITEM 12:","section_12":"ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the only stockholders known to the Registrant to be the beneficial owners, as of January 29, 1994, of more than five percent (5%) of the Voting Common Stock of the Registrant:\nAmount and Nature of Beneficial Ownership Name and Address (1) Percent of Class\nEmma H. Currigan P.O. Drawer 947 254,000 (D) 3.1% Henderson, NC 27536 173,836 (B) 2.1%\nGeorge M. Harvin P.O. Drawer 947 473,562 (D) 5.7% Henderson, NC 27536 176,618 (B) 2.1%\nLucius H. Harvin, III P.O. Drawer 947 437,224 (D) 5.3% Henderson, NC 27536 174,324 (B) 2.1%\nRose Harvin P.O. Drawer 947 279,784 (D) 3.4% Henderson, NC 27536 173,836 (B) 2.1% _____________________ Footnotes:\n(D) Shares held by direct ownership (B) Shares which may be deemed by the SEC to be beneficially owned but as to which the listed person may have disclaimed beneficial ownership. (1) Includes 695,344 (8.4%) shares of Voting Common Stock beneficially attributed in the table to Emma H. Currigan, George M. Harvin, Lucius H. Harvin, III and Rose Harvin (173,836 shares of Voting Common Stock respectively to each person) who exercise sole voting control and shared investment power to such shares, but does not separately attribute such shares to Mrs. L. H. Harvin, Jr. who shares investment power as to all such shares.\nThe table below gives the indicated information as to both classes of equity securities of the Registrant beneficially owned by each director, nominee, the chief executive officer and the four other most highly compensated executive officers, and, as a group, by such person and other executive officers:\n_______________________\nFootnotes: * Less than 1% of outstanding shares. (a) The following shares are not included in the figures for beneficial ownership by individual directors and executive officers but are included in the total figure for all directors, nominees and executive officers as a group: 229,626 shares of Non-Voting Class B Stock held in the Registrant's Variable Investment Plan; the 579,024 shares of Voting Common Stock shown in the table of principal holders of voting securities of the Registrant which are beneficially attributed as a group to John T. Church, Sr., Lucius H. Harvin, III and George T. Blackburn, II, Trustees and 409,302 shares of Non-Voting Class B Stock attributable to the same persons as trustees.\nITEM 13:","section_13":"ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nJohn T. Church, Sr. retired as a full-time employee of the Registrant on December 31, 1982. The Registrant entered into a Consultation Agreement with Mr. Church at that time. Under an extension of the agreement, Mr. Church was paid $52,500 during the fiscal year which ended January 29, 1994.\nPursuant to existing leases, during the past fiscal year the Registrant paid The Rosemyr Corporation (\"Rosemyr\") $213,809 as rent for its store building in Morganton Shopping Center, Morganton, N.C.; $312,779 for its store building in Newmarket Plaza Shopping Center, Newport News, Va. (Rosemyr owns a 31.5% interest); $4,838 in rent for office space in Henderson, N.C.; and $11,700 for parking facilities in Henderson, N.C. The Registrant leases a store in Nags Head, N.C. (Rosemyr owns a 95% interest). Rental under the lease during the past fiscal year was $151,875. The Registrant leased a store in Tryon Hills Shopping Center, Raleigh, N.C. in which Rosemyr owns a 36\/60ths interest. Rental under the lease during the past fiscal year was $21,000. Eighty percent (80%) of the stock of Rosemyr is owned by Mrs. L.H. Harvin, Jr. and her children and by the Estate and trusts of the late Emma Rose Church, whose beneficiaries are Mr. John T. Church, Sr. (Director of the Registrant), Mrs. E.C. Bacon and Mr. John T. Church, Jr. During the past fiscal year, the Registrant paid Emrose Corporation (\"Emrose\") under pre-existing leases $24,828 in rent for office space in Henderson, N.C. and $12,014 for lease of storage facilities. Also during the past fiscal year, the Registrant paid Arrowhead Plaza Limited Partnership (a partnership in which Emrose owns a 51% interest) $12,487 in rent for a store in Arrowhead Plaza Shopping Center in Norfolk, Virginia. Emrose is owned by Mrs. L.H. Harvin, Jr. and Mr. John T. Church, Sr., Mrs. E.C. Bacon and Mr. John T. Church, Jr. Messrs. John T. Church, Sr. and George M. Harvin, who are directors of the Registrant, are executive officers of Rosemyr and Emrose. The Registrant also paid H.H.C. Co., Inc. (\"H.H.C.\") $142,298 in rent during the past fiscal year for a store building in High Point, N.C. Mrs. L.H. Harvin, Jr. and Mr. John T. Church, Sr. own 61% of the stock of H.H.C. Golden Corral Corporation (\"Golden Corral\") leases certain restaurant facilities from Rosemyr and from Emrose. Golden Corral paid said corporations a total of $234,832 under these leases. James H. Maynard (a Director of the Corporation) is Chairman of Golden Corral.\nIn the opinion of Management, all of the foregoing leases and other transactions are competitive, and the rents paid approximate the rate of rent paid by the Registrant to independent landlords under leases for comparable property negotiated at comparable times, and represent the fair market value for comparable transactions.\nPART IV\nITEM 14:","section_14":"ITEM 14: EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. FINANCIAL STATEMENTS\nIndependent Auditors' Report\nConsolidated Statements of Operations for the years ended January 29, 1994; January 30, 1993 and January 25, 1992\nConsolidated Balance Sheets - January 29, 1994 and January 30, 1993\nConsolidated Statements of Stockholders' Equity for the years ended January 29, 1994; January 30, 1993 and January 25, 1992\nConsolidated Statements of Cash Flows for the years ended January 29, 1994; January 30, 1993 and January 25, 1992\nNotes to the Financial Statements\n2. FINANCIAL STATEMENT SCHEDULES\nIndependent Auditors' Report\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 financial statements or notes thereto.\n3. EXHIBITS\nExhibit No. Page\n10.1 The Registrant's Equity Compensation Plan Incorporated (incorporated by reference to the identified by reference exhibit under the Registrant's Quarterly Report on Form 10-Q for its fiscal quarter ended October 26, 1991)\n10.2 First Amendment to Equity Compensation Plan Incorporated (incorporated by reference to the identified by reference exhibit under the Registrant's Annual Report on Form 10-K for its fiscal year ended January 30, 1993)\n10.3 Second Amendment to Equity Compensation Plan Incorporated (incorporated by reference to the identified by reference exhibit under the Registrant's Annual Report on Form 10-K for its fiscal year ended January 30, 1993)\n10.4 The Registrant's Variable Investment Plan P (the \"Plan\"), as amended and restated effective January 1, 1989.\n10.5 The Registrant's Employment Agreement with Incorporated George L. Jones (incorporated by reference by reference to Exhibit 19 to Registrant's Quarterly Report on Form 10-Q for the Quarter Ended October 26, 1991 dated December 9, 1991).\n10.6 Loan Agreement dated September 20, 1993 Incorporated between the Registrant and General by reference Electric Capital Corporation (Incorporated by reference to Exhibit 10.1 to the Registrant's Current Report on Form 10-K dated September 20, 1993).\n10.7 The Registrant's Severance Program, as P adopted effective March 24, 1994 pursuant to order of the Bankruptcy Court presiding over the Registrant's proceeding under chapter 11 of Title 11 of the United States Code (the \"Court\")\n10.8 The Registrant's obligations with respect to P the compensation of its officers and directors as specified in the following orders of the Court:\n(a) Order Authorizing Compensation of Senior Vice Presidents (dated November 18, 1993)\n(b) Order Authorizing Compensation of Executive Vice Presidents (dated November 18, 1993)\n(c) Order Authorizing Compensation of Vice Presidents and Treasurer (dated November 18, 1993)\n(d) Order Authorizing Compensation of George L. Jones (dated November 18, 1993)\n(e) Order Continuing Compensation of Chairman of the Board of Directors Pending Hearing (dated November 18, 1993)\n(f) Order Authorizing Payment of Compensation to Directors (dated November 18, 1993)\n23. Consent of Independent Certified Public Accountants P\n(b) REPORTS ON FORM 8-K\nNo reports on Form 8-K have been filed by registrant during the last quarter of the period covered by this report.\nINDEPENDENT AUDITOR'S REPORT\nThe Board of Directors Rose's Stores, Inc.:\nUnder date of April 4, 1994, we reported on the consolidated balance sheets of Rose's Stores, Inc., Debtor-in-Possession (the Company), as of January 29, 1994 and January 30, 1993 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended January 29, 1994, contained elsewhere herein. Our report included an explanatory paragraph discussing the Company's voluntary filing for reorganization under Chapter 11 of the United States Bankruptcy Code. Our report also included an additional explanatory paragraph indicating that the Company adopted Statement of Financial Accounting Standards No. 106 in 1992 and changed its method of determining retail price indices used in the valuation of LIFO inventories in 1991. 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. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\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.\nRaleigh, North Carolina KPMG Peat Marwick April 4, 1994\nROSE'S STORES, INC.\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nColumn A Column B Item Charged to Costs and Expenses, Years Ended:\n1-29-94 1-30-93 1-25-92\nMaintenance and Repairs $ 9,074,590 10,099,509 8,956,703 Taxes, Other than Payroll and Income Taxes 5,995,125 6,149,938 6,235,483 Advertising Costs 30,870,842 32,022,144 34,084,177\nMANAGEMENT'S REPORT ON CONSOLIDATED FINANCIAL STATEMENTS\nJanuary 29, 1994\nThe consolidated financial statements on the following pages have been prepared by management in conformity with generally accepted accounting principles. Management is responsible for the reliability and fairness of the financial statements and other financial information included herein. To meet its responsibilities with respect to financial information, management maintains and enforces internal accounting policies, procedures and controls which are designed to provide reasonable assurance that assets are safeguarded and that transactions are properly recorded and executed in accordance with management's authorization. Management believes that the Company's accounting controls provide reasonable, but not absolute, assurance that errors or irregularities which could be material to the financial statements are prevented or would be detected within a timely period by Company personnel in the normal course of performing their assigned functions. The concept of reasonable assurance is based on the recognition that the cost of controls should not exceed the expected benefits. Management maintains an internal audit function and an internal control function which are responsible for evaluating the adequacy and application of financial and operating controls and for testing compliance with Company policies and procedures. The responsibility of our independent auditors, KPMG Peat Marwick, is limited to an expression of their opinion on the fairness of the financial statements presented. Their opinion is based on procedures, described in the second paragraph of their report, which include evaluation and testing of controls and procedures sufficient to provide reasonable assurance that the financial statements neither are materially misleading nor contain material errors. The Audit Committee of the Board of Directors meets periodically with management, internal auditors and independent auditors to discuss auditing and financial matters and to assure that each is carrying out its responsibilities. The independent auditors have full and free access to the Audit Committee and meet with it, with and without management being present, to discuss the results of their audit and their opinions on the quality of financial reporting.\nGeorge L. Jones President and Chief Executive Officer\nR. Edward Anderson Executive Vice President, Chief Financial Officer\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors Rose's Stores, Inc.:\nWe have audited the accompanying consolidated balance sheets of Rose's Stores, Inc., Debtor-in-Possession (the Company), as of January 29, 1994 and January 30, 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended January 29, 1994. 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 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 Rose's Stores, Inc., Debtor-in-Possession, at January 29, 1994 and January 30, 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended January 29, 1994, in conformity with generally accepted accounting principles.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court (Bankruptcy Court) on September 5, 1993. The Chapter 11 filing, the Company's leveraged financial structure, and recurring net losses resulting in the substantial elimination of stockholders' equity, raise substantial doubt about the Company's ability to continue as a going concern. Additionally, as discussed in Note 17 to the consolidated financial statements, on April 4, 1994 the Company announced a first quarter charge aggregating approximately $55 million relating to its plans to close approximately 58 stores during 1994. The Company is currently operating its business as debtor-in-possession under the jurisdiction of the Bankruptcy Court. The continuation of the Company as a going concern is contingent upon, among other things, its ability to (1) formulate a plan of reorganization that will be confirmed by the Bankruptcy Court, (2) achieve satisfactory levels of future profitable operations, (3) maintain adequate financing, and (4) generate sufficient cash from operations to meet future obligations. The consolidated financial statements as of and for the year ended January 29, 1994 do not include any adjustments that might result from the outcome of this uncertainty.\nAs discussed in Note 15 to the consolidated financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" in 1992. As discussed in Note 4 to the consolidated financial statements, the Company changed its method of determining retail price indices used in the valuation of LIFO inventories in 1991.\nKPMG Peat Marwick Raleigh, North Carolina April 4, 1994\nCONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands except per share amounts)\n(a) In 1991, the Company changed its method of accounting for LIFO inventories from the use of the inflation index provided by the Bureau of Labor Statistics to an internally generated price index to measure inflation in the retail prices of its merchandise inventories. This change decreased 1991 cost of sales by $21,428 (or $1.15 per share). Net loss would have been $44,732 in 1991 if the change in accounting method had not been made. (b) The 1991 provision for future store closings and remerchandising represents the anticipated costs of closing approximately 15 stores during fiscal 1992 and costs incurred during fiscal 1992 in the remerchandising of the remaining stores. (c) On September 5, 1993, the Company filed a voluntary petition in the United States Bankruptcy Court for the Eastern District of North Carolina seeking to reorganize under Chapter 11 of the Bankruptcy Code. The consolidated financial Statements contained herein have been prepared in accordance with generally accepted accounting principles applicable to a going concern and do not purport to reflect or to provide for all the consequences of the ongoing Chapter 11 reorganization. Included in the reorganization expense is a provision of $39,500 for the costs of closing 43 stores in January 1994, as well as the DIP fee amortization and expenses, professional fees and other reorganization costs. Offsetting these expenses is a reversal of prior reserves for closings due to the anticipated rejection of closed store leases. (d) In 1992, the Company adopted SFAS 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the Company to accrue health insurance benefits over the period in which associates become eligible for such benefits. The cumulative effect of adopting SFAS 106 was a one-time charge of $5,031.\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED BALANCE SHEETS (Amounts in thousands)\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\n(Amounts in thousands)\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands)\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYears Ended January 29, 1994; January 30, 1993; and January 25, 1992\n(Amounts in thousands except per share amounts)\n1 PROCEEDINGS UNDER CHAPTER 11\nOn September 5, 1993 (the \"Petition Date\"), the Company filed a voluntary petition for Relief under Chapter 11, Title 11 of the United States Bankruptcy Code (the \"Bankruptcy Code\") with the United States Bankruptcy Court for the Eastern District of North Carolina (the Bankruptcy Court). The Company is in possession of its property and is maintaining and operating its property as a debtor-in-possession pursuant to the provisions of Sections 1107 and 1108 of the Bankruptcy Code.\nThe accompanying consolidated financial statements have been prepared on a going concern basis assuming the realization of assets and liquidation of liabilities in the ordinary course of business. However, under Chapter 11, actions to enforce certain claims against the Company are stayed if such claims arose, or are based on events that occurred, before the Petition Date. The terms of the ultimate settlement of these liabilities will be determined based upon a plan of reorganization to be confirmed by the Bankruptcy Court. Such liabilities are reflected in the Consolidated Balance Sheets as liabilities subject to settlement under reorganization proceedings. Additional liabilities subject to settlement may arise subsequent to the Petition Date as a result of claims filed by parties affected by the Company's rejection of executory contracts, including leases, and from the Bankruptcy Court's resolution of allowed rejection of executory contracts, including leases, and from the Bankruptcy Court's resolution of allowed claims for contingencies and other disputed amounts. During 1993, the Company endeavored to notify all known potential creditors of the filing for the purpose of identifying all pre- petition date claims. Generally, creditors had until the January 13, 1994 \"Bar Date\" to file claims. The Company is actively negotiating with creditors to reconcile and resolve the balance of disputed claims totaling approximately $150,000. A significant portion of this amount is comprised of disputed claims that, in the opinion of management, will not result in additional liability to the Company.\nUnder Section 1121 of the Bankruptcy Code, for 120 days after the date of the filing of a voluntary petition for relief under Chapter 11, only the debtor-in-possession has the right to propose and file a plan of reorganization with the Bankruptcy Court. If a debtor-in-possession files a plan of reorganization during the 120-day exclusivity period, no other party may file a plan of reorganization until 180 days after the date of filing of the Chapter 11 petition, during which period the debtor-in-possession has the exclusive right to solicit acceptances of the plan. If a debtor-in-possession fails to file a plan during the 120-day exclusivity period or such additional period as may be ordered by the Bankruptcy Court or, after such plan has been filed, fails to obtain acceptance of such plan from impaired classes of creditors and equity security holders during the exclusive solicitation period, any party in interest, including a creditors' committee, an equity security holders' committee, a creditor, an equity security holder, or any indenture trustee may file a plan of reorganization for such debtor. Additionally, if the Bankruptcy Court were to appoint a trustee, the exclusivity period, if not previously terminated, would terminate.\nThe Company has not yet filed a plan of reorganization with the Bankruptcy Court and has obtained from the Bankruptcy Court an extension of the exclusivity period to May 31, 1994. The Company intends to file a plan of reorganization prior to May 31, 1994.\nAfter a plan of reorganization has been filed with the Bankruptcy Court, it will be sent, together with a disclosure statement approved by the Bankruptcy Court following a hearing, to members of all classes of impaired creditors and equity security holders for acceptance or rejection. Following acceptance or rejection of any plan by impaired classes of creditors and equity security holders, the Bankruptcy Court after notice and a hearing would consider whether to confirm the plan. Among other things, to confirm a plan the Bankruptcy Court is required to find (i) with respect to each impaired class of creditors and equity security holders, that each holder of a claim or interest of such class either (a) will, pursuant to the plan, receive or\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nretain property of a value, as of the effective date of the plan, that is at least as much as such holder would have received in a liquidation on such date of the Company, or (b) has accepted the plan, (ii) with respect to each class of claims or equity security holders, that such class has accepted the plan or such class is not impaired under the plan and (iii) confirmation of the plan is not likely to be followed by the liquidation or need for further financial reorganization of the Company or any successors unless such liquidation or reorganization is proposed in the plan.\nUnder the Bankruptcy Code, the rights of stockholders and pre-petition creditors may be substantially altered by the plan of reorganization, either voluntarily or by order of the Bankruptcy Court. The Company's objective is a plan of reorganization that will permit the Company to fund its current operations and meet its obligations to creditors (as they may be restructured under the plan) out of the cash flow generated by the Company after approval and confirmation of the plan. The Company's objective is subject to a number of factors, some of which are within the ability of the Company to control and others of which are not. At this time it is not possible to predict whether the Company will achieve its objective or the effect of the plan of reorganization on the rights of creditors and stockholders of the Company.\nOn confirmation of a plan of reorganization, the Company expects to utilize \"Fresh Start Accounting\" in accordance with the guidelines for accounting for emergence from bankruptcy. Fresh Start Accounting is expected to result in a restatement of Company assets to reflect current values.\n2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGoing Concern Basis The Company's consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the payment of liabilities in the ordinary course of business, in accordance with the American Institute of Certified Public Accountants' Statement of Position 90-7, \"Financial Reporting by Entities Under the Bankruptcy Code.\" Substantially all current and long-term liabilities existing at the time the petition for reorganization under Chapter 11 was filed have been reclassified as liabilities subject to settlement under reorganization proceedings. The financial statements do not include any adjustments or reclassifications that might be necessary should the Company be unable to continue in existence.\nConsolidated Financial Statements The Company's consolidated financial statements include the accounts of a wholly-owned subsidiary. Intercompany accounts and transactions are eliminated.\nFiscal Year Fiscal years 1993, 1992 and 1991 ended on January 29, 1994; January 30, 1993; and January 25, 1992, respectively. Fiscal year 1993 contained 52 weeks; fiscal year 1992 contained 53 weeks and fiscal year 1991 contained 52 weeks.\nCash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Interest-bearing cash equivalents are carried at cost, which approximates market. Bank drafts outstanding have been reported as a current liability.\nInventories Substantially all merchandise inventories are valued on a last-in, first-out (LIFO) cost basis.\nRevenue Sales are recorded at the time merchandise is exchanged for tender. The Company does not make any warranties on the merchandise sold, but allows customers to return merchandise which reduces sales. In many cases, the Company returns damaged goods to the vendor for credit or has negotiated a damage allowance to offset the cost of writing off the merchandise. In the case of layaways, sales are recorded for the total amount of the merchandise when the customer puts it on layaway. If the layaway is not paid in full by the end of 60 days, the Company's policy is to cancel the layaway, reduce sales and return the merchandise to stock.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDepreciation and Amortization The provision for depreciation and amortization is based upon the estimated useful lives of the individual assets and is computed principally by the declining balance and straight-line methods. The principal lives for depreciation purposes are 40 to 45 years for buildings and 5 to 10 years for furniture, fixtures, and equipment. Improvements to leased premises are amortized by the straight-line method over the term of the lease or the useful lives of the improvements, whichever is shorter. Capitalized leases are generally amortized on a straight-line basis over the lease term.\nStore Pre-Opening Expenses Pre-opening expenses associated with the opening of new stores are charged to expense as incurred.\nProfit-Sharing Plan The Company has a noncontributory trusteed profit-sharing plan for eligible associates. The amount of the contribution is determined by a formula plus additional amounts authorized by the Board of Directors, but may not exceed the maximum allowable deduction for income tax purposes. The plan may be terminated at any time, and if terminated, the Company will not be required to make any further contributions to the trust.\nIncome Taxes In 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 31, 1993, the Company adopted Statement 109 and reported that the cumulative effect of that change in the method of accounting for income taxes in the 1993 consolidated statement of operations is immaterial.\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.\nReclassifications Certain reclassifications were made to 1992 balances to conform to the 1993 presentation. These reclassifications have no effect on stockholders' equity as previously reported.\nEarnings (Loss) Per Share Earnings (loss) per share is computed on the weighted average number of shares outstanding during the year. The average number of shares used to compute earnings (loss) per share was 18,740 shares in 1993; 18,638 shares in 1992; and 18,593 shares in 1991. The exercise of outstanding stock options and warrants would result in an anti-dilutive effect on earnings (loss) per share and are excluded from the calculation.\nPostretirement Health Insurance Benefits The Company provides health insurance benefits for retirees who meet minimum age and service requirements and are covered by the medical plan at retirement. Beginning in 1992, the Company recognizes the cost of retiree health insurance benefits over the associates' period of service.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3 ACCOUNTS RECEIVABLE\nAccounts Receivable are comprised of layaway receivables ($3,262 and $4,574 in 1993 and 1992, respectively) and other receivables ($11,795 and $8,710 in 1993 and 1992, respectively). Other receivables consist primarily of amounts due from vendors for returns, co-op advertising, shoe department income, and coupons.\nThe Company does not provide for an allowance for doubtful accounts for layaways because the Company holds the merchandise or for other receivables because the Company expects uncollectible amounts to be immaterial as deductions can be taken against future amounts due to vendors.\n4 INVENTORIES\nA summary of inventories as of January 29, 1994 and January 30, 1993 is as follows:\nFiscal Years 1993 1992 Inventories valued at FIFO cost $ 237,579 268,638 LIFO reserve (34,429) (35,596) Inventories substantially valued at LIFO cost $ 203,150 233,042\nIn the fourth quarter of 1991, the Company changed its method of accounting for LIFO inventories. Prior to 1991, the Company used the inflation index provided by the Bureau of Labor Statistics to measure inflation in retail prices. In 1991, the Company developed and used internal price indices to measure inflation in the retail prices of its merchandise inventories. The Company believes the use of internal indices results in a more accurate measurement of the impact of inflation in the prices of merchandise sold in its stores. This change resulted in a LIFO credit of $10,323 compared to a charge of $11,105 that would have been recorded if the accounting change had not been made; therefore, the accounting change had the effect of decreasing cost of sales by $21,428 (or $1.15 per share) in 1991.\nDuring 1993 and 1992, inventories were reduced, resulting in the liquidation of LIFO inventory layers. The effect of this inventory liquidation was a reduction in the costs related to closed stores of approximately $1,347 in 1993, and an increase in cost of sales by approximately $3,564 in 1992.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n5 PROPERTY AND EQUIPMENT\nProperty and equipment consists of the following:\n6 DEBT\nDebt outstanding was as follows:\nAs a result of the Company's Chapter 11 filing on September 5, 1993 (See Note 1), debt and accrued interest at the time of filing totaling $91,861 have been reclassified as \"Liabilities Subject to Settlement Under Reorganization Proceedings\" (See Note 7). The Company wrote-off the unamortized balance of deferred financing costs of $4,528 associated with the long-term debt as it was determined no future benefit would be realized from these costs. The write-off is included in reorganization costs for the year ended January 29, 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nGenerally, under the Bankruptcy Code, interest on pre- petition claims ceases accruing upon the filing of a petition; however, if the claims are collateralized by an interest in property with value (less the cost of preserving such property) exceeding the amount of the debt, post- petition interest may be payable. No determination has yet been made regarding the value of the property which allegedly collateralizes various creditors' claims. While there can be no certainty that post-petition interest will be payable or paid, interest may be paid pursuant to an order of the Bankruptcy Court. In the absence of such an order, no principal or interest payments will be made until a plan of reorganization defining such repayment terms is confirmed. The Bankruptcy Court has ordered the Company to make adequate protection payments to various creditors. Although payments have been made without prejudice to any such future determination of payment classification, certain monthly payments made since September 5, 1993 have been booked as interest expense. Additional adequate protection payments were made to various creditors in January 1994 as described more fully below.\nOn May 29, 1992 the Company signed an agreement with its long-term lenders to restructure the principal payments of its long-term debt. The agreement resulted in a six and one-half year amortization of the then outstanding long-term notes of $102,500. The restructuring of the term note required a fee payment. The agreement with some of the long-term lenders granted them warrants exercisable into the Company's Non-Voting Class B stock at an option price of $5 per share. Also on May 29, 1992, the Company signed an agreement with its banks to provide revolving credit facilities through May 31, 1994, including an amount designated for letters of credit related to imports. The Company pledged inventories located in approximately 50% (currently 64% of remaining stores) of its stores and a collateral pool of $26,500 to its long- term lenders and banks. The $26,500 collateral pool consisted of the Company's Distribution Center and, to the extent necessary, the inventory located in the Distribution Center. In addition, all other property and equipment were pledged as collateral. The Company also pledged approximately $3,000 of inventory to a long-term lender to collateralize the lender's deferral of previously scheduled payments.\nAt the time of the Company's filing on September 5, 1993, debt and accrued interest totaling $92,762 were outstanding under its long-term notes and debt and accrued interest totaling $15,617 were outstanding under its revolving credit facilities. The Bankruptcy Court ordered the Company to make certain adequate protection payments relating to cash collateral and proceeds resulting from the stores closed in January 1994 that were pledged to its lenders and banks. In January 1994, the Company made adequate protection payments totaling $16,518 to its lenders in accordance with the related Bankruptcy Court orders. Although the payments were made without prejudice to any such future determination of payment classification, the payments were applied against debt and accrued interest outstanding as of September 5, 1993, in accordance with the applicable loan documents. The Company entered into a Debtor-in-Possession Revolving Credit Agreement dated as of September 20, 1993, (the \"DIP Facility\") with G. E. Capital Corporation, as lender, under which the Company is allowed to borrow or issue letters of credit up to $125,000 for general corporate purposes, subject to certain restrictions defined in the DIP Facility. The term of the DIP Facility is for twenty-four months unless extended by the lender and the Bankruptcy Court upon request by the Company. On October 14, 1993, a motion was entered in Bankruptcy Court authorizing the Debtor-in-Possession to borrow funds with priority over administrative expenses and secured by liens on property of the Company, subject to certain defined restrictions as further amended on January 31, 1994. The DIP Facility included limitations on capital expenditures, limitations on the incurrence of additional liens and indebtedness, limitations on the sale of assets, limitations on adequate protection payments, and a prohibition on paying dividends. The DIP Facility also includes financial covenants pertaining to EBITDA (earnings before interest, taxes, depreciation, and amortization) and net cash flows. The DIP Lender has a super-priority claim against the property of the Company, other than real property.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe DIP Facility has a sub-limit of $35,000 for the issuance of letters of credit. As of January 29, 1994, approximately $19,316 in letters of credit were outstanding.\nAt the Company's option, the Company may borrow at an index rate, which is the highest prime or base rates of interest quoted by specified banks or the latest annualized yield on 90 day commercial paper, plus 1.25% or at the LIBOR rate plus 2.25%. Although there are no compensating balance requirements, the Company is required to pay a fee of .5% per annum of the average unused portion of the DIP Facility.\nAt January 29, 1994, no borrowings were outstanding under the DIP Facility. The average borrowings amount under the facility was $27,781 with a daily weighted average annual interest rate of 5.9%. The maximum amount of borrowings outstanding under the DIP Facility at any period end was $33,930.\nThe average amount of short-term borrowings under the Company's revolving credit facilities prior to September 5, 1993, was $6,767 with a daily weighted average annual interest rate of 9.0%. The maximum amount of short-term borrowings at any period-end under the Company's revolving credit facilities prior to September 5, 1993, was $15,500.\nNo short-term borrowings were outstanding at January 30, 1993 and January 25, 1992. The average amount of short-term debt outstanding was $10,849 for 1992 and $30,145 for 1991 with daily weighted average interest rates of 9.3% and 8.9%, respectively. The maximum amount of short-term debt outstanding at any period-end was $40,500 in 1992 and $58,000 in 1991.\n7 LIABILITIES SUBJECT TO SETTLEMENT UNDER REORGANIZATION PROCEEDINGS\nLiabilities subject to settlement under the reorganization proceedings have been separately classified and consist of the following:\nFiscal\nPre-petition debt and interest $ 91,861\nAccounts payable 85,057\nLease rejection claims 21,314\nAccrued liabilities 9,224\n$207,456\nIncluded in current liabilities is $4,000 related to estimated vendor reclamation claims for merchandise received immediately prior to the filing date. Under the terms of the bankruptcy, once court approval is obtained, such claims may be settled in full currently for 60% of their agreed upon value or partially with 42% being paid currently and the remaining portion settled with other administrative claims.\nActions to enforce liabilities subject to settlement are stayed while the Company is under the protection of the Bankruptcy Code. As part of the Chapter 11 reorganization process, the Company has endeavored to notify all known or potential creditors of the Filing for the purpose of identifying all pre-petition claims against the Company. Generally, creditors whose claims arose prior to the Petition Date had until the January 13, 1994 \"Bar Date\" to file claims or be barred from asserting claims in the future, except in instances of claims arising from the subsequent rejection of executory contracts by the Company, the Company's subsequent recovery of property transferred to claimants prior to September 5, 1993, and for claims related to certain other items including income taxes.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe Company is actively negotiating with creditors to reconcile and resolve the balance of disputed claims totaling approximately $150,000. A significant portion of this amount is comprised of disputed claims that, in the opinion of management, will not result in additional liability to the Company. The additional liability, if any, relating to the remainder of outstanding disputed claims is not subject to reasonable estimation. As a result, no provision has been recorded for these claims. The Company will recognize the additional liability, if any, as these amounts become subject to reasonable estimation.\nAdditional bankruptcy claims and pre-petition liabilities may arise from the termination of other contractual obligations and the settlement of disputed claims. Consequently, the amount included in the consolidated balance sheet as liabilities subject to settlement under reorganization proceedings may be subject to further adjustment.\n8 INTEREST EXPENSE\nInterest expense consisted of the following:\nFiscal Years 1993 1992 1991 Long-term debt $ 9,629 10,559 9,423 Short-term debt 917 1,004 2,647 Capital leases 579 794 1,100 Other 929 1,524 754 Interest expense $12,054 13,881 13,924\nThe Company paid interest of $10,747 in 1993, including $299 related to the DIP facility classified as reorganization expense, $17,235 in 1992 and $15,325 in 1991.\n9 RESERVE FOR FUTURE STORE CLOSINGS AND REMERCHANDISING\nNegatively impacting the results of 1991 was a $33,891 provision for future store closings and remerchandising. $24,891 of this charge provided for the closing expenses of approximately 15 stores closed in 1992 including expected losses on dispositions of related store fixtures and the present value of anticipated future rental payments on these stores. The remaining $9,000 of the provision related to the payroll costs and inventory reductions that were incurred in 1992 in order to make a significant change in the Company's merchandise mix.\nThe closed store reserve was increased by $39,500 in 1993 to provide for the effect of 43 stores closed in January 1994. This expense was offset by $13,026 relating to the rejection of certain closed store leases during the reorganization process. Included under liabilities subject to settlement under reorganization proceedings is $21,314 related to closed store lease rejection claims.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe closed store reserve has decreased by $8,153 in 1993 and $24,944 in 1992. Following are the cash and noncash items charged to the reserves in 1993 and 1992:\nThe cash expenses include the operating results until closing, rental payments and costs of removing fixtures from closed stores, and the payroll costs and inventory reductions associated with the remerchandising.\n10 STOCKHOLDERS' EQUITY\nThere are 30,000 shares (with no par value per share) each of Voting Common and Non-Voting Class B Stock authorized. The number of shares issued and outstanding was as follows:\nFiscal Years\n1993 1992 Voting Common Stock 8,262 8,262 Non-Voting Class B Stock 10,496 10,422 Total 18,758 18,684\nOn January 24, 1991, the Board of Directors adopted a resolution suspending the payment of dividends until future operating profits warrant reinstatement. Among other things, the Company's DIP Facility includes restrictions on the payment of cash dividends and the repurchase of stock. At January 29, 1994, such restrictions preclude the payment of dividends or the repurchase of stock. In addition, the Company is precluded from paying dividends while the Chapter 11 case is pending and the Registrant does not believe it is likely that it will pay dividends for the foreseeable future following termination of the Chapter 11 case.\n11 STOCK OPTIONS\nThe Company's Equity Compensation Plan, which was approved by the stockholders on May 22, 1991, is designed to benefit the executives and key employees of the Company by allowing the grant of a variety of different types of equity-based compensation to eligible participants. The plan provides for the granting of a maximum of 1,500 shares of Non-Voting Class B Stock. One half of the options are exercisable one year after the date of grant with the balance exercisable two years after grant date. The option price per share is equal to the fair market value on the date of grant for all options granted prior to June 1992. Effective June 1992, the option price per share is equal to the greater of $5 or the fair market value on the date of grant.\nOn October 19, 1992, the Board of Directors approved the Adjunct Stock Plan for officers of the Company for issuance as of November 2, 1992, and authorized 842 shares of the Non-Voting Class B Stock currently held as treasury shares to be made available for issuance under the Equity Compensation Plan. This plan was approved by stockholders on May 26, 1993. The stock options granted to the officers are contingent on a stock price of $15 being attained during the three-year period beginning November 2, 1992 and the stock price remaining above $12 for at\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nleast 30 days thereafter. The option price is $5.\nOn May 26, 1993, the stockholders approved a provision for nondiscretionary grants of stock options to Outside Directors with an initial grant dated January 1, 1993. The stock options granted to Outside Directors consist of an option to purchase 5 shares of Non-Voting Class B Stock. Each Outside Director is entitled to receive a maximum of three such awards. The exercise price per share for each Outside Director is the greater of the fair market value as of each option grant date or $5. Each award of a nondiscretionary stock option to Outside Directors is fully vested and may be exercised in full or in part. These options cease to be exercisable three months after the optionee ceases to be an Outside Director, unless attributable to death or disability, in which case such option expires one year thereafter. The Company has granted 55 shares to Outside Directors year- to-date at an exercise price of $5 per share.\nInformation regarding the Company's stock option plan is summarized below:\nPrice Number of Range Shares\nOutstanding, January 25, 1992 $2.50 - 7.00 1,379 Granted 3.63 - 6.22 275 Exercised 2.50 - 3.88 (101) Canceled 2.50 - 6.38 (212) Outstanding, January 30, 1993 2.50 - 7.00 1,341 Granted 5.00 - 6.31 687 Exercised 2.50 - 4.75 (74) Canceled 2.50 - 6.69 (224) Outstanding, January 29, 1994 2.50 - 7.00 1,730 Exercisable, January 29, 1994 2.50 - 7.00 1,274\n12 REORGANIZATION COSTS\nProfessional fees and expenditures directly related to the filing have been segregated from normal operations and are disclosed separately. The major components of these costs for fiscal 1993 are as follows:\nClosed store provision $ 39,500\nClosed store lease rejections (13,026)\nDIP financing fees and expense\namortization 1,238\nWrite-off of pre-petition debt\nissue costs 4,528\nProfessional fees and other bankruptcy related expenses 6,898\nTotal reorganization costs $ 39,138\nThe store closing provision covers both the costs incurred in closing 43 stores in January, 1994, together with penalties to be incurred upon the rejection of related building and personal property leases. Offsetting these expenses is a reversal of prior reserves for closings due to the rejection of closed store leases.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n13 INCOME TAXES\nEffective January 31, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" As permitted under the new rule, prior years' financial statements have not been restated. The cumulative effect of adopting this Statement as of January 31, 1993 was immaterial to net earnings.\nThe components of income taxes (benefits) were as follows:\nFiscal Years 1993 1992 1991 Taxes currently payable (receivable): Federal $ - (7,578) (4,930) State - (21) (395)\n- (7,599) (5,325) Deferred: Federal - 6,650 10,095 State - - 9 - 6,650 10,104 $ - (949) 4,779\nA reconciliation of income taxes (benefits) from federal\nstatutory rates to actual tax rates follows:\nAs discussed above, the company changed its method of accounting for income taxes from the deferred method to the liability method. The objective of the liability method is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled.\nThe significant components of deferred income tax expense for the year ended January 29, 1994 are as follows:\nDeferred tax expense (exclusive of the effects of other components listed below) $(22,674) Increase in beginning-of-the-year balance of the valuation allowance for deferred tax assets 22,674 -\nNOTES 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 January 29, 1994 are presented below:\nDeferred Deferred Tax Tax Assets Liabilities Depreciation $ - 2,579 Vacation pay accrual 1,300 - Self insurance 2,454 - Accrued store closing costs 17,131 2,295 LIFO - 6,444 Postretirement health insurance 2,395 - Net operating loss carryovers 36,984 - TJTC carryforwards 738 - Altmin credit carryforwards 427 - Other 3,441 560\n64,870 11,878 Valuation allowance (52,992) - Total $11,878 11,878\nDeferred income taxes prior to January 31, 1994 generally resulted from timing differences in the recognition of income and expense for tax and financial statement purposes. Such timing differences related primarily to closed stores, depreciation, and the remerchandising reserve. For 1991, $8,970 of deferred tax assets were written off as having no realizable value. The deferred tax assets that were written off represented the deferred taxes primarily resulting from the 1990 and 1991 accruals of closed store expenses. The write-down of deferred tax assets in 1991 was necessary because 1991 year-end deferred tax assets would have exceeded the potential Federal and State carrybacks that remained after the carryback of the 1991 NOL. Additional tax losses incurred during 1992 consumed the remaining deferred tax assets with the resulting NOL, thus eliminating the need for an additional write-off.\nFor the years ended January 30, 1993 and January 25, 1992, deferred income tax expense of $6,650 and $10,104, respectively, results from timing differences in the recognition of income and expense for income tax and financial reporting purposes.\nThe changes to deferred taxes were as follows:\nFiscal Years 1992 1991\nWrite-down of excess deferred tax assets $ - 8,970 LIFO (249) 8,850 Remerchandising reserve 2,383 (3 717) Closed stores 3,998 (3,672) Depreciation (551) (842) Deferred income 372 533 Insurance 633 (357) Compensation (31) (152) Capitalized inventory costs 145 117 Other (50) 374 $6,650 10,104\nThe Company has federal net operating loss income tax carryforwards totaling $108,776. These carryforwards consist of $63,434 from 1992 and $45,342 from 1993 that expire in January, 2008 and 2009, respectively, and will be available to reduce future federal income tax liabilities.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n14 LEASED ASSETS AND LEASE COMMITMENTS\nThe Company has entered into leases for store locations which expire during the next 20 years. Computer equipment, transportation equipment and certain other equipment are also leased under agreements which will expire during the next five years. Management expects that leases which expire in the normal course of business will be renewed or replaced by other leases. Under Chapter 11, the Company may renegotiate or reject leases that it may otherwise have retained had no filing been made.\nAt January 29, 1994, minimum rental payments due under the above leases are as follows:\nExecutory costs, such as real estate taxes, insurance, and maintenance, are generally the obligation of the lessor.\nAmortization of capitalized leases was approximately $2,191 in 1993, $2,345 in 1992, and $3,402 in 1991.\nTotal rental expense for the three years ended January 29, 1994 was as follows:\nFiscal Years 1993 1992 1991 Operating Leases: Minimum rentals $40,842 42,652 45,537 Contingent rentals 5,205 10,254 10,050 $46,047 52,906 55,587\nContingent rentals are determined on the basis of a percentage of sales in excess of stipulated minimums for certain store facilities and on the basis of mileage for transportation equipment.\nThe Company is a guarantor on leases of property which have been re-leased to other parties. The amount of the outstanding minimum rentals over the next one to five years under those leases was $3,637 at January 29, 1994.\nIncluded in rent expense was $908 for 1993, $1,071 for 1992, and $974 for 1991, paid to lessors controlled by or affiliated with certain current directors of the Company.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n15 POSTRETIREMENT HEALTH INSURANCE BENEFITS\nThe Company provides health insurance benefits for retirees who meet minimum age and service requirements. In addition, the associate must be covered under the active medical plan at the time of retirement to be eligible for postretirement benefits and must agree to contribute a portion of the cost. The Company has the right to modify or terminate these benefits, including the retiree contribution. The plan is not funded.\nIn 1992, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" (SFAS 106), retroactive to January 26, 1992. SFAS 106 requires the Company to recognize the cost of retiree health insurance benefits over the associates' period of service. The cumulative effect of adopting SFAS 106 was a one-time charge to net earnings of $5,031.\nThe periodic postretirement benefit cost under SFAS 106 was as follows:\nNet Periodic Postretirement Benefit Costs: Fiscal Years 1993 1992 Service costs $ 203 181 Interest costs 451 426 Other 12 - $ 666 607\nThe present value of accumulated postretirement benefit obligations\nand the amount recognized in the consolidated balance sheets were as follows:\nAccumulated Postretirement Benefit Obligations: Fiscal Years 1993 1992 Retirees $1,730 1,710 Fully eligible active plan participants 1,577 1,251 Other active plan participants 3,738 3,054 7,045 6,015 Unrecognized Loss (1,431) (719) Total accumulated postretirement benefit obligations $5,614 5,296\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.0% for 1993 and 8.5% for 1992.\nAn increase in the cost of health insurance benefits of 9% was assumed for fiscal year 1994. The rate is assumed to decline gradually to 5% in 2001, and remain at that level thereafter. A 1% increase in the health-care cost trend rate would increase the accumulated postretirement benefit obligation at January 29, 1994, by $605 and the 1993 annual expense by $67.\n16 CONTINGENCIES\nCertain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against the Company. In the opinion of management and counsel, all material contingencies are either adequately covered by insurance or are without merit.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n17 SUBSEQUENT EVENTS\nOn April 4, 1994, the Company announced plans to close approximately 58 additional stores. An additional reorganization expense of approximately $55,000 will be included in the first quarter of 1994 to provide for these closings. The following reflects, on a proforma basis, the impact of these store closings on the consolidated balance sheet as of January 29, 1994:\n18 QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nFollowing is a summary of the quarterly results of operations during the years ended January 29, 1994 and January 30, 1993:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(a) Included in the fourth quarter of 1993 reorganization cost is a $5,000 reduction of a $44,500 third quarter charge taken for the estimated costs of closing 43 stores in January 1994. Included in 1993 reorganization costs, in addition to the costs of closing the 43 stores, are DIP fee amortization and expenses, professional fees and other reorganization costs. Offsetting these expenses is a reversal of prior provisions for closings due to the anticipated rejections of closed store leases.\n(b) In 1992, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the Company to accrue health insurance benefits over the period in which associates become eligible for such benefits. The cumulative effect of adopting SFAS 106 was a one-time charge of $5,031.","section_15":""}
{"filename":"37481_1994.txt","cik":"37481","year":"1994","section_1":"ITEM 1.\tBUSINESS \tFlightSafety International, Inc., a New York corporation (the \"Company\"), was organized in 1951. The Company is engaged in the business of providing high technology training to operators of aircraft and ships. The Company owns and operates the largest civil aviation simulator fleet in the world, consisting of more than 165 simulators and training devices. \tThe Company operates primarily in one industry segment which is training. The Company is also engaged in the design, manufacture and sale of full-motion flight simulators and other training equipment through its Simulation Systems Division (the \"Simulation Division\") and visual displays and systems for flight simulators through its Visual Simulation Systems Division (the \"Visual Division\"). The Company's Instructional Systems Division (the \"Instructional Division\") develops classroom presentation systems, interactive computer-based software, courseware and manuals primarily for the Company's educational and training activities and is not considered an industry segment. \tTraining revenues amounted to 90% of operating revenues in 1994, 82% in 1993 and 86% in 1992, while product sales by the Simulation Division and Visual Division (for 1994 and 1993 only) to unaffiliated customers were 10% of operating revenues in 1994, 18% in 1993 and 14% in 1992. Sales of products to unaffiliated customers developed by the Instructional Division were not material for these periods and were included in the Company's training revenues. Further financial information regarding the Company's industry segments (including identifiable assets by segment) can be found in the Company's consolidated financial statements (and notes thereto) which are incorporated by reference in Part II of this Form 10-K. \tThe Company's activities include (a) advanced pilot training in the operation of aircraft and air traffic control procedures, (b) air crew training for military and other governmental personnel, (c) aircraft maintenance technician training, (d) ab-initio (primary) pilot training to qualify individuals for private or commercial pilot licenses, (e) ship handling and related training through the Company's wholly-owned subsidiary, MarineSafety International, Inc. (\"MarineSafety\"), (f) the design and manufacture of full-motion flight simulators and other training equipment through the Company's Simulation Division, (g) the design and manufacture of visual displays and systems used for flight simulators through the Company's Visual Division and (h) the development of instructional methods and materials through its Instructional Division.\n\tMuch of the Company's training is conducted on simulators, which incorporate advanced computer-based technology to replicate, with a high degree of accuracy, certain sights, sounds, movements and control responses in order to reproduce the total environment experienced by the operator of a particular aircraft or ocean-going vessel. Such simulators are used in the Company's aviation and marine training programs. Through the Simulation Division, the Company manufactures training equip -ment, including flight simulators, and is complemented by the Visual Division which produces visual systems for flight simulators, both of which are primarily for use in the Company's training operations and for sale to unaffiliated parties. \tAdvanced pilot training accounted for 65% of the Company's operating revenues in 1994 and 61% in 1993 and 1992; government crew training accounted for 18% of the Company's operating revenues in 1994, 16% in 1993 and 17% in 1992. \tThe Company's training activities are conducted primarily in the United States. The Company also maintains two learning centers in Canada, one learning center in Paris, France and one learning and research center in Rotterdam, the Netherlands. Many foreign aircraft operators use the Company's U.S. learning centers to train their crews. Export product sales, consisting of simulators and visuals, were four percent of operating revenues in 1994, 12% in 1993 and 10% in 1992. Further information regarding the Company's export sales can be found in the Company's consolidated financial statements (and notes thereto) which are incorporated by reference in Part II of this Form 10-K.\n1.\tAdvanced Pilot Training \tThe Company's advanced pilot training consists of initial and recurrent courses in the operation and performance of various aircraft. A majority of this training is provided to pilots employed by corporations and in general business aviation. Such training includes ground school instruction in air traffic control and international flight procedures, navigation, meteorology, crew resource management, Federal Aviation Administration (\"FAA\") regulations and aircraft performance and systems. Training is also conducted on full-motion simulators, which replicate the in-flight performance and characteristics of a particular aircraft, and on training devices, including cockpit systems simulators and cockpit procedures trainers, which familiarize the student with general flight procedures and cockpit instruments. In-flight instruction is normally provided in the customer's own aircraft, although the Company occasionally leases aircraft for this purpose. The Company uses its own aircraft when providing primary pilot training. \tThe most significant aspect of the Company's advanced pilot training program is the training conducted on sophisticated simulators. Such simulators recreate the pilot's total cockpit environment, including all flight instrumentation. The cockpit section of the simulator is connected to computers which reproduce the conditions and movements of actual flight for the trainee who sits at the controls within the cockpit. A large hydraulically powered platform, together with the instruments within the cockpit, is connected to complex digital computer systems which move the cockpit and adjust the instrument readings in response to either the actions of the trainee or those of the instructor at a separate control station. The instructor may program the computers to change flight conditions, aircraft performance and airport approaches as desired. Training in a simulator enables a pilot to practice and perfect procedures and techniques (including emergency maneuvers which would be hazardous to attempt in actual flight) in a controlled environment, eliminating the danger of using the aircraft itself and at a substantial cost reduction. In addition, Federal Aviation Administration (\"FAA\") regulations related to certain sophisticated simulators (Level \"C\" and Level \"D\") have expanded the permissible use of such simulators in pilot evaluation and certification such that many certifications can be achieved without flying the actual aircraft. \tThe Company maintains agreements with more than 20 aircraft manufacturers pursuant to which the manufacturer has designated the Company as its authorized training organization. Under these agreements, the Company provides initial training to crews of aircraft purchased from the manufacturer at a fixed fee per aircraft paid by the manufacturer. Many of the Company's learning centers are located near a manufacturer's factory or service center which facilitates access to technical information provided during training. This decentralized system is also designed to locate learning centers near actual and potential customers. \tAdvanced pilot training is offered to flight crews (pilots, co- pilots and engineers) in order to (i) instruct such crews in the operation of new or different types of aircraft thereby enabling them to obtain \"type ratings\", where applicable, on their pilots' licenses and (ii) keep such crews proficient by providing recurrent training courses in the latest safety and flight procedures relating to such aircraft. Pursuant to certain FAA regulations for pilot checking, testing and certification, no person may act as a pilot-in-command of an aircraft unless such person has accomplished a flight review within the preceding 24 months and, if the aircraft is type certificated for more than one required pilot, such person must have satisfactorily completed prescribed proficiency checks within the preceding 12 months. At the pilot's option, both the 12-month and 24-month proficiency checks can be accomplished in an FAA Level \"C\" or Level \"D\" approved simulator. In addition, depending on the type of operation, the flight crewmember may be required to complete periodic recurrent training. All of this recurrent training can also be accomplished in an FAA-approved Level \"C\" or Level \"D\" simulator. \tIn addition to training provided pursuant to agreements with aircraft manufacturers, the Company provides training for type-ratings and recurrent training courses pursuant to agreements with the air crew member's employer. Under such agreements, the customer pays an annual course fee which provides for training to proficiency of up to two different types of aircraft and incorporates training in simulators. Alternatively, the customer may elect to pay for each course or training as taken rather than enter into such agreements. \tThe Company also expanded its training of pilots employed by some domestic and foreign commercial air carriers (both regional and major carriers) with the addition of new concept air carriers and continues to provide access to its training equipment to pilots employed by other air carriers in which they provide their own instruction. FAA regulations require all pilots employed by domestic commercial carriers flying aircraft above a certain weight to pass examinations with respect to their proficiency in handling the type of aircraft which they fly and to undergo recurrent training every six months. While the majority of air carriers, particularly the major airlines, provide all training (including simulator-based training) necessary to enable their pilots to comply with FAA requirements, certain major airlines have used the Company's Airbus A-310, Fokker 100, McDonnell Douglas (\"MD\") DC-9, MD-80 and MD-88\/87 and Boeing 727, 737, 757 and 767-300ER simulators for this purpose. Foreign air carriers, while not subject to the same FAA regulations, also engage the Company to provide their pilots with initial training and recurrent courses in various types of aircraft. In addition, regional airlines utilize the Company's Piper Navajo, Fairchild Metro II, III, and 23 de Havilland Twin Otter, Dash 7 and Dash 8, Embraer 120, Saab-340, ATR 42\/72, Beech 1900, Shorts 360 and BAe Jetstream 31\/32 simulators to provide required training for their pilots. The Company owns and operates 26 major and 30 regional airline flight simulators for these purposes. \tIn 1994, the Company completed construction of a new 45,000 square foot Learjet learning center in Tucson, Arizona which will have more than triples the capacity of the center it replaces. The Company also added three business and four regional airline simulator to its other learning centers.\n2.\tGovernment Pilot and Crew Training \tThe Company provides training for pilots and other crew members operating aircraft for agencies of the United States government at substantially all of its learning centers. In addition, the Company has several learning centers, including its Dothan and Daleville learning centers, which are primarily dedicated to military training. The Company's customers include the U.S. Air Force, Army, Navy, Marine Corps and Coast Guard, and pilots employed by the National Aeronautics and Space Administration, the FAA, the U.S. Customs Service, the Drug Enforcement Administration and various other government agencies. \tThe Dothan, Alabama learning center is located near the United States Army Aviation Center at Fort Rucker. Hangars are located at this facility to house classroom and repair facilities for a fleet of fixed- wing aircraft which are used to train Army helicopter pilots to become fixed-wing pilots. The U. S. Army has renewed its existing contract that will total $31 million in revenue over a five-year period. \tThe Company was also awarded a five-year contract for C-12C\/D\/F pilot training to be provided at its Daleville, Alabama learning center which houses five simulators for training military personnel on these versions of the King Air 200 business aircraft. \tFlightSafety Services Corporation, a subsidiary of the Company (\"Services Corporation\"), received a five-year, two-phase contract in support of the U.S. Joint Surveillance Target Attach Radar System (Joint STARS) which involves highly sophisticated aerial surveillance and communications systems intended to provide real-time information about ground personnel movements deep within hostile territory. Services Corporation also has two significant contracts, renewable annually at the government's option through 1999 and 2007, respectively, pursuant to which Services Corporation operates seven government-owned C-5A\/B simulators and provides instructors and technicians at four U.S. Air Force bases for training of U.S. Air Force C-5A\/B transport crews. \tThe other contract is for training of U.S. Air Force C-135 cargo aircraft pilots and flight engineers and for Air Force KC-135 aerial refueling aircraft flight crew training. The 19 simulators are used for training at 11 U.S. Air Force bases for aerial refueling and low-level flight training and permit many flight training maneuvers currently performed in the aircraft to be more economically accomplished in the simulator. In addition, the Company provides computer-based training at three U.S. Air Force Reserve bases. \t The U.S. Air Force and the Navy awarded contracts to the Company in 1994 for the training of C-20H (Gulfstream) pilots and flight engineers. Additionally contracts were awarded in 1994 by NASA for pilot and technician training of Gulfstream, Learjet and King Air aircraft and by the FAA for various aircraft. \tAs noted earlier, 18% of the Company's 1994 operating revenues (16% in 1993 and 17% in 1992) were attributed to U.S. Government pilot and crew training. In general, contracts with agencies of the U.S. Government are subject to renewal, renegotiation and termination at the election of the U.S. Government.\n3.\tMaintenance Technician Training \tThe Company provides maintenance training to aircraft technicians for a wide range of aircraft at most of its learning centers and at customer locations around the world. In addition, the Company maintains four learning centers dedicated to maintenance technician training. Two of these centers are located in Wichita, Kansas and provide training for Beech and Cessna aircraft technicians; a third center is located in Savannah, Georgia and provides training for Gulfstream aircraft technicians; and a fourth center is located in Little Rock, Arkansas and provides Falcon Jet technician training. In addition, the Company continues to add additional maintenance courses and programs at its other learning centers. The Company now offers more than 150 maintenance training courses. Maintenance technicians can choose from a type-specific core curriculum, supplemented by additional courses, including troubleshooting training programs that use computer graphics to provide high fidelity training environments for technicians to practice and enhance troubleshooting skills using manufacturer's data rather than the actual equipment.\n4.\tPrimary Pilot Training \tThe Company provides primary pilot training necessary to enable qualified individuals to obtain private, commercial or airline transport licenses with single-engine, multi-engine and instrument fixed-wing and rotary-wing ratings. Such training is conducted in the classroom, in electronic trainers and in aircraft owned by the Company, but does not involve the use of sophisticated simulators. The Company currently conducts most of its primary training operations, except helicopter training, at the FlightSafety Academy in Vero Beach, Florida. The FlightSafety Academy currently provides training programs for several international and domestic airlines, including Olympic Airways, Swissair, Asiana Airlines, Air China, Royal Air Maroc, Chicago Express and other airlines. The Company maintains facilities at Vero Beach, Florida for fueling, maintenance and storage of its own light fixed-wing aircraft as well as dormitories for its students. The Company has developed the FlightSafety Academy into a training facility where only students planning a career in professional flying are enrolled providing an environment where airline-sponsored \"ab-initio\" (primary) and self-funded students are given instruction devoted solely to preparing them for a career in flying. \tThe Company has two other primary learning centers at Lakeland, Florida and Alliance Airport in Fort Worth, Texas. The Lakeland learning center provides full-service flight training for fixed-wing student pilots and the Fort Worth Learning center provides full-service training for rotary and fixed-wing student pilots. The helicopter training complements training services provided at the Company's nearby simulator- equipped Bell Helicopter Learning Center.\n5.\tMaritime Training and Research \tThrough MarineSafety, the Company provides training to crews of large ocean- going vessels owned by business concerns, as well as the United States Navy, Coast Guard and Merchant Marine Academy. Simulation research studies are also performed by MarineSafety, including studies to assist in determining channel dredging requirements and waterway and port improvements. \tIn 1987, the U.S. Department of Transportation ( the \"DOT\") assigned the management and operations of its Computer Aided Operations Research Facility (CAORF) at Kings Point, New York to MarineSafety. A full-mission ship simulator at Kings Point simulates the control bridge of large ocean going vessels and, through advanced engineering techniques, simulates the actual operating conditions experienced by the crews of such vessels. The shiphandling training simulator thus provides training in a controlled environment without the potential hazard and expense of using an actual ship. At Kings Point, MarineSafety also operates two restricted visibility bridge simulators, devoted exclusively to training deck officers in vessel maneuvers and navigation, which use automated collision avoidance systems during conditions of restricted visibility. \tIn 1994 MarineSafety entered into an agreement with the California Maritime Academy to provide two simulators at the Academy's installation in Valejo, California. Operation of the simulators is scheduled to begin in April 1995 and the simulators will be available to MarineSafety for training of its customers. MarineSafety also provides ship-handling simulator training for the U.S. Navy at MarineSafety's facilities in Newport, Rhode Island and San Diego, California. The Newport facility houses four ship-handling simulators that are used to train approximately 800 Naval officers each year, many from the Navy's nearby Surface Warfare Officers' School, in handling combat or support ships under many operating and environmental conditions. The U.S. Navy may renew this contract each year through 1996. \tThe San Diego facility provides training to U.S. Navy deck officers for approximately 50 surface ships operated by the U.S. Navy. The contract is renewable annually at the U.S. Navy's option through 1998. The center has a full-mission bridge simulator and a bridge wing simulator, and is used to perform commercial training when not in use by the Navy. \tIn 1994, MarineSafety International Rotterdam, B.V. in Rotterdam, the Netherlands, began operations in a new maritime research and training center that houses six simulators for the training of ship's officers, harbor pilots, cadets and vessel traffic controllers and conducts maritime research projects. North Sea Ferries has signed an agreement to train its Masters and chief officers at the Rotterdam facility. A contract was also signed to train captains and crews of the new 900-ft. high-speed container ships. MarineSafety is the majority shareholder of MarineSafety International Rotterdam B.V.\n6.\tManufacture of Training Equipment \tThe Simulation Division manufactures flight simulators and other advanced training devices, including cockpit systems simulators and cockpit procedures trainers, for installation at the Company's learning centers and for sale by the Company to unaffiliated parties. The Simulation Division delivered eight simulators in 1994. Seven simulators were installed at the Company's learning centers and one simulator was shipped to the U.S. Government. The Simulation Division also delivered five OH-58D Helicopter Cockpit Procedure Trainers to Fort Rucker, Alabama for U.S. Army combat training. The Simulation Division also provides maintenance support for the Company's simulators and other training equipment. \tIn 1995, the Simulation Division plans to deliver nine flight simulators, of which seven are for Company use, one for the U.S. Government and one for an overseas customer. Five helicopter training devices for the U.S. Army are also currently being manufactured. The Company requires cash deposits, progress payments and\/or letters of credit for the simulators which the Simulation Division manufactures for export in order to ensure that it receives timely collection of the related account receivable. \tThe Company's Visual Simulation Systems Division designs, develops and manufactures, under the trade name VITAL, computer-generated visual systems and display equipment that are installed on flight simulators. Approximately 360 VITAL visual systems have been delivered to customers around the world. The new generation VITAL VIII ChromaView visual system creates more realistic scenes through a photo-imagery-based technology. Three Vital VIII visual systems were shipped in 1994 to an overseas customer.\n7.\tDesign and Development of Training Systems \tThe Instructional Division provides the initial analysis of system training and performance requirements and designs and develops classroom presentation systems, courseware, interactive computer-based software and manuals primarily for use in the Company's educational and training activities. The Instructional Division also produces training manuals and other instructional materials for the U.S. military and the FAA. Many of the Instructional Division's training systems use high technology applications and task performance requirements.\n8.\tCompetition \tThe Company faces competition in each of its training services. There are numerous training organizations located throughout the United States which provide primary flight training to the public. In the area of advanced pilot training, the customers served by the Company are also served by the larger airlines (which often train their own pilots and provide training to pilots of other airlines), by government agencies (which often train their own flight personnel) and by other commercial training organizations. The Company also faces competition from numerous training organizations that do not use simulators in their training programs. In addition, there are many organizations that provide training and may operate simulators for aircraft for which the Company also provides simulator-based flight training. The Company is also aware of a number of domestic and foreign-based organizations and corporations which provide shiphandling training. \tThe Company competes principally by attempting to provide the best, most accessible and reasonably priced training service available. The Company is continually improving the quality of its services for business and commercial aviation and developing new and innovative products for its customers. In 1994, seven new simulators were added to the Company's fleet. The products manufactured by the Simulation Division and Visual Division are at the leading edge of aircraft simulation, employing such features as digital control loading and weather radar; digitized sound and automated voice systems; automatic testing features and advanced hydrostatic motion systems and touch-screen instructor stations. The Company also attempts to conveniently locate its training facilities near existing and potential customers. \tIn addition, the Company has designed new programs to support a renewed emphasis on total quality in all areas of training development and delivery. All of the Company's instructors participate in programs designed to maintain and upgrade their teaching skills on a continuing basis. Other programs have been designed to better meet the specific requirements of individual customers and to deliver a broader range of services and support. \tThe Company believes that the growing complexity and operating cost of the new generation of aircraft make training with simulators highly desirable. Moreover, the substantial capital costs and long lead time involved in obtaining appropriate simulators suggest that certain commercial airlines might prefer to use flight training programs utilizing simulators offered by independent contractors rather than maintain and operate the training equipment themselves. There can be no assurance, however, that these commercial airlines will continue to use training programs offered by independent contractors such as the Company. \tThe sale of products, including simulators and visual systems, is a competitive industry both domestically and internationally. There are several manufacturing companies worldwide that have the same ability as the Company to design and manufacture a complete flight simulator, including a visual system. There are also a number of companies that can manufacture either a simulator or a visual system, but do not have the capability to do both. \tThe Company competes in the sale of products primarily by offering training devices and visual systems that are reasonably priced, easily maintained and delivered on a timely basis. The 1993 acquisition of the Visual Division enhanced the Company's ability to manufacture and sell a complete simulator or total training system.\n9.\tNumber of Persons Employed \tAs of December 31, 1994, the Company and its subsidiaries had 2,246 full-time employees. Of these, 858 were instructors in ground school, simulator or in-flight training, 848 were administrative, clerical and maintenance personnel, 392 were employees of the Simulation Division, 88 were employees of the Visual Division and 60 were employees of the Instructional Division.\n10.\tExecutive Officers \tEach executive officer of the Company serves at the pleasure of the Company's Board of Directors and, subject to removal, holds office until the regular meeting of the Board of Directors which follows the annual meeting of shareholders and until his successor has been appointed and qualified. The following table sets forth certain information with respect to the executive officers of the Company. \t\t\t\tYears \t\t\t\tPosition \tName\tAge\tPosition with Company\t Held\nAlbert L. Ueltschi\t77\tPresident and Chairman of the Board\t44 years\nBruce N. Whitman\t61\tExecutive Vice President and Director\t33 years\nElmer G. Gleske\t64\tVice President - Government Affairs\t18 years\nDennis Gulasy(1)\t52\tVice President - Simulation Systems\t 3 years\nKenneth W. Motschwiller(2)\t38\tVice President - Treasurer\t4 years\nJames S. Waugh\t47\tVice President - Marketing\t15 years\nMario D'Angelo(3)\t42\tController\t4 years \t______________________\n(1)\tMr. Gulasy was elected Vice President-Simulation Systems of the Company in September 1992. Mr. Gulasy has also been General Manager of the Company's Simulation Division since 1985. Prior thereto, Mr. Gulasy held various positions with the Company.\n(2)\tPrior to becoming Vice President-Treasurer, Mr. Motschwiller was Controller of the Company from December 1983 until July 1991.\n(3)\tPrior to becoming Controller, Mr. D'Angelo was Assistant Controller of the Company from September 1988 until July 1991. Prior thereto, Mr. D'Angelo held various positions with the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2.\tPROPERTIES \tThe Company's corporate offices are located at the Marine Air Terminal, La Guardia Airport, Flushing, New York 11371. In addition, there are four flight simulators, and related training facilities, located at the La Guardia Airport facility. Including this facility, the Company currently operates 32 advanced and maintenance technician learning centers and two primary learning centers in various cities throughout the United States, one advanced learning center in France, two advanced learning centers in Canada and one marine training and research center in the Netherlands. FlightSafety Services Corporation provides training at U.S. Air Force bases in facilities furnished by the U.S. government and maintains its administrative office in Littleton, Colorado. The Simulation Division maintains its offices and plant in Broken Arrow, Oklahoma. The Visual Division maintains its offices and plant in St. Louis, Missouri. The Instructional Division maintains its general offices in Hurst, Texas. \tIn the aggregate, the Company occupies approximately 1,233,000 square feet of building space which is devoted to office and administrative purposes, classrooms, repair service, maintenance facilities, the housing of simulators and aircraft, the design and manufacturing of simulators, visual displays and systems and other training equipment, the development of classroom presentation systems, manuals, interactive computer-based programs and the design and production of instructional systems. Approximately 93% of the facilities owned or leased by the Company are presently utilized for these purposes. The remaining space is being put to various temporary uses and is potentially available for expansion of the Company's operations. The Company considers its facilities well maintained, in good operating condition, adequately insured and satisfactory for their various uses. \t\n\tThe following table sets forth more detailed information related to the facilities of the Company:\n\tApproximate\tLease Location\tSquare Feet\tExpiration Date\t Principal Activities La Guardia Airport\t36,000\t2000\tCorporate offices and advanced Flushing, New York\t\t\tpilot learning center\n4619 Le Bourget Drive\t25,700\t(1)\tAdvanced learning center Berkeley, Missouri\nWiley Post Airport\t10,100\t1996(2)\tAdvanced learning center 7310 N.W. 50th Street Bethany, Oklahoma\n1804 Hyannis Court\t27,300\t1997(3)\tAdvanced learning center College Park, Georgia\n24 Industrial Boulevard\t16,500\t(4)\tAdvanced learning center Daleville, Alabama\nDothan\/Houston County Airport \t30,300\t2001(5)\tAdvanced learning center 600 FlightSafety Drive Dothan, Alabama\n1600 Dolwick Drive\t7,700\t1997(6)\tAdvanced learning center Erlanger, Kentucky\n2250 Alliance Blvd.\t10,700\t1995(7)\tPrimary learning center Fort Worth, Texas\n9601 Trinity Boulevard\t16,500\t2004(8)\tAdvanced learning center Fort Worth, Texas\n8900 Trinity Boulevard\t23,000\t(9)\tOffices of the Instructional Hurst, Texas\t\t\tDivision\nLakeland Airport\t17,700\t2009(10)\tAdvanced and primary learning 2949 Medulla Road\t\t\tcenter Lakeland, Florida\nLambert-St. Louis\t12,100\t1996(11)\tAdvanced learning center International Airport 6185 Aviation Drive St. Louis, Missouri\nLe Bourget Airport\t36,900\t2001(12)\tAdvanced learning center BP25 Zone d'Aviation d'Affaires Building 404 Aeroport Le Bourget, France\nAdams Field\t725\t1995(13)\t Maintenance learning center Little Rock, Arkansas\n4900 E. Conant Street\t11,700\t1995(14)\tAdvanced learning center Long Beach, California\nLong Beach Municipal Airport\t27,100\t1997(15)\tAdvanced learning center 4330 Donald Douglas Drive Long Beach, California\n4800 NW 36th Street\t62,000\t1998(16)\tAdvanced learning center Miami, Florida\nDorval International Airport\t19,100\t1999(17)\tAdvanced learning center 9555 Ryan Avenue Dorval, Montreal Quebec, Canada\nSalt Lake City\t23,600\t2016(18)\tAdvanced learning center International Airport 201 N. 2200 W. Salt Lake City, Utah\nSan Antonio International Airport\t18,000\t2000(19)\tAdvanced learning center 9027 Airport Boulevard San Antonio, Texas\n1505 South 192nd Street\t68,600\t(20)\tAdvanced learning center Seattle, Washington\nTeterboro Airport\t25,400\t(21)\tAdvanced learning center 100 Moonachie Avenue Moonachie, New Jersey\nToledo Express Airport\t16,500\t2000(22)\tAdvanced learning center 11600 West Airport Road Swanton, Ohio\n95 Garratt Boulevard\t18,000\t2005(23)\tAdvanced learning center Downsview, Toronto Ontario, Canada\nTravis Field \t43,900\t2004(24)\tAdvanced and maintenance Savannah, Georgia\t\t\tlearning centers\nTucson International Airport\t45,000\t2006(25)\tAdvanced learning center 1071 E. Aero Park Blvd. Tucson, Arizona\nVero Beach Municipal Airport\t50,900\t2006(26)\tPrimary learning center 2805 Airport Drive Vero Beach, Florida\nPalm Beach International Airport\t38,000\t2004(27)\tAdvanced learning center 3887 Southern Boulevard West Palm Beach, Florida\nWichita Mid-Continent Airport\t18,000\t2006(28)\tAdvanced learning center 2 Learjet Way Wichita, Kansas\nWichita Mid-Continent Airport\t25,700\t2006(29)\tAdvanced learning center 1951 Airport Road Wichita, Kansas\nWichita Mid-Continent Airport\t30,300\t2006(30)\tAdvanced learning center 1851 Airport Road Wichita, Kansas\n9720 East Central Avenue\t63,000\t2015(31)\tAdvanced learning center Wichita, Kansas\n9525 East Central Avenue\t17,900\t(32)\tMaintenance learning center Wichita, Kansas\n1962 Midfield Road \t17,000\t2020(33)\t Maintenance learning center Wichita, Kansas\nWilliam B. Hobby Airport\t36,600\t(34)\tAdvanced learning center 7525 Fauna Street Houston, Texas\nNew Castle County Airport\t39,500\t2010(35)\tAdvanced learning center 155 N. duPont Highway New Castle, Delaware\n2700 North Hemlock Circle\t101,200\t(36)\tOffices and plant of the Broken Arrow, Oklahoma\t\t\tSimulation Division, \t\t\tmanufacturing facility \t\t\tfor training equipment\n5695 Campus Parkway\t30,000\t(37)\tOffices and plant of the St. Louis, Missouri \t\tVisual Division, manufacturing \t\t\tfacility for visual systems\n7700 East 38th Street\t25,000\t(38)\tFormer manufacturing facilities Tulsa, Oklahoma\t\t\tnow used for Company \t\t\tstorage\nU.S. Merchant Marine Academy\t22,000\t(39)\tMarineSafety Computer Aided Operations\t\t\tResearch and marine Research Facility\t\t\tlearning center Steamboat Road Kings Point, New York\n344 Aquidneck Avenue\t17,400\t(40)\tMarineSafety Middletown, Rhode Island\t\t\tMarine learning center\n32nd Street Naval Station\t4,800\t(41)\tMarineSafety Building 3149\t\t\tMarine learning center San Diego, California\nWilhelminakade 701\t34,000\t(42)\tMarineSafety 3OO7 GG Rotterdam\t\t\tResearch and Netherlands\t\t\tMarine learning center\n10184 West Bellview Avenue \t11,700\t1997\tServices Corporation Littleton, Colorado\t\t\tAdministrative offices \t _________________________\n(1)\tThis building was constructed by the Company on land owned by the Company and currently houses McDonnell Douglas MD-80 and DC-9 simulators, Boeing 727 simulators, Metro II and III simulators, a Jetstream 31\/32 simulator and a SAAB-340 simulator. (2)\tThis building was constructed by the Company on land leased from the Oklahoma County Industrial Authority to house the Company's Commander aircraft learning center. (3)\tThe Company leases space to house its JetStar, King Air and Embraer 120 simulators. (4)\tThis building, constructed on land owned by the Company, houses C-12 and U-21 simulators. (5)\tThe Company constructed hangars on land leased from the Dothan\/Houston County Airport Authority. A fleet of fixed-wing aircraft is maintained at this facility. (6)\tThe Company leases space to house its Boeing 727-200 and Embraer 120 simulators. (7)\tThe Company leases space to house fixed-wing and rotary-wing aircraft and provides primary flight training. (8)\tThis building was constructed by the Company on land leased from Bell Helicopter Textron to house the Company's Bell Helicopter learning center. (9)\tThis building was purchased to house the offices of the Company's Instructional Systems Division. (10)\tThis building was constructed by the Company on land leased from the City of Lakeland, Florida to house the Company's Piper Aircraft learning center and also provides non-career primary aviation training. (11)\tThis facility is on land leased from the City of St. Louis and houses the Company's Sabreliner learning center. (12)\tThe Company constructed a building on land leased from Aeroport de Paris. This building houses Falcon 10, 20, 50 and 900, King Air, Citation V, Embraer 120 and Dash-8 simulators. (13)\tThe Company leases space to house its Falcon Maintenance learning center. (14)\tThese premises, leased from McDonnell Douglas Corporation, house an MD-80 learning center. (15)\tThis building was constructed by the Company on land leased from the City of Long Beach to house the Company's Boeing 737-300, McDonnell Douglas MD 88\/87, Cessna 300\/400 series, Citation, King Air, and Gulfstream II simulators. (16)\tThe Company leases space from the Dade County Airport to house simulators for the Airbus A-310, Citation, Boeing 727 and 757 and McDonnell Douglas DC-9 and MD-88. (17)\tThis building was constructed by the Company to house its Challenger learning center. It is located on premises leased from the City of Dorval for a term expiring in May 1999, renewable at the Company's option for up to four additional five-year terms. (18)\tThis building was constructed by the Company on property leased from Salt Lake City and houses a Boeing 737 simulator. (19)\tThis building was constructed on land leased from the San Antonio Airport Authority and houses regional airline simulators. (20)\tThe Company purchased this land and building which houses eight major and regional airline simulators. The Company is using 34,000 square feet and leasing the remaining space to third parties. (21)\tThis building was constructed on land owned by the Company, is adjacent to Teterboro Airport and houses the Company's Falcon Jet learning center. (22)\tThis building, which houses Citation and King Air simulators, was constructed by the Company on property leased from the Toledo Express Airport Authority. (23)\tThe Company constructed a building on land leased from de Havilland Inc. and houses simulators for such manufacturer's aircraft.\n(24)\tTwo buildings were constructed by the Company on property leased from Gulfstream American Corporation to house the Company's Gulfstream pilot and maintenance learning centers. (25)\tThe Company constructed a building on land leased from Learjet Corporation for housing its Tucson Learning Center. The Company can extend the lease at its option to 2048. (26)\tThree buildings, containing a total of 28,500 square feet of space and the land on which they are situated, are owned by the Company. The remaining property is held under a lease expiring in 2006. A fleet of light-fixed wing aircraft is maintained here to provide primary pilot training. (27)\tThis building was constructed by the Company on land leased from Palm Beach County to house Sikorsky helicopter and Learjet simulators. (28)\tThis building was constructed by the Company on land leased from the Wichita Airport Authority to house the Company's Wichita Learjet learning center. (29)\tThis building, which houses the Company's Cessna learning center, is located on approximately one acre of land leased from the Wichita Airport Authority. (30)\tThis building was constructed by the Company on land leased from the Wichita Airport Authority to house the Company's Cessna Citation learning center. (31)\tThe Company leases space from the Beech Aircraft Corporation to house its Beech learning center. (32)\tThis building was constructed by the Company on land owned by the Company to house the Company's Beech Maintenance learning center. (33)\tThis building was constructed by the Company on land leased from the Wichita Airport Authority to house the Company's Cessna Maintenance learning center. (34)\tThis building is located on two acres of land owned by the Company and houses the Company's Houston learning center at which simulator training for several types of aircraft is conducted. (35)\tThis building is located on land leased from the New Castle County Airport and houses both business and regional aircraft simulators. (36)\tSeven acres of land and a building are owned by the Company in Broken Arrow. This building houses the Company's Simulation Division which manufactures training equipment. (37)\tThis building and land is owned by the Company and houses the Visual Division which manufacturers visual systems. (38)\tThis building and land is owned by the Company and is used primarily for storage. (39)\tThis facility is leased under a cooperative agreement with the U.S. Maritime Administration to provide marine simulation research and training. (40)\tThis building, constructed on five acres of land owned by the Company, houses four marine simulators. (41)\tThe Company houses two marine simulators at this facility in space provided by the U.S. Navy. (42)\tThis building is leased from the municipality of Rotterdam and houses six marine simulators. \t____________________________\n\tThe Company's rent expense for 1994 was $1,811,000.\nITEM 3.","section_3":"ITEM 3.\tLEGAL PROCEEDINGS \tThe Company is involved in litigation relating to claims arising out of its operations in the normal course of business. Such claims against the Company are generally covered by insurance. It is the opinion of management that uninsured liability, if any, resulting from existing litigation and claims will not have a material adverse effect on the Company's business or financial position.\nITEM 4.","section_4":"ITEM 4.\tSUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS \tNone.\n\tPART II ITEM 5.","section_5":"ITEM 5.\tMARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\n\tThe information set forth under the caption \"Common Stock Price Range and Dividend Information\" on page 1 of the Company's Annual Report to Shareholders for the Fiscal Year Ended December 31, 1994 (the \"1994 Annual Report\") is incorporated herein by reference. No other information contained in the 1994 Annual Report shall be deemed to be filed with the Commission, except as expressly stated herein. \tOn February 19, 1993, the Board of Directors authorized a stock repurchase program for up to three million shares of the Company's common stock. On December 3, 1993, the Board of Directors authorized an increase in the stock repurchase program to four million shares. As of March 13, 1995, 3,291,700 shares of the Company's Common Stock had been repurchased pursuant to this program.\nITEM 6.","section_6":"ITEM 6.\tSELECTED FINANCIAL DATA\n\tThe information set forth under the caption \"Five Year Financial Highlights\" on page 1 of the 1994 Annual Report is incorporated herein by reference .\nITEM 7.","section_7":"ITEM 7.\tMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION \tThe information set forth under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" on page 14 of the 1994 Annual Report is incorporated herein by reference\nITEM 8.","section_7A":"","section_8":"ITEM 8.\tFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\n\tThe consolidated financial statements and notes thereto, together with the report thereon of Price Waterhouse LLP, independent accountants, dated January 31, 1995, appearing on pages 15 to 25 of the 1994 Annual Report are incorporated herein by reference. With the exception of the information incorporated by reference in Items 5, 6 and 7 and this Item 8 of this Form 10-K, the 1994 Annual Report is not to be deemed filed as part of this Form 10-K.\nITEM 9.","section_9":"ITEM 9.\tCHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING\n\tNone.\n\tPART III ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10.\tDIRECTORS AND EXECUTIVE OFFICERS OF THE COMPANY \tThe information concerning the directors of the Company set forth on page 2 of the Proxy Statement dated March 24, 1995 relating to the Company's Annual Meeting of Shareholders scheduled to be held on April 26, 1995 (the \"1995 Proxy Statement\") under the caption \"Election of Directors,\" and the information concerning compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended, set forth on pages 11 and 12 of the 1995 Proxy Statement under the caption \"Compliance With Section 16(a) of the Exchange Act\" are incorporated herein by reference. No other information contained in the 1995 Proxy Statement shall be deemed to be filed with the Commission, except as expressly stated herein. \tInformation relating to the executive officers of the Company is set forth in Item 1, section 10, of this Form 10-K under the caption \"Executive Officers\".\nITEM 11.","section_11":"ITEM 11.\tDIRECTORS' AND EXECUTIVE OFFICERS' COMPENSATION \tThe information regarding directors' compensation set forth on pages 3 through 4 of the 1995 Proxy Statement under the caption \"Committees, Meetings and Compensation of the Board of Directors,\" and the information regarding executive officers' compensation set forth on pages 5 through 10 of the 1995 Proxy Statement under the caption \"Executive Compensation\" other than the information set forth on pages 5 through 7 and pages 10 and 11 under the captions \"Report of the Compensation Committee on Executive Compensation\" and \"Five-Year Stock Performance Graph,\" respectively, are incorporated herein by reference. ITEM 12.","section_12":"ITEM 12.\t\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (a)\tSet forth below is certain information relating to each person known to the Company to be the beneficial holder of more than five percent of the Company's Common Stock as of March 13, 1995.\n\t\tPercentage of Name and Address of\tAmount and Nature of\tOutstanding Common Stock Beneficial Owner\tBeneficial Ownership\tOwned as of March 13, 1995\nAlbert L. Ueltschi\t9,617,040 (1)\t30.7% Marine Air Terminal La Guardia Airport Flushing, NY 11371\nPutnam Investment, Inc.\t 4,129,572 (2)\t13.2% One Post Office Square Boston, MA 02109\nFMR Corp.\t3,093,300 (3)\t9.9% 82 Devonshire Street Boston, MA 02109\n(1)\tIncludes 9,616,540 shares held pursuant to a revocable trust for which Mr. Ueltschi is the sole beneficiary during his lifetime and 500 shares held pursuant to a partnership. Does not include approximately 1,513,000 shares beneficially owned by various members of Mr. Ueltschi's family, in respect of which Mr. Ueltschi disclaims beneficial ownership.\n(2)\tPutnam Investment, Inc., is a wholly-owned subsidiary of Marsh and McLennan. Putnam Investment Inc.'s subsidiaries, Putnam Investment Management, Inc., and the Putnam Advisory Company, Inc., are investment advisors to investment companies. This represents the number of shares owned as of December 31, 1994 as indicated in a Schedule 13G filed by Putnam Investment, Inc., with the Securities and Exchange Commission (SEC) on January 23, 1995. Putnam has shared power to vote or to direct the vote for 375,560 shares and has shared power to dispose or to direct the disposition of all the shares.\t\t\t\t\t\t\t\n(3)\tFMR Corp. is a holding company and its subsidiary, Fidelity Management & Research Company, is an investment advisor to investment companies. This represents the number of shares owned as of December 31, 1994, as indicated in a Schedule 13(G) filed by FMR with the SEC on February 13, 1995. FMR has neither sole nor shared voting power with respect to such shares and has sole power to dispose of such shares. \t____________________\n(b)\tThe information regarding beneficial ownership of shares of the Company's Common Stock as of March 13, 1995 by the directors and named executive officers of the Company (those named in the Summary Compensation Table on page 8 of the 1995 Proxy Statement), and by all directors and executive officers of the Company as a group, set forth under the caption \"Security Ownership of Certain Beneficial Owners and Management\" on page 4 of the 1995 Proxy Statement, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13.\tCERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n\tNone.\n\tPART IV\nITEM 14.","section_14":"ITEM 14.\tEXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\na.\tList of documents filed as part of this Form 10-K: \t\t\tPage In 1994 \t\t\tAnnual \t\t\tReport to \t\t\tShareholders \t1.\tFinancial Statements\n\t\tReport of Independent Accountants\t\t25\n\t\tConsolidated Statements of Income \t\tfor each of the three years in the period ending December 31, 1994\t15\n\t\tConsolidated Balance Sheets at December 31, 1994 and 1993 \t\tConsolidated Statements of Cash Flows for each of the \t\tthree years in the period ending December 31, 1994\t\t17\n\t\tNotes to Consolidated Financial Statements \t\t18-25\n\t2.\tFinancial Statement Schedules - 1994, 1993 and 1992\t\tPage In \t\t\t\tThis \t\t\t\tForm 10-K\n\t\tReport of Independent Accountants on Financial Statement Schedules\t27\n\t\tI.\t Marketable Securities\t30-35\n\t\tV.\t Property, Plant and Equipment\t36\n\t\tVI.\tAccumulated Depreciation, Depletion \t\t\tand Amortization of Property, Plant and Equipment\t 37\n\t\tVIII.\tValuation and Qualifying Accounts\t38\n\t\tX.\tSupplementary Income Statement Information\t39\n\tFinancial statement schedules not included in this Form 10-K have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nITEM 14(a)\t3.\tEXHIBITS \t3)\t(a)\tCertificate of Incorporation of the Company, as amended, filed as Exhibit 3(a) to theCompany's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (the \"1993 Form 10-K\"), is incorporated herein by reference. \t \t(b)\tThe By-Laws of the Company, as amended, filed as Exhibit 3(b) to the 1993 Form 10-K, is herein incorporated by reference. 10) (a)\tCompany's 1979 Stock Option Plan, with first and second amendments thereto, filed as Exhibit 10(i) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991 (the \"1991 Form 10-K\"), is incorporated herein by reference. \t\t(b)\tCompany's Employee Stock Purchase Plan, as amended April 27, 1994. \t\t(c)\tCompany's 1982 Incentive Stock Option Plan with first and second amendments thereto, filed as Exhibit 10(k) to the 1991 Form 10-K, is incorporated herein by reference. \t\t(d)\tCompany's 1984 Restricted Stock Compensation Plan, and first amendment thereto, filed as Exhibit 10(l) to the 1991 Form 10-K, is incorporated herein by reference. \t\t(e)\tCompany's Retirement Plan for Non-Employee Directors, and first amendment thereto. \t\t(f)\tCompany's 1992 Stock Option Plan, filed as Exhibit 10(n) to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, (the \"1992 Form 10-K\") is incorporated herein by reference. \t\t(g)\tChange of Control severance agreement for Executive Officers. \t13)\tCompany's Annual Report to Shareholders for the Fiscal Year Ended December 31, 1994. \t21)\tSubsidiaries of the Company. \t23)\tConsent of Independent Accountants.\nITEM 14 (b).\tNo reports on Form 8-K were filed with the Commission by the Company during the fiscal year ended December 31, 1994. ITEM 14 (c).\tSee Item 14 (a)(3) above.\nITEM 14 (d).\tSee Item 14 (a)(2) above.\n\tReport of Independent Accountants on Financial Statement Schedules\nTo the Board of Directors of FlightSafety International, Inc.\n\tOur audits of the consolidated financial statements referred to in our report dated January 31, 1995 appearing on page 25 of the 1994 Annual Report to Shareholders of FlightSafety 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, such 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 LLP\nNew York, New York January 31, 1995\n\tSIGNATURES\n\tPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. \tFLIGHTSAFETY INTERNATIONAL, INC. \t(Company)\nDate: March 27, 1995\tBy:\t \/s\/ Albert L. Ueltschi \t\tAlbert L. Ueltschi \t\tPresident\n\tPursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated.\nDate: March 27, 1995\tBy:\t \/s\/ Albert L. Ueltschi \t\tAlbert L. Ueltschi \t\tChairman of the Board, \t\tDirector and President \t\t(Principal Executive Officer)\nDate: March 27, 1995\t\t \/s\/ George B. Beitzel \t\tGeorge B. Beitzel \t\tDirector\nDate: March 27, 1995\t\t \/s\/ Charles R. Longsworth \t\t Charles R. Longsworth \t\tDirector\nDate: March 27, 1995\t\t \/s\/ Edward E. Hood, Jr. \t\t Edward E. Hood, Jr. \t\tDirector\nDate: March 27, 1995\t\t \/s\/ John A. Morgan \t\t John A. Morgan \t\tDirector\nDate: March 27, 1995\t\t \/s\/ Bruce N. Whitman \t\tBruce N. Whitman \t\tDirector and Executive Vice President\nDate: March 27, 1995\t\t \/s\/ Kenneth W. Motschwiller \t\t Kenneth W. Motschwiller \t\tVice President - Treasurer \t\t(Principal Financial Officer)\nDate: March 27, 1995\t\t \/s\/ Mario D'Angelo \t\tMario D'Angelo \t\tController \t\t(Principal Accounting Officer) \tExhibit (21)\n\t Subsidiaries of FlightSafety International, Inc.\n\t\t\tPercentage owned \t\tJurisdiction of\tby Company \tName of Subsidiary\tIncorporation\t(Directly or Indirectly)\nFlightSafety Capital Corporation\tDelaware\t100%\nMarineSafety International, Inc.\tNew York\t100%\nMarineSafety International Rotterdam B.V. \tNetherlands\t 51%\nFlightSafety Canada, Ltd\/Ltee\tCanada \t100%\nFlightSafety International, S.A.R.L.\tFrance\t100%\nFlightSafety New York, Inc.\tNew York\t100%\nFlightSafety Properties, Inc.\tDelaware\t100%\nFlightSafety Services Corporation\tDelaware\t100%\nFlightSafety Texas, Inc.\tDelaware\t100%\nFlightSafety China, Inc.\tDelaware\t100%\nKunming FlightSafety Aviation Training Company, Limited\tChina\t85%\n\t\t\t\t\t\t\t\t\nEXHIBIT 10(b)\n\tFLIGHTSAFETY INTERNATIONAL, INC. \tEMPLOYEE STOCK PURCHASE PLAN, \tAS AMENDED APRIL 27, 1994\n\tSection 1. Purpose. The purpose of this Plan (the \"Plan\") is to provide an opportunity for employees of FlightSafety International, Inc. (the \"Company\") and any subsidiary (a \"Subsidiary\") that is (i) designated by the Board of Directors of the Company (the \"Board\") and (ii) meets the requirements of Section 424(f) of the Internal Revenue Code of 1986, as amended (the \"Code\"), to purchase Common Stock (the \"Stock\") of the Company and thereby have an additional incentive to contribute to the prosperity of the Company. It is the intention of the Company to have the Plan qualify as an \"Employee Stock Purchase Plan\" under Section 423 of the Code, and the Plan shall be construed in accordance with such purpose.\n\tSection 2. Eligibility. Any person regularly employed by the Company or its Subsidiaries shall be eligible to participate in the Plan on an Offering Date (as hereinafter defined), provided that as of such Offering Date he shall have completed at least seventeen consecutive months of full- time employment with the Company or a Subsidiary. For purposes of the Employee Stock Purchase Plan, the term \"full-time\" when used in connection with an employee's eligibility to participate, means employment which customarily involves more than 20 hours per week and more than five months in a calendar year. No employee may participate in an offering under the Plan if after giving effect to an option granted in such offering such employee would own (within the meaning of the Code) shares of Stock, including Stock which he may purchase under outstanding options, possessing 5 percent or more of the total combined voting power or value of all classes of stock of the Company or any Subsidiary. All employees who participate in the Plan shall have the same rights and privileges thereunder.\n\tSection 3. Offering. The maximum number of shares of Stock which may be issued pursuant to the Plan shall be 1,112,500 shares. The shares of stock sold by the Company pursuant to the Plan shall be either authorized but unissued shares or shares acquired by the Company and held in its treasury. The Stock Purchase Plan Committee (the \"Committee\"), established pursuant to Section 11 hereof, may designate any amount of such shares for offering at any of the Offering Dates, as hereinafter defined. In the event of a stock split, stock dividend, combination or recapitalization of shares of Stock subsequent to the effective date of the Plan, the maximum number of shares of Stock for which rights to purchase may therefore be granted under the Plan will be, pursuant to action taken by the Board, proportionately increased or decreased, and such other action will be taken as in the opinion of the Board of the Company will be appropriate under the circumstances.\n\tOfferings of Stock under the Plan shall commence July 1, 1977 and terminate June 30, 1997 (the \"Offering Period\"). During such period options will be granted each July 1 in 1977 through 1996 (the \"Offerings Dates\") to eligible employees who elect to participate in the Plan under Section 4. Each option shall expire on the June 30 following the year in which the option was granted. The number of shares of Stock to be subject to each option shall be fixed in full shares as of each Offering Date and shall be that number of shares of Stock resulting from the division of the option price hereinafter specified in the next paragraph into the percentage (up to a maximum of 10%) of each Participant's annual gross basic compensation rate on such Offering Dates which the Participant commits through payroll deductions as provided in Section 4 hereof.\n\tThe option price under each option shall be the lower of: (1) 85% of the closing price of the Stock on the New York Stock Exchange (or the principal exchange on which such shares are traded at that time) on the date such option is granted, or (ii) 85% of such closing price on the date of exercise, and may be adjusted pursuant to Section 7 hereof.\n\tNo option shall be granted which would permit a Participant's right to purchase stock of any class of the Company under all employee Stock Purchase Plans of the Company and any Subsidiary to accrue (as specified in Section 423 of the Code) at a rate which exceeds $25,000 of fair market value of such stock (determined at the time such option is granted) during each calendar year in which such option will be outstanding at any time.\n\tIf options granted on any Offering Date would be exercisable for an aggregate number of shares of Stock that exceeds the maximum number of shares offered on any Offering Date, the options so granted and the number of shares which may be purchased under such options shall be reduced on a pro rata basis in as nearly a uniform manner as shall be practicable and equitable. In such event, payroll deductions shall also be reduced or refunded accordingly and the Company shall give written notice of such reduction or refund to each Participant affected thereby.\n\tSection 4. Participation. An eligible employee may become a participant in the Plan (\"Participant\") by filing on or before an applicable Offering Date of grant a completed payroll deduction authorization form provided by the Company. Employees may authorize payroll deductions at the rate of any whole percentage up through 10% of their gross basic compensation (excluding any overtime, bonuses, or other extra compensation). Payroll deductions in accordance with such authorization shall commence on the applicable Offering Date and shall end one year thereafter. All payroll deductions may be held by the Company and commingled with its other corporate funds. A separate account for each Participant shall be maintained by the Company under the Plan and the amount of each Participant's payroll deductions shall be credited to such account.\n\tParticipants may discontinue participation in the Plan, in which event the amount credited to their accounts shall thereupon be paid to them with 6% per annum simple interest. In the event Participants terminate their employment with the Company or a Subsidiary for any reason (including death) prior to the expiration of the one-year option period, their participation in the Plan shall terminate and all amounts credited to their accounts with interest shall thereupon be paid to them or their estates, except that if Participants' employment is terminated not more than three months immediately preceding the date upon which their stock would be purchased pursuant to Section 5, the Participants or their estates may elect to leave amounts then credited to their accounts in the Plan until such stock purchase.\n\tSection 5. Purchase of Stock. Upon the expiration of each one-year option period, Participants' options shall be exercised automati cally for the purchase of that number of full shares of Stock which the accumulated payroll deductions credited to their accounts at that time will purchase at the applicable price specified in Section 3. Notwith standing the foregoing, Participants may by written notice to the Company prior to the expiration of the one-year option period elect to terminate such options and withdraw all accumulated payroll deductions credited to their accounts with interest, or to exercise their options for a specified number of full shares less than the number which may be purchased pursuant to Section 3.\n\tSection 6. Payment and Delivery. Upon the exercise of an option, the Company will deliver to the Participants the Stock purchased upon such exercise and the balance of any amount of payroll deductions credited to their accounts not used for such purchase with interest. The Participants may elect to have such unused cash balance credited to their accounts for the next option period, if they are Participants therein. The Company shall retain the amount of payroll deductions used to purchase the Stock in full payment therefore and such Stock shall thereupon be fully paid and non-assessable. Except as otherwise provided herein, no Participant shall have any voting, dividend or other stockholder rights with respect to shares subject to any option granted under the Plan until such option is exercised and such shares are issued to them.\n\tSection 7. Recapitalization. If after the grant of an option but prior to the purchase of the Stock thereunder, there shall be any increase or decrease in the amount of outstanding shares of Stock by reason of a stock split, stock dividend, combination or recapitalization of such shares, the number of shares to be purchased pursuant to such option and the option price per share will be proportionately increased or decreased, and such other action will be taken as in the opinion of the Board will be appropriate under the circumstances.\n\tSection 8. Merger or Liquidation. In the event of a dissolution or liquidation of the Company or a merger or consolidation in which the Company is not the surviving corporation, the Plan shall terminate upon the date of approval of such dissolution, liquidation, merger or consolidation by the Company's shareholders. The exercise date of all options outstanding under the Plan shall be exercised in the manner provided in Section 5 as though such approval date constituted the expiration of the normal one-year option period.\n\tSection 9. Transferability. Options granted to Participants may not be assigned, transferred, pledged or otherwise disposed of in any way, and any such attempted assignment, transfer, pledge or other disposition shall be null and void and without effect.\n\tSection 10. Amendment or Termination of the Plan. The Board may at any time and from time to time amend or terminate the Plan, provided that no such amendment or termination may adversely affect the rights of any Participant under outstanding options under this Plan, and provided further that no amendment shall be effective unless shareholder approval has been obtained if such approval is required (i) in order for the Plan to meet the conditions specified in Rule 16b-3(a) under the Securities and Exchange Act of 1934, as amended, or (ii) by any other provision of applicable law.\n\tSection 11. Administration. The Plan shall be administered by a Committee of at least three members who shall be appointed by the Board. The Committee shall have full power and authority to promulgate such rules and regulations as it deems necessary for the proper administration of the Plan, to interpret the provisions and supervise the administration of the Plan, and to take all action in connection therewith or in relation thereto as it deems necessary or advisable. Decisions of the Committee shall be made by a majority of its members and shall be final and binding upon all Participants. Any decision reduced to writing and signed by a majority of the members of the Committee shall be fully effective as if it had been made at a meeting of the Committee duly held. The Company will pay all expenses incurred in the administration of the Plan.\nEXHIBIT 10(e)\n\tRETIREMENT PLAN FOR NON-EMPLOYEE DIRECTORS \tOF FLIGHTSAFETY INTERNATIONAL, INC.\n\tARTICLE I.\n\tSection 1.1 - Purpose: The purpose of the Retirement Plan for Non-Employee Directors of FlightSafety International, Inc. is to provide non-employee directors with pension benefits at retirement.\n\tARTICLE II.\n\tDEFINITIONS AND CONSTRUCTION\n\tSection 2.1 Definitions: The following definitions shall apply for purposes of the Plan, unless a different meaning is plainly indicated by the context:\n\t\t(a)\t\"Accrued Benefit\": The amount determined in accordance with Article IV, Section 4.1 for Retirement at the Normal Retirement Date and Article IV, Section 4.2 for Retirement for Disability.\n\t\t(b)\t\"Annual Retainer\": the annual amount payable to a Director for serving on the Board, excluding (i) any annual amount payable to a Director for serving on a committee of the Board and (ii) any per meeting fee paid for attending meetings of the Board or a committee thereof.\n\t\t(c)\t\"Board\": The Board of Directors of the Company, as constituted from time to time.\n\t\t(d)\t\"Code\": The Internal Revenue Code of 1986, as amended from time to time, and the applicable rulings and regulations thereunder (including the corresponding revisions of any succeeding law).\n\t\t(e)\t\"Company\": FlightSafety International, Inc. a New York Corporation, its successors and assigns.\n\t\t(f)\t\"Director\": Any non-employee director of the Company. A director of the Company who is also an employee of the Company or any of its subsidiaries shall not be considered a Director under this Plan.\n\t\t(g)\t\"Disability\": A condition of incapacity due to physical or mental illness as a result of which a Participant is unable to perform his duties and responsibilities as a Director for a period of six consecutive months.\n\t\t(h)\t\"Disability Retirement Pension\": The Pension that Participants are entitled to receive upon fulfilling all of the requirements under Section 4.2.\n\t\t(i)\t\"Effective Date\": December 8, 1988.\n\t\t(j)\t\"Eligible Spouse\": The husband or wife to whom the Participant had been legally married throughout the six-month period ending on the earlier of 1) the Participant's Normal Retirement Date or 2) the date of the Participant's death.\n\t\t(k)\t\"ERISA\": Public Law No. 93-406, the Employee Retirement Income Security Act of 1974, as amended from time to time.\n\t\t(l)\t\"Normal Retirement Date\": The date upon which the Participant attains age 70.\n\t\t(m)\t\"Normal Retirement Pension\": The Pension that Participants are entitled to receive upon fulfilling all of the requirements under Section 4.1.\n\t\t(n)\t\"Participant\": A Director participating in the Plan in accordance with the provisions of Article III or a former Director entitled to receive a Pension under the Plan.\n\t\t(o)\t\"Pension\": A series of semi-annual amounts, as described in Article IV hereof, which are payable to a person who is entitled to receive benefits under the Plan.\n\t\t(p)\t\"Plan\": The Retirement Plan for Non-Employee Directors of FlightSafety International, Inc. as amended from time to time.\n\t\t(q)\t\"Plan Year\": The twelve-month period commencing on December 8, and ending on December 7.\n\t\t(r)\t\"Retirement\": Termination of service as a Director for any reason other than death after a Participant has fulfilled all requirements for a Normal Retirement Pension pursuant to Section 4.1 or a Disability Retirement Pension pursuant to Section 4.2. Retirement shall be considered as commencing on the day immediately following a Participant's last day of service as a Director.\n\t\t(s)\t\"Service\": The period of a Participant's service as a Director of the Company considered in the determination of his eligibility for benefits under the Plan in accordance with Section 3.1.\n\t\t(t)\t\"Year of Service\": A twelve-month period commencing on the anniversary date of a Director's election to the Board.\n\tSection 2.2 - Construction of Language: Whenever appropriate in the Plan, words used in the singular may be read in the plural, words used in the plural may be read in the singular, and words importing the masculine gender may read as referring equally to the feminine or the neuter. Any reference to an Article or Section number shall refer to an Article or Section of the Plan unless otherwise indicated.\n\tARTICLE III.\n\tPARTICIPATION AND SERVICE\n\tSection 3.1 - Participation: All Directors on the Effective Date of the Plan shall be eligible to participate in the Plan as of the Effective Date. All other Directors shall become Participants in this Plan on the date they are elected Directors of the Company. Any Director who was previously an employee of the Company shall be eligible to participate in the Plan upon his retirement as an employee of the Company, provided that he remains a Director following such retirement.\n\tARTICLE IV.\n\tPENSION\n\tSection 4.1 - Normal Retirement Pension: Upon a Participant's Normal Retirement Date, regardless of whether such Participant is still then serving as a Director, such Participant shall become entitled to receive an annual Normal Retirement Pension, equal to one hundred percent (100%) of the Annual Retainer payable to him as a Director immediately prior to the date of his Retirement.\n\tSection 4.2 - Disability Retirement Pension: In the event that a Participant shall retire as a Director of the Company prior to his Normal Retirement Date by reason of his Disability, such Participant shall be granted a Disability Retirement Pension. The annual amount of such Participant's Disability Retirement Pension shall be equal to one hundred (100%) of the Annual Retainer payable to him as a Director on the date of his Retirement by reason of Disability, without reduction for Retirement prior to his Normal Retirement Date.\n\tSection 4.3 - Payment of Pension: A Participant's Normal Retirement Pension or Disability Retirement Pension shall be paid in semi-annual installments, each installment equalling 1\/2 of his annual Pension. The first installment of such Pension shall be paid to a Participant on the first day of the semi-annual period commencing January 1 or July 1, as the case may be, next following the month in which he actually terminates his Service with the Company as a Director.\n\tSection 4.4 - Termination of Service: In no event shall any Pension be paid to a Participant prior to actual termination of Service. In the event a Participant does not retire at his Normal Retirement Date, but continues to serve as a Director of the Company beyond such date, his Pension shall be determined based upon his Annual Retainer on the date of his Retirement; it being understood, however, that his Pension shall not be otherwise increased by reason of the fact that he continued to serve as a Director after the date he was entitled to receive a Normal Retirement Pension hereunder.\n\tSection 4.5 - Duration of Payments: Payment of a Normal Retirement Pension or a Disability Retirement Pension shall be made to a Participant (or to his Eligible Spouse, if any, in accordance with Article V hereof) for a number of years equal to the shorter of the Participant's Years of Service or Ten Years, or, in the event such Participant dies prior to receiving all of such payments, as provided in Section 5.1.\n\tSection 4.6 - Death of Participant: Upon the death of a Participant all of his interest in or right to Pension benefits shall cease except as set forth under the provisions of Article V.\n\tARTICLE V.\n\tJOINT AND SURVIVOR PENSION\n\tSection 5.1 - 100% Joint and Survivor Pension: If a Participant has an Eligible Spouse on the date his Pension payments commence, his Pension shall be paid in the form of a 100% Joint and Survivor Pension.\n\tUnder such Pension, if a Participant dies prior to receiving all of the payments to which he would otherwise have been entitled under Section 4.5, said payments shall be made to his Eligible Spouse, if any, until all of such payments have been made or such Eligible Spouse shall die, whichever shall first occur. If at the time of the Participant's death there is no Eligible Spouse surviving such Participant, the Company's obligations under the Plan to such Participant shall cease.\n\tSection 5.2 - Death Prior to Retirement:\n\t\t(a)\t(1)\tIf a Participant dies prior to Retirement (regardless of whether he has attained his Normal Retirement Date) and leaves surviving an Eligible Spouse, he shall automatically be deemed, as of the date of his death, to have:\n\t\t\t(i)\tbeen entitled to receive a Normal Retirement Pension, and\n\t\t\t(ii)\tretired.\n\tThe Pension shall be paid in the form of a 100% Joint and Survivor Pension, as described in Section 5.1, and the deceased Participant's surviving Eligible Spouse shall thereupon become entitled to receive a Pension thereunder.\n\tARTICLE VI.\n\tADMINISTRATION\n\tSection 6.1 - Administration: The Plan shall be administered by the Board.\n\tSection 6.2 - Duties: The Board shall perform the required duties and it shall have the necessary powers of administering the Plan and carrying out the provisions thereof.\n\tSection 6.3 - Powers: The powers of the Board shall be as follows:\n\t\t(a)\tTo determine any question arising in connection with the Plan, and its decision or action in respect thereof shall be final, conclusive, and binding upon the Company, and the Participant.\n\t\t(b)\tTo engage the services of counsel or attorney (who may be counsel or attorney for the Company), if it deems necessary, and such other agents or assistants as it deems advisable for the proper administration of the Plan.\n\t\t(c)\tTo receive from the Company and from Participants such information as shall be necessary for the proper administration of the Plan.\n\tSection 6.4 - Claims Procedure: The Board shall make all determinations as to the right of any person to a Pension. Any denial by the Board of the claim for benefits under the Plan by a Participant or his Eligible Spouse shall be stated in writing by the Board and delivered or mailed to the Participant or his Eligible spouse, as the case may be. Such notice shall set forth the specific reasons for the denial, written to the best of the Board's ability in a manner that may be understood without legal or actuarial counsel. In addition, the Board shall afford a reasonable opportunity to any Participant or his Eligible Spouse whose claim for benefits has been denied for a review of the decision denying the claim.\n\tSection 6.5 - Records and Reports: The Board shall exercise such authority and responsibility as it deems appropriate in order to comply with ERISA and governmental regulations issued thereunder relating to the following: records of Participants' Service, Accrued Benefits and the percentage of such benefits which are nonforfeitable under the Plan; notifications to Participants; and any applicable reports to the Department of Labor or other government agencies.\n\tSection 6.6 - Expenses: All expenses of the Plan shall be borne by the Company.\n\tARTICLE VII.\n\tAMENDMENT OR TERMINATION OF PLAN\n\tSection 7.1 - Amendment or Termination of the Plan: The Board reserves the right to (i) amend the Plan at any time and from time to time by any such amendment or amendments to this Plan as it deems appropriate or (ii) terminate the Plan at any time; provided, however, that any amendment or termination of the Plan shall not adversely affect the Pension accrued by a Participant as of the date of such amendment or termination without the prior written consent of the Participant (or, if such Participant is not then living, his Eligible Spouse, if any).\n\tARTICLE VIII\n\tSUCCESSOR EMPLOYER AND MERGER AND \tCONSOLIDATION OF PLANS \t \tSection 8.1 - Successor Company: Subject to Section 7.1 hereof, in the event of a dissolution, merger, consolidation, or reorganization of the Company, provision may be made by which the Plan will be continued by the successor; and, in that event, such successor shall be substituted for the Company under the Plan. The substitution of the successor shall constitute an assumption of Plan liabilities by the successor, and the successor shall have all of the powers, duties and responsibilities of the Company under the Plan.\n\tARTICLE IX.\n\tMISCELLANEOUS\n\tSection 9.1 - Status: This Plan is not intended to satisfy the requirements for qualification under Section 401(a) of the Code. It is intended to be an unfunded, non-qualified defined benefit plan which is exempt from the regulatory requirements of ERISA. The Plan shall be construed and administered so as to effectuate this intent.\n\tSection 9.2 - Governing Law: The Plan shall be construed and enforced in accordance with the laws of the State of New York, except to the extent that such laws are preempted by the federal laws of the United States of America.\n\tSection 9.3 - Headings: The headings of Articles and sections are included solely for convenience of reference. If there is any conflict between such headings and the text of the Plan, the text shall control.\n\tSection 9.4 - Nonalienation of Benefits: the right to receive a benefit under the Plan shall not be subject in any manner to anticipation, alienation or assignment, nor shall such right be liable for or subject to debts, contracts, liabilities, engagements or torts.\n\tSection 9.5 - No Right of Service: Nothing contained in this Plan shall give any Director the right to remain as Director.\nFIRST AMENDMENT TO THE RETIREMENT PLAN FOR NON-EMPLOYEE DIRECTORS OF FLIGHTSAFETY INTERNATIONAL, INC.\n\t\tWHEREAS, FlightSafety International, Inc., a New York corporation (the \"Company\"), has heretofore maintained the Retirement Plan for Non-Employee Directors of FlightSafety International, Inc. (the \"Plan\") for the benefit of its non-employee directors; and \t\tWHEREAS, the Company considers it advisable to amend the Plan in the following respect; and \t\tWHEREAS, the Board of Directors, pursuant to Article VII of the Plan, has the authority to amend the Plan; \t\tNOW THEREFORE, effective as of June 14, 1994 (the \"Effective Date\"), the Company hereby amends the Plan to provide as follows: \t\t1. Section 4.5 of the Plan is hereby amended by deleting the word \"Payment\" the first place it appears therein and substituting therefor, \"Subject to the provisions of Section 4.7 hereof, payment.\" \t\t2. A new Section 4.7 is added to the Plan, reading in its entirety as follows: \t\t\t\"Section 4.7 Change in Control: Upon the occurrence of a \"Change in Control\" (as defined below), payment of a Normal Retirement Pension or a Disability Retirement Pension shall be made to a Participant (or to his Eligible Spouse, if any, in accordance with Article V hereof) for ten years, or in the event such Participant dies prior to receiving all of such payments, as provided in Section 5.1.\n\t\t\tFor purposes of this Section 4.7, a \"Change in Control\" shall be deemed to have occurred if the conditions set forth in any one of the following subsections shall have occurred:\n\t\t\t\t(a) any \"Person\" (as defined below) is or be comes the \"Beneficial Owner\" (as defined below), directly or indirectly, of securities of the Company (not including in the securities benefi cially owned by such Person any securities acquired directly from the Company or its affiliates) representing 30% or more of the combined voting power of the Company's then outstanding securities (other than any Beneficial Owner with such voting power as of June 14, 1994); or\n\t\t\t\t(b) during any period of two consecutive years, individuals who at the beginning of such period constitute the Board and any new director (other than a director designated by a Person who has entered into an agreement with the Company to effect a transaction described in clause (a), (c) or (d) of this subsection) whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2\/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previously so approved, cease for any reason to constitute a majority thereof; or\n\t\t\t\t(c) the shareholders of the Company approve a merger or consolidation of the Company with any other corporation, other than (i) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of the Company, at least 75% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (ii) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no Person acquires more than 50% of the combined voting power of the Company's then outstanding securities; or\n\t\t\t\t(d) the shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets.\n\t\t\"Person\" shall have the meaning given in Section 3(a)(9) of the Securities Exchange Act of 1934,as amended from time to time (the \"Exchange Act\"), as modified and used in Sections 13(d) and 14(d) thereof; however, a Person shall not include (i) the Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its subsidiaries, (iii) an underwriter temporarily holdings securities pursuant to an offering of such securities, or (iv) a corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company.\n\t\t\"Beneficial Owner\" shall have the meaning defined in Rule 13d-3 under the Exchange Act.\"\n\t\t3. Section 5.1 of the Plan is hereby amended by adding the words \"or Section 4.7, as the case may be,\" following the words \"Section 4.5\" where they appear in the second paragraph thereof.\n\t\tThus done and signed as of the Effective Date in the presence of the undersigned and competent witness, who hereunto sign their name.\nWITNESSES:\t\t\tFLIGHTSAFETY INTERNATIONAL, INC. _____________________ By:____________________________ _____________________\t\t\t\t\t\t\t\t\t\nEXHIBIT 10(g)\n\tFLIGHTSAFETY INTERNATIONAL, INC. \t SEVERANCE AGREEMENT\n\t\tTHIS SEVERANCE AGREEMENT, dated December 2, 1994, is made by and between FLIGHTSAFETY INTERNATIONAL, INC., a New York corporation (the \"Company\"), and (the \"Executive\").\n\t\tThe Executive is presently employed by the Company as Vice President-Treasurer.\n\t\tThe Board recognizes that the Executive's contribution to the growth and success of the Company has been substantial. The Board desires to reinforce and encourage the continued attention and dedication to the Company of the Executive as a member of the Company's management, in the best interest of the Company and its stockholders.\n\t\tIn order to effect the foregoing, the Company and the Executive wish to enter into this severance agreement (\"Agreement\") on the terms and conditions set forth below. Accordingly, in consideration of the premises and the respective covenants and agreements of the parties herein contained, and intending to be legally bound hereby, the parties hereto agree as follows:\n\t\t1. Defined Terms. The definition of capitalized terms used in this Agreement is provided in the last Section hereof.\n\t\t2. Term of Agreement. This Agreement shall commence on the date hereof and shall continue in effect through December 31, 1995; provided that, commencing on January 1, 1996 and each January 1 thereafter, the term of this Agreement shall automatically be extended for one additional year unless, not later than September 30 of the preceding year, the Company or the Executive shall have given notice not to extend this Agreement or a Change in Control shall have occurred prior to such January 1; provided, however, that if a Potential Change in Control or a Change in Control shall have occurred during the term of this Agreement (even if subsequent to a notice not to extend), this Agreement shall continue in effect for a period of not less than twelve (12) months beyond the month in which the later of such Potential Change in Control or Change in Control occurred.\n\t\t3. Company's Covenants. In order to induce the Executive to remain in the employ of the Company and in consideration of the Executive's covenants set forth in Section 4 hereof, the Company agrees, under the condi tions described herein, to pay the Executive the \"Severance Payments\" described in Section 6.1 hereof and the other payments and benefits described herein in the event the Executive's employment with the Company is terminated within one (1) year following a Change in Control and during the term of this Agreement. No amount or benefit shall be payable under this Agreement unless there shall have been (or, under the terms hereof, there shall be deemed to have been) such a termination of the Executive's employment with the Company following a Change in Control. This Agreement shall not be construed as creating an express or implied contract of employment and, except as otherwise agreed in writing between the Executive and the Company, the Executive shall not have any right to be retained in the employ of the Company.\n\t\t4. The Executive's Covenants. The Executive agrees that, subject to the terms and conditions of this Agreement, in the event of a Potential Change in Control during the term of this Agreement, the Executive will remain in the employ of the Company until the earliest of (i) a date which is six (6) months from the date of such Potential Change of Control, (ii) the date of a Change in Control, (iii) the date of termination by the Executive of\nthe Executive's employment for Good Reason (determined by treating the Potential Change in Control as a Change in Control in applying the definition of Good Reason), by reason of death, Disability or Retirement, or (iv) the termination by the Company of the Executive's employment for any reason.\n\t\t5. Compensation Other Than Severance Payments.\n\t\t5.1 During the term of this Agreement and following a Change in Control, during any period that the Executive fails to perform the Executive's full-time duties with the Company as a result of incapacity due to physical or mental illness, the Company shall pay the Executive's full salary to the Executive at the rate in effect at the commencement of any such period, together with all compensation and benefits payable to the Executive under the terms of any compensation or benefit plan, program or arrangement maintained by the Company during such period, until the Executive's employment is terminated by the Company for Disability.\n\t\t5.2 If the Executive's employment shall be terminated for any reason following a Change in Control and during the term of this Agreement, the Company shall pay the Executive's full salary to the Executive through the Date of Termination at the rate in effect at the time the Notice of Termination is given, together with all compensation and benefits payable to the Executive through the Date of Termination under the terms of any compensation or benefit plan, program or arrangement maintained by the Company during such period. The Company shall pay the Executive's normal post-termination compensation and benefits to the Executive as such payments become due. Such post-termination compensation and benefits shall be determined under, and paid in accordance with, the Company's retirement, insurance and other compensation or benefit plans, programs and arrangements.\n\t\t6. Severance Payments.\n\t\t6.1 The Company shall pay the Executive the payments described in this Section 6.1 (the \"Severance Payments\") upon the termination of the Executive's employment within one (1) year following a Change in Control and during the term of this Agreement, in addition to the payments and benefits described in Section 5 hereof, unless such termination is (i) by the Company for Cause, (ii) by reason of death, Disability or Retirement, or (iii) by the Executive without Good Reason. The Executive's employment shall be deemed to have been terminated following a Change in Control by the Company without Cause or by the Executive with Good Reason if the Executive's employment is termi nated prior to a Change in Control without Cause at the direction or request of a Person who has entered into an agreement with the Company the consummation of which will constitute a Change in Control or if the Executive terminates his employment with Good Reason prior to a Change in Control (determined by treat ing a Potential Change in Control as a Change in Control in applying the definition of Good Reason) if the circumstance or event which constitutes Good Reason occurs at the direction or request of such Person.\n\t\t\t(A) In lieu of any further salary payments to the Executive for periods subsequent to the Date of Termination, the Company shall pay, within five (5) days after the Date of Termination, to the Executive a lump sum severance payment, in cash, equal to the sum of three times (i) the Executive's annual base salary in effect immediately prior to the occurrence of the event or circumstance upon which the Notice of Termination is based and (ii) the greater of the amount paid to the Executive as bonus compensation for the year preceding the year in which the Date of Termination occurs and the amount of bonus compensation that would have been paid to the Executive for such year if 100% of the Performance Percentage applicable to the bonus award had been realized.\n\t\t\t(B) In lieu of Company Shares issuable upon exercise of outstanding Options (which Options shall be cancelled upon the making of the payment referred to below), the Company shall pay the Executive a lump sum amount, in cash, equal to the product of (i) the excess of (x) in the case of ISOs granted after the date hereof, the closing price of Company Shares as reported on the New York Stock Exchange Composite Tape on or nearest the Date of Termination (or, if not listed on such exchange, on the nationally recognized exchange or quotation system on which trading volume in Company Shares is highest), or (y) in the case of all other Options, the higher of such closing price or the highest per share price for Company Shares actually paid in connection with any Change in Control, over the per share exercise price of each such Option held by the Executive (whether or not then fully exercisable), times (ii) the number of Company Shares covered by each such Option.\n\t\t(C) For a thirty-six (36) month period after the Date of Termination, the Company shall arrange to provide the Executive with life, disability, accident and health insurance benefits substantially similar to those which the Executive is receiving immediately prior to the Notice of Termination (without giving effect to any reduction in such benefits subsequent to a Potential Change in Control or a Change in Control which reduction constitutes Good Reason). Benefits otherwise receivable by the Executive pursuant to this Section 6.1(C) shall be reduced to the extent comparable benefits are actually received by or made available to the Executive without cost during the twelve (12) month period following the Executive's termination of employment (and any such benefits actually received by the Executive shall be reported to the Company by the Executive).\n\t\t(D) The restrictions on all Restricted Shares shall lapse upon the occurrence of a Change in Control.\n\t\t6.2 Notwithstanding any other provisions of this Agreement, in the event that any payment or benefit received or to be received by the Executive in connection with a Change in Control or the termination of the Executive's employment (whether pursuant to the terms of this Agreement or any other plan, arrangement or agreement with the Company, any Person whose actions result in a Change in Control or any Person affiliated with the Company or such Person) (all such payments and benefits, including the Severance Payments, being hereinafter called \"Total Payments\") would be subject (in whole or part), to the Excise Tax, then the Severance Payments shall be reduced to the extent necessary so that no portion of the Total Payments is subject to the Excise Tax (after taking into account any reduction in the Total Payments provided by reason of section 280G of the Code in such other plan, arrangement or agree ment) if (A) the net amount of such Total Payments, as so reduced, (and after deduction of the net amount of federal, state and local income tax on such reduced Total Payments) is greater than (B) the excess of (i) the net amount of such Total Payments, without reduction (but after deduction of the net amount of federal, state and local income tax on such Total Payments), over (ii) the amount of Excise Tax to which the Executive would be subject in respect of such Total Payments. For purposes of determining whether and the extent to which the Total Payments will be subject to the Excise Tax, (i) no portion of the Total Payments the receipt or enjoyment of which the Executive shall have effectively waived in writing prior to the Date of Termination shall be taken into account, (ii) no portion of the Total Payments shall be taken into account which in the opinion of tax counsel selected by the Company does not constitute a \"parachute payment\" within the meaning of section 280G(b)(2) of the Code (including by reason of section 280G(b)(4)(A) of the Code) and, in calculating the Excise Tax, no portion of such Total Payments shall be taken into account which constitutes reasonable compensation for services actually rendered, within the meaning of section 280G(b)(4)(B) of the Code, in excess of the Base Amount allocable to such reasonable compensation, and (iii) the value of any non-cash benefit or any deferred payment or benefit included in the Total Pay ments shall be determined by the Company in accordance with the principles of sections 280G(d)(3) and (4) of the Code. Prior to the payment date set forth in Section 6.3 hereof, the Company shall provide the Executive with its calculation of the amounts referred to in this Section and such supporting materials as are reasonably necessary for the Executive to evaluate the Company's calculations. If the Executive objects to the Company's calcula tions, the Company shall pay to the Executive such portion of the Severance Payments (up to 100% thereof) as the Executive determines is necessary to result in the Executive receiving the greater of clauses (A) and (B) of this Section.\n\t\t6.3 The payments provided for in Section 6.1 (other than Section 6.1(C)) and 6.2 hereof shall be made not later than the fifth (5th) day following the Date of Termination; provided that, if the amounts of such pay ments cannot be finally determined on or before such day, the Company shall pay to the Executive on such day an estimate, as determined in good faith by the Company, of the minimum amount of such payments to which the Executive is clearly entitled and shall pay the remainder of such payments as soon as the amount thereof can be determined but in no event later than the thirtieth (30th) day after the Date of Termination. In the event that the amount of the estimated payments exceeds the amount subsequently determined to have been due, such excess shall constitute a loan by the Company to the Executive, payable on the fifth (5th) business day after demand by the Company (together with interest at the rate provided in section 1274(b)(2)(B) of the Code). At the time that payments are made under this Section, the Company shall provide the Executive with a written statement setting forth the manner in which such payments were calculated and the basis for such calculations including, without limitation, any opinions or other advice the Company has received from outside counsel, auditors or consultants (and any such opinions or advice which are in writing shall be attached to the statement).\n\t\t6.4 The Company also shall pay to the Executive all legal fees and expenses incurred by the Executive as a result of a termination which entitles the Executive to the Severance Payments (including all such fees and expenses, if any, incurred in disputing any such termination or in seeking in good faith to obtain or enforce any benefit or right provided by this Agreement or in connection with any tax audit or proceeding to the extent attributable to the application of section 4999 of the Code to any payment or benefit provided hereunder). Such payments shall be made within five (5) business days after delivery of the Executive's written requests for payment accompanied with such evidence of fees and expenses incurred as the Company reasonably may require.\n\t\t7. Termination Procedures and Compensation During Dispute.\n\t\t7.1 Notice of Termination. After a Change in Control and during the term of this Agreement, any purported termination of the Executive's employment (other than by reason of death) shall be communicated by written Notice of Termination from one party hereto to the other party hereto in accordance with Section 10 hereof. For purposes of this Agreement, a \"Notice of Termination\" shall mean a notice which shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances claimed to provide a basis for termination of the Executive's employment under the provision so indicated. Further, a Notice of Termination for Cause is required to include a copy of a resolution duly adopted by the affirmative vote of not less than three-quarters (3\/4) of the entire membership of the Board at a meeting of the Board which was called and held for the purpose of considering such termination (after reasonable notice to the Executive and an opportunity for the Executive, together with the Executive's counsel, to be heard before the Board) finding that, in the good faith opinion of the Board, the Executive was guilty of conduct set forth in clause (i) or (ii) of the definition of Cause herein, and specifying the particulars thereof in detail.\n\t\t7.2 Date of Termination. \"Date of Termination\", with respect to any purported termination of the Executive's employment after a Change in Control and during the term of this Agreement, shall mean (i) if the Execu tive's employment is terminated for Disability, thirty (30) days after Notice of Termination is given (provided that the Executive shall not have returned to the full-time performance of the Executive's duties during such thirty (30) day period), and (ii) if the Executive's employment is terminated for any other reason, the date specified in the Notice of Termination (which, in the case of a termination by the Company, shall not be less than thirty (30) days (except in the case of a termination for Cause) and, in the case of a termination by the Executive, shall not be less than fifteen (15) days nor more than sixty (60) days, respectively, from the date such Notice of Termination is given).\n\t\t7.3 Dispute Concerning Termination. If within fifteen (15) days after any Notice of Termination is given, or, if later, prior to the Date of Termination (as determined without regard to this Section 7.3), the party receiving such Notice of Termination notifies the other party that a dispute exists concerning the termination, the Date of Termination shall be the date on which the dispute is finally resolved, either by mutual written agreement of the parties or by a final judgment, order or decree of a court of competent jurisdiction (which is not appealable or with respect to which the time for appeal therefrom has expired and no appeal has been perfected); provided that, the Date of Termination shall be extended by a notice of dispute only if such notice is given in good faith and the party giving such notice pursues the resolution of such dispute with reasonable diligence.\n\t\t7.4 Compensation During Dispute. If a purported termination occurs following a Change in Control and during the term of this Agreement, and such termination is disputed in accordance with Section 7.3 hereof, the Company shall continue to pay the Executive the full compensation in effect when the notice giving rise to the dispute was given (including, but not limited to, any bonus payments) and continue the Executive as a participant in all compensa tion, benefit and insurance plans in which the Executive was participating when the notice giving rise to the dispute was given, until the dispute is finally resolved in accordance with Section 7.3 hereof. Amounts paid under this Section 7.4 are in addition to all other amounts due under this Agreement (other than those due under Section 5.2 hereof) and shall not be offset against or reduce any other amounts due under this Agreement.\n\t\t8. No Mitigation. The Company agrees that, if the Execu tive's employment by the Company is terminated during the term of this Agreement, the Executive is not required to seek other employment or to attempt in any way to reduce any amounts payable to the Executive by the Company pursuant to Section 6 or Section 7.4. Further, the amount of any payment or benefit provided for in Section 6 (other than Section 6.1(C)) or Section 7.4 shall not be reduced by any compensation earned by the Executive as the result of employment by another employer, by retirement benefits, by offset against any amount claimed to be owed by the Executive to the Company, or otherwise.\n\t\t9. Successors; Binding Agreement.\n\t\t9.1 In addition to any obligations imposed by law upon any successor to the Company, the Company will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and\/or assets of the Company to expressly assume and agree to perform this Agreement in the same manner and to the same extent that the Company would be required to perform it if no such succession had taken place. Failure of the Company to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle the Executive to compensation from the Company in the same amount and on the same terms as the Executive would be entitled to hereunder if the Executive were to terminate the Executive's employment for Good Reason after a Change in Control, except that, for purposes of implementing the foregoing, the date on which any such succession becomes effective shall be deemed the Date of Termination.\n\t\t9.2 This Agreement shall inure to the benefit of and be enforceable by the Executive's personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If the Executive shall die while any amount would still be payable to the Executive hereunder (other than amounts which, by their terms, terminate upon the death of the Executive) if the Executive had continued to live, all such amounts, unless otherwise provided herein, shall be paid in accordance with the terms of this Agreement to the executors, personal representatives or administrators of the Executive's estate.\n\t\t10. Notices. For the purpose of this Agreement, notices and all other communications provided for in the Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth below, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon actual receipt:\n\t\t\tTo the Company:\n\t\t\tFlightSafety International, Inc. \t\t\tMarine Air Terminal \t\t\tLaGuardia Airport \t\t\tFlushing, New York 11371 \t\t\tAttention: President\n\t\t\tTo the Executive:\n\t\t\t \t\t\t \t\t\t\n\t\t11. Miscellaneous. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by the Executive and such officer as may be specifically designated by the Board. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not expressly set forth in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of New York. All references to sections of the Exchange Act or the Code shall be deemed also to refer to any successor provisions to such sections. Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law and any additional withholding to which the Executive has agreed. The obligations of the Company and the Executive under Sections 6 and 7 shall survive the expiration of the term of this Agreement.\n\t\t12. Validity. The invalidity or unenforce-ability or any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect.\n\t\t13. Counterparts. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument.\n\t\t14. Settlement of Disputes; Arbitration. All claims by the Executive for benefits under this Agreement shall be directed to and determined by the Board and shall be in writing. Any denial by the Board of a claim for benefits under this Agreement shall be delivered to the Executive in writing and shall set forth the specific reasons for the denial and the specific provisions of this Agreement relied upon. The Board shall afford a reasonable opportunity to the Executive for a review of the decision denying a claim and shall further allow the Executive to appeal to the Board a decision of the Board within sixty (60) days after notification by the Board that the Executive's claim has been denied. Any further dispute or controversy arising under or in connection with this Agreement shall be settled exclusively by arbitration in New York, New York in accordance with the rules of the American Arbitration Association then in effect. Judgment may be entered on the arbitrator's award in any court having jurisdiction; provided, however, that the Executive shall be entitled to seek specific performance of the Executive's right to be paid until the Date of Termination during the pendency of any dispute or controversy arising under or in connection with this Agreement.\n\t\t15. Definitions. For purposes of this Agreement, the following terms shall have the meanings indicated below:\n\t\t(A) \"Base Amount\" shall have the meaning defined in section 280G(b)(3) of the Code.\n\t\t(B) \"Beneficial Owner\" shall have the meaning defined in Rule 13d-3 under the Exchange Act.\n\t\t(C) \"Board\" shall mean the Board of Directors of the Company.\n\t\t(D) \"Cause\" for termination by the Company of the Executive's employment, after any Change in Control, shall mean (i) the willful and continued failure by the Executive to substantially perform the Executive's duties with the Company (other than any such failure resulting from the Executive's incapacity due to physical or mental illness or any such actual or anticipated failure after the issuance of a Notice of Termination for Good Reason by the Executive pursuant to Section 7.1) after a written demand for substantial performance is delivered to the Executive by the Board, which demand specifically identifies the manner in which the Board believes that the Executive has not substantially performed the Executive's duties, or (ii) the willful engaging by the Executive in conduct which is demonstrably and materi ally injurious to the Company or its subsidiaries, monetarily or otherwise. For purposes of clauses (i) and (ii) of this definition, no act, or failure to act, on the Executive's part shall be deemed \"willful\" unless done, or omitted to be done, by the Executive not in good faith and without reasonable belief that the Executive's act, or failure to act, was in the best interest of the Company.\n\t\t(E) A \"Change in Control\" shall be deemed to have occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied:\n\t\t\t\t(i) any Person is or becomes the Beneficial Owner, directly or indirectly, of securities of the Company (not including in the securities beneficially owned by such Person any securities acquired directly from the Company or its affiliates) representing 30% or more of the combined voting power of the Company's then outstanding securities (other than any Beneficial Owner with such voting power as of the date of this Agreement); or\n\t\t\t\t(ii) during any period of two consecutive years (not including any period prior to the execution of this Agreement), individuals who at the beginning of such period constitute the Board and any new director (other than a director designated by a Person who has entered into an agreement with the Company to effect a transaction described in clause (i), (iii) or (iv) of this paragraph) whose election by the Board or nomination for election by the Company's stockholders was approved by a vote of at least two-thirds (2\/3) of the directors then still in office who either were directors at the beginning of the period or whose election or nomination for election was previ ously so approved, cease for any reason to constitute a majority thereof; or\n\t\t\t\t(iii) the shareholders of the Company ap prove a merger or consolidation of the Company with any other corporation, other than (i) a merger or consolidation which would result in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving entity), in combination with the ownership of any trustee or other fiduciary holding securities under an employee benefit plan of the Company, at least 75% of the combined voting power of the voting securities of the Company or such surviving entity outstanding immediately after such merger or consolidation, or (ii) a merger or consolidation effected to implement a recapitalization of the Company (or similar transaction) in which no Person acquires more than 50% of the combined voting power of the Company's then outstanding securities; or\n\t\t\t\t(iv) the shareholders of the Company approve a plan of complete liquidation of the Company or an agreement for the sale or disposition by the Company of all or substantially all the Company's assets.\nNotwithstanding the foregoing, a Change in Control shall not include any event, circumstance or transaction occurring during the six-month period following a Potential Change in Control which results from the action of any entity or group which includes, is affiliated with or is wholly or partly controlled by one or more executive officers of the Company, including the Executive (a \"Man agement Group\"); provided that, such action shall not be taken into account for this purpose if it occurs within a six-month period following a Potential Change in Control resulting from the action of any Person which is not a Management Group.\n\t\t(F) \"Code\" shall mean the Internal Revenue Code of 1986, as amended from time to time.\n\t\t(G) \"Company\" shall mean FlightSafety International, Inc., a New York corporation, and any successor to its business and\/or assets which assumes and agrees to perform this Agreement by operation of law, or otherwise (except in determining, under Section 15(E) hereof, whether or not any Change in Control of the Company has occurred in connection with such succession).\n\t\t(H) \"Company Shares\" shall mean shares of common stock of the Company or any equity securities into which such shares have been converted.\n\t\t(I) \"Date of Termination\" shall have the meaning stated in Section 7.2 hereof.\n\t\t(J) \"Disability\" shall be deemed the reason for the termina tion by the Company of the Executive's employment, if, as a result of the Executive's incapacity due to physical or mental illness, the Executive shall have been absent from the full-time performance of the Executive's duties with the Company for a period of six (6) consecutive months, the Company shall have given the Executive a Notice of Termination for Disability, and, within thirty (30) days after such Notice of Termination is given, the Executive shall not have returned to the full-time performance of the Executive's duties.\n\t\t(K) \"Exchange Act\" shall mean the Securities Exchange Act of 1934, as amended from time to time.\n\t\t(L) \"Excise Tax\" shall mean any excise tax imposed under section 4999 of the Code.\n\t\t(M) \"Executive\" shall mean the individual named in the first paragraph of this Agreement.\n\t\t(N) \"Good Reason\" for termination by the Executive of the Executive's employment shall mean the occurrence (without the Executive's express written consent) of any one of the following acts by the Company, or failures by the Company to act, unless, in the case of any act or failure to act described in paragraph (i), (v), (vi), (vii), or (viii) below, such act or failure to act is corrected prior to the Date of Termination specified in the Notice of Termination given in respect thereof:\n\t\t\t\t(i) the assignment to the Executive of any duties inconsistent with the Executive's status as a senior executive officer of the Company or a substantial adverse alteration in the nature or status of the Executive's responsibilities from those in effect immediately prior to the Change in Control;\n\t\t\t\t(ii) a reduction by the Company in the Executive's annual base salary as in effect on the date hereof or as the same may be increased from time to time;\n\t\t\t\t(iii) the relocation of the Company's princi pal executive offices to a location outside the New York City Metropolitan Area (or, if different, the metropolitan area in which such offices are located immediately prior to the Change in Control) or the Company's requiring the Executive to be based anywhere other than the Company's principal executive offices except for required travel on the Company's business to an extent substantially consistent with the Executive's present business travel obligations;\n\t\t\t\t(iv) the failure by the Company, without the Executive's consent, to pay to the Executive any portion of the Executive's current compensation, or to pay to the Executive any portion of an installment of deferred compensation under any deferred compensation program of the Company, within seven (7) days of the date such compensation is due;\n\t\t\t\t(v) the failure by the Company to continue in effect any compensation plan in which the Executive participates immediately prior to the Change in Control which is material to the Executive's total compensation, including but not limited to any stock option, restricted stock, stock appreciation right, incentive compensation, bonus and other plans or any substitute plan(s) adopted prior to the Change in Control, unless an equitable arrangement (embodied in an ongoing substitute or alternative plan) has been made with respect to such plan, or the failure by the Company to continue the Executive's participation therein (or in such substitute or alternative plan) on a basis not materially less favorable, both in terms of the amount of benefits provided and the level of the Executive's participation relative to other participants, as existed at the time of the Change in Control;\n\t\t\t\t(vi) the failure by the Company to continue to provide the Executive with benefits substantially similar to those enjoyed by the Executive under any of the Company's pension, life insurance, medical, health and accident, or disability plans in which the Executive was participating at the time of the Change in Control, the taking of any action by the Company which would directly or indirectly materially reduce any of such benefits or deprive the Executive of any material fringe benefit enjoyed by the Executive at the time of the Change in Control, or the failure by the Company to provide the Executive with the number of paid vacation days to which the Executive is entitled on the basis of years of service with the Company in accordance with the Company's normal vacation policy in effect at the time of the Change in Control; or\n\t\t\t\t(vii) any purported termination of the Executive's employment which is not effected pursuant to a Notice of Termination satisfying the requirements of Section 9.1; for purposes of this Agreement, no such purported termination shall be effective.\n\t\tThe Executive's right to terminate the Executive's employment for Good Reason shall not be affected by the Executive's incapacity due to physical or mental illness. The Executive's continued employment shall not constitute consent to, or a waiver of rights with respect to, any act or failure to act constituting Good Reason hereunder.\n\t\t(O) \"ISOs\" shall mean options qualifying as incentive stock options under section 422 of the Code.\n\t\t(P) \"Notice of Termination\" shall have the meaning stated in Section 7.1 hereof.\n\t\t(Q) \"Options\" shall mean options for Company Shares granted to the Executive under the Company's 1979 Stock Option Plan, 1982 Stock Option Plan and 1992 Stock Option Plan, other than ISOs granted on or before the date of this Agreement and ISOs which have not become exercisable on the Date of Termination.\n\t\t(R) \"Performance Percentage\" shall mean the percentage of the bonus base of the Executive's annual salary determined by the Compensation Committee of the Board of Directors to have been achieved by the Executives.\n\t\t(S) \"Person\" shall have the meaning given in Section 3(a)(9) of the Exchange Act, as modified and used in Sections 13(d) and 14(d) thereof; however, a Person shall not include (i) the Company or any of its subsidiaries, (ii) a trustee or other fiduciary holding securities under an employee benefit plan of the Company or any of its subsidiaries, (iii) an underwriter temporari ly holding securities pursuant to an offering of such securities, or (iv) a corporation owned, directly or indirectly, by the stockholders of the Company in substantially the same proportions as their ownership of stock of the Company.\n\t\t(T) \"Potential Change in Control\" shall be deemed to have occurred if the conditions set forth in any one of the following paragraphs shall have been satisfied:\n\t\t\t\t(i) the Company enters into an agreement, the consummation of which would result in the occurrence of a Change in Control;\n\t\t\t\t(ii) the Company or any Person publicly an nounces an intention to take or to consider taking actions which, if consummated, would constitute a Change in Control;\n\t\t\t\t(iii) any Person after the date of this Agreement becomes the Beneficial Owner, directly or indirectly, of securities of the Company representing 15% or more of the combined voting power of the Company's then outstanding securities (other than (i) a person who acquires voting securities of the Company by devise or by operation of the laws of descent and distribution or interstate succession from any Person who is a Beneficial Owner with such voting power as of the date of this Agreement or (ii) any Person who acquires securities with such voting power directly from the Company or its affiliates); or\n\t\t\t\t(iv) the Board adopts a resolution to the effect that, for purposes of this Agreement, a Potential Change in Control has occurred.\t\n\t\t(U) \"Restricted Shares\" shall mean Company Shares awarded pursuant to the 1984 Restricted Stock Compensation Plan of the Company.\n\t\t(V) \"Retirement\" shall be deemed the reason for the termina tion by the Company or the Executive of the Executive's employment if such employment is terminated in accordance with the Company's retirement policy, not including early retirement, generally applicable to its salaried employees, as in effect immediately prior to the Change in Control, or in accordance with any retirement arrangement established with the Executive's consent with respect to the Executive.\n\t\t(W) \"Severance Payments\" shall mean those payments described in Section 6.1 hereof.\n\t\t(X) \"Shares\" shall mean shares of the common stock, $.10 par value, of the Company.\n\t\t(Y) \"Total Payments\" shall mean those payments described in Section 6.2 hereof.\n\t\t\t\t\tFLIGHTSAFETY INTERNATIONAL, INC.\n\t\t\t\t\tBy\t \t\t\t\t\t Name: \t\t\t\t\t Title:\n\t\t\t\t\t\t ANNUAL REPORT\t\t\t\t Selected pages from the Annual Report of FlightSafety International for 1994\nManagement's Discussion and Analysis of Results of Operations and Financial Condition\nResults of Operations 1994 Compared with 1993\nTraining revenues increased by $27.0 million, or 11 percent, in 1994 as compared to 1993. Business aviation training revenues increased by $10.6 million primarily because of increased demand for the Company s training services. Commercial airline training revenues increased by $4.5 million as demand from South American customers increased and from the continued expansion of the Company s Airline New Hire Program. Primary flight training revenues increased by $2.0 million, primarily from more individual pilots seeking careers as professional pilots. There was also an increase in training revenues of $7.8 million from two aircrew training systems contracts with the U.S. Air Force. The most significant of which was for training of KC-135 tanker aircraft crews, and included contract revenues of $1.9 million related to an equivalent amount of retroactive salary and benefit expenses from October 1, 1992 paid to employees in accordance with the United States Government Services Contract Act.\nProduct sales in 1994 decreased $22.8 million, or 44 percent, from 1993. The decrease in product sales was primarily attributable to a decrease in market demand and customer orders for equipment being produced by the Company s Simulation Systems Division.\nTotal expenses decreased $1.6 million, or one percent, in 1994 as compared to 1993. Salary expense increased $6.6 million principally due to additional personnel hired for the U.S. Air Force KC-135 contract and the retroactive salary paid as indicated above. Depreciation and amortization increased by $2.4 million due to a full year of depreciation on simulators added in 1993 and a partial year of depreciation for simulators added in 1994. General and administrative expenses increased by $3.3 million primarily because of costs associated with the KC-135 contract with the U.S. Air Force and increases in employee benefit costs. Operating expenses increased by $1.9 million primarily from increases in costs of training supplies and simulator maintenance. Cost of product sales decreased by $15.7 primarily from the related decrease in product sales. Research and development expenditures incurred by the Visual Simulation Systems Division amounted to $1.2 million in 1994 ($3.2 million in 1993) and are included in cost of product sales. The decrease in gross profit margin of product sales to 19.5% in 1994 from 24.6% in 1993 was principally due to an increased percentage of sales to the U.S. Government which have lower profit margins.\nInterest and other income increased by $0.8 million in 1994 as compared to 1993 principally due to proceeds from the corporate owned life insurance policies. Interest expense increased primarily from higher interest rates in 1994 on the Company s borrowings and increases in borrowings against the cash surrender value of corporate owned life insurance policies.\nIncome taxes decreased by $1.6 million, or four percent, in 1994 as compared to 1993 due primarily to the additional deferred income tax liability recorded in 1993 offset by increased taxable income in 1994 as compared to 1993. The effective income tax rate decreased to 35.8% in 1994 from 39.4% in 1993 primarily due to the previously mentioned deferred income taxes recorded in 1993.\nEarnings per share and net income increased by 17 percent and 12 percent to $2.35 per share from $2.01 per share and $74,475,000 from $66,414,000 in 1994 as compared to 1993, respectively. The higher percentage increase of earnings per share than net income is a result of the Company s stock repurchase program and its corresponding effect on the weighted average shares outstanding.\nIn December 1994, the Company divested itself of PowerSafety International, Inc. to focus on its core business. The divestiture had no significant effect on the Company s financial statements.\nInflation continued to increase operating costs and costs of equipment and facilities during 1994. The Company expects to recover its additional costs due to inflation with increases in volume and prices.\nFinancial Condition\nIn 1994, $118.4 million of cash was provided by operations and $10.3 million was provided by additional borrowings against the cash surrender value of corporate owned life insurance. Cash was principally used to purchase equipment and facilities ($64.4 million), repurchase common stock ($29.2 million), purchase short-term investments ($16.0 million), pay dividends ($13.9 million) and pay corporate owned life insurance premiums ($7.5 million).\nAccounts receivable at December 31, 1994 increased by $10.8 million, or 22 percent, from December 31, 1993 due primarily to an increase in amounts billed in the 1994 fourth quarter as compared to the 1993 fourth quarter.\nIn 1995, the Company expects to spend in excess of $55 million for additional equipment and facilities. If appropriate market conditions exist, the Company will continue to repurchase shares of its common stock. The Board of Directors increased the shares authorized for the stock repurchase program from 3,000,000 shares to 4,000,000 shares on December 3, 1993. The Company expects to fund these items with cash provided by operations and short-term investments. As of December 31, 1994, the Company had repurchased 3,291,700 shares of its common stock.\nResults of Operations 1993 Compared with 1992\nTraining revenues increased by $5.4 million, or two percent, in 1993 as compared to 1992. Business aviation training revenues increased by $6.3 million primarily because of new business aircraft simulators that were added and increases in initial training related to new aircraft deliveries in the fourth quarter of 1993. Commercial airline training revenues increased by $3.9 million as demand from South American and Asian customers increased and as a result of the continued success of the Company s New Hire Program. There was also an increase in training revenues of $10.2 million from a contract with the U.S. Air Force to train KC-135 tanker aircraft crews. These increases were offset by lower revenues of $8.9 million from the U.S. Air Force C-5 contract and $2.9 million in primary flight training.\nProduct sales in 1993 increased $13.3 million, or 34 percent, from 1992. The increase in product sales was primarily attributable to sales of visual systems by the Visual Simulation Systems Division which was acquired in January 1993. Total expenses increased $23.6 million, or 14 percent, in 1993 as compared to 1992. Salary expense increased $6.7 million principally due to additional personnel hired for the U.S. Air Force KC-135 contract. Depreciation and amortization increased by $4.4 million due to a full year of depreciation on simulators added in 1992 and a partial year of depreciation for simulators added in 1993. General and administrative expenses increased primarily because of costs associated with the KC-135 contract with the U.S. Air Force. These increases were offset by a net decrease in operating expenses of $0.5 million primarily due to a $3.6 million reduction of effort for the U.S. Air Force C-5 contract offset by increases in operating expenses from the KC-135 contract. Cost of product sales increased by $11.8 million principally due to sales of visual systems. Research and development expenditures incurred by the Visual Simulation Systems Division amounted to $3.2 million and are included in cost of product sales. The decrease in gross profit margin to 24.6% in 1993 from 29.1% in 1992 was principally due to the research and development expenditures in cost of product sales.\nInterest and other income decreased by $1.7 million in 1993 as compared to 1992 principally due to lower investment balances in 1993 resulting from funds used for the Company s stock repurchase program. Interest expense decreased primarily from lower interest rates in 1993 on the Company s borrowings against the cash surrender value of corporate-owned life insurance policies.\nNote Notes to Consolidated Financial Statements\nNote 1- Summary of Significant Accounting and Reporting Policies\nConsolidation and Reporting The accompanying financial statements include the accounts of the Company and its majority-owned subsidiaries.\nThe Company operates primarily in one industry segment: training. Training activities include advanced training of professional pilots and crews, primary training for individuals to obtain private or commercial pilot licenses, training in the maintenance of aircraft, design and implementation of integrated training systems and training crews of large ocean-going vessels in ship and cargo handling. The Company is also engaged in the manufacture and sale of products including simulators and visual systems. The Company s clients include corporations, commercial airlines, ship operators, the military and other government agencies.\nRevenues Revenue from training is recognized when the training is provided except for revenue from training provided pursuant to annual contracts which is recognized on the straight-line method over the life of the contract. Revenues and costs arising from product sales are accounted for principally under the percentage of completion method.\nDepreciation and Amortization Depreciation is provided on the straight-line method over estimated useful lives as follows: simulators, training equipment and spare parts, 4 to 20 years; buildings, 25 to 40 years; and furniture, fixtures and equipment, 4 to 10 years. Leasehold improvements, including buildings on leased property, are amortized over the life of the lease or the life of the improvement, whichever is shorter.\nInterest is capitalized as an integral component of cost during the construction period of simulators and facilities and is amortized over the life of the related assets.\nShort-term Investments Short-term investments consist primarily of state and municipal obligations and are stated at amortized cost, which approximates market value.\nCommon Stock Repurchase The Company records the repurchase of its common stock by reducing the common stock account by the par value of the common stock purchased and reducing retained earnings by the amounts in excess of par value. Repurchased common stock is cancelled and returned to the Company s authorized and unissued common shares.\nAmortization of Intangible Assets Intangible assets arose principally from the acquisitions of a subsidiary in 1988 and a division in 1993 and are amortized over periods from 3 to 20 years.\nIncome Taxes The Company records income taxes in accordance with Statement of Financial Accounting Standards No.109- Accounting for Income Taxes, which was adopted in 1993 and had no effect on the Company s financial statements since the Company had previously recorded income taxes in accordance with Statement of Financial Accounting Standards No. 96.\nNet Income Per Share Net income per share is based upon the weighted average number of shares outstanding during each year. Stock options have not been included in the calculation of net income per share because their inclusion would not have a significant dilutive effect.\nNote 2- Acquisition\nOn January 29, 1993, the Company purchased the assets of the Visual Simulation Systems business unit of McDonnell Douglas Corporation. The assets purchased included accounts receivable, inventory, contracts in process, furniture, fixtures and various intangible assets arising from the acquisition. The new Division manufactures computer generated image display systems for aircraft simulators, under the trade name VITAL, at its St. Louis, Missouri facility.\nNotes to Consolidated Financial Statements\nState and local income taxes amounted to $5,591,000 in 1994 ($5,645,000 in 1993 and $6,760,000 in 1992). Foreign income before taxes and foreign income taxes were not material. The principal temporary difference generating deferred income taxes in the current year and past years is depreciation of equipment and facilities which is recognized in different years for financial reporting than for tax reporting. Due to an increase in the federal income tax rate in 1993, additional deferred income tax liabilities of $3.4 million were recorded in 1993 related to temporary differences that arose in prior years.\nThe Company does not provide taxes on undistributed earnings of foreign subsidiaries since the Company anticipates no significant incremental U.S. income taxes on the repatriation of these earnings due to tax rates in foreign jurisdictions in which the Company has operations approximating or exceeding the U.S. statutory income tax rates.\nThe Company made tax payments of $33.9 million in 1994 ($33.5 million in 1993 and $40.9 million in 1992).\nNotes to Consolidated Financial Statements\nThe Company s industrial development obligations had variable rates between 2.1 and 5.8 percent during 1994. The weighted average interest rate for the above borrowings was 3.6 percent in 1994 (3.3 percent in 1993). At December 31, 1994, approximately $15 million of the Company s assets were pledged as security for the industrial development obligations. Under the most restrictive covenants, the Company must maintain positive working capital, a long-term debt to net worth ratio of less than 0.75 to 1.0 and a minimum net worth of $100 million.\nIntangible and other assets include investments in corporate-owned life insurance which have a cash surrender value of $52.7 million offset by borrowings against cash surrender values of $30.6 million at December 31, 1994 ($43.6 million and $20.3 million, respectively, at December 31, 1993). In 1994, the interest rate on borrowings against cash surrender value of corporate owned life insurance was 8.9 percent (9.3 percent in 1993).\nThe amounts of debt payable in the five years subsequent to 1994 are: $1,759,000 in 1995 and 1996, $1,259,000 in 1997, $1,224,000 in 1998 and no debt payable in 1999.\nThe Company paid interest of $1,506,000 in 1994, $2,402,000 in 1993 and $2,605,000 in 1992, net of amounts capitalized. The amount of interest capitalized was $1,484,000 in 1994 ($1,543,000 in 1993 and $2,262,000 in 1992).\nNote 6- Retirement Plans\nSubstantially all employees of the Company and all but one of its domestic subsidiaries are eligible to participate in the Company s noncontributory defined benefit retirement plan. Benefits are based principally on years of service and compensation during an employee s career. An employee becomes vested upon completion of five years of service or the attainment of age 55 and is entitled to receive a minimum monthly benefit at normal retirement age. The Company also has a defined Contribution Plan for certain employees. Pension cost amounted to $1,821,000 in 1994 ($1,799,000 in 1993 and $1,225,000 in 1992).\nThe Company s funding policy is to contribute amounts sufficient to meet the requirements of the Employee Retirement Income Security Act of 1974, plus any additional amounts which the Company may determine to be appropriate. The assets of the Plan include insurance contracts, marketable equity securities and mutual funds.\nNotes to Consolidated Financial Statements\nNote 8- Employee Stock Plans\nStock Option Plans The Company has three active stock option plans for its key employees, the \"1979 Plan\", the \"1982 Plan\" and the \"1992 Plan\".\nThe 1979 Plan provided for awards consisting of non-qualified options for the purchase of shares of common stock at the market price at date of grant. Options granted under the 1979 Plan expire ten years from date of grant. As of December 1989, pursuant to its terms, no further grants of options were available under the 1979 plan.\nThe 1982 Plan permitted awards consisting of non-qualified and incentive stock options at the market price at date of grant. As of August 1992, pursuant to its terms, no further grants of options were available under the 1982 Plan. The 1992 Plan permits awards consisting of non-qualified and incentive stock options for the purchase of up to 600,000 shares of common stock at the market price at date of grant. Options for 110,340 shares were granted in 1994 (102,410 in 1993 and 67,275 in 1992). At December 31, 1994, shares available for future options under the 1992 Plan were 324,975.\nProceeds received from the exercise of options under the plans are credited to the capital accounts in the year the options are exercised. The plans permit employeesto tender shares to the Company in lieu of cash for the exercise of stock options. No amounts are charged or credited to income as a result of these plans.\nNotes to Consolidated Financial Statements\nNotes to Consolidated Financial Statements\nNote 9- Sale of Minority Interest in European Venture\nIn July 1992, the Company sold its minority financial interest in a European venture to the majority shareholder for a pre-tax gain of $12.6 million which increased net income per share by $7.7 million, or 22 cents per share.\nNotes to Consolidated Financial Statements Note 10- Commitments and Contingencies\nThe Company is obligated under long-term operating leases for offices, facilities and real property. The future minimum rental payments under these leases are as follows: $1,619,000 in 1995, $1,387,000 in 1996, $1,155,000 in 1997, $648,000 in 1998, $641,000 in 1999 and $4,589,000 thereafter. These leases are generally subject to renewal. Rent for 1994 was $1,811,000 ($1,790,000 in 1993 and $1,407,000 in 1992).\nReport of Independent Accountants\nTo the Board of Directors and Shareholders of FlightSafety International, Inc.\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income and of cash flows present fairly, in all material respects, the financial position of FlightSafety International, Inc. and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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 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, 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 LLP New York, New York January 31, 1995\nBoard of Directors and Officers\nDirectors\nAlbert L. Ueltschi Chairman President, FlightSafety International, Inc.\nGeorge B. Beitzel* Senior Vice President and Director, Retired International Business Machines Corporation Information Handling Systems, Equipment and Services\nEdward E. Hood, Jr.* Vice Chairman and Executive Officer, Retired General Electric Company Diversified technology, manufacturing and services\nCharles R. Longsworth* Chairman, Emeritus Colonial Williamsburg Foundation Museum, education, hotel and restaurant services\nJohn A. Morgan* Partner Morgan Lewis Githens & Ahn Investment Bankers\nBruce N. Whitman Executive Vice President FlightSafety International, Inc.\n* Member of the Audit Committee\nOfficers\nAlbert L. Ueltschi President\nBruce N. Whitman Executive Vice President\nElmer G. Gleske Vice President-Government Affairs\nDennis Gulasy Vice President-Simulation Systems\nKenneth W. Motschwiller Vice President-Treasurer\nJames S. Waugh Vice President-Marketing\nMario D'Angelo Controller\nPeter P. Mullen Secretary Partner, Skadden, Arps, Slate, Meagher & Flom\nRegistrar and Transfer Agent American Stock Transfer and Trust Co., 40 Wall Street, New York, New York 10005\nAnnual Meeting The Annual Meeting of Shareholders is scheduled for 4 p.m., Wednesday, April 26, 1995 at the corporate headquarters, Marine Air Terminal, LaGuardia Airport, Flushing, New York 11371\nForm 10-K The Form 10-K report to the Securities and Exchange Commission will be made available to interested persons upon written request to the Treasurer of the Corporation.\nCorporate Brochure A brochure on the Company and its services will be gladly provided upon request. Please contact the office of the Treasurer.\nFlightSafety Learning Centers and Other Locations\nAlliance Flight Training Academy 2250 Alliance Blvd. Fort Worth, Texas 76177 toll free (800) 791-1414 tel (817) 491-9699 fax (817) 491-4002 Helicopter Primary Flight Training plus Add On Ratings Private through ATP Bell JetRanger 206B III Schweizer\/Hughes H300C\nAtlanta Learning Center 1804 Hyannis Court College Park, Georgia 30337 toll free (800) 889-7916 tel (404) 991-6064 fax (404) 991-5959 Embraer 120 DC-9 JetStar -6, -8, 731 JetStar II King Air 90, 100, 200 Series\nBethany Learning Center Wiley Post Airport 7310 N.W. 50th Street P.O. Box 1640 Bethany, Oklahoma 73008 tel (405) 495-6400 fax (405) 495-6404 Cmdr. Jetprop 840, 900, 980, 1000 Cmdr: Turbo 690, 690A, 690B\nCincinnati Airline Learning Center 1600 Dolwick Drive Erlanger, Kentucky 41018 tel (606) 283-2345 fax (606) 283-2362 Boeing 727 Embraer 120\nDaleville Learning Center 600 Industrial Blvd. Daleville, Alabama 36322 tel (334) 598-4485 fax (334) 598-4488 C-12, C, D, F U-21, RC-12\nDothan Learning Center 600 FlightSafety Drive Dothan, Alabama 36303 tel (334) 983-5652 fax (334) 983-1393 A-90\/U-21 C-182\nFlightSafety Academy Vero Beach Municipal Airport 2805 Airport Drive Vero Beach, Florida 32961 toll free (800) 800-1411 tel (407) 567-5178 fax (407) 567-5228 Airline Ab Initio & Transition tel (407) 778-4992 fax (407) 778-6496 Ab Initio Airline Training Career-Oriented Primary Flight Training, Private through Instructor\nFort Worth Learning Center 9601 Trinity Blvd. Fort Worth, Texas 76053 toll free (800) 379-7413 tel (817) 282-2557 fax (817) 282-8543 Bell 212, 214ST, 222, 222B, 222U, 230, 412\nGreater Philadelphia\/Wilmington Learning Center New Castle County Airport 155 N. Dupont Hwy. New Castle, Delaware 19720 toll free (800) 733-7548 tel (302) 328-7548 fax (302) 322-6664 HS-125\/1A-400, \/600, \/700 Hawker 800\/1000 Jet Commander 1121 Westwind 1123,1124 Westwind 2 Astra ATR 42\/72 Fokker 100\nHouston Learning Center William P. Hobby Airport 7525 Fauna Street Houston, Texas 77061 toll free (800) 927-1521 tel (713) 644-1521 fax (713) 644-2118 MU-2 Embraer 120 King Air 90, 100, 200 Series Hawker 800 HS-125\/700 Falcon 20 Boeing 737 ATR 42\/72 Challenger 601-3A Gulfstream I\nLaGuardia Airline Learning Center Marine Air Terminal LaGuardia Airport Flushing, New York 11371 toll free (800) 877-5343 tel (718) 565-4100 fax (718) 565-4174 Beech 1900 Series Shorts 360 Saab 340\nLakeland Flight Academy Lakeland Airport 2949 Medulla Road Lakeland, Florida 33811 toll free (800) 726-5037 tel (813) 646-5037 fax (813) 644-6211 Primary Flight Training plus Add On Ratings, Private through ATP Cheyenne I, IA, II, IIXL, III, IIIA, 400 Chieftain Mojave Aerostar Navajo 310, 325, 350 T1020, T1040 King Air\nLong Beach Learning Center Long Beach Municipal Airport 4330 Donald Douglas Drive Long Beach, California 90808 toll free (800) 487-7670 Corporate Scheduling tel (310) 420-7670 Airline Scheduling tel (310) 420-7733 fax (310) 429-1226 Boeing 737 Citation I, II Cessna 300\/400 Series King Air 90, 100, 200 Series MD-80 MD-88\/87 Gulfstream II\nMiami Airline Learning Center 4800 N.W. 36th Street Miami, Florida 33122 P.O. Box 661198 Miami, Florida 33266-1198 tel (305) 871-8625 fax (305) 871-8659 A310-300\/A300-600 MD-88\/87 Boeing 727, B757 DC-9\nMontreal Learning Center 9555 Ryan Avenue Dorval, Quebec Canada H9P 1A2 tel (514) 631-2084 fax (514) 631-2263 Challenger 600, 601, 601-3A\nParis Learning Center BP 25, Zone d Aviation d Affaires, Bldg. 404 Aeroport du Bourget 93352 Le Bourget CEDEX France tel +33 (1) 49-92-19-19 fax +33 (1) 49-92-18-92 Falcon 10\/100, 20, 50, 200, 900 King Air 200 Citation I, II, V Embraer 120 Dash 8 Mooney\nSt. Louis (Sabreliner) Learning Center Lambert-St. Louis International Airport 6185 Aviation Drive St. Louis, Missouri 63134-0888 toll free (800) 349-5447 tel (314) 731-2040 fax (314) 731-3077 Sabreliner 40\/60, 65, 75A\/80\nSt. Louis Airline Learning Center 4619 Le Bourget Drive St. Louis, Missouri 63134-0888 toll free (800) 258-4351 tel (314) 426-6160 fax (314) 426-2834 Jetstream 31\/32 Metro II, III Series MD-80 DC-9 Saab 340 Boeing 727\nSalt Lake City Airline Learning Center 201 North 2200 West Salt Lake City, Utah 84116 tel (801) 355-3901 fax (801) 355-3801 Boeing 737\nSan Antonio Airline Learning Center San Antonio International Airport 9027 Airport Blvd. San Antonio, Texas 78216 toll free (800) 889-7917 tel (210) 826-6358 fax (210) 826-4008 Metro II, III Series, Metro 23 Saab 340 Mooney TBM 700\nSavannah Learning Center Savannah Maintenance Learning Center Travis Field P.O. Box 2307 Savannah, Georgia 31402 toll free (800) 625-9369 tel (912) 964-6421 fax (912) 964-6430 Gulfstream I, II, III, IV\nSeattle Airline Learning Center 1505 South 192nd Street Seattle, Washington 98148 tel (206) 243-9081 fax (206) 243-0357 Boeing 737, B757, B767 Jetstream 31\/32 Embraer 120 Metro III Series Dash 8\nTeterboro Learning Center Teterboro Airport 100 Moonachie Avenue Moonachie, New Jersey 07074 toll free (800) 827-8058 tel (201) 939-1810 fax (201) 939-7341 Falcon 10\/100, 20\/20-731, 50, 200, 900, 2000\nToledo Learning Center Toledo Express Airport 11600 West Airport Service Road Swanton, Ohio 43558 toll free(800) 497-4023 tel (419) 865-0551 fax (419) 865-0754 Citation I, II, S\/II, III, V, VI, VII King Air 90, 100, 200 Series\nToronto Airline Learning Center 95 Garratt Blvd. Downsview, Ontario Canada M3K 2A5 tel (416) 638-9313 fax (416) 638-3348 de Havilland Twin Otter Dash 7, Dash 8\nTucson Learning Center Tucson International Airport 1071 E. Aero Park Blvd. Tucson, Arizona 85706 toll free (800) 203-5627 tel (602) 889-9538 fax (602) 889-9619 Learjet 20, 30, 50, 60 Series\nWest Palm Beach Learning Center Palm Beach International Airport 3887 Southern Blvd. West Palm Beach, Florida 33406 toll free (800) 769-6763 tel (407) 686-7677 fax (407) 689-7719 Sikorsky S-76 Series Learjet 30 Series Composite Structures\nWichita (Beech) Learning Center 9720 E. Central Avenue Wichita, Kansas 67206 toll free (800) 488-3747 tel (316) 685-4949 fax (316) 685-2476 Beech 1900, C99 Baron 55, 58, 58P\/58TC King Air 90, 100, 200, 300 Series Bonanza Duke Starship Diamond MU-300 Beechjet 400\nWichita (Beech) Maintenance Learning Center 9525 East Central Avenue Wichita, Kansas 67206 toll free (800) 808-0976 tel (316) 685-5510 fax (316) 685-2448 Beech 1900, C99 King Air 90, 100, 200, 300 Series Bonanza Baron 58 Starship Diamond MU-300 Beechjet 400 King Air 200 Series Troubleshooting Starship Composite Repair\nWichita (Cessna) Learning Center 1951 Airport Road Wichita, Kansas 67209 P.O. Box 12304 Wichita, Kansas 67277 toll free (800) 227-5656 tel (316) 943-2140 fax (316) 943-1017 Cessna 210, 300\/400 Series Conquest I, II Caravan I, II\nWichita (Cessna) Maintenance Learning Center 1962 Midfield Road Wichita, Kansas 67209 P.O. Box 12263 Wichita, Kansas 67277 toll free (800) 491-9796 tel (316) 945-0123 fax (316) 945-0161 Cessna 182, R182, 206, 208, 210, T210, P210, 303, 340A, 402C, 406, 414, 421, 425, 441 Citation I, II, S\/II, III, V, VI, VII Composite Repair Citation 500 Series CitationJet Troubleshooting\nWichita (Citation) Learning Center 1851 Airport Road Wichita, Kansas 67209 P.O. Box 12323 Wichita, Kansas 67277 toll free (800) 488-3214 tel (316) 943-3214 fax (316) 943-7651 Citation I, II, S\/II, III, V, V Ultra, VI, VII CitationJet\nWichita (Learjet) Learning Center 2 Learjet Way Wichita, Kansas 67209 toll free (800) 491-9807 tel (316) 943-3394 fax (316) 943-0314 Learjet 20, 30, 50, 60 Series\nFLIGHTSAFTEY INTERNATIONAL PROXY STATEMENT\n[Logo]\nNOTICE OF ANNUAL MEETING OF SHAREHOLDERS\nNOTICE IS HEREBY GIVEN that the Annual Meeting of Shareholders of FlightSafety International, Inc., a New York corporation (the 'Company'), will be held at the offices of the Company, Marine Air Terminal, La Guardia Airport, Flushing, New York 11371, on Wednesday, April 26, 1995, at 4:00 P.M., New York City time (with any adjournment or postponement thereof, the 'Meeting'), for the following purposes:\n1. To elect a Board of six Directors, each to serve until the next Annual Meeting and until his successor shall have been duly elected and qualified;\n2. To ratify and approve the appointment by the Board of Directors of Price Waterhouse LLP as independent accountants for the Company for the year ending December 31, 1995; and\n3. To transact such other business as may properly come before the Meeting.\nThe Board of Directors has fixed the close of business on March 13, 1995 as the record date for the determination of shareholders entitled to notice of and to vote at the Meeting.\nYou are cordially invited to attend the Meeting in person and vote. Even if you plan to attend the Meeting in person, you are urged to complete, sign and date the enclosed proxy card and to return it promptly in the prepaid return envelope provided. If you attend the Meeting in person, you may then withdraw your proxy and vote in person if you so desire.\nBy Order of the Board of Directors,\nPETER P. MULLEN Secretary\nFlushing, New York March 24, 1995\nFLIGHTSAFETY INTERNATIONAL, INC. PROXY STATEMENT ANNUAL MEETING OF SHAREHOLDERS\nThis Proxy Statement is furnished in connection with the solicitation of proxies by the Board of Directors of FlightSafety International, Inc., a New York corporation (the 'Company'), to be used at the Annual Meeting of Shareholders of the Company which is scheduled to be held at the offices of the Company, Marine Air Terminal, La Guardia Airport, Flushing, New York 11371, on Wednesday, April 26, 1995, at 4:00 P.M., New York City time, and any adjournment or postponement thereof (the 'Meeting'). This proxy statement, the accompanying notice and the enclosed proxy card are first being mailed to shareholders on or about March 24, 1995.\nThe Board of Directors does not intend to bring any matter before the Meeting except as specifically indicated in the notice, nor does the Board of Directors know of any matters which anyone else proposes to present for action at the Meeting. If any other matters properly come before the Meeting, however, the persons named in the enclosed proxy, or their duly constituted substitutes acting at the Meeting, will be authorized to vote or otherwise act thereon in accordance with their judgment on such matters.\nShares represented by properly executed proxies received by the Company in time for the Meeting will be voted in accordance with the instructions given therein. If no instructions are specified in a proxy, the shares represented by that proxy will be voted 'For' the election of all six nominees for the Board of Directors and 'For' the ratification and approval of Price Waterhouse LLP as independent accountants for the Company for the year ending December 31, 1995.\nA shareholder giving a proxy may revoke such proxy at any time before it is exercised by giving written notice to the Company (bearing a date later than the proxy) or by executing a subsequent proxy relating to the same shares, and by filing with or hand delivering to the Secretary, at the offices of the Company, such written notice or subsequent proxy at or before the taking of the vote at the Meeting. In addition, any shareholder attending the Meeting may vote in person whether or not such shareholder has previously filed a proxy, although attendance at the Meeting will not in and of itself constitute a revocation of a proxy.\nThe accompanying form of proxy is being solicited on behalf of the Board of Directors of the Company. The expenses of solicitation of proxies for the Meeting will be paid by the Company. In addition to the mailing of the proxy materials, such solicitation may be made in person or by telephone by directors, officers and employees of the Company, who will receive no additional compensation therefor. Upon request, the Company will reimburse brokers, dealers, banks and trustees, or their nominees, for reasonable expenses incurred by them in forwarding solicitation materials to beneficial owners of shares of the Company's Common Stock.\nThe Board of Directors has fixed the close of business on March 13, 1995 as the record date for the Meeting. Accordingly, only shareholders of record of the Company's Common Stock at the close of business on such date will be entitled to notice of and to vote at the Meeting. On that date, there were issued and outstanding 31,325,878 shares of the Company's Common Stock.\nThe presence, in person or by proxy, of the holders of one-third of the total number of issued and outstanding shares of the Company's Common Stock entitled to vote at the Meeting will constitute a quorum. Shareholders granting a proxy to vote on one issue but abstaining as to the other issue will be counted for the purpose of determining a quorum. On all matters voted upon at the Meeting, the holders of shares of the Company's Common Stock vote together as a single class, with each record holder entitled to one vote per share.\nELECTION OF DIRECTORS\nThe Board of Directors of the Company has nominated six candidates to be elected at the Meeting. Each nominee is currently serving as a director of the Company. The directors elected at the Meeting will hold office until the next annual meeting of shareholders and until their successors have been duly elected and qualified.\nDirectors shall be elected by a plurality of votes cast in the election of directors. Under applicable New York law, in tabulating the vote, broker non-votes will be disregarded and will have no effect on the outcome of the vote. Unless a contrary instruction is indicated, a properly executed and returned proxy will be voted 'For' the election of Messrs. George B. Beitzel, Edward E. Hood, Jr., Charles R. Longsworth, John A. Morgan, Albert L. Ueltschi and Bruce N. Whitman.\nEach nominee has consented to being named in the proxy statement and to serve if elected. If, prior to the Meeting, any nominee should become unavailable to serve, the shares of the Company's Common Stock represented by a properly executed and returned proxy will be voted for a substitute nominee designated by the Board of Directors, unless the Board should determine to reduce the number of directors pursuant to the Company's By-laws.\nThe table below sets forth certain information concerning the nominees for election as directors at the Meeting, including such nominee's positions with the Company and principal occupation, a brief account of such nominee's business experience during the last five years, certain other directorships currently held by such nominee, such nominee's age and the year such nominee was first elected a director of the Company.\nYear First Positions with the Company, Principal Elected Occupation and Other Directorships Age Director\nGeorge B. Beitzel......... Retired (March 1987); prior thereto, Senior 66 1974 Vice President and Director, International Business Machines Corporation, an information handling systems, equipment and services company. Mr. Beitzel is Chairman of the Colonial Williamsburg Foundation and a director of Bankers Trust Company, Bankers Trust New York Corporation, Computer Task Group, Inc., Phillips Petroleum Company, Phillips Gas Company, Rohm and Haas Company, Roadway Services, Inc. and Xillix Technologies Corp. Mr. Beitzel is also Trustee Emeritus of Amherst College.\nEdward E. Hood, Jr........ Retired (February 1993); prior thereto, Vice 64 1991 Chairman, Executive Officer and Director, General Electric Company, a diversified technology, manufacturing and services company. Mr. Hood is a director of Lockheed Martin Corp., Gerber Scientific,Inc. and Lincoln Electric Company and is also Chairman of the Board of Trustees of Rensselaer Polytechnic Institute.\nCharles R. Longsworth..... Chairman Emeritus, Colonial Williamsburg 65 1985 Foundation, museum, education, hotel and restaurant services. Mr. Longsworth is a director of Public Radio International, Crestar Financial Corporation, Houghton Mifflin Company, Roadway Services, Inc., Saul Centers, Inc. and Virginia Eastern Shore Corporation and is also Chairman of the Board of Trustees of Amherst College.\nJohn A. Morgan............ Partner, Morgan Lewis Githens & Ahn, 64 1961 investment bankers. Mr. Morgan is a director of Masco Corporation, Masco Industries, Inc., McDermott International,Inc. and Tri Mas Corporation.\nAlbert L. Ueltschi........ Chairman of the Board of Directors and 77 1951 President of the Company. Bruce N. Whitman.......... Executive Vice President of the Company. 61 1962\nCommittees, Meetings and Compensation of the Board of Directors\nThe Board of Directors held one special and four regular meetings during 1994. Each director attended at least 75 percent of the aggregate number of meetings of the Board and Committees of the Board of which he was a member, except Mr. Morgan.\nThe Company's Board of Directors has a standing Audit Committee, Executive Committee, Nominating Committee, Compensation Committee and Employee Stock Purchase Plan Committee. The Audit Committee is composed of Messrs. Morgan (Chairman), Beitzel, Hood and Longsworth and recommends to the Board of Directors the accounting firm to be appointed as independent accountants for the Company; reviews with the Company's management and independent accountants the Company's annual operating results; and reviews with the Company's independent accountants the scope and results of the audit and the adequacy of the Company's internal accounting procedures and systems. The Audit Committee met twice during 1994.\nThe Executive Committee is composed of Messrs. Ueltschi (Chairman), Beitzel, Morgan and Whitman, and is authorized to exercise all of the powers and authority of the Board except those powers reserved to the Board of Directors by law, the Company's Certificate of Incorporation or By-laws, or by resolution of the Board of Directors. The Executive Committee did not meet during 1994.\nThe Nominating Committee consists of Messrs. Ueltschi (Chairman), Beitzel, Morgan and Whitman, and considers and makes recommendations to the Board of Directors of the names of persons to be nominated for election as directors by the shareholders of the Company, and also those to be elected by the Board to fill vacancies that may arise between annual meetings of the shareholders of the Company. The Nominating Committee will consider nominees recommended by the Company's shareholders. Any such recommendations should be mailed to the Nominating Committee, at the Company's address, and should include the name, address and a statement of qualifications of each nominee as well as the signed consent of such person to serve if nominated and elected. The Nominating Committee did not meet during 1994.\nThe Compensation Committee consists of Messrs. Beitzel (Chairman), Hood and Morgan and considers and makes recommendations to the Board of Directors on matters relating to the cash compensation of employees of the Company, including, with respect to executive officers, salaries and bonuses. The Compensation Committee also administers the Company's 1979 Stock Option Plan, 1982 Incentive Stock Option Plan, 1984 Restricted Stock Compensation Plan and 1992 Stock Option Plan. The Compensation Committee met three times during 1994.\nThe Employee Stock Purchase Plan Committee consists of Messrs. Ueltschi (Chairman), Morgan and Whitman, and administers the Company's Employee Stock Purchase Plan. The Employee Stock Purchase Plan Committee did not meet during 1994.\nMembers of the Board of Directors, who are not employees of the Company, currently receive an annual retainer of $22,000 and are paid $500 per Board or Committee meeting attended (other than Committee meetings held on the same day as a Board meeting). Such directors are reimbursed for expenses they incur in attending such meetings. Members of the Board of Directors who are employees of the Company do not receive additional compensation for serving in such capacity.\nThe Company maintains a retirement plan for its non-employee directors pursuant to which directors of the Company who are not employees of the Company and who retire as a director of the Company are entitled to receive the semi-annual payments described below after reaching age 70 (or earlier if their retirement as a director of the Company is due to disability). Any director of the Company who serves as an employee of the Company is eligible to participate in the plan upon such director's retirement as an employee of the Company, provided that such director remains a director of the Company following such retirement. Directors are paid semi-annual amounts under the plan equal to one-half of the last annual retainer fee paid to such director for such director's last active year as a director of the Company and receive such payments for the same number of years that such director served as a director of the Company or ten years, whichever is shorter. If a director dies before retiring or before receiving all scheduled retirement payments, such payments are paid to such director's spouse, but only if such spouse survives such director and, commencing upon the death of such director, continue until all retirement payments which would otherwise have been paid to such director have been paid or until such spouse's death, whichever occurs first.\nThe Company maintains directors and officers liability insurance which insures directors and officers of the Company and its subsidiaries against certain liabilities incurred by them while serving in such capacities, and reimburses the Company for certain indemnification payments made by the Company to directors and officers of the Company and its subsidiaries. This policy extends through August 15, 1995 at a premium of $106,800 per year. No claims have been made under this policy.\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set forth on the following table is furnished as of March 13, 1995 with respect to any person (including any 'group' as that term is used in Section 13(d)(3) of the Securities Exchange Act of 1934, as amended (the 'Exchange Act')), who is known to the Company to be the beneficial owner of more than 5% of the Company's Common Stock, as to those shares beneficially owned by each of the Company's directors, each of the Company's executive officers named in the Summary Compensation Table (see page 9) and all directors and executive officers of the Company as a group.\nNumber of Shares Beneficially Percent of Owned Outstanding as of March 13, Common Stock Name of Beneficial Owner 1995 as of March 13, 1995\nDirectors Albert L. Ueltschi(1).......... 9,617,040(2) 30.7% George B. Beitzel.............. 3,860(3) * Edward E. Hood, Jr.............. 1,000 * Charles R. Longsworth........... 725 * John A. Morgan.................. 118,885 * Bruce N. Whitman(4)............. 263,184(5) * Executive Officers Kenneth W. Motschwiller......... 22,598(5)(6) * James S. Waugh.................. 27,615(5) * Dennis Gulasy................... 31,537(5)(7) Directors and Executive Officers as a group (11 persons)....................... 10,121,497(5) 32.3% Putnam Investments, Inc.(8)..... 4,129,572(8) 13.2% FMR Corp.(9).......................3,093,300(9) 9.9%\n---------\n* Indicates beneficial ownership of less than 1% of the shares of Common Stock outstanding on such date.\n(1) The address for Mr. Ueltschi is Marine Air Terminal, La Guardia Airport, Flushing, NY 11371. Mr. Ueltschi is also the President of the Company.\n(2) Includes 9,616,540 shares held pursuant to a revocable trust for which Mr. Ueltschi is the sole beneficiary during his lifetime and 500 shares held pursuant to a partnership. Does not include approximately 1,513,000 shares beneficially owned by various members of Mr. Ueltschi's family, in respect of which Mr. Ueltschi disclaims beneficial ownership.\n(3) Does not include 275 shares beneficially owned by Mr. Beitzel's spouse, in respect of which Mr. Beitzel disclaims beneficial ownership.\n(4) Mr. Whitman is also Executive Vice President of the Company.\n(5) Includes shares which the executive officer has the right to acquire within 60 days through the exercise of stock options granted under the Company's stock option plans. These amounts are as follows: Mr. Whitman, 14,805 shares; Mr. Motschwiller, 16,516 shares; Mr. Waugh, 17,050 shares; Mr. Gulasy, 20,478 shares; and all directors and executive officers as a group, 77,512 shares.\n(6) Includes 1,234 shares held by Mr. Motschwiller as custodian for his minor children.\n(7) Does not include 1,022 shares beneficially owned by Mr. Gulasy's spouse, in respect of which Mr. Gulasy disclaims beneficial ownership.\n(8) Putnam Investment, Inc.'s address is: One Post Office Square, Boston, MA 02109. Putnam Investment, Inc. is a wholly-owned subsidiary of Marsh and McLennan. Putnam Investment, Inc's subsidiaries, Putnam Investment Management, Inc. and The Putnam Advisory Company, Inc., are investment advisors to investment companies. This represents the number of shares owned as of December 31, 1994 as indicated in a Schedule 13G filed by Putnam Investment, Inc. with the Securities and Exchange Commission (SEC) on January 23, 1995. Putnam has shared power to vote\nor to direct the vote for 375,560 shares and has shared power to dispose or to direct the disposition of all the shares.\n(9) FMR Corp.'s address is: 82 Devonshire Street, Boston, MA 02109. FMR Corp. is a holding company and its subsidiary, Fidelity Management & Research Company, is an investment advisor to investment companies. This represents the number of shares owned as of December 31, 1994 as indicated in a Schedule 13G filed by FMR with the SEC on February 13, 1995. FMR has neither sole nor shared voting power with respect to such shares and has sole power to dispose of such shares.\nEXECUTIVE OFFICERS\nEach executive officer of the Company serves at the pleasure of the Company's Board of Directors, and, subject to removal, holds office until the regular meeting of the Board of Directors which follows the annual meeting of shareholders and until his successor has been appointed and qualified.\nThe following table sets forth certain information with respect to the executive officers of the Company.\nYears Position Name Age Position with Company Held --------------------------------------------------------------------------- ----\nAlbert L. Ueltschi................. 77 President and Chairman of the Board 44 years Bruce N. Whitman................... 61 Executive Vice President 33 years Elmer G. Gleske.................... 64 Vice President -- Government Affairs 18 years Dennis Gulasy(1)................... 52 Vice President -- Simulation Systems 3 years Kenneth W. Motschwiller(2)......... 38 Vice President -- Treasurer 4 years James S. Waugh..................... 47 Vice President -- Marketing 15 years Mario D'Angelo(3).................. 42 Controller 4 years\n---------\n(1) Mr. Gulasy was elected Vice President -- Simulation Systems of the Company on September 17, 1992. Mr. Gulasy has also been General Manager of the Company's Simulation Systems Division since 1985. Prior thereto, Mr. Gulasy held various positions with the Company.\n(2) Prior to becoming Vice President -- Treasurer, Mr. Motschwiller was Controller of the Company from December 1983 until July 1991.\n(3) Prior to becoming Controller, Mr. D'Angelo was Assistant Controller of the Company from September 1988 until July 1991. Prior thereto, Mr. D'Angelo held various positions with the Company.\nEXECUTIVE COMPENSATION\nReport of the Compensation Committee on Executive Compensation\nOverall Compensation Policy. The Compensation Committee of the Board of Directors has three members, all of whom are non-employee directors. Each member of the Committee is a 'disinterested director' within the meaning of Rule 16b-3 under the Exchange Act. As noted earlier in this proxy statement, the Committee is responsible for considering matters relating to the annual cash compensation for the Company's executive officers (including the named executive officers) and administering the Company's stock-based employee benefit plans (other than the Company's Employee Stock Purchase Plan).\nThe Company's executive compensation program has been designed to (i) provide compensation comparable to that offered by other companies of similar size (which are in the geographic area of the Company's headquarters and the Standard and Poor's Specialized Services Index which is used in the stock performance graph presented below), thereby allowing the Company to attract and retain highly qualified executives, (ii) motivate these executives to achieve the goals inherent in the Company's business strategy, (iii) align the interests of these executives with the long-term interests of the Company's shareholders through stock-based employee benefit plans, (iv) provide a compensation package that recognizes individual contributions as well as overall Company performance and (v) be cost effective. A basic tenet of the compensation philosophy of the program is that a substantial portion of each executive officer's annual compensation relates to and must be contingent upon the\nperformance of the Company, as well as the individual contributions of such executive. The Committee believes that the cash compensation of the executive officers, consisting of their annual base salary and annual bonus, are slightly below the median ranges of such items paid by companies of a comparable size in the Company's geographic area and with other companies in the Standard and Poor's Specialized Services Index.\nThe key elements of the Company's executive compensation program are base salary, annual bonus, stock option grants and restricted stock awards. Mr. Ueltschi, the President of the Company, does not participate in the Company's stock option and restricted stock programs. The Committee's policies with respect to each of these elements, including the bases for the compensation awarded to Mr. Ueltschi, are discussed below. While the elements of compensation described below are considered separately, the Committee takes into account the full compensation package provided by the Company to the individual executive.\nBase Salaries. Executive officer base salaries are reviewed annually by the Compensation Committee in order to consider any adjustments for the upcoming year. Annual salary adjustments are determined by evaluating the competitive marketplace, changes in the cost of living, the Company's current and historical performance (taking into account changes in the Company's business and economic conditions affecting the Company), the executive's contributions and any change in the executive's responsibilities. Mr. Ueltschi evaluates the performance of the other executive officers of the Company and recommends appropriate adjustments for the Compensation Committee's consideration.\nWithin this framework, in making its recommendations to the Board for 1994 annual salary adjustments, the Compensation Committee focused on, among other things, that the base salaries of the Company's executive officers were less than 70 percent of the average base salaries of executive officers of comparable companies in the Company's geographic area. After the 1994 base salary increases, the executive officers' base salaries were less than 80 percent of the average salaries of executive officers at such companies. The base salaries were also increased to allow the Company to increase the salary of other personnel to a competitive level since the salaries being paid to executive officers of the Company were compressing the level of salaries which could be paid to such personnel. The Compensation Committee independently, and the Board after receiving the recommendation of the Compensation Committee (and without the involvement of any employee director), evaluates the performance of Mr. Ueltschi and reaches a determination regarding his salary. Similar to the other executive officers, Mr. Ueltschi's 1994 base salary was also increased but after such increase, was no more than approximately 70 percent of the average salary of other chief executive officers of companies in the Company's geographic area.\nAnnual Bonus. Annual bonus awards in respect of any year are considered by the Compensation Committee in the following March in conjunction with their review of the Company's audited financial statements for the prior year. Bonus awards are normally paid in two increments; two-thirds payable upon award and one-third payable on the first business day of the year following the award, subject to the condition that the executive officer be employed by the Company at the time of payment unless such employment is terminated as a result of the death of such officer.\nAnnual bonus awards are determined as a percentage (the 'Performance Percentage') of the applicable bonus base of the executive officer's annual salary (the 'Bonus Base'). Bonus Bases have historically ranged between 25 percent to 60 percent. In determining the Bonus Base for a particular executive officer, the Compensation Committee considers, among other things, the length of employment, current responsibilities, individual contributions and past bonus history for such executive. In determining the applicable Performance Percentage, the Compensation Committee considers the Company's overall performance for the preceding year, including the earnings for that year and for prior years (taking into account general economic conditions and the performance of relevant sectors of the economy). In order to foster a team approach among senior management, the Performance Percentage normally does not vary greatly as between individual executive officers. Performance Percentages usually range from 75 percent to 150 percent.\nIn making its determinations of annual bonus awards in respect of 1994, the Compensation Committee focused on, among other things, the Company's 11 percent increase in training revenues, a 17 percent increase in net income per share in 1994 as compared to 1993 and the Company's executive officers' total cash compensation being below that of comparable-sized companies' cash compensation.\nThe Bonus Bases were all increased due to the 1994 base salary increases previously mentioned and the Performance Percentages were also increased in 1994 for the same reasons for all named executive officers, except for Mr. Gulasy. Mr. Ueltschi's annual bonus increased due to both his Bonus Base and Performance Percentage increasing due primarily for the items indicated earlier.\nStock Option Grants and Restricted Stock Awards. The objective in granting stock options and restricted stock is to create an incentive for grantees with respect to future performance of the Company, rather than to reward them for past contributions. The stock awards are designed to align the long-term interests of the Company's executive officers with those of its shareholders by creating a direct link between executive compensation and shareholder return and by enabling such executives to develop and maintain a significant, long-term stock ownership position in the Company's Common Stock.\nUnder the Company's 1992 Stock Option Plan, stock options to purchase 110,340 shares were granted in December 1994 to key employees of the Company (including certain named executive officers). Such options were granted with an exercise price equal to the closing market price of the Company's Common Stock on the date of grant, become exercisable in 20 percent increments on the first five anniversaries of the date of grant and expire 10 years after the date of grant.\nThe Compensation Committee, in considering award levels, granted to certain named executive officers, options to purchase a number of shares of the Company's Common Stock, based on the closing market price of the Company's Common Stock on the date of grant, equal to twice such executive officer's 1994 base salary. This formula was utilized to increasingly link executive officers' total compensation to a greater extent to shareholder return. The number of options previously awarded to the executive officers also was considered.\nUnder the Company's 1984 Restricted Stock Plan, restricted shares were awarded in June 1994 to key employees of the Company (including the named executive officers). Shares of restricted stock generally vest upon normal retirement, death or total disability. Recipients of restricted stock awards are entitled to receive dividends on such shares as of the date of the award. The Compensation Committee, in recommending to the Board the 1994 restricted stock awards for executive officers, recommended that each of the executive officers participating in the restricted stock program be awarded a number of shares of restricted stock equal in value, based on the closing market price of the Company's Common Stock on the date of grant, to 10 percent of such executive's 1994 base salary, which is the percentage that has been used for all employees in this program since 1986.\nDue to his significant stock ownership in the Company, Mr. Ueltschi does not participate in any of the Company's stock-based employee benefit programs.\nSeverance Agreements. In 1994, the Company entered into change in control severance agreements with the named executive officers, except Mr. Ueltschi. The Compensation Committee believes that these agreements are in the best interest of the shareholders in order to insure that, in case of a change in control event, the Company will have continuity of management and independent judgement will be exercised by the named executive officers to maximize shareholder value. For additional information on the severance agreements, see the description on page 10 of this proxy statement.\nAlthough new federal income tax laws limit the deductibility of executive officer compensation if the compensation is above certain levels, the Compensation Committee believes that these laws will not impact the Company's tax deduction in 1994.\nCompensation Committee George B. Beitzel, Chairman Edward E. Hood, Jr. John A. Morgan\nSummary Compensation Table\nThe following table sets forth the cash and non-cash compensation for each of the last three fiscal years awarded to or earned by the chief executive officer of the Company and the four other most highly compensated executive officers of the Company at the end of 1994.\nSUMMARY COMPENSATION TABLE\nLong-Term\n------------------------ Annual Compensation Compensation Awards\n---------------------- ------------------------ All Other Base Restricted Stock Compensation Year Salary(1) Bonus(2) Stock($)(3) Options(#) ($)(4) --------- ----------- --------- ----------- ----------- -----------\nAlbert L. Ueltschi(5) ........ 1994 $ 250,000 $ 150,000 -- -- $ 1,584 President and Chairman of 1993 $ 220,000 $ 118,800 -- -- $ 2,257 the Board 1992 $ 220,000 $ 118,800 -- -- $ 2,769 Bruce N. Whitman ............. 1994 $ 210,000 $ 126,000 $ 21,000 10,910 $ 9,277 Executive Vice President and 1993 $ 190,000 $ 102,600 $ 19,000 11,240 $ 11,614 Director 1992 $ 190,000 $ 102,600 $ 19,000 4,305 $ 8,960 Kenneth W. Motschwiller ...... 1994 $ 130,000 $ 101,400 $ 13,000 6,750 $ 2,120 Vice President-Treasurer 1993 $ 103,000 $ 68,000 $ 10,300 6,090 $ 2,507 1992 $ 103,000 $ 68,000 $ 10,300 3,000 $ 2,020 James S. Waugh ............... 1994 $ 130,000 $ 78,000 $ 13,000 6,750 $ 3,771 Vice President-Marketing 1993 $ 108,000 $ 58,300 $ 10,800 6,390 $ 4,729 1992 $ 108,000 $ 58,300 $ 10,800 2,447 $ 3,777 Dennis Gulasy ................ 1994 $ 135,000 $ 48,600 $ 13,500 -- $ 2,925 Vice President-Simulation 1993 $ 110,000 $ 72,600 $ 11,000 6,520 $ 3,493 Systems 1992 $ 107,500 $ 72,600 $ 10,500 3,000 $ 2,486\n---------\n(1) The amounts shown in this column include amounts deferred pursuant to the Company's 401(k) plan. There are no Company funds contributed to this plan.\n(2) Annual bonus includes amounts awarded in March of the following year. Such bonuses are normally paid two-thirds upon award and, subject to certain conditions, one-third on the first business day of the following year.\n(3) The amounts shown in this column represent the market value of the restricted stock awarded and were calculated by multiplying the closing market price of the Company's Common Stock on the date of award by the number of shares awarded. Shares of restricted stock generally vest upon normal retirement, death or total disability. Recipients of restricted stock awards are entitled to receive dividends on such shares as of the date of the award. As of December 31, 1994, the number and value of the aggregate restricted stock holdings of each of the named executive officers was as follows: Mr. Ueltschi, 0 shares; Mr. Whitman, 7,992 shares ($324,700); Mr. Motschwiller, 3,644 shares ($148,000); Mr. Waugh, 4,765 shares ($193,600) and Mr. Gulasy, 3,987 shares ($162,000).\n(4) The amounts shown in this column represent (i) above-market interest in excess of 120 percent of the applicable federal long-term rate which was credited to the executive officer's 1986 deferred income account and the amounts for 1994 were: Mr. Ueltschi, $1,365; Mr. Whitman, $9,058; Mr. Motschwiller, $1,901; Mr. Waugh, $3,552; and Mr. Gulasy, $2,706; and (ii) the dollar value of group term life insurance premiums of $219 paid by the Company for each of the named executive officers. Subject to certain eligibility requirements, the Company's group term life insurance is available to all employees of the Company.\n(5) Mr. Ueltschi does not participate in the Company's restricted stock or stock option programs.\nStock Option Grants Table\nThe following tables summarize stock options granted during 1994 to the named executive officers of the Company.\nSTOCK OPTION GRANTS IN 1994\nPotential Realizable Value\nat Assumed Annual Rates of\nStock Price Appreciation for % of Total Options Option Stock Granted to All Exercise Term Compounded Annually Executive Options Employees Price Expiration -------------------------------- Officer(1) Granted(2) in 1994(3) ($ Per Share) Date 5% 10% ------------------ ----------- ------------------- ------------- ----------- --------------- ---------------\nBruce N. Whitman.. 10,910 9.9% $ 38.50 12\/02\/04 $ 264,200 $ 669,400 Kenneth W. Motschwiller.... 6,750 6.1% $ 38.50 12\/02\/04 $ 163,400 $ 414,200 James S. Waugh.... 6,750 6.1% $ 38.50 12\/02\/04 $ 163,400 $ 414,200\n---------\n(1) Mr. Ueltschi does not participate in the Company's stock option programs.\n(2) The options become exercisable to purchase shares of the Company's Common Stock at the fair market value of such stock on the date of grant in 20 percent increments on the first five anniversaries of the date of the grant and expire ten years from date of grant.\n(3) The Company granted stock options for an aggregate of 110,340 shares to its employees in 1994.\nStock Option Exercises and Year-End Value Table\nThe following table summarizes the exercise of stock options by the named executive officers and the value of stock options held by such executives as of the end of 1994.\nAGGREGATED STOCK OPTION EXERCISES IN 1994 AND VALUE OF STOCK OPTIONS AT END OF 1994\nValue of Unexercised\nNumber of Unexercised In-the-Money Options at\nOptions at End of 1994 End of Fiscal 1994(2) Executive Shares Acquired Value -------------------------- ------------------------ Officer(1) On Exercise Realized Exercisable Unexercisable Exercisable Unexercisable ----------------------- --------------- --------- ----------- ------------- ----------- -----------\nBruce N. Whitman....... 1,786 $ 21,200 14,805 25,044 $ 15,300 $ 84,400 Kenneth W. Motschwiller......... - 0 - $ - 0 - 16,516 14,694 $ 195,000 $ 47,500 James S. Waugh......... - 0 - $ - 0 - 17,050 14,771 $ 253,700 $ 49,200 Dennis Gulasy.......... - 0 - $ - 0 - 20,478 8,471 $ 294,900 $ 35,500\n---------\n(1) Mr. Ueltschi does not participate in the Company's stock option programs.\n(2) Value based on closing market price of the Company's Common Stock at December 31, 1994, minus the exercise price, multiplied by the applicable number of options.\nPension Plan\nThe Company maintains a defined benefit pension plan (the 'Pension Plan') which covers substantially all of its employees and those of its North American subsidiaries, excluding employees of the Company's subsidiary, FlightSafety Services Corporation (who participate in such subsidiary's defined contribution plan). Full-time employees are eligible to participate in the Pension Plan on the December 31st or June 30th coincident with or next following such employee's 21st birthday and the completion of one year of service. The normal retirement benefit provided by the Pension Plan is (i) the benefit accrued by the participant to December 30, 1989, plus .75% of average monthly compensation, excluding overtime, multiplied by the participant's total number of credited years of service up to 35 less credited service prior to December 31, 1989, plus (ii) .75% of such average monthly compensation in excess of a specified level of compensation tied to social security benefits multiplied by the participant's total number of years of credited service up to 35 less credited service prior to December 31, 1989. When an employee has completed five years of service with the Company or has attained age 55, the\nemployee becomes 100% vested under the Pension Plan. Normal retirement age under the Pension Plan is 65 and five years of participation, although early retirement benefits are available. For the named executive officers, the projected annual benefits under the Pension Plan, assuming (i) retirement at normal retirement age or deferred retirement and (ii) current salary levels, are as follows: Mr. Ueltschi, $59,900; Mr. Whitman, $44,000; Mr. Motschwiller, $57,000; Mr. Waugh, $54,500 and Mr. Gulasy, $40,000.\nSeverance Agreements. On December 2, 1994, the Compensation Committee of the Board of Directors authorized the entering into severance agreements with each individual named in the Summary Compensation Table (each such person being an executive officer) except for Mr. Ueltschi. The Company believes that these severance agreements are in the best interest of the shareholders in order to insure that, in case of a change in control event, the Company will have continuity of management and independent judgement will be exercised by the executives to maximize shareholder value. The severance agreements continue through December 31, 1995 and are automatically extended in one-year increments unless the Company has given prior notice of termination to the executive.\nIn the event, that following a 'Change in Control', employment is terminated by the executive officer for 'Good Reason' or the employee is involuntarily terminated by the Company other than for 'Cause' (as those terms are defined in the severance agreements), the severance agreements generally provide for: (a) a lump sum cash payment equal to the sum of three times (i) the annual base salary and (ii) the amount of bonus compensation for the year preceding the year in which the date of termination occurs; (b) a cash payment for each outstanding option equal to the amount of the higher of the closing price for shares of the Company's Common Stock or the price actually paid in connection with any Change in Control over the per share exercise price of each such option held by the executive officer (whether or not then fully exercisable) times the number of shares covered by each such option; (c) a lapse of restrictions on all shares of restricted stock; and (d) life, disability, and health insurance benefits for a period of 36 months. Benefits under the severance agreements are limited to the extent they would result in the disallowance of a deduction to the Company under the Parachute payment provisions of Section 280G of the Internal Revenue Code.\nFive-Year Stock Performance Graph\nThe annual changes for the five-year period shown in the following graph are based on the assumption that $100 had been invested in the Company's Common Stock and each index on December 31, 1989, and that all dividends were reinvested. The total cumulative dollar return shown on the graph represents the value (to the nearest dollar) that such investments would have had on December 31, 1994.\nThe stock performance graph in the proxy statement uses the following indexes, return values and coordinates:\nAPPOINTMENT OF INDEPENDENT ACCOUNTANTS\nThe Board of Directors of the Company, on the recommendation of the Audit Committee, has appointed Price Waterhouse LLP ('Price Waterhouse') as independent accountants for the Company for the year ending December 31, 1995, subject to ratification by the shareholders of the Company. Price Waterhouse has served as independent accountants for the Company since 1955. The Board of Directors believes that the retention of the services of Price Waterhouse is in the best interests of the Company's shareholders and recommends that shareholders approve their appointment. Representatives of Price Waterhouse are expected to attend the Meeting and will have an opportunity to make a statement, if they desire to do so, and to respond to questions from the Company's shareholders.\nA majority of the votes cast at the Meeting is required to ratify the appointment of Price Waterhouse as independent accountants for the Company for the year ending December 31, 1995. Under applicable New York law, in determining whether this proposal has received the requisite number of affirmative votes, abstentions and broker non-votes will be disregarded and will have no effect on the outcome of the vote. Unless a contrary instruction is indicated, a properly executed and returned proxy will be voted FOR the ratification and approval of Price Waterhouse as independent accountants for the Company for the year ending December 31, 1995.\nCOMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT\nSection 16(a) of the Exchange Act requires that the Company's officers and directors, and persons who own more than 10 percent of the Company's Common Stock, file reports of ownership and changes in ownership on Forms 3, 4 and 5 with the SEC and The New York Stock Exchange, Inc. Officers, directors and greater than 10 percent shareholders are also required by rules of the SEC to furnish the Company with copies of all Forms 3, 4 and 5 which they file.\nBased solely on the Company's review of the copies of such reports it has received, and written representations from certain reporting persons that they were not required to file a Form 5 for 1994, the Company believes that all officers, directors and greater than 10 percent shareholders complied with all filing requirements applicable to them with respect to transactions in the Company's Common Stock during 1994.\nSHAREHOLDER PROPOSALS\nUnder the rules of the SEC, proposals which shareholders of the Company intend to present at next year's annual meeting of shareholders must be received, in order to be considered at such meeting, by the Secretary of the Company, at the Company's executive offices located at Marine Air Terminal, La Guardia Airport, Flushing, New York 11371, no later than the close of business on November 30, 1995. Shareholder proposals received after that date will not be included in the Company's proxy statement or form of proxy prepared in connection with such meeting.\nADDITIONAL INFORMATION\nThe Company's 1994 Annual Report to Shareholders, which contains financial statements for the year ended December 31, 1994 and other information concerning the operations of the Company, is enclosed with this proxy statement, but is not to be regarded as proxy soliciting materials.\nUpon written request, the Company will provide without charge to each shareholder of the Company a copy of the Company's Annual Report on Form 10-K for its prior fiscal year, as filed with the SEC. Address all such requests to: Treasurer, FlightSafety International, Inc., Marine Air Terminal, La Guardia Airport, Flushing, New York 11371.\nBy Order of the Board of Directors,\nPETER P. MULLEN Secretary\nFlushing, New York March 24, 1995\n\tExhibit (23)\n\tConsent of Independent Accountants\n\tWe hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-8 (Reg. No. 2-67335, Reg. No. 2-79846, Reg. No. 2-92050 and Reg. No. 33-52998) of FlightSafety International, Inc. of our report dated January 31, 1995, appearing on page 25 of the 1994 Annual Report to Shareholders which is incorporated by reference 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 __27__ of this Form 10-K.\nPRICE WATERHOUSE LLP\nNew York, New York March 27, 1995","section_15":""}
{"filename":"778424_1994.txt","cik":"778424","year":"1994","section_1":"Item 1. Business.\nGeneral\nThe Company manufactures and sells roofing materials used primarily in commercial re-roofing projects. These materials are also used in new construction projects. The Company was organized in 1980 and imported roofing materials from Europe until it opened its first manufacturing facility in Port Arthur, Texas in April 1982. The Company has subsequently built or acquired manufacturing facilities in North Branch, New Jersey; Stockton, California; Corvallis, Oregon; and Monroe, Georgia.\nThe Company's operating and marketing philosophy emphasizes a quality product with available warranty, application training and support services for wholesale distributors and roofing contractors. As of December 31, 1994, the Company sold domestically to approximately 650 independent distributors, for resale to an estimated 5,500 roofing contractors who install the Company's roofing products for their customers. Sales to its largest customer, ABC Supply Co., Inc., accounted for approximately 15.5% of the Company's total 1994 sales.\nThe Company is one of the leading domestic producers of modified bitumen roofing products. Based upon industry information supplied by Ducker Research Co., Inc., United States sales of modified bitumen roofing materials, measured in square feet, accounts for an estimated 25% of the total low-slope roofing market.\nThe Company also engages in the manufacture and sale of roll products utilized in the built-up roofing (``BUR'') business. According to information furnished by Ducker Research Co., Inc., BUR accounts for approximately 45% of the total low-slope roofing market. The Company's BUR roofing activities are conducted through its Intec\/Permaglas Division which utilizes the same sales and distribution network used to market the Company's other products.\nThe Company holds a 40% interest in Thermo Manufacturing Company, L.P. (the \"Partnership\"). The Partnership purchases products manufactured by the Company, and the Company purchases products manufactured by the Partnership. During the first quarter of 1994, the Partnership purchased assets to manufacture roof coating products and will focus its marketing and manufacturing efforts principally in this area, although it will continue to market a complete line of roofing products. To date, incremental sales by the Partnership have not been significant.\nIn 1993, the Company purchased a manufacturing facility and related assets in Houston, Texas where the Company has installed a residential shingle manufacturing line. The Company began shingle production at this location during the first quarter of 1995. This represents the Company's entry into the residential roofing segment of the roofing products market.\nAccording to information furnished by Ducker Research Co., Inc. the pitched (primarily residential) roofing market, measured in square feet, is approximately 75% of the total roofing market, or about three times the size of the total low-slope roofing market.\nProducts\nThe Company's atactic polypropylene (``APP'') modified bitumen roofing membrane is sold in rolls, each consisting of a sheet approximately 33 feet long and 40 inches wide. To apply the material, the installer applies heat to the underside of the roll, usually with a hand held propane torch, as the material is unrolled onto the roof. The material's flexibility allows proper forming around vent openings and other protrusions.\nThe Company also manufactures granulated surface APP products. The embedded granules provide solar reflectivity and ultraviolet-ray protection to the roof membrane surface, thereby promoting energy efficiency and longer roof life.\nThe Company also manufactures styrene butadiene styrene(``SBS'') modified bitumen membrane. SBS modified bitumen membrane is sold in rolls of approximately the same length and width as APP modified bitumen membrane and is applied to the roof with hot asphalt or cold adhesive. SBS modified bitumen membrane has a granulated surface of minerals to provide solar reflectivity and ultraviolet-ray protection. This product provides the contractor who has made a large capital investment in BUR roofing equipment and application technology with the opportunity to install modified bitumen membrane roofing systems as well.\nThrough the Intec\/Permaglas Division, the Company also manufactures and sells base and inter-ply sheets. Base sheet is used as the primary layer in modified bitumen and built-up roofing systems, while inter-ply sheets are used as secondary layers in built-up systems as well as multiple-ply modified bitumen systems.\nDuring the first quarter of 1995, the Company began manufacturing residential shingle products. Initially the Company will focus most of its shingle marketing efforts on conventional asphalt laminate shingles, but with time, hopes to move most of its Houston production capacity over to an APP modified laminate product.\nThrough a wholly-owned subsidiary, the Company manufactures and sells roofing accessories designed to improve labor efficiency in the installation process. These include a perimeter edge metal roof flashing with modified bitumen membrane attached; prefabricated aluminum roof drains, pitch pans, and adjustable and standard vent covers with modified bitumen membrane attached to assist the roofing contractor with application. The Company also provides application training, roof inspection, consulting, and diagnostic services.\nThe Market\nThe commercial roofing market is divided into three major product segments: built-up roofing, single-ply roofing, and modified bitumen roofing. A built-up roof is constructed by using a vapor barrier and insulation topped with three to five layers of fiberglass sheets which are attached and waterproofed using layers of hot asphalt. Built-up roofing has been the traditional commercial roofing technology used in the United States. Advantages of built-up systems include proven technology, a large body of trained applicators, and excellent durability resulting from multiple material layers. A single-ply roof is constructed by adhering to the roof a single-ply membrane system (which is principally rubber or plastic-based) through mechanical means or through the use of various adhesive methods. The Company does not compete in the single-ply roofing segment. Modified bitumen roofs are applied by heating the membrane, or by applying hot asphalt or cold adhesive, as it is unrolled on the roof. Modified bitumen systems offer excellent waterproofing characteristics, durability, flexibility and relative ease of application. The Company has also introduced to the market the concept of the hybrid multiple-ply modified bitumen system, utilizing built-up roofing techniques with modified bitumen materials.\nThe residential shingle market is divided into two major product segments: the commodity market and the premium market. In the commodity market, the three-tab shingle is the dominant product. Commodity three-tab shingles are constructed of a single-ply and are usually lighter in weight than premium shingles. The premium shingle market consists of five major product groups: premium asphalt shingles, laminated asphalt shingles, wood shingles, concrete roof tile and metal roofing products. Premium and laminated shingles are thicker and heavier in weight than the typical commodity shingle, and usually provide a high fire resistance rating. In addition, laminated shingles are double-ply and have a higher profile appearance than other asphalt shingles. Typically, asphalt shingles are lower in cost than the other premium shingle market products. The Company manufactures premium and laminated asphalt shingles.\nCompetition\nThe Company competes with a large number of concerns which manufacture materials used in commercial roofing and re-roofing projects, many of which have significantly greater financial resources than does the Company. At December 31, 1994, there were approximately 15 domestic producers of modified bitumen roofing membranes and a significantly greater number of BUR and shingle manufacturers. Management believes that the Company accounted for approximately 23% of 1994 sales (in square feet) of modified bitumen roofing membranes and approximately 6% of BUR materials.\nFor the foreseeable future, the Company does not expect to be a major factor in the market for shingle roofing products.\nManufacturing\nThe Company's APP modified bitumen membrane is composed primarily of three raw materials: asphalt, polyester fabric, and APP. After testing, asphalt and APP are blended together in heated tanks. Once blending is complete, the compound is sampled by the Company's quality control laboratory and, if within specification, is pumped into a holding tank. From the holding tank, the compound is pumped into a vat through which a polyester fabric passes and is saturated with the compound. The saturated mat then goes through sizing rollers that regulate membrane thickness. On granular surfaced materials, the granules are applied just after exiting the sizing rollers and the second cooling tank is bypassed. The Company manufactures material in thicknesses of two, three, and four millimeters. The material then passes through a cooling tray to solidify the bottom surface. At the end of the first cooling tray, a plastic film is applied to the still-molten top surface and the material is then submerged into a second cooling tank, completely solidified and dried with a fan. The material is then coated with talc to prevent sticking, wound into rolls and prepared for shipment.\nThe SBS modified bitumen membrane manufactured by the Company is composed of asphalt, reinforcement fabric, and SBS. The manufacturing process is similar to that used to produce APP modified bitumen membrane except that certain changes are made in the method of blending the SBS and asphalt and in the method of cooling the membrane.\nThe built-up roofing products manufactured by the Company's Intec\/Permaglas Division are composed of an asphalt saturated fiberglass mat. The manufacturing process is similar to that used to produce modified bitumen products.\nThe Company began production of asphalt shingle products in the first quarter of 1995. Asphalt shingles are composed primarily of asphalt, fiberglass mat, mineral filler and granules. The manufacturing process is similar to that used to produce built-up roofing products.\nQuality Control\nThe Company's quality control department monitors production to insure product quality. There is separate testing and evaluation of raw materials, compound and finished product. Raw materials are evaluated for basic physical characteristics such as viscosity, flexibility, flash point and volatility. Compound evaluation ensures that formulation is acceptable and provides batch analysis information prior to manufacturing. To ensure consistency, batches are then transferred to holding tanks and blended with previously transferred material. Finally, samples of the finished product are inspected to assure proper roll length, weight, width, thickness and general appearance.\nRaw Materials\nThe principal raw materials used by the Company in the manufacture of its roofing products are asphalt, APP, SBS, polyester fabric and fiberglass mat, granules, and mineral filler. These raw materials are purchased by the Company under short-term or spot-market arrangements, or alternatively under longer term contracts when management believes such contracts to be advantageous to the Company. The Company utilizes or has available multiple sources for each of its raw materials. The prices and availability of raw materials have generally reflected the price and availability of crude oil and other petrochemical feedstocks.\nDistribution and Marketing\nThe Company sells its products nationwide to wholesale distributors of building products and roofing materials. No significant backlog of orders exists. As of December 31, 1994, the Company had approximately 60 sales and independent representatives who contact architects, distributors and contractors.\nThe Company has historically focused its marketing efforts on re-roofing, which is believed by management to have represented approximately 75% of total U.S. commercial roofing sales during 1994. This market has been relatively stable, growing at approximately 2-3% per year.\nThe Company concentrates its marketing efforts on developing a quality distribution network and educating contractors on the advantages of using its products. Also, the Company devotes substantial effort to educating architects, consultants and large property managers on the benefits of using its products.\nThe Company plans to market its shingle products through its existing distribution network.\nWarranty\nUnder certain circumstances, the Company warrants that its modified bitumen membrane will be free from manufacturing defects and will not fail due to ordinary wear and tear from exposure to the elements or under certain other specified conditions. Through December 31, 1994, the Company's warranty had been issued for approximately 25% of its total production. The limited warranty, which is offered at no additional cost to the purchaser, is for a period of 10 to 12 years. The Company also offers 15 and 20 year warranties at additional cost.\nThe Company also offers, at additional cost, a pro-rated guarantee on its built-up roofing products.\nThe Company offers, at no additional cost, a pro-rated 20 to 40 year warranty on certain of its shingle products.\nThe Company maintains a reserve for warranty claims, which is in an amount management believes is adequate to cover such claims. As of December 31, 1994, such reserve amounted to $6,139,000. The amounts of warranty claims paid by the Company during 1994 and 1993 were $1,266,000 and $1,330,000, respectively.\nLicensing and Trademark Matters\nThe Company produces certain of its APP modified bitumen membranes pursuant to an agreement with Asfalti Breitner S.p.A., an Italian company, under which the Company is granted the non-transferable right to produce and sell in the United States modified bitumen roofing membranes utilizing technology developed by Asfalti Breitner. The BRAI name under which certain of the Company's products are sold is registered by Asfalti Breitner with the United States Patent and Trademark Office, and Asfalti Breitner has granted the Company all rights it possesses to use the BRAI name in the United States through 1995. The Company pays Asfalti Breitner an annual royalty based on the amount of APP modified bitumen membrane of a certain thickness or weight sold by the Company. The Company's right to use the BRAI name after 1995 is subject to negotiation of a new, mutually acceptable royalty agreement. The inability to conclude a mutually acceptable agreement, in management's opinion, would not have a material impact on the Company's operating results or financial condition.\nGovernment Regulation\nThe application of federal, state and local laws, particularly those concerning occupational safety (Occupational Safety and Health Act) and environmental matters (Federal Clean Air Act), involves or may involve review, certification or issuance of permits with respect to construction, modification and operation of the Company's manufacturing facilities. The Company believes that it is in substantial compliance with all presently applicable requirements. The cost of compliance with such laws and with the regulations promulgated thereunder has not been a major factor in the Company's operating costs or the costs of its capital projects.\nEmployees\nAs of December 31, 1994, the Company had 356 employees. Employees are provided competitive wages and fringe benefits. None of the employees is represented by unions, and management believes that its relations with employees are satisfactory.\nExecutive Officers of the Company\nSet forth below is certain information with respect to the executive officers of the Company: Positions and Offices Name Age with Company\nDanny J. Adair. . . . . . . 50 President and Chief Executive Officer J. Roane Ruddy . . . . . . 41 Chief Financial Officer Ken D. Latiolais. . . . . . 48 Vice President-Production S. Craig Noble. . . . . . . 49 Vice President-Technical Services\nNo family relationships exist among any of the officers of the Company, and there are or were no arrangements or understandings between any of the officers and any other person pursuant to which any officer was selected as an officer.\nMr. Adair has served as President and Chief Executive Officer and a Director of the Company since its founding in 1980.\nMr. Ruddy was elected Chief Financial Officer of the Company in November 1992 and became a Director in May of 1993. He has been with the Company since 1986 and served as the Company's Controller prior to assuming his present position.\nMr. Latiolais has been with the Company since 1982. He was Plant Manager of the Company's Port Arthur, Texas facility prior to assuming his present position as Vice President in 1984 and became a Director in 1985.\nMr. Noble has been with the Company since 1982. Prior to becoming Vice President in 1984, he served as Manager of Technical Services. He became a Director of the Company in 1987.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company operates five manufacturing facilities for the production of its roofing products. The table below presents certain information regarding the facilities.\nThe Company also owns a manufacturing facility in Houston, Texas, situated on six acres. The facility has 3,750 square feet of office space, 87,000 square feet of manufacturing space and a 700 square foot laboratory. The Company began production of shingles for residential roofing applications at this facility during the first quarter of 1995.\nSubstantially all of the assets of the Company are pledged to secure indebtedness. See Note B of ``Notes to the Consolidated Financial Statements'' under Item 14.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nNot applicable.\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\nThe Company's Common Stock is traded on the American Stock Exchange under the symbol USI. The high and low quarterly closing prices for the Common Stock as reported on the American Stock Exchange, are shown below.\n1994 High Low First Quarter........................................ 9 1\/4 6 1\/8 Second Quarter....................................... 6 3\/4 5 1\/2 Third Quarter........................................ 6 1\/8 4 7\/8 Fourth Quarter....................................... 7 5\/8 5 1\/4\n1993 High Low First Quarter........................................ 6 3\/8 3 3\/4 Second Quarter....................................... 5 3\/8 4 5\/8 Third Quarter........................................ 7 7\/8 4 1\/2 Fourth Quarter....................................... 7 6 1\/8\nThe number of record holders of the Company's Common Stock as of March 27, 1995, was 116.\nSince its inception, the Company has not paid cash dividends on its Common Stock. The Company has no present plans to pay any cash dividends. The Company intends to continue a policy of retaining earnings for use in its business. Any payments of cash dividends in the future will depend upon the Company's earnings, financial condition, capital requirements and other factors that the Board of Directors deems relevant.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following table sets forth selected financial data of the Company. This data should be read in conjunction with the Company's financial statements and the notes thereto and ``Management's Discussion and Analysis of Financial Condition and Results of Operations'' included elsewhere herein.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nResults of Operations\nYears ended December 31, 1993 and 1994. Sales increased 14.8% from $83,311,000 in 1993 to $95,622,000 in 1994. The increase is due principally to increased roll sales, initiated in part by aggressive spring promotional programs during the second quarter, and to increased relabeled product sales, which are products manufactured by outside suppliers. The increase in the number of rolls sold was somewhat offset by lower pricing introduced in certain regions to improve product positioning.\nGross profit increased from $20,608,000 in 1993 to $21,198,000 in 1994. Gross profit as a percentage of sales decreased from 24.7% in 1993 to 22.2% in 1994. The decrease in profit margin percentage is due principally to the combined effect of generally lower selling prices and a shift in product sales mix. Roll product prices were adversely impacted by severe winter weather in the first quarter and by aggressive pricing used throughout the year to maintain and gain market share. This along with strong sales gains in both relabeled and built-up roofing products, both of which have lower margins, combined to lower the 1994 overall margin percentage. Also during 1994 the Company absorbed certain costs associated with its new Houston manufacturing facility.\nSelling, general and administrative expenses increased from $16,390,000, or 19.7% of sales in 1993, to $18,694,000, or 19.6% of sales in 1994. The increase in expense primarily relates to the increase in sales volume.\nInterest expense increased $281,000 from $919,000 in 1993 to $1,200,000 in 1994. The increase is largely the result of increased debt associated with increased sales and related accounts receivable. Construction period interest of $1,079,000 associated with the Houston facility was capitalized during 1994.\nNet earnings were $991,000 or $.33 per share in 1994 compared with $2,203,000 or $.74 per share in 1993.\nWith the start of production at the new Houston manufacturing facility in February 1995, the Company will cease capitalizing certain construction period costs, including interest costs, incurred to acquire and build out the facility. Initially the Company plans to focus shingle marketing efforts on conventional laminate shingles, and with time, hopes to move most of the Houston production capacity over to the Company's new modified laminate product. The Company expects downward pressure on earnings from the Houston facility until a large percentage of the production capacity is moved to the new modified product, which is expected to be a gradual process that will be completed after 1995.\nYears ended December 31, 1992 and 1993. Sales increased 12.8% from $73,856,000 in 1992 to $83,311,000 in 1993. The Company achieved sales increases in basically all of its sales regions, but the principal increase was along the West Coast. The Company continued to expand into the built-up roofing market and significantly increased its sales of relabeled products manufactured by outside suppliers.\nGross profit as a percentage of sales increased from 23.8% or $17,550,000 in 1992 to 24.7% or $20,608,000 in 1993. The increase in profit margin, in terms of total dollars, was primarily attributable to the sales increase for 1993, while the increase in profit margin, as a percentage of sales, was reflective of the Company's continued focus on reducing production costs through increased manufacturing efficiencies.\nSelling, general and administrative expenses, as a percentage of sales, decreased 2.3% from 22.0% or $16,265,000 in 1992 to 19.7% or $16,390,000 in 1993. The percentage decrease relate primarily to the increased sales volume.\nNet earnings increased $1,424,000 in 1993, from $779,000 or $.26 per share in 1992 to $2,203,000 or $.74 per share in 1993. Net earnings for 1992 reflect the adoption of the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 109, which requires an asset and liability approach in accounting for income taxes. Under this new method, the deferred tax liability is calculated by applying the provisions and rates of current tax law to determine the amount of taxes payable. The cumulative effect of the change was to increase net income by $500,000 or $.17 per share.\nThe following table sets forth, for the time periods indicated, the percentage of certain income and expense items as they relate to total sales:\nLiquidity and Capital Resources\nWorking capital as of December 31, 1994 was $8,562,000 compared with $13,035,000 as of December 31, 1993, a decrease of $4,473,000. Accounts receivable increased $2,378,000 primarily as a result of increased 1994 fourth quarter sales. Accounts payable increased $7,631,000 because of increased production volumes and because of construction costs incurred at the new shingle manufacturing facility in Houston.\nProperty, plant and equipment increased $21,243,000 and long-term debt increased $12,362,000, both primarily as a result of the Houston facility construction costs. As of December 31, 1994, the Company has expended $25,748,000 relating to the Houston facility, and during the first quarter of 1995, the Company expects additional capital expenditures of $1,000,000 relating to this facility. The Company does not anticipate any significant capital expenditures after construction at the Houston facility is completed.\nThe Company's $25 million credit facility is subject to an available borrowing base determined by certain manufacturing equipment and levels of trade receivables and inventories. The credit facility expires in 1999 and bears interest at prime rate. The credit agreement for the credit facility contains various restrictive covenants which, among other things, requires that the Company maintain a certain minimum tangible net worth. During February 1995, the loan balance exceeded the available borrowing base limit by approximately $4.7 million. As a result, the Company obtained a grace period in which to cure the over-extension. This over-extension of the credit facility is attributable to capital expenditures relating to the new Houston manufacturing facility, which amounted to approximately $19 million in 1994, and to a delay in obtaining term loans for that facility.\nDuring March 1995, the over-extension was substantially reduced. The Company also obtained commitments for approximately $4.2 million of secured loans from other lenders to cure the over-extension position. The Company anticipates that the funds required to meet its seasonal increase in working capital needs will be available through the existing credit facility.\nInflation and Seasonality\nInflation has not been a significant factor in the Company's sales growth. The Company's sales of its roofing materials follow usual seasonal construction patterns and are highest in the third quarter and lowest in the first quarter. Borrowings tend to follow this trend.\nEnvironmental Matters\nThe Company has made a commitment to protect the health and welfare of its employees, the public, and our environment. The Company's staff continuously reviews regulations and regularly interfaces with state and\nfederal environmental agencies to maintain a thorough knowledge of current requirements, and to ensure cost effective compliance with agency regulations. The Company expects the trend toward more stringent environmental regulations to continue, and uses this general philosophy when making capital expenditures for environmental purposes. The Company believes it is in compliance with all presently applicable requirements (primarily as they relate to the Environmental Protection Agency and comparable state agencies) and does not anticipate any significant expenditures to maintain its compliance.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe financial statements of the Company and its subsidiary required to be included in this Item 8 are set forth in Item 14 of this Report. The quarterly results of operations are included in the \"Notes to the Consolidated Financial Statements\" under Item 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.(*)\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.(*) _________ * The information called for by Items 10, 11, 12 and 13, to the extent not set forth under Item 1. ``Executive Officers of the Company,'' is or will be set forth in the definitive proxy statement relating to the 1995 Annual Meeting of Shareholders of U. S. Intec, Inc. pursuant to the Commission's Regulation 14A (File No. 1-10665). Such definitive proxy statement relates to a meeting of shareholders involving the election of directors and the portions therefrom called for by Items 10, 11, 12 and 13 (excluding, in the case of Item 11, the information required by paragraphs (i), (k), and (l) of Item 402 of Regulation S-K) are incorporated herein by reference pursuant to Instruction G to Form 10-K.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) Financial Statements and Financial Statement Schedules.\n(1) Financial Statements-\nPage\nReport of Independent Auditors....................................... Consolidated Balance Sheets as of December 31, 1994 and 1993 ........ Consolidated Statements of Earnings for the Three Years Ended December 31, 1994................................................. Consolidated Statements of Shareholders' Equity for the Three Years Ended December 31,1994..................................... Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1994........................................... Notes to the Consolidated Financial Statements.......................\n(2) Schedules Supporting Financial Statements-\nSchedule VIII-Valuation and Qualifying Accounts.............................................................\nOther schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are either not required under the related instructions or inapplicable.\n(3) Listing of Exhibits-See Item 14(c).\n(b) Current Reports on Form 8-K.\nNone\n(c) Exhibits.\n*10(a) - Lease agreement, effective as of February 1, 1993, by and between U.S. Intec, Inc., as Lessor, and Thunderhawk Manufacturing Company, L.P., as Lessee, pertaining to the Company's Georgia plant facility located in Walton County, Georgia, together with purchase option. (See form 10-K for 1992 filed March 1993). *10(b) - Amendment to the security agreement between U.S. Intec, Inc. and LaSalle National Bank of Chicago, formerly Exchange National Bank of Chicago, dated February 8, 1994. (See form 10-K for 1993 filed March 1994). *10(c) - Promissory Note and related Letter Agreement between U.S. Intec, Inc. and Danny J. Adair effective December 31, 1993. (See form 10-K for 1993 filed March 1994).\n*10(d) - Asset Purchase Agreement between U.S. Intec, Inc. and Betontex, Inc. dated as of September 8, 1993. (See form 10-K for 1993 filed March 1994). *21 - List of Subsidiaries of U.S. Intec, Inc (see Form 10-K for 1990 filed in March 1991). 23(a) - Consent of Independent Auditors.\n* Incorporated herein by reference as indicated.\n(d) Not 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, in the City of Port Arthur, Texas, on March 29, 1995.\nU.S. Intec, Inc.\nBy Danny J. Adair ----------------------------- Danny J. Adair President, Chief Executive Officer and Director\nPursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed on March 29, 1995 by the following persons in the capacities indicated.\nSignature Title\nDanny J. Adair President, Chief Executive ------------------------------- Danny J. Adair Officer and Director\nJ. Roane Ruddy Chief Financial Officer ------------------------------- J. Roane Ruddy and Director\nKen D. Latiolais Vice President ------------------------------ Ken D. Latiolais and Director\nS. Craig Noble Vice President ------------------------------ S. Craig Noble and Director\nAlbert E. Brammer Director ------------------------------ Albert E. Brammer\nAustin W. Gonsoulin Director ------------------------------ Austin W. Gonsoulin\nRobert G. Hoag Director ----------------------------- Robert G. Hoag\nRichard Earl Purkey, Sr. Director ------------------------------ Richard Earl Purkey, Sr.\nPage Report of Independent Auditors ..................................... Consolidated Balance Sheets as of December 31, 1994 and 1993........ Consolidated Statements of Earnings for the Three Years Ended December 31, 1994........................................... Consolidated Statements of Shareholders' Equity for the Three Years Ended December 31, 1994............................... Consolidated Statements of Cash Flows for the Three Years Ended December 31, 1994........................................... Notes to the Consolidated Financial Statements...................... Schedule VIII-Valuation and Qualifying Accounts.....................\nREPORT OF INDEPENDENT AUDITORS\nTo the Board of Directors and Shareholders U.S. Intec, Inc.\nWe have audited the accompanying consolidated balance sheets of U. S. Intec, Inc. as of December 31, 1994 and 1993, and the related consolidated statements of earnings, shareholders equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of U. S. Intec, Inc. at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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, present fairly in all material respects the information set forth therein.\nAs discussed in Note C to the consolidated financial statements, in 1992 the Company changed its method of accounting for income taxes.\nErnst & Young LLP\nHouston, Texas February 17, 1995, Except Note B as to which the date is March 24, 1995\nSee notes to the consolidated financial statements.\nSee notes to the consolidated financial statements\nU.S. INTEC, INC. CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nAdditional Common Paid-In Retained Stock Capital Earnings Total ------- ---------- ---------- -----------\nBalance at December 31, 1991 $59,384 $7,143,399 $11,388,455 $18,591,238 Net earnings for 1992..... 779,189 779,189 ------- ---------- ----------- ----------- Balance at December 31, 1992 $59,384 $7,143,399 $12,167,644 $19,370,427 Stock options exercised in 1993.................... 310 74,090 74,400 Net earnings for 1993..... 2,203,162 2,203,162 ------- ---------- ----------- ----------- Balance at December 31, 1993 $59,694 $7,217,489 $14,370,806 $21,647,989 Stock options exercised in 1994.................... 325 103,425 103,750 Restricted stock issuance and amortization........ 600 47,213 47,813 Net earnings for 1994..... 990,883 990,883 ------- ---------- ----------- ----------- Balance at December 31, 1994 $60,619 $7,368,127 $15,361,689 $22,790,435 ======= ========== =========== ===========\nSee notes to the consolidated financial statements\nSee notes to the consolidated financial statements\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS December 31, 1994\nNOTE A-SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation: The consolidated financial statements include the accounts of the Company and its subsidiary. The Company's 40% interest in a partnership is accounted on the equity method. Because the Company has provided substantially all start-up funding for the partnership, the Company recorded 100% of the partnership earnings (losses) for 1994 and 1993 which, after elimination of intercompany transactions, were approximately $100,000 and ($200,000), respectively. All material intercompany amounts and transactions have been eliminated.\nInventories: Inventories are stated at the lower of cost (first-in, first-out method) or market.\nProperty, Plant and Equipment: Property, plant and equipment, including capitalized interest, is stated on the basis of cost. Interest of $1,079,204 and $143,027 was capitalized in 1994 and 1993, respectively. No interest was capitalized in 1992. Depreciation is computed by the straight-line method using the following estimated useful lives:\nAsset Class Years Buildings and leasehold improvements. . . . . 15 Manufacturing equipment . . . . . . . . . . . 10 Furniture and fixtures. . . . . . . . . . . . 5 Automotive equipment. . . . . . . . . . . . . 3\nGoodwill and Intangibles: Goodwill and intangibles are recorded at cost and are amortized using the straight-line method over their respective useful lives of 40 and 5 years. The Company periodically assesses and measures for impairment of goodwill and intangibles using projected net earnings (attributable to goodwill and intangibles) over the remaining amortization period.\nIncome Taxes: Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Deferred income taxes arise principally from timing differences related to depreciation expense, warranty expense and safe harbor lease transactions.\nProduct Warranty: The Company offers a limited warranty covering up to twenty years on some of its products. The Company accrues for estimated warranty costs at the time of sale of warranted products. As of December 31, 1994, the reserve for warranty claims was $6,139,013. The Company feels that this reserve is adequate to provide for future warranty obligations.\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) December 31, 1994\nNet Earnings Per Share: Net earnings per share is based on the weighted average number of shares of common stock outstanding during each period - 2,999,425 in 1994, 2,974,703 in 1993 and 2,969,161 in 1992. Stock options are not included in the computation of the weighted average number of common shares outstanding since their effect is not significant. Fully diluted earnings per share is not presented because the stock options are not materially dilutive.\nSupplemental Cash Flow Information: The Company paid interest (net of amounts capitalized) of approximately $1,199,800 in 1994, $919,000 in 1993 and $1,052,000 in 1992. The Company paid income taxes, net of refunds, of $450,000, $1,973,000 and $71,000 in 1994, 1993 and 1992, respectively.\nCash and Cash Equivalents: For purposes of the statements of cash flows, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.\nDebt Maturities:\nAggregate maturities of long-term debt during the next five years, are as follows:\n1995 . . . . . . . . . . . . . 867,299 1996 . . . . . . . . . . . . . 925,783 1997 . . . . . . . . . . . . . 988,519 1998 . . . . . . . . . . . . . 1,055,818 1999 . . . . . . . . . . . . . 24,781,105\nRevolving Credit Facility: The facility, which expires in 1999, is subject to an available borrowing base determined by certain manufacturing equipment and levels of trade accounts receivable and inventory. During\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) December 31, 1994\nFebruary 1995, the loan balance exceeded the available borrowing base limit by approximtely $4.7 million. As a result, the Company obtained a grace period in which to cure the over-extension. During March 1995, the over-extension was substantially reduced. The Company also obtained commitments for approximately $4.2 million of secured loans from other lenders to cure the over-extension position. Accordingly, the credit facility is classified as long-term.\nRestrictive Covenants: The Company's credit agreements contain various restrictive covenants which, among other things, require that the Company maintain a minimum tangible net worth.\nCollateral: Substantially all of the assets of the Company are pledged under the terms of the lending agreements.\nNOTE C-INCOME TAXES\nThe income tax provision (benefit) consists of the following:\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) December 31, 1994\nNOTE C-INCOME TAXES (CONTINUED)\nThe income tax effect of the factors accounting for the difference between the statutory federal income tax rates and the actual provision for taxes on income are as follows:\nThe components of the net deferred tax liability as of December 31, 1994, 1993 and 1992 are as follows:\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) December 31, 1994\nIn 1992, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 requires the adjustment of previously deferred taxes for changes in tax rates under the liability method. The Company chose to reflect the cumulative effect of adopting the pronouncement as a change in accounting principle at the beginning of 1992. The effect of the change increased 1992 net earnings by $500,000, or $.17 per share, and is reported separately in the consolidated statement of operations. This benefit represents the writedown of net deferred tax assets and liabilities from tax rates in effect when they arose to current statutory tax rates.\nNOTE D-RELATED PARTY TRANSACTIONS\nDuring 1990, the Company accepted a note from its President for $2,803,000 bearing interest at the rate paid by the Company for funds borrowed under its senior credit facility. In December 1993, the Company renegotiated the note by extending the due date of principal payments and the note's maturity to December 31, 1996. Accrued interest on the note has been paid through December 31, 1994. The note is secured by 814,521 shares of the Company's Common Stock and certain real estate. The President has agreed that in the event the Company elects to raise capital through an underwritten public offering of its Common Stock prior to maturity of the renegotiated note, he will sell in such public offering a sufficient number of pledged shares in order to enable him to prepay the note in full. The President has also agreed that until the renegotiated note is paid in full, he will not be eligible to participate in any long-term incentive plans or programs based on the Company's Common Stock.\nDuring the years ended December 31, 1994, 1993 and 1992, the Company purchased approximately $32,000, $32,000 and $33,000, respectively, of goods and services from the President of the Company or entities in which the President owns a controlling interest. These amounts were charged to expense in the respective periods and relate primarily to rental payments.\nNOTE E-COMMITMENTS AND CONTINGENCIES\nThe Company is committed to pay an annual royalty of not less than $200,000 nor more than $500,000 for the use of the BRAI brand name in the United States through 1995.\nThe Company is installing a residential shingle manufacturing line in its newly acquired Houston facility. The Company expects capital expenditures of $1,000,000 during the first quarter of 1995 relating to this facility.\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) December 31, 1994\nVarious claims are pending against the Company arising in the ordinary course of business. The Company maintains insurance, which serves to minimize exposure to claim losses. Beginning in 1992 through 1993, the Company's general liability coverage includes self-insured obligations of $250,000 per occurrence and $1,000,000 in the aggregate. In 1994 the per occurrence self-insured obligation was reduced to $100,000. For the period beginning in 1982 through August 1988, the Company purchased comprehensive general liability coverage from Employers Casualty Company (\"Employers\"). In 1994, Employers was placed in receivership which could potentially affect the direct indemnity obligations of Employers under the policies issued to the Company. However, the receivership is not expected to result in any material loss or deprivation of coverage to the Company due to other available insurance coverage and insurance guarantee pools maintained by the various states.\nAdditionally, for the period August 5, 1983 through March 17, 1985, the Company purchased excess liability coverage from an insurance company (\"Mission National Insurance Company\") which subsequently was placed in liquidation, such coverage being in addition to the Company's comprehensive general liability coverage. For the period referred to above, there is one lawsuit pending alleging total damages which, if awarded, would exceed coverage provided by the underlying comprehensive general liability policy. However, it is expected that additional funds for the satisfaction of this claim will be available through state insurance guarantee pools and from the liquidation of the assets of the bankrupt excess liability carrier.\nThe Company's claim liability has been determined based on an evaluation of claims incurred. The estimated liability of $1,034,000 at December 31, 1994 is included in other accrued liabilities in the consolidated balance sheet.\nThe Company does not possess sufficient information to evaluate certain claims. However, after taking into consideration legal counsel's evaluation and insurance coverage maintained by the Company, management believes that recoveries by claimants, if any, will not be material to the consolidated financial statements of the Company.\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) December 31, 1994\nNOTE F-RETIREMENT PLANS\nThe Company has a 401(k) Plan, which covers substantially all employees. The Company matches the first $500 the employee contributes to the Plan. Additionally, profit sharing contributions are made by the Company at the discretion of the Board of Directors. The Board approved contributions of $150,000 for 1994, 1993 and 1992. Total expense for the Plan was $300,000, $275,000 and $277,000 in 1994, 1993 and 1992, respectively.\nDuring 1994, the Company terminated its Non-Qualified Deferred Compensation Plan for designated key employees. Plan assets of approximately $400,000 were transferred to Plan participants subsequent to year-end.\nNOTE G-STOCK OPTION PLANS\nEffective May 1994, the shareholders of the Company adopted the 1994 Long Term Incentive Plan of the Company (the \"Incentive Plan\"), which provides for the grant of stock options, stock appreciation rights, restricted stock, performance cash awards, performance stock awards, dividends equivalent rights, or any combination thereof. The Incentive Plan replaced the Company's 1985 Employee Stock Option Plan; however, stock options granted under the 1985 Plan which were outstanding at the time of adoption of the Incentive Plan are counted in determining the shares available for issuance under the Incentive Plan. The total number of shares of the Company's Common Stock available for issuance under the Incentive Plan is 450,000.\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) December 31, 1994\nStock option transactions are summarized as follows:\nAll outstanding options are for terms of 5 to 10 years from date of grant.\nThe Non-Employee Director Stock Option Plan (the \"Outside Director Plan\") adopted in 1988 was terminated upon approval of the Incentive Plan. Accordingly, outstanding options to purchase 20,000 shares of Common Stock under the Outside Director Plan were cancelled. Pursuant to the Incentive Plan, the independent directors are each granted 10,000 shares of restricted stock, vesting 25% for each full year of service as an independent director. As of December 31, 1994, 30,000 restricted shares had been issued, of which 7,500 shares had vested.\nNOTE H-MAJOR CUSTOMERS AND CREDIT CONCENTRATION\nThe Company's customers are not concentrated in any specific geographic region, but are concentrated in the building materials industry. The Company derived 15.5% of total revenue from a single customer in 1994.\nThe Company reviews a customer's credit history before extending credit. The Company establishes an allowance for doubtful accounts based upon factors affecting the creditworthiness of specific customers, historical trends and other information.\nU.S. INTEC, INC. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS - (Continued) December 31, 1994\nNOTE I-SUMMARY OF QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nSelected quarterly financial results for the years ended December 31, 1994 and 1993 are summarized below:\nEXHIBIT 23(a)\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-35861)pertaining to the 1985 Stock Option Plan of U.S. Intec, Inc. and in the related Prospectus and in the Registration Statement (Form S-3 No. 33-88528) and in the related Prospectus pertaining to the registration of 545,290 shares of common stock of our report dated February 17, 1995, with respect to the consolidated financial statements and schedules of U.S. Intec, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1994.\nErnst & Young LLP\nMarch 28, 1995 Houston, Texas","section_15":""}
{"filename":"109284_1994.txt","cik":"109284","year":"1994","section_1":"Item 1. Business.\nZERO Corporation (the \"Company\", ZERO, or \"Registrant\") was incorporated in Delaware in 1988 as a successor in interest to a California corporation of the same name that was originally incorporated in 1952. Its executive offices are located at 444 South Flower Street, Suite 2100, Los Angeles, CA 90071-2922, telephone (213) 629-7000.\nThe Company, through nine U.S. companies and one foreign company, considers itself a leader in the engineering, manufacturing and marketing of engineered cases, system packaging, and various products used in the airline\/air cargo industry. ZERO's engineered cases include custom and standard deep drawn aluminum ZERO boxes; ZERO Halliburton (Register Mark) luggage, attaches and carrying cases; thermoformed and rotationally molded plastic cases and enclosures; other standard and custom fabricated cases (marketed under the Anvil Cases (Register Mark) brand name); and specialized case hardware. The Company's engineered cases are widely used in commercial, industrial and government\/military applications. The Company's system packaging business involves engineering, manufacturing and\/or integrating standard and custom electronic enclosures and cabinets, and related components such as card cages, backplanes, and power supplies; and cooling equipment, including motorized impellers, blowers, fan trays, heat exchangers and air conditioners. The Company's airline\/air cargo products include specialized aluminum, polycarbonate and fiberglass air cargo containers; patented telescoping baggage\/cargo systems; air cargo restraint systems and hardware; and transit cases engineered to meet the Air Transport Association's highest specifications. Over fifty percent of ZERO's net sales in fiscal 1994 were linked to the electronics industry through customers doing business in the telecommunication\/instrumentation, and data processing\/peripherals markets.\nZERO's operations are classified under two business segments: Enclosures and Accessories, and Other. Information about ZERO's business segments is set forth in Note 8 \"Segment Information\" on page 28 of the 1994 Annual Report, which is incorporated herein by reference.\nDuring the three years ended March 31, 1994, the Company did not derive a material portion of its sales or net income from its foreign operations nor has the Company been dependent upon a single customer, or a few customers, the loss of which would have a material adverse effect on its operations.\nPatents, licenses, franchises and concessions are not an important factor in ZERO's overall production process and are not material to its results of operation.\nDevelopment of new products is not a significant part of the Company's business. During the year ended March 31, 1994, the Company spent less than 1% of net sales on research and development activities.\nMarketing\nIn marketing non-consumer oriented products in its two business segments, ZERO employs manufacturers' representatives, direct salespeople and some distributors to market its products worldwide. Technical support for these manufacturers' representatives, salespeople and distributors is provided by engineering personnel from ZERO's various plants. The Company's standard enclosure products and accessories are sold through catalogs, advertisements, trade journals and independent distributors. Nonstandard or specialized enclosure products and accessories are marketed through manufacturers' representatives and direct sales. ZERO's consumer oriented products are marketed worldwide through catalogs, advertisements in selected publications, telemarketing programs, trade journals and are distributed through established independent dealers who specialize in the market to which each of ZERO's products is related.\nCompetition\nWhile reliable statistics are not available that would permit the Company to accurately estimate its share of the total market for each of its business segments, the Company believes it has a significant share of the enclosures and accessories market that it serves. ZERO competes with a number of other companies, both larger and smaller. The degree and type of competition that ZERO encounters varies for both of its business segments.\nThe Company believes it effectively competes in both of its business segments by providing engineering expertise, innovative design, superior quality and on-time delivery at a competitive price. ZERO's ability to successfully compete in the Enclosures and Accessories segment is also attributable to its broad range of standard products. Approximately 2,000 dies, capable of producing over 75,000 standard deep drawn aluminum enclosures, provides ZERO with both a cost and service advantage in a large portion of its metal case and enclosure business. In addition, ZERO offers thousands of sizes of fabricated cases and hundreds of standard configurations for system packaging. Competitive strength is also derived by the Company's ability to modify standard products to satisfy a virtually limitless number of applications and customer requirements.\nSales and Backlog\nZERO's backlog at March 31, 1994 and 1993 was $40,302,000 and $39,415,000, respectively. Backlog is based on contracts which were signed as of the respective dates set forth. Approximately 93% of the backlog at March 31, 1994 is scheduled for delivery during fiscal 1995.\nCertain contracts, particularly those with the United States Government and its contractors, provide for cancellation for convenience of the customer. If such cancellation occurs, the contractor is paid for costs incurred to date plus the costs of settling and paying claims of terminated subcontractors, other settlement expenses and a reasonable profit on its costs. During the five years ended March 31, 1994, the aggregate amount of orders cancelled for the convenience of the United States Government has not been material. However, no assurance can be given that this pattern will continue in the future.\nFor the year ended March 31, 1994, approximately 12% of Zero's sales were made to the government\/military market.\nA majority of ZERO's sales orders are in amounts of less than $10,000 each. These orders generally are delivered 1 to 6 weeks from the time the order is booked. Larger orders and custom orders may take several weeks to over a year depending on the delivery schedule set by the customer. Because of the large number of customers served (in excess of 19,000), the relatively small size of each order and the relatively short delivery cycles involved, the Company believes the risk of any order being cancelled which would have a significant adverse effect on operations is low.\nRaw Materials\nThe principal raw materials used by ZERO in manufacturing its products are aluminum and steel and, to a lesser extent, plastics. Such materials are purchased under competitive bids at levels sufficient to meet foreseeable production and delivery schedules. For the year ended March 31, 1994, ZERO purchased aluminum and steel from over ten principal suppliers. Plastics and other raw materials and supplies necessary for the production of ZERO's products are purchased from a variety of suppliers. As of June 17, 1994, the Company was not experiencing shortages in the supply of its raw materials. Based on market and economic conditions at that date, ZERO believes that the supply and availability of these materials will be adequate to support its level of operations projected through March 31, 1995. However, the Company can make no assurances that such materials will be available beyond that period, and any shortage of such materials could have a significant and material adverse impact on the operations of the Company.\nEnvironmental Matters\nZERO has developed and implemented an environmental program to reduce or eliminate the use of hazardous material and possible contamination. Through changes in production processes, capital expenditures, proper training and the use of state-of-the-art treatment and monitoring equipment, the Company believes its program is controlling the use and discharge of hazardous materials and is in substantial compliance with applicable local, state and Federal regulations. The Company does not expect that any assertions of noncompliance with such laws will materially adversely affect its earnings or competitive position or will require any significant capital expenditures during fiscal year 1995.\nInformation in Note 7 - \"Contingent Liabilities\" on page 27 of the 1994 Annual Report addressing environmental matters in which ZERO has been named a \"potentially responsible party\" is incorporated herein by reference.\nEmployees\nAs of May 31, 1994, ZERO employed 1,684 persons. Employee relations are considered good. Certain employees at the Company's Samuel Groves & Co. Limited subsidiary and ZERO Stantron Cabinets division are represented by unions which are not affiliated with any national unions. In the past ten years the Company has not experienced a significant work stoppage from a labor dispute.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAs of June 17, 1994, ZERO used manufacturing plants and office buildings containing an aggregate of approximately 1,389,000 square feet of floor space. ZERO's plants are located in California (Camarillo, City of Industry, El Monte, Pacoima, Rancho Dominguez and San Diego); Utah (North Salt Lake); Massachusetts (Monson); New Jersey (Princeton Junction); Minnesota (Brooklyn Park); Connecticut (Hartford); Tijuana, Mexico; and Birmingham and Feltham, England. The plants located in Camarillo, City of Industry, El Monte, Pacoima and San Diego, California; in Brooklyn Park, Minnesota; in Princeton Junction, New Jersey; and in North Salt Lake, Utah, are used in the production of enclosures and accessories. The remaining plants are used by both business segments.\nZERO owns all its plants and facilities, except for the following leased properties:\nPLANT SQUARE FOOTAGE LEASE EXPIRES - - --------------------------------------------------------------------------------\nCamarillo, CA 36,000 June 30, 1996 Camarillo, CA 22,000 February 28, 1996* City of Industry, CA 63,000 November 30, 1996* El Monte, CA 72,000 May 31, 2006 Hartford, Ct 8,000 January 31, 1996 Pacoima, CA 114,000 August 5, 1999* Rancho Dominguez, CA 33,000 November 30, 1994* Rancho Dominguez, CA 121,000 September 30, 1999* Tijuana, Mexico 35,000 January 31, 1995* Feltham, England 31,000 October 1, 2002 --------- TOTAL 535,000 =========\n* Lease contains renewal option.\nZERO's plants and facilities used in operations are generally constructed of concrete block, brick, concrete tilt-up, steel or a combination thereof. ZERO's facilities and equipment are well maintained and are believed to be adequate to support a substantial increase in its operations, assuming a comparable product mix.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nInformation concerning legal proceedings in Note 7 - \"Contingent Liabilities\" on page 27 of the 1994 Annual Report is incorporated herein by reference.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nRegistrant submitted no matters to a vote of its security holders during the fiscal quarter ended March 31, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------\nInformation regarding the Company's officers as of June 17, 1994 is as follows:\nEXECUTIVE NAME AGE POSITION OFFICER SINCE - - --------------------------------------------------------------------------------\nJohn B. Gilbert 73 Chairman Emeritus 1952\nWilford D. Godbold Jr. 56 President, Chief Executive Officer and Director 1982\nHoward W. Hill 67 Chairman of the Board 1960\nGeorge A. Daniels 56 Vice President and Chief Financial Officer 1987\nJames F. Hermanson 57 Vice President 1984\nBernard B. Heiler 48 Vice President of Marketing and Sales 1992\nAnita J. Cutchall 55 Director of Legal Affairs and Corporate Secretary 1992\nNone of the directors or executive officers are related to one another. All executive officers except Mr. Heiler and Ms. Cutchall have served in their current capacities or in other managerial positions with the Company for a minimum of the past five years. Mr Heiler has held his current position with the Company since October 1992, prior to which he was Vice President of GTE California, a telephone public utility, from 1984 through 1992, and President of GTEL, a telecommunications integrator and a subsidiary of GTE, from January 1986 through October 1992. Ms. Cutchall has held her current position with the Company since August 1992, prior to which she held the same position with Continental Graphics Corporation, a provider of specialty graphics, commercial printing and film services, from July 1990 through August 1992, and was Legal Associate and Corporate Secretary at Triton Group Ltd,. a diversified holding company, from 1986 through 1990.\nPART II\nItem 5.","section_5":"Item 5. Market For Registrant's Common Equity and Related Stockholder Matters.\nThe information under the caption \"Market and Dividend Information\" on page 30 of the 1994 Annual Report is incorporated herein by reference. On June 17, 1994 the Company had 6,122 stockholders of record.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information under the caption \"Five Year Consolidated Financial Highlights\" on the inside front cover of the 1994 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 of Results of Operations and Financial Condition\" on page 18 of the 1994 Annual Report 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 Registrant and its subsidiaries included in the 1994 Annual Report (on the pages therein shown in parentheses) are incorporated herein by reference:\nStatements of Consolidated Income--Years Ended March 31, 1994, 1993 and 1992. (Page 19)\nConsolidated Balance Sheets--March 31, 1994 and 1993. (Pages 20 and 21)\nStatements of Consolidated Stockholders' Equity--Years ended March 31, 1994, 1993 and 1992. (Page 22)\nStatements of Consolidated Cash Flows--Years Ended March 31, 1994, 1993 and 1992. (Page 23)\nNotes to Consolidated Financial Statements. (Pages 24 to 28, inclusive)\nThe independent auditors' report and management's report on page 29 of the 1994 Annual Report covering ZERO's consolidated financial statements are also 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 under the caption \"Election of Directors\" in the 1994 Proxy Statement is incorporated herein by reference.\nInformation concerning the Company's executive officers is included under the caption \"Executive Officers of the Registrant\" following Part I, Item 4 of this report.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information under the captions \"Meetings of the Board of Directors, Committees of the Board and Directors' Fees\" and \"Executive Compensation\" in the 1994 Proxy Statement is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information under the captions \"General Information\" and \"Voting Securities and Certain Stockholders\" in the 1994 Proxy Statement is incorporated herein by reference.\nRegistrant does not know of any arrangement, including any pledge by any person of securities of Registrant, which may at a subsequent date result in a change of control of Registrant.\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.\nReference is made to Item 8 in Part II of this report, where these statements are listed.\n(a)(2). Financial Statement Schedules.\nThe following consolidated financial statement schedules of Registrant are included in Item 14(d) below:\nSchedule I--Short-Term Investments as of March 31, 1994.\nSchedule VIII--Valuation and Qualifying Accounts for the years ended March 31, 1994, 1993 and 1992.\nSchedule IX--Short-Term Bank Borrowings for the years ended March 31, 1994, 1993 and 1992.\nSchedule X--Supplementary Income Statement Information for the years ended March 31, 1994, 1993 and 1992.\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 or are inapplicable, and therefore have been omitted.\n(a)(3). Exhibits.\nThe following exhibits are part of this Form 10-K and are either incorporated by reference to the prior filings indicated below or are filed herewith under Item 14(c):\n3.1 The Restated Certificate of Incorporation filed as Exhibit 3-(3)(a) of the Company's Form 8-B filed on September 7, 1988.\n3.2 Bylaws of ZERO Corporation, as amended on April 22, 1994.\n4.2 Specimen form of certificate of common stock $0.01 par value per share filed as Exhibit 3-(4) of the Company's Form 8-B filed on September 7, 1988.\n10.1 Deferred Compensation Plan adopted by the Board of Directors on December 17, 1973 as amended by the Board of Directors on December 11, 1974 filed as Exhibit 13.10 to the Company's Form 10-K for the year ended March 31, 1975.\n10.2 Deferred Compensation Plan as amended through April 1, 1986 filed as Exhibit 10.13 to the Company's Form 10-K for the year ended March 31, 1986.\n10.3 Directors' Deferred Compensation Plan adopted by the Board of Directors on October 20, 1993.\n10.4 Executive Deferred Compensation Plan adopted by the Board of Directors on October 20, 1993.\n10.5 ZERO Corporation Management Bonus Plan adopted by the Board of Directors on April 22, 1994.\n10.6 Articles of Association of the ZERO Corporation Employees Stock Purchase Plan filed as Exhibit 1 to Form S-8 Registration Statement (File No. 2-26009).\n10.7 ZERO Corporation 1988 Stock Option Plan, as amended, filed on Form S-8 Registration Statements (File Nos. 33-44143, 33-27929 and 2-54344).\n10.8 ZERO Corporation 1994 Stock Option Plan, filed as Appendix A to the Company's 1994 Proxy Statement.\n10.9 Description of ZERO Corporation Supplemental Executive Retirement Plan adopted by the Board of Directors on January 19, 1994.\n10.10 Description of ZERO Corporation Contract and Joint Supplemental Life Insurance Plan adopted by the Board of Directors on April 22, 1994.\n13 Annual Report for the year ended March 31, 1994 (not deemed filed except for those portions specifically incorporated by reference herein).\n21 Listing of the Company's subsidiaries as of March 31, 1994.\n23 Consent of Independent Auditors dated June 27, 1994 to the incorporation by reference of their reports filed herewith into the Company's Form S-8 Registration Statements (File Nos. 33-53943, 33-44143, 33-27929 and 2- 54344).\n(b). REPORTS ON FORM 8-K.\nDuring the quarter ended March 31, 1994 the Company filed no reports on Form 8-K.\n(c). EXHIBITS.\nSee listing of exhibits filed herewith on page 16 of this report.\n(d). FINANCIAL STATEMENT SCHEDULES.\nThe financial statement schedules listed in Item 14(a)(2) above are shown on pages 12 through 15 of this report. The report of the Registrant's independent auditors, Deloitte & Touche, is set forth on page 11 of this report.\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of Registrant and in the capacities and on the dates indicated.\nSIGNATURE TITLE DATE - - --------- ----- ----\nVice President and Chief \/s\/ GEORGE A. DANIELS Financial Officer June 27, 1994 - - ----------------------- George A. Daniels\nController and Chief \/s\/ ERIC A. SAND Accounting Officer June 27, 1994 - - ----------------------- Eric A. Sand\nDIRECTORS:\n\/s\/ GARY M. CUSUMANO Director June 27, 1994 - - ----------------------- Gary M. Cusumano\n\/s\/ BRUCE J. DEBEVER Director June 27, 1994 - - ----------------------- Bruce J. DeBever\n\/s\/ CLINTON G. GERLACH Director June 27, 1994 - - ----------------------- Clinton G. Gerlach\n\/s\/ JOHN B. GILBERT Director June 27, 1994 - - ----------------------- John B. Gilbert\nDirector and Chief \/s\/ WILFORD D. GODBOLD JR. Executive Officer June 27, 1994 - - ----------------------- Wilford D. Godbold Jr.\n\/s\/ BERNARD B. HEILER Director June 27, 1994 - - ----------------------- Bernard B. Heiler\n\/s\/ HOWARD W. HILL Director June 27, 1994 - - ----------------------- Howard W. Hill\n\/s\/ WHITNEY A. MCFARLIN Director June 27, 1994 - - ----------------------- Whitney A. McFarlin\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTo the Stockholders of ZERO Corporation:\nWe have audited the consolidated financial statements of ZERO Corporation and its subsidiaries (the \"Company\") as of March 31, 1994 and 1993, and for each of the three years in the period ended March 31, 1994, and have issued our report thereon dated May 12, 1994; such financial statements and report are included in your 1994 Annual Report to Stockholders and are incorporated herein by reference. Our audits also included the financial statement schedules of the Company, listed in Item 14(a)(2). 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\nLos Angeles, California May 12, 1994\nS C H E D U L E I\nZERO CORPORATION AND SUBSIDIARIES\nSHORT-TERM INVESTMENTS\nAS OF MARCH 31, 1994\nS C H E D U L E V I I I\nZERO CORPORATION AND SUBSIDIARIES ---------------------------------\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992\n(1) Net of recoveries\nS C H E D U L E IX\nZERO CORPORATION AND SUBSIDIARIES ---------------------------------\nSHORT-TERM BANK BORROWINGS\nFOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992\nS C H E D U L E X\nZERO CORPORATION AND SUBSIDIARIES ---------------------------------\nSUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992\nZERO CORPORATION AND SUBSIDIARIES\nFORM 10K, ITEM 14(c)\nEXHIBITS FILED HEREWITH\n3.2 Bylaws of ZERO Corporation, as amended on April 22, 1994.\n10.3 Directors' Deferred Compensation Plan adopted by the Board of Directors on October 20, 1993.\n10.4 Executive Deferred Compensation Plan adopted by the Board of Directors on October 20, 1993.\n10.5 ZERO Corporation Management Bonus Plan adopted by the Board of Directors on April 22, 1994.\n10.9 Description of ZERO Corporation Supplemental Executive Retirement Plan adopted by the Board of Directors on January 19, 1994.\n10.10 Description of ZERO Corporation Contract and Joint Life Insurance Plan adopted by the Board of Directors on April 22, 1994.\n13 Annual Report for the year ended March 31, 1994 (not deemed filed except for those portions specifically incorporated by reference herein).\n21 Subsidiaries of Registrant as of March 31, 1994.\n23 Consent of Independent Auditors to incorporation by reference of $599,000 reports filed herewith into the Company's Form S-8 Registration Statements (File Nos. 33-53943, 33-44143, 33-27929 and 2-54344).","section_15":""}
{"filename":"103392_1994.txt","cik":"103392","year":"1994","section_1":"ITEM 1. BUSINESS - - -----------------\n(a) General Development of Business -------------------------------\nContinental Can Company, Inc. (the Company) is a publicly traded company incorporated in Delaware in 1970 under the name Viatech, Inc. The name of the Company was changed to Continental Can Company, Inc. in October 1992. The Company is engaged in the packaging business through a number of consolidated operating subsidiaries. The Company's packaging business consists of (i) its 50%-owned domestic subsidiary, Plastic Containers, Inc. (PCI), which owns Continental Plastic Containers, Inc. and Continental Caribbean Containers, Inc. (collectively, CPC), (ii) its wholly owned German operating subsidiary, Dixie Union Verpackungen GmbH (Dixie Union) and (iii) its majority-owned European operating subsidiaries, Ferembal S.A. (Ferembal), which in turn owns 64% of Obalex, A.S. (Obalex), and Onena Bolsas de Papel, S.A. (Onena). PCI is a leading manufacturer of extrusion blow-molded containers in the United States. Ferembal is a manufacturer of rigid packaging, primarily food cans, of which it is the second largest supplier in France. Obalex is a manufacturer of metal cans in the Czech Republic. Dixie Union manufactures plastic films and packaging machines, primarily for the food and pharmaceutical industries. Onena manufactures film, and laminates and prints plastic, paper and foil packaging materials for the food and snack food industries in Spain. The Company also owns Lockwood, Kessler & Bartlett, Inc. (LKB) which provides services principally in the fields of mapping and survey, civil and structural engineering, mechanical and electrical engineering, and construction administration and inspection.\n(b) Financial Information About Industry Segments ---------------------------------------------\nThe Company has one reportable industry segment - packaging, as determined in accordance with the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 14.\n(c) Narrative Description of Business ---------------------------------\nThe Company manufactures packaging which accounted for 98%, 97.5% and 97.3%, of its consolidated revenues in 1994, 1993 and 1992, respectively.\nCPC - The Company's 50%-owned subsidiary, PCI, acquired CPC in November --- 1991. CPC, headquartered in Norwalk, Connecticut, has fifteen manufacturing plants in the continental United States and one in Puerto Rico. CPC is a leader in the development, manufacture and sale of a wide range of extrusion blow- molded plastic containers for household chemicals, food and beverages, automotive products and motor oil, industrial and agricultural chemicals and cosmetics and toiletries. CPC manufactures single and multi-layer containers, primarily from high density polyethylene and polypropylene resins, ranging in size from two ounces to five gallons. Some of these multi-layer containers include a barrier layer of ethyl vinyl alcohol which renders the container oxygen tight and makes it suitable for use in food products which are subject to spoilage or deterioration if exposed to oxygen. CPC sells containers to national consumer products companies, including Clorox Company, Coca-Cola Foods, Colgate-Palmolive Company, Lever Brothers, Mobil Oil Corporation, Pennzoil Products Company, Procter & Gamble Company, Quaker Oats Company and Quaker State Oil Refining Corporation. CPC, in many cases, manufactures substantially all of a customer's container requirements for specific product categories or for particular container sizes. CPC has long-standing relationships with most of its customers and has long-term contracts or agreements with customers representing approximately 70% of its dollar sales volume.\nFerembal - The Company acquired a 68% interest in Ferembal in the fourth -------- quarter of 1989, increased its interest to 84% in August, 1991 and at December 31, 1994 owned 85% of Ferembal. Ferembal, headquartered in Paris, has five manufacturing plants located in each of the main agricultural regions of France. The Roye plant, located in Picardie, was built in 1964 and expanded substantially in 1968. Its three main divisions include coil\ncutting, printing and varnishing; the manufacture of ends and bodies; and assembly. There are five welded lines in operation at Roye and all industrial products are manufactured at this plant. The Moelan plant, located in Brittany, is set up along similar lines as the Roye plant with five welded lines. The Ludres plant, in eastern France, is Ferembal's largest facility. In addition to twelve presses and two easy-open end manufacturing units, Ludres has nine body assembly lines. Ferembal's research and development and technical service departments are also located at Ludres. The Veauche plant was built in 1982 to service southern France. Approximately 90% of the output of the two welded lines is \"passed through the wall\" to a customer for the canning of pet food. The Ville Neuve sur Lot plant was built in 1991 and went into production with a three piece can line in early 1992. A two piece can line went into production at this facility in mid-1992.\nFerembal is the second largest producer of food cans in France and also produces cans for pet foods and industrial products. Ferembal's products include three piece cans for food with over two hundred sets of specifications, two piece cans in several different diameters, easy open ends, \"hi-white enamel\" cans, and a large number of can products for industrial end uses. Ferembal's production for the food and pet food markets accounts for approximately 85% of its sales with remaining sales coming from cans produced for industrial products. Ferembal's customers are primarily vegetable and prepared food processors, pet food processors, and paint and other industrial can users.\nObalex - The Company, through Ferembal, owns 64% of the outstanding stock ------ of Obalex. Obalex is headquartered in a three building complex on a 5 acre site in Znojmo, Czech Republic, which also serves as its sole manufacturing facility. Obalex manufacturers both two and three piece cans for food which account for approximately 80% of its sales and a number of can products for industrial end users.\nDixie Union - The Company, through wholly owned subsidiaries, owns all of ----------- the outstanding stock of Dixie Union. Dixie Union is headquartered in Kempten, Germany and has subsidiary companies in France and the United Kingdom, which function as a sales, distribution and customer service network. Dixie Union manufactures three main product lines for the packaging industry: multi-layer shrink bags, composite plastic films and packaging machines and slicers. Most of Dixie Union's customers are in the food and pharmaceutical industries.\nOnena - The Company owns 57% of the stock of Onena located in Pamplona, ----- Spain. Onena manufactures plastic film and prints and laminates paper, plastic and foil packaging material for the food and snack food industries in Spain. In 1994 the Company merged its subsidiary, Industrias Gomariz S.A. (Ingosa) with Onena. Ingosa printed and laminated paper, plastic and foil packaging material for the food and snack food industries in Spain and was also located in Pamplona.\nLKB - The Company owns 100% of LKB, a consulting engineering firm, located --- in Syosset, New York. LKB provides services to clients in the fields of transportation, site, municipal, electrical and mechanical, and environmental engineering. Most of LKB's clients are public sector state and municipal agencies, utilities, financial institutions and developers. Most of its projects involve infra-structure design and rehabilitation, environmental reports and services, and utility substation design.\nOther Matters - The primary users of products manufactured by the Company ------------- are firms in the food and snack food, pet food, household chemical, motor oil and pharmaceutical industries.\nThe raw materials used in the production of plastic containers, cans and packaging films are readily available commodity materials and chemicals produced by a large number of manufacturers. It is the practice of the Company to obtain these raw materials from several sources in order to ensure an economical, adequate and timely supply.\nSome of the products manufactured by the Company are manufactured pursuant to license. With regard to composite films, a fully paid up license from the American National Can Company is in effect. With regard to shrink\nbags and film, a license from the American National Can Company is in effect. Present patents under this license expire at various times through 2000. The license will expire on the date the last of the licensed patents expire. This license is non-exclusive as to manufacture and sale of shrink bags and film in Europe and non-exclusive as to sales to the rest of the world. Sales may not be made in the Western Hemisphere. The Company does not believe these licenses are material to its packaging business taken as a whole.\nThe Company's business is seasonal insofar as the sales of Ferembal and Obalex to the vegetable packing industry is dependent on agricultural production and occurs primarily in the second and third quarters. The Company's remaining products are not seasonal.\nThe Company is not dependent upon a single customer or a few customers. Sales to no single customer exceeded 10% of the Company's consolidated revenues in 1994.\nAs of December 31, 1994, the Company's backlog was approximately $29,952,000 (compared to $19,868,000, at December 31, 1993). All backlog is expected to be filled within the current fiscal year. Ferembal, Obalex, and Plastic Containers, Inc. produce most of their products under open orders. As a result, none of the foregoing backlog is attributable to them.\nThe Company's business in total is highly competitive with a large number of competitors. The main competitors include Owens Illinois, Inc. and Graham Packaging with regard to plastic containers, CMB Packaging with regard to cans, W. R. Grace & Co. with regard to barrier shrink films, and Multi-Vac with regard to packaging machinery. The principal methods of competition are price, quality and service.\nThe amount spent on research and development activities amounted to approximately $12,461,000 in 1994, $12,862,000 in 1993 and $14,603,000 in 1992.\nThe number of persons employed by the Company as of December 31, 1994 and 1993 was 3,729 and 3,712, respectively.\n(d) Foreign and Domestic Operations -------------------------------\nSales to unaffiliated customers are set out below:\nInformation regarding the operating profit and the identifiable assets attributable to the Company's foreign operations is incorporated herein by reference to Note 16 of the Consolidated Financial Statements appearing in the Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - - -------------------\nThe Company believes its facilities are suitable, adequate, and properly sized to provide the capacity necessary to meet its sales. The Company's production facilities are utilized for the manufacture and storage of the Company's products. The extent of utilization in each of the Company's facilities varies based on a number of factors but primarily on sales and inventory levels for specific products. The location of the customer also affects\nutilization since shipment costs beyond a certain distance can make production of some products at a remote facility uneconomic. Seasonality affects utilization substantially at Ferembal and Obalex with very high utilization in the pre-harvest and harvest season and substantially lower utilization during the late fall and winter. The Company adjusts labor levels and capital investment at each of its facilities in order to optimize their utilization.\nThe Company's general corporate offices and the main production facility for LKB are located in Syosset, New York in a 25,000 square foot building owned by the Company. This steel and concrete block building was constructed in 1955 on a 2-1\/2 acre lot.\nCPC is headquartered in 19,812 square feet of leased office space in Norwalk, Connecticut. CPC also leases its technical center in Elk Grove, Illinois (78,840 sq. ft.), its accounting office space in Omaha, NE (5,489 sq. ft.), and sales offices in Cincinnati, Ohio (1,266 sq. ft.) and Houston, Texas (703 sq. ft.).\nThe following table sets forth the location and square footage of CPC's production facilities which are used for both manufacture and warehousing of finished goods:\nCPC owns the plants in Santa Ana, Fairfield, Oil City, Baltimore and Puerto Rico; all others are leased. As of December 31, 1994, CPC had a total of 114 production lines spread throughout its manufacturing facilities. The smallest plants have as few as two lines while the largest has eleven.\nFerembal is headquartered in 20,000 square feet of office space subject to a capital lease in Clichy, a suburb of Paris. Ferembal operates five manufacturing facilities in five locations in France. Ferembal owns a 384,000 square foot manufacturing facility on a 21 acre site in Roye for the production of food and industrial cans. Ferembal owns a 42,000 square foot manufacturing facility for the production of food cans at Veauche on a 5 acre site. The facility at Veauche is located next to a customer's plant and food can production is \"passed through the wall\" to the customer. Ferembal has a capital lease with regard to several buildings totaling 229,000 square feet on a 23 acre site in Ludres. In addition, Ferembal owns a 29,000 square foot building on a 3 acre site. These facilities are used for the manufacture of food cans and for research and development activities. Ferembal has a capital lease with regard to several buildings totaling 252,000 square feet on an 18 acre site in Moelan which are used for the manufacture of food cans. Ferembal operates a manufacturing facility for food cans in a 42,000 square foot building on a 4 acre site in Villeneuve sur Lot under a rental agreement. Each of the manufacturing facilities utilizes a portion of its building space for warehousing its finished goods.\nObalex is located in several buildings with approximately 182,000 square feet on an 5 acre site in Znojmo, Czech Republic. This facility is the sole manufacturing site for Obalex which also uses the complex for the storage of its finished goods.\nDixie Union is headquartered in a three-story, 108,000 square foot manufacturing facility on a 5 acre site in Kempten, Germany, leased through 2004. In addition, two small facilities are leased as sales and distribution centers in Milton Keynes, England and Redon, France.\nOnena owns two buildings totaling 173,000 square feet located on a 6.6 acre site in Pamplona, Spain, which also serve as its headquarters, manufacturing and warehousing facility. The former Onena headquarters and manufacturing facility consisting of 89,200 square feet on a 3.7 acre site is expected to be sold.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - - --------------------------\nThe Company's subsidiaries are defendants in a number of actions which arose in the normal course of business. In the opinion of management, the eventual outcome of these actions will not have a significant 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 quarter ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER - - -------------------------------------------------------------------------- MATTERS - - -------\nThe information required by this item is incorporated herein by reference to the section entitled \"Common Stock Prices and Related Matters\" of the Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA(1) - - -----------------------------------\n(1) In thousands, except per share amounts and current ratio.\n(2) In 1993, includes sales of $10,682 and net income of $238 related to the purchase of Obalex. In 1991, includes sales of $17,030 and a net loss of $1,045 related to the purchase of PCI.\n(3) Includes a charge for the cumulative effect of an accounting change of $262 ($.08 per share both primary and fully-diluted) and an extraordinary charge of $108 ($.03 per share both primary and fully-diluted) in 1994. Includes income for the cumulative effect of an accounting change of $460 ($.15 per share primary and $.14 per share fully-diluted) and an extraordinary charge of $1,502 ($.49 per share primary and $.44 per share fully-diluted) in 1992. Includes income for an extraordinary item of $22 ($.01 per share both primary and fully-diluted) in 1990.\n(4) The 1991 weighted average shares outstanding include 1,020 shares and 255 warrants to purchase shares sold in June 1991 for net proceeds of $29,453. The 1990 weighted average shares outstanding include 460 shares sold in January 1990 for net proceeds of $6,756.\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 incorporated herein by reference to the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in the Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - - ----------------------------------------------------\nThe information required by this item is incorporated by reference to the Company's consolidated financial statements and related notes, together with the independent auditors' report in the Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - - ------------------------------------------------------------------------ FINANCIAL DISCLOSURE - - --------------------\nThere have been no changes in nor disagreements with the Company's accountants on accounting and financial disclosure during the twenty-four month period ended December 31, 1994.\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 of the registrant, will be included under the caption \"Election of Directors\" of a definitive Proxy Statement to be dated March 28, 1994 which will be filed with the Commission pursuant to Regulation 14A and is hereby incorporated into this report by this reference.\nExecutive officers of the registrant include Messrs. Donald J. Bainton and Abdo Yazgi who are also directors of the registrant and for whom information required by this item is included in the Proxy Statement as previously mentioned.\nInformation for other executive officers, is as follows:\n(1) The term of office of all executive officers is indefinite, at the pleasure of the Board of Directors.\nThe business experience of each executive officer is as follows:\nMr. Andreas has served as Vice President of Manufacturing since April 1992. Prior to that time, he was an independent business consultant. Prior to his retirement in 1988, Mr. Andreas was employed by the former Continental Can Company, Inc. for 33 years, most recently as General Manager.\nMr. L'Hommedieu has served as Treasurer or Assistant Treasurer of the Company and its subsidiary, Lockwood, Kessler & Bartlett, Inc., since 1963.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - - --------------------------------\nThe information required by this item is included under the caption \"Executive Compensation\" of a definitive Proxy Statement to be dated March 28, 1995 which will be filed with the Commission pursuant to Regulation 14A and is hereby incorporated into this report by this reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - - -----------------------------------------------------------------------\nThe information required by this item is included under the caption \"Stock Ownership\" of a definitive Proxy Statement to be dated March 28, 1995 which will be filed with the Commission pursuant to Regulation 14A and is hereby incorporated into this report by this reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - - -------------------------------------------------------\nThe information required by this item is included under the caption \"Transactions with Management\" of a definitive Proxy Statement to be dated March 28, 1995 which will be filed with the Commission pursuant to Regulation 14A and is hereby incorporated into this report by this reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - - --------------------------------------------------------------------------\n(a) 1. Financial Statements:\nConsolidated Balance Sheets as of December 31, 1994 and 1993 Consolidated Statements of Earnings for the years ended December 31, 1994, 1993, and 1992 Consolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992\nThe above financial statements are included under Item 8 or Part II of this report.\n2. Financial Statement Schedules:\nIII Condensed Financial Information of Registrant........ p. 11 VIII Allowance for Doubtful Accounts...................... p. 13\nAll other schedules are omitted because they are not applicable, not required, or the information is given in the financial statements or the notes thereto.\n3. Exhibits Required:\n* Management contract or compensatory plan or arrangement.\n(1) These documents have been previously filed with the Commission as Exhibits to 1992 Quarterly Reports on Form 10-Q for Plastic Containers, Inc.\n(2) These documents have previously been filed with the Commission as Exhibits to 1993 Quarterly Reports on Form 10-Q for Continental Can Company, Inc.\nAll other items for which provision is made in the applicable regulations of the Securities and Exchange Commission have been omitted as they are not required under the related instructions or they are inapplicable.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended December 31, 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 CAN COMPANY, INC.\nBy: \/s\/ Abdo Yazgi Date: March 7, 1994 --------------- -------------- Abdo Yazgi, Executive Vice President (Principal Financial & 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.\nSchedule III - Condensed Financial Information of Registrant\nContinental Can Company, Inc. Balance Sheets Years Ended December 31, 1994 and 1993\n(a) See Note 9, Items (a) and (b) of Notes to Consolidated Financial Statements of Continental Can Company, Inc. and Subsidiaries. At December 31, 1993, current liabilities include $1,164 of Convertible Subordinated Debentures due in 1994. At December 31, 1994, current liabilities include $158 of current installments of long term debt.\nContinental Can Company, Inc. Statements of Earnings Years Ended December 31, 1994, 1993 and 1992\n(b) Includes for 1994 an extraordinary charge of $108 relating to the extinguishment of debt and a charge of $262 relating to the cumulative effect of adopting SFAS No. 112. Includes for 1992 an extraordinary charge of\n$1,502 relating to the retirement of a promissory note and a benefit of $460 relating to the cumulative effect of adopting SFAS No. 109.\nSchedule III - Condensed Financial Information of Registrant (Continued)\nContinental Can Company, Inc. Statements of Cash Flows Years Ended December 31, 1994, 1993 and 1992\nContinental Can Company, Inc. and Subsidiaries Schedule VIII - Allowance for Doubtful Accounts Years Ended December 31, 1994, 1993 and 1992\n(1) Represents uncollectible accounts written-off.\n(2) Represents $418 from the consolidation of acquired subsidiary in 1993.\nEXHIBITS ATTACHED: ------------------\nSubsidiaries of the Registrant\nIndependent Auditors' Report on Schedules\nConsent of Independent Auditors\nAmendment No. 1 to Revolving Credit and Term Loan Agreement\n1995 Restricted Stock Compensation Plan\nFinancial Data Schedule\n1994 Annual Report to Stockholders","section_15":""}
{"filename":"835582_1994.txt","cik":"835582","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral\nHomeland Holding Corporation (\"Holding\"), through its wholly-owned subsidiary, Homeland Stores, Inc. (\"Homeland,\" and, together with Holding, the \"Company\"), is the leading supermarket chain in the Oklahoma, southern Kansas and Texas Panhandle region. As of April 14, 1995, the Company operated 104 stores throughout these markets as well as a 659,000 square foot warehouse and distribution center in Oklahoma City. On April 21, 1995, the Company sold 29 of its stores and its warehouse and distribution center to Associated Wholesale Grocers, Inc. (\"AWG\") pursuant to an Asset Purchase Agreement dated as of February 6, 1995 (the \"Purchase Agreement\") for a cash purchase price of approximately $75 million including inventory. At the closing, the Company and AWG also entered into a seven-year supply agreement, whereby the Company became a retail member of the AWG cooperative and AWG became the Company's primary supplier. The transactions between the Company and AWG are referred to herein as the \"AWG Transaction.\" See \"Business--AWG Transaction.\"\nThe Company estimates that in 1994 it accounted for approximately 27% of total supermarket sales over its entire market region through the operation of 111 stores. Approximately 58% of the Company's stores operated by the Company after the AWG Transaction are located in its three major metropolitan areas, Oklahoma City, Tulsa and Amarillo.\nThe Company's executive offices are located at 400 N.E. 36th Street, Oklahoma City, Oklahoma 73105, and its telephone number is (405) 557-5500.\nBackground\nThe Company was organized in 1987 by a group of investors led by Clayton, Dubilier & Rice, Inc. (\"CD&R\"), a private investment firm specializing in leveraged acquisitions with the participation of management, for the purpose of acquiring substantially all of the assets and assuming specified liabilities of the Oklahoma division (the \"Oklahoma Division\") of Safeway Inc. (\"Safeway\") (the \"Acquisition\"). The stores changed their name to Homeland in order to highlight the Company's regional identity. A majority of the Company's current management (excluding store managers) consists of key executives of the Oklahoma Division and currently owns approximately 6.1% of the outstanding common stock of Holding.\nPrior to the Acquisition, the Company did not have any significant assets or liabilities or engage in any activities other than those incident to the Acquisition. Holding owns all of the outstanding capital stock of Homeland and has no other significant assets. The Clayton & Dubilier Private Equity Fund III Limited Partnership (\"C&D Fund III\"), a Connecticut limited partnership managed by CD&R, currently owns 34.1% of Holding's outstanding Class A Common Stock, par value $.01 per share (including redeemable Class A Common Stock, the \"Common Stock\"). The Clayton & Dubilier Private Equity Fund IV Limited Partnership (\"C&D Fund IV\"), a Connecticut limited partnership also managed by CD&R, currently owns 38.4% of the Class A Common Stock.\nOn April 21, 1995, the Company made an offer to repurchase shares of its Common Stock owned by certain officers and employees of the Company at a cash purchase price of $0.50 per share, plus a warrant equal to the number of shares purchased with an exercise price of $0.50. However, such repurchases shall not exceed $600,000 in the aggregate (net of amounts to be repaid in respect of loans from the Company) and individual repurchases shall not exceed any outstanding loan balance that the officers or employees may have related to their purchase of Common Stock.\nBusiness Strategy\nFollowing the Acquisition, Homeland adopted a business strategy which was designed to maintain and improve its market leadership in its operating area. The Company's business strategy from 1987 through 1993 involved: (a) substantial investment to upgrade and remodel the existing store network and to build or acquire additional stores, which could be serviced by Homeland's existing warehouse and distribution center; and (b) adoption of a value-oriented merchandising concept combining a flexible high-low pricing structure (i.e., pricing of advertised or promotional items below the store's regular price and at or below the price offered by the store's competitors while allocating prime shelf space to high margin items) with a wide selection of products and an emphasis on quality and service. Increased advertising and promotion were used to expand the Company's customer base. The Company's decision to commit significant financing and human resources to upgrade and remodel its existing stores marked a sharp turn-around for the supermarket business that had constituted Safeway's Oklahoma Division.\nThe Company's business has been adversely affected in recent years by the entry of new competition into the Company's key markets, which has resulted in a decline in the Company's comparable store sales. The Company was unable to effectively respond to this increased competition because (i) the high labor costs associated with the Company's unionized workforce made it difficult for the Company to price its goods competitively with competitors (none of which has a unionized workforce), and (ii) the high fixed overhead costs associated with its warehouse operation made the closure of marginal and unprofitable stores financially prohibitive.\nIn the fourth quarter of 1994, the Company developed a plan to improve its financial position and to address the operating problems discussed above. In December 1994, the Company hired James A. Demme to be the Company's new President and Chief Executive Officer. Mr. Demme has over 35 years of experience in wholesale and retail food distribution, most recently as Executive Vice President of Retail Operations for Scrivner, Inc. Mr. Demme and his management team have developed and have begun to implement a more effective strategy for responding to competitive pressures in the marketplace, including (i) exploiting the advantages the Company has over its competitors, such as convenience of store locations and variety of offerings, (ii) increasing the offering of competitively-priced, private label products, (iii) improving advertising and merchandising and coordinating marketing efforts, (iv) increasing sales of perishables and (v) reducing overhead and other costs in conjunction with the AWG Transaction.\nThe AWG Transaction is an important step in the Company's effort to complete an operational restructuring that should allow the Company to reduce its debt burden and fixed operating costs and improve its financial performance.\nFurthermore, also in late 1994 the Company's new management team developed a plan to close certain marginal and unprofitable stores. Such a plan is now financially feasible because of the sale of the warehouse and the elimination of the high fixed costs associated with the warehouse operation. The Company closed one store in 1994 and seven stores during the first quarter of 1995 and expects to close an additional eight stores by the end of 1995.\nAlso in connection with the AWG Transaction, the Company became a member of the AWG cooperative. The Company believes that its membership in the AWG cooperative will benefit the Company in a number of ways: (i) the Company will be able to increase its purchases of private label lines, which will allow it to improve mix and gross profits; (ii) as AWG's largest customer, the Company may receive special product purchases and may participate in dedicated support programs; and (iii) the Company will have access to AWG's store systems, which will allow the Company to manage its business strategically on a store-by-store and regional basis. In addition, the Company will also receive the benefit of membership rebate and patronage programs available to all AWG members as well as certain quarterly cash payments from AWG. See \"Business--Warehousing and Distribution.\"\nFor additional information, see also \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources.\"\nAWG Transaction\nOn February 6, 1995, the Company and AWG entered into the Purchase Agreement, pursuant to which the Company agreed to sell 29 of its stores (the \"Purchased Stores\") and its warehouse and distribution center to AWG for a purchase price of $45 million, plus the value of the inventory at the Purchased Stores and the warehouse (estimated to be approximately $30 million) subject to certain possible purchase price adjustments. The closing of the sale occurred on April 21, 1995.\nAWG is a buying cooperative which sells groceries on a wholesale basis to its retail member stores. AWG has 716 member stores located in a nine-state region and is the nation's fifth largest wholesale distributor, with approximately $2.6 billion in revenues in 1994.\nThe Purchase Agreement requires AWG to assume, or provide certain undertakings with respect to, certain contracts and lease obligations and pension liabilities of the Company. The AWG sale was subject to the satisfaction of certain conditions precedent, including, without limitation, (i) the Company's receipt of the required consents under the Senior Notes (as hereafter defined under \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\") and (ii) the execution and delivery of the supply agreement between the Company and AWG described below (See \"Business--Warehousing and Distribution\").\nThe Company estimates that net proceeds from the AWG Transaction will be approximately $37.2 million, approximately $25.0 million of which will be allocated to the Senior Notes and approximately $12.2 million of which will be allocated to indebtedness under the Revolving Credit Agreement (as hereafter defined under \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\"). The remaining proceeds from the AWG Transaction will be (i) used to pay certain costs, expenses and liabilities required to be paid in connection with the AWG Transaction or (ii) deposited into escrow pending reinvestment by the Company or application against a subsequent offer to redeem the Senior Notes. Under the Senior Note Indenture (as hereafter defined under \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\"), the Company is required to apply the net proceeds allocable to the Senior Notes to an offer to redeem the Senior Notes on a pro rata basis. (See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\".)\nThe purposes of the AWG Transaction are: (i) to reduce the Company's borrowed money indebtedness in respect of the Senior Notes and under the Revolving Credit Agreement by approximately $37.2 million in the aggregate; (ii) to have AWG assume, or provide certain undertakings with respect to, certain contracts and leases and certain pension liabilities of the Company; (iii) to sell the Company's warehouse and distribution center, which will eliminate the high fixed overhead costs associated with the operation of the warehouse and distribution center and thereby permit the Company to close marginal and unprofitable stores; and (iv) to obtain the benefits of becoming a member of the AWG cooperative, including increased purchases of private label products, special product purchases, dedicated support programs and access to AWG's store systems.\nHomeland Supermarkets\nThe Company's current network of stores features three basic store formats. Homeland's conventional stores range from 12,000 to 35,000 total square feet and carry the traditional mix of grocery, meat, produce and variety products. These stores contain more than 20,000 stock keeping units, including food and general merchandise. Sales volumes of conventional stores range from $60,000 to $150,000 per week. Homeland's superstores range in size from 35,000 to 50,000 total square feet and offer, in addition to the traditional departments, two or more specialty departments. Sales volumes of superstores range from $80,000 to $280,000 per week. Homeland's combo store format includes stores larger than 50,000 total square feet and was designed to enable the Company to expand shelf space devoted to general merchandise. Sales volume of combo stores range from $130,000 to $345,000 per week. The Company's new stores and certain remodeled locations have incorporated Homeland's new, larger superstore and combo formats.\nOf the 67 stores retained and operated by the Company following the sale to AWG (excluding 16 stores which the Company has closed in 1994 and 1995 or expects to close in 1995), 11 are conventional stores, 43 are superstores and 13 are combo stores.\nThe chart below summarizes Homeland's store development over the last three years:\nFiscal Year Ended 12\/31\/94 01\/01\/94 01\/02\/93 * Average sales per store (in millions)............... $ 7.1 $ 7.2 $ 7.3\nAverage total square feet per store................... 34,700 34,700 34,300\nAverage sales per square foot................. $205 $208 $213\nNumber of stores: Stores at start of period... 112 113 114 Stores remodeled............ 10 3 0 New stores opened........... 0 1 1 Stores acquired............. 0 0 0 Stores sold or closed....... 1 2 2 Stores at end of period..... 111 112 113\nSize of stores: Less than 25,000 sq. ft..... 24 24 26 25,000 to 35,000 sq. ft..... 38 39 40 35,000 sq. ft. or greater... 49 49 47\nStore formats: Conventional................ 29 29 28 SuperStore.................. 65 66 71 Combo....................... 17 17 14\n* 53 week reporting period\nMerchandising Strategy and Pricing\nThe Company's merchandising strategy emphasizes competitive pricing through a high-low pricing structure, as well as Homeland's leadership in quality product and service, selection, convenience and specialty departments with a focus on perishable products (i.e., meat, produce, bakery and seafood). The Company's strategy is to price competitively with each conventional supermarket operator in each market area. In areas with discount store competition, the Company attempts to be competitive on high-volume, price sensitive items. The Company's in-store promotion strategy is to offer all display items at a lower price than the store's regular price and at or below the price offered by the store's competitors. The Company also currently offers double coupons, with some limitations, in all areas in which it operates. In addition, Homeland's stores utilize a shelf management scanner-driven program which allocates shelf space based upon specific unit sales. This scanner program provides adequate information to evaluate shelf stock to avoid excessive inventories. The program allows allocation of products that are the best sellers and the products that contribute the greatest gross profit dollars, in each commodity group, to prime eye level shelves.\nCustomer Service\nHomeland stores provide friendly and efficient customer services which emphasize, among other things, quick check out services and many stores offer additional services such as postal, pharmacy, video rental, check cashing and money orders. Some of the stores also offer in-store banking facilities and automated teller machines. Homeland helps to attract and retain its customers by providing a high level of customer service in clean, well-stocked stores with quality products.\nAdvertising and Promotion\nThe Company's advertising strategy is designed to enhance its value-oriented merchandising concept and emphasize its reputation for fast, friendly service, variety and quality. Accordingly, Homeland is focused on presenting itself in the media as a competitively-priced, promotions oriented operator that offers value to its customers and an extensive selection of high quality merchandise in clean, attractive stores. This strategy allows the Company to accomplish its marketing goals of attracting new customers and building loyalty with existing customers.\nAn element of the Company's plan to improve its financial position includes improving its advertising and merchandising and coordinating marketing efforts by redesigning the advertising circulars to improve the promotions of advertised specials and organizing the in-store presentation of these items.\nThe Company currently utilizes a broad range of print and broadcast advertising in the markets it serves, including newspaper advertisements, advertising inserts and circulars, television and radio commercials and promotional campaigns that cover substantially all of the markets it serves. Gross advertising expenses were $13.6 million in fiscal 1994, $14.1 million in fiscal 1993 and $14.5 million in fiscal 1992. Homeland receives co-op advertising reimbursements from major vendors which reduces its gross advertising expenses.\nProduct Selection\nThe Company carries nationally advertised brands and a wide selection of private label products. Part of the Company's plan to improve its financial position involves increasing its offering of competitively-priced private label products and increasing sales of perishables. All stores carry a full line of meat, dairy, produce, frozen food, health and beauty aids and selected general merchandise. As of April 14, 1995, approximately 76% of the stores have service delicatessens and\/or bakeries and approximately 52% have in- store pharmacies. In addition, some stores provide additional specialty departments that offer ethnic food, fresh and frozen seafood, floral services and salad bars.\nWarehousing and Distribution\nUntil the consummation of the AWG Transaction, the Company supplied approximately 75% of the products sold in its supermarkets from its 659,000 square foot warehouse and distribution facility, which included 241,000 square feet of refrigerated space for storing produce and meats as well as a large freezer section for vegetables, ice cream and other frozen products. As part of the AWG Transaction, the Company sold its warehouse and distribution center to AWG and entered into a seven year supply agreement, pursuant to which the Company became a retail member of the AWG cooperative and AWG became the Company's primary supplier.\nPursuant to the supply agreement, AWG will supply products to the Company at the lowest prices and on the best terms available to AWG's retail members from time to time. In addition, the Company will (i) be eligible to participate in certain cost-savings programs available to AWG's other retail members and (ii) be entitled to receive (a) certain member rebates and refunds based on the dollar amount of the Company's purchases from AWG's warehouse and (b) quarterly cash payments from AWG, up to a maximum of approximately $1.3 million per fiscal quarter, based on the dollar amount of the Company's purchases from AWG's warehouse during such fiscal quarter.\nThe Company will purchase goods from AWG on an open account basis. AWG requires that each member's account be secured by a letter of credit or certain other collateral, in an amount based on such member's estimated weekly purchases through the AWG warehouse. The Company's open account with AWG is secured by a $10 million letter of credit (the \"Letter of Credit\") issued in favor of AWG by one of the banks party to the Amended and Restated Revolving Credit Agreement (as hereafter defined under \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\"). In addition, the Company's obligations to AWG are secured by a first lien on all \"AWG Equity\" owned from time to time by the Company, which includes, among other things, AWG membership stock, the Company's right to receive quarterly payments and certain other rebates, refunds and other credits owed to the Company by AWG (including members deposit certificates, patronage refund certificates, members savings, direct patronage or year-end patronage and concentrated purchase allowances).\nThe amount of the Letter of Credit may be decreased on a biannual basis upon the request of the Company (i) based on the Company's then-current average weekly volume of purchases and (ii) by an amount equal to the face amount of the Company's issued and outstanding AWG patronage refund certificates. In the event that the Company's open account with AWG exceeds the amount of the Letter of Credit plus any other AWG Equity held as collateral for the Company's open account, AWG is not required to accept orders from, or deliver goods to, the Company until the amount of the Letter of Credit has been increased to make up for any such deficiency.\nUnder the supply agreement, AWG has certain \"Volume Protection Rights,\" including (i) the right of first offer (the \"First Offer Rights\") with respect to (a) proposed sales of stores to be owned or operated by the Company after the closing of the sale (the \"Retained Stores\") and, under certain circumstances, certain other stores which the Company has closed, or expects to close, during 1995 and (b) proposed transfers of more than 50% of the outstanding stock of the Company or Holding to an entity primarily engaged in the retail or wholesale grocery business, (ii) the Company's agreement not to compete with AWG as a wholesaler of grocery products during the term of the supply agreement, and (iii) the Company's agreement to dedicate the Retained Stores to the exclusive use of a retail grocery facility owned by a retail member of AWG (the \"Use Restrictions\"). The Company's agreement not to compete and the Use Restrictions are terminable with respect to a particular Retained Store upon the occurrence of certain events, including the Company's compliance with AWG's First Offer Rights with respect to proposed sales of such store. In addition, the supply agreement provides AWG with certain purchase rights in the event the Company closes 90% or more of the Retained Stores.\nTransportation\nIn March 1992, the Company entered into a transportation agreement (the \"Transportation Agreement\") with Drake Refrigerated Lines, Inc. (\"Drake\"). Pursuant to the Transportation Agreement, the Company sold substantially all of its trailers and certain non-material related equipment at fair market value to Drake, which then provided all transportation services for Homeland products through a network of independent drivers. The Transportation Agreement has a five-year term and is terminable by either party on six months' notice and upon certain other conditions. In conjunction with the AWG Transaction, the Company's obligations under the Transportation Agreement were assumed by AWG.\nSupply of Dairy Products\nThe Company previously produced private-label milk, water, juice and ice cream at two owned and managed facilities located in Oklahoma City. In November 1993, the Company sold certain of the Company's milk and ice cream processing equipment and certain other assets and inventory relating to its milk and ice cream plants to Borden, Inc. (\"Borden\"). In connection with the sale, the Company entered into a seven- year supply agreement with Borden under which Borden was to supply all of the Company's requirements for most of its dairy, juice and ice cream products and the Company agreed to purchase minimum volumes of products. The Company recognized a gain on the sale of such personal property in the amount of $2.6 million in 1993 and received a $4 million payment in connection with the Borden supply agreement which was to be recognized over the seven-year term of the Supply Agreement.\nIn December 1994, the Company entered into a settlement agreement with Borden whereby Borden ceased supplying the Company in April 1995. As part of the settlement agreement, the Company repaid $1.6 million plus interest in December 1994 and $1.7 million plus interest in April 1995.\nThe Company has made arrangements for Farm Fresh, Inc. to begin supplying its dairy and ice cream requirements in April 1995. Farm Fresh, Inc. is a cooperative and 1% of the Company's purchases will be rebated to the Company at the end of each year in the form of stock in Farm Fresh,Inc..\nEmployees and Labor Relations\nAt March 31, 1995, Homeland had a total of 5,938 employees, of whom 3,504 or approximately 59% were employed on a part-time basis. Homeland employs 5,499 and 234 persons in its supermarket operations and supply and distribution operations, respectively. The remaining employees are corporate and administrative personnel.\nHomeland is the only unionized grocery chain in its market areas and approximately 90% of the Company's employees are unionized, represented primarily by the United Food and Commercial Workers of North America (\"UFCWNA\"). In 1993, the UFCWNA ratified a modified collective bargaining agreement with the Company (the \"Labor Agreement'). The term of the Labor Agreement is from December 1993 through October 1996. The Labor Agreement provides for average wages and benefits for store employees of $9.25 per hour compared to the average wages and benefits before modification of $10.47 per hour. Management estimates that this wage reduction will result in annualized savings of approximately $4.5 million less anticipated bumping costs of $1.3 million for a net savings of $3.2 million for the remaining 67 stores in each year of the Labor Agreement through October 1996. Homeland's average wages and benefits continue to exceed wages and benefits paid by its competitors by an estimated average of $2.40 per hour. This estimated average could increase by as much as 10% following the AWG Transaction due to the effects of bumping. Such higher labor costs is one of the reasons the Company has not been able to remain competitive and entered into the AWG Transaction.\nIn conjunction with the sale to AWG, three class grievances have been filed by the UFCWNA and have been submitted to binding arbitration under the terms of the Labor Agreement. The grievances involve: (i) the question of whether a special termination pay provision in the Labor Agreement is triggered by the sale to AWG; (ii) the application of the severance pay provision in the Labor Agreement; and (iii) calculation of accrued but unused vacation pay due employees at the time of termination. The maximum aggregate amount being sought pursuant to the grievances is $5.1 million. The arbitrations will be held during May through July. The Company believes that its position on these grievances will be upheld by the arbitrator and that the disposition of these grievances through arbitration will not have a material adverse effect on the Company's financial position.\nWarehouse personnel are members of the International Brotherhood of Teamsters (the \"Teamsters\") and wages paid to these employees are on parity with those paid by other similar unionized warehouse operations in the area. In November 1992, the Company signed a three and one-half year contract with the Teamsters resulting in a 25 cent per hour wage increase effective July 1994 and an increase in the pension contribution per employee of $10 per week effective November 1992, an additional $4 per week effective November 1993, and another $2 per week effective November 1994. Homeland terminated the employment of all Teamsters on April 21, 1995.\nEffective January 1, 1989, the Company implemented a stock appreciation rights (\"SAR\") plan for certain of its hourly union employees and its non-union hourly and salaried employees. Effective as of November 4, 1989, the Company implemented a similar SAR plan for its hourly Teamster employees. A participant in the SAR plans is granted at specified times \"appreciation units\" which, upon the occurrence of certain triggering events, entitle the participant to receive cash payments equal to the product of the number of appreciation units then vested in such participant multiplied by the increase in value of a share of the Common Stock over $1.00 as determined in good faith by the Board of Directors. Trigger events include the sale or exchange of all or substantially all of the assets or stock of Homeland or Holding, the liquidation or dissolution of Homeland or Holding, the sale to the public of 20% or more of the Common Stock or of the common equity of Homeland and the sale, other than to Homeland or Holding, by C&D Fund III of more than 2,925,000 shares of Common Stock. The sale to AWG will not constitute a trigger event under any of the SAR plans. Under the SAR plans, Homeland may grant up to 200 appreciation units per employee to part-time employees, 500 units to full-time employees, 750 units to supervisors and 1,000 units to managers (e.g., store managers); provided that Homeland may not grant more than an aggregate of 1,939,500 appreciation units under all union and non-union SAR plans. Assuming all units were vested under the SAR plans, such units would represent approximately 5% of the equivalent equity in the Company.\nComputer and Management Information Systems\nEffective October 1, 1991, the Company entered into a ten-year agreement with K-C Computer Services, Inc. (a subsidiary of Kimberly-Clark Company), providing for the outsourcing of Homeland's management information system and electronic data processing functions. Pursuant to the outsourcing agreement, K-C Computer Services, Inc. assumed substantially all of the Company's existing hardware and software leases and related maintenance agreements. The outsourcing agreement provides for minimum annual service charges, increasing over the term of the agreement, as well as other variable charges. Based on current estimates, future minimum annual service charges under the ten-year outsourcing agreement as of December 31, 1994 were in the aggregate amount of $30.7 million. The agreement is cancelable by either party subject to a penalty that declines over the term of the agreement. In conjunction with the AWG Transaction, AWG has undertaken approximately 52% of the annual service charges of the outsourcing agreement incurred to June 1, 1997. The Company will remain liable for any service charges incurred after June 1, 1997. The Company and AWG have agreed to use their best efforts to terminate the outsourcing agreement by January 1, 1997, and arrange alternative service for the Company. The Company can terminate the outsourcing agreement at any time by payment to K-C Computer Services, Inc. of an early termination penalty. If the outsourcing agreement is terminated prior to June 1, 1997, AWG will be responsible for payment of approximately 52% of the early termination penalty. If the outsourcing agreement is terminated during 1997, the Company's portion of the early termination penalty will be $954,000.\nThe Company has installed laser-scanning checkout systems in all of the 67 retained stores. The Company utilizes the information collected through its scanner systems to track product movement and inventory levels and to coordinate purchasing. Coupon scanning software upgrades were added in 1993 for all stores which have scanner systems. This software reduces the expense related to coupons by verifying that the coupon presented was for the product purchased and reduces clerical errors. A new store labor scheduling system was also installed in 1993 that determines the required hours to be worked based on engineered standards combined with sales projections and traffic patterns.\nCompetition\nAlthough the supermarket business is highly competitive, as the only statewide operator of supermarkets in its entire market region, Homeland occupies a leading position in substantially all of the markets it serves. The Company's management believes that Homeland's principal competitive advantages include significant economies of scale for advertising, excellent store locations and continuity with experienced store management. The market in which Homeland competes is highly fragmented by many small independent operators.\nThe Company's business has been adversely affected in recent years by the entry of new competition into the Company's key markets, which has resulted in a decline in the Company's comparable store sales. For example, in 1994, there were 14 competitive openings in the Company's market areas (including 11 new Wal-Mart supercenters, 2 new Albertsons Inc. stores and 1 new Mega Market store). The 1994 competitive openings directly affected 28 of the Company's stores, where average weekly sales decreased by 10.9% as compared to 1993, including 19 of the 67 Retained Stores, where average weekly sales decreased by 10.7% as compared to 1993. By contrast, average weekly sales of the remaining 48 Retained Stores increased in 1994 by 2.7% as compared to 1993. The Company was unable to effectively respond to the competitive openings because (i) the high labor costs associated with the Company's unionized workforce made it difficult for the Company to price its goods competitively with competitors (none of which has a unionized workforce), and (ii) the high fixed overhead costs associated with its warehouse operation made the closure of marginal and unprofitable stores financially prohibitive.\nTrademarks, Trade Names and Licenses\nDuring the transition from \"Safeway\" to \"Homeland\" the Company has been able to generate a substantial amount of familiarity with the \"Homeland\" name. The Company continues to build and enhance this name recognition through advertising and annual birthday and anniversary promotional campaigns. The \"Homeland\" name is considered material to the Company's business and is registered for use as a service mark and trademark. Homeland has received federal and state registrations of the \"Homeland\" mark as a service mark and a trademark for use on certain products. The Company also received a federal registration of the service mark \"A Good Deal Better\" in early 1994.\nDuring 1990, Homeland began developing a private label line of products which currently includes over 350 items. The line includes every major category in the Company's stores, including dairy products, meat, frozen foods, canned fruits and vegetables, eggs and plastic wrap. As a result of the AWG Transaction, Homeland intends to further improve the private label offerings.\nRegulatory Matters\nHomeland is subject to regulation by a variety of local, state and federal governmental agencies, including the United States Department of Agriculture, state and federal pharmacy regulatory agencies and state and local alcoholic beverage and health regulatory agencies. By virtue of this regulation, Homeland is obligated to observe certain rules and regulations, violation of which could result in suspension or revocation of various licenses or permits held by Homeland. In addition, most of Homeland's licenses and permits require periodic renewals. Homeland has experienced no material difficulties with respect to obtaining or renewing its regulatory licenses and permits.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOf the 111 supermarkets operated by Homeland at December 31, 1994, 19 are owned and the balance are held under leases which expire at various times between 1995 and 2017. Most of the leases are subject to six five-year renewal options. Out of 92 stores with leases, only eleven have terms (including option periods) of fewer than 20 years remaining. Most of the leases require the payment of taxes, insurance and maintenance costs and many of the leases provide for additional contingent rentals based on sales. The Company also leases its executive offices and warehouse and distribution center in Oklahoma City and owns the land and buildings in Oklahoma City in which its milk and ice cream plants were located. Substantially all of the Company's facilities are subject to mortgages securing the Company's Senior Notes (as hereinafter defined). See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\" No individual store operated by Homeland is by itself material to the financial performance or condition of Homeland as a whole. The average rent per square foot under Homeland's existing leases is $3.77 (without regard to amortization of beneficial interest). Management believes that many of its existing leases, depending on the location of the store, provide the Company rents which are below the current market rate.\nOf the 67 stores remaining after the AWG Transaction and closing of certain stores, 11 are owned and 56 are leased. Of those stores which are leased, eight have terms (including option periods) of fewer than 20 years remaining. The average rent per square foot for these 67 stores under Homeland's existing leases is $3.90 (without regard to amortization of beneficial interest).\nOn approximately June 12, 1995, the Company plans to relocate its executive offices to 2601 Northwest Expressway, Suite 1100 E, Oklahoma City, Oklahoma 73112. The Company will be leasing the new executive offices.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is party to various lawsuits and proceedings in the ordinary course of its operations relating to alleged personal injuries and other claims. None of the proceedings pending against the Company or, to the knowledge of management, threatened against the Company, is expected to have a material effect on the Company's financial condition or results of operations.\nThe Internal Revenue Service (\"IRS\") concluded in December 1993 a field audit of the Company's income tax returns for the fiscal years 1990, 1991 and 1992. On January 31, 1994, the IRS issued a Revenue Agent's Report for those fiscal years proposing adjustments that would result in additional taxes in the amount of $1.6 million (this amount is net of any available operating loss carryforwards, which would be eliminated under the proposed adjustment). The Company filed its protest to the IRS Appeals Office on June 14, 1994. The IRS Appeals Office is currently in the process of reviewing the Company's protest. The major proposed adjustment involves the allocation of the initial purchase price of the Company to inventory. The Company believes that it has meritorious legal defenses to the IRS adjustments and intends to vigorously protest the assessment. Management has analyzed all of these matters and has provided for, in accordance with generally accepted accounting principles, amounts which it currently believes are adequate.\nIn conjunction with the sale to AWG, three class grievances have been filed by the UFCWNA and have been submitted to binding arbitration under the terms of the Labor Agreement. The grievances involve: (i) the question of whether a special termination pay provision in the Labor Agreement is triggered by the sale to AWG; (ii) the application of the severance pay provision in the Labor Agreement; and (iii) calculation of accrued but unused vacation pay due employees at the time of termination. The maximum aggregate amount being sought pursuant to the grievances is $5.1 million. The arbitrations will be held during May through July. The Company believes that its position on these grievances will be upheld by the arbitrator and that the disposition of these grievances through arbitration will not 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\nDuring the quarter ended December 31, 1994, the Company obtained a consent to a waiver from United States Trust Company of New York, as trustee for the holders of the Senior Notes, waiving compliance with certain financial covenant requirements in effect as of fiscal year ended December 31, 1994. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources\" for information regarding the Company's consent solicitation in April 1995.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThere is no established public trading market for the Common Stock, the only class of common equity of Holding currently issued and outstanding.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe following table sets forth selected consolidated financial data of the Company which have been derived from financial statements of the Company for the 52 weeks ended December 31, 1994 and January 1, 1994, the 53 weeks ended January 2, 1993, the 52 weeks ended December 28, 1991 and December 29, 1990 respectively, which have been audited by Coopers & Lybrand, L.L.P. See Notes to Selected Consolidated Financial Data for additional information.\nThe selected consolidated financial data should be read in conjunction with the respective consolidated financial statements and notes thereto which are contained elsewhere herein.\nNOTES TO SELECTED CONSOLIDATED FINANCIAL DATA (In thousands)\n(1) Operational restructuring costs during 1994 included the estimated losses to be incurred on the AWG Transaction and associated expenses and the estimated losses and expenses in connection with the anticipated closing of 15 stores during 1995.\n(2) Extraordinary items during 1993 included the payment of approximately $2,776 in premiums on the redemption of $47,750 in aggregate principal amount of the Company's remaining 15-1\/2% Subordinated Notes due November 1, 1997 (the \"Subordinated Notes\") at a purchase price of 105.8% of the outstanding principal amount, and $1,148 in unamortized financing costs related to the Subordinated Notes so redeemed.\n(3) Extraordinary items during 1992 included the payment of approximately $1,225 in premiums on the repurchase of $12,250 in aggregate principal amount of the Company's Subordinated Notes at a purchase price of 110% of the outstanding principal amount, $371 in unamortized financing costs related to the Subordinated Notes so purchased, and a credit representing the discount of $500 on the Company's prepayment of $1,500 on the $5,000 note payable to Furr's issued in connection with the Company's acquisition of certain stores from Furr's in September 1991. The extraordinary items have been shown net of income taxes of $219.\n(4) Common Stock held by management investors is presented as redeemable common stock and excluded from stockholders' equity since the Company has agreed to repurchase such shares under certain defined conditions, such as death, retirement or permanent disability. See \"Management -- Management Stock Purchases.\" This presentation represents a change from previously issued financial statements. In addition, net income (loss) per common share reflects the accretion in\/reduction to redemption value as a reduction\/increase in income available to all common stockholders.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nGeneral\nThe Company's net sales declined by 3.2% in fiscal year 1994 to $785.1 million compared to fiscal year 1993. The Company's net sales declined by .5% in fiscal year 1993 to $811 million compared to a comparable 52 week year for fiscal year 1992. The preceding two fiscal years showed a compound annual growth rate of 3.0%, from $767.8 million in fiscal year 1990 to $815.3 million in fiscal year 1992 on a comparative 52 week basis. The decline in sales during 1994 was due to the increased competition in the Company's market area resulting primarily from additional store openings of Wal-Mart supercenter stores (see \"Business--Competition\"). The 67 stores retained following the AWG Transaction comprised 67.7% of the 1994 sales.\nThe following table sets forth selected items from the Company's consolidated income statement as a percentage of net sales for the periods indicated:\nPercentage of Net Sales Fiscal Year 1994 1993 1992\nNet Sales........................ 100.00% 100.00% 100.00% Cost of sales.................... 74.94 74.38 73.40 Gross profit................... 25.06 25.62 26.60\nSelling and administrative....... 24.67 23.49 24.01 Operational restructuring costs 2.96 - - Operating profit (loss)........ (2.57) 2.13 2.59 Gain on sale of plants........... - .32 - Interest expense................. (2.30) (2.33) (2.93)\nIncome (loss) before income taxes and extraordinary items.. (4.87) .12 (.34) Provision for income taxes....... ( .31) .40 (.12) Income (loss) before extraordinary items............ (5.18) .52 (.46)\nExtraordinary items.............. - (.48) (.11)\nNet income (loss)................ (5.18) (.04) (.57)\nComparison of Fifty-Two Weeks Ended December 31, 1994 with Fifty-Two Weeks Ended January 1, 1994.\nSales. Net sales for 1994 decreased to $785.1 million, a 3.2% decrease over 1993 net sales. The decrease in net sales for fiscal 1994 is primarily attributable to the increased competition in the Company's market area resulting primarily from additional store openings of Wal-Mart supercenter stores during 1993 and 1994. There were 11 new Wal-Mart supercenter stores opened in the Company's market area during 1994. The Company's comparable store sales decreased by 2.6% compared to the prior year due primarily to competitors' store openings in the Company's market area.\nThe Company has developed and begun to implement a more effective strategy for responding to competitive pressures in the market place, including (i) exploiting the advantages the Company has over its competitors, such as convenience of store locations and variety of offerings, (ii) increasing the offering of competitively-priced, private label products, (iii) improving advertising and merchandising and coordinating marketing efforts and (iv) increasing sales of perishables.\nCost and Expenses. Gross profit as a percentage of sales for fiscal 1994 decreased to 25.1% compared to 25.6% in fiscal 1993. The decrease in the gross profit margin was partially due to increased promotional pricing in response to the increased competition in the Company's market area. The decrease was also partially due to a decrease in the period of time for amortizing video rental tapes. The decrease was partially offset by a reduction in the inventory losses accounted for in the Company's retail stores during 1994. The retail store inventory losses were approximately $1.8 million less than inventory losses in 1993, resulting principally from a reduction in the losses in the meat department. The improvement in the meat department losses was due to a change in the procedures to process only the amount of product anticipated to be sold and not processing excessive quantities of fresh beef and pork to fill the display areas.\nThe decline in gross profit margin was also due in part to an increase in warehouse and transportation expense as a percent of sales in 1994 which was due to an increase in the warehouse square footage and an increase in the number of warehouse personnel resulting from converting the former ice cream plant into additional frozen food warehouse space.\nSelling and administrative expenses as a percentage of sales increased in fiscal 1994 to 24.7% from 23.5% for fiscal 1993. The increase in selling and administrative expenses as a percentage of sales was due in large part to the decrease in sales for 1994 as compared to the prior year. However, the expenses also increased during 1994 due in part to the contractual increase in the monthly fees in connection with the Company's computer services agreement and a one-time change in the administration of the vacation policy which occurred during 1993 and did not recur in 1994. Expenses also increased due to additional reserves recorded for estimated bad debts on accounts receivable due from vendors and wholesale customers which may not be collected in full as a result of the AWG Transaction and the Company wrote down certain fixed assets to fair market value. The Company also recorded an increase of $5.7 million in the accrual for workers' compensation claims in 1994 as compared to the prior year due to an increase in the actuarially projected ultimate costs of the self-insured plans reflecting increases in claims and related settlements. These increases in expense were partially offset by a reduction in retail wages and benefits resulting from the modified collective bargaining agreement entered into with the United Food and Commercial Workers of North America in December 1993.\nFollowing the AWG Transaction, the Company plans to take steps to reduce its selling and administrative expenses as well as improve its overall financial position. The Company has developed a plan to close fifteen marginal and unprofit- able stores during 1995 (seven of which have already been closed in 1995). The Company also plans to reduce administra- tive headcount by approximately 110 people by the end of 1996 following the AWG Transaction. In conjunction with fewer stores and reduced headcount, the Company also plans to reduce related administrative expenses including travel, phone, bank service charges and computer services, among others.\nOperational restructuring costs. Operational restructuring costs for 1994 were $23.2 million which included an estimate of the expenses to be incurred in connection with the sale of the warehouse and 29 stores to AWG and the closing of 15 stores during 1995. The accrual includes the fixed costs of the closed stores from the time they are closed until they can be sold or the lease expires.\nOperating Loss. Operating loss was $20.1 million for 1994 compared to operating profit of $17.3 million in 1993. The decrease in operating profit was due to the decrease in sales, the decrease in gross profit margin, the increase in selling and administrative expenses and the operational restructuring costs recorded in 1994.\nGain on Sale of Plants. The Company recognized a $2.6 million gain from the sale of equipment and related assets associated with its milk and ice cream plants in 1993. No similar gain was recognized in 1994.\nInterest Expense. Interest expense for fiscal 1994 decreased to $18.1 million from $18.9 million in fiscal 1993 due primarily to the redemption of the Company's Subordinated Notes. All remaining outstanding Subordinated Notes were redeemed by the Company on March 1, 1993. See \"Liquidity and Capital Resources.\"\nIncome Tax Provision. The Company recognized income tax expense of $2.4 million in 1994, compared to an income tax benefit of $3.3 million in 1993. The expense in 1994 was the result of increasing the valuation allowance on the Company's deferred tax asset from the prior year due to the uncertainty of realizing the future tax benefits. The expense was offset in part by the recognition of a tax benefit for alternative minimum tax net operating losses that were carried back to prior years. The income tax benefit for 1993 was the result of the reversal of the prior valuation allowance on the Company's deferred tax asset due to the proposed disposition of assets, net of the estimated amount management believed the Company may be required to pay in connection with the IRS audit (see below). At December 31, 1994, the Company had tax net operating loss carryforwards of approximately $20.1 million. The IRS concluded in December 1993 a field audit of the Company's income tax returns for the fiscal years 1990, 1991 and 1992. On January 31, 1994, the IRS issued a Revenue Agent's Report for those fiscal years proposing adjustments that would result in additional taxes in the amount of $1.6 million (this amount is net of any available operating loss carryforwards, which would be eliminated under the proposed adjustment). The Company filed its protest with the IRS Appeals Office on June 14, 1994. The IRS Appeals Office is currently in the process of reviewing the Company's protest. The major proposed adjustment involves the allocation of the initial purchase price of the Company to inventory. The Company believes that it has meritorious legal defenses to the IRS adjustments and intends to vigorously protest the assessment. Management has analyzed all of these matters and has provided for, in accordance with generally accepted accounting principles, amounts which it currently believes are adequate.\nExtraordinary Items. There were no extraordinary items incurred during fiscal 1994. Extraordinary items in 1993 consisted of the payment of $2.776 million in premiums on the redemption of $47.750 million in aggregate principal amount of the Subordinated Notes at a purchase price of 105.8% of the outstanding principal amount and $1.148 million in unamortized financing costs related to the redemption of the Subordinated Notes on March 1, 1993. See \"Liquidity and Capital Resources.\"\nIncome or Loss. The Company had net loss of $40.6 million during 1994 compared to net income of $282,000 in 1993. The net loss experienced in 1994 was due primarily to the operational restructuring costs, reduction of sales and gross profit margin, increase in selling and administrative expenses and an increase in income tax expense.\nComparison of Fifty-Two Weeks Ended January 1, 1994 with Fifty-Three Weeks Ended January 2, 1993.\nSales. Net sales for 1993 decreased to $811.0 million, a 2.4% decrease over 1992 net sales. The decrease in net sales for fiscal 1993 was primarily attributable to the 53 week year in fiscal 1992 as compared to a 52 week year in fiscal 1993. Net sales for 1993 compared to an adjusted comparable 52 week year for 1992 decreased 0.5%. Apart from the effect of a 53 week year in fiscal 1992, the decrease in net sales was primarily attributable to increased competition including the opening of seven Wal-Mart supercenter stores and Sam's Clubs in the Company's market area during 1993. The decrease in net sales was also due to a reduction in wholesale sales due to the loss of one wholesale customer and the termination by the Company of four other wholesale customers. Continuing store sales on a comparable 52 week basis decreased by .5% compared to the prior year due primarily to competitors' store openings in the Company's market area. Cost and Expenses. Gross profit as a percentage of sales for fiscal 1993 decreased to 25.6% compared to 26.6% in fiscal 1992. The decrease in gross profit margin was partially due to a reduction in prices and increased markdowns in response to the increased competition in the Company's market area. In addition, the decrease in gross profit margin was partially attributable to inventory losses accounted for in the Company's retail stores during the third and fourth quarters of 1993. The retail store inventory losses were approximately $2.2 million greater than inventory losses in 1992, resulting principally from above-normal losses in the produce and meat departments. The produce department losses were due to an isolated incidence of excess inventories in connection with a one-time promotional sale in the third quarter in response to increased competition. The meat department losses were due to processing excessive quantities of fresh beef and pork and taking earlier markdowns which created larger distress losses. Procedures were implemented in 1994 to process only the amount of product anticipated to be sold. The decrease in gross profit margin for 1993 was also due to lower vendor retail allowances than in 1992 because more nonrecurring vendor retail allowances were received during 1992 compared to 1993. Retail allowances were approximately $3.6 million less in 1993 compared to 1992. Consistent with general industry trends, many of the Company's major vendors have switched to a net pricing policy, which lowers overall item prices to the Company, but also reduces the retail allowances.\nThe decline in gross profit margin was partially offset by a reduction in warehouse and transportation expense in 1993 which was due to a reduction of hours worked in the Company's warehouse and the outsourcing of the Company's transportation operations in the second quarter of 1992. The transportation charges incurred during fiscal 1993 were $7.4 million as compared to $8.6 million in 1992. Compared to costs prior to the outsourcing, annual savings under the Transportation Agreement are approximately $2.0 million.\nGross profit without regard to warehouse and transportation costs as a percentage of sales decreased to 27.9% in fiscal 1993 compared to 29.1% in fiscal 1992. This decrease was primarily due to the reduced prices and higher markdowns as a result of the Company's response to increased competition, the above-normal inventory losses experienced at the Company's stores during the third and fourth quarters of 1993, and the reduction in vendor retail allowances.\nSelling and administrative expenses as a percentage of sales decreased for fiscal 1993 to 23.5% from 24.0% for fiscal 1992 on a total sales decline of $20 million. The decrease was partially due to management's cost reduction and containment program, including the reduction of retail store personnel hours, a staff reduction in the first quarter of 1993 and a reduction in management's salaries and non-union employee benefits effective June 1993. The expense reduction and control program is an on-going program, and the Company continued its efforts to reduce expenses during fiscal 1994. The decrease was also due to a smaller accrual for workers' compensation and general liability claims in 1993 compared to 1992. A contractual provision in the Company's agreement for computer services allowing for a reduction in the monthly fees as a result of any point of sale invoices paid during the month and a one-time change in the administration of the vacation policy, both of which occurred in fiscal 1993, also contributed significantly to the decreases in selling and administrative expenses. The decrease was partially offset by an increase in consulting expenses incurred to accelerate the Company's profit improvement plan, an increase in the bonuses paid under the Management Incentive Plan (as discussed in \"Executive Compensation -- Management Incentive Plan\") and expenses incurred in connection with the closing of two stores during the third quarter of 1993 (the closing of these two stores is not expected to have a material adverse effect on the Company's on-going operations and profitability).\nIn the fourth quarter of 1993, the UFCWNA ratified a modified collective bargaining agreement which provides for average wages and benefits for store employees of $9.25 per hour compared to the average wages and benefits before modification of $10.47 per hour. Management estimates that this wage and benefit reduction will result in annualized savings of approximately $6.7 million in 1994 and each year thereafter through October 1996 as compared to fiscal 1993.\nOperating Profit. Operating profit was $17.3 million for 1993 compared with $21.5 million in 1992. The decrease in operating profit was due to the decrease in sales and the decrease in gross profit margin, offset in part by the decrease in selling and administrative expenses.\nGain on Sale of Plants. The Company recognized a $2.6 million gain from the sale of equipment and related assets associated with its milk and ice cream plants in 1993.\nInterest Expense. Interest expense for fiscal 1993 decreased to $18.9 million from $24.3 million in fiscal 1992 due primarily to the redemption of the Company's Subordinated Notes. All remaining outstanding Subordinated Notes were redeemed by the Company on March 1, 1993. As a result of this redemption, the Company's average interest rate on its debt at the end of fiscal 1993 was 9.3% compared to 11.5% at the end of fiscal 1992. See \"Liquidity and Capital Resources.\"\nIncome Tax Provision. The Company recognized an income tax benefit of $3.3 million in 1993, compared to an expense of $763,000 in 1992. The income tax benefit for 1993 is the result of the reversal of the prior valuation allowance on the Company's deferred tax asset due to the proposed disposition of assets discussed below (see \"Liquidity and Capital Resources\"), net of the estimated amount management believes the Company may be required to pay in connection with the IRS audit (see below), while the expense for 1992 is comprised of alternative minimum tax expense. At January 1, 1994, the Company had tax net operating loss carryforwards of approximately $9.6 million, which might be affected by the outcome of the IRS proposed adjustments described above.\nExtraordinary Items. Extraordinary items in 1993 consist of the payment of $2.776 million in premiums on the redemption of $47.750 million in aggregate principal amount of the Subordinated Notes at a purchase price of 105.8% of the outstanding principal amount and $1.148 million in unamortized financing costs related to the redemption of the Subordinated Notes on March 1, 1993. See \"Liquidity and Capital Resources.\"\nIncome or Loss. The Company had net income of $282,000 during 1993 compared to a net loss of $4.7 million in 1992. The increase in net income was due primarily to the gain on the sale of the milk and ice cream plants, lower selling and administrative costs and interest expense and the tax benefit from the reversal of the prior valuation allowance, which was offset in part by a reduction of sales and gross profit margin and the extraordinary items described above.\nLiquidity and Capital Resources\nDebt. The major sources of liquidity for the Company's operations and expansion have been internally generated funds and borrowings under revolving credit facilities. In March 1992, the Company refinanced its indebtedness by entering into an Indenture with United States Trust Company of New York, as trustee (the \"Senior Note Indenture\"), pursuant to which the Company issued $45 million in aggregate principal amount of Series A Senior Secured Floating Rate Notes Due 1997, bearing interest at a floating rate of 3% over LIBOR (the \"Old Floating Rate Notes\"), and $75 million in aggregate principal amount of Series B Senior Secured Fixed Rated Rate Notes due 1999, bearing interest at 11-3\/4% per annum (the \"Old Fixed Rate Notes,\" and together with the old Floating Rate Notes, the \"Old Notes\"). The Old Fixed Rate Notes are not redeemable by the Company until on or after March 1, 1997.\nIn October and November 1992, the Company conducted an offer to exchange its Series D Senior Secured Floating Rate Notes Due 1997 (the \"New Floating Rate Notes\") for an equal principal amount of its outstanding Old Floating Rate Notes, and Series C Senior Secured Fixed Rate Notes Due 1999 (the \"New Fixed Rate Notes,\" and together with the New Floating Rate Notes, the \"New Notes\") for an equal principal amount of its Old Fixed Rate Notes. The Old Notes and the New Notes are collectively referred to herein as the \"Senior Notes;\" the Old Floating Rate Notes and the New Floating Rate Notes are collectively referred to herein as the \"Senior Floating Rate Notes;\" and the Old Fixed Rate Notes and the New Fixed Rate Notes are collectively referred to herein as the \"Senior Fixed Rate Notes.\" The New Notes are substantially identical to the Old Notes, except that the offering of the New Notes was registered with the Securities and Exchange Commission. Holders of the New Notes are not entitled to certain rights of holders of the Old Notes, as described in the prospectus relating to the exchange offer. The Company conducted the exchange offer to satisfy its obligations under agreements with the holders of the Senior Notes. At April 14, 1995, $75 million of New Fixed Rate Notes, $33 million of New Floating Rate Notes and $12 million of Old Floating Rate Notes are outstanding.\nOn April 13, 1995, the Company received consents for certain amendments to the Senior Note Indenture from a majority of the holders of Senior Notes. The amendments (a) increased the interest rate on each series of Notes by one- half of one percent (0.5%) per annum; (b) amended, added and deleted certain financial covenants and related definitions under the Senior Note Indenture (including modifying the Consolidated Fixed Charge Coverage Ratio covenant, adding a new Debt-to-EBITDA ratio and a new Capital Expenditures covenant, deleting the Adjusted Consolidated Net Worth covenant) to reflect the Company's size, operations and financial position following the AWG Transaction; (c) amended certain provisions of the Senior Note Indenture to permit the Company to incur certain liens and indebtedness and to make an investment in certain membership stock and receive or earn patronage certificates or other equity in connection with the supply agreement to be entered into with AWG; (d) amended certain provisions of the security agreement to provide that AWG will have a first lien on certain collateral to be acquired by the Company in connection with the AWG supply agreement; (e) amended certain other provisions of the Senior Note Indenture to, among other things, limit the Company's ability to incur certain future indebtedness and guarantees, and to provide that a certain amount of net proceeds from future asset sales must be applied to an offer to redeem the Senior Notes; (f) made certain technical amendments to the Senior Notes' Intercreditor Agreement; (g) and amended the Senior Notes' Mortgage to provide that defaults under, or modifications or terminations of, a certain lease related to a store to be closed, will not constitute a default or event of default under the Senior Notes' Mortgage. On April 21, 1995, the Company and United States Trust Company of New York, as trustee for the holders of the Senior Notes, entered into a supplemental indenture effecting these amendments.\nAlso in March 1992, the Company entered into a Revolving Credit Agreement (the \"Revolving Credit Agreement\") with Union Bank of Switzerland, New York Branch (\"UBS\"), as agent and as lender, and any other lenders and other financial institutions thereafter parties thereto. As a result of the Company's redemption of the remaining outstanding Subordinated Notes on March 1, 1993, and satisfying certain other conditions, the Revolving Credit Agreement provided a commitment of up to $50 million in secured revolving credit loans, including a swing loan and certain letters of credit (the \"Revolving Credit Facility\"). The Revolving Credit Agreement by its terms permitted borrowings (a) for working capital purposes and (b) subject to certain conditions, for corporate acquisitions. Borrowings under the Revolving Credit Agreement bore interest at the UBS Base Rate plus 1.5% or at an adjusted Eurodollar Rate plus 2.5%, which rates were subject to increase upon certain conditions. All borrowings under the Revolving Credit Agreement were subject to a borrowing base and mature no later than March 2, 1997. At April 14, 1995, $21.1 million was outstanding under the Revolving Credit Facility.\nOn April 21, 1995, the Company replaced its Revolving Credit Agreement with a revised revolving facility (the \"Amended and Restated Revolving Credit Agreement\"). The Amended and Restated Revolving Credit Agreement is with National Bank of Canada, (\"NBC\") as agent and as lender, Heller Financial, Inc. and any other lenders thereafter parties thereto. The Amended and Restated Revolving Credit Agreement provides a commitment of up to $25 million in secured revolving credit loans, including certain letters of credit. The Amended and Restated Revolving Credit Agreement permits borrowings (a) to refinance the existing Revolving Credit Agreement, (b) for working capital needs and (c) issue standby letters of credit and documentary letters of credit. Borrowings under the Amended and Restated Revolving Credit Agreement bear interest at the NBC Base Rate plus 1.5% for the first year. Subsequent year's interest rates will be dependent upon the Company's earnings but will not exceed the NBC base rate plus 2.0%. All borrowings under the Amended and Restated Revolving Credit Agreement are subject to a borrowing base and mature no later than February 27, 1997, with the possibility of extending the maturity date to March 31, 1998 if the Company's Series A Senior Secured Floating Rate Notes due February 27, 1997, are extended or refinanced on terms acceptable to NBC.\nThe obligations of the Company under the Senior Notes are secured by a pledge of substantially all present and future property, plant and equipment, trademarks, leaseholds and other assets of the Company, other than inventory, accounts and certain related collateral that is pledged to NBC under the Amended and Restated Revolving Credit Agreement. Holding has guaranteed the obligations of Homeland under the Senior Notes, and such guarantee is secured by Holding's pledge of 100% of the stock of Homeland. Commencing each year on and after June 1, 1993, Homeland must apply 80% of its Excess Cash Flow (as defined in the Senior Note Indenture), after accounting for reductions in amounts outstanding under the Amended and Restated Revolving Credit Agreement, to prepay the Senior Floating Rate Notes. Additionally, Homeland must apply net proceeds of asset dispositions (other than sales of inventory and certain other property in the ordinary course of business and certain other excepted dispositions) to prepay indebtedness under the Senior Notes and\/or the Amended and Restated Revolving Credit Agreement.\nWorking Capital, Cash Flow and Capital Expenditures. At December 31, 1994, the Company's working capital was $43.9 million or a current ratio of 1.65 to 1, compared to $53.6 million or 1.82 to 1 at January 1, 1994. The decrease in working capital in 1994 was due to the decrease in cash, the write off of certain inventory costs in connection with the restructuring, and an increase in sales tax payable.\nCash flow from operations is used by the Company to support working capital needs and to reduce its debt level. The Company generated cash flow from operations of $.3 million in fiscal 1994, $13.0 million in fiscal 1993 and $11.2 million in fiscal 1992. The Company continues to review its cash flow to identify areas where the cash flow can be increased. Areas which are being reviewed include increasing inventory turnover levels, improving the collection of accounts receivable, and reducing the cash in the stores.\nHomeland made total capital expenditures (including capital leases) of approximately $6.9 million in fiscal 1994 compared to $10.4 million in fiscal 1993, $8.6 million in fiscal 1992, $23.2 million in fiscal 1991, and $32.8 million in fiscal 1990. Homeland expects to make total capital expenditures (including capital leases) of approximately $6.0 million in fiscal 1995, primarily for store remodels. The source of funds for the fiscal 1995 capital expenditures will be reinvestment of net proceeds generated from the AWG Transaction and the Amended and Restated Revolving Credit Facility, if needed.\nOther Liabilities. In fiscal 1994, the Company added $5.0 million to its existing accruals, in addition to its planned accrual of $4.7 million for 1994, for workers' compensation and general liability claims based upon newly available information and revised assumptions. The increase in the workers compensation and the general liability accruals is due to an increase in the actuarially projected ultimate costs of the self-insured plans reflecting increases in claims and related settlements.\nRecently-Issued Accounting Standards\nThere are no recently issued accounting standards that effect the Company.\nInflation\/Deflation\nIn recent years, deflation has not had a material impact upon the Company's operating results. Although the Company does not expect inflation or deflation to have a material impact in the future, there can be no assurance that the Company's business will not be affected by inflation or deflation in future periods.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company's consolidated financial statements and notes thereto are included in this report following the signature pages.\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 are the names, ages, present positions and years of service (in the case of members of management) of the directors and management of Homeland:\n(1) Mr. Demme joined the Company as President, Chief Executive Officer and a director as of November 30, 1994.\n(2) Mr. Raydon was President and Chief Executive Officer of the Company until his resignation on November 30, 1994.\n(3) Personal benefits provided to the Named Executive Officer under various Company programs do not exceed 10% of total annual salary and bonus reported for the Named Executive Officer.\n(4) All other compensation includes contributions to the Company's defined contribution plan on behalf of each of the Named Executive Officers to match 1993 and 1992 pre- tax elective deferral contributions (there was no match for 1994) (included under Salary) made by each to such plan, as follows: Max E. Raydon, $4,497; Jack M. Lotker, $4,497; and Steven M. Mason, $2,956.\n(5) The Company provides reimbursement for medical benefit insurance premiums for the Named Executive Officers. These persons obtain individual fully-insured private medical benefit insurance policies with benefits substantially equivalent to the medical benefits currently provided under the Company's group plan. The Company also provides for life insurance premiums for executive officers, including the Named Executive Officers and one other executive officer, who obtain fully-insured private term life insurance policies with benefits of $500,000 per person. Amounts paid during 1994 are as follows: Max E. Raydon, $31,295; Mark S. Sellers, $38,972; Jack M. Lotker, $7,826; Steven M. Mason, $8,963; and Prentess E. Alletag, Jr., $4,467.\n(6) Salary in 1992 includes an extra week compared to fiscal years 1993 and 1994 (53 weeks versus 52 weeks).\n(7) Mr. Sellers joined the Company in September 1992.\n(8) Includes reimbursement of relocation expenses in the amount of $95,378 in 1994, $78,058 in 1993 and $49,781 in 1992.\nDirectors who are not employees of the Company or otherwise affiliated with the Company (presently consisting of Messrs. Black, Paroly, Meyer, Dresdale and Shields) are paid annual retainers of $15,000 and meeting fees of $1,000 for each meeting of the board or any committee attended. Mr. John Bell, who was a director of the Company until his resignation in January 1995, also served as a consultant to the Company from time to time at the request of the Company. At such times as he provided such consulting services, Mr. Bell received $1,000 per day from the Company. During 1994, Mr. Bell received $36,000 from the Company for consulting fees and was also reimbursed for business expenses. Mr Shields also serves as a consultant to the Company from time to time at the request of CD&R. During 1994, Mr. Shields received $133,330 from CD&R for consulting fees for services provided to the Company.\nEmployment Agreements\nIn November 1994, the Company entered into an employment agreement with James A. Demme, the Company's President and Chief Executive Officer for an indefinite term. The Agreement provides a base annual salary of not less than $200,000 and entitles Mr. Demme to participate in the Company's Management Incentive Plan with a maximum annual bonus equal to 100% of base salary; provided that for calendar year 1995 Mr. Demme will receive a minimum bonus of $100,000. The agreement also provides for awards under a long term incentive compensation plan which is to be established by the Company and authorizes reimbursement for certain business- related expenses. If the agreement is terminated by Homeland for other than cause or disability prior to the third anniversary of the agreement or is terminated by Mr. Demme following the sale of at least 50% of the voting stock of the Company, the Company will continue to pay Mr. Demme his base salary for one year.\nOn January 30, 1995, Homeland entered into a revised employment agreement with Mark S. Sellers, the Company's Executive Vice President-Finance, Chief Financial Officer, Treasurer and Secretary. The agreement is effective as of January 1, 1995 and expires on the thirtieth day following the closing of the AWG Transaction, unless terminated sooner due to death or disability. The agreement provides a base annual salary of not less than $170,000 and entitles Mr. Sellers to participate in the Management Incentive Plan established by Homeland including a pro rata bonus in 1995 based on the Company's performance. The agreement provides for reimbursement of all relocation expenses in connection with Mr. Sellers' move to Oklahoma including reimbursement of any loss incurred in connection with the sale of his previous home based on the total investment and expenses he had in the house not to exceed $271,613. The agreement provides for a retention payment of $195,000 within 10 business days after the date of expiration of the agreement. The agreement also provides that the Company will reimburse Mr. Sellers up to a maximum of $30,000 for all reasonable costs of moving his household goods from Oklahoma City and costs of selling his house in Oklahoma, subject to a reduction to the extent of any reimbursement received from other employment.\nIn August 1994, the Company entered into a two-year employment agreement with Jack M. Lotker, the Company's Senior Vice President of Administration. The agreement provides a base annual salary of not less than $130,500, subject to increase from time to time at the discretion of the Board of Directors and authorizes reimbursement for certain business- related expenses. Under the agreement, Mr. Lotker is entitled to participate in the Management Incentive Plan established by Homeland. Mr. Lotker is also entitled to receive a special one-time non-recurring cash bonus in an amount to be determined pursuant to a formula based on the Company's stock price at the time of a transaction if a Trigger Event occurs on or prior to December 31, 1995 (or by February 28, 1996 if a definitive agreement is in place at December 31, 1995). If the agreement is terminated by Homeland for other than cause prior to a change of control or is terminated by Mr. Lotker for any reason prior to a change of control, Mr. Lotker is entitled to continue to receive his compensation until the first anniversary of such termination, subject to reduction to the extent of any compensation received from other employment. If the agreement is terminated, whether voluntary or involuntary, within 180 days following a change of control or a Trigger Event, Mr. Lotker is entitled to receive payment equal to one year's salary, plus a pro rata amount of the incentive compensation for the portion of the incentive year that precedes the date of termination, plus any amount forgone by Mr. Lotker under the 10% reduction in management salaries effected in June 1993, and would not be subject to any offset as a result or his receiving compensation from other employment. Furthermore, if Mr. Lotker is entitled to receive severance benefits as outlined or if his employment terminates due to his death or disability (as defined), Homeland will pay his relocation expenses from Oklahoma to any location in the continental United States and will reimburse him for any loss incurred on the sale of his current home following a reasonable effort to obtain a good sales price, subject to reduction to the extent of any compensation received from other employment.\nIn August 1994, the Company entered into a two-year employment agreement, with both Steve Mason, the Company's Vice President of Marketing and Al Fideline, the Company's Vice President of Retail Operations. The agreements provide a base annual salary of not less than $130,500 and $80,000, respectively, subject to increase from time to time at the discretion of the Board of Directors and authorizes reimbursement for certain business-related expenses. Under the agreements, Messrs. Mason and Fideline are entitled to participate in the Management Incentive Plan established by Homeland. Messrs. Mason and Fideline are also entitled to receive a special one-time non-recurring cash bonus in an amount to be determined pursuant to a formula based on the Company's stock price at the time of a transaction if a Trigger Event occurs on or prior to December 31, 1995 (or by February 28, 1996 if a definitive agreement is in place at December 31, 1995). If the agreements are terminated by Homeland for other than cause prior to a change of control, Messrs. Mason and Fideline are each entitled to receive severance benefits in accordance with Homeland's generally applicable plans, policies or procedures, subject to any offset as a result of receiving compensation from other employment. If the agreements are terminated, whether voluntary or involuntary, within 180 days following a change of control or a Trigger Event, Messrs. Mason and Fideline are each entitled to receive payment equal to one year's salary, plus a pro rata amount of the incentive compensation for the portion of the incentive year that precedes the date of termination, plus any amount forgone by Messrs. Mason or Fideline under the 10% reduction in management salaries effected in June 1993, and would not be subject to any offset as a result of them receiving compensation from other employment.\nIn December 1994, the Company entered into a settlement agreement with Max E. Raydon whereby his employment with the Company was terminated. In connection with the termination, Mr. Raydon received a lump sum amount of $600,000 and resigned as an officer and director of the Company. For a period of thirty-six months, the Company will continue to provide to Mr. Raydon the same medical, dental, vision, life and disability insurance and other welfare benefits as it provides to its executive officers. In March 1995, the Company repurchased 455,000 shares of Class A Common Stock of Holding from Mr. Raydon at $0.50 per share plus the issuance of a warrant for the same number of shares with an exercise price of $0.50.\nManagement Incentive Plan\nHomeland maintains a Management Incentive Plan to provide incentive bonuses for members of its management and key employees. Bonuses are determined according to a formula based on both corporate, store and individual performance and accomplishments or other achievements and are paid only if minimum performance and\/or accomplishment targets are reached. Minimum bonuses range from 0 to 100% of salary for officers (as set forth in the plan), including the Chief Executive Officer. Maximum bonus payouts range from 75% to 200% of salary for officers and up to 200% of salary for the Chief Executive Officer. Performance levels must significantly exceed target levels before the maximum bonuses will be paid. Under limited circumstances, individual bonus amounts can exceed these levels if approved by the Compensation Committee of the Board. Incentive bonuses paid to managers and supervisors vary according to their reporting and responsibility levels. The plan is administered by a committee consisting, unless otherwise determined by the Board of Directors, of members of the Board who are ineligible to participate in the plan. Incentive bonuses earned for certain highly compensated executive officers under the plan for performance during fiscal year 1994 are included in the Summary Compensation Table.\nRetirement Plan\nHomeland maintains a retirement plan in which all non-union employees, including members of management, participate. Under the plan, employees who retire at or after age 65 after completing five years of vesting service (defined as calendar years in which employees complete at least 1,000 hours of service) will be entitled to retirement benefits equal to 1.50% of career average compensation (including basic, overtime and incentive compensation) plus .50% of career average compensation in excess of the social security covered compensation, such sum multiplied by years of benefit service (not to exceed 35 years). Service with Safeway prior to the Acquisition is credited for vesting purposes under the plan. Retirement benefits will also be payable upon early retirement beginning at age 55, at rates actuarially reduced from those payable at normal retirement. Benefits are paid in annuity form over the life of the employee or the joint lives of the employee and his or her spouse or other beneficiary.\nUnder the plan, estimated annual benefits payable to the named executive officers of Homeland upon retirement at age 65, assuming no changes in covered compensation or the social security wage base, would be as follows: James A. Demme, $27,226; Max E. Raydon, $26,535; Mark S. Sellers, $62,026; Jack M. Lotker, $58,944; Steven M. Mason, $84,753; and Chester R. Misialek, $14,644.\nCompensation Committee Interlocks and Insider Participation\nMessrs. Ames, Paroly and Shields served on the Company's Compensation and Benefits Committee of the Board of Directors for the 1994 fiscal year. Mr. Ames, Chairman of the Board, is a principal of CD&R, the holder of an economic interest in the general partner of C&D Fund III and a general partner of the general partner of C&D Fund IV. See \"Certain Relationships and Related Transactions\". Mr. Shields serves as a consultant to the Company from time to time at the request of CD&R. During 1994, Mr. Shields received $133,330 from CD&R for consulting fees for services provided to the Company.\nManagement Stock Purchases\nShares of Common Stock purchased by members of management, including Named Executive Officers Max E. Raydon, Jack Lotker, Steven M. Mason, and Chester R. Misialek and key employees, (the \"Management Investors\"), directly and indirectly through an individual retirement account, are subject to certain transfer restrictions (including successive rights of first refusal on the part of Holding and C&D Fund III or, with respect to certain shares, C&D Fund IV) and repurchase rights (including successive rights by Holding and C&D Fund III or with respect to certain shares, C&D Fund IV, to purchase shares from Management Investors whose employment with Homeland terminates). In addition, the Management Investors have the right to require Holding to repurchase their shares upon the occurrence of certain events, such as a termination without \"cause\" (as defined) or death, retirement or permanent disability, subject to (a) there being no default under the Company's prior credit agreement with Manufacturers Hanover Trust Company, as agent and certain other banks (the \"Prior Credit Agreement\"), the Subordinated Note Indenture, any other financing or security agreement or document permitted under the Prior Credit Agreement or the Subordinated Note Indenture (including the Senior Note Indenture and the Revolving Credit Agreement), or certain other financing or security agreements or documents, (b) the repurchase not violating any such agreement or document or Holding's certificate of incorporation and (c) Holding having sufficient funds legally available for such repurchase under Delaware law. Holding has also agreed to use its best efforts to repurchase shares from any Management Investor who experiences certain unforeseen personal hardships, subject to the authorization of Holding's Board of Directors. During 1994, the Company exercised its repurchase rights to repurchase an aggregate of 106,000 shares of Common Stock at the fair market value as determined by the Board from Management Investors.\nThe shares held by each Management Investor, directly and indirectly through an individual retirement account, are entitled to the benefits of and are bound by the obligations set forth in certain registration and participation agreements. See \"Security Ownership of Certain Beneficial Owners and Management -- Registration and Participation Agreements.\" For information concerning the holdings of Common Stock as of April 14, 1995 by certain officers and directors, see \"Security Ownership of Certain Beneficial Owners and Management -- Ownership of Certain Holders.\" The Common Stock sold to members of management and key employees has been accounted for as redeemable Common Stock. Homeland has made certain temporary loans which are due July 21, 1995, to certain members of management and key employees to enable such persons to make principal payments under loans to finance such persons' purchase of redeemable Common Stock. See \"Certain Relationships and Related Transactions.\"\nOn April 21, 1995, the Company made an offer to repurchase shares of its Common Stock owned by certain officers and employees of the Company at a cash purchase price of $0.50 per share, plus a warrant equal to the number of shares purchased with an exercise price of $0.50. However, such repurchases shall not exceed $600,000 in the aggregate (net of amounts to be repaid in respect of loans from the Company) and individual repurchases shall not exceed any outstanding loan balance that the officers or employees may have related to their purchase of Common Stock.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOwnership of Certain Holders\nSet forth below is information as of April 14, 1995, concerning certain holders of the currently outstanding shares of Common Stock (including Named Executive Officers, officers and directors of the Company and holders of 5% or more of the Common Stock).\nShares Percent of Name of Beneficial Owner Beneficially Owned Class\nThe Clayton & Dubilier Private Equity Fund III Limited Partnership, 270 Greenwich Avenue, Greenwich, CT 06830 11,700,000 34.1% The Clayton & Dubilier Private Equity Fund IV Limited Partnership, 270 Greenwich Avenue, Greenwich, CT 06830 13,153,089 38.4 B. Charles Ames (1)(2) 13,153,089 38.4 Joseph L. Rice, III (1)(3) 24,853,089 72.5 Alberto Cribiore (1)(3) 24,853,089 72.5 Donald J. Gogel (1) 13,153,089 38.4 Hubbard Howe (1) 13,153,089 38.4 James A. Demme -- -- Mark S. Sellers -- -- Jack M. Lotker 450,000 1.3 Steven M. Mason (4) 200,000 * Chester Misialek 200,000 * Alfred F. Fideline, Sr. 101,000 * Bernard S. Black (5) 70,000 * Bernard Paroly 50,000 * Richard C. Dresdale -- -- Andrall E. Pearson (2) -- -- Edward H. Meyer -- -- John A. Shields -- -- Michael G. Babiarz -- --\nOfficers and directors as a group (16 persons) (6)(7) 14,324,089 41.8\n*Indicates less than 1%\n(1) Messrs. Ames, Rice, Cribiore, Gogel and Howe may be deemed to share beneficial ownership of the shares owned of record by C&D Fund IV by virtue of their status as general partners of the general partner of C&D Fund IV, but Messrs. Ames, Rice, Cribiore, Gogel and Howe each expressly disclaims such beneficial ownership of the shares owned by C&D Fund IV. Messrs. Ames, Rice, Cribiore, Gogel and Howe share investment and voting power with respect to securities owned by C&D Fund IV. The business address for Messrs. Ames, Rice, Cribiore, Gogel and Howe is c\/o Clayton, Dubilier & Rice, Inc., 126 East 56th Street, 25th Floor, New York, New York 10022.\n(2) Mr. Ames was a limited partner in the general partner of C&D Fund III until October 1990, when he assigned his limited partnership interest to B. Charles Ames as Trustee of the trust created pursuant to a Declaration of Trust, dated July 25, 1982. Thus, he does not share investment discretion with respect to securities held by C&D Fund III. Mr. Pearson is a limited partner in the general partner of C&D Fund IV, but does not share investment discretion with respect to securities held by C&D Fund IV.\n(3) Messrs. Rice and Cribiore may be deemed to share beneficial ownership of the shares owned of record by C&D Fund III by virtue of their status as general partners of the general partner of C&D Fund III, but Messrs. Rice and Cribiore each expressly disclaims such beneficial ownership of the shares owned by C&D Fund III. Messrs. Rice and Cribiore share investment and voting power with respect to securities owned by C&D Fund III.\n(4) Includes 27,900 shares held in Mr. Mason's individual retirement account. Shares held by officers in their respective individual retirement accounts (\"IRA\") are subject to a power of attorney authorizing Mr. Dresdale to instruct the trustee of the IRA to take certain actions with respect to the shares held in the IRA in accordance with the stock subscription agreements executed by such officers.\n(5) Includes 13,000 shares held in Mr. Black's individual retirement account. See note 4.\n(6) Includes shares owned by C&D Fund IV, over which Mr. Ames, a director of the Company, shares investment and voting control. See notes 1 and 2.\n(7) Includes 130,900 shares held by officers and directors in their respective individual retirement accounts. See note 4.\nRegistration and Participation Agreements\nHolders of the 20,180,000 shares of Common Stock outstanding prior to the August 1990 private offering, net of 85,000 shares repurchased by the Company from former key employees (the \"Existing Holders\"), are entitled to the benefits of and are bound by the obligations set forth in a Registration and Participation Agreement, dated as of November 24, 1987 (the \"1987 Registration and Participation Agreement\"), among Holding, C&D Fund III and the other initial purchasers of Common Stock. Under the 1987 Registration and Participation Agreement, the holders of specified percentages of Common Stock may require the registration of such Common Stock, subject to certain limitations. Any number of such registrations may be requested, and Holding is required to bear all expenses in connection with the first three requests for registration. Prior to an initial public offering of Holding Common Stock, a demand for such registration can be made only by the holders of at least 40% of the Common Stock subject to the 1987 Registration and Participation Agreement (but not less than 3 million shares); thereafter, or at any time after November 24, 1994, such a demand may be made by the holders of at least 10% of the Common Stock subject to the Agreement (but not less than l.2 million shares). Holders of Common Stock also have the right to participate in any registered offering initiated by Holding, subject to certain conditions and limitations. In addition, the 1987 Registration and Participation Agreement entitles holders of Common Stock to participate proportionately in certain \"qualifying sales\" of Common Stock by C&D Fund III. Subject to certain qualifications, \"qualifying sales\" are sales by C&D Fund III of more than one million shares of Common Stock. Under the 1987 Registration and Participation Agreement, Holding must offer certain stockholders the right to purchase their pro rata share of Common Stock in connection with any proposed issuance of additional shares of Common Stock to C&D Fund III or any of its affiliates (other than persons who may be deemed affiliates solely by reason of being members of the management of the Company).\nHolders of the 15,000,000 shares of Common Stock purchased in the August 1990 private offering are entitled to the benefits of and are bound by the obligations set forth in the Registration and Participation Agreement dated as of August 13, 1990 (the \"1990 Registration and Participation Agreement\") among Holding, C&D Fund IV and those purchasers of such Common Stock (the \"New Holders\"). The registration rights are, however, expressly subordinate in nearly all respects to the registration rights granted to the Existing Holders with respect to the Common Stock that is covered by the 1987 Registration and Participation Agreement. The 1990 Registration and Participation Agreement provides, among other things, that New Holders of specified percentages of registrable Common Stock may initiate one or more registrations at Holding's expense, provided that the Existing Holders shall have the right to include their own shares of Common Stock in any such registration on a pro rata basis. In addition, if Holding proposes to register any equity securities, and certain conditions are met, New Holders will be entitled to include shares in the registration, provided that the Existing Holders shall have been given the opportunity to include all of their shares in such offering. The 1990 Registration and Participation Agreement does not entitle the New Holders to participate in sales of Common Stock by C&D Fund IV, but does give each New Holder the right to be offered additional shares of Common Stock if additional shares are proposed to be issued to C&D Fund IV or its affiliates.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company's largest stockholders, C&D Fund III and C&D Fund IV, are private investment funds managed by CD&R. Amounts contributed to C&D Fund III and C&D Fund IV by the limited partners thereof are invested at the discretion of the general partner in the equity of corporations organized for the purpose of carrying out leveraged acquisitions involving the participation of management, or, in the case of C&D Fund IV, in corporations where the infusion of capital coupled with the provision of managerial assistance by CD&R can be expected to generate returns on investments comparable to returns historically achieved in leveraged buy-out transactions. The general partner of C&D Fund III is Clayton & Dubilier Associates III Limited Partnership, a Connecticut limited partnership (\"Associates III\"). The general partner of C&D Fund IV is Clayton & Dubilier Associates IV Limited Partnership, a Connecticut limited partnership (\"Associates IV\"). B. Charles Ames, a principal of CD&R, a holder of an economic interest in Associates III and a general partner of Associates IV, also serves as Chairman of the Board of the Company. Andrall E. Pearson, a principal of CD&R and director of the Company, is a limited partner of Associates IV. Michael G. Babiarz, a director of the company, is a professional employee of CD&R. Richard C. Dresdale, a director of the Company, is a limited partner of Associates III. He was a professional employee of CD&R and was a limited partner of Associates IV until his withdrawal from CD&R and Associates IV effective March 1, 1994. He retains an economic interest in the investments in the Company by C&D Fund IV.\nCD&R receives an annual fee for management and financial consulting services provided to the Company and reimbursement of certain expenses. The consulting fees paid to CD&R were $150,000 in 1994 and $200,000 in each of the years 1992 and 1993.\nCD&R, C&D Fund III and the Company entered into an Indemnification Agreement on August 14, 1990, pursuant to which the Company agreed, subject to any applicable restrictions in the Prior Credit Agreement and the Subordinated Note Indenture, to indemnify CD&R, C&D Fund III, Associates III and their respective directors, officers, partners, employees, agents and controlling persons against certain liabilities arising under the federal securities laws and certain other claims and liabilities.\nCD&R, C&D Fund III, C&D Fund IV and the Company entered into a separate Indemnification Agreement, dated as of March 4, 1992, pursuant to which the Company agreed, subject to any applicable restrictions in the Senior Note Indenture, the Revolving Credit Agreement, the Subordinated Note Indenture, the 1987 Registration and Participation Agreement, and the 1990 Registration and Participation Agreement, to indemnify CD&R, C&D Fund III, C&D Fund IV, Associates III, Associates IV and their respective directors, officers, partners, employees, agents and controlling persons against certain liabilities arising under the federal securities laws and certain other claims and liabilities.\nHomeland has made temporary loans in 1993 and 1994 to certain members of management, in a maximum principal amount of $1,076,506, to enable such persons to make principal payments under loans from a third-party financial institution, which third-party loans were used solely to finance such persons' purchase of redeemable Common Stock of Holding. Such temporary loans are due July 21, 1995, and bear interest at a variable rate equal to the Company's Base Rate as determined by the Revolving Credit Agreement plus a margin of one percent per annum, and in any event no less than 11.5%. At April 14, 1995, $731,554 in aggregate principal amount of such loans was outstanding. In addition, the Company made a temporary loan in the aggregate principal amount of $200,000 to Mark S. Sellers, Executive Vice President-Finance, Treasurer, Chief Financial Officer and Secretary of the Company in connection with his relocation to Oklahoma and purchase of a new home. The loan bears interest at 8.3% and is to be repaid with the equity in his former home. At April 14, 1995, $23,446 of this loan remains outstanding.\nOn April 21, 1995, the Company made an offer to repurchase shares of its Common Stock owned by certain officers and employees of the Company at a cash purchase price of $0.50 per share, plus a warrant equal to the number of shares purchased with an exercise price of $0.50. However, such repurchases shall not exceed $600,000 in the aggregate (net of amounts to be repaid in respect of loans from the Company) and individual repurchases shall not exceed any outstanding loan balance that the officers or employees may have related to their purchase of Common Stock.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nThe following documents are filed as part of this Report:\n(a) Financial Statements and Financial Statement Schedules.\n1. Financial Statements. The Company's financial statements are included in this report following the signature pages. See Index to Financial Statements and Financial Statement Schedules on page.\n2. Financial Statement Schedules. The Company's Financial Statement Schedules are included in this report following the signature pages. See Index to Financial Statements and Financial Statement Schedules on page.\n3. Exhibits. See attached Exhibit Index on page E-1.\n(b) Reports on Form 8-K. A report on Form 8-K was filed during the last quarter of the period covered by this Report disclosing the Company entering into a letter of intent with AWG to sell certain of its assets. The Form 8-K was dated November 29, 1994.\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT\nThe Company has previously furnished to the Commission its proxy material in connection with the 1994 annual meeting of security holders. No separate annual report was distributed to security holders covering the Company's last fiscal year. The Company intends to furnish to its security holders proxy material in connection with the 1995 annual meeting of security holders. The Company will furnish copies of such material to the Commission when it is sent to security holders.\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.\nHOMELAND HOLDING CORPORATION\nDate: April 24, 1995 By: James A. Demme James A. Demme, 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\nB. Charles Ames Chairman of the Board April 21, 1995 B. Charles Ames\nJohn A. Shields Vice Chairman of the Board April 21, 1995 John A. Shields\nJames A. Demme President, Chief Executive April 24, 1995 James A. Demme Officer and Director (Principal Executive Officer)\nMark S. Sellers Executive Vice President\/ April 24, 1995 Mark S. Sellers Finance, Treasurer, C.F.O. and Secretary (Principal Financial Officer)\nMary Mikkelson Chief Accounting Officer, April 24, 1995 Mary Mikkelson Assistant Treasurer and Assistant Secretary (Principal Accounting Officer)\nSignature Title Date\nMichael G. Babiarz Director April 21, 1995 Michael G. Babiarz\nDirector April , 1995 Bernard S. Black\nRichard C. Dresdale Director April 20, 1995 Richard C. Dresdale\nBernard Paroly Director April 20, 1995 Bernard Paroly\nAndrall E. Pearson Director April 19, 1995 Andrall E. Pearson\nEdward H. Meyer Director April 20, 1995 Edward H. Meyer\nHOMELAND HOLDING CORPORATION Consolidated Financial Statements\nReport of Independent Accountants . . . . . . . . . . . Consolidated Balance Sheets as of December 31, 1994 and January 1, 1994 . . . . . . . . . . . . . . . . . Consolidated Statements of Operations for the 52 weeks ended December 31, 1994 and January 1, 1994, and the 53 weeks ended January 2, 1993 . . . . . . . . Consolidated Statements of Stockholders' Equity for the 52 weeks ended December 31, 1994 and January 1, 1994, and the 53 weeks ended January 2, 1993 . . . . . Consolidated Statements of Cash Flows for the 52 weeks ended December 31, 1994 and January 1, 1994, and the 53 weeks ended January 2, 1993 . . .. . . Notes to Consolidated Financial Statements . . . . . . .\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Homeland Holding Corporation\nWe have audited the accompanying consolidated financial statements of Homeland Holding Corporation and Subsidiary listed in the index on page of this Form 10-K. 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 statements presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs discussed in Note 15, subsequent to the year ended December 31, 1994, the Company completed the sale of its warehouse and distribution center and 29 retail stores to Associated Wholesale Grocers, Inc. In connection with this transaction, the Company executed a Supplemental Indenture, incorporating certain amendments to its Senior Note Indenture, and replaced its Revolving Credit Agreement.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Homeland Holding Corporation and Subsidiary as of December 31, 1994 and January 1, 1994, and the consolidated results of their operations and their cash flows for the 52 weeks ended December 31, 1994 and January 1, 1994, and the 53 weeks ended January 2, 1993, in conformity with generally accepted accounting principles.\nCoopers & Lybrand\nNew York, New York March 24, 1995, except as to the information presented in Note 15, for which the date is April 21, 1995\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\n(In thousands, except share and per share amounts)\nASSETS (Note 3)\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS, Continued\n(In thousands, except share and per share amounts)\nLIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF OPERATIONS\n(In thousands, except share and per share amounts)\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(In thousands, except share and per share amounts)\n1. Organization and Basis of Presentation:\nHomeland Holding Corporation, (\"Holding\"), a Delaware corporation, was incorporated on November 6, 1987, but had no operations prior to November 25, 1987. Effective November 25, 1987, Homeland Stores, Inc. (\"Homeland\"), a wholly-owned subsidiary of Holding, acquired substantially all of the net assets of the Oklahoma Division of Safeway Stores, Incorporated. Holding and its consolidated subsidiary, Homeland, are collectively referred to herein as the \"Company\".\nHolding has guaranteed substantially all of the debt issued by Homeland. Holding is a holding company with no significant operations other than its investment in Homeland. Separate financial statements of Homeland are not presented herein since they are identical to the consolidated financial statements of Holding in all respects except for stockholder's equity (which is equivalent to the aggregate of total stockholders' equity and redeemable common stock of Holding) which is as follows:\n2. Summary of Significant Accounting Policies:\nFiscal year - The Company has adopted a fiscal year which ends on the Saturday nearest December 31.\nBasis of consolidation - The consolidated financial statements include the accounts of Homeland Holding Corporation and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.\n2. Summary of Significant Accounting Policies, continued:\nRevenue recognition - The Company recognizes revenue when its retail or wholesale divisions distribute groceries and related items to its customers.\nConcentrations of credit risk - Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and receivables. The Company places its temporary cash investments with high quality financial institutions. Concentrations of credit risk with respect to receivables are limited due to the diverse nature of those receivables, including a large number of retail and wholesale customers within the region and receivables from vendors throughout the country.\nRestricted Cash - At December 31, 1994, the Company had $467 of cash in an escrow account at United States Trust Company of New York. The cash is restricted for reinvestment in capital expenditures within 180 days of being deposited in the account or must be used to permanently pay down the Senior Notes (as subsequently defined under Note 3).\nInventories - Inventories are stated at the lower of cost or market. Cost is determined on a first-in first-out basis primarily using the retail method.\nProperty, plant and equipment - Property, plant and equipment obtained at acquisition are stated at appraised fair market value as of that date; whereas all subsequently acquired property, plant and equipment are stated at cost or, in the case of leased assets under capital leases, at cost or the present value of future lease payments. Depreciation and amortization, including amortization of leased assets under capital leases, are computed on a straight-line basis over the lesser of the estimated useful life of the asset or the remaining term of the lease.\nDepreciation and amortization for financial purposes are based on the following estimated lives:\nEstimated lives --------------- Buildings 10 - 40 Fixtures and equipment 5 - 12.5 Leasehold improvements 15 Transportation equipment 5 - 10 Software 5 - 10 2. Summary of Significant Accounting Policies, continued:\nThe costs of repairs and maintenance are expensed as incurred, and the costs of renewals and betterments are capitalized and depreciated at the appropriate rates. Upon sale or retirement, the cost and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss is included in the results of operations for that period.\nExcess of purchase price over fair value of net assets acquired - The excess of purchase price over fair value of net assets acquired is being amortized on a straight-line basis over 40 years. The net remaining balance of the excess of purchase price over fair value of net assets acquired is assessed periodically based on the estimated recoverable value related to the assets acquired. Approximately $250 was written off during 1994 as a result of this assessment. The net amount of the excess of purchase price over fair value of net assets acquired as of December 31, 1994, related to the 29 stores and stores to be closed in 1995 has been written off in 1994 as part of the operational restructuring costs (see Note 14).\nOther assets and deferred charges - Other assets and deferred charges consist primarily of financing costs amortized using the effective interest rate method over the term of the related debt and beneficial interests in operating leases amortized on a straight-line basis over the remaining terms of the leases, including all available renewal option periods.\nNet income (loss) per common share - Net income (loss) per common share is computed based on the weighted average number of shares, including shares of redeemable common stock outstanding during the period. Net income (loss) is reduced (increased) by the accretion to (reduction in) redemption value to determine the net income (loss) available to common stockholders.\nCash and cash equivalents - For purposes of the statements of cash flows, the Company considers all short-term investments with an original maturity of three months or less when purchased to be cash equivalents.\nCapitalized interest - The Company capitalizes interest as a part of the cost of acquiring and constructing certain assets. Interest costs of $35, $44, and $195 were capitalized in 1994, 1993 and 1992, respectively.\n2. Summary of Significant Accounting Policies, continued:\nPre-opening costs - Costs associated with the opening of new stores are expensed in the year the stores are opened.\nAdvertising Costs - Costs of advertising are expensed as incurred. Gross advertising costs for 1994, 1993 and 1992, respectively, were $13,615, $14,100 and $14,531.\nIncome taxes - The Company accounts for income taxes on the liability method as required by Statement of Financial Accounting Standards No. 109. Accordingly, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Deferred taxes also are recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future Federal income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities, net of applicable valuation allowances.\nSelf-insurance reserves - The Company is self-insured for property loss, general liability and automotive liability coverage, and was self-insured for workers' compensation coverage until June 30, 1994, subject to specific retention levels. Estimated costs of these self-insurance programs are accrued at their present value based on projected settlements for claims using actuarially determined loss development factors based on the Company's prior history with similar claims. Any resulting adjustments to previously recorded reserves are reflected in current operating results.\nImpact of Recently Issued Accounting Pronouncement - The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, \"Accounting for Postemployment Benefits\" in November 1992. The adoption of this new standard in 1994, as required, did not have a material effect on the Company's consolidated results of operations or financial position.\nReclassification - Certain reclassifications have been made to the 1993 consolidated financial statements to conform with the 1994 presentations. 3. Long-term Debt:\nPrior to a March 1992 refinancing, the Company's long-term debt consisted of borrowings under a credit agreement (\"Prior Credit Agreement\") from a group of banks that included term notes and revolving credit loans (including a swing loan and certain letters of credit), subordinated notes, and a note payable issued as a result of an acquisition of certain stores.\nIn March 1992, the Company entered into an Indenture with United States Trust Company of New York, as trustee, pursuant to which the Company issued $45,000 in aggregate principal amount of Series A Senior Secured Floating Rate Notes due 1997 (the \"Old Floating Rate Notes\") and $75,000 in aggregate principal amount of Series B Senior Secured Fixed Rate Notes due 1999 (the \"Old Fixed Rate Notes\", and collectively, the \"Old Notes\"). Certain proceeds from this issuance were used to repay all amounts outstanding under the Prior Credit Agreement, to repurchase $12,250 in aggregate principal amount of the subordinated notes at a purchase price of 110% of the principal amount and to make a prepayment of $1,500 on the note payable. In conjunction with the prepayment on the note payable, the Company issued a new $3,000 note.\nIn October and November 1992, the Company exchanged a portion of its Series D Senior Secured Floating Rate Notes due 1997 and its Series C Senior Secured Fixed Rate Notes due 1999 (the \"New Notes\") for equal principal amounts of the Old Notes. The New Notes are substantially identical to the Old Notes, except that the offering of the New Notes was registered with the Securities and Exchange Commission. At the expiration of the exchange offer in November 1992, $33,000 in principal amount of the Old Floating Rate Notes and $75,000 in principal amount of the Old Fixed Rate Notes had been tendered and accepted for exchange and $12,000 of the Old Floating Rate Notes remain outstanding.\nAlso in March 1992, the Company entered into a Revolving Credit Agreement (the \"Revolving Credit Agreement\") with Union Bank of Switzerland, New York Branch (\"UBS\"), as agent and as lender, and any other lenders and other financial institutions thereafter parties thereto. As a result of the Company's redemption of the remaining outstanding Subordinated Notes on March 1, 1993, and satisfying certain other conditions, the Revolving Credit Agreement provides a commitment of up to $50,000 in secured revolving credit loans, including a swing loan and certain letters of credit.\n3. Long-term Debt, continued:\nOn March 1, 1993, the Company redeemed all remaining outstanding subordinated notes ($47,750 principal amount), at the optional redemption price (including a premium of $2,776 or 5.8% of the outstanding principal amount) specified in the subordinated notes, together with accrued interest. The Company borrowed $32,000 under its Revolving Credit Agreement and used $21,000 of the remaining net proceeds from the issuance of the Old Notes to redeem the Subordinated Notes.\nAs a result of the March 1993 redemption and the March 1992 refinancing, the Company incurred the following extraordinary gains and losses:\nCash and cash equivalents - The carrying amounts of this item is a reasonable estimate of its fair value due to its short- term nature.\nLong-term debt - The fair value of publicly traded debt (the Senior Secured Notes) is valued based on quoted market values. The amount reported in the balance sheet for the remaining long term debt approximates fair value based on quoted market prices of comparable instruments or by discounting expected cash flows at rates currently available for debt of the same remaining maturities.\n5. Income Taxes:\nThe components of the income tax benefit (provision) for fiscal 1994, 1993 and 1992 were as follows:\nA reconciliation of the income tax benefit (provision) at the statutory Federal income tax rate to the Company's effective tax rate is as follows:\nA valuation allowance was established in the fourth quarter of fiscal 1994 to entirely offset the net deferred tax assets due to the uncertainty of realizing the future tax benefits, of which $3,997 related to net deferred tax assets carried forward from the prior year.\n5. Income Taxes, continued:\nAt December 31, 1994, the Company had the following operating loss and tax credit carryforwards available for tax purposes:\nThe Internal Revenue Service (\"IRS\") concluded a field audit of the Company's income tax returns for the fiscal years 1990, 1991 and 1992. On January 31, 1994, the IRS issued a Revenue Agent's Report for those fiscal years proposing adjustments that would result in additional taxes of $1,589 (this amount is net of any available operating loss carryforwards which would be eliminated under the proposed adjustment). The Company filed its protest with the IRS Appeals Office on June 14, 1994. The IRS Appeals Office is currently in the process of reviewing the Company's protest. The major proposed adjustment involves the allocation of the initial purchase price of the Company to inventory. The Company believes that it has meritorious legal defenses to the proposed adjustments and intends to vigorously protest the assessment. Management has analyzed all of the matters and has provided for amounts which it currently believes are adequate.\n6. Incentive Compensation Plan:\nThe Company has bonus arrangements for store management and other key management personnel. During 1994, 1993, and 1992, approximately $1,939, $2,900, and $2,319, respectively, was charged to costs and expenses for such bonuses.\n7. Retirement Plans:\nEffective January 1, 1988, the Company adopted a non- contributory, defined benefit retirement plan for all executive and administrative personnel. Benefits are based on length of service and career average pay with the Company. The Company's funding policy is to contribute an amount equal to or greater than the minimum funding requirement of the\n7. Retirement Plans, continued:\nEmployee Retirement Income Security Act of 1974, but not in excess of the maximum deductible limit. Assets were held in short-term investment mutual funds during 1994 and 1993.\nIn accordance with the provisions of Statement of Financial Accounting Standards No. 87 - \"Employers' Accounting for Pensions\", the Company recorded an additional minimum liability at January 1, 1994 representing the excess of the accumulated benefit obligation over the fair value of plan assets and accrued pension liability. The additional liability was offset by intangible assets to the extent of previously unrecognized prior service cost. Amounts in excess of previously unrecognized prior service cost were recorded as a $572 reduction of stockholders' equity in 1993. During 1994, additional contributions were made to the plan resulting in the fair value of plan assets being in excess of the accumulated benefit obligation. The entry made in 1993 to stockholders' equity was reversed in 1994.\nNet pension cost consists of the following:\n1994 1993 1992 ---- ---- ---- Service cost $709 $663 $659 Interest cost 366 293 222 Loss (return) on assets 63 (319) 17 Net amortization and deferral (419) 43 (230) ---- ---- ---- Net periodic pension cost $719 $680 $668 ==== ==== ====\nThe funded status of the plan and the amounts recognized in the Company's balance sheet at December 31, 1994 and January 1, 1994 consist of the following:\nFor 1994, a discount rate of 7 1\/2% was used for the determination of net periodic pension cost and 9% for the determination of plan disclosure at the end of the plan year. For 1993, a discount rate of 7 1\/2% was used. A long term rate of return of 9% was used for both 1994 and 1993. For 1994, assumed annual rates of future compensation increases ranging from 3 1\/2% to 5 1\/2% (graded by age) were used for the determination of net periodic pension cost and rates ranging from 5% to 7% (graded by age) were used for the plan disclosures at the end of the plan year. For 1993, assumed annual rates of future compensation increases ranging from 3 1\/2% to 5 1\/2% (graded by age) were used. The prior service cost is being amortized on a straight-line basis over approximately 13 years.\nThe Company also contributes to various union-sponsored, multi-employer defined benefit plans in accordance with the collective bargaining agreements. The Company could, under certain circumstances, be liable for the Company's unfunded vested benefits or other costs of these multi-employer plans. The allocation to participating employers of the actuarial present value of vested and nonvested accumulated benefits in multi-employer plans as well as net assets available for benefits is not available and, accordingly, is not presented. The costs of these plans for 1994, 1993 and 1992 were $3,309, $3,565, and $3,766, respectively. 7. Retirement Plans, continued:\nEffective January 1, 1988, the Company adopted a defined contribution plan covering substantially all non-union employees of the Company. Prior to 1994, the Company contributed a matching 50% for each one dollar the participants contribute in pre-tax matched contributions. Participants may contribute from 1% to 6% of their pre-tax compensation which was matched by the Company. Participants may make additional contributions of 1% to 6% of their pre-tax compensation, but such contributions were not matched by the Company. Effective January 2, 1994, the plan was amended to allow a discretionary matching contribution formula based on the Company's operating results. The cost of this plan for 1994, 1993, and 1992, was $0, $425, and $616, respectively.\n8. Leases:\nThe Company leases substantially all of its retail store properties under noncancellable agreements, the majority of which range from 15 to 25 years. These leases, which include both capital leases and operating leases, generally are subject to six five-year renewal options. Most leases also require the payment of taxes, insurance and maintenance costs and many of the leases covering retail store properties provide for additional contingent rentals based on sales. Leased assets under capital leases consists of the following:\nFuture minimum lease payments under capital leases and noncancellable operating leases as of December 31, 1994 are as follows:\n8. Leases, continued:\n9. Common Stock:\nHolding has agreed to repurchase shares of stock held by management investors under certain conditions (as defined), such as death, retirement, or permanent disability.\nPursuant to requirements of the Securities and Exchange Commission, the shares of Class A common stock held by management investors have been presented as redeemable common stock and excluded from stockholders' equity. The changes in the number of shares outstanding and the value of the redeemable common stock is as follows:\n9. Common Stock, continued:\nThe shares of redeemable common stock are reported on the balance sheets at redemption value, which is the estimated fair market value of the stock. In 1994, the reduction in redemption value has been reflected as an increase in additional paid-in capital.\nHolding also has 40,500,000 shares of Class B nonvoting common stock authorized at December 31, 1994 and January 1, 1994 with a $.01 par value. No shares were issued or outstanding at either December 31, 1994 or January 1, 1994.\n10. Related Party Transactions:\nClayton, Dubilier & Rice, Inc., a private investment firm of which three directors of the Company are employees, received $150 in 1994 and $200 annually during 1993 and 1992, for financial advisory and consulting services.\nThe Company made loans during 1994 and 1993 to certain members of management and key employees for principal payments on their loans made by the credit union in connection with their purchase of common stock. The loans bear interest at a variable rate equal to the Company's prime lending rate plus 1.0%. Loans outstanding at December 31, 1994 and January 1, 1994 were $794 and $715, respectively, and are shown in the consolidated balance sheet as a reduction in the redeemable common stock. The loans mature in 1995.\n11. Commitments and Contingencies:\nEffective January 1, 1989, the Company implemented stock appreciation rights plans for certain of its hourly union and non-union employees as well as salaried employees. Effective as of November 4, 1989, the Company implemented a similar stock appreciation rights plan for its Teamster union employees. Participants in the plans are granted at specified times \"appreciation units\" which, upon the occurrence of certain triggering events, entitle them to receive cash payments equal to the increase in value of a share of the common stock from the date of the plan's establishment. It is uncertain whether such triggering events will occur.\nEffective October 1, 1991, the Company entered into an outsourcing agreement whereby an outside party provides virtually all of the Company's EDP requirements and assumed substantially all of the Company's existing hardware and software leases and related maintenance agreements. The ten year agreement calls for minimum annual service charges, increasing over its term, as well as other variable charges. Future minimum annual service charges under the agreement as of December 31, 1994 aggregate $30,653. The agreement is cancelable by either party subject to a penalty that declines over the term of the agreement.\nEffective May 26, 1992, the Company entered into an outsourcing agreement whereby an outside party provides transportation of grocery and other supermarket products from the Company's distribution facilities to the Company's stores and other locations designated by the Company. The agreement is effective through March 1997. Payments under the agreement are determined based on miles traveled in accordance with predetermined rates. During 1994 and 1993, the Company paid $6,473 and $7,367, respectively, for services received.\nThe Company has entered into employment contracts with certain key executives providing for the payment of minimum salary and bonus amounts in addition to certain other benefits in the event of termination of the executives or change of control of the Company.\nIn conjunction with the sale to AWG, three class grievances have been filed by the United Food and Commercial Workers of North America (\"UFCWNA\") and have been submitted to binding arbitration under the terms of the Labor Agreement. The grievances involve: (i) the question of whether a special 11. Commitments and Contingencies, continued:\ntermination pay provision in the Labor Agreement is triggered by the sale to AWG; (ii) the application of the severance pay provision in the Labor Agreement; and (iii) calculation of accrued but unused vacation pay due employees at the time of termination. The maximum aggregate amount being sought pursuant to the grievances is $5.1 million. The arbitrations will be held during May through July. The Company believes that its position on these grievances will be upheld by the arbitrator and that the disposition of these grievances through arbitration will not have a material adverse effect on the Company's financial position.\nThe Company is also a party to various lawsuits arising in the normal course of business. Management believes that the ultimate outcome of these matters will not have a material effect on the Company's consolidated financial position, results of operations and cash flows.\nThe Company has outstanding at December 31, 1994, $7,345 in letters of credit which are not reflected in the accompanying financial statements. The letters of credit are issued under the Revolving Credit Agreement and the Company paid fees of $195 and $97 in 1994 and 1993, respectively.\n12. Sale of Plants:\nIn November 1993 the Company entered into an asset purchase agreement with Borden, Inc. (\"Borden\") whereby certain of the Company's milk and ice cream processing equipment and certain other assets and inventory relating to its milk and ice cream plants was sold. In connection with the sale, the Company entered into a seven-year agreement with Borden under which Borden would supply all of the Company's requirements for most of its dairy, juice and ice cream products and the Company agreed to purchase minimum volumes of products. The Company recognized a gain on the sale of personal property in the amount of $2,618. A $4,000 payment received in connection with the supply agreement was deferred and was to be recognized as earned over the term of the supply agreement.\nIn December 1994, the Company entered into a settlement agreement with Borden whereby the seven-year supply agreement entered into in November 1993 was terminated and a temporary supply agreement for a maximum period of 120 days was entered into. As part of the settlement agreement, the Company repaid $1,650 plus interest in December 1994 and must make another 12. Sale of Plants, continued:\npayment of $1,650 plus interest upon termination of the temporary supply agreement. The Company has made arrangements with another dairy supplier to begin supplying its dairy and ice cream requirements in April 1995.\n13. Fourth Quarter Adjustment:\nIn the fourth quarter of 1994, the Company made an adjustment to increase its workers compensation accruals by $5,000. This increase was due to an increase in the actuarially projected ultimate costs of the self-insured plans, reflecting increases in claims and related settlements.\n14. Restructuring:\nIn accordance with a strategic plan approved by the Board of Directors in December 1994, the Company entered into an agreement with Associated Wholesale Grocers, Inc. (\"AWG\") on February 6, 1995, pursuant to which the Company has agreed to sell 29 of its stores and its warehouse and distribution center to AWG for a purchase price of $45 million plus the value of the inventory in the 29 stores and the warehouse, subject to certain possible purchase price adjustments. In connection with this agreement, the Company will enter into a seven year supply agreement pursuant to which AWG will be the Company's primary supplier for the remaining stores. The AWG sale closed on April 21, 1995. The Company plans to use the net proceeds from the transaction to reduce its indebtedness under both the Senior Notes and the Revolving Credit Agreement.\nThe Company also plans to close 15 under-performing stores during 1995. The Company plans to sell certain stores or lease some stores to other retailers and in some cases seek to abandon certain leases and dispose of any equipment in the most productive manner. The Company intends to buy-out operating and capital leased equipment related to the closed stores from current lessors and dispose of them in the same manner. Five stores were closed in February 1995 and two in March 1995.\nIn connection with the sale of 29 stores and the warehouse facility to AWG and the closing of stores, the Company recorded a $23,205 charge in the fourth quarter of fiscal 1994. The major components of the restructuring charge are summarized as follows: 14. Restructuring, continued:\nWrite-down of inventory to estimated realizable value $4,479\nWrite-down of prepaid expenses and other current assets associated with the AWG Transaction 898\nWrite-down of net property, plant and equipment associated with closed stores, net of estimated proceeds 7,402\nWrite-down of unamortized beneficial leaseholds, transportation outsourcing costs and other deferred charges 3,132\nWrite-down of unamortized excess of purchase price over fair value of net assets acquired associated with the stores sold to AWG or closed 977\nExpenses associated with the planned store closings, primarily occupancy costs from closing date to lease termination or sublease date 8,319\nExpenses associated with the AWG Transaction, primarily service and equipment contract cancellation fees 5,649\nEstimated severance costs associated with the AWG Transaction (see below) 5,624\nLegal and consulting fees associated with the AWG Transaction 6,217\nNet gain on sale of property, plant and equipment to AWG (19,492) -------- Total restructuring charges $ 23,205 ========\nThe estimated severance costs accrued during the fourth quarter are for approximately 165 non-union employees and approximately 1,360 union employees whose employment will be 14. Restructuring, continued:\nterminated in connection with the sale of 29 stores and the warehouse facility to AWG. Approximately $1.0 million of severance costs are expected to be incurred subsequent to fiscal 1994 in connection with the planned store closings. These severance costs have not been accrued in fiscal 1994 since the affected employees were not notified prior to December 31, 1994.\nApproximately $1,300 of bank fees, noteholder fees and premium for early extinguishment of debt are expected to be incurred subsequent to fiscal 1994 in connection with the restructuring of debt discussed in Note 15. In addition, approximately $1,400 of refinancing costs previously capitalized are expected to be written off subsequent to fiscal 1994 when a portion of the debt is extinguished early. These costs have not been accrued in fiscal 1994 since the extinguishment of debt has not yet occurred.\nAs of December 31, 1994, the Company had paid approximately $1,312 of legal and consulting fees associated with the AWG Transaction. The asset write-downs described above, aggregating $16,888, have been reflected in their respective balance sheet account classifications as of December 31, 1994. The remaining charges, aggregating $5,005, have been included in the consolidated balance sheet at December 31, 1994 under the caption Noncurrent restructuring reserve.\nIn connection with the sale of 29 stores and the warehouse and distribution center to AWG, $29,375 net book value of property, plant and equipment is held for resale at December 31, 1994. In addition, $2,200 net book value of property, plant and equipment related to the 15 stores to be closed in 1995 is held for resale at December 31, 1994.\nThe separately identifiable revenue and store contribution to operating profit (loss) related to the stores being sold to AWG or closed and expenses related to the warehouse facility are as follows:\n14. Restructuring, continued:\nUnder the AWG supply agreement, the ongoing costs of warehousing will be built into the cost of goods purchased from AWG.\n15. Subsequent Events:\nOn April 13, 1995, the Company received consents for certain amendments to the Senior Note Indenture from a majority of the holders of Senior Notes. The amendments include, among other things, (a) increasing the interest rate on each series of Notes by one-half of one percent (0.5%) per annum; (b) amending, adding and deleting certain financial covenants and related definitions under the Senior Note Indenture (including modifying the Consolidated Fixed Charge Coverage Ratio covenant, adding a new Debt-to-EBITDA ratio and a new Capital Expenditures covenant, deleting the Adjusted Consolidated Net Worth covenant) to reflect the Company's size, operations and financial position following the AWG Transaction. Until the consent was approved, the Company had obtained a waiver from the Senior Noteholders waiving compliance with certain financial covenant requirements in effect as of December 31, 1994 through June 30, 1995. On April 21, 1995, the Company and United States Trust Company of New York, as trustee for the holders of the Senior Notes, entered into a supplemental indenture effecting these amendments.\nThe Company replaced its current Revolving Credit Agreement with a revised revolving facility (the \"Amended and Restated Revolving Credit Agreement\") on April 21, 1995. The Amended and Restated Revolving Credit Agreement is with National Bank of Canada, (\"NBC\") as agent and as lender, Heller Financial, Inc. and any other lenders thereafter parties thereto. The Amended and Restated Revolving Credit Agreement provides a commitment of up to $25 million in secured revolving credit loans, including certain letters of credit. The Amended and Restated Revolving Credit Agreement permits borrowings (a) to refinance the previous Revolving Credit Agreement, (b) for working capital needs and (c) to issue standby letters of credit and documentary letters of credit. Borrowings under the Amended and Restated Revolving Credit Agreement bear interest at the NBC Base Rate plus 1.5% for the first year (10.5% as of April 21, 1995). Subsequent year's interest rates will be dependent upon the Company's earnings but will not exceed NBC base rate plus 2.0%. All borrowings under the amended and Restated Revolving Credit Agreement are subject\n15. Subsequent Events, continued:\nto a borrowing base and mature no later than February 27, 1997, with the possibility of extending the maturity date to March 31, 1998 if the Company's Series A Senior Secured Floating Rate Notes due February 27, 1997, are extended or refinanced on terms acceptable to NBC. The Amended and Restated Credit Agreement, among other things, requires the maintenance of leverage and coverage ratios as defined, and limits the Company's net capital expenditures and incurrence of additional indebtedness and limits the payment of dividends. The notes are collateralized by accounts receivable and inventories of the Company.\nThe AWG sale described in Note 14 closed on April 21, 1995, on the same basis as described within Note 14.\nOn April 21, 1995, the Company made an offer to repurchase shares of its Common Stock owned by certain officers and employees of the Company at a cash purchase price of $0.50 per share, plus a warrant equal to the number of share purchased with an exercise price of $0.50. However, such repurchases shall not exceed $600,000 in the aggregate (net of amounts to be repaid in respect of loans from the Company) and individual repurchases shall not exceed any outstanding loan balance that the officers or employees may have related to their purchase of Common Stock.\nEXHIBIT INDEX\nExhibit No. Description\n3a Restated Certificate of Incorporation of Homeland Holding Corporation (\"Holding\"), dated August 2, 1990. (Incorporated by reference to Exhibit 3a to Form 10-Q for quarterly period ended September 8, 1990)\n3b By-laws of Holding, as amended and restated on November 14, 1989 and further amended on September 23, 1992. (Incorporated by reference to Exhibit 3b to Form 10-Q for quarterly period ended June 19, 1993)\n3c Restated Certificate of Incorporation of Homeland Stores, Inc. (\"Homeland\"), dated March 2, 1989. (Incorporated by reference to Exhibit 3c to Form 10-K for fiscal year ended December 31, 1988)\n3d By-laws of Homeland, as amended and restated on November 14, 1989 and further amended on September 23, 1992. (Incorporated by reference to Exhibit 3d to Form 10-Q for quarterly period ended June 19, 1993)\n4a Indenture, dated as of November 24, 1987, among Homeland, The Connecticut National Bank (\"CNB\"), as Trustee, and Holding, as Guarantor. (Incorporated by reference to Exhibit 4a to Form S-1 Registration Statement, Registration No. 33-22829)\n4a.1 First Supplement to Indenture, dated as of August 15, 1988, among Homeland, CNB and Holding. (Incorporated by reference to Exhibit 4a.1 to Form S-1 Registration Statement, Registration No. 33-22829)\n4b Purchase Agreement, dated November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 4b to Form S-1 Registration Statement, Registration No. 33-22829) 4c Form of Registration Rights Agreement, dated as of November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 4c to Form S-1 Registration Statement, Registration No. 33-22829)\n4d Indenture, dated as of March 4, 1992, among Homeland, United States Trust Company of New York (\"U.S.Trust\"), as Trustee, and Holding, as Guarantor. (Incorporated by reference to Exhibit 4d to form 10-K for fiscal year ended December 28, 1991)\n4d.1 First Supplement to Indenture, dated as of June 17, 1992, among Homeland, Holding and U.S. Trust. (Incorporated by reference to Exhibit 4d.1 to Form S-1 Registration Statement, Registration No. 33-48862)\n4d.3 Partial Release of Collateral, dated as of May 22, 1992, by U.S. Trust, as Collateral Trustee, in favor of Homeland. (Incorporated by reference to Exhibit 4d.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n4e Form of Purchase Agreement, dated as of March 4, 1992, among Homeland and initial purchasers of Senior Notes. (Incorporated by reference to Exhibit 4e to Form 10-K for fiscal year ended December 28, 1991)\n4f Form of Registration Rights Agreement, dated as of March 4, 1992, among Homeland and the initial purchasers of Senior Notes. (Incorporated by reference to Exhibit 4f to Form 10-K for fiscal year ended December 28, 1991)\n10a Asset Purchase Agreement, dated as of September 15, 1987. (Incorporated by reference to Exhibit 10a to Form S-1 Registration Statement, Registration No. 33-22829)\n10b First Amendment to Asset Purchase Agreement, dated November 24, 1987. (Incorporated by reference to Exhibit 10b to Form S-1 Registration Statement, Registration No. 33-22829)\n10c Stock Subscription Agreement, dated as of November 24, 1987, between Holding and The Clayton & Dubilier Private Equity Fund III Limited Partnership. (Incorporated by reference to Exhibit 10c to Form S-1 Registration Statement, Registration No. 33-22829)\n10e Purchase Agreement for Safeway Brand Products, dated as of November 24, 1987, between Homeland and Safeway. (Incorporated by reference to Exhibit 10e to Form S-1 Registration Statement, Registration No. 33-22829)\n10f Manufacturing and Supply Agreement, dated as of November 24, 1987, between Homeland and Safeway. (Incorporated by reference to Exhibit 10f to Form S-1 Registration Statement, Registration No. 33-22829)\n10g Form of Common Stock Purchase Agreement, dated November 24, 1987, between Holding and certain institutional investors. (Incorporated by reference to Exhibit 10g to Form S-1 Registration Statement, Registration No. 33-22829)\n10h (1) Form of Management Stock Subscription Agreement, dated as of October 20, 1988, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated by reference to Form 10-K for fiscal year ended December 31, 1988)\n10h.1 (1) Form of Management Stock Subscription Agreement, dated as of October 20, 1988, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated by reference to Form 10-K for fiscal year ended December 31, 1988)\n10h.2 (1) Form of Management Stock Subscription Agreement, dated as of November 29, 1989, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated by reference to Form 10-K for fiscal year ended December 30, 1989)\n10h.3 (1) Form of Management Stock Subscription Agreement, dated as of November 29, 1989, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated by reference to Form 10-K for fiscal year ended December 30, 1989)\n10h.4 (1) Form of Management Stock Subscription Agreement dated as of August 14, 1990, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated herein by reference to Exhibit 10h.4 to Form 10-K for fiscal year ended December 29, 1990)\n10h.5 (1) Form of Management Stock Subscription Agreement dated as of August 14, 1990, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated herein by reference to Exhibit 10h.5 to Form 10-K for fiscal year ended December 29, 1990)\n10i.1 Form of Registration and Participation Agreement, dated as of November 24, 1987, among Holding, The Clayton & Dubilier Private Equity Fund III Limited Partnership, and initial purchasers of Common Stock. (Incorporated by reference to Exhibit 10i to Form S-1 Registration Statement, Registration No. 33-22829)\n10i.2 1990 Registration and Participation Agreement dated as of August 13, 1990, among Homeland Holding Corporation, Clayton & Dubilier Private Equity Fund IV Limited Partnership and certain stockholders of Homeland Holding Corporation. (Incorporated by reference to Exhibit 10y to Form 10-Q for quarterly period ended September 8, 1990)\n10i.3 Form of Store Managers Stock Purchase Agreement. (Incorporated by reference to Exhibit 10z to Form 10-Q for quarterly period ended September 8, 1990)\n10j Indenture, dated as of November 24, 1987. (Incorporated by reference to Exhibit 10j to Form S-1 Registration Statement, Registration No. 33-22829)\n10j.1 First Supplement to Indenture, dated as of August 15, 1988. (Incorporated by reference to Exhibit 10j.1 to Form S-1 Registration Statement, Registration No. 33-22829)\n10k Form of Purchase Agreement, dated November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes (Filed as Exhibit 4b). (Incorporated by reference to Exhibit 10k to Form S-1 Registration Statement, Registration No. 33-22829)\n10l Form of Registration Rights Agreement, dated as of November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 10l to Form S-1 Registration Statement, Registration No. 33-22829)\n10q (1) Homeland Profit Plus Plan, effective as of January 1, 1988. (Incorporated by reference to Exhibit 10q to Form S-1 Registration Statement, Registration No. 33-22829)\n10q.1 (1) Homeland Profit Plus Plan, effective as of January 1, 1989 (Incorporated by reference to Exhibit 10q.1 to Form 10-K for the fiscal year ended December 29, 1990)\n10r Homeland Profit Plus Trust, dated March 8, 1988, between Homeland and the individuals named therein, as Trustees. (Incorporated by reference to Exhibit 10r to Form S-1 Registration Statement, Registration No. 33-22829)\n10r.1 Homeland Profit Plus Trust, dated January 1, 1989, between Homeland and Bank of Oklahoma, N.A., as Trustee (Incorporated by reference to Exhibit 10r.1 to Form 10-K for the fiscal year ended December 29, 1990)\n10s (1) 1988 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s to Form S-1 Registration Statement, Registration No. 33-22829)\n10s.1 (1) 1989 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.1 to Form 10-K for fiscal year ended December 31, 1988)\n10s.2 (1) 1990 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.2 to Form S-1 Registration Statement, Registration No. 33-48862)\n10s.3 (1) 1991 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n10s.4 (1) 1992 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.4 to Form S-1 Registration Statement, Registration No. 33-48862)\n10s.5 (1) 1993 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.5 to Form 10-K for fiscal year ended January 1, 1994) 10s.6* (1) 1994 Homeland Management Incentive Plan.\n10t (1) Form of Homeland Employees' Retirement Plan, effective as of January 1, 1988. (Incorporated by reference to Exhibit 10t to Form S-1 Registration Statement, Registration No. 33-22829)\n10t.1 (1) Amendment No. 1 to Homeland Employees' Retirement Plan effective January 1, 1989. (Incorporated herein by reference to Form 10-K for fiscal year ended December 30, 1989)\n10t.2 (1) Amendment No. 2 to Homeland Employees' Retirement Plan effective January 1, 1989. (Incorporated herein by reference to Form 10-K for fiscal year ended December 30, 1989)\n10t.3 (1) Third Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1988. (Incorporated herein by reference to Exhibit 10t.3 to Form 10-K for fiscal year ended December 29, 1990)\n10t.4 (1) Fourth Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1989. (Incorporated herein by reference to Exhibit 10t.4 to Form 10-K for the fiscal year ended December 28, 1991)\n10u (1) Employment Agreement, dated as of January 11, 1988, between Homeland and Jack M. Lotker. (Incorporated by reference to Exhibit 10u to Form S-1 Registration Statement, Registration No. 33- 22829)\n10v UFCW Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v to Form 10-Q for quarterly period ended March 25, 1989)\n10v.1 Stock Appreciation Rights Plan of Homeland for Non-Union Employees. (Incorporated by reference to Exhibit 10v.1 to Form 10-Q for quarterly period ended March 25, 1989)\n10v.2 Teamsters Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v.2 to Form S-1 Registration Statement, Registration No. 33-48862)\n10v.3 BC&T Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n10w (1) Employment Agreement, dated as of September 26, 1989, between Homeland and Max E. Raydon. (Incorporated by reference to Exhibit 10w to Form 10-Q for quarterly period ended September 9, 1989)\n10x Indemnification Agreement, dated as of August 14, 1990, among Holding, Homeland, Clayton & Dubilier, Inc. and The Clayton & Dubilier Private Equity Fund III Limited Partnership. (Incorporated by reference to Exhibit 10x to Form 10-Q for quarterly period ended September 8, 1990)\n10y Indenture, dated as of March 4, 1992, among Homeland, United States Trust Company of New York, as Trustee, (\"U.S. Trust\") and Holding, as Guarantor. (Filed as Exhibit 4d)\n10y.1 First Supplement to Indenture, dated as of June 17, 1992, among Homeland, Holding and U.S. Trust. (Filed as Exhibit 4d.1)\n10z Form of Purchase Agreement, dated as of March 4, 1992, among Homeland, Holding and the initial purchasers of Senior Notes. (Filed as Exhibit 4e).\n10aa Form of Registration Rights Agreement, dated as of March 4, 1992, among Homeland and the initial purchasers of Senior Notes. (Filed as Exhibit 4f).\n10bb Form of Parent Pledge Agreement, dated as of March 4, 1992, made by Holding in favor of U.S. Trust, as collateral trustee for the holders of the Senior Notes. (Incorporated by reference to Exhibit 10bb to Form 10-K for the fiscal year ended December 28, 1991)\n10cc Revolving Credit Agreement, dated as of March 4, 1992, among Homeland, Holding, Union Bank of Switzerland, New York Branch, as Agent and lender, and any other lenders and other financial institutions thereafter parties thereto. (Incorporated by reference to Exhibit 10cc to Form 10-K for the fiscal year ended December 28, 1991)\n10cc.1 Letter Waiver (Truck Sale), dated as of May 19, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.1 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.2 Form of Amendment Agreement, dated as of June 15, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.2 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.3 Form of Second Amendment Agreement, dated as of September 23, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.4 Third Amendment Agreement, dated as of February 10, 1993, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement.\n10cc.5 Fourth Amendment Agreement, dated as of June 8, 1993, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.5 to Form 10-Q for the quarterly period ended June 19, 1993)\n10cc.6 Fifth Waiver and Amendment Agreement, dated as of April 14, 1994, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.6 to Form 10-K for the fiscal year ended January 1, 1994)\n10cc.7* Sixth Waiver and Amendment Agreement, dated as of February 7, 1995, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement.\n10dd Agreement for Systems Operations Services, effective as of October 1, 1991, between Homeland and K-C Computer Services, Inc. (Incorporated by reference to Exhibit 10dd to Form 10-K for the fiscal year ended December 28, 1991)\n10dd.1 Amendment No. 1 to Agreement for Systems Operations Services, dated as of September 10, 1993, between Homeland and K-C Computer Services, Inc. (Incorporated by reference to Exhibit 10dd.1 to Form 10-K for the fiscal year ended January 1, 1994)\n10ee Form of Indemnification Agreement, dated as of March 4, 1992, among Homeland, Holding, Clayton & Dubilier, Inc., The Clayton & Dubilier Private Partnership Equity Fund III Limited Partnership, and The Clayton & Dubilier Private Equity Fund IV Limited Partnership. (Incorporated by reference to Exhibit 10ee to Form 10-K for the fiscal year ended December 28, 1991)\n10ff Product Transportation Agreement, dated as of March 18, 1992, between Homeland and Drake Refrigerated Lines, Inc. (Incorporated by reference to Exhibit 10ff to Form 10-K for the fiscal year ended December 28, 1991)\n10gg Assignment and Pledge Agreement, dated March 5, 1992, made by Homeland in favor of Manufacturers Hanover Trust Company. (Incorporated by reference to Exhibit 10gg to Form 10-K for the fiscal year ended December 28, 1991)\n10hh Transportation Closure Agreement Summary, dated May 28, 1992, between Homeland and the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America. (Incorporated by reference to Exhibit 10hh to Form S-1 Registration Statement, Registration No. 33-48862)\n10ii (1) Description of terms of employment with Mark S. Sellers. (Incorporated by reference to Exhibit 10ii to Form 10-K for the fiscal year ended January 2, 1993)\n10jj (1) Settlement Agreement, dated as of July 26, 1993, between Homeland and Donald R. Taylor. (Incorporated by reference to Exhibit 10jj to Form 10-K for the fiscal year ended January 1, 1994)\n10kk (1) Executive Officers Medical\/Life Insurance Benefit Plan effective as of December 9, 1993. (Incorporated by reference to Exhibit 10kk to Form 10-K for the fiscal year ended January 1, 1994)\n10ll (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Max E. Raydon. (Incorporated by reference to Exhibit 10ll to Form 10-Q for the quarterly period ended September 10, 1994)\n10mm (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Jack M. Lotker. (Incorporated by reference to Exhibit 10mm to Form 10-Q for the quarterly period ended September 10, 1994)\n10nn (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Steve Mason. (Incorporated by reference to Exhibit 10nn to Form 10-Q for the quarterly period ended September 10, 1994)\n10oo (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Al Fideline. (Incorporated by reference to Exhibit 10oo to Form 10-Q for the quarterly period ended September 10, 1994)\n10pp Letter of Intent, executed on November 30, 1994, between Homeland and Associated Wholesale Grocers, Inc. (Incorporated by reference to Exhibit 10pp to Form 8-K dated November 29, 1994)\n10pp.1* Asset Purchase Agreement, dated as of February 6, 1995, between Homeland and Associated Wholesale Grocers, Inc.\n10qq Solicitation Statement, dated April 4, 1995. (Incorporated by reference to Exhibit 10qq to Form 8-K dated April 4, 1995)\n10rr* (1) Employment Agreement, dated as of November 22, 1994, between Homeland and James A. Demme.\n10ss* (1) Settlement Agreement, dated as of December 31, 1994, between Homeland and Max E. Raydon.\n10tt* (1) Employment Agreement, dated as of January 30, 1995, between Homeland and Mark S. Sellers.\n22 Subsidiaries. (Incorporated by reference to Exhibit 22 to Form S-1 Registration Statement, Registration No. 33-22829)\n24* Consent of Coopers & Lybrand, L.L.P.\n27* Financial Data Schedule.\n99a Press release issued by Homeland on November 30, 1994. (Incorporated by reference to Exhibit 99a to Form 8-K dated November 29, 1994)\n99b Unaudited Summary Financial Data for the 52 weeks ended December 31, 1994. (Incorporated by reference to Exhibit 99b to Form 8-K dated November 29, 1994)","section_11":"","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOwnership of Certain Holders\nSet forth below is information as of April 14, 1995, concerning certain holders of the currently outstanding shares of Common Stock (including Named Executive Officers, officers and directors of the Company and holders of 5% or more of the Common Stock).\nShares Percent of Name of Beneficial Owner Beneficially Owned Class\nThe Clayton & Dubilier Private Equity Fund III Limited Partnership, 270 Greenwich Avenue, Greenwich, CT 06830 11,700,000 34.1% The Clayton & Dubilier Private Equity Fund IV Limited Partnership, 270 Greenwich Avenue, Greenwich, CT 06830 13,153,089 38.4 B. Charles Ames (1)(2) 13,153,089 38.4 Joseph L. Rice, III (1)(3) 24,853,089 72.5 Alberto Cribiore (1)(3) 24,853,089 72.5 Donald J. Gogel (1) 13,153,089 38.4 Hubbard Howe (1) 13,153,089 38.4 James A. Demme -- -- Mark S. Sellers -- -- Jack M. Lotker 450,000 1.3 Steven M. Mason (4) 200,000 * Chester Misialek 200,000 * Alfred F. Fideline, Sr. 101,000 * Bernard S. Black (5) 70,000 * Bernard Paroly 50,000 * Richard C. Dresdale -- -- Andrall E. Pearson (2) -- -- Edward H. Meyer -- -- John A. Shields -- -- Michael G. Babiarz -- --\nOfficers and directors as a group (16 persons) (6)(7) 14,324,089 41.8\n*Indicates less than 1%\n(1) Messrs. Ames, Rice, Cribiore, Gogel and Howe may be deemed to share beneficial ownership of the shares owned of record by C&D Fund IV by virtue of their status as general partners of the general partner of C&D Fund IV, but Messrs. Ames, Rice, Cribiore, Gogel and Howe each expressly disclaims such beneficial ownership of the shares owned by C&D Fund IV. Messrs. Ames, Rice, Cribiore, Gogel and Howe share investment and voting power with respect to securities owned by C&D Fund IV. The business address for Messrs. Ames, Rice, Cribiore, Gogel and Howe is c\/o Clayton, Dubilier & Rice, Inc., 126 East 56th Street, 25th Floor, New York, New York 10022.\n(2) Mr. Ames was a limited partner in the general partner of C&D Fund III until October 1990, when he assigned his limited partnership interest to B. Charles Ames as Trustee of the trust created pursuant to a Declaration of Trust, dated July 25, 1982. Thus, he does not share investment discretion with respect to securities held by C&D Fund III. Mr. Pearson is a limited partner in the general partner of C&D Fund IV, but does not share investment discretion with respect to securities held by C&D Fund IV.\n(3) Messrs. Rice and Cribiore may be deemed to share beneficial ownership of the shares owned of record by C&D Fund III by virtue of their status as general partners of the general partner of C&D Fund III, but Messrs. Rice and Cribiore each expressly disclaims such beneficial ownership of the shares owned by C&D Fund III. Messrs. Rice and Cribiore share investment and voting power with respect to securities owned by C&D Fund III.\n(4) Includes 27,900 shares held in Mr. Mason's individual retirement account. Shares held by officers in their respective individual retirement accounts (\"IRA\") are subject to a power of attorney authorizing Mr. Dresdale to instruct the trustee of the IRA to take certain actions with respect to the shares held in the IRA in accordance with the stock subscription agreements executed by such officers.\n(5) Includes 13,000 shares held in Mr. Black's individual retirement account. See note 4.\n(6) Includes shares owned by C&D Fund IV, over which Mr. Ames, a director of the Company, shares investment and voting control. See notes 1 and 2.\n(7) Includes 130,900 shares held by officers and directors in their respective individual retirement accounts. See note 4.\nRegistration and Participation Agreements\nHolders of the 20,180,000 shares of Common Stock outstanding prior to the August 1990 private offering, net of 85,000 shares repurchased by the Company from former key employees (the \"Existing Holders\"), are entitled to the benefits of and are bound by the obligations set forth in a Registration and Participation Agreement, dated as of November 24, 1987 (the \"1987 Registration and Participation Agreement\"), among Holding, C&D Fund III and the other initial purchasers of Common Stock. Under the 1987 Registration and Participation Agreement, the holders of specified percentages of Common Stock may require the registration of such Common Stock, subject to certain limitations. Any number of such registrations may be requested, and Holding is required to bear all expenses in connection with the first three requests for registration. Prior to an initial public offering of Holding Common Stock, a demand for such registration can be made only by the holders of at least 40% of the Common Stock subject to the 1987 Registration and Participation Agreement (but not less than 3 million shares); thereafter, or at any time after November 24, 1994, such a demand may be made by the holders of at least 10% of the Common Stock subject to the Agreement (but not less than l.2 million shares). Holders of Common Stock also have the right to participate in any registered offering initiated by Holding, subject to certain conditions and limitations. In addition, the 1987 Registration and Participation Agreement entitles holders of Common Stock to participate proportionately in certain \"qualifying sales\" of Common Stock by C&D Fund III. Subject to certain qualifications, \"qualifying sales\" are sales by C&D Fund III of more than one million shares of Common Stock. Under the 1987 Registration and Participation Agreement, Holding must offer certain stockholders the right to purchase their pro rata share of Common Stock in connection with any proposed issuance of additional shares of Common Stock to C&D Fund III or any of its affiliates (other than persons who may be deemed affiliates solely by reason of being members of the management of the Company).\nHolders of the 15,000,000 shares of Common Stock purchased in the August 1990 private offering are entitled to the benefits of and are bound by the obligations set forth in the Registration and Participation Agreement dated as of August 13, 1990 (the \"1990 Registration and Participation Agreement\") among Holding, C&D Fund IV and those purchasers of such Common Stock (the \"New Holders\"). The registration rights are, however, expressly subordinate in nearly all respects to the registration rights granted to the Existing Holders with respect to the Common Stock that is covered by the 1987 Registration and Participation Agreement. The 1990 Registration and Participation Agreement provides, among other things, that New Holders of specified percentages of registrable Common Stock may initiate one or more registrations at Holding's expense, provided that the Existing Holders shall have the right to include their own shares of Common Stock in any such registration on a pro rata basis. In addition, if Holding proposes to register any equity securities, and certain conditions are met, New Holders will be entitled to include shares in the registration, provided that the Existing Holders shall have been given the opportunity to include all of their shares in such offering. The 1990 Registration and Participation Agreement does not entitle the New Holders to participate in sales of Common Stock by C&D Fund IV, but does give each New Holder the right to be offered additional shares of Common Stock if additional shares are proposed to be issued to C&D Fund IV or its affiliates.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company's largest stockholders, C&D Fund III and C&D Fund IV, are private investment funds managed by CD&R. Amounts contributed to C&D Fund III and C&D Fund IV by the limited partners thereof are invested at the discretion of the general partner in the equity of corporations organized for the purpose of carrying out leveraged acquisitions involving the participation of management, or, in the case of C&D Fund IV, in corporations where the infusion of capital coupled with the provision of managerial assistance by CD&R can be expected to generate returns on investments comparable to returns historically achieved in leveraged buy-out transactions. The general partner of C&D Fund III is Clayton & Dubilier Associates III Limited Partnership, a Connecticut limited partnership (\"Associates III\"). The general partner of C&D Fund IV is Clayton & Dubilier Associates IV Limited Partnership, a Connecticut limited partnership (\"Associates IV\"). B. Charles Ames, a principal of CD&R, a holder of an economic interest in Associates III and a general partner of Associates IV, also serves as Chairman of the Board of the Company. Andrall E. Pearson, a principal of CD&R and director of the Company, is a limited partner of Associates IV. Michael G. Babiarz, a director of the company, is a professional employee of CD&R. Richard C. Dresdale, a director of the Company, is a limited partner of Associates III. He was a professional employee of CD&R and was a limited partner of Associates IV until his withdrawal from CD&R and Associates IV effective March 1, 1994. He retains an economic interest in the investments in the Company by C&D Fund IV.\nCD&R receives an annual fee for management and financial consulting services provided to the Company and reimbursement of certain expenses. The consulting fees paid to CD&R were $150,000 in 1994 and $200,000 in each of the years 1992 and 1993.\nCD&R, C&D Fund III and the Company entered into an Indemnification Agreement on August 14, 1990, pursuant to which the Company agreed, subject to any applicable restrictions in the Prior Credit Agreement and the Subordinated Note Indenture, to indemnify CD&R, C&D Fund III, Associates III and their respective directors, officers, partners, employees, agents and controlling persons against certain liabilities arising under the federal securities laws and certain other claims and liabilities.\nCD&R, C&D Fund III, C&D Fund IV and the Company entered into a separate Indemnification Agreement, dated as of March 4, 1992, pursuant to which the Company agreed, subject to any applicable restrictions in the Senior Note Indenture, the Revolving Credit Agreement, the Subordinated Note Indenture, the 1987 Registration and Participation Agreement, and the 1990 Registration and Participation Agreement, to indemnify CD&R, C&D Fund III, C&D Fund IV, Associates III, Associates IV and their respective directors, officers, partners, employees, agents and controlling persons against certain liabilities arising under the federal securities laws and certain other claims and liabilities.\nHomeland has made temporary loans in 1993 and 1994 to certain members of management, in a maximum principal amount of $1,076,506, to enable such persons to make principal payments under loans from a third-party financial institution, which third-party loans were used solely to finance such persons' purchase of redeemable Common Stock of Holding. Such temporary loans are due July 21, 1995, and bear interest at a variable rate equal to the Company's Base Rate as determined by the Revolving Credit Agreement plus a margin of one percent per annum, and in any event no less than 11.5%. At April 14, 1995, $731,554 in aggregate principal amount of such loans was outstanding. In addition, the Company made a temporary loan in the aggregate principal amount of $200,000 to Mark S. Sellers, Executive Vice President-Finance, Treasurer, Chief Financial Officer and Secretary of the Company in connection with his relocation to Oklahoma and purchase of a new home. The loan bears interest at 8.3% and is to be repaid with the equity in his former home. At April 14, 1995, $23,446 of this loan remains outstanding.\nOn April 21, 1995, the Company made an offer to repurchase shares of its Common Stock owned by certain officers and employees of the Company at a cash purchase price of $0.50 per share, plus a warrant equal to the number of shares purchased with an exercise price of $0.50. However, such repurchases shall not exceed $600,000 in the aggregate (net of amounts to be repaid in respect of loans from the Company) and individual repurchases shall not exceed any outstanding loan balance that the officers or employees may have related to their purchase of Common Stock.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nThe following documents are filed as part of this Report:\n(a) Financial Statements and Financial Statement Schedules.\n1. Financial Statements. The Company's financial statements are included in this report following the signature pages. See Index to Financial Statements and Financial Statement Schedules on page.\n2. Financial Statement Schedules. The Company's Financial Statement Schedules are included in this report following the signature pages. See Index to Financial Statements and Financial Statement Schedules on page.\n3. Exhibits. See attached Exhibit Index on page E-1.\n(b) Reports on Form 8-K. A report on Form 8-K was filed during the last quarter of the period covered by this Report disclosing the Company entering into a letter of intent with AWG to sell certain of its assets. The Form 8-K was dated November 29, 1994.\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT\nThe Company has previously furnished to the Commission its proxy material in connection with the 1994 annual meeting of security holders. No separate annual report was distributed to security holders covering the Company's last fiscal year. The Company intends to furnish to its security holders proxy material in connection with the 1995 annual meeting of security holders. The Company will furnish copies of such material to the Commission when it is sent to security holders.\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.\nHOMELAND HOLDING CORPORATION\nDate: April 24, 1995 By: James A. Demme James A. Demme, 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\nB. Charles Ames Chairman of the Board April 21, 1995 B. Charles Ames\nJohn A. Shields Vice Chairman of the Board April 21, 1995 John A. Shields\nJames A. Demme President, Chief Executive April 24, 1995 James A. Demme Officer and Director (Principal Executive Officer)\nMark S. Sellers Executive Vice President\/ April 24, 1995 Mark S. Sellers Finance, Treasurer, C.F.O. and Secretary (Principal Financial Officer)\nMary Mikkelson Chief Accounting Officer, April 24, 1995 Mary Mikkelson Assistant Treasurer and Assistant Secretary (Principal Accounting Officer)\nSignature Title Date\nMichael G. Babiarz Director April 21, 1995 Michael G. Babiarz\nDirector April , 1995 Bernard S. Black\nRichard C. Dresdale Director April 20, 1995 Richard C. Dresdale\nBernard Paroly Director April 20, 1995 Bernard Paroly\nAndrall E. Pearson Director April 19, 1995 Andrall E. Pearson\nEdward H. Meyer Director April 20, 1995 Edward H. Meyer\nHOMELAND HOLDING CORPORATION Consolidated Financial Statements\nReport of Independent Accountants . . . . . . . . . . . Consolidated Balance Sheets as of December 31, 1994 and January 1, 1994 . . . . . . . . . . . . . . . . . Consolidated Statements of Operations for the 52 weeks ended December 31, 1994 and January 1, 1994, and the 53 weeks ended January 2, 1993 . . . . . . . . Consolidated Statements of Stockholders' Equity for the 52 weeks ended December 31, 1994 and January 1, 1994, and the 53 weeks ended January 2, 1993 . . . . . Consolidated Statements of Cash Flows for the 52 weeks ended December 31, 1994 and January 1, 1994, and the 53 weeks ended January 2, 1993 . . .. . . Notes to Consolidated Financial Statements . . . . . . .\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Homeland Holding Corporation\nWe have audited the accompanying consolidated financial statements of Homeland Holding Corporation and Subsidiary listed in the index on page of this Form 10-K. 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 statements presentation. We believe that our audits provide a reasonable basis for our opinion.\nAs discussed in Note 15, subsequent to the year ended December 31, 1994, the Company completed the sale of its warehouse and distribution center and 29 retail stores to Associated Wholesale Grocers, Inc. In connection with this transaction, the Company executed a Supplemental Indenture, incorporating certain amendments to its Senior Note Indenture, and replaced its Revolving Credit Agreement.\nIn our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Homeland Holding Corporation and Subsidiary as of December 31, 1994 and January 1, 1994, and the consolidated results of their operations and their cash flows for the 52 weeks ended December 31, 1994 and January 1, 1994, and the 53 weeks ended January 2, 1993, in conformity with generally accepted accounting principles.\nCoopers & Lybrand\nNew York, New York March 24, 1995, except as to the information presented in Note 15, for which the date is April 21, 1995\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\n(In thousands, except share and per share amounts)\nASSETS (Note 3)\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS, Continued\n(In thousands, except share and per share amounts)\nLIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF OPERATIONS\n(In thousands, except share and per share amounts)\nThe accompanying notes are an integral part of these consolidated financial statements.\nHOMELAND HOLDING CORPORATION AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(In thousands, except share and per share amounts)\n1. Organization and Basis of Presentation:\nHomeland Holding Corporation, (\"Holding\"), a Delaware corporation, was incorporated on November 6, 1987, but had no operations prior to November 25, 1987. Effective November 25, 1987, Homeland Stores, Inc. (\"Homeland\"), a wholly-owned subsidiary of Holding, acquired substantially all of the net assets of the Oklahoma Division of Safeway Stores, Incorporated. Holding and its consolidated subsidiary, Homeland, are collectively referred to herein as the \"Company\".\nHolding has guaranteed substantially all of the debt issued by Homeland. Holding is a holding company with no significant operations other than its investment in Homeland. Separate financial statements of Homeland are not presented herein since they are identical to the consolidated financial statements of Holding in all respects except for stockholder's equity (which is equivalent to the aggregate of total stockholders' equity and redeemable common stock of Holding) which is as follows:\n2. Summary of Significant Accounting Policies:\nFiscal year - The Company has adopted a fiscal year which ends on the Saturday nearest December 31.\nBasis of consolidation - The consolidated financial statements include the accounts of Homeland Holding Corporation and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.\n2. Summary of Significant Accounting Policies, continued:\nRevenue recognition - The Company recognizes revenue when its retail or wholesale divisions distribute groceries and related items to its customers.\nConcentrations of credit risk - Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and receivables. The Company places its temporary cash investments with high quality financial institutions. Concentrations of credit risk with respect to receivables are limited due to the diverse nature of those receivables, including a large number of retail and wholesale customers within the region and receivables from vendors throughout the country.\nRestricted Cash - At December 31, 1994, the Company had $467 of cash in an escrow account at United States Trust Company of New York. The cash is restricted for reinvestment in capital expenditures within 180 days of being deposited in the account or must be used to permanently pay down the Senior Notes (as subsequently defined under Note 3).\nInventories - Inventories are stated at the lower of cost or market. Cost is determined on a first-in first-out basis primarily using the retail method.\nProperty, plant and equipment - Property, plant and equipment obtained at acquisition are stated at appraised fair market value as of that date; whereas all subsequently acquired property, plant and equipment are stated at cost or, in the case of leased assets under capital leases, at cost or the present value of future lease payments. Depreciation and amortization, including amortization of leased assets under capital leases, are computed on a straight-line basis over the lesser of the estimated useful life of the asset or the remaining term of the lease.\nDepreciation and amortization for financial purposes are based on the following estimated lives:\nEstimated lives --------------- Buildings 10 - 40 Fixtures and equipment 5 - 12.5 Leasehold improvements 15 Transportation equipment 5 - 10 Software 5 - 10 2. Summary of Significant Accounting Policies, continued:\nThe costs of repairs and maintenance are expensed as incurred, and the costs of renewals and betterments are capitalized and depreciated at the appropriate rates. Upon sale or retirement, the cost and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss is included in the results of operations for that period.\nExcess of purchase price over fair value of net assets acquired - The excess of purchase price over fair value of net assets acquired is being amortized on a straight-line basis over 40 years. The net remaining balance of the excess of purchase price over fair value of net assets acquired is assessed periodically based on the estimated recoverable value related to the assets acquired. Approximately $250 was written off during 1994 as a result of this assessment. The net amount of the excess of purchase price over fair value of net assets acquired as of December 31, 1994, related to the 29 stores and stores to be closed in 1995 has been written off in 1994 as part of the operational restructuring costs (see Note 14).\nOther assets and deferred charges - Other assets and deferred charges consist primarily of financing costs amortized using the effective interest rate method over the term of the related debt and beneficial interests in operating leases amortized on a straight-line basis over the remaining terms of the leases, including all available renewal option periods.\nNet income (loss) per common share - Net income (loss) per common share is computed based on the weighted average number of shares, including shares of redeemable common stock outstanding during the period. Net income (loss) is reduced (increased) by the accretion to (reduction in) redemption value to determine the net income (loss) available to common stockholders.\nCash and cash equivalents - For purposes of the statements of cash flows, the Company considers all short-term investments with an original maturity of three months or less when purchased to be cash equivalents.\nCapitalized interest - The Company capitalizes interest as a part of the cost of acquiring and constructing certain assets. Interest costs of $35, $44, and $195 were capitalized in 1994, 1993 and 1992, respectively.\n2. Summary of Significant Accounting Policies, continued:\nPre-opening costs - Costs associated with the opening of new stores are expensed in the year the stores are opened.\nAdvertising Costs - Costs of advertising are expensed as incurred. Gross advertising costs for 1994, 1993 and 1992, respectively, were $13,615, $14,100 and $14,531.\nIncome taxes - The Company accounts for income taxes on the liability method as required by Statement of Financial Accounting Standards No. 109. Accordingly, deferred income taxes are recognized for the tax consequences in future years of differences between the tax bases of assets and liabilities and their financial reporting amounts at each year-end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Deferred taxes also are recognized for operating losses that are available to offset future taxable income and tax credits that are available to offset future Federal income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities, net of applicable valuation allowances.\nSelf-insurance reserves - The Company is self-insured for property loss, general liability and automotive liability coverage, and was self-insured for workers' compensation coverage until June 30, 1994, subject to specific retention levels. Estimated costs of these self-insurance programs are accrued at their present value based on projected settlements for claims using actuarially determined loss development factors based on the Company's prior history with similar claims. Any resulting adjustments to previously recorded reserves are reflected in current operating results.\nImpact of Recently Issued Accounting Pronouncement - The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, \"Accounting for Postemployment Benefits\" in November 1992. The adoption of this new standard in 1994, as required, did not have a material effect on the Company's consolidated results of operations or financial position.\nReclassification - Certain reclassifications have been made to the 1993 consolidated financial statements to conform with the 1994 presentations. 3. Long-term Debt:\nPrior to a March 1992 refinancing, the Company's long-term debt consisted of borrowings under a credit agreement (\"Prior Credit Agreement\") from a group of banks that included term notes and revolving credit loans (including a swing loan and certain letters of credit), subordinated notes, and a note payable issued as a result of an acquisition of certain stores.\nIn March 1992, the Company entered into an Indenture with United States Trust Company of New York, as trustee, pursuant to which the Company issued $45,000 in aggregate principal amount of Series A Senior Secured Floating Rate Notes due 1997 (the \"Old Floating Rate Notes\") and $75,000 in aggregate principal amount of Series B Senior Secured Fixed Rate Notes due 1999 (the \"Old Fixed Rate Notes\", and collectively, the \"Old Notes\"). Certain proceeds from this issuance were used to repay all amounts outstanding under the Prior Credit Agreement, to repurchase $12,250 in aggregate principal amount of the subordinated notes at a purchase price of 110% of the principal amount and to make a prepayment of $1,500 on the note payable. In conjunction with the prepayment on the note payable, the Company issued a new $3,000 note.\nIn October and November 1992, the Company exchanged a portion of its Series D Senior Secured Floating Rate Notes due 1997 and its Series C Senior Secured Fixed Rate Notes due 1999 (the \"New Notes\") for equal principal amounts of the Old Notes. The New Notes are substantially identical to the Old Notes, except that the offering of the New Notes was registered with the Securities and Exchange Commission. At the expiration of the exchange offer in November 1992, $33,000 in principal amount of the Old Floating Rate Notes and $75,000 in principal amount of the Old Fixed Rate Notes had been tendered and accepted for exchange and $12,000 of the Old Floating Rate Notes remain outstanding.\nAlso in March 1992, the Company entered into a Revolving Credit Agreement (the \"Revolving Credit Agreement\") with Union Bank of Switzerland, New York Branch (\"UBS\"), as agent and as lender, and any other lenders and other financial institutions thereafter parties thereto. As a result of the Company's redemption of the remaining outstanding Subordinated Notes on March 1, 1993, and satisfying certain other conditions, the Revolving Credit Agreement provides a commitment of up to $50,000 in secured revolving credit loans, including a swing loan and certain letters of credit.\n3. Long-term Debt, continued:\nOn March 1, 1993, the Company redeemed all remaining outstanding subordinated notes ($47,750 principal amount), at the optional redemption price (including a premium of $2,776 or 5.8% of the outstanding principal amount) specified in the subordinated notes, together with accrued interest. The Company borrowed $32,000 under its Revolving Credit Agreement and used $21,000 of the remaining net proceeds from the issuance of the Old Notes to redeem the Subordinated Notes.\nAs a result of the March 1993 redemption and the March 1992 refinancing, the Company incurred the following extraordinary gains and losses:\nCash and cash equivalents - The carrying amounts of this item is a reasonable estimate of its fair value due to its short- term nature.\nLong-term debt - The fair value of publicly traded debt (the Senior Secured Notes) is valued based on quoted market values. The amount reported in the balance sheet for the remaining long term debt approximates fair value based on quoted market prices of comparable instruments or by discounting expected cash flows at rates currently available for debt of the same remaining maturities.\n5. Income Taxes:\nThe components of the income tax benefit (provision) for fiscal 1994, 1993 and 1992 were as follows:\nA reconciliation of the income tax benefit (provision) at the statutory Federal income tax rate to the Company's effective tax rate is as follows:\nA valuation allowance was established in the fourth quarter of fiscal 1994 to entirely offset the net deferred tax assets due to the uncertainty of realizing the future tax benefits, of which $3,997 related to net deferred tax assets carried forward from the prior year.\n5. Income Taxes, continued:\nAt December 31, 1994, the Company had the following operating loss and tax credit carryforwards available for tax purposes:\nThe Internal Revenue Service (\"IRS\") concluded a field audit of the Company's income tax returns for the fiscal years 1990, 1991 and 1992. On January 31, 1994, the IRS issued a Revenue Agent's Report for those fiscal years proposing adjustments that would result in additional taxes of $1,589 (this amount is net of any available operating loss carryforwards which would be eliminated under the proposed adjustment). The Company filed its protest with the IRS Appeals Office on June 14, 1994. The IRS Appeals Office is currently in the process of reviewing the Company's protest. The major proposed adjustment involves the allocation of the initial purchase price of the Company to inventory. The Company believes that it has meritorious legal defenses to the proposed adjustments and intends to vigorously protest the assessment. Management has analyzed all of the matters and has provided for amounts which it currently believes are adequate.\n6. Incentive Compensation Plan:\nThe Company has bonus arrangements for store management and other key management personnel. During 1994, 1993, and 1992, approximately $1,939, $2,900, and $2,319, respectively, was charged to costs and expenses for such bonuses.\n7. Retirement Plans:\nEffective January 1, 1988, the Company adopted a non- contributory, defined benefit retirement plan for all executive and administrative personnel. Benefits are based on length of service and career average pay with the Company. The Company's funding policy is to contribute an amount equal to or greater than the minimum funding requirement of the\n7. Retirement Plans, continued:\nEmployee Retirement Income Security Act of 1974, but not in excess of the maximum deductible limit. Assets were held in short-term investment mutual funds during 1994 and 1993.\nIn accordance with the provisions of Statement of Financial Accounting Standards No. 87 - \"Employers' Accounting for Pensions\", the Company recorded an additional minimum liability at January 1, 1994 representing the excess of the accumulated benefit obligation over the fair value of plan assets and accrued pension liability. The additional liability was offset by intangible assets to the extent of previously unrecognized prior service cost. Amounts in excess of previously unrecognized prior service cost were recorded as a $572 reduction of stockholders' equity in 1993. During 1994, additional contributions were made to the plan resulting in the fair value of plan assets being in excess of the accumulated benefit obligation. The entry made in 1993 to stockholders' equity was reversed in 1994.\nNet pension cost consists of the following:\n1994 1993 1992 ---- ---- ---- Service cost $709 $663 $659 Interest cost 366 293 222 Loss (return) on assets 63 (319) 17 Net amortization and deferral (419) 43 (230) ---- ---- ---- Net periodic pension cost $719 $680 $668 ==== ==== ====\nThe funded status of the plan and the amounts recognized in the Company's balance sheet at December 31, 1994 and January 1, 1994 consist of the following:\nFor 1994, a discount rate of 7 1\/2% was used for the determination of net periodic pension cost and 9% for the determination of plan disclosure at the end of the plan year. For 1993, a discount rate of 7 1\/2% was used. A long term rate of return of 9% was used for both 1994 and 1993. For 1994, assumed annual rates of future compensation increases ranging from 3 1\/2% to 5 1\/2% (graded by age) were used for the determination of net periodic pension cost and rates ranging from 5% to 7% (graded by age) were used for the plan disclosures at the end of the plan year. For 1993, assumed annual rates of future compensation increases ranging from 3 1\/2% to 5 1\/2% (graded by age) were used. The prior service cost is being amortized on a straight-line basis over approximately 13 years.\nThe Company also contributes to various union-sponsored, multi-employer defined benefit plans in accordance with the collective bargaining agreements. The Company could, under certain circumstances, be liable for the Company's unfunded vested benefits or other costs of these multi-employer plans. The allocation to participating employers of the actuarial present value of vested and nonvested accumulated benefits in multi-employer plans as well as net assets available for benefits is not available and, accordingly, is not presented. The costs of these plans for 1994, 1993 and 1992 were $3,309, $3,565, and $3,766, respectively. 7. Retirement Plans, continued:\nEffective January 1, 1988, the Company adopted a defined contribution plan covering substantially all non-union employees of the Company. Prior to 1994, the Company contributed a matching 50% for each one dollar the participants contribute in pre-tax matched contributions. Participants may contribute from 1% to 6% of their pre-tax compensation which was matched by the Company. Participants may make additional contributions of 1% to 6% of their pre-tax compensation, but such contributions were not matched by the Company. Effective January 2, 1994, the plan was amended to allow a discretionary matching contribution formula based on the Company's operating results. The cost of this plan for 1994, 1993, and 1992, was $0, $425, and $616, respectively.\n8. Leases:\nThe Company leases substantially all of its retail store properties under noncancellable agreements, the majority of which range from 15 to 25 years. These leases, which include both capital leases and operating leases, generally are subject to six five-year renewal options. Most leases also require the payment of taxes, insurance and maintenance costs and many of the leases covering retail store properties provide for additional contingent rentals based on sales. Leased assets under capital leases consists of the following:\nFuture minimum lease payments under capital leases and noncancellable operating leases as of December 31, 1994 are as follows:\n8. Leases, continued:\n9. Common Stock:\nHolding has agreed to repurchase shares of stock held by management investors under certain conditions (as defined), such as death, retirement, or permanent disability.\nPursuant to requirements of the Securities and Exchange Commission, the shares of Class A common stock held by management investors have been presented as redeemable common stock and excluded from stockholders' equity. The changes in the number of shares outstanding and the value of the redeemable common stock is as follows:\n9. Common Stock, continued:\nThe shares of redeemable common stock are reported on the balance sheets at redemption value, which is the estimated fair market value of the stock. In 1994, the reduction in redemption value has been reflected as an increase in additional paid-in capital.\nHolding also has 40,500,000 shares of Class B nonvoting common stock authorized at December 31, 1994 and January 1, 1994 with a $.01 par value. No shares were issued or outstanding at either December 31, 1994 or January 1, 1994.\n10. Related Party Transactions:\nClayton, Dubilier & Rice, Inc., a private investment firm of which three directors of the Company are employees, received $150 in 1994 and $200 annually during 1993 and 1992, for financial advisory and consulting services.\nThe Company made loans during 1994 and 1993 to certain members of management and key employees for principal payments on their loans made by the credit union in connection with their purchase of common stock. The loans bear interest at a variable rate equal to the Company's prime lending rate plus 1.0%. Loans outstanding at December 31, 1994 and January 1, 1994 were $794 and $715, respectively, and are shown in the consolidated balance sheet as a reduction in the redeemable common stock. The loans mature in 1995.\n11. Commitments and Contingencies:\nEffective January 1, 1989, the Company implemented stock appreciation rights plans for certain of its hourly union and non-union employees as well as salaried employees. Effective as of November 4, 1989, the Company implemented a similar stock appreciation rights plan for its Teamster union employees. Participants in the plans are granted at specified times \"appreciation units\" which, upon the occurrence of certain triggering events, entitle them to receive cash payments equal to the increase in value of a share of the common stock from the date of the plan's establishment. It is uncertain whether such triggering events will occur.\nEffective October 1, 1991, the Company entered into an outsourcing agreement whereby an outside party provides virtually all of the Company's EDP requirements and assumed substantially all of the Company's existing hardware and software leases and related maintenance agreements. The ten year agreement calls for minimum annual service charges, increasing over its term, as well as other variable charges. Future minimum annual service charges under the agreement as of December 31, 1994 aggregate $30,653. The agreement is cancelable by either party subject to a penalty that declines over the term of the agreement.\nEffective May 26, 1992, the Company entered into an outsourcing agreement whereby an outside party provides transportation of grocery and other supermarket products from the Company's distribution facilities to the Company's stores and other locations designated by the Company. The agreement is effective through March 1997. Payments under the agreement are determined based on miles traveled in accordance with predetermined rates. During 1994 and 1993, the Company paid $6,473 and $7,367, respectively, for services received.\nThe Company has entered into employment contracts with certain key executives providing for the payment of minimum salary and bonus amounts in addition to certain other benefits in the event of termination of the executives or change of control of the Company.\nIn conjunction with the sale to AWG, three class grievances have been filed by the United Food and Commercial Workers of North America (\"UFCWNA\") and have been submitted to binding arbitration under the terms of the Labor Agreement. The grievances involve: (i) the question of whether a special 11. Commitments and Contingencies, continued:\ntermination pay provision in the Labor Agreement is triggered by the sale to AWG; (ii) the application of the severance pay provision in the Labor Agreement; and (iii) calculation of accrued but unused vacation pay due employees at the time of termination. The maximum aggregate amount being sought pursuant to the grievances is $5.1 million. The arbitrations will be held during May through July. The Company believes that its position on these grievances will be upheld by the arbitrator and that the disposition of these grievances through arbitration will not have a material adverse effect on the Company's financial position.\nThe Company is also a party to various lawsuits arising in the normal course of business. Management believes that the ultimate outcome of these matters will not have a material effect on the Company's consolidated financial position, results of operations and cash flows.\nThe Company has outstanding at December 31, 1994, $7,345 in letters of credit which are not reflected in the accompanying financial statements. The letters of credit are issued under the Revolving Credit Agreement and the Company paid fees of $195 and $97 in 1994 and 1993, respectively.\n12. Sale of Plants:\nIn November 1993 the Company entered into an asset purchase agreement with Borden, Inc. (\"Borden\") whereby certain of the Company's milk and ice cream processing equipment and certain other assets and inventory relating to its milk and ice cream plants was sold. In connection with the sale, the Company entered into a seven-year agreement with Borden under which Borden would supply all of the Company's requirements for most of its dairy, juice and ice cream products and the Company agreed to purchase minimum volumes of products. The Company recognized a gain on the sale of personal property in the amount of $2,618. A $4,000 payment received in connection with the supply agreement was deferred and was to be recognized as earned over the term of the supply agreement.\nIn December 1994, the Company entered into a settlement agreement with Borden whereby the seven-year supply agreement entered into in November 1993 was terminated and a temporary supply agreement for a maximum period of 120 days was entered into. As part of the settlement agreement, the Company repaid $1,650 plus interest in December 1994 and must make another 12. Sale of Plants, continued:\npayment of $1,650 plus interest upon termination of the temporary supply agreement. The Company has made arrangements with another dairy supplier to begin supplying its dairy and ice cream requirements in April 1995.\n13. Fourth Quarter Adjustment:\nIn the fourth quarter of 1994, the Company made an adjustment to increase its workers compensation accruals by $5,000. This increase was due to an increase in the actuarially projected ultimate costs of the self-insured plans, reflecting increases in claims and related settlements.\n14. Restructuring:\nIn accordance with a strategic plan approved by the Board of Directors in December 1994, the Company entered into an agreement with Associated Wholesale Grocers, Inc. (\"AWG\") on February 6, 1995, pursuant to which the Company has agreed to sell 29 of its stores and its warehouse and distribution center to AWG for a purchase price of $45 million plus the value of the inventory in the 29 stores and the warehouse, subject to certain possible purchase price adjustments. In connection with this agreement, the Company will enter into a seven year supply agreement pursuant to which AWG will be the Company's primary supplier for the remaining stores. The AWG sale closed on April 21, 1995. The Company plans to use the net proceeds from the transaction to reduce its indebtedness under both the Senior Notes and the Revolving Credit Agreement.\nThe Company also plans to close 15 under-performing stores during 1995. The Company plans to sell certain stores or lease some stores to other retailers and in some cases seek to abandon certain leases and dispose of any equipment in the most productive manner. The Company intends to buy-out operating and capital leased equipment related to the closed stores from current lessors and dispose of them in the same manner. Five stores were closed in February 1995 and two in March 1995.\nIn connection with the sale of 29 stores and the warehouse facility to AWG and the closing of stores, the Company recorded a $23,205 charge in the fourth quarter of fiscal 1994. The major components of the restructuring charge are summarized as follows: 14. Restructuring, continued:\nWrite-down of inventory to estimated realizable value $4,479\nWrite-down of prepaid expenses and other current assets associated with the AWG Transaction 898\nWrite-down of net property, plant and equipment associated with closed stores, net of estimated proceeds 7,402\nWrite-down of unamortized beneficial leaseholds, transportation outsourcing costs and other deferred charges 3,132\nWrite-down of unamortized excess of purchase price over fair value of net assets acquired associated with the stores sold to AWG or closed 977\nExpenses associated with the planned store closings, primarily occupancy costs from closing date to lease termination or sublease date 8,319\nExpenses associated with the AWG Transaction, primarily service and equipment contract cancellation fees 5,649\nEstimated severance costs associated with the AWG Transaction (see below) 5,624\nLegal and consulting fees associated with the AWG Transaction 6,217\nNet gain on sale of property, plant and equipment to AWG (19,492) -------- Total restructuring charges $ 23,205 ========\nThe estimated severance costs accrued during the fourth quarter are for approximately 165 non-union employees and approximately 1,360 union employees whose employment will be 14. Restructuring, continued:\nterminated in connection with the sale of 29 stores and the warehouse facility to AWG. Approximately $1.0 million of severance costs are expected to be incurred subsequent to fiscal 1994 in connection with the planned store closings. These severance costs have not been accrued in fiscal 1994 since the affected employees were not notified prior to December 31, 1994.\nApproximately $1,300 of bank fees, noteholder fees and premium for early extinguishment of debt are expected to be incurred subsequent to fiscal 1994 in connection with the restructuring of debt discussed in Note 15. In addition, approximately $1,400 of refinancing costs previously capitalized are expected to be written off subsequent to fiscal 1994 when a portion of the debt is extinguished early. These costs have not been accrued in fiscal 1994 since the extinguishment of debt has not yet occurred.\nAs of December 31, 1994, the Company had paid approximately $1,312 of legal and consulting fees associated with the AWG Transaction. The asset write-downs described above, aggregating $16,888, have been reflected in their respective balance sheet account classifications as of December 31, 1994. The remaining charges, aggregating $5,005, have been included in the consolidated balance sheet at December 31, 1994 under the caption Noncurrent restructuring reserve.\nIn connection with the sale of 29 stores and the warehouse and distribution center to AWG, $29,375 net book value of property, plant and equipment is held for resale at December 31, 1994. In addition, $2,200 net book value of property, plant and equipment related to the 15 stores to be closed in 1995 is held for resale at December 31, 1994.\nThe separately identifiable revenue and store contribution to operating profit (loss) related to the stores being sold to AWG or closed and expenses related to the warehouse facility are as follows:\n14. Restructuring, continued:\nUnder the AWG supply agreement, the ongoing costs of warehousing will be built into the cost of goods purchased from AWG.\n15. Subsequent Events:\nOn April 13, 1995, the Company received consents for certain amendments to the Senior Note Indenture from a majority of the holders of Senior Notes. The amendments include, among other things, (a) increasing the interest rate on each series of Notes by one-half of one percent (0.5%) per annum; (b) amending, adding and deleting certain financial covenants and related definitions under the Senior Note Indenture (including modifying the Consolidated Fixed Charge Coverage Ratio covenant, adding a new Debt-to-EBITDA ratio and a new Capital Expenditures covenant, deleting the Adjusted Consolidated Net Worth covenant) to reflect the Company's size, operations and financial position following the AWG Transaction. Until the consent was approved, the Company had obtained a waiver from the Senior Noteholders waiving compliance with certain financial covenant requirements in effect as of December 31, 1994 through June 30, 1995. On April 21, 1995, the Company and United States Trust Company of New York, as trustee for the holders of the Senior Notes, entered into a supplemental indenture effecting these amendments.\nThe Company replaced its current Revolving Credit Agreement with a revised revolving facility (the \"Amended and Restated Revolving Credit Agreement\") on April 21, 1995. The Amended and Restated Revolving Credit Agreement is with National Bank of Canada, (\"NBC\") as agent and as lender, Heller Financial, Inc. and any other lenders thereafter parties thereto. The Amended and Restated Revolving Credit Agreement provides a commitment of up to $25 million in secured revolving credit loans, including certain letters of credit. The Amended and Restated Revolving Credit Agreement permits borrowings (a) to refinance the previous Revolving Credit Agreement, (b) for working capital needs and (c) to issue standby letters of credit and documentary letters of credit. Borrowings under the Amended and Restated Revolving Credit Agreement bear interest at the NBC Base Rate plus 1.5% for the first year (10.5% as of April 21, 1995). Subsequent year's interest rates will be dependent upon the Company's earnings but will not exceed NBC base rate plus 2.0%. All borrowings under the amended and Restated Revolving Credit Agreement are subject\n15. Subsequent Events, continued:\nto a borrowing base and mature no later than February 27, 1997, with the possibility of extending the maturity date to March 31, 1998 if the Company's Series A Senior Secured Floating Rate Notes due February 27, 1997, are extended or refinanced on terms acceptable to NBC. The Amended and Restated Credit Agreement, among other things, requires the maintenance of leverage and coverage ratios as defined, and limits the Company's net capital expenditures and incurrence of additional indebtedness and limits the payment of dividends. The notes are collateralized by accounts receivable and inventories of the Company.\nThe AWG sale described in Note 14 closed on April 21, 1995, on the same basis as described within Note 14.\nOn April 21, 1995, the Company made an offer to repurchase shares of its Common Stock owned by certain officers and employees of the Company at a cash purchase price of $0.50 per share, plus a warrant equal to the number of share purchased with an exercise price of $0.50. However, such repurchases shall not exceed $600,000 in the aggregate (net of amounts to be repaid in respect of loans from the Company) and individual repurchases shall not exceed any outstanding loan balance that the officers or employees may have related to their purchase of Common Stock.\nEXHIBIT INDEX\nExhibit No. Description\n3a Restated Certificate of Incorporation of Homeland Holding Corporation (\"Holding\"), dated August 2, 1990. (Incorporated by reference to Exhibit 3a to Form 10-Q for quarterly period ended September 8, 1990)\n3b By-laws of Holding, as amended and restated on November 14, 1989 and further amended on September 23, 1992. (Incorporated by reference to Exhibit 3b to Form 10-Q for quarterly period ended June 19, 1993)\n3c Restated Certificate of Incorporation of Homeland Stores, Inc. (\"Homeland\"), dated March 2, 1989. (Incorporated by reference to Exhibit 3c to Form 10-K for fiscal year ended December 31, 1988)\n3d By-laws of Homeland, as amended and restated on November 14, 1989 and further amended on September 23, 1992. (Incorporated by reference to Exhibit 3d to Form 10-Q for quarterly period ended June 19, 1993)\n4a Indenture, dated as of November 24, 1987, among Homeland, The Connecticut National Bank (\"CNB\"), as Trustee, and Holding, as Guarantor. (Incorporated by reference to Exhibit 4a to Form S-1 Registration Statement, Registration No. 33-22829)\n4a.1 First Supplement to Indenture, dated as of August 15, 1988, among Homeland, CNB and Holding. (Incorporated by reference to Exhibit 4a.1 to Form S-1 Registration Statement, Registration No. 33-22829)\n4b Purchase Agreement, dated November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 4b to Form S-1 Registration Statement, Registration No. 33-22829) 4c Form of Registration Rights Agreement, dated as of November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 4c to Form S-1 Registration Statement, Registration No. 33-22829)\n4d Indenture, dated as of March 4, 1992, among Homeland, United States Trust Company of New York (\"U.S.Trust\"), as Trustee, and Holding, as Guarantor. (Incorporated by reference to Exhibit 4d to form 10-K for fiscal year ended December 28, 1991)\n4d.1 First Supplement to Indenture, dated as of June 17, 1992, among Homeland, Holding and U.S. Trust. (Incorporated by reference to Exhibit 4d.1 to Form S-1 Registration Statement, Registration No. 33-48862)\n4d.3 Partial Release of Collateral, dated as of May 22, 1992, by U.S. Trust, as Collateral Trustee, in favor of Homeland. (Incorporated by reference to Exhibit 4d.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n4e Form of Purchase Agreement, dated as of March 4, 1992, among Homeland and initial purchasers of Senior Notes. (Incorporated by reference to Exhibit 4e to Form 10-K for fiscal year ended December 28, 1991)\n4f Form of Registration Rights Agreement, dated as of March 4, 1992, among Homeland and the initial purchasers of Senior Notes. (Incorporated by reference to Exhibit 4f to Form 10-K for fiscal year ended December 28, 1991)\n10a Asset Purchase Agreement, dated as of September 15, 1987. (Incorporated by reference to Exhibit 10a to Form S-1 Registration Statement, Registration No. 33-22829)\n10b First Amendment to Asset Purchase Agreement, dated November 24, 1987. (Incorporated by reference to Exhibit 10b to Form S-1 Registration Statement, Registration No. 33-22829)\n10c Stock Subscription Agreement, dated as of November 24, 1987, between Holding and The Clayton & Dubilier Private Equity Fund III Limited Partnership. (Incorporated by reference to Exhibit 10c to Form S-1 Registration Statement, Registration No. 33-22829)\n10e Purchase Agreement for Safeway Brand Products, dated as of November 24, 1987, between Homeland and Safeway. (Incorporated by reference to Exhibit 10e to Form S-1 Registration Statement, Registration No. 33-22829)\n10f Manufacturing and Supply Agreement, dated as of November 24, 1987, between Homeland and Safeway. (Incorporated by reference to Exhibit 10f to Form S-1 Registration Statement, Registration No. 33-22829)\n10g Form of Common Stock Purchase Agreement, dated November 24, 1987, between Holding and certain institutional investors. (Incorporated by reference to Exhibit 10g to Form S-1 Registration Statement, Registration No. 33-22829)\n10h (1) Form of Management Stock Subscription Agreement, dated as of October 20, 1988, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated by reference to Form 10-K for fiscal year ended December 31, 1988)\n10h.1 (1) Form of Management Stock Subscription Agreement, dated as of October 20, 1988, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated by reference to Form 10-K for fiscal year ended December 31, 1988)\n10h.2 (1) Form of Management Stock Subscription Agreement, dated as of November 29, 1989, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated by reference to Form 10-K for fiscal year ended December 30, 1989)\n10h.3 (1) Form of Management Stock Subscription Agreement, dated as of November 29, 1989, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated by reference to Form 10-K for fiscal year ended December 30, 1989)\n10h.4 (1) Form of Management Stock Subscription Agreement dated as of August 14, 1990, between Holding and the purchasers named therein, involving purchase of Holding common stock for cash. (Incorporated herein by reference to Exhibit 10h.4 to Form 10-K for fiscal year ended December 29, 1990)\n10h.5 (1) Form of Management Stock Subscription Agreement dated as of August 14, 1990, between Holding and the purchasers named therein, involving purchase of Holding common stock using funds held under purchasers' individual retirement accounts. (Incorporated herein by reference to Exhibit 10h.5 to Form 10-K for fiscal year ended December 29, 1990)\n10i.1 Form of Registration and Participation Agreement, dated as of November 24, 1987, among Holding, The Clayton & Dubilier Private Equity Fund III Limited Partnership, and initial purchasers of Common Stock. (Incorporated by reference to Exhibit 10i to Form S-1 Registration Statement, Registration No. 33-22829)\n10i.2 1990 Registration and Participation Agreement dated as of August 13, 1990, among Homeland Holding Corporation, Clayton & Dubilier Private Equity Fund IV Limited Partnership and certain stockholders of Homeland Holding Corporation. (Incorporated by reference to Exhibit 10y to Form 10-Q for quarterly period ended September 8, 1990)\n10i.3 Form of Store Managers Stock Purchase Agreement. (Incorporated by reference to Exhibit 10z to Form 10-Q for quarterly period ended September 8, 1990)\n10j Indenture, dated as of November 24, 1987. (Incorporated by reference to Exhibit 10j to Form S-1 Registration Statement, Registration No. 33-22829)\n10j.1 First Supplement to Indenture, dated as of August 15, 1988. (Incorporated by reference to Exhibit 10j.1 to Form S-1 Registration Statement, Registration No. 33-22829)\n10k Form of Purchase Agreement, dated November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes (Filed as Exhibit 4b). (Incorporated by reference to Exhibit 10k to Form S-1 Registration Statement, Registration No. 33-22829)\n10l Form of Registration Rights Agreement, dated as of November 24, 1987, among Homeland, Holding and initial purchasers of Subordinated Notes. (Incorporated by reference to Exhibit 10l to Form S-1 Registration Statement, Registration No. 33-22829)\n10q (1) Homeland Profit Plus Plan, effective as of January 1, 1988. (Incorporated by reference to Exhibit 10q to Form S-1 Registration Statement, Registration No. 33-22829)\n10q.1 (1) Homeland Profit Plus Plan, effective as of January 1, 1989 (Incorporated by reference to Exhibit 10q.1 to Form 10-K for the fiscal year ended December 29, 1990)\n10r Homeland Profit Plus Trust, dated March 8, 1988, between Homeland and the individuals named therein, as Trustees. (Incorporated by reference to Exhibit 10r to Form S-1 Registration Statement, Registration No. 33-22829)\n10r.1 Homeland Profit Plus Trust, dated January 1, 1989, between Homeland and Bank of Oklahoma, N.A., as Trustee (Incorporated by reference to Exhibit 10r.1 to Form 10-K for the fiscal year ended December 29, 1990)\n10s (1) 1988 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s to Form S-1 Registration Statement, Registration No. 33-22829)\n10s.1 (1) 1989 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.1 to Form 10-K for fiscal year ended December 31, 1988)\n10s.2 (1) 1990 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.2 to Form S-1 Registration Statement, Registration No. 33-48862)\n10s.3 (1) 1991 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n10s.4 (1) 1992 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.4 to Form S-1 Registration Statement, Registration No. 33-48862)\n10s.5 (1) 1993 Homeland Management Incentive Plan. (Incorporated by reference to Exhibit 10s.5 to Form 10-K for fiscal year ended January 1, 1994) 10s.6* (1) 1994 Homeland Management Incentive Plan.\n10t (1) Form of Homeland Employees' Retirement Plan, effective as of January 1, 1988. (Incorporated by reference to Exhibit 10t to Form S-1 Registration Statement, Registration No. 33-22829)\n10t.1 (1) Amendment No. 1 to Homeland Employees' Retirement Plan effective January 1, 1989. (Incorporated herein by reference to Form 10-K for fiscal year ended December 30, 1989)\n10t.2 (1) Amendment No. 2 to Homeland Employees' Retirement Plan effective January 1, 1989. (Incorporated herein by reference to Form 10-K for fiscal year ended December 30, 1989)\n10t.3 (1) Third Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1988. (Incorporated herein by reference to Exhibit 10t.3 to Form 10-K for fiscal year ended December 29, 1990)\n10t.4 (1) Fourth Amendment to Homeland Employees' Retirement Plan effective as of January 1, 1989. (Incorporated herein by reference to Exhibit 10t.4 to Form 10-K for the fiscal year ended December 28, 1991)\n10u (1) Employment Agreement, dated as of January 11, 1988, between Homeland and Jack M. Lotker. (Incorporated by reference to Exhibit 10u to Form S-1 Registration Statement, Registration No. 33- 22829)\n10v UFCW Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v to Form 10-Q for quarterly period ended March 25, 1989)\n10v.1 Stock Appreciation Rights Plan of Homeland for Non-Union Employees. (Incorporated by reference to Exhibit 10v.1 to Form 10-Q for quarterly period ended March 25, 1989)\n10v.2 Teamsters Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v.2 to Form S-1 Registration Statement, Registration No. 33-48862)\n10v.3 BC&T Stock Appreciation Rights Plan of Homeland. (Incorporated by reference to Exhibit 10v.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n10w (1) Employment Agreement, dated as of September 26, 1989, between Homeland and Max E. Raydon. (Incorporated by reference to Exhibit 10w to Form 10-Q for quarterly period ended September 9, 1989)\n10x Indemnification Agreement, dated as of August 14, 1990, among Holding, Homeland, Clayton & Dubilier, Inc. and The Clayton & Dubilier Private Equity Fund III Limited Partnership. (Incorporated by reference to Exhibit 10x to Form 10-Q for quarterly period ended September 8, 1990)\n10y Indenture, dated as of March 4, 1992, among Homeland, United States Trust Company of New York, as Trustee, (\"U.S. Trust\") and Holding, as Guarantor. (Filed as Exhibit 4d)\n10y.1 First Supplement to Indenture, dated as of June 17, 1992, among Homeland, Holding and U.S. Trust. (Filed as Exhibit 4d.1)\n10z Form of Purchase Agreement, dated as of March 4, 1992, among Homeland, Holding and the initial purchasers of Senior Notes. (Filed as Exhibit 4e).\n10aa Form of Registration Rights Agreement, dated as of March 4, 1992, among Homeland and the initial purchasers of Senior Notes. (Filed as Exhibit 4f).\n10bb Form of Parent Pledge Agreement, dated as of March 4, 1992, made by Holding in favor of U.S. Trust, as collateral trustee for the holders of the Senior Notes. (Incorporated by reference to Exhibit 10bb to Form 10-K for the fiscal year ended December 28, 1991)\n10cc Revolving Credit Agreement, dated as of March 4, 1992, among Homeland, Holding, Union Bank of Switzerland, New York Branch, as Agent and lender, and any other lenders and other financial institutions thereafter parties thereto. (Incorporated by reference to Exhibit 10cc to Form 10-K for the fiscal year ended December 28, 1991)\n10cc.1 Letter Waiver (Truck Sale), dated as of May 19, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.1 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.2 Form of Amendment Agreement, dated as of June 15, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.2 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.3 Form of Second Amendment Agreement, dated as of September 23, 1992, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.3 to Form S-1 Registration Statement, Registration No. 33-48862)\n10cc.4 Third Amendment Agreement, dated as of February 10, 1993, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement.\n10cc.5 Fourth Amendment Agreement, dated as of June 8, 1993, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.5 to Form 10-Q for the quarterly period ended June 19, 1993)\n10cc.6 Fifth Waiver and Amendment Agreement, dated as of April 14, 1994, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement. (Incorporated by reference to Exhibit 10cc.6 to Form 10-K for the fiscal year ended January 1, 1994)\n10cc.7* Sixth Waiver and Amendment Agreement, dated as of February 7, 1995, among Homeland, Holding, UBS, as agent, and the other lenders and financial institutions parties to the Revolving Credit Agreement.\n10dd Agreement for Systems Operations Services, effective as of October 1, 1991, between Homeland and K-C Computer Services, Inc. (Incorporated by reference to Exhibit 10dd to Form 10-K for the fiscal year ended December 28, 1991)\n10dd.1 Amendment No. 1 to Agreement for Systems Operations Services, dated as of September 10, 1993, between Homeland and K-C Computer Services, Inc. (Incorporated by reference to Exhibit 10dd.1 to Form 10-K for the fiscal year ended January 1, 1994)\n10ee Form of Indemnification Agreement, dated as of March 4, 1992, among Homeland, Holding, Clayton & Dubilier, Inc., The Clayton & Dubilier Private Partnership Equity Fund III Limited Partnership, and The Clayton & Dubilier Private Equity Fund IV Limited Partnership. (Incorporated by reference to Exhibit 10ee to Form 10-K for the fiscal year ended December 28, 1991)\n10ff Product Transportation Agreement, dated as of March 18, 1992, between Homeland and Drake Refrigerated Lines, Inc. (Incorporated by reference to Exhibit 10ff to Form 10-K for the fiscal year ended December 28, 1991)\n10gg Assignment and Pledge Agreement, dated March 5, 1992, made by Homeland in favor of Manufacturers Hanover Trust Company. (Incorporated by reference to Exhibit 10gg to Form 10-K for the fiscal year ended December 28, 1991)\n10hh Transportation Closure Agreement Summary, dated May 28, 1992, between Homeland and the International Brotherhood of Teamsters, Chauffeurs, Warehousemen and Helpers of America. (Incorporated by reference to Exhibit 10hh to Form S-1 Registration Statement, Registration No. 33-48862)\n10ii (1) Description of terms of employment with Mark S. Sellers. (Incorporated by reference to Exhibit 10ii to Form 10-K for the fiscal year ended January 2, 1993)\n10jj (1) Settlement Agreement, dated as of July 26, 1993, between Homeland and Donald R. Taylor. (Incorporated by reference to Exhibit 10jj to Form 10-K for the fiscal year ended January 1, 1994)\n10kk (1) Executive Officers Medical\/Life Insurance Benefit Plan effective as of December 9, 1993. (Incorporated by reference to Exhibit 10kk to Form 10-K for the fiscal year ended January 1, 1994)\n10ll (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Max E. Raydon. (Incorporated by reference to Exhibit 10ll to Form 10-Q for the quarterly period ended September 10, 1994)\n10mm (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Jack M. Lotker. (Incorporated by reference to Exhibit 10mm to Form 10-Q for the quarterly period ended September 10, 1994)\n10nn (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Steve Mason. (Incorporated by reference to Exhibit 10nn to Form 10-Q for the quarterly period ended September 10, 1994)\n10oo (1) Employment Agreement, dated as of August 11, 1994, between Homeland and Al Fideline. (Incorporated by reference to Exhibit 10oo to Form 10-Q for the quarterly period ended September 10, 1994)\n10pp Letter of Intent, executed on November 30, 1994, between Homeland and Associated Wholesale Grocers, Inc. (Incorporated by reference to Exhibit 10pp to Form 8-K dated November 29, 1994)\n10pp.1* Asset Purchase Agreement, dated as of February 6, 1995, between Homeland and Associated Wholesale Grocers, Inc.\n10qq Solicitation Statement, dated April 4, 1995. (Incorporated by reference to Exhibit 10qq to Form 8-K dated April 4, 1995)\n10rr* (1) Employment Agreement, dated as of November 22, 1994, between Homeland and James A. Demme.\n10ss* (1) Settlement Agreement, dated as of December 31, 1994, between Homeland and Max E. Raydon.\n10tt* (1) Employment Agreement, dated as of January 30, 1995, between Homeland and Mark S. Sellers.\n22 Subsidiaries. (Incorporated by reference to Exhibit 22 to Form S-1 Registration Statement, Registration No. 33-22829)\n24* Consent of Coopers & Lybrand, L.L.P.\n27* Financial Data Schedule.\n99a Press release issued by Homeland on November 30, 1994. (Incorporated by reference to Exhibit 99a to Form 8-K dated November 29, 1994)\n99b Unaudited Summary Financial Data for the 52 weeks ended December 31, 1994. (Incorporated by reference to Exhibit 99b to Form 8-K dated November 29, 1994)","section_15":""}
{"filename":"799149_1994.txt","cik":"799149","year":"1994","section_1":"ITEM 1. Business\n(a)\tGeneral Development of Business. Stamford Towers Limited Partnership (the \"Partnership\") is a Delaware limited partnership which was formed on August 14, 1986. The general partner of the Partnership is Stamford Towers Inc., a Delaware corporation (the \"General Partner\") and an affiliate of Lehman Brothers Inc. The sole limited partner of the Partnership is Stamford Towers Depositary Corp., a Delaware corporation (the \"Assignor Limited Partner\") and also an affiliate of Lehman Brothers Inc. The control and management of the Partnership's business and affairs are vested solely in the General Partner.\nOn November 19, 1986, the Partnership began an offering of 7,826,300 depositary units (\"Units\") representing assignments of the limited partnership interests in the Partnership. The offering was on a \"best efforts\" basis through Shearson Lehman Brothers Inc. (\"Shearson\") at a price of $10 per Unit. On June 30, 1987, a supplement to the prospectus for the offering of the Units was issued for the purpose of updating, modifying and amending certain information contained in the original prospectus.\nOn July 30, 1987, the Partnership commenced operations with the acceptance of subscriptions for 4,562,075 Units ($45,620,750). The remaining Units were sold pursuant to eight additional Partnership closings occurring on a monthly basis from August 1987 through March 1988. Net proceeds to the Partnership from the public offering of the Units were $71,808,474, after deducting offering and organizational costs and setting aside funds for a working capital reserve.\nThe Partnership was formed to acquire, construct, develop, own and operate two parcels of land located in Stamford, Connecticut (the \"Land\") and two commercial office buildings together with ancillary facilities (the \"Buildings\") constructed thereon which contain 325,416 net rentable square feet (the Land and the Buildings are collectively referred to as the \"Project\"). See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nOn July 30, 1987, the Developer, pursuant to the terms of the Development Agreement, caused its affiliate, a trust controlled by Edward Feldman, to convey the Land to the Partnership. The Land has been developed with two architecturally integrated, eleven-story, multi-tenant office buildings (comprised of four levels of parking and seven levels of office space), one of which contains approximately 192,939 square feet of rentable floor space (the \"North Tower\"), and the other of which contains approximately 132,477 square feet of rentable floor space (the \"South Tower\"). The Project is located on two parcels of land, totalling approximately 3.63 acres, in the central business district of Stamford, Connecticut. The Partnership owns no real property other than the Land and the Buildings. A 3,000 square foot cafeteria available for the use of all tenants was completed in December 1990, on the 5th floor of the North Tower.\nThe Partnership entered into a lease with Citicorp POS Information Services, Inc. (\"Citicorp POS\") which became effective on May 15, 1990 (the \"Lease Agreement\"). For information regarding the lease with Citicorp POS, refer to Note 5 \"Lease Agreement with Citicorp POS Information Services\" of the Notes to the Financial Statements contained in Item 8 of this report. Occupancy at the Project remained at 46% as of December 31, 1994, unchanged from December 31, 1993. In addition to Citicorp POS, there are four other tenants occupying space in the Project. Three of these tenants occupy approximately 12,750 square feet of office space. The fourth tenant occupies approximately 500 square feet of retail space.\nAccording to leasing reports prepared by CB Commercial, the total office inventory available for lease in Stamford, Connecticut was 2.9 million square feet at December 31, 1994. This represents a decline from the prior year and reflects absorption of approximately 200 thousand square feet. The Stamford market remained stable as reflected by the vacancy rate which declined slightly from 20.6% at year-end 1993 to 19.9% at the end of 1994. Average asking gross rental rates for class A office space in Stamford was approximately $22 per square foot. The increase in leasing activity is beginning to reduce the availability of class A space in Stamford and the surrounding areas and may lead to an increase in rental rates during 1995.\nOne of the most significant developments in Stamford during 1994 was the announcement that Swiss Bank Corporation (\"Swiss Bank\") would be constructing a 20-story North American headquarters building across the street from the Project. While construction is scheduled to commence in mid-1995 and take several years to complete, Swiss Bank's commitment is evidence of major corporations' continuing interest in Stamford as an alternative to New York. Swiss Bank's plans call for the relocation of approximately 1,300 employees from its current Manhattan location to Stamford by late 1997 or early 1998.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nIn early 1993, the Partnership received the decision of a five-member arbitration board impaneled to determine numerous disputes between and among the Partnership, the Developer and Gilbane arising from the development and construction of the Project. In their decision, the arbitrators awarded the Partnership approximately $8.1 million in damages and costs on its claims against the Developer and awarded the Developer no amounts on its claims against the Partnership. The arbitrators also awarded Gilbane approximately $2.6 million in damages and costs on its claims against the Developer, and ordered that the Developer hold the Partnership harmless with respect to any mechanics liens filed against the Partnership's property in connection with the Project. The Partnership has obtained a judgment in New York for the full amount of the arbitrator's award against Edlar and Edward Feldman, pursuant to the Guaranty.\nHowever, the General Partner's preliminary investigation indicates that the Developer has no significant assets from which the Partnership's arbitration award could be satisfied. Moreover, Mr. Feldman has advised the Partnership that he has no significant liquid assets from which to satisfy the judgment against him, and that he has outstanding debts to other creditors in the approximate amount of $53,000,000. Mr. Feldman has proposed that his creditors, including the Partnership, enter into a non-judicial workout arrangement whereby his debts might be partially satisfied in the event that his real estate investments appreciate in value in future years. Currently, those investments appear to be over leveraged and without significant market value. The Partnership along with Mr. Feldman's other creditors are in the process of evaluating and potentially proposing alternatives to Mr. Feldman's proposal. Berkshire Bank, one of Mr. Feldman's creditors has thus far not participated in this process.\nOn February 1, 1991, Gilbane filed a mechanic's lien against the property in the sum of $4,583,481. On August 9, 1991, Gilbane commenced an action entitled Gilbane Building Co. v. Stamford Towers Limited Partnership, et. al., in the Connecticut Superior Court for the Judicial District of Stamford\/Norwalk at Stamford (the \"Gilbane Action\"). The defendants include the Partnership. Gilbane alleges breach of various contracts and unfair trade practices and seeks foreclosure of its mechanic's lien, monetary damages, attorney fees, punitive damages, possession of the premises, and the appointment of a receiver. The Partnership expects to vigorously defend against each of the plaintiff's claims. On May 17, 1993, at the request of the Partnership, Gilbane reduced the amount of the lien to $2,650,018.\nOn September 21, 1993, Gilbane filed a motion for Partial Summary Judgment as to Liability Only. The Partnership successfully opposed this motion, and the motion was denied by the court on November 4, 1993. On October 28, 1993, the Partnership filed a Motion for Summary Judgment which has not yet been acted upon by the court. On October 21, 1993, the Partnership filed its Answer, Special Defenses and Counterclaims to Gilbane's action. The Partnership's Counterclaim against Gilbane alleges breach of various contracts, unfair trade practices and slander of title. On November 10, 1993, Gilbane filed its reply to Stamford Towers' Special Defenses and Answer to Stamford Towers' Counterclaim and claimed the action to the jury trial list.\nOn November 3, 1994, the Partnership filed a Request for Leave to File Amended Special Defenses, Counterclaims, Set-Offs and Recoupment. On January 25, 1995, this request was granted by the Court over Gilbane's objection. The Partnership's Amended Counterclaim against Gilbane adds, in addition to the allegations of its original Counterclaim, additional allegations of negligence, breach of warranty, breach of contract, products liability and unfair trade practices. Gilbane has not yet answered the Partnership's Amended Counterclaim. The parties are currently engaged in discovery, and a trial has been tentatively scheduled to begin on August 1, 1995.\nOn March 7, 1995, Gilbane filed a Motion to Implead Beer Precast Concrete, Ltd., one of Gilbane's subcontractors on the Project. On March 20, 1995, that Motion was granted. As of March 21, 1995, Beer had not yet responded to Gilbane's Third-Party Complaint against them.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of the Unit Holders at a meeting or otherwise during the fourth quarter in the year for which this report is filed.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Partnership's Limited Partnership Interests and Related Security Holder Matters\n(a) Market Price Information. There is no established trading market for the Units. The Partnership originally intended to apply to include the Units on NASDAQ or another quoted securities market upon the completion of the lease-up of the Project. However, an application is not anticipated at this time.\n(b) Holders. As of December 31, 1994, there were 8,852 Unit Holders.\n(c) Distribution of Net Cash Flow. For information regarding the Partnership's policy with respect to distribution of net cash flow, refer to Note 3 \"The Partnership Agreement\" of the Notes to the Financial Statements contained in Item 8 of this report.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nSet forth below is the selected financial data for the referenced periods.\n\t For the years ended December 31,\n1994 1993 1992 1991 1990\nRental Income $ 2,486,730 $ 2,392,211 $ 2,359,242 $ 2,200,820 $ 1,098,598\nInterest Income 192,911 182,101 259,422 489,484 746,884\nNet Income (Loss) (3,711,936) (4,387,694) (4,180,101) (5,001,682) (4,178,429)\nNet Income (Loss) per Unit (1) (.47) (.56) (.53) (.63) (.53)\nTotal Assets 70,989,125 74,328,520 76,917,606 79,778,759 83,516,926\nRevolving loan payable 15,407,772 14,951,320 13,312,685 11,465,501 8,862,860\nCash Distributions per Unit -0- -0- -0- -0- -0-\n(1) Based upon the weighted average number of Units (7,826,300) outstanding at year end.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nInitially, the principal source of the Partnership's liquidity was the proceeds from the offering of Units which was completed in March 1988 and totalled $78,263,000. After paying offering expenses and syndication costs of the Partnership and establishing a working capital reserve, the Partnership had approximately $71,808,474 available to invest in the acquisition of the Land and the construction, lease up and operation of the Buildings. On July 30, 1987, the Partnership acquired the Land for $14,714,483. As of December 31, 1994, $59,155,584 had been invested in the construction of the Buildings and tenant improvements.\nThe Partnership is currently preserving its funds to lease and operate the Project. Through December 31, 1994, the Partnership's sources of liquidity have been net proceeds from the public offering of the Units, rental payments under the terms of the leases discussed in Item 2, proceeds from the Financing discussed in Item 1 and Note 7, \"Mortgage Note Payable\", of the Notes to the Financial Statements contained in Item 8","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nSee Item 14 for a listing of the financial statements and supplementary data filed with 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 Partnership has no Directors or Executive Officers. The affairs of the Partnership are conducted through the General Partner. Certain officers and directors of the General Partner are now serving (or in the past have served) as officers and 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 for bankruptcy petitions own real estate which has been adversely affected by the economic condition in the markets in which the real estate is located and, consequently, the partnerships sought protection of the bankruptcy laws to protect the partnerships' assets from loss through foreclosure.\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 this sale, Shearson changed its name to Lehman Brothers Inc. (\"Lehman\"). The transaction did not affect the ownership of the Partnership or the General Partner.\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 Director and Executive Officer of the General Partner and the Assignor Limited Partner as of December 31, 1994. Each such officer and director holds a similar position in the General Partner and the Assignor Limited Partner.\nName Age Office\nRegina M. Hertl 36 President Rocco F. Andriola 36 Vice President, Director and Chief Financial Officer\nRegina M. Hertl is a First Vice President of Lehman Brothers in its Diversified Asset Group and is responsible for the investment management of commercial and residential real estate, and a venture capital portfolio. From January 1988 through December 1988, Ms. Hertl was Vice President of the Real Estate Accounting Group within the Controller's Department of Shearson Lehman Brothers. From September 1986 through December 1987, she was an Assistant Vice President responsible for real estate accounting analysis within the Controller's Department at Shearson. From September 1981 to September 1986, Ms. Hertl was employed by the accounting firm of Coopers & Lybrand. Ms. Hertl, who is a Certified Public Accountant, graduated from Manhattan College in 1981 with a B.S. degree in Accounting.\nRocco F. Andriola is a Senior Vice President of Lehman Brothers in its Diversified Asset Group. Since joining Lehman Brothers in 1986, Mr. Andriola has been involved in a wide range of restructuring and asset management activities involving real estate and other direct investment transactions. From 1986-89, Mr. Andriola served as a Vice President in the Corporate Transactions Group of Shearson Lehman Brothers' office of the general counsel. Prior to joining Lehman Brothers, Mr. Andriola practiced corporate and securities law at Donovan Leisure Newton & Irvine in New York. Mr. Andriola received a B.A. degree from Fordham University, a J.D. degree from New York University School of Law, and an LL.M degree in Corporate Law from New York University's Graduate School of Law.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe Directors and Officers of the General Partner and the Assignor Limited Partner do not receive any salaries or other compensation from the Partnership or the Assignor Limited Partner.\nThe General Partner is entitled to varying percentages of Net Cash Flow distributed in any fiscal year and to varying percentages of the Net Proceeds of capital transactions. See Item 5 hereof for a description of such arrangements.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nAs of December 31, 1994, the only entity known by the Partnership to be the beneficial owner of more than five percent of the Units was Chrysler Master Pension Trust, U\/A\/D 5\/28\/56, 12,000 Chrysler Drive, Highland Park, Michigan, which was the beneficial owner of 450,000 Units or approximately 5.74% of the total outstanding Units.\nAs of December 31, 1994, neither the General Partner nor any of its officers or directors held any Units.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nThe General Partner or its affiliates earned fees and compensation in connection with the syndication, acquisition, and organization services rendered to the Partnership. As of December 31, 1994, $127,921 remained unpaid.\nUnder the terms of the Partnership Agreement, the General Partner and certain affiliates may be reimbursed by the Partnership for certain operational expenses, including but not limited to audit, appraisal, legal and tax preparation fees as well as costs of data processing. The Shareholder Services Group provides partnership accounting and investor relations services for the Registrant. Prior to May 1993, these services were provided by an affiliate of the General Partner. The Registrant's transfer agent and certain tax reporting services are provided by Service Data Corporation, an unaffiliated company. For the amounts paid to affiliates for the three years ended December 31, 1994, see Note 4 \"Transactions with Related Parties\" of the Notes to the Financial Statements included in Item 8 of this report.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) Financial Statements and Schedules.\nPage Report of Independent Auditors\nBalance Sheets at December 31, 1994 and 1993\nStatements of Operations for the years ended December 31, 1994, 1993 and 1992\nStatements of Partners' Capital (Deficit) for the years ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows for the years ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements\nSchedule III - Real Estate and Accumulated Depreciation\nNo other schedules are presented because the information is not applicable or is included in the Financial Statements or the notes thereto.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the last quarter of the year ended December 31, 1994.\n(c) Exhibits\nSubject to Rule 12b-32 of the Securities and Exchange Act of 1934 regarding incorporation by reference, listed below are the exhibits which are filed as part of this report:\n3. The Partnership's Amended and Restated Agreement of Limited Partnership, dated as of November 1, 1986, is hereby incorporated by reference to Exhibit A to the Prospectus contained in Registration Statement No. 33-8105, which registration statement (the \"Registration Statement\") was declared effective by the SEC on November 19, 1986.\n4. The form of Unit Certificate is hereby incorporated by reference to Exhibit 4.1 to the Registration Statement.\n10.1 Subscription Agreement and Signature Page is included as Exhibits B and C to the Prospectus contained in the Registration Statement, and is incorporated herein by reference.\n10.2 Escrow Agreement between the Partnership and United States Trust Company of New York is hereby incorporated by reference to Exhibit 10.3 to the Registration Statement.\n10.3 Property Management Agreement between the Partnership and Feldman Realty relating to the Project is hereby incorporated by reference to Exhibit 10.3 to the Registration Statement.\n10.4 Supervisory Leasing and Management Agreement between the Partnership and the Manager relating to the Project is hereby incorporated by reference to Exhibit 10.4 to the Registration Statement.\n10.5 Demand Promissory Note from Shearson to the General Partner is hereby incorporated by reference to Exhibit 10.5 to the Registration Statement.\n10.6 Contract of Sale, as amended to date, relating to the land portion of the Project and all exhibits thereto is included as Exhibit L to the Development Agreement, and is hereby incorporated herein by reference to Exhibit 10.6 to the Registration Statement.\n10.7 Development Agreement between the Developer and the Partnership is hereby incorporated by reference to Exhibit 10.7 to the Registration Statement.\n10.8 Guaranty of the Developer's obligations is hereby incorporated by reference to Exhibit 10.8 to the Registration Statement.\n10.9 Form of Letter Agreement between Edward Feldman and the Partnership relating to the Guaranty is hereby incorporated by reference to Exhibit 10.9 to the Registration Statement.\n10.10 Modification of Development Agreement between the Developer and the Partnership is hereby incorporated by reference to Exhibit 10.10 to the Registration Statement.\n10.11 Commitment Letter from Shearson Lehman Brothers Holdings Inc. to the Partnership is hereby incorporated by reference to Exhibit 10.11 to the Registration Statement.\n10.12 Agreement Regarding Securities Law Liability between Developer, Feldman Realty & Management Corp., Edward Feldman, Shearson, Registrant and the General Partner is hereby incorporated by reference to Exhibit 10.14 to the Registration Statement.\n10.13 Modification of Supervisory Leasing and Management Agreement between the Partnership and the Manager is hereby incorporated by reference to Exhibit 10.15 to the Registration Statement.\n10.14 Commercial Revolving Loan Agreement between the Partnership and People's Bank dated July 19, 1990 is hereby incorporated by reference to Exhibit 10.14 to the Partnership's report on Form 10-K for the year ended December 31, 1990.\n10.15 Modification of Loan Agreement, Mortgage, Collateral Assignment of Leases and Other Loan Documents, between the Partnership and Peoples Bank, dated February 17, 1994, is hereby incorporated by reference to Exhibit 10.15 to the Partnership's report on Form 10-K for the year 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.\nDated: March 30, 1995 STAMFORD TOWERS LIMITED PARTNERSHIP\nBY: Stamford Towers, Inc. General Partner\nBY: \/S\/ Rocco F. Andriola Name: Rocco F. Andriola Title: Director, Chief Financial Officer and Vice President\nSTAMFORD TOWERS DEPOSITARY CORP.\nBY: \/S\/ Rocco F. Andriola Name: Rocco F. Andriola Title: Director, Chief Financial Officer and 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 in the capabilities and on the dates indicated.\nSTAMFORD TOWERS, INC. and STAMFORD TOWERS DEPOSITARY CORP. General Partner\nDate: March 30, 1995 BY: \/S\/ Rocco F. Andriola Rocco F. Andriola Vice President, Director and Chief Financial Officer\nDate: March 30, 1995 BY: \/S\/ Regina Hertl Regina Hertl President\nReport of Independent Auditors\nGeneral and Limited Partners Stamford Towers Limited Partnership\nWe have audited the accompanying balance sheets of Stamford Towers Limited Partnership as of December 31, 1994 and 1993, and the related statements of operations, partners' capital (deficit), and cash flows for each of the three years in the period ended December 31, 1994. 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 Partnership'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.\nNote 2 to the financial statements discusses the Partnership's real estate investments and Note 5 discusses the Partnership's lease agreement with its major tenant.\nIn our opinion, the financial statements referred to above, present fairly, in all material respects, the financial position of Stamford Towers Limited Partnership at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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.\nERNST & YOUNG LLP\nBoston, Massachusetts January 25, 1995\nBalance Sheets December 31, 1994 and 1993\nAssets 1994 1993\nReal estate investments, at cost: Land $ 14,714,483 $ 14,714,483 Buildings and improvements 52,537,022 52,365,750 Tenant improvements 6,618,562 6,590,665 Furniture, fixtures and equipment 372,541 372,541\n74,242,608 74,043,439 Less-accumulated depreciation (12,226,266) (9,585,930)\n62,016,342 64,457,509\nCash and cash equivalents 5,768,902 6,552,078 Restricted cash 89,294 82,592\n5,858,196 6,634,670\nAccounts receivable 103,201 70,970 Deferred rent receivable 2,381,869 2,408,725 Deferred charges, net of accumulated amortization of $445,587 in 1994 and $322,034 in 1993 309,496 295,427 Prepaid expenses, net of accumulated amortization of $636,235 in 1994 and $487,246 in 1993 320,021 461,219\nTotal Assets $ 70,989,125 $ 74,328,520\nLiabilities and Partners' Capital\nLiabilities: Accounts payable and accrued expenses $ 857,084 $ 888,450 Interest payable 95,400 142,876 Due to affiliates 159,091 164,160 Revolving loan payable 15,407,772 14,951,320\nTotal Liabilities 16,519,347 16,146,806\nPartners' Capital (Deficit):\t General Partner (173,287) (136,168) Limited Partners 54,643,065 58,317,882\nTotal Partners' Capital 54,469,778 58,181,714\nTotal Liabilities and Partners' Capital $ 70,989,125 $ 74,328,520\nSee accompanying notes to the financial statements.\nStatements of Operations For the years ended December 31, 1994, 1993 and 1992\nIncome 1994 1993 1992\nRental $ 2,486,730 $ 2,392,211 $ 2,359,242 Interest 192,911 182,101 259,422 Other 293,767 224,612 206,317\nTotal Income 2,973,408 2,798,924 2,824,981\nExpenses\nDepreciation and amortization 2,912,878 2,860,958 3,113,557 Property operating 2,313,161 2,380,642 2,000,089 Interest 1,188,986 1,627,333 1,440,519 Professional fees 146,489 188,344 239,111 Partnership service fees 99,724 113,572 131,973 General and administrative 24,106 15,769 79,833\nTotal Expenses 6,685,344 7,186,618 7,005,082\nNet Loss $ (3,711,936) $ (4,387,694) $ (4,180,101)\nNet Loss Allocated:\nTo the General Partner $ (37,119) $ (43,877) $ (41,801) To the Limited Partners (3,674,817) (4,343,817) (4,138,300)\n$ (3,711,936) $ (4,387,694) $ (4,180,101)\nPer limited partnership unit (7,826,300 outstanding) $ (.47) $ (.56) $ (.53)\nSee accompanying notes to the financial statements.\nStatements of Partners' Capital (Deficit) For the years ended December 31, 1994, 1993 and 1992\nGeneral Partner's Limited Total Capital Partners' Partners' (Deficit) Capital Capital\nBalance at December 31, 1991 $ (50,490) $ 66,799,999 $ 66,749,509 Net loss (41,801) (4,138,300) (4,180,101)\nBalance at December 31, 1992 (92,291) 62,661,699 62,569,408 Net loss (43,877) (4,343,817) (4,387,694)\nBalance at December 31, 1993 (136,168) 58,317,882 58,181,714 Net loss (37,119) (3,674,817) (3,711,936)\nBalance at December 31, 1994 $ (173,287) $ 54,643,065 $ 54,469,778\nSee accompanying notes to the financial statements.\nStatements of Cash Flows For the years ended December 31, 1994, 1993 and 1992\nCash Flows from Operating Activities: 1994 1993 1992\nNet loss $ (3,711,936) $ (4,387,694) $ (4,180,101) Adjustments to reconcile net loss to net cash used for operating activities: Depreciation and amortization 2,912,878 2,860,958 3,113,557 Increase (decrease) in cash arising from changes in operating assets and liabilities: Restricted cash (6,702) (2,079) 683,294 Accounts receivable (32,231) (10,355) (14,475) Deferred rent receivable 26,856 (704,396) (698,375) Prepaid expenses (7,791) (61,729) (1,062) Accounts payable and accrued expenses (31,366) 144,701 (325,240) Due to affiliates (5,069) (587) 2,596 Interest payable (47,476) 15,859 17,486\nNet cash used for operating activities (902,837) (2,145,322) (1,402,320)\nCash Flows from Investing Activities:\nAdditions to real estate assets (199,169) (152,409) (436,314)\nNet cash used for investing activities (199,169) (152,409) (436,314)\nCash Flows from Financing Activities:\nBorrowings under the revolving loan payable 456,452 1,638,635 1,847,184 Deferred Charges (137,622) -- --\nNet cash provided by financing activities 318,830 1,638,635 1,847,184\nNet increase (decrease) in cash and cash equivalents (783,176) (659,096) 8,550 Cash and cash equivalents at beginning of year 6,552,078 7,211,174 7,202,624\nCash and cash equivalents at end of year $ 5,768,902 $ 6,552,078 $ 7,211,174\nSupplemental Disclosure:\nWrite-off of excess Real Estate Tax Capitalization $ -- $ -- $ 223,078\nCash paid for Interest $ 949,390 $ -- $ --\nSee accompanying notes to the financial statements.\nNotes to the Financial Statements December 31, 1994, 1993 and 1992\n1. Organization and Business Stamford Towers Limited Partnership (the \"Partnership\"), a Delaware limited partnership, was formed on August 14, 1986 for the purpose of acquiring two parcels of land, aggregating 3.63 acres, located in Stamford, Connecticut and developing, owning and operating two class A office buildings (the \"Buildings\") to be constructed thereon (collectively the \"Project\"). The Buildings contain approximately 325,000 square feet of rentable space.\nThe general partner of the Partnership is Stamford Towers, Inc. (the \"General Partner\") is an affiliate of Lehman Brothers Inc. (see below).\nConstruction of the Buildings commenced in July 1987. However, certificates of occupancy were not received from the City of Stamford until February 6, 1990, representing a substantial delay from the originally scheduled completion date of February 1989. Moreover, during the course of construction, substantial cost overruns were incurred. The Partnership initiated an arbitration proceeding against Edlar, Inc., a Delaware corporation, (\"Edlar\") in order to establish Edlar's responsibility for certain cost overruns, delays, expenses and liquidated damages in connection with the construction phase of the Project. In January 1993, the arbitrators issued their decision which, in substance, awards the Partnership approximately $8.1 million in damages and costs against Edlar. However, the General Partner's preliminary investigation indicates that Edlar has no significant assets from which the Partnership's arbitration award could be satisfied. Moreover, Edward Feldman, the principal of E dlar, has advised the Partnership that he has no significant, liquid assets from which to satisfy the judgment against him pursuant to his personal guaranty of Edlar's obligation to the Partnership. Mr. Feldman has proposed that his creditors, including the Partnership, enter into a non-judicial workout arrangement whereby his debts might be partially satisfied in the event that his real estate investments appreciate in value in future years. Currently, those investments appear to be over leveraged and without significant market value. The Partnership is in the process of evaluating Mr. Feldman's proposal. (see Note 9).\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. 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 partner.\nThe Partnership will terminate on December 31, 2036 unless dissolved sooner as provided within the Agreement.\n2. Significant Accounting Policies\nCash Equivalents - Cash equivalents consist of short-term highly liquid investments which have maturities of three months or less from the date of purchase. Substantially all the Partnership's cash balances are invested with an affiliate of the General Partner.\nOffering Costs - Offering costs of $6,454,526 are non-amortizable and have been deducted from the limited partners' capital.\nDeferred Charges - Costs incurred in connection with obtaining mortgage financing are included in deferred charges. These costs are amortized over the life of the related mortgage loan.\nLeasing Commissions - Leasing commissions included in prepaid expenses are being amortized over the term of the non-cancelable portions of the leases.\nDeferred Rent Receivable - Deferred rent receivable consists of rental income which is recognized on a straight-line basis over the non-cancelable portion of the leases which will not be received until later periods as a result of rental concessions.\nReal Estate Investments - Real estate investments, which consist of buildings and improvements, tenant improvements and furniture, fixtures and equipment, are recorded at cost less accumulated depreciation. Cost of the buildings includes the initial purchase price of the property plus closing costs, acquisition and legal fees and capital improvements. Depreciation on the buildings and improvements is computed using the straight-line method based on estimated useful lives of 35 years. Tenant improvements are depreciated by the straight-line method over the terms of the related leases. Furniture, fixtures and equipment are depreciated over their estimated useful lives.\nThe current estimated value of the real estate investments as of December 31, 1994 is comparable to 1993, however, down significantly from prior years. This decline in value has resulted in a current market value that is lower than what is expected over the long term holding period for the investment. The real estate investments will be carried at cost less accumulated depreciation unless facts and circumstances arise in future periods that indicate the carrying value of the real estate investments is permanently impaired.\nIncome Taxes - No provision for income taxes has been made in the financial statements since such taxes are the responsibility of the individual partners rather than that of the Partnership.\n3. The Partnership Agreement Pursuant to the terms of the Partnership Agreement, all net income from operations of the Partnership will be allocated in substantially the same manner as cash distributions from operations. All net losses from operations of the Partnership generally will be allocated 99% to the limited partners and 1% to the General Partner.\nDistributions of net cash flow from operations, if any, as defined in the Partnership Agreement, shall be made to the partners quarterly during each year on the basis of 99% to the limited partners and 1% to the General Partner until the limited partners have received their Preferred Return (14% per annum), as defined in the Partnership Agreement, and then 90% to the limited partners and 10% to the General Partner. Cash distributions from operations will be reduced to the extent of any debt service payable with respect to the financing (see Note 7).\nUpon sale or an interim capital transaction, net proceeds will be distributed after the close of the calendar quarter in which such a sale or capital transaction occurs. Such net proceeds will first be distributed 99% to the limited partners and 1% to the General Partner until the limited partners receive their Preferred Return Arrearage and Unrecovered Capital, as defined in the Partnership Agreement, with any remaining proceeds to be distributed 90% to the limited partners and 10% to the General Partner.\nUpon sale or an interim capital transaction, net gains will first be allocated to the extent of net proceeds distributed to the limited partners and General Partner from related transactions, then to the limited partners and General Partner in proportion to their respective negative balances in their capital accounts; then the remainder of such net gains should be allocated to the extent possible so that the positive balances in the capital accounts of the limited partners and the General Partner are in the proportions of 90% and 10%, respectively. Tax losses from sale or an interim capital transaction will be allocated to the limited partners and General Partner in proportion to their respective positive balances in their capital accounts after such allocation, the remainder of the tax losses should be allocated to the extent possible so that the negative balances in the capital accounts of the limited partners and General Partner are in the proportions of 90% and 10%, respectively.\nAll net gains and tax losses in connection with the sale of all or substantially all of the assets of the Partnership or any other event causing a dissolution of the Partnership shall be allocated in substantially the same manner as net gains and tax losses from sale or an interim capital transaction.\nIf, as a result of the dissolution of the Partnership, the capital account of the General Partner is less than zero, the General Partner shall contribute to the Partnership an amount equal to the lesser of the deficit balance in its capital account or the excess of one and one one-hundredth percent of the total capital contribution of the limited partners over the total capital contributions previously made by the General Partner to the Partnership.\n4. Transactions with Related Parties The General Partner earned fees and compensation in connection with organization, syndication and acquisition services rendered to the Partnership. As of December 31, 1994, $127,921 of these amounts remain accrued and unpaid.\nUnder the terms of the Partnership Agreement, the Partnership reimburses the General Partner, at cost, for the performance of certain administrative services provided by a third party. For the years ended December 31, 1994, 1993 and 1992, costs of such services were $51,044, $55,375, and $73,057, respectively. At December 31, 1994 and 1993, $31,027 and $36,239, respectively, were due to the General Partner for the performance of these services.\n5. Lease Agreement with Citicorp POS Information Services The Partnership entered into a lease with Citicorp POS Information Services (\"Citicorp POS\") on May 15, 1990 (the \"Lease Agreement\"). Citicorp POS leased approximately 136,000 rentable square feet of the North Tower, representing 41% of the Project. The lease term is for eleven years with the option to cancel after June, 1996. If the option to cancel is elected, Citicorp POS will be required to pay a substantial penalty to the Partnership. Using occupancy percentages at December 31, 1994, if Citicorp POS vacated the premises, only 14% of the Project would remain rented. Under the Lease Agreement, the Partnership is recording a minimum annual rental revenue of $2,197,196, calculated on a straight-line basis, during the non-cancelable term of the lease. Citicorp POS's performance of its obligation under the terms of its lease is guaranteed by Citicorp.\nIn December, 1992, Citicorp POS discontinued operations, vacated the space and assigned the Lease Agreement to Citicorp North America, Inc. (\"Citicorp N.A.\"). As of December 1994, substantially all of the space is occupied by Citicorp N.A. and its affiliates.\nDuring 1994, 1993 and 1992, Citicorp and other tenants, have reimbursed the Partnership for tenant electricity, overtime heating and air conditioning charges and certain other operating expenses, in accordance with their respective lease agreements, in the total amount of $288,472, $220,012, and $165,009, respectively. These amounts have been included in other income on the statement of operations.\n6. Future Minimum Lease Rental Payments Future minimum rental payments (excluding cancellation penalties) to be received under the non-cancelable portion of the existing operating leases as of December 31, 1994 are as follows:\n1995 $ 3,767,596 1996 2,289,122 1997 280,993 1998 283,741 1999 254,927 Thereafter 687,953\n$ 7,564,332\n7. Mortgage Note Payable On July 19, 1990, the Partnership closed a loan with People's Bank (\"People's\") to provide mortgage financing to the Partnership. As part of this loan, the Partnership paid People's a fee equal to one and one-half percent of the aggregate loan amount. The mortgage note payable was a $25 million, seven year, non-recourse first mortgage loan with an 11.5% fixed interest rate for the first five years which was set at three percent over the five year United States treasury security rate at loan closing.\nOn February 17, 1994, the Partnership entered into a loan modification agreement with People's (the \"Loan Modification\"). The Loan Modification: (i) reduced the interest rate on the loan from 11.5% to 7.43% commencing February 1, 1994 and continuing until the first adjustment date on July 19, 1995; (ii) reduced the principal balance of the loan from $25 million to $24,449,795; and (iii) eliminated the interest reserve line item. Payments of interest are due monthly in arrears and are required to be paid from the Partnership's own funds. Loan proceeds may continue to be used on an \"as needed\" basis to fund all other approved line items. Payment of the outstanding principal amount is due at the end of the seven year term. The loan may be prepaid in whole or in part at any time without penalty. As of December 31, 1994, the principal balance of the loan was $15,407,772 plus interest payable of $95,400 for a total balance of $15,503,172.\nDuring 1994, the Partnership drew down on the loan $456,452 for capital expenditures and interest expenses. In 1993 and 1992, the Partnership drew down on the loan $1,611,474 and $1,423,023, respectively, for interest expense only.\n8. Reconciliation of Net Loss to Tax Loss For the year ended December 31, 1994, net loss reported in the financial statements exceeded the tax loss by $28,358. For the years ended December 31, 1993 and 1992 the tax loss exceeded the net loss reported in the financial statements by $730,926 and $453,806, respectively. These differences are due to the differences between the tax basis and financial statement basis of buildings and improvements and the use of accelerated methods of depreciating real estate for tax purposes as compared to the straight-line method used for financial statement purposes. In addition, rental income is recorded on a straight-line basis over the terms of the leases for financial statement purposes, and is reportable for tax purposes when received or receivable.\n9. Arbitration Proceedings with the Developer In late January of 1989, the Partnership initiated an arbitration proceeding against Edlar in order to establish Edlar's responsibility for certain cost overruns, delays, expenses and liquidated damages in connection with the construction phase of the Stamford Towers office project (the \"Project\"). Subsequently, the arbitration was consolidated with a separate arbitration between Edlar and the Project's construction manager, Gilbane Building Company (\"Gilbane\").\nIn January 1993, the arbitrators issued their decision which, in substance, awards the Partnership approximately $8.1 million in damages and costs against Edlar and awards Gilbane approximately $2.6 million in damages and costs against Edlar. In addition, the arbitrators ordered Edlar to hold the Partnership harmless with respect to (i) the mechanic's lien filed by Gilbane against the Partnership, which is presently the subject of an action in Connecticut state court and (ii) any similar liens filed by subcontractors who worked on the project. The arbitrators further found that the Partnership properly terminated Edlar under the Development Agreement. That finding has the effect of eliminating the residual interest in the Project of Edlar's affiliate, Feldco, Inc. Edlar was not awarded any amounts on its claims against the Partnership or Gilbane. The Partnership has entered judgment against both Edlar and Edward Feldman, pursuant to his personal guaranty of Edlar's obligation to t he Partnership, for the full amount of the arbitration award.\nBased on preliminary investigation by the General Partner, it appears that Edlar has no significant assets from which to satisfy the arbitration award. Moreover, based on the General Partner's discussions with Edward Feldman concerning his proposal for a non-judicial workout, it would appear that his assets, consisting largely of illiquid real estate investments, are insufficient to satisfy his substantial outstanding obligations to his creditors, including the Partnership.\n10. Litigation On February 1, 1991, the construction manager at the Project, Gilbane, filed a mechanic's lien against the Project in the sum of $4,583,481. On August 9, 1991, Gilbane commenced an action entitled Gilbane Building Co. v. Stamford Towers Limited Partnership, et. al., in the Connecticut Superior Court for the Judicial District of Stamford\/Norwalk at Stamford (the \"Gilbane Action\"). The defendants include the Partnership. Gilbane alleges breach of various contracts and unfair trade practices and seeks foreclosure of its mechanic's lien, monetary damages, attorney fees, punitive damages, possession of the premises, and the appointment of a receiver. On May 17, 1993, at the request of the Partnership, Gilbane reduced the amount of the lien to $2,650,018.\nOn September 21, 1993, Gilbane filed a motion for Partial Summary Judgment as to Liability Only. The Partnership successfully opposed this motion, and the motion was denied by the court on November 4, 1993. On October 28, 1993, the Partnership filed a Motion for Summary Judgment which has not yet been acted upon by the court. On October 21, 1993, the Partnership filed its Answer, Special Defences and Counterclaims to Gilbane's action. The Partnership's Counterclaim against Gilbane alleges breach of various contracts, unfair trade practices and slander of title. On November 10, 1993, Gilbane filed its Reply to Stamford Towers' Special Defenses and Answer to Stamford Towers' Counterclaim and claimed the action to the jury trial list.\nOn November 3, 1994, the Partnership filed a Request for Leave to File Amended Special Defenses, Counterclaims, Set-Offs and Recoupment. On January 25, 1995, this Request was granted by the Court over Gilbane's objection. The Partnership's Amended Counterclaim against Gilbane adds, in addition to the allegations of its original Counterclaim, additional allegations of negligence, breach of warranty, breach of contract, products liability and unfair trade practices. Gilbane has not yet answered the Partnership's Amended Counterclaim. The parties are currently engaged in discovery, and a trial has been tentatively scheduled to begin on August 1, 1995. The Partnership expects to vigorously defend against each of Gilbane's claims.\nOn December 31, 1990, a subcontractor of the Project, Moliterno Stone Sales, Inc. (\"Moliterno\") filed a mechanic's lien against the Property in the sum of $155,936. On December 11, 1991, Moliterno filed a cross-claim against the Partnership in the Gilbane Action. Moliterno seeks foreclosure on its mechanic's lien and monetary damages, along with possession of the premises. An application to discharge Moliterno's mechanic's lien was filed by the Partnership on April 30, 1993. The Partnership expects to vigorously defend against Moliterno's claim.\nSTAMFORD TOWERS LIMITED PARTNERSHIP Schedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1994\nCost Capitalized Initial Subsequent Cost to Partnership (A) To Acquisition\nBuildings and Buildings and Description Encumbrances Land Improvements Improvements\nOffice Buildings:\nNorth Tower Stamford, CT $ 9,244,663 $ 8,828,690 $ 31,289,872 $ 7,404,213\nSouth Tower Stamford, CT 6,163,109 5,885,793 20,859,915 197,203\n$ 15,407,772 $ 14,714,483 $ 52,149,787 $ 7,601,416\nSTAMFORD TOWERS LIMITED PARTNERSHIP Schedule III - Real Estate and Accumulated Depreciation (continued)\nDecember 31, 1994\nGross Amount at Which Carried at Close of Period (B, C)\nBuildings and Accumulated Description Land Improvements Total Depreciation\nOffice Buildings:\nNorth Tower Stamford, CT $ 8,828,690 $ 38,560,238 $ 47,388,928 $ 9,276,328\nSouth Tower Stamford, CT 5,885,793 20,967,887 26,853,680 2,949,938\n$ 14,714,483 $ 59,528,125 $ 74,242,608 $ 12,226,266\nSTAMFORD TOWERS LIMITED PARTNERSHIP Schedule III - Real Estate and Accumulated Depreciation (continued)\nDecember 31, 1994\nLife on which Depreciation Date Date in Latest Construction Construction Income Statements Description Complete Began is Computed\nOffice Buildings:\nNorth Tower Stamford, CT February 1990 August 1987 5-35 years\nSouth Tower Stamford, CT February 1990 August 1987 5-35 years\n(A) The initial cost to the Partnership represents the original purchase price of the properties. (B) For Federal income tax purposes, the aggregate cost of real estate at December 31, 1994 and 1993 is $74,649,569 and $74,450,400, respectively. (C) For Federal income tax purposes, the amount of accumulated depreciation at December 31, 1994 and 1993 is $9,267,837 and $7,328,080, respectively.\nA reconciliation of the carrying amount of real estate and accumulated depreciation for the years ended December 31, 1994, 1993 and 1992:\nReal Estate investments: 1994 1993 1992\nBeginning of year $ 74,043,439 $ 73,891,030 $ 73,677,794 Additions 199,169 152,409 436,314 Less retirements -- -- (223,078)\nEnd of year $ 74,242,608 $ 74,043,439 $ 73,891,030\nAccumulated Depreciation:\nBeginning of year $ 9,585,930 $ 6,957,448 $ 4,376,639 Depreciation expense 2,640,336 2,628,482 2,580,809\nEnd of year $ 12,226,266 $ 9,585,930 $ 6,957,448","section_15":""}
{"filename":"811828_1994.txt","cik":"811828","year":"1994","section_1":"Item 1. Business\nThe Company\nIn May 1994, Atlantis Group, Inc. changed its name to Atlantis Plastics, Inc. (\"Atlantis\" or the \"Company\"), moved its state of incorporation from Delaware to Florida, and cancelled its shares of Class A and Class B treasury stock then outstanding. Atlantis is a leading U.S. manufacturer of polyethylene stretch and custom films used in a variety of industrial and consumer applications and molded plastic products for the appliance, automotive, recreational vehicle, and dairy industries.\nAtlantis Plastic Films currently accounts for approximately two-thirds of the Company's net sales and consists of (i) stretch films (multi-layer plastic films that are used principally to stretch-wrap pallets of materials for shipping or storage), and (ii) custom film products (high-grade laminating films, embossed films and specialty film products targeted primarily to industrial and agricultural markets).\nAtlantis Molded Plastics currently accounts for approximately one-third of the Company's net sales and consists of three principal technologies, serving a wide variety of specific market segments: (i) injection-molded thermoplastic parts that are sold primarily to original equipment manufacturers and used in major household appliances, agricultural and automotive products, (ii) a variety of standard and custom extruded parts (profile extrusion) that are incorporated into a broad range of consumer and commercial products, including plastic moldings, trims, channels, seals and gaskets that are used in recreational vehicles, doors, residential windows, office furniture and retail store fixtures, and (iii) blow-molded milk, juice, water and industrial containers in a variety of shapes and sizes.\nThe Company believes that Atlantis Plastic Films' size and market positions provide significant competitive advantages in the stretch film markets. The Atlantis Molded Plastics subsidiaries compete in highly fragmented segments of the plastics industry that are distinguished by numerous small regional producers manufacturing custom products or targeting specific market niches. The Company believes that the market positions of its Atlantis Molded Plastics subsidiaries and the custom nature of many of their products provide barriers to competition and frequently afford these subsidiaries with opportunities for higher profit margins.\nThe Company's sixteen plastics manufacturing facilities produce a wide spectrum of products for industrial, commercial and consumer markets. Management believes that the Company's diversification and broad range of capabilities reduce the Company's exposure to economic downturns in specific industries and permit the Company to react efficiently to specific market opportunities. In addition, in recent years the Company has directed significant efforts toward maintaining or improving its operating profitability in the face of continued industry pricing pressures. These efforts have included consolidating management functions to enhance coordination of marketing, manufacturing and research and development activities, and expanding marketing, sales and distribution systems to generate new customers. The Company intends to continue these efforts, which management believes have generally enabled the Company to become a low-cost producer.\nThe Company's growth strategy seeks to capitalize on the Company's existing manufacturing capabilities and reputation for product quality and customer service. The Company's specific strategies include (i) intensified efforts to reduce cost of sales, control the Company's cost base and realize manufacturing efficiencies, (ii) concentrated efforts to continually improve product quality and customer satisfaction by training employees in and applying Total Quality Management and Statistical Process Control systems, (iii) developing new products to increase sales to new and existing customers, to improve profit margins and to enhance the Company's position as a provider of value-added products and services, (iv) expanding and refining the marketing activities of its direct sales force and independent representative organizations to target national accounts and penetrate new market niches, and (v) focusing its acquisition activities on selected plastics operations that will augment the Company's existing operations or provide entry into new markets.\nThe Company was founded in 1984 and has grown primarily through acquisitions in the plastics, insurance and furniture manufacturing industries. In recent years the Company has concentrated its resources in the plastics industry, and, as part of this strategic focus, in April 1991 the Company sold a 51% interest in its furniture operations (\"Loewenstein\"). In October 1993, the Company sold a portion of its remaining 49% Loewenstein stock interest as part of Loewenstein's initial public offering, reducing its ownership to approximately 20%. Events subsequent to December 31, 1993 reduced the Company's share ownership to 18% as of February 14, 1994, and during December 1994 Loewenstein and another furniture manufacturer were merged into WinsLoew Furniture, Inc. (\"WinsLoew\"). Subsequent to the merger, Atlantis owned approximately 10% of WinsLoew, which is subject to further reduction to approximately 9% in the event certain stock options are exercised. The Company's insurance operations and its remaining WinsLoew stock interest are held for sale. See \"-- Discontinued Operations.\"\nProfiles of the Company's businesses and facilities are set forth within Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAtlantis' Miami corporate offices consist of approximately 13,138 square feet of space that is shared with several entities controlled by the principal stockholders of the Company (or their affiliates). The present annual lease expense of $329,000, as well as certain other general and administrative expenses, are allocated among the Company and these entities. See Part III Item 13 - \"Certain Relationships and Related Transactions.\" In addition, during 1992 the Company began to sublease approximately 2,500 square feet of such office space to an unaffiliated third party. The Company also leases certain office space in Atlanta, Georgia.\nThe following table describes the operating facilities owned or leased by the Company, with substantially all of the owned plastics facilities pledged as security for debt. Management believes that the Company's manufacturing facilities are adequate to meet current needs and increases in sales volume for the foreseeable future.\n(1) New facility purchased in February 1995, 87,000 square feet.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company believes that it is not presently a party to any litigation the outcome of which would have a material adverse effect on its consolidated financial condition or 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 security holders during the fiscal quarter ended December 31, 1994.\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 is traded on the American Stock Exchange (the \"AMEX\") and the Pacific Stock Exchange under the symbol \"AGH\". The following table sets forth the high and low sales prices for the Class A Common Stock on the AMEX for each quarter of the years 1993 and 1994.\nAs of January 31, 1995, there were approximately 244 holders of record of the 4,082,437 outstanding shares of Class A Common Stock. The closing sales price for the Class A Common Stock on January 31, 1995 was $6.00.\nPrior to 1994, the Company did not pay cash dividends on any class of its Common Stock. During February 1994 the Company's Board of Directors approved a quarterly dividend program and the Company paid 2.5 cents per share quarterly dividends in April, July and October, 1994. The Company's ability to pay cash dividends is subject to the dividend preference of the Company's presently outstanding Series A Convertible Preferred Stock. Payment of dividends is also restricted under the terms of the Company's Senior Notes and its revolving credit facility. In addition, insurance regulations generally limit Western Pioneer's dividends to net investment income.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSelected Financial Data on page 1 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994 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 on pages 12 through 16 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994 is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statement information and the supplemental data required in response to this item is incorporated herein by reference to pages 18 through 31 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994.\nCertain other financial statement schedules are included in Part IV-Item 14(b) of this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Company has had no changes in or disagreements with its independent certified public accountants on accounting and financial disclosure.\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 and executive officers of the Company is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required in response to this item is incorporated by reference to the registrant's Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\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:\nThe following financial statements have been incorporated into Part II of this report by reference to the registrant's Annual Report to Shareholders for the year ended December 31, 1994.\n(2) Financial Statement Schedules.\nThe following financial statement schedules for the years ended December 31, 1994, 1993 and 1992 are submitted herewith:\nSCHEDULE I Articles 5 and\nATLANTIS PLASTICS, INC. AND SUBSIDIARIES (Parent Company Only)\nINCOME STATEMENTS For the years ended December 31, 1994, 1993 and 1992 (In thousands)\n(1) 1993 and 1992 includes the Parent's equity of $ 1,437,000 and $414,000, respectively, in subsidiary extraordinary losses on early extinguishment of debt, net of taxes.\nSCHEDULE I Articles 5 and\nATLANTIS PLASTICS, INC. AND SUBSIDIARIES\n(Parent Company Only)\nSTATEMENTS OF CASH FLOWS\nFor the years ended December 31, 1994, 1993 and 1992 (In thousands)\nSCHEDULE I Articles 5 and\nATLANTIS PLASTICS, INC. AND SUBSIDIARIES\n(Parent Company Only)\nSTATEMENTS OF CASH FLOWS\nFor the years ended December 31, 1994, 1993 and 1992 (In thousands)\nSCHEDULE II Articles 5 and\nATLANTIS PLASTICS, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(In thousands)\n(3) Exhibits (An asterisk to the left of an exhibit number denotes a management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K.)\n2.1 Agreement and Plan of Merger by and between Atlantis Plastics, Inc., a Florida corporation and Atlantis Group, Inc., a Delaware corporation, dated as of April 22, 1994. (2)(1)\n3.1 Registrant's Articles of Incorporation (3.1)(1)\n3.2 Registrant's Bylaws (February 1988) (3.2)(1)\n4.1 Trust Indenture between Registrant and American Stock Transfer and Trust Company (4.2)(10)\n4.2 Form of Senior Note, dated February 15, 1993 (4.3)(10)\n10.1 Preferred Stock Subscription and Purchase Agreement, dated October 24, 1986, between Registrant and Southeast Banking Corporation (10.20)(1)\n*10.2 Registrant's Amended and Restated Stock Option Plan, dated as of March 16, 1989 (10.1)(6)\n*10.3 Registrant's 1987 Disinterested Directors Stock Option Plan (10.2)(2)\n*10.4 Registrant's Amended and Restated 1990 Stock Option Plan (10.2)(6)\n*10.5 Fourth Amended and Restated Management Agreement between Registrant and Trivest, Inc. (10.5)(9)\n*10.6 Second Amended and Restated Employment Agreement, dated January 1, 1990 between Registrant and Earl W. Powell (10.6) (5)\n*10.7 First Amendment To Second Amended and Restated Employment Agreement, dated as of April 1, 1992, between Registrant and Earl W. Powell (10.7) (10)\n*10.8 Employment Agreement, dated January 1, 1990, between Registrant and Phillip T. George, M.D. (10.7) (5)\n*10.9 First Amendment to Employment Agreement, dated as of April 1, 1992, between the Registrant and Phillip T. George, M.D. (10.9) (10)\n10.10 Form of Indemnification Agreement (10.47)(12)\n10.11 Office Lease, dated as of December 31, 1993, between Grand Bay Plaza Joint Venture and the Registrant, and First Addendum thereto (11)\n10.12 Settlement Agreement by and between Mobil Oil Corporation and Linear Films, Inc. of Civil Action No. 87 civ. 874-B in the Northern District of Oklahoma, effective as of February 21, 1992 (10.40)(8)\n10.13 License Agreement by and between Mobil Oil Corporation and Linear Films, Inc. for use of U.S. Patent No. 4,518,654, effective as of February 21, 1992 (10.41)(8)\n10.14 Loan Contract, dated October 30, 1987, between State of Minnesota and National Poly Products, Inc. (10.11)(2)\n10.15 Letter of Consent to the Loan Contract between State of Minnesota and National Poly Products, Inc., dated October 30, 1991 (10.43)(8)\n10.16 Letter of Consent to the Loan Contract between State of Minnesota and National Poly Products, Inc., dated January 13, 1992 (10.44 )(8)\n10.17 Consent and Acknowledgement to the Loan Contract between State of Minnesota and National Poly Products, Inc., dated February 18, 1993 (10.22)(10)\n10.18 Joint Venture Agreement, dated as of January 26, 1990 between Rigal Plastics, Inc. and CKS Plastics, Inc. (\"CKS\/Rigal Plastics\") (10.65)(5)\n10.19 Amendment to CKS\/Rigal Plastics Joint Venture Agreement, dated as of January 17, 1994.(11)\n10.20 Amendment to CKS\/Rigal Plastics Joint Venture Agreement dated as of January 24, 1994.(11)\n10.21 Limited Guarantee of the Registrant dated as of January 19, 1994, of the obligations of CKS\/Rigal Plastics in favor of Bank South, N.A. (11)\n10.22 Loan Agreement between Arkansas Development Finance Authority and Cyanede, dated March 18, 1992 (10.69)(9)\n10.23 Promissory Note from Cyanede to the Arkansas Development Finance Authority, in the amount of $1,600,000, dated June 1, 1992 (10.70)(9)\n10.24 Office Lease, dated as of April 1, 1992, between Euram 1870 Exchange Associates and National Poly Products, Inc. (10.78)(9)\n10.25 Subordination and Attornment Agreement between State Farm Life Insurance Company and National Poly Products, Inc. dated April 6, 1992 (10.78)(9)\n10.26 Intercreditor Agreement between Heller Financial, Inc., Arkansas Development Finance Authority and Worthen Trust Company, Inc. (10.40)(10)\n10.27 Asset Purchase Agreement, dated May 17, 1994, among the Registrant, Advanced Plastics, Inc. and Frederick R. Warren. (12)\n10.28 Credit Agreement, dated February 22, 1993, between the Registrant and Heller Financial, Inc. (the \"Heller Credit Agreement\") (10.39)(10)\n10.29 First Amendment and Waiver, dated March 28, 1994, to Heller Credit Agreement.(13)\n10.30 Consent Letter, dated May 23, 1994, to Heller Credit Agreement.(13)\n10.31 Second Amendment, dated August 15, 1994, to Heller Credit Agreement.(13)\n10.32 Consent Letter, dated September 9, 1994, to Heller Credit Agreement.(13)\n10.33 Consent Letter, dated February 13, 1995, to Heller Credit Agreement.(1)\n10.34 Consent and Waiver Letter, dated February 24, 1995, to Heller Credit Agreement.(13)\n10.35 Lease with option to purchase Real Estate between Atlantis Plastic Films, Inc. and the City of Mankato, Minnesota, dated as of March 2, 1995.(13)\n11.1 Calculation of Earnings Per Share(13)\n13.1 Registrant's Annual Report to Shareholders for the year ended December 31, 1994(13)\n21.1 Registrant's Subsidiaries(13)\n23.1 Consent of Coopers & Lybrand L.L.P.(13)\n(1) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's form 8-B filed June 7, 1994.\n(2) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.\n(3) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n(4) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989.\n(5) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990.\n(6) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's registration statement on Form S-8 (No. 33-41012).\n(7) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Form 8-K, dated April 10, 1991.\n(8) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.\n(9) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's registration statement on Form S-2 (33-53152).\n(10) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992.\n(11) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993.\n(12) Incorporated by reference to the exhibit shown in parentheses and filed with the Registrant's Report on Form 8-K filed June 3, 1994.\n(13) Filed herewith\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant during the last quarter of the period covered by this Report.\n(c) Exhibits required by Item 601 of Regulation S-K\nThe index to exhibits that are listed in Item 14(a)(3) of this report and not incorporated by reference follows the \"Signatures\" section hereof and is incorporated herein by reference.\n(d) Financial Statement Schedules required by Regulation S-X\nThe financial statement schedules required by Regulation S-X which are excluded from the Registrant's Annual Report to Shareholders for the year ended December 31, 1994, by Rule 14a-3(b)(1) are included above. See Item 14(a)2 for index.\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, there- unto duly authorized.\nATLANTIS PLASTICS, INC.\nDate: March 30, 1995 By:\/s\/ Paul Rudovsky Paul Rudovsky Executive Vice President, Finance and Planning\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.\nINDEX TO EXHIBITS\n(1) The conversion of preferred stock is not considered, as the dilutive effect was not material.\nEXHIBIT 13.1\nFinancial Highlights\n(In thousands, except per share data)\n(A) EBITDA represents income (loss) from continuing operations before interest, taxes, depreciation, and amortization.\n(B) Core earnings (loss) represents income (loss) from continuing operations excluding litigation settlements and costs, net of tax.\n(C) For 1992, fully diluted income per share from continuing operations was $.62.\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nAtlantis is a leading U.S. manufacturer of polyethylene stretch and custom films used in a variety of industrial and consumer applications and molded plastic products for the appliance, agricultural, automotive, recreational vehicle, residential window, and dairy industries. Its continuing operations consist of two primary operating segments: Atlantis Plastic Films manufactures polyethylene stretch film and a variety of custom film products, and Atlantis Molded Plastics manufactures products using three distinct technologies: injection molding, profile extrusion, and blowmolding.\nDiscontinued operations in 1994 consist of the operations of Western Pioneer, the Company's California property-casualty insurance subsidiary. Prior to 1994, discontinued operations included both Western Pioneer and the Company's interest in Loewenstein Furniture Group, Inc. (\"Loewenstein\"). See Note 17 of Notes to the Company's Consolidated Financial Statements.\nResults of Continuing Operations\nSales, gross profit, operating income and core earnings for the years ended December 31, 1994, 1993, and 1992 were as follows:\n(A) Core earnings represent income from continuing operations excluding litigation settlements and costs, net of tax.\nComparison of Years Ended December 31, 1994 and 1993\nThe Company's sales of $260.8 million were ahead of last year's by 18%, due to higher selling prices during 1994 resulting from increases in resin prices, and also due to increases in sales volume in both the film and injection molding operating units. In addition, 1994 sales include incremental sales volume resulting from added capacity created by the Company's recent capital expansion programs, and the contribution from the May 1994 acquisition of Advanced Plastics, Inc. (\"Advanced\"), an injection molder located in Warren, Ohio. (See Note 2 of Notes to the Company's Consolidated Financial Statements.)\nThe 1994 increase in sales resulted in higher gross profit dollar levels compared to the same periods last year, while gross profit as a percentage of sales remained constant for the 1994 and 1993 periods. During 1994, gross profit equaled $51.6 million, or 20% of sales, compared to last year's gross profit of $43.4 million, also 20% of sales.\nFor Atlantis Plastic Films, the 1994 gross profit percentage of 21% improved compared to last year's 19%, reflecting stronger profitability in the custom film unit resulting from improved plant efficiencies combined with lower scrap rates, which served to offset the margin pressure experienced as a result of the significant increase in resin prices during the period.\nThe 1994 Atlantis Molded Plastics gross profit percentage of 18% decreased from last year's gross profit percentage of 20%. This decrease reflects lower injection molding profitability resulting from a variety of factors, including: (i) a higher level of tooling sales during 1994, which produced lower margins in comparison to the normal product line, (ii) additional expenses related to debugging costs of new tools, which were placed in service in late 1994, or will be placed in service in 1995, (iii) higher subcontracted and overtime labor costs due to the shortage of qualified labor resulting from this year's low national unemployment levels, (iv) unfavorable product mix, and (v) a decline in blow molding profitability due to ongoing competitive pricing pressures in the dairy plastic container markets.\nSelling, general and administrative expenses during 1994 totaled $29.2 million, or 11% of sales, compared to last year's selling, general and administrative expenses of $23.9 million, also 11% of sales.\nThe dollar increase in selling, general and administrative expenses for 1994 reflects additional employees to support volume growth, a higher cost base in the injection molding unit, which includes the operating results of Advanced since May 1994, and higher commission costs in the stretch film unit resulting from increased sales volume.\nOperating income for 1994 of $22.4 million was 15% ahead of last year's operating income of $19.5 million.\nDespite the increase in indebtedness and interest rates during 1994, interest expense of $13.2 million was comparable to the $13.1 million in interest expense for 1993, primarily due to the Company's lower cost of capital resulting from the refinancing of substantially all of its indebtedness during the first quarter of 1993.\nThe Company's effective tax rates during 1994 and 1993 were affected by nondeductible goodwill amortization.\nThe Company's core earnings for 1994 of $5.2 million exceeded last year's core earnings of $3.8 million by 37%, due to higher operating income. Core earnings represent income from continuing operations excluding litigation settlements and costs, net of tax.\nComparison of Years Ended December 31, 1993 and 1992\nThe Company's sales of $220.2 million during 1993 increased 17% over the $188.7 million posted during 1992. Atlantis Plastic Films sales of $150.1 million were 12% higher than 1992's $134.4 million, with substantially all of the increase from the stretch film unit. Sales for Atlantis Molded Plastics of $70.1 million during 1993 were 29% higher than the $54.3 million in 1992, due primarily to increased sales in the injection molding unit resulting from higher sales of appliance-related parts.The Company posted 1993 gross profit of $43.4 million, or 20% of sales, compared to $37.2 million, also 20% of sales during 1992. The Atlantis Plastic Films gross profit percentage remained constant for 1993 and 1992 at 19%, reflecting reduced operating profitability in the custom film unit during 1993, offset by stronger profitability in the stretch film unit. During 1992 and 1993, the custom film industry was characterized by severe competition and over-capacity, resulting in consolidation efforts and reduced profit margins. In order to restore profitability to prior historical levels, the custom film unit focused on increasing sales of higher margin, specialty films while reducing sales of lower margin, commodity-type film products.\nIn the Atlantis Molded Plastics segment, the 1993 gross profit percentage fell below that posted during 1992 due to product mix in the injection molding unit, as well as lower sales prices and higher shipping costs in the blow molding units.\nThe Company's selling, general and administrative expenses for 1993 equaled 11% of sales, compared to 10% of sales for 1992. The $5.0 million increase in selling, general and administrative expenses during 1993 was due to (i) higher commission costs within the stretch film unit resulting from increased sales volume, (ii) higher costs within the custom film unit related to its strategy of focusing on specialty film sales, and (iii) higher labor costs within the injection molding unit required to support higher volume.\nOperating income for 1993 of $19.5 million was 6% ahead of operating income for 1992, due primarily to higher stretch film and injection molding sales volume. The 1993 operating income percentage of 9% was lower than 1992's primarily due to lower custom film profitability.\nDuring 1993, Atlantis settled its Charter-Crellin litigation, with the Company receiving cash of $2.5 million, and recognizing a pre-tax gain of approximately $2.2 million, net of associated litigation expenses. During 1992, Atlantis settled certain litigation involving Ameriwood Industries and various related defendants, with the Company receiving $16.1 million in cash and recognizing a pre-tax gain of approximately $4.6 million. As part of the settlement, Atlantis conveyed to Ameriwood its shares of Ameriwood common stock (see Note 15 of Notes to Consolidated Financial Statements).\nThe first quarter 1993 refinancing of substantially all of Atlantis' debt reduced interest expense during 1993 compared to 1992. Interest expense for 1993 was also reduced as a result of the reduction in revolving credit borrowings since the completion of the refinancing, as well as declining interest rates. Total debt at December 31, 1993 of $102.4 million was $12.2 million lower than total debt at December 31, 1992. Interest expense for 1993 of $13.1 million was $2.0 million lower than 1992 interest expense of $15.1 million.\nThe Company's effective tax rates during 1993 and 1992 were affected by nondeductible goodwill amortization. Throughout 1992 and during the first quarter of 1993 (periods prior to the refinancing), the effective tax rates were also affected by tax- free interest income.\nThe extraordinary losses of $4.6 million in 1993 and $433,000 in 1992 related to debt extinguishments and represented redemption premiums and the write-off of deferred loan fees and unamortized discounts. (See Note 7 of Notes to the Company's Consolidated Financial Statements.)\nThe Company's 1993 core earnings of approximately $3.8 million were more than double the previous year. The 1993 increase was primarily attributable to higher operating income and lower interest expense.\nResults of Discontinued Operations\nWestern Pioneer Comparison of Years Ended December 31, 1994 and 1993\nWestern Pioneer's 1994 income totaled $1.2 million, compared to 1993's $881,000. Losses and loss adjustment expenses during 1994 of $14.9 million equaled 68% of premiums earned, compared to 72% during 1993. The decrease is primarily due to improved collections of salvage and subrogation, combined with an increase in the 1994 estimate of salvage and subrogation receivable.\nDuring October 1994, the Company announced that the previously disclosed agreement for the sale of Western Pioneer to an insurance company based in Seattle, Washington had terminated by its terms. The Company expects to dispose of Western Pioneer during 1995, and has engaged an outside broker to assist it in pursuing potential sale opportunities. In this connection, a selling memorandum was prepared and distributed to potential buyers. The Company has received expressions of interest from several parties; however, no arrangement or understanding exists for a sale at the present time.\nComparison of Years Ended December 31, 1993 and 1992\nWestern Pioneer's 1993 income totaled $881,000 compared to 1992's $569,000. The 1992 results included the effects of the settlement of Western Pioneer's Proposition 103 rollback liability with the California Department of Insurance.\nThis settlement resulted in an after-tax charge to Western Pioneer's 1992 results of approximately $900,000, net of the effects of a gain on the sale of a portion of Western Pioneer's investment portfolio, which was sold in order to offset a portion of the Proposition 103 liability. Excluding the net Proposition 103 charge, Western Pioneer's 1992 income from discontinued operations would have approximated $1.5 million. The 1993 decline in income for Western Pioneer was primarily attributable to higher losses and loss adjustment expenses.\nLosses and loss adjustment expenses during 1993 of $13.1 million equaled 72% of premiums earned, compared to 68% during 1992. The increase was primarily due to a larger number of claims reported during 1993.\nWinsLoew Investment\nIn October 1993, Atlantis sold a portion of its stock in Loewenstein as part of an initial public offering. The sale resulted in an after-tax gain of approximately $1.9 million, including approximately $600,000 related to the Company's write-up of its remaining investment in Loewenstein, based upon the difference between the post-offering book value per share of Loewenstein and the carrying value of Atlantis' remaining investment.\nThe Loewenstein initial public offering reduced Atlantis' investment in Loewenstein from 49% to approximately 20%. On February 14, 1994, Loewenstein acquired New West Industries, Inc. for stock, the issuance of which diluted Atlantis' ownership of Loewenstein to approximately 18%. During December 1994, Loewenstein and another furniture manufacturer were merged into WinsLoew Furniture, Inc. (\"WinsLoew\"), and Atlantis' ownership interest decreased to approximately 10% of WinsLoew's outstanding shares. The Company's interest is subject to further reduction to approximately 9% in the event that certain stock options are exercised. The Company began accounting for this investment under the cost method in 1994.\nLiquidity and Capital Resources\nManagement believes that (i) funds generated from continuing operations, (ii) funds generated from the 1995 financing of equipment as described below, and (iii) funds available under its revolving credit facility will be sufficient to satisfy the Company's debt service obligations, working capital requirements (principally inventory and accounts receivable), and commitments for capital expenditures for the foreseeable future.\nThe Company's working capital at December 31, 1994 increased to $33.0 million, compared to $22.9 million at December 31, 1993, as described below. The Company's cash and equivalents totaled $1.4 million at December 31, 1994, compared to $2.2 million at December 31, 1993. At December 31, 1994, the Company had approximately $129.2 million of outstanding indebtedness and $7.1 million of additional availability under the revolving credit facility based on eligible collateral.\nCash Flows From Operating Activities\nNet cash provided by operating activities was $2.0 million during 1994, compared to $16.6 million during 1993. Accounts receivable and inventories increased by $10.9 million and $5.6 million, respectively, during 1994, primarily due to the effects of significant resin price increases during the year, and also due to increased sales volume in the stretch film and injection molding units.\nAccounts payable and accrued expenses increased by $5.3 million during 1994 due to an increase in tooling construction activity for the injection molding unit, with longer duration payment terms for tooling vendors, and the effects of the resin price increases during 1994.\nCash Flows From Investing Activities\nNet cash used in investing activities was $28.3 million during 1994, compared to $6.4 million last year. Capital expenditures totaled $16.4 million, compared to $10.2 million for 1993. This increase is due to capital expansion programs, as well as maintenance capital expenditures, principally in the film and injection molding units. New stretch film production lines have been installed in Atlantis Plastic Films, and productivity improvements are being implemented for stretch and custom films. In Atlantis Molded Plastics, the injection molding capital expenditures include equipment additions, as well as plant expansions, in order to provide continued support for this unit's volume growth.\nDuring May 1994, the Company utilized borrowings from its revolving credit facility to acquire Advanced for approximately $12.4 million (see Note 2 of the Company's Notes to Consolidated Financial Statements).\nCash Flows From Financing Activities\nNet cash provided by financing activities was $25.5 million during 1994, compared to net cash used in financing activities of $21.4 million for 1993. Net borrowings on the revolving credit facility of $21.6 million were used to fund the acquisition of Advanced, working capital needs, and the capital programs mentioned above. In addition, borrowings of $5.8 million were used to finance a portion of the film manufacturing equipment acquired during the year.\nDuring the first quarter of 1995, the Company also borrowed approximately $4.8 million to finance equipment acquired during 1994, and established additional borrowing facilities to finance up to $15 million of equipment purchases during 1995 and through May 1996.\nApproximately $729,000 was used in the first quarter of 1994 as part of the common stock share repurchase program initiated during 1993. The Company also used $852,000 for dividends on common and preferred stock.\nAccounting Pronouncements\nAs discussed in Note 5 of Notes to the Company's Consolidated Financial Statements, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective January 1, 1994. This Standard addresses the accounting and reporting for investments in equity securities that have readily determinable fair value and for all investments in debt securities. The adoption of this Standard increased shareholders' equity by approximately $1,020,000, net of tax, as of January 1, 1994 and decreased shareholders' equity by approximately $284,000, net of tax, as of December 31, 1994.\nManagement's Responsibility for Financial Reporting\nThe Company's management is responsible for the preparation of the financial statements in accordance with generally accepted accounting principles and for the integrity of all the financial data included in this Annual Report. In preparing the financial statements, management makes informed judgments and estimates of the expected effects of events and transactions that are currently being reported.\nManagement maintains a system of internal accounting controls that is designed to provide reasonable assurance that assets are safeguarded and that transactions are executed and recorded in accordance with management's policies for conducting its business. This system includes policies which require adherence to ethical business standards and compliance with all laws to which the Company is subject. The internal controls process is continuously monitored by direct management review.\nThe Board of Directors, through its Audit Committee, is responsible for determining that management fulfills its responsibility with respect to the Company's financial statements and the system of internal accounting controls.\nThe Audit Committee, comprised solely of directors who are not officers or employees of the Company, meets periodically with representatives of management and the Company's independent accountants to review and monitor the financial, accounting, and auditing procedures of the Company in addition to reviewing the Company's financial reports. The independent accountants have full and free access to the Audit Committee.\n\/s\/ Anthony F. Bova \/s\/ Paul Rudovsky Anthony F. Bova Paul Rudovsky President and Executive Vice President Chief Executive Finance and Planning Officer\nReport of Independent Accountants\nTo the Board of Directors and Shareholders of Atlantis Plastics, Inc.:\nWe have audited the accompanying consolidated balance sheets of Atlantis Plastics, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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 Atlantis Plastics, Inc. and subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\n\/s\/ Coopers & Lybrand L.L.P. Coopers & Lybrand L.L.P. Miami, Florida February 6, 1995\nConsolidated Income Statements\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.\nConsolidated Balance Sheets\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.\nConsolidated Statements of Shareholders' Equity\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.\nConsolidated Statements of Cash Flows\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these financial statements.\nNotes to Consolidated Financial Statements\nNote 1. Nature of Business and Summary of Significant Accounting Policies\nDuring May 1994, Atlantis Group, Inc. changed its name to Atlantis Plastics, Inc. (\"Atlantis\" or the \"Company\"), moved its state of incorporation from Delaware to Florida, and canceled its shares of Class A and Class B treasury stock then outstanding.\nAtlantis is a leading U.S. manufacturer of polyethylene stretch and custom films used in a variety of industrial and consumer applications and molded plastic products for the appliance, automotive, recreational vehicle, and dairy industries.\nAtlantis Plastic Films manufactures stretch films which are multilayer plastic films that are used principally to stretch-wrap pallets of materials for shipping or storage and custom film products which include high-grade laminating films, embossed films, and specialty film products targeted primarily to industrial and agricultural markets.\nAtlantis Molded Plastics employs three principal technologies, serving a wide variety of specific market segments: (i) injection molded thermoplastic parts that are sold primarily to original equipment manufacturers and used in major household appliances, agricultural, and automotive products, (ii) a variety of standard and custom extruded parts (profile extrusion) that are incorporated into a broad range of consumer and commercial products, including plastic moldings, trims, channels, seals and gaskets that are used in recreational vehicles, residential doors and windows, office furniture, and retail store fixtures, and (iii) blow molded milk, juice, water and industrial containers in a variety of shapes and sizes.\nDiscontinued operations in 1994 consist of the operations of Western Pioneer, the Company's California property-casualty insurance subsidiary. Prior to 1994, discontinued operations include both Western Pioneer and the Company's interest in Loewenstein Furniture Group, Inc. (\"Loewenstein\"). See Note 17.\nAll material intercompany balances and transactions have been eliminated. Certain amounts included in prior period financial statements have been reclassified to conform with the current year presentation.\nThe following is a summary of the Company's significant accounting policies:\nCash and equivalents\nThe Company classifies as cash and equivalents all highly liquid investments which present insignificant risk of changes in value and have maturities at the date of purchase of three months or less. The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts.\nInventories\nInventories are stated at the lower of cost (first-in, first- out) or market.\nProperty and equipment\nProperty and equipment are carried at cost less accumulated depreciation and amortization. The provisions for depreciation and amortization have been computed, using both straight-line and accelerated methods, over the estimated useful lives of the respective assets. Such useful lives generally fall within the following ranges: buildings and improvements - 15 to 30 years; office furniture and equipment - 5 to 10 years; manufacturing equipment - 5 to 30 years; and vehicles - 3 to 8 years.\nWhen assets are retired or otherwise disposed, the costs and accumulated depreciation are removed from the respective accounts, and any related profit or loss is recognized. Maintenance and repair costs are charged to expense as incurred. Renewals and improvements are capitalized.\nGoodwill\nGoodwill is being amortized on a straight-line basis over forty years from the date of the respective acquisitions. Accumulated amortization amounted to approximately $10,805,000 and $9,002,000 at December 31, 1994 and 1993, respectively. On a continual basis, the Company assesses the carrying value of goodwill in order to determine whether an impairment has occurred, taking into account both historical and forecasted results of operations.\nAmortization\nLoan acquisition costs, related legal fees, and debt discount are amortized over the respective terms of the related debt utilizing the straight line and effective interest methods, as appropriate.\nFederal income taxes\nThe Company and its subsidiaries file consolidated Federal income tax returns. Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Prior to 1993, deferred taxes were computed in accordance with APB Opinion No. 11, \"Accounting for Income Taxes,\" based on timing differences in the recognition of income and expense for financial reporting and for income tax purposes.\nPer share data\nPrimary earnings per share are computed by dividing net income after deduction of annual preferred dividend requirements, by the weighted average number of shares and dilutive share equivalents outstanding during each year. The Company's convertible preferred stock was determined not to be a common share equivalent in computing primary earnings per share (see Note 9). In computing fully diluted income per share, the assumed conversion of the convertible preferred stock was not material.\nNote 2. Acquisition\nDuring May 1994, the Company purchased substantially all of the assets (excluding cash) and assumed all of the liabilities (excluding interest bearing indebtedness and other amounts due to the seller) of Advanced Plastics, Inc. (\"Advanced\"), an injection molder located in Warren, Ohio, for approximately $12.4 million. The Company also purchased real estate leased by Advanced and owned by the seller. The acquisition was funded with borrowings from the Company's revolving credit facility. The acquisition has been accounted for using the purchase method, and accordingly, the results of operations of Advanced have been included in the consolidated income statements since the date of the acquisition. The assets and liabilities of Advanced have been recorded at their estimated fair market values at the acquisition date. Total goodwill associated with this acquisition amounted to $9,485,000.\nThe following table presents unaudited pro forma operating results for the Company for the years ended December 31, 1994 and 1993, as if the acquisition of Advanced had occurred on January 1, 1993. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of what would have occurred had the acquisition actually occurred on January 1, 1993, or of results that may occur in the future.\n(A) 1993 includes income from litigation settlements, net of costs of $1,438,000, and net of tax ($.19 per share). (B) 1993 includes an extraordinary loss on early extinguishment of debt of $4,644,000, net of tax ($.60 per share). (C) 1993 includes a gain on the Loewenstein stock transaction of $1,884,000, net of tax ($.24 per share).\nNote 3. Inventories\nInventories at December 31, 1994 and 1993 consisted of the following:\nNote 4. Property and Equipment\nProperty and equipment at December 31, 1994 and 1993 consisted of the following:\nNote 5. Investments in Debt and Equity Securities\nEffective January 1, 1994, the Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\",\nwhich addresses the accounting and reporting for investments in equity securities that have readily determinable fair value and for all investments in debt securities.\nThe Standard classifies investments into one of three categories: held-to-maturity, available-for-sale, or trading. Debt securities that an enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value with unrealized gains and losses included in earnings. Debt and equity securities, not classified as either held-to-maturity securities or trading securities, are classified as available-for- sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity. If a decline in fair value is judged to be other than temporary, the cost basis of the individual security is written down to fair value, and the amount of the write-down is included in earnings. The Company has classified all investments as available-for-sale.\nThe adoption of this Standard impacted the accounting for Western Pioneer's investment portfolio and the Company's interest in WinsLoew Furniture, Inc. (\"WinsLoew\"), the successor by merger to Loewenstein, decreasing shareholders' equity by approximately $284,000, net of tax, as of December 31, 1994.\nThe following table summarizes the cost and fair value of the Company's investments at December 31, 1994 based on quoted market prices:\nIn light of the present federal securities law restrictions associated with the disposal of WinsLoew stock, pursuant to SFAS No. 115 only the portion of the stock that could be reasonably disposed of within one year is considered to have a readily determinable fair value. However, without taking into consideration present federal securities law restrictions, the pre- tax unrealized gain on WinsLoew stock equaled $1,435,000 at December 31, 1994.\nThe amortized cost and fair value, respectively, of debt securities at December 31, 1994, by contractual maturity, due after one year through five years, are $1,494,000 and $1,493,000; due after five years through ten years, are $19,043,000 and $18,150,000, totalling $20,537,000 and $19,643,000.\nNote 6. Accounts Payable and Accrued Expenses\nAccounts payable and accrued expenses consisted of the following at December 31, 1994 and 1993:\nNote 7. Long-term Debt\nLong-term debt consisted of the following at December 31, 1994 and 1993:\nDuring the first quarter of 1993, the Company refinanced substantially all of its existing indebtedness through a $100 million, 11% Senior Note offering due February 15, 2003 (the \"Notes\"), and borrowings under a $30 million revolving credit facility which matures in 1998. During 1993, an extraordinary loss of $4.6 million was recorded related to debt extinguishments, representing redemption premiums and the write-off of deferred loan fees and unamortized discounts.\nThe Notes are senior unsecured obligations of the Company, with the Company's plastics subsidiaries guaranteeing the payment of principal and interest. The Company's discontinued operation and investment in WinsLoew are generally not subject to the indenture, and the discontinued operation has not guaranteed any obligations under the Notes. The Notes may not be redeemed prior to February 15, 1998. On and after that date and until February 15, 2001, the Company may redeem all or any portion of the Notes at redemption prices ranging from 104.125% to 101.375% of the principal amount. After February 15, 2001, the Company may redeem all of any portion of the Notes at 100% of the principal amount. The Company must redeem $25 million of the Notes on February 15, 2001 and 2002, which will retire 50% of the Notes prior to maturity.\nCovenants relating to the Notes prohibit the Company from making certain payments or taking certain actions as described in the related indenture. Among other restrictions, the Company and its subsidiaries may not make certain restricted payments, including dividend payments, stock redemptions or repurchases, or investments in affiliates during the existence and continuation of an event of default under the Notes, or if immediately after giving effect to such restricted payment, certain net equity or other tests are violated. The Company and its subsidiaries are prohibited from incurring new debt or otherwise becoming directly or indirectly obligated with respect to any debt unless certain interest coverage ratio tests are met.\nBorrowings on the revolving credit facility are subject to a borrowing base formula which is based on eligible collateral (accounts receivable, inventories and fixed assets of the subsidiaries), and interest is computed using either LIBOR based rates plus 3%, or prime plus 1.5%, or a combination of both. At December 31, 1994, the unused availability on the revolving credit facility was $7,100,000. At December 31, 1994 the 30-day LIBOR rate and the prime rate were 6.1% and 8.5%, respectively.\nUnder the terms of the revolving credit facility, the Company and its subsidiaries are required to, among other things, maintain certain financial ratios and minimum specified levels of net worth; refrain from paying dividends unless certain requirements are met; refrain from incurring additional indebtedness, or guaranteeing the obligations of others; and limit capital expenditures.\nThe other senior and subordinated indebtedness outstanding at December 31, 1994 consists of industrial revenue bonds which were not refinanced in 1993, along with capitalized lease obligations entered into during 1993 and $5.8 million of equipment financings entered into during 1994. At December 31, 1994 and 1993, the weighted average interest rates on these borrowings were 7.8% and 6.5%, respectively.\nScheduled maturities of indebtedness in each of the next five years are as follows:\nBased on the quoted market price of the Notes, and the borrowing rates available to the Company for loans with similar terms and average maturities, the fair value of the Company's indebtedness at December 31, 1994 and 1993 was $123,334,000 and $107,380,000, respectively.\nNote 8. Minority Interests\nIn December 1992, the Company acquired the outstanding minority interest in Cyanede Plastics, Inc. (\"Cyanede\") for, among other things, 120,400 shares of treasury stock with a cost and market value of $481,600. In connection with this transaction, the Company granted the former Cyanede minority shareholders the right to require the Company to repurchase such stock in 1995 at a specified formula price based on Cyanede's 1994 earnings, and established a liability of $481,600 to be utilized in the event that the repurchase provision was exercised. Based on the calculation of the formula price, the Company believes that the repurchase provision will not be exercised and accordingly, has reclassified the carrying value of the repurchase obligation to additional paid-in capital as of December 31, 1994.\nIn November 1992, Atlantis acquired the Linear Films, Inc. (\"Linear\") minority interest and $7 million of the $20 million outstanding principal amount of Linear's subordinated debt for a cash payment of $7.3 million. In conjunction with the Company's 1993 refinancing, Atlantis acquired the remaining $13 million outstanding principal amount for a cash payment of $13.2 million. The Company allocated the cash payments between the debt and the minority interest based on the estimated fair values of each instrument. In this connection, extraordinary losses of $640,000 and $394,000, net of income taxes, were recognized in 1993 and 1992, respectively, related to the Linear debt extinguishment; and credits to additional paid-in capital of $1,900,000 and $1,018,000 were recognized in 1993 and 1992, respectively, related to the redemption of the Linear minority interest.\nNote 9. Capital Stock\nGenerally, the Class A Common Stock has one vote per share and the Class B Common Stock has ten votes per share. Holders of the Class B Common Stock are entitled to elect 75% of the Board of Directors; holders of Class A Common Stock are entitled to elect the remaining directors.\nEach share of Class B Common Stock is convertible, at the option of the holder thereof, into one share of Class A Common Stock. Class A Common Stock is not convertible into shares of any other equity security.\nDuring February 1994, the Company's Board of Directors approved a 2.5 cents per share quarterly dividend program beginning in April 1994.\nAs part of a share repurchase program initiated by the Company during 1993, 122,184 and 185,878 shares of Class A and B Common Stock were repurchased during 1994 and 1993 at a total cost of approximately $729,000 and $1,110,000, respectively.\nEach share of Series A Convertible Preferred Stock has a liquidation preference of $100 and entitles the holder to an annual cumulative dividend, payable in equal semiannual installments, of $7.25. The shares of Series A Convertible Preferred Stock may be redeemed in whole or part through October 15, 1995 at the option of the Company for a price of $299.25 per share in 1995, plus any accrued but unpaid dividends. The holders of the Series A Convertible Preferred Stock have the right to elect one director of the Company in the event three or more dividend payments on the Series A Convertible Preferred Stock are in arrears.\nThe Series A Convertible Preferred Stock is convertible at the option of the holder thereof into an aggregate of 205,074 shares of Class A Common Stock. The Company has the right to compel conversion of the Series A Convertible Preferred Stock, if the Class A Common Stock has a market value in excess of specified percentages (100.725% in 1995, decreasing to 100% in 1996) of the Series A Convertible Preferred Stock's conversion price. The current conversion price is $9.75.\nNote 10. Income Taxes\nThe income tax provision for the years ended December 31, 1994, 1993 and 1992 consisted of the following:\nThe following table provides a reconciliation between the Federal income tax rate and the Company's effective income tax rate:\nAt December 31, 1994 and 1993, deferred tax assets and liabilities consisted of the following:\nIn 1992, deferred income taxes (credits) resulted from timing differences in the recognition of income and expenses for financial reporting and income tax purposes. The tax effect of the principal timing differences for the year ended December 31, 1992 was as follows:\nNote 11. Stock Option Plans\nThe Company's Stock Option Plans (\"Option Plans\") are designed to serve as an incentive for retaining qualified and competent employees, directors and agents. The Board of Directors of the Company administers and interprets the Option Plans and is authorized to grant options thereunder to approximately 30 persons who provide management related services to the Company, including officers and key employees of the Company and its subsidiaries, non-employee directors and Trivest, Inc. (See Note 14).\nOptions may be granted under the Option Plans on such terms and at such prices as determined by the Board (or appropriate committee thereof); provided, however, that the exercise price of certain options will not be less than 90% of the fair market value of the Class A Common Stock on the date of grant. Each option will be exercisable after the period or periods specified in the option agreement, but no option shall be exercisable after the expiration of ten years from the date of grant. Options granted under the Option Plans are not transferable other than by will or by the laws of descent and distribution.\nThe Option Plans also authorize the Company to make loans to optionees to exercise their options. Information with respect to the Option Plans is as follows:\nThe terms of the Company's Disinterested Directors Stock Option Plan (\"DSOP\") are substantially identical to the terms of the Option Plans, except that the only class of persons eligible to receive options under the DSOP are directors of the Company who are not employees of the Company and are not directors or officers of Trivest, Inc. Information with respect to the DSOP is as follows:\nNote 12. Business Segments\nThe Company considers its continuing operations to comprise two segments: Atlantis Plastic Films and Atlantis Molded Plastics.\nDuring 1994, 1993 and 1992, an Atlantis Molded Plastics customer accounted for approximately 13%, 15%, and 12%, respectively, of the Company's net sales. Summary data for 1994, 1993 and 1992 is as follows:\nCorporate assets consist primarily of cash and equivalents, the investment in WinsLoew stock and net assets of discontinued operations.\nNote 13. Profit Sharing and Retirement Plans\nAtlantis and certain of its subsidiaries have profit sharing and defined contribution retirement plans. Generally, such plans cover all employees who have attained the age of 21 and have at least one year of service. Contributions to the plans are determined by the individual companies' Boards of Directors on an annual basis. Related expenses applicable to continuing operations were approximately $1,067,000, $855,000 and $962,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nNote 14. Related Parties\nA management agreement exists between the Company and Trivest, Inc. (\"Trivest\"). Trivest has certain common shareholders, officers and directors with the Company. Fees charged to expense under this agreement, including the portion related to discontinued operations, amounted to $399,000, $326,000 and $320,000 for the years ended December 31, 1994, 1993 and 1992, respectively. This agreement expires in December 1997. In addition to the above fees, Atlantis paid Trivest an acquisition fee of $405,000 relating to the May 1994 acquisition of Advanced.\nAtlantis shares office space with several related entities. Rent expense, as well as certain non-direct general and administrative expenses, are allocated among Atlantis and these entities.\nNote 15. Litigation\nThe Company is, from time to time, involved in routine litigation. None of such litigation, in which the Company is presently involved, is believed to be material to its financial position or results of operations. Set forth below is a description of certain non-routine litigation which Atlantis or its subsidiaries were parties.\nCharter-Crellin, Inc.\nIn December 1989, Atlantis filed a complaint against Charter- Crellin, Inc., and certain related parties alleging fraud and misrepresentation relating to a July 8, 1988 stock purchase agreement between Atlantis and Charter-Crellin, Inc. This lawsuit was settled during January 1993, with Atlantis receiving $2.5 million in cash. All litigation relating to this claim has been dismissed.\nAmeriwood\nDuring 1992, Atlantis settled certain litigation involving Ameriwood Industries and various related defendants. The Company received $16.1 million in cash and recognized a pre-tax gain of approximately $4.6 million. As part of the settlement, Atlantis conveyed to Ameriwood its shares of Ameriwood common stock.\nNote 16. Commitments\nAtlantis and its subsidiaries lease various office space, buildings, transportation and production equipment with terms in excess of one year. Total expense under these agreements for the years ended December 31, 1994, 1993 and 1992 was approximately $2,150,000, $2,565,000 and $2,473,000, respectively.\nThe total minimum rental commitments under operating leases at December 31, 1994 consisted of the following:\nNote 17. Discontinued Operations\nDiscontinued operations in 1994 consist of the operations of Western Pioneer, the Company's California property-casualty insurance subsidiary. Prior to 1994, discontinued operations included both Western Pioneer and the Company's interest in Loewenstein.\nAt December 31, 1993, the net assets of Western Pioneer and the investment in Loewenstein were presented as net assets of discontinued operations in the accompanying balance sheet, as follows:\nFor the years ended December 31, 1994, 1993 and 1992, income associated with discontinued operations was as follows:\nThe Company's interest in Loewenstein's net income represented 49% of the net income from January 1, 1992 to October 6, 1993; and 20% from October 7, 1993 to December 31, 1993.\nWinsLoew Investment\nIn October 1993, Atlantis sold a portion of its stock in Loewenstein as part of an initial public offering. The sale resulted in an after-tax gain of approximately $1.9 million, including approximately $600,000 related to the Company's write-up of its remaining investment in Loewenstein based upon the difference between the post-offering book value per share of Loewenstein and the carrying value of Atlantis' remaining investment.\nThe Loewenstein initial public offering reduced Atlantis' investment in Loewenstein from 49% to approximately 20%. On February 14, 1994, Loewenstein acquired New West Industries, Inc. for stock, the issuance of which further reduced Atlantis' ownership of Loewenstein to approximately 18%. During December 1994, Loewenstein and another furniture manufacturer were merged into WinsLoew Furniture, Inc., and Atlantis' ownership interest decreased to approximately 10% of WinsLoew's outstanding shares. The Company's interest is subject to further reduction to approximately 9% in the event that certain stock options are exercised. In light of the foregoing transactions, the Company began accounting for this investment under the cost method in 1994.\nThe following table provides 1993 and 1992 condensed income statement data for Loewenstein:\nWestern Pioneer\nDuring October 1994, the Company announced that the previously disclosed agreement for the sale of Western Pioneer to an insurance company based in Seattle, Washington had terminated by its terms. The Company expects to dispose of Western Pioneer during 1995, and has engaged an outside broker to assist it in pursuing potential sale opportunities. In this connection, a selling memorandum was prepared and distributed to potential buyers. The Company has received expressions of interest from several parties; however, no arrangement or understanding exists for a sale at the present time.\nThe Company believes that the ultimate sale proceeds will equal or exceed Western Pioneer's net assets.\nThe following tables summarize operating results and specific balance sheet items of Western Pioneer, which have been segregated in the accompanying financial statements:\nMarketable securities\nThe cost of marketable securities that individually exceeded ten percent of Western Pioneer's shareholder's equity as of December 31, 1994 and 1993 were as follows:\nA summary of net investment income for the years ended December 31, 1994, 1993 and 1992 is as follows:\nThe following table summarizes the gains and losses, net of applicable taxes, on investments in marketable securities for the years ended December 31, 1994, 1993, and 1992:\nDeferred policy acquisition costs\nCommissions, taxes and other policy acquisition costs are deferred and amortized over the policy periods in which the related premiums are earned. Amortization of deferred policy acquisition costs was $5,601,000, $4,862,000 and $4,339,000 during the years ended December 31, 1994, 1993 and 1992, respectively.\nInsurance premiums earned\nInsurance premiums written are earned ratably over the related policy term. Premiums written in 1994, 1993 and 1992 amounted to $24,184,000, $19,179,000 and $17,559,000, respectively, which were net of premiums ceded to the reinsurer amounting to $1,222,000, $823,000 and $698,000 in 1994, 1993, and 1992, respectively.\nReinsurance\nUnder a reinsurance agreement, the maximum retention on any loss under insurance policies issued by Western Pioneer for all lines of business is $25,000 on losses occurring after September 1, 1993; $25,000 for all lines of business except comprehensive and collision on losses occurring between July 1, 1991 and August 31, 1993; and $20,000 on losses occurring prior to June 30, 1991, plus the pro rata share of loss adjustment expenses, not to exceed $5,000. Risks in excess of these limits are reinsured to applicable policy limits. Premiums ceded to the reinsurer, net of commissions received, aggregated $833,000, $518,000 and $454,000 during the years ended December 31, 1994, 1993 and 1992, respectively.\nReinsurance recoverable on paid losses aggregated approximately $185,000 and $342,000 at December 31, 1994 and 1993, respectively. The estimated amounts recoverable from the reinsurer that related to unpaid losses, aggregating approximately $274,000 and $265,000 at December 31, 1994 and 1993, respectively, have been deducted from the liability for insurance losses and loss adjustment expenses. A contingent liability exists with respect to reinsurance that would become an actual liability of Western Pioneer in the event that the reinsurer should be unable to meet the obligations it has assumed under the reinsurance agreement.\nDividends\nInsurance regulations generally limit Western Pioneer's dividends to net investment income.\nQuarterly Financial Highlights\n(A) Core earnings represent income from continuing operations excluding litigation settlements and costs, net of tax. (B) During the first quarter of 1993, a pre-tax gain of approximately $2.2 million was recognized resulting from the settlement of the Company's Charter-Crellin litigation, and a $4.6 million extraordinary loss was recorded related to the Company's refinancing of indebtedness. (C) During the fourth quarter of 1993, a $1.9 million after-tax gain was recognized within discontinued operations from the Company's Loewenstein stock transactions.\nMarket for Common Stock\nThe Company's Class A Common Stock trades on the American Stock Exchange under the symbol \"AGH\". The Company had 244 shareholders of record as of January 31, 1995. The following table shows high and low sales prices for 1994 and 1993.\nDuring February 1994, the Company's Board of Directors approved a 2.5 cents per share quarterly dividend program beginning in April 1994.\nEXHIBIT 22.1\nATLANTIS PLASTIC FILMS, INC., a Delaware corporation\nATLANTIS MOLDED PLASTICS, INC., a Florida corporation\nCYANEDE PLASTICS, INC., a Kentucky corporation\nPIERCE PLASTICS, INC., a Delaware corporation\nPLASTIC CONTAINERS, INC., an Alabama corporation\nRIGAL PLASTICS, INC., a Florida corporation\nWESTERN PIONEER INSURANCE COMPANY, a California corporation\nEXHIBIT 23.1\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statements of Atlantis Plastics, Inc. on Form S-8 (Registration Nos. 33-25983 and 33-41012) of our report dated February 6, 1995 on our audit of the consolidated financial statements and financial statement schedules of Atlantis Plastics, Inc. as of December 31, 1994 and 1993 and for the years ended December 31, 1994, 1993 and 1992 which report is included in this Annual Report on Form 10-K.\nCOOPERS & LYBRAND L.L.P.\nMiami, Florida March 29, 1995","section_15":""}
{"filename":"36537_1994.txt","cik":"36537","year":"1994","section_1":"ITEM 1. BUSINESSES\nFirst Mississippi Corporation (the \"Company\") was incorporated in Mississippi in 1957. Principal activities as of June 30, 1994, are in the following industry segments: Chemicals, Fertilizer, Gold, and Combustion, Thermal Plasma and Other.\nIn December 1992, the Company adopted plans for discontinuing its coal operations which were conducted through Pyramid Mining, Inc. (\"PMI\") based in Owensboro, Kentucky. The disposition of PMI was completed in October 1993.\nOn June 29, 1993, the Company sold its oil and gas operations, which were begun in the mid-1970's. These operations were conducted primarily through First Energy Corporation of Houston, Texas.\nAt year-end 1994, the Company had 1,215 employees, which includes employees of the parent company, all wholly owned subsidiaries and proportionate shares of all employees at other subsidiaries and joint ventures, depending on ownership interest.\nIn February 1990, the Company, which holds approximately 81% of the stock of FirstMiss Gold Inc. (\"FirstMiss Gold\"), announced plans to distribute this stock to its shareholders. The spin-off was subject to a favorable tax ruling from the Internal Revenue Service and a favorable operating and financial outlook. The required ruling was received in December 1990. However, in the interim, gold prices had fallen and the spin-off was put on hold. In July 1994, a new ruling was requested to permit a tax-free spin-off. Upon receipt of a favorable ruling, the spin-off will be contingent on FirstMiss Gold's ability to succeed as a viable, stand-alone company.\nCHEMICALS\nProduction Facilities and Businesses\nProduction facilities are located in Pascagoula, Mississippi; Tyrone, Pennsylvania; Dayton, Ohio; Hayward, California; and East Kilbride, Scotland, U.K.\nFirst Chemical Corporation (\"FCC\"), located in Pascagoula, Mississippi, operates facilities for the continuous production of aniline, nitrobenzene, nitrotoluenes, toluidine and other nitrated and aromatic chemicals, plus related storage, rail and barge distribution facilities and quality control laboratories. The plant also includes a research laboratory, a pilot plant, semi-works equipment and batch facilities for the production of specialty chemicals. The Pascagoula facilities' total nitrated aromatic production capacity is approximately 450 million pounds per year. Actual fiscal 1994 production was 369 million pounds, approximately 82% of average annual capacity.\nThe Pascagoula complex is one of the largest aniline production facilities in the United States. FCC is among the largest merchant marketers of aniline in the United States.\nThe Company conducts research and development to improve existing products and to produce new specialty chemicals. Approximately $4.3 million, $3.7 million and $3.4 million was spent on research and development in fiscal 1994, 1993 and 1992, respectively. Research facilities include laboratories, pilot plant and semi-works for process research and development with gram to multi-pound sample production capabilities. The Company's first specialty chemical was produced in June 1982 at the Pascagoula plant. Since then, 27 new products have been introduced at FCC and 16 at Quality Chemicals, Inc. (\"QCI\"), a subsidiary. In addition, research and development efforts during fiscal 1994 resulted in custom manufacturing agreements with several new customers. The Company also sponsors applied research at several leading universities in the United States and Europe. These closely directed programs have led to the development and introduction of patented technology in EKC Technology, Inc.'s (\"EKC\") line of performance chemicals and in the FIRSTCURE(TM) line of performance polymer products. The Company plans to spend approximately $12.0 million during fiscal 1995 to add facilities for the production of new specialty chemicals.\nThe Company acquired QCI, located in Tyrone, Pennsylvania, in July 1986. Facilities include multi-step batch processing to custom produce complex fine chemicals used by chemical and pharmaceutical companies. Following capacity additions and plant modifications in fiscal 1993, annual production capacity is now between 2.5 million and 3.5 million pounds depending on the products being produced and the type of custom processing required. Fiscal 1994 production was approximately 2.1 million pounds.\nIn August 1992, FCC acquired a production facility in Dayton, Ohio, from Monsanto Company. The facility is being operated by QCI and includes equipment for multi-step batch processing to custom produce complex fine chemicals used by chemical and pharmaceutical companies. Annual production capacity is between approximately 1.5 million and 2.0 million pounds, depending on the products being produced and the type of custom processing required. Fiscal 1994 production was approximately 0.4 million pounds.\nFCC acquired EKC, located in Hayward, California, in September 1989. EKC is a manufacturer of performance chemicals for the semiconductor industry and has facilities in California and Scotland. EKC's California operations include bulk storage and mixing vessels and an advanced quality control analytical lab. The California facility is currently utilizing 95% of production capability on a single shift basis.\nRaw Materials\nPrimary raw materials for chemical production are benzene, toluene, natural gas, ethanol and ammonia. The Company uses natural gas and ammonia, respectively, to produce on site 98% of the hydrogen and 90% of the nitric acid used in its chemical production. All raw materials are generally available in adequate quantities from several suppliers, subject to market variation in supply and price.\nMarketing and Sales\nChemicals are marketed domestically and internationally. Approximately 15% of FCC's sales are exports. Products are sold in drums and in bulk as intermediates into the construction, transportation, agricultural chemical, dye, photographic, specialty polymer and human health care markets. Most exported product is shipped in ocean-going tankers. Domestic shipments are by barge, rail or tank trucks. QCI's specialty chemical products are sold in drums into pharmaceutical, electronic chemical, agricultural chemical and specialty polymer markets. EKC's products are sold to the semiconductor industry with approximately 39% representing exports. Performance chemicals are sold in gallon and drum containers.\nCompetitive Conditions\nFCC is one of five major United States producers of aniline with approximately 17% of domestic capacity and an estimated 6% of world capacity. FCC is the only United States producer of nitrotoluenes with an estimated 15% of world capacity. Major competitors are large chemical companies. Competition is based on price, service, quality, marketing and research and development support capabilities. Based on market share, QCI is among the top 10 custom chemical manufacturing companies in the United States. Major competitors are both smaller and larger companies. Competition is based on service, quality, manufacturing expertise in chemistries and processes, and research and development capabilities. EKC is one of the largest producers of organic photoresist strippers. Although there are approximately 15 companies participating in this market worldwide, only EKC and three others specialize in organic stripping solutions. Competition is based on service, quality and product development capabilities. Performance chemicals are sold on function rather than chemical specifications.\nSeasonality of Business\nGenerally, chemical sales are not seasonal and working capital requirements do not vary significantly from period to period.\nFERTILIZER\nProduction Facilities\nThe Company produces and sells anhydrous ammonia (\"ammonia\") and urea. Two production facilities are located in Donaldsonville, Louisiana, and are owned by Triad Chemical (\"Triad\"), an unincorporated 50% joint venture, and by AMPRO Fertilizer, Inc. (\"AMPRO\"), a wholly owned subsidiary. The 50\/50 joint venturers of Triad participate equally in management and each markets one-half of production. Each joint venturer shares equal responsibility for all obligations of Triad. The AMPRO facility was formerly owned by a partnership, which was 50% owned by the Company. In February 1989, the Company completed purchase of the remaining 50% interest. Marketing and administration are conducted by FirstMiss Fertilizer, Inc., in Jackson, Mississippi.\nTriad facilities include a Kellogg process ammonia plant with annual production design capacity of 420,000 tons and a urea plant with annual production design capacity of 520,000 tons. Actual fiscal 1994 production was approximately 478,000 tons of ammonia and approximately 510,000 tons of urea, compared to 429,000 tons of ammonia and 541,000 tons of urea in fiscal 1993. Ammonia production was up in fiscal 1994, primarily due to prior year outages caused by Hurricane Andrew. Urea production was down in fiscal 1994, primarily because of a maintenance turnaround. Ammonia production exceeded production design capacity due to above average on-stream operating rate. Triad's facilities include storage for 30,000 tons of ammonia and 40,000 tons of urea. The Donaldsonville production complex, in which both Triad and AMPRO are located, includes facilities for rail shipments, transmission via pipeline, bulk and tank truck loading and direct loading of barges and ocean-going vessels on the Mississippi River for transportation to domestic and export markets.\nAMPRO facilities include a Kellogg process ammonia plant with annual production design capacity of 446,000 tons and storage for 30,000 tons. Actual fiscal 1994 production was approximately 500,000 tons, 33,000 tons more than fiscal 1993. Fiscal 1994 production was up due to downtime in fiscal 1993 caused by high natural gas prices and Hurricane Andrew. Fiscal 1994 production exceeded design capacity primarily due to above average on-stream operating rate.\nRaw Materials\nNatural gas is the raw material in ammonia production. Ammonia and carbon dioxide are the raw materials in urea production. A reliable supply of natural gas at competitive prices and in sufficient quantities is currently available to the Company. Both Triad and AMPRO purchase natural gas from several pipelines at market price on short-term contracts. Additionally, the Company periodically hedges anticipated purchases of natural gas. Sixty-one percent of the ammonia produced by Triad in fiscal 1994 was used as a raw material in the production of urea. Carbon dioxide needed for Triad's urea plant production is supplied by Triad's ammonia plant, with a back-up supply available from AMPRO's ammonia plant.\nMarketing\nThe Company sells ammonia and urea for agricultural and industrial uses in domestic and international markets. Domestic agricultural customers are primarily large national accounts with extensive dealer and retail distribution operations, cooperatives and other fertilizer producers, who operate as wholesalers. The Company's domestic industrial customers use ammonia and urea as raw materials in their production operations, including adhesives, pharmaceuticals, fibers, resins, plastics and explosives. Approximately 10% of sales volume was attributed to international markets, unchanged from last year. Captive production accounted for 64% of sales, up from 62% last year. The balance of sales was brokerage transactions that involved the purchase and resale of products produced by others.\nCompetitive Conditions\nCompetitive factors include distribution, price, availability, service and quality. Ammonia and urea are essentially undifferentiated commodities, both physically and chemically. The Company believes it is among\nthe most efficient U.S. producers with ideal geographic location for competitively priced feedstock and distribution. Competitors include many large domestic and foreign producers. No material part of the Company's business is dependent on government contracts, a single customer or a few customers. Ammonia and urea are commodities subject to wide fluctuations in price. In early 1994, intermittent shortages of ammonia developed, resulting in a sharp increase in domestic prices. Factors contributing to this shortage were increased corn acreage due to prior year flooding in the midwest, excellent early planting weather, strong industrial demand, several unplanned short-term plant outages, and less merchant ammonia due to plant upgrades. International supplies were also a factor due to continued disruptions of production and shipments out of Russia and Ukraine, including an accident in the Bosphorous Straits that temporarily blocked passage of ammonia vessels leaving the Black Sea. Because prices are subject to a variety of factors beyond the Company's control, there can be no assurance that prices experienced in fiscal 1994 will continue. Total U.S. ammonia imports increased 15% during fiscal 1994 due to increased U.S. demand as noted above. Total U.S. ammonia exports increased 13% primarily due to supply shortages in the world market in early fiscal 1994. Total U.S. urea imports were up 32% due to a weak world market. Total U.S. urea exports increased 21% due primarily to a weakening of the U.S. market late in fiscal 1994, caused, in part, by excessive imports during the first half of the fiscal year.\nSeasonality and Cyclicality of Business\nFertilizer sales vary seasonally with geographic location, agronomic considerations and weather. Domestic demand typically peaks in the spring, drops off in the summer, increases in the fall and drops again in the winter. Prices fluctuate with seasonal and longer cyclical variations due to industry supply and demand balances. Cash and working capital requirements generally correlate with the seasonality of the business.\nGOLD\nProperties and Production\nThe Company began a minerals exploration program in 1980 and acquired the Getchell gold property (the \"Getchell Property\") in July 1983. In 1987, the Getchell Property and other mineral related assets were assigned to a wholly owned subsidiary, FirstMiss Gold Inc. FirstMiss Gold was incorporated for the principal purpose of financing, developing and operating a gold mining project and conducting mineral exploration. Subsequently, a public offering of 3,250,000 shares of FirstMiss Gold stock was completed in May 1988. The Company currently owns approximately 81% of the outstanding stock of FirstMiss Gold.\nThe Getchell Property is located in the Potosi Mining District on the eastern side of the Osgood Mountain Range, 35 miles northeast of the town of Winnemucca, Nevada. (See map on page 13.) The Getchell Property consists of approximately 18,900 acres of unpatented lode and mill site mining claims and 14,100 acres of fee land owned by the Company. Exploration activities on the Getchell Property include drilling, geological mapping, geophysical and geochemical surveys, aerial photo interpretation and soil and rock testing programs.\nThe Getchell mill and ancillary facilities consist of an ore processing plant using a pressure oxidation system (autoclaves), ancillary facilities for milling refractory sulfide ores and open pit mining located on the Getchell Property. The Getchell gold mill was designed to process an average daily nominal throughput of 3,000 tons at an average recovery rate of 89%. Since September 1991, liquid oxygen has been purchased to supplement oxygen produced by an on-site plant. This additional oxygen has helped to increase average daily throughput above nominal capacity. In fiscal 1994, the average daily mill throughput was 3,268 tons. Gold recovery was 89%. Production from approximately 65% of the Getchell Property (all of the current production and proven and probable reserves) is subject to a 2% net smelter royalty owned by a third party. The Getchell mill and ancillary facilities were financed by proceeds from a gold loan and the sale of FirstMiss Gold stock. FirstMiss Gold and FMG Inc. (\"FMG\"), a wholly owned subsidiary, entered into a limited recourse loan facility, as well as a gold production purchase agreement, to provide a major portion of the necessary financing and initial working capital requirements. The gold loan and production purchase agreement expired on June 30, 1994.\nThere are currently three open pit mines in operation on the Getchell Property: the Main Pit, which produces sulfide mill feed, the Turquoise Ridge Pit, which produces oxide ore for the heap leach operation and the recently reactivated Hansen Creek Pit, which will also produce oxide ore for heap leaching. Mining of the North Pit sulfide ore body was completed during the year.\nFirstMiss Gold heap leach operations consist of three active pads, five ponds and a processing plant. A new leach pad is currently under construction. In fiscal 1994, oxide ore for heap leaching was mined from the Turquoise Ridge Pit, North Pit and Main Pit and old dumps and stockpiles. Heap leach recovery has averaged 75% of the cyanide soluble gold for the last three years.\nAn underground sulfide operation is now nearing its operational phase. This is FirstMiss Gold's first underground mine. Access to the underground workings is via a 950 foot decline. Underground stope testing has begun and small tonnages of development ore have been mined and milled. The mineralogy of the underground ore is similar to that previously mined in the Main Pit, but carries a higher gold grade averaging in excess of 0.300 ounces per ton. The underground reserves are located immediately west and below the main pit, in tabular zones sub-parallel to the Getchell Fault.\nThe underground operation will initially utilize a conventional drift-and-fill method but will switch to open stoping when ground conditions permit. Both methods are widely used for the mining of gold and other minerals. Underground mining is inherently more difficult, more costly and more hazardous than surface mining. Mining costs are higher than those of a surface pit operation because smaller, less efficient mobile equipment is required by the limited size of underground openings. Unanticipated changes in ore thickness, orientation and stability can also add difficulty, affect production rates and contribute to higher costs.\nMining in the Main Pit will be complete by mid-fiscal 1995 as underground production commences. Portions of the remaining Main Pit ore will be stockpiled and subsequently used, along with lower grade stockpiles, to supplement higher grade underground ore for mill feedstock.\nAll mining is performed by independent contractors who also provide and maintain substantially all of the mining equipment. Both open pit and underground mining operations are performed under the direction of FirstMiss Gold employees, who are responsible for mine design, planning, scheduling, surveying, sampling and ore control.\nFiscal 1994 production was as follows:\n- - - ---------------\n* Turquoise Ridge Pit\nAncillary Facilities and Raw Materials\nOxygen for the mill is produced by an on-site plant owned and operated by an independent contractor who also provides supplemental liquid oxygen. Electricity is provided by an independent utility company under an electric services agreement. The mill uses reclaimed water pumped from the tailings pond and from the dewatering of the pits and is supplemented by two existing wells on the Getchell Property. Other materials necessary in the milling process are available for purchase from more than one supplier and are hauled by truck to the Getchell Property. These materials may be subject to shortages from time to time resulting in higher costs.\nSales and Marketing\nGold is traded on numerous commodity exchanges around the world with daily adjustments to a market clearing price. Prices typically fluctuate over a wide range in response to numerous factors, all of which are beyond FirstMiss Gold's control, including expectations of inflation, interest rates, political and monetary policies of various national governments, the needs of industrial and jewelry manufacturers, trends in worldwide mine output and currency exchange rates.\nThe aggregate effect of the above factors on gold prices is impossible to predict. FirstMiss Gold's revenues, cash flow and operating results are all materially impacted by gold prices. A prolonged downturn in gold prices could also adversely affect the carrying value of various assets and FirstMiss Gold's reserve position.\nFirstMiss Gold has arrangements with two refineries for refining its dore. FirstMiss Gold's dore can be sold to a large number of refiners or trading companies throughout the world on a competitive basis. Gold is normally sold to the refineries on the spot market.\nFirstMiss Gold periodically employs hedging techniques to reduce the impact of gold price fluctuations on earnings and cash flow. In August 1993, the Company began selling gold using spot deferred forward contracts which allows FirstMiss Gold to establish a forward price and delivery date, but also roll any contracted delivery ahead to a new date and higher price while selling at the spot price if the spot price is higher than the contract price on the scheduled date of delivery. The new forward price equals the original contract price plus the \"contango,\" which is the difference between market interest rates and gold loan borrowing rates. The contango compounds each time a contract is rolled forward. The current hedging program is designed to cover 60% to 70% of the ensuing 18 months' scheduled gold production. At June 30, 1994, 225,000 ounces were hedged for fiscal 1995 delivery at an average price of $391 per ounce, and 92,000 ounces were hedged for fiscal 1996 delivery at an average price of $392 per ounce. See Note 11 to the Consolidated Financial Statements.\nWorking Capital Requirements and Seasonality of Business\nChanges in ore inventory will typically have the most effect on working capital requirements. Ore inventory tonnages fluctuate in response to various factors including milling rates, ore availability, weather conditions and mining rates.\nWinter weather extremes may affect gold production, particularly heap leach operations.\nCOMBUSTION, THERMAL PLASMA AND OTHER\nCombustion, Thermal Plasma and Other, identified in prior years as Other -- Technology, principally includes the development and marketing of proprietary equipment and systems for environmental applications and manufacturing processes. These include design and manufacture of burner, flare and incinerator equipment and technology to reduce industrial emissions; thermal plasma equipment and processes; aluminum recovery systems; and production of steel ingots and billets. Raw materials and components for these operations are available from numerous vendors. The businesses are not considered materially seasonal, with working capital requirements remaining generally level throughout the year.\nBURNER, FLARE AND INCINERATOR EQUIPMENT AND TECHNOLOGY\nBusiness, Properties and Products. Callidus Technologies Inc. (\"CTI\"), a wholly owned subsidiary headquartered in Tulsa, Oklahoma, was organized in fiscal 1990. CTI's principal products and services are custom designed and fabricated gas\/liquid incinerators, flares, solid waste systems, vapor recovery units, burners and predictive emissions monitoring and process optimization software. CTI also provides engineering and consulting services for environmental and combustion applications. CTI leases office space in Tulsa and owns a manufacturing and test facility in Beggs, Oklahoma, and has offices in Belgium, England, Italy and France.\nMarketing. CTI markets worldwide to refining, petrochemical and other industries requiring disposal of gas, liquid and solid wastes. Marketing is primarily through a combination of manufacturers' representatives and company personnel. The market is well established but growing through advancements of existing technology, driven primarily by increasingly strict environmental regulations both in the United States and abroad. Competition is based on a wide variety of factors, with the most prominent being technological innovation, price and delivery schedule. CTI competes with the John Zink Company, which has a significant market share of the burner, flare and vapor recovery markets. Numerous competitors exist in the solid waste systems market. CTI offers predictive emissions monitoring and processing optimization software and has an exclusive licensing agreement to market this software for applications to furnaces in the refining and petrochemical industries. CTI is affected by a variety of factors beyond its control, including governmental control of environmental standards and compliance deadlines, competitor pricing strategies and changing technology, any of which could impact CTI's operating results.\nTHERMAL PLASMA\nBusiness and Properties. Plasma Energy Corporation (\"PEC\"), a wholly owned subsidiary formed in January 1983, develops, manufactures, sells and services thermal plasma heating systems and processes for use in steel manufacturing, aluminum recovery, vacuum melting of titanium and various environmental uses, including ash treatment and minimization. PEC owns an assembly and testing facility and leases a separate administrative office, both located in Raleigh, North Carolina.\nTechnology and Products. Thermal plasma heating systems convert electrical energy into high temperature thermal energy using an ionized gas or \"plasma.\" These high temperatures are produced instantly with no combustion or combustion by-products. A thermal plasma heating system typically consists of a torch, power supply, cooling system and control panel. The torch usually operates within a furnace or heating vessel, in which it can be inserted or retracted according to operational requirements. PEC holds more than 20 patents in 10 countries, including several in steel, vacuum melting and waste applications.\nSales and Marketing. PEC has sold large-scale systems for tundish heating in steel making, recovery of aluminum from dross, vacuum melting of titanium and treatment of ash from incinerators. Marketing is principally performed directly by PEC or through representatives overseas. Plasma heating systems have been sold in both the domestic and international markets. PEC has two principal domestic competitors and four foreign competitors involved in various applications of thermal plasma heating systems. Price competition is intense and competitors' pricing strategies may impact PEC's operating results.\nALUMINUM RECOVERY\nBusiness and Properties. Plasma Processing Corporation (\"PPC\"), with its principal offices near Nashville, Tennessee, was formed during fiscal 1990 to commercialize patented technology developed by PEC and Alcan International Limited (\"Alcan\") of Canada. PPC and Alcan entered into a cross license agreement for recovery of aluminum from dross using thermal plasma energy. The most recently issued applicable patents expire in 2007. PPC uses the technology to recover aluminum from dross, a by-product of aluminum processing and recycling. The conventional salt-flux process uses salt additives for recovering aluminum from dross, creating a saltcake by-product which requires disposal in landfills. PPC's aluminum dross recovery process does not use salt additives and creates no known hazardous by-products, a major advantage over existing processes. Recovered aluminum is returned to the customer. The process also produces a co-product that potentially can be utilized in the metallurgical, refractory, abrasives and ceramics industries. Markets for the co-product are in the early stages of development. Annual North American production of aluminum dross is estimated at approximately one million tons. Dross typically contains 30% to 80% aluminum by weight.\nIn June 1991, PPC completed construction of its dross processing plant located in Millwood, West Virginia. The plant is designed to process 73 million pounds of aluminum dross per year. Fiscal 1994 throughput was 54 million pounds. Production was limited primarily due to depressed aluminum industry conditions.\nMarketing. It is anticipated that the current baseload contract will utilize 30% of the Millwood plant's processing capacity. Although PPC will compete against numerous other dross processors in the United States, none of these competitors currently use plasma technology. Markets are very fragmented and freight-sensitive.\nExcept in aluminum plants in which Alcan has an equity interest, PPC has the exclusive right to use the patented technology in the United States and Canada. Alcan has the exclusive right to use the same technology in Europe. Until mid-year 2000, PPC has the exclusive right to license the patented technology to third parties worldwide, except in Europe. Beginning in mid-year 2000, both parties have the right to license the technology anywhere in the world. Pursuant to the arrangement with Alcan, revenues from licensing or sublicensing to third parties will be shared.\nSTEEL\nThe Company also operates a steel melting and production facility through its wholly owned subsidiary FirstMiss Steel, Inc. (\"FMS\") in Hollsopple, Pennsylvania. The approximately 400,000 square foot facility is located about 100 miles east of Pittsburgh. In late fiscal 1990, a horizontal billet caster and a thermal plasma heating system were installed. Start-up of the caster occurred during fiscal 1991. Annual capacity of the operation includes 125,000 tons of carbon, alloy and specialty grade bottom-poured ingots and 50,000 tons of high-grade steel billets through the caster. Horizontally cast billets are produced for sale to the specialty remelt and reroll markets. Production during fiscal 1994 totaled 102,000 tons consisting primarily of cast ingots and value-added products. The value-added product line was introduced in fiscal 1992 and includes specialty stainless and tool steel ingots or billets which are converted into forged billets, bars and plate by outside processors. A new unit, FirstMiss Alloys, was formed during fiscal 1993 to produce small quantities of cobalt, nickel, copper and iron-based alloys in bars and wire produced from two small horizontal continuous casters, small bottom-poured forging ingots, and remelt sand ingots. Raw materials consist of steel scrap and various alloys, of which there is an adequate supply in the North American market.\nCarbon and alloy steel ingots and billets are sold directly to the forging industry, integrated steel producers and mini-mill and tool steel producers. FMS competes primarily with three other steel companies in this market and, within the group, ranks second in total steel production capacity. Specialty steel products are sold primarily to steel service centers and forgers. FirstMiss Alloy products are sold as feedstock directly to forgers, extruders and investment casters. There are numerous competitors, both domestic and foreign, that compete with FMS in the specialty steel and ferrous and non-ferrous metals markets. Competitive factors include price, quality and service. Carbon ingots and billets are commodities and are extremely price competitive. FMS emphasizes those grades that are technically difficult to produce on vertical casters.\nSee pages 31-33, Note 14 of the 1994 Annual Report for additional Industry Segment Information.\nOTHER OPERATIONS\nThe Company owns 50% of Power Sources, Inc. (\"PSI\") of Charlotte, North Carolina, which burns wood waste in industrial boilers to create steam energy. The steam is sold under long-term contracts to industrial users. PSI operates four plants in North Carolina and South Carolina. A fifth plant is currently under construction in Tennessee.\n------------------------\nENVIRONMENTAL\nCompany operations are subject to a wide variety of environmental laws and regulations governing emissions to the air, discharges to water sources, and the handling, storage, treatment and disposal of waste materials, as well as other laws and regulations concerning health and safety conditions. The Company holds a number of environmental permits and licenses regulating air emissions, water discharges and hazardous waste disposal and, to the best of its knowledge, is in material compliance with such requirements at all locations. The Company makes capital and other expenditures in a continuing effort to comply with environmental laws\nand regulations, or changing interpretations of existing laws and regulations. Environmental capital expenditures for fiscal 1994 were $1.3 million. Projected capital expenditures for fiscal 1995 are $4.9 million. These projected capital expenditures are primarily related to the chemicals and gold segments. While these expenditures are necessary to comply with environmental laws and regulations, they may also reduce operating expenses and improve efficiencies.\nThe Company monitors and participates in the environmental regulatory development process which assists it in evaluating new laws and regulations. The Company does not anticipate a material increase in expenses related to current environmental regulations, but because federal and state environmental laws and regulations are constantly changing, the Company is unable to predict their future impact. Federal legislation has recently been proposed by both the U.S. Senate and House of Representatives that would place extensive new environmental and permitting restrictions on the mining industry. Other federal legislation has been proposed which, if enacted, would extend federal regulation of surface and groundwater quality and laws related to endangered species. Substantial stiffening of applicable mine waste management requirements or the imposition of substantially different environmental control regulations could have a material adverse impact on the Company. The Company's domestic competitors are subject to the same environmental laws and regulations, but foreign competitors are not, which may give foreign competitors an advantage.\nThe Company has received notices from the EPA or a similar state agency that it is a potentially responsible party (\"PRP\") under Superfund or a comparable state statute and, thus, may be liable for a share of the costs associated with cleaning up various hazardous waste sites. The EPA or state agency has designated the Company as a PRP at seven sites. The Company currently estimates its potential liability in these matters to be $0.5 million. This estimate is affected by several uncertainties such as, but not limited to, the method and extent of remediation, the percentage of material attributable to the Company at the sites relative to that attributable to other parties, and the financial capabilities of the other PRPs at most sites. This estimate is not offset by any amounts projected to be received from insurance companies or other third parties.\nThe current owner of a fertilizer manufacturing facility, previously operated under lease by a subsidiary of the Company, is involved in developing a closure plan and assessment at that site. Another previous owner has indicated the Company may have some financial responsibility for the closure activities. Any ultimate responsibilities and obligations of the parties are unknown due to the early nature of the investigation and assessment.\nIn accordance with the State of Nevada Division of Environmental Protection (\"NDEP\"), FirstMiss Gold has submitted a plan to the NDEP for the eventual closure and reclamation of the Getchell Property and is awaiting approval and permitting. As of June 30, 1994, FirstMiss Gold had accrued a total of $3.0 million for reclamation and closure costs. FirstMiss Gold has begun reclamation of surface mining disturbances and anticipates an ongoing program of additional reclamation over the next several years. Activities have included regrading, revegetation and soil stabilization.\nThe Company continues as guarantor on $29.2 million of reclamation bonds related to the disposed coal operations until bonding is obtained by the purchaser, which is not to be later than June 1996. The total reclamation liability covered by the bonding is currently estimated at $5.5 million.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nA. General\nA description of properties and the segments to which they relate is also included in the Business discussion located on pages 3 through 12 of this Form 10-K. The Company believes that its properties are suitable and adequate for the purposes for which they are used.\nB. Gold Ore Reserves\nThe following table sets forth the proven and probable mineable ore reserves on the Getchell Property.\nPROVEN AND PROBABLE MINEABLE RESERVES\nCONFIRMED BY MINE DEVELOPMENT ASSOCIATES AS OF JULY 1, 1994\nSulfide reserves assume a 0.100 ounce per ton cutoff for open pit reserves and a 0.200 ounce per ton cutoff for underground reserves. Oxide reserves are based on a 0.010 cyanide soluble cutoff grade. Included in sulfide reserves are low-grade stockpiles containing 2,080,500 tons at an average grade of 0.115 ounces per ton, or 238,400 contained ounces. Also included in sulfide reserves are 3,733,700 tons of underground ore at an average grade of 0.302 ounces per ton, or 1,127,700 contained ounces. The proven and probable mineable ore reserve ounces are \"contained\" ounces. Actual ounces expected to be recovered during milling and heap leach processing will be less due to recovery process inefficiencies.\nProven and probable mineable ore reserves reflect estimates of quantities and grades of ore which can be economically recovered based on assumptions of a $400 per ounce future gold price and projected future mining and milling costs. Although FirstMiss Gold has carefully prepared and verified these reserves, such figures are estimates. Prolonged decreases in gold prices may render uneconomic the mining of various ore reserves containing low grades of mineralization.\nDuring the year, proven and probable mineable sulfide ore reserves increased 22% to 1,511,800 ounces at year-end and the average sulfide grade increased 9% to 0.225 ounces per ton in 6,725,400 ore tons. Exploration added 558,700 new contained ounces of reserves during the year, while ore containing 280,000 ounces was processed through the mill and heap leach. Oxide proven and probable mineable ore reserves increased slightly to 79,900 ounces from 76,600 ounces. Oxide reserves consist of 2,860,800 tons at an average grade of 0.028 ounces per ton.\nGold mineralization on the Getchell Property occurs in a series of discrete zones associated with the north-trending Getchell Fault and with the northeast-trending Turquoise Ridge Fault. Both systems cut through a thick sequence of interbedded early paleozoic sedimentary and volcanic units. The northwest-dipping Turquoise Ridge Fault and the eastward-dipping Getchell Fault intersect in the Main Pit.\nGold sulfide mineral deposits are found at depth along the Getchell Fault and in sedimentary units in contact with the Getchell Fault. Recent drilling has identified similar gold sulfide mineral deposits in various sedimentary and volcanic units in contact with the Turquoise Ridge Fault northeast of its intersection with the Getchell Fault.\nOxidized gold mineral deposits are also associated with the Getchell and Turquoise Ridge fault zones, typically occurring as discrete zones at depths shallower than the sulfide mineralization.\nA mineral deposit is a naturally occurring concentration of minerals that may or may not be economically mineable. A mineable reserve is that part of a mineral deposit that has been sufficiently drilled to define the tonnage and grade, which may be extracted at a profit. Mineral deposits do not qualify as commercially mineable ore bodies (proven and probable mineable reserves) under Securities and Exchange Commission rules until a final and comprehensive economic, technical and legal feasibility study based upon adequate test results is concluded.\n(MAP)\nGETCHELL MINE AREA HUMBOLDT COUNTY, NEVADA\n(See Appendix for narrative description of map to be included on this page.)\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn July 15, 1986, the first of seventeen lawsuits was filed in the Twenty-First Judicial District Court, Livingston Parish, Louisiana, against approximately ninety defendants, including Triad Chemical. The plaintiffs' multi-billion dollar claims are based on alleged personal injuries and property damage as a result of exposure to hazardous waste allegedly contributed by the defendants to the Combustion Inc. site, which was operated as a waste and used oil reclamation and reprocessing facility in Livingston Parish. The pending litigation has been consolidated into a class action and removed to federal district court for the Middle District of Louisiana. On April 20, 1993, one of the defendants filed a third party claim against AMPRO Fertilizer, Inc. and 210 other entities seeking to have the new defendants pay a share of the claims made by the plaintiffs and clean-up costs for the site. Triad and AMPRO are each vigorously defending their positions and the Company considers their defenses meritorious. Despite assertions by certain third parties that Triad and AMPRO sent waste to the Combustion site, neither company's records reflect that any waste was sent to the site.\nTriad has received and responded to letters issued by the EPA under Section 104 of the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") relative to the possibility that Triad waste was disposed at the Combustion site. Under CERCLA, generators of waste may be held responsible for investigation and site cleanup costs. Triad is involved in discussions regarding a possible de minimis settlement from cleanup liability.\nBased upon facts known to date, the Company is of the opinion that the ultimate disposition of the litigation and any site cleanup obligations should not have a material effect upon the financial position or results of operation of the Company.\nAdditionally, the Company has pending several claims incurred in the normal course of business which, in the opinion of management and legal counsel, can be disposed of without material effect on the Company's financial statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nPART II\nITEMS 5-8. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS, SELECTED FINANCIAL DATA, MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION, AND FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information called for by Part II, Items 5-8, has been included in the Registrant's Annual Report to Stockholders for the year ended June 30, 1994, which has been furnished to the Commission. See the Cross Reference Sheet on Page 2 hereof for the locations of such information.\nITEM 9.","section_5":"","section_6":"","section_7":"","section_7A":"","section_8":"","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nITEMS 10-13. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT, EXECUTIVE COMPENSATION, SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT, AND CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by Part III, Items 10-13, has been included in the Registrant's definitive Proxy Statement, which will be mailed to the Commission by October 3, 1994, pursuant to Regulation 14A, and is incorporated herein by reference. See the Cross Reference Sheet on Page 2 hereof for the location of such information.\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)(1) Financial Statements and Supplementary Data\n(a)(2) Financial Statement Schedules\nSchedules other than those listed above are omitted because they are not required, are not applicable or the information required has been included elsewhere herein.\n(a)(3) Exhibits\n- - - ---------------\n* Indicates management contract or compensatory plan or arrangement.\nCertain debt instruments have not been filed. The Company agrees to furnish a copy of such agreement(s) to the Commission upon request.\n(Note: The exhibits filed with the Commission are not included in this copy of the Form 10-K. A copy of the exhibits will be provided upon payment of a reasonable fee, to be specified at the time a request is made).\n(b) A Form 8-K dated June 13, 1994, was filed by the Company relating to the First Mississippi Corporation 401(K) Savings Plan, as amended and restated, effective July 1, 1989. (Please see Item 4(h) in (a)(3) above.)\n(c) Please see (a)(3) above.\n(d) Please see (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.\nFIRST MISSISSIPPI CORPORATION\nDate: September 23, 1994 By: \/s\/ J. KELLEY WILLIAMS J. Kelley Williams, 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.\nINDEPENDENT AUDITORS' REPORT ON SCHEDULES\nThe Board of Directors and Stockholders First Mississippi Corporation:\nUnder date of September 9, 1994, we reported on the consolidated balance sheets of First Mississippi Corporation and subsidiaries as of June 30, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended June 30, 1994, as contained in the 1994 Annual Report to Stockholders. These financial statements and our report thereon are incorporated by reference in the annual report on Form 10-K for the year 1994. In connection with our audits of the aforementioned consolidated financial statements, we have audited the financial statement schedules listed in Item 14(a)(2) of 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 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 LLP\nJackson, Mississippi September 9, 1994\nSCHEDULE V\nFIRST MISSISSIPPI CORPORATION AND CONSOLIDATED SUBSIDIARIES\nPROPERTY, PLANT AND EQUIPMENT YEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS OF DOLLARS)\n- - - ---------------\n(a) Includes $9,846 of deferred stripping costs reclassified to amortization expense and $457 of certain spare parts reclassified to inventory.\n(b) Includes capital project refund of $1,161 which reduced the cost basis of certain property assets.\nSCHEDULE VI\nFIRST MISSISSIPPI CORPORATION AND CONSOLIDATED SUBSIDIARIES\nACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT YEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS OF DOLLARS)\nSCHEDULE VIII\nFIRST MISSISSIPPI CORPORATION AND CONSOLIDATED SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS OF DOLLARS)\nSCHEDULE IX\nFIRST MISSISSIPPI CORPORATION AND CONSOLIDATED SUBSIDIARIES\nCONSOLIDATED SHORT-TERM BORROWINGS THREE YEARS ENDED JUNE 30, 1994 (IN MILLIONS OF DOLLARS)\n- - - ---------------\n(1) Average of daily balances for 366 days in 1992 and 365 days in 1993 and 1994.\n(2) Total interest accrued divided by average daily balance.\nSCHEDULE X\nFIRST MISSISSIPPI CORPORATION AND CONSOLIDATED SUBSIDIARIES\nSUPPLEMENTARY INCOME STATEMENT INFORMATION YEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS OF DOLLARS)\nINDEPENDENT AUDITORS' CONSENT\nThe Board of Directors First Mississippi Corporation:\nWe consent to incorporation by reference in the Registration Statements on Form S-8 (Nos. 2-93584, 2-93585, 2-74337, 2-54048, 33-512, 33-9106, 33-17483, 33-24413, 33-24414, 33-26895, 33-31343, 33-33135, 33-37084, 33-39137, 33-43586, 33-43600, 33-45344 and 33-56026) of our reports dated September 9, 1994, relating to the consolidated financial statements and financial statement schedules of First Mississippi Corporation and subsidiaries as of June 30, 1994 and 1993 and for each of the years in the three-year period ended June 30, 1994, which reports appear or are incorporated by reference in the June 30, 1994 annual report on Form 10-K of First Mississippi Corporation. Our report on the consolidated financial statements refers to a change in the method of accounting for income taxes.\nKPMG PEAT MARWICK LLP\nJackson, Mississippi September 27, 1994\nEXHIBITS\nINDEX TO EXHIBITS\nAPPENDIX\n1. In the top right corner of Page 13 is an outline map of the state of Nevada showing the location of the Getchell Property and the towns of Winnemucca and Reno.\nIn the bottom left portion of the page is an outline map of the Getchell Property showing property boundaries and the location of the underground mine, pits, ridges, facilities and nearby competitors' operations.","section_15":""}
{"filename":"84244_1994.txt","cik":"84244","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's headquarters is located in a building owned by the Company at One Rollins Plaza, Wilmington, DE 19803.\nThe Company's principal operating properties consist of land and buildings used in its truck leasing and rental business. Rollins owns or leases 198 facilities in 41 states.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNeither the Company nor any of its subsidiaries is a party to any material legal proceedings. The Company and its subsidiaries are engaged in ordinary routine litigation incidental to the business.\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 THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nSTOCK PRICES AND DIVIDENDS\nThe range of share prices for the Common Stock on the New York and Pacific Stock Exchanges and per share dividends paid on Common Stock for the fiscal years ended September 30, 1994 and 1993 are as follows:\nPrices Dividends 1994 1993 1994 1993 High Low High Low Fiscal Quarter First ........... $14 $11 1\/4 $10 5\/8 $ 7 7\/8 $.033 $.03 Second .......... 14 3\/8 11 1\/2 12 9 1\/2 .033 .03 Third ........... 12 3\/8 11 1\/8 11 3\/4 9 3\/8 .033 .03 Fourth .......... 12 1\/2 10 7\/8 13 7\/8 10 1\/2 .033 .03\nAll stock prices and dividend amounts have been adjusted for the three-for- two common stock split distributed on September 15, 1994.\nAt September 30, 1994, there were 2,580 holders of record of the Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nFIVE YEAR SELECTED FINANCIAL DATA (Dollars in Millions, Except Per Share Amounts)\nFiscal Year Ended September 30, 1994 1993 1992 1991 1990 Revenues 450.9 408.8 380.4 341.9 331.2 Earnings before income taxes 66.4 54.7 40.7 31.5 29.6 Earnings 39.8 30.4 24.6 19.0 18.0 Earnings per share (1) .86 .66 .53 .45 .43 Dividends per common share (1) .13 .12 .11 .09 .09 Total assets 909.7 781.2 708.5 656.4 658.5 Equipment on operating leases, net 637.8 543.4 468.3 441.1 453.8 Equipment financing obligations 498.4 427.3 390.3 378.9 407.2 Long-term debt .8 .9 6.8 9.1 22.6 Shareholders' equity 251.2 216.8 191.0 169.4 133.9\n(1) Adjusted for the three-for-two common stock split distributed on September 15, 1994.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nResults of Operations Fiscal Year 1994 vs. 1993\nRevenues increased by $42.1 million (10.3%) as full-service lease, commercial rental and dedicated contract carriage revenues all improved over the prior year.\nOperating expenses increased by $16.0 million (9.6%) reflecting the higher revenues. Operating expenses as a percentage of revenues decreased to 40.6% in 1994 from 40.9% in 1993. This improved operating cost ratio resulted from lower maintenance costs on new equipment and continued expense control efforts.\nNet depreciation expense increased by $10.0 million (8.9%) due to the increased gross investment in equipment on operating leases and transportation service facilities offset in part by increased gains on the sale of equipment, which are shown as a reduction of depreciation expense. Equipment sale gains increased to $8.5 million from $6.1 million in 1993 as the used equipment market remained strong during 1994.\nSelling and administrative expenses increased by $2.0 million (5.0%) mainly due to higher payroll costs in the sales area and to continued emphasis on sales and marketing programs. Selling and administrative expenses decreased to 9.4% of revenues in 1994 from 9.9% of revenues in 1993.\nInterest expense increased by $2.4 million (7.0%) due to the increase in average borrowings and higher short-term interest rates offset in part by the refinancing of certain higher interest rate debt.\nThe effective income tax rates for 1994 and 1993 were 40.0% and 44.4%, respectively.\nNet earnings increased by $9.4 million (30.9%) to $39.8 million or $.86 per share from $30.4 million or $.66 per share in 1993. The improvement in net earnings was due mainly to increased revenues and the lower operating cost ratio offset in part by higher depreciation, selling and administrative and interest expenses.\nFiscal Year 1993 vs. 1992\nRevenues increased by $28.4 million (7.5%) as full-service lease, commercial rental, guaranteed maintenance and dedicated contract carriage revenues all improved over the prior year. Part of the revenue improvement resulted from the inclusion for a full year of the operations of several small acquisitions made at various dates in fiscal 1992.\nOperating expenses increased by $7.2 million (4.5%) reflecting the higher revenues. Operating expenses as a percentage of revenues decreased to 40.9% in 1993 from 42.1% in 1992. Depreciation expense increased by $5.5 million (5.2%) due to the increased investment in equipment on operating leases and transportation service facilities, offset in part by increased gains on the sale of equipment. Gains on the sale of equipment, which are shown as a reduction of depreciation expense, increased to $6.1 million from $3.1 million in 1992 as the market for used equipment improved in 1993.\nSelling and administrative expenses increased by $2.6 million (6.8%) due in part to higher payroll costs resulting from personnel additions and increases in other compensation. In addition, data processing, bad debts and office expenses were also higher in 1993. Selling and administrative expenses were 9.9% of revenues in 1993 compared with 10.0% of revenues in 1992.\nInterest expense decreased by $.9 million (2.6%) due mainly to the lower interest rates on short-term bank borrowings and to the refinancing of certain higher interest rate debt.\nThe effective income tax rates for 1993 and 1992 were 44.4% and 39.4%, respectively. The 1993 tax rate includes the deferred tax adjustment of $2.3 million resulting from the increase in the federal income tax rate from 34% to 35%. Excluding the deferred income tax adjustment, the effective income tax rate for 1993 was 40.2%.\nNet earnings increased by $5.8 million (23.4%) to $30.4 million or $.66 per share from $24.6 million or $.53 per share in 1992. The increase in earnings was due mainly to the higher revenues and to the reduction in interest expense, offset in part by the $2.3 million deferred income tax adjustment.\nLiquidity and Capital Resources\nThe Company's primary operation is the full-service leasing and rental of tractors, trucks and trailers which requires substantial amounts of capital and constant access to financing sources. At September 30, 1994, equipment on operating leases of $637.8 million represented 70.1% of the Company's assets. Funds for the acquisition of these assets are provided principally by the cash flows from operations, the proceeds from the sale of used equipment and borrowings under the Company's revolving credit facility. Cash flows from operations arising from net earnings, depreciation and changes in deferred income taxes and working capital were $173.7 million in 1994, a 4.3% increase from $166.5 million in 1993. Because the primary source of funds from operations is from existing leases already under contract, the Company expects to continue to generate a substantial amount of funds from operations in 1995.\nEquipment financing obligations and long-term debt increased to $499.3 million at September 30, 1994 from $428.4 million a year earlier. Borrowings from external sources include equipment term loans furnished by commercial banks and the issuance of Collateral Trust Debentures.\nThe Company's principal subsidiary, Rollins Leasing Corp., has a $100.0 million revolving credit facility of which $66.5 million was available at September 30, 1994. This facility is used primarily to finance vehicle purchases on an interim basis pending placement of long-term financing. On March 21, 1994, the Company sold $60.0 million of 7% Series M Collateral Trust Debentures due March 15, 2001. Additionally, on September 21, 1994, the Company arranged for the private placement of $100.0 million of 8.27% Series N Collateral Trust Debentures due March 15, 2002. Closing will occur on March 15, 1995 with the proceeds used to refinance certain existing indebtedness and for new equipment purchases committed for in the Spring of 1995.\nAt September 30, 1994, the Company could sell an additional $140.0 million of Collateral Trust Debentures under its current shelf registration statement. Based on its access to the debt markets and the relationships with current lending institutions and others who have expressed an interest in providing financing, the Company expects to continue to be able to obtain financing for its equipment and facility purchases at market rates and under satisfactory terms and conditions.\nAt September 30, 1994 and 1993, the debt to equity ratio of the Company was 2.0 to 1.\nCapital expenditures were $297.5 million in 1994 compared with $242.9 million in 1993. The level of economic activity, which in part dictates demand for the Company's services, remained strong in 1994. At September 30, 1994, the Company's commitment for the purchase of revenue equipment was $169.0 million. Based on the current level of business and including commitments already made at September 30, 1994, the Company anticipates spending approximately $300.0 million for equipment and facilities in 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe consolidated financial statements of the Company, the Independent Auditors' Report and the financial statement schedules included in this report are shown on the Index to the Consolidated Financial Statements and Schedules on page 9.\nITEM 9.","section_9":"ITEM 9. 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 presented below, the information called for by this Item 10 is incorporated by reference from the Company's Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Shareholders to be held on January 26, 1995.\nExecutive Officers of the Registrant. As of October 31, 1994, the Executive Officers of the registrant were:\nName Position Age Term of Office Patrick J. Bagley Vice President-Finance and 47 7\/87 to date Treasurer 1\/87 to date\nDavid F. Burr Chairman and Chief Executive 56 10\/92 to date Officer, Rollins Leasing Corp.\nMichael B. Kinnard Vice President-General Counsel 37 10\/94 to date and Secretary 10\/94 to date\nJohn W. Rollins Chairman of the Board and 78 1954 to date Chief Executive Officer 10\/74 to date\nJohn W. Rollins, Jr. President and Chief Operating 52 9\/75 to date Officer and Director\nHenry B. Tippie Chairman of the Executive 67 3\/74 to date Committee and Vice Chairman of the Board\nThe Company's Executive Officers are elected for the ensuing year and until their successors are elected.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information called for by this Item 11 is incorporated by reference from the Company's Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Shareholders to be held on January 26, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information called for by this Item 12 is incorporated by reference from the Company's Proxy Statement to be filed pursuant to Regulation 14A for the Annual Meeting of Shareholders to be held on January 26, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nDuring the year ended September 30, 1994, the following officers and\/or directors of the Company were also officers and\/or directors of Rollins Environmental Services, Inc.; Patrick J. Bagley, William B. Philipbar, Jr., John C. Peet, Jr. (retired effective September 30, 1994), John W. Rollins, John W. Rollins, Jr. and Henry B. Tippie. The following officers and\/or directors of the Company were also officers and\/or directors of Matlack Systems, Inc.; Patrick J. Bagley, William B. Philipbar, Jr., John W. Rollins, John W. Rollins, Jr. and Henry B. Tippie. John W. Rollins owns directly and of record 6.2% and 12.0% of the outstanding shares of Common Stock of Rollins\nEnvironmental Services, Inc. and Matlack Systems, Inc. October 31, 1994. The description of transactions between the Company and Rollins Environmental Services, Inc. and between the Company and Matlack Systems, Inc. appears under the caption \"Transactions with Related Parties\" on page 21 of this 1994 Annual Report on Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) Financial Statements, Financial Statement Schedules and Exhibits.\n(1) Financial Statements - See accompanying Index to Consolidated Financial Statements and Schedules on page 12.\n(2) Financial Statements Schedules - See accompanying Index to Consolidated Financial Statements and Schedules on page 12.\n(3)Exhibits: (3) (a) Restated Certificate of Incorporation of Rollins Truck Leasing Corp. as last amended on January 25, 1990 as filed with the Company's annual report on Form 10-K for the fiscal year ended September 30, 1992 is incorporated herein by reference.\n(3) (b) By-Laws of Rollins Truck Leasing Corp. as last amended on November 25, 1987 as filed with the Company's annual report on Form 10-K for the fiscal year ended September 30, 1992 is incorporated herein by reference.\n(4) (a) Collateral Trust Indenture dated as of March 21, 1983, between RLC CORP. (now known as Rollins Truck Leasing Corp.) and Bank of America Illinois (formerly Continental Illinois National Bank and Trust Company of Chicago), as Trustee, as filed with the Company's Registration Statement No. 33-40476 on Form S-3 dated May 10, 1991, is incorporated herein by reference.\n(4) (b) Third Supplemental Collateral Trust Indenture dated February 20, 1986 to the Collateral Trust Indenture dated March 21, 1983 between RLC CORP. (now known as Rollins Truck Leasing Corp.) and Bank of America Illinois (formerly Continental Illinois National Bank and Trust Company of Chicago), as Trustee, as filed with the Company's Registration Statement No. 33-40476 on Form S-3 dated May 10, 1991, is incorporated herein by reference.\n(4) (c) Sixth Supplemental Collateral Trust Indenture dated March 15, 1988 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986, between RLC CORP. (now known as Rollins Truck Leasing Corp.) and Bank of America Illinois (formerly Continental Illinois National Bank and Trust Company of Chicago), as Trustee.\n(4) (d) Seventh Supplemental Collateral Trust Indenture dated March 15, 1989 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986, between RLC CORP. (now known as Rollins Truck Leasing Corp.) and Bank of America Illinois (formerly Continental Bank N.A.), as Trustee.\n(4) (e) Eighth Supplemental Collateral Trust Indenture dated May 15, 1990 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's Registration Statement No. 33-67682 on Form S-3 dated August 20, 1993 is incorporated herein by reference.\n(4) (f) Ninth Supplemental Collateral Trust Indenture dated December 1, 1991 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated December 12, 1991, is incorporated herein by reference.\n(4) (g) Tenth Supplemental Collateral Trust Indenture dated April 28, 1992 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated April 28, 1992, is incorporated herein by reference.\n(4) (h) Eleventh Supplemental Collateral Trust Indenture dated March 15, 1993 to the Collateral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated March 30, 1993, is incorporated herein by reference.\n(4) (i) Twelfth Supplemental Collateral Trust Indenture dated March 15, 1994 to the Colalteral Trust Indenture dated March 21, 1983 as supplemented and amended by a Third Supplemental Indenture thereto dated as of February 20, 1986 and by an Eighth Supplemental Indenture dated May 15, 1990, between Rollins Truck Leasing Corp. and Bank of America Illinois (formerly Continental Bank, N.A.), as Trustee, as filed with the Company's report on Form 8-K dated March 21, 1994, is incorporated herein by reference.\n(4) (j) RLC CORP. (now known as Rollins Truck Leasing Corp.) Rights Agreement dated as of June 14, 1989 as filed as an Exhibit to Form 8-A filed by Registrant on June 15, 1989 is incorporated herein by reference.\n(10) (a) RLC CORP. (now known as Rollins Truck Leasing Corp.) 1982 Incentive Stock Option Plan, as filed with the Company's Proxy Statement for the Annual Meeting of Shareholders held on January 27, 1983, is incorporated herein by reference.\n(10) (b) RLC CORP. (now known as Rollins Truck Leasing Corp.) 1986 Stock Option Plan, as filed with the Company's Proxy Statement for the Annual Meeting of Shareholders held on January 29, 1987, is incorporated herein by reference.\n(10) (c) Rollins Truck Leasing Corp. 1993 Stock Option Plan, as filed with the Company's Proxy Statement for the Annual Meeting of Shareholders held on January 27, 1994, is incorporated herein by reference.\n(21) Rollins Truck Leasing Corp. Subsidiaries at September 30, 1994.\n(23) Consent of KPMG Peat Marwick LLP, Independent Auditors, for incorporation by reference in Registration Statement No. 33- 67682 filed on Form S-3.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed by Rollins Truck Leasing Corp. during the last quarter of the period covered by this report. However, on October 13, 1994, a report on Form 8-K was filed disclosing that effective at the close of business September 30, 1994, Michael B. Kinnard was appointed Vice President-General Counsel and Secretary to Rollins Truck Leasing Corp. Mr. Kinnard succeeds John C. Peet, Jr., who previously held the same positions and whose resignation was accepted effective at the close of business September 30, 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: November 23, 1994 ROLLINS TRUCK LEASING CORP. (Registrant)\nBY: \/s\/ John W. Rollins, Jr. John W. Rollins, Jr. President and Chief Operating 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:\n\/s\/Patrick J. Bagley Vice President-Finance and Treasurer November 23, 1994 Patrick J. Bagley Chief Financial Officer Chief Accounting Officer\n\/s\/John W. Rollins Chairman of the Board and November 23, 1994 John W. Rollins Chief Executive Officer\n\/s\/Gary W. Rollins Director November 23, 1994 Gary W. Rollins\n\/s\/Henry B. Tippie Chairman of the Executive November 23, 1994 Henry B. Tippie Committee and Vice Chairman of the Board\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\n(1) Consolidated Page(s) Independent Auditors' Report on Financial Statements and Financial Statement Schedules 14\nConsolidated Statement of Earnings for the years ended September 30, 1994, 1993 and 1992 15\nConsolidated Balance Sheet at September 30, 1994 and 1993 16\nConsolidated Statement of Cash Flows for the years ended September 30, 1994, 1993 and 1992 17\nNotes to the Consolidated Financial Statements 18 to 26\n(2) Financial Statement Schedules\nRollins Truck Leasing Corp. (Parent) Schedule III - Condensed Financial Information\nBalance Sheet at September 30, 1994 and 1993 27\nStatement of Earnings for the years ended September 30, 1994, 1993 and 1992 28\nStatement of Cash Flows for the years ended September 30, 1994, 1993 and 1992 29\nNotes to Financial Statements 30\nRollins Truck Leasing Corp. and Subsidiaries Consolidated\nSchedule II - Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees (Other Than Related Parties) for the years ended September 30, 1994, 1993 and 1992 31\nSchedule IV - Indebtedness of Related Parties - Not Current for the years ended September 30, 1994, 1993 and 1992 32\nSchedule V - Property, Plant and Equipment for the years ended September 30, 1994, 1993 and 1992 33\nSchedule VI - Accumulated Depreciation of Property, Plant and Equipment for the years ended September 30, 1994, 1993 and 1992 34\nSchedule VIII - Valuation and Qualifying Accounts for the years ended September 30, 1994, 1993 and 1992 35\nSchedule X - Supplementary Income Statement Information for the years ended September 30, 1994, 1993 and 1992 36\nAny financial statement schedules otherwise required have been omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\nIndependent Auditors' Report\nThe Shareholders and Board of Directors Rollins Truck Leasing Corp.\nWe have audited the consolidated financial statements of Rollins Truck Leasing Corp. and subsidiaries 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 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 Rollins Truck Leasing Corp. and subsidiaries as of September 30, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 1994, 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 LLP\nWilmington, Delaware October 25, 1994\nCONSOLIDATED STATEMENT OF EARNINGS\nYear Ended September 30, 1994 1993 1992 Revenues $450,903,000 $408,778,000 $380,384,000 Expenses: Operating 183,222,000 167,248,000 160,023,000 Depreciation, net of gain on disposition of property and equipment 121,982,000 112,005,000 106,493,000 Selling and administrative 42,473,000 40,440,000 37,855,000 347,677,000 319,693,000 304,371,000\nEarnings before interest expense and income taxes 103,226,000 89,085,000 76,013,000 Interest expense, net 36,836,000 34,428,000 35,345,000 Earnings before income taxes 66,390,000 54,657,000 40,668,000 Income taxes 26,562,000 24,241,000 16,029,000\nNet earnings $ 39,828,000 $ 30,416,000 $ 24,639,000\nEarnings per share (1) $ .86 $ .66 $ .53\nAverage common shares and equivalents outstanding 46,310,000 46,260,000 46,007,000\n(1) Adjusted for the three-for-two common stock split distributed on September 15, 1994.\nThe Notes to the Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED BALANCE SHEET\nSeptember 30, 1994 1993 ASSETS Current assets Cash $ 15,094,000 $ 15,081,000 Accounts receivable, net of allowance for doubtful accounts: 1994-$1,770,000; 1993-$1,620,000 52,031,000 48,917,000 Inventory of parts and supplies 8,558,000 8,679,000 Prepaid expenses 12,726,000 10,147,000 Refundable income taxes 2,571,000 - Deferred income taxes 11,472,000 7,331,000 102,452,000 90,155,000 Equipment on operating leases, at cost, net of accumulated depreciation 637,768,000 543,396,000 Other property and equipment, at cost, net of accumulated depreciation 146,618,000 124,170,000 Note receivable-Matlack, Inc. (including $900,000 due within one year) 6,000,000 6,000,000 Excess of cost over net assets of businesses acquired 11,903,000 12,131,000 Other assets 4,976,000 5,309,000 $909,717,000 $781,161,000\nLIABILITIES AND SHAREHOLDERS' EQUITY\nCurrent liabilities (excluding equipment financing obligations) Accounts payable $ 7,205,000 $ 5,153,000 Accrued liabilities 40,114,000 38,310,000 Current maturities of long-term debt 146,000 209,000 47,465,000 43,672,000 Equipment financing obligations including maturities due within one year: 1994-$30,214,000; 1993-$24,665,000 498,365,000 427,307,000 Long-term debt 782,000 922,000 Other liabilities 8,898,000 9,158,000 Deferred income taxes 103,010,000 83,352,000\nCommitments and contingent liabilities (see Notes to the Consolidated Financial Statements)\nShareholders' equity: Common stock, $1 par value Outstanding: 1994-45,770,678 shares; 1993-45,544,355 shares 45,771,000 30,363,000 Capital in excess of par value 20,319,000 35,016,000 Retained earnings 185,107,000 151,371,000 251,197,000 216,750,000 $909,717,000 $781,161,000\nThe Notes to the Consolidated Financial Statements are an integral part of these statements.\nCONSOLIDATED STATEMENT OF CASH FLOWS\nYear Ended September 30, 1994 1993 1992 Cash flows from operating activities: Net earnings $ 39,828,000 $ 30,416,000 $ 24,639,000 Reconciliation of net earnings to net cash flows from operating activities: Depreciation and amortization 130,741,000 118,366,000 109,828,000 Current and deferred income taxes 12,946,000 11,542,000 7,687,000 Net (increase) decrease in notes and accounts receivable (3,114,000) 9,769,000 (6,694,000) Net increase in accounts payable and accrued liabilities 3,856,000 3,892,000 6,581,000 Net gain on sale of property and equipment (8,530,000) (6,139,000) (3,110,000) Other (2,072,000) (1,315,000) 1,944,000 Net cash flows from operating activities 173,655,000 166,531,000 140,875,000\nCash flows from investing activities: Purchase of property and equipment (297,492,000) (242,910,000) (202,689,000) Proceeds from sales of equipment 58,376,000 48,953,000 53,834,000 Net cash flows used in investing activities (239,116,000) (193,957,000) (148,855,000)\nCash flows from financing activities: Proceeds of equipment financing obligations 177,126,000 177,498,000 167,822,000 Repayment of equipment financing obligations (106,068,000) (140,447,000) (156,493,000) Repayment of long-term debt (203,000) (7,414,000) (3,687,000) Payment of dividends (6,092,000) (5,452,000) (4,831,000) Proceeds of stock options exercised 780,000 759,000 637,000 Preferred stock acquired and retired - - (95,000) Other (69,000) - 309,000 Net cash flows from financing activities 65,474,000 24,944,000 3,662,000\nNet increase (decrease) in cash 13,000 (2,482,000) (4,318,000) Cash beginning of period 15,081,000 17,563,000 21,881,000 Cash end of period $ 15,094,000 $ 15,081,000 $ 17,563,000\nSupplemental information: Interest paid $ 36,425,000 $ 34,933,000 $ 34,581,000 Income taxes paid $ 13,616,000 $ 12,699,000 $ 8,341,000\nThe Notes to the Consolidated Financial Statements are an integral part of these statements.\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nAccounting Policies\nThe consolidated financial statements include the accounts of all subsidiaries. Intercompany transactions and balances among these subsidiaries have been eliminated.\nLease, rental and other transportation service revenues are recognized pro rata from the date the vehicles are placed in service with the customer. Expenses are recognized concurrently with revenues.\nEarnings per common share are computed assuming the conversion of all potentially dilutive securites, namely outstanding stock options and convertible preferred shares prior to their redemption.\nThe excess of cost over net assets of businesses acquired prior to October 30, 1970 is not being amortized since its value, in management's opinion, has not diminished. The excess of cost over net assets of businesses acquired subsequently is being amortized on a straight-line basis over 40 years.\nInventories of transportation equipment parts and supplies are valued at the lower of first-in, first-out cost or market.\nMarketable securities are classified as current or noncurrent assets as appropriate and are carried at the lower of cost or market.\nProperty and equipment is carried at cost, net of applicable allowances. Depreciation is provided on a straight-line, specific-item basis net of salvage or residual values. The cost and related accumulated depreciation of property and equipment sold or retired are eliminated from the property accounts and the resulting gain or loss is reflected in the Consolidated Statement of Earnings as an adjustment of depreciation expense. Repairs and maintenance are charged to expense as incurred. Major additions and improvements are capitalized and written off over the remaining depreciable lives of the assets.\nAs of October 1, 1991, the Company adopted SFAS No. 109 Accounting for Income Taxes. The adoption of this accounting rule had no effect on net earnings for the year ended September 30, 1992.\nLeasing operations consist of the long-term leasing and short-term rental of transportation equipment. All leases are classified as operating leases and expire on various dates during the next ten years.\nEquipment to be sold within one year and equipment financing obligations payable within one year are not classified as current assets or current liabilities.\nEquipment on Operating Leases\nThe Company's investment in equipment on operating leases is as follows:\nSeptember 30, 1994 1993 Transportation equipment (1) $951,349,000 $833,232,000 Less accumulated depreciation (313,581,000) (289,836,000) $637,768,000 $543,396,000\n(1) Estimated useful life 3 to 12 years\nThe net gain on disposition of property and equipment was $8,530,000 in 1994, $6,139,000 in 1993 and $3,110,000 in 1992.\nCommitments for the purchase of transportation equipment amounted to $169,014,000 at September 30, 1994.\nAt September 30, 1994, minimum future revenues from non-cancelable leases are as follows:\nYear Ending September 30, 1995 $144,295,000 1996 114,944,000 1997 85,796,000 1998 55,552,000 1999 23,819,000 Later Years 1,110,000 Total future minimum lease revenues $425,516,000\nRevenues include contingent rentals, which represent all commercial rental revenues and the mileage charges on full-service leases, of $169,755,000 in 1994, $128,528,000 in 1993 and $118,787,000 in 1992.\nOther Property and Equipment\nThe Company's other property and equipment accounts are as follows:\nSeptember 30, 1994 1993 Land $ 35,376,000 $ 30,291,000 Transportation service facilities (1) 128,414,000 101,784,000 Other operating assets (1) 33,951,000 35,769,000 Less accumulated depreciation (51,123,000) (43,674,000) $146,618,000 $124,170,000\n(1) Estimated useful life 3 to 45 years\nLease Commitments\nThe Company leases some of the premises and equipment used in its operations. Leases classified as operating leases expire on various dates during the next 20 years. Some of the leases are renewable at the Company's option.\nMinimum future rental payments required under operating leases having non- cancelable terms in excess of one year as of September 30, 1994 are as follows:\nYear Ending September 30, 1995 $ 3,556,000 1996 3,073,000 1997 2,298,000 1998 1,695,000 1999 1,110,000 Later years 4,388,000 Total minimum payments required $16,120,000\nTotal rental expense for all operating leases except those with terms of a month or less was $7,695,000 in 1994, $8,134,000 in 1993 and $8,144,000 in 1992.\nIncome Taxes\nThe income tax provisions for the three years ended September 30, 1994 are comprised as follows:\nYear Ended September 30, 1994 1993 1992 Current: Federal $ 8,692,000 $ 9,101,000 $ 6,668,000 State 2,796,000 2,280,000 1,547,000 Deferred: Federal 13,516,000 8,362,000 6,470,000 State 1,558,000 2,223,000 1,344,000 Rate change - 2,275,000 - Total income taxes $26,562,000 $24,241,000 $16,029,000\nA reconciliation of the income tax provisions for the three years ended September 30, 1994 with amounts calculated by applying the statutory federal income tax rate (35.0% in 1994, 34.75% in 1993 and 34.0% in 1992) to earnings before income taxes for those years is as follows: Year Ended September 30, 1994 1993 1992 Federal tax at statutory rate $23,236,000 $18,993,000 $13,827,000 State income taxes 2,830,000 2,939,000 1,908,000 Rate change - 2,275,000 - Other 496,000 34,000 294,000 Total income taxes $26,562,000 $24,241,000 $16,029,000\nThe tax effect of temporary differences and the tax credit carryforwards which comprise the current and non-current deferred income tax amounts shown on the balance sheet are as follows:\nSeptember 30 1994 1993 Depreciation $111,833,000 $101,297,000 Expenses deductible when paid (8,214,000) (7,196,000) Investment tax credit carryforward - (4,902,000) Alternative minimum tax credit carryforward (12,861,000) (12,899,000) Other 780,000 (279,000) Deferred income taxes, net $ 91,538,000 $ 76,021,000\nAt September 30, 1994, the Company had alternative minimum tax credit carryforwards of $12,861,000 which have no expiration date. The Company has no tax credit carryforwards for financial reporting purposes since all such credits have been considered in the determination of deferred income tax amounts.\nShareholders' Equity\nChanges in the components of shareholders' equity are as follows:\nCapital in Stated $1 Par Excess of Value of Value Par of Preferred Common Stated Retained Stock Stock Values Earnings Balance at 9\/30\/91 $ 51,000 $19,940,000 $43,778,000 $105,624,000 Net earnings 24,639,000 Dividends on preferred stock $1.00 per share (24,000) Dividends on common stock $.16 per share (4,807,000) 3-for-2 common stock split 10,050,000 (10,109,000) Investment valuation allowance 975,000 Conversion of preferred stock (45,000) 53,000 (8,000) Preferred stock retired (6,000) (89,000) Exercise of stock options 109,000 528,000 Other 32,000 336,000 Balance at 9\/30\/92 - 30,184,000 34,436,000 126,407,000 Net earnings 30,416,000 Dividends on common stock $.18 per share (5,452,000) Exercise of stock options 179,000 580,000 Balance at 9\/30\/93 - 30,363,000 35,016,000 151,371,000 Net earnings 39,828,000 Dividends on common stock $.20 per share (6,092,000) 3-for-2 common stock split 15,252,000 (15,321,000) Exercise of stock options 156,000 624,000 Balance at 9\/30\/94 $ - $45,771,000 $20,319,000 $185,107,000\nThe Company is authorized to issue 50,000,000 shares of its $1 Par Value Common Stock and 1,000,000 shares of Preferred Stock. The preferred shares are without par value, with terms and conditions of each issue as determined by the Board of Directors. On April 30, 1992, the Comp its then outstanding 3,172 shares of Series C Preferred Stock for $30 per share. No Preferred Stock is now outstanding.\nEach share of common stock outstanding includes one common stock purchase right (a \"Right\") which is non-detachable and non-exercisable until certain defined events occur, including certain tender offers or the acquisition by a person or group of affiliated or associated persons of 20% of the Company's common stock. Upon the occurrence of certain defined events, the Right entitles the registered holder to purchase one share of common stock of the Company for $26.67 and may be modified to permit certain holders to purchase common stock of the Company or common stock of an acquiring company at a 50% discount. The Right expires on June 30, 1999 unless earlier redeemed by the Company as permitted under certain conditions at a price of $.0045 per Right.\nUnder the terms of a credit agreement, $129,202,000 of retained earnings was available for the payment of cash dividends at September 30, 1994.\nUnder the Company's stock option plans, options to purchase common stock of the Company may be granted to officers and key employees at not less than 100% of the fair market value at the date of grant. Option activity, adjusted for the September 15, 1994 three-for-two common stock split, is summarized as follows: Year Ended September 30, 1994 1993 1992 Number of options: Outstanding at beginning of year 1,368,005 1,388,700 1,361,349 Granted 7,515 261,900 315,900 Exercised (226,321) (268,164) (220,302) Expired or canceled (27,700) (14,431) (68,247) Outstanding at September 30 1,121,499 1,368,005 1,388,700 At September 30: Options available for grant 1,305,789 85,604 333,072 Options exercisable 470,500 409,163 416,639\nPer share prices: Options granted $12.08 $11.92 $7.56 Options exercised $2.39 to $7.56 $2.39 to $7.56 $2.39 to $4.59 Options outstanding $2.39 to $12.08 $2.39 to $11.92 $2.39 to $7.56\nAccrued Liabilities\nAccrued liabilities are as follows: September 30, 1994 1993 Employee compensation $8,722,000 $ 7,608,000 Interest 6,052,000 5,641,000 Taxes other than income 9,349,000 9,265,000 Insurance 6,013,000 4,867,000 Unbilled services and supplies 8,024,000 8,572,000 Other 1,954,000 2,357,000 $40,114,000 $38,310,000\nIndebtedness\nEquipment financing obligations are as follows: September 30, 1994 1993 Revolving Credit Agreement $33,500,000 $28,000,000 Collateral Trust Debentures: Series G, 9 7\/8 %, due 1995 to 1998 50,000,000 50,000,000 Series H, 10.60 %, due 1999 75,000,000 75,000,000 Series I, 10.35 %, due 2000 50,000,000 50,000,000 Series J, 8 5\/8 %, due 1998 30,000,000 30,000,000 Series K, 7 3\/4 %, due 1997 50,000,000 50,000,000 Series L, 7 %, due 2003 70,000,000 70,000,000 Series M, 7 %, due 2001 60,000,000 - Other equipment financing obligations, at interest rates ranging from 5.1% to 9.8%, of which $22,714,000 is due within one year; payable through 1999 79,865,000 74,307,000 $498,365,000 $427,307,000\nThe $100,000,000 line under the Revolving Credit Agreement is unsecured. During 1994, the quoted rates ranged from 3.4% to 6.3% and averaged 6.1% at September 30, 1994. The Collateral Trust Debentures are secured by notes from a subsidiary and Matlack, Inc., a former subsidiary. Certain other equipment financing obligations are collateralized by certain leasing equipment. At the option of the banks, the Revolving Credit Agreement and the Collateral Trust Debentures may be secured by other leasing and bulk transportation equipment. Termination of the Revolving Credit Agreement would result in repayment of outstanding loans over 60 months in equal installments; otherwise, no repayments are required except for repayments which would be required if the financing value of the equipment falls below the outstanding loan. The agreement provides for the maintenance of specified financial ratios and restricts payments to the Company by a consolidated subsidiary. Net assets of all subsidiaries not restricted under the agreement totaled $139,728,000 at September 30, 1994.\nOn September 21, 1994, the Company arranged for the private placement of $100,000,000 of 8.27%, Series N Collateral Trust Debentures due March 15, 2002. Closing will occur on March 15, 1995.\nBased on published bid prices, at September 30, 1994, the estimated fair value of the Company's Collateral Trust Debentures was $386,019,000 compared to the recorded book amount of $385,000,000. The fair value of the remaining $113,365,000 of equipment indebtedness approximates its recorded amount.\nLong-term debt consists of real estate and other obligations payable in installments over various periods to 2001, at interest rates ranging from 6.4% to 7.0%. Land and buildings with a carrying value of $1,585,000 is pledged as collateral.\nThe aggregate amounts of maturities and sinking fund requirements for all indebtedness over the next five years are as follows: 1995-$30,360,000; 1996-$26,618,000; 1997-$73,556,000; 1998-$38,350,000 and 1999-$109,143,000.\nCommitments and Contingent Liabilities\nThere are various claims and legal actions pending against the Company. In the opinion of management, based on the advice of counsel, the outcome of such litigation will not have a material adverse effect upon the Company's financial position or results of operations.\nPension Plan\nThe Company maintains a noncontributory pension plan for full-time employees not covered by pension plans under collective bargaining agreements. Pension costs are funded in accordance with the provisions of the Internal Revenue Code. The Company also maintains a nonqualified, noncontributory defined benefit pension plan for certain employees to restore pension benefits reduced by federal income tax regulations. The cost associated with the plan is determined using the same actuarial methods and assumptions as those used for the Company's qualified pension plan.\nThe components of net periodic pension cost are as follows:\nYear Ended September 30, 1994 1993 1992 Service cost $2,283,000 $1,798,000 $1,548,000 Interest cost 2,152,000 1,846,000 1,658,000 Return on plan assets (947,000) (4,336,000) (2,558,000) Net amortization and deferral (1,580,000) 2,271,000 706,000 Net periodic pension cost $1,908,000 $1,579,000 $1,354,000\nThe following table sets forth the funded status and the amount recognized in the Company's balance sheet for the plans:\nSeptember 30, 1994 1993 Actuarial present value of accumulated benefit obligation: Vested $24,708,000 $22,010,000 Non-vested 1,227,000 1,102,000 $25,935,000 $23,112,000\nProjected benefit obligation $31,190,000 $26,989,000 Plan assets at market value 27,481,000 25,976,000 Projected benefit obligation in excess of plan assets 3,709,000 1,013,000 Unrecognized gain 1,289,000 2,383,000 Unrecognized prior service costs (998,000) 157,000 Unrecognized overfunding at adoption 421,000 492,000 Accrued pension liability $ 4,421,000 $ 4,045,000\nAt September 30, 1994, the assets of the pension plans were invested 73% in equity securities, 24% in fixed income securities and the balance in other interest bearing accounts.\nThe discount rate was 8.0% for 1994 and 1993 and 8.5% for 1992. The rate of assumed compensation increase was 5.0% for all three years. The expected long-term rate of return on assets was 9.5% for 1994 and 1993 and 10.0% for 1992.\nThe Company expensed payments to multi-employer pension plans required by collective bargaining agreements of $172,000 in 1994, $265,000 in 1993 and $293,000 in 1992. The actuarial present value of accumulated plan benefits and net assets available for benefits to employees under these plans are not available.\nTransactions with Related Parties\nCertain directors and officers of the Company are also directors and officers of Rollins Environmental Services, Inc. and Matlack Systems, Inc.\nThe Company sold materials (principally vehicle fuel) and services (including data processing services) and rented transportation equipment and office space to Rollins Environmental Services, Inc. The aggregate charges for these materials and services, which have been included in revenues or offset against operating expense, as appropriate, in the Consolidated Statement of Earnings, were $6,551,000 in 1994, $7,359,000 in 1993 and $6,579,000 in 1992.\nThe Company provided administrative services and rented office space to Matlack, Inc. for aggregate charges of $2,949,000 in 1994, $3,077,000 in 1993 and $3,403,000 in 1992, which have been included in revenues or offset against operating expense, as appropriate, in the Consolidated Statement of Earnings. Interest charges to Matlack, Inc., which have been offset against interest expense, were $593,000 in 1994, $1,023,000 in 1993 and $1,500,000 in 1992.\nAn officer of the Company is the trustee of an employee benefits trust which provides certain insurance and health care benefits to employees of the Company. Contributions to the trust, which were charged to operating or selling and administrative expense, as appropriate, were $8,166,000 in 1994, $7,068,000 in 1993 and $7,085,000 in 1992.\nIn the opinion of management of the Company, the foregoing transactions were effected at rates which approximate those which the Company would have realized or incurred had such transactions been effected with independent third parties.\nQuarterly Results (Unaudited) December March June September 1994 31 31 30 30 Revenues $107,444,000 $107,111,000 $115,823,000 $120,525,000 Gross profit $ 34,202,000 $ 33,409,000 $ 38,053,000 $ 40,035,000 Earnings before income taxes $ 16,196,000 $ 13,811,000 $ 17,504,000 $ 18,879,000 Net earnings $ 9,474,000 $ 8,155,000 $ 10,450,000 $ 11,749,000 Earnings per share(1) $ .21 $.17 $ .23 $ .25\nRevenues $100,095,000 $ 97,042,000 $104,589,000 $107,052,000 Gross profit $ 30,439,000 $ 28,758,000 $ 33,845,000 $ 36,483,000 Earnings before income taxes $ 12,497,000 $ 10,823,000 $ 14,762,000 $ 16,575,000 Net earnings $ 7,498,000 $ 6,494,000 $ 8,857,000 $ 7,567,000 Earnings per share(1) $ .16 $ .14 $ .19 $ .17\n(1) Adjusted for the three-for-two common stock split distributed on September 15, 1994.\nSCHEDULE III - Condensed Financial Information\nROLLINS TRUCK LEASING CORP. BALANCE SHEET ($000 Omitted)\nAssets September 30, 1994 1993 Current Assets (excluding notes receivable from subsidiaries) Cash $ 699 $ 413 Accounts receivable 80 91 Accounts receivable from subsidiaries* 14 31 Other current assets 63 67 856 602 Notes receivable - Matlack, Inc. (including $900 due within one year) 6,000 6,000 Notes receivable from subsidiary* 379,000 319,000 Investments in subsidiaries, at equity* 234,263 196,368 Advances to subsidiaries* 18,430 20,680 Property and equipment, at cost, net of accumulated depreciation 921 894 Other assets 173 365 $639,643 $543,909 Liabilities and Shareholders' Equity\nCurrent Liabilities Accounts payable to subsidiaries* $ 37 $ 11 Accounts payable to others 164 120 Accrued liabilities 571 632 Income taxes payable 769 417 1,541 1,180 Collateral Trust Debentures 9 7\/8% Series G, due 1995 to 1998 50,000 50,000 10.60% Series H, due 1999 75,000 75,000 10.35% Series I, due 2000 50,000 50,000 8 5\/8% Series J, due 1998 30,000 30,000 7 3.4% Series K, due 1997 50,000 50,000 7 % Series L, due 2003 70,000 70,000 7 % Series M, due 2001 60,000 -\nOther liabilities 1,531 528 Deferred federal income taxes 374 451 Commitments and contingent liabilities - see notes to the financial statements\nShareholders' equity Common shares $1 Par Value, 50,000,000 shares authorized; issued and outstanding: 1994: 45,770,678; 1993: 45,544,355 45,771 30,363 Capital in excess of par or stated values 20,319 35,016 Retained earnings 185,107 151,371 251,197 216,750 $639,643 $543,909\n* Eliminated in consolidation.\nSCHEDULE III - Condensed Financial Information (continued)\nROLLINS TRUCK LEASING CORP. STATEMENT OF EARNINGS ($000 Omitted)\nYear Ended September 30, 1994 1993 1992\nRevenues: Dividends from subsidiaries $ 1,800 $ 4,800 $ 4,800 Other income 4,502 171 470 6,302 4,971 5,270\nExpenses: Administrative 3,498 3,686 3,223 Depreciation and amortization, net of gain (loss) on disposals 124 211 225 3,622 3,897 3,448\nEarnings before income taxes 2,680 1,074 1,822\nIncome taxes (benefit) 825 (1,460) (1,625)\nNet earnings of Rollins Truck Leasing Corp. 1,855 2,534 3,447\nEquity in undistributed net earnings of subsidiaries 37,973 27,882 21,192\nNet earnings $39,828 $30,416 $24,639\nSCHEDULE III - Condensed Financial Information (continued)\nROLLINS TRUCK LEASING CORP. STATEMENT OF CASH FLOWS ($000 Omitted)\nYear Ended September 30, 1994 1993 1992\nCash flows from operating activities: Earnings prior to equity in subsidiaries' undistributed earnings $ 1,855 $ 2,534 $ 3,447\nReconciliation of earnings to net cash flows from operating activities: Depreciation and amortization 193 216 231 Current and deferred income taxes 275 (176) (408) Net decrease (increase) in accounts receivable 28 74 (41) Net increase (decrease) in accounts payable and accrued liabilities 9 (230) 253 Other (241) 87 97 Net cash flows from operating activities 2,119 2,505 3,579\nCash flows from investing activities: Purchase of equipment (152) (108) (54) Proceeds from sale of equipment - 5 10 Net cash flows used in investing activities (152) (103) (44)\nCash flows from financing activities: Proceeds of equipment financing 60,000 70,000 80,000 Advances to subsidiaries (56,300) (68,072) (81,600) Repayment of notes by subsidiary - 39,500 41,650 Repayment of notes by Matlack, Inc. - 7,750 2,250 Repayment of equipment financing - (47,250) (42,500) Payment of dividends (6,092) (5,452) (4,831) Proceeds of stock options exercised 780 759 637 Preferred stock acquired and retired - - (95) Other (69) - (59) Net cash flows used in financing activities (1,681) (2,765) (4,548)\nNet increase (decrease) in cash 286 (363) (1,013)\nCash beginning of period 413 776 1,789\nCash end of period $ 699 $ 413 $ 776\nSupplemental information:\nInterest paid, net $ - $ - $ - Income taxes paid $10,660 $ 9,572 $ 6,236\nSCHEDULE III - Condensed Financial (continued)\nROLLINS TRUCK LEASING CORP. Notes to Financial Statements\nAccounting Policies\nThe accounting policies of the Registrant and its subsidiaries are set forth on page 14 of this 1994 Annual Report on Form 10-K.\nThe Company's principal sources of earnings are dividends and management fees paid by its subsidiaries. Certain loan agreements restrict payments to the Company by its subsidiaries. Net assets of subsidiaries not restricted under such loan agreements totaled $139,728,000 at September 30, 1994. The Company also realizes cash receipts by assessing subsidiaries for federal taxes on income and expends cash in payment of such taxes on a consolidated basis. Tax assessments are based on the amount of federal income taxes which would be payable (recoverable) by each subsidiary company based on its current year's earnings (loss) reduced by that subsidiary's applicable portion of any consolidated carryforward or carryback of net operating losses, investment tax credits, alternative minimum tax credits or similar items utilized currently in the consolidated federal income tax return.\nInterest income on notes receivable from a subsidiary and from Matlack, Inc. which are pledged to secure the Collateral Trust Debentures (described on page 19 of this 1994 Annual Report on Form 10-K) has been offset against interest expense of $31,700,000, $29,451,000 and $29,298,000 in 1994, 1993 and 1992, respectively.\nCommitments and Contingencies\nThe Company is obligated to an affiliated company for $398,000 annually ($2,886,000 in the aggregate) of future rentals under a lease to 2001. Rent expense was $391,000 in 1994 and 1993 and $353,000 in 1992.\nCommitments of the Company have been collateralized by bank letters of credit issued on behalf of the Company in the amount of $4,950,000.\nThe aggregate amounts of maturities and sinking fund requirements for the Collateral Trust Debentures during the next five years are $7,500,000 in 1995, $7,500,000 in 1996, $57,500,000 in 1997, $27,500,000 in 1998 and $105,000,000 in 1999.\nROLLINS TRUCK LEASING CORP. AND SUBSIDIARIES SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 and 1992 ($000 OMITTED)\nCOLUMN A COLUMN B Item Charged to Costs and Expenses 1994 1993 1992\nMaintenance and Repairs $ 83,039 $ 84,828 $ 82,113\nDepreciation and Amortization $130,741 $118,366 $109,828\nTaxes Other Than Payroll and Income Taxes\nLicenses and Titles $ 14,768 $ 13,062 $ 11,583 Federal Highway Use Tax $ 4,549 $ 4,920 $ 4,489 Other $ 5,121 $ 4,063 $ 3,844\nROLLINS TRUCK LEASING CORP.\nExhibits to Form 10-K\nFor Fiscal Year Ended September 30, 1994\nIndex to Exhibits Page Nos.\nExhibit 21 Rollins Truck Leasing Corp. Subsidiaries at September 30, 1994\nExhibit 23 Consent of Independent Auditors\nExhibit 21\nROLLINS TRUCK LEASING CORP. Subsidiaries of Registrant at September 30, 1994\nJURISDICTION OF NAME INCORPORATION\nRollins Dedicated Carriage Services, Inc. Delaware\nRollins Leasing Corp. Delaware\nRollins Properties, Inc. Delaware\nTransrisk, Limited Bermuda\nExhibit 23\nThe Board of Directors Rollins Truck Leasing Corp.:\nWe consent to incorporation by reference in Registration Statement No. 33-67682 filed on Form S-3 by Rollins Truck Leasing Corp. of our report dated October 25, 1994, relating to the consolidated balance sheets of Rollins Truck Leasing Corp. and subsidiaries as of September 30, 1994 and 1993 and the related consolidated statements of earnings and cash flows and related schedules for each of the years in the three-year period ended September 30, 1994, which report appears on page 10 of this 1994 Annual Report on Form 10-K of Rollins Truck Leasing Corp.\nKPMG Peat Marwick LLP\nWilmington, Delaware November 22, 1994","section_15":""}
{"filename":"747605_1994.txt","cik":"747605","year":"1994","section_1":"Item 1 Business\nMOSCOM was incorporated in New York in January 1983 and reincorporated in Delaware in 1984. MOSCOM has three wholly-owned subsidiaries, MOSCOM Limited and Global Billing Services, Ltd., formed under the Laws of England and MOSCOM GmbH, formed under the Laws of Germany. In 1991 MOSCOM acquired the assets of Votan Corporation, a leader in voice recognition over telephone circuits. Votan is now a division of MOSCOM Corporation.\nMOSCOM is engaged in the design, production, servicing and marketing of telecommunications management, voice processing and voice recognition products for users and providers of telecommunications services in the global market.\nTelemanagement at the Business Location\nMOSCOM is the leading producer of call accounting products, which are used by organizations to better control their telecommunications usage and expense.\nCall accounting systems give businesses easy access to complete information on telephone usage including the calling extension, duration, time of day, destination, trunk and cost of each call. All of MOSCOM's call accounting products provide this fundamental information, without monitoring actual phone conversations, in clear, concise summary and detailed report formats.\nCall accounting systems save money. Telephone bills, which typically represent the third largest business expense after payroll and rent, can be reduced by 10% - 30% through heightened awareness and management of telephone use. As a result, MOSCOM call accounting systems can generally pay for themselves in less than a year through direct expense reduction.\nThere are also many other valuable uses for call accounting systems including:\nDetermining optimal number of trunks and best long distance facilities. Allocating telephone expense to specific cost centers or clients based on actual use. Generating revenues by reselling phone services to professional firm clients or hotel guests. Detecting fraudulent use of the phone system by hackers and unauthorized use of company phones for personal calls or 900 numbers. Evaluating employee productivity.\nMOSCOM's premier call accounting product is the Emerald CAS for Windows software. Utilizing all the power and user friendly features of Windows, Emerald CAS for Windows has the capacity to support up to 30,000 telephone extensions yet, is affordable for businesses with fewer than 25 telephones. A significant feature of Emerald CAS for Windows not found in predecessor products is the ability to collect and process data from up to 100 different telephone switches (PBX's) simultaneously from one central location.\nMOSCOM's economical Pollable Storage Unit collects data from remote PBX's and stores it until polled by a central Emerald CAS for Windows system. Emerald CAS for Windows is designed to be a global product and is available in several languages. Emerald CAS for Windows has been selected for private branding by leading manufacturers and sellers of PBX's, including AT&T in the United States and Philips in Germany.\nMOSCOM also produces a call accounting software product that is based on the UNIX operating system. The UNIX operating system offers the advantage of supporting multiple terminals and users from a single system. MOSCOM's Unix- based call accounting software is marketed very successfully by AT&T as an integrated solution with other AT&T products.\nDespite the prevalence of PC's, some call accounting users prefer stand- alone proprietary hardware systems designed specifically for that purpose. MOSCOM is a leader in this market segment as well. MOSCOM produces private- labeled call accounting hardware systems for Siemens, marketed in Germany under the name GCM, and for British Telecom, marketed in the United Kingdom under the name Q30.\nA use for call accounting systems that has received considerable attention lately is the detection of PBX fraud. Sophisticated telephone hackers and their customers now generate fraudulent calls estimated to exceed $1 billion annually. Alert PBX owners use call accounting systems to spot the fraud and take corrective measures to minimize the loss. MOSCOM offers an optional HackerTracker module with the Emerald CAS for Windows system to automate the detection of fraud and instantly send out alarms to initiate preventive measures.\nTelephone Company Products\nMOSCOM's INFO family of products capture, at the telephone company's central office, vital information in the form of Message Detail Records(MDR) on every originating or terminating call passing through that particular central office. Those raw detail records can then be processed into meaningful formats and distributed to a central telephone company computer or to business subscribers.\nThe first INFO product was the INFO\/MDR series which consists of three distinct components:\n1. INFO Monitor connects directly to the central office switch, via the message detail port or automatic message accounting port, to capture and store the call records.\n2. INFO Collector aggregates at a single location call records from different INFO Monitors serving as many as 500 central offices. This aggregated information is then made available to the phone company's billing system or transferred to a customer's INFO Manager.\n3. INFO Manager is a customer premises system based on MOSCOM's Emerald CAS for Windows call accounting software. These allow the customer to download call records from an INFO Collector or INFO Monitor in real time or at scheduled times, in summary or detailed, statistical or graphical reports.\nAlthough MOSCOM envisions a wide variety of valuable applications for INFO\/MDR the first choice of telephone companies has been to use INFO\/MDR to enhance the appeal of Centrex and virtual private network service. Centrex allows a customer to utilize the telephone company's central office switch to route calls to individual extensions. In recent years Centrex service has grown rapidly and continues to gain market share from PBX's. However, surveys of Centrex users indicated that the greatest weakness of Centrex is the unavailability of complete, timely and accurate call detail information. INFO\/MDR gives telephone companies the ability to provide economically and efficiently the detailed information customers are demanding. Telephone companies are also using INFO\/MDR to provide message accounting for virtual private networks, another rapidly growing segment of the telecommunications market. Virtual private networks utilize the public switched network with customized software to provide users network control at a very competitive price.\nThe call detail records captured by the INFO Monitor can also be used by telephone companies to generate subscriber bills. One means of doing so is MOSCOM's INFO Bill, an extension of the INFO family that provides a comprehensive operations support system for telephone, cellular and cable television companies. In addition to generating customer bills, INFO Bill also maintains reports for the general ledger, accounts receivables, inventory, payroll, service orders, and other critical operating functions. In essence, INFO Bill automates virtually all the systems needed to run a telephone or cable television company. MOSCOM's target markets for INFO Bill are primarily outside the United States where substantial investments are being made in upgrading telephone companies or creating entirely new providers of telephone and cable service.\nAnother INFO family member, INFO Verabill, is a rating and billing system for telephone and cellular companies with up to 30,000 access lines. INFO Verabill is a very economical yet robust system that runs on 486 or Pentium PC's under Windows. It is designed for start-up companies and requires a relatively minimal investment in training and capital. MOSCOM's target market for Verabill is the impressive number of new telephone and cellular companies being created worldwide. In November of 1994, MOSCOM signed a six-year agreement with Alcatel SEL for worldwide distribution of Verabill as a private label Alcatel product.\nWith the INFO family, MOSCOM has a uniquely broad array of products to support telephone cable and wireless companies of all sizes and levels of sophistication. These service providers have the technology today to vastly expand the types of information they convey to their subscribers. As economic and regulatory conditions enable expansion of these services the value of the INFO family will only be enhanced. As a result, MOSCOM's target market for the INFO family of products has grown beyond traditional telephone companies to include alternative providers of local service, cable television companies expanding into telephony, cellular and PCN service providers and managers of virtual private networks.\nGlobal Billing Services, Ltd.\nMOSCOM has established Global Billing Services, Ltd. (\"GBS\") in the United Kingdom as an alternative means of marketing the INFO Bill software. Some providers of telephone, cable and virtual private network services appreciate the flexibility of the INFO Bill system but prefer not to make the investment in licensing the software, purchasing hardware, and hiring and training operations and support staffs. GBS offers an outsourcing alternative that can provide a wide variety of services ranging from simple rating of transaction messages to complete customer care, billing and collection services.\nMOSCOM chose to start a telecommunications service bureau in the United Kingdom because the regulatory environment in that country has spawned the most competitive telecommunications market in the world. That has resulted in entry into the market of a sizable number of new service providers and the convergence of telephone and cable television services. The resultant stiff competition has mandated a higher degree of service and pricing flexibility by all market participants. This is an ideal market environment for a service bureau able to provide timely comprehensive service at a competitive price. GBS charges for its services are believed to be 30%-50% less than the costs presently paid by telephone and cable companies in the UK for comparable services provided by internal support staff for outside service providers.\nGBS will market its services by means of a direct sales force as well as through strategic partnerships with providers of central office switches in the United Kingdom.\nVoice Processing\nVoice processing involves recording, responding to, recognizing, or other manipulation of the spoken word. This technology is commonly used in voice mail and interactive voice information systems.\nVoice Recognition\nThe foundation for MOSCOM's voice processing business and what sets MOSCOM apart from others in the industry is the use of voice recognition technology. MOSCOM became the beneficiary of many years of advanced research in voice recognition technology with the acquisition of Votan in September of 1991. Prior to the acquisition, Votan had invested over $14 million in the development of high performance voice recognition systems. MOSCOM has continued to invest in improving the base recognition technology but has focused more on developing an economic hardware platform and key telecommunications applications.\nVotan products use complex algorithms and proprietary microprocessor design to create distinctly recognizable digital voice prints from the spoken word. These prints are then stored in the memory of the Votan system. By comparing these stored voice prints to prints of a new utterance, the system is able to recognize spoken words or verify the identity of the speaker.\nThe hardware platform for the Votan voice recognition technology is the new Model 2400 series 4-port voice processing card introduced by MOSCOM in 1994. The 2400 card, available in either telephone or microphone input models, operates under Microsoft Windows in standard 486 or Pentium PC's. Combined with Votan's superior noise immune voice recognition and verification software, the 2400 card is setting industry standards for accuracy and economy.\nVoiceBuilder for Windows puts the power of the Model 2400 card within easy reach of applications developers. With VoiceBuilder for Windows and a one- week programmer training class provided by MOSCOM, value added resellers can create their own customized voice recognition applications.\nThe TeleVoice system is an interactive telephone information system that responds to both phone generated tone and voice commands. It is a highly flexible user friendly product easily adapted to different vertical market industries. Callers to a TeleVoice system can use spoken words to select recorded messages, transfer to a live attendant or leave a message. North Americans are quite familiar with similar applications that use Touchtones to activate the system. However, in much of Europe, Latin America, Asia and Africa these applications are rare because the majority of callers do not have tone capability. MOSCOM sees these regions as the best markets for TeleVoice. Siemens markets a customized version of TeleVoice in Germany and Austria under the name InfoVoice.\nMVM for Windows is a MOSCOM developed voice mail application using the Model 2400 card. The combination of voice processing and voice recognition technology gives MOSCOM two significant advantages over traditional voice mail products: (i) it is voice controlled and therefore can operate without tone, and (ii) includes voice verification technology to provide superior security. MOSCOM's target markets for MVM for Windows are those countries without significant touch tone usage and proportionately low acceptance of traditional voice mail products. We believe the availability of a voice controlled system will make voice mail as popular in these markets as it has become in the United States.\nMarketing and Sales\nMOSCOM's marketing and sales personnel are located at its headquarters in Pittsford, New York as well as in Chicago, St. Louis, New Jersey, Pleasanton, California and Virginia.\nMarketing and sales personnel of MOSCOM's subsidiary, MOSCOM Ltd., located in Slough, England, market MOSCOM's products in the United Kingdom.\nSales personnel employed by MOSCOM GmbH in Munich, Germany, market the Company's products throughout continental Europe.\nMOSCOM's marketing and distribution strategy is founded on building mutually beneficial relationships with companies with large, established distribution networks for telecommunications and computer products. The nature of the relationships varies depending on the product and market. For\nsome, MOSCOM develops and manufactures customized products under a private label while others purchase and resell MOSCOM's standard products.\nMOSCOM's marketing strategy is focused upon telephone switch manufacturers and sellers and providers of telephone services. A partial listing of companies using or selling MOSCOM products follows:\nPHONE SYSTEM MANUFACTURERS Alcatel SEL (Germany) AT&T (USA) Northern Telecom (US and UK) Philips (Germany) Siemens (Germany)\nTELEPHONE SERVICE PROVIDERS Ameritech (USA) British Telecom (UK) Sprint (USA) Teleport Communications (USA)\nSales to AT&T and Siemens AG accounted for 50% and 14% respectively of MOSCOM's 1994 revenue.\nNew Product Development\nMOSCOM is currently pursuing several opportunities to expand its telemanagement product lines and to offer products for related markets.\nSoftware development costs meeting recoverability tests are capitalized under Statement of Financial Accounting Standard No. 86 effective January 1, 1986. The cost of software capitalized is amortized on a product-by-product basis over its estimated economic life, or the ratio of current revenues to current and anticipated revenues from such software, whichever provides the greater amortization. The Company periodically records adjustments to write down certain capitalized costs to their net realizable value.\nBacklog\nAt December 31, 1994 MOSCOM had a backlog of $1,452,458. Backlog as of December 31, 1993 was $1,451,178. Backlog is not deemed to be a material indicator of 1995 revenues.\nThe Company's policy is to recognize orders only upon receipt of firm purchase orders.\nCompetition\nThe telecommunications management industry is highly competitive and highly fragmented. The number of domestic suppliers of telemanagement systems for business users is estimated to exceed 100 companies. The vast majority of those are regional firms with limited product lines and limited sales and development resources. Several competitors are established companies that are able to compete with MOSCOM on a national basis.\nThere are fewer competitors in the market for telemanagement systems for regulated telephone companies. However, competition in this market is expected to increase as the market matures.\nA large number of firms have or are developing voice recognition technology. Success in this market will depend most heavily in technical performance but also on the ability to apply technology in useful applications.\nSome competing firms have greater name recognition and more financial, marketing and technological resources than MOSCOM. Competition in the industry is based on price, product performance, depth of product line and customer service. MOSCOM believes its products are priced competitively based upon their performance and functionality. However, MOSCOM does not strive to be consistently the lowest priced supplier in its markets.\nIn common with other information industries, the markets into which the Company sells have recently been characterized by rapid shift toward the software component of product content and away from the hardware element. Historically, prices for application software have declined rapidly in the face of competition. Increased competition for the Company's Emerald product or softness in demand for its hardware based products would, if they were to materialize, adversely affect the Company's volume and profits.\nManufacturing\nMOSCOM assembles its products from components purchased from a large variety of suppliers both domestic and international. Wherever feasible, the Company secures multiple sources, but in some cases it is not possible.\nMOSCOM offers warranty coverage on all products for 90 days or one year on parts and 90 days on labor. Repair services are offered at the Pittsford, New York facility, at the U. K. facility in Slough, England, and by some of the Company's larger customers.\nEmployees\nAs of December 31, 1994, MOSCOM employed 155 full-time personnel, including 14 based in Europe employed by MOSCOM's subsidiaries.\nMOSCOM's employees are not represented by any labor unions.\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Facilities\nThe Company's principal administrative office and manufacturing facility is located in a one-story building in Pittsford, New York. MOSCOM presently leases approximately 51,430 square feet of the building of which approximately 14,500 square feet is devoted to manufacturing. The initial term of the lease expires on June 30, 1998.\nThe Company also leases approximately 3,750 square feet in Pleasanton, California which houses the Votan division of MOSCOM acquired in September 1991. That lease expires on December 31, 1996.\nThe Company's subsidiary in the United Kingdom, MOSCOM Limited, occupies approximately 4,250 square feet in Slough, England pursuant to a lease which expires on December 31, 1998.\nThe Company's subsidiary in Germany, MOSCOM GmbH, leases approximately 4,000 square feet in Ismaning, Germany. This lease expires July 31, 1995.\nItem 3","section_3":"Item 3 Legal Proceedings\nThe Company is engaged in litigation with a former employee with respect to termination of employment. The Company believes this action is unlikely to have a material impact on the Company.\nThere are no other material pending legal proceedings against the Company or to which the Company is a party or of which any of its property is the subject.\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\nMOSCOM Corporation's Common Stock, $.10 par value, is traded on the NASDAQ National Market System (symbol: MSCM). The following quotations are furnished by NASDAQ for the periods indicated. These quotations reflect inter-dealer quotations that do not include retail markups, markdowns or commissions and may not represent actual transactions.\nCOMMON STOCK PRICE RANGE\nQuarters Ended March 31 June 30 September 30 December 31\n1994 12 3\/8 - 7 5\/8 12 - 4 1\/8 8 3\/4 - 4 1\/4 9 1\/4 - 7\n1993 6 5\/8 - 4 7 1\/4 - 5 1\/8 6 7\/8 - 5 9 1\/4 - 5 1\/2\nAs of December 31, 1994, there were 886 holders of record of the Company's Common Stock and approximately 3,500 additional beneficial holders.\nMOSCOM initiated a semi-annual cash dividend during 1990. The Company has paid dividends of $.02 per share during the months of January and July of each year since 1990.\nMOSCOM acquired virtually all of the assets of Auditech Communications in January, 1991 for $296,770 in cash. Auditech, located in Bothell, Washington, produced the TDR call accounting system, a stand-alone proprietary, hardware system for businesses and hotels. All operations of Auditech were moved to MOSCOM's Pittsford, New York facility in 1991.\nMOSCOM acquired all assets and certain liabilities of Votan Corporation, based in Fremont, California, in September of 1991 for $323,730 in cash. Votan developed and produced voice recognition technology. Votan is being operated as a division of MOSCOM with its principal facility remaining in the San Francisco area. Votan products are manufactured at MOSCOM's facility in Pittsford, New York.\nItem 7:","section_6":"","section_7":"Item 7: Management's Discussion and Analysis of Results of Operations and Financial Condition\nThe Company's sales of $14,260,683 for the year ended December 31, 1994 represented an increase of 6% over the 1993 sales level of $13,455,810. The increase in sales reflects a strong showing for the Company's products in the international market place during 1994, with export sales increasing by 47% over 1993 levels. During 1994 export sales accounted for 29% of the Company's sales revenues compared with 21% during 1993. Most of the growth in international markets stem from the growth of MOSCOM GmbH, the Company's German subsidiary, primarily from the sale of voice products such as TeleVoice and MVM through Siemens A.G. Late in 1994 MOSCOM GmbH was also responsible for signing a six year agreement with Alcatel SEL for worldwide sales of our Verabill, TeleVoice, Emerald CAS for Windows and INFO\/MDR products, and a three year agreement with Phillips for the distribution of the Emerald call accounting product. As a result of our expanded product offerings and these key new distribution agreements, the Company expects continued sales growth in international markets during 1995.\n1994 was a disappointing year for domestic sales, which declined by 5% from 1993 levels, largely as a result of inventory reductions undertaken by AT&T. During 1994 MOSCOM established a sales support organization of ten people working directly in the largest AT&T branches whose sole focus is to promote and support AT&T sales of MOSCOM produced products. As a result of the reduced inventory and the efforts of this dedicated support group we anticipate AT&T sales to increase in 1995.\nThe 1994 cost of sales percentage of 35% compared favorably with a cost of sales percentage of 37% for the year ended December 31, 1993. The lower cost of sales reflected a significant reduction in manufacturing and overhead costs resulting from lower warranty costs and a streamlining of operations. These savings were more than enough to offset a 20% increase in amortization expense recorded, primarily for capitalized software.\nNet engineering and development costs of $1,633,902 increased by 7% over the $1,522,770 realized during 1993. Gross spending before the effects of software capitalization, however, declined from $3,081,908 during 1993 to $3,044,466.\nThe following chart illustrates the net effect of the Company's research and development efforts, including the amounts amortized and charged to cost of sales, on the Company's 1994 and 1993 operating results.\n1994 1993 Gross expenditures for engineering and software development $3,044,466 $3,081,908\nLess: Costs capitalized 1,410,564 1,559,138 --------- --------- Net engineering & software development expense $1,633,902 $1,522,770\nPlus: Amounts amortized and charged to cost of sales 1,136,733 970,083 --------- --------- Total expense recognized for the year $2,770,635 $2,492,853 ========= =========\nTotal selling, general and administrative costs incurred during 1994 of $8,153,042 in total, were slightly lower than the 1993 expense level of $8,183,622. Selling expenses accounted for approximately 59% of the total expenditures, up from 50% of the total selling, general and administrative costs incurred during 1993. The higher selling costs reflect the continued expansion of MOSCOM GmbH in Germany, as well as a significant strengthening of the Company's support and training capabilities.\nInterest income earned on the investment of surplus capital declined from $278,965 for 1993, to $61,378 for 1994. The lower interest income generated results from the combination of lower balances under investment, and the recording of adjustments required on certain bond funds held in the Company's portfolio reflecting the poor performance of the worldwide bond markets during 1994.\nThe Company's net loss for 1994 was $387,743 or $.06 per share. For 1993 the Company incurred a net loss of $3,854,641 or $.59 per share, a year impacted by the write-off of intangible assets of approximately $3,650,000 (see note 8 of the financials presented as part of this document.)\nResults of Operations 1993 Compared with 1992\nThe Company's 1993 sales of $13,455,810 represented an increase of 7% as compared with the 1992 sales level of $12,616,448. Fourth quarter sales of $4,106,536 represented the company's highest quarterly sales level since the fourth quarter of 1991. Fourth quarter sales were particularly strong for call accounting software in the United States and also included our first sale of INFO\/MDR outside the United States, to Mercury Communications Ltd. in the United Kingdom.\nFor all of 1993 domestic sales increased by 12%, with much of the increase attributable to newer product offerings such as Emerald CAS for Windows and INFO\/MDR. International sales for 1993 were approximately 6% lower than levels achieved during 1992, but this was due primarily to $1.0 million dollars of revenue from the Petroleos Mexicanos contract being recognized in 1992. A large portion of that revenue was replaced by a continued strong demand for the GCM call accounting product marketed by Siemens A.G., and the INFO\/MDR sale to Mercury Communication Ltd. referenced above.\nWhile the Company's voice activated information systems did not contribute to 1993 sales, important product approvals have been received from the national telephone companies of Germany and Austria, as well as the Siemens test lab. Interest from the domestic markets continues to grow as well, and the Company expects significant sales contributions from this new product segment beginning in the first half of 1994.\nThe 1993 cost of sales percentage was 37% as compared to a cost of sales percentage of 34% for 1992. The cause of the increased cost is two-fold. The first factor was an increase in the amortization of capitalized software and purchased software costs charged to cost of sales increasing from $848,000 in 1992 (6.7% of sales) to $1,190,000 in 1993 (8.8% of sales). The second factor was an increase in amounts charged to shrinkage and obsolescence provisions (0.2% of sales in 1992, versus 1.7 % of sales in 1993) for slower moving stand-alone products, primarily the AP2000, PL series and Q30\/30E series of products.\nNet engineering and software development expenses were $1,522,770 for the year ended December 31, 1993 as compared to net engineering and development expenses of $1,220,519 for the year ended December 31, 1992. Gross spending for 1993, however, declined by 13% from 1992 levels before applying the effects of capitalized software.\nThe following chart summarizes both gross and net engineering and development expenses, including both the amounts capitalized and the amounts amortized and charged to cost of sales for the year 1993 and 1992.\n1993 1992\nGross expenditures for engineering and software development $3,081,908 $3,564,318\nLess: Costs capitalized $1,559,138 2,343,799 --------- --------- Net engineering & software development expense $1,522,770 $1,220,519\nPlus: Amounts amortized and charged to cost of sales 970,083 646,585 --------- --------- Total expense recognized for the year $2,492,853 $1,867,104 ========= =========\nThe major focus of the 1993 engineering and development efforts was targeted toward the enhancement and broadening of the Emerald CAS for Windows and INFO\/MDR product lines, as well as a significant investment in the development of the voice recognition product lines.\nSelling, general, and administrative expenses were $8,183,622 for 1993, an increase of 12% over the $7,335,617 of expenses during 1992. As cited in previous 10-Q reports filed in 1993, the increased spending is primarily the result of additional marketing and selling costs associated with the introduction of the Emerald CAS for Windows and INFO\/MDR product lines, combined with the expansion of the Company's presence in Germany through MOSCOM GmbH.\nThe Company recognized other expenses during the third quarter of 1993 of $3,650,744 consisting of 3 components:\n1.The write-off of $1,758,502 of capitalized software associated with the domestic version of the AP2000 product line. Over the past several years, MOSCOM has embarked on an aggressive plan to develop four major new product lines. Market indications for three of those -- Emerald CAS, INFO\/MDR, and voice recognition systems have given us reason to expect significant long- term successes. The fourth, the AP2000, has not met our expectations due to development delays and ensuing dramatic changes in the market.\nAs a result of the steep decline in PC prices since the AP2000 was conceived, most of the telecom applications intended for AP2000 are now more economically done on PC's. MOSCOM's success with Emerald CAS for Windows is a clear example of that. With that in mind, we have discontinued development of additional AP2000 applications, other than those related to the GCM product sold to Siemens. Sales of AP2000 call accounting products will continue. We have also reevaluated all intangible assets associated with the AP2000 and other stand-alone hardware products relative to probable future revenues from these products. Given the investment MOSCOM has made in the AP2000, and our lowered expectations of future sales, we concluded that the write-off was both appropriate and necessary.\n2.The write-off of $1,337,242 of goodwill remaining from the 1988 acquisition of the PL stand-alone call accounting system. The PL product has also suffered erosion of market from less expensive PC-based products. Our expectation had been that its replacement by the AP2000 would reverse that decline. As that no longer is probable, we elected not to continue to reflect goodwill related to the PL line as an asset of the Company.\nThe adjustments to capitalized software and goodwill bring two important results for MOSCOM: (1) Future expenses will more accurately reflect the actual costs of the products contributing to future sales without the distortive effect of discontinued products or projects; and (2) MOSCOM's efforts will be more focused on the three new product lines referred to above, that have bright prospects.\n3.The settlement of a lawsuit which was initiated in December 1991 against MOSCOM by PEP Modular Computers Inc. Under the settlement, MOSCOM paid PEP $555,000 during the fourth quarter of 1993.\nInterest income earned from investments for 1993 amounted to $278,965, down slightly from the $311,925 of interest income recognized during 1992. The decline reflects primarily the effect of lower average balances available for investment purposes.\nMOSCOM's 1993 loss, net of tax recoveries, was $3,854,641, or $.59 per share. For 1992 MOSCOM realized a net after tax profit of $70,992, or $.01 per share.\nLiquidity and Capital Reserves The Company's December 31, 1994 balance sheet includes cash and investments of $4,113,346, which compares with a total cash and investment position of $4,650,169 at December 31, 1993. The working capital ratio of 6.0 at December 31, 1994 compares with working capital ratios of 5.3 and 6.3 for the years ended December 31, 1993 and 1992 respectively.\nCash outflows for additions of property and equipment of $143,128 declined from levels of $265,267 in 1993 and $258,076 in 1992.\nAfter increases of approximately $680,000 in 1993 and $733,000 in 1992 in anticipation of new product introductions, net inventories were reduced by approximately $345,000 at December 31, 1994, and are expected to decline further in 1995.\nAccounts receivable increased by approximately $693,000 during 1994 to $3,473,667 at December 31, 1994. This increase is due to the timing of shipments, and as such does not indicate any significant unfavorable trend in payments from the Company's customers.\nThe Company has an unsecured revolving line of credit arrangement with a commercial bank for a maximum of $3,000,000 at an interest rate of the lower of the bank's prime rate of interest or the bank's offered rate of interest. The Company must pay a loan commitment fee of 1\/4% per annum of the difference between the maximum amount available under the line less loans outstanding at the end of each quarter. The line of credit arrangement is subject to certain financial covenants relating primarily to the Company's current ratio, tangible net worth, liabilities to tangible net worth and a limit on the amount of dividends declared or paid each year. The Company has satisfied these financial covenants as of December 31, 1994 and 1993. This agreement originally was to expire on January 31, 1995 but has been extended to January 31, 1996.\nItem 8","section_7A":"","section_8":"Item 8 Consolidated Financial Statements and Supplementary Data Required to be Included Herein as Follows:\nIndependent Auditors' Report Page 19\nFinancial Statements:\nConsolidated Balance Sheets Pages 20 - 21\nConsolidated Statements of Operations Page 22\nConsolidated Statements of Stockholders Equity Page 23\nConsolidated Statements of Cash Flows Page 24\nNotes to Consolidated Financial Statements Pages 25 - 33\nItem 9","section_9":"Item 9 Disagreements on Accounting and Financial Disclosure\nNone.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of MOSCOM Corporation Pittsford, New York\nWe have audited the accompanying consolidated balance sheets of MOSCOM Corporation and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the 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 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 referred to above present fairly, in all material respects, the financial position of MOSCOM Corporation and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in 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.\nDeloitte & Touche LLP\/s\/ Rochester, New York February 9, 1995\nMOSCOM CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1. DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe accompanying consolidated financial statements include the accounts of MOSCOM Corporation and its wholly-owned subsidiaries, MOSCOM Limited (a company incorporated in England) and Moscom GmbH (a company incorporated in Germany). All significant intercompany accounts and transactions have been eliminated. The Company and its subsidiaries design and manufacture computer products, software and services for the telecommunications industry. Substantially all sales and accounts receivable are with companies in this industry.\nInvestments - The Company's investments are classified as trading securities since the Company intends to buy and sell the securities in the near term with the objective of generating profits on short-term differences in price. Such securities are reported at fair value in the consolidated financial statements and any unrealized holding gains and losses are included in earnings.\nAs of December 31, 1994, the unrealized holding loss for the investments was approximately $60,000. As of December 31, 1993, the fair value of the investments approximated cost.\nConcentrations of credit risk - Financial instruments which potentially subject the Company to concentration of credit risk consist principally of investments and accounts receivable. The Company places its investments ($3,736,385 and $4,416,234 as of December 31, 1994 and 1993, respectively) with quality financial institutions and, by policy, limits the amount of credit exposure to any one financial institution.\nThe Company's customers are not concentrated in any specific geographic region, but are concentrated in the telecommunications industry. As of December 31, 1994 and 1993, one specific customer in this industry accounted for approximately $1,399,000 and $1,528,000, respectively, of the total accounts receivable balance. The Company performs ongoing credit evaluations of its customers' financial conditions but does not require collateral to support customer receivables. The Company establishes an allowance for doubtful accounts based upon factors surrounding the credit risk of specific customers, historical trends and other information.\nInventories are stated at the lower of cost (first-in, first-out method) or market. The Company evaluates the net realizable value of inventory on hand considering deterioration, obsolescence, replacement costs and other pertinent factors, and records adjustments as necessary.\nPlant and equipment is recorded at cost and depreciated on a straight-line basis using the following useful lives:\nComputer hardware and software 3-5 years Machinery and equipment 4-7 years Furniture and fixtures 5-10 years Leasehold improvements Term of lease\nAll maintenance and repair costs are charged to operations as incurred.\nLicense fees are being amortized over the periods expected to be benefited, not exceeding five years.\nSoftware development costs meeting recoverability tests are capitalized, and amortized on a product-by-product basis over their economic life, generally three years, or the ratio of current revenues to current and anticipated revenues from such software, whichever provides the greater amortization. The Company periodically records adjustments to write down certain capitalized costs to their net realizable value (see Note 8).\nRevenue recognition - The Company recognizes revenue from product sales upon shipment to the customer. Revenues from maintenance and extended warranty agreements are recognized ratably over the term of the agreements. The Company also enters into license agreements for certain of its products. Revenues from such agreements are recognized based on the terms of the agreements, generally upon the delivery of the licensed product.\nIncome taxes are provided on the income earned in the financial statements. Deferred income taxes are provided to reflect the impact of \"temporary differences\" between the amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. Tax credits are recognized as a reduction to income taxes in the year the credits are earned.\nNet (loss) income per share is based upon the weighted average number of common shares outstanding during each year assuming exercise of dilutive outstanding stock options and warrants under the treasury stock method.\nConsolidated statements of cash flows - The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nThe consolidated statements of cash flows for 1993 and 1992 have been restated to include the change in investments, which are classified as trading securities under Statement of Financial Accounting Standards No. 115, in cash provided (used) by operating activities.\n2. INVENTORIES\nThe major classifications of inventories as of December 31, 1994 and 1993 are:\n1994 1993 Purchased parts and components $2,030,800 $2,351,491 Work in process 529,933 518,233 Finished Goods 149,495 185,173 ---------- ---------- $2,710,228 $3,054,897 ========== ==========\n3. PLANT AND EQUIPMENT\nThe major classifications of plant and equipment as of December 31, 1994 and 1993 are:\n1994 1993\nMachinery and equipment $1,875,572 $1,955,247 Computer hardware and software 2,113,911 1,902,669 Furniture and fixtures 899,164 894,250 Demonstration Equipment 86,234 84,036 Leasehold improvements 246,441 241,992 ---------- ---------- $5,221,322 $5,078,194 ========== ==========\nDepreciation expense was approximately $398,000, $437,000 and $384,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\n4. ENGINEERING AND SOFTWARE DEVELOPMENT EXPENDITURES\nEngineering and software development expenditures incurred during the years ended December 31, 1994, 1993 and 1992 were recorded as follows:\n1994 1993 1992\nEngineering and software development expense included in the consolidated statements of operations $1,633,902 $1,522,770 $1,220,519\nAmounts capitalized and included in the consolidated balance sheets 1,410,564 1,559,138 2,343,799 ---------- ---------- ----------\nTotal expenditures for engineering and software development $3,044,466 $3,081,908 $3,564,318 ========== ========== ==========\nAdditionally, the Company recorded amortization of capitalized software development costs of approximately $1,137,000, $970,000 and $647,000 for the years ended December 31, 1994, 1993 and 1992, respectively. Such amortization is included in cost of sales in the consolidated statements of operations.\n5. BENEFIT PLANS\nThe Company sponsors an employee incentive savings plan under section 401(K) for all eligible employees. The Company's contributions to the plan are discretionary. No contributions were made in 1994 and 1993 and $28,000 was contributed in 1992.\nThe Company also sponsors an unfunded Supplemental Executive Retirement Program, which is a nonqualified plan that provides certain key employees defined pension benefits. Periodic pension expense for the years ended December 31, 1994, 1993 and 1992 consists of the following:\n1994 1993 1992\nService cost $ 100,852 $ 66,798 $ 49,890 Interest cost 55,909 43,912 35,591 Net amortization and deferral 36,965 29,154 26,550 --------- --------- --------- Pension expense $ 193,726 $ 139,864 $ 112,031 ========= ========= =========\nA reconciliation of the pension plan's funded status with amounts recognized in the Company's balance sheets follows:\n1994 1993\nActuarial present value of accumulated benefit obligation $ 955,464 $ 798,703 --------- --------- Actuarial present value of projected benefit obligation $ 955,464 $ 798,703\nPlan assets - - --------- --------- Projected benefit obligation in excess of plan assets 955,464 798,703\nPrior service cost not yet recognized in net periodic pension cost (482,738) (519,703)\nAdditional minimum liability 482,738 519,703 --------- --------- Accrued pension expense $ 955,464 $ 798,703 ========= =========\nIncluded in the deposits and other assets caption in the consolidated balance sheets as of December 31, 1994 and 1993 is an intangible asset of $482,738 and $519,703, respectively, related to the minimum liability adjustment for the unfunded accumulated benefit obligation.\nThe following assumptions were used in determining the actuarial present value of the projected benefit obligation as of December 31, 1994 and 1993.\nDiscount rate 7% 7% Rate of increase in future compensation levels 3% 3%\n6. STOCKHOLDERS' EQUITY\nThe Company has reserved 650,000 shares of its Common Stock for issuance under its 1993 Stock Option Plan, the successor Plan to the 1983 Stock Option Plan. The Plan provides for options which may be issued as nonqualified or qualified incentive stock options. All options granted to date are exercisable 25% per year beginning one year from the date of grant. All options granted to employees of MOSCOM Corporation have a ten year term and all options granted to employees of MOSCOM Limited and MOSCOM GmbH have a seven year term.\nA summary of stock option transactions for the years ended December 31, 1994, 1993 and 1992 is shown below:\n1994 1993 1992\nShares under option, beginning of year 380,780 517,111 513,801 Options granted 42,020 20,160 120,440 Options exercised at prices ranging from $.66 to $5.00 (45,163) (129,241) (90,045) Options terminated (36,022) (27,250) (27,085) -------- -------- -------- Shares under option, end of year 341,615 380,780 517,111 ======== ======== ======== Shares exercisable 254,459 232,402 298,778 ======== ======== ======== Exercise price of shares exercisable $1.33-5.00 $1.33-5.00 $.66-4.75 ========== ========== =========\nA summary of warrant transactions for the years ended December 31, 1994, 1993 and 1992 is shown below:\n1994 1993 1992\nWarrants outstanding, beginning of year 138,383 182,216 159,770\nWarrants granted 7,223 16,202 22,446\nWarrants exercised (42,957) (15,035) -\nWarrants expired - (45,000) - -------- -------- -------- Warrants outstanding, end of year 102,649 138,383 182,216 ======== ======== ======== Exercise price of shares exercisable $2.31-10.25 $1.75-7.75 $1.50-7.75 ========== ========== =========\nOn January 12, 1995, the Company's Board of Directors declared a cash dividend of $.02 per share payable on January 30, 1995.\n7. SALES INFORMATION\nSales to two customers were approximately $7,180,000 and $2,058,000, or 50% and 14% of the Company's total sales in 1994.\nSales to these two customers were approximately $7,490,000 and $1,468,000 or 56% and 11% of the Company's total sales in 1993 and $6,296,000 and $1,376,000 or 50% and 11% of the Company's total sales in 1992.\nExport sales to unaffiliated customers in Europe were approximately $3,843,000, $2,673,000 and $2,084,000 in 1994, 1993 and 1992, respectively. Additionally, the Company recognized revenues under a long-term contract to a single customer in Mexico of $1,048,000 in 1992 comprising 8% of total sales.\n8. OTHER EXPENSES\nDuring the third quarter of 1993, other expenses of $3,650,744, were charged to operations which consisted of the following:\nWrite-down of capitalized software development costs to net realizable value $1,758,502\nWrite-down of excess purchase price over net assets acquired 1,337,242\nSettlement of litigation claim 555,000 ---------- $3,650,744 ==========\nIn the opinion of management, a market decline occurred and was expected to continue in the future relative to certain of the Company's software development projects. As a result, the Company wrote-down the related capitalized software development costs to net realizable value. Additionally, in the opinion of management, the future economic benefit of the excess purchase price over net assets acquired (goodwill) related to their Control Key division diminished due, in part, to current market conditions and the Company's sales forecasts. As a result, the Company wrote-down the remaining goodwill value, which was originally being amortized over ten years.\nThe Company settled a lawsuit relative to a contract dispute over a specific product previously purchased by the Company.\n9. INCOME TAXES\nThe components of the (loss) income before income taxes for the years ended December 31, 1994, 1993 and 1992 is presented below:\n1994 1993 1992\nDomestic (loss) income $ 73,191 $(4,113,097) $ 322,240 Foreign loss (474,835) (494,529) (214,546) -------- ---------- -------- $(401,644) $(4,607,626) $ 107,694 ======== ========== ========\nThe income tax (benefit) provision includes the following:\n1994 1993 1992 Current income tax payable (refundable):\nFederal $ (9,876) $ (156,169) $ (80,183) State 1,550 1,489 1,489 Foreign 1,099 (2,985) - ---------- ----------- ---------- (7,227) (157,665) (78,694) ---------- ----------- ---------- Deferred income tax: Federal (18,156) (870,968) 119,038 State (210,127) 10,663 (3,642) Foreign (215,427) (218,472) - Increase in valuation allowance 437,036 483,457 - ---------- ----------- ---------- (6,674) (595,320) 115,396 ---------- ----------- ---------- $ (13,901) $ (752,985) $ 36,702 ========== =========== ==========\nThe income tax (benefit) provision differs from those computed using the statutory federal tax rate of 34%, due to the following:\n1994 1993 1992\nTax at statutory federal rate $ (136,559) $(1,566,661) $ 36,616 Differences between foreign and U.S. tax rates (51,791) (50,332) 72,946 State taxes, net of federal tax benefit (209,104) 8,020 (1,421) Amortization of excess purchase price over net assets acquired - 497,963 86,602 Tax-exempt interest income - (35,829) (95,331) Utilization of tax credits (65,000) - (79,675) Increase in valuation allowance 437,036 483,457 - Other 11,507 (89,603) 16,965 ----------- ------------ ---------- $ (13,901) $ (752,985) $ 36,702 =========== ============ ==========\nThe deferred income tax asset (liability) recorded in the consolidated balance sheets results from differences between financial statement and tax reporting of income and deductions. A summary of the composition of the deferred income tax asset (liability) follows:\n1994 1993 Domestic Foreign Domestic Foreign\nGeneral business credits $ 837,253 $ - $ 691,664 $ - Net operating losses 470,918 502,229 427,828 291,757 Deferred compensation 389,816 - 274,536 - Alternative minimum tax credits 205,431 - 212,929 - Inventory 143,881 - 90,195 - Accounts receivable 38,867 - 32,441 - Capitalized software (1,071,923) - (891,487) - Fixed assets (67,549) 6,655 (72,859) 5,156 Other 3,969 13,163 (42,867) 9,707 ----------- ----------- ----------- ----------- 950,663 522,047 722,380 306,620 Valuation allowance (811,594) (522,047) (589,985) (306,620) ----------- ----------- ----------- ----------- Deferred asset (liability) $ 139,069 $ - $ 132,395 $ - ========== =========== =========== ===========\nThe deferred asset as of December 31, 1994 and 1993 is included in the deposits and other assets caption in the consolidated balance sheet.\nThe Company has $1,014,850 of federal net operating loss carryforwards available as of December 31, 1994, of which approximately $100,000 may be utilized annually. The carryforwards expire in varying amounts in 1998 through 2001. The 1994 regular federal tax net operating loss remaining to be carried forward is $68,000 which expires in the year 2008. The valuation allowance has increased by $437,036 during the year ended December 31, 1994, primarily due to operating loss and tax credit carryforwards that, in the opinion of management, may not be realized within the carryforward period.\nAs of December 31, 1994, the Company has $13,000 of net operating loss carryforwards available to offset future earnings of Moscom Limited and net operating loss carryforwards of $1,230,000 to offset future earnings of Moscom GmbH.\nThe Company's tax credit carryforwards as of December 31, 1994 are as follows:\nDescription Amount Expiration Dates\nGeneral business credits $ 756,829 1998 - 2009\nNew York State investment tax credits 121,854 1996 - 2004\nAlternative minimum tax credits 205,431 No expiration date --------- $ 1,084,114\nCash paid (received) for income taxes during the years ended December 31, 1994, 1993 and 1992 totalled $(231,885), $(10,731) and $9,747, respectively.\n10.COMMITMENTS\nOperating Lease Obligations - The Company and its subsidiary lease their current manufacturing and office facilities and certain equipment under operating leases which expire at various dates through 1998. The facility leases provide for extension privileges. Rent expense under all operating leases (exclusive of real estate taxes and other expenses payable under the leases) was $773,000, $573,000, and $583,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nMinimum lease payments as of December 31, 1994 under operating leases are as follows:\nYear Ending December 31,\n1995 $ 512,000 1996 508,000 1997 467,000 1998 313,000 ----------- Total minimum lease payments $ 1,800,000 ===========\nLine of Credit - The Company has an unsecured revolving line of credit arrangement with a commercial bank for a maximum of $3,000,000 at an interest rate of the lower of the bank's prime rate of interest or the bank's offered rate of interest. The Company must pay a loan commitment fee of 1\/4% per annum of the difference between the maximum amount available under the line less loans outstanding at the end of each quarter. The line of credit arrangement is subject to certain financial covenants relating primarily to the Company's current ratio, tangible net worth, liabilities to tangible net worth and a limit on the amount of dividends declared or paid each year. The Company has satisfied these financial covenants as of December 31, 1994 and 1993. This agreement originally was to expire on January 31, 1995 but has been extended to January 31, 1996.\nPART III\nItem 10","section_9A":"","section_9B":"","section_10":"Item 10 Directors and Executive Officers of the Registrant\nInformation relating to directors of the Company is incorporated herein by reference to page 3, 4 and 6 of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held May 12, 1995 {see \"Election of Directors\" and \"Compliance With Section 16 (a)\".}\nThe following lists the names and ages of all executive officers of the Company, all persons chosen to become executive officers, all positions and offices with the Company held by such persons, and the business experience during the past five years of such persons. All officers were elected or re- elected to their present positions for terms ending in May 12, 1995 and until their respective successors are elected and qualified.\nMANAGEMENT\nDirectors and Executive Officers of the Registrant The Directors and executive officers of MOSCOM are as follows: Name Age Position Albert J. 58 Chairman of the Montevecchio Board, President, C.E.O., Director\nRobert L. Boxer 41 Vice President, Secretary Corporate Counsel\nJames H. Herbert 58 Vice President, Corporate Marketing\nJames W. Karr 51 Vice President, International Sales\nJohn P. King 57 Vice President Customer Support and Quality Assurance\nRonald C. Lundy 43 Treasurer\nRichard C. Vail 64 Vice President, General Manager, Votan\nVictor de Jong 49 Director\nJohn E. Mooney 50 Director\nHarvey E. Rhody 55 Director\nFred E. Strauss 67 Director\nAll Directors hold office until the next annual meeting of stockholders, and until their successors are duly elected and qualified. Officers are elected annually by the Board of Directors and serve at the discretion of the Board.\nAlbert J. Montevecchio is a founder of MOSCOM and has been its President, Chief Executive Officer and a Director since its incorporation in January 1983. He became Chairman of the Board in February 1985. Prior to founding MOSCOM, he was a director and Executive Vice President of Sykes Datatronics, Inc. with responsibility for marketing and sales, customer service and new product planning. Prior to that he held senior technical positions with Xerox Corporation and General Electric Corporation. He holds degree in Electrical Engineering (BSEE).\nRobert L. Boxer became a Vice President of MOSCOM in November 1991. Prior to that he had been Secretary and Corporate Counsel of MOSCOM since March 1983. Prior to that he had been Counsel at Sykes Datatronics, Inc. and an attorney with the firm of Middleton-Wilson.\nJames H. Herbert has been Vice President-Corporate Marketing since September, 1990. He was co-founder and Executive Vice President of Phoenix Telecom, Inc. from November 1985 until joining MOSCOM. Phoenix Telecom develops and markets application software products for the telephone industry. Prior to founding Phoenix, he held sales and marketing management positions with Sykes Datatronics, Inc., Northern Telecom, Inc., Mid-Continent Telephone Corporation and Ohio Bell.\nJames W. Karr has been Vice President-International Sales since May 1, 1989. After joining MOSCOM in 1983, he had held various sales management positions. Prior to that he held sales management positions with Sykes Datatronics, Inc., Itel Corporation, Honeywell Information Systems, and NCR Corporation.\nJohn P. King has been Vice President of Corporate Quality Assurance since August 31, 1992. He was President and CEO of Computer Consoles, Inc. from 1990 through 1992 and COO from 1989 to 1990. Prior to that held various management positions with Northern Telecom from 1962 to 1989.\nRonald C. Lundy was appointed Treasurer of MOSCOM in July 1993. Since joining MOSCOM in 1984 he has held a variety of financial management positions, the most recent having been Corporate Controller since December of 1992. Prior to that he held various financial positions with Rochester Instrument Systems from 1974-1983.\nRichard C. Vail has been Vice President and General Manager of the Votan Division since October, 1991. Prior to that he had been Vice President- Engineering and Operations since March 1987 and prior to that Director of Operations since October 1984. Mr. Vail held a series of Senior Management positions with Taylor Instrument Company from 1974 through 1984.\nVictor de Jong has been a Director of MOSCOM since May 1984. He is President of Huntington General Management, Inc., a management consulting firm and President of Haller Plastics Corp., a plastic injection molding company and manufacturer of point-of-purchase displays since 1990. Prior to that, Mr. de Jong was President of Venture Management Associates, an investment holding company, and its subsidiaries, Golden Metal Products Corporation and Precise Metal Parts Company, Inc., both engaged in the fabrication of metal parts. Prior to 1982, Mr. de Jong held various management positions with McGraw Edison.\nJohn E. Mooney became a Director of MOSCOM in May 1985. He is Chief Executive Officer of Essex Investment Group and a general partner of Great Lakes Capital. For the past five years, he has been President of MM&S Resources, Inc., First Rochester Corporation and First Rochester Capital Corporation. All of these affiliated companies are engaged in investment management and financial services.\nHarvey E. Rhody has been a Director of MOSCOM since September 1983. He has been President of RIT Research Corporation since July 1992. Prior to that and since 1988, he was a Professor of Electrical Engineering and Imaging Science at the Rochester Institute of Technology and director of Intelligent Systems Division of RIT Research Corporation.\nFred E. Strauss has been a Director of MOSCOM since September 1983. In 1990, he retired as Regional President of Manufacturers Hanover Trust Company in Rochester, New York, a position he held for more than five years. Mr. Strauss is a Chairman of the Board of Nazareth College Board of Trustees, an institution of higher learning; Chairman of the Boards of Park Ridge Hospital, Inc. and Park Ridge Health Systems, Inc., providers of health care; and Chairman of the Board of Rochester Community Baseball, Inc., an operator of a minor league professional baseball team.\nItem 11","section_11":"Item 11 Executive Compensation\nInformation relating to executive compensation is incorporated by reference on pages 5, 6 and 7 of the Company's Proxy Statement for the Annual Meeting of Shareholders to be held May 12 1995. (See \"Executive Compensation\" and \"Corporate Governance Information.\")\nItem 12","section_12":"Item 12 Security Ownership of Certain Beneficial Owners and Management\nInformation relating to the security holdings of more than five percent holders and directors and officers of the Company is incorporated herein by reference to pages 3 through 6 of the Company's Proxy Statement for the Annual Meeting of shareholders to be held May 12, 1995.\nItem 13","section_13":"Item 13 Certain Relationships and Related Transactions\nNone.\nPART IV\nItem 14","section_14":"Item 14 Exhibits, Consolidated Financial Statement Schedule and Reports on Form 8-K\n(a) The following document is filed as part of this report:\nVIII. Valuation and Qualifying Accounts\nSchedules other than those listed above are omitted because they are not applicable.\nIndividual financial statements of the subsidiaries of the Company have been omitted as the Company is primarily an operating company and the subsidiaries included in the consolidated financial statements filed, in the aggregate, do not have minority equity interest and\/or indebtedness to any person other than the Company in amounts which together (excepting indebtedness incurred in the ordinary course of business which is not overdue and matures within one year from the date of its creation, whether or not evidenced by securities, and indebtedness of the subsidiary which is collateralized by the Company by guarantee, pledge, assignment or otherwise) exceed 5 percent of the total assets as shown by the most recent year-end statement of consolidated financial position. There are no unconsolidated subsidiaries or 50% or less owned persons accounted for by the equity method.\n(b) There have been no reports on form 8-K filed during the last quarter of the period covered by this report.\n(c) Exhibits (numbered in accordance with item 601 of regulation S-K)\n(11.1) Calculation of earnings per share\n(22) Subsidiaries of registrant\n(22.1) Neither of the Company's wholly owned subsidiaries would constitute a significant subsidiary as of December 31, 1994.\nMOSCOM CORPORATION AND SUBSIDIARIES\nSchedule VIII - Valuation and Qualifying Accounts Years Ended December 31, 1994, 1993, and 1992\nColumn A Column B Column C Column D Column E\nAllowance for Balance At Charged To Accounts Balance Doubtful Accounts Beginning Costs And Written Off At End of Of Year Expenses (Recovered) Year\n1994 $132,000 $(23,188) ($ 3,812) $105,000 1993 122,000 20,254 10,254 132,000 1992 105,000 24,544 7,544 122,000\nProvision for Balance At Charged to Inventory Balance Inventory Shrinkage Beginning Cost of Written At End & Obsolescence of Year Sales Off of Year\n1994 $208,291 173,499 34,316 347,474 1993 183,884 234,500 210,093 208,291 1992 296,483 30,000 142,599 183,884\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.\nMOSCOM CORPORATION\n----------------------------------------------- Albert J. Montevecchio, Chairman of the Board President and CEO Dated: 03\/28\/95\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 Capacity Date\n_____________________________ Chairman of the Board, March 28, 1995 Albert J. Montevecchio President, C.E.O. and Director\n_____________________________ Director March 28, 1995 Victor de Jong\n_____________________________ Director March 28, 1995 John E. Mooney\n_____________________________ Director March 28, 1995 Harvey E. Rhody\n_____________________________ Fred E. Strauss Director March 28, 1995\n_____________________________ Ronald C. Lundy Treasurer March 28, 1995\nExhibit 11.1\nMOSCOM CORPORATION and Subsidiaries Calculation of Earnings per Share\nTwelve Months Ended December 31, Primary 1994 1993 1992 Net Earnings (Loss) $(387,743) $(3,854,641) $ 70,992\nAverage common shares outstanding 6,707,449 6,589,130 6,476,645\nDilutive effect of stock options and warrants after application of treasury stock method - - 177,435 _________ __________ __________\nWeighted average shares outstanding 6,707,449 6,589,130 6,654,080 ========= ========== ==========\nEarnings (Loss) per common & common equivalent share $(.06) $(.59) $.01 ========= ========== ========== Assuming Full Dilution\nNet Earnings (Loss) $(387,743) $(3,854,641) 70,992 ========= ========== ==========\nWeighted average shares outstanding 6,707,449 6,589,130 6,654,080\nAdditional dilutive effect of stock options & warrants after application of treasury stock method - - 14,249 _________ __________ __________\nWeighted average shares outstanding 6,707,449 6,589,130 6,668,329 ========= ========== ========== Earnings (Loss) per common share assuming full dilution $(.06) $(.59) $.01 ========= ========== ==========","section_15":""}
{"filename":"6879_1994.txt","cik":"6879","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES -----------------------------------------------------------------\nAt December 31, 1994, subsidiaries of AEP owned (or leased where indicated) generating plants with the net power capabilities (winter rating) shown in the following table:\n--------------- (a) Unit 1 of the Rockport Plant is owned one-half by AEGCo and one-half by I&M. Unit 2 of the Rockport Plant is leased one-half by AEGCo and one-half by I&M. The leases terminate in 2022 unless extended. (b) Unit 3 of the John E. Amos Plant is owned one-third by APCo and two-thirds by OPCo. (c) Represents CSPCo's ownership interest in generating units owned in common with CG&E and DP&L. (d) Leased from the City of Fort Wayne, Indiana. Since 1975, I&M has leased and operated the assets of the municipal system of the City of Fort Wayne, Indiana under a 35-year lease with a provision for an additional 15-year extension at the election of I&M. (e) Kanawha Valley Power Company has requested regulatory approval to merge into APCo. (f) The scrubber facilities at the Gavin Plant are leased. The lease terminates in 2029 unless extended or terminated earlier.\nSee Item 1 under Fuel Supply, for information concerning coal reserves owned or controlled by subsidiaries of AEP.\nThe following table sets forth the total circuit miles of transmission and distribution lines of the AEP System, APCo, CSPCo, I&M, KEPCo and OPCo and that portion of the total representing 765,000-volt lines:\n--------------- (a) Includes 766 miles of 345,000-volt jointly owned lines. (b) Includes lines of other AEP System companies not shown.\nTITLES\nThe AEP System's electric generating stations are generally located on lands owned in fee simple. The greater portion of the transmission and distribution lines of the System has been constructed over lands of private owners pursuant to easements or along public highways and streets pursuant to appropriate statutory authority. The rights of the System in the realty on which its facilities are located are considered by it to be adequate for its use in the conduct of its business. Minor defects and irregularities customarily found in title to properties of like size and character may exist, but such defects and irregularities do not materially impair the use of the properties affected thereby. System companies generally have the right of eminent domain whereby they may, if necessary, acquire, perfect or secure titles to or easements on privately-held lands used or to be used in their utility operations.\nSubstantially all the physical properties of APCo, CSPCo, I&M, KEPCo and OPCo are subject to the lien of the mortgage and deed of trust securing the first mortgage bonds of each such company.\nSYSTEM TRANSMISSION LINES AND FACILITY SITING\nLegislation in the states of Indiana, Kentucky, Michigan, Ohio, Virginia, and West Virginia requires prior approval of sites of generating facilities and\/or routes of high-voltage transmission lines. Delays and additional costs in constructing facilities have been experienced as a result of proceedings conducted pursuant to such statutes, as well as in proceedings in which operating companies have sought to acquire rights-of-way through condemnation, and such proceedings may result in additional delays and costs in future years.\nPEAK DEMAND\nThe AEP System is interconnected through 119 high-voltage transmission interconnections with 29 neighboring electric utility systems. The all-time and 1994 one-hour peak System demand was 25,940,000 kilowatts (which included 7,314,000 kilowatts of scheduled deliveries to unaffiliated systems which the System might, on appropriate notice, have elected not to schedule for delivery) and occurred on June 17, 1994. The net dependable capacity to serve the System load on such date, including power available under contractual obligations, was 23,457,000 kilowatts. The all-time and 1994 one-hour internal peak demand was 19,236,000 kilowatts and occurred on January 19, 1994. The net dependable capacity to serve the System load on such date, including power dedicated under contractual arrangements, was 23,995,000 kilowatts. The all-time one-hour integrated and internal net system peak demands and 1994 peak demands for AEP's generating subsidiaries are shown in the following tabulation:\nHYDROELECTRIC PLANTS\nLicenses for hydroelectric plants, issued under the Federal Power Act, reserve to the United States the right to take over the project at the expiration of the license term, to issue a new license to another entity, or to relicense the project to the existing licensee. In the event that a project is taken over by the United States or licensed to a new licensee, the Federal Power Act provides for payment to the existing licensee of its \"net investment\" plus severance damages. Licenses for six System hydroelectric plants expired in 1993 and applications for new licenses for these plants were filed in 1991. The existing licenses for these plants were extended on an annual basis and will be renewed automatically until new licenses are issued. No competing license applications were filed. Four new licenses were issued in 1994.\nCOOK NUCLEAR PLANT\nUnit 1 of the Cook Plant, which was placed in commercial operation in 1975, has a nominal net electric rating of 1,020,000 kilowatts. Unit 1's availability factor was 71.0% during 1994 and 100% during 1993. Unit 2, of slightly different design, has a nominal net electrical rating of 1,090,000 kilowatts and was placed in commercial operation in 1978. Unit 2's availability factor was 54.3% during 1994 and 96.6% during 1993. The availability of Units 1 and 2 was affected in 1994 by outages to refuel.\nUnits 1 and 2 are licensed by the NRC to operate at 100% of rated thermal power to October 25, 2014 and December 23, 2017, respectively.\nCosts associated with the operation, maintenance and retirement of nuclear plants have continued to increase and become less predictable, in large part due to changing regulatory requirements and safety standards and experience gained in the construction and operation of nuclear facilities. I&M may also incur costs and experience reduced output at its Cook Plant because of the design criteria prevailing at the time of construction and the age of the plant's systems and equipment. In addition, for economic or other reasons, operation of the Cook Plant for the full term of its now assumed life cannot be assured. Nuclear industry-wide and Cook Plant initiatives have contributed to slowing the growth of operating and maintenance costs. However, the ability of I&M to obtain adequate and timely recovery of costs associated with the Cook Plant, including replacement power and retirement costs, is not assured.\nNuclear Incident Liability\nThe Price-Anderson Act limits public liability for a nuclear incident at any licensed reactor in the United States to $8.9 billion. I&M has insurance coverage for liability from a nuclear incident at its Cook Plant. Such coverage is provided through a combination of private liability insurance, with the maximum amount available of $200,000,000, and mandatory participation for the remainder of the $8.9 billion liability, in an industry retrospective deferred premium plan which would, in case of a nuclear incident, assess all licensees of nuclear plants in the U.S. Under the deferred premium plan, I&M could be assessed up to $158,600,000 payable in annual installments of $20,000,000 in the event of a nuclear incident at Cook or any other nuclear plant in the U.S. There is no limit on the number of incidents for which I&M could be assessed these sums.\nI&M also has property damage, decontamination and decommissioning insurance for loss resulting from damage to the Cook Plant facilities in the amount of $3.6 billion. Energy Insurance Bermuda (EIB), Nuclear Mutual Limited (NML) and Nuclear Electric Insurance Limited (NEIL) provide $2.75 billion of coverage and nuclear insurance pools provide the remainder. If EIB's, NML's and NEIL's losses exceed their available resources, I&M would be subject to a total retrospective premium assessment of up to $34,000,000. NRC regulations require that, in the event of an accident, whenever the estimated costs of reactor stabilization and site decontamination exceed $100,000,000, the insurance proceeds must be used, first, to return the reactor to, and maintain it in, a safe and stable condition and, second, to decontaminate the reactor and reactor station site in accordance with a plan approved by the NRC. The insurers then would indemnify I&M for property damage up to $3.35 billion less any amounts used for stabilization and decontamination. The remaining $250,000,000, as provided by NEIL (reduced by any stabilization and decontamination expenditures over $3.35 billion), would cover decommissioning costs in excess of funds already collected for decommissioning. See Fuel Supply -- Nuclear Waste.\nNEIL's extra-expense program provides insurance to cover extra costs resulting from a prolonged accidental outage of a nuclear unit. I&M's policy insures against such increased costs up to approximately $3,500,000 per week (starting 21 weeks after the outage) for one year, $2,800,000 per week for the second and third years, or 80% of those amounts per unit if both units are down for the same reason. If NEIL's losses exceed its available resources, I&M would be subject to a total retrospective premium assessment of up to $7,900,000.\nPOTENTIAL UNINSURED LOSSES Some potential losses or liabilities may not be insurable or the amount of insurance carried may not be sufficient to meet potential losses and liabilities, including liabilities relating to damage to the Cook Plant and costs of replacement power in the event of a nuclear incident at the Cook Plant. Future losses or liabilities which are not completely insured, unless allowed to be recovered through rates, could have a material adverse effect on results of operation and the financial condition of AEP, I&M and other AEP System companies.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS -----------------------------------------------------------------\nIn February 1990, the Supreme Court of Indiana overturned an order of the IURC, affirmed by the Indiana Court of Appeals, which had awarded I&M the right to serve a General Motors Corporation light truck manufacturing facility located in Fort Wayne. In August 1990, the IURC issued an order transferring the right to serve the GM facility to an unaffiliated local distribution utility. In October 1990, the local distribution utility sued I&M in Indiana under a provision of Indiana law that allows the local distribution utility to seek damages equal to the gross revenues received by a utility that renders retail service in the designated service territory of another utility. On November 30, 1992, the DeKalb Circuit Court granted I&M's motion for summary judgment to dismiss the local distribution utility's complaint. The local distribution utility has appealed the decision to the Indiana Court of Appeals. I&M received revenues of approximately $29,000,000 from serving the GM facility. It is not clear whether the plaintiffs claim will be upheld on appeal because the service was rendered in accordance with an IURC order I&M believed in good faith to be valid.\nOn April 4, 1991, then Secretary of Labor Lynn Martin announced that the U.S. Department of Labor (DOL) had issued a total of 4,710 citations to operators of 847 coal mines who allegedly submitted respirable dust sampling cassettes that had been altered so as to remove a portion of the dust. The cassettes were submitted in compliance with DOL regulations which require systematic sampling of airborne dust in coal mines and submission of the entire cassettes (which include filters for collecting dust particulates) to the Mine Safety and Health Administration (MSHA) for analysis. The amount of dust contained on the cassette's filter determines an operator's compliance with respirable dust standards under the law. OPCo's Meigs No. 2, Meigs No. 31, Martinka, and Windsor Coal mines received 16, 3, 15 and 2 citations, respectively. MSHA has assessed civil penalties totalling $56,900 for all these citations. OPCo's samples in question involve about 1 percent of the 2,500 air samples that OPCo submitted over a 20-month period from 1989 through 1991 to the DOL. OPCo is contesting the citations before the Federal Mine Safety and Health Review Commission. An administrative hearing was held before an administrative law judge with respect to all affected coal operators. On July 20, 1993, the administrative law judge rendered a decision in this case holding that the Secretary of Labor failed to establish that the presence of a \"white center\" on the dust sampling filter indicated intentional alteration. In the case of an unaffiliated mine, the administrative law judge ruled on April 20, 1994, that there was not an intentional alteration of the dust sampling filter. The Secretary of Labor has appealed to the Mine Safety and Health Review Commission the July 20, 1993 and April 20, 1994 administrative law judge decisions. All remaining cases, including the citations involving OPCo's mines, have been stayed.\nOn October 4, 1993, I&M was served with a complaint issued by Region V, Federal EPA which alleged violations by Breed Plant of the Clean Water Act and proposed a penalty of $70,000, which demand was subsequently reduced to $40,000.\nOn September 30, 1994, Federal EPA served APCo and Global Power Company, an independent contractor retained by APCo, with a complaint alleging violations of the Clean Air Act. The complaint is based on alleged violations of the National Emission Standard for Asbestos related to an asbestos abatement project at APCo's Kanawha River Plant. The complaint seeks a civil administrative penalty of $167,500. On October 27, 1994, APCo and Global jointly filed an answer to this complaint and requested both a formal hearing and informal settlement conference.\nOn February 28, 1994, Ormet Corporation filed a complaint in the U.S. District Court, Northern District of West Virginia, against AEP, OPCo, the Service Corporation and two of its employees, Federal EPA and the Administrator of Federal EPA. Ormet is the operator of a major aluminum reduction plant in Ohio and is a customer of OPCo. See Certain Industrial Contracts. Pursuant to the Clean Air Act Amendments of 1990, OPCo received sulfur dioxide emission allowances for its Kammer Plant. See Environmental and Other Matters. Ormet's complaint seeks a declaration that it is the owner of approximately 89% of the Phase I and Phase II allowances issued for use by the Kammer Plant. On May 2, 1994, AEP, OPCo and AEP Service Corporation and its two employee defendants filed a motion seeking to dismiss the complaint filed by Ormet Corporation. On May 2, 1994, the Federal EPA defendants also filed a motion to dismiss. OPCo believes that since it is the owner and operator of Kammer Plant and Ormet is a contract power customer, Ormet is not entitled to any of the allowances attributable to the Kammer Plant.\nSee Item 1 for a discussion of certain environmental and rate matters.\nMeigs Mine -- On July 11, 1993, water from an adjoining sealed and abandoned mine owned by Southern Ohio Coal Company (SOCCo), a mining subsidiary of OPCo, entered Meigs 31 mine, one of two mines currently being operated by SOCCo. Ohio EPA approved a plan to pump water from the mine to certain Ohio River tributaries under stringent conditions for biological and water quality monitoring and restoring the streams after pumping. On July 30, pumping commenced in accordance with the Ohio EPA approved plan and, after all water was removed from the mine, the mine was returned to service in February 1994.\nIn April 1994, the U.S. Court of Appeals for the Sixth Circuit reversed the judgement of the U.S. District Court for the Southern District of Ohio which had granted a preliminary injunction to SOCCo preventing Federal EPA and the Federal Office of Surface Mining, Reclamation and Enforcement (OSM) from interfering with the removal of water from SOCCo's Meigs 31 mine.\nThe West Virginia Division of Environmental Protection (West Virginia DEP) had proposed fining SOCCo $1,800,000 for violations of West Virginia Water Quality Standards and permitting requirements alleged to have resulted from the release of mine water into the Ohio River. As a result of the West Virginia DEP proposing to fine SOCCo, SOCCo filed an action on June 1, 1994 in the U.S. District Court for the Southern District of West Virginia seeking a determination that the state of West Virginia has no jurisdiction to impose penalties with respect to the mine water discharges. On July 27, 1994, West Virginia filed an answer to SOCCo's complaint disputing SOCCo's entitlement to a declaratory judgement and asserting a counterclaim seeking an award of $2,550,000 in civil penalties, reimbursement of monitoring costs and compensation for unspecified natural resources damage. On October 27, 1994, SOCCo filed a motion for summary judgement or alternatively to dismiss West Virginia's counterclaim.\nSOCCo is currently negotiating a resolution of federal and West Virginia claims. The resolution of these legal actions is not expected to have a material adverse impact on results of operations.\nKammer Plant -- In August 1994, Federal EPA issued a Notice of Violation (NOV) to OPCo alleging that its Kammer Plant has been operating in violation of applicable federally enforceable air pollution control requirements for sulfur dioxide since January 1, 1989. The Clean Air Act provides that Federal EPA may commence a civil action for injunctive relief and\/or civil penalties of up to $25,000 per day for each day of violation. On November 15, 1994, a civil complaint containing the allegations included in the NOV was filed by Federal EPA against OPCo in the U.S. District Court for the Northern District of West Virginia. At that time, a consent decree entered into by Federal EPA and OPCo specifying compliance by the Kammer Plant with the federally enforceable sulfur dioxide emission limit by September 1, 1995 was lodged with the court. On January 23, 1995, the consent decree was entered by the court.\nThe portion of the NOV relating to penalties will be addressed independently. At this time, management is unable to estimate the amount of any civil penalties that may be imposed by Federal EPA. It is not anticipated that the ultimate resolution of this matter will have a material adverse impact on results of operations.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS -----------------------------------------------------------------\nAEP, APCO, I&M AND OPCO. None.\nAEGCO, CSPCO AND KEPCO. Omitted pursuant to Instruction J(2)(c). --------------------\nEXECUTIVE OFFICERS OF THE REGISTRANTS\nAEP\nThe following persons are, or may be deemed, executive officers of AEP. Their ages are given as of March 15, 1995.\n---------- (a) All of the executive officers listed above have been employed by the Service Corporation or System companies in various capacities (AEP, as such, has no employees) during the past five years, except E. Linn Draper, Jr. who was Chairman of the Board, President and Chief Executive Officer of Gulf States Utilities Company from 1987 until 1992 when he joined AEP and the Service Corporation. All of the above officers are appointed annually for a one-year term by the board of directors of AEP, the board of directors of the Service Corporation, or both, as the case may be.\nAPCO\nThe names of the executive officers of APCo, the positions they hold with APCo, their ages as of March 15, 1995, and a brief account of their business experience during the past five years appears below. The directors and executive officers of APCo are elected annually to serve a one-year term.\n--------------- (a) Positions are with APCo unless otherwise indicated.\nOPCO\nThe names of the executive officers of OPCo, the positions they hold with OPCo, their ages as of March 15, 1995, and a brief account of their business experience during the past five years appear below. The directors and executive officers of OPCo are elected annually to serve a one-year term.\n--------------- (a) Positions are with OPCo unless otherwise indicated. PART II ---------------------------------------------------------\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANTS' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS -----------------------------------------------------------------\nAEP. AEP Common Stock is traded principally on the New York Stock Exchange. The following table sets forth for the calendar periods indicated the high and low sales prices for the Common Stock as reported on the New York Stock Exchange Composite Tape and the amount of cash dividends paid per share of Common Stock.\n--------------- (1) See Note 5 of the Notes to the Consolidated Financial Statements of AEP for information regarding restrictions on payment of dividends.\nAt December 31, 1994, AEP had approximately 183,000 shareholders of record.\nAEGCO, APCO, CSPCO, I&M, KEPCO AND OPCO. The information required by this item is not applicable as the common stock of all these companies is held solely by AEP.\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA -----------------------------------------------------------------\nAEGCO. Omitted pursuant to Instruction J(2)(a).\nAEP. The information required by this item is incorporated herein by reference to the material under Selected Consolidated Financial Data in the AEP 1994 Annual Report (for the fiscal year ended December 31, 1994).\nAPCO. The information required by this item is incorporated herein by reference to the material under Selected Consolidated Financial Data in the APCo 1994 Annual Report (for the fiscal year ended December 31, 1994).\nCSPCO. Omitted pursuant to Instruction J(2)(a).\nI&M. The information required by this item is incorporated herein by reference to the material under Selected Consolidated Financial Data in the I&M 1994 Annual Report (for the fiscal year ended December 31, 1994). KEPCO. Omitted pursuant to Instruction J(2)(a).\nOPCO. The information required by this item is incorporated herein by reference to the material under Selected Consolidated Financial Data in the OPCo 1994 Annual Report (for the fiscal year ended December 31, 1994).\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION -----------------------------------------------------------------\nAEGCO. Omitted pursuant to Instruction J(2)(a). Management's narrative analysis of the results of operations and other information required by Instruction J(2)(a) is incorporated herein by reference to the material under Management's Narrative Analysis of Results of Operations in the AEGCo 1994 Annual Report (for the fiscal year ended December 31, 1994).\nAEP. The information required by this item is incorporated herein by reference to the material under Management's Discussion and Analysis of Results of Operations and Financial Condition in the AEP 1994 Annual Report (for the fiscal year ended December 31, 1994).\nAPCO. The information required by this item is incorporated herein by reference to the material under Management's Discussion and Analysis of Results of Operations and Financial Condition in the APCo 1994 Annual Report (for the fiscal year ended December 31, 1994).\nCSPCO. Omitted pursuant to Instruction J(2)(a). Management's narrative analysis of the results of operations and other information required by Instruction J(2)(a) is incorporated herein by reference to the material under Management's Narrative Analysis of Results of Operations in the CSPCo 1994 Annual Report (for the fiscal year ended December 31, 1994).\nI&M. The information required by this item is incorporated herein by reference to the material under Management's Discussion and Analysis of Results of Operations and Financial Condition in the I&M 1994 Annual Report (for the fiscal year ended December 31, 1994).\nKEPCO. Omitted pursuant to Instruction J(2)(a). Management's narrative analysis of the results of operations and other information required by Instruction J(2)(a) is incorporated herein by reference to the material under Management's Narrative Analysis of Results of Operations in the KEPCo 1994 Annual Report (for the fiscal year ended December 31, 1994).\nOPCO. The information required by this item is incorporated herein by reference to the material under Management's Discussion and Analysis of Results of Operations and Financial Condition in the OPCo 1994 Annual Report (for the fiscal year ended December 31, 1994).\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -----------------------------------------------------------------\nAEGCO. The information required by this item is incorporated herein by reference to the financial statements and supplementary data described under Item 14 herein. AEP. The information required by this item is incorporated herein by reference to the financial statements and supplementary data described under Item 14 herein.\nAPCO. The information required by this item is incorporated herein by reference to the financial statements and supplementary data described under Item 14 herein.\nCSPCO. The information required by this item is incorporated herein by reference to the financial statements and supplementary data described under Item 14 herein.\nI&M. The information required by this item is incorporated herein by reference to the financial statements and supplementary data described under Item 14 herein.\nKEPCO. The information required by this item is incorporated herein by reference to the financial statements and supplementary data described under Item 14 herein.\nOPCO. The information required by this item is incorporated herein by reference to the financial statements and supplementary data described under Item 14 herein.\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE -----------------------------------------------------------------\nAEGCO, AEP, APCO, CSPCO, I&M, KEPCO AND OPCO. None.\nPART III --------------------------------------------------------\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS -----------------------------------------------------------------\nAEGCO. Omitted pursuant to Instruction J(2)(c).\nAEP. The information required by this item is incorporated herein by reference to the material under Nominees for Director and Share Ownership of Directors and Executive Officers of the definitive proxy statement of AEP, dated March 9, 1995, for the 1995 annual meeting of shareholders. Reference also is made to the information under the caption Executive Officers of the Registrants in Part I of this report.\nAPCO. The information required by this item is incorporated herein by reference to the material under Election of Directors of the definitive information statement of APCo for the 1995 annual meeting of stockholders, to be filed within 120 days after December 31, 1994. Reference also is made to the information under the caption Executive Officers of the Registrants in Part I of this report.\nCSPCO. Omitted pursuant to Instruction J(2)(c).\nI&M. The names of the directors and executive officers of I&M, the positions they hold with I&M, their ages as of March 15, 1995, and a brief account of their business experience during the past five years appear below. The directors and executive officers of I&M are elected annually to serve a one-year term.\n(a) Positions are with I&M unless otherwise indicated. (b) Dr. Draper is a director of VECTRA Technologies, Inc., Mr. Lhota is a director of Huntington Bancshares Incorporated and Mr. Menge is a director of Fort Wayne National Corporation. (c) Drs. Draper and Markowsky and Messrs. DeMaria, Lhota and Maloney are directors of AEGCo, APCo, CSPCo, KEPCo and OPCo. Dr. Draper and Messrs. DeMaria and Maloney are also directors of AEP.\nKEPCO. Omitted pursuant to Instruction J(2)(c).\nOPCO. The information required by this item is incorporated herein by reference to the material under the heading Election of Directors of the definitive information statement of OPCo for the 1995 annual meeting of shareholders, to be filed within 120 days after December 31, 1994. Reference also is made to the information under the caption Executive Officers of the Registrants in Part I of this report.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION -----------------------------------------------------------------\nAEGCO. Omitted pursuant to Instruction J(2)(c).\nAEP. The information required by this item is incorporated herein by reference to the material under Compensation of Directors, Executive Compensation and the performance graph of the definitive proxy statement of AEP, dated March 9, 1995, for the 1995 annual meeting of shareholders.\nAPCO. The information required by this item is incorporated herein by reference to the material under Executive Compensation of the definitive information statement of APCo for the 1995 annual meeting of stockholders, to be filed within 120 days after December 31, 1994.\nCSPCO. Omitted pursuant to Instruction J(2)(c).\nKEPCO. Omitted pursuant to Instruction J(2)(c). OPCO. The information required by this item is incorporated herein by reference to the material under Executive Compensation of the definitive information statement of OPCo for the 1995 annual meeting of shareholders, to be filed within 120 days after December 31, 1994.\nI&M. Certain executive officers of I&M are employees of the Service Corporation. The salaries of these executive officers are paid by the Service Corporation and a portion of their salaries has been allocated and charged to I&M. The following table shows for 1994, 1993 and 1992 the compensation earned from all AEP System companies by the chief executive officer and four other most highly compensated executive officers (as defined by regulations of the SEC) of I&M at December 31, 1994.\nSUMMARY COMPENSATION TABLE\n--------------- (1) Reflects payments under the Management Incentive Compensation Plan (MICP). Amounts for 1994 are estimates but should not change significantly. For 1994 and 1993, these amounts include both cash paid and a portion deferred in the form of restricted stock units. These units are paid out in cash after three years based on the price of AEP Common Stock at that time. Dividend equivalents are paid during the three-year period. At December 31, 1994, the deferred amounts (included in the above table) and accrued dividends for Dr. Draper, Messrs. DeMaria, Maloney and Lhota and Dr. Markowsky were equivalent to 2,204, 1,109, 1,080, 1,004 and 956 units having values of $72,456, $36,458, $35,505, $33,006 and $31,428, respectively, based upon a $32-7\/8 per share closing price of AEP's Common Stock as reported on the New York Stock Exchange. For 1992, MICP payments were made entirely in cash. (2) Reflects payments under the Performance Share Incentive Plan (which became effective January 1, 1994) for the one-year transition performance period ending December 31, 1994. Dr. Draper, Messrs. DeMaria, Maloney and Lhota and Dr. Markowsky received 2,050, 881, 867, 812 and 775 shares of AEP Common Stock, respectively, representing one-half of their payments. See the discussion below for additional information. (3) For 1994, includes (i) employer matching contributions under the AEP System Employees Savings Plan: $4,500 for each of the named executive officers; (ii) employer matching contributions under the AEP System Supplemental Savings Plan (which became effective January 1, 1994), a non-qualified plan designed to supplement the AEP Savings Plan: Dr. Draper, $14,100; Mr. DeMaria, $4,650; Mr. Maloney, $4,500; Mr. Lhota, $3,900; and Dr. Markowsky, $3,510; and (iii) subsidiary companies director fees: Dr. Draper, $10,785; Mr. DeMaria, $9,600; Mr. Maloney, $10,745; Mr. Lhota, $10,785; and Dr. Markowsky, $6,745.\nLong-Term Incentive Plans -- Awards In 1994\nEach of the awards set forth below constitutes a grant of performance share units, which represent units equivalent to shares of AEP Common Stock, pursuant to AEP's Performance Share Incentive Plan. Since it is not possible to predict future dividends and the price of AEP Common Stock, credits of performance share units in amounts equal to the dividends that would have been paid if the performance share units were granted in the form of shares of AEP Common Stock are not included in the table.\nThe ability to earn performance share units is tied to achieving specified levels of total shareowner return (TSR) relative to the S&P Electric Utility Index. Notwithstanding AEP's TSR ranking, no performance share units are earned unless AEP shareowners realize a positive TSR over the relevant three-year performance period. The Human Resources Committee may, at its discretion, reduce the number of performance share units otherwise earned. In accordance with the performance goals established for the periods set forth below, the threshold, target and maximum awards are equal to 25%, 100% and 200%, respectively, of the performance share units held. No payment will be made for performance below the threshold.\nPayment of awards earned for the one-year transition performance period ending December 31, 1994 were made 50% in cash and 50% in AEP Common Stock. For subsequent performance periods, payments of earned awards are deferred in the form of restricted stock units (equivalent to shares of AEP Common Stock) until the officer has met the equivalent stock ownership target. Once officers meet and maintain their respective targets, they may elect either to continue to defer or to receive further earned awards in cash and\/or AEP Common Stock.\n--------------- (1) For the 1994 transition performance period, the actual number of performance share units earned was: Dr. Draper 4,100; Mr. DeMaria 1,761; Mr. Maloney 1,734; Mr. Lhota 1,624; and Dr. Markowsky 1,550 (see Summary Compensation Table for the cash value of these payouts).\nRetirement Benefits\nThe American Electric Power System Retirement Plan provides pensions for all employees of AEP System companies (except for employees covered by certain collective bargaining agreements), including the executive officers of I&M. The Retirement Plan is a noncontributory defined benefit plan.\nThe following table shows the approximate annual annuities under the Retirement Plan that would be payable to employees in certain higher salary classifications, assuming retirement at age 65 after various periods of service. The amounts shown in the table are the straight life annuities payable under the Plan without reduction for the joint and survivor annuity. Retirement benefits listed in the table are not subject to any deduction for Social Security or other offset amounts. The retirement annuity is reduced 3% per year in the case of retirement between ages 60 and 62 and further reduced 6% per year in the case of retirement between ages 55 and 60. If an employee retires after age 62, there is no reduction in the retirement annuity.\nPension Plan Table\nCompensation upon which retirement benefits are based consists of the average of the 36 consecutive months of the employee's highest salary, as listed in the Summary Compensation Table, out of the employee's most recent 10 years of service. As of December 31, 1994, the number of full years of service credited under the Retirement Plan to each of the executive officers of the Company named in the Summary Compensation Table were as follows: Dr. Draper, two years; Mr. DeMaria, 35 years; Mr. Maloney, 39 years; Mr. Lhota, 30 years; and Dr. Markowsky, 23 years.\nDr. Draper's employment agreement described below provides him with a supplemental retirement annuity that credits him with 24 years of service in addition to his years of service credited under the Retirement Plan less his actual pension entitlement under the Retirement Plan and any pension entitlements from prior employers.\nAEP has determined to pay supplemental retirement benefits to 23 AEP System employees (including Messrs. DeMaria, Maloney and Lhota and Dr. Markowsky) whose pensions may be adversely affected by amendments to the Retirement Plan made as a result of the Tax Reform Act of 1986. Such payments, if any, will be equal to any reduction occurring because of such amendments. Assuming retirement in 1995 of the executive officers named in the Summary Compensation Table, none would be eligible to receive supplemental benefits.\nAEP made available a voluntary deferred-compensation program in 1982 and 1986, which permitted certain executive employees of AEP System companies to defer receipt of a portion of their salaries. Under this program, an executive was able to defer up to 10% or 15% annually (depending on the terms of the program offered), over a four-year period, of his or her salary, and receive supplemental retirement or survivor benefit payments over a 15-year period. The amount of supplemental retirement payments received is dependent upon the amount deferred, age at the time the deferral election was made, and number of years until the executive retires. The following table sets forth, for the executive officers named in the Summary Compensation Table, the amounts of annual deferrals and, assuming retirement at age 65, annual supplemental retirement payments under the 1982 and 1986 programs.\nEmployment Agreement\nDr. Draper has a contract with AEP and the Service Corporation which provides for his employment for an initial term from no later than March 15, 1992 until March 15, 1997. Dr. Draper commenced his employment with AEP and the Service Corporation on March 1, 1992. AEP or the Service Corporation may terminate the contract at any time and, if this is done for reasons other than cause and other than as a result of Dr. Draper's death or permanent disability, the Service Corporation must pay Dr. Draper's then base salary through March 15, 1997, less any amounts received by Dr. Draper from other employment.\n---------------\nDirectors of I&M receive a fee of $100 for each meeting of the Board of Directors attended in addition to their salaries.\n---------------\nThe AEP System is an integrated electric utility system and, as a result, the member companies of the AEP System have contractual, financial and other business relationships with the other member companies, such as participation in the AEP System savings and retirement plans and tax returns, sales of electricity, transportation and handling of fuel, sales or rentals of property and interest or dividend payments on the securities held by the companies' respective parents.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -----------------------------------------------------------------\nAEGCO. Omitted pursuant to Instruction J(2)(c).\nAEP. The information required by this item is incorporated herein by reference to the material under Share Ownership of Directors and Executive Officers of the definitive proxy statement of AEP, dated March 9, 1995, for the 1995 annual meeting of shareholders.\nAPCO. The information required by this item is incorporated herein by reference to the material under Share Ownership of Directors and Executive Officers in the definitive information statement of APCo for the 1995 annual meeting of stockholders, to be filed within 120 days after December 31, 1994.\nCSPCO. Omitted pursuant to Instruction J(2)(c).\nI&M. All 1,400,000 outstanding shares of Common Stock, no par value, of I&M are directly and beneficially held by AEP. Holders of the Cumulative Preferred Stock of I&M generally have no voting rights, except with respect to certain corporate actions and in the event of certain defaults in the payment of dividends on such shares.\nThe table below shows the number of shares of AEP Common Stock that were beneficially owned, directly or indirectly, as of December 31, 1994, by each director and nominee of I&M and each of the executive officers of I&M named in the summary compensation table, and by all directors and executive officers of I&M as a group. It is based on information provided to I&M by such persons. No such person owns any shares of any series of the Cumulative Preferred Stock of I&M. Unless otherwise noted, each person has sole voting power and investment power over the number of shares of AEP Common Stock set forth opposite his name. Fractions of shares have been rounded to the nearest whole share.\n--------------- (a) The amounts include shares held by the trustee of the AEP Employees Savings Plan, over which directors, nominees and executive officers have voting power, but the investment\/disposition power is subject to the terms of such Plan, as follows: Mr. Bailey, 1,005 shares; Mr. DeMaria, 2,398 shares; Mr. D'Onofrio, 3,251 shares; Mr. Lhota, 5,986 shares; Mr. Maloney, 2,464 shares; Mr. Menge, 2,925 shares; Mr. Potter, 2,741 shares; Mr. Trenary, 165 shares; Mr. Walters, 4,197 shares; and all directors and executive officers as a group, 33,608 shares. Messrs. Bailey's, DeMaria's, D'Onofrio's, Lhota's, Maloney's, Menge's, Potter's, Trenary's and Walter's holdings include 44, 83, 59, 60, 85, 62, 41, 41 and 45 shares, respectively; and the holdings of all directors and executive officers as a group include 633 shares, each held by the trustee of the AEP Employee Stock Ownership Plan, over which shares such persons have sole voting power, but the investment\/disposition power is subject to the terms of such Plan. (b) Includes shares with respect to which such directors, nominees and executive officers share voting and investment power as follows: Mr. DeMaria, 3,624 shares; Mr. D'Onofrio, 500 shares; Dr. Draper, 124 shares; Mr. Lhota, 1,368 shares; Mr. Maloney, 1,700 shares; Mr. Menge, 24 shares; and Mr. Potter, 13 shares; and all directors and executive officers as a group, 4,956 shares. Mr. DeMaria disclaims beneficial ownership of 2,392 shares. (c) 85,231 shares in the American Electric Power System Educational Trust Fund, over which Messrs. DeMaria, Lhota and Maloney share voting and investment power as trustees (they disclaim beneficial ownership of such shares), are not included in their individual totals, but are included in the group total. (d) Represents less than 1 percent of the total number of shares outstanding on December 31, 1994.\nKEPCO. Omitted pursuant to Instruction J(2)(c).\nOPCO. The information required by this item is incorporated herein by reference to the material under Share Ownership of Directors and Executive Officers in the definitive information statement of OPCo for the 1995 annual meeting of shareholders, to be filed within 120 days after December 31, 1994.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS -----------------------------------------------------------------\nAEP. The information required by this item is incorporated herein by reference to the material under Transactions With Management of the definitive proxy statement of AEP, dated March 9, 1995, for the 1995 annual meeting of shareholders.\nAPCO, I&M AND OPCO. None.\nAEGCO, CSPCO, AND KEPCO. Omitted pursuant to 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 a part of this report:\n(b) No Reports on Form 8-K were filed during the quarter ended December 31, 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. THE SIGNATURE OF THE UNDERSIGNED COMPANY SHALL BE DEEMED TO RELATE ONLY TO MATTERS HAVING REFERENCE TO SUCH COMPANY AND ANY SUBSIDIARIES THEREOF.\nAEP Generating Company\nBy: \/s\/ G. P. Maloney ---------------------------- (G. P. MALONEY, VICE PRESIDENT)\nDate: March 23, 1995\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.\nSIGNATURE TITLE DATE --------- ----- ---- (I) PRINCIPAL EXECUTIVE OFFICER:\n*E. Linn Draper, Jr. President, Chief Executive Officer and Director\n(II) PRINCIPAL FINANCIAL OFFICER:\n\/s\/ G. P. Maloney Vice President March 23, 1995 ----------------------- and Director (G. P. MALONEY)\n(III) PRINCIPAL ACCOUNTING OFFICER:\n\/s\/ P. J. DeMaria Vice President, March 23, 1995 ----------------------- Treasurer and (P. J. DEMARIA) Director\n(IV) A MAJORITY OF THE DIRECTORS:\n*Henry Fayne *John R. Jones, III *Wm. J. Lhota *James J. Markowsky\n*By: \/s\/ G. P. Maloney March 23, 1995 ----------------------- (G. P. MALONEY, ATTORNEY-IN-FACT)\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 Electric Power Company, Inc.\nBy: \/s\/ G. P. Maloney ---------------------------- (G. P. MALONEY, VICE PRESIDENT)\nDate: March 23, 1995\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 --------- ----- ---- (I) PRINCIPAL EXECUTIVE OFFICER:\n*E. Linn Draper, Jr. Chairman of the Board, President, Chief Executive Officer and Director\n(II) PRINCIPAL FINANCIAL OFFICER:\n\/s\/ G. P. Maloney Vice President, March 23, 1995 ----------------------- Secretary and (G. P. MALONEY) Director\n(III) PRINCIPAL ACCOUNTING OFFICER:\n\/s\/ P. J. DeMaria Treasurer and March 23, 1995 ----------------------- Director (P. J. DEMARIA)\n(IV) A MAJORITY OF THE DIRECTORS:\n*Robert M. Duncan *Arthur G. Hansen *Lester A. Hudson, Jr. *Angus E. Peyton *Toy F. Reid *Donald G. Smith *Linda Gillespie Stuntz *Morris Tanenbaum *Ann Haymond Zwinger\n*By: \/s\/ G. P. Maloney March 23, 1995 ----------------------- (G. P. MALONEY, ATTORNEY-IN-FACT)\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 AND ANY SUBSIDIARIES THEREOF.\nAppalachian Power Company\nBy: \/s\/ G. P. Maloney ---------------------------- (G. P. MALONEY, VICE PRESIDENT)\nDate: March 23, 1995\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.\nSIGNATURE TITLE DATE --------- ----- ---- (I) PRINCIPAL EXECUTIVE OFFICER:\n*E. Linn Draper, Jr. Chairman of the Board, Chief Executive Officer and Director\n(II) PRINCIPAL FINANCIAL OFFICER:\n\/s\/ G. P. Maloney Vice President March 23, 1995 ----------------------- and Director (G. P. MALONEY)\n(III) PRINCIPAL ACCOUNTING OFFICER:\n\/s\/ P. J. DeMaria Vice President, March 23, 1995 ----------------------- Treasurer and (P. J. DEMARIA) Director\n(IV) A MAJORITY OF THE DIRECTORS:\n*Henry Fayne *Luke M. Feck *Wm. J. Lhota *James J. Markowsky *J. H. Vipperman\n*By: \/s\/ G. P. Maloney March 23, 1995 ----------------------- (G. P. MALONEY, ATTORNEY-IN-FACT)\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 AND ANY SUBSIDIARIES THEREOF.\nColumbus Southern Power Company\nBy: \/s\/ G. P. Maloney ---------------------------- (G. P. MALONEY, VICE PRESIDENT)\nDate: March 23, 1995\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.\nSIGNATURE TITLE DATE --------- ----- ---- (I) PRINCIPAL EXECUTIVE OFFICER:\n*E. Linn Draper, Jr. Chairman of the Board, Chief Executive Officer and Director\n(II) PRINCIPAL FINANCIAL OFFICER:\n\/s\/ G. P. Maloney Vice President March 23, 1995 ----------------------- and Director (G. P. MALONEY)\n(III) PRINCIPAL ACCOUNTING OFFICER:\n\/s\/ P. J. DeMaria Vice President, March 23, 1995 ----------------------- Treasurer and (P. J. DEMARIA) Director\n(IV) A MAJORITY OF THE DIRECTORS:\n*C. A. Erikson *Henry Fayne *Wm. J. Lhota *James J. Markowsky\n*By: \/s\/ G. P. Maloney March 23, 1995 ----------------------- (G. P. MALONEY, ATTORNEY-IN-FACT)\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 AND ANY SUBSIDIARIES THEREOF.\nIndiana Michigan Power Company\nBy: \/s\/ G. P. Maloney ---------------------------- (G. P. MALONEY, VICE PRESIDENT)\nDate: March 23, 1995\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.\nSIGNATURE TITLE DATE --------- ----- ---- (I) PRINCIPAL EXECUTIVE OFFICER:\n*E. Linn Draper, Jr. Chairman of the Board, Chief Executive Officer and Director\n(II) PRINCIPAL FINANCIAL OFFICER:\n\/s\/ G. P. Maloney Vice President March 23, 1995 ----------------------- and Director (G. P. MALONEY)\n(III) PRINCIPAL ACCOUNTING OFFICER:\n\/s\/ P. J. DeMaria Vice President, March 23, 1995 ----------------------- Treasurer and (P. J. DEMARIA) Director\n(IV) A MAJORITY OF THE DIRECTORS:\n*Mark A. Bailey *W. N. D'Onofrio *Wm. J. Lhota *James J. Markowsky *Richard C. Menge *A. H. Potter *D. M. Trenary *W. E. Walters\n*By: \/s\/ G. P. Maloney March 23, 1995 ----------------------- (G. P. MALONEY, ATTORNEY-IN-FACT)\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 AND ANY SUBSIDIARIES THEREOF.\nKentucky Power Company\nBy: \/s\/ G. P. Maloney ---------------------------- (G. P. MALONEY, VICE PRESIDENT)\nDate: March 23, 1995\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.\nSIGNATURE TITLE DATE --------- ----- ---- (I) PRINCIPAL EXECUTIVE OFFICER:\n*E. Linn Draper, Jr. Chairman of the Board, Chief Executive Officer and Director\n(II) PRINCIPAL FINANCIAL OFFICER:\n\/s\/ G. P. Maloney Vice President March 23, 1995 ----------------------- and Director (G. P. MALONEY)\n(III) PRINCIPAL ACCOUNTING OFFICER:\n\/s\/ P. J. DeMaria Vice President, March 23, 1995 ----------------------- Treasurer and (P. J. DEMARIA) Director\n(IV) A MAJORITY OF THE DIRECTORS:\n*C. R. Boyle, III *Wm. J. Lhota *James J. Markowsky *Ronald A. Petti\n*By: \/s\/ G. P. Maloney March 23, 1995 ----------------------- (G. P. MALONEY, ATTORNEY-IN-FACT)\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 AND ANY SUBSIDIARIES THEREOF.\nOhio Power Company\nBy: \/s\/ G. P. Maloney ---------------------------- (G. P. MALONEY, VICE PRESIDENT)\nDate: March 23, 1995\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.\nSIGNATURE TITLE DATE --------- ----- ---- (I) PRINCIPAL EXECUTIVE OFFICER:\n*E. Linn Draper, Jr. Chairman of the Board, Chief Executive Officer and Director\n(II) PRINCIPAL FINANCIAL OFFICER:\n\/s\/ G. P. Maloney Vice President March 23, 1995 ----------------------- and Director (G. P. MALONEY)\n(III) PRINCIPAL ACCOUNTING OFFICER:\n\/s\/ P. J. DeMaria Vice President, March 23, 1995 ----------------------- Treasurer and (P. J. DEMARIA) Director\n(IV) A MAJORITY OF THE DIRECTORS:\n*C. A. Erikson *Henry Fayne *Wm. J. Lhota *James J. Markowsky\n*By: \/s\/ G. P. Maloney March 23, 1995 ----------------------- (G. P. MALONEY, ATTORNEY-IN-FACT)\nINDEPENDENT AUDITORS' REPORT\nAmerican Electric Power Company, Inc. and Subsidiaries:\nWe have audited the consolidated financial statements of American Electric Power Company, Inc. and its subsidiaries and the financial statements of certain of its subsidiaries, listed in Item 14 herein, as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our reports thereon dated February 21, 1995; such financial statements and reports are included in your respective 1994 Annual Report to Shareowners and are incorporated herein by reference. Our audits also included the financial statement schedules of American Electric Power Company, Inc. and its subsidiaries and of certain of its subsidiaries, listed in Item 14. These financial statement schedules are the responsibility of the respective 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 corresponding basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.\n\/s\/ Deloitte & Touche\nDeloitte & Touche LLP Columbus, Ohio February 21, 1995\n---------------\n++Certain instruments defining the rights of holders of long-term debt of the registrants included in the financial statements of registrants filed herewith have been omitted because the total amount of securities authorized thereunder does not exceed 10% of the total assets of registrants. The registrants hereby agree to furnish a copy of any such omitted instrument to the SEC upon request.","section_15":""}
{"filename":"741124_1994.txt","cik":"741124","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE PARTNERSHIP. Cable TV Fund 11-D, Ltd. (the \"Partnership\") is a Colorado limited partnership that was formed pursuant to the public offering of limited partnership interests in the Cable TV Fund 11 Limited Partnership Program (the \"Program\"), which was sponsored by Jones Intercable, Inc. (the \"General Partner\"). Cable TV Fund 11-A, Ltd. (\"Fund 11-A\"), Cable TV Fund 11-B, Ltd. (\"Fund 11-B\") and Cable TV Fund 11-C, Ltd. (\"Fund 11-C\") are the other partnerships that were formed pursuant to the Program. The Partnership, Fund 11-A, Fund 11-B and Fund 11-C formed a general partnership known as Cable TV Joint Fund 11 (the \"Venture\") in which the Partnership owns a 47 percent interest, Fund 11-A owns an 18 percent interest, Fund 11-B owns an 8 percent interest and Fund 11-C owns a 27 percent interest. The Partnership and the Venture were formed for the purpose of acquiring and operating cable television systems.\nThe Partnership does not directly own any cable television systems. The Venture operates a cable television system in Manitowoc, Wisconsin (the \"Manitowoc System\").\nOn June 29, 1990, the Venture sold its Wisconsin cable television systems, except for the Manitowoc System. The Manitowoc System was not sold because the City of Manitowoc (the \"City\") did not consent to the transfer of the franchise. The City of Manitowoc franchise contained a provision that the City claimed allowed the City to acquire the Manitowoc System upon expiration of the franchise in 1995. On April 9, 1991, the Venture took legal action, seeking a declaration as to whether the buyout right was enforceable under Federal law. In February 1993, the court ruled in favor of the Venture and found that the buyout right would not be triggered upon the expiration of the franchise, assuming the franchise is renewed. The court did not determine the question of whether the buyout right was enforceable per se under Federal law. The City appealed the decision. In October 1993, the City and the Venture settled the legal action, and the appeal has been dismissed. In the settlement, the City conceded that its buyout right was not applicable in the event the franchise is renewed, and represented to the Venture that it knew of no reason for non-renewal of the franchise. The City also agreed that the term of the renewal franchise would be 12 years and that the applicable franchise fee would be 5 percent. The Venture paid the City $1,850,000, which will be returned to the Venture, with interest, in the event that the City does not renew the franchise. The franchise renewal process has begun, and the General Partner expects that it will be completed in 1995.\nCABLE TELEVISION SERVICES. The Manitowoc System offers to its subscribers various types of programming, which include basic service, tier service, premium service, pay-per-view programs and packages including several of these services at combined rates.\nBasic cable television service usually consists of signals of all four national television networks, various independent and educational television stations (both VHF and UHF) and certain signals received from satellites. Basic service also usually includes programs originated locally by the system, which may consist of music, news, weather reports, stock market and financial information and live or videotaped programs of a public service or entertainment nature. FM radio signals are also frequently distributed to subscribers as part of the basic service.\nThe Manitowoc System offers tier services on an optional basis to its subscribers. A tier generally includes most of the cable networks such as Entertainment and Sports Programming Network (ESPN), Cable News Network (CNN), Turner Network Television (TNT), Family Channel, Discovery and others, and the cable television operators buy tier programming from these networks. The Manitowoc System also offers a package that includes the basic service channels and the tier services.\nThe Manitowoc System also offers premium services to its subscribers, which consist of feature films, sporting events and other special features that are presented without commercial interruption. The cable television operators buy premium programming from suppliers such as HBO, Showtime, Cinemax or others at a cost based on the number of subscribers the cable operator serves. Premium service programming usually is significantly\nmore expensive than the basic service or tier service programming, and consequently cable operators price premium service separately when sold to subscribers.\nThe Manitowoc System also offers to subscribers pay-per-view programming. Pay-per-view is a service that allows subscribers to receive single programs, frequently consisting of motion pictures that have recently completed their theatrical exhibitions and major sporting events, and to pay for such service on a program-by-program basis.\nREVENUES. Monthly service fees for basic, tier and premium services constitute the major source of revenue for the Manitowoc System. In addition, advertising sales are becoming a significant source of revenues for the Manitowoc System. As a result of the adoption by the FCC of new rules under the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), and several rate regulation orders, the rate structures for cable programming services and equipment have been revised. See Regulation and Legislation. At December 31, 1994, the Manitowoc System's monthly basic service rate was $10.78, the monthly basic and tier (\"basic plus\") service rate was $19.86 and the monthly premium services ranged from $6.28 to $9.95 per premium service. Charges for additional outlets have been eliminated, and charges for remote controls and converters have been \"unbundled\" from the programming service rates. In addition, the Venture earns revenues from the pay-per-view programs and advertising fees. Related charges may include a nonrecurring installation fee that ranges from $6.10 to $35.00; however, from time to time the Manitowoc System has followed the common industry practice of reducing or waiving the installation fee during promotional periods. Commercial subscribers such as hotels, motels and hospitals are charged a nonrecurring connection fee that usually covers the cost of installation. Except under the terms of certain contracts with commercial subscribers and residential apartment and condominium complexes, the subscribers are free to discontinue the service at any time without penalty. For the year ended December 31, 1994, of the total fees received by the Manitowoc System, basic service and tier service fees accounted for approximately 73% of total revenues, premium service fees accounted for approximately 16% of total revenues, pay-per-view fees were approximately 1% of total revenues, advertising fees were approximately 4% of total revenues and the remaining 6% of total revenues came principally from equipment rentals, installation fees and program guide sales. The Venture is dependent upon the timely receipt of service fees to provide for maintenance and replacement of plant and equipment, current operating expenses and other costs of the Manitowoc System.\nThe Venture's business consists of providing cable television services to a large number of customers, the loss of any one of which would have no material effect on the Venture's business. The Manitowoc System has had some subscribers who later terminated the service. Terminations occur primarily because people move to another home or to another city. In other cases, people terminate on a seasonal basis or because they no longer can afford or are dissatisfied with the service. The amount of past due accounts in the Manitowoc System is not significant. The General Partner's policy with regard to past due accounts is basically one of disconnecting service before a past due account becomes material.\nThe Venture does not depend to any material extent on the availability of raw materials; it carries no significant amounts of inventory and it has no material backlog of customer orders. Neither the Venture nor the Partnership has any employees because all properties are managed by employees of the General Partner. The General Partner has engaged in research and development activities relating to the provision of new services but the amount of the Venture's funds expended for such research and development has never been material.\nCompliance with Federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment or otherwise relating to the protection of the environment has had no material effect upon the capital expenditures, earnings or competitive position of the Venture.\nCOMPETITION FOR SUBSCRIBERS IN THE MANITOWOC SYSTEM. There are two MMDS operators in the Manitowoc System that have begun operation in the Manitowoc System's service area and provide minimal competition, and there are four TVRO dealers that provide minimal competition.\nREGULATION AND LEGISLATION. The cable television industry is regulated through a combination of the Federal Communications Commission (\"FCC\"), some state governments, and most local governments. In addition, the Copyright Act of 1976 imposes copyright liability on all cable television systems. Cable television operations are subject to local regulation insofar as systems operate under franchises granted by local authorities.\nCable Television Consumer Protection and Competition Act of 1992. On October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which became effective on December 4, 1992. This legislation has caused significant changes to the regulatory environment in which the cable television industry operates. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. Under the 1992 Cable Act's definition of effective competition, nearly all cable television systems in the United States, including those owned and managed by the General Partner, are subject to rate regulation of basic cable services. In addition, the 1992 Cable Act allows the FCC to regulate rates for non-basic service tiers other than premium services in response to complaints filed by franchising authorities and\/or cable subscribers. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. The FCC's rules became effective on September 1, 1993.\nIn compliance with these rules, the General Partner reduced rates charged for certain regulated services effective September 1, 1993. These reductions resulted in some decrease in revenues and operating income before depreciation and amortization; however, the decrease was not as severe as originally anticipated. The General Partner has undertaken actions to mitigate a portion of these reductions primarily through (a) new service offerings in some systems, (b) product re-marketing and re- packaging and (c) marketing efforts directed at non-subscribers.\nOn February 22, 1994, however, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The FCC's new regulations generally require rate reductions, absent a successful cost-of-service showing, of 17% of September 30, 1992 rates, adjusted for inflation, channel modifications, equipment costs, and increases in programming costs. However, the FCC held rate reductions in abeyance in certain systems. The new regulations became effective on May 15, 1994, but operators could elect to defer rate reductions to July 14, 1994, so long as they made no changes in their rates and did not restructure service offerings between May 15 and July 14.\nOn February 22, 1994, the FCC also adopted interim cost-of-service regulations. Rate reductions will not be required where it is successfully demonstrated that rates for basic and other regulated programming services are justified and reasonable using cost-of-service standards. The FCC established an interim industry-wide 11.25% permitted rate of return, and requested comments on whether this standard and other interim cost-of-service standards should be made permanent. The FCC also established a presumption that acquisition costs above a system's book value should be excluded from the rate base, but the FCC will consider individual showings to rebut this presumption. The need for special rate relief will also be considered by the FCC if an operator demonstrates that the rates set by a cost-of-service proceeding would constitute confiscation of investment, and that, absent a higher rate, the return necessary to operate and to attract investment could not be maintained. The FCC will establish a uniform system of accounts for operators that elect cost-of-service rate regulation, and the FCC has adopted affiliate transaction regulations. After a rate has been set pursuant to a cost-of-service showing, rate increases for regulated services will be indexed for inflation, and operators will also be permitted to increase rates in response to increases in costs beyond their control, such as taxes and increased programming costs.\nAfter analyzing the effects of the two methods of rate regulation, the Venture complied with the new benchmark regulations and further reduced rates in its Manitowoc System. The Venture will continue its efforts to mitigate the effect of such rate reductions.\nAmong other issues addressed by the FCC in its February rate orders was the treatment of packages of a la carte channels. The FCC in its rate regulations adopted April 1, 1993, exempted from rate regulation the price of packages of a la carte channels upon the fulfillment of certain conditions. On November 10, 1994, the FCC\nreversed its policy regarding rate regulation of packages of a la carte services. A la carte services that are offered in a package will now be subject to rate regulation by the FCC, although the FCC indicated that it cannot envision circumstances in which any price for a collective offering of premium channels that have traditionally been offered on a per-channel basis would be found to be unreasonable.\nOn November 10, 1994, the FCC also announced a revision to its regulations governing the manner in which cable operators may charge subscribers for new cable programming services. In addition to the present formula for calculating the permissible rate for new services, the FCC instituted a three-year flat fee mark-up plan for charges relating to new channels of cable programming services. Commencing on January 1, 1995, operators may charge for new channels of cable programming services added after May 14, 1994 at a rate of up to 20 cents per channel, but may not make adjustments to monthly rates totaling more than $1.20 plus an additional 30 cents for programming license fees per subscriber over the first two years of the three-year period for these new services. Operators may charge an additional 20 cents in the third year only for channels added in that year plus the costs for the programming. Operators electing to use the 20 cent per channel adjustment may not also take a 7.5% mark-up on programming cost increases, which is permitted under the FCC's current rate regulations. The FCC has requested further comment as to whether cable operators should continue to receive the 7.5% mark-up on increases in license fees on existing programming services.\nThe FCC also announced that it will permit operators to offer a \"new product tier\" (\"NPT\"). Operators will be able to price this tier as they elect so long as, among other conditions, other channels that are subject to rate regulation are priced in conformity with applicable regulations and operators do not remove programming services from existing tiers and offer them on the NPT.\nThere have been several lawsuits filed by cable operators and programmers in Federal court challenging various aspects of the 1992 Cable Act, including provisions relating to mandatory broadcast signal carriage, retransmission consent, access to cable programming, rate regulations, commercial leased channels and public access channels. On April 8, 1993, a three-judge Federal district court panel issued a decision upholding the constitutionality of the mandatory signal carriage requirements of the 1992 Cable Act. That decision was appealed directly to the United States Supreme Court. The United States Supreme Court vacated the lower court decision on June 27, 1994 and remanded the case to the district court for further development of a factual record. The Supreme Court's majority determined that the must-carry rules were content neutral, but that it was not yet proven that the rules were needed to preserve the economic health of the broadcasting industry. In the interim, the must-carry rules will remain in place during the pendency of the proceedings in district court. In 1993, a Federal district court for the District of Columbia upheld provisions of the 1992 Cable Act concerning rate regulation, retransmission consent, restrictions on vertically integrated cable television operators and programmers, mandatory carriage of programming on commercial leased channels and public, educational and governmental access channels and the exemption for municipalities from civil damage liability arising out of local regulation of cable services. The 1992 Cable Act's provisions providing for multiple ownership limits for cable operators and advance notice of free previews for certain programming services have been found unconstitutional, and these decisions have been appealed. In November 1993, the United States Court of Appeals for the District of Columbia held that the FCC's regulations implemented pursuant to Section 10 of the 1992 Cable Act, which permit cable operators to ban indecent programming on public, educational or governmental access channels or leased access channels, were unconstitutional, but the court has agreed to reconsider its decision. All of these decisions construing provisions of the 1992 Cable Act and the FCC's implementing regulations have been or are expected to be appealed.\nOwnership and Market Structure. The FCC rules and Federal law generally prohibit the direct or indirect common ownership, operation, control or interest in a cable television system, on the one hand, and a local television broadcast station whose television signal reaches any portion of the community served by the cable television system, on the other hand. The FCC recently lifted its ban on the cross-ownership of cable television systems by broadcast networks. The FCC revised its regulations to permit broadcast networks to acquire cable television systems serving up to 10% of the homes passed in the nation, and up to 50% of the homes passed in a local market. Neither the Partnership nor the General Partner has any direct or indirect ownership, operation,\ncontrol or interest in a television broadcast station, or a telephone company, and they are thus presently unaffected by the cross-ownership rules.\nThe Cable Communications Policy Act of 1984 (the \"1984 Cable Act\") and FCC regulations generally prohibit the common operation of a cable television system and a telephone company within the same service area. Until recently, a provision of a Federal court antitrust consent decree also prohibited the regional Bell operating companies (\"RBOCs\") from engaging in cable television operations. This prohibition was recently removed when the court retaining jurisdiction over the consent decree ruled that the RBOCs could provide information services over their facilities. This decision permits the RBOCs to acquire or construct cable television systems outside of their own service areas.\nThe 1984 Cable Act prohibited local exchange carriers, including the RBOCs, from providing video programming directly to subscribers within their local exchange telephone service areas, except in rural areas or by specific waiver of FCC rules. Several Federal district courts have struck down the 1984 Cable Act's telco\/cross-ownership provision as facially invalid and inconsistent with the First Amendment. The United States Courts of Appeals for the Fourth and the Ninth Circuits have upheld the appeals of two of these district court decisions, and the United States Justice Department is expected to request the United States Supreme Court to review these two decisions. This Federal cross-ownership rule is particularly important to the cable industry since these telephone companies already own certain facilities needed for cable television operation, such as poles, ducts and associated rights-of-way.\nThe FCC amended its rules in 1992 to permit local telephone companies to offer \"video dialtone\" service for video programmers, including channel capacity for the carriage of video programming and certain noncommon carrier activities such as video processing, billing and collection and joint marketing arrangements. In its video dialtone order, which was part of a comprehensive proceeding examining whether and under what circumstances telephone companies should be allowed to provide cable television services, including video programming to their customers, the FCC concluded that neither the 1984 Cable Act nor its rules apply to prohibit the interexchange carriers (i.e., long distance telephone companies such as AT&T) from providing such services to their customers. Additionally, the FCC also concluded that where a local exchange carrier (\"LEC\") makes its facilities available on a common carrier basis for the provision of video programming to the public, the 1984 Cable Act does not require the LEC or its programmer customers to obtain a franchise to provide such service. This aspect of the FCC's video dialtone order was upheld on appeal by the United States Court of Appeals for the D.C. Circuit. The FCC recently issued an order reaffirming its initial decision, and this order has been appealed. Because cable operators are required to bear the costs of complying with local franchise requirements, including the payment of franchise fees, the FCC's decision could place cable operators at a competitive disadvantage vis-a-vis services offered on a common carrier basis over local telephone company provided facilities. In its Reconsideration Order, the FCC, among other actions, refused to require telephone companies to justify cost allocations prior to the construction of video dialtone facilities, and indicated that it would provide guidance on costs that must be included in proposed video dialtone tariffs. The FCC also established dual Federal\/state jurisdiction over video dialtone services based on the origination point of the video dialtone programming service. In a separate proceeding, the FCC has proposed to increase the numerical limit on the population of areas qualifying as \"rural\" and in which LECs can provide cable service without a FCC waiver.\nOn January 12, 1995, the FCC adopted a Fourth Further Notice of Proposed Rulemaking in its video dialtone docket. The FCC tentatively concluded that it should not ban telephone companies from providing their own video programming over their video dialtone platforms in those areas in which the cable\/telephone cross-ownership rules have been found unconstitutional. The FCC requested comments on this issue and on further refinements of its video dialtone regulatory framework concerning, among other issues, telephone programmer affiliation standards, the establishment of structural safeguards to prevent cross-subsidization of video dialtone and programming activities, and the continuation of the FCC's ban prohibiting telephone companies from acquiring cable systems within their telephone service areas for the provision of video dialtone services. The FCC will also consider whether a LEC offering video dialtone service must secure a local franchise if that LEC also engages in the provision of video programming carried on its video dialtone platform. The FCC has also proposed to broadly interpret its authority to waive the cable\/telephone cross-ownership ban upon a showing by\ntelephone companies that they comply with the safeguards which the FCC establishes as a condition of providing video programming.\nA number of bills that would have permitted telephone companies to provide cable television service within their own service areas were considered during the last Congress, but none were adopted. These bills would have permitted the provision of cable television service by telephone companies in their own service areas conditioned on the establishment of safeguards to prevent cross-subsidization between telephone and cable television operations and the provision of telecommunication services by cable television systems. Similar legislation is expected to be considered by Congress during its current session. The outcome of these FCC, legislative or court proceedings and proposals or the effect of such outcome on cable system operations cannot be predicted.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Manitowoc System was acquired by the Venture in April 1984. The following sets forth (i) the monthly basic plus service rates charged to subscribers, (ii) the number of basic subscribers and pay units and (iii) the range of franchise expiration dates for the Manitowoc System. The monthly basic service rates set forth herein represent the basic service rate charged to the majority of the subscribers within the Manitowoc System. While the charge for basic plus service may have increased in 1993 in some cases as a result of the FCC's rate regulations, overall revenues to the Venture may have decreased due to the elimination of charges for additional outlets and certain equipment. In cable television systems, basic subscribers can subscribe to more than one pay TV service. Thus, the total number of pay services subscribed to by basic subscribers are called pay units. As of December 31, 1994, the Manitowoc System operated approximately 200 miles of cable plant, passing approximately 15,000 homes, representing an approximate 67% penetration rate. Figures for numbers of subscribers, miles of cable plant and homes passed are compiled from the General Partner's records and may be subject to adjustments.\nThe franchise expiration date is November 1995. The franchise renewal process has begun, and the General Partner expects that it will be completed in 1995.\nProgramming Services\nProgramming services provided by the Manitowoc System include local affiliates of the national broadcast networks, local independent broadcast channels, the traditional satellite services (e.g., American Movie Classics, Arts & Entertainment, Black Entertainment Network, C-SPAN, The Discovery Channel, Lifetime, Entertainment Sports Network, Home Shopping Network, Mind Extension University, Music Television, Nickelodeon, Turner Network Television, The Nashville Network, Video Hits One, and superstations WOR, WGN and TBS. The Manitowoc System also provides a selection of premium channel programming (e.g., Cinemax, Encore, Home Box Office, Showtime and The Movie Channel).\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 STOCK AND RELATED SECURITY HOLDER MATTERS\nWhile the Partnership is publicly held, there is no public market for the limited partnership interests, and it is not expected that a market will develop in the future. As of February 15, 1995, the approximate number of equity security holders in the Partnership was 4,003.\nItem 6.","section_6":"Item 6. Selected Financial Data\n* Activity in Cable TV Fund 11-D is limited to its approximate 47 percent equity interest in Joint Fund 11. See selected financial data for Joint Fund 11.\n(a) The sale of Joint Fund 11's Wisconsin systems, except the City of Manitowoc area, in June 1990 resulted in a gain of $112,939,662.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nCABLE TV FUND 11-D\nResults of Operations\nSubstantially all of the Partnership's operations are generated through its 47 percent interest in Cable TV Joint Fund 11 (\"Joint Fund 11\"). Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations for Joint Fund 11 for details pertaining to its operations.\nFinancial Condition\nThe Partnership's investment in Joint Fund 11, accounted for under the equity method, has increased by $174,985 from $2,324,240 at December 31, 1993 to $2,499,225 at December 31, 1994. This increase represents the Partnership's proportionate share of income generated by Joint Fund 11. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations for Joint Fund 11 for details pertaining to its financial condition.\nCABLE TV JOINT FUND 11\nResults of Operations\n1994 compared to 1993\nRevenues in Joint Fund 11's Manitowoc System increased $3,428 from $3,292,675 in 1993 to $3,296,103 in 1994. An increase in the subscriber base primarily accounted for the increase in revenues. Basic subscribers increased 1,066, or approximately 11 percent, from 9,768 at December 31, 1993 to 10,834 at December 31, 1994. Premium service subscriptions increased 1,795, or approximately 34 percent, from 5,296 at December 31, 1993 to 7,091 at December 31, 1994. The increase in revenues would have been greater but for reductions in basic rates due to basic rate regulations issued by the FCC in April 1993 and February 1994. See Item 1. No other individual factor was significant to the increase in revenues.\nOperating, general and administrative expense in the Manitowoc System increased $79,695, or approximately 4 percent, from $1,947,068 in 1993 to $2,026,763 in 1994. The increase in expense was due primarily to increases in programming fees and marketing related costs due to increases in basic subscribers and premium service subscriptions. These increases were partially offset by a decrease in copyright fees. No other individual factors contributed significantly to the increase in expense. Operating, general and administrative expense represented 59 percent of revenues in 1993 compared to 61 percent of revenues in 1994. Management fees and allocated overhead from the General Partner increased $25,981, or approximately 6 percent, from $411,577 in 1993 to $437,558 in 1994. The increase was due to an increase in allocated expenses from the General Partner. The General Partner has experienced increases in expenses, including personnel costs and reregulation costs, a portion of which is allocated to Joint Fund 11.\nDepreciation and amortization expense in the Manitowoc System increased $5,152, or approximately 1 percent, from $517,441 in 1993 to $522,593 in 1994 due to capital additions in 1993 and 1994.\nOperating income in the Manitowoc System decreased $107,400, or approximately 26 percent, from $416,589 in 1993 compared to $309,189 in 1994. The decrease was due to the increases in operating, general and administrative expense, allocated overhead from the General Partner and depreciation and amortization expense exceeding the increase in revenues. Operating income before depreciation and amortization for the Manitowoc System decreased $102,248, or approximately 11 percent, from $934,030 in 1993 to $831,782 in 1994. The decrease was due to the increases in operating, general and administrative expense and allocated overhead from the General Partner exceeding the increase in revenues. The decrease in operating income before depreciation and amortization reflects the current operating environment of the cable television industry. The FCC rate regulations under the 1992 Cable Act have caused revenues to increase more slowly than otherwise would have been the case. In turn, this has caused certain expenses which are a function of revenue, such as franchise fees, copyright fees and management fees to increase more slowly than otherwise would have been the case. However, other operating costs such as programming fees, salaries and benefits, and marketing costs as well as other costs incurred by the General Partner, which are allocated to Joint Fund 11, continue to increase at historical rates. This situation has led to reductions in operating income before depreciation and amortization as a percent of revenue (\"Operating Margin\"). Such reductions in Operating Margins may continue in the near term as Joint Fund 11 and the General Partner incur cost increases due to, among other things, programming fees, reregulation and competition, that exceed increases in revenue. The General Partner will attempt to mitigate a portion of these reductions through (a) new service offerings; (b) product re-marketing and re-packaging and (c) marketing efforts directed at non-subscribers.\nInterest expense for Joint Fund 11 decreased $7,196, or approximately 31 percent, from $22,912 in 1993 to $15,716 in 1994 due to a lower outstanding balance on interest bearing obligations. Other expense decreased from $248,912 in 1993 to $7,426 in 1994, primarily as a result of Joint Fund 11 incurring costs associated with the litigation with the City of Manitowoc during 1993. No such costs were incurred in 1994. Net income for Joint Fund 11 increased $126,645, or approximately 51 percent, from $246,536 in 1993 to $373,181 in 1994 due primarily to the decrease in litigation costs discussed above.\n1993 compared to 1992\nRevenues in the Manitowoc System increased $48,652, or approximately 2 percent, from $3,244,023 in 1992 to $3,292,675 in 1993. An increase in basic subscribers primarily accounted for the increase in revenues. The system added\napproximately 350 basic subscribers in 1993, an increase of 4 percent. The increase in revenues would have been greater but for the reduction in basic rates due to basic rate regulations issued by the FCC in April 1993 with which Joint Fund 11 complied effective September 1, 1993. No other individual factor contributed significantly to the increase in revenues.\nOperating, general and administrative expense in the Manitowoc System increased $32,175, or approximately 2 percent, from $1,914,893 in 1992 to $1,947,068 in 1993. The increase in expense was due primarily to increases in programming fees and marketing related expense. No other individual factors contributed significantly to the increase in expense. Operating, general and administrative expense represented 59 percent of revenues in both 1992 and 1993. Management fees and allocated overhead from Jones Intercable, Inc. increased $7,615, or approximately 2 percent, from $403,962 in 1992 to $411,577 in 1993. The increase was due to the increase in revenues, upon which such fees and allocations are based, and increases in allocated expenses from the General Partner. Depreciation and amortization expense in the Manitowoc System increased $18,331, or approximately 4 percent, from $499,110 in 1992 to $517,441 in 1993. This increase was due to capital additions in 1992 and 1993.\nOperating income in the Manitowoc System decreased $9,469, or approximately 2 percent, from $426,058 in 1992 compared to $416,589 in 1993. The decrease was due to the increases in operating, general and administrative expense and management fees and allocated overhead from the General Partner and depreciation and amortization expense exceeding the increase in revenues. Operating income before depreciation and amortization for the Manitowoc System increased $8,862, or approximately 1 percent, from $925,168 in 1992 to $934,030 in 1993. The increase was due to the increase in revenues exceeding the increases in operating, general and administrative expense and management fees and allocated overhead from the General Partner.\nInterest expense for Joint Fund 11 increased from $14,803 in 1992 to $22,912 in 1993. Other expense, due primarily to costs associated with the litigation with the City of Manitowoc in 1993, totalled $248,912 compared to $184,118 in 1992. Net income for Joint Fund 11 decreased $79,011, or approximately 24 percent, from $325,547 in 1992 to $246,536 in 1993. The decrease was due primarily to the aforementioned litigation costs.\nFinancial Condition\nOn June 29, 1990, Joint Fund 11 completed the sale of all of its Wisconsin cable television systems, except for the system serving the City of Manitowoc (the \"Manitowoc System\"). The Manitowoc System was not sold because the City of Manitowoc (the \"City\") did not consent to the transfer of the franchise. The City of Manitowoc franchise contains a provision that the City claimed allowed the City to acquire the Manitowoc System upon expiration of the franchise. On April 9, 1991, Joint Fund 11 took legal action, seeking a declaration as to whether the buy-out right was enforceable under Federal law. In October 1993, the City and Joint Fund 11 settled the legal action. In the settlement, the City conceded that its buy-out right was not applicable in the event the franchise is renewed, and represented to Joint Fund 11 that it knew of no reason for non-renewal of the franchise. The City also agreed that the term of the renewal franchise would be 12 years and that the applicable franchise fee would be 5 percent. Joint Fund 11 paid the City $1,850,000, which will be returned, with interest, in the event that the City does not renew the franchise. If the franchise is renewed, the $1,850,000 will be amortized over the life of the franchise. The franchise renewal process has begun and the General Partner expects that it will be completed in 1995.\nJoint Fund 11 had no bank debt outstanding at December 31, 1994.\nDuring 1994, Joint Fund 11 expended approximately $380,000 for capital expenditures in the Manitowoc System. These expenditures were used for various projects to maintain the value of the system. These expenditures were funded from cash generated from operations.\nBudgeted capital expenditures in 1995 for the Manitowoc System are approximately $273,000. These expenditures will relate to various enhancements to maintain the value of the Manitowoc System. It is expected that these capital expenditures will be funded from cash on hand and cash generated from operations. Joint Fund 11 has sufficient liquidity and capital resources, including cash on hand and its ability to generate cash from operations, to meet its anticipated needs.\nRegulation and Legislation\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. Joint Fund 11 complied with the February 1994 benchmark regulations and further reduced rates in its Manitowoc System effective July 1994. See Item 1 for further discussion of the provisions of the 1992 Cable Act and the FCC regulations promulgated thereunder.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements\nCABLE TV FUND 11-D AND CABLE TV JOINT FUND 11\nFINANCIAL STATEMENTS\nAS OF DECEMBER 31, 1994 AND 1993\nINDEX\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Cable TV Fund 11-D:\nWe have audited the accompanying balance sheets of CABLE TV FUND 11-D (a Colorado limited partnership) as of December 31, 1994 and 1993, and the related statements of operations, partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the General Partner'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 Cable TV Fund 11-D as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1995.\nCABLE TV FUND 11-D (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV FUND 11-D (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-D (A Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-D (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV FUND 11-D (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nCable TV Fund 11-D, Ltd. (\"the Partnership\"), a Colorado limited partnership, was formed on January 24, 1984, under a public program sponsored by Jones Intercable, Inc. The Partnership was formed to acquire, construct, develop and operate cable television systems. Jones Intercable, Inc. is the \"General Partner\" and manager of the Partnership. The General Partner and its subsidiaries also own and operate cable television systems. In addition, the General Partner manages cable television systems for other limited partnerships for which it is general partner and for affiliated entities. The Partnership owns an interest of approximately 47 percent in Cable TV Joint Fund 11 (\"Joint Fund 11\") through capital contributions made during 1984 of $21,100,000, net of commissions and syndication costs.\nContributed Capital\nThe capitalization of the Partnership is set forth in the accompanying statements of partners' capital (deficit). No limited partner is obligated to make any additional contribution to partnership capital.\nThe General Partner purchased its interest in the Partnership by contributing $1,000 to partnership capital.\nAll profits and losses of the Partnership are allocated 99 percent to the limited partners and 1 percent to the General Partner, except for income or gain from the sale or disposition of cable television properties, which will be allocated to the partners based upon the formula set forth in the Partnership Agreement and interest income earned prior to the first acquisition by the Partnership of a cable television system, which was allocated 100 percent to the limited partners.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. The Partnership's tax returns are also prepared on the accrual basis.\nInvestment in Cable Television Joint Venture\nThe Partnership's investment in Joint Fund 11 is accounted for under the equity method. When compared to the December 31, 1993 balance, this investment has increased by $174,985. This increase represents the Partnership's share of income generated by Joint Fund 11 during 1994. The operations of Joint Fund 11 are significant to the Partnership and should be reviewed in conjunction with these financial statements. Reference is made to the accompanying financial statements of Joint Fund 11 on pages 22 to 31.\n(3) TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES\nManagement Fees and Distribution Ratios\nThe General Partner manages the Partnership and Joint Fund 11 and receives a fee for its services equal to 5 percent of the gross revenues of Joint Fund 11, excluding revenues from the sale of cable television systems or franchises.\nAny distributions made from cash flow (defined as cash receipts derived from routine operations, less debt principal and interest payments and cash expenses) are allocated 99 percent to the limited partners and 1 percent to the General Partner. Any distributions other than interest income on limited partner subscriptions earned prior to the acquisition of the Partnership's first cable television system or from cash flow, such as from the sale or refinancing of a system or upon dissolution of the Partnership, will be made as follows: first, to the limited partners in an amount which, together with all prior distributions, will equal the amount initially contributed to the Partnership capital by the limited partners; the balance, 75 percent to the limited partners and 25 percent to the General Partner. In July 1990, a distribution of $49,016,548 was made to the limited partners from funds received from Joint Fund 11. This amount included the return of initial contributed capital of $25,000,000. In addition, $8,005,517 was distributed to the General Partner. Any future distributions will be made 75 percent to the limited partners and 25 percent to the General Partner.\n(4) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because they accrue directly to the partners. The Federal and state income tax returns of the Partnership are prepared and filed by the General Partner.\nThe Partnership's tax returns, the qualification of the partnership as such for tax purposes, and the amount of distributable income or loss are subject to examination by Federal and state taxing authorities. If such examinations result in changes with respect to the Partnership's qualification as such, or in changes with respect to the Partnership's recorded income or loss, the tax liability of the general and limited partners would likely be changed accordingly.\nTaxable income reported to the partners is different from that reported in the statements of operations due to the difference in depreciation allowed under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable income and the net income reported in the statements of operations.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Cable TV Joint Fund 11:\nWe have audited the accompanying balance sheets of CABLE TV JOINT FUND 11 (a Colorado general partnership) as of December 31, 1994 and 1993, and the related statements of operations, partners' capital and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the General Partners' 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 Cable TV Joint Fund 11 as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1995.\nCABLE TV JOINT FUND 11 (A General Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV JOINT FUND 11 (A General Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nCABLE TV JOINT FUND 11 (A General Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV JOINT FUND 11 (A General Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV JOINT FUND 11 (A General Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nCABLE TV JOINT FUND 11 (A General Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION AND PARTNERS' INTERESTS\nFormation and Business\nCable TV Joint Fund 11 (\"Joint Fund 11\"), a Colorado general partnership, was formed on February 1, 1984, through a joint venture agreement made by and among Fund 11-A, Fund 11-B, Fund 11-C, and Fund 11-D, all Colorado limited partnerships (the \"Joint Venturers\"). Joint Fund 11 was formed to acquire, construct, develop and operate cable television systems. Jones Intercable, Inc. (\"Intercable\"), general partner of each of the Joint Venturers, manages Joint Fund 11. Intercable and its subsidiaries, also own and operate other cable television systems. In addition, Intercable manages cable television systems for limited partnerships for which it is general partner and for affiliated entities.\nOn June 29, 1990, Joint Fund 11 completed the sale of all of its Wisconsin cable television systems, except for the system serving the City of Manitowoc (the \"Manitowoc System\"). The Manitowoc System was not sold because the City of Manitowoc (the \"City\") did not consent to the transfer of the franchise. The City of Manitowoc franchise contains a provision that the City claimed allowed the City to acquire the Manitowoc System upon expiration of the franchise. On April 9, 1991, Joint Fund 11 took legal action, seeking a declaration as to whether the buy-out right was enforceable under Federal law. In October 1993, the City and Joint Fund 11 settled the legal action. In the settlement, the City conceded that its buy-out right was not applicable in the event the franchise is renewed, and represented to Joint Fund 11 that it knew of no reason for non-renewal of the franchise. The City also agreed that the term of the renewal franchise would be 12 years and that the applicable franchise fee would be 5 percent. Joint Fund 11 paid the City $1,850,000, which will be returned, with interest, in the event that the City does not renew the franchise. If the franchise is renewed, the $1,850,000 will be amortized over the life of the franchise. The franchise renewal process has begun and the General Partner expects that it will be completed in 1995.\nContributed Capital, Sharing Ratios and Distribution\nThe capitalization of Joint Fund 11 is set forth in the accompanying statements of partners' capital. Profits and losses of Joint Fund 11 are allocated to the partners in proportion to their respective partnership interests.\nAll partnership distributions, including those made from cash flow (defined as cash receipts derived from routine operations, less debt principal and interest payments and cash expenses), from the sale or refinancing of partnership property and on dissolution of Joint Fund 11, are made to the partners also in proportion to their approximate respective interests in Joint Fund 11 as follows:\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. Joint Fund 11's tax returns are also prepared on the accrual basis.\nProperty, Plant and Equipment\nDepreciation is determined using the straight-line method over the following estimated service lives:\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nIntangible Assets\nCosts assigned to franchises and subscriber lists are amortized using the straight-line method over the following remaining estimated useful lives:\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\n(3) TRANSACTIONS WITH JONES INTERCABLE, INC. AND AFFILIATES\nManagement Fees and Reimbursements\nIntercable manages Joint Fund 11 and receives a fee for its services equal to 5 percent of the gross revenues, excluding revenues from the sale of the cable television systems or franchises. Management fees paid to Intercable during 1994, 1993 and 1992 were $164,805, $164,634 and $162,201, respectively.\nIntercable is reimbursed for certain allocated overhead and administrative expenses. These expenses represent the salaries and related benefits paid to corporate personnel, rent, data processing services and other corporate facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to Joint Fund 11. Allocations of personnel costs are primarily based upon actual time spent by employees of Intercable with respect to each partnership managed. Remaining overhead costs are allocated based on total revenues and\/or the cost of the partnership assets managed. Effective December 1, 1993, the allocation method was changed to be based only on revenue, which Intercable believes provides a more accurate method of allocation. Systems owned by Intercable and all other systems owned by partnerships for which Intercable is the general partner are also allocated a proportionate share of these expenses. Intercable believes that the methodology used in allocating overhead and administrative expenses is reasonable. The amount of allocated overhead and administrative expenses charged to Joint Fund 11 during 1994, 1993 and 1992 was $272,753, $246,943 and $241,761, respectively.\nJoint Fund 11 was charged interest during 1994 at an average interest rate of 10 percent on the amounts due Intercable, which approximated Intercable's weighted average cost of borrowings. Total interest charged during 1994, 1993 and 1992 was $13,306, $21,071 and $12,369, respectively.\nPayments to\/from Affiliates for Programming Services\nJoint Fund 11 receives programming from Product Information Network, Superaudio, The Mind Extension University and Jones Computer Network, affiliates of Intercable. Payments to Superaudio totalled $6,105, $6,040 and $6,007 in 1994, 1993 and 1992, respectively. Payments to The Mind Extension University totalled $5,532, $3,515 and $3,442 in 1994, 1993 and 1992, respectively. Payments to Jones Computer Network, which initiated service in 1994, totalled $3,316 during 1994. Joint Fund 11 receives a commission from Product Information Network based on a percentage of advertising revenue and number of subscribers. Product Information Network, which initiated service in 1994, paid commissions to Joint Fund 11 totalling $510 in 1994.\n(4) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment as of December 31, 1994 and 1993, consisted of the following:\n(5) DEBT\nDebt consists of capital lease obligations with maturities of 1 to 4 years. Installments due on debt principal for the five years in the period ending December 31, 1999, respectively, are: $7,916, $7,916, $7,916, $2,637, and $-0-.\n(6) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because they accrue to the partners of Funds 11-A, 11-B, 11-C and 11-D, which are general partners in Joint Fund 11.\nJoint Fund 11's tax returns, the qualification of the partnership as such for tax purposes, and the amount of distributable partnership income or loss are subject to examination by Federal and state taxing authorities. If such examinations result in changes with respect to the Joint Fund 11's qualification as such, or in changes with respect to the Joint Fund 11's recorded income or loss, the tax liability of the general and limited partners would likely be changed accordingly.\nTaxable income reported to the partners is different from that reported in the statements of operations due to the difference in depreciation allowed under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System (MACRS). There are no other significant differences between taxable income and the net income reported in the statements of operations.\n(7) SUPPLEMENTARY PROFIT AND LOSS INFORMATION\nSupplementary profit and loss information is presented below:\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 Partnership itself has no officers or directors. Certain information concerning the directors and executive officers of the General Partner is set forth below.\nMr. Glenn R. Jones has served as Chairman of the Board of Directors and Chief Executive Officer of the General Partner since its formation in 1970, and he was President from June 1984 until April 1988. Mr. Jones was elected a member of the Executive Committee of the Board of Directors in April 1985. Mr. Jones is the sole shareholder, President and Chairman of the Board of Directors of Jones International, Ltd. He is also Chairman of the Board of Directors of the subsidiaries of the General Partner and of certain other affiliates of the General Partner. Mr. Jones has been involved in the cable television business in various capacities since 1961, is a past and present member of the Board of Directors of the National Cable Television Association, and is a former member of its Executive Committee. Mr. Jones is a past director and member of the Executive Committee of C-Span. Mr. Jones has been the recipient of several awards including the Grand Tam Award in 1989, the highest award from the Cable Television Administration and Marketing Society; the Chairman's Award from the Investment Partnership Association, which is an association of sponsors of public syndications; the cable television industry's Public Affairs Association President's Award in 1990, the Donald G. McGannon award for the advancement of minorities and women in cable; the STAR Award from American Women in Radio and Television, Inc. for exhibition of a commitment to the issues and concerns of women in television and radio; and the Women in Cable Accolade in 1990 in recognition of support of this organization. Mr. Jones is also a founding member of the James Madison Council of the Library of Congress and is on the Board of Governors of the American Society of Training and Development.\nMr. Derek H. Burney was appointed a Director of the General Partner in December 1994 and Vice Chairman of the Board of Directors in January 1995. He is also a member of the Executive Committee of the Board of Directors. Mr. Burney joined BCE Inc., Canada's largest telecommunications company, in January 1993 as Executive Vice President, International. He has been the Chairman of Bell Canada International Inc., a\nsubsidiary of BCE, since January 1993 and, in addition, has been Chief Executive Officer of BCI since July 1993. Prior to joining BCE, Mr. Burney served as Canada's ambassador to the United States from 1989 to 1992. Mr. Burney also served as chief of staff to the Prime Minister of Canada from March 1987 to January 1989 where he was directly involved with the negotiation of the U.S. -- Canada Free Trade Agreement. In July 1993, he was named an Officer of the Order of Canada. Mr. Burney is chairman of Bell Cablemedia plc. He is a director of Mercury Communications Limited, Videotron Holdings plc, Tele-Direct (Publications) Inc., Teleglobe Inc., Bimcor Inc., Maritime Telegraph and Telephone Company, Limited, Moore Corporation Limited and Northbridge Programming Inc.\nMr. James B. O'Brien, the General Partner's President, joined the General Partner in January 1982. Prior to being elected President and a Director of the General Partner in December 1989, Mr. O'Brien served as a Division Manager, Director of Operations Planning\/Assistant to the CEO, Fund Vice President and Group Vice President\/Operations. Mr. O'Brien was appointed to the General Partner's Executive Committee in August 1993. As President, he is responsible for the day-to-day operations of the cable television systems managed and owned by the General Partner. Mr. O'Brien is also President and a Director of Jones Cable Group, Ltd., Jones Global Funds, Inc. and Jones Global Management, Inc., all affiliates of the General Partner. Mr. O'Brien is a board member of Cable Labs, Inc., the research arm of the U.S. cable television industry. He also serves as a director of the Cable Television Administration and Marketing Association and as a director of the Walter Kaitz Foundation, a foundation that places people of any ethnic minority group in positions with cable television systems, networks and vendor companies.\nMs. Ruth E. Warren joined the General Partner in August 1980 and has served in various operational capacities, including system manager and Fund Vice President, since then. Ms. Warren was elected Group Vice President\/Operations of the General Partner in September 1990.\nMr. Kevin P. Coyle joined The Jones Group, Ltd. in July 1981 as Vice President\/Financial Services. In September 1985, he was appointed Senior Vice President\/Financial Services. He was elected Treasurer of the General Partner in August 1987, Vice President\/Treasurer in April 1988 and Group Vice President\/Finance and Chief Financial Officer in October 1990.\nMr. Christopher J. Bowick joined the General Partner in September 1991 as Group Vice President\/Technology and Chief Technical Officer. Previous to joining the General Partner, Mr. Bowick worked for Scientific Atlanta's Transmission Systems Business Division in various technical management capacities since 1981, and as Vice President of Engineering since 1989.\nMr. Timothy J. Burke joined the General Partner in August 1982 as corporate tax manager, was elected Vice President\/Taxation in November 1986 and Group Vice President\/Taxation\/Administration in October 1990.\nMr. Raymond L. Vigil joined the General Partner in June 1993 as Group Vice President\/Human Resources. Previous to joining the General Partner, Mr. Vigil served as Executive Director of Learning with USWest. Prior to USWest, Mr. Vigil worked in various human resources posts over a 14-year term with the IBM Corporation.\nMs. Cynthia A. Winning joined the General Partner as Group Vice President\/Marketing in December 1994. Previous to joining the General Partner, Ms. Winning served since 1994 as the President of PRS Inc., Denver, Colorado, a sports and event marketing company. From 1979 to 1981 and from 1986 to 1994, Ms. Winning served as the Vice President and Director of Marketing for Citicorp Retail Services, Inc., a provider of private-label credit cards for ten national retail department store chains. From 1981 to 1986, Ms. Winning was the Director of Marketing Services for Daniels & Associates cable television operations, as well as the Western Division Marketing Director for Capital Cities Cable. Ms. Winning also serves as a board Member of Cities in Schools, a dropout intervention\/prevention program.\nMs. Elizabeth M. Steele joined the General Partner in August 1987 as Vice President\/General Counsel and Secretary. From August 1980 until joining the General Partner, Ms. Steele was an associate and then a partner at the Denver law firm of Davis, Graham & Stubbs, which serves as counsel to the General Partner.\nMr. Larry Kaschinske joined the General Partner in 1984 as a staff accountant in the General Partner's former Wisconsin Division; was promoted to Assistant Controller in 1990 and named Controller in August 1994.\nMr. James J. Krejci was President of the International Division of International Gaming Technology International headquartered in Reno, Nevada, until March 1995. Prior to joining IGT in May 1994, Mr. Krejci was Group Vice President of Jones International, Ltd. and a Group Vice President of the General Partner. Prior to May 1994, he also served as Group Vice President of Jones Futurex, Inc., an affiliate of the General Partner engaged in manufacturing and marketing data encryption devices, Jones Interactive, Inc., a subsidiary of Jones International, Ltd. providing computer data and billing processing facilities and Jones Lightwave, Ltd., a company owned by Jones International, Ltd. and Mr. Jones, which is engaged in the provision of telecommunications services. Mr. Krejci has been a Director of the General Partner since August 1987.\nMs. Christine Jones Marocco was appointed a Director of the General Partner in December 1994. She is the daughter of Glenn R. Jones. Ms. Marocco is also a director of Jones International, Ltd.\nMr. Daniel E. Somers was appointed a Director of the General Partner in December 1994 and also serves on the General Partner's Audit Committee. From January 1992 to January 1995, Mr. Somers worked as Senior Vice President and Chief Financial Officer of Bell Canada International Inc. and was appointed Executive Vice President and Chief Financial Officer on February 1, 1995. He is also a Director of certain of its affiliates. Prior to joining Bell Canada International Inc. and since January 1989, Mr. Somers was the President and Chief Executive Officer of Radio Atlantic Holdings Limited. Mr. Somers is a member of the North American Society of Corporate Planning, the Financial Executives Institution and the Financial Analysts Federation.\nMr. Robert S. Zinn was appointed a Director of the General Partner in December 1994. Mr. Zinn joined the General Partner in January 1991 and is a member of its Legal Department. He is also Vice President\/Legal Affairs of Jones International, Ltd. Prior to joining the General Partner, Mr. Zinn was in private law practice in Denver, Colorado for over 25 years.\nMr. David K. Zonker was appointed a Director of the General Partner in December 1994. Mr. Zonker has been the President of Jones International Securities, Ltd., a subsidiary of Jones International, Ltd. since January 1984 and he has been its Chief Executive Officer since January 1988. From October 1980 until joining Jones International Securities, Ltd. in January 1984, Mr. Zonker was employed by the General Partner. Mr. Zonker is a member of the Board of Directors of various affiliates of the General Partner, including Jones International Securities, Ltd. Mr. Zonker is licensed by the National Association of Securities Dealers, Inc. and he is a past chairman of the Investment Program Association, a trade organization based in Washington, D.C. that promotes direct investments. He is a member of the Board of Trustees of Graceland College, Lamoni, Iowa; the International Association of Financial Planners and the American and Colorado Institutes of Certified Public Accountants.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no employees; however, various personnel are required to operate the cable television systems owned by the Partnership. Such personnel are employed by the General Partner and, pursuant to the terms of the limited partnership agreement of the Partnership, the cost of such employment is charged by the General Partner to the Partnership as a direct reimbursement item. See Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGERS\nNo person or entity owns more than 5 percent of the limited partnership interests of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe General Partner and its affiliates engage in certain transactions with the Venture. The General Partner believes that the terms of such transactions are generally as favorable as could be obtained by the Venture from unaffiliated parties. This determination has been made by the General Partner in good faith, but none of the terms were or will be negotiated at arm's-length and there can be no assurance that the terms of such transactions have been or will be as favorable as those that could have been obtained by the Venture from unaffiliated parties.\nThe General Partner charges a management fee, and the General Partner is reimbursed for certain allocated overhead and administrative expenses. These expenses consist primarily of salaries and benefits paid to corporate personnel, rent, data processing services and other facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner. Remaining overhead costs are allocated based on revenues and\/or the costs of assets managed. Systems owned by the General Partner and all other systems owned by partnerships for which Jones Intercable, Inc. is the general partner, are also allocated a proportionate share of these expenses.\nThe General Partner also advances funds and charges interest on the balance payable. The interest rate charged approximates the General Partner's weighted average cost of borrowing.\nThe Manitowoc System receives stereo audio programming from Superaudio, a joint venture owned 50% by an affiliate of the General Partner and 50% by an unaffiliated party, educational video programming from Mind Extension University, Inc., an affiliate of the General Partner, and computer video programming from Jones Computer Network, Ltd., an affiliate of the General Partner, for fees based upon the number of subscribers receiving the programming.\nProduct Information Network (\"PIN\"), an affiliate of the General Partner, provides advertising time for third parties on the Manitowoc System. In consideration, the revenues generated from the third parties are shared two-thirds and one-third between PIN and the Venture. During the year ended December 31, 1994, the Venture received revenues from PIN of $510.\nThe charges to the Venture for related party transactions are as follows for the periods indicated:\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. See index to financial statements for the list of financial statements and exhibits thereto filed as part of this report.\n3. The following exhibits are filed herewith.\n4.1 Limited Partnership Agreement of Cable TV Fund 11-D. (1)\n10.1.1 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Manitowoc, Wisconsin. (Joint Fund 11) (1)\n27 Financial Data Schedule\n- ----------\n(1) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1985.\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.\nCABLE TV FUND 11-D, LTD. a Colorado limited partnership By: Jones Intercable, Inc.\nBy: \/s\/ Glenn R. Jones ------------------ Glenn R. Jones Chairman of the Board and Chief Dated: March 21, 1995 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.\nINDEX TO EXHIBITS\nEXHIBIT DESCRIPTION ------- -----------\n4.1 Limited Partnership Agreement of Cable TV Fund 11-D. (1)\n10.1.1 Copy of a franchise and related documents thereto granting a community antenna television system franchise for the City of Manitowoc, Wisconsin. (Joint Fund 11) (1)\n27 Financial Data Schedule\n- ----------\n(1) Incorporated by reference from Registrant's Report on Form 10-K for the fiscal year ended December 31, 1985.","section_15":""}
{"filename":"30819_1994.txt","cik":"30819","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe following is a summary by industry segment of the properties occupied by the Company.\nAll plants are of adequate capacity and are utilized generally on a one-shift basis except for the Burbank, California facility, portions of which are utilized on a two-shift basis. The Winsted, CT facility of the Waring Products Division is utilized as a records storage facility and is also available for sale. Approximately 76,000 square feet of the Scranton, PA facility of the Anemostat Products Division has been leased on a short-term basis.\nProperties Held for Sale:\nThe following property, previously operated by the Company, is being held for sale or disposition by the Company:\nYazoo City, MS 80,000 Modern 1 Lease expiring story 3\/4\/98\nThe above property is currently subleased on a short-term basis.\nThe following property, which continues to be occupied and operated by the Fermont division, is held for sale in connection with the sale of the Fermont business.\nBridgeport, CT 97,000 2 Modern Fee Ownership bldgs; 2 stories & 1 story\nItem 3.","section_3":"Item 3. Legal Proceedings\nWith respect to claims and actions against the Company, including environmental matters, it is the opinion of Management that they will have no material effect on the 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 Registrant\nName Age Office\nAndrew Lozyniak 63 Chairman of the Board and President\nHenry V. Kensing 61 Vice President, General Counsel and Secretary\nPatrick J. Dorme 59 Vice President-Finance and Chief Financial Officer\nRichard E.Smith 46 Treasurer\nThe officers named above were elected to hold the offices set opposite their respective names until the meeting of directors following the next annual meeting of shareholders. Henry V. Kensing was elected Secretary of the Corporation by the Board of Directors on February 23, 1994.\nExcept as above stated, the officers named above have served in their respective capacities for the past five years.\nThere are no family relationships between any directors or executive officers of the Company.\nPart II Item 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters\nRange of Stock Prices and Dividend Information on page 24 of the annual report to security holders for the year ended December 31, 1994 is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected Financial Data on page 22 of the annual report to security holders for the year ended December 31, 1994 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 Results of Operations and Financial Condition on pages 4 through 7 of the annual report to security holders for the year ended December 31, 1994 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 registrant and its subsidiaries are included in the annual report to security holders for the year ended December 31, 1994 and are incorporated herein by reference.\nPage(s) in the Annual Report\nConsolidated Balance Sheets--As of December 31, 1994 and 1993 8\nConsolidated Statements of Income--For the Years Ended December 31, 1994, 1993 and 1992 9\nConsolidated Statements of Stockholders' Equity--For the Years Ended December 31, 1994, 1993 and 1992 10\nConsolidated Statements of Cash Flows--For the Years Ended December 31, 1994, 1993 and 1992 11\nNotes to Consolidated Financial Statements 12-20\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\nIdentification of directors of the registrant and information related thereto is included in the definitive proxy statement for the Annual Meeting of Shareholders to be held on May 5, 1995, under caption \"Election of Directors\", and said information is incorporated herein by reference.\nIdentification of executive officers of the registrant and information related thereto is included in Part I of this Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nRemuneration of directors and officers and information related thereto is included in the definitive proxy statement for the Annual Meeting of Shareholders to be held on May 5, 1995, under the captions \"Election of Directors\", including information on the Stock Retirement Plan for Outside Directors, and under the captions \"Executive Compensation\", \"Pension Benefits\", \"Savings and Investment Plan\" and \"1980 Restricted Stock and Cash Bonus Plan\", and said information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nSecurity ownership of management and of certain beneficial owners and information related thereto is included in the definitive proxy statement for the Annual Meeting of Shareholders to be held May 5, 1995, under the captions \"Election of Directors\" and \"Security Ownership of Certain Beneficial Owners\", and said information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nTransactions with management and others and information related thereto is included in the definitive proxy statement for the Annual Meeting of Shareholders to be held on May 5, 1995, under the caption \"Transactions with Management and Others\", and said 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)(1) The report of independent auditors and the following consolidated financial statements of the registrant and its subsidiaries included in the annual report to security holders for the year ended December 31, 1994 are incorporated by reference in Item 8 above:\nConsolidated Balance Sheets--As of December 31, 1994 and 1993\nConsolidated Statements of Income--For the Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Stockholders' Equity--For the Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows--For the Years Ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n(a)(2) and(d) The following consolidated financial statement schedules of the registrant and its subsidiaries are included in this Form 10-K.\nPage(s) Schedule II--Valuation and Qualifying Accounts--For the Years Ended December 31, 1994, 1993 and 1992 15-17\nThe consolidated financial statements of CTS Corporation, the registrant's investment in which is accounted for by the equity method, are subject to the Rules and Regulations of the Securities and Exchange Commission and have been examined by Price Waterhouse, independent accountants for CTS Corporation. The following consolidated financial statement information and schedules concerning CTS Corporation, which are included in CTS Corporation's annual report on Form 10-K for the year ended December 31, 1994, certain consolidated financial statement schedules included in said Form 10-K and CTS Corporation's annual report to stockholders for 1994 attached to said Form 10-K as Exhibit 13 thereto (all of which are included as Exhibit 99 to this Form 10-K), are incorporated by reference herein. Page(s) in CTS Corporation's annual report to stockholders for 1994\nConsolidated Statements of Earnings -- years ended December 31, 1994, 1993 and 1992 12\nConsolidated Statements of Stockholders' Equity -- years ended December 31, 1994, 1993 and 1992 13\nConsolidated Balance Sheets -- December 31, 1994 and 1993 14\nConsolidated Statements of Cash Flows-- years ended December 31, 1994, 1993 and 1992 15\nNotes to Consolidated Financial Statements 16-23\nReport of independent accountants 24\nPage(s) in CTS Corporation annual report on Form 10-K for the year ended December 31, 1994\nReport of independent accountants on financial statement schedule S-2\nSchedule II - Valuation and qualifying accounts S-3\nThe above financial statement information and schedules concerning CTS Corporation incorporated herein by reference were furnished to the registrant by CTS Corporation and were used by the registrant as the basis of recording registrant's net income (loss) from its equity investment in CTS Corporation, and the amounts of income (loss) included in registrant's financial statements are based solely on the aforesaid CTS Corporation financial statement information and schedules and report of Price Waterhouse, independent accountants for CTS Corporation.\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 or are not applicable, and therefore have been omitted, or the information is included in the consolidated financial statements, or notes thereto, of registrant or of CTS Corporation incorporated by reference herein.\n(a) (3) and (c) Exhibits\nThe response to this portion of Item 14 appears on the Exhibits Index in a separate section of this Form 10-K on pages 18 and 19.\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed for the three months ended December 31, 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.\nDYNAMICS CORPORATION OF AMERICA\n\/S\/ Patrick J. Dorme March 29, 1995 (Signature) Patrick J. Dorme - Vice President- Finance 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.\n\/S\/ Andrew Lozyniak March 29, 1995 Andrew Lozyniak - Chairman of the Board and President\n\/S\/ Henry V. Kensing March 29, 1995 Henry V. Kensing - Director, Vice President, General Counsel and Secretary\n\/S\/ Patrick J. Dorme March 29, 1995 Patrick J. Dorme - Director, Vice President- Finance and Chief Financial Officer\n\/S\/ Harold Cohan March 29, 1995 Harold Cohan - Director\n\/S\/ Frank A. Gunther March 29, 1995 Frank A. Gunther - Director\n\/S\/ Russell H. Knisel March 29, 1995 Russell H. Knisel - Director\n\/S\/ Saul Sperber March 29, 1995 Saul Sperber - Director\n\/S\/ M. Gregory Bohnsack March 29, 1995 M. Gregory Bohnsack - Corporate Controller and Principal Accounting Officer\nCONSENT OF INDEPENDENT AUDITORS\nTo the Board of Directors and Stockholders Dynamics Corporation of America\nWe consent to the incorporation by reference in this Annual Report (Form 10-K) of Dynamics Corporation of America of our report dated February 22, 1995, included in the 1994 Annual Report to Stockholders of Dynamics Corporation of America.\nOur audits also included the financial statement schedules of Dynamics Corporation of America 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. 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 set forth therein.\nERNST & YOUNG LLP\nStamford, Connecticut February 22, 1995\nDYNAMICS CORPORATION OF AMERICA AND SUBSIDIARIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nFor the Year Ended December 31, 1994\n(in thousands)\nColumn A Column B Column C Column D Column E\nAdditions Balance At Charged To Balance Beginning Costs And At End Description Of Period Expenses Deductions Of Period\nValuation accounts deducted from assets to which they apply:\nAllowance for net unrealized losses on marketable equity securities $ 1,428 $ 56 $ -0- $ 1,484\nAllowance for doubtful accounts $ 505 $ 33 $ (33)(a) $ 571\nAllowance for cash discounts $ 26 $ 138 $ 131(b) $ 33\nReserves not shown elsewhere:\nReserve for warranties $ 1,182 $ 1,006 $ 1,221(c) $ 967\nNotes: (a)-- Recoveries, net of amounts written off against allowance provided therefor.\n(b)-- Discounts charged against allowance provided therefor.\n(c)-- Warranty costs incurred and charged against reserve provided therefor.\nDYNAMICS CORPORATION OF AMERICA AND SUBSIDIARIES SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nFor the Year Ended December 31, 1993\n(in thousands)\nColumn A Column B Column C Column D Column E\nAdditions Balance At Charged To Balance Beginning Costs And At End Description Of Period Expenses Deductions Of Period\nValuation accounts deducted from assets to which they apply:\nAllowance for net unrealized losses on marketable equity securities $1,607 $ -0- $ 179(a) $1,428\nAllowance for doubtful accounts $ 571 $ 113 $ 179(b) $ 505\nAllowance for cash discounts $ 29 $ 94 $ 97(c) $ 26\nReserves not shown elsewhere:\nReserve for warranties $1,672 $ 918 $1,408(d) $1,182\nNotes:\n(a)-- Market recoveries, net of changes to portfolio holdings.\n(b)-- Bad debts, net of recoveries, written off against allowance provided therefor.\n(c)-- Discounts charged against allowance provided therefor.\n(d)-- Warranty costs incurred and charged against reserve provided therefor.\nDYNAMICS CORPORATION OF AMERICA AND SUBSIDIARIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nFor the Year Ended December 31, 1992\n(in thousands)\nColumn A Column B Column C Column D Column E\nAdditions Balance At Charged To Balance Beginning Costs And At End Description Of Period Expenses Deductions Of Period\nValuation accounts deducted from assets to which they apply:\nAllowance for net unrealized losses on marketable equity securities $1,561 $ 46 $ -0- $1,607\nAllowance for doubtful accounts $ 560 $ 255 $ 244(a) $ 571\nAllowance for cash discounts $46 $ 139 $ 156(b) $ 29\nReserves not shown elsewhere:\nReserve for warranties $1,233 $1,701 $1,262(c) $1,672\nNotes:\n(a)-- Bad debts, net of recoveries, written off against allowance provided therefor.\n(b)-- Discounts charged against allowance provided therefor.\n(c)-- Warranty costs incurred and charged against reserve provided therefor.\nExhibits Index\nItem 14. (a) (3) and (c)\nPursuant to Regulation S-K, Item 601, following is a list of Exhibits:\n(A) Exhibits incorporated by reference.\nExhibit 3 - Articles of incorporation and bylaws:\n1. Bylaws, as amended, were included in the Exhibits of the registrant's Form 10-K Annual Report for the year ended December 31, 1993.\nExhibit 4 - Instruments defining the rights of security holders:\n1. The rights of common stockholders and preferred stockholders (currently unissued) are defined in the Articles of Incorporation referred to in Exhibit 3 and in the Form 8A for registration of certain classes of securities (Rights and Preferred Stock), Rights Agreement dated as of January 30, 1986, Summary of Rights, letter to stockholders, press release and Listing Application to the New York Stock Exchange with respect to the Rights, all of which were included in the Exhibits of the registrant's Form 10-Q Quarterly Report for the period ended March 31, 1986.\nExhibit 10 - Material contracts:\nManagement Compensatory Plans, Contracts and Arrangements\n1. 1980 Restricted Stock and Cash Bonus Plan, as amended, was included in the registrant's definitive proxy statement for the Annual Meeting of Shareholders on May 6, 1988.\n2. Employment contracts dated February 1, 1991 with: Andrew Lozyniak - Chairman of the Board and President, Patrick J. Dorme - Vice President-Finance and Chief Financial Officer and Henry V. Kensing - Vice President, General Counsel and Secretary were included in the Exhibits of the registrant's Form 10-K Annual Report for the year ended December 31, 1990.\n3. Stock Retirement Plan for Outside Directors, as amended, was included in the registrant's definitive proxy statement for the Annual Meeting of Shareholders on May 1, 1992.\n4. Incentive Performance Plan was included in the Exhibits of the registrant's Form 10-K Annual Report for the year ended December 31, 1992.\n5. Executive Life Insurance Policies was included in the Exhibits of the registrant's Form 10-K Annual Report for the year ended December 31, 1992.\n6. Prescription Drug Plan for Outside Directors was included in the Exhibits of the registrant's Form 10-K Annual Report for the year ended December 31, 1992.\nOther Agreement dated October 9, 1990 between Dynamics Corporation of America and Gabelli Funds, Inc. and GAMCO Investors, Inc. was included in the Exhibits of the registrant's Form 10-K Annual Report for the year ended December 31, 1990.\nExhibit 21 - Subsidiaries of the registrant were included in the Exhibits of the registrant's Form 10-K Annual Report for the year ended December 31, 1984.\n(B) Exhibits filed in or as a separate section of this report.\nPage\nExhibit 13 - Annual report to security holders for the year ended December 31, 1994. (a)\nExhibit 23 - Consent of Independent Auditors 14\nExhibit 27 - Financial Data Schedule (b)\nExhibit 99 - CTS Corporation annual report on Form 10-K for the year ended December 31, 1994, (without Exhibits except as noted), the Report of Independent Accountants and the Financial Statement Schedule II included in said Form 10-K, and CTS Corporation's annual report to stockholders for 1994 included in said Form 10-K as Exhibit 13 thereto. (c)\n(a) Unnumbered and immediately following the final numbered page of this report. (b) Filed electronically only pursuant to regulations. (c) Unnumbered and immediately following the registrant's annual report to security holders for the year ended December 31, 1994.","section_15":""}
{"filename":"354964_1994.txt","cik":"354964","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nHousehold International, Inc. (\"Household International\" or the \"Company\") is a publicly owned corporation which, with its subsidiaries, primarily provides consumer finance and banking services and consumer insurance and investment products. The Company employs approximately 15,500 people and serves approximately 19 million customer accounts in the United States, Canada and the United Kingdom. The Company's operations are divided into two business segments: Finance and Banking and Individual Life Insurance.\nHousehold International was created in 1981 as a result of a shareholder approved restructuring of Household Finance Corporation (\"HFC\"), a publicly owned corporation since 1925, whereby Household International became a holding company for various subsidiaries, including HFC. At that time Household International had operations in the financial services, manufacturing, transportation and merchandising industries.\nIn 1985 the Company began to restructure its operations away from being a diversified conglomerate. This action resulted in the disposition of its merchandising (1985), transportation (1986) and manufacturing (1989-1990) businesses, including the spin-off to its common stock shareholders of three manufacturing companies in 1989: Eljer Industries, Inc., Schwitzer, Inc. and Scotsman Industries, Inc.\nThe products offered by Household International, a description of the geographic markets in which the Company operates and summary financial information for each of the Company's business segments is set forth in the Company's Annual Report to Shareholders (the \"1994 Annual Report\"), portions of which are incorporated herein by reference. See pages 10, 12 and 21 through 70 of the 1994 Annual Report. The Company markets its products to its customers through a number of different distribution channels, including consumer finance branch offices, consumer bank branch offices, retail merchants, independent insurance agents and direct mail and telemarketing.\n1994 DEVELOPMENTS. For financial reporting purposes, the Company recharacterized its business segment data in 1994. The assets and results of operations relating to that portion of the commercial finance business which the Company had previously discontinued as of December 31, 1991 had been reported in a separate segment called Liquidating Commercial Lines (\"LCL\"). LCL assets were reduced to approximately $700 million and nonperforming LCL assets were reduced to $205 million at December 31, 1994 compared to $2.1 billion and almost $700 million at December 31, 1991, respectively. As a result of the reduction in total assets and nonperforming assets of these discontinued product lines, the Company eliminated separately reporting the LCL segment in its financial statements. The results of operations of the LCL product lines have been combined with the results of other products in the Finance and Banking segment. Earnings and selected balance sheet data for years prior to 1994 have been reclassified to reflect the combination of LCL into the Finance and Banking segment.\nDuring 1994, the Company also began to refocus its emphasis on certain businesses in order to take advantage of its operating efficiencies and competitiveness in the marketplace and initiated a number of measures to reduce costs, including the discontinuation of its first mortgage origination business in the United States; the consolidation of certain of its Canadian operations with certain of its United States operations; the consolidation of certain operations of its private-label and credit card operations and the initiation of a reduction in the Company's workforce by approximately 12 percent. In the fourth quarter of 1994, the Company recorded $14 million in after-tax expenses in connection with these initiatives. In addition, the Company sold its Australian operation in 1994, incurring a $14 million after-tax loss. The Company also sold its retail securities brokerage business, which had no significant effect on 1994 operating results.\nIn 1994 the Company's bankcard operations continued to grow, principally through the continuing success of the GM Cardsm. The GM Card is a general-purpose credit card which allows the users thereof to earn credit toward the purchase of new General Motors vehicles. The GM Card was publicly introduced in September 1992 and as of December 31, 1994, there were approximately 7.6 million accounts which had generated approximately $6.8 billion of credit card receivables. During 1994, the Company expanded its\nalliance with General Motors Corporation with the introduction of the GM Card from Vauxhall in the United Kingdom, permitting users to earn rebates toward the purchase of a new Vauxhall vehicle and entered into a new alliance program with Pacific Bell. The Pacific Bell program allows users of the general-purpose credit card to apply a percentage of charges made on such card against their telephone bills. The Company's bankcard operations also expanded into other markets, such as entering into a joint venture with Banco Mexicano.\nThe Company's United Kingdom operation reported higher earnings in 1994, earning $27.7 million compared to $10.3 million in 1993. This was primarily attributable to portfolio growth and lower credit costs. During 1994, the performance of the Company's operation in Canada was impacted by a high cost base in relation to its assets. In the fourth quarter of 1994, the Company began integrating certain portions of the Canadian consumer finance and private-label credit card operations with the Company's U.S. operations in order to improve efficiency.\nFINANCE AND BANKING\nTotal receivables at December 31, classified by type, consisted of the following (in millions):\nCONSUMER OPERATIONS. Household International is primarily a consumer financial services company, with consumer receivables of $19.4 billion, representing approximately 56 percent of total assets at December 31, 1994. The Company's primary target customer for consumer lending is generally between 25 and 50 years of age with a household income of $15,000 to $50,000. Approximately 82 percent of the Company's consumer receivables are located in the United States.\nIn its consumer lending businesses, the Company competes with banks, thrifts, finance companies and other financial institutions by offering a variety of consumer products, maintaining a strong service orientation and developing innovative marketing programs. The Company has focused on being a low-cost producer in its consumer financial services businesses. Highly automated processing facilities have been developed to support underwriting, loan administration and collection functions across business lines. By supporting its multiple-distribution networks with centralized processing centers, the Company has improved efficiency through specialization and economies of scale. In addition, by removing such functions from branch offices, the Company is able to concentrate on sales activities in the branch offices.\nUnderwriting and collection of consumer credit products and internal controls over these functions have been improved over the last several years through the segregation of the sales, underwriting and collection functions. For example, loan approvals are handled by non-sales personnel located in regional servicing centers (\"RSC\") whose primary concern is credit quality, not volume. Underwriting and collections are supported by automated systems which analyze the likelihood of delinquency or bankruptcy. The Company believes it is an industry leader in implementing automated underwriting and collection management systems which improve its ability to manage credit quality. The Company considers factors such as the applicant's income, expenses, paying habits, value of collateral, if any, and length and stability of employment, in its effort to determine whether the borrower has the ability to support the loan.\nThe objective of the Company's program to automate and centralize the back office processing of U.S. consumer finance accounts has been to transfer the record keeping and collection tasks necessary to service\naccounts from its branch offices to an RSC. The RSCs were created to provide higher quality customer service and cost savings resulting from greater efficiency through economies of scale. By doing so, the Company's branch offices have been able to focus on sales and marketing efforts. The Company's first RSC began operations in Illinois in 1987. By the first quarter of 1990, all U.S. branch offices of HFC were served by RSCs. As a result of efficiencies achieved since that time, the operations of the servicing centers have been further consolidated, and in 1993 the servicing operation for all HFC originated loans was moved to a single servicing center located in Illinois. The former western region RSC in California now supports HFC's portfolio acquisition business and services acquired consumer credit receivables. The former eastern region RSC in Virginia now principally supports the GM Card. Additional facilities exist to provide the Company's bankcard and merchant participation business with centralized automated support. The Company has also established regional processing centers (\"RPC\") in California, Illinois, Maryland and Nevada to perform payment processing, check processing, statement billings and other administrative tasks for all domestic consumer operations. In the United Kingdom, HFC Bank plc's Birmingham Business Center provides operating and administrative functions in a center modeled after the RSCs and RPCs used in the United States. The Canadian operation has two centers similar to the United Kingdom center.\nThe Company has continued to invest in the development of its bankcard, private-label credit card and consumer finance services which have been an important contributor to the Company's growth. During 1994, net income on an operating basis from these businesses increased approximately 24 percent over the prior year-end period, while overall net income was 23 percent higher than in 1993.\nSince 1988 the Company has increased significantly its portfolio of receivables sold and serviced with limited recourse. This portfolio has grown to approximately $12.5 billion at year-end 1994 from none at the beginning of 1988. The Company was the first public issuer of home equity loan asset-backed securities in 1988 and continues to be one of the largest issuers of asset-backed securities. In 1994, including replenishments of certificateholders interests, the Company securitized and sold approximately $16.5 billion of receivables. Prior to its discontinuance of the origination of first mortgages, the Company also sold first mortgages with no recourse while retaining the servicing rights associated therewith and also acquired and sold servicing rights for first mortgages.\nMajor consumer business units within the Finance and Banking segment are described below.\nHousehold Finance Corporation\nHousehold Finance Corporation traces its origins to a loan office established in 1878. HFC offers a variety of secured and unsecured lending products to middle-income customers through a network of 460 branch lending offices throughout the United States. This business is conducted primarily through state-licensed companies.\nHFC's operations primarily focus on home equity loans and unsecured credit products as these products are preferred by consumers due to the flexible nature of the credit relationship, where the timing and amount of borrowing can be tailored to the borrower's particular circumstances. These products also are advantageous to HFC due to lower relative administrative costs and typically have variable rate terms which move with market rates of interest. Home equity loans and unsecured consumer credit products in the HFC network represented approximately 29 percent of total consumer managed receivables at December 31, 1994. Home equity loans, representing approximately 20 percent of total consumer managed receivables at December 31, 1994, have lower chargeoff rates than unsecured credit products.\nIn 1992, HFC launched a new portfolio acquisition business focusing on open-end and closed-end home equity loan products. The Company believes that the portfolio acquisition business provides an additional source for developing new customer relationships.\nHousehold Retail Services\nHousehold Retail Services (\"HRS\") is a revolving credit merchant participation business. HRS purchases and services merchants' revolving charge accounts. These accounts result from consumer purchases of furniture, appliances, home improvement products and other durable merchandise, and generally are without credit recourse to the originating merchant. Loans are underwritten by HRS based on its credit\nstandards. This business is an important source of new customers to HFC's direct lending business. HRS believes it is the second largest provider of private-label credit cards in the United States. This business is conducted through state-licensed companies and through Household Bank (Illinois), National Association. During 1994, the Company began integrating portions of HRS' operations into Household Credit Services in order to reduce costs and better utilize the Company's resources.\nHousehold Credit Services\nHousehold Credit Services is the tradename used for the marketing of bankcards throughout the United States issued by one of the Company's subsidiary national credit card banks, Household Bank, f.s.b., or one of the other financial institutions affiliated with Household International. Household Credit Services had $10.8 billion of bankcard receivables owned and serviced with limited recourse at December 31, 1994, an increase of $1.9 billion from December 31, 1993. The Company has been rated as one of the top 6 issuers of VISA* and MasterCard* credit cards in the United States.\nThe Company strives to build its bankcard business by developing strategic alliances with industry leaders to effectively create and market general purpose credit cards to targeted consumers. In accordance with this philosophy, the Company established a program with Ameritech Corporation in 1991, General Motors Corporation in 1992 (expanding the relationship with General Motors in 1993 to issue the GM Card from Vauxhall in the United Kingdom), Charles Schwab & Co. in 1993 and Pacific Bell in 1994. The Company also entered into a joint venture with Banco Mexicano in 1994. The Company intends to continue to explore other similar relationships with various entities.\nThe Company evaluates bankcard acquisitions utilizing criteria related to strategic fit and economic value. To assess strategic fit, the Company considers the following: the composition and behavior of the customer franchise; product pricing compatibility with the Company's pricing strategies; geographic distribution of the customer base; and opportunities to add value through improved portfolio management. To assess economic value, the Company evaluates the risk\/return characteristics of the portfolio, particularly with respect to revenue-generating potential and asset quality, and identifies and quantifies legitimate opportunities to add value through price changes, more efficient servicing, improved collections, and credit line management. The Company also applies traditional financial analysis techniques to evaluate financial returns in relation to the proposed investment.\nThe bankcard business is a highly competitive and fragmented industry currently in the process of consolidation. The Company believes that its relatively large size in the industry provides substantial competitive advantages over smaller credit card issuers through operating efficiencies. The Company's focus is to develop a diverse customer franchise that contains three to four hubs of concentration while employing value-based pricing. These hubs are expected to promote operating and marketing efficiencies without creating overdependence on a single geographic area that would potentially expose the Company to regional credit risk and usage patterns. Currently, the Company's largest account base is in California supplemented by significant hubs in the Midwest and on the East coast.\nHousehold Bank, f.s.b.\nHousehold Bank, f.s.b. (the \"Bank\"), a federally chartered savings bank, is engaged in the consumer banking and mortgage business. At December 31, 1994, the Bank's assets totaled $9.4 billion, while total deposits were approximately $7.2 billion. During the fourth quarter of 1994, the Bank acquired approximately $1.2 billion in deposits through the purchase from an unaffiliated thrift institution of 26 consumer bank branches in Illinois. The Company views deposits as a stable and relatively low-cost source of funding. The Company's consumer banking strategy is intended to diversify its funding base, provide a stable and relatively low-cost funding source, create a more competitively leveraged entity and market financial service products to a different customer base.\n---------------\n* VISA and MasterCard are registered trademarks of VISA USA, Inc. and MasterCard International, Incorporated, respectively.\nDuring 1994, the Bank began to realign the geographic presence of its banking activities by focusing its activities in Illinois. In addition, the Bank discontinued its first mortgage origination business. In early 1995, it entered into agreements to sell its banking operations, including the related deposits, of the East Coast and West Coast regions as well as Ohio.\nInternational Operations\nInternational operations in Canada and the United Kingdom accounted for approximately 18 percent of consumer owned receivables at December 31, 1994. Due to the similarities of operations and in order to provide the lowest cost services possible, the Company began to integrate certain consumer finance and private-label credit card operations previously conducted in Canada with such business operations in the United States. The Canadian consumer finance business has operated under the HFC tradename. In addition, the Canadian consumer banking business, with 3 branches, operates as Household Trust Company. At December 31, 1994, the Canadian operations had $2.0 billion of receivables. In the United Kingdom, the Company owns HFC Bank plc, a fully licensed United Kingdom bank. HFC Bank plc had 150 branches at December 31, 1994 and approximately $1.4 billion of receivables.\nCredit Insurance\nIn conjunction with its consumer lending operations and where applicable laws permit, the Company makes credit life, credit accident and health, term and specialty insurance products available to its customers. This insurance generally is directly written by or reinsured with Alexander Hamilton Life Insurance Company of America (\"Alexander Hamilton\"). Financial results for sales of these types of products through affiliated operations are reported as part of the Finance and Banking segment.\nCOMMERCIAL OPERATIONS. Commercial receivables declined by $798 million in 1994. In addition, commercial assets that had previously been reported as LCL assets declined by approximately 55 percent when compared with the level of LCL assets as of December 31, 1993. The former LCL results are now reported together with other results described for the Company's Finance and Banking segment. See \"1994 Developments\" above. Approximately 4 percent of total managed receivables portfolio at December 31, 1994 consisted of commercial receivables.\nSince 1974, the commercial finance business of the Company has primarily been operated under Household Commercial Financial Services (\"Household Commercial\"). The industry in which Household Commercial operates (offering various loan and lease financing for aircraft, other transportation equipment, capital equipment and specialized secured corporate loans, as well as investing in term preferred stocks) is highly competitive and the Company's position in this market is relatively small. A description of Household's credit management policy with respect to commercial receivables is set forth on page 32 of the 1994 Annual Report.\nINDIVIDUAL LIFE INSURANCE\nThe Company's individual life insurance operations are conducted by Alexander Hamilton Life Insurance Company of America. Alexander Hamilton markets universal life, term life and annuity products to a higher income category consumer than that targeted by the consumer lending businesses. Alexander Hamilton also underwrites credit life, credit accident and health, and other specialty products sold through the Company's consumer businesses. The Alexander Hamilton products sold by affiliated entities are included in results of the Finance and Banking segment.\nAlexander Hamilton offers universal life insurance, term life insurance and annuity products through approximately 10,600 independent agents and 1,500 licensed consumer finance and banking employees. These individual products are sold in all states, with the largest concentration in 10 states (California, Delaware, Florida, Illinois, Michigan, New Jersey, New York, Ohio, Pennsylvania and Texas) accounting for 72 percent of premium income in 1994. The Company also sells credit insurance to customers of banks and retail merchants which are not affiliated with Household International. Alexander Hamilton has been assigned a claims-paying ability rating of \"AA\" from three nationally recognized statistical rating organizations.\nINVESTMENT SECURITIES\nInvestment securities of the Company are principally held by Alexander Hamilton. At December 31, 1994, Alexander Hamilton had $6.7 billion or approximately 74 percent of the Company's $9.0 billion total investment portfolio. The composition of this portfolio is set forth on pages 47 and 48 of the 1994 Annual Report. Approximately 15 percent of the Company's investment securities are also held by the Bank, with the remaining portion of the Company's investment portfolio being held by its other subsidiaries.\nFUNDING RESOURCES\nAs a financial services organization, Household International must have access to funds at competitive rates, terms and conditions to be successful. Household International and its subsidiaries fund their operations in the global capital markets, primarily through the use of commercial paper, thrift notes, medium-term notes and long-term debt, and have used financial instruments to hedge their currency and interest-rate exposure. Four nationally recognized statistical rating organizations currently assign investment grade ratings to the debt and preferred stock issued by the Company and its subsidiaries. In addition, these organizations rated the commercial paper of HFC in their highest rating category. A portion of the Company's funding base also consists of deposits obtained through its consumer banking business. At December 31, 1994 deposits were $8.4 billion. Due to the previously referenced sales of operations by the Bank, the amount of deposits will decrease by approximately $3.4 billion, which source of funding will be substantially replaced by the issuance of debt instruments in the capital markets.\nThe securitization and sale of consumer receivables continues to be an important source of liquidity for the Company. During 1994 the Company's subsidiaries securitized and sold approximately $4.5 billion of home equity, merchant participation, bankcard and unsecured receivables.\nIn the normal course of its business, the Company enters into a variety of off-balance sheet transactions primarily to manage and reduce its exposure to certain risks, including interest rate and foreign exchange risks. Interest rate swaps are the principal arrangements used by the Company to manage interest rate risk. These swaps synthetically alter the interest rate risk inherent in the various products offered by the Company. The majority of the Company's interest rate swaps are used to synthetically convert floating rate assets to fixed rate, fixed rate debt to floating rate, or floating rate assets or debt from one floating rate index to another. Interest rate swaps are also used to synthetically alter interest rate characteristics on certain receivables that are securitized and serviced with limited recourse. Since the currency with which each of the Company's foreign operations does business is its local currency, the Company also enters into foreign exchange contracts primarily to hedge its investment in such foreign operations. A description of the Company's use of interest rate swaps and foreign exchange contracts is set forth on pages 38 and 39 and 54 through 57 of the 1994 Annual Report.\nREGULATION AND COMPETITION\nREGULATION. The Company's businesses are subject to various regulations covering their conduct. Generally, HFC's consumer branch lending offices are regulated by legislation and licensed in those jurisdictions where they operate. Such licenses have limited terms but are renewable, and are revocable for cause. In addition to licensing provisions, statutes in some jurisdictions may provide that a loan not exceed a certain period of time, or may place limits on the size or interest rate of the loan. HFC's sales finance business is also subject to regulatory legislation in certain jurisdictions which, among other things, may limit the interest rates or fees which may be charged or which may inhibit HFC's ability to collect or foreclose upon delinquent loans. All of Household International's consumer finance operations are subject to federal laws relating to discrimination in credit extensions, use of credit reports, disclosure of credit terms, and correction of billing errors.\nThe Bank is chartered by the Office of Thrift Supervision (\"OTS\") and is a member of the Federal Home Loan Bank System. The Bank has its customer deposit accounts insured for up to $100,000 per insured account by the Federal Deposit Insurance Corporation (\"FDIC\"), for which the Bank is assessed a fee. The Bank is subject to examination and supervision by the OTS and FDIC and to federal regulations governing such matters as general investment authority, acquisitions of financial institutions, transactions with affiliates,\nestablishment of branch offices, subsidiaries' investments and activities, and restrictions on dividend payments to Household International. The Bank is also subject to regulatory requirements setting forth minimum capital and liquidity levels. Because of its ownership of the Bank, Household International is a savings and loan holding company subject to reporting and other regulations of the OTS. Household International and HFC have agreed with the OTS to maintain the regulatory capital of the Bank at certain specified levels.\nHousehold Bank (California), National Association; Household Bank (Illinois), National Association; Household Bank (Nevada), National Association and Household Bank (SB), National Association are chartered by the Comptroller of the Currency and are members of the Federal Reserve System. The deposit accounts of these national banks are insured by the FDIC. National banks are generally subject to the same type of regulatory supervision and restrictions as the Bank, although these national banks only engage in credit card operations.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), enacted in December 1991, significantly expanded the regulatory and enforcement powers of federal banking regulators, in particular the FDIC. FDICIA also created additional reporting, disclosure and independent auditing requirements, changed FDIC insurance premiums from flat amounts to a new system of risk-based assessments, and placed limits on the ability of depository institutions to acquire brokered deposits.\nUnder FDICIA, there are five tiers of capital measurement for regulatory purposes ranging from \"Well-Capitalized\" to \"Critically Undercapitalized\". FDICIA directs banking regulators to take increasingly strong corrective steps, based on the capital tier of any subject insured depository institution, to cause such bank to achieve and maintain capital adequacy. Even if an insured depository institution is adequately capitalized, the banking regulators are authorized to apply corrective measures if the insured depository institution is determined to be in an unsafe or unsound condition or engaging in an unsafe or unsound activity. FDICIA grants the banking regulators broad powers to require undercapitalized institutions to adopt and implement a capital restoration plan and to restrict or prohibit a number of activities, including the payment of cash dividends, which may impair or threaten the capital adequacy of the insured depository institution. FDICIA also expanded the grounds upon which a receiver or conservator may be appointed for an insured depository institution. Pursuant to FDICIA, federal banking regulatory agencies have adopted new safety and soundness standards governing operational and managerial activities of insured depository institutions and their holding companies regarding internal controls, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation.\nThe Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (\"FIRREA\"), among other things, provides generally that, upon the default of any insured institution, the FDIC may assess an affiliated insured depository institution for the estimated losses incurred by the FDIC. Specifically, FIRREA provides that 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 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. \"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.\nAs an insurance company, Alexander Hamilton is subject to regulatory supervision under the laws of the states in which it operates. Regulations vary from state to state but generally cover licensing of insurance companies, premium rates, dividend restrictions, types of insurance that may be sold, permissible investments, policy reserve requirements, and insurance marketing practices.\nCOMPETITION. The consumer credit industry is highly fragmented, with thousands of banks, thrifts and other financial institutions competing in the United States alone. The industry has been consolidating in recent years, and the Company expects this consolidation to continue. The Company believes it has positioned itself to compete effectively and benefit from this consolidation because of its streamlined operations, centralized distribution, processing and marketing capabilities, and advanced technology to support these activities.\nThe financial services industry is highly competitive, and the Company's financial services businesses compete with a number of institutions that extend credit to consumers and businesses, some of which are larger than the Company. The Company competes not only with other finance companies, banks, and savings\nand loan companies, but also with credit unions and retailers. Alexander Hamilton competes with many other life insurance companies offering similar products.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nHousehold International has operations in 39 states in the United States, 10 provinces in Canada and in the United Kingdom with principal facilities located in Anaheim, California; Chesapeake, Virginia; Elmhurst, Illinois; Farmington Hills, Michigan; Hanover, Maryland; Las Vegas, Nevada; North York, Ontario, Canada; Pomona, California; Prospect Heights, Illinois; Salinas, California; Windsor, Berkshire, United Kingdom and Wood Dale, Illinois.\nSubstantially all branch offices, bank branches, divisional offices, corporate offices, RPC and RSC space is operated under lease with the exception of the principal executive offices of Household International in Prospect Heights, Illinois; the headquarters building for HFC Bank plc in the United Kingdom; Alexander Hamilton's headquarters building in Farmington Hills, Michigan; administration buildings in Northbrook, Illinois and Salinas, California and an administrative facility in Las Vegas, Nevada. The Company believes that such properties are in good condition and are adequate to meet its current and reasonably anticipated needs.\nHousehold International has invested in property and technological improvements to achieve greater efficiencies in the marketing, servicing and production of its loan products. During 1994 the Company invested $197 million in capital expenditures, compared to $110 million in 1993 and $90 million in 1992. Automobiles, office equipment and real estate properties owned and in use by the Company are not significant in relation to the total assets of the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company and its subsidiaries are parties to various legal proceedings, including product liability and environmental claims, resulting from ordinary business activities related to its current operations and\/or former businesses which were managed as independent subsidiaries of the Company. Certain of these actions are or purport to be class actions seeking damages in very large amounts. Due to the uncertainties in litigation and other factors, no assurance can be given that the Company or its subsidiaries will ultimately prevail in each instance. However, for all litigation involving the Company and\/or its subsidiaries, the Company believes that amounts, if any, that may ultimately be paid by the Company as damages in any such proceedings will not 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 REGISTRANT.\nThe following information on executive officers of Household International is included pursuant to Item 401(b) of Regulation S-K. Information with respect to Messrs. Aldinger and Clark is incorporated herein by reference to \"Election of Household Directors--Information Regarding Nominees\" in Household International's definitive Proxy Statement for its 1995 Annual Meeting of Stockholders scheduled to be held May 10, 1995 (the \"1995 Proxy Statement\"). References herein to \"Household\" refer to Household International, Inc. for all periods after June 26, 1981 (the date of the corporate restructuring by which Household International became the holding company of Household Finance Corporation) and to Household Finance Corporation on and before such date.\nLawrence N. Bangs, age 58, was appointed Group Executive-Alexander Hamilton, Household Bank and HFC Bank plc in 1995. Mr. Bangs joined Household in 1959 and has served in various capacities in the Company's U.S. consumer finance operations and United Kingdom operations, most recently as Managing Director and Chief Executive Officer of HFC Bank plc.\nRobert F. Elliott, age 54, was appointed Group Executive-U.S. Consumer Finance and Canada in 1994. Prior thereto, from April 1993 to September 1994, he was Group Executive-Office of the President and from 1988 to 1993 he was Group Executive-U.S. Consumer Finance and Australia. Mr. Elliott joined Household in\n1964 and has served in various capacities in the Company's consumer finance business during his career with Household.\nJoseph W. Saunders, age 49, was appointed Group Executive-U.S. BankCard and Household Retail Services, Inc. in 1994, having previously served, from April 1993 to September 1994, as Group Executive-Office of the President and prior thereto as Group Executive-U.S. BankCard and Canada. Prior to joining Household in 1985, Mr. Saunders was Vice President-Credit Card Operations of Bank of America.\nAntonia Shusta, age 45, resigned on February 10, 1995, from her appointment as Group Executive-U.S. Consumer and Mortgage Banking, Alexander Hamilton and HFC Bank plc, a position she had held since September, 1994. Ms. Shusta joined Household in 1988 as Group Executive-Mortgage Banking and Acquisitions and most recently served from April 1993 to September 1994, as Group Executive-Office of the President. Prior to joining Household, she was employed with Citicorp for 16 years.\nDavid A. Schoenholz, age 43, was appointed Senior Vice President-Chief Financial Officer of Household in 1994, having previously served as Vice President-Chief Accounting Officer in 1993, Vice President in 1989 and Controller in 1987. He joined Household in 1985 as Director-Internal Audit. Prior to joining Household, Mr. Schoenholz was employed with The Commodore Corporation, a manufacturer of mobile homes, as Vice President\/Controller from 1983 to 1985.\nGlen O. Fick, age 48, was appointed Group Executive-Commercial Finance in 1991. Mr. Fick joined Household in 1971 and has served in various capacities in the Company's treasury, corporate finance and investor relations departments, as well as the specialty commercial services division of its commercial finance business.\nRichard H. Headlee, age 64, has been Chairman of the Board of Alexander Hamilton since 1988. Mr. Headlee joined Alexander Hamilton in 1970 and served as its Chief Executive Officer from 1972 to 1993.\nEdgar D. Ancona, age 42, joined Household in 1994 as Vice President-Treasurer. For the previous 17 years he held a variety of treasury and operational positions with Citicorp.\nDavid B. Barany, age 51, was appointed to his present position as Vice President-Chief Information Officer of Household in 1988. Mr. Barany joined Household in 1985 as Vice President\/Controller of Household's financial services business. Prior to joining Household, he was employed by Four Phase Systems, Inc., a subsidiary of Motorola, Inc., as Vice President\/Finance.\nJohn W. Blenke, age 39, is Assistant General Counsel and Secretary of Household. Mr. Blenke joined Household in 1989 as Corporate Finance Counsel, was promoted to Assistant General Counsel-Securities & Corporate Law and Assistant Secretary in 1991 and was appointed Secretary in 1993. Prior to joining Household, Mr. Blenke was employed with a subsidiary of Transamerica Corporation.\nMichael A. DeLuca, age 46, joined Household in 1985 as Director of Tax Planning and Tax Counsel and was appointed to his present position as Vice President-Taxes in 1988.\nColin P. Kelly, age 52, is Vice President-Human Resources of Household. Mr. Kelly joined Household in 1965 and has served in various management positions, most recently as Senior Vice President-Human Resources of Household's financial services business. Mr. Kelly was appointed to his present position in 1988.\nTheresa F. Kendziorski, age 42, was appointed Vice President-Analysis & Projects in 1995. Since joining Household in 1987, Ms. Kendziorski has served in various capacities within the Company's internal audit department and its banking subsidiary, most recently as President-Midwest Division of Household Bank, f.s.b.\nRichard J. Kolb, age 42, joined Household in 1995 as Vice President-Controller. Prior to joining Household, Mr. Kolb held a variety of financial positions with Wells Fargo Bank since 1982, most recently serving as Vice President and Group Finance Officer.\nMichael H. Morgan, age 40, was appointed to his present position as Vice President-Corporate Communications in 1989. Mr. Morgan joined Household in 1984, and has served in various capacities within the planning and analysis and investor relations areas. From 1978 until joining Household, Mr. Morgan was employed with Arthur Andersen LLP.\nRandall L. Raup, age 41, was appointed Vice President-Strategy and Development in 1995, having most recently served as Vice President-Planning. Since joining Household in 1984, Mr. Raup has held positions in the treasury control, corporate reporting and internal audit areas. Prior to joining Household, he served as an auditor with Esmark, Inc. and KPMG Peat Marwick LLP.\nKenneth H. Robin, age 48, was appointed Vice President-General Counsel of Household in 1993, having previously served as Assistant General Counsel-Financial Services. Prior to joining Household in 1989, Mr. Robin was employed with Citicorp from 1977 to 1989, most recently as a vice president responsible for legal policies for its operations in 23 countries in the Caribbean, Central America and South America.\nThere are no family relationships among the executive officers of the Company. The term of office of each executive officer is at the discretion of the Board of Directors.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe number of record holders of Household International's Common Stock, as of March 15, 1995, was 14,212. Household International common stock is listed on the New York and Chicago Stock Exchanges. During 1994 Household International common stock quarterly results were as follows:\nAdditional information required by this Item is incorporated by reference to page 12 of Household International's 1994 Annual Report.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nInformation required by this Item is incorporated by reference to page 22 of Household International's 1994 Annual Report.\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 pages 26 through 39 of Household International's 1994 Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nFinancial Statements of Household International and subsidiaries meeting the requirements of Regulation S-X, and supplementary financial information specified by Item 302 of Regulation S-K, is incorporated by reference to pages 23 through 25 and pages 40 through 70 of Household International's 1994 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.\nInformation required by this Item is incorporated by reference to \"Election of Household Directors-- Information Regarding Nominees\" and \"Shares of Household Stock Beneficially Owned by Directors and Executive Officers\" in Household International's 1995 Proxy Statement. Also, information on certain Executive Officers appears in Part I of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation required by this Item is incorporated by reference to \"Remuneration of Executive Officers\", \"Savings--Stock Ownership and Pension Plans\", \"Incentive and Stock Option Plans\", and \"Directors' Compensation\" in Household International's 1995 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation required by this Item is incorporated by reference to \"Shares of Household Stock Beneficially Owned by Directors and Executive Officers\" and \"Security Ownership of Certain Beneficial Owners\" in Household International's 1995 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation required by this Item is incorporated by reference to \"Remuneration of Executive Officers\" in Household International's 1995 Proxy Statement.\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, together with the opinion thereon of Arthur Andersen LLP, dated February 3, 1995, appearing on pages 23 through 25 and pages 40 through 70 of Household International's 1994 Annual Report are incorporated herein by reference. An opinion of Arthur Andersen LLP is included in this Annual Report on Form 10-K.\nHousehold International, Inc. and Subsidiaries:\nStatements of Income for the Three Years Ended December 31, 1994.\nBalance Sheets, December 31, 1994 and 1993.\nStatements of Cash Flows for the Three Years Ended December 31, 1994.\nStatements of Changes in Preferred Stock and Common Shareholders' Equity for the Three Years Ended December 31, 1994.\nBusiness Segment Data.\nNotes to Financial Statements.\nIndependent Auditors' Report.\nSelected Quarterly Financial Data (Unaudited).\n(B) REPORTS ON FORM 8-K.\nDuring the three months ended December 31, 1994, the Company filed a Current Report on Form 8-K with the Securities and Exchange Commission disclosing supplementary financial information for Household International as of and for the years ended December 31, 1993, 1992 and 1991.\n(C) EXHIBITS.\nCopies of exhibits referred to above will be furnished to stockholders upon written request at a cost of fifteen cents per page. Requests should be made to Household International, Inc., 2700 Sanders Road, Prospect Heights, Illinois 60070, Attention: Office of the Secretary.\n(D) SCHEDULES.\nReport of Independent Public Accountants.\nIII--Condensed Financial Information of Registrant.\nVIII--Valuation and Qualifying Accounts.\nX--Supplementary Statements of Income Information.\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, HOUSEHOLD INTERNATIONAL, INC. HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nHOUSEHOLD INTERNATIONAL, INC.\nDated: March 24, 1995\nBy \/s\/ W. F. ALDINGER\n---------------------------------------- W. F. Aldinger, 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 HOUSEHOLD INTERNATIONAL, INC. AND IN THE CAPACITIES AND ON THE DATE INDICATED.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nHousehold International, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the financial statements included in Household International, Inc.'s 1994 annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 3, 1995. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in Item 14(d) 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 LLP\nChicago, Illinois February 3, 1995\nSCHEDULE III\nHOUSEHOLD INTERNATIONAL, INC.\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT -------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF INCOME (ALL DOLLAR AMOUNTS EXCEPT PER SHARE DATA ARE STATED IN MILLIONS.)\n---------------\n* 1992 amounts have been restated to reflect the two-for-one stock split in the form of a 100 percent stock dividend, effective October 15, 1993.\nSee accompanying condensed notes to financial statements.\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nSCHEDULE III (CONTINUED)\nHOUSEHOLD INTERNATIONAL, INC.\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT -------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nCONDENSED BALANCE SHEETS (IN MILLIONS)\nSee accompanying condensed notes to financial statements.\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nSCHEDULE III (CONTINUED)\nHOUSEHOLD INTERNATIONAL, INC.\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT -------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nCONDENSED STATEMENTS OF CASH FLOWS (IN MILLIONS)\nSee accompanying condensed notes to financial statements\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nSCHEDULE III (CONTINUED)\nHOUSEHOLD INTERNATIONAL, INC.\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- NOTES TO CONDENSED FINANCIAL STATEMENTS OF REGISTRANT\n1. FINANCE RECEIVABLES\nReceivables at December 31 consisted of the following (in millions):\n2. SENIOR DEBT (WITH ORIGINAL MATURITIES OVER ONE YEAR)\nSenior debt at December 31 consisted of the following (in millions):\n3. COMMITMENTS\nUnder an agreement with the Office of Thrift Supervision, the company will maintain the net worth of Household Bank, f.s.b. at a level consistent with certain minimum net worth requirements.\nThe company has guaranteed payment of all debt obligations issued subsequent to 1989 (excluding deposits) of Household Financial Corporation Limited (\"HFCL\"), a Canadian subsidiary. The amount of guaranteed debt outstanding at HFCL on December 31, 1994 was approximately $947 million.\nThe company has also guaranteed payment of all debt obligations (excluding certain deposits) of Household International (U.K.) Limited (\"HIUK\"). The amount of guaranteed debt outstanding at HIUK on December 31, 1994 was approximately $1,150 million.\nThe company has guaranteed payment of a $46 million deposit held by one of its operating subsidiaries on behalf of another operating subsidiary.\n4. CONVERTIBLE PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION\nAt December 31, 1994 and 1993 the company had outstanding 52,010 and 385,439 shares, respectively, of $6.25 cumulative convertible preferred stock subject to mandatory redemption provisions (the \"$6.25 stock\"). Each share of $6.25 stock is convertible, at the option of its holder, into 4.654 shares of common stock; is entitled to one vote, as are common shares; and has a liquidation value of $50 per share. Holders of such stock are entitled to payment before any capital distribution is made to common shareholders. The company is required to call for redemption, on an annual basis through 2010, a minimum of 4 percent to a maximum of 8 percent of the 3.5 million originally issued shares and is required to redeem all of the remaining unconverted and unredeemed shares in 2011. The company called for redemption 8 percent of the originally issued shares\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nSCHEDULE III (CONTINUED)\nHOUSEHOLD INTERNATIONAL, INC.\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- NOTES TO CONDENSED FINANCIAL STATEMENTS OF REGISTRANT -- (CONTINUED)\nin both 1994 and 1993. The company redeemed 2,312 and 2,323 shares for $50 per share in 1994 and 1993, respectively. The remaining shares called, but not redeemed for cash, were converted into common stock. If certain conditions are met, the company may redeem the entire $6.25 stock issue at $50 per share plus accrued and unpaid dividends. At December 31, 1994, 242,055 shares of common stock were reserved for conversion of $6.25 stock.\n5. COMMON STOCK\nOn September 14, 1993 the Board of Directors of the company declared a two-for-one stock split in the form of a 100 percent stock dividend effective October 15, 1993. The stock split resulted in an increase in common stock and a reduction in additional paid-in capital of $56.6 million. All share and per share data, except as otherwise indicated, have been restated to give retroactive effect to the stock split.\nOn March 8, 1993 the company sold 4,025,000 shares of common stock at $68.88 per share, on a pre-split basis. Net proceeds of approximately $269 million were used for general corporate purposes, including investments in the company's subsidiaries and reduction of short-term debt. Assuming the additional shares of common stock had been issued on January 1, 1993 and the proceeds resulted in after-tax interest savings from reduction of short-term debt since that date, earnings per share for 1993 would have been $2.82 per share on a fully diluted basis.\nCommon stock at December 31 consisted of the following (millions of shares):\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nSCHEDULE III (CONTINUED)\nHOUSEHOLD INTERNATIONAL, INC.\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- NOTES TO CONDENSED FINANCIAL STATEMENTS OF REGISTRANT -- (CONTINUED)\n6. PREFERRED STOCK\nPreferred stock at December 31 consisted of the following (all dollar amounts are stated in millions):\n---------------\n(1) Depositary share represents 1\/4 share of preferred stock. (2) Depositary share represents 1\/10 share of preferred stock. (3) Depositary share represents 1\/40 share of preferred stock.\nDividends on the 9.50 percent preferred stock, Series 1989-A are cumulative and payable quarterly. The company may, at its option, redeem in whole or in part, the 9.50 percent preferred stock, Series 1989-A at $26.19 per depositary share beginning on November 9, 1994 and at amounts declining to $25 per depositary share thereafter, plus accrued and unpaid dividends. No shares were redeemed in 1994.\nDividends on the 9.50 percent preferred stock, Series 1991-A are cumulative and payable quarterly. The company may, at its option, redeem in whole or in part, the 9.50 percent preferred stock, Series 1991-A on any date after August 13, 1996 for $10 per depositary share plus accrued and unpaid dividends.\nDividends on the 8.25 percent preferred stock, Series 1992-A are cumulative and payable quarterly. The company may, at its option, redeem in whole or in part, the 8.25 percent preferred stock, Series 1992-A on any date after October 15, 2002 for $25 per depositary share plus accrued and unpaid dividends.\nDividends on the 7.35 percent preferred stock, Series 1993-A are cumulative and payable quarterly. The company may, at its option, redeem in whole or in part, the 7.35 percent preferred stock, Series 1993-A on any date after October 15, 1998 for $25 per depositary share plus accrued and unpaid dividends.\nDividends on the flexible rate auction preferred stock (\"Flex APS\") are cumulative and payable when and as declared by the Board of Directors of the company. The initial dividend rate on the Flex APS Series B is 9.50 percent. The initial rate on the Flex APS Series B extends through July 15, 1995 with subsequent dividend rates determined in accordance with a formula based on orders placed in a dutch auction generally held every 49 days. The company may, at its option, redeem in whole or in part, the Flex APS Series B for $100 per share plus accrued and unpaid dividends beginning on July 15, 1995.\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nSCHEDULE III (CONTINUED)\nHOUSEHOLD INTERNATIONAL, INC.\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- NOTES TO CONDENSED FINANCIAL STATEMENTS OF REGISTRANT -- (CONTINUED)\nEach preferred stock issue ranks equally with the $6.25 stock and has a liquidation value of $100 per share except for the 8.25 percent preferred stock, Series 1992-A and the 7.35 percent preferred stock, Series 1993-A which have a liquidation value of $1,000 per share. Holders of all issues of preferred stock are entitled to payment before any capital distribution is made to common shareholders. The company is authorized to issue cumulative nonconvertible preferred stock in one or more series in an amount not to exceed $500 million.\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nSCHEDULE VIII\nHOUSEHOLD INTERNATIONAL, INC.\nVALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 31, 1994 -------------------------------------------------------------------------------- --------------------------------------------------------------------------------\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nSCHEDULE X\nHOUSEHOLD INTERNATIONAL, INC.\nSUPPLEMENTARY STATEMENTS OF INCOME INFORMATION FOR THE THREE YEARS ENDED DECEMBER 31, 1994 -------------------------------------------------------------------------------- --------------------------------------------------------------------------------\n---------------\n* Represents less than 1 percent of total revenues as reported in the related statements of income.\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nEXHIBIT INDEX","section_15":""}
{"filename":"42293_1994.txt","cik":"42293","year":"1994","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":"739878_1994.txt","cik":"739878","year":"1994","section_1":"ITEM 1. BUSINESS\nRuss Berrie and Company, Inc. was incorporated in New Jersey in 1966. The term \"Company\" refers to Russ Berrie and Company, Inc. and its consolidated subsidiaries, unless the context requires otherwise. Its principal executive offices are located at 111 Bauer Drive, Oakland, New Jersey 07436, and its telephone number is (201) 337-9000.\nThe Company designs, manufactures through third parties and markets to retail stores throughout the United States and most countries throughout the world, a wide variety of impulse gift and toy items.\nThe gift products are designed to appeal to the emotions of consumers, who purchase the products impulsively to reflect their feelings of friendship, fun, love and affection. The Company believes that its present position as one of the leaders in the gift industry is due primarily to its imaginative product design, broad and effective marketing of its products, efficient distribution, high product quality and commitment to customer service.\nTwo recently acquired toy companies, Cap Toys, Inc., and OddzOn Products, Inc., market toys, novelty candy and sports related products to mass merchandisers, sporting goods and specialty toy stores. Products of these companies are marketed primarily through independent representative groups and international distributors.\nFinancial information related to business segments and geographic areas are presented in Note 13 in the Notes to Consolidated Financial Statements.\nPRODUCTS\nThe Company's extensive gift product line of over 10,000 items (including distinctive variations on basic product designs) encompasses both seasonal and everyday products that focus on theme or concept groupings such as Baby, Home Decor, Lifestyles and Collectibles. Individual products include stuffed animals, picture frames, ceramic mugs, porcelain gifts, figurines, kitchen magnets, stationery products, and National Football League and Major League Baseball merchandise. The Company's toy line includes a variety of innovative toys, novelty candies, and sports related products. Cap Toys Inc. products include proprietary items such as Stretch Armstrong, Vac-Man, Katie Kiss 'N' Giggles, and Shout 'N' Shoot. OddzOn Products, Inc. items are marketed under the brand name Koosh and include products such as Koosh Ball, Koosh Vortex, Koosh Accessories and Koosh Soft Sport.\nMost of the Company's gift products have suggested retail prices between $1 and $30. For example, the suggested retail prices for mugs generally range from $5 to $8. Toy products generally have suggested retail prices between $3 and $25.\n(3)\nThe Company markets its gift product line under the trade name \"RUSS\" and through its wholly-owned subsidiary, Papel\/Freelance, Inc. The Company markets its product line of toys through two subsidiaries, Cap Toys, Inc. and OddzOn Products, Inc. The Company's Bright of America, Inc. subsidiary markets gift products directly to mass merchandisers. In addition, the Company operates a chain of outlet stores under the name \"Russ\" and a chain of retail stores, Fluf N' Stuf, Inc., which sell the Company's products and products of unaffiliated companies.\nThe percentages of dollar sales accounted for by business segment during the periods indicated are as follows:\n* Includes Cap Toys, Inc., acquired in October 1993 and OddzOn Products, Inc., acquired in October 1994.\nThe Company's toy business has experienced success with its product, Stretch Armstrong, and related items. During 1994, sales of Stretch Armstrong and related items accounted for approximately 31% of the Company's toy sales.\nBeginning with the third quarter of 1991 through the first quarter of 1993, the Company had experienced success with its product line of Trolls which were marketed through the Russ Gift division. Net sales of the various products associated with Trolls accounted for approximately 4%, 33% and 56% of the Company's gift sales during 1994, 1993 and 1992, respectively.\nDESIGN AND PRODUCTION\nThe Company's gift business has a continuing program of new product development. The Company designs its own products and then generally evaluates consumer response through test marketing in selected unaffiliated retail stores and those operated by Fluf N' Stuf, Inc.Items are added to the product line only if they can be obtained and marketed on a basis that meets the Company's profitability standards. The Company believes that the breadth of its gift product line and the continuous development of new products are key elements to its success and that it is capable of designing and producing large numbers of new products quickly.\nThe Company has more than 190 employees responsible for gift product development and design in the United States and in the Far East. Generally, a new design is brought to market in less than nine months after a decision is made to produce a new product. Sales of the Company's gift products are, in large part, dependent on the Company's ability to identify and react quickly to changing consumer preferences and to utilize its sales and distribution systems to bring new products to market.\n(4)\nThe Company engages in market research and test marketing to evaluate consumer reactions to its gift products. Research into consumer buying trends often suggest new products. The Company assembles information from retail stores, including those operated by Fluf N' Stuf, Inc., the Company's salesforce and the Company's own Product Development department. The Company continually analyzes its products to determine whether they should be adapted into new or different products using elements of the initial design or whether they should be removed from the gift product line.\nThe Company's toy subsidiaries develop products in conjunction with independent toy inventors. The products are evaluated by the Design and Development staff and undergo a testing process to determine the reaction and acceptability in the marketplace. Products are then selected based on manufacturing and marketing profitability criteria.\nMany popular toy products result in product line extensions enabling the Company to increase its product line and expand on the marketing success of these popular products.\nSubstantially all of the Company's products are produced by independent manufacturers, generally in the Far East, under close supervision by Company personnel. During 1994, products accounting for approximately 94% of its gift products were produced in the Far East and 6% in the United States. During 1994, products accounting for approximately 48% of toy products were produced outside the United States, primarily in the Far East and 52% in the United States. Purchases in the United States predominantly represent domestically produced component parts, packaging and labor costs associated with items requiring final assembly in the United States.\nThe Company utilizes approximately 280 manufacturers in the Far East, primarily in the People's Republic of China, Hong Kong, Taiwan, Korea, Thailand and Indonesia. During 1994, approximately 68% of the Company's dollar amount of purchases were attributable to manufacturing in the People's Republic of China. In December 1994, Congress passed the General Agreement on Tariffs and Trade (GATT) which eliminates or greatly reduces duty on many of the Company's imported products. For example, effective January 1, 1995, duty on items imported from the People's Republic of China classified as \"toys\" by U.S. Customs was reduced from 6.8% to zero. This classification includes products such as stuffed animals and dolls within the gift business as well as the products associated with the Company's toy business. Legislation has been proposed from time to time that would revoke the most-favored nation status (which is a designation determined annually by the President of the United States, subject to possible override by Congress) of the People's Republic of China. Such a revocation would cause import duties to increase or become applicable to products imported by the Company from the People's Republic of China.\nA significant portion of the Company's staff of approximately 350 employees in Hong Kong, Taiwan, Korea, Thailand and Indonesia monitors the production process with responsibility for ensuring the quality, safety and prompt delivery of Company products. Members of the Company's Far East staff make frequent visits to the manufacturers for\n(5)\nwhich they are responsible. Many of the Company's manufacturers are small operations, some selling exclusively to the Company. The Company believes that there are many alternate manufacturers for the Company's products and the loss of any manufacturer will not significantly adversely affect the operations of the Company. In 1994, the supplier accounting for the greatest dollar volume of the Company's purchases accounted for approximately 8% of such purchases and the five largest suppliers accounted for approximately 26% in the aggregate.\nMARKETING\nThe Company's gift products are marketed primarily through its own direct salesforce of approximately 500 full-time employees. Products are sold directly to retail stores in the United States, and in certain foreign countries, including gift stores, pharmacies, card shops, book stores, stationery stores, hospitals, college and airport gift shops, resort and hotel shops, florists, chain stores and military post exchanges. During 1994, the Company sold gift products to approximately 75,000 customers. No single gift customer accounted for more than 1.8% of gift dollar sales.\nThe Company reinforces the marketing efforts of its salesforce through an active promotional program, including showrooms, participation in trade shows, trade advertising and catalogs. In addition, beginning in 1992, the Company engaged in advertising through consumer publications. These advertising programs are designed to increase consumer awareness of, and esteem toward, RUSS products. The amount of consumer advertising related to this program for the years ended December 31, 1994, 1993 and 1992 were $1,342,000, $4,071,000, and $10,474,000, respectively.\nThe Company believes that effective packaging and merchandising of its gift products are very important to its marketing success. Many gift products are shipped in colorful corrugated cartons which can be used as free-standing displays and can be discarded when all the products have been sold. The Company also prepares semi-permanent free-standing lucite, metal and wooden displays, thereby providing an efficient promotional vehicle for selling the Company's products. The displays are designed to stimulate consumers' impulse purchase decisions.\nThe Company believes that customer service is an important component of its marketing strategy and therefore has established a Customer Service Department at each distribution facility that responds to customer requests, investigates and resolves problems and generally assists customers.\nThe Company's general terms of sale are believed to be competitive in the gift industry. The Company provides limited extended payment terms to gift customers on sales of seasonal merchandise, e.g., Christmas, Halloween, Easter and other seasons. Within the gift business, the Company has a general policy of not accepting returns or selling on consignment.\n(6)\nThe Company supports certain of its toy products through an extensive advertising campaign, which is unrelated to the consumer advertising program promoting its gift products under the name RUSS. Advertising expense related to the Company's toy business for the years ended December 31, 1994 and 1993 was $10,650,000 and $1,883,000, respectively. The majority of its advertising budget is allocated to television advertising.\nThe Company's toy business sells its products primarily through independent representative organizations to mass merchandisers, which represent a significant portion of its sales. During 1994, approx-imately 24% of the toy business sales were sold to its largest customer and 58% to its five largest customers.\nThe Company's toy business generally does not sell its products on consignment and ordinarily accepts returns only for defective merchandise. In certain instances, the Company may, in accordance with industry practice, assist retailers in order to enable them to sell excess inventory by offering discounts and other concessions.\nThe Company maintains a direct salesforce and distribution network to serve its gift customers in Great Britain, Holland, Belgium, Ireland and Canada. The remainder of the Company's foreign sales, primarily in Japan, Australia, Italy, Germany, Latin America, Spain and Portugal, are made to distributors for resale to their customers. Additionally, sales of toy products are sold through distributors in Great Britain, Canada and many other foreign countries. The Company's foreign sales, including export sales from the United States, aggregated $62,342,000, $68,295,000 and $101,471,000 in the years ended December 31, 1994, 1993 and 1992, respectively.\nDISTRIBUTION\nThe Company has customers located throughout the United States and throughout the world. In order to serve them quickly and effectively, the Company maintains U.S. distribution centers for its gift business in South Brunswick, New Jersey, Columbus, Ohio, and Petaluma, California which receive products directly from suppliers and then distributes them to the Company's customers. The Company also maintains a facility in the Toronto, Canada area for its Canadian customers and two distribution centers in Southampton, England to serve its customers in Europe. The Company generally uses common carriers to distribute to its customers.\nThe Company's toy product line is distributed through Cap Toys, Inc., which maintains an office and warehouse distribution facility in Bedford Heights, Ohio and through OddzOn Products, Inc., which maintains an office in Campbell, California and a warehouse distribution facility in Santa Clara, California.\nSEASONALITY\nIn addition to its everyday gift products, the Company produces specially designed products for individual seasons during the year, including Christmas, Valentine's Day, St. Patrick's Day, Easter, Mother's Day, Graduation, Father's Day, Halloween and Thanksgiving.\nThe pattern of the Company's gift sales is influenced by the shipment of seasonal merchandise. The Company generally ships the majority of gift orders each year for Christmas in the quarter ended\n(7)\nSeptember 30, for Valentine's Day in the quarter ended December 31 and for Easter in the quarter ended March 31.\nDuring 1994, gift items specially designed for individual seasons accounted for approximately 44% of the Company's gift sales; no individual season accounted for more than 14% of the Company's gift sales.\nThe toy industry is highly seasonal in nature due to the demand for toy products during the Christmas season. To reduce the impact of this seasonality, the Company's toy business produces items specially designed for the summer season. Such items include Shout 'N' Shoot and sports related products.\nThe following table sets forth the Company's quarterly sales by business segment during 1994, 1993 and 1992.\n* Includes Cap Toys, Inc., acquired in October 1993 and OddzOn Products, Inc., acquired in October 1994.\nThe Company has historically had higher profit margins in the quarter ended September 30 as a result of the economies of scale which accompany the higher sales volume. Commencing late in the second quarter of 1991, net sales of the Company were favorably impacted by the success of products associated with the Troll product line which continued into the first quarter of 1993.\n(8)\nBACKLOG\nIt is characteristic of the Company's gift business that orders for seasonal merchandise are taken in advance of shipment. In the toy industry, historically, new toy products have been introduced to the trade at the annual industry trade shows during the quarter ended March 31 and, as such, the order backlog at the end of any fiscal year may not be a meaningful predictor of financial results of the succeeding year. The Company's total backlog at December 31, 1994 was $30,340,000 and at December 31, 1993 was $32,546,000.\nCOMPETITION\nThe gift and toy industries are highly competitive and certain of the Company's existing or potential competitors may have financial resources that are substantially greater than those of the Company. The Company believes that the principal competitive factors in the gift and toy business are marketing ability, reliable delivery, product design, quality, customer service and price. The Company's principal gift competitors are Gund, Inc., Ganz Bros., Ty, Inc., Applause, Inc., Dakin Inc., American Greetings, Hallmark, Recycled Paper Products, Enesco and numerous small suppliers. The Company's principal toy competitors are Bandai, Toy Biz, Tyco, Mattel and Hasbro Inc.\nCOPYRIGHTS, TRADEMARKS, PATENTS AND LICENSES\nThe Company prints notices of claim of copyright on substantially all of its products and has registered hundreds of its designs with the United States Copyright Office. It also has registered, in the United States and certain foreign countries, the trademark \"RUSS\" with a distinctive design, which it utilizes on most of its gift products. The Company believes its copyrights, trademarks and patents are valid, and has pursued a policy of aggressively protecting them from infringement. However, it does not consider its business materially dependent on copyright, trademark or patent protection.\nThe Company enters into various license agreements to market gift products compatible with its product line. Examples of licensed products include designs of the National Football League and Major League Baseball. Licensed products represented approximately 7% of the Company's gift dollar sales in 1994 and 10% in 1993. During 1994, no single gift business license accounted for more than 2% of gift dollar sales.\nThe Company's toy products are most often developed in conjunction with independent toy inventors and, as such, license agreements exist for the majority of the toy product line. Products are also developed around popular characters and additional license agreements exist.\n(9)\nEMPLOYEES\nAs of January 31, 1995, the Company employed approximately 1,850 persons on a full-time basis. The Company considers its employee relations to be good; substantially all of the Company's employees are not covered by a collective bargaining agreement. The Company's policy is to require that its management, sales and product development and design personnel enter into contracts in which they agree not to disclose confidential information concerning the Company and, in the case of management and sales personnel, not to compete with the Company(subject to certain territorial limitations in the case of salespersons) for a period of six months after termination of their employment.\nGOVERNMENT REGULATION\nCertain of the Company's products are subject to the provisions of, among other laws, the Federal Hazardous Substances Act and the Federal Consumer Product Safety Act. Those laws empower the Consumer Product Safety Commission to protect children from certain hazardous articles by excluding them from the market and requiring a manufacturer to repurchase articles which become banned. The Commission's determination is subject to judicial review. Similar laws exist in some states and cities in the United States and in Canada and Europe. The Company maintains a quality control program to ensure compliance with applicable laws.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal facilities consist of its corporate offices in Oakland, New Jersey, and distribution centers in South Brunswick, New Jersey; Petaluma, California; and Reynoldsburg, Ohio. Additionally, office and distribution facilities are located in Southampton, England and in the Toronto, Canada area. The Company's toy subsidiary Cap Toys, Inc., maintains an office and warehouse distribution facility in Bedford Heights, Ohio and OddzOn Products, Inc., maintains an office in Campbell, California and a warehouse distribution facility in Santa Clara, California. The Company owns the facility used by Bright of America, Inc. in Summersville, West Virginia, one of its facilities in Southampton, England and most of the office space it uses in Hong Kong. The Company leases its other facilities. The facilities of the Company are maintained in good operating condition, are generally adequate for the Company's purposes and, except for the Dayton, New Jersey and Lakeland, Florida facilities, which were closed as part of restructuring of the Company's distribution system, are generally fully utilized.\n(10)\nTHE COMPANY'S CURRENT PRINCIPAL FACILITIES ARE AS FOLLOWS:\n(1) Not including renewal options.\n(2) Properties owned directly or indirectly by Russell Berrie or members of his immediate family. See ITEM 13 - \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\n(3) Regional distribution center.\n(4) Corporate headquarters.\n(5) Property leased from a partnership of which a director of the Company is a general partner. See ITEM 13 - \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\n(6) Subsidiary (or division) headquarters.\n(7) Subsidiary (or division) distribution center.\n(8) Facility closed in connection with a restructuring undertaken by the Company. The Company has subleased the Lakeland facility, and continues its efforts to sublease or otherwise terminate the lease with regard to the Dayton and Rexdale Facilities.\nIn addition, the Company leases an aggregate of approximately 24,375 square feet of showroom facilities in New York City; Los Angeles and San Francisco, California; Atlanta, Georgia; Chicago, Illinois; Dallas, Texas; Montreal and Vancouver, Canada; Brussels, Belgium; and Utrecht, Holland. The remaining lease terms at these facilities range between one and ten years.\n(11)\nFluf N' Stuf, Inc., leases retail store space in shopping and outlet malls located within the United States. The aggregate square footage of these 23 stores is approximately 47,000 square feet. The remaining lease terms at these facilities range between two and eight years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn the ordinary course of its business, the Company is party to various copyright, patent and trademark infringement, unfair competition, breach of contract, customs, employment and other legal actions, as plaintiff or defendant.\nThe Company believes that the outcome of the proceedings to which it is currently a party will not have a material adverse effect on its business or financial condition. (See Note 14 of the Notes to Consolidated Financial Statements).\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\n(12)\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table provides information with respect to the executive officers of the Company. All officers are elected by the Board of Directors and may be removed with or without cause by the Board.\nRussell Berrie, the founder of the Company, has been Chairman of the Board and Chief Executive Officer of the Company since its incorporation in 1966.\nArnold S. Bloom has been employed by the Company as Vice President and General Counsel since January 1988 and as Secretary since March 1990.\nPaul Cargotch has been employed by the Company as Chief Financial Officer since March 1990 and Vice President - Finance for more than the past five years.\n(13)\nA. Curts Cooke has been employed as President and Chief Operating Officer of the Company since March 17, 1990; Executive Vice President of the Company, from December 1984 and Chief Financial Officer and Secretary of the Company from 1984 until March 17, 1990. Mr. Cooke has served as a director of the Company since 1982.\nJimmy Hsu has been employed by the Company as Executive Vice President of the Company since July 1, 1994. Prior to that, Mr. Hsu's titles were Senior Vice President - Product Development and Far East Operations since August 1991 and Senior Vice President - Far East Operations from January 1987 through July 1991.\nY.B. Lee has been employed by the Company as either Managing Director or President - Korean Operations from 1977 to February 1990, when he was elected Vice President - Far East Plush Division.\nGuy M. Lombardo has been employed by the Company as Vice President - Administration and Information Systems since January 1994; and prior to that, was Vice President-Management Information Systems for more than the past five years.\nBernard Tenenbaum has been employed by the Company as Vice President - Corporate Development since January 14, 1993; he also serves as President and Chief Executive Officer of a division of the Company which focuses on evaluating possible acquisitions for the Company and overseeing the management of the Company's toy subsidiaries. From September 1988 until joining the Company as an officer, Mr. Tenenbaum was a founding Director of the George Rothman Institute of Entrepreneurial Studies, Fairleigh Dickenson University, and was previously Associate Director of the Snider Entrepreneurial Center of the Wharton School.\n(14)\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAt December 31, 1994 the Company's Common Stock was held by approximately 817 shareholders of record. The following table sets forth the high and low sale prices on the New York Stock Exchange Composite Tape for the calendar periods indicated, as furnished by the New York Stock Exchange:\nThe Board of Directors declared its first dividend to holders of the Company's Common Stock in November 1986. Since then, a cash dividend has been paid quarterly. The current quarterly rate is $.15 per share. This rate has been in effect since February 1993. From February 1992 to February 1993 the quarterly rate was $.117 per share (restated to reflect the 3-for-2 stock split effective April 1, 1993). The quarterly rate from December 1990 to February 1992 was $.10 (restated). The Board of Directors will review its dividend policy from time to time and declaration of dividends will remain within its discretion.\n(15)\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n* Includes a restructuring charge of $5.0 million in 1993 and $9.5 million in 1989.\n** Includes special dividend of $.40 per share.\n(16)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nRESULTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 1994 AND 1993\nFor the year ended December 31, 1994 the Company's net sales of $278,105,000 compares to net sales for the year ended December 31, 1993 of $279,111,000. Included in the results for the year ended December 31, 1994 are the net sales of $82,402,000 achieved by Cap Toys, Inc., which was acquired in October 1993, compared to net sales of Cap Toys, Inc. of $12,653,000 included in the year ended December 31, 1993. Also included in the results for the year ended December 31, 1994 are net sales of $8,315,000 of OddzOn Products, Inc. which was acquired in October 1994. Excluding the net sales of Cap Toys, Inc. and OddzOn Products, Inc., consolidated net sales for the year ended December 31, 1994 decreased $79,070,000 compared to the year ended December 31, 1993. This decrease can be attributed to the significant decrease in the sales of Troll products compared to the prior year. During the year ended December 31, 1994 net sales of Troll products were approximately $7,300,000 compared to approximately $86,700,000 for the year ended December 31, 1993.\nCost of sales were 51.7% of net sales in 1994 compared to 45.1% of net sales in 1993. This increase can be attributed primarily to the higher gross profit margins on sales of Troll products which represented a larger portion of net sales during 1993 and the effects of the reduction of the selling price of certain of the Company's products in August 1993. Also contributing to the increase in cost of sales are the lower gross profit margins achieved by Cap Toys, Inc. compared to certain of the Company's other sales and distribution channels.\nSelling, general and administrative expense was $129,645,000 or 46.6% of net sales for the year ended December 31, 1994 compared to $133,188,000 or 47.7% of net sales in 1993, a decrease of $3,543,000 or 2.7%. Excluding the increase in selling, general and administrative expense of Cap Toys, Inc. (approximately $20,400,000) and the inclusion of the selling, general and administrative expense of OddzOn Products, Inc.(approximately $3,100,000), selling, general and administrative expense decreased $27,043,000. This decrease can be attributed to a decrease in expenses required to support lower sales levels (approximately $16,600,000), including a reduction in of the number of salespeople, and cost reductions associated with the restructuring program implemented during 1993 of closing and consolidating distribution centers and administrative functions (approximately $7,700,000). Cost reductions related to this restructuring were partly realized in the year ended December 31, 1993, resulting in total annualized savings in excess of $10,000,000. Also contributing to the decrease in selling, general and administrative expense are lower expenses related to the Company's \"Just say it with a Russ\" consumer advertising program (approximately $2,500,000).\n(17)\nInvestment and other income of $2,431,000 for the year ended December 31, 1994 compares to $2,573,000 in 1993.\nThe provision for income taxes as a percent of income before taxes for the year ended December 31, 1994 was 24.2% compared to 25.0% in the prior year.\nNet income for the year ended December 31, 1994 of $5,327,000 compares to net income of $13,182,000 in 1993. This decrease in net income can be attributed to the increase in cost of sales as described above partially offset by the decrease in selling, general and administrative expense. Included in the results of operation for the year ended December 31, 1993 is a restructuring charge of $5,000,000 resulting in an after tax effect on net income of $3,150,000.\nRESULTS OF OPERATIONS - YEARS ENDED DECEMBER 31, 1993 AND 1992\nFor the year ended December 31, 1993 the Company's net sales of $279,111,000 represents a decrease of $165,271,000 or 37.2% compared to the year ended December 31, 1992. This decrease can be attributed to the significant reduction in net sales of the Company's Troll product line. During 1993 net sales of the products associated with the Troll product line were approximately $86,700,000 or 31.1% of consolidated net sales compared to approximately $250,000,000 or 56.3% of consolidated net sales during 1992. In addition, the Company believes that its customers had experienced a general softness in their business as a result of the growth of mass merchandisers, factory outlet malls and warehouse clubs. Included in the results for the year ended December 31, 1993 are the net sales of $12,653,000 achieved by Cap Toys, Inc., since its acquisition in October 1993.\nCost of sales was 45.1% of net sales in 1993 compared to 39.7% of net sales in 1992. This increase can be attributed to the higher gross profit margins on sales of Troll products during 1992. In addition, certain components of cost of sales are fixed costs, primarily costs associated with the sourcing of product in the Far East and provisions for slow moving inventory, which were absorbed by the higher sales volume in 1992. Also contributing to the increase are the effects of the reduction of the selling price of certain of the Company's products in August 1993.\nSelling, general and administrative expense was $133,188,000 for the year ended December 31, 1993 compared to $170,948,000 in 1992, a decrease of $37,760,000 or 22.1%. This decrease can be primarily attributed to a decrease in the expenses required to support lower sales levels, principally salesforce commissions (approximately $30,750,000), and to lower expenses related to the Company's consumer advertising program (approximately $6,200,000).\n(18)\nIncluded in the results of operations in 1993 is a restructuring charge of $5,000,000 representing the write-down of certain assets, employee severance costs and other costs related to the closing and consolidating of distribution centers and administrative functions. Also included are additional provisions for future lease obligations relating to a previously closed facility. The restructuring charge resulted in an after tax effect on net income of $3,150,000 or $.15 per share. As expected, this restructuring, in addition to a reduction in the salesforce, resulted in an annualized savings in selling, general and administrative expense of approximately $10,000,000.\nThe provision for income taxes as a percentage of income before taxes decreased to 25.0% in 1993 compared to 35.1% in 1992. The lower effective rate can be attributed to an increased relative benefit associated with investment income resulting from tax- advantaged investments within the Company's short-term investment portfolio, an increased proportion of income before income taxes related to certain foreign subsidiaries with lower tax provisions and to an increased relative benefit for deductions permitted on contribution to charitable organizations.\nNet income of $13,182,000 for 1993 decreased by $47,166,000 when compared to 1992. The decrease in net income can be attributed to the decrease in net sales, partially offset by the decrease in selling, general and administrative expense.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1994 the Company had cash and cash equivalents and short-term investments of $47,961,000 compared to $82,899,000 at December 31, 1993.\nDuring the year ended December 31, 1994, the Company generated net cash flows from operating activities of $787,000. In 1994 funds of $23,709,000 were used for the acquisition of OddzOn Products, Inc., which was acquired in October, 1994. Funds were also used for the payment of dividends amounting to $12,874,000.\nThe Company has available $88,089,000 in bank lines of credit that provide for direct borrowings and letters of credit used for the purchase of inventory. At December 31, 1994 letters of credit of $29,894,000 were outstanding. There were no direct borrowings under the bank lines of credit. Working capital requirements during 1994 were met entirely through internally generated funds. The Company remains in a highly liquid position and believes that the resources available from operations and bank lines of credit are sufficient to meet the foreseeable requirements of its business.\n(19)\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors Russ Berrie and Company, Inc.:\nWe have audited the accompanying consolidated balance sheets of Russ Berrie and Company, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 Russ Berrie and Company, Inc. and subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the Consolidated Financial Statements, effective January 1, 1992 the Company changed its method of accounting for income taxes.\nCOOPERS & LYBRAND L.L.P.\nParsippany, New Jersey February 3, 1995\n(20)\nCONSOLIDATED STATEMENT OF INCOME FOR THE YEARS ENDED DECEMBER 31\n(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of the consolidated financial statements.\n(21)\nCONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY\n(Dollars in Thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\n(22)\nCONSOLIDATED BALANCE SHEET AT DECEMBER 31, (Dollars in Thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\n(23)\nCONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31 (Dollars in Thousands)\nThe accompanying notes are an integral part of the consolidated financial statements.\n(24)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING PRACTICES:\nPRINCIPALS OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Russ Berrie and Company, Inc. and its wholly-owned subsidiaries (collectively, the \"Company\") after elimination of intercompany accounts and transactions.\nADVERTISING COSTS\nProduction costs for advertising are charged to operations in the year the related advertising campaign begins. All other advertising costs are charged to results of operations during the year in which they are incurred.\nCASH EQUIVALENTS\nCash equivalents consist of investments in interest bearing accounts and highly liquid securities having a maturity of three months or less.\nSHORT-TERM INVESTMENTS\nThe Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", effective with the year ended December 31, 1994.\nAs of December 31, 1994 short-term investments in debt securities have been categorized as available for sale and as a result are stated at fair value. As of December 31, 1993 short-term investments were stated at cost plus accrued interest which approximates market.\nINVENTORIES\nInventories, which mainly consist of finished goods, are stated at the lower of cost (first-in, first-out) or market value.\nPROPERTY\nProperty, plant and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives which range from three to eighteen years. Leasehold improvements are amortized using the straight-line method over the term of the respective lease or asset life, whichever is shorter. Expenditures for maintenance and repairs are charged to operations as incurred. Gain or loss on retirement or disposal of individual assets is recorded as income or expense.\n(25)\nGOODWILL AND OTHER INTANGIBLE ASSETS\nGoodwill, which represents the excess of purchase price of acquired assets over the fair market value of net assets acquired, is being amortized using the straight-line method over fifteen years or less. The Company evaluates the recoverability of goodwill based upon estimated future income of operating entities. Other intangible assets acquired are being amortized over the period for which benefit is derived which ranges from two to six years. Accumulated amortization was $6,366,000 and $3,876,000 at December 31, 1994 and 1993, respectively.\nFOREIGN CURRENCY TRANSLATION\nAggregate foreign exchange gains or losses resulting from the translation of those foreign currency financial statements which are denominated in the local currency of each foreign subsidiary are recorded as a separate component of shareholders' equity. Gains and losses from foreign currency transactions are included in investment and other income - net.\nACCOUNTING FOR INCOME TAXES\nFor the year ended December 31, 1992 the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\".\nNET INCOME PER SHARE\nNet income per share is based on the weighted average number of shares outstanding during the year. The number of shares used in the computation at December 31, 1994, 1993 and 1992 were 21,458,099; 21,470,672; and 22,391,739, respectively.\nPOST-EMPLOYMENT BENEFITS\nIn November 1992, Statement of Financial Accounting Standards No. 112 was issued which establishes the method of accounting for post-employment benefits. The Company does not offer any post-employment benefits to employees and, as such, there is no impact of this statement on the consolidated financial statements.\n(26)\nFOREIGN CURRENCY CONTRACTS\nThe Company enters into forward exchange contracts and currency options, principally to hedge the purchase of inventory by its foreign subsidiaries. Gains and losses are reported as a component of the related transactions. The Company does not speculate in foreign currencies. At December 31, 1994 and 1993 the aggregate amount of foreign exchange contracts was $1,500,000 and $1,000,000, respectively.\nACQUISITION\nIn October 1994, the Company completed the acquisition of substantially all of the assets, including inventory, of OddzOn Products, Inc., a toy company based in Campbell, California. The acquisition, accounted for as a purchase, was funded entirely by the Company's cash and $19,344,000 of goodwill was recorded. Additional payments may be required based upon the attainment of certain future operating profit levels of OddzOn Products, Inc. Amounts related to additional payments will be accrued and charged to goodwill when they become earned.\nIn October 1993, the Company acquired substantially all of the assets of Cap Toys, Inc., a toy company based in Ohio, and $13,606,000 of goodwill was recorded. Under the purchase agreement, additional payments may be required based upon the attainment of certain operating profit levels of Cap Toys, Inc. During the year ended December 31, 1994, $2,563,000 was charged to goodwill related to these additional payments.\nNOTE 2 - SHORT-TERM INVESTMENTS\nShort-term investments as of December 31, 1994 and December 31, 1993 include the following:\nThe maturities of short-term investments as of December 31, 1994 are due after one year and before five years.\n(27)\nNOTE 3 - PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consist of the following:\nNOTE 4 - LINES OF CREDIT\nUnder its existing domestic bank lines of credit, the Company has available $75,000,000 of direct borrowings and letters of credit at any one time.\nThe maximum amount available to the Company's foreign operations at December 31, 1994 under local lines of credit is $13,089,000. These lines, which are guaranteed by the Company, provide for direct borrowings, letters of credit, and overdraft facilities.\nIn connection with the purchase of imported merchandise, the Company, at December 31, 1994 had letters of credit outstanding of $29,894,000.\nNOTE 5 - ACCRUED EXPENSES\nAccrued expenses at December 31, 1994 and 1993 include accrued sales commissions of $1,625,000 and $2,110,000, respectively. At December 31, 1994 accrued expenses include accrued advertising of $2,653,000 and an accrual of $2,349,000 related to additional payments required pursuant to the asset purchase agreement with Cap Toys, Inc. Accrued expenses at December 31, 1994 and 1993 also include accrued litigation of $6,300,000 (see Note 14).\nNOTE 6 - RESTRUCTURING CHARGE\nA restructuring charge of $5,000,000 was recorded in the year ended December 31, 1993. This charge includes the write-down of certain assets, employee severance costs and other incremental costs related to the closing, moving and consolidating of distribution and administrative functions. As of December 31, 1994 the remaining accrual primarily represents future lease obligations, through 1997, related to previously closed facilities. One such facility is leased from a partnership in which a director of the Company is a general partner (see Note 9).\n(28)\nNOTE 7 - INVESTMENT AND OTHER INCOME - NET\nThe significant components of investment and other income - net for the years ended December 31, 1994, 1993, and 1992 are shown as follows:\nNOTE 8 - INCOME TAXES\nThe Company and its domestic subsidiaries file a consolidated Federal income tax return.\nIncome before income taxes was:\nThe provision for income taxes consists of the following:\n(29)\nA reconciliation of the provision for income taxes with amounts computed at the statutory Federal rate is shown below:\nThe components of the net deferred tax asset, net of a valuation allowance of $2,025,000 (primarily relating to deferred state taxes), resulting from differences between accounting for financial reporting purposes and accounting for tax purposes were as follows:\nU.S. income taxes or foreign withholding taxes are not provided on undistributed earnings of foreign subsidiaries, which are considered to be permanently reinvested. The amount of such earnings was approximately $58,566,000 as of December 31, 1994. Determination of the net amount of unrecognized deferred tax liability with respect to these earnings is not practicable.\n(30)\nNOTE 9 - RELATED PARTY TRANSACTIONS\nCertain buildings, referred to in Note 10, are leased from Russell Berrie, the Company's majority shareholder, or entities owned or controlled by him. Rentals under these leases for the years ended December 31, 1994, 1993 and 1992 were $4,307,000, $4,406,000 and $4,133,000, respectively. The Company is also a guarantor under two mortgages for property so leased with a principal amount aggregating approximately $8,373,000 as of December 31, 1994, $2,000,000 of which is collateralized by assets of the Company.\nThe Company also leases a facility from a partnership in which a director of the Company is a general partner. Annual rentals under this lease agreement for the years ended December 31, 1994, 1993, and 1992 were $996,000, $996,000 and $831,000, respectively. This facility is included in the estimate for future lease obligations with respect to the accrued restructuring costs (see Note 6).\nNOTE 10 - LEASES\nAt December 31, 1994, the Company and its subsidiaries are obligated under operating lease agreements (principally for buildings and other leased facilities) for remaining lease terms ranging from one to twenty-four years.\nRent expense for the years ended December 31, 1994, 1993 and 1992, amounted to $8,264,000, $8,456,000 and $8,167,000, respectively.\nThe approximate aggregate future rental payments as of December 31, 1994 under operating leases are as follows:\nNOTE 11 - STOCK OPTION AND EMPLOYEE STOCK PURCHASE PLANS\nThe Company has three stock option plans and an employee stock purchase plan. As of December 31, 1994 and January 1, 1994 there were 3,533,713 and 3,800,000 shares of common stock, respectively, reserved for issuance under all stock plans. There are outstanding options under prior plans; however, these plans have been terminated and no additional options can be granted. The option price for all stock option plans is equal to the closing price of the stock as of the date the option is granted and no options may be exercised within one year from the date of grant.\n(31)\nOptions are exercisable at prices ranging from $9.34 to $21.17 per share under the various plans. The exercise price of options exercised during 1994 ranged from $9.34 to $14.25. Summarized stock option data follows:\n* These plans allowed for the granting of Stock Appreciation Rights (SARs). The SARs, which relate to specific options under the plans, permit the participant to exercise the SAR and be entitled to an amount equal to the excess of the closing market price of Russ Berrie and Company, Inc. Common Stock on the date of exercise over the exercise price of the related option.\nUnder the Employee Stock Purchase Plan, the option price is 90% of the closing market price of the stock on the first business day of the plan year. During 1994, 4,981 shares were acquired under this plan. The 1994 Employee Stock Purchase Plan has 145,019 shares reserved for future issuance.\nNOTE 12 - RETIREMENT PLAN AND 401(K) PLAN\nAs of December 31, 1994, the Company had a non-contributory retirement plan for substantially all employees which provides for contributions by the Company, on a calendar year basis, in such amounts (subject to certain maximum limitations) as the Board of Directors may determine.\n(32)\nThere were no provisions for contributions charged to operations for the year ended December 31, 1994. The provisions for contributions charged to operations for the years ended December 31, 1993 and 1992 were $1,991,000 and $2,384,000, respectively. Effective February 1, 1995, the Company converted its retirement plan to a 401(k) Plan. Employees may, up to certain prescribed limits, contribute to the 401(k) Plan and a portion of these contributions is matched by the Company.\nNOTE 13 - BUSINESS SEGMENTS AND GEOGRAPHIC AREAS\nThe Company's operations by business segment and geographic area are presented below:\n*Includes short-term investments.\n(33)\nNOTE 14 - LITIGATION\nThe Company is subject to legal proceedings and claims which arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the results of operations or the financial position of the Company.\nFor the year ended December 31, 1992, the Company reserved $6,300,000 relating to an award by a jury in February 1993 for slander and other pending claims made by the plaintiff. It is the opinion of the Company that the verdict is not supported by the evidence and the claims are without merit. The Company will vigorously defend its position before the trial court and, if necessary, on appeal.\n(34)\nNOTE 15 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nThe following selected financial data for the eight quarters ended December 31, 1994 are derived from unaudited financial statements and include, in the opinion of management, all adjustments necessary for fair presentation of the results for the interim periods presented and are of a normal recurring nature. However, the quarter ended December 31, 1993 includes a restructuring charge of $5,000,000 ($3,150,000 or $.15 per share after taxes) and a provision for slow moving inventory of $4,380,000 ($2,760,000 or $.13 per share after taxes):\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\n(35)\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation relating to this item appears under the caption \"ELECTION OF DIRECTORS\" on pages 1 through 3 of the 1995 Proxy Statement, which is incorporated herein by reference and under the caption \"EXECUTIVE OFFICERS OF THE REGISTRANT\" on pages 12 and 13 of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to this item appears under the caption \"THE BOARD OF DIRECTORS AND COMMITTEES OF THE BOARD\" on page 3, \"DIRECTOR COMPENSATION\" on pages 3 through 5, \"EXECUTIVE COMPENSATION\" on pages 11 through 13 and \"COMPENSATION COMMITTEE REPORT\" on pages 6 and 7 in the 1995 Proxy Statement, which are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation relating to this item appears under the captions \"SECURITY OWNERSHIP OF MANAGEMENT\" and \"SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\" on pages 9 and 10 of the 1995 Proxy Statement, which is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation relating to this item appears under the captions \"EXECUTIVE COMPENSATION\" on pages 11 through 13, \"CERTAIN TRANSACTIONS\" on pages 14 and 15 and \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\" on page 7 of the 1995 Proxy Statement, which is incorporated herein by reference.\n(36)\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\n(a) DOCUMENTS FILED AS PART OF THIS REPORT.\n1. FINANCIAL STATEMENTS:\n-------------- Other schedules are omitted because they are either not applicable or not required or the information is presented in the Consolidated Financial Statements or Notes thereto.\n(37)\n----------------\n(1) Incorporated by reference to Amendment No. 2 to Registration Statement No. 2-88797 on Form S-1, as filed on March 29, 1984.\n(2) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1984.\n(3) Incorporated by reference to Amendment No. 1 to Registration Statement No. 2-88797 on Form S-1, as filed on March 13, 1984.\n(9) Incorporated by reference to Amendment No. 1 to Registration Statement No. 33-10077 on Form S-1, as filed on December 16, 1986.\n(11) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1987.\n(23) Incorporated by reference to Registration No. 33-51823 on Form S-8, as filed on January 6, 1994.\n(38)\n---------------- (4) Incorporated by reference to Registration Statement No. 2-88797 on Form S-1 as filed on February 2, 1984.\n(39)\n---------------- (1) Incorporated by reference to Amendment No. 2 to Registration Statement No. 2-88797 on Form S-1, as filed on March 29, 1984.\n(4) Incorporated by reference to Registration Statement No. 2-88797 on Form S-1, as filed on February 2, 1984.\n(6) Incorporated by reference to Post-Effective Amendment No. 1 to Registration Statement No. 2-96238 on Form S-8, as filed on November 6, 1985.\n(8) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1985.\n(9) Incorporated by reference to Amendment No. 1 to Registration Statement No. 33-10077 of Form S-1, as filed on December 16, 1986.\n(11) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1987.\n(13) Incorporated by reference to Form S-8 Registration Statement No. 33-26161, as filed on December 16, 1988.\n(40)\n--------------\n(9) Incorporated by reference to Amendment No. 1 to Registration Statement No. 33-10077 of Form S-1, as filed on December 16, 1986.\n(11) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1987.\n(14) Incorporated by reference to Form S-8 Registration Statement No. 33-27406, as filed on March 16, 1989.\n(15) Incorporated by reference to Form S-8 Registration Statement No. 33-27897, as filed on April 5, 1989.\n(16) Incorporated by reference to Form S-8 Registration Statement No. 33-27898, as filed on April 5, 1989.\n(17) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1988.\n(41)\n---------------- (17) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1988.\n(18) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1989.\n(19) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1990.\n(42)\n----------------\n(20) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1991.\n(21) Incorporated by reference to Annual Report on Form 10-K for the year ended December 31, 1992.\n(22) Incorporated by reference to Quarterly Report on Form 10-Q for the quarter ended September 30, 1993.\n(23) Incorporated by Reference to Quarterly Report on Form 10-Q for the quarter ended September 30, 1994.\n(b) REPORTS ON FORM 8-K\nNo reports on From 8-K were filed by the Company during the quarter ended December 31, 1994.\n(43)\nUndertaking\nIn order to comply with amendments to the rules governing the use of Form S-8 under the Securities Act of 1933, as amended, as set forth in Securities Act Release No. 33-6867, the undersigned Registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into Registrant's Registration Statements on Forms S-8 (File Nos. 2-96238, 2-96239, 2-96240, 33-10779, 33-26161, 33-27406, 33-27897 and 33-27898):\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 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.\n(44)\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.\nRuss Berrie and Company, Inc. (Registrant)\nBy \/s\/ Paul Cargotch ----------------------------- Paul Cargotch Vice President - Finance and Chief Financial Officer\n3\/24\/95 -----------------------\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 Date ---------- ----\n\/s\/ Russell Berrie 3\/24\/95 ---------------------------------------------- --------- Russell Berrie, Chairman of the Board, Chief Executive Officer, and Director (Principal Executive Officer)\n\/s\/ A. Curts Cooke 3\/24\/95 ---------------------------------------------- --------- A. Curts Cooke, President, Chief Operating Officer and Director (Principal Operating Officer)\n\/s\/ Paul Cargotch 3\/24\/95 ---------------------------------------------- --------- Paul Cargotch, Vice President - Finance and Chief Financial Officer (Principal Financial and Accounting Officer)\n(45)\n3\/ \/95 ----------------------------------------------- ------- Raphael Benaroya, Director\n\/s\/ Art Charpentier 3\/24\/95 ----------------------------------------------- ------- Arthur D. Charpentier, Director\n\/s\/ Jimmy Hsu 3\/23\/95 ----------------------------------------------- ------- Jimmy Hsu, Director\n3\/ \/95 ----------------------------------------------- ------- Charles Klatskin, Director\n\/s\/ Joseph Kling 3\/24\/95 ----------------------------------------------- ------- Joseph Kling, Director\n3\/ \/95 ----------------------------------------------- ------- William A. Landman, Director\n\/s\/ Sidney Slauson 3\/24\/95 ----------------------------------------------- ------- Sidney Slauson, Director\n\/s\/ Bernard Tenenbaum 3\/24\/95 ----------------------------------------------- ------- Bernard Tenenbaum, Director\nS-2\nRUSS BERRIE AND COMPANY, INC. AND SUBSIDIARIES SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS (Dollars in Thousands)\n*Principally account write-offs, allowances and disposal of merchandise, respectively.\nExhibit Index\nExhibit Numbers\n21.1 List of Subsidiaries\n23.1 Report of Independent Accountants\n23.2 Consent of Independent Accountants\n27.1 Financial Data Schedule","section_15":""}
{"filename":"702165_1994.txt","cik":"702165","year":"1994","section_1":"Item 1. Business. ------ --------\nand\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. ------ ----------\nGENERAL - Norfolk Southern Corporation (Norfolk Southern) was incorporated on July 23, 1980, under the laws of the Commonwealth of Virginia. On June l, 1982, Norfolk Southern acquired control of two major operating railroads, Norfolk and Western Railway Company (NW) and Southern Railway Company (Southern). In accordance with an Agreement of Merger and Reorganization dated as of July 31, 1980, and related Plans of Merger, and with the approval of the transaction by the Interstate Commerce Commission (ICC), each issued share of NW's common stock was converted into one share of Norfolk Southern Common Stock and each issued share of Southern common stock was converted into l.9 shares of Norfolk Southern Common Stock. The outstanding shares of Southern's preferred stock remained outstanding without change.\nEffective December 31, 1990, Norfolk Southern transferred all the common stock of NW to Southern, and Southern's name was changed to Norfolk Southern Railway Company (Norfolk Southern Railway). As of February 28, 1995, all the common stock of NW (100 percent voting control) is owned by Norfolk Southern Railway, and all the common stock of Norfolk Southern Railway and 9.6 percent of its preferred stock (resulting in 94.4 percent voting control) are owned directly by Norfolk Southern.\nOn June 21, 1985, Norfolk Southern acquired control of North American Van Lines, Inc. and its subsidiaries (NAVL), a diversified motor carrier. In accordance with an Acquisition Agreement dated May 2, 1984, and with the approval of the transaction by the ICC, Norfolk Southern acquired all the issued and outstanding common stock of NAVL from PepsiCo, Inc. During 1993, NAVL underwent a restructuring (see discussion on page 6 and in Note 15 of Notes to Consolidated Financial Statements on page 71) designed to enhance its opportunities to return to profitability.\nUnless indicated otherwise, Norfolk Southern and its subsidiaries are referred to collectively as NS.\nRAILROAD OPERATIONS - As of December 31, 1994, NS' railroads operated 14,652 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, 12,780 miles are owned, 677 miles are leased and 1,195 miles are operated under trackage rights; also, of this total, 11,991 miles are main line and 2,661 miles are branch line. In addition, NS' railroads operate approximately 10,907 miles of passing, industrial, yard and side tracks.\nNS' railroads have major leased lines in North Carolina and between Cincinnati, Ohio, and Chattanooga, Tennessee. The North Carolina leases, covering approximately 300 miles, expired by their terms at the end of 1994. However, NS expects these leases to be renewed or extended and NS' railroads have reached tentative understandings for such renewal or extension. The tentative arrangements call for payment of an annual rental of $8 million in 1995, with inflation adjustments in succeeding years. Pending the approval of a form of lease extension agreement by the parties, NS' railroads continue to operate over these lines under the terms of the expired leases. If these leases ultimately are not renewed or extended, NS' railroads could be required to continue using the lines subject to conditions prescribed by the ICC or they might find it necessary to operate over an alternate route or routes. It is not expected that the resolution of this matter (whether resulting in renewal or extension 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' consolidated financial position.\nThe Cincinnati-Chattanooga lease, 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' 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 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.\nThe lines of NS' railroads 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, the system's 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.\nNS rail subsidiaries and other railroads have entered into service interruption agreements, effective December 30, 1994, providing indemnities to parties affected by a strike over specified industry issues. If NS were so affected, it could receive daily\nindemnities from non-affected parties; if parties other than NS were affected, NS could be required to pay indemnities to those parties. If NS were required to pay the maximum amount of indemnities required of it under these agreements--an event considered unlikely at this time--such liability should not exceed approximately $85 million.\nMOTOR CARRIER OPERATIONS - DOMESTIC OPERATIONS - NAVL's principal transportation activity now is the domestic, irregular route common and contract carriage of used household goods and special commodities between points in the United States. NAVL also operates as an intrastate carrier of property in 19 states.\nPrior to its restructuring in 1993, NAVL's domestic motor carrier business was organized into three primary divisions: Relocation Services (RS) specializing in residential relocation of used household goods; High Value Products (HVP) specializing in office and industrial relocations and transporting exhibits; and Commercial Transport (CT) specializing in the transportation of truckload shipments of general commodities. In 1993, NAVL underwent a restructuring involving termination of the CT Division and sale of the operations of Tran-Star, Inc. (Tran-Star), NAVL's refrigerated trucking subsidiary. In 1993, NAVL discontinued CT's operations, transferred some parts of CT's business to other divisions and began selling CT's assets that were not needed in NAVL's other operations. The sale of Tran-Star's operations was completed on December 31, 1993.\nDuring 1994, the RS and HVP divisions conducted operations through agents at 696 locations in the United States. Agents are local moving and storage companies that provide NAVL with such services as solicitation, packing and warehousing in connection with the movement of household goods and specialized products. NAVL's future domestic operations are expected to be conducted principally through the RS and HVP divisions.\nCustomized Logistics Services (CLS) was established in 1993 as an operating unit of the HVP Division. CLS' business is to focus NAVL's resources to respond to a variety of customer needs for integrated logistics services. The services include emergency parts order fulfillment, time-definite transportation and in-transit merge programs.\nFOREIGN OPERATIONS - NAVL's foreign operations are conducted through the RS and HVP Divisions and through foreign subsidiaries, including North American Van Lines Canada, Ltd. The latter subsidiary provides motor carrier service for the transportation of used household goods and specialized commodities between most points in Canada through a network of approximately 179 agent locations. NAVL's international operations consist primarily of forwarding used household goods to and from the United States and between foreign countries through a network of approximately 330 foreign agents and representatives. NAVL's international operations are structurally aligned with the services provided by its domestic operating divisions. All international household goods operations and related subsidiaries in Alaska, Canada and Panama are assigned to the RS Division. The remaining international operations, which include subsidiaries in the United States, Germany and the United Kingdom,\nare involved in the transportation of selected general and specialized commodities and are assigned to the HVP Division.\nTRIPLE CROWN OPERATIONS - Until April 1993, Norfolk Southern's intermodal subsidiary, Triple Crown Services, Inc. (TCS), offered intermodal service using RoadRailer (Registered Trademark) (RT) equipment and domestic containers. RoadRailer(RT) units are enclosed vans which can be pulled over highways in tractor- trailer configuration and over the rails by locomotives. On April 1, 1993, the business, name and operations of TCS were transferred to Triple Crown Services Company (TCSC), a partnership in which subsidiaries of Norfolk Southern and Consolidated Rail Corporation (CR) are equal partners. RoadRailer(RT) equipment owned or leased by TCS (which was renamed TCS Leasing, Inc.) is operated by TCSC. Because NS indirectly owns only 50 percent of TCSC, the revenues of TCSC are not consolidated with the results of NS. TCSC offers door-to- door intermodal service using RoadRailer(RT) equipment and domestic containers in the corridors previously served by TCS, as well as service to the New York and New Jersey markets via CR. Major traffic corridors include those between New York and Chicago, Chicago and Atlanta, and Atlanta and New York.\nTRANSPORTATION OPERATING REVENUES - NS' total transportation operating revenues were $4.58 billion in 1994. These revenues were received for the transportation of revenue freight: 282.7 million tons by rail and 0.9 million tons by motor carrier. Of the rail tonnage, approximately 221.9 million tons originated on line, approximately 242.8 million tons terminated on line (including 187.9 million tons of local traffic -- originating and terminating on line) and approximately 5.9 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 transportation operating revenue sources for the period 1990 through 1994 are set forth in the following table:\nCOAL TRAFFIC - Ranked by tons handled, coal, coke and iron ore--most of which is bituminous coal--is NS' railroads' principal commodity group. NS' railroads originated 114.7 million tons of coal, coke and iron ore in 1994 and handled a total of 125.9 million tons. Originated tonnage increased 2.3 percent from 112.1 million tons in 1993, and total tons handled increased 6.7 percent from 118.0 million tons in 1993. Revenues from coal, coke and iron ore, which accounted for 28 percent of NS' total transportation operating revenues and 36 percent of total revenue ton miles in 1994, were $1.26 billion, an increase of 4 percent from $1.21 billion in 1993.\nThe following table shows total coal tonnage originated on- line, received from connections and handled for the five years ended December 31, 1994:\nOf the 112.0 million tons of coal originating on NS railroad lines in 1994, the approximate breakdown by origin state is as follows: 41.2 million tons from West Virginia, 36.5 million tons from Virginia, 23.6 million tons from Kentucky, 5.7 million tons from Alabama, 3.0 million tons from Illinois, 1.5 million tons from Tennessee, and 0.5 million tons from Indiana. Of this NS-origin coal, approximately 25.0 million tons moved for export, principally through NS pier facilities at Norfolk (Lamberts Point), Va.; 18.3 million tons moved to domestic and Canadian steel industries; 59.8 million tons of steam coal moved to electric utilities; and 8.9 million tons moved to other industrial and miscellaneous users. NS' railroads moved 10.4 million tons of originated coal to various docks on the Ohio River for further movement by barge and 5.2 million tons to various Lake Erie ports. Other than coal for export, virtually all coal handled by NS' railroads was terminated in states situated east of the Mississippi River.\nTotal coal tonnage handled through all system ports in 1994 was 43.6 million. Of this total, 64 percent moved through the pier facilities at Lamberts Point. In 1994, total tonnage handled at Lamberts Point, including coastwise traffic, was 27.8 million tons, a 0.7 percent increase from the 27.6 million tons handled in 1993.\nFor the five years ended December 31, 1994, the quantities of NS coal handled only for export through Lamberts Point were as follows:\nSee the discussion of coal traffic, by type of coal, in Part II, Item 7, \"Management's Discussion and Analysis,\" on page 34.\nMERCHANDISE RAIL TRAFFIC - The merchandise traffic group consists of Intermodal and five major commodity groupings (Chemicals; Paper\/Forest; Automotive; Agriculture; and Metals\/Construction). Total NS railroad merchandise revenues increased in 1994 to $2.54 billion, a 6 percent increase over 1993. Railroad merchandise carloads handled in 1994 were 3.03 million, compared with 2.82 million handled in 1993, an increase of 8 percent.\nIntermodal results reflect the effect of the formation, in April 1993, of TCSC, a partnership between NS and Conrail subsidiaries (see also page 7). This partnership provides RoadRailer(RT) and domestic container services previously offered by a wholly owned NS subsidiary. Because NS owns only 50 percent of TCSC, its revenues are not consolidated, and NS' 1994 and 1993 intermodal revenues include only revenues for rail service provided by NS to the partnership. Excluding this partnership effect, 1994 intermodal revenues increased 14%, compared with 1993, and 1993 intermodal revenues increased 10 percent, compared with 1992.\nIn 1994, 106.4 million tons of merchandise freight, or approximately 68 percent of total rail merchandise tonnage handled by NS, originated on line. The balance of NS' railroad 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- received traffic included Chicago, Memphis, New Orleans, Cincinnati, Kansas City, Detroit, Hagerstown, St. Louis\/East St. Louis and Louisville.\nRevenues in all six market groups comprising merchandise traffic improved over 1993, with four of the six increasing by 8% or more. The biggest gains were in Intermodal, up $53.6 million (adjusted for the effect of the TCSC partnership); Chemicals, up $39.3 million; Agriculture, up $27.8 million; and Metals\/Construction, up $25.3 million.\nSee the discussion of merchandise rail traffic by commodity group in Part II, Item 7, \"Management's Discussion and Analysis,\" on page 34.\nMOTOR CARRIER TRAFFIC - NAVL's traffic volume decreased during 1994 due to the restructuring in 1993 (see page 6). Total motor carrier revenues were $663.2 million, down 7 percent from 1993, which included six months of revenues from the subsequently discontinued operations prior to the restructuring of NAVL. Adjusted for the effect of discontinued truckload operations in 1993, motor carrier operating revenues in 1994 increased 15 percent. NAVL's expenses decreased 17 percent in 1994, also resulting from the restructuring.\nDOMESTIC OPERATIONS now are conducted through NAVL's RS and HVP divisions. In 1994, total domestic shipments for these divisions were 379,294, up 8 percent from 1993. Further comments about each division follow.\nDomestic shipments of used household goods transported by the RS Division fall into three market categories. Approximately 50 percent of the domestic shipment volume comes from the sale of moving services to individual consumers. Another 38 percent comes from corporations and other businesses that pay for the relocation of their employees. The remaining 12 percent is derived from military, government and other sources. Total domestic RS Division shipments in 1994 represented 31 percent of the NAVL domestic motor carrier shipments transported by the two primary divisions. Total domestic revenues from this division were up 5 percent, compared with 1993, and represented 43 percent of total revenues from operations.\nThe HVP Division specializes in providing transportation services in less-than-truckload (LTL) and truckload (TL) quantities of sensitive products. These products are divided into the following categories: office furniture and equipment, exhibits and displays, electronic equipment, industrial machinery, commercial relocation, LTL furniture and selected general commodities. Total HVP Division shipments transported in 1994, including TL and LTL, represented 69 percent of the NAVL domestic motor carrier shipments transported by the two primary divisions. Revenues from this division were up 29 percent from 1993 levels and represented 46 percent of total revenues from operations.\nThe operations of the CT Division were discontinued in 1993. Total CT Division shipments transported in 1993 represented 36 percent of NAVL's total domestic motor carrier shipments transported for the entire year by the three primary divisions. Revenues from this division were down 50 percent in 1993 compared with 1992 levels and represented 19 percent of total revenues from operations.\nFOREIGN OPERATIONS include NAVL's Canadian subsidiary, North American Van Lines Canada, Ltd., as well as operating subsidiaries in England, Germany and Panama. Foreign operations involving the transportation of used household goods and selected general and specialized commodities generated revenues of $71.1 million in 1994, up 3 percent from 1993. Revenues from foreign operations represented 11 percent of NAVL's total revenues.\nFREIGHT RATES - In 1994 NS' railroads continued their reliance on private contracts and exempt price quotes as their predominant pricing mechanisms. Thus, a major portion of NS' railroads' 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. Proposals pending in Congress in early 1995 would further reduce rate regulation of railroads.\nIn 1994, the ICC found NS' railroads \"revenue inadequate\" based on results for the year 1993. A railroad is \"revenue inadequate\" under the Interstate Commerce Act when its return on net investment does not exceed the rail industry's composite cost of capital. The absence of \"revenue adequacy\" lets a railroad use a provision in the Interstate Commerce Act allowing increases in regulated rates by a specific percentage. However, with the decreasing importance of regulated tariff traffic to NS' railroads, the ICC's \"revenue adequacy\" findings have less impact than formerly.\nPricing and service flexibility afforded by the Motor Carrier Act of 1980 and the Household Goods Transportation Act of 1980 has resulted in NAVL's increased emphasis on innovative pricing action in order to remain competitive. Since 1980, NAVL has increasingly operated as a contract carrier. As of December 31, 1994, domestic contract carriage agreements accounted for the following percentage of shipments: RS Division, 28 percent and HVP Division, 80 percent.\nPASSENGER OPERATIONS - Regularly scheduled passenger operations on NS' 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 on November 3, 1993. Commuter trains continued operations on the NS 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. 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 an agreement under which NS had provided commuter rail service for the Authority.\nNONCARRIER OPERATIONS - Norfolk Southern's noncarrier subsidiaries engage principally in the acquisition and subsequent leasing of coal, oil, gas and timberlands, the development of commercial real estate and the leasing or sale of rail property and equipment. In 1994, no such noncarrier subsidiary or industry segment grouping of noncarrier subsidiaries met the requirements for a reportable business segment set forth in Statement of Financial Accounting Standards No. 14.\nIn January 1994, certain Norfolk Southern subsidiaries purchased rights with respect to an estimated 210 million recoverable tons of coal located primarily in eastern Kentucky and southern West Virginia. The cash purchase price for the acquisition was $71 million. These coal reserves have been leased to various producers who operate and mine the properties under long-term leases providing royalty income to NS.\nThe average age of the freight car fleet at December 31, 1994, was 21.9 years. During 1994, NS retired 3,333 freight cars. As of December 31, 1994, the average age of the locomotive fleet was 15.8 years. During 1994, NS retired 24 locomotives, the average age of which was 23.6 years. Since 1988, NS has rebodied more than 17,200 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 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 cars for which present and future customers' needs could be adequately met without such repair programs. Also, NS' own standards of what constitutes a \"serviceable\" car have risen, and NS continues its disposition program for underutilized, unserviceable and overage cars.\nTRACKAGE - All NS trackage is standard gauge, and the rail in approximately 96 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 23,172 miles of track maintained by NS as of December 31, 1994, 15,712 were laid with welded rail.\nMICROWAVE SYSTEM - The NS microwave system, consisting of 6,584 radio path miles, 374 active stations and 7 passive repeater stations, provides communications for 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 2,168,990 individual voice channel miles of circuits. The microwave 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 13,457 road miles operated by NS, excluding trackage rights over foreign lines, 5,274 road miles are governed by centralized traffic control systems (of which 81 miles are controlled by data radio from seven microwave site locations) 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 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 has extensive facilities for support of railroad operations, including freight depots, car construction shops, maintenance shops, office buildings, and signals and communications facilities.\nMOTOR CARRIER PROPERTY:\nREAL ESTATE - NAVL owns and leases real estate in support of its operations. Principal real estate holdings include NAVL's headquarters complex and warehouse and vehicle maintenance facilities in Fort Wayne, Indiana, vehicle maintenance facilities in Fontana, California, and terminal facilities in Grand Rapids, Michigan, and Great Falls, Montana. NAVL also leases facilities throughout the United States for sales offices, maintenance facilities and for warehouse, terminal and distribution center operations.\nEQUIPMENT - NAVL relies extensively on independent contractors (owner-operators) who supply the power equipment (tractors) used to pull NAVL trailers. Agents also provide a substantial portion of NAVL's equipment needs, particularly for the transportation of household goods, by furnishing tractors and trailers on either a permanent or an intermittent lease basis.\nAs of December 31, 1994, agents and owner-operators together supplied 3,531 tractors, representing 97 percent of the U.S. power equipment operated in NAVL service. Also as of December 31, 1994, NAVL owned 3,028 trailer units, representing 55 percent of the U.S. trailer fleet in NAVL service. The remaining 45 percent was provided mainly by agents and owner-operators. Agents and owner-operators also provided 1,088 straight trucks, or 98 percent of such units in NAVL service.\nNAVL has an extensive program for the repair and maintenance of its trailer equipment. In 1994, work orders on approximately 15,475 trailers were completed at NAVL's facility in Fort Wayne. As of December 31, 1994, the average age of trailer equipment in the NAVL fleet was 7.9 years.\nCOMPUTERS - NAVL relies extensively on data processing facilities for shipment planning and dispatch functions as well as shipment tracing. Data processing capabilities are also utilized in revenue processing functions, driver and agent account settlement activity, and internal accounting and record keeping service.\nENCUMBRANCES - Certain railroad equipment is subject to the prior lien of equipment financing obligations amounting to approximately $520.9 million as of December 31, 1994, and $551.4 million at December 31, 1993. In addition, a significant portion of NS' properties is subject to liens securing, as of December 31, 1994, and 1993, approximately $83.9 million and $125.9 million of mortgage debt, respectively.\nMany of the tractors utilized in NAVL service are purchased by NAVL from manufacturers and resold to agents and owner-operators under a NAVL-sponsored financing program. At December 31, 1994, NAVL had $21.3 million in such tractor contracts receivable. This program allows NAVL to generate the funds necessary to purchase the tractors and to resell them under favorable financing terms. The equipment is sold under conditional sales contracts with the agents and owner- operators.\nNS' capital spending and maintenance programs are and have been designed to assure NS' ability to provide safe, efficient and reliable transportation services. For 1995, NS is planning $695 million of capital spending, of which $686 million will be for railway projects and $9 million for motor carrier property. NS anticipates new equipment financing of approximately $110 million in 1995. Looking further ahead, total rail and motor carrier capital spending is expected to remain in the $600 to $700 million range for the next few years. 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 goal. To date, such compliance has not affected materially NS' capital additions, earnings, liquidity or competitive position.\nSee the discussion of \"Environmental Matters\" in Part II, Item 7, \"Management's Discussion and Analysis\" on page 34, and in Note 17 to the Consolidated Financial Statements on page 72.\nEMPLOYEES - NS employed an average of 27,168 employees in 1994, compared with an average of 29,304 in 1993. The approximate average cost per employee during 1994 was $40,667 in wages and $17,417 in employee benefits. Approximately 75 percent of these employees are represented by various labor organizations.\nGOVERNMENT REGULATION - In addition to environmental, safety, securities and other regulations generally applicable to all businesses, NS' railroads are subject to regulation by the ICC, various state regulatory agencies and the Department of Transportation. The ICC has jurisdiction over many rates, routes, conditions of service, and the extension or abandonment of rail lines. The ICC also has jurisdiction over the consolidation, merger or acquisition of control of and by rail common carriers. The Department of Transportation regulates certain track and mechanical equipment standards.\nThe relaxation of economic regulation of the railroads by the ICC, started over a decade ago under the Staggers Rail Act of 1980, has continued. The ICC has recently authorized the partial deregulation of the charges railroads pay for the use of rail cars. NS is expected to benefit from the deprescription of car hire because it owns older cars of types which are in high demand. These cars will likely bring higher rentals under deprescription than under regulated rates.\nCertain revenue transactions and classes of traffic have been exempted from ICC regulation. Those most significant for NS' railroads are TOFC\/COFC (i.e., \"piggyback\") business, rail boxcar traffic, lumber, manufactured steel, automobiles and certain bulk commodities such as sand, gravel, pulpwood and wood chips for paper manufacturing. Transportation contracts on regulated shipments, after approval by the ICC, effectively remove those shipments from regulation as well. Over 80 percent of NS' freight revenues come from either exempt traffic or traffic moving under ICC-approved transportation contracts.\nIn early 1995, Congress had under consideration proposals for additional reductions in economic regulation of railroads, including proposals for \"sunsetting\" the ICC and transferring its remaining functions to another agency.\nFor motor carrier operations conducted by NAVL, the ICC and Department of Transportation remain the principal regulatory entities. The ICC continues to exercise jurisdiction over common carrier rates, the relationship between carriers and owner-operators, and carrier practices relating to the transportation of household goods. The primary focus of the Department of Transportation is on driver qualification and safety standards, including maximum trailer length and width.\nCOMPETITION - There is continuing strong competition among rail, water and highway carriers. Price is usually only one factor of importance as shippers and receivers choose a transport mode and specific hauling company. Inventory carrying costs, service reliability, ease of handling and the desire to avoid loss and damage during transit are increasingly important considerations, especially for higher valued finished goods, machinery and consumer products. Even for raw materials, semi-finished goods and work-in-process, users are increasingly sensitive to transport arrangements which minimize problems at successive production stages.\nNS' primary rail competitor is the CSX system; both operate throughout much of the same territory. Other railroads also operate in parts of the territory. NS also competes with motor carriers, water carriers and with shippers who have the additional option of handling their own goods in private carriage. Increasingly, cooperative strategies between railroads (such as the TCSC partnership involving NS and CR, see page 7) and between railroads and motor carriers enable carriers to compete more effectively in specific markets.\nNAVL continues to face vigorous competition due to deregulation and overcapacity in the industry that will keep profits at a modest level. While service remains a key issue, many shippers now place greater emphasis on price. For the RS Division, contract carriage and volume discount programs dominate the corporate relocation segment, and guaranteed price options are common to the individual consumer segment. Contract carriage agreements are also utilized extensively by the HVP Division to meet the service and price requirements of its customers.\nItem 3.","section_3":"Item 3. Legal Proceedings. ------ -----------------\nNone.\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 1994.\nExecutive Officers of the Registrant. -------------------------------------\nNorfolk Southern'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, 1995, relating to these officers:\nBusiness Experience during Name, Age, Present Position past 5 Years --------------------------- ------------------------------------ David R. Goode, 54, Present position since September Chairman, President and 1992. Served as President from Chief Executive Officer October 1991 to September 1992, Executive Vice President- Administration from January to October 1991 and prior thereto as Vice President-Taxation.\nJohn R. Turbyfill, 63, Present position since June 1993. Vice Chairman Served prior thereto as Executive Vice President-Finance.\nR. Alan Brogan, 54, Executive Present position since December Vice President-Transportation 1992. Served as Vice President- Logistics (and President-North Quality Management from April American Van Lines, Inc.) 1991 to December 1992, Vice President-Material Management and Property Services from July 1990 to April 1991, and prior thereto as Vice President-Material Management.\nJohn S. Shannon, 64, Executive Present position since June Vice President-Law 1982.\nStephen C. Tobias, 50, Present position since July Executive Vice President- 1994. Served as Senior Vice Operations President-Operations from October 1993 to July 1994, Vice President- Strategic Planning from December 1992 to October 1993, and prior thereto as Vice President- Transportation.\nD. Henry Watts, 63, Executive Present position since July Vice President-Marketing 1986.\nBusiness Experience during Name, Age, Present Position past 5 Years --------------------------- ------------------------------------ Henry C. Wolf, 52, Executive Present position since June 1993. Vice President-Finance Served as Vice President-Taxation from January 1991 to June 1993, and prior thereto as Assistant Vice President-Tax Counsel.\nPaul N. Austin, 51, Vice Present position since June 1994. President-Personnel Served as Assistant Vice President-Personnel from February 1993 to June 1994, and prior thereto as Director Compensation.\nWilliam B. Bales, 60, Vice Present position since August 1993. President-Coal Marketing Served prior thereto as Vice President-Coal and Ore Traffic.\nJames C. Bishop, Jr., 58, Present position since August Vice President-Law 1989.\nJohn F. Corcoran, 54, Vice- Present position since March 1992. President-Public Affairs Served prior thereto as Assistant Vice President-Public Affairs.\nThomas L. Finkbiner, 42, Present position since August 1993. Vice President-Intermodal Served as Senior Assistant Vice President-International and Intermodal from April to August 1993, and prior thereto as Assistant Vice President- International and Intermodal.\nJames L. Granum, 58, Vice Present position since March 1992. President-Public Affairs Served prior thereto as Assistant Vice President-Public Affairs.\nJames A. Hixon, 41, Vice Present position since June 1993. President-Taxation Served as Assistant Vice President-Tax Counsel from January 1991 to June 1993, and prior thereto as General Tax Attorney.\nJon L. Manetta, 57, Vice Present position since June 1994. President-Transportation Served as Assistant Vice President-Transportation from October 1993 to June 1994, Assistant Vice President- Strategic Planning from January 1993 to October 1993, Director Joint Facilities and Budget from March 1992 to January 1993, Assistant Terminal Superintendent- Transportation from January 1991 to March 1992, and prior thereto as Assistant Superintendent-St. Louis Terminal.\nBusiness Experience during Name, Age, Present Position past 5 Years --------------------------- ------------------------------------ Harold C. Mauney, Jr., 56, Present position since December Vice President-Quality 1992. Served as Assistant Vice Management President-Quality Management from April 1991 to December 1992, and prior thereto as General Manager- Intermodal Transportation Services.\nDonald W. Mayberry, 51, Present position since October Vice President-Mechanical 1987.\nJames W. McClellan, 55, Vice Present position since October President-Strategic Planning 1993. Served as Assistant Vice President-Corporate Planning from March 1992 to October 1993, and prior thereto as Director- Corporate Development.\nKathryn B. McQuade, 38, Present position since December Vice President-Internal Audit 1992. Served as Director-Income Tax Administration from May 1991 to December 1992, and prior thereto as Director-Federal Income Tax Administration.\nCharles W. Moorman, 43, Vice Present position since October President-Information 1993. Served as Vice President- Technology Employee Relations 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 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, 54, Vice Present position since December President-Engineering 1992. Served as Assistant Vice President-Maintenance from November 1990 to December 1992, and prior thereto as Chief Engineer-Line Maintenance North.\nBusiness Experience during Name, Age, Present Position past 5 Years --------------------------- ------------------------------------\nL. I. Prillaman, Jr., 51, Present position since December Vice President-Properties 1992. Served prior thereto as Vice President and Controller.\nMagda A. Ratajski, 44, Vice Present position since July 1984. President-Public Relations\nJohn P. Rathbone, 43, Vice Present position since December President and Controller 1992. Served prior thereto as Assistant Vice President-Internal Audit.\nWilliam J. Romig, 50, Vice Present position since April 1992. President and Treasurer Served prior thereto as Assistant Vice President-Finance.\nDonald W. Seale, 42, Vice Present position since August 1993. President-Merchandise Served as Assistant Vice Marketing President-Sales and Service from May 1992 to August 1993, Director- Metals, Waste and Construction from March 1990 to May 1992, and prior thereto as Director- Marketing Development.\nPowell F. Sigmon, 55, Vice Present position since January 1995. President-Research and Served as Vice President-Safety, Tests Environmental and Research Development from October 1993 to January 1995, Assistant Vice President-Mechanical (Car) from January 1991 to October 1993, and prior thereto as General Manager- Mechanical Facilities.\nRobert S. Spenski, 60, Vice Present position since June 1994. President-Labor Relations Served prior thereto as Senior Assistant Vice President-Labor Relations.\nDonald E. Middleton, 64, Present position since June Corporate Secretary 1982.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related ------- ------------------------------------------------ Stockholder Matters. -------------------\nItem 6.","section_6":"Item 6. Selected Financial Data. ------ -----------------------\nItem 6. Selected Financial Data. (continued) ------ -----------------------\nItem 6. Selected Financial Data. (continued) ------ -----------------------\nItem 6. Selected Financial Data. (continued) ------ -----------------------\nItem 6. Selected Financial Data. (continued) ------ -----------------------\nItem 6. Selected Financial Data. (continued) ------ -----------------------\nItem 6. Selected Financial Data. (continued) ------ -----------------------\nNORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES Table of Graphs Included with the Eleven-Year Financial Review\nThe following financial information appears as four (4) separate graphs following the Eleven-Year Financial Review in the 1994 Norfolk Southern Corporation Annual Report to Stockholders.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. -----------------------------------\nNORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES 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 50 and the Eleven-Year Financial Review beginning on page 27. The Condensed Summary provides a brief overview of results of operations, and the text beginning under \"Results of Operations\" is a more detailed analysis.\nCONDENSED SUMMARY OF RESULTS OF OPERATIONS\n1994 Compared with 1993 ----------------------- Net income was $667.8 million, or $4.90 per share, in 1994, compared with $772.0 million, or $5.54 per share, in 1993. However, net income in 1993 was increased by $223.3 million, or $1.60 per share, related to the implementation of required accounting changes (see Note 1 on page 56) and reduced by $46.2 million, or $0.33 per share, for the prior years' effect of a federal income tax rate increase (see Note 3 on page 58). Excluding the effect of the 1993 accounting changes and the tax rate increase, 1994's net income was 12% above the $594.9 million in 1993, and earnings per share were 15% above the $4.27 in 1993, both setting records for NS. Income from railway operations rose $128.0 million, or 14%, compared with 1993, producing most of the improvement. These results reflect a 5% increase in railway operating revenues (largely due to higher traffic volume) combined with only a 2% increase in railway operating expenses. Income from motor carrier operations improved to $22.1 million in 1994, compared with a $4.6 million loss in 1993 (excluding the 1993 restructuring charge, see Note 15 on page 71). Nonoperating income was $85.2 million, compared with $136.8 million in 1993 (see Note 2 on page 58), principally a result of reduced gains on sales of stock and property.\n1993 Compared with 1992 ----------------------- Net income was $772.0 million in 1993, compared with $557.7 million in 1992. However, as discussed previously, results for 1993 were significantly affected by required accounting changes and by an increase in the federal income tax rate. Excluding the effect of the accounting changes and the tax rate increase related to prior years, 1993 earnings would have been $594.9 million, or $4.27 per share, a $37.2 million, or 7%, increase over 1992. Income from railway operations in 1993 was about even with 1992. Railway operating revenues declined 1%, primarily as a result of lower coal traffic levels and a reduced share of certain intermodal revenues after formation of Triple Crown Services Company (TCSC), a partnership between NS and Consolidated Rail Corporation (Conrail) subsidiaries. Motor carrier operations resulted in a $54.9 million loss in 1993, largely due to a restructuring of NAVL (see Note 15 on page 71), which resulted in the disposition of two of its businesses. Offsetting the decline in income from operations was a $39.0 million increase in nonoperating income, due principally to gains from sales of stock and property (see Note 2 on page 58).\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nRESULTS OF OPERATIONS\nRailway Operating Revenues -------------------------- Railway operating revenues were $3.92 billion in 1994, compared with $3.75 billion in 1993 and $3.78 billion in 1992. The following table presents a three-year comparison of revenues by market group and reflects (in Intermodal) the effect of the formation in April 1993 of TCSC. This partnership provides RoadRailer(RT) and domestic container services previously offered by a wholly owned NS subsidiary. Since NS owns only 50% of TCSC, its revenues are not consolidated, and NS' intermodal revenues include only revenues for rail service provided by NS to the partnership. Excluding this partnership effect, 1994 intermodal revenues increased 14%, compared with 1993, and 1993 intermodal revenues were up 10%, compared with 1992.\nTraffic volume increased or remained steady for all market groups in 1994 and increased for all market groups except coal in 1993. The revenue per unit\/mix variance in both years was attributable to: (1) shorter haul business that has a lower average rate; (2) increased double-stack business that has a lower average rate; and (3) the effect of the TCSC partnership previously described.\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nSome of the fastest growing market segments are in shorter haul, repetitive movements. This type of traffic complements NS' efforts to improve asset utilization and demonstrates that efficient operations can generate profit opportunities in nontraditional markets. COAL (including coke and iron ore) traffic volume in 1994 increased 5%, and revenues, which represented 32% of total railway operating revenues, were up 4% from 1993. Coal accounted for about 98% of this market group's volume, and 91% of coal shipments originated on NS' lines. As shown in the following table, the decline in steel coal was more than offset by a significant increase in utility coal, up 16%, compared with 1993.\nUtility coal traffic was up early in the year as a result of bitter weather and the resulting depletion of plant stockpiles. The pace at which 1994 outperformed 1993 slowed as the weather normalized, power generation demand lessened and coal inventories grew. New movements of western coal into Georgia also contributed to the 1994 increase. NS handled five million tons of western coal in 1994, and this volume is expected to increase in 1995. The favorable outlook for utility coal reflects increasing demand for low-sulfur coal as utilities seek to comply with Clean Air Act Amendments. A high proportion of the mines served by NS produce low- sulfur coal. The January 1, 1995, Phase I deadline under the Clean Air Act has already caused an increase in NS' low-sulfur coal handlings. This trend is expected to accelerate as the Phase II deadline of January 1, 2000, approaches. Export coal traffic at the beginning of 1994 continued to reflect the poor demand seen in 1993. Shipments remained depressed as a result of the weak European economy and strong competition from other producing countries. Excess world capacity pushed coal prices lower in early 1994. However, by mid-1994, U.S. coal supplies for the export market had been reduced due to a strong domestic market and mine closings. Economic recovery in Europe and Japan improved demand for steel and electricity, and within a short time the coal supply-demand situation tightened. By the end of 1994, delivery times were longer and prices had risen.\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nContinued economic growth in the Far East and Europe is expected to increase demand for U.S. coal, especially steam coal. Reduced mining subsidies in Europe, primarily in Germany, may reduce European coal production. On the other hand, overseas demand for coal used in steelmaking is expected to be flat in the short term and to decline over the longer term as new technologies slowly diminish the need for this type of coal. On balance, U.S. coal exports are expected to increase, but at rates below those seen in previous economic recoveries. During 1994, NS completed modifications to the two shiploaders at Pier 6 in Norfolk, Va., enabling large vessels to be loaded more quickly. Steel coal domestic traffic was reduced by the closing of one coke battery and extended maintenance at another battery. These batteries produce coke for making steel; however, because advancing technologies allow for production of steel with little or no coke, this domestic market is expected to decline slowly. Coal volume in 1993 decreased 6%, compared with 1992, and revenues also were down 6%. The export coal market was weak for all of 1993. Additionally, stockpiles were at high levels in the United Kingdom, and two Italian generating stations were closed all year. A UMWA strike, settled in December 1993, although not widespread at mines served by NS, idled four operations heavily oriented toward export shipments. In contrast to the export market, domestic coal remained steady in 1993, compared with 1992, as extended periods of warmer-than-usual summer temperatures in the Southeast resulted in increased business for a number of utility customers. NS also did well in 1993 in the domestic steel market. While total volumes in this market remained flat, compared with 1992, NS was able to increase its market share. MERCHANDISE traffic volume in 1994 increased 8%, and revenues (excluding, for comparative purposes, the effect of the TCSC partnership; see page 35) increased by $151.3 million, or 6%, compared with 1993. Merchandise carloads handled in 1994 were 3.0 million, compared with 2.8 million in 1993. Revenues in all six market groups comprising merchandise traffic improved over 1993, with four of the six increasing 8% or more. CHEMICALS traffic rose 9% over 1993, and revenues increased 8%. A strong economy strengthened the demand for chemicals, and shipments of fertilizer and plastics were stronger in 1994 than in recent years. NS is continuing its expansion of rail-truck bulk distribution facilities to handle a variety of dry and liquid products. One new Thoroughbred Bulk Transfer facility opened in 1994, and construction started on five more. These facilities should play an important part in fostering the growth of chemicals traffic in 1995 and beyond. PAPER\/FOREST traffic and revenues were both about even with 1993, reflecting weak production, severe winter weather and floods in south Georgia. Some of the weakness in paper was offset by an 8% gain in lumber traffic, in part due to the opening of five new lumber distribution centers. These centers facilitate combined rail-truck movements of lumber and wood products to retail outlets. A resumption of moderate growth is expected as paper market conditions improve and distribution center traffic increases. AUTOMOTIVE traffic remained steady in 1994, compared with 1993, and revenues increased to their highest level in NS' history. NS' revenues from automotive traffic have grown 32% since 1991, although only 1% of this growth occurred in 1994. Traffic volume in 1994 was adversely affected by retooling at four plants located on NS' lines. These plants are scheduled to resume production between early 1995 and mid-1996. During 1994, NS implemented a number of train coordination projects with Conrail and Florida East Coast Railway to improve transit times for the growing network of automotive assembly plants. Over the next few years, growth in NS' automotive traffic is expected to resume as the plant retoolings are completed and new plants come on line. Production began at Toyota's second Georgetown, Ky., plant in March 1994 and at BMW's new facility in Greer, S.C., in September 1994. Mercedes' plant in Alabama is expected to come on line in 1997.\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nAGRICULTURE traffic rose 7%, and revenues increased 9%. Early in the year, favorable harvest conditions in NS sourcing areas and poor conditions elsewhere boosted traffic. Later in the year, NS traffic levels also were very strong, reflecting record corn and soybean harvests and aggressive programs to increase car utilization through greater use of 50- and 100-car unit trains. Agriculture has become a growth market for NS, with revenues increasing 21% during the last five years. This group is expected to continue to grow as poultry consumption, with the commensurate rise in demand for feed grain, increases. In 1995, three new feed mills are expected to open along NS' lines. NS is continuing efforts to locate new poultry processing facilities along its lines. Growth also is expected from short-haul movements diverted from truck due to improved train service. METALS\/CONSTRUCTION traffic and revenues both rose 9%. Most of the revenue gain was in shipments of steel, as this industry had its best year since 1973. Business also increased because of new steel plants and from aluminum traffic diverted from truck. Late in 1994, NS began sheet- steel movements to Mexico under a new six-year contract. Construction markets were strong, with output up 5%. Movements of sand and gravel were up 13% due to increased highway repair and construction activity. Growth prospects for metals\/construction appear good. Business is expected to benefit from new steel plants on NS' lines, new municipal solid waste movements and the increased business to Mexico. INTERMODAL traffic rose 13%, and revenues (adjusted for the effect of the TCSC partnership) increased 14%, compared with 1993. Intermodal is NS' fastest growing line of business, achieving record levels of volume, revenue and profitability in 1994. Intermodal growth in 1994 was led by an increase in trailer-on-flatcar (TOFC) business and, in particular, the less-than-truckload segment. Notably, these customers, generally major trucking companies, tend to use their own trailers rather than NS' trailers. During 1994, these trucking companies switched substantial amounts of business from highway to rail. This trend is expected to continue in 1995 and beyond, although at a rate lower than that experienced in 1994. Containers-on-flatcar (COFC) business also improved in 1994. The export container segment, NS' largest COFC market, improved as the economies in Europe recovered and the countries in the Asia\/Pacific region experienced rapid growth in production. Revenues from domestic COFC movements also improved, as NS increased its market share. Much of this growth was related to aggressive facility and transit-time improvements, including expanding or upgrading five terminal facilities. Current capacity, combined with three planned terminal expansions, will accommodate an expected growth in COFC and double-stack business. During 1993, all six merchandise market groups showed improvement over 1992. Traffic volume increased 6% and revenues increased $104.6 million, or 5%. The largest revenue increases were in the intermodal group, up $34.1 million, or 10% (excluding the TCSC effect), the automotive group, up $28.0 million, or 7%, and metals\/construction, up $19.8 million, or 7%. The 1993 growth in intermodal was led by a 21% increase in Triple Crown(RT) activity due to strong automotive shipments and expansion of service to the Northeast. COFC revenues were up 6% compared with 1992, a smaller increase than in previous years due to recessions in Europe and Japan. TOFC revenues were up 11%, boosted by gains from haulage arrangements with truckload carriers. The 1993 growth in automotive traffic was primarily due to strong demand for vehicles produced at plants served by NS. In addition, NS benefited from a full year of production at the Ford\/Nissan plant located near Avon Lake, Ohio. Successful marketing efforts, such as the program with GM for just-in- time movement of auto parts, also contributed to the higher traffic levels in 1993. The improvement in the metals\/construction group in 1993, compared with 1992, was largely a result of increased iron and steel shipments related to strong industry production and new plants located on NS' lines. Shipments of construction commodities also were strong due to a recovery in housing.\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nRailway Operating Expenses -------------------------- Railway operating expenses in 1994 totaled $2.9 billion, only 2% higher than 1993, despite a 7% increase in traffic volume. Railway operating expenses in 1993 were $2.8 billion, a 1% decline compared with 1992, despite a 2% increase in traffic volume. The 1994 NS railway operating ratio continued to be the best among the major railroads in the United States and improved by more than two full points compared with 1993.\nThe following table shows the changes in railway operating expenses summarized by major classifications.\nCOMPENSATION AND BENEFITS represents about half of total railway operating expenses and declined 1% in 1994, compared with 1993, but increased 1% in 1993, compared with 1992. The 1994 decline was principally a result of (1) lower accruals for stock-based compensation plans as a result of a lower stock price; (2) reduced accruals for postretirement benefits resulting from a change in the benefit plan's creditable service period (see Note 11 on page 67); (3) the expiration of the Railroad Retirement Repayment Tax in June 1993; (4) the early retirement program in 1993 (see Note 10 on page 65); and (5) productivity improvements as a result of continuing reductions in train crew sizes. The slightly higher expenses in 1993, compared with 1992, were mainly due to accruals for postretirement and postemployment benefits that, prior to 1993, were accounted for on a pay-as-you-go basis (see \"Required Accounting Changes\" in Note 1 on page 56) and to 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 10 on page 65). Also in 1993, a $46 million credit was recorded in compensation and benefits, reflecting a partial reversal of the 1991 special charge (see Note 16 on page 72).\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nMATERIALS, 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 of using freight equipment owned by other railroads or private owners, less the rent paid to NS 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 increased 2% in 1994, compared with 1993, but declined 6% in 1993, compared with 1992. The 1994 increase was principally due to higher joint- facility and leased-road costs and to increased locomotive repair costs, resulting mostly from higher traffic volume. However, a decrease in usage by other railroads of NS' facilities also contributed to the increase in joint facilities expense. The cost of leasing lines of road is expected to increase in the future as a result of tentative understandings reached with respect to certain North Carolina leases (see Note 8 on page 64). Partly offsetting these increases was a decline in equipment rent expenses resulting from the partial deprescription (deregulation by the ICC) of car hire rates among railroads. NS expects additional future benefits as deprescription is fully implemented. The decrease in 1993's materials, services and rents, compared with 1992, was largely due to the inclusion in 1992 of certain expenses which, subsequent to March 31, 1993, were incurred by TCSC (see discussion on page 35). DEPRECIATION expense (see Note 1 \"Properties\" on page 56 for NS' depreciation policy) was up 3% in 1994, compared with 1993, and 7% in 1993, compared with 1992. The increases in both periods were due to property additions, reflecting substantial levels of capital spending during the three-year period ended December 31, 1994. DIESEL FUEL costs increased 5% in 1994, compared with 1993, but declined 2% in 1993, compared with 1992. The 1994 increase was entirely due to increased consumption, driven by a 7% increase in carloadings. On average, 1994's prices were slightly lower than 1993's. NS uses substantial quantities of diesel fuel; therefore, changes in price or consumption have a significant impact on the cost of providing transportation services. Diesel fuel expenses declined in 1993, compared with 1992, mainly due to a lower price offset partially by increased consumption. CASUALTIES AND OTHER CLAIMS (including insurance costs, estimates of costs related to personal injury, property damage and environmental matters) increased 13% in 1994, compared with 1993, but decreased 2% in 1993, compared with 1992. The 1994 increase was primarily attributable to environmental cleanup costs associated with a tankcar leak (see also \"Environmental Matters\" on page 45) and to higher personal injury claim settlement costs. By far the largest component, personal injury expenses, which relates primarily to the cost of on-the-job employee injuries, has shown a favorable trend in the number of incidents since 1990, reflecting success in reducing accidental employee injuries. Unfortunately, the favorable trend in the number of accidental injuries has been more than offset by increased claim costs and higher costs related to non- accidental \"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. 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 that under the no-fault workers' compensation systems to which non-rail 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 increased 12% in 1994, compared with 1993, and declined 3% in 1993, compared with 1992. The increase over 1993 was due to favorable property tax settlements in 1993 and to higher relocation expenses in 1994 related to new job assignments following 1993's early retirement program. The 1993 decline was largely the result of favorable settlements of issues related to property and other taxes.\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nMotor Carrier Results --------------------- Motor carrier operating income was $22.1 million in 1994, compared with operating losses of $54.9 million in 1993 and $39.7 million in 1992. The large loss reported in 1993 was almost entirely attributable to a restructuring of the business as described below. The continuing operations, comprising Relocation Services (RS) and High Value Products (HVP), produced operating income of $22.1 million in 1994 and $14.4 million in 1993, and an operating loss of $9.3 million in 1992. A restructuring decision was made in 1993 due to persistently poor performance in the general commodities operations despite repeated turnaround efforts. The restructuring led to the liquidation of the Commercial Transport (CT) Division and the sale of Tran-Star (TS), a refrigerated carrier. A restructuring charge of $50.3 million was recorded in 1993 (see Note 15 on page 71). The following table presents a three-year comparison of revenues by principal operations.\nRS' revenues depend on four primary segments of household goods transportation: corporate national accounts, interstate C.O.D. movements, military business and international relocations. RS' 1994 revenues increased 3% over 1993 and were even in 1993, compared with 1992. Volume gains were achieved in the military and C.O.D. segments; however, prices were flat. The domestic market-share gains were partly offset by lower revenues from Canadian operations. Revenues in 1993 were adversely affected by a decline in domestic military volume and fewer Canadian shipments. These decreases were partly offset by gains in the international household relocation segment. The continued downsizing of U.S. corporations and changes in policy relative to military staffing levels are likely to result in ongoing pressure on this division's operating revenues. HVP's main line of business is transporting office products and other sensitive equipment, as well as exhibits and displays. A Customized Logistic Services (CLS) segment provides integrated logistics expertise. A Blanketwrap segment that had been part of the discontinued CT Division provides specialized handling of uncartoned truckload freight. HVP's revenues increased 29% in 1994, compared with 1993, and 8% in 1993, compared with 1992. The increase in 1994 was due to (1) the inclusion of Blanketwrap, which was in HVP for only two months of 1993, and (2) to CLS which was awarded a significant logistics contract by IBM in third quarter 1993. The 1993 revenue increase was largely due to the IBM contract, two months of Blanketwrap revenues and expansion of air freight services into several new markets. HVP may benefit from a continued increase in movements of office products and other sensitive commodities,\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nsuch as medical equipment; however, a trend toward smaller shipment sizes could subject this operation to increasing competition from other specialized carriers. Additional growth in the CLS segment is possible as more shippers look to carriers like NAVL to provide logistics expertise to reduce overall shipping and handling costs. Motor carrier operating expenses as a percentage of revenues were 97%, 108% and 105%, respectively, in 1994, 1993 and 1992. In 1993 and 1992, the highly unfavorable operating ratios were caused largely by losses sustained in the truckload operations, which more than offset positive results of RS and HVP. The high operating ratio in 1993 also was attributable to the restructuring charge and in 1992 to increased reserves for casualty claims, litigation and workers' compensation. Operating expenses for 1992 included a $27 million accrual to record actuarially determined reserve increases for casualty claims and workers' compensation. NAVL's continuing operations generated operating ratios of 97% in 1994 and 1993 and 99% in 1992, excluding the insurance reserve adjustments. Due to deregulation and overcapacity in the industry, motor carriers will continue to face vigorous competition that will keep margins at a modest level.\nOther Income-Net ---------------- Nonoperating income decreased $51.6 million, or 38%, in 1994, compared with 1993, but increased $39.0 million, or 40%, in 1993, compared with 1992 (see Note 2 on page 58). These fluctuations principally arose because of large gains on sales of stock and property in 1993.\nInterest Expense on Debt ------------------------ Interest expense on debt increased 3% in 1994, compared with 1993, but declined 10% in 1993, compared with 1992. The 1994 increase was due to a higher rate of interest on commercial paper debt (see Note 6 on page 62) and a decrease in the amount of capitalized interest (see Note 5 on page 61). The 1993 decline was due to lower levels of equipment debt and lower interest rates on commercial paper debt.\nIncome Taxes ------------ Income tax expense in 1994 was $381.2 million for an effective rate of 36.3%, compared with an effective rate of 38.9% in 1993 and 36.3% in 1992. Income tax expense in 1994 and 1993 was accrued under Statement of Financial Accounting Standards No. 109, rather than under the prior accounting rules (see \"Required Accounting Changes\" in 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 $295.8 million for an effective rate of 32.9%. The effective rate in 1994 benefited from favorable adjustments resulting from settlement of the consolidated federal income tax years 1988 and 1989; from an adjustment to the valuation allowance for deferred tax assets; and from a favorable adjustment upon filing the 1993 tax return. Deferred tax expense was an unusually high proportion of total tax expense in 1994. A corresponding reduction is reflected in 1994's current tax expense for the effects of expenditures that affect book and tax accounts in different years, primarily in the areas of compensation, discontinued operations and property. The low effective rate of 32.9% in 1993 (excluding the tax rate increase) was partly due to tax benefits related to the motor carrier restructuring (see Note 15 on page 71). Current income tax expense in 1993 was a higher proportion of total taxes, primarily because of tax payments made in anticipation of Revenue Agent Reports for the 1988-1989 federal income tax audit. Deferred tax expense for 1993, compared to 1992, decreased primarily for the same reason (see Note 3 on page 58 for the components of income tax expense).\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nRequired Accounting Changes --------------------------- Effective January 1, 1994, NS adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115). SFAS 115 did not have a significant effect on NS (see also Note 1 on page 56). Effective January 1, 1993, NS 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 non-cash adjustments increased 1993's net income by $223.3 million, or $1.60 per share.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nFINANCIAL CONDITION refers to the assets, liabilities and stockholders' equity of an organization (see Consolidated Balance Sheets on page 52). LIQUIDITY refers to the ability of an organization to generate adequate amounts of cash, principally from operating results or through borrowing power, to meet its short-term and long-term cash requirements (see Consolidated Statements of Cash Flows on page 53). CAPITAL RESOURCES refers to the ability of an organization to raise funds through the sale of either debt or equity (stock) securities.\nCASH PROVIDED BY OPERATING ACTIVITIES, which is NS' principal source of liquidity, increased $269.7 million, or 31%, in 1994, compared with 1993, but declined $83.6 million, or 9%, in 1993, compared with 1992. Since the NS consolidation in 1982, 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). The improvement in 1994 was primarily a result of increased income from operations, which was $205 million higher than 1993, and to lower income tax payments. The 1993 decline was largely attributable to the timing of tax payments, which were $139.9 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 had been low. Implementation of the labor portion of the 1991 special charge also contributed to the fluctuations in cash provided by operations. In 1994, 1993 and 1992, $41.9 million, $36.1 million and $134.7 million, respectively, were used for labor costs related to the special charge. The lower payments in 1994 and 1993 were 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 Note 16 on page 72). Looking ahead, the labor portion of the special charge is expected to require approximately $30 million in each of the\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nnext two years to achieve productivity gains permitted by the agreements. NS regards this cash outflow as an investment because, in view of the high cost of labor and fringe benefits, these payments produce significant future labor savings. In 1994, it is estimated that NS' expenses were reduced by $130 million as a result of these programs, and upon full implementation of the labor agreements, there will be additional savings of about $20 million per year. CASH USED FOR INVESTING ACTIVITIES increased 4% in 1994, compared with 1993, but declined 30% in 1993, compared with 1992. Property additions account for most of the spending in this category. In 1994, property additions included $71 million for the acquisition of coal reserves in West Virginia and Kentucky. Excluding this large property acquisition, 1994's rail and motor carrier capital expenditures were 4% below 1993. Efforts to hold down capital spending while increasing business are ongoing as NS seeks to maximize utilization of its assets. In this connection, NS continues to review its route network to identify areas where efficiencies can be achieved by coordinated agreements with other railroads, or through sales or abandonments. Large borrowings on corporate-owned life insurance, reflected in \"Investment sales and other transactions\" in the Consolidated Statements of Cash Flows (see Note 4 on page 61), offset much of the use of cash for property additions in 1994. In 1993, a combination of higher proceeds from sales of property and investments and lower capital spending was responsible for the improvement compared with 1992.\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nThe average age of locomotives retired during 1994 was 23.6 years. Since 1988, NS has rebodied more than 17,200 coal cars and plans to continue that program at the rate of about 3,500 cars per year for the next several years. This work, performed at NS' 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 shown above. For 1995, NS is planning $695 million of capital spending, of which $686 million will be for railway projects and $9 million for motor carrier property. NS anticipates new equipment financing of approximately $110 million in 1995. Barring unforeseen events, total rail and motor carrier capital spending is expected to remain in the $600 to $700 million range for the next few years. 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. CASH USED FOR FINANCING ACTIVITIES increased 56% in 1994, compared with 1993, and 32% in 1993, compared with 1992. The 1994 increase was a result of increased purchases under the stock purchase program (see Note 13 on page 71). Cash spent since 1987 to purchase and retire stock totaled $2.5 billion, of which $344.8 million, $138.1 million and $177.2 million was spent in 1994, 1993 and 1992, respectively. During 1994 and 1993, a significant portion of this total spending was from cash reserves, although purchases in 1994 were funded partially by the corporate-owned life insurance proceeds. The 1992 stock purchases were funded largely through issuance of debt. Debt activity over the past five years was as follows:\nDebt requirements for 1995 are expected to increase related to the planned acquisition of 125 locomotives and to continuation of the stock purchase program.\nHedging Activities ------------------ Certain subsidiaries of NS have entered into hedging transactions relating to diesel fuel purchases and foreign exchange transactions. The notional amount of agreements settled from 1992 through 1994 was less than $2 million, and outstanding agreements at December 31, 1994, were less than $5 million.\nENVIRONMENTAL MATTERS\nNS is subject to various jurisdictions' environmental laws and regulations. It is NS' policy to record a liability where such liability or loss is probable and can be reasonably estimated. Claims, if any, against third parties for recovery of cleanup costs incurred by NS are reflected as receivables in the balance sheet and are not netted against the associated NS liability. Environmental engineers participate in ongoing evaluations of all identified sites, and--after consulting with counsel--any necessary adjustments to initial liability estimates are made. NS also has established an Environmental Policy Council, composed of senior managers, to prescribe and direct its environmental initiatives. Operating expenses for environmental protection totaled approximately $20 million in 1994 and are anticipated to decrease in 1995. Expenses in 1994 included $10.5 million associated with emergency response and cleanup resulting from release of arsenic acid from a tankcar leased by the shipper from a third party. Capital expenditures for environmental projects amounted to approximately $4 million in 1994 and are expected to be approximately $4 million in 1995. As of December 31, 1994, NS' balance sheet included a reserve for environmental exposures in the amount of $50 million (of which $13 million is accounted\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nfor as a current liability), which is NS' best estimate of ultimate liability at 80 identified locations. On that date, eight sites accounted for $23 million of the reserve, and no individual site was considered to be material. NS anticipates that the majority of this liability will be paid out over five years; however, some costs will be paid out over a longer period. At many of the 80 locations, certain NS subsidiaries, usually in conjunction with a number of other parties, have been identified as potentially responsible parties by the Environmental Protection Agency (EPA) or similar state authorities under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, or comparable state statutes, which often impose joint and several liability for cleanup costs. With respect to known environmental sites (whether identified by NS or by the EPA or comparable state authorities), estimates of NS' ultimate potential financial exposure for a given site or in the aggregate for all such sites are necessarily imprecise because of the widely varying costs of currently available cleanup techniques, the likely development of new cleanup technologies, the difficulty of determining in advance the nature and full extent of contamination and each potential participant's share of any estimated loss (and that participant's ability to bear it) and evolving statutory and regulatory standards governing liability. The risk of incurring environmental liability--for acts and omissions, past, present and future--is inherent in the railroad business. Some of the commodities, particularly those classified as hazardous materials, in NS' traffic mix can pose special risks that NS and its subsidiaries work diligently to minimize. In addition, several NS subsidiaries have land holdings that serve as operating property, or which are leased or may have been leased and operated by others, or held for sale. Because certain conditions may exist on these properties related to environmental problems that are latent or undisclosed, there can be no assurance that NS will not incur liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably now. Moreover, lawsuits and claims involving these and other now-unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial condition, results of operations or liquidity in a particular year or quarter. 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 Corporation is aware. Further, Management believes that it is unlikely that any identified matters, either individually or in aggregate, will have a material adverse effect on NS' financial position, results of operations or liquidity.\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, a capital-intensive company, has approximately $13 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.\nItem 7. Management's Discussion and Analysis of Financial ------- ------------------------------------------------- Condition and Results of Operations. (continued) -----------------------------------\nINDUSTRY TRENDS\n- Negotiations at the national level on agreements with the major labor organizations were under way during 1994, but no new agreements have been concluded. The outcome of these negotiations is uncertain at this time.\n- The Interstate Commerce Commission (ICC) may be abolished or its role substantially redefined. Whether and to what extent the ICC's traditional regulatory functions will be carried out at the federal level--and if so, by what agency or agencies--remain unclear and are a source of uncertainty.\n- NS and other railroads are continuing to seek opportunities to share traffic routes and facilities, furthering the goals of providing seamless service to customers and maximizing efficiency of the respective railroads.\n- NS and the rail industry are continuing their efforts to replace the FELA with no-fault workers' compensation laws comparable to those covering employees in other industries.\n- There have been some recent merger and consolidation overtures within the railroad industry. NS is closely monitoring this activity in light of its own long-term strategic objectives to protect the interests of its stockholders.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data. ------- -------------------------------------------\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nIndex to Financial Statements: Page ----------------------------- ---- Consolidated Statements of Income Years ended December 31, 1994, 1993 and 1992 50-51\nConsolidated Balance Sheets As of December 31, 1994 and 1993 52\nConsolidated Statements of Cash Flows Years ended December 31, 1994, 1993 and 1992 53-54\nConsolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1994, 1993 and 1992 55\nNotes to Consolidated Financial Statements 56-73\nIndependent Auditors' Report 74\nThe Index to Consolidated Financial Statement Schedule appears in Item 14 on page 76.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nNORFOLK SOUTHERN CORPORATION AND SUBSIDIARIES 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 Corporation (Norfolk Southern) and its majority-owned and controlled subsidiaries (collectively NS). The major subsidiaries are Norfolk Southern Railway Company and North American Van Lines, Inc. (NAVL). All significant intercompany balances and transactions have been eliminated in consolidation.\nCash Equivalents ---------------- \"Cash equivalents\" are highly liquid investments purchased three months or less from maturity.\nInvestments ----------- \"Investments\" are reported at amortized cost or fair value depending upon their classification as held-to-maturity, trading or available-for- sale securities in accordance with SFAS No. 115 (see \"Required Accounting Changes\").\nMaterials and Supplies ---------------------- \"Materials and supplies,\" consisting 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 25%. In 1994, the overall depreciation rate averaged 2.7% for roadway and 4.3% for equipment. NS 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, net of sale proceeds or salvage, is charged to accumulated depreciation rather than recognized through income. Gains and losses on disposal of land, a nondepreciable asset, are included in other income (see Note 2).\nRevenue Recognition ------------------- Revenue is recognized proportionally as a shipment moves from origin to destination.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\nEarnings Per Share ------------------ \"Earnings per share\" are computed by dividing net income by the weighted average number of common shares outstanding during the respective periods. Recent decreases in the number of shares outstanding are the result of the stock purchase program described in Note 13.\nRequired Accounting Changes --------------------------- 1994 - Effective January 1, 1994, NS adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115), which addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. The implementation of SFAS 115 had no impact on earnings and resulted in a $6.3 million increase in stockholders' equity, as of January 1, 1994 (and a $1.2 million decrease as of December 31, 1994), reflecting unrealized market changes in certain investments, net of the related deferred taxes. 1993 - Effective January 1, 1993, NS 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 accrual of the cost of specified health care and death benefits over an employee's creditable service period rather than, as was the previously prevailing practice, accounting for such expenses on a pay-as-you-go basis. SFAS 112 requires recognition of the cost of benefits payable to former or inactive employees after employment but before retirement on an accrual basis. For NS, such postemployment benefits consist principally of benefit obligations under the long-term disability plan. NS recognized the effects of these changes in accounting on the immediate recognition basis. The cumulative effect on years prior to 1993 of adopting SFAS 106 and SFAS 112 increased pretax expenses $360.2 million ($223.8 million after-tax), and $31.8 million ($19.7 million after-tax), respectively (see also Note 11). Also effective January 1, 1993, NS adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). SFAS 109 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. 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 $466.8 million (see also Note 3). The effect on net income and earnings per share of implementing the accounting changes was to increase net income and earnings per share $223.3 million and $1.60 per share, respectively.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n1993 Federal 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. The 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 $7.9 million, or $0.06 per share. The second component increased the provision for the net deferred tax liability in the Consolidated Balance Sheet, which reduced net income by $46.2 million, or $0.33 per share. Excluding the one-time non-cash charge of $0.33 per share, 1993's earnings per share before accounting changes would have been $4.27.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\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 SFAS 109 for 1994 and 1993 (see Note 1) and with APB Opinion No. 11 for 1992. The components of deferred income tax expense for 1992 were as follows: employee separation costs, $49.7 million; property-related adjustments, principally depreciation, $45.8 million; casualty and other claims, $(14.6) million; tax benefit leases, $(7.2) million; employee benefits, $(5.6) million; and other items-net, $(4.0) million--a total of $64.1 million.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\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 $9.8 million. The net change in the total valuation allowance was a $9.5 million decrease for 1994 and a $1.1 million increase for 1993.\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.\nTax Benefit Leases ------------------ In January 1995, the United States Tax Court issued a preliminary decision that would disallow some of the tax benefits an NS subsidiary purchased from a third party pursuant to a safe harbor lease agreement in 1981. Management continues to believe that NS should realize no loss from this decision, because the lease agreement provides for full indemnification if any such disallowance is sustained.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nCorporate-Owned Life Insurance ------------------------------ The planned borrowing of $220 million of cash surrender value on certain corporate-owned life insurance policies resulted in this amount being reclassified in the December 31, 1993, Consolidated Balance Sheet from \"Investments\" to \"Other current assets.\" The borrowing, which was completed in May 1994, resulted in the decline in \"Other current assets.\"\nCapitalized Interest -------------------- Total interest cost incurred on debt for 1994, 1993 and 1992 was $119.4 million, $120.2 million and $126.9 million, respectively, of which $17.8 million, $21.6 million and $17.9 million was capitalized.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n6. DEBT\nCommercial Paper Program ------------------------ In 1990, NS established a commercial paper program principally to finance the purchase and retirement of its common stock (see Note 13). As of December 31, 1994 and 1993, there were $517.3 million and $521.8 million, respectively, principal amount of notes outstanding under this program. Commercial paper debt is due within one year, but a portion has been classified as long-term because NS has the ability and intends to refinance its commercial paper on a long-term basis, either by issuing additional commercial paper (supported by a revolving credit agreement) or by replacing commercial paper notes with long-term debt. In 1994, NS entered into a new credit agreement effective through March 29, 1999, which increased the credit limit under its revolving credit agreement from $400 million to $500 million. Accordingly, the amount of commercial paper notes classified as \"Long-term debt\" in the December 31, 1994, Consolidated Balance Sheet increased to $500 million. The credit agreement provides for interest on borrowings at prevailing short-term rates and contains customary financial covenants, including principally a minimum tangible net worth requirement of $3.3 billion and a restriction on the creation or assumption of certain liens.\nThe \"other notes\" were assumed in connection with the 1990 acquisition of a coal terminal facility. The weighted average interest rate on these notes was 2.6% in 1994 and 2.3% in 1993.\nShelf Registration ------------------ In 1991, NS filed with the Securities and Exchange Commission a shelf registration statement on Form S-3 covering the issuance of up to $750 million principal amount of unsecured debt securities. In March 1991, NS issued and sold $250 million principal amount of its 9% notes due March 1, 2021. In February 1992, NS issued and sold $250 million principal amount of its 7-7\/8% notes due February 15, 2004. These notes are not redeemable prior to maturity and are not entitled to any sinking fund. Proceeds from the sale of these notes were used to purchase and retire shares of NS common stock, to retire short-term commercial paper debt issued to fund previous share purchases and for general corporate purposes.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n6. DEBT (continued)\nA substantial portion of NS' properties and certain investments in affiliated companies are pledged as collateral for much of the secured debt.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\nNS has reached tentative understandings for leases on approximately 300 miles of road in North Carolina. The leases call for payment of an annual rental of $8 million in 1995, with inflation adjustments in succeeding years. These estimated payments are included in the future minimum operating lease commitments above.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n8. LEASE COMMITMENTS (continued)\n10. PENSION PLANS\nNorfolk Southern and certain subsidiaries have defined benefit pension plans that principally cover salaried employees. Pension benefits are based primarily on years of creditable service with NS 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.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n10. PENSION PLANS (continued)\nEarly Retirement Program in 1993 -------------------------------- During 1993, NS 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.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n10. PENSION PLANS (continued)\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. No transfer was made in 1994. Since 1991, $42.5 million has been transferred from the pension plan to reimburse NS for retirees' medical payments. NS contributed equal amounts to a Voluntary Employee Beneficiary Association trust in those years to fund future medical costs for retirees (see Note 11).\n401(k) Plan ----------- Norfolk Southern and certain subsidiaries provide a 401(k) savings plan for salaried employees. Under the plan, NS matches a portion of the employee contributions, subject to applicable limitations. NS' expenses under this plan were $5.1 million, $5.2 million and $4.9 million in 1994, 1993 and 1992, respectively.\n11. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nNorfolk Southern and certain subsidiaries provide specified health care and death benefits to eligible retired employees and their dependents, principally salaried employees. Under the present plans, which may be amended or terminated at NS' 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 prior to retirement. Death benefits are determined based on various factors, including, in some cases, salary at time of retirement. NS continues to fund benefit costs principally on a pay-as-you-go basis. However, in 1991, NS established a Voluntary Employee Beneficiary Association (VEBA) account to fund a portion of the cost of future health care benefits for retirees. Although no 401(h) transfer occurred in 1994 (see Note 10), NS made a corporate contribution of $10 million to the VEBA. Effective January 1, 1994, NS amended the attribution period for postretirement health care benefits. The amendment generally provides for benefits to be determined ratably over a 10-year period based on creditable service commencing at age 45, or from date of hire if employment began after age 45. The amendment reduced the accumulated postretirement health care benefit obligation by $90 million and 1994's net periodic postretirement benefit cost by $16 million.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n11. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (continued)\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n11. 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 1994; the rate in 1995 will be 11.5% and is 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, 1994, by about $24 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year 1994 by about $4.5 million. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation, the salary increase assumption and the long-term rate of return on plan assets are the same as those used for the pension plans (see table of rate assumptions in Note 10). 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. Under collective bargaining agreements, NS 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 $4.8 million, $5.3 million and $5.6 million in 1994, 1993 and 1992, respectively.\n12. LONG-TERM INCENTIVE PLAN\nUnder the stockholder-approved Long-Term Incentive Plan, a disinterested committee of the Board of Directors may grant stock options, stock appreciation rights (SARs), and performance share units (PSUs), up to a maximum 11,675,000 shares of Norfolk Southern common stock. Grants of SARs and PSUs result in charges to earnings, while grants of stock options currently have no effect on earnings. Options may be granted for a term not to exceed 10 years but may not be exercised prior to the first anniversary date of grant. Options are exercisable at the fair market value of Norfolk Southern stock on the date of grant. SARs were granted on a one-for-one basis in tandem with certain of the stock option shares. Upon the exercise of an SAR, the optionee receives in common stock or cash or both (as determined by the committee administering the plan) the amount by which the fair market value of common stock on the exercise date exceeds the option price. Exercise of an SAR or option cancels any related option\/SAR. During 1991, the Securities and Exchange Commission issued new regulations under Section 16(b) of the Securities Exchange Act of 1934. In view of these new regulations, plan participants surrendered, without cash or other consideration, all outstanding SARs granted after 1988. Consistent with the new regulations and the surrender of post-1988 SARs, future grants of SARs are not anticipated at this time. SARs outstanding as of each year end were as follows: 74,519 in 1994; 95,852 in 1993; and 133,659 in 1992.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n12. LONG-TERM INCENTIVE PLAN (continued)\nPerformance Share Units ----------------------- Performance share units, which were added to this plan by a 1989 amendment, entitle participants to earn shares of common stock at the end of a three-year performance cycle based upon achievement of certain predetermined corporate performance goals. PSU grants totaled 163,000 in 1994; 160,500 in 1993; and 196,000 in 1992. Shares earned and issued may be subject to share retention agreements and held by NS for up to five years. The plan also permits the payment, in cash or in stock, of dividend equivalents on shares of common stock covered by options and PSUs granted after January 1, 1989, commensurate with dividends paid on common stock. Tax absorption payments, in an amount estimated to equal the federal and state income taxes applicable to shares of common stock issued subject to a share retention agreement, also are authorized. Dividend equivalents and tax absorption payments, if made, result in charges to earnings.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n13. STOCK PURCHASE PROGRAMS\nSince 1987, the Board of Directors has authorized the purchase and retirement of up to 65 million shares of common stock. Purchases under the programs initially were made with internally generated cash. Beginning in May 1990, some purchases were financed with proceeds from the sale of commercial paper notes. In March 1991, $250 million of long- term notes was issued in part to repay a portion of the commercial paper notes, as well as to provide funds for additional purchases. An additional $250 million of long-term notes was issued in February 1992 (see Note 6 for debt details). The recent decreases in the average number of outstanding common shares, as disclosed in the Eleven-Year Financial Review on page 30, are the results of these purchase programs. Since the first purchases in December 1987 and through December 31, 1994, NS has purchased and retired 59,160,800 shares of its common stock under these programs at a cost of $2.5 billion. Future purchases are dependent on market conditions, the economy, cash needs and alternative investment opportunities.\n14. FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe fair value of \"Cash and cash equivalents,\" \"Short-term investments,\" \"Accounts receivable,\" \"Short-term debt\" and \"Accounts payable\" approximates carrying value because of the short maturity of these financial instruments. The fair value of long-term \"Investments\" approximated $261 million and $217 million at December 31, 1994, and 1993, respectively. Quoted market prices were used to determine the fair value of marketable securities which, beginning in 1994 (see Note 1, \"Required Accounting Changes\"), were recorded at fair value. Gross unrealized holding losses on marketable securities were $2.0 million at December 31, 1994. Underlying net assets were used to estimate the fair value of non- marketable investments; however, if any such investment was sold after the end of the year, its sales price determined its fair value for these purposes. For the remaining investments, consisting principally of corporate-owned life insurance, the carrying value approximates fair value (see Note 4 for carrying values of \"Investments\"). The fair value of \"Long-term debt,\" including current maturities, approximated $1.63 billion at December 31, 1994, and $1.74 billion 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 (see Note 6 for carrying values of \"Long-term debt\").\n15. MOTOR CARRIER RESTRUCTURING IN 1993\nIn mid-1993, NS began a restructuring of its motor carrier subsidiary by seeking buyers for the truckload freight portion of NAVL, which consisted of the Commercial Transport Division (CT), a nationwide truckload carrier, and Tran-Star (TS), a refrigerated carrier. The restructuring resulted in the liquidation or transfer to other divisions of most of CT's assets and, in December 1993, the sale of TS' operations. NAVL's revenues and expenses after June 30, 1993, reflect the results of its remaining operations. In 1993, as a result of these planned dispositions, NS recorded a $50.3 million pretax ($32.3 million after-tax) charge and recognized an additional tax benefit of $36.8 million. The proceeds from the December 31, 1993, sale of TS' operations are reflected in \"Investment sales and other\" in the 1993 Consolidated Statement of Cash Flows. CT's assets remaining at December 31, 1993, were classified in the Consolidated Balance Sheet in \"Other current assets\" and were disposed of during 1994.\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n16. PARTIAL REVERSAL OF SPECIAL CHARGE IN 1993\nIncluded in 1991 results was a $680 million special charge for labor force reductions and asset write-downs. However, based on NS' 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 expense. The principal factor contributing to the reversal was the failure in 1993 to reach agreement on terms for certain further labor savings. Accordingly, it became apparent that a surplus existed in the labor portion of the provision established in the 1991 special charge.\n17. CONTINGENCIES\nLawsuits -------- Norfolk Southern 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 the amount of NS' ultimate liability will not materially affect NS' consolidated financial position.\nDebt Guarantees --------------- As of December 31, 1994, certain Norfolk Southern subsidiaries are contingently liable as guarantors with respect to $72.5 million of indebtedness of related entities.\nChange-in-Control Arrangements ------------------------------ Norfolk Southern has compensation agreements with officers and certain key employees, which become operative only upon a change in control of the Corporation, as defined in those agreements. The agreements provide generally for payments based on compensation at the time of a covered individual's involuntary or other specified termination and for certain other benefits.\nEnvironmental Matters --------------------- NS is subject to various jurisdictions' environmental laws and regulations. It is NS' policy to record a liability where such liability or loss is probable and can be reasonably estimated. Claims, if any, against third parties for recovery of cleanup costs incurred by NS are reflected as receivables in the balance sheet and are not netted against the associated NS liability. Environmental engineers participate in ongoing evaluations of all identified sites, and--after consulting with counsel--any necessary adjustments to initial liability estimates are made. NS also has established an Environmental Policy Council, composed of senior managers, to prescribe and direct its environmental initiatives. Operating expenses for environmental protection totaled approximately $20 million in 1994 and are anticipated to decrease in 1995. Expenses in 1994 included $10.5 million associated with emergency response and cleanup resulting from release of arsenic acid from a tank car leased by the shipper from a third party. Capital expenditures for environmental projects amounted to approximately $4 million in 1994 and are expected to be approximately $4 million in 1995. As of December 31, 1994, NS' balance sheet included a reserve for environmental exposures in the amount of $50 million (of which $13 million is accounted for as a current liability), which is NS' best estimate of ultimate liability at 80 identified locations. On that date,\nItem 8. Financial Statements and Supplementary Data. (continued) ------- -------------------------------------------\n17. CONTINGENCIES (continued)\neight sites accounted for $23 million of the reserve, and no individual site was considered to be material. NS anticipates that the majority of this liability will be paid out over five years; however, some costs will be paid out over a longer period. At many of the 80 locations, certain NS subsidiaries, usually in conjunction with a number of other parties, have been identified as potentially responsible parties by the Environmental Protection Agency (EPA) or similar state authorities under the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, or comparable state statutes, which often impose joint and several liability for cleanup costs. With respect to known environmental sites (whether identified by NS or by the EPA or comparable state authorities), estimates of NS' ultimate potential financial exposure for a given site or in the aggregate for all such sites are necessarily imprecise because of the widely varying costs of currently available cleanup techniques, the likely development of new cleanup technologies, the difficulty of determining in advance the nature and full extent of contamination and each potential participant's share of any estimated loss (and that participant's ability to bear it) and evolving statutory and regulatory standards governing liability. The risk of incurring environmental liability--for acts and omissions, past, present and future--is inherent in the railroad business. Some of the commodities, particularly those classified as hazardous materials, in NS' traffic mix can pose special risks that NS and its subsidiaries work diligently to minimize. In addition, several NS subsidiaries have land holdings that serve as operating property, or which are leased or may have been leased and operated by others, or held for sale. Because certain conditions may exist on these properties related to environmental problems that are latent or undisclosed, there can be no assurance that NS will not incur liabilities or costs with respect to one or more of them, the amount and materiality of which cannot be estimated reliably now. Moreover, lawsuits and claims involving these and other now-unidentified environmental sites and matters are likely to arise from time to time. The resulting liabilities could have a significant effect on financial condition, results of operations or liquidity in a particular year or quarter. 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 Corporation is aware. Further, Management believes that it is unlikely that any identified matters, either individually or in aggregate, will have a material adverse effect on NS' financial position, results of operations or liquidity.\nINDEPENDENT AUDITORS' REPORT\nThe Stockholders and Board of Directors Norfolk Southern Corporation:\nWe have audited the consolidated financial statements of Norfolk Southern Corporation and subsidiaries as listed in Item 8. In connection with our audits of the consolidated financial statements, we also have audited the consolidated financial statement schedule listed in Item 14(a)2. These consolidated financial statements and this consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and this consolidated 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 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 Corporation and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related consolidated 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.\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 LLP\nNorfolk, Virginia January 24, 1995\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. --------------\nand\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 Norfolk Southern's definitive Proxy Statement, to be dated April 3, 1995, for the Norfolk Southern Annual Meeting of Stockholders to be held on May 11, 1995, 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 hereof beginning on page 22 under \"Executive Officers of the Registrant.\"\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on ------- ------------------------------------------------------- Form 8-K. --------\n(a) The following documents are filed as part of this report:\n1. Index to Financial Statements: Page ----------------------------- ---- Consolidated Statements of Income Years ended December 31, 1994, 1993 and 1992 50-51\nConsolidated Balance Sheets As of December 31, 1994, and 1993 52\nConsolidated Statements of Cash Flows Years ended December 31, 1994, 1993 and 1992 53-54\nConsolidated Statements of Changes in Stockholders' Equity Years ended December 31, 1994, 1993 and 1992 55\nNotes to Consolidated Financial Statements 56-73\nIndependent Auditors' Report 74\n2. Financial Statement Schedule:\nThe following consolidated financial statement schedule should be read in connection with the consolidated financial statements:\nIndex to Consolidated Financial Statement Schedule Page -------------------------------------------------- ---- Schedule II - Valuation and Qualifying Accounts 82-83\nSchedules other than the one listed above are omitted either because they are not required or are inapplicable or because the information is included in the consolidated financial statements or related notes.\nItem 14. Exhibits, Financial Statement Schedule, and Reports on ------- ------------------------------------------------------- Form 8-K. --------\n3. Exhibits\nExhibit Number Description ------- ------------------------------------------------- 3 Articles of Incorporation and Bylaws -\n3(i) The Restated Articles of Incorporation of Norfolk Southern are incorporated herein by reference from Exhibit 1 of Norfolk Southern's Form 10-Q report for the quarter ended September 30, 1989.\n3(ii) The Bylaws of Norfolk Southern, as last amended January 24, 1995, are incorporated herein by reference from Exhibit 4 of Norfolk Southern's Registration Statement on Form S-8, filed electronically on January 25, 1995.\n4 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 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 Supplementary Agreement, entered into as of January 1, 1987, between the Trustees of the Cincinnati Southern Railway and The Cincinnati, New Orleans and Texas Pacific Railway Company (the latter a wholly owned subsidiary of Norfolk Southern Railway) - extending and amending a Lease, dated as of October 11, 1881 (both the Lease and Supplementary Agreement, formerly incorporated by reference from Exhibit 10(b) of Southern's 1987 Annual Report on Form 10-K) - is filed herewith electronically.\nItem 14. Exhibits, Financial Statement Schedule, and Reports on ------- ------------------------------------------------------- Form 8-K. (continued) --------\nExhibit Number Description ------- -------------------------------------------------\nManagement Compensation Plans ----------------------------- (b) The Norfolk Southern Corporation Management Incentive Plan, formerly incorporated by reference from Exhibit 10(h) of Norfolk Southern's 1987 Annual Report on Form 10-K, is filed herewith electronically.\n(c) The Norfolk Southern Corporation Long-Term Incentive Plan is incorporated herein by reference from Appendix A to Norfolk Southern's definitive Proxy Statement dated April 3, 1989, for the Norfolk Southern Annual Meeting of Stockholders held May 11, 1989.\n(d) The Norfolk Southern Corporation Officers' Deferred Compensation Plan is incorporated herein by reference from Exhibit 10(g) of Norfolk Southern's 1993 Annual Report on Form 10-K.\n(e) The Directors' Deferred Fee Plan of Norfolk Southern Corporation is incorporated herein by reference from Exhibit 10(h) of Norfolk Southern's 1993 Annual Report on Form 10-K.\n(f) The Norfolk Southern Corporation Directors' Restricted Stock Plan effective January 26, 1994, is incorporated herein by reference from Exhibit 99 to Norfolk Southern's Form S-8 filed electronically on January 26, 1994.\n(g) Form of Severance Agreement, dated as of September 1, 1994, between the Corporation and certain executive officers: D. R. Goode, J. R. Turbyfill, R. A. Brogan, J. S. Shannon, S. C. Tobias, D. H. Watts and H. C. Wolf is incorporated herein by reference from Exhibit 10 to Norfolk Southern's Form 10-Q Report for the quarter ended September 30, 1994.\n(h) The Excess Benefit Plan of Norfolk Southern Corporation and Participating Subsidiary Companies, formerly incorporated by reference from Exhibit 10(k) of Norfolk Southern's 1988 Annual Report on Form 10-K, is filed herewith electronically.\nItem 14. Exhibits, Financial Statement Schedule, and Reports on ------- ------------------------------------------------------- Form 8-K. (continued) --------\nExhibit Number Description ------- -------------------------------------------------\n(i) The Directors' Pension Plan of Norfolk Southern Corporation is incorporated herein by reference from Exhibit 10(l) of Norfolk Southern's 1989 Annual Report on Form 10-K.\n11 Statement re: Computation of Earnings Per Share.\n12 Statement re: Computation of Ratio of Earnings to Fixed Charges.\n21 Subsidiaries of the Registrant.\n23 Consents of Experts and Counsel -\nConsent of Independent Auditors.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed for the three months ended December 31, 1994.\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 statements specified by this Item are included in Item 14(a)2 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 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 of 1934, Norfolk Southern Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on this 28th day of March, 1995.\nNORFOLK SOUTHERN CORPORATION\nBy \/s\/ David R. Goode ----------------------------------------- (David R. Goode, 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 28th day of March, 1995, by the following persons on behalf of Norfolk Southern Corporation and in the capacities indicated.\nSignature Title --------- -----\n\/s\/ David R. Goode ------------------------------ Chairman, President and Chief (David R. Goode) Executive Officer and Director (Principal Executive Officer)\n\/s\/ Henry C. Wolf ------------------------------ Executive Vice President-Finance (Henry C. Wolf) (Principal Financial Officer)\n\/s\/ John P. Rathbone ------------------------------ Vice President and Controller (John P. Rathbone) (Principal Accounting Officer)\n\/s\/ Gerald L. Baliles ------------------------------ Director (Gerald L. Baliles)\nSignature Title --------- -----\n------------------------------ Director (Gene R. Carter)\n\/s\/ L. E. Coleman ------------------------------ Director (L. E. Coleman)\n\/s\/ T. Marshall Hahn, Jr. ------------------------------ Director (T. Marshall Hahn, Jr.)\n\/s\/ Landon Hilliard ------------------------------ Director (Landon Hilliard)\n\/s\/ E. B. Leisenring, Jr. ------------------------------ Director (E. B. Leisenring, Jr.)\n\/s\/ Arnold B. McKinnon ------------------------------ Director (Arnold B. McKinnon)\n\/s\/ Robert E. McNair ------------------------------ Director (Robert E. McNair)\n\/s\/ Jane Margaret O'Brien ------------------------------ Director (Jane Margaret O'Brien)\n------------------------------ Director (Harold W. Pote)\nEXHIBIT INDEX -------------\nElectronic Submission Exhibit Page Number Description Number ---------- ------------------------------------------- ------ 10 Material Contracts -\n(a) The Supplementary Agreement entered into as of January 1, 1987, between the Trustees of the Cincinnati Southern Railway and The Cincinnati, New Orleans and Texas Pacific Railway Company. 85-107\n(b) The Norfolk Southern Corporation Management Incentive Plan, as amended effective January 1, 1988. 108-115\n(h) The Excess Benefit Plan of Norfolk Southern Corporation and Participating Subsidiary Companies, as amended January 1, 1989. 116-120\n11 Statement re: Computation of Earnings Per Share. 121-124\n12 Statement re: Computation of Ratio of Earnings to Fixed Charges. 125\n21 Subsidiaries of Norfolk Southern Corporation. 126-128\n23 Consent of Independent Auditors. 129\n27 Financial Data Schedule (This exhibit is required to be submitted electronically pursuant to the rules and regulations of the Securities and Exchange Commission and shall not be deemed filed for purposes of Section 11 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934). 130","section_15":""}
{"filename":"874783_1994.txt","cik":"874783","year":"1994","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 Bank of America Illinois 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 1994 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, 1995, 100% of the Investor Certificates were held in the nominee name of CEDE and Co. for beneficial owners.\nSRFG, as of March 15, 1995, 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. 1994 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT ACCOUNTANTS' REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Agreed Upon Procedures Letter.\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 17, 1994, November 15, 1994, and December 15, 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.\nSears Credit Account Trust 1991 B (Registrant)\nBy: Sears Receivables Financing Group, Inc. (Originator of the Trust)\nBy: \/S\/Perry N. Weine Perry N. Weine Vice President, Administration\nDated: March 30, 1995\nEXHIBIT INDEX\nPage number in sequential Exhibit No. number system\n21. 1994 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT ACCOUNTANTS' REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Agreed Upon Procedures Letter.\n(b) Annual Servicing Letter.","section_15":""}
{"filename":"790070_1994.txt","cik":"790070","year":"1994","section_1":"ITEM 1. BUSINESS\nEMC Corporation and its subsidiaries (\"EMC\" or the \"Company\") design, manufacture, market and support high performance storage products and provide related services for mainframe and midrange computer systems manufactured primarily by International Business Machines Corporation (\"IBM\"), Unisys Corporation (\"Unisys\") and Compagnie des Machines Bull S.A. (\"Bull\"). The Company develops its products by integrating technologically advanced industry standard components and devices with Company designed proprietary controller technology to produce storage products that enhance the performance, reliability, availability and functionality of computer systems.\nThe Company's principal products are based on Integrated Cached Disk Array (\"ICDA\") technology which combines high-speed semiconductor cache memory with an array of industry standard disk drives. ICDA-based products represented approximately 91% of the Company's combined revenues in 1993 and 74% in 1992. These products include the Symmetrix series of high speed ICDA-based storage systems for the IBM and IBM-compatible mainframe computer market. In November 1992, the Symmetrix product line was expanded to include the Model 5500 which features storage capacities of up to 360 gigabytes (\"GB's\"), hardware and channel redundancy, full system battery backup, nondisruptive component upgrade and replacement, and remote diagnostic features. The Company also markets the Harmonix series of high speed ICDA-based storage systems for the IBM AS\/400 midrange computer market. Additionally, the Company provides solid-state disk (\"SSD\") devices, main memory products and tape back-up systems.\nThe customers for these products are located worldwide and represent a cross section of industries and government agencies that range in size from Fortune 500 companies to small businesses. The Company markets its products in North and South America, Europe and the Asia Pacific region through its direct sales force, distributors and original equipment manufacturers (\"OEMs\"). All products sold directly to end-users are maintained and serviced by the Company or third party providers. Products sold through distributors or OEMs are normally maintained by the reseller.\nEMC, a Massachusetts corporation incorporated in 1979, has its corporate headquarters located at 171 South Street, Hopkinton, Massachusetts.\n3.\nCompany Strategy\nThe Company's objective is to be the leading provider of high performance, high reliability storage systems to selected mainframe and midrange computer markets. The Company has recently announced its intention to expand its storage products into the client\/server market as well. Over the past decade the technological advances made in central processing units (\"CPUs\") have far exceeded advances made in the area of data storage systems. These CPU advances have created an input\/output bottleneck which limits the performance of computer systems running applications requiring frequent access to data. The Company's products have been designed to significantly reduce this performance bottleneck. The major elements of the Company's strategy are set forth below.\nInnovative Architectural Design\nThe Company has developed a common architecture, called MOSAIC:2000, on which its principal products are based. This architectural framework is based upon a modular design and industry standard interfaces that allow for new technologies to be incorporated more rapidly than with traditional architectures and enhances portability to non- IBM environments. This facilitates upgrades and enhancements that can not only extend the useful life of the Company's storage systems, but also extend the useful life of the customer's CPU.\nProprietary Software Technology\nThe Company's products achieve high performance levels due in part to proprietary software and microcode controller technology. This proprietary controller technology, combined with large amounts of high speed cache memory and arrays of industry standard disk drives, creates storage devices that provide computer systems with enhanced performance, reliability and functionality. The Company believes that by dedicating significant resources to the further development of this proprietary controller technology, it should be able to maintain the performance leadership it has established.\nMulti-Channel Distribution Focus\nThe Company's strategy is to continue to expand in four distinct product markets: the IBM and IBM- compatible mainframe market, the IBM AS\/400 midrange market, the client\/server market and the OEM market. To access these markets the Company has adopted a multi- channel distribution approach. The Company utilizes a direct salesforce in the U.S., Canada and Europe, and plans to develop a direct salesforce in Japan. The Company also utilizes third party distributors and OEMs.\n4.\nMainframe Market\nThe mainframe storage market is a multibillion dollar market which the Company has penetrated with its ICDA-based products. The Company believes that it is currently the leading manufacturer of storage systems that allow users to bridge the gap between the speed at which the CPU can process data and the traditional storage device's ability to provide the data to the CPU.\nProduct sales to the mainframe storage market represented approximately 85% of EMC's 1993 product revenue and 70% of 1992 product revenue. In September 1990, EMC introduced the Symmetrix series of ICDA-based products for IBM and IBM compatible mainframe computers. Symmetrix was the first commercially available disk storage system for the IBM mainframe marketplace that utilized arrays of smaller, industry standard 51\/4\" disk drives as an alternative to the larger more expensive disk drives that traditionally had been used with mainframe computers. By combining these smaller disk drives with an integrated control unit, large amounts of cache memory and battery backup, Symmetrix provides the user with what the Company believes to be the highest performing disk storage product available in the marketplace today. As a result of this integrated design, Symmetrix also occupies a smaller footprint and has lower operating costs than data storage systems based on conventional technology.\nSince the introduction of the first Symmetrix model, the Model 4400 with a maximum capacity of 24 GB's, EMC has added additional models that are both smaller (the Model 4200 with a capacity of up to 8 GB's) and larger (the Model 4800 with a capacity of up to 90 GB's) than the original. In November 1992, EMC introduced a new series of Symmetrix products called the Model 5500 (with a capacity of up to 360 GB's). The Model 5500 has many built-in redundancy features allowing for continuous operation of the disk storage system. This is particularly attractive to users whose data storage requirements are dependent upon high performance and continuously available data for mission critical applications. Each Model 5500 contains EMC's Auto Call feature, which automatically generates a diagnostic phone call from the unit to EMC's 24 hour Remote Support Facility if the unit detects a possible problem. The Company has continually enhanced the Symmetrix family of products with additional features and improved performance through a combination of hardware and microcode enhancements. The announcements in September 1993 included the Model 4208-2S which increased the capacity of the Symmetrix Model 4200 from 8 GB's to 15 GB's by using 31\/2\" disk technology. The wide range of Symmetrix models allows EMC to broaden its marketing efforts to address the storage needs of virtually all sizes of IBM mainframe computer users.\nEMC also designs and manufactures plug compatible main memory products for IBM air cooled model 9121 mainframe computers and provides plug-in storage modules for IBM 3990- 3 cache control units. 5.\nMidrange Market\nThe Company believes that there is a large portion of the IBM AS\/400 midrange storage market that has not been penetrated by the Company's ICDA-based products.\nMidrange revenues grew modestly during 1993, with product sales to the midrange storage market representing approximately 15% of EMC's product revenue in 1993, as compared to 28% in 1992. In 1992, the Company introduced the first ICDA-based storage systems for the IBM AS\/400 midrange computer market. This series of products, called Harmonix, uses both 51\/4\" and 31\/2\" disk drives integrated with cache memory to provide high performance, high capacity storage solutions for the AS\/400 user. During 1993, the Company expanded the Harmonix product line to allow the Company to reach new users by including models featuring high capacity at a lower cost as well as other models emphasizing high availability.\nEMC also offers the Champion line of 8 millimeter (\"mm\") based Intelligent Cached Tape Subsystems, which provides AS\/400 users with high capacity, high performance and unattended backup. These products feature an advanced controller design and cache buffer combined with the ability to interleave data to up to four 8mm tape transports simultaneously, greatly improving the speed of the backup operations. In August 1993, EMC acquired Magna Computer Corporation (\"Magna\"), a manufacturer of tape backup systems for the AS\/400 marketplace. This acquisition augmented the Champion line of tape products by adding 4 mm and additional 8 mm and reel to reel tape products to the Company's product portfolio.\nThe Company also provides main memory upgrades for selected AS\/400 CPU models.\nOEM Market\nThe MOSAIC:2000 framework and the inherent flexibility of its open system make EMC's products well suited to be sold by strategic OEMs in partnership with the Company.\nSince January 15, 1992, EMC has had an OEM agreement with Unisys for the sale of Unisys compatible Symmetrix products. This agreement, which currently extends to December 31, 1996, requires Unisys to meet certain minimum purchase requirements and provides Unisys with exclusive worldwide marketing rights to these products. During 1993, Unisys purchased over $39 million of such products under this agreement, which accounted for 5% of the Company's 1993 combined revenues.\nOn February 11, 1993, the Company entered into a three- year OEM agreement with Bull. Pursuant to the agreement, EMC granted Bull exclusive worldwide marketing rights, with the exception of Japan, to EMC's Symmetrix 4800 series of ICDA-based storage products for Bull mainframe computers, provided that Bull purchases all of its requirements for high speed cached disk array storage devices from EMC and meets certain minimum purchase requirements. During 1993, Bull purchased approximately $22 million of such products, which accounted for 3% of the Company's 1993 combined revenues. 6.\nClient\/Server Market\nIn May 1993, the Company formed a Client\/Server Division to develop storage products for the growing client\/server market. The Company believes that this market requires sophisticated data management technology to allow for sharing of information while maintaining data integrity and reliability. The Company's efforts are currently focused on hiring engineering and marketing personnel and developing a marketing strategy and business plan for this marketplace. Meaningful contributions to the Company's revenue from this business unit are not expected until at least 1995.\nEpoch Systems\nIn August 1993, the Company completed the acquisition of Epoch Systems, Inc. (\"Epoch\"). Epoch is a leading supplier of client\/server data management software for certain Unix-based systems. It is the Company's intent to expand Epoch's software product line to be compatible with multiple hardware and software platforms. The Company currently plans to incorporate various Epoch software products into its development of products for the client\/server market. Epoch utilizes a variety of distribution channels to sell its software products, including telemarketing, value added resellers, OEMs and system integrators.\nCopernique, S.A.\nIn January 1994, the Company acquired the majority interest in Copernique S.A. (\"Copernique\") formerly held by Cap Gemini Sogeti S.A. Copernique, located near Paris, France, specializes in high-performance data management hardware and software systems. The Company believes that this acquisition will enable the Company to extend its offerings in the field of distributed Information Technology systems and to strengthen its European presence.\nMarketing and Customers\nEMC markets its products through multiple distribution channels, including its direct sales force, selected distributors and OEMs. The Company has a direct sales presence throughout North America and Europe, and uses distributors as its primary distribution channel in the Asia Pacific region, the Middle East, Africa and South America. Over the past two years, the Company has expanded its North American and European sales and marketing organizations significantly and currently is expanding its sales and marketing organizations in the Asia Pacific region. In this regard, in January 1994, the Company and its existing Japanese distributor jointly formed a company in Japan, in which the Company holds a majority interest. Through this entity, the Company will acquire a direct salesforce in Japan, which it then plans to further expand. During 1993, the Company derived 65% of its product revenue from shipments into North and South America, 30% from shipments\n7.\ninto Europe, the Middle East and Africa, and 5% from shipments into the Asia Pacific region. EMC's marketing and sales personnel are organized into mainframe and midrange customer groups to ensure that the necessary expertise is available to understand the customer's requirements and properly apply the Company's product solutions. In addition, the Company has dedicated personnel to support the needs of its distributors and OEM customers, both domestically and internationally.\nOperations\nEMC's products utilize the Company's engineering designs, with industry standard and semi-custom components and subsystems. The majority of EMC's products are manufactured and tested at the Company's facilities in Hopkinton, Massachusetts and Cork, Ireland. Products manufactured by subcontractors in the U.S. and Europe are assembled in accordance with production standards and quality controls established by EMC. The Company discontinued board assembly at its Canovanas, Puerto Rico facility in February 1994 and such assembly is now being performed by existing subcontractors. The Company believes its present level of manufacturing capacity will be sufficient to accommodate its requirements.\nThe Company purchases certain components and products from suppliers who the Company believes are currently the only suppliers of those components or products that meet the Company's requirements. Among the most important components that the Company uses are high density memory components (\"DRAMs\") and 51\/4\" and 31\/2\" disk devices, which the Company purchases from a small number of qualified suppliers, and in some instances there is only a single source for such components. A failure by any supplier of high density DRAMs or disk drives to meet the Company's requirements for an extended period of time could have a material adverse effect on the Company. From time to time during 1993, because of high industry demand, the Company experienced delays in deliveries of high density DRAMs and disk drives needed to satisfy orders for ICDA products. If such shortages were to intensify, the Company could lose some time-sensitive customer orders.\nEMC considers it crucial that there be a close working relationship between its product development staff and its marketing organization. The Company believes that its success is in part tied to its ability to respond quickly to the needs and problems of end-users in each of its markets. As the marketing organization identifies these end-user needs, the Company utilizes advanced computer-aided engineering and design (\"CAE\/CAD\") technology to expedite the design and production of new products.\nThe Company has implemented a Total Quality Management philosophy to ensure the quality of its designs, manufacturing process and suppliers.\nThe Company's U.S. operation currently holds an ISO9001 Certificate of Registration from National Quality Assurance, Ltd. This internationally recognized endorsement of ongoing quality management represents the highest level of certification available. The Company's Irish manufacturing operation also holds ISO9002 certification. In the first quarter of 1993, the Company's principal manufacturing\n8.\noperation in Hopkinton was awarded Class A MRP II status by an independent evaluation organization.\nManufacturing Risks\nThe Company's products operate near the limits of electronic and physical performance and are designed and manufactured with relatively small performance margins. If flaws in design or production occur, the Company could experience a rate of failure in its products that would result in substantial costs for the repair or replacement of defective products and potential damage to the Company's reputation. Continued improvement in manufacturing capabilities, control of supplier quality and manufacturing costs will be critical factors in the future growth of the Company. The Company frequently revises and updates manufacturing and test processes to address engineering and component changes to its products and evaluates the reallocation of manufacturing resources among its facilities. The Company's failure to monitor, develop and implement appropriate test and manufacturing processes for its products, especially the Symmetrix and Harmonix series, could have substantial adverse effects on the Company's operation and ultimately on its financial results.\nCompetition\nEMC competes primarily with IBM in the sale of storage products in the IBM and IBM-compatible mainframe and midrange marketplaces. The Company believes that it has a number of competitive advantages over IBM, especially in the areas of product performance, cost of ownership, and time-to- market. While the Company believes that its ICDA technology provides a significant technological advantage, it is likely that competition in this area will increase significantly in the future which could adversely affect the Company's profitability. The Company also realizes that IBM has certain competitive advantages including significantly greater financial and technological resources, a larger distribution capability, earlier access to customers and a greater level of customer loyalty. Other important elements of competition in the computer storage industry are product reliability and quality, continuing technological improvements, marketing and customer service, and product design.\nThere are also a number of independent competitors in each of EMC's markets. In the mainframe market those competitors include Hitachi Data Systems, Inc., Amdahl Corporation and Storage Technology Corporation (\"STK\"). In the midrange market, competition has historically come from smaller companies, as well as IBM and STK. EMC believes that it has similar advantages over these midrange competitors, but increased competition from these or future entrants could adversely effect the Company's profitability.\nTechnological Factors\nThe computer data storage industry is characterized by rapidly changing technology and user needs which require ongoing technological development and introduction of new products. Recognizing this fact, the Company has developed a storage system architecture called MOSAIC:2000 to allow\n9.\nthe Company to take advantage of technological developments. By employing this architectural approach to product development, EMC is able to quickly integrate new technologies into its basic design. The Company works closely with its suppliers to understand their technology direction and to plan for the integration of this technology into its product architecture. Both the Symmetrix series and Harmonix series are products derived from the MOSAIC:2000 architectures.\nIn 1993, sales of the Symmetrix series remained a significant source of revenues for the Company and sales of such products are expected to continue to be a significant source of revenues. In April 1992, EMC released a new series of midrange disk storage systems, the Harmonix series, which have also become a significant source of revenues for the Company. The Company expects competition in the sales of ICDA-based products to increase and there can be no assurance that the Symmetrix series and Harmonix series of products will continue to achieve market acceptance. Significant delays in the development of ICDA technology for future products or product enhancements would be to the advantage of the Company's competitors, many of whom have significantly greater resources, and could ultimately affect the Company's financial condition. Furthermore, the continued development of ICDA technology and its incorporation into the Company's future generations of products cannot be assured even with significant additional investments.\nProduct Development\nEMC's ability to compete successfully in present and future markets depends upon the timely development and introduction of products offering price\/performance or capacity advantages and compatibility with the computer systems for which they are designed. Achieving these goals requires that the Company remain abreast of changing technology and design products that operate within the architecture of various computer systems and deliver performance or capacity advantages not offered by the original systems developer or by other storage competitors. Moreover, the computer industry is subject to rapid technological developments. Consequently, achieving such goals may become more difficult, costly and time consuming as a result of technological developments that cannot now be foreseen. Research and development costs were $58,977,000, $33,591,000 and $22,496,000 for the fiscal years ended January 1, 1994, January 2, 1993 and December 28, 1991, respectively.\nSeasonality\nThe Company has from time to time experienced seasonal revenue fluctuations in the third quarter of its fiscal year which it believes are due primarily to business slowdowns associated with European vacation periods.\nWorking Capital\nIt is typical for companies in the computer industry to require significant amounts of working capital to finance inventory and receivables. The Company believes that its working capital requirements are in accordance with industry practices. In 1993, the Company financed its working capital requirements from internally generated funds and existing cash and investments. This also includes the net proceeds of $100,141,000 received from the sale in March 1993 of the Company's common stock and the net proceeds received from the sale in December 1993 and January 1994 of $229,600,000 of 41\/4% Convertible Subordinated Notes due 2001 ($29,600,000 of which was sold upon exercise of the underwriters' over-allotment option in January 1994).\n10.\nIn 1993, the Company invested an additional $29,100,000 in long term investments. As of February 1, 1994, the Company had available for use its entire $15,000,000 credit line. However, the Company may elect to borrow capital at any time to fund new growth opportunities. As the Company's product mix shifts to higher cost products with longer sales cycles, the Company's need for working capital is expected to increase.\nBacklog\nThe Company manufactures its products on the basis of its forecast of near-term demand and maintains inventory in advance of receipt of firm orders from customers. Orders are generally shipped by the Company shortly after receipt of the order. Customers may reschedule orders with little or no penalty. For these reasons, the Company's backlog at any particular time is not indicative of future sales levels.\nEmployees\nAs of February 28, 1994, EMC had approximately 2452 employees, including temporary employees. Continued growth in the Company's business will require the hiring of additional qualified personnel. Under current market conditions, the Company does not expect to encounter any difficulty in hiring such personnel. None of the Company's employees is represented by a labor union, and the Company has never suffered an interruption of business as a result of a labor dispute. The Company considers its relations with its employees to be good.\nDependence Upon Key Personnel\nThe Company's success is highly dependent upon senior management and other key employees, the loss of whom could adversely affect the Company. The Company also believes that its future success will depend in large part upon its ability to attract and retain additional key employees, of which there can be no assurance.\nEnvironment\nThe Company's manufacturing facilities are subject to numerous laws and regulations designed to protect the environment, particularly from wastes generated as a result of assembling certain EMC products. The cost of compliance with such regulations has not to date involved a significant expense or had a material effect on the capital expenditures, earnings or competitive position of the Company. 11.\nPatents\nEMC has received seven U.S. patents and has numerous applications pending in the U.S. and foreign patent offices relating to the Symmetrix and Harmonix series of products. The Company also has a number of other patent and patent applications filed in the U.S. and foreign patent offices. While the Company believes that the pending applications relate to patentable devices or concepts, there can be no assurance that any patents will issue or that any patent issued can be successfully defended. In any case, the Company believes that patents are of less significance in its industry than such factors as innovative skills, technological expertise and the management ability of its personnel.\nEarnings Fluctuations\nDue to (i) customers' tendencies to make purchase decisions late in each fiscal quarter, (ii) the desire by customers to evaluate new, more expensive products for longer periods of time, (iii) the timing of product and technology announcements by the Company and its competitors, and (iv) fluctuating currency exchange rates, the Company's period-to-period revenues and earnings can fluctuate significantly.\nRecent Developments\nOn February 11, 1994 the Board of Directors of the Company voted to adopt the provisions of Section 50A of Chapter 156B of the Massachusetts General Laws. Pursuant to Section 50A, the Board of Directors is presently divided into three classes, having staggered terms of three years each after an initial transition period. Under Section 50A and the by-laws of the Company, the Board of Directors may determine the total number of directors and the number of directors to be elected at any Annual Meeting of Stockholders or Special Meeting in lieu thereof. The Board of Directors has fixed at eight the total number of directors and has fixed at two the number of directors to be elected at the 1994 Annual Meeting. Of the current total of eight directors, two Class I Directors have terms expiring at the 1994 Annual Meeting, three Class II Directors have terms expiring at the 1995 Annual Meeting and three Class III Directors have terms expiring at the 1996 Annual Meeting.\nOn March 15, 1994, the Company acquired certain assets of Array Technology Corporation (\"Array\"), a wholly-owned subsidiary of Tandem Computers Incorporated. Array, located in Boulder, Colorado, specializes in the development and manufacture of Redundant Arrays of Independent Disk (RAID) storage solutions. The Company believes that this acquisition will enhance the Company's ability to develop additional advanced storage solutions for those customers and markets that have a need for them.\n12.\nFinancial Information About Foreign and Domestic Operations and Export Sales\nThe Company is active in only one business segment: designing, manufacturing and marketing high performance storage products. Information by geographic area is presented below with exports shown in their area of origin. Sales and marketing operations outside the U.S. are conducted through sales subsidiaries and branches located principally in Europe and by direct sales from the parent corporation or its Irish manufacturing subsidiary. The U.S. market amounted to greater than 95% of the Company's sales, income and identifiable assets in the North\/South America segment.\nIntercompany transfers between geographic areas are accounted for at prices which are designed to be representative of unaffiliated party transactions. (in thousands) Europe, North\/ Middle- Consol- South East, Asia Elimi- idated America Africa Pacific nations Total Sales $526,771 $251,363 $ 4,487 $ --- $782,621 Transfers between areas 100,237 83,726 --- (183,963) --- Total sales 627,008 335,089 4,487 (183,963) 782,621 Income (loss) from operations 107,512 70,324 (990) 3,582 180,428 Identifiable assets at year end 684,576 192,682 2,383 (49,995) 829,646\nSales $263,465 $111,117 $11,124 $ --- $385,706 Transfers between areas 83,813 36,303 --- (120,116) ---\nTotal sales 347,278 147,420 11,124 (120,116) 385,706 Income from operations 34,915 25,008 1,255 (12,603) 48,575 Identifiable assets at year end 252,308 98,232 4,309 (16,069) 338,780\nSales $200,008 $51,411 $8,918 $ --- $260,337 Transfers between areas 35,946 15,036 --- (50,982) --- Total sales 235,954 66,447 8,918 (50,982) 260,337 Income (loss) from operations 22,798 (6,406) (531) 4,517 20,378 Identifiable assets at year end 164,096 41,608 4,166 (4,367) 205,503\n13.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's mainframe marketing, research and development, customer service and manufacturing functions are located in a 229,000 square foot complex at 171 South Street in Hopkinton, Massachusetts. This building complex consists of a building purchased in December 1986, and an adjacent building constructed in 1988 and occupied in January 1989. In October 1992, EMC purchased a 62,000 square foot facility and an additional 6 acres of land at 42 South Street in Hopkinton, Massachusetts. This facility has been renovated by the Company and is in use as its customer demonstration center and for midrange marketing, research and development and manufacturing. In November 1993, the Company transferred certain of its corporate and administrative functions to a leased 80,000 square foot building at 35 Parkwood Drive in Hopkinton, Massachusetts.\nProduction currently is carried on in the Hopkinton facility at 171 South Street, and a leased 87,000 square foot facility in Cork, Ireland (of which 40,000 square feet was added in 1993). The Company discontinued production at its Canovanas, Puerto Rico facility in February 1994 and plans to close the facility completely in March 1994.\nThe Company also leases space for its sales and service offices worldwide.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn June 10, 1993, STK filed suit against EMC in the United States District Court for the District of Colorado (Case No. 93-S-1238) alleging that EMC is infringing three patents. In the complaint, STK seeks injunctive relief, unspecified damages, including treble damages plus attorney's fees and costs. On July 20, 1993, EMC answered the complaint and denied STK's allegations. In addition, EMC counterclaimed against STK alleging that the patents in suit are invalid and unenforceable. In the counterclaim, EMC seeks unspecified damages, attorney's fees, costs and interest. Discovery in the matter is currently in process. A scheduling order has been entered and a trial date has been set for October 1994.\nThe Company is involved in other litigation which it considers routine and incidental to its business, and EMC's management does not expect the results of any of these actions to have a material adverse effect on EMC's business or financial condition.\n14.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nA Special Meeting of Stockholders was held on November 17, 1993. The stockholders approved amendments to the Company's Articles of Organization to increase the number of shares of authorized common stock, $.01 par value, to 330,000,000 shares from the previous authorization of 150,000,000 shares and to authorize a new class of capital stock consisting of 25,000,000 shares of series preferred stock, $.01 par value. The results of the votes for each of these proposals were as follows:\n1. To amend the Articles of Organization to increase the authorized common stock:\nFor: 78,244,601 Against: 3,954,529 Abstain: 186,232 Delivered But Not Voted -0-\n2. To amend the Articles of Organization to authorize a new class of capital stock consisting of series preferred stock:\nFor: 61,759,842 Against: 11,012,647 Abstain: 289,621 Delivered But Not Voted 9,323,252\n15.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company are as follows:\nName Age Position\nRichard J. Egan 58 Chairman of the Board and Director Michael C. Ruettgers 51 President, Chief Executive Officer and Director W. Paul Fitzgerald 53 Senior Vice President, Finance and Administration, Chief Financial Officer, Treasurer and Director John R. Egan 36 Executive Vice President, Sales and Marketing and Director Frank M. Keaney 57 Senior Vice President, North American Sales Richard B. Plummer 48 Senior Vice President and General Manager, Client\/Server Systems Division Harold P. Ano 45 Senior Vice President, Marketing L. Daniel Butler 55 Senior Vice President, Customer Service Michael L. Schoonover 45 Senior Vice President, Operations Paul T. Dacier 36 Vice President and General Counsel Michael R. Grilli 54 Vice President-Sales, Europe, Middle East and Africa Paul E. Noble, Jr. 38 Vice President and General Manager, OEM Operations Colin G. Patteson 45 Vice President and Controller Michael G. Salter 57 Vice President and General Manager, Asia Pacific\nRichard J. Egan is a founder of the Company and has served as a Director since the Company's inception in 1979. He was elected Chairman of the Board of the Company in January 1988. Prior to January 1988, he was also President of EMC. From 1979 to January 1992, he was Chief Executive Officer of the Company. He is also a director of Cognition Corporation, a CAD\/CAM software supplier.\nMichael C. Ruettgers served as Executive Vice President, Operations of EMC from July 1988 to October 1989, when he became President. From September 1989 to January 1992, Mr. Ruettgers served as Chief Operating Officer of EMC. In January 1992, he became Chief Executive Officer and in May 1992, he was elected a Director of the Company. Before joining EMC, he was Chief Operating Officer at Technical Financial Services, Incorporated, a high technology consulting company which he joined in February 1987. Prior to that, he was a Senior Vice President of Keane, Inc., a software application consulting firm. He is also a director of Keane, Inc. and Cross Comm, Inc., a manufacturer of computer network products.\n16.\nW. Paul Fitzgerald has been a Director of the Company since March 1991. Since January 1988, he has been Senior Vice President, Finance and Administration and Chief Financial Officer of EMC. In October 1991, Mr. Fitzgerald was elected Treasurer of the Company. From January 1985 to January 1988, he was Vice President, Finance of EMC.\nJohn R. Egan became Executive Vice President, Sales and Marketing of EMC in January 1992 and was elected a Director in May 1992. Previously he held several executive positions with the Company, including Executive Vice President, International Sales and Executive Vice President, Marketing.\nFrank M. Keaney was Vice President, North American Sales of EMC from June 1989 to October 1989, when he became Senior Vice President, North American Sales. Prior to June 1989, he was Vice President, Sales of Data General Corporation, a computer manufacturer.\nRichard B. Plummer joined EMC in March 1990 as Senior Vice President of Engineering and became Senior Vice President and General Manager, Client\/Server Systems Division in June 1993. Previously, he held a number of executive positions with Apollo Computer Inc., a computer manufacturer, and its successor, the Apollo Systems Division of Hewlett-Packard Company.\nHarold P. Ano joined EMC in April 1990 as Senior Vice President of Marketing. Previously, he held several executive positions with Wang Laboratories, Inc., a computer manufacturer, most recently as Senior Vice President and General Manager of the Wang Microsystems Division.\nL. Daniel Butler joined EMC in August 1990 as Vice President of Customer Service and became Senior Vice President of Customer Service in February 1993. Prior to joining EMC, Mr. Butler was the founder and President of DMX, Inc., an electronic board assembling company, from October 1989 to August 1990. From October 1987 to September 1989, he was Director of Logistics Planning at Data General Corporation, a computer manufacturer.\nMichael L. Schoonover joined EMC in April 1991 as Vice President of Manufacturing Operations and in February 1993 he became Senior Vice President of Operations at EMC. From September 1988 through March 1991, Mr. Schoonover was Vice President of Operations at Westerbeke Corporation, a manufacturer of marine power products.\nPaul T. Dacier joined EMC in March 1990 as General Counsel and became Vice President and General Counsel in February 1993. Prior to joining EMC he was Senior Counsel, Corporate Operations at Apollo Computer Inc., a computer manufacturer, from January 1987 to January 1990.\n17.\nMichael R. Grilli has been Vice President-Sales, Europe, Middle East and Africa since October 1993. From January 1993 to September 1993, he was Vice President, Europe and from October 1989 to December 1992, he was Southern Area Manager for EMC. From 1982 to September 1989, Mr. Grilli was a Regional Manager for Hitachi Data Systems Inc., a computer manufacturer.\nPaul E. Noble, Jr. has been Vice President and General Manager of OEM Operations at the Company from June 1992 to present. From June 1989 through May 1992 he was a Vice President of Sales and from March 1987 to May 1989, he was Vice President of Customer Service at EMC.\nColin G. Patteson joined EMC in January 1989 as European Controller. In March 1991 he became Corporate Controller and in February 1993 he became Vice President and Controller.\nMichael G. Salter joined EMC in October 1991 as Vice President, International Operations. In July 1992 he became Vice President of International Distribution and in January 1994 he became Vice President and General Manager, Asia Pacific and President, EMC Japan K.K. Prior to joining EMC, Mr. Salter was President of Technical Financial Services, Incorporated, a high technology consulting company, from 1982 to September 1991. ____________\nRichard J. Egan, Chairman of the Board and a Director, is the husband of Maureen E. Egan, a Director of the Company. He also is the brother-in-law of W. Paul Fitzgerald, the Company's Senior Vice President, Finance and Administration, Chief Financial Officer, Treasurer and Director. W. Paul Fitzgerald is the brother of Maureen E. Egan. John R. Egan, Executive Vice President, Sales and Marketing and a Director of the Company is the son of Richard J. and Maureen E. Egan. ____________\nThe President and Treasurer are elected annually to serve until the first meeting of the Board of Directors following the next annual meeting of stockholders and until their successors are elected and qualified. The other executive officers are appointed to serve in such positions and serve at the pleasure of the Board of Directors.\n************************************************************** EMC, Symmetrix, Harmonix, ICDA, Champion and MOSAIC: 2000 are trademarks of EMC Corporation. IBM and AS\/400 are registered trademarks of IBM Corporation.\n18.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nEMC's common stock $.01 par value (the \"Common Stock\") began trading on the over-the-counter market on April 4, 1986 under the NASDAQ symbol EMCS. On March 22, 1988, the Company's stock began trading on the New York Stock Exchange under the symbol EMC.\nThe following stock splits were effected in the form of stock dividends in the following amounts and at the following dates: three-for-two stock split effective November 24, 1992, for stockholders of record on November 9, 1992, a two-for-one stock split effective June 8, 1993, for stockholders of record on May 24, 1993, and a two-for-one stock split effective December 10, 1993, for stockholders of record on November 26, 1993.\nThe following table sets forth the range of high and low prices on the New York Stock Exchange for the past two years during the fiscal periods shown, adjusted to reflect the effect of stock splits.\nFiscal 1993 High Low\nFirst Quarter $ 7.19 $ 5.13 Second Quarter 11.31 5.81 Third Quarter 19.00 10.13 Fourth Quarter 19.50 14.75\nFiscal 1992 High Low\nFirst Quarter $ 2.81 $ 1.94 Second Quarter 3.10 1.81 Third Quarter 3.50 2.53 Fourth Quarter 6.06 3.00\nThe Company has never paid cash dividends on its Common Stock. While subject to periodic review, the current policy of its Board of Directors is to retain all earnings to provide funds for the continued growth of the Company.\n19.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\n20.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following table represents certain statement of operations information stated as a percentage of revenues.\nFiscal year ended January 1, January 2, December 28, 1994 1993 1991\nRevenues: Net sales 96.8% 94.7% 94.5% Service and rental income 3.2 5.3 5.5 100.0 100.0 100.0\nCost and expenses: Cost of sales and service 48.7 53.7 54.1 Research and development 7.5 8.7 8.6 Selling, general and administrative 20.8 25.0 29.5\nOperating income 23.0 12.6 7.8\nInvestment income and interest (expense), net --- (0.3) 0.3 Other (expense), income, net --- (1.1) (1.0)\nIncome before income taxes 23.0 11.2 7.1\nProvision for income taxes 6.8 3.5 2.7\nNet income 16.2% 7.7% 4.4%\nRevenues\nRevenues increased by $396,915,000, or 103% in 1993 from 1992 compared to an increase of $125,369,000, or 48%, in 1992 from 1991. Revenues from net sales increased by $392,495,000, or 107%, in 1993 from 1992 levels, while revenues from service and rental income increased by $4,420,000, or 22%, in 1993 from 1992.\nIn 1993, the Company continued to experience a significant increase in the percentage of its revenues derived from the sale of disk systems compared to the percentage derived from the sale of its other products. This increase was due primarily to the market acceptance and unit sales growth from products featuring the Company's Integrated Cached Disk Array (\"ICDA\") technology, which includes the Symmetrix and Harmonix series of products. Revenues from the Symmetrix series in the IBM, Bull and Unisys mainframe markets increased to $620,178,000 in 1993 from $235,720,000 in 1992, an increase of $384,458,000 or 163%. Introduced in March 1992, the Harmonix series generated revenues of $92,672,000 in 1993 and $49,147,000 in 1992. In 1993, the Company generated\n21.\nITEM 7 continued...\napproximately 91% of its revenue from sales of ICDA-based products, versus approximately 74% in 1992. It is expected that revenues from ICDA-based products will continue to be a significant component of the Company's revenues in 1994.\nRevenues from memory products, including Solid State Disk (\"SSD\") devices, declined significantly in 1993. Competitive pricing pressures and reduced unit sales of midrange memory products contributed to the decline.\nSales to customers in the North and South American market increased by $257,798,000, or 99%, in 1993 due primarily to increased unit sales of the Symmetrix series in both the IBM and Unisys mainframe storage markets. Revenues on shipments from the North and South American segment were $526,771,000 and $263,465,000 in 1993 and 1992, respectively.\nRevenues from midrange products increased by $17,853,000 in 1993 over 1992. A decline in the sales of IBM AS\/400 compatible memory products was offset by increased revenues from the sales of Harmonix and other midrange tape and storage products. Unit sales of the Harmonix series accounted for 85% of the revenues from midrange disk storage systems into the North and South American markets.\nSales to customers in the markets in Europe, the Middle East and Africa increased by $118,272,000, or 110%, in 1993 due primarily to a growth in unit sales of the Symmetrix series in the IBM and Bull mainframe storage markets. Revenues on shipments from this segment were $251,363,000 and $111,117,000 in 1993 and 1992, respectively.\nSales to customers in the markets in the Asia Pacific region increased by $20,844,000, or 125%, during 1993, due primarily to the growth in unit sales of the Symmetrix product line. Revenues from midrange products in this market segment remained relatively constant during 1993 with increased Harmonix sales offsetting decreased unit sales of other midrange disk storage systems and decreased sales of IBM AS\/400 compatible memory products. Revenues on shipments from this segment were $4,487,000 and $11,124,000 in 1993 and 1992, respectively.\nOn January 15, 1992, EMC entered into a two-year OEM agreement for the sale of the Company's mainframe products as Unisys compatible products to Unisys. Revenues from product sales under this agreement aggregated $39,529,000 in 1993 and $43,486,000 in 1992. In September 1993, the Company and Unisys extended the term of the original agreement for up to an additional three years, through December 31, 1996.\nIn February 1993, the Company entered into a three-year OEM agreement with Bull. Pursuant to this agreement, EMC grants Bull the exclusive worldwide marketing rights, with the exception of Japan, to EMC's Symmetrix 4800 series of ICDA- based storage products for Bull mainframe computers, provided that Bull purchases all of its requirements for high speed cached disk array storage devices from EMC. Failure by Bull in the future to purchase at least 45% of forecasted purchases at\n22.\nITEM 7 continued...\ndesignated times, on a cumulative basis, may result in loss of exclusivity to Bull. Revenues from product sales under this agreement were $22,298,000 in 1993.\nHistorically, the Company has competed with OEM manufacturers and other independent suppliers on the basis of product performance, quality and price. The Company expects that there will be performance and pricing pressures with respect to the sale of its products throughout 1994.\nCost of Sales and Service\nAs a percentage of revenue, cost of sales amounted to 48.7% in 1993, 53.7% in 1992, and 54.1% in 1991. The improvement in the cost of sales percentage in 1993 versus 1992 and 1991 was due primarily to increased sales of the higher margin Symmetrix products through the Company's direct sales force, and, to a lesser extent, improved component reliability, establishment of key vendor alliances, aggressive production management and increased focus on Total Quality Management. These improvements were partially offset by lower product margins from the Company's OEM business, and pricing pressures in the midrange business, especially sales through distribution channels. Continuing margin pressure in Mainframe and Midrange markets may require the Company to adapt and re-assess its cost structure and marketing strategy.\nResearch and Development\nResearch and development (\"R&D\") expenses were $58,977,000, $33,591,000, and $22,496,000 in 1993, 1992, and 1991, respectively. As a percentage of revenue, such expenses were 7.5%, 8.7% and 8.6% in 1993, 1992, and 1991, respectively. The Company is committed to utilizing state-of-the-art CAE\/CAD design tools to sustain its design and development efforts. Increases in spending reflect the cost of such tools and the cost of additional technical staff. The Company expects to continue to spend substantial amounts for R&D in 1994.\nSelling, General and Administrative\nSelling, general and administrative (\"SG&A\") expenses increased by $66,200,000, or 69% in 1993, $19,567,000, or 26%, in 1992 and $19,328,000, or 34%, in 1991. As a percentage of revenues, SG&A expenses were 20.8%, 25.0% and 29.5% in 1993, 1992 and 1991, respectively.\nThe increases in all three years were due primarily to costs associated with additional sales and support personnel, and related overhead costs, both domestically and internationally, required to support the increased revenue levels and the expansion of the Company's OEM and international distribution programs. Advertising and sales promotion costs were approximately $9,555,000 in 1993, $4,964,000 in 1992 and $3,857,000 in 1991. SG&A expenses are expected to increase in dollar terms in 1994, in line with expected growth in revenues.\n23.\nITEM 7 continued...\nInvestment Income and Interest Expense\nInvestment income increased to $7,988,000 in 1993 from $3,830,000 in 1992 and $2,718,000 in 1991. Income was earned from investments in cash equivalents and long- term investments and from sales-type leases of the Company's products. Investment income in 1993 increased due to higher average cash balances caused primarily by the proceeds from the offering of EMC common stock, $.01 par value (the \"Common Stock\") in March 1993, the proceeds from the sale of the Convertible Subordinated Notes (the \"Notes\") in December 1993, and a full year's availability of funds from the issuance of the Convertible Subordinated Debentures due 2002 (the \"Debentures\") in March 1992. Investment income increased in 1992 due to higher average cash balances during the year resulting primarily from the proceeds received from the issuance of the Debentures. Lower interest rates throughout 1993 and 1992 partially offset the higher cash balances.\nInterest expense increased to $6,043,000 in 1993 from $4,865,000 in 1992 and $2,011,000 in 1991. The increase of $1,178,000 in 1993 from 1992 levels was due primarily to the provision for interest payments due on the Debentures and to interest accrued in December for the Notes.\nOther Expense, Net\nNet other expense amounted to $2,717,000, $4,465,000 and $2,578,000 in 1993, 1992 and 1991, respectively. Other expense for 1993 related primarily to foreign currency transaction losses of $1,838,000, losses on sales of fixed assets and customer service equipment of $2,324,000, amortization of technology license costs of $417,000 and $428,000 of other expense, net of $2,290,000 of other income, primarily from technology license fees. Other expense for 1992 related primarily to a net loss from the disposal of customer service equipment and other fixed assets of $2,324,000, the amortization of technology license costs of $1,667,000, a provision for litigation settlement of $1,057,000, and foreign currency transaction costs of $1,093,000, net of other income of $1,676,000 consisting primarily of technology license fees. Other expense in 1991 consisted primarily of currency transaction costs of $1,542,000 and amortization of technology license costs of $1,566,000, net of other income of $530,000.\nProvision for Taxes\nThe provision for income taxes was $52,534,000 in 1993, $13,567,000 in 1992 and $7,098,000 in 1991, which resulted in effective tax rates of 29%, 32% and 38% in 1993, 1992 and 1991, respectively. The decrease in the effective tax rate in 1993 from 1992 is mainly attributable to an increase of tax benefits from the Company's Irish operations. The decrease in the effective tax rate in 1992 from 1991 is mainly attributable to the utilization of foreign net operating loss carryforwards.\n24.\nITEM 7 continued...\nSee Note B of the Notes to Consolidated Financial Statements for detailed analysis of the Company's effective tax rates for 1993, 1992 and 1991. Also see Note A for a discussion of the impact of the adoption of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes.\nFinancial Position\nAt the end of the fiscal years 1993, 1992 and 1991, cash and cash equivalents totalled $345,300,000, $62,103,000 and $22,406,000, respectively. The $283,197,000 increase in 1993 over 1992 is primarily attributable to $100,141,000 net proceeds received in the March 1993 sale of 17,350,000 shares of Common Stock, and $195,000,000 net proceeds received in the December 1993 offering of $200,000,000 of the Notes. Additionally, the Company invested $29,100,000 in long term investments. The $39,697,000 increase in 1992 over 1991 is primarily attributable to the net proceeds received from the Debentures issued in March 1992, which were used to support the introduction of new products based on ICDA technology, including the Symmetrix Model 5500 and the Harmonix product lines, to fund a $30,021,000 increase in property, plant and equipment and an increase in long-term investments of $12,594,000, and to support accounts receivable and inventory growth related to the expansion of revenues. In 1993, working capital increased by $367,541,000 from $149,335,000 to $516,876,000. In 1992, working capital increased by $72,302,000 from $77,033,000 to $149,335,000.\nThe Company maintains substantial inventory levels which are required for extensive test cycles and customer evaluations of high cost products. Inventory increased by $61,095,000 or 107% from 1992 to 1993, supporting revenue growth of 103%. Inventory levels increased by $27,152,000, or 91%, from 1991 to 1992 supporting a 48% growth in revenues.\nNet trade and notes receivable increased by $60,304,000, or 62%, from 1992 to 1993 associated with a revenue increase of 103% during the same period.\nAs of February 1, 1994, the Company had available for use its entire $15,000,000 credit line. Based on its current operating and capital expenditure forecasts, the Company believes funds generated from operations, its available line of credit, and the net proceeds to the Company from the Common Stock Offering, the Debentures and the Notes will be adequate to finance its operations.\nTo date, inflation has not had a material impact on the Company's financial results.\n25.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and the Board of Directors of EMC Corporation:\nWe have audited the accompanying consolidated balance sheets of EMC Corporation as of January 1, 1994 and January 2, 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended January 1, 1994. 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 EMC Corporation as of January 1, 1994 and January 2, 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 1, 1994 in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND\nBoston, Massachusetts February 1, 1994\n26.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nEMC CORPORATION CONSOLIDATED BALANCE SHEETS (amounts in thousands except share amounts)\nJanuary 1, January 2, 1994 1993 ASSETS Current assets: Cash and cash equivalents $ 345,300 $ 62,103 Trade and notes receivable less allowance for doubtful accounts of $5,262 and $2,915 in 1993 and 1992, respectively 157,225 96,921 Inventories 118,263 57,168 Deferred income taxes 24,199 10,588 Other assets 5,023 6,372 Total current assets 650,010 233,152\nLong-term investments, at cost 50,392 21,292 Notes receivable, net 21,808 8,538 Property, plant and equipment, net 96,480 69,039 Deferred income taxes 2,761 --- Other assets, net 8,195 6,759\nTotal assets $829,646 $338,780\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Current portion of long-term obligations $ 1,262 $ 2,379 Accounts payable 44,179 27,648 Accrued expenses 59,755 30,676 Income taxes payable 20,892 17,372 Deferred Revenue 7,046 5,742 Total current liabilities 133,134 83,817\nDeferred revenue 3,389 5,804 Deferred income taxes --- 4,800 Long-term obligations: 4 1\/4% Convertible Subordinated Notes due 2001 200,000 --- 6 1\/4% Convertible Subordinated Debentures due 2002 59,260 60,000 Notes payable 14,013 14,449 Capital lease obligations 756 1,644 Total liabilities 410,552 170,514\nCommitments and contingencies (Notes H and J) Stockholders' equity: Series Preferred Stock, par value $.01; authorized 25,000,000 shares --- --- Common stock, par value $.01; authorized 330,000,000 shares; issued 189,936,120 and 166,505,268 shares in 1993 and 1992, respectively 1,899 1,665 Additional paid-in capital 226,668 105,873 Deferred compensation (3,552) (4,545) Retained earnings 193,045 65,923 Cumulative translation adjustment 1,537 (147) Treasury stock,at cost, 2,607,996 shares (503) (503) Total stockholders' equity 419,094 168,266\nTotal liabilities and stockholders' equity $829,646 $338,780\nThe accompanying notes are an integral part of the consolidated financial statements. 27.\nITEM 8 continued... EMC CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (amounts in thousands except per share amounts)\nFor the years ended January 1, January 2, December 28, 1994 1993 1991\nRevenues: Net sales $757,793 $365,298 $245,893 Service and rental income 24,828 20,408 14,444\n782,621 385,706 260,337 Costs and expenses: Cost of sales and service 380,755 207,279 140,769 Research and development 58,977 33,591 22,496 Selling, general and administrative 162,461 96,261 76,694\n602,193 337,131 239,959\nOperating income 180,428 48,575 20,378 Investment income 7,988 3,830 2,718 Interest expense (6,043) (4,865) (2,011) Other expense, net (2,717) (4,465) (2,578)\nIncome before income taxes 179,656 43,075 18,507 Provision for income taxes 52,534 13,567 7,098\nNet income $127,122 $ 29,508 $ 11,409\nNet income per weighted average common share (primary) $0.65 $0.17 $0.07\nNet income per weighted average common share (fully diluted) $0.60 $0.16 $0.07\nThe accompanying notes are an integral part of the consolidated financial statements. 28.\nITEM 8 continued... CONSOLIDATED STATEMENTS OF CASH FLOWS EMC Corporation (amounts in thousands) For the years ended January 1, January 2, December 28, 1994 1993 1991 Cash flows from operating activities: Net income $127,122 $29,508 $11,409 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation and amortization 21,741 18,289 10,136 Deferred income taxes (21,172) (10,492) (290) (Gain) loss on disposal of property and equipment 2,324 2,232 (47) Changes in assets and liabilities: Trade and notes receivable (73,252) (29,686) (28,699) Inventories (60,937) (26,312) (3,645) Other assets 4,381 (2,997) (7,076) Accounts payable 16,500 13,709 1,930 Accrued expenses 28,893 11,588 7,057 Income taxes payable 3,520 10,356 2,721 Deferred revenue (1,100) 8,936 749\nTotal adjustments (79,102) (4,377) (17,164) Net cash provided (used) by operating activities 48,020 25,131 (5,755)\nCash flows from investing activities: Additions to property and equipment (51,303) (30,021) (20,961) Proceeds from sale of property and equipment 574 1,280 2,578 Purchase of long-term investments (29,100) (12,594) (3,683)\nNet cash used by investing activities (79,829) (41,335) (22,066)\nCash flows from financing activities: Sale of common stock, net of issuance costs 112,451 4,765 10,943 Disqualifying dispositions of stock options exercised 8,776 - 289 Purchase of treasury stock - - (17) Issuance of 6 1\/4% Convertible Subordinated Debentures due 2002, net of issuance costs - 58,208 - Issuance of 4 1\/4% Convertible Subordinated Notes due 2001, net of issuance costs 194,987 - - Payment of long-term and short-term obligations (2,430) (6,397) (2,687) Issuance of long-term and short-term obligations - 2,004 7,511 Net cash provided by financing activities 313,784 58,580 16,039\nEffect of exchange rate changes on cash 1,222 (2,679) (71) Net increase (decrease) in cash and cash equivalents 281,975 42,376 (11,782) Cash and cash equivalents at beginning of year 62,103 22,406 34,259 Cash and cash equivalents at end of year 345,300 $62,103 $22,406\nThe accompanying notes are an integral part of the consolidated financial statements. \t 29.\nITEM 8 continued...\nThe accompanying notes are an integral part of the consolidated financial statements. 30.\nITEM 8 continued...\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS EMC Corporation\nA. Summary of Significant Accounting Policies\nBasis of Presentation\nCertain prior year amounts in the financial statements have been reclassified to conform with the 1992 presentation. The Company's fiscal year ends on the Saturday closest to December 31. Fiscal 1992 was a 53 week year and fiscal 1993 and 1991 were 52 week years.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany transactions and balances have been eliminated.\nIn August 1993, EMC exchanged 9,443,996 shares of EMC common stock, $.01 par value (the \"Common Stock\") for all of the outstanding stock and stock options of Epoch Systems, Inc. (\"Epoch\") and Magna Computer Corp. (\"Magna\"). These business combinations were accounted for as poolings of interests. Accordingly, all financial information has been restated as if the transactions occurred at the beginning of the first period presented. Epoch designs, manufactures, markets and supports high performance client\/server data management software. Magna manufactures and markets IBM compatible AS\/400 tape products. Magna and Epoch are now wholly owned subsidiaries of EMC.\nThe separate company results for 1993 before the combinations were consummated were:\nEight Months Ended 8\/30\/93 Revenues Net Income\/(loss)\nEMC $410,369,000 $61,993,000 Epoch 16,429,000 (447,000) Magna 4,994,000 (472,000) Total $431,792,000 $61,074,000\n31.\nITEM 8 continued...\nRevenue Recognition\nThe Company generally recognizes revenue from sales when products are shipped. Revenue from rentals is recorded over the life of the lease. Revenue from sales-type leases is recognized at the net present value of expected future payments, and the resulting discount is accreted to investment income over the collection period. Revenue from service contracts is recognized over the life of the contracts.\nForeign Currency Translation\nThe functional currency of operations in Europe is the local currency. The assets and liabilities of these operations are translated into U.S. dollars at the exchange rates in effect at the balance sheet date and income and expense items are translated at average rates for the period. The Company's other foreign operations are generally dependent on the U.S. dollar. The assets and liabilities of these operations are translated into U.S. dollars at exchange rates in effect at the balance sheet date except for inventories and property and equipment which are translated at historical exchange rates. Income and expense items are translated at average rates for the period except for cost of sales and depreciation which are translated at historical exchange rates.\nConsolidated transaction losses included in other expense, net amounted to $1,838,000 in 1993, $1,093,000 in 1992, and $1,542,000 in 1991. Accumulated net translation adjustments of $1,537,000 and $(147,000) are included in stockholders' equity at January 1, 1994 and January 2, 1993, respectively.\n32.\nITEM 8 continued...\nCash and Cash Equivalents and Long-Term Investments\nCash and cash equivalents include $310,723,000 and $31,482,000 of temporary cash investments at January 1, 1994 and January 2, 1993, respectively. Temporary cash investments consist primarily of money market funds and repurchase agreements stated at cost plus accrued interest which approximates market. Short term investments which have a maturity of ninety days or less are considered cash equivalents.\nLong-term investments at cost, consisting of intermediate debt instruments, amounted to $50,392,000 in 1993 and $21,292,000 in 1992 with fair market values of $50,042,000 and $21,373,000, respectively. The Company intends to hold these investments to maturity.\nInvestment income consists principally of interest and dividend income, including interest on notes receivable from sales-type leases.\nStatement of Cash Flows Supplemental Information\nJanuary 1, January 2, December 28, 1994 1993 1991 Cash paid during the years ended For: Income taxes $59,739,000 $13,474,000 $4,025,000 Interest 6,486,000 3,797,000 3,076,000\nDuring the year ended January 1, 1994, the Company issued 241,612 shares of Common Stock upon the conversion of $740,000 of Debentures.\nIn 1991 the Company purchased from an unrelated corporation a license for $3,000,000 cash, and 563,000 shares of Common Stock valued at approximately $3,841,000. Amortization of the license cost of approximately $6,841,000 was completed in 1993.\nInventories\nInventories are stated at the lower of cost (first in, first out) or market. 33.\nITEM 8 continued...\nProperty, Plant and Equipment\nProperty, plant and equipment are recorded at cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, as follows:\nFurniture and fixtures 7 years Equipment 3-7 years Vehicles 5 years Improvements 5 years Buildings 25-31 1\/2 years\nCustomer service spare parts inventory is included in equipment and depreciated over three years for assets placed in service in 1992, and four years for assets placed in service prior to 1992.\nWhen assets are retired or disposed of, the cost and accumulated depreciation thereon are removed from the accounts and the related gains or losses are included in operations.\nWarranty and Research and Development\nThe Company accounts for warranty expense on an accrual basis. Research and development costs are expensed as incurred.\nIncome Taxes\nIn 1992, the Company adopted Statement of Financial Accounting Standards No. 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 B).\nPrior to 1992, 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 then applicable statutes and regulations were classified as deferred taxes arising from timing differences. 34.\nITEM 8 continued. . . .\nTax credits are generally recognized as reductions of income tax provisions in the year in which the credits arise. Since 1989, the Company has not provided for the U.S. income tax liability on earnings of its foreign subsidiaries as these earnings are considered to be permanently reinvested. At January 1, 1994, undistributed earnings of foreign subsidiaries approximated $71,606,000. Taxes for the Company's foreign subsidiaries are provided for at applicable statutory rates. The Company is currently undergoing an examination of its 1990 and 1991 tax returns by the Internal Revenue Service.\nNet Income Per Share\nNet income per share was computed on the basis of weighted average common and dilutive common equivalent shares outstanding. Primary and fully diluted weighted average shares outstanding and earnings for 1993 reflect the dilutive effects of the Notes. Fully diluted weighted average shares outstanding and earnings for 1993 and 1992 reflect the dilutive effects of the Debentures. Net income for computation of fully diluted earnings per share includes an add back of $2,496,000 and $1,768,000 in 1993 and 1992, respectively, representing interest expense, net of its tax effect. Primary weighted average shares for net income per share computations amounted to 196,486,160, 171,951,696 and 164,414,816 in 1993, 1992 and 1991, respectively. Fully diluted weighted average shares were 217,224,726, 190,547,980 and 166,220,132 in 1993, 1992 and 1991, respectively. These calculations of weighted average shares have been restated to reflect all stock splits to date (see Note I).\nB. Income Taxes\nProvision for income taxes consists of: 1993 1992 1991 Federal and State Current $69,176,000 $16,791,000 $7,176,000 Deferred (21,830,000) (5,863,000) (407,000) 47,346,000 10,928,000 6,769,000 Foreign Current 4,530,000 3,155,000 212,000 Deferred 658,000 (516,000) 117,000 5,188,000 2,639,000 329,000 Total provision for Income taxes $52,534,000 $13,567,000 $7,098,000\n35.\nITEM 8 continued...\nIncome (loss) before income taxes for foreign operations amounted to approximately $49,392,000 in 1993, $12,353,000 in 1992 and ($5,909,000) in 1991. The components of the deferred tax provision are:\n1993 1992 1991\nUnrepatriated earnings $ (5,772,000) $ 926,000 $ 697,000 Sales-type leases (434,000) (129,000) (1,192,000) Intercompany profit elimination 2,457,000 (1,831,000) 225,000 Accounts receivable related items (7,972,000) (389,000) (142,000) Inventory related items (5,973,000) (1,369,000) 93,000 Depreciation (377,000) (931,000) (162,000) Deferred revenue (374,000) (2,317,000) --- Warranty reserve (1,378,000) (262,000) (191,000) Health Insurance reserve (868,000) (145,000) --- Other (481,000) 68,000 382,000 $(21,172,000) $(6,379,000) $ (290,000)\nA reconciliation of the Company's income tax provision to the statutory federal tax rate is as follows:\n1993 1992 1991\nStatutory federal tax rate 35.0% 34.0% 34.0% State taxes, net of federal tax benefits 3.1 3.9 3.8 Puerto Rico tax benefits (.9) (2.2) (6.3) Ireland tax benefits (6.4) (.6) (3.4) Net operating losses not benefited .6 2.0 14.5 Tax credits (1.3) (.6) (3.2) Utilization of foreign net operating loss carryforwards (.7) (5.4) --- Other (.2) .4 (1.0) 29.2% 31.5% 38.4%\nThe Company's Puerto Rico operation enjoys a ten year exemption, expiring in 1995, on up to 90% of EMC Caribe's income as determined under Federal tax laws. EMC Caribe ceased manufacturing operations in February, 1994. The Company's manufacturing facility in Ireland enjoys a 10% tax rate on income from manufacturing operations until the year 2000. The impact of these benefits on the Company's earnings per share was $0.06 for the year ended January 1, 1994, $.01 for the year ended January 2, 1993 and $0.01 for the year ended December 28, 1991.\n36.\nITEM 8 continued...\nThe Company's adoption of FAS 109 in 1992 did not have a material effect on earnings. The Company increased its domestic deferred tax asset in 1993 as a result of U.S. legislation enacted during 1993 increasing the federal corporate tax rate from 34% to 35%. The components of the current and non-current deferred tax assets and liabilities as of January 1, 1994 and January 2, 1993 were as follows:\nCurrent Deferred Tax Assets 1993 1992\nSales Reserve $ 9,644,000 $ 2,259,000 Warranty Reserve 2,527,000 1,149,000 Inventory Reserve 8,625,000 1,909,000 Deferred Intercompany Profit 671,000 3,128,000 Other Reserves 2,805,000 1,200,000 Other Assets 1,722,000 943,000 Puerto Rico Tollgate Tax (854,000) --- Domestic NOL Carryforward 4,928,000 --- Foreign NOL Carryforward 4,355,000 8,227,000 Research and Development Credit Carryforward 1,151,000 --- Valuation Reserve (11,375,000) (8,227,000) Total Current Deferred Tax Assets $24,199,000 $10,588,000\nNon-Current Deferred Tax Assets\/(Liabilities)\nDeferred Revenue 1,787,000 2,317,000 Other Reserves 524,000 150,000 Other Liabilities 450,000 (241,000) Puerto Rico Tollgate Tax --- (6,626,000) Property Plant & Equipment --- (400,000) Total Non-Current Deferred Tax Assets\/(Liabilities) $2,761,000 $(4,800,000)\n37.\nITEM 8 continued...\nThe Company's valuation reserve has increased as a result of the inclusion of the current deferred tax assets of Epoch and Magna which were acquired during 1993.\nThe Company has net operating loss carryforwards as of January 1, 1994 which are summarized as follows:\nCarryforward period\/ Approximate value Years during which losses Country in U.S. dollars will expire\nBelgium $ 1,018,000 Indefinite France 1,012,000 5 years\/1996 Italy 2,775,000 5 years\/1995 - 1997 United Kingdom 6,122,000 Indefinite United States 12,438,000 15 Years\/2001- 2008\nThe U.S. losses relate to pre-acquisition losses of Epoch and Magna.\n38.\nITEM 8 continued...\nC. Inventories\nInventories consist of: January 1, January 2, 1994 1993\nPurchased parts $17,319,000 $ 7,711,000 Work-in-process 46,348,000 22,726,000 Finished goods 54,596,000 26,731,000 $118,263,000 $57,168,000\nD. Notes Receivable\nNotes receivable primarily from sales-type leases of equipment, are stated net of discounts amounting to approximately $4,753,000 and $2,484,000 and net of allowance for doubtful accounts of $491,000 and $249,000 at January 1, 1994 and January 2, 1993, respectively. Implicit interest rates range from 8% to 15%.\nThe payment schedule for such notes at January 1, 1994 is as follows:\nFiscal year Notes Receivable\n1994 $15,278,000 1995 10,625,000 1996 8,715,000 1997 3,681,000 1998 1,388,000 Thereafter --- Face value 39,687,000 Less amounts representing interest 4,753,000 Present value 34,934,000 Less allowance for doubtful accounts 491,000 34,443,000 Less current portion 12,635,000 Long-term portion $21,808,000\n39.\nITEM 8 continued...\nE. Property, Plant and Equipment Property, plant and equipment consist of: January 1, January 2, 1994 1993\nFurniture and fixtures $ 4,278,000 $ 4,910,000 Equipment 102,670,000 70,909,000 Vehicles 923,000 1,661,000 Buildings and improvements 29,864,000 27,567,000 Land 1,870,000 1,870,000 Construction in progress 4,891,000 761,000 144,496,000 107,678,000 Accumulated depreciation and amortization (48,016,000) (38,639,000) $96,480,000 $69,039,000\nF. Accrued Expenses Accrued expenses consist of: January 1, January 2, 1994 1993\nSalaries and benefits $23,350,000 $11,555,000 Warranty 16,112,000 3,693,000 Other 20,293,000 15,428,000 $59,755,000 $30,676,000\nG. Employee Compensation Plans\nIn 1983, the Company initiated a profit-sharing plan (the \"1983 Plan\") for employees, whose eligibility to participate is based on certain service requirements. Contributions are made at the discretion of the Board of Directors.\n40.\nITEM 8 continued...\nNo profit-sharing contributions were made in 1993 or 1991. During December 1992 the Company made a profit- sharing contribution to active employees who were employed by the Company on or before January 1, 1992, whose compensation was less than $60,000 for 1992 and who did not participate in any bonus or incentive program. The amount of the contribution was $248,000.\nIn July 1985, the Company supplemented the 1983 Plan with a deferred compensation program for certain employees. Under the program, which is qualified under Section 401(k) of federal tax laws, the Company has provided a matching contribution, as described below.\nEffective January 1, 1993, the Company introduced a new matching formula for the 1983 Plan. The Company intends, at the end of each calendar quarter, to make a contribution that matches 100% of the employee's contribution up to a maximum of 2% of the employee's quarterly compensation. Additionally, provided that certain quarterly profit goals are attained, the Company in succeeding quarters, will provide an additional matching contribution of 1% of the employee's quarterly compensation up to a maximum quarterly matching contribution not to exceed 5% of compensation. However, the Company's matching contribution per participant has a quarterly limit of $500. The Company's contribution amounted to approximately $1,463,000 in 1993.\nDuring 1992 and 1991, the Company made a contribution at the end of each calendar quarter that matched 100% of the employee's contribution up to a maximum of 2% of the employee's quarterly compensation. Additionally, provided that certain quarterly profit goals were attained, the Company, in succeeding quarters, provided an additional matching contribution of 1\/2% of the employee's quarterly compensation up to a maximum quarterly matching contribution not to exceed 3 1\/2% of compensation. The Company's matching contribution per participant had a quarterly limit of $500. The Company's contribution amounted to approximately $889,000 in 1992 and $600,000 in 1991.\nIn 1988, Epoch and in 1991, Magna, which are both wholly- owned subsidiaries of the Company, instituted Retirement Savings Plans under Section 401(k) of the Internal Revenue Code. Eligible employees may elect to contribute to their respective plans a percentage of their compensation up to the maximum amount allowable by the Internal Revenue Code.\nThe Company does not offer a postretirement or postemployment benefit plan.\n41.\nITEM 8 continued...\nH. Lease Commitments and Long-Term Obligations\nLease Commitments\nThe Company had $4,153,000 and $4,629,000 of equipment leased under capital leases with accumulated amortization of $1,975,000 and $1,428,000 at January 1, 1994 and January 2, 1993, respectively.\nThe Company leases office and warehouse facilities under various operating leases. Facilities rent expense amounted to $6,050,000, $4,404,000, $3,852,000 in 1993, 1992 and 1991, respectively. The Company's commitments under its capital and operating leases are as follows:\nCapital Operating Fiscal Year Leases Leases\n1994 $1,043,000 $7,409,000 1995 628,000 5,546,000 1996 92,000 3,603,000 1997 30,000 1,717,000 1998 --- 916,000 Thereafter --- 921,000 Total minimum lease payments 1,793,000 $20,112,000 Less amounts representing interest 126,000 Present value of net minimum lease payments 1,667,000 Less current portion 911,000 Long-term portion $ 756,000\nLong-Term Obligations\nConvertible Subordinated Notes\nIn December 1993, the Company issued $200,000,000 of 4 1\/4% convertible subordinated notes due 2001 (the \"Notes\"). The Notes are generally convertible into shares of Common Stock of the Company at a conversion price of $19.84 per share, subject to adjustment in certain events. Interest is payable semiannually and the Notes are redeemable at the option of the Company at set redemption prices, plus accrued interest, commencing January 1, 1997. Redemption prices range from 100.61% to 102.43% of principal. In January 1994, the Company issued approximately an additional $30,000,000 in Notes in accordance with overallotment provisions of the offering.\n42.\nITEM 8 continued...\nConvertible Subordinated Debentures\nIn March 1992, the Company issued $60,000,000 of 6 1\/4% convertible subordinated debentures due 2002 (the \"Debentures\"), of which $740,000 has been converted as of January 1, 1994. The Debentures are generally convertible at any time prior to maturity into shares of common stock of the Company at a conversion price of $3.063 per share, subject to adjustment in certain events. Interest is payable semiannually and the Debentures are redeemable at the option of the Company at set redemption prices from April 1, 1995, which range from 100.63% to 104.38% of principal.\nIn 1989, the Company obtained a $14,000,000 long-term mortgage with an unrelated party at an interest rate of 10.5%. Borrowings under this mortgage are collateralized by the Company's facility at 171 South Street, Hopkinton, Massachusetts. The mortgage is payable in monthly installments, calculated on a 30 year amortization schedule, with a lump sum payment of approximately $12,835,000 due on April 1, 1999.\nPayments remaining on notes are as follows:\nFiscal Year Amount Payable\n1994 $1,537,000 1995 1,537,000 1996 1,537,000 1997 1,537,000 1998 1,537,000 Thereafter 13,296,000 Total minimum payments 20,981,000 Less amounts representing interest 7,188,000 Present value of net payments 13,793,000 Less current portion 320,000 Long-term portion $13,473,000\nThe Company has one line of credit, which provides a maximum of $15,000,000, at the bank's prime rate. At January 1, 1994 and January 2, 1993, there were no borrowings outstanding against the line. The Company must maintain certain minimum financial ratios including a minimum level of working capital and tangible net worth.\nAnother line provided a maximum of $1,000,000, payable on demand, and collateralized by Company assets, which was discontinued during 1993. At January 2, 1993, $645,000 was outstanding against this line with interest accruing at 8.5%.\n43.\nITEM 8 continued...\nIn January 1989, EMC purchased its premises in Ireland from the Industrial Development Authority (IDA). The purchase price of $1,180,000 was partially financed by an IDA grant of $531,000. EMC Ireland paid a deposit of $65,000 and signed a $584,000 note, payable over 5 years in semi-annual installments. This debt was fully paid at January 1, 1994. In addition to the $531,000 discussed above, the IDA granted the Company an additional $259,000 for improvements to the premises. The total grants of $790,000 are included in long-term obligations and are amortized over a period of 25 years. The total remaining unamortized grants at January 1, 1994 are $571,000, of which $31,000 is current and $540,000 is long-term.\nI. Common Stock, Preferred Stock and Stock Options\nCommon Stock\nAt the Stockholder meetings of the Company in 1993 and 1992, the stockholders approved amendments to the Company's Articles of Organization to increase the number of shares of authorized Common Stock, to 330,000,000 shares.\nThe following stock splits were effected in the form of stock dividends in the following amounts and at the following dates: a three-for-two stock split effective November 24, 1992, for stockholders of record on November 9, 1992, a two-for-one stock split effective June 8, 1993, for stockholders of record on May 24, 1993, and a two-for-one stock split effective December 10, 1993, for stockholders of record on November 26, 1993.\nAll share and per share data have been restated to reflect these splits.\nPreferred Stock\nAt the Special Meeting of Stockholders of the Company on November 17, 1993, the stockholders approved an amendment to the Company's Articles of Organization to authorize a new class of capital stock consisting of 25,000,000 shares of Series Preferred Stock, $.01 par value, which may be issued from time to time in one or more series, with such terms as the Board of Directors may determine, without further action by the stockholders of the Company, except as may be required by applicable law or stock exchange rules.\nStock Options\nThe Board of Directors and stockholders adopted the EMC Corporation 1993 Stock Option Plan (the \"1993 Plan\") to provide qualified incentive stock options and nonqualified stock options to key employees. A total of 6,000,000 shares of Common Stock have been reserved for issuance under this Plan.\n44.\nITEM 8 continued...\nUnder the terms of the 1993 Plan the exercise price of incentive stock options issued must be equal to at least the fair market value of the Common Stock at the date of grant. In the event that nonqualified stock options are granted, the exercise price may be less than the fair market value at the time of grant but not less than par value which is $.01 per share. In general, options become exercisable in equal annual installments over the first five years after the date of grant. As of January 1, 1994 there were no options exercisable. During 1993, 852,000 options were granted at an exercise price of $17.625, and no options were canceled or exercised under the 1993 Plan. Shares available for future options as of January 1, 1994 amounted to 5,148,000.\nThe Board of Directors and stockholders adopted the 1985 Stock Option Plan (the \"1985 Plan\") to provide qualified incentive stock options and nonqualified stock options to key employees. At the Annual Meeting of the Company on May 13, 1992, the stockholders approved an amendment to the 1985 Plan to increase the number of shares available for grant to 36,000,000 from 27,000,000.\nUnder the terms of the 1985 Plan the exercise price of incentive stock options issued must be equal to at least the fair market value of the Common Stock at the date of grant. In the event that nonqualified stock options are granted, the exercise price may be less than the fair market value at the time of grant but no less than par value which is $.01 per share. In general, options become exercisable in equal annual installments over the first five years after the date of grant. As of January 1, 1994 and January 2, 1993, options exercisable approximated 3,648,000 and 4,436,000, respectively. There were no shares available for future options as of January 1, 1994. Activity under the 1985 Plan for the three years ended January 1, 1994 is as follows:\n45.\nITEM 8 continued Number of Exercise Shares Price\nBalance at 12\/29\/90 13,905,312 $.06 - 2.17 Granted in 1991 5,748,752 .06 - 1.98 Canceled in 1991 (2,387,880) .58 - 1.98 Exercised in 1991 (2,033,672) .06 - 1.56 Balance at 12\/28\/91 15,232,512 .06 - 2.17 Granted in 1992 8,595,600 1.42 - 3.71 Canceled in 1992 (948,900) .58 - 3.71 Exercised in 1992 (2,838,072) .58 - 1.98 Balance at 1\/2\/93 20,041,140 .06 - 3.71 Granted in 1993 3,537,200 6.47-17.63 Canceled in 1993 (331,000) .58 -12.44 Exercised in 1993 (5,448,069) .06 - 3.71 Balance at 1\/1\/94 17,799,271 $.06 -17.63\nOn July 17, 1992, certain executive officers of the Company were granted non-qualified options to purchase an aggregate of 3,900,000 shares of common stock under the Company's 1985 Stock Option Plan at per share prices ranging from $1.43 to $2.43. These prices represent 50% to 85% of the per share fair market value at the date of grant. The discount from fair market value has been recorded as deferred compensation and is being charged to earnings over the five year vesting period of the options.\nGenerally, when shares acquired pursuant to the exercise of incentive stock options are sold within one year of exercise or within two years from the date of grant, the Company derives a tax deduction measured by the amount that the market value exceeds the option price at the date the options are exercised.\nOn January 31, 1989, the Board of Directors adopted the 1989 Employee Stock Purchase Plan (the \"1989 Plan\") which was approved and adopted by the shareholders of the Company on May 10, 1989. Under the 1989 Plan, eligible employees of the Company are given the option to purchase shares of common stock at 85% of fair market value by means of payroll deductions. At the Annual Meeting of the Company on May 12, 1993 the stockholders approved an amendment to the 1989 Plan to increase the number of shares available from 2,700,000 to 3,900,000. Options are granted twice yearly, on January 1 and July 1, and are exercisable on the succeeding June 30 or December 31. The purchase price for shares is the lower of 85% of the fair market value of the stock at the time of grant or 85% of said value at the time of exercise. In 1993, 190,492 shares were exercised at $5.05 per share and 152,679 shares were exercised at $9.19 per share. In 1992, 292,088 shares were exercised at $1.47 per share, 290,436 shares were exercised at $1.79 per share and 248,396 shares were exercised at $2.55 per share. In 1991, 235,164 shares were exercised at $.80 per share and 347,436 shares were exercised at $1.13 per share. 46.\nITEM 8 continued...\nAt the Annual Meeting of the Company on May 12, 1992, the stockholders adopted the 1992 EMC Corporation Stock Option Plan for Directors (the \"Directors Plan\").\nA total of 1,800,000 shares of Common Stock have been reserved for issuance under the Directors Plan which is administered by the Executive Stock Option and Compensation Committee (the \"Committee\") of the Board of Directors. The exercise price for each option granted under the Directors Plan will be at a price per share determined by the Committee at the time the option is granted, which price shall not be less than 50% of the fair market value per share of Common Stock on the date of grant. Options will be exercisable in increments of 20% for the shares covered thereby on each of the first through fifth anniversaries of the grant.\nOn May 12, 1993, a director was granted options to purchase 160,000 shares of Common Stock at a per share price of $8.25, which represents 100% of the per share fair market value at the date of grant. On May 12, 1992, a director was granted options to purchase 240,000 shares of Common Stock at a per share price of $1.26, which represents 50% of the per share fair market value at the date of grant. The discount from fair market value has been recorded as deferred compensation and is being amortized to earnings over the five year vesting period of the options. In 1993, options to purchase 48,000 shares were exercised at $1.26 per share. All stock option plans and the employee stock purchase plan are administered by the Compensation Committee.\nJ. Litigation\nOn June 10, 1993, Storage Technology Corporation, (\"STK\") filed suit against EMC in the United States District Court for the District of Colorado alleging that EMC is infringing three patents. In the complaint, STK seeks injunctive relief, unspecified damages, including treble damages plus attorney's fees and costs. On July 20, 1993, EMC answered the complaint and denied STK's allegations. In addition, EMC counterclaimed against STK alleging that the patents in suit are invalid and unenforceable. In the counterclaim, EMC seeks unspecified damages, attorney's fees, costs and interest. Discovery in the matter is currently in process. A scheduling order has been entered and a trial date has been set for October 1994.\nThe Company is a party to other litigation which it considers routine and incidental to its business. Management does not expect the results of any of these actions to have a material adverse effect on the Company's business or financial condition.\n47.\nITEM 8 continued...\nK. Off-Balance-Sheet Risk and Concentrations of Credit Risk\nOff-Balance-Sheet Risk\nThe Company enters into forward exchange contracts to hedge foreign currency transactions on a continuing basis for periods consistent with its committed exposures. The Company does not engage in currency speculation. The Company's foreign exchange contracts do not subject the Company to risk due to exchange rate movements because gains and losses on these contracts offset losses and gains on the assets, liabilities and transactions being hedged. The maximum amount of foreign currency contracts outstanding during 1993 and 1992 was $53,390,000 and $31,072,000, respectively. At January 1, 1994 and January 2, 1993, the Company had $50,354,000 and $19,243,000 of foreign exchange contracts outstanding, respectively.\nConcentrations of Credit Risk\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments, long-term investments and trade and notes receivables. The Company places its temporary cash investments and long- term investments with high credit quality financial institutions and limits the amount of investment with any one financial institution.\nThe credit risk associated with trade receivables is minimal due to the large number of customers and their broad dispersion over many different industries and geographic areas. During 1993, no single customer accounted for greater than 10% of the Company's revenues. During 1992, one customer accounted for 13% of the Company's revenues.\nL. Segment Information\nThe Company is active in only one business segment: designing, manufacturing and marketing high performance storage products. Information by geographic area is presented below with revenue derived from exports shown in their area of origin. Sales and marketing operations outside the United States are primarily conducted through sales subsidiaries and branches located principally in Europe and by direct sales from the parent corporation or its Irish manufacturing subsidiary. The United States market amounted to greater than 95% of the Company's sales, income and identifiable assets in the North\/South America segment.\n48.\nITEM 8 continued...\nIntercompany transfers between geographic areas are accounted for at prices which are designed to be representative of unaffiliated party transactions. (in thousands) Europe, North\/ Middle- Consol- South East, Asia Elimi- idated America Africa Pacific nations Total Sales $526,771 $251,363 $4,487 $ --- $782,621 Transfers between areas 100,237 83,726 --- (183,963) --- Total sales 627,008 335,089 4,487 (183,963) 782,621 Income (loss) from operations 107,512 70,324 (990) 3,582 180,428 Identifiable assets at year end 684,576 192,682 2,383 (49,995) 829,646\nSales $263,465 $111,117 $11,124 $ --- $385,706 Transfers between areas 83,813 36,303 --- (120,116) --- Total sales 347,278 147,420 11,124 (120,116) 385,706 Income from operations 34,915 25,008 1,255 (12,603) 48,575 Identifiable assets at year end 252,308 98,232 4,309 (16,069) 338,780\nSales $200,008 $51,411 $8,918 $ --- $260,337 Transfers between areas 35,946 15,036 --- (50,982) --- Total sales 235,954 66,447 8,918 (50,982) 260,337 Income (loss) from operations 22,798 (6,406) (531) 4,517 20,378 Identifiable assets at year end 164,096 41,608 4,166 (4,367) 205,503\n49.\nITEM 8 continued...\nM. Selected Quarterly Financial Data (unaudited) (amounts in thousands except share amounts)\nFiscal Year 1993 Q1 1993 Q2 1993 Q3 1993 Q4 1993\nNet Sales $138,773 $179,542 $215,747 $248,559 Gross Profit 66,480 88,996 113,723 132,667 Net Income 14,913 26,888 38,487 46,834 Net income per share, (fully diluted) $0.08 $0.13 $0.18 $0.21\nFiscal Year 1992 Q1 1992 Q2 1992 Q3 1992 Q4 1992\nNet Sales $74,556 $90,208 $103,105 $117,837 Gross Profit 34,741 40,432 47,251 56,003 Net Income 5,277 6,443 7,351 10,437 Net income per share, (fully diluted) $0.03 $0.04 $0.04 $0.06\nEarnings per share data has been adjusted to reflect all prior stock splits and pooling of interests.\nN. Subsequent Events\nIn January 1994, the Company acquired the majority interest in Copernique S.A. (\"Copernique\") formerly held by Cap Gemini Sogeti S.A. Copernique, located near Paris, France, specializes in high-performance data management hardware and software systems. The Company believes that this acquisition will enable the Company to extend its offerings in the field of distributed Information Technology systems and to strengthen its European presence.\nIn January 1994, the Company jointly formed a company in Japan with its existing Japanese distributor, in which the Company holds a majority interest. Through this entity, the Company will acquire a direct salesforce in Japan, which it then plans to further expand.\n50.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURES\nNone.\n51.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Company will furnish to the Securities and Exchange Commission a definitive Proxy Statement (the \"Proxy Statement\") not later than 120 days after the close of the fiscal year ended January 1, 1994. The information required by this item is incorporated herein by reference to the Proxy Statement. Also see \"Executive Officers of the Registrant\" in Part I of this form.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated herein by reference to the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is incorporated herein by reference to the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated herein by reference to the Proxy Statement.\n52.\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 in the accompanying Index to Consolidated Financial Statements and Schedules on page 58 are filed as part of this report.\n2. Schedules\nThe schedules listed in the accompanying Index to Consolidated Financial Statements and Schedules on page 59 are filed as part of this report.\n3. Exhibits\nSee Index to Exhibits pages 60 through 62 of this report.\nThe exhibits are filed with or incorporated by reference in this report.\n(b) On November 19, 1993, the registrant filed a report (Date of Report: November 19, 1993) on Form 8-K reporting, under Item 5, the increase in authorized common stock, authorization of a new class of preferred stock, the intent to proceed with the previously announced stock split and the intention to file a registration statement for an offering of convertible subordinated notes. In this report, the registrant also filed the following consolidated financial statements giving effect to the acquisition of Magna Computer Corporation and Epoch Systems, Inc. accounted for as poolings of interests:\ni. Consolidated Balance Sheets as of January 2, 1993 and December 28, 1991;\nii. Consolidated Statements of Income for the Three Years in the period ended January 2, 1993;\niii.Consolidated Statements of Stockholders' Equity for the Three Years in the period ended January 2, 1993;\niv. Consolidated Statements of Cash Flows for the Three Years in the period ended January 2, 1993;\nv. Notes to Consolidated Financial Statements; and\nvi. Report of Independent Accountants.\n53.\nOn December 29, 1993, the registrant filed a report (Date of Report: December 29, 1993) on Form 8-K filing, under Item 7, the following Exhibits related to the offering in December 1993 of the 4 1\/4% Convertible Subordinated Notes due 2001:\ni. Underwriting Agreement dated December 10, 1993 by and between EMC Corporation, Smith Barney Shearson Inc., Alex Brown & Sons Incorporated and Merrill Lynch, Pierce, Fenner & Smith Incorporated.\nii. Indenture dated as of December 17, 1993 between EMC Corporation and State Street Bank and Trust Company, as Trustee.\n54.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, EMC Corporation has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on March 23, 1994.\nEMC CORPORATION\nBy: Richard J. Egan Richard J. Egan Chairman of the Board\n55.\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 date indicated as of March 23, 1994.\nSignature Title\nRichard J. Egan Chairman of the Board Richard J. Egan (Principal Executive Officer) and Director\nMichael C. Ruettgers President and Chief Executive Michael C. Ruettgers Officer and Director\nW. Paul Fitzgerald Senior Vice President, W. Paul Fitzgerald Finance and Administration, Chief Financial Officer (Principal Financial Officer), Treasurer and Director\nJohn R. Egan Executive Vice President John R. Egan Sales and Marketing and Director\nColin G. Patteson Vice President and Controller Colin G. Patteson (Principal Accounting Officer)\nMichael J. Cronin Director Michael J. Cronin\nJohn F. Cunningham Director John F. Cunningham\nMaureen E. Egan Director Maureen E. Egan\nJoseph F. Oliveri Director Joseph F. Oliveri 56.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and the Board of Directors of EMC Corporation:\nIn connection with our audits of the consolidated financial statements of EMC Corporation as of January 1, 1994 and January 2, 1993 and for each of the three years in the period ended January 1, 1994, which financial statements and reports are included herein, 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 basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND\nBoston, Massachusetts February 1, 1994\n57.\nEMC CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES COVERED BY REPORTS OF CERTIFIED PUBLIC ACCOUNTANTS\nForm 10-K\nConsolidated Balance Sheets at January 1, 1994 and January 2, 1993 p. 27\nConsolidated Statements of Operations for the years ended January 1, 1994, January 2, 1993 and December 28, 1991 p. 28\nConsolidated Statements of Cash Flows for the years ended January 1, 1994, January 2, 1993 and December 28, 1991 p. 29\nConsolidated Statements of Stockholders' Equity for the years ended January 1, 1994, January 2, 1993 and December 28, 1991 p. 30\nNotes to Consolidated Financial Statements p.p. 31 - 50\nReport of Independent Accountants p.p. 26 and 57\n58.\nForm 10-K\nSchedules:\nSchedule V - Property Page S-1 Plant and Equipment\nSchedule VI - Accumulated Page S-2 Depreciation - Property, Plant and Equipment\nSchedule VIII - Valuation Page S-3 and Qualifying Accounts\nSchedule IX - Short Page S-4 Term Borrowings\nSchedule X - Supplementary Page S-5 Income Statement Information\nReport of Independent Accountants on Financial Statement Schedules\nNote: All other financial statement schedules are omitted because they are not applicable or the required information is included in the financial statements or notes thereto.\n59.\nThe exhibits listed below are filed with or incorporated by reference in this report.\n3.1 Articles of Organization of EMC Corporation\n3.2 Articles of Amendment filed February 26, 1986\n3.3 Articles of Amendment filed April 2, 1986\n3.4 Articles of Amendment filed May 13, 1987\n3.5 Articles of Amendment filed June 19, 1992\n3.6 Articles of Amendment filed May 12, 1993\n3.7 Articles of Amendment filed November 12, 1993\n3.8 By-laws of EMC Corporation, as amended on October 16, 1992\n4.1 Form of Stock Certificate\n4.2 Indenture, dated as of March 25, 1992 between EMC Corporation and State Street Bank and Trust Company, Trustee\n4.3 Indenture, dated as of December 17, 1993 between EMC Corporation and State Street Bank and Trust Company, Trustee\n4.4 Form of 6 1\/4% Convertible Subordinated Debenture Due 2002\n4.5 Form of 4 1\/4% Convertible Subordinated Note Due 2001\n10.1 EMC Corporation 1985 Stock Option Plan, as amended\n10.2 EMC Corporation 1989 Employee Stock Purchase Plan, as amended\n10.3 EMC Corporation 1992 Stock Option Plan for Directors\n10.4 EMC Corporation 1993 Stock Option Plan\n10.5 EMC Corporation Profit-Sharing Plan\n10.6 Mortgage Agreement with and Note Payable to John Hancock Mutual Life Insurance Company\n10.7 Loan and Credit Agreement dated December 10, 1991 between EMC Corporation and Shawmut Bank, N.A.\n10.8 Agreement between EMC Corporation and Unisys Corporation dated January 15, 1992 60.\n10.9 Amendment No. 1 to Agreement between EMC Corporation and Unisys Corporation dated March 10, 1992\n11.1 Computation of net income (loss) per share (filed herewith)\n22.1 Subsidiaries of Registrant (filed herewith)\n23.1 Consent of Independent Accountants (filed herewith)\n61.\nIncorporated herein by reference to the Company's Registration Statement on Form S-1 (No. 33-3656)\nIncorporated herein by reference to the Company's Registration Statement on Form S-1 (No. 33-17218).\nIncorporated herein from Annual Report on Form 10-K of EMC Corporation filed February 12, 1993.\nIncorporated herein by reference to the Company's Registration Statement on Form S-1 (No. 33-67224).\nIncorporated herein from Current Report on Form 8-K of EMC Corporation filed November 19, 1993.\nIncorporated herein from Annual Report on Form 10-K of EMC Corporation filed March 31, 1988.\nIncorporated herein by reference to the Company's Registration Statement on Form S-3 (No. 33-46075).\nIncorporated herein from Current Report on Form 8-K of EMC Corporation filed December 29, 1993.\nIncorporated herein by reference to the Company's Registration Statement on Form S-3 (No. 33-71916).\nIncorporated herein from Annual Report on Form 10-K of EMC Corporation filed February 28, 1992.\nIncorporated herein by reference to the Company's Registration Statement on Form S-8 (No. 33-54860).\nIncorporated herein by reference to the Company's Registration Statement on Form S-8 (No. 33-71598).\n62.\nEMC CORPORATION AND SUBSIDIARIES SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT\nBalance at Balance at Beginning Additions Other End of of Period at Cost Retirements Changes Period\nYear Ended 12\/28\/91 Furniture & Fixtures $ 4,087,000 $ 165,000 $ (77,000) $ -0- $ 4,175,000 Equipment 36,609,000 18,322,000 (2,414,000) -0- 52,517,000 Vehicles 1,169,000 428,000 (246,000) -0- 1,351,000 Buildings & Improvements 23,074,000 1,405,000 (149,000) -0- 24,330,000 Land 1,520,000 -0- -0- -0- 1,520,000 Construction in Progress 121,000 -0- -0- (45,000) 76,000 $66,580,000 $20,320,000 $(2,886,000) $(45,000) $83,969,000\nYear Ended 1\/2\/93 Furniture & Fixtures $ 4,175,000 $ 776,000 $ (41,000) $ -0- $ 4,910,000 Equipment 52,517,000 24,052,000 (5,660,000) -0- 70,909,000 Vehicles 1,351,000 639,000 (329,000) -0- 1,661,000 Buildings & Improvements 24,330,000 3,258,000 (21,000) -0- 27,567,000 Land 1,520,000 350,000 -0- -0- 1,870,000 Construction in Progress 76,000 685,000 -0- -0- 761,000 $83,969,000 $29,760,000 $(6,051,000) $ -0- $107,678,000\nNote: The 1991 balance of equipment is restated to include balance and activity of equipment leased to others, which is included in equipment in 1992.\nNote: Information for the year ended January 1, 1994 is omitted because the net property plant and equipment of the Company accounted for less than 25% of total assets at January 1, 1994 and January 2, 1993.\nS-1\n63.\nEMC CORPORATION AND SUBSIDIARIES SCHEDULE VI - ACCUMULATED DEPRECIATION - PROPERTY, PLANT AND EQUIPMENT\nBalance at Balance at Beginning Other End of of Period Additions Retirements Changes Period\nYear Ended 12\/28\/91 Furniture & Fixtures $ 1,801,000 $ 530,000 $ (163,000) $ -0- $ 2,168,000 Equipment 12,626,000 5,781,000 (699,000) -0- 17,708,000 Vehicles 487,000 265,000 (235,000) -0- 517,000 Buildings & Improvements 2,921,000 1,936,000 (32,000) -0- 4,825,000 Land -0- -0- -0- -0- -0- Construction in Progress -0- -0- -0- -0- -0- $17,835,000 $8,512,000 $(1,129,000) $ -0- $25,218,000\nYear Ended 1\/2\/93 Furniture & Fixtures $ 2,168,000 $ 481,000 $ (23,000) $ -0- $ 2,626,000 Equipment 17,708,000 13,980,000 (2,548,000) -0- 29,140,000 Vehicles 517,000 261,000 (143,000) -0- 635,000 Buildings & Improvements 4,825,000 1,454,000 (41,000) -0- 6,238,000 Land -0- -0- -0- -0- -0- Construction in Progress -0- -0- -0- -0- -0- $25,218,000 $16,176,000 $(2,755,000) $ -0- $38,639,000\nS-2\nEMC CORPORATION AND SUBSIDIARIES SCHEDULE VI - ACCUMULATED DEPRECIATION - PROPERTY, PLANT AND EQUIPMENT (continued)\nDepreciation is computed on a straight line basis over the estimated useful lives of the assets as follows:\nFurniture 7 years Equipment 3-7 years Vehicles 5 years Improvements 5 years Buildings 25 - 31 1\/2 years\nNote: The 1991 balance of equipment is restated to include the balance and activity of equipment leased to others, which is included in equipment in 1992.\nNote: Information for the year ended January 1, 1994 is omitted because the net property plant and equipment of the Company accounted for less than 25% of total assets at January 1, 1994 and January 2, 1993.\nS-2\n65.\nEMC CORPORATION AND SUBSIDIARIES SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nBalance at Charged to Charged Balance at Beginning Costs and to Other Deduc- End of Description of Period Expenses Accounts tions Period\nYear ended January 1,1994 Allowance for doubtful accounts $2,915,000 $2,699,000 $-0- $(352,000) $5,262,000\nYear ended January 2,1993 Allowance for doubtful accounts $2,892,000 $488,000 $-0- $(465,000) $2,915,000\nYear ended December 28,1991 Allowance for doubtful accounts $1,047,000 $2,152,000 $-0- $(307,000) $2,892,000\nS-3\n66.\nEMC CORPORATION AND SUBSIDIARIES SCHEDULE IX - SHORT TERM BORROWINGS\nAverage Weighted Interest Maximum Amount Average Balance Rate Outstanding Outstanding Interest at End at End During During Rate for of Year of Year Year Year (a) Year (a)\nYear ended January 1, 1994 Line of Credit - - Bank EMC Corporation $ 0 N\/A $ 0 $ 0 N\/A Magna 0 N\/A 545,000 131,000 8.4%\nYear ended January 2, 1993 Line of Credit - - Bank EMC Corporation $ 0 N\/A $5,000,000 $ 26,954 6.5% Magna 645,000 8.5% 695,000 515,000 8.0%\nYear ended December 28, 1991 Line of Credit - - Bank EMC Corporation $5,000,000 6.5% $5,000,000 $103,763 7.1% Magna 470,000 9.0% 470,000 333,000 9.6%\n(a)The average amount outstanding and weighted average interest rate during the year are based on the average daily balances outstanding.\nS-4\n67.\nEMC CORPORATION AND SUBSIDIARIES SCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\n1991 1992 1993\nAdvertising Costs $3,857,000 $4,964,000 $9,555,000\nS-5\n68.\nEMC CORPORATION\nEXHIBIT 11.1 Computation of Primary and Fully Diluted Net Income Per Share 1993 1992 1991 PRIMARY Net income (in thousands) $127,122 $29,508 $11,409\nAdd back interest expense on convertible notes 373 --- --- Less tax effect on interest expense on convertible notes (149) --- ---\nNet income for purpose of calculating primary net income per share $127,346 $29,508 $11,409\nWeighted average shares outstanding during the period 180,204,169 162,308,044 159,184,880\nCommon equivalent shares 16,281,991 9,643,652 5,229,936\nCommon and common equivalent shares outstanding for purpose of calculating primary net income per share 196,486,160 171,951,696 164,414,816\nPrimary net income per share $0.65 $0.17 $0.07\nFULLY DILUTED Net income (in thousands) $127,122 $29,508 $11,409\nAdd back interest expense on convertible debt and notes 4,097 2,853 --- Less tax effect on interest expense on convertible debt and notes (1,601) (1,085) ---\nNet income for purpose of calculating fully diluted net income per share $129,618 $31,276 $11,409\nCommon and common equivalent shares outstanding for purpose of calculating primary net income per share 196,486,160 171,951,696 164,414,816\nIncremental shares to reflect full dilution 20,738,566 18,596,284 1,805,316\nTotal shares for purpose of calculating fully diluted net income per share 217,224,726 190,547,980 166,220,132\nFully diluted net income per share (Note A in footnotes) $0.60 $0.16 $0.07\nNote: Prior year earnings per share and weighted average shares have been restated to reflect the December 1993 2 for 1 stock split, the June 1993 2 for 1 stock split and the November 1992 3 for 2 stock split. 69.\nEXHIBIT 22.1 - SUBSIDIARIES OF REGISTRANT\nThe following is a list of the Corporation's consolidated subsidiaries as of March 15, 1994. The Corporation owns, directly or indirectly, 100% of the voting securities of each subsidiary, unless noted otherwise. STATE OR JURISDICTION OF NAME ORGANIZATION\nCopernique, S.A. France\nEMC Caribe, Inc. Delaware\nEMC Computer Storage Systems (Israel) Ltd. Israel\nEMC Computer Systems AG Switzerland\nEMC Computer Systems France Sarl France\nEMC Computer Systems (H.K.) Limited Hong Kong\nEMC Computer Systems Italy SPA Italy\nEMC Computer Systems (Japan) K.K. Japan\nEMC Computer Systems (U.K.) Limited United Kingdom\nEMC (Benelux) B.V. Holland\nEMC Computer-Systems Deutschland GMBH Germany\nEMC Computer-Systems Svenska AB Sweden\nEMC International Holdings, Inc. Delaware\nEMC Securities Corporation Massachusetts\nEMC System Peripherals Canada, Inc. Canada\nEpoch Systems, Inc. Delaware\nMagna Computer Corporation Delaware\nMajority owned by EMC (Benelux) B.V., the remainder owned by Compagnie des Machines Bull, S.A., and not including certain directors' qualifying shares. Majority owned by EMC Corporation, the remainder owned by CLC Corporation. 70.\nEXHIBIT 23.1 - CONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the Registration Statements of EMC Corporation on Form S-8 (File Nos. 33-71262 and 33-71598) of our reports dated February 1, 1994, on our audits of the consolidated financial statements and financial statement schedules of EMC Corporation as of January 1, 1994 and January 2, 1993 and for the years ended January 1, 1994, January 2, 1993 and December 28, 1991 which reports are included in this Annual Report on Form 10-K.\nCOOPERS & LYBRAND\nBoston, Massachusetts March 21, 1994","section_15":""}
{"filename":"79282_1994.txt","cik":"79282","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nPoe & Brown, Inc. (the Company) is a general insurance agency headquartered in Daytona Beach and Tampa, Florida that resulted from an April 28, 1993 merger involving Poe & Associates, Inc. (Poe) and Brown & Brown, Inc. (Brown). Poe was incorporated in 1958 and Brown commenced business in 1939. Industry segment information is not presented because the Company realizes substantially all of its revenues from the general insurance agency business.\nThe Company's insurance agency business is comprised of (i) general retail operations, which provide all types of insurance products to a broad range of commercial, professional, and personal clients; (ii) national program operations, which market professional liability, property and casualty insurance to members of various professional and trade associations through independent agents; (iii) brokerage operations, which distribute excess and surplus commercial insurance through independent agents; and (iv) service operations, which provide insurance-related services such as third-party administration and consultation for workers' compensation and employee benefit self-insurance markets.\nThe Company's activities are conducted by 21 offices located throughout Florida, and in offices located in Arizona, California, Colorado, Connecticut, Georgia, New Jersey, North Carolina and Texas. Because the Company's business is concentrated in Florida, the occurrence of adverse economic conditions or an adverse regulatory climate in Florida could have a materially adverse effect on its business, although the Company has not encountered such conditions in the past.\nThe following table sets forth a summary of the commission and fee revenues realized from each of the Company's operating divisions for each of the five years in the period ended December 31, 1994 (in thousands of dollars):\n---------------\n(1) Certain 1993 Retail Operations revenues (totaling approximately $1.6 million) have been reclassified to National Programs to conform with the 1994 classification. Prior to 1993, the program revenues being reclassified were included in the individual retail branch results. Accordingly, 1992, 1991 and 1990 revenues have not been reclassified.\nThe amount of the Company's income from commissions and fees is a function of, among other factors, continued new business production, retention of existing customers, acquisitions, and fluctuations in insurance premium rates and insurable exposure units.\nThe Company is compensated for its services primarily by commissions paid by insurance companies. The commission is usually a percentage of the premium paid by an insured. Commission rates generally depend upon the type of insurance, the particular insurance company and the nature of the services provided by the Company. In some cases, a commission is shared with other agents or brokers who have acted jointly with the Company in the transaction. The Company may also receive from an insurance company a contingent\ncommission that is generally based on the profitability and volume of business placed with it by the Company over a given period of time. Fees of the Company are principally generated by the service operations division, which offers administration and benefit consulting services primarily in the workers' compensation and employee benefit self-insurance markets.\nInsurance premium rates are cyclical in nature and can vary widely based on insurance market conditions. Significant reductions in premium rates occurred during the years 1987 through 1989 and continued, although to a lesser degree, during 1990 through 1994. Because the insurance companies control the pricing of the products the Company sells, the Company is unable to predict the effect of this cyclical pattern on its future operating results.\nRETAIL OPERATIONS\nThe Company's retail insurance agency business consists primarily of the selling and marketing of property and casualty insurance coverages to commercial, professional, and to a limited extent, individual customers. The categories of insurance principally sold by the Company are: Casualty -- insurance relating to legal liabilities, workers' compensation, commercial and private passenger automobile coverages, and fidelity and surety insurance; and Property -- insurance against physical damage to property and resultant interruption of business or extra expense caused by fire, windstorm or other perils. The Company also sells and services all forms of group and individual life, accident, health, hospitalization, medical and dental insurance programs. Each category of insurance is serviced by insurance specialists employed by the Company.\nNo material part of the Company's retail business depends upon a single customer or a few customers. During 1994, the Company received approximately $1,107,000 of fees and commissions from Rock-Tenn Company, the Company's largest single retail customer, of which approximately $742,000 was attributed to the service operations division. Such aggregate amount represented less than 2% of the Company's total commission and fee revenues for 1994.\nIn connection with the selling and marketing of insurance coverages, the Company provides a broad range of related services to its customers, such as risk management surveys and analysis, consultation in connection with placing insurance coverages and claims processing. The Company believes these services are important factors in securing and retaining customers.\nNATIONAL PROGRAMS\nThe Company engages extensively in the mass marketing and placement of professional liability insurance and property and casualty insurance for members of various professional and trade associations, including dentists, attorneys, physicians, optometrists, and opticians, and to members of the wholesale distribution industry, towing operators and automobile dealerships. Typically, the Company tailors an insurance product to the needs of a particular professional or trade association, negotiates policy forms, coverages, and premium and commission rates with an insurance company, and in certain cases, secures the formal or informal endorsement of the product by an association. Under agency agreements with the insurance companies that underwrite these programs, the Company usually has authority to bind coverages, subject to established guidelines, to bill and collect premiums and, in some cases, to process claims. Insurance products are marketed nationally to association members primarily through independent agents who solicit customers through advertisements in association publications, direct mailings and personal contact.\nThe largest program marketed by the Company is a package insurance policy known as the Professional Protector Plan(R), which provides comprehensive coverages for dentists, including practice protection and professional liability. This program is endorsed by more than 25 state dental societies and is presently marketed in 49 states, the District of Columbia, Puerto Rico and the U.S. Virgin Islands. Since 1984, substantially all dental policies under this program have been underwritten through CNA Insurance Companies (CNA), with the Company serving as an agent for CNA.\nThe Company markets the Professional Protector Plan(R) through a network of independent agents who solicit customers through advertisements in professional publications, direct mail and personal contact. This\nprogram presently insures approximately 37,600 dentists, representing approximately 27% of the practicing dentists within the Company's marketing territories.\nThe Company began marketing lawyers' professional liability insurance in 1973. The national Lawyer's Protector Plan(R) was introduced in 1983 and is presently marketed in 45 states, the District of Columbia and the U.S. Virgin Islands. Since 1983, the Lawyer's Protector Plan has been underwritten through CNA. The Company markets the program through a network of independent agents who solicit customers through advertisements in professional publications, direct mailings and personal contact. The program presently insures approximately 37,500 attorneys.\nThe Company markets professional liability insurance for physicians, surgeons, and other health care providers through a program known as the Physicians Protector Plan(R). This program is served by the Company's offices in Tampa, Florida and Glastonbury, Connecticut. The program is underwritten by CNA and is sold and marketed by, or through, independent insurance agents in Florida, Georgia, Delaware, Connecticut, New Hampshire, Rhode Island and Vermont.\nThe Optometric Protector Plan(R) was created in 1973 to provide optometrists and opticians with a package of practice and professional liability coverage. This program, which insures approximately 7,100 optometrists and opticians in 50 states, is predominantly underwritten by CNA. In addition to these professional liability programs, National Programs also includes a number of commercial programs as follows:\nInsurance Administration Center, Inc., a wholly-owned subsidiary of the Company, operates as insurance advisor and consultant to the National Association of Wholesaler-Distributors, which represents some 40,000 wholesaler-distributors across the nation.\nThe Company's Professional Services Program, which originated in 1993, serves as a retail outlet within the National Programs Division and provides direct insurance sales to dentists, physicians, lawyers and optometrists in Florida.\nThe Towing Operator Protector Plan(R) was introduced in 1993 and currently provides specialized insurance products to tow-truck operators in 12 states. The Automobile Dealers Protector Plan(R) insures used car dealers in Florida through a program endorsed by the Florida Independent Auto Dealers Association. In 1994, this Plan expanded into five additional states, and currently insures approximately 2,200 dealers in six states.\nSERVICE OPERATIONS\nThe Company's service operations division consists of two separate components: (i) insurance and related services as a third-party administrator (TPA) for employee health and welfare benefit plans, and (ii) insurance and related services providing comprehensive risk management and third-party administration to self-funded workers' compensation plans.\nIn connection with its employee benefit plan administrative services, the Company provides TPA services, including benefit consulting, benefit plan design and costing, arrangement for the placement of stop-loss insurance and other employee benefit coverages, and settlement of claims. The Company provides access to effective utilization management strategies such as pre-admission review, concurrent\/retrospective review, pre-treatment review of certain non-hospital treatment plans, and medical and psychiatric case management. In addition to the administration of self-funded health care plans, the Company offers administration of flexible benefit plans, including plan design, employee communication, enrollment and reporting. The Company's workers' compensation TPA services include risk management services such as loss control, claim administration, access to major reinsurance markets, cost containment consulting, and services for secondary disability and subrogation recoveries.\nThe Company provides workers' compensation TPA services for approximately 2,000 employers representing more than $1.7 billion of employee payroll. The Company's largest workers' compensation contract represents approximately 76% of the Company's workers' compensation TPA revenues, or 5% of the Company's total commission and fee revenues.\nBROKERAGE OPERATIONS\nThe Company markets excess and surplus lines, and specialty insurance products, to both the Company's retail division and other retail agencies throughout Florida and the Southeast. The Company represents various U.S. and U.K. surplus lines companies and is also a Lloyd's of London correspondent. In addition to surplus lines carriers, the Company represents admitted carriers for smaller agencies that do not have access to large insurance carrier representation. Excess and surplus products include commercial automobile, garage, restaurant, builder's risk and inland marine lines. Difficult-to-insure general liability and products liability coverages are a specialty, as is excess workers' compensation. Retail agency business is solicited through mailings and direct contact with retail agency representatives.\nEMPLOYEES\nAs of December 31, 1994, the Company had 971 full-time equivalent employees, compared to 980 at the beginning of the year. The Company has contracts with its sales employees that include provisions restricting their right to solicit the Company's customers after termination of employment with the Company. The enforceability of such contracts varies from state to state depending upon state statutes, judicial decisions, and factual circumstances. The majority of these contracts are terminable by either party; however, the agreement not to solicit the Company's customers continues generally for a period of at least three years after employment termination.\nNone of the Company's employees are represented by a labor union, and the Company considers its relations with its employees to be satisfactory.\nCOMPETITION\nThe insurance agency business is highly competitive, and numerous firms actively compete with the Company in every area in which it does business. There are several hundred insurance companies and insurance agencies that conduct business in Florida and with which the Company, either directly or indirectly, competes.\nAlthough the Company is the largest insurance agency headquartered in Florida, a number of national firms with greater resources have offices in Florida and actively compete with the Company. Because competition in the insurance business is largely based on innovation, quality of service and price, the Company believes it is well positioned to successfully compete in the markets it serves. The Company's business outside the state of Florida consists principally of the marketing and placement of association programs and localized general retail agency activities.\nSeveral large stock and mutual insurance companies are engaged in the direct sale of insurance and do not pay commissions to agents and brokers. To date, such direct writing has had relatively little effect on the Company's operations, primarily because the Company's retail operations are commercially oriented.\nREGULATION, LICENSING, AND AGENCY CONTRACTS\nThe Company or its designated employees must be licensed to act as agents by the Florida Department of Insurance or comparable state regulatory authorities in the other states in which the Company conducts business. Regulations and licensing laws vary in individual states and are often complex.\nThe applicable licensing laws and regulations in all states are subject to amendment or reinterpretation by state regulatory authorities, and such authorities are vested in most cases with relatively broad discretion as to the granting, revocation, suspension and renewal of licenses. The possibility exists that the Company could be excluded or temporarily suspended from carrying on some or all of its activities in, or otherwise subjected to penalties by, a particular state.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company occupies office premises under noncancellable operating leases expiring at various dates. These leases generally contain renewal options and escalation clauses based on increases in the lessors' operating expenses and other charges. The Company expects that most leases will be renewed or replaced upon expiration. See Note 8 of the \"Notes to Consolidated Financial Statements\" in the 1994 Annual Report to Shareholders for additional information on the Company's lease commitments. Information on the Company's office locations is included on pages 4 and 5 and the inside back cover of the Company's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nAt December 31, 1994 the Company owned three buildings located in downtown Daytona Beach, Florida having an aggregate book value of approximately $350,000, including improvements. There are no outstanding mortgages on these buildings. These buildings generated lease revenue during 1994 of approximately $13,000. In March 1995, one of these buildings having an aggregate book value approximating $57,000 was sold for a minimal gain. The Company also owns an office condominium in Venice, Florida which has a net book value of $201,000, with no outstanding mortgage. This building is currently vacant.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn February 21, 1995, an Amended Complaint was filed in an action pending in the Superior Court of Puerto Rico, Bayamon Division, and captioned Cadillac Uniform & Linen Supply Company, et al. v. General Accident Insurance Company, Puerto Rico, Limited, et al. The case was originally filed on November 23, 1994, and named General Accident Insurance Company, Puerto Rico Limited, and Benj. Acosta, Inc. as defendants. The Amended Complaint added several defendants, including the Company and Poe & Brown of California, Inc. (\"P&B\/Cal.\"), a subsidiary of the Company, as parties to the case. As of March 23, 1995, neither the Company nor P&B\/Cal. had been served. The Plaintiffs allege that P&B\/Cal. failed to procure sufficient coverage for a commercial laundry facility which was rendered inoperable for a period of time as the result of a fire, and further allege that the Company is vicariously liable for the actions of P&B\/Cal. The Amended Complaint seeks damages of $11.2 million against P&B\/Cal., the Company, the Producer who handled the account and LBI Corp., a\/k\/a Levinson Bros., Inc. The Company and P&B\/Cal. believe that P&B\/Cal. has meritorious defenses to each of the claims asserted against it, and that the Company likewise has meritorious defenses to allegations premised upon theories of vicarious liability. Both the Company and P&B\/Cal. intend to contest this action vigorously. In the event that damages are awarded against P&B\/Cal. or the Company, P&B\/Cal. and the Company believe that insurance would be available to cover such loss.\nOn September 9, 1994, the Company was named as a third-party defendant in a case pending in the United States District Court, Eastern District of New York, captioned Alec Sharp, an Underwriter at Lloyds on behalf of himself and other Lloyd's Underwriters and Colin Trevor Dingley, on behalf of himself and other Lloyd's Underwriters v. Best Security Corp., d\/b\/a Independent Armored, et al. The action has been pending since March 9, 1994, and names a number of companies (but not the Company) as defendants. The third-party complaint was filed against the Company by some of the defendants in the underlying action. The case arises from the theft of jewelry claimed to be worth approximately $7 million from an armored car owned and operated by Best Security Corp. Plaintiffs in the underlying action seek a declaratory judgment that the policy was void from inception because the insured made misrepresentations on the application. In the third-party complaint, the third-party plaintiffs allege that the Company issued certificates of insurance naming additional insureds without authorization, and claim the Company failed to communicate information given to the Company by the insured to the Underwriters at Lloyd's of London. In the event that the Underwriters prevail in the underlying action, the third-party plaintiffs seek damages in an unspecified amount from the Company. The Company intends to contest this action vigorously, and believes it has meritorious defenses to all claims alleged against it. In the event that damages are assessed against the Company, the Company believes that insurance would be available to cover such loss.\nIn 1992, the Internal Revenue Service (the Service) completed its examinations of the Company's federal income tax returns for the years 1988, 1989, and 1990. As a result of its examinations, the Service\nissued Reports of Proposed Adjustments asserting income tax deficiencies which, by including interest and state income taxes for the periods examined and the Company's estimates of similar tax adjustments for subsequent periods through December 31, 1994, would total $6,100,000. The disputed issues related primarily to the deductibility of amortization of purchased customer accounts of approximately $5,107,000 and non-compete agreements of approximately $993,000. In addition, the Service's report included a dispute regarding the time at which the Company's payments made pursuant to certain indemnity agreements would be deductible for tax reporting purposes. During 1994, the Company was able to reach a settlement agreement with the Service with respect to certain of the disputed amortization items and the indemnity agreement payment issue. This settlement has reduced the total remaining asserted income tax deficiencies to approximately $2,800,000. Based on this settlement and review of the remaining unsettled items, the Company believes that its general income tax reserves of $800,000 are sufficient to cover its ultimate liability resulting from the settlement of the remaining items. In March 1995, the Company reached an agreement with the Service on the remaining unsettled items which will result in final assessed deficiencies of approximately $600,000. The Company's general income tax reserves are adequate to cover this amount plus any penalties and interest that may be assessed.\nThe Company is involved in various other pending or threatened proceedings by or against the Company or one or more of its subsidiaries that involve routine litigation relating to insurance risks placed by the Company and other contractual matters. Management of the Company does not believe that any of such pending or threatened proceedings (including the proceedings described above) will have a materially adverse effect on the consolidated financial position or future operations of the Company.\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 Company's fourth fiscal quarter ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation under the captions \"Stock Price Range\" and \"Cash Dividends Per Share\" as included in Note 15 of the Notes to Consolidated Financial Statements included in the Company's 1994 Annual Report to Shareholders and information under the caption \"Stock Listing\" on the inside back cover page of the Company's 1994 Annual Report to Shareholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation under the caption \"Selected Financial Data\" on page 1 of the Company's 1994 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\nInformation under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 20 through 25 of the Company's 1994 Annual Report to Shareholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements of Poe & Brown, Inc. and its subsidiaries, together with the report thereon of Ernst & Young LLP, appearing on pages 26 through 43 of the Company's 1994 Annual Report to Shareholders are 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\nInformation contained under the caption \"Management\" on pages 4-6 of the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation contained under the caption \"Executive Compensation\" on pages 7-10 of the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders is incorporated herein by reference; provided, however, the report of the Compensation Committee on executive compensation, which begins on page 10 thereof, and the stock performance graph shall not be deemed to be incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation contained under the caption \"Security Ownership of Management and Certain Beneficial Owners\" on pages 2-3 of the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation contained under the caption \"Executive Compensation -- Compensation Committee Interlocks and Insider Participation\" on pages 9-10 of the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders 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 part of this report:\n1. Consolidated Financial Statements of Poe & Brown, Inc. (incorporated herein by reference from pages 26 through 43 of the Company's 1994 Annual Report to Shareholders for the year ended December 31, 1994) consisting of:\n(a) Consolidated Statements of Income for each of the three years in the period ended December 31, 1994.\n(b) Consolidated Balance Sheets as of December 31, 1994 and 1993.\n(c) Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 1994.\n(d) Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1994.\n(e) Notes to Consolidated Financial Statements.\n(f) Report of Independent Certified Public Accountants.\n2. Consolidated Financial Statement Schedule included on page 10 of this report, consisting of:\n(a) Schedule II -- Valuation and Qualifying Accounts.\nAll 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 the Notes thereto.\n3. EXHIBITS\n---------------\n* The registrant has Indemnification Agreements with certain of its other directors and former directors (Joseph E. Brown, Bruce G. Geer, V.C. Jordan, Jr., Byrne Litschgi, Charles W. Poe, William F. Poe, Jr., and Bernard H. Mizel) that are identical in all material respects to Exhibit 10g except for the parties involved and the dates executed.\n(b) REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed during the fourth quarter of 1994.\nSCHEDULE II\nPOE & BROWN, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n---------------\n(A) Uncollectible accounts written off, net of recoveries.\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.\nPOE & BROWN, INC. Registrant\nBy: \/s\/ J. HYATT BROWN ------------------------------------ J. Hyatt Brown Chief Executive Officer Date: March 29, 1995\nPursuant to the requirements of the Securities 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":"66570_1994.txt","cik":"66570","year":"1994","section_1":"Item 1. Business -----------------\nProducts and Markets: --------------------\nThe primary business of the registrant and its affiliated companies is the manufacture and sale of products designed to protect the safety and health of workers throughout the world.\nPrincipal products include respiratory protective equipment that is air- purifying, air-supplied and self-contained in design. The registrant also produces instruments that monitor and analyze workplace environments and control industrial processes. Personal protective products include head, eye and face, body and hearing protectors. For the mining industry, the registrant provides mine lighting, rockdusting equipment, fire-fighting foam and foam application equipment. Health-related products include emergency care items and hospital instruments.\nMany of these products are sold under the registered trademark \"MSA\", and have wide application for workers in industries that include manufacturing, fire service, public utilities, mining, chemicals, petroleum, construction, pulp and paper processing, transportation, government, automotive, aerospace, asbestos abatement, and hazardous materials clean-up.\nOther products manufactured and sold, which do not fall within the category of safety and health equipment, include boron-based and other specialty chemicals.\nThe registrant and its affiliated companies are in competition with many large and small enterprises. In the opinion of management, the registrant is a leader in the manufacture of safety and health equipment.\nOrders, except under contracts with the Department of Defense and with international governments, are generally filled promptly after receipt and the production period for special items is usually less than one year. The backlog of orders under contracts with the Department of Defense and certain international governments is summarized as follows:\nApproximately $8,900,000 under contracts with the Department of Defense and $3,800,000 with international governments are expected to be shipped after December 31, 1995.\nFurther information with respect to the registrant's products, operations in different geographic areas, equity in earnings and assets of international affiliated companies, and significant customers is reported at Note 6 of Notes to Consolidated Financial Statements contained in the registrant's Annual Report to Shareholders for the year ended December 31, 1994, incorporated herein by reference.\nResearch: --------\nThe registrant and its affiliated companies engage in applied research with a view to developing new products and new applications for existing products. Most of its products are designed and manufactured to meet currently applicable performance and test standards published by groups such as ANSI (American National Standards Institute), MSHA (Mine Safety & Health Administration), NIOSH (National Institute for Occupational Safety and Health), UL (Underwriters' Laboratories), SEI (Safety Equipment Institute) and FM (Factory Mutual). The registrant also from time to time engages in research projects for others such as the Bureau of Mines and the Department of Defense or its prime contractors. Registrant-sponsored research and development costs were $20,575,000 in 1994, $21,000,000 in 1993, and $20,938,000 in 1992.\nIn the aggregate, patents have represented an important element in building up the business of the registrant and its affiliates, but in the opinion of management no one patent or group of patents is of material significance to the business as presently conducted.\nGeneral: -------\nThe company was founded in 1914 and is headquartered in Pittsburgh, Pennsylvania. As of December 31, 1994, the registrant and its affiliated companies had approximately 4,500 employees, of which 2,000 were employed by international affiliates. None of the U.S. employees are subject to the provisions of a collective bargaining agreement.\nIn the United States and in those countries in which the registrant has affiliates, its products are sold primarily by its own salespersons, supplemented in the case of certain markets by independent distributors and\/or manufacturers' representatives. In international countries where the registrant has no affiliate, products are sold primarily through independent distributors located in those countries.\nThe registrant is cognizant of environmental responsibilities and has taken affirmative action regarding this responsibility. There are no current or expected legal proceedings or expenditures with respect to environmental matters which would materially affect the operations of the registrant and its affiliates. Generally speaking, the operations of the registrant and its affiliates are such that it is possible to maintain sufficient inventories of raw materials and component parts on the manufacturing premises. Equipment and machinery for processing chemicals and rubber, plastic injection molding equipment, molds, metal cutting, stamping and working equipment, assembly fixtures and similar items are regularly acquired, repaired or replaced in the ordinary course of business at prevailing market prices as necessary.\nAs of the end of 1992, the registrant decided to discontinue the operation of Transfer-Metallisierte Produkte GmbH (TMP), a joint venture in Germany to produce metallized paper. This venture, unrelated to the registrant's safety products, had been a financial drain on the registrant. Operating activities ceased during 1993; the registrant continues to dispose of its assets and settle its liabilities, and continues to believe that this action will not have a significant effect on the registrant's financial condition. In the third quarter of 1993, the registrant acquired HAZCO Services, a U.S. based distribution and rental supplier serving the hazardous materials\/environmental market. No material changes in the registrant's commercial operations are expected to occur during 1995. Sales of defense products, which continue to be an important market segment, increased in 1994. Incoming orders were significantly less than shipments in 1994, and lower than 1993 incoming orders. In January 1995 the registrant was awarded an additional contract for gas masks totalling $15,200,000, for which deliveries are scheduled over a one year period from October 1995. Further information about the registrant's business is included in Discussion and Analysis of Financial Condition and Results of Operations at pages 10 to 12 of the Annual Report to Shareholders, incorporated herein by reference.\n(Item 1 continued at page 7)\nExecutive Officers and Significant Employees: --------------------------------------------\nAll the executive officers and significant employees have been employed by the registrant since prior to January 1, 1990 and have held their present positions since prior to that date except as follows:\n(a) Mr. Ryan III was elected Chief Executive Officer and Chairman of the Board on August 28, 1991, effective from October 1, 1991. On April 25, 1990 he was elected President. He previously was the Executive Vice President.\n(b) Mr. Hotopp was employed by the registrant on July 29, 1991 and elected Senior Vice President and General Manager, Safety Products. From prior to January 1, 1990 until he joined the registrant, Mr. Hotopp was Senior Vice President, Sales and Marketing and later President of Kingston Warren Corporation, a manufacturer of rubber-metal composites for automotive, computer and material handling industries.\n(c) Mr. Christen was elected a corporate Vice President on October 31, 1991. He was previously General Director, Auergesellschaft, an affiliate of the registrant, and Vice President and Managing Director of MSA Europe, a division of the registrant.\n(d) Mr. Joy was elected Vice President on October 31, 1991. He was previously Director, Sales and Market Development.\n(e) Mr. Steggles was employed by the registrant on May 4, 1992 and elected Vice President. From prior to January 1, 1990 until he joined the registrant, Mr. Steggles was Vice President of International Marketing and Sales with the BMY Division of Harsco Corp., a manufacturer of tracked and wheeled vehicles.\n(f) Mr. DeMaria was appointed Director, Human Resources on September 1, 1994. He previously was Manager, Employee Benefits.\nThe primary responsibilities of these officers and significant employees follows:\nIndividual Responsibilities ---------- ---------------- Mr. Hotopp Product planning and engineering, manufacturing development and sales of safety products in the U.S.\nMr. Christen European operations\nMr. Joy Sales and marketing of safety products in the U.S.\nMr. Miller Product planning and engineering for safety products in the U.S.\nMr. Steggles International operations outside the U.S. and Europe.\nMr. Tepper Product planning and engineering, manufacturing development and sales of instrument and battery products in the U.S.\nMr. Cuozzo General Counsel and corporate taxes\nMr. Zeitler Cash and risk insurance management\nMr. DeMaria Personnel, benefits, training\nMr. Heggestad Manufacturing operations, safety products in the U.S.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties ------------------ World Headquarters: ------------------\nThe registrant's executive offices are located at 121 Gamma Drive, RIDC Industrial Park, O'Hara Township, Pittsburgh, Pennsylvania 15238. This facility contains approximately 138,000 sq. ft.\nProduction and Research Facilities: ----------------------------------\nThe registrant's principal U.S. manufacturing and research facilities are located in the Greater Pittsburgh area in buildings containing approximately 1,104,000 square feet. Other U.S. manufacturing and research facilities of the registrant are located in Esmond, Rhode Island (186,000 sq. ft.), Jacksonville, North Carolina (107,000 sq. ft.), Lyons, Colorado (10,000 sq. ft.), Sparks, Maryland (37,000 sq. ft.), and Dayton, Ohio (23,000 sq. ft.).\nManufacturing facilities of international affiliates of the registrant are located in major cities in Australia, Brazil, Canada, France, Germany, Italy, Japan, Mexico, Peru, Scotland, Spain, and Sweden. The most significant are located in Germany (approximately 430,000 sq. ft., excluding 127,000 sq. ft. leased to others), and in Glasgow, Scotland (approximately 141,000 sq. ft.); research activities are also conducted at these facilities.\nVirtually all of these buildings are owned by the registrant and its affiliates and are constructed of granite, brick, concrete block, steel or other fire-resistant materials. The German facility is owned subject to encumbrances securing indebtedness in the aggregate amount of $5,587,000 as of December 31, 1994.\nSales Offices and Warehouses: ----------------------------\nThe registrant and its U.S. affiliates own seven warehouses and lease 13 other distribution warehouses with aggregate floor space of approximately 279,000 sq. ft. in or near principal cities in 13 states in the United States. Leases expire at various dates through 1998. Sales offices and distribution warehouses are owned or leased in or near principal cities in 22 other countries in which the registrant's affiliates are located.\nItem 3.","section_3":"Item 3. Legal Proceedings -------------------------- Not applicable.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders ------------------------------------------------------------ No matters were submitted to a vote of security holders during fourth quarter 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nItem 6.","section_6":"Item 6 - \"Five-Year Summary of Selected Financial Data\" appearing at page\nItem 7","section_7":"Item 7 - \"Discussion and Analysis of Financial Condition and Results of Operations\" appearing at pages 10 to 12\nItem 8","section_7A":"","section_8":"Item 8 - \"Financial Statements and Notes to Consolidated Financial Statements\" appearing at pages 13 to 22\nof the Annual Report to Shareholders for the year ended December 31, 1994. Said pages of the Annual Report are submitted with this report and pursuant to Item 601(b)(13) of Regulation S-K shall be deemed filed with the Commission only to the extent that material contained therein is expressly incorporated by reference in Items 1, 5, 6, 7, 8 and 14 (a) hereof.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and ------------------------------------------------------------------------ Financial Disclosure -------------------- Not applicable.\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 -------------------------------------------------------------------------------\nIncorporated by reference herein pursuant to Rule 12b - 23 are (1) \"Election of Directors\" appearing at pages 1 to 3, (2) \"Other Information Concerning Directors and Officers\" appearing at pages 4 to 9 (except as excluded below), and (3) \"Security Ownership\" appearing at pages 10 to 12 (except as excluded below) of the Proxy Statement filed pursuant to Regulation 14A in connection with the registrant's Annual Meeting of Shareholders to be held on April 26, 1995. The information appearing in such Proxy Statement under the captions \"Compensation Committee Report on Executive Compensation\" and \"Comparison of Five-Year Cumulative Total Return\" is not incorporated herein.\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\nThe following information appearing on pages 13 to 22 inclusive in the Annual Report to Shareholders of the registrant for the year ended December 31, 1994, is incorporated herein by reference pursuant to Rule 12b-23.\nReport of Independent Accountants\nConsolidated Balance Sheet - December 31, 1994 and 1993\nConsolidated Statement of Income - three years ended December 31, 1994\nConsolidated Statement of Earnings Retained in the Business - three years ended December 31, 1994\nConsolidated Statement of Cash Flows - three years ended December 31, 1994\nNotes to Consolidated Financial Statements\nSaid pages of the Annual Report are submitted with this report and, pursuant to Item 601(b)(13) of Regulation S-K shall be deemed to be filed with the Commission only to the extent that material contained therein is expressly incorporated by reference in Items 1, 5, 6, 7, 8 and 14 (a)(1) and (2) hereof.\nThe following additional financial information for the three years ended December 31, 1994 is filed with the report and should be read in conjunction with the above financial statements:\nReport of Independent Accountants on Financial Statement Schedule\nSchedule II - Valuation and Qualifying Accounts\nAll other schedules are omitted because they are not applicable, not material or the required information is shown in the financial statements listed above.\n(a) 3. Exhibits (3)(i) Restated Articles of Incorporation as amended to April 27, 1989, filed in Form 10-Q on August 5, 1994, are incorporated herein by reference.\n(3)(ii) By-laws of the registrant, as amended to August 29, 1990, filed in Form 10-Q on November 9, 1990, are incorporated herein by reference.\n(10)(a) * 1987 Management Share Incentive Plan, filed in Form 10-K on March 25, 1994, is incorporated herein by reference.\n(10)(b) * 1990 Non-Employee Directors' Stock Option Plan, as amended to April 27, 1994, filed in Form 10-Q on August 5, 1994, is incorporated herein by reference.\n(10)(c) * Executive Insurance Program, filed in Form 10-Q on August 5, 1994, is incorporated herein by reference.\n(10)(d) * Extension of Consulting Agreement for the period January 1, 1992 through December 31, 1996, and June 30, 1977 Consulting Agreement with John T. Ryan, Jr. filed in Form 10-K on March 27, 1992, is incorporated herein by reference.\n(10)(e) * December 29, 1993 Consulting agreement with Leo N. Short, Jr., filed in Form 10-K on March 25, 1994, is incorporated herein by reference.\n(10)(f) * Board of Directors April 24, 1984 Resolution providing for payment by the Company to officers the difference between amounts payable under terms of the Company's Non-Contributory Pension Plan and the benefit limitations of Section 415 of the Internal Revenue Code, filed in Form 10-K on March 28, 1990 is incorporated herein by reference.\n* The exhibits marked by an asterisk are management contracts or compensatory plans or arrangements.\n(a) 3. Exhibits (continued)\n(13) Annual Report to Shareholders for year ended December 31, 1994\n(21) Affiliates of the registrant\n(23) Consent of Price Waterhouse LLP, independent accountants\n(27) Financial Data Schedule (filed in electronic format only)\nThe registrant agrees to furnish to the Commission upon request copies of all instruments with respect to long-term debt referred to in Note 12 of the Notes to Consolidated Financial Statements filed as part of Exhibit 13 to this annual report which have not been previously filed or are not filed herewith.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the last quarter of the year ended December 31, 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.\nMINE SAFETY APPLIANCES COMPANY\nMarch 27, 1995 By \/s\/ John T. Ryan III -------------------- -------------------------------- (Date) John T. Ryan III President, 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.\nSignature Title Date ----------------- --------- --------\n\/s\/ John T. Ryan III Director; President, March 27, 1995 --------------------------- Chairman of the Board John T. Ryan III and Chief Executive Officer\n\/s\/ James E. Herald Vice President--Finance; March 27, 1995 --------------------------- Principal Financial and James E. Herald Accounting Officer\n\/s\/ Joseph L. Calihan Director March 27, 1995 --------------------------- Joseph L. Calihan\n\/s\/ Calvin A. Campbell, Jr. Director March 27, 1995 --------------------------- Calvin A. Campbell, Jr.\n\/s\/ G. Donald Gerlach Director March 27, 1995 --------------------------- G. Donald Gerlach\n\/s\/ Helen Lee Henderson Director March 27, 1995 --------------------------- Helen Lee Henderson\n\/s\/ John T. Ryan, Jr. Director March 27, 1995 --------------------------- John T. Ryan, Jr.\n\/s\/ Leo N. Short, Jr. Director March 27, 1995 --------------------------- Leo N. Short, Jr.\nReport of Independent Accountants on Financial Statement Schedule\nTo the Board of Directors of Mine Safety Appliances Company\nOur audits of the consolidated financial statements referred to in our report dated February 17, 1995, appearing on page 13 of the 1994 Annual Report to Shareholders of Mine Safety Appliances Company (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 Schedule listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPrice Waterhouse LLP\nPittsburgh, Pennsylvania February 17, 1995\nSCHEDULE II\nMINE SAFETY APPLIANCES COMPANY AND AFFILIATES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED DECEMBER 31, 1994 (IN THOUSANDS)\n(1) Bad debts written off, net of recoveries.","section_15":""}
{"filename":"922404_1994.txt","cik":"922404","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company and its subsidiaries are defendants in various routine litigation incident to its business, none of which 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.\nOn April 22, 1994, the Company, as the sole shareholder of EGOC and acting by unanimous consent in lieu of a meeting, approved an amendment to the Articles of Incorporation of the subsidiary changing its name from Empire Gas Corporation to Empire Gas Operating Corporation.\nOn April 22, 1994, the shareholders of the Company, acting by unanimous consent in lieu of a meeting, approved an amendment to the Articles of Incorporation of the Company changing its name from Empire Gas Acquisition Corporation to Empire Gas Corporation.\nOn June 20, 1994, the Company, as the sole shareholder of EGOC and acting by unanimous consent in lieu of a meeting, approved the Transaction, pursuant to which the shares of certain shareholders of the Company were redeemed in exchange for cash and the shares of Energy. See \"Item 1 -- Business (The Transaction)\" and \"Item 13 -- Certain Relationships and Related Transactions (The Transaction).\"\nOn June 20, 1994, the shareholders of the Company, acting by unanimous consent in lieu of a meeting, approved the Transaction, pursuant to which the shares of certain shareholders of the Company were redeemed in exchange for cash and the shares of Energy. See \"Item 1 -- Business (The Transaction)\" and \"Item 13 -- Certain Relationships and Related Transactions (The Transaction).\"\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAs of September 15, 1994, the Company's Common Stock was held of record by 8 shareholders. There is currently no active trading market in the Company's Common Stock.\nAs of September 15, 1994, there are outstanding Warrants to purchase 175,536 shares of the Company's Common Stock.\nNo dividends on the Common Stock of the Company were paid during the Company's 1993 or 1994 fiscal years. The indenture relating to the 12 7\/8 % Senior Secured Notes due 2004 and the terms of the Company's revolving credit facility each contain dividend restrictions that prohibit the Company from paying common stock cash dividends. As a result, the Company has no current intention of paying cash dividends on the Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table presents selected consolidated operating and balance sheet data of Empire Gas as of and for each of the years in the five-year period ended June 30, 1994. The financial data of the Company as of and for each of the years in the five-year period ended June 30, 1994 were derived from the Company's audited consolidated financial statements. The financial and other data set forth below should be read in conjunction with the Company's consolidated financial statements, including the notes thereto, included with this report. Because the operating data do not take into account the effects of the Transaction on the Company, management does not believe they are indicative of the results of the Company that can be expected after the Transaction.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following discussion and analysis of the Company's results of operations, financial condition and liquidity should be read in conjunction with the and the historical consolidated financial statements of Empire Gas and the notes thereto included in this Report.\nRESULTS OF OPERATIONS\nGENERAL\nEmpire Gas' primary source of revenue is retail propane sales, which accounted for approximately 91% of its revenue (without taking account of the Transaction) in fiscal year 1994. Other sources of revenue include sales of gas appliances and rental of customer tanks.\nThe Company's operating revenue is subject to both price and volume fluctuations. Price fluctuations are generally caused by changes in the wholesale cost of propane. The Company is not materially affected by these price fluctuations, inasmuch as it can generally recover any cost increase through a corresponding increase in retail prices. Consequently, the Company's gross profit per retail gallon is relatively stable from year to year within each customer class. Volume fluctuations from year to year are generally caused by variations in the winter weather from year to year. Because a substantial amount of the propane sold by the Company to residential and commercial customers is used for heating, the severity of the weather will affect the volume sold. Volume fluctuations do materially affect the Company's operations because lower volume produces less revenue to cover the Company's fixed costs, including any debt service costs.\nThe Company's expenses consist primarily of cost of products sold, general and administrative expenses and, to a much lesser extent, depreciation and amortization and interest expense. Purchases of propane inventory account for the vast majority of the cost of products sold. The Company's general and administrative expenses consist mainly of salaries and related employee benefits, vehicle expenses, and insurance. The Company's interest expense has consisted primarily of interest on its existing credit facility, 12% Senior Subordinated Debentures, 1998 9% Convertible Subordinated Debentures, and 2007 9% Subordinated Debentures. The Company retired the 12% Senior Subordinated Debentures and the 1998 9% Convertible Subordinated Debentures in connection with the Transaction, but the Company's interest expense will increase substantially as a result of the issuance of the 12 7\/8% Senior Secured Notes due 2004. Through 1999 a significant portion of the increase will be non-cash interest expense.\nThe following discussion does not reflect either the transfer of Energy or the acquisition of the assets of PSNC in the Transaction and therefore is not indicative of results\nthat can be expected in the future. In general, these transactions will result in a net reduction in the number of gallons sold, and thus in results (including operating revenue, cost of products sold, gross profit, and provisions for doubtful accounts) that are related to the number of gallons sold. General and administrative expenses are also expected to decline as a result of the elimination of salaries and related expenses of departing officers, the termination of certain agreements between the Company and Mr. Plaster or entities controlled by him, and the elimination of costs related to service centers that are no longer part of the Company.\nFISCAL YEARS ENDED JUNE 30, 1994 AND JUNE 30, 1993\nOPERATING REVENUE. Operating revenue decreased $3.8 million or 3.0%, from $128.4 million in fiscal year 1993 to $124.6 million in fiscal year 1994. This decrease was the result of a $4.0 million decrease in propane sales and a $300,000 decrease in other revenue, offset by a $500,000 increase in sales of parts and gas appliances. The decrease in propane sales was caused by a 1.9% decrease in gallons sold and a 1.1% decrease in the average gross sales price per gallon. The decreased volume reflects the results of slightly warmer winter weather.\nCOST OF PRODUCTS SOLD. Cost of products sold decreased $2.3 million, or 3.8%, from $60.2 million in fiscal year 1993 to $57.9 million in fiscal year 1994. The decrease resulted from the 1.9% decrease in gallons sold, which reflects the slightly warmer winter weather, and a 3.7% decrease in the wholesale cost of propane.\nGROSS PROFIT. The Company's gross profit for the year decreased $1.6 million, or 2.3%. The decrease was caused by the 3.0% decrease in operating revenue partially offset by the 3.8% decrease in cost of products sold. The Company's gross profit per gallon was relatively constant at $.430 in fiscal year 1994 and $.429 in fiscal year 1993.\nGENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expenses increased $3.0 million, or 7.5% from $40.4 million in fiscal year 1993 to $43.5 million in fiscal year 1994. The increase was due primarily to increases of $1.0 million in insurance and liability claims, $800,000 in salaries and commissions, and $400,000 in professional fees. The increase in insurance and liability claims was due primarily to increased claims. The increase in salaries and commissions was due to annual pay increases combined with a slight decrease in the total number of employees. The increase in professional fees was due to increased litigation fees relating to liability claims and increased accounting and other fees related to the Transaction that were not capitalized. Other smaller increases were incurred in transportation, office expenses, taxes and licenses, rent and maintenance, payroll taxes and employee benefits, travel and entertainment, and advertising.\nPROVISION FOR DOUBTFUL ACCOUNTS. The provision for doubtful accounts increased $100,000 from $960,000 in fiscal year 1993 to $1.1 million in fiscal year 1994. This\nincrease was the result of a slightly older aging of accounts receivable at June 30, 1994, compared to June 30, 1993.\nDEPRECIATION AND AMORTIZATION. Depreciation and amortization remained relatively constant, decreasing by $200,000, or 1.9%, from $10.4 million in fiscal year 1993 to $10.2 million in fiscal year 1994.\nINTEREST EXPENSE. Cash interest expense decreased by approximately $1.3 million, or 13.1%, from $9.8 million in fiscal year 1993 to $8.5 million in fiscal year 1994. This decrease was the result of lower interest rates and reduced borrowing levels as compared to the prior year. Amortization of debt discount and expense increased $300,000, or 19.6%, from $1.7 million in 1993 to $2.0 million in 1994. This increase related to increased amortization of the discounts on the Company's 1998 9% Subordinated Debentures, 2007 9% Subordinated Debentures, and 12% Senior Subordinated Debentures, as well as amortization of expenses related to the Company's credit facility.\nRECAPITALIZATION COSTS. During fiscal years 1994 and 1993, the Company incurred $398,000 and $223,000, respectively, in expenses relating to proposed recapitalizations that the Company later decided not to pursue.\nINCOME TAXES. The effective tax rate for the fiscal year ended June 30, 1994, was approximately 41.7% compared to 47.8% for the fiscal year ended June 30, 1993. The Company had a positive effective tax rate in 1994 despite its reported loss primarily because of the amortization of the excess of cost over fair value of assets sold and state income taxes imposed on operations that were profitable in individual states.\nFISCAL YEARS ENDED JUNE 30, 1993 AND JUNE 30, 1992\nOPERATING REVENUE. Operating revenue increased $16.3 million, or 14.5%, from $112.1 million in fiscal year 1992 to $128.4 million in fiscal year 1993. This increase was the result of a $15.9 million increase in propane sales and $800,000 increase in sales of parts and gas appliances, offset by a $400,000 decrease in other revenues. The increase in propane sales was caused by a 12.1% increase in gallons sold and a 2% increase in the average gross sales price per gallon. The increased volume reflects the results of a winter heating season that was considered nearly normal based on historical standards as compared to a warmer winter heating season in fiscal year 1992. Other revenues decreased by $400,000 primarily due to a decrease in fixed asset sales.\nCOST OF PRODUCTS SOLD. Cost of products sold increased $9.2 million, or 18%, from $51.0 million in fiscal year 1992 to $60.2 million in fiscal year 1993. The increase resulted from the 12.1% increase in gallons sold, which reflects the increase in weighted average heating degree days, and a 4% increase in the wholesale cost of propane.\nGROSS PROFIT. The Company's gross profit for the year increased $7.1 million, or 11.6%. The increase was caused by a 14.5% increase in operating revenue offset by an 18% increase in cost of products sold. The Company's gross profit per gallon was relatively constant at $.429 in fiscal year 1993 and $.425 in fiscal year 1992.\nGENERAL AND ADMINISTRATIVE EXPENSE. General and administrative expenses increased $1.0 million, or 2.5%, from $39.4 million in fiscal year 1992 to $40.4 million in fiscal year 1993. The increase was due primarily to increases of $800,000 in salaries and commissions and $600,000 in insurance and liability claims, offset by a decrease of $200,000 in professional fees. The increase in salaries and commissions reflects an increase in the commissions earned due to the increased sales activity. The increase in insurance costs is primarily due to higher worker compensation insurance premiums. The decrease in professional fees is due to reduced legal fees primarily related to federal income tax matters that have been settled.\nPROVISION FOR DOUBTFUL ACCOUNTS. The provision for doubtful accounts increased $760,000 from $200,000 in fiscal year 1992 to $960,000 in fiscal year 1993. This increase reflects the adjustment of the Company's annual provision to a level that the Company believes will be indicative of normal provisions for future years. The provision for fiscal year 1992 was much lower because the Company had significantly increased its provision in fiscal year 1991 due to concerns about the effect of the Persian Gulf crisis and the economy on its operations. The provision for fiscal year 1991 was more than adequate due, in part, to certain measures the Company implemented in fiscal year 1992 that improved the monitoring of its accounts receivable. Accordingly, a relatively small provision was required for fiscal year 1992.\nDEPRECIATION AND AMORTIZATION. Depreciation and amortization remained relatively constant, increasing by $300,000 or 3%, from $10.1 million in 1992 to $10.4 million in 1993.\nINTEREST EXPENSE. Cash interest expense decreased by approximately $900,000 or 8.4%, from $10.7 million in fiscal year 1992 to $9.8 million in fiscal year 1993. This decrease was primarily attributable to lower interest rates in fiscal year 1993. Amortization of debt discount and expense increased $700,000 or 70% from $1.0 million in 1992 to $1.7 million in 1993. This increase related to increased amortization of the discounts on the Company's 1998 9% Subordinated Convertible Debentures, 2007 9% Subordinated Debentures, and 12% Senior Subordinated Debentures, as well as amortization of expenses related to the Company's credit facility.\nRECAPITALIZATION COSTS. During fiscal year 1993, the Company incurred $200,000 in expenses relating to a proposed recapitalization that the Company later decided not to pursue.\nINCOME TAXES. The effective tax rate for the fiscal year ended June 30, 1993 was 47.8% compared to 24.5% for the fiscal year ended June 30, 1992. The increase was the result of the Company's reporting an income in the 1993 period compared to a loss in the 1992 period. The Company had a positive effective tax rate in 1992 despite its reported loss primarily because of state taxes imposed on operations that were profitable in individual states and because of the effective tax resulting from the amortization of the excess of cost over fair value of assets sold.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's liquidity requirements have arisen primarily from funding its working capital needs, capital expenditures and debt service obligations. Historically, the Company has met these requirements from cash flow generated by operations and from borrowings under its revolving credit line.\nCash flow provided from operating activities was $12.9 million in fiscal year 1994 as compared to $6.2 million in fiscal year 1993. Working capital provided from operating activities was $9.1 million in fiscal year 1994 as compared to $13.6 million in fiscal year 1993. This reduction in working capital resulted from the $4.5 million decrease in operating income in fiscal 1994 compared to 1993. This reduction in net income and working capital did not reduce cash flow provided by operations due to the following factors: (i) checks in the process of collection increased $3.3 million in 1994 and (ii) inventories and accounts receivable decreased $1.0 million and accounts payable and accrued expenses related to self insurance claims increased by $1.1 million offset by an increase in prepaid expenses principally related to refundable income taxes of $1.6 million. The working capital items noted above that increased cash flow by $3.8 million in 1994 contributed a decrease in cash flow of $7.4 million in 1993.\nThe Company will be required to use a significant portion of its cash flow from operations to meet its debt service obligations. In addition to normal operating cash needs, the Company anticipates debenture interest payments of approximately $9.8 million in fiscal 1995. The Company's high degree of leverage makes it vulnerable to adverse changes in the weather and may limit its ability to respond to market conditions, to capitalize on business opportunities, and to meet its contractual and financial obligations. Fluctuations in interest rates will affect the Company's financial condition inasmuch as the Company's credit facility bears interest at a floating rate. The Company believes that, based on current levels of operations and assuming winter weather that is not substantially warmer in the various regions in which it operates than the historical average of winter temperatures for those regions, it will be able to fund its debt service obligations from funds generated from operations, proceeds of potential sales of service centers and funds available under its credit facility.\nThe seasonal nature of the Company's business will require it to rely on borrowings under its $15.0 million credit facility as well as cash from operations,\nparticularly during the summer and fall months when the Company is building its inventory in preparation for the winter heating season. While approximately two-thirds of the Company's operating revenue is earned in the second and third quarters of its fiscal year, certain expense items such as general and administrative expense are recognized on a more annualized basis. Interest expense also tends to be higher during the summer and fall months because the Company relies in part on increased borrowings on its revolving credit line to finance inventory purchases in preparation for the Company's winter heating season.\nThe Company's capital expenditures consist of routine expenditures for existing operations as well as non-recurring expenditures, purchases of assets for the start-up of new retail service centers, and acquisition costs (including costs of acquiring retail service centers). Routine expenditures usually consist of expenditures relating to the Company's bulk delivery trucks, customer tanks, and costs associated with the installation of new tanks.\nThe Company's capital expenditures in fiscal year 1994 were $20.0 million which increased approximately $15.6 million from the preceding year. The increase was due primarily to the acquisition of PSNC Propane Corporation, an acquisition of a service center in Colorado (requiring a cash payment of $273,000 and the issuance of two five-year notes) and increased purchases of new transportation equipment. The Company's proceeds from sales of fixed assets decreased approximately $700,000 which was due to the lack of any sales of existing companies and the reduction of other sales of property compared to the previous year.\nThe Company intends to fund its routine capital expenditures and the purchase of assets for new retail service centers with cash from operations, borrowings under its credit facility, or other bank financing. The Company intends to fund acquisitions with seller financing, to the extent feasible, and with cash from operations or bank financing. The Company is exploring the possibility of making modifications to its underground storage facility, and management believes that the required modifications can be made for a cost of approximately $2.0 million. The Company is currently exploring options for financing these modifications, and there is no assurance that such financing will be available.\nThe Company's credit facility and the indenture for the Senior Secured Notes impose restrictions on the Company's ability to incur additional indebtedness. Such restrictions, together with the highly leveraged position of the Company, could restrict the ability of the Company to acquire financing for capital expenditures and other corporate activities. These restrictions permit additional indebtedness of $6 million for the current fiscal year for the purpose of financing acquisitions, but allow additional indebtness to be incurred by subsidiaries formed for the purpose of making acquisitions as long as the Company does not transfer over $3,000,000 (in the aggregate) of assets to such subsidiaries.\nThe Company's $15.0 million credit facility will mature on or about July, 1997, at which time the Company will have to refinance or replace some portion of the facility and may be required to pay some portion of any outstanding balance. There can be no assurance that the Company will be able to refinance or replace the credit facility, or the\nterms upon which any such financing may occur. Beginning in fiscal year 1999, the cash interest rate on the Senior Secured Notes will increase to 12 7\/8%. The Company believes cash from operations will be sufficient to meet the increased interest payments.\nCHANGE IN ACCOUNTING PRINCIPLE\nEffective July 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). As a result of this change, there was no material effect upon the Company's financial statements. SFAS 109 requires recognition of deferred tax liabilities and assets for the difference between the financial statement and tax basis of assets and liabilities. Under this new standard, a valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized. Prior to fiscal year 1994, deferred taxes were determined using the Statement of Financial Accounting Standards No. 96.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee the Consolidated Financial Statements included elsewhere 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 the Company are as follows:\nNAME AGE POSITION HELD WITH THE COMPANY AND PRINCIPAL OCCUPATION\nPaul S. Lindsey, Jr. 49 Chairman of the Board, Chief Executive Officer, and President since June 1994; previously Vice Chairman of the Board (since February 1987) and Chief Operating Officer (since March 1988); term as director expires 1997\nDouglas A. Brown 34 Director since July 1994; member Holding Capital Group, Inc. (since 1989); term as director expires 1997\nKristin L. Lindsey 46 Director\/Vice President since June 1994; previously pursued charitable and other personal interests; term as director expires\nBruce M. Withers, Jr.67 Director since July 1994; Chairman and Chief Executive Officer of Trident NGL Holding, Inc. (since August 1991) and President of the Transmission and Processing Division of Mitchell Energy Corporation (1979 to 1991); term as director expires 1996\nJim J. Shoemake 56 Director since July 1994; partner of Guilfoil, Petzall & Shoemake (since 1970); term as director expires 1995\nMark W. Buettner 52 Divisional Vice President since mid-1993; and Regional Vice President and Regional Manager from 1989 to 1993\nKenneth J. DePrinzio 47 Divisional Vice President since mid-1993; previously Regional Manager of the Company (1992 to 1993), restaurant owner 1991 to 1992, Vice President of Star Gas Corporation (1990 to 1991) and Area Vice President at Petrolane, Inc. (from prior to 1989 through 1990)\nRobert C. Heagerty 47 Divisional Vice President since mid-1993; previously Regional Manager and Regional Vice President since 1987\nJames E. Acreman 57 Vice President\/Treasurer since June 1994; previously Senior Vice President since 1989\nValeria Schall 40 Vice President since 1992; Corporate Secretary since 1985 and Assistant to the Chairman (Assistant to the Vice Chairman prior to June 1994) since 1987\nWillis D. Green 57 Controller since 1989\nAfter expiration of the initial terms of directors as set forth above, each director will serve for a term of three years. Officers of the Company are elected by the Board of Directors of the Company and will serve at the discretion of the Board, except for Mr. Lindsey who is employed pursuant to an employment agreement that expires June 24, 1999 (subject to extension).\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nEXECUTIVE COMPENSATION\nThe following table provides compensation information for each of the years ended June 30, 1994, 1993, and 1992 for (i) the Chief Executive Officer of the Company, (ii) the four other executive officers of the Company who are most highly compensated and whose total compensation exceeded $100,000 for the most recent fiscal year and (iii) those persons who are no longer executive officers of the Company but were among the four most highly compensated and whose total compensation exceeded $100,000 for the most recent year.\nEMPLOYMENT AGREEMENTS\nOn June 24, 1994, the Company entered into an employment agreement with Mr. Lindsey. The agreement has a five-year term and provides for the payment of an annual salary of $350,000 and reimbursement for reasonable travel and business expenses. The agreement requires Mr. Lindsey to devote substantially all of his time to the Company's business. The agreement is for a term of five years, but is automatically renewed for one year unless either party elects to terminate the agreement at least four months prior to the end of the term or any extension. The agreement may be terminated by Mr. Lindsey or the Company, but if the agreement is terminated by the Company and without cause, the Company must pay one year's salary as severance pay.\nINCENTIVE STOCK OPTION PLAN\nThe following table sets forth certain information concerning options exercised during fiscal year 1994. There were no unexercised options held as of the end of the 1994 fiscal year.\nAGGREGATED OPTION EXERCISES IN THE FISCAL YEAR ENDED JUNE 30, 1994 AND FISCAL YEAR-END OPTION VALUES\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company did not during its last completed fiscal year have a compensation committee. A compensation committee was formed in July 1994, consisting of Messrs. Withers, Shoemake and Brown. An entity affiliated with Mr. Brown received $500,000 in the year ended June 30, 1994 with respect to certain financial and advisory services. See \"Item 13 - Certain Relationships and Related Transactions (Other Transactions and Relationships).\" Mr. Lindsey makes the initial decision concerning executive compensation for the executive officers of the Company, other than decisions concerning his own and his wife's compensation, which are then approved by the compensation committee. The compensation committee will determine the compensation of Mr. Lindsey and his wife.\nDIRECTOR COMPENSATION\nDuring the last completed fiscal year, the directors of Empire Gas did not receive any compensation for their services. Directors of a subsidiary of Empire Gas, other than Mr. Lindsey and Mr. Stephen Plaster, received an annual fee of $25,000, payable quarterly, for their services. Beginning with the 1995 fiscal year, all directors of Empire Gas will receive an annual fee of $25,000, payable quarterly.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe table below sets forth information with respect to the beneficial ownership of shares of Common Stock of the Company as of September 15, 1994, by persons owning more than five percent of any class, by all directors of the Company, by the individuals named in the Summary Compensation Table owning shares, and by all directors and executive officers of the Company as a group.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nTHE TRANSACTION\nThe following occurred in connection with the Transaction:\nPursuant to the terms of a stock redemption agreement entered into between the Company, Robert W. Plaster and certain other shareholders (the \"Stock Redemption Agreement\"), the Company repurchased the shares of Common Stock held by Mr. Robert W. Plaster, and trusts for the benefit of Mr. Plaster, Mr. Stephen R. Plaster, and certain of their relatives by exchanging one share of common stock (\"Energy Common Stock\") of Energy for each share of Common Stock of the Company held by such shareholders. The Stock Redemption Agreement also obligated the Company to repurchase the shares of Common Stock held by Mr. Robert L. Wooldridge, an executive officer of the Company, and Mr. S. A. Spencer, a director of a subsidiary of the Company. Mr. Wooldridge and Mr. Spencer received $7.00 per share for a portion of their shares of Common Stock and one share of Energy Common Stock for each of their remaining shares of Common Stock of the Company. The aggregate amount of shares of Common Stock held by these individuals and the consideration received for the shares are as set forth below:\nUpon consummation of the Transaction, Mr. Plaster resigned from his positions as Chairman of the Board and as Chief Executive Officer of the Company and from his positions with the Company's subsidiaries. Messrs. S. Plaster, Wooldridge, and Spencer also resigned from their positions with the Company and its subsidiaries. Energy and Messrs. Plaster and S. Plaster have entered into a non-competition agreement which restricts them and their respective affiliates from competing with the Company, Mr. Lindsey and their respective affiliates in the territories in which the Company is doing business immediately\nfollowing the Stock Purchase. Similarly, Empire Gas, Mr. Lindsey, and their respective affiliates are restricted from competing with Energy, Messrs. Plaster and S. Plaster and their respective affiliates in seven states and certain areas within five states. The non-competition agreement is for a term of three years from the date on which the Transaction is consummated. Certain relatives of Mr. Plaster and Mr. Lindsey, and the officers of Energy and the Company entered into a substantially similar non-competition agreement.\nPursuant to the Stock Redemption Agreement: (i) Empire Gas made a payment of $1,497,031 to Energy based on the balance of certain liabilities net of certain assets as of the date on which the Transaction is consummated; (ii) the Company paid Energy approximately $4.1 million; (iii) the Company and Energy entered into an agreement regarding use of the Empire Gas name and logo; and (iv) the responsibility for litigation relating to matters or events occurring prior to the Transaction (most of which is related to liability within the Company's deductibles under its insurance policies), and the responsibility for any costs related to any such litigation were allocated 52.3% to the Company and 47.7% to Energy. The Company and Energy also entered into a tax indemnity agreement allocating liability for taxes incurred prior to the Transaction.\nPursuant to the terms of the Stock Redemption Agreement, the Company repurchased, at face value, $4.7 million principal amount of the Company's 2007 9% Subordinated Debentures from Robert W. Plaster and purchased, at face value, $285,000 principal amount of the Company's 2007 9% Subordinated Debentures from certain departing officers and employees of the Company.\nOTHER TRANSACTIONS AND RELATIONSHIPS\nThe Company and Service Corp., a wholly owned subsidiary of Energy controlled by Mr. Robert W. Plaster as a result of the Transaction, entered into an agreement (the \"Service Agreement\") pursuant to which Service Corp. provides to the Company certain data processing and management information services. The Company pays a monthly fee equal to (i) its proportionate share of the actual costs incurred by Service Corp. in providing these services to the Company and to Energy, less approximately $2,500 for services provided to two other entities controlled by Mr. Plaster, and (ii) the actual cost incurred for certain telephone and postal costs and for the maintenance contract for the computer terminals used by the Company in its operations. At any time after June 30, 1998, the Company may terminate the Service Agreement in the event of a change in its business circumstances, such as an acquisition. In the event that the Company terminates the Service Agreement prior to its expiration date, the Company will continue to be obligated to pay, for the remainder of the original term, a monthly payment equal to the amount paid by the Company for the last full month for which services were rendered. The Service Agreement is for a term expiring June 30, 2001, subject to earlier termination if the Company's new lease for its headquarters expires or if there is a change in control of the Company.\nPrior to the Transaction, the Company leased its headquarters in Lebanon, Missouri from a corporation controlled by Mr. Robert W. Plaster, under a lease agreement effective June 30, 1991 for an initial term ending June 30, 2001. The Company made annual lease payments of $200,000 in fiscal year 1994. The Company also paid the utilities, taxes and maintenance costs during that year. That lease was terminated and a new lease became effective upon consummation of the Transaction. The new lease provides the Company the right to use approximately 8,020 square feet of office space in the Lebanon location as well as the use of the parking facilities for a term expiring June 30, 2001. The Company pays monthly rent of $6,250 and is responsible for its proportionate share of utilities and taxes and for the payment of certain repairs and maintenance costs. The lease is subject to earlier termination, at the option of the lessor, in the event of a change in control of the Company. At any time after June 30, 1998, the Company may terminate the lease in the event of a change in its business circumstances, such as an acquisition. In the event the Company terminates the lease prior to its expiration date, the Company will continue to be obligated to pay, for the remainder of the original term, the monthly rent payment; provided, however, that the lessor shall use its best efforts to re-let the premises.\nPursuant to an agreement (\"the Aircraft Facility Agreement\"), the Company leased a jet aircraft and an airport hangar from a corporation owned by Mr. Robert W. Plaster during fiscal year 1994. Under the terms of this agreement, the Company was responsible for direct lease payments and operating costs, including insurance, of the aircraft and the hangar. The Company paid direct rent of $75,000 in fiscal year 1994. In connection with the Transaction, the Aircraft Facility Agreement was terminated; however, pursuant to the Stock Redemption Agreement, the Company may use the hangar, at no cost, for storage and maintenance of the Company's two turbo prop aircraft for a term that coincides with the Company's new lease for its headquarters.\nMrs. Kristin L. Lindsey, who beneficially owns approximately 47.7% of the Company's outstanding Common Stock and became a director of the Company upon consummation of the Transaction, is the majority stockholder in a company that supplies paint to the Company. The Company's purchases of paint from this company totalled $210,400 in fiscal year 1994.\nDuring fiscal year 1994, the Company received certain financial advisory services in connection with the negotiation of the Company's revolving credit facility and with the structuring and execution of the offering of the Senior Secured Notes from Mr. Douglas A. Brown and Holding Capital Group, Inc. (\"HCGI\"). HCGI received $500,000 in aggregate with respect to those services.\nThe Company has entered into an agreement with each person who was a shareholder prior to the Transaction (all of whom were directors or employees of the Company) providing the Company with a right of first refusal with respect to the sale of any shares by such shareholders. In addition, the Company has the right to purchase from such shareholders all shares they hold at the time of their termination of employment with the\nCompany at the then current fair market value of the shares. The fair market value is determined in the first instance by the Board of Directors and by an independent appraisal (the cost of which is split between the Company and the departing shareholder) if the departing shareholder disputes the board's determination.\nDuring fiscal year 1994, pursuant to an agreement (the \"Ranch Agreement\"), the Company paid $150,000 and provided services at a cost of approximately $25,000 to a wildlife preserve owned by Empire Ranch, Inc., a corporation wholly owned by Mr. Robert W. Plaster and members of his family. The Company used the facilities at the preserve for meetings with Company employees and business guests. The Ranch Agreement was terminated in connection with the Transaction.\nPrior to the Transaction, the Company provided bookkeeping, data processing, and accounting services to two corporations controlled by Mr. Robert W. Plaster. The Company received an annual fee of $84,000 in fiscal year 1994 for providing these services. Since the Transaction, the Company no longer provides these services to the two corporations.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) Exhibits\nEXHIBIT NO. DESCRIPTION - - -- ----------- 2.1 Stock Redemption Agreement, dated May 7, 1994, between the Company, EGOC, Energy, Robert W. Plaster, Paul S. Lindsey, Jr., Stephen R. Plaster, Joseph L. Schaefer, the Robert W. Plaster Trust dated December 13, 1988, the Stephen Robert Plaster Trust dated October 30, 1988, the Stephen Robert Plaster Trust dated July 30, 1984, Empire Ranch, Inc., Empire Airlines, Inc., and Evergreen National Corporation (incorporated herein by reference to Exhibit 10.1 to the Empire Gas Operating Corporation (Commission File No. 1-6537-3) Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994)\n2.2 Stock Redemption Agreement, dated May 7, 1994, between the Company, the Dolly Francine Plaster Trust dated July 30, 1984, the Tammy Jane Plaster Trust dated July 30, 1984, the Cheryl Jean Plaster Schaefer Trust dated October 30, 1988, and the Cheryl Jean Plaster Schaefer Trust dated July 30, 1984 (incorporated herein by reference to Exhibit 2.2 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n2.3 Merger Agreement by and between the Company and EGOC\n3.1 Articles of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n3.2 Certificate of Amendment of the Certificate of Incorporation of the Company, dated April 26, 1994, relating to the change of name (incorporated herein by reference to Exhibit 3.2 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n3.3 By-laws of the Company (incorporated herein by reference to Exhibit 3.3 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n4.1 Indenture between Empire Gas Corporation and J. Henry Schroder Bank & Trust Company, Trustee, relating to the 9% Subordinated Debentures due December 31, 2007 and the form of 9% Subordinated Debentures due December 31, 2007 (incorporated herein by reference to Exhibit 4(a) to the Empire Incorporated and Exco Acquisition Corp. (Commission File No. 2-83683) Registration Statement on Form S-14 filed with the Commission on May 11, 1983); and First Supplemental Indenture thereto between Empire Gas Corporation (now known as EGOC) and IBJ Schroder Bank & Trust Co., dated as of December 13, 1989 (incorporated herein by reference to Exhibit 4(c) to Empire Gas Corporation (now known as EGOC) Registration Statement on Form 8-B filed with the Commission on February 1, 1990)\n4.2 Indenture between the Company and Shawmut Bank Connecticut, National Association, Trustee, relating to the 12 7\/8% Senior Secured Notes due 2004, including the 12 7\/8% Senior Secured Notes due 2004, the Guarantee and the Pledge Agreement\n4.3 Warrant Agreement\n10.1 Shareholder Agreement, dated as of October 28, 1988, by and among Empire Gas Acquisition Corporation and Robert W. Plaster Trust, Robert W. Plaster, Trustee; Paul S. Lindsey, Jr.; Stephen R. Plaster Trust, Lynn C. Hoover, Trustee; Cheryl Plaster Schaefer Trust, Lynn C. Hoover, Trustee; Robert L. Wooldridge; Gwendolyn B. VanDerhoef; Dwight Gilpin; Luther Henry Gill; Valeria Schall; Floyd J. Waterman; Larry W. Bisig; Larry Weis; Robert Heagerty; Murl J. Waterman; Earl L. Noe; Thomas Flak; Michael Kent St. John; James E. Acreman; Carolyn S. Rein; Dan Weatherly; Nina Irene Craighead; Joyce Sue Kinnett; Edwin H. McMahon; Paul Stahlman; Ralph Wilson; Alan Simer; Ferrell Stamper; and Empire Gas Corporation Employee Stock Ownership Plan, Robert W. Plaster, Trustee (incorporated herein by\nreference to Exhibit 10.1 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.2 1989 Incentive Stock Option Plan (incorporated herein by reference to Exhibit 10.2 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.3 Credit Agreement between the Company and Continental Bank, as agent\n10.4 Lease Agreement, dated May 7, 1994, between the Company and Evergreen National Corporation (incorporated herein by reference to Exhibit F of Exhibit 10.1 to the Empire Gas Operating Corporation (Commission File No. 1-6537-3) Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994)\n10.5 Services Agreement, dated May 7, 1994, between the Company and Empire Service Corporation (incorporated herein by reference to Exhibit G of Exhibit 10.1 to the Empire Gas Operating Corporation (Commission File No. 1-6537-3) Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994)\n10.6 Non-Competition Agreement, dated May 7, 1994, by and among the Company, Energy, Robert W. Plaster, Stephen R. Plaster, Joseph L. Schaefer, Paul S. Lindsey, Jr. (incorporated herein by reference to Exhibit E of Exhibit 10.1 to the Empire Gas Operating Corporation (Commission File No. 1-6537-3) Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 1994)\n10.7 Employment Agreement between the Company and Paul S. Lindsey, Jr. (incorporated herein by reference to Exhibit 10.7 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.8 Asset Purchase Agreement by and among the Company, Empire Gas, Inc. of North Carolina, PSNC Propane Corporation, and Public Service Company of North Carolina, Incorporated (incorporated herein by reference to Exhibit 10.8 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.9 Indemnification Agreement between the Company and Douglas A. Brown (incorporated herein by reference to Exhibit 10.9 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.10 Tax Indemnification Agreement between the Company and Energy (incorporated herein by reference to Exhibit 10.10 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.11 Supply Contract No. 1, dated September 13, 1991, between EGOC and Phillips 66 Company (incorporated herein by reference to Exhibit 10.11 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.12 Supply Contract No. 2, dated September 13, 1991, between EGOC and Phillips 66 Company; and Amendment thereto between EGOC and Phillips 66 Company, dated October 15, 1992 (incorporated herein by reference to Exhibit 10.12 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.13 Supply Contract, dated as of November 4, 1991, between EGOC and Conoco, Inc. (incorporated herein by reference to Exhibit 10.13 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.14 Supply Contract, dated as of January 21, 1992, between EGOC and Conoco Inc. (incorporated herein by reference to Exhibit 10.14 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.15 Supply Contract, dated as of January 24, 1992, between EGOC and Conoco, Inc. (incorporated herein by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.16 Supply Contract No. 1, dated November 20, 1986, between EGOC and Warren Petroleum Company (incorporated herein by reference to Exhibit 10.16 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.17 Supply Contract No. 2, dated November 20, 1986, between EGOC and Warren Petroleum Company (incorporated herein by reference to Exhibit 10.17 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.18 Supply Contract, dated November 22, 1986, between EGOC and Warren Petroleum Company (incorporated herein by reference to Exhibit 10.18 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.19 Supply Contract, dated November 24, 1986, between EGOC and Warren Petroleum Company (incorporated herein by reference to Exhibit 10.19 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.20 Supply Contract No. 1, dated June 1, 1993, between EGOC and Warren Petroleum Company (incorporated herein by reference to Exhibit 10.20 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n10.21 Supply Contract No. 2, dated June 1, 1993, between EGOC and Warren Petroleum Company (incorporated herein by reference to Exhibit 10.21 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n21.1 Subsidiaries of the Company (incorporated herein by reference to Exhibit 21.1 to the Company's Registration Statement on Form S-1 (No. 33-53343))\n27.1 Financial Data Schedules\n(b) Financial Statement Schedules\nSCHEDULE DESCRIPTION\nV. Property and Equipment VI. Accumulated Depreciation VIII. Valuation and Qualifying Accounts X. Supplementary Income Statement Information\n(c) Reports on Form 8-K\nThe predecessor of the Company filed a report on Form 8-K on April 29, 1994 reporting under Item 5 of Form 8-K the agreement to enter into the Transaction and the filing of the registration statement with respect to the Senior Secured Notes.\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.\nEmpire Gas Corporation\nBy: \/S\/ PAUL S. LINDSEY, JR. ------------------------- Paul S. Lindsey, Jr.\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 CAPACITY IN WHICH SIGNED DATE\n\/s\/ Paul S. Lindsey, Jr. Chief Executive Officer and September 27, 1994 - - ------------------------ Chairman of the Board of Paul S. Lindsey, Jr. Empire Gas Corporation (principal financial and executive officer)\n\/s\/ Willis D. Green Vice President\/Controller September 27, 1994 - - ------------------- of Empire Gas Corporation Willis D. Green (principal accounting officer)\n\/s\/ Douglas A. Brown Director of Empire Gas September 27, 1994 - - -------------------- Corporation Douglas A. Brown\n\/s\/ Kristin L. Lindsey Director of Empire Gas September 27, 1994\n- - ---------------------- Corporation Kristin L. Lindsey\n\/s\/ Bruce M. Withers, Jr. Director of Empire Gas September 27, 1994 - - ------------------------- Corporation Bruce M. Withers, Jr.\n\/s\/ Jim J. Shoemake Director of Empire Gas September 27, 1994 - - ------------------- Corporation Jim J. Shoemake\nFINANCIAL STATEMENT INDEX\nEmpire Gas Corporation - Consolidated Financial Statements for June 30, 1994\nIndependent Accountants' Report........................................... 34\nConsolidated Balance Sheets as of June 30, 1994 and 1993.................. 35\nConsolidated Statements of Operations - Years Ended June 30, 1994, 1993, and 1992............................................................ 37\nConsolidated Statements of Stockholder's Equity - Years Ended June 20, 1994, 1993, and 1992............................................. 39\nConsolidated Statements of Cash Flows - Years Ended June 30, 1994, 1993, and 1992...................................................... 40\nFINANCIAL STATEMENT SCHEDULE INDEX\nEmpire Gas Corporation - Consolidated Financial Statements for June 30, 1994\nIndependent Accountants' Report.................................61\nSchedule V - Property and Equipment.............................62\nSchedule VI - Accumulated Depreciation and Depletion............63\nSchedule VIII - Valuation and Qualifying Accounts...............64\nSchedule X - Supplementary Information..........................65\nINDEPENDENT ACCOUNTANTS' REPORT\nBoard of Directors and Stockholders Empire Gas Corporation Lebanon, Missouri\nWe have audited the accompanying consolidated balance sheets of EMPIRE GAS CORPORATION (FORMERLY EMPIRE GAS ACQUISITION CORPORATION) as of June 30, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three years in the period ended June 30, 1994. 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 financial position of EMPIRE GAS CORPORATION as of June 30, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 4, the Company changed its method of accounting for income taxes in 1994.\nSpringfield, Missouri August 26, 1994\nSee Notes to Consolidated Financial Statements\nEMPIRE GAS CORPORATION\nCONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee Notes to Consolidated Financial Statements\nEMPIRE GAS CORPORATION\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee Notes to Consolidated Financial Statements\nEMPIRE GAS CORPORATION\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)\nYEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS)\nSee Notes to Consolidated Financial Statements\nEMPIRE GAS CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS)\nSee Notes to Consolidated Financial Statements\nEMPIRE GAS CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS)\nSee Notes to Consolidated Financial Statements\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1994\nNOTE 1: ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNATURE OF BUSINESS\nThe Company's principal operations are the sale of LP gas at retail and wholesale. Most of the Company's customers are owners of residential single or multi-family dwellings who make periodic purchases on credit. Such customers are located throughout the United States with the larger number concentrated in the central and western states and along the Pacific coast. The Company was formed in September 1988 to acquire 100% of the stock of Empire Gas Operating Corporation (formerly Empire Gas Corporation) in a transaction which was accounted for by the purchase method of accounting. At acquisition date, asset and liability values were recorded at their market values with respect to the purchase price. At June 30, 1994, the Company's ownership and management was changed. See Note 2 for a description of this restructuring transaction.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Empire Gas Corporation and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.\nREVENUE RECOGNITION POLICY\nSales and related cost of product sold are recognized upon delivery of the product or service.\nINVENTORIES\nInventories are valued at the lower of cost or market. Cost is determined by the first-in, first-out method for retail operations and specific identification method for wholesale operations. At June 30 the inventories were:\nNOTE 1:ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nPROPERTY AND EQUIPMENT\nDepreciation is provided on all property and equipment on the straight-line method over estimated useful lives of 5 to 33 years.\nINCOME TAXES\nDeferred tax liabilities and assets are recognized for the tax effects of differences between the financial statement and tax bases of assets and liabilities. A valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.\nAMORTIZATION\nDebt acquisition costs are being amortized on a straight-line basis over the terms of the debt to which the costs are related as follows: the revolving credit facility and term credit facility costs (originally $525,000) were amortized over an original five-year period ending in fiscal 1994; the 1994 senior secured note costs (originally $5,105,000) are amortized over ten years; and the new revolving credit facility costs (originally $301,000) are amortized over three years.\nAmortization of discounts on debentures and notes (Note 3) is on the effective interest, bonds outstanding method.\nThe excess of cost over fair value of net assets acquired (originally $25,600,000 in 1993, $20,750,000 in 1994 after giving effect to the restructuring transaction) is being amortized on the straight-line basis over 20 years.\nINCOME PER COMMON SHARE\nIncome per common share is computed by dividing net income by the weighted average number of common shares and, except where anti-dilutive, common share equivalents outstanding, if any. The weighted average number of common shares outstanding used in the computation of earnings per share was 13,961,520, 14,055,407 and 13,885,087 for each of the fiscal years ended June 30, 1994, 1993 and 1992, respectively.\nNOTE 2: RESTRUCTURING TRANSACTION\nOn June 30, 1994, the Company implemented a change in ownership and management by repurchasing 12,004,430 shares of Company common stock from its former principal shareholder (Former Shareholder) and certain other departing officers in exchange for all of the shares of a subsidiary Empire Energy Corporation (Energy) that owns 133 retail service centers located principally in the Southeast plus certain home office assets and liabilities. Certain departing officers and employees received $7.00 per share net of the stock option exercise price for the remaining 377,865 shares of common stock that they held. The Company will retain ownership of 158 retail service centers located in 20 states plus certain home office assets and liabilities.\nIn connection with the stock purchase, the Former Shareholder terminated his employment with the Company as well as terminated certain lease and use agreements with the Company (see Note 3). Following the stock repurchase, the Company's previous chief operating officer became the Company's president, chairman of the board and principal shareholder (Principal Shareholder).\nThe Company has received a private letter ruling from the Internal Revenue Service which provides that, based on certain representations contained in the ruling, neither income nor gain for federal income tax purposes will be recognized by the Company as a result of the stock purchase.\nIn connection with the stock purchase, the Company issued $127.2 million of new debentures (with proceeds of $100.1 million before expenses of $3.5 million) which was used to retire $77.9 million of existing debt. The remaining net proceeds were used to finance a $12.9 million acquisition of six retail service centers in North Carolina, $2.5 million to repurchase treasury stock and $3.3 million for working capital.\nThe following table sets forth selected aggregate operating data for the retail service centers of the Company that will be retained after the restructuring transaction and for the six retail service centers the Company acquired in North Carolina. This acquisition was consummated June 30, 1994, and was accounted for as a purchase of assets; accordingly, no revenues or expenses related to the acquisition are included in the statement of operations.\nNOTE 2: RESTRUCTURING TRANSACTION (CONTINUED)\nThe Company and Energy have agreed to share certain liabilities at June 30, 1994, based on an agreed-upon percentage which is intended to estimate the relative historical revenue of the retail subsidiaries of the Company (52.3%) and Energy (47.7%). In addition, certain home office assets and liabilities have been retained by the Company and a payable to Energy of $497,031 has been recorded at June 30, 1994, reflecting the settlement of these assets and liabilities in accordance with the stock redemption agreement.\nThe retirement of existing debt (described in Note 4) resulted in an extraordinary loss of $8,655,000, including net unamortized debt acquisition costs of $420,000 related to the debt retired. These amounts were expensed in June 1994 net of $3,100,000 of tax benefit.\nThe excess of fair value of net assets of Energy ($84,031,000) over book value ($46,111,000) was an extraordinary credit to income ($37,870,000) in June 1994, net of $50,000 of income tax expense.\nNOTE 3: RELATED-PARTY TRANSACTIONS\nThe Company has periodically borrowed funds from its Former Shareholder and from individuals and corporations related to the Former Shareholder. The Company had no outstanding borrowings from this related party at June 30, 1994 and 1993. The amount of outstanding borrowings from this Former Shareholder at June 30, 1992, was $2,996,000. The maximum amounts borrowed from this Former Shareholder during the years ended June 30, 1994, 1993 and 1992, were $-0-, $3,000,000 and $5,753,000, respectively. The interest rate on these borrowings was equal to or below the rates available through the working capital facility. Interest expense incurred on these related-party borrowings was $200,000 and $315,000 for the years ended June 30, 1993 and 1992, respectively. During November 1992 the Former Shareholder loaned under a separate agreement $13.25 million to the Company to repay the acquisition credit facility (see Note 4). Interest expense incurred on this related-party borrowing for the year ended June 30, 1993, was $749,000. In June 1993, all outstanding borrowings from the Former Shareholder were repaid using the proceeds from the term credit facility.\nIn connection with the stock purchase, the Company repurchased, at face value, $4.7 million principal amount of the Company's 2007 9% Subordinated Debentures from the Former Shareholder and purchased, at face value, $285,000 principal amount of the Company's 2007 9% Subordinated Debentures from certain departing officers and employees of the Company.\nThe Company provided data processing, office rent and other clerical services to two corporations owned principally by the Former Shareholder and was being reimbursed $7,000 per month for these services. The Company has discontinued providing these services as of June 30, 1994.\nThe Company leased a jet aircraft and an airport hanger from a corporation owned by the Former Shareholder. The lease required annual rent payments of $100,000 beginning April 1, 1992. In addition to direct lease payments, the Company was also responsible for the operating costs of the aircraft and the hanger. During the years ended June 30, 1994, 1993 and 1992, the Company paid direct rent of $75,000, $100,000 and $25,000, respectively. This lease was terminated effective June 30, 1994, at no additional expense to the Company.\nThe Company paid $150,000 in each of the three years ended June 30, 1994, to a corporation owned by the Former Shareholder pursuant to an agreement providing the\nCompany the right to use business guest facilities owned by the corporation. This agreement was terminated effective June 30, 1994, at no additional expense to the Company.\nThe Company leased the corporate home office, land, buildings and equipment from a corporation principally owned by the Former Shareholder. The Company paid $200,000 during each of the three years ended June 30, 1994, related to this lease. This lease was terminated effective June 30, 1994, at no additional expense to the Company. The Company has entered into a new lease agreement with a corporation owned principally by the Former Shareholder principally to lease its corporate office space. The new lease requires annual rent payments of $75,000 beginning July 1, 1994, for a period of seven years, with two three-year renewal options.\nThe Company has entered into a seven-year services agreement with a subsidiary of Energy to provide data processing and management information services beginning July 1, 1994. The services agreement provides for payments by the Company to be based on an allocation of the subsidiary's actual costs based on the gallons of LP gas sold by the Company as a percentage of the gallons of LP gas sold by the Company and Energy.\nDuring 1994, 1993 and 1992, the Company has purchased $210,400, $68,900 and $116,300, respectively, of paint from a corporation owned by the spouse of the Principal Shareholder of the Company.\nDuring fiscal year 1994, the Company paid an investment banking firm affiliated with a director of the Company $500,000 in return for services rendered in connection with the negotiation of the Company's revolving credit facility and with the Restructuring Transaction.\nNOTE 4: LONG-TERM DEBT\nNOTE 4: LONG-TERM DEBT (CONTINUED)\nNOTE 4: LONG-TERM DEBT (CONTINUED)\n(D) The notes, issued June 1994, were issued at a discount and bear interest at 7% through July 15, 1999, and at 12 7\/8 % thereafter. The notes are redeemable at the Company's option. Prior to July 15, 1999, only 35% of the original principal issued may be redeemed, as a whole or in part, at 110% of the principal amount through July 15, 1997, and at declining percentages thereafter. The notes are guaranteed by the subsidiaries of the Company and secured by the common stock of the subsidiaries of the Company.\nThe original principal amount of the notes issued ($127,200,000) was adjusted ($27,980,000) to give effect for the original issue discount and the common stock purchase warrants (effective interest rate of 13.0%). The discount on these notes is being amortized over the remaining life of the notes using the effective interest, bonds outstanding method. The face value of notes outstanding at June 30, 1994, is $127,200,000.\nThe proceeds from this new offering were used to repay the term credit facility, revolving credit facility, 9% Convertible Subordinated Debentures, due 1998; 12% Senior Subordinated Debentures, due 2007; repurchase a portion of the 9% Subordinated Debentures, due 2007; fund an acquisition; repurchase Company stock; and for working capital (Note 2).\nSeparate financial statements of the guarantor subsidiaries are not included because such subsidiaries have jointly and severally guaranteed the notes on a full and unconditional basis, the aggregate assets and liabilities of the guarantor subsidiaries are substantially equivalent to the assets and liabilities of the parent on a consolidated basis and the separate financial statements and other disclosures concerning the subsidiary guarantors are not deemed to be material.\nThe guarantor subsidiaries are restricted from paying dividends to the Company during any periods of default under the respective debt agreements or in periods where the Company has borrowed under the overadvance option described below.\n(E) The new revolving credit facility was provided to the Company in June 1994 in conjunction with the offering of the 12 7\/8% Senior Secured Notes, due 2004. All of the Company's receivables and inventories are pledged to the agreement which contains working capital, capital expenditure, debt and certain dividend restrictions. These dividend restrictions prohibit the Company from paying common stock cash dividends.\nNOTE 4: LONG-TERM DEBT (CONTINUED)\nThe facility provides for borrowings up to $15 million, subject to a sufficient borrowing base. The borrowing base generally limits the Company's total borrowings to 85% of eligible accounts receivable and 60% of eligible inventory. In addition, the Company can borrow an additional $3 million during the period August 1, 1994, to January 31, 1995, and $1.5 million during the period August 1, 1995, to January 31, 1996 (overadvance option). The facility bears interest at either 1% over prime or 2.5% over the LIBOR rate. The agreement provides for a commitment fee of .375% per annum of the unadvanced portion of the commitment. The Company's available revolving credit line amounted to $3,441,000 at June 30, 1994, after considering $1,858,000 of outstanding letters of credit.\n(F) The convertible debentures issued in January 1981 were convertible into common stock at a rate equal to $10.31 of principal amount for each share of common stock through December 1989. In December 1989 the Company executed a supplemental indenture for the convertible debentures. The supplemental indenture provided that the holder of each convertible debenture had, in lieu of the right to convert each debenture into common stock, the right to convert each debenture into the right to receive $3.75 cash for each $10.31 face amount of debentures. The debentures were to mature in 1998; and at maturity, an 8% premium of the outstanding principal amount would have been paid. Such premium was being accrued over the term to maturity. The debentures were redeemable at the Company's option, as a whole or in part, at 100% of the principal amount plus accrued interest to the redemption date, on any date prior to maturity. A sinking fund payment sufficient to retire $1,250,000 of principal was required annually on each December 31. In June 1994, the Company used proceeds from the Issuance of the 12 7\/8% Senior Secured Notes, due 2004, to repurchase $19,980,000 face value of these debentures which resulted in an extraordinary charge (Note 2).\nThe original principal amount of debentures outstanding ($21,854,000) was adjusted to market value (effective interest rate of 14.5%) at June 9, 1983, in accordance with the purchase method of accounting. The discount on these debentures was being amortized over the remaining life of the debentures using the effective interest, bonds outstanding method. There are no debentures outstanding at June 30, 1994.\n(G) The debentures, issued June 1983, are redeemable at the Company's option, as a whole or in part, at par value. A sinking fund payment sufficient to retire $191,000 of principal outstanding is required on December 31, 2005. Notes, due 2004. In June 1994, the Company used proceeds from the issuance of the 12 7\/8% Senior Secured Notes, due 2004, to\nNOTE 4: LONG-TERM DEBT (CONTINUED)\nrepurchase $16,201,200 face value of these debentures at a discount which resulted in an extraordinary charge (Note 2).\nThe original principal amount of debentures issued ($27,313,000) was adjusted to market at issuance (effective interest rate of 16.5%). The remaining discount on these debentures is being amortized over the remaining life of the debentures using the effective interest, bonds outstanding method. The face value of debentures outstanding at June 30, 1994, is $9,745,800.\n(H) The debentures, issued April 1986, were redeemable at the Company's option, as a whole or in part, at 100% of the principal amount plus accrued interest to the redemption date, on any date prior to maturity. Annual sinking fund payments sufficient to retire $690,000 of principal outstanding was required each March 31. In June 1994, the Company used proceeds from the issuance of the 12 7\/8% Senior Secured Notes, due 2004, to repurchase $22,308,000 face value of these debentures which resulted in an extraordinary charge (Note 2).\nThe original principal amount of debentures issued ($23,000,000) was adjusted to market at issuance (effective interest rate of 15.0%). The discount on the debentures was being amortized over the remaining life of the debentures using the effective interest, bonds outstanding method. There are no debentures outstanding at June 30, 1994.\n(I) Purchase contract obligations arise from the purchase of operating businesses and are collateralized by the equipment and real estate acquired in the respective acquisitions. At June 30, 1994 and 1993, these obligations carried interest rates from 7% to 10% and are due periodically through 1999.\nAggregate annual maturities and sinking fund requirements (in thousands) of the long-term debt outstanding at June 30, 1994, are:\nNOTE 5: INCOME TAXES\nCHANGE IN ACCOUNTING PRINCIPLE\nEffective July 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109). As a result of the change, there was no effect on income tax expense, and the effect on current-noncurrent classification of deferred assets and liabilities was not material.\nSFAS 109 requires recognition of deferred tax liabilities and assets for the difference between the financial statement and tax basis of assets and liabilities. Under this new standard, a valuation allowance is established to reduce deferred tax assets if it is more likely than not that a deferred tax asset will not be realized.\nPrior to July 1, 1993, deferred taxes were determined using the Statement of Financial Accounting Standards No. 96.\nThe provision for income taxes includes these components:\nThe tax effects of temporary differences related to deferred taxes were:\nNOTE 5: INCOME TAXES (CONTINUED)\nCHANGE IN ACCOUNTING PRINCIPLE (Continued)\nThe above net deferred tax asset (liability) is presented on the June 30, 1994, balance sheet as follows (in thousands):\nA reconciliation of income tax expense at the statutory rate to the Company's actual income tax expense is shown below:\nNOTE 6: MERGER PROPOSAL COSTS\nDuring the year ended June 30, 1992, the Company submitted a proposal to acquire a large competitor in the propane business after incurring due diligence costs including professional fees and out-of-pocket expenses in connection with the proposed acquisition. The Company abandoned the proposal and expensed the related $450,000 of costs in 1992.\nNOTE 7: RESTRUCTURING PROPOSAL COSTS\nDuring the years ended June 30, 1994 and 1993, the Company was considering proposals to restructure the debt and equity of the Company. The Company abandoned the proposals and expensed the related costs of $398,000 and $223,000 in 1994 and 1993, respectively.\nNOTE 8: EMPLOYEE BENEFIT PLANS\nThe Company had a qualified profit-sharing plan which covered substantially all full-time employees under which annual Company contributions were determined by the Board of Directors. No contributions to the plan were made in the past three fiscal years.\nThe Company had an employee stock bonus plan which covered substantially all full-time employees under which no contributions to the plan were made in fiscal year ended June 30, 1992.\nIn April 1992 the Company's Board of Directors voted to terminate both employee benefit plans effective June 30, 1992. Applications for a Determination Upon Plan Termination were filed with the Internal Revenue Service (IRS) and were approved in December 1992. The Company liquidated the plans' assets and paid out the plans' funds to participants on March 31, 1993. The Company purchased from the plans the Company's common stock for $1.3 million and Company debentures for $.8 million.\nNOTE 9: SELF INSURANCE AND RELATED CONTINGENCIES\nUnder the Company's current insurance program, coverage for comprehensive general liability and vehicle liability is obtained for catastrophic exposures as well as those risks required to be insured by law or contract. The Company retains a significant portion of certain expected losses related primarily to comprehensive general and vehicle liability. Under these current insurance programs, the Company self-insures the first $500,000 of coverage (per incident). Effective July 1994, the Company reduced its self insured retention for vehicle liability to $250,000 per incident. The Company obtains excess coverage from carriers for these programs on claims-made basis policies. The excess coverage for comprehensive general liability provides a loss limitation that limits the Company's aggregate of self-insured losses to $1 million per policy period. The aggregate cost of obtaining this excess coverage from carriers for the years ended June 30, 1994, 1993 and 1992, was $1,634,000, $1,441,000 and $1,222,000, respectively.\nFor the policy periods July 1, 1989, through December 30, 1989, December 31, 1989, through June 30, 1991, and July 1, 1993, through June 30, 1994, the Company has provided for aggregate comprehensive general liability losses through the policies' $1 million loss limit. Additional losses (except for punitive damages), if any, are insured by the excess carrier and should not result in additional expense to the Company. As of June 30, 1994, the Company has not provided for losses which exceed the $1 million loss limit for the comprehensive general liability policy periods July 1, 1991, through June 30, 1992, and July l, 1992, through June 30, 1993.\nDuring the years ended June 30, 1993 and 1992, the Company had obtained workers' compensation coverage from carriers and state insurance pools at annual costs of $1,743,000 and $733,000, respectively. Effective July 1, 1993, the Company changed its policy to self-insure the first $500,000 of workers' compensation coverage (per incident). The Company purchased excess coverage from carriers for workers' compensation claims in excess of the self-insured coverage. Provisions for losses expected under this program were recorded based upon the Company's estimates of the aggregate liability for claims incurred. The Company provided letters of credit aggregating approximately $2.3 million in connection with this program of which $1,218,000 is outstanding at June 30, 1994. Effective July 1994, the Company changed its policy so that it will obtain workers' compensation coverage from carriers and state insurance pools.\nProvisions for self-insured losses are recorded based upon the Company's estimates of the aggregate self-insured liability for claims incurred. A summary of the self-insurance liability, general, vehicle and workers' compensation liabilities (in thousands) for the years ended June 30, 1994, 1993 and 1992, are:\nNOTE 9: SELF INSURANCE AND RELATED CONTINGENCIES (CONTINUED)\nThe ending accrued liability includes $125,000 for incurred but not reported claims at June 30, 1994, and $500,000 at both June 30, 1993 and 1992. The current portion of the ending liability of $500,000, $460,000 and $1,103,000 at June 30, 1994, 1993 and 1992, respectively, is included in accrued expenses in the consolidated balance sheets. The noncurrent portion at the end of each period is included in accrued self-insurance liability.\nThe Company and its subsidiaries are also defendants in various lawsuits related to the self-insurance program which are not expected to have a material adverse effect on the Company's financial position or results of operations.\nThe Company currently self insures health benefits provided to the employees of the Company and its subsidiaries. Provisions for losses expected under this program are recorded based upon the Company's estimate of the aggregate liability for claims incurred. The aggregate cost of providing the health benefits was $979,000, $873,000 and $1,011,000 for the years ended June 30, 1994, 1993 and 1992, respectively.\nIn conjunction with the restructuring transaction (Note 2) the Company and Energy have agreed to share on a percentage basis the self-insured liabilities incurred prior to June 30, 1994, including both reported and unreported claims. The self-insured liabilities included under this agreement include general, vehicle, workers' compensation and health insurance liabilities. Under the agreement, the Company will assume 52.3% of the liability with Energy assuming the remaining 47.7%. The self-insured liability included in the Company's financial statements at June 30, 1994, represents its 52.3% portion of the total liability as of that date.\nNOTE 10: LITIGATION CONTINGENCIES\nThe Company's federal income tax returns for the fiscal years 1979 and 1980 were audited by the IRS. During August 1992, the Company paid $2.4 million which represented interest on previously paid income taxes. This payment settled all outstanding federal tax audits. The Company has no federal income tax audits in process at June 30, 1994.\nThe Company and its subsidiaries are presently involved in two state income tax audits and are also defendants in other business-related lawsuits which are not expected to have a material adverse effect on the Company's financial position or results of operations.\nIn conjunction with the restructuring transaction (Note 2) the Company and Energy have agreed to share on a percentage basis amounts incurred related to federal and state audits and other business related lawsuits incurred prior to June 30, 1994. The liability recorded at June 30, 1994, in the Company's financial statements related to these contingencies represents its 52.3% portion of the total liability as of that date.\nNOTE 11: STOCK OPTIONS AND WARRANTS\nSTOCK OPTIONS\nThe table below summarizes transactions under the Company's stock option plan:\nAll outstanding stock options were exercised on June 30, 1994, in connection with the restructuring transaction (see Note 2).\nNOTE 11: STOCK OPTIONS AND WARRANTS (CONTINUED)\nCOMMON STOCK PURCHASE WARRANTS\nIn connection with the Company's restructuring, the Company attached warrants to purchase common stock to the new issuance of 12 7\/8% Senior Secured Notes, due 2004. Each warrant represents the right to purchase one share of the Company's common stock for $.01 per warrant. The warrants are exercisable after January 15, 1995, and will expire on July 15, 2004.\nThe table below summarizes warrant activity of the Company:\nNOTE 12: ADDITIONAL CASH FLOW INFORMATION (IN THOUSANDS)\nNOTE 12: ADDITIONAL CASH FLOW INFORMATION (IN THOUSANDS) (CONTINUED)\nDistribution of operating assets other than cash with Empire Energy Corporation:\nNOTE 13: UNDERGROUND STORAGE FACILITY\nThe Company owns salt cavern LPG underground storage facilities which are not in use and are subject to a consent agreement with the State of Kansas. Under the agreement, the Company was to submit a plan to the state for resuming use of the facilities or permanently closing them. The due date of the plan was initially January 1, 1994. The state has verbally extended the due date until October 1, 1994.\nThe Company has obtained from an engineering and construction company a study of the costs of rehabilitating and opening the facilities. The Company has received various reports which estimate the cost of rehabilitating and opening the facility to be from $500,000 to $3.0 million. Management believes that the needed work can be accomplished for $2.0 million. Based on the approximately one million barrel capacity of the facilities, management believes the fair value of the facilities after rehabilitation would be approximately $4.0 million. Accordingly, the Company has reduced the current carrying value of the facilities to $1.0 million by charging $1.4 million against 1994 earnings.\nManagement is presently evaluating several options after rehabilitation of the facility, including use as expanded storage for company inventories, use as leased storage to customers and other distributors, and sale. If the rehabilitation work is not performed and the facilities cannot be sold, then\nEMPIRE GAS CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nJUNE 30, 1994\nNOTE 13: UNDERGROUND STORAGE FACILITY (CONTINUED)\nthe Company would be required to close the facilities at a cost not yet estimated and write off any remaining book value.\nINDEPENDENT ACCOUNTANTS' REPORT ON FINANCIAL STATEMENT SCHEDULES\nBoard of Directors and Stockholders Empire Gas Corporation Lebanon, Missouri\nIn connection with our audit of the financial statements of EMPIRE GAS CORPORATION for each of the three years in the period ended June 30, 1994, we have also audited the following financial statement schedules. 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 of the basic financial statements. The schedules are presented for purposes of complying with the Securities and Exchange Commission's rules and regulations and are not a required part of the consolidated financial statements.\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.\nSpringfield, Missouri August 26, 1994\nSCHEDULE V - PROPERTY AND EQUIPMENT\nYEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS)\nSCHEDULE VI - ACCUMULATED DEPRECIATION\nYEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS)\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS)\nSCHEDULE X - SUPPLEMENTARY INFORMATION\nYEARS ENDED JUNE 30, 1994, 1993 AND 1992 (IN THOUSANDS)\n- 65 -","section_15":""}
{"filename":"817161_1994.txt","cik":"817161","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nAdvanced Medical, Inc. (\"Advanced Medical\" or the \"Company\") through its major operating subsidiary, IMED Corporation (\"IMED\"), is a leading developer and manufacturer of infusion systems and related technologies for the health care industry. IMED is one of the largest manufacturers of intravenous infusion instruments (which consist of pumps and controllers) and disposable administration sets in the United States. The Company acquired IMED on April 2, 1990 and owns 90% of IMED's common stock (on a fully diluted basis).\nAdvanced Medical was incorporated on September 28, 1988 under the laws of the State of Delaware.\nA description of the business of IMED and the other enterprises which the Company controls or in which the Company has invested is set forth below.\nIMED CORPORATION\nGENERAL\nIMED is one of the largest manufacturers of intravenous infusion pumps and disposable administration sets in the United States. IMED's infusion pumps are used to deliver fluids, generally pharmaceuticals or nutritionals, to patients in hospitals or in alternate-care sites, such as patients' homes or free-standing outpatient clinics. IMED's pumps can be used only with IMED's proprietary disposable administration sets, each of which consists of a plastic pump interface and tubing. IMED's products are widely used in hospitals and other patient care settings where accuracy and safety in fluid delivery and monitoring are crucial. IMED has been an innovator in the intravenous instrument market since developing the first volumetric pump in 1974. Its infusion products in development incorporate recent innovations in microprocessor and electromechanical technologies that are designed to reduce instrument size and weight significantly. These innovations are also intended to enhance clinical performance, reduce manufacturing cost and simplify operation of IMED's products.\nManagement currently estimates that IMED has a domestic installed base of approximately 93,000 infusion instruments, approximately 24,000 of which have been leased to customers. Approximately 150 IMED proprietary disposable administration sets are used per year with each pump. For the year ended December 31, 1992, IMED's revenues attributable to pumps and to disposable administration sets were $44.4 million and $78.6 million, respectively. During the year ended December 31, 1993, such revenues were $30.6 million and $78.8 million, respectively. For the year ended December 31, 1994, such revenues were $25.4 million and $75.9 million, respectively.\nIMED's products are sold principally in the critical care segment of the domestic hospital market. The Company is seeking to expand IMED's customer base by taking advantage of opportunities it perceives in other areas of the domestic hospital market and in the home health care and international markets for infusion products. In October 1991, IMED sold certain European assets to Pharmacia AB (\"Pharmacia\"), a major European pharmaceutical company, and entered into a marketing, distribution and development arrangement with Pharmacia, pursuant to which IMED granted Pharmacia exclusive marketing and distribution rights for IMED products in territories which include most of Europe. See \"Marketing and Sales -- INTERNATIONAL.\" In March 1992, IMED entered into a five-year agreement with McGaw, Inc. (\"McGaw\") pursuant to which McGaw has an exclusive right in the alternate-site market to market, sell and distribute IMED's ReadyMED 50 mL, 100 mL and 250 mL lightweight disposable ambulatory infusion pumps in the United States and Puerto Rico. See \"Marketing and Sales -- DOMESTIC.\"\n------------------------ IMED-Registered Trademark-, Accuset-Registered Trademark-, Graviset-Registered Trademark-, Microset-Registered Trademark-, Flo-Stop-Registered Trademark-, Gemini-Registered Trademark-, Gemini PC-1-Registered Trademark-, Gemini PC-2-Registered Trademark-, Gemini PC-4-Registered Trademark-, Gemini PC-2TX-Registered Trademark-, PC-1-Registered Trademark-, PC-2-Registered Trademark-, PC-4-Registered Trademark-, Autotaper-Registered Trademark-, Versataper-Registered Trademark- and ReadyMED-Registered Trademark- are registered trademarks of IMED. IMED has applied to register the trademark Versasafe.\nINFUSION THERAPY INDUSTRY\nInfusion therapy generally involves the delivery of one or more fluids, primarily pharmaceuticals or nutritionals, to a patient through an infusion line inserted into the circulatory system. The intravenous infusion of fluids was pioneered in the early 1900's and is now a frequent and sophisticated component of patient care. Over the past 20 years, as both the reliance on intravenous drug therapy and the potency of the drugs administered have increased, the need for extremely precise administration and monitoring of intravenous fluids has risen significantly.\nThe infusion therapy industry can be divided generally into two markets: the hospital market and the alternate-site market. The hospital market can be further divided into a critical care segment, which includes pediatric and adult intensive care units (ICUs), coronary care and oncology units, operating rooms, and a general care segment, which also includes hospital outpatient clinics. The alternate-site market is comprised primarily of home health care and also includes free standing clinics and nursing homes.\nIn recent years, a number of trends have affected the hospital market for infusion products. Sophisticated treatments and technologies, often involving more complex infusion therapies, now allow hospitals to treat more acutely ill patients. Consequently, the average patient now requires a greater number of intravenous lines and has a greater need for technologically advanced infusion instruments. For example, while in 1985 a typical ICU patient required approximately two instrumented intravenous lines, today it is not unusual for such a patient to require four or more instrumented intravenous lines. Other factors work to reduce demand for IMED products. Demand for disposable administration sets, for example, depends on the frequency with which sets must be changed. Some hospitals have introduced new clinical protocols increasing the maximum time between disposable set changes for certain applications from every 24 hours to as much as every 72 hours.\nComplications associated with intravenous therapy are well recognized, and technology to minimize patient risks and enhance safety of infusion systems is increasingly demanded. One such complication is unintentional free-flow -- the unregulated flow of fluids into the patient. Unintentional free-flow can result in severe patient injury or death. All of IMED's infusion products are designed to prevent unintentional free-flow. Most of IMED's competitors have incorporated a version of free-flow protection into some of their products.\nAs intravenous therapies have become more complex, the need for monitoring of patients has increased. Implementation of cost containment measures by hospitals has reduced the number of hospital personnel available to monitor patients. Accordingly, health care providers have become increasingly aware of the need for accuracy and safety features in infusion instruments. IMED's products compete primarily on the basis of technological sophistication, quality, accuracy, safety and flexibility in application.\nIn addition, implementation of cost containment measures, including those relating to Medicare reimbursement, has resulted in the treatment of less seriously ill patients as outpatients, often in the alternate-site market. This growth in the alternate-site market has stimulated the development of new infusion instrument technology. In 1992, IMED introduced the ReadyMED which is a lightweight disposable ambulatory infusion pump for the alternate-site market. See \"Marketing and Sales -- DOMESTIC.\"\nINFUSION INSTRUMENTS\nInfusion instruments may be classified according to the method by which they deliver fluids. Controllers, which use gravity; and infusion pumps, which use positive pressure. Controllers typically are nonvolumetric devices that regulate flow by electronically counting drops rather than by measuring a specific volume of fluid. Since an equal number of drops of two different fluids may represent significantly different fluid volumes, this method of regulating flow is less accurate than volumetric methods. Drop-counting controllers have generally been used to administer less critical fluids and drugs that do not require precise volumetric measurement.\nInfusion pumps use positive pressure to overcome the resistance existing in infusion sets and the back pressure generated by the patient's circulatory system. Infusion pumps administer precise, volumetrically\nmeasured quantities of fluids more accurately and over a wider range of infusion rates than drop-counting controllers. For this reason infusion pumps are used with increasing frequency to administer expensive, high-potency therapeutics.\nHistorically, controllers held a major share of the installed base of instruments, principally because they were significantly less expensive than pumps. As pump prices declined and their technological capabilities increased, the purchasing trend has been toward pumps. As of the end of 1994, infusion pumps represented approximately 96%, and controllers represented approximately 4%, of the installed base of infusion instruments in the U.S. hospital market.\nAll intravenous pumps and controllers require the use of disposable administration sets. A set consists of a plastic pump interface and tubing and may have a variety of features including multiple entry ports for injecting medications or combining several lines. Almost all of these sets, including those manufactured by IMED, are proprietary and compatible only with their particular manufacturer's line of intravenous infusion instruments.\nIMED PRODUCT LINE\nIMED manufactures and markets single channel (one intravenous line), dual channel and four channel infusion instruments and disposable administration sets. The Company estimates that IMED has a domestic installed base of approximately 93,000 intravenous instruments, of which approximately 63,000 are single channel instruments, approximately 27,000 are dual channel instruments and approximately 3,000 are four channel instruments. Based upon past experience and current usage patterns, the Company estimates that IMED's single channel instruments use on average approximately 130 disposable administration sets per year, its dual channel instruments use on average approximately 190 disposable administration sets per year and its four channel instruments use on the average 300 disposable administration sets per year. For the year ended December 31, 1992, disposable administration sets accounted for approximately 61%, and infusion instruments accounted for approximately 35%, of IMED's total revenues. For the year ended December 31, 1993, disposable administration sets accounted for approximately 66%, and infusion instruments accounted for approximately 26%, of IMED's total revenue. For the year ended December 31, 1994, disposable administration sets accounted for approximately 68%, and infusion instruments accounted for approximately 23%, of IMED's total revenue.\nIMED's inventory levels reflect the need to deliver critical supplies immediately and minimize back-ordered products. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe following table summarizes the key features and actual or estimated market introduction dates of IMED's current infusion product line and products in development. For sales information for IMED's major product groups, see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nINFUSION INSTRUMENTS\nPISTON CASSETTE PUMPS. Since 1974, IMED has manufactured and marketed various models of volumetric piston cassette pumps which utilize IMED's Accuset, Graviset or Microset disposable administration sets to regulate the flow of fluid through a syringe-like mechanism. IMED's piston cassette pumps are as accurate as its Gemini series of peristaltic pumps but do not have some of the features of the Gemini series, such as multi-channel capability, programmable drug delivery and the ability to operate either as a pump or a controller. The installed base of piston cassette pumps is expected to decline in size over time as customers replace piston cassette pumps with the Gemini product line or other new technology offered by IMED or its competitors. IMED currently intends to discontinue manufacturing piston cassette pumps by the end of the first quarter 1995.\nPERISTALTIC PUMPS -- GEMINI SERIES OF PUMPS. The Gemini series is a line of peristaltic pumps that regulate fluid flow by means of a multi-finger-like mechanism that alternately compresses sections of the tubing contained in the pumping chamber. The family of Gemini pumps is based on the foundation of a flexible hardware and software technology platform. This technology platform has allowed incremental feature enhancements based on evolving customer needs.\nIn late 1987, IMED introduced the Gemini PC-2, the first of its line of Gemini pumps. Peristaltic pumps represent the largest portion of IMED's installed base of instruments. The PC-2 has two channels that can be programmed from the pump's single keypad. Each channel can operate independently and can be easily switched from pump to controller mode without changing the disposable administration set.\nIn the second half of 1988, IMED introduced the Gemini PC-1, a single channel version of the PC-2. The PC-1 can be programmed automatically to taper-up and taper-down infusion rates to facilitate delivery of total parenteral nutrition therapy (the intravenous administration of nutrients, such as proteins, carbohydrates, fats and vitamins, in predigested form) and other complex drug-dosing regimens.\nIn the third quarter of 1989, IMED incorporated into the PC-1 a capability to operate in either micro mode (0.1 to 99.9mL\/hr) for use with neonatal patients, among others, or macro mode (1 to 999mL\/hr) for use with adult patients. This micro\/macro capability, which is not available in IMED's piston cassette pumps, was added to the PC-2 during the second quarter of 1991. During the same period, IMED incorporated into the PC-2 a rapid rate titration feature, which allows rapid adjustments of the flow rate in small increments and is designed for use in the operating room and critical care settings. IMED incorporated rapid rate titration into the PC-1 during the first quarter of 1992.\nIn December 1992, IMED introduced the Gemini PC-4, a four channel version of the PC-1. The PC-4 has all the features currently available with the PC-2 and, in addition, offers such features as drug dose calculation and programmable drug delivery to meet the special needs associated with intensive care, anesthesia and oncology applications.\nIMED introduced the PC-2TX, an enhanced version of the PC-2, in the second quarter of 1994. The PC-2TX has all the features currently available with the PC-2 and the PC-4 discussed previously and, in addition, offers enhanced features such as pressure monitoring, pressure history and volume\/time dosing. IMED incorporated these enhanced features into the PC-4 during the fourth quarter of 1994.\nThe Gemini series of instruments incorporates a patented pressure sensor system within the peristaltic pumping mechanism. This technology permits the Gemini to be operated as either a pump or a controller. When operated in the pump mode, the Gemini automatically adjusts pressure settings to permit rapid detection of occlusions (blockages) at all flow rates. The Gemini pressure sensor system also allows an instrument to operate as a volumetric controller, thereby eliminating the need for remote electronic drop sensing used in traditional controllers. The Gemini technology significantly reduced the frequency of nuisance alarms (alarms with no clinical significance) associated with patient movement and transport. Nuisance alarms often occur during transport of patients, when the IV bag can sway and cause the controller's remote electronic drop sensor to monitor drop flow incorrectly.\nUnintentional free-flow can result in severe patient injury or death and IMED believes this feature is important in the infusion instrument market. IMED pioneered free-flow protection and all Gemini instruments use a patented Flo-Stop mechanism in the disposable administration set, which is designed to automatically clamp off the administration set to prevent unintentional free-flow of fluids into the patient when the set is removed from an instrument. By the end of 1994 most of IMED's competitors had incorporated some version of free-flow protection in their products.\nIn addition, the Gemini pumps have an internal computer interface capability that is designed to enable the device to be monitored from a remote nursing station. See \"Status.\"\nREADYMED. ReadyMED is a disposable, compact, ambulatory device for the intravenous administration of antibiotics. The ReadyMED pump is designed to offer a number of advantages over systems currently in use for this purpose. With traditional systems, the patient must attach a small bag and tubing set, through which the antibiotics are administered, to a catheter placed in the patient's circulatory system. The patient must eliminate all air from the system and set a manual rate adjustment clamp, a process that generally must be repeated every four to six hours. Since traditional systems are gravity driven, the bag must remain on an IV pole during infusion, thereby restricting the patient's movement. The ReadyMED pump is provided to patients pre-filled (in 50 mL, 100 mL and 250 mL sizes) and pre-primed, allowing infusion to be initiated when the patient simply opens a clamp. In addition, since the ReadyMED pump is small and uses positive pressure, the patient is able to carry the device in a pocket or wear it on a belt.\nMODULAR INFUSION SYSTEM. During the fourth quarter of 1993, IMED commenced designing a modular infusion system as the basis for its next generation of infusion instruments. In addition to all of the features available on the Gemini series, the system is being designed to incorporate advanced programming capabilities in a smaller system that is simpler to operate and less expensive to manufacture. A modular, building-block design is intended to allow the user of the system to easily combine a number of infusion instruments into an integrated multi-channel delivery system tailored for a specific patient's needs.\nThe Company's strategy will be to unbundle certain hardware and software features to stratify pricing and thus increase customer value. This will allow flexibility in providing product configurations to meet the requirements of both the domestic and international marketplaces. The design of this system is intended to supply the best combination of price and performance by allowing a low pump acquisition cost, extended product life cycle, improved asset utilization and lower cost per use over the product life.\nDuring the fourth quarter of 1993, the Company cancelled its research and development arrangements with AM Development Limited Partnership (\"AMD\") which provided such services through Deka Products (the principal of Deka Products is Dean Kamen). Therefore, the modular infusion system currently under development by IMED is not the same as the system which was being developed for IMED by Deka Products in prior years.\nDISPOSABLE ADMINISTRATION SETS\nThe Company estimates that IMED has a domestic installed base of approximately 93,000 intravenous infusion instruments, each of which uses proprietary disposable administration sets designed and manufactured only by IMED. Disposable administration sets consist of a plastic pump interface and tubing and have a variety of features, such as clamps for flow regulation and multiple entry ports for injecting medications or combining several lines. Each of IMED's current and proposed infusion instrument product lines uses disposable sets designed for that particular product line.\nBased upon past experience and current usage patterns, the Company estimates that single channel pumps typically use approximately 130 disposable sets per year, dual channel pumps typically use approximately 190 disposable sets per year and its four channel instruments use on the average 300 disposable administration sets per year. The rate at which disposables are used depends on the utilization rate for the pump and the frequency with which sets must be changed, which in turn depends on the therapy being administered. Certain hospitals have effected a change in protocol increasing the maximum time between set changes for certain applications from every 24 hours to as much as every 72 hours. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nIMED's disposable sets are designed to automatically stop or restrict the flow of fluids when removed from an infusion instrument, protecting against unintentional free-flow. Given the potency of medications administered to seriously ill patients, the Company believes that this has become an increasingly important feature in the infusion market. IMED pioneered free-flow protection. Most of IMED's competitors have incorporated a version of free-flow protection in some of their products. As a result, IMED improved its free-flow protection and introduced into the market an enhanced Flo-Stop in late 1994.\nThere is increasing pressure by regulatory agencies, such as Occupational Safety and Health Administration (\"OSHA\") and the Food and Drug Administration (\"FDA\"), for more stringent control of needles in hospitals. OSHA requires that hospitals must put in place systems to reduce the potential for needle sticks. The FDA recommends using needleless systems or protected needle systems to replace hypodermic needles for accessing intravenous lines. IMED's needleless strategy is a dual product line approach which incorporates the ability to access IMED's administration sets without the use of needles, thus reducing the potential for accidental needle sticks. The VersaSafe system utilizes a blunt cannula device, combined with a split-septum \"Y\" site. IMED has a non-exclusive license to the VersaSafe system which was a cooperative development effort of IMED, Elcam Plastic of Israel and Medical Associates Network. Additionally, IMED has entered into an agreement with B. Braun, Inc. for the purchase of their SAFSITE-Registered Trademark- valve. The SAFSITE-Registered Trademark- valve provides needle-free access through the use of a standard male luer, eliminating the need for needleless blunt cannulae to access the administration set. This parallel product strategy will satisfy IMED customer requirements for needle-free systems, as well as assist its customers in complying with OSHA standards.\nSTATUS\nThe Status system monitors, in real-time, the status of intravenous infusion instruments and other bedside devices, such as pulse oximeters and ventilators that can save hospitals valuable time documenting equipment readouts, searching for the source of equipment alarms, and assessing the progress of intravenous therapy. Status automatically gathers data from bedside instruments and, through touch-screen technology, displays the information on computer monitors. These monitors can be at one or more locations, such as the central nursing station, so clinicians can see immediately what is occurring at the bedside. In addition, Status can recall data for documentation and other reports, which assists health care facilities fulfill their obligations under the Safe Medical Device Act (\"SMDA\") of 1990. SMDA requires user facilities to track and report problems with many medical devices, including ventilators and infusion pumps, to the FDA and the manufacturer. Status can also improve coordination between nursing and pharmacy, and assist in tracking and documenting instrument uses. As of December 31, 1994, seven systems have been installed.\nMARKETING AND SALES\nDOMESTIC. IMED supplies its infusion instruments and related proprietary disposable administration sets to approximately 1,300 hospitals in the United States. Sales are made primarily through IMED's experienced direct sales force of approximately 55 sales representatives and regional managers. IMED's domestic marketing efforts are supported by a staff of 15 nurses and pharmacists who consult with customers with respect to evaluation, installation and use of IMED products and provide ongoing clinical support. IMED operates six instrument service centers from which service engineers provide product maintenance and conduct training seminars.\nIn response to cost containment pressures, many hospitals have joined buying groups that negotiate contracts with suppliers of medical products. These contracts typically establish pricing structures for qualified vendors' products. In many cases, qualification as an approved vendor to a buying group is important in gaining access to the member hospitals. IMED has been approved as a qualified vendor for a number of buying groups. IMED is actively seeking contracts with additional groups.\nIMED also sells its products to a number of alternate site care providers. Management believes that this segment of the infusion market, although much smaller than the hospital segment, should experience significant growth. In 1992, IMED introduced the ReadyMED which is a lightweight disposable ambulatory infusion pump. In March 1992, IMED entered into a five-year agreement with McGaw pursuant to which\nIMED granted McGaw exclusive right in the alternate-site market to market, sell and distribute IMED's ReadyMED 50 mL, 100 mL and 250 mL lightweight disposable ambulatory infusion pumps in the United States and Puerto Rico.\nApproximately 24,000 of IMED's 93,000 domestic installed base of infusion instruments are leased to customers. IMED's leases have terms ranging from one to five years and generally provide the customers with a purchase option at the end of the lease term. In the case of some customers who lease infusion instruments, the related supply agreements for disposables also provide for the purchase of minimum quantities at agreed prices. As of December 31, 1994, disposables relating to approximately 18,000 instruments were being sold under such agreements. IMED does not rely on one or a small number of customers. In 1994, no single customer accounted for more than 2% of IMED's sales. For information concerning domestic and foreign sales, see \"Item 8. Financial Statements and Supplementary Data -- Note 14 to the Consolidated Financial Statements.\"\nINTERNATIONAL. In 1994, approximately 12% of IMED's sales were made to customers by its foreign subsidiaries. These sales were concentrated in Australia (approximately 39%), Canada (approximately 27%) and Europe (approximately 34%). Additionally, products exported in 1994 from IMED's domestic operation to unaffiliated customers were approximately 7% of sales.\nIn October 1991, IMED sold certain European assets to Pharmacia and entered into a marketing, distribution and development arrangement with Pharmacia (the \"Pharmacia Transaction\"), pursuant to which Pharmacia obtained the exclusive right to market and distribute IMED's infusion products in a territory that includes most of Europe. IMED supplies its pumps and related proprietary disposable administration sets to hospitals outside the United States (excluding territories served by Pharmacia) through a combination of 11 direct sales representatives and a network of 32 dealers.\nOn August 12, 1994, Advanced Medical, IMED and Pharmacia amended their distribution agreement. Under the terms of the Amended and Restated Distribution Agreement (\"Amended Distribution Agreement\"), Pharmacia retains the exclusive right (subject to certain exceptions) to distribute IMED's infusion products in the territory that includes most of Europe. Under the Amended Distribution Agreement, Pharmacia has the right not to distribute certain products currently under development by IMED. In the event of such an election, IMED has the right to sell such products directly or through others, and under certain circumstances, has the right to repurchase from Pharmacia the distribution rights to IMED products currently distributed by Pharmacia in the territory. In addition, Pharmacia has the right to terminate the Amended Distribution Agreement at any time on 12 months notice, in which event Pharmacia would be required to make a payment of $2.5 million to IMED and IMED would be required to make payments to Pharmacia based on net sales of products currently distributed by Pharmacia for the 4 years following termination.\nCOMPETITION\nThe primary market for IMED's existing products is mature and highly competitive. IMED's primary domestic competitors are major diversified health care companies with greater financial and other resources than IMED. Management believes that IMED's products, which are in the upper price range of infusion products, compete primarily on the basis of technical sophistication, quality, accuracy, safety and flexibility of application. IMED's competitors engage in a strategy of offering their products at reduced prices in order to enhance their market share positions. Two of IMED's largest domestic competitors, Abbott Laboratories (\"Abbott\") and Baxter Healthcare Corporation (\"Baxter\"), offer customers volume discounts based on purchases of a broad range of their medical equipment and supplies, including infusion instruments and intravenous solutions, a strategy that IMED is unable to pursue.\nAccording to industry sources, as of December 31, 1994, IMED together with IVAC Corporation (\"IVAC\"), Abbott, Baxter and McGaw accounted for approximately 94% of the U.S. installed base of instrument channels.\nIMED sells infusion instruments which are multi-channeled. According to industry sources, IMED also had the fourth largest installed base of instrument channels as of December 31, 1994 with a market share of\n19.4%, behind Baxter (24.1%), IVAC (23.3%), Abbott (20.8%) and ahead of McGaw (6.3%). For the year ended December 31, 1994, IMED was fourth in the domestic placement of new infusion instrument channels with a market share of 18.1%, Baxter was first (25.9%), Abbott was second (24.8%), IVAC was third (21.0%) and McGaw was fifth (7.9%). See \"Marketing and Sales -- INTERNATIONAL\" for information concerning the foreign markets in which IMED competes.\nRESEARCH AND DEVELOPMENT\nIMED engages in product design, engineering, development and performance validation to enhance its existing products and to develop new products. IMED expended approximately $5.5 million, $5.5 million and $6.3 million on in-house research and development for the years ended December 31, 1992, 1993 and 1994, respectively. In addition, the Company expended $3.9 million and $3.6 million for the years ended December 31, 1992 and 1993 on early-state and new products research and development performed by Deka Products Limited Partnership (\"Deka\"), an outside contractor.\nUnder an agreement with Deka established in 1990, a modular infusion system was being designed. IMED had planned to introduce this product by late 1993. Development features to enhance marketability required further engineering work resulting in substantial delays and increase in costs. As a result, the Company no longer considered the Deka program to be commercially feasible and discontinued its funding of that program in October 1993. However, IMED retains a royalty interest in certain commercial applications of the Deka technology. As described below, IMED has accelerated its own in-house development of a new line of hospital infusion pumps and associated disposables based upon its patented technology and know-how.\nDuring the fourth quarter of 1993, IMED's product development process was re-engineered to utilize concurrent engineering and cross-functional development teams (R&D, marketing, manufacturing, etc.). Management believes the new development process will reduce product development time, improve product manufacturability, and meet customers' needs. The increase in IMED's research and development expenses in 1994 resulted primarily from the costs of additional personnel.\nIMED expended approximately $8.9 million on research and development for the year ended December 31, 1992 and $8.6 million for the year ended December 31, 1993, including amounts paid to Deka Products through AMD. For the year ended December 31, 1994, IMED expended approximately $6.3 million.\nMANUFACTURING\nIMED's instrument manufacturing facility is located in San Diego, California. A contractor provides IMED with assembly services for disposable administration sets in Tijuana, Mexico. The agreement between IMED and the contractor may be terminated by either party on 90 days' notice and requires that IMED pay the contractor an hourly rate per employee hour worked on assembly of IMED products. At the end of 1994, approximately 95% of IMED's completed disposable administration sets were assembled at the Tijuana facility.\nDuring 1994, IMED sold its Irish manufacturing facility to Pharmacia. The Irish manufacturing facility primarily produced molded components used to assemble disposable administration sets. In connection with the sale of the Irish manufacturing facility, IMED entered into an agreement with Pharmacia for the purchase, at fixed prices, of minimum quantities of disposable administration sets and components used to assemble disposable administration sets for three years, effective January 1, 1994. See Note 2 to the Consolidated Financial Statements.\nThe raw materials used in IMED's production process are available from several suppliers. IMED generally either has an alternate supplier for its raw materials or can readily replace the primary supplier. Although IMED is generally not dependent upon any single source of supply, it has chosen to rely upon a single supplier for certain components used in its infusion pumps and disposable administration sets. Although the Company believes that IMED can find an alternate supplier for these components, the loss of any such supplier could result in a temporary interruption in the manufacturing of its instruments and disposables.\nPATENTS AND PROPRIETARY RIGHTS\nIMED's policy is to secure patent protection for significant innovations. IMED currently holds 90 unexpired patents in the United States and in foreign countries, principally in Europe, Canada, Japan and Australia. Additional applications are pending or in preparation. In addition, Advanced Medical currently holds 48 unexpired patents granted in the United States and various foreign countries which it has licensed to IMED on an exclusive worldwide basis for $1.1 million annually. The patents owned or licensed to IMED which the Company deems material to IMED's operations expire at various times through 2010. A patent covering IMED's piston cassette pumps and Accuset disposable administration sets expired in Australia during 1992, in the United States during 1993 and in Germany in 1994. The Company does not believe that the expiration of this patent had or will have a material effect on the Company's results of operations. Although the Company is not aware of any generic manufacturers of disposable administration sets which intend to manufacture a product similar to the Accuset, it is possible that other manufacturers could decide to manufacture and distribute disposable administration sets to IMED piston cassette pump customers in direct competition with IMED. The percentage of IMED's total installed base of infusion pumps represented by piston cassette pumps is declining as sales of Accuset disposable administration sets accounted for approximately 27%, 24% and 19% of the Company's consolidated revenues in 1992, 1993 and 1994, respectively. Sales of disposable administration sets could be adversely affected if a competitor were to begin manufacturing a product that competed with IMED's Accuset disposable administration set. However, because IMED holds an additional patent relating to the Accuset disposable administration set that does not expire until 2001 and in light of other competitive factors, the Company believes that the loss of the patent that expired in 1993 will not have a material effect on the Company's future results of operations. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThere can be no assurance that the patents on which IMED principally relies will not be invalidated or that any issued patent will provide protection that has commercial significance. Litigation may be necessary to protect IMED's patent position. Such litigation can be costly and time consuming, and there can be no assurance that IMED would be successful if such litigation were instituted. The validation of patents owned by or licensed to IMED could have a material adverse effect on IMED.\nIMED sells its products under a variety of trademarks, some of which are considered by IMED to be of sufficient importance to warrant registration in the United States and various foreign countries in which IMED does business. IMED also relies on trade secrets, unpatented know-how and continuing technological advancement to maintain its competitive position. It is IMED's practice to enter into confidentiality agreements with key technical employees and consultants. There can be no assurance, however, that these measures will prevent the unauthorized disclosure or use of IMED's trade secrets and know-how or that others may not independently develop similar trade secrets or know-how or obtain access to IMED's trade secrets, know-how or proprietary technology.\nGOVERNMENT REGULATION\nThe research, development, testing, production and marketing of IMED's products are subject to extensive governmental regulation in the United States and certain other countries. Non-compliance with applicable requirements may result in recall or seizure of products, total or partial suspension of production, refusal of the government to allow clinical testing or commercial distribution of products, civil penalties or fines and criminal prosecution.\nThe FDA regulates the development, production, distribution and promotion of medical devices in the United States. Virtually all of the products being developed, manufactured and sold by IMED (and products likely to be developed, manufactured or sold in the foreseeable future) are subject to regulation as medical devices by the FDA. Pursuant to the Federal Food, Drug and Cosmetic Act (the \"FDA Act\"), a medical device is classified as either a Class I, Class II or Class III device. Class I devices are subject to general controls, including registration, device listing, recordkeeping requirements, labeling requirements and \"Good Manufacturing Practices\" (as such term is defined in the FDA Act). In addition to general controls, Class II devices may be subject to special controls that could include performance standards, postmarket surveillance, patient registries, guidelines, recommendations and other actions as the FDA deems necessary\nto provide reasonable assurance of safety and effectiveness. Class III devices must meet the most stringent regulatory requirements and must be approved by the FDA before they can be marketed. Such premarket approval can involve extensive pre-clinical and clinical testing to prove safety and effectiveness of the devices.\nVirtually all of IMED's products are Class II devices. IMED is not currently developing, manufacturing or distributing any Class III devices, although it may do so in the future.\nAll medical devices introduced to the market since 1976 are required by the FDA, as a condition of marketing, to secure either a 510(k) premarket notification clearance (\"510(k)\") or an approved Premarket Approval Application (\"PMA\"). A product qualifies for a 510(k) if it is substantially equivalent in terms of safety, effectiveness and intended use to another legally marketed medical device. If a product is not substantially equivalent to such a device, the FDA must first approve a PMA application before it can be marketed. An approved PMA application indicates that the FDA has determined the device has been proven, through the submission of clinical data and manufacturing information, to be safe and effective for its labeled indications. The PMA process typically takes more than a year and requires the submission of significant quantities of clinical data and supporting information, while the process of obtaining a 510(k) typically takes less than one year and involves the submission of less clinical data and supporting information. Management believes that IMED's proposed products described under \"IMED Product Line\" should qualify for the 510(k) procedure.\nAt present, all of IMED's products and manufacturing facilities and all phases of its manufacturing and distribution process are subject to pervasive and continuing regulation by the FDA. Labeling and promotional activities are subject to scrutiny by the FDA and, in certain instances, by the Federal Trade Commission. The export of infusion products is also subject to regulation. In complying with the standards set forth in these regulations, manufacturers must continue to expend time, money and effort in the areas of production and quality systems to ensure full technical compliance. Failure to comply subjects the manufacturer to possible FDA action, such as recall or seizure of the product or the suspension of manufacturing of the product. IMED's manufacturing facilities are subject to periodic inspections by the FDA and the Food and Drug Branch of the California Department of Health Services, as well as by several foreign governments. If significant violations of applicable regulations are noted during these inspections, the continued marketing of any product manufactured by IMED may be adversely affected.\nThe Medical Device Reporting (\"MDR\") regulations obligate IMED to provide information to the FDA on serious injuries or death which may have been associated with the use of a product or in connection with certain product malfunctions which could potentially cause injury. If, as a result of FDA inspections, MDR reports or other information, the FDA believed that IMED was not in compliance with the law, the FDA could institute proceedings to detain or seize products, enjoin future violations, or assess civil or criminal penalties against IMED, its officers and employees. In addition, if the FDA believed any of IMED's products presented a potential health hazard, the FDA could also require IMED to notify the users to cease use of the product, and could require IMED to recall, or repair or replace, or refund to the user the cost of, such product. To date, IMED and its products have not been the subject of such FDA enforcement action, although MDR reports with respect to the Company's products have been filed in the past. From time to time, the Company has voluntarily recalled products to make repairs and enhancements\/upgrades to its products and may do so in the future as circumstances warrant. Any enforcement action by the FDA could result in a disruption of IMED's operations for an undetermined period of time.\nIMED is also subject to foreign regulatory authorities. Whether or not FDA market clearance has been obtained, registration of a product by comparable regulatory authorities of foreign countries must be obtained prior to the commencement of marketing of the product in those countries. The approval process varies from country to country, and the time required may be longer or shorter than that required by the FDA.\nThe European Community is in the process of developing a new approach to regulation of medical products which may significantly change the way products are regulated in these countries within the next several years.\nIMED is subject to regulation by the OSHA and the Environmental Protection Agency (\"EPA\") and their state and local counterparts. IMED, like most medical device manufacturing companies, is subject to regulation under the Toxic Substances Control Act, the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability Act and other environmental regulatory statutes and may in the future be subject to other federal, state or local regulations. Either one or both of OSHA and the EPA or their state or local counterparts may promulgate regulations that may affect IMED's development or manufacturing programs. The Company is unable to predict whether any agency will adopt any regulation or take other action which would have a material adverse effect on IMED's operations, and there can be no assurance that changes in such regulations will not impose the need for additional capital expenditures or other requirements. Compliance with federal, state and local environmental and employee health safety laws has not had a material effect on the capital expenditures, earnings and competitive position of IMED, and management does not anticipate that it will make any material capital expenditures for environmental control facilities in the near future.\nHeightened public awareness and concerns regarding the growth in overall health care expenditures in the United States may result in the enactment of national health care reform or other legislation affecting payment mechanisms and health care delivery. Legislation which imposes limits on the number and type of medical procedures which may be performed or which has the effect of restricting a provider's ability to select specific devices or products for use in administrating medical care may adversely impact the demand for the Company's products. In addition, legislation which imposes restrictions on the price which may be charged for medical products may adversely affect the Company's results of operations. However, it is not possible to predict the extent to which the Company or the health care industry in general may be adversely affected by the aforementioned in the future.\nEMPLOYEES\nAs of March 1, 1995, IMED employed a work force of 559 individuals. Of these employees, 422 were located in San Diego, 105 were located in the field in the United States and 32 were located in foreign locations. In addition, IMED's contractor in Tijuana employed approximately 485 employees who assemble certain IMED products. Of IMED's employees, 58 were engaged in product development. IMED's employees are not represented by a union.\nManagement considers IMED's relationship with its employees to be good and is not aware of any problems with respect to the work force employed in Tijuana.\nAM DEVELOPMENT LIMITED PARTNERSHIP\nOn April 2, 1990, AM General Development Corp. (\"AM General\"), AM Development Limited (\"AM Limited\") and Deka Products entered into an agreement to form AMD, a joint venture partnership for the primary purpose of developing medical technologies, including those of Deka Products. AM General and Deka Products were the general partners of AMD, and AM Limited was the sole limited partner. AM General and AM Limited are both wholly-owned subsidiaries of Advanced Medical. The general partner of Deka Products is a corporation wholly-owned by Dean L. Kamen.\nDeka Products and its employees, including Mr. Kamen, provided certain research and development services to AMD pursuant to a development agreement between AMD and Deka Products. As consideration for the research and development activities, AMD paid Deka Products on a cost-plus basis. For the years ended December 31, 1992 and 1993, AMD paid Deka Products approximately $500,000 and $300,000, respectively, pursuant to the development agreement for research and development activities conducted by Deka Products for AMD, which amounts did not include approximately $3.8 million and $3.3 million for 1992 and 1993, respectively, paid to Deka Products in connection with research and development conducted on behalf of IMED. See \"Business -- IMED Corporation -- Research and Development.\"\nDuring the fourth quarter of 1993, the Company entered into an agreement with Deka Products and Kamen to terminate AMD as well as licenses and development agreements among Advanced Medical and its subsidiaries and Kamen and his affiliates and pursuant to which the Company discontinued its funding of\nAMD. Kamen and his affiliates can independently commercialize products based on Kamen's fluid management technology. IMED retains a royalty interest in certain future commercial applications of Kamen's technology.\nDESCRIPTION OF OTHER HOLDINGS\nALTEON, INC. (\"ALTEON\")\nAlteon is a development stage pharmaceutical company engaged in the discovery and development of novel therapeutic and diagnostic products for the complications associated with diabetes and aging. Alteon's present focus is on the development of compounds to treat the major complications of diabetes, which include diseases of the kidney, cardiovascular system, nervous system and the eye.\nThe Company owns 512,600 shares of Alteon common stock, which represented less than 5% of the issued and outstanding shares of Alteon common stock on a fully diluted basis as of December 31, 1994. The Alteon shares owned by the Company were registered under the Securities Act on October 1, 1993. The Alteon common stock owned by the Company is pledged to secure senior debt. Under the terms of senior debt agreements, the Company is permitted to sell such shares, see \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nFIDATA CORPORATION\nAt the time of the Company's acquisition of Fidata in March 1989, Fidata had cash but no operations, and its business primarily consisted of defending and settling claims and liquidating its business. Fidata disposed of substantially all of its businesses in 1985 and 1986. As of this date, Fidata has settled substantially all of the claims against it and is continuing to wind down its business which should be completed in 1995.\nCOMPANY EMPLOYEES\nThe Company's operations are supported by persons employed by IMED. The Company's principal offices are located in San Diego, California.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nPursuant to six separate leases, IMED rents a total of approximately 216,000 square feet in San Diego, California. These facilities house Advanced Medical's principal executive offices, IMED's principal executive offices, engineering and development facilities and IMED's approximately 131,000 square foot domestic manufacturing and warehouse operations. One of the leases for the San Diego facility provides for termination by either IMED or the landlord on six months' notice. The remaining leases have terms expiring at various times through 1998 and have varying clauses providing for renewal at IMED's option. In addition, the disposable administration sets assembly is provided by a contractor in a 41,190 square foot facility in Tijuana, Mexico.\nDuring the fourth quarter of 1993, IMED adopted a plan to reduce by approximately 27,000 square feet its facilities in San Diego. This plan is currently scheduled to be completed in the second quarter of 1995.\nFidata leases approximately 200 square feet of office space in New York, New York under a lease that will expire in May 1995. The Company is planning to rent this space on a monthly basis until the wind down is complete.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is a defendant in various actions, claims, and legal proceedings arising from normal business operations. Management believes they have meritorious defenses and intends to vigorously defend against all allegations and claims.\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.\nThe Company's common stock is listed on the American Stock Exchange under the symbol AMA. The following table sets forth the high and low last reported sale prices for the common stock of the Company as reported by the American Stock Exchange for the quarters indicated.\nAs of March 30, 1995, there were 546 holders of record of the Company's common stock.\nThe Company has not paid any dividends on its common stock since its organization, and it is not contemplated that it will pay any dividends on the common stock in the foreseeable future. The Company is prohibited from declaring and paying dividends on the common stock under certain debt agreements and pursuant to the terms of its convertible preferred stock. In addition, the Amended IMED Loan Agreement limits IMED's ability to declare and pay dividends and to make other distributions and payments to the Company. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe Company did not declare and pay the September 1993, March 1994 and September 1994 dividends and the March 1994 redemption and does not anticipate declaring dividends and redeeming its preferred stocks in the foreseeable future on its 10% mandatorily redeemable preferred stocks, $.01 per share par value (\"10% Preferred Stocks\"). As a result, the 10% Preferred Stock shareholders are entitled to elect, as a class, two members to the Company's board of directors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA. The following selected historical consolidated financial data of the Company at December 31, 1990, 1991, 1992, 1993 and 1994, and for the years then ended, have been derived from the Company's annual financial statements including the consolidated balance sheets at December 31, 1993 and 1994 and the related consolidated statements of operations for the three years ended December 31, 1994 and notes thereto which appear elsewhere herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nAdvanced Medical is a holding company for IMED, Fidata and several investments. It also identifies and evaluates potential acquisitions and investments and performs various corporate functions. As a holding company, Advanced Medical currently has no revenues to fund its operating and interest expense and relies on cash generated by cash flow from IMED, external borrowings, sale of investments and other external sources of funds to meet its obligations.\nThe following discussion and analysis should be read in conjunction with \"Item 6. Selected Financial Data,\" and \"Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Advanced Medical, Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 58 present fairly, in all material respects, the financial position of Advanced Medical, Inc. and its subsidiaries at December 31, 1993 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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.\nAs discussed in Note 1 to the financial statements, the Company changed its method of accounting for income taxes in 1993 to comply with the provisions of Statement of Financial Accounting Standards No. 109.\nAs discussed in Note 1 to the financial statements, the Company changed its method of accounting for investments in 1994 to comply with the provisions of Statement of Financial Accounting Standards No. 115.\nPRICE WATERHOUSE LLP\nSan Diego, California March 17, 1995\nADVANCED MEDICAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS\nThe accompanying notes are an integral part of these consolidated financial statements.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\nThe accompanying notes are an integral part of these consolidated financial statements.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) (DOLLAR AND SHARE AMOUNTS IN THOUSANDS)\nThe accompanying notes are an integral part of these consolidated financial statements.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 1 -- BUSINESS AND ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES:\nBUSINESS AND ORGANIZATION:\nAdvanced Medical, Inc. (\"Advanced Medical\"), operating through its consolidated subsidiaries, is a leading developer and manufacturer of infusion products and related technologies for the health care industry. On April 2, 1990, Advanced Medical acquired the IMED Division of Fisher Scientific Company through IMED Corporation (\"IMED\"). IMED is a 90% owned subsidiary on a fully-diluted basis. (Advanced Medical and its subsidiaries are collectively referred to as the \"Company\".)\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nCONSOLIDATION:\nThe financial statements include the accounts of Advanced Medical and its greater than 50 percent-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. IMED's foreign subsidiaries are consolidated as of and for the periods ended November 30, 1992, 1993 and 1994 in the December 31, 1992, 1993 and 1994 consolidated financial statements, respectively.\nREVENUE RECOGNITION:\nRevenues from sales of fluid delivery instruments and related disposable products, and from instrument capital lease contracts, are recognized at the time such products are shipped. Revenues from instrument operating lease contracts are recognized over the terms of the lease agreements, ranging from 1 to 5 years.\nLICENSE FEE REVENUE RECOGNITION:\nDuring 1991, IMED entered into a marketing, distribution and development agreement with Pharmacia AB (\"Pharmacia\"). Pursuant to the agreement, a product distribution fee of $6,530 was classified as deferred revenue (a non-current liability) and is recognized on a straight-line basis over the 15 year term of the agreement.\nCONCENTRATIONS OF CREDIT RISK:\nThe Company provides a variety of financing arrangements for its customers. The majority of the Company's accounts receivable are from hospitals throughout the United States with credit terms of generally 30 days. The Company maintains adequate reserves for potential credit losses and such losses, which have been minimal, have been within management's estimates.\nSECURITIES AVAILABLE FOR SALE:\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS 115\"). As permitted under SFAS 115, the Company adopted the standard on a prospective basis. In accordance with SFAS 115, the Company's investment in Alteon, Inc. (Note 5) is classified as securities available for sale and is required to be carried at fair market value. During 1993, the Company accounted for its securities available for sale using the cost method.\nINVENTORIES:\nInventories are stated at the lower of cost (determined using the first-in, first-out method) or market.\nPROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment are stated at cost. Depreciation and amortization are provided using the straight-line method based upon the following estimated useful lives of the assets or lease terms, if shorter, for leasehold improvements and instrument operating leases:\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 1 -- BUSINESS AND ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) INTANGIBLE ASSETS:\nThe excess of purchase price over the estimated fair values of assets acquired and liabilities assumed has been recorded as goodwill and is amortized using the straight-line method over 35 years. Patents are amortized using the straight-line method over estimated useful lives of 4 to 12 years. Technology licenses are amortized using the straight-line method over estimated useful lives of 15 years. Management periodically reviews intangible assets for impairment.\nDEBT ISSUE COSTS:\nDebt issue costs of $3,901 and $4,074 at December 31, 1993 and 1994, respectively, are amortized using the straight-line method over the respective terms of the debt agreements and are included in other non-current assets.\nFOREIGN CURRENCY TRANSLATION:\nThe accounts of foreign subsidiaries which use local currencies as functional currencies are translated into U.S. dollars using year-end exchange rates for assets and liabilities, historical exchange rates for equity and weighted average exchange rates during the period for revenues and expenses. The gains or losses resulting from translations are excluded from results of operations and accumulated as a component of stockholders' deficit.\nRESEARCH AND DEVELOPMENT COSTS:\nResearch and development costs are expensed as incurred.\nINCOME TAXES:\nThe Company and its domestic subsidiaries file a consolidated Federal income tax return. Domestic subsidiaries file income tax returns in multiple states on either a stand-alone or combined basis. Foreign subsidiaries file income tax returns in their respective jurisdictions based on their separate taxable income. The Company provides for deferred income taxes on undistributed earnings of its foreign subsidiaries.\nEffective January 1, 1993 the Company adopted 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 bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse (see Note 7). As permitted under SFAS 109, the Company's 1992 consolidated statement of operations has not been restated.\nPrior to 1993, the provision for income taxes was based on income and expense 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.\nSTATEMENT OF CASH FLOWS:\nFor the purpose of the statement of cash flows, the Company considers short-term investments with an original maturity of three months or less to be cash equivalents, excluding restricted amounts held in escrow or trust.\nNET INCOME (LOSS) PER COMMON SHARE:\nThe Company's net income (loss) per common share assuming no dilution is computed using the weighted average number of common shares outstanding during the respective periods. Net income (loss)\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 1 -- BUSINESS AND ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED) per common share assuming no dilution does not include common stock equivalents (options and warrants) because the effect would be antidilutive. The Company's net income (loss) per common share assuming full dilution is computed using the weighted average number of common shares outstanding plus, for the year ended December 31, 1994, the shares that would be outstanding assuming conversion of the $6,000 secured promissory note (\"Decisions Note\") issued to Decisions Incorporated (\"Decisions\") on January 4, 1994, and conversion of the $6,500 secured promissory note (\"the Note\") issued to Decisions on August 12, 1994 (see Note 6). Net income (loss) applicable to common stock for the year ended December 31, 1994 has been increased by $386 for the interest expense (net of tax) on the convertible debt since conversion on January 4, 1994 and August 12, 1994, respectively, was assumed. The calculation of net income (loss) per common share assuming full dilution excludes common stock equivalents and convertible securities that are antidilutive.\nNOTE 2 -- RESTRUCTURINGS AND ASSETS HELD FOR SALE: During 1993, the Company adopted a plan to sell its Irish manufacturing facility to a wholly-owned subsidiary of its European marketing and distribution partner, Pharmacia. The Irish manufacturing facility primarily produces molded components used to assemble disposable administration sets (\"Sets\").\nNet assets held for sale in the accompanying balance sheet consists of the following at December 31, 1993:\nAssets held for sale are presented at their expected net realizable values and liabilities are presented at their carrying amounts.\nThe Company recorded a $3,515 restructuring charge during 1993 in connection with the proposed sale of its Irish manufacturing operations and the relocation of its molding operations to the United States. Professional fees and relocation costs of $1,300 are included in the restructuring charge. During 1993, the Company also recorded a $1,898 charge to consolidate certain of the Company's operations. The provision includes severance payments, facilities consolidation costs and the write-off of equipment associated with discontinued products, net of the defined benefit plan curtailment gain (see Note 11).\nDuring 1994, the Company sold its Irish manufacturing facility to Pharmacia for $4,089, from which the net proceeds were used to repay a portion of the GECC long-term debt. The Company entered into an agreement with Pharmacia for the purchase, at fixed prices, of minimum quantities of Sets and components used to assemble Sets through 1996. The Company is obligated to purchase approximately $2,300 and $800 from Pharmacia during 1995 and 1996, respectively.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 3 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS:\nDepreciation expense was $6,709, $5,659 and $3,893 for 1992, 1993 and 1994, respectively.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 3 -- COMPOSITION OF CERTAIN FINANCIAL STATEMENT CAPTIONS: (CONTINUED)\nNOTE 4 -- INTANGIBLES:\nDuring 1993, the Company discontinued its funding of Dean Kamen and his affiliates (\"Kamen\") to develop hospital infusion pumps and related disposables based on Kamen's fluid management technology. Other expenses in 1993 includes a loss of $1,919, consisting of the write off of unamortized technology licenses of $3,919 less a non-refundable product development fee of $2,000. The product development fee was received in 1991 from Pharmacia as part of a $10,000 arrangement to develop products using Kamen's fluids management technology. The fees were to be earned upon the attainment of certain development milestones. Since IMED discontinued funding Kamen, the deferred revenue of $2,000 was released to income and IMED will not receive any of the remaining $8,000 of product development fees.\nGoodwill was reduced by $3,234 during 1993 as a result of Advanced Medical acquiring Kamen's interests in IMED (see Note 9).\nNOTE 5 -- SECURITIES AVAILABLE FOR SALE: Current marketable securities comprise the following:\nDuring 1993, the Company sold 327 shares of its AIS common stock for $6,332, resulting in a realized gain of $3,681. During 1994, the Company sold all remaining 107 shares of its AIS common stock for $1,005, resulting in a realized gain of $133.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 5 -- SECURITIES AVAILABLE FOR SALE: (CONTINUED) During 1993, the Company sold 554 shares of its Alteon common stock for $5,180, resulting in a realized gain of $3,020. During 1994, the Company sold 378 shares of its Alteon common stock for $2,763, resulting in a realized gain of $1,293. At December 31, 1994, the Company owned 513 shares of Alteon common stock.\nThe market value at December 31, 1994 is based on the quoted market price and is considered to represent fair value as determined under SFAS 115. The fair value may not represent actual value of the Alteon common stock that could have been realized as of December 31, 1994 or that will be realized in the future.\nThe gross unrealized gain as of March 17, 1995 on the current marketable equity securities was $1,332.\nNOTE 6 -- NOTES PAYABLE AND LONG-TERM DEBT: In connection with the acquisition of the IMED Division, IMED entered into a revolving credit facility and a term loan agreement with GECC. During 1994, IMED restructured its loan agreement with GECC (\"Amended Loan Agreement\").\nLong-term debt comprises the following:\nGECC LONG-TERM DEBT\nThe Amended Loan Agreement includes a $42,000 revolving credit facility that replaces the previous $22,000 revolving credit facility and the term loan. The interest rate on the Amended Loan Agreement is the index rate plus 2% (10 1\/2% at December 31, 1994). Outstanding indebtedness under the Amended Loan Agreement will mature in March 1999. Advances under the Amended Loan Agreement will be made against a borrowing base consisting of 85% of eligible accounts receivable, 65% of eligible inventory and 85% of the future value of eligible instrument lease receivables. The Amended Loan Agreement contains affirmative and negative covenants, including, among others, the maintenance of certain financial ratios, balances, and earnings levels, limitations on capital expenditures and transfer of funds to Advanced Medical and restrictions on incurring additional debt. The Amended Loan Agreement is secured by a first priority interest in all of IMED's assets and the IMED capital stock and certain patents used in IMED's business, owned by Advanced Medical.\nDEBENTURES\nThe Company has outstanding 7 1\/4% convertible subordinated debentures (\"Debentures\") in the princi- pal amount of $60,000. The Debentures are convertible at the option of the holder into common stock of the Company at any time prior to maturity, unless previously redeemed or repurchased, at a conversion price of $18.14 per share, subject to adjustment in certain events. The Debentures mature on January 15, 2002. Interest on the Debentures is payable semi-annually on each January 15 and July 15. The Debentures are\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 6 -- NOTES PAYABLE AND LONG-TERM DEBT: (CONTINUED) redeemable in whole or in part at the option of the Company at any time on or after January 15, 1993, at the redemption prices set forth in the indenture, together with accrued and unpaid interest, provided that the Debentures may not be redeemed during the twelve-month periods commencing on January 15, 1993 and January 15, 1994, unless the last reported sale price of the common stock for a specified period prior to such redemption is at least 170% and 160%, respectively, of the conversion price then in effect. The Debenture holders may require the Company to repurchase the Debentures, in whole or in part, in certain circumstances involving a change in control of the Company. The Debentures are subordinate to all existing or future senior indebtedness of the Company, and are also effectively subordinated to liabilities of the Company's subsidiaries. The indenture does not restrict the incurrence of senior indebtedness or other indebtedness by the Company or any subsidiary (see Note 16).\nREFINANCINGS\nOn January 4, 1994, the Company issued the Decisions Note and borrowed $6,000 from Decisions. The Note bears interest at 7% and is payable on the earlier of January 4, 2001 or on demand by Decisions provided the repayment is generated by net income of the Company exclusive of IMED, any borrowing or debt or equity offering by the Company, or funds available through distribution from affiliates, including IMED. The principal portion of the note is convertible at the option of the holder into 6,000,000 shares of the Company's common stock at a conversion price of $1.00 per share (subject to antidilution protection). The Decisions Note is secured by a first priority security interest in all of the Company's assets subject to the rights of GECC under the Amended Loan Agreement. The proceeds of the Note were used by the Company to pay $6,000 of indebtedness to Aeneas Venture Corporation (\"Aeneas\").\nOn August 12, 1994, the Company issued the Note and borrowed an additional $6,500 from Decisions. The proceeds of the loan were used to (i) pay all remaining indebtedness to Aeneas in the amount of $3,188, (ii) make the July 15, 1994 interest payment on the Debentures in the amount of $2,187 and (iii) pay other obligations of the Company. The payment of all indebtedness owed by Advanced Medical to Aeneas released Advanced Medical from its obligations under a letter agreement with Aeneas thereby removing the restrictions imposed on Advanced Medical's use of its available cash. The Note is payable on January 4, 2001 and has an annual interest rate of 9%. Interest on the principal is due on June 30 and December 31 of each year. In regards to security, the Note ranks pari passu with the Decisions Note. The Note is convertible, at the option of the holder, into up to 10,483,870 shares of the Company's common stock at a conversion price of $.62 per share (subject to antidilution protection). Any shares of common stock converted cannot be sold into the public market prior to August 12, 1996.\nMATURITIES\nMaturities of long-term debt during the years subsequent to December 31, 1995 are as follows:\nAt December 31, 1994, the fair value, as determined under SFAS No. 107, of long-term debt, including current maturities, was $69,017. The estimated fair values represent the quoted market price for the Debentures and carrying amounts for all other debt.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 7 -- INCOME TAXES: Income (loss) before income taxes, minority interests, extraordinary item and cumulative effect of change in accounting principle comprises the following:\nThe provision for income taxes comprises the following:\nThe principal items accounting for the differences in income taxes computed at the U.S. statutory rate (34%) and the effective income tax rate comprise the following:\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 7 -- INCOME TAXES: (CONTINUED) As of December 31, 1994 the Company has net operating loss carryforwards of approximately $29,000 for federal income tax purposes which expire in varying amounts through 2008. As of December 31, 1994 the Company has capital loss carryforwards of approximately $5,000 for federal income tax purposes which expire in varying amounts through 1996. The availability of the Company's net operating loss and capital loss carryforwards would be subject to substantial limitations if it should be determined that certain stockholders of the Company have increased their percentage of ownership of the Company's stock by more than 50% during a specified period.\nThe components of the net deferred tax asset as of December 31, 1994 are as follows:\nNOTE 8 -- LITIGATION AND CONTINGENCIES: The Company is a defendant in various actions, claims, and legal proceedings arising from normal business operations. Management believes they have meritorious defenses and intends to vigorously defend against all allegations and claims. As the ultimate outcome of these matters is uncertain, no contingent liabilities or provisions have been recorded in the accompanying financial statements for such matters. However, in management's opinion, based upon discussion with legal counsel, liabilities arising from these matters, if any, will not have a material adverse effect on the consolidated financial position or results of operations.\nAn action was commenced during 1986 against various parties including the corporate predecessor of IMED alleging, among other matters, breach of employment contract and wrongful discharge and seeking $5,000 and $40,000 in actual and punitive damages, respectively. During 1993, IMED settled this action with the plaintiff. Pursuant to the settlement agreement, the action was dismissed and IMED paid $1,000 to the plaintiff during 1993 and delivered to the plaintiff a promissory note, payable over 2 years, in the principle amount of $1,275. As a $1,375 contingent liability was previously recorded, $900 was charged to other expense during 1993.\nAn action was commenced during 1991 against IMED, Fisher and various other parties alleging, among other matters, breach of contract and misappropriation of trade secrets. The plaintiffs were seeking unspecified punitive and compensatory damages. During 1994, IMED settled this action with the plaintiffs. Pursuant\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 8 -- LITIGATION AND CONTINGENCIES: (CONTINUED) to the settlement agreement, the action was dismissed and IMED paid $250 to the plaintiff and delivered to a subsidiary of Fisher a promissory note, payable over 5 years, in the principal amount of $750. A charge related to this liability in the amount of $1,200 was recorded in the fourth quarter of 1993.\nNOTE 9 -- MANDATORILY REDEEMABLE EQUITY SECURITIES AND MINORITY INTERESTS IN CONSOLIDATED SUBSIDIARIES:\nPREFERRED STOCK:\nMandatorily redeemable preferred stock activity comprises the following:\nIn connection with the capitalization of Advanced Medical and mergers during 1989, 1,594 shares of $.01 par value mandatorily redeemable preferred stock (\"10% preferred stock\") were issued (1,800 shares authorized). The 10% preferred stockholders are entitled to cumulative dividends in preference to any dividends on common stock, payable semi-annually on March 27 and September 27, if declared, out of funds legally available. The 10% preferred stock has a liquidation value of $10.00 per share plus accrued and unpaid dividends. The 10% preferred stockholders have limited voting rights under certain circumstances; the stock is not convertible into any other class of stock.\nThe 10% preferred stock was recorded at its fair value at the issuance date ($6.26 per share). The carrying amount is periodically increased for the amounts which will be payable upon redemption. The accretion to the carrying amount is determined using the interest method and results in a corresponding decrease to paid-in capital.\nThe 10% preferred stock is redeemable at any time at the option of the Board of Directors, in whole or in part, and is mandatorily redeemable in the amount of $3,985 by March 27 of each year from 1991 through 1994, if declared (aggregate redemption price of $15,940).\nThe Company redeemed 180 shares of its 10% preferred stock during 1990. To satisfy the remaining redemption requirement of 219 shares, the Company redeemed 262 shares of its 10% preferred stock in March 1991 through the issuance of 333 shares of a newly created class of mandatorily redeemable convertible preferred stock (\"convertible preferred stock\") to a stockholder or entities controlled by the stockholder. The convertible preferred stock is subordinate to the existing 10% preferred stock and has a liquidation preference of $6.40 per share. Cumulative dividends are payable semi-annually at 15% of the liquidation preference. Each share is convertible into .617 common shares, subject to anti-dilution adjustments, at any time prior to redemption. The convertible preferred stock is redeemable after all the 10% preferred shares are redeemed (a) at the holder's option at the liquidation preference plus accrued dividends, or (b) at the Company's option at the liquidation preference plus accrued dividends, plus $1.50 per share. The convertible preferred stock is mandatorily redeemable at the liquidation preference plus accrued dividends on the later of March 26, 1998 or the date all existing 10% preferred stock is redeemed.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 9 -- MANDATORILY REDEEMABLE EQUITY SECURITIES AND MINORITY INTERESTS IN CONSOLIDATED SUBSIDIARIES: (CONTINUED) On July 12, 1994, IMED commenced a Tender Offer for up to all of the outstanding shares of 10% Preferred Stock for a cash price equal to $9.00 per share (the \"Tender Offer\"). The Tender Offer expired on August 30, 1994, at which time 68,517 shares of the 10% Preferred Stock were tendered. Immediately upon purchase thereof, IMED distributed all such shares of the 10% Preferred Stock acquired by it pursuant to the Tender Offer to Advanced Medical and received a credit from Advanced Medical against the amount of accrued and unpaid dividends on shares of IMED's preferred stock held by Advanced Medical in an amount equal to the liquidation value of the 10% Preferred Stock ($10 per share) plus accrued and unpaid dividends thereon ($1.45 per share).\nCOMMON STOCK WARRANT\nIMED's common stock warrant held by GECC and included in minority interests in consolidated subsidiaries on the accompanying consolidated balance sheet is comprised of the following:\nIn connection with the loan agreements, IMED issued a warrant allowing GECC to purchase 10% of IMED's common stock on a fully-diluted basis for nominal consideration, subject to adjustment as provided in the agreement, and exercisable at any time until August 12, 2004. IMED is required to purchase not less than 25% of the shares under the warrant, or warrant stock if exercised, at the option of GECC, and also upon (a) the filing of a registration statement for the offering of IMED's common stock; (b) the sale of IMED; (c) the prepayment in full of the GECC loans, or (d) the termination by GECC of the revolving loan under provisions of the loan agreement. Additionally, IMED has the option to redeem not less than 25% of the shares under warrant, or warrant stock if exercised, beginning April 2, 1995. The purchase price per share will be the higher of fair value (determined by either an investment banking firm or at quoted price if the shares are publicly traded) or fully-diluted net book value at the purchase date. Additionally, the warrant shares, or warrant stock if exercised, have specified registration rights.\nIn September 1993, the Company acquired all of the interests of IMED held by Kamen, which included a 10.79% common equity interest and $1,690 of 10% redeemable preferred stock, for $1,750. Minority interests were reduced by the carrying amount of Kamen's interests of $4,984. The excess of the carrying amount ($4,984) over the purchase price ($1,750) has been recorded as a reduction in goodwill.\nNOTE 10 -- STOCK OPTION PLANS: The Company maintains several stock option and purchase plans under which incentive stock options may be granted to key employees and nonqualified stock options may be granted to key employees, directors, officers, independent contractors and consultants. A maximum of 1,950 shares of common stock are subject to issuance under the Plans.\nThe exercise price for incentive stock options generally may not be less than the underlying stock's fair market value at the grant date. The exercise price for non-qualified stock options granted to non-directors will not be less than the par value of a share of common stock, as determined by a committee appointed by the Board of Directors (\"the Committee\"). The exercise price for non-qualified stock options granted to directors may not be less than the underlying stock's fair market value at the grant date.\nOptions granted to non-directors generally vest and become exercisable as determined by the Committee. Options granted to directors generally vest and become exercisable at a rate of four thousand shares for\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 10 -- STOCK OPTION PLANS: (CONTINUED) each 12 month period of continuous service as a director. Options granted to non-directors generally expire upon the earlier of the termination of the optionee's employment or ten years from the grant date. Options granted to directors generally expire upon the earlier of the date the optionee is no longer a director or five years from the grant date.\nSTOCK OPTION ACTIVITY\nAt December 31, 1994, there were 1,551 shares reserved for future grants.\nDuring January 1995, the Company cancelled options to acquire 266 shares of common stock (at prices ranging from $4.47 to $16.94 per share) and granted options to acquire 1,224 shares of common stock (at $1.8125 per share) to key employees of the Company.\nNOTE 11 -- BENEFIT PLANS:\nPENSION PLANS\nThe Company has a defined benefit pension plan (the \"Plan\") which covers substantially all of its U.S. employees. On December 1, 1993, the Company's Board of Directors approved amendments to the Plan provisions which include, among other matters, cessation of benefit accruals after December 31, 1993. All earned benefits as of that date are preserved and the Company continues to contribute to the Plan as necessary to fund earned benefits. The portion of the projected benefit obligation based on the expected future compensation levels decreased $1,381, and nonvested benefits decreased $508. The Plan also had an unrecognized net loss, resulting from Plan asset performance experience different than assumed, remaining unamortized of $1,219 and unrecognized prior service costs of $18 at December 31, 1993. The sum of the effects resulting from the Plan curtailment was a gain of $652 and was included in restructuring charges at December 31, 1993 as described in Note 2.\nCertain of the Company's foreign employees are covered by defined benefit pension plans. Benefits are based on years of service and the employee's compensation during the last five years of employment. The Company's funding policy is to contribute the net pension cost annually to the plan. As a result of the Company's plan to sell its Irish manufacturing facility, the foreign accrued pension cost of $298 is included in net assets held for sale at December 31, 1993 as described in Note 2.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 11 -- BENEFIT PLANS: (CONTINUED) The following table sets forth the plans' estimated funded status and amounts recognized in the Company's balance sheet:\nThe components of net periodic pension cost (benefit) are as follows:\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 12 -- LEASES:\nLEASE RECEIVABLES\nThe Company leases instruments to customers under non-cancelable capital and operating lease contracts with terms ranging generally from 1 to 5 years. Scheduled future minimum lease payments are as follows:\nOperating lease revenue totaled $7,673, $2,838 and $2,033 during 1992, 1993 and 1994, respectively.\nLEASE COMMITMENTS\nThe Company leases buildings and equipment under non-cancelable operating leases with initial terms ranging from 1 to 6 years. Scheduled future minimum lease commitments as of December 31, 1994 are as follows:\nRent expense was $3,840, $3,845 and $3,740 during 1992, 1993 and 1994, respectively.\nNOTE 13 -- RELATED PARTY ARRANGEMENTS AND COMMITMENTS: On April 2, 1990, IMED entered into an agreement with Deka Products Limited Partnership (\"Deka\") whereby Deka granted IMED an exclusive, worldwide, royalty-free license of certain intravenous infusion pump technology developed by Deka. In consideration for this technology, IMED issued Deka 10.79% of its common stock and 13% of its preferred stock (each on a fully-diluted basis). During 1993, the Company discontinued its funding of Deka and AMD to develop hospital infusion pumps and related disposables based on Deka's fluid management technology and the Company acquired all the interests of IMED held by Deka (see Notes 4 and 9).\nDuring 1990, IMED entered into a five year purchase and supply agreement with a hospital buying group. Pursuant to the agreement, the buying group is to market IMED's products to the individual hospitals which are members of the buying group. In exchange for such marketing efforts, IMED granted the buying\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 13 -- RELATED PARTY ARRANGEMENTS AND COMMITMENTS: (CONTINUED) group stock appreciation rights (\"SARs\") of up to an aggregate of 250,000 shares of Advanced Medical common stock, subject to a vesting schedule based on purchasing volumes. Upon signing the agreement the buying group was immediately vested in 50,000 SARs and during 1991 the buying group's purchasing volumes qualified it to become vested in an additional 50,000 SARs. The recorded liability related to such SARs totaled $400 at December 31, 1993. During 1994, IMED repurchased all vested SARs and paid $400 to the buying group.\nIn October 1991, IMED sold certain European assets to Pharmacia and entered into a marketing, distribution and development arrangement with Pharmacia (the \"Pharmacia Transaction\"), pursuant to which Pharmacia obtained the exclusive right to market and distribute IMED's infusion products in a territory that includes most of Europe. On August 12, 1994, the Company, IMED and Pharmacia amended their distribution agreement. Under the terms of the Amended and Restated Distribution Agreement (\"Amended Distribution Agreement\"), Pharmacia retains the exclusive right (subject to certain exceptions) to distribute IMED's infusion products in the territory that includes most of Europe. Under the Amended Distribution Agreement, Pharmacia has the right not to distribute certain products currently under development by IMED. In the event of such an election, IMED has the right to sell such products directly or through others, and under certain circumstances, has the right to repurchase from Pharmacia the distribution rights to IMED products currently distributed by Pharmacia in the territory. In addition, Pharmacia has the right to terminate the Amended Distribution Agreement at any time on 12 months notice, in which event Pharmacia would be required to make a payment of $2,500 to IMED and IMED would be required to make payments to Pharmacia based on net sales of products currently distributed by Pharmacia for the 4 years following termination.\nDuring 1994, the Company issued the Decisions Note and the Note to Decisions, a corporation affiliated with Jeffry M. Picower. Mr. Picower is an officer, director and significant stockholder of the Company. (See Note 6.)\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 14 -- SEGMENT INFORMATION:\nNOTE 15 -- SUPPLEMENTAL INFORMATION TO STATEMENTS OF CASH FLOWS: Foreign and state income taxes paid during 1992, 1993 and 1994 totaled $2,061, $870 and $1,433, respectively. Interest paid during 1992, 1993 and 1994 totaled $19,568, $10,280 and $7,745, respectively. Interest paid during 1992 includes $12,451 accrued in previous periods.\nNOTE 16 -- SUBSEQUENT EVENT (UNAUDITED): Effective March 31, 1995, the Company completed an exchange (the \"Exchange\") wherein $28,245, or approximately 47%, in principal amount of the Company's Debentures were exchanged for an aggregate of $14,123 in principal amount of the Company's newly created 15% Subordinated Debentures due 1999 (\"15% Debentures\") and 1,340,441 shares of the Company's common stock (\"Common Stock\"). As a result of this transaction, the Company will recognize an extraordinary gain on the extinguishment of debt of approximately $8,200 in the first quarter of 1995.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE)\nNOTE 16 -- SUBSEQUENT EVENT (UNAUDITED): (CONTINUED) PRO FORMA CONDENSED BALANCE SHEET\nThe unaudited Pro Forma Condensed Balance Sheet is based upon the Company's historical consolidated balance sheet at December 31, 1994, after giving effect to the pro forma adjustments described in the footnotes hereto as if the Exchange had been consummated on December 31, 1994.\nThe pro forma adjustments described herein are based upon currently available information and upon certain assumptions that the Company believes are reasonable under current circumstances and which are described herein. The unaudited Pro Forma Condensed Balance Sheet should be read in conjunction with the Company's historical consolidated financial statements and accompanying notes thereto. Due to the fact that the Exchange and certain related transactions occurred subsequent to December 31, 1994, the pro forma financial information presented herein is not necessarily indicative of the results or balances that would have been attained had the Exchange actually taken place prior to December 31, 1994 and the actual adjustments and balances may vary from those presented in the unaudited Pro Forma Condensed Balance Sheet. However, management believes that any differences between actual adjustments and pro forma adjustments will not have a material impact on the pro forma financial statements.\nPRO FORMA CONDENSED STATEMENT OF OPERATIONS\nThe unaudited Pro Forma Condensed Statement of Operations is based upon the Company's historical consolidated statement of operations for the year ended December 31, 1994, after giving effect to the pro forma adjustments described in the footnotes hereto as if the Exchange had been consummated on January 1, 1994.\nThe pro forma adjustments described herein are based upon currently available information and upon certain assumptions that the Company believes are reasonable under current circumstances and which are described herein. The unaudited Pro Forma Condensed Statement of Operations should be read in conjunction with the historical consolidated financial statements and accompanying notes thereto. The Pro Forma Condensed Statement of Operations is not necessarily indicative of what actual results of operations would have been for the respective period presented had the Exchange actually taken place on January 1, 1994 and does not purport to project the Company's results of operations for any future period.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES PRO FORMA CONDENSED BALANCE SHEET (UNAUDITED) DECEMBER 31, 1994 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO PRO FORMA CONDENSED BALANCE SHEET (UNAUDITED) DECEMBER 31, 1994 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNote 1 -- The Exchange pro forma adjustments assume the surrender of $28,245 in principal amount of Debentures in exchange for an aggregate of $14,123 in principal amount of the Company's newly-created 15% Debentures and 1,340,441 of Common Stock. The Exchange pro forma adjustments are made as follows:\n(A) Reflects the surrender of $28,245 of Debentures in exchange for an aggregate of $14,123 in principal amount of the Company's newly created 15% Debentures and 1,340,441 shares of Common Stock ($2.75\/share) and the corresponding extraordinary gain on retirement of debt of $10,436. The extraordinary gain is recorded net of $1,393, comprising the write-off of approximately 47% of the unamortized Debenture debt issue costs and net of $620, the effective tax rate applicable to the Exchange.\n(B) Reflects the use of cash to pay $300 of debt issue costs in connection with the Company's newly created 15% Debentures.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES PRO FORMA CONDENSED STATEMENT OF OPERATIONS (UNAUDITED) YEAR ENDED DECEMBER 31, 1994 (DOLLAR AND SHARE AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)\nADVANCED MEDICAL, INC. AND SUBSIDIARIES NOTES TO PRO FORMA CONDENSED STATEMENT OF OPERATIONS (UNAUDITED) YEAR ENDED DECEMBER 31, 1994 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)\nNote 1 -- The Exchange pro forma adjustments assume the surrender of $28,245 in principal amount of Debentures in exchange for an aggregate of $14,123 in principal amount of the Company's newly-created 15% Debentures and 1,340,441 of Common Stock. The Exchange pro forma adjustments are made as follows:\n(C) Reflects the extraordinary gain of $10,436 on the extinguishment of debt due to the Exchange of $28,245 in principal amount of Debentures for an aggregate of $14,123 in principal amount of 15% Debentures and 1,340,441 shares of Common Stock ($2.75\/share). The extraordinary gain is recorded net of $1,590, comprising the write-off of approximately 47% of the unamortized Debenture debt issue costs and net of $620, the effective tax rate applicable to the Exchange.\n(D) Reflects the elimination of approximately 47% of the amortization of Debenture debt issue costs of $197, net of additional amortization of debt issue costs of $75 incurred with the Exchange.\n(E) Reflects additional interest expense of $2,118 incurred on the $14,123 of 15% Debentures, net of the elimination of interest expense of $2,048 related to the $28,245 of Debentures which is assumed to have been retired in connection with the Exchange.\n(F) Reflects the tax effect on items (D) and (E) above, calculated at the statutory rate.\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 executive officers and directors of the Company and executive officers of IMED are as follows:\nJEFFRY M. PICOWER -- Mr. Picower was a Director, Vice President and Assistant Treasurer of the Company from September 1988 to March 1989 and Vice Chairman from December 1988 to June 1989. Mr. Picower was re-elected as a Director and Co-chairman of the Board on March 8, 1993 and became Chairman of the Board on May 4, 1993. Mr. Picower has been Chief Executive Officer since September 7, 1993. He has, since 1984, been Chairman of the Board and Chief Executive Officer of Monroe Systems for Business, Inc. (\"Monroe\"), a world-wide office equipment, distribution and service organization. Mr. Picower has been a director of Physician Computer Network, Inc. (\"PCN\") since January 1994 and Chairman of the Board since June 1994. PCN, a corporation whose principal shareholder is Mr. Picower, operates a computer network linking its office-based physician members to health care organizations.\nJOSEPH W. KUHN -- Mr. Kuhn was appointed President of the Company and IMED in January 1995. Since August 1993, Mr. Kuhn has been Chief Financial Officer, Treasurer and Secretary of the Company and Treasurer and Secretary of IMED. From August 1993 to January 1995, Mr. Kuhn was Vice President of the Company and Executive Vice President of IMED. Mr. Kuhn was Corporate Controller of the Company from January 1990 to August 1993. Mr. Kuhn joined Controlled Therapeutics Corporation (\"CTC\") (a development stage pharmaceutical company and a former subsidiary of the Company) in September 1989 and was its Corporate Controller through December 1991. From 1983 to 1989, Mr. Kuhn held positions of increasing responsibility, including senior manager, with Price Waterhouse, a public accounting firm. From 1982 to September 1983, Mr. Kuhn was employed by Main Hurdman, a public accounting firm. Mr. Kuhn holds a B.A. degree from Rutgers University and is a Certified Public Accountant.\nANTHONY CERAMI, PH.D. -- Dr. Cerami was first elected to the Board of Directors of the Company in March 1989. He has been President of The Picower Institute for Medical Research since October 1991. Dr. Cerami was Dean, Graduate and Postgraduate Studies at The Rockefeller University from 1986 through January 1991 and was a Professor at The Rockefeller University from 1978 until October 1991. He is an editor of the JOURNAL -- MOLECULAR MEDICINE and is on the editorial boards of several biomedical journals. He has been an author of numerous publications covering many aspects of medical biochemistry. He holds a B.S. from Rutgers University and a Ph.D. from The Rockefeller University. Dr. Cerami is Chairman of the Scientific Advisory Board and a director of Alteon.\nNORMAN M. DEAN -- Mr. Dean was first elected to the Board of Directors of the Company in March 1989. Mr. Dean has been a director and President of Foothills Financial Corporation, a venture capital company, since January 1985 and Chairman of the Board of Miller Diversified Corp. since May 1990.\nHENRY GREEN -- Mr. Green was President and Chief Operating Officer of the Company from September 1990 to March 1993 and has been a director of the Company since 1991. Mr. Green was also President and Chief Executive Officer of CTC from February 1991 to December 1992. Mr. Green became an employee of PCN in March 1993 and Chief Executive Officer in June 1994. Mr. Green was elected President of PCN in May 1993 and Chief Executive Officer in June 1994. He was elected as a director of PCN in July 1993. From 1988 to September 1990, Mr. Green was Vice President of Johnson & Johnson International. From 1981 to 1988, Mr. Green was President of Vistakon, Inc., a subsidiary of Johnson & Johnson. Mr. Green holds a B.S. and an M.B.A. from Drexel University.\nRICHARD B. KELSKY -- Mr. Kelsky has been a Director of the Company since June 1989. Since 1984, Mr. Kelsky has been Vice President and General Counsel of Monroe. Mr. Kelsky has been a director of PCN since January 1992.\nDirectors are elected for terms of one year and until their successors are duly elected and have qualified. There are no family relationships among the above directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe following table provides certain summary information concerning compensation paid or accrued by the Company and IMED to or on behalf of the Company's Chief Executive Officer and each of the other most highly compensated executive officers of the Company whose salary and bonus exceeded $100,000 (determined for and as of the end of 1994) (the \"Named Executive Officers\") for the years ended December 31, 1992, 1993 and 1994:\nSUMMARY COMPENSATION TABLE\nEMPLOYMENT AGREEMENTS\nMr. Kuhn is employed by the Company and IMED as President pursuant to an employment agreement providing for a base salary of $175,000. The agreement provides that, upon termination of his employment by the Company other than for cause, Mr. Kuhn will receive an amount, to be paid over a six-month period commencing with the date his employment terminates, equal to six months' salary, which amount will be reduced by any salary or compensation that Mr. Kuhn receives from any other sources during such six-month period. In addition, subject to certain conditions, the option to purchase shares of common stock previously granted to Mr. Kuhn will become fully vested when his employment terminates. From September 1993 through December 1994, Mr. Kuhn was employed by the Company as Chief Financial Officer and by IMED as Executive Vice President pursuant to an employment agreement providing for a base salary of $135,500.\nDuring 1994, Mr. Kuhn received a performance bonus of $40,650 pursuant to his employment contract.\nIn connection with Mr. Kuhn's acceptance of employment as the Company's Chief Financial Officer on September 1, 1993, he received supplemental income of $67,750 and the cancellation of a $35,543 loan made by the Company to Mr. Kuhn in connection with his relocation to California in 1990.\nSTOCK-BASED BENEFIT PLANS\nSTOCK OPTION PLAN\nThe Company's Stock Option Plan (the \"Option Plan\"), was originally adopted by the Board of Directors on December 27, 1988. The Option Plan in its first amended and restated form was adopted by the Board of Directors on July 12, 1990 and became effective on September 7, 1990. The Option Plan in it second amended and restated form was adopted by the Board of Directors on June 30, 1992. The Option Plan in its third amended and restated form was approved by the Board of Directors and became effective on June 28, 1994. Under the Option Plan, incentive stock options (\"ISOs\"), as provided in Section 422 of the Internal Revenue Code, may be granted to key employees of the Company and its subsidiaries, and nonqualified stock options (\"NQSOs\") may be granted to key employees, directors (except directors eligible to participate in the Directors Plan), and officers of the Company, its subsidiaries or affiliates, as well as independent contractors and consultants performing services for such entities. The maximum aggregate number of shares of the Company's common stock that may be issued under the Option Plan is 1,700,200. The number of shares of common stock which remained available for issuance under the Option Plan was 1,638,680 of which 1,107,305 are subject to currently outstanding options. The number of shares of common stock available under the Option Plan will be reduced on a share for share basis in respect of each share issued other than under the Option Plan to persons eligible to participate in the Option Plan. In the event of a change in the capitalization of the Company which affects the common stock, the Committee may make proportionate adjustments to the number of shares of common stock for which options may be granted and the number and exercise price of shares of common stock subject to outstanding options. Options may not be granted under the Stock Option Plan after December 27, 1998.\nThe Option Plan provides for administration by a committee appointed by the Board of Directors (the \"Committee\"). No member of the Committee is eligible to receive options under the Option Plan. The Committee has authority, subject to the terms of the Option Plan, to determine the individuals to whom options may be granted, the exercise price and number of shares of common stock subject to each option, whether the options granted to employees are to be ISOs, the time or times during which all or a portion of each option may be exercised and certain other provisions of each option.\nPursuant to the Option Plan, the purchase price of shares of common stock subject to ISOs must be not less than the fair market value of the common stock at the date of the grant; provided, that the purchase price of shares subject to ISOs granted to any optionee who owns shares possessing more than 10% of the combined voting power of the Company or any parent or subsidiary of the Company (\"Ten Percent Shareholder\") must be not less than 110% of the fair market value of the common stock at the date of the grant. With respect to NQSOs, the purchase price of shares will be determined by the Committee at the time of the grant, but will not be less than the par value of a share of common stock. The maximum term of an option may not exceed 10 years from the date of grant, except with respect to ISOs granted to Ten Percent\nShareholders which must expire within five years of the date of grant. Options granted vest and become exercisable as determined by the Committee. The Committee will limit the grant so that no more than 250,000 shares of common stock (subject to certain adjustments) may be awarded to any one employee in any calendar year. During the lifetime of an optionee, his or her options may be exercised only by such optionee. Options are not transferable other than by will or by the laws of descent and distribution.\nPayment of the purchase price for the shares of common stock to be received upon exercise of an option may be made in cash, in shares of common stock or in any combination thereof. In addition, the Committee may, pursuant to the terms of the stock option agreement between the optionee and the Company, provide for payment of the purchase price by promissory note or by any other form of consideration permitted by law.\nOptions granted to participants under the Option Plan are subject to forfeiture under certain circumstances in the event an optionee is no longer employed by or performing services for the Company. In the event an optionee is terminated for cause, all unexercised options held by such optionee (whether or not vested) expire upon such termination. If an optionee is no longer an Officer, Director or Employee (as defined in the Option Plan) other than as the result of having been terminated for cause, all unvested options expire at such time and all vested options expire twelve months thereafter, unless by their terms such options expire sooner.\nIn the event of a change in control, as defined in the Option Plan, unless otherwise determined by the Committee at the time of grant or by amendment (with the holder's consent) of such grant, all options not vested on or prior to the effective time of any such change of control shall immediately vest as of such effective time.\nNo options were granted under the Option Plan in 1994 to any director of the Company or Named Executive Officer.\nAGGREGATED OPTION EXERCISES IN FISCAL YEAR 1994 AND OPTION VALUES AS OF DECEMBER 31, 1994\nDIRECTORS PLAN\nThe Company's Non-Qualified Stock Option Plan for Non-Employee Directors (the \"Directors Plan\"), a separate plan pursuant to which it grants NQSOs to its non-employee directors, was originally adopted by the Board on July 12, 1990 and became effective on September 7, 1990. The Directors Plan in its amended and restated form was adopted by the Board of Directors and became effective on June 30, 1992. The Directors Plan in its second amended and restated form was approved by the Board of Directors and became effective on June 28, 1994. Directors who are eligible participants in the Directors Plan are not eligible to receive awards under the Option Plan. An aggregate of 250,000 shares of the Company's common stock may be issued under the Directors Plan. The number of shares of common stock which remained available for issuance under the Directors Plan was 240,000, of which 62,000 are subject to currently outstanding options.\nThe number of shares of common stock available under the Directors Plan will be reduced on a share for share basis in respect of each share issued other than under the Directors Plan to persons eligible to participate in the Directors Plan. In the event of a change in the capitalization of the Company which affects the common stock, the committee which administers the Directors Plan (the \"Plan Committee\") may make proportionate adjustments to the number of shares of common stock for NQSOs which may be granted and to the number and exercise price of shares of common stock subject to outstanding NQSOs. NQSOs may not be granted under the Directors Plan after September 7, 2000.\nThe Plan Committee consists of at least two individuals who are not eligible to participate in the Directors Plan. The Plan Committee has the authority to administer all aspects of the Directors Plan other than (i) the grant of NQSOs; (ii) the number of shares of common stock subject to NQSOs; (iii) the rate at which options granted thereunder vest and become first exercisable; and (iv) the price at which each share covered by a NQSO may be purchased, all of which are determined automatically under the Directors Plan.\nOn September 10, 1990, initial grants of NQSOs covering 12,000 shares of common stock were made automatically under the Directors Plan to each of the Company's three non-employee directors. An initial grant of NQSOs covering 12,000 shares of common stock also will be made automatically to any person who becomes an eligible participant after September 10, 1990, on the business day following such person's election to the Board of Directors. During the term of the Directors Plan, additional grants of NQSOs covering 12,000 shares of common stock will be made to each participant in the Directors Plan every three years on the anniversary of such person's initial NQSO grant. The NQSOs granted under the Directors Plan will vest and become exercisable at the rate of 4,000 for every twelve month period of continuous service on the Board, provided that the optionee is still a member of the Board on that date. For purposes of vesting, participants will receive credit for any period of continuous service prior to September 7, 1990. The term of each NQSO is five years from the date of grant. During the lifetime of an optionee, his or her NQSOs may be exercised only by the optionee and the NQSOs are not transferable other than by will or by the laws of descent and distribution. NQSOs granted under the Directors Plan which have not yet vested are subject to termination if the optionee ceases to be a director or becomes an employee of the Company and all NQSOs which have vested expire twelve months after such change in status, unless by their terms such NQSOs expire sooner. In the event that an optionee is removed from the Board for cause, all unexercised NQSOs, whether or not vested, expire upon such removal.\nThe purchase price of shares of common stock subject to NQSOs is the fair market value of the common stock on the date of the grant. Payment for the shares of Common Stock to be received by a optionee upon exercise of a NQSO may be in cash or in shares of common stock. In addition, the Plan Committee may provide in such optionee's stock option agreement for payment of the purchase price by promissory note or any other form of consideration permitted by law.\nIn the event of a change in control, as defined in the Directors Plan, all NQSOs not vested on or prior to the effective time of any such change in control shall immediately vest as of such effective time.\nCOMPENSATION OF DIRECTORS\nThe Company's current policy is to compensate members of its Board of Directors who are not employees of the Company at the annual rate of $10,000 plus options to purchase 4,000 shares of the Company's Common Stock pursuant to the Directors Plan. See \"Stock-Based Benefit Plans Directors Plan.\" Travel and accommodation expenses of directors incurred in connection with meetings are reimbursed by the Company.\nIn March 1993, the Company and Mr. Green entered into a consulting agreement with a three year term, expiring on March 15, 1996, and providing for the payment to Mr. Green of consulting fees in the amount of $100,000 annually. Mr. Green does not currently receive the $10,000 annual director's compensation or the option to purchase the Company's common stock pursuant to the Directors Plan.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe table below sets forth, as of March 30, 1995, information regarding the beneficial ownership of the Company's Common Stock by (i) all persons known by the Company to own beneficially more than 5% of its\noutstanding Common Stock, (ii) each director of the Company, (iii) each of the Named Executive Officers who still hold an office with the Company and\/or its subsidiaries, and (iv) all directors and officers of the Company as a group. Unless otherwise stated, the Company believes that the beneficial owners of the shares listed below have sole investment and voting power with respect to such shares.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nOn January 4, 1994, the Company issued a secured promissory note to Decisions in the amount of $6,000,000, the proceeds of which were used to repay principal to Aeneas Venture Corporation (\"Aeneas\"). The note bears interest at 7% and is payable on the earlier of January 4, 2001 or on demand by Decisions provided the repayment is generated by net income of the Company exclusive of IMED, any borrowing or debt or equity offering by the Company, or funds available through distribution from affiliates, including IMED. The principal portion of the note is convertible at the option of the holder into 6,000 shares of the Company's common stock at a conversion price of $1.00 per share (subject to antidilution protection). The Decisions Note is secured by a first priority security interest in all of the Company's assets subject to the rights of GECC under the Amended Loan Agreement.\nOn August 12, 1994, the Company issued the Note and borrowed $6,500,000 from Decisions. The proceeds of the loan were used to (i) pay all indebtedness to Aeneas in the amount of $3,188,000, (ii) make the July 15, 1994 interest payment on the Company's 7% convertible subordinated debentures (\"Debentures\") in the amount of $2,187,000 and (iii) pay other obligations of the Company. The payment of the interest due on the Debentures cured Advanced Medical's default in its payment of interest. The payment of all indebtedness owed by Advanced Medical to Aeneas released Advanced Medical from its obligations under a letter agreement with Aeneas thereby removing the restrictions imposed therein on Advanced Medical's use of its available cash. The Note is payable on January 4, 2001 and has an annual interest rate of 9%. Interest on the principal is due on June 30 and December 31 of each year. In regards to security, the Note ranks pari passu with the Decisions Note. The Note is convertible, at the option of the holder, into up to 10,483,870 shares of Common Stock at a conversion price of $.62 per share (subject to antidilution protection). Any shares of Common Stock converted cannot be sold into the public market prior to August 12, 1996.\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:\nThe following financial statements of Advanced Medical, Inc. and its subsidiaries are included in Part II, Item 8 of this report, on the following pages:\n2. FINANCIAL STATEMENT SCHEDULES:\nSchedule III -- Condensed Financial Information of Advanced Medical, Inc. as of December 31, 1993 and 1994 and for the three years ended December 31, 1994.\nSchedule VIII -- Valuation and Qualifying Accounts and Reserves for the three years ended December 31, 1994.\nAll other schedules have been omitted because they are inapplicable, not required or the required information is included in the financial statements or notes thereto.\n3. EXHIBITS.\n(b) Report on Form 8-K\nThe Company did not file any reports during the last quarter of the period covered by this report.\nSIGNATURES\nPursuant to the requirements of Sections 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.\nADVANCED MEDICAL, INC.\nBy: \/s\/ JEFFRY M. PICOWER\n-------------------------------------- Jeffry M. Picower CHAIRMAN OF THE BOARD, CHIEF EXECUTIVE OFFICER AND DIRECTOR\nDate: March 31, 1995\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 DATE ----------------------------------- ------------------------- ----------------\nChairman of the Board, \/s\/ JEFFRY M. PICOWER Chief Executive Officer ------------------------------ and Director (Principal March 31, 1995 Jeffry M. Picower executive officer)\nPresident, Treasurer and \/s\/ JOSEPH W. KUHN Secretary (Principal ------------------------------ accounting and financial March 31, 1995 Joseph W. Kuhn officer)\n\/s\/ ANTHONY CERAMI ------------------------------ Director March 31, 1995 Anthony Cerami\n\/s\/ NORMAN M. DEAN ------------------------------ Director March 31, 1995 Norman M. Dean\n\/s\/ HENRY GREEN ------------------------------ Director March 31, 1995 Henry Green\n\/s\/ RICHARD B. KELSKY ------------------------------ Director March 31, 1995 Richard B. Kelsky\nADVANCED MEDICAL, INC. AND SUBSIDIARIES SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF ADVANCED MEDICAL, INC. CONDENSED BALANCE SHEETS (DOLLARS IN THOUSANDS) ASSETS\nThe accompanying notes are an integral part of these condensed financial statements.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF ADVANCED MEDICAL, INC. CONDENSED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these condensed financial statements.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF ADVANCED MEDICAL, INC. CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nThe accompanying notes are an integral part of these condensed financial statements.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES SCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF ADVANCED MEDICAL, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS OF ADVANCED MEDICAL, INC. (DOLLARS IN THOUSANDS)\nNOTE 1 -- STATEMENT OF ACCOUNTING POLICY: The accompanying condensed financial statements have been prepared by Advanced Medical pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations. It is therefore suggested that these condensed financial statements be read in conjunction with the Consolidated Financial Statements and notes thereto.\nNOTE 2 -- SECURITIES AVAILABLE FOR SALE: The market value at December 31, 1994 is based on the quoted market price and is considered to represent fair value as determined under SFAS 115. The fair value may not represent actual value of the Alteon common stock that could have been realized as of December 31, 1994 or that will be realized in the future.\nSee Note 5 to the Consolidated Financial Statements.\nNOTE 3 -- INVESTMENTS IN AND NET ADVANCES FROM SUBSIDIARIES: Advanced Medical accounts for its investments in subsidiaries using the equity method. Under the equity method, investments are carried at cost, adjusted for Advanced Medical's proportionate share of their undistributed earnings on losses. Investments in preferred stock are stated at cost.\nInvestments in and net advances to\/(from) subsidiaries comprise the following:\nThe IMED preferred stock held by Advanced Medical is entitled to receive 12% cumulative dividends on its stated value ($13,000) and is redeemable at Advanced Medical's option, after January 1, 2000, at $13,000 plus accrued and unpaid dividends. IMED paid dividends to Advanced Medical in the amount of $2,273 during 1994.\nNOTE 4 -- PATENTS: Advanced Medical acquired patents for $10,000 on April 2, 1990. These patents are licensed to IMED for a royalty of $1,100 per annum.\nNOTE 5 -- LONG-TERM DEBT: The terms and maturities of Advanced Medical's long-term debt are described in Note 6 to the Consolidated Financial Statements.\nNOTE 6 -- MANDATORILY REDEEMABLE EQUITY SECURITIES: Advanced Medical's mandatorily redeemable equity securities are described in Note 9 to the Consolidated Financial Statements.\nNOTE 7 -- LITIGATION AND CONTINGENCIES: Litigation and contingencies are described in Note 8 to the Consolidated Financial Statements.\nADVANCED MEDICAL, INC. AND SUBSIDIARIES SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE THREE YEARS ENDED DECEMBER 31, 1993 (DOLLARS IN THOUSANDS)\nEXHIBIT INDEX","section_15":""}
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{"filename":"716006_1994.txt","cik":"716006","year":"1994","section_1":"Item 1. Business.\n(a) Yellow Corporation and its wholly-owned subsidiaries are collectively referred to as \"the company\". The company provides transportation services primarily to the less-than-truckload (LTL) market throughout North America. There were no material changes in the method of conducting business by the company in 1994. However, in November 1994 the company acquired Johnson's Freighlines (renamed WestEx), a Phoneix, AZ-based regional carrier with annual revenue of approximately $17 million. Additionally, the company's subsidiaries expanded geographically and improved their service offerings during the year as described below.\n(b) The operation of the company is conducted through one predominant industry segment, which is the interstate transportation of general commodity freight, primarily LTL, by motor vehicle.\n(c) Yellow Corporation is a holding company providing freight transportation services through its subsidiaries, Yellow Freight System, Inc. (Yellow Freight), Preston Trucking Company, Inc. (Preston Trucking), Saia Motor Freight Line, Inc. (Saia), CSI\/Reeves, Inc. (CSI\/Reeves), WestEx, Inc. (WestEx), Yellow Logistics Services, Inc. (Yellow Logistics) and Yellow Technology Services, Inc. (Yellow Technology). The company employed an average of 33,400 persons in 1994.\nYellow Freight, the company's principal subsidiary, had operating revenue of $2.221 billion in 1994 (77% of the company's total revenue) and is based in Overland Park, Kansas. It is the nation's largest provider of LTL transportation services with direct service to over 35,000 points in all 50 states, Puerto Rico, Canada and Mexico. Yellow Freight services Europe via an alliance with The Royal Frans Maas Group based in the Netherlands.\nPreston Trucking is primarily a regional LTL carrier serving the Northeast and upper Midwest markets of the United States. Preston Trucking had operating revenue of $417 million in 1994 (15% of the company's total revenue) and is headquartered in Preston, Maryland.\nSaia is a regional LTL carrier that provides overnight and second-day service in nine Southeastern states. It had operating revenue of $138 million in 1994 and is based in Houma, Louisiana. Effective January 1, 1995, Smalley Transportation Company (Smalley), an affiliated company, was merged into Saia. Smalley was a regional carrier providing service to customers in Georgia and throughout Florida, with operating revenue of $40 million in 1994.\nCSI\/Reeves is in the business of transporting, warehousing and distributing carpet and related products. It had operating revenue of $36 million in 1994 and is based in Calhoun, Georgia.\nWestEx, formerly Johnson's Freightlines, was acquired in November 1994. This regional LTL carrier provides mostly overnight service to the states of Arizona, New Mexico and parts of Texas and Nevada and is based in Phoenix, Arizonia.\nYellow Logistics offers integrated logistics management services including transportation management, warehousing, information systems, distribution, package design and testing. Its headquarters are in Overland Park, Kansas.\nItem 1. Business. (cont.)\nYellow Technology supports the company's subsidiaries - primarily Yellow Freight - with information technology. It ensures that information systems anticipate and meet customers' needs and that the systems are an integral part of the transportation process. Its headquarters are in Overland Park, Kansas.\nThe operations of the freight transportation companies are partially regulated by the Interstate Commerce Commission and state regulatory bodies. As a result of the passage of the Trucking Industry Regulatory Reform Act of 1994, the entry and rates for the intrastate operations of all transportation companies became deregulated January 1, 1995. Competition includes contract motor carriers, private fleets, railroads and other motor carriers. No single carrier has a dominant share of the motor freight market.\nThe company operates in a highly price-sensitive and competitive industry, making pricing, customer service and cost control major competitive factors. Traditionally, rate increases have been implemented to offset increases in labor and other operating costs. The motor carrier subsidiaries have implemented rate increases of between four and five percent during the first quarter of 1994 to cover increases in operating costs. The full impact of rate increases is not realized immediately as a result of pricing that is on a contract basis and can only be increased when the contract is renewed or renegotiated. A relatively stable pricing environment enabled the company to retain most of the 1994 rate increases. The company's subsidiaries are continuing to work toward improved account profitability and maintaining pricing stability. The motor carrier subsidiaries have implemented rate increases of between four and five percent during the first quarter of 1995 to cover increases in operating costs.\nThe company's strategy focuses on introducing new customer services, improving existing services and providing service to new markets. The company strives to control operating costs by maintaining efficient operations, optimum capacity utilization and strict budgetary controls. Increased technology investments are expected to reduce costs and increase productivity while providing improved information benefits for customers.\nTwo events materially impacted Yellow Freight's operating results in 1994. In the first quarter, severe winter weather caused significant business disruptions and higher operating expenses. In April, Yellow Freight experienced a 24-day national labor strike by the International Brotherhood of Teamsters (Teamsters). During this period, virtually no revenue was generated to cover fixed and general\/administrative costs. This resulted in a six percent decrease in revenue in 1994 compared to 1993. The impact of decreased tonnage and number of shipments handled was partially offset by price increases and a stable pricing environment. However, a new four-year labor contract was reached which provides Yellow Freight greater operational flexibility while giving Teamster employees increased wages, benefits and job security. The increased flexibility means that Yellow Freight has the ability to lower operating costs by gaining the right to use more rail transportation and dock casual workers whose rate of pay is fixed during the contract. In return, the carriers agreed to a 14% increase in wages and benefits over the four-year contract term.\nYellow Freight's salaries, wages and employees' benefits expense as a percentage of revenue was essentially the same in 1994 and 1993. Slightly lower employee levels were offset by wage and benefit increases of approximately three percent effective\nItem 1. Business. (cont.)\nApril 1 under the new labor agreement. In the third quarter, Yellow Freight implemented a change of linehaul operations, which allows substantially more freight to be transported via rail. This change, which was made possible by the new labor agreement, is expected to hold down operating costs, reduce capital expenditures for revenue equipment and improve service for customers. Purchased transportation costs were higher in 1994 as a result of this increased rail usage in the third and fourth quarters. With business near pre-strike levels, a stable pricing environment, and a new four-year labor agreement which will help reduce costs and improve efficiency, Yellow Freight expects improved operating performance in 1995.\nPreston Trucking had an annualized revenue increase of five percent in 1994 compared to 1993. However, their operating margin deteriorated slightly during the year as a result of severe winter weather in the Northeast during the first quarter, the impact of the second quarter strike and shipper uncertainty concerning approval of the wage reduction agreement described below. Preston Trucking saw a dramatic increase in revenue during the second quarter of 1994 when employees returned to work under an interim agreement with the Teamsters after only six days on strike. The increased business adversely affected service performance and costs, reducing profitability in the latter part of the second quarter and into the third quarter. In mid-1994, the Teamster employees of Preston Trucking approved a plan to reduce wages in return for a share of profits if certain operating results are achieved. The plan lessens pay by seven percent from standard wages under the new contract until April 1, 1995 and by five percent until April 1, 1996 when pay levels return to standard contract wages. This plan replaced a one year, nine percent wage reduction approved in March 1993, shortly after Preston Trucking was acquired by the company.\nPreston Trucking achieved significant service improvements in the fourth quarter through the implementation of a new regional concept featuring a 170-door distribution center near Cleveland, Ohio. Called the SuperRegion, it provides reduced transit times and superior service across an expanded geographic area. This service began attracting new revenue during the quarter. Preston Trucking plans to continue to leverage its new SuperRegion concept and expects improvement in both revenue growth and operating profit. Revenue growth, improved service and improved productivity are expected to produce benefits in excess of the phase down of the wage reduction agreement.\nIn 1994 Saia maintained an operating margin similar to 1993 while expanding geographically in Texas, Tennessee and Georgia. Start up costs for these expansions burdened 1994 operating expenses while the full revenue benefits will not be realized until 1995 and subsequent years. Saia achieved an annualized revenue increase of 15% in 1994 compared to 1993 due to growth and second quarter benefits from the labor strike. Smalley experienced improvement in controlling its operating costs in 1994, while achieving four percent revenue growth and absorbing some merger-related costs. Effective January 1, 1995, Smalley was merged into Saia to offer customers more comprehensive regional coverage and to reduce costs. Merger-related costs in 1994 are estimated to have negatively impacted Saia and Smalley's operating expenses by $1 million. Saia, following the completion of its merger with Smalley anticipates strong revenue growth by expanding both within and outside of their present service area. Expansion costs and pricing pressures related to the deregulation of intrastate operations may have some negative impact on operating performance in 1995. However, benefits are expected from cost savings as a result of the merger and revenue opportunities from the 1994 and 1995 expansions, including access to new intrastate markets.\nItem 1. Business. (cont.)\nThe operations of the company are generally funded by cash flows generated from operating activities except in periods of accelerated capital spending. The company requires working capital to fund capital expenditures and pay shareholder dividends. The rapid turnover of accounts receivable, effective cash management and ready access to credit provided by commercial paper, medium-term notes and flexible banking agreements allows the company to effectively manage its working capital. Additionally, the company maintains credit availability under a $100 million credit agreement to support the commercial paper program and provide additional borrowing capacity. Total debt increased by $21 million in 1994, primarily due to a higher level of capital expenditures and the impact on cash flow of lower earnings. Commercial paper borrowings and medium-term note issuances were used to meet these cash needs and scheduled maturities of other debt. It is anticipated that 1995 capital expenditures and shareholder dividends will be primarily financed through internally-generated funds and to a lesser extent external borrowings.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nAt December 31, 1994, the company operated 671 freight terminals located in 50 states, Puerto Rico, parts of Canada and Mexico. Of this total, 314 were owned terminals and 357 were leased, generally for terms of three years or less. The number of vehicle back-in doors totaled 19,534, of which 14,846 were at owned terminals and 4,688 were at leased terminals. The freight terminals vary in size ranging from one to three doors at small local terminals, up to 304 doors at Yellow Freight's largest consolidation and distribution terminal. Substantially all of the larger terminals, containing the greatest number of doors, are owned. In addition, the company and most of its subsidiaries own and occupy general office buildings in their headquarters city.\nAt December 31, 1994, the company's subsidiaries operated the following number of linehaul units: tractors - 5,367, 45' and 48' trailers - 6,465, and 27' and 28' trailers - 33,873. The number of city units operated were: trucks and tractors - 8,362 and trailers - 5,775.\nThe above facilities and equipment are used in the company's predominant industry, the interstate transportation of general commodity freight. The company expects moderate growth in 1995 and has projected no significant changes to its operational capacity. Projected net capital expenditures for 1995 are $175 million. Facility expenditures of $25 million will target maintenance and expansion of existing locations and the construction or purchase of new locations to improve efficiency and enter new markets in selected areas. Revenue equipment expenditures of $85 million are estimated to consist mostly of replacement units, similar to 1994. The anticipated increase in rail use by Yellow Freight for 1995 resulted in lower projected revenue equipment expenditures. There is expected to be an even split in revenue equipment expenditures between Yellow Freight and the regional companies as a group for 1995. Other operating property expenditures of $65 million are primarily for improving efficiency through technological enhancements and advanced information systems.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe information set forth under the caption \"Commitments and Contingencies\" in the Notes to Consolidated Financial Statements on page 31 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, is incorporated by reference under Item 14 herein.\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 the executive officers of the company as of March 20, 1995 are listed below. Officers are appointed annually by the Board of Directors at their meeting which immediately follows the annual meeting of shareholders.\nExecutive Officers of the Registrant (cont.)\nThe terms of each officer of the company designated above are scheduled to expire April 19, 1995. The terms of each officer of the subsidiary companies are scheduled to expire on the date of the next annual meeting of shareholders of that company. No family relationships exist between any of the executive officers named above.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters.\nThe information set forth under the caption \"Common Stock\" on page 33 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, is incorporated by reference under Item 14 herein.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information set forth under the caption \"Financial Summary\" on pages 18 and 19 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, is incorporated by reference under Item 14 herein.\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,\" appearing on pages 14 through 17 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, is incorporated by reference under Item 14 herein.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe financial statements and supplementary information, appearing on pages 20 through 33 of the registrant's Annual Report to Shareholders for the year ended December 31, 1994, are incorporated by reference under Item 14 herein.\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 regarding Directors of the registrant has previously been reported in the registrant's definitive proxy statement, filed pursuant to Regulation 14A, and is incorporated by reference. For information with respect to the executive officers of the registrant, see \"Executive Officers of the Registrant\" at the end of Part I of this report.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThis information has previously been reported in the registrant's definitive proxy statement, filed pursuant to Regulation 14A, and is incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThis information has previously been reported in the registrant's definitive proxy statement, filed pursuant to Regulation 14A, and is incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThis information has previously been reported in the registrant's definitive proxy statement, filed pursuant to Regulation 14A, and is incorporated by reference.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K.\n(a) (1) Financial Statements\nThe following information appearing in the 1994 Annual Report to Shareholders is incorporated by reference in this Form 10-K Annual Report as Exhibit (13):\nWith the exception of the aforementioned information, the 1994 Annual Report to Shareholders is not deemed filed as part of this report. Financial statements other than those listed are omitted for the reason that they are not required or are not applicable. The following additional financial data should be read in conjunction with the consolidated financial statements in such 1994 Annual Report to Shareholders.\n(a) (2) Financial Statement Schedule\nSchedules other than those listed 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.\n(a) (3) Exhibits\n(13) - 1994 Annual Report to Shareholders. (24) - Consent of Independent Public Accountants. (27) - Financial Data Schedule (for SEC use only).\nThe remaining exhibits required by Item 7 of Regulation S-K are omitted for the reason that they are not applicable or have previously been filed.\n(b) Reports on Form 8-K\nOn October 5, 1994, a Form 8-K was filed under Item 5, Other Events, which reported that the company announced on September 29, 1994, that it will record a charge to earnings in the third quarter of $6.7 million, $4.1 million after taxes, or $.14 per share. This charge, recorded as an extraordinary item, is to write-off the book value of its intrastate operating rights. The non-cash charge resulted from the recent passage of the Trucking Industry Regulatory Reform Act of 1994 which deregulates the entry and rates for the intrastate operations of all transportation companies.\nOn March 14, 1995, a Form 8-K was filed under Item 5, Other Events, which reported that the company announced on March 9, 1995, that based on business activity in January and February, it expects to report near break-even results for the first quarter ended March 31, 1995. Comparatively, the company had a net loss for the first quarter of 1994 of $6.4 million, or $.23 per share.\nYellow Freight System, the company's largest subsidiary, is expected to report an improvement in profitability over the prior year's quarter due to the benefits of improved weather. However, this gain will be partially offset by some softening in seasonally adjusted business levels relative to fourth quarter trends. Yellow Freight also incurrd additional costs in the current quarter related to achieving new highs in on-time service performance.\nPreston Trucking Company expects to show significant improvement year-to-year with break-even operating results for the current quarter compared to an operating loss of $5.8 million in 1994's first quarter. Improved weather and benefits from its SuperRegion offering contributed to Preston Trucking's recovery.\nOn March 21, 1995, a Form 8-K was filed under Item 5, Other Events, which reported that the company announced on March 14, 1995, that its Board of Directors voted not to renew the company's Share Purchase Rights Plan upon the Plan's scheduled expiration in 1996. The Plan is commonly known as a \"Poison Pill\" and was intended to deter abusive takeover tactics. The decision was made in response to general criticism of such plans from large institutional shareholders. Additionally, the takeover environment has changed significantly since the Plan was implemented in 1986 and the risk that the company could be the target of abusive takeover tactics is substantially reduced.\nReport of Independent Public Accountants on Financial Statement Schedule\nTo the Shareholders of Yellow Corporation:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Yellow Corporation and Subsidiaries' annual report to shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 31, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in Item 14(a)(2) is the responsibility of the company's management and is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states 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 LLP\nKansas City, Missouri, January 31, 1995\nSchedule II\nYellow Corporation and Subsidiaries Valuation and Qualifying Accounts For the Years Ended December 31, 1994, 1993 and 1992\n(1) Addition from Preston Corporation and subsidiaries acquired in February 1993. (2) Primarily uncollectible accounts written off - net of recoveries.\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.\nYellow Corporation\nBY: \/s\/ George E. Powell III George E. Powell III March 24, 1995 President, 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.","section_15":""}
{"filename":"93389_1994.txt","cik":"93389","year":"1994","section_1":"ITEM 1. BUSINESS - ----------------- (a) General Development of Business ------------------------------- Registrant manufactures replacement parts for automotive ignition systems, wires and cables, fuel system parts, temperature control systems, power steering parts and brake systems parts, and distributes a general service line of automotive related items.\nIn January 1994 the Company entered into a Joint Venture Agreement with Autoline Industries, Inc. for the purpose of remanufacturing bare and loaded brake calipers. The joint venture, a general partnership named Eisline Manufacturing Company, is located at the Company's Ontario, California facility and sells its remanufactured product exclusively to the co-venturers under a long-term supply agreement with each. The Company's investment was approximately $600,000. Profit or loss from the joint venture is shared equally by the partners and for 1994 was not material.\nIn September 1994, the Company acquired, for approximately $750,000, certain assets of Mintex Canada, a formulator of friction material. The assets were transfered to a separate, wholly-owned Canadian corporation, EIS Brake Manufacturing, Ltd. This company, located in Mississauga, Ontario, will supply brake pads and shoes for the Canadian market and produce friction material for other EIS Brake Parts manufacturing facilities.\nIn February 1995, the Company acquired, for approximately $3,900,000, the assets and certain liabilities of PIK-A-NUT Corporation. Located in Huntington, Indiana, PIK-A-NUT Corporation distributes a complete line of general fasteners, brass fittings, expansion plugs and clamps primarily to the automotive aftermarket. PIK-A-NUT Corporation revenues in 1994 were approximately $4,100,000. This acquisition will expand the capability of Standard's Champ Service Line Division to supply a full line of service products to the automotive aftermarket.\nReplacement Parts Market The size of the replacement parts market ------------------------ depends, in part, upon the average age and number of cars on the road and the number of miles driven per year. According to the Motor Vehicle Manufacturers Association and United States government sources, all three of the above factors increased from 1989 through 1994 and this trend is projected to continue during the 1990's.\n(b) Financial Information about Industry Segments --------------------------------------------- Distribution of Sales The table below shows the registrant's sales --------------------- by product groups. [CAPTION]\n- 3 -\nNo class of products other than those listed in the chart on page 3 accounted for more than ten percent (10%) of total sales in any of such years. The business of the registrant is not dependent on any single customer. In the year ended December 31, 1994, the registrant's five largest customers accounted for approximately 27.0% of sales, or approximately $173,000,000.\nIgnition Parts Replacement parts for automotive ignition and -------------- emission control systems account for about 36% of the registrant's revenues. These parts include distributor caps and rotors, electronic ignition control modules, voltage regulators, coils, switches and sensors. The registrant is a basic manufacturer of many of the ignition parts it markets. These products cover a wide range of applications, from 30-year old vehicles to current models, both domestic and import, including passenger car, truck, farm, off-road and marine applications.\nLike most automotive aftermarket suppliers, registrant began by offering ignition parts which were equal in quality to O.E. (original equipment parts installed on new vehicles). Soon afterward, registrant pioneered the concept of offering an alternate higher level of quality, significantly better than O.E. and priced proportionately higher. This has now evolved to a \"good-better-best\" concept, and a lower priced line has been made available under the registrant's Tru-Tech and Modern Mechanic brands.\nNearly all new vehicles are factory-equipped with computer-controlled engine management systems to control ignition, emission control, and fuel injection. The on-board computer monitors inputs from many types of sensors located throughout the vehicle, and controls a myriad of valves, switches and motors. The registrant is a leader in the manufacture and sale of these engine management component parts, including remanufactured automotive computers.\nElectronic control modules and electronic voltage regulators comprise a significant and growing portion of registrant's total ignition sales. The registrant is one of the few aftermarket companies that manufactures these parts, and the only independent aftermarket supplier to manufacture the complex electronic control modules for distributorless ignition systems. The registrant's electronic production is divided between highly-automated operations, which are performed in Long Island City, NY, and assembly operations, which are performed in assembly plants in Hong Kong and Puerto Rico. Production of printed circuit boards was moved to Puerto Rico in 1994.\nThe registrant's sales of such parts as sensors, valves and solenoids have increased steadily as auto manufacturers equip their cars with more complex engine management systems. New government emission laws, including the 1990 Federal Clean Air Act, are expected to increase automotive repair activity creating an increase in parts sales. Although there is much controversy over how quickly these new procedures will be implemented, it is no doubt going to have a positive impact on sales of the registrant's products. The registrant is a basic manufacturer of throttle position sensors, air pump check valves, coolant temperature sensors, air charge temperature sensors, EGR valves, idle air control valves and MAP sensors.\nThe joint venture entered into in 1992 with Blue Streak Electronics, Inc., a rebuilder of engine management computers and MAF sensors, has positioned the registrant as a key supplier in the fast growing remanufactured electronics market. In 1994, registrant vastly increased its offering of remanufactured computers, and instituted a program to offer slower-moving items by overnight shipment from its factory. This has enabled the registrant's customers to expand their coverage without increasing inventory investment.\n- 4 - Brake System Products As of August 31, 1986, the registrant --------------------- acquired the EIS Brake Parts Division from Parker-Hannifin Corporation. In the aftermarket, brake parts represent the single largest product group in a warehouse distributor's inventory.\nThe division manufactures a full line of brake replacement parts and also markets many special tools and fluids used by mechanics who perform brake service. EIS has a long- established reputation in the industry for quality products and engineering excellence.\nEIS brake products account for approximately 26% of the registrant's revenues, making it the second largest revenues source for the registrant. We anticipate that EIS's growth will be enhanced in 1995 and the future as a result of the increased wear on friction products resulting from front wheel drives and other vehicle design dynamics. The Company's growth should also be enhanced by the continued vertical integration of its manufacturing capabilities, which includes the addition of a joint venture in Ontario, California to remanufacture bare and loaded calipers and the addition of a friction manufacturing facility in Mississauga, Canada, as well as the addition of ABS systems to this divisions product lines.\nWires and Cables Wire and cable parts account for about 8% of the ---------------- registrant's revenues. These products include ignition (spark plug) wires, battery cables and a wide range of electrical wire, terminals, connectors and tools for servicing an automobile's electrical system.\nA major part of this division's business is the sale of ignition wire sets. The registrant has historically offered a premium brand of ignition wires and battery cables, which capitalize on the market's awareness of the importance of quality. With the growing customer interest in lower-priced products, the registrant introduced a second line of wire and cable products, known as Modern Mechanic, in 1989. This line has steadily expanded to include import coverage, and in 1995 will also be offered under the registrant's Tru-Tech brand name.\nFuel System Parts Fuel system parts account for about 7% of the ----------------- registrant's revenues. The registrant manufactures and markets over 2,000 parts for the maintenance and repair of automotive fuel systems. These include parts for carburetors, mechanical and electric fuel pumps, and fuel injection systems.\nFor several decades, the registrant's most important fuel system product was the carburetor rebuilding kit. Sales of these kits have been declining in recent years, since nearly all new cars are equipped with electronic fuel injection systems. However, the registrant's sales of fuel injection parts have steadily increased, and this segment of the business is expected to continue to grow.\nThe assembly of carburetor rebuilding kits was moved in 1994 from Edwardsville, KS to Puerto Rico. This move will consolidate the assembly of carburetor kits in one location, improving efficiencies and expanding the registrant's favorable tax benefits of its Puerto Rico subsidiary.\nIn 1988 the registrant began manufacturing mechanical fuel pumps, and added the manufacture of electric fuel pumps in 1994. Electric pumps are replacing the traditional mechanical units at O.E. levels, since they are more easily integrated\n- 5 - into an electronic fuel injection system. Electric pumps are expected to become the dominant technology, and the fuel pump is now seen as an integral part of the engine management system.\nTemperature Control Systems & Power Steering Parts The registrant -------------------------------------------------- markets a line of replacement parts for automotive temperature control systems (air conditioning and heating), primarily under the brand name Four Seasons. However, in recent years Four Seasons has offered private label packaging to its larger accounts which are experiencing significant growth. Revenues from Four Seasons account for approximately 17% of the registrant's total sales.\nFederal regulation of CFC (fluorocarbon) refrigerants is changing the climate control industry. Legislation is phasing out R-12 refrigerant (DuPont's Freon and other brands) production completely. This is generating wide industry demand for refrigeration recycling equipment, retrofit kits, and for training in recycling and retrofit techniques. In the near future, vehicle air conditioners needing repair or recharge become candidates for retrofit to use the new R-134a refrigerant, at a cost as high as several hundred dollars per car. Installers are urgently seeking training and certification in the new technology, and the Company's Four Seasons Division has taken the lead in providing these services.\nThese major technological changes require many new parts, as well as new service equipment. As a result, our climate control division is enjoying excellent growth opportunities as evidenced by a 25% growth in sales in 1994.\nFour Seasons also markets a full line of power steering products, which currently number over 1,500 parts including replacement hose assemblies and pumps.\nChamp Service Line Products In 1994, Champ accounted for --------------------------- approximately 6% of the registrant's total sales. The division markets over 8,000 different automotive-related items, ranging from mirrors, window cranks and antennas to cleaning and polishing materials, specialty tools and maintenance supplies.\nChamp purchases products from a wide range of manufacturers and packages them under the Champ and Big A private brand label, enabling its customers to conveniently order items in many separate product groups from a single source. Champ's marketing program offers its customers ordering efficiency, marketing support and effective shipping that are considered key benefits by the registrant's customers.\nEarly in 1993, Champ's flexibility was enhanced by the designation of its own management team and sales force. This improved customer responsiveness paid a dividend in 1994, as Champ's unit sales, excluding Big A sales, increased for the first time in four years.\nIn February 1995, the Company acquired the assets and certain liabilities of PIK-A-NUT Corporation, a reseller of a complete line of general fasteners, brass fittings, expansion plugs and clamps primarily to the automotive aftermarket in both retail and bulk packaging. This acquisition will expand the capability of Champ to supply a full line of service products to the automotive aftermarket.\n(c) Narrative Description of Business --------------------------------- Sales and Distribution The registrant sells its products throughout ---------------------- the United States and Canada under its proprietary brand names, to approximately 1,600 warehouse distributors, who distribute to approximately 23,000 jobber outlets. The jobbers sell the registrant's products primarily to professional mechanics, and secondarily to consumers who perform their own automobile repairs. The registrant has a direct field sales force of approximately 490 persons. - 6 - The registrant generates demand for its products by directing the major portion of its sales effort to its customers' customers (i.e. jobbers and professional mechanics). In 1994 the registrant conducted approximately 4,000 instructional clinics, which teach mechanics how to diagnose and repair complex new electronic ignition systems, including computerized ignition and emission controls, automotive brake systems and temperature control systems. The registrant also publishes and sells related service manuals and video\/cassettes and provides a free technical information bulletin service to registered mechanics. In addition, our Standard Plus Club, a professional service dealer network comprising approximately 10,000 members, offers technical and business development support and has a technical service telephone hotline.\nThe registrant continued expansion into the retail market by selling its products to large retail chains. The registrant expects continued growth in the retail market in future years.\nProduction and Engineering The registrant engineers, tools and -------------------------- manufactures many of the components for its products, except for certain commonly available small parts in temperature control, brake system and fuel system products and all of the Champ Service Line. It also performs its own plastic and rubber molding operations, extensive screw machining and stamping operations, automated electronics assembly and a wide variety of other processes.\nThe registrant has engineering departments staffed by 89 persons, approximately 61% of whom are graduate engineers. The departments perform product research and development and quality control and, wherever practical, design machinery for automation of the registrant's factories.\nAs new models of automobiles, trucks, tractors, buses and other equipment are introduced, the registrant engineers and manufactures replacement parts for them. The registrant employs and trains tool and die makers needed in its manufacturing operations.\nCompetition Although the registrant is a leading independent ----------- manufacturer of automotive replacement parts and supplies, it faces substantial competition in all markets that it serves. A number of major manufacturers of replacement parts and supplies are divisions of companies having greater financial resources than those of the registrant. In addition, automobile manufacturers supply virtually every replacement part sold by the registrant.\nThe competitive factors affecting the registrant's products are primarily product quality, customer service and price. The registrant's business requires that it maintain inventory levels sufficient for the rapid delivery requirements of customers. Management believes that it is able to compete effectively and that its trademarks and trade names are well known and command respect in the industry and the marketplace.\nBacklog Backlog is maintained at minimal levels by the registrant. ------- The registrant primarily fills orders, as received, from inventory and manufactures to maintain inventory levels.\n- 7 -\nSupplies The principal raw materials purchased by the registrant -------- consist of brass, electronic components, fabricated copper (primarily in the form of magnet wire and insulated cable), ignition wire, stainless steel coils and rods, aluminum coils and rods, lead, rubber molding compound, thermo-set and thermo plastic molding powders, cast iron castings and friction lining materials. All of these materials are purchased in the open market and are available from a number of prime suppliers.\nInsurance In 1990, 1991 and 1992 the registrant maintained basic --------- liability coverage (general, product and automobile) of $1 million and umbrella liability coverage of $20 million. In 1993 the umbrella coverage was increased to $50 million and remains at $50 million. Historically, the registrant has not experienced casualty losses in any year in excess of its coverage. Management has no reason to expect this experience to change, but can offer no assurances that liability losses in the future will not exceed the registrant's coverage.\nEmployees The registrant has approximately 3,300 employees --------- in the United States, Canada, Puerto Rico and Hong Kong. Of these, approximately 1,550 are production employees. Long Island City, New York production employees are covered by a collective bargaining agreement with the United Auto Workers, which expires on October 1, 1995. Edwardsville, Kansas production employees are covered by a United Auto Workers contract that expires April 2, 1997. Berlin, Connecticut employees are covered by a collective bargaining agreement with the United Auto Workers, which expires on June 1, 1995. The registrant believes that its facilities are in favorable labor markets with ready access to adequate numbers of skilled and unskilled workers. In the opinion of management, employee relations have been good. There have been no significant strikes or work stoppages in the last five years.\n(d) Financial Information About Export Sales ---------------------------------------- The registrant sells its general line of products primarily through Canada, Latin America, Europe and the Middle East. The table below shows the registrant's export sales for the last three years:\n(U.S. Dollars in thousands)\nYears Ended December 31, 1994 1993 1992 - ------------------------ ---- ---- ---- Canada $38,109 $32,341 $29,083 All Others 12,341 12,746 12,209 ------- ------- ------- Total $50,450 $45,087 $41,292 ======= ======= =======\n- 8 -\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - ------------------- The registrant maintains its executive offices and a manufacturing plant at 37-18 Northern Boulevard, Long Island City, NY.\nThe table below describes the registrant's major (a) manufacturing and packaging properties and (b) warehousing properties. (For information with respect to rentals, see note 16 of Notes to Consolidated Financial Statements on page.).\n(a) Manufacturing Properties ------------------------ Approximate Products Number of (See Key Location Square Feet Owned or Leased Employees On Page 10) - -------- ----------- --------------- ----------- ----------- Long Island City, 318,000 Owned (1) (2) (6) 492 A, B, I New York Edwardsville, 150,000 Owned (11) 193 C Kansas Puerto Rico 114,000 Leased (expires in 1997) 261 A, B, H, I Puerto Rico 24,100 Leased (expires in 2004) 51 B Hong Kong 22,500 Leased (expires in 1997) 82 I Grapevine, Texas 180,000 Owned (2) (4) 335 E, J Middleton, CT 161,700 Owned (8) -0- Berlin, CT 165,000 Owned (1) 254 H Manila, AR 119,300 Leased (expires in 1995) (10) 211 F Manila, AR 100,000 Owned (2) (9) 20 F Rural Retreat, VA 72,300 Leased (expires in 2003) (13) 31 F West Bend, WI 110,600 Owned (5) -0- Ontario, CA 107,600 Leased (expires in 2003) 28 F Mississauga, Canada 94,600 Leased (expires in 2004) 7 F\n-Continued-\nSee Notes on page 11\n- 9 - (b) Warehousing Properties ---------------------- Approximate Products Number of (See Key Location Square Feet Owned or Leased Employees On Page 10) - -------- ----------- --------------- ----------- ----------- Disputanta, VA 411,000 Owned 251 A, B, D, I\nEdwardsville, 205,000 Owned (1) (11) 169 C, D Kansas Reno, Nevada 67,000 Owned (3) 20 A, B, C, E, I Coppell, Texas 168,000 Owned (1) 155 E, J Berlin, CT 66,000 Owned 159 H Manila, AR 150,000 Owned (2) (7) 34 F, G Mississauga, Canada 96,800 Leased (expires in 1996) (1) 44 A, B, C, D, E, F, H, I Calgary, Canada 33,500 Leased (expires in 1998) 8 A, B, C, D, E, F, G, H, I Ontario, CA 142,600 Leased (expires in 2003) 24 A, B, C, E, F, G, H, I Grand Prairie, Texas 51,200 Leased (expires in 1996) 5 E, J Huntington, Indiana 62,600 Leased (expires in 2000) (12)-0- D\nProduct Key: A) Ignition B) Fuel System Parts C) Wire & Cable D) Champ Service Line E) Temperature Control System Parts F) Friction - Brake Shoes & Pads G) Drums & Rotors H) Hydraulic Brake System Components I) Electronic Ignition J) Power Steering Parts\nSee Notes on page 11\n- 10 -\nNOTES TO PROPERTY SCHEDULE: - --------------------------- (1) Includes executive or division offices.\n(2) While owned by the registrant for accounting purposes, these properties were actually sold to local industrial development authorities and leased to the registrant under the terms of Industrial Revenue Bond (\"IRB\") financing agreements. Under those agreements, title to these properties passes to the registrant at maturity for little or no consideration. The rental payments made by the registrant equal the principal and interest due under each IRB.\n(3) This property is owned subject to a mortgage held by the Massachusetts Mutual Life Insurance Company, in the original amount of $465,000, the final payment of which is due in 1995.\n(4) Financed with a bond issue in 1980 for $2,670,000 fully paid off in 1993 and a bond issue in 1984 for $2,000,000 maturing through 1999.\n(5) As of January 1, 1987, the registrant vacated this facility. It is now being leased by the registrant to a third party. This facility is presently being offered for sale.\n(6) This property was purchased on January 5, 1988.\n(7) Financed with a bond issue in 1989 for $2,500,000 maturing through 1999.\n(8) Part of this facility is now being leased by the registrant to a third party. This facility is presently being offered for sale.\n(9) Financed with a bond issue in 1990 for $1,800,000 maturing through 2000.\n(10) Under terms of the lease, the registrant has an option to purchase the property for $1,000 at the expiration of the lease.\n(11) Financed with Industrial Revenue Bonds fully paid off in 1994.\n(12) This lease agreement was entered into in February 1995 in connection with the acquisition of the assets of the PIK-A-NUT Corporation.\n(13) Under terms of the lease, the registrant has an option to purchase the property for $350,000 at 12\/31\/97 or $200,000 at 12\/31\/2002.\n- 11 -\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - ------------------------------ Currently, there are no legal proceedings which management deems would have a material economic impact on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ---------------------------------------------------------------- None\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND - ----------------------------------------------------------- RELATED STOCKHOLDER MATTERS --------------------------- The Company's stock is listed on the New York Stock Exchange. The number of Shareholders of record of Common Stock on February 28, 1995 was approximately 1,000 including brokers who hold approximately 7,126,615 shares in street name. The quarterly market price and dividend information is presented in the following chart.\nPrice Range of Common Stock and Dividends\nThe Company's Common Stock is traded on the New York Stock Exchange under the symbol SMP. The following table shows the high and low sale prices on the composite tape of, and the dividend paid per share on, the Common Stock during the periods indicated.\n1994 Quarter High Low Dividend 1993 Quarter High Low Dividend - ------------------------------------- ------------------------------------- 1st $26.88 $16.00 $.08 1st $17.38 $13.13 $.08\n2nd 18.38 14.75 .08 2nd 20.25 16.13 .08\n3rd 19.75 17.38 .08 3rd 24.13 18.88 .08\n4th 19.75 16.88 .08 4th 26.88 21.00 .08 - ------------------------------------- -------------------------------------\nThe Board of Directors will consider the payment of future dividends on the basis of earnings, capital requirements and the financial condition of the Company. The Company's loan agreements limit dividends and distributions by the Company. As of December 31, 1994, approximately $12,194,000 of retained earnings was available under those agreements for payment of cash dividends and purchase of capital stock.\n- 12 - PART II (CONT'D) ------- ITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - -------------------------------------- [CAPTION]\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL - ---------------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS ----------------------------------- Liquidity and Capital Resources - During 1994, stockholders' equity increased $16,906,000 to $195,089,000 and working capital increased $987,000 to $189,207,000. Cash provided by operations in 1992 amounted to $31,550,000, primarily due to the $18,971,000 reduction in inventories. In 1993, cash provided by operations amounted to $20,105,000 primarily due to net earnings of $17,508,000. In 1994, cash provided by operations amounted to $21,104,000 primarily due to net earnings of $23,665,000. Cash used in investing activities, primarily due to capital expenditures, was $15,048,000 in 1992 and $11,899,000 in 1993. Cash used in investing activities in 1994 was $20,299,000 primarily due to capital expenditures and held-to-maturity transactions. Cash used in financing activities, primarily due to repayment of debt and dividend payments, was $23,519,000 in 1992. In December 1992, the Company secured $80,000,000 in long-term financing which was used to reduce short-term bank borrowings. Cash used in financing activities in 1993 was $12,879,000 which consisted primarily of repayments of debt and dividend payments. In 1993, cash provided by the exercise of employee stock options was almost\n- 13 - PART II (CONT'D) ------- entirely offset by the repurchase of treasury stock. Cash used in financing activities in 1994 was $10,335,000 primarily due to dividend payments, repayment of debt and repurchase of treasury stock.\nThe Company expects capital expenditures for 1995 to be approximately $18,000,000 primarily for new machinery and equipment. At December 31, 1994, the Company had unused lines of credit aggregating approximately $98,000,000 which will be used as a source of funding capital expenditures and working capital requirements. The Company anticipates that its present sources of funds will continue to be adequate to meet its needs.\nTotal debt (current and non-current) decreased $4,035,000. In 1995, required long-term debt payments will be approximately $19,987,000.\nAs part of an ongoing operating strategy, the Company is reviewing potential acquisition candidates in related automotive component businesses. If such an acquisition is made, additional sources of capital could be required. It presently is anticipated that any such acquisition could be funded in the short term by presently available lines of credit with new long term financing to follow.\nRestructuring plans started in 1993 were completed by the end of 1994.\nComparison of 1994 to 1993 - Property, plant and equipment additions of $12,557,000 were primarily attributable to expenditures for new machinery and equipment.\nNet sales increased $57,959,000 or 9.9%. Sales increases were evident in all divisions with the largest percentage increases at the Temperature Control Division and the Canadian Division. The increase in sales was predominantly due to volume increases.\nCost of goods sold increased $42,099,000 from $373,588,000 to $415,687,000. Cost of sales, as a percentage of net sales, increased from 64.1% to 64.9%. The increase reflects the required price reductions implemented early in the first quarter to respond to competitive actions. It also reflects the continuing shift of sales mix to lower margin market segments. The Company is aggresively implementing cost reduction programs, and although the results of these programs have had a positive impact upon 1994 gross margins, many of these programs have not yet achieved their full impact. By the fourth quarter of 1994, gross margins were slightly ahead of the comparable period in 1993. However, any favorable impacts could be offset by an acceleration of purchased material inflation or a further shift to lower margin market segments.\nSelling, general and administrative expenses increased by 5.7% or $9,693,000, but as a percentage of net sales, decreased from 29% to 27.9%. The expense increase was primarily due to increased new customer acquisition costs in the first half of 1994 and higher variable costs due to increased sales, partially offset by cost reduction programs.\nRestructuring charges of $2,781,000 were incurred in 1993 primarily due to the consolidation of the EIS Brake Parts operation within Connecticut and the rationalization of the Company's manufacturing operations involving the relocation of several product lines.\n- 14 - PART II (CONT'D) ------- Other income (expense), net decreased $412,000 primarily due to an increase in the loss on sale of accounts receivables and a lower rate of return on investments in 1994, partially offset by an increase in income from Blue Streak Electronics, Inc.\nTaxes based on earnings increased by $3,525,000 due to increased earnings and a higher effective tax rate. The higher effective tax rate in 1994 was primarily due to a lower relative benefit from earnings of the Company's Hong Kong and Puerto Rico subsidiaries.\nCumulative effect of changes in accounting for postretirement benefits and income taxes, net is the result of the Company adopting, as of January 1, 1993, two changes in accounting principles, Statement of Financial Accounting Standards (SFAS) No. 106 - \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 109 - \"Accounting for Income Taxes\". The after-tax charge for SFAS No. 106 of $6,135,000 (after an income tax benefit of $4,090,000), combined with the tax benefit for SFAS No. 109 of $5,045,000 reduced net earnings by $1,090,000.\nComparison of 1993 to 1992 - Property, plant and equipment additions of $12,329,000 were primarily attributable to expenditures for new machinery and equipment.\nShort-term notes payable increased $5,100,000 primarily due to principal payments of long-term debt and capital expenditures. Long-term debt (current and non-current) decreased $16,010,000.\nNet sales increased $47,298,000 or 8.8%. The sales increase was primarily attributable to increased sales at the Standard Division, Four Seasons Division and the Champ Service Line Division. The sales increase at the Champ Service Line Division was primarily due to the acquisition of substantially all of the General Service Line inventory and certain other related assets of APS, Inc. in the second quarter of 1993 (see Note 2). Excluding the sales resulting from the acquisition, revenues increased by 6.8% in 1993 compared to a year ago.\nCost of goods sold increased $27,018,000 from $346,570,000 to $373,588,000. Cost of sales, as a percentage of net sales, decreased from 64.7% to 64.1%. The improvement was attributable to continuous cost reduction programs, and increased absorption of manufacturing overhead partially offset by the lower gross margins of the new product line acquired by the Champ Service Line Division.\nSelling, general and administrative expenses increased by 1.5% or $2,460,000. This increase was primarily due to costs to support the service line expansion, higher variable costs due to increased sales, higher administrative expenses, ongoing postretirement expenses and increased employee profit sharing contributions due to the higher level of earnings. This increase was partially offset by lower new customer acquisition costs.\n- 15 - PART II (CONT'D) ------- Restructuring charges of $2,781,000 were incurred in 1993 primarily due to the consolidation of the EIS Brake Parts operation within Connecticut and the rationalization of the Company's manufacturing operations involving the relocation of several product lines.\nOther income (expense), net increased $951,000 primarily due to income from Blue Streak Electronics, Inc., a decrease on the loss on sale of receivables and realized gains on investments sold.\nTaxes based on earnings increased by $6,265,000 due to increased earnings and a higher effective tax rate. The higher effective tax rate in 1993 was primarily due to an increase in tax rates resulting from the Omnibus Budget Reconciliation Act of 1993 and lower United States tax exempt earnings of the Company's Puerto Rican operation relative to the Company's Domestic operations.\nCumulative effect of changes in accounting for postretirement benefits and income taxes, net is the result of the Company adopting, as of January 1, 1993 two changes in accounting principles, Statement of Financial Accounting Standards (SFAS) No. 106 - \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and SFAS No. 109 - \"Accounting for Income Taxes\". The after-tax charge for SFAS No. 106 of $6,135,000 (after an income tax benefit of $4,090,000), combined with the tax benefit for SFAS No. 109 of $5,045,000 reduced net earnings by $1,090,000.\nImpact of Inflation - Although inflation is not a significant issue, the Company's management believes it will be able to continue to minimize any adverse effect of inflation on earnings. This will be achieved principally by cost reduction programs and, where competitive situations permit, selling price increases.\nFuture Results of Operations - Inventory levels increased significantly in the fourth quarter of 1994 partially reflecting open orders which have been shipped during the first quarter of 1995 and a build-up in temperature control products to meet anticipated strong orders for the 1995 season. The Company will continue to focus on its inventory reduction plans during 1995 and future years.\nThe company is continuing to face competitive pressures and is implementing cost reduction programs targeted to offset any price reductions.\n- 16 -\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------------\nINDEPENDENT AUDITORS' REPORT - ----------------------------\nTo the Board of Directors and Stockholders Standard Motor Products, Inc.\nWe have audited the consolidated balance sheet of Standard Motor Products, Inc. and subsidiaries as of December 31, 1994, and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for the year 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 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 Standard Motor Products, Inc. and subsidiaries as of December 31, 1994, 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 LLP\nShort Hills, New Jersey February 23, 1995\n- - INDEPENDENT AUDITORS' REPORT - ----------------------------\nTo the Board of Directors and Stockholders Standard Motor Products, Inc.\nWe have audited the consolidated balance sheet of Standard Motor Products, Inc. and subsidiaries as of December 31, 1993, and the related consolidated statements of earnings, changes in stockholders' equity and cash flows for each of the two 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 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 Standard Motor Products, Inc. and subsidiaries as of December 31, 1993, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 1993 in conformity with generally accepted accounting principles.\nNew York, New York David Berdon & Co. LLP February 25, 1994 Certified Public Accountants\n- - [CAPTION]\nSee accompanying notes to consolidated financial statements.\n- - [CAPTION]\nSee accompanying notes to consolidated financial statements. - - [CAPTION]\nSee accompanying notes to consolidated financial statements. - -\n[CAPTION]\nSee accompanying notes to consolidated financial statements. - -\nStandard Motor Products, Inc. and Subsidiaries Notes to Consolidated Financial Statements\n1. Summary of Significant Accounting Policies\nPrinciples of Consolidation The Company is engaged in the manufacture and sale of automotive replacement parts. The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. As more fully described in Note 2, the Company's investments in unconsolidated affiliates are accounted for on the equity method. All significant intercompany items have been eliminated.\nReclassifications Where appropriate, certain amounts in 1992 and 1993 have been reclassified to conform with the 1994 presentation.\nCash and Cash Equivalents The Company considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\nMarketable Securities Effective January 1, 1994 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Prior years' financial statements have not been restated to apply the provisions of SFAS No. 115. The adoption of the standard had an immaterial impact on the Company's financial position and results of operations for the year ended December 31, 1994. At December 31, 1994, held-to-maturity securities amounted to approximately $10,790,000 and trading securities amounted to approximately $28,000. Held-to-maturity securities consist primarily of U.S. Treasury Bills and corporate debt securities which are reported at unamortized cost which approximates fair value. As of December 31, 1994, $5,990,000 of the held-to-maturity securities mature within one year and $4,800,000 mature within five to ten years.\nThe first-in, first-out method is used in computing realized gains or losses.\nInventories Inventories are stated at the lower of cost (determined by means of the first-in, first-out method) or market.\nProperty, Plant and Equipment These assets are recorded at cost and are depreciated over their respective useful lives using the straight-line method of depreciation.\nRevenue Recognition The Company recognizes revenues from product sales upon shipment to the customers.\nNet Earnings Per Common and Common Equivalent Share Net earnings per common and common equivalent share are calculated using the daily weighted average number of common shares outstanding during each year and if material, the net additional number of shares which would be issuable upon the exercise of stock options, assuming that the Company used the proceeds received to purchase additional shares at market value. Shares held by the ESOP are considered outstanding and are included in the calculation to determine earnings per share.\nIncome Taxes Deferred income taxes result from temporary differences in methods of recording certain revenues and expenses for financial reporting and income tax purposes (see Note 14).\nCustomer Acquisition Costs Costs associated with the acquisition of new customer accounts are deferred and amortized over a twelve-month period.\nForeign Currency Translation Assets and liabilities are translated into U.S. dollars at year end exchange rates and revenues and expenses are translated at average exchange rates during the year. The resulting translation adjustments are recorded in a separate component of stockholders' equity.\nConcentrations of Credit Risk Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash investments and accounts receivable. The Company places its cash investments with high quality financial institutions and limits the amount of credit exposure to any one institution. With respect to accounts receivable, such receivables are primarily from warehouse distributors in the automotive aftermarket industry located in the United States. The Company performs ongoing credit evaluations of its customers' financial conditions and does require collateral or other security to support customer receivables where appropriate. Members of one of marketing groups represents the Company's largest group of customers and accounted for 15% of consolidated net sales for the year ended December 31, 1994. No individual member of this marketing group accounted for more than 10% of net sales for the year ended December 31, 1994. For the year ended December 31, 1994 the Company's five largest individual customers, including the members of this marketing group, accounted for 27% of net sales.\n2. Acquisitions The Company acquired, as of September 1, 1992, 50% ownership in Blue Streak Electronics, Inc. for approximately $360,000. Blue Streak Electronics, Inc., located in Concord, Canada, is a remanufacturer of automotive on-board computers, sensors and related parts. The investment is accounted for under the equity method. The accompanying consolidated balance sheets include the investment in subsidiary at December 31, 1994 and 1993 of approximately $1,384,000 and $597,000, respectively in \"Other Assets: Sundry.\" In April 1993, the Company acquired, for approximately $9,000,000, substantially all of the general service line inventory and certain other related assets of APS, Inc., a national distributor of automotive parts, along with a ten-year agreement to supply this product line to APS, Inc. on an exclusive basis. This acquisition has been accounted for as a purchase. The acquisition increased consolidated net sales by approximately $16,300,000 in 1994 and $10,900,000 in 1993.\nDuring 1994 the Company made two additional investments. The investments had no significant effect on the Company's financial position or results of operations.\n3. Sale of Accounts Receivables On December 20, 1993, the Company entered into a new three-year agreement whereby it can sell up to a $25,000,000 undivided interest in a designated pool of certain eligible accounts receivable. At December 31, 1994 and 1993, net receivables amounting to $25,000,000 had been sold under these - - STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued)\nagreements. As collections reduce previously sold undivided fractional interest, new receivables are customarily sold up to the $25,000,000 level. At the expiration of the agreement, the Company and the purchaser share a proportionate risk of loss as the eligible pool of account receivable is liquidated (see Note 13).\n4. Inventories (In thousands) December 31, -------------------- 1994 1993 ---------------------------------------------------------------- Inventories consist of: Finished goods $114,021 $100,004 Work in process 19,336 18,249 Raw materials 52,498 42,015 ---------------------------------------------------------------- Total inventory 185,855 160,268 ----------------------------------------------------------------\n5. Property, Plant and Equipment (In thousands) December 31, -------------------- 1994 1993 ---------------------------------------------------------------- Property, plant and equipment consist of the following: Land and buildings $67,819 $67,470 Machinery and equipment 65,146 55,341 Tools, dies and auxiliary equipment 7,244 6,526 Furniture and fixtures 15,025 13,756 Leasehold improvements 4,641 4,622 Construction in progress 7,481 8,147 -------------------- 167,356 155,862 Less, accumulated depreciation and amortization 63,230 52,858 ---------------------------------------------------------------- Total property, plant and equipment, net 104,126 103,004 ----------------------------------------------------------------\n6. Other Assets - Sundry (In thousands) December 31, -------------------- 1994 1993 ---------------------------------------------------------------- Other assets - sundry consist of the following: Deferred new customer acquisition costs $12,233 $14,742 Unamortized customer supply agreements 6,908 8,178 Marketable securities 4,800 3,000 Equity in joint ventures 2,196 792 Pension assets 632 713 Other 2,078 2,480 ---------------------------------------------------------------- Total other assets - sundry $28,847 $29,905 ---------------------------------------------------------------- Included in Other is a preferred stock investment in a customer of the Company. Net sales to such customer amounted to $51,935,000 and $42,823,000 in 1994 and 1993, respectively.\n7. Notes Payable - Banks The maximum amount of short-term bank borrowings outstanding at any month-end was $38,500,000 in 1994 and $27,700,000 in 1993, and averaged $27,268,000 and $16,958,000, respectively. The weighted average short-term interest rate was 4.77% for 1994 and 3.99% for 1993. At December 31, 1994, the Company had unused lines of credit aggregating approximately $98,000,000.\n8. Long-Term Debt (In thousands) December 31, -------------------- 1994 1993 ---------------------------------------------------------------- Long-term debt consists of: 7.85% senior note payable $65,000 $65,000 10.50%-11.50% senior note payable 4,000 6,000 9.47% senior note payable 30,000 30,000 6.01% senior note payable 15,000 15,000 Credit Agreement 6,714 8,394 7.35%-12.875% purchase obligations 8,200 9,862 Floating rate purchase obligation 950 1,100 9.50% mortgage payable 50 93 ---------------------------------------------------------------- 129,914 135,449 Less current portion 19,987 4,935 ---------------------------------------------------------------- Total noncurrent portion of long-term debt 109,927 130,514 ---------------------------------------------------------------- Under the terms of the $65,000,000 senior note agreement, the Company is required to repay the loan in seven equal annual installments beginning in 1996. Under the terms of the $4,000,000 senior note agreement, the Company is required to repay the remaining loan in two equal annual installments ending in 1996. Under the terms of the $30,000,000 senior note agreement, the Company is required to repay the loan in seven varying annual installments beginning in 1998. Subject to certain restrictions, the Company may make prepayments without premium beginning in 1998. Under the terms of the $15,000,000 senior note agreement, the Company is required to repay the loan in full in 1995. The Company also entered into an interest rate swap agreement. The swap agreement modifies the interest rate on the $15,000,000 senior note agreement, adjusted favorably or unfavorably for the spread between 5.66% and the 6-month reserve unadjusted London Interbank Offering rate (\"LIBOR\"). The Credit Agreement matures in varying annual installments through 1998 and bears interest at the lower of 91% of prime rate, or 91% of the \"LIBOR\" plus 1.092%. The Company also entered into an interest rate swap agreement to reduce the impact of changes in interest rates on its Credit Agreement. The swap agreement modifies the interest rate on $6,412,500 of the Credit Agreement, adjusted favorably or unfavorably for the spread between 77.52% of the 3-month reserve unadjusted \"LIBOR\" and 7.69%. The proceeds of such note were loaned to the Company's Employee Stock Ownership Plan (ESOP) to purchase 1,000,000 shares of the Company's common stock to be distributed in accordance with the terms of the ESOP established in 1989 (see Note 11). 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 purchase obligations, due under agreements with municipalities, mature in annual installments through 2003, and are secured by properties having a net book value of approximately $20,794,000 at December 31, 1994. An optional prepayment of $600,000 was made on July 1, 1994. - - STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued)\nThe floating rate purchase obligation matures in annual installments through 1999, bears interest at sixty-five percent of prime, and is secured by property having a net book value of approximately $1,334,000 at December 31, 1994. The mortgage payable is due in installments through 1995. Maturities of long-term debt during the five years ending December 31, 1999 are $19,987,000, $14,262,000, $12,312,000, $16,601,000 and $14,982,000 respectively. Certain loan agreements require the maintenance of a specified amount of working capital and limit, among other items, investments, leases, indebtedness and distributions for the payment of dividends and the acquisition of capital stock. At December 31, 1994, the Company had unrestricted retained earnings of $12,194,000.\n9. Stockholders - Equity The Company has authority to issue 500,000 shares of preferred stock, $20 par value, and the Board of Directors is vested with the authority to establish and designate series of preferred, to fix the number of shares therein and the variations in relative rights as between series. No such shares are outstanding at December 31, 1994. The Company announced on October 18, 1993 that the Board of Directors has authorized the repurchase by the Company of up to 325,000 shares of its common stock to be used to meet present and future requirements of its stock option program. The repurchase program was completed in early March 1994 and 325,000 shares were repurchased at a cost of $7,345,000. On April 20, 1994, the Company announced that the Board of Directors has authorized the repurchase by the Company of up to 200,000 shares of its common stock to be used to meet present and future requirements of its stock option program. As of December 31, 1994, 90,300 shares were repurchased at a cost of $1,480,000.\n10.Stock Options Under the Company's stock option plans, while the holder is an employee of the Company, the options are exercisable in whole or in part anytime during the five years following the date of grant for options granted prior to 1994. For options granted in 1994, while the holder is an employee of the Company, the options are exercisable in whole or in part anytime during the five years following the date of vesting. On May 26, 1994, the shareholders approved an increase of 400,000 shares for issuance under the Company's 1994 Omnibus Stock Option Plan. At December 31, 1994, 438,000 shares of authorized but unissued common stock were reserved for issuance under the Company's stock option plans, of which 288,000 shares were subject to outstanding options. The change in outstanding options are as follows: 1994 1993 1992 Outstanding at beginning.. 82,300 437,700 441,600 Granted ......................... 250,000 32,000 72,000 Exercised (1994 and 1993 - $10.13 to $16.88, 1992 - $10.13) (35,950) (378,650) (2,000) Terminated and expired (8,350) (8,750) (73,900) -------------------------------------------------------------------- Outstanding at end 288,000 82,300 437,700 -------------------------------------------------------------------- Vested at end 38,000 82,300 437,700 -------------------------------------------------------------------- Aggregate option price $4,756,375 $1,337,688 $5,968,938 -------------------------------------------------------------------- At a price range per share of: 1994 1993 1992 --------------------------------------------------------------------------- Beginning $10.13 to $18.56 $10.13 to $16.88 $10.13 to $17.56 End $12.75 to $18.56 $10.13 to $18.56 $10.13 to $16.88 ---------------------------------------------------------------------------\n11.Employee Benefit Plans The Company has a defined benefit pension plan covering substantially all of the unionized employees of the EIS Brake Parts Division. The benefits are based on years of service. The Company's funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. 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. (In thousands) December 31, ------------------------------ 1994 1993 1992 ---------------------------------------------------------------- Net periodic pension cost for 1994, 1993 and 1992 includes the following components: Service cost - benefits earned during the period.. 250 248 220 Interest cost on projected benefit obligation 631 613 590 Actual return on plan assets (88) (960) (724) Net amortization and deferral (521) 391 59 ---------------------------------------------------------------- Net periodic pension cost 272 292 145 ---------------------------------------------------------------- The following table sets forth the plan's funded status at December 31, 1994 and 1993: (In thousands) December 31, -------------------- 1994 1993 ---------------------------------------------------------------- Actuarial present value of benefit obligations: Accumulated benefit obligation, including vested benefits of $(9,706) and $(9,474) in 1994 and 1993, respectively ($10,322) ($10,032) ---------------------------------------------------------------- Projected benefit obligation for service rendered to date ($10,322) ($10,032) Plan assets at fair value (primarily debt securities, commercial mortgages and listed stocks) 8,486 8,738 ---------------------------------------------------------------- Plan assets (less than) projected benefit obligation (1,836) (1,294) Unrecognized prior service cost 460 503 Unrecognized net loss 1,343 747 Unrecognized net obligation being recognized over 15 years 172 198 Adjustment required to recognize minimum liability (1,975) (1,448) ---------------------------------------------------------------- Accrued pension cost included in accrued expenses (1,836) (1,294) ---------------------------------------------------------------- Assumptions used in accounting for the pension plan are as follows: ------------------------------ 1994 1993 1992 ---------------------------------------------------------------- Discount rates 6.5% 6.5% 6.6% Expected long-term rate of return on assets 8.0% 8.0% 8.5% ---------------------------------------------------------------- - - STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued)\nIn addition, the Company participates in several multiemployer plans which provide defined benefits to substantially all unionized workers. The Multiemployer Pension Plan Amendments Act of 1980 imposes certain liabilities upon employers associated with multiemployer plans. The Company has not received information from the plans' administrators to determine its share, if any, of unfunded vested benefits. The Company and certain of its subsidiaries also maintain various defined contribution plans, which includes profit sharing, providing retirement benefits for other eligible employees. The provisions for retirement expense in connection with the plans are as follows:\nDefined Multi- Contribution employer Plans and Other Plans ------------------------------------------------------------------ Year-end December 31, 1994 $379,000 $5,033,000 1993 358,000 4,760,000 1992 498,000 1,895,000 ------------------------------------------------------------------ In January 1989, the Company established an Employee Stock Ownership Plan and Trust for employees who are not covered by a collective bargaining agreement. The ESOP authorized the Trust to purchase up to 1,000,000 shares of the Company's common stock in the open market. In 1989, the Company entered into an agreement with a bank authorizing the Company to borrow up to $18,000,000 in connection with the ESOP. Under this agreement, the Company borrowed $16,729,000, payable in annual installments through 1998 (see Note 8), which was loaned on the same terms to the ESOP for the purchase of common stock. During 1989, the ESOP made open market purchases of 1,000,000 shares at an average cost of $16.78 per share. Future company contributions plus dividends earned will be used to service the debt. During 1994, 1993 and 1992, 96,800, 100,700 and 101,600 shares were allocated to the employees, leaving 398,800 unallocated shares in the ESOP trust at December 31, 1994. Contributions to the ESOP are based on a predetermined formula which is primarily tied into dividends earned by the ESOP and loan repayments. The provision for expense in connection with the ESOP was approximately $1,321,000 in 1994, $1,380,000 in 1993 and $1,387,000 in 1992. The expense was calculated by subtracting dividend and interest income earned by the ESOP, which amounted to approximately $296,000, $305,000 and $313,000 for the years ended December 31, 1994, 1993 and 1992, respectively, from the principal repayment on the outstanding bank loan. Interest costs amounted to approximately $645,000, $772,000 and $756,000 for the years ended December 31, 1994, 1993 and 1992, respectively. At December 31, 1994 and 1993, indebtedness of the ESOP to the Company in the amounts of $6,705,000 and $8,385,000, respectively, are shown as deductions from stockholders' equity in the consolidated balance sheets. Dividends paid on ESOP shares are recorded as reductions in retained earnings in the consolidated balance sheet. In August 1994 the Company established an unfunded Supplemental Executive Retirement Plan for key employees of the Company. Under the plan, employees may elect to defer a portion of their compensation and, in addition, the Company may at its discretion make contributions to the plan on behalf of the employees. Such contributions were not significant in 1994.\n12.Postretirement Benefits The Company provides certain medical and dental care benefits to eligible retired employees. Approximately 1,900 employees and 200 retirees are eligible under this plan. Salaried employees become eligible for retiree health care benefits after reaching age 65 if they retire at age 65 or older with at least 15 years of continuous service. EIS Brake Parts unionized employees become eligible after reaching age 65 if they retire at age 65 or older with at least 10 years of continuous service. Other unionized employees are covered under union health care plans. Generally, the health care plans pay a stated percentage of most health care expenses reduced for any deductible and payments made by government programs and other group coverage. The costs of providing most of these benefits has been shared with retirees since 1991. Retiree annual contributions will increase proportionally if the Company's health care payments increase. Effective January 1, 1993 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Prior years' financial statements have not been restated to apply the provisions of SFAS No. 106. SFAS No. 106 requires that the expected cost of these postretirement benefits be charged to expense during the years that the employees render services. SFAS No. 106 was adopted using the immediate recognition transition option; the accumulated postretirement benefit obligation of $10,225,000, and related deferred tax benefit of $4,090,000 (net of $6,135,000), has been included in \"cumulative effect of changes in accounting for postretirement benefits and income taxes, net\" in the 1993 consolidated statement of earnings. This new accounting method has no effect on the Company's cash outlays for retiree benefits. The Company's current policy is to fund the cost of the health care plans on a pay-as-you-go basis. - - STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued)\nThe components of the net periodic benefit cost, excluding the cumulative effect of this accounting change, for the years ended December 31, 1994 and 1993 are as follows: (In thousands) 1994 1993 ---------------------------------------------------------------- Service cost $701 $672 Interest cost 960 800 ---------------------------------------------------------------- 1,661 1,472 ---------------------------------------------------------------- The following table sets forth the amounts included in the accompanying consolidated balance sheets at December 31, 1994 and 1993: (In thousands) 1994 1993 ---------------------------------------------------------------- Accumulated Postretirement Benefit Obligation (APBO): Retirees 4,012 4,015 Fully eligible active participants 1,011 936 Other active participants 7,779 6,501 ---------------------------------------------------------------- Total 12,802 11,452 ---------------------------------------------------------------- For measuring the expected postretirement benefit obligation, a health care cost trend rate of 13 and 14 percent was assumed for 1994 and 1993, respectively, declining 1 percent per year to 7 percent in 2000, then 0.5 percent per year to 6 percent in 2002 and remain at that level thereafter. The weighted-average discount rate used in determining the APBO was 8 percent at January 1, 1994 and 1993. The health care cost trend rate has a significant effect on the APBO and net periodic benefit cost. A 1 percent increase in the trend rate for health care costs would increase the APBO by $2,479,000 and service and interest costs by $359,000.\n13.Other Income (Expense), Net (In thousands) December 31, ------------------------------ 1994 1993 1992 ---------------------------------------------------------------- Other income (expense), net consists of: Interest and dividend income $1,724 $1,648 $1,630 (Loss) on sale of accounts receivables (Note 3) (1,107) (660) (997) Income (loss) from Blue Streak Electronics, Inc. 828 352 (97) Other - net (209) 308 161 ---------------------------------------------------------------- Total other income (expense), net $1,236 $1,648 $697 ----------------------------------------------------------------\n14.Taxes Based on Earnings Effective January 1, 1993 the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" Prior years' financial statements have not been restated to apply the provisions of SFAS No. 109. Under SFAS No. 109, deferred tax balances are stated at tax rates expected to be in effect when taxes are actually paid or recovered. The cumulative catch-up adjustment resulted in a deferred tax benefit of $5,045,000, which has been included in the consolidated statements of earnings as \"cumulative effect of changes in accounting for postretirement benefits and income taxes, net.\" Reconciliations between the U.S. federal income tax rate and the Company's effective income tax rate as a percentage of earnings before income taxes and cumulative effect of changes in accounting principles follow: ---------------------------------------------------------------- 1994 1993 1992 ---------------------------------------------------------------- U.S. federal income tax rate... 35.0% 35.0% 34.0% Increase (decrease) in tax rate resulting from: State and local income taxes, net of federal income tax benefit 5.2 5.5 1.5 (Tax-exempt income)\/ non-deductible items - net 0.1 0.2 0.2 Benefits of income subject to taxes at lower than the U.S. federal rate (8.6) (9.7) (16.8) Other 1.4 (0.4) (1.0) ---------------------------------------------------------------- Effective tax rate 33.1% 30.6% 17.9% ---------------------------------------------------------------- The following is a summary of the components of the net deferred tax assets and liabilities recognized in the accompanying consolidated balance sheets: (In thousands) December 31, -------------------- 1994 1993 ---------------------------------------------------------------- Deferred tax assets: Inventory 12,161 9,291 Allowance for customer returns 6,075 5,412 Postretirement benefits 4,827 4,581 Allowance for doubtful accounts 1,287 1,348 Accrued salaries 1,315 1,424 Restructuring charges -- 1,023 Other 1,704 408 ---------------------------------------------------------------- Total 27,369 23,487 ---------------------------------------------------------------- Deferred tax liabilities: Depreciation $8,847 $8,093 Promotional costs 1,820 728 Other 1,454 831 ---------------------------------------------------------------- Total 12,121 9,652 ---------------------------------------------------------------- Net deferred tax assets 15,248 13,835 ---------------------------------------------------------------- Based upon the level of historical taxable income and projections for future taxable income over the periods which the deferred tax assets are deductible, the Company believes that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the net deferred tax assets. The Company has not provided for federal income taxes on the undistributed income of its foreign subsidiaries because of the availability of foreign tax credits and\/or the Company's intention to permanently reinvest such undistributed income. Cumulative undistributed earnings of foreign subsidiaries on which no United States income tax has been provided were $12,502,000 at the end of 1994, $10,011,000 at the end of 1993 and $7,181,000 at the end of 1992. Earnings of a subsidiary operating in Puerto Rico, amounting to approximately $9,482,000 (1993 - $7,285,000; 1992 - $6,941,000), which are not subject to United States income taxes, are partially exempt from Puerto Rican income taxes under a tax exemption grant expiring on December 31, 2002. The tax benefits of the exemption, reduced by a minimum tollgate tax instituted in 1993, amounted to $.24 per share in 1994 (1993 - $.19; 1992 - $.23). - - STANDARD MOTOR PRODUCTS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (continued)\nForeign income taxes amounted to approximately $1,097,000, $838,000 and $697,000 for 1994, 1993 and 1992, respectively.\n15.Fair Value of Financial Instruments 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 those instruments.\nMarketable securities The fair values of investments are estimated based on quoted market prices for these or similar instruments.\nLong-term debt The fair value of the Company's long-term debt is estimated based on the current rates offered to the Company for debt of the same remaining maturities.\nInterest rate swap agreements The fair value of interest rate swaps (used for hedging purposes) is the estimated amount that the Company would receive or pay to terminate the swap agreements at the reporting dates, taking into account current interest rates. The estimated fair values of the Company's financial instruments are as follows: (In thousands) Carrying Fair December 31, 1994 Amount Value ---------------------------------------------------------------- Cash and cash equivalents $2,796 $2,796 Marketable securities 10,818 10,811 Long-term debt (129,914) (127,077) Off-Balance Sheet financial instruments: Interest rate swaps: In a net payable position -- (482) ---------------------------------------------------------------- (In thousands) Carrying Fair December 31, 1994 Amount Value ---------------------------------------------------------------- Cash and cash equivalents $12,346 $12,346 Marketable securities 3,011 3,011 Long-term debt (135,449) (151,587) Off-Balance Sheet financial instruments: Interest rate swaps: In a net receivable position -- 415 In a net payable position -- (1,146) ----------------------------------------------------------------\n16.Commitments and Contingencies Total rent expense for the three years ended December 31, 1994 was as follows: (In thousands) Real Total Estate Other ---------------------------------------------------------------- 1994 $5,345 $ 2,223 $3,122 1993 5,544 2,320 3,224 1992 5,931 2,618 3,313\nAt December 31, 1994, the Company is obligated to make minimum rental payments (exclusive of real estate taxes and certain other charges) through 2004, under operating leases for real estate, as follows: (In thousands) 1995 $2,389 1996 2,093 1997 1,577 1998 1,217 1999 1,175 Thereafter 4,643 ---------------------------------------------------------------- $13,094 ---------------------------------------------------------------- At December 31, 1994, the Company had letters of credit outstanding aggregating approximately $1,652,000. The contract amount of the letters of credit is a reasonable estimate of their value as the value for each is fixed over the life of the commitment. The Company is involved in various litigation matters arising in the ordinary course of business. Although the final outcome of these matters cannot be determined, it is management's opinion that the final resolution of these matters will not have a material effect on the Company's financial position and results of operations.\n17.Restructuring Charges During 1993, the Company recorded a $2,781,000 provision for restructuring charges. Included in the restructuring plan are charges for the expected costs of facility consolidations, asset retirements, employee separations, relocations and related costs. Restructuring plans started in 1993 were completed by the end of 1994.\n18.Quarterly Financial Data (Unaudited) Net Gross Net Per Sales Profit Earnings Share ---------------------------------------------------------------------- (In thousands, except per share amounts) ---------------------------------------------------------------------- 1994 Quarter: First $147,126 $50,226 $2,745 $0.21 Second 187,645 63,989 8,216 0.62 Third 168,291 58,825 7,730 0.59 Fourth 137,748 52,083 4,974 0.38 ---------------------------------------------------------------------- Total 640,810 225,123 23,665 $1.80 ---------------------------------------------------------------------- 1993 Quarter: First $127,755 $45,684 $1,763 $0.13 Second 161,201 56,760 6,779 0.51 Third 161,340 56,786 5,703 0.43 Fourth 132,555 50,033 3,263 0.25 --------------------------------------------------------------------- Total 582,851 209,263 17,508 $1.32 --------------------------------------------------------------------- The fourth quarter of 1994 results reflect physical inventory adjustments which had the effect of increasing fourth quarter operating income by approximately $3,245,000 ($1,947,000 net of income taxes). The fourth quarter 1993 reflects an improved gross profit percentage, compared to the prior 1993 quarters, primarily due to favorable year-end inventory adjustments. - -\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTo the Board of Directors and Stockholders Standard Motor Products, Inc.\nUnder date of February 23, 1995, we reported on the consolidated balance sheet of Standard Motor Products, Inc. and subsidiaries as of December 31, 1994, and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for the year then ended, as contained in the annual report on Form 10-K for the year 1994. In connection with our audit of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our 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 LLP\nShort Hills, New Jersey February 23, 1995\n- 17 - INDEPENDENT AUDITORS' REPORT ----------------------------\nTo the Board of Directors and Stockholders Standard Motor Products, Inc.\nIn connection with our audits of the consolidated financial statements of Standard Motor Products, Inc. and subsidiaries for the years ended December 31, 1993 and 1992, we have also audited the financial statement schedule listed in the accompanying index at Item 14(a)(2) for the years ending December 31, 1993 and 1992. Our audits of the financial statements were made for the purpose of forming an opinion on those statements taken as a whole. The financial statement schedule is presented for the purpose of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This financial statement schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.\nDavid Berdon & Co. LLP New York, New York Certified Public Accountants February 25, 1994\n- 18 -\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE - ------------------------------------------------------------- None.\nPART III -------- ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT - -------------------------------------------------------------- Information relating to Directors and Executive Officers is set forth in the 1995 Annual Proxy Statement.\nITEM 11.","section_11":"ITEM 11. MANAGEMENT REMUNERATION AND TRANSACTIONS - ---------------------------------------------------- Information relating to Management Remuneration and Transactions is set forth in the 1995 Annual Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS - ----------------------------------------------------------- AND MANAGEMENT -------------- Information relating to Security Ownership of Certain Beneficial Owners and Management is set forth in the 1995 Annual Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - ---------------------------------------------------------- Information relating to Certain Relationships and Related Transactions is set forth under \"Certain Transactions\" in the 1995 Annual Proxy Statement.\n- 19 -\nPART IV ------- ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON - ------------------------------------------------------------------- FORM 8-K -------- 14.(a) Document List ------------- (a)(1) Among the responses to this Item 14(a) are the following financial statements.\nReport of Independent Certified Public Accountants\nFinancial Statements:\nConsolidated Balance Sheets - December 31, 1994 and 1993\nConsolidated Statements of Earnings - Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Changes in Stockholders' Equity - Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows - Years Ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n(a)(2) The following financial schedule for the years 1994, 1993 and 1992 is submitted herewith:\nSchedule Page -------- ---- II. Valuation and Qualifying Accounts 26\nSelected Quarterly Financial Data, for the Years Ended December 31, 1994 and 1993, are included herein by reference to Part II, Item 8.\nAll other schedules are omitted because they are not required, inapplicable or the information is included in the financial statements or notes thereto.\n- 20 - (a)(3) Exhibits required by Item 601 of Securities and Exchange Commission Regulations S-K.\n(A) The following such Exhibits are filed as a separate section of this report.\n(22) List of Subsidiaries of Standard Motor Products, Inc. is included on Page 27.\n(B) The following such Exhibits are incorporated herein by reference.\n(3) By-Laws filed as an Exhibit of Registrant's annual report on Form 10-K for the year ended December 31, 1986 is incorporated herein by reference.\nRestated Certificate of Incorporation, dated July 31, 1990, filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 is incorporated herein by reference.\n(4) Note Purchase Agreement of January 15, 1987 between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company, and the Woodmen Accident and Life Company filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1986 is incorporated herein by reference.\nLetter Agreement of January 25, 1989 amending the Note Agreement between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company, and the Woodmen Accident and Life Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference.\n- 21 - Credit Agreement dated March 10, 1989 between the Registrant and Chemical Bank filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference.\nNote Purchase Agreement dated October 15, 1989 between the Registrant and the American United Life Insurance Company, the General American Life Insurance Company, the Jefferson-Pilot Life Insurance Company, the Ohio National Life Insurance Company, the Crown Insurance Company, the Great-West Life Assurance Company, the Guarantee Mutual Life Company, the Security Mutual Life Insurance Company of Lincoln, Nebraska, and the Woodmen Accident and Life Company filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference.\nLetter Agreement of January 15, 1990 amending the Note Agreement between the Registrant and the Travelers Insurance Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 is incorporated herein by reference.\nLetter Agreement of July 20, 1990 amending the Credit Agreement between the Registrant and Chemical Bank dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1990 is incorporated herein by reference.\nLetter Agreement of September 30, 1990 amending the Note Agreement between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company, and the Woodmen Accident and Life Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 is incorporated herein by reference.\n- 22 - Letter Agreement of March 4, 1991 amending the Credit Agreement between the Registrant and Chemical Bank dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 is incorporated herein by reference.\nLetter Agreement of December 20, 1991 amending the Credit Agreement between the Registrant and Chemical Bank dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 is incorporated herein by reference.\nLetter Agreement of February 28, 1992 amending the Note Agreement between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company and the Woodmen Accident and Life Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.\nLetter Agreement of July 22, 1992 amending the Note Agreement between the Registrant and the Travelers Insurance Company, the Great-West Life Assurance Company, the Franklin Life Insurance Company, the Franklin United Life Insurance Company, and the Woodmen Accident and Life Company dated January 15, 1987 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.\nLetter Agreement dated October 30, 1992 amending the Credit Agreement between the Registrant and Chemical Bank, assigned to NBD Bank, N.A. with amendment dated December 20, 1991, dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.\n- 23 - Note Agreement of November 15, 1992 between the Registrant and Kemper Investors Life Insurance Company, Federal Kemper Life Assurance Company, Lumbermens Mutual Casualty Company, Fidelity Life Association, American Motorists Insurance Company, American Manufacturers Mutual Insurance Company, Allstate Life Insurance Company, Teachers Insurance & Annuity Association of America, and Phoenix Home Life Mutual Insurance Company filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.\nNote Agreement of November 15, 1992 between the Registrant and Principal Mutual Life Insurance Company, and Principal National Life Insurance Company filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 is incorporated herein by reference.\nLetter Agreement dated December 27, 1993 amending the Credit Agreement between the Registrant and Chemical Bank, assigned to NBD Bank, N.A. with amendment dated December 20, 1991, dated March 10, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 is incorporated herein by reference.\n(5) Employee Stock Ownership Plan and Trust dated January 1, 1989 filed as an Exhibit of Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 is incorporated herein by reference.\n(C) The following exhibits have been included in the filing made with the SEC and are available upon request.\nSupplemental Executive Retirement Plan dated August 15, 1994 is included as Exhibit A.\n14(b) Reports on Form 8-K ------------------- No reports on Form 8-K were required to be filed for the three months ended December 31, 1994.\n- 24 - SIGNATURES ---------- Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nSTANDARD MOTOR PRODUCTS, INC. (Registrant)\nLawrence I. Sills -------------------------------------------- Lawrence I. Sills, President, Director Chief Operating Officer\nMichael J. Bailey ------------------------------------------- Michael J. Bailey, Vice President Finance, Chief Financial Officer\nJames J. Burke -------------------------------------------- James J. Burke, Corporate Controller\nDated: New York, New York March 31, 1995\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:\nMarch 31, 1995 Lawrence I. Sills - -------------- -------------------------------------------- (Dated) Lawrence I. Sills, President, Director Chief Operating Officer\nMarch 31, 1995 Bernard Fife - -------------- -------------------------------------------- (Dated) Bernard Fife Co-Chairman, Director\nMarch 31, 1995 Nathaniel L. Sills - -------------- -------------------------------------------- (Dated) Nathaniel L. Sills Co-Chairman, Director\nMarch 31, 1995 Arlene R. Fife - -------------- -------------------------------------------- (Dated) Arlene R. Fife, Director\nMarch 31, 1995 Ruth F. Sills - -------------- -------------------------------------------- (Dated) Ruth F. Sills, Director\n- 25 - [CAPTION]\n(a) Recoveries of accounts previously written off.\nEXHIBIT 22\nSUBSIDIARIES OF THE REGISTRANT\nAS OF FEBRUARY 28, 1995\nPercent State or of Voting Country of Securities Name Incorporation Owned\nBlue Streak-Hygrade Motor Products, Ltd. Canada 100 Marathon Auto Parts and Products, Inc. New York 100 Motortronics, Inc. New York 100 Reno Standard Incorporated Nevada 100 Stanric, Inc. Delaware 100 Mardevco Credit Corp. (1) New York 100 Standard Motor Products (Hong Kong) Limited Hong Kong 100 Industrial & Automotive Associates, Inc. California 100 EIS Brake Manufacturing, Ltd. Canada 100\nAll of the subsidiaries are included in the consolidated financial statements.\n(1) Wholly owned subsidiary of Stanric, Inc.\n- 27 - EXHIBIT A\nSTANDARD MOTOR PRODUCTS, INC.\nSUPPLEMENTAL EXECUTIVE RETIREMENT PLAN\nEFFECTIVE AS OF AUGUST 15, 1994\nStandard Motor Products, Inc.\nSupplemental Executive Retirement Plan\nSection PAGE I. Establishment and Purpose................................. 1\nII. Definitions............................................... 2\nIII. Eligibility and Participation............................. 3\nIV. Deferred Compensation Amounts............................. 5\nV. Time of Payment and Manner of Payments.................... 6\nVI. Deferred Compensation Account............................. 8\nVII. Change of Control......................................... 10\nVIII. Administration............................................ 11\nIX. Miscellaneous............................................. 12\nAppendix Schedule of Participants\nSection I\nEstablishment and Purpose\n1.01 Establishment Standard Motor Products, Inc. (hereinafter -------------\nreferred to as the \"Company\") hereby establishes, effective as of August 15,\n1994, an unfunded supplemental deferred compensation plan for a select group of\nmanagement or highly compensated employees as described herein, which shall be\nknown as the \"STANDARD MOTOR PRODUCTS, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT\nPLAN\" (hereinafter referred to as the \"Plan\").\n1.02 Purpose The purpose of this Plan is to enable the Company ------- to supplement the benefits under the Standard Motor Products, Inc. Capital\nAccumulation Plan which will be reduced because of the new compensation\nlimitation under Section 401(a)(17) of the Internal Revenue Code of 1986, as\namended, to certain key executive employees of the Company as well as to\nprovide a means whereby certain amounts payable by the Company to key\nexecutive employees may be deferred to some future period, and to attract and\nretain key executive employees of outstanding competence.\n- 1 - Section II\nDefinitions\nThe following words and phrases shall have the following\nmeanings, unless a different meaning is plainly required by the context. Any\nmasculine terminology used in the Plan shall also include the feminine gender\nand the definition of any terms in the singular shall also include the plural.\n\"Account\" or \"Deferred Compensation Account\" means the\ndeferred compensation account established for a Participant pursuant to Section\nVI.\n\"Beneficiary\" means any person or entity validly designated by\nthe Participant in accordance with Section III to receive the benefits, if any,\npayable under the Plan to such Participant.\n\"Board\" means the Board of Directors of the Company.\n2.04 \"Committee\" means the Compensation Committee of the\nBoard.\n\"Company\" means Standard Motor Products, Inc., or any successor thereto.\n\"Company Contribution\" means the amount, if any, contributed\nby the Company to the Plan on behalf of the Participant. For any Plan Year, the\ndecision to make Company Contributions shall be made in the sole discretion of\nthe Company.\n\"Disability\" means a physical or mental disability which is\ndetermined by a physician acceptable to the Committee to have rendered the\nParticipant incapable of continuing in the regular active employment of the\nCompany for at least six months.\n\"Early Retirement\" means the date on which a Participant\nattains his early retirement date as defined in accordance with the Standard\nMotor Products, Inc. Capital Accumulation Plan.\n- 2 - \"Effective Date\" means August 15, 1994.\n\"Eligible Employee\" means any employee designated by the Committee who satisfies the requirements of Section III.\n\"Normal Retirement Date\" means the date the Participant\nattains sixty-five (65) years of age.\n\"Participant\" means an Eligible Employee of the Company who is\nselected to participate in the Plan in the manner described in Section III.\n\"Plan\" means the Standard Motor Products, Inc. Supplemental\nExecutive Retirement Plan as set forth herein and, as the same may be amended\nfrom time to time.\n\"Plan Year\" means the calendar year.\n\"Total Compensation\" means base wages and any bonuses payable\nin cash to the Participant as reflected on the Participant's Form W-2 during a\nPlan Year, excluding any compensation from the exercise of stock options.\n\"Trust\" means the Standard Motor Products, Inc. Supplemental\nExecutive Retirement Plan Trust or any other trust established by agreement\nbetween the Company and the Trustee in connection with the Plan under which Plan\nassets are held and invested and from which benefits under the Plan are paid.\n\"Trustee\" means the corporation, or other entity acting as\ntrustee of the Trust at any time of reference.\n\"Year of Service\" means a one year period of employment with\nthe Company in which the Participant completes at least 1,000 hours.\n\"Valuation Date\" means each business day of the Plan year.\n- 3 - Section III\nEligibility and Participation\n3.01 Eligibility -----------\n(a) All officers of the Company and other key executives shall\nbe Eligible Employees and the Committee may select from time to time the other\nkey executive employees who shall be eligible to participate under the Plan.\n(b) In order for an Eligible Employee to participate in the\nPlan, he must file with the Committee, before the beginning of the applicable\nPlan Year, an election on the form attached hereto as Exhibit A.\nNotwithstanding the above, for the first Plan Year, a Participant shall be\npermitted to elect to defer his Compensation within (30) thirty days from the\nEffective Date of the Plan.\n(c) Participation in the Plan shall continue until the balance\ncredited to the Participant's Account has been paid in full.\n3.02 Beneficiary Designation The Participant shall submit to the -----------------------\nCompany upon enrollment in the Plan or at such time as the Committee requests\nand on the form attached hereto as Exhibit B, a written designation of a primary\nbeneficiary to whom payment of his Deferred Compensation Account under the Plan\nshall be made in the event of his death. Each beneficiary designation shall\nbecome effective only when received by the Committee.\n- 4 - Section IV\nDeferred Compensation Amounts\n4.01 Employee Salary Deferrals. An Eligible Employee may --------------------------\nirrevocably elect on an election form attached hereto as Exhibit B, to defer\nreceipt of (a) all or a portion of his bonus for the year or (b) his\nCompensation which would otherwise be payable for the applicable Plan Year up\nto a maximum of 50%. The deferred amount may be expressed as a dollar\namount, or a percentage of such bonus or Compensation payable during the Plan\nyear.\n4.02 Company Contributions. Notwithstanding Section 4.01, the ----------------------\nCompany may contribute to the Trust for each Plan Year and on behalf of each\nParticipant, a Company Contribution in such amount as may be determined by the\nCommittee in its sole discretion.\n4.03 Deferral Period At the time the Participant makes a deferral ---------------\nelection pursuant to Section 4.01, he shall specify the date on which payments\nof the balance credited to his Account shall be made in accordance with Section\nV.\n4.04 Vesting -------\n(a) All employee salary deferrals made by a Participant and\ncredited to his Deferred Compensation Account shall be nonforfeitable at all\ntimes.\n(b) All Company Contributions made on behalf of a Participant\nand credited to his Deferred Compensation Account shall be fully vested provided\nthat the Employee has completed (3) three consecutive Years of Service with the\nCompany. Notwithstanding the preceding sentence, the Committee may in its\ndiscretion accelerate the vesting of any Company Contributions made on behalf of\na Participant who terminates employment before the completion of the three year\nperiod.\n- 5 - Section V\nTime of Payment and Manner of Payments\n5.01 Time of Payment. Deferrals under the Plan will be made until ----------------\nthe earliest to occur of:\n(a) death,\n(b) disability,\n(c) early retirement or normal retirement date, or\n(d) other termination of employment\nManner of Payment Election. A Participant may irrevocably\nelect the manner in which amounts deferred under the Plan and Company\nContributions made under the Plan will be paid. Any such election must be made\nat the Participant's initial enrollment in the Plan. The Participant may select\neither a single lump sum payment or periodic payments over a period not to\nexceed 10 years, payable in installments of equal or varying percentages of\nthe balance of his bookkeeping account under the Trust or such other method\nas approved by the Committee. Notwithstanding the above and subject to the\napproval of the Committee, the Participant may change the method of payment by\nfiling an election with the Committee on the form attached hereto as Exhibit A\napproved by it prior to the beginning of the year preceding the year in which\npayment of the Participant's Account with respect to such election is to be\nmade or commenced. Distribution of the Participant's Deferred Compensation\nAccount shall commence as soon as practicable following the Participant's\ntermination of employment.\n- 6 - 5.03 Death Benefit. --------------\n(a) In the event of the Participant's death while in the\nemployment of the Company and prior to the commencement of his Deferred\nCompensation Account, the Company shall pay the amount of the Participant's\nDeferred Compensation Account in a lump sum payment as of the date of death to\nthe Participant's designated Beneficiary in accordance with the such\ndesignation received by the Committee.\n(b) In the event of the Participant's death after the\ncommencement of his Deferred Compensation Account, but prior to the completion\nof all such payments due and owing hereunder, the Company shall continue to make\nsuch payments, in equal annual installments over the remainder of the period\nthat would have been applicable to the Participant had he survived. Such\ncontinuing payments shall be made to the Participant's designated\nBeneficiary, in accordance with the last such designation received by the\nCommittee from the Participant prior to his death.\n- 7 - Section VI\nDeferred Compensation Account\n6.01 Participant Accounts. The Committee shall cause the\nTrustee to maintain a bookkeeping account to be kept in the name of each\nParticipant which shall reflect the value of the deferrals made by a Participant\nand the Company Contributions, if any, made by the Company, on the\nParticipant's behalf. The Participant's Account shall be credited as of the\ndate the amounts deferred otherwise would have become due or payable,\nand with respect to Company Contributions at times as the Committee shall\ndirect.\n6.02 Investment of Accounts. In accordance with the terms of the -----------------------\nTrust, the value of funds credited to the Participant's bookkeeping account may\nbe kept in cash or invested and reinvested in mutual funds, stocks, bonds,\nsecurities or any other investment funds as may be selected by the Committee\nin its discretion and reflected in Investment Guidelines which may be\nfurnished to the Trustee from time to time. In providing such\nInvestment Guidelines to the Trustee, the Committee may consult Participants\nwith regard to investment decisions, engage investment counsel and, if it so\ndesires, may delegate to such counsel full or limited authority to select the\ninvestment vehicles described in the Investment Guidelines in which the\naccounts are deemed to be invested. As of each Valuation Date, the\nbookkeeping account of each Participant shall be credited with a gain or loss\nequal to the adjustment which would be made if assets equal to the bookkeeping\naccount had been invested in accordance with such Investment Guidelines.\n- 8 - 6.03 Assumption of Risk. The Participant agrees on behalf of -------------------\nhimself and his designated beneficiary to assume all risk in connection with any\ndecrease in value of the funds which are deemed to be invested or which continue\nto be invested in accordance with the provisions of this Plan. Funds invested\nor deemed invested under this Plan shall continue for all purposes to be part of\nthe general assets of the Company, and no person, other than the Company shall,\nby virtue of the provisions of this Plan, have any interest in such funds.\n6.04 Charges Against Accounts. There shall be charged against each -------------------------\nParticipant's bookkeeping account any payments made to the Participant or his\nbeneficiary in accordance with Plan Article V.\n- 9 - Section VII\nChange of Control\n7.01 Effect of Change of Control. In the event of a Change of\nControl, as defined in Section 13(d) of the Trust, the Company shall, as soon as\npossible, but in no event longer than 60 days following the Change of Control,\nmake an irrevocable contribution to the Trust in the amount that is sufficient\nto pay each Plan Participant or beneficiary the benefits to which Plan\nParticipants or their beneficiaries would be entitled pursuant to the terms of\nthe Plan as of the date on which the Change of Control occurred. Upon a Change\nof Control each Participant's Deferred Compensation Account shall be fully\nvested.\n- 10 - Section VIII\nAdministration\n8.01 Authority. The Plan shall be administered by the Compensation ----------\nCommittee thereof appointed by the Board, which shall have full power and\nauthority to administer and interpret the Plan.\n8.02 Liability. No member of the Board or management of the ----------\nCompany shall be liable to any persons for any actions taken under the Plan.\n8.03 Procedures. The Board may from time to time adopt such -----------\nprocedures as it deems appropriate to assist in the administration of the Plan.\n- 11 - Section IX\nMiscellaneous\n9.01 Claim for Benefits. No employee or other person shall have -------------------\nany claim or right to payment of any amount hereunder until payment has been\nauthorized and directed by the Board.\n9.02 Not an Employment Contract. This Plan is not and shall not be ---------------------------\ndeemed to constitute a contract of employment between the Company and any\nemployee or other person, nor shall anything herein contained be deemed to give\nany employee or other person any right to be retained in the Company's employ or\nin any way limit or restrict the Company's right or power to discharge any\nemployee or other person at any time and to treat him without regard to the\neffect which such treatment might have upon him as a Participant in the Plan.\nEach Participant, Beneficiary and any other person or persons having or\nclaiming a right to payments thereunder shall rely solely on the unsecured\npromise of the Company, and nothing herein shall be construed to give a\nParticipant, Beneficiary or any other person or persons any right, title,\ninterest or claim in or to any specific asset, fund, reserve, account or\nproperty of any kind whatsoever owned by the Company or in which it may have\nany right, title or interest now or in the future.\n9.03 Nontransferability. A Participant's rights and interest under -------------------\nthe Plan, including amounts payable, may not be assigned, pledged or transferred\nexcept, in the event of a Participant's death, to his Beneficiary.\n9.04 Tax Withholding. The Company shall withhold the amount of any ----------------\nfederal, state or local income tax or other tax required to be withheld by the\nCompany under applicable law with respect to any amount payable under the Plan.\n- 12 - 9.05 Expenses. All expenses of administering the Plan shall be ---------\nborne by the Company.\n9.06 Governing Law. The Plan shall be construed in accordance with --------------\nand governed by the laws of the State of New York.\n9.07 Amendment and Termination. The Board, in its discretion, may --------------------------\namend or terminate the Plan at any time. Notice of any amendment or termination\nshall be promptly communicated to Participants.\n- 13 -","section_15":""}
{"filename":"100122_1994.txt","cik":"100122","year":"1994","section_1":"ITEM 1. - BUSINESS\nTHE COMPANY\nTucson Electric Power Company was incorporated under the laws of the State of Arizona on December 16, 1963. The Company is the successor by merger as of February 20, 1964, to a Colorado corporation which was incorporated on January 25, 1902. The Company is an operating public utility engaged in the generation, purchase, transmission, distribution and sale of electricity for customers in the City of Tucson and the surrounding area and to wholesale customers. The Company holds a franchise which expires in 2001 to provide electric service to customers in the City of Tucson.\nThe Company owns all of the outstanding stock of Valencia Energy Company (Valencia), which supplies coal to the Springerville Generating Station (see Fuel Supply, Valencia), all of the outstanding stock of San Carlos Resources Inc. (San Carlos), which holds title to Springerville Unit 2, and all of the outstanding stock of Nations Energy Corporation. See Competition below for a description of Nations Energy. The Company owns all of the outstanding stock of two investment subsidiaries, Tucson Resources Inc. (TRI) and Sierrita Resources Inc. (SRI). See Consolidated Statements of Income (Loss) and Note 5 of Notes to Consolidated Financial Statements, Discontinued Operations for comparative financial information relating to the Company's investment business segments. TRI and SRI have substantially completed the process of liquidating their respective investments.\nCERTAIN RISKS\nFor descriptions of certain factors affecting the Company, including commitments and contingencies, which subject the Company to continuing risks, see (i) 1994 Rate Order; (ii) Discontinued Investment Subsidiary Operations; (iii) Item 3., Legal Proceedings; (iv) Item 7., Management's Discussion and Analysis of Financial Condition and Results of Operations, Overview; and (v) Notes 2 and 7 of Notes to Consolidated Financial Statements, 1994 Rate Order, and Commitments and Contingencies, respectively.\nTHE FINANCIAL RESTRUCTURING\nIn December 1992, the Company consummated a comprehensive restructuring of obligations to certain creditors and reclassified its preferred stock into common stock. The Financial Restructuring was concluded following negotiations with various creditors including, but not limited to, bank lenders and lease participants. See Note 3 of Notes to Consolidated Financial Statements, 1992 Consummation of the Financial Restructuring. The Company initiated the Financial Restructuring because it projected that it might have insufficient liquidity to meet its cash obligations by the end of the first quarter of 1991. A payment moratorium on certain of the Company's debt, lease, coal and rail obligations during part of the period of negotiations provided cash flow sufficient to meet the Company's other obligations.\nThe Company believes that the Financial Restructuring provides the Company the opportunity to return gradually to long-term financial viability. However, the Financial Restructuring itself will not be sufficient to assure the Company's long-term financial viability. Also, the Company's capital structure remains highly leveraged and the Company's financial prospects and cash flows remain subject to significant economic, regulatory and other uncertainties, many of which are beyond the Company's control.\nUTILITY OPERATIONS\nPEAK DEMAND AND CUSTOMERS\nCertain operating and system data related to the Company's utility operations for each of the last five years were as follows:\nThe peak demand for the Company's retail service area occurs during the summer months due to the space cooling requirements of its retail customers. The Company has experienced growth in peak demand (excluding the demand of its copper mining customers which fluctuates widely) at an average annual rate of approximately 4.9% for the past five years. Including the load of its mining customers, which comprised approximately 8.0% of the retail peak demand for the past five years, the Company experienced growth in peak demand of retail customers at an average annual rate of approximately 4.0% during the same period.\nIn 1994, based on non-coincident peak demand, the Company's reserve margin was only 9% compared with 18% in the prior year. The Company seeks to maintain a reserve margin equal to its largest single hazard plus 5% of its non- coincident peak demand in accordance with guidelines established by the WSCC. The targeted reserve requirement was 295 MW in 1994 or 16% of non-coincident peak demand. The Company's operations were not adversely affected by the Company's failure to maintain its targeted reserve requirement in 1994. It is expected that near-term growth in demand will be met with existing resources and the additional capacity provided under a power exchange agreement between the Company and SCE. See SCE\/TEP Power Exchange Agreement below. Also, see Generating Resources below for a discussion of the Company's electric generating resources.\nThe average number of retail customers served by the Company increased 2.9% in 1994 compared with 1993 and 2.1% on average annually over the past five years. The Company is currently projecting an average annual customer growth rate of approximately 2.5% and an average annual growth rate in the peak demand of retail customers of approximately 1.4% for the period 1995 through 1999. Realized growth in customers and retail demand may be affected by factors discussed under Competition below. Customer growth rates are projected to exceed historical growth rates because the Company anticipates greater population and economic growth than occurred in the past five years.\nAlso, the Company is projecting a 2.3% average annual growth rate in sales to retail customers over the next five years. Sales to residential, non-mining industrial and mining customers account for approximately 41%, 26% and 10%, respectively, of the projected sales.\nThe Company has two principal copper mining customers. In 1994, sales to such customers represented 11% and 6% of the Company's retail sales and their contract demands were 6% and 5%, respectively, of the Company's 1994 retail non- coincident peak demand. The total coincident peak load for the Company's two mining customers was 8.6% of the Company's 1994 retail peak demand. Revenues from sales to mining customers have comprised between 10% and 11% of the Company's revenues from retail customers in each of the three years in the period ended December 31, 1994.\nIn March 1994, the Company and the large mining customer to which the Company supplied approximately 50 MW, executed a new contract that included a reduced rate designed to induce such customer to remain on the Company's system rather than self-generate. In April 1994, the ACC approved such contract. Revenues from this customer were $23.6 million and $22.3 million in 1993 and 1994, respectively. In 1993, the Company entered into a similar contract with its largest mining customer although at a different rate level. These contracts expire after the year 2000. However, such contracts contain various provisions allowing the customers to terminate partially or entirely, under certain circumstances, provided that the Company has been notified at least one and up to two years prior to such termination. The ability to extend contracts, and to avoid early termination, will be dependent on market conditions at the time and alternatives available to customers at that time.\nFuture markets and prices for fuel, access to capital, as well as ACC decisions regarding rate design and the timing of rate decisions will affect the economics of self-generation projects (including cogeneration) and may ultimately affect whether customers, such as the mining customers described above, if any, might reduce or terminate their contract demand on the Company's system. See Competition below.\nSALES FOR RESALE\nThe Company makes sales for resale to others on both a firm and an interruptible basis. To the extent capacity is not providing energy to the Company's retail customers, such as during off-peak periods, the Company markets this capacity and energy at wholesale. Surplus energy is sold from time to time under various power pooling arrangements. The Company currently has contracts to sell firm capacity as follows:\nMinimum (or Maximum) Contract Company Demand MW Contract Term\nSRP 100 June 1, 1991 - May 31, 2011 NPC 50 May 16, 1990 - December 31, 1995 NTUA (1) 45 June 1, 1993 - May 31, 1999\n(1)The agreement with NTUA provides for a minimum contract demand of 45 MW and requires NTUA to obtain all of its electric power requirements from the Company. NTUA's peak demand is expected to be about 70 MW.\nCOMPETITION\nUnder current law, the Company is not in direct competition with any other regulated electric utility for electric service in the Company's retail service territory. Regardless of such regulation, the Company competes for retail markets against gas service suppliers and others who may provide energy services which would be substitutes for, or bypass of, the Company's services.\nThe Company does compete with other utilities, marketers and independent power producers in the sale of electric capacity and energy in the wholesale market. It is expected that competition to sell capacity will remain vigorous and that prices will remain depressed for several years due to increased competition and surplus capacity in the southwestern United States. Competition for the sale of capacity and energy is influenced by many factors, including the availability of capacity of the 3,810 MW Palo Verde nuclear generating station and other generating stations in the southwestern United States, the availability and prices of natural gas and oil, spot energy prices and transmission access. In addition, the Energy Act has increased competition in the wholesale electric power markets.\nThe Energy Act addresses a wide range of energy issues, including several matters affecting bulk power competition in the electric utility industry. It creates exemptions from regulation under the Holding Company Act for persons or corporations that own and\/or operate in the United States certain generating and interconnecting transmission facilities dedicated exclusively to wholesale sales, thereby encouraging the participation of utility affiliates, independent power producers and other non-utility participants in the development of power generation. In order to facilitate competition in power generation, the Energy Act also confers expanded authority upon FERC to issue orders requiring electric utilities to transmit power and energy to or for wholesale purchasers and sellers, and to require electric utilities to enlarge or construct additional transmission capacity to provide these services. While the Energy Act prohibits FERC from issuing any such order that would unreasonably impair the continuing reliability of affected electric systems or that would be conditioned upon or require transmission services directly to an ultimate consumer, the Energy Act creates the potential for utilities and other power producers to gain increased access to the transmission systems of other entities to facilitate wholesale sales. FERC is encouraging all parties interested in transmission access to form RTGs to facilitate access to and development of transmission service and to assist in settling disputes regarding such matters. RTGs will not relieve FERC of its responsibilities related to transmission access; however, such organizations could provide for more efficient handling of transmission service requests and planning for regional transmission needs. The Company is currently involved in the development of two RTGs in the West, SWRTA and WRTA. WRTA and SWRTA both filed applications for approval with the FERC during 1994 which have yet to be accepted. The Company currently intends to become a member of SWRTA and is also considering membership in WRTA.\nOn the retail level, industrial and large commercial customers may have the ability to own and operate facilities to generate their own electric energy requirements and, if such facilities are qualifying facilities, to require the displaced electric utility to purchase the output of such facilities at \"avoided costs\" pursuant to PURPA. Such facilities may be operated by the customers themselves or by other entities engaged for such purpose.\nFinally, the legislatures and\/or the regulatory commissions in several states have considered or are considering \"retail wheeling\" which, in general terms, means the transmission by an electric utility of energy produced by another entity over its transmission and distribution system to a retail customer in such utility's service territory. A requirement to transmit directly to retail customers could have the result of permitting retail customers to purchase electric capacity and energy from, at the election of such customers, the electric utility in whose service area they are located or from other electric utilities or independent power producers.\nIn Arizona, the ACC Staff issued its first report on a retail electric competition workshop held in October of 1994. This report is the first in a series of reports that will be issued on various workshops that will be held from time to time to identify and address policy issues related to competition. While other states are considering competition proposals, the ACC effort is designed to obtain information about competition. No specific proposals are currently being considered. The report proposes that Staff develop a comprehensive set of options to better inform the ACC about its choices. Staff recommended that three options be considered: 1) encouraging retail competition, 2) tolerating limited retail competition, and 3) discouraging retail competition by prohibiting retail wheeling and tolerating distributed energy services. The ACC has also established a working group on retail electric competition. Membership in the working group includes ACC Staff, Arizona utilities, and other interested parties, and the first meeting of the group took place in January 1995. A report from the group is expected by August 1995. The Company cannot predict what the working group will recommend and what, if any, changes in electric regulation and competition will be implemented by the ACC.\nSee Peak Demand and Customers above for information concerning mining customers which have considered self-generation and Generating and Other Resources and Other Purchases and Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. - PROPERTIES\nThe Company's transmission facilities are located within the states of Arizona and New Mexico. The primary purpose of the Company's transmission facilities is to transmit electricity from the Company's remote electric generating stations at Four Corners, Navajo, San Juan and Springerville to the Tucson area for use by the Company's retail customers. The transmission system is directly interconnected with systems operated by the following utilities:\nUtility Location\nArizona Public Service Co. Arizona Arizona Electric Power Cooperative Arizona El Paso Electric Co. New Mexico, Texas Public Service Co. of New Mexico New Mexico Salt River Project Arizona\nThe Company has arrangements with approximately 74 companies, including the five listed above, which are utilized to interchange capacity and energy.\nAs of December 31, 1994, the Company owned or participated in an overhead electric transmission and distribution system consisting of 511 circuit-miles of 500 kV lines, 1,122 circuit-miles of 345 kV lines, 335 circuit-miles of 138 kV lines, 454 circuit-miles of 46 kV lines and 8,947 circuit-miles of lower voltage primary lines. The underground electric distribution system was comprised of 4,223 cable-miles. Approximately 25% of the poles upon which the lower voltage lines are located are not owned by the Company. Electric substation capacity associated with the above-described electric system consisted of 165 substations with a total installed transformer capacity of 5,209,355 kVA.\nThe electric generating stations (except as noted below), the Company's general office building, operating headquarters and the warehouse and service center are located on land owned by the Company in fee. The electric distribution and transmission facilities owned by the Company are located (1) on property owned in fee by the Company, (2) under or over streets, alleys, highways and other public places, the public domain and national forests and state lands under franchises, easements or other rights which, with some exceptions, are subject to termination, (3) under or over private property by virtue of easements obtained for the most part from the record holder of title, and (4) under Indian reservations under grant of easement by the Secretary of Interior or lease by Indian tribes. In most instances, no examination has been made by counsel for the Company as to the title to easements of the Company from the record holder or to the property over which the easement has been granted, or as to possible liens, encumbrances, reservations or restrictions thereon. Therefore, some of the easements and the property over which the easements have been secured may be subject to title defects and encumbered by, or subject to, mortgages and liens existing at the time the easements were acquired.\nMost of the land parcels comprising Springerville are held by the Company under a long-term surface ownership agreement with the State of Arizona. The Company's 50% interest in the common facilities of Springerville and its 100% interest in Irvington Unit 4 and related common facilities were sold and are leased back by the Company. The coal-handling facilities at Springerville were sold and leased back by Valencia. The Company leases Springerville Unit 1 and the remaining 50% interest in the common facilities at Springerville.\nFour Corners and Navajo are located on properties held under easements from the United States and under leases from the Navajo Indian Tribe. The Company, individually and in conjunction with PNM in connection with San Juan, has acquired easements and leases for transmission lines and a water diversion facility located on the Navajo Indian Reservation. The Company has also acquired easements for transmission facilities, related to San Juan and Navajo, across the Zuni, Navajo and Tohono O'odham Indian Reservations.\nThe Company's rights under the various easements and leases described under this heading may be subject to possible defects (including conflicting grants or encumbrances not ascertainable because of absence of or inadequacies in the recording laws or the record systems of the Bureau of Indian Affairs and the Indian tribes, the possible inability of the Company to resort to legal process to enforce its rights against certain possible adverse claimants and the Indian tribes without Congressional consent, the possible failure or inability of the Indian tribes to protect the Company's interests in, and use and occupancy of, these facilities from interference or interruption, and, in the case of the leases, possible impairment or termination under certain circumstances by Congress, the Secretary of the Interior or certain possible adverse claimants). However, these possible defects have not and are not expected to materially interfere with the Company's interest in and operation of its facilities.\nWith the exception of Springerville Unit 2, substantially all of the utility assets of the Company are subject to the lien of the General First Mortgage and the General Second Mortgage. Legal title to Springerville Unit 2, which is not subject to such lien, is held by San Carlos. Springerville Unit 2 is subject to the Unit 2 First Mortgage.\nThe Company provided to certain banks, at the time of the Closing, the Unit 2 First Mortgage, a first mortgage lien on and security interest in Springerville Unit 2, and $50 million in principal amount of collateral bonds issued under the General Second Mortgage, a second mortgage, junior to the lien of the General First Mortgage, on all the utility assets (other than excepted property).\nITEM 3.","section_3":"ITEM 3. - LEGAL PROCEEDINGS\nSDGE\/FERC PROCEEDINGS\nSee SDGE\/FERC Proceedings in Note 7 of Notes to Consolidated Financial Statements.\nWATER RIGHTS ADJUDICATION\nOn March 13, 1975, the State of New Mexico filed an action entitled State of New Mexico v. United States, et al., in the District Court of San Juan County, New Mexico, to adjudicate all water rights in the San Juan River Stream System. The action is expected to adjudicate certain water rights applicable to the water supply for San Juan and Four Corners. The Company was made a party to this action in June 1976 and an answer was filed on behalf of the Company and others in May 1978. For the past several years, the State of New Mexico Engineer's Office has reportedly been completing reports on hydrographic surveys performed in conjunction with the litigation. It is anticipated that once those reports are completed, offers of judgment will be issued to the Company and other parties. The Company is unable to predict the effect, if any, of any adjudication on its present arrangements for a water supply to these stations. However, pursuant to an agreement reached in 1985, the Navajo Tribe will provide sufficient water to Four Corners from its own allocation to offset any portion of the water rights affected by this proceeding.\nTAX ASSESSMENTS\nSee Tax Assessments in Note 7 of Notes to Consolidated Financial Statements.\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\nThe following table sets forth, for the periods indicated, the high and low sale prices of the Company's Common Stock on the consolidated tape as reported by The Wall Street Journal. No dividends were paid on Common Stock during such periods.\nMarket Price per Quarter Share of Common Stock\nHigh Low\nFirst $4.13 $3.38 Second 3.88 2.88 Third 3.75 2.88 Fourth 3.88 3.00\nFirst $3.75 $1.88 Second 4.50 2.75 Third 4.63 3.63 Fourth 4.38 3.25\nThe closing price of the Common Stock on March 6, 1995 was $3.375.\nThe Common Stock is traded on the New York Stock Exchange and the Pacific Stock Exchange. At March 6, 1995, there were 39,199 shareholders of record of the Common Stock.\nSee Item 7., Management's Discussion and Analysis of Financial Condition and Results of Operations, Dividends on Common Stock.\nITEM 6.","section_6":"ITEM 6. - SELECTED CONSOLIDATED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following contains information regarding the Company's continuing and discontinued operations during 1994 compared with 1993 and 1993 compared with 1992 and changes in liquidity and capital resources of the Company during 1994. Also, management's expectations of identifiable material trends are discussed herein.\nOVERVIEW\nIn December 1992, the Company consummated a comprehensive Financial Restructuring of obligations to certain creditors and reclassified its preferred stock into common stock. The Financial Restructuring was concluded following nearly two years of negotiations with various creditors including, but not limited to, bank lenders and lease participants. The Company initiated the Financial Restructuring because it projected that it might have insufficient liquidity to meet its cash obligations by the end of the first quarter of 1991. A payment moratorium on certain of the Company's debt, lease, coal and rail obligations during part of the period of negotiations provided cash flow sufficient to meet the Company's other obligations.\nThe Company believes that the Financial Restructuring provides the Company the opportunity to return gradually to long-term financial viability. However, the Financial Restructuring itself is not sufficient to assure the Company's long-term financial viability.\nThe Company's capital structure remains highly leveraged and the Company's financial prospects and cash flows remain subject to significant economic, regulatory and other uncertainties, some which are beyond the Company's control. These uncertainties include the degree of utilization of capacity through either retail electric service or wholesale sales and the extent to which the Company can alter operations and reduce costs in response to unanticipated economic downturns or industry changes due to continued high financial and operating leverage. The Company's ability to recover the costs of serving retail customers is dependent upon pricing of the Company's services, which requires ACC approval, and the level of sales to such customers. The Company anticipates continued growth in sales over the next five years primarily as a result of anticipated population and economic growth in the Tucson area. However, a number of factors such as changes in economic conditions and the increasingly competitive electric markets, could affect the Company's levels of sales.\nIncreased revenues, including increases for the recovery of plant and operating costs associated with the remaining 37.5% of Springerville Unit 2, which is not currently included in rate base, may be required in order for the Company to maintain its existing level of liquidity over the longer term as obligations become due. See Item 1., Business, Rates and Regulation, 1994 Rate Order. Also, see Notes 2 and 7 of Notes to Consolidated Financial Statements, 1994 Rate Order and Commitments and Contingencies, respectively. The level of cash flow from wholesale sales is affected generally by factors affecting the market for such sales, including the availability of capacity and energy in the western United States with pricing and procurement processes influenced by the ongoing review of bulk power markets by FERC and the various state public utility commissions. In addition, because the Company has a significant amount of variable rate debt, the Company's future cash flows are also affected by the level of interest rates. See Liquidity and Capital Resources, Cash Flows below.\nIf the Company is unable to make sales at prices adequate to recover its costs or if for other reasons the Company fails to maintain or improve its cash flows, the Company's ability to meet its obligations may be jeopardized. The Company has approximately $1.1 billion of long-term debt maturing, including approximately $774 million in reimbursement agreements relating to letters of credit which expire, during the 1997-2001 period. See Consolidated Statements of Capitalization and Note 6 of Notes to Consolidated Financial Statements. The Company intends to pay or refinance maturing bonds and bank loans and to replace or extend such reimbursement agreements. There can be no assurance, however, that the Company will be able to pay such debt or replace or extend such reimbursement agreements.\nIn addition, the Company's ability to raise capital (through either public or private financings) is limited. The Company's ability to obtain debt financing will be limited by reason of limited free cash flow available to meet additional interest expense and due to the restrictive covenants contained in its obligations to creditors. Further, if the Company is required to refinance its debt obligations in order to repay them when due, such refinancing may be made on terms which are adverse to the Company. Access to equity capital may be limited because of the Company's likely limited future profitability and its inability to pay dividends for the foreseeable future. See Dividends below.\nDuring the next twelve months, the Company does not expect any need to obtain new debt financing to fund continuing operating activities and construction expenditures. The Company instead will rely on internal cash flows, existing cash balances and, if necessary, borrowings under the Renewable Term Loan and\/or a revolving credit line provided under the MRA. The Company's cash balance, excluding the cash of the investment subsidiaries, but including cash equivalents, at December 31, 1994, was approximately $233 million. Cash balances are invested in investment grade, money-market securities with an emphasis on preserving the principal amount invested.\nIn 1993 and 1992, the Company's results from continuing operations were affected by certain unusual and infrequent adjustments and accruals. The table below shows the Company's income or losses from continuing operations and income\/loss from continuing operations per average share of Common Stock had such unusual and infrequent adjustments and accruals not been recorded.\nDecember 31, 1994 1993 1992 - Thousands of Dollars -\nIncome (Loss) From Continuing Operations $20,740 $(21,816) $(79,022) ------- -------- -------- Regulatory Disallowances and Adjustments-Net - 13,177 - Financial Restructuring Costs - 1,498 29,511 Loss on Financial Restructuring - - 26,669 SCECorp\/SCE Litigation Settlement - - (40,000) ------- -------- -------- Total Adjustments to Income (Loss) From Continuing Operations - 14,675 16,180 ------- -------- -------- Adjusted Income (Loss) From Continuing Operations $20,740 $ (7,141) $(62,842) ======= ======== ========\nAdjusted Income (Loss) From Continuing Operations Per Average Share of Common Stock $0.13 $(0.04) $(1.97) ===== ====== ======\nPROPOSED HOLDING COMPANY\nThe Company intends to establish in early 1996 a new corporate structure in which the Company will be a subsidiary of a new holding company, UniSource Energy Corporation (UniSource). The Company proposes to establish a holding company structure because the Company believes that it is in the best interests of its shareholders for the Company to participate in various segments of the evolving and expanding electric energy business. The Company believes that such participation would be enhanced by the holding company structure, a commonly used structure in the electric and other industries, to conduct different lines of business.\nApproval of a holding company structure will require the affirmative vote of holders of shares of common stock representing not less than a majority of all votes entitled to be cast by all holders of shares of common stock. In addition to shareholder approval, consummation of the holding company plan is predicated upon receiving approval from the ACC and FERC. The Company will also seek a \"no action\" position from the Staff of the SEC under the Public Utility Holding Company Act of 1935, as amended, or, in the alternative, will seek approval of the SEC under such Act. The Company is in the process of obtaining such approvals.\nIf approved by the requisite vote of the Company shareholders and if required regulatory approvals are satisfactorily obtained, the outstanding shares of the Company common stock would be exchanged, on a share-for-share basis, for shares of UniSource. As a result, the holders of the Company common stock will become the owners of UniSource common stock, and UniSource will become the owner of the Company common stock.\nDuring the second quarter of 1995, the Company intends to provide a proxy statement-prospectus to all shareholders which will set forth in detail the holding company structure, the plan of the share exchange and a shareholder meeting date. Accompanying the proxy statement-prospectus will be a form of proxy solicited on behalf of the Board of Directors of the Company.\nRESULTS OF OPERATIONS\nRESULTS OF UTILITY OPERATIONS\nSALES AND REVENUES\nRevenues from sales to retail customers increased 9.0% in 1994 compared with 1993 and 2.1% in 1993 compared with 1992. The table below identifies the components of the increases in 1994 and 1993.\n1994 1993 - Millions of Dollars -\nPrice Change $17 $(3) Consumption Change 15 3 Customer Growth 15 12 --- --- Increase in Retail Revenues $47 $12 === ===\nThe revenue increase in 1994 resulted from greater kWh sales due to continued growth in the average number of retail customers, increase in usage due to warmer than normal temperatures, and increased prices as a result of the 1994 Rate Order. There were 289,697 electric customers on average during 1994, an increase of 2.9% over 1993. Based on billed cooling degree days, a commonly used measure in the electric industry, that are calculated by subtracting 75 degrees from the daily average of the high and low temperatures, the Tucson area registered a 26% increase in such cooling degree days in 1994 over 1993, and a 33% increase in such cooling degree days in 1994 over the 10 year average from 1984 to 1993. The 1993 revenue decrease due to change in price, shown in the table above, resulted from lower rates charged under a renegotiated contract with one of the Company's mining customers.\nAmortization of the MSR Option Gain Regulatory Liability increased in 1994 compared with 1993 as a result of the 1991 Rate Order which set the non-cash operating revenue for the amortization of the regulatory liability for the MSR option gain at $6 million for 1992 and 1993, $20 million in 1994, 1995 and 1996, and $8 million in 1997 at which point the MSR Option Gain will be fully amortized. See Note 1 of Notes to Consolidated Financial Statements, Nature of Operations and Summary of Significant Accounting Policies.\nIn 1994, revenues from Other Utilities increased 7.2% over 1993 as a result of a 13% increase in revenues from firm sales of energy, offset by a 4% decrease in revenues from economy sales. Revenues from Other Utilities increased 33% in 1993 compared with 1992 primarily due to a 56% increase in revenues from firm sales of energy and a 12% increase in the average revenue per kWh sold on a non- firm basis. In 1994, firm sales accounted for 37% of sales to Other Utilities and 58% of revenues from Other Utilities. In 1993, firm sales accounted for 33% of sales to Other Utilities and 56% of revenues from Other Utilities. The Company's ability to market available capacity and energy in the future, at levels comparable with 1994, may be limited due to lower prevailing prices and other market conditions.\nOPERATING EXPENSES\nAs a result of the Financial Restructuring, the Company's Irvington Lease, Valencia Leases and the Springerville Common Facilities Leases were reclassified from operating leases to capital lease obligations. The effect of this reclassification significantly increased recorded assets and liabilities relating to these leases and resulted in the reallocations of the lease expenses relating to the Irvington and Springerville Common Facilities Leases from Other Operations expense to Capital Lease Expense. The Valencia Leases expense continues to be expensed as a component of Fuel expense. In addition, as part of the Financial Restructuring, the Company became the direct lessee under the Springerville Unit 1 Leases which is also stated as a capital lease obligation. The assumption of the Springerville Unit 1 Leases and the termination of the Restated Century Purchase Contract increased assets and liabilities relating to capital leases and, for periods subsequent to the Financial Restructuring, result in the recognition of certain expenses, which were previously included in Purchased Power-Demand expense, as Capital Lease Expense and various other operating expenses.\nFuel expenses increased 6.4% in 1994 over 1993 as a result of the fourth quarter 1994 reallocation of a reserve for sales tax disputes from Taxes Other than Income Taxes. See Note 7 of Notes to Consolidated Financial Statements, Commitments and Contingencies, Tax Assessments. Aggregate fuel expense increased 48.6% in 1993 compared with 1992 due to greater generation to accommodate increased sales to Other Utilities and Retail Customers and fuel expenses from Springerville Unit 1, which were previously accounted for as Purchased Power-Energy. Average cost per kWh of fuel and its transportation only were 1.79 cents in 1994 and 1.76 cents in 1993. Following the Financial Restructuring, the Company no longer makes purchases under the Restated Century Purchase Contract, which was terminated, but purchases fuel directly from Valencia. Increased generation requirements were met primarily through increased generation at Springerville Unit 1.\nPurchased Power-Energy increased in 1994 over 1993 as a result of greater kWh requirements to provide for increased sales. Purchased Power-Energy expense decreased in 1993 compared with 1992 as a result of the termination of the Restated Century Purchase Contract and the change in the status of Springerville Unit 1 described above.\nPurchased Power-Demand expense decreased in 1993 compared with 1992 due to the termination of the Restated Century Purchase Contract.\nThe increase in Capital Lease Expense in 1993 compared with 1992 reflects the reclassification of the Irvington Lease and Springerville Common Facilities Leases to capital lease obligations and the assumption of the Springerville Unit 1 Leases.\nAmortization of Springerville Unit 1 Allowance, a non-cash item, decreased in 1994 compared with 1993 due to lower projected operation and maintenance expenses included in the calculation of the Springerville Unit 1 Allowance. The Springerville Unit 1 Allowance was originally calculated by projecting the yearly costs associated with Springerville Unit 1 over the remaining life of the Springerville Unit 1 Leases and taking the present value of the difference between such costs and the ACC allowed level of recovery. Such costs are then recognized in each period along with a corresponding interest accrual and amortization of the allowance as a credit to operating expenses. The interest accrual is included in the Consolidated Statements of Income (Loss) as Regulatory Interest. Amortization of Springerville Unit 1 Allowance, a non- cash credit originally resulting from the write-off of the portion of Springerville Unit 1 demand charges under the Restated Century Purchase Contract in excess of the $15 per kW per month allowed by the ACC, increased in 1993 compared with 1992 due to increased Springerville Unit 1 Leases expense. As a result of the assumption of the Springerville Unit 1 Leases, the Company's levelized amortization of lease expenses is based on rents over the full primary term of the leases rather than through 2001, the date utilized when the rents were paid by Century and passed through under the Restated Century Purchase Contract. See Note 1 of Notes to Consolidated Financial Statements, Nature of Operations and Summary of Significant Accounting Policies.\nOther Operations expense increased in 1994 compared with 1993 as a result of the accrual of increased employee expenses related to compensation and pension benefits. Other Operations expense decreased in 1993 compared with 1992 primarily due to the reclassification of the Irvington Lease and the Springerville Common Facilities Leases expenses to Capital Lease Expense.\nMaintenance and Repairs expense was higher in 1993 compared with 1992 because of the change in the status of Springerville Unit 1 described above.\nDepreciation and Amortization increased in 1994 over 1993 as a result of the amortization of 62.5% of the Springerville Unit 2 rate synchronization deferral costs over 3 years (beginning in January 1994) pursuant to the 1994 Rate Order. Depreciation expense increased in 1993 compared with 1992 primarily reflecting various additions to plant and equipment and a one-time adjustment decreasing depreciation expense mandated by FERC which was recorded in the second quarter of 1992.\nTaxes Other than Income Taxes decreased in 1994 compared with 1993 as a result of the fourth quarter 1994 reallocation of a reserve for sales tax disputes to Fuel. See Note 7 of Notes to Consolidated Financial Statements, Commitments and Contingencies, Tax Assessments. The increase in Taxes Other than Income Taxes in 1993 compared with 1992 reflects that property tax expense related to the Company's assumption of the Springerville Unit 1 Leases, which expense previously had been part of demand charges paid under the Restated Century Purchase Contract and included in Purchased Power-Demand is currently recorded as Taxes Other than Income Taxes.\nFinancial Restructuring costs decreased in 1993 compared with 1992 as a result of the completion of the Financial Restructuring in December 1992.\nOTHER INCOME (DEDUCTIONS)\nRegulatory Disallowances and Adjustments in 1993 reflect primarily the write-off of Springerville Unit 2 deferred expenses mandated by the 1994 Rate Order.\nDeferred Springerville Unit 2 Carrying Costs decreased in 1994 compared with 1993 as a result of the incorporation into rate base of 62.5% of Springerville Unit 2.\nThe Loss on Financial Restructuring in 1992 was based on, among other things, the excess of the fair value of the Common Stock and Warrants issued, at values of $2.33 per share and $0.82 per warrant, respectively, compared to the amount of plant, materials and supplies inventories received by the Company from Century and accrued rent under the Springerville Unit 1 Leases, reflected on the Company's financial statements as of December 15, 1992 as demand charges payable to Century. In addition, the Company reversed a reserve of approximately $9 million due to the dismissal of related regulatory matters as a part of the Financial Restructuring. The restructuring of Bank obligations gave rise to a deferred gain of $21 million, which is being amortized as a reduction of interest expense over an eight-year period. See Note 3 of Notes to Consolidated Financial Statements, 1992 Consummation of the Financial Restructuring.\nLitigation Settlement income in 1993 decreased compared with 1992 due to the settlement of litigation against SCE in the third quarter of 1992. See Item 1., Business, SCE\/TEP Power Exchange Agreement.\nOther Income increased in 1994 compared with 1993 due to greater interest earned on cash and cash equivalents. Other Income decreased in 1993 compared with 1992 due to the collection in 1992 of approximately $8 million in interest income on a Federal income tax refund.\nINTEREST EXPENSE\nInterest expense on Long-Term Debt-Net increased in 1994 compared with 1993 as a result of slightly higher interest rates. Interest expense on Long-Term Debt-Net decreased in 1993 compared with 1992 due to the prepayment of $68 million of long-term debt combined with significantly lower interest rates on the Company's obligations in the first quarter of 1993 compared with interest rates during the same period of 1992. The lower rates reflect primarily the elimination of default rates on such obligations in 1993 as a result of the Financial Restructuring (discussed below), and in part, lower market rates. The effect of lower rates was partly offset by the reclassification of previously outstanding short-term debt into the Term Loan which is classified as Long-Term Debt.\nIn the first quarter of 1992, the Payment Moratorium was in effect on most obligations of the Company. Therefore, the Company accrued interest on such obligations at default rates, which were substantially higher than market rates. Interest at default rates was accrued on approximately $900 million of bank credit obligations including approximately $650 million of reimbursement obligations related to LOCs that provide credit support for variable-rate tax- exempt bond issues. The irrevocable LOCs were fully drawn through the first quarter of 1992. In March 1992, such issues were remarketed and the proceeds were used to pay reimbursement obligations for the drawn LOCs and interest was no longer accrued at default rates.\nThere was no interest expense on Short-Term Debt in 1994 and 1993 as a result of the reclassification of previously outstanding short-term debt into the Term Loan which is classified as Long-Term Debt.\nInterest Expense - Other decreased in 1994 compared with 1993 due to an accrual in 1993 for interest on contested tax payments and litigation settlement. Interest Expense - Other increased in 1993 compared with 1992 primarily due to the reinstatement of LOC fees and remarketing fees related to the remarketing of the tax exempt bonds supported by the LOCs. LOC fees and remarketing fees were not paid for part of 1992 because the LOCs were drawn and the IDBs were held by the banks.\nRESULTS OF DISCONTINUED OPERATIONS\nSee Note 5 of Notes to Consolidated Financial Statements.\nACCOUNTING FOR THE EFFECTS OF REGULATION\nThe Company prepares its financial statements in accordance with the provisions of FAS 71. This statement requires a cost-based rate-regulated utility to reflect the effect of regulatory decisions in its financial statements. In certain circumstances, FAS 71 requires that certain costs and\/or obligations be reflected in a deferral account in the balance sheet and not be reflected in the statement of income or loss until matching revenues are recognized. Therefore, the Company's Consolidated Balance Sheets at December 31, 1994 and 1993 contain certain line items solely as a result of the application of FAS 71. In addition, a number of line items in the Company's Consolidated Statements of Income (Loss) for the years ended December 31, 1994, 1993 and 1992 also reflect the application of FAS 71. See Note 1 of Notes to Consolidated Financial Statements, Nature of Operations and Summary of Significant Accounting Policies, Accounting for the Effects of Regulation.\nIf, at some point in the future, the Company determines that all or a portion of the Company's regulated operations no longer meet the criteria for continued application of FAS 71, the Company would be required to adopt the provisions of FAS 101 for that portion of the operations for which FAS 71 no longer applied. Adoption of FAS 101 would require the Company to write off its regulatory assets and liabilities as of the date of adoption of FAS 101 and would preclude the future deferral in the balance sheet of costs not recovered through rates at the time such costs were incurred, even if such costs were expected to be recovered in the future. Based on the balances of the Company's regulatory assets and liabilities as of December 31, 1994, the Company estimates that future adoption of FAS 101 for all of the Company's regulated operations would result in an extraordinary loss of $142 million, which includes a reduction for the related deferred income taxes. The Company's cash flows would not be affected by the adoption of FAS 101.\nDIVIDENDS\nThe Company does not expect to be able to pay cash dividends on its Common Stock for the foreseeable future. The Company is currently precluded by State statute and restrictive covenants in certain debt agreements from declaring or paying dividends. No dividends on Common Stock have been declared or paid since 1989.\nUnder current applicable provisions of the Arizona General Corporation Law, the Company is permitted to declare and pay dividends on its shares in cash, property, or its own shares, only out of unreserved and unrestricted earned surplus or out of the unreserved and unrestricted net earnings of the current fiscal year and the immediately preceding fiscal year taken as a single period, except that the Company may not declare or pay dividends when the Company is insolvent (unable to pay its debts as they become due in the ordinary course of business) or when the payment of the dividend would render the Company insolvent, or when the declaration or payment of the dividend would be contrary to any restriction contained in the Articles.\nAt December 31, 1994, the Company had no earned surplus (its accumulated deficit on that date was $681 million), and the Company had no net earnings for the two fiscal years then ended taken together. Also, the Company expects to have no earned surplus and limited net earnings and cash flow for several years.\nUnder applicable provisions of amendments to the Arizona General Corporation Law, which will be effective in 1996, a company will be permitted to make distributions to shareholders unless, after giving effect to such distribution, either (i) the company would not be able to pay its debts as they come due in the usual course of business, or (ii) the company's total assets would be less than the sum of its total liabilities plus the amount necessary to satisfy any liquidation preferences of shareholders with preferential rights. As of December 31, 1994, the Company's common stock deficit was $42 million.\nAlthough the Company expects to meet the requirements under the amended corporation law for making distributions to shareholders within several years, restrictive covenants in certain existing debt agreements may continue to preclude the Company from declaring or paying dividends.\nThe General First Mortgage contains covenants, applicable so long as certain series of First Mortgage Bonds (aggregating $194 million in principal amount) are outstanding, which restrict the payment of dividends on Common Stock if certain cash flow coverage and retained earnings tests are not met. The retained earnings test will prevent the Company from paying dividends on its Common Stock until such time as the Company has positive retained earnings rather than an accumulated deficit. Such covenants will remain in effect until the First Mortgage Bonds of such series have been paid or redeemed. The latest maturity of such First Mortgage Bonds is in 2003. The MRA includes a similar dividend restriction based on retained earnings.\nLIQUIDITY AND CAPITAL RESOURCES\nCASH FLOWS\nThe Company's cash and cash equivalents, including such amounts held by the Company's investment subsidiaries, increased $86 million or 53%, over the 1993 year end balance of $162 million, to the 1994 year end balance of $248 million.\nReceipts from retail customers increased $55 million over 1993 reflecting the sales and customers growth discussed above. Cash expenditures for continuing operating activities increased, in aggregate, $10 million, due primarily to increased sales levels. As a result, Net Cash Flow - Continuing Operating Activities increased 61% to $144 million for 1994.\nConstruction expenditures, primarily for expansion and reinforcement of the Company's transmission and distribution systems, increased $14 million over 1993 levels. In addition, the Company continued reducing its debt and lease obligations by retiring $37 million of such obligations in 1994.\nDuring 1995, the Company expects to generate sufficient internal cash flows to fund its continuing operating activities and construction expenditures provided short-term interest rates remain near current levels and revenues from wholesale sales are similar to last year. An increase in short-term interest rates of 100 basis points (1%) would result in an approximate $10 million increase in interest expense. If 1994 cash flows fall short of expectations, the Company would expect to use its cash balances or its Renewable Term Loan and\/or a revolving credit line provided under the MRA to meet operating and capital requirements.\nThe Company's cash balance including cash equivalents at March 7, 1995 was approximately $185 million (including the cash and cash equivalents of the investment subsidiaries). Cash balances are invested in investment grade, money-market securities with an emphasis on preserving the principal amounts invested.\nFINANCING DEVELOPMENTS\nOn December 30, 1994, the Company purchased and cancelled $17.25 million principal amount of its First Mortgage Bonds 12.22% Series due June 1, 2000. The payment was made to fulfill the Company's requirement under the MRA to utilize Extraordinary Cash to reduce outstanding indebtedness. The Extraordinary Cash was generated from cash dividends paid to the Company by the investment subsidiaries. See Restrictive Covenants, Prepayments.\nOn March 7, 1995, the Company and its banks completed the Sixth Amendment to the MRA which eased certain debt prepayment restrictions and modified the Term Loan to allow reborrowing of amounts which will have been previously prepaid (Renewable Term Loan). The amendment will allow the Company to better manage its cash position and reduce capital costs while maintaining liquidity.\nPrior to the amendment the Company was not permitted to prepay non-MRA debt except to the extent that Excess Cash and Extraordinary Cash were generated, see Restrictive Covenants, Prepayments below for the description of such terms. The amendment, now in effect, renders the Excess Cash and Extraordinary Cash provisions inapplicable and allows the Company to optionally prepay outstanding debt of the Company provided certain conditions are met. Such conditions include that $1 of principal outstanding under the Renewable Term Loan is permanently prepaid, and the commitment therefore terminated, for every $2 used to permanently prepay other debt such as First Mortgage Bonds. The Renewable Term Loan allows the Company to reborrow amounts paid down to the extent of the remaining outstanding loan commitment. The commitment fee on the Renewable Term Loan will be 0.5% of the unused portion of such commitment.\nAs a condition to the amendment becoming effective, the Company permanently prepaid $19.3 million of the Term Loan reducing the outstanding balance from $193.4 million to approximately $174 million. Thus, the initial commitment and outstanding balance of the Renewable Term Loan was approximately $174 million.\nSHORT-TERM CREDIT FACILITIES\nREVOLVING CREDIT\nThe Banks provided as part of the MRA a $50 million Revolving Credit for working capital purposes. The Revolving Credit has a termination and maturity date of December 31, 1999, and bears interest at a variable rate based upon, at the option of the Company, either (i) prime rate or (ii) an adjusted eurodollar rate plus a percentage ranging from 0.75% during 1994, gradually increasing to 2% by 1998 and thereafter. The Company is required to repay loans under the Revolving Credit in full for at least 30 consecutive days in each twelve-month period prior to November 30 of each year. The annual commitment fee for the Revolving Credit equals 0.5% of the unused portion. The Revolving Credit is secured and contains restrictive covenants. See Restrictive Covenants below.\nAs of December 31, 1994 the Company had not borrowed any funds under the $50 million Revolving Credit.\nOTHER\nThe balances of $12 million, $12 million and $18 million of short-term debt of the investment subsidiaries as of December 31, 1994, 1993 and 1992, respectively, were associated with wholly-owned subsidiaries indirectly owned by SRI and, therefore, such debt is reflected in net assets of discontinued operations. Such debt is without recourse to SRI or the Company. Approximately $220 million of utility and utility-related short-term debt was restructured upon the Closing and reclassified as long-term debt.\nRESTRICTIVE COVENANTS\nGENERAL FIRST MORTGAGE COVENANTS\nThe Company's General First Mortgage places limits on the amount of additional First Mortgage Bonds which can be issued. Under the General First Mortgage, the Company may issue additional First Mortgage Bonds (a) to the extent of 60% of net additions to utility property if net earnings, as defined therein, for a specified period of 12 consecutive calendar months out of the 15 calendar months preceding the date of issuance are at least two (2.0) times the annual interest requirements on all First Mortgage Bonds to be outstanding and (b) to the extent of the principal amount of retired bonds. The net earnings test specified in clause (a) above generally need not be satisfied prior to the issuance of bonds in accordance with clause (b) above unless (x) (i) the new bonds are issued within one year after the issuance of, or more than two years prior to the stated maturity of, the retired bonds and (ii) the new bonds bear a greater rate of interest than the retired bonds or (y) the new bonds are issued in respect of retired bonds the interest charges on which have been excluded from any net earnings certificate filed with the indenture trustee since the retirement of such bonds. At December 31, 1994, the Company had the ability to issue approximately $152 million of new First Mortgage Bonds on the basis of property additions, as described above, and, in addition, the Company had the ability to issue approximately $74 million of new First Mortgage Bonds on the basis of retired bonds. However, issuance of such amounts may be limited by MRA covenants. See Additional Restrictive Covenants below.\nSee Dividends above for discussion of restrictions on the payment of Common Stock dividends under the General First Mortgage.\nGENERAL SECOND MORTGAGE COVENANTS\nThe General Second Mortgage establishes a second mortgage lien on and security interest in substantially all of the utility assets of the Company, subordinate only to the first mortgage lien and security interest. At December 31, 1994, $50 million of such General Second Mortgage bonds had been issued and provided to the Banks as collateral for the Revolving Credit and, subsequent to January 2, 1997, subject to certain conditions, the Renewable Term Loan and the Replacement Reimbursement Agreement.\nThe Company's General Second Mortgage allows the issuance of additional Second Mortgage Bonds under certain circumstances. The Company may issue additional Second Mortgage Bonds (a) to the extent of 70% of net additions to utility property if net earnings as defined therein, for a specified period of 12 consecutive calendar months within the 16 calendar months preceding the date of issuance are at least one and three-quarter (1-3\/4) times the annual interest requirements on all First Mortgage Bonds and Second Mortgage Bonds to be outstanding and (b) to the extent of the principal amount of retired Second Mortgage Bonds and First Mortgage Bonds. Issuance of Second Mortgage Bonds on the basis of an amount of retired First Mortgage Bonds reduces by the same amount of First Mortgage Bonds which could be issued under the General First Mortgage on the basis of retired bonds. The net earnings test specified in clause (a) above generally need not be satisfied prior to the issuance of bonds in accordance with clause (b) above unless (x) (i) the new bonds are issued within one year after the issuance of, or more than two years prior to the stated maturity of, the retired bonds and (ii) the new bonds bear a greater rate of interest than the retired bonds or (y) the new bonds are issued in respect of retired bonds the interest charges on which have been excluded from any net earnings certificate filed with the indenture trustee since the retirement of such bonds. At December 31, 1994, the amount of net additions and retired bonds would permit (and the net earnings test would not prohibit) the issuance of $455 million aggregate principal amount of new Second Mortgage Bonds (at an assumed interest rate of 12% per annum). The issuance of such amount of Second Mortgage Bonds assumes that the $226 million of First Mortgage Bonds available to be issued at December 31, 1994 would be issued first at a rate of 11%. However, issuance of such amounts may be limited by MRA covenants. See Additional Restrictive Covenants below.\nPREPAYMENTS\nPrior to the Sixth Amendment to the MRA becoming effective on March 7, 1995, see Financing Developments above, certain prepayments of indebtedness were required. The required prepayment equaled the Company's adjusted operating income, as defined in the MRA, less certain capital expenditures and charges, for the preceding twelve-month period as of June 30 of each year; provided, however, that the prepayment amount (Excess Cash) was limited to the excess (if any) over $25 million of (i) the Company's cash balance, including cash equivalents, as of each June 30 plus (ii) the cumulative amount of all dividends, if any, paid on Common Stock from December 15, 1992 to such June 30. The Company was required to apply the Excess Cash to the prepayment of indebtedness. For the period ended June 30, 1994, the Company had $31 million which constituted Excess Cash. The Company had no such Excess Cash for the period ended June 30, 1993.\nThe Company was also required to apply other funds as defined in the MRA (Extraordinary Cash) to the prepayment of its indebtedness. Extraordinary Cash included the net proceeds from the issuance of equity and certain debt securities of the Company or any subsidiary; provided, however, that upon prepayment of the Term Loan in a principal amount of $50 million, Extraordinary Cash did not include proceeds from the issuance of equity securities, and included only 50% of the proceeds from the issuance of debt securities. Extraordinary Cash also included all cash dividends received by the Company from its investment subsidiaries, TRI and SRI, or any subsidiary thereof. In 1993 and 1994, the Company received cash dividends of $6 million and $50 million, respectively, from TRI which constituted Extraordinary Cash.\nIn April 1993, the MRA lenders waived, to the extent of $68 million, as consideration for certain prepayments, the requirement that the Company use Excess Cash and Extraordinary Cash to prepay debt as described above. Therefore, no mandatory prepayments were made during 1993 as a result of such prepayment provisions and although $81 million of excess cash and extraordinary cash was generated in 1994 ($87 million for 1993 and 1994 combined), the Company was required to prepay only $19 million of indebtedness in 1994. See Financing Developments above.\nADDITIONAL RESTRICTIVE COVENANTS\nIn addition to the prepayment provisions described above, the MRA contains a number of restrictive covenants including, but not limited to, covenants limiting, with certain exceptions, (i) the incurrence of additional indebtedness, including lease obligations, or the prepayment of existing indebtedness, or the guarantee of any such indebtedness, (ii) the incurrence of liens, (iii) the sale of assets or the merger with or into any other entity, (iv) the declaration or payment of dividends on Common Stock or any other class of capital stock, (v) the making of capital expenditures beyond those contemplated in the Company's 1992 ten-year capital budget, and (vi) the Company's ability to enter into sale-leaseback arrangements, operating lease arrangements and coal and railroad arrangements. All of these restrictive covenants described above, other than (i), (iv) and (vi), will be in effect until at least December 1997. The covenants described in (i), (iv) and (vi) will cease to be binding on the Company when both the Renewable Term Loan and the Revolving Credit are paid in full and commitments thereunder terminate and the Company's senior long-term debt is rated at least investment grade. In addition, the Company is required pursuant to the MRA to maintain an interest coverage ratio of (a) operating cash flows plus interest paid to (b) interest paid, through the year 2003, ranging from 1.2 to 1 in 1994 and gradually increasing to 2 to 1 in 2000 continuing through the year 2003. For the year ended December 31, 1994, the Company's MRA interest coverage ratio was 2.98 to 1. With respect to dividends, the MRA incorporates, until the Renewable Term Loan and the Revolving Credit are paid in full and commitments thereunder terminate, a restrictive covenant similar to that currently in the General First Mortgage which limits the Company's ability to pay dividends on Common Stock until it has positive retained earnings (through future earnings or otherwise) rather than an accumulated deficit (such accumulated deficit was $681 million at December 31, 1994). The Company does not anticipate being able to satisfy the test of this and other dividend restrictions (see Dividends above) and therefore, does not anticipate being permitted to pay cash dividends on its Common Stock for the foreseeable future.\nCONSTRUCTION EXPENDITURES\nEstimated construction expenditures of the Company, including AFDC, for the five years 1995 through 1999, respectively, are $74 million, $67 million, $81 million, $85 million and $62 million. These amounts include the following: $190 million for transmission and distribution facilities in the Tucson area; $44 million for expenditures which are necessary to upgrade pollution control facilities at Navajo (see Item 1., Business, Environmental Matters, Navajo Generating Station); and $135 million for modifications to existing production facilities. These estimated construction expenditures include costs to comply with current federal and state environmental regulations. All of these estimates are subject to continuing review and adjustment. Actual construction expenditures may vary from these estimates due to factors such as changes in business conditions, construction schedules and environmental requirements. Due to the limitation on the Company's ability to issue debt or equity capital and to apply such proceeds, if any, to capital requirements, the Company must finance these construction expenditures with internally generated funds and\/or reductions of its cash and short-term investments. In the event that funds from such sources are unavailable, the Company would be unable to expend the amounts shown above.\nAlso, see Note 6 of Notes to Consolidated Financial Statements, Long and Short-Term Debt and Capital Lease Obligations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. - CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Item 14, page 57, for a list of the Consolidated Financial Statements which are included in the following pages. See Note 11 of Notes to Consolidated Financial Statements.\nINDEPENDENT AUDITORS' REPORT\nTUCSON ELECTRIC POWER COMPANY\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of Tucson Electric Power Company and subsidiaries (the Company) as of December 31, 1994 and 1993, and the related consolidated statements of income (loss), cash flows, and changes in stockholders' equity (deficit) for each of the three years in the period ended December 31, 1994. 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 consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 2 to the financial statements, the timing of the recovery of the costs associated with 37.5% of Springerville Unit 2 cannot presently be determined because the Company has not yet received rate relief for such costs.\nDELOITTE & TOUCHE LLP\nTucson, Arizona January 31, 1995 (March 7, 1995 as to Note 6)\nCONSOLIDATED STATEMENTS OF INCOME (LOSS) For the Years Ended December 31, 1994 1993 1992 - Thousands of Dollars - Operating Revenues Retail Customers $ 571,433 $ 524,813 $ 514,014 Amortization of MSR Option Gain Regulatory Liability 20,053 6,053 6,053 Other Utilities 99,987 93,273 70,026 ---------- ---------- ---------- Total Operating Revenues 691,473 624,139 590,093 ---------- ---------- ---------- Operating Expenses Fuel 209,889 197,323 132,775 Purchased Power - Energy 13,878 9,032 62,726 Purchased Power - Demand - - 88,288 Deferred Fuel and Purchased Power 7,359 10,716 7,030 Capital Lease Expense 93,056 92,844 19,854 Amortization of Springerville Unit 1 Allowance (26,204) (33,398) (31,228) Other Operations 100,948 90,880 95,218 Maintenance and Repairs 42,122 42,300 34,386 Depreciation and Amortization 89,905 74,184 69,445 Taxes Other than Income Taxes 46,118 54,814 48,632 Financial Restructuring Costs - 1,498 29,511 ---------- ---------- ---------- Total Operating Expenses 577,071 540,193 556,637 ---------- ---------- ---------- Operating Income 114,402 83,946 33,456 ---------- ---------- ---------- Other Income (Deductions) Regulatory Disallowances and Adjustments - (13,777) - Deferred Springerville Unit 2 Carrying Costs 1,133 5,359 4,143 Loss on Financial Restructuring - - (26,669) Litigation Settlement - - 27,576 Interest Income 7,556 3,909 4,568 Income Taxes 4,820 5,186 5,654 Other Income 489 805 7,744 ---------- ---------- ---------- Total Other Income (Deductions) 13,998 1,482 23,016 ---------- ---------- ---------- Interest Expense Long-Term Debt - Net 69,353 68,053 72,687 Regulatory Interest 32,280 31,303 29,781 Short-Term Debt - - 26,311 Other 7,118 8,604 7,770 Allowance for Borrowed Funds Used During Construction (1,091) (716) (1,055) ---------- ---------- ---------- Total Interest Expense 107,660 107,244 135,494 ---------- ---------- ---------- (continued on next page)\nCONSOLIDATED STATEMENTS OF INCOME (LOSS) (Continued) For the Years Ended December 31, 1994 1993 1992 - Thousands of Dollars -\nIncome (Loss) from Continuing Operations 20,740 (21,816) (79,022) Provision for Loss on Disposal of Discontinued Operations - (4,000) (44,047) ---------- ---------- ---------- Net Income (Loss) $ 20,740 $ (25,816) $(123,069) ========== ========== ========== Average Shares of Common Stock Outstanding (000) 160,724 160,544 31,872 ========== ========== ========== Net Income (Loss) per Average Share Continuing Operations $ 0.13 $ (0.14) $ (2.48) Discontinued Operations - (0.02) (1.38) ---------- ---------- ---------- Total Net Income (Loss) per Average Share $ 0.13 $ (0.16) $ (3.86) ========== ========== ==========\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED BALANCE SHEETS\nASSETS December 31, 1994 1993 - Thousands of Dollars -\nUtility Plant Plant in Service $2,053,123 $2,004,112 Utility Plant Under Capital Leases 893,064 894,508 Construction Work in Progress 40,870 33,568 ----------- ----------- Total Utility Plant 2,987,057 2,932,188 Less Accumulated Depreciation and Amortization (791,617) (727,101) Less Accumulated Amortization of Capital Leases (25,595) (12,634) Less Allowance for Springerville Unit 1 (162,423) (162,689) ----------- ----------- Total Utility Plant - Net 2,007,422 2,029,764 ----------- -----------\nInvestments Net Assets of Discontinued Operations 8,685 58,480 Other Investments 4,307 4,370 ----------- ----------- Total Investments 12,992 62,850 ----------- -----------\nCurrent Assets Cash and Cash Equivalents 233,300 139,817 Accounts Receivable 66,332 65,212 Materials and Fuel 36,109 36,312 Deferred Income Tax - Current 12,870 8,927 Other 10,719 10,538 ----------- ----------- Total Current Assets 359,330 260,806 ----------- -----------\nDeferred Debits - Regulatory Assets Income Taxes Recoverable Through Future Rates 143,372 149,508 Deferred Common Facility Costs 65,843 68,383 Deferred Springerville Unit 2 Costs 54,983 67,543 Deferred Lease Expense 25,228 32,602 Deferred Fuel and Purchased Power Expense 5,872 13,231 Other Deferred Regulatory Assets 9,362 8,165 Deferred Debits - Other 17,532 21,244 ----------- ----------- Total Deferred Debits 322,192 360,676 ----------- ----------- Total Assets $2,701,936 $2,714,096 =========== ===========\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED BALANCE SHEETS\nCAPITALIZATION AND OTHER LIABILITIES December 31, 1994 1993 - Thousands of Dollars - Capitalization Common Stock Equity (Deficit) $ (42,233) $ (62,973) Capital Lease Obligations 922,735 927,201 Long-Term Debt 1,381,935 1,416,352 ----------- ----------- Total Capitalization 2,262,437 2,280,580 ----------- -----------\nCurrent Liabilities Current Maturities of Long-Term Debt 17,167 2,203 Accounts Payable 39,777 40,190 Interest Accrued 59,480 65,738 Taxes Accrued 29,215 20,269 Accrued Employee Expenses 15,247 4,222 Current Obligations Under Capital Leases 12,803 14,825 Other 6,624 6,389 ----------- ----------- Total Current Liabilities 180,313 153,836 ----------- -----------\nDeferred Credits and Other Liabilities MSR Option Gain Regulatory Liability 41,214 54,924 Accumulated Deferred Investment Tax Credits Regulatory Liability 24,368 29,279 Accumulated Deferred Income Taxes 166,684 168,833 Other 26,920 26,644 ----------- ----------- Total Deferred Credits and Other Liabilities 259,186 279,680 ----------- ----------- Total Capitalization and Other Liabilities $2,701,936 $2,714,096 =========== ===========\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CAPITALIZATION December 31, 1994 1993 COMMON STOCK EQUITY (DEFICIT) - Thousands of Dollars - Common Stock--No Par Value 1994 1993 ----------- ----------- Shares Authorized 200,000,000 200,000,000 Shares Outstanding 160,723,702 160,723,702 $ 645,479 $ 645,479 Capital Stock Expense (6,357) (6,357) Accumulated Deficit (681,355) (702,095) ----------- ----------- Total Common Stock Equity (Deficit) (42,233) (62,973) ----------- ----------- PREFERRED STOCK, No Par Value, 1,000,000 Shares Authorized, None Outstanding - -\nCAPITAL LEASE OBLIGATIONS Springerville Unit 1 458,092 449,984 Springerville Common Facilities 139,076 144,114 Irvington Unit 4 143,407 143,909 Valencia Coal Handling Facilities 187,523 195,309 Other Leases 7,440 8,710 ----------- ----------- Total Capital Lease Obligations 935,538 942,026 Less Current Maturities (12,803) (14,825) ----------- ----------- Total Long-Term Capital Lease Obligations 922,735 927,201 ----------- ----------- LONG-TERM DEBT Interest Issue Maturity Rate - ----------------------------------------------------- First Mortgage Bonds Corporate 1995 - 2009 4.55% to 12.22% 269,750 287,000\nIndustrial Development 2005 - 2025 6.10% to 8.25% Revenue Bonds (IDBs) and variable* 232,200 232,200\nLoan Agreements (IDBs) 2003 - 2022 6.25% and variable* 703,600 704,555\nTerm Loan 1997 - 1999 variable* 193,400 193,400\nPromissory Note 1992 - 1995 8.00% 152 1,400 ----------- ----------- Total Stated Principal Amount 1,399,102 1,418,555 Less Current Maturities (17,167) (2,203) ----------- ----------- Total Long-Term Debt 1,381,935 1,416,352 ----------- ----------- Total Capitalization $2,262,437 $2,280,580 =========== =========== * Interest rates on variable rate tax-exempt (IDB) debt ranged from 1.50% to 5.75% during 1994 and 1993, and the average interest rate on such debt was 2.96% in 1994 and 2.65% in 1993. Interest rates on the Term Loan ranged from 3.63% to 6.69% in 1994 and 1993, and the average interest rate on such debt was 4.92% in 1994 and 4.03% in 1993.\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1994 1993 1992 - Thousands of Dollars - Cash Flows from Continuing Operating Activities Cash Receipts from Retail Customers $611,917 $557,222 $546,801 Cash Receipts from Other Utilities 99,198 91,799 68,775 Purchased Power - Energy (15,829) (9,610) (7,896) Purchased Power - Demand - (1,006) (34,114) Fuel Costs Paid (171,301) (157,075) (139,146) Wages Paid, Net of Amounts Capitalized (49,284) (44,394) (37,275) Payment of Other Operations and Maintenance Costs (78,808) (91,924) (110,993) Capital Lease Interest Paid (82,511) (81,932) - Interest Paid, Net of Amounts Capitalized (72,556) (70,316) (91,531) Taxes Paid, Net of Amounts Capitalized (104,498) (103,005) (92,673) Litigation Settlements - Net - (5,000) 35,000 Lease Payments, Net of Amounts Capitalized - - (61,328) Interest Received 7,288 4,652 11,588 Federal Income Tax Refund Received - - 1,440 Other - (80) (18) --------- --------- --------- Net Cash Flows - Continuing Operating Activities 143,616 89,331 88,630 --------- --------- --------- Net Cash Flows - Discontinued Operations 42,685 5,677 41,878 --------- --------- --------- Cash Flows from Capital Transactions Construction Expenditures (62,599) (48,162) (34,512) Other Investments 103 (286) 58 --------- --------- --------- Net Cash Flows - Capital Transactions (62,496) (48,448) (34,454) --------- --------- --------- Cash Flows from Financing Activities Proceeds from Long-Term Debt - 20,000 16,732 Payments to Retire Long-Term Debt (19,424) (72,187) (32,908) Payments to Retire Capital Lease Obligations (17,747) (10,690) (320) Other (478) 862 (306) --------- --------- --------- Net Cash Flows - Financing Activities (37,649) (62,015) (16,802) --------- --------- --------- Net Increase (Decrease) in Cash and Cash Equivalents 86,156 (15,455) 79,252 Cash and Cash Equivalents, Beginning of Year * 161,996 177,451 98,199 --------- --------- --------- Cash and Cash Equivalents, End of Year ** $248,152 $161,996 $177,451 ========= ========= ========= * Beginning of year balance includes cash and cash equivalents from discontinued operations of $22,179,000 for 1994, $22,502,000 for 1993 and $11,856,000 for 1992. ** End of year balance includes cash and cash equivalents from discontinued operations of $14,852,000 for 1994, $22,179,000 for 1993 and $22,502,000 for 1992.\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)\nPremium on Capital Accumulated Preferred Common Capital Stock Earnings Stock Stock Stock Expense (Deficit) ---------------------------------------------- - Thousands of Dollars -\nBalances at December 31, 1991 $82,793 $357,782 $7,007 $(3,482) $(553,210) 1992 Net Loss - - - - (123,069) 1992 Issuances: 134,713,860 Shares of Common Stock, including the reclassification of all Preferred Stock to Common Stock. See Note 3. (82,793) 286,645 (7,007) (2,875) - -------- -------- ------- -------- ---------- Balances at December 31, 1992 - 644,427 - (6,357) (676,279) 1993 Net Loss - - - - (25,816) 1993 Sale of Treasury Stock: 294,050 Shares of Common Stock - 1,052 - - - -------- -------- ------- -------- ---------- Balances at December 31, 1993 - 645,479 - (6,357) (702,095) 1994 Net Income - - - - 20,740 -------- -------- ------- -------- ---------- Balances at December 31, 1994 $ - $645,479 $ - $(6,357) $(681,355) ======== ======== ======= ======== ==========\nSee Note 6. Long-Term Debt - Additional Restrictive Covenants for discussion of restrictions on the Company's ability to pay dividends.\nSee Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ----------------------------------------------------------------------------\nNATURE OF OPERATIONS\nThe Company is a public utility engaged in the business of generation, transmission, distribution and sale of electricity. The Company's retail service area encompasses 1,155 square miles in Pima and Cochise counties in Southern Arizona. The Company also engages in wholesale sales to other utilities in Arizona, California, Colorado, New Mexico, Oregon, Texas and Utah. Approximately 63% of the Company's work force is subject to a collective bargaining unit. The collective bargaining agreement in place at December 31, 1994 terminates on December 1, 1996.\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of the Company and three wholly-owned, utility-related subsidiaries on a consolidated basis. All significant intercompany balances and transactions have been eliminated in the consolidation. The results of operations, estimated net realizable value of net assets and cash flows of the Company's two investment subsidiaries have been classified as discontinued operations since June 30, 1990.\nUSE OF ESTIMATES\nThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nREGULATION\nThe Company's utility accounting practices and electricity rates are subject to regulation by the ACC and, in certain areas, by the FERC.\nACCOUNTING FOR THE EFFECTS OF REGULATION\nThe Company prepares its financial statements in accordance with the provisions of FAS 71. A regulated enterprise can prepare its financial statements in accordance with FAS 71 only if (i) the enterprise's rates for regulated services are established by or subject to approval by an independent third-party regulator, (ii) the regulated rates are designed to recover the enterprise's costs of providing the regulated services and (iii) in view of demand for the regulated services and the level of competition, it is reasonable to assume that rates set at levels that will recover the enterprise's costs can be charged to and collected from customers. FAS 71 requires a cost-based, rate-regulated enterprise to reflect the impact of regulatory decisions in its financial statements. In certain circumstances, FAS 71 requires that certain costs and\/or obligations (such as incurred costs not currently recovered through rates, but expected to be so recovered in the future) be reflected in a deferral account in the balance sheet and not be reflected in the statement of income or loss until matching revenues are recognized. It is the Company's policy to assess the recoverability of costs recognized as regulatory assets and the Company's ability to continue to account for its activities in accordance with FAS 71, based on each rate action and the criteria set forth in FAS 71.\nThe Company's Consolidated Balance Sheets at December 31, 1994 and 1993 contain certain amounts solely as a result of the application of FAS 71:\nAssets (Liabilities) 1994 1993 -------------------- ----- ----- - Millions of Dollars -\nIncome Taxes Recoverable Through Future Rates $143 $150 Deferred Common Facility Costs 66 68 Deferred Springerville Unit 2 Costs 55 68 Deferred Lease Expense 25 33 Deferred Fuel and Purchased Power Expense 6 13 Other Deferred Charges 9 8 MSR Option Gain Regulatory Liability (41) (55) Deferred Investment Tax Credits (24) (29) Other Deferred Credits (1) (1)\nRegulatory assets are recorded based on prior rate orders issued by the ACC which provide a mechanism for recovery in regulated rates or historical rate treatment which provides evidence as to the probability of future rate recovery. The material regulatory assets listed above earn either a return on investment through inclusion in rate base or earn a set rate of interest stipulated by the ACC.\nA number of accounts in the Company's Consolidated Statements of Income (Loss) for the three years in the period ended December 31, 1994 also reflect the application of FAS 71:\nIncome (Expense) 1994 1993 1992 ---------------- ----- ----- ----- - Millions of Dollars - Amortization of MSR Option Gain Regulatory Liability $ 20 $ 6 $ 6 Amortization of Springerville Unit 2 Rate Synchronization (14) - - Deferred Fuel and Purchased Power (7) (11) (7) Amortization of Deferred Common Facility Costs (3) (3) (4) Deferred Springerville Unit 2 Carrying Costs 1 5 4 Regulatory Disallowances and Adjustments - (14) - Amortization of Investment Tax Credit 5 5 6 Regulatory Interest Relating to MSR Option Gain Regulatory Liability (6) (7) (7)\nIf the Company had not applied the provisions of FAS 71 in these years, each of these amounts appearing in the Consolidated Statements of Income (Loss) would have been reflected in the Consolidated Statements of Income or Loss in prior periods, except for two items which would not have been recorded: 1) the amortization of the MSR Option Gain Regulatory Liability, including regulatory interest; and 2) the Springerville Unit 2 carrying cost deferrals. Lease expense relating to the capital leases, while the same over the life of the leases, would be recognized at different annual amounts if the Company were to discontinue the application of FAS 71. See Utility Plant Under Capital Leases below.\nIf at some point in the future the Company determines that it no longer meets the criteria for continued application of FAS 71 to all or a portion of the Company's regulated operations, the Company would be required to adopt the provisions of FAS 101 for that portion of the operations for which FAS 71 no longer applied. Adoption of FAS 101 would require the Company to write off its regulatory assets and liabilities as of the date of adoption of FAS 101 and would preclude the future deferral in the Consolidated Balance Sheet of costs not recovered through rates at the time such costs were incurred, even if such costs were expected to be recovered in the future. Based on the balances of the Company's regulatory assets and liabilities as of December 31, 1994, the Company estimates that future adoption of FAS 101, if applied to all of the Company's regulated operations, would result in an extraordinary loss of $142 million, which includes a reduction for the related deferred income taxes. The Company's cash flows would not be affected by the adoption of FAS 101.\nUTILITY PLANT\nUtility Plant by major classes at December 31, 1994 and 1993 is as follows:\n1994 1993 ---------- ---------- - Thousands of Dollars - Utility Plant: Production Plant $1,002,409 $ 988,241 Transmission Plant 460,055 454,105 Distribution Plant 495,336 473,830 General Plant 84,441 77,874 Intangible Plant 10,238 8,685 Electric Plant Held for Future Use 644 1,377 ---------- ---------- Total Utility Plant $2,053,123 $2,004,112 ========== ==========\nUtility plant is stated at original cost. In accordance with the Uniform System of Accounts prescribed by the FERC and accepted by the ACC, the Company capitalizes AFDC based on the cost of borrowed funds and a reasonable rate upon equity funds used to finance CWIP, when recovery of such costs from ratepayers is probable. The component of AFDC attributable to borrowed funds is presented as a reduction of Interest Expense. The Consolidated Statements of Income (Loss) reflect no AFDC - Equity as all construction expenditures were deemed under FERC prescribed rules to be financed with debt. In accordance with FERC Accounting Release No. 13, AFDC is recorded on construction expenditures and on the balances of construction funds held in trust, if any are held. Interest income from construction funds held in trust, if any, net of income taxes, is credited to CWIP. Interest Expense on Long-Term Debt - Net reflects interest expense on the stated principal amount of bonds in excess of the average month-end balance of construction funds held in trust during the period. Interest expense on stated bond principal equal to the average month-end balance of construction funds held in trust is charged against AFDC. In 1994, 1993 and 1992, gross AFDC rates of 4.94%, 4.85% and 8.01%, respectively, were used for all CWIP.\nDepreciation is computed on a straight-line basis at component rates which are based on the economic lives of the assets. These component rates, which are authorized by the ACC, averaged 3.73%, 3.68% and 3.71% in 1994, 1993 and 1992, respectively. The economic lives for production plant are based on remaining lives. The economic lives for transmission plant, distribution plant, general plant and intangible plant are based on average lives. The component rates also reflect estimated removal costs, net of estimated salvage value. Minor replacements and repairs are expensed as incurred. Retirements of utility plant, together with removal costs less salvage, are charged to accumulated depreciation.\nUTILITY PLANT UNDER CAPITAL LEASES\nAs described in Note 3, since December 15, 1992, the date of closing of the Company's Financial Restructuring, the Company's leases of the Springerville Common Facilities, Springerville Unit 1, Valencia coal handling facilities and Irvington Unit 4 have been classified as capital leases in the Consolidated Balance Sheets. For rate making purposes, the ACC treats these leases as operating leases and has allowed for recovery of the lease costs by straight-line amortization of the total amount of lease rent payments over the primary term of the leases, except for the Valencia coal handling facilities lease. The Valencia coal handling facilities lease is being amortized on a straight-line basis over the primary term of the lease plus the first optional renewal period of six years to reflect the recovery period mandated by the ACC. Under GAAP, the lease term would have been only the primary term of the lease. Interest and depreciation relating to the leases are recorded as expense on a basis which reflects the regulatory straight- line treatment. The amount of lease amortization incurred for the four above- described leases, as well as the Company's remaining leases, for the years 1994, 1993 and 1992 amounted to:\nYears Ended December 31, 1994 1993 1992 ----- ----- ----- - Millions of Dollars - Lease Amortization: Interest $ 94 $ 93 $ 22 Depreciation 13 12 2 ---- ---- ---- Total Lease Amortization $107 $105 $ 24 ==== ==== ==== Lease Amortization Included In: Operating Expenses - Fuel $ 20 $ 17 $ 1 Operating Expenses - Capital Lease Expense 93 93 20 Balance Sheet - Deferred Lease Expense (6) (5) 3 ----- ----- ---- Total Lease Amortization $107 $105 $ 24 ===== ===== ====\nThe Deferred Lease Expense of $25 million and $33 million at December 31, 1994 and 1993, respectively, reflects: 1) the cumulative difference between the straight-line method of amortizing the leases for regulatory purposes and capital lease amortization as promulgated by GAAP; and 2) the balance of the deferred costs described under Fuel and Purchased Power Costs below. Also, see Allowance for Springerville Unit 1 below.\nALLOWANCE FOR SPRINGERVILLE UNIT 1\nThe 1989 Rate Order limited recovery through retail rates of Century demand charges for Springerville Unit 1 under the Restated Century Purchase Contract to a rate of only $15 per kW per month. From inception through termination of such contract on December 15, 1992, capacity costs for Springerville Unit 1 averaged approximately $20 per kW per month.\nPrior to its termination as a part of the Financial Restructuring described in Note 3, the Restated Century Purchase Contract required the Company to purchase all of Springerville Unit 1 capacity through 2014, but was subject to cancellation by Century after 2001 on five years' advance notice. In addition, in 1990, industry and Company projections for the demand for power in the western United States indicated that excess capacity conditions would be likely to continue for a few years, but should not exist by the year 2000. Due to the significant uncertainties regarding the power markets beyond 2001 and the existence of Century's cancellation option, the amount of loss, if any, which may have been incurred as a result of the $15 per kW per month limitation beyond such date appeared significantly uncertain. In December 1990, the Company, therefore, recognized a loss of approximately $178 million and established a deferred liability for this estimated loss, the Allowance for Springerville Unit 1, equal to the present value of the excess of the Company's costs estimated to be incurred during the period through 2001 over $15 per kW per month using a discount rate of 13%.\nIn connection with the Financial Restructuring, the Company assumed Century's lease of Springerville Unit 1 under a capital lease agreement extending to January 1, 2015. Accordingly, in December 1992, the remaining unamortized balance of the Allowance for Springerville Unit 1 was recalculated based on the $15 per kW rate currently permitted pursuant to the 1991 Rate Order and current cost estimates through the year 2014. This resulted in an additional loss of approximately $7 million, which was recorded as a component of the Loss on Financial Restructuring in the Consolidated Statement of Income (Loss) for the year ended December 31, 1992. In addition, the liability was reclassified to a contra-asset, Allowance for Springerville Unit 1. The Allowance for Springerville Unit 1 increases each year by the accrual of interest and decreases by the amount which is being amortized to income, as a contra-expense, through 2014. The imputed interest expense, calculated using a 13% discount rate, associated with this liability is included as part of Regulatory Interest in the Interest Expense section in the Consolidated Statements of Income (Loss).\nDEFERRED COMMON FACILITY COSTS\nSpringerville Common Facility Costs are lease costs and operating costs incurred for the Springerville Common Facilities during the period after Springerville Unit 1 was placed in service and before Springerville Unit 2 was placed in service. Pursuant to an accounting order from the ACC, these costs were deferred and are being amortized over the primary term of the Springerville Common Facilities Leases. The ACC has allowed for the recovery of the amortization costs plus a return on investment.\nUTILITY OPERATING REVENUES\nOperating Revenues include accruals for unbilled revenues, thereby recognizing revenue that is earned, but not billed, at the end of an accounting period.\nAMORTIZATION OF MSR OPTION GAIN REGULATORY LIABILITY\nThe 1989 Rate Order allocated to retail customers a portion of the price paid to the Company upon the 1982 sale of an option to purchase a 28.8% interest in San Juan Unit 4, asserting that such option was related to an interconnection agreement which the Company also entered into with MSR at that time. In the 1989 Rate Order, the ACC ordered the MSR Option Gain be amortized over a six-year period through 1995 as a $20 million per year revenue credit, and in 1990 the Company established a deferred liability for the present value of the amount to be amortized, calculated using a 13% discount rate. Such deferred liability increases each year by the accrual of interest at 13% and decreases by the amount of revenue credit prescribed by the ACC. Such revenue credit is included in Operating Revenues. The interest accrual is included as part of Regulatory Interest in the Interest Expense section of the Consolidated Statements of Income (Loss). The 1991 Rate Order deferred amortization of a portion of the regulatory liability to 1996 and 1997.\nFUEL AND PURCHASED POWER COSTS\nFuel inventory, primarily coal, is stated on a basis which approximates weighted average cost. The Company utilizes full absorption costing.\nCertain lease and interest costs incurred by Valencia, the Company's fuel-handling and procurement subsidiary for Springerville, are accounted for as deferred costs, which were allocated to fuel inventory based on fuel quantities purchased and then amortized to Fuel expense and, prior to the closing of the Financial Restructuring on December 15, 1992, to Purchased Power - Energy, based on the rate of fuel burn at Springerville through December 31, 1992. Effective January 1, 1993, these costs are amortized to Fuel expense on a straight-line basis over 37.4 years pursuant to the 1994 Rate Order.\nFINANCIAL RESTRUCTURING COSTS\nFinancial Restructuring costs include costs incurred for legal, accounting and other consulting services in connection with the restructuring of the Company's obligations, as described in Note 3.\nINCOME TAXES\nReductions in federal income taxes resulting from ITC relating to utility operations have been deferred. As authorized by the ACC, these amounts are amortized over the tax lives of the related property. As the Company has been in a net operating loss carryforward position, the income tax benefits reflected in the Consolidated Statements of Income (Loss) result only from such ITC amortization.\nIncome taxes are allocated to the subsidiaries based on contributions to the consolidated tax return liability. The investment subsidiaries' losses in 1994, 1993 and 1992 provided no tax benefits to the consolidated group and, therefore, no tax benefits are recorded as a reduction of the 1993 and 1992 Provisions for Loss on Disposal of Discontinued Operations in the Consolidated Statements of Income (Loss).\nDEBT EXPENSE\nDebt discount and issuance costs are amortized over the lives of the related issues or the related refunding issues.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe carrying value and fair value at December 31, 1994 and 1993 of the Company's financial instruments are as follows: 1994 1993 ------ ------ Carrying Fair Carrying Fair Value Value Value Value -------- ----- -------- ----- - Thousands of Dollars - Assets: Cash and Cash Equivalents $ 233,300 $ 233,300 $ 139,817 $ 139,817 Accounts Receivable 66,332 66,332 65,212 65,212 Other Investments 4,307 4,307 4,370 4,370 Liabilities: Accounts Payable (39,777) (39,777) (40,190) (40,190) Long-Term Debt, Including Current Portion (See Note 6) (1,399,102) (1,372,236) (1,418,555) (1,397,838)\nThe carrying amounts of all financial instruments, except Long-Term Debt, are considered to be reasonable estimates of the fair value of each because of the short maturity of those instruments.\nRECLASSIFICATION\nMinor reclassifications have been made to the prior year financial statements presented to conform to the current year's presentation.\nBeginning in the fourth quarter of 1994, state and city sales taxes and similar taxes collected on revenues were removed from Operating Revenues and Taxes Other Than Income Taxes on the Consolidated Statements of Income (Loss). These taxes are included as part of Accounts Receivable and Taxes Accrued on the Consolidated Balance Sheets. Such reclassification was made to enhance the comparability of the Company's income statements with those of other companies. All financial information presented has been restated to conform to this presentation. The tax amounts reclassified were as follows:\nYears Ended December 31, 1994 1993 1992 ------- ------- ------- - Thousands of Dollars -\nState Sales Taxes $28,392 $26,027 $25,379 City Sales and Franchise Taxes 12,585 11,351 11,052 ACC Assessment Fee 934 920 952 ------- ------- ------- Total Taxes Reclassified $41,911 $38,298 $37,383 ======= ======= =======\nNOTE 2. 1994 RATE ORDER - ------------------------\nEffective January 11, 1994, the ACC authorized a 4.2% increase in base rates. The 1994 Rate Order recognized that an additional 17.5% of the Springerville Unit 2 capacity was used and useful for the retail jurisdiction, which lowered the percentage of that unit's capacity that is not in rate base to 37.5%. Therefore, the Company is not presently recovering through retail rates the depreciation, property taxes, operating and maintenance expenses other than fuel, or interest costs associated with the 37.5% of Springerville Unit 2 capacity which was not then considered to be used and useful for the retail jurisdiction and therefore was not included in rate base (hereinafter referred to as \"retail excess capacity deferrals\"). These expenses are being expensed as incurred. However, the 1994 Rate Order permits such costs to be deferred for future recovery over the remaining useful life of Springerville Unit 2. This phase-in plan does not qualify under FAS 92 and, therefore, such retail excess capacity deferrals, while deferred for regulatory purposes, cannot be deferred for financial reporting purposes. Such regulatory deferrals associated with the excluded Springerville Unit 2 capacity, not included in the financial statements, totaled $63 million at December 31, 1994. Either inclusion in costs recoverable through retail rates or additional wholesale sales at sufficient prices of an equivalent amount of capacity (or a combination thereof) will be required to recover these retail excess capacity deferrals.\nAs a result of the 1994 Rate Order, the retail excess capacity deferrals allocable to the 62.5% of Springerville Unit 2 capacity allowed in rate base was also included in rate base. At December 31, 1993, the retail excess capacity deferrals allocable to the 17.5% of the Springerville Unit 2 capacity amounted to $17 million. As specified in the 1994 Rate Order, for rate purposes, these costs are being recovered over a 37.4 year period.\nThe 1994 Rate Order allowed in rate base 62.5% of deferred Springerville Unit 2 rate synchronization costs, $42 million at December 31, 1993, which were non-fuel costs of Springerville Unit 2 incurred from January 1, 1991 through October 14, 1991, including an interest carrying charge, deferred pursuant to the 1991 Rate Order. For rate making purposes, such costs are being recovered over a three-year period and are included in Depreciation and Amortization on the Consolidated Statements of Income (Loss), in accordance with the 1994 Rate Order. The Company is not presently recovering through retail rates 37.5% of the deferred Springerville Unit 2 rate synchronization costs ($26 million at December 31, 1994). This amount, together with the balance of such costs ($29 million at December 31, 1994) that the Company is presently recovering through rates, are reported in the Company's consolidated financial statements as Deferred Springerville Unit 2 Costs.\nThe 1994 Rate Order provided that the rate synchronization and retail excess capacity deferrals associated with the 37.5% of Springerville Unit 2 capacity not found to be used and useful for the retail jurisdiction will continue to incur an interest charge of 7.19% until authorized to be included in rate base or for a period of three years ending in 1997, whichever occurs first.\nThe 1994 Rate Order disallowed recovery of $13.6 million of previously capitalized Springerville Unit 2 rate synchronization costs and certain other minor costs. The $13.6 million is comprised of $5.2 million for wholesale power sale revenue credits which the Company had offset against the off- balance sheet retail excess capacity deferrals which the ACC stated should have been offset against the rate synchronization deferrals. The remaining $8.4 million of disallowance results from the ACC's finding that the Company should have calculated the 7.19% carrying charge on a net-of-tax basis rather than pre-tax, as calculated by the Company. Such disallowances were recorded in December 1993 and are reflected in Regulatory Disallowances and Adjustments in the Consolidated Statement of Income (Loss) for the year ended December 31, 1993.\nIn connection with the 1994 Rate Order, on August 26, 1993, the ACC authorized the Company to collect the sum of $2.1 million through a temporary fuel surcharge of .96 mills per kWh beginning September 1, 1993 until further order of the ACC. The Company had requested a temporary rate surcharge to recover $4 million of previously authorized but uncollected deferred fuel expenses. The Company wrote-off $1.9 million of unrecovered deferred fuel costs in 1993.\nNOTE 3. 1992 CONSUMMATION OF THE FINANCIAL RESTRUCTURING - ---------------------------------------------------------\nOn December 15, 1992, the Company consummated the transactions required to finalize its financial restructuring plan, including the comprehensive restructuring of obligations to certain of its creditors, lease participants, Century and the Springerville Unit 1 lease participants and the reclassification of all outstanding Preferred Stock into Common Stock. Approximately 135 million shares of Common Stock were issued in the Financial Restructuring, increasing the number of common shares outstanding to approximately 160 million. In addition, warrants to purchase an additional 12 million shares of Common Stock at an exercise price of $3.20 per share were issued in the Financial Restructuring. The issuance of Common Stock and Warrants is further discussed below. In accordance with FAS 15 such stock (other than the 55 million shares of Common Stock into which the Preferred Stock was reclassified) was recorded at fair value as determined by the Company on or about the date of issuance. In the accompanying financial statements, the Common Stock issued pursuant to the Financial Restructuring was recorded based on a fair value of $2.33 per share, which was the average of the high and low trading price reported by the Dow Jones Stock Quote Reporter Service during the period December 16, 1992 through December 31, 1992, the period immediately following the Closing. The Warrants were valued for purposes of these financial statements at an estimated value of $0.82 per share, calculated using an option pricing model and the $2.33 estimated fair value per share of Common Stock. Losses and deferred gains related to the issuance of the Common Stock and Warrants in the Financial Restructuring described in the succeeding paragraphs were determined using these values for such Common Stock and Warrants. Such values are not intended to be indicative of current or future trading values for either the Common Stock or the Warrants.\nBANKS\nThe Company provided the banks approximately 32 million shares of Common Stock, a first mortgage lien on Springerville Unit 2, $50 million of bonds issued under a second mortgage as collateral, and $20.8 million in first mortgage bonds as collateral and became subject to certain restrictive financial and operating covenants. In exchange, the Company received the waiver of $96 million in accrued interest payments, more favorable credit terms, extensions of LOCs and related agreements, the restructuring of several prior debt agreements into the Term Loan, a new $20 million LOC and a new $50 million working capital revolving credit facility. The restructuring of these Bank obligations gave rise to a deferred gain of $21 million, which is being amortized as a reduction of interest expense over an eight-year period, the weighted average life of the restructured credit arrangements. These restructured bank credit arrangements also increased Common Stock Equity $75 million. See the Consolidated Statements of Changes in Stockholders' Equity (Deficit).\nSPRINGERVILLE UNIT 1\nThe Company provided the participants in the Springerville Unit 1 Leases approximately 48 million shares of Common Stock and Warrants to purchase 12,054,278 shares of Common Stock at an exercise price of $3.20 per share. The Warrants were exercisable at the Closing of the Financial Restructuring and expire in 2002. In addition, the Company assumed Century's former obligations under the Springerville Unit 1 Leases and released Century from its obligations relating to the 1981 Apache A Bonds. Amendments were also made to the Interconnection Agreement which the Company has with Century. In exchange, the Company received Century's leasehold interests in Springerville Unit 1, Century's investment in plant and inventories at Springerville Unit 1 and the Restated Century Purchase Contract was terminated. The Company also received the waiver of demand charge payments due under the Restated Century Purchase Contract equivalent to $57 million, the release from certain tax indemnification liabilities related to Springerville Unit 1, and the dismissal with prejudice of certain actions which had been filed against the Company by some of the Springerville Unit 1 owner participants.\nThe restructuring of these obligations gave rise to approximately $31 million of the Loss on Financial Restructuring appearing in the Consolidated Statement of Income (Loss) for the year ended December 31, 1992. These transactions also increased Common Stock Equity by $122 million. See the Consolidated Statements of Changes in Stockholders' Equity (Deficit). Also, see Note 1 regarding the loss of approximately $7 million, which was recorded as a component of the Loss on Financial Restructuring in the Consolidated Statement of Income (Loss) for the year ended December 31, 1992, as a result of the assumption of the Springerville Unit 1 Leases.\nCAPITAL LEASES\nThe terms of the Irvington Lease, the Valencia Leases, the Springerville Common Facilities Leases and the assumed Springerville Unit 1 Leases (see Note 1) were amended to waive certain accrued payment obligations, defer certain lease payments due in the next several years to later years, and extend the terms of certain leases. As a result of the lease amendments, in accordance with FAS 13, as amended by FAS 98, these leases are accounted for as capital leases subsequent to December 15, 1992. Amendment of these leases increased rent expense by $18 million in the Consolidated Statement of Income (Loss) for the year ended December 31, 1992.\nPREFERRED STOCK\nAll of the Company's outstanding Preferred Stock was reclassified into approximately 55 million shares of newly issued Common Stock. The reclassification was recorded at the book value of the Preferred Stock. This increased Common Stock Equity by $90 million, decreased the Premium on Capital Stock by $7 million and decreased Preferred Stock by $83 million. See the Consolidated Statements of Changes in Stockholders' Equity (Deficit).\nOTHER\nThe reversal of other reserves and accruals that were resolved by the Closing, primarily through the dismissal of certain regulatory proceedings, reduced the Loss on Financial Restructuring included in the Consolidated Statement of Income (Loss) for the year ended December 31, 1992 by $11 million.\nNOTE 4. INCOME TAXES - ---------------------\nIn January 1993, the Company adopted Statement of Financial Accounting Standards No. 109 (FAS 109), Accounting for Income Taxes, on a prospective basis. The adoption of FAS 109 changed the Company's method of accounting for income taxes from the deferred method (APB 11) to an asset and liability approach. Previously, the Company deferred the past income tax effects of timing differences between financial reporting and taxable income. The asset and liability approach requires the recognition of deferred income tax liabilities and assets for the expected future income tax consequences of temporary differences between the carrying amounts and the tax bases of other assets and liabilities.\nThe adoption of FAS 109 increased both total assets and total liabilities of the Company by $149 million in 1993. The increase in assets results primarily from the recording of a regulatory asset for the recovery of income taxes from future ratepayers. See Note 1. Such regulatory asset consists primarily of the right to recover income taxes relating to previously flowed-through differences, both timing and permanent, which provided rate benefits to past ratepayers. The increase in liabilities is primarily the net increase in deferred income tax assets and deferred income tax liabilities resulting from the adoption of FAS 109.\nDeferred tax assets (liabilities) are comprised of the following:\nDecember 31, 1994 1993 ----------- ---------- - Thousands of Dollars - Gross Deferred Income Tax Liabilities: Electric Plant - Net $(558,509) $(554,441) Regulatory Asset (Income Taxes Recoverable Through Future Rates) (57,902) (60,615) Deferred Springerville Unit 2 Costs (22,206) (27,384) Deferred Valencia Inventory Costs (21,780) (21,628) Deferred Lease Payments (15,510) (16,329) Property Taxes (10,465) (10,340) Deferred Fuel (2,372) (5,364) Other (6,016) (7,371) ---------- ---------- Gross Deferred Income Tax Liability (694,760) (703,472) ---------- ----------\nGross Deferred Income Tax Assets: Capital Lease Obligations 377,825 384,506 Tax Operating Loss Carryforwards 199,564 181,200 Springerville Unit 1 Disallowed Costs 65,597 65,959 Investment in Loans and Partnerships 7,757 34,205 Investment Tax Credit Carryforwards 28,088 28,100 MSR Option Gain Regulatory Liability 16,645 22,268 Capital Loss Carryforwards 19,078 20,700 Lease Interest Payable 17,429 17,570 Deferred Regulatory Capital Lease Expense 11,397 8,213 Financial Restructuring Costs Not Yet Deductible for Tax Purposes 8,034 7,773 Gain on Financial Restructuring of Long-Term Debt 6,458 7,571 Other 27,166 29,492 ---------- ---------- Gross Deferred Income Tax Asset 785,038 807,557 Deferred Tax Assets Valuation Allowance (244,092) (263,991) ---------- ---------- Net Deferred Income Tax Liability $(153,814) $(159,906) ========== ==========\nThe decrease in the gross deferred tax assets valuation allowance of approximately $20 million primarily resulted from the sale of the discontinued operation's assets (see Note 5) which had corresponding deferred tax assets, which were fully reserved by the valuation allowance.\nThe net deferred income tax liability is included in the Consolidated Balance Sheets in the following accounts:\nDecember 31, 1994 1993 ---------- ---------- - Thousands of Dollars -\nDeferred Income Tax - Current $ 12,870 $ 8,927 Accumulated Deferred Income Taxes (166,684) (168,833) ---------- ---------- Net Deferred Income Tax Liability $(153,814) $(159,906) ========== ==========\nIncome Tax Benefit is included in the Consolidated Statements of Income (Loss) in the following accounts:\nYears Ended December 31, 1994 1993 1992 ---------- ---------- ---------- - Thousands of Dollars -\nOperating Expenses - Other Operations $ 91 $ 91 $ 91 Other Income (Deductions) - Income Taxes 4,820 5,186 5,654 ---------- ---------- ---------- Total Income Tax Benefit $ 4,911 $ 5,277 $ 5,745 ========== ========== ==========\nThe differences between income tax benefit and the amount obtained by multiplying income (loss) before income taxes by the U.S. statutory federal income tax rate for each of the three years in the period ended December 31, 1994, are as follows:\nYears Ended December 31, 1994 1993 1992 ---------- ---------- ---------- - Thousands of Dollars - Federal Income Tax (Expense) Benefit at Statutory Rate $ (5,540) $ 10,883 $ 43,797 Investment Tax Credit amortization 4,911 5,277 5,745 Loss for Which No Tax Benefit is Available - (10,883) (43,797) Net Operating Loss Carryforwards 5,540 - - ---------- ---------- ---------- Total Benefit for Federal and State Income Taxes $ 4,911 $ 5,277 $ 5,745 ========== ========== ==========\nOn August 10, 1993, the Revenue Reconciliation Act of 1993 was signed into law which, among other things, raised the maximum corporate U.S. statutory federal income tax rate from 34% to 35%, retroactively effective to January 1, 1993. The Company increased its deferred tax balances and the corresponding deferred tax asset valuation allowance at December 31, 1993 as a result of this rate change.\nAt December 31, 1994, the Company had, for federal income tax purposes, $28 million of unused ITC, the use of which will expire during 2001 through 2005, $2 million of alternative minimum tax credit which will carry forward to future years, and $47 million of capital loss carryforwards which expire during 1995 through 1999. In addition, for federal income tax purposes the Company has approximately $494 million of net operating loss carryforwards expiring in 2004 through 2009 and $169 million of alternative minimum tax loss carryforwards expiring in 2005 through 2007. For state income tax purposes, the Company has approximately $352 million of net operating loss carryforwards expiring in 1995 through 1999.\nDue to the Company's Financial Restructuring, as described in Note 3, the Company experienced a change in ownership under section 382 of the Internal Revenue Code in December 1991. As a result of that change, the amount of the taxable income for any post-change year which may be offset by pre-change loss will be limited to the section 382 limitation. The section 382 limitation is based on the value of the Company on the ownership change date. The Company estimates an annual section 382 limit of approximately $23 million. This limit may be increased to the extent of gain recognized on sales of assets whose fair market value was greater than tax basis at the ownership change date, the built-in-gain. The section 382 limitation may increase by built-in-gain recognized within a period of five years after the change in ownership. The 1992 section 382 limitation increased by approximately $84 million of built-in-gain recognized due to asset sales. Unused section 382 limitation may be carried forward until the pre-change tax attributes expire. At December 31, 1994, the Company had pre-change net operating loss, ITC, capital loss and alternative minimum tax carryforwards of approximately $365 million, $28 million, $31 million and $136 million, respectively.\nThe 1980 through 1985 Federal Income Tax Audit resulted in a 1992 federal tax refund of approximately $1 million and approximately $8 million in interest. The interest income had not been previously accrued and is included as Other Income in the Consolidated Statement of Income (Loss) for the year ended December 31, 1992.\nNOTE 5. DISCONTINUED OPERATIONS - --------------------------------\nIn July 1990, the Boards of Directors of the Company's investment subsidiaries adopted formal plans of liquidation of the investment operations. Pursuant to such actions, investment subsidiaries' results of operations, estimated net realizable value of net assets and cash flows have been classified as discontinued operations in the Company's consolidated financial statements since June 30, 1990. The Company recorded a provision for losses on disposal of discontinued operations of $105 million in 1990 to reduce the carrying values of the assets to their then-estimated net realizable values. The financial results of activities from discontinued operations subsequent to June 30, 1990 have been recorded as an adjustment to the reserve for losses. Additional provisions for losses on disposal of discontinued operations of $36 million in 1991, $44 million in 1992, and $4 million in 1993 were made to reflect further weakening of markets for certain subsidiary investments, increased estimates of holding-period costs for those assets and a $10 million addition to the reserve for litigation in 1992.\nThe components of net assets of discontinued operations are summarized as follows: December 31, 1994 1993 --------- --------- - Thousands of Dollars -\nCash and Cash Equivalents $ 14,852 $ 22,179 Investment in Citadel - 23,374 Real Estate Investments 17,127 65,119 Vehicle Contracts Receivable 17,509 17,509 Other Assets and Investments 6,859 19,403 Reserve for Loss on Disposal of Discontinued Operations (34,494) (74,109) --------- --------- Total Assets 21,853 73,475 Current Liabilities (13,168) (14,995) --------- --------- Net Assets of Discontinued Operations $ 8,685 $ 58,480 ========= =========\nLoss from discontinued operations is as follows:\nYears Ended December 31 1994 1993 1992 --------- --------- --------- - Thousands of Dollars -\nInvestment Losses $(35,447) $(20,403) $(27,473) Hotel Revenues 13,171 13,930 13,669 Hotel Depreciation and Other Expense (16,242) (17,129) (16,914) Other Investment Expense (1,097) (2,289) (1,927) --------- --------- --------- Operating Loss (39,615) (25,891) (32,645) Reduction in Reserve for Losses 39,615 25,891 32,645 --------- --------- --------- Loss from Discontinued Operations $ - - $ - ========= ========= =========\nNet assets of discontinued operations declined by approximately $50 million between December 31, 1993 and December 31, 1994 as a result of dividends paid by TRI to the Company.\nGross investment losses during 1994 included losses of: $21 million on sales of real estate; $21 million on the sale of the remaining Citadel common stock; and $5 million on the sale of two small power projects. Offsetting these losses were gains of: $9 million on the sale of various marketable securities and $1 million on the sale of a vehicle contracts receivable portfolio. The resulting net losses reduced the Reserve for Losses by an equal amount. Also included in Investment Losses is $2 million of other investment income.\nAs of December 31, 1994, Real Estate Investments consist of 1) loans collateralized by real property and 2) land held for sale in Arizona. Vehicle Contracts Receivable consists principally of automobile installment sales contracts of Brookland, a financial services company. In January 1991, the Board of Directors of Brookland elected to discontinue its business operations. Brookland remains liable for credit obligations to outside lenders of $12 million. These credit obligations are collateralized by Brookland's vehicle contracts portfolio and other interests in Vehicle Contracts Receivable.\nAs of December 31, 1994, the Company has substantially completed its disposal of discontinued operations. The losses from discontinued operations for the period June 30, 1990 through December 31, 1994 of $139 million have been recorded as reductions in the Reserve for Losses. The gross proceeds from the sale of assets, excluding scheduled collections on loans and notes receivable, for the period June 30, 1990 through December 31, 1994 amounted to $498 million. The remaining assets and liabilities will be accounted for as a part of continuing operations beginning January 1, 1995.\nNOTE 6. LONG AND SHORT-TERM DEBT AND CAPITAL LEASE OBLIGATIONS - ---------------------------------------------------------------\nLONG-TERM-DEBT\nFirst Mortgage Bonds and Installment Sale Agreement\nFirst Mortgage Bond and Installment Sale Agreement maturities and cash sinking fund requirements for the next five years include $17 million in 1995, $12 million in 1996, $2 million in 1997, $3 million in 1998, and $19 million in 1999. In addition, certain First Mortgage Bonds have additional annual sinking fund requirements which total approximately $3 million for each of the next five years. These sinking fund requirements can be and have been satisfied to date primarily by pledges of additional property. The Company's utility plant, with the exception of Springerville Unit 2, is subject to the lien of the General First Mortgage and the General Second Mortgage.\nRestructured Arrangements\nApproximately $900 million of the Company's previous bank obligations including bank lines, LOCs and related reimbursement agreements (excluding the reimbursement agreement relating to the 1981 Apache B Bonds) were combined and restructured into a master restructuring agreement between the Company and the Banks (the MRA) on December 15, 1992. The MRA provided for a $243.3 million Term Loan, Replacement LOCs supporting $674 million of IDBs, and a $50 million Revolving Credit. Obligations under the MRA are secured by a first mortgage lien on and security interest in Springerville Unit 2, and, under certain conditions, are secured by $50 million in principal amount of collateral bonds issued under the General Second Mortgage, junior to the General First Mortgage securing the Company's First Mortgage Bonds.\nAdditionally, the MRA provided for an additional $20 million LOC which was issued in March 1993 to the indenture trustee for industrial development revenue bonds originally issued in 1990. The reimbursement agreement related to that LOC, which is secured by first mortgage bonds, allowed the debt proceeds to be released to the Company which reimbursed the Company for costs of qualifying facilities. See Letters of Credit below.\nIn March 1995, the Company and its banks completed an amendment to the MRA which eased certain debt prepayment restrictions and modified the Term Loan to allow reborrowing of amounts which will have been previously prepaid (Renewable Term Loan) (see Term Loan below). The amendment will allow the Company to better manage its cash position and reduce capital costs while maintaining liquidity. Prior to the amendment the Company was not permitted to prepay non-MRA debt except to the extent that certain cash amounts, as defined in the MRA, were generated. The amendment, now in effect, allows the Company to optionally prepay non-MRA debt provided certain conditions are met. Such conditions include that $1 of principal outstanding under the Renewable Term Loan is permanently prepaid and the commitment therefore terminated for every $2 used to permanently prepay other debt such as First Mortgage Bonds.\nTo comply with provisions of the MRA prior to the March 7, 1995 amendment, the Company prepaid $17.25 million of First Mortgage Bonds during 1994. During 1993 the Company, under a bank waiver to certain restrictions of the MRA, voluntarily prepaid $49 million of First Mortgage Bonds and $19 million of the Term Loan.\nAdditional details regarding the components and covenants of the MRA are described below.\nLetters of Credit\nAt December 31, 1994 there were $774 million principal amount of variable rate tax-exempt IDBs outstanding. Payment of principal and interest on these bonds is secured by LOCs. The LOCs expire at various dates during the period December 31, 1999 through December 31, 2002. However, all the LOCs could expire by December 31, 2000, including an expiration as early as August 1997, if the Company's senior long-term debt is rated investment grade on certain dates or during certain periods subsequent to December 31, 1996. The reimbursement agreement related to the 1981 Apache B Bonds is secured by First Mortgage Bonds. The weighted average commitment fee on the Replacement LOCs is approximately 0.53% through 1997 and increases to 0.82% in 1998, 1.07% in 1999 and thereafter.\nTerm Loan\nThe Term Loan, on March 7, 1995, was amended and renamed the Renewable Term Loan. As a condition to the amendment becoming effective the Company permanently prepaid $19.34 million of the Term Loan reducing the outstanding balance from $193.4 million to approximately $174 million at March 7, 1995. Thus, the initial commitment and outstanding balance of the Renewable Term Loan was approximately $174 million.\nThe Renewable Term Loan commitment amount at March 31, 1997 will be reduced as follows: 20% in 1997, 40% in 1998 and 40% in 1999. Any outstanding Renewable Term Loan balance in excess of the commitment will be payable immediately. The Renewable Term Loan bears interest at a variable rate based on an adjusted eurodollar rate plus 0.5% and the commitment fee is 0.5% of the unused portion. The adjusted eurodollar rate was approximately 4.92% per annum and 4.03% per annum for the years ended December 31, 1994 and 1993, respectively, and was approximately 3.66% for the one month period ended December 31, 1992. During 1993 and 1992 the Company prepaid $19 million and $31 million, respectively, of the outstanding balance.\nAdditional Restrictive Covenants\nIn addition to the prepayment provisions described above, the MRA contains a number of restrictive covenants including, but not limited to, covenants limiting, with certain exceptions, (i) the incurrence of additional indebtedness, including lease obligations, or the prepayment of existing indebtedness, or the guarantee of any such indebtedness, (ii) the incurrence of liens, (iii) the sale of assets or the merger with or into any other entity, (iv) the declaration or payment of dividends on Common Stock or any other class of capital stock, (v) the making of capital expenditures beyond those contemplated in the Company's 1992 ten-year capital budget, and (vi) the Company's ability to enter into sale-leaseback arrangements, operating lease arrangements and coal and railroad arrangements. All of these restrictive covenants described above, other than (i), (iv) and (vi), will be in effect until at least December 1997. The covenants described in (i), (iv) and (vi) will cease to be binding on the Company when both the Renewable Term Loan and the Revolving Credit are paid in full and commitments thereunder terminate, and the Company's senior long-term debt is rated at least investment grade. In addition, the Company is required pursuant to the MRA to maintain an interest coverage ratio of (a) operating cash flows plus interest paid to (b) interest paid, through the year 2003, ranging from 1.2 to 1 in 1994 and gradually increasing to 2 to 1 in 2000 continuing through the year 2003. For the year ended December 31, 1994, the Company's MRA interest coverage ratio was 2.98 to 1. With respect to dividends, the MRA incorporates, until the Renewable Term Loan and the Revolving Credit are paid in full and commitments thereunder terminate, a restrictive covenant similar to that currently in the General First Mortgage which limits the Company's ability to pay dividends on Common Stock until it has positive retained earnings (through future earnings or otherwise) rather than an accumulated deficit (such accumulated deficit was $681 million at December 31, 1994). For the foreseeable future, the Company does not anticipate being able to satisfy the tests of this restrictive covenant, and therefore, does not anticipate being permitted to pay cash dividends on its Common Stock.\nFair Value of Long-Term Debt\n1994 1993 Carrying Fair Carrying Fair Value Value Value Value -------- ----- -------- ----- - Thousands of Dollars - First Mortgage Bonds: Corporate $ 269,750 $ 256,009 $ 287,000 $ 275,687 IDBs 1981 Apache B Bonds 100,000 100,000 100,000 100,000 Pollution Control Financing Bonds 112,200 102,944 112,200 106,030 1990 Pima A Bonds 20,000 20,000 20,000 20,000 Loan Agreements: Installment Sale Agreement 50,000 46,131 50,955 47,646 IDBs 653,600 653,600 653,600 653,600 Term Loan 193,400 193,400 193,400 193,400 Promissory Note 152 152 1,400 1,475 ---------- ---------- ---------- ---------- $1,399,102 $1,372,236 $1,418,555 $1,397,838 ========== ========== ========== ==========\nThe principal amount of variable rate debt outstanding at December 31, 1994 and 1993 of the 1981 Apache B Bonds, the 1990 Pima A Bonds, the Loan Agreements-IDBs, and the Term Loan are considered reasonable estimates of their fair value as these are variable interest rate liabilities. The fair value of the Company's fixed rate obligations including the Corporate First Mortgage Bonds, the Pollution Control Financing Bonds, the Installment Sale Agreement and Promissory Note was determined by calculating the present value of the cash flows of each fixed rate obligation. The discount rate used for each calculation was a rate consistent with market yields generally available as of December 1994 for 1994 amounts and December 1993 for 1993 amounts, obtained from the Moody's Bond Survey report, for bonds with similar characteristics with respect to: credit rating, time-to-maturity, and the tax status of the bond coupon for Federal income tax purposes. The use of different market assumptions and\/or estimation methodologies may yield different estimated fair value amounts.\nSHORT-TERM DEBT\nRevolving Credit\nThe $50 million Revolving Credit, provided as part of the MRA, has a termination and maturity date of December 31, 1999. No amounts have been borrowed by the Company under this facility. Revolving Credit borrowings would bear interest at variable rates based upon, at the option of the Company, either (i) prime rate or (ii) an adjusted eurodollar rate plus a margin of 0.75% in 1994 and 1995 which gradually increases to 2% by 1998 and thereafter. The Company is required to repay the Revolving Credit in full for at least 30 consecutive days in each twelve-month period prior to November 30 of each year. The annual commitment fee for the Revolving Credit equals 0.5% of the unused portion.\nDiscontinued Operations\nVehicle contracts receivable and other interests in vehicle contracts receivable held by Brookland are financed through a warehouse line of credit and a loan which totaled approximately $12 million at December 31, 1994 and 1993. The weighted average interest rate applicable to the warehouse line of credit at December 31, 1994 and 1993 was 17%.\nCAPITAL LEASE OBLIGATIONS\nA schedule by years of future minimum lease payments under capital leases together with the present value of the net minimum lease payments (Capital Lease Obligations) as of December 31, 1994 follows:\nYears ending December 31, - Thousands of Dollars -\n1995.......................... $ 99,262 1996.......................... 119,155 1997.......................... 95,019 1998.......................... 97,200 1999.......................... 103,277 Thereafter.................... 1,913,905 ------------ 2,427,818 Imputed Interest.............. (1,492,280) ------------ Capital Lease Obligations..... $ 935,538 ============\nThe Irvington Lease has an initial term to January 2011 and provides for renewal periods of two or more years through 2020. The Springerville Common Facilities Leases have an initial term of 2017 for one owner participant and 2021 for the other two owner participants, subject to optional renewal periods of two or more years through 2025. The Springerville Unit 1 Leases have an initial term to January 2015 and provide for renewal periods of three or more years through 2030. The Valencia Leases have an initial term to April 2015 and provide for an initial renewal period of six years, then additional renewal periods of five or more years through 2035.\nNOTE 7. COMMITMENTS AND CONTINGENCIES - -------------------------------------\nUTILITY CONTRACTUAL MATTERS\nCoal and Transportation Contracts\nOn October 14, 1991, amendments to the contract with the Springerville coal supplier were entered into, and became effective, which, among other things, reduced the price of coal shipments at Springerville. The amended contract contains provisions which protect the claims of the Springerville coal supplier under the original agreement in the event that the Company does not perform its obligations under the terms of the amended agreement at any time prior to August 23, 1995. If such a failure to perform occurs, the Company would be responsible for approximately $7 million per year in additional payments to the Springerville coal supplier. Also, at December 31, 1994, a $3 million accrued liability remained on the Company's Consolidated Balance Sheet which will be forgiven if all conditions are met during the four years subsequent to the amendment of the Springerville coal agreement.\nThe Company has contracted with P&M to supply coal to Irvington. Originally, all units at Irvington were scheduled to be converted and coal supplies were contracted for those units. The original contract required annual minimum quantities of 650,000 tons. However, the conversion of Units 1, 2 and 3 at Irvington was canceled. The then-existing P&M contract contained minimum take-or-pay provisions which required the Company to pay one-half of the base price of coal for any contract quantities not scheduled and delivered. On November 5, 1991, amendments to the contract with P&M were entered into and became effective, which, among other things, substantially reduced the minimum annual coal quantities to levels which the Company estimates can be utilized by Irvington Unit 4 alone (Irvington Unit 4 is expected to burn approximately 225,000 tons of coal per year), amended contract price adjustment procedures, extended the expiration date of the agreement from 2002 to 2015 and provided for an exchange of the proceeds of the sale of undeveloped land for the $8 million 1990 penalty payment which was withheld during the period of the Payment Moratorium (the $8 million 1990 penalty payment remains an accrued liability on the Company's Consolidated Balance Sheet at December 31, 1994). Additionally, the penalty provisions of the contract were amended. P&M maintains their claim under the prior contract if the Company does not perform its obligations under the terms of the amended agreement at any time prior to November 4, 1995. If the Company fails to perform, the Company would be required, pursuant to the prior contract, to pay for approximately 5.1 million tons, that would not be delivered to the Company, at one-half the base price of coal through 2002, at an estimated aggregate cost of $98 million.\nAmendments to transportation agreements have also been executed, effective October 18, 1991, with the Springerville and Irvington rail transportation suppliers which, among other things, reduced the price for coal shipments and limited annual changes in the contract price. As discussed above with respect to the coal contracts, the Springerville amended rail transportation agreement includes provisions which protect the supplier's claims under the original contract in the event the Company does not perform its obligations under the terms of the amended agreement at any time during the four years subsequent to the amendment. If such a failure to perform occurs, the Company would be responsible for approximately $3 million per year to the Springerville transportation supplier at current contract prices. At December 31, 1994, a $3 million accrued liability remained on the Company's Consolidated Balance Sheet which will be forgiven, if all conditions are met during the four years subsequent to amendment of the Springerville agreement.\nThe Company's contracts to purchase coal for use at the joint projects in which the Company participates expire at various dates from 2005 to 2017 and, in the aggregate, require the Company to take 1.5 million tons of coal per year at an estimated annual cost of $16 million.\nFuel Purchase Commitments\nThe Company's contracts to purchase coal for use at Springerville, Irvington and each of the joint projects in which the Company participates contain various provisions calling for the payment of a take-or-pay amount, if certain minimum quantities of coal are not scheduled and delivered. The Company's present fuel requirements are generally in excess of the stated take-or-pay minimum amounts; however, from time to time, the Company has purchased spot market alternative fuels or switched fuel burn from one generating station to another in order to achieve lower overall fuel costs, while incurring take-or-pay minimum charges. As a result, the Company incurred take-or-pay minimum charges of approximately $1 million during 1993 and 1992. The Company incurred no take-or-pay charges in 1994.\nCOMMITMENTS - ENVIRONMENTAL REGULATION\nIn the fall of 1990, Congress adopted certain Federal Clean Air Act Amendments (CAAA) with respect to reductions in sulfur dioxide and nitrogen oxide emissions which will affect the Company's operation. The nitrogen oxide reductions will be based upon EPA regulations expected to be finalized in 1995 for certain boilers and by 1997 for all remaining boilers. In addition, the rules expected to be promulgated in 1995 may be revised in 1997. The required reductions of sulfur dioxide emissions will be implemented in two phases which will be effective in 1995 and 2000, respectively.\nThe Company is not affected by the requirements for sulfur dioxide emissions and nitrogen oxide reductions which go into effect in 1995 (Phase I), but is subject to the requirements that go into effect January 1, 2000 (Phase II). In Phase II, the maximum sulfur dioxide emission rates are set at 1.2 pounds per million BTU. Because of the Company's general use of low- sulfur coal and installed scrubbers at certain units, the Company's coal- fired generating stations already meet the sulfur dioxide emission rate requirements for Phase II. Additionally, further reductions are to be met through a proposed market-based system. Affected Company generating units will be allocated allowances based on required emission reductions and past use. An allowance permits emission of one ton of sulfur dioxide and may be sold. Generating station units must hold allowances equal to their level of emissions or face penalties and a requirement to offset excess tons in future years. On March 23, 1993, the EPA published the final sulfur dioxide allowance allocations for all Phase I and Phase II affected utility units, including the allowances that will be allocated to all Company units. An analysis of the sulfur dioxide allowances that were allocated to the Company shows that the Company would have sufficient allowances to permit normal plant operation and be in compliance with the sulfur dioxide regulations once the Phase II requirements become effective. However, until all the rulemaking regulation processes for implementing the CAAA are completed, the Company is unable to predict the specific impacts of all such amendments.\nThe CAAA also require multi-year studies of visibility impairment in specified areas and studies of hazardous air pollutants which relate to the necessity of future regulations of electric utility generating units. Since these activities involve the gathering of information not currently available, the Company cannot predict the outcome of these studies.\nAs a result of recent and possible future changes in federal and state environmental laws, regulations and permit requirements, the Company may incur additional costs for the purchase or upgrading of pollution control emission monitoring equipment on existing electric generating facilities and may experience a reduction in operating efficiency. There may be a need for variances from certain environmental standards and operating permit conditions until required equipment and processes for control, handling and disposal of emissions are operational and reliable. Failure to comply with any EPA or state compliance requirements may result in substantial penalties or fines which are provided for by law and which in some cases are mandatory.\nIn 1991, the EPA adopted a rule for the reduction of Navajo's sulfur dioxide emissions on an annual averaging basis by 90% to address visibility impairment at Grand Canyon National Park. The Company estimates that its share of the required capital expenditures remaining as of December 31, 1994 relating to the rule's implementation will be approximately $44 million, including AFDC, through 1999.\nCONTINGENCIES\nSDGE\/FERC Proceedings\nSan Diego Gas & Electric v. Tucson Electric Power Company\nOn February 11, 1993, SDGE filed a complaint and motion for summary disposition against the Company and Century before the FERC (San Diego Gas & Electric Company v. Tucson Electric Power Company and Century Power Corporation, Docket No. EL93-13-000). The complaint alleges that the Company and Century overbilled SDGE during Phases 3 through 5 of the Ten Year Power Sale Agreement (Ten Year Agreement) and requests that the FERC order refunds by the Company of an aggregate amount of approximately $14.5 million, plus interest. On April 23, 1993, the Company filed an answer denying the allegations of the complaint. The matter is pending.\nAlamito Company, Docket No. ER79-97-009\nOn September 27, 1993, SDGE filed a motion for decision by the FERC in Alamito Company, Docket No. ER79-97-009. This proceeding involved the proper capital structure and rate of return for rates under which Century Power Corporation (formerly Alamito Company) sold Company system power to SDGE during Phase 5 of the Ten Year Agreement, from June 1, 1987 through May 31, 1989. An initial decision of an administrative law judge in January 1986, found the Company's capital structure was inflated and its return on equity excessive. SDGE claimed that the Company would owe Century on SDGE's behalf up to approximately $12 million plus interest. On October 8, 1993, the Company filed an answer opposing SDGE's motion. It was the Company's position that the FERC's order of July 19, 1991 approving a settlement between SDGE and Century in Docket No. ER79-97-009, as well as the Company's and Century's mutual release of all claims against each other as part of their Financial Restructuring, bars SDGE's claim. On December 23, 1993, the FERC issued an order confirming that the July 19, 1991 order disposed of this case, and denied SDGE's September 27, 1993 motion. On January 21, 1994, SDGE requested rehearing of the FERC's order. That request is pending.\nBased on consultations with counsel, the Company believes that the resolution of the SDGE\/FERC Proceedings described herein should not have a material adverse effect, if any, on the Company's Consolidated Financial Statements.\nTax Assessments\nDuring the first quarter of 1993, the IRS completed an examination of the Company's consolidated federal income tax returns for tax years 1986 through 1990. The Company has reached a tentative settlement with the IRS, pending final approval, which would result in the Company paying additional taxes and interest, of approximately $5.4 million, as of December 31, 1994.\nThe Arizona Department of Revenue has issued transaction privilege tax assessments to the Company for the period November 1985 through May 1993 alleging that Valencia is liable for sales tax on gross income received from coal sales, transportation, and coal-handling services during such period. The Company protested the assessments. On March 11, 1994, the Arizona Tax Court issued a Minute Entry granting Summary Judgment to the Arizona Department of Revenue and upholding the validity of the assessment issued for the period November 1985 through March 1990. The Company appealed this decision to the Court of Appeals.\nAlso, the Arizona Department of Revenue has issued transaction privilege tax assessments to the lessors from whom the Company leases certain property alleging sales tax liability on a component of rents paid by the Company on the Springerville Unit 1 Leases, Springerville Common Facilities Leases, Irvington Lease and Valencia Leases. Assessments cover the period August 1, 1988 to September 30, 1993. Under the terms of the lease agreements, if the Arizona Department of Revenue prevails the Company must indemnify the lessors for taxes paid.\nIn the opinion of management, the Company has recorded, through the Consolidated Statement of Income (Loss) in current and prior years, a liability for the amount of federal and state taxes and interest thereon which the Company feels is probable of incurrence as of December 31, 1994. In the event that all or most of the Arizona Department of Revenue's proposed assessments are sustained, additional liabilities would result. Based on the current status of the legal proceedings, the Company believes that the ultimate resolution of such disputes will occur over a period of one and a half to four years. Although it is reasonably possible that the ultimate resolution of such matters could result in a loss of up to approximately $25 million in excess of amounts accrued, management and outside tax counsel believe that the Company has meritorious defenses to mitigate or eliminate the assessed amounts. Based on consultations with counsel, the Company believes that the resolution of the tax matters described herein should not have a material adverse effect on the Company's Consolidated Financial Statements.\nNOTE 8. SCECorp\/SCE LITIGATION SETTLEMENT - ------------------------------------------\nOn September 5, 1990, the Company commenced an action against SCECorp and SCE in the Superior Court of California for the County of San Diego. On September 15, 1992, the action was settled. Under the terms of the settlement agreement, SCECorp paid the Company $25 million in settlement of claims of interference with the proposed merger between the Company and SDGE, plus $15 million to cover the Company's litigation and related expenses. Pursuant to the terms of the settlement agreement, the lawsuit was dismissed with prejudice on September 28, 1992. In the Consolidated Statement of Income (Loss) for the year ended December 31, 1992, the proceeds from the settlement agreement are included as a reduction of Other Operations to the extent of litigation expenses incurred by the Company in pursuit of its claim (approximately $12 million as of December 31, 1992) and the remainder of the proceeds are included as Litigation Settlement.\nThe Company and SCE also agreed to a ten-year power exchange agreement beginning in 1995. Under the agreement, beginning in 1995 SCE will provide firm system capacity of 110 MW to the Company during summer months, for which the Company will pay an annual capacity charge of approximately $1 million annually increasing to a maximum of approximately $2 million annually. The Company will be entitled to schedule firm energy deliveries from SCE during the summer of up to 36,300 MWh per month, and will be obligated to return to SCE on an interruptible basis the same amount of energy the following winter season.\nNOTE 9. JOINTLY OWNED FACILITIES - ---------------------------------\nAt December 31, 1994, the Company's interests in jointly owned generating and transmission facilities were as follows:\nPercent Plant Construction Owned By in Work in Accumulated Company Service Progress Depreciation ----------- -------- ------------ ------------ - Thousands of Dollars -\nSan Juan Units 1 and 2 50.0 $294,156 $ 1,712 $190,721 Navajo Station 7.5 77,963 6,524 36,819 Four Corners Units 4 and 5 7.0 75,725 1,520 47,565 Transmission Facilities 7.5 to 95.0 204,930 1,166 90,159 -------- ------- -------- Total $652,774 $10,922 $365,264 ======== ======= ========\nThe Company has financed or provided funds for the above facilities and its share of operating expenses is included in the Consolidated Statements of Income (Loss).\nNOTE 10. EMPLOYEE BENEFITS PLANS - ---------------------------------\nPENSION PLANS\nThe Company has noncontributory pension plans for all regular employees. Benefits are based on years of service and the employee's average compensation. The Company makes annual contributions to the plans that are not greater than the maximum tax deductible contribution and not less than the minimum funding requirement by the Employee Retirement Income Security Act of 1974. Contributions are intended to provide for both current and future accrued benefits.\nThe following table sets forth the plans' funded status and amount recognized in the Company's Consolidated Financial Statements at December 31, 1994 and 1993. The actuarial present value of benefit obligations and reconciliation of funding status at October 1, were as follows:\n1994 1993 -------- -------- - Thousands of Dollars - Accumulated Benefit Obligations Vested $46,679 $51,955 Non-Vested 6,318 6,497 -------- -------- Total $52,997 $58,452 ======== ========\nPlan Assets at Fair Value, Principally Equity and Fixed Income Securities $77,021 $78,478 Projected Benefit Obligations (67,393) (78,997) -------- -------- Plan Assets in Excess of (Less Than) Projected Benefit Obligations 9,628 (519) Unrecognized Net (Gain) Loss from Past Experience (10,549) 568 Prior Service Cost Not Yet Recognized in Net Periodic Pension Cost 5,198 5,404 Unrecognized Net Assets at Transition Being Amortized Over 15 Years (2,017) (2,305) -------- -------- Prepaid Pension Cost Included in the Balance Sheet $ 2,260 $ 3,148 ======== ========\nYears Ended December 31, 1994 1993 1992 -------- -------- -------- - Thousands of Dollars - Components of Net Pension Cost Service Cost of Benefits Earned During Period $ 2,680 $ 1,558 $ 1,390 Interest Cost of Projected Benefit Obligation 5,615 4,689 4,283 Actual (Gain) Loss on Plan Assets 492 (14,508) (4,075) Net Amortization and Deferral (6,214) 10,187 54 -------- -------- -------- Net Periodic Pension Cost $ 2,573 $ 1,926 $ 1,652 ======== ======== ========\nAssumed Rates Used to Determine Pension Cost 1994 1993 1992 ---- ---- ---- Discount Rate - Funding Status 8.5% 7.0% 8.0% Average Compensation Increase 5.0 5.5 5.5 Expected Long-Term Rate of Return on Plan Assets 9.0 7.5 7.5\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nHealth care and life insurance benefits are provided for retired employees. All regular employees may become eligible for those benefits if they reach retirement age while working for the Company. Those and similar benefits are provided through an independent administrator handling health claims and a life insurance company that has premiums based on group rates.\nThe Company adopted FAS 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, in 1993. The accumulated postretirement benefit obligation as of January 1, 1993 of $19 million is being amortized to expense over a twenty-year period, in accordance with the provisions of FAS 106. The Company recognizes the FAS 106 periodic benefit cost as expense. In January 1994, the Company was authorized by the ACC to recover through rates the costs of benefits only as payments are made to retired employees; the postretirement benefits are currently funded entirely on a pay-as-you-go basis. Therefore, the Company has not recorded a regulatory asset for the excess of FAS 106 expense over actual benefit payments.\n1994 1993 --------- --------- - Thousands of Dollars - Accumulated Postretirement Benefits Obligation Retirees $ (5,270) $ (5,832) Fully Eligible Active Plan Participants (3,286) (3,130) Other Active Participants (9,849) (11,295) --------- --------- Total Accumulated Postretirement Benefits Obligation (18,405) (20,257) Unrecognized Net Gain from Past Experience (4,429) (786) Unrecognized Portion of the Transition Obligation Being Amortized Over 20 Years 17,247 18,205 --------- --------- Accrued Postretirement Benefit Cost Included in the Balance Sheet $ (5,587) $(2,838) ========= =========\n1994 1993 --------- --------- - Thousands of Dollars - Components of Net Postretirement Benefit Cost Service Cost of Benefits Earned During Period $ 931 $ 950 Interest Cost of Projected Benefit Obligation 1,395 1,491 Amortization of the Unrecognized Transition Obligation 958 958 --------- --------- Net Periodic Postretirement Benefit Cost $ 3,284 $ 3,399 ========= =========\nThe accumulated postretirement benefit obligation was determined using an 8.5% and 7% discount rate for 1994 and 1993, respectively. The health care cost trend rates were assumed to be 10% and 11% for 1994 and 1993, respectively, gradually declining to 5% in 2003 and 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, 1994 by approximately $2.8 million and the net periodic cost by $0.4 million for the year.\nADOPTION OF FAS 112\nIn January 1994 the Company adopted FAS 112, Employers' Accounting for Postemployment Benefits. Prior to 1994, postemployment benefits other than those related to retirement benefits were recognized on a pay-as-you-go basis. The effect of this change was an increase in postemployment benefits expense of $0.6 million for the year ended December 31, 1994.\nSTOCK OPTION PLANS\nOn May 20, 1994, the Shareholders of the Company approved two stock option plans, the 1994 Outside Director Stock Option Plan (Directors' Plan) and the 1994 Omnibus Stock and Incentive Plan (Omnibus Plan).\nThe Directors' Plan provides for the annual grant of 6,000 non- qualified stock options to each eligible director. Under the Directors' Plan, the first grant on January 3, 1995 consisted of 48,000 options at an exercise price of $3.125; these options vest ratably and become exercisable in one-third increments on each anniversary date of the grant and expire in 2005.\nThe Omnibus Plan allows the Compensation Committee, a committee comprised solely of non-employee directors, to grant any or all of the following types of awards to each eligible employee of the Company: stock options, including incentive stock options, non-qualified stock options and discounted stock options; stock appreciation rights; restricted stock; performance units; performance shares; and dividend equivalents. The total number of shares of the Company's stock which may be awarded under the Omnibus Plan cannot exceed eight million.\nDuring 1994, the Compensation Committee granted stock options intended to qualify as incentive stock options under the Internal Revenue Code to all employees, with exercise prices of $3.25 - $3.50. The options vest ratably over a three year period, with the first third becoming exercisable in 1995, and expire in 2004. The aggregate number of shares attributable to the 1994 grants is 2,214,205.\nThe Company's 1985 Stock Option Plan remains in effect and the options outstanding thereunder, which are fully exercisable, expire in 1995 to 1997. No options were exercised and the Company incurred no expense for the 1985 Plan during 1992 through 1994. The following summarizes the stock option transactions during the period December 31, 1992 through December 31, 1994:\nNumber of Exercise Options Price ------- ----------- Options Outstanding, December 31, 1992 and 1993: 1985 Plan - Primary 23,750 $40.375 to $58.625 Dividend Equivalents 14,053 --- Granted During 1994: 1994 Omnibus Plan 2,214,205 $3.25 to $3.50 --------- Options Outstanding, December 31, 1994 2,252,008 =========\nNOTE 11. QUARTERLY FINANCIAL DATA (unaudited) - ----------------------------------------------\nFirst Second Third Fourth --------- --------- --------- --------- - Thousands of Dollars - (except per share data) Operating Revenue $146,579 $171,097 $220,486 $153,311 Operating Income 8,259 27,951 64,310 13,882 Net Income (Loss) (14,580) 4,432 40,688 (9,800) Net Income (Loss) per Average Share (0.09) 0.03 0.25 (0.06)\nOperating Revenue $136,149 $148,349 $189,432 $150,209 Operating Income 4,511 14,179 44,902 20,354 Income (Loss) from Continuing Operations (18,522) (7,978) 22,386 (17,702) Provision for Loss on Disposal of Discontinued Operations - - - (4,000) Net Income (Loss) (18,522) (7,978) 22,386 (21,702) Net Income (Loss) per Average Share Continuing Operations (0.12) (0.05) 0.14 (0.11) Provision for Loss on Disposal of Discontinued Operations - - - (0.02) Total Net Income (Loss) per Average Share (0.12) (0.05) 0.14 (0.13)\nDue to seasonal fluctuations in sales, recognition of regulatory disallowances and adjustments, and provisions for loss on discontinued operations, the quarterly results are not indicative of annual operating results. See Notes 2 and 5 regarding significant adjustments which were recorded during the fourth quarter of 1993.\nBeginning in the fourth quarter of 1994, state and city sales taxes and similar taxes collected on revenues were removed from Operating Revenues and Taxes Other Than Income Taxes on the Consolidated Statement of Income (Loss). See Note 1. The tax amounts reclassified were as follows:\nFirst Second Third Fourth --------- --------- --------- --------- - Thousands of Dollars - Operating Revenue - Historical $155,475 $180,671 $234,083 N\/A Total Taxes Reclassified (8,896) (9,574) (13,597) N\/A --------- --------- --------- --------- Operating Revenue - Restated $146,579 $171,097 $220,486 N\/A ========= ========= ========= =========\nOperating Revenue - Historical $144,424 $157,434 $201,204 $159,375 Total Taxes Reclassified (8,275) (9,085) (11,772) (9,166) --------- --------- --------- --------- Operating Revenue - Restated $136,149 $148,349 $189,432 $150,209 ========= ========= ========= =========\nNOTE 12. SUPPLEMENTAL CASH FLOW INFORMATION - --------------------------------------------\nFor purposes of this statement, the Company defines Cash and Cash Equivalents as cash (unrestricted demand deposits) and all highly liquid investments purchased with a maturity of three months or less related to all of the Company's operations, including discontinued operations (see below). A reconciliation of net income (loss) to net cash flows from operating activities for the three years ended December 31, 1994 follows:\n1994 1993 1992 ---------- ---------- ---------- - Thousands of Dollars -\nIncome (Loss) from Continuing Operations $ 20,740 $ (21,816) $ (79,022) Adjustments to Reconcile Income (Loss) from Continuing Operations to Net Cash Flow Depreciation Expense 89,905 74,184 69,445 Capital Lease Rent Expense - - 13,161 Taxes Accrued 8,946 (2,303) 6,578 Deferred Income Taxes and Investment Tax Credits - Net (4,911) (5,277) (11,194) Deferred Fuel and Purchased Power 7,359 10,716 7,030 Litigation Settlements - Net - (5,000) (5,000) Lease Payments Deferred 32,024 29,870 10,830 Deferred Springerville Unit 2 Costs (1,133) (5,359) (4,143) Regulatory Disallowances and Adjustments, Net of Amortization (13,977) 5,629 (4,501) Loss on Financial Restructuring - - 26,669 Payments Withheld due to Payment Moratorium - - 46,665 Other (506) 314 13,188 Changes in Assets and Liabilities which Provided (Used) Cash Exclusive of Changes Shown Separately Accounts Receivable - Other (375) 1,119 4,526 Materials and Fuel 343 6,484 (629) Unbilled Revenues 625 (1,438) (631) Other Current Assets and Liabilities 601 (2,029) 3,034 Other Deferred Assets and Liabilities 3,975 4,237 (7,376) ---------- ---------- ---------- Net Cash Flows - Continuing Operating Activities $ 143,616 $ 89,331 $ 88,630 ========== ========== ==========\nNon-cash capital transactions and financing activities of the Company that affected recognized assets and liabilities but did not result in cash receipts or payments during the three years ended December 31, 1994 were:\n1994 1993 1992 ---------- ---------- ---------- - Thousands of Dollars -\nCapital Lease Obligations $ 8,107 $ 10,523 $ 926,169 Acquisition of Leased Assets - 3,385 883,607 Issuance of Common Stock and Warrants - - 197,128 Acquisition of Springerville Assets - - 30,645\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\nDIRECTORS\nInformation concerning Directors is contained under Election of Directors in the Company's Proxy Statement relating to the 1995 Annual Meeting of Shareholders, which information is incorporated herein by reference.\nEXECUTIVE OFFICERS\nExecutive Officers of the Company who are elected annually by the Company's Board of Directors, are as follows:\nExecutive\nOfficer Name Age Title Since\nCharles E. Bayless 52 Chairman of the Board, President and Chief Executive Officer (a) 1989\nIra R. Adler 44 Senior Vice President and Chief Financial Officer (b) 1988\nJames S. Pignatelli 51 Senior Vice President - Business Development (c) 1994\nThomas A. Delawder 48 Vice President - Energy Resources (d) 1985\nGary L. Ellerd 44 Vice President - Operations (e) 1985\nSteven J. Glaser 37 Vice President - Wholesale \/Retail Pricing and System Planning (f) 1994\nThomas N. Hansen 44 Vice President - Technical Advisor (g) 1992\nKaren G. Kissinger 40 Vice President and Controller (h) 1991\nGeorge W. Miraben 53 Vice President - Human Resources and Public Affairs (i) 1990\nDennis R. Nelson 44 Vice President, General Counsel and Corporate Secretary (j) 1991\nGerald A. O'Brien 53 Vice President - Customer Services & Marketing (k) 1990\nRomano Salvatori 57 Vice President - Independent Power (l) 1994\nSusan R. Wallach 47 Vice President - Business Development (m) 1990\nKevin P. Larson 38 Treasurer (n) 1994\n(a) Charles E. Bayless: Mr. Bayless joined the Company as Senior Vice President and Chief Financial Officer in December 1989. He was elected President and Chief Executive Officer in July 1990 and was elected to the Board of Directors in June 1990. On January 28, 1992, Mr. Bayless was named Chairman of the Board of Directors. Prior to joining the Company, he was Senior Vice President and Chief Financial Officer of Public Service Company of New Hampshire from 1981 through 1989.\n(b) Ira R. Adler: Mr. Adler joined the Company in 1986 as Manager of Financial Planning. In 1987 he was elected as Vice President and Treasurer of TRI, one of the Company's investment subsidiaries, from which position he resigned in October 1988, when he was elected Treasurer of the Company. He was elected Vice President - Finance and Treasurer in July 1989 and was elected Senior Vice President and Chief Financial Officer in July 1990 and President of TRI and SRI in April 1992. Prior to joining the Company, he was Vice President - Finance of US WEST Financial Services, Inc.\n(c) James S. Pignatelli: Mr. Pignatelli joined the Company as Senior Vice President in August 1994. Prior to joining the Company, he was President and Chief Executive Officer from 1988 to 1993 of Mission Energy Company, a subsidiary of SCE Corp.\n(d) Thomas A. Delawder: Mr. Delawder joined the Company in 1974 and thereafter served in various engineering and operations positions. In April 1985 he was named Manager, Systems Operations and was elected Vice President - Power Supply and System Control in November 1985. In February 1991, he became Vice President - - Engineering and Power Supply and in January 1992 he became Vice President - System Operations. In 1994, he became Vice President - Energy Resources.\n(e) Gary L. Ellerd: Mr. Ellerd joined the Company as Vice President and Controller in January 1985. He was elected Vice President - Services and Chief Information Officer in January 1991 and in January 1992 he became Vice President - - Corporate Information Services and Chief Information Officer. In 1994, he was named Vice President - Retail Customers. In 1995, he was named Vice President - - Operations.\n(f) Steven J. Glaser: Mr. Glaser joined the Company in 1990 as a Senior Attorney in charge of Regulatory Affairs. He was Manager of the Company's Legal department from 1992 to 1994, and Manager of Contracts and Wholesale Marketing from 1994 until elected Vice President - Business Development. In 1995, he was named Vice President - Wholesale\/Retail Pricing and System Planning.\n(g) Thomas N. Hansen: Mr. Hansen joined the Company in December 1992 as Vice President - Power Production. Prior to joining the Company, Mr. Hansen was Century's Vice President - Operations from 1989 and Plant Manager at Springerville from 1987 through 1988. In 1994, he was named Vice President - Technical Advisor.\n(h) Karen G. Kissinger: Ms. Kissinger joined the Company as Vice President and Controller in January 1991. Prior to joining the Company, she was a Manager with Deloitte & Touche from 1986 through 1989 and a Senior Manager through 1990.\n(i) George W. Miraben: Mr. Miraben was elected Vice President, Public Affairs, effective March 1990, and named Vice President - Human Resources and Public Affairs in 1994. Prior to joining the Company, he was Director of External Affairs for US WEST Communications' Arizona operation from 1981 through March 1990.\n(j) Dennis R. Nelson: Mr. Nelson joined the Company in 1976. He was manager of the Legal Department from 1985 to 1990. He was elected Vice President, General Counsel and Corporate Secretary in January 1991.\n(k) Gerald A. O'Brien: Mr. O'Brien joined the Company in 1961. Formerly Manager, Customer and Corporate Services, he was elected Vice President - - Customer Services and Human Resources in May 1990 and in January 1992 he became Vice President - Customer Operations. In 1994, he was named Vice President - Operations Support. In 1995, he was named Vice President - - Customer Services & Marketing.\n(l) Romano Salvatori: Mr. Salvatori joined the Company as Vice President - Independent Power in December 1994. Prior to joining the Company, he was Deputy General Manager, Power Generation Business Unit and General Manager, Power Generation Strategic Affairs Division of Westinghouse Electric Corporation from 1990 to 1994, and General Manager, Power Generation Commercial Operations Division from 1990 to 1993. In 1995, he was named President of Nations Energy Corporation, in addition to his responsibilities as Vice President - Independent Power.\n(m) Susan R. Wallach: Ms. Wallach joined the Company in 1974. Formerly Manager of Accounting Services and Assistant Controller, she was elected Vice President and Treasurer in July 1990. She was named Vice President - Future Marketing\/Sales\/Planning in 1994. In 1995, she was named Vice President - Business Development.\n(n) Kevin P. Larson: Mr. Larson joined the Company in 1985 and thereafter held various positions in its finance department and at the Company's investment subsidiaries. In January 1991, he was elected Assistant Treasurer of the Company and named Manager of Financial Programs. He was elected Treasurer in August 1994.\nITEM 11.","section_11":"ITEM 11. - EXECUTIVE COMPENSATION\nInformation concerning Executive Compensation is contained under Executive Compensation and Other Information in the Company's Proxy Statement relating to the 1995 Annual Meeting of Shareholders, which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nGENERAL\nAt March 6, 1995, the Company had outstanding 160,723,702 shares of Common Stock. As of March 6, 1995, the number of shares of Common Stock beneficially owned by all directors and officers of the Company as a group amounted to less than 1% of the outstanding Common Stock.\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS\nInformation concerning the security ownership of certain beneficial owners of the Company is contained under Security Ownership of Certain Beneficial Owners in the Company's Proxy Statement relating to the 1995 Annual Meeting of Shareholders, which information is incorporated herein by reference.\nSECURITY OWNERSHIP OF MANAGEMENT\nInformation concerning the security ownership of the Directors and Executive Officers of the Company is contained under Security Ownership of Certain Beneficial Owners in the Company's Proxy Statement relating to the 1995 Annual Meeting of Shareholders, which information is incorporated herein by references.\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\nPage\n(a) 1. Consolidated Financial Statements as of December 31, 1994 and 1993 and for Each of the Three Years in the Period Ended December 31, 1994.\nIndependent Auditors' Report 27 Consolidated Statements of Income (Loss) 28 Consolidated Balance Sheets 29 Consolidated Statements of Capitalization 30 Consolidated Statements of Cash Flows 31 Consolidated Statements of Changes in Stockholders' Equity (Deficit) 32 Notes to Consolidated Financial Statements 33\n2. Supplemental Consolidated Schedules for the Years Ended December 31, 1992 to 1994.\nSchedules I to V, inclusive, are omitted because they are not applicable or not required.\n3. Exhibits.\nReference is made to the Exhibit Index commencing on page 60\n(b) Reports on Form 8-K.\nThe Company has not filed any Current Reports on Form 8-K during the last quarter of the period covered in 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.\nTUCSON ELECTRIC POWER COMPANY\nDate: March 8, 1995 By Ira R. Adler ----------------------------------- IRA R. ADLER Senior Vice President and Principal 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 dates indicated.\nDate: March 8, 1995 Charles E. Bayless* ------------------------------------- Charles E. Bayless Chairman of the Board, President and Principal Executive Officer\nDate: March 8, 1995 Ira R. Adler ------------------------------------ Ira R. Adler Principal Financial Officer\nDate: March 8, 1995 Karen G. Kissinger* ------------------------------------ Karen G. Kissinger Principal Accounting Officer\nDate: March 8, 1995 Jose Canchola* ------------------------------------ Jose Canchola Director\nDate: March 8, 1995 Kathryn N. Dusenberry* ------------------------------------ Kathryn N. Dusenberry Director\nDate: March 8, 1995 John Jeter* ------------------------------------ John Jeter Director\nDate: March 8, 1995 R. B. O'Rielly* ------------------------------------ R. B. O'Rielly Director\nDate: March 8, 1995 Martha R. Seger* ------------------------------------ Martha R. Seger Director\nDate: March 8, 1995 Donald G. Shropshire* ------------------------------------ Donald G. Shropshire Director\nDate: March 8, 1995 H. Wilson Sundt* ------------------------------------ H. Wilson Sundt Director\nDate: March 8, 1995 By Ira R. Adler --------------------------------- Ira R. Adler as attorney-in-fact for each of the persons indicated\nEXHIBIT INDEX\n*3(a) -- Restated Articles of Incorporation, filed with the ACC on August 11, 1994. (Form 10-Q for the quarter ended September 30, 1994, File No. 1-5924--Exhibit 3).)\n*3(b) -- Bylaws of the Registrant, as amended May 20, 1994. (Form 10-Q for the quarter ended June 30, 1994, File No. 1-5924--Exhibit 3).)\n*4(a)(1) -- Indenture dated as of April 1, 1941, to The Chase National Bank of the City of New York, as Trustee. (Form S-7, File No. 2-59906-- Exhibit 2(b)(1).)\n*4(a)(2) -- First Supplemental Indenture, dated as of October 1, 1946. (Form S-7, File No. 2-59906--Exhibit 2(b)(2).)\n*4(a)(3) -- Second Supplemental Indenture dated as of October 1, 1947. (Form S-7, File No. 2-59906--Exhibit 2(b)(3).)\n*4(a)(4) -- Third Supplemental Indenture, dated as of April 1, 1949. (Form S-7, File No. 2-59906--Exhibit 2(b)(4).)\n*4(a)(5) -- Fourth Supplemental Indenture, dated as of December 1, 1952. (Form S-7, File No. 2-59906--Exhibit 2(b)(5).)\n*4(a)(6) -- Fifth Supplemental Indenture, dated as of January 1, 1955. (Form S-7, File No. 2-59906--Exhibit 2(b)(6).)\n*4(a)(7) -- Sixth Supplemental Indenture, dated as of January 1, 1958. (Form S-7, File No. 2-59906--Exhibit 2(b)(7).)\n*4(a)(8) -- Seventh Supplemental Indenture, dated as of November 1, 1959. (Form S-7, File No. 2-59906--Exhibit 2(b)(8).)\n*4(a)(9) -- Eighth Supplemental Indenture, dated as of November 1, 1961. (Form S-7, File No. 2-59906--Exhibit 2(b)(9).)\n*4(a)(10)-- Ninth Supplemental Indenture, dated as of February 20, 1964. (Form S-7, File No. 2-59906--Exhibit 2(b)(10).)\n*4(a)(11)-- Tenth Supplemental Indenture, dated as of February 1, 1965. (Form S-7, File No. 2-59906--Exhibit 2(b)(11).)\n*4(a)(12)-- Eleventh Supplemental Indenture, dated as of February 1, 1966. (Form S-7, File No. 2-59906--Exhibit 2(b)(12).)\n*4(a)(13)-- Twelfth Supplemental Indenture, dated as of November 1, 1969. (Form S-7, File No. 2-59906--Exhibit 2(b)(13).)\n*4(a)(14)-- Thirteenth Supplemental Indenture, dated as of January 20, 1970. (Form S-7, File No. 2-59906--Exhibit 2(b)(14).)\n*4(a)(15)-- Fourteenth Supplemental Indenture, dated as of September 1, 1971. (Form S-7, File No. 2-59906--Exhibit 2(b)(15).)\n*4(a)(16)-- Fifteenth Supplemental Indenture, dated as of March 1, 1972. (Form S-7, File No. 2-59906--Exhibit 2(b)(16).)\n*4(a)(17)-- Sixteenth Supplemental Indenture, dated as of May 1, 1973. (Form S-7, File No. 2-59906--Exhibit 2(b)(17).)\n*4(a)(18)-- Seventeenth Supplemental Indenture, dated as of November 1, 1975. (Form S-7, File No. 2-59906--Exhibit 2(b)(18).)\n*4(a)(19)-- Eighteenth Supplemental Indenture, dated as of November 1, 1975. (Form S-7, File No. 2-59906--Exhibit 2(b)(19).)\n*4(a)(20)-- Nineteenth Supplemental Indenture, dated as of July 1, 1976. (Form S-7, File No. 2-59906--Exhibit 2(b)(20).) *4(a)(21)-- Twentieth Supplemental Indenture, dated as of October 1, 1977. (Form S-7, File No. 2-59906--Exhibit 2(b)(21).)\n*4(a)(22)-- Twenty-first Supplemental Indenture, dated as of November 1, 1977. (Form 10-K for year ended December 31, 1980, File No. 1-5924-- Exhibit 4(v).)\n*4(a)(23)-- Twenty-second Supplemental Indenture, dated as of January 1, 1978. (Form 10-K for year ended December 31, 1980, File No. 1-5924-- Exhibit 4(w).)\n*4(a)(24)-- Twenty-third Supplemental Indenture, dated as of July 1, 1980. (Form 10-K for year ended December 31, 1980, File No. 1-5924--Exhibit 4(x).)\n*4(a)(25)-- Twenty-fourth Supplemental Indenture, dated as of October 1, 1980. (Form 10-K for year ended December 31, 1980, File No. 1-5924-- Exhibit 4(y).)\n*4(a)(26)-- Twenty-fifth Supplemental Indenture, dated as of April 1, 1981. (Form 10-Q for quarter ended March 31, 1981, File No. 1-5924--Exhibit 4(a).)\n*4(a)(27)-- Twenty-sixth Supplemental Indenture, dated as of April 1, 1981. (Form 10-Q for quarter ended March 31, 1981, File No. 1-5924--Exhibit 4(b).)\n*4(a)(28)-- Twenty-seventh Supplemental Indenture, dated as of October 1, 1981. (Form 10-Q for quarter ended September 30, 1982, File No. 1-5924- -Exhibit 4(c).)\n*4(a)(29)-- Twenty-eighth Supplemental Indenture, dated as of June 1, 1990. (Form 10-Q for quarter ended June 30, 1990, File No. 1-5924--Exhibit 4(a)(1).)\n*4(a)(30)-- Twenty-ninth Supplemental Indenture, dated as of December 1, 1992. (Form S-1, Registration No. 33-55732--Exhibit 4(a)(30).)\n*4(a)(31)-- Thirtieth Supplemental Indenture, dated as of December 1, 1992. (Form S-1, Registration No. 33-55732--Exhibit 4(a)(31).)\n*4(b)(1) -- Installment Sale Agreement, dated as of December 1, 1973, among the City of Farmington, New Mexico, Public Service Company of New Mexico and the Registrant. (Form 8-K for the month of January 1974, File No. 0-269--Exhibit 3.)\n*4(b)(2) -- Ordinance No. 486, adopted December 17, 1973, of the City of Farmington, New Mexico. (Form 8-K for the month of January 1974, File No. 0-269--Exhibit 4.)\n*4(c)(1) -- Loan Agreement, dated as of September 15, 1981, between the Industrial Development Authority of the County of Apache, Arizona and the Registrant, relating to Floating Rate Monthly Demand Pollution Control Revenue Bonds, 1981 Series B (Tucson Electric Power Company Project). (Form 10-K for year ended December 31, 1981, File No. 1- 5924--Exhibit 4(d)(1).)\n*4(c)(2) -- Indenture of Trust, dated as of September 15, 1981, between the Apache County Authority and Morgan Guaranty Trust Company of New York, authorizing Floating Rate Monthly Demand Pollution Control Revenue Bonds, 1981 Series B (Tucson Electric Power Company Project). (Form 10-K for year ended December 31, 1981, File No. 1-5924--Exhibit 4(d)(2).)\n*4(d)(1) -- Second Supplemental Loan Agreement, dated as of October 1, 1981, between the Apache County Authority and the Registrant, relating to Floating Rate Monthly Demand Pollution Control Revenue Bonds, 1981 Series B (Tucson Electric Power Company Project). (Form 10-K for year ended December 31, 1982, File No. 1-5924--Exhibit 4(f)(1).)\n*4(d)(2) -- Second Supplemental Indenture, dated as of October 1, 1981, between the Apache County Authority and Morgan Guaranty, relating to Floating Rate Monthly Demand Pollution Control Revenue Bonds, 1981 Series B (Tucson Electric Power Company Project). (Form 10-K for year ended December 31, 1982, File No. 1-5924--Exhibit 4(f)(2).)\n*4(d)(3) -- Third Supplemental Loan Agreement, dated as of December 1, 1985, between the Apache County Authority and the Registrant, relating to Floating Rate Monthly Demand Pollution Control Revenue Bonds, 1981 Series B (Tucson Electric Power Company Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924--Exhibit 4(d)(3).)\n*4(d)(4) -- Third Supplemental Indenture, dated as of December 1, 1985, between the Apache County Authority and Morgan Guaranty, relating to Floating Rate Monthly Demand Pollution Control Revenue Bonds, 1981 Series B (Tucson Electric Power Company Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924--Exhibit 4(d)(4).)\n*4(d)(5) -- Fourth Supplemental Indenture of Trust, dated as of March 31, 1992, between the Apache County Authority and Morgan Guaranty, relating to Pollution Control Revenue Bonds, 1981 Series B (Tucson Electric Power Company Project). (Form S-4, Registration No. 33-52860- -Exhibit 4(d)(5).)\n*4(d)(6) -- Fourth Supplemental Loan Agreement, dated as of March 31, 1992, between the Apache County Authority and the Registrant, relating to Pollution Control Revenue Bonds, 1981 Series B (Tucson Electric Power Company Project). (Form S-4, Registration No. 33-52860--Exhibit 4(d)(6).)\n*4(e)(1) -- Loan Agreement, dated as of October 1, 1981, between The Industrial Development Authority of the County of Pima, Arizona (the Pima County Authority) and the Registrant, relating to Floating Rate Monthly Demand Pollution Control Revenue Bonds, 1981 Series A (Tucson Electric Power Company Project). (Form 10-K for year ended December 31, 1981, File No. 1-5924--Exhibit 4(f)(1).)\n*4(e)(2) -- Indenture of Trust, dated as of October 1, 1981, between the Pima County Authority and Morgan Guaranty, authorizing Floating Rate Monthly Demand Pollution Control Revenue Bonds, 1981 Series A (Tucson Electric Power Company Project). (Form 10-K for year ended December 31, 1981, File No. 1-5924--Exhibit 4(f)(2).)\n*4(f)(1) -- Loan Agreement, dated as of July 1, 1982, between the Pima County Authority and the Registrant, relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form 10-Q for quarter ended June 30, 1982, File No. 1-5924--Exhibit 4(a).)\n*4(f)(2) -- Indenture of Trust, dated as of July 1, 1982, between the Pima County Authority and Morgan Guaranty, authorizing Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form 10-Q for quarter ended June 30, 1982, File No. 1-5924--Exhibit 4(b).)\n*4(f)(3) -- First Supplemental Loan Agreement, dated as of March 31, 1992, between the Pima County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form S-4, Registration No. 33-52860- -Exhibit 4(f)(3).)\n*4(f)(4) -- First Supplemental Indenture of Trust, dated as of March 31, 1992, between the Pima County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form S-4, Registration No. 33-52860--Exhibit 4(f)(4).)\n*4(g)(1) -- Loan Agreement, dated as of July 1, 1982, between the Pima County Authority and the Registrant, relating to Quarterly Tender Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power General Project). (Form 10-Q for quarter ended June 30, 1982, File No. 1-5924--Exhibit 4(c).)\n*4(g)(2) -- Indenture of Trust, dated as of July 1, 1982, between the Pima County Authority and Morgan Guaranty, authorizing Quarterly Tender Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form 10-Q for quarter ended June 30, 1982, File No. 1-5924--Exhibit 4(d).)\n*4(g)(3) -- First Supplemental Loan Agreement, dated as of March 31, 1992, between the Pima County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form S-4, Registration No. 33-52860- -Exhibit 4(g)(3).)\n*4(g)(4) -- First Supplemental Indenture of Trust, dated as of March 31, 1992, between the Pima County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form S-4, Registration No. 33-52860--Exhibit 4(g)(4).)\n*4(h)(1) -- Loan Agreement, dated as of October 1, 1982, between the Pima County Authority and the Registrant relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company Irvington Project). (Form 10-Q for quarter ended September 30, 1982, File No. 1-5924--Exhibit 4(a).)\n*4(h)(2) -- Indenture of Trust, dated as of October 1, 1982, between the Pima County Authority and Morgan Guaranty authorizing Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company Irvington Project). (Form 10-Q for quarter ended September 30, 1982, File No. 1-5924--Exhibit 4(b).)\n*4(h)(3) -- First Supplemental Loan Agreement, dated as of March 31, 1992, between the Pima County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company Irvington Project). (Form S-4, Registration No. 33- 52860--Exhibit 4(h)(3).)\n*4(h)(4) -- First Supplemental Indenture of Trust, dated as of March 31, 1992, between the Pima County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company Irvington Project). (Form S-4, Registration No. 33-52860--Exhibit 4(h)(4).)\n*4(i)(1) -- Loan Agreement, dated as of December 1, 1982, between the Pima County Authority and the Registrant relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company Projects). (Form 10-K for year ended December 31, 1982, File No. 1-5924--Exhibit 4(k)(1).)\n*4(i)(2) -- Indenture of Trust, dated as of December 1, 1982, between the Pima County Authority and Morgan Guaranty authorizing Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company Projects). (Form 10-K for year ended December 31, 1982, File No. 1-5924--Exhibit 4(k)(2).)\n*4(i)(3) -- First Supplemental Loan Agreement, dated as of March 31, 1992, between the Pima County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company Projects). (Form S-4, Registration No. 33-52860--Exhibit 4(i)(3).)\n*4(i)(4) -- First Supplemental Indenture of Trust, dated as of March 31, 1992, between the Pima County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company Projects). (Form S-4, Registration No. 33-52860- -Exhibit 4(i)(4).)\n*4(j)(1) -- Loan Agreement, dated as of March 1, 1983, between the Pima County Authority and the Registrant relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form 10-Q for the quarter ended March 31, 1983, File No. 1-5924--Exhibit 4(a).)\n*4(j)(2) -- Indenture of Trust, dated as of March 1, 1983, between the Pima County Authority and Morgan Guaranty authorizing Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1982 Series A (Tucson Electric Power Company General Project). (Form 10-Q for the quarter ended March 31, 1983, File No. 1-5924--Exhibit 4(b).)\n*4(j)(3) -- First Supplemental Loan Agreement, dated as of March 31, 1992, between the Pima County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1983 Series A (Tucson Electric Power Company General Project) (Form S-4 dated October 2, 1992, Registration No. 33-52860--Exhibit 4(j)(3).)\n*4(j)(4) -- First Supplemental Indenture of Trust, dated as of March 31, 1992, between the Pima County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1983 Series A (Tucson Electric Power Company General Project) (Form S-4 dated October 2, 1992, Registration No. 33-52860--Exhibit 4(j)(4).)\n*4(k)(1) -- Loan Agreement, dated as of December 1, 1983, between the Apache County Authority and the Registrant relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1983 Series A (Tucson Electric Power Company Springerville Project). (Form 10-K for year ended December 31, 1983, File No. 1-5924--Exhibit 4(l)(1).)\n*4(k)(2) -- Indenture of Trust, dated as of December 1, 1983, between the Apache County Authority and Morgan Guaranty authorizing Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1983 Series A (Tucson Electric Power Company Springerville Project). (Form 10-K for year ended December 31, 1983, File No. 1-5924--Exhibit 4(l)(2).)\n*4(k)(3) -- First Supplemental Loan Agreement, dated as of December 1, 1985, between the Apache County Authority and the Registrant relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1983 Series A (Tucson Electric Power Company Springerville Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924-- Exhibit 4(k)(3).)\n*4(k)(4) -- First Supplemental Indenture, dated as of December 1, 1985, between the Apache County Authority and Morgan Guaranty relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1983 Series A (Tucson Electric Power Company Springerville Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924-- Exhibit 4(k)(4).)\n*4(k)(5) -- Second Supplemental Loan Agreement, dated as of March 31, 1992, between the Apache County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1983 Series A (Tucson Electric Power Company Springerville Project). (Form S-4, Registration No. 33- 52860--Exhibit 4(k)(5).)\n*4(k)(6) -- Second Supplemental Indenture of Trust, dated as of March 31, 1992, between the Apache County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1983 Series A (Tucson Electric Power Company Springerville Project). (Form S-4, Registration No. 33-52860--Exhibit 4(k)(6).)\n*4(l)(1) -- Loan Agreement, dated as of December 1, 1983, between the Apache County Authority and the Registrant relating to Variable Rate Demand Industrial Development Revenue Bonds, 1983 Series B (Tucson Electric Power Company Springerville Project). (Form 10-K for year ended December 31, 1983, File No. 1-5924--Exhibit 4(m)(1).)\n*4(l)(2) -- Indenture of Trust, dated as of December 1, 1983, between the Apache County Authority and Morgan Guaranty authorizing Variable Rate Demand Industrial Development Revenue Bonds, 1983 Series B (Tucson Electric Power Company Springerville Project). (Form 10-K for year ended December 31, 1983, File No. 1-5924--Exhibit 4(m)(2).)\n*4(l)(3) -- First Supplemental Loan Agreement, dated as of December 1, 1985, between the Apache County Authority and the Registrant relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1983 Series B (Tucson Electric Power Company Springerville Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924-- Exhibit 4(l)(3).)\n*4(l)(4) -- First Supplemental Indenture, dated as of December 1, 1985, between the Apache County Authority and Morgan Guaranty relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1983 Series B (Tucson Electric Power Company Springerville Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924-- Exhibit 4(l)(4).)\n*4(l)(5) -- Second Supplemental Loan Agreement, dated as of March 31, 1992, between the Apache County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1983 Series B (Tucson Electric Power Company Springerville Project). (Form S-4, Registration No. 33- 52860--Exhibit 4(l)(5).)\n*4(l)(6) -- Second Supplemental Indenture of Trust, dated as of March 31, 1992, between the Apache County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1983 Series B (Tucson Electric Power Company Springerville Project). (Form S-4, Registration No. 33-52860--Exhibit 4(l)(6).)\n*4(m)(1) -- Loan Agreement, dated as of December 1, 1983, between the Apache County Authority and the Registrant relating to Variable Rate Demand Industrial Development Revenue Bonds, 1983 Series C (Tucson Electric Power Company Springerville Project). (Form 10-K for year ended December 31, 1983, File No. 1-5924--Exhibit 4(n)(1).)\n*4(m)(2) -- Indenture of Trust, dated as of December 1, 1983, between the Apache County Authority and Morgan Guaranty authorizing Variable Rate Demand Industrial Development Revenue Bonds, 1983 Series C (Tucson Electric Power Company Springerville Project). (Form 10-K for year ended December 31, 1983, File No. 1-5924--Exhibit 4(n)(2).)\n*4(m)(3) -- First Supplemental Loan Agreement, dated as of December 1, 1985, between the Apache County Authority and the Registrant relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1983 Series C (Tucson Electric Power Company Springerville Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924-- Exhibit 4(m)(3).)\n*4(m)(4) -- First Supplemental Indenture, dated as of December 1, 1985, between the Apache County Authority and Morgan Guaranty relating to Floating Rate Monthly Demand Industrial Development Revenue Bonds, 1983 Series C (Tucson Electric Power Company Springerville Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924-- Exhibit 4(m)(4).)\n*4(m)(5) -- Second Supplemental Loan Agreement, dated as of March 31, 1992, between the Apache County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1983 Series C (Tucson Electric Power Company Springerville Project). (Form S-4, Registration No. 33- 52860--Exhibit 4(m)(5).)\n*4(m)(6) -- Second Supplemental Indenture of Trust, dated as of March 31, 1992, between the Apache County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1983 Series C (Tucson Electric Power Company Springerville Project). (Form S-4, Registration No. 33-52860--Exhibit 4(m)(6).)\n*4(n) -- Reimbursement Agreement, dated as of September 15, 1981, as amended, between the Registrant and Manufacturers Hanover Trust Company. (Form 10-K for the year ended December 31, 1984, File No. 1- 5924--Exhibit 4(o)(4).)\n*4(o)(1) -- Loan Agreement, dated as of December 1, 1985, between the Apache County Authority and the Registrant relating to Variable Rate Demand Industrial Development Revenue Bonds, 1985 Series A (Tucson Electric Power Company Springerville Project). (Form 10-K for the year ended December 31, 1985, File No. 1-5924---Exhibit 4(r)(1).)\n*4(o)(2) -- Indenture of Trust, dated as of December 1, 1985, between the Apache County Authority and Morgan Guaranty authorizing Variable Rate Demand Industrial Development Revenue Bonds, 1985 Series A (Tucson Electric Power Company Springerville Project). (Form 10-K for the year ended December 31, 1985, File No. 1-5924--Exhibit 4(r)(2).)\n*4(o)(3) -- First Supplemental Loan Agreement, dated as of March 31, 1992, between the Apache County Authority and the Registrant relating to Industrial Development Revenue Bonds, 1985 Series A (Tucson Electric Power Company Springerville Project). (Form S-4, Registration No. 33- 52860--Exhibit 4(o)(3).)\n*4(o)(4) -- First Supplemental Indenture of Trust, dated as of March 31, 1992, between the Apache County Authority and Morgan Guaranty relating to Industrial Development Revenue Bonds, 1985 Series A (Tucson Electric Power Company Springerville Project). (Form S-4, Registration No. 33-52860--Exhibit 4(o)(4).)\n*4(p)(1) -- Loan Agreement, dated as of February 22, 1991, between the Industrial Development Authority of the County of Pima and the Registrant, amending and restating the Loan Agreement, dated as of May 1, 1990, relating to Industrial Development Revenue Bonds, 1990 Series A (Tucson Electric Power Company Project). (Form 10-K for the year ended December 31, 1990, File No. 1-5924--Exhibit 4(p)(1).)\n*4(p)(2) -- Indenture of Trust, dated as of February 22, 1991, between the Industrial Development Authority of the County of Pima and Texas Commerce Bank National Association, amending and restating the Indenture of Trust, dated as of May 1, 1990, authorizing Industrial Development Revenue Bonds, 1990 Series A (Tucson Electric Power Company Project). (Form 10-K for the year ended December 31, 1990, File No. 1-5924--Exhibit 4(p)(2).)\n*4(q) -- Warrant Agreement and Form of Warrant, dated as of December 15, 1992. (Form S-1, Registration No. 33-55732--Exhibit 4(q).)\n*4(r)(1) -- Indenture of Mortgage and Deed of Trust dated as of December 1, 1992, to Bank of Montreal Trust Company, Trustee. (Form S-1, Registration No. 33-55732--Exhibit 4(r)(1).)\n*4(r)(2) -- Supplemental Indenture No. 1 creating a series of bonds designated Second Mortgage Bonds, Collateral Series A, dated as of December 1, 1992. (Form S-1, Registration No. 33-55732-Exhibit 4(r)(2).)\n*+10(a) -- 1985 Stock Option Plan of the Registrant. (Form 10-K for the year ended December 31, 1985, File No. 1-5924--Exhibit 10(b).)\n*+10(b) -- 1987 Phantom Stock Plan of the Registrant. (Form 10-K for the year ended December 31, 1987, File No. 1-5924--Exhibit 10(c).)\n*10(c)(1)-- Lease Agreements, dated as of December 1, 1984, between Valencia Energy Company (\"Valencia\") and United States Trust Company of New York, as Trustee, and Thomas B. Zakrzewski, as Co-Trustee, as amended and supplemented. (Form 10-K for the year ended December 31, 1984, File No. 1-5924--Exhibit 10(d)(1).)\n*10(c)(2)-- Guaranty and Agreements, dated as of December 1, 1984, between the Registrant and United States Trust Company of New York, as Trustee, and Thomas B. Zakrzewski, as Co-Trustee. (Form 10-K for the year ended December 31, 1984, File No. 1-5924--Exhibit 10(d)(2).)\n*10(c)(3)-- General Indemnity Agreements, dated as of December 1, 1984, between Valencia and the Registrant, as Indemnitors; General Foods Credit Corporation, Harvey Hubbell Financial, Inc. and J. C. Penney Company, Inc. as Owner Participants; United States Trust Company of New York, as Owner Trustee; Teachers Insurance and Annuity Association of America as Loan Participant; and Marine Midland Bank, N.A., as Indenture Trustee. (Form 10-K for the year ended December 31, 1984, File No. 1-5924--Exhibit 10(d)(3).)\n*10(c)(4)-- Tax Indemnity Agreements, dated as of December 1, 1984, between General Foods Credit Corporation, Harvey Hubbell Financial, Inc. and J. C. Penney Company, Inc., each as Beneficiary under a separate Trust Agreement dated December 1, 1984, with United States Trust of New York as Owner Trustee, and Thomas B. Zakrzewski as Co-Trustee, Lessor, and Valencia, Lessee, and the Registrant, Indemnitors. (Form 10-K for the year ended December 31, 1984, File No. 1-5924--Exhibit 10(d)(4).)\n*10(c)(5)-- Amendment No. 1, dated December 31, 1984, to the Lease Agreements, dated December 1, 1984, between Valencia and United States Trust Company of New York, as Owner Trustee, and Thomas B. Zakrzewski as Co-Trustee. (Form 10-K for the year ended December 31, 1986, File No. 1-5924--Exhibit 10(e)(5).)\n*10(c)(6)-- Amendment No. 2, dated April 1, 1985, to the Lease Agreements, dated December 1, 1984, between Valencia and United States Trust Company of New York, as Owner Trustee, and Thomas B. Zakrzewski as Co- Trustee. (Form 10-K for the year ended December 31, 1986, File No. 1- 5924--Exhibit 10(e)(6).)\n*10(c)(7)-- Amendment No. 3, dated August 1, 1985, to the Lease Agreements, dated December 1, 1984, between Valencia and United States Trust Company of New York, as Owner Trustee, and Thomas Zakrzewski as Co- Trustee. (Form 10-K for the year ended December 31, 1986, File No. 1- 5924--Exhibit 10(e)(7).)\n*10(c)(8)-- Amendment No. 4, dated June 1, 1986, to the Lease Agreement, dated December 1, 1984, between Valencia and United States Trust Company of New York as Owner Trustee, and Thomas Zakrzewski as Co- Trustee, under a Trust Agreement dated as of December 1, 1984, with General Foods Credit Corporation as Owner Participant. (Form 10-K for the year ended December 31, 1986, File No. 1-5924--Exhibit 10(e)(8).)\n*10(c)(9)-- Amendment No. 4, dated June 1, 1986, to the Lease Agreement, dated December 1, 1984, between Valencia and United States Trust Company of New York as Owner Trustee, and Thomas Zakrzewski as Co- Trustee, under a Trust Agreement dated as of December 1, 1984, with J. C. Penney Company, Inc. as Owner Participant. (Form 10-K for the year ended December 31, 1986, File No. 1-5924--Exhibit 10(e)(9).)\n*10(c)(10) -- Amendment No. 4, dated June 1, 1986, to the Lease Agreement, dated December 1, 1984, between Valencia and United States Trust Company of New York as Owner Trustee, and Thomas Zakrzewski as Co- Trustee, under a Trust Agreement dated as of December 1, 1984, with Harvey Hubbell Financial Inc. as Owner Participant. (Form 10-K for the year ended December 31, 1986, File No. 1-5924--Exhibit 10(e)(10).)\n*10(c)(11) -- Lease Amendment No. 5 and Supplement No. 2, to the Lease Agreement, dated July 1, 1986, between Valencia, United States Trust Company of New York as Owner Trustee, and Thomas Zakrzewski as Co- Trustee and J. C. Penney as Owner Participant. (Form 10-K for the year ended December 31, 1986, File No. 1-5924--Exhibit 10(e)(11).)\n*10(c)(12) -- Lease Amendment No. 5, to the Lease Agreement, dated June 1, 1987, between Valencia, United States Trust Company of New York as Owner Trustee, and Thomas Zakrzewski as Co-Trustee and General Foods Credit Corporation as Owner Participant. (Form 10-K for the year ended December 31, 1988, File No. 1-5924--Exhibit 10(f)(12).)\n*10(c)(13) -- Lease Amendment No. 5, to the Lease Agreement, dated June 1, 1987, between Valencia, United States Trust Company of New York as Owner Trustee, and Thomas Zakrzewski as Co-Trustee and Harvey Hubbell Financial Inc. as Owner Participant. (Form 10-K for the year ended December 31, 1988, File No. 1-5924--Exhibit 10(f)(13).)\n*10(c)(14) -- Lease Amendment No. 6, to the Lease Agreement, dated June 1, 1987, between Valencia, United States Trust Company of New York as Owner Trustee, and Thomas Zakrzewski as Co-Trustee and J. C. Penney Company, Inc. as Owner Participant. (Form 10-K for the year ended December 31, 1988, File No. 1-5924--Exhibit 10(f)(14).)\n*10(c)(15) -- Lease Supplement No. 1, dated December 31, 1984, to Lease Agreements, dated December 1, 1984, between Valencia, as Lessee and United States Trust Company of New York and Thomas B. Zakrzewski, as Owner Trustee and Co-Trustee, respectively (document filed relates to General Foods Credit Corporation; documents relating to Harvey Hubbel Financial, Inc. and JC Penney Company, Inc. are not filed but are substantially similar). (Form S-4, Registration No. 33-52860--Exhibit 10(f)(15).)\n*10(c)(16) -- Amendment No. 1, dated June 1, 1986, to the General Indemnity Agreement, dated as of December 1, 1984, between Valencia and the Registrant, as Indemnitors, General Foods Credit Corporation, as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form 10-K for the year ended December 31, 1986, File No. 1-5924-- Exhibit 10(e)(12).)\n*10(c)(17) -- Amendment No. 1, dated June 1, 1986, to the General Indemnity Agreement, dated as of December 1, 1984, between Valencia and the Registrant, as Indemnitors, J. C. Penney Company, Inc., as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form 10-K for the year ended December 31, 1986, File No. 1-5924-- Exhibit 10(e)(13).)\n*10(c)(18) -- Amendment No. 1, dated June 1, 1986, to the General Indemnity Agreement, dated as of December 1, 1984, between Valencia and the Registrant, as Indemnitors, Harvey Hubbell Financial, Inc., as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form 10-K for the year ended December 31, 1986, File No. 1- 5924--Exhibit 10(e)(14).)\n*10(c)(19) -- Amendment No. 2, dated as of July 1, 1986, to the General Indemnity Agreement, dated as of December 1, 1984, between Valencia and the Registrant, as Indemnitors, J. C. Penney Company, Inc., as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form S-4, Registration No. 33-52860--Exhibit 10(f)(19).)\n*10(c)(20) -- Amendment No. 2, dated as of June 1, 1987, to the General Indemnity Agreement, dated as of December 1, 1984, between Valencia and the Registrant, as Indemnitors, General Foods Credit Corporation, as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form S-4, Registration No. 33-52860--Exhibit 10(f)(20).)\n*10(c)(21) -- Amendment No. 2, dated as of June 1, 1987, to the General Indemnity Agreement, dated as of December 1, 1984, between Valencia and the Registrant, as Indemnitors, Harvey Hubbell Financial, Inc., as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form S-4, Registration No. 33-52860--Exhibit 10(f)(21).)\n*10(c)(22) -- Amendment No. 3, dated as of June 1, 1987, to the General Indemnity Agreement, dated as of December 1, 1984, between Valencia and the Registrant, as Indemnitors, J. C. Penney Company, Inc., as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form S-4, Registration No. 33-52860--Exhibit 10(f)(22).)\n*10(c)(23) -- Supplemental Tax Indemnity Agreement, dated July 1, 1986, between J. C. Penney Company, Inc., as Owner Participant, and Valencia and the Registrant, as Indemnitors. (Form 10-K for the year ended December 31, 1986, File No. 1-5924--Exhibit 10(e)(15).)\n*10(c)(24) -- Supplemental General Indemnity Agreement, dated as of July 1, 1986, among Valencia and the Registrant, as Indemnitors, J. C. Penney Company, Inc., as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form 10-K for the year ended December 31, 1986, File No. 1-5924--Exhibit 10(e)(16).)\n*10(c)(25) -- Amendment No. 1, dated as of June 1, 1987, to the Supplemental General Indemnity Agreement, dated as of July 1, 1986, among Valencia and the Registrant, as Indemnitors, J. C. Penney Company, Inc., as Owner Participant, United States Trust Company of New York, as Owner Trustee, Teachers Insurance and Annuity Association of America, as Loan Participant, and Marine Midland Bank, N.A., as Indenture Trustee. (Form S-4, Registration No. 33-52860--Exhibit 10(f)(25).)\n*10(c)(26) -- Valencia Agreement, dated as of June 30, 1992, among the Registrant, as Guarantor, Valencia, as Lessee, Teachers Insurance and Annuity Association of America, as Loan Participant, Marine Midland Bank, N.A., as Indenture Trustee, United States Trust Company of New York, as Owner Trustee, and Thomas B. Zakrzewski, as Co-Trustee, and the Owner Participants named therein relating to the Restructuring of Valencia's lease of the coal-handling facilities at the Springerville Generating Station. (Form S-4, Registration No. 33-52860--Exhibit 10(f)(26).)\n*10(c)(27) -- Amendment, dated as of December 15, 1992, to the Lease Agreements, dated December 1, 1984, between Valencia, as Lessee, and United States Trust Company of New York, as Owner Trustee, and Thomas B. Zakrzewski, as Co-Trustee. (Form S-1, Registration No. 33-55732-- Exhibit 10(f)(27).)\n*10(d)(1)-- Lease Agreements, dated as of December 1, 1985, between the Registrant and San Carlos Resources Inc. (San Carlos) (a wholly-owned subsidiary of the Registrant) jointly and severally, as Lessee, and Wilmington Trust Company, as Trustee, as amended and supplemented. (Form 10-K for the year ended December 31, 1985, File No. 1-5924-- Exhibit 10(f)(1).)\n*10(d)(2)-- Tax Indemnity Agreements, dated as of December 1, 1985, between Philip Morris Credit Corporation, IBM Credit Financing Corporation and Emerson Finance Co., each as beneficiary under a separate trust agreement, dated as of December 1, 1985, with Wilmington Trust Company, as Owner Trustee, and William J. Wade, as Co-Trustee, and the Registrant and San Carlos, as Lessee. (Form 10-K for the year ended December 31, 1985, File No. 1-5924--Exhibit 10(f)(2).)\n*10(d)(3)-- Participation Agreement, dated as of December 1, 1985, among the Registrant and San Carlos as Lessee, Philip Morris Credit Corporation, IBM Credit Financing Corporation, and Emerson Finance Co. as Owner Participants, Wilmington Trust Company as Owner Trustee, The Sumitomo Bank, Limited, New York Branch, as Loan Participant, and Bankers Trust Company, as Indenture Trustee. (Form 10-K for the year ended December 31, 1985, File No. 1-5924--Exhibit 10(f)(3).)\n*10(d)(4)-- Restructuring Commitment Agreement, dated as of June 30, 1992, among the Registrant and San Carlos, jointly and severally, as Lessee, Philip Morris Credit Corporation, IBM Credit Financing Corporation and Emerson Capital Funding William J. Wade, as Owner Trustee and Cotrustee, respectively, The Sumitomo Bank, Limited, New York Branch, as Loan Participant and United States Trust Company of New York, as Indenture Trustee. (Form S-4, Registration No. 33-52860--Exhibit 10(g)(4).)\n*10(d)(5)-- Lease Supplement No. 1, dated December 31, 1985, to Lease Agreements, dated as of December 1, 1985, between the Registrant and San Carlos, jointly and severally, as Lessee Trustee and Co-Trustee, respectively (document filed relates to Philip Morris Credit Corporation; documents relating to IBM Credit Financing Corporation and Emerson Financing Co. are not filed but are substantially similar). (Form S-4, Registration No. 33-52860--Exhibit 10(g)(5).)\n*10(d)(6)-- Amendment No. 1, dated as of December 15, 1992, to Lease Agreements, dated as of December 1, 1985, between the Registrant and San Carlos, jointly and severally, as Lessee, and Wilmington Trust Company and William J. Wade, as Owner Trustee and Co-Trustee, respectively, as Lessor. (Form S-1, Registration No. 33-55732-- Exhibit 10(g)(6).)\n*10(d)(7)-- Amendment No. 1, dated as of December 15, 1992, to Tax Indemnity Agreements, dated as of December 1, 1985, between Philip Morris Credit Corporation, IBM Credit Financing Corporation and Emerson Capital Funding Corp., as Owner Participants and the Registrant and San Carlos, jointly and severally, as Lessee. (Form S-1, Registration No. 33-55732--Exhibit 10(g)(7).)\n*10(e)(1)-- Amended and Restated Participation Agreement, dated as of November 15, 1987, among the Registrant, as Lessee, Ford Motor Credit Company, as Owner Participant, Financial Security Assurance Inc., as Surety, Wilmington Trust Company and William J. Wade in their respective individual capacities as provided therein, but otherwise solely as Owner Trustee and Co-Trustee under the Trust Agreement, and Morgan Guaranty, in its individual capacity as provided therein, but Secured Party. (Form 10-K for the year ended December 31, 1987, File No. 1-5924--Exhibit 10(j)(1).)\n*10(e)(2)-- Lease Agreement, dated as of January 14, 1988, between Wilmington Trust Company and William J. Wade, as Owner Trust Agreement described therein, dated as of November 15, 1987, between such parties and Ford Motor Credit Company, as Lessor, and the Registrant, as Lessee. (Form 10-K for the year ended December 31, 1987, File No. 1- 5924--Exhibit 10(j)(2).)\n*10(e)(3)-- Tax Indemnity Agreement, dated as of January 14, 1988, between the Registrant, as Lessee, and Ford Motor Credit Company, as Owner Participant, beneficiary under a Trust Agreement, dated as of November 15, 1987, with Wilmington Trust Company and William J. Wade, Owner Trustee and Co-Trustee, respectively, together as Lessor. (Form 10-K for the 10(j)(3).)\n*10(e)(4)-- Loan Agreement, dated as of January 14, 1988, between the Pima County Authority and Wilmington Trust Company and William J. Wade in their respective individual capacities as expressly stated, but otherwise solely as Owner Trustee and Co-Trustee, respectively, under and pursuant to a Trust Agreement, dated as of November 15, 1987, with Ford Motor Credit Company as Trustor and Debtor relating to Industrial Development Lease Obligation Refunding Revenue Bonds, 1988 Series A (the Registrant's Irvington Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924--Exhibit 10(j)(4).)\n*10(e)(5)-- Indenture of Trust, dated as of January 14, 1988, between the Pima County Authority and Morgan Guaranty authorizing Industrial Development Lease Obligation Refunding Revenue Bonds, 1988 Series A (Tucson Electric Power Company Irvington Project). (Form 10-K for the year ended December 31, 1987, File No. 1-5924--Exhibit 10(j)(5).)\n*10(e)(6)-- Lease Amendment No. 1, dated as of May 1, 1989, between the Registrant, Wilmington Trust Company and William J. Wade as Owner Trustee and Co-trustee, respectively under a Trust Agreement dated as of November 15, 1987 with Ford Motor Credit Company. (Form 10-K for the year ended December 31,1990, File No. 1-5924--Exhibit 10(i)(6).)\n*10(e)(7)-- Lease Supplement, dated as of January 1, 1991, between the Registrant, Wilmington Trust Company and William J. Wade as Owner Trustee and Co-Trustee, respectively, under a Trust Agreement dated as of November 15, 1987, with Ford. (Form 10K for the year ended December 31, 1991, File No. 1-5924--Exhibit 10(i)(8).)\n*10(e)(8)-- Lease Supplement, dated as of March 1, 1991, between the Registrant, Wilmington Trust Company and William J. Wade as Owner Trustee and Co-Trustee, respectively, under a Trust Agreement dated as of November 15, 1987, with Ford. (Form 10-K for the year ended December 31, 1991, File No. 1-5924--Exhibit 10(i)(9).)\n*10(e)(9)-- Lease Supplement No. 4, dated as of December 1, 1991, between the Registrant, Wilmington Trust Company and William J. Wade as Owner Trustee and Co-Trustee, respectively, under a Trust Agreement dated as of November 15, 1987, with Ford. (Form 10-K for the year ended December 31, 1991, File No. 1-5924--Exhibit 10(i)(10).)\n*10(e)(10) -- Supplemental Indenture No. 1, dated as of December 1, 1991, between the Pima County Authority and Morgan Guaranty relating to Industrial Lease Development Obligation Revenue Project). (Form 10-K for the year ended December 31, 1991, File No. 1-5924--Exhibit 10(i)(11).)\n*10(e)(11) -- Restructuring Commitment Agreement, dated as of June 30, 1992, among the Registrant, as Lessee, Ford Motor Credit Company, as Owner Participant, Wilmington Trust Company and William J. Wade, as Owner Trustee and Co-Trustee, respectively, and Morgan Guaranty, as Indenture Trustee and Refunding Trustee, relating to the restructuring of the Registrant's lease of Unit 4 at the Irvington Generating Station. (Form S-4, Registration No. 33-52860--Exhibit 10(i)(12).)\n*10(e)(12) -- Amendment No. 1, dated as of December 15, 1992, to Amended and Restated Participation Agreement, dated as of November 15, 1987, among the Registrant, as Lessee, Ford Motor Credit Company, as Owner Participant, Wilmington Trust Company and William J. Wade, as Owner Trustee and Co-Trustee, respectively, Financial Security Assurance Inc., as Surety, and Morgan Guaranty, as Indenture Trustee. (Form S- 1, Registration No. 33-55732--Exhibit 10(h)(12).)\n*10(e)(13) -- Amended and Restated Lease, dated as of December 15, 1992, between the Registrant, as Lessee and Wilmington Trust Company and William J. Wade, as Owner Trustee and Co-Trustee, respectively, as Lessor. (Form S-1, Registration No. 33-55732--Exhibit 10(h)(13).)\n*10(e)(14) -- Amended and Restated Tax Indemnity Agreement, dated as of December 15, 1992, between the Registrant, as Lessee, and Ford Motor Credit Company, as Owner Participant. (Form S-1, Registration No. 33- 55732--Exhibit 10(h)(14).)\n*10(f) -- Power Sale Agreement for the years 1990 to 2011, dated as of March 10, 1988, between the Registrant and Salt River Project Agricultural Improvement and Power District. (Form 10-K for the year ended December 31, 1987, File No. 1-5924--Exhibit 10(k).)\n*+10(g)(1) -- Employment Agreements between the Registrant and Thomas A. Delawder and Gary L. Ellerd. (Form 10-K for the year ended December 31, 1987, File No. 1-5924--Exhibit 10(l).)\n*+10(g)(2) -- Employment Agreements between the Registrant and currently in effect with Ira R. Adler, Charles E. Bayless, Karen G. Kissinger, George W. Miraben, Dennis R. Nelson, Gerald A. O'Brien, Susan R. Wallach, James S. Pignatelli and Steven J. Glaser. (Form 10-K for the year ended December 31, 1989, File No. 1-5924--Exhibit 10(n)(2).)\n+10(g)(3)-- Release and Settlement Agreement between the Registrant and Frederic N. Finney.\n+10(g)(4)-- Release and Settlement Agreement between the Registrant and Norman B. Johnsen.\n*10(g)(5)-- Letter, dated February 25, 1992, from Dr. Martha R. Seger to the Registrant and Capital Holding Corporation. (Form S-4, Registration No. 33-52860--Exhibit 10(k)(4).)\n*+10(g)(6) -- Employment Agreement between the Registrant and Thomas N. Hansen. (Form 10-K for the year ended December 31, 1993, File No. 1- 5924--Exhibit 10(i)(5).)\n*10(h) -- Power Sale Agreement, dated April 29, 1988, for the dates of May 16, 1990 to December 31, 1995, between the Registrant and Nevada Power Company. (Form 10-K for the year ended December 31, 1988, File No 1- 5924--Exhibit 10(m)(2).)\n*10(i) -- Master Restructuring Agreement, dated as of June 30, 1992, among the Registrant, Escavada Company, Gallo Wash Development Company, Valencia, Barclays Bank PLC, New York Branch, as administrative agent and collateral agent and the several banks parties thereto. (Form S-4, Registration No. 33-52860--Exhibit 10(bb).)\n*10(j) -- Amendment No. 1, dated as of December 15 , 1992, to Master Restructuring Agreement, dated as of June 30, 1992, among the Registrant, Escavada Company, Gallo Wash Development Company, Valencia, Barclays Bank PLC, New York Branch, as administrative agent and collateral agent and the several banks parties thereto. (Form S- 1, Registration No. 33-55732--Exhibit 10(s)(2).)\n*10(k) -- Amendment No. 2, dated as of October 12, 1993, to Master Restructuring Agreement, dated as of June 30, 1992, among the Registrant, Escavada Company, Gallo Wash Development Company, Valencia, Barclays Bank PLC, New York Branch, as administrative agent and collateral agent and the several banks parties thereto. (Form 10- K for the year ended December 31, 1993, File No. 1-5924--Exhibit 10(n).)\n*10(l) -- Amendment No. 3, dated as of December 20, 1993, to Master Restructuring Agreement, dated as of June 30, 1992, among the Registrant, Escavada Company, Gallo Wash Development Company, Valencia, Barclays Bank PLC, New York Branch, as administrative agent and collateral agent and the several banks parties thereto. (Form 10- K for the year ended December 31, 1993, File No. 1-5924--Exhibit 10(o).)\n*10(m) -- Amendment No. 4, dated as of April 13, 1994, to Master Restructuring Agreement, dated as of June 30, 1992, among the Registrant, Escavada Company, Gallo Wash Development Company, Valencia, Barclays Bank PLC, New York Branch, as administrative agent and collateral agent and the several banks parties thereto. (Form 10- Q for the quarter ended June 30, 1994, File No. 1-5924--Exhibit 10(a).)\n*10(n) -- Amendment No. 5, dated as of June 30, 1994, to Master Restructuring Agreement, dated as of June 30, 1992, among the Registrant, Escavada Company, Gallo Wash Development Company, Valencia, Barclays Bank PLC, New York Branch, as administrative agent and collateral agent and the several banks parties thereto. (Form 10- Q for the quarter ended June 30, 1994, File No. 1-5924--Exhibit 10(b).)\n10(o) -- Amendment No. 6, dated as of November 1, 1994, to Master Restructuring Agreement, dated as of June 30, 1992, among the Registrant, Escavada Company, Gallo Wash Development Company, Valencia, Barclays Bank PLC, New York Branch, as administrative agent and collateral agent and the several banks parties thereto.\n*10(p) -- Deed of Trust, Assignment of Rents and Leases and Security Agreement, dated as of June 30, 1992, from San Carlos to Transamerica Title Insurance Company, as trustee for the use and benefit of Barclays Bank PLC, New York Branch, as collateral agent. (Form S-1, Registration No. 33-55732--Exhibit 10(t).)\n*10(q) -- Participation Agreement, dated as of June 30, 1992, among the Registrant, as Lessee, various parties thereto, as Owner Wilmington Trust Company and William J. Wade, as Owner Trustee and Co-Trustee, respectively, and LaSalle National Bank, as Indenture Trustee relating to the Registrant's lease of Springerville Unit 1. (Form S-1, Registration No. 33-55732--Exhibit 10(u).)\n*10(r) -- Lease Agreement, dated as of December 15, 1992, between the Registrant, as Lessee and Wilmington Trust Company and William J. Wade, as Owner Trustee and Co-Trustee, respectively, as Lessor. (Form S-1, Registration No. 33-55732--Exhibit 10(v).)\n*10(s) -- Tax Indemnity Agreements, dated as of December 15, 1992, between the various Owner Participants parties thereto and the Registrant, as Lessee. (Form S-1, Registration No. 33-55732, Exhibit 10(w).)\n*10(t) -- Restructuring Agreement, dated as of December 1, 1992, between the Registrant and Century Power Corporation. (Form S-1, Registration No. 33-55732--Exhibit 10(x).)\n*10(u) -- Voting Agreement, dated as of December 15, 1992, between the Registrant and Chrysler Capital Corporation (documents relating to CILCORP Lease Management, Inc., MWR Capital Inc., US West Financial Services, Inc. and Philip Morris Capital Corporation are not filed but are substantially similar). (Form S-1, Registration No. 33-55732-- Exhibit 10(y).)\n*10(v) -- Wholesale Power Supply Agreement between the Registrant and Navajo Tribal Utility Authority dated January 5, 1993. (Form 10-K for the year ended December 31, 1992, File No. 1-5924--Exhibit 10(t).)\n11 -- Statement re computation of per share earnings.\n21 -- Subsidiaries of the Registrant.\n23 -- Consents of experts and counsel.\n24 -- Power of Attorney.\n27 -- Financial Data Schedule.\n(*)Previously filed as indicated and incorporated herein by reference. (+)Management contracts or compensatory plans or arrangements required to be filed as exhibits to this Form 10-K by item 601(10)(iii) of Regulation S-K.","section_15":""}
{"filename":"799274_1994.txt","cik":"799274","year":"1994","section_1":"ITEM 1. BUSINESS\nReeves Industries, Inc., incorporated in Delaware in 1982 (\"Reeves\" or the \"Registrant\"), a wholly-owned subsidiary of Hart Holding Company Incorporated (\"Hart Holding\"), is a holding company whose principal asset is the common stock of its wholly-owned subsidiary, Reeves Brothers, Inc. (\"Reeves Brothers\"). Reeves Brothers is a diversified industrial company with operations in two principal business segments consisting of: (i) the Industrial Coated Fabrics Group, which manufactures and sells rubber and synthetic coated fabrics, and (ii) the Apparel Textile Group, which manufactures, processes and sells specialty textile fabrics.\nEffective October 25, 1993, HHCI, Inc., a newly formed, wholly-owned subsidiary of Hart Holding, merged with and into the Registrant with the Registrant surviving the merger. Subsequent to and as a result of this merger, 100% of the Registrant's outstanding common stock is held by Hart Holding. See Footnote 11, Shareholder's Equity, of the Notes to Consolidated Financial Statements of Reeves.\nINDUSTRY SEGMENTS\nReeves is a diversified industrial company with operations in two principal industry segments: industrial coated fabrics, conducted through its Industrial Coated Fabrics Group, and apparel textiles, conducted through its Apparel Textile Group. The Industrial Coated Fabrics Group manufactures and sells rubber and synthetic coated fabrics such as (i) offset printing blankets and other graphic arts products for industrial applications, and (ii) specialty coated fabrics (truck tarpaulins, gaskets, gas meters and other molded, flat diaphragms and materials used in automotive airbags). The Apparel Textile Group manufactures, processes and sells specialty textile fabrics to apparel and other manufacturers. Throughout its businesses, Reeves emphasizes specialty products, product quality, technological innovation and quick response to the changing needs of its customers.\nThe products of the Industrial Coated Fabrics Group and the Apparel Textile Group are sold in the United States and in foreign countries primarily by Reeves Brothers' merchandising and sales personnel and through a network of independent distributors to a variety of customers including converters, apparel manufacturers, industrial users and contractors. Sales offices are maintained in New York, New York; Dallas, Texas; Los Angeles, California; Spartanburg, South Carolina and Lodivecchio, Italy.\nThe following table sets forth the amount of total revenue contributed by product line in each of Reeves' industry segments which accounted for 10% or more of Reeves' consolidated revenue in any of the last three fiscal years (in thousands).\n1992 1993 1994\nIndustrial Coated Fabrics Group: Graphic Arts $ 64,892 $ 62,584 $ 66,807 Specialty Coated Fabrics 61,684 78,151 89,229 -------- -------- -------- $126,576 $140,735 $156,036 ======== ======== ========\nApparel Textile Group: Finished Goods and Dyeing and Finishing $ 72,977 $ 77,416 $ 89,008 Greige Goods 69,706 63,480 57,588 -------- -------- -------- $142,683 $140,896 $146,596 ======== ======== ========\nOther $ 1,845 $ 2,022 $ 2,637 ======== ======== ========\nReeves does not hold any patents, trademarks, licenses and\/or franchises the loss of which would have a material adverse effect on any of its industry segments.\nAdditional information about Reeves' industry segments is contained in Footnote 15, Financial Information About Industry Segments, of the Notes to Consolidated Financial Statements of Reeves.\nINDUSTRIAL COATED FABRICS GROUP\nThe Industrial Coated Fabrics Group (\"ICF\") specializes in the coating of various substrate fabrics with a variety of products, such as synthetic rubber, vinyl, neoprene, urethane, and other elastomers, to produce a diverse line of products for industrial applications.\nICF's products include: (1) a complete line of printing blankets used in offset lithography, (2) specialty coated fabrics, including fluid control diaphragm materials, tank seals, ducting materials, coated automotive airbag materials, and coated fabric materials used for military and commercial life rafts and vests, aircraft escape slides, flexible fuel tanks and general aviation products, and (3) coated fabrics used in industrial coverings, including fabrics coated with rubber and vinyl which are used to make tarpaulins, loading dock shelters and other industrial products.\nICF's products require significant amounts of technological expertise and Reeves believes that ICF's product development, formulation and production methods are among the most sophisticated in the coated fabrics industry. Since 1990, ICF has been awarded seven patents with respect to polyurethane coatings and currently has eight pending patent applications relating to printing blankets, airbag fabric and specialty coatings. Approximately eight other patent applications are in process.\nICF generally manufactures specialty coated fabrics according to a production backlog. ICF's products, other than printing blankets and coated automotive airbag materials, involve relatively short runs and custom manufacturing. Printing blankets are sold primarily to distributors and dealers. ICF's other products are sold directly to end-users and fabricators by its direct sales force.\nPrinting Blankets ICF is a leading producer of printing blankets used in offset lithography, the predominant printing process for the commercial, financial, publication and industrial printing markets.\nOffset printing blankets are used in the printing process to transfer a printed image from a metal printing plate onto paper or other printed material. ICF markets a complete line of conventional, compressible and sticky-back blankets under the VULCAN (registered trademark) name. Reeves' line includes the 714 (registered trademark), the first compressible printing blanket, the 2,000 PLUS (registered trademark), an advanced general purpose blanket, the VISION SR and REFLECTION (trademarks), two premium blankets targeted at the sheet-fed market, and the MARATHON and HORIZON (registered trademarks), blankets targeted to the high- speed web press market. Each blanket in the product line is designed for a specific printing need and ICF sells an appropriate blanket for most types of commercial, financial, publication and industrial printing applications. Reeves is a co-licensee of the latest blanket technology known to offset printing. Heidelberg Harris, a world leader in the manufacture of printing presses, chose Reeves as one of only two worldwide blanket manufacturers to license and produce the new cylindrical blanket for their high speed gapless \"Sunday\" press, the M3000. This press utilizes Reeves' new VULCAN GENESIS (registered trademark) cylindrical blanket.\nReeves believes that ICF's blankets consistently offer high performance and quality. This performance is due to a number of proprietary features of the blankets, many of which are the subject of pending patent applications. Distinctive characteristics of ICF's blankets include unique printing surface compounds, improved composition and placement of compressible layers, surface buffing and water and solvent-resistant back plies.\nPurchasers of ICF's blankets include commercial, financial and industrial printers and publishers of newspapers and magazines. ICF's blankets are sold to over 10,000 U.S. printers and more than 15,000 foreign printers, in 64 countries worldwide.\nICF has established a network of over 60 distributors and 125 dealers in the United States, Canada and Latin America to market its printing blankets. In addition, ICF is represented by a distributor in most of the other countries in which it does business. Reeves' distributors typically purchase rolls of uncut blankets from ICF and then cut, finish and package the blankets prior to delivery to dealers or end-users. Internationally, ICF's relationship with distributors tend to be long-standing and exclusive, with most distributors dealing only in ICF's printing blankets and ICF selling only to such distributors in their respective territories. Domestic distributors tend to carry printing blankets from a number of manufacturers. Dealers generally purchase finished blankets from distributors for resale. ICF services all of its customers and its direct sales force actively markets and promotes ICF's printing blankets, to both distributors and end-users.\nSpecialty Coated Fabrics Reeves believes that ICF is a leading domestic producer of specialty coated fabrics used for a broad range of industrial applications. ICF's specialty coated fabrics business is largely customer or specialty oriented. In 1994, more than 90% of ICF's sales of specialty coated fabrics were derived from fabrics manufactured to meet particular customers' specifications.\nSpecialty coated fabrics generally consist of a fabric base, a substrate layer, and an elastomer coating (i.e.,coating consisting of an elastic substance, such as rubber) which is applied to the fabric base. Reeves believes that ICF's line of elastomer-fabric combinations is the most comprehensive in the industry, enabling it to design products to satisfy its customers' needs. Fabric bases used in ICF's specialty coated fabrics include polyester, nylon, cotton, fiberglass and silk. ICF's elastomers include natural rubber, nitrile, Thiokol (registered trademark), Neoprene (registered trademark), silicone, Hypalon (registered trademark), Viton (registered trademark) and polyurethane.\nICF sells its specialty coated fabrics under the registered trademark Reevecote. Reeves believes that ICF has established a reputation for quality and product innovation in specialty coated fabrics by virtue of ICF's technological capability, advanced plant and equipment, research and development facilities and specialized chemists and engineers.\nICF's specialty coated fabrics include the following:\nGeneral purpose goods. This product line includes air cells, tank seals, gaskets, compressor valves, aerosol seals and washers and coated fabrics used by other manufacturers in the production of insulation material, soundproofing and inflatable \"lifting bags\" used to jack up automobiles or trucks.\nGas meter diaphragms. ICF manufactures a line of rubber diaphragm material for use in gas meters which are the primary mechanisms in gas meters for controlling gas flow. ICF's products are sold to most of the major manufacturers of gas meters. ICF has the leading share of the domestic market in the segment.\nSynthetic diaphragms. ICF's synthetic diaphragms are used in carburetors, controls, meters, compressors, fuel pumps and other applications.\nSpecialty products. ICF manufactures a large number of miscellaneous specialty products, including V-cups for oil rig drills, expansion joints and urethane specialty items, such as fuel containers, commercial diaphragms and desiccant bags.\nMilitary, marine and aerospace products. ICF produces coated fabrics used in truck and equipment covers, waterproof duffel bags, pneumatic air mattresses, collapsible tanks for fuel and water storage, temporary shelters, rafts, inflatable boats, various types of safety devices, pneumatic and electrical plane de-icers, specialty molded aircraft parts, aerospace fuel cells, aircraft evacuation slides, helicopter floats, surveillance balloons, environmental applications and miscellaneous items. A portion of ICF's work in this area is performed as a subcontractor on United States government contracts.\nAutomotive Airbag Materials. Reeves believes that ICF has the leading share of the domestic market for coated automotive airbag materials. ICF is a significant supplier of such material to TRW, Inc. (\"TRW\") and the Safety Restraints Division of Allied-Signal, Inc. (\"Allied-Signal\"). Allied-Signal supplies Morton International(\"Morton\") with airbag components. TRW and Morton are two of four major domestic manufacturers of airbag systems and, together with Allied-Signal, supply all of the domestic automobile manufacturers and many of the European and Japanese automobile manufacturers. Reeves believes that TRW and Morton account for a majority of the worldwide market for airbag systems.\nNational Highway Traffic Safety Administration regulations currently mandate the use of both driver-side and passenger-side airbags for all 1998 model passenger cars and 1999 model year light trucks, vans and multipurpose vehicles (\"LTVs\"). A phase-in schedule establishes that at least 95% of a manufacturer's passenger cars built on or after September 1, 1996 for sale in the United States, must be equipped with an airbag at the driver's and the right front passenger's seating positions. All LTVs built after September 1, 1997, must have some form of automatic occupant protection, and at least 80% must have either driver-side or driver-side and passenger-side airbags.\nDue to market demand for airbag-equipped vehicles, automobile manufacturers have been installing airbags (primarily driver-side) more extensively than required by the foregoing regulations. Reeves expects sales of airbag systems and associated fabrics to increase substantially in future years and believes that ICF is well-positioned to benefit from such growth.\nFollowing the lead of the U.S. automobile manufacturers, European and Asian automobile manufacturers have begun installation of automotive airbags. No legislation or regulation presently requires the installation of airbags outside of the United States market. Reeves S.p.A., a wholly-owned subsidiary located in Lodivecchio, Italy, has sufficient capacity for production of coated automotive airbag materials if demand develops outside of the United States for such products.\nReeves' participation in the airbag market to date has been through the use of coated airbag fabric in driver-side applications where coated airbag fabric offers certain advantages such as impermeability to allow rapid inflation. Coated airbag fabrics also act as an insulator to withstand the means of inflation (currently hot gases). Side-impact airbags (presently offered on certain models of Volvo, BMW and Mercedes Benz) are also expected to use coated airbag fabric.\nMost passenger-side airbags are currently designed to use uncoated fabrics. Passenger-side airbags do not require coated fabrics because space is available to permit less rapid inflation of the airbag and impermeability is not required. Consequently, they can be manufactured at a lower cost using uncoated fabric. Reeves plans to participate in the growth of passenger-side applications through an expansion program capitalizing on its textile expertise and research and development efforts. As part of this program, Reeves has constructed a facility in Spartanburg, South Carolina for weaving fabric for both coated and uncoated airbag applications. The facility is producing fabric for customer review.\nThrough its research and development activities, Reeves is continuously working to develop new proprietary fabric technologies and procedures for the next generation of driver-side and passenger-side airbags. Airbag fabrics must meet rigorous specifications, testing and certification requirements and airbag fabric contracts tend to be awarded several years in advance. These factors may deter the entry of other manufacturers into this business.\nICF's direct sales force sells primarily to fabricators who use ICF's specialty coated fabrics in products sold to end-users.\nIndustrial Coverings Fabrics ICF sells coated fabrics to customers that produce a wide variety of industrial coverings, including truck tarpaulins, trailer covers, cargo covers, agricultural covers, hangar curtains, industrial curtains, boat covers, athletic field covers, play ground covers for Discovery Zone, temporary shelters, semi-bulk containers and specialized flotation devices used for the containment of oil spills and other environmental pollutants. ICF's industrial coverings fabrics are produced by the same methods as its specialty coated fabrics and are sold under the Coverlight registered trademark.\nThe industrial coverings fabrics business also includes coated fabric for loading dock shelters, which are pads or bumpers placed around the exterior of a loading dock door for weather sealing. ICF sells to manufacturers of loading dock shelter systems and believes it is the leading supplier of loading dock shelter material produced with rubber and other special elastomers.\nICF's sales force sells primarily to fabricators of industrial coverings who in turn sell to end-users. Sales personnel concentrate on the largest producers of industrial coverings and loading dock shelter systems in the United States.\nCompetition ICF's competitive environment varies by product line. For graphic arts products (in which Reeves believes it is one of the three leading firms), the Company's principal competitors are Day International and Polyfibron Technologies, formerly a division of W. R. Grace. To a lesser extent, ICF also competes with a number of other firms. In its specialty materials product line, ICF produces numerous products and competes in a number of highly fragmented market segments where competition varies by product. In the United States, competition comes from Chemprene, Archer Rubber, Seaman Corp., Cooley, Fairprene and selected foreign suppliers. Reeves' coated automotive airbag materials compete against those of Milliken and Highland Industries as well as several other small manufacturers. Quality, compliance with exacting product specifications, delivery terms and price are important factors in competing effectively in ICF's markets.\nPrincipal Customers ICF did not have a customer accounting for more than 10% of consolidated Reeves' sales during the years 1992, 1993 or 1994.\nAPPAREL TEXTILE GROUP\nThe Apparel Textile Group (\"ATG\") consists of two divisions: Greige Goods and Finished Goods. ATG concentrates on segments of the market where its manufacturing flexibility, rapid response time, superior service, quality and the ability to supply customers with exclusive blends are key competitive factors.\nATG's Greige Goods Division processes raw materials into undyed woven fabrics known as greige goods. The Greige Goods Division manufactures greige goods of synthetic fibers, cotton, wool, silk, flax and various combinations of these fibers. Products of the Greige Goods Division are primarily utilized for apparel. The Greige Goods Division's most significant customers are outside converters and, to a lesser extent, ATG's Finished Goods Division.\nReeves believes that the Greige Goods Division is distinguished from its competitors by its ability to manufacture small yardage runs, its rapid response time, the high quality of its products and the ability to produce samples rapidly on demand. ATG's greige goods plants engage principally in short production runs producing specialty fabrics requiring a variety of blends and textures. Fabrics are produced by the Greige Goods Division according to an order backlog and are typically \"sold ahead\" three to four months in advance. Most of the Greige Goods Division's sales are sold under firm contracts.\nATG's Finished Goods Division functions as a converter and commission finisher. The Finished Goods Division purchases greige goods from the Greige Goods Division and other greige suppliers and either contracts to have such goods converted into finished fabrics of varying weights, colors, designs and finishes or converts them itself. The dyed and finished fabrics are used in various end-products and sold primarily to apparel manufacturers in the women's wear, rainwear\/outerwear, men's-boy's and career apparel markets.\nReeves believes that ATG's Finished Goods Division is one of the most flexible operations of its kind in the United States due to the variety of products it can finish and the broad range of dyeing processes and finishes it is able to offer. The Finished Goods Division focuses on high value-added fabrics with unique colors and specialty finishes. The Finished Goods Division's fabrics are currently being used by a number of the leading men's and women's sportswear manufacturers and its dyeing and finishing services are sold to major domestic converters.\nA wide variety of fabrics can be woven at the Greige Goods Division's two weaving plants. The dyeing and finishing plant of the Finished Goods Division is equipped to do a variety of piece dyeing, as well as to provide specialty finishings. This manufacturing flexibility increases ATG's ability to respond rapidly to changes in market demand.\nSubstantially all of ATG's products are sold directly to customers through its own sales force. The balance is sold through brokers and agents.\nCompetition The textile industry is highly competitive. While there are a number of integrated textile companies, many larger than ATG, no single company dominates the United States market. Competition from imported fabrics and garments continues to be a significant factor adversely affecting much of the domestic textile industry. The most important factors in competing effectively in ATG's product markets are service, price, quality, styling, texture, pattern design and color. ATG seeks to maintain its market position in the industry through a high degree of manufacturing flexibility, product quality and competitive pricing policies.\nThe Greige Goods Division distinguishes itself from its competitors by its ability to manufacture runs as small as 40,000 square yards, its rapid response time and the high quality of the products manufactured. The Greige Goods Division has extensive proprietary technical knowledge in the structure of its spinning and weaving operations, which Reeves believes represents a significant competitive advantage.\nThe Finished Goods Division is capable of finishing a wide variety of products and offers a broad range of dyeing processes and finishes. Reeves believes that this increases the Finished Goods Division's ability to respond rapidly to changes in market demand and enhances its competitive position.\nPrincipal Customers ATG markets its fabrics to a wide range of customers including H.I.S., the THOMPSON (registered trademark) men's pants division of Salant Corporation, and V. F. Corporation. ATG also markets its fabrics to major retailers, including J. C. Penney and catalogue houses such as Patagonia, L. L. Bean and Eddie Bauer.\nATG did not have a customer accounting for more than 10% of consolidated Reeves' sales during the years 1992, 1993 or 1994.\nFOREIGN OPERATIONS\nAll of Reeves' foreign operations are conducted through Reeves S.p.A., a wholly-owned subsidiary located in Lodivecchio, Italy. Reeves S.p.A. forms a part of Reeves' ICF Group. The following table provides approximate sales, net income and identifiable assets (in thousands) for each of the last three years attributable to Reeves S.p.A. In addition, Reeves' domestic operations generated export sales of approximately $6,898,000, $7,088,000 and $5,104,000 in 1992, 1993 and 1994, respectively:\n1992 1993 1994\nSales $ 38,444 $ 36,932 $ 41,339 Net income 9,165 7,446 6,989 Identifiable assets 31,608 33,092 39,738\nThe decrease in net income is primarily attributable to an increase in Reeves S.p.A.'s effective tax rate and a $3.5 million credit in 1992 related to the adoption of SFAS 109, Accounting for Income Taxes (\"FAS 109\"). Income before income taxes and cumulative effect of the adoption of FAS 109 increased from $7.2 million in 1992 to $9.4 million in 1994.\nThe financial results of Reeves S.p.A. do not include any allocations of corporate expenses or consolidated interest expense.\nBACKLOG\nAt December 31, 1994, Reeves had unfilled orders of approximately $64,024,000 as compared to approximately $56,462,000 at December 31, 1993. The following is a comparison, by Group, of open order backlogs at December 31 of each year presented (in thousands):\n1992 1993 1994 Industrial Coated Fabrics Group $16,824 $17,072 $24,223 Apparel Textile Group 32,994 39,390 39,801 ------- ------- ------- Total $49,818 $56,462 $64,024 ======= ======= =======\nThe increase in ATG's backlog from 1992 to 1993 is due to the addition of several new Finished Goods Division customers. ATG's backlog increased in 1994 compared to 1993 due to growth in the greige goods business, offset by a decline in the finished goods business. The greige goods business increased as a result of Reeves' modernization and expansion program, which increased ATG's greige goods manufacturing capacity and allowed this Division to accept more orders. The finished goods business decreased due to a slow down in the 100% cotton goods retail market.\nThe increase in the ICF Domestic backlog from 1992 to 1994 is due to growth in the coated automotive airbag materials business and, to a lesser extent, growth in the offset printing blanket business.\nThe December 31, 1994, backlogs for ICF and ATG are reasonably expected to be filled in 1995. Under certain circumstances, orders may be cancelled at Reeves' discretion prior to the commencement of manufacturing. Any significant decrease in backlog resulting from lost customers could adversely affect future operations if these customers are not replaced in a timely manner.\nRAW MATERIALS, MANUFACTURING AND SUPPLIERS\nThe principal raw materials used by ICF include polymeric resins, natural and synthetic elastomers, organic and inorganic pigments, aromatic and aliphatic solvents, polyurethanes and polyaramid and calendared fabrics. ATG principally utilizes cotton, wool, flax, specialty yarn, man-made fibers, including acrylics, polyesters, acetates, rayon and nylon and a wide variety of dyes and chemicals. Such raw materials are largely purchased in domestic markets and are available from a variety of sources. Reeves is not presently experiencing any difficulty in obtaining raw materials.\nENVIRONMENTAL MATTERS\nReeves is subject to a number of federal, state and local laws and regulations pertaining to air emissions, water discharges, waste handling and disposal, workplace exposure and release of chemicals. During 1994, expenditures in connection with Reeves' compliance with federal, state and local environmental laws and regulations did not have a material adverse effect on its earnings, capital expenditures or competitive position. Although Reeves cannot predict what laws, regulations and policies may be adopted in the future, based on current regulatory standards, Reeves does not expect such expenditures to have a material adverse effect on its operations.\nEMPLOYEES\nOn February 1, 1995, Reeves employed approximately 2,370 people, of whom 1,891 were in production, 184 were in general and administrative functions, 71 were in sales and 224 were at Reeves S.p.A. At such date, ICF had approximately 955 employees, including employees at Reeves S.p.A., ATG had approximately 1,305 employees, with the remainder of Reeves' employees in other and general and administrative positions.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal facilities of Reeves and their locations as of March 27, 1995, are as follows:\nSize (Sq. Ft.) Location Function Owned Leased\nManufacturing Industrial Coated Fabrics Group Rutherfordton, NC Coated Fabrics 215,000 Rutherfordton, NC Warehouse 45,000 Spartanburg, SC Graphic Arts and Airbag Fabric 408,364 Lodivecchio, Italy Graphic Arts and Coated Fabrics 160,000 4,900 --------- ------- Subtotal 783,364 49,900 --------- ------- Apparel Textile Group Woodruff, SC Yarn Mill 368,587 Chesnee, SC Greige Goods 303,100 Bessemer City, NC Greige Goods 218,992 Bishopville, SC Finished Goods 226,684 2,400 Bishopville, SC Warehouse 72,650 --------- ------- Subtotal 1,117,363 75,050 --------- ------- Total Manufacturing Facilities 1,900,727 124,950 --------- ------- Non-Manufacturing New York, NY Administrative\/ Sales 12,000 Spartanburg, SC Administrative\/ Sales 43,000 Norwalk, CT Administrative 6,800 --------- ------- Total Non-Manufacturing Facilities 43,000 18,800 --------- ------- Total 1,943,727 143,750 ========= =======\nReeves is party to leases with terms ranging from month-to-month to fifteen years, with rental expense aggregating $.5 million for the twelve months ended December 31, 1994. Reeves believes that all of its facilities are suitable and adequate for the current conduct of its operations.\nAll of the listed facilities were occupied by Reeves, Reeves Brothers or its subsidiaries as of December 31, 1994.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nReeves believes that there are no legal proceedings, other than ordinary routine litigation incidental to the business of Reeves, to which Reeves or any of its subsidiaries is a party. Management is of the opinion that the ultimate outcome of existing legal proceedings would not have a material adverse effect on Reeves' consolidated financial position.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to stockholders during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAt March 27, 1995, 100% or 35,021,666 shares of the Registrant's Common Stock was held by Hart Holding. There is no established public trading market for the Common Stock.\nReeves' debt instruments restrict Reeves from declaring or paying any dividends or making any distributions in respect of its capital stock (other than dividends payable solely in shares of common stock), except under certain conditions as defined therein. See Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Footnote 8, Long-Term Debt, of the Notes to Consolidated Financial Statements of Reeves.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe historical operations and balance sheet data included in the selected financial data set forth below are derived from the consolidated financial statements of Reeves (in thousands except per share data and ratios). This summary should be read in conjunction with the consolidated financial statements and related notes contained herein.\nDecember 31, 1990 1991 1992 1993 1994 Statement of Operations Data:\nNet sales Industrial Coated Fabrics Group $119,749 $121,264 $126,576 $140,735 $156,036 Apparel Textile Group 136,384 146,568 142,683 140,896 146,596 Other 1,726 1,727 1,845 2,022 2,637 -------- -------- -------- -------- -------- Total net sales $257,859 $269,559 $271,104 $283,653 $305,269 ======== ======== ======== ======== ========\nOperating income Industrial Coated Fabrics Group $ 23,250 $ 23,940 $ 24,732 $ 29,287 $ 30,918 Apparel Textile Group 9,787 9,848 10,407 11,251 12,264 Other 272 273 286 332 197 Corporate expenses (8,643) (8,435) (9,658) (11,773) (12,059) Restructuring charges (1,003) (402) -------- -------- -------- -------- -------- Total operating income $ 24,666 $ 25,626 $ 25,767 $ 28,094 $ 30,918 ======== ======== ======== ======== ========\nIncome from continuing operations $ 5,757 $ 4,544 $ 5,976 $ 7,857 $ 8,794 ======== ======== ======== ======== ========\nInterest expense and amortization of financing costs and debt discount $ 19,935 $ 21,777 $ 17,633 $ 16,394 $ 16,385 ======== ======== ======== ======== ========\nRatio of earnings to fixed charges (1) 1.3x 1.2x 1.5x 1.7x 1.8x ======== ======== ======== ======== ========\nOperating Data:\nDepreciation and goodwill amortization expense $ 6,637 $ 7,108 $ 8,116 $ 8,544 $ 9,678\nCapital expenditures 7,007 11,015 15,788 16,506 27,264\nBalance Sheet Data:\nTotal assets (2) $228,256 $214,987 $192,931 $203,025 $237,198\nLong-term debt (including current portion) 148,837 148,960 132,576 132,677 146,278\nShareholder's equity (3) 11,345 18,627 13,715 19,561 28,815\nFootnotes to Statement of Operations and Balance Sheet Data:\n(1) For the purposes of calculating the ratio of earnings to fixed charges, earnings consist of income from continuing operations before income taxes, plus fixed charges. Fixed charges consist of interest on all indebtedness, amortization of financing costs and debt discount, and one-third of all rentals, which is considered representative of the interest portion included therein, after adjustments for amounts related to discontinued operations. See Exhibit 12, Ratio of Earnings to Fixed Charges.\n(2) Total assets include the assets of discontinued operations prior to disposal. In 1990, Reeves discontinued the operations of Reeves' ARA Automotive Group.\n(3) During 1994 Reeves determined that the 1986 tax expense was understated by approximately $1,850,000 due to an error in the calculation of the 1986 tax provision. Accordingly during 1994, Reeves recorded an adjustment to retained earnings and income taxes payable of $1,850,000. The adjustment is reflected in Reeves' selected financial data as if it occurred on December 31, 1990. The decline in shareholder's equity from 1991 to 1992 primarily reflects translation adjustments of $6,626,000 caused by foreign currency fluctuations.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nReeves operates in two principal industry segments, Industrial Coated Fabrics and Apparel Textiles. The table below sets forth selected operating data (in thousands of dollars and as a percentage of net sales) in each of the last three years for Reeves:\nDecember 31, 1992 1993 1994\nNet Sales $271,104 $283,653 $305,269\nOperating income before restructuring charges $ 25,767 $ 29,097 $ 31,320 9.5% 10.3% 10.3%\nRestructuring charges $ 1,003 $ 402 .4% .1%\nOperating income $ 25,767 $ 28,094 $ 30,918 9.5% 9.9% 10.1%\n1994 Compared to 1993\nNet sales for 1994 increased $21.6 million or 7.6% to $305.3 million compared to $283.7 million in 1993. The increase is due to a 10.9% increase in sales of the Industrial Coated Fabrics Group, primarily increased sales of coated automotive airbag materials and offset printing blankets, and a 4.0% increase in the sale of apparel textiles, primarily finished goods.\nOperating income before restructuring charges in 1994 increased 7.6% to $31.3 million or 10.3% of net sales. This compares to operating income before restructuring charges in 1993 of $29.1 million or 10.3% of net sales. Operating income, after restructuring charges in 1994 of $.4 million, increased 10.0% to $30.9 million or 10.1% of net sales.\nIndustrial Coated Fabrics\nICF reported a 10.9% increase in 1994 net sales to $156.0 million compared to $140.7 million in 1993. 1994 net sales increased primarily due to an 11.7% increase in domestic sales, primarily due to higher coated automotive airbag materials and offset printing blankets sales volumes. The increase in sales of coated automotive airbag fabrics and offset printing blankets was partially offset by a decrease in sales of specialty coated fabrics. The decrease in specialty coated fabrics sales was primarily due to lower sales of rubber specialty products used by the military.\nICF's operating income increased 5.6% to $30.9 million in 1994 compared to $29.3 million in 1993, and represented 19.8% of ICF's net sales in 1994 compared to 20.8% in 1993. The 5.6% increase in operating income in 1994 as compared to 1993 was primarily due to higher coated automotive airbag materials and offset printing blanket volume plus foreign currency exchange gains which resulted from the weakening of the Italian Lira against most other currencies. The increases were partially offset by lower unit volumes in specialty coated fabrics, primarily military related business.\nApparel Textiles\nATG reported a 4.0% increase in 1994 net sales to $146.6 million compared to $140.9 million in 1993. The increase is due to a higher sales volume of finished goods products offset by lower greige goods sales. Greige goods sales decreased primarily due to the cessation of weaving operations at the Woodruff, South Carolina facility.\nATG's operating income before restructuring charges increased 9.0% to $12.3 million in 1994 compared to $11.3 million in 1993, and represented 8.4% of ATG's net sales in 1994 compared to 8.0% in 1993. The 9.0% increase in operating income in 1994 as compared to 1993 was primarily due to the higher finished goods sales volume and an increase in the greige goods gross margins. The increase in operating income was offset by a decrease in finished goods gross margins, primarily due to lower prices.\nCorporate Expenses\nCorporate expenses increased approximately 2.4% in 1994 compared to 1993. The increase is primarily due to higher legal fees and outside consulting fees related to strategic planning. Increases in corporate expenses were offset by lower pension and management incentive costs. The management fee paid to Hart Holding decreased in 1994 compared to 1993. The decrease was due to Reeves paying more of the expenses formerly covered by the management fee. Accordingly, the net effect on corporate expenses was not material.\nRestructuring Charge\nIn 1994 Reeves recorded a facility restructuring charge of $.4 million. The one time charge, representing only costs incurred during 1994, related to the cessation of yarn operations at Reeves' Bessemer City, North Carolina facility and the transfer of those operations to Reeves' Woodruff, South Carolina yarn mill.\nInterest Expense\nInterest expense and amortization of financing costs and debt discount was $16.4 million compared to $16.4 million in 1993. Interest capitalized during 1994 as part of the cost of constructing and equipping the new weaving facility in Spartanburg, South Carolina was $419,000.\nIncome Taxes\nThe effective income tax rate on income from operations before income taxes for 1994 and 1993 was 39.7% and 33.7%, respectively. The effective income tax rate on income from operations differed from the federal statutory rate of 34% primarily due to the impact of goodwill amortization, Reeves S.p.A.'s lower effective tax rate of approximately 25.0% versus a statutory rate of 52.2% and the expiration of foreign tax credits.\n1993 Compared to 1992\nNet sales for 1993 increased $12.6 million or 4.6% to $283.7 million compared to $271.1 million in 1992. The increase is due to an 11.2% increase in the sale of industrial coated fabrics, primarily growth in sales of coated automotive airbag materials. Sales of apparel textiles decreased 1.3% in 1993 compared to 1992 due to a shift to basic, lower margin products, price competition, adverse recessionary influences affecting domestic textile markets and the cessation of ATG's weaving operations at its Woodruff, South Carolina facility in 1993.\nOperating income before restructuring charges increased 12.9% to $29.1 million or 10.3% of net sales. This compares to 1992 operating income of $25.8 million or 9.5% of net sales. After restructuring charges of $1 million, Reeves' operating income increased 9.0% to $28.1 million or 9.9% of net sales.\nIndustrial Coated Fabrics\nICF reported an 11.2% increase in 1993 net sales to $140.7 million compared to $126.6 million in 1992. The increase in 1993 sales is primarily due to a 17.8% increase in domestic sales primarily due to an increase in the volume of coated automotive airbag materials caused by the increased use of driver-side airbags primarily in cars manufactured in the United States. The increase in coated automotive airbag materials sales was offset by a decrease in offset printing blanket sales. The decrease in offset printing blanket sales was primarily due to pricing pressures as a result of the slowdown in the printing industry.\nICF's operating income increased 18.4% compared to 1992 primarily due to the increase in sales of coated automotive airbag materials. Operating income from offset printing blankets declined in 1993 reflecting the worldwide slowdown in the printing industry partially offset by efficiencies experienced by Reeves S.p.A. related to increased material yields.\nApparel Textiles\nATG reported a 1.3% decrease in 1993 net sales to $140.9 million compared to $142.7 million in 1992. The decrease is primarily due to continued pricing pressures in the textile market and foreign competition.\nATG's operating income before restructuring charges increased 8.1% compared to 1992. The increase occurred even though sales decreased, as ATG continues to benefit from cost reductions derived from previous and current capital investments and other cost and manufacturing process improvements. In addition, ATG benefited from the restructuring of the weaving operations discussed in the Restructuring Charge section below.\nCorporate Expenses\nCorporate expenses increased 21.9% to $11.8 million in 1993 compared to $9.7 million in 1992. The increase related primarily to increased staffing and compensation expense necessary to support corporate development activities and a $.5 million provision for costs related to Reeves' discontinued Buena Vista, Virginia, operation.\nRestructuring Charge\nIn 1993 Reeves recorded a facility restructuring charge of $1 million. The one-time charge related primarily to the cessation of weaving activities at Reeves' Woodruff, South Carolina facility due to declining sales to the U.S. military, the conversion of that facility into a captive yarn mill and consolidation of weaving capacity at ATG's remaining facilities.\nInterest Expense\nInterest expense and amortization of financing costs and debt discounts decreased 7.0% to $16.4 million in 1993 compared to $17.6 million in 1992. The 7.0% decrease reflects the full year effect of the 1992 refinancing of Reeves' long-term debt and the redemption of $5.0 million of the 13 3\/4% Subordinated Debentures.\nIncome Taxes\nThe effective income tax rate on income from operations before income taxes for 1993 and 1992 was 33.7% and 30.3%, respectively. The effective income tax rate on income from operations differed from the federal statutory rate of 34% primarily due to the impact of goodwill amortization, Reeves S.p.A.'s lower effective tax rate of approximately 22% versus a statutory rate of 52.2% and the valuation reserve established related to Reeves estimate of the benefit for utilization of foreign tax credits.\nLIQUIDITY AND CAPITAL RESOURCES\nCash provided by operations in 1994 was $19.1 million compared to $25.2 million in 1993. The decrease in cash provided by operations was primarily due to increases in (i) inventories, related to an expansion of operations, and (ii) other assets, related to the pre-operating costs associated with the new weaving facility in Spartanburg, South Carolina. In addition, cash provided by operations was higher in 1993 compared to 1994 due to receipt in 1993 of a tax refund receivable and proceeds from a lease transaction completed in 1992. Increases in net income, deferred income taxes and accounts payable, related to the expansion of operations, offset these decreases.\nCash provided by operations is the major internal source of liquidity and is supplemented by a revolving loan agreement with a group of banks which provides Reeves and Reeves Brothers with an aggregate $35.0 million revolving line of credit (the \"Credit Agreement\"). The Credit Agreement terminates April 1, 1996 and is secured by Reeves' accounts receivable and inventory. As of December 31, 1994, Reeves and Reeves Brothers had available borrowing, net of $1,250,000 of outstanding letters of credit, of $20,250,000 under the Credit Agreement. Management believes the funding available is sufficient to meet anticipated requirements for working capital, capital expenditures and other needs.\nReeves, as a result of a June 1992 public offering, has outstanding $121,841,000, net of unamortized discount of $659,000, of 11% Senior Notes due July 15, 2002. In addition, Reeves has outstanding $10,937,000, net of unamortized discount of $63,000, of 13 3\/4% Subordinated Debentures, payable $6,000,000 on May 1, 1999 and $5,000,000 on May 1, 2000.\nReeves' debt instruments (the 11% Senior Notes, 13 3\/4% Subordinated Debentures and the Credit Agreement) contain certain restrictive covenants. See Footnote 8, Long-Term Debt, of the Notes to Consolidated Financial Statements of Reeves.\nIn May 1994, Reeves received a $12.0 million commitment from an equipment lessor for long-term operating leases of equipment. This commitment was increased to $18.8 million in August 1994. As of December 31, 1994, $14.8 was utilized. Reeves believes that the balance will be utilized in 1995.\nReeves believes that its cash flow from operations, available leasing capacity and funds available under the Credit Agreement will be sufficient to fund working capital needs, capital expenditure requirements, and debt service obligations in future years.\nInvestment Activities\nCapital expenditures were $15.8 million, $16.5 million and $27.3 million in 1992, 1993 and 1994, respectively. During 1994, Reeves constructed a facility in Spartanburg, South Carolina for weaving fabric for both coated and uncoated automotive airbag materials applications and expanded its Chesnee, South Carolina facility. Reeves plans to continue the modernization of its manufacturing operations and expand its automotive airbag materials capacity with capital spending in 1995 anticipated to approximate $30.5 million.\nEFFECTS OF INFLATION\nManagement believes that the relatively moderate rate of inflation has had minimal impact on Reeves' operating results over the last three years.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Part IV, Item 14, for index to 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 following table and narrative sets forth the age, as of January 1, 1995, positions with Reeves and Reeves Brothers and principal business experience during the past five years of each director, executive officer and significant employee of Reeves and Reeves Brothers. Any director or executive officer, unless otherwise stated, holds the identical position or positions in both Reeves and Reeves Brothers. Significant employees are employed by Reeves Brothers.\nName Position Age\nAnthony L. Cartagine Vice President; 60 President - Apparel Textile Group\nAugustus I. duPont Vice President - 43 General Counsel\nWilliam Ewing, III Vice President and Treasurer 48\nJennifer H. Fray Secretary and Assistant 30 General Counsel\nDouglas B. Hart Senior Vice President - 32 Operations\nJames W. Hart Chairman of the Board and 61 Director\nJames W. Hart, Jr. President, Chief Executive 41 Officer and Chief Operating Officer\nSteven W. Hart Executive Vice President 38 and Chief Financial Officer\nV. William Lenoci Vice President; President 59 and Chief Executive Officer - Industrial Coated Fabrics Group\nDonald R. Miller Vice President - Finance 47\nJeffrey W. Potter Vice President - 32 Business Development\nPatrick M. Walsh Vice President - 54 Administration\nMr. Cartagine has been with Reeves Brothers since 1964. He was named President-Greige Goods Division of the Apparel Textile Group in 1984 and President of the Apparel Textile Group in 1986. He was named Vice President of Reeves and Reeves Brothers in 1988.\nMr. duPont joined Reeves and Reeves Brothers in May 1994 as Vice President-General Counsel. From 1987 through 1993 Mr. duPont was Vice President, General Counsel and Secretary for Sprague Technologies, Inc., a manufacturer of electronic components.\nMr. Ewing joined Reeves and Reeves Brothers in March 1995 as Vice President and Treasurer. Prior to joining Reeves, Mr. Ewing had 20 years experience with Chemical Bank and its predecessor, Manufacturers Hanover Trust Co. From 1990 to 1995 Mr. Ewing was Managing Director of Banking and Corporate Finance. From 1985 to 1990 he was Senior Vice President for Corporate Banking of Manufacturers Hanover Bank of Delaware.\nMs. Jennifer H. Fray joined Hart Holding, Reeves and Reeves Brothers in September 1992 as Assistant General Counsel. In 1994, she was named General Counsel of Hart Holding. In 1992, she was named Secretary of Hart Holding, Reeves Industries and Reeves Brothers. From 1990 to 1992, Ms. Fray was engaged in studies leading to a Master of Laws Degree in Taxation from Boston University, from 1990 to 1991 she was employed as a Tax Associate at Coopers & Lybrand, certified public accountants, in Boston, Massachusetts and from 1987 to 1990 she was engaged in studies leading to a Juris Doctor Degree from Suffolk University.\nMr. Douglas B. Hart served as a Director of Reeves and Reeves Brothers from 1991 to 1992. He was named Vice President-Real Estate in 1989, Senior Vice President in 1991 and Senior Vice President-Operations in 1992 of Reeves and Reeves Brothers. Mr. Hart served as a Director of Hart Holding from 1991 to 1992, as Vice President-Real Estate of Hart Holding from 1989 to 1991 and as Senior Vice President of Hart Holding from 1991 to 1992. In 1992, Mr. Hart became President, Chief Executive Officer and Chief Operating Officer of Hart Investment Properties Corporation, a wholly-owned diversified corporate investment entity of Hart Holding, with current holdings in real estate.\nMr. James W. Hart has been a Director of Reeves and Reeves Brothers since 1986 and became Chairman of the Board in 1987. Mr. Hart served as President and Chief Executive Officer of Reeves and Reeves Brothers from 1988 until 1992. Mr. Hart has been a Director, President, Chief Executive Officer, and Chairman of the Board of Hart Holding since 1975 and became Chief Operating Officer and Chief Financial Officer of Hart Holding in 1992.\nMr. James W. Hart, Jr. served as a Director of Reeves and Reeves Brothers from 1986 to 1992. Mr. Hart became Vice President of Reeves and Reeves Brothers in 1987 and was named Senior Vice President-Operations in 1988 and Executive Vice President and Chief Operating Officer in 1989. In 1992, he was named President, Chief Executive Officer and Chief Operating Officer of Reeves and Reeves Brothers. Mr. Hart served as a Director of Hart Holding from 1984 to 1992. He served as Vice President of Hart Holding from 1984 to 1992, Senior Vice President-Operations of Hart Holding from 1988 to 1992 and as Executive Vice President and Chief Operating Officer of Hart Holding from 1989 to 1992.\nMr. Steven W. Hart served as a Director of Reeves and Reeves Brothers from 1986 to 1992. He became Vice President of Reeves and Reeves Brothers in 1987 and was named Senior Vice President and Chief Financial Officer in 1988 and Executive Vice President and Chief Financial Officer in 1989. Mr. Hart served as a Director, Treasurer and Chief Financial Officer of Hart Holding from 1984 to 1992, Vice President of Hart Holding from 1984 to 1988, Senior Vice President of Hart Holding from 1988 to 1989 and Executive Vice President of Hart Holding from 1989 to 1992. In 1992, Mr. Hart was named President, Chief Executive Officer and Chief Operating Officer of Hart Capital Corporation, Hart Holding's investment firm, whose primary business is the investment in private equity transactions.\nMr. Lenoci has been with Reeves since 1967. He was named President-Industrial Coated Fabrics Group in 1986 and Vice President of Reeves and Reeves Brothers in 1988. In 1990 he became Chief Executive Officer of the Industrial Coated Fabrics Group.\nMr. Miller joined Reeves and Reeves Brothers in August 1992 as the Industrial Coated Fabrics Group Controller. He was named Vice President-Finance in August 1994. From 1988 to 1992, Mr. Miller served as an Area Controller for Mead Corporation, a manufacturer of paper and paper products.\nMr. Potter joined Reeves and Reeves Brothers in July 1994 as Vice President-Business Development. From 1990 through 1994, Mr. Potter was an Associate with CS First Boston Corporation, an investment bank. From 1988 to 1990 Mr. Potter was engaged in studies leading to a Masters Degree in Public and Private Management from Yale University.\nMr. Walsh has been with Reeves since 1987, as Director of Human Resources. In 1990, he was elected Vice President- Administration of Reeves Brothers and in 1993, Vice President- Administration of Reeves and Reeves Brothers.\nMr. James W. Hart is the father of Ms. Jennifer H. Fray and Messrs. Douglas B. Hart, James W. Hart, Jr. and Steven W. Hart.\nDirectors of Reeves and Reeves Brothers are elected at each annual meeting of the stockholders. The term of office of each director is from the time of his election and qualification until the next annual meeting of stockholders and until his successor shall have been duly elected and qualified, unless such director shall have earlier been removed. Executive officers serve at the discretion of the Boards of Directors of Reeves and Reeves Brothers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nEXECUTIVE COMPENSATION\nThe following table sets forth information concerning the cash compensation and cash equivalent remuneration paid or accrued by Reeves during the years ended December 31, 1994, 1993 and 1992, for those persons who were at December 31, 1994, (i) the chief executive officer, and (ii) the other four most highly compensated executive officers of Reeves.\nSummary Compensation Table\nAnnual Compensation All Name and Principal Position Year Salary Bonus(1) Other\nAnthony L. Cartagine 1994 $266,694 $101,000 - Vice President; President - 1993 256,357 92,000 - Apparel Textile Group 1992 235,144 100,000 -\nDouglas B. Hart 1994 $246,576 $165,000 - Senior Vice President - 1993 204,500 125,000 - Operations 1992 - 100,000 -\nJames W. Hart, Jr. 1994 $432,500 $270,000 - President, Chief Executive 1993 398,750 380,000 - Officer and Chief Operating 1992 365,000 200,000 - Officer\nSteven W. Hart 1994 $432,500 $270,000 - Executive Vice President 1993 398,750 230,000 - Chief Financial Officer 1992 365,000 200,000 $31,819 (2)\nV. William Lenoci 1994 $312,375 $165,740 - Vice President; President 1993 293,750 142,000 - and Chief Executive 1992 240,249 105,000 - Officer - Industrial Coated Fabrics Group\n(1) Annual bonus amounts are earned and accrued under the Management Incentive Bonus Plan during the years indicated and paid subsequent to the end of each year except for a portion of those amounts awarded and paid to the officers during 1993. A portion of those amounts awarded during 1992 for James W. Hart, Jr., Steven W. Hart, and Anthony L. Cartagine were paid in 1992. The amounts awarded during 1994 for Douglas B. Hart, James W. Hart, Jr. and Steven W. Hart were paid in 1994.\n(2) Represents reimbursement of certain moving expenses.\nEMPLOYMENT CONTRACTS\nReeves Brothers entered into employment agreements (the \"Agreements\") with Messrs. Cartagine and Lenoci during 1991 for a term expiring on June 30, 1995 (subject to extension for up to four successive six-month periods) and October 31, 1996 (subject to extension for two one year periods), respectively. Reeves or the employee must provide 120 days notice if they do not intend to renew the Agreement. The Agreements provide for base compensation and that each employee participate in the Management Incentive Bonus Plan, plus certain other benefits.\nDIRECTORS' COMPENSATION\nReeves pays no remuneration to directors for serving as such.\nPENSION PLANS\nReeves sponsors a noncontributory defined benefit pension plan covering all of its domestic salaried and hourly employees. Reeves' funding policy is to fund at least the minimum amount required by the employee Retirement Income Security Act of 1974.\nEffective June 1, 1994, The Reeves Brothers, Inc. Pension Plan for Hourly employees merged into The Reeves Brothers, Inc. Pension Plan for Salaried Employees (the \"Salaried Plan\") with the Salaried Plan surviving the merger. Concurrent with the merger, the Salaried Plan changed its name to the \"Reeves Brothers, Inc. Pension Plan\" (the \"Pension Plan\"). Pursuant to the merger, the general provisions of the Salaried Plan govern the benefits earned by the participants of the Pension Plan subsequent to the merger. The Pension Plan benefits are based on an employee's years of accredited service.\nThe basic annual benefit for salaried employees under the Pension Plan is equal to 12 times 1.5% of the average W-2 earnings for the highest five consecutive calendar years of compensation multiplied by the years of service less the Social Security benefit.\nAnnual Pension at Age 65 After Years of Service\nRemuneration 15 20 25 30 35\n$125,000 $21,243 $30,618 $ 39,993 $ 49,368 $ 58,743 150,000 26,868 38,118 49,368 60,618 71,868 175,000 32,493 45,618 58,743 71,868 84,993 200,000 38,118 53,118 68,118 83,118 98,118 225,000 43,743 60,618 77,493 94,368 111,243 250,000 49,368 68,118 86,868 105,618 120,000 300,000 60,618 83,118 105,618 120,000 120,000 350,000 71,868 98,118 120,000 120,000 120,000\nNotes To Pension Plan Table\n(A)(1) Compensation covered by the tax-qualified salaried employees Pension Plan each year is generally all compensation reported on a participant's Form W-2. The plan's formula is based on average compensation for the participant's highest five consecutive calendar years. However, except in the cases of Messrs. Cartagine and Lenoci, compensation for any year is limited by the compensation cap for that year under section 401(a)(17) of the Internal Revenue Code (the \"Code\"). For 1993, that limit was $235,840. Under a supplemental non-qualified plan, Messrs. Cartagine and Lenoci would receive a supplemental pension benefit to make up the limitation of section 401 (a)(17) of the Code upon retirement in accordance with the Pension Plan. The retirement benefit payable under the supplemental plan to Messrs. Cartagine and Lenoci, assuming retirement at age 65 and increases in covered compensation of five percent per year, would be $45,000 and $62,000, respectively.\n(2) Starting in 1994, the maximum annual compensation under applicable IRS Regulations that may be taken into account is $150,000. Participants in the Pension Plan prior to 1994 may have accrued higher benefits than those shown in the table to the extent their average highest compensation exceeded $150,000. Those higher accrued benefits are preserved by law.\n(3) For 1995, the Pension Plan's maximum benefit under applicable IRS Regulations is $120,000.\n(B) Years of service for named executive officers:\nOfficer Years of Service\nAnthony L. Cartagine 31.02 Douglas B. Hart 5.42 James W. Hart, Jr. 10.68 Steven W. Hart 11.75 V. William Lenoci 27.63\n(C) Benefits are computed on the basis of a straight life annuity and are reduced by 50% of the participant's primary Social Security benefit.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION DECISIONS\nThe Reeves' Salary Compensation Committee is comprised of Douglas B. Hart, James W. Hart, Jr., Steven W. Hart and Patrick M. Walsh, all of whom are officers of Reeves. See \"Certain Relationships and Related Transactions\" regarding transactions involving Douglas B. Hart and Steven W. Hart.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nOwnership of Common Stock of Reeves\nThe following table sets forth certain information at March 27, 1995 with respect to ownership of Reeves common stock by each person who is known by Reeves to own beneficially, or who may be deemed to own beneficially, more than 5% of the outstanding shares of Reeves common stock, directors, the chief executive officer, the four most highly compensated executive officers and all directors and executive officers of Reeves as a group. Unless otherwise stated, Reeves common stock is directly owned.\nAmount and Name and Nature of Address of Beneficial Percent of Beneficial Owner Ownership Class\nHart Holding Company Incorporated . . . . . . . 35,021,666 100.0% 401 Merritt 7 Corporate Park Norwalk, CT 06856\nAnthony L. Cartagine (1) . . 0 0.0% 104 West 40th Street New York, NY 10018\nDouglas B. Hart . . . . . . 0 0.0% 401 Merritt 7 Corporate Park Norwalk, CT 06856\nJames W. Hart (2) . . . . . 35,021,666 100.0% 401 Merritt 7 Corporate Park Norwalk, CT 06856\nJames W. Hart, Jr. (3) . . . 0 0.0% 401 Merritt 7 Corporate Park Norwalk, CT 06856\nSteven W. Hart (4) . . . . . 0 0.0% 401 Merritt 7 Corporate Park Norwalk, CT 06856\nV. William Lenoci (5). . . . 0 0.0% Highway 29 South Spartanburg, SC 29304\nReeves Industries . . . . . 35,021,666 100.0% Directors and Executive Officers as a Group (6)\n(1) As of March 27, 1995, Anthony L. Cartagine is the indirect beneficial owner of 2 shares of Hart Holding common stock, representing less than 1% of such outstanding common stock.\n(2) As of March 27, 1995, James W. Hart is the beneficial owner of 25,206 shares of Hart Holding common stock (96.5%), of which (i) 20,206 shares are owned directly, and (ii) 5,000 shares are subject to a presently exercisable option (the \"Hart Holding Option\") granted in November 1993. The Hart Holding Option expires on December 31, 2028 and provides for the issuance of up to 6,667 shares upon exercise of options as follows: 2,500 immediately at $1,350 per share; 2,500 exercisable one year from grant date at $1,500 per share; and 1,667 exercisable two years from grant date at $1,650 per share.\nOn January 26, 1994, James W. Hart was granted options to purchase 3,800,000 shares of common stock of the Registrant, par value $.01 per share, and has an expiration date of December 31, 2023. The options contain an exercise price of $.56 per share for 1,400,000 shares (exercisable immediately), $.75 per share for 1,400,000 shares (exercisable one year from grant date) and $1.00 per share for 1,000,000 shares (exercisable two years from grant date).\n(3) As of March 27, 1995, James W. Hart, Jr. is the beneficial owner of 100 shares of Hart Holding common stock (representing less than 1% of such outstanding common stock), all of which are subject to a presently exercisable option.\n(4) As of March 27, 1995, Steven W. Hart is the beneficial owner of 401 shares of Hart Holding common stock (1.9%).\n(5) As of March 27, 1995, V. William Lenoci is the beneficial owner of 9 shares of Hart Holding common stock, representing less than 1% of such outstanding common stock.\n(6) As of March 27, 1995, the directors and executive officers of Hart Holding as a group beneficially own an aggregate of 26,119 shares of Hart Holding common stock (99.7%).\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIn connection with the acquisition of Reeves, Hart Holding, Reeves, Reeves Brothers and certain subsidiaries entered into a Tax Allocation Agreement dated as of May 1, 1986, as amended and restated effective January 1, 1992 (the \"Tax Agreement\"). The Tax Agreement provides that Hart Holding and Reeves will file consolidated Federal income tax returns as long as they remain members of the same affiliated group.\nDuring the years ended December 31, 1992, 1993 and 1994, Reeves' paid management fees to Hart Holding of $1,910,000, $1,804,000 and $980,000, respectively.\nEffective December 31, 1991, Hart Holding exchanged its 1,000 shares of Reeves Series I Preferred Stock, par value $1.00 per share, valued in the aggregate at $9,410,000, for 18,820,000 shares of Reeves common stock, par value $.01 per share, valued at $.50 per share. This transaction resulted in Hart Holding's percentage ownership in Reeves' common stock increasing from 86.7% to 93.5%.\nPursuant to a November 1992 court-ordered settlement of a lawsuit brought by Hart Holding and Reeves against Drexel Burnham Lambert and certain of its affiliates (collectively, \"the Defendants\"), Reeves received 1,918,132 shares of its common stock from the Defendants which were subsequently cancelled and retired. This transaction resulted in Hart Holding's percentage ownership in Reeves common stock increasing from 93.5% to 98.6%.\nEffective October 25, 1993, HHCI, Inc., a newly formed, wholly-owned subsidiary of Hart Holding, merged with and into the Registrant with the Registrant surviving the merger. HHCI, Inc. was formed as a shell corporation (no operations) with a $300,000 capital contribution from Hart Holding. As a result of this merger, Hart Holding was issued 535,000 shares of the Registrant's common stock. Additionally, the Registrant purchased 481,307 shares of its common stock not held by Hart Holding and the shares were subsequently cancelled and retired. As a result of this merger, Hart Holding owns 100% of the outstanding shares of the common stock of the Registrant.\nDuring 1992, Reeves purchased the residences of three officers of Reeves, Jennifer H. Fray, Douglas B. Hart, and Steven W. Hart, for $215,000, $225,000 and $575,000, respectively. In each case, the price paid was less than a current appraisal on such property or, in the case of Jennifer H. Fray, less than the cost of such property in 1990 plus the cost of improvements. The Board of Directors determined at the time that the price for each residence was not greater than the fair market value for such property. During 1993 and 1994, Reeves recognized a loss of approximately $161,000 and $105,000, respectively, on the sale of the properties including related expenses.\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. Consolidated Financial Statements of Reeves Industries, Inc. and Subsidiary:\nReport of Independent Accountants\nConsolidated Balance Sheet at December 31, 1993 and\nConsolidated Statement of Income for the Years Ended December 31, 1992, 1993, and 1994\nConsolidated Statement of Changes in Shareholder's Equity for the Years Ended December 31, 1992, 1993, and\nConsolidated Statement of Cash Flows for the Years Ended December 31, 1992, 1993, and 1994\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules for the Years Ended December 31, 1992, 1993 and 1994\nSchedule VIII - Valuation and qualifying accounts\nSchedule X - Supplementary income statement information\nAll other schedules are omitted because they are not applicable or required information is shown in the consolidated financial statements or notes thereto.\n3. Exhibits\nExhibit Name No.\n3.1 Restated Certificate of Incorporation of Reeves Industries, Inc.\n3.2 (1) Bylaws of Reeves Industries, Inc.\n4.1 (2) Purchase Agreement, dated as of May 1, 1986, among Schick Acquisition Corp., A.R.A. Manufacturing Company of Delaware, Inc. and each of the Purchasers.\n4.2 (2) Subordinated Debenture Indenture, dated as of May 1, 1986, between Schick Acquisition Corp. and Fleet National Bank, as Trustee (the \"Subordinated Debenture Trustee\").\n4.3 (2) First Supplemental Indenture, dated as of May 6, 1986, between Reeves Industries, Inc. and the Subordinated Debenture Trustee.\n4.4 (2) Second Supplemental Indenture, dated as of October 15, 1986, between Reeves Industries, Inc. and the Subordinated Debenture Trustee.\n4.5 (3) Third Supplemental Indenture, dated as of March 24, 1988, between Reeves Industries, Inc. and the Subordinated Debenture Trustee.\n4.6 (4) Fourth Supplemental Indenture, dated as of May 7, 1991, between Reeves Industries, Inc. and the Subordinated Debenture Trustee.\n4.7 (1) Fifth Supplemental Indenture, dated as of June 30, 1992, between Reeves Industries, Inc. and the Subordinated Debenture Trustee.\n4.8 (2) Registration Rights Agreement, dated as of May 1, 1986, among Schick Acquisition Corp. and the purchasers.\n4.9 (5) Senior Note Indenture dated as of June 1, 1992, between Reeves Industries, Inc. and Chemical Bank, as Trustee.\n10.01 (1) Credit Agreement, dated as of August 6, 1992 (the \"Credit Agreement\") among Reeves Brothers, Inc., Reeves Industries, Inc., the Banks signatory thereto and Chemical Bank, as Agent.\n10.02 (6) First Amendment, Waiver and Consent, dated as of October 25, 1993, to the Credit Agreement.\n10.03 (9) Second Amendment, dated as of December 28, 1993, to the Credit Agreement.\n10.04 Third Amendment and Waiver, dated as of September 27, 1994, to the Credit Agreement.\n10.05 Fourth Amendment and Waiver, dated as of March 10, 1995, to the Credit Agreement.\n10.06 (7) Tax Allocation Agreement, effective as of January 1, 1992 by and among Hart Holding Company Incorporated, Reeves Industries, Inc., Reeves Brothers, Inc., Fenchurch, Inc., Turner Trucking Company, Reeves Penna, Inc., A.R.A. Manufacturing Company, Hart Investment Properties Corporation and Hart Capital Corporation.\n10.07 (8) Reeves Corporate Management Incentive Bonus Plan.\n10.08 Employment Agreement dated July 1, 1991, and amended December 1, 1994, between Reeves Brothers, Inc. and Anthony L. Cartagine.\n10.09 (9) Employment Agreement dated November 1, 1991 and amended May 18, 1993, between Reeves Brothers, Inc. and Vito W. Lenoci.\n10.10 (9) Reeves Brothers, Inc. 401(a)(17) Plan, effective January 1, 1989.\n10.11 (9) Non-Qualified Stock Option Agreement, dated as of January 26, 1994, between Reeves Industries, Inc. and James W. Hart.\n10.12 (6) Agreement and Plan of Merger, dated as of October 22, 1993, between Reeves Industries, Inc. and HHCI, Inc.\n10.13 (4) Lease Agreement, dated March 28, 1991, between Springs Industries, Inc., Lessor, and Reeves Brothers, Inc., Lessee.\n12 Statement of Computation of Ratio of Earnings to Fixed Charges.\n21 Subsidiaries of Reeves Industries, Inc.\n27 Financial Data Schedule\n(1) Previously filed by Reeves Industries, Inc. as an exhibit to Reeves' Annual Report on Form 10-K dated March 31, 1993, which is incorporated by reference herein.\n(2) Previously filed by Reeves Industries, Inc. as an exhibit to Newreeveco's Registration Statement on Form S-1, Registration No. 33-8192, dated August 21, 1986, as amended October 20, 1986, which is incorporated by reference herein.\n(3) Previously filed by Reeves Industries, Inc. as an exhibit to Reeves' Annual Report on Form 10-K dated April 12, 1988, which is incorporated by reference herein.\n(4) Previously filed by Reeves Industries, Inc. as an exhibit to Reeves' Annual Report of Form 10-K dated March 30, 1992, which is incorporated by reference herein.\n(5) Previously filed by Reeves Industries, Inc. as an exhibit to Reeves' Quarterly Report on Form 10-Q dated August 12, 1992, which is incorporated by reference herein.\n(6) Previously filed by Reeves Industries, Inc. as an exhibit to Reeves' Quarterly Report on Form 10-Q dated November 10, 1993, which is incorporated by reference herein.\n(7) Previously filed by Reeves Industries, Inc. as an exhibit to Reeves' Registration Statement on Form S-2, Registration No. 33-47254, dated April 16, 1992, as amended May 28, 1992, which is incorporated by reference herein.\n(8) Previously filed by Reeves Industries, Inc. as an exhibit to Reeves' Annual Report on Form 10-K dated March 28, 1991, which is incorporated by reference herein.\n(9) Previously filed by Reeves Industries, Inc. as an Exhibit to Reeves' Annual Report on Form 10-K dated March 31, 1994, which is in corporated by reference herein.\n(b) Reports on Form 8-K:\nThere were no reports on Form 8-K filed during the fourth quarter of 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.\nREEVES INDUSTRIES, INC. Registrant\nDate: March 27, 1995 By:\/s\/ Steven W. Hart -------------- ---------------------------- Steven W. Hart Executive Vice-President & 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 dates indicated.\nSignature Title Date\n(i) Principal Executive Officer:\n\/s\/ James W. Hart, Jr. President, Chief March 27, 1995 ---------------------- Executive Officer and -------------- James W. Hart, Jr. Chief Operating Officer\n(ii) Principal Financial Officer:\n\/s\/ Steven W. Hart Executive Vice President March 27, 1995 ---------------------- & Chief Financial Officer -------------- Steven W. Hart\n(iii) Principal Accounting Officer:\n\/s\/ Donald R. Miller Vice President - Finance March 27, 1995 ---------------------- -------------- Donald R. Miller\n(iv) A Majority of the Board of Directors:\n\/s\/ James W. Hart Director March 27, 1995 ---------------------- -------------- James W. Hart\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT\nNo annual report to security holders covering the Registrant's last fiscal year or proxy material with respect to any meeting of security holders has been sent to security holders of the Registrant.\nREEVES INDUSTRIES, INC. CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993 AND 1994\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholder of Reeves Industries, Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 42, after giving retroactive effect to the adjustment described in Note 11, present fairly, in all material respects, the financial position of Reeves Industries, Inc. and its subsidiary at December 31, 1993 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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 LLP Atlanta, Georgia February 17, 1995\nREEVES INDUSTRIES, INC. CONSOLIDATED BALANCE SHEET (in thousands except share data)\nDecember 31, 1993 1994 ASSETS Current assets Cash and cash equivalents of $7,222 and $1,550 $ 12,015 $ 17,429 Accounts receivable, less allowance for doubtful accounts of $1,467 and $1,232 45,925 52,890 Inventories (Note 4) 33,969 35,909 Deferred income taxes (Note 9) 5,442 4,259 Other current assets 2,909 4,114 -------- -------- Total current assets 100,260 114,601 Property, plant and equipment, at cost less accumulated depreciation (Note 5) 51,415 70,629 Unamortized financing costs, less accumulated amortization of $1,177 and $1,830 3,946 3,293 Goodwill, less accumulated amortization of $9,431 and $10,771 43,357 42,017 Deferred income taxes (Note 9) 2,153 1,246 Other long-term assets (Note 6) 1,894 5,412 -------- -------- Total assets $203,025 $237,198 ======== ========\nREEVES INDUSTRIES, INC. CONSOLIDATED BALANCE SHEET (in thousands except share data)\nDecember 31, 1993 1994 LIABILITIES AND SHAREHOLDER'S EQUITY Current liabilities Accounts payable $ 22,810 $ 32,109 Accrued expenses and other liabilities (Note 7) 18,671 18,738 -------- -------- Total current liabilities 41,481 50,847 Long-term debt (Note 8) 132,677 146,278 Deferred income taxes (Note 9) 4,367 5,637 Other long-term liabilities (Note 7) 4,939 5,621 -------- -------- Total liabilities 183,464 208,383 -------- -------- Shareholder's equity (Note 11) Common stock, $.01 par value, 50,000,000 shares authorized; 35,021,666 shares issued and outstanding 350 350 Capital in excess of par value 5,099 5,099 Retained earnings (Note 11) 18,114 26,908 Equity adjustments from translation (4,002) (3,542) -------- -------- 19,561 28,815 -------- -------- Commitments and contingencies (Note 16) -------- -------- Total liabilities and shareholder's equity $203,025 $237,198 ======== ========\nThe accompanying notes are an integral part of these financial statements.\nREEVES INDUSTRIES, INC. CONSOLIDATED STATEMENT OF INCOME (in thousands)\nYear ended December 31, 1992 1993 1994\nNet sales $271,104 $283,653 $305,269 Cost of sales 216,043 222,016 243,575 -------- -------- -------- Gross profit on sales 55,061 61,637 61,694 Selling, general and administrative expenses 29,294 32,540 30,374 Restructuring charges (Note 3) 1,003 402 -------- -------- -------- Operating income 25,767 28,094 30,918 Other income (expense) Other income, net 435 158 44 Interest expense and amortization of financing costs and debt discounts (17,633) (16,394) (16,385) -------- -------- -------- (17,198) (16,236) (16,341) -------- -------- -------- Income before income taxes, extraordinary item and cumulative effect of a change in accounting principle 8,569 11,858 14,577 Income taxes (Note 9) 2,593 4,001 5,783 -------- -------- -------- Income before extraordinary item and cumulative effect of a change in accounting principle 5,976 7,857 8,794 Extraordinary loss from early extinguishment of debt, less applicable income tax benefits of $3,148 (Note 8) (6,112) Cumulative effect of a change in accounting for income taxes (Note 9) 3,221 -------- -------- -------- Net income $ 3,085 $ 7,857 $ 8,794 ======== ======== ========\nThe accompanying notes are an integral part of these financial statements.\nREEVES INDUSTRIES, INC. CONSOLIDATED STATEMENT OF CASH FLOWS (in thousands)\nYear ended December 31, 1992 1993 1994 Cash flows from operating activities Net income $ 3,085 $ 7,857 $ 8,794 Adjustments to reconcile net income to net cash provided by operating activities Write-off of financing costs due to early extinguishment of debt 6,112 Cumulative effect of a change in accounting for income taxes (3,221) Depreciation and amortization 9,146 9,272 10,433 Deferred income taxes (112) 694 3,360 Changes in operating assets and liabilities Decrease (increase) in accounts receivable 2,574 (7,049) (6,965) Decrease (increase) in inventories 4,200 1,341 (1,940) (Increase) decrease in other current assets (9,167) 6,514 (1,205) Decrease (increase) in other assets 134 (900) (3,518) (Decrease) increase in accounts payable (546) 7,458 9,299 Increase in accrued expenses and other liabilities 6,451 133 749 Equity adjustments from translation (3,450) (117) (163) Other 236 -------- -------- -------- Net cash provided by operating activities 15,206 25,203 19,080 -------- -------- --------\nCash flows from investing activities Purchases of property, plant and equipment (15,788) (16,506) (27,264) Net proceeds (payments) from disposal of discontinued operations 12,438 (536) -------- -------- -------- Net cash used by investing activities (3,350) (17,042) (27,264) -------- -------- --------\nCash flows from financing activities Principal payments of long-term debt (108,726) Net (payments) borrowings on revolving loans (30,000) 13,500 Borrowings of long-term debt 121,644 Debt issuance costs (5,115) Premium on early retirement of debt (4,876) Issuance of common stock 300 Purchases of common stock (1,075) (270) -------- -------- -------- Net cash (used) provided by financing activities (28,148) 30 13,500 -------- -------- -------- Effect of exchange rate changes on cash (535) (341) 98 -------- -------- -------- (Decrease) increase in cash and cash equivalents (16,827) 7,850 5,414 Cash and cash equivalents, beginning of year 20,992 4,165 12,015 -------- -------- -------- Cash and cash equivalents, end of year $ 4,165 $ 12,015 $ 17,429 ======== ======== ========\nThe accompanying notes are an integral part of these financial statements.\nREEVES INDUSTRIES, INC. CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDER'S EQUITY (in thousands)\nEquity Capital Adjust- Common Stock in ments $.01 Par Value Excess From --------------- of Par Retained Trans- Shares Amount Value Earnings lation Total\nDecember 31, 1991 36,886 $369 $6,421 $ 9,022 $4,665 $20,477 Prior period adjustment (Note 11) (1,850) (1,850) Net income 3,085 3,085 Translation adjustments (6,626) (6,626) Purchase and cancellation of common stock (1,918) (19) (1,352) (1,371) ------ ---- ------ ------- ------- ------- December 31, 1992 34,968 350 5,069 10,257 (1,961) 13,715 Net income 7,857 7,857 Translation adjustments (2,041) (2,041) Issuance of common stock 535 5 295 300 Purchase and cancellation of common stock (481) (5) (265) (270) ------ ---- ------ ------- ------- ------- December 31, 1993 35,022 350 5,099 18,114 (4,002) 19,561 Net income 8,794 8,794 Translation adjustments 460 460 ------ ---- ------ ------- ------- ------- December 31, 1994 35,022 $350 $5,099 $26,908 $(3,542) $28,815 ====== ==== ====== ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nREEVES INDUSTRIES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1993 AND 1994\n1. BUSINESS AND ORGANIZATION\nReeves Industries, Inc. (\"Reeves\" or the \"Company\"), a wholly- owned subsidiary of Hart Holding Company Incorporated (\"Hart Holding\" or the \"Parent\"), is a holding company whose principal asset is the common stock of its wholly-owned subsidiary, Reeves Brothers, Inc. (\"Reeves Brothers\"). The Company was acquired by Hart Holding on May 6, 1986. Reeves is a diversified industrial company engaged in two business segments: industrial coated fabrics and apparel textiles.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Reeves Brothers. All significant intercompany balances and transactions have been eliminated.\nInventories Inventories are stated at the lower of cost or market. Cost for approximately 27% and 31% of total inventories was determined on the last-in, first-out (\"LIFO\") method at December 31, 1993 and 1994, respectively. With respect to the remainder of the inventories, cost is determined principally on the first-in, first-out (\"FIFO\") method. Market is determined on the basis of replacement costs or selling prices less costs of disposal. The application of Accounting Principles Board Opinion No. 16, Business Combinations, for the acquisition of Reeves caused the inventories in the accompanying Consolidated Balance Sheet to exceed inventories used for income tax purposes by approximately $6,833,000 as of December 31, 1994.\nProperty, plant and equipment Property, plant and equipment are stated at cost. Improvements which extend the useful lives of the assets are capitalized while repairs and maintenance are charged to operations as incurred. Depreciation is provided using primarily the straight-line method for financial reporting purposes while accelerated methods are used for income tax purposes. When assets are replaced or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is reflected in income.\nThe Company capitalizes interest as part of the cost of constructing major facilities and equipment. Interest capitalized during 1992, 1993 and 1994 was $0, $0 and $419,000, respectively.\nFair value of financial instruments Cash, accounts receivable, accounts payable and accrued liabilities are reflected in the consolidated financial statements at fair value because of the short-term maturity of these instruments. The fair value of the Company's 11% Senior Notes is determined based upon a recent market price quote and is disclosed in Note 8. The fair value of the Company's 13 3\/4% Subordinated Debentures is estimated by discounting the future cash flows using the current rates at which similar loans would be made with similar credit ratings and for the same remaining maturity. The fair value of foreign currency exchange contracts (used for hedging purposes) is estimated using quoted exchange rates and is disclosed in Note 12.\nForeign currency exchange and translation For Reeves Brothers' wholly-owned foreign subsidiary, the local currency of the country of operation is used as the functional currency for purposes of translating the local currency asset and liability accounts at current exchange rates into the reporting currency. The resulting translation adjustments are accumulated as a separate component of shareholder's equity reflected in the equity adjustments from translation account in the accompanying consolidated financial statements. Gains and losses resulting from translating asset and liability accounts that are denominated in currencies other than the functional currency and gains and losses on forward foreign currency exchange contracts not designated as hedges are included in income. Gains and losses on long-term intercompany transactions are recorded net of tax in the equity adjustments from translation account.\nAmortization policy The Company is amortizing goodwill on a straight-line basis over forty years. Financing costs and debt discounts are being amortized by the interest method over the life of the respective debt securities. Pre-operating costs associated with significant new operations are deferred and amortized over five years or the life of the asset associated with the pre-operating costs, which is generally five to seven years.\nRevenue recognition Sales are generally recorded when the goods are shipped. At the customer's request, shipment of the completed product is sometimes delayed. In such instances, revenues are recognized when the customer acknowledges transfer of title and accepts the related billing.\nIncome taxes The Company is a member of an affiliated group of which Hart Holding is the common parent. Pursuant to a tax allocation agreement with Hart Holding, the Company files a consolidated federal income tax return with Hart Holding. Under the agreement, the Company's tax liability is determined on a separate return basis and any taxes payable are remitted to Hart Holding.\nDuring 1992, the Company adopted Statement of Financial Accounting Standards No. 109 \"Accounting for Income Taxes\" (\"FAS 109\"). Income tax accounting information is disclosed in Note 9 to the consolidated financial statements.\nThe provision for income taxes was based on reported earnings before income taxes and includes appropriate provisions for deferred income taxes resulting from the tax effect of the differences between the tax basis of assets and liabilities and their carrying amounts for financial reporting purposes.\nAt December 31, 1994, unremitted earnings of the foreign subsidiary were approximately $26,500,000. United States income taxes have not been provided on these unremitted earnings as it is the Company's intention to indefinitely reinvest these earnings. However, the foreign subsidiary has, in previous years, remitted a portion of its current year earnings as dividends and expects to continue this practice in the future.\nPension plans The Company has a noncontributory pension plan covering all eligible domestic employees (Note 10).\nStatement of cash flows For purposes of the statement of cash flows, cash equivalents are defined as highly liquid investment securities with an original maturity of three months or less.\nReclassifications Certain amounts in the 1992 and 1993 consolidated financial statements and notes have been reclassified to conform with the 1994 presentation.\n3. RESTRUCTURING CHARGES\nDuring 1993 and 1994, the Company implemented restructuring plans to reduce the Company's overall cost structure and to improve productivity. The Consolidated Statement of Income for the year ended December 31, 1993 includes a charge of approximately $1,003,000 related to the plan implemented in 1993 (the \"1993 Plan\"). The 1993 Plan includes the cessation of weaving activities at one location and conversion of that facility into a captive yarn mill, consolidating weaving capacity at remaining facilities and implementing cost saving\/state-of-the-art finishing technology. The Consolidated Statement of Income for the year ended December 31, 1994 includes a charge, representing only costs incurred during 1994, of approximately $402,000 related to the plan implemented in 1994 (the \"1994 Plan\"). The 1994 Plan includes the cessation of yarn operations at one location and the transfer of those operations to another location.\n4. INVENTORIES\nInventories at December 31, 1993 and 1994 are comprised of the following (in thousands):\n1993 1994\nRaw materials $ 6,815 $ 7,591 Work in process 8,792 8,536 Manufactured and finished goods 18,362 19,782 ------- ------- $33,969 $35,909 ======= =======\nIf inventories had been calculated on a current cost basis, they would have been valued higher by approximately $2,038,000 and $2,397,500 at December 31, 1993 and 1994, respectively.\n5. PROPERTY, PLANT AND EQUIPMENT\nThe principal categories of property, plant and equipment at December 31, 1993 and 1994 are as follows (in thousands):\n1993 1994\nLand and land improvements $ 797 $ 735 Buildings and improvements 16,570 23,232 Machinery and equipment 56,555 65,719 Construction in progress 8,929 17,077 -------- -------- 82,851 106,763 Less - Accumulated depreciation and amortization (31,436) (36,134) -------- -------- $ 51,415 $ 70,629 ======== ========\nOn June 13, 1994 and December 13, 1994, the Company entered into Inducement Agreements (the \"Inducement Agreements\") with Spartanburg County, South Carolina, and Lee County, South Carolina, respectively (the \"Counties\"), under South Carolina Code Section 4-29-67 (the \"Statute\"). The Inducement Agreements provide the Company an incentive to make capital investments in the Counties in the form of qualified investments in land, buildings, and\/or machinery and equipment by allowing the Company to pay a fee in lieu of ad valorem property taxes. The Company must make capital investments equal to $85 million in the Counties beginning in 1994 and continuing through December 31, 1999. Under the Statute, the investment threshold will be lowered in the event that the Company meets certain job creation levels. Should the Company not invest the specified threshold amounts by December 31, 1999, the Company will pay the difference between the ad valorem taxes that would have been due and the actual fee paid plus interest. Qualified investments, which include assets leased under operating leases, total $22,490,000 at December 31, 1994.\nOn December 29, 1994, the Company entered into the agreements required by the Statute whereby the Company transferred to the Counties title to certain qualifying assets placed in productive use in 1994 (the \"Assets\"). The Company retains all rights associated with the possession and use of the Assets, and the Counties cannot transfer or otherwise dispose of the Assets except as requested in writing by the Company. The Company can reacquire title to the Assets at any time for $1.00.\nThe sole purpose and the economic substance of this transaction is to establish the property tax incentive permitted under the Statute. The Company does not believe an economic transfer of the Assets has occurred. Accordingly, the Company has not recorded the transfer of title to the Assets to the Counties in the Company's financial statements. The net book value at December 31, 1994 of Assets to which nominal title was transferred to the Counties is $12,190,000.\n6. OTHER LONG-TERM ASSETS\nOther long-term assets at December 31, 1993 and 1994 are comprised of the following (in thousands):\n1993 1994\nPre-operating costs $ 742 $ 3,666 Other 1,152 1,746 ------- ------- $ 1,894 $ 5,412 ======= =======\n7. ACCRUED EXPENSES AND OTHER LIABILITIES\nAccrued expenses and other liabilities at December 31, 1993 and 1994 are comprised of the following (in thousands):\n1993 1994\nAccrued salaries, wages and incentives $ 3,145 $ 4,920 Product claims reserve 1,237 437 Interest payable 6,512 6,626 Income taxes payable 2,398 1,662 Deferred compensation 171 Italian severance pay program 421 22 Other 4,787 5,071 ------- ------- $18,671 $18,738 ======= =======\nOther long-term liabilities at December 31, 1993 and 1994 are comprised of the following (in thousands):\n1993 1994\nDeferred compensation $ 1,016 $ 1,117 Accrued costs related to discontinued operations 1,390 1,174 Italian severance pay program 1,970 2,727 Other 563 603 ------- ------- $ 4,939 $ 5,621 ======= =======\n8. LONG-TERM DEBT\nLong-term debt at December 31, 1993 and 1994 consists of the following (in thousands):\n1993 1994\n11% Senior Notes due July 15, 2002, net of unamortized discount of $747 and $659 $121,753 $121,841 13 3\/4% Subordinated Debentures due May 1, 2000, net of unamortized discount of $76 and $63 10,924 10,937 Revolving loan payable to bank 13,500 -------- -------- $132,677 $146,278 ======== ========\nIn June 1992, the Company completed a public offering of $122,500,000 of 11% Senior Notes due 2002 (the \"Senior Notes\"). Proceeds of the offering were used to redeem all of the Company's then outstanding 12 1\/2% Senior Notes and 13% Senior Subordinated Debentures and to pay and terminate the revolving loan outstanding under a prior loan agreement.\nIn connection with the liquidation of the 12 1\/2% Senior Notes, the 13% Senior Subordinated Debentures and the prior revolving loan, the Company paid early payment premiums of $4,601,000 and wrote off related debt issuance costs and debt discounts of $3,016,000. In addition, during 1992, the Company purchased $5,000,000 face value of its 13 3\/4% Subordinated Debentures for $5,275,000. As a result of these transactions, the Company recognized an extraordinary loss in 1992 of $5,775,000 ($.16 per share), net of applicable income tax benefits of $2,974,000.\nReeves is required to make sinking fund payments with respect to the remaining 13 3\/4% Subordinated Debentures of $6,000,000 on May 1, 1999 and $5,000,000 on May 1, 2000.\nOn August 7, 1992, Reeves and Reeves Brothers entered into a credit agreement, as amended, (the \"Credit Agreement\") with a group of banks which provides the Company and Reeves Brothers with an aggregate $35,000,000 revolving line of credit (the \"Revolving Loan\") and letter of credit facility. The Revolving Loan bears interest at the Alternate Base Rate (defined below) plus 1 1\/2% or Eurodollar Rate plus 2 1\/2%, at the election of the borrower. The Alternate Base Rate is defined as the higher of the Prime Rate (8.5% at December 31, 1994), Base CD Rate plus 1%, or the Federal Funds Effective Rate plus 1\/2%. The Alternate Base Rate and Eurodollar Rate decline based on a ratio of earnings to fixed charges, as defined. The Revolving Loan weighted average interest rate at December 31, 1994 was 8.9%. The Revolving Loan is due April 1, 1996. The Revolving Loan is secured by Reeves Brothers' accounts receivable and inventory. As of December 31, 1994, the Company and Reeves had available borrowings, net of $1,250,000 of outstanding letters of credit, of $20,250,000 under the Revolving Loan. A commitment fee of 1\/2% per annum is required on the unused portion of the Revolving Loan.\nThe Senior Notes, Credit Agreement, and 13 3\/4% Subordinated Debentures contain certain restrictive covenants with respect to Reeves and Reeves Brothers including, among other things, maintenance of working capital, limitations on the payments of dividends, the incurrence of additional indebtedness and certain liens, restrictions on capital expenditures, mergers or acquisitions, investments and transactions with affiliates, and require the maintenance of certain financial ratios and compliance with certain financial tests and limitations.\nInterest paid, including that related to discontinued operations, amounted to $12,350,000, $15,306,000 and $15,753,000 in 1992, 1993 and 1994, respectively.\nThe estimated fair value of the Company's Senior Notes and 13 3\/4% Subordinated Debentures at December 31, 1994 is $122,500,000 and $10,919,000, respectively.\n9. INCOME TAXES\nDuring the third quarter of 1992, the Company adopted FAS 109 effective as of the beginning of 1992. Under FAS 109, in the year of adoption, previously reported results of operations for the year are restated to reflect the effects of applying FAS 109, and the cumulative effect of adoption on prior years' results of operations is shown in the income statement in the year of change. The adoption of FAS 109 did not have a material effect on the Company's 1992 income from continuing operations before income taxes.\nThe provision for income taxes from continuing operations is comprised of the following (in thousands):\n1992 1993 1994 Current: Federal $ (401) $1,278 $ 934 Foreign 954 811 1,596 State 174 138 241 ------ ------ ------ 727 2,227 2,771 ------ ------ ------ Deferred: Federal 983 945 2,063 Foreign 641 826 832 State 242 3 117 ------ ------ ------ $2,593 $4,001 $5,783 ====== ====== ======\nThe provision for income taxes from continuing operations differs from taxes computed using the statutory federal income tax rate as follows (in thousands):\n1992 1993 1994\nConsolidated computed statutory taxes $2,914 $4,050 $5,002 State income taxes, net of federal income tax benefit 275 93 236 Amortization of goodwill 456 456 456 Foreign tax rate less than statutory rate (868) (1,451) (774) Expiring foreign tax credits 1,577 Other, net (184) 53 86 Valuation reserve 800 (800) ------ ------ ------ $2,593 $4,001 $5,783 ====== ====== ======\nIn 1990, Reeves Brothers' foreign subsidiary implemented a reorganization allowed under the applicable country's income tax laws. This transaction resulted in the foreign subsidiary revaluing upward its net assets for income tax purposes. Additional depreciation and amortization relating to this revaluation is deductible in determining income tax expense for both financial and income tax reporting. The effect of this revaluation resulted in the foreign subsidiary's effective income tax rate declining from its statutory rate of approximately 52.2% to 22% for both 1992 and 1993 and approximately 25% for 1994.\nDeferred tax liabilities (assets) under FAS 109 are comprised of the following temporary differences (in thousands):\n1993 1994 Deferred tax liabilities Inventories $ 2,584 $ 2,392 Depreciation 1,783 2,145 Amortization 1,100 ------- ------- $ 4,367 $ 5,637 ======= =======\nCurrent deferred tax assets Tentative minimum tax credits $ 854 $ 500 Accrued expenses 3,490 3,438 Foreign tax credit carryforwards 1,898 321 Valuation reserve (800) ------- ------- 5,442 4,259 ------- ------- Long-term deferred tax assets Depreciation on foreign subsidiary assets 1,219 (140) Tentative minimum tax credits 895 Foreign exchange on note of foreign subsidiary 934 491 ------- ------- 2,153 1,246 ------- ------- $ 7,595 $ 5,505 ======= =======\nThe sources of income from operations before income taxes are as follows (in thousands):\n1992 1993 1994\nDomestic $ 1,327 $ 2,774 $ 5,160 Foreign 7,242 9,084 9,417 ------- ------- ------- $ 8,569 $11,858 $14,577 ======= ======= =======\nIncome taxes paid amounted to approximately $2,406,000, $1,686,000 and $2,016,000 in 1992, 1993 and 1994, respectively.\n10. PENSION PLANS\nThe Company sponsors a noncontributory defined benefit pension plan covering all of its domestic salaried and hourly employees. The Company's funding policy is to fund at least the minimum amount required by the Employee Retirement Income Security Act of 1974.\nEffective June 1, 1994, The Reeves Brothers, Inc. Pension Plan for Hourly Employees (the \"Hourly Plan\") was merged into The Reeves Brothers, Inc. Pension Plan for Salaried Employees (the \"Salaried Plan\") with the Salaried Plan surviving the merger. Concurrent with the merger, the Salaried Plan changed its name to the \"Reeves Brothers, Inc. Pension Plan\" (the \"Pension Plan\"). Pursuant to the merger, the general provisions of the Salaried Plan will begin to govern the benefits earned by the participants of the Pension Plan subsequent to the merger. The Pension Plan benefits are based on an employee's years of accredited service.\nThe Pension Plan also provides benefits to both the ARA union and non-union employees in accordance with their separate benefit calculations. The ARA non-union plan was merged with the Hourly Plan effective December 1990; the ARA union plan was merged with the Hourly Plan effective April 1993.\nThe following table presents the funded status of the Pension Plan at December 31, 1993 and 1994 (in thousands):\n1993 1994 Actuarial present value of accumulated benefit obligation: Vested $19,300 $18,145 Nonvested 914 663 ------- ------- Accumulated benefit obligation $20,214 $18,808 ======= =======\nPlan assets at fair value $25,450 $24,412 Projected benefit obligation for services rendered to date 24,553 22,291 ------- ------- Plan assets greater than projected benefit obligation 897 2,121 Unrecognized net transition obligation 1,955 2,303 Unrecognized net gain subsequent to transition (3,696) (5,317) ------- ------- Pension liability recognized in the consolidated balance sheet $ (844) $ (893) ======= =======\nPlan assets consist primarily of fixed income securities, equity securities, and certificates of deposit.\nPension cost includes the following components (in thousands):\n1992 1993 1994 Service cost - benefits earned during the period $ 942 $ 936 $1,243 Interest cost on projected benefit obligation 1,456 1,643 1,623 Actual return on plan assets (2,961) (2,531) (2,106) Net amortization and deferral 1,351 754 125 ------ ------ ------ Pension cost $ 788 $ 802 $ 885 ====== ====== ======\nA weighted average discount rate of 7.25% and 8.0%, and rate of increase in future compensation of 5.0% and 5.5% were used in determining the actuarial present value of the projected benefit obligation in 1993 and 1994, respectively. The long-term expected rate of return on assets was 8.0% in 1993 and 1994.\nIn December 1990, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\"), which requires accrual, during an employee's active years of service, of the expected costs of providing postretirement benefits to employees and their beneficiaries and dependents. The Company adopted FAS 106 in 1992, the effect of which was not material to the financial statements.\n11. SHAREHOLDER'S EQUITY\nCapital stock The capitalization of Reeves consists of one class of common stock, $.01 par value (the \"Common Stock\"). 250,000 shares of Preferred Stock remain authorized, with no Preferred Stock currently outstanding.\nRetained Earnings During 1994 the Company determined that the 1986 tax expense was understated by approximately $1,850,000 due to an error in the calculation of the 1986 tax provision. Accordingly, during 1994, the Company recorded an adjustment to retained earnings and income taxes payable of $1,850,000. The adjustment is reflected in the Company's consolidated financial statements as if it occurred on December 31, 1991.\nSettlement of litigation In November 1992, pursuant to a court ordered settlement of a lawsuit brought by the Company against Drexel Burnham Lambert and certain of its affiliates (collectively, the \"Defendants\"), Reeves received 1,918,132 shares of its common stock from the Defendants which were subsequently cancelled and retired.\nMerger with HHCI, Inc. Effective October 25, 1993, HHCI, Inc., a newly formed, wholly- owned subsidiary of Hart Holding, merged with and into the Company with the Company surviving the merger. HHCI, Inc. was formed as a shell corporation (no operations) with a $300,000 capital contribution from Hart Holding. As a result of the merger, Hart Holding was issued 535,000 shares of the Company's common stock. Additionally, the Company purchased the 481,307 shares of its common stock not held by Hart Holding and the shares were subsequently cancelled and retired. As a result of this merger, Hart Holding owns 100% of the outstanding shares of the common stock of the Company.\nNon-qualified Stock Option On January 26, 1994, the Board of Directors approved a non- qualified stock option agreement between the Company and the Chairman of the Board of Directors. The agreement grants options to purchase up to 3,800,000 shares of common stock of the Company, par value $.01 per share, and has an expiration date of December 31, 2023. The options contain an exercise price of $.56 per share for 1,400,000 shares (exercisable immediately), $.75 per share for 1,400,000 shares (exercisable one year from grant date) and $1.00 per share for 1,000,000 shares (exercisable two years from grant date).\n12. FOREIGN EXCHANGE\nThe Company's foreign subsidiary enters into forward currency exchange contracts to hedge certain firm sales commitments and certain anticipated but not yet committed sales expected to be denominated in currencies other than the Italian Lire. The purpose of the Company's foreign currency hedging activities is to protect the Company from the risk that the eventual Lire cash flows resulting from sales to international customers will be adversely affected by changes in exchange rates. The term of the foreign currency exchange contracts usually does not exceed one year. Counterparties to the forward currency exchange contracts are major Italian financial institutions. Credit loss from counterparty nonperformance is not anticipated.\nAt December 31, 1993 and 1994, the Company had foreign currency exchange contracts outstanding, equivalent to $14,883,000 and $0, respectively, to exchange various currencies, including the U.S. dollar, Japanese yen, pound sterling, Deutsche mark, and French franc into Italian Lire. Gross deferred unrealized gains and losses from hedging firm sales commitments and anticipated but not yet committed sales transactions, based on market prices, were a $23,000 gain and a $499,000 loss at December 31, 1993. The contracts outstanding at December 31, 1993 matured during 1994 and all gains or losses on the contracts were recognized in earnings in 1994. The December 31, 1993, fair value of these foreign currency contracts as hedge instruments was $14,407,000.\n13. CONCENTRATIONS OF CREDIT RISK\nConcentrations of credit risk with respect to trade receivables are limited due to the wide variety of customers and markets into which the Company's products are sold, as well as their dispersion across many different geographic areas. As a result, at December 31, 1994, the Company does not consider itself to have any significant concentrations of credit risk.\n14. RELATED PARTY TRANSACTIONS\nDuring the years ended December 31, 1992, 1993 and 1994, the Company and its subsidiary paid management fees to Hart Holding of $1,910,000, $1,804,000 and $980,000, respectively.\nDuring 1992, Reeves purchased the residences of three officers of Reeves for an aggregate amount of $1,015,000. During 1993 and 1994, the Company recognized a loss of approximately $161,000 and $105,000, respectively, on the sale of the properties including related expenses.\n15. FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nThe Company, through Reeves Brothers, operates in two principal industry segments: industrial coated fabrics and apparel textiles. The Industrial Coated Fabrics Group manufactures newspaper and graphic arts printing press blankets, protective coverings, inflatable aerospace and survival equipment, diaphragms for meters, pump and tank seals and material used in automotive airbags. The Apparel Textiles Group manufactures, dyes and finishes greige goods.\nThe products of the Industrial Coated Fabrics Group and the Apparel Textiles Group are sold in the United States and in certain foreign countries primarily by Reeves Brothers' merchandising and sales personnel and through a network of independent distributors to a variety of customers including converters, apparel manufacturers and industrial users. Sales offices are maintained in New York, New York; Dallas, Texas; Los Angeles, California; Spartanburg, South Carolina and Lodivecchio, Italy.\nThe following table presents certain information concerning each segment (in thousands):\n1992 1993 1994\nNet sales: Industrial coated fabrics $126,576 $140,735 $156,036 Apparel textiles 142,683 140,896 146,596 Other 1,845 2,022 2,637 -------- -------- -------- $271,104 $283,653 $305,269 ======== ======== ========\nOperating income: Industrial coated fabrics $ 24,732 $ 29,287 $ 30,918 Apparel textiles 10,407 11,251 12,264 Other 286 332 197 Corporate expenses (9,658) (11,773) (12,059) Restructuring charges (1,003) (402) -------- -------- -------- Operating income 25,767 28,094 30,918 Other income, net 435 158 44 Interest expense and amortization of financing costs (17,633) (16,394) (16,385) -------- -------- -------- Income before income taxes, extraordinary item and cumulative effect of a change in accounting principle $ 8,569 $ 11,858 $ 14,577 ======== ======== ========\nDepreciation: Industrial coated fabrics $ 3,175 $ 3,632 $ 4,515 Apparel textiles 2,782 3,303 3,384 Other 131 162 270 Corporate 688 107 169 -------- -------- -------- $ 6,776 $ 7,204 $ 8,338 ======== ======== ========\nCapital expenditures: Industrial coated fabrics $ 6,353 $ 11,459 $ 22,502 Apparel textiles 8,483 4,140 1,825 Other 140 553 284 Corporate 812 354 2,653 -------- -------- -------- $ 15,788 $ 16,506 $ 27,264 ======== ======== ========\nIdentifiable assets: Industrial coated fabrics $ 65,752 $ 75,625 $103,995 Apparel textiles 64,293 62,528 64,217 Other 818 1,077 1,190 Corporate, principally discontinued operations (in 1992), cash, goodwill and debt issuance costs 62,068 63,795 67,796 -------- -------- -------- $192,931 $203,025 $237,198 ======== ======== ========\nFinancial data of Reeves' foreign operation is as follows (in thousands):\n1992 1993 1994\nSales $ 38,444 $ 36,932 $ 41,339 Net income 9,165 7,446 6,989 Assets 31,608 33,092 39,738\nIntersegment sales are not material.\n16. COMMITMENTS AND CONTINGENCIES\nThe Company leases certain operating facilities and equipment under long-term operating leases. At December 31, 1994 future minimum rentals, required by operating leases having initial or remaining noncancellable lease terms in excess of one year are as follows: 1995 - $4,862,000; 1996 - $4,718,000; 1997 - $4,685,000; 1998 - $4,630,000; 1999 - $4,613,000; thereafter - $6,409,000.\nRental expense charged to continuing operations was approximately $1,420,000, $1,473,000 and $2,800,000 during the years ended December 31, 1992, 1993 and 1994, respectively.\nThere are various lawsuits and claims pending against the Company and its subsidiary, including those relating to commercial transactions. The outcome of these matters is not presently determinable but, in the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the results of operations and financial position of the Company.\nSCHEDULE VIII - ANALYSIS OF THE ALLOWANCE FOR DOUBTFUL ACCOUNTS REEVES INDUSTRIES, INC. AND SUBSIDIARIES (In thousands)\nColumn A Column B Column C Column D Column E -------------------- charged Balance, (credited) charged begin- to costs to other Balance, ning of and accounts Deductions end of Description period expenses describe describe period\nDecember 31, 1991 $2,081 Provision $(148) Recoveries $ 23 Write-off $(386) ------ ----- ---- ----- ------ December 31, 1992 $2,081 $(148) $ 23 $(386) $1,570 ====== ===== ==== ===== ======\nProvision $ 427 Recoveries $108 Write-off $(638) ------ ----- ---- ----- ------ December 31, 1993 $1,570 $ 427 $108 $(638) $1,467 ====== ===== ==== ===== ======\nProvision $ 335 Recoveries $ 26 Write-off $(596) ------ ----- ---- ----- ------ December 31, 1994 $1,467 $ 335 $ 26 $(596) $1,232 ====== ===== ==== ===== ======\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\nREEVES INDUSTRIES, INC. AND SUBSIDIARIES\nColumn A Column B Charged to Item (1) Costs and Expenses (In thousands)\nMaintenance and repairs\nYear Ended December 31, 1992 $ 7,745 ========\nYear Ended December 31, 1993 $ 6,328 ========\nYear Ended December 31, 1994 $ 7,341 ========\n(1) Other items are less than 1% of revenues or not applicable.\nINDEX TO EXHIBITS\nExhibit Name No.\n3.1 Restated Certificate of Incorporation of Reeves Industries, Inc.\n10.04 Third Amendment and Waiver, dated as of September 27, 1994, to the Credit Agreement.\n10.05 Forth Amendment and Waiver, dated as of March 10, 1995, to the Credit Agreement.\n10.08 Employment Agreement dated July 1, 1991, and amended December 1, 1994, between Reeves Brothers, Inc. and Anthony L. Cartagine.\n12 Statement of Computation of Ratio of Earnings to Fixed Charges.\n21 Subsidiaries of Reeves Industries, Inc.\n27 Financial Data Schedule","section_15":""}
{"filename":"22698_1994.txt","cik":"22698","year":"1994","section_1":"Item 1. Business\nGENERAL INFORMATION\nBusiness Segments\n\tCOMSAT Corporation (COMSAT, the Corporation or Registrant) has four business segments: International Communications, Mobile Communications, Entertainment and Technology Services.\n\tInternational Communications consists of COMSAT World Systems, which provides satellite communications services using the satellite system of the International Telecommunications Satellite Organization (INTELSAT), and COMSAT International Ventures, which operates and invests in telecommunications ventures internationally. Mobile Communications consists of COMSAT Mobile Communications, which provides satellite communications services using the satellite system of the International Maritime Satellite Organization (Inmarsat). Entertainment consists of COMSAT Video Enterprises, Inc. and the Corporation's majority ownership interest in On Command Video Corporation, which provide entertainment services to the hospitality industry throughout the United States and domestic video distribution services to television networks, the Denver Nuggets, a franchise of the National Basketball Association, and Beacon Communications Corp., a producer of theatrical films and television programming. Technology Services consists of COMSAT RSI, Inc., which designs, manufactures, and integrates satellite earth stations, advanced antennas and other turnkey systems for telecommunications, radar, air traffic control and military uses, and provides turnkey voice, video and data communications networks and products, and communications and information services worldwide, and COMSAT Laboratories, the Corporation's center for applied research and technology development.\n\tThe revenues, operating income (loss) and assets of the Corporation, by business segment, for each of the last three years are shown in Note 15 to the 1994 Financial Statements.\n\tThe Corporation had 2,894 employees on December 31, 1994. None of the employees is represented by a labor union, except for approximately 23 employees working for COMSAT RSI, Inc. on a 100- meter radio telescope.\nCommunications Satellite Act of 1962\n\tCOMSAT was incorporated in 1963 under District of Columbia law, as authorized by the Communications Satellite Act of 1962 (the Satellite Act). Effective June 1, 1993, COMSAT changed its corporate name from \"Communications Satellite Corporation\" to \"COMSAT Corporation.\" COMSAT is not an agency or establishment of the U.S. Government. The U.S. Government has not invested funds in COMSAT, guaranteed funds invested in COMSAT or guaranteed the payment of dividends by COMSAT.\n\tAlthough COMSAT is a private corporation, the Satellite Act governs certain aspects of COMSAT's structure, ownership and operations, most significantly the following: three of COMSAT's 15 directors are appointed by the President of the United States with the advice and consent of the United States Senate; COMSAT's issuances of capital stock and borrowings of money must be authorized by the Federal Communications Commission (FCC); there are limitations on the classes of persons that may hold shares of COMSAT's Common Stock and on the number of shares a person or class of persons may hold; and, on matters that may affect the national interest and foreign policy of the United States, COMSAT's representatives to INTELSAT and Inmarsat receive instructions from the U.S. Government. Congress has reserved the right to amend the Satellite Act, and amendments, if any, could materially affect the Corporation.\nGovernment Regulation\n\tUnder the Satellite Act, the International Maritime Satellite Telecommunications Act of 1978 (the Inmarsat Act) and the Communications Act of 1934, as amended (the Communications Act), COMSAT is subject to regulation by the FCC with respect to its COMSAT World Systems and COMSAT Mobile Communications services and the rates charged for those services. FCC decisions and policies have had and will continue to have a significant impact on the Corporation. For a discussion of these matters, see Notes 8 and 9 to the 1994 Financial Statements.\nINTERNATIONAL COMMUNICATIONS\n\tThe International Communications segment consists of the FCC rate-regulated business of COMSAT World Systems, and COMSAT International Ventures.\nCOMSAT World Systems\n\tServices. COMSAT World Systems provides satellite capacity for telephone, data, video and audio communications services between the United States and the rest of the world using the global network of INTELSAT satellites. COMSAT World Systems' customers include U.S. international communications common carriers, private network providers, multinational corporations, U.S. and international broadcasters, newsgathering organizations, digital audio companies and the U.S. government.\n\tThe largest portion of COMSAT World Systems revenues comes from leasing full-time voice grade half-circuits (two-way communications links between an earth station and an INTELSAT satellite) to U.S. international communications common carriers. The three largest carrier customers are AT&T Corporation (AT&T), MCI International Inc. (MCI) and Sprint Communications Company (Sprint). COMSAT World Systems offers significant discounts to customers entering into long-term commitments for full-time voice-grade half-circuits. More than 91.3% of all eligible voice-grade half-circuits are now under such commitments.\n\tCOMSAT World Systems voice and data services are primarily digital, which provides higher quality transmissions than analog services. COMSAT World Systems International Digital Route (IDR) service, for example, makes it possible for communications carriers to provide digital public-switched telephone network circuits. The carriers apply techniques to such circuits that permit a single digital circuit to handle multiple telephone calls simultaneously.\n\tFor private line customers, COMSAT World Systems offers an all-digital International Business Service (IBS), as well as an international VSAT (Very Small Aperture Terminal) service. IBS offers customers high-speed, digital communications for voice, data, facsimile and video-conferencing using on-premise earth stations that eliminate the need for costly land-line connections. At year-end 1994, approximately 54% of COMSAT World Systems IBS traffic was covered by long-term commitments. COMSAT World Systems has established international VSAT networks to both Latin America and Europe. Using on-premise antennas as small as 1.8 meters in combination with the high-power satellites in the INTELSAT network, international corporations can deliver communications to multiple sites. Used primarily for data transmissions, VSATs can also accommodate voice and video communications.\n\tTo the growing international broadcasting community, COMSAT World Systems provides both digital and analog transmission services on a long-term, short-term or occasional as-needed basis. With the launch in 1992 of the INTELSAT K satellite over the Atlantic Ocean and the launch of the INTELSAT VII satellites discussed under \"INTELSAT Satellites\" in Item 2, Properties, on page 20, COMSAT World Systems has expanded the availability of high-power, flexible capacity for broadcasters and satellite newsgatherers. In particular, COMSAT World Systems introduced a flexible digital television service and a digital audio service to attract new customers using digital compression in the broadcast industry to satellite broadcasting.\n\tTo maintain the quality of the INTELSAT network, COMSAT World Systems provides tracking, telemetry, control and monitoring services to INTELSAT and engages in a program of research and development to ensure that the satellite system accommodates the latest communications technologies, including both broadband and integrated services digital networks (ISDN).\n\tTariffs and Revenues. Under the Satellite Act and the Communications Act, COMSAT is subject to regulation by the FCC with respect to COMSAT World Systems communications services, the rates charged for those services and earnings levels. COMSAT World Systems provides its services on a non-discriminatory basis to all customers, either under tariffs filed with the FCC or on the basis of inter-carrier contracts.\n\tEffective January 1, 1992, COMSAT World Systems introduced a regional growth plan through which customers can benefit from rate reductions as certain threshold traffic levels are attained in each of four geographic regions: Europe, Latin America, Pacific and Mid-East\/Other. In addition, COMSAT World Systems reduced its rates by 10% on 10- and 15-year IDR and Time Division Multiple Access (TDMA) digital \"base\" circuits activated prior to January 1, 1992. In May 1992, rates for all multi-year \"base\" circuits with transmissions between large Standard A earth stations were also reduced by 10%. During 1992, COMSAT World Systems also introduced rates for Digital Television Service coupled with transitional rates for customers who commenced service in an analog mode and opted to convert to digital modulation techniques within the same lease period.\n\tIn January 1992, COMSAT World Systems filed a petition for rulemaking with the FCC seeking incentive-based regulation of its multi-year, switched-voice services for carriers. The petition requests a regulatory framework to replace traditional rate-base regulation and enable COMSAT World Systems to respond more effectively to competitive market forces. This framework would have three parts: (1) COMSAT World Systems would agree to cap its prices for existing multi-year, switched-voice services at the reduced rates that went into effect on January 1, 1992; (2) COMSAT World Systems could lower its rates for these services on 14 days notice, and those rates would be presumed lawful as long as they were above its average variable costs (i.e., streamlined tariff review); and (3) multi-year, switched-voice services would no longer be subject to annual rate-of-return reviews,\nalthough they would still be subject to review in the event of a customer complaint. The FCC has not yet taken action on this petition. As a result, in July 1994, COMSAT World Systems filed a Petition for Partial Relief. This petition requested expedited FCC action to approve streamlined tariff review for all of COMSAT World Systems' INTELSAT satellite services. The petition was also accompanied by an extensive economic study which concluded that COMSAT World Systems faces substantial effective competition in all geographic and service market segments from existing and planned fiber optic cables and separate satellite facilities, and that its access to the INTELSAT system does not confer upon COMSAT World Systems any market power in the provision of transoceanic telecommunications facilities.\n\tIn 1993 and 1994, COMSAT World Systems entered into new inter-carrier contracts with each of its three largest customers, AT&T, MCI and Sprint. Pursuant to those contracts, COMSAT World Systems further reduced its rates for 10- and 15-year IDR and TDMA digital \"base\" circuits activated prior to January 1, 1992, and also reduced its rates beginning in 1996 for 7-year and longer IDR and TDMA circuits activated after January 1, 1992. In addition, the contracts provided AT&T and Sprint with leases and with options to lease capacity from COMSAT World Systems in 36 MHz increments under specified rates, terms and conditions.\n\tApproximately 30% of the Corporation's consolidated revenues in 1994 were derived from COMSAT World Systems services (32% in 1993, 37% in 1992). Approximately 9% of the Corporation's consolidated revenues in 1994 were derived from COMSAT World Systems services to AT&T. Also in 1994, COMSAT World Systems' three largest customers, AT&T, MCI and Sprint were the source of approximately 31%, 18% and 8%, respectively, of COMSAT World Systems revenues.\n\tCompetition. COMSAT World Systems competes with operators of high capacity fiber-optic and other submarine cables in service along major traffic routes worldwide. COMSAT World Systems' major carrier customers (including its three largest customers, AT&T, MCI and Sprint) are co-owners of submarine cables.\n\tUnder the Satellite Act and FCC orders, COMSAT is the only U.S. entity that may provide international space segment services to customers using INTELSAT satellites. In 1985 the FCC authorized the establishment of separate international communications satellite systems that would compete with INTELSAT, subject to certain restrictions that are being phased out. For a discussion of separate satellite systems competition to COMSAT World Systems, see Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 9 to the 1994 Financial Statements.\n\tINTELSAT. INTELSAT is a 135-nation organization headquartered in Washington, D.C. It operates under two agreements: (1) an intergovernmental agreement; and (2) an operating agreement signed by each nation's government or designated telecommunications entity (Signatory). COMSAT is the U.S. Signatory. It represents the United States in INTELSAT, subject to instructions from the Department of State (in concert with the Department of Commerce and the FCC) on matters that may affect the national interest and foreign policy of the United States.\n\tEach Signatory has rights and obligations in INTELSAT analogous to those of a partner. Each owns an investment share, makes proportionate contributions to INTELSAT's capital costs, and receives proportionate distributions of INTELSAT's net revenues after deductions for operating expenses. The investment shares are readjusted as of March 1 of each year to approximate the Signatories' respective portions of the total use of the INTELSAT space segment for the previous six months. COMSAT's investment share, the largest in INTELSAT, was 19.12% as of March 1, 1995 (20.2% as of March 1, 1994; 21.8% as of March 1, 1993).\n\tSignatories also pay INTELSAT for their use of the satellite system. While INTELSAT has targeted a pretax cumulative rate of return of 20% on Signatory's capital used by another Signatory or from non-owners who use the satellite system, COMSAT expects to receive an actual pretax cumulative rate of return of between 16% to 18% on its capital investment after appropriate accounting adjustments. COMSAT World Systems realized revenue from its INTELSAT ownership, net of use charges paid, of $25.4 million in 1994. This net revenue is reflected in COMSAT World Systems revenue requirements for FCC ratemaking purposes.\n\tAt December 31, 1994, total INTELSAT Owners' Equity was approximately $1,693 million, and INTELSAT's outstanding contractual commitments totaled approximately $1,749 million.\n\tIn each of 1989 through 1994, the Corporation entered into agreements with INTELSAT to place COMSAT World Systems FM, digital bearer, IBS and video traffic on the INTELSAT system under long-term commitments.\n\tUnder the INTELSAT agreements, the member nations that authorize international satellite systems separate from INTELSAT are required to ensure that such systems are technically compatible with the INTELSAT system and will not cause significant economic harm to the INTELSAT system. During 1990, INTELSAT initiated certain reforms to its process for coordinating with these separate satellite systems, which reforms were superseded in November 1992 and again in October 1994. Under the streamlined procedures approved in 1992, carriage by separate systems of any amount of traffic or services not interconnected to the public switched network and of up to 1,250 circuits of public switched traffic per satellite is presumed not to cause significant economic harm to the INTELSAT system. The 1,250 circuits threshold was raised in 1994 to 8,000 circuits of public switched traffic per satellite. In addition, in 1994 INTELSAT approved further liberalization of coordination procedures with a view toward eliminating the economic harm test in\nthe 1996-98 timeframe. For a discussion of separate satellite systems competition to COMSAT World Systems, see Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 9 to the 1994 Financial Statements.\n\tThe Corporation is a strong advocate of the privatization of INTELSAT, based upon management's belief that only if INTELSAT is converted into a commercial entity responsible to shareholders rather than member nations will it be competitive in the dynamic telecommunications markets of tomorrow. In 1994, the United States Government formally endorsed the privatization of INTELSAT. Intergovernmental proceedings under the procedures of INTELSAT are now underway to debate privatization and other possible alternative structures favored by other member nations of the organization.\nCOMSAT International Ventures\n\tCOMSAT International Ventures (CIV) manages investments in a group of companies that provides a variety of telecommunications services throughout the world, including private-line and public switched services. CIV is also actively engaged in the development of prospective international telecommunications opportunities, and its existing and prospective ventures are typically located in markets that the Corporation expects to be the world's emerging, high growth telecommunications markets.\n\tAs of March 1, 1995, CIV manages investments in a total of 13 ventures in Latin America, Asia, Europe, Russia and other countries of the Commonwealth of Independent States (the CIS). CIV ventures take various forms, including minority equity investments, joint ventures and wholly-owned subsidiaries. Customers of these ventures include U.S. and foreign multinational corporations, and domestic (non-U.S.) companies operating in their own countries.\n\tCIV continued to develop new investment opportunities around the world in 1994. In particular, CIV initiated service in Brazil, and its Venezuelan venture continued to explore opportunities to provide communications services in that country. CIV also increased its investment in BelCom, Inc., a company providing telecommunications services in Russia and other CIS countries, to majority ownership, making BelCom one of several CIV ventures whose results were consolidated in 1994. Further, CIV expanded its European and Middle Eastern presence by concluding a revenue sharing agreement with the Government of Turkey to provide VSAT services, and by purchasing a minority stake in Viatel, Inc., a U.S.-based telecommunications company whose primary activity is the international resale of voice telephony and value-added services in Europe. CIV also extended its operations to the Pacific region, through the acquisition of a minority equity share of Philippine Global Communications, Inc. (PhilCom), a full-service telecommunications company in the Philippines. CIV expects to continue to expand its existing businesses and to develop investment opportunities in other markets of the world.\n\tCIV operates in numerous and diverse markets. Consequently, the level of competition in the countries where CIV's ventures conduct business varies considerably. In some countries there is full competition, and in others competition is limited. The competitive conditions faced by each venture are the result of differing regulatory policies, as well as economic and market conditions, in the particular country in which a venture operates. Because CIV's ventures operate in some of the world's most dynamic markets, the competitive environment faced by these ventures is subject to constant change.\nMOBILE COMMUNICATIONS\n\tThe Mobile Communications segment consists of the FCC- regulated business of COMSAT Mobile Communications.\nCOMSAT Mobile Communications\n\tCOMSAT Mobile Communications provides satellite telecommunications services for maritime, aeronautical and land mobile applications, using the Inmarsat satellites and COMSAT's land earth stations in Connecticut, California, Malaysia and Turkey, which serve the Atlantic, Pacific and Indian Ocean Regions, respectively. These stations enable COMSAT Mobile Communications to offer global coverage for its services. There are currently more than 40,000 mobile terminals operating in the Inmarsat system. As described below, COMSAT Mobile Communications provides a full range of voice, facsimile, data and telex services, as well as certain value-added services.\n\tMaritime Services. COMSAT Mobile Communications provides satellite services for communications to and from ships and other vessels. Customers for these services include transport ship operators, cruise ships and their passengers, fishing vessel operators, oil and mining interests, pleasure boat operators, U.S. Navy ships and foreign telecommunications administrations.\n\tServices include group call messaging to a fleet of ships, an electronic mail service, a direct-dial telephone service for passengers and crew on board ships, a news summary distribution service, access to data bases through personal computers and other office communications services for facsimile transmissions, worldwide teleconferencing and current financial news reports.\n\tIn 1992, COMSAT Mobile Communications initiated its two new digital services, Inmarsat-B and Inmarsat-M, in the Atlantic and Pacific Ocean Regions. These services provide more efficient use of the Inmarsat satellite capacity, help to significantly lower the cost of using satellite communications, and expand the potential customer base for maritime and land mobile services. COMSAT Mobile Communications also introduced a multi-channel version of Inmarsat-M service that allows cruise ships and other high-volume users to increase their channel capacity and offer lower rates to their customers. In 1994, COMSAT Mobile\nCommunications opened a new land earth station in Malaysia to provide these new digital services to the Indian Ocean Region.\n\tAeronautical Services. COMSAT Mobile Communications provides satellite telecommunications services for aeronautical applications, including airline operational and administrative communications, passenger telephone service and, prospectively, air traffic control.\n\tBy an FCC Report and Order issued in 1989, COMSAT was authorized (1) to be the sole U.S. provider of Inmarsat space segment capacity for aeronautical services; (2) to provide ground segment aeronautical services in connection with the Inmarsat space segment on a non-exclusive basis; and (3) to provide such aeronautical services only to aircraft engaged in international flights, including international flights over U.S. airspace. Another entity, the American Mobile Satellite Corporation (AMSC), was designated as the sole provider of certain domestic aeronautical satellite services. However, COMSAT Mobile Communications has been authorized by the FCC to provide domestic aeronautical satellite services on an interim basis until the commercial deployment of AMSC's satellite, which AMSC expects to occur in early 1995.\n\tCustomers of COMSAT Mobile Communications for aeronautical services include airline service providers, commercial airlines, government aircraft and owners and operators of corporate aircraft.\n\tCOMSAT Mobile Communications began providing aeronautical services in 1990 with a data service for cockpit communications on commercial flights under a 10-year agreement with Aeronautical Radio, Inc., an airline-owned service organization. In 1991, COMSAT Mobile Communications began providing aeronautical voice services in the Atlantic and Pacific Ocean Regions through its earth stations at Southbury, Connecticut and Santa Paula, California. There are currently more than 500 aircraft equipped to use the Inmarsat aeronautical system, equally split between voice and data services.\n\tA service agreement with Kokusai Denshin Denwa Co., Ltd. (KDD), the Japanese Signatory to Inmarsat, provides that COMSAT Mobile Communications may use KDD's ground earth station serving the Indian Ocean Region to serve COMSAT Mobile Communications' aeronautical customers. COMSAT Mobile Communications may serve KDD's customers flying in the Atlantic Ocean Region, and COMSAT Mobile Communications and KDD will provide mutual back-up in the Pacific Ocean Region for aeronautical customers of both companies.\n\tService agreements with GTE Airfone, Incorporated, Claircom and In-Flight Phone, Inc., all of which are providers of air-to- ground passenger telephone service using terrestrial facilities, enable these providers to extend their current service to transoceanic flights by acquiring satellite and ground earth station services from COMSAT Mobile Communications.\n\tIn 1993, COMSAT signed a service agreement with United Airlines to provide satellite communications services for passengers, including telephone, fax and data transmission on approximately 74 aircraft, once such aircraft are equipped with satellite terminals. In 1994, COMSAT was selected by Air Canada to provide passenger voice service on 16 aircraft.\n\tLand Mobile Services. COMSAT Mobile Communications provides telecommunications services for international land mobile applications, using mobile and portable terminals located outside of the United States. Customers for these services include broadcasters, foreign telecommunications authorities and U.S. and foreign corporations and government agencies.\n\tCOMSAT Mobile Communications land mobile services are currently available using transportable versions of Inmarsat's Standard-A and Standard-B mobile earth station (telephone, facsimile, data, and telex), a briefcase-size Standard-M terminal and a smaller data-only Standard-C terminal through COMSAT Mobile Communications' C-Link(sm) service. C-Link service is a low-cost text messaging service that permits smaller vessels and land mobile units to use the global satellite network. The briefcase- size Standard-M terminals provide a more portable and less expensive telephone service for international travelers, the news media, government officials and others who travel to remote parts of the world where reliable communications services are often not available. COMSAT Mobile Communications is developing a six pound, laptop computer sized \"mini-M\" terminal which is expected to be available in 1996.\n\tCOMSAT is not regularly authorized to provide domestic land mobile services. However, it is providing Inmarsat satellite capacity to AMSC, the authorized U.S. domestic land mobile entity, for an interim service pending the launch of AMSC's own satellite, and it is providing interim domestic service to certain other end users under special temporary authority from the FCC.\n\tRevenues. Approximately 23% of the Corporation's consolidated revenues in 1994 were derived from COMSAT Mobile Communications (25% in 1993, 23% in 1992). No single customer of COMSAT Mobile Communications provided more than 10% of the Corporation's consolidated revenues in 1994.\n\tCompetition. Under the Inmarsat Act, COMSAT is the sole U.S. operating entity and investor in the Inmarsat system. COMSAT Mobile Communications competes for maritime, land mobile and aeronautical communications business with other Inmarsat Signatories operating land earth stations and with IDB Mobile Communications, Inc. (IDB), another carrier, co-owned by the Canadian signatory to Inmarsat, which provides maritime, land mobile and aeronautical services through its own U.S. land earth stations, using Inmarsat satellite capacity obtained from COMSAT Mobile Communications, as well as through foreign earth stations on the ship-to-shore direction (and on the shore-to-ship direction in the Indian Ocean region). COMSAT Mobile Communications also competes for maritime communications business with operators of cellular radio services, high frequency\nradio services and fixed C-band satellites, domestic and international, and, when launched, the FCC-licensed low earth orbit, or \"Big Leo\", satellite systems of Iridium, GlobalStar and Odyssey. These competitive forces continue to exert downward pressure on COMSAT Mobile Communication's pricing for services provided through the Inmarsat system.\n\tIn November 1993, the FCC authorized AT&T to provide shore- to-ship Inmarsat service under an agreement with COMSAT Mobile Communications whereby COMSAT Mobile Communications is indicated in AT&T's tariff as a \"participating carrier\" and pursuant to which COMSAT Mobile Communications reduced its charge for space and ground segment to AT&T by more than 20%. In December 1993, AT&T filed a new application to provide \"branded end-to-end\" Standard A mobile satellite service in the ship-to-shore direction. In February 1994, COMSAT opposed this application, arguing that it is contrary to the Inmarsat Act. The FCC has not acted on this matter.\n\tIn December 1994, IDB filed two applications seeking authority to provide two new digital services, Inmarsat-M and Inmarsat-B, to maritime and land mobile users through foreign earth stations in the shore-to-ship direction in the Atlantic and Pacific Ocean regions. COMSAT filed a petition to deny both applications. In that proceeding, IDB is contending that the Inmarsat Act allows U.S. carriers to use Inmarsat earth stations and space segment outside of the United States for U.S.- originating traffic, a position COMSAT is opposing. The FCC has not yet ruled on the IDB applications.\n\tIn March 1993, the FCC granted COMSAT's petition seeking waivers of the structural separation requirements, subject to COMSAT's establishing certain accounting and non-structural safeguards. This relief allows COMSAT to provide equipment, software and value-added services to customers directly through COMSAT Mobile Communications, rather than through a separate subsidiary that would require substantial duplication of personnel and other costs. In satisfaction of conditions placed on COMSAT by the FCC in granting the COMSAT application, in January 1994, COMSAT filed with the FCC its new Cost Allocation Manual, and in February 1994, COMSAT filed its plan for implementing certain non-structural safeguards desired by the FCC. Both filings are subject to FCC approval before the FCC waivers take effect.\n\tInmarsat. Inmarsat is a 76-nation organization headquartered in London, England. It operates under two agreements: (1) an intergovernmental convention; and (2) an operating agreement signed by each nation's government or designated telecommunications entity (Signatory). COMSAT is the U.S. Signatory. It represents the United States in Inmarsat, subject to instructions from the Department of State (in concert with the Department of Commerce and the FCC) on matters that may affect the national interest and foreign policy of the United States.\n\tEach Signatory has rights and obligations in Inmarsat analogous to those of a partner. Each owns an investment share, makes proportionate contributions to Inmarsat's capital costs, and receives proportionate distributions of Inmarsat's space segment charges after deductions for operating expenses. The investment shares are readjusted as of February 1 of each year to approximate the Signatories' respective portions of the total use of the Inmarsat space segment for the previous year. COMSAT's investment share, the largest in Inmarsat, was 24.1% as of February 1, 1995 (22.5% as of February 1, 1994; 23.1% as of February 1, 1993).\n\tAt December 31, 1994, total Inmarsat Owners' Equity was approximately $660 million, including undistributed compensation for use of capital totaling approximately $132 million, and Inmarsat's outstanding contractual commitments totaled approximately $493 million.\n\tThe Corporation is a strong advocate of the privatization of Inmarsat, based upon management's belief that if Inmarsat is converted from a treaty organization into a commercial enterprise responsible to shareholders it will be more competitive in the dynamic telecommunications markets of tomorrow. Intergovernmental proceedings under the procedures of Inmarsat are now underway to debate privatization and other possible alternative structures favored by other member nations of the organization.\n\tInmarsat-P. As part of the Corporation's international telecommunications strategy, COMSAT Mobile Communications has responsibility for the Corporation's investment of $147 million in Inmarsat-P, a newly created company formed outside of the Inmarsat organization to allow a more commercial focus than the current Inmarsat system. Inmarsat signatories interested in investing in hand-held satellite communications can invest in Inmarsat-P in concert with other prospective strategic investors. Inmarsat-P's intermediate circular orbit (ICO) satellite system is to have 12 satellites and is expected to begin service in 1999 and be fully operational by the year 2000. Inmarsat-P users will be able to communicate worldwide using hand-held units similar to cellular phones. The units are expected to cost less than $1,000 and operate through both satellite and cellular links.\n\tTo ensure a leading position as a wholesaler of the Inmarsat-P satellite service, the Corporation plans to invest $94 million directly, $20 million through COMSAT Argentina and approximately $33 million through Inmarsat. The investment through COMSAT Argentina supports the Corporation's strategy of positioning itself in major emerging markets, where the demand for hand-held communications is expected to be the greatest.\nENTERTAINMENT\n\tThe Entertainment segment consists of COMSAT Video Enterprises, Inc. (CVE), a wholly owned subsidiary of the Corporation; On Command Video Corporation (OCV), a majority-owned subsidiary that developed and markets a proprietary on-demand video entertainment and information system for the lodging industry; the Denver Nuggets, a franchise of the National Basketball Association (NBA); and Beacon Communications, Corp., (Beacon Communications), a wholly owned subsidiary which produces theatrical films and television programming.\n\tCVE and OCV provide in-room entertainment and information services to the hospitality industry throughout the United States, Canada and the Caribbean. The services to the hotels consist of pay-per-view feature films, free-to-guest programming (such as Showtime, HBO, ESPN, The Disney Channel, CNN and TBS, among others), and pay-per-view sports and entertainment special events. OCV's pay-per-view film service is on-demand and its system also provides interactive in-room services such as folio review and guest check out. CVE's pay-per-view service is provided using OCV's on-demand system in certain hotel customers and a scheduled, satellite-broadcast service to the remainder of its hotel customers. At December 31, 1994, CVE and OCV had a customer base installed or under contract of approximately 2,400 hotels and approximately 550,000 rooms, including hotels in each major hospitality chain.\n\tIn 1994, CVE raised its ownership of OCV from 73.5% to 79.7% through purchases of common stock from minority stockholders and of additional common stock from OCV. Beginning with the third quarter of 1992, OCV's financial results have been consolidated with CVE. Previously, this investment was accounted for using the equity method. \t \tIn COMSAT's 1992 restructuring, the Corporation's video distribution business was transferred to CVE, which allowed CVE to capitalize on certain operational synergies. CVE management's focus was directed to rapidly install upscale hotel properties using the OCV product. This refocus rendered significant property and equipment obsolete which had been purchased for CVE's mid-priced hotel business and this property and equipment was written down in the 1992 restructuring charges. For a further discussion of the restructuring, see Note 14 to the 1994 Financial Statements.\n\tAll of the Corporation's domestic video distribution services and products have been consolidated within CVE. This includes the distribution of network television programming of the National Broadcasting Company (NBC) via satellite to NBC affiliate stations nationwide pursuant to a service contract which runs to 1999.\n\tThe Denver Nuggets are one of 27 franchises in the NBA. In 1995, the NBA is expected to add two expansion teams. During 1992, the Corporation acquired the partnership shares it did not already own and has consolidated the partnership results with the Corporation beginning with the third quarter of 1992. Previously, this investment was accounted for using the equity method. In the second quarter of 1994, the partnership results were moved from Eliminations and Other to the Entertainment segment. Results for prior periods were restated to reflect this change. In connection with its Nuggets ownership, CVE owns one- third of Mountain Mobile Television, LLC, a company which produces television broadcasts of sports events, including the Nuggets basketball games.\n\tIn January 1995, a proposed joint venture between CVE and The Anschutz Corporation reached an agreement-in-principle with the City and County of Denver, Colorado for the construction of a new sports and entertainment complex in downtown Denver. Construction of the new complex is conditioned on the negotiation of final agreements with the City and the current owner of the land. If the new arena is constructed, the Nuggets would begin playing there in the 1997-1998 NBA season. For a further discussion of this investment, see Note 17 to the 1994 Financial Statements.\n\tCVE acquired the assets of Beacon Communications in December 1994, including a multi-picture development, production and domestic distribution agreement with SONY Pictures Entertainment, Inc., certain recording and music publishing assets and certain other contracts and intellectual property. The Corporation has entered into five-year employment agreements with Beacon Communications' two principal personnel. For a further discussion of this investment, see Note 6 to the 1994 Financial Statements.\n\tThe Corporation's entertainment properties compete with a broad spectrum of other entertainment alternatives. In providing entertainment services to the lodging industry, CVE and OCV operate in a highly competitive and rapidly changing environment in which the principal methods of competition are service, product features and price. Several competing companies, especially SpectraVision, Inc. and Lodgenet Entertainment Corporation, provide hotels with in-room video entertainment. The Denver Nuggets compete not only with other major league sports, which are quite competitive among the leagues (i.e., the NBA, the National Football League, the National Hockey League, and Major League Baseball), but also with minor league sports, college athletics and other sports entertainment for the sports fans' entertainment dollars. Beacon Communications has numerous competitors in the motion picture and television industry, many of whom have significantly greater financial and other resources than the Corporation for the development and production of motion pictures and television programming.\nTECHNOLOGY SERVICES\n\tThe Technology Services segment consists of COMSAT RSI, Inc. (CRSI), a wholly-owned subsidiary of the Corporation which merged in June 1994 with Radiation Systems, Inc. (RSi), and COMSAT Laboratories, the Corporation's applied research and development organization. CRSI combines RSi's capabilities in the design, manufacture, and integration of satellite earth stations, advanced antennas and other turnkey systems for telecommunications, radar, air traffic control and military uses, with the Corporation's former COMSAT Technology Services division (CTS), which provided turnkey voice, video and data communications networks and products, and communications and information services worldwide. For a further discussion of the merger, see Note 2 to the 1994 Financial Statements.\nCOMSAT RSI\n\tCRSI is comprised of 11 operating divisions, 10 of which are vertically integrated to serve global advanced telecommunications markets and one of which serves global machine tool markets. CRSI designs, manufactures and integrates a range of systems, subsystems and components for advanced microwave communication, satellite communication, radar and related applications, air traffic control, and intelligence and scientific applications, and supplies antenna systems for cellular, troposcatter, personal, mobile and last-mile wireless markets. CRSI's customers include the U.S. government, U.S. government prime contractors, foreign governments, domestic and foreign telecommunication service providers, and a wide variety of other commercial customers.\n\tCRSI's manufactured products include parabolic antennas from .6 meters to 32 meters in diameter, line-of-site microwave antennas, cellular and Personal Communication System (PCS) antennas, low noise satellite frequency converters, microwave components, modems, VSAT terminals, servo control systems, antenna monitor and control systems, antenna positioning systems, tactical military antennas, air traffic control antennas, radar antennas, radio telescope antennas, optical measuring devices and tactical masts. In addition to marketing its own proprietary manufactured products, CRSI integrates its products, as well as other equipment, to provide turnkey systems for satellite gateway, cellular, rural telephony, VSAT and television broadcast.\n\tCRSI's services include systems installation, operations and maintenance, satellite construction monitoring, engineering development, system design and tracking, telemetry and command (TT&C) services.\n\tCRSI purchases parts and materials from a number of reliable commercial suppliers and does not depend on any single source for a significant portion of its supplies. It has encountered delays and adjustments from time to time, but operations have not been materially affected.\n\tMajor contracts ongoing during 1994 included: a contract with the Cote d'Ivoire (Ivory Coast) government to provide a national television and radio distribution network; a contract with the Guatemalan telephone company (Guatel) to provide a VSAT network for rural telephony service; a contract with the National Science Foundation to install the world's largest steerable radio telescope; a contract with the Federal Aviation Administration to provide tactical air navigation antennas; contracts to provide PCS antennas to both service providers in the United Kingdom; a contract with Indiana Higher Educational System (IHETS) to expand its digital education network; a contract with Cornell University to upgrade the world's largest fixed position radio telescope in Arecibo, Puerto Rico; a contract with Unisys to provide antenna positioners for the next generation weather radar (NEXRAD) program; contracts with the U.S. Navy for restoration and repair of SPS-49 air search radar pedestals; contracts with Rockwell and Raytheon to provide antennas and pedestals for the U.S. government's MILSTSAR communication system; and a contract to install cellular antenna systems in Argentina.\n\tCRSI also includes the activities of COMSAT General Corporation (COMSAT General), a wholly owned subsidiary of the Corporation. COMSAT General owns an 86.3% interest in and manages the MARISAT Joint Venture, which owns and operates three satellites and leases capacity in the satellites to Inmarsat and the U.S. Navy. In addition, CRSI manages the Corporation's minority investment in Plexsys International Corporation, a manufacturer of thin route cellular telephone equipment.\n\tCRSI's business is such that its total customer base is quite large; however, in any one 12-month period relatively few customers can represent a large portion of sales. In particular, CRSI sells to the U.S. Government as a prime contractor and as a subcontractor. In 1994, sales to the U.S. Government accounted for 44% of CRSI's sales. If the U.S. Department of Defense is considered separately, it accounted for 24% of CRSI's 1994 sales.\n\tAt December 31, 1994, CRSI's backlog of orders believed to be firm totaled approximately $152 million, as compared to approximately $198 million at December 31, 1993 (which included a Kuwait government order valued at $18 million which was canceled in 1994). Of the December 31, 1994 backlog, approximately $110 million is expected to be recognized as sales in 1995 and approximately $24 million is unfunded. Included in this order backlog is approximately $85 million of U.S. Government contracts. As is customary, these contracts include provisions for cancellation at the convenience of the U.S. Government or the prime contractor. If such a provision were exercised, CRSI would have a claim for reimbursement of costs incurred and a reasonable allowance for profit thereon.\n\tCRSI competes with major companies around the world in several of the telecommunications markets for its products and services. Major competitors in the communications systems markets include Scientific Atlanta, Inc., California Microwave, Inc., Miteq, Inc., LNR Communications, Inc., NEC and Mitsubishi. In the wireless networks market, competitors include GM Hughes Electronics Corporation, Kathrein, Cellwave, Swedcom, Gabriel Electronics, Inc., Alcatel NV, The Allen Group, Inc., Prodelin and Channel Master. The advanced systems markets competition includes Orbit Technologies, Inc., Datron Systems, Inc., Tecom Industries, Incorporated, TIW Systems, Inc., Electrospace Systems, Inc., GTE Corporation, and Vertex Communications Corporation. Many of these companies are considerably larger and have greater financial resources than the Corporation. In all market areas, COMSAT RSI competes on the basis of price, performance, on-time delivery, reliability and customer support.\nCOMSAT Laboratories\n\tCOMSAT Laboratories conducts research and development on a broad range of telecommunications devices, subsystems, transmission systems, technologies and techniques in support of COMSAT RSI and other COMSAT businesses, as well as for outside customers. Customers include U.S. and foreign government agencies, commercial entities, INTELSAT and Inmarsat. COMSAT Laboratories also licenses new technology it develops to other companies for commercialization of such technology.\n\tMajor new COMSAT Laboratories contracts awarded or begun in 1994 include: contracts with INTELSAT and AT&T to design, manufacture and deliver second generation TDMA traffic terminals; a contract with INTELSAT to develop a software system for generating TDMA burst time plans; a contract with Hughes Communications, Inc. to build and deliver an in-orbit test (IOT) system for Indonesia; and a contract with NASA to develop a satellite-based low-rate ATM network product. All together, COMSAT Laboratories won a total of 78 contracts in 1994, with a total value of $15.8 million.\n\tOn-going contracts being implemented in 1994 include a contract with INTELSAT to design and implement STRIP7, a software system used to optimize communications traffic on INTELSAT satellites, and a contract with NASA to provide operation and maintenance support for ACTS (Advanced Communications Technology Satellite). In 1994, COMSAT Laboratories also completed a subcontract with Magnavox Electronics Systems Company to develop satellite communications control software and a computer interface for a new U.S. Army satellite ground terminal system.\n\tIn 1994, COMSAT Laboratories acquired a minor interest in Superconducting Technologies, Inc. (SCT), a small start-up firm that is developing practical applications for superconducting materials in communications services.\n\tSupport of COMSAT Laboratories from outside sources was 46% of total funding in 1994. The Corporation's total expenditures for research and development were $16 million in 1994, $15 million in 1993, and $17 million in 1992. The majority of this research and development was performed by COMSAT Laboratories.\nINVESTMENTS\n\tAs discussed above, the Corporation owns the Denver Nuggets, a franchise of the NBA. As a result of the Corporation's acquiring all of the remaining interests in the partnership in 1992, the partnership's financial results have been consolidated with the Corporation's financial statements beginning with the third quarter of 1992. Previously, this investment was accounted for using the equity method. Also as discussed above, in 1994 the Corporation acquired a minority equity share of Philippine Global Communications, Inc., a full-service telecommunications company in the Philippines. For a further discussion of the Corporation's investments, see Note 6 to the 1994 Financial Statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nCOMSAT Properties\n\tEffective in 1993, the headquarters of the Corporation and the headquarters of the International Communications and Entertainment segments are located in a building in Bethesda, Maryland which the Corporation leases from a limited partnership in which it holds a 50% interest, primarily as a limited partner. The managing general partner also owns a 50% interest in the partnership. An affiliate of the managing general partner owns the building site and has leased this site to the partnership. The Corporation has entered into a 15-year lease with the partnership for the new building. For a further discussion of the Corporation's ownership interest and lease of this property, see Notes 6 and 8 to the 1994 Financial Statements.\n\tThe Corporation owns buildings and land in Clarksburg, Maryland that serve as the headquarters of COMSAT Mobile Communications and COMSAT Laboratories, as well as offices for certain operations of CRSI. The Corporation also owns buildings and land in Sterling, Virginia that serve as the headquarters of CRSI, in addition to being used for manufacturing and as an antenna test range. Further, the Corporation owns or leases 11 other properties in the United States and leases two properties in England for the operations of CRSI's divisions. \t \tThe Corporation owns two satellites that are used by the Entertainment segment in its video distribution services and its television distribution network for NBC. The Corporation, through the 86.3%-owned MARISAT Joint Venture, also operates three satellites, the capacity of which is leased by CRSI to Inmarsat and the U.S. Navy.\n\tThe Corporation leases earth stations in Turkey and Malaysia, and owns earth stations at Santa Paula, California and Southbury, Connecticut that are used by COMSAT Mobile Communications to provide mobile communications services. The California and Connecticut earth stations are also used by CRSI to provide communications services and TT&C services. The Corporation also owns earth stations at Clarksburg, Maryland and Paumalu, Hawaii that are used by COMSAT World Systems to provide TT&C services to INTELSAT.\n\tThe Corporation's properties are suitable and adequate for the Corporation's business operations.\nINTELSAT Satellites\n\tCOMSAT World Systems uses the satellites of INTELSAT, an organization in which COMSAT owns a 19.12% interest. The INTELSAT satellites currently used and under construction are described below.\n\tThe INTELSAT V series consists of eight satellites having an average capacity of at least 15,000 voice-grade bearer circuits or 51 television channels. The INTELSAT V-A series consists of five satellites having an average capacity of at least 16,000 bearer circuits or 57 television channels.\n\tThe INTELSAT VI series consists of five satellites, constructed by Hughes Aircraft Company, a subsidiary of General Motors Corporation, having an average capacity of at least 24,000 bearer circuits or 87 television channels.\n\tThe INTELSAT-K satellite, constructed by General Electric Technical Services Company, Inc., a subsidiary of General Electric Company, has an average capacity of 7,000 bearer circuits or 32 television channels.\n\tThe INTELSAT VII series consists of six satellites constructed or being constructed by Space Systems\/Loral (formerly Ford Aerospace and Communications Company). These satellites have an average capacity of at least 17,050 bearer circuits or 62 television channels. To date, five INTELSAT VII satellites have been launched, in October 1993, June 1994, October 1994, January 1995 and March 1995.\n\tThe INTELSAT VII-A series, also being constructed by Space Systems\/Loral, consists of three satellites having an average capacity of at least 19,250 bearer circuits or 70 television channels. The first INTELSAT VII-A satellite is expected to be launched in 1995.\n\tThe INTELSAT VIII series consists of four satellites that are being constructed by Martin Marietta Astro Space, a division of the Martin Marietta Corporation. These satellites will have an average capacity of 21,000 bearer circuits or 76 television channels. The first INTELSAT VIII satellite is expected to be launched in 1996.\n\tCOMSAT has applied to the FCC for authorization to participate in the procurement of two INTELSAT VIII-A spacecraft. These satellites, which are being constructed by Martin Marietta Astro Space, will have an average capacity of at least 11,600 bearer circuits, or 38 television channels, and are expected to be launched in 1997.\n\tThe Corporation has purchased insurance to cover fully the launch phase of the INTELSAT VII, VII-A, VIII and VIII-A satellites. Total loss in-orbit insurance for the first five INTELSAT VII satellites has been purchased for 360 days with a one satellite loss deductible. Total loss in-orbit insurance for the remaining INTELSAT VII, VII-A, VIII and VIII-A satellites has been purchased for 180 days with a one satellite loss deductible.\nInmarsat Satellites\n\tCOMSAT Mobile Communications uses the satellites of Inmarsat, an organization in which COMSAT owns a 24.1% interest. The Inmarsat satellites currently used and under construction are described below.\n\tThe first-generation Inmarsat satellite system consists of satellite capacity leased from INTELSAT, the European Space Agency and the MARISAT Joint Venture for periods expiring at various times through January 1996.\n\tThe second-generation Inmarsat satellite system, known as the Inmarsat II series, consists of four satellites constructed by an international consortium led by British Aerospace Dynamics Corporation. A financing arrangement with respect to the first three Inmarsat II satellites is discussed in Note 7 to the 1994 Financial Statements.\n\tThe third-generation Inmarsat satellite system, known as the Inmarsat III series, consists of five satellites which are being constructed by General Electric Technical Services Company, Inc. These satellites will use spot-beam technology, which allows reuse of the scarce frequency resources allocated for mobile satellite communications. Their capacity will be more than 20 times that of the largest satellites in the first-generation Inmarsat system and about eight times more powerful than the Inmarsat II series. No decision has been made regarding launch insurance for the Inmarsat III series. The first Inmarsat III satellite is scheduled to be launched in late 1995. A financing arrangement with respect to the first three Inmarsat III satellites is discussed in Note 7 to the 1994 Financial Statements.\nItem 3.","section_3":"Item 3. Legal Proceedings\n\tNeither COMSAT nor any of its subsidiaries is a party to, and none of their property is the subject of, material pending legal proceedings, and no such proceedings are known to be contemplated by governmental authorities, except the matters described in Notes 8 and 9 to the Corporation's 1994 Financial Statements. COMSAT and certain of its subsidiaries are parties to other pending legal proceedings arising in the ordinary course of business. While the outcome of such proceedings cannot be predicted with certainty, the Corporation believes that the resolution of such proceedings will not have a material effect on the financial condition of the Corporation.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders \tNone.\nExecutive Officers of The Registrant \t\t\t\t\t\t\t\tAge as of Name Officer March 31, 1995\nBruce L. Crockett President and Chief Executive Officer 51 Betty C. Alewine President, COMSAT International 46 \t\t\t Communications John V. Evans. President, COMSAT Laboratories 61 Charles Lyons. President, COMSAT Video Enterprises, Inc. 40 Ronald J. Mario President, COMSAT Mobile Communications 51 Richard E. Thomas President, COMSAT RSI, Inc. 68 C. Thomas Faulders, III Vice President and Chief Financial Officer 45 Steven F. Bell Vice President, Human Resources and 45 \t\t\t Organization Development Warren Y. Zeger Vice President, General Counsel and 48 \t\t\t Secretary Allen E. Flower Controller 51 Wesley D. Minami Treasurer 38\n\tNormally, the officers are elected annually by the Board of Directors, at its first meeting following the Annual Meeting of Shareholders, to serve until their successors are elected and qualified.\n\tThere is no family relationship between an officer and any other officer or director and no arrangement or understanding between an officer and any other person pursuant to which he or she was selected as an officer.\n\tThe following is a brief account of each executive officer's experience for the past five years:\n\tMr. Crockett has been President and Chief Executive Officer of the Corporation since February 1992. He was President and Chief Operating Officer of the Corporation from April 1991 to February 1992. He was President, World Systems Division from February 1987 to April 1991. He has been an employee of COMSAT since 1980 and has held various operational and financial positions including Vice President and Chief Financial Officer. Mr. Crockett also is a director of Augat, Inc. and a director or trustee of funds of The AIM Management Group, Inc.\n\tMs. Alewine has been President, COMSAT International Communications since January 1995, and President, COMSAT World Systems, from May 1991 to May 1994. She was Vice President and General Manager, INTELSAT Satellite Services from January 1989 to May 1991.\n\tDr. Evans has been President, COMSAT Laboratories since September 1991. He was Vice President and Director, COMSAT Laboratories from October 1983 to September 1991.\n\tMr. Lyons has been President, COMSAT Video Enterprises, Inc. (CVE) since February 1992. He was Vice President and General Manager, CVE from October 1990 to January 1992. Prior to joining the Corporation, he was with Marriott Corporation, serving as National Director of Group Marketing from September 1989 to October 1990 and Regional Director of Operations and National Director of Group Sales from September 1988 to September 1989.\n\tMr. Mario has been President, COMSAT Mobile Communications (CMC) since May 1991. He was Vice President and General Manager, CMC from April 1988 to May 1991.\n\tMr. Thomas has been President, COMSAT RSI, Inc. since June 1994. Prior to the merger of Radiation Systems, Inc. (RSi), a communications and radar systems manufacturing company, with COMSAT, he was with RSi since 1965, serving as President, Chairman of the Board, and Chief Executive Officer from June 1978 to June 1994.\n\tMr. Bell has been Vice President of Human Resources and Organization Development since October 1993. Prior to joining the Corporation, he was with American Express Worldwide Technologies, serving as Vice President of Human Resources from September 1992 to September 1993; and with US Sprint, serving as Regional Director of Human Resources from October 1987 to August 1992.\n\tMr. Faulders has been Vice President and Chief Financial Officer since February 1992. Prior to joining the Corporation, he was with MCI Communications Corporation (MCI), serving as Senior Vice President of Business Marketing from August 1991 to February 1992, Senior Vice President of Government Systems and Enterprise Group from August 1990 to August 1991, and Vice President of National Accounts for MCI Southeast from August 1988 to August 1990.\n\tMr. Zeger has been Vice President, General Counsel and Secretary since August 1994. He was Vice President and General Counsel from March 1992 to July 1994. He was Acting General Counsel from September 1991 to March 1992 and Associate General Counsel of the Corporation and Vice President, Law, World Systems Division from February 1988 to September 1991.\n\tMr. Flower has been Controller since June 1992. He was Vice President, Finance and Administration, CVE from May 1990 to June 1992. He was Vice President, Finance and Administration, World Systems Division from August 1987 to May 1990.\n\tMr. Minami has been Treasurer since May 1993. Prior to joining the Corporation, he was with Oxford Realty Services Corp., a privately held investment\/property management company, serving as Senior Vice President, Finance and Administration and Chief Financial Officer from December 1989 to April 1993.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related \tStockholder Matters.\n\tAs of December 31, 1994, there were 46,811,242 shares of Common Stock, without par value, of the Corporation (COMSAT Common Stock) outstanding: 46,790,354 were Series I shares, held by approximately 36,000 holders of record other than communications common carriers; and 20,888 were Series II shares, held by 35 common carriers.\n\tThe principal market for COMSAT Common Stock is the New York Stock Exchange, where it is traded under the symbol \"CQ.\" COMSAT Common Stock is also traded on the Chicago Stock Exchange and the Pacific Stock Exchange.\n\tThe Corporation's Transfer Agent, Registrar and Dividend Disbursing Agent is The Bank of New York, 101 Barclay Street, New York, New York.\n\tThe high and low sales prices of, and the dividends declared on, each share of COMSAT Common Stock for the last two years are as follows:\n\t\t\t\t COMSAT \t\t\t Common Stock* \t\t\t------------------------ Calendar Year 1993 High Low Dividend \t\t\t------------------------ \tFirst Quarter 27 7\/8 23 3\/4 .185 \tSecond Quarter 31 5\/8 27 1\/4 .185 \tThird Quarter 31 7\/8 26 3\/4 .185 \tFourth Quarter 35 1\/4 27 1\/2 .185\nCalendar Year 1994 \tFirst Quarter 30 24 7\/8 .185 \tSecond Quarter 26 1\/2 20 1\/2 .185 \tThird Quarter 26 1\/2 23 .195 \tFourth Quarter 25 5\/8 17 1\/2 .195\n* Prices reflect the two-for-one stock split which occurred in June 1993.\nItem 6.","section_6":"Item 6. Selected Financial Data for the Registrant for Each of \tthe Last Five Fiscal Years.\nNote: As discussed in Note 2 to the financial statements, the Corporation consummated its merger with Radiation Systems, Inc. (RSi) in June 1994. The merger has been treated as a pooling of interests for accounting purposes. Accordingly, information for all periods prior to the merger has been restated to include RSi.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial \t Condition and Results of Operations.\nANALYSIS OF OPERATIONS\nConsolidated Operations\n\tThe corporation consummated its merger with Radiation Systems, Inc. (RSi) on June 3, 1994. The merger has been accounted for as a pooling of interests. Accordingly, the 1993 and 1992 financial statements have been restated to include RSi.\n\tConsolidated revenues totaled $827 million in 1994, an increase of $73 million above record 1993 revenues. Revenue increases came from all business segments. The largest improvement was in the Entertainment segment, where On Command Video system installations grew substantially and revenues from the Denver Nuggets improved. In addition, international venture revenues as consolidated in the International Communications segment increased more than threefold. Growth in 1993 revenues of $66 million over 1992 was primarily attributable to improved operating performance, particularly in COMSAT Mobile Communications, which had higher traffic volumes, and the rapid growth in On Command Video system installations. In addition, the Denver Nuggets were consolidated for a full year in 1993 versus six months of 1992.\n\tOperating income in 1994 was $150 million, a decline of $1 million from 1993. Results decreased as improved performances from the Entertainment and Technology Services segments were more than offset by merger and integration costs. As discussed in Note 2 to the financial statements, the corporation recorded nonrecurring charges to operations in 1994 of $7 million for costs associated with the RSi merger.\n\tOperating income for 1993 increased by $47 million over 1992. In 1992, the corporation announced a restructuring, principally of its systems integration and video distribution businesses. This resulted in a $39 million charge to operations (see Note 14 to the financial statements). Operating income for 1993 increased by $8 million over 1992 excluding the provision for restructuring. This improvement was based on strong performance from the Mobile Communications segment and on cost benefits from the restructuring.\n\tOther income, net, declined in 1994 by $7 million from 1993 levels due to proceeds from corporate-owned life insurance policies received in 1993 which did not recur in 1994, and to lower equity profits associated with unconsolidated businesses. Other income, net, improved in 1993 over 1992 due to the insurance proceeds, improvement in profits from equity investments, and the inclusion of the Denver Nuggets' losses in other income in the first half of 1992.\n\tInterest costs increased by $3 million in 1994 as interest rates and borrowings increased. Interest costs in 1993 declined slightly from the levels of 1992 based on lower borrowings and lower interest rates. Capitalized interest continued to increase over 1993 and 1992 levels as property under-construction balances have continued to grow.\n\tThe corporation adopted Statement of Financial Accounting Standards (SFAS) No. 109 in 1993. This standard requires that deferred tax assets and liabilities be adjusted to reflect current tax rates. The cumulative effect of adopting this standard was to increase income by $2 million in 1993. In addition, the corporation recorded a charge to income tax expense of $3 million in 1993 under the new standard to reflect the impact on the prior year's deferred tax accounts of the change in Federal income tax rate to 35% from 34%.\n\tNet income was $78 million in 1994, a reduction of $7 million from results in 1993. Earnings per share for 1994 were $1.64, down from $1.79 in 1993. Merger and integration costs reduced income in 1994 by $6 million, net of taxes, or $0.13 per share. Excluding these costs, income was $84 million or $1.77 per share in 1994, versus $82 million or $1.75 per share in 1993 before the cumulative effect of the accounting change.\n\tIncome in 1993 before the cumulative effect of the accounting change increased $29 million over the results for 1992. However, the provision for restructuring reduced the corporation's income by $23 million, after tax, in 1992 or $0.51 per share. Absent this expense in 1992, and the accounting change in 1993, income for 1993 increased $6 million or 7% over 1992.\nSegment Operating Results\nInternational Communications\nIn millions 1994 1993 1992 ------------------------------------------------------------------- Revenues $ 271 $ 250 $ 253 Operating income 89 90 97\n\tInternational Communications includes COMSAT International Ventures (CIV) and the FCC-regulated and non-regulated businesses of COMSAT World Systems (CWS). CWS provides international voice, data, video and audio communications as the statutory-designated U.S. participant in the global INTELSAT satellite system. CIV invests in and operates telecommunications businesses internationally.\n\tCWS's 1994 revenues increased 3% from 1993. Revenues from full-time leased television services increased by 25%, while short-term lease revenues, which were driven by world events including the Winter Olympics and World Cup Soccer, rose 59%. Revenues from new service offerings such as VSAT leases, digital audio and wide-band mobile more than doubled in 1994. These increases were partially offset by reduced revenues from voice circuits, which declined 7% due to the anticipated conversion of analog circuits to more efficient digital service, and to rate reductions. The rate reductions, which went into effect in late 1993, were contained in long-term carrier agreements with AT&T, MCI and Sprint, CWS's three largest international carrier customers. CWS's share of revenues from the INTELSAT system also declined, as expected, with the 1% reduction in the corporation's ownership share in 1994.\n\tThe decline in CWS revenues in 1993 from 1992 levels resulted primarily from anticipated full-time voice circuit conversions from analog to more efficient digital circuits, partially offset by increases in revenues from television services.\n\tCWS's 1994 operating income declined 3% from 1993. The decrease was due to increased operating expenses, primarily depreciation, which increased as a result of the launch of one INTELSAT VII satellite in the fourth quarter of 1993 and two INTELSAT VII satellites in 1994. Additionally, CWS's 1994 expenses increased due to two events designed to control future staff costs: a voluntary early retirement offering at INTELSAT ($7 million), and a reduction in force within CWS ($1 million). The 5% decline in operating results in 1993 versus 1992 was due to the reduction in revenue discussed above.\n\tCIV has business interests in telecommunication operations in Latin America, Asia and Europe. Revenues from owned or controlled ventures were consolidated for the first time in 1993, adding 2% to segment revenues. In 1994, CIV's revenues grew more than threefold and accounted for 7% of segment revenues. As anticipated, CIV incurred operating losses of $5 million in 1994, an improvement of $1 million over 1993. CIV's operating loss in 1993 was $2 million greater than in 1992. This was primarily attributable to the operating losses of ventures which were consolidated for the first time in 1993.\nMobile Communications\nIn millions 1994 1993 1992 ------------------------------------------------------------------ Revenues $ 194 $ 190 $ 158 Operating income 48 49 37\n\tThis segment consists of COMSAT Mobile Communications (CMC), which provides maritime, aeronautical and land mobile communications services as the statutory-designated U.S. participant in the Inmarsat satellite system.\n\tCMC's overall telephone traffic minutes increased in 1994. However, revenues were flat due to rate reductions and the migration of traffic to less expensive, more efficient digital services such as Standard-M. Continued traffic growth is expected as the lower-cost digital Standard-M service dominates new terminal commissionings in the next few years. The number of Standard-M digital terminals in the marketplace at year end grew to more than 4,000.\n\tTelephone revenues declined about 8% from 1993 levels due in part to rate reductions instituted in late 1993. Additionally, the first nine months of 1993 included record traffic volumes due to international events such as the conflict in Somalia. Telex revenues declined 15% from 1993 levels. However, this decline was partially offset by revenue growth of almost 60% generated from smaller, less expensive Standard-C digital terminals. Aeronautical system revenues grew 20% from 1993 levels. It is anticipated that revenues from this market will continue to grow as additional terminals, for which several airlines have already committed, are installed on aircraft in the near future.\n\tRevenues from service contracts with IDB Mobile Communications, Inc. (IDB), American Mobile Satellite Corporation (AMSC) and Inmarsat increased almost 48% over last year due principally to additional capacity requirements.\n\tOperating income for 1994 declined slightly from 1993. Operating expenses increased about 3% year-to-year, attributable mainly to depreciation on upgrades to earth station equipment installed to meet traffic demand.\n\tRevenue increases of 20% in 1993 over the 1992 levels were across a broad range of services and were bolstered by international events. Operating expenses increased by 17%, largely attributable to higher depreciation and other traffic related costs. Operating income improved by almost 30% in 1993 from 1992.\nEntertainment\nIn millions 1994 1993 1992 ----------------------------------------------------------------- Revenues $ 157 $ 122 $ 86 Operating income 11 7 3\n\tThe Entertainment segment is comprised of COMSAT Video Enterprises, Inc. (CVE) and On Command Video Corporation (OCV), which provide video distribution and on-demand video entertainment services to the hospitality industry, and video distribution services to television networks. This segment also includes the Denver Nuggets National Basketball Association (NBA) franchise, and Beacon Communications Corp., a producer of theatrical films and television programming.\n\tThe corporation increased its ownership of OCV to almost 80% from 74% during 1994, and has consolidated OCV's results since July 1992. In December 1994, CVE purchased substantially all of the assets of Beacon Communications Corp.\n\tRevenues from video programming provided to the hospitality industry grew almost 35% in 1994 and 34% in 1993 as OCV and CVE continued to install on-demand video systems manufactured by OCV in newly contracted hotels and in hotels already served by CVE that were converted to the OCV system. In 1994, the revenue trend continued the pattern of 1993: the revenue decline from the mid-priced hotel market was more than offset by the increase in revenues from OCV's upscale hotels and from CVE hotels converted to the OCV system. OCV doubled the number of rooms equipped during 1994 while maintaining a substantial backlog of rooms to be installed.\n\tRevenues from video distribution services, for which the primary customer is the National Broadcasting Company (NBC), rose slightly in 1994. Revenue from these services remained flat in 1993 compared to 1992.\n\tRevenues for the Denver Nuggets improved in 1994 due to higher attendance and sponsor revenues and participation in the first two rounds of the NBA playoffs. Revenues increased in 1993 due to improved attendance, ticket sales and sponsor revenues, and a full year of consolidation versus six months in 1992.\n\tOperating income in 1994 grew 62% over 1993. Gains in operating results from the Denver Nuggets led to the improved performance. Results from video programming and distribution were unchanged from 1993. Operating income in 1993 improved 110% over 1992 primarily due to improved performance from OCV and CVE rooms converted to the OCV system.\nTechnology Services\nIn millions 1994 1993 1992 ------------------------------------------------------------------ Revenues $ 219 $ 202 $ 205 Operating income 15 12 12\n\tThe Technology Services segment includes COMSAT Laboratories and COMSAT RSI (CRSI), which designs, manufactures and integrates a range of turnkey systems, subsystems and components for advanced microwave communication, satellite communication, radar and related applications. In addition, this segment provides operations and maintenance, satellite construction monitoring and applied research services.\n\tRevenues in 1994 increased by $17 million, or 8%, over 1993. Improvements came primarily from continued work on the VSAT rural telephony program in Guatemala and the television and radio distribution network in Cote d'Ivoire (Ivory Coast) as well as from new projects to install cellular antennas in Argentina and to provide digital upgrades to telephony equipment at a number of earth stations internationally. In addition, 1994 revenues reflected increased business interruption insurance proceeds associated with tornado damage sustained in 1992 at the corporation's facility in Florida, offset partially by lower U.S. Government contract sales of military radar and air navigation products. Revenues were also lower at\nCOMSAT Laboratories primarily due to the sale of a microwave electronics group in 1993.\n\tOperating profit in 1994 improved slightly as a result of higher revenues noted above and the $2 million increase in insurance income, offset in part by the costs associated with the cancellation of a large infrastructure project in Kuwait. The 1994 sales mix was affected by less favorable U.S. Government contracts and an increase in lower-margin commercial programs, such as an Argentine cellular installation contract.\n\tRevenues in 1993 declined from 1992 primarily as a result of declining sales of military radar and other antenna products under U.S. Government contracts, offset by improved sales from new programs in Guatemala and the Ivory Coast and new sales associated with the acquisition of Anghel Laboratories in January 1993 and an increase in business interruption insurance income.\n\tOperating profit in 1993 was flat compared to 1992, due to the combination of the lower sales noted above and a less favorable sales mix of equipment contracts which contributed to a decline in operating margins.\nOutlook\n\tThe corporation continues to lead efforts to restructure INTELSAT and Inmarsat as privatized commercial enterprises to ensure that services offered on the INTELSAT and Inmarsat systems remain competitive in tomorrow's marketplace. The rapid evolution of telecommunications technology and increased competition have made privatization necessary so that these treaty-based organizations can become more flexible and responsive to customer needs.\n\tCOMSAT World Systems and INTELSAT will be faced with increased competition for the provision of satellite services from new and existing satellites launched by separate systems such as Pan American Satellite (PanAmSat) and Orion Network Systems, Inc. In late 1993, the Federal Communications Commission (FCC) substantially eliminated prior restrictions on access of separate system satellite operators to the public switched telephone network. This action, along with the FCC's stated goal of eliminating all restrictions on separate satellite systems by 1997, will increase competition.\n\tOver the next few years, continuing increases in satellite competition and the expected doubling of fiber optic cable capacity available in the marketplace will put increased pressure on service revenues and operating margins and could result in some loss of market share. In addition, under CWS's long-term service contracts, 1995 is the first year in which AT&T may cancel certain circuits upon paying a termination charge and the first year in which it is not obligated to activate additional circuits.\n\tCWS continues to be well positioned with long-term agreements with major international carriers to provide cost- competitive services for bulk usage beyond the year 2000. In addition, CWS expects continued growth in several emerging markets, particularly in international television distribution, where new opportunities are being created in the marketplace. Opportunities are also expanding for international VSAT services.\n\tIn addition to the ten satellites currently on order, INTELSAT has signed a lease for capacity aboard the INSAT-2E satellite in the Asia-Pacific region, planned for launch in 1997. During 1994, INTELSAT launched two satellites and plans another five launches in 1995. These new INTELSAT VII satellites, along with the INTELSAT VIII series satellites, will offer higher-power capabilities enabling CWS to remain competitive in this fast- paced market.\n\tCOMSAT International Ventures plans to continue to manage its current international businesses, as well as to pursue investments in new telecommunications ventures. CIV expects to invest up to $150 million in 1995 in strategic telecommunications ventures, primarily in countries which are liberalizing their telecommunications regulations.\n\tIn 1995, CIV's existing businesses are expected to be profitable in the aggregate. However, new ventures and acquisitions are expected to yield losses during the year. Thus, the group anticipates only a small profit overall from its operations before headquarters, management and administrative costs.\n\tCOMSAT Mobile Communications will continue to expand its service offerings and value-added products to meet customers' growing needs. The increasing number of digital terminals with improved operating efficiency and reduced service charges should continue to provide traffic growth. The smaller digital terminals should facilitate growth in the land mobile, small commercial and pleasure boat, and business traveler markets. Additionally, CMC has signed agreements to provide multi-channel terminals to major airline customers to expand the aeronautical service.\n\tCMC will continue to face increasing competition from other wireless communications services as well as from other members of the Inmarsat system. In addition, the service contracts with AMSC and IDB will expire at the end of 1995 and in September 1996, respectively. AMSC is scheduled to launch its own satellite in 1995 and, if successful, the corporation does not expect it to be a significant customer in 1996. The IDB contract is a five-year contract and discussions have begun on renewing the agreement.\n\tCMC will build on its established position of leadership in mobile satellite communications to evolve toward handheld satellite service. The next generation of personal satellite communications will be a six-pound, laptop computer-sized, \"mini- M\" satellite terminal expected to be available for use in mid- 1996 via the Inmarsat satellite system. Mini-M will feature greater convenience, global mobility management and unprecedented affordability. This product will provide a bridge from the briefcase-sized terminal of today to the small handheld terminals expected by the year 2000.\n\tAs part of the corporation's international telecommunications strategy, CMC has responsibility for the corporation's investment of $147 million in Inmarsat-P (see Note 8 to the financial statements). This newly created company was formed outside of the Inmarsat organization to allow a more commercial focus than the current Inmarsat system. Inmarsat-P's intermediate circular orbit (ICO) satellite system is to have 12 satellites and is expected to begin service in 1999 and be fully operational by the year 2000. Inmarsat-P users would then be able to communicate worldwide using handheld units similar to cellular phones. The units are expected to cost less than $1,000 and operate through both satellite and cellular links.\n\tThe Entertainment segment will continue to derive a majority of its revenues from the hospitality industry video distribution business. Revenue and income growth are expected from the continued installation of OCV systems in new properties as well as in properties of qualified existing CVE customers. For those properties receiving in-room video entertainment by satellite, CVE has an agreement for free satellite capacity through 1995. Beginning in 1996, additional operating costs may be required for satellite distribution to these CVE properties.\n\tContracted revenues for video distribution services provided to NBC will decrease by $12 million in 1995 and remain at that level through the end of the contract in 1999, resulting in a reduction of $12 million in annual operating income from this service.\n\tContinued improvement in the financial performance of the Denver Nuggets is anticipated as additional season tickets and sponsorships are sold. Further improvement in the Nuggets operating performance will depend on the team's success in reaching and remaining in the NBA playoffs. In addition, the Nuggets will receive a share of franchise fees for two new NBA expansion teams. The fees, which will total almost $10 million, are expected to be received in the third quarter of 1995. The collective bargaining agreement between the NBA and the NBA Players Association expired before the beginning of the 1994-1995 NBA season. A \"no strike, no lockout\" agreement was reached for the 1994-1995 season and it is anticipated that the league and the Players Association will reach a new agreement without a material impact on the corporation.\n\tIn January 1995, the corporation reached an agreement in principle with the City and County of Denver to construct a sports and entertainment complex in Denver, Colorado. The 19,000-seat, $132 million complex would be constructed by a proposed joint venture between the corporation and The Anschutz Corporation, and is subject to the negotiation of final agreements with the city and the landowner. The arena will be scheduled to open for the 1997-1998 NBA season. Each of the venture partners would provide up to $30 million in equity during the construction period, with the remainder to be financed with debt, sponsorships and other sources.\n\tBeacon Communications is expected to release two low-cost feature films in the second half of 1995 and begin production on two additional films for release in 1996. There is a significant degree of variability in the performance of theatrical films. Therefore, the effects of Beacon Communications operations on the corporation's operating results are difficult to estimate.\n\tThe Technology Services segment, through CRSI, continues to target the growing international markets for the building of communication infrastructure equipment. CRSI products leverage its own engineering and systems expertise, as well as the technical capabilities of COMSAT Laboratories, primarily to address the satellite and wireless communication systems currently being implemented around the world, and the expected new market for Personal Communication Systems. CRSI has completed or is in the final stages of completion on several large telecommunication infrastructure projects which provided significant revenues in the first half of 1994. The company expects that the research and development initiatives underway in the first half of 1995, including new VSAT products from its recently acquired Intelesys business unit, will contribute to sales in the second half of 1995. Earnings in the first half of 1994 benefited from the receipt of the last business interruption insurance proceeds associated with the 1992 tornado damage. Absence of any such proceeds, together with the cancellation of a significant infrastructure project in Kuwait during the fourth quarter of 1994, are expected to hold down revenues and profits in the first half of 1995.\nANALYSIS OF BALANCE SHEETS\nConsolidated Balance Sheets\n\tAssets. The corporation ended 1994 with $1,976 million of assets, an increase of $202 million over 1993.\nInternational Communications\nIn millions 1994 1993 --------------------------------------------------------------- Assets $ 885 $ 822 Property and equipment additions 137 117\n\tInternational Communications segment property and equipment additions are principally related to CWS's share of INTELSAT's satellite programs for the VII, VII A and VIII series of satellites. These new series of satellites, the first of which was launched in 1993, will offer higher power and deliver better performance characteristics to meet increasing demand from customers worldwide.\n\tCIV invested $18 million for new communications plant and equipment in 1994. The majority of the investments were needed to meet specific customer requirements for technologically advanced applications in developing countries. The corporation anticipates investing up to an additional $45 million in 1995 to meet demand in existing ventures, and may invest additional amounts if warranted by new opportunities.\nMobile Communications\nIn millions 1994 1993 ------------------------------------------------------------------ Assets $ 421 $ 402 Property and equipment additions 55 51\n\tMobile Communications segment property and equipment additions primarily relate to Inmarsat third-generation satellites currently under construction. The first of the five Inmarsat III series satellites is expected to be launched in early 1996. These satellites will provide increased capacity to meet growing demand for services in all four service regions.\n\tA second CMC ground station in the Indian Ocean region began service during 1994 to provide digital Standard-M and -B service. Stations in California and Connecticut were also upgraded to handle traffic under the new digital standards for Inmarsat M, B and C terminals.\nEntertainment\nIn millions 1994 1993 ------------------------------------------------------------------ Assets $ 369 $ 258 Property and equipment additions 90 65\n\tEntertainment segment additions to property and equipment were primarily installations of on-demand video entertainment systems for new hotel customers. With a large backlog of hotels waiting for OCV system installations, the corporation expects to make additional investments in these systems during 1995. The corporation will also continue to purchase on-demand video entertainment systems from OCV to convert a limited number of hotels in CVE's existing satellite-serviced hotel base.\nTechnology Services\nIn millions 1994 1993 ----------------------------------------------------------------- Assets $ 147 $ 165 Property and equipment additions 4 7\n\tTechnology Services segment total assets declined in 1994 principally from collection of certain long-term government contract receivables. Property and equipment additions for 1994 were primarily purchases of assets used to design, manufacture and test antenna subassemblies and microwave components. Requirements for new capital in 1995 are expected to be comparable to 1994.\nCorporate and Other\nIn millions 1994 1993 ----------------------------------------------------------------- Assets $ 155 $ 127 Property and equipment additions 1 3\n\tCorporate and Other assets include investments in unconsolidated businesses, corporate-owned life insurance policies and certain land, property and equipment. Assets increased in 1994 primarily due to the purchase of an equity interest in Philippine Global Communications, Inc. (PhilCom), offset by a reduction in the cash value of corporate-owned life insurance policies.\n\tLiabilities. During 1994, the corporation's share of long- term debt issued by INTELSAT increased by $78 million as INTELSAT issued $200 million of 6.625% Asian bonds due in March 2004 and $200 million of 8.375% Eurobonds due in October 2004. The corporation issued two medium-term notes under a $100 million medium-term note program filed with the SEC in 1994. The two notes totaling $32 million have rates of 8.05% to 8.66%. In February 1995, the corporation issued a $5 million note at 8.5% interest under the same program. The corporation repaid $70 million of 9.55% notes due in April 1994. The corporation's short-term borrowings increased by $74 million from year-end 1993 to year-end 1994.\nANALYSIS OF CASH FLOWS, LIQUIDITY AND CAPITAL RESOURCES\nCash Flows\n\tCWS, CMC and the Entertainment segment generated the majority of the corporation's cash from operations. The corporation made interest payments, net of amounts capitalized, of $25 million and tax payments of $31 million.\n\tThe corporation made cash investments of $275 million for property and equipment in 1994. Of this, $134 million was invested by the International Communications businesses, $48 million by CMC and $89 million by CVE and OCV.\n\tThe corporation received approximately $14 million when its share of INTELSAT declined from 20.9% to 20.1% in 1994; its share of INTELSAT is again expected to decrease slightly during 1995. The corporation also received approximately $4 million when its share of Inmarsat declined from 23.0% to 22.4% in 1994. The corporation's share of Inmarsat increased to 24.1% in February 1995 for an additional investment of $9 million.\n\tA total of $53 million was used to purchase equity interests, principally shares of PhilCom and other CIV ventures. In addition, $36 million was invested in wholly owned subsidiaries, primarily to purchase the assets of Beacon Communications Corp., and $4 million was used to purchase shares of OCV from minority shareholders. The corporation increased its ownership share of OCV to 79.7% at December 31, 1994.\n\tThe corporation's investment in property and equipment in 1995 will be higher than in 1994. Investments in INTELSAT satellites, international ventures, mobile terminal equipment, OCV systems and entertainment property will increase over 1994 levels.\n\tQuarterly dividends were $0.195 per share in the second half of 1994, compared to $0.185 per share in 1993 and the first half of 1994. During 1994 the corporation received $81 million in proceeds from long-term debt issued by INTELSAT and $32 million in proceeds from medium-term notes issued by the corporation. Some of these proceeds were used to redeem or repay other long- term debt obligations. In addition, the corporation issued commercial paper totaling $74 million, net of repayments, in 1994 and borrowed $32 million against certain company-owned life insurance policies. The corporation anticipates that it will issue additional long-term debt during 1995.\nLiquidity and Capital Resources\n\tThe corporation's working capital deficit improved by $11 million in 1994 as compared to 1993 principally due to the increase in receivables and a reduction in amounts due to related parties. This reduction is primarily attributable to advances from INTELSAT funded by INTELSAT commercial paper in 1993. These advances were reduced as a result of the 1994 INTELSAT bond issue discussed above.\n\tThe corporation has access to short- and long-term financing at favorable rates with an A rating from Standard and Poor's and an A-2 from Moody's. A $200 million commercial paper program had $121 million of borrowings outstanding as of December 31, 1994, at an average interest rate of 6.1%. A $200 million credit agreement, expiring in 1999, is a back-up to the corporation's commercial paper program.\n\tIn addition, at year end, the corporation had two notes totaling $32 million outstanding under a $100 million medium-term note program. The medium-term note program is part of a $200 million debt securities shelf registration program initiated in 1994. Another $5 million note was issued in February 1995.\n\tThe corporation's debt-financing activities, as regulated by the FCC, allow long-term financing up to 45% of total capital, and up to $200 million of short-term borrowings.\n\tThe corporation expects operations to fund the majority of the 1995 cash requirements and it is anticipated that additional long-term debt will be required. In addition, the corporation is reviewing other alternative sources of funding in an effort to further strengthen its balance sheet. Working capital requirements will continue to be met using commercial paper.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders of COMSAT Corporation:\nWe have audited the accompanying consolidated balance sheets of COMSAT Corporation and its subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity and cash flow for each of the three years in the period ended December 31, 1994. The consolidated financial statements give retroactive effect to the merger of COMSAT Corporation and subsidiaries and Radiation Systems, Inc. and subsidiaries on June 3, 1994, which has been accounted for as a pooling-of-interests as described in Note 2. Our audit also included the financial statement schedule listed in the Index at Item 14(a)2. These financial statements and the financial statement schedule are the responsibility of the corporation's management. Our responsibility is to express an opinion on these financial statements and the 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 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 COMSAT Corporation and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 after giving retroactive effect to the merger between COMSAT Corporation and Radiation Systems, Inc. as described in Note 2, in conformity with generally accepted accounting principles. Also, in 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.\nAs discussed in Note 13 to the consolidated financial statements, in 1993 the corporation changed its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109.\nDeloitte & Touche LLP Washington, D.C. February 10, 1995\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\nThe accompanying notes are an integral part of these financial statements.\n\t COMSAT CORPORATION AND SUBSIDIARIES\n\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS \t FOR EACH OF THE THREE YEARS IN THE PERIOD \t\t ENDED DECEMBER 31, 1994\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n\tThe significant accounting policies that have guided the preparation of these financial statements are:\n\tPrinciples of Consolidation. Accounts of COMSAT Corporation and its majority-owned subsidiaries (the corporation) have been consolidated. Significant intercompany transactions have been eliminated. Minority interest on the balance sheet is primarily comprised of the interest of other shareholders of On Command Video Corporation (OCV). As of December 31, 1994, the corporation owned 79.7% of OCV. The minority interest share of the net income of consolidated businesses is included in \"Other income, net.\"\n\tThe corporation has consolidated its shares of the accounts of the International Telecommunications Satellite Organization (INTELSAT) and Inmarsat. The corporation's ownership interests in INTELSAT and Inmarsat are based primarily on the corporation's usage of these systems. As of December 31, 1994, the corporation owned 20.1% of INTELSAT and 22.4% of Inmarsat.\n\tRevenue Recognition. Revenue from satellite services is recognized over the period during which the satellite services are provided. Revenue from long-term product, system integration and related services contracts is accounted for using the percentage-of-completion (cost-to- cost) method. Revenue from other services is recorded as services are provided.\n\tIncome Taxes and Investment Tax Credits. The corporation adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. This accounting standard requires the use of the asset and liability approach for financial accounting and reporting for income taxes.\n\tThe provision for income taxes includes taxes currently payable and those deferred because of differences between the financial statement and tax bases of assets and liabilities. The corporation has earned investment tax credits on certain INTELSAT and Inmarsat satellite costs. These tax credits have been deferred and are being recognized as reductions to the tax provision over the estimated service lives of the related assets.\n\tEarnings Per Share. Earnings per share are computed using the average number of shares outstanding during each period, adjusted for outstanding stock options, restricted stock units and unissued restricted stock awards. The weighted average number of shares for each year is 47,356,000 for 1994, 47,095,000 for 1993 and 45,875,000 for 1992. Earnings per share and the weighted average number of shares outstanding for 1992 have been adjusted for a two-for-one stock split on June 1, 1993 (see Note 10).\n\tGoodwill. The balance sheet includes goodwill related to the acquisitions of OCV, the Denver Nuggets Limited Partnership and other ventures. Goodwill is amortized over 15 to 25 years. Accumulated goodwill amortization was $7,131,000 and $4,513,000 at December 31, 1994 and 1993, respectively.\n\tFranchise Rights and Other Assets. Franchise rights were recorded in connection with the consolidation of the Nuggets in 1992 and are being amortized over 25 years. The amounts shown on the balance sheets are net of accumulated amortization of $4,920,000 and $2,955,000 at December 31, 1994 and 1993, respectively.\n\tThe cash surrender values of life insurance policies (net of loans) totaling $12,784,000 and $40,849,000 at December 31, 1994 and 1993, respectively, are included in \"Other assets.\" Other income on the income statement includes the increases in the cash surrender values of these policies. Additionally, other income for 1993 includes income of $4,131,000 ($3,137,000 net of tax) from the death benefit proceeds of corporate-owned policies.\n\tCash Flow Information. The corporation considers highly liquid investments with a maturity of three months or less at the time of purchase to be cash equivalents.\n\tNew Accounting Pronouncements. SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" was issued in May 1993 and was adopted by the corporation in 1994. This statement requires that certain investments in debt or equity securities be carried on the balance sheet at fair value. The effect of adopting this statement is not material to the corporation as of December 31, 1994.\n\tStatement Presentation. The financial statements for 1993 and 1992 have been restated for the merger accounted for as a pooling of interests as discussed in Note 2. Certain amounts have been reclassified to conform with the current year's presentation.\n2. MERGER WITH RADIATION SYSTEMS, INC.\n\tOn June 3, 1994, the corporation consummated its merger with Radiation Systems, Inc. (RSi), based in Sterling, Virginia. RSi designs, manufactures and integrates satellite earth stations, advanced antennas and other turnkey systems for telecommunications, radar, air traffic control and military uses.\n\tEach share of RSi's common stock was converted into 0.780 of a share of the corporation's common stock. A total of 6,147,000 shares of the corporation's common stock were issued for RSi's common stock. The January 1994 merger agreement stipulated that each share of RSi's common stock would be exchanged for $18.25 in the corporation's common stock, based on the average closing price of the corporation's stock during the 20 trading days ending five trading days before the closing of the transaction. The agreement also provided that in no event would a share of RSi common stock be exchanged for less than 0.638 or more than 0.780 of a share of the corporation's common stock.\n\tThe merger has been accounted for as a pooling of interests. Accordingly, the 1993 and 1992 financial statements have been restated to include RSi. Prior to the merger, RSi reported on a June 30 fiscal year basis. The accompanying financial statements include RSi's financial statements restated on a calendar year basis. There were no significant intercompany transactions between the two companies prior to the merger. The corporation recorded nonrecurring charges to operations in 1994 totaling $7,367,000 ($6,269,000 net of taxes or $0.13 per share) for merger and integration costs. These charges consisted of $4,446,000 for investment banking, legal and other professional fees, $2,226,000 for the costs associated with closing a former RSi division and $695,000 for severance and related costs.\n\tOperating results of the separate companies for the periods prior to the merger are as follows:\n\t\t\t\t Six Months \t\t\t\t Ended Year Ended In thousands, except June 30, December 31, per share amounts 1994 1993 1992 ---------------------------------------------------------------------- Revenues: \tCOMSAT $ 337,436 $ 640,390 $ 563,615 \tRSi 70,920 113,895 124,478 \t\t\t\t ---------- ---------- ---------- \t\t\t\t $ 408,356 $ 754,285 $ 688,093 \t\t\t\t ========== ========== ========== Income before cumulative effect of accounting change:* \tCOMSAT $ 39,217 $ 74,044 $ 42,924 \tRSi 6,695 8,425 10,368 \t\t\t\t ---------- ---------- ---------- \t\t\t\t $ 45,912 $ 82,469 $ 53,292 \t\t\t\t ========== ========== ========== Net income:* \tCOMSAT $ 39,217 $ 75,282 $ 42,924 \tRSi 6,695 9,112 10,368 \t\t\t\t ---------- ---------- ---------- \t\t\t\t $ 45,912 $ 84,394 $ 53,292 \t\t\t\t ========== ========== ========== Earnings per share: \tIncome before cumulative effect of \taccounting change:* \t\tBefore merger $ 0.96 $ 1.82 $ 1.09 \t\tAfter merger $ 0.97 $ 1.75 $ 1.16\n\tNet income:* \t\tBefore merger $ 0.96 $ 1.85 $ 1.09 \t\tAfter merger $ 0.97 $ 1.79 $ 1.16\n* Excludes $4,264,000 of merger and integration costs ($4,114,000 after tax, or $0.08 per share) recorded in the second quarter of 1994.\n3. RECEIVABLES\n\tReceivables at each year end are composed of:\n\tIn thousands 1994 1993 \t--------------------------------------------------------------- \tCommercial receivables $ 155,552 $ 121,391 \tReceivables under long-term contracts: \t U.S. Government: \t Amounts billed 5,530 13,946 \t Unbilled costs and accrued profits 34,265 47,651 \t Commercial customers: \t Amounts billed 8,029 7,639 \t Unbilled costs and accrued profits 21,713 24,765 \tRelated party receivables 8,889 3,846 \tOther 1,586 3,782 \t\t\t\t\t ---------- ---------- \tTotal 235,564 223,020 \tLess allowance for doubtful accounts (9,375) (12,838) \t\t\t\t\t ---------- ---------- \tNet $ 226,189 $ 210,182 \t\t\t\t\t ========== ==========\n\tUnbilled amounts represent accumulated costs and accrued profits which will be billed at future dates in accordance with contract terms and delivery schedules. All but approximately $5,100,000 of these amounts are expected to be collected within one year.\n\tUnbilled amounts are net of progress payments of $55,563,000 in 1994 and $42,616,000 in 1993.\n4. INVENTORIES\n\tInventories, stated at the lower of cost (first-in, first- out) or market, consist of the following at each year end.\n\tIn thousands 1994 1993 \t--------------------------------------------------------------- \tFinished goods $ 5,228 $ 4,705 \tWork in progress 9,187 8,346 \tRaw materials 7,518 6,277 \t\t\t\t\t ------------- ------------- \tTotal $ 21,933 $ 19,328 \t\t\t\t\t ============= =============\n5. PROPERTY AND EQUIPMENT\n\tProperty and equipment include the corporation's shares of INTELSAT and Inmarsat property and equipment.\n\tIn thousands 1994 1993 \t--------------------------------------------------------------- \tProperty and equipment at cost: \tSatellites $ 1,255,019 $ 1,182,924 \tFurniture, fixtures and \t equipment 674,407 538,774 \tBuildings and improvements 121,596 122,369 \tLand 7,044 7,059 \t\t\t\t\t ------------- ------------- \tTotal 2,058,066 1,851,126 \tLess accumulated depreciation (990,596) (858,008) \t\t\t\t\t ------------- ------------- \tNet property and equipment in \t service 1,067,470 993,118\n\tProperty and equipment under \t construction: \tINTELSAT satellites 222,793 222,223 \tInmarsat third-generation \t satellites 93,328 66,962 \tOther 47,475 50,129 \t\t\t\t\t ------------- ------------- \tTotal $ 1,431,066 $ 1,332,432 \t\t\t\t\t ============= =============\n\tDepreciation is calculated using the straight-line method over the estimated service life of each asset. The service lives for property and equipment are: satellites, 10 to 13 years; furniture, fixtures and equipment, 3 to 15 years; buildings and improvements, 3 to 40 years.\n\tCosts of satellites which are lost at launch or that fail in orbit are carried, net of any insurance proceeds, in the property accounts. The remaining net amounts are depreciated over the estimated service life of a satellite of the same series.\n6. ACQUISITIONS AND INVESTMENTS\n\tBeacon Communications Corp. In December 1994, the corporation acquired the assets of Beacon Communications Corp., a film and television production company based in Los Angeles. The cost of this acquisition was $29,133,000. The purchase agreement calls for future cash consideration of up to $16,900,000 which is contingent on the production and performance of motion pictures over the next five years.\n\tInvestments. In June 1994, the corporation acquired an approximately 17% interest in Philippine Global Communications, Inc. (PhilCom), a provider of international communications services in the Philippines, for $42,141,000. The corporation's share of PhilCom's income or losses is recorded using the \"equity method\" of accounting and is included in the \"Other income, net\" on the income statement.\n\tThe corporation has investments in other businesses that are accounted for using the equity and cost methods of accounting. These investments (including PhilCom in 1994) totaled $69,541,000 and $15,414,000 at December 31, 1994 and 1993, respectively.\n\tRock Spring II Limited Partnership. The corporation entered into a limited partnership to build and lease a new headquarters facility. The corporation holds a 50% interest in the partnership, primarily as a limited partner. The managing general partner, a regional real estate investment company, owns the remaining 50% interest in the partnership. An affiliate of the managing general partner owns the building site and has leased this site to the partnership. The corporation's investment in the partnership is included in the Investments line on the balance sheet.\n\tThe corporation relocated its headquarters operations to the new building during the second quarter of 1993. The corporation entered into a 15-year lease with the partnership for the building starting April 1993 (see Note 8).\n\tThe partnership borrowed $27,000,000 in the form of a 26- year mortgage at a fixed interest rate of 9.45% to cover construction costs. As of December 31, 1994, the corporation has guaranteed repayment of this loan. The corporation's guarantee will be reduced to $2,700,000 after satisfaction of certain contractual requirements which are expected to be completed in 1995. Subsequently, the corporation's guarantee will be reduced as the principal balance is paid down and completely eliminated once the outstanding loan balance is less than $24,300,000. The loan balance was $26,978,000 as of December 31, 1994.\n7. DEBT\n\tThe corporation, as regulated by the Federal Communications Commission (FCC), is allowed to undertake long-term borrowings of up to 45% of its total capital (long-term debt plus equity) and $200,000,000 in short-term borrowings.\n\tCommercial Paper. The corporation issues short-term commercial paper with repayment terms of 90 days or less under a $200,000,000 program. The corporation had $121,356,000 and $43,233,000 in borrowings outstanding at December 31, 1994 and 1993, respectively. The weighted average interest rate on these borrowings was 6.1% and 3.4% at December 31, 1994 and 1993, respectively.\n\tCredit Facilities. The corporation has a $200,000,000 revolving credit agreement which expires in December 1999 as a backup to the commercial paper program. There have been no borrowings under this agreement. The corporation had a $4,000,000 current note payable at December 31, 1993 under a separate credit agreement which was terminated in connection with the merger discussed in Note 2.\n\tLong-Term Debt. Long-term debt including the corporation's share of INTELSAT and Inmarsat debt at each year end consists of:\nIn thousands 1994 1993 ---------------------------------------------------------------------- 8.125% notes due 2004 $ 160,000 $ 160,000 8.95% notes due 2001 75,000 75,000 9.55% notes due 1994 - 70,000 6.75% INTELSAT Eurobonds due 2000 30,194 31,344 7.375% INTELSAT Eurobonds due 2002 40,258 41,793 8.375% INTELSAT Eurobonds due 2004 40,258 - 6.625% INTELSAT Asian bonds due 2004 40,258 - Inmarsat lease financing obligations 100,434 98,659 Medium-term notes, due 2006 interest rates of 8.05% to 8.66% 32,000 - ESOP debt 1,877 2,651 Other, net of discounts on notes payable 2,378 8,018 \t\t\t\t\t ---------- ---------- Total 522,657 487,465 Less current maturities (7,115) (76,915) \t\t\t\t\t ---------- ----------- Total long-term debt $ 515,542 $ 410,550 \t\t\t\t\t ========== =========== \t \tIn March 1994, INTELSAT issued $200,000,000 of 6.625% notes payable. Interest is payable annually in arrears and the principal is due March 22, 2004. Additionally, in October 1994, INTELSAT issued $200,000,000 of 8.375% notes payable. Interest is payable annually in arrears and the principal is due October 14, 2004. The corporation received its share of the proceeds of these notes and has recorded its share of the long-term debt.\n\tIn 1993, the corporation prepaid $30,000,000 of its 9.55% notes with the proceeds from INTELSAT's 6.75% Eurobonds. The remaining $70,000,000 balance of the 9.55% notes was repaid in April 1994 and, accordingly, was classified as a current liability on the December 31, 1993 balance sheet.\n\tIn July 1994, the corporation filed a shelf registration statement with the Securities and Exchange Commission (SEC) to issue up to $200,000,000 of debt securities. The corporation also filed a prospectus supplement with the SEC to issue up to $100,000,000 of such securities under a \"medium-term note program.\" The corporation issued two medium-term notes totaling $32,000,000 in 1994 with rates of 8.05% to 8.66% and a $5,000,000 note (8.5% interest) in February, 1995. The remaining $63,000,000 may be issued from time to time, at fixed or floating interest rates, as determined at the time of issuance.\n\tThe principal amount of debt (excluding the Inmarsat lease financing obligation) maturing over the next five years is $2,110,000 in 1995, $1,719,000 in 1996, $505,000 in 1997, $305,000 in 1998 and $305,000 in 1999.\n\tInmarsat Lease Financing Obligations. Inmarsat borrowed 140,400,000 pounds sterling under a capital lease agreement to finance the construction of second-generation Inmarsat satellites. Inmarsat also entered into another capital lease arrangement to finance the construction costs of its third-generation satellites. As of December 31, 1994, 80,000,000 pounds sterling of the 197,000,000 pounds sterling available for this purpose has been borrowed. The corporation's share of these lease obligations is included in long-term debt. Inmarsat has hedged its obligations through various foreign exchange transactions to minimize the effect of fluctuating interest and exchange rates (see Note 16).\n\tThe corporation's share of the payments under these lease obligations for each of the next five years from 1995 through 1999 is $9,481,000, $10,506,000, $14,230,000, $15,407,000 and $16,717,000, and $72,482,000 thereafter. These payments include interest totaling $38,389,000 and a current maturity of $5,005,000.\n\tESOP Debt. As discussed in Note 11, the corporation has an Employee Stock Ownership Plan (ESOP). The ESOP has bank notes payable outstanding which are guaranteed by the corporation. Accordingly, these notes are reported as long- term debt of the corporation. The ESOP debt includes an 8.75% note with quarterly principal and interest payments through 1996 and a 10.95% note with quarterly principal and interest payments through 1997.\n8. COMMITMENTS AND CONTINGENCIES\n\tProperty and Equipment. As of December 31, 1994, the corporation had commitments to acquire property and equipment totaling $140,138,000. Of this total, $117,787,000 is payable over the next three years. These commitments are related principally to the purchase of INTELSAT and Inmarsat satellites.\n\tEmployment and Consulting Agreements. The corporation has employment and consulting agreements with certain officers, coaches and players. Virtually all of these agreements provide for guaranteed payments. Other contracts provide for payments contingent upon the fulfillment of certain terms and conditions. Amounts required to be paid under such agreements total approximately $23,900,000 in 1995, $25,200,000 in 1996, $22,700,000 in 1997, $19,000,000 in 1998, $9,300,000 in 1999 and $3,500,000 thereafter.\n\tLeases. As discussed in Note 6, the corporation has a 15- year lease which started April 1993 on its headquarters building in Bethesda, Maryland. The corporation also has leases of other property and equipment. Rental expense under operating leases was $8,381,000 in 1994, $7,993,000 in 1993 and $4,253,000 in 1992. The future rental payments under operating leases are $7,155,000 in 1995, $6,462,000 in 1996, $6,597,000 in 1997, $6,599,000 in 1998 and $5,621,000 in 1999.\n\tGovernment Contracts. The corporation is subject to audit and investigation by various agencies which oversee contract performance in connection with the corporation's contracts with the U.S. Government. Management believes that potential claims from such audits and investigations will not have a material adverse effect on the consolidated financial statements.\n\tEnvironmental Issue. The corporation is engaged in a program to monitor a toxic solvent spill of limited scope at the site of its former manufacturing subsidiary in California. The corporation believes that it has complied with the directions of state authorities to date, including removing approximately 458 cubic yards of soil from the site soon after the leak was discovered in 1986 and conducting ongoing groundwater monitoring at the site. The corporation has accruals to cover monitoring costs over the near term, but it is unclear at this time whether or to what extent groundwater remediation may be required.\n\tInvestment in Inmarsat Affiliate. In 1994, the corporation committed to invest $114 million directly in a new satellite system affiliated with Inmarsat. The corporation has also committed to invest $33 million indirectly as its pro rata share of Inmarsat's $150 million investment in the venture. This new affiliate plans to construct, deploy and operate spacecraft in intermediate circular orbit, and interconnecting terrestrial facilities, for the provision of worldwide mobile communications via handheld devices. In two orders\nreleased November 1994 and December 1994, the FCC ruled in a contested proceeding that the corporation would be legally qualified to participate directly in the new venture provided that the corporation does not extend its statutory role in Inmarsat to obtain exclusive U.S. rights to access the venture's satellites. The corporation has petitioned the U.S. Court of Appeals for the District of Columbia Circuit to review the FCC ruling generally with regard to the standard applied to determine the corporation's scope of authority under the Inmarsat Act and particularly with regard to the proviso on participating in the new venture. At the same time, the corporation is acting to structure its relationship with the new venture to enable it to comply with the FCC proviso.\n\tIn consideration for the above-referenced Inmarsat investment, the new venture will provide Inmarsat with satellite capacity for the provision of specialized maritime and aeronautical communications services. The corporation's legal qualifications to participate in Inmarsat's investments will be contingent on showing that Inmarsat's planned operations are consistent with the corporation's scope of authority under the Inmarsat Act, which the FCC has ruled is limited to maritime communications and non-maritime services ancillary thereto.\n\tThe corporation has been directed by the FCC to file an application for authorization to participate in the new venture directly and indirectly through its investment in Inmarsat by May 1, 1995.\n9. REGULATORY ENVIRONMENT AND LITIGATION\n\tRegulatory Environment. Under the Communications Act of 1934 and the Satellite Act, as amended, the corporation is subject to regulation by the FCC with respect to communications services provided through the INTELSAT and Inmarsat systems and the rates charged for those services.\n\tUntil 1985, the corporation was, with minor exceptions, the sole U.S. provider of international satellite communications services using the INTELSAT system. Since then, the FCC has authorized several international satellite systems separate from INTELSAT. These separate systems currently compete against the corporation for voice, video and data traffic. In 1993, the FCC substantially eliminated prior restrictions on the ability of separate systems to offer public switched telephony services, thereby increasing competition to the corporation in the voice market. The U.S. Government has established a goal of eliminating all restrictions on competitive systems by 1997.\n\tIn 1993, the FCC initiated an audit of the corporation's role as the U.S. signatory to Inmarsat and as a provider of international mobile satellite services. In 1994, the FCC completed its audit and informed the corporation that earnings from international mobile satellite services do not appear excessive, and the FCC does not intend to take enforcement action based on the audit.\n\tThe corporation has received FCC authorization to participate in the construction of five third-generation Inmarsat satellites, despite opposition which argued that the satellites are outside the corporation's scope of authority under the Inmarsat Act on the basis that these satellites are principally designed to serve land-based users. The FCC postponed consideration of the scope of authority contention until it acts on the corporation's application to provide commercial services via the satellites, which is planned to be filed in 1995. The corporation believes that all requisite operating authorizations with respect to these satellites will be obtained.\n\tLitigation. In 1989, Pan American Satellite (PanAmSat) filed an antitrust suit against the corporation alleging interference with PanAmSat's efforts to compete in the international satellite communications market and seeking trebled damages of approximately $1.5 billion. In 1991, a U.S. Court of Appeals ruled that the corporation is immune from antitrust suits in its role as a signatory to INTELSAT. In February 1992, the U.S. Supreme Court denied PanAmSat's request for a review of the lower court's decision. An amended complaint was filed alleging that the corporation violated antitrust laws in its business activities purportedly outside of its role as a signatory to INTELSAT. In March 1993, a U.S. District Court denied the corporation's motion to dismiss the amended complaint and allowed PanAmSat to proceed with discovery. In February 1994, PanAmSat submitted a report estimating its alleged damages (before trebling) at a 1994 present value of $227,436,000. Also in February 1994, PanAmSat filed a motion with the District Court for acceptance of a third amended and supplemental complaint that would add several new claims and 15 new defendants to the suit, primarily as alleged co-conspirators with the corporation. In June 1994, the court denied PanAmSat's motion and ruled that discovery be completed. Discovery in the suit ended in November 1994; however, PanAmSat has motions pending which, if granted, would result in additional discovery. In December 1994, the corporation filed a motion for summary judgment directed to dismissal of all claims in the complaint. In the opinion of management, the complaint against the corporation is without merit, and the ultimate disposition of this matter will not have a material effect on the corporation's financial statements.\n\tThe corporation is defending an intellectual property infringement suit initiated by Spectradyne, Inc. against its COMSAT Video Enterprises, Inc. and On Command Video Corporation subsidiaries in 1992, seeking damages in an unspecified amount and injunctive relief. The initial patent claims were\ndismissed. Spectradyne thereafter twice amended its complaint, first to substitute new patent infringement claims along with claims that the corporation's subsidiaries induced unnamed third parties to infringe a copyrighted software interface, and then to substitute direct copyright infringement claims for the inducement to infringe claims. In 1994, a U.S. District Court granted summary judgment dismissing all of these claims except one copyright issue. The corporation believes that the suit is without merit and that the ultimate disposition of this matter will not have a material effect on the corporation's financial statements.\n10. STOCKHOLDERS' EQUITY\n\tEffective June 1, 1993, the corporation's Articles of Incorporation were amended to increase the number of authorized shares of the corporation's common stock from 40,000,000 shares to 100,000,000 shares and to split each share of common stock outstanding on June 1, 1993 into two shares of common stock. Earnings per share and share amounts for all prior periods have been restated to reflect this stock split. The corporation's Articles of Incorporation were also amended to increase the number of authorized shares of the corporation's preferred stock from 1,000 shares to 5,000,000 shares and to permit preferred stock to be convertible into any other class of stock. No preferred stock is currently outstanding.\n\tTreasury Stock. The corporation acquired 404,500 shares of RSi common stock in 1993 for $5,098,000. Additionally, RSi acquired 80,000 shares of its own common stock for $870,000. These shares, which were equivalent to 378,000 shares of COMSAT common stock, were accounted for as treasury stock transactions as of December 31, 1993. These shares, in addition to RSi's other treasury shares, were retired upon consummation of the merger discussed in Note 2. Accordingly, 683,000 shares of the corporation's common stock with a total cost of $8,163,000 were retired in 1994.\n\tInvestors' Plus Plan. The corporation has a plan which allows investors to purchase shares of common stock directly from the corporation. In 1994, 76,000 shares were issued with total proceeds of $977,000.\n11. STOCK INCENTIVE PLANS\n\tThe corporation has stock incentive plans which provide for the issuance of stock options, restricted stock awards, stock appreciation rights and restricted stock units. A total of 5,550,000 shares of common stock may be granted under the current plans. As of December 31, 1994, 1,234,000 shares of the corporation's treasury stock and 750,000 unissued common shares were reserved for these plans. As of December 31, 1994, no stock appreciation rights were outstanding.\n\tStock Options. Under the current plans, the exercise price for stock options may not be less than 50% of the fair market value of the stock when granted. Options vest over three years and expire after 15 years. Stock option activity was as follows: \t\t In thousands, Number of Exercise except per share amounts Shares Price Range ------------------------------------------------------------------- Balance at January 1, 1992 2,256 $ 5.97-19.23 \tOptions granted 464 9.72-23.08 \tOptions exercised (1,032) 5.97-19.22 \tOptions canceled (22) 5.97-13.94 \t\t\t\t ------- -------------- Balance at December 31, 1992 1,666 5.97-23.08 \tOptions granted 1,288 16.99-30.31 \tOptions exercised (408) 5.97-18.42 \tOptions canceled (27) 5.97-27.03 \t\t\t\t ------- -------------- Balance at December 31, 1993 2,519 5.97-30.31 \tOptions granted 1,398 23.08-27.63 \tOptions exercised (126) 5.97-25.41 \tOptions canceled (49) 5.97-27.63 \t\t\t\t ------- -------------- Balance at December 31, 1994 3,742 $ 5.97-30.31 Options exercisable at ======= ============== December 31, 1994 1,377 $ 5.97-30.31 \t\t\t\t ======= ==============\n\tThe exercise price of certain options granted prior to 1993 is equal to 50% of the market price on the grant date. The cost of these awards, which is the 50% discount to market when granted, was recorded as unearned compensation and is shown as a separate component of stockholders' equity. This unearned compensation is being amortized to expense over the three-year vesting period.\n\tThe exercise price for options awarded after 1992 is equal to the fair market value on the grant date. Accordingly, no expense is recorded for these options.\n\tRestricted Stock Awards. Restricted stock awards are shares of stock that are subject to restrictions on their sale or transfer. During 1993 and 1992, respectively, 348,000 and 68,000 restricted stock awards were granted, net of awards forfeited. The 1993 awards vest over six years and the 1992 awards vest over five years. The market value of the shares awarded was recorded as unearned compensation and is being amortized to expense over the vesting period for each grant.\n\tIn 1994, 265,000 \"performance-based\" restricted stock awards were granted. Grantees do not have record ownership of the underlying shares of stock until the end of a two-year performance period. The actual shares awarded will be based upon the achievement of the applicable financial performance targets. The shares issued will then be subject to restrictions on their sale or transfer for three additional years. The expected cost of these grants is being amortized over five years. The 1994 amortization was recorded as compensation expense of $1,420,000 and a corresponding increase to stockholders' equity described as \"amortization of stock performance awards.\"\nUnearned compensation has not been recorded for these grants since actual shares have not been issued and the number of shares to be issued is not yet known.\n\tRestricted Stock Units. Restricted stock units entitle the holder to receive a combination of stock and cash equal to the market price of common stock for each unit, when vested. These units vest over three years. During 1994, 1993 and 1992, respectively, 115,000, 49,000 and 42,000 restricted stock units were granted. At December 31, 1994, 189,000 partially vested restricted stock units were outstanding. The cost of these awards, which is the market value of the units when vested, is amortized to expense over the three- year vesting period. The amounts amortized to expense in 1994, 1993 and 1992 were $335,000, $1,538,000 and $1,048,000, respectively.\n\tEmployee Stock Purchase Plan. Employees may purchase stock at a discount through the corporation's Employee Stock Purchase Plan. The purchase price of the shares is the lower of 85% of the fair market value of the stock on the offering date, or 85% of the fair market value of the stock on the last business day of each month throughout the one- year offering period. The offering date for 1995 purchases was November 18, 1994, when 85% of the fair market value was $16.74.\n\tA total of 2,248,000 shares of the corporation's unissued common stock has been reserved for this plan.\n\tEmployee Stock Ownership Plan. The corporation has an Employee Stock Ownership Plan (ESOP) which was established in 1988 by RSi for the benefit of eligible employees. The ESOP has acquired 714,000 shares of common stock with bank loan proceeds. The corporation makes periodic contributions to the ESOP at least sufficient to make principal and interest payments as they are due. Contributions to the ESOP charged to expense totaled $864,000 in 1994, $1,049,000 in 1993 and $1,026,000 in 1992.\n\tThe corporation has guaranteed the ESOP's bank notes payable and has reported the unpaid balance of these loans as a liability of the corporation (see Note 7). An unearned ESOP compensation amount, which is equal to the unpaid bank loans, has been reported as a reduction to stockholders' equity.\n12. PENSION AND OTHER BENEFIT PLANS\n\tThe corporation has a non-contributory, defined benefit pension plan for qualifying employees. Pension benefits are based on years of service and compensation prior to retirement.\n\tThe components of net pension expense for each year are:\nIn thousands 1994 1993 1992 --------------------------------------------------------------------- Service cost for benefits earned \tduring the year $ 3,719 $ 3,087 $ 3,583 Interest cost on projected benefit \tobligation 6,817 7,044 6,556 Credit for actual return on pension \tplan assets (624) (13,010) (5,197) Net amortization and deferral (7,572) 5,427 (2,697) \t\t\t\t -------- -------- -------- Net pension expense $ 2,340 $ 2,548 $ 2,245 \t\t\t\t ======== ======== ========\n\tIn September 1992, the corporation offered an early retirement program to some employees in connection with its restructuring of certain operations (see Note 14). This program provided enhanced retirement benefits and an option for a lump sum payment of all benefits. The additional pension expense for this program was $6,582,000 and is included in the provision for restructuring in the 1992 income statement.\n\tThe following table shows the pension plan's obligations and assets as well as the amount recognized in the corporation's balance sheets at each year end.\nIn thousands 1994 1993 ---------------------------------------------------------------------- Actuarial present value of benefit obligations: \tVested benefit obligation $ 72,620 $ 88,271 \t\t\t\t\t\t ========= ========= \tAccumulated benefit obligation $ 74,403 $ 90,981 \t\t\t\t\t\t ========= ========= Actuarial present value of projected benefit obligation for service rendered to date $ 87,347 $ 109,543 Pension plan assets at fair value 95,003 99,070 \t\t\t\t\t\t --------- --------- Plan assets greater than (less than) \tprojected benefit obligation 7,656 (10,473) Unrecognized net loss (gain) (9,459) 12,116 Unrecognized transition asset at January 1, \t1986 being amortized over 11 years (4,818) (6,026) \t\t\t\t\t\t --------- --------- Net pension liability $ (6,621) $ (4,383) \t\t\t\t\t\t ========= ========= Assumed discount rate 8.5% 7.0% Assumed rate of compensation increase 5.5% 5.0% Expected rate of return on pension plan assets 9.0% 9.0%\n\tThe plan's assets consist primarily of common stock, corporate and government bonds and short-term investments. The corporation's policy is to fund the minimum actuarially computed contributions required by law. The corporation made a $102,000 cash contribution to the plan in 1994, and $4,100,000 in 1993.\n\tSupplemental Executive Retirement Plan. The corporation has an unfunded supplemental pension plan for executives. The expense for this plan was $2,976,000, $2,058,000 and $1,917,000 for 1994, 1993 and 1992, respectively.\n\tIn accordance with the provisions of Financial Accounting Standard No. 87, the corporation recorded a minimum plan liability for the excess of the accumulated benefit obligation over the accrued plan liability. This was reported as a reduction to stockholders' equity of $1,557,000 as of December 31, 1994 and $2,301,000 as of December 31, 1993. These amounts are net of deferred income taxes and net of an intangible asset recorded for the unrecognized transition obligation.\n\tThe corporation's accrued liabilities for this plan were $16,041,000 and $15,679,000 at December 31, 1994 and 1993, respectively. As of December 31, 1994, the accumulated benefit obligation was approximately $16,041,000, and the projected benefit obligation was approximately $16,558,000, assuming a discount rate of 8.5% and future salary increases of 5.5%.\n\t401(k) Plan. The corporation has a 401(k) plan for qualifying employees. A portion of employee contributions is matched by the corporation. Prior to 1994, these matching contributions were made in cash. The corporation's matching contributions for the years ended December 31, 1993 and 1992 were $3,237,000 and $2,860,000, respectively. Starting in 1994, the matching contributions have been made in shares of the corporation's common stock. During 1994, 79,000 shares of common stock with a total market value of $1,941,000 were contributed to the plan.\n\tPostretirement Benefits. The corporation provides health and life insurance benefits to qualifying retirees. The expected cost of these benefits is recognized during the years in which employees render service.\n\tThe components of the net postretirement benefit expense for each year were:\nIn thousands 1994 1993 1992 ---------------------------------------------------------------------- Service cost for benefits earned \tduring the year $ 1,756 $ 1,898 $ 2,157 Interest cost on accumulated \tpostretirement benefit \tobligation 2,867 3,518 3,762 Net amortization and deferral (1,221) (321) 232 \t\t\t\t\t-------- -------- -------- Net postretirement benefit expense $ 3,402 $ 5,095 $ 6,151 \t\t\t\t\t======== ======== ========\n\tThe early retirement program discussed earlier in this note resulted in an additional postretirement benefit expense of $2,107,000 in 1992.\n\tThe following table shows the plan's obligations as well as the liability recognized in the corporation's balance sheet at each year end.\nIn thousands 1994 1993 ---------------------------------------------------------------------- Accumulated postretirement benefit obligation: \tRetirees $ 20,598 $ 25,258 \tFully eligible active participants 3,845 3,826 \tOther active participants 12,363 14,846 \t\t\t\t\t\t --------- --------- \tTotal 36,806 43,930 Unrecognized gain from plan changes 11,614 12,873 Unrecognized net gain (loss) 2,397 (6,789) \t\t\t\t\t\t --------- --------- Net postretirement benefit liability $ 50,817 $ 50,014 \t\t\t\t\t\t ========= =========\nAssumed discount rate 8.5% 7.0% Assumed rate of compensation increase 5.5% 5.0%\n\tIn 1993, the corporation made several modifications to its postretirement benefits program including higher participant premium payments, higher deductibles and out-of-pocket maximums and reduced benefits for certain participants. Additionally, the corporation implemented a managed health care program to better control costs. These changes resulted in a reduction in the accumulated postretirement benefit obligation and an unrecognized gain of $12,873,000 as of December 31, 1993.\n\tA 10.0% increase in health care costs was assumed for 1995 with the rate decreasing 0.5% each year to an ultimate rate of 6.0%. Increasing the assumed trend rate by 1.0% each year would have increased the accumulated postretirement benefit obligation as of December 31, 1994 by $4,647,000 and the benefit expense for 1994 by $763,000.\n13. INCOME TAXES\n\tThe corporation adopted SFAS No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. This accounting statement changed the method for the recognition and measurement of deferred tax assets and liabilities. The cumulative effect of adopting SFAS No. 109 on the corporation's financial statements was to increase income by $1,925,000 ($0.04 per share) and was recorded in the first quarter of 1993. Prior year financial statements were not restated.\n\tThe components of income tax expense for each year are:\nIn thousands 1994 1993 1992 ---------------------------------------------------------------------- Federal: \tCurrent $ 28,655 $ 32,646 $ 25,349 \tDeferred 18,064 19,419 3,682 \tInvestment tax credits (3,550) (3,627) (3,943) State and local 6,510 6,754 4,883 \t\t\t\t --------- --------- --------- Total $ 49,679 $ 55,192 $ 29,971 \t\t\t\t ========= ========= =========\n\tThe difference between tax expense computed at the statutory Federal tax rate and the corporation's effective tax rate is:\nIn thousands 1994 1993 1992 ---------------------------------------------------------------------- Federal income taxes computed at \tthe statutory rate $ 44,562 $ 48,182 $ 28,309 Reduction under gross change tax \tmethod - - (2,694) Investment tax credits (3,550) (3,627) (3,943) Dispositions of assets - - 2,913 State income taxes, net of \tFederal income tax benefit 4,227 4,326 2,547 Rate increase on prior year \tdeferred taxes - 2,977 - Goodwill 920 670 707 Merger costs 1,556 - - Other 1,964 2,664 2,132 \t\t\t\t --------- --------- --------- Income tax expense $ 49,679 $ 55,192 $ 29,971 \t\t\t\t ========= ========= =========\n\tSFAS No. 109 requires that deferred tax liabilities and assets be adjusted for the effect of a change in tax laws or rates. Accordingly, the corporation recorded a charge to income tax expense of $2,977,000 in the third quarter of 1993 to adjust prior years' deferred tax assets and liabilities for an increase in the Federal income tax rate from 34% to 35%.\n\tThe net current and net non-current components of deferred tax accounts as shown on the balance sheet at December 31, 1994 and 1993 are:\nIn thousands 1994 1993 ---------------------------------------------------------------------- Current deferred tax asset $ 10,914 $ 8,333 Non-current deferred tax liability (104,309) (81,468) \t\t\t\t\t\t --------- --------- Net liability $ (93,395) $ (73,135) \t\t\t\t\t\t ========= ========= \t\t \tThe deferred tax assets and liabilities at December 31, 1994 and 1993 are:\nIn thousands 1994 1993 ---------------------------------------------------------------------- Assets: \tPostretirement benefits $ 22,947 $ 20,902 \tAccrued expenses 41,247 32,291 \tITC carryforwards - 13,115 \tAlternative minimum tax credit 35,688 32,368 \tContract revenue 8,432 7,135 \tOther 377 2,486 \t\t\t\t\t\t --------- --------- \tTotal deferred tax assets 108,691 108,297 \t\t\t\t\t\t --------- --------- Liabilities: \tProperty and equipment (202,086) (179,376) \tOther - (2,056) \t\t\t\t\t\t --------- --------- \tTotal deferred tax liabilities (202,086) (181,432) \t\t\t\t\t\t --------- --------- \tNet liability $ (93,395) $ (73,135) \t\t\t\t\t\t ========= =========\nThe corporation's investment tax credit carryforwards have been fully utilized as of December 31, 1994.\nThe Internal Revenue Service (IRS) has completed examinations of the Federal income tax returns of the corporation through 1989 and is currently examining Federal income tax returns for 1990 through 1992. The corporation has also amended its returns and filed claims for refunds for 1979 through 1987. The IRS has denied these claims. The corporation is contesting this denial by the IRS. In the opinion of the corporation, adequate provision has been made for income taxes for all periods through 1994.\n14. PROVISION FOR RESTRUCTURING\n\tIn September 1992, the corporation recorded a $38,961,000 charge for restructuring costs. At that time, the corporation announced its plans to realign business activities, downsize certain functions, and reposition COMSAT Video Enterprises, Inc. (CVE) to capitalize on the growing market for on-demand entertainment. The restructuring costs relate to headcount reductions throughout the corporation and the elimination of the former COMSAT Systems Division and the consolidation of its operations with those of COMSAT Laboratories into a new division, COMSAT Technology Services, as well as the transfer of television distribution services from COMSAT Systems Division to CVE. This charge consists of $12,644,000 for early retirement and reduction in force costs related to the reorganization and $26,317,000 for equipment, property and other items.\n15. BUSINESS SEGMENT INFORMATION\n\tThe corporation reports operating results and financial data in four business segments: International Communications, Mobile Communications, Entertainment and Technology Services. The International Communications segment consists of activities undertaken by the corporation in its COMSAT World Systems business, including INTELSAT services. This segment also includes the activities of COMSAT International Ventures. The Mobile Communications segment consists of activities undertaken by the corporation in its COMSAT Mobile Communications business, including Inmarsat services. The Entertainment segment includes entertainment services and video distribution services to television networks. The results for CVE, On Command Video Corporation, the Denver Nuggets and Beacon Communications Corp. are reported in the Entertainment segment. The Technology Services segment includes the design and manufacture of voice and data communications networks and products, systems integration services, and applied research and technology services and includes the operations of COMSAT RSI and COMSAT Laboratories.\n(1) Segment information for 1993 and 1992 has been restated for \tthe merger with RSi as discussed in Note 2.\n(2) Technology Services segment revenues include intersegment \tsales totaling $8,625,000 in 1994, $10,132,000 in 1993 and \t$19,500,000 in 1992. Intersegment sales for other segments \tare not significant. On October 3, 1992, the corporation \tsustained tornado damage at its Largo, Florida facility. \tRevenues reported for the Technology Services segment include \tbusiness interruption insurance proceeds of $4,835,000 in \t1994, $3,021,000 in 1993 and $1,572,000 in 1992.\n(3) The Denver Nuggets results were reported in Eliminations and \tother corporate activities prior to 1994. Segment results for \t1993 and 1992 have been restated to report these results in \tthe Entertainment segment.\n(4) If the 1992 provision for restructuring (see Note 14) had \tbeen charged to segment operating income, the amounts \tallocated to each segment would have been: International \tCommunications - $6,955,000; Mobile Communications - \t$3,332,000; Entertainment - $14,146,000; Technology Services - \t$10,240,000; and Other Corporate - $4,288,000.\n(5) The corporation's investments in unconsolidated businesses \tare included in Corporate and other assets.\n\tRelated Party Transactions and Significant Customers. The corporation provides support services to INTELSAT and support services and satellite capacity to Inmarsat. The revenues from these services were $26,162,000 in 1994, $23,190,000 in 1993 and $21,477,000 in 1992. These revenues were recorded primarily in the International Communications and Technology Services segments.\n\tCustomers comprising 10% or greater of the corporation's revenues are: \t In thousands 1994 1993 1992 ----------------------------------------------------------------------- U.S. Government $ 121,715 $ 115,446 $ 117,245 AT&T 100,096 117,582 135,499\n16. FINANCIAL INSTRUMENTS AND OFF-BALANCE-SHEET RISKS\n\tSFAS No. 107, which became effective in 1992, and SFAS No. 119, which became effective in 1994, require disclosures about the fair value of financial instruments. In these disclosures, fair values are estimates and do not necessarily represent the amounts that would be received or paid in an actual sale or settlement of the financial instruments.\n\tAt December 31, 1994, the corporation was contingently liable to banks for $26,214,000 for outstanding letters of credit securing performance of certain contracts. As discussed in Note 6, the corporation has guaranteed repayment of the construction loan related to its headquarters building. The corporation has other financial guarantees totaling approximately $9,600,000 as of December 31, 1994. The majority of these guarantees expire in 1995 through 1999. The estimated fair value of these instruments is not significant.\n\tInmarsat has entered into foreign currency contracts designed to minimize exposure to exchange rate fluctuations on fixed operating expenses denominated in British pounds sterling. At December 31, 1994, Inmarsat had several contracts maturing in 1995 through 1997 to purchase 87,500,000 pounds sterling for a total of $139,347,000. The corporation's share of the estimated fair value of these contracts, as determined by a bank, is an unrealized gain of approximately $700,000 at December 31, 1994.\n\tInmarsat has entered into interest rate and foreign currency swap arrangements to minimize the exposure to interest rate and foreign currency exchange fluctuations related to its satellite financing obligations. Inmarsat borrowed and is obligated to repay pounds sterling. The pounds sterling borrowed were swapped for U.S. dollars with an agreement to exchange the dollars for pounds sterling in order to meet the future lease payments. Inmarsat pays interest on the dollars at an average fixed rate of 8.4%, and it receives variable interest on the sterling amounts based on short- term LIBOR rates. The differential to be paid or received is accrued as interest rates change and is recognized over the life of the agreements. The currency swap arrangements have been designated as hedges and any gains or losses are\nincluded in the measurement of the debt. The effect of these swaps is to change the sterling lease obligation into fixed interest rate dollar debt. As of December 31, 1994, Inmarsat had $416,936,000 of swaps to be exchanged for 255,282,000 pounds sterling at various dates through 2006. Inmarsat is exposed to loss if one or more of the counterparties defaults. However, Inmarsat does not anticipate non-performance by the counterparties as all are major financial institutions. The corporation's share of the estimated fair value of these swaps is an unrealized loss of $3,713,000 at December 31, 1994. The fair value was estimated by computing the present value of the dollar obligations using current rates available for issuance of debt with similar terms, and the current value of the sterling at year-end exchange rates.\n\tThe fair value of long-term debt (excluding capitalized leases) was estimated by computing present values of the related cash flows using risk adjustments to U.S. Treasury rates obtained from investment bankers.\n\t\t\t\t\tDecember 31, 1994 \t\t\t ------------------------------- In thousands Book Amount Fair Value -------------------------------------------------------------- 8.125% notes $ 160,000 $ 156,010 8.95% notes 75,000 76,671 6.75% INTELSAT Eurobonds 30,194 28,370 7.375% INTELSAT Eurobonds 40,258 38,282 6.625% INTELSAT Asian bonds 40,258 35,700\n\tThe fair values of the remaining long-term debt not itemized above and the corporation's other financial instruments are approximately equal to their carrying values.\n17. SUBSEQUENT EVENTS\n\tDenver Sports Arena. In January 1995, the corporation, through a proposed joint venture between the corporation and The Anschutz Corporation, reached an agreement in principle with the City and County of Denver pursuant to which the joint venture would construct a sports and entertainment complex in Denver, Colorado. The 19,000-seat arena's construction is contingent on the negotiation of final agreements with the city and the landowner. The arena would be scheduled to open for the 1997-98 NBA season. The new facility would generate additional revenue and augment fan amenities to strengthen the Denver Nuggets franchise. The arena construction costs are expected to total approximately $132 million. The corporation would contribute up to $30 million during the three-year construction period and the other partner would contribute a like amount. The remaining construction costs would be financed with debt, sponsor advances and other sources.\n\tDebt. INTELSAT intends to issue $200 million of bonds in the first quarter of 1995. The corporation will record its share of the borrowings as long-term debt of approximately $40 million when the bonds are issued.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure. \t None.\nPART III\n\tExcept for the portion of Item 10","section_9A":"","section_9B":"","section_10":"Item 10. Directors and 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 \t Management. Item 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on \t Form 8-K.\n(a) Documents filed as part of this Report.\n1. Consolidated Financial Statements and Supplementary Data of Registrant.\n\t\t\t\t\t\t\t\tPage a. Independent Auditors' Report 41 b. Consolidated Financial Statements of COMSAT \tCorporation and Subsidiaries\n\t(i) Consolidated Income Statements for the Years \t Ended December 31, 1994, 1993 and 1992 42\n\t(ii) Consolidated Balance Sheets as of \t December 31, 1994 and 1993 43\n\t(iii) Consolidated Cash Flow Statements for \t the Years Ended December 31, 1994, 1993 \t and 1992 44\n\t(iv) Statements of Changes in Consolidated \t Stockholders' Equity for the Years Ended \t December 31, 1994, 1993 and 1992 45\n\t(v) Notes to Consolidated Financial Statements for \t Each of the Three Years in the Period Ended \t December 31, 1994 46-67\n2. Financial Statement Schedule Relating to the Consolidated Financial Statements of COMSAT Corporation for Each of the Three Years in the Period Ended December 31, 1994. \t\t\t\t\t\t \t\t\t\t\t\t\t Page a. Independent Auditors' Report 41 b. Schedule II - Valuation and Qualifying Accounts 80\nAll Schedules except that listed above have been omitted because they are not applicable or not required or because the required information is included elsewhere in the financial statements in this filing. Separate financial statements and schedules of COMSAT Corporation are omitted because the Corporation is primarily an operating corporation and all subsidiaries included in the consolidated financial statements, in the aggregate, do not have minority equity interests and indebtedness to any person other than the Corporation and its consolidated subsidiaries in amounts which together exceed 5 percent of the total assets shown by the consolidated statements in this filing.\n(b) Reports on Form 8-K.\nA report on Form 8-K dated October 27, 1994 was filed by the Registrant to file the press release reporting certain developments in the Registrant's Entertainment segment, including a definitive agreement to purchase the assets of Beacon Communications Corp., a film and television production company, and a memorandum of understanding with The Anschutz Corporation regarding construction of a new sports and entertainment complex in Denver.\nA report on Form 8-K dated November 3, 1994, as amended on Form 8-K\/A dated November 3, 1994, was filed by the Registrant to file (a) a press release describing the Registrant's financial results for the quarter ended September 30, 1994 and (b) a press release describing certain strategic initiatives of the Registrant.\n(c) Exhibits (listed according to the number assigned in the table in Item 601 of Regulation S-K).\nExhibit No. 3 - Articles of Incorporation and By-laws.\na. Articles of Incorporation of Registrant, composite copy, \tas amended through June 1, 1993. (Incorporated by \treference from Exhibit No. 4(a) to Registrant's \tRegistration Statement on Form S-3 (No. 33-51661) filed \ton December 22, 1993).\nb. By-laws of Registrant, as amended through January 17, \t1995.\nc. Regulations adopted by Registrant's Board of Directors \tpursuant to Section 5.02(c) of Registrant's Articles of \tIncorporation. (Incorporated by reference from Exhibit \tNo. 3(c) to Registrant's Report on Form 10-K for the \tfiscal year ended 1992.)\nExhibit No. 4 - Instruments defining the rights of security holders, including indentures.\na. Specimen of a certificate representing Series I shares \tof Registrant's Common Stock, without par value, \tregistered under Section 12 of the Securities Exchange \tAct of 1934, which are held by citizens of the United \tStates. (Incorporated by reference from Exhibit No. \t4(a) to Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1993.)\nb. Specimen of a certificate representing Series I shares \tof Registrant's Common Stock, without par value, \tregistered under Section 12 of the Securities Exchange \tAct of 1934, which are held by aliens. (Incorporated by \treference from Exhibit No. 4(b) to Registrant's Report \ton Form 10-K for the fiscal year ended December 31, \t1982.)\nc. Specimen of a certificate representing Series II shares \tof Registrant's Common Stock, without par value, \tregistered under Section 12 of the Securities Exchange \tAct of 1934. (Incorporated by reference from Exhibit No. \t4(c) to Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1982.)\nd. Standard Multiple-Series Indenture Provisions, dated \tMarch 15, 1991. (Incorporated by reference from Exhibit \tNo. 4(a) to Registrant's Registration Statement on Form \tS-3 (No. 33-39472) filed on March 15, 1991.)\ne. Indenture dated as of March 15, 1991 between Registrant \tand The Chase Manhattan Bank, N.A. (Incorporated by \treference from Exhibit No. 4(b) to Registrant's \tRegistration Statement on Form S-3 (No. 33-39472) filed \ton March 15, 1991.)\nf. Supplemental Indenture, dated as of June 29, 1994, from \tthe Registrant to The Chase Manhattan Bank, N. A. \t(Incorporated by reference from Exhibit No. 4(c) to \tRegistrant's Registration Statement on Form S-3 (No. 33- \t54369) filed on June 30, 1994.)\ng. Officers' Certificate pursuant to Section 3.01 of the \tIndenture, dated as of March 15, 1991, from the \tRegistrant to the Chase Manhattan Bank (National \tAssociation), as Trustee, relating to the authorization \tof $75,000,000 aggregate principal amount of \tRegistrant's 8.95% Notes Due 2001 (with form of Note \tattached). (Incorporated by reference from Exhibit No. \t4 to Registrant's Current Report on Form 8-K filed on \tMay 15, 1991.)\nh. Officers' Certificate pursuant to Section 3.01 of the \tIndenture, dated as of March 15, 1991, from the \tRegistrant to the Chase Manhattan Bank (National \tAssociation), as Trustee, relating to the authorization \tof $160,000,000 aggregate principal amount of \tRegistrant's 8.125% Debentures Due 2004 (with form of \tDebenture attached). (Incorporated by reference from \tExhibit No. 4 to Registrant's Current Report on Form 8-K \tfiled on April 9, 1992.)\ni. Officers' Certificate pursuant to Section 3.01 of the \tIndenture, dated as of March 15, 1991, as supplemented \tby the Supplemental Indenture, dated as of June 29, \t1994, from the Registrant to the Chase Manhattan Bank \t(National Association), as Trustee, relating to the \tauthorization of $100,000,000 aggregate principal amount \tof Registrant's Medium Term Notes, Series A (with forms \tof Notes attached).\nExhibit No. 10 - Material Contracts\na. Agreement Relating to the International \tTelecommunications Satellite Organization (INTELSAT) by \tGovernments, which entered into force on February 12, \t1973. (Incorporated by reference from Exhibit No. 10(a) \tto Registrant's Report on Form 10-K for the fiscal year \tended December 31, 1980.) \t b. Operating Agreement Relating to the International \tTelecommunications Satellite Organization (INTELSAT) by \tGovernments which entered into force on February 12, \t1973. (Incorporated by reference from Exhibit No. 10(b) \tto Registrant's Report on Form 10-K for the fiscal year \tended December 31, 1980.)\nc. Agreement dated August 15, 1975, among COMSAT General \tCorporation, RCA Global Communications, Inc., Western \tUnion International, Inc. and ITT World Communications, \tInc. relating to the establishment of a joint venture \tfor the purpose of participating in the ownership and \toperation of a maritime communications satellite system \tand Amendment Nos. 1-4 and Amendment No. 5 dated March \t24, 1980. (Incorporated by reference from Exhibit No. \t10(p) to Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1980.)\n\t(i) Amendment No. 6 dated September 1, 1981. \t\t(Incorporated by reference from Exhibit No. \t\t10(p)(ii) to Registrant's Report on Form 10-K for \t\tthe fiscal year ended December 31, 1981.)\nd. Convention on the International Maritime Satellite \tOrganization (INMARSAT) dated September 3, 1976. \t(Incorporated by reference from Exhibit No. 11 to \tRegistrant's Report on Form 10-K for the fiscal year \tended December 31, 1978.)\ne. Operating Agreement on the International Maritime \tSatellite Organization (INMARSAT) dated September 3, \t1976. (Incorporated by reference from Exhibit No. 12 to \tRegistrant's Report on Form 10-K for the fiscal year \tended December 31, 1978.)\nf.* Registrant's 1982 Stock Option Plan. (Incorporated by \treference from Exhibit No. 10(x) to Registrant's Report \ton Form 10-K for the fiscal year ended December 31, \t1981.)\ng. Agreement dated October 6, 1983, between COMSAT General \tCorporation and National Broadcasting Company for the \tprovision of satellite distribution network programming. \t(Incorporated by reference from Exhibit No. 10(r) to \tRegistrant's Report on Form 10-K for the fiscal year \tended December 31, 1983.)\n\t(i) Amendment dated September 1, 1992. (Incorporated by \t\treference from Exhibit No. 10(j)(i) to Registrant's \t\tReport on Form 10-K for the fiscal year ended \t\tDecember 31, 1992.)\nh.* Registrant's Insurance and Retirement Plan for \tExecutives adopted by Registrant's Board of Directors on \tJune 21, 1985, as amended by the Board of Directors on \tJuly 15, 1993. (Incorporated by reference from Exhibit \tNo. 10(h) to Registrant's Report on Form 10-K for the \tfiscal year ended December 31, 1993.)\ni.* Registrant's 1986 Key Employee Stock Plan. \t(Incorporated by reference from Exhibit No. 10(g) to \tRegistrant's Registration Statement on Form S-4 (File \tNo. 33-9966) filed on November 4, 1986.)\nj.* Registrant's Non-Employee Directors Stock Option Plan \tadopted by Registrant's Board of Directors on January \t15, 1988 and approved by Registrant's shareholders on \tMay 20, 1988. (Incorporated by reference from Exhibit \tNo. 10(h) to Registrant's Report on Form 10-K for the \tfiscal year ended December 31, 1987.)\n\t(i) Amendment No. 1 dated March 16, 1990. (Incorporated \t\tby reference from Exhibit No. 10 (g)(i) to \t\tRegistrant's Report on Form 10-K for the fiscal year \t\tended December 31, 1989.)\n\t(ii) Amendment No. 2 dated January 15, 1993. \t\t(Incorporated by reference from Exhibit No. \t\t10(k)(ii) to Registrant's Report on Form 10-K for \t\tthe fiscal year ended December 31, 1993.)\nk. Agreement to Acquire and Lease (and Supplemental \tAgreements thereto) dated September 28 and October 10, \t1988, respectively, among the International Maritime \tSatellite Organization (Inmarsat), the North Sea Marine \tLeasing Company, British Aerospace Public Limited \tCompany, the European Investment Bank, Kreditanstalt \tFuer Wiederaufbau, European Investment Bank (as Agent \tand as Trustee), Instituto Mobiliare Italiano, Credit \tNational, Hellenic Industrial Development Bank, and \tSociety Nationale de Credit a L'Industrie relating to \tthe financing of three Inmarsat spacecraft. \t(Incorporated by Reference from Exhibit No. 3(a) to \tRegistrant's Report on Form 10-k for the fiscal year \tended December 31, 1988.)\nl. Service Agreement, dated September 14, 1989, between \tRegistrant and Aeronautical Radio, Inc. relating to \tsatellite-based communications services. (Incorporated \tby reference from Exhibit No. 10(y) to Registrant's \tReport on Form 10-K for the fiscal year ended December \t31, 1989.)\nm. Agreement, dated January 22, 1990, between Registrant \tand Kokusai Denshin Denwa Co., Ltd. for provision of \taeronautical services. (Incorporated by reference from \tExhibit No. 10(z) to Registrant's Report on Form 10-K \tfor the fiscal year ended December 31, 1990.)\n\t(i) Amendment No. 1 dated May 20, 1993. (Incorporated \t\tby reference from Exhibit No. 10(q)(i) to \t\tRegistrant's Report on Form 10-K for the fiscal year \t\tended December 31, 1993.)\nn.* Registrant's 1990 Key Employee Stock Plan adopted by the \tBoard of Directors on March 16, 1990. (Incorporated by \treference from Exhibit No. 10 (p) to Registrant's Report \ton Form 10-K for the fiscal year ended December 31, \t1989.)\n\t(i) Amendment No. 1 dated January 15, 1993. \t\t(Incorporated by reference from Exhibit No. 10(r)(i) \t\tto Registrant's Report on Form 10-K for the fiscal \t\tyear ended December 31, 1993.)\n\t(ii) Amendment No. 2 dated January 16, 1994.\no. Agreement, dated May 25, 1990, between Registrant and \tIDB Communications Group, Inc. (Incorporated by \treference from Exhibit No. 10(bb) to Registrant's Report \ton Form 10-K for the fiscal year ended December 31, \t1990.)\np. Amended and Restated Agreement, dated November 14, 1990, \tof Limited Partnership of Rock Spring II Limited \tPartnership. (Incorporated by reference from Exhibit \tNo. 10(a) to Registrant's Current Report on Form 8-K \tfiled on February 24, 1992.) \t\t \t(i) Amended and Restated Lease Agreement, dated November \t\t14, 1990, by and between Rock Spring II Limited \t\tPartnership and Registrant. (Incorporated by \t\treference from Exhibit No. 10(b) to Registrant's \t\tCurrent Report on Form 8-K filed on February 24, \t\t1992.)\n\t(ii) Amended and Restated Ground Lease Indenture, dated \t\tNovember 14, 1990, between Anne D. Camalier \t\t(Landlord) and Rock Spring II Limited Partnership \t\t(Tenant). (Incorporated by reference from Exhibit \t\tNo. 10(c) to Registrant's Current Report on Form 8-K \t\tfiled on February 24, 1992.)\nq. Finance Facility Contract (and Supplemental Agreements \tthereto), dated December 20, 1991, among the \tInternational Maritime Satellite Organization \t(Inmarsat), Abbey National plc, General Electric \tTechnical Services Company, Inc., European Investment \tBank, Kreditanstalt Fuer Wiederaufbau, Instituto \tMobiliare Italiano S.p.A., Credit National, Societe \tNationale de Credit a L'Industrie, \tFinansieringsinstituttet for Industri OG Haandvaerk A\/S, \tDe Nationale Investeringsbank NV, and Osterreichische \tInvestitionkredit Aktiengesellschaft relating to the \tfinancing of three Inmarsat spacecraft. (Incorporated \tby reference from Exhibit No. 10 (dd) to Registrant's \tReport on Form 10-K for the fiscal year ended December \t31, 1991.)\nr.* Registrant's Directors and Executives Deferred \tCompensation Plan, as amended by the Board of Directors \ton July 15, 1993. (Incorporated by reference from \tExhibit No. 10(v) to Registrant's Report on Form 10-K \tfor the fiscal year ended December 31, 1993.)\ns. Service Agreement, dated April 2, 1992, between \tRegistrant and GTE Airfone, Incorporated, for the \tprovision of aeronautical satellite services. \t(Incorporated by reference from Exhibit No. 10(r) to \tRegistrant's Report on Form 10-K for the fiscal year \tended December 31, 1990.)\nt. Fiscal Agency Agreement, dated as of August 6, 1992, \tbetween International Telecommunications Satellite \tOrganization and Morgan Guaranty Trust Company of New \tYork. (Incorporated by reference from Exhibit No. 10 \t(dd) to Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1992.)\nu. Fiscal Agency Agreement, dated as of January 19, 1993, \tbetween International Telecommunications Satellite \tOrganization and Morgan Guaranty Trust Company of New \tYork. (Incorporated by reference from Exhibit No. 10 \t(ee) to Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1992.)\nv. Lease Agreement, dated June 8, 1993, between GTE \tAirfone, Incorporated, United Airlines, Inc. and \tRegistrant for the provision and financing of \taeronautical satellite equipment. (Incorporated by \treference from Exhibit No. 10(aa) to Registrant's Report \ton Form 10-K for the fiscal year ended December 31, \t1993.)\nw. Agreement dated July 1, 1993, between Registrant and \tAT&T Easylink Services relating to exchange of telex \ttraffic. (Incorporated by reference from Exhibit No. \t10(bb) to Registrant's Report on Form 10-K for the \tfiscal year ended December 31, 1993.)\nx. Agreement dated July 27, 1993, between the Registrant \tand American Telephone & Telegraph Company relating to \tutilization of space segment. (Incorporated by \treference from Exhibit No. 10(cc) to Registrant's Report \ton Form 10-K for the fiscal year ended December 31, \t1993.)\ny. Agreement dated September 1, 1993, between Registrant \tand MCI International, Inc. relating to exchange of \ttraffic. (Incorporated by reference from Exhibit No. \t10(dd) to Registrant's Report on Form 10-K for the \tfiscal year ended December 31, 1993.)\nz. Agreement dated November 30, 1993, between the \tRegistrant and Sprint Communications Company L.P. \trelating to utilization of space segment. (Incorporated \tby reference from Exhibit No. 10(ee) to Registrant's \tReport on Form 10-K for the fiscal year ended December \t31, 1993.)\naa. Agreement dated December 10, 1993, between Registrant \tand Sprint International relating to the exchange of \ttraffic. (Incorporated by reference from Exhibit No. \t10(ff) to Registrant's Report on Form 10-K for the \tfiscal year ended December 31, 1993.)\nbb. Credit Agreement dated as of December 17, 1993 among \tRegistrant, NationsBank of North Carolina, N.A., Bank of \tAmerica National Trust and Savings Association, The \tFirst National Bank of Chicago, The Chase Manhattan \tBank, N.A., The Sumitomo Bank, Limited, New York Branch, \tSwiss Bank Corporation, New York Branch, as lenders, and \tNationsBank of North Carolina, N.A., as agent. \t(Incorporated by reference from Exhibit No. 10(gg) to \tRegistrant's Report on Form 10-K for the fiscal year \tended December 31, 1993.)\n\t(i) Amendment No. 1 dated as of December 17, 1994.\ncc. Agreement dated January 24, 1994, between MCI \tInternational, Inc. and Registrant relating to \tutilization of space segment. (Incorporated by \treference from Exhibit No. 10(ii) to Registrant's Report \ton Form 10-K for the fiscal year ended December 31, \t1993.)\ndd. Agreement dated February 18, 1994, between Registrant \tand AT&T relating to exchange of traffic. (Incorporated \tby reference from Exhibit No. 10(jj) to Registrant's \tReport on Form 10-K for the fiscal year ended December \t31, 1993.)\nee. Fiscal Agency Agreement between International \tTelecommunications Satellite Organization, Issuer, and \tBankers Trust Company, Fiscal Agent and Principal Paying \tAgent, dated as of 22 March 1994. (Incorporated by \treference from Exhibit No. 10(kk) to Registrant's Report \ton Form 10-K for the fiscal year ended December 31, \t1993.)\nff. Distribution Agreement dated July 11, 1994 between \tRegistrant and CS First Boston Corporation, Salomon \tBrothers Inc. and Nationsbanc Capital Markets, Inc., as \tDistributors, of Registrant's Medium-Term Notes, Series \tA. (Incorporated by reference from Exhibit No. 1 to \tRegistrant's Registration Statement on Form S-3 (No. 33- \t54369) filed on June 30, 1994).\ngg. Fiscal Agency Agreement between International \tTelecommunications Satellite Organization, Issuer, and \tMorgan Guaranty Trust Company of New York, Fiscal Agent \tand Principal Paying Agent, dated as of 14 October 1994.\nhh.* Registrant's 1995 Annual Incentive Plan adopted by \tRegistrant's Board of Directors on January 17, 1995.\nii. Fiscal Agency Agreement between International \tTelecommunications Satellite Organization, Issuer, and \tMorgan Guaranty Trust Company of New York, Fiscal Agent \tand Principal Paying Agent, dated as of 28 February \t1995.\n*Compensatory plan or arrangement.\nExhibit No. 11 - Statement regarding computation of per share \t\t earnings.\nExhibit No. 21 - Subsidiaries of the Registrant as of March 31, \t\t 1995.\nExhibit No. 23 - Consents of experts and counsel. \t\t Consent of Independent Auditors dated March 27, 1995.\nExhibit No. 27 - Financial Data Schedule\nSIGNATURES\n\tPursuant 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.\n\t\t\t\t\t COMSAT CORPORATION \t\t\t\t\t (Registrant)\nDate: March 30, 1995 By \/s\/ Allen E. Flower \t\t\t\t\t(Allen E. Flower, Controller)\n\tPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by each of the following persons on behalf of the Registrant and in the capacity and on the date indicated.\n\t(1) Principal executive officer\n\t\t\t\t\t\t\t Date: March 30, 1995 By \/s\/ Bruce L. Crockett \t\t\t\t\t(Bruce L. Crockett, President \t\t\t\t\t and Chief Executive Officer)\n\t(2) Principal financial officer\nDate: March 30, 1995 By \/s\/ C. Thomas Faulders, III \t\t\t\t\t(C. Thomas Faulders, III, Vice \t\t\t\t\t President and Chief Financial \t\t\t\t\t Officer)\n\t(3) Principal accounting officer\nDate: March 30, 1995 By \/s\/ Allen E. Flower \t\t\t\t\t(Allen E. Flower, Controller)\n\t(4) Board of Directors\nDate: March 30, 1995 By \/s\/ Melvin R. Laird \t\t\t\t\t(Melvin R. Laird, Chairman and \t\t\t\t\t Director)\n\t\t\t\t By \/s\/ Lucy Wilson Benson \t\t\t\t\t(Lucy Wilson Benson, Director)\n\t\t\t\t By \/s\/ Rudy E. Boschwitz \t\t\t\t\t(Rudy E. Boschwitz, Director)\n\t\t\t\t By \/s\/ Edwin I. Colodny \t\t\t\t\t(Edwin I. Colodny, Director)\n\t\t\t\t By \/s\/ Bruce L. Crockett \t\t\t\t\t(Bruce L. Crockett, Director)\n\t\t\t\t By \/s\/ Frederick B. Dent \t\t\t\t\t(Frederick B. Dent, Director)\n\t\t\t\t By \/s\/ Neal B. Freeman \t\t\t\t\t(Neal B. Freeman, Director)\n\t\t\t\t By \/s\/Barry M. Goldwater \t\t\t\t\t(Barry M. Goldwater, Director)\n\t\t\t\t By \/s\/ Arthur Hauspurg \t\t\t\t\t(Arthur Hauspurg, Director)\n\t\t\t\t By \/s\/ Peter S. Knight \t\t\t\t\t(Peter S. Knight, Director)\n\t\t\t\t By \/s\/ Peter W. Likins \t\t\t\t\t(Peter W. Likins, Director)\n\t\t\t\t By \/s\/ Howard M. Love \t\t\t\t\t(Howard M. Love, Director)\n\t\t\t\t By \/s\/ Robert G. Schwartz \t\t\t\t\t(Robert G. Schwartz, Director)\n\t\t\t\t By \/s\/ C.J. Silas \t\t\t\t\t(C. J. Silas, Director)\n\t\t\t\t By \/s\/ Dolores D. Wharton \t\t\t\t\t(Dolores D. Wharton, Director)\n\t\t COMSAT CORPORATION AND SUBSIDIARIES\n\t SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED DECEMBER 31, 1994 \t\t\t (in thousands)\n\t\t\t Balance at Balance at \t\t\t Beginning Charged to End of \t\t\t Of Year Expenses Deductions(a) Year --------------------------------------------------------------------------- 1992: Allowance for loss on accounts receivable $ 9,245 $ 4,677 $ 2,942 $ 10,980 \t\t\t========= ========= ========= =========\nAllowance for loss on investments $ 457 $ 1,000 $ 457 $ 1,000 \t\t\t========= ========= ========= =========\n1993: Allowance for loss on accounts receivable $ 10,980 $ 3,525 $ 1,667 $ 12,838 \t\t\t========= ========= ========= =========\nAllowance for loss on investments $ 1,000 $ - $ - $ 1,000 \t\t\t========= ========= ========= =========\n1994: Allowance for loss on accounts receivable $ 12,838 $ 2,428 $ 5,891 $ 9,375 \t\t\t========= ========= ========= =========\nAllowance for loss on investments $ 1,000 $ - $ 250 $ 750 \t\t\t========= ========= ========= =========\n(a) Uncollectible amounts written off, recoveries of amounts \tpreviously reserved, and other adjustments.\nEXHIBIT INDEX\nExhibit No. Description Page ---------------------------------------------------------------------------- 3(a) Articles of Incorporation of Registrant, composite \tcopy, as amended through June 1, 1993. \t(Incorporated by reference from Exhibit No. 4(a) to \tRegistrant's Registration Statement on Form S-3 \t(No. 33-51661) filed on December 22, 1993).\n3(b) By-laws of Registrant, as amended through January \t17, 1995. 89\n3(c) Regulations adopted by Registrant's Board of \tDirectors pursuant to Section 5.02(c) of \tRegistrant's Articles of Incorporation. \t(Incorporated by reference from Exhibit No. 3(c) to \tRegistrant's Report on Form 10-K for the fiscal \tyear ended 1992.)\n4(a) Specimen of a certificate representing Series I \tshares of Registrant's Common Stock, without par \tvalue, registered under Section 12 of the \tSecurities Exchange Act of 1934, which are held by \tcitizens of the United States. (Incorporated by \treference from Exhibit No. 4(a) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1993.)\n4(b) Specimen of a certificate representing Series I \tshares of Registrant's Common Stock, without par \tvalue, registered under Section 12 of the \tSecurities Exchange Act of 1934, which are held by \taliens. (Incorporated by reference from Exhibit \tNo. 4(b) to Registrant's Report on Form 10-K for \tthe fiscal year ended December 31, 1982.)\n4(c) Specimen of a certificate representing Series II \tshares of Registrant's Common Stock, without par \tvalue, registered under Section 12 of the \tSecurities Exchange Act of 1934. (Incorporated by \treference from Exhibit No. 4(c) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1982.)\n4(d) Standard Multiple-Series Indenture Provisions, \tdated March 15, 1991. (Incorporated by reference \tfrom Exhibit No. 4(a) to Registrant's Registration \tStatement on Form S-3 (No. 33-39472) filed on March \t15, 1991.)\n4(e) Indenture dated as of March 15, 1991 between \tRegistrant and The Chase Manhattan Bank, N.A. \t(Incorporated by reference from Exhibit No. 4(b) to \tRegistrant's Registration Statement on Form S-3 \t(No. 33-39472) filed on March 15, 1991.)\nExhibit No. Description Page ----------------------------------------------------------------------------\n4(f) Supplemental Indenture, dated as of June 29, 1994, \tfrom the Registrant to The Chase Manhattan Bank, N. \tA. (Incorporated by reference from Exhibit No. 4(c) \tto Registrant's Registration Statement on Form S-3 \t(No. 33-54369) filed on June 30, 1994.)\n4(g) Officers' Certificate pursuant to Section 3.01 of \tthe Indenture, dated as of March 15, 1991, from the \tRegistrant to the Chase Manhattan Bank (National \tAssociation), as Trustee, relating to the \tauthorization of $75,000,000 aggregate principal \tamount of Registrant's 8.95% Notes Due 2001 (with \tform of Note attached). (Incorporated by reference \tfrom Exhibit No. 4 to Registrant's Current Report \ton Form 8-K filed on May 15, 1991.)\n4(h) Officers' Certificate pursuant to Section 3.01 of \tthe Indenture, dated as of March 15, 1991, from the \tRegistrant to the Chase Manhattan Bank (National \tAssociation), as Trustee, relating to the \tauthorization of $160,000,000 aggregate principal \tamount of Registrant's 8.125% Debentures Due 2004 \t(with form of Debenture attached). (Incorporated by \treference from Exhibit No. 4 to Registrant's \tCurrent Report on Form 8-K filed on April 9, 1992.)\n4(i) Officers' Certificate pursuant to Section 3.01 of 116 \tthe Indenture, dated as of March 15, 1991, as \tsupplemented by the Supplemental Indenture, dated \tas of June 29, 1994, from the Registrant to the \tChase Manhattan Bank (National Association), as \tTrustee, relating to the authorization of \t$100,000,000 aggregate principal amount of \tRegistrant's Medium Term Notes, Series A (with \tforms of Notes attached).\n10(a) Agreement Relating to the International \tTelecommunications Satellite Organization \t(INTELSAT) by Governments, which entered into force \ton February 12, 1973. (Incorporated by reference \tfrom Exhibit No. 10(a) to Registrant's Report on \tForm 10-K for the fiscal year ended December 31, \t1980.)\n10(b) Operating Agreement Relating to the International \tTelecommunications Satellite Organization \t(INTELSAT) by Governments which entered into force \ton February 12, 1973. (Incorporated by reference \tfrom Exhibit No. 10(b) to Registrant's Report on \tForm 10-K for the fiscal year ended December 31, \t1980.)\nExhibit No. Description Page ---------------------------------------------------------------------------- 10(c) Agreement dated August 15, 1975, among COMSAT \tGeneral Corporation, RCA Global Communications, \tInc., Western Union International, Inc. and ITT \tWorld Communications, Inc. relating to the \testablishment of a joint venture for the purpose of \tparticipating in the ownership and operation of a \tmaritime communications satellite system and \tAmendment Nos. 1-4 and Amendment No. 5 dated March \t24, 1980. (Incorporated by reference from Exhibit \tNo. 10(p) to Registrant's Report on Form 10-K for \tthe fiscal year ended December 31, 1980.)\n10(c)(i)Amendment No. 6 dated September 1, 1981. \t(Incorporated by reference from Exhibit No. \t10(p)(ii) to Registrant's Report on Form 10-K for \tthe fiscal year ended December 31, 1981.)\n10(d) Convention on the International Maritime Satellite \tOrganization (INMARSAT) dated September 3, 1976. \t(Incorporated by reference from Exhibit No. 11 to \tRegistrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1978.)\n10(e) Operating Agreement on the International Maritime \tSatellite Organization (INMARSAT) dated September \t3, 1976. (Incorporated by reference from Exhibit \tNo. 12 to Registrant's Report on Form 10-K for the \tfiscal year ended December 31, 1978.)\n10(f)* Registrant's 1982 Stock Option Plan. (Incorporated \tby reference from Exhibit No. 10(x) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1981.)\n10(g) Agreement dated October 6, 1983, between COMSAT \tGeneral Corporation and National Broadcasting \tCompany for the provision of satellite distribution \tnetwork programming. (Incorporated by reference \tfrom Exhibit No. 10(r) to Registrant's Report on \tForm 10-K for the fiscal year ended December 31, \t1983.)\n10(g)(i)Amendment dated September 1, 1992. (Incorporated \tby reference from Exhibit No. 10(j)(i) to \tRegistrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1992.)\n10(h)* Registrant's Insurance and Retirement Plan for \tExecutives adopted by Registrant's Board of \tDirectors on June 21, 1985, as amended by the Board \tof Directors on July 15, 1993. (Incorporated by \treference from Exhibit No. 10(h) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1993.)\nExhibit No. Description Page ---------------------------------------------------------------------------- 10(i)* Registrant's 1986 Key Employee Stock Plan. \t(Incorporated by reference from Exhibit No. 10(g) \tto Registrant's Registration Statement on Form S-4 \t(File No. 33-9966) filed on November 4, 1986.)\n10(j)* Registrant's Non-Employee Directors Stock Option \tPlan adopted by Registrant's Board of Directors on \tJanuary 15, 1988 and approved by Registrant's \tshareholders on May 20, 1988. (Incorporated by \treference from Exhibit No. 10(h) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1987.) \t 10(j)(i)*Amendment No. 1 dated March 16, 1990. (Incorporated \tby reference from Exhibit No. 10 (g)(i) to \tRegistrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1989.)\n10(j)(ii)*Amendment No. 2 dated January 15, 1993. \t(Incorporated by reference from Exhibit No. \t10(k)(ii) to Registrant's Report on Form 10-K for \tthe fiscal year ended December 31, 1993.)\n10(k) Agreement to Acquire and Lease (and Supplemental \tAgreements thereto) dated September 28 and October \t10, 1988, respectively, among the International \tMaritime Satellite Organization (Inmarsat), the \tNorth Sea Marine Leasing Company, British Aerospace \tPublic Limited Company, the European Investment \tBank, Kreditanstalt Fuer Wiederaufbau, European \tInvestment Bank (as Agent and as Trustee), \tInstituto Mobiliare Italiano, Credit National, \tHellenic Industrial Development Bank, and Society \tNationale de Credit a L'Industrie relating to the \tfinancing of three Inmarsat spacecraft. \t(Incorporated by Reference from Exhibit No. 3(a) to \tRegistrant's Report on Form 10-k for the fiscal \tyear ended December 31, 1988.)\n10(l) Service Agreement, dated September 14, 1989, \tbetween Registrant and Aeronautical Radio, Inc. \trelating to satellite-based communications \tservices. (Incorporated by reference from Exhibit \tNo. 10(y) to Registrant's Report on Form 10-K for \tthe fiscal year ended December 31, 1989.)\n10(m) Agreement, dated January 22, 1990, between \tRegistrant and Kokusai Denshin Denwa Co., Ltd. for \tprovision of aeronautical services. (Incorporated \tby reference from Exhibit No. 10(z) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1990.)\nExhibit No. Description Page ---------------------------------------------------------------------------- 10(m)(i)Amendment No. 1 dated May 20, 1993. (Incorporated \tby reference from Exhibit No. 10(q)(i) to \tRegistrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1993.)\n10(n)* Registrant's 1990 Key Employee Stock Plan adopted \tby the Board of Directors on March 16, 1990. \t(Incorporated by reference from Exhibit No. 10 (p) \tto Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1989.)\n10(n)(i)*Amendment No. 1 dated January 15, 1993. \t(Incorporated by reference from Exhibit No. \t10(r)(i) to Registrant's Report on Form 10-K for \tthe fiscal year ended December 31, 1993.)\n10(n)(ii)*Amendment No. 2 dated January 16, 1994. 150\n10(o) Agreement, dated May 25, 1990, between Registrant \tand IDB Communications Group, Inc. (Incorporated \tby reference from Exhibit No. 10(bb) to \tRegistrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1990.)\n10(p) Amended and Restated Agreement, dated November 14, \t1990, of Limited Partnership of Rock Spring II \tLimited Partnership. (Incorporated by reference \tfrom Exhibit No. 10(a) to Registrant's Current \tReport on Form 8-K filed on February 24, 1992.)\n10(p)(i)Amended and Restated Lease Agreement, dated \tNovember 14, 1990, by and between Rock Spring II \tLimited Partnership and Registrant. (Incorporated \tby reference from Exhibit No. 10(b) to Registrant's \tCurrent Report on Form 8-K filed on February 24, \t1992.)\n10(p)(ii)Amended and Restated Ground Lease Indenture, dated \tNovember 14, 1990, between Anne D. Camalier \t(Landlord) and Rock Spring II Limited Partnership \t(Tenant). (Incorporated by reference from Exhibit \tNo. 10(c) to Registrant's Current Report on Form 8- \tK filed on February 24, 1992.)\nExhibit No. Description Page ---------------------------------------------------------------------------- 10(q) Finance Facility Contract (and Supplemental \tAgreements thereto), dated December 20, 1991, among \tthe International Maritime Satellite Organization \t(Inmarsat), Abbey National plc, General Electric \tTechnical Services Company, Inc., European \tInvestment Bank, Kreditanstalt Fuer Wiederaufbau, \tInstituto Mobiliare Italiano S.p.A., Credit \tNational, Societe Nationale de Credit a \tL'Industrie, Finansieringsinstituttet for Industri \tOG Haandvaerk A\/S, De Nationale Investeringsbank \tNV, and Osterreichische Investitionkredit \tAktiengesellschaft relating to the financing of \tthree Inmarsat spacecraft. (Incorporated by \treference from Exhibit No. 10 (dd) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1991.)\n10(r)* Registrant's Directors and Executives Deferred \tCompensation Plan, as amended by the Board of \tDirectors on July 15, 1993. (Incorporated by \treference from Exhibit No. 10(v) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1993.)\n10(s) Service Agreement, dated April 2, 1992, between \tRegistrant and GTE Airfone, Incorporated, for the \tprovision of aeronautical satellite services. \t(Incorporated by reference from Exhibit No. 10(r) \tto Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1990.)\n10(t) Fiscal Agency Agreement, dated as of August 6, \t1992, between International Telecommunications \tSatellite Organization and Morgan Guaranty Trust \tCompany of New York. (Incorporated by reference \tfrom Exhibit No. 10 (dd) to Registrant's Report on \tForm 10-K for the fiscal year ended December 31, \t1992.)\n10(u) Fiscal Agency Agreement, dated as of January 19, \t1993, between International Telecommunications \tSatellite Organization and Morgan Guaranty Trust \tCompany of New York. (Incorporated by reference \tfrom Exhibit No. 10 (ee) to Registrant's Report on \tForm 10-K for the fiscal year ended December 31, \t1992.)\n10(v) Lease Agreement, dated June 8, 1993, between GTE \tAirfone, Incorporated, United Airlines, Inc. and \tRegistrant for the provision and financing of \taeronautical satellite equipment. (Incorporated by \treference from Exhibit No. 10(aa) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1993.)\nExhibit No. Description Page ---------------------------------------------------------------------------- 10(w) Agreement dated July 1, 1993, between Registrant \tand AT&T Easylink Services relating to exchange of \ttelex traffic. (Incorporated by reference from \tExhibit No. 10(bb) to Registrant's Report on Form \t10-K for the fiscal year ended December 31, 1993.)\n10(x) Agreement dated July 27, 1993, between the \tRegistrant and American Telephone & Telegraph \tCompany relating to utilization of space segment. \t(Incorporated by reference from Exhibit No. 10(cc) \tto Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1993.)\n10(y) Agreement dated September 1, 1993, between \tRegistrant and MCI International, Inc. relating to \texchange of traffic. (Incorporated by reference \tfrom Exhibit No. 10(dd) to Registrant's Report on \tForm 10-K for the fiscal year ended December 31, \t1993.)\n10(z) Agreement dated November 30, 1993, between the \tRegistrant and Sprint Communications Company L.P. \trelating to utilization of space segment. \t(Incorporated by reference from Exhibit No. 10(ee) \tto Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1993.)\n10(aa) Agreement dated December 10, 1993, between \tRegistrant and Sprint International relating to the \texchange of traffic. (Incorporated by reference \tfrom Exhibit No. 10(ff) to Registrant's Report on \tForm 10-K for the fiscal year ended December 31, \t1993.)\n10(bb) Credit Agreement dated as of December 17, 1993 \tamong Registrant, NationsBank of North Carolina, \tN.A., Bank of America National Trust and Savings \tAssociation, The First National Bank of Chicago, \tThe Chase Manhattan Bank, N.A., The Sumitomo Bank, \tLimited, New York Branch, Swiss Bank Corporation, \tNew York Branch, as lenders, and NationsBank of \tNorth Carolina, N.A., as agent. (Incorporated by \treference from Exhibit No. 10(gg) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1993.)\n10(bb)(i)Amendment No. 1 dated as of December 17, 1994. 154\n10(cc) Agreement dated January 24, 1994, between MCI \tInternational, Inc. and Registrant relating to \tutilization of space segment. (Incorporated by \treference from Exhibit No. 10(ii) to Registrant's \tReport on Form 10-K for the fiscal year ended \tDecember 31, 1993.)\nExhibit No. Description Page ---------------------------------------------------------------------------- 10(dd) Agreement dated February 18, 1994, between \tRegistrant and AT&T relating to exchange of \ttraffic. (Incorporated by reference from Exhibit \tNo. 10(jj) to Registrant's Report on Form 10-K for \tthe fiscal year ended December 31, 1993.)\n10(ee) Fiscal Agency Agreement between International \tTelecommunications Satellite Organization, Issuer, \tand Bankers Trust Company, Fiscal Agent and \tPrincipal Paying Agent, dated as of 22 March 1994. \t(Incorporated by reference from Exhibit No. 10(kk) \tto Registrant's Report on Form 10-K for the fiscal \tyear ended December 31, 1993.)\n10(ff) Distribution Agreement dated July 11, 1994 between \tRegistrant and CS First Boston Corporation, Salomon \tBrothers Inc. and Nationsbanc Capital Markets, \tInc., as Distributors, of Registrant's Medium-Term \tNotes, Series A. (Incorporated by reference from \tExhibit No. 1 to Registrant's Registration \tStatement on Form S-3 (No. 33-54369) filed on June \t30, 1994).\n10(gg) Fiscal Agency Agreement between International 163 \tTelecommunications Satellite Organization, Issuer, \tand Morgan Guaranty Trust Company of New York, \tFiscal Agent and Principal Paying Agent, dated as \tof 14 October 1994.\n10(hh)* Registrant's 1995 Annual Incentive Plan adopted by 206 \tRegistrant's Board of Directors on January 17, \t1995.\n10(ii) Fiscal Agency Agreement between International 222 \tTelecommunications Satellite Organization, Issuer, \tand Morgan Guaranty Trust Company of New York, \tFiscal Agent and Principal Paying Agent, dated as \tof 28 February 1995.\n*Compensatory plan or arrangement.\nExhibit 11 - Statement regarding computation of per share earnings 264\nExhibit 21 - Subsidiaries of the Registrant as of March 31, 1995 266\nExhibit 23 - Consent of Independent Auditors dated March 27, 1995 268\nExhibit 27 - Financial Data Schedule 270","section_15":""}
{"filename":"65771_1994.txt","cik":"65771","year":"1994","section_1":"Item 1. Business\nGeneral. M\/A-COM, Inc. (the \"Company\" or \"M\/A-COM\"), a Massachusetts corporation founded in 1950 as Microwave Associates, Inc., adopted its present name in 1978. M\/A-COM is primarily a supplier to the wireless telecommunications, surveillance and the defense-related industries of radio frequency (\"RF\"), microwave and millimeter wave semiconductors, components and subsystems, utilizing advanced circuit and semiconductor technologies, for systems applications in wireless communications, sensor systems, radar, navigation, missile guidance, electronic warfare and surveillance in air, ground, sea and space environments. M\/A-COM's products are used in a substantial variety of commercial applications and defense systems. The Company also manufactures surveillance products used in intelligence collection applications.\nThe Company reports its operations within one principal industry segment: electronic components and equipment.\nMarketing and Distribution. The principal customers for M\/A-COM's products are manufacturers and users of electronic equipment based upon the transmission and reception of RF waves, microwaves (including millimeter waves) and light waves. M\/A-COM supplies a customer base ranging from the commercial and civil sectors to the military and defense sectors in a variety of electronic equipment applications including mobile, ground-fixed, shipboard, airborne, satellite-borne and space vehicle-borne systems. Commercial applications extend to cellular telephone networks, personal communications services (\"PCS\"), wireless communications, wireless computer networking, intelligent vehicle highway systems, global positioning systems, satellite data links, microwave sensors, motion detection sensors and medical sensors, among others. Defense systems applications include radar, electronic countermeasures, missile guidance and missile fuses. The Company considers its commercial business to consist of all products not specifically manufactured for direct or indirect use by the U.S. Department of Defense, other U.S. Government agencies or foreign governments.\nThe original equipment manufacturers comprising the majority of the Company's customer base include suppliers to telecommunications equipment companies, other communications carriers, automotive and computer industries, U.S. Government agencies (particularly, the Department of Defense) and government agencies of U.S. allies. The Company's largest single source of revenue is the U.S. Government and its agencies, whose direct purchases from M\/A-COM and indirect purchases through prime contractors and subcontractors accounted for 31%, 38% and 43% of M\/A-COM's consolidated net sales in 1994, 1993 and 1992, respectively. No other customer accounted for more than 10% of consolidated net sales for those periods. All of the U.S. Government prime contracts and subcontracts are subject to termination for convenience of the Government, in which event M\/A-COM normally would be entitled to receive the contract price for completed items plus any costs incurred with respect to incomplete items and, in general, a reasonable profit on work done as provided in applicable government regulations.\nDomestic sales of the Company's products to customers other than the U.S. Government are made through the Company's sales force, through field offices located in key areas and through distributors and manufacturers' representatives. Certain products are marketed directly to customers by technical and marketing personnel, in some instances with the support of field offices and independent sales representatives.\nSales of M\/A-COM's products to foreign customers (which are located primarily in Western Europe and the Pacific Rim) are made principally through subsidiaries, including direct sales personnel and independent sales representatives and distributors. Domestic export sales were $38.5, $44.2 and $46.0 million in 1994, 1993 and 1992, respectively, while sales of foreign operations amounted to approximately $94.1, $82.4 and $67.9 million, respectively, for those years. Total sales to foreign customers were approximately $132.6, $126.6 and $113.9 million in 1994, 1993 and 1992, respectively. M\/A-COM does not believe that its foreign sales activities entail materially greater risks than its domestic activities.\nThe amounts of net sales, operating profit or loss and identifiable assets attributable to each of the Company's geographic areas for the last three years are shown in Note 15 to the Company's consolidated financial statements contained in Part II, Item 8 of this annual report on Form 10-K.\nNew Orders and Backlog. New orders for 1994 and 1993 were $328.3 and $345.6 million, respectively. New orders in 1994 are net of debookings of $17.0 million as further discussed in Part II, Item 7 of this annual report on Form 10-K. The backlog at October 1, 1994 was $200.1 million compared with $213.5 million at October 2, 1993. Approximately $32.7 million of the backlog at October 1, 1994 is expected to be recorded as revenue by the Company after 1995. A substantial portion of the backlog pertains to U.S. Government and other orders which permit termination.\nProducts. M\/A-COM has a broad range of technologies and product lines addressing a multitude of RF and microwave (including millimeter wave) requirements, from basic semiconductors and components to monolithic integrated circuits, complex subsystems and specialized equipment. The Company's products are used for diverse commercial, civil and defense applications -- based upon wireless communications, radar and other radio- type principles -- in systems that are mobile, ground-fixed, shipboard, airborne, satellite-borne or space vehicle-borne. These systems applications range from cellular telephones and base stations, PCS, wireless local area networks, vehicular sensor systems, satellite data links and MRI (magnetic resonance imaging) to global positioning systems, electronic countermeasures, solid-state phased-array radars and missile guidance. The broad range of products and technologies is integrated vertically within the Company such that the more basic are used in the design and manufacture of the more complex. Starting with a semiconductor material fabrication capability, the vertical integration progresses from substrates to devices to components to subsystems and, in certain applications, to equipment.\nM\/A-COM is a leading supplier of semiconductors to the microwave industry. In addition, the Company utilizes semiconductor technology in the majority of its other products for the generation, transmission, reception, control and processing of RF and microwave energy. The Company's semiconductor products include a wide variety of discrete semiconductors utilizing both silicon and gallium arsenide (\"GaAs\") materials. The basic RF and microwave semiconductor products include PIN diodes, used to control the passage of electrical signals through circuits; varactor diodes, used to modulate electrical signals and also to generate them; Schottky barrier and point-contact diodes, used to detect electrical signals; transistors, used to amplify electrical signals; and Gunn and Impatt diodes, used to generate microwave power. In addition, the Company is also a supplier of basic semiconductor materials, such as silicon epitaxial wafers and gallium arsenide substrates.\nIn its advanced semiconductor activities, M\/A-COM develops and produces GaAs and silicon microwave monolithic integrated circuits (\"MMICs\") and hybrid integrated circuits. MMICs are among the fundamental building blocks in many microwave and wireless systems, and GaAs semiconductors, in general, have become increasingly important in high-volume production and high-performance and portable applications in commercial and military markets. Advanced semiconductor products constitute important elements in the design of M\/A- COM's own component and subsystem product lines.\nThe Company's broad range of component products performs a wide variety of RF and microwave functions. Among M\/A-COM's component products are miniature, subminiature and microminiature connectors, essential for interconnecting RF and microwave components and subsystems. Also essential for interconnecting microwave components, subsystems and systems are cable assemblies, which the Company manufactures particularly for high-performance avionics applications. M\/A-COM also manufactures fiber optic cable assemblies (singlemode and multimode), connectors and attenuators primarily for commercial telecommunications applications.\nThe Company's passive components, used for directing RF and microwave signals, include a multitude of coaxial and waveguide products including ferrite isolators and circulators, power splitters and combiners, attenuators, filters and rotary joints. The control components, used to change the direction of or to time-vary RF and microwave signals, include solid-state switches, attenuators, phase shifters and limiters which are used to automatically prevent damage from high power signals. Receiver components, used to detect and convert RF and microwave signals and extract information and data from them, include mixers, detectors and low-noise and IF (Intermediate Frequency) amplifiers; similar components are used to impress information and data on transmitted signals.\nThe component lines include products used as sources for RF and microwave signals, such as solid-state oscillators, frequency synthesizers and frequency multipliers. The Company manufactures a broad line of small signal and medium power solid-state amplifiers, as well as antennas including dipole\/colinear, conformal and helical types and horns and blades for commercial and government markets.\nM\/A-COM's vertical product integration continues into RF and microwave subsystems, which exploit all the technologies of the semiconductor and component products. The RF and microwave subsystems combine the individual circuit functions of basic devices and components into multifunction assemblies, which allow system manufacturers to produce smaller-size, lighter- weight equipment, while reducing interface problems. In addition, M\/A-COM manufactures certain specialized equipment for surveillance applications, the sales of which are included with multifunction assemblies in the table below. These products include receivers, signal distribution networks, off-line signal processors, receiver-to-tape converters, demodulators, displays and associated test equipment for use in intelligence collection to determine the source, magnitude, frequency and profile of electronic signals.\nThe Company's main product lines have generated revenue for each of the last three years as follows (in thousands):\nResearch and Development. Research and development is undertaken by the Company both on its own initiative and on specific customer requests. In the latter case, the customer may pay all or a portion of the expenses incurred. In addition, the Company undertakes research contracts which are reimbursed by the U.S. Government, such as Title III of the Defense Production Act (\"Title III\") to support world-class, domestic GaAs production capabilities with commercial and defense applications. In addition, during 1994, the Company received a grant under the U.S. Government's Technology Reinvestment Program (\"TRP\") for the development of dual use technology and products that will have applications for wireless communications and automotive sensors. The technology involved in many of the Company's products is complex and technological change may affect some of the products which the Company currently produces or may develop. In order to compete successfully, the Company must attract and retain qualified personnel and maintain a program of improvement and refinement of existing products, as well as the development of new products.\nResearch and development expenditures during the last three years are stated below (amounts in thousands):\n*Non-reimbursed costs incurred by the Company on customer sponsored engineering contracts. Patents. M\/A-COM holds numerous domestic and foreign patents and paid-up licenses for the use of certain patents, trade secrets, inventions, know-how and technical data for the manufacture and sale of various products. While patents are an important part of its business, M\/A-COM does not deem any one of its patents or licenses to be material to the conduct of its business. M\/A- COM regards as more important its general technological know-how and experience, including certain proprietary information which it has developed and maintains as trade secrets.\nManufacturing Operations. M\/A-COM's manufacturing operations range from complete assembly of a particular component or product by one individual or a small group of individuals to manufacture by semi-automated, computer-aided production lines. Because many of M\/A-COM's products are precision components requiring close tolerances, M\/A-COM strives to maintain rigorous and exacting test and inspection procedures designed to prevent production error. M\/A-COM continues to invest significantly in its manufacturing operations and production techniques to achieve competitive levels of efficiency, quality, productivity and reliability as evidenced by its recent move to a new facility in Lowell, Massachusetts. This new facility provides the Company with additional high volume automated production capabilities for use in commercial and defense business.\nCompetition. The Company believes that all of its markets are highly competitive. The commercial marketplace for the Company's products and technologies requires high quality at competitive prices. The defense electronics marketplace has been particularly competitive since United States defense spending has decreased. Over recent years the Company has seen an increased emphasis on competitive bidding for contracts, a decline in the number of new programs, a decline in defense spending and delays in funding. As anticipated, the above factors have continued to produce downward pressure on prices and correspondingly on profit margins. To respond to this anticipated pressure, the Company has continued to formulate and implement plans for lowering costs and making its production efforts more efficient and of higher quality.\nThe Company's subsystems products compete with those of larger companies, as well as smaller, specialized companies. In semiconductors and component products, the Company's competition consists of smaller, specialized companies, as well as divisions of larger organizations, and in some cases certain of its customers may perform certain activities in-house rather than through subcontracts with third parties. The principal elements of competition in the markets that the Company serves are technical superiority, price, delivery schedules and reliability.\nGeneral Development of Business. During 1994, the Company continued its transition from a government to a commercial customer base. Commercial orders now approximate 50% of total orders and the Company has become a key supplier of microwave technology and products to the industry leaders of the wireless infrastructure, or base station market. This transformation of the business has resulted in a number of actions in recent years, including the divestiture of several businesses, rationalization and restructuring of the Company's core operations, and other cost structure improvements.\nDuring 1990, the Company began implementing the strategic repositioning of its business, including a redeployment of its assets and the divestiture of certain businesses engaged in military satellite communications, development and production of subassemblies, microwave high power amplifiers, transmission equipment and radar antenna assemblies. As part of the strategic restructuring plan, the Company decided to contract certain continuing operations in which the level of technical risk and required investment was determined not to be commensurate with the potential return. It also decided to consolidate certain businesses and facilities and to implement other cost reduction actions, including severance and early retirement. The results of operations for 1990 include charges approximating $32.2 million relating to these decisions. During 1991, the Company provided an additional $3.0 million in continuing operations relating to this restructuring plan.\nDuring 1990, the Company also recorded an estimated loss from discontinued operations of $73.9 million, which consisted of an operating loss of $15.5 million and a loss on the disposal of discontinued operations of $58.4 million. The loss on disposal included estimated operating losses through the phase-out period, provisions to reduce the related assets to estimated realizable value and provisions for anticipated disposal costs. In the third quarter of 1991, the Company reversed $14.1 million of reserves previously provided for estimated losses on disposals and liabilities of discontinued operations. This reversal was due to the favorable progress of the ongoing divestiture program, the collection of an outstanding note and the settling of certain matters in prior tax years. The Company completed its divestiture program in 1992.\nAs part of its strategy, in 1992 the Company decided to further consolidate and restructure several of its core operations to take advantage of certain administrative and operational efficiencies, resulting in a $20.4 million charge. This strategy included the physical consolidation of six separate operations into the newly created Microelectronics Division. The physical consolidation of facilities related to this plan was completed during the last half of 1993. In connection with its strategic restructuring plans, the Company announced its decision to restore its Advanced Semiconductor facility to its original state and to occupy that facility with operations which utilize its special purpose technological features and reversed certain previously established reserves related to excess lease costs and other restructuring actions of $20.4 million.\nDuring the third quarter of 1992, the Company acquired Greenpar Connectors Limited (\"Greenpar\"), a United Kingdom manufacturer of coaxial connectors and cable assemblies for the commercial marketplace, for approximately $12.6 million to further its presence in the commercial and international markets.\nIn 1993, based primarily on the continued decline in its defense business, the Company determined the need for further consolidation of its operations to reduce operating costs and to enhance its competitive position in the commercial and defense electronics markets. In addition, as a result of a change in marketing strategy, the Company determined that a writedown in the estimated realizable value of facilities held for sale at the end of 1992 was warranted. To accomplish these actions, the Company provided $27.5 million in restructuring charges in 1993. Additionally in the fourth quarter, the Company decided to refocus the direction of its commercial business to products with a broader application to existing and emerging markets, resulting in a charge of $5.3 million for anticipated losses on technically complex development programs related to existing commercial contracts.\nDuring 1994, the Company continued its progress in the execution of its 1993 restructuring plan, incurring charges of $11.0 million for involuntary employee terminations, further consolidation of manufacturing and office space, carrying costs associated with previously vacated facilities and the disposition of abandoned assets. This progress also included successfully negotiating the termination of three technically complex development contracts which had limited future market potential, thereby enabling the Company to refocus the direction of its commercial business.\nIn the fourth quarter of 1994, based on operating issues encountered during the execution of the restructuring plan, the Company determined its estimate of cost savings would not be achieved from outsourcing certain manufacturing operations at its Microelectronics Division and, as a result, reversed its prior decision to outsource certain manufacturing operations. In connection with this decision, the Company determined that approximately 100 planned involuntary terminations would not take place. Also, the Company decided that it would continue to use certain assets under operating leases, which it had previously decided to abandon. As a result of these fourth quarter decisions the Company reversed to income $2.8 million of the restructuring reserve.\nIn the fourth quarter of 1994, the Company committed to undertake a plan to reduce general and administrative expenses, including the consolidation of its semiconductor operations into its Microelectronics Division, as well as corporate level involuntary employee terminations. In connection with this plan, the Company has provided $2.5 million in selling, general and administrative expenses (\"SG&A\") for severance and related benefit costs for the termination of these employees.\nSources of Raw Materials. M\/A-COM has a number of sources of supply for materials and components for the production of most of its products and systems. M\/A-COM has not experienced any significant difficulties in obtaining these materials and does not anticipate any such difficulties in the foreseeable future.\nEnvironmental Protection. M\/A-COM's manufacturing activities have generated and continue to generate materials classified as hazardous wastes. The Company devotes appropriate resources to compliance with legal and regulatory requirements relating to minimization of the use of these materials, to their proper disposal as wastes, and to the protection of the environment. Those requirements include clean-up activities at various sites. The Company does not believe that expenditures relating to these requirements will have a material effect on the Company's financial condition or results of operations. However, no assurance can be given that any future discovery of new facts and the retroactive application of such legal and regulatory requirements to those facts would not be material and would not change the estimate of costs that the Company could be required to pay in any particular situation.\nEmployees. The Company employed 3,585 persons at its various subsidiaries and divisions as of October 1, 1994. None of the Company's employees is represented by a union. The Company believes that its relations with its employees are satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's principal executive offices are located in Lowell, Massachusetts. The Company's principal operating facilities consist of light manufacturing and associated engineering and support facilities and currently are located in several states, Puerto Rico, Ireland and the United Kingdom. During 1993, the Company completed the relocation and consolidation of several of its operations from both owned and leased facilities in Maine, Massachusetts and New Hampshire to a newly leased facility and to an already existing facility, both in Lowell, Massachusetts. Of its principal operating facilities, the Company owns 412,743 square feet in the aggregate in Maryland (Hunt Valley), Massachusetts (Amesbury, Burlington and Waltham) and New Hampshire (Hudson) and leases 835,385 square feet in the aggregate in California (Torrance), Massachusetts (Lowell and Watertown), Virginia (Sterling), Ireland (Cork), Puerto Rico (Arecibo) and the United Kingdom (Dunstable, Harlow and Milton Keynes). The Company also leases space in a number of cities in the U.S. and foreign countries for sales and field service operations.\nThe Company believes that it maintains its properties in good operating condition and repair and considers its facilities to be suitable and adequate for the present activities of the Company. Certain of the properties owned by the Company are subject to mortgages. The Company also currently owns 407,370 square feet of space in facilities not being utilized in the Company's operations, which space the Company anticipates selling or leasing to third parties. For additional information with respect to mortgage indebtedness and lease commitments see Notes 5 and 13 to the Company's consolidated financial statements included in Part II, Item 8 of this annual report on Form 10-K.\nItem 3.","section_3":"Item 3. Legal Proceedings\nM\/A-COM is a defendant in various legal proceedings incidental to the nature of its business. However, the Company believes that the outcome of these proceedings will not materially affect 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\nItem 4.1. Executive Officers of the Registrant\nThe Company's executive officers and the capacities in which they serve as of December 19, 1994 are listed on page 56 of this annual report.\nThe executive officers of the Company have held their current positions as follows: Dr. Vanderslice since November 1994; Mr. Glaudel since February 1993; Mr. Mihalchik since September 1994; and Mr. Rice since January 1991. Mr. Glaudel (age 54) served as Vice President, Human Resources of the Company from January 1988 to February 1993. Mr. Mihalchik (age 47) has served as Senior Vice President and Chief Financial Officer of the Company since September 1993, and prior to joining M\/A-COM, served as Executive Vice President and Chief Financial Officer and Director of Loyalty Management Group, Inc., a consumer promotion company, from 1991 to September 1993; and as Senior Vice President and Chief Financial Officer and Director of The Timberland Company, a footwear and apparel manufacturer and distributor, from 1986 to 1991. Mr. Rice (age 42) served as Vice President, Strategic Planning and Business Analysis of the Company from 1990 to 1991 and, prior to joining M\/A-COM, served as Director of Financial Planning, Reporting and Analysis with Apollo Computer, Inc., a computer equipment maker, from 1984 to 1990. Dr. Vanderslice (age 62) has served as Chairman of the Board since November 1989, and also served as Chief Executive Officer of the Company from November 1989 to November 1993, and as President of the Company from May 1990 through March 1991. Each of the Company's executive officers is a full time employee of the Company, was elected by the Board of Directors and holds office until the first meeting of the Board of Directors following the annual meeting of Stockholders and until his successor is chosen and qualified.\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 for trading on the New York Stock Exchange and the Boston Stock Exchange. For the fiscal periods indicated, the high and low sales price for shares of M\/A-COM Common Stock as reported on the New York Stock Exchange-Composite Transaction Reporting System were as follows:\nThere were 7,314 holders of record of the Company's Common Stock as of December 19, 1994. Included in the number of stockholders of record are stockholders who hold shares in \"nominee\" or \"street\" name. The closing price per share of the Company's Common Stock as of December 19, 1994, as reported under the New York Stock Exchange - Composite Transaction Reporting System, was $7.00.\nM\/A-COM has not paid cash dividends on its Common Stock since fiscal 1989 and intends to continue its policy of investing earnings in its business as an alternative to paying dividends.\nItem 6.","section_6":"Item 6. Selected Financial Data\n*Continuing operations. Facilities excludes those held for sale.\nSee also Item 1 and Notes 1, 2, 3, 5, and 7 for a description of certain matters relevant to this Item 6.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nOverview\nOperations\nThe Company reported income from continuing operations of $3.4 million, or $.13 per share, for 1994 compared with a loss of $22.5 million, or a loss of $.92 per share for 1993. Net income for 1994 was $6.7 million and included $3.3 million attributable to the cumulative effect of an accounting change upon the adoption of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The net loss for 1993 was $21.5 million and included $1.0 million of income from discontinued operations.\nNew orders for 1994 were $328.3 million compared with $345.6 million in 1993. The decrease is mainly attributable to a decrease of $9.7 million in orders from non-defense United States government and foreign government markets, a $6.6 million decrease in United States defense-related orders, and a $1.1 million decrease in commercial orders. The decrease in non-defense United States government and foreign government orders is attributable to spending reductions in the U.S. agencies which the Company supplies. The decrease in U.S. defense-related orders reflects the continued contraction of this market. The decrease in commercial orders includes the negotiated termination of three technically complex contracts totaling $10.8 million during 1994, as well as debookings of $6.2 million relating mainly to the amounts of blanket purchase orders with undefined delivery dates and to adjustments of backlog due to customer modification of recorded amounts. Absent these debookings, commercial orders increased by approximately $15.9 million.\nDuring 1994, the Company continued its transition from dependence upon defense business to becoming a key supplier of technology and products to industry leaders in the commercial marketplace. Commercial orders now approximate 50% of the Company's total orders. M\/A-COM's fastest growing product segments are those products introduced into wireless communication applications such as cellular portable telephones, cellular infrastructure and wireless data systems.\nThe Company's commitment to expansion into commercial markets is supported by its research and development (\"R&D\") activities. During 1994, the Company invested $21.7 million in R&D, an increase of $2.3 million from the prior year. M\/A-COM's emphasis on new product development and introduction brought nearly 100 new product platforms to the market in 1994, the majority for wireless applications.\nIn spite of its current efforts in transitioning to the commercial marketplace, the Company remains committed to its governmental customers and the portion of its business that is defense market related. This is demonstrated by the Company's participation in government sponsored programs such as Title III and TRP, as previously discussed.\nIn addition, the Company continues to focus on its consolidation and cost reduction initiatives. During 1994, M\/A-COM made significant progress in the execution of its 1993 restructuring plan, including involuntary employee terminations, further consolidation of manufacturing and office space and the disposition of abandoned assets. The Company also refined this plan during the year with its decision not to pursue certain manufacturing outsourcing opportunities that were previously contemplated. Further, in an effort to achieve greater operational synergies, the Company has decided to consolidate all of its semiconductor operations into its Microelectronics Division and has undertaken an initiative to reduce certain general and administrative expenses.\nRestructuring\nThe Company's restructuring reserve balances and activity for each of the last three years are as follows (in millions):\nDuring 1992, the Company provided $20.4 million to execute its plans to consolidate and restructure several of its operations. The Company also reversed approximately $5.0 million in reserves established in prior years as execution of the related restructuring actions was integrated into the 1992 restructuring decision. These plans included the physical consolidation of six separate operations into the new Microelectronics Division facility in Lowell, Massachusetts, reduction in the workforce of approximately 340 employees related to such operations and the planned sale of excess facilities and equipment. The physical consolidation of facilities related to this plan was completed during the last half of 1993 and has created administrative and operational efficiencies, resulting from the elimination of certain redundancies. Severance and related benefit charges incurred with the workforce reduction totaled $11.3 million. Additionally, the Company wrote off excess equipment and incurred expenses associated with disposition of this equipment totaling $5.3 million. Carrying and closure costs of vacant facilities totaled $2.1 million. In 1993, based primarily on a continued decline in its defense business, the Company initiated actions for additional consolidation and downsizing of its business. In the second quarter of 1993, the Company recorded a charge to selling, general and administrative expenses (\"SG&A\") of $4.0 million. Approximately $2.0 million of this charge was attributable to a change in the estimated realizable value of vacated facilities and additional expenses associated with an extension of the period required for the disposal of these facilities. These facilities had been vacated as part of the Company's 1992 restructuring program. The remainder of the charge related to incremental workforce reductions of approximately 450 employees at the Company's Microelectronics Division. In the fourth quarter of 1993, the Company recorded a $23.5 million charge in SG&A. The actions contemplated in this charge primarily included a workforce reduction of approximately 430 employees, the carrying and closure cost of a facility in Merrimack, New Hampshire and vacating certain leased space in Massachusetts.\nDuring 1993, the Company incurred severance and related benefit charges of $6.9 million in connection with the workforce reductions included in this plan as well as final payments on 1992 workforce reduction actions. Charges for facilities and equipment write-downs consisted of $7.0 million for real estate written down to net realizable value, and $2.3 million for the disposal of redundant equipment in 1993. Additionally, the costs of closing, preparing for sale and carrying the vacant buildings totaled $6.2 million in 1993.\nDuring 1994, the Company continued its progress in the execution of the actions contemplated by its 1993 restructuring plan. Charges incurred in 1994 were comprised of $5.5 million of severance and related benefit charges for the termination of approximately 300 employees, write-offs of fixed assets of $1.3 million associated with its vacated Merrimack, New Hampshire facility, carrying and closure costs of $2.9 million associated with facilities vacated by the Company, and operating lease payments for vacated facilities and other charges of $1.3 million.\nIn the fourth quarter of 1994, based on operating issues encountered during the execution of the restructuring plan, the Company determined its estimate of cost savings would not be achieved from outsourcing certain manufacturing operations at its Microelectronics Division and, as a result, reversed its prior decision to outsource certain manufacturing operations. In connection with this decision, the Company determined that approximately 100 planned involuntary terminations would not take place. Also, the Company decided that it would continue to use certain assets under operating leases, which it had previously decided to abandon. As a result of these fourth quarter decisions, the Company reversed to income approximately $2.8 million of the restructuring reserve.\nAlso, in the fourth quarter of 1994, the Company committed to undertake a plan of involuntary employee terminations in an effort to reduce general and administrative expenses. In connection with the plan, the Company recorded, in SG&A, a charge for expected termination benefits of $2.5 million. The plan, which has been communicated to the Company's employees, calls for the involuntary termination of approximately 175 employees, primarily comprised of individuals functioning in a financial, general, or administrative capacity. Through October 1, 1994 the Company has terminated 20 employees, incurring severance charges of $.1 million.\nAt October 1, 1994, the remaining balance in the restructuring reserve of $6.3 million is considered adequate to complete the remaining actions from the 1993 fourth quarter restructuring plan and 1994 involutary termination plan. Of the remaining reserve balance, $4.0 million will be used to complete the remaining severance actions, $1.9 million will be used for carrying and closure costs associated with vacated facilities held for sale and $.4 million will cover the remaining lease costs (18 months) associated with vacated office space. The Company expects to complete the severance initiatives by the end of the second quarter of 1995 and anticipates disposing of the facilities held for sale over the next two years.\nThe Company anticipates that the cash expenditures related to these actions will approximate $5.1 million in 1995 and $1.2 million 1996.\nOther\nIn the fourth quarter of 1993, the Company decided to refocus the direction of its commercial business and reallocated certain resources associated with that aspect of its operations. As a result of these actions, the Company recorded a $5.3 million reserve for anticipated losses relating to its manufacturing obligations on certain technically complex commercial contracts. Beginning in 1994, in connection with certain changes in operational management, the Company embarked upon a new strategy of negotiating the termination of these contracts in an effort to minimize the anticipated losses and maximize the Company's resources. During 1994, the Company successfully negotiated the termination of three technically complex contracts resulting in the reversal of $3.1 million of the previously established reserve. This reversal was reflected as a reduction of cost of sales. The remainder of the reserve was used primarily to cover other contract overruns and unusable inventory associated with a terminated contract.\nDuring the fourth quarter of 1994, the Company charged $2.6 million to cost of sales due to an inventory valuation adjustment in one of the Company's semiconductor operations. The adjustment was primarily the result of a revaluation of current inventory production in excess of current backlog requirements and anticipated future business. As previously discussed, this operation will be consolidated into the Company's Microelectronics Division in order to align its cost structure with current market conditions.\nIn the first quarter of 1994, the Company prospectively adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\"), effective as of October 3, 1993. The cumulative effect of adopting SFAS 109 amounted to $3.3 million of income and is reflected in the consolidated statement of operations for 1994 as the cumulative effect of a change in accounting principle. It primarily represents the reversal of deferred tax assets and liabilities resulting from the adoption of SFAS 109. The deferred tax assets and liabilities were established in connection with a previous acquisition and were recorded as reductions of the respective assets and liabilities.\nResults of continuing operations: 1994 compared with 1993\nNet sales for 1994 increased by $1.7 million compared with 1993. The increase is primarily attributable to a $28.2 million increase in sales to commercial customers partially offset by a $21.8 million decrease in U.S. Department of Defense (\"DoD\") related sales and a $4.7 million decrease in sales to non-defense U.S. government agencies and foreign governments.\nThe change in sales mix reflects the Company's strategy of developing products for the commercial marketplace in response to the continued decline in demand by the U.S. defense market. Sales of commercial products in 1994 have increased by 20% in comparison with 1993. Domestic and international commercial sales of telecommunications related products increased more than $16.5 million in 1994.\nThe Company's gross margin, as a percent of sales, was 34.2% in 1994 compared with 31.6% in 1993. The increase in gross margin percentage is attributable to increased sales of higher margin connector and circulator products resulting in margin growth of 2.0%, productivity improvement and cost savings in the Company's Microelectronics Division of 1.2% and the reversal of previously established inventory reserves due to contract terminations of .3% partially offset by the previously described inventory valuation adjustment of .8%, declines in the selling prices of semiconductor products of .7% and the effect of volume declines in sales of power hybrid products of 1.0%. The 1993 gross margin also included the charges for anticipated losses on technically complex commercial development programs which decreased 1993 gross margins by 1.6%.\nThe Company incurred costs, included in cost of sales, on customer sponsored research and development of $9.8 million and $18.5 million in 1994 and 1993, respectively. Of these costs, $2.0 million and $3.6 million in 1994 and 1993, respectively, were not recoverable under fixed price engineering contracts. The decrease in customer sponsored research and development expense reflects the change to a commercial business environment where customer funding for research and development is less prevalent than in government contracting and a decrease in development costs for contracts which have moved from development stages into production.\nCompany sponsored research and development expense increased by $2.3 million in 1994 compared with 1993. The increase in company sponsored research and development is attributable to a reallocation of engineers from production to research and development as the Company continues to invest in products with significant potential in both commercial and defense applications.\nSelling, general and administrative expenses decreased by $26.3 million compared with 1993. The decrease is primarily attributable to a $27.5 million restructuring charge recorded in 1993, which was partially offset in 1993 by: (1) a gain on the sale of a product line of $2.3 million; (2) recovery of insurance proceeds related to reimbursement of expenditures incurred prior to 1993 of $2.5 million; and (3) $1.0 million attributable to the excess of insurance recovery over the net book value of assets damaged by a fire at a production facility. The 1994 results include the reversal of restructuring accruals in excess of requirements totaling $2.8 million and the accrual of $2.5 million for involuntary termination benefits related to its 1994 plan to reduce general and administrative expenses. The remaining decrease in SG&A is mainly attributable to efficiencies realized from the Company's consolidation and downsizing actions of the past two years.\nInterest expense increased by $.7 million in 1994 compared with 1993. This increase is mainly attributable to increased borrowings and higher interest rates.\nInterest income decreased by $3.4 million in 1994 compared with 1993. The decrease results from the recording of $2.8 million in interest income associated with a tax refund claim in 1993 and lower invested cash balances in 1994.\nDuring 1994, the Company recognized tax benefits primarily associated with certain current and prior year expenditures that were eligible for carryback under provisions of Federal tax law (approximately $1.0 million in the third quarter). The benefit was recognized as the result of the issuance, during the third quarter, of a favorable revenue ruling by the Internal Revenue Service as to the deductibility of such expenditures. Prior to the third quarter, the Company had not recognized any tax benefit for such expenditures due to the uncertainty of their deductibility. This benefit offset the Company's tax provision for the third quarter, which was primarily attributable to the Company's foreign and Puerto Rico operations.\nDuring the second quarter of 1993, the Company reached initial resolution with the Internal Revenue Service of certain prior years' tax returns. As a result, the Company recorded a reversal, net of the second quarter tax provision of $3.6 million of accrued liabilities ($1.0 million of which was attributable to discontinued operations). This reversal of accrued liabilities resulted in a tax benefit for 1993 which is net of tax provisions for earnings, primarily of foreign subsidiaries.\nThe variance between the statutory federal tax rate of 35% and the Company's effective tax rate of 25% is due to the differential in tax rates applied to earnings of foreign subsidiaries and Puerto Rico operations, as well as the previously discussed recognition of tax benefits of expenses eligible for federal tax carryback refunds.\nResults of continuing operations: 1993 compared with 1992\nNet sales for 1993 decreased by $47.9 million in comparison with 1992. The decrease was primarily attributable to final shipments on several large defense programs which occurred in 1992 and were not replaced in 1993 ($37.2 million) and the sale of two product lines in 1992 ($9.6 million), partially offset by the incremental sales of Greenpar Connectors Limited ($7.6 million) which was acquired in the third quarter of 1992. The remaining decrease in sales resulted from the general decline in demand for the Company's defense- related products and the negative impact of business interruption related to the execution of the previously described physical consolidation.\nGross margin, as a percent of sales, was 31.6% in 1993 compared with 32.5% in 1992. The decrease in gross margin is attributable to the previously described charges taken in the fourth quarter for anticipated losses on technically complex commercial development programs (1.6%) and lost margin on certain defense programs on which final shipments occurred in 1992 (1.1%). These decreases were partially offset by the improved operating performance of M\/A-COM's Power Hybrids Operation (1.0%) and the final shipments of a technically complex defense contract that experienced favorable manufacturing results, thus allowing the release of reserves that were previously established (.6%).\nThe Company incurred costs, included in cost of sales, on customer sponsored research and development of $18.5 million and $23.3 million in 1993 and 1992, respectively. Of these costs, $3.6 million in each of the years were not recoverable under fixed price engineering contracts. The decrease in customer sponsored research and development expenses was due mainly to the completion of a contract for block converters for a personal communication network application and to a general decrease in funding for product development as existing defense-related programs progressed from developmental to mature production phases. Company sponsored research and development was comparable with prior year amounts.\nSelling, general and administrative expenses increased by $20.6 million compared with 1992. The increase was caused mainly by provisions totaling $27.5 million for additional consolidation and downsizing of the Company's facilities and workforce and adjustments to the estimated realizable value of property being held for sale as part of its restructuring program. The increase in SG&A was partially offset by a $2.3 million gain on the sale of the Company's high power, narrow band receiver protector product line, $2.5 million of insurance proceeds related to reimbursement of expenditures incurred in prior periods and $1.0 million attributed to the excess of insurance recovery over the net book value of assets damaged by a fire at a production facility.\nInterest expense decreased by $1.6 million in 1993 compared with 1992. The decrease is mainly attributable to the retirement of the Company's 10 7\/8% Notes in the fourth quarter of 1992.\nInterest income increased by $1.1 million in 1993 compared with 1992. The increase was caused by the recording of $2.8 million of interest income on a tax refund claim partially offset by reduced interest income due to lower invested cash balances.\nIn the second quarter of 1993, the Company reached initial resolution with the Internal Revenue Service on matters relating to certain prior years' tax returns. As a result the Company recorded a reversal, net of the second quarter tax provision of $3.6 million of accrued liabilities ($1.0 million of which was attributable to discontinued operations). This reversal of accrued liabilities resulted in a tax benefit for 1993 which is net of tax provisions for earnings, primarily of foreign subsidiaries.\nLiquidity and Capital Resources\nThe Company's cash and marketable securities position was $5.9 million at October 1, 1994 compared with $11.3 million at October 2, 1993. The decrease is mainly attributable to additions to plant assets and a reduction in cash generated from operating activities. The Company's operating activities generated $10.4 million of cash in 1994 as compared with $14.4 million in 1993. The decrease was mainly attributable to cash expenditures for restructuring actions and payments of other current liabilities.\nThe Company expended $15.8 million during 1994 for additions to plant assets to meet production and operating requirements. Further investments in plant assets are necessary to meet future requirements. Additionally, continued investments in research and development are necessary for the Company to enhance its position in commercial markets and to maintain its position in its defense and government markets.\nAs of October 1, 1994, the Company's accounts receivable, as measured by the number of days sales outstanding, decreased to 61 days in comparison with 70 days at October 2, 1993. The decrease is due to an increased focus on collections.\nThe Company's inventory balance increased by $2.2 million at October 1, 1994 in comparison with October 2, 1993. The increase is mainly attributable to an increase in inventory balances for standard products (connectors and semiconductors) to improve response time in fulfilling customer orders. This increase was partially offset by reduced inventory levels in the Company's Microelectronics Division resulting from improved manufacturing operations.\nDuring 1994, the Company borrowed and repaid $39.0 million under its revolving line of credit, however, the maximum amount outstanding at any month end during the year did not exceed $7.5 million. Additionally, the Company repaid $.7 million of long-term debt and $2.6 million of debt attributable to a previously discontinued operation.\nThe Company's foreign subsidiaries have lines of credit available to fund local working capital requirements. During 1994, these subsidiaries reduced their borrowings by a net of $.5 million under these lines of credit. Outstanding borrowings under these lines of credit were approximately $5.7 million at October 1, 1994 and unused lines of credit available aggregated approximately $10.4 million at that time.\nDuring 1994, the Company completed negotiations for a new unsecured revolving line of credit. The new line of credit, which permits maximum borrowings of $30.0 million, expires on August 30, 1995. The maximum borrowings are restricted based on the amount of the Company's domestic accounts receivable and also contains certain restrictive covenants including, but not limited to, minimum levels of profitability and liquidity and restrictions related to indebtedness, cash flow and capital expenditures. The agreement also contains restrictions with respect to acquisitions and the repurchase of the Company's public debt. As of October 1, 1994, there were no outstanding borrowings under this agreement and the Company's borrowing availability under this agreement was $26.1 million.\nThe Company has retained certain liabilities associated with the previously discussed discontinued operations that were disposed of in prior years. These liabilities include items such as taxes and contractual obligations entered into by the Company in connection with the sale of the businesses. The Company considers its reserves for these contingencies to be adequate. Currently, the Company is unable to determine when these contingencies will be fully resolved, but expects that the resolution of these matters will not have a material negative effect on the Company's financial condition or results of operations.\nIn February 1990, the Board of Directors authorized the repurchase of 5.0 million shares of the Company's common stock, from time to time as funds are available, extending a previous stock repurchase program. At October 1, 1994, there remains authorization to acquire a further 2.1 million shares under the stock repurchase program. The Company will continue to monitor its repurchase program and evaluate the advantages offered by additional repurchases.\nThe Company believes that its cash balances, funds to be generated by future operations and available borrowing capacity are sufficient to finance the previously described restructuring actions, to provide for ongoing capital requirements, research and development expenditures and to take advantage of further investment opportunities.\nM\/A-COM's manufacturing activities have generated and continue to generate materials classified as hazardous wastes. The Company devotes appropriate resources to compliance with legal and regulatory requirements relating to minimization of the use of these materials, to their proper disposal as wastes, and to the protection of the environment. Those requirements include clean-up activities at various sites. The Company does not believe that expenditures relating to these requirements will have a material effect on the Company's financial condition or results of operations. However, no assurance can be given that any future discovery of new facts and the retroactive application of such legal and regulatory requirements to those facts would not be material and would not change the estimate of the costs that the Company could be required to pay in any particular situation.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nNotes to Consolidated Financial Statements M\/A-COM, Inc. and Subsidiaries\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of M\/A-COM, Inc. and all subsidiary companies. All significant intercompany transactions and balances have been eliminated. The Company's charter specifies that its fiscal year ends on the Saturday closest to September 30.\nCash Equivalents and Marketable Securities\nCash equivalents and marketable securities are stated at cost plus accrued interest, which approximates market value. Cash equivalents consist of short term investments in time deposits, municipal obligations and certificates of deposit which aggregate $2.5 million and $5.6 million at October 1, 1994 and October 2, 1993, respectively. The Company considers all highly liquid securities purchased with an original maturity of three months or less to be cash equivalents, while those having maturities in excess of three months are classified as marketable securities and generally consist of municipal obligations.\nRevenue Recognition\nRevenue is recognized generally when a product is shipped and services are performed. Certain long-term contracts are accounted for using the percentage- of-completion method, whereby revenue and profit are recognized throughout the performance period of the contract. The effects of changes in estimates of contract costs are recorded currently. If estimates of cost, including general and administrative costs, indicate a loss, provision is made currently for the total loss anticipated.\nUnbilled revenue under customer contracts represents revenue earned under the percentage-of-completion method but not yet billable under the terms of the contract. These amounts are billable based on the terms of the contract which include shipment of the product, achievement of milestones or completion of the contract.\nInventories\nInventories are stated at the lower of cost or market. Cost, which includes engineering and production costs only, is determined principally on a first- in, first-out basis.\nEnvironmental Matters\nEnvironmental 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 without regard to possible recoveries from third parties, including insurers, when environmental assessments and\/or remedial efforts are probable and the costs can be reasonably estimated.\nPlant Assets and Depreciation\nPlant assets are stated at cost. Depreciation is provided on the straight- line method over the estimated useful lives.\nOther Assets\nOther assets include the excess of cost over the net assets of acquired companies (goodwill) which is being amortized on a straight-line basis over periods ranging from twenty to forty years. Goodwill amounted to approximately $30.6 million and $30.8 million at October 1, 1994 and October 2, 1993, respectively, which is net of accumulated amortization of approximately $5.0 million and $3.7 million, respectively.\nIncome Taxes\nAs more fully discussed in Note 6, in the first quarter of 1994, the Company prospectively adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\"), effective as of October 3, 1993. SFAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences 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 enactments of changes in the tax law or rates. The measurement of deferred tax assets is reduced, if necessary, by a valuation allowance. 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. Accordingly, amounts shown for 1993 and 1992 reflect income tax accounting under SFAS 96.\nThe Company has not provided deferred taxes on the undistributed earnings of its foreign subsidiaries as such earnings are expected to be reinvested for an indefinite period of time.\nIncome (Loss) Per Share\nIncome per share has been calculated using the weighted average number of shares outstanding during each year, adjusted for the impact of the Company's stock option and deferred compensation plans. Conversion of the Convertible Debentures has not been assumed as the impact would be anti-dilutive. Loss per share has been calculated using only the weighted average number of shares outstanding.\nNOTE 2 - CHANGES IN BUSINESS:\nContinuing Operations\nIn the first quarter of 1993 the Company sold its high power, narrow band receiver protector product line for $5.1 million in cash, resulting in a gain of $2.3 million which was recorded as a reduction of selling, general and administrative expenses (\"SG&A\") in the accompanying consolidated statement of operations.\nIn the second quarter of 1993, the Company made an investment approximating 7% of the equity of IVHS Technologies, Inc. (\"IVHS\") for $2.3 million. IVHS is in the business of innovating, designing and manufacturing specialized electronic products that enhance the safety and efficiency of vehicles, drivers and roadways. The investment is accounted for by the cost method.\nDuring the third quarter of 1992, the Company acquired Greenpar Connectors Limited (\"Greenpar\"), a United Kingdom manufacturer of coaxial connectors and cable assemblies for the commercial marketplace, for approximately $12.6 million. The acquisition has been accounted for as a purchase and, accordingly, the Company's consolidated statement of operations includes the operating results of Greenpar from the date of acquisition. The excess of purchase price over the fair value of the net assets acquired, which approximated $8.8 million, is being amortized on a straight-line basis over 20 years.\nDiscontinued Operations\nIn the first quarter of 1993, the Company decided to retain its M\/A-COM Power Hybrids Operation (\"PHO\") as part of the Company's continuing operations. The decision to retain this business resulted from PHO's improved operating performance and market potential. PHO was identified for disposition in 1990 and had been accounted for as a discontinued operation since that time. The accompanying consolidated statements of operations and of cash flows for the year ended October 3, 1992 have been reclassified to present PHO within continuing operations.\nAs a result of the 1990 decision to dispose of PHO, the Company had recorded a loss from discontinued operations of $10.5 million for estimated operating losses during the phase out period and to reduce the related assets to estimated realizable value. PHO's actual operating losses during the period that it was accounted for as a discontinued operation were $10.5 million. Accordingly, there were no remaining discontinued operations accrued losses associated with PHO as of October 3, 1992.\nIn 1992 the Company completed its divestiture program initiated in 1990 with the sale of its Microwave Design and Manufacturing, Inc. subsidiary for $6.4 million in cash. This sale had no effect on the results of discontinued operations.\nLiabilities of the Company incurred in connection with the discontinued businesses of $7.4 million and $8.0 million at October 1, 1994 and October 2, 1993, respectively, are included in accrued liabilities. In addition, long- term debt related to discontinued businesses of $2.6 million at October 2, 1993 is also included in accrued liabilities. This amount was repaid in 1994.\nNOTE 3 - RESTRUCTURING COSTS AND UNUSUAL ITEMS:\nRestructuring\nDuring 1992 the Company provided $20.4 million to execute its plans to consolidate and restructure several of its operations. The Company also reversed approximately $5.0 million in reserves established in prior years as execution of the related restructuring actions was integrated into the 1992 restructuring decision. These plans included the physical consolidation of six separate operations into the new Microelectronics Division facility in Lowell, Massachusetts, reduction in the workforce of approximately 340 employees related to such operations and the planned sale of excess facilities and equipment. The physical consolidation of facilities related to this plan was completed during the last half of 1993 and has created administrative and operational efficiencies, resulting from the elimination of certain redundancies. Severance and related benefit charges incurred with the workforce reduction totaled $11.3 million. Additionally, the Company wrote off excess equipment and incurred expenses associated with disposition of this equipment totaling $5.3 million. Carrying and closure costs of vacant facilities totaled $2.1 million.\nIn 1993, based primarily on a continued decline in its defense business, the Company initiated actions for additional consolidation and downsizing of its business. In the second quarter of 1993, the Company recorded a charge to SG&A of $4.0 million. Approximately $2.0 million of this charge was attributable to a change in the estimated realizable value of vacated facilities and additional expenses associated with an extension of the period required for the disposal of these facilities These facilities had been vacated as part of the Company's 1992 restructuring program. The remainder of the charge related to incremental workforce reductions of approximately 450 employees at the Company's Microelectronics Division. In the fourth quarter of 1993, the Company recorded a $23.5 million charge in SG&A. The actions contemplated in this charge primarily included a workforce reduction of approximately 430 employees, the carrying and closure cost of a facility in Merrimack, New Hampshire and vacating certain leased space in Massachusetts. The restructuring charges taken by the Company in 1993 related to the consolidation and downsizing are comprised of the following: severance and personnel related costs of $9.5 million; facilities and equipment write-downs of $9.6 million; carrying and closure costs of vacated buildings of $6.0 million; and leases and other restructuring costs of $2.4 million.\nDuring 1993, the Company incurred severance and related benefit charges of $6.9 million in connection with the workforce reductions included in this plan as well as final payments on 1992 workforce reduction actions. Charges for facilities and equipment write-downs consisted of $7.0 million for real estate written down to net realizable value, and $2.3 million for the disposal of redundant equipment in 1993. Additionally, the costs of closing, preparing for sale and carrying the vacant buildings totaled $6.2 million in 1993.\nDuring 1994, the Company continued its progress in the execution of the actions contemplated by its 1993 restructuring plan. Charges incurred in 1994 were comprised of $5.5 million of severance and related benefit charges for the termination of approximately 300 employees, write-offs of fixed assets of $1.3 million associated with its vacated Merrimack, New Hampshire facility, carrying and closure costs of $2.9 million associated with facilities vacated by the Company, and operating lease payments for vacated facilities and other charges of $1.3 million.\nIn the fourth quarter of 1994, based on operating issues encountered during the execution of the restructuring plan, the Company determined its estimate of cost savings would not be achieved from outsourcing certain manufacturing operations at its Microelectronics Division and, as a result, reversed its prior decision to outsource certain manufacturing operations. In connection with this decision, the Company determined that approximately 100 planned involuntary terminations would not take place. Also, the Company decided that it would continue to use certain assets under operating leases, which it had previously decided to abandon. As a result of these fourth quarter decisions, the Company reversed to income approximately $2.8 million of the restructuring reserve.\nAlso, in the fourth quarter of 1994, the Company committed to undertake a plan of involuntary employee terminations in an effort to reduce general and administrative expenses. In connection with the plan, the Company recorded, in SG&A, a charge for expected termination benefits of $2.5 million. The plan, which has been communicated to the Company's employees, calls for the involuntary termination of approximately 175 employees, primarily comprised of individuals functioning in a financial, general, or administrative capacity. Through October 1, 1994 the Company has terminated 20 employees, incurring severance charges of $.1 million.\nThe facilities held for sale as a result of the previously described restructurings have been stated at an estimated net realizable value of $10.5 and $11.4 million at October 1, 1994 and October 2, 1993, respectively, and are included in other assets in the accompanying consolidated balance sheet. Additionally, $3.9 million and $17.6 million of accrued liabilities related to the Company's restructuring program are included in the accompanying consolidated balance sheet at October 1, 1994 and October 2, 1993, respectively.\nOther Unusual Items\nIn the fourth quarter of 1993, the Company decided to refocus the direction of its commercial business and reallocated certain resources associated with that aspect of its operations. As a result of these actions, the Company recorded a $5.3 million reserve for anticipated losses relating to its manufacturing obligations on certain technically complex commercial contracts. Beginning in 1994, in connection with certain changes in operational management, the Company embarked upon a new strategy of negotiating the termination of these contracts in an effort to minimize the anticipated losses and maximize the Company's resources. During 1994, the Company successfully negotiated the termination of three technically complex contracts resulting in the reversal of $3.1 million of the previously established reserve. Such reversals were reflected as reductions of cost of sales. The remainder of the reserve was used primarily to cover other contract overruns and unusable inventory associated with a terminated contract.\nDuring the fourth quarter of 1994, the Company charged $2.6 million to cost of sales due to an inventory valuation adjustment in one of the Company's semiconductor operations. The adjustment was primarily the result of a revaluation of current inventory production in excess of current backlog requirements and anticipated future business.\nDuring the second quarter of 1993, the Company benefited from the recovery of $2.2 million in insurance proceeds. The proceeds represent the reimbursement of expenditures made for certain liabilities at a site previously occupied by the Company and were recorded as a reduction of SG&A. The expenditures had been charged to the results of operations in previous periods.\nIn the first quarter of 1993, a production facility of a foreign subsidiary was damaged by fire. The Company recorded a gain of approximately $1.0 million related to the excess of the insurance recovery over the net book value of the assets damaged by the fire. The gain was recorded as a reduction of SG&A during the quarter.\nThe Company recorded charges to cost of sales of $3.2 million in 1994 related to cost overruns on fixed price defense contracts ($5.5 million in each of 1993 and 1992). These charges relate mainly to complex multifunction assembly programs.\nNOTE 4 - INVENTORIES:\nInventories are summarized as follows (in thousands):\nNOTE 5 - INDEBTEDNESS AND LINES OF CREDIT:\nLong-term debt is summarized as follows (in thousands):\nThe Subordinated Debentures are convertible into common stock at $36.50 per share, subject to adjustment. As of May 15, 1992, the Company is required to redeem $5.0 million face value of Debentures annually. Debentures with a face value of $34.2 million have been acquired through October 1, 1994, $15.0 million of which have been retired since their acquisition and the remainder of which can be credited to future sinking fund requirements. At the Company's option, the Debentures are redeemable at any time, in whole or in part, currently at 101.2% of par, declining annually to par on May 15, 1996. The fair market value for the Debentures approximated carrying value at October 1, 1994.\nThe aggregate maturities during the next five years of long-term debt outstanding at October 1, 1994 are as follows (in thousands): 1995-$797; 1996- $570; 1997-$396; 1998-$1,289; and 1999-$5,238.\nIn the first quarter of 1994, the Company repaid $2.6 million of an Industrial Revenue Bond (\"IRB\") associated with a previously discontinued operation. The IRB was included in accrued liabilities in the accompanying consolidated balance sheet at October 2, 1993.\nDuring 1994, the Company completed negotiations for a new unsecured revolving line of credit. During the term of the agreement, the Company can borrow at the bank's base rate (7.75% at October 1, 1994) or an adjusted Eurodollar rate, plus one and one-half percent. The new line of credit, which permits maximum borrowings of $30.0 million, expires on August 30, 1995. The maximum borrowings are restricted based on the amount of the Company's domestic accounts receivable and also contains certain restrictive covenants including, but not limited to, minimum levels of profitability and liquidity and restrictions related to indebtedness, cash flow and capital expenditures. The agreement also contains restrictions with respect to acquisitions and the repurchase of the Company's public debt. As of October 1, 1994, there were no outstanding borrowings under this agreement and the Company's borrowing availability under this agreement was $26.1 million. Additionally, certain of the Company's foreign subsidiaries have lines of credit available to fund local working capital requirements. The lines of credit provide for borrowings aggregating approximately $16.1 million. At October 1, 1994, total borrowings outstanding under these lines of credit approximated $5.7 million at interest rates ranging from 3.0% to 11.5%.\nNOTE 6 - INCOME TAXES:\nIn the first quarter of 1994, the Company prospectively adopted SFAS 109, effective as of October 3, 1993. The cumulative effect of adopting SFAS 109 amounted to $3.3 million of income. This amount is reflected in the consolidated statement of operations for 1994 as the cumulative effect of a change in accounting principle. It primarily represents the reversal of deferred tax assets and liabilities resulting from the adoption of SFAS 109. The deferred tax assets and liabilities were established in connection with a previous acquisition and were recorded as reductions of the respective assets and liabilities.\nThe sources of income (loss) from continuing operations before income taxes and the components of the related provision for (benefit from) domestic, including Puerto Rico, and foreign income taxes are shown below (in thousands):\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 and operating loss carryforwards.\nThe following is a summary of the significant components of the Company's deferred tax assets and liabilities as of October 1, 1994 (in thousands):\nDeferred Tax Assets: - ------------------- Inventory capitalization and reserves $ 9,779 Capitalized research and development 7,221 Deferred compensation 3,193 Net operating loss carryovers 32,448 Restructuring reserve 6,473 Other accruals and reserves 13,788 72,902 -------- Deferred Tax Liabilities: - ------------------------ Depreciation and amortization (18,793) Other (5,968) (24,761) -------- Valuation allowance (53,092) -------- Net deferred tax liability $ (4,951) ========\nThe net deferred tax liability above is comprised of a net current deferred tax asset of $7.4 million, included in other current assets and a net non- current deferred tax liability of $12.3 million in the consolidated balance sheet at October 1, 1994.\nThe difference between the provision for (benefit from) taxes on income (loss) from continuing operations and the amount computed by applying the United States Federal income tax rate is reconciled below:\nThe Company has U.S. Federal net operating loss carryforwards amounting to approximately $60.0 million at October 1, 1994. The net operating loss carryforwards expire primarily in 2005 through 2009.\nDuring 1994, the Company recognized tax benefits primarily associated with certain current and prior year expenditures that were eligible for carryback under provisions of Federal tax law (approximately $1.0 million in the third quarter. The benefit was recognized as the result of the issuance, during the third quarter, of a favorable revenue ruling by the Internal Revenue Service as to the deductibility of such expenditures. Prior to the third quarter, the company had not recognized any tax benefit for such expenditures due to the uncertainty as to their deductibility.\nIn the second quarter of 1993, the Company reached initial resolution with the Internal Revenue Service of certain prior years' tax returns. As a result, the Company recorded $2.8 million of interest income on a tax refund claim at that time. Additionally, the Company recorded a reversal, net of the second quarter's tax provision, of $3.6 million of accrued tax liabilities ($1.0 million of which was applicable to discontinued operations).\nNOTE 7 - STOCKHOLDERS' EQUITY:\nChanges in components of stockholders' equity were as follows (in thousands):\nThe Company repurchased .5 million shares of its common stock in 1993 and 1.2 million shares in 1992.\nThe Company has outstanding a class of Common Share Purchase Rights, which are currently attached to and trade with the common stock. The rights were issued to help ensure that all stockholders receive fair and equal treatment in the event of any proposal to acquire control of the Company. Each right entitles the holder to purchase eight-tenths of one share of common stock at an exercise price of $60 per share, subject to adjustment.\nThe rights will trade separately and become exercisable only if a person or group acquires or announces an offer to acquire 10% or more of the common stock. Thereafter, if such an acquisition is made, each holder with certain exceptions would be entitled, upon exercise of each right, to receive shares of common stock (or, if the Company were acquired, of the acquiring company's common stock) having a market value equal to 1.6 times the exercise price of the right.\nThe Company may lower the 10% threshold, exempt certain acquisitions, or redeem the rights at one cent per right under certain circumstances. The rights will expire on August 7, 1996.\nNOTE 8 - SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:\nCash receipts and expenditures related to interest and income taxes from continuing operations are as follows (in thousands):\nCash flows from discontinued activities are as follows (in thousands):\nNon-cash activity relating to the Company's matching contribution to the domestic defined contribution retirement plan was $3.7 million, $3.5 million and $3.0 million for 1994, 1993 and 1992, repectively. NOTE 9 - EMPLOYEE STOCK PLANS:\nStock Award Plans\nThe M\/A-COM Long Term Incentive Plan (the \"Incentive Plan\"), adopted in 1990, authorizes an aggregate of 1.2 million shares of the Company's common stock for the granting of non-qualified and incentive stock options, outside Directors' options, stock appreciation rights (\"SARs\") and restricted stock. The Incentive Plan replaced all existing stock award plans but the awards outstanding under such existing plans were not affected. At October 1, 1994, .1 million stock awards were available for grant under the Incentive Plan.\nA summary of the status of the Company's stock option plans follows (in thousands, except per share amounts):\nAll outstanding options are non-qualified and have been granted at option prices per share not less than the then fair market value of the Company's common stock. Options become exercisable over a four-year period and expire ten years after the date granted. Options for 1.9 million and 1.7 million shares were exercisable at October 1, 1994 and October 2, 1993, respectively.\nOf the outstanding options at October 1, 1994, 1.1 million SARs, with an option price of $5.69 per share, were granted in tandem with 1.1 million of the stock options. Based on past experience, the expressed intent of the two holders not to elect the SAR option and the underlying economics to the holders, management's opinion is that SARs will not be exercised and, therefore, no compensation expense has been recognized.\nAt October 1, 1994, there were .2 million stock units issued and outstanding. These units were granted prior to the adoption of the Incentive Plan. Stock units are convertible into shares of common stock on a one-for-one basis upon the lapsing of certain restrictions. In 1994, .2 million units were converted to shares (.2 million in each of 1993 and 1992).\nRestricted Treasury Stock Plan\nThe M\/A-COM, Inc. 1990 Restricted Treasury Stock Plan (the \"Stock Plan\") was approved by the Company's stockholders at its Annual Meeting on February 20, 1991.\nThe Stock Plan reserved 2.0 million shares of the Company's common stock for granting share allocations as an incentive to officers and key employees. After receiving an allocation of restricted shares of common stock, a participant in the Stock Plan is awarded specified portions of such share allocation on subsequent dates based on the achievement of performance targets representing increases in the average market value of the Company's common stock above the initial stock price of such allocation (the \"Stock Price Increase\") as follows: if the Stock Price Increase (in terms of multiple of initial stock price) is .5, the participant would be awarded 50% of such share allocations, and if the Stock Price Increase is 1.0, the participant would be awarded 100% of such allocations.\nThe awarded restricted shares become unrestricted over a three-year period commencing on the date on which the target share price is achieved. Contingent upon continued employment with the Company through September 19, 2000, all granted share allocations are awarded and become unrestricted on that date.\nA summary of the status of the Company's Stock Plan follows (in thousands, except per share amounts):\nAt October 1, 1994, .6 million shares were available for grant allocations under the Stock Plan.\nThe fair market value of the share allocations, based on the market price at date of grant, is recorded as deferred compensation, a component of stockholders' equity. Deferred compensation is amortized over the periods to be benefited. NOTE 10 - RETIREMENT PLANS:\nThe Company and its subsidiaries have defined contribution retirement plans covering substantially all employees. The expense for these plans related to continuing operations was $3.9 million in 1994 ($4.2 million in 1993 and $4.5 million in 1992).\nIn addition, the Company has a supplemental defined benefit pension plan for certain employees to replace retirement benefits which were reduced as a result of limitations in the Tax Reform Act of 1986. Plan benefits are to be paid from the general funds of the Company. Amounts charged to continuing operations expense for 1994, 1993 and 1992 related to this supplemental plan were $.4, $.5 and $.4 million, respectively. The projected benefit obligation associated with this plan is not significant in relation to the consolidated financial statements.\nDuring the second quarter of 1992, the Company began matching employee contributions to the Company's domestic defined contribution retirement plan (the \"retirement plan\") with the Company's common stock. A total of .5 million and .6 million shares were contributed to the retirement plan during 1994 and 1993, respectively.\nNOTE 11 - EMPLOYEE STOCK OWNERSHIP PLAN:\nThe Company has an Employee Stock Ownership Plan (\"ESOP\") which enables employees to accumulate shares of the Company's common stock. The cost of the Plan is borne by the Company through contributions to the ESOP. Shares of common stock are allocated to each employee and are held in trust until the employee's termination, retirement or death. The Company's ESOP contribution related to continuing operations amounted to $.1 million for 1994, $.1 million for 1993 and $.4 million for 1992.\nAt October 1, 1994, the M\/A-COM Employee Stock Ownership Trust owned .9 million shares of common stock, of which .8 million have been allocated to employees. Employees are entitled to vote allocated shares and the Trustees are entitled to vote unallocated shares.\nNOTE 12 - LITIGATION:\nM\/A-COM is a defendant in various legal proceedings incidental to the nature of its business. However, the Company believes that the outcome of these proceedings will not materially affect the Company's financial position or results of operations.\nOn October 27, 1993, at the request of the Company's insurance carrier, the Company entered into a Stipulation of Settlement in connection with the class action entitled Rand, et al. v. M\/A-COM, Inc., et al. On February 1, 1994, the court approved the Stipulation of Settlement. Pursuant to the Stipulation of Settlement the Company's insurance carrier has paid into a settlement fund the amount of $3.9 million in full settlement of all claims in the action. The Company is not required to make any payment to the plaintiffs out of its own funds, and the Company's insurance carrier has paid the Company $325,000 to compensate the Company for certain costs associated with the litigation.\nNOTE 13 - COMMITMENTS AND CONTINGENCIES:\nCertain office and production space and equipment used in continuing operations were rented at an annual net cost of approximately $8.1 million in 1994 ($6.7 million in 1993 and $5.1 million in 1992). At October 1, 1994, the Company was committed under noncancelable operating leases which provide for the following rentals: 1995-$8.5 million; 1996-$7.8 million; 1997-$7.2 million; 1998-$6.6 million; 1999-$6.3 million and $53.4 million thereafter.\nAt October 1, 1994 outstanding letters of credit totaled approximately $3.2 million.\nIn the fourth quarter of 1992, the Company paid $2.9 million and agreed to be responsible for certain possible additional environmental liabilities relating to a site occupied until 1971 by a division of the Company. The Company had previously established reserves for this matter and does not believe that the resolution of the remaining possible liabilities will have a material effect on its financial condition or results of operations (see Note 1).\nM\/A-COM's manufacturing activities have generated and continue to generate materials classified as hazardous wastes. The Company devotes appropriate resources to compliance with legal and regulatory requirements relating to minimization of the use of these materials, to their proper disposal as wastes, and to the protection of the environment. Those requirements include clean-up activities at various sites. The Company does not believe that expenditures relating to these requirements will have a material effect on the Company's financial condition or results of operations. However, no assurance can be given that any future discovery of new facts and the retroactive application of such legal and regulatory requirements to those facts would not be material and would not change the estimate of the costs that the Company could be required to pay in any particular situation.\nNOTE 14 - QUARTERLY INFORMATION (Unaudited):\nThe following is a summary of selected quarterly financial data (in thousands, except per share amounts). Refer to Notes 1, 2, 3 and 5 for matters relating to this note.\nNOTE 15 - FINANCIAL INFORMATION BY GEOGRAPHIC AREA AND MAJOR CUSTOMER: (in thousands)\nEliminations represent transfers from the United States to foreign field offices and European operating facilities. Such transfers are generally at inventory cost of the selling location plus a margin. United States sales include export sales of approximately $38.5, $44.2 and $46.0 million in 1994, 1993 and 1992, respectively.\nGeneral corporate assets are principally cash, marketable securities and assets held for sale.\nThe largest source of revenue for the Company is the United States Government and its agencies (primarily the Department of Defense), whose direct purchases accounted for 6% of consolidated net sales in 1994 (7% in 1993 and 9% in 1992). In addition, United States Government subcontract sales approximated 25% in 1994 (31% in 1993 and 34% in 1992) of consolidated net sales. The Company does not believe that accounts receivable from these sales involve a material degree of credit risk. REPORT OF INDEPENDENT ACCOUNTANTS\nNovember 15, 1994\nTo the Board of Directors and Stockholders of M\/A-COM, Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14 (a)(1) and (2) on page 47 present fairly, in all material respects, the financial position of M\/A-COM, Inc. and its subsidiaries at October 1, 1994 and October 2, 1993, and the results of their operations and their cash flows for each of the three years in the period ended October 1, 1994 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.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1994 in accordance with the requirements of Statement of Financial Accounting Standards No. 109.\nPRICE WATERHOUSE LLP\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 the directors of the Company is incorporated by reference from the section entitled \"Election of Directors\" in the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders to be held on February 15, 1995, to be filed pursuant to Regulation 14A. Information concerning the executive officers of the Company appears in Part I of this annual report on Form 10-K and the directors and executive officers and the capacities in which they serve are listed on page 56.\nItem 11.","section_11":"Item 11. Executive Compensation\nIncorporated by reference from the sections entitled \"Election of Directors\" and \"Executive Compensation\" in the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders to be held on February 15, 1995, to be filed pursuant to Regulation 14A.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nIncorporated by reference from the sections entitled \"Voting Securities\" and \"Election of Directors\" in the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders to be held on February 15, 1995, to be filed pursuant to Regulation 14A.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIncorporated by reference from the section entitled \"Election of Directors\" in the Company's Definitive Proxy Statement for the Annual Meeting of Stockholders to be held on February 15, 1995, to be filed pursuant to Regulation 14A.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, Reports on Form 8-K\n(a)(1) Consolidated Financial Statements Page\nConsolidated Statement of Operations - Years Ended October 1, 1994, October 2, 1993 and October 3, 1992 24 Consolidated Balance Sheet - October 1, 1994 and October 2, 1993 25 Consolidated Statement of Cash Flows - Years Ended October 1, 1994, October 2, 1993 and October 3, 1992 27 Notes to Consolidated Financial Statements 28 Report of Independent Accountants 45\n(a)(2) Financial Statement Schedules for the Three Years Ended October 1, 1994\nSchedule II - Amounts Receivable from Directors, Officers and Employees 48 Schedule V - Plant Assets 49 Schedule VI - Accumulated Depreciation 51 Schedule VIII - Valuation and Qualifying Accounts and Reserves 52 Schedule IX - Short-Term Borrowings 53 Schedule X - Supplementary Income Statement Information 53\nAll other Schedules are omitted because they are not applicable or required, or because the required information is included in the consolidated financial statements or notes thereto.\nSeparate financial statements of the registrant have been omitted since it is primarily an operating company and the minority interests in subsidiaries and long-term debt of the subsidiaries held by entities other than the registrant are less than five percent of consolidated total assets.\n(a)(3) List of Exhibits. Exhibits required as part of this report are listed in the exhibit index beginning on page 57.\n(b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of the period covered by this report.\n(1) Loan related to relocation.\n(1) Inter-account transfers. (2) Impact of change in foreign exchange rates on translation of foreign subsidiaries fixed asset balances. (3) Reclassification to\/from discontinued operations, which includes additions and retirements or sales of discontinued businesses in the current year. (4) Increases due to the acquisition of Greenpar. (5) Assets held for sale. (6) Impact of adoption of SFAS 109. (7) Other.\nRanges of Useful Lives Years\nLand improvements 5-35 Building and building equipment 3-40 Machinery and equipment 3-12\n(1) Inter-account transfers. (2) Impact of change in foreign exchange rates on translation of foreign subsidiaries' accumulated depreciation balances. (3) Reclassification to\/from discontinued operations, which includes additions and retirements or sales of discontinued businesses in the current year. (4) Increases due to the acquisition of Greenpar. (5) Assets held for sale. (6) Impact of adoption of SFAS 109. (7) Other.\n(1) Based on month-end balances. (2) Average of month-end balances. (3) Calculated by dividing the actual short-term interest expense by the average amount outstanding during the period.\n(1) Amounts for other captions required by this schedule have been omitted since they are less than one percent of sales or disclosed elsewhere in the Consolidated Financial Statements. Amounts are for the Company's continuing operations only.\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, on December 23, 1994.\nM\/A-COM, Inc.\nBy: PETER J. RICE --------------------------- Peter J. Rice Vice President, Chief Accounting Officer and 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 below.\nSignature Title Date - -----------------------------------------------------------------------------\nTHOMAS A. VANDERSLICE Chairman of the Board, December 23, 1994 - --------------------- President, Chief Executive Thomas A. Vanderslice Officer and Director (Principal Executive Officer)\nLARRY L. MIHALCHIK Senior Vice President, Chief December 23, 1994 - --------------------- Administrative Officer and Larry L. Mihalchik Chief Financial Officer (Principal Financial Officer)\nPETER J. RICE Vice President, Chief December 23, 1994 - --------------------- Accounting Officer and Controller Peter J. Rice (Principal Accounting Officer)\n* Director - --------------------- Daniel J. Fink\n* Director - --------------------- George N. Hutton, Jr.\n* Director - --------------------- Robert E. La Blanc\n* Director - --------------------- Dr. James D. Meindl\n* Director - --------------------- E. James Morton\n* Director - --------------------- Raymond F. Pettit\n* Director - --------------------- Dr. William F. Pounds\n* Director - --------------------- Hon. Paul E. Tsongas\n*By: THOMAS A. VANDERSLICE December 23, 1994 --------------------- Thomas A. Vanderslice (Attorney-in-Fact)\nEXECUTIVE OFFICERS\nThomas A. Vanderslice Chairman of the Board, President and Chief Executive Officer\nRobert H. Glaudel Senior Vice President, Human Resources\nLarry Mihalchik Senior Vice President, Chief Administrative Officer and Chief Financial Officer\nPeter J. Rice Vice President, Chief Accounting Officer and Controller\nDIRECTORS\nThomas A. Vanderslice\nDaniel J. Fink President, D. J. Fink Associates, Inc.\nGeorge N. Hutton, Jr. Private Investor\nRobert E. La Blanc President, Robert E. La Blanc Associates, Inc.\nDr. James D. Meindl J.M. Pettit Chaired Professor, Microelectronics Research Center, Georgia Institute of Technology\nE. James Morton Director and Former Chairman of the Board and Chief Executive Officer John Hancock Mutual Life Insurance Co.\nRaymond F. Pettit Retired, the Rockefeller Group\nDr. William F. Pounds Professor of Management Alfred P. Sloan School of Management Massachusetts Institute of Technology\nPaul E. Tsongas Partner, Foley, Hoag & Eliot\nEXHIBIT INDEX\nExhibit Description Number\n3.1 Amended and Restated Articles of Organization of M\/A-COM, Inc., incorporated by reference to Exhibit 3.1 to Annual Report for fiscal year ended September 30, 1989 (File No. 1-4236).\n3.2 By-laws, as amended through September 10, 1992, of M\/A-COM, Inc., incorporated by reference to Exhibit 3.2 to Annual Report for fiscal year ended October 3, 1992 (File No. 1-4236).\n4.1 Amended and Restated Articles of Organization of M\/A-COM, Inc., incorporated by reference to Exhibit 3.1 to Annual Report for fiscal year ended September 30, 1989 (File No. 1-4236).\n4.2 By-laws, as amended through September 10, 1992, of M\/A-COM, Inc., incorporated by reference to Exhibit 3.2 to Annual Report for fiscal year ended October 3, 1992 (File No. 1-4236).\n4.3 Indenture dated May 1, 1981 between M\/A-COM, Inc. and State Street Bank and Trust Company, incorporated by reference to Exhibit 4 to Amendment No. 1 to Registration Statement No. 2-72072.\n4.4 Rights Agreement between M\/A-COM, Inc. and The First National Bank of Boston, as amended and restated as of May 16, 1990, incorporated by reference to Exhibit 4.6 to Annual Report for fiscal year ended September 29, 1990 (File No. 1-4236).\n10.1 Revolving Credit Agreement among M\/A-COM, Inc. and The First National Bank of Boston, et al., dated as of March 15, 1994, incorporated by reference to Exhibit 10.1 to Quarterly Report for quarterly period ended April 2, 1994 (File No. 1-4236).\n10.2 Unlimited Guaranty made by M\/A-COM Government Products, Inc., M\/A-COM Light Control Systems, Inc., M\/A-COM Omni Spectra, Inc., M\/A-COM PHI, Inc. and M\/A-COM Puerto Rico, Inc. in favor of The First National Bank of Boston, et al., dated as of March 15, 1994, incorporated by reference to Exhibit 10.2 to Quarterly Report for quarterly period ended April 2, 1994 (File No. 1-4236).\n10.3 Indenture dated May 1, 1981 between M\/A-COM, Inc. and State Street Bank and Trust Company, incorporated by reference to Exhibit 4 to Amendment No. 1 to Registration Statement No. 2-72072.\n10.4 Lease dated July 29, 1972 between Brixton Estate Limited and Microwave Associates Limited, incorporated by reference to Exhibit 10.43 to Registration Statement No. 2-70255.\n10.5 Lease dated May 3, 1979 between Sevan Associates and Power Hybrids Incorporated, incorporated by reference to Exhibit 10.46 to Annual Report for fiscal year ended October 3, 1981 (File No. 1-4236).\n10.6 Lease Contract made as of the 30th day of November, 1982 between Puerto Rico Industrial Development Authority and M\/A-COM Puerto Rico, Inc., incorporated by reference to Exhibit 10.34 to Annual Report for fiscal year ended October 1, 1983 (File No. 1-4236), together with Supplement and Amendment to Lease Contract, dated November 4, 1987 between Puerto Rico Industrial Development Company and M\/A-COM Puerto Rico, Inc., and a Second Supplement and Amendment to Lease Contract dated February 11, 1988, incorporated by reference to Exhibit 10.34 to Annual Report for fiscal year ended October 1, 1988 (File No. 1-4236).\n10.7 Indenture of Lease dated May 31, 1983 between Northwest Associates and M\/A-COM, Inc. together with Lease Extension Agreement dated May 20, 1988, incorporated by reference to Exhibit 10.35 to Annual Report for fiscal year ended October 1, 1988 (File No. 1-4236).\n10.8 Ground Lease dated as of May 15, 1984 between M\/A-COM, Inc. and Lowell Investors Associates Limited Partnership, together with Realty Sublease and Sub-sublease Agreement dated as of May 15, 1984 between Lowell Real Estate Corporation and M\/A-COM, Inc., and Deed of Improvements dated as of May 15, 1984 from M\/A-COM, Inc. to Lowell Investors Associates Limited Partnership, incorporated by reference to Exhibit 10.46 to Annual Report for fiscal year ended September 29, 1984 (File No. 1-4236).\n10.9 Lease dated September 1, 1984 between Barry Wright Corporation and M\/A-COM Omni Spectra, Inc., incorporated by reference to Exhibit 10.31 to Annual Report for fiscal year ended September 28, 1985 (File No. 1-4236), together with Amendment to Lease dated September 24, 1990 between Bridge Street Realty Trust and M\/A-COM Omni Spectra, Inc., incorporated by reference to Exhibit 10.39 to Annual Report for fiscal year ended September 29, 1990 (File No. 1-4236).\n10.10 Lease dated November 19, 1985 between M\/A-COM, Inc. and Raymond A. Carye and Barbara F. Carye as Trustees of First Altid Realty Trust, incorporated by reference to Exhibit 10.41 to Annual Report for fiscal year ended October 3, 1987 (File No. 1-4236), together with Amendment to Lease dated November 21, 1990 between M\/A-COM, Inc. and Raymond A. Carye and Barbara F. Carye as Trustees of First Altid Realty Trust, incorporated by reference to Exhibit 10.41 to Annual Report for fiscal year ended September 29, 1990 (File No. 1-4236).\n10.11 Lease dated July 20, 1986 between Milton Keynes Development Corporation and Microwave Associates Limited, incorporated by reference to Exhibit 10.38 to Annual Report for fiscal year ended October 3, 1987 (File No. 1-4236).\n10.12 Indenture of Lease dated November 24, 1980 between Philip Pagliazzo and Adams-Russell Co., Inc., incorporated by reference to Exhibit 10.47 to Annual Report for fiscal year ended September 30, 1989 (File No. 1-4236).\n10.13 Equipment Sublease Agreement dated as of May 15, 1984 between Lowell Real Estate Corporation and M\/A-COM, Inc., incorporated by reference to Exhibit 10.47 to Annual Report for fiscal year ended September 29, 1984 (File No. 1-4236).\n10.14 Rights Agreement between M\/A-COM, Inc. and The First National Bank of Boston, as amended and restated as of May 16, 1990, incorporated by reference to Exhibit 4.6 to Annual Report for fiscal year ended September 29, 1990 (File No. 1-4236).\n10.15 Letter Agreement regarding Regulation S-K, Item 601(b)(4)(iii)(A) Agreement, dated December 15, 1988 from M\/A-COM, Inc. to Securities and Exchange Commission, incorporated by reference to Exhibit 10.49 to Annual Report for fiscal year ended October 1, 1988 (File No. 1-4236).\nManagement Contracts, Compensatory Plans and Arrangements\n10.16 Form of Indemnification Agreement between M\/A-COM, Inc. and directors and officers of M\/A-COM, Inc., incorporated by reference to Exhibit 10.6 to Annual Report for fiscal year ended September 30, 1989 (File No. 1-4236), together with a schedule listing the names of the current directors and officers who have entered such Agreement and the dates thereof, filed herewith.\n10.17 M\/A-COM, Inc. Long Term Incentive Plan dated as of October 18, 1989, as amended on May 16,1990, incorporated by reference to Exhibit 10.11 to Annual Report for fiscal year ended September 29, 1990 (File No. 1-4236), together with amendments adopted on May 7, 1991 and November 10, 1993, incorporated by reference to Exhibit 10.16 to Annual Report for fiscal year ended October 2, 1993 (File No. 1-4236).\n10.18 M\/A-COM, Inc. 1980 Stock Option and Performance Incentive Stock Option Plan (formerly entitled the \"M\/A-COM, Inc. 1980 Stock Option Plan\") dated December 15, 1980, as amended and restated November 12, 1981, as amended as of January 1, 1987 and as amended and restated as of September 25, 1987, incorporated by reference to Exhibit 10.20 to Annual Report for fiscal year ended October 3, 1987 (File No. 1-4236).\n10.19 M\/A-COM, Inc. 1981 Stock Option and Performance Incentive Stock Option Plan (formerly entitled the \"M\/A-COM, Inc. 1981 Stock Option Plan\") dated November 12, 1981, as amended as of January 1, 1987 and amended and restated as of September 25, 1987, incorporated by reference to Exhibit 10.21 to Annual Report for fiscal year ended October 3, 1987 (File No. 1-4236).\n10.20 M\/A-COM, Inc. 1983 Stock Option and Performance Incentive Stock Option Plan (formerly entitled the \"M\/A-COM, Inc. 1983 Stock Option Plan\") dated November 17, 1983, as amended as of January 1, 1987 and amended and restated as of September 25, 1987, incorporated by reference to Exhibit 10.22 to Annual Report for fiscal year ended October 3, 1987 (File No. 1-4236).\n10.21 Annual Executive Performance Incentive Plan (formerly entitled the \"M\/A-COM, Inc. Contingent Compensation Plan\") dated January 15, 1952, as amended on December 21, 1953, September 22, 1955, November 21, 1974, November 18, 1976, October 13, 1977, November 18, 1980, December 15, 1980, November 12, 1981 and September 25, 1987, incorporated by reference to Exhibit 10.26 to Annual Report for fiscal year ended October 3, 1987 (File No. 1-4236).\n10.22 M\/A-COM, Inc. Supplemental Executive Retirement Plan dated March 4, 1986 and Amendment No. 1 adopted May 6, 1987, incorporated by reference to Exhibit 10.27 to Annual Report for fiscal year ended October 3, 1987 (File No. 1-4236), together with Amendment No. 2 adopted August 19, 1988, incorporated by reference to Exhibit 10.22 to Annual Report for fiscal year ended October 1, 1988 (File No. 1-4236), and Amendment No. 3 adopted as of April 1, 1989, incorporated by reference to Exhibit 10.21 to Annual Report for fiscal year ended September 30, 1989 (File No. 1-4236).\n10.23 M\/A-COM, Inc. Long Term Executive Performance Incentive Plan (formerly entitled the \"M\/A-COM, Inc. Executive Stock Unit Plan\") dated November 17, 1983, incorporated by reference to Exhibit 10.41 to Annual Report for fiscal year ended September 29, 1984 (File No. 1-4236).\n10.24 Microwave Associates, Inc. Split-Dollar Insurance Plan, effective as of September 28, 1976, incorporated by reference to Exhibit 10.21 to Annual Report for fiscal year ended September 29, 1990 (File No. 1-4236), together with Amendment to M\/A-COM, Inc. Split Dollar Insurance Plan, effective as of November 18, 1985, incorporated by reference to Exhibit 10.24 to Annual Report for fiscal year ended September 30, 1989 (File No. 1-4236).\n10.25 M\/A-COM, Inc. Split Dollar Insurance Plan Agreement with Thomas A. Vanderslice, effective as of November 28, 1989, incorporated by reference to Exhibit 10.23 to Annual Report for fiscal year ended September 29, 1990 (File No. 1-4236).\n10.26 M\/A-COM, Inc. 1990 Restricted Treasury Stock Plan, effective as of September 19, 1990, incorporated by reference to Exhibit 10.17 to Annual Report for fiscal year ended September 28, 1991 (File No. 1-4236).\n10.27 Stock Option Plan and Agreement and Deferred Compensation Trust Agreement, all dated as of November 28, 1989, between M\/A-COM, Inc. and Dr. Thomas A. Vanderslice, incorporated by reference to Exhibit 10 to the registrant's Current Report on Form 8-K dated December 15, 1989 (File No. 1-4236), together with Stock Option Plan and Agreement as corrected and restated as of September 11, 1991, incorporated by reference to Exhibit 10.18 to Annual Report for fiscal year ended September 28, 1991 (File No. 1-4236).\n10.28 M\/A-COM, Inc. Retirement Plan for Directors, effective as of October 18, 1989, as amended and restated as of May 7, 1991, incorporated by reference to Exhibit 10.19 to Annual Report for fiscal year ended September 28, 1991 (File No. 1-4236), together with amendments adopted on June 1, 1994, filed herewith.\n10.29 Severance Agreement dated November 20, 1991 between M\/A-COM, Inc. and Robert Glaudel, incorporated by reference to Exhibit 10.22 to Annual Report for fiscal year ended October 3, 1992 (File No. 1-4236).\n10.30 M\/A-COM, Inc. 1992 Supplemental Executive Retirement Plan dated April 1, 1992, incorporated by reference to Exhibit 10.30 to Annual Report for fiscal year ended October 2, 1993 (File No. 1-4236).\n10.31 Form of Trust Agreement between M\/A-COM, Inc. and Boston Harbor Trust Company, N.A., incorporated by reference to Exhibit 10.30 to Annual Report for fiscal year ended October 2, 1993 (File No. 1-4236), together with a schedule listing the beneficiaries of such Agreements, filed herewith.\n10.32 Severance Agreement dated July 1, 1993 between M\/A-COM, Inc. and J. Kermit Birchfield, Jr., incorporated by reference to Exhibit 10.32 to Annual Report for fiscal year ended October 2, 1993 (File No. 1-4236), together with Amendment to Severance Agreement dated as of October 31, 1994, filed herewith.\n10.33 Severance Agreement dated September 1, 1993 between M\/A-COM, Inc. and Larry L. Mihalchik, incorporated by reference to Exhibit 10.33 to Annual Report for fiscal year ended October 2, 1993 (File No. 1-4236).\n10.34 Severance Agreement dated November 23, 1993 between M\/A-COM, Inc. and Peter J. Rice, incorporated by reference to Exhibit 10.34 to Annual Report for fiscal year ended October 2, 1993 (File No. 1-4236).\n10.35 Severance Agreement dated March 20, 1994 between M\/A-COM, Inc. and Allan L. Rayfield, incorporated by reference to Quarterly Report for quarterly period ended April 2, 1994 (File No. 1-4236).\n10.36 Severance Agreement dated November 30, 1994 between M\/A-COM, Inc. and Thomas A. Vanderslice, filed herewith. - -------------------------\n11 Calculation of Earnings Per Share.\n21 Subsidiaries of M\/A-COM, Inc.\n23 Consent of Price Waterhouse LLP.\n24 Power of Attorney.\n27 Financial Data Schedule.","section_15":""}
{"filename":"12570_1994.txt","cik":"12570","year":"1994","section_1":"ITEM 1. BUSINESS\nLexington Precision Corporation (the \"Company\") is a Delaware corporation which was incorporated in 1966. The Company manufactures, to customer specifications, rubber and metal component parts used primarily by manufacturers of automobiles, automotive replacement parts, computers, office equipment, medical devices, home appliances and industrial equipment. The Company's business is conducted primarily in the continental United States. Unless the context otherwise requires, all references herein to the Company are to Lexington Precision Corporation and its wholly-owned subsidiary, Lexington Components, Inc. (\"LCI\").\nRUBBER GROUP\nThe Company's Rubber Group manufactures, to customer specifications, close tolerance silicone and organic rubber components. The Group conducts its business through four operating divisions of LCI.\nPRECISION SEALS DIVISION. The Precision Seals Division manufactures molded rubber seals used in primary wire harnesses for automobiles and trucks. Primary wire harnesses distribute electrical power to interior and exterior lighting fixtures, electrically powered accessories and other electrical equipment. The seals are used to assure the integrity of the many connections which are required throughout the harnesses. The Division's largest customer is Delphi Packard Electric Systems, a division of General Motors Corporation (\"Delphi Packard Electric\").\nELECTRICAL INSULATOR DIVISION. The Electrical Insulator Division manufactures molded rubber insulators used in ignition wire harnesses for automobiles and trucks. Insulators are used to shield the electrical connections made by the ignition wire at the distributor and at the spark plug. Approximately 30% of the insulators manufactured by the Division are used in new vehicles, primarily those manufactured by Ford Motor Company and Chrysler Corporation, with the balance used in automotive replacement parts.\nLEXINGTON MEDICAL DIVISION. The Lexington Medical Division manufactures molded rubber components which are used in a variety of medical devices, such as syringes, laparoscopic instruments, catheters and intravenous feeding systems.\nEXTRUDED AND LATHE CUT PRODUCTS DIVISION. The Extruded and Lathe Cut Products Division manufactures extruded rubber components which are used primarily by manufacturers of industrial equipment, lighting products and home appliances.\nMETALS GROUP\nThe Company's Metals Group manufactures, to customer specifications, close tolerance metal components. The Group conducts its business through Falconer Die Casting Company (\"Falconer\") and Ness Precision Products (\"Ness\"), both of which are divisions of the Company.\nFALCONER DIE CASTING COMPANY. Falconer manufactures aluminum, magnesium and zinc die castings used primarily by manufacturers of computers, office equipment, leisure time equipment, communications equipment, industrial equipment and automobiles. Many of the die castings which are\nproduced by Falconer are also machined by Falconer using computer-controlled machining centers and other secondary machining equipment.\nNESS PRECISION PRODUCTS. Ness produces precision-machined aluminum, brass and stainless steel components used primarily by manufacturers of automobiles, home appliances, office equipment, communications equipment and industrial equipment. In 1994, approximately half of the revenues of Ness were generated by sales of components for automotive air bag systems.\nPRINCIPAL END USES FOR THE COMPANY'S PRODUCTS\n(For additional information concerning the Rubber Group and the Metals Group, see Note 11 to the Consolidated Financial Statements in Part II, Item 8.)\nMARKETING AND SALES\nThe marketing and sales effort within the Rubber Group is carried out by management personnel and internal sales personnel. The marketing and sales effort within the Metals Group is carried out by management personnel, internal sales personnel and independent sales representatives.\nRAW MATERIALS\nEach of the principal raw materials used by the Company is available at competitive prices from several major manufacturers. All raw materials have been readily available and the Company does not foresee any significant shortages.\nSEASONAL VARIATIONS\nThe Company's business generally is not subject to significant seasonal variations.\nMAJOR CUSTOMERS\nNet sales to two customers of the Rubber Group accounted for 26.7%, 27.4% and 27.2% of the Company's total net sales during 1994, 1993 and 1992, respectively. During such years, net sales to Delphi Packard Electric accounted for 20.6%, 22.3% and 20.4%, respectively, of the Company's total net sales. During 1994, 1993 and 1992, net sales to one customer of the Metals Group, TRW Vehicle Safety Systems, Inc. (\"TRW VSSI\"), accounted for 13.0%, 11.8% and 9.0%, respectively, of the Company's total net sales. Sales to TRW VSSI consisted primarily of sales of one component part. Loss of a significant amount of business from any of the Company's three largest customers would have a material adverse effect on the business of the affected Group and the Company as a whole if such business were not replaced by additional business from existing or new customers. (See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" in Part II, Item 7.)\nBACKLOG\nCOMPETITION\nThe Company competes for business primarily on the basis of quality, service, technical and engineering capabilities and price. The Rubber Group and the Metals Group encounter substantial competition from a large number of manufacturing companies. Competitors range from small and medium-sized specialized firms to large diversified companies, many of which have resources substantially greater than those of the Company. Additionally, some of the Company's customers have captive manufacturing operations which compete with the Company.\nPRODUCT LIABILITY RISKS\nThe Company is subject to potential product liability risks which are inherent in the manufacture and sale of precision components, including components of medical devices. Although there have been no\nclaims made to date against the Company which the Company believes will have a material adverse effect upon its financial position, there can be no assurance that any existing claims or any claims made in the future will not have a material adverse effect upon the financial position of the Company. (For a description of a product liability claim against LCI, see \"Legal Proceedings\" in Part I, Item 3.)\nENVIRONMENTAL COMPLIANCE\nThe Company's operations are subject to numerous federal, state and local laws and regulations controlling the discharge of materials into the environment or otherwise relating to the protection of the environment. Although the Company continues to make expenditures for the protection of the environment, compliance with federal, state and local environmental regulations has not had a significant impact on the capital spending requirements, earnings or competitive position of the Company. There can be no assurance that changes in environmental laws and regulations, or the interpretation or enforcement thereof, will not require material expenditures by the Company in the future. (See also \"Legal Proceedings\" in Part I, Item 3.)\nEMPLOYEES\nThirty hourly workers at one plant location within the Rubber Group are subject to a collective bargaining agreement. Although certain of the Company's facilities have experienced union organizing activity from time to time, the Company believes that its employee relations are generally good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAt December 31, 1994, the Company conducted its operations at eight manufacturing plants located in the United States. In December 1994, the Company acquired an additional manufacturing facility in LaGrange, Georgia, at which production is expected to commence during the second quarter of 1995. The following table sets forth the manufacturing facilities of the Rubber Group and the Metals Group and the Company's corporate offices as of December 31, 1994:\nAll of the plants are well maintained, general manufacturing facilities which are suitable for the Company's operations. Although the Company believes that, to varying degrees, each of the Company's manufacturing facilities has the flexibility to meet increased demand for the Company's products, the Company currently plans to add approximately 62,000 square feet of manufacturing space within the Rubber Group and approximately 95,000 square feet of manufacturing space within the Metals Group during 1995.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nDuring the fourth quarter of 1994, the Company settled an action commenced on April 26, 1991 in New York Supreme Court, County of Chautauqua, and previously reported in the Company's Annual Reports on Form 10-K for the years ended December 31, 1991 through 1993, by the purchaser of certain assets of\nthe Company's discontinued office furniture division. As part of the settlement, the Company sold certain real estate to a designee of the purchaser for $200,000 in cash. In addition, the Company and the purchaser agreed to dismiss the action with prejudice and exchanged mutual releases. During the fourth quarter of 1994, the Company recorded a pre-tax gain of $200,000 relating to the sale and settlement.\nOn December 3, 1993, Kingston Oil Supply Corp. (\"Kingston\") commenced a third party action against, among others, LCI in New York Supreme Court, Ulster County, alleging that LCI had manufactured a defective gasket used in a furnace which leaked oil and caused damage to a party who has sued Kingston seeking $2,000,000 in compensatory damages plus punitive damages. Kingston has sought contribution or indemnification from LCI and other third party defendants with respect to any judgment awarded against Kingston. LCI has asserted a crossclaim in this action against the customer for whom LCI manufactured the gasket, seeking indemnification in the event LCI is held liable in the action. LCI intends to appeal a decision denying its motion for summary judgment dismissing the complaint against LCI. A trial of the action has been tentatively scheduled for April 1995. LCI intends to defend the allegations against it vigorously. Based upon the information presently available to the Company, the Company believes that the outcome of the action will not have a material adverse effect upon its financial position.\nThe Company has been one of approximately 150 potentially responsible parties under the federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (\"CERCLA\"), for aggregate costs of approximately $2,000,000 incurred by the Environmental Protection Agency (\"EPA\") in connection with, among other things, inventorying, sampling, analyzing, removing and disposing of containerized hazardous substances found at a site to which such substances had been transported from a hazardous substance treatment and disposal facility. The Company and other potentially responsible parties have entered into an Administrative Order on Consent with the EPA settling the matter. The Company has paid its pro rata share of the settlement in the amount of $6,000. The Order on Consent is currently pending approval by the Department of Justice. It is not anticipated that the EPA will take any further action with respect to the site.\nThe Company has been one of approximately 50 potentially responsible parties under CERCLA for costs of approximately $1,000,000 incurred by the EPA in connection with, among other things, inventorying, sampling, analyzing, removing and disposing of containerized hazardous substances found at a hazardous substance treatment and disposal facility. The Company and other potentially responsible parties have entered into an Administrative Order on Consent with the EPA settling the matter. The Company has paid its pro rata share of the settlement in the amount of $15,000. The Order on Consent was approved by the Department of Justice in November 1994.\nThe Company is a party to certain other legal actions arising in the ordinary course of its business, including actions naming the Company as a potentially responsible party or as a third-party defendant in cost recovery actions initiated by the EPA pursuant to applicable sections of CERCLA. Based upon the information presently available to the Company, the Company believes that the ultimate outcome of these actions will not have a material adverse effect upon its financial position.\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\nThe Company's common stock, held by approximately 1,100 holders of record as of February 28, 1995, is traded in the over-the-counter market. The Company's common stock has not been listed on the National Association of Securities Dealers Automated Quotation System (NASDAQ) since May 24, 1991 because the Company has failed to meet applicable net worth requirements. Trading of shares of the Company's common stock is limited. No material trading data for the Company's common stock was publicly available for the period January 1, 1993 through April 7, 1994. Since April 8, 1994, trading information has been available from the OTC Bulletin Board provided by the National Association of Securities Dealers (NASD). The following table sets forth information regarding selling prices obtained from the OTC Bulletin Board:\nThe Company is not able to determine whether or not retail mark-ups, mark-downs or commissions were included in the above prices. The Company believes that four brokerage firms currently make a market in the Company's common stock, although both bid and asked quotations may at times be limited.\nNo dividends have been paid on the Company's common stock since 1979. The future payment of dividends is dependent upon, among other things, the earnings and capital requirements of the Company. The agreements pursuant to which certain of the Company's indebtedness is outstanding contain provisions limiting the Company's ability to make dividend payments on its common stock. The most restrictive of such provisions would have permitted the Company to pay $2,264,000 of dividends on its common stock as of December 31, 1994.\nThe Board of Directors intends, for the foreseeable future, to follow a policy of retaining the Company's earnings in order to reduce the indebtedness of the Company and finance the development and expansion of its business.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThrough its two business segments, the Rubber Group and the Metals Group, the Company manufactures, to customer specifications, close tolerance rubber and metal components. The Rubber Group manufactures silicone and organic rubber components for sale primarily to manufacturers of automobiles, automotive replacement parts and medical devices. The Metals Group manufactures metal components for sale primarily to manufacturers of automobiles, automotive replacement parts, industrial equipment, home appliances and business machines.\nLIQUIDITY AND CAPITAL RESOURCES\nDEBT RESTRUCTURING\nIn January 1994, the Company completed a restructuring of substantially all of its outstanding debt. The restructuring included the completion of an exchange offer (the \"Exchange Offer\") for the Company's 12-3\/4% Subordinated Notes, due February 1, 1997 (the \"12-3\/4% Subordinated Notes\"), the restructuring of the Company's 14% Junior Subordinated Convertible Notes, due May 1, 2000 (the \"14% Convertible Notes\"), and the amendment of the Company's borrowing arrangement (the \"Working Capital Facility\") with its working capital lender (the \"Working Capital Lender\"). Upon the completion of the restructuring, all defaults which existed on the Company's debt at the time of the restructuring were eliminated.\nPursuant to the Exchange Offer, all of the 12-3\/4% Subordinated Notes (principal of $25,275,000 and accrued interest of $10,079,000) were tendered in exchange for $31,720,000 principal amount of 12-3\/4% Senior Subordinated Notes, due February 1, 2000 (the \"12-3\/4% Senior Subordinated Notes\"), and $3,634,000 of cash. The restructuring of the 14% Convertible Notes included the satisfaction of past due interest through the payment of $99,000 in cash and the issuance of $347,000 principal amount of 14% Junior Subordinated Non-Convertible Notes, due May 1, 2000 (the \"14% Non-Convertible Notes\"). The funds used to make the cash payments required at the closing of the debt restructuring in January 1994 were obtained through increased borrowings under the Working Capital Facility.\nThe Company did not record any gain or loss for book purposes or for tax purposes from the restructuring of its indebtedness in January 1994.\nWORKING CAPITAL FINANCING\nThe Company's working capital financing is provided through the Working Capital Facility, originally entered into between the Company and the Working Capital Lender in 1990. The Working Capital Facility currently permits the Company to borrow up to $40,000,000, provided that the aggregate borrowings may not exceed an availability formula set by the Working Capital Lender. During 1994, the Working Capital Facility was amended to, among other things, increase the Company's maximum borrowing availability from $10,000,000 to $25,000,000, convert certain borrowings thereunder from revolving loans to term loans, reduce the rate of interest charged on loans outstanding under the Working Capital Facility from Prime plus 2% to Prime plus 1-1\/2% and revise certain financial covenants.\nIn January 1995, the Working Capital Facility was further amended to, among other things, increase the Company's maximum borrowing availability from $25,000,000 to $40,000,000, subject to availability formulas set by the Working Capital Lender, convert $7,873,000 of term loans and $7,267,000 of revolving loans into new term loans in the aggregate amount of $15,140,000 payable in 84 monthly principal\ninstallments of $181,000 each, reduce the rate of interest charged on loans outstanding under the Working Capital Facility from Prime plus 1-1\/2% to either Prime plus 1% or the London Interbank Offered Rate plus 3-1\/4% and revise a financial covenant. As amended, the Working Capital Facility includes a line (the \"Equipment Line\") of $11,300,000 which, subject to availability formulas set by the Working Capital Lender, can be used to finance a portion of the purchase price of new equipment. If utilized, borrowings under the Equipment Line will convert to term loans which will be payable in equal monthly principal installments through February 1, 2002. As of March 1, 1995, the Company had borrowings of $23,943,000 outstanding under the Working Capital Facility and had approximately $3,097,000 of unused availability, without giving effect to new borrowings which are expected to be available under the Equipment Line to finance purchases of new equipment.\nAmounts outstanding under the Working Capital Facility are collateralized by substantially all of the accounts receivable, inventory, equipment and other personal property, and certain real property of the Company.\nOPERATING ACTIVITIES OF THE COMPANY\nDuring 1994, net cash provided by the operating activities of the Company totaled $5,957,000, a decrease of $3,644,000 when compared to 1993. The decrease was attributable, in large part, to the payment during January 1994, in connection with the restructuring of substantially all of the Company's indebtedness, of all past due interest of the Company. During 1993, cash provided by operating activities included an increase in accrued interest of $4,152,000 resulting from the Company's failure to pay, during 1993, interest due on the 12-3\/4% Subordinated Notes and the 14% Convertible Notes.\nDuring 1994, accounts receivable increased by $3,384,000. The increase was primarily the result of increased net sales during the fourth quarter of 1994 compared to the fourth quarter of 1993 and a slowdown in payments from one of the Company's largest customers. Inventories increased by $2,458,000 during 1994, primarily as a result of increased sales levels during the fourth quarter of 1994 and anticipated higher sales levels during the first quarter of 1995.\nAccounts payable increased by $6,037,000 during 1994. The increase included an increase of $2,293,000 in payables relating to purchases of capital equipment, an increase of $1,218,000 in payables relating to purchases of tooling, and a general slowing of payments to suppliers during the fourth quarter of 1994 pending the completion of the amendments to the Working Capital Facility. Subsequent to the completion of the amendments to the Working Capital Facility in January 1995, the Company reduced its accounts payable to bring the amounts outstanding to its suppliers generally within terms which the Company believes are customary in the industries in which the Company operates. The funds used to reduce the Company's trade debt were obtained through increased borrowings under the Working Capital Facility.\nAlthough 1994 net income exceeded 1993 net income by $1,481,000 and non-cash charges for depreciation and amortization expenses increased by $763,000 during 1994, net working capital declined by $4,659,000 primarily because, at December 31, 1994, the Company classified as short-term debt $5,052,000 of revolving loans outstanding under the Working Capital Facility. Although the revolving loans, as amended in January 1995, have a maturity date of January 2, 1998, the revolving loans have been classified as short-term debt because the Company's cash receipts are automatically used to reduce the revolving loans on a daily basis, by means of a lock-box sweep agreement, and the Working Capital Lender has the ability to modify certain terms of the revolving loan financing agreements without the prior approval of the Company.\nDuring 1994, aggregate income from operations of the Rubber Group and the Metals Group totaled $9,920,000. After deducting corporate operating expenses of $1,818,000, income from operations totaled $8,102,000, or 9.2% of net sales. Included in income from operations for 1994 were non-cash expenses of $5,018,000 (principally depreciation expense of $4,239,000). Net income for 1994 included a gain, net of income taxes, of $336,000 from the sale of marketable equity securities and a gain, net of applicable income taxes, of $200,000 from a sale of real estate in connection with the settlement of certain litigation.\nINVESTING ACTIVITIES OF THE COMPANY\nDuring 1994, the investing activities of the Company used $14,966,000 of cash. During the year, the Company made $15,319,000 of capital expenditures, which included $1,500,000 for the purchase of a 77,000 square foot manufacturing facility in LaGrange, Georgia. During 1994, capital expenditures attributable to the Rubber Group and the Metals Group totaled $8,651,000 and $6,656,000, respectively. The Company estimates that approximately $3,000,000 of the 1994 capital expenditures were made to maintain or replace existing equipment or to effect cost reductions. The Company estimates that approximately $10,000,000 of the 1994 capital expenditures were for the purchase and installation of production equipment to meet orders which have been awarded to the Company. During 1994, the capital expenditure program included the purchase and rebuilding of die casting machines, the purchase of metal machining equipment, the purchase and rebuilding of rubber molding machines and ancillary equipment, the expansion of clean room facilities for the molding of rubber components for medical devices and the purchase of the LaGrange facility to provide space for ongoing expansion of production capacity within the Rubber Group. The Company presently projects that 1995 capital expenditures will total approximately $19,000,000. As of December 31, 1994, the Company had commitments outstanding to purchase equipment of approximately $4,727,000.\nFINANCING ACTIVITIES OF THE COMPANY\nDuring 1994, the financing activities of the Company provided $9,055,000 of cash, primarily from increased borrowings under the Working Capital Facility.\nThe Company operates with high financial leverage. As of December 31, 1994, the Company's aggregate indebtedness, excluding trade payables, was $57,278,000, compared to $48,077,000 as of December 31, 1993, an increase of $9,201,000. As a result of increased borrowings under the Working Capital Facility during the first two months of 1995, aggregate indebtedness, excluding trade payables, totaled $60,780,000 as of March 1, 1995 an increase of $3,502,000. The additional borrowings were used for the payment, on February 1, 1995, of the interest due on the 12-3\/4% Senior Subordinated Notes and the 14% Convertible and Non-Convertible Notes and the reduction of trade payables. During 1994, cash interest and principal payments required and paid under the terms of the Company's various financing agreements (exclusive of cash interest payments of $3,733,000 made upon completion of the debt restructuring in January 1994) totaled $6,046,000 and $1,804,000, respectively. During 1995, the cash interest and principal payments required under the terms of the Company's loan agreements are currently projected to total $7,900,000 and $2,599,000, respectively.\nBased upon the Company's present business plan, the achievement of which cannot be assured, the Company believes that for the foreseeable future anticipated borrowings under the Working Capital Facility and cash generated from operations should be adequate to meet its presently anticipated working capital, capital expenditure and debt service requirements. If cash flow from operations or availability under the Working Capital Facility fall below expectations, the Company's capital expenditure program will be reduced or delayed.\nACQUISITIONS OF BUSINESSES\nThe Company is seeking to acquire assets and businesses related to its current operations with the intention of expanding its existing operations. Depending on, among other things, the size and terms of such acquisitions, the Company may be required to obtain additional financing and, in some cases, the approval of the Working Capital Lender and the holders of other debt of the Company. The Company's ability to effect acquisitions may be dependent upon its ability to obtain such financing and, to the extent applicable, consents.\nDEPENDENCE ON LARGE CUSTOMERS\nThe Company has limited ability to predict the volume and pricing of orders from its existing and potential customers. For example, since 1992, Delphi Packard Electric and other divisions of General Motors Corporation have followed a policy of soliciting bids from large groups of manufacturers for the majority of the component parts purchased by General Motors and its divisions, including those parts which have previously been awarded to the Company and its competitors. The Company is unable to predict the timing or the outcome of future rounds of competitive bidding or other programs designed to lower Delphi Packard Electric's cost of purchased parts. During 1994, 1993, and 1992, net sales to Delphi Packard Electric accounted for 20.6%, 22.3% and 20.4%, respectively, of the Company's total net sales. Loss of all or a major portion of the Delphi Packard Electric business would have a material adverse effect on the Company's operations.\nDuring 1994, 1993 and 1992, net sales to TRW VSSI, the Company's second largest customer, accounted for 13.0%, 11.8% and 9.0%, respectively, of the Company's total net sales and consisted primarily of a single component part. The Company has limited ability to predict the customer's future requirements for this component part and the percentage of production, if any, which will be awarded to the Company. Currently, management of the Company believes that the part will remain in production for all of 1995 and at substantially reduced quantities during 1996 and 1997. During 1993 and 1994, the Company received several orders for new parts from TRW VSSI and anticipates receiving orders for additional new parts during 1995, although there can be no assurance such orders will be received. Loss of all or a major portion of the TRW VSSI business, if not replaced by equivalent volume of other parts, would have a material adverse effect on the Company's operations.\nRESULTS OF OPERATIONS\n1994 VERSUS 1993\nNET SALES\nA summary of the net sales of the Rubber Group and the Metals Group follows (dollar amounts in thousands):\nNet sales of the Rubber Group increased by $6,480,000 in 1994. Net sales to automotive customers increased by $4,823,000, or 14.7%, primarily as a result of increased sales of wire harness seals to Delphi Packard Electric and increased sales of ignition wire insulators for new vehicles. Net sales of rubber components for medical devices increased to $5,536,000 in 1994 from $3,946,000 in 1993, primarily as a result of increased sales efforts.\nNet sales of the Metals Group increased by $7,076,000 in 1994, primarily due to a 30.5% increase in net sales to TRW VSSI of component parts used in automotive airbag systems.\nCOST OF SALES\nA summary of the cost of sales (in thousands of dollars and as a percentage of net sales) for the Rubber Group and the Metals Group follows:\nCost of sales of the Rubber Group as a percentage of net sales increased from 82.4% in 1993 to 83.9% in 1994, primarily as a result of increased factory overhead costs as a percentage of net sales. During 1994, increased factory overhead costs included higher indirect labor costs, increased depreciation and amortization expenses resulting from the installation and startup of new and refurbished equipment and new tooling and increased workers' compensation costs. Increased factory overhead costs as a percentage of net sales were offset in part by lower direct labor costs as a percentage of net sales resulting from the installation of new and refurbished equipment and the introduction of improved manufacturing processes.\nCost of sales of the Metals Group as a percentage of net sales decreased from 79.3% in 1993 to 77.6% in 1994. During 1994, material and direct labor costs as percentages of net sales were essentially unchanged,\nwhile factory overhead costs as a percentage of net sales decreased, primarily because sales increased while certain components of factory overhead costs remained relatively unchanged.\nSELLING AND ADMINISTRATIVE EXPENSES\nIn 1994, consolidated selling and administrative expenses totaled $8,796,000, or 9.9% of net sales, compared to $7,936,000, or 10.6% of net sales, in 1993. Selling and administrative expenses of the Rubber Group increased to $3,694,000, or 7.9% of net sales, during 1994, compared to $3,166,000, or 7.8% of net sales, during 1993, primarily as a result of the addition of sales and administrative personnel. Selling and administrative expenses of the Metals Group increased to $3,284,000, or 7.9% of net sales, during 1994, compared to $2,894,000, or 8.4% of net sales, during 1993. Increased sales of products subject to sales commissions and increased advertising costs were more than offset by efficiencies related to increased volume. Corporate office administrative expenses decreased by $58,000, or 3.1%, primarily as a result of reduced legal fees. During 1993, corporate office administrative expenses included $730,000 of expenses recorded in connection with the Company's restructuring of its 12-3\/4% Subordinated Notes and 14% Convertible Notes which were partially offset by a credit of $215,000 resulting from the settlement of litigation. Effective for 1994, the Company determined that amortization of the excess of cost over net assets of businesses acquired (goodwill) should be classified as part of selling and administrative expenses. Previously, amortization of goodwill had been classified as other expense. Prior period presentations have been reclassified to conform to the current year's presentation. During each of the years presented, amortization of goodwill totaled $316,000.\nINTEREST EXPENSE\nInterest expense totaled $6,272,000 during 1994, an increase of $776,000 compared to 1993. This increase was caused primarily by an increase of approximately $7,690,000 in average borrowings outstanding under the Working Capital Facility and an increase in the weighted average rate of interest charged on the Working Capital Facility due to increases in the Prime rate which more than offset interest rate reductions negotiated by the Company.\nOTHER INCOME\nDuring 1994, other income consisted of a realized gain of $336,000 on the sale of marketable securities and a gain of $200,000 from the sale of real estate in connection with the settlement of litigation.\nPROVISION FOR INCOME TAXES\nThe provisions for income tax otherwise recognizable during 1994 and 1993 were reduced by the utilization of portions of the Company's tax loss and tax credit carryforwards. For information concerning income tax expense and the utilization of tax loss and tax credit carryforwards, see Note 10 to the Consolidated Financial Statements in Part II, Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Lexington Precision Corporation and Subsidiary\nWe have audited the accompanying consolidated balance sheets of Lexington Precision Corporation and subsidiary as of December 31, 1994 and 1993, and the related consolidated statements of operations, stockholders' deficit, and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the table of contents in Part IV, 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 consolidated 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lexington Precision Corporation and subsidiary at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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 as a whole, presents fairly in all material respects the information set forth therein.\nAs discussed in the notes to 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 LLP\nCleveland, Ohio February 28, 1995\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED BALANCE SHEETS (CONT.) (THOUSANDS OF DOLLARS)\nSee notes to consolidated financial statements.\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED STATEMENTS OF OPERATIONS (THOUSANDS OF DOLLARS, EXCEPT PER SHARE DATA)\nSee notes to consolidated financial statements.\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' DEFICIT YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (THOUSANDS OF DOLLARS)\nSee notes to consolidated financial statements.\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS (THOUSANDS OF DOLLARS)\nLEXINGTON PRECISION CORPORATION\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONT.) (THOUSANDS OF DOLLARS)\nSee notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Lexington Precision Corporation and its wholly-owned subsidiary (collectively, the \"Company\"). All significant intercompany accounts and transactions have been eliminated.\nCONCENTRATION OF CREDIT RISK\nAs of December 31, 1994 and 1993, trade accounts receivable outstanding from automotive customers totaled $7,904,000 and $5,364,000, respectively. The Company provides for credit losses based upon historical experience and ongoing credit evaluations of its customers' financial condition but does not generally require collateral from its customers to support the extension of trade credit. As of December 31, 1994 and 1993, the Company had reserves for credit losses of $174,000 and $159,000, respectively.\nINVENTORIES\nInventories are valued at the lower of cost (first-in, first-out method) or market. Inventory levels by principal classification are set forth below (in thousands of dollars):\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are carried at cost less accumulated depreciation. Depreciation is calculated principally on the straight-line method over the estimated useful life of the various assets (15 to 32 years for buildings and 3 to 10 years for equipment). Maintenance and repair expenses were $2,484,000, $2,189,000 and $1,395,000 for 1994, 1993 and 1992, respectively. Maintenance and repair expenses are charged against income as incurred, while major improvements are capitalized. When property is retired or otherwise disposed of, the related cost and accumulated depreciation are eliminated.\nEXCESS OF COST OVER NET ASSETS OF BUSINESSES ACQUIRED\nExcess of cost over the net assets of businesses acquired (goodwill) is amortized on the straight-line method, principally over 40 years. As of December 31, 1994 and 1993, accumulated amortization of goodwill was $1,948,000 and $1,632,000, respectively. Effective for 1994, the Company determined that amortization of goodwill should be classified as part of selling and administrative expenses. Previously, amortization of goodwill had been classified as other expense. Prior period presentations have been reclassified to conform to the current year's presentation. During each of the periods presented, amortization\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nof goodwill totaled $316,000. The carrying value of goodwill is reviewed quarterly using an analysis of historical and projected operating performance of the business to which the goodwill relates. Based upon such analysis, the Company believes that no impairment of goodwill existed as of December 31, 1994.\nINCOME PER SHARE\nIncome per common and dilutive common equivalent share were computed based upon the weighted average number of common shares and dilutive common equivalent shares outstanding. For purposes of the income per share calculations, income for each period was reduced by preferred stock dividends and by the amount by which payments made to redeem shares of the Company's $8 Cumulative Convertible Redeemable Preferred Stock, Series B (the \"Redeemable Preferred Stock\"), exceeded the par value of such shares. Common equivalent shares were those shares issuable upon the assumed exercise of outstanding stock options and conversion of Redeemable Preferred Stock, calculated using the treasury stock method. Fully diluted income per share assumes conversion of the 14% Junior Subordinated Convertible Notes, due May 1, 2000 (the \"14% Convertible Notes\"), if dilutive.\nREPORTING OF CASH FLOWS\nThe Company considers all highly liquid investments with maturities at the time of purchase of less than three months to be cash equivalents.\nRECLASSIFICATIONS\nCertain amounts in the consolidated financial statements for 1993 and 1992 have been reclassified to conform to the statement presentation for 1994.\nNOTE 2 -- OTHER CURRENT ASSETS\nAs of December 31, 1994 and 1993, other current assets included $1,242,000 and $237,000, respectively, of tooling acquired by the company for certain customers. Upon customer approval of the components produced from such tooling, which normally takes less than 90 days, the customer is required to purchase the tooling from the Company.\nNOTE 3 -- OTHER NONCURRENT ASSETS\nAs of December 31, 1994 and 1993, other noncurrent assets included $797,000 and $438,000, respectively, which represented amounts paid by the Company for tooling owned by the Company's customers in excess of the amounts paid by the customers for such tooling. Such excess amounts are amortized over periods not exceeding three years. During 1994 and 1993, amortization expense related to tooling owned by customers but funded by the Company was $272,000 and $115,000, respectively.\nNOTE 4 -- SHORT-TERM DEBT\nAs of December 31, 1994, short-term debt consisted of $5,052,000 of revolving loans outstanding under the Company's borrowing arrangement (the \"Working Capital Facility\") with its working capital lender (the \"Working Capital Lender\"). Although the revolving loans, as amended in January 1995, have a maturity date of January 2, 1998, the revolving loans have been classified as short-term debt as of\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 31, 1994 because the Company's cash receipts are automatically used to reduce the revolving loans on a daily basis, by means of a lock-box sweep arrangement, and the Working Capital Lender has the ability to modify certain terms of the revolving loan financing agreements without the prior approval of the Company.\nAt December 31, 1994, 1993 and 1992, the interest rate on borrowings under the revolving line of credit was 10.0%, 7.5% and 8.5%, respectively. (Also see Note 6, Long-Term Debt.)\nNOTE 5 -- ACCRUED EXPENSES\nAccrued expenses are summarized below (in thousands of dollars):\n- 31 -\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nWORKING CAPITAL FACILITY\nAs of December 31, 1994 and 1993, the Working Capital Facility consisted of loans outstanding under a revolving line of credit and term loans. At December 31, 1994, the long-term portion of the Working Capital Facility consisted of $8,029,000 of term loans and $7,267,000 of revolving loans which were converted into new term loans in January 1995. In January 1995, the Working Capital Facility was further amended to, among other things, increase the company's maximum borrowing availability from $25,000,000 to $40,000,000, subject to availability formulas set by the Working Capital Lender, convert $7,873,000 of term loans and $7,267,000 of revolving loans into new term loans in the aggregate amount of $15,140,000 payable in 84 monthly principal installments of $181,000 each, reduce the rate of interest charged on loans outstanding under the Working Capital Facility from Prime plus 1-1\/2% to either Prime plus 1% or the London Interbank Offered Rate plus 3-1\/4% and revise a financial covenant. As amended, the Working Capital Facility includes a line (the \"Equipment Line\") of $11,300,000 which, subject to availability formulas set by the Working Capital Lender, can be used to finance a portion of the purchase price of new equipment. If utilized, borrowings under the equipment line will convert to term loans which will be payable in equal monthly principal installments through February 1, 2002. As of March 1, 1995, the Company had borrowings of $23,943,000 outstanding under the Working Capital Facility and had approximately $3,097,000 of unused availability, without giving effect to new borrowings which are expected to be available under the Equipment Line to finance purchases of new equipment.\nUnder the terms of the Working Capital Facility the Company is required, among other things, to maintain at all times working capital, exclusive of amounts borrowed under the Working Capital Facility which are classified as current liabilities, of not less than $1,000,000 and net worth of not less than negative $9,500,000.\nAmounts outstanding under the Working Capital Facility are collateralized by substantially all of the accounts receivable, inventory, equipment and other personal property and certain real property of the Company.\n12% TERM NOTE\nThe 12% Term Note, due April 30, 2000 (the \"12% term note\"), is payable by the Company's wholly-owned subsidiary, Lexington Components, Inc. (\"LCI\"), is secured by a mortgage on the premises of LCI's Rock Hill, South Carolina, facility and is guaranteed by the Company. Level payments of principal and interest in the amount of $66,000 are due monthly until the 12% Term Note is paid in full.\n12-3\/4% SENIOR SUBORDINATED NOTES AND 12-3\/4% SUBORDINATED NOTES\nThe 12-3\/4% Senior Subordinated Notes, due 2000 (the \"12-3\/4% Senior Subordinated Notes\"), are unsecured obligations of the Company, redeemable at the option of the Company, in whole or in part, at a declining premium over the principal amount thereof. Interest on the 12-3\/4% Senior Subordinated Notes is due semi-annually on February 1 and August 1. In January 1994, in connection with the restructuring of substantially all of the Company's indebtedness, the Company issued $31,720,000 principal amount of the 12-3\/4 % Senior Subordinated Notes to the holders of the Company's 12-3\/4% Subordinated Notes, due February 1, 1997 (the \"12-3\/4 Subordinated Notes\"), in exchange for $25,275,000 principal amount of the 12-3\/4% Subordinated Notes and accrued but unpaid interest on the 12-3\/4% Subordinated Notes in the amount of $6,445,000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n14% NOTES\nThe 14% Junior Subordinated Convertible and Non-Convertible Notes, due May 1, 2000 (collectively the \"14% Notes\"), are unsecured obligations of the Company and are redeemable at the option of the Company, in whole or in part, at a declining premium over the principal amount thereof. Interest on the 14% Notes is due quarterly on February 1, May 1, August 1 and November 1. the 14% Convertible Notes are convertible into 440,000 shares of the Company's common stock.\nThe holders of the 14% Notes are the Chairman of the Board and the President of the Company, each of whom has a controlling equity interest in the Company. As of December 31, 1994, the Chairman and the President held 14% Notes in the amounts of $680,000 and $667,000, respectively.\nRESTRUCTURING OF INDEBTEDNESS\nIn January 1994, the Company completed the restructuring of the 12-3\/4% Subordinated Notes, the 14% Convertible Notes, the Working Capital Facility and a certain industrial revenue bond. The restructuring eliminated all defaults that existed at December 31, 1993. Accordingly, obligations previously classified as current liabilities due to the defaults were reclassified as long-term liabilities as of December 31, 1993.\nRESTRICTIVE COVENANTS\nCertain of the Company's loan agreements contain covenants restricting the Company's business and operations, including restrictions on the issuance or assumption of additional debt, the sale of all or substantially all of the Company's assets, the purchase of common stock, the redemption of preferred stock and the payment of cash dividends and prohibitions against any material adverse change in the Company's business, assets or financial condition.\nSCHEDULED MATURITIES OF LONG-TERM DEBT\nMaturities of long-term debt for the five-year period ending December 31, 1999 and for the years thereafter are listed below (in thousands of dollars):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 7 -- PREFERRED STOCK\nREDEEMABLE PREFERRED STOCK\nEach share of $8 Cumulative Convertible Redeemable Preferred Stock, Series B, is (1) entitled to one vote, (2) redeemable for $200 plus accumulated unpaid dividends, (3) convertible into 14.8148 shares of common stock (subject to adjustment) and (4) entitled, upon voluntary or involuntary liquidation and after payment of the debts and other liabilities of the Company, to a liquidation preference of $200 plus accumulated and unpaid dividends. On November 30, 1994, 450 shares of Redeemable Preferred Stock were redeemed for $90,000. Further redemptions of $90,000 are scheduled on November 30 of each year in order to annually retire 450 shares of Redeemable Preferred Stock. Scheduled redemptions for the years 1995 through 1999 total $450,000. For accounting purposes, when such stock is redeemed, the redeemable preferred stock account is reduced by the $100 par value of each share redeemed and paid-in-capital is charged for the $100 excess of redemption value over par value of each share redeemed. Under the terms of the Redeemable Preferred Stock, the Company may not declare any cash dividends on its common stock if there exists a dividend arrearage on the Redeemable Preferred Stock. During 1994, the Company paid the holders of the Redeemable Preferred Stock regular dividends aggregating $8.00 per share and past due dividends aggregating $24.00 per share which had been accrued by the Company as of December 31, 1993.\nOTHER AUTHORIZED PREFERRED STOCK\nThe Company's Restated Certificate of Incorporation provides that the Company is authorized to issue 2,500 shares of 6% Cumulative Convertible Preferred Stock, Series A, $100 par value (\"Series A Preferred Stock\"). As of December 31, 1994 and 1993, no shares of the Series A Preferred Stock were issued or outstanding.\nThe Company's Restated Certificate of Incorporation also provides that the Company is authorized to issue 2,500,000 shares of Preferred Stock having a par value of $1 per share. As of December 31, 1994 and 1993, no shares of the preferred stock, $1 par value, were issued or outstanding.\nNOTE 8 -- COMMON STOCK\nCOMMON STOCK, $.25 PAR VALUE\nAs of December 31, 1994 and 1993, there were 4,203,036 and 4,048,036 shares, respectively, of the Company's common stock outstanding and 410,000 and 475,000 shares, respectively, reserved for issuance under the Company's Incentive Stock Option and Restricted Stock Award Plans.\nRESTRICTED STOCK AWARD PLAN\nThe Company has a Restricted Stock Award Plan pursuant to which the Company may award restricted shares of common stock to officers and key employees. Plan participants are entitled to receive cash dividends (if any) and to vote their respective shares. The restricted shares vest at a rate set by the Compensation Committee of the Company's Board of Directors which has generally set the rate at 25% per year on each of the four anniversary dates subsequent to the award date. Unless otherwise amended, the Restricted Stock Award Plan expires on December 31, 2001.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDuring 1994, 1993 and 1992, no shares of restricted common stock were awarded. As of December 31, 1994 and 1993, 350,000 shares of common stock were available for grant under the terms of the Restricted Stock Award Plan.\nINCENTIVE STOCK OPTION PLAN\nThe Company has an Incentive Stock Option Plan that provides for grants to officers and key employees of options to purchase shares of the Company's common stock. The exercise prices of the options granted thereunder are established at the date of grant at prices not less than the market price of the Company's common stock on the date of grant. As of December 31, 1994, options for 60,000 shares were outstanding and no options were available for future grant.\nActivity in the Company's Incentive Stock Option Plan for 1994 and 1993 is summarized below:\nAs of December 31, 1994 and 1993, options for 51,250 and 98,750 shares, respectively, were exercisable.\nNOTE 9 -- EMPLOYEE BENEFIT PLANS\nRETIREMENT AND SAVINGS PLAN\nThe Company maintains a retirement and savings plan (the \"Plan\") pursuant to section 401 of the Internal Revenue Code (i.e., a 401(k) plan). All employees of the Company are entitled to participate in the Plan after meeting the eligibility requirements. Generally, employees may contribute up to 15% of their annual compensation but not more than prescribed amounts as established by the United States Secretary of the Treasury. Employee contributions, up to a maximum of 6% of an employee's compensation, are matched 50% by the Company. During 1994, 1993 and 1992, provisions for company matching contributions totaled approximately $339,000, $296,000 and $248,000, respectively. In addition, the Company has the option of making a profit sharing contribution to the Plan. The size of the profit sharing contribution is set annually at the end of each Plan year by the Company's Board of Directors. Provisions\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nrecorded for profit sharing contributions authorized by the Company's Board of Directors totaled $370,000, $334,000 and $153,000 during 1994, 1993 and 1992, respectively. The Company's matching and profit sharing contributions vest over a seven-year period, with 20% vesting after three years of service and an additional 20% vesting for each year of service thereafter until fully vested.\nINCENTIVE COMPENSATION PLAN\nThe Company has incentive compensation plans which provide for the payment of cash bonus awards to certain officers and key employees of the Company. The Compensation Committee (the \"Committee\") of the Company's Board of Directors, which consists of two directors who are not employees of the Company, oversees the administration of the plans. Cash bonus awards, which are subject to the approval of the Committee, are based upon prescribed formulae relating to the attainment of predetermined consolidated and divisional operating profit and sales targets and the achievement of other objectives. The amounts charged against operations for bonus expense totaled $214,000, $386,000 and $103,000 during 1994, 1993 and 1992, respectively.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company maintains programs to fund certain costs related to a prescription drug card program for retirees of one of its former divisions and to fund certain insurance premiums for retirees of one of its divisions.\nEffective January 1, 1993, the Company adopted \"Financial Accounting Standard No. 106, Employers' Accounting For Postretirement Benefits Other Than Pensions\" (\"FAS 106\"). As a result, during 1994 and 1993, the Company recognized the estimated future cost of providing retiree health and welfare benefits as an expense while employees render service. in 1993, the adoption of FAS 106 reduced earnings before income taxes by approximately $61,000.\nAs of January 1, 1993, the Company's accumulated postretirement benefit obligation (the \"transition obligation\") totaled $692,000. The Company is amortizing the transition obligation over the remaining life expectancy of the participants (i.e., an annual rate of $57,000). During 1992, the Company's cost of providing postretirement health care benefits (accounted for on a cash basis) totaled $65,000.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe following table presents the plan's funded status (in thousands of dollars):\nThe weighted-average annual assumed rate of increase in the per capita cost of covered benefits for the prescription drug card program is 10.7% for 1995 and is assumed to decrease gradually to 6.45% in 2005. Changing the assumed rate of increase in the prescription drug cost by one percentage point in each year would not have a significant effect on the accumulated postretirement benefit obligation. The Company's program to fund certain insurance premiums for retirees of one of its divisions has a defined dollar benefit and is therefore unaffected by increases in the health care cost trend rates. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 8.25% and 7.25% as of December 31, 1994 and 1993, respectively. The change in the discount rate at December 31, 1994, reflects the higher prevailing interest rates.\nNOTE 10 -- INCOME TAXES\nEffective January 1, 1993, the Company changed its method of accounting for income taxes from the deferred method to the liability method as required by \"Financial Accounting Standard No. 109, Accounting For Income Taxes\" (\"FAS 109\"). The Company recorded a valuation allowance equal to 100% of its net deferred tax asset at January 1, 1993. As a result, the adoption of FAS 109 did not affect the Company's results for 1993. As permitted by FAS 109, prior year financial statements were not restated.\nIn accordance with the provisions of FAS 109, at December 31, 1994 and 1993, the Company has recorded deferred tax assets and deferred tax liabilities. Deferred tax assets and liabilities recorded by the Company reflect the tax effects of loss carryforwards, tax credit carryforwards and temporary differences between the values of assets and liabilities for financial reporting purposes and income tax purposes. The tax effects of loss carryforwards, tax credit carryforwards and temporary differences existing at\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 31, 1994 and 1993 that gave rise to the deferred tax assets and deferred tax liabilities are presented below (in thousands of dollars):\nManagement of the Company believes, after reviewing the positive and negative evidence available with respect to the realization of its net deferred tax assets, that a valuation allowance equal to 100% of its net deferred tax asset is appropriate. In 1994 and 1993, the change in the valuation allowance was $1,156,000 and $835,000, respectively.\nAt December 31, 1994, the Company had net operating loss carryforwards for federal income tax purposes of $8,319,000 that expire in the years 2004 through 2007. Capital loss carryforwards for federal income tax purposes totaled $6,802,000 at December 31, 1994 and expire in 1995 and 1996. For purposes of the Federal Alternative Minimum Tax, the Company essentially utilized all of its Alternative Minimum Tax operating loss carryforward during 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nA reconciliation of income taxes at the United States federal statutory rate to the effective income tax rate are summarized below (liability method of accounting in 1994 and 1993 and deferred method of accounting in 1992):\nNOTE 11 -- INDUSTRY SEGMENTS\nThrough its two business segments, the Rubber Group and the Metals Group, the Company manufactures, to customer specifications, close tolerance rubber and metal components. The Rubber Group manufactures silicone and organic rubber components for sale primarily to manufacturers of automobiles, automotive replacement parts and medical devices. The Metals Group manufactures metal components for sale primarily to manufacturers of automobiles, automotive replacement parts, industrial equipment, home appliances and business machines.\nDuring 1994, 1993 and 1992, net sales to automotive industry customers totaled $53,005,000, $45,213,000 and $34,596,000, respectively, which represented 59.9%, 60.3% and 53.1%, respectively, of the Company's total net sales. The Company's three largest customers accounted for 39.7% 39.2% and 36.2% of net sales during the same respective periods. One customer of the Company's Rubber Group accounted for 20.6%, 22.3% and 20.4% of the Company's total net sales during the same respective periods. In addition, one customer of the Metals Group accounted for 13.0%, 11.8% and 9.0% of the Company's total net sales during such respective periods. Loss of a significant amount of business from any of the Company's three largest customers could have a material adverse effect on the Company's business.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nInformation relating to the Company's industry segments is summarized below (in thousands of dollars):\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 12 -- INCOME PER SHARE\nPRIMARY INCOME PER SHARE\nPrimary income per share is based upon the weighted average number of common shares outstanding and, if dilutive, the common share equivalents outstanding during each period. The weighted average number of common and dilutive common equivalent shares used in the calculation of primary income per share totaled 4,209,000 in 1994 and 4,048,000 in each of 1993 and 1992. For purposes of the primary income per share calculations, net income for 1994 was reduced by (1) $47,000 of dividends on Redeemable Preferred Stock and (2) $45,000, the amount by which the payment made to effect the scheduled redemption of 450 shares of Redeemable Preferred Stock exceeded the par value of such shares. Net income for 1993 was reduced by (1) $176,000 of dividends on Redeemable Preferred Stock and (2) $135,000, the amount by which the payment made to effect the redemption of 1,350 shares of redeemable preferred stock exceeded the par value of such shares. Net income for 1992 was not reduced by preferred stock dividends or the redemption of preferred shares because the Company did not pay any such dividends and did not redeem any of such shares.\nFULLY DILUTED INCOME PER SHARE\nFully diluted income per share is based upon the total of the weighted average number of common shares outstanding, the exercise or conversion of common share equivalents, if dilutive, as of the beginning of each period or, if later, their date of issuance and the conversion, as of the beginning of each period, of $1,000,000 principal amount of 14% Convertible Notes, if dilutive, into 440,000 shares of the Company's common stock. The weighted average number of common and dilutive common equivalent shares used in the calculation of fully diluted income per share totaled 4,666,000 in 1994 and 4,048,000 in each of 1993 and 1992. For purposes of the fully diluted income per share calculations, net income for 1994 and 1993 was reduced to reflect dividends on the Redeemable Preferred Stock and the amount by which payments made to effect the redemption of Redeemable Preferred Stock exceeded the par value of such shares. In addition, net income for 1994 was increased by $140,000, net of applicable income taxes, to reflect the pro forma elimination of interest expense on the 14% Convertible Notes. For 1993 and 1992, exercise or conversion of common stock equivalents and the conversion of the 14% Convertible Notes was not assumed because such exercise or conversion would have been antidilutive.\nNOTE 13 -- COMMITMENTS AND CONTINGENCIES\nLEASES\nThe Company is lessee under various leases relating to buildings and equipment. Total rent expense under operating leases aggregated $177,000, $89,000 and $85,000 for 1994, 1993 and 1992, respectively. As of December 31, 1994, future minimum lease commitments under non-cancelable operating leases were not significant for any year or in the aggregate.\nLEGAL ACTIONS\nThe Company is subject to various claims and legal proceedings covering a wide range of matters that arose in the ordinary course of its business activities. In addition, the Company has been named a potentially responsible party or a third-party defendant, along with other companies, for certain waste disposal sites.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nEach of these matters is subject to various uncertainties, and it is possible that some of these matters may be decided unfavorably to the Company. Management believes that any liability that may ultimately result from the resolution of these matters will not have a material adverse effect on the financial position of the Company.\nNOTE 14 -- RELATED PARTIES\nThe Chairman of the Board and the President of the Company are the two largest holders of the Company's common stock and are the holders of the 14% Notes.\nThe Chairman and the President of the Company are partners of an investment banking firm which was retained by the Company to provide management and investment banking services through December 31, 1994, for an annual fee of $400,000 and additional compensation related to the Company's operating performance and for specific transactions completed by the Company with the assistance of the firm. The Company also has agreed to reimburse the firm for certain expenses. During 1994, the Company paid the firm aggregate fees in the amount of $678,000 (including $328,000 which the company had accrued at December 31, 1993 relating to the restructuring of the Company's debt in January 1994) and reimbursed it for direct and indirect expenses incurred by the Chairman of the Board and the President in an amount totaling $135,000. During each of 1993 and 1992, the Company paid the firm aggregate fees of $300,000 and reimbursed it for indirect expenses of $50,000.\nThe Secretary of the Company, who is also a member of the Company's Board of Directors, is a stockholder of a professional corporation which is a partner in a law firm which serves as general counsel to the Company. During 1994, 1993 and 1992, the Company made payments to the law firm for legal services in the amounts of $364,000, $383,000 and $342,000, respectively. As of December 31, 1994 and 1993, outstanding accounts payable for legal services to the law firm totaled $36,000 and $67,000, respectively.\nA member of the Board of Directors of the Company is a member of the board of directors of an insurance brokerage firm which specializes in brokering commercial, life and accident insurance coverage and providing third party administration of health claims. After a competitive bidding process, the Company has from time to time secured large portions of its insurance coverage through this firm and purchased third party administrative services from this firm. During 1994, 1993 and 1992, the Company made cash payments to the brokerage firm for (1) insurance premiums, including commissions thereon, of $1,319,000, $1,518,000 and $1,794,000, respectively, and (2) administrative fees for services performed in connection with the administration of the Company's hospital and medical plans of $70,000, $76,000 and $85,000, respectively. As of December 31, 1994, and 1993, the Company did not have a balance due to or from the brokerage firm. As of December 31, 1992, the Company had a net refund due from the brokerage firm of approximately $65,000.\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 by Item 10 is incorporated by reference from the Company's proxy statement to be issued in connection with its 1995 Annual Meeting of Stockholders and to be filed with the Securities and Exchange Commission (the \"Commission\") not later than 120 days after December 31, 1994.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation required by Item 11 is incorporated by reference from the Company's proxy statement to be issued in connection with its 1995 Annual Meeting of Stockholders and to be filed with the Commission not later than 120 days after December 31, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by Item 12 is incorporated by reference from the Company's proxy statement to be issued in connection with its 1995 Annual Meeting of Stockholders and to be filed with the Commission not later than 120 days after December 31, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by Item 13 is incorporated by reference from the Company's proxy statement to be issued in connection with its 1995 Annual Meeting of Stockholders and to be filed with the Commission not later than 120 days after December 31, 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 consolidated financial statements of Lexington Precision Corporation are included in Part II, Item 8.\n2. FINANCIAL STATEMENT SCHEDULES\nSchedule II, Valuation and Qualifying Accounts and Reserves, is included in this Part IV, item 14, on page 49. All other schedules are omitted because the required information is not applicable, not material or included in the consolidated financial statements or notes thereto.\n3. EXHIBITS\n* Indicates a management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to item 14(a)(3).\n** Not deemed filed for purposes of section 11 of the Securities Act of 1933, Section 18 of the Securities Exchange Act of 1934 and Section 323 of the Trust Indenture Act of 1939, or otherwise subject to the liabilities of such sections and not deemed part of any regulation statement to which such exhibit relates.\nNote: Pursuant to section (b)(4)(iii) of item 601 of Regulation S-K, the Company agrees to furnish to the Securities and Exchange Commission upon request documents defining the rights of other holders of long-term debt.\n(b) Reports on Form 8-K:\nOn February 2, 1995, the Company filed with the Securities and Exchange Commission a Current Report on Form 8-K dated January 31, 1995 which stated, among other things, that the Company had amended its Working Capital Facility with its Working Capital Lender.\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.\nLEXINGTON PRECISION CORPORATION --------------------------------------- (Registrant)\nBy: \/s\/ Warren Delano ----------------------------------- Warren Delano, President\nMarch 29, 1995\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 indicated on March 29, 1995:\nPRINCIPAL EXECUTIVE OFFICERS:\n\/s\/ Michael A. Lubin ------------------------------------------------------- Michael A. Lubin, Chairman of the Board\n\/s\/ Warren Delano -------------------------------------------------------- Warren Delano, President and Director\nPRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:\n\/s\/ Dennis J. Welhouse ------------------------------------------------------ Dennis J. Welhouse, Senior Vice President and Chief Financial Officer\nDIRECTORS:\n\/s\/ William B. Conner ------------------------------------------------------ William B. Conner, Director\n\/s\/ Kenneth I. Greenstein ----------------------------------------------------- Kenneth I. Greenstein, Secretary and Director\n\/s\/ Arnold W. MacAlonan -------------------------------------------------- Arnold W. MacAlonan, Director\n\/s\/ Phillips E. Patton ---------------------------------------------------------- Phillips E. Patton, Director\nEXHIBIT INDEX\n-2-\n-3-\n-4-\n-5-\n-6-\n-7-","section_15":""}
{"filename":"808240_1994.txt","cik":"808240","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nAmerican Health Properties, Inc. (the \"Company,\" which term refers to the Company and its subsidiaries unless the context otherwise requires) is a self-administered real estate investment trust (\"REIT\") that commenced operations in 1987. The Company has investments in health care facilities, including 13 acute care hospitals, three rehabilitation hospitals and five psychiatric hospitals, all of which are operated by qualified third party health care providers, and a medical office building. As of December 31, 1994, the net book value of the Company's assets was $579.5 million. Of the Company's real estate assets at that date, 80% in net book value represented the acute care segment, 6% in net book value represented the rehabilitation segment, 13% in net book value represented the psychiatric segment and 1% in net book value represented the medical office building segment. As of December 31, 1994, 89% in net book value were held in fee and 11% in net book value were held as mortgages. The Company sold its psychiatric property in Torrance, California in October 1994 for $5.8 million and sold two of its psychiatric hospital investments in Massachusetts in February 1995 for $13.8 million.\nThe facilities are diversified geographically across 12 states, are distributed among large and small population centers, and are operated by 12 experienced management companies. These operators include, among others, American Medical International, Inc. (\"AMI\"), Columbia\/HCA Healthcare Corporation (\"Columbia\/HCA\"), Continental Medical Systems, Inc., HealthTrust, Inc. -- The Hospital Company (\"HealthTrust\"), NovaCare, Inc., Paracelsus Healthcare Corporation, Quorum Health Group, Inc. (\"Quorum\") and Dynamic Health, Inc. Facilities operated by AMI represented 50% of the Company's revenues for the year ended December 31, 1994. AMI has merged with National Medical Enterprises, Inc. (\"NME\") pursuant to which AMI has become a wholly-owned subsidiary of NME and NME has changed its name to Tenet Healthcare Corporation. Columbia\/HCA has entered into an agreement with HealthTrust pursuant to which HealthTrust is to become a wholly-owned subsidiary of Columbia\/HCA. The transaction is subject to certain conditions, including certain regulatory approvals. The Company's psychiatric hospitals are managed by independent, private local operators.\nApproximately 70% of the Company's property revenues for the year ended December 31, 1994 were secured by corporate guarantees. Also, as of December 31, 1994, letters of credit from commercial banks and cash deposits aggregating $17.9 million were available to the Company as security for lease and construction development obligations. Leases for nine of the Company's facilities, representing 72% of the Company's 1994 property revenues, contain cross-default provisions.\nThe nature of health care delivery in the United States is currently undergoing change and further review at both the national and state levels. Generally accepted goals of reform continue to include controlling costs and improving access to medical care. The Company's Board and management are monitoring potential changes closely. The Company believes that these potential changes may pose risks for certain institutions that are unwilling or unable to respond. However, the Company believes that this changing health care environment will provide the Company with new opportunities for investment in its current facilities as well as new facilities.\nThe Company recognizes that the health care industry in the United States is undergoing significant evolution. The ongoing changes in the health care industry include trends toward shorter lengths of hospital stay, increased outpatient services, downward pressure on reimbursement rates from government, insurance company and managed care payors and an increasing trend toward capitation of health care delivery costs (delivery of services on a fixed price basis to a defined group of covered parties). Outpatient business is expected to increase as advances in medical technologies allow more procedures to be performed on an outpatient basis. Payors continue to direct more patients from inpatient care to outpatient care. The portion of providers' patient services reimbursed under Medicare and Medicaid continues to increase as the population ages and states expand Medicaid programs. States and insurance companies continue to negotiate actively the amounts they will pay for services. In addition, the entrance of insurance companies into managed care\nprograms is accelerating the introduction of managed care in new localities. As a result, the revenues and margins may decrease at the Company's hospitals.\nNotwithstanding the potential for increasing government regulation, the Company believes that health care will continue to be delivered on a local basis and that well-managed, high-quality, cost-controlled facilities will continue to be an integral part of local health care delivery systems. The Company also believes that certain acute care hospitals will need to reconfigure or expand existing facilities or to affiliate themselves with other providers so as to become part of comprehensive and cost-effective health care systems. Such systems will likely include lower cost treatment settings, such as ambulatory care clinics, outpatient surgery centers, skilled nursing facilities and medical office buildings. In general, the Facilities are part of local health delivery systems or are in the process of becoming integrated into such systems.\nThe Company was organized in Delaware on December 17, 1986, and commenced operations in February 1987. The Company's principal executive offices are located at 6400 South Fiddler's Green Circle, Suite 1800, Englewood, Colorado 80111, and its telephone number is (303) 796-9793.\nTHE FACILITIES\nThe Company's 22 facilities consist of 12 acute care hospitals owned by the Company (the \"Acute Care Hospitals\"), three rehabilitation hospitals owned by the Company (the \"Rehabilitation Hospitals\"), an acute care hospital currently under construction in Austin, Texas to which the Company has made a participating mortgage loan (\"Austin Diagnostic Hospital\"), five psychiatric hospitals, three of which are owned by the Company and two to which the Company has made mortgage loans (the \"Psychiatric Hospitals\"), and one medical office building owned by the Company (together, the \"Facilities\").\nThe Acute Care Hospitals provide a wide range of services which may include fully-equipped operating and recovery rooms, obstetrics, radiology, intensive care, open-heart surgery and coronary care, neurosurgery, neonatal intensive care, magnetic resonance imaging, nursing units, oncology, clinical laboratories, respiratory therapy, physical therapy, nuclear medicine, rehabilitation services and outpatient services.\nThe Rehabilitation Hospitals provide acute rehabilitation care on a multi-disciplinary, physician-directed basis to severely disabled patients. In addition to general medical rehabilitation programs, the Rehabilitation Hospitals offer a number of specialty programs, including pulmonary, ventilator, neurobehavioral, brain injury and pain programs. Each of the Rehabilitation Hospitals is operated pursuant to a joint venture between a publicly-held, national rehabilitation hospital operator and a local health care provider.\nThe Company is funding a $30 million participation in an $86 million participating mortgage loan to Austin Diagnostic Hospital, a 158-bed acute care hospital and medical office building currently under construction in Austin, Texas. Austin Diagnostic Hospital is owned by a joint venture comprised of HealthTrust and The Austin Diagnostic Clinic Association (\"ADC\"), the largest primary care and multi-specialty physician group practice in the Austin area. HealthTrust will manage the facility upon completion of construction, which is scheduled for the second quarter of 1995.\nThe Psychiatric Hospitals provide a wide range of inpatient and outpatient care for children, adolescents and adults, including specialized care relating to eating disorders, substance abuse and psychiatric illness. Fundamental changes in the psychiatric industry in recent years have reduced the facility-specific operating cash flow at the Psychiatric Hospitals. These changes have had and could continue to have an adverse effect on the results of operations of the Psychiatric Hospital operators and borrowers. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Operating Results -- Future Operating Results.\"\nThe Company owns a 60,000 square-foot medical office building located in Murrieta, California known as Walsh Medical Arts Center. The medical office building is located across the street from Sharp Healthcare Murrieta, a developing medical campus that includes 49 acute care beds and 42 skilled nursing beds operated by Sharp Healthcare System of San Diego.\nThe following is a listing of the Facilities as of March 1, 1995. Unless otherwise indicated, all Facilities listed are owned by the Company:\nTHE FACILITIES\n- --------------- (1) Reflects gross investments less write-downs, except Austin Diagnostic Medical Center, which reflects the Company's total investment commitment.\n(2) Reflects contract rate of annual base rent or interest.\n(3) Each lease and mortgage provides the lessee or borrower with renewal options to extend the term of the lease or mortgage beyond the primary term.\n(4) Quorum is the operator and Desert Valley Hospital, Inc. is the lessee.\n(5) AMI has merged with NME pursuant to which AMI has become a wholly-owned subsidiary of NME and NME has changed its name to Tenet Healthcare Corporation.\n(6) The Company's investment in Halstead Hospital was consummated on June 30, 1993 by the acquisition of ten year industrial revenue bonds secured by the hospital, which the Company expects to exchange for ownership of the hospital at the end of the ten year term.\n(7) Columbia\/HCA has entered into an agreement with HealthTrust pursuant to which HealthTrust is to become a wholly-owned subsidiary of Columbia\/HCA. The transaction is subject to certain conditions, including certain regulatory approvals.\n(8) Such Rehabilitation Hospital is leased by a joint venture comprised of the operator and other health care providers.\n(9) Investment held in the form of a mortgage rather than owned by the Company.\n(10) Base interest for the first two years is 9.75%. The interest rate in years three through ten will be 10.25%. The interest rate will reset in years 11 and 21 to the greater of the then current loan rate or 450 basis points over the then current ten year Treasury rate. Beginning in year three, monthly principal payments are required based on a thirty year amortization.\n(11) Based on scheduled completion date of facility.\nSee the Notes to the Consolidated Financial Statements and Schedule III -- Real Estate and Accumulated Depreciation included in this Annual Report on Form 10-K for additional information regarding the Leased Properties (as defined below) and the mortgage loans and for the carrying value and accumulated depreciation of the Leased Properties.\nLEASES AND MORTGAGE LOANS\nThe Company owns the 12 Acute Care Hospitals, the three Rehabilitation Hospitals, three of the Psychiatric Hospitals and one medical office building, which are collectively referred to herein as the \"Leased Properties\" or individually as a \"Leased Property.\"\nLeases.\nGeneral. The leases for the Leased Properties provide for base rental rates which generally range from 8.9% to 13.4% per annum of the acquisition price less write-downs of the related Leased Property. Rental rates vary by lease, taking into consideration many factors, including, but not limited to, credit of the lessee, operating performance of the Leased Property, interest rates, and location, type and physical condition of the\nLeased Property. The leases provide for additional rents which are based upon a percentage of increased revenues over specific base period revenues of the related Leased Properties.\nThe obligations under the leases are generally guaranteed by the parent corporation of the lessee, if the lessee is a subsidiary, or has some other form of credit enhancement such as a letter of credit or a security deposit. Certain of the Company's leases are with subsidiaries of the operator's described above and are non-recourse to such operators. Approximately 70% of the Company's property revenues for the year ended December 31, 1994 were secured by corporate guarantees. Also, as of December 31, 1994, letters of credit from commercial banks and cash deposits aggregating $17.9 million were available to the Company as security for lease and construction development obligations.\nThe leases are on a triple \"net\" basis, and the lessee is responsible thereunder, in addition to the base and additional rents, for all additional charges, including every fine, penalty, interest and cost which may be levied for non-payment or late payment thereof, all taxes, assessments, levies, fees, water and sewer rents and charges, all governmental charges with respect to the Leased Property and all utility and other charges incurred with the operation of the Leased Property. Each lessee is required, at its expense, to maintain the Leased Property in good order and repair. The Company is not required to repair, rebuild or maintain the Leased Properties.\nAcute Care Hospitals. The Acute Care Hospital leases provide for a fixed term of from ten to 17 years and one or more renewal options of from five to ten years each. In addition to monthly base rent, all of the Acute Care Hospital leases provide for the quarterly payment of additional rent in an amount equal to (i) a specified percentage of the amount by which the Gross Revenues (as defined) attributable to the Leased Property for the year exceed the Gross Revenues derived from such Leased Property during a specified base year (\"Excess Gross Revenues\") up to a designated dollar amount (the \"Transition Amount\"). Should the Transition Amount be reached in any year, additional rent shall be equal to a reduced percentage of the Excess Gross Revenues for the remainder of such year.\nPursuant to the terms of the Acute Care Hospital leases, the Company has the right to approve capital expenditures (only in excess of $2 million for certain leases), the option to fund certain capital expenditures under some of the leases and, in certain situations, is obligated to fund approved capital expenditures on terms comparable to the original investment. The base and additional rental provisions of leases are amended when such capital expenditures are funded to reflect the Company's increased investment.\nSix of the Acute Care Hospitals are operated by subsidiaries of AMI under long-term leases with the Company, which comprised 50% of the Company's 1994 total revenues. AMI has guaranteed certain obligations of its subsidiaries under such leases and each such lease is cross-defaulted with the other AMI leases. Five of the AMI leases grant to AMI the option, exercisable on not less than six months' nor more than 24 months' notice, to purchase the Leased Property upon the expiration of any term of the lease at the Fair Market Value of the Leased Property at the expiration of said term. The expiration of the initial terms of such leases are shown in the table above. For purposes of the second preceding sentence, \"Fair Market Value\" means the price that a willing buyer not compelled to buy would pay to a willing seller not compelled to sell for such property at the applicable expiration less the portion of such price attributable to capital additions paid for by AMI. The determination of such price will take into account (i) that the applicable lease is assumed not to be in effect on the Leased Property and (ii) that the seller of such Leased Property must pay for title insurance and closing costs.\nThe leases of five other Acute Care Hospitals generally provide the lessee with an option to purchase the property at the end of the term of the lease at the greater of fair market value or Total Investment Cost (as defined). Two of the leases provide the lessee with a purchase option during the term of the lease at a predetermined purchase price designed to provide the Company a favorable total return on its investment. Two of the leases provide the lessee with a purchase option during the term of the lease at the greater of fair market value or Total Investment Cost (as defined).\nTwo of the Acute Care Hospitals are operated by subsidiaries of Paracelsus under long-term leases with the Company, which comprised 8% of the Company's 1994 total revenues. The leases for the two Acute Care Hospitals operated by Paracelsus contain reciprocal cross-default provisions.\nRehabilitation Hospitals. The Rehabilitation Hospital leases provide for an initial term of ten years and three renewal periods of five years each, except in the case of the Mountain View Regional Rehabilitation Hospital lease, which provides for two renewal periods of ten years each and a third renewal period of up to fifteen years. In addition to monthly base rent, the Rehabilitation Hospital leases provide for the quarterly payment of additional rent in an amount equal to a specified percentage of Excess Gross Revenues. The Rehabilitation Hospital leases each grant to the operator the option to purchase the Rehabilitation Hospital upon expiration of any term of the lease at the greater of the Fair Market Value of or the Company's cost basis in the Rehabilitation Hospital at the expiration of said term. One of the Rehabilitation Hospital leases grants an interim purchase option exercisable at the end of the fifth year of the lease at a purchase price equal to the greater of the fair market value of the facility based on the income approach or the Company's costs basis in the facility.\nPsychiatric Hospitals. The leases for two of the owned Psychiatric Hospitals provide for an initial term expiring in 2000 with three renewal periods for ten years each. The lease for the third owned Psychiatric Hospital has an initial term expiring in 1997 with one renewal period for five years and two renewal periods for ten years each. In addition to monthly base rent, the leases provide for the quarterly payment of additional rent in an amount equal to a specified percentage of Excess Gross Revenues.\nMedical Office Building. The medical office building is master-leased for a nine-year remaining term to a partnership consisting of 22 physicians who are the primary tenants of the building.\nMortgage Loans.\nAs of December 31, 1994, the Company had funded $21.4 million of its $30 million participation in an $86 million participating mortgage loan for the development of the 158-bed Austin Diagnostic Hospital. The mortgage loan is secured by the hospital and related land and improvements. In addition, an $8.6 million bank letter of credit will be provided to secure the obligations under the mortgage upon issuance of a certificate of occupancy and will be limited to 10% of the final amount of the mortgage loan. HealthTrust and ADC have each guaranteed 50% of the obligations under the mortgage.\nThe Company has made mortgage loans to two of the Psychiatric Hospitals. The two mortgage loans are secured by first mortgages and security interests in the two separate Psychiatric Hospitals. The two mortgage loans have an initial term of ten years with two optional ten-year extension terms. Pursuant to the terms of the mortgage loans, the Company may receive additional interest each year in an amount equal to a specified percentage of Excess Gross Revenues. See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Operating Results -- Future Operating Results\" and Notes to the Consolidated Financial Statements.\nCOMPETITION\nThe Company competes with health care providers, real estate partnerships, other real estate investment trusts and other investors, including insurance companies and banks, generally in the acquisition, leasing and financing of health care facilities.\nManagement of the Company believes that the Facilities in which it has invested are providers of high quality health care services in their respective markets. The operators of the Facilities compete on a local and regional basis with other operators of comparable facilities. They compete with independent operators as well as managers of multiple facilities, some of which are substantially larger and have greater resources than the operators of the Facilities. Some of these competing facilities are operated for profit while others are owned by governmental agencies or tax-exempt, not-for-profit organizations. The Company believes that the Facilities compete favorably with other hospitals based upon many factors, including the services and specialties offered, quality of management, ease of access, reputation and the ability to attract competent physicians and maintain strong physician relationships.\nENVIRONMENTAL MATTERS\nUnder various federal, state and local laws and regulations, an owner of real estate is liable for the costs of removal or remediation of certain hazardous or toxic substances on such property. Such laws often impose such liability without regard to whether the owner knew of, or was responsible for, the presence of such hazardous or toxic substances. The costs of remediation or removal of such substances may be substantial, and the presence of such substances, or the failure to promptly remediate such substances, may adversely affect the owner's ability to sell such real estate or to borrow using such real estate as collateral. In connection with its ownership and operation of the Facilities, the Company may be potentially liable for such costs.\nAll of the Facilities have been subject to Phase I environmental assessments, which are intended to discover information regarding, and to evaluate the environmental condition of, the surveyed properties and surrounding properties. The Phase I assessments included a historical review, a public records review, a preliminary investigation of the site and surrounding properties, screening for the presence of asbestos, polychlorinated biphenyls and underground storage tanks and the preparation and issuance of a written report, but do not include soil sampling or subsurface investigations. In each case where Phase I assessments resulted in specific recommendations for remedial actions, the Company's management has taken the recommended action.\nThe Phase I assessments have not revealed any environmental liability that the Company believes would have a material adverse effect on the Company's business, assets or results of operations, nor is the Company aware of any such liability. Nevertheless, it is possible that these assessments do not reveal all environmental liabilities or that there are material environmental liabilities of which the Company is unaware. Moreover, no assurances can be given that (i) future laws, ordinances or regulations will not impose any material environmental liability or (ii) the current environmental condition of the Facilities will not be affected by tenants and occupants of the Facilities, by the condition of properties in the vicinity of the Facilities (such as the presence of underground storage tanks) or by third parties unrelated to the Company.\nThe Company believes that the Facilities are in compliance in all material respects with all federal, state and local ordinances and regulations regarding hazardous or toxic substances. The Company has not been notified by any governmental authority, or is otherwise aware, of any material noncompliance, liability or claim relating to hazardous or toxic substances in connection with any of its present or former properties.\nGOVERNMENT REGULATION AND PAYOR ARRANGEMENTS\nEach of the Facilities is a health care related facility and the amount of additional rent or additional interest, if any, which is based on the lessee's or mortgagee's gross revenue, is in most cases subject to changes in the reimbursement and licensing policies of federal, state and local governments. In addition, the acquisition of health care facilities is generally subject to state and local regulatory approval.\nAcute Care Hospitals. Acute care hospitals are subject to extensive federal, state and local legislation and regulation. Acute care hospitals undergo periodic inspections regarding standards of medical care, equipment and hygiene as a condition of licensure. Various licenses and permits also are required for narcotics, laboratories, pharmacies, radioactive materials and certain equipment. Each facility eligible for accreditation is accredited by the Joint Commission on Accreditation of Health Care Organizations. Accreditation is required for participation in government-sponsored provider programs, such as Medicare and Medicaid.\nAcute care hospitals are subject to and comply with various forms of utilization review. In addition, under the Medicare program, each state must have a Professional Review Organization to carry out a federally-mandated system of review of Medicare patient admission, treatment and discharge. Medical and surgical services and practices are extensively supervised by committees of staff doctors at each acute care hospital, and are reviewed by each acute care hospital's local governing board and quality-assurance personnel. New regulations governing the control of disposal of hazardous wastes may increase the costs of operating acute care facilities.\nThe lessees and mortgagees of the Facilities, which provide acute care hospital services, receive payments for patient care from federal Medicare programs for elderly and disabled patients, Medicaid and other state\nprograms for medically indigent patients, private insurance carriers, employers, Blue Cross plans, health maintenance organizations, preferred provider organizations and directly from patients.\nMedicare payments for most inpatient hospital services provided by acute care general hospitals are made under a \"prospective payment system\" (\"PPS\") under which a hospital is paid a prospectively determined rate per discharge. The PPS payment rate includes reimbursement for capital related costs. These rates vary according to a patient classification system that is based on clinical, diagnostic and other factors. Acute care hospitals are reimbursed for cost reimbursable items at a tentative rate with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. In general, payments made by Medicare are less than established charges for such services. Additionally, Medicare payments may be delayed due to Federal government regulations.\nMedicaid payments for acute care hospitals will vary between states. These payments may be based on a percentage of reasonable cost, a fixed rate per discharge, a capitated payment, or other payment arrangements. If a state selects a cost based reimbursement methodology, acute care hospitals are reimbursed at a tentative rate with final settlement determined after submission of annual cost reports and audits thereof by Medicaid. In general, payments made by Medicaid are less than established charges for such services. Additionally, Medicaid payments may be delayed due to State budget deficits.\nBlue Cross payments in different states and areas are based on cost, a per diem, or other negotiated rates and may also be subject to payment delay. Payments from health maintenance organizations and preferred provider organizations generally are negotiated, either at a discount from charges or on a per capita, shared-risk basis with stop-loss provisions for high severity cases. In more developed markets such as California and Florida, the Company's hospitals are now entering into risk sharing, or capitated, arrangements. These arrangements reimburse the hospital based on a fixed fee per participant in a managed care plan with the hospital assuming the costs of services provided, regardless of the level of utilization. If utilization is higher than anticipated and\/or costs are not effectively controlled, such arrangements could produce low or negative operating margins.\nRehabilitation Hospitals. Rehabilitation hospitals are also subject to extensive federal, state and local legislation and regulation. Rehabilitation hospitals are subject to periodic inspections and licensure requirements. Outpatient rehabilitation services and free-standing inpatient rehabilitation facilities are generally reimbursed under the same payment arrangement as acute care hospitals, except as noted below. Medicare payments for inpatient rehabilitative services are made based on reasonable operating cost, subject to a per discharge limitation. If a facility operates below the cost per discharge limitation, it will qualify for a bonus payment. If a facility operates above the cost per discharge limitation, it will be reimbursed solely to the extent of the limitation. Defined capital costs and outpatient services related to Medicare beneficiaries are reimbursed based on reasonable cost. All Medicare inpatient and outpatient services are reimbursed at a tentative rate with final settlement determined after submission of annual cost reports and audits thereof by the Medicare fiscal intermediary. In general, payments made by Medicare are less than established charges for such services. Additionally, Medicare payments may be delayed due to Federal government regulations.\nPsychiatric Hospitals. In addition to the licensing, certificate of need and Medicare\/Medicaid rules and regulations, there are a number of specific federal and state laws affecting psychiatric hospitals, such as the regulation of civil commitments of patients, admitting procedures, and disclosure of information regarding patients being treated for chemical dependency. Many states have adopted a \"patient's bill of rights\" which sets forth standards governing the treatment of patients of psychiatric hospitals, such as using the least restrictive treatment method, allowing patient access to telephone and mail, allowing a patient to see a lawyer, and requiring the patient to be treated with dignity. The lessees and mortgagees of the Psychiatric Hospitals receive payments for patient care from federal Medicare programs for elderly and disabled patients, Medicaid and other state programs for medically indigent patients, private insurance carriers, employers, Blue Cross plans, health maintenance organizations, preferred provider organizations and directly from patients.\nRECENT EVENTS\nOn January 31, 1995, the Company's Board of Directors authorized management to pursue a transaction which is designed to separate the economic attributes of its investments in psychiatric hospitals (the \"Psychiatric Group\") and its core investments in acute care hospitals, rehabilitation hospitals and a medical office building (the \"Core Group\") into two distinct portfolios, with two distinct classes of publicly traded shares intended to represent those portfolios. The transaction would entail the distribution to holders of Common Stock of depositary shares representing a new series of preferred stock, par value $0.01 per share, to be designated Psychiatric Group Preferred Stock (the \"Psychiatric Group Stock\"). The Psychiatric Group Stock would be intended to reflect the separate performance of the Psychiatric Group. The Company's existing Common Stock would be intended to reflect the separate performance of the Core Group. In connection with the proposed transaction, the Company would specifically identify or allocate its assets, liabilities and stockholders' equity, and its revenues, expenses and cash flow items, between the Core Group and Psychiatric Group. However, each holder of Common Stock or Psychiatric Group Stock would be a holder of an issue of capital stock of the entire Company and would be subject to the risks associated with an investment in the Company and all of its businesses, assets and liabilities. A registration statement relating to the proposed distribution was filed with the Securities and Exchange Commission on February 28, 1995.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company are as follows:\nWALTER J. MCNERNEY -- Chairman of the Board since February 1988 and Chief Executive Officer of the Company from February 1988 to May 15, 1992 and from January 15, 1993 to February 11, 1993. He is also Herman Smith Professor of Health Policy, J.L. Kellogg Graduate School of Management, Northwestern University since 1982 and was managing partner of Walter J. McNerney and Associates, a management consulting firm in the health field during 1982-1992. He is a director of The Stanley Works, Nellcor Incorporated, Value Health, Inc., Medicus Systems, Inc., Hanger Orthopedic, Inc., Osteotech, Inc. and Ventritex, Inc. Mr. McNerney was elected a director of the Company in January 1987.\nJOSEPH P. SULLIVAN -- Mr. Sullivan was elected President and Chief Executive Officer of the Company and a member of the Board of Directors effective February 11, 1993. Prior to that, Mr. Sullivan spent 20 years with Goldman, Sachs & Co. where he had overall investment banking responsibility for numerous companies in the health care field.\nVICTOR C. STREUFERT -- Executive Vice President and Chief Financial Officer of the Company since April 1989. Mr. Streufert was Vice President Finance and Administration for Kendall Canada, a subsidiary of the Kendall Company, a manufacturer and distributor of medical products, from 1987 to March 1989.\nGEOFFREY D. LEWIS -- Senior Vice President, General Counsel and Secretary of the Company since August 1991. Mr. Lewis was an attorney with Jones, Day, Reavis & Pogue from 1986 to August 1991.\nC. GREGORY SCHONERT -- Senior Vice President-Business Development of the Company since April 1988. Prior to that Mr. Schonert was Assistant Administrator of Marketing and Planning at St. Joseph's Hospital, Houston, Texas from February 1987. From September 1985 until February 1987, Mr. Schonert was a Manager in the Corporate Development Department of American Medical International, Inc.\nMICHAEL J. MCGEE -- Vice President, Controller and Assistant Secretary of the Company since November 1989. Mr. McGee was a certified public accountant with Arthur Andersen & Co. from 1977 to November 1989.\nEach executive officer is elected by the Board of Directors at its first meeting after each annual meeting of the shareholders and serves until such time as his successor is elected.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nSee \"Item 1. Business\" for a description of properties owned by the Company and subject to mortgages held by the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is not currently involved in any material litigation nor, to the Company's knowledge, is any litigation currently threatened against the Company or its properties, other than routine litigation arising in the ordinary course of business.\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 STOCKHOLDER MATTERS.\nThe Common Stock of American Health Properties, Inc. is listed on the New York Stock Exchange under the trading symbol AHE. The table below lists the reported high and low sales price of the Company's Common Stock on the New York Stock Exchange for the last two fiscal years and the cash dividends declared per share with respect to such periods.\nAs of March 1, 1995, the reported high and low sales prices of the Company's Common Stock for 1995 were $22 1\/8 and $19 3\/8. As of March 1, 1995, there were approximately 4,566 holders of record of the Company's Common Stock and 20,865,539 shares outstanding.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSet forth below is selected consolidated financial data with respect to the Company for the years ended December 31, 1994, 1993, 1992, 1991 and 1990.\n- ---------------\n(1) Includes gains of $19,742,000 and $11,064,000 in 1993 and 1992, respectively, on the sale of properties or partnership interests therein. Also reflects write-downs of $30,000,000 in 1994 and $45,000,000 in 1992 relating to investments in psychiatric hospitals.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nOPERATING RESULTS\n1994 Compared to 1993\nIn 1994, the Company reported net income of $9,693,000, or $.46 per share compared with net income of $50,987,000, or $2.71 per share in 1993.\nSeveral significant items impacted net income in both 1994 and 1993. Net income in 1994 reflected a write-down of psychiatric hospital investments of $30,000,000, or $1.44 per share, as a result of accelerating negative trends in the psychiatric industry. In 1994, $1,450,000, or $.07 per share, was accrued for the cost of the planned issuance of Psychiatric Group Stock (see Item 1. Business -- Recent Events). Net income in 1993 included a gain of $19,742,000, or $1.05 per share, on the sale of an acute care property in March 1993. Litigation costs were $2,234,000, or $.12 per share, in 1993 as a result of the defense and settlement of a shareholder class action lawsuit against the Company.\nRental income was $67,732,000 in 1994, an increase of $3,177,000 or 5% from $64,555,000 in 1993. This net increase is primarily attributable to rental income from new properties acquired and various capital additions subsequent to the first quarter of 1993 partially offset by a reduction in rental income due to the previously mentioned property sale in March 1993.\nAdditional rental and interest income was $9,506,000 in 1994, an increase of $172,000 or 2% from $9,334,000 in 1993. This increase is attributable to increased additional rent from six of the Company's original acute care properties and more recently purchased properties generating additional rent for the first time in 1994. This increase is net of the loss of additional rent due to the previously mentioned property sale.\nOther interest income increased $2,055,000 to $4,002,000 in 1994 from $1,947,000 in 1993. This increase resulted from higher average balances of construction loans, other notes receivable and direct financing leases in 1994 compared with 1993. In addition, 1994 included the recognition of $710,000 of fee income related to the prepayment of a construction loan in February 1994.\nInterest expense was $26,101,000 in 1994, a decrease of $1,168,000 or 4% from $27,269,000 in 1993. An equity offering in July 1993 resulted in lower average short-term borrowings during 1994 compared with 1993.\nA higher level of construction in progress during 1994 compared with 1993 resulted in an increase in capitalized interest. In addition, the Company prepaid mortgage notes payable of $14.4 million in February 1994.\nGeneral and administrative expenses decreased to $5,376,000 in 1994 from $6,437,000 in 1993. The decrease for 1994 was attributable to the reversal of $750,000 of a corporate relocation accrual recorded in the fourth quarter of 1993, after the Company decided to maintain its headquarters in Denver, Colorado. This was partially offset by higher expense from the Company's stock incentive plans and increased shareholder reporting and distribution costs in 1994.\n1993 Compared to 1992\nIn 1993, the Company reported net income of $50,987,000, or $2.71 per share, compared with a net loss of ($6,317,000), or ($.37) per share, in 1992.\nNet income in 1993 and net loss in 1992 were impacted by several significant items. Net income in 1993 included a gain of $19,742,000, or $1.05 per share, on the sale of an acute care property in March 1993, while the net loss in 1992 included total gains of $11,064,000, or $.64 per share, on the sale of the Company's partnership interests in four rehabilitation properties. Litigation costs were $2,234,000, or $.12 per share, in 1993 as a result of the defense and settlement of a shareholder class action lawsuit against the Company. Litigation costs related to this lawsuit in 1992 were $786,000, or $.05 per share. Net loss in 1992 reflected a write-down of $45,000,000, or $2.61 per share, related to the restructuring of two psychiatric mortgage notes receivable and a cost of $2,225,000, or $.13 per share, as a result of the Company exercising its right to terminate a purchase commitment to enhance its liquidity position.\nRental income was $64,555,000 in 1993, a decrease of $1,206,000 or 2% from $65,761,000 in 1992. This decrease is attributable to a reduction in rental income due to the sale of the Company's 97% partnership interests in three rehabilitation properties in October 1992 and the sale of an acute care property in March 1993, partially offset by rental income from a newly acquired property and various capital additions coming under lease subsequent to the first quarter of 1992. Additionally, 1993 includes rental income from a psychiatric property conveyed to the Company in late 1992 in satisfaction of a mortgage note receivable. The conveyance of this property together with the modification and restructuring of another mortgage note receivable in 1992 resulted in a decrease in mortgage interest income of $1,457,000 in 1993 compared with 1992.\nAdditional rental and interest income was $9,334,000 in 1993, an increase of $805,000 or 9% from $8,529,000 in 1992. This increase is attributable to increased additional rent from six of the Company's original acute care properties and more recently purchased properties generating additional rent for the first time in 1993. This increase is net of the loss of additional rent from properties sold in 1992 and 1993.\nDepreciation and amortization increased $1,265,000 to $14,087,000 in 1993 compared with 1992 primarily as a result of the Company's revision of the estimated remaining lives of its psychiatric real estate properties from an average of 38 years to 21 years effective as of January 1, 1993.\nInterest expense was $27,269,000 in 1993, a decrease of $2,508,000 or 8% from $29,777,000 in 1992. Property sales in the last quarter of 1992 and first quarter of 1993, and an equity offering in July 1993, resulted in lower average short-term borrowings in 1993. Lower short-term interest rates in 1993 contributed to the decrease in interest expense in 1993.\nGeneral and administrative expenses decreased to $6,437,000 in 1993 from $8,221,000 in 1992. In the fourth quarter of 1993, the Company recorded an accrual of $850,000 related to the planned relocation of its corporate offices to Southern California in the middle of 1994. General and administrative expenses in 1992 include severance costs of $1.5 million related to personnel changes announced during 1992. Additionally, in 1992 the negotiation and restructuring of two psychiatric mortgage notes receivable, the review of a potential business combination and other matters resulting from a legal action against the Company, resulted in increases in consulting, professional and travel costs totaling $1.3 million.\nMinority interest decreased $378,000 to $251,000 in 1993 compared with 1992 as a result of the Company's sale of three real estate partnerships in October 1992.\nFuture Operating Results\nThe nature of health care delivery in the United States is currently undergoing change and further review at both the national and state levels. Generally accepted goals of reform continue to include controlling costs and improving access to medical care. The Company's Board and management are monitoring potential changes closely. The Company believes that these potential changes may pose risks for certain institutions that are unwilling or unable to respond. However, the Company believes that this changing health care environment will provide the Company with new opportunities for investment in its current facilities as well as new facilities.\nThe Company recognizes that the health care industry in the United States is undergoing significant evolution. The ongoing changes in the health care industry include trends toward shorter lengths of hospital stay, increased outpatient services, downward pressure on reimbursement rates from government, insurance company and managed care payors and an increasing trend toward capitation of health care delivery costs (delivery of services on a fixed price basis to a defined group of covered parties). Outpatient business is expected to increase as advances in medical technologies allow more procedures to be performed on an outpatient basis. Payors continue to direct more patients from inpatient care to outpatient care. The portion of providers' patient services reimbursed under Medicare and Medicaid continues to increase as the population ages and states expand Medicaid programs. States and insurance companies continue to negotiate actively the amounts they will pay for services. In addition, the entrance of insurance companies into managed care programs is accelerating the introduction of managed care in new localities. As a result, the revenues and margins may decrease at the Company's hospitals.\nNotwithstanding the potential for increasing government regulation, the Company believes that health care will continue to be delivered on a local basis and that well-managed, high-quality, cost-controlled facilities will continue to be an integral part of local health care delivery systems. The Company also believes that certain acute care hospitals will need to reconfigure or expand existing facilities or to affiliate themselves with other providers so as to become part of comprehensive and cost-effective health care systems. Such systems will likely include lower cost treatment settings, such as ambulatory care clinics, outpatient surgery centers, skilled nursing facilities and medical office buildings. In general, the Facilities are part of local health care delivery systems or are in the process of becoming integrated into such systems.\nThe Company's future operating results could be affected by the operating performance of the Company's lessees and borrowers. The rental and interest obligations of its facility operators are primarily supported by the facility-specific operating cash flow. Real estate investments in the Company's portfolio are further supported by one or more credit enhancements that take the form of cross-default provisions, letters of credit, corporate and personal guarantees, security interests in cash reserve funds, accounts receivable or other personal property and requirements to maintain specified financial ratios.\nFundamental changes in the psychiatric industry continue to negatively impact the facility-specific operating cash flow at the Company's psychiatric hospitals. Institutions responsible for providing insurance coverage to patients who use inpatient psychiatric treatment services have directed efforts toward decreasing their payments for such services, thereby reducing hospital operating revenues. Some cost-cutting measures used by such institutions include decreasing the inpatient length of stay, intensively reviewing utilization, directing patients from inpatient care to outpatient care and negotiating reduced reimbursement rates for services. In addition, such institutions have extended the length of time for making payments, resulting in increases in accounts receivable. The wider use of psychotropic drugs has also resulted in significant declines in the average length of stay. Although the operators of the psychiatric hospitals are responding by developing lower cost outpatient and daypatient programs, increasing case management and reducing operating costs, their efforts are generally not consistently mitigating the negative impact of these fundamental psychiatric industry changes. For example, as the inpatient length of stay has decreased, offset by an increased number of admissions in some cases, the costs of performing initial testing and other administrative procedures associated\nwith each admission have increased. As a result, certain of the psychiatric hospital operators have had difficulty meeting their payment obligations to the Company on a timely basis and there can be no assurance that they will be able to meet their payment obligations in the future.\nThe Company is currently providing working capital loans to the operators of four of its psychiatric hospitals. As of March 6, 1995, outstanding working capital loans totalled $5,100,000, and the Company has committed to make an additional $1,200,000 of such working capital loans upon request, subject to certain conditions. These working capital loans, which are secured by accounts receivable and certain personal property and which contain events of default that would be triggered by defaults under the lease or mortgage loan relating to the relevant psychiatric hospital, are the primary source of financing for these operators' operating and capital needs. These psychiatric hospitals have, from time to time, been unable to generate sufficient cash flow for working capital and the development of new programs. In certain cases, these psychiatric hospitals have not been able to pay down the working capital loans provided by the Company or to secure replacement loans from third-party lenders. To the extent the psychiatric hospitals have increased working capital needs in the future, the Company may be the only source of such financing.\nIn 1992, the Company recorded a $45,000,000 write-down of its investments in two psychiatric hospitals and restructured the payment obligations of these two facilities. In addition, at June 30, 1994, in view of negative trends that caused declining cash flow at a number of the psychiatric hospitals, the Company recorded a $30,000,000 write-down of its investments in the psychiatric hospitals. Although management believes that the recorded investments in the psychiatric hospitals are realizable, if the cash flow at the psychiatric hospitals continues to decline, the Company may be required to further restructure payment obligations or make additional write-downs of the value of its investments in the psychiatric hospitals. The Company is pursuing alternatives for the psychiatric portfolio including selected sales of hospitals to operators or other parties, restructuring of financial obligations or other approaches that might allow the effective separation of these assets from the Company's core portfolio of acute care and rehabilitation hospitals and a medical office building. As part of this initiative, the Company sold its psychiatric property in Torrance, California in October 1994 for $5,772,000 in cash (at net book value), sold two of its psychiatric properties in Massachusetts in February 1995 for $13,825,000 in cash (at net book value), restructured the leases and working capital loans of two Florida psychiatric investments in March 1995 and is issuing the Psychiatric Group Stock.\nAdditional rental income and interest income from the Company's existing investments will be affected by changes in the revenues of the underlying business operations upon which such income is based. The Company's acute care investments accounted for 85% of net additional rental and interest income for the year ended December 31, 1994, while rehabilitation and psychiatric investments accounted for 9% and 6%, respectively. Over the years, a substantial portion of the Company's additional rental and interest income has been attributable to six of the Company's original acute care properties (the \"Original Properties\"). Also, with the significant revenue growth at a majority of the Original Properties in recent years, two properties had reached the additional rent transition point at the end of 1994 and it is anticipated that other properties may do so over the next few years. The Company's revenue participation rate for the six Original Properties declines from 5% to 1% when the additional rent transition point is reached. At December 31, 1994, the amount of potential additional rent at the 5% revenue participation rate for the six Original Properties was approximately $2.8 million per annum. As a result, the Company anticipates slower growth in additional rental and interest income in the near term from its current portfolio of properties.\nFuture operating results of the Company will be affected by additional factors including the amount, timing and yield of additional real estate investments and the competition for such investments. Operating results will also be affected by the availability and terms of the Company's future equity and debt financing. The Company's financing strategy includes the objective to reduce its cost of capital over time and enhance its financial flexibility to facilitate future growth. Toward achievement of this objective, the Company raised $80.8 million of new equity in 1993. The proposed distribution of depositary shares representing Psychiatric Group Stock is also intended to facilitate this objective.\nThe Company's unsecured revolving credit facility was increased to $100 million in April 1994. In August 1994, the Company's BBB- implied senior debt rating was affirmed by Standard & Poor's but the outlook was revised to negative from stable. Duff & Phelps Credit Rating Co. assigned an initial implied senior debt rating of BBB- in November 1994.\nLIQUIDITY AND CAPITAL RESOURCES\nAs of March 6, 1995, the Company had commitments of $10,300,000 to fund construction obligations and capital expenditures over approximately the next twelve months. Aggregate unfunded commitments under revolving credit agreements provided to facility operators totalled $1,200,000 as of March 6, 1995.\nThe Company has continued to increase its liquidity and enhance its financial flexibility. In July 1993, the Company completed an offering of 3,450,000 additional shares of Common Stock resulting in net proceeds of $80.8 million. Proceeds from the offering were used to pay off the outstanding balance under the Company's revolving credit facility and fund additional real estate investments. In April 1994, the Company increased its unsecured revolving credit facility to $100 million. The facility bears interest at either LIBOR plus a margin of 125 to 200 basis points or the prime rate plus, in certain circumstances, a margin of 50 basis points, and matures on December 31, 1996. Currently, the Company is able to borrow at either LIBOR plus 125 basis points or the prime rate. As of March 6, 1995, the Company had no outstanding borrowings under its credit facility. The Company currently believes it has sufficient capital to meet its commitments and that its cash flow and liquidity will continue to be sufficient to fund current operations and to provide for the payment of dividends to stockholders in compliance with the applicable sections of the Internal Revenue Code governing real estate investment trusts.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe Company's consolidated balance sheets as of December 31, 1994 and 1993 and its consolidated statements of operations, stockholders' equity and cash flows for the years ended December 31, 1994, 1993 and 1992, together with a report of Arthur Andersen LLP, independent public accountants, are included elsewhere herein. Reference is made to the \"Index to Consolidated 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.\nThere is hereby incorporated by reference the information to appear under the caption \"Election of Directors\" in the Company's proxy statement for its May 19, 1995 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1994. See \"Item 1. Business -- Executive Officers of the Company\" for a description of the Executive Officers of the Company.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThere is hereby incorporated by reference the information to appear under the caption \"Compensation of Directors and Executive Officers\" in the Company's proxy statement for its May 19, 1995 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThere is hereby incorporated by reference the information to appear under the captions \"Security Ownership of Management\" and \"Principal Shareholders of the Company\" in the Company's proxy statement for its May 19, 1995 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission within 120 days after December 31, 1994.\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) AND (2) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.\nThe financial statements and schedule listed in the accompanying index to the consolidated financial statements on page 18 are filed as part of this annual report on Form 10-K.\n(A)(3) EXHIBITS.\n- ---------------\n* Filed herewith\n(B) REPORTS ON FORM 8-K.\nNone.\nAMERICAN HEALTH PROPERTIES, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo American Health Properties, Inc.:\nWe have audited the accompanying consolidated balance sheets of American Health Properties, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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 American Health Properties, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nDenver, Colorado, March 6, 1995.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTHE COMPANY\nAmerican Health Properties, Inc., a Delaware corporation (the Company, which term refers to the Company and its subsidiaries unless the context otherwise requires) is a self-administered real estate investment trust (REIT) that commenced operations in 1987. The Company has investments in health care facilities, including 13 acute care hospitals, three rehabilitation hospitals and five psychiatric hospitals, all of which are operated by qualified third party health care providers, and a medical office building.\nPsychiatric Group Preferred Stock Distribution. On January 31, 1995, the Company's Board of Directors authorized management to pursue a transaction which is designed to separate the economic attributes of its investments in psychiatric hospitals (the Psychiatric Group) and its investments in acute care hospitals, rehabilitation hospitals and a medical office building (the Core Group) into two distinct portfolios, with two distinct classes of publicly traded shares intended to represent those portfolios. The transaction would entail the distribution to holders of Common Stock of depositary shares representing a new series of preferred stock, par value $0.01 per share, to be designated Psychiatric Group Preferred Stock (the Psychiatric Group Stock). The Psychiatric Group Stock would be intended to reflect the separate performance of the Psychiatric Group. The Company's existing Common Stock would be intended to reflect the separate performance of the Core Group. In connection with the proposed transaction, the Company would specifically identify or allocate its assets, liabilities and stockholders' equity, and its revenues, expenses and cash flow items, between the Core Group and Psychiatric Group. However, each holder of Common Stock or Psychiatric Group Stock would be a holder of an issue of capital stock of the entire Company and would be subject to the risks associated with an investment in the Company and all of its businesses, assets and liabilities.\nThe conversion rights of the Company's convertible subordinated bonds, and the Common Stock reserved for issuance upon conversion, will be appropriately adjusted in accordance with the terms of the indenture to reflect the planned distribution. In addition, appropriate adjustments will be made to the Company's stock incentive plans.\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Presentation. The accompanying consolidated financial statements include the accounts of the Company and all subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nNew Accounting Standards. The Financial Accounting Standards Board has issued Statements of Financial Accounting Standards No.'s 114 and 118, \"Accounting by Creditors for Impairment of a Loan\" and \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures\", respectively (SFAS 114 and 118). SFAS 114 and 118 are applicable to all creditors and to all loans that are restructured in a troubled debt restructuring involving a modification of terms. SFAS 114 and 118 require estimating the value of impaired loans 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 if the loan is collateral dependent.\nSFAS 114 and 118 are effective in fiscal 1995. Management believes that adoption of SFAS 114 and 118 will not have a material impact on the accompanying consolidated financial statements.\nReal Estate Properties. The Company accounts for its property leases as operating leases. The Company records properties at cost and allocates the cost between land and buildings and improvements based on independent appraisals. Depreciation of acute care and rehabilitation properties is recorded on a straight-line basis over the estimated useful lives of the buildings and improvements (27 to 42 years). The Company prospectively revised the estimated remaining lives of its psychiatric real estate properties from an average of 38 years to 21 years effective as of January 1, 1993. This estimate revision increased depreciation and reduced net income by $1,165,000, or $.06 per share, for the year ended December 31, 1993.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nDeferred Income. Fees received, net of related direct costs, associated with the origination or amendment of leases and mortgages are deferred and amortized at a constant effective rate over the remaining initial term of the related leases and mortgage notes receivable.\nDeferred Costs. Deferred financing costs are amortized over the term of the related debt at a constant effective rate.\nFederal Income Taxes. The Company intends at all times to operate so as to qualify as a REIT under Sections 856 to 860 of the Internal Revenue Code. As such, the Company will not be subject to federal income tax.\nEarnings and profits, which determine the taxability of dividends to stockholders, differ from net income for financial reporting purposes due primarily to timing differences in the recognition of fee income, real estate property write-downs, mortgage note impairment reserves and various accruals and differences between the estimated useful lives used to compute depreciation for financial statement purposes and a 40-year life used in determining earnings and profits. The cost basis of the Company's real estate properties is generally the same for financial reporting and earnings and profits purposes, except for properties written down for financial reporting purposes.\nCash and Short-Term Investments. Cash and short-term investments consist of cash and all highly liquid investments with an original maturity date of less than three months.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nREAL ESTATE PROPERTIES\nThe following table summarizes the Company's investment in health care real estate properties as of December 31, 1994:\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nAt June 30, 1992, the Company recorded an $11,400,000 write-down on a $21,400,000 mortgage note receivable (the \"RCC Note\") secured by a first mortgage and security interest in the real property of The Rock Creek Center (\"RCC\") in Lemont, Illinois. Subsequent recovery of cash in an interest reserve fund maintained by RCC reduced the Company's recorded investment in the RCC Note to $8,812,000. At the end of 1992, a formal restructuring of the RCC Note was completed, pursuant to which the RCC real property was conveyed to the Company in return for the Company's forgiveness of the RCC Note. The RCC real property was then leased to the existing operator for an initial term of five years at an annual rate of $1 million with monthly payments commencing January 1, 1993. Income received and recognized by the Company on its RCC investment in 1994 and 1993 was $1,000,000 and in 1992 was $1,332,000. Income of $2,664,000 would have been recorded in 1994, 1993 and 1992, had the RCC Note performed in accordance with its original terms.\nIn addition, at June 30, 1994, in view of negative trends that caused declining cash flow at a number of the psychiatric hospitals, the Company recorded a $30,000,000 write-down of its investments in psychiatric hospitals at such date. Of the $30,000,000 write-down, $22,050,000 related to the Company's investments in psychiatric hospital properties and $7,950,000 was established as a mortgage note impairment reserve. Over time, the Company intends to reduce its investments in the psychiatric sector. This is expected to be accomplished through the Company's announced program to sell, restructure or seek other means to reduce its investments in the psychiatric sector. In connection with this program, the Company sold one of its psychiatric properties to a third party in October, 1994. Additionally, subsequent to year end, the Company sold its psychiatric hospitals in Westwood and Pembroke, Massachusetts. These sales were accomplished at net book value. The Company also restructured the terms of its two Florida psychiatric hospital investments subsequent to year end. Pursuant to the restructuring, the annual minimum rental obligation of The Retreat psychiatric hospital in Sunrise, Florida was reduced from $2,359,000 to $1,100,000, and the annual minimum rental obligation of The Manors psychiatric hospital in Tarpon Springs, Florida was reduced from $855,000 to $600,000. The Company will have an enhanced participation in future revenue growth of both facilities. As part of the restructuring, The Retreat used an existing $1,000,000 lease reserve fund to pay down outstanding borrowings under a revolving credit agreement provided by the Company, and the maximum amount available for borrowing under the credit agreement was reduced from $2,250,000 to $1,000,000. The Manors used an existing $325,000 lease reserve fund to pay down outstanding borrowings under a $2,000,000 revolving credit agreement provided by the Company.\nThe Company's properties are leased under \"net\" leases pursuant to which the lessees are responsible for all maintenance, repairs, taxes, and insurance of the leased properties. The leases provide for the payment of minimum base rent and additional rent during the fixed term and any renewal terms. Additional rent is based on the increase in annual gross revenues of the related hospital as specified in the lease agreements.\nThe Company has the right to approve capital expenditures at all properties, the option to fund certain capital expenditures and, in certain situations, is obligated to fund approved capital expenditures on terms comparable to the original investment. The Company has committed to fund approximately $5,000,000 of capital expenditures pursuant to these rights and obligations. The base and additional rent provisions of the leases are amended when such capital expenditures are funded to reflect the Company's increased investment.\nSix of the Company's acute care properties are leased to subsidiaries of American Medical International, Inc. (AMI). The six leases are covered by cross-default provisions and the lease obligations are unconditionally guaranteed by AMI. In 1994, income from these leases accounted for 50% of the Company's total revenues.\nFuture minimum rentals under the Company's noncancellable operating leases, after consideration of the sale of the two Massachusetts psychiatric properties and the restructuring of the lease obligations of the two Florida psychiatric properties, are approximately $65,100,000 annually in 1995 through 1997, $64,100,000 in 1998, $41,200,000 in 1999 and $136,800,000 thereafter.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nMORTGAGE NOTES RECEIVABLE\nFour Winds Hospital -- Saratoga $18,225,000. The Company has a mortgage note receivable secured by a first mortgage and security interest in the real property of Four Winds Hospital in Saratoga Springs, New York. The note has an initial term of ten years with two optional ten-year extension terms. The initial term maturity date is June 30, 1999. The interest rate on the note is 12.42%. Interest is payable monthly for the first six years, and thereafter, principal and interest payments will be payable in level monthly installments based on a thirty-year amortization schedule.\nFour Winds Hospital -- Katonah $27,600,000. The Company has a mortgage note receivable secured by a first mortgage and security interest in the real property of Four Winds Hospital in Katonah (Westchester County), New York (the \"Four Winds Note\"). At June 30, 1992, the Company recorded a $33,600,000 write-down on the original $61,200,000 Four Winds Note which reduced the Company's recorded investment in the Four Winds Note to $27,600,000.\nAt the end of 1992, a formal restructuring of the Four Winds Note was completed, pursuant to which monthly interest payments amount to $3,400,000 in the first year, increase $100,000 annually in each of the succeeding six years and remain at $4,000,000 per year through maturity. The restructured note has an initial term of ten years with two optional ten-year extension terms. The initial term maturity date is November 30, 2002. Interest income received and recognized by the Company on the Four Winds Note in 1994, 1993 and 1992 was $3,508,000, $3,408,000 and $3,524,000, respectively. Interest income of $7,635,000 would have been recorded in 1994, 1993 and 1992 had the Four Winds Note performed in accordance with its original terms.\nPursuant to the terms of the mortgage notes receivable, the Company may receive additional interest each year based on the increase in annual operating revenues of the related psychiatric facility. The Company may provide permanent financing for capital additions at the facilities.\nMortgage Note Impairment Reserve. As discussed above, at June 30, 1994, in view of negative trends that caused declining cash flows at a number of the psychiatric hospitals, the Company recorded a $30,000,000 write-down of its investments in psychiatric hospitals. In connection with a review of Four Winds Hospital -- Saratoga and Four Winds Hospital -- Katonah, as well as uncertainties surrounding possible changes in Medicaid reimbursement in the State of New York, $7,950,000 of the $30,000,000 write-down was recorded as a mortgage note impairment reserve. The Company will record interest on such mortgage notes as interest payments are received.\nCONSTRUCTION LOANS\nAt December 31, 1994, the Company had funded $21,383,000 of a $30,000,000 commitment to participate in an $86 million construction and mortgage financing of a 670,000 square foot integrated hospital and medical office building presently under construction in Austin, Texas.\nAt December 31, 1993, the Company had funded $15,039,000 under a construction loan commitment on an ambulatory care and medical office complex in Overland Park, Kansas. This construction loan was prepaid by the borrower in February 1994 at which time the balance outstanding was $16,836,000.\nOTHER NOTES RECEIVABLE\nThe Company provides financing at variable rates to certain operators under revolving credit agreements. The aggregate commitment under these credit agreements was $9,950,000 as of December 31, 1994. Borrowings under the credit agreements are subject to compliance with various covenants and may not exceed a specified percentage of the operators' net accounts receivable. Borrowings under the credit agreements are secured by accounts receivable and other personal property of the operator. As of December 31, 1994, $8,800,000 was outstanding under these revolving credit agreements at a weighted average interest rate of 11.8%. The weighted average amount of borrowings under these credit agreements outstanding during 1994\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nwas $8,458,000 at a weighted average interest rate of 10.6% with a maximum of $8,800,000 outstanding during the year. As a result of the Company's sale of its two Massachusetts psychiatric investments and the restructuring of its two Florida psychiatric investments, all subsequent to year end, the Company's aggregate commitment to provide financing under revolving credit agreements was reduced to $5,700,000, of which $1,200,000 was unfunded as of March 6, 1995.\nIn connection with the Four Winds Note restructuring, the $950,000 balance outstanding under a revolving credit agreement was converted to a five-year amortizing term note. The note bears interest at an annual rate of 10.5%, and requires monthly principal and interest payments of $21,000 through maturity on December 1, 1997. As of December 31, 1994, the outstanding balance of this note was $628,000.\nDIRECT FINANCING LEASES\nIn connection with its investment in the real property of an acute care general hospital on June 30, 1993, the Company also provided a five-year equipment lease to the hospital operator which is classified as a direct financing lease. As of December 31, 1994, the Company's net investment in this direct financing lease is $2,296,000, represented by total minimum lease payments receivable of $2,722,000 less unearned income of $426,000. Future minimum lease payments under this lease are approximately $765,000 annually in 1995 through 1997 and $427,000 in 1998.\nIn connection with its investment in the real property of an acute care general hospital on January 3, 1994, the Company also provided a seven-year equipment lease to the hospital operator which is classified as a direct financing lease. As of December 31, 1994, the Company's net investment in this direct financing lease is $1,520,000, represented by total minimum lease payments receivable of $2,015,000 less unearned income of $495,000. Future minimum lease payments under this lease are approximately $333,000 annually in 1995 through 2000 and $17,000 in 2001.\nDEBT\nShort-Term Loan Payable. The Company has a $100 million unsecured revolving credit agreement with a syndicate of banks maturing on December 31, 1996. This agreement provides for interest on outstanding borrowings at either LIBOR plus a margin of 125 to 200 basis points or the prime rate plus, in certain circumstances, a margin of 50 basis points. The margin on LIBOR or prime rate borrowings is dependent upon various conditions, including the Company's leverage and debt ratings, and the level and duration of borrowings outstanding. Currently, the Company is able to borrow at either LIBOR plus 125 basis points or the prime rate.\nThe weighted average amount of borrowings under bank credit agreements outstanding during 1994, 1993 and 1992 was $5,404,000, $11,227,000 and $54,007,000 at weighted average interest rates of 6.9%, 4.7% and 5.1%, respectively. The maximum amount outstanding under bank credit agreements in 1994, 1993 and 1992 was $20,500,000, $44,500,000 and $72,000,000, respectively. As of December 31, 1994, the Company had $14,500,000 outstanding under its bank credit agreement with a weighted average interest rate of 7.6%.\nMortgage Notes Payable. Two of the properties owned by the Company had existing mortgages with remaining balances at December 31, 1993 of approximately $8.8 million and $5.7 million with interest rates of 10.0% and 8.75%, respectively. The Company prepaid both mortgages in February 1994.\nSenior Notes Payable. The Company's two issues of unsecured senior notes (the Senior Notes) were sold pursuant to private placements with institutional investors.\nIn May 1989, the Company sold $5 million of 11.33% Series A Senior Notes and $120 million of 11.40% Series B Senior Notes. As provided under the terms of the note agreement, the interest rates on these notes were automatically adjusted to 11.38% on Series A and 11.45% on Series B effective as of October 25, 1989,\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nconcurrent with the downgrading of AMI's publicly rated unsecured senior debt obligations. In the event that such AMI debt obligations are subsequently upgraded to an investment grade rating, the interest rates on the Series A and Series B Senior Notes will automatically readjust to 11.33% and 11.40%, respectively. Interest is payable quarterly in arrears. The Series A Senior Notes mature May 31, 1996, and the Series B Senior Notes require annual principal payments of $24 million beginning May 31, 1995 through maturity on May 31, 1999.\nIn September 1990, the Company sold $100 million of 10.41% Senior Notes. Interest is payable semi-annually in arrears. The Senior Notes require annual principal payments of $20 million beginning September 15, 1996 through maturity on September 15, 2000.\nSubordinated Convertible Bonds Payable. The Company's Convertible Dual Currency Subordinated Bonds (the Swiss Bonds) were sold in Switzerland pursuant to public subscription.\nThe 1990 Swiss Bonds have a coupon rate of 8 1\/2% and are convertible at the option of the holder at any time until July 9, 2000 into shares of the Company's Common Stock at a conversion price of $25.875 per share and a fixed exchange rate of SFr. 1.41 per U.S. $1.00. In 1994 and 1993, no conversions of 1990 Swiss Bonds were made. In 1992, $2,590,000 of the 1990 Swiss Bonds, with accrued interest, were converted into 91,259 shares of common stock resulting in additional equity of $2,472,000, net of conversion and unamortized issuance costs of $118,000. Final redemption of the 1,491 remaining 1990 Swiss Bonds will be made in U.S. dollars of $7,455,000 on July 19, 2000 provided additional conversions or redemption have not occurred earlier.\nInterest on outstanding Swiss Bonds is payable annually in arrears in Swiss Francs in July. Accrued and accreted interest is not paid on Swiss Bonds converted into common stock.\nThe Company has reserved approximately 204,000 unissued shares of Common Stock for potential future Swiss Bond conversions.\nDebt Covenants. Covenants and restrictions in the Company's various debt agreements include limitations on secured borrowings, restrictions covering the use of proceeds from asset sales and payments of dividends and requirements relating to the maintenance of specified financial covenants, including those relating to minimum tangible net worth, fixed charge coverage and ratios of liabilities to minimum tangible net worth and asset values.\nAnnual Maturities. The aggregate amount of annual maturities of the Company's debt for calendar years 1995 through 1999 and thereafter is $24,000,000, $49,000,000, $44,000,000, $44,000,000, $44,000,000 and $27,455,000, respectively. In addition, the outstanding balance of $14,500,000 at December 31, 1994 under the Company's unsecured revolving credit agreement matures on December 31, 1996, although certain events, including sales of assets, may require the earlier paydown of the outstanding balance.\nInterest. Interest capitalized on construction in progress was $883,000, $577,000 and $872,000 in 1994, 1993 and 1992, respectively. Interest paid, net of interest capitalized, in 1994, 1993, and 1992 was $24,924,000, $26,686,000 and $29,127,000, respectively.\nPENSION PLANS\nThe Company has a defined contribution pension plan covering all of its employees. Pension expense in 1994, 1993 and 1992 was $207,000, $202,000 and $229,000, respectively.\nThe Company has an unfunded defined benefit pension plan covering non-employee members of its Board of Directors upon completion of sixty months of membership on the Board. The benefits, limited to ten years, are based on years of service and the annual base director fee in effect as of the date a director ceases to be a member of the Board.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe following table sets forth the amounts recognized in the Company's financial statements:\nActuarial present value of benefit obligations:\nNet pension cost included the following components:\nA discount rate of 8.5% for 1994 and 7.0% for 1993, and a 10.0% increase in annual base director fees once every five years were used in determining the actuarial present value of the projected benefit obligation.\nSTOCK INCENTIVE PLANS\nThe Company's stock incentive plans provide for the issuance of up to 2,600,000 shares of common stock for restricted stock awards and options to directors and key employees of the Company. There were 1,369,754 and 149,183 shares available to grant further restricted stock awards and options at December 31, 1994 and 1993, respectively.\nRestricted stock awards are granted with transfer restrictions as described in the stock incentive plans. At December 31, 1994, 32,941 shares of the Company's common stock awarded to key employees remained restricted. Restrictions relating to these shares will lapse each year following the date of grant with respect to one-sixth, one-fifth or one-half of the total number of shares granted, as the case may be. Expense is determined based on the market value at the date of grant and is recognized over the period the restrictions lapse. Expense recorded in 1994, 1993 and 1992 related to stock awards granted was $367,000, $399,000 and $344,000, respectively.\nOutstanding stock options granted to directors and key employees of the Company were 753,130 and 688,166 at December 31, 1994 and 1993, respectively. The exercise price of stock options outstanding ($18 to $35 1\/4) is equal to the fair market value of the shares on the dates the options were granted. In 1994, 174,964 stock options were granted with exercise prices of $26 to $27 1\/8, and in 1993, 204,596 stock options were granted with exercise prices of $23 1\/2 and $27 3\/4. In 1992, 98,145 stock options were granted with exercise prices of $29 1\/4 and $35 1\/4. Stock options granted to directors are exercisable immediately and stock options granted to key employees become exercisable over two to four years. In 1994, 90,000 stock options with exercise prices of $18 1\/8 to $25 3\/4 were exercised, and in 1993, 20,000 stock options with exercise prices of $23 1\/2 to $25 3\/4 were exercised. In 1992, 73,650 stock options with exercise prices of $18 to $23 1\/8 were exercised. In\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\n1994, 20,000 stock options with exercise prices of $27 1\/8 and $35 1\/4 expired. Stock options of 611,987 and 538,751 at December 31, 1994 and 1993, respectively, were exercisable at prices of $18 to $35 1\/4. Stock options terminate ten years from the date of grant.\nDividend Equivalent Rights (DER) were granted in tandem with 74,964 and 104,596 of the stock options granted in 1994 and 1993, respectively. At each dividend declaration date, a calculation is made to determine the number of shares that could be acquired if dividends were paid on shares under option and accumulated DERs, and such number of shares are accumulated for the benefit of option holders for a period of five years from the date of the option grant. Upon exercise or expiration of the related option, each option holder is entitled to receive additional shares equivalent to the accumulated number of related DER shares. At December 31, 1994 and 1993, the accumulated number of DER shares were 27,856 and 9,198, respectively. Expense related to the DER shares is equal to the equivalent amount of dividends used to determine the number of DER shares. Expense recorded in 1994, 1993 and 1992 related to DER shares was $577,000, $255,000 and $60,000, respectively. Under the terms of the Company's stock incentive plans, in connection with the planned issuance of Psychiatric Group Stock, outstanding restricted stock awards, stock options, and DERs will be adjusted to reflect the issuance of Psychiatric Group Stock.\nPREFERRED STOCK PURCHASE RIGHTS PLAN\nOn April 20, 1990, the Company distributed to shareholders one preferred stock purchase right (each a Right) for each outstanding share of Common Stock. Under certain conditions, each Right may be exercised to purchase one one-hundredth of a share of preferred stock, Series A, par value $.01 per share (the Series A Preferred Shares), of the Company at a price of $45. The total number of Rights currently issued or issuable, including Rights issuable in connection with Common Stock which may be issued under the Company's stock incentive plans and upon the conversion of the Company's outstanding Swiss Bonds, is approximately 23,206,000. Approximately 232,000 Series A Preferred Shares could be purchased upon the exercise of all Rights currently issued or issuable. The number of Rights outstanding and Series A Preferred Shares issuable upon exercise, as well as the Series A Preferred Share purchase price, are subject to customary antidilution adjustments.\nThe Rights are evidenced by the certificates for shares of Common Stock, and in general are not transferable apart from the Common Stock or exercisable until after a party has acquired beneficial ownership of or made a tender offer for 10% or more of the outstanding Common Stock of the Company (an Acquiring Person), or the occurrence of other events as specified in the Rights Plan. Under certain conditions as specified in the Rights Plan, including but not limited to the acquisition by a party of 15% or more of the outstanding Common Stock of the Company or the acquisition of the Company in a merger or other business combination, each holder of a Right (other than an Acquiring Person whose Rights will be void) will receive upon exercise thereof and payment of the exercise price that number of shares of Common Stock of the Company or of the other party, as applicable, having a market value of two times the exercise price of the Right.\nThe Rights expire on April 20, 2000, and until exercised, the holder thereof, as such, will have no rights as a shareholder of the Company. At the Company's option, the Rights may be redeemed in whole at a price of $.01 per Right at any time prior to becoming exercisable. In general, the Company may also exchange the Rights at a ratio of one share of Common Stock per Right after becoming exercisable but prior to the acquisition of 50% or more of the outstanding shares of Common Stock by any party.\nSeries A Preferred Shares issuable upon exercise of the Rights will not be redeemable. Each Series A Preferred Share will have 100 votes and will be entitled to (a) dividends in an amount equal to the greater of $1.00 or 100 times the amount of the dividends per share paid on the Common Stock, (b) a liquidation preference in an amount equal to the greater of $100 or 100 times the amount per share paid on the Common\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nStock and (c) a payment in connection with a business combination (in which shares of Common Stock are exchanged) equal to 100 times the amount per share paid on the Common Stock.\nDIVIDENDS\nA quarterly dividend of $.575 per share, or approximately $11,989,000 in the aggregate, was declared by the Board of Directors on January 31, 1995, payable on February 24, 1995 to shareholders of record on February 10, 1995. This dividend has been reflected as dividends payable in the accompanying financial statements as of December 31, 1994. Dividends of $2.295 per share paid during the year ended December 31, 1994 are characterized as $1.8275 of ordinary income and $0.4675 return of capital.\nIn general, dividends on the Company's capital stock are limited by the Company's unsecured revolving credit agreement to 95% of cash flow available for debt service, less interest expense, plus gains on asset dispositions.\nLEGAL PROCEEDINGS\nIn August 1992, a shareholder class action lawsuit was filed against the Company and certain directors and officers of the Company in the Federal District Court in Denver, Colorado, alleging that among other things, the defendants knowingly or recklessly disseminated false and misleading information regarding the performance and creditworthiness of two of the Company's mortgage loan investments. On May 28, 1993, the Company reached an agreement with the plaintiffs, the other defendants to the lawsuits and its insurance carrier regarding settlement and dismissal of the cases with prejudice. The Company contributed $2,615,000 to the settlement in 1993. The Company's total costs related to this matter were $3,020,000 including the Company's settlement contribution, legal fees and other expenses. Of this amount, $786,000 was accrued in the fourth quarter of 1992, and the remaining $2,234,000 was charged against income in 1993. The settlement became effective upon approval by the court in December 1993.\nDISCLOSURES 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.\nMortgage Notes Receivable. The carrying amount of mortgage notes receivable is a reasonable estimate of fair value, as the pricing and terms of the notes are indicative of current rates and credit risk.\nConstruction Loans. The carrying amounts of these construction loans are a reasonable estimate of fair value, as the variable rate pricing and terms of the loans are indicative of current rates and credit risk.\nOther Notes Receivable. The Company's pricing and terms of variable-rate financing and commitments provided to certain operators and a term note are indicative of current rates and credit risk, and therefore, the carrying amount of these financial instruments is a reasonable estimate of fair value.\nCash and Short-Term Investments. The carrying amount approximates fair value because of the short maturity of these financial instruments.\nShort-Term Loan Payable. The terms of borrowings under the Company's unsecured revolving credit agreement are generally less than 90 days at variable pricing indicative of current short-term borrowing rates. Accordingly, the carrying amount is a reasonable estimate of fair value.\nMortgage Notes Payable. The carrying amount of mortgage notes payable generally reflects current rates for similar type borrowings and is a reasonable estimate of fair value.\nSubordinated Convertible Bonds Payable. The fair value of the Company's subordinated convertible bonds payable is based on the quoted market price of the bonds as traded in Switzerland.\nAMERICAN HEALTH PROPERTIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nSenior Notes Payable. An estimate of rates currently available to the Company for debt with similar terms was used to determine the fair value of the Company's senior notes payable.\nLoan Commitments. The terms and pricing of the Company's $30,000,000 commitment at December 31, 1994 to participate in the funding of a construction loan that will convert to a mortgage note receivable are indicative of current rates and terms for similar arrangements. The amount shown as carrying amount and fair value at December 31, 1993 represents the construction financing fee that was received and deferred by the Company on another construction loan that was prepaid by the borrower in February 1994.\nThe carrying amounts and estimated fair values of the Company's financial instruments at December 31, 1994 and 1993 are as follows:\nQUARTERLY FINANCIAL DATA (UNAUDITED)\n- ---------------\n(1) Reflects a write-down of $30,000,000 relating to investments in psychiatric hospitals.\n(2) Includes a gain of $19,742,000 on the sale of a property.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULE\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in this Annual Report on Form 10-K, and have issued our report thereon dated March 6, 1995. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index of financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states 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 LLP\nDenver, Colorado, March 6, 1995.\nSCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION\nAMERICAN HEALTH PROPERTIES, INC.\nDECEMBER 31, 1994 (DOLLARS IN THOUSANDS)\n- ---------------\n(a) The cost basis of the properties for Federal income tax purposes is the same as the gross carrying amount, except for those properties for which a write-down was recorded in 1994. For Federal income tax purposes, the gross carrying amount for the Halstead, Kansas facility is classified as an investment in an Industrial Revenue Bond and is not depreciated.\n(b) Most properties have had improvements since their initial construction. The range of dates reflects the construction date of the original structures through the latest date of improvements.\n(c) This property was conveyed to the Company in December 1992 in connection with the restructuring and forgiveness of a mortgage note receivable. The $21.4 million mortgage note receivable had been written down in June 1992 to $10 million. Subsequent recovery of a $1.1 million interest reserve fund from the mortgagee reduced the Company's recorded investment in the note to $8.8 million (net of unamortized fees) which became the Company's basis in the property upon its conveyance. The property was written down by $3 million in 1994 to its current gross carrying amount of $5.8 million.\n(d) In view of negative trends that caused declining cash flow at these psychiatric hospitals, the Company recorded a write-down of its investment in each of these properties in 1994. The write-downs by property were: Sunrise, Florida $6.6 million; Lemont, Illinois $3 million; Pembroke, Massachusetts $3.5 million; and Westwood, Massachusetts $2.8 million.\nSCHEDULE III -- REAL ESTATE AND ACCUMULATED DEPRECIATION\nAMERICAN HEALTH PROPERTIES, INC.\nDECEMBER 31, 1994 (IN THOUSANDS)\nSummary of Real Estate and Accumulated Depreciation Activity:\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 the 22nd day of March, 1995.\nAMERICAN HEALTH PROPERTIES, INC.\nBy: VICTOR C. STREUFERT Victor C. Streufert Executive Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Joseph P. Sullivan, Victor C. Streufert and Geoffrey D. Lewis, and each or either of them as his true and lawful attorney-in-fact and agent, with full power of substitution, for him and in his name, place and stead, in any and all capacities, to sign any or all amendments to this 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 attorney-in-fact and agent, 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 to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorney-in-fact and agent, or his substitute 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 by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\nINDEX TO EXHIBITS\n- ------------\n* Filed herewith\n(B) REPORTS ON FORM 8-K.\nNone.","section_15":""}
{"filename":"85961_1994.txt","cik":"85961","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral\nRyder System, Inc. (\"the Company\") was incorporated in Florida in 1955. Through its subsidiaries, the Company engages primarily in the following businesses: 1) full service leasing and short-term rental of trucks, tractors, and trailers; 2) dedicated logistics services; 3) public transit management and student transportation; and 4) transportation of new automobiles and trucks. The Company's main operating segments are Vehicle Leasing & Services and Automotive Carriers. General Motors Corporation (\"GM\") is the largest single customer of the Company, accounting for approximately 10%, 11%, and 12% of consolidated revenue of the Company in 1994, 1993 and 1992, respectively.\nAt December 31, 1994, the Company and its subsidiaries had a fleet of 188,831 vehicles and 43,095 employees.(1)\nSegment Information\nFinancial information about industry segments is incorporated by reference from the table \"Selected Financial and Operational Data\" on page 32, and \"Notes to Consolidated Financial Statements - Segment Information\" on page 46, of the Ryder System, Inc. 1994 Annual Report to Shareholders.\nVehicle Leasing & Services\nThe Vehicle Leasing & Services Division, comprised of Ryder Truck Rental, Inc. (\"RTR\"), Ryder Dedicated Logistics, Inc., and the Ryder Public Transportation Services group of companies, engages in a variety of highway transportation services including full service truck leasing, dedicated logistics services, commercial and consumer truck rental, truck maintenance, student transportation, and public transit management, operations and maintenance.\nAs of December 31, 1994, the Vehicle Leasing & Services Division had 179,725 vehicles and 36,929 employees, excluding reimbursed public transit and leased personnel. Full service truck leasing was provided to more than 12,300 customers (ranging from small companies to large national enterprises), with a fleet of 83,100 vehicles (including 10,480 vehicles leased to affiliates), through 1,008 locations in 49 states, Puerto Rico, and 8 Canadian provinces. Under full service leases, RTR (as Ryder Commercial Leasing & Services) provides customers with the vehicles, maintenance, supplies and equipment necessary for operation, while the customers furnish drivers and dispatch and exercise control over the vehicles. A fleet of 73,265 vehicles, ranging from heavy-duty tractors and trailers to light trucks, is available for short-term rental from over 4,800 Division locations and independent dealers in 49 states and Canada. Short-term truck rental, which tends to be seasonal, is used by commercial customers to supplement their fleets during peak business seasons. Additionally, RTR (as Ryder Consumer Truck Rental) serves the short-term consumer truck rental market, which also tends to be seasonal and is principally used by consumers for moving household goods. At December 31, 1994, RTR was servicing 32,163 vehicles (including 7,877 vehicles of affiliates) under Ryder Programmed Maintenance, which provides essentially the same maintenance services for customer-owned vehicles as are provided through full service truck leasing.\nThrough Ryder Dedicated Logistics, Inc. (\"RDL\"), the Division offers customer-tailored industrial and consumer product distribution and logistics services from 661 locations in the U.S. and Canada. Services include varying combinations of logistics system design, provision of vehicles and equipment, maintenance, provision of drivers, warehouse management, transportation management, vehicle dispatch, just-in-time delivery, and information systems support. RDL also offers integrated logistics, the single source management of a customer's primary logistics activities.\n____________________\n(1) This number does not include: (a) operating personnel of local transit authorities managed by certain subsidiaries of the Company (in such situations, the entire cost of compensation and benefits for such personnel is passed through to the transit authority, which reimburses the Company's subsidiaries); or (b) drivers obtained by certain subsidiaries of the Company under driver leasing agreements for some of their operations.\nLogistics systems include metropolitan shuttles, interstate long-haul operations, just-in-time service to assembly plants, and factory-to-warehouse-to-retail facility service. These services are employed in the automotive industry (RDL specializes in inbound and aftermarket parts delivery for customers such as GM (including Saturn), Chrysler Corporation (\"Chrysler\"), Toyota Motor Manufacturing USA Inc. (\"Toyota\"), Ford Motor Company (\"Ford\") and auto parts retailers), and in the paper and paper packaging, chemical, electronic and office equipment, news, food and beverage, housing, general retail and other industries.\nThrough Ryder Public Transportation Services (\"RPTS\"), in 1994 the Division continued to expand its presence in the public transportation management, operations and maintenance and student transportation markets through internal growth. RPTS now manages or operates 89 public transit systems with 4,741 vehicles in 29 states, operates 7,753 school buses in 20 states, maintains about 17,500 public transit or fleet vehicles in 18 states and provides public transportation management consulting services.\nThe Division has historically disposed of its used and surplus revenue earning equipment at prices in excess of book value. The Division reported gains on the sale of revenue earning equipment (reported as reductions in depreciation expense) of approximately 19%, 16% and 12% of the Division's earnings before interest and taxes in 1994, 1993 and 1992, respectively. The extent to which the Division may consistently continue to realize gains on disposal of its revenue earning equipment is dependent upon various factors including the general state of the used vehicle market, the condition and utilization of the Division's fleet and depreciation policies with respect to its vehicles.\nInternational\nThe Company's International Division has developed and is in the process of implementing a strategy for growth in international markets outside the United States and Canada. This strategy is designed to enable the International Division to take advantage of, and build upon, the Company's expertise in providing services to businesses involved in the over-the-road transportation of goods. The Company's previously existing lease, rental, maintenance and logistics operations in the United Kingdom, Germany and Poland have been integrated into the International Division and expanded. In the fourth quarter of 1994, the International Division opened offices and its first maintenance facility in Mexico City. As of December 31, 1994, the International Division had 9,973 vehicles, 2,918 employees, and provided service through 93 locations in the United Kingdom, Germany, Mexico and Poland. (For financial reporting purposes, the International Division's results are included with those of the Vehicle Leasing & Services Division).\nAutomotive Carriers\nThe Company's Automotive Carrier Division transports new automobiles and trucks to dealers and to and from distribution points throughout the United States and several Canadian provinces for GM, Chrysler, Toyota, Ford, Honda and most other automobile and light truck manufacturers. GM remains the Division's largest customer, accounting for 54%, 54% and 57% of the Division's revenue in 1994, 1993 and 1992, respectively. The GM carriage contracts are typically subject to cancellation upon 30 days' notice by either party. The business is primarily dependent on the level of North American production, importation and sales by GM and various other manufacturers. Consequently, the business is adversely affected by any significant reductions in or prolonged curtailments of production by customers because of market conditions, strikes or otherwise.\nAs of December 31, 1994, the Automotive Carrier Division had 4,306 auto transport vehicles, 5,769 employees (exclusive of leased drivers), and provided service through 80 locations in 32 states and 3 Canadian provinces. Most of the Division's employees are covered by an industry-wide collective bargaining agreement, the term of which ends in May 1995. A new industry-wide collective bargaining agreement is currently being negotiated.\nCompetition\nThe Vehicle Leasing & Services Division's customers may finance lease or purchase their own vehicles and provide maintenance services for themselves substantially similar to those offered by the Division, or purchase such services from others, or obtain transportation services from other common or contract carriers. The Division also competes with other companies conducting nationwide truck leasing, rental or bus operations, a large number of regional truck leasing\ncompanies with multiple branches, many smaller companies operating primarily on a local basis, but frequently with nationwide service and maintenance capabilities resulting from their participation in cooperative programs and membership in various associations, and both local and nationwide common and contract carriers. Competition in the truck leasing business is based on a number of factors which include price, equipment, maintenance and geographical coverage. The Division also competes, to an extent, with a number of trailer and vehicle manufacturers who have entered the field of trailer and vehicle leasing, extended warranty maintenance, rental and other forms of transportation services.\nThe carriage and dedicated logistics operations of the Vehicle Leasing & Services Division and the Automotive Carrier Division are subject to potential competition in most of the regions they serve from railroads and motor carriers providing similar services, and from customers insofar as they may own or lease equipment and provide the services for themselves.\nA growing number of U.S. school districts now have the option of contracting with private operators for student transportation services. In areas where private contractors are utilized, the market is fragmented and competitive. Even where private operators are being utilized, school districts still may have the option of performing student transportation services themselves.\nPublic transit agencies generally have the option of contracting with private operators for public transportation services or providing such services themselves. The market for most types of public transportation services is fragmented and competitive.\nIn the United Kingdom, both truck leasing and dedicated logistics are well developed competitive markets, similar to those in the U.S. and Canada. Value-added differentiation of the Company's service offerings continues to be the Company's strategy in those markets. Recent developments in Mexico following the approval of the North American Free Trade Agreement (NAFTA), Germany's continued integration into the European Community and consequent deregulation, and Poland's transformation to a market economy, create a growing opportunity for the Company to provide services in these new markets. The Company expects that competition with the Company's services in these emerging markets will develop.\nOther Developments and Further Information\nMany federal, state and local laws designed to protect the environment, and similar laws in some foreign jurisdictions, have varying degrees of impact on the way the Company and its subsidiaries conduct their business operations, primarily with regard to their use, storage and disposal of petroleum products and various wastes associated with vehicle maintenance activities. Compliance with these laws and with the Company's environmental protection policies involves the expenditure of considerable amounts. Based on information presently available, management believes that the ultimate disposition of such matters, although potentially material to the Company's results of operations in any one year, will not have a material adverse effect on the Company's financial condition or liquidity.\nFor further discussion concerning the business of the registrant and its subsidiaries see the information referenced under Items 7 and 8 of this report.\nExecutive Officers of the Registrant\nAll of the executive officers of the Company were elected or re-elected to their present offices either at or subsequent to the meeting of the Board of Directors held on May 6, 1994, in conjunction with the Company's 1994 Annual Meeting on the same date. They all hold such offices, at the discretion of the Board of Directors, until their removal, replacement or retirement.\nM. Anthony Burns has been Chairman of the Board since May 1985, Chief Executive Officer since January 1983 and President and a director since December 1979.\nC. Robert Campbell has been Executive Vice President - Human Resources and Administration since March 1991. Mr. Campbell served as Executive Vice President - Finance of the Vehicle Leasing & Services Division from October 1981 to March 1991.\nDwight D. Denny has been President - Ryder Commercial Leasing & Services since December 1992, and was Executive Vice President and General Manager - Commercial Leasing & Services of Ryder Truck Rental, Inc. from June 1991 until December 1992. Mr. Denny served Ryder Truck Rental, Inc. as Senior Vice President and General Manager - Eastern Area from March 1991 to June 1991 and Senior Vice President - Central Area from December 1990 to March 1991. Mr. Denny previously served Ryder Truck Rental, Inc. as Region Vice President in Tennessee from July 1985 to December 1990.\nR. Ray Goode has been Senior Vice President - Public Affairs since November 1993 and was President and Chief Executive Officer of We Will Rebuild from September 1992 to November 1993. He was Managing Partner of Goode, Olcott, Knight & Associates from April 1989 to September 1992, and served successively as Vice President, President and Chairman and Chief Executive Officer of The Babcock Company (a subsidiary of Weyerhaeuser Company) from 1976 to 1989. Mr. Goode served as County Manager for Metropolitan Dade County, Florida from 1970 to 1976.\nJames B. Griffin has been President - Ryder Automotive Carrier Group, Inc. since February 1993, and was Vice President and General Manager - Mid-South Region of Ryder Truck Rental, Inc. from December 1990 to February 1993. Mr. Griffin previously served Ryder Truck Rental, Inc. as Region Vice President in Syracuse, New York from April 1988 to December 1990.\nJames M. Herron has been Senior Executive Vice President since July 1989 and General Counsel since April 1973. Mr. Herron was also Secretary from February 1983 through February 1986.\nEdwin A. Huston has been Senior Executive Vice President - Finance and Chief Financial Officer since January 1987. Mr. Huston was Executive Vice President - Finance from December 1979 to January 1987.\nLarry S. Mulkey has been President - Ryder Dedicated Logistics, Inc. (formerly Ryder Distribution Resources, Inc.) since November 1990. Mr. Mulkey was President - Ryder Public Transportation Services from June 1993 to October 1994 and, prior to the organization of the Ryder Public Transportation Services group in June 1993, from November 1990 to June 1993 he was President of each of the companies comprising that group. From November 1990 to December 1992, Ryder's operations in the United Kingdom and Germany reported to Mr. Mulkey. He was Senior Vice President and General Manager - Central Area of Ryder Truck Rental, Inc. from January 1986 to November 1990, and was Senior Vice President and General Manager - Eastern Area of Ryder Truck Rental, Inc. from August 1985 to January 1986.\nBruce D. Parker has been Senior Vice President - Management Information Systems and Chief Information Officer since September 1994. Mr. Parker previously served American Airlines, Inc. as a Vice President of American and President of Sabre Development Services Division from April 1993 to September 1994, as a Vice President of Sabre Computer Services Division from 1988 to April 1993, and as Managing Director of Customer Services for Sabre Computer Services Division from 1987 to 1988.\nJ. Ernest Riddle has been Executive Vice President - Marketing since June 1994. Mr. Riddle previously served as Senior Vice President - Marketing and Sales of Ryder Commercial Leasing & Services from January 1993 to June 1994. Mr. Riddle served Xerox Corporation as European Director of Marketing and Sales from October 1992 to January 1993, as Vice President - Worldwide Marketing Operations from November 1990 to October 1992, and as Vice President - Marketing for the U.S. Marketing Group from November 1988 to November 1990.\nGerald R. Riordan has been President - Ryder Consumer Truck Rental since December 1992 and has been President - Ryder Public Transportation Services since October 1994. Mr. Riordan previously served as Senior Vice President and General Manager - Consumer Rental of Ryder Truck Rental, Inc. from June 1991 to December 1992. He served Ryder Truck Rental, Inc. as Senior Vice President - Rental and Quality from December 1990 to June 1991, as Vice President of Quality from January 1988 to December 1990, and as Vice President of Rental from January 1983 to January 1988.\nAnthony G. Tegnelia has been Senior Vice President since March 1991 and Controller since August 1988. He is the Company's principal accounting officer. Mr. Tegnelia was Vice President - Corporate Systems from November 1986 to August 1988. Mr. Tegnelia served as Executive Vice President - Finance of the Company's former Freight System\nDivision from September 1985 to October 1986, and Senior Vice President - Finance of Ryder Distribution System (now Ryder Dedicated Logistics, Inc.) from March 1984 to August 1985.\nRandall E. West has been Senior Vice President and General Manager of the International Division since December 1993, and was Vice President and General Manager - Southwest Region of Ryder Truck Rental, Inc. (Ryder Commercial Leasing & Services) from September 1991 to December 1993. Mr. West previously served Ryder Truck Rental, Inc. as Region Vice President at New Orleans from November 1988 to September 1991.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's property consists primarily of vehicles, vehicle maintenance and repair facilities and other real estate and improvements. Information regarding vehicles is included in Item 1, which is incorporated herein by reference.\nThe Vehicle Leasing & Services Division has 1,968 locations in the United States, Canada and Puerto Rico; 470 of these facilities are owned and the remainder are leased. Such locations generally include a repair shop and administrative offices.\nThe International Division has 93 locations in the United Kingdom, Germany, Mexico and Poland; 18 of these facilities are owned and the remainder are leased. Such locations generally include a repair shop and administrative offices.\nThe Automotive Carrier Division has 72 operating locations in 32 states throughout the United States and 8 operating locations in Canada; 25 locations are owned and the remainder are leased.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are involved in various claims, law suits, and administrative actions arising in the course of their businesses. Some involve claims for substantial amounts of money and\/or claims for punitive damages. While any proceeding or litigation has an element of uncertainty, management believes that the disposition of such matters, in the aggregate, will not have a material impact on the consolidated financial condition, results of operation or liquidity of the Company and its subsidiaries.\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 quarter ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information required by Item 5 is incorporated by reference from page 47 (\"Common Stock Data\") of the Ryder System, Inc. 1994 Annual Report to Shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by Item 6 is incorporated by reference from pages 48 and 49 of the Ryder System, Inc. 1994 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 pages 26 through 31 of the Ryder System, Inc. 1994 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 34 through 46 and page 47 (\"Quarterly Data\") of the Ryder System, Inc. 1994 Annual Report to Shareholders.\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 Item 10 regarding directors is incorporated by reference from pages 4 through 8 of the Ryder System, Inc. 1995 Proxy Statement.\nThe information required by Item 10 regarding executive officers is set out in Item 1 of Part I of this Form 10-K Annual Report.\nAdditional information required by Item 10 is incorporated by reference from page 24 (\"Filings Under Section 16(a)\") of the Ryder System, Inc. 1995 Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 is incorporated by reference from pages 9, 10 (\"Compensation of Directors\") and 28 through 31 of the Ryder System, Inc. 1995 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 page 23 of the Ryder System, Inc. 1995 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 is incorporated by reference from page 10 of the Ryder System, Inc. 1995 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements for Ryder System, Inc. and Consolidated Subsidiaries:\nItems A through E are incorporated by reference from pages 33 through 46 of the Ryder System, Inc. 1994 Annual Report to Shareholders.\nA) Consolidated Statements of Earnings for years ended December 31, 1994, 1993 and 1992.\nB) Consolidated Balance Sheets for December 31, 1994 and 1993.\nC) Consolidated Statements of Cash Flows for years ended December 31, 1994, 1993 and 1992.\nD) Notes to Consolidated Financial Statements.\nE) Independent Auditors' Report.\n2. Not applicable.\nAll other schedules and statements 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.\nSupplementary Financial Information consisting of selected quarterly financial data is incorporated by reference from page 47 of the Ryder System, Inc. 1994 Annual Report to Shareholders.\n3. Exhibits:\nThe following exhibits are filed with this report or, where indicated, incorporated by reference (Forms 10-K, 10-Q and 8-K referenced herein have been filed under the Commission's file No. 1-4364). The Company will provide a copy of the exhibits filed with this report at a nominal charge to those parties requesting them.\nEXHIBIT INDEX\nExhibit Number Description ------ --------------------------------------------------------------------\n3.1 The Ryder System, Inc. Restated Articles of Incorporation, dated November 8, 1985, as amended through May 18, 1990, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, are incorporated by reference into this report.\n3.2 The Ryder System, Inc. By-Laws, as amended through November 23, 1993, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, are incorporated by reference into this report.\n4.1 The Company hereby agrees, pursuant to paragraph (b)(4)(iii) of Item 601 of Regulation S-K, to furnish the Commission with a copy of any instrument defining the rights of holders of long-term debt of the Company, where such instrument has not been filed as an exhibit hereto and the total amount of securities authorized thereunder does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis.\n4.2(a) The Form of Indenture between Ryder System, Inc. and The Chase Manhattan Bank (National Association) dated as of June 1, 1984, filed with the Commission on November 19, 1985 as an exhibit to the Company's Registration Statement on Form S-3 (No. 33-1632), is incorporated by reference into this report.\n4.2(b) The First Supplemental Indenture between Ryder System, Inc. and The Chase Manhattan Bank (National Association) dated October 1, 1987.\n4.3 The Form of Indenture between Ryder System, Inc. and The Chase Manhattan Bank (National Association) dated as of May 1, 1987, and supplemented as of November 15, 1990 and June 24, 1992, filed with the Commission on July 30, 1992 as an exhibit to the Company's Registration Statement on Form S-3 (No. 33-50232), is incorporated by reference into this report.\n4.4 The Rights Agreement between Ryder System, Inc. and First Chicago Trust Company of New York (then named Morgan Guaranty Trust Company of New York) dated as of February 28, 1986, previously filed with the Commission as an exhibit to the Company's Registration Statement on Form 8-A dated March 7, 1986, is incorporated by reference into this report.\n4.5 The Amendment to Rights Agreement between Ryder System, Inc. and First Chicago Trust Company of New York dated as of July 28, 1989, previously filed with the Commission as an exhibit to the Company's Amendment to Application or Report on Form 8 dated August 2, 1989, is incorporated by reference into this report.\n10.1(a) The change of control severance agreement for the Company's chief executive officer dated as of January 1, 1992, and the severance agreement for the Company's chief executive officer dated as of January 1, 1992, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1991, are incorporated by reference into this report.\n10.1(b) Amendments dated as of August 20, 1993 to the change of control severance agreement for the Company's chief executive officer dated as of January 1, 1992, and the severance agreement for the Company's chief executive officer dated as of January 1, 1992, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, are incorporated by reference into this report.\n10.2(a) The form of amended and restated change of control severance agreement for executive officers dated as of February 24, 1989.\n10.2(b) Amendment dated as of August 20, 1993 to the form of amended and restated change of control severance agreement for executive officers dated as of February 24, 1989, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.2(c) The form of change of control severance agreement for executive officers effective as of July 1, 1993, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.3(a) The form of amended and restated severance agreement for executive officers dated as of February 24, 1989.\n10.3(b) Amendment dated as of August 20, 1993 to the form of amended and restated severance agreement for executive officers dated as of February 24, 1989, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.3(c) The form of severance agreement for executive officers effective as of July 1, 1993, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.4(a) The form of Ryder System, Inc. incentive compensation deferral agreement dated as of November 30, 1993, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.4(b) The form of Ryder System, Inc. incentive compensation deferral agreement dated as of November 30, 1994.\n10.5(a) The form of Ryder System, Inc. salary deferral agreement dated as of November 30, 1993, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.5(b) The form of Ryder System, Inc. salary deferral agreement dated as of November 30, 1994.\n10.6(a) The form of Ryder System, Inc. director's fee deferral agreement dated as of December 31, 1993, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.6(b) The form of Ryder System, Inc. director's fee deferral agreement dated as of December 31, 1994.\n10.7(a) The Ryder System, Inc. and Vehicle Leasing & Services Division 1994 Incentive Compensation Plan for Headquarters Executive Management, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.7(b) The Ryder System, Inc. 1995 Incentive Compensation Plan for Headquarters Executive Management.\n10.8(a) The Ryder System, Inc. 1994 Incentive Compensation Plan for Ryder System, Inc. Senior Executive Vice Presidents, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.8(b) The Ryder System, Inc. 1995 Incentive Compensation Plan for Ryder System, Inc. Senior Executive Vice Presidents.\n10.9(a) The Ryder System, Inc. 1994 Incentive Compensation Plan for Senior Vice President and General Manager of the International Division, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.9(b) The Ryder System, Inc. 1995 Incentive Compensation Plan for Senior Vice President and General Manager, International Division.\n10.10(a) The Ryder System, Inc. 1994 Incentive Compensation Plan for President, Automotive Carrier Division, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.10(b) The Ryder System, Inc. 1995 Incentive Compensation Plan for President, Automotive Carrier Division.\n10.11(a) The Ryder System, Inc. 1994 Incentive Compensation Plan for Chairman, President & Chief Executive Officer, Ryder System, Inc., previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.11(b) The Ryder System, Inc. 1995 Incentive Compensation Plan for Chairman, President & Chief Executive Officer, Ryder System, Inc.\n10.12(a) The Ryder System, Inc. 1994 Incentive Compensation Plan for President-Commercial Leasing & Services, Vehicle Leasing & Services Division, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.12(b) The Ryder System, Inc. 1995 Incentive Compensation Plan for President-Commercial Leasing & Services.\n10.13(a) The Ryder System, Inc. 1994 Incentive Compensation Plan for President-Consumer Rental, Vehicle Leasing & Services Division, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.13(b) The Ryder System, Inc. 1995 Incentive Compensation Plan for President-Consumer Truck Rental.\n10.14(a) The Ryder System, Inc. 1994 Incentive Compensation Plan for President-Ryder Dedicated Logistics, Vehicle Leasing & Services Division, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.14(b) The Ryder System, Inc. 1995 Incentive Compensation Plan for President-Ryder Dedicated Logistics.\n10.15(a) The Ryder System, Inc. 1980 Stock Incentive Plan, as amended and restated as of October 22, 1993, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.15(b) Form of Combined Non-Qualified Stock Option and Limited Stock Appreciation Right Agreement, dated May 6, 1994.\n10.15(c) Form of Combined Non-Qualified Stock Option and Limited Stock Appreciation Right Agreement, dated October 21, 1994.\n10.15(d) Combined Non-Qualified Stock Option and Limited Stock Appreciation Right Agreement, dated December 15, 1994, between Ryder System, Inc. and M. Anthony Burns.\n10.16 The Ryder System, Inc. Directors Stock Plan, as amended and restated as of December 17, 1993, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.17(a) The Ryder System Benefit Restoration Plan, effective January 1, 1985, previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1992, is incorporated by reference into this report.\n10.17(b) The First Amendment to the Ryder System Benefit Restoration Plan, effective as of December 16, 1988.\n10.18 Amendment, dated November 10, 1994, to the Amended and Restated Severance Agreement between Ryder System, Inc. and C. R. Campbell.\n10.19 Letter agreement, dated April 9, 1993, between Ryder System, Inc. and James Ernest Riddle.\n10.20 Distribution and Indemnity Agreement dated as of November 23, 1993 between Ryder System, Inc. and Aviall, Inc., previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n10.21 Tax Sharing Agreement dated as of November 23, 1993 between Ryder System, Inc. and Aviall, Inc., previously filed with the Commission as an exhibit to the Company's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated by reference into this report.\n11.1 Statement regarding computation of per share earnings.\n13.1 The Ryder System, Inc. 1994 Annual Report to Shareholders. Those portions of the Ryder System, Inc. 1994 Annual Report to Shareholders which are not incorporated by reference into this report are furnished to the Commission solely for information purposes and are not to be deemed \"filed\" as part of this report.\n21.1 List of subsidiaries of the registrant, with the state or other jurisdiction of incorporation or organization of each, and the name under which each subsidiary does business.\n23.1 Auditors' consent to incorporation by reference in certain Registration Statements on Forms S-3 and S-8 of their reports on consolidated financial statements and schedules of Ryder System, Inc. and its consolidated subsidiaries.\n24.1 Manually executed powers of attorney for each of:\nArthur H. Bernstein Edward T. Foote II John A. Georges Vernon E. Jordan, Jr. Howard C. Kauffmann David T. Kearns Lynn M. Martin James W. McLamore Paul J. Rizzo Donald V. Seibert Hicks B. Waldron Alva O. Way Mark H. Willes\n27.1 Financial Data Schedule.\n(b) Reports on Form 8-K:\nThe Company did not file any reports on Form 8-K during the last quarter of 1994.\n(c) Executive Compensation Plans and Arrangements:\nPlease refer to the description of Exhibits 10.1 through 10.19 set forth under Item 14(a)3 of this report for a listing of all management contracts and compensation plans and arrangements filed with this report pursuant to Item 601(b)(10) of Regulation S-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.\nDate: March 29, 1995 RYDER SYSTEM, INC.\nBy: M. Anthony Burns --------------------------------- M. Anthony Burns 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.\nDate: March 29, 1995 By: M. Anthony Burns --------------------------------- M. Anthony Burns Chairman, President and Chief Executive Officer (Principal Executive Officer)\nDate: March 29, 1995 By: Edwin A. Huston --------------------------------- Edwin A. Huston Senior Executive Vice President-Finance and Chief Financial Officer (Principal Financial Officer)\nDate: March 29, 1995 By: Anthony G. Tegnelia --------------------------------- Anthony G. Tegnelia Senior Vice President and Controller (Principal Accounting Officer)\nDate: March 29, 1995 By: Arthur H. Bernstein * --------------------------------- Arthur H. Bernstein Director\nDate: March 29, 1995 By: Edward T. Foote II * --------------------------------- Edward T. Foote II Director\nDate: March 29, 1995 By: John A. Georges * --------------------------------- John A. Georges Director\nDate: March 29, 1995 By: Vernon E. Jordan, Jr. * --------------------------------- Vernon E. Jordan, Jr. Director\nDate: March 29, 1995 By: Howard C. Kauffmann * ------------------------------ Howard C. Kauffmann Director\nDate: March 29, 1995 By: David T. Kearns * --------------------------------- David T. Kearns Director\nDate: March 29, 1995 By: Lynn M. Martin * --------------------------------- Lynn M. Martin Director\nDate: March 29, 1995 By: James W. McLamore * ------------------------------ James W. McLamore Director\nDate: March 29, 1995 By: Paul J. Rizzo * ----------------------------- Paul J. Rizzo Director\nDate: March 29, 1995 By: Donald V. Seibert * --------------------------------- Donald V. Seibert Director\nDate: March 29, 1995 By: Hicks B. Waldron * -------------------------------- Hicks B. Waldron Director\nDate: March 29, 1995 By: Alva O. Way * ---------------------------------- Alva O. Way Director\nDate: March 29, 1995 By: Mark H. Willes * -------------------------------- Mark H. Willes Director\n*By: Ann E. Neal --------------------------------- Ann E. Neal Attorney-in-Fact","section_15":""}
{"filename":"741339_1994.txt","cik":"741339","year":"1994","section_1":"ITEM 1. BUSINESS\nAltron is a leading contract manufacturer of interconnect products used in advanced electronic equipment. The Company manufactures complex products in the mid-volume sector of the electronic interconnect industry. Altron's products generally require greater engineering and manufacturing expertise than mass- produced, less complex products. The Company manufactures custom-designed backplanes, surface mount assemblies and total systems, as well as multilayer, high density printed circuit boards. Altron works closely with its customers from the early stages of product design and development. The Company provides original design, engineering prototype, preproduction and volume production capabilities.\nAltron believes its capabilities both in manufacturing multilayer, high density printed circuit boards and in providing value added contract manufacturing services advantageously position the Company to serve high growth OEMs in the rapidly changing electronics markets. Altron's OEM customers include a diversified base of manufacturers in the telecommunications, data communications, computer, industrial and medical systems segments of the electronics industry, such as AT&T Corp., Cabletron Systems, Inc., Cascade Communications Corp., Cisco Systems, Inc., Data General Corporation, EMC Corporation, General Datacomm Industries, Inc., General Electric Company, Hewlett-Packard Company, Motorola, Inc., Pyramid Technology Corporation, Siemens Rolm Communications, Inc., Silicon Graphics, Inc., and Stratacom, Inc.\nAltron's strategy is to continue to use its well established high technology printed circuit board manufacturing and engineering capabilities to further expand into the rapidly growing contract manufacturing business, providing products and services including backplanes, surface mount assemblies, power supplies and total systems. Key elements of this strategy include providing its customers with the highest levels of quality, superior service and leading edge technology. In fiscal 1994, approximately 61% of Altron's net sales were attributable to value added contract manufacturing, with the remaining 39% of net sales attributable to printed circuit board manufacturing.\nELECTRONIC INTERCONNECT INDUSTRY OVERVIEW\nMultilayer, High Density Printed Circuit Boards. According to The Institute for Interconnecting and Packaging Electronic Circuits (\"IPC\"), the United States printed circuit board market was approximately $6 billion in 1994, of which approximately $4.9 billion was attributable to independent manufacturers like Altron. IPC's data also shows that this market grew approximately 10% in 1994, with multilayer, high density printed circuit boards, the fastest growing segment, accounting for approximately 62% of the 1994 market. IPC estimates that the percentage of the printed circuit board market available to independent printed circuit board manufacturers, such as Altron, has increased from 66% to 82% since 1991.\nValue Added Contract Manufacturing. According to IPC, the United States value added contract manufacturing market was approximately $9.4 billion in 1994 and is growing about 20% per year. Based on industry data, the Company believes that OEMs are increasingly relying upon independent manufacturers of complex electronic interconnect products, such as Altron, rather than on in-house (\"captive\") production. OEMs which have discontinued or curtailed domestic captive printed circuit board or backplane production since 1990 include AT&T Corp., Data General Corporation, Digital Equipment Corporation, General Electric Company, GTE Corporation, Hewlett-Packard Company, Northern Telecomm Limited, Raytheon Company, Unisys Corporation, and Xerox Corporation. Altron believes that the current trend towards increased reliance by OEMs on independent manufacturers reflects the OEMs' recognition that, for complex electronic interconnect products, independent manufacturers can provide greater specialization, expertise, responsiveness and flexibility and can offer shorter delivery cycles than can be achieved by internal production.\nOther factors which lead OEMs to utilize contract manufacturers include:\nReduced Time-to-Market. Due to intense competitive pressures in the electronics industry, OEMs are faced with increasingly shorter product life-cycles and therefore have a growing need to reduce the time required to bring a product to market. OEMs can reduce their time to market by using a contract manufacturer's established manufacturing expertise and infrastructure.\nReduced Capital Investment Requirements. As electronic products have become more technologically advanced, the manufacturing process has become increasingly sophisticated and automated, requiring a greater level of investment in capital equipment. By using contract manufacturers, OEMs can reduce their overall capital equipment requirements while maintaining access to advanced manufacturing facilities.\nFocused Resources. Because the electronics industry is experiencing greater levels of competition and rapid technological change, many OEMs increasingly are seeking to focus their resources on activities and technologies in which they add the greatest value. By offering comprehensive electronic assembly and turnkey manufacturing services, contract manufacturers allow OEMs to focus on core technologies and activities such as product development, marketing and distribution.\nAccess to Leading Manufacturing Technology. Electronic interconnect products and electronic interconnect product manufacturing technology have become increasingly sophisticated and complex, making it difficult for OEMs to maintain the necessary technological expertise in process development and control. OEMs are motivated to work with a contract manufacturer in order to gain access to the contract manufacturer's process expertise and manufacturing know-how.\nImproved Inventory Management and Purchasing Power. Electronics industry OEMs are faced with increasing difficulties in planning, procuring and managing their inventories efficiently due to frequent design changes, short product life-cycles, large investments in electronic components, component price fluctuations and the need to achieve economies of scale in materials procurement. OEMs can reduce production costs by using a contract manufacturer's volume procurement capabilities. By utilizing a contract manufacturer's expertise in inventory management, OEMs can better manage inventory costs and increase their return on assets.\nBUSINESS STRATEGY\nIn response to the foregoing industry trends, Altron has transitioned its business from primarily supplying printed circuit boards to producing sophisticated value added electronic interconnect products.\nAltron's business strategy encompasses several elements:\n. Focus on quality. The Altron team strives to insure the highest levels of quality control in all phases of its operations, as quality is a critical competitive factor in the electronic interconnect market. The Company strives for continuous improvement of its processes and has adopted a number of quality improvement and measurement techniques to improve its performance. Altron's two principal plants are ISO 9002 registered.\n. Provide service oriented manufacturing. The Company manufactures almost all of the printed circuit boards used in its total systems, surface mount assemblies and custom designed backplanes in order to maintain control over costs, quality and timely delivery of its products. This vertical integration also allows the Company to provide a broader range of assembly services, including prototype and high technology products.\n. Maintain technology leadership. Altron seeks to deliver advanced manufacturing and test engineering, responsive materials management, and technologically advanced, flexible and service-oriented manufacturing for the complex, leading-edge products of its OEM customers throughout the full product life cycle.\n. Target high value added electronic interconnect products. Altron focuses on leading manufacturers of advanced electronic equipment who generally require custom-designed, more complex interconnect products and short lead-time manufacturing services such as quick turn multilayer printed circuit boards, backplanes and surface mount assemblies and in-house power supply and total systems design. By focusing on such customer needs, Altron has been able to achieve higher margins than many other participants in the electronic interconnect industry.\n. Maintain a diversified customer base. Altron services a diversified customer base spread over a variety of growing industry segments, including more than 100 customers in the telecommunications, data communications, computer, industrial and medical systems segments of the electronics industry. During fiscal 1994, in aggregate Altron's twelve largest customers accounted for approximately 57% of the Company's net sales.\n. Pursue a \"partnership\" approach with customers. Altron seeks to establish \"partnerships\" with its customers by involving Altron engineers and staff in the early design stages of its customers' product development, and by providing quick-turnaround manufacturing services and just-in-time, kanban and dock-to-stock delivery. Through this approach, Altron seeks to forge lasting customer relationships across a number of products and through multiple product generations.\nPRODUCTS AND SERVICES\nAltron produces total systems, surface mount assemblies, custom designed backplanes and multilayer printed circuit boards that are used in the manufacture of sophisticated electronic equipment. For fiscal 1994, Altron's sales of value added contract manufacturing products such as total systems, surface mount assemblies and custom designed backplanes grew 37% and accounted for approximately 61% of total sales. For fiscal 1994, Altron's sales of printed circuit boards grew approximately 10% and accounted for approximately 39% of total sales. Approximately 85% of Altron's printed circuit board sales in fiscal 1994 were sales of multilayer, high density printed circuit boards.\nTotal systems include printed circuit board assemblies, backplanes, card racks, and power supplies that are enclosed in housings, which are usually fabricated from steel or aluminum. Altron has developed a highly sophisticated mechanical design capability to provide its customers with design services. This capability allows Altron to establish a close partnership with its customers and gives Altron visibility for potential future customer requirements.\nCustom designed backplanes are assemblies of stamped and plated pins, plastic housings and other components on multilayer or two-sided printed circuit boards. Backplanes are used in electronic systems to distribute power and ground, and to connect printed circuit boards which plug into the backplane with other printed circuit boards, power supplies, and other circuit elements. They also are used to transfer information into and out of the system. As semiconductor speeds have increased and design requirements have become more stringent, backplane complexity has increased significantly, often requiring the use of large multilayer printed circuit boards of six or more layers. The Company manufactures backplanes with up to 32 layers, .300 inches thick, and 2 feet by 3 feet in size. Altron has recently added a complete fine-pitch surface mount assembly operation to its backplane assembly capabilities, and also uses press-fit technologies in backplane assembly.\nSurface mount assembly is a largely automated advanced interconnect technology that involves placing semiconductor components directly on the surface of both sides of a printed circuit board. This surface mount technology (\"SMT\") allows the leads on integrated circuits and other electronic components to be soldered to the surface of the backplane assembly or printed circuit board rather than being inserted into holes, thereby accommodating a substantially higher number of leads than can be accommodated with less sophisticated pin-through-hole technology. More leads permit the printed circuit board to interconnect a greater density of components, which permits a reduction in the size of the backplane assembly or printed circuit board.\nAdditionally, SMT allows components to be placed on both sides of the printed circuit board, thereby permitting even greater density.\nMultilayer printed circuit boards consist of three or more layers of a printed circuit board laminated together and interconnected by plated-through holes. Printed circuit boards consist of metallic interconnecting paths on a non-conductive material, typically laminated epoxy glass. Holes drilled in the laminate and plated through with conductive material from one surface to another, called plated-through holes, are used to receive component leads and to interconnect the circuit layers. Multilayer boards increase packaging density, improve power and ground distribution, and permit the use of higher speed circuitry. The development of electronic components with increased speed, higher performance and smaller size has stimulated a demand for multilayer printed circuit boards, as they provide increased reliability, density and complexity. Since even the most sophisticated two-sided printed circuit boards cannot meet the requirements of today's circuit designers for packaging density, an increasing number of designs use multilayer technology.\nMANUFACTURING CAPABILITIES AND SERVICES\nAltron seeks to establish \"partnerships\" with its customers by providing high quality, responsive, flexible manufacturing capabilities and services which include:\nAdvanced Manufacturing Equipment. Altron's concentration on more complex electronic interconnect products has necessitated a substantial capital investment in advanced equipment and the continued introduction of new manufacturing processes. Altron has established an engineering capability to select and implement the latest manufacturing technology. For example, the fine lead spacing or \"pitch\" in SMT requires an exacting printed circuit board manufacturing and assembly process, and Altron has state-of-the-art surface mount assembly operations in all three of its plants. The Company also uses numerically controlled pin installation and high voltage electrical test equipment in its backplane assembly manufacturing, and has developed a design and manufacturing capability for controlled impedance multilayer printed circuit boards and backplane assemblies. Altron's printed circuit board manufacturing operations also require state-of-the-art equipment and processes, and Altron has a computerized artwork generation system, numerically controlled drillers and routers, automatic electroless deposition, dry film photo-imaging, automatic gold plating, computerized electrical testing and automatic optical inspection. In addition, Altron has seven SMT machines, as well as Hewlett- Packard and GenRad Test Equipment, new Nitrogen blanket flow soldering equipment, and two automatic axial lead assembly lines. All three of Altron's plants are staffed with highly experienced SMT engineering and manufacturing teams which provide cost effective, high quality, assembled printed circuit boards, backplanes and total systems.\nValue Added Contract Manufacturing. Computer integrated manufacturing (\"CIM\") services provided by Altron consist of developing manufacturing processes and tooling and test sequences for new products from product designs received from customers. In addition, Altron's interconnect products division provides design and engineering services in the early stages of product development, thus assuring that both mechanical and electrical considerations are integrated into a total system approach to achieve a producible, high quality and cost effective product. Altron also evaluates customer designs for manufacturability and, when appropriate, recommends design changes to reduce manufacturing costs or lead times or to increase manufacturing yields and the quality of finished backplane assemblies and printed circuit boards.\nQuick-turnaround. Altron's quick-turnaround manufacturing capabilities allow it to better serve the needs of its customers for quick response to their product designs. Shorter customer product life cycles and the need to bring new products to market quickly have created a demand for small quantities of complex multilayer printed circuit boards delivered in relatively short periods of time, typically from three to ten days. Sales of printed circuit boards produced in this manner accounted for approximately 21% of the Company's printed circuit board sales in fiscal 1994. After engineering of an interconnect product is completed, Altron has the capability to manufacture prototype or preproduction versions of such product on a quick-turnaround basis. Altron expects that the demand for engineering and quick-turnaround prototype and preproduction\nmanufacturing services will increase as OEMs' products become more complex and as product life cycles shorten. The Company's continued success depends upon its ability to respond to the evolving needs of customers in a timely manner.\nMultilayer Printed Circuit Board Manufacturing. Altron's ability to manufacture printed circuit boards, including large, complex multilayer printed circuit boards with close tolerance plated-through hole diameters and other characteristics important to backplane applications, is one of the major factors that has enabled it to become an important supplier of complex, technologically advanced backplane assemblies and multilayer printed circuit boards to the electronics industry. The Company began manufacturing multilayer boards in 1979 and in fiscal 1994 multilayer sales constituted 85% of the Company's printed circuit board revenues. Today Altron is capable of efficiently producing commercial quantities of printed circuit boards with up to thirty two layers and circuit track widths as narrow as four mils.\nThe manufacture of complex multilayer interconnect products often requires the use of sophisticated circuit interconnections between certain layers (called \"blind or buried vias\") and adherence to strict electrical characteristics to maintain consistent circuit transmission speeds (referred to as \"controlled impedance boards\"). These technologies require very tight lamination and etching tolerances and are especially critical for printed circuit boards with ten or more layers. The Company specializes in multilayer boards requiring controlled impedance, and has developed the ability to manufacture large, thick multilayer backplane boards using Cyanate Ester and GETEK base materials for ultra high speed applications. By concentrating on the multilayer segment of the printed circuit board market, where quality, technology and customer service are more important than in the market for less complex boards, the Company faces less direct competition.\nThe manufacture of printed circuit boards involves several steps including dry film imaging, photoimageable soldermask processing, computer controlled drilling and routing, automated plating and process controls and achievement of controlled impedance. Manufacture of printed circuit boards used in backplane assemblies requires specialized expertise and equipment because of the size of the backplane relative to other printed circuit boards and the closer hole diameter tolerances required for press-fit pin assembly. Multilayer manufacturing, which involves placing multiple layers of electrical circuitry within a single printed circuit board or backplane, expands the number of circuits and components that can be contained on the interconnect product and increases the operating speed of the system by reducing the distance that electrical signals must travel. Increasing the density of the circuitry in each layer is accomplished by reducing the width of the circuit tracks and placing them closer together on the printed circuit board or backplane. Interconnect products having narrow, closely spaced circuit tracks are known as \"fine line\" products.\nMaterials Procurement and Handling. Materials procurement and handling services provided by Altron include planning, purchasing and warehousing of electronic components and metal housings used in interconnect products. Altron uses a variety of materials in the manufacture of its products, including copper clad laminates, dry film photo resists, connectors, terminals and pins.\nThe Company maintains more than one supply source wherever possible, however, a component for a major OEM contract is obtained from a single source. An interruption or loss of this component supply could have a material adverse effect on the Company's business and results of operations.\nISO 9002 Registration. Altron's Wilmington, Massachusetts plant and its surface mount assembly operations in its Fremont, California plant are ISO 9002 registered. The Company is currently pursuing such registration for its other operations. ISO 9002 registration, which is based on successful implementation of quality assurance requirements and includes continuous examination of every aspect of the Company's business and compliance audits conducted by an independent quality assessor, provides for worldwide acceptance of Altron's quality systems. Altron was one of the first companies in the electronic interconnect industry to achieve ISO 9002 registration. This achievement has been well received by Altron customers, as certain customers will only do business with ISO 9002 registered companies.\nCUSTOMERS AND MARKETS\nAltron's twenty-five years of experience is an important factor in attracting and retaining customers, as its business is not protected by any patents. Altron services a diversified customer base spread over a variety of growing industry segments, including more than 100 customers in the telecommunications, data communications, computer, industrial and medical systems segments of the electronics industry. The following table illustrates the major industry segments served by Altron and the products and services provided by the Company to certain OEM customers.\nAltron seeks to serve a sufficiently large and varied group of customers to avoid dependence on any one major customer or industry segment. For the year ended December 31, 1994, one of the Company's customers, Motorola, Inc., accounted for approximately 13% of the Company's revenues. In addition, in aggregate the Company's twelve largest customers (including Motorola, Inc.) accounted for approximately 57% of the Company's revenues during such period.\nThe Company markets its products and services through its marketing and customer service organization of 39 employees, and utilizes 17 independent sales representative organizations located in the major electronics market areas in the United States.\nCOMPETITION\nThe electronic interconnect industry, which includes contract manufacturing, is highly fragmented and is characterized by intense competition. Altron competes in the technologically advanced segment of the electronic interconnect industry, which is also highly competitive but is less fragmented than the industry as a whole. The Company competes against numerous domestic electronic interconnect product manufacturers. In addition, current and prospective customers continually evaluate the merits of manufacturing products internally and will from time to time offer manufacturing services to third parties in order to utilize excess capacity. Certain of the Company's competitors have substantially greater manufacturing, financial and marketing resources than the Company. The Company may be operating at a cost disadvantage compared to manufacturers who have greater direct buying power with component suppliers or who have lower cost structures. During downturns in the electronics industry, OEMs may become more price sensitive.\nThe Company believes that the principal competitive factors in the electronic interconnect industry are quality, service, technology, manufacturing capability, regional access, price, reliability, timeliness and flexibility. There can be no assurance that competition from existing or potential competitors will not have a material adverse effect on the Company's results of operations.\nThe introduction of lower priced competitive products or significant price reductions by the Company's competitors could result in price reductions that would adversely affect the Company's results of operations, as would the introduction of new technologies which would render existing electronic interconnect technology less competitive or obsolete.\nBACKLOG\nAltron's sales are made principally through purchase orders for current needs. The Company's backlog at February 25, 1995 was approximately $41.5 million compared to approximately $27.0 million at February 26, 1994, the majority of which was scheduled to be shipped within 120 days. Variations in the size and delivery schedules of purchase orders received by the Company, as well as changes in customers' delivery requirements, may result in substantial fluctuations in backlog from period to period; accordingly, the Company believes that backlog cannot be considered a meaningful indicator of long-term future financial results.\nEMPLOYEES\nThe Company had 925 full-time employees as of December 31, 1994. The employees are not represented by a union, and the Company believes its employee relations to be satisfactory. A majority of Company management, officers and executives have over five years of service with the Company.\nENVIRONMENTAL QUALITY\nProper waste disposal is a major consideration for printed circuit board manufacturers because metals and chemicals are used in the manufacturing process. Water used in the printed circuit board manufacturing process must be treated to remove metal particles and other contaminants before it can be discharged into the municipal sanitary sewer system. Altron has an existing waste treatment system at its Wilmington plant which enables it to comply with governmental regulations relating to the protection of the environment and accommodate anticipated future growth. The Company believes that continued compliance with governmental requirements relating to protection of the environment will not have a material adverse effect on the Company.\nAltron has been advised that contamination resulting from activities of prior owners of an adjacent property has migrated under the Company's manufacturing plant in Wilmington, Massachusetts. The present owner of the adjacent property has assumed responsibility for any remediation activities that may be required and has agreed to indemnify and hold the Company harmless from liabilities and expenses arising from any requirement that the contamination be remediated. Although the Company believes that the present owner's assumption of responsibility will result in no remediation costs to the Company from the contamination, there can be no assurance that the Company will not be subject to some costs regarding this matter.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company are as follows:\nMR. ALTSCHULER, a founder of the Company, has been President and a Director of the Company since 1970. In December 1983, Mr. Altschuler was elected Chairman of the Board of Directors. Mr. Altschuler is also a director of MASSBANK Corp.\nMR. DOO, a founder of the Company, has been a Director of the Company since 1970. He was Treasurer from 1973 to 1992 and Senior Vice President from 1978 to December 1983. In December 1983, he was elected Executive Vice President. Mr. Doo has been President of Altron Systems Corporation since its inception.\nMR. BRENNAN has been Chief Financial Officer and Treasurer since June 1992. He has been Vice President of Finance and Corporate Controller since he began his employment with the Company in 1987.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAltron operates a 185,000 square foot manufacturing plant in Wilmington, Massachusetts which is approximately 15 miles north of Boston. The plant produces multilayer printed circuit boards and interconnect products. Altron believes that this plant is one of the largest independent facilities of its kind in the United States. In 1994, Altron began leasing a 70,000 square foot facility in Fremont, California to manufacture interconnect systems, surface mount assemblies and backplanes for its West Coast customers. Also in 1994, Altron leased a 30,000 square foot plant in Woburn, Massachusetts for the design and manufacture of interconnect systems, surface mount assemblies and power supplies. The Company believes that its existing facilities are adequate for its current needs. See \"--Environmental Quality.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTo the Company's knowledge there are no pending legal proceedings which are material to the Company to which it 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\nThere were no matters submitted during the fourth quarter of the fiscal year covered by this report to a vote of security holders through solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe following table sets forth, for the periods indicated, the range of high and low sale prices for the Company's common stock in 1994 and 1993 on The Nasdaq Stock Market's National Market. Prices of the Company's common stock have been retroactively restated to reflect the three-for-two splits of its common stock distributed February 10, 1995 and September 3, 1993. The Company's common stock has been traded under the Nasdaq symbol ALRN since the initial public offering on August 8, 1984.\nThe Company has not paid any cash dividends on its common stock and its Board of Directors presently intends to continue this policy in order to retain earnings for the development of the Company's business. As of December 31, 1994, there were approximately 5,000 beneficial shareholders of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe income statement data for each of the years in the three-year period ended December 31, 1994 and balance sheet data as of January 1, 1994 and December 31, 1994 are derived from the audited Consolidated Financial Statements included elsewhere in this Form 10-K. The income statement data for each of the years in the two-year period ended December 28, 1991 and the balance sheet data as of December 29, 1990, December 28, 1991, and January 2, 1993, are derived from audited Consolidated Financial Statements not included in this Form 10-K. The information set forth below should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" the Consolidated Financial Statements, related Notes and other financial information included elsewhere in this Form 10-K.\n-------- (1) Adjusted to reflect the three-for-two splits of the Company's common stock effected February 10, 1995 and September 3, 1993. See Note 8 of Notes to Consolidated Financial Statements. (2) Reflects the June 9, 1994 acquisition of Astrio, a manufacturer of complex surface-mount assemblies, for $4,685,000, including $3,000,000 in cash and 167,108 shares of Common Stock. In connection with said acquisition, the Company also assumed $1,565,000 in liabilities and incurred $64,000 in acquisition costs. See Note 2 to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the Selected Consolidated Financial Data and the Consolidated Financial Statements and Notes thereto contained elsewhere herein.\nPrinted circuit boards manufactured by the Company and used in its assembly operations are included in value added contract manufacturing sales. Printed circuit board sales represent sales to third parties.\nOn June 9, 1994, Altron acquired Astrio, a manufacturer of complex surface mount assemblies, for $4,685,000, including $3,000,000 in cash and 167,108 shares of Common Stock (the \"Astrio Acquisition\").\nThe following table sets forth for the periods indicated the percentage of net sales represented by each line item in the Company's statements of income:\nRESULTS OF OPERATIONS\nFISCAL 1994 COMPARED TO FISCAL 1993\nNet sales for 1994 increased 25% to $104.2 million from net sales of $83.4 million for 1993. The increase was primarily the result of increased shipments to the Company's largest customers in the data communications, telecommunications and computer segments of the electronics industry, as well as shipments to new customers in these industries. Improvement in general economic conditions in the electronics industry has resulted in overall growth for the Company's major customers in these industries. Data communications and telecommunications customers accounted for approximately 54% of net sales in each of 1994 and 1993. The Company's largest customer in each of 1994 and 1993 was Motorola, Inc., which accounted for approximately 13% of net sales in each year.\nValue added contract manufacturing sales for 1994 increased 37% to $63.1 million or approximately 61% of net sales, compared to 1993 value added contract manufacturing sales of $46.1 million or 55% of net sales. Of the $17.0 million increase, $5.9 million is attributable to the Astrio Acquisition. Printed circuit board sales for 1994 increased 10% to $41.1 million or approximately 39% of net sales, compared to 1993 printed circuit board sales of $37.3 million or 45% of net sales. Although the printed circuit board business will continue to be an important part of the Company's operations, management believes that printed circuit board sales growth will not keep pace with the sales growth anticipated in the value added contract manufacturing business for the foreseeable future.\nGross profit for 1994 increased 41% to $23.0 million from $16.4 million in 1993. Gross margin as a percentage of net sales for 1994 increased to 22.1% as compared to 19.6% in 1993. The improvement in the Company's gross margin was primarily a result of better absorption of fixed costs due to higher shipment\nlevels, and was also due to manufacturing efficiencies gained through productivity and product yield improvements resulting from additional automated manufacturing systems and processes. Although there can be no assurance that the Company can maintain its current gross margin, management expects to focus on market niches and product mix where there is less competitive pricing pressure and to continue to improve productivity, yields and utilization.\nSelling, general and administrative expenses increased 18% to $8.6 million in 1994 from $7.3 million in 1993. Selling, general and administrative expenses as a percentage of net sales decreased to 8.3% in 1994 from 8.8% in 1993. The increase of $1.3 million in 1994 over 1993 was primarily due to added selling, general and administrative expenses attributable to the Astrio operations since the acquisition. The decline in selling, general and administrative expenses as a percentage of net sales was principally the result of higher net sales combined with management's ability to control expenses.\nOther income for 1994 increased $152,000 to $261,000 from other income of $109,000 in 1993. This increase was principally due to increased interest income which resulted from higher rates of return earned on investments and higher cash balances available for investment. Interest expense for 1994 decreased to $574,000 from $582,000 in 1993. This decrease resulted from a reduced mortgage interest rate which was partially offset by higher term loan borrowings.\nThe Company's effective tax rate in 1994 and 1993 reflects a provision of 40% of pretax income.\nFISCAL 1993 COMPARED TO FISCAL 1992\nNet sales for 1993 increased 22% to $83.4 million from net sales of $68.2 million in 1992. This increase was primarily the result of a higher volume of shipments to existing customers and shipments to major new customers in the data communications and telecommunications segments of the electronics industry. Value added contract manufacturing sales for 1993 increased 21% to $46.1 million or 55% of net sales, compared to 1992 value added contract manufacturing sales of $38.1 million or 56% of net sales. Printed circuit board sales for 1993 increased 24% to $37.3 million or 45% of net sales, compared to 1992 printed circuit board sales of $30.1 million or 44% of net sales. During 1993, the Company continued to experience pricing pressures from excess capacity in the industry.\nGross profit for 1993 increased 71% to $16.4 million from $9.6 million in 1992. Gross margin as a percentage of net sales for 1993 increased to 19.6% as compared to 14.1% in 1992. The improvement in the Company's gross margin was due to a higher volume of shipments, product mix, recovery of fixed costs over higher volume and improvements in operating efficiencies resulting primarily from productivity and yield improvements. These increases more than offset the lower pricing which resulted from excess capacity in the industry.\nSelling, general and administrative expenses increased 4% to $7.3 million in 1993 from $7.0 million in 1992. Selling, general and administrative expenses as a percentage of net sales decreased to 8.8% in 1993 from 10.3% in 1992. The increase of $282,000 in 1993 over 1992 was due primarily to higher sales commission costs on increased commissionable sales made by independent sales representatives. The improvement in selling, general and administrative expenses as a percentage of net sales was principally the result of higher net sales.\nOther income for 1993 was approximately the same as for 1992. Interest expense for 1993 decreased to $582,000 from $613,000 in 1992. This decrease resulted from a reduced mortgage interest rate, lower borrowings under the line of credit and higher interest capitalized, which were partially offset by higher term loan borrowings.\nThe Company's effective tax rate in 1993 and 1992 reflects a provision of 40% of pretax income.\nLIQUIDITY AND CAPITAL RESOURCES\nIn 1994, the Company funded its growth primarily from cash generated from operations. These funds were sufficient to meet increased working capital needs, capital expenditures of approximately $7.0 million, and to fund the Astrio Acquisition which utilized $3.0 million in cash.\nAt December 31, 1994, the Company had working capital of $24.5 million compared to working capital of $21.5 million at January 1, 1994. Cash and cash equivalents and short term investments at December 31, 1994 were $10.3 million compared to $8.9 million at January 1, 1994.\nAt December 31, 1994, the Company had a $5.0 million unsecured line of credit with its bank, all of which was available.\nOn February 10, 1995, the Board of Directors adopted a resolution to increase the authorized shares of Common Stock outstanding from 10,000,000 shares to 30,000,000 shares with a par value of $.05 per share. The proposal will be submitted for approval by the stockholders at a special meeting scheduled to be held March 31, 1995.\nThe Company believes that its existing bank credit and working capital, together with cash generated from operations, will be sufficient to satisfy anticipated sales growth and investment in manufacturing facilities and equipment. The Company had commitments for approximately $1.5 million of capital expenditures as of December 31, 1994. Management anticipates that capital expenditures in 1995 will approximate 1994 capital expenditures. On March 29, 1995, the Company filed a Registration Statement on Form S-3 to register shares of its common stock with the Securities and Exchange Commission.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Altron Incorporated:\nWe have audited the accompanying consolidated balance sheets of Altron Incorporated (a Massachusetts corporation) and subsidiary as of January 1, 1994 and December 31, 1994 and the related consolidated income statements, statements of stockholders' investment and cash flows for the years ended January 2, 1993, January 1, 1994 and December 31, 1994. 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 Altron Incorporated and Subsidiary as of January 1, 1994 and December 31, 1994, and the results of their operations and their cash flows for the years ended January 2, 1993, January 1, 1994 and December 31, 1994 in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index at item 14(a)(2) is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. The schedule has been subjected to the auditing procedures applied in our audits of the basic financial statements and, in our opinion, fairly states, 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 LLP\nBoston, Massachusetts March 2, 1995\nALTRON INCORPORATED AND SUBSIDIARY\nCONSOLIDATED BALANCE SHEETS\nJANUARY 1, 1994 AND DECEMBER 31, 1994\nThe accompanying notes are an integral part of these consolidated financial statements.\nALTRON INCORPORATED AND SUBSIDIARY\nCONSOLIDATED INCOME STATEMENTS\nFOR THE YEARS ENDED JANUARY 2, 1993, JANUARY 1, 1994 AND DECEMBER 31, 1994\nThe accompanying notes are an integral part of these consolidated financial statements.\nALTRON INCORPORATED AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' INVESTMENT\nFOR THE YEARS ENDED JANUARY 2, 1993, JANUARY 1, 1994 AND DECEMBER 31, 1994\nThe accompanying notes are an integral part of these consolidated financial statements.\nALTRON INCORPORATED AND SUBSIDIARY\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nFOR THE YEARS ENDED JANUARY 2, 1993, JANUARY 1, 1994 AND DECEMBER 31, 1994\nSupplemental Disclosure of Noncash Investing Activities: (See Note 2).\nThe accompanying notes are an integral part of these consolidated financial statements.\nALTRON INCORPORATED AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1994\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS\nAltron Incorporated (\"the Company\") is a leading contract manufacturer of interconnect products used in advanced electronic equipment. The Company manufactures complex products in the mid-volume sector of the electronic interconnect industry including custom-designed backplanes, surface mount assemblies and total systems, as well as multilayer, high density printed circuit boards. Altron's customers include a diversified base of manufacturers in the telecommunications, data communications, computer, industrial and medical systems segments of the electronics industry.\nOn June 9, 1994, Altron Systems Corporation, a wholly-owned subsidiary, completed the acquisition of Astrio Corporation, a manufacturer of complex surface mount assemblies. The acquisition has been accounted for as a purchase, and the results of operations have been included in the accompanying consolidated income statements from the date of acquisition.\nFISCAL YEAR\nThe Company's fiscal year ends on the Saturday closest to December 31. In the financial statements, \"1992\" refers to the year ended January 2, 1993; \"1993\" refers to the year ended January 1, 1994; and \"1994\" refers to the year ended December 31, 1994. Operations for fiscal year 1992 include 53 weeks while all other years presented include 52 weeks.\nPRINCIPLES OF CONSOLIDATION\nThe accompanying consolidated financial statements include the accounts of the Company and Altron Systems Corporation, its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation.\nREVENUE RECOGNITION\nThe Company recognizes product sales upon shipment.\nCASH AND CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS\nThe Company considers all highly liquid investment instruments purchased with a maturity of three months or less to be cash equivalents. Short-term investments are carried at cost, which approximates market value, and have maturities of less than one year.\nThe Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" This statement addresses the accounting and reporting for investments in marketable equity securities that have readily determinable fair values and for all investments in debt securities.\nThe Company classifies its investment in commercial paper and short-term treasury bills as held-to-maturity given the Company's intent and ability to hold the securities to maturity. In accordance with the statement, held-to- maturity securities are carried at amortized cost.\nIn October 1994, the Financial Accounting Standards Board issued SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\", which is effective for fiscal years ending after December 15, 1994. As of December 31, 1994, the Company had no financial instruments requiring disclosure under SFAS No. 119.\nALTRON INCORPORATED AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1994\nNET INCOME PER COMMON AND COMMON EQUIVALENT SHARE\nNet income per common and common equivalent share was computed based on the weighted average number of common and common equivalent shares outstanding during each year. Common equivalent shares include outstanding stock options. Fully diluted net income per share has not been separately presented as it would not be materially different from net income per share as presented.\n(2) ACQUISITION\nOn June 9, 1994, Altron Systems Corporation, a wholly owned subsidiary, completed the acquisition of Astrio Corporation, a manufacturer of complex surface-mount assemblies, for $4,685,000 consisting of $3,000,000 cash and $1,685,000 in Altron's common stock (167,108 shares). In addition, $1,565,000 in liabilities were assumed and related acquisition costs of $64,000 were incurred.\nThe acquisition has been accounted for as a purchase, and the results of operations of Altron Systems Corporation since June 9, 1994 have been included in the accompanying consolidated income statements. The aggregate cost of the acquisition exceeded the estimated fair value of the acquired net assets by $4,154,000 which is being amortized on a straight-line basis over an estimated useful life of 15 years. The allocation of the purchase price was based on the fair value of the net assets acquired and is subject to adjustment. The Company continually assesses whether a change in circumstances has occurred subsequent to the acquisition that would indicate that the future useful life of the asset (Costs in Excess of Net Assets of Acquired Company) should be revised. The Company considers the future earnings potential of the original business in assessing the recoverability of this asset.\nThe following table presents selected financial information for the Company and its subsidiary on a proforma basis, assuming the companies had been combined as of January 3, 1993. The proforma results are not necessarily indicative of the actual results or future results of operations that would have occurred had the acquisition been made on January 3, 1993.\n(3) INVENTORIES\nInventories are stated at the lower of cost (first-in, first-out method) or market. Cost includes materials, labor and manufacturing overhead. Inventories are summarized as follows:\nALTRON INCORPORATED AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1994 (4) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are recorded at cost and consist of the following:\nThe Company provides for depreciation using the straight-line method over the estimated useful lives of 7 to 40 years for buildings and improvements and 3 to 8 years for equipment.\n(5) INCOME TAXES\nEffective January 3, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" which requires the liability method of accounting. This accounting change had no material effect on net income or net worth.\nThe provision for income taxes shown in the accompanying statements of income consists of the following (in thousands):\nThe Company had federal and state income taxes currently payable of $81,000 and $154,000 at January 1, 1994 and December 31, 1994, respectively.\nA reconciliation of the Company's effective income tax rate and the statutory federal income tax rate is as follows:\nALTRON INCORPORATED AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1994\nThe tax effects of temporary differences included in other current assets as of January 1, 1994 are $420,000 for inventory and receivables, $533,000 for accruals, $72,000 for non-qualified stock options and $120,000 for other net differences. The temporary differences as of December 31, 1994 are $555,000 for inventory and receivables, $615,000 for accruals, $72,000 for non-qualified stock options and $37,000 for other net differences.\nDeferred income taxes as of January 1, 1994 and December 31, 1994 are $3,561,000 and $4,044,000, respectively, and resulted principally from the difference between book and tax depreciation methods.\nFor 1993 and 1994, the Company realized tax benefits of $1,265,000 and $408,000, respectively, for disqualifying dispositions of stock options exercised which are deemed compensation for tax purposes. For financial reporting purposes, the benefit is accounted for as a credit to paid-in capital rather than as a reduction of income tax expense.\n(6) LONG AND SHORT-TERM DEBT\nLong-term debt consists of the following (in thousands):\nMaturities of long-term debt are as follows (in thousands):\nTEN-YEAR REAL ESTATE MORTGAGE NOTE\nIn October 1993, the Company renegotiated its ten-year, first mortgage note with a bank. Under the amended terms, the loan is payable in monthly installments of principal and interest of $37,300 at a fixed interest rate of 5.97% for three years, at which time the interest rate will be renegotiated. The Company's facility, located in Wilmington, Massachusetts, is the security for this loan.\nUNSECURED TERM LOANS\nOn May 29, 1992, the Company borrowed $3,000,000 under a five-year, unsecured term loan agreement with quarterly principal payments of $150,000 and monthly interest payable at 7.5%. On September 15, 1993, the Company borrowed a $3,000,000 three-year unsecured term loan at an interest rate of 5.8% payable monthly, and principal payable on September 15, 1996, under an amendment to its term loan agreement with its bank. The term loan agreement contains provisions that the Company maintain certain financial ratios and covenants which the Company met as of January 1, 1994 and December 31, 1994.\nALTRON INCORPORATED AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1994\nSHORT-TERM DEBT\nThe Company has an unsecured line of credit with its bank of $5,000,000 at the bank's prime rate. There were no borrowings outstanding under the line of credit and the entire line was available at January 1, 1994 and December 31, 1994.\n(7) OPERATING LEASES\nThe Company leases computer equipment under noncancelable operating leases. Rental expense for computer leases was $33,000 in 1992, $37,000 in 1993 and $14,000 in 1994.\nThe Company rents manufacturing space under lease agreements. Aggregate minimum lease payments under the leases at December 31, 1994 are $342,000, $432,000, $552,000, $566,000 and $582,000 for each of the years 1995 through 1999, respectively, and $899,000 thereafter. Rental expense under the leases was $103,000 in 1992, $120,000 in 1993 and $210,000 in 1994.\n(8) STOCKHOLDERS' INVESTMENT\nOn August 3, 1993, the Board of Directors declared a three-for-two stock split of its common stock, effected as a 50% stock dividend, to shareholders of record on August 16, 1993 and distributed September 3, 1993. On January 5, 1995, the Board of Directors declared a three-for-two stock split of its common stock effected as a 50% stock dividend to shareholders of record on January 20, 1995 and distributed February 10, 1995. Share quantities and related per share amounts have been retroactively restated to reflect the stock splits.\nOn February 10, 1995, the Board of Directors adopted a resolution to increase the authorized shares of common stock outstanding from 10,000,000 shares to 30,000,000 shares with a par value of $.05 per share. The proposal will be submitted for approval by the stockholders at a special meeting scheduled to be held March 31, 1995.\nPREFERRED STOCK\nThe stockholders approved the authorization of 1,000,000 shares of preferred stock, $1 par value, on February 14, 1984. The preferred stock is divisible and issuable into one or more series. The rights and preferences of the different series may be established by the Board of Directors without further action by the stockholders. The Board of Directors is authorized, with respect to each series, to fix and determine, among other things: (i) the dividend rate, (ii) the liquidation preference, (iii) whether or not such shares will be convertible into, or exchangeable for, any other securities and (iv) whether or not such shares will have voting rights and, if so, the conditions under which such shares will vote as a separate class.\nSTOCK OPTIONS\nThe 1981 Stock Option Plan provided for incentive stock options granted at fair market value at the date of grant and nonqualified stock options granted at prices determined by the Board of Directors. All options under the plan are exercisable over a five-year period and expire 10 years from the date of grant. In December 1991, this plan terminated and at December 31, 1994, 64,200 shares were reserved.\nThe 1991 Stock Option Plan includes incentive stock options granted at fair market value at the date of grant and nonqualified stock options granted at prices determined by a committee of the Board of Directors. All options are exercisable over a five-year period, commencing 12 months from the date of grant unless\nALTRON INCORPORATED AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1994 accelerated and expire 10 years from the date of grant. On May 19, 1994 the stockholders approved an increase in the total number of shares of common stock reserved for issuance under the Plan to 1,200,000. At December 31, 1994, 901,575 shares of common stock were reserved for issuance.\nThe 1989 Nonqualified Stock Option Plan for Non-Employee Directors provided for options exercisable over five years commencing 12 months from the date of grant and expiring 10 years from the date of grant. At December 31, 1994, 18,000 shares were reserved.\nThe 1992 and 1993 Stock Option Plans for Non-Employee Directors provided for options exercisable over a two year period from the date of grant and expiring 10 years from the date of grant. The 1993 Stock Option Plan for Non-Employee Directors was approved by the stockholders on May 19, 1994. At December 31, 1994, 67,500 and 75,000 shares were reserved for the 1992 and 1993 Plans, respectively.\nThe following table summarizes the stock option activity for the three-year period ended December 31, 1994 (restated for the stock splits):\nOptions outstanding at December 31, 1994 expire between April 2, 1996 and December 12, 2004.\nCompensation on nonqualified stock options granted during 1993 amounted to $179,000. All options granted in 1994 were at fair market value.\nEMPLOYEE STOCK PURCHASE PLAN\nThe Company maintains an Employee Stock Purchase Plan which provides for two purchase periods during the Company's fiscal year. The purchase price of shares under the Plan is 90% of the lower of the fair market value at the beginning and the end of the period. Substantially all employees with more than one year of service are eligible to participate in the Plan. At December 31, 1994, 147,915 shares of common stock were reserved for issuance.\nALTRON INCORPORATED AND SUBSIDIARY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nDECEMBER 31, 1994\n(9) OTHER INCOME\nOther income consists of interest income of $13,000, $218,000 and $351,000 for the years ended 1992, 1993 and 1994, respectively and other income (expense), net of $95,000, $(109,000) and $(90,000) for these respective years.\n(10) INTEREST EXPENSE\nInterest expense was $709,000, $710,000 and $654,000 for the years ended 1992, 1993 and 1994, respectively, of which $96,000, $128,000 and $80,000 was capitalized to property, plant and equipment.\n(11) SIGNIFICANT CUSTOMERS\nFor 1992, no customer accounted for 10% or more of net sales. One customer, Motorola Inc., accounted for approximately 13% of net sales for 1993 and 1994.\n(12) EMPLOYEE BENEFIT PLAN\nThe Altron Savings and Investment Plan allows all full-time employees with at least one year of service with the Company to participate. Plan participants elect to have contributions made to the Plan under Section 401(k) of the Internal Revenue Code. Company contributions become vested at the rate of 20% for each year of service with the Company. Annual Company contributions to the plan are at the discretion of the Board of Directors and are discretionary in amount. The Company contributed approximately $134,000, $150,000 and $230,000 for the years 1992, 1993 and 1994.\nThe Company does not provide post-retirement benefits. Accordingly SFAS No. 106 \"Accounting for Post-Retirement Benefits Other Than Pensions\" has no impact upon the Company. The Company does not provide benefits for periods after employment but prior to retirement. Accordingly, SFAS No. 112 \"Employers' Accounting for Postemployment Benefits\" has no impact upon the Company.\n(13) QUARTERLY RESULTS (UNAUDITED)\nThe following summarized unaudited results of operations for the fiscal quarters in the years ended January 1, 1994 and December 31, 1994 have been accounted for using generally accepted accounting principles for interim reporting purposes and include adjustments (consisting of normal recurring adjustments) which the Company considers necessary for the fair presentation of results for these interim periods:\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot Applicable\nPART III\nThe information required by Items 10, 11, 12 and 13 is hereby incorporated by reference from the Registrant's definitive Proxy Statement for the 1995 Annual Meeting to be held on May 25, 1995.\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following documents are filed as a part of this Report:\n(1) Financial Statements included in Part II of this Report:\nReport of Independent Public Accountants\nConsolidated Income Statements for the fiscal years ended January 2, 1993, January 1, 1994 and December 31, 1994.\nConsolidated Balance Sheets as of January 1, 1994 and December 31, 1994.\nConsolidated Statements of Stockholders' Investment for the fiscal years ended January 2, 1993, January 1, 1994 and December 31, 1994.\nConsolidated Statements of Cash Flows for the fiscal years ended January 2, 1993, January 1, 1994 and December 31, 1994.\nNotes to Consolidated Financial Statements\n(2) Financial Statement Schedule Included in Part IV of this Report:\nSchedule II--Valuation and Qualifying Accounts\nSchedules other than those listed above have been omitted since they are either not required or the information is otherwise included.\n(3) Exhibits\nThe following exhibits are incorporated herein by reference:\n3.1 Articles of Organization of Registrant, as amended (filed as Ex- hibit 3.1 to the Registration Statement Form S-1 [Registration No. 2-89704]). 3.2 By-laws of Altron Incorporated as amended through March 12, 1990 (filed as Exhibit 3.2 to the Annual Report on Form 10-K for fis- cal year ended December 29, 1990). 10.1 Altron Incorporated Non-Qualified Stock Option Plan (filed as Ex- hibit 4B to the Registration Statement on Form S-8 [Registration No. 2-94712]). 10.2 Altron Incorporated 1981 Stock Option Plan (filed as Exhibit 4A to the Registration Statement on Form S-8 [Registration No. 2- 94712]). 10.3 First Amendment to Altron Incorporated 1981 Stock Option Plan (filed as Exhibit 4AA to Post-Effective Amendment No. 1 to Regis- tration Statement on Form S-8 [Registration No. 2-94712]). 10.4 Altron Incorporated Employee Stock Purchase Plan (filed as Ex- hibit 4A to the Registration Statement on Form S-8 [Registration No. 2-94713]).\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed during the fourth quarter of the fiscal year ended December 31, 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.\nAltron Incorporated\nBy: \/s\/ Samuel Altschuler ------------------------------- Samuel Altschuler President\nDate: March 28, 1995\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.\nNAME TITLE DATE ---- ----- ----\n\/s\/ Samuel Altschuler Chairman of the March 28, 1995 ------------------------------------- Board of Directors SAMUEL ALTSCHULER and President (principal executive officer)\n\/s\/ Burton Doo Executive Vice March 28, 1995 ------------------------------------- President and BURTON DOO Director\n\/s\/ Peter D. Brennan Vice President, March 28, 1995 ------------------------------------- Chief Financial PETER D. BRENNAN Officer and Treasurer (principal financial and accounting officer)\n\/s\/ Anthony J. Medaglia, Jr. Director March 28, 1995 ------------------------------------- ANTHONY J. MEDAGLIA, JR.\n\/s\/ Daniel A. Cronin, Jr. Director March 28, 1995 ------------------------------------- DANIEL A. CRONIN, JR.\n\/s\/ Thomas M. Claflin, II Director March 28, 1995 ------------------------------------- THOMAS M. CLAFLIN, II\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our report, included in this Form 10-K, into Altron Incorporated's previously filed Registration Statements on Form S-8 (File Nos. 2-94712, 2-94713, 33- 39744, 33-39980 and 33-45884).\nArthur Andersen LLP\nBoston, Massachusetts March 28, 1995\nSCHEDULE II\nALTRON INCORPORATED\nVALUATION AND QUALIFYING ACCOUNTS\n(IN THOUSANDS)\n-------- (1) Amounts deemed uncollectible.","section_15":""}
{"filename":"732712_1994.txt","cik":"732712","year":"1994","section_1":"Item 1. Business\nGENERAL\nBell Atlantic Corporation (the \"Company\" or \"Bell Atlantic\") is one of the seven regional holding companies (\"RHCs\") formed in connection with the court- approved divestiture (the \"Divestiture\"), effective January 1, 1984, of those assets of American Telephone and Telegraph Company (\"AT&T\") related to exchange telecommunications, exchange access functions, printed directories and cellular mobile communications.\nPursuant to the Divestiture, AT&T transferred to the Company, among other assets, its 100% ownership interest in seven Bell System operating companies (\"BOCs\"): New Jersey Bell Telephone Company; The Bell Telephone Company of Pennsylvania; The Diamond State Telephone Company; The Chesapeake and Potomac Telephone Company; The Chesapeake and Potomac Telephone Company of Maryland; The Chesapeake and Potomac Telephone Company of Virginia; and The Chesapeake and Potomac Telephone Company of West Virginia (collectively, the \"Network Services Companies\"). In January 1994, to facilitate the creation of a uniform \"Bell Atlantic\" brand name across the territories served by these seven telephone subsidiaries, the names of the Network Services Companies were changed to Bell Atlantic - New Jersey, Inc. (\"Bell Atlantic - New Jersey\"), Bell Atlantic - Pennsylvania, Inc. (\"Bell Atlantic - Pennsylvania\"), Bell Atlantic - Delaware, Inc. (\"Bell Atlantic - Delaware\"), Bell Atlantic - Washington, D.C., Inc. (\"Bell Atlantic - Washington, D.C.\"), Bell Atlantic - Maryland, Inc. (\"Bell Atlantic - Maryland\"), Bell Atlantic - Virginia, Inc. (\"Bell Atlantic - Virginia\") and Bell Atlantic - West Virginia, Inc. (\"Bell Atlantic - West Virginia\"), respectively.\nThe Company's business currently encompasses one principal segment -- Communications and Related Services -- which includes the Network Services Companies as well as subsidiaries which are engaged in the business of providing wireless communications products and services, including cellular mobile service; selling directory advertising and providing photocomposition services; and servicing and repairing computers. During 1993, Bell Atlantic reorganized certain functions performed by each of the Network Services Companies into nine lines of business (\"LOBs\") organized across the Network Services Companies around specific market segments. See \"The Network Services Companies- Operations\".\nPrior to December 31, 1994, the Company reported segment information for Financial, Real Estate and Other Services, which was comprised of subsidiaries engaged in lease financing of commercial, industrial, medical and high- technology equipment, and other forms of financing; real estate investment and management; and the sale and distribution of liquefied petroleum gas. In 1994, the Company disposed of substantially all of its lease financing business and sold its liquefied petroleum gas business.\nThe Company was incorporated in 1983 under the laws of the State of Delaware and has its principal executive offices at 1717 Arch Street, Philadelphia, Pennsylvania 19103 (telephone number 215-963-6000).\nLINE OF BUSINESS RESTRICTIONS\nThe consent decree entitled \"Modification of Final Judgment\" (\"MFJ\") approved by the United States District Court for the District of Columbia (the \"D.C. District Court\") which, together with the Plan of Reorganization (\"Plan\") approved by the D.C. District Court, set forth the terms of Divestiture also established certain restrictions on the post-Divestiture activities of the RHCs, including Bell Atlantic. Currently, the MFJ's principal restrictions on post- Divestiture RHC activities are prohibitions on (i) providing interexchange telecommunications, and (ii) engaging in the manufacture of telecommunications equipment and customer premises equipment (\"CPE\"). Since Divestiture, the D.C. District Court has retained jurisdiction over the construction, modification, implementation and enforcement of the MFJ.\nLegislation has been introduced in the current session of Congress pursuant to which the line of business restrictions established by the MFJ could be eliminated or modified. No definitive prediction can be made as to whether or when any such legislation will be enacted, the provisions thereof or the impact on the business or financial condition of the Company.\nTHE NETWORK SERVICES COMPANIES\nGeneral\nThe Network Services Companies presently serve a territory (\"Territory\") consisting of 19 Local Access and Transport Areas (\"LATAs\"). These LATAs are generally centered on a city or based on some other identifiable common geography and, with certain limited exceptions, each LATA marks the boundary within which a Network Services Company may provide telephone service.\nThe Network Services Companies provide two basic types of telecommunications services. First, they transport telecommunications traffic between subscribers located within the same LATA (\"intraLATA service\"), including both local and toll services. Local service includes the provision of local exchange (\"dial tone\"), local private line and public telephone services (including dial tone service for pay telephones owned by the Company and other pay telephone providers). Among other local services provided are Centrex (telephone company central office-based switched telephone service enabling the subscriber to make both intercom and outside calls) and a variety of special and custom calling services. Toll service includes message toll service (calling service beyond the local calling area) within LATA boundaries, and intraLATA Wide Area Toll Service (WATS)\/800 services (volume discount offerings for customers with highly concentrated demand). As permitted by the Plan, Bell Atlantic - New Jersey and Bell Atlantic - Pennsylvania also earn toll revenue from the provision of telecommunications service between LATAs (\"interLATA service\") in corridors between the cities (and certain surrounding counties) of (i) New York, New York and Newark, New Jersey and (ii) Philadelphia, Pennsylvania and Camden, New Jersey. Second, the Network Services Companies provide exchange access service, which links a subscriber's telephone or other equipment to the transmission facilities of interexchange carriers which, in turn, provide interLATA service to their customers. Bell Atlantic - Pennsylvania, Bell Atlantic - Delaware, Bell Atlantic - Maryland, Bell Atlantic - West Virginia and Bell Atlantic - New Jersey also provide exchange access service to interexchange carriers which provide intrastate intraLATA long distance telecommunications service.\nOperations\nAlthough the Network Services Companies remain responsible within their respective service areas for the provision of telephone services, financial performance and regulatory matters, during 1993 Bell Atlantic reorganized certain functions formerly performed by each of these companies into LOBs organized across the Network Services Companies around specific market segments. These LOBs are:\nThe Consumer Services LOB markets communications services to residential customers within the Territory (11 million households and 29 million people) and plans to market information services and entertainment programming. 1994 revenues generated by the Consumer Services LOB were approximately $4 billion, representing approximately 34% of the Network Services Companies' aggregate revenues. These revenues were derived primarily from the provision of telephone services to residential users.\nThe Carrier Services LOB markets (i) switched and special access to the Network Services Companies' local exchange networks, and (ii) billing and collection services, including recording, rating, bill processing and bill rendering. 1994 revenues generated by the Carrier Services market were approximately $2.5 billion, representing approximately 21% of the Network Services Companies' aggregate revenues. Approximately 93% of total Carrier Services revenues were derived from interexchange carriers; AT&T is the largest single customer. Most of the remaining revenues came from business customers and government agencies with their own special access network connections, wireless companies and other local exchange carriers (\"LECs\") which resell network connections to their own customers.\nThe Small Business Services LOB markets communications and information services to small businesses (customers having up to 20 access lines or 100 Centrex lines). The Small Business Services LOB has approximately 1.2 million small business customers in the Territory which in 1994 generated approximately $1.8 billion in revenues, representing approximately 15% of the Network Services Companies' aggregate revenues.\nThe Large Business Services LOB markets communications and information services to large businesses (customers having more than 20 access lines or more than 100 Centrex lines). These services include voice switching\/processing services (e.g., dedicated private lines, custom Centrex, call management and voice messaging), end-user networking (e.g., credit and debit card transactions, and personal computer-based conferencing, including data and video), internetworking (establishing links between the geographically disparate networks of two or more companies or within the same company), network integration (integrating multiple geographically disparate networks into one system), network optimization (disaster avoidance, 911, intelligent vehicle highway systems), video services (distance learning, telemedicine, surveillance, videoconferencing) and integrated multi-media applications services. 1994 revenues from the Large Business Services LOB were approximately $1.5 billion, representing approximately 13% of the Network Services Companies' aggregate revenues.\nThe Directory Services LOB manages the provision of (i) advertising and marketing services to advertisers, and (ii) listing information (e.g., White Pages and Yellow Pages). These services are currently provided primarily through print media, but the Company expects that use of electronic formats will increase in the future. In addition, the Directory Services LOB manages the provision of photocomposition, database management and other related products and services to\npublishers. 1994 revenues from the Directory Services LOB were approximately $1 billion, representing approximately 9% of the Network Services Companies' aggregate revenues.\nThe Public and Operator Services LOB markets pay telephone and operator services in the Territory to meet consumer needs for accessing public networks, locating and identifying network subscribers, providing calling assistance and arranging billing alternatives (e.g., calling card, collect and third party calls). 1994 revenues from the Public and Operator Services LOB were approximately $700 million, representing approximately 6% of the Network Services Companies' aggregate revenues.\nThe Federal Systems LOB markets communications and information technology and services to departments, agencies and offices of the executive, judicial and legislative branches of the federal government. 1994 revenues from the Federal Systems LOB were approximately $300 million, representing approximately 2% of the Network Services Companies' aggregate revenues.\nThe Network LOB manages the technologies, services and systems platforms required by the other LOBs and the Network Services Companies to meet the needs of their respective customers, including switching, feature development and on-premises installation and maintenance services.\nThe Network Services Companies have been making and expect to continue to make significant capital expenditures to meet the demand for communications services and to further improve such services. Capital expenditures of the Network Services Companies were approximately $2.2 billion in 1992, $2.1 billion in 1993, and $2.2 billion in 1994. The total investment in plant, property and equipment was approximately $29.6 billion at December 31, 1992, $30.6 billion at December 31, 1993, and $33.7 billion at December 31, 1994, in each case after giving effect to retirements, but before deducting accumulated depreciation at such date.\nThe Network Services Companies as a whole are projecting construction expenditures for 1995 at approximately the same level as in the past several years. However, subject to regulatory approvals, the Network Services Companies plan to allocate a greater portion of capital resources to the deployment of broadband network platforms (technologies ultimately capable of providing a switched facility for access to and transport of high-speed data services, video-on-demand, and image and interactive multimedia applications). Most of the funds for these expenditures are expected to be generated internally. Some additional external financing may be necessary or desirable for some of the Network Services Companies.\nFCC Regulation and Interstate Rates\nThe Network Services Companies are subject to the jurisdiction of the Federal Communications Commission (\"FCC\") with respect to interstate services and certain related matters. The FCC prescribes a uniform system of accounts for telephone companies, interstate depreciation rates and 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\nand those applicable to intrastate services under the jurisdiction of the respective state regulatory authorities (\"separations procedures\"). The FCC also prescribes procedures for allocating costs and revenues between regulated and unregulated activities.\nInterstate Access Charges\nThe Network Services Companies provide intraLATA service and, with certain limited exceptions, do not participate in the provision of interLATA service except through offerings of exchange access service. See \"The Network Services Companies-General\". The FCC has prescribed structures for exchange access tariffs to specify the charges (\"Access Charges\") for use and availability of the Network Services Companies' facilities for the origination and termination of interstate interLATA service.\nIn general, the tariff structures prescribed by the FCC provide that interstate costs of the Network Services Companies which do not vary based on usage (\"non-traffic sensitive costs\") are recovered from subscribers through flat monthly charges (\"Subscriber Line Charges\"), and from interexchange carriers through usage-sensitive Carrier Common Line (\"CCL\") charges. Traffic- sensitive interstate costs are recovered from carriers through variable access charges based on several factors, primarily usage.\nIn May 1984, the FCC authorized the implementation of Access Charge tariffs for \"switched access service\" (access to the local exchange network) and of Subscriber Line Charges for multiple line business customers (up to $6.00 per month per line). In 1985, the FCC authorized Subscriber Line Charges for residential and single-line business customers at the rate of $1.00 per month per line, which increased in installments to $3.50, effective April 1, 1989.\nFCC Access Charge Pooling Arrangements\nThe FCC previously required that all LECs, including the Network Services Companies, pool revenues from CCL and Subscriber Line Charges that cover the non-traffic sensitive costs of the local exchange network, that is, the interstate costs associated with the lines from subscribers' premises to telephone company central offices. To administer such pooling arrangements, the FCC mandated the formation of the National Exchange Carrier Association, Inc. (\"NECA\"). All but one of the Network Services Companies received substantially less from the pool than the amount billed to their interexchange carrier customers.\nThe FCC changed its mandatory pooling requirements, effective April 1, 1989. As a result, the Network Services Companies as a group withdrew from the pool and were permitted to charge CCL rates which more closely reflected their non- traffic sensitive costs. The Network Services Companies are still obligated to make contributions of CCL revenues to companies who choose to continue to pool non-traffic sensitive costs so that the pooling companies can charge a CCL rate no greater than the nationwide average CCL rate of price cap companies. In addition to this continuing obligation, the Network Services Companies had a transitional support obligation to high cost companies who left the pool in 1989 and 1990. This transitional support obligation ended in July 1994.\nIn February 1995, the FCC issued an Order to Show Cause with respect to certain findings contained in an independent audit concluded in December 1991\nwith respect to certain filings by the Network Services Companies with NECA. Resolution of these issues is expected in the second half of 1995.\nPrice Caps\nThe price cap system, which has been in effect since 1991, places a cap on overall LEC prices for interstate access services which is modified annually, in inflation-adjusted terms, by a fixed percentage which is intended to reflect increases in productivity. The price cap level can also be adjusted to reflect \"exogenous\" changes, such as changes in FCC separations procedures or accounting rules. LECs subject to price caps have somewhat increased flexibility to change the prices of existing services within certain groupings of interstate services, known as \"baskets\".\nFCC regulations applicable to the Network Services Companies provide for an authorized rate of return of 11.25% for the years 1991 and beyond. To the extent that a company is able to earn a higher rate of return through improved efficiency, the FCC's price cap rules permit them to retain the full amount of this higher return up to 100 basis points above the authorized rate of return (currently, up to a 12.25% rate of return). If a company's rate of return is between 100 and 500 basis points above the authorized rate of return (that is, currently, between 12.25% and 16.25%), the company must share 50% of the earnings above the 100-basis-point level with customers by reducing rates prospectively. All earnings above the 500-basis-point level must be returned to customers in the form of prospective rate decreases. If, on the other hand, a company's rate of return is more than 100 basis points below the authorized rate of return (that is, currently, below 10.25%), the company is permitted to increase rates prospectively to make up the deficiency.\nUnder FCC-approved tariffs, the Network Services Companies are charging uniform rates for interstate access services (with the exception of Subscriber Line Charges) throughout the Territory and are regarded as a single unit by the FCC for rate of return measurement.\nIn February 1994, the FCC initiated a rulemaking proceeding to determine the effectiveness of LEC price cap rules and to decide what changes, if any, should be made to those rules. This rulemaking is expected to be concluded in the first half of 1995.\nEnhanced Services\nIn 1985, the FCC initiated an examination of its regulations requiring that \"enhanced services\" (e.g. voice messaging services, electronic mail, videotext gateway, protocol conversion) be offered only through a structurally separated subsidiary. In 1986, the FCC eliminated this requirement, permitting the Network Services Companies to offer enhanced services, subject to compliance with a series of non-structural safeguards. These safeguards include detailed cost accounting, protection of customer information, public disclosure of technical interfaces and certain reporting requirements. In 1990, the U.S. Court of Appeals for the Ninth Circuit (Court of Appeals) vacated and remanded the matter to the FCC. In 1991, the FCC adopted an order which reinstated relief from the separate subsidiary requirement upon a company's compliance with the FCC's Open Network Architecture requirements and strengthened some of the non-structural safeguards. In 1992, the Network Services Companies certified to the FCC that they had complied with applicable requirements, and the FCC granted them structural relief.\nIn October 1994, the Court of Appeals vacated the 1991 order and remanded the matter to the FCC for further proceedings. As a result, the FCC has initiated a broad examination of the state of competition in the enhanced services business and the adequacy of existing non-structural safeguards. The Network Services Companies are permitted to continue to offer existing enhanced services pending further action.\nFCC Cost Allocation and Affiliate Transaction Rules\nFCC rules govern: (i) the allocation of costs between the regulated and unregulated activities of a communications common carrier and (ii) transactions between the regulated and unregulated affiliates of a communications common carrier.\nThe cost allocation rules apply to certain unregulated activities: activities that have never been regulated as communications common carrier offerings and activities that have been preemptively deregulated by the FCC. The costs of these activities are removed prior to the separations procedures process and are assigned to unregulated activities in the aggregate, not to specific services, for pricing purposes. Other activities must be accounted for as regulated activities, and their costs are subject to separations procedures.\nThe affiliate transaction rules govern the pricing of assets transferred to and services provided by affiliates. These rules generally require that assets be transferred between affiliates at \"market price\", if such price can be established through a tariff or a prevailing price actually charged to third parties. In the absence of a tariff or prevailing price, \"market price\" cannot be established, in which case (i) asset transfers from a regulated to an unregulated affiliate must be valued at the higher of cost or fair market value, and (ii) asset transfers from an unregulated to a regulated affiliate must be valued at the lower of cost or fair market value.\nThe FCC has not attempted to make its cost allocation or affiliate transaction rules preemptive. State regulatory authorities are free to use different cost allocation methods and affiliate transaction rules for intrastate ratemaking and to require carriers to keep separate allocation records.\nTelephone Company Provision of Video Dial Tone and Video Programming\nIn August 1992, the FCC issued an order permitting telephone companies such as the Network Services Companies to provide \"video dial tone\" service. Video dial tone permits telephone companies to provide video transport to multiple programmers on a non-discriminatory common carrier basis. In November 1994, the FCC issued an order which stated that jurisdiction for video dial tone service will be divided between the FCC and the states. Over the air services and services transported across state lines will be deemed interstate services subject to regulation by the FCC. Services delivered entirely within a single state will be deemed intrastate services subject to state regulation. The order also generally prohibits telephone companies from acquiring in-region cable television facilities or entering into a joint venture with an in-region cable television company or other video programmer to jointly construct or operate a video dial tone platform.\nIn December 1992, Bell Atlantic - Virginia and Bell Atlantic Video Services Company filed a lawsuit against the federal government in the United States District Court for the Eastern District of Virginia seeking to overturn the\nprohibition in the Cable Communications Policy Act of 1984 against LECs providing video programming in their respective telephone service areas. In 1993, the court struck down this prohibition as a violation of the First Amendment's freedom of speech protections and enjoined its enforcement against the Company, the Network Services Companies and Bell Atlantic Video Services Company. This decision was affirmed by the United States Court of Appeals for the Fourth Circuit in 1994. The federal government is expected to petition the United States Supreme Court to review the decision.\nIn 1992, Bell Atlantic - New Jersey entered into an agreement with Future Vision of America Corporation (\"Future Vision\") pursuant to which Bell Atlantic - New Jersey will deploy fiber optic technology in the Dover Township, New Jersey telephone network to establish a video dial tone platform that will allow Future Vision and other video information providers to deliver video programming services. The FCC approved the deployment of this system in late 1994. Service is expected to commence later in 1995.\nIn 1993, the FCC granted the Company authority to test a new technology known as Asynchronous Digital Subscriber Line (\"ADSL\") for use in delivering video entertainment and information over existing copper telephone lines. Beginning in March 1993, the Company began a one-year technical trial of ADSL serving up to 400 Bell Atlantic employees in northern Virginia. In the Fall of 1993, Bell Atlantic petitioned the FCC for authorization to expand and convert this technical trial, upon its completion, into a six month market trial serving up to 2,000 customers. The FCC approved this application in early 1995. Bell Atlantic has also requested authority to offer a commercial video dial tone service to customers served by 25 central offices in parts of northern Virginia and southern Maryland upon completion of the six month market trial. This application remains pending at the FCC.\nInterconnection and Collocation\nIn order to encourage greater competition in the provision of interstate special access services, the FCC issued an order in 1992 allowing third parties to collocate their equipment in telephone company offices to provide special access (private line) services to the public. The order permits collocating parties to pay LECs an interconnection charge that is lower than the existing tariffed rates for similar non-collocated services and it allows LECs limited additional pricing flexibility for their own special access services when collocated interconnection is operational. In 1993, the FCC extended collocation to switched access services under terms and conditions similar to those for special access collocation. In June 1994, the U.S. Court of Appeals for the District of Columbia vacated the FCC's special access collocation order insofar as it required physical collocation. In July 1994, the FCC voted to require LECs to offer virtual collocation, with the LECs having the option to offer physical collocation.\nState Regulation and Competitive Environment\nThe communications services of the Network Services Companies are subject to regulation by the public utility commissions in the jurisdictions in which they operate with respect to intrastate rates and services and other matters. In 1994, there were a number of proceedings dealing with such issues as the adoption of flexible regulation procedures and competition for local exchange and toll services.\nBell Atlantic - New Jersey, Inc.\nThe New Jersey Telecommunications Act of 1992 authorized the Board of Public Utilities (\"BPU\") to adopt alternative regulatory frameworks to address changes in technology and the structure of the telecommunications industry and to promote economic development. It also deregulated services which the BPU found to be competitive. Pursuant to that legislation, Bell Atlantic - New Jersey filed a Plan for Alternative Form of Regulation (the \"NJPAR\"), which became effective in May 1993.\nThe NJPAR replaced the Rate Stability Plan, which was approved by the BPU in 1987. In general, the Rate Stability Plan separated intrastate services into two categories: Group I (more competitive) and Group II (less competitive). Only Group II services were subject to financial performance monitoring by the BPU.\nThe NJPAR divides Bell Atlantic - New Jersey's services into Rate-Regulated Services (formerly Group II services) and Competitive Services (formerly Group I services and services which have never been regulated by the BPU). Rate- Regulated Services are grouped in two categories:\n-\"Protected Services\": Basic residence and business service, Touch-Tone, access services, message toll services and the ordering, installation and restoration of these services. Rates for Protected Services, other than basic residence service, may be increased beginning January 1996 in an amount limited to the prior year's increase in the Gross National Product-Price Index (\"GNP-PI\") less a 2% productivity offset, as long as the return on equity for Rate-Regulated Services does not exceed 11.7%. Basic residence service rates are frozen through December 1999.\n-\"Other Services\": Custom Calling, Custom Local Area Signaling Services (\"CLASS\" services which utilize Signaling System 7), operator services and 911 enhanced service. Rates for Other Services may be increased beginning January 1996 in an amount limited to the prior year's increase in the GNP-PI less a 2% productivity offset, as long as the return on equity for Rate-Regulated Services does not exceed 12.7%.\nAll earnings above a return on equity of 13.7% for Rate-Regulated Services will be shared equally with customers. There is no point at which the earnings are capped. Competitive Services are deregulated under the New Jersey Telecommunications Act. An appeal of the NJPAR is pending.\nIn May 1994, the BPU approved a settlement of a proceeding addressing intraLATA toll competition. The settlement permitted IXCs to compete for the provision of intraLATA toll services on an access code basis (e.g., customers must dial 10XXX to use an IXC), beginning July 1, 1994, and granted Bell Atlantic - New Jersey substantial flexibility in the pricing and marketing of the services it offers to enable it to compete with the IXCs. In January 1995, the BPU\ncommenced a further proceeding to examine issues of intraLATA toll competition including whether presubscription should be authorized, and if so, under what terms and conditions. Currently, intraLATA toll calls default to the Network Services Companies unless the customer dials a five-digit access code to use an alternate carrier. Presubscription would enable customers to make intraLATA toll calls using the carrier of their choice without having to dial the five-digit access code. The BPU will also address the issue of subsidies embodied in Bell Atlantic - New Jersey's rates. A decision is expected by the end of 1995.\nIn January 1995, MFS - Intelenet filed a petition with the BPU requesting authority to provide local exchange services in areas served by Bell Atlantic - New Jersey.\nBell Atlantic - Pennsylvania, Inc.\nIn July 1993, legislation was enacted in Pennsylvania which enabled Bell Atlantic - Pennsylvania to petition the Pennsylvania Public Utility Commission (\"PPUC\") to regulate Bell Atlantic - Pennsylvania under an alternative form of regulation. In October 1993, Bell Atlantic - Pennsylvania filed its petition and plan with the PPUC. In June 1994, the PPUC approved, with modifications, Bell Atlantic - Pennsylvania's Alternative Regulation Plan, (\"PAPAR\") which was accepted by Bell Atlantic - Pennsylvania in July 1994.\nThe PAPAR provides for a pure price cap plan with no sharing and replaces rate base rate of return regulation. The PPUC's order confirmed that current rates are just and reasonable, and therefore, required no change to current rates. The PAPAR removed from price and earnings regulation six competitive services, including directory advertising, billing service, Centrex service, paging, speed calling and repeat calling. All remaining noncompetitive services will be price regulated.\nUnder price regulation, annual price increases up to, but not exceeding, the inflation rate (GDP-PI) minus 2.93% will be permitted. Annual price decreases are required when the GDP-PI falls below 2.93%. Protected services in the noncompetitive category, which include residential and business basic exchange services, special access and switched access, are capped through December 31, 1999. However, revenue neutral rate restructuring for non-competitive services is permitted.\nThe PAPAR requires Bell Atlantic - Pennsylvania to propose a Lifeline service for residential customers on a revenue neutral basis The Plan also requires deployment of a universal broadband network, which must be completed in phases: 20% by 1998; 50% by 2004; and 100% by 2015. Deployment must be reasonably balanced among urban, suburban and rural areas. An appeal of the PAPAR is pending.\nSeveral large competitors have requested authority from the PPUC to provide local exchange service in areas served by Bell Atlantic - Pennsylvania. Applications are currently pending from MFS - Intelenet, MCI Metro ATS and Teleport Communications Group. Decisions on these applications are expected later in 1995.\nThe PPUC is currently conducting a proceeding to examine issues regarding intraLATA toll competition, including whether to authorize presubscription and, if so, under what terms and conditions. A decision is expected later in 1995.\nBell Atlantic - Delaware, Inc.\nIn March 1994, Bell Atlantic - Delaware elected to be regulated under the alternative regulation provisions of the Delaware Telecommunications Technology Investment Act of 1993 (the \"Delaware Telecommunications Act\"). The Delaware Telecommunications Act provides:\n-that the prices of \"Basic Telephone Services\" (e.g., dial tone and local usage) will remain regulated and cannot change in any one year by more than the rate of inflation (GDP-PI), less 3%;\n-that the prices of \"Discretionary Services\" (e.g., Identa Ring\/SM\/ and Call Waiting) cannot increase more than 15% per year per service, after an initial one-year cap;\n-that the prices of \"Competitive Services\" (e.g., directory advertising and message toll service) will not be subject to tariff; and\n-that Bell Atlantic - Delaware will develop a technology deployment plan with a commitment to invest a minimum of $250 million in Delaware's telecommunications network during the first five years of the plan.\nThe Delaware Telecommunications Act also provides protections to ensure that competitors will not be unfairly disadvantaged, including a prohibition on cross-subsidization, imputation rules, service unbundling and resale service availability requirements, and a review by the Delaware Public Service Commission (DPSC) during the fifth year of the plan.\nThe DPSC has initiated a rulemaking docket to develop regulations for the implementation of the Delaware Telecommunications Act. Public hearings were held in March 1995, with a DPSC decision expected during the second quarter of 1995.\nThe DPSC has also initiated a proceeding to examine issues regarding intraLATA toll competition, including whether to authorize presubscription and dialing parity (\"1+ dialing\") for intrastate toll competitors and, if so, under what terms and conditions. A decision is expected in the second quarter of 1995.\nBell Atlantic - Washington, D.C., Inc.\nIn January 1993, the District of Columbia Public Service Commission (DCPSC) adopted a regulatory reform plan (\"D.C. Reform Plan\") for the intra-Washington, D.C. services of Bell Atlantic - Washington, D.C., for a three year trial period. The D.C. Reform Plan provides a banded rate of return of 100 basis points over or under the authorized return on equity (which was set at 11.45% in December 1993). Bell Atlantic - Washington, D.C. is permitted to seek a rate increase if its return on equity falls below 10.45% and is required to share, through refunds, 50% of any earnings in excess of a return on equity of 12.45%. The D.C. Reform Plan also provides for pricing flexibility, including custom contracting and 14-day tariffing, for certain competitive services, including Centrex, High Speed Private Line Services, Digital Data Services, Paging Services, Speed Calling, Repeat Call, Home Intercom and Home Intercom Extra.\nIn December 1993, the DCPSC approved a $15,800,000 rate increase, effective January 1, 1994.\nIn May 1994, the DCPSC issued an order requiring Bell Atlantic - Washington, D.C. to show cause why it should not refund to its customers $2,300,000, plus interest, related to certain surcharge revenues in 1993. Bell Atlantic - Washington, D.C. has responded to the order.\nIn January 1995, Bell Atlantic - Washington, D.C. filed a petition with the DCPSC seeking approval of a proposed price cap plan to become effective upon the expiration of the D.C. Reform Plan in 1996. The price cap plan would: i) divide services into three categories: basic, discretionary and competitive; (ii) cap basic residential prices through January 1, 2000 and then allow basic prices to be increased annually at one half the rate of inflation (GNP - PI); (iii) permit annual increases of up to 25% for discretionary services; (iv) eliminate price regulation for all competitive services; and (v) classify services among the three categories and establish a process for moving services between categories going forward. Hearings on the proposed price cap plan are expected to commence later in 1995.\nMFS - Intelenet of Washington, D.C., a subsidiary of MFS Communications Company, Inc., has filed an application with the DCPSC for authority to provide local exchange services.\nBell Atlantic - Maryland, Inc.\nIn 1990, the Public Service Commission of Maryland (\"MPSC\") instituted a regulatory reform plan (the \"Reform Plan\") for regulation of intrastate services provided by Bell Atlantic - Maryland. The Reform Plan provides for sharing of earnings on other-than-competitive services (e.g., basic business and residential dial tone line and usage, pay telephone services and intraLATA toll services) within a prescribed range (13.6% to 15.6% return on equity), for the direct refund to ratepayers of all earnings above that range and for no sharing of earnings if earnings fall below that range. Earnings on competitive services (e.g., Centrex intercom and high capacity, special access and private line services) are not subject to a rate of return limitation. In connection with its approval of the Reform Plan, the MPSC required Bell Atlantic - Maryland to initiate a rate proceeding to examine Bell Atlantic - Maryland's financial and operating results under the Reform Plan and to serve as a rate case for determining rates and rate structure on a going-forward basis for services that the MPSC has determined are other-than-competitive.\nIn January 1993, the MPSC issued an order directing Bell Atlantic - Maryland to reduce rates prospectively in the aggregate amount of $28.6 million annually. Tariffs reducing rates by that amount became effective on January 23, 1993.\nThe Reform Plan was extended through 1995 and the sharing range was changed to 12.7% to 14.7%. This range was expanded on reconsideration to 12.7% to 16.5%.\nLegislation was passed by both houses of the Maryland General Assembly that would enable the MPSC to regulate Bell Atlantic - Maryland by a method other than rate base rate of return regulation. If signed into law, the legislation would become effective in June 1995.\nIn April 1994, the MPSC approved an application from MFS-Intelenet of Maryland, Inc. (MFS-I), a subsidiary of MFS Communications Company, Inc.(MFS), to provide and resell local exchange and interexchange telecommunications services to business customers in areas served by Bell Atlantic - Maryland. MFS-I is authorized to be a co-carrier in Maryland and has been assigned its own\ncentral office codes for use with its customers, and Bell Atlantic - Maryland is required to provide intrastate switched access collocation. The rates that MFS- I will pay to interconnect with Bell Atlantic - Maryland must include MFS-I's fair share of the joint and common costs that support universal service. On an interim basis, MFS-I will pay 6.1 cents per call to terminate a call on Bell Atlantic - Maryland's network. The MPSC established a schedule, which extends into 1995, for Phase II of this case. Final interconnection rates will be decided in Phase II. In late 1994, MCI Metro ATS and Teleport Communications Group received approval for the same waivers and interconnection rates established in the MFS-I proceeding. An application by SBC Media Ventures (SBC) to provide residential service in Montgomery County was suspended at SBC's request pending completion of Phase II of the MFS-I proceeding.\nBell Atlantic - Virginia, Inc.\nFrom January 1989 through December 1993, Bell Atlantic - Virginia participated in the Experimental Plan for Alternative Regulation of Virginia telephone companies (the \"Experimental Plan\"), adopted by the Virginia State Corporation Commission (\"VSCC\") in December 1988. The Experimental Plan marked a departure from traditional regulation, segregating telephone services into four categories and capping earnings on Bell Atlantic - Virginia's non-competitive services at a 14% return on equity. Refunds of excess earnings are required to be made.\nIn December 1993, following an evaluation of the Experimental Plan, the VSCC adopted a Modified Plan for Alternative Regulation, effective January 1, 1994 (the \"Modified Plan\"). Under the Modified Plan, Bell Atlantic - Virginia's telephone services remained categorized, but earnings on non-competitive services were capped at a 12.55% return on equity. Additionally, in assessing whether earnings exceeded the permitted cap, the Modified Plan required an imputation to regulated earnings of an amount equal to 25% of the net profits of Yellow Page advertising.\nBell Atlantic - Virginia's financial results under the Experimental Plan for the years 1989 through 1993 have been filed with the VSCC. The VSCC issued orders making Bell Atlantic - Virginia's rates final for 1989, 1990 and 1991. Therefore, rates for these years are no longer subject to refunds. Bell Atlantic - Virginia's financial results for 1992 and 1993, which as filed with the VSCC indicate that no refunds are due, are still subject to VSCC audit.\nUnder legislation passed in the 1993 session of the Virginia General Assembly, the VSCC is no longer statutorily required to regulate telephone companies on the basis of rate of return regulation; for example, the VSCC is free to adopt a price cap form of regulation. In February 1994, Bell Atlantic - Virginia filed a proposal to have its non-competitive services regulated on a price cap basis; competitive services would not be regulated.\nFollowing public hearings, the VSCC approved a new optional regulatory plan, effective January 1, 1995, which allows Bell Atlantic - Virginia to replace traditional cost-based regulation with a plan that relies on price constraints. The new plan, which eliminates regulation of profits, includes a temporary moratorium on rate increases for basic local telephone service until 2001, eliminates the monthly charge for Touch-Tone service and expands universal telephone service to the poor. In November 1994, Bell Atlantic - Virginia notified the VSCC of its election to participate in the new regulatory plan. An appeal of this plan is pending.\nDuring the 1995 session of the Virginia General Assembly, legislation was passed that will allow the VSCC to authorize other telephone companies, beginning January 1, 1996, to compete with Bell Atlantic - Virginia in the provision of local exchange services. These telephone companies will come under the jurisdiction of the VSCC and will be required to comply with rules and regulations which will be determined by the VSCC during 1995. The VSCC is also investigating whether to allow competition in the provision of intraLATA toll services.\nBell Atlantic - West Virginia, Inc.\nIn 1988, the Public Service Commission of West Virginia (\"WVPSC\") approved a plan (\"Flexible Regulation Plan\") which gave Bell Atlantic - West Virginia flexibility in the pricing of competitive services (e.g., intraLATA toll service, intraLATA \"800\" service, intraLATA WATS service, billing and collection services and directory advertising) and provided for a freeze on rates for basic local exchange services through December 31, 1990, and a lifting on January 1, 1989 of the moratorium on intraLATA toll competition. The Flexible Regulation Plan was subsequently extended through 1991.\nIn March 1990, the West Virginia legislature enacted legislation, which became effective on January 1, 1991, requiring the WVPSC to cease its regulation of the rates charged by a telephone utility for any service that the WVPSC finds to be subject to \"workable competition\", unless the WVPSC finds that to do so would adversely affect the continued availability of adequate, economical and reliable local telephone service.\nIn December 1991, the WVPSC approved a new \"Incentive Regulation Plan\". The Incentive Regulation Plan continued the major provisions of the Flexible Regulation Plan, including pricing flexibility for competitive services and a freeze on rates for basic local exchange service. It also committed Bell Atlantic - West Virginia to invest $450 million from 1991 through 1995 in West Virginia's telecommunications infrastructure.\nIn December 1994, the WVPSC issued an order extending the Incentive Regulation Plan for three years, with certain modifications. Basic rates remain frozen through January 15, 1998 and Touch-Tone charges will be eliminated over a three year period. Bell Atlantic - West Virginia is committed to invest at least $375 million in its network over the next five years.\nThe WVPSC set aside for separate proceedings issues regarding intraLATA presubscription and local service competition.\nCompetition - General\nRegulatory proceedings, as well as new technology, are continuing to expand the types of available communications services and equipment and the number of competitors offering such services. An increasing amount of this competition is from large companies which have substantial capital, technological and marketing resources, many of which do not face the same regulatory constraints as the Company.\nAlternative Access\nA substantial portion of the Network Services Companies' revenues from business and government customers is derived from a relatively small number of large, multiple-line subscribers.\nThe Network Services Companies face competition from alternative communications systems, constructed by large end users, interexchange carriers and alternative access vendors, which are capable of originating and\/or terminating calls without the use of the local telephone company's plant. MFS has an optical fiber network which currently competes with Bell Atlantic - Pennsylvania and Bell Atlantic - Maryland in the Philadelphia, Pittsburgh and Baltimore metropolitan areas. In the Washington, D.C. metropolitan area, Institutional Communications Company, in which MFS has acquired a controlling interest, has deployed an optical fiber network to compete with Bell Atlantic - Washington, D.C., Bell Atlantic - Maryland and Bell Atlantic - Virginia in the provision of switched and special access services and local services. Eastern TeleLogic Corporation is currently providing service in the Philadelphia area over an optical fiber network, and Digital Direct of Pittsburgh, Inc. (dba Penn Access) has multiple fiber rings in service in the Pittsburgh metropolitan area, with additional fiber rings under construction. In July 1993, Virginia Metrotel Inc. was granted authority by the VSCC to compete against Bell Atlantic - Virginia in the provision of access services in the Richmond metropolitan area. Teleport Communications Group and MFS provide competitive access service in the Princeton-Trenton corridor and northern New Jersey. The ability of such alternative access providers to compete with the Network Services Companies has been enhanced by the FCC's orders requiring the Network Services Companies to offer virtual collocated interconnection for special and switched access services.\nOther potential sources of competition are cable television systems, shared tenant services and other non-carrier systems which are capable of bypassing the Network Services Companies' local plant, either partially or completely, through substitution of special access for switched access or through concentration of telecommunications traffic on fewer of the Network Services Companies' lines.\nIntraLATA Toll Competition\nThe ability of interexchange carriers to engage in the provision of intrastate intraLATA toll service in competition with the Network Services Companies is subject to state regulation. Such competition is permitted in New Jersey, Pennsylvania, Delaware, Maryland and West Virginia. The issue is inapplicable to Washington, D.C. since intraLATA toll service is not offered within the District of Columbia. The VSCC has instituted a proceeding to consider whether, and on what terms, to permit intraLATA toll competition in Virginia. See \"The Network Services Companies -- State Regulation and Competitive Environment\".\nPersonal Communications Services\nRadio-based personal communications services (\"PCS\") also constitute potential sources of competition to the Network Services Companies and to Bell Atlantic's cellular communications companies. PCS consists of wireless portable telephone services which would allow customers to make and receive telephone calls from any location using small handsets, and which could also be used for\ndata transmission. The FCC has authorized trials of such services, using a variety of technologies, by numerous companies, including the Company's cellular telecommunications subsidiaries (collectively, \"Bell Atlantic Mobile\").\nIn September 1993, the FCC issued an order allocating radio spectrum to be licensed for use in providing PCS. Under the order, seven separate bandwidths of spectrum, ranging in size from 10 MHz to 30 MHz, would be auctioned to potential PCS providers in each geographic area of the United States; five of the spectrum blocks would be auctioned by \"basic trading area\" and the remaining two would be auctioned by larger \"major trading area\" (as such trading areas are defined by Rand McNally). LECs and companies with LEC subsidiaries, such as the Company, are eligible to bid for PCS licenses, except that cellular carriers such as the Company are limited to obtaining only 10 MHz of PCS bandwidth in areas where they provide cellular service. Bidders other than cellular providers may obtain multiple licenses aggregating up to 40 MHz of bandwidth in any area.\nIn October 1994, the Company, NYNEX, AirTouch Communications and U S WEST, Inc., formed a partnership to bid jointly in the FCC's auctions for PCS licenses. In March 1995, this partnership was a successful bidder for licenses for spectrum to provide PCS services in the following markets: Chicago; Dallas; Tampa; Houston; Miami; New Orleans; Milwaukee; Richmond; San Antonio; Jacksonville; and Honolulu. The partnership will pay $1.1 billion for these licenses.\nCentrex\nThe Network Services Companies offer Centrex service, which is a telephone company central office-based communications system for business, government and other institutional customers consisting of a variety of integrated software- based features located in a centralized switch or switches and extended to the customer's premises primarily via local distribution facilities. In the provision of Centrex, the Network Services Companies are subject to significant competition from the providers of CPE systems, such as private branch exchanges (\"PBXs\"), which perform similar functions with less use of the Network Services Companies' switching facilities.\nUsers of Centrex systems generally require more subscriber lines than users of PBX systems of similar capacity. The FCC increased the maximum Subscriber Line Charge on embedded Centrex lines to $6.00 per month per line, effective April 1, 1989. Increases in Subscriber Line Charges result in Centrex users incurring higher charges than users of comparable PBX systems. Some of the state regulatory commissions having jurisdiction over the Network Services Companies have approved Centrex tariff revisions designed to offset the effects of such higher Subscriber Line Charges and to provide for stability of Centrex rates.\nDirectories\nThe Network Services Companies continue to face significant competition from other providers of directories, as well as competition from other advertising media. In particular, the former sales representative of the Network Services Companies (other than Bell Atlantic - New Jersey) publishes directories in competition with those published by the Network Services Companies in New Jersey, Pennsylvania, Delaware and the Washington, D.C. and Baltimore metropolitan areas.\nPublic Telephone Services\nThe Company faces increasing competition in the provision of pay telephone services from other pay telephone service providers. In addition, the growth of wireless communications negatively impacts usage of public telephones.\nOperator Services\nAlternative operator services providers have entered into competition with the Network Services Companies' operator services product line.\nNew Products and Services\nBell Atlantic\/(R)\/IQ\/(SM)\/ Services\nThe Network Services Companies have introduced the Bell Atlantic\/(R)\/IQ\/(SM)\/ Services family of calling features (although not all features are available in all states). These features include Identa Ring\/(SM)\/, which allows a single line to have multiple telephone numbers, each with a distinctive ring; Repeat Call, which allows customers automatically to redial busy phone numbers; Return Call, which allows customers automatically to return the last incoming call, even without knowing the number; Ultra Forward\/(SM)\/, which customers can use to program call-forwarding instructions; Home Intercom, which allows for phone-to- phone dialing within the home; Caller ID, which displays the number of the calling party; and Caller ID Deluxe, which displays the name and number of the calling party.\nData Services\nThe Network Services Companies have introduced several high speed data transmission services (although not all services are available in all states). Switched Multi-Megabit Data Service (\"SMDS\", a high-speed, public, packet- switched data transmission service); Fiber Distributed Data Interface Network Service; and Frame Relay Service (which allows high-speed interconnection of a customer's multiple locations).\nIntegrated Services Digital Network\nIntegrated Services Digital Network (\"ISDN\") is an all digital switched network architecture that allows voice, data and video services to be integrated on one telephone line. The Network Services Companies had approximately 90,000 ISDN lines in service at the end of 1994. All of the Network Services Companies introduced ISDN Anywhere in 1994. This service allows customers in non-equipped ISDN offices to be offered service from a designated host switch until such time as their home office becomes equipped with ISDN.\nInformation Services\nThe Network Services Companies offer various types of information services, such as message storage services, voice mail, electronic mail and Answer Call, a telephone answering service aimed at residential and small business customers.\nDOMESTIC WIRELESS COMMUNICATIONS\nBell Atlantic Mobile provides cellular telecommunications service in certain portions of the Network Services Companies' Territory and in other parts of the United States. These entities market cellular telecommunications service and related equipment directly to consumers, wholesale such service to businesses which resell the service to consumers, and authorize agents to sell such service to consumers. They also resell paging service in some locations. In 1992, the Company acquired Metro Mobile CTS, Inc., then the second-largest independent provider of cellular telecommunications service in the United States.\nCellular telecommunications service is subject to FCC regulation and licensing requirements. Some states also regulate the service. To assure competition, the FCC awarded two competitive licenses in each market. Many such competing cellular providers are substantial businesses with experience in broadcasting, telecommunications, cable television and radio common carrier services. Competition is based on the price of cellular service, the quality of the service and the size of the geographic area served.\nBell Atlantic Mobile has established cellular telecommunications service in the standard metropolitan statistical areas (\"SMSAs\") for Washington, D.C.; Wilmington, Delaware; Baltimore, Maryland; Allentown, Philadelphia, Pittsburgh and Reading, Pennsylvania; Trenton, Vineland and Atlantic City, New Jersey; Phoenix and Tucson, Arizona; Bridgeport, Hartford, New Haven, and New London, Connecticut; New Bedford, Pittsfield and Springfield, Massachusetts; Albuquerque and Las Cruces, New Mexico; Charlotte and Hickory, North Carolina; Providence, Rhode Island; Anderson, Columbia and Greenville, South Carolina; and El Paso, Texas.\nBell Atlantic Mobile also has established service in the rural service areas of Kent (Dover), Delaware; Kent (Eastern Shore) and Frederick, Maryland; Ocean, Sussex and Hunterdon, New Jersey; Greene, Jefferson, Huntingdon, Lawrence and McKean, Pennsylvania; Madison, Caroline, Frederick (Fauquier) and Lee, Virginia; Wetzel and Mason, West Virginia; Windham, Connecticut; Cabarrus and Anson, North Carolina; Newport, Rhode Island; Cherokee, Lancaster and Oconee, South Carolina; and Gila, Arizona.\nBell Atlantic Mobile also owns a significant minority interest in a partnership providing cellular telecommunications service in the New York City metropolitan area and the adjoining SMSAs of New Brunswick and Long Branch, New Jersey. Under reciprocal agreements between Bell Atlantic Mobile and certain other providers of cellular telecommunications service, the customers of Bell Atlantic Mobile may use the services of those other providers in areas where Bell Atlantic Mobile is not licensed to provide service.\nIn June 1994, Bell Atlantic and NYNEX Corporation executed a Joint Venture Formation Agreement which sets forth the terms and conditions under which the parties intend to combine their domestic cellular properties. This transaction, which is subject to regulatory approvals and various other conditions to closing, is expected to close in mid-1995. Upon completion of the merger, Bell Atlantic Mobile will dispose of certain competing properties in Massachusetts and Rhode Island.\nIn October 1994, Bell Atlantic, NYNEX, AirTouch Communications and U S WEST, Inc. formed two partnerships to provide nationwide wireless communications services. The first partnership participated in the FCC auctions for PCS licenses. See \"Competition-Personal Communications Services\". The second partnership will\ndevelop a national brand and provide coordination and centralization of various functions for the companies' cellular and PCS businesses.\nBell Atlantic Paging, Inc. markets paging services in portions of the Network Services Companies' Territory.\nINTERNATIONAL\nBell Atlantic International, Inc. and its subsidiaries (\"International\") serve as the Company's principal vehicle for new business development outside the United States. International provides telecommunications consulting and software systems integration services to telecommunications authorities in several countries, and has entered into business development agreements with various governmental authorities.\nIn 1990, wholly-owned New Zealand subsidiaries of International and Ameritech Corporation (\"Ameritech\") each purchased approximately 49% of the common shares of Telecom Corporation of New Zealand Limited (\"TCNZ\") for a purchase price of approximately $2.4 billion. Under the terms of the acquisition and subsequent agreements with the New Zealand government, International and Ameritech were required to sell equity interests in TCNZ such that their combined ownership would, within four years of the acquisition, be reduced to 49.9%. In furtherance of that requirement, International and Ameritech in 1991 sold a portion of their equity shares in TCNZ in a worldwide public offering, thereby reducing their combined ownership in TCNZ to approximately 68%. In 1993, International privately sold an aggregate of 9.8% of TCNZ, reducing its ownership interest in TCNZ to 24.8%, and, together with private sales by Ameritech, completing its sell-down obligations.\nInternational is also a shareholder in joint ventures, begun in November 1990, with a subsidiary of U S WEST, Inc. and the telecommunications administrations of The Czech Republic and The Slovak Republic, to build and operate cellular and packet data networks in these republics.\nIn 1993, International acquired for $1.04 billion an interest of approximately 42% in Grupo Iusacell, S.A. de C.V., the second largest telecommunications company in Mexico and the primary business of which is the provision of cellular telephone service.\nIn March 1994, a consortium in which International has the second largest interest (approximately 11.5%) was awarded the second cellular license for Italy.\nBUSINESS SYSTEMS COMPANIES\nBell Atlantic Business Systems Services, Inc. (\"Business Systems Services\"), which was formerly known as Sorbus Inc., is a computer services company which provides hardware and software maintenance, network support, disaster recovery and other services on over 10,000 hardware and software products. Business Systems Services provides service to more than 80,000 customer sites worldwide. Business Systems Services' major competitors are computer equipment manufacturers which offer to service the equipment they sell as well as other vendors of computer maintenance and service. In some cases, Business Systems Services is\ndependent on computer manufacturers and distributors for spare parts necessary for the products it services.\nThe Bell Atlantic Computer Technology Services Division of Business Systems Services provides parts repair and sales and refurbishment services for International Business Machines Corporation, Digital Equipment Corporation, Sun Microsystems, Inc. and other computer manufacturers' equipment to end users, manufacturers and service companies throughout the world.\nVIDEO SERVICES\nIn October 1994, the Company, NYNEX and Pacific Telesis Group formed two companies to deliver nationally branded home entertainment, information and interactive services. A media company will license, acquire and develop entertainment and information services. Creative Artists Agency, Inc. has entered into a consulting arrangement with the media company to develop a branding and marketing strategy and to provide assistance in acquiring programming. A technology and integration company will provide the systems necessary to deliver these services over the companies' networks.\nCERTAIN CONTRACTS AND RELATIONSHIPS\nCertain planning, marketing, procurement, financial, legal, accounting, technical support and other management services are provided on behalf of the Network Services Companies on a centralized basis by Bell Atlantic's wholly- owned subsidiary, Bell Atlantic Network Services, Inc. (\"NSI\"). Bell Atlantic Network Funding Corporation provides short-term financing and cash management services to the Network Services Companies.\nCertain corporate services also are provided to other subsidiaries on a centralized basis by NSI. Bell Atlantic Financial Services, Inc. provides short-, medium- and long-term financing services and cash management services to subsidiaries of the Company other than the Network Services Companies.\nThe seven RHCs each own (directly or through subsidiaries) a one-seventh interest in Bell Communications Research, Inc. (\"Bellcore\"). Pursuant to the Plan, Bellcore furnishes the RHCs and their BOC subsidiaries with technical assistance such as network planning, engineering and software development, as well as various other consulting services that can be provided more effectively on a centralized basis. Bellcore is the central point of contact for coordinating the efforts of the RHCs in meeting the national security and emergency preparedness requirements of the federal government. It also helps to mobilize the combined resources of the RHCs in times of natural disasters.\nEMPLOYEE RELATIONS\nAs of December 31, 1994, the Company and its subsidiaries had approximately 72,300 employees, which represents approximately a 1.8% decrease from the number of employees at December 31, 1993.\nApproximately 65% of the employees of the Company and its subsidiaries are represented by unions. Of those so represented, approximately 80% are represented by the Communications Workers of America, and approximately 20% are represented by the International Brotherhood of Electrical Workers, which are both affiliated with the American Federation of Labor-Congress of Industrial Organizations.\nThe terms of the contracts ratified in October 1992 by unions representing associate employees of the Network Services Companies and NSI expire in August 1995.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal properties of the Company do not lend themselves to simple description by character and location. The Company's investment in plant, property and equipment, 94% of which was held by the Network Services Companies in 1994 (92% in 1993), consisted of the following at December 31:\n\"Central office equipment\" consists of switching equipment, transmission equipment and related facilities. \"Cable, wiring, and conduit\" consists primarily of aerial cable, underground cable, conduit and wiring. \"Land and buildings\" consists of land owned in fee and improvements thereto, principally central office buildings. \"Other equipment\" consists of public telephone instruments and telephone equipment (including PBXs) used by the Network Services Companies in their operations, poles, furniture, office equipment, vehicles and other work equipment, and cellular plant. \"Other\" property consists primarily of plant under construction, capital leases and leasehold improvements.\nThe customers of the Network Services Companies are served by electronic switching systems that provide a wide variety of services. The Network Services Companies' network is in a transition from an analog to a digital network, which provides the capabilities to furnish advanced data transmission and information management services. At December 31, 1994, approximately 75% of the access lines were served by digital capability.\nItem 3.","section_3":"Item 3. Legal Proceedings\nPre-Divestiture Contingent Liabilities and Litigation\nThe Plan provides for the recognition and payment by AT&T and the former BOCs (including the Network Services Companies) of liabilities that are attributable to pre-Divestiture events but do not become certain until after Divestiture. These contingent liabilities relate principally to litigation and other claims with respect to the former Bell System's rates, taxes, contracts and torts (including business torts, such as alleged violations of the antitrust laws). Except to the extent that affected parties otherwise agree, contingent liabilities that are attributable to pre-Divestiture events are shared by AT&T and the BOCs in accordance with formulas prescribed by the Plan, whether or not an entity was a party to the proceeding and regardless of whether an entity was dismissed from the proceeding by virtue of settlement or otherwise. Each company's allocable share of liability under these formulas depends on several factors, including the type of contingent liability involved and each company's relative net investment as of the effective date of Divestiture. Under the formula generally applicable to most of the categories of these contingent liabilities, the Network Services Companies' aggregate allocable share of liability is approximately 10.2%.\nAT&T and various of its subsidiaries and the BOCs (including in some cases one or more of the Network Services Companies) have been and are parties to various types of litigation relating to pre-Divestiture events, including actions and proceedings involving environmental claims and allegations of violations of equal employment laws. Damages, if any, ultimately awarded in the remaining actions relating to pre-Divestiture events could have a financial impact on the Company whether or not the Company is a defendant since such damages will be treated as contingent liabilities and allocated in accordance with the allocation rules established by the Plan.\nWhile complete assurance cannot be given as to the outcome of any contingent liabilities or litigation, in the opinion of the Company's management, any monetary liability or financial impact to which the Company would be subject after final adjudication of all of the remaining potential or actual pre- Divestiture claims would not be material in amount to the financial position of the Company.\nOther Pending Cases\nIn January 1991, the Company, its Chief Executive Officer and its former Chief Financial Officer were named as defendants in several identical class action complaints. These complaints, which have been consolidated in a single proceeding in the United States District Court for the Eastern District of Pennsylvania and have subsequently been amended, allege that, during a class period from June 14, 1990 through January 22, 1991, the plaintiffs purchased shares of Bell Atlantic stock at inflated prices as a result of the defendants' alleged failure to disclose material information regarding certain aspects of the Company's financial performance and prospects. The trial court's earlier decision granting defendants' motion to dismiss this action was reversed by the United States Court of Appeals for the Third Circuit upon appeal by the plaintiffs. Discovery in this action is in progress.\nWhile complete assurance cannot be given as to the outcome of any litigation, in the opinion of the Company's management, any monetary liability or financial impact to which the Company would be subject after final adjudication of the foregoing actions would not be material in amount to the financial position of the Company.\nPrior Cases\nOn April 12, 1990, a letter was submitted to the Company's Board of Directors by a law firm, purportedly on behalf of a shareowner of the Company, requesting that the Company commence action against any present or former director, officer or employee of the Company or any of its subsidiaries who might be found to have violated any duty to the Company in connection with (i) certain litigation involving Bell Atlantic - Pennsylvania and (ii) a temporary suspension of the Company and Bell Atlantic - Washington, D. C. from eligibility for future federal government contracts (the \"Treasury suspension\"). As previously reported by the Company in its Quarterly Reports on Form 10-Q for the quarters ended March 31 and September 30, 1990 and its Annual Reports on Form 10-K for the years ended December 31, 1990 and 1991, the Bell Atlantic - Pennsylvania litigation involved allegations that this subsidiary had engaged in improper practices while selling certain optional services, and resulted in a settlement pursuant to which Bell Atlantic - Pennsylvania made payments and refunds aggregating approximately $42 million; the Treasury suspension involved allegations that the Company and Bell Atlantic - Washington, D.C. had misrepresented certain facts in connection with a bid for a particular government contract, and was terminated approximately one month later after the Company agreed to re-emphasize to employees the need to verify information provided to the government, including information supplied to the Company by sub-contractors.\nIn response to the demand letter (a similar letter, purportedly on behalf of a different shareowner, was received shortly thereafter), the Board of Directors of the Company (the \"Board\") on April 24, 1990 appointed a committee of three outside directors (James H. Gilliam, Jr. (Chairman), William G. Copeland and John F. Maypole) to investigate these matters and present its recommendation to the Board (the \"Special Committee\").\nOn May 11, 1990, the Company was served with a complaint filed in the Court of Common Pleas of Philadelphia County, Pennsylvania, naming certain then-current directors and officers as defendants in a shareholder derivative suit. The complaint alleged that the defendants had breached their fiduciary duties to the Company and its shareowners by failing to implement and enforce adequate safeguards to prevent the activities which resulted in the Bell Atlantic - Pennsylvania litigation and the Treasury suspension referred to above. The Company was not a defendant in this litigation.\nThe Special Committee retained independent outside counsel and conducted a five-month investigation. After completion of its investigation, the Special Committee concluded that it would not be in the best interest of the Company and its shareowners to assert claims or take any other action against any director or officer of the Company or any of its subsidiaries with respect to either the Bell Atlantic - Pennsylvania litigation or the Treasury suspension. Accordingly, the Special Committee recommended that the Board reject the demands expressed in the shareowner letters, and the Board on October 23, 1990 adopted this recommendation. Counsel for each of the demanding shareowners was advised of the Board's determination.\nOn June 19, 1991, the Company was served with a complaint filed in the United States District Court for the Eastern District of Pennsylvania naming all of the then-current directors of the Company and one former officer as defendants in a shareowner class action and derivative suit. This lawsuit made allegations very similar to the Court of Common Pleas suit referenced above with respect to the Bell Atlantic - Pennsylvania litigation and Treasury suspension matters and, in addition, alleged that the Company violated federal proxy rules and regulations and its duty of candor under state law by failing to disclose, in its 1987-1991 proxy materials, information about the Bell Atlantic - Pennsylvania litigation, the Treasury suspension, the appointment of the Special Committee and the Court of Common Pleas litigation referenced above.\nOn March 25, 1992, the parties to the federal court action reached an agreement to settle that action, subject to court approval after notice to the Company's shareowners, without the payment of any damages but subject to payment of the plaintiffs' attorneys fees up to $450,000. In June 1992, this settlement agreement was approved by the United States District Court for the Eastern District of Pennsylvania. A single shareowner, who is also the plaintiff in the related Court of Common Pleas litigation, filed an appeal with the United States Court of Appeals for the Third Circuit challenging the approval of the settlement agreement by the lower court. On August 18, 1993, the Third Circuit affirmed the lower court approval of the settlement agreement. After expiration of the time in which to file an appeal of the Third Circuit affirmation, the Company paid the plaintiffs' attorneys fees stipulated by the settlement agreement and the federal court action was dismissed.\nIn March 1995, the parties in the Court of Common Pleas action filed a Consent Order to Settle, Discontinue and End.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is certain information with respect to the Company's executive officers.\nPrior to serving as an executive officer of the Company, each of the above officers, with the exception of Mr. Johnson, has held high level managerial positions with the Company or one of its subsidiaries for at least five years. From 1987 until joining the Company in 1992, Mr. Johnson served as President, GTE-Contel Federal Sector for GTE Corporation.\nOfficers are not elected for a fixed term of office but are removable at the discretion of the Board of Directors.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nThe principal market for trading in the common stock of Bell Atlantic Corporation is the New York Stock Exchange. The common stock is also listed in the United States on the Boston, Chicago, Pacific, and Philadelphia stock exchanges. As of December 31, 1994, there were 990,652 shareowners of record.\nHigh and low stock prices, as reported on the New York Stock Exchange composite tape of transactions, and dividend data are as follows:\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe Selected Financial and Operating Data on page 2 of the Company's 1994 Annual Report to shareowners is incorporated herein by reference.\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 on pages 6 through 15 of the Company's 1994 Annual Report to shareowners is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe Report of Independent Accountants, Consolidated Statements of Operations, Consolidated Balance Sheets, Consolidated Statements of Cash Flows, and Notes to Consolidated Financial Statements on pages 17 through 41 of the Company's 1994 Annual Report to shareowners 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 Registrant\nFor information with respect to the executive officers of the Company, see \"Executive Officers of the Registrant\" at the end of Part I of this Report. For information with respect to the Directors of the Company, see \"Election of Directors\" on pages 1 through 6 of the Proxy Statement for the Company's 1995 Annual Meeting of Shareowners, which is incorporated herein by reference. For information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, see \"Section 16 Reporting\" on page 19 of the Proxy Statement for the Company's 1995 Annual Meeting of Shareowners, which is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nFor information with respect to executive compensation, see \"Executive Compensation\" on pages 11 through 18, \"Stock Performance\" on page 19, and \"Employment Agreements\" on page 20 of the Proxy Statement for the Company's 1995 Annual Meeting of Shareowners, which are incorporated herein by reference.\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 Executive Officers of the Company, see \"Ownership of Bell Atlantic Common Stock\" on pages 18 and 19 of the Proxy Statement for the Company's 1995 Annual Meeting of Shareowners, which 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) The following documents are filed as part of this report:\n(1) Financial Statements\nSee Index to Financial Statements and Financial Statement Schedule appearing on Page.\n(2) Financial Statement Schedules\nSee Index to Financial Statements and Financial Statement Schedule appearing on Page.\n(3) Exhibits\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated herein by reference as exhibits hereto.\n10b Bell Atlantic Senior Management Long-Term Disability and Survivor Protection Plan, as amended. (Exhibit 10h to Form SE filed on March 27, 1986, File No. 1-8606.)*\n10b (i) Resolutions amending the Plan, effective as of January 1, 1989 (Exhibit 10d to Form SE dated March 29, 1989, File No. 1-8606.)*\n10c Bell Atlantic Personal Financial Services Program for Senior and Executive Managers and Key Employees, effective as of July 1, 1990, as amended. (Exhibit 10f to Form SE dated March 28, 1991, File No. 1- 8606.)*\n10d Bell Atlantic Deferred Compensation Plan for Outside Directors, as amended and restated as of February 1, 1995.*\n10e Bell Atlantic Insurance Plan for Directors. (Exhibit 10hh to Registration Statement on Form S-1 No. 2-87842, File No. 1-8606.)*\n10f Description of Bell Atlantic Plan for Non-Employee Directors' Travel Accident Insurance. (Exhibit 10ii to Registration Statement on Form S-1 No. 2-87842, File No. 1-8606.)*\n10g Article V from Bell Atlantic Management Pension Plan regarding limitations on payment of pension amounts which exceed the limitations contained in the Employee Retirement Income Security Act of 1974. (Exhibit 10j to Form SE dated March 26, 1992, File No. 1- 8606.)*\n10h Bell Atlantic Senior Management Retirement Income Plan, as amended and restated effective as of January 1, 1993. (Exhibit 10k to Form SE dated March 29, 1993, File No. 1-8606.)*\n10h (i) Resolutions amending the Bell Atlantic Senior Management Retirement Income Plan effective as of December 31, 1993. (Exhibit 10k(i) to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10i Bell Atlantic Deferred Compensation Plan (formerly the Bell Atlantic Senior Management Incentive Award Deferral Plan), as amended and restated effective as of January 1, 1993. (Exhibit 101 to Form SE dated March 29, 1993, File No. 1-8606.)*\n10i (i) Resolutions amending the Bell Atlantic Deferred Compensation Plan, effective October 25, 1993. (Exhibit 10l(i) to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10i (ii) Resolution amending the Bell Atlantic Deferred Compensation Plan, effective November 21, 1994.*\n10j Bell Atlantic Stock Incentive Plan, consisting of (1) The Bell Atlantic 1985 Performance Share Plan as amended and restated effective as of January 1, 1993 and (2) The Bell Atlantic 1985 Incentive Stock Option Plan as amended and restated effective as of January 1, 1993. (Exhibit 10m to Form SE dated March 29, 1993, File No. 1-8606.)*\n10j (i) Resolutions amending The Bell Atlantic 1985 Incentive Stock Option Plan, (Exhibit 10m(i) to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10k Bell Atlantic Retirement Plan for Outside Directors, as amended and restated as of February 1, 1995.*\n10l Bell Atlantic Stock Compensation Plan for Outside Directors, as amended and restated as of October 25, 1994.*\n10m Bell Atlantic Corporation Directors' Charitable Giving Program. (Exhibit 10p to Form SE dated March 29, 1990, File No. 1-8606.)*\n10m (i) Resolutions amending and partially terminating the Program. (Exhibit 10p to Form SE dated March 29, 1993, File No. 1-8606.)*\n10n Employment Agreement dated January 24, 1994 between the Company and William O. Albertini. (Exhibit 10q to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10o Employment Agreement dated January 24, 1994 among the Company, Bell Atlantic Enterprises International, Inc. and Lawrence T. Babbio, Jr. (Exhibit 10n to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10p Resolution dated January 24, 1994 granting Lawrence T. Babbio, Jr. certain nonqualified stock options to purchase American Depository Receipts representing Series L shares of the capital stock of Grupo Iusacell, S.A. de C.V. (Exhibit 10s to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10q Employment Agreement dated January 24, 1994 between the Company and James G. Cullen. (Exhibit 10t to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10r Non-Compete and Proprietary Information Agreement dated August 10, 1993 between the Company and James G. Cullen. (Exhibit 10u to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10s Employment Agreement dated January 24, 1994 among the Company, Bell Atlantic Network Services, Inc. and Stuart C. Johnson. (Exhibit 10v to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10t Non-Compete and Proprietary Information Agreement dated August 9, 1993 among the Company, Bell Atlantic Network Services, Inc. and Stuart C. Johnson. (Exhibit 10w to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10u Employment Agreement dated January 24, 1994 between the Company and James R. Young. (Exhibit 10x to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n11 Computation of Earnings Per Common Share.\n12 Computation of Ratio of Earnings to Fixed Charges.\n*Indicates management contract or compensatory plan or arrangement.\nShareowners may request a copy of the exhibits to this Annual Report on Form 10-K by writing to the Corporate Secretary, Bell Atlantic Corporation, 1717 Arch Street, Philadelphia, Pennsylvania 19103.\n(b) Current Reports on Form 8-K filed during the quarter ended December 31, 1994:\nA Current Report on Form 8-K, dated October 20, 1994, was filed regarding the Company's third quarter 1994 financial results. This report contained unaudited condensed consolidated statements of income for the three- and nine- month periods ended September 30, 1994 and 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.\nBELL ATLANTIC CORPORATION\nBy \/s\/ William O. Albertini --------------------------- William O. Albertini Executive Vice President and Chief Financial Officer\nMarch 29, 1995\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.\nBELL ATLANTIC CORPORATION\nIndex to Financial Statements and Financial Statement Schedule\nFinancial statement schedules other than that listed above have been omitted because such schedules are not required or applicable.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareowners of Bell Atlantic Corporation\nOur report on the consolidated financial statements of Bell Atlantic Corporation and subsidiaries has been incorporated by reference in this Form 10- K from page 17 of the 1994 Annual Report to shareowners of Bell Atlantic Corporation and subsidiaries. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index on page of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\n\/s\/Coopers & Lybrand L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania February 6, 1995\nBELL ATLANTIC CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1994, 1993, and 1992 (Dollars In Millions)\n____________ (a) Amounts include beginning balances for businesses acquired during the year. Allowance for Uncollectible Accounts Receivable includes (1) amounts previously written off which were credited directly to this account when recovered, and (2) accruals charged to accounts payable for anticipated uncollectible charges on purchases of accounts receivable from others which were billed by the Company. (b) Amounts written off as uncollectible or obsolete or transferred to other accounts (except for the valuation allowance for deferred tax assets). In 1994, amounts include ending balances for businesses sold during the year. (c) Represents the valuation allowance at implementation of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" effective January 1, 1993. (d) Other Allowances include allowances for obsolete equipment and allowances for probable losses incurred in the directory businesses arising in the normal course of operations.\nEXHIBITS TO FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE YEAR ENDED DECEMBER 31, 1994 COMMISSION FILE NO. 1-8606 BELL ATLANTIC CORPORATION\nEXHIBIT INDEX\n10e Bell Atlantic Insurance Plan for Directors. (Exhibit 10hh to Registration Statement on Form S-1 No. 2-87842, File No. 1-8606.)*\n10f Description of Bell Atlantic Plan for Non-Employee Directors Travel Accident Insurance. (Exhibit 10ii to Registration Statement on Form S-1 No. 2-87842, File No. 1-8606.)*\n10g Article V from Bell Atlantic Management Pension Plan regarding limitations on payment of pension amounts which exceed the limitations contained in the Employee Retirement Income Security Act of 1974. (Exhibit 10j to Form SE dated March 26, 1992, File No. 1- 8606.)*\n10h Bell Atlantic Senior Management Retirement Income Plan, as amended and restated effective as of January 1, 1993. (Exhibit 10k to Form SE dated March 29, 1993, File No. 1-8606.)*\n10h (i) Resolutions amending the Bell Atlantic Senior Management Retirement Income Plan effective as of December 31, 1993. (Exhibit 10k(i) to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10i Bell Atlantic Deferred Compensation Plan (formerly the Bell Atlantic Senior Management Incentive Award Deferral Plan), as amended and restated effective as of January 1, 1993. (Exhibit 101 to Form SE dated March 29, 1993, File No. 1-8606.)*\n10i (i) Resolutions amending the Bell Atlantic Deferred Compensation Plan, effective October 25, 1993. (Exhibit 10l(i) to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10i (ii) Resolution amending the Bell Atlantic Deferred Compensation Plan, effective November 21, 1994.*\n10j Bell Atlantic Stock Incentive Plan, consisting of (1) The Bell Atlantic 1985 Performance Share Plan as amended and restated effective as of January 1, 1993 and (2) The Bell Atlantic 1985 Incentive Stock Option Plan as amended and restated effective as of January 1, 1993. (Exhibit 10m to Form SE dated March 29, 1993, File No. 1-8606.)*\n10j (i) Resolutions amending The Bell Atlantic 1985 Incentive Stock Option Plan, (Exhibit 10m(i) to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n10k Bell Atlantic Retirement Plan for Outside Directors, as amended and restated as of February 1, 1995.*\n10l Bell Atlantic Stock Compensation Plan for Outside Directors, as amended and restated as of October 25, 1994.*\n10m Bell Atlantic Corporation Directors' Charitable Giving Program. (Exhibit 10p to Form SE dated March 29, 1990, File No. 1-8606.)*\n10m (i) Resolutions amending and partially terminating the Program. (Exhibit 10p to Form SE dated March 29, 1993, File No. 1- 8606.)*\n10n Employment Agreement dated January 24, 1994 between the Company and William O. Albertini. (Exhibit 10q to Form 10-K for the year ended December 31, 1993, File No. 1-8606.)*\n*Indicates management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"714710_1994.txt","cik":"714710","year":"1994","section_1":"Item 1. Business:\nCommunity Banks, Inc. (Bank) is a bank holding company whose banking subsidiary is Community Banks, N.A. (CBNA) and whose non-banking subsidiaries are Community Banks Investments, Inc. (CBI) and Community Banks Life Insurance Company, Inc. (CBLIC).\nThe Bank conducts a full service commercial banking business and provides trust services in northern Dauphin County, Northumberland County, western Schuylkill County, and southern Luzerene County. The Bank currently has fifteen offices. There are 57 offices of commercial banks and savings and loan associations within its market area with which the Bank competes. Deposits of the Bank represent approximately 11% of the total deposits in the market area. The Bank has six offices in Dauphin County, two offices in Northumberland County, five offices in Schuylkill County, and two offices in Luzerne County.\nLike other depository institutions, the Bank has been subjected to competition from brokerage firms, money market funds, consumer finance and credit card companies and other companies providing financial services and credit to consumers. As a result of federal legislation, regulatory restrictions previously imposed on the Bank with respect to establishing money market fund accounts have been eliminated and the Bank is now better able to compete with other financial institutions in its service area with respect to interest rates paid on time and savings deposits, service charges on deposit accounts and interest rates charged on loans.\nDuring 1986 the Bank formed CBLIC to provide credit life insurance to its consumer credit borrowers. Total premiums earned were $396,000 for the year ended December 31, 1994. During 1985 the Bank formed CBI to make investments primarily in equity securities of other banks. Total assets of CBI at December 31, 1994 were $1,735,000.\nThe Bank has approximately 172 full and part-time employees and considers its employee relations to be satisfactory.\nCommunity Banks, Inc. is registered as a bank holding company with the Board of Governors of the Federal Reserve System in accordance with the requirements of the Bank Holding Company Act of 1956. It is subject to regulation by the Federal Reserve Board and the Comptroller of the Currency.\nIn 1989, the Federal Reserve Board issued final risk-based capital guidelines for bank holding companies which were phased in through December 31, 1992. The intent of regulatory capital guidelines is to measure capital adequacy based upon the credit risk of various assets and off-balance sheet items. Risk categories, weighted at 0%, 20%, 50% and 100%, are specifically identified. The sum of the results of each such category is then related to the adjusted capital account of the Company. A minimum required capital ratio at December 31, 1994, was 8 percent. The Bank's December 31, 1994 ratio approximated 17%. Subsequently, in August 1990 the board announced approval of capital to total assets (leverage) guidelines. This minimum leverage ratio was set at 4% and would apply only to those banking organizations receiving a regulatory composite 1 rating. Most banking organizations will be required to maintain a leverage ratio ranging from 1 to 2 percentage points above the minimum standard. The Bank's leverage ratio at December 31, 1994, approximated 10.%. Risk-based capital requirements replace previous capital guidelines which established minimum primary and total capital requirements.\n\t\t\t\t The following summarizes the Bank's capital adequacy position:\n\t\t\t\t\t\t Required \t\t\t Bank Regulatory Capital (in thousands) December 31, 1994 December 31, 1994\nRisk-based capital $34,136 17.2% $15,877 8.0% Leverage ratio (tier 1 capital) 30,740 10.0% 12,296 4.0%\nStatistical Data: \t Pages 18 through 20 of the Community Banks, Inc. Annual report to stockholders dated December 31, 1994 contain information concerning:\nFinancial Highlights\nAverage Balances, Effective Interest Differential, and Interest Yields for the three years ended December 31, 1994.\nRate\/Volume Analysis for the two years ended December 31, 1994.\n\tAppendix A attached to Part I contains information concerning:\nReturn on Equity and Assets for the five years ended December 31, 1994. \t\t\t Amortized cost and Estimated Market Values of Investment Securities as of December 31, 1994, 1993, and 1992.\nMaturity Distribution of Securities as of December 31, 1994 (Market Value).\nLoan Account Composition as of December 31, 1994, 1993, 1992, 1991, and 1990.\nMaturities and Sensitivity to Changes in Interest Rates for Commercial, Financial, and Agricultural Loans as of December 31, 1994.\nNonperforming Loans as of December 31, 1994, 1993, 1992, 1991, and 1990.\nLoan Loss Experience for the five years ended December 31, 1994.\nLoans Charged Off and Recovered for the five years ended December 31, 1994.\nAllowance for Loan Losses as of December 31, 1994, 1993, 1992, 1991, and 1990.\nMaturity Distribution of Time Deposits over $100,000 as of December 31, 1994.\nInterest Rate Sensitivity as of December 31, 1994.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties:\n\t The Bank owns no real property except through its subsidiary bank, CBNA which owns the following buildings: 150 Market Street, Millersburg, Pennsylvania (its corporate headquarters); 13-23 South Market Street, Elizabethville, Pennsylvania; 3679 Peters Mountain Road, Halifax, Pennsylvania; 906 N. River Road, Halifax, Pennsylvania; 800 Peters Mountain Road, Dauphin, Pennsylvania; Main and Market Streets, Lykens, Pennsylvania; Route 209, Porter Township, Schuylkill County, Pennsylvania; 29 E. Main Street, Tremont, Schuylkill County, Pennsylvania; Second and Carroll Streets, St. Clair, Schuylkill County, Pennsylvania; R.D. 3, Mill Creek Manor, Pottsville, Schuylkill County, Pennsylvania; 300 East Independence Street, Shamokin, Northumberland County, Pennsylvania; Route 61, R.D. 1, Orwigsburg, Schuylkill County, Pennsylvania; One South Arch Street, Milton, Northumberland County, Pennsylvania; 4 West Broad Street, Hazleton, Luzerne County, Pennsylvania; and Route 93, Conyngham, Luzerne County, Pennsylvania. In addition thereto, CBNA leases an office on Main Street, Pillow, Pennsylvania, pursuant to a lease which, with renewal options, will extend to the year 2008. From time to time, the subsidiary bank also acquires real estate by virtue of foreclosure proceedings, which real estate is disposed of in the usual and ordinary course of business as expeditiously as is prudently possible.\nAll the buildings used by the Bank are free-standing and are used exclusively for banking purposes with the exception of offices and retail space rented at the St. Clair and Milton locations.\nItem 3.","section_3":"Item 3. Legal Proceedings:\nThere are no material pending legal actions, other than routine litigation incidental to the business of the Bank, to which the Bank is a party.\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 1994.\n\t\t\t\n\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\n\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\t\n\t\t\t\t\t\t\t\t APPENDIX A \t\t\t\t\t\t\t\t Continued \t\t\t\t\t\n\t\t\t\t INTEREST RATE SENSITIVITY\n\t The excess of interest-earning assets over interest-bearing liabilities which are expected to mature or reprice within a given period is commonly referred to as the \"GAP\" for that period. For an institution with a negative GAP, the amount of income earned on its assets fluctuates less than the cost of its liabilities in response to changes in the prevailing rates of interest during the period. Accordingly, in a period of decreasing interest rates, institutions with a negative GAP will experience a smaller decrease in the yield on their assets than in the cost of their liabilities. Conversely, in a period of rising interest rates, institutions with a negative GAP face a smaller increase in the yield on their assets than in the cost of their liabilities. A decreasing interest rate environment is favorable to institutions with a negative GAP because more of their liabilities than their assets adjust during the period and, accordingly, the decrease in the cost of their liabilities is greater than the decrease in the yield on their assets.\n\t The negative GAP between the Bank's interest-earning assets and interest-bearing liabilities maturing or repricing within one year approximated 10.3% of total assets at December 31, 1994.\n\t Significant maturity\/repricing assumptions include the presentation of all savings and NOW accounts as being 100% interest rate sensitive. Equity securities are reflected in the shortest time interval. Assumed paydowns on mortgage-backed securities and loans have also been included in all time intervals.\n\t The following table sets forth the scheduled repricing or maturity of the Bank's interest-earning assets and interest-bearing liabilities at December 31, 1994.\n\t\t\t\t\t PART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and \t Related Stockholder Matters:\n\t Incorporated by reference is the information appearing under the heading \"Market for the Holding Company's Common Stock and Related Securities Holder Matters\" on page 3 of the Annual Report to Stockholders for the year ended December 31, 1994 (hereafter referred to as the \"Annual Report\").\nItem 6.","section_6":"Item 6. Selected Financial Data:\n\t Incorporated by reference is the information appearing under the heading \"Financial Highlights\" on page 18 of the Annual Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial \t Condition and Results of Operations:\n\t Incorporated by reference is the information appearing under the headings \"Rate\/Volume Analysis\"; \"Average Balances, Effective Interest Differential and Interest Yields\"; and \"Management's Discussion of Financial Condition and Results of Operations\" on pages 19 through 23 of the Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data:\n\t The consolidated financial statements, together with the report thereon of Coopers & Lybrand L.L.P. dated January 15, 1995, are incorporated by reference to pages 6 through 18 of the Annual Report.\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosures:\n\t None.\n\t\t\t\t\t PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant:\n\t The following table sets forth the name and age of each director of Community Banks, Inc. as well as the director's business experience, including occupation for the past 5 years, the period during which he has served as a director of the Bank, or its wholly-owned subsidiary, Community Banks, N.A. (Formerly Upper Dauphin National Bank), and the number and percentage of outstanding shares of Common Stock of the Bank beneficially owned by said directors as of December 31, 1994.\nCompliance with Section 16(a) of Securities Exchange Act\n\t In 1994, to the knowledge of CBI, all directors filed on a timely basis reports required by the Securities Exchange Commission.\n\t None of the directors or nominee directors are directors of other companies with a class of securities registered pursuant to Section 12 of the Securities Exchange Act of 1934.\n\t\nItem 11.","section_11":"Item 11. Executive Compensation: \t \t Information regarding executive compensation is omitted from this report as the holding company has filed a definitive proxy statement for its annual meeting of shareholders to be held May 2, 1995; and the information included therein with respect to this item is incorporated herein by reference.\nPension Plan:\n\t The Bank maintains a pension plan for its employees. An employee becomes a participant in the pension plan on January 1 or July 1 after completion of one year of service (12 continuous months) and attainment of the age 21 years. The cost of the pension is actuarially determined and paid by the Bank. The amount of monthly pension is equal to 1.15% of average monthly pay up to $650, plus .60% of average monthly pay in excess of $650, multiplied by the number of years of service completed by an employee. Average\nmonthly pay is based upon the 5 consecutive plan years of highest pay preceding retirement. The maximum amount of annual compensation used in determining retirement benefits is $150,000. A participant is eligible for early retirement after attainment of the age of 60 years and the completion of 5 years of service. The early retirement benefit is the actuarial equivalent of the pension accrued to the date of early retirement. Thomas L. Miller and Ernest L. Lowe have been credited with 36 and 10 years of service, respectively, under the pension plan as of December 31, 1994. The amounts shown on the following table assume an annual retirement benefit for an employee who chose a straight-line annuity and who is presently 50 years old and who will retire at the age of 65 years.\n\t Directors' Compensation:\n\t Each director of CBI is paid a quarterly fee of $600.00. In addition, each outside director receives a fee of $200.00 for attendance at the regular quarterly meetings of the Board of Directors of CBI. Each director who is not an executive officer also receives $150 for attendance at each committee meeting of CBI.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial \t Owners and Management:\n\t Refer to Item 10 on pages 13 through 16.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions:\n\t (a) Transactions with Management and Others\n\t Incorporated by reference is the information appearing in Note 12 (Related Parties) of Notes to Consolidated Financial Statements on page 14 of the Annual Report.\n\t (b) Certain Business Relationships\n\t Allen Shaffer, a director of the Bank, is an attorney practicing in Harrisburg and Millersburg, Pennsylvania, who has been retained in the last two fiscal years by the Bank and who the Bank proposes to retain in the current fiscal year. James A. Ulsh, a director of the Bank, is a shareholder\/employee of the law firm of Mette, Evans & Woodside, Harrisburg, Pennsylvania, which the Bank has retained in the last two fiscal years and proposes to retain in the current fiscal year.\n\t All loans to directors and their business affiliates, executive officers and their immediate families were made by the subsidiary bank in the ordinary course of business, at the subsidiary bank's normal credit terms, including interest rates and collateralization prevailing at the time for comparable transactions with other non-related persons, and do not represent more than a normal risk of collection. \t\t\t\t\t\t PART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements Schedules and \t Reports on Form 8-K: \t\t\t\t\t\t\t\tReference (page) \t\t\t\t\t\t\t\t Annual \t\t\t\t\t\t\t Form Report to \t\t\t\t\t\t\t 10-K Shareholders (a) (1) Consolidated Financial Statements \t Report of Independent Public \t Accountants -- 18\n\t Balance Sheets as of December 31, 1994 \t and 1993 -- 6\n\t Statements of Income for each of the three years \t ended December 31, 1994 -- 7\n\t Statements of Changes in Stockholders' \t Equity for each of the three years ended \t December 31, 1994 -- 8\n\t Statements of Cash Flows for each of the three \t years ended December 31, 1994 -- 8\n\t \t Notes to Financial Statements -- 9-17\n\t All other schedules are omitted since the required information is not applicable or is not present in amounts sufficient to require submission of the schedule.\n(3) Exhibits\n\t (3) Articles of Incorporation and By-Laws. Incorporated Registration by reference to the Proxy Statements dated April 14, 1987 and April 12, 1988 and Amendment 2 to Form S-2 dated May 13, 1987.\n\t (13) Portions of the Annual Report to Security Holders incorporated by within this document.\n\t (21) Subsidiaries of the Registrant (see Item 1, pages 2 and 3).\n(b) The registrant did not file on Form 8-K during the Fourth quarter of the Fiscal year ended December 31, 1994.\n\t\t\t CONSENT OF INDEPENDENT ACCOUNTANTS \t \t \t We consent to the incorporation by reference in the registration statements of Community Banks, Inc. on Form S-8 (File No. 0-15786 and File No. 33-24908) of our report, dated January 13, 1995 on our audits of the consolidated financial statements of Community Banks, Inc. as of December 31, 1994 and 1993, and for the years ended December 31, 1994, 1993, and 1992, which report is incorporated by reference in this Annual Report on Form 10-K. \t \t \t\t\t\t\t\t Signature \t\t\t\t\t\t \t\t\t\t\t\t \/S\/ Coopers & Lybrand L.L.P.\n\t \t \t \t One South Market Square \t Harrisburg, Pennsylvania \t March 22, 1995 \t \t\n\t\t \t\t\t Signatures\n\t 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. \t\t\t \t\t\t Community Banks, Inc. \t\t\t\t\t\t\t\t\t\t \t\t By:\/S\/__Thomas L. Miller_____ \t\t\t (Thomas L. Miller) \t\t\t\t Chairman \t\t\t Chief Executive Officer \t\t\t and Director\nDate: March 17, 1995\n\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 and in the capacities and on the dates indicated.\nSignature Title Date\n\/S\/ Terry L. Burrows Ex. Vice President and 3\/17\/95 (Terry L. Burrows) Principal Financial Officer\n\/S\/ Ronald E. Boyer Director 3\/17\/95 (Ronald E. Boyer)\n\/S\/ Samuel E. Cooper Director 3\/17\/95 (Samuel E. Cooper)\n\/S\/ Kenneth L. Deibler Director 3\/17\/95 (Kenneth L. Deibler)\n\/S\/ Ray N.Leidich Director 3\/17\/95 (Ray N. Leidich)\n\/S\/ Ernest L. Lowe Director 3\/17\/95 (Ernest L. Lowe)\n\/S\/ Donald L. Miller Director 3\/17\/95 (Donald L. Miller)\n\/S\/ Robert W. Rissinger_ Director 3\/17\/95 (Robert W. Rissinger)\n\/S\/ Allen Shaffer _ Director 3\/17\/95 (Allen Shaffer)\n\/S\/ William C. Troutman Director 3\/17\/95 (William C. Troutman)\n\/S\/ James A. Ulsh _ Director 3\/17\/95 (James A. Ulsh)","section_15":""}
{"filename":"746969_1994.txt","cik":"746969","year":"1994","section_1":"Item 1. Business.\nOld Kent Financial Corporation (\"Old Kent\") is a bank holding company with its headquarters in Grand Rapids, Michigan. As of December 31, 1994, Old Kent owned directly and indirectly all of the stock of 17 commercial banks and 6 operating nonbank subsidiaries that had their principal offices in various cities in Michigan and Illinois. As of December 31, 1994, Old Kent Bank and Trust Company (\"OKB-MI\"), which is headquartered in Grand Rapids, Michigan, was Old Kent's largest subsidiary. On January 1, 1995, Old Kent consolidated 15 of its bank subsidiaries, all of which were Michigan banks, into a single bank that operates under the name \"Old Kent Bank.\"\nOld Kent's business is concentrated in a single industry segment--commercial banking. Old Kent's subsidiaries offer a wide range of commercial banking and fiduciary services. These include accepting deposits, commercial lending, consumer financing, real estate and lease financing, equipment leasing, bank credit cards, debit cards, safe deposit facilities, automated transaction machine services, cash management, electronic banking services, money transfer services, international banking services, corporate and personal trust services, personal investment and securities brokerage services, credit life insurance and other banking services.\nThe principal markets for these financial services are the Michigan and Illinois communities in which Old Kent subsidiaries are located and the areas immediately surrounding those communities. As of December 31, 1994, Old Kent and its subsidiaries served these markets through 207 full service banking offices located in and around those communities.\nAs of December 31, 1994, OKB-MI accounted for 41% of total deposits and 42% of total loans of Old Kent and its subsidiaries on a consolidated basis. At December 31, 1994, OKB-MI had assets of $4.6 billion, representing 42% of Old Kent's consolidated assets. Old Kent's 16 other subsidiary banks ranged in size from $78 million to $1.9 billion in total assets as of December 31, 1994. On a pro forma basis giving effect to the consolidation of the Michigan banks, at December 31, 1994, OKB-MI would have accounted for 81% of total deposits and 83% of total loans of Old Kent and its subsidiaries on a consolidated basis, with assets of $8.7 billion.\nThe principal source of revenues for Old Kent is interest and fees on loans, which accounted for 54.5% of total revenues in 1994, 49.7% in 1993, and 53.5% in 1992. Interest on securities is also a significant source of revenue, accounting for 25.8% of total revenues in 1994, 28.9% in 1993, and 29.7% in 1992.\nOld Kent has had no foreign loans at any time during the last five years. The foreign activities of Old Kent primarily involve time\ndeposits with banks and placements for domestic customers of the banks. These activities did not significantly impact Old Kent's financial condition or results of operations. More detailed information concerning these foreign activities is contained in the statistical information that appears below.\nOKB-MI's subsidiary, Old Kent Mortgage Company, originates residential mortgages through its offices located in Grand Rapids, suburban Chicago, Illinois, Central and Southern Florida, Minnesota, Ohio and Texas. On March 1, 1994, this subsidiary acquired Princeton Financial Corp. headquartered in Orlando with 12 other Florida offices. The acquisition was treated as a purchase for accounting purposes and, accordingly, results of operations of Princeton Financial Corp. subsidiaries are included from the date of purchase. At December 31, 1993, Princeton had assets of $65.6 million and stockholders' equity of $5.4 million. Old Kent Mortgage Company conducts a traditional retail and wholesale mortgage banking business in one- to four-family residential mortgage loans. Substantially all mortgage production is sold into the secondary market with servicing retained. Mortgage servicing for all of Old Kent's subsidiaries and independent investors is performed by OKB-MI's subsidiary, Old Kent Mortgage Services, Inc.\nEffective May 2, 1994, Old Kent acquired EdgeMark Financial Corporation (\"EdgeMark\"), a bank holding company located in Chicago, Illinois. The acquisition was effected by a merger of EdgeMark with and into Old Kent - Illinois, Inc., a wholly owned subsidiary of Old Kent. The acquisition was treated as a purchase for accounting purposes and, accordingly, results of operations of EdgeMark subsidiaries are included from the date of purchase. At the effective date, EdgeMark had, on a consolidated basis, assets totaling approximately $522 million and deposits of approximately $456 million. EdgeMark stockholders received 1,917,566 shares of common stock of Old Kent. EdgeMark owned all the stock of five commercial banks located in Chicago, Countryside, Lombard, Lockport, and Rosemont, Illinois, that operated eight banking offices in six Illinois communities. The principal market for the financial services offered by EdgeMark and its subsidiaries was downtown Chicago and the surrounding metropolitan area. As described below, EdgeMark's subsidiary banks in Chicago, Lombard and Rosemont were consolidated with Old Kent Bank (Illinois) in October, 1994.\nOn October 14, 1994, Old Kent consolidated four of its six Illinois bank subsidiaries into a single bank, Old Kent Bank (\"OKB-IL\"), under the name \"Old Kent Bank.\" OKB-IL has 26 branches primarily serving Cook, DuPage and Kane Counties. At December 31, 1994, the consolidated bank had assets of $1.9 billion, deposits of $1.5 billion and a total loan portfolio of $0.9 billion.\nEffective February 1, 1995, Old Kent acquired First National Bank Corp. (\"FNBC\"), a bank holding company located in Clinton Township, Michigan. The acquisition was effected by a merger of FNBC with and into Old Kent. This transaction will be accounted for as a \"pooling-of- interests.\" At December 31, 1994, FNBC had, on a consolidated basis, assets totaling approximately $531 million and deposits of approximately\n$472 million. FNBC stockholders received approximately 2,636,817 shares of common stock of Old Kent. FNBC owned all the stock of First National Bank in Macomb County, a national banking association (\"First National\"), that operates 15 banking offices in Macomb County, Michigan. The principal market for the financial services offered by FNBC and First National was Macomb County, Michigan, and the communities within Macomb County.\nThe business of banking is highly competitive. In addition to competition from other commercial banks, banks face significant competition from nonbank financial institutions. Savings associations compete aggressively with commercial banks for deposits and loans. Credit unions and finance companies are significant factors in the consumer loan market. Insurance companies, investment firms and retailers are significant competitors for some types of business. Banks compete for deposits with a broad spectrum of other types of investments such as mutual funds, debt securities of corporations and debt securities of the federal government, state governments and their respective agencies. The principal methods of competition for financial services are price (interest rates paid on deposits, interest rates charged on borrowings and fees charged for services) and service (convenience and quality of services rendered to customers).\nBanks and bank holding companies are extensively regulated. Other than First National, Old Kent's subsidiary banks are chartered under state law and are supervised and regulated by the Federal Deposit Insurance Corporation (\"FDIC\") and either the Financial Institutions Bureau of the State of Michigan or the Commissioner of Banks and Trust Companies of the State of Illinois. First National is a national banking association chartered under federal law and is supervised, examined and regulated by the United States Office of the Comptroller of the Currency. Some of the banks are members of the Federal Reserve System and are supervised, examined and regulated by the Federal Reserve System. Deposits of all of the banks are insured by the FDIC to the extent provided by law.\nFederal and state laws which govern banks significantly limit their business activities in a number of respects. Prior approval of the Board of Governors of the Federal Reserve System (\"Federal Reserve Board\"), and in some cases various other governing agencies, is required for Old Kent to acquire control of any additional banks. The business activities of Old Kent and its subsidiaries are limited to banking and other activities closely related to banking.\nOld Kent is a legal entity separate and distinct from its subsidiary banks and other subsidiaries. Transactions between Old Kent's subsidiary banks are significantly restricted. There are legal limitations on the extent to which Old Kent's subsidiary banks can lend or otherwise supply funds to Old Kent or certain of its affiliates. In addition, payment of dividends to Old Kent by subsidiary banks is subject to various state and federal regulatory limitations.\nFederal law contains a \"cross-guarantee\" provision which could result in insured depository institutions owned by Old Kent being assessed\nfor losses incurred by the FDIC in connection with assistance provided to, or the failure of, any other insured depository institution owned by Old Kent. Under Federal Reserve Board policy, Old Kent is expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each subsidiary bank. Under federal law, the FDIC also has authority 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 Bank Insurance Fund (\"BIF\") member banks to maintain the BIF at the designated reserve ratio required by law.\nRecently the FDIC has proposed a substantial reduction in assessment rates on deposits covered by the BIF. The amount and timing of that reduction is uncertain, but a reduction is not, in any event, expected to occur before the fourth quarter of 1995. If the proposal is adopted and implemented as announced, the lowering of assessment rates on Old Kent's subsidiary bank deposits covered by the BIF may have a favorable effect on Old Kent's results of operations. As a result of acquisitions, Old Kent subsidiaries also have some deposits insured under the FDIC's Savings Association Insurance Fund (\"SAIF\"). The FDIC does not presently propose to reduce assessment rates on SAIF insured deposits.\nBanks are subject to a number of federal and state laws and regulations which have a material impact on their business. These include, among others, state usury laws, state laws relating to fiduciaries, the Truth In Lending Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Expedited Funds Availability Act, the Community Reinvestment Act, electronic funds transfer laws, redlining laws, antitrust laws, environmental laws and privacy laws. The instruments of monetary policy of authorities such as the Federal Reserve Board may influence the growth and distribution of bank loans, investments and deposits, and may also affect interest rates on loans and deposits. These policies may have a significant effect on the operating results of banks.\nThe nature of the business of Old Kent's subsidiaries is such that they hold title, on a temporary or permanent basis, to a number of parcels of real property. These include property owned for branch offices and other business purposes as well as properties taken in or in lieu of foreclosure to satisfy loans in default. Under current state and federal laws, present and past owners of real property are exposed to liability for the cost of clean up of contamination on or originating from those properties, even if they are wholly innocent of the actions that caused the contamination. These liabilities can be material and can exceed the value of the contaminated property.\nCurrently, Old Kent is authorized to acquire subsidiary banks in any state in which state laws permit such acquisitions. Out-of-state bank holding companies in any state are permitted to acquire banks located in Michigan and Illinois if the laws of the state in which the out-of-state bank holding company is located authorize a bank holding company located in Michigan or Illinois to acquire ownership of banks in that state on a reciprocal basis. Under the recent Riegle-Neal Interstate Banking and\nBranching Efficiency Act of 1994 (\"IBBEA\"), a bank holding company may, after September 29, 1995, make certain interstate acquisitions even if state law would otherwise prohibit it. Starting June 1, 1997, IBBEA permits a bank in one state to acquire an out-of-state bank unless one of the states has enacted legislation prohibiting interstate bank acquisitions. IBBEA also permits a bank to establish a de novo branch in another state if the state has a law expressly permitting all out-of-state banks to establish de novo branches in that state.\nIn the aggregate, Old Kent and its subsidiaries had 4,998 employees (on a full time equivalent basis) at December 31, 1994. Old Kent and its subsidiaries are equal opportunity employers whose affirmative action programs comply with applicable federal laws and executive orders.\nThe statistical information on the following pages further describes certain aspects of the business of Old Kent. Additional statistical information describing the business of Old Kent appears in Management's Discussion and Analysis of Financial Condition and Results of Operations incorporated by reference in Item 7 and the Selected Financial Data incorporated by reference in Item 6.\nInvestment Portfolio\nThe following table shows, by class of maturities as of December 31, 1994, the amounts and weighted average yields of securities held-to-maturity and securities available-for-sale on the basis of amortized cost:\nLoan Portfolio\nThe following table shows the maturity of loans (excluding residential mortgages of 1-4 family residences, consumer loans, credit card loans, and lease financing) outstanding at December 31, 1994. Also provided are the amounts due after one year classified according to their sensitivity to changes in interest rates.\nLoan Portfolio (continued)\nForeign Outstandings: A summary of significant foreign outstandings for the three years ended December 31, 1994, is as follows:\nDeposits The daily average amounts of deposits and rates paid on such deposits for the periods indicated are:\nThe time remaining until maturity of time deposits (all of which are time certificates of deposit) of $100,000 or more at December 31, 1994, is as follows:\nTime deposits in the foreign office are all in amounts of $100,000 or more.\nShort-Term Borrowed Funds\nShort-term borrowed funds consist of federal funds purchased and securities sold under agreements to repurchase, bank notes, and treasury tax and loan demand notes. The following amounts and rates applied during the last three years:\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe executive offices of Old Kent and the main office of OKB-MI are located in an office complex in downtown Grand Rapids, Michigan. This complex consists of two interconnected buildings, including a 10-story office building. Approximately 65% of the 281,000 square feet of space in the complex is occupied by Old Kent and OKB-MI. The balance is leased to others for terms of varying lengths.\nOld Kent's operations center is housed in two buildings located near Grand Rapids. The two buildings, which have a total of 340,000 square feet, are owned by OKB-MI.\nOld Kent's subsidiary banks conducted business from a total of 207 full service banking offices as of December 31, 1994. Of the full service banking offices, 157 are owned by the banks or their subsidiaries, and 50 are leased from various independent parties for various lease terms.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nOld Kent's subsidiaries are parties, as plaintiff or defendant, to a number of legal proceedings. Except as described below, all of these proceedings are considered to be ordinary routine litigation incidental to their business, and none is considered to be a material pending legal proceeding.\nOld Kent and its subsidiary, OKB-MI, are named, among other defendants, in a lawsuit filed by Grow Group, Inc. (\"Grow\"), presently pending in the United States District Court for the Southern District of New York. Principal defendants in this case include Perrigo Company (\"Perrigo\"), Michael J. Jandernoa (Chairman of the Board and Chief Executive Officer of Perrigo, and presently a director of Old Kent) and certain other persons who are believed to have been directors and officers of Perrigo (the \"Non-bank Defendants\"), as well as Old Kent, OKB-MI, and National Bank of Detroit (\"NBD\"; now NBD Bank), with which OKB-MI participated in the financing arrangement that is in part the subject of the case.\nThe case was initiated on April 13, 1994, with the filing of a \"Summons With Notice\" in the Supreme Court, State of New York, County of New York. However, Old Kent was not then served with process or notice of the case. The case was subsequently removed to Federal Court where a complaint was filed on March 1, 1995.\nIn 1988, OKB-MI participated in a credit facility which partially financed the purchase of all of the stock of Perrigo from Grow by the Non- bank Defendants in the case. Grow now alleges that NBD and OKB-MI conspired with and aided and abetted the Non-bank Defendants in certain breaches of duties, fraud, and usurpation of corporate opportunity; misappropriated and used confidential and proprietary information for their own benefit; and breached a relationship of trust and confidence with Grow. Grow demands judgment against the defendants, jointly and severally, for\ndamages in an unspecified but apparently material amount, profits and benefits accruing to the defendants as a result of the alleged wrongful acts, punitive damages, interest and costs.\nDiscovery proceedings in this case have not yet been commenced. Accordingly, Old Kent presently has only limited information available to make an informed assessment of the materiality of the claims. However, based on the limited information presently available, Old Kent has no reason to believe that there is a basis for a meritorious claim against it in this case and intends to oppose the action vigorously.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nSupplemental Item. Executive Officers of the Registrant.\nOld Kent's executive officers are appointed annually by, and serve at the pleasure of, the Old Kent board of directors. Biographical information concerning executive officers who are not directors or nominated for election to the board of directors is presented below:\nMartin J. Allen, Jr. (age 58) has been secretary of Old Kent since 1986 and a senior vice president of Old Kent since 1985. Prior to that, he served Old Kent in various other executive capacities. Mr. Allen is also a member of Old Kent's Management Committee.\nDavid A. Dams (age 42) has been an executive vice president of OKB-MI since 1986. Prior to that, he served Old Kent in various other executive capacities. Mr. Dams is also a member of Old Kent's Management Committee and a director of Old Kent Financial Life Insurance Company, an Old Kent subsidiary.\nE. Philip Farley (age 55) has been an executive vice president of OKB-MI since 1987. Prior to that, he served Old Kent in various other executive capacities. Mr. Farley is also a member of Old Kent's Management Committee.\nRalph W. Garlick (age 58) has been an executive vice president-senior credit officer of Old Kent since 1989. He was an executive vice president of OKB-MI from 1984 until 1989. Prior to that, he served Old Kent in various other executive capacities. Mr. Garlick is also President-Metro Detroit (since February, 1995) and a member of Old Kent's Management Committee.\nRichard L. Haug (age 55) has been a senior vice president and general auditor of Old Kent since 1986.\nCharles W. Jennings, Jr. (age 55) has been a senior vice president of human resources of Old Kent since 1984. Prior to\nthat, he served Old Kent in various other executive capacities. Mr. Jennings is also a member of Old Kent's Management Committee.\nKevin T. Kabat (age 38) has been an executive vice president of Old Kent since February 1995. He was senior vice president and manager of corporate operations and technology of Old Kent from 1993 until 1995, senior vice president and manager of corporate operations from 1990 until 1993, and a vice president and director of human resources of OKB-MI from 1986 until 1990. Prior to that, he served Old Kent in various other executive capacities. Mr. Kabat is also a member of Old Kent's Management Committee.\nDavid L. Kerstein (age 51) became an executive vice president, retail banking, of Old Kent and OKB-MI in 1992. Prior to that, he was a senior vice president of Bank One (Texas), a bank, from 1990 until 1992, and a senior vice president of Citibank FSB (Chicago), a bank, from 1987 until 1990. Mr. Kerstein is also a member of Old Kent's Management Committee.\nLeigh I. Sherman (age 46) has been a senior vice president and marketing director of Old Kent since 1989. He was formerly a senior vice president and marketing director of American Security Bank, a bank, for over 5 years. Mr. Sherman is also a member of Old Kent's Management Committee.\nRobert H. Warrington (age 47) has been president of Old Kent Mortgage Company, an indirect subsidiary of Old Kent, since 1993. He was a senior vice president of OKB-MI from 1988 until 1993. Prior to that, he served Old Kent in various other executive capacities. Mr. Warrington is also a director of Old Kent Mortgage Company, president and a director of Old Kent Mortgage Services, Inc., and a member of Old Kent's Management Committee.\nThomas D. Wisnom (age 56) has been an executive vice president of Old Kent since 1985. Prior to that, he served Old Kent in various other executive capacities. Mr. Wisnom is also a member of Old Kent's Management Committee.\nRichard W. Wroten (age 42) has been an executive vice president and chief financial officer of Old Kent since September 1991. From 1989 until 1991 he was an executive vice president and chief financial officer of First City Bancorporation of Texas, Inc., a bank holding company, and chief financial officer and a director of First City, Texas-Houston N.A., a commercial\nbank.1 Until 1989, Mr. Wroten was a partner of Arthur Andersen & Co., an accounting firm. Mr. Wroten is also a member of Old Kent's Management Committee and a director of Old Kent Financial Life Insurance Company and Old Kent Mortgage Company, both of which are Old Kent subsidiaries. __________________________\n1 On October 30, 1992, over a year after Mr. Wroten joined Old Kent, First City, Texas-Houston N.A. was placed in Federal Deposit Insurance Corporation receivership by bank regulators, and an involuntary, but uncontested, petition was filed placing First City Bancorporation of Texas, Inc., into a proceeding under Chapter 11 of the Federal Bankruptcy Code.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.\nThe information under the caption \"Cash Dividends\" on pages 37 and 38 and under the captions \"Old Kent Common Stock\" and \"Two-Year Range of Common Stock Prices\" on page 71 of Old Kent's annual report to shareholders for the year ended December 31, 1994, is here incorporated by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe information under the caption \"Five Year Summary of Selected Financial Data\" on page 20 of Old Kent's annual report to shareholders for the year ended December 31, 1994, is here incorporated 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 \"Financial Review\" on pages 21 through 47 of Old Kent's annual report to shareholders for the year ended December 31, 1994, is here incorporated by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe financial statements, notes and the report of independent public accountants on pages 51 through 70 of Old Kent's annual report to shareholders for the year ended December 31, 1994, are here incorporated by reference.\nThe information under the caption \"Quarterly Financial Data\" on page 48 of Old Kent's annual report to shareholders for the year ended December 31, 1994, is here incorporated 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 set forth under the captions \"Board of Directors\" and \"Compliance with Section 16(a) of the Exchange Act\" in Old Kent's definitive Proxy Statement for its April 17, 1995, annual meeting of shareholders is here incorporated by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information set forth under the captions \"Compensation of Executive Officers and Directors,\" \"Executive Severance Agreements\" and \"Compensation of Directors\" in Old Kent's definitive Proxy Statement for its April 17, 1995, annual meeting of shareholders is here incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information set forth under the caption \"Voting Securities\" in Old Kent's definitive Proxy Statement for its April 17, 1995, annual meeting of shareholders is here incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information set forth under the caption \"Certain Relationships and Related Transactions\" in Old Kent's definitive Proxy Statement for its April 17, 1995, 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) Financial Statements. The following financial statements and report of independent public accountants of Old Kent Financial Corporation and its subsidiaries are filed as part of this report:\nReport of Independent Public Accountants dated January 16, Consolidated Balance Sheets--December 31, 1994 and 1993 Consolidated Statements of Income for each of the three years in the period ended December 31, 1994 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1994 Consolidated Statements of Shareholders' Equity for each of the three years in the period ended December 31, 1994 Notes to Consolidated Financial Statements\nThe financial statements, the notes to financial statements, and the report of independent public accountants listed above are set forth in Item 8 of this report.\n(2) Financial Statement Schedules. Not applicable.\n(3) Exhibits. The following exhibits are filed as part of this report:\nOld Kent will furnish a copy of any exhibit listed above to any shareholder of the registrant without charge upon written request to Mr. Martin J. Allen, Jr., Secretary, Old Kent Financial Corporation, One Vandenberg Center, Grand Rapids, Michigan 49503.\n(b) Reports on Form 8-K.\nOld Kent filed no Current Reports on Form 8-K 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 Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nOLD KENT FINANCIAL CORPORATION (Registrant)\nDate: March 29, 1995 By \/s\/ Richard W. Wroten Richard W. Wroten Executive Vice President and Chief Financial Officer (Duly authorized signatory for the Registrant and Principal Financial and 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 indicated.\nMarch 29, 1995 \/s\/ John M. Bissell* John M. Bissell Director\nMarch 29, 1995 \/s\/ John D. Boyles* John D. Boyles Director\nMarch 29, 1995 \/s\/ John C. Canepa* John C. Canepa Chairman of the Board and Director\nMarch __, 1995 __________________________________ Richard M. DeVos, Jr. Director\nMarch 29, 1995 \/s\/ Earl D. Holton* Earl D. Holton Director\nMarch 29, 1995 \/s\/ Michael J. Jandernoa* Michael J. Jandernoa Director\nMarch 29, 1995 \/s\/ John P. Keller* John P. Keller Director\nMarch 29, 1995 \/s\/ Jerry K. Myers* Jerry K. Myers Director\nMarch 29, 1995 \/s\/ William U. Parfet* William U. Parfet Director\nMarch 29, 1995 \/s\/ Percy A. Pierre* Percy A. Pierre Director\nMarch 29, 1995 \/s\/ Robert L. Sadler* Robert L. Sadler Vice Chairman of the Board and Director\nMarch 29, 1995 \/s\/ Peter F. Secchia* Peter F. Secchia Director\nMarch 29, 1995 \/s\/ B. P. Sherwood, III* B. P. Sherwood, III Vice Chairman of the Board, Treasurer, and Director\nMarch 29, 1995 \/s\/ David J. Wagner* David J. Wagner President and Chief Executive Officer, and Director (Principal Executive Officer)\n*By \/s\/ Richard W. Wroten Richard W. Wroten Attorney-in-Fact","section_15":""}
{"filename":"10329_1994.txt","cik":"10329","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL DEVELOPMENT OF BUSINESS Bassett Furniture Industries, Incorporated was incorporated under the laws of the Commonwealth of Virginia in 1930. The executive offices are located in Bassett, Virginia.\nCapital expenditures totaled $10 million in 1994. Major projects included new material handling systems in two Wood Products plants. These \"rough-end\" systems are designed to improve lumber yield and labor efficiency.\nThere have been no material changes in the mode of conducting business in the fiscal year beginning December 1, 1993.\nINDUSTRY SEGMENT\nIn accordance with the instructions for this item, Bassett Furniture Industries, Incorporated and its subsidiaries, all of which are wholly-owned (Company), is deemed to have been engaged in only one business segment, manufacture and sale of furniture, for the three years ended November 30, 1994.\nDESCRIPTION OF BUSINESS\nThe Company manufactures and sells a full line of furniture for the home: bedroom and dining suites and accent pieces; occasional tables, wall and entertainment units; upholstered sofas, chairs and love seats (motion and stationary); recliners; and mattresses and box springs. The Company's products are distributed through a large number of retailers, principally in the United States. The retailers selling the Company's products include mass merchandisers, department stores, independent furniture stores, chain furniture stores, decorator showrooms, warehouse showrooms, specialty stores and rent-to-own stores.\nBecause of the dramatic changes that have taken place in recent years in the retail home furnishings distribution network, including consolidation and elimination of many small retail stores, Bassett developed the Bassett Gallery Program. At November 30, 1994, 256 galleries are operational with 33 more being added.\nIn October of 1994, the Company announced a new program that was developed in conjunction with several of the Bassett Gallery retail dealers. The new concept is called The Bassett Direct Plus Dealership Program. A Bassett Direct Plus Dealership is a free standing exclusive Bassett store, between 15,000 and 20,000 square feet, which displays in gallerized settings all Bassett product groups. The cornerstone of this program is the alliance between Bassett and the retail dealer designed to create the closest possible working relationship between the two. This is accomplished by the use of the very latest computer technologies such as EDI and BassNet, which are part of a streamlined management system for the retail dealer.\nIn 1994, the Company became the first furniture manufacturer to take advantage of the \"Information Superhighway\" through the Company's new Electronic Showroom on CompuServe (the nation's largest computer information service). Consumers have the ability to tour the on-line showroom, learn about the Page 3 of 24\nCompany and its products and, at their request, be referred to the Bassett retail dealer nearest them.\nIn addition, in 1994 the Company signed three licensing agreements: Bassett Divisions for the \"Bassett - J.G. Hook Home Fashions Collection\"; National\/Mt. Airy Division for the \"Carson Prairie Collection\"; and Weiman Division for designs by the Japanese designer, Yoshiharu Hatano.\nRaw materials used by the Company are generally available from numerous sources and are obtained principally from domestic sources. The cost pressures on lumber and lumber related products (which increased significantly in 1993) eased off somewhat in 1994; however, cost increases in other raw materials were experienced in 1994. Further, it continued to be very difficult to pass through the incurred cost increases to retail dealers in the form of increased sales prices.\nThe Company's trademark \"Bassett\" and the names of its marketing divisions and product collections are significant to the conduct of its business. This importance is due to consumer recognition of the names and identification with the Company's broad range of products. The Company owns certain patents and licenses that are important in the conduct of the Company's business.\nThe furniture industry is not considered to be a seasonal industry.\nThere are no special practices in the furniture industry, or applicable to the Company, that would have a significant effect on working capital items.\nThe Company is not dependent upon a single customer, the loss of which would have a material adverse effect on the Company. Sales to one customer (J. C. Penney Company) amounted to approximately 13% of gross sales in 1994, 12% in 1993 and 13% in 1992.\nThe Company's backlog of orders believed to be firm was $66,500,000 at November 30, 1994 and $67,400,000 at November 30, 1993. It is expected that the November 30, 1994 backlog will be filled within the 1995 fiscal year.\nNone of the Company's business involves government contracts.\nThe furniture industry is very competitive as there are a large number of manufacturers both within the United States and offshore who compete in the marketplace on the basis of quality of the product, price, delivery and service. Based on annual sales revenue, the Company is one of the largest furniture manufacturers in the United States. The Company has been successful in this competitive environment because its products represent excellent values combining price and superior quality and styling; prompt delivery; and quality, courteous service. Competition from foreign manufacturers is not any more significant in the marketplace today than competition from domestic manufacturers.\nThe furniture industry is considered to be a \"fashion\" industry subject to constant change to meet the changing consumer preferences and tastes. As such, the Company is continuously involved in the development of new products and designs. Due to the nature of these efforts and the close relationship to the manufacturing operations, the costs thereof are considered normal operating costs and are not segregated.\nThe Company is not involved in \"traditional\" research and development activities. Neither are there any customer - sponsored research and development activities involving the Company. Page 4 of 24\nIn management's view, the Company has complied with all federal, state and local standards in the area of safety, health and pollution and environmental controls. Compliance with these standards has not had a material adverse effect on past earnings, capital expenditures or competitive position.\nThe Company anticipates increased regulation on the furniture industry from federal and state agencies particularly in the areas of emission of fumes from the furniture finishing processes and emission of particulates into the atmosphere (saw dust and boiler ash). The Company cannot at this time estimate the impact of compliance with these new, more stringent standards on the Company's operations or costs of compliance.\nThe Company had approximately 7,800 employees at November 30, 1994.\nFOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nThe Company has no foreign operations, and its export sales are insignificant.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company owns the following facilities:\nPage 5 of 24\nThe Company also owns its general office building in Bassett, Virginia (brick, concrete and steel), two warehouses in Bassett, Virginia (brick and concrete) and a showroom in High Point, North Carolina (brick, concrete and steel).\nIn general, these facilities are suitable and are considered to be adequate for the continuing operations involved. All facilities are in regular use, except the plant noted below.\n(*) Plant closed as part of the restructuring program announced in 1990.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable\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\nThe information contained in the Annual Report under the caption \"Other Business Data\" - \"Market and Dividend Information\" with respect to number of stockholders, market prices and dividends paid is incorporated herein by reference thereto.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information for the five years ended November 30, 1994, contained in the \"Other Business Data\" in the Annual Report is incorporated herein by reference thereto.\nPage 6 of 24\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information contained in \"Other Business Data\" in the Annual Report is incorporated herein by reference thereto.\nThe change in the level of the Company's net sales has historically been principally due to the change in the volume of units sold, as contrasted to changes in unit prices. The level of the Company's net sales has fluctuated with the level of consumer confidence and housing starts.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of the registrant and its subsidiaries, together with the independent auditors' report thereon of KPMG Peat Marwick LLP dated December 17, 1994, included in the annual report of the registrant to its stockholders for the year ended November 30, 1994 are incorporated herein by reference thereto:\nConsolidated Balance Sheet--November 30, 1994 and 1993\nConsolidated Statement of Income--Years Ended November 30, 1994, 1993 and 1992\nConsolidated Statement of Stockholders' Equity - Years Ended November 30, 1994, 1993 and 1992\nConsolidated Statement of Cash Flows--Years Ended November 30, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nThe information contained in \"Other Business Data\" for \"Quarterly Results of Operations\" in the Annual Report is incorporated herein by reference thereto.\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, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS OF THE REGISTRANT\nThe information contained on pages 2 through 5 of the Proxy Statement under the captions \"Principal Stockholders and Holdings of Management\" and \"Election of Directors\" is incorporated herein by reference thereto.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information contained on page 6 through 12 of the Proxy Statement under the captions \"Organization and Compensation Committee Report\", \"Stockholder Return Performance Graph\", \"Executive Compensation\", and \"Supplemental Retirement Income Plan\" is incorporated herein by reference thereto. Page 7 of 24\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information contained on page 2 of the Proxy Statement under the heading \"Principal Stockholders and Holdings of Management\" is incorporated herein by reference thereto.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information contained on page 6 of the Proxy statement under the heading \"Organization and Compensation Committee Interlocks and Insider Participation\" is incorporated herein by reference thereto.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K\n(a) (1) The response to this portion of Item 14 is submitted as a separate section of this report.\n(2) All financial statement schedules 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.\n(3) Listing of Exhibits\n3. Articles of Incorporation as amended and By Laws are incorporated herein by reference to Form 10-Q for the fiscal quarter ended February 28, 1994.\n13. The registrant's Annual Report to Stockholders for the year ended November 30, 1994.*\n21. List of subsidiaries of the registrant\n23. Consent of experts and counsel\n27. Financial Data Schedule (EDGAR filing only)\n*With the exception of the information incorporated in this Form 10-K by reference thereto, the Annual Report shall not be deemed \"filed\" as a part of this Form 10-K.\n(b) No reports on Form 8-K have been filed during the last quarter of the registrant's 1994 fiscal year.\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: All financial statement schedules 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. Page 8 of 24\nANNUAL REPORT ON FORM 10-K ITEM 14(a)(1) AND (c)\nLIST OF FINANCIAL STATEMENTS\nCERTAIN EXHIBITS\nYEAR ENDED NOVEMBER 30, 1994\nBASSETT FURNITURE INDUSTRIES, INCORPORATED AND SUBSIDIARIES\nBASSETT, VIRGINIA Page 9 of 24\nITEM 14(a)(1)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nThe following consolidated financial statements of the registrant and its subsidiaries, included in the annual report of the registrant to its stockholders for the year ended November 30, 1994 are incorporated herein by reference:\nConsolidated Balance Sheet--November 30, 1994 and 1993\nConsolidated Statement of Income--Years Ended November 30, 1994, 1993 and 1992\nConsolidated Statement of Stockholders' Equity - Years Ended November 30, 1994, 1993 and 1992\nConsolidated Statement of Cash Flows--Years Ended November 30, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements Page 10 of 24\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.\nBASSETT FURNITURE INDUSTRIES, INCORPORATED (Registrant)\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 and in the capacities and on the dates indicated.\nPage 11 of 24\nSIGNATURES -- CONTINUED\nPage 12 of 24\nIndex to Exhibits","section_15":""}
{"filename":"72909_1994.txt","cik":"72909","year":"1994","section_1":"Item 1: Business-Electric Operations). The company's increased electric sales during 1994 over 1993, combined with increased costs per MWH for nuclear and fossil fuels and increased costs associated with capacity charges from the power purchase agreements with Manitoba Hydro-Electric Board, which went into effect in May 1993, resulted in the company's purchased power and fuel purchased under its interchange agreement with its parent to increase by approximately $10.7 million. Total interchange power also increased by $0.4 million as a result of increased operation and maintenance expenses and by $0.5 million as a result of increased fixed charges such as depreciation and property taxes.\nFuel for Electric Generation Fuel for electric generation, which represents the Company's portion of the NSP System's fuel generation, increased $2.2 million or 70.0 percent in 1994 from 1993. This is due to the Minnesota Company's decreased fuel generation combined with the Company's increased requirements due to the increased sales in 1994.\nGas Purchased for Resale This cost increased $2.0 million or 3.9 percent. A seven percent increase in total gas deliveries was responsible for $3.6 million of increase in 1994. A 1.3 percent decrease in prices resulted in the balance of the change from 1993.\nAdministrative and General, Other Operation and Maintenance The $1.6 million increase in Other Operation expense is partially due to demand side management expense increases ($0.7 million) and increases in transmission expenses charged from the Minnesota Company ($0.3 million). The remaining increases were related to postemployment benefit costs and general increases in operating expenses.\nDepreciation and Amortization The increase in depreciation between 1994 and 1993 primarily reflects higher levels of depreciable plant, particularly shorter-lived computer equipment.\nProperty and General Taxes The property and general taxes increase is primarily due to higher gross receipts tax (a tax assessed on prior year revenues) as a result of 1993 revenues increasing over 1992 revenues.\nIncome Taxes $2.2 million of the decrease in income taxes in 1994 below 1993 is the result of a non-recurring adjustment to the balance of the tax accruals for prior years due to the recent conclusion by the Internal Revenue Service of audits of all the Company's tax years through 1988. The balance of the change is primarily attributable to the decrease in pretax book income. See Note 8 to the Financial Statements for a detailed reconciliation of effective tax rates and statutory rates.\nAllowances for Funds Used During Construction (AFC) The differences in AFC for the reported periods are attributable to varying levels of qualifying construction and lower AFC rates associated with increased use of low-cost short-term borrowings.\nInterest Charges In March 1993, the Company issued $110.0 million of first mortgage bonds due March 1, 2023 with an interest rate of 7-1\/4%. The proceeds from these bonds were used to redeem $47.5 million of 9-1\/4% bonds, $38.4 million of 9- 3\/4%bonds, and $7.8 million of 9-1\/4% bonds. In October 1993, the Company issued $40.0 million of first mortgage bonds due October 1, 2003 with an interest rate of 5-3\/4%. The proceeds from these bonds were used to redeem $24.3 million of 7-3\/4% bonds and $10.8 million of 4-1\/2% bonds. These transactions caused decreases in the 1994 interest and amortization charges compared to the charges of 1993 because in 1993 for one year only, all costs associated with the redemption of these bonds were treated on a basis by which all savings of interest due to refinancing was offset by the amortization of the costs as required and approved by the PSCW.\nIn February 1995, the Company purchased $2.9 million of it's 9 1\/8 Series bonds at the rate of 101 1\/8.\nItem 8 Financial Statements and Supplementary Data\nSee Item 14(a)-1 in Part IV for financial statements included herein.\nSee Note 12 to the financial statements for summarized quarterly financial data.\nINDEPENDENT AUDITORS' REPORT\nNorthern States Power Company (Wisconsin):\nWe have audited the accompanying financial statements, of Northern States Power Company (Wisconsin), listed in the accompanying table of contents of Item 14(a)1. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the 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, 1994 and 1993 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nMinneapolis, Minnesota January 27, 1995\nItem 8 Financial Statements and Supplementary Data\nStatements of Income and Retained Earnings Year Ended December 31\n(Thousands of dollars) 1994 1993 1992\nOperating Revenues Electric $ 374 777 $ 362 473 $ 345 289 Gas 76 715 72 760 61 071\nTotal 451 492 435 233 406\nOperating Expenses Purchased and interchange power 174 144 162 510 156 196 Fuel for electric generation 5 414 3 185 2 034 Gas purchased for resale 53 484 51 501 41 814 Administrative and general 26 487 26 842 21 610 Other operation 44 260 43 351 42 254 Conservation 7 211 6 556 5 216 Maintenance 22 385 21 703 21 806 Depreciation and amortization 30 736 28 585 26 832 Property and general taxes 13 710 13 091 12 925 Income taxes 19 077 23 103 22 184\nTotal operating expenses 396 908 380 427 352 871\nOperating Income 54 584 54 806 53 489\nOther Income and Deductions Allowance for funds used during construction-equity 671 694 907 Other income and deductions 864 844 1 361\nTotal Other Income 1 535 1 538 2 268\nIncome Before Interest Charges 56 119 56 344 55 757\nInterest Charges Interest on long-term debt 15 995 16 343 17 269 Other interest and amortization 2 060 2 406 857 Allowance for funds used during construction-debt (481) (411) (569) Total interest charges 17 574 18 338 17 557\nNet Income 38 545 38 006 38 200 Retained Earnings, January 1 205 114 192 816 179 510 Dividends (24 826) (25 708)(24 894)\nRetained Earnings, December 31 $ 218 833 $ 205 114 $ 192 816\nSee Notes to Financial Statements.\nItem 8 Financial Statements and Supplementary Data\nStatements of Cash Flow Year Ended December 31\n(Thousands of dollars) 1994 1993 1992\nCash Flows from Operating Activities: Net Income $38 545 $38 006 $38 200 Adjustments to reconcile net income to cash from operating activities: Depreciation and amortization 32 382 33 580 28 179 Deferred income taxes 7 614 7 228 3 089 Investment tax credit adjustments (943) (948) (956) AFC-equity (671) (694) (907) Insurance receivable (3 091) Other (6 076) (2 440) Cash (used for) provided by changes in certain working capital items (9 568) 299 2 438\nNet Cash Provided by Operating Activities58 192 77 471 67 603\nCash Flows from Financing Activities: Proceeds from issuance of long-term debt 0 146 587 0 Proceeds from issuance of notes payable-parent company 17 800 0 12 600 Repayment of notes payable-parent company 0 (800) 0 Repayment of long-term debt (990) (136 090) (1 415) Dividends paid to parent (24 826) (25 708) (24 894)\nNet Cash Used for Financing Activities (8 016) (16 011) (13 709)\nCash Flows from Investing Activities: Construction expenditures capitalized (52 639) (59 954) (54 588) Decrease in construction payables (633) (2 143) (2 013) AFC-equity 671 694 907 Other 2 037 (489) 0\nNet Cash Used for Investing Activities (50 564) (61 892) (55 694)\nNet Decrease in Cash (388) (432) (1 800) Cash at Beginning of Period 449 881 2 681\nCash at End of Period $ 61 $ 449 $ 881\nCash (used for) provided by changes in certain working capital items: Accounts receivable-net $ 770 $ (1 597) $ 921 Materials and supplies( (4 708) (453) (647) Accounts payable and accrued liabilities 332 7 633 412 Payables to affiliated companies (2 655) 127 2 444 Income and other taxes accrued (4 174) (2 762) 634 Other 867 (2 649) (1 326)\nNet $ (9 568) $ 299 $ 2 438\nSupplemental Disclosures of Cash Flow Information: Cash paid during the year for: Interest (net of amount capitalized) $ 15 870 $ 17 440 $ 17 136 Income taxes $18 773 $ 18 825 $ 19 256 See Notes to Financial Statements.\nItem 8 Financial Statements and Supplementary Data\nBalance Sheets December 31\n(Thousands of dollars) 1994 1993\nAssets Utility Plant Electric-including construction work in progress: 1994, $14,599; 1993, $16,697 $ 836 665 $ 810 691 Gas 88 350 81 567 Other 54 675 43 279\nTotal 979 690 935 537\nAccumulated provision for depreciation (344 675) (320 938)\nNet utility plant 635 015 614 599\nOther Property and Investments Nonutility property - at cost 3 082 3 157 Accumulated provision for depreciation (365) (364) Other investments - at cost which approximates market 3 974 4 094\nTotal other property and investments 6 691 6 887\nAssets Cash 61 449 Accounts receivable 37 484 38 424 Accumulated provision for uncollectible accounts (538) (708) Materials and supplies - at average cost Fuel 3 413 2 293 Other 12 280 8 692 Accrued utility revenues 16 409 17 230 Prepayments and other 11 030 9 855 Deferred tax asset 1 415 1 254\nTotal current assets 81 554 77 489\nOther Assets Unamortized debt expense 2 928 3 078 Regulatory assets 31 376 30 036 Federal Income tax receivable 3 307 0 Insurance receivable 3 091 0 Other 4 338 4 890\nTotal deferred debits 45 040 38 004\nTotal $ 768 300 $ 736 979\nSee Notes to Financial Statements.\nItem 8 Financial Statements and Supplementary Data\nDecember 31\n(Thousands of dollars) 1994 1993\nLiabilities and Equity Capitalization Common stock-authorized 870,000 shares of $100 par value; issued shares: 1994 and 1993, 862,000 $ 86 200 $ 86 200 Premium on common stock 10 461 10 461 Retained earnings 218 833 205 114\nTotal common equity 315 494 301 775\nLong-term debt 213 700 217 600\nTotal capitalization 529 194 519 375\nCurrent Liabilities Notes payable - parent company 41 300 23 500 Long-term debt due within one year 2 910 0 Accounts payable 14 415 15 264 Salaries, wages, and vacation pay accrued 6 028 5 481 Payables to affiliated companies (principally parent) 8 982 11 636 Federal income taxes accrued 0 1 606 Other taxes accrued 936 2 492 Interest accrued 5 485 4 823 Other 1 463 1 917\nTotal current liabilities 81 519 66 719\nDeferred Credits Accumulated deferred income taxes 99 748 88 426 Accumulated deferred investment tax credits 22 332 23 653 Regulatory liability 17 961 22 416 Customer advances 5 543 5 071 Other 12 003 11 319\nTotal deferred credits 157 587 150 885\nCommitments and Contingent Liabilities\nTotal $ 768 300 $ 736 979\nSee Notes to Financial Statements. NORTHERN STATES POWER COMPANY (WISCONSIN) NOTES TO FINANCIAL STATEMENTS\n1. Summary of Accounting Policies\nSystem of Accounts Northern States Power Company (Wisconsin), (\"the Company\"), maintains the accounting records in accordance with either the uniform system of accounts prescribed by the Federal Energy Regulatory Commission (FERC) or those prescribed by the Public Service Commission of Wisconsin (PSCW) and the Michigan Public Service Commission (MPSC), which systems are the same in all material respects.\nInvestment in Subsidiaries The Company carries its investment in its subsidiaries (Chippewa and Flambeau Improvement Company, 75.86% owned; NSP Lands, Incorporated, 100% owned; and Clearwater Investments, Incorporated, 100% owned) at cost plus equity in earnings since acquisition. The impact of consolidation of these subsidiaries is considered immaterial to the Company's financial position.\nUtility Plant and Retirements Utility Plant is stated at original cost. The cost of additions to utility plant includes contracted work, direct labor and materials, allocable overheads and allowance for funds used during construction (AFC). The cost of units of property retired, plus net removal cost, is charged to the accumulated provision for depreciation and amortization. Maintenance and replacement of items determined to be less than units of property are charged to operating expenses.\nInsurance Receivable The Company has incurred repair costs on a gas turbine that will be recovered from insurance. These costs have caused the Company to pay out approximately $ 3 million.\nFederal Income Tax Receivable The Company has filed an amended tax return for the year 1992 which has resulted in a reduction in taxes owed of approximately $3.3 million. The two major items for the Wisconsin Company were the additional deduction for the prepaid Wisconsin Annual License Fee and an additional deduction for a change in Depreciation Expense.\nAllowance for Funds Used during Construction (AFC) AFC, a non-cash item, is computed by applying a composite pretax rate, representing the cost of capital used to fund utility construction, to qualified Construction Work in Progress (CWIP). The rates used for the FERC calculation were 7.55 percent in 1994, 7.93 percent in 1993 and 8.78 percent in 1992. The rates used for the PSCW calculation were 10.13 percent in 1994, 10.84 percent in 1993 and 11.52 percent in 1992. The amount of AFC capitalized as a construction cost in CWIP is credited to other income and interest charges. AFC amounts capitalized in CWIP are included in utility rate base for establishing utility service rates.\nRelated Party Transactions All significant intercompany transactions and balances have been eliminated in consolidation except for intercompany and intersegment profits for sales among the electric and gas utility businesses of the Company, the Minnesota Company and Viking, which are allowed in utility rates.\nDepreciation For financial reporting purposes, depreciation is computed on the straight-line method based on the annual rates certified by the PSCW and MPSC for the various classes of property. Depreciation provisions, as a percentage of the average balance of depreciable property in service, were 3.45% in 1994, 3.40% in 1993, and 3.38% in 1992.\nRevenues Customers' meters are read and bills rendered on a cycle basis. The Company accrues the amount of estimated unbilled revenues for services provided from the monthly meter reading date to month-end. The current asset, accrued utility revenues, is being adjusted monthly, with a corresponding adjustment to revenues, to reflect changes in unbilled revenues.\nRegulatory Deferrals As a regulated utility, the Company accounts for certain income and expense items under the provisions of SFAS No. 71 - Accounting for the Effects of Certain Types of Regulation. In doing so, certain costs which would otherwise be charged to expense are deferred as regulatory assets based on expected recovery from customers in future rates. Likewise, certain credits which would otherwise be reflected as income are deferred as regulatory liabilities based on expected flowback to customers in future rates. Management's expected recovery of deferred costs and expected flowback of deferred credits is generally based on specific ratemaking decisions or precedent for each item. Regulatory assets and liabilities are being amortized consistent with ratemaking treatment as established by regulators.\nIncome Taxes The Company records income taxes in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109) - Accounting For Income Taxes. SFAS 109 requires the use of the liability method of accounting for deferred income taxes. Before 1993, the Company followed Statement of Accounting Standards No. 96 (SFAS 96) - Accounting for Income Taxes, resulting in substantially the same accounting for the Company as SFAS No. 109.\nIncome taxes are deferred for temporary differences between pretax financial and taxable income, and between the book and tax bases of assets and liabilities. Deferred taxes are recorded using the tax rates scheduled by tax law to be in effect when the temporary differences reverse. Due to the effects of regulation, income tax expense is provided for the reversal of some temporary differences previously accounted for by the flow-through method. Deferred income tax expense for 1994, 1993, and 1992 consists primarily of excess tax depreciation over book depreciation of $4,800,000, $5,413,000, and $5,526,000, respectively.\nInvestment tax credits are deferred and amortized over the estimated lives of the related property.\nPurchased Tax Benefits The Company purchased tax-benefit transfer leases under the Safe Harbor Lease provisions of the Economic Recovery Tax Act of 1981. For both financial reporting and regulatory purposes, the Company is amortizing the difference between the cost of the purchased tax benefits and the amounts to be realized through reduced current income tax liabilities over the remaining terms of the lease after the initial investments have been recovered.\nEnvironmental Costs Accruals for environmental costs are recognized when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. When a single estimate of the liability cannot be determined, the low end of the estimated range is recorded. Costs are charged to expense (or deferred as a regulatory asset based on expected recovery from customers in future rates) if they relate to the remediation of conditions caused by past operations or if they are not expected to mitigate or prevent contamination from future operations. Where environmental expenditures related to facilities currently in use (such as pollution control equipment), the costs may be capitalized and depreciated over the future service periods. Estimated remediation costs are recorded at undiscounted amounts, independent of any insurance or rate recovery, based on prior experience, assessments and current technology. Accrued obligations are regularly adjusted as environmental assessments and estimates are revised, and remediation efforts proceed. For sites where NSP has been designated as one of several potentially responsible parties, the amount accrued represents NSP's estimated share of the cost. NSP intends to treat any future costs related to decommissioning and restoration of its power plants and substation sites as a removal cost of retirement through plant depreciation expense.\n2. Rate Matters\nThe Company filed a proposal for a new high load factor rate with the PSCW in November, 1994, that becomes effective January 1, 1995. Under the proposal, qualifying customers would receive a credit on their bills of up to 3.0% depending on their load factor. This is expected to reduce 1995 revenues by approximately $1.5 million.\nOn December 23, 1993, the PSCW issued an order approving a $1.41 million (2.0 percent) increase on an annual basis in the Company's gas rates. A January 1, 1994 effective date was authorized for these rate changes. No change in the retail electric rates was requested.\nThe Company will file a submittal in June 1995 as required by the PSCW biennial filing requirement.\nIn May, 1994, the Company offered its municipal wholesale customers a discount of one to two percent off the FERC authorized rate for a long-term full requirements commitment between five and ten years with comparable cancellation notices. Five of the ten municipal wholesale customers signed up for the discounts. The total annual decrease in revenues is approximately $80,000.\n3. Accounting Changes\nPostemployment Benefits Effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 112---Employer's Accounting for Postemployment Benefits. This standard required the accrual of certain postemployment costs (such as injury compensation and severance) that are payable in future time periods. The annual expense for costs accrued under SFAS No. 112 is not materially different than amounts recognized under the Company's prior accounting method. The Company has recorded as expense its full liability related to such costs in 1994.\n4. Investments Accounted for by the Equity Method\nNSP has subsidiaries with investments in domestic affordable housing and real estate projects. The equity method of accounting is applied to such investments.\n5. Long-Term Debt\nFirst Mortgage Bonds - less reacquired bonds of $490 and $0 at December 31, 1994 and 1993, respectively:\nDecember 31 December 31 Series due: 1994 1993\nApr. 1, 2021, 9-1\/8% $ 48 010 $ 49 000 Mar. 1, 2023, 7 1\/4% 110 000 110 000 Oct. 1, 2003, 5 3\/4% 40 000 40 000\nTotal $198 010 $199 000\nLess April 1, 2021, 9 1\/8% bonds redeemed in February 1995 2 910\nNet $195 100 $199 000\nCity of LaCrosse Resource Recovery Revenue Bonds - Series due Nov. 1, 2011, 7 3\/4% 18 600 18 600\nTotal long-term debt $ 213 700 $ 217 600\nThe Supplemental and Restated Trust Indenture dated March 1, 1991, permits an amount of established Permanent Additions to be deemed equivalent to the payment of cash necessary to redeem 1% of the highest principal amount of each series of first mortgage bonds (other than pollution control financing) at any time outstanding. This Supplemental and Restated Trust Indenture became effective for the Company on October 1, 1993.\nOn March 16, 1993 the Company issued $110.0 million of first mortgage bonds due March 1, 2023, with an interest rate of 7 1\/4%. NSP entered into an interest rate swap agreement with $20.0 million of this first mortgage bonds. This agreement effectively converts the interest costs of this debt issue from fixed to variable rates based on six-month London Interbank Offered Rates (LIBOR) with the rates changing semi-annually, March 1 and September 1. This Series is due March 1, 2023, has a Swap Agreement Term dated March 1, 1998 and had a net effective interest rate of 7.43% at December 31, 1994.\nMarket risks associated with this agreement results from short-term interest rate fluctuations. Credit risk related to non- performance of the counterparties is not deemed significant, but would result in NSP terminating the swap transaction and recognizing a gain or loss, depending on the fair market value of the swap. While such agreements are not reflected on NSP's balance sheets, interest rate swap transactions are recognized as an adjustment of interest expense over the terms of the agreements. The interest rate swaps serve to hedge the interest rate risk associated with fixed rate debt in a declining interest rate environment. This hedge is produced by the tendency for changes in the fair market value of the swap to be offset by changes in the present value of the liability attributable to the fixed rate debt issued in conjunction with the interest rate swap. If the interest rate swap had been terminated at Dec. 31, 1994, $1.7 million would have been payable by NSP while the present value of the fixed rate debt issued with the swaps was $3.1 million below par value.\nOn February 1, 1995, the Company redeemed $2.9 million of its 9 1\/8% bonds at 101-1\/8%; this amount has, therefore, been classified as current on the December 31, 1994 financial statements.\nMaturities on capital leases in the next five years are approximately $943,000, $1,034,000, $724,000, $409,000, and $92,000, respectively for the years 1995-1999.\nExcept for minor exclusions, all real and personal property is subject to the lien of the Company First Mortgage Bond Trust Indenture.\n6. Commitments and Contingent Liabilities\nThe Company presently estimates capital expenditures will be $55.2 million in 1995 and $286 million for 1995-99.\nRentals under operating leases were approximately $1,792,000, $2,651,000, and $2,547,000, for 1994, 1993, and 1992, respectively.\nAlthough the Company does not own a nuclear facility, any assessment made against Northern States Power Company (Minnesota), the parent company, (\"Minnesota Company\") and under the Price- Anderson liability provisions of the Atomic Energy Act of 1954, would be a cost included under the Interchange Agreement (Note 9) and the Company would be charged its proportion of the assessment. Such provisions set a limit of $8.9 billion for public liability claims that could arise from a nuclear incident. The parent company has secured insurance of $200 million to satisfy such claims. The remaining $8.7 billion of exposure is funded by the Secondary Financial Protection Fund, a fund available from assessments by the Federal government in the event of nuclear incidents. The parent company is subject to an assessment of $79.3 million for each of its three licensed reactors to be applied for public liability arising from a nuclear incident at any licensed nuclear facility in the United States with a maximum funding requirement of $10 million per reactor during any one year.\nThe NSP Wisconsin policy is to proactively prevent adverse environmental impacts, regularly monitor operations to ensure the environment is not adversely affected, and take timely corrective actions where past practices have had a negative impact on the environment. Significant resources are dedicated to environmental training, monitoring and compliance matters. The Company strives to maintain compliance with all applicable environmental laws. A preliminary allocation has been established for one of the landfills for those contributing any type of wastes to it. Based on the preliminary allocation of costs, the Company's share of one of the landfills would be less than $20,000. An allocation has not yet been made on the second landfill site.\nOn March 2, 1995, the Wisconsin Department of Natural Resources (WDNR) notified the Company that it is a PRP on a creosote\/coal tar contamination site in Ashland, WI. The Company has informed the WDNR of its belief that two sites exist. The first site, formerly a coal gas plant site, is NSP property. The second site is adjacent to the NSP site and is not owned by the Company. An existing condition report has been completed on an adjacent site. An estimate of site remediation costs, and the extent of the Company's responsibility, if any, for sharing such costs, is not known at this time. Investigations are underway to determine the Company's responsibility as well as that of predecessor companies contributing to the contamination on the adjacent site. The current estimate of the Company's share of future remediation costs at the NSP site is less than $750,000. This estimate is not based upon a formal remediation investigation and feasability study. To the Company's knowledge, no study has been completed for the adjacent site, that describes remedial alternatives and clean-up cost estimates. The Company intends to seek rate recovery of significant costs it incurs associated with the clean-up of either Ashland Site.\n7. Fair Value of Financial Instruments\nStatement of Financial Accounting Standards No. 107 (SFAS 107) - Disclosures About Fair Value of Financial Instruments became effective in 1992. For cash and investments, the carrying amount approximates fair value. 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. The estimated fair value of the Company's long term debt (including debt due within one year classified as current) of $216.6 million at December 31, 1994, and $217.6 million at December 31, 1993, is $196.2 million and $233.3 million, respectively.\n8. Pension Plans and Other Post Retirement Benefits\nEmployees of the Company participate in the Northern States Power Company Pension Plan. This noncontributory defined benefit pension plan covers substantially all employees. Benefits are based on a combination of years of service, the employees highest average pay for 48 consecutive months and Social Security benefits. The Company's portion of annual pension costs was $(631,000) for 1994, $1,236,000 for 1993, and $2,400,000 for 1992.\nUntil 1993, for financial reporting and regulatory purposes, the Company's pension expense was determined and recorded under the aggregate cost method, using market value of assets of the trust fund. Statement of Financial Accounting Standards No. 87 - Employers' Accounting for Pensions (SFAS 87) provides that any difference between the pension expense recorded for rate making purposes and the amounts determined under SFAS 87 should be recorded as an asset or liability on the balance sheet.\nEffective January 1, 1993, for financial reporting and regulatory purposes, the Company's pension expense was determined and recorded under the SFAS-87 method and the Company's accumulated SFAS-87 asset is being amortized over a 15-year period.\nNet periodic pension costs for the total (the Company and Minnesota Company) plan include the following components: 1994 1993 1992\n(Thousands of dollars)\nService Cost - benefits earned during the period $ 27 536 $ 25 015 $ 24 080\nInterest cost on projected benefit obligation 65 107 71 075 69 853\nActual return on assets (12 668)(152 019)(115 455) Net amortization and deferral (82 114) 66 299 39 019\nNet periodic pension cost determined under SFAS 87 (2 139) 10 370 17 497\nExpenses recognized (deferred) due to actions of regulators 3 922 5 117 2 741 Pension expense recorded during the period 1 783 15 487 20 238\nPortion of expense recognized for early retirement program 0 0 ( 165) Net periodic pension cost recognized for ratemaking $ 1 783 $ 15 487 $ 20 073\nThe funding status for the total plan is as follows:\nActuarial present value of benefit obligation: Vested $ 571 254 $ 655 002 Nonvested 120 420 139 346 Accumulated benefit obligation $ 691 674 $ 794 348\nProjected benefit obligation $ 836 957 $974 160 Plan assets at fair value 1 165 584 1 244 650\nPlan assets in excess of projected benefit obligation (328 627) (270 490) Unrecognized prior service cost (21 538) (22 580) Unrecognized net (gain) 370 289 315 049 Unrecognized net transitional (asset) 691 767\nNet pension liability recorded $ 20 815 $ 22 746\nThe weighted average discount rate used in determining the actuarial present value of the projected obligation was 8% in 1994 and 7% in 1993. The rate of increase in future compensation levels used in determining the actuarial present value of the projected obligation was 5% in 1994 and 1993. The assumed long-term rate of return on assets used for cost determinations under SFAS 87 was 8% in 1994, 1993 and 1992. Plan assets consist principally of common stock of public companies and U.S. Government Securities.\nEffective Jan. 1, 1993, the Company adopted the provisions of SFAS No. 106 - Employers' Accounting for Postretirement Benefits Other Than Pensions. SFAS No. 106 requires that the actuarially determined obligation for postretirement health care and death benefits is to be fully accrued by the date employees attain full eligibility for such benefits, which is generally when they reach retirement age. This is a significant change from the Company's pre-1993 policy of recognizing benefit costs on a cash basis after retirement. In conjunction with the adoption of SFAS No. 106, for financial reporting purposes, NSP elected to amortize on a straight-line basis over 20 years the unrecognized accumulated postretirement benefit obligation (APBO) of approximately $215.6 million (including the Company and Minnesota Company) for current and future retirees. This obligation considered 1994 plan design changes, including Medicare integration, increased retiree cost sharing and managed indemnity measures not in effect in 1993.\nBefore 1993, NSP funded payments for retiree benefits internally. While the Company generally prefers to continue using internal funding of benefits paid and accrued, there have been some external funding requirements imposed by the Company's regulators, as discussed below, including the use of tax advantaged trusts. Plan assets held in such trusts as of Dec. 31, 1994, consisted of investments in equity mutual funds and cash equivalents. The\nfollowing table sets forth the total (the Company and Minnesota Company) health care plans funded status at December 31.\n(Millions of dollars) 1994 1993\nAPBO: Retirees $132.2 $120.2 Fully eligible plan participants 21.5 18.8 Other active plan participants 79.4 90.8 Total APBO 233.1 229.8 Plan Assets 8.0 6.1 APBO in excess of plan assets 225.1 223.7 Unrecognized net actuarial gain (loss) 2.3 (1.3) Unrecognized transition obligation (194.0) (204.8) Postretirement benefit obligation included in balance sheet $ 33.4 $ 17.6\nThe assumed health care cost trend rate used in measuring the APBO at Dec. 31, 1994 and 1993, respectively, were 11.0 and 14.1 percent for those under age 65 and 7.5 and 8.0 percent for those over age 65. The assumed cost trend rates are expected to decrease each year until they reach 5.5 percent for both age groups in the year 2004, after which they are assumed to remain constant. A one percent increase in the assumed health care cost trend rate for each year would increase the APBO as of December 31, 1994, by approximately 13 percent and service and interest cost components of the net periodic postretirement cost by approximately 16 percent. The assumed discount rate used in determining the APBO was 8 percent for Dec. 31, 1994, 7 percent for Dec. 31, 1993 and 7 percent for Jan. 1, 1993, compounded annually. The assumed long- term rate of return on assets used for cost determinations under SFAS No. 106 was 8 percent for all periods. While the 1994 assumption changes had no effect on 1994 benefit costs, the effect of the changes in 1995 is expected to be a cost increase of approximately $0.6 million (for the Company and the Minnesota Company). Similarly, the assumption changes made for the Dec. 31, 1993 calculations had no effect on 1993 benefit costs, but decreased 1994 costs by approximately $2 million (for the Company and the Minnesota Company).\nIn 1992, the Company recognized $1.9 million as the cost attributable to postretirement health care and death benefits based on payments made. The net annual periodic postretirement benefit cost recorded for 1994 and 1993 consists of the following components (millions of dollars):\n1994 1993 Service cost-benefits earned during the year $ 0.6 0.6 Interest cost (on service cost and APBO) 2.3 2.4 Amortization of transition obligation 1.5 1.5\nReturn on assets (.2) (.1) Net periodic postretirement health care cost under SFAS No. 106 4.2 4.4\nThe Company's regulators have allowed full recovery of increased benefit costs under SFAS No. 106, effective in 1993. External funding was required in Wisconsin and Michigan to the extent it is tax advantaged. The FERC has required external funding for all benefits paid and accrued under SFAS No. 106. Funding began for both retail and FERC in 1993.\n401(k) NSP has a contributory, defined contribution Retirement Savings Plan (the Plan), which complies with section 401-K of the Internal Revenue code and covers substantially all employees. The NSP match to this Plan began in 1994 and is required to match a specified amount of employee contributions. The Company's contribution to the Plan in 1994 was $0.3 million. 9. Parent Company and Intercompany Agreements\nThe Company is wholly-owned by Northern States Power Company (Minnesota). The electric production and transmission costs of the NSP system are shared by the Company and the Minnesota Company. A FERC approved agreement (Interchange Agreement) between the Company and the Minnesota Company provides for the sharing of all costs of electric generation and transmission facilities of the NSP System, including capital costs. Billings under the Interchange Agreement and an intercompany gas agreement which are included in the statement of income are as follows: Year Ended December 31\n1994 1993 1992\n(Thousands of dollars) Operating revenues: Electric $ 73 503 $ 72 162 $ 70 671 Gas 50 56 55 Operating expenses: Purchased &interchg power 174 144 162 510 156 196 Gas purchased for resale 227 267 214 Other operation 12 824 12 515 11 668\n10. Regulatory Assets and Liabilities\nThe following summarizes the individual components of unamortized regulatory assets and liabilities shown on the Balance Sheet at Dec. 31:\n(Thousands of dollars) Amortization Period 1994 1993\nAFC recorded in plant on a net-of-tax basis Plant Lives 8 325 8 795 Losses on reacquired debt Term of Debt 10 303 10 857 Conservation and energy management programs Up to 10 years 10 622 8 291 Pensions and other 3-15 years 2 126 2 093 Total Regulatory Assets 31 376 30 036\nExcess deferred income taxes collected from customers 2 853 5 914 Investment tax credit deferrals 14 950 15 841 Fuel refunds and other 158 661\nTotal Regulatory Liabilities 17 961 22 416\nThe AFC regulatory asset and the tax-related regulatory liabilities result from the Company's adoption of SFAS No. 96 in 1988 and SFAS No. 109 in 1993. The excess deferred income tax liability represents the net amount expected to be reflected in future customer rates based on the collection in prior ratemaking of deferred income tax amounts in excess of the actual liabilities currently recorded by the Company. This excess is the net effect of the use of \"flow through\" tax accounting in prior ratemaking and the impact of changes in statutory tax rates in 1981, 1986-87 and 1993. This regulatory liability will change each year as the related deferred income tax liabilities reverse.\n11. Income Tax Expense\nThe Company is included in the consolidated Federal income tax return filed by the Minnesota Company and files separate state returns for Wisconsin and Michigan. The Company records current and deferred income taxes at the statutory rates as if it filed a separate return for Federal income tax purposes. All tax payments are made directly to the taxing authorities.\nThe total income tax expense differs from the amount computed by applying the Federal income tax statutory rate of 35% to net income before income tax expense. The reasons for the difference are as follows:\n1994 1993 1992\n(Thousands of dollars)\nTax computed at statutory rate $ 20 074 $ 21 387 $20 434 Increases (decreases) in tax from: State income taxes, net of Federal income tax benefit 2 393 3 165 3 037 Allowance for funds used during construction (235) (243) (284) Investment tax credit adjustments - net (943) (948) (956) Use of the flow-through method for depreciation in prior years 551 474 673 Effect of tax rate changes for plant related items (498) (487) (420) Gain on sale of tax benefit transfer leases 0 (88) 0 Non-recurring adjustment for tax accrual of prior years (2 430) Other - net (101) (162) (583) Total income tax expense $ 18 811 $ 23 098 $ 21 901\nEffective income tax rate 32.8% 37.8% 36.4%\nIncome tax expense is comprised of the following: Included in income taxes: Current Federal tax expense 8 075 $ 12 919 $15 340 Current state tax expense 2 810 3 180 3 598 Deferred Federal tax expense 7 967 6 173 3 075 Deferred state tax expense 1 168 1 778 1 127 Investment tax credit adjustments - net (943) (948) (956) Total 19 077 23 103 22 184\nIncluded in income deductions: Current Federal tax expense 1 039 875 953 Current state tax expense 216 (90) (123) Deferred Federal and state tax expense (1 521) (790) (1 113) Total income tax expense $ 18 811 $ 23 098 $ 21 901 The components of the Company's net deferred tax liability at Dec. 31 were as follows: (Thousands of dollars) 1994 1993\nDeferred tax liabilities: Differences between book and tax bases of property $ 98 526 $ 91 195 Tax benefit transfer leases 4 950 6 146 Regulatory assets 11 626 11 371 Other 3 332 398 Total deferred tax liabilities 118 434 109 110\nDeferred tax assets: Deferred investment tax credits 7 409 9 487 Regulatory liabilities 8 955 8 726 Deferred compensation accrued vacation and other reserves not currently deductible 3 155 3 193 Other 582 532 Total deferred tax assets 20 101 21 938\nNet deferred tax liability $ 98 333 $ 87 172 The Omnibus Budget Reconciliation Act of 1993 (Act) was signed into law on August 10, 1993, and increased the federal corporate income tax rate from 34 percent to 35 percent retroactive to January 1, 1993. Deferred tax liabilities were increased for the rate change by $2.7 million. However, due to the effects of regulation, earnings were reduced only by immaterial adjustments to deferred tax liabilities related to nonutility operations.\n12. Segment Information\nYear Ended December 31\n1994 1993 1992\n(Thousands of dollars) Operating revenues: Electric $374 777 $362 473 $345 289 Gas 76 715 72 760 61 071 Total operating revenues $451 492 $435 233 $406 360\nOperating income before income taxes: Electric $ 67 164 $ 73 012 $ 70 202 Gas 6 498 4 897 5 471 Total operating income before income taxes $ 73 662 $ 77 909 $ 75 673\nDepreciation and amortization: Electric $26 836 $ 25 179 $ 23 870 Gas 3 900 3 406 2 962 Total depreciation & amortization $ 30 736 $ 28585 $26832\nConstruction expenditures: Electric $ 42 820 $ 49 664 $ 44 332 Gas 9 895 10 258 10 235 Total construction expenditures $ 52 715 $ 59 922 $ 54 567\nNet utility plant: Electric $575 059 $560 999 $537 576 Gas 59 956 53 600 47 419 Total net utility plant 635 015 614 599 584 995\nOther corporate assets 133 285 122 380 109 474 Total assets $768 300 $736 979 $694 469\n13. Short-Term Borrowings\nThe Company had bank lines of credit aggregating $1,000,000 at December 31, 1994. Compensating balance arrangements in support of such lines of credit were not required. These credit lines make short-term financing available by providing bank loans. During 1994 and 1993 there were no bank loans outstanding as the Company obtained short-term borrowings from the Minnesota Company at the Minnesota Company's average daily interest rate, including the cost of their compensating balance requirements.\nThe Company had short-term borrowings of the following for the years ended December 31,\n1994 1993 1992\nBalance at the end of the period 41 300 23 500 24300 Weighted average interest rate 5.0% 3.3% 3.5% Maximum amount outstanding during the period 45 700 28 200 24 300 Average amount outstanding during the period 13 124 10 693 8 837 Weighted average interest rate during the period 5.0% 3.4% 3.7%\n14. Common Stock\nThe Company's common shares have a par value of $100 per share. At December 31, 1994 and 1993, 870,000 shares were authorized and 862,000 shares were issued.\n15. Summarized Quarterly Financial Data (Unaudited)\nQuarter Ended\nMarch 31, June 30, September 30 December31 1994 1994 1994 1994 (Thousands of dollars)\nOperating revenues $ 134 004 $ 100 105 $ 101 100 $ 116 283\nOperating income 22 268 7 273 9 416 15 627\nNet income 18 306 3 441 4 894 11 904\nQuarter Ended\nMarch 31, June 30, September 30 December31 1993 1993 1993 1993 (Thousands of dollars)\nOperating revenues $ 124 285 $ 97 107 $ 97 821 $ 116 020\nOperating income 20 080 10 199 7 986 16 541\nNet income 15 857 6 062 3 762 12 325\nItem 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nDuring 1994 there were no disagreements with the Company's independent certified public accountants on accounting procedures or accounting and financial disclosures.\nPART III\nPart III of Form 10-K has been omitted from this report in accordance with conditions set forth in general instructions J (1) (a) and (b) of Form 10-K for wholly-owned subsidiaries.\nItem 10. Directors and Executive Officers of the Registrant\nItem 11. Executive Compensation\nItem 12. Security Ownership of certain beneficial Owners and Management\nItem 13. Certain Relationships and Related Transactions\nPART IV\nItem 14. Exhibits, Financial Statement Schedules Page and Reports on Form 8-K\n(a) 1. Financial Statements Included in Part II of this report:\nReport of Independent Public Accountants. 13\nStatements of Income and Retained Earnings for the three years ended December 31, 1994. 14\nStatements of Cash Flows for the three years ended December 31, 1994. 15\nBalance Sheets, December 31, 1994 and 1993. 16\nNotes to Financial Statements. 18\n2. Financial Statement Schedules\nSchedules above are omitted because of the absence of the conditions under which they are required or because the information required is included in the financial statements or the notes.\n3. Exhibits\n* indicates incorporation by reference\n3.01*Restated Articles of Incorporation as of December 23, 1987. (Filed as Exhibit 30.01 to Form 10-K Report 10-3140 for the year 1987)\n3.02* Copy of the By-Laws of the Company as amended August 19, 1992. (Filed as Exhibit 3.02 to Form 10-K Report 10-3140 for the year 1992)\n4.01* Copy of Trust Indenture, dated April 1, 1947, From the Wisconsin Company to First Wisconsin Trust Company. (Filed as Exhibit 7.01 to Registration Statement 2-6982)\n4.02* Copy of Supplemental Trust Indenture, dated March 1, 1949. (Filed as Exhibit 7.02 to Registration Statement 2- 7825)\n4.03* Copy of Supplemental Trust Indenture, dated June 1, 1957. (Filed as Exhibit 2.13 to Registration Statement 2- 13463)\n4.04* Copy of Supplemental Trust Indenture, dated August 1, 1964. (Filed as Exhibit 4.20 to Registration Statement 2- 23726)\n4.05* Copy of Supplemental Trust Indenture, dated December 1, 1969. (Filed as Exhibit 2.03E to Registration Statement 2- 36693)\n4.06* Copy of Supplemental Trust Indenture, dated September 1, 1973. (Filed as Exhibit 2.01F to Registration Statement 2- 48805)\n4.07* Copy of Supplemental Trust Indenture, dated February 1, 1982. (Filed as Exhibit 4.01G to Registration Statement 2- 76146)\n4.08* Copy of Supplemental Trust Indenture, dated March 1, 1982. (Filed as Exhibit 4.08 to form 10-K Report 10-3140 for the year 1982)\n4.09* Copy of Supplemental Trust Indenture, dated June 1, 1986. (Filed as Exhibit 4.09 to Form 10-K Report 10-3140 for the year 1986)\n4.10* Copy of Supplemental Trust Indenture, dated March 1, 1988. (Filed as Exhibit 4.10 to Form 10-K Report 10-3140 for the year 1988)\n4.11* Copy of Supplemental and Restated Trust Indenture, dated March 1, 1991. (Filed as Exhibit 4.01K to Registration Statement 33-39831)\n4.12* Copy of Supplemental Trust Indenture, dated April 1, 1991. (Filed as Exhibit 4.01 to Form 10-Q Report 10-3140 for the quarter ended March 31, 1991)\n4.13* Copy of Supplemental Trust Indenture, dated March 1, 1993. (Filed as Exhibit to Form 8-K Report dated March 3, 1993)\n4.14* Copy of Supplemental Trust Indenture, dated October 1, 1993. (Filed as Exhibit 4.01 to Form 8-K Report dated September 21, 1993) 10.01 *Copy of MAPP Agreement, dated March 31, 1972, between the local power suppliers in the North Central States area. (Filed as Exhibit 5.06B to Registration Statement 2- 44530)\n10.02* Copy of Interchange Agreement dated September 17, 1984, and Settlement Agreement dated May 31, 1985, between the Company, the Minnesota Company and LSDP. (Filed as Exhibit 10.10 to Form 10-K Report 10-3140 for the year 1985)\n(b) Reports on Form 8-K\nOn December 20, 1994, a Form 8-K was filed reporting (as Item 4, Changes in Registrant's Certifying Accountant and Item 7, Financial Statements and Exhibits), the Company's change in Certifying Accountant.\nSIGNATURES Pursuant 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 authorized. NORTHERN STATES POWER COMPANY\n\/s\/ John A. Noer President and Chief Executive\nPursuant to the requirements of the Securities Exchange Act of 1934, this report signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\n\/s\/ John A. Noer (Principal Executive Officer)\n\/s\/ \/s\/ M. N. Gregerson H. Lyman Bretting Vice President-Customer Services Director\n\/s\/ \/s\/ A. G. Schuster P. M. Gelatt Vice President Director Power Delivery and Generation\n\/s\/ \/s\/ Patrick D. Watkins Wayne E. Harrison Vice President-Corporate Services Director\n\/s\/ \/s\/ John P. Moore, Jr. Loren L. Taylor General Counsel and Secretary Director\n\/s\/ \/s\/ Kenneth J. Zagzebski Ray A. Larson, Jr. Controller Director (Principal Accounting Officer)\n\/s\/ \/s\/ Neal A. Siikarla Larry G. Schnack Treasurer Director (Principal Financial Officer) SIGNATURES Pursuant 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 authorized. NORTHERN STATES POWER COMPANY\nJohn A. Noer President and Chief Executive\nPursuant to the requirements of the Securities Exchange Act of 1934, this report signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.\nJohn A. Noer President and Director (Principal Executive Officer)\nM. N. Gregerson H. Lyman Bretting Vice President-Customer Services Director\nA. G. Schuster P. M. Gelatt Vice President Director Power Delivery and Generation\nPatrick D. Watkins Wayne E. Harrison Vice President-Corporate Services Director\nJohn P. Moore, Jr. Loren L. Taylor General Counsel and Secretary Director\nKenneth J. Zagzebski Ray A. Larson, Jr. Controller Director (Principal Accounting Officer)\nNeal A. Siikarla Larry G.Schnack Treasurer Director (Principal Financial Officer) UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549\nFORM 10-K (Mark One)\nX Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (fee required)\nor\nTransition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (no fee required)\nFor the fiscal year ended December 31, 1994 Commission file number: 10-3140\nNorthern States Power Company, a Wisconsin corporation, meets the conditions set forth in general instruction J (1) (a) and (b) of Form 10-K and is therefore filing this form with the reduce disclosure format. (In general instruction J(2)\nNorthern States Power Company (Exact name of registrant as specified in its charter) Wisconsin 39-0508315 (State or other jurisdiction of (I.R.S. employer identification number) incorporation or organization) 100 North Barstow Street 54702-0008 (Address of principal executive offices) (Zip code)\nRegistrant's telephone number, including area code (715) 839-2621\nSecurities registered pursuant to Section 12(b) of the Act: None\nSecurities registered pursuant to Section 12(g) of the Act: None\nIndicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No .\nIndicate the number of shares outstanding of each of the registrant's classes of common stock as of the latest practicable date.\nClass Outstanding at March 23, 1995 Common Stock, $100 Par Value 862,000 Shares\nAll outstanding common stock is owned beneficially and of record by Northern States Power Company, a Minnesota corporation.\nDocuments Incorporated by Reference\nNone\nINDEX Page No. PART I Item 1 Business . . . . . . . . . . . . . . . . . . . . . . . 1\nREGULATION AND RATES Regulation . . . . . . . . . . . . . . . . . . . .. . 1 Rate Changes . . . . . . . . . . . . . . . . . . .. . 2 Fuel and Purchased Gas Adjustment Clauses. . . . .. . 3 Demand Side Management . . . . . . . . . . . . . .. . 3\nELECTRIC OPERATIONS Competition. . . . . . . . . . . . . . . . . .. . . . 4 NSP System . . . . . . . . . . . . . . . . . .. . . . 4 Capability and Demand. . . . . . . . . . . . .. . . . 5 Interchange Agreement. . . . . . . . . . . . .. . . . 6 Electric Power Pooling Agreements. . . . . . .. . . . 6 Fuel Supply. . . . . . . . . . . . . . . . . .. . . . 6 Electric Operating Statistics . . . . . . . .. . . . 7 GAS OPERATIONS . . . . . . . . . . . . . . . . .. . . . 7\nENVIRONMENTAL MATTERS . . . . . . . . . . . .. . . . . 8\nCONSTRUCTION AND FINANCING . . . . . . . . . . . . . . 9\nEMPLOYEES AND EMPLOYEE BENEFITS. . . . . . . .. . . . . 10\nItem 2","section_1A":"","section_1B":"","section_2":"Item 2 Properties . . .. . . . . . . . . . . . . . . . . . . . 12 Item 3","section_3":"Item 3 Legal Proceedings. . .. . . . . . . . . . . . . . . . . 12 Item 4","section_4":"Item 4 Submission of Matters to a Vote of Security Holders . . .. . . . . . . . . . . . 13\nPART II Item 5","section_5":"Item 5 Market Price of and Dividends on the Registrant's Common Equity and Related Stockholder Matters. . . . . . . . 14 Item 6","section_6":"Item 6 Selected Financial Data. . . . . . . . . . . . . . . . . 14 Item 7","section_7":"Item 7 Management's Discussion and Analysis . . . . . . . . . . 14 Item 8","section_7A":"","section_8":"Item 8 Financial Statements and Supplementary Data. . . . . . . 17 Item 9","section_9":"Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure . . . . 32\nPART III Item 10","section_9A":"","section_9B":"","section_10":"Item 10 Directors and Executive Officers of the Registrant . . . . . . . . . . . . . . . . . . 33 Item 11","section_11":"Item 11 Executive Compensation . . . . . . . . . . . . . . . . . 33 Item 12","section_12":"Item 12 Security Ownership of Certain Beneficial Owners and Management. . . . . . . . . . . . . 33 Item 13","section_13":"Item 13 Certain Relationships and Related Transactions . . . . . 33\nPART IV Item 14","section_14":"Item 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K. . . . . . . . . . . . . . 34\nSIGNATURES . . . .. . . . . . . . . . . . . . . . . . . . . . . . 36","section_15":""}
{"filename":"813764_1994.txt","cik":"813764","year":"1994","section_1":"ITEM 1. BUSINESS.\nTHE CORPORATION. Texas Security Bancshares, Inc. (the \"Corporation\"), a corporation incorporated under the laws of the state of Texas in 1979, is a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the \"BHC Act\"). The Corporation owns, indirectly, through a wholly- owned subsidiary, all of the issued and outstanding shares of capital stock of one state banking corporation, Central Bank & Trust, Fort Worth, Texas (the \"Subsidiary Bank\").\nAt December 31, 1994 the Corporation had consolidated total assets of $884,867,571, consolidated total loans of $272,825,001, consolidated total deposits of $726,247,915 and consolidated total stockholders' equity of $55,326,307.\nThe Corporation provides advice and services to the Subsidiary Bank and coordinates its activities in the areas of accounting, auditing, public relations, insurance, business development, credit and loan administration, financial planning, asset and liability management, employee benefit programs, and compliance with governmental regulations. The Subsidiary Bank is engaged in general commercial banking and consumer banking.\nThe Corporation's major source of income is dividends received from the Subsidiary Bank. Dividend payments by the Subsidiary Bank are based upon the Subsidiary Bank's earnings, deposits and capital.\nThe Corporation's business is neither seasonal in nature nor in any manner related to or dependent upon patents, licenses, franchises or concessions and the Corporation has not spent material amounts on research activities.\nTHE SUBSIDIARY BANK. The Subsidiary Bank was founded in 1947 and is currently in its 48th year of operation. The services offered by the Subsidiary Bank are generally those offered by commercial banks of comparable size in their respective areas. Some of the major services are described below.\nCOMMERCIAL BANKING. The Subsidiary Bank provides general commercial banking services for corporate and other business clients located in Tarrant County and Dallas County, Texas. Loans are made for a wide variety of purposes, including interim construction and mortgage financing on real estate and financing of equipment and inventories.\nCONSUMER BANKING. The Subsidiary Bank provides a full range of consumer banking services, including checking accounts, \"NOW\" and \"money market\" accounts, savings programs, installment and real estate loans, money transfers and safe deposit facilities.\nTRUST SERVICES. The Subsidiary Bank's trust department offers a full range of trust services to the public, including administrating estates and personal trusts and managing investment accounts for individuals, employee benefit plans and charitable foundations.\nSECURITIES SERVICES. The Subsidiary Bank provides discount brokerage services through which customers can buy or sell listed and over-the-counter preferred and common stock on a cash basis. The Subsidiary Bank also purchases and sells municipal and government securities, as well as beneficial interests in various mutual funds, for the account of its customers.\nMORTGAGE BANKING. In 1994 the Subsidiary Bank acquired Havran Mortgage Corporation and began providing mortgage banking services to its customers. Such services consist of originating and servicing home mortgage loans.\nCertain information with respect to the Subsidiary Bank as of December 31, 1994 is set forth in the following table.\nACQUISITIONS. During the past five years the Subsidiary Bank has successfully completed numerous bank acquisitions. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Acquisitions.\"\nAs a result of such acquisitions and the merger of the Subsidiary Bank and North Fort Worth Bank, the Subsidiary Bank now operates sixteen (16) full service branch banking facilities in Tarrant County and Dallas County, Texas.\nCOMPETITION. There is significant competition among bank holding companies in Tarrant County and Dallas County, Texas and the Corporation believes that such competition among bank holding companies will continue to increase in the future.\nAdditionally, the Subsidiary Bank encounters intense competition in its commercial banking business, primarily from other banks located in its market area, many of which have far greater assets and financial resources. The Subsidiary Bank also encounters intense competition in its commercial banking business from savings and loan associations, credit unions, factors, insurance companies, commercial and captive finance companies and certain other types of financial institutions located in other major metropolitan areas in the United States, many of which are larger in terms of capital, resources and personnel.\nEMPLOYEES. As of December 31, 1994 the Corporation and the Subsidiary Bank collectively had a total of 390 full-time employees and 75 part-time employees.\nSUPERVISION AND REGULATION. --------------------------\nGENERAL. The Corporation and the Subsidiary Bank are extensively regulated under federal and state law. These laws and regulations are generally intended to protect depositors, not shareholders.\nTo the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of the Corporation and the Subsidiary Bank. The operations of the Corporation and the Subsidiary Bank may be affected by legislative changes and by the policies of various regulatory authorities. The Corporation is unable to predict the nature or the extent of the effects on its business and earnings that fiscal or monetary policies, economic control or new federal or state legislation may have in the future.\nFEDERAL BANK HOLDING COMPANY REGULATION. The Corporation is a bank holding company within the meaning of the BHC Act and as such, is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (the \"FRB\"). A bank holding company is required to file with the FRB an annual report and to provide such additional information regarding its business operations and those of its subsidiaries as the FRB may require.\nWith certain limited exceptions, the BHC Act requires every bank holding company to obtain the prior approval of the FRB before: (i) acquiring direct or indirect ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than five percent (5%) of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. The FRB will not approve any acquisition, merger or consolidation that would have a substantially anti-competitive result, unless the anti-competitive effects of the proposed transaction are clearly outweighed by a greater public interest in meeting the convenience and needs of the community to be served. The FRB also considers capital adequacy and other financial and managerial factors in reviewing acquisitions or mergers.\nWith certain exceptions, the BHC Act also prohibits a bank holding company from acquiring or retaining direct or indirect ownership or control of more than five percent (5%) of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or of managing or controlling banks. In making this determination, the FRB considers whether the performance of such activities by a bank holding company can be expected to produce benefits to the public such as greater convenience, increased competition or gains in efficiency of resources, which can be expected to outweigh the risks of possible adverse effects such as decreased or unfair competition, conflicts of interest or unsound banking practices.\nAt the present time, the BHC Act generally prohibits bank holding companies located in Texas from acquiring or establishing banks located outside of the state in which the operations of such bank holding company's subsidiaries are principally conducted unless the laws of such state expressly authorize out- of-state bank holding companies to acquire or establish banks in such state. Texas law permits the acquisition of banks domiciled in Texas by out-of-state bank holding companies. However, an out-of-state bank holding company cannot own or control (i) a newly formed bank, (ii) both a bank and a savings and loan association located in Texas, or (iii) both a bank and a non-bank located in Texas. Texas banks acquired by an out-of-state bank holding company must be adequately capitalized and the board of directors of any such bank must have a Texas resident majority (which majority does not include insiders of the bank or the bank holding company). Unlike similar laws which have been adopted in other states, Texas law does not limit the geographic region of out-of-state bank holding companies that may acquire a Texas bank, nor does it require a reciprocal law in the out-of-state bank holding company's home state. The lack of such requirements significantly increases the number of bank holding companies eligible to invest in Texas. An out-of-state bank holding company seeking to acquire ownership or control of a Texas state bank, national bank located in Texas or any bank holding company owning or controlling a state bank or a national bank located in Texas must obtain the prior approval of both the FRB and the Banking Commissioner of Texas.\nThe Riegle-Neal Interstate Banking and Branching Act of 1994 (the \"Interstate Banking Act\") was signed into law by President Clinton on September 29, 1994. The Interstate Banking Act will allow adequately capitalized and managed bank holding companies to acquire banks in any state commencing September 29, 1995, regardless of whether the acquisition would be prohibited by applicable state law. As discussed above, Texas law permits the acquisition of banks domiciled in Texas by out-of-state bank holding companies. Under the Interstate Banking Act a bank holding company and its insured depository institution affiliates may not complete an acquisition which would cause it to control more than 10% of total deposits in insured depository institutions nationwide or to control 30% or more of total deposits in insured depository institutions in the home state of the target bank. However, state deposit concentration caps adopted by various states, such as the State of Texas, which limit control of in-state insured deposits to a greater extent than the Interstate Banking Act will be given effect. The State of Texas has adopted a deposit concentration cap of 25% of in-state insured deposits. Additionally, state minimum age provisions will be honored; provided, however, acquisitions may be approved when the target bank has been in existence for at least five years, notwithstanding state provisions to the contrary. The minimum age provision adopted by the State of Texas is five years and therefore this provision will not be preempted by the federal provision.\nThe Interstate Banking Act will also allow out-of-state branches through interstate mergers commencing June 1, 1997, provided each bank involved in the merger is adequately capitalized and managed. States are permitted, however, to pass legislation providing for either earlier approval of mergers with out-of- state banks or \"opting-out\" of interstate mergers entirely, provided such legislation applies equally to all out-of-state banks. The Interstate Banking Act also provides for interstate mergers involving an out-of-state bank's acquisition of a branch of an insured bank without the acquisition of the entire bank, if permitted under the laws of the state where the branch is located. The deposit concentration caps and the minimum age provisions applicable to interstate bank acquisitions also apply to interstate bank mergers. It is\nimpossible to predict at this time what legislation will be adopted by the Texas State Legislature in response to the Interstate Banking Act.\nThe Interstate Banking Act also provides for de novo branches in a state if that state expressly elects to permit de novo branching on a non- discriminatory basis. A \"de novo branch\" is defined as a branch office of a national or state bank that is originally established as a branch and does not become a branch as a result of an acquisition, conversion, merger or consolidation. De novo interstate branching is subject to the same conditions applicable to interstate mergers under the Interstate Banking Act, other than deposit concentration limits.\nSubsidiary banks of a bank holding company are subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to the bank holding company or its subsidiaries, on investments in their securities and on the use of their securities as collateral for loans to any borrower. These regulations and restrictions may limit the Corporation's ability to obtain funds from the Subsidiary Bank for its cash needs, including funds for payment of dividends, interest and operating expenses.\nUnder the BHC Act and certain regulations of the FRB, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or lease or sale of property or furnishing of services. For example, the Subsidiary Bank may not generally require a customer to obtain other services from the Subsidiary Bank or the Corporation, and may not require that customer to promise not to obtain other services from a competitor, as a condition to an extension of credit to the customer.\nAdditionally, under the BHC Act the FRB is endowed with cease and desist powers over bank holding companies and non-banking subsidiaries to forestall activities which represent unsafe or unsound practices or constitute violations of law. The FRB is also empowered to assess civil penalties against companies or individuals who violate the BHC Act in amounts up to $25,000 for each day's violation, to order termination of non-banking activities of non-banking subsidiaries of bank holding companies and to order termination of ownership and control of a non-banking subsidiary by a bank holding company.\nThe FRB has adopted risk-based capital standards and a minimum leverage ratio applicable to bank holding companies. See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital.\"\nSTATE BANK REGULATION. The Subsidiary Bank is a state banking corporation organized under the laws of the state of Texas pursuant to the provisions of the Texas Banking Code of 1943, as amended (the \"Texas Banking Code\").\nThe Subsidiary Bank, as a Texas state bank that is not a member of the FRB, is subject to regulation and supervision, of which regular bank examinations are a part, by the Banking Commissioner of Texas and the Federal Deposit Insurance Corporation (the \"FDIC\").\nThe FDIC has adopted risk-based capital standards and proposed a minimum leverage ratio for state nonmember banks which are substantially similar to the risk-based capital\nstandards and the minimum leverage ratio adopted by the FRB for bank holding companies. See \"Item 1. Business - Supervision and Regulation: Federal Bank Holding Company Regulation.\" and \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital.\"\nThe interest and usury laws of the state of Texas, which laws are preempted to a certain extent by federal law, generally limit the amount of interest which lenders, including the Subsidiary Bank, may charge on loans. This limit may vary depending upon, among other things, the identity, nature and location of the lender and the particular state or federal law applicable thereto, and the type of loan.\nThe Subsidiary Bank is also subject to certain restrictions on extensions of credit to executive officers, directors, principal shareholders or any related interest of such persons. Extensions of credit (i) must be made on substantially the same terms, including interest rates and collateral as, and following credit underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with persons not covered above and who are not employees, and (ii) must not involve more than the normal risk of repayment or present other unfavorable features. The Subsidiary Bank is also subject to certain lending limits and restrictions on overdrafts to such persons. A violation of these restrictions may result in the assessment of substantial civil monetary penalties on the Subsidiary Bank or any officer, director, employee, agent or other person participating in the conduct of the affairs of the Subsidiary Bank, the imposition of a cease and desist order, and other regulatory sanctions.\nTexas state banks are now permitted to engage in unlimited branch banking within the state of Texas. A state bank seeking to establish a branch must obtain prior approval from the Banking Commissioner of Texas.\nDEPOSIT INSURANCE. As an FDIC member institution, the deposits of the Subsidiary Bank are currently insured to a maximum of $100,000 per depositor through the Bank Insurance Fund (\"BIF\"), administered by the FDIC, and the Subsidiary Bank is required to pay semi-annual deposit insurance premium assessments to the FDIC.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") included provisions to reform the federal deposit insurance system, including the implementation of risk-based deposit insurance premiums, and permits the FDIC to make special assessments on insured depository institutions, in amounts determined by the FDIC to be necessary to give it adequate assessment income to repay amounts borrowed from the U.S. Treasury and other sources or for any other purpose the FDIC deems necessary. Pursuant to FDICIA, the FDIC implemented a transitional risk-based insurance premium system on January 1, 1993 which became the permanent risk-based premium system on January 1, 1994. Generally, under this system, banks are assessed insurance premiums according to how much risk they are deemed to present the BIF. Such premiums currently range from 0.23% of insured deposits to 0.31% of insured deposits. Banks with higher levels of capital and involving a low degree of supervisory concern are assessed lower premiums than banks with lower levels of capital or involving a higher degree of supervisory concern. The Subsidiary Bank is currently being assessed at the rate of $0.23 per $100 of deposits.\nCORRECTIVE MEASURES FOR CAPITAL DEFICIENCIES. FDICIA requires the banking regulators to take \"prompt corrective action\" with respect to capital- deficient institutions. In addition to requiring the submission of a capital restoration plan, FDICIA contains broad restrictions on certain activities of undercapitalized institutions involving asset growth, acquisitions, branch establishment, and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment.\nAs an institution's capital decreases, the powers of the banking regulators become greater. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management, and other restrictions. The regulators have very limited discretion in dealing with a critically undercapitalized institution and are required to appoint a receiver or conservator if the capital deficiency is not corrected promptly.\nINTERNAL OPERATING REQUIREMENTS. Under FDICIA, each federal banking agency is required to prescribe, by regulation, non-capital safety and soundness standards for institutions under its authority. The federal banking agencies, including the FDIC and the FRB, have recently proposed standards covering internal controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, and standards for asset quality and earnings sufficiency. An institution which fails to meet those standards would be required to develop a plan acceptable to the agency, specifying the steps that the institution will take to meet the standards. Failure to submit or implement such a plan may subject the institution to regulatory sanctions. Under the proposed regulations of the FRB, a bank holding company would be required to ensure that its subsidiary bank returns to compliance with the safety and soundness standards if a deficiency is detected. The Corporation believes the Subsidiary Bank already meets substantially all the standards which have been proposed, and therefore does not believe the implementation of these regulatory standards will materially affect the Corporation's business operations.\nMONETARY POLICY. The earnings of a bank holding company are affected by the policies of regulatory authorities, including the FRB, in connection with the FRB's regulation of the money supply. Various methods employed by the FRB are open market operations in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These methods are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may also affect interest rates charged on loans or paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Corporation's executive offices, containing approximately 2,027 square feet of space, are located in a three-story building located at 777 West Rosedale, Fort Worth, Texas and are leased from the Subsidiary Bank.\nThe Subsidiary Bank conducts its banking business in both owned and leased facilities. The Subsidiary Bank's main offices are located in its own one-story building, containing approximately 18,000 square feet, located at 777 West Rosedale, Fort Worth, Texas. The Subsidiary Bank also owns a connecting three-story tower (occupied by the Corporation) which contains approximately 76,000 square feet. The Subsidiary Bank also owns a drive-in facility across the street from its main banking facility, as well as a partially improved six acre tract of land located adjacent to its main banking facility. The Subsidiary Bank also owns a three-story building containing approximately 47,000 square feet, on approximately 2.6 acres of land, located at 8851 West Highway 80, Fort Worth, Texas. Approximately 29,000 square feet of space are being used by the Subsidiary Bank for operations and item processing.\nThe Subsidiary Bank owns the following properties on which it operates branch banking facilities:\nA one-story building containing approximately 4,000 square feet, on approximately one acre of land, located at 8800 Highway 80 West, Fort Worth, Texas.\nA one-story building containing approximately 5,550 square feet, on approximately one acre of land, located at 200 Mansfield Highway, Kennedale, Texas.\nA four-story building containing approximately 52,000 square feet, on approximately 3.5 acres of land, located at 2315 North Main Street, Fort Worth, Texas, together with a drive-in facility located on approximately one acre of land across the street from the branch facility.\nA one-story building containing approximately 4,000 square feet, on approximately 2.2 acres of land, located at the corner of N.E. Loop 820 and Blue Mound Road, Fort Worth, Texas.\nA one-story building containing approximately 5,400 square feet, on approximately two acres of land, located at 6700 Industrial Park Boulevard, Fort Worth, Texas.\nA one-story building containing approximately 5,000 square feet, on approximately 2.31 acres of land, located at 1326 N.W. 19th Street, Grand Prairie, Texas.\nA two-story building containing approximately 22,886 square feet, on approximately 2.54 acres of land, located at 4900 E. Belknap Street, Haltom City, Texas, together with a drive-in facility located on approximately 1.8 acres of land across the street from the branch facility.\nA one-story building containing approximately 2,205 square feet, on approximately 0.94 acre of land, located at 5604 Broadway Avenue, Haltom City, Texas.\nA one-story building containing approximately 32,000 square feet, on approximately 4.642 acres of land, located at 201 East Abram Street, Arlington, Texas, with a separate motor bank facility of approximately 2,400 square feet.\nThe Subsidiary Bank also leases the following properties on which it operates branch banking facilities:\nOffice space consisting of approximately 3,800 square feet, located at 300 West Seventh Street in downtown Fort Worth, Texas.\nOffice space consisting of approximately 1,600 square feet, located at 5324 Wedgmont Circle North, Fort Worth, Texas.\nA 1.12 acre tract of land located at 3100 Hulen, Fort Worth, Texas; all improvements located thereon, consisting of a one-story building containing approximately 3,500 square feet, are owned by the Subsidiary Bank.\nOffice space consisting of approximately 13,495 square feet, located at 101 Loop 820 North at White Settlement Road, White Settlement, Texas.\nOffice space consisting of approximately 2,000 square feet, located at 6003 I-20, Arlington, Texas.\nOffice space consisting of approximately 2,293 square feet, located at 6112 McCart, Fort Worth, Texas.\nOffice space consisting of approximately 5,398 square feet, located at 1600 Airport Freeway, Bedford, Texas.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn the opinion of management, the disposition of all outstanding legal actions will not have a material adverse effect on the Corporation.\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 1994.\nITEM 4A. EXECUTIVE OFFICERS OF THE CORPORATION.\nThe executive officers of the Corporation, each elected to serve at the pleasure of the Board of Directors until the next annual meeting of the Board of Directors to be held on April 5, 1995, their respective ages, and their present position with the Corporation are as follows:\nThe business experience of each of these executive officers during the past five (5) years is set forth below:\nMr. J. Andy Thompson is currently serving as the Chairman of the Board of Directors and Chief Executive Officer of the Corporation. He has served as Chairman of the Executive Committee since April 1990. From April 1993 to April 1994 he served as President of the Corporation. He has served as a director of Central Bank & Trust since January 1975, and served as a director of North Fort Worth Bank from January 1974 until its merger with and into Central Bank & Trust in March 1992. In January 1988 he became Chairman of the Board and Chief Executive Officer of Central Bank & Trust; he also served as Chairman of the Board and Chief Executive Officer of North Fort Worth Bank from January 1988 until its merger with and into Central Bank & Trust in March 1992. Mr. Thompson is also managing partner of Thompson Financial, Ltd.\nMr. Stuart W. Murff has served as President of the Corporation since April 1994 and as Vice Chairman of Central Bank & Trust since February 1993. From 1982 to 1993 he served as a principal in a bank consulting firm, as well as president of a bank data processing company. He has served as a director of Central Bank & Trust since January 1993.\nMr. Michael J. Tyler has been serving as the Senior Vice President and Chief Financial Officer of the Corporation since June 1989, and as Treasurer since April 1990. He has served as Executive Vice President of Central Bank & Trust since January 1992. He served as Vice President of Central Bank & Trust from September 1990 to December 1991.\nMr. Brian W. Garrison has served as the Vice Chairman of Central Bank & Trust since January 1992. He served as the President of the Corporation from July 1989 to April 1993 and\nas a director of the Corporation from August 1989 to April 1993. He has served as a director of Central Bank & Trust since December 1990 and served as President and a director of North Fort Worth Bank from July 1990 until its merger with and into Central Bank & Trust in March 1992.\nMr. Tom F. Turner has served as President of Central Bank & Trust since November 1981 and has served as a director of Central Bank & Trust since December 1981. From April 1991 to April 1993 he also served as a director of the Corporation.\nNo family relationships exist among the executive officers and directors of the Corporation, except as follows: J. Andy Thompson, Fred D. Thompson, Jr. and C. Rhea Thompson are brothers. Fred D. Thompson, Jr. is the father of Kelly R. Thompson, and J. Andy Thompson and C. Rhea Thompson are the uncles of Kelly R. Thompson.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nMARKET INFORMATION. There is no established public trading market for the issued and outstanding shares of common stock, $2.50 par value (the \"Common Stock\"), of the Corporation, and the management of the Corporation expects that no established trading market will exist for shares of Common Stock in the foreseeable future. Accordingly, there exists no published information with respect to market prices. From time to time, however, moderate numbers of shares of Common Stock are purchased and sold. The following table sets forth the number of shares of Common Stock traded and the average price of such shares for the periods indicated. Due to the limited trading volume, however, the specified sales prices may not reflect true market value.\nThe table below sets forth the range of high and low sales prices by quarter for 1994 and 1993:\nSHAREHOLDERS. At the close of business on February 14, 1995 there were 455 shareholders of record of Common Stock of the Corporation.\nDIVIDENDS. The following table sets forth the annual cash dividends declared and paid per share of Common Stock since the commencement of fiscal year 1993.\nAlthough the Board of Directors intends to continue to pay quarterly cash dividends in the future, there can be no assurance that cash dividends will be paid in the future or, if paid, that such cash dividends will be comparable to cash dividends previously paid by the Corporation, since future dividend policy is subject to the discretion of the Board of Directors of the Corporation and will depend upon a number of factors, including future earnings of the Corporation, the financial condition of the Corporation, the Corporation's cash needs, general business conditions and the amount of dividends paid to the Corporation by the Subsidiary Bank.\nThe appropriate regulatory authorities are authorized to prohibit banks and bank holding companies from paying dividends which would constitute an unsafe and unsound banking practice. The Subsidiary Bank and the Corporation are not currently subject to any regulatory restrictions on the payment of dividends.\nThe amount of dividends which will be paid to the Corporation by the Subsidiary Bank will be subject to the discretion of the Board of Directors of the Subsidiary Bank as well as dependent upon the level of earnings of the Subsidiary Bank, continued capital adequacy of the Subsidiary Bank, and compliance with regulatory requirements.\nUnder its loan agreement with The Frost National Bank, pursuant to which the Corporation obtained a $12,500,000 line of credit for the purpose of financing the acquisition of financial institutions in Texas and for general corporate purposes, the Corporation may not declare or pay any dividends which are in excess of $1,500,000 in the aggregate per year.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe following table sets forth certain highlights from the Corporation's audited year-end consolidated financial statements for the last six years:\nSELECTED FINANCIAL DATA (Dollars in Thousands)\nAlthough these statistics are satisfactory indicators of general trends, the daily average balance sheets are more meaningful for analysis purposes than December 31 data because they minimize the effect of day-to-day fluctuations that are common to bank balance sheets. Also, average balances for earning assets and interest-bearing liabilities can be related directly to the components of interest income and interest expense on the statements of operations. This provides the basis for analysis of rates earned and paid, and sources of increases and decreases in net interest income as derived from changes in volumes and rates. The schedule on the next page presents consolidated average balance sheets for the most recent three years in a format that highlights earning assets and interest-bearing liabilities. Following the consolidated average balance sheets are comparative consolidated statements of operations for the past six years.\nCONDENSED CONSOLIDATED AVERAGE BALANCE SHEETS (Dollars in Thousands)\nCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars In Thousands Except Per Share Data)\n______________________ (1) The extraordinary item represents a reduction of Federal income taxes arising from utilization of net operating loss carryforwards.\nITEM 7","section_7":"ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion highlights the major changes affecting the operations and financial condition of the Corporation for the three years ended December 31, 1994. The discussion should be read in conjunction with the consolidated financial statements, accompanying notes, and selected financial data appearing elsewhere in this report.\nACQUISITIONS\nEffective March 1, 1994, Central Bank & Trust acquired certain assets (primarily single family residential mortgage loans) and assumed certain liabilities (primarily short-term notes payable) of Havran Mortgage Corporation. The acquisition resulted in an increase in both consolidated loans and short- term borrowings of approximately $1.5 million at the date of acquisition. The acquisition was accounted for as a purchase with the assets and liabilities recorded at their fair values as of the purchase date. The acquisition has improved the Corporation's ability to efficiently provide real estate mortgage loans to customers.\nOn February 5, 1993, Central Bank & Trust acquired certain assets (primarily cash equivalents, premises and equipment, investment securities, and certain nonclassified loans) and assumed certain liabilities (primarily customer deposits) of an insolvent banking association, American Bank of Haltom City (\"American\"), Haltom City, Texas. The transaction resulted in an increase in consolidated assets and liabilities of approximately $94 million at the acquisition date. The acquisition has improved operating efficiencies and results by increasing market share within Tarrant County. Further details of this transaction are provided in the Form 8-K filing dated February 5, 1993. The acquisition of American was accounted for as a purchase with the assets and liabilities recorded at their fair market values as of the purchase date. Accordingly, the accompanying consolidated financial statements include the results of operations of American from February 5, 1993.\nOn February 6, 1992, Central Bank & Trust acquired certain assets (primarily cash equivalents, investment securities, and consumer loans) and assumed certain liabilities (primarily customer deposits) of an insolvent banking association, Landmark Bank of Fort Worth (Landmark), Fort Worth, Texas. The transaction resulted in the increase in consolidated deposits and loans of approximately $74 million and $8 million, respectively. Further details of this transaction are provided in the Form 8-K filing dated February 6, 1992.\nOn March 6, 1992, the operations of the Corporation's two wholly owned banking subsidiaries, North Fort Worth Bank and Central Bank & Trust, were merged together under the name of Central Bank & Trust. For purposes of Management's Discussion and Analysis, the two subsidiaries will collectively be referred to as the \"Subsidiary Bank.\" The merging of the two subsidiaries has provided greater opportunities in the areas of marketing, product delivery and operating efficiencies.\nOVERVIEW OF 1994 PERFORMANCE\nTexas Security Bancshares, Inc. reported net income for the year ended December 31, 1994 of $8,021,940 or $3.07 per share. For the year ended December 31, 1993, net income was $8,093,343 or $3.11 per share. 1993 results include a one-time adjustment for $1,370,000 or $0.53 per share relating to accounting for income taxes. 1993 earnings excluding the adjustment were $6,723,343 or $2.58 per share.\nNet interest income increased to $29,898,715 in 1994 from $27,546,040 in 1993. This increase resulted as increases in deposits and short-term borrowings allowed the Corporation to increase its earning assets. The increase in net interest income also occurred despite a ten basis point decrease from 1993 in the Corporation's net interest margin (net yield on earning assets).\nThe Corporation's noninterest income rose by $1,000,458 over the 1993 level. The increase is primarily attributable to service charges and fees on customer deposit accounts which increased as the customer deposit base grew and due to income from the Corporation's significantly expanded mortgage lending operations. Income from investment services declined in 1994 as market volatility and rising interest rates made traditional bank products more appealing to customers.\nNoninterest expenses increased by $1,396,536 over 1993. The increases are primarily due to the continued increases in officer and employee compensation and the expenses associated with the Corporation's investment in technology and systems for the future.\nNET INTEREST INCOME\nNet interest income, the principal source of earnings, is the amount of income generated by earning assets (primarily loans and investment securities) reduced by total interest costs of the funds (primarily deposits) obtained to carry them.\nA summary of average earning assets and interest-bearing liabilities of each major type together with interest earned and incurred are presented for the last three years in the following table.\nThe presentation of net interest income is a \"taxable equivalent\" basis to adjust for the tax-favored status of earnings from certain loans and investments, the majority of which are obligations of state and local governments.\nSUMMARY OF EARNING ASSETS AND INTEREST-BEARING LIABILITIES (Dollars in Thousands)\n____________________________________ (1) Presented on a taxable equivalent basis using a 34% Federal income tax rate. (2) Including nonaccrual loans, thereby reducing yield. (3) Net of unearned discount.\nPresented below is a comparison of net interest income and the net interest margin on a taxable equivalent basis (using a 34% Federal income tax rate) for the last three years:\nThe Corporation's taxable-equivalent net interest income increased $2.614 million due to increases in earning assets and deposit volumes. The average yield on earning assets was 6.95% in 1994, compared to 6.83% in 1993. The average cost of interest-bearing liabilities was 3.15% in 1994 compared to 2.98% in 1993. Thus, the net interest spread was 3.80% in 1994 compared to 3.85% in 1993, a decrease of five basis points.\nThe net yield on earning assets in 1994 was at 4.29%, a decrease of ten basis points from 4.39% in 1993. The Corporation's interest-bearing liabilities remain more sensitive to rate changes than the Corporation's earning assets. In 1994, the rate increases on interest-bearing liabilities were greater than the increases in yields on loans and investment securities. The net yield on earning assets is expected to decline further in 1995 based on an anticipated increase in short-term interest rates.\nThe following table presents the changes in the components of the net interest margin on a taxable equivalent basis and identifies the part of each change in such components due to differences in the average volume of earning assets and interest-bearing liabilities, and due to differences in the average rate on those assets and liabilities for each of the last two years. Nonaccrual loans have been included in assets for purposes of computations, thereby reducing yields. The allocation of the rate\/volume variance has been made on a pro rata basis on the percentage that volume and rate variances produce in each category.\nANALYSIS OF CHANGES IN THE NET INTEREST MARGIN (Dollars in Thousands)\nPROVISION FOR LOAN LOSSES, ALLOWANCE FOR LOAN LOSSES AND CREDIT QUALITY\nInherent with the extension of credit is a degree of risk taking. The primary factors influencing the amount of risk and loss associated with the lending function are economic conditions and lending practices.\nManagement recognized that it is not possible to predict loan losses with complete certainty, but strives to reduce the amount of loss by responsible lending procedures and loan review processes. Credit risk management, through extensive evaluation of new credit requests to determine if the extension of credit is prudent, has been strengthened. Further control of risk and assessment of the overall quality of the loan portfolio is accomplished by ongoing internal review as well as periodic reviews by external independent loan reviewers, external auditors and regulatory agency examiners.\nIn conjunction with the reviews, the Corporation utilizes: (a) historical loan loss experience; (b) the evaluation of underlying collateral for secured loans; (c) expected loan growth; (d) portfolio composition; (e) current and forecasted local and national economic conditions to establish an allowance for loan losses and the provision necessary to maintain it at an adequate level.\nThe allowance for loan losses is used to cover future loan losses. Recoveries of loans previously charged-off, in addition to periodic charges to operating expense, increase the balance in the allowance while it is decreased by loan charge-offs.\nThe Texas economy, in general, continued a recovery which began in 1993. Growth was experienced by small and medium size companies and, overall, Texas was second nationally behind only Florida in job creation.\nIn 1994, the real estate market, as a whole, continued to improve. The most encouraging news came from the areas of residential, retail and industrial markets. The Dallas\/Fort Worth area currently rates as one of the top residential markets in the U.S. with sales of single-family homes remaining strong. The apartment market maintained over 90% occupancy in 1994, which resulted in higher rental rates and new development. The retail market reported approximately 85% occupancy in 1994 with increasing rent levels. The industrial market has improved to above 90% occupancy. However, the office market is still having problems due to tenant downsizing, competition from liquidation properties and declining rental rates in some areas.\nWith the improving economy, the Corporation achieved moderate loan growth for the second consecutive year. Most of the growth came from small and medium size companies and from new or refinanced real estate mortgages. The Corporation's loan portfolio, although concentrated in real estate, does not have any industry concentrations and is primarily extended to user occupied property.\nBased upon current information and conditions, management believes the known risks in the existing loan portfolio have been properly evaluated and the allowance is at a satisfactory level. Subsequent evaluations, however, could necessitate changes in the balance of the allowance.\nThe following table presents the provision for loan losses, loans charged-off, recoveries of loans previously charged-off, the amounts of the allowance for loan losses, the loans outstanding and certain pertinent ratios for the periods indicated (dollars in thousands).\nIn 1994, the provision for loan losses was $500,000 and net charge-offs totaled $700,000, or 0.28% of average loans. In 1993, the provision amounted to $200,000 with net charge-offs amounting to $791,000 or 0.36% of average loans.\nAt December 31, 1994, the allowance for loan losses was $3.872 million, or 1.42% of year-end loans, compared to $4.072 million, or 1.73% at December 31, 1993. The allowance at the close of 1994 provided coverage for 109% of nonaccrual and restructured loans compared to 192% at the end of 1993 and 111% at the end of 1992.\nThe following table shows the allowance for loan losses by loan category for the past three years (dollars in thousands):\nALLOWANCE FOR LOAN LOSSES BY LOAN CATEGORY (Dollars in Thousands)\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards No. 114 (\"Statement No. 114\"), \"Accounting by Creditors for Impairment of a Loan\" and Statement of Financial Accounting Standards No. 118 (\"Statement No. 118\"), \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures.\" Both statements are effective for fiscal years beginning after December 15, 1994 and will be applied on a prospective basis. Statement No. 114 requires that impaired loans within the scope of the statement be measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Impairment shall be recognized by creating a valuation allowance with a corresponding charge to the provision for loan losses. Statement No. 118 amends Statement No. 114 and allows the use of existing methods for recognizing interest income on impaired loans. The effect of adopting these statements is not considered material.\nNonperforming assets (loans accounted for on a nonaccrual basis, restructured loans and other real estate owned) at December 31, 1994 totaled $3.911 million, a 58.98% increase from the $2.460 million reported at the close of 1993. Nonperforming assets at December 31, 1993 decreased 65.76% from the $7.185 million reported at the close of 1992.\nThe following table summarizes the nonperforming assets as of December 31 for each of the last five years (dollars in thousands).\nNonaccrual loans are those on which the accrual of interest has been suspended and on which interest is recorded as earned when it is received. Loans are placed on nonaccrual status when principal or interest is past due 90 days or more, and the loan is not both well-secured and in the process of collection, or immediately, if in the opinion of management, full collection of principal or interest is unlikely. At the time a loan is placed on nonaccrual status, interest previously recorded but not collected is reversed and charged against current income.\nOther real estate owned includes properties for which the Corporation has foreclosed and taken title. In April 1992, the American Institute of Certified Public Accountants issued Statement of Position 92-3 \"Accounting for Foreclosed Assets\" (SOP 92-3) which is effective for annual financial statements for periods ending on or after December 15, 1992. Under SOP 92-3 there is a refutable presumption that foreclosed assets are held for sale. All of the Corporation's foreclosed assets are held for sale, as required by regulatory guidelines. SOP 92-3 requires that foreclosed assets held for sale be carried at the lower of fair value, net of estimated selling costs, or cost. Because the Corporation previously carried its foreclosed assets on a similar basis, the effect of implementation of SOP 92-3 was not significant.\nAny write-downs in properties acquired in satisfaction of debts are charged to the allowance for loan losses at the date of acquisition. Estimates for costs to sell, expenses incurred in maintaining other real estate owned and subsequent write-downs to reflect declines in the fair value of the property are included in other real estate owned expense (income), net.\nManagement provides for possible future declines in real estate values through periodic specific write-downs. These charges to earnings are made based upon updated periodic independent appraisals and internal evaluations of property and market conditions.\nRestructured loans are loans on which the interest and\/or the principal has been reduced due to a deterioration in the borrower's financial condition. A restructured loan is neither on nonaccrual status nor 90 days past due.\nThe Corporation has no nonperforming assets which are energy related. Management is not aware of any potential problem loans which are not included in nonperforming loans to which serious doubts exist as to the ability of the borrower to substantially comply with the present repayment terms.\nThe following schedule presents loan amounts past due 90 days or more and not classified as non-performing as of the dates indicated by the type of loan (dollars in thousands).\nIn 1994, the amount of interest on the above loans that was included in income was approximately $4,200.\nThe Corporation's problem loan monitoring program examines on a monthly basis the status and specific action plan for resolution or liquidation of all major nonperforming assets.\nNONINTEREST INCOME\nNoninterest income represents service charges and fees earned by the Subsidiary Bank, trust fees, gains on sales of investment securities and other miscellaneous fee income, including income from mortgage lending operations. Noninterest income increased 12.44% to $9.047 million in 1994 and 13.50% in 1993 to $8.046 million from the respective preceding years. Increases in service charges and fees are largely due to the increased customer deposit base.\nThe increase in trust fees is attributable to new personal and institutional business generated. The decrease in investment services income in 1994 from 1993 is due primarily to the increase in the number of bank customers shifting to traditional bank products due to the increased stock market volatility and to rising interest rates.\nOther noninterest income increased primarily due to gains on sales of mortgage loans from the Corporation's expanded mortgage lending operations.\nThe following table summarizes the changes in noninterest income during the past two years (dollars in thousands):\nNONINTEREST EXPENSES\nNoninterest expenses were $27.773 million in 1994, up 5.29% from the $26.377 million incurred in 1993. Noninterest expenses in 1993 increased 16.87% from the $22.569 million incurred in 1992.\nThe largest item of noninterest expenses, salaries and employee benefits, increased $1,418,000, or 10.34% from 1993 to 1994 and $2,736,000, or 24.91% from 1992 to 1993. Higher personnel expenses for 1994 and 1993 reflect an increase in staffing levels from acquisition and branch expansion activities in addition to merit adjustments, averaging 3.5%, and increased costs associated with Corporate provided employee benefits.\nNet occupancy expense decreased $181,000 or 6.37% from 1993 to 1994 compared to an increase of $881,000 or 44.93% from 1992 to 1993. The Corporation added new banking facilities in 1994 and 1993. In 1993, facilities management was outsourced, increasing net occupancy expense. In 1994, facilities management was brought back in-house, shifting expense from net occupancy to salaries and employee benefits.\nEquipment and data processing expense in 1994 increased by $206,000 or 7.91% over 1993 expense levels. Equipment and data processing expense in 1993 increased by $651,000 or 33.33% from 1992 expense levels primarily due to an increase in depreciation expense resulting from the purchase of a new ATM processing system.\nOther real estate owned expense (income), net decreased $220,000 or 152.78% from 1993 and decreased $1,367,000 or 90.47% from 1992 to 1993. The high level of expense in 1992 is attributed to write-downs in the carrying value of foreclosed property to reflect declining market values. Other real estate owned expenses have decreased as the number of properties held has declined.\nFederal deposit insurance fees in 1994 increased $121,000 or 8.74% over 1993 and $146,000 or 11.78% between 1993 and 1992. The increase in both 1994 and 1993 was attributable to the increase in average deposits.\nThe early retirement expense in 1993 of $118,000 represents the cost of providing lump sum and increased future pension benefits to employees who elected to take voluntary early retirement under a plan offered to them in the fourth quarter of 1993.\nCommunications expense and stationery and supplies expense increased $78,000 or 6.28% and decreased $76,000 or 8.25%, respectively, in 1994 from 1993. Communications expense in 1993 increased $293,000 or 30.84% from 1992 and stationery and supplies expense increased $141,000 or 18.08% in the same period. The increases in 1993 are the result of expanded banking operations.\nThe following table summarizes the changes in noninterest expenses for the past three years (dollars in thousands):\nANALYSIS OF CHANGES IN NONINTEREST EXPENSES (Dollars in Thousands)\nINCOME TAXES\nIn 1994, the Corporation recorded income tax expense of $2,650,000. This compares to $2,292,000 recorded in 1993 and $1,622,953 recorded in 1992. The 1992 amount includes the tax effect of net operating loss carryforwards of $356,094.\nIn 1991, the Corporation recorded state income tax expense of $172,241 resulting from changes in the state franchise tax legislation enacted in September, 1991. In 1992, the expense recorded in 1991 was reversed due to subsequent clarifications in regulations regarding taxable state income.\nEffective January 1, 1993, the Company adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" (\"Statement No. 109\") on a prospective basis. Statement No. 109 requires a change from the deferred method of accounting for income taxes under Accounting Principles Board Opinion 11 to the asset and liability method. The effect of initially applying this pronouncement has been recorded as the cumulative effect of change in accounting for income taxes in the Corporation's consolidated statement of operations for the year ended December 31, 1993. Adopting the statement resulted in an increase in the Corporation's deferred tax asset of $1,370,000.\nThe Corporation has recorded a net deferred tax asset of $3,626,813 and $1,839,000 at December 31, 1994 and 1993, respectively. The Corporation is not dependent on future taxable income as a basis for realization of the deferred tax asset. The Corporation believes it is more likely than not that the entire deferred tax asset will be realized or settled, and accordingly, no valuation allowance has been recorded as of December 31, 1994 and 1993.\nCAPITAL\nThe Corporation recognizes the importance of proper capitalization. The continuing philosophy is to maintain a highly capitalized organization operating with capital levels well in excess of those required by regulatory agencies.\nIn January 1989, the Federal Reserve Board issued guidelines to United States banking organizations for the application of a risk-based capital framework. The guidelines classify capital into two tiers, referred to as Tier 1 and Tier 2. Tier 1 consists of core capital elements less certain intangible assets, while Tier 2 includes the allowance for loan losses, but is limited to 100% of Tier 1 and 1.25% of risk-weighted adjusted assets. The denominator or asset portion of risk based capital aggregates generic classes of balance sheet and off-balance-sheet exposures, each weighted by one of four factors, ranging from 0% to 100%, based upon the relative risk of the exposure class.\nThe final Federal Reserve Board guidelines took effect at year-end 1992 and require a minimum capital of 8%, of which at least 4% must be Tier 1.\nIn 1990, the Federal Reserve Board issued guidelines that set forth the leverage standards to be applied to banking organizations in conjunction with the risk-based capital framework adopted in 1989. The leverage standard requires a minimum ratio of 3% Tier 1 capital to average total adjusted assets, as defined. However, regulators are given wide discretion to set a level appropriate for each bank, with most banks expected to maintain a leverage capital ratio of 4% to 5%.\nAmendments to the capital rules for the adoption of the Financial Accounting Standards Board's (\"FASB\") Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" have not yet been adopted and as such, net unrealized losses on available-for-sale securities resulting from the accounting change have been excluded from the computation of Tier 1 (and total) capital.\nThe following table presents the Corporation's risk-based and leverage capital ratios for 1994 and 1993 (dollars in thousands):\nThe above capital ratios, under all regulatory measurements, are in excess of required minimum levels. In 1991 the Texas State Banking Department issued a 6% minimum leverage capital ratio standard for all state banks.\nLIQUIDITY\nLiquidity is defined as the Corporation's ability to meet deposit withdrawals, provide for the legitimate credit needs of customers, and take advantage of certain investment opportunities as they arise. While maintaining adequate liquid assets to fulfill these functions, it must also maintain compatible levels of maturity and rate concentrations between its sources of funds and earning assets. The liability structure of the Corporation is short- term in nature and the asset structure is likewise oriented towards maturities.\nThe Corporation's primary internal source of liquidity is its short-term marketable assets, primarily federal funds sold, and United States Government and Agency securities maturing within the next twelve months.\nThe Corporation maintains liquidity levels well in excess of regulatory guidelines of 20-25%. As of December 31, 1994, the Corporation's liquidity ratio, computed under the Texas State Banking Department formula, was 71% for Central Bank & Trust. In addition, the Corporation maintained liquidity levels in excess of regulatory guidelines at December 31, 1993 and 1992.\nINVESTMENT PORTFOLIO\nThe following schedule presents the book value of the consolidated investment securities portfolio as of December 31 for the last three years.\nBOOK VALUE OF INVESTMENT SECURITIES (Dollars in Thousands)\nThe investment portfolio, including Federal funds sold, as a percentage of total assets was 59.87% at December 31, 1994, 58.26% at December 31, 1993, 61.84% at December 31, 1992.\nMortgage-backed securities represent 63.57% of the total investment portfolio as of December 31, 1994 up from 58.02% at December 31, 1993. The mortgage-backed securities are backed by U.S. or Federal Agency guarantees limiting the credit risk associated with mortgage loans. Mortgage-backed securities do possess other risks, namely uncertain yields due to repayment uncertainties.\nThe following schedule presents the consolidated investment securities portfolio at December 31, 1994, classified according to maturities, along with the weighted average interest yield for each range of maturities. The weighted average yields on tax-exempt obligations are computed on a taxable equivalent basis using a 34% Federal income tax rate. FHLB stock is excluded from the schedule as it has no specified maturity. Mortgage-backed securities are included with maturities based on estimated prepayments.\nMATURITIES AND AVERAGE YIELD (Dollars in Thousands)\nThe fair value of the investment portfolio is always different from the amortized cost of the portfolio due to interest rate fluctuations which cause fair market valuations to change. As of December 31, 1994, the amortized cost of the Corporation's investment portfolio exceeded the fair value by $22,015,000 or 4.3%, while as of December 31, 1993, the fair value of the investment portfolio exceeded amortized cost by $5,657,000 or 1.4%. The decline in fair value relative to amortized cost was due to the rapid rise in short-term interest rates in 1994.\nEffective January 1, 1994, the Company adopted the FASB's Statement of Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"Statement No. 115\"). Statement No. 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and all investments in debt securities.\nIn accordance with Statement No. 115, these investments are classified at the time of purchase into one of three categories as follows:\n- Held-to-Maturity Securities - Debt securities that the Company has the positive intent and ability to hold to maturity are reported at amortized cost.\n- Trading Securities - Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are to be reported at fair value, with unrealized gains and losses included in earnings.\n- Available-for-Sale Securities - Debt and equity securities not classified as either held-to-maturity securities or trading securities are reported at fair value with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity (net of tax effects).\nThe Company does not have any securities classified as trading as of December 31, 1994.\nInvestment securities have been generally acquired with the intent to hold them to maturity, as management believes the Company has the ability to do so. After reviewing Statement No. 115 and considering the implications of selling securities classified as held-to-maturity, management has classified a portion of the investment portfolio as available-for-sale. Recording such securities classified as available-for-sale at fair value upon the adoption of Statement No. 115 resulted in an increase in stockholders' equity of $2,025,625, net of tax of $1,043,503. Subsequent decreases in the fair value of securities classified as available-for-sale have decreased stockholders' equity by $5,923,154, net of tax of $3,051,316.\nThe Corporation does not own any investment securities of any one issuer which is a state or political subdivision of which aggregate adjusted cost exceed 10% of consolidated stockholders' equity as of December 31, 1994 or 1993.\nLOANS\nThe following schedule presents the Corporation's loan balances at the date indicated according to loan type.\nDISTRIBUTION OF LOANS (Dollars in Thousands)\nNet loans increased $37.215 million or 15.80% between year-end 1993 and 1994, compared to an increase of $44.958 million or 23.58% between year-end 1992 and 1993. The increase in 1994 is attributable to new and refinanced real estate mortgages resulting from an improved economy and is also attributable to continued increased emphasis on commercial lending.\nThe following table presents the distribution of commercial, financial and real estate construction loans at December 31, 1994 based on scheduled principal repayments. The table also presents the portion of these loans that are sensitive to interest rates (dollars in thousands).\nDEPOSITS\nThe most important source of the Corporation's funds is the deposits of the Subsidiary Bank. The types of deposits that were in the Subsidiary Bank on a daily average basis and the related rate paid during each of the last three years are shown in the following table (dollars in thousands).\nTotal average deposits were $693.754 million in 1994 compared to $663.996 million in 1993 and $575.939 million in 1992. Interest-bearing demand deposits continue to increase as the rates on these products are competitive with those offered by other financial institutions and with similar investments alternatives.\nSHORT-TERM BORROWINGS\nDuring 1994, the Corporation began selling securities under agreements to repurchase (\"repurchase agreements\") and began borrowing from the Federal Home Loan Bank (\"FHLB\"). The Corporation initiated the repurchase agreements primarily as a service to customers, while borrowing from the FHLB provided a new source of funds for increasing earning assets.\nAt December 31, 1994, short-term borrowings included repurchase agreements totaling $59,137,190 ($34,137,190 with customers and $25,000,000 with the FHLB), with a weighted average interest rate of 5.47%, and a FHLB advance for $25,000,000 with an interest rate of 5.90%. The repurchase agreements with customers have a maturity of one day and are repricable on daily basis, while the repurchase agreements with the FHLB mature and reprice monthly.\nThe maximum amount of repurchase agreements outstanding at any month-end during 1994 was $89,821,319 and the maximum FHLB advance during 1994 was $25,000,000. The average amounts outstanding and the weighted average interest rates were approximately $30,284,000 and $24,110,000 and 4.46% and 4.36% for the repurchase agreements and the FHLB advance, respectively.\nINTEREST RATE SENSITIVITY\nAsset\/liability management involves the maintenance of an appropriate balance between interest-sensitive assets and interest-sensitive liabilities to reduce interest rate exposure while also providing liquidity to satisfy the cash flow requirement of operations to meet customers' fluctuating demands for funds, either in terms of loan requests or deposit withdrawals.\nA volatile rate environment combined with industry deregulation has placed an increased emphasis on interest rate sensitivity management. Interest- sensitive earning assets and interest-bearing liabilities are those which have yields or rates which are subject to change within a future time period due to maturity of the instrument or changes in the rate environment. Gap refers to the difference between the rate sensitive assets and rate sensitive liabilities.\nInterest rate sensitivity management seeks to protect earnings by maintaining an appropriate balance between interest-sensitive earning assets and interest-bearing liabilities in order to minimize fluctuations in the net interest margin and net earnings in periods of volatile interest rates.\nThe following table quantifies the interest rate sensitivity of both earning assets and interest-bearing liabilities as of December 31, 1994.\nINTEREST RATE SENSITIVITY ANALYSIS (Dollars in Thousands)\nPERFORMANCE SUMMARY\nThe table below presents the return on average assets and the return on average equity for the Corporation over the last three years. Return on average assets is calculated by dividing net income by average assets for the year. The return on average equity ratio is calculated by dividing net income by average stockholders' equity for the year. The dividend payout ratio is computed by dividing cash dividends declared by net income. The average stockholders' equity to average total assets is calculated by dividing average stockholders' equity by average total assets for the year.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATE\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS: PAGE -------------------------------------------- ----\nIndependent Auditor's Report.......................... 39\nConsolidated Balance Sheets as of December 31, 1994 and 1993............................................ 40\nConsolidated Statements of Operations for the years ended December 31, 1994, 1993 and 1992.............. 42\nConsolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992............................................ 44\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992.............. 45\nNotes to Consolidated Financial Statements............ 47\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Texas Security Bancshares, Inc. Fort Worth, Texas:\nWe have audited the consolidated financial statements of Texas Security Bancshares, Inc. and subsidiaries (the Company) as listed in the accompanying index. 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 Texas Security Bancshares, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in note 1 to the consolidated financial statements, the Company changed its method of accounting for investment securities in 1994 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" As discussed in notes 1 and 11, 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 LLP\nFort Worth, Texas February 2, 1995\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1994 and 1993\n(Continued)\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Consolidated Balance Sheets, Continued\nSee accompanying notes to consolidated financial statements.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Operations Years ended December 31, 1994, 1993 and 1992\n(Continued)\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Operations, Continued\nSee accompanying notes to consolidated financial statements.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Years ended December 31, 1994, 1993 and 1992\nSee accompanying notes to consolidated financial statements.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended December 31, 1994, 1993 and 1992\n(Continued)\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows, Continued\nSUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:\nCash paid for interest was $18,778,071, $16,124,843 and $18,986,780 in 1994, 1993 and 1992, respectively.\nCash paid for Federal income taxes was $2,675,000, $2,420,205 and $2,172,000 in 1994, 1993 and 1992, respectively.\nSUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING ACTIVITIES:\nLoans transferred to other real estate owned in 1994, 1993 and 1992 were $164,493, $559,642 and $1,687,745, respectively.\nOther real estate owned transferred to premises and equipment during 1994 and 1993 totaled $40,000 and $1,000,000, respectively.\nProceeds from sales of other real estate owned financed through loans were $124,001, $619,300 and $513,200 in 1994, 1993 and 1992, respectively.\nNet unrealized losses on investment securities available-for-sale and the related net increase in deferred Federal income taxes as of December 31, 1994 were $5,905,342 and $2,007,813, respectively.\nDuring 1994 investment securities were transferred from available-for-sale to held-to-maturity. At the date of the transfer, the amortized cost and fair value of these securities were $100,979,079 and $99,508,729, respectively.\nSee accompanying notes to consolidated financial statements.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) BUSINESS\nTexas Security Bancshares, Inc. (the \"Company\"), a bank holding company, provides a full range of banking services to individual and corporate customers through its subsidiaries and branch banks. The Company is subject to competition from other financial institutions. The Company is also subject to the regulations of certain Federal and state agencies and undergoes periodic examinations by those regulatory authorities.\n(b) BASIS OF FINANCIAL STATEMENT PRESENTATION\nThe consolidated financial statements include the accounts of Texas Security Bancshares, Inc. and its subsidiaries, Central Bank & Trust, Texas Security Bancshares Corporation, and TSB Operations Corporation. On March 6, 1992, the operations of the Company's two wholly owned banking subsidiaries, North Fort Worth Bank and Central Bank & Trust, were merged together under the name of Central Bank & Trust. All significant intercompany balances and transactions have been eliminated in consolidation.\nOn February 6, 1992, Central Bank & Trust acquired certain assets and assumed certain liabilities of an insolvent banking association, Landmark Bank of Fort Worth, Fort Worth, Texas, through a purchase and assumption agreement with the Federal Deposit Insurance Corporation. The acquisition resulted in an increase in consolidated deposits and loans of approximately $74 million and $8 million, respectively, at the date of acquisition.\nOn February 5, 1993, Central Bank & Trust entered into a purchase and assumption agreement with the Federal Deposit Insurance Corporation to acquire certain assets (primarily cash equivalents, premises and equipment, investment securities, and certain nonclassified loans) and assume certain liabilities (primarily customer deposits) of an insolvent banking association, American Bank of Haltom City (\"American\"), Haltom City, Texas. The transaction resulted in an increase in the Company's consolidated assets and liabilities of approximately $94 million at the acquisition date.\nThe consolidated financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and income and expenses for the period. Actual results could differ significantly from those estimates.\nMaterial estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowances for loan losses and losses on other real estate owned. In connection with the determination of the allowances for loan losses and losses on other real estate owned, management normally obtains independent appraisals for significant properties.\nA substantial portion of the Company's loans are secured by real estate in local markets. In addition, other real estate owned is located in this same market. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio and the recovery of the carrying amount of other real estate owned are susceptible to changes in local market conditions.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\n(b) BASIS OF FINANCIAL STATEMENT PRESENTATION, CONTINUED\nManagement believes that the allowance for loan losses and losses on other real estate owned are adequate. While management uses available information to recognize losses on loans and other real estate owned, future provisions for losses on loans and other real estate owned may be necessary based on changes in local economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowances for loan losses and losses on other real estate owned. Such agencies may require the Company to record additional provisions for losses based on their judgments about information available to them at the time of their examination.\n(c) INVESTMENT SECURITIES\nPrior to January 1, 1994, all investment securities were recorded at cost, adjusted for amortization of premiums and accretion of discounts using methods approximating the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments.\nEffective January 1, 1994, the Company adopted the Financial Accounting Standards Board's (\"FASB\") Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"Statement No. 115\"). Statement No. 115 addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and all investments in debt securities.\nIn accordance with Statement No. 115, these investments are classified at the time of purchase into one of three categories as follows:\n. Held-to-Maturity Securities - Debt securities that the Company has the positive intent and ability to hold to maturity are reported at amortized cost.\n. Trading Securities - Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are to be reported at fair value, with unrealized gains and losses included in earnings.\n. Available-for-Sale Securities - Debt and equity securities not classified as either held-to-maturity securities or trading securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity (net of tax effects).\nThe Company does not have any securities classified as trading as of December 31, 1994.\nInvestment securities have been generally acquired with the intent to hold them to maturity, as management believes the Company has the ability to do so. After reviewing Statement No. 115 and considering the implications of selling securities classified as held-to-maturity, management has classified a portion of the investment portfolio as available-for-sale. Recording such securities classified as available- for-sale at fair value upon the adoption of Statement No. 115 resulted in an increase in stockholders' equity of $2,025,625, net of tax of $1,043,503. Subsequent decreases in the fair value of securities classified as available-for-sale have decreased stockholders' equity by $5,923,154, net of tax of $3,051,316.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\n(c) INVESTMENT SECURITIES, CONTINUED\nMortgage-backed securities, which include privately issued collateralized mortgage obligations, represent participating interests in pools of long-term first mortgage loans originated and serviced by the issuers of the securities. Privately issued collateralized mortgage loans originated are debt securities that are secured by mortgage loans or other mortgage-backed securities.\nIn the case that investment securities are sold, gains and losses are computed under the specific identification method.\n(d) LOANS\nLoans held for sale (primarily real estate mortgage loans - see note 4) are carried at the lower of cost or market determined on an aggregate basis. Cost of loans sold is determined on a specific identification basis and gains or losses on sales of loans held for sale are recognized at settlement dates. Net fees and costs associated with originating and acquiring loans held for sale are deferred and are included in the basis for determining the gain or loss on sales of loans held for sale.\nUnearned discount is recognized as income over the terms of the loans in decreasing amounts related to declining balances of the loans which approximates the interest method.\nLoan origination and commitment fees, as well as certain direct loan origination and commitment costs, are deferred and amortized as a yield adjustment over the lives of the related loans using the interest method.\nNonaccrual loans are loans on which the accrual of interest ceases when the collection of principal or interest payments is determined to be doubtful by management. It is the general policy of the Company to discontinue the accrual of interest when principal or interest payments are delinquent 90 days or more. Any unpaid amounts previously accrued on these loans are reversed from income, and thereafter interest is recognized only to the extent payments are received.\nReduced rate loans are loans that have been restructured to provide for a reduction of the originally contracted rate of interest as a result of the weakening in the financial position of the borrower. Interest income on these loans is accrued at the reduced rate.\nThe allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged off against the allowance when management believes that the collectibility of the principal is unlikely. Recoveries of amounts previously charged off are credited to the allowance. The charge to operations is based on management's evaluation of the loan portfolio, including such factors as the volume and character of loans outstanding, past loss experience, and general economic conditions.\n(e) PREMISES AND EQUIPMENT\nPremises and equipment are carried at cost less accumulated depreciation. Depreciation is calculated principally on the straight- line method over the estimated useful lives the of assets.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\n(f) OTHER REAL ESTATE OWNED\nOther real estate owned consists primarily of properties the Company has foreclosed upon and taken title. At the time of foreclosure, other real estate owned is recorded at the lower of the Company's cost of acquisition or the asset's fair value, less estimated costs to sell, which becomes the property's new basis. Any write-downs based on the asset's fair value at date of acquisition are charged to the allowance for loan losses. Estimates for cost to sell, expenses incurred in maintaining other real estate owned and subsequent write-downs to reflect declines in fair value of the property are included in other real estate owned expense.\n(g) EXCESS OF COST OVER NET ASSETS ACQUIRED\nThe excess of the acquisition cost over net assets acquired is being amortized over periods ranging from ten to fifteen years using the straight-line method.\n(h) INCOME TAXES\nThe Company files a consolidated tax return under the consolidation provisions of the Internal Revenue Code. Generally, the consolidated tax liability is settled between the Company and its subsidiaries as if each had filed a separate return. Payments are made to the Company by its subsidiaries with net tax liabilities on a separate return basis. Subsidiaries with losses or excess tax credits on a separate return basis receive payment for these benefits when they are usable in the consolidated return.\nEffective January 1, 1993, the Company adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"Statement No. 109\"), on a prospective basis. Through December 31, 1992, the Company accounted for income taxes under Accounting Principles Board Opinion 11 (\"APB 11\"). Statement No. 109 requires a change from the deferred method of accounting for income taxes under APB 11 to the asset and liability method. Under the deferred method, annual income tax expense is matched with pretax accounting income by providing deferred taxes at current tax rates for timing differences between the determination of net income for financial reporting and tax purposes. The objective of the asset and liability method is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. Deferred tax assets are to be recognized for temporary differences that will result in deductible amounts in future years and for tax loss carryforwards, if, in the opinion of management, it is more likely than not that the deferred tax assets will be realized or settled.\n(i) RETIREMENT PLANS\nThe Company has a pension plan covering substantially all employees. It is the policy of the Company to fund the maximum amount that can be deducted for Federal income tax purposes but in amounts not less than the minimum amounts required by law.\nThe Company also has a savings plan under Section 401(k) of the Internal Revenue Code, also covering substantially all employees. Under this plan, employee contributions are partially matched by the Company. The Company's contributions are paid to the plan administrator each month.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\n(i) RETIREMENT PLANS, CONTINUED\nEffective January 1, 1994, the Company established a pension plan covering only designated employees. This plan is being administered as an unfunded plan that is not intended to meet the qualification requirements of section 401(a) of the Internal Revenue Code.\n(j) FAIR VALUES OF FINANCIAL INSTRUMENTS\nFinancial Accounting Standards Board Statement No. 107, \"Disclosures about Fair Value of Financial Instruments\" (\"Statement No. 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. Statement No. 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 Company.\nThe following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:\n. Cash and cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair values.\n. Investment securities (including mortgage-backed securities): Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.\n. Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans (e.g., commercial real estate and rental property mortgage loans, commercial and industrial loans, financial institution loans, and agricultural loans) are estimated using discounted cash flow analysis, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The carrying amount of accrued interest receivable approximates its fair value.\n. Deposits: The fair values disclosed for demand deposits (e.g., interest and noninterest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts for variable-rate, fixed- term money market accounts and certificates of deposits approximate their fair values at the reporting date. 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 contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates its fair value.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, CONTINUED\n(j) FAIR VALUES OF FINANCIAL INSTRUMENTS, CONTINUED\n. Short-term borrowings: The carrying amounts of short-term borrowings approximate their fair values.\n. Note payable: The carrying amount of the note payable approximates its fair value.\n(k) EARNINGS PER SHARE\nEarnings per share is computed on the basis of the weighted average number of shares outstanding each year. The effect of stock options for the years presented is not material.\n(l) STATEMENTS OF CASH FLOWS\nThe Company considers all cash and due from banks, interest-bearing demand deposits in other banks, and Federal funds sold to be cash equivalents for purposes of the statements of cash flows.\n(2) CASH AND DUE FROM BANKS\nCash and due from banks includes reserve balances that the Company is required to maintain with a Federal Reserve bank. These required reserves are based principally on deposits outstanding and were approximately $7,169,000 at December 31, 1994 and $7,487,000 at December 31, 1993.\n(3) INVESTMENT SECURITIES\nThe amortized cost and fair values of investment securities as of December 31, 1994 are as follows:\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(3) INVESTMENT SECURITIES, CONTINUED\nDuring 1994, investment securities with amortized cost of $100,979,079 were transferred from available-for-sale to held-to-maturity. The securities were transferred at their fair value at the date of the transfer, $99,508,729. The unrealized loss associated with those securities remains in stockholders' equity and is being amortized over the estimated lives of those securities. The portion amortized during 1994 was $139,796.\nThe amortized cost and fair values of investment securities as of December 31, 1993 are as follows:\nThe amortized cost and fair values of investment securities at December 31, 1994, by contractual maturity, are shown below. FHLB stock is excluded from the contractual maturities as it has no specific maturity. In addition, mortgage-backed securities are excluded from the contractual maturities because they generally have contractual maturities greater than ten years, but have significantly shorter expected maturities as a result of prepayments. Management anticipates the actual maturities of mortgage- backed securities to be one to five years.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(3) INVESTMENT SECURITIES, CONTINUED\nThe Company has entered into an agreement to loan certain available-for-sale securities to approved brokerage firms and other borrowers for which the Company receives a fee. The total par value of investment securities loaned under this agreement was $57,325,000 at December 31, 1994. Securities valued at 102% of the securities loaned collateralize this loan agreement.\nInvestment securities with amortized cost of approximately $36,649,000 and $29,715,000 at December 31, 1994 and 1993, respectively, were pledged to secure deposits as required or permitted by law. In addition, at December 31, 1994 and 1993, investment securities with amortized cost of approximately $23,997,000 and $24,266,000, respectively, were pledged to secure available federal funds lines (see note 13). Also, at December 31, 1994, investment securities with amortized cost of approximately $78,270,000 collateralized the Company's repurchase agreements (see note 8).\n(4) LOANS AND ALLOWANCE FOR LOAN LOSSES\nMajor classifications of loans as of December 31, 1994 and 1993 are summarized as follows:\nThe carrying value of loans, net of the allowance for loan losses, totaled $268,953,348 and $231,537,892 as of December 31, 1994 and 1993, respectively. The fair value of the loans amounted to approximately $268,414,000 and $235,402,000 as of December 31, 1994 and 1993, respectively.\nAt December 31, 1994, the Company had approximately $6,016,000 of real estate mortgage loans classified as held for sale. Cost approximates fair value for these loans as of December 31, 1994. Prior to 1994, the Company had no loans classified as held for sale.\nNonaccrual and reduced rate loans amounted to approximately $3,559,000 and $2,125,000 at December 31, 1994 and 1993, respectively. If interest on these loans had been accrued normally, additional income earned would approximate $147,000 and $150,000 for the years ended December 31, 1994 and 1993, respectively.\nCertain officers and directors of the Company and certain entities and individuals related to such persons incurred indebtedness, in the form of loans, as customers. These loans were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other customers and did not involve more than the normal risk of collectibility.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(4) LOANS AND ALLOWANCE FOR LOAN LOSSES, CONTINUED\nFollowing is a summary of activity during 1994 for such loans:\n(5) PREMISES AND EQUIPMENT\nPremises and equipment at December 31, 1994 and 1993 consist of:\n(6) OTHER REAL ESTATE OWNED\nA summary of other real estate owned at December 31, 1994 and 1993 is as follows:\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(6) OTHER REAL ESTATE OWNED, CONTINUED\nA summary of changes in the allowance for losses on other real estate owned for the years ended December 31, 1994, 1993 and 1992 is as follows:\n(7) DEPOSITS\nThe carrying amounts and fair values of deposits as of December 31, 1994 and 1993 consisted of the following:\nInterest expense on certificates of deposit for $100,000 and over amounted to approximately $1,685,000, $1,612,000 and $2,421,000 in 1994, 1993 and 1992 respectively.\n(8) SHORT-TERM BORROWINGS\nShort-term borrowings as of December 31, 1994 and 1993 are summarized as follows:\nThe maximum amount of repurchase agreements outstanding at any month-end during 1994 was $89,821,319. The average amount of repurchase agreements outstanding during 1994 was $30,284,000. The securities collateralizing these agreements have been delivered to other financial institutions for safekeeping (see note 3).\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(8) SHORT-TERM BORROWINGS, CONTINUED\nThe FHLB advance is unsecured and matures January 25, 1995.\n(9) NOTE PAYABLE\nAt December 31, 1994, the Company had borrowed $500,000 under the terms of a $12,500,000 revolving line of credit. This line is secured by 100% of the stock of Central Bank & Trust and has a variable interest rate equal to the lending bank's prime rate (8.5% at December 31, 1994) and matures April 1996. Any outstanding balance on the maturity date will convert to term debt with principal and interest payments due quarterly based on a five year amortization.\n(10) STOCK OPTIONS\nThe Company offers a stock option plan under a plan approved by the Board of Directors, for officers and key employees of the Company. This plan permits the granting of up to an aggregate of 250,000 shares at prices not to be less than fair market value on the date of the grant. All options are exercisable over a period of five to ten years. A summary of the stock options transactions follows:\n(11) INCOME TAXES\nThe consolidated Federal income tax expense for the years presented differs from the \"expected\" consolidated Federal income tax expense for those years, computed by applying the statutory U.S. Federal Corporate tax rate of 34% to income before income taxes, extraordinary item and cumulative effect of change in accounting for income taxes, as follows:\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(11) INCOME TAXES, CONTINUED\nThe tax effects of temporary differences that give rise to significant portions of the net deferred tax asset, including the deferred tax liability, at December 31, 1994 and 1993 are presented below:\nAs discussed in note 1(h), the Company adopted Statement No. 109 as of January 1, 1993. The cumulative effect of this change in accounting for income taxes of $1,370,000 is determined as of January 1, 1993 and is reported separately in the consolidated statement of operations for the year ended December 31, 1993. Based on the Company's historical ability to generate taxable income exclusive of reversing timing differences, management of the Company believes it is more likely than not that the entire deferred tax asset will be realized or settled, and accordingly, no valuation allowance has been recorded as of December 31, 1994 and 1993.\nConsolidated deferred Federal income tax benefits for the year ended December 31, 1992 result from the following timing differences in financial and tax reporting:\nThe Company utilized net operating loss carryforwards for financial reporting purposes in 1992 to offset Federal income tax expense of $356,094. This amount is reported as an extraordinary item in the accompanying consolidated statements of operations.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(12) EMPLOYEE BENEFITS\nThe Company participates in a noncontributory defined benefit plan (\"qualified plan\") covering substantially all employees, after one year of continuous employment. The benefits are primarily based on years of service and earnings, except where limited by section 401(a)(17) of the Internal Revenue Code.\nEffective January 1, 1994, the Company established a pension plan (\"nonqualified plan\") covering only designated employees. This plan is being administered as an unfunded plan that is not intended to meet the qualification requirements of Section 401(a) of the Internal Revenue Code. The benefits of this plan are also primarily based on years of service and earnings.\nThe following is a summary of the plans' funded status as of December 31, 1994 and 1993:\nThe weighted-average discount rate and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 8.50% and 5.00%, respectively, in 1994, and 7.25% and 4.50%, respectively, in 1993. The weighted-average expected long-term rate of return on plan assets was 8.5% in 1994 and 1993. The vested benefit obligation was $23,700 at December 31, 1994 for the nonqualified plan and $5,053,246 and $5,541,222 at December 31, 1994 and 1993, respectively, for the qualified plan.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(12) EMPLOYEE BENEFITS, CONTINUED\nThe net pension income (expense) includes the following components:\nDuring 1993, the Company offered a voluntary early retirement opportunity, enabling certain employees to elect early retirement. The early retirement opportunity, which was accounted for under Statement of Financial Accounting Standards No. 88, \"Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and for Termination Benefits\", resulted in a charge to other operating expense in 1993 of $118,466.\nIn 1993, the Company implemented a savings plan under Section 401(k) of the Internal Revenue Code which covers substantially all employees after one year of continuous employment. Under this plan, the employees may contribute up to 15% of their pre-tax earnings into various savings alternatives. The Company matches one-half of each employee's contribution up to 6% of the employee's earnings. The Company's contribution expense under this plan totaled approximately $194,000 and $115,000 in 1994 and 1993, respectively.\nThe Company does not provide post-retirement or post-employment health and life insurance benefits to its employees.\n(13) COMMITMENTS AND CONTINGENCIES\nIn the normal course of business, various commitments and contingent liabilities are outstanding, such as standby letters of credit and commitments to extend credit, which are not reflected in the consolidated financial statements. Management does not anticipate any significant losses as a result of these transactions. Commitments to extend credit totaled approximately $58,670,000 and standby letters of credit totaled approximately $2,143,000 at December 31, 1994 (see note 14).\nThe Company and its subsidiaries are defendants in various legal proceedings arising in connection with their business. It is the best judgment of management that neither the consolidated financial position nor results of operations of the Company will be materially affected by the final outcome of these legal proceedings.\nAt December 31, 1994, Central Bank & Trust had three unused Federal Funds lines of credit with other banks. One line, in the amount of $20,000,000, has a variable interest rate based on the lending bank's daily Federal funds rate, and is due on demand, or if no demand is made, the line matures on March 1, 1995. This line is collateralized by investment securities with amortized cost of approximately $23,997,000 as of December 31, 1994.\nThe second line, also in the amount of $20,000,000, has a variable interest rate based on the lending bank's daily Federal funds rate, and matures April 30, 1995. Central Bank & Trust would be required to pledge U.S. Treasury or U.S. Government agency securities equal to 110% of any advances drawn on the line.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(13) COMMITMENTS AND CONTINGENCIES, CONTINUED\nThe third line is in the amount of $15,000,000 and has a variable interest rate based on the lending bank's daily federal funds rate. This line would require collateral of U.S. Treasury or U.S. Government agency securities equal to 120% of any advances drawn on the line if the line has an amount outstanding for five consecutive days. This line matures July 31, 1995.\nAdditionally, the Company has two $1,000,000 lines of credit for the issuance of standby letters of credit. Both of these lines mature in 1995.\n(14) FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK\nThe Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.\nThe Company's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments (see note 13). The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.\nCommitments to extend credit are agreements to lend to a customer 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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount and type of collateral obtained, if deemed necessary by the Company upon extension of credit, varies and is based on management's credit evaluation of the counterparty.\nStandby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company's policy for obtaining collateral and the nature of such collateral is essentially the same as that involved in making commitments to extend credit.\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(15) PARENT COMPANY INFORMATION\nThe following is condensed financial information for the parent company, Texas Security Bancshares, Inc.:\nTEXAS SECURITY BANCSHARES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements\n(15) PARENT COMPANY INFORMATION, CONTINUED\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere have been no disagreements with accountants on any matter of accounting principles or practices or financial statement disclosures during the twenty-four (24) month period ended December 31, 1994.\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 caption \"PROPOSAL NO. 1: ELECTION OF DIRECTORS\" on pages 4 through 7 of the Corporation's Proxy Statement dated March 6, 1995, relating to the 1995 Annual Meeting of Shareholders of the Corporation, the information set forth under the caption \"STOCK OWNERSHIP--Compliance with Section 16(a) of the Securities Exchange Act of 1934\" on pages 12 through 13 of such Proxy Statement, and the information set forth under the caption \"EXECUTIVE OFFICERS OF THE CORPORATION\" on pages 11 and 12 of Part I of this report is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information set forth under the caption \"EXECUTIVE COMPENSATION AND OTHER INFORMATION\" on pages 13 through 27 of the Corporation's Proxy Statement dated March 6, 1995, relating to the 1995 Annual Meeting of Shareholders of the Corporation, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information with respect to shareholders of the Corporation who are known to be beneficial owners of more than five percent (5%) of the outstanding shares of Common Stock of the Corporation set forth under the caption \"STOCK OWNERSHIP--By Others\" on pages 11 through 12 of the Corporation's Proxy Statement dated March 6, 1995, relating to the 1995 Annual Meeting of Shareholders of the Corporation, is incorporated herein by reference. The information relating to the beneficial ownership of the outstanding shares of Common Stock of the Corporation by its directors and executive officers set forth under the caption \"STOCK OWNERSHIP--By Management\" on pages 8 through 10 of the Corporation's Proxy Statement dated March 6, 1995, relating to the 1995 Annual Meeting of Shareholders of the Corporation, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information set forth under the caption \"CERTAIN TRANSACTIONS\" on page 27 of the Corporation's Proxy Statement dated March 6, 1995, relating to the 1995 Annual Meeting of Shareholders of the Corporation, 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. The following financial statements are included in \"Part II, Item 8. Financial Statements and Supplementary Data\":\nIndependent Auditors' Report\nConsolidated Balance Sheets as of December 31, 1994 and 1993\nConsolidated Statements of Operations for the years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n(2) FINANCIAL STATEMENT SCHEDULES. All schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.\n(3) EXHIBITS. The following exhibits are filed as a part of this report:\n3(a) Articles of Incorporation of the Corporation, and all amendments thereto (incorporated herein by reference to Exhibit 3.1 to the Corporation's Registration Statement on Form 10 filed April 30, 1987)\n3(b) Articles of Amendment to the Articles of Incorporation of the Corporation filed with the Secretary of State of Texas on May 11, 1988 (incorporated herein by reference to Exhibit 3(b) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1988 filed April 5, 1989)\n3(c) Restated Bylaws of the Corporation (incorporated herein by reference to Exhibit 3.2 to the Corporation's Registration Statement on Form 10 filed April 30, 1987); as amended January 19, 1993 (incorporated herein by reference to Exhibit 3(c) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1992 filed April 15, 1993)\n10(a) Texas Security Bancshares, Inc.'s 1988 Incentive Stock Option Plan (incorporated herein by reference to Exhibit 10(c) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1988 filed April 5, 1989)\n10(b) Texas Security Bancshares, Inc.'s Executives' Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.4 to the Corporation's Registration Statement on Form 10 filed April 30, 1987)\n10(c) Purchase and Assumption Agreement by and between the Federal Deposit Insurance Corporation, in its capacity as Receiver for Landmark Bank of Fort Worth, Fort Worth, Texas and in its corporate capacity and Central Bank & Trust dated February 6, 1992 (incorporated herein by reference to Exhibit 2.01 to the Corporation's Current Report on Form 8-K dated February 6, 1992 and filed February 21, 1992)\n10(d) Indemnity Agreement by and between the Federal Deposit Insurance Corporation and Central Bank & Trust dated February 6, 1992 (incorporated herein by reference to Exhibit 2.02 to the Corporation's Current Report on Form 8-K dated February 6, 1992 and filed February 21, 1992)\n10(e) Comprehensive Banking System License and Service Agreement between the Corporation and Citicorp. Information Resources, Inc., dated March 27, 1991 (incorporated herein by reference to Exhibit 10(m) to the Corporation's Annual Report on Form 10-K for the year ended December 31, 1991 filed March 30, 1992)\n10(f) Purchase and Assumption Agreement by and between the Federal Deposit Insurance Corporation, in its capacity as Receiver for American Bank of Haltom City, Haltom City, Texas and in its corporate capacity and Central Bank & Trust dated February 5, 1993 (incorporated herein by reference to Exhibit 2.01 to the Corporation's Current Report on Form 8-K dated February 5, 1993 and filed February 16, 1993)\n10(g) Indemnity Agreement by and between the Federal Deposit Insurance Corporation and Central Bank & Trust dated February 5, 1993 (incorporated herein by reference to Exhibit 2.02 to the Corporation's Current Report on Form 8-K dated February 5, 1993 and filed February 16, 1993)\n10(h) Retirement Trust for Employees of Texas Security Bancshares, Inc. and Affiliates as Amended and Restated effective January 1, 1993 (incorporated herein by reference to Exhibit 10(i) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and filed March 30, 1994)\n10(i) Retirement Plan for Employees of Texas Security Bancshares, Inc. and Affiliates as Amended and Restated effective January 1, 1989 (incorporated herein by\nreference to Exhibit 10(j) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and filed March 30, 1994)\n10(j) First Supplement to Retirement Plan for Employees of Texas Security Bancshares, Inc. and Affiliates as Amended and Restated effective January 1, 1989 (incorporated herein by reference to Exhibit 10(k) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and filed March 30, 1994)\n10(k) Second Supplement to Retirement Plan for Employees of Texas Security Bancshares, Inc. and Affiliates as Amended and Restated effective January 1, 1989 (incorporated herein by reference to Exhibit 10(l) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and filed March 30, 1994)\n10(l) Third Supplement to Retirement Plan for Employees of Texas Security Bancshares, Inc. and Affiliates as Amended and Restated effective January 1, 1989 (incorporated herein by reference to Exhibit 10(m) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and filed March 30, 1994)\n10(m) Amendment One to Retirement Plan for Employees of Texas Security Bancshares, Inc. and Affiliates as Amended and Restated effective January 1, 1989*\n10(n) Amendment Two to Retirement Plan for Employees of Texas Security Bancshares, Inc. and Affiliates as Amended and Restated effective January 1, 1989*\n10(o) Executive Deferred Compensation Plan of Texas Security Bancshares, Inc. (incorporated herein by reference to Exhibit 10(n) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and filed March 30, 1994)\n10(p) Executive Deferred Compensation Plan of Central Bank & Trust (incorporated herein by reference to Exhibit 10(o) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and filed March 30, 1994)\n10(q) Letter agreement between Texas Security Bancshares, Inc. and Brian W. Garrison regarding additional payment in conjunction with the Executive Deferred Compensation Plan of Central Bank & Trust, dated July 26, 1993 (incorporated herein by reference to Exhibit 10(p) to the Corporation's Annual Report on Form 10-K for the fiscal year ended December 31, 1993 and filed March 30, 1994)\n10(r) Restoration Retirement Plan for Certain Employees of Texas Security Bancshares, Inc. and Affiliates, effective as of January 1, 1994*\n10(s) Trust Agreement for Restoration Retirement Plan for Certain Employees of Texas Security Bancshares, Inc. and Affiliates, effective as of January 1, 1994*\n10(t) Loan Agreement by and between Texas Security Bancshares, Inc., as borrower, and The Frost National Bank, as lender, dated October 12, 1994; Revolving Credit Note in the original principal amount of $12,500,000; and related Security Agreement-Pledge*\n11 Computation of Earnings Per Common Share*\n21 Subsidiaries of the Corporation*\n24 Special Power of Attorney*\n27 Financial Data Schedule*\n- ----------------------------------------\n* Filed herewith.\n(b) REPORTS ON FORM 8-K. -------------------\nNo reports on Form 8-K were filed by the Corporation during the last quarter of 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.\nTEXAS SECURITY BANCSHARES, INC.\nDATE: March 23, 1995 \/s\/ J. Andy Thompson --------------------------------------- J. Andy Thompson, Chairman of the Board and Chief Executive Officer\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 in the capacities indicated on this 23rd day of March, 1995.\nSIGNATURE TITLE --------- -----\n\/s\/ J. Andy Thompson Chairman of the Board and Chief Executive -------------------- Officer and Director (Principal Executive J. Andy Thompson Officer)\n\/s\/ Michael J. Tyler Senior Vice President, Chief Financial -------------------- Officer and Treasurer (Chief Accounting Michael J. Tyler Officer & Chief Financial Officer)\nRichard L. Brown* Director -------------------- Richard L. Brown\nErvin D. Cruce* Director -------------------- Ervin D. Cruce\nNancy W. Smith* Director -------------------- Nancy W. Smith\nC. Rhea Thompson* Director -------------------------------------- C. Rhea Thompson\nF. D. Thompson, Jr.* Director -------------------------------------- F. D. Thompson, Jr.\nKelly R. Thompson* Director -------------------------------------- Kelly R. Thompson\n\/s\/ J. Andy Thompson -------------------------------------- *J. Andy Thompson, as Attorney-in- Fact for each of the persons indicated\nEXHIBIT INDEX","section_15":""}
{"filename":"784161_1994.txt","cik":"784161","year":"1994","section_1":"ITEM 1. BUSINESS.\nThe Registrant, Dean Witter Realty Income Partnership III, L.P. (the \"Partnership\"), is a limited partnership formed in August 1985 under the Uniform Limited Partnership Act of the State of Delaware for the purpose of investing primarily in income-producing office, industrial and retail properties.\nThe Managing General Partner of the Partnership is Dean Witter Realty Income Properties III Inc. (the \"Managing General Partner\"), a Delaware corporation which is wholly owned by Dean Witter Realty Inc. The Associate General Partner is Dean Witter Realty Income Associates III, L.P. (the \"Associate General Partner\"), a Delaware limited partnership, the general partner of which is Dean Witter Realty Income Properties III Inc., a wholly-owned subsidiary of the Managing General Partner. The Managing General Partner manages and controls all aspects of the business of the Partnership. The terms of transactions between the Partnership and its affiliates are set forth in Item 13 below.\nThe Partnership issued 534,020 units of limited partnership interest (the \"Units\") with gross proceeds from the offering of $267,010,000. The offering has been terminated and no additional Units will be sold.\nThe proceeds from the offering were used to make equity investments in six office properties and five retail properties which have been acquired without mortgage debt. The properties are described below in Item 2, the Operations section of Item 7 and footnotes 4 and 5 to the consolidated financial statements included in Item 8.\nThe Partnership considers its business to include one industry segment, investment in real property.\nThe Partnership's real property investments are subject to competition from similar types of properties in the vicinities in which they are located. In recent years, an oversupply condition has persisted nationally and many markets have experienced high vacancy rates. Currently, many real estate markets are beginning to stabilize, primarily due to the continued absence of significant construction activity; however, the recovery is expected to be slow. Further information regarding competition in the markets where the Partnership's properties are located is set forth in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe Partnership has no employees.\nAll of the Partnership's business is conducted in the United States.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Partnership owns directly or through a partnership interest the following eleven property interests, none of which is encumbered by indebtedness. Generally, the leases pertaining to the properties provide for pass-throughs to the tenants of their pro-rata share of certain operating expenses.\n1. The remaining general partnership (\"GP\") interest is held by the Managing General Partner.\n2. The remaining GP interests are held by Dean Witter Realty Income Partnership II, L.P. (14.8%) and Dean Witter Realty Income Partnership IV, L.P. (40.6%). The total cost of the property was $51.8 million\n3. The remaining GP interest is held by Dean Witter Realty Income Partnership IV, L.P. The total cost of the property was $57.6 million.\n4. The remaining GP interests are held by Dean Witter Realty Income Partnership IV, L.P. (41.2%) and an affiliate of the Managing General Partner (32.1%). The total cost of the property was $1\nEach property has been built with on-site parking facilities.\nAn affiliate of the Partnership is the property manager for Laurel Lakes Centre, Taxter Corporate Park, Hall Road Crossing, Delta Center, Fashion Corners and Westland Crossing and the co-property manager for the Glenhardie buildings and five buildings at the Chesterbrook Corporate Center.\nFurther information relating to the Partnership's properties is included in Item 7 below and footnotes 4 and 5 to the consolidated financial statements included in Item 8 below.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNeither the Partnership nor any of its properties is subject to any material pending legal proceedings.\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 Unit holders.\nPART II.\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAn established public trading market for the Units does not exist, and it is not anticipated that such a market will develop in the future. Accordingly, information as to the market value of a Unit at any given date is not available. However, the Partnership does allow its limited partners (the \"Limited Partners\") to transfer their Units if a suitable buyer can be located.\nAs of October 31, 1994, there were 38,732 holders of limited partnership interests.\nThe Partnership is a limited partnership and, accordingly, does not pay dividends. It does, however, make quarterly distributions of cash to its partners. Pursuant to the partnership agreement, distributable cash, as defined, is paid 90% to the Limited Partners and 10% to the general partners (the \"General Partners\").\nDuring the year ended October 31, 1994, the Partnership paid cash distributions aggregating $11,867,112, with $10,680,400 distributed to the Limited Partners and $1,186,712 to the General Partners. The distributions aggregated $20.00 per Unit to the Limited Partners.\nOn November 29, 1994, the Partnership paid the fourth quarter distribution of $5.00 per Unit to the Limited Partners. The total cash distribution amounted to $2,966,778, with $2,670,100 distributed to the Limited Partners and $296,678 to the General Partners.\nThe Partnership anticipates making regular distributions to its partners in the future.\nSale or financing proceeds will be distributed, to the extent available, first, to each Limited Partner, until there has been a return of the Limited Partner's capital contribution plus cumulative distributions of distributable cash and sale or refinancing proceeds in an amount sufficient to provide a 9% cumulative annual return on the Limited Partner's adjusted capital contribution. Thereafter, any remaining sale or financing proceeds will be distributed 85% to the Limited Partners and 15% to the General Partners after the Managing General Partner receives a brokerage fee of up to 3% of the selling price of any equity investment.\nTaxable income generally will be allocated in the same proportions as distributions of distributable cash or sale or financing proceeds. In the event there is no distributable cash or sale or financing proceeds, taxable income will be allocated 90% to the Limited Partners and 10% to the General Partners. Any tax loss will be allocated 90% to the Limited Partners and 10% to the General Partners.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nLiquidity and Capital Resources\nThe Partnership raised $267,010,000 in a public offering of 534,020 units which was terminated in 1987. The Partnership has no plans to raise additional capital.\nThe Partnership has purchased eight properties and has made three investments in partnerships on an all-cash basis. The Partnership's acquisition program has been completed. No additional investments are planned.\nMany real estate markets are stabilizing, primarily due to the continued absence of significant construction activity. However, the recovery of the office market will be slow, because tenant demand is weak, as a result of continued downsizing by many major corporations. Increased consumer spending has helped the retail property market although increased interest rates have slowed spending.\nReal estate markets are generally divided into sub-markets by geographic location and property type. Not all sub-markets have been affected equally by the above factors.\nThe Partnership's liquidity depends in part upon cash flow from operations of its properties, expenditures for tenant improvements and leasing commissions in connection with the leasing of vacant space. In 1994, all of the Partnership's properties and joint venture interests generated positive cash flow from operations, and it is anticipated that they will continue to do so.\nIn 1994, Partnership cash flow from operations and distributions received from its joint venture investment exceeded distributions to investors and capital expenditures. The Partnership expects that such cash flows will be sufficient to fund capital expenditures and distributions to investors in 1995. The Partnership expects to increase the cash distribution rate from 4.0% to 4.75% per Unit beginning with the cash distribution for the first fiscal quarter of 1995.\nAlso, in 1994, the Partnership incurred approximately $2,605,000 of tenant improvements and leasing commissions, primarily relating to the Glenhardie and Holcomb Woods properties. The Partnership also invested approximately $1,234,000, representing its share of building improvements, tenant improvements and leasing commissions at the Taxter and Chesterbrook joint ventures.\nThe Vanguard Group, the largest tenant in the Chesterbrook joint venture, vacated its space in two of the buildings in November 1993 and October 1994 and will vacate its remaining space upon the expiration of its leases in November 1995. In September 1994, the Partnership signed leases with two new tenants to fill a significant portion of the space vacated by Vanguard to date. The Partnership's share of capital expenditures which will result from these new leases in 1995 is approximately $777,000. The Partnership expects to incur significant additional capital expenditures in order to attract new tenants to the Holcomb Woods and Glenhardie properties, where there is also significant vacant space.\nIn fiscal 1993, the Partnership concluded that there was a decline in the value of the Taxter Corporate Park property, and that the decline was other-than-temporary. Accordingly, the general partners of the partnership which owns the property recorded a loss on impairment of its investment in the property of approximately $27.8 million at October 31, 1993. The Partnership's share of this loss, which was included in equity in earnings (losses) of joint ventures was $12,411,356.\nOn November 29, 1994, the Partnership paid the fourth quarter distribution of $5.00 per Unit to the Limited Partners. The total cash distribution amounted to $2,966,778 with $2,670,100 distributed to the Limited Partners and $296,678 to the General Partners.\nOperations\nFluctuations in the Partnership's operating results for the year ended October 31, 1994 compared to 1993 and for the year ended October 31, 1993 compared to 1992 are primarily attributable to the following:\nThe increase in equity in earnings (losses) of joint ventures in 1994 compared to 1993 and the decrease in 1993 compared to 1992 are primarily attributable to the loss incurred in 1993 when the Partnership recorded its share ($12,411,356) of the loss on impairment of the Taxter property. Excluding the 1993 loss, the equity in earnings (losses) of joint ventures decreased by approximately $254,000 in 1994 compared to 1993. This decrease was primarily caused by lower rental income from the Chesterbrook and Taxter joint ventures. These decreases were partially offset by lower depreciation charges from the Taxter joint venture (due to the writedown of the property in 1993).\nThe decrease in property operating expenses for 1994 compared to 1993 is primarily due to lower real estate taxes incurred at most of the Partnership's properties in 1994 and lower building services costs at the Partnership's office buildings. The increase in property operating expenses in 1993 compared to 1992 was primarily due to write-offs of uncollectible tenant receivables at various properties of $190,000 and higher real estate taxes incurred at the Partnership's retail properties.\nA summary of the markets in which the Partnership's office properties are located and the performance of each property is as follows:\nThe office market in suburban Atlanta, the location of Business Park at Holcomb Woods, is improving; the current vacancy in this market is approximately 16%. During 1994, average occupancy at the property was 76%, and at October 31, 1994, the property was 88% leased to 29 tenants (including one tenant which moved into its space in November 1994). No single tenant occupies more than 15% of the property's space. Leases on approximately 21% and 34% of the property's space are scheduled to expire in 1995 and 1996, respectively.\nChesterbrook Corporate Center is located in Valley Forge, Pennsylvania, a market in which the vacancy rate is approximately 14%. During 1994, average occupancy at the property was 87%, and at October 31, 1994, the property was 90% leased to 20 tenants (including two tenants which moved into their space in December 1994). Vanguard has been vacating its space to move into its own newly-constructed space in this market. This, and other new construction in the Valley Forge area, will cause the office market to deteriorate further. The leases of Philadelphia Electric company, the other major tenant at the property (occupying 25% of the space), expire in 1998. No other significant leases are scheduled to expire in the near future.\nGlenhardie Corporate Center III and IV is also located in Valley Forge, Pennsylvania. During 1994, average occupancy at the property was 74% and at October 31, 1994, the property was 80% leased to 21 tenants. No single tenant occupies more than 15% of the property's space. No significant leases are scheduled to expire before 1999.\nThe office market in Westchester County, New York, the location of Taxter Corporate Park, has experienced a significant decline. The current vacancy level in the Westchester office market is approximately 25%. It is unlikely that this vacant space will be absorbed in the market for several years. However, during 1994, average occupancy at the property was 98%, and at October 31, 1994, the property was 99% leased to 26 tenants. One of the tenants purchased a long-term leasehold interest in approximately 20% of the space at the property. The leases of Fuji Photo Film, the other major tenant (covering 21% of the property's space) expire in 1996. No other significant leases are scheduled to expire in the near future.\nThe Reston market in Virginia, the location of Tech Park Reston, has a vacancy rate of 12% due to the contraction of the high-tech and defense firms which are the major tenants in the market. The leases with Sprint Communications, the sole tenant, expire in 2003. Sprint has the option to terminate its leases on two of the three buildings beginning in 1997 and 1998.\nA summary of the markets in which the Partnership's retail properties are located and the leasing status of each property is as follows:\nLaurel Lakes Centre is located in a suburb of Baltimore and Washington, D.C. Retail centers in this market have generally experienced lower net rental rates and, currently, a vacancy rate of approximately 16%. However, the property's design, location and tenant mix has enabled it to maintain an average occupancy rate of 94% in 1994 and retain relatively stable rental rates. At October 31, 1994, the property was 95% leased to 46 tenants (including one tenant which moved into its space in November 1994). The lease of K-Mart (covering approximately 18% of the space) expires in 2005; other leases totaling approximately 10% of the space are scheduled to expire in 1995.\nThe Partnership owns four shopping centers in Michigan. Sterling Heights, the location of Hall Road Crossing, is currently a strong and expanding market with a vacancy rate of less than 5%. During 1994, average occupancy at the property was 75%, and at October 31, 1994 the property was 95% leased to 16 tenants (including two tenants who moved into their spaces in November 1994). No significant leases are scheduled to expire before 1997. The lease of Gander Mountain (covering approximately 21% of the property's space) expires in 2009.\nSaginaw, Michigan, the location of Fashion Corners, has a vacancy rate of approximately 10%. During 1994, and at October 31, 1994, the property was 94% leased to 21 tenants. In the third quarter of 1994, Best Products, which occupies approximately 21% of the property's space and whose lease expires in 2005, emerged from bankruptcy, and is now current on all rental payments. The lease of Best Buy (covering approximately 19% of the space) expires in 2009, and the lease of another tenant (covering approximately 12% of the space) expires in 1996.\nA retail center is under construction near Fashion Corners. This center as well as a nearby center may compete with Fashion Corners for larger tenants.\nLansing, Michigan, the location of Delta Center, is a strong and stable market with a vacancy rate of approximately 7%. During 1994, average occupancy at the property was 97%, and at October 31, 1994, the property was 98% leased to 23 tenants. In May 1994, Pet Food Warehouse moved into approximately 15% of the property's space under a sub-lease from Perry Drugs who vacated its space in 1991 but continued to pay rent pursuant to its lease (which expires in 2005). The lease of Service Merchandise (covering approximately 18% of the space) expires in 2006, and the lease of another tenant (covering approximately 13% of the space) expires in 1995.\nWestland Crossing is situated outside downtown Detroit and is in an overbuilt market. Several large retailers left their locations during the first quarter of 1994, and the vacancy rate in this market is currently 16%. During 1994, average occupancy at the property was 89%, and at October 31, 1994, the property was 90% leased to 21 tenants (including one tenant who moved into its space in December 1994). Toys R Us owns a 47,800 square foot store at the property. The leases of Marshall's (covering approximately 18% of the space) and Frank's Supercrafts (covering approximately 16% of the space) expire in 1996 and 2006, respectively.\nA 110,000 square foot retail center is under construction near Westland Crossing. When complete, this center as well as a nearby center which recently lost a large anchor tenant to the new retail center may compete with Westland Crossing for tenants.\nInflation\nInflation has been consistently low during the periods presented in the financial statements and, as a result, has not had a significant effect on the operations of the Partnership or its properties.\n5. Investments in Joint Ventures\nTaxter Corporate Park, Westchester County, New York\nIn 1986, the Partnership purchased a 44.6% partnership interest in the general partnership which owns the property. Affiliates of the Partnership, Dean Witter Realty Income Partnership II, L.P., and Dean Witter Realty Income Partnership IV, L.P., purchased the remaining interests of 14.8% and 40.6%, respectively.\nThe partners each receive cash flow and profits and losses according to their pro rata shares.\nIn fiscal 1993, because of continuing weakness in the Westchester County, New York office market, and the likelihood that such weakness would persist for several years, the general partners of the partnership which owns the property concluded that there was a decline in its value and that the decline was other-than-temporary. Accordingly, the partnership which owns the property recorded a loss on impairment of the property of $27,828,152 at October 31, 1993. The Partnership's share of this loss ($12,411,356) was included in equity in earnings (losses) of joint ventures in 1993.\nSummarized balance sheet information of the joint venture is as follows:\nTech Park Reston, Reston, Virginia\nIn 1987, the Partnership purchased a 35% partnership interest in the general partnership which owns the property. The remaining 65% interest in the general partnership is owned by Income Partnership IV, L.P.\nThe partners receive cash flow and profits and losses according to their pro rata shares.\nSummarized balance sheet information of the joint venture is as follows:\nChesterbrook Corporate Center, Valley Forge, Pennsylvania\nIn 1987, the Partnership, Income Partnership IV, and affiliates of the Managing General Partner acquired 26.7%, 41.2% and 32.1% interests in the general partnership which owns the property.\nThe partners receive cash flow and profits and losses according to their pro rata shares.\n6. Leases\nMinimum future rental income under noncancellable operating leases as of October 31, 1994 is as follows:\nYear ending October 31: 1995 $12,767,145 1996 10,814,987 1997 9,189,072 1998 8,091,929 1999 7,118,424 Thereafter 37,654,035 Total $ 85,635,592\nThe Partnership has determined that all leases relating to its properties are operating leases. The terms range from one to twenty-five years, and generally provide for fixed minimum rents with rental escalation and\/or expense reimbursement clauses.\n7. Related Party Transactions\nAn affiliate of the Managing General Partner provided property management services for eight properties in 1994 and 1993 and six properties in 1992, as well as for five buildings at the Chesterbrook Corporate Center. The Partnership incurred management fees of $459,128, $449,164 and $429,159 for the years ended October 31, 1994, 1993 and 1992, respectively.\nAnother affiliate of the Managing General Partner performs administrative functions, processes investor transactions and prepares tax information for the Partnership. The Partnership incurred approximately $761,000 for these services in each of the years ended October 31, 1994, 1993 and 1992.\nAs of October 31, 1994, the affiliates were owed a total of approximately $138,000 for these services.\n8. Subsequent Event\nOn November 29, 1994, the Partnership paid a cash distribution of $5.00 per Unit to the Limited Partners. The total cash distribution amounted to $2,966,778, with $2,670,100 distributed to the Limited Partners and $296,678 to the General Partners.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III.\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe Partnership is a limited partnership which has no directors or officers.\nThe directors and executive officers of the Managing General Partner are as follows:\nPosition with the Name Managing General Partner\nWilliam B. Smith Chairman of the Board of Directors E. Davisson Hardman, Jr. President and Director Lawrence Volpe Controller, Assistant Secretary and Director Ronald T. Carman Secretary and Director\nAll of the directors have been elected to serve until the next annual meeting of the shareholder of the Managing General Partner or until their successors are elected and qualify. Each of the officers has been elected to serve until his successor is elected and qualifies.\nWilliam B. Smith, age 51, is a Managing Director of Dean Witter Realty Inc. and has been with Dean Witter Realty Inc. since April 1982.\nE. Davisson Hardman, Jr., age 45, is a Managing Director of Dean Witter Realty Inc. and has been with Dean Witter Realty Inc. since April 1982.\nLawrence Volpe, age 47, is a Director and the Controller of Dean Witter Realty Inc. He is a Senior Vice President and Controller of Dean Witter Reynolds Inc., which he joined in 1983.\nRonald T. Carman, age 43, is a Director and the Secretary of Dean Witter Realty Inc. He is a Senior Vice President and Associate General Counsel of Dean Witter Reynolds Inc., which he joined in 1984.\nThere is no family relationship among any of the foregoing persons.\nITEM 11. EXECUTIVE COMPENSATION\nThe General Partners are entitled to receive cash distributions, when and as cash distributions are made to the Limited Partners, and a share of taxable income or tax loss. Descriptions of such distributions and allocations are in Item 5 above. The General Partners received cash distributions of $1,186,712, $1,186,712 and $1,854,236 during the years ended October 31, 1994, 1993 and 1992, respectively.\nThe General Partners and their affiliates were paid certain fees and reimbursed for certain expenses. Information concerning such fees and reimbursements is contained in Note 7 to the Consolidated Financial Statements in Item 8","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.\n(a) No person is known to the Partnership to be the beneficial owner of more than five percent of the Units.\n(b) The directors of the Managing General Partner and the current and former officers and directors of the Managing General Partner as a group own the following Units as of January 27, 1995:\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nAs a result of their being partners of a limited partnership which is the Limited Partner of the Associate General Partner, certain current and former officers and directors of the Managing General Partner also own indirect partnership interests in the Partnership. The Partnership Agreement of the Partnership provides that cash distributions and allocations of income and loss to the General Partners be distributed or allocated 50% to the Managing General Partner and 50% to the Associate General Partner. The General Partners' share of cash distributions and income or loss is described in Item 5 above.\nAll of the outstanding shares of common stock of the Managing General Partner are owned by Dean Witter Realty Inc. (\"Realty\"), a Delaware corporation which is a wholly-owned subsidiary of Dean Witter, Discover & Co. The general partner of the Associate General Partner is the Managing General Partner. The limited partner of the Associate General Partner is LSA 86 L.P., a Delaware limited partnership. Realty and certain current and former officers and directors of the Managing General Partner are partners of LSA 86 L.P. Additional information with respect to the directors and executive officers and compensation of the Managing General Partner and affiliates is contained in Items 10 and 11 above.\nThe General Partners and their affiliates were paid certain fees and reimbursed for certain expenses. Information concerning such fees and reimbursements is contained in Note 7 to the Consolidated Financial Statements in Item 8 above.\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:\n1. Financial Statements (see Index to Financial Statements filed as part of Item 8 of this Annual Report).\n2. Financial Statement Schedules (see Index to Financial Statements filed as part of Item 8 of this Annual Report).\n3. Exhibits (3) Amended and Restated Agreement of Limited Partnership dated as of February 11, 1986 set forth in Exhibit A to the Prospectus included in the Registration Statement Number 33-1912 is incorporated herein by reference.\n(4) Not applicable.\n(9) Not applicable.\n(10) Purchase and Sale Agreements for properties purchased were filed as Exhibits to Form 8-K on June 27, 1986, December 29, 1986, December 30, 1986, June 1, 1987, December 7, 1987, and December 15, 1987 and are incorporated herein by reference.\n(11) Not applicable.\n(12) Not applicable.\n(13) Not applicable.\n(18) Not applicable.\n(19) Not applicable.\n(22) Subsidiaries: Part Six Associates, a Pennsylvania limited partnership. Laurel Vincent Place Associates, a Maryland limited partnership. (23) Not applicable.\n(24) Not applicable.\n(25) Not applicable.\n(28) Not applicable.\n(29) Not applicable.\n(b) No Forms 8-K were filed by the Partnership 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 Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.","section_15":""}
{"filename":"853890_1994.txt","cik":"853890","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nDescriptions of properties owned or utilized by the Partnership are contained in Item 1 of this report and such descriptions are hereby incorporated by reference into this Item 2. Under the captioned \"Leases\" in notes to the Partnership's financial statements included in Item 8 herein below, additional information is presented concerning obligations for lease and rental commitments. Said additional information is hereby incorporated by reference into this Item 2.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is a party to several lawsuits arising in the ordinary course of business. Subject to certain deductibles and self-insurance retentions, substantially all the claims made in these lawsuits are covered by insurance policies.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nIn July, 1994, the unitholders of the Partnership overwhelmingly approved a consent solicitation amending the Partnership Agreement to allow the Partnership to issue up to an additional 7.5 million Senior Preference Units. The Partnership has no current plans to issue these units, however, this gives the Partnership added flexibility for future acquisitions or refinancing.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S SENIOR PREFERENCE UNITS AND RELATED UNITHOLDER MATTERS\nThe Partnership's senior preference limited partner interests (\"Senior Preference Units\") are listed and traded on the New York Stock Exchange. At March 17, 1995, there were approximately 1,164 Senior Preference Unitholders of record. Set forth below are Senior Preference Unit prices on the New York Stock Exchange and cash distributions per Senior Preference Unit paid for the periods indicated.\nThe Partnership has paid the Minimum Quarterly Distribution on each outstanding Senior Preference Unit for each quarter since the Partnership's inception. The Partnership has also paid the Minimum Quarterly Distribution on Preference Units with respect to all quarters since inception of the Partnership, except for the failure to pay distributions in the second, third and fourth quarters of 1991 totalling $9,323,000. All such arrearages have since been satisfied and none remain as of December 31, 1994. No distributions were paid on the outstanding Common Units, which are not entitled to arrearages in the payment of the Minimum Quarterly Distribution thereon, until 1994 when distributions totalling $1,738,000 were paid.\nUnder the terms of its financing agreements, the Partnership is prohibited from declaring or paying any distribution if a default exists thereunder.\nITEM 6.","section_6":"ITEM 6. SUMMARY HISTORICAL FINANCIAL AND OPERATING DATA\nThe following table sets forth, for the periods and at the dates indicated, selected historical financial and operating data for Kaneb Pipe Line Partners, L.P. and Subsidiaries (\"Partnership\"). The data in the table (in thousands, except per unit amounts) is derived from the historical financial statements of the Partnership and should be read in conjunction with the Partnership's audited financial statements. See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\n(a) Includes the operations of ST since its acquisition on March 2, 1993.\n(b) Subsequent to the acquisition of ST in March 1993, certain operations are conducted in a taxable entity.\n(c) Net income of the Partnership for each reporting period is allocated to the Senior Preference Units (SPU) in an amount equal to the cash distributions to the SPU declared for that reporting period.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis discussion should be read in conjunction with the financial statements of Kaneb Pipe Line Partners, L.P. and notes thereto and the summary historical and pro forma financial and operating data included elsewhere in this report.\nGENERAL\nIn September, 1989 Kaneb Pipe Line Company (\"Company\"), a wholly owned subsidiary of Kaneb Services, Inc. (\"Kaneb\"), formed a master limited partnership, Kaneb Pipe Line Partners, L.P. (\"Partnership\"), to own and operate its refined petroleum products pipeline business. The Partnership operates through Kaneb Pipe Line Operating Partnership, L.P. (\"KPOP\"), a limited partnership in which the Partnership holds a 99% interest as limited partner. The Partnership's business consists primarily of the transportation, as a common carrier, of refined petroleum products, including propane, from refineries and pipeline connections in Kansas to destinations in Kansas, Nebraska, Iowa, South Dakota and North Dakota, and related terminaling activities. The Partnership owns a 2,075 mile integrated pipeline system with 16 terminals in Kansas, Nebraska, Iowa, South Dakota and North Dakota. The pipeline serves oil companies, railroads and farm cooperatives in such states and in portions of three adjoining states. Three refineries have direct access to the pipeline; these refineries obtain crude oil primarily from producing areas in Kansas, Oklahoma and Texas.\nEffective March 2, 1993, the Partnership acquired, through KPOP, Support Terminal Services, Inc. (\"ST\"), a petroleum products and specialty liquids storage and terminaling company headquartered in Dallas, Texas, for approximately $65 million (including $2 million in acquisition costs). In connection with the acquisition, the Partnership borrowed $65 million from a group of banks. In April 1993, the Partnership completed a public offering of 2.25 million Senior Preference Units at $25.25 per unit. The bank loan was partially repaid with $50.8 million of the proceeds from the offering. The Partnership continually evaluates other potential acquisitions.\nThe Pipeline's common carrier operations are subject to federal or state tariff regulation. The Partnership has not engaged, nor does it currently intend to engage, in the merchant function of buying and selling refined petroleum products.\nThe Partnership's business depends in large part on (i) the level of demand for refined petroleum products in the geographic locations served by the pipeline and (ii) the ability and willingness of refiners and marketers having access to the pipeline to supply such demand by deliveries through the pipeline.\nRESULTS OF PARTNERSHIP OPERATIONS\nNet income increased $2.8 million or 11% in 1994 to $29.5 million due primarily to the inclusion of ST results for the full year in 1994 versus the 10 months in 1993 from the acquisition in March 1993. The increase in interest expense is attributable to the acquisition debt incurred for ST.\nPIPELINE OPERATIONS\nRevenues increased 5% in both 1994 and 1993. KPOP implemented a tariff increase of approximately 5.5% in April, 1994 and approximately 5.6% in July, 1992. Barrel miles increased 2% in both 1994 and 1993. The increase in barrel miles is primarily due to increased long-haul shipments related to product pricing advantages for shippers to western area terminals served by the Pipeline.\nOperating costs increased 8% in 1994 and 13% in 1993. Property taxes increased $.3 and $.9 million in 1994 and 1993, respectively. The 1994 increase was primarily due to tax rate adjustments in Kansas and Nebraska and the 1993 increase was primarily due to non-recurring refunds received in 1992 and tax rate adjustments in Nebraska. Power costs increased by $.6 million in 1994 due to increased barrel miles, utility rates and increased usage of drag reducer. Material, supplies and outside services increased $.4 million in 1994 primarily due to unusually high repair and maintenance expenditures.\nTERMINALING OPERATIONS\nRevenues increased $2.7 million in 1994 as average tankage utilized increased .2 million barrels to 6.1 million barrels compared to 5.9 million barrels in 1993. Revenues per barrel stored increased by $.26 in 1994 to $5.33 per barrel.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Partnership borrowed approximately $10 million on its term facility in the fourth quarter of 1993 in anticipation of terminal acquisitions to be made in 1994. The ratio of current assets to current liabilities decreased to .8 to 1 at December 31, 1994 from 1.29 to 1 at December 31, 1993 primarily as a result of terminal acquisitions in 1994 funded from the Partnership's cash balances. Cash provided by operating activities was $37.9 million, $37.2 million, and $26.6 million for the years 1994, 1993 and 1992, respectively. The increase in cash flow from operating activities in 1993 was due to the acquisition of ST.\nCapital expenditures were $19.5 million, $8.1 million and $3.2 million for the years 1994, 1993 and 1992, respectively. Included in 1994 capital expenditures are three terminal acquisitions by ST that totalled $12.3 million. During these periods, adequate pipeline capacity existed to accommodate volume growth, and the expenditures required for environmental and safety improvements were not material. Capital expenditures for 1995 are expected to be approximately $8.0 million, excluding the Wyco acquisition.\nThe Partnership makes distributions of 100% of its Available Cash to holders of LP Units and the General Partner. Available Cash consists generally of all the cash receipts less all cash disbursements and reserves. A distribution of $2.20 per unit was paid to Senior Preference Unitholders in 1994, 1993 and 1992. In 1995, the Partnership anticipates distributing $2.20 per Senior Preference Unit, which is the annualized Minimum Quarterly Distribution. During 1994, 1993, and 1992, the Partnership paid distributions of $12.3 million ($2.20 per unit), $19.3 million ($2.20 per unit and $1.21 per unit in arrearages) and $15.0 million ($2.20 per unit and $.45 per unit in arrearages) to the Preference Unitholders. During 1994, the Partnership paid distributions of $1.7 million ($.55 per unit) to the Common Unitholders.\nThe Partnership expects to fund future cash distributions and maintenance capital expenditures with existing cash and cash flows from operating activities and expansionary capital expenditures are expected to be funded through Partnership borrowings.\nIn 1994, a wholly-owned subsidiary of the Partnership sold $33 million of notes to a group of insurance companies. The notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. In 1994, KPOP entered into a Restated Credit Agreement with a group of banks that provides a $15 million revolving credit facility through November 30, 1997. The credit facility bears interest at variable rates and has a commitment fee of .2% per annum of the unused credit facility. No amounts were drawn under this credit facility at December 31, 1994. The notes and credit facility are secured by a mortgage on substantially all of the pipeline assets of the Partnership.\nEffective February 24, 1995, the Partnership, through KPOP, acquired the refined petroleum product pipeline assets of Wyco Pipe Line Company for $27.1 million. The acquisition was financed by the sale of additional first mortgage notes to three insurance companies. The notes are due February 24, 2002 and bear interest at the rate of 8.37% per annum.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data of the Partnership begin on page of this report. Said information is hereby incorporated by reference into this Item 8.\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 is a limited partnership and has no directors. The Partnership is managed by the Company as general partner. Set forth below is certain information concerning the directors and officers of the Company. All directors of the Company are elected annually by Kaneb, as its sole stockholder. All officers serve at the discretion of the Board of Directors of the Company.\n____________________________________________________________ * Less than one percent\n(1) Mr. Doherty, Chairman of the Board of the Company since September 1989, is also Senior Vice President of Kaneb. In addition to the Senior Preference Units set forth above, Mr. Doherty owns 75,000 Common Units representing an aggregate limited partnership interest of less than one percent. (2) Mr. Hutchens has served as President of the Company since January 1994. Having been with the Company since January 1960, Mr. Hutchens was Manager of Product Movement from July 1976 to January 1981 and Vice President - Transportation until assuming his present position. (3) Mr. Easum has served the Company as Vice President of Business Development since August 1988, prior to which he was Director of Purchasing with Union Pacific Railroad Company since August 1980. (4) Mr. Wadsworth also serves as an officer of Kaneb. Mr. Wadsworth joined Kaneb in October, 1990, prior to which he served as general manager of Dorchester Hugoton, Ltd. for more than five years. (5) Mr. Harrison has served as Controller of the Company since November, 1992. Mr. Harrison was previously employed in various financial positions, including Assistant Secretary and Treasurer, by ARCO Pipe Line Company since April 1974. (6) Mr. Barnes, a director of the Company, is also Chairman of the Board, President and Chief Executive Officer of Kaneb. In addition to the Senior Preference Units set forth above, Mr. Barnes owns 79,000 common and 60,500 preference units representing an aggregate limited partner interest of approximately 1%.\n(7) Mr. Bentley, a director of the Company since July 1989, is also a director of Kaneb. Mr. Bentley has been President of Bentley Investment Corp., a private investment firm, since November 1985. (8) Mr. Ahn, a director of the Company since July 1989, is also a director of Kaneb. Mr. Ahn has been a partner of Morgan Lewis Githens & Ahn, L.P., an investment banking firm, since 1982 and currently serves as a director of Broadcasting Partners, Inc., Haynes International, Inc., ITI Technologies, Inc., PAR Technology, Inc., Quaker Fabric Corporation, and Stuart Entertainment, Inc. (9) Mr. Peak, a director of the Company since July 1989, is also a director of Kaneb. Mr. Peak has been General Partner of Dorchester Hugoton, Ltd., an oil and gas exploration and production partnership, for more than the past five years. (10) Mr. Whatley, a director of the Company since July 1989, is also a director of Kaneb. In addition to serving as Chairman of the Board of Directors of Kaneb from February 1981 until April 1989, Mr. Whatley was elected and served in the additional offices of President and Chief Executive Officer of Kaneb from June until October 1986. He also serves as a director of United Financial Group, Inc.. (11) Mr. Ralph Rehm, who is also a director of Kaneb, is President of Northlake Consulting Company, which provides financial consulting services. Mr. Rehm provided consulting services on behalf of one of Kaneb's subsidiaries in 1993 and 1994. Mr. Rehm previously was engaged in financial consulting services for Northlake Consultants from June 1989 to May 1990, prior to which he served as Senior Vice President of Finance and Administration of Kaneb from December 1986. (12) Mr. Biles joined the Company in November 1953 and served as President from January 1985 until his retirement at the close of 1993. He presently serves as a Director of the Company. (13) Units of the Partnership listed are those which are owned by the person indicated, his spouse or children living at home. None of the directors of the Company owns more than two percent of the outstanding Senior Preference Units of the Partnership. Each director had sole power with respect to the Units attributed to him.\nAUDIT COMMITTEE\nMessrs. Sangwoo Ahn and James R. Whatley currently serve as the members of the Audit Committee of the Company. Such Committee will, on an annual basis, or more frequently as such Committee may determine to be appropriate, review policies and practices of the Company and the Partnership and deal with various matters as to which conflicts of interest may arise.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Company's Board of Directors does not have a compensation committee or any other committee that performs the equivalent functions. During the fiscal year ended December 31, 1994, none of the Company's officers or employees participated in the deliberations of the Company's Board of Directors concerning executive officer compensation.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no executive officers, but is obligated to reimburse the Company for compensation paid to the Company's executive officers in connection with their operation of the Partnership's business.\nThe following table sets forth information with respect to the aggregate compensation paid or accrued by the Company during the fiscal years 1994, 1993 and 1992, to the President and each of the most highly compensated executive officers and other key policy making personnel of the Company whose aggregate cash compensation exceeded $100,000.\nSUMMARY COMPENSATION TABLE --------------------------\nANNUAL COMPENSATION -------------------\n_________________________\n(1) Does not include the values of the personal use of Company paid club memberships, nor the personal use of assets, facilities and services of Company employees. The aggregate amount of additional benefits or compensation to any of the individuals listed in the Summary Compensation Table above did not exceed 10% of the reported compensation.\n(2) Represents the Company's annual contributions in 1994 to Kaneb's defined contribution thrift plan in which all of the individuals listed in the Summary Compensation Table above were 100% vested with respect to the amounts indicated.\n(3) Represents a lump sum payment in lieu of cost-of-living salary increases in 1992 and 1993.\nRetirement Plan\nEffective April 1, 1991, Kaneb established a defined contribution thrift plan applicable to the Company that permits all full-time employees who have completed one year of service to contribute 2% to 12% of base compensation, on a pre-tax basis, into participant accounts. In addition to mandatory contribution equal to 2% of base compensation per year for each plan participant, the Company makes matching contributions from 25% to 50% of up to the first 6% of base pay contributed by a plan participant. Employee contributions, together with earnings thereon, are not subject to forfeiture. That portion of a participant's account balance attributable to Company contributions, together with earnings thereon, is vested over a five year period at 20% per year. Participants are credited with their prior years of service for vesting purposes, however, no amounts are accrued for the accounts of participants, including the Company's executive officers, for years of service previous to the plan commencement date. Participants may direct the investment of their contributions into any of four funds, including Kaneb common stock. Plan assets are\nheld and distributed pursuant to a trust arrangement. Because levels of future compensation, participant contributions and investment yields cannot be reliably predicted over the span of time contemplated by a plan of this nature, it is impractical to estimate the annual benefits payable at retirement to the individuals listed in the Summary Cash Compensation Table above.\nDirector's Fees. During 1994, each member of the Company's Board of Directors who was not also an employee of the Company or Kaneb was paid an annual retainer of $4,000 in lieu of all attendance fees.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAt March 17, 1995, no person was known to the Partnership to be the beneficial owner of more than 5% of the Units. See Item 10 with respect to ownership of Senior Preference Units by officers and directors of the Company.\nAt March 17, 1995, the Company owned a combined 2% General Partner interest in the Partnership and the Operating Partnership, and owned preference units and common units representing a limited partner interest of approximately 52%.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company is entitled to certain reimbursements under the Partnership Agreement. For additional information regarding the nature and amount of such reimbursements, see Notes 4 and 5 to the Partnership's financial statements.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A)(1) FINANCIAL STATEMENTS\n(A) (2) FINANCIAL STATEMENT SCHEDULES\nAll 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.\n(A) (3) LIST OF EXHIBITS\n3.1 Amended and Restated Agreement of Limited Partnership dated September 27, 1989, filed as Appendix A to the Registrant's Prospectus, dated September 25, 1989, in connection with the Registrant's Registration Statement on Form S-1, S.E.C. File No. 33-30330 and incorporated herein by reference.\n10.1 ST Agreement and Plan of Merger date December 21, 1992 by and between Grace Energy Corporation, Support Terminal Services, Inc., Standard Transpipe Corp., and Kaneb Pipe Line Operating Partnership, NSTS, Inc. and NSTI, Inc. as amended by Amendment of STS Merger Agreement dated March 2, 1993. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on March 16, 1993, and said exhibit is hereby incorporated by reference.\n10.2 Note Purchase Agreement dated December 22, 1994. Said document is on file as Exhibit 10.2 of the exhibits to Registrant's report on Form 8-K filed on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.3 Restated Credit Agreement dated December 22, 1994 between Kaneb Pipe Line Operating Partnership, L.P., Texas Commerce Bank National Association, and certain Lendors, filed herewith.\n10.4 Agreement for Sale and Purchase of Assets dated February 19, 1995 by and among Wyco Pipe Line Company and Kaneb Pipe Line Operating Partnership, L.P.. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on March 13, 1995, and said exhibit is hereby incorporated by reference.\n21 List of Subsidiaries, filed herewith.\n24.1 Powers of Attorney, filed herewith.\n27 Financial Data Schedule, filed herewith.\n(B) REPORTS ON FORM 8-K - NONE.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, Kaneb Pipe Line Partners, L.P. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKANEB PIPE LINE PARTNERS, L.P.\nBy: Kaneb Pipe Line Company ----------------------- General Partner\nBy: LEON E. HUTCHENS ------------------------ (Leon E. Hutchens) President and Chief Executive Officer Date: March 29, 1995\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 Kaneb Pipe Line Partners, L.P. and in the capacities with Kaneb Pipe Line Company and on the date indicated.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Kaneb Pipe Line Partners, L.P.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 29 present fairly, in all material respects, the financial position of Kaneb Pipe Line Partners, L.P. and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Partnership's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits 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 LLP Dallas, Texas March 16, 1995\nF - 1\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME --------------------------------------------------------------------------------\nSee accompanying notes to consolidated financial statements.\nF - 2\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 AND 1993 --------------------------------------------------------------------------------\nSee accompanying notes to consolidated financial statements.\nF - 3\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS --------------------------------------------------------------------------------\nSee accompanying notes to consolidated financial statements.\nF - 4\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF PARTNERS' CAPITAL YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 --------------------------------------------------------------------------------\n(a) Kaneb Pipe Line Company owns a 1% interest in Kaneb Pipe Line Partners, L.P. as General Partner.\n(b) The partnership agreement allows for an additional issuance of up to 7.5 million senior preference units.\nSee accompanying notes to consolidated financial statements.\nF - 5\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n1. PARTNERSHIP ORGANIZATION\nKaneb Pipe Line Partners, L.P. (\"Partnership\"), a master limited partnership, owns and operates a refined petroleum products pipeline business. The Partnership operates through Kaneb Pipe Line Operating Partnership, L.P. (\"KPOP\"), a limited partnership in which the Partnership holds a 99% interest as limited partner. Kaneb Pipe Line Company (\"Company\"), a wholly-owned subsidiary of Kaneb Services, Inc. (\"Kaneb\"), as general partner holds a 1% general partner interest in both the Partnership and KPOP. The Company's 1% interest in KPOP is reflected as the minority interest in the financial statements.\nEffective March 1, 1993, the Partnership acquired Support Terminal Services, Inc. (\"ST\"), a petroleum products and specialty liquids storage and terminaling company headquartered in Dallas, Texas, for approximately $65 million. The acquisition was accounted for as a purchase, and, accordingly, the Partnership's consolidated statement of income includes the results of operations of ST since March 1, 1993. In connection with the acquisition, the Partnership borrowed $65 million from a group of banks, which was partially repaid with $50.8 million of the proceeds from a Senior Preference Unit (\"SPU\") offering.\nIn April 1993, the Partnership completed a public offering of 2.25 million SPU at $25.25 per unit. The net proceeds from the offering of $52.8 million was allocated among the equity accounts of the unitholders, general partner and minority interest based on the ownership percentages of the partnership subsequent to the offering. The Partnership believes that this allocation approximates the distribution of the net assets upon liquidation, assuming the Partnership was liquidated at net book value. However, the actual distribution of the net assets upon liquidation could be significantly different as a result of the fair market value of the net assets being substantially different than the net book value of the Partnership's assets in the accompanying financial statements.\nThe SPUs represent an approximate 44% ownership interest in the Partnership. The Company owns an approximate 52% interest as limited partner in the form of Preference Units and Common Units, and as the general partner owns a combined 2% interest. An approximate 2% ownership interest in the form of 60,500 Preference Units and 154,000 Common Units is held by officers of Kaneb.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe following significant accounting policies are followed by the Partnership in the preparation of the consolidated financial statements.\nCASH AND CASH EQUIVALENTS\nThe Partnership's policy is to invest cash in highly liquid investments with maturities of three months or less, upon purchase. Accordingly, uninvested cash balances are kept at minimum levels. Such investments are valued at cost, which approximates market, and are classified as cash equivalents.\nF - 6\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nPROPERTY AND EQUIPMENT\nProperty and equipment are carried at historical cost. Certain leases have been capitalized and the leased assets have been included in property and equipment. Additions of new equipment and major renewals and replacements of existing equipment are capitalized. Repairs and minor replacements that do not materially increase values or extend useful lives are expensed. Depreciation of property and equipment is provided on a straight-line basis at rates based upon expected useful lives of various classes of assets. The rates used for pipeline and storage facilities of KPOP are the same as those which have been promulgated by the Federal Energy Regulatory Commission.\nREVENUE AND INCOME RECOGNITION\nKPOP provides pipeline transportation of refined petroleum products and liquified petroleum gases. Revenue is recognized upon receipt of the products into the pipeline system.\nST provides terminaling and other ancillary services. Fees are billed one month in advance and are reported as deferred income. Revenue is recognized in the month services are provided.\nENVIRONMENTAL MATTERS\nThe operations of the Partnership are subject to federal, state and local laws and regulations relating to protection of the environment. Although the Partnership believes that its operations are in general compliance with applicable environmental regulation, risks of additional costs and liabilities are inherent in pipeline and terminal operations, and there can be no assurance that significant costs and liabilities will not be incurred by the Partnership. Moreover, it is possible that other developments, such as increasingly stringent environmental laws, regulations and enforcement policies thereunder, and claims for damages to property or persons resulting from the operations of the Partnership, could result in substantial costs and liabilities to the Partnership.\nEnvironmental 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 environmental assessments and\/or remedial efforts are probable, and the costs can be reasonably estimated. Generally, the timing of these accruals coincides with the completion of a feasibility study or the Partnership's commitment to a formal plan of action.\nThe Company has indemnified the Partnership against liabilities for damage to the environment resulting from operations of the pipeline prior to October 3, 1989 (date of formation of the Partnership). The indemnification does not extend to any liabilities that arise after such date to the extent that the liabilities result from changes in environmental laws and regulations. In addition, ST's former owner has agreed to indemnify the Partnership against liabilities for damages to the environment from operations conducted by the former owner prior to March 2, 1993. The indemnity, which expires March 1, 1998, is limited in amount to 60% of any claim exceeding $100,000 until an aggregate amount of $10 million has been paid by ST's former owner. The Partnership has recorded a reserve for environmental claims in the amount of $1.0 million at December 31, 1994 in other liabilities on the accompanying balance sheet.\nF - 7\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nINCOME TAX CONSIDERATIONS\nIncome before income tax expense is made up of the following components:\nThe Partnership is not subject to federal and state income taxes. However, certain operations of ST are conducted through wholly-owned subsidiaries which are taxable entities. The provision for income taxes for the periods ended December 31, 1994 and 1993 consists of deferred U.S. federal income taxes of $.6 million and $.4 million, respectively, and current federal income taxes of $.2 million in 1994.\nSince the income or loss of the operations which are conducted through limited partnerships will be included in the tax return of the individual partners of the Partnership, no provision for income taxes has been recorded in the accompanying financial statements on these earnings. The tax returns of the Partnership are subject to examination by federal and state taxing authorities. If such examination results in adjustments to distributive shares of taxable income or loss, the tax liability of the partners would be adjusted accordingly.\nThe tax attributes of the Partnership's net assets flow directly to each individual partner. Individual partners will have different investment bases depending upon the timing and prices of acquisition of partnership units. Further, each partner's tax accounting, which is partially dependent upon their individual tax position, may differ from the accounting followed in the financial statements. Accordingly, there could be significant differences between each individual partner's tax basis and their proportionate share of the net assets reported in the financial statements. Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" requires disclosure by a publicly held partnership of the aggregate difference in the basis of its net assets for financial and tax reporting purposes. Management does not believe that, in the Partnership's circumstances, the aggregate difference would be meaningful information.\nALLOCATION OF NET INCOME AND EARNINGS PER SENIOR PREFERENCE UNIT\nNet income is allocated to the limited partnership units in an amount equal to the cash distributions declared for each reporting period and any remaining income or loss is allocated to the class of units that did not receive full distributions. If full distributions are declared to all classes of units, income will be allocated pro rata based on the aggregate amount of distributions declared.\nEarnings per SPU are calculated by dividing the amount of net income allocated to the SPUs by the weighted average number of SPUs outstanding.\nF - 8\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nCASH DISTRIBUTIONS\nThe Partnership makes quarterly distributions of 100% of its Available Cash, as defined in the Partnership Agreement, to holders of limited partnership units (\"Unitholders\") and the Company. Available Cash consists generally of all the cash receipts of the Partnership plus the beginning cash balance less all of its cash disbursements and reserves. The Partnership expects to make distributions of Available Cash for each quarter of not less than $.55 per Senior Preference Unit (the \"Minimum Quarterly Distribution\"), or $2.20 per Senior Preference Unit on an annualized basis, for the foreseeable future, although no assurance is given regarding such distributions. The Partnership expects to make distributions of all Available Cash within 45 days after the end of each quarter to holders of record on the applicable record date. A distribution of $2.20 per unit was paid to Senior Preference Unitholders in 1994, 1993 and 1992. During 1994, 1993 and 1992, the Partnership paid distributions of $2.20, $3.41 (includes $1.21 of arrearage payments) and $2.65 (includes $.45 of arrearage payments), respectively, to the Preference Unit holders. During 1994, the Partnership paid distributions of $.55 per unit to the Common Unitholders. As of December 31, 1994, no arrearages existed on any class of partnership interest.\nDistributions by the Partnership of its Available Cash are made 99% to Unitholders and 1% to the Company, subject to the payment of incentive distributions to the General Partner if certain target levels of cash distributions to the Unitholders are achieved. The distribution of Available Cash for each quarter within the Preference Period, as defined, is subject to the preferential rights of the holders of the Senior Preference Units to receive the Minimum Quarterly Distribution for such quarter, plus any arrearages in the payment of the Minimum Quarterly Distribution for prior quarters, before any distribution of Available Cash is made to holders of Preference Units of Common Units for such quarter. In addition, for each quarter within the Preference Period, the distribution of any amounts to holders of Common Units is subject to the preferential rights of the holders of the Preference Units to receive the Minimum Quarterly Distribution for such quarter, plus any arrearages in the payment of the Minimum Quarterly Distribution for prior quarters. The Common Units are not entitled to arrearages in the payment of the Minimum Quarterly Distribution. In general, the Preference Period will continue indefinitely until the Minimum Distribution has been paid to the holders of the Senior Preference Units, the Preference Units and the Common Units for twelve consecutive quarters. Prior to the end of the Preference Period, 2,650,000 of the Preference Units shall be converted into Senior Preference Units on a one-for-one basis if the Third Target Distribution, as defined, is paid to all Unitholders for four full consecutive quarters. The Third Target distribution is reached when distributions of Available Cash equals $2.80 per Limited Partner (\"LP\") Unit on an annualized basis. After the Preference Period ends all differences and distinctions between the three classes of units for the purposes of cash distributions will cease.\nF - 9\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n3. PROPERTY AND EQUIPMENT\nThe cost of property and equipment is summarized as follows:\n4. LONG-TERM DEBT AND LEASES\nIn 1994, a wholly-owned subsidiary of the Partnership issued $33 million of first mortgage notes (\"Notes\") to a group of insurance companies. The Notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. In 1994, a wholly-owned subsidiary entered into a Restated Credit Agreement with a group of banks that provides a $15 million revolving credit facility through November 30, 1997. The credit facility bears interest at variable interest rates and has a commitment fee of .2% per annum of the unused credit facility. No amounts were drawn under the credit facility at December 31, 1994. The Notes and credit facility are secured by a mortgage on substantially all of the pipeline assets of the Partnership and contain certain financial and operational covenants.\nF - 10\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nThe following is a schedule by years of future minimum lease payments under capital and operating leases together with the present value of net minimum lease payments for capital leases as of December 31, 1994:\n(a) The capital lease is secured by certain pipeline equipment and the Partnership has accrued its option to purchase this equipment at the termination of the lease.\nTotal rent expense under operating leases amounted to $.9 million, $.9 million and $.2 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nKPOP and the Company entered into a payment priority agreement related to the capital lease obligation for pipeline equipment under which the Company is primarily liable for rental payments of approximately $2.9 million per year through April 1997 and KPOP is primarily liable for the remaining rental payments. KPOP has recorded a receivable of $5.8 million at December 31, 1994 from the Company for the present value of these future lease payments. This receivable bears interest at an annual rate of 13.8%, which reflects the imputed interest rate on the capital lease. KPOP recorded interest income of $.9 million, $1.2 million and $1.4 million from the Company on this receivable balance for the periods ended December 31, 1994, 1993 and 1992, respectively. The amount of the capital lease obligation that exceeds the receivable from the Company ($6.0 million at December 31, 1994) represents the present value of the lease obligation and purchase option due subsequent to April 1997.\nThe Partnership believes that the carrying value of the notes represents their estimated fair value as the notes were issued in December 1994 and that it is not practicable to estimate the fair value of the capital lease obligation and the associated receivable from the general partner.\nF - 11\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n5. RELATED PARTY TRANSACTIONS\nThe Partnership has no employees and is managed and controlled by the Company. The Company and Kaneb are entitled to reimbursement of all direct and indirect costs related to the business activities of the Partnership. These costs, which totaled $9.0 million, $8.7 million and $7.2 million for the years ended December 31, 1994, 1993 and 1992, respectively, include compensation and benefits paid to officers and employees of the Company and Kaneb, insurance premiums, general and administrative costs, tax information and reporting costs, legal and audit fees. Included in this amount is $7.0 million, $7.0 million and $6.3 million of compensation and benefits, including pension costs, paid to officers and employees of the Company for the periods ended December 31, 1994, 1993 and 1992, respectively, which represent the actual amounts paid by the Company or Kaneb. In addition, the Partnership paid $.2 million during each of these respective periods for an allocable portion of the Company's overhead expenses. At December 31, 1994 and 1993, the Partnership owed the Company $.8 million and $.5 million, respectively, for these expenses which are due under normal invoice terms.\n6. QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly operating results for 1994 and 1993 are summarized as follows:\nF - 12\nKANEB PIPE LINE PARTNERS, L.P. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n7. SUBSEQUENT EVENT\nEffective February 24, 1995, the Partnership, through KPOP, acquired the refined petroleum product pipeline assets of Wyco Pipe Line Company (\"Wyco\") for $27.1 million. The acquisition was financed by the issuance of first mortgage notes to three insurance companies. The notes are due February 24, 2002 and bear interest at the rate of 8.37% per annum. The acquisition will be accounted for as a purchase and, accordingly, the results of operations of Wyco will be included in the Partnership's consolidated statement of income subsequent to the date of acquisition.\nThe following summarized unaudited pro forma consolidated results of operations for years ended December 31, 1994 and 1993, assume the acquisition occurred as of the beginning of the period presented. These pro forma results have been prepared for comparative purposes only and do not purport to be indicative of the results of operations which might have resulted had the combination been in effect at the dates indicated, or which may occur in the future.\nF - 13\nINDEX TO EXHIBITS -----------------\n3.1 Amended and Restated Agreement of Limited Partnership dated September 27, 1989, filed as Appendix A to the Registrant's Prospectus, dated September 25, 1989, in connection with the Registrant's Registration Statement on Form S-1, S.E.C. File No. 33-30330 and incorporated herein by reference.\n10.1 ST Agreement and Plan of Merger date December 21, 1992 by and between Grace Energy Corporation, Support Terminal Services, Inc., Standard Transpipe Corp., and Kaneb Pipe Line Operating Partnership, NSTS, Inc. and NSTI, Inc. as amended by Amendment of STS Merger Agreement dated March 2, 1993. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on March 16, 1993, and said exhibit is hereby incorporated by reference.\n10.2 Note Purchase Agreement dated December 22, 1994. Said document is on file as Exhibit 10.2 of the exhibits to Registrant's report on Form 8-K filed on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.3 Restated Credit Agreement dated December 22, 1994 between Kaneb Pipe Line Operating Partnership, L.P., Texas Commerce Bank National Association, and certain Lendors, filed herewith.\n10.4 Agreement for Sale and Purchase of Assets dated February 19, 1995 by and among Wyco Pipe Line Company and Kaneb Pipe Line Operating Partnership, L.P.. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the Securities and Exchange Commission on March 13, 1995, and said exhibit is hereby incorporated by reference.\n21 List of Subsidiaries, filed herewith.\n24.1 Powers of Attorney, filed herewith.\n27 Financial Data Schedule, filed herewith.","section_15":""}
{"filename":"101788_1994.txt","cik":"101788","year":"1994","section_1":"ITEM 1. BUSINESS.\nNATURE OF BUSINESS\nUnited States Surgical Corporation (the Company) is a Delaware corporation primarily engaged in developing, manufacturing and marketing a proprietary line of technologically advanced surgical wound management products to hospitals throughout the world. The Company currently operates domestically and internationally through subsidiaries, divisions and distributors. Except where the context otherwise requires, the term Company includes the Company's divisions and subsidiaries.\nThe market that the Company services continues to be adversely affected by cost consciousness on the part of health care providers and payors and to experience slower growth rates created by efforts to reduce costs and by uncertainties connected with industry-led and government sponsored health care reform proposals. The Company believes, however, that in any scenario that results from evolution of the domestic health care system, its products offer a significant opportunity for reducing costs for the total health care system while providing considerable advantages for the patient. The Company has also been impacted negatively by aggressive pricing by competition. The Company continues to innovate and develop new products that provide better patient care and an effective means of reducing hospital costs.\nTo respond to these business conditions, the Company has expanded its marketing efforts to meet the needs of hospital management through cost effective pricing programs, by assisting hospitals in implementing more efficient surgical practices, and by demonstrating the favorable economics associated with the use of the Company's products. In addition, the Company took steps during 1993 and 1994 to significantly reduce its own cost of doing business in order to strengthen its competitive position.\nThe Company is the leading manufacturer and marketer of innovative mechanical products for the wound closure market. In this category, principal products consist of a series of surgical stapling instruments (both disposable and reusable), disposable surgical clip appliers and disposable loading units (DLUs) for use with stapling instruments. The instruments are an alternative to manual suturing techniques utilizing needle\/suture combinations and enable surgeons to reduce blood loss, tissue trauma and operating time while joining internal tissue, reconstructing or sealing off organs, removing diseased tissue, occluding blood vessels and closing skin, either with titanium, stainless steel, or absorbable POLYSORB copolymer staples or with titanium, stainless steel, or absorbable POLYSURGICLIP copolymer clips. Surgical stapling also makes possible several surgical procedures which cannot be achieved with surgical needles and suturing materials. The disposable instruments and DLUs are expended after a single use or, in the case of reloadable disposable instruments, after a single surgical procedure.\nThe Company is the leading manufacturer and marketer of specialized wound management products designed for use in the rapidly growing field of minimally invasive surgery. This surgical technique (also referred to as minimally invasive or laparoscopic surgery) requires incisions of up to one half inch through which various procedures are performed using laparoscopic instruments and optical devices, known as laparoscopes, for viewing inside the body cavity. Laparoscopy generally\n- ------------------------------ Trademarks of United States Surgical Corporation are in italicized capital letters.\nprovides patients with significant reductions in post-operative hospital stay, pain, recuperative time and hospital costs, improved cosmetic results, and the ability to return to work and normal life in a shorter time frame. The Company has developed and markets disposable surgical clip appliers and stapling instruments designed for laparoscopic uses in a variety of sizes and configurations. The Company's products in this area also include trocars, which provide entry ports to the body in laparoscopic surgery, and a line of instruments which allows the surgeon to see, cut, clamp, retract or otherwise manipulate tissue during a laparoscopic procedure. The Company also designs and markets laparoscopes. Applications for minimally invasive surgery currently include cholecystectomy (gall bladder removal), hysterectomy, hernia repair, anti-reflux procedures for correction of heartburn, and various forms of bowel, stomach, gynecologic, urologic, and thoracic (chest) surgery.\nDisposable instruments reduce the user's capital investment, eliminate the risks and costs associated with maintenance, sterilizing and repair of reusable instruments, and provide the surgeon with a new sterile instrument for each procedure, offering more efficacious and safer practice for both patients and operating room personnel.\nIn 1994, the Company continued to expand manufacturing and marketing of its line of suture products, which was introduced in 1991. The Company believes that sutures, which represent a major portion of the wound closure market, are a natural complement to its other wound management products. This market is currently dominated by other manufacturers, however, the Company expects continuing growth in its market share as a result of offering technologically advanced suture products.\nPRODUCT CONTRIBUTION\nThe Company's current products constitute a single business segment. Surgical wound management products accounted for substantially all of the Company's net sales and profits in each of the years ended December 31, 1994, 1993 and 1992.\nAUTO SUTURE Stapling Products and Clip Appliers\nAUTO SUTURE stapling products consist of disposable single-use, and disposable instruments and reusable stainless steel instruments that utilize and can be reloaded with disposable loading units (DLUs) containing surgical staples. The staples are made of titanium, stainless steel, or a proprietary absorbable copolymer. The Company markets both disposable instruments and reusable stainless steel instruments in a variety of sizes and configurations for use in various surgical applications. Although the Company predominately markets disposable staplers, the availability of both reusable and disposable staplers gives surgeons the opportunity of using either in accordance with their preference. The Company's stapling instruments have application in abdominal, thoracic, gynecologic, obstetric, urologic and other fields of surgery. Common uses of AUTO SUTURE staplers include closure and resection (the removal of tissue or organs), anastomosis (the surgical joining of hollow structures, as in organ reanastomosis), vessel occlusion, biopsies, skin and fascia closure and Cesarean section deliveries.\nThe Company's MULTIFIRE and PREMIUM MULTIFIRE disposable staplers can be reloaded with DLUs for multiple use within the same surgical procedure. The MULTIFIRE and PREMIUM MULTIFIRE TA line of staplers are used for resection and creation of anastomosis; the MULTIFIRE GIA line of staplers staples and simultaneously transects tissue. These instruments are useful in a variety of procedures.\nThe Company also markets a specialized line of advanced skin stapling instruments, including the MULTIFIRE VERSATACK stapler, the only stapler designed for open hernia repair, and which is also usable in a wide variety of other open procedures.\nThe Company continued to enhance other existing products during 1994, including announcement of the PREMIUM PLUS CEEA, an improved version of its instrument designed for circular anastomoses. The PREMIUM PLUS CEEA instrument, expected to reach the market in early 1995, is easy to insert and remove from the lumen in bowel resections, while retaining the advantage of superior anastomotic security. The Company also offered a greater variety of sizes and features in many of its existing instruments.\nAUTO SUTURE clip applier instruments individually apply a sequence of titanium, stainless steel, or absorbable clips for ligation of blood vessels and other tubular body structures. They are offered in a variety of clip sizes for use in a broad range of surgical procedures. All clip appliers marketed by the Company are disposable instruments which provide the surgeon with a new, sterilized instrument for each procedure. The Company's LDS disposable staplers simultaneously ligate and divide tubular body structures.\nThe materials used in the Company's POLYSORB absorbable staples and POLYSURGICLIP clips are proprietary copolymers developed and manufactured by the Company. The copolymers are radio transparent, facilitate postoperative diagnosis without X-ray or CAT scan interference, maintain significant strength during the critical postoperative period, and are totally absorbed during subsequent months. Among other applications, these absorbable staples are used in the Company's POLY GIA 75 stapler, which places four rows of absorbable staples and immediately cuts the tissue between the innermost staple lines. It is used in gynecologic and urologic surgical procedures.\nThe Company believes that, where applicable, AUTO SUTURE staplers and clip appliers provide benefits to surgeons, patients and hospitals that are superior to manual suturing methods. Depending on the type of operation and instruments used, these benefits may include: shorter operating time resulting in less time under anesthesia; reduction in blood loss; reduction in tissue handling, which can result in reduced tissue trauma and edema; lowering of the incidence of postoperative infection; enhanced cosmetic results; and faster healing. These benefits reduce the overall medical cost of the operation by significantly reducing operating room time, postoperative care and anesthesiology services. The Company believes these benefits are advantageous to the total health care system.\nAUTO SUTURE Products for Minimally Invasive Surgery\nThe Company provides a full line of products to serve the needs of the surgical community in performing minimally invasive surgery, including a number of proprietary products not offered by any other company.\nThe Company markets a line of disposable trocars. The initial application of a trocar results in a sharp obturator tip or a cutting instrument within the trocar making a small opening in the abdominal wall or chest cavity. The obturator or cutting instrument is then removed, leaving the trocar sleeve in place to serve as an access tube through which a laparoscope and other surgical instruments may be inserted. Each disposable trocar is used in a single surgical procedure, assuring a sharp obturator point or cutting instrument for each application and eliminating the expense and risks of resharpening and resterilizing associated with reusable trocars. The Company's trocars are available in a wide range of sizes, some of which are offered with radiolucent sleeves to permit unobstructed X-rays.\nThe SURGIPORT trocar, introduced in February 1987, was the first disposable trocar incorporating a safety shield, which enhances patient safety by reducing the chance of injuring organs during trocar insertion. The Company's PREMIUM SURGIPORT version of its disposable trocar, introduced in 1993, offers alternative safety features including a retractable obturator tip and a seal system incorporating an adaptor to accommodate a variety of instrument sizes. In 1994, the Company introduced the VERSAPORT trocar. This trocar features the unique VERSASEAL system, the first self-adjusting trocar seal accommodates 5mm to 12mm instrument sizes without the need for a converter. The VERSAPORT trocar reduces the costs, additional inventory, and operating room time associated with the use of converters, and provides surgeons with a better seal and reduced friction on instruments in laparoscopic procedures.\nIn the latter part of 1994, the Company introduced the VISIPORT optical trocar, which allows a surgeon to visualize entry into the patient's body cavity. The VISIPORT trocar consists of a transparent blunt-domed obturator, housing a crescent shaped blade which, by means of a trigger, is extended and retracted. A laparoscope is incorporated into the shaft of the instrument for viewing through the obturator dome. This method of controlled blunt and sharp dissection with direct visualization of each tissue layer during penetration enhances surgeon control and maximizes safe entry into the patient cavity. The VISIPORT trocar can be used in additional PREMIUM SURGIPORT sleeves for secondary ports of entry to provide additional cost effectiveness.\nThe Company introduced in 1994 the SURGISPIKE trocar (a lower priced trocar for secondary punctures), a cost effective device which provides the quality of the same seal system utilized in the Company's PREMIUM SURGIPORT trocar. The Company also markets its THORACOPORT line of trocars for use in thoracic surgery, including an electrically conductive version, and the BLUNTPORT II blunt tip trocar designed for open laparoscopic techniques.\nThe Company offers various instruments for use in conjunction with its line of trocars. The PREMIUM SURGIPATCH and SURGIGRIP devices provide a method for anchoring the SURGIPORT, PREMIUM SURGIPORT or VERSAPORT trocars and facilitates adjustment of the trocar within the body cavity, the SEAL-UP II converter, which allows surgeons to convert SURGIPORT trocars to a smaller seal to accommodate 5mm instruments, improving the versatility of the instrument, and the SURGINEEDLE disposable pneumoperitoneum needle, which is used to provide insufflation prior to trocar insertion.\nThe Company also introduced in 1994 the SURGIVIEW 0 degree 10 mm single-use laparoscope for visualization of the patient cavity. This device offers the increased safety and convenience of a single use device, as well as a convenient BLINK feature which allows the surgeon to cleanse the lens without removal from the patient's cavity, providing significant time savings in the operating room. The SURGIVIEW device offers a cost effective alternative to the considerable expense of purchasing and maintaining reusable laparoscopes.\nSince 1990, the Company has marketed the ENDO CLIP applier, the world's first disposable multiple clip applier designed for minimally invasive surgery. The Company introduced the second generation ENDO CLIP II instrument in 1993. Both automatic clip appliers are available with titanium clips in a range of sizes and can be used to ligate a variety of tissue structures and to perform dissection. Designed to be applied through the SURGIPORT, PREMIUM SURGIPORT, VERSAPORT, or VISIPORT trocars, the ENDO CLIP and ENDO CLIP II appliers have application in a variety of surgical procedures and have gained great acceptance for use in laparoscopic cholecystectomy, a procedure which has become the standard technique for removal of the gallbladder. The advent of these instruments revolutionized the way surgeons perform gallbladder surgery. As the result of numerous surgeon education and training programs presented under the Company's sponsorship or with its assistance, the Company believes that hundreds of thousands of patients have benefited from this technology.\nThe Company markets a variety of instruments under the MULTIFIRE name designed for endoscopic application, including the MULTIFIRE ENDO GIA 30 instrument, the world's first stapler for endoscopic procedures, and the gas powered MULTIFIRE ENDO GIA 60 instrument. These instruments have expanded the scope of procedures which can be performed by a minimally invasive approach. Each of these devices, which are inserted through a SURGIPORT, PREMIUM SURGIPORT, VERSAPORT or VISIPORT trocar, places six rows of titanium staples and immediately cuts the tissue between the two centermost staple lines. Each may be reloaded with new DLUs several times during a single surgery. The Company offers DLUs for the instrument in different staple sizes to accommodate varying tissue thicknesses. The MULTIFIRE ENDO GIA 30 stapler is used in a variety of procedures, including appendectomies, laparoscopically assisted vaginal hysterectomies, and general, gynecologic and thoracic procedures. The MULTIFIRE ENDO GIA 60 stapler is designed for use in bowel procedures such as colectomies and interior resections and a variety of thoracic procedures.\nThe Company also markets the MULTIFIRE ENDO TA 60, a non-cutting gas powered instrument with the same features as the MULTIFIRE ENDO GIA 60 instrument. This instrument places three rows of titanium staples and is designed for use in bowel procedures such as anastomotic closure and various stomach and thoracic procedures. The Company's MULTIFIRE ENDO TA 30 stapler, introduced in 1993, permits stapling in minimal access areas in a variety of gynecological, thoracic and colorectal procedures.\nThe Company's SURGIWAND instrument is a high flow suction and irrigation device, incorporating an electrocautery tip, which is useful in many surgical applications. In 1994, the line was expanded with the introduction of the second generation version, the SURGIWAND II series, which is available without electrocautery capability. These instruments also offer laser capability.\nThe Company markets a variety of fully disposable hand instruments designed especially for use in minimally invasive surgery which fit through the SURGIPORT, PREMIUM SURGIPORT, VERSAPORT or VISIPORT trocars, including its ENDO CLINCH clamp, ENDO SHEARS rotating scissors, ENDO GRASP graspers, ENDO DISSECT dissectors, ENDO BABCOCK clamps, and the ENDO VERSASHEAR scissors, designed for cutting through a diverse range of tissue thicknesses. The Company's advanced line of laparoscopic hand instruments includes the ENDO MINI SHEARS and the ENDO SCIZ instruments, which are designed for dissecting and cutting, the ENDO MINI RETRACT and the ENDO MAXI RETRACT 10 MM retractors, which are designed for retracting tissues and structures, such as liver, lung, stomach and bowel, the ENDO LUNG device, a specialized clamp with a ratchet mechanism designed for reduced tissue trauma for use in lung surgery, and the ENDO BOWEL clamp, an atraumatic clamp designed for use in bowel surgery. Longer and shorter versions of many of these instruments are offered for use in specialty applications (such as thoracic and pediatric surgery). The Company also markets the ROTICULATOR line of instruments which are versions of certain of its instruments with an articulating and rotating head that may be guided around curves of up to 80 degrees. In 1993, the Company introduced an enhanced version of its ENDO RETRACT instrument, the ENDO RETRACT II instrument, which permits enhanced maneuverability and precision in retraction of tissue by the inclusion of five fingers articulating from 0 degree to 45 degrees.\nThe Company also introduced in 1993 the disposable ENDO CATCH pouch for insertion into the body cavity through the SURGIPORT, PREMIUM SURGIPORT, VERSAPORT or VISIPORT trocars for laparoscopic tissue removal through the trocar site. The ENDO CATCH II device, introduced in 1994, allows for removal of larger volumes of tissue.\nIn 1994 the Company introduced the revolutionary ENDO STITCH instrument and associated DLUs. This device allows the surgeon to suture and tie knots laparoscopically by passing a proprietary needle with different types of the Company's proprietary suture material (POLYSORB, SURGIDAC, SOFSILK, and BRALON suture materials) attached between two jaws located at the end of an endoscopic shaft, quickly, accurately and easily in comparison with manual endoscopic suturing techniques. Manual techniques are time consuming and difficult to learn, and have inhibited conversion of certain procedures which require endoscopic suturing to the laparoscopic method.\nThe Company markets a line of products for use in endoscopic suturing, including the SURGITIE ligating loop and the SURGIWIP ligature, which utilize a variety of suturing materials including SURGIGUT plain and chromic gut, POLYSORB synthetic absorbable, and SURGIDAC polyester. The ENDO CLOSE device, offered in 1994, facilitates the suture closure of trocar incision sites.\nSince 1991, the Company has marketed the ENDO HERNIA disposable surgical stapler, the world's first fully automated endoscopic instrument designed specifically for hernia repair, which features an articulating and rotating head. A reloadable version of this stapler was introduced in 1992, marketed as the MULTIFIRE ENDO HERNIA stapler. In 1993, the Company introduced the MULTIFIRE ENDO HERNIA 0 degree stapler, a non-articulating version of this product designed for procedures in which a surgeon desires to use greater force in applying staples, and the ENDO UNIVERSAL 65 degrees stapler which rotates and expands the range of articulation. The latter instrument is ideal for hernia repair and a variety of other procedures.\nDuring 1994, the Company entered a three year agreement with General Surgical Innovation, Inc. (\"GSI\") to sell the GSI Spacemaker (tm) balloon dissector for laparoscopic hernia procedures, combining the advantages of laparoscopy with the accepted technique of extraperitoneal procedures. This device may also be used in performing Burch bladder suspensions for relieving urinary incontinence.\nEndoscopic products are offered individually, in pre-assembled kits and in custom kits designed for specific surgical procedures such as cholecystectomy, hernia repair, laparoscopically assisted vaginal hysterectomy, bowel and other procedures. Kits are intended to offer the surgeon and operating room staff convenience and ease of accessibility to instruments, and provide a cost efficient means of purchasing the Company's products for hospital materials management departments.\nSUTURE PRODUCTS\nSutures comprise a major portion of the wound closure market. Since most surgical procedures which use staples also require manual suturing, the Company considers sutures to be a natural complement to its stapling instrumentation. The Company is continuing its planned expansion into this mature but very large market. The Company's product line includes both non-absorbable products (SURGIPRO polypropylene, MONOSOF and BRALON nylon, SOFSILK silk, SURGIDAC polyester and stainless steel sutures) and absorbable products (SURGIGUT plain and chromic gut and the Company's proprietary POLYSORB synthetic absorbable sutures).\nThe Company believes that its sutures have significant technological advantages over competitors' products. The Company's POLYSORB sutures are designed for removal from the package without kinking, are smoother (which helps to reduce trauma) and pull through tissue more easily, and provide greater holding power during the critical wound healing period than other absorbable sutures. In late 1994, the Company introduced an improved coating on its POLYSORB sutures which, in combination with the patented braid structure, facilitates the surgeon's ability to place and secure knots. Some of these suturing materials are utilized in the Company's endoscopic suturing devices, discussed above. The Company also markets SURGIPRO mesh, a mesh fabric designed for applications in both open and endoscopic surgery such as hernia repair. In the second half of 1993, the Company introduced SURGALLOY needles for the important cardiovascular segment of the market. The SURGALLOY needles are significantly stronger and sharper than existing technologies. During 1994, the Company expanded the use of SURGALLOY needles into the plastic surgery and ophthalmic surgery specialties. The Company believes that the SURGALLOY needles will enhance the competitive position of its sutures by offering these three key surgical specialties a superior product. The Company offers other suture-needle combinations for general and specialty applications.\nThe suture program also allows the Company to compete more effectively for contracts with customers that prefer to purchase all of the hospital's wound closure needs from a single vendor, particularly as individual hospitals, buying groups and hospital alliances continue to consolidate their purchasing.\nOTHER PRODUCTS\nIn 1991, the Company entered into a cooperative effort with Biomet, Inc. to develop and market a line of bioresorbable orthopedic products utilizing the Company's proprietary polymer technology. The Company has contributed its existing research developments to the venture and will continue with pertinent research and development work, while Biomet, a leader in the development and marketing of orthopedic products, is responsible for sales, distribution and marketing of the newly developed products. The profits and expenses of the venture are being shared.\nMARKETING AND SALES\nDomestically, the Company markets its products to surgeons and materials managers of hospitals primarily through the sales employees of its Auto Suture Company division. Outside the United States, the Company markets its products in 22 countries and in the Commonwealth of Puerto Rico by direct sales employees of 15 sales and marketing subsidiaries, and through its authorized distributors in 61 other countries. In 5 additional countries the Company sells its products directly to the user through the distributor sales department at its headquarters.\nThe Company maintains its own direct sales force employed by subsidiaries operating in Algeria, Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Italy, Luxembourg, Morocco, the Netherlands, New Zealand, Norway, Poland, Puerto Rico, Russia, Spain, Sweden, Switzerland, Tunisia and the United Kingdom. The Company has entered an agreement to acquire assets of its Japanese distributor in order to begin marketing directly in Japan.\nAll sales employees of the Auto Suture Company, of the Company's subsidiaries, and of the Company's authorized international distributors receive identical training with respect to the Company's products, consisting of an extensive training course that prepares them to provide surgeons and hospital personnel with technical assistance, including scrubbing in surgery as technical advisors in connection with the use of the Company's products. The training courses are developed and conducted by the Company at its expense. The training course includes an introduction to anatomy and physiology, the study of surgical terminology, aseptic surgical techniques such as scrubbing, gowning, gloving and operating room protocol and the use of the Company's instruments on artificial foam organs for sales demonstrations and on anesthetized animals in the laboratory for teaching purposes. During 1994, the Company broadened its training curriculum to prepare sales personnel to assist hospital administrators in implementing efficient surgical practices and in realizing the economic benefits afforded by the Company's products.\nThe Company demonstrates its products on artificial foam organs and through the use of films, video cassettes, technical manuals and surgical atlases.\nSince 1993, the Company has also sold to domestic distributors under a program known as Just-in-Time (JIT) distribution. Under the Just-in-Time program, the Company sells its products to a distributor selected by a participating hospital and the distributor sells the products to the hospital on an as needed basis. The Company compensates the distributor for handling and other services. Distributor sales are common in the medical product industry. The Company's JIT program responds to customer needs, many of which desire distributorship arrangements in order to avoid costs associated with inventory management. Distribution arrangements also negate distributor incentives to promote competing brands, allow the Company's technical sales force more time to support user surgeons and hospital management, and provide the Company with opportunities to enhance or protect its competitive position through an additional channel of sales. Sales through the JIT program currently comprise approximately 44% of the Company's domestic business.\nThe Company is committed to the continuing education of the surgical community by assisting a substantial number of medical schools, hospitals and educational organizations in training residents, nurses, surgeons and administrators in the techniques of wound management using AUTO SUTURE instrumentation. With the increasing number of advanced surgical procedures being performed using the minimally invasive approach, the Company also supports proctorships and preceptorships where an experienced surgeon clinically assists and teaches a surgeon in the operating room. Initially, the primary focus of the training programs was on laparoscopic cholycestectomy. Widespread training has been accomplished for that procedure, and the emphasis in future training will be on more advanced applications of laparoscopy, including hernia, bowel, and thoracic procedures, laparoscopically assisted vaginal hysterectomies, laparoscopic bladder suspension, and procedures for the correction of esophageal reflux. The Company believes that acceptance of laparoscopic techniques as the preferred method in a broad range of procedures will be an important element of the Company's future growth.\nNumerous studies have shown that, in addition to reduced patient recovery time, laparoscopy is a safe and efficacious technique. However, and particularly in more complex procedures, surgeons must receive adequate training before achieving competency to perform laparoscopy. The Company supports certification of surgeons in this technique to ensure that the Company's products are used properly. The costs of training for newer, more complicated procedures and concerns as to reimbursement for newer procedures in view of changes in the health care system have affected the rate at which the surgical community is learning the more advanced laparoscopic procedures.\nDuring 1994, the Company also expanded its marketing efforts to administrators of hospitals and hospital purchasing groups, demonstrating the economic efficiencies of the Company's' products and assisting hospital management in implementing efficient surgical practices. The Company's BEST PRACTICES program assists hospitals in a continuous effort to perform surgery more efficiently, enabling hospitals to reduce costs, enhance their competitiveness, and realize the benefits of laparoscopy.\nInternational sales represented approximately 46% of the Company's net sales in 1994, 40% of the Company's net sales in 1993, and 33% in 1992. International sales included sales through international subsidiaries, which were approximately 37% in 1994, 33% in 1993, and 28% in 1992, and sales to international distributors and to end users in countries not otherwise serviced by the Company, which were approximately 9% in 1994, 7% in 1993, and 5% in 1992, of the Company's net sales. (See Note J of Notes to Consolidated Financial Statements for additional information by geographical area.)\nOrders for the Company's products are generally filled on a current basis, and order backlog is not material to the Company's business.\nMANUFACTURING AND QUALITY ASSURANCE\nManufacturing is conducted principally at two facilities: North Haven, Connecticut, and Ponce, Puerto Rico. Manufacturing includes major assembly, packaging and sterilization of products. The Company produces all material for its synthetic absorbable staples, clips and sutures internally. Needles contained in certain of the Company's suture products are produced either at its facilities in North Haven, Connecticut, Germany or Switzerland. Other needles and suture materials are supplied by several manufacturers. The Company's reusable steel surgical staplers, components for the products the Company manufactures, and a minor portion of the Company's DLUs are supplied by several independent non-affiliated vendors using the Company's proprietary designs.\nRaw materials necessary for the manufacture of parts and components and packaging supplies for all of the Company's products that are manufactured by it are readily available from numerous third-party suppliers.\nThe Company considers quality assurance to be a significant aspect of its business. It has a staff of professionals and technical employees who develop and implement standards and procedures for quality control and quality assurance. These standards and procedures cover detailed quality specifications for parts, components, materials, products, packaging and labeling, testing of all raw materials, in-process subassemblies and finished products, and inspection of vendors' facilities and performance to assure compliance with the Company's standards. Recently, the Company applied for and received International Standards Organization (\"ISO\") certification for its plants in Connecticut and Puerto Rico.\nRESEARCH AND DEVELOPMENT\nThe Company believes that research and development is an important factor in its future growth. The Company engages in a continuing product research, development and improvement program at its Norwalk and North Haven, Connecticut facilities and through funding of research and development activities at major universities and other third parties. It employs a staff of engineers, designers, toolmakers and machinists that performs research and development as well as manufacturing support functions. During 1994, 1993, and 1992, the Company's research and development expenses, including suture-related research and development expenses, were approximately $37,500,000, $50,800,000, and $43,800,000, respectively. In addition to its suture line, within the past three years the Company has introduced 30 new products and size variations in 61 categories, that are the result of research and development conducted by the Company. Approximately 74% of 1994 sales revenues were received from the sale of products introduced within the preceding five years.\nDuring 1994, the Company reduced its research and development costs through enhancement of design technology which streamlined the development process, and by focusing resources on products and redesign of existing products which are best suited to customer needs in the current cost conscious health care environment. The Company's restructuring program during 1993 and 1994 also contributed significantly to the reduction of research and development expense, while allowing the Company to continue its aggressive program of exploring new opportunities for advancement in the surgical field.\nPATENTS AND TRADEMARKS\nPatents are significant to the conduct of the Company's business. The Company owns 117 new U.S. patents issued in 1994, 58 such patents issued in 1993, and 50 patents issued in 1992. Overall, the Company currently owns over 400 unexpired U.S. utility and design patents covering products it has developed or acquired and having expiration dates ranging from less than one year to 17 years. No patents will expire in the near future which are material to the Company's financial position. Moreover, the Company has many additional U.S. patent applications pending. The Company's practice and experience is to develop or acquire rights or licenses to new patented products and continuously update its technology. The Company also has a significant number of foreign patents and pending applications.\nThe Company has registered various trademarks in the U.S. Patent and Trademark Office and has other trademarks which have acquired both national and international recognition. The Company also has trademark registrations or pending applications in a number of foreign countries.\nSee Item 3, \"Legal Proceedings\", for details of certain patent infringement actions to which the Company is a party.\nCOMPETITION\nThere is intense competition in the markets in which the Company engages in business. Products competitive with the Company's staplers and clip appliers include various absorbable and non-absorbable sutures, clips and tape, as well as disposable and steel stapling instruments, DLUs and some hand loaded staplers. Many major companies that compete with the Company, such as Johnson & Johnson, Minnesota Mining and Manufacturing Company (\"3M\") and Davis & Geck which has been a division of American Cyanamid Company (the Company understands the sale of Davis & Geck may be pending), have a wider range of other medical products and dominate much of the markets for these other products. Ethicon, Inc. (\"Ethicon\"), a Johnson & Johnson subsidiary, markets, in addition to sutures and other wound closure products, disposable skin staplers, clip appliers, and internal staplers. 3M markets disposable skin staplers and internal stapling instruments. Davis & Geck markets disposable skin staplers, clip appliers and suture materials. The Company believes that these major companies will continue their efforts to develop and market competitive devices.\nThe market for products for minimally invasive surgery is highly competitive. The Company believes it is the leader in this field as the result of its successful innovative efforts and superior products. Ethicon, through a division known as Ethicon Endo- Surgery, markets a line of endoscopic instruments directly competitive with the Company's products and is its principal competitor. The Company believes that Ethicon devotes considerable resources to research and development and sales efforts in this field. Numerous other companies manufacture and distribute disposable endoscopic instruments. In addition, manufacturers of reusable trocars and other reusable endoscopic instruments, including Richard Wolf Medical Instruments Corp. (a subsidiary of Richard Wolf, GmbH) and Karl Storz Endoscopy-America Inc. (a subsidiary of Karl Storz, GmbH), compete directly with the Company.\nIndustry studies show Ethicon currently has approximately 80% of the suture market, while Davis & Geck has about 13% of this market. The Company expects that, because the size of the total sutures market is relatively stable, any increase in the Company's market share in this area will have to be earned at the expense of the other current market participants. The Company believes that the technological advantages of its sutures will enable it to compete effectively with these companies and that its market share in sutures will continue to grow.\nThe Company's principal methods of competing are the development of innovative products, the performance and breadth of its products, its technically trained sales force, educational services, including sponsorship of training programs in advanced laparoscopic techniques, and more recently, assisting hospital management with cost containment and marketing programs. The Company's major competitors have greater financial resources than the Company. Some of its competitors, particularly Ethicon, have engaged in substantial price discounting and other significant efforts to gain market share, including bundled contracts for a wide variety of healthcare products with group purchasing organizations. In the current health care environment, cost containment has become the predominant factor in purchasing decisions by hospitals. As a result, the Company's traditional advantage of product superiority has been impacted. The Company has responded to this aspect of competition by competitive pricing and by offering products which meet hospital cost containment needs, while maintaining the technical superiority of its products and the support of its sales organization.\nThe Company believes that the advantages of its various products will continue to provide the best value to its customers. However, there is considerable competition in the industry and no assurance can be given as to the Company's competitive position. The impact of competition will likely have a continuing effect on sales volumes and on prices charged by the Company. In addition, increased cost consciousness has revived competition from reusable instruments to some extent. The Company believes that disposable instruments are safer and more cost efficient for hospitals and the healthcare system than are reusable instruments, but it can not predict the extent to which reusable instruments will competitively impact the Company. The Company also offers reusable instruments to respond to the preferences of its customers.\nGOVERNMENT REGULATION\nThe Company's business is subject to varying degrees of governmental regulation in the countries in which it operates. In the United States, the Company's products are subject to regulation as medical devices by the United States Food and Drug Administration (the \"FDA\"), as well as by other federal and state agencies. These regulations pertain to the manufacturing, labeling, development and testing of the Company's devices as well as to the maintenance of required records. An FDA regulation requires prompt reporting by all medical device manufacturers of an event or malfunction involving a medical device where such device caused or contributed to death or serious injury or is likely to do so.\nFederal law provides for several routes by which the FDA reviews medical devices prior to their entry into the marketplace. To date, all of the Company's new products have been cleared by the FDA under the most expedited form of pre-market review since the initiation of the program. The Company, along with the rest of the industry, continues to experience lengthy delays in the FDA approval process. Timely product approval is important to the Company's maintaining its technological competitive advantages. Other than increased FDA product approval periods, the Company has not encountered any other unusual regulatory impediments to the introduction of new products.\nOverseas, the degree of government regulation affecting the Company varies considerably among countries, ranging from stringent testing and approval procedures in certain locations to simple registration procedures in others, while in some countries there is virtually no regulation of the sale of the Company's products. In general, the Company has not encountered material delays or unusual regulatory impediments in marketing its products internationally. Establishment of uniform regulations for European Community nations has taken place beginning January 1, 1995. The Company believes it will be subject to a single regulatory scheme for all of the participating countries, and has taken the necessary steps to assure ongoing compliance with these new, more rigorous regulations, including obtaining ISO certification for its manufacturing operations which will allow the Company to market products in Europe with a single registration applicable to all participating countries.\nHEALTH CARE MARKET\nThe health care industry continues to undergo change, led primarily by market forces which are demanding greater efficiencies and reduced costs. Government proposed health care mandates in the United States have not occurred, and it is unclear whether, and to what extent, any government mandate will affect the domestic health care market. Industry led changes are expected to continue irrespective of any governmental efforts toward health care reform. The scope and timing of any further government sponsored proposals for health care reform are presently unclear.\nThe primary trend in the industry is toward cost containment. Payors have been able to exercise greater influence through managed treatment and hospitalization patterns, including a shift from reimbursement on a cost basis to per capita limits for patient treatment. Hospitals have been severely impacted by the resulting cost restraints. The increasing use of managed care, centralized purchasing decisions, consolidations among hospitals and hospital groups, and integration of health care providers, are continuing to affect purchasing patterns in the health care system. Purchasing decisions are often shared by a coalition of surgeons, nursing staff, and hospital administrators, with purchasing decisions taking into account whether a product reduces the cost of treatment and\/or attracts additional patients to a hospital. All of these factors have contributed to reductions in prices for the Company's products and, in the near term, to slower acceptance of more advanced surgical procedures in which the Company's products are used, given hospital and surgeon concerns as to the costs of training and reimbursement by payors.\nThe Company could potentially benefit from this focus on cost containment. Stapling and laparoscopy decrease operating room time including anesthesia, patient recovery time and in many cases are highly cost effective. Doctors, patients, employers and payors all value decreased patient recovery time. This could lead to potential increases in volume as surgical stapling and laparoscopic procedures are selected over alternative techniques. However, an undue focus on discrete costs or similar limits which fail to consider the overall value of laparoscopy could adversely impact the Company. Some hospitals may also lose per night revenues through reduced post-operative care requirements as to procedures performed by laparoscopy, which could influence their analysis of acceptance of newer procedures. The Company is adapting itself to this new environment by promoting the cost effectiveness of its products, by striving to efficiently produce the highest quality products at the lowest cost, and by assisting hospitals and payors in achieving meaningful cost reductions for the health care system while retaining the quality of care permitted by the Company's products.\nRESTRUCTURING\nDuring the several years prior to 1993, the Company's sales and earnings increased substantially each year. In anticipation of continued comparable business growth, the Company expanded its workforce and constructed additional administrative and manufacturing facilities. Following the first quarter of 1993, sales volumes declined due to various factors impacting the health care industry and the Company. By the fourth quarter of 1993 it became apparent that the downtrend in the Company's business would be longer term than originally anticipated and the Company determined that significant efforts to reduce costs and fixed expenses through a restructuring were desirable. The Company reduced its workforce during 1993 and the first quarter of 1994 through voluntary and involuntary terminations of approximately 2,400 employees and through normal attrition, by approximately 29% from levels preceding the restructuring. Included in the reduction were approximately 14% of the management group, and 44% of the Company's corporate officers. Many of these positions, including executive positions, were eliminated or consolidated with other positions in the restructuring.\nConcurrent with the workforce reduction, the Company consolidated its operations as a means of reducing expenses and is in the process of leasing, sub-leasing, selling or consolidating facilities which are underutilized. The restructuring and other cost saving measures resulted in annualized cost savings of approximately $150 million, compared to what operating expenses would have been had such measures not been taken. The Company's operations effectively absorbed the impact of the workforce reduction and other aspects of the restructuring program, and it continues to evaluate opportunities for decreasing its selling, general and administrative expenses.\nEMPLOYEES\nAt December 31, 1994, the Company employed 5,922 persons, 5,124 domestically and 798 in foreign countries. None of the Company's domestic employees is represented by a labor union for purposes of collective bargaining. The Company considers its relations with its employees to be excellent.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company owns its corporate headquarters, which is located at 150 Glover Avenue, Norwalk, Connecticut, and owns or leases other facilities in Norwalk, North Haven and Wilton, Connecticut, in Ponce, Puerto Rico, and in seventeen foreign countries. The Norwalk corporate headquarters includes executive and administrative facilities and research laboratories. The other facilities in the United States and the facilities in Puerto Rico and in foreign countries consist variously of administrative offices, manufacturing, research, warehouse, distribution, sterilizer operation and assembly space. The North Haven, Connecticut and Puerto Rico facilities are the primary manufacturing facilities of the Company. The facilities at each of these locations are leased by the Company under longer term operating leases. The Company also maintains needle manufacturing facilities in Switzerland and Germany.\nDuring 1992 and 1993, the Company expanded its facilities in North Haven, Connecticut, Ponce, Puerto Rico, and various locations in Europe to accommodate current and anticipated increased demand for its products, and constructed a European headquarters and training facility in Elancourt, a suburb of Paris, France. The Elancourt properties are leased under a 15 year financing lease and a portion of the facility constructed is being used by the Company as a surgeon training facility and for administrative offices. The Company is presently attempting to sublease the unutilized portion of the Elancourt facility (refer to Note B in Notes to Consolidated Financial Statements).\nThe Company's facilities and equipment are in good operating condition, are suitable for their respective uses and are adequate for current needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nA. On July 12, 1989, Ethicon, Inc. filed a complaint against the Company in the United States District Court for the District of Connecticut alleging infringement of a single United States patent relating to trocars. In counterclaims, the Company has alleged, among other grounds, that Ethicon's actions tortiously interfered with the Company's business dealings and that Ethicon is infringing three of the Company's patents. The parties' cross-motions for preliminary injunctions were denied by the District Court in April 1991. The Company's motion to dismiss Ethicon's pending patent infringement action is pending. Ethicon has responded to this motion, but a hearing date has not yet been set. No trial date has been set. In the opinion of management, based upon the advice of counsel, the Company has valid claims against Ethicon and meritorious defenses against the claims by Ethicon. The Company believes that the ultimate outcome of this action should not have a materially adverse effect on the Company's consolidated financial statements.\nB. On March 10, 1992, the Company filed a complaint in the United States District Court for the District of Connecticut against Johnson & Johnson subsidiaries Johnson & Johnson Hospital Supplies, Inc. and Ethicon, Inc., alleging infringement of United States patents issued to the Company on January 28, 1992 covering the Company's endoscopic multiple clip applier. On February 16, 1994, a jury returned a verdict in favor of the defendants, holding that the Company's patent claims were invalid. The Company has appealed the verdict to the United States Court of Appeals for the Federal Circuit and argued the appeal on February 6, 1995. No decision has yet been rendered on the appeal.\nC. On April 16, 1992, a complaint in a shareholder's derivative action was filed in the Delaware Chancery Court, naming as defendants the Company and the members of its Board of Directors. The complaint, as amended, alleges the payment of excessive compensation in certain years to four executive officers of the Company. On April 20, 1993, another complaint was filed in the same court in a separate putative shareholder's derivative action, naming as defendants the Company and the members of its Board of Directors. The allegations in the additional complaint are comparable to those in the earlier filed action. On January 12, 1994, notwithstanding defenses believed to be meritorious, the defendants agreed to settle the claims asserted in these actions, subject to Court approval. Under the settlement, the defendants deny the allegations but have agreed to adjustments to the vesting and exercise terms of stock option grants for certain executives within three years of the court's approval of the settlement. On June 1, 1994, the Delaware Chancery Court issued an opinion that it was satisfied that the claims of excessive compensation were adequately investigated and reasonably settled, but that it was unable to evaluate the overall reasonableness of the proposed settlement pending further investigation by the plaintiff in connection with allegations of insider trading. Discovery on this issue is continuing following which the Court is expected to reconsider the proposed settlement.\nD. On May 27, 1992, the Company filed a complaint in the United States District Court for the Northern District of California against Origin Medsystems, Inc. (\"Origin\"), a subsidiary of Eli Lilly & Co., and Frederic Moll, an officer of Origin and a former employee and director of EndoTherapeutics. The Company acquired EndoTherapeutics in July 1992. On January 12, 1993, the District Court granted the Company's motion for a preliminary injunction. The infringing trocars were ordered removed from the market. The United States Court of Appeals for the Federal Circuit on December 13, 1993 denied Origin's appeal and affirmed the lower court's order for a preliminary injunction. A date for trial has not been set. The United States Patent Office, on the defendant Origin's request, is reexamining one of the Company's patents on its PREMIUM SURGIPORT retracting tip trocar. The reexamination does not apply to other patents held by the Company on the PREMIUM SURGIPORT trocar, or to patents on other trocars sold by the Company, including the SURGIPORT trocar and the newer VISIPORT and VERSAPORT trocars. In the opinion of management, based upon the advice of counsel, the Company has valid claims against the defendants.\nE. In August and September 1992, four complaints brought by shareholders as class actions were filed in the United States District Court for the District of Connecticut, naming the Company and two executives as defendants. The complaints allege wrongful conduct in violation of federal securities law and related state law which resulted in damages in connection with the plaintiff shareholders' purchases of the Company's common stock. During the second quarter 1993, the Company and certain executive officers were named as defendants in additional complaints styled as shareholder class actions, making comparable allegations to those in the earlier filed complaints. On June 23, 1993, the Court entered orders consolidating these cases. On October 8, 1993, the defendants moved to dismiss and\/or strike the consolidated complaint. No answers have yet been filed. In February and March 1994, three additional complaints brought by shareholders as class actions were filed in the United States District Court for the District of Connecticut, naming the Company and certain executives as defendants. The complaints allege wrongful conduct in violation of federal securities laws in connection with the plaintiff shareholders' purchases of the Company's common stock. In the opinion of management, based upon the advice of counsel, the defendants have meritorious defenses against the claims asserted in the actions. The Company believes that the ultimate outcome of these actions should not have a materially adverse effect on the Company's consolidated financial statements.\nF. On September 17, 1993, Ethicon, Inc. filed a Complaint against the Company in the United States District Court for the District of Delaware alleging that the Company's manufacture, use and sale of surgical staples used in a variety of the Company's staplers infringes certain patents. Ethicon, Inc. subsequently amended its complaint to add Ethicon Endo-Surgery and Design Standards Corporation, a Connecticut corporation and a supplier to the Company, as co-plaintiffs. The Company successfully moved to transfer the case to the United States District Court for the District of Connecticut. On December 13, 1993, the Company asserted counterclaims against Ethicon, Inc. and Ethicon Endo-Surgery for, among other things, infringing the Company's patents relating to surgical staples. In addition, the Company has asserted counterclaims against Design Standards Corporation for breach of its contractual obligations to the Company and for statutory unfair trade practices by purporting to assign rights to Ethicon which belong to the Company. In the opinion of management, based upon the advice of counsel, the Company has meritorious defenses against the claims asserted in this action and valid claims against the plaintiffs and Ethicon. The Company believes that the ultimate outcome of this action should not have a materially adverse effect on the Company's consolidated financial statements.\nG. In February 1994, Ethicon Endo-Surgery filed suit against the Company in the United States District Court for the Southern District of Ohio, alleging infringement by the Company's instruments of a single patent for a safety lockout mechanism on a linear cutter\/stapler. On June 7, 1994, the court denied the plaintiffs' motion for a preliminary injunction against the Company. The Company has asserted counterclaims under two patents owned by the Company. Ethicon has contested one of such patents in an interference proceeding before the Patent Office. In the opinion of management, based upon the advice of counsel, the Company has meritorious defenses against the claims asserted in the complaint and valid counterclaims against the plaintiffs. The Company believes that the ultimate outcome of this action should not have a materially adverse effect on the Company's consolidated financial statements.\nH. The Company is engaged in other litigation, primarily as a defendant in cases involving product liability claims. The Company is also involved in various other cases. The Company believes it is adequately insured in material respects against the product liability claims and, based upon advice of counsel, that the Company has meritorious defenses and\/or valid cross claims in these actions.\nIn the opinion of management, based upon the advice of counsel, the ultimate outcome of the above actions, individually or in the aggregate, should not have a materially adverse effect on the Company's consolidated financial statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth certain information pertaining to the executive officers of the Company as of January 31, 1995:\nVarious of the above-named persons are also officers of one or more of the Company's subsidiaries. Leon C. Hirsch and Turi Josefsen are husband and wife. No other family relationship exists between any of the above-named persons. Officers are elected for annual terms to hold office until their successors are elected, or until their earlier resignation or removal by the Board of Directors. All of the executive officers have for at least the past five years held high level management or executive positions with the Company or its subsidiaries, except for Mr. Douville, who joined the Company in 1993, Mr. Mazzarese, who joined the Company in 1991, and Mr. Sharma, who joined the Company in 1994. Mr. Douville was previously employed from 1977 to 1992 by the accounting firm of Deloitte & Touche, where he was a partner, and was Vice President and Controller with PepsiCo. Foods International from 1992 until joining the Company. Mr. Mazzarese was previously Vice President, Regulatory Affairs\/Clinical Affairs, Product Assurance, at the Shiley division of Pfizer Corporation's Hospital Products Group from 1987 until October, 1991. Mr. Sharma was previously with General Electric Medical Systems, where he was General Manager of the Global Nuclear Medicine and Positron Emission Tomography business, and from 1987 through 1991, in various management positions at Rohm and Haas Company, a specialty chemicals manufacturer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nThe Company's Common Stock is traded on the New York Stock Exchange under the symbol USS. The following table sets forth for the periods indicated the high and low of the daily sales prices, which represent actual transactions, as reported by the New York Stock Exchange. In addition, the table sets forth the amounts of quarterly cash dividends per share that were declared and paid by the Company.\nAt December 31, 1994, the number of record holders of the Company's Common Stock was 12,715. See discussion below in Management's Discussion and Analysis of Financial Condition and Results of Operations as to restrictions imposed by a credit agreement on registrant's level of dividend payments.\n- 19 -\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n(1) In the fourth quarter of 1994 the Company signed a letter of intent to purchase the assets of its independent distributor in Japan, which includes inventory of the Company's products purchased by the independent distributor but not yet sold to third parties at December 31, 1994. Sales and Net income were reduced by $17 million and $8 million ($.14 per common share), respectively, in anticipation of the pending reacquisition of these products and valuing these products at the Company's production cost.\n(2) Income (loss) before income taxes and net income (loss) for 1993 include restructuring charges of $137.6 million and $129.6 million ($2.31 per share), respectively.\n- 20 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nIn 1994, the Company attained sales of $919 million compared with sales of $1.04 billion in 1993 and sales of $1.2 billion in 1992. Sales decreased by $119 million or 11% in 1994, and decreased by $160 million or 13% in 1993 and increased by $354 million or 42% in 1992. In 1994, the Company reported net income of $19 million or $.08 per common share (after preferred stock dividends of $15 million), compared with a net loss of $139 million or $2.48 per common share in 1993 and net income of $139 million or $2.32 per common share in 1992. Net income and net income per common share increased $158 million and $2.56, respectively, in 1994 compared to 1993 and decreased $278 million and $4.80, respectively, in 1993 compared to 1992 and increased $48 million and $.74, respectively, in 1992 over 1991. The effects of foreign currency exchange rate changes on net income in 1994, 1993 and 1992 were immaterial.\nIn the second half of 1993 the Company adopted restructuring plans designed to reduce its cost structure and improve its competitive position through property divestitures and consolidations and a reduction in its management, administrative and direct labor workforce. These plans were adopted when it became apparent that projected worldwide sales growth and the pace of reduction in trade barriers and other related considerations among European countries did not meet Company expectations. Increased price competition in the Company's domestic markets also prompted the Company to reduce its cost structure. At the end of the 1993 third quarter the Company announced a layoff of approximately 700 administrative staff personnel, closure of its manufacturing plants for thirteen days in the fourth quarter of 1993 and the adoption of a four day work week for certain manufacturing employees during the early part of 1994. In the fourth quarter of 1993 the Company expanded its restructuring plan to include real estate divestitures and consolidations and employee voluntary and involuntary severance programs. The monthly payments under such severance programs will be substantially completed by March 31, 1995.\nIn 1993 the Company recorded restructuring charges of $138 million ($130 million or $2.31 per share net of taxes). These charges consisted primarily of write downs of certain real estate to estimated net realizable value ($79 million, of which $58 million related to the Company's new European office building complex and distribution center in Elancourt, France), provisions for lease buyout expenses ($24 million), accruals for severance costs ($30 million) and write down of other assets ($5 million). Approximately $38 million of the restructuring charges resulted in cash outflows related to severance and accrued lease obligations, the majority of which was funded through operating cash flows and credit facilities in 1994. The Company has several companies interested in subleasing the unutilized space in its office building complex and distribution center in Elancourt, France and is hopeful that a subleasing arrangement will be consummated in 1995 at a lease rental which approximates the written down carrying value of the facility. The Company has either terminated or bought out the leases on the majority of those leased properties which were part of the 1993 restructuring charges. All of the employees whose severance was included in the 1993 restructuring charges have been terminated and the vast majority of the Company's severance obligations have been paid as of December 31, 1994. Accrued restructuring charges at December 31, 1994 are approximately $18 million and relate primarily to accrued lease buyout expenses ($15 million) and unpaid severance costs ($3 million). The majority of accrued restructuring charges are expected to be liquidated by December 31, 1995.\nOther cost savings measures taken by the Company in 1994 included the reduction of salaries of all corporate officers by 10% and the salary of the Chief Executive Officer by 20%, freezing the salaries of substantially all other employees worldwide, and requiring higher co-payments and deductibles in connection with employee health benefits programs. The Company estimates that the future annual operating cost savings associated with the restructuring plans will approximate $110 million of which more than $80 million represents cash flow savings from reduced salaries expense and the remainder of which represents reduced rent and depreciation expense. Cost saving measures beyond such restructuring plans should result in additional annual operating cost savings of approximately $40 million. As a result of the restructuring plans and other cost saving measures, 1994 compensation expenses were approximately $67 million lower than 1993 compensation expenses.\nThe reduction in sales in 1994 to $919 million compared to 1993 was significantly affected by initial distributor stocking programs in early 1993, which were not repeated in 1994 and by competition and pricing pressures due to proposed health care reform. Distributor inventory purchases were made in connection with the implementation of the Company's Just-In-Time (JIT) domestic hospital distribution program during the first quarter of 1993. The initial stocking of JIT distributors precipitated an inventory reduction period during which the hospitals formerly supplied directly by the Company worked their inventories down and distributors adjusted their own inventories. The Company believes that inventories at JIT distributors at the end of 1994 are down significantly, because distributor sales to hospitals during the year significantly exceeded distributor purchases from the Company. The Company believes that distributor inventories are reaching optimum levels and that its sales to distributors for hospitals currently in a JIT program will approximate distributor sales to hospitals during 1995.\nSales in the fourth quarter of 1994 were reduced by $17 million and net income was reduced by $8 million ($.14 per common share) in anticipation of the Company's acquisition of the assets of its independent distributor in Japan, which includes inventory of the Company's products purchased by the independent distributor but not yet sold to third parties at December 31, 1994 (see Note C in Notes to Consolidated Financial Statements). Sales and gross profit were reduced in anticipation of the pending reacquisition of these products and valuing the reacquired products at the Company's production cost.\nThe Company continues to be affected by intense competition, and by ongoing changes in the health care industry which impact hospital purchasing decisions. The rate of acceptance of newer procedures utilizing the Company's products also continues to be affected by uncertainty surrounding health care reform and by the increased educational requirements for more complex procedures.\nThe following table analyzes the change in sales in 1994, 1993 and 1992 compared with the prior years.\nSales unit decreases and the effects of foreign currency exchange rate fluctuations accounted for 80% and 2%, respectively, of the total 1994 sales decrease compared with 1993 and 71% and 25%, respectively, of the total 1993 sales decrease compared with 1992. The net price change component of the 1994 and 1993 sales decreases, accounting for 18% and 4% of the total sales decreases in these years, respectively, reflect the net effect of selling price discounts granted to hospitals and JIT distributors, partially offset by price list increases. Increased sales of the Company's minimally invasive surgery products was the primary factor in the strong sales gains in 1992, when sales unit increases accounted for 87% of the total sales increases.\nSales in 1994 were reduced by approximately $6 million representing the effect of establishing a sales reserve in connection with a new returned goods policy which was effective July 1, 1994. Under the previous policy, the Company did not grant credits for product returns. The new policy grants full credit to direct hospital customers for certain products returned up to one year after initial shipment and a partial credit for certain products returned up to four years after initial shipment. The initial establishment of this reserve reduced second quarter sales by approximately $8 million, partially offset by a $4 million adjustment of other sales reserves in the second quarter of 1994. The returned goods reserve was reduced from $8 million to $6 million in the third quarter of 1994 based upon lower than estimated product returns, and other sales reserves in the fourth quarter of 1994 were also reduced by $2 million.\nGross margin from operations (sales less cost of products sold divided by sales) was 50% in 1994, 50% in 1993 and 60% in 1992. Although the Company implemented the majority of its restructuring plans during the last quarter of 1993 and the first quarter of 1994, the major benefits of the cost reduction measures adopted by the Company did not start being realized until the last nine months of 1994, which resulted in improved quarterly gross margins the last three quarters in 1994 compared to the corresponding periods in 1993. Gross margins in 1993 compared to 1992 were negatively impacted by higher costs associated with the increase in productive capacity, the introduction of new products and increases in related inventory and fixed asset reserves from the consequent obsolescence of production tooling and inventories and additional selling price discounts granted to JIT distributors with the implementation of the JIT distribution program. The reserve for obsolescence of production tooling and inventories, which are an ongoing cost of business, amounted to $61 million, $62 million and $34 million, respectively, in the years ended December 31, 1994, 1993 and 1992. Changes in foreign currency exchange rates from those existing in 1992 had the effect of reducing cost of products sold by $18 million in 1993. The effects of foreign currency exchange rate changes on cost of products sold in 1994 and 1992 were immaterial.\nThe Company's investment in research and development during the past three years (1994 - $38 million; 1993 - $51 million; 1992 - $44 million) has yielded numerous product improvements as well as the development of numerous new products. The decrease in research and development expense in 1994 compared to 1993 reflects the impact of a program initiated in the second half of 1993 to increase efficiency and reduce the cost connected with the pilot development of new products which are classified as research and development. In 1993 and 1992 the primary focus of the Company's research and development program had been directed at minimally invasive surgery products. The Company is continuing its commitment to develop unique new products for use in new surgical procedures and specialty areas. The Company presently plans to continue its investment in research and development at levels approximating 3% - - 5% of annual sales in the future.\nSelling, administrative and general expenses expressed as a percentage of sales were 40% in 1994, 43% in 1993, and 39% in 1992. The Company began to realize the major cost saving benefits from its restructuring program in the form of reduced selling, administrative and general expenses as a percentage of sales in the second quarter of 1994. The percentage increase in 1993 resulted primarily from higher depreciation and amortization charges related to the Company's facilities expansion. Expressed in total dollars, the reduction in these expenses in 1993 compared to 1992 reflects lower salespersons commission and related expenses which were influenced by decreased sales. In 1992 these expenses increased primarily as a result of the continued expansion of the Company's domestic and international sales organizations, growth in sales expenses relating to the Company's increased sales and an increase in expenses relating to training of surgeons in the use of the Company's products. Changes in foreign currency exchange rates in 1993 from those existing in 1992 had the effect of reducing selling, administrative and general expenses by $21 million in 1993. The effects of foreign currency exchange rate changes on selling, administrative and general expenses in 1994 and 1992 were immaterial.\nThe tax provisions for 1994 and 1993 relate primarily to foreign taxes including taxes in Puerto Rico. The 1993 tax provision is a result of the Company incurring net operating losses in certain tax jurisdictions for which it is not able to recognize the corresponding tax benefits. The Company's tax provisions in 1994 reflect the lower effective tax rates on a subsidiary's operations in Puerto Rico and the availability of a tax credit under Section 936 of the Internal Revenue Code and the tax benefit of certain net operating loss carryforwards which were not previously usable. The Internal Revenue Service has examined the Company's income tax returns for the period 1984 to 1990 and it has proposed adjustments to increase the Company's tax liability for certain of these years. Based upon advice of tax counsel, the Company believes that it has substantial support for its filing positions and does not believe that the results of the tax audit will have a material adverse effect on the consolidated financial statements of the Company but may reduce the availability of fully reserved net operating loss and tax credit carryforwards.\nFINANCIAL CONDITION\nThe Company's current cash and cash equivalents, existing borrowing capacity and projected operating cash flows are currently well in excess of its foreseeable requirements. Following the successful issuance of $200 million of convertible preferred stock in March 1994, the proceeds from which were utilized to reduce bank debt, the Company entered into a new syndicated credit agreement in June 1994 which replaced its revolving credit and term loan agreements and reduced the size of the credit facility from $675 million to $400 million. The new credit agreement matures in January 1997 and provides for certain restrictions including sales of assets, capital expenditures, dividends and subsidiary debt and requires the maintenance of certain minimum levels of tangible net worth and fixed charge coverage ratios and its debt to total capitalization ratio may not exceed a certain stipulated level. The Company is in full compliance with all of the covenants associated with its various bank and leasing agreements.\nThe Company's building programs have been essentially completed, which enabled the Company to reduce its capital spending by more than 78% in 1994 compared to 1993 levels. Additions to property, plant, and equipment on the accrual method totaled $49 million ($47 million on a cash basis) in 1994, compared with $187 million in 1993, and $272 million in 1992, and consist of additions to machinery and equipment ($32 million), leasehold improvements ($2 million), molds and dies ($13 million) and land and buildings ($2 million). During 1994 the Company removed from its Balance Sheet property, plant, and equipment which was fully depreciated and out of service with a cost of $19 million.\nThe increase in cash and cash equivalents and the reduction of long-term debt at December 31, 1994 in comparison to the prior year-end is primarily attributable to the receipt of the net proceeds ($191 million ) from the issuance of the Company's preferred stock (liquidation value $200 million) and the generation of positive cash flow from operations. The reduction in inventories ($45 million) from the prior year-end level resulted primarily from improved utilization and management of raw materials in the Company's production process. The reduction in accrued liabilities ($12 million) from the prior year-end level was primarily attributable to 1994 payments of accrued severance obligations which were expensed in 1993 as a component of the restructuring charges partially offset by an accrual ($17 million) for the pending acquisition of the assets of its independent distributor in Japan, which includes inventory of the Company's products purchased by the independent distributor but not yet sold to third parties at December 31, 1994 (see Note C in Notes to Consolidated Financial Statements). Severance payments are generally being made over a period of up to twelve months.\nThe Company routinely enters into foreign currency exchange contracts to reduce its exposure to foreign currency exchange rate changes on the results of operations of its foreign subsidiaries. As of December 31, 1994 the Company had approximately $16 million of such contracts outstanding that will mature at various dates through February 1995. Realized and unrealized foreign currency gains and losses are recognized when incurred. As a result of the Company's hedging program the changes in foreign currency exchange rates had an immaterial effect on its results of operations. The weakening of the dollar relative to most foreign currencies caused the $12 million movement in the Company's Accumulated Translation Adjustments component of Stockholders' Equity at December 31, 1994 compared to the prior year end.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nA. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED).\nThe following is a summary of the quarterly results of operations for the years ended December 31, 1994 and 1993.\n(1) In the second quarter of 1993 in anticipation of the pending purchase by the Company of an international distributor, the Company accrued for the reacquisition of inventory from this distributor and reduced Net sales by $10 million and Cost of products sold by $4 million. In the fourth quarter of 1993 the negotiations for the purchase of the distributor were suspended and the Company reversed the second quarter entries and increased Net sales by $9 million and Cost of products sold by $3 million. In the fourth quarter of 1994 the Company reached an agreement to purchase the assets of this distributor and accrued for the reacquisition of inventory from this distributor and reduced Net sales by $17 million and Net income by $8 million ($.14 per common share).\n(2) Income (loss) before income taxes for 1993 includes restructuring charges of $138 million (third quarter - $8 million; fourth quarter - $130 million). Net income (loss) for 1993 includes restructuring charges of $130 million or $2.31 per share (third quarter - $ 6 million or $.11 per share; fourth quarter - $124 million or $2.20 per share).\n(3) Cost of products sold in the fourth quarter includes $16 million of inventory and fixed asset reserves ($19 million in the corresponding period in 1993) resulting from the continued introduction of new products and the consequent obsolescence of production tooling and inventories.\nB. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.\nSee Index to Consolidated Financial Statements and Financial Statement Schedules on page herein.\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.\nA. DIRECTORS\nThe section entitled \"Election of Directors\" in the Definitive Proxy Statement for the 1995 Annual Meeting of Stockholders of the registrant (the 1995 Proxy Statement) is hereby incorporated by reference.\nB. OFFICERS\nSee Part I.\nC. COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934\nThe section entitled \"Executive Compensation and Transactions - Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the 1995 Proxy Statement is hereby incorporated by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe section entitled \"Executive Compensation and Transactions\" in the 1995 Proxy Statement is hereby incorporated by reference, except for those portions entitled \"Performance Graph\" and \"Report of Compensation Committee\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe sections entitled \"Outstanding Shares, Voting Rights and Principal Stockholders\" and \"Share Ownership of Management\" in the 1995 Proxy Statement are hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe section entitled \"Executive Compensation and Transactions - Certain Transactions\" in the 1995 Proxy Statement is hereby incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\nA. AND D. FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE. See Index to Consolidated Financial Statements and Financial Statement Schedule on Page herein.\nB. REPORTS ON FORM 8-K. None.\nC. EXHIBITS. (The Company will furnish a copy of any exhibit upon payment of 15 cents per page plus postage.)\n(3) ARTICLES OF INCORPORATION AND BY-LAWS.\n(a) Certificate of Incorporation filed March 14, 1990 - Exhibit 3(a) to registrant's Form 8-B declared effective August 3, 1990.*\n(b) Certificate of Merger filed May 1, 1990 - Exhibit 3(b) to registrant's Form 8- B declared effective August 3, 1990.*\n(c) Certificate of Amendment filed May 15, 1991 - Exhibit 3(c) to registrant's Form 10-K for 1991.*\n(d) By-laws adopted March 14, 1990 - Exhibit 3(c) to registrant's Form 8-B declared effective August 3, 1990.*\n(e) Certificate of Designations relating to the issuance of the Company's Series A Convertible Preferred Stock, filed March 28, 1994. Exhibit 3(e) to registrant's Form 10-K for 1993.*\n(4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES.\n(a) Credit Agreement as of June 27, 1994 among registrant, signatory banks, Morgan Guaranty Trust Company of New York as Documentation Agent and Nations Bank of North Carolina, N.A., as Administration Agent - Exhibit 4(a) to registrant's Form 10-Q for the quarter ended June 30, 1994.*\n(10) MATERIAL CONTRACTS.\n(a) 1981 Employee Stock Option Plan, as amended through May 5, 1987 - Exhibit 10(a)(1) to registrant's Form 10-K for 1987.* +\n(b) Amendment to 1981 Employee Stock Option Plan adopted May 2, 1989 - Exhibit 10(b) to registrant's Form 10-K for 1989.* +\n(c) Amendment to 1981 Employee Stock Option Plan adopted May 1, 1990 - Exhibit 10(c) to registrant's Form 10-K for 1990.* +\n(d) 1990 Employee Stock Option Plan - Exhibit B to registrant's Proxy Statement dated March 19, 1990, for its May 1, 1990, Annual Meeting of Stockholders.* + (e) Amendment to 1990 Employee Stock Option Plan adopted July 30, 1990 - Exhibit 10(e) to registrant's Form 10-K for 1990.* +\n(f) Amendment to 1990 Employee Stock Option Plan adopted May 15, 1991 - Exhibit 10(f) to registrant's Form 10-K for 1991.* +\n(g) Amendment to 1981, 1990 and 1993 Employee Stock Option Plans adopted March 9, 1993. Exhibit 10(h) to registrant's Form 10-K for 1993.* +\n(h) Restricted Stock Incentive Plan, as amended through May 5, 1987 - Exhibit 10(a)(2) to registrant's Form 10-K for 1987.* +\n(i) Amendment to Restricted Stock Incentive Plan adopted May 15, 1991 - Exhibit 10(h) to registrant's Form 10-K for 1991.* +\n(j) Installment Option Purchase Agreement with Leon C. Hirsch dated September 10, 1984, as amended through May 18, 1994. Filed herewith.+\n(k) Outside Directors Stock Plan - Exhibit 10(a)(4) to registrant's Form 10-K for 1988.* +\n(l) Amendment to Outside Directors Stock Plan adopted May 1, 1990 - Exhibit 10(j) to registrant's Form 10-K for 1990.* +\n(m) Long-Term Incentive Plan - Exhibit 10(a)(5) to registrant's Form 10-K for 1988.* +\n(n) Lease Agreement dated as of January 14, 1993 between State Street Bank and Trust Company of Connecticut, National Association, as Lessor and the registrant, as Lessee - Exhibit 10(o) to registrant's Form 10-K for 1992.*\n(o) Participation Agreement dated as of January 14, 1993 among registrant, Lessee, Baker Properties Limited Partnership, Owner Participant, The Note Purchasers listed in Schedule 1 thereto, State Street Bank and Trust Company of Connecticut, National Association, Owner Trustee, and Shawmut Bank Connecticut, N.A., Indenture Trustee - Exhibit 10(p) to registrant's Form 10-K for 1992.*\n(p) Letter Agreement between the registrant and Bruce S. Lustman dated March 11, 1994 - Exhibit 10(q) to registrant's Form 10-K for 1993.* +\n(q) Lease and financing agreements dated January 4, 1994 between registrant's French subsidiary, A.S.E. Partners, and (i) the Corporation for the Financing of Commercial Buildings (\"FINABAIL\") and (ii) the Association for the Financing of Commercial Buildings (\"U.I.S.\") - Exhibit 10(r) to registrant's Form 10-K for 1993.*\n(r) Lease and financing agreement dated December 26, 1991 between registrant's subsidiary, U.S.S.C. Puerto Rico, Inc., and The Puerto Rico Industrial Development Company (\"PRIDCO\") - Exhibit 10(s) to registrant's Form 10-K for 1993.*\n(11) Statement regarding computation of per share earnings. Filed herewith.\n(12) Statement of Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends. Filed herewith.\n(21) Subsidiaries of the registrant. Filed herewith.\n(27) Financial Data Schedule. Filed herewith\n* Previously filed as indicated and incorporated herein by reference. Exhibits incorporated by reference are located in SEC File No. 1-9776.\n+ Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of this report.\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 on the 7th day of February, 1995.\nUNITED STATES SURGICAL CORPORATION (REGISTRANT)\nBy: \/s\/ HOWARD M. ROSENKRANTZ -------------------------------- (HOWARD M. ROSENKRANTZ SENIOR VICE PRESIDENT, FINANCE 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 dates indicated.\nUNITED STATES SURGICAL CORPORATION\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\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 or are inapplicable, and therefore have been omitted.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders UNITED STATES SURGICAL CORPORATION\nWe have audited the accompanying consolidated financial statements and financial statement schedule of United States Surgical Corporation and subsidiaries listed in the Index to Consolidated Financial Statements and Financial Statement Schedule of the Annual Report on Form 10-K of United States Surgical Corporation for the year ended December 31, 1994. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the 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 consolidated 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 United States Surgical Corporation and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in 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.\n\/s\/ DELOITTE & TOUCHE LLP - --------------------- Deloitte & Touche LLP\nStamford, Connecticut January 24, 1995, except for Note C, as to which the date is February 1, 1995\nINDEPENDENT AUDITORS' CONSENT TO INCORPORATION BY REFERENCE IN REGISTRATION STATEMENTS ON FORM S-3 AND FORM S-8\nWe consent to the incorporation by reference in United States Surgical Corporation's Registration Statement No. 2-96790 on Form S-3 and Registration Statements Nos. 2-64804, 2-78663, 33-3419, 33-13997, 33-37328, 33-38710, 33-40171, 33-59278 and 33-61912 on Form S-8 of our report dated January 24, 1995 (except for Note C, as to which the date is February 1, 1995) and appearing on page of the Annual Report on Form 10-K for the year ended December 31, 1994. We also consent to the reference to us, under the heading \"Financial Statements\" in the Registration Statement on Form S-3.\n\/s\/ DELOITTE & TOUCHE LLP - --------------------- Deloitte & Touche LLP\nStamford, Connecticut February 1, 1995\nMANAGEMENT REPORT ON RESPONSIBILITY FOR FINANCIAL REPORTING\nThe management of United States Surgical Corporation and its subsidiaries (the \"Company\") has the responsibility for preparing the accompanying consolidated financial statements and related notes. The consolidated financial statements were prepared in accordance with generally accepted accounting principles and necessarily include amounts based upon judgments and estimates by management. Management also prepared the other information in the annual report and is responsible for its accuracy and consistency with the consolidated financial statements.\nManagement of the Company has established and maintains a system of internal controls that provide reasonable assurance that the accounting records may be relied upon for the preparation of the consolidated financial statements. Management continually monitors the system of internal controls for compliance. Also, the Company maintains an internal auditing function that independently assesses the effectiveness of the internal controls and recommends possible improvements thereto. The Company's consolidated financial statements have been audited by Deloitte & Touche LLP, independent auditors. Management has made available to Deloitte & Touche LLP all the Company's financial records and related data. In addition, in order to express an opinion on the Company's consolidated financial statements, Deloitte & Touche LLP considered the internal accounting control structure in order to determine the extent of their auditing procedures for the purpose of expressing such opinion but not to provide assurance on the internal control structure. Management believes that the Company's system of internal controls is adequate to accomplish the objectives discussed herein.\nThe Board of Directors monitors the internal control system through its Audit Committee which consists solely of outside directors. The Audit Committee meets periodically with the independent auditors, internal auditors and senior financial management to determine that they are properly discharging their responsibilities.\nLeon C. Hirsch Chief Executive Officer\nHoward M. Rosenkrantz Chief Financial Officer\nUNITED STATES SURGICAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nSee Notes to Consolidated Financial Statements.\nUNITED STATES SURGICAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nSee Notes to Consolidated Financial Statements.\nUnited States Surgical Corporation and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity\nSee Notes to Consolidated Financial Statements.\nUnited States Surgical Corporation and Subsidiaries Consolidated Statements of Cash Flows\nSee Notes to Consolidated Financial Statements.\nUNITED STATES SURGICAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION. The consolidated financial statements include the accounts and transactions of United States Surgical Corporation and Subsidiaries (the \"Company\"), excluding intercompany accounts and transactions. Certain subsidiaries (including branches), primarily operating outside the United States, are included in the consolidated financial statements on a fiscal-year basis ending November 30.\nPROPERTY, PLANT, AND EQUIPMENT. Depreciation and amortization is provided using the straight-line method over the following estimated useful lives:\nThe Company capitalizes interest incurred on funds used to construct property, plant, and equipment. Interest capitalized during 1994, 1993 and 1992 was immaterial.\nINVENTORIES. Inventories are stated at the lower of cost (first-in, first-out method) or market.\nOTHER ASSETS. The Company capitalizes and includes in Other Assets the costs of acquiring patents on its products, the costs of computer software developed and used in its information processing systems, goodwill arising from the excess of cost over the fair value of net assets of purchased businesses and deferred start-up costs incurred prior to 1991 relating to the Company's entrance in 1991 into the suture portion of the wound management market. These costs are amortized on the straight-line basis over the following estimated useful lives:\nREVENUE RECOGNITION. Revenues from sales are recognized when products are sold directly by the Company to ultimate consumers, primarily hospitals, or to authorized distributors.\nFOREIGN CURRENCY TRANSLATION. For translation of the financial statements of its international operations the Company has determined that the local currencies of its international subsidiaries are the functional currencies. Assets and liabilities of foreign operations are translated at year end exchange rates, and income statement accounts are translated at average exchange rates for the year. The resulting translation adjustments are made directly to the Accumulated Translation Adjustments component of Stockholders' Equity. Foreign currency transactions are recorded at the exchange rate prevailing at the transaction date.\nNET INCOME (LOSS) PER COMMON SHARE AND COMMON SHARE EQUIVALENT. Net income (loss) per common share and common share equivalent is based on the weighted average number of common shares and, where material, common share equivalents (stock options) outstanding. Common share equivalents are not included in the computation of net income (loss) per share in 1994 and 1993 since the effect of their inclusion would be antidilutive.\nNOTE B - RESTRUCTURING CHARGES\nIn the second half of 1993 the Company adopted a restructuring plan designed to reduce its cost structure and improve its competitive position through property divestitures and consolidations and a reduction in its management, administrative and direct labor workforce. During 1993 the Company recorded restructuring charges of $138 million ($130 million after taxes). These charges consisted primarily of write downs of certain real estate to estimated net realizable value ($79 million), provisions for lease buyout expenses ($24 million), severance costs ($30 million) and write down of other assets ($5 million).\nThe majority of the restructuring charges were non-cash in nature. Accrued Liabilities at December 31, 1993 included $56 million related primarily to severance costs and accrued lease obligations, the majority of which was paid in 1994. Included in restructuring charges was a $58 million charge related to the Company's new European building complex and distribution center at Elancourt, France. The Company decided to sublease unutilized space rather than occupy the entire Elancourt facility when it became apparent that projected worldwide sales growth and the pace of reduction in trade barriers and related considerations among European countries did not meet Company expectations. The estimated net realizable value of these facilities was based upon the present value of rental income expected to be received, assuming the facilities were subleased after one year.\nThe Company has several companies interested in subleasing the unutilized space in its building complex and distribution center in Elancourt, France and is hopeful that a subleasing arrangement will be consummated in 1995 at a lease rental which approximates the written down carrying value of the facility. The Company has either terminated or bought out the leases on the majority of those other leased properties which were part of the 1993 restructuring charges. All of the employees whose severance was included in the 1993 restructuring charges have been terminated and the vast majority of the Company's severance obligations have been paid as of December 31, 1994. Approximately $38 million of the restructuring charges resulted in cash outflows related to severance and accrued lease obligations, the majority of which was funded through operating cash flows and credit facilities in 1994. Accrued restructuring charges at December 31, 1994 are approximately $18 million and relate primarily to accrued lease buyout expenses ($15 million) and unpaid severance costs ($3 million). The majority of accrued restructuring charges are expected to be liquidated by December 31, 1995.\nNOTE C - ACQUISITIONS\nIn November 1994 the Company signed a letter of intent to purchase the assets of its independent distributor in Japan, which consist of real property with a book value of approximately $10 million, inventories of products purchased by the distributor from the Company at the distributor's cost of approximately $17 million and intangible assets (primarily goodwill). The Company substantially completed its due diligence investigations in December 1994 and it signed the Asset Purchase Agreement on February 1, 1995 for a purchase price of approximately $61 million payable over seven years at no interest (present value of the purchase price approximately $46 million). Before the closing of the transaction can occur the transaction must receive the approval of two governmental authorities in Japan, which the Company expects to receive in March 1995. In anticipation of the reacquisition of the distributor's inventory of products previously purchased by the distributor from the Company, the Company reduced 1994 sales revenue and gross profit by approximately $17 million and $8 million ($.14 per common share), respectively, based upon the inventory quantities on-hand at the distributor's warehouse as of December 31, 1994.\nIn July 1992, the Company purchased all of the outstanding common stock of EndoTherapeutics for approximately $60 million of the Company's common stock (approximately 580,000 shares). Under the purchase agreement the Company acquired EndoTherapeutics' laparoscopic surgical technology, including the trocar and pneumoperitoneum needle patents which the Company previously licensed from EndoTherapeutics, technical know-how and other assets. The acquisition has been accounted for by the purchase method. The purchase price has been primarily allocated to the acquired patents which are included in Other Assets.\nNOTE D - PROPERTY, PLANT, AND EQUIPMENT\nAt December 31, 1994 and 1993, Property, plant, and equipment (at cost) were comprised of the following items:\nProperty, plant, and equipment at December 31, 1994 includes land and building in Elancourt, France with a net book value of $70 million. During 1994 the Company removed from its Balance Sheet Property, plant and equipment which was fully depreciated with a cost of $19 million.\nNOTE E - OTHER ASSETS\nAt December 31, 1994 and 1993 Other Assets (net of accumulated amortization of $57 million and $61 million in 1994 and 1993, respectively) were comprised of the following items:\nDuring 1994 the Company removed from its Balance Sheet fully amortized Other Assets with a cost of $23 million.\nNOTE F - INCOME TAXES\nThe Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109 - \"Accounting for Income Taxes\" (FAS 109) in February 1992, and the Company was required to adopt FAS 109 by January 1, 1993. This statement requires that deferred income taxes reflect the tax consequences on future years of differences between the tax return bases of assets and liabilities and their financial statement amounts.\nPrior to 1993, provisions were made by the Company for deferred income taxes where differences existed between the time that transactions affected taxable income and the time that these transactions entered into the determination of income for financial reporting purposes. The effect of the adoption of FAS 109 on a prospective basis from January 1, 1993 was not material.\nA summary of the source of income (loss) before income taxes follows:\n(a) Includes Puerto Rico and U.S. branches in foreign locations.\nA summary of the provision for income taxes follows:\n(a) Includes Puerto Rico.\nA reconciliation between income taxes based on the application of the statutory federal income tax rate (1994 and 1993 - 35%; 1992 - 34%) to income before income taxes and the provision for income taxes as set forth in the Consolidated Statements of Operations follows:\nThe Company has provided for taxes on the income of its manufacturing subsidiary's operations in Puerto Rico at an effective rate that is lower than the U.S. federal income tax statutory rate. This rate reflects the fact that approximately 90% of income is exempt from local taxes in Puerto Rico as well as the availability of a tax credit under Section 936 of the Internal Revenue Code. Withholding taxes at a negotiated rate of 7% (6% in 1993 and 5% in 1992) have been provided on the expected repatriation of the income of this subsidiary.\nAt December 31, 1994 deferred tax liabilities and assets under FAS 109 were comprised of the following:\nDeferred taxes resulted from temporary differences in the recognition of revenue and expense for tax and financial statement purposes. The source of the temporary differences, none of which are individually material, are: the use of accelerated methods of computing depreciation for income tax purposes and the straight-line method for financial reporting purposes; expensing certain patent costs as incurred for income tax purposes and capitalizing and amortizing them over their estimated useful lives for financial reporting purposes; accruals and provisions not currently deductible for tax purposes; expensing certain deferred start-up costs incurred for income tax purposes and deferring and amortizing such costs over a five year period for financial reporting purposes; and other temporary differences applicable to current assets and liabilities.\nAt December 31, 1994 current deferred tax assets of $6 million and non-current deferred tax assets of $12 million were included in the Consolidated Balance Sheet captions Other Current Assets and Other Assets, respectively. Current deferred tax liabilities of $1 million and non-current deferred tax liabilities of $9 million were included in the Consolidated Balance Sheet captions Income Taxes Payable and Deferred Income Taxes, respectively.\nThe Company's loss carryforwards prior to 1993 are primarily attributable to compensation expense deductions on its income tax return which were not recognized for financial accounting purposes. A valuation allowance in the amount of $205 million has been recorded as of December 31, 1994 ($198 million at December 31, 1993) because of the uncertainty over the future utilization of the tax benefit of its gross deferred tax assets.\nAt December 31, 1994 the Company's consolidated subsidiaries have unremitted earnings of $110 million on which the Company has not accrued a provision for U.S. federal income taxes since these earnings are considered to be permanently invested. The amount of the unrecognized deferred tax liability relating to unremitted earnings was approximately $28 million at December 31, 1994.\nThe Internal Revenue Service completed its examination of the Company's tax returns through December 31, 1983 resulting in no material impact on the Company's consolidated financial statements. The Internal Revenue Service has examined the Company's tax returns for the period 1984 through 1990 and it has proposed adjustments to increase the Company's tax liability for certain of these years. Based upon the advice of tax counsel, the Company believes that it has substantial support for its filing positions and does not believe that the results of the tax audit will have a material effect on the consolidated financial statements of the Company but may reduce the availability of fully reserved net operating loss and tax credit carryforwards.\nThe Company has available for U.S. Federal income tax return purposes the following net operating loss and tax credit carryforwards:\nIn addition, the Company has available for state and foreign income tax return purposes net operating loss carryforwards of $141 million and $93 million, respectively, and tax credits of $5 million which expire at various dates.\n(a) The exercise of stock options which have been granted under the Company's various stock option plans and the vesting of restricted stock give rise to compensation which is includable in the taxable income of the applicable employees and deductible by the Company for federal and state income tax purposes. Such compensation results from increases in the fair market value of the Company's Common Stock subsequent to the date of grant of the applicable exercised stock options and restricted stock and, accordingly, in accordance with Accounting Principles Board Opinion No. 25, such compensation is not recognized as an expense for financial accounting purposes and the related tax benefits are taken directly to Additional Paid-in Capital - Common Stock. In the years ended December 31, 1990 - 1992 such deductions resulted in significant federal and state deductions which may be carried forward. Utilization of such deductions will increase Additional Paid-in Capital. The compensation deductions arising from the exercise of stock options were not material in 1993 and 1994.\nNOTE G - ACCRUED LIABILITIES\nIncluded in Accrued Liabilities at December 31, 1994 are accrued restructuring charges $18 million (1993 - $56 million), accrued inventory repurchase $17 million (1993 - $0), accrued payroll, property and sales taxes $15 million (1993 - $15 million) and accrued commissions $12 million (1993 - $14 million).\nNOTE H - LONG-TERM DEBT\nAt December 31, 1994 the Company had $161 million in bank borrowings and $88 million in financing lease obligations outstanding relating to its European headquarters office building and distribution center complex in Elancourt, France.\nDuring 1994, the Company entered into a new $400 million syndicated credit agreement which replaced its previous $675 million revolving credit and term loan agreement with various banks and which matures in January 1997. The syndicated credit facility provides the Company with a choice of borrowings with interest rates based upon the banks' CD rate, the Euro-dollar rate or the London Interbank Offered Rate (LIBOR). The actual interest charges paid by the Company are determined by a pricing schedule which considers the ratio of consolidated debt at each calendar quarter end to consolidated earnings before interest, taxes, depreciation and amortization for the trailing twelve months. The effective interest rate on long-term bank debt outstanding as of December 31, 1994 and 1993 was 7.7% and 5.3%, respectively.\nThe new credit agreement and the Company's operating lease for its primary domestic manufacturing, distribution and warehousing complex in North Haven, Connecticut, provide for certain restrictions including sales of assets, capital expenditures, dividends and subsidiary debt. The most restrictive covenants of the Company's financing agreements require the maintenance of certain minimum levels of tangible net worth ($476 million), fixed charges coverage and a maximum ratio of total debt to total capitalization (60%), as defined. The Company is prohibited from declaring dividends on its common stock in excess of $1.25 million per quarter, subject to changes in the number of common shares outstanding, until it achieves investment grade status, as defined. The Company is in full compliance with all of the covenants associated with its various financing agreements.\nAt December 31, 1994, the scheduled principal repayments under loan agreements and future minimum payments under a financing lease were as follows:\nNOTE I - STOCKHOLDERS' EQUITY\nOn March 28, 1994 the Company issued approximately $200 million of 9.76% Series A Convertible Preferred Stock (convertible into a maximum of approximately 8.9 million shares or a minimum of approximately 8.5 million shares of the Company's Common Stock), par value $5 per share, in an offering exempt from the registration requirements of the Securities Act of 1933, as amended. Dividends on the Convertible Preferred Stock are cumulative at the annual rate of $110 per share, payable quarterly in arrears commencing July 1, 1994. On April 1, 1998 each share of Convertible Preferred Stock outstanding will automatically convert into 50 shares of Common Stock of the Company, and prior to this date it may be converted into 47.65 shares of Common Stock at any time at the option of the holder. The Company may redeem the Convertible Preferred Stock at any time after April 1, 1997 for 50 shares of Common Stock together with an additional cash dividend of up to $27.50 per share, declining ratably after April 1, 1997 to $0 by March 1, 1998. The Preferred Stock trades principally as depositary receipts, each representing a one-fiftieth interest in a share of Preferred Stock. The proceeds from the sale of Preferred Stock were used to reduce bank indebtedness.\nThe Company had 56,836,139 and 56,257,758 shares of its $.10 par value Common Stock outstanding as of December 31, 1994 and 1993, respectively. In the past, the Company announced programs to repurchase up to a total of 9,200,000 shares of its outstanding Common Stock. As of December 31, 1994, a total of 8,712,537 shares (0 in 1994 and 1,010 in 1993) had been acquired at a total cost of $89.3 million. Acquired shares are being held as treasury shares, the majority of which are reserved for issuance upon conversion of the Company's Preferred Stock.\nShares of Common Stock reserved for future issuance in connection with restricted stock awards, stock option plans and employee stock purchase plans, etc. amounted to 17,631,774 and 16,057,440 at December 31, 1994 and 1993, respectively. The Compensation\/Option Committee (the \"Committee\") of the Board of Directors is responsible for administering the Company's stock compensation plans.\nThe Restricted Stock Incentive Plan (the \"Incentive Plan\") provides for grants to key employees of the Company's Common Stock in the maximum aggregate amount of 5,000,000 shares. As of December 31, 1994, 3,839,740 shares were issued and vested under the Incentive Plan and 142,160 shares were cancelled. There were no restricted stock grants during the three-year period ended December 31, 1994.\nThe 1990 Employee Stock Option Plan (the \"1990 Option Plan\") provides for grants to key employees and certain key consultants of options and stock appreciation rights for up to 11,000,000 shares of the Company's Common Stock at the per share market price at the date of grant unless the Committee determines otherwise. As of December 31, 1994, no stock appreciation rights have been granted. Subject to a maximum exercise period of fifteen years, the exercise period of awards under the 1990 Option Plan will be as determined by the Committee.\nThe 1993 Employee Stock Option Plan (the \"1993 Option Plan\") provides for grants to key employees (excluding executive officers) of options and stock appreciation rights for up to 3,500,000 shares of the Company's Common Stock at the per share market price at the date of grant unless the Committee deems otherwise. As of December 31, 1994 no stock appreciation rights have been granted. Subject to a maximum exercise period of fifteen years, the exercise period of awards under the 1993 Option Plan will be as determined by the Committee.\nThe Service-Based Stock Option Plan (the \"Service Option Plan\") provides for grants of options for up to 1,144,132 shares of the Company's Common Stock at the per share market price at the date of grant to individuals employed by the Company who are within an eligible category. Options under the Service Option Plan are awarded for a fixed number of shares of Common Stock based solely upon the eligible recipient's years of service within the eligible category, and are exercisable for a period of up to ten years.\nThe Outside Directors Stock Plan provides for an aggregate maximum of up to 160,000 shares of Common Stock to be issued under restricted stock awards and option grants to certain non-employee members of the Board of Directors. At December 31, 1994 and 1993, restricted stock awards and option grants for 112,000 shares and 96,000 shares, respectively, had been granted under the Outside Directors Stock Plan. As of December 31, 1994 and 1993, 48,000 and 64,000 shares, respectively, are reserved for future issuance under the Outside Directors Stock Plan.\nA summary of stock option transactions under the employee Option Plans and the Outside Directors Stock Plan for each of the three years in the period ended December 31, 1994 follows:\nUnder the USSC Employees 1979 Stock Purchase Plan (the \"1979 Purchase Plan\") and the 1994 Employees Stock Purchase Plan (the \"1994 Purchase Plan\"), all eligible employees may authorize payroll deductions of up to 10% of their base earnings, as defined, to purchase shares of the Company's Common Stock at 85% of the market price when such deductions are made. There are no charges or credits to income in connection with the Purchase Plan The plans will continue in effect as long as shares authorized under the Purchase Plan remain available for issuance thereunder. The Company has reserved 2,400,000 shares of its Common Stock for issuance under the 1979 Purchase Plan, of which 140,375 shares are available for future issuance, and it has reserved 650,000 shares of its Common Stock for issuance under the 1994 Purchase Plan, of which 546,391 are available for future issuance, at December 31, 1994.\nNOTE J - SEGMENT AND GEOGRAPHIC AREA INFORMATION\nThe Company develops, manufactures and markets wound management products which constitute a single business segment. The following information sets forth geographic information with respect to the Company's net sales, operating profits and identifiable assets.\n(1) Principally Europe.\n(2) Does not include sales made primarily to international distributors (1994 - $84,800, 1993 - $69,600 and 1992 - $54,500) from a location in the United States. The combination of sales to international distributors and international sales above approximate 46% in 1994, 40% in 1993 and 33% in 1992 of consolidated sales, respectively.\nNOTE K - COMMITMENTS AND CONTINGENCIES\nThe Company is engaged in litigation as a defendant in cases involving alleged patent infringement, product liability claims and shareholders' derivative and class action suits (see Item 3). In the opinion of management, based upon advice of counsel, the ultimate outcome of these lawsuits should not have a material adverse effect on the Company's consolidated financial statements.\nAs part of the ongoing expansion of its Puerto Rico operations, the Company is committed to certain undertakings, including the maintenance of specified levels of employment and capitalization for the Puerto Rican subsidiary.\nThe future minimum rental commitments for building space, leasehold improvements, data processing and automotive equipment for all operating leases as of December 31, 1994, were as follows: 1995 - $27 million; 1996 - $54 million; 1997 - $68 million; 1998 - $86 million; 1999 - $66 million; after 1999 - $251 million. Rent expense was $31 million, $34 million and $24 million in 1994, 1993 and 1992, respectively. The Company's North Haven lease agreement includes contingent rent provisions based on formulas utilizing the consumer price index. The amount of the contingent rent over the life of the lease is estimated to be $18 million.\nNOTE L - FINANCIAL INSTRUMENTS AND OFF BALANCE SHEET RISK\nDERIVATIVES The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. They are used to manage well-defined interest rate and foreign exchange rate risks.\nThe Company enters into contracts to reduce its exposure to and risk from foreign currency exchange rate changes and interest rate fluctuations in the regular course of the Company's global business. As of December 31, 1994, the Company had approximately $16 million of foreign currency exchange contracts outstanding that will mature at various dates through February 1995. Realized and unrealized foreign currency gains and losses with respect to such contracts are recognized when incurred and amounted to losses of $4 million, $1 million and $4 million in 1994, 1993 and 1992, respectively.\nThe Company has swapped with certain banks its exposure to floating interest rates on $50 million of its variable rate U.S. dollar debt and $37 million (200 million French francs) of variable rate French franc debt. These swap agreements expire in August 1996 and December 1997 for the U.S. dollar debt and French franc debt, respectively. The Company makes fixed interest payments at rates of approximately 7.8% for the U.S. dollar swap and 8.1% for the French franc swap and receives payments based on the floating six-month LIBOR and three-month LIBOR, respectively. The net gain or loss from the exchange of interest rate payments, which is immaterial, is included in interest expense. Based upon the fair value of the Company's interest rate swap agreements at December 31, 1994, termination of such agreements would require a payment by the Company of approximately five hundred thousand dollars. The Company does not currently intend to terminate its interest rate swap agreements prior to their expiration dates.\nCONCENTRATION OF CREDIT RISK The Company invests its excess cash in both deposits with major banks throughout the world and other high quality short-term liquid money market instruments (commercial paper, government and government agency notes and bills, etc.). The Company has a policy of making investments only with institutions that have at least an \"A\" (or equivalent) credit rating from a national rating agency. The investments generally mature within six months but certain investments in bank CDs mature within five years. The Company has not incurred losses related to these investments.\nThe Company sells products in the surgical wound management field in most countries of the world. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer base. Ongoing credit evaluations of customers' financial condition are performed and, generally, no collateral is required. In certain European countries the Company's receivables are not paid until the customers receive governmental reimbursement for their purchases. The Company has not encountered difficulty in ultimately collecting accounts receivable in these countries. The Company maintains reserves for potential credit losses and such losses, in the aggregate, have not significantly exceeded management's estimates.\nDISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amount of cash and cash equivalents approximates fair value due to the short-term maturities of these instruments. The fair value of certificates of deposit, long-term debt and foreign interest rate swap agreements were estimated based on quotes obtained from brokers for those or similar instruments. The fair value of interest rate swap contracts were estimated based on quoted market prices at year-end.\nThe estimated fair value of the Company's financial instruments are as follows:\nSCHEDULE VIII\nUNITED STATES SURGICAL CORPORATION AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\n(A) Represents amounts written off. Normal recurring credits and returns are charged against sales.\n(B) Represents disposition of inventory which has been superseded by a new generation of products.\n(C) Represents disposition of fixed assets.\nS-1\nEXHIBIT INDEX\n(3) ARTICLES OF INCORPORATION AND BY-LAWS.\n(a) Certificate of Incorporation filed March 14, 1990 - Exhibit 3(a) to registrant's Form 8-B declared effective August 3, 1990.*\n(b) Certificate of Merger filed May 1, 1990 - Exhibit 3(b) to registrant's Form 8- B declared effective August 3, 1990.*\n(c) Certificate of Amendment filed May 15, 1991 - Exhibit 3(c) to registrant's Form 10-K for 1991.*\n(d) By-laws adopted March 14, 1990 - Exhibit 3(c) to registrant's Form 8-B declared effective August 3, 1990.*\n(e) Certificate of Designations relating to the issuance of the Company's Series A Convertible Preferred Stock, filed March 28, 1994. Exhibit 3(e) to registrant's Form 10-K for 1993.*\n(4) INSTRUMENTS DEFINING THE RIGHTS OF SECURITY HOLDERS, INCLUDING INDENTURES.\n(a) Credit Agreement as of June 27, 1994 among registrant, signatory banks, Morgan Guaranty Trust Company of New York as Documentation Agent and Nations Bank of North Carolina, N.A., as Administration Agent - Exhibit 4(a) to registrant's Form 10-Q for the quarter ended June 30, 1994.*\n(10) MATERIAL CONTRACTS.\n(a) 1981 Employee Stock Option Plan, as amended through May 5, 1987 - Exhibit 10(a)(1) to registrant's Form 10-K for 1987.* +\n(b) Amendment to 1981 Employee Stock Option Plan adopted May 2, 1989 - Exhibit 10(b) to registrant's Form 10-K for 1989.* +\n(c) Amendment to 1981 Employee Stock Option Plan adopted May 1, 1990 - Exhibit 10(c) to registrant's Form 10-K for 1990.* +\n(d) 1990 Employee Stock Option Plan - Exhibit B to registrant's Proxy Statement dated March 19, 1990, for its May 1, 1990, Annual Meeting of Stockholders.* + (e) Amendment to 1990 Employee Stock Option Plan adopted July 30, 1990 - Exhibit 10(e) to registrant's Form 10-K for 1990.* +\n(f) Amendment to 1990 Employee Stock Option Plan adopted May 15, 1991 - Exhibit 10(f) to registrant's Form 10-K for 1991.* +\n(g) Amendment to 1981, 1990 and 1993 Employee Stock Option Plans adopted March 9, 1993. Exhibit 10(h) to registrant's Form 10-K for 1993.* +\n(h) Restricted Stock Incentive Plan, as amended through May 5, 1987 - Exhibit 10(a)(2) to registrant's Form 10-K for 1987.* +\n(i) Amendment to Restricted Stock Incentive Plan adopted May 15, 1991 - Exhibit 10(h) to registrant's Form 10-K for 1991.* +\n(j) Installment Option Purchase Agreement with Leon C. Hirsch dated September 10, 1984, as amended through May 18, 1994. Filed herewith.+\n(k) Outside Directors Stock Plan - Exhibit 10(a)(4) to registrant's Form 10-K for 1988.* +\n(l) Amendment to Outside Directors Stock Plan adopted May 1, 1990 - Exhibit 10(j) to registrant's Form 10-K for 1990.* +\n(m) Long-Term Incentive Plan - Exhibit 10(a)(5) to registrant's Form 10-K for 1988.* +\n(n) Lease Agreement dated as of January 14, 1993 between State Street Bank and Trust Company of Connecticut, National Association, as Lessor and the registrant, as Lessee - Exhibit 10(o) to registrant's Form 10-K for 1992.*\n(o) Participation Agreement dated as of January 14, 1993 among registrant, Lessee, Baker Properties Limited Partnership, Owner Participant, The Note Purchasers listed in Schedule 1 thereto, State Street Bank and Trust Company of Connecticut, National Association, Owner Trustee, and Shawmut Bank Connecticut, N.A., Indenture Trustee - Exhibit 10(p) to registrant's Form 10-K for 1992.*\n(p) Letter Agreement between the registrant and Bruce S. Lustman dated March 11, 1994 - Exhibit 10(q) to registrant's Form 10-K for 1993.* +\n(q) Lease and financing agreements dated January 4, 1994 between registrant's French subsidiary, A.S.E. Partners, and (i) the Corporation for the Financing of Commercial Buildings (\"FINABAIL\") and (ii) the Association for the Financing of Commercial Buildings (\"U.I.S.\") - Exhibit 10(r) to registrant's Form 10-K for 1993.*\n(r) Lease and financing agreement dated December 26, 1991 between registrant's subsidiary, U.S.S.C. Puerto Rico, Inc., and The Puerto Rico Industrial Development Company (\"PRIDCO\") - Exhibit 10(s) to registrant's Form 10-K for 1993.*\n(11) Statement regarding computation of per share earnings. Filed herewith.\n(12) Statement of Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends. Filed herewith.\n(21) Subsidiaries of the registrant. Filed herewith.\n(27) Financial Data Schedule. Filed herewith\n* Previously filed as indicated and incorporated herein by reference. Exhibits incorporated by reference are located in SEC File No. 1-9776.\n+ Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of this report.","section_15":""}
{"filename":"9672_1994.txt","cik":"9672","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"ITEM 3. LEGAL PROCEEDINGS ________________________________________________________________________________\nDue to the nature of its business, BAC is subject to various threatened or filed legal actions. Although the amount of the ultimate exposure, if any, cannot be determined at this time, BAC, based upon the advice of counsel, does not expect the final outcome of threatened or filed suits to have a material adverse effect on its financial position.\nItem 4.","section_4":"Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ________________________________________________________________________________\nNone.\nPART II\n================================================================================\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ________________________________________________________________________________\nInformation on dividend restrictions, dividend payments, the principal market for and trading price of the Parent's common stock, and the number of holders of such stock is incorporated by reference from pages 18, 19, and 44, Note 24 on pages 80 through 82, and Note 26 on page 84 of the 1994 Annual Report to Shareholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ________________________________________________________________________________\nSelected financial data is incorporated by reference from pages 18 and 19 of the 1994 Annual Report to Shareholders.\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 is incorporated by reference from pages 18 through 45 of the 1994 Annual Report to Shareholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ________________________________________________________________________________ The Report of Independent Auditors and the consolidated financial statements of BAC are incorporated by reference from pages 47 through 84 of the 1994 Annual Report to Shareholders. See Item 14 of this report for information concerning financial statements and schedules filed with this report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE ________________________________________________________________________________\nNone.\nPART III\n================================================================================\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT ________________________________________________________________________________\nReference is made to the text under the captions, \"Executive Compensation, Benefits and Related Matters\" (excluding the material under the headings \"Report of Executive Personnel and Compensation Committee\" and \"Shareholder Return Performance Graph\" therein) and \"Item No. 1--Election of Directors\" in the Proxy Statement for the May 25, 1995 Annual Meeting of Shareholders of the Parent for incorporation of information concerning directors and persons nominated to become directors. Information concerning executive officers of the Parent as of March 1, 1995 is set forth below.\nRICHARD M. ROSENBERG was appointed Chairman and Chief Executive Officer of the Parent and the Bank on May 24, 1990, in addition to his title as President. He was appointed President of the Parent and the Bank on February 5, 1990. On April 22, 1992, Mr. Rosenberg relinquished his title as President, but was reappointed President on October 5, 1992. Previously, Mr. Rosenberg was Vice Chairman of the Board of the Parent and the Bank from 1987 to 1990.\nLEWIS W. COLEMAN was appointed Chief Financial Officer of the Parent and the Bank on February 1, 1993, in addition to his title of Vice Chairman of the Board. He was appointed Vice Chairman of the Board of the Parent and the Bank on February 5, 1990. Previously, he was Vice Chairman of the Parent and the Bank from 1988 to 1990.\nKATHLEEN J. BURKE was appointed Vice Chairman of the Parent and the Bank on March 14, 1994, in addition to her title as Public Relations Officer of the Parent. She was appointed Executive Vice President and Personnel Relations Officer of the Parent and Executive Vice President of the Bank on April 22, 1992 and Group Executive Vice President of the Bank on April 27, 1992. From 1989 to 1992, Ms. Burke served as an Executive Vice President of SPC and SPNB. She also served as Executive Vice President and Secretary of SPC and its principal subsidiary, Security Pacific National Bank.\n================================================================================\nDAVID A. COULTER was appointed Vice Chairman of the Parent and the Bank on February 1, 1993. Previously, he was Group Executive Vice President of the Bank and head of the Bank's U.S. Division from 1992 to February 1993. From 1990 to 1992, he was Executive Vice President of the Bank and head of the Bank's U.S. Division. From 1989 to 1990, he was Executive Vice President and head of the Bank's Capital Markets Division.\nLUKE S. HELMS was appointed Vice Chairman of the Parent and the Bank on August 2, 1993. Previously, he was Chairman and Chief Executive Officer of Seafirst and Seattle-First. He was appointed President of Seafirst and Seattle-First in 1987.\nJACK L. MEYERS was appointed Vice Chairman of the Parent and the Bank on October 4, 1993. He was appointed Chief Credit Officer of the Bank on September 3, 1993. He was Group Executive Vice President responsible for the Bank's Commercial Business Group from 1991 to 1993. He was named head of the Commercial Banking Division in September 1990. He was Executive Vice President of the California Commercial Banking Group from 1989 to 1990.\nTHOMAS E. PETERSON was appointed Vice Chairman of the Parent and the Bank on February 5, 1990. Previously, he was appointed Executive Vice President of the Bank and head of the Retail Banking Division in 1987.\nMICHAEL E. ROSSI was appointed Vice Chairman of the Parent and the Bank on October 7, 1991. He was appointed Executive Vice President of the Parent on December 3, 1990, when he was also designated to be the head of Credit Policy for the Bank. He was Executive Vice President of the Commercial Banking Division-Commercial Markets Group of the Bank from 1988 to 1990.\nMARTIN A. STEIN was appointed Vice Chairman of the Parent and the Bank on April 27, 1992. He was appointed Executive Vice President of the Parent and the Bank on June 25, 1990. At the same time, he was appointed head of the BankAmerica Systems Engineering Group of the Bank. Prior to joining the Bank, he was Executive Vice President, Director of National Operations, and Chief Information Officer for PaineWebber, Inc., a securities brokerage and investment banking firm, from 1985 to 1990.\nThe present term of office for the officers named above will expire on May 25, 1995 or on their earlier retirement, resignation, or removal. There is no family relationship between any such officers.\n================================================================================\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ________________________________________________________________________________\nInformation concerning executive compensation is incorporated by reference from the text under the captions, \"Corporate Governance-Director Remuneration, Retirement Policy and Attendance\" and \"Executive Compensation, Benefits and Related Matters\" (excluding the material under the headings \"Report of the Executive Personnel and Compensation Committee\" and \"Shareholder Return Performance Graph\" therein) in the Proxy Statement for the May 25, 1995 Annual Meeting of Shareholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ________________________________________________________________________________\nInformation concerning ownership of equity stock of the Parent by certain beneficial owners and management is incorporated by reference from the text under the caption, \"Security Ownership of Certain Beneficial Owners\" in the Proxy Statement for the May 25, 1995 Annual Meeting of Shareholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ________________________________________________________________________________\nInformation concerning certain relationships and related transactions with officers and directors is incorporated by reference from the text under the caption, \"Executive Compensation, Benefits and Related Matters\" (excluding the material under the headings \"Report of the Executive Personnel and Compensation Committee\" and \"Shareholder Return Performance Graph\" therein) in the Proxy Statement for the May 25, 1995 Annual Meeting of Shareholders.\nPART IV\n================================================================================\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K ________________________________________________________________________________\n(A)(1) FINANCIAL The report of independent auditors and the following STATEMENTS consolidated financial statements of BAC are incorporated herein by reference from the 1994 Annual Report to Shareholders; page number references are to the 1994 Annual Report to Shareholders.\n_____________________________________________________________________________\n(A)(2) FINANCIAL Schedules to the consolidated financial statements STATEMENT (Nos. I and II of Rule 9-07) for which provision is made SCHEDULES in the applicable accounting regulation of the Securities and Exchange Commission (Regulation S-X) are inapplicable and therefore, are not included.\nFinancial statements and summarized financial information of unconsolidated subsidiaries or 50% or less owned persons accounted for by the equity method are not included as such subsidiaries do not, either individually or in the aggregate, constitute a significant subsidiary.\n_____________________________________________________________________________ (A)(3) EXHIBITS\n================================================================================\n____________________________________________________ \/a\/Management contract or compensatory plan, contract, or arrangement.\n_______________________________________________________________________________\n(B)REPORTS ON During the fourth quarter of 1994, the Parent filed a FORM 8-K report on Form 8-K dated October 19, 1994. The October 19, 1994 report filed, pursuant to Items 5 and 7 of the report, a copy of the Parent's press release titled \"BankAmerica Third Quarter Earnings.\" After the fourth quarter of 1994, the Parent filed reports on Form 8-K dated January 6, 1995, January 18, 1995, January 23, 1995, and February 6, 1995. The January 6, 1995 report filed, pursuant to Items 5 and 7 of the report, a copy of the joint press release from the Parent and Arbor National Holdings, Inc. titled \"Arbor National Holdings\/BankAmerica Merger -- Regulatory Approvals.\" The January 18, 1995 report filed, pursuant to Items 5 and 7 of the report, a copy of the Parent's press release titled \"BankAmerica Fourth Quarter Earnings.\" The January 23, 1995 report filed, pursuant to Items 5 and 7 of the report, a tax opinion and related consent in connection with offerings of the Parent's debt securities relating to the shelf registration for such debt securities. The February 6, 1995 report filed, pursuant to Items 5 and 7 of the report, a copy of the Parent's press release titled \"BankAmerica Board Increases Common Stock Dividend and Approves Stock Repurchase Program.\"\nSIGNATURES\n================================================================================\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.\nMarch 17, 1995 BANKAMERICA CORPORATION\nBy \/s\/ JAMES H. WILLIAMS ------------------------- (James H. Williams, Executive Vice President and 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.\nA majority of the members of the Board of Directors.\n*By \/s\/ CHERYL SOROKIN ------------------------------------------ (Cheryl Sorokin, Attorney-in-Fact)\nDated: March 17, 1995\nOther information about BankAmerica Corporation may be found in its quarterly Analytical Review and Form 10-Q and its Annual Report to Shareholders. These reports, as well as additional copies of this Form 10-K, may be obtained from:\nCorporate Public Relations #3124 Bank of America P.O. Box 37000 San Francisco, CA 94137\n================================================================================\n[BANKAMERICA CORPORATION LOGO APPEARS HERE]\nBANKAMERICA ________________________________________________________________________________\nNL-9 2-95 [RECYCLED PAPER LOGO APPEARS HERE] RECYCLED PAPER\nEXHIBIT INDEX\nEXHIBIT INDEX","section_15":""}
{"filename":"30828_1994.txt","cik":"30828","year":"1994","section_1":"ITEM 1. BUSINESS:\nGENERAL\nCobra Electronics Corporation (the \"company\") was incorporated in Delaware in 1961 and is a designer and wholesale marketer of consumer electronics products. The company markets products under the COBRA brand name. The company also markets clock radios under the LLOYD'S brand name. Management believes that the company's future success will depend upon its ability to predict and respond in a timely and effective manner to changes in the markets it serves. Product performance, reliability, price, availability and service are the main competitive factors, with sales also being dependent upon timely introduction of new products which incorporate new features desired by consumers at competitive prices.\nRECENT DEVELOPMENTS\nThe company strengthened its senior management team in late 1994 and early 1995 with the additions of a chief operating officer, a vice president of operations and a vice president of marketing. These additions to senior management bring new skills to the company, particularly in the consumer marketing and product development areas.\nDuring 1994, the company called for a national campaign to improve highway safety by expanding the use of radar technology to alert motorists, who have radar detectors, about hazardous travel conditions and approaching emergency vehicles. To facilitate the expansion of safety radar use, the company has developed equipment that transmits unique signals that trigger audible and visual alarms on all brands of existing automotive radar detectors. The company is currently working with agencies and organizations concerned with highway safety, and manufacturers of traffic radar systems and detectors, to cooperate in using this technology to reduce highway accidents. Recently, this technology received formal approval for use by the Federal Communications Commission, which allowed the company to begin shipping Safety Alert (trademark) radar transmitters. By the end of 1995, the company expects to have Safety Alert radar transmitters on law enforcement and other emergency vehicles nationwide.\nPRODUCTS\nThe company operates only in the consumer electronics industry. Principal products include:\nMobile Electronics: Citizen Band (\"CB\") Radios Integrated Laser\/Radar Detectors\nTelecommunication: Cordless Telephones Phone Answering Systems\nAudio: Clock Radios\nThe following table shows the company's percentages of net sales by product category for the three years ended December 31, 1994.\nOne of the company's primary strengths is its product sourcing ability. Substantially all of the company's products are manufactured to its specifications and engineering designs by a number of suppliers in China, Hong Kong, Japan, Korea, Malaysia, Taiwan, Thailand and the U.S.A. Through its Cobra Electronics (HK) Ltd. subsidiary in Hong Kong, the company maintains stringent control over the design and production quality of its products. Thesubsidiary also helps to seek out new suppliers, monitor technological changes and evaluate new products and product enhancements.\nOver a period of years, the company has developed a network of suppliers for its products. To maintain flexibility in product sourcing, the company has not entered into long-term contracts with any of its suppliers. Despite management's belief that it maintains strong relationships with its current suppliers, it also believes that, if necessary, other suppliers could be found. The extent to which a change in a supplier would have an adverse effect on the company's business depends upon the timing of the change, the product or products that the supplier produces for the company and the volume of that production. The company also maintains insurance coverage that would, under certain limited circumstances, reimburse the company for lost profits resulting from a vendor's inability to fulfill its commitments to the company.\nThe company competes primarily in the United States with various manufacturers and distributors of mobile electronics products and telecommunication products. The company competes principally on the basis of product features and price and expects the market for its products to remain highly competitive. The company negotiates substantially all of its purchases in U.S. Dollars to protect itself from currency fluctuations. Assets located outside of the United States, excluding company-owned tooling at suppliers, are not material.\nResearch, engineering and product development expenditures are expensed as incurred. For 1994, 1993 and 1992, these expenditures amounted to $1.1 million, $1.0 million and $1.4 million, respectively.\nExcept for certain patents, such as its patented INTENNA (Registered Trademark) technology, the company does not believe that patents are of material importance to its products. However, should the company develop a unique technology, patents will be applied for to preserve exclusivity, wherever possible.\nMobile Electronics Products: These products, which include CB radios and integrated laser\/radar detectors, are marketed under the COBRA trademark. The company is the industry leader in CB radios, most of which are purchased by professional drivers. In this segment, a significant portion of the market is made up of replacement purchases, often upgrades. The company was the first CB radio marketer to combine a National Weather Service receiver with a mobile CB radio, enabling motorists to obtain travel informationbroadcasts. As a major enhancement of this feature, the company also introduced the industry's first mobile CB radio that incorporates an automatic alert feature to warn of National Weather Service emergency travel advisories. The company also markets CB radios to nonprofessional drivers and hand-held CB radios for sport and recreational use.\nCobra is also one of the leading brands in integrated laser\/radar detectors. Cobra commands significant market share by offering innovative products with the latest technology. For example, in 1992, the company introduced the industry's first detector to monitor the new laser speed detection guns. Additionally, at the January 1994 International Consumer Electronics Show, the company called for a national campaign to improve highway safety by expanding the use of radar technology to alert motorists, who have radar detectors, about hazardous travel conditions and approaching emergency vehicles. As discussed above in RECENT DEVELOPMENTS, the company's pioneering safety radar technology recently received formal approval for use by the Federal Communications Commission.\nMajor competitors in mobile electronics products include Cincinnati Microwave, Beltronics, Whistler, Uniden, Radio Shack (Tandy Corp.), General Electric and Midland.\nTelecommunication Products: These products, which include cordless phones and telephone answering systems, are marketed under the COBRA trademark. The company entered the telecommunications market in 1979 with its first cordless telephone and has since supplemented that entry with other innovative new products. For example, the company introduced the market's first two-line cordless phone and the first cordless phone answering system. In 1989, the company introduced its first INTENNA cordless phone, which utilized the company's patented technology to eliminate the external handset antenna, an industry first. The company later refined this technology to also make it possible to eliminate the base antenna, as well. Currently, Cobra offers the only cordless phones in the marketplace that have no external handset or base antennas. This eliminates the problem of antennas that can bend, break, or get in the way, and makes it easier to mount the product under cabinets in the kitchen or on book shelves in other rooms. The company offers these phones in a variety of designer colors, another industry first.\nIn 1993, the company began offering INTENNA models with electronic voice scrambling to ensure complete security by eliminating potential eavesdropping over scanning radios, baby monitoring devices and other cordless phones. The company also has entered the fast-growing 900 MHz cordless phone market. In mid-1993, the company began shipments of its INTENNA 900 which was the first 900 MHz phone incorporating digital spread spectrum, a technology derived from military signal encryption to ensure conversation privacy. The INTENNA 900 also offers extended range and interference-free use making the phone ideal for both office and home use.\nIn the market for phone answering systems, the company began shipping two new all digital cordless phone answering systems in late 1994. Ideal for home or office use, these models offer electronic voice mail, with one offering up to five different users the opportunity to record and retrieve messages. In addition, the company will soon begin shipping a new stand-alone phone answering system that uses all digital technology.\nThe telecommunications market is dominated by large companies, including AT&T, General Electric, Panasonic, Sony, and Southwestern Bell. Because of this, the company's strategy is to look for profitable niches and position Cobra as an alternative line of quality products with innovative features at competitive prices.\nSALES AND DISTRIBUTION\nDemand for consumer electronics products is seasonal. Historically, sales in the last half of the year are greater than in the first half, reflecting increased purchases by retailers for the holiday selling season.\nIn 1994, sales to QVC, Inc. represented 10.2% of net sales. For the years 1993 and 1992, there were no sales in excess of 10% of total net sales to a single customer or a group of entities under common control. The company does not believe that the loss of any one customer would have a material adverse effect on the business of the company. The company's foreign sales were $11.7 million, $9.3 million, and $6.3 million in 1994, 1993 and 1992, respectively.\nThe company's return policies and payment terms are consistent with those of other companies serving the consumer electronics market. Market conditions are such that products generally must be shipped within a short time after an order is placed. As a result, order backlog is not significant.\nCobra products are distributed through a strong, well-established network of approximately 400 retailers and distributors located primarily in the United States. Approximately 60 percent of the sales are made directly to the mass marketers, such as catalog showrooms, consumer electronics specialty stores, large department store chains, television home-shopping, direct-mail merchandisers, home centers and specialty stores, which feature telephone products or mobile electronics products. Because of changes in the retail marketplace, the company has sought to expand its distribution to retailers that offer assisted-selling environments to help consumers be better informed about product features and functions when making purchase decisions. The company believes that these retailers are more profitable because they offer higher margins and lower servicing costs. The remaining sales are through two-step wholesale distributors that carry Cobra products to fill orders for truck stops, small department stores and appliance dealers. Cobra's primary sales force is comprised of independent sales representatives who work on a straight commission basis. They do not sell products of the company's competitors.\nThe company's right to sell products under the COBRA trademark is substantially worldwide. The selling rights under the LLOYD'S trademark excludes Canada and Europe. The company believes the COBRA trademark, which is indefinitely renewable by the company, is a significant factor in the successful marketing of its products.\nEMPLOYEES\nAs of December 31, 1994, the company employed 146 persons in the U.S. and 14 in its international operations. None of the company's employees is a member of a union.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES:\nThe company owns three adjacent buildings in Chicago, Illinois containing a total of 250,000 square feet of office and warehouse space. Maxtec International Corporation leases approximately 83,000 square feet under an agreement that will expire on December 31, 1996. The company believes that its facilities are adequate to meet its current needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS:\nCertain lawsuits and claims are pending against the company. However, after consultation with legal counsel on these matters, management believes that the liabilities which may result from these cases, if any, will not be material to the company's results of operations or financial position.\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:\nThe company's common stock trades on The Nasdaq Stock Market under the symbol COBR. As of March 10, 1995, the company had approximately 1,400 shareholders of record and approximately 2,300 shareholders for whom securities firms acted as nominees. The company's common stock is the only class of equity securities outstanding. Before April 1, 1993, the common stock of the company traded under the symbol DYNA.\nUnder the terms of its credit agreement, the company may not pay cash dividends.\nSTOCK PRICE AND TRADING VOLUME DATA\nNote: Data compiled from The Nasdaq Stock Market monthly Summary of Activity reports.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA:\nFIVE YEAR FINANCIAL SUMMARY\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:\nCORPORATE OVERVIEW\nIn 1994, the company made great strides toward its goal of returning to profitability. The company continued to improve its customer mix and product offerings, which resulted in a substantial increase in its gross margin. The gains from improved gross margins were partially offset by product availability problems experienced in the second half of 1994. The company significantly reduced its annual loss in 1994 compared to the prior year.\nThe company strengthened its senior management team in late 1994 and early 1995 with the additions of a chief operating officer, a vice president of operations and a vice president of marketing. These additions to the company's senior management bring new skills to the company, particularly in the consumer marketing and product development areas.\nManagement expects that its sales decline will reverse in 1995 and that the company's successful effort to improve product lines, develop a more favorable customer mix and resolve the product availability problems will result in a profitable 1995.\nRESULTS OF OPERATIONS\n1994 Compared to 1993 - - ---------------------\nSales for 1994 were $82 million compared to $99 million in 1993. The net loss for 1994 was $1.5 million, or $.24 per share, compared to $4.4 million, or $.70 per share in 1993. The sales decline reflected mainly lower unit sales volumes in all principal product lines, except CB radios. In addition, the prior year included $5 million in sales from the company's former Professional Products Group, which was sold in late 1993.\nSales of mobile electronics products (including CB radios, integrated laser\/radar detectors and single unit laser and radar detectors) declined approximately $5 million in 1994 compared to 1993. The decline reflected mainly lower unit sales of detectors and was partially offset by higher CB sales. Sales of integrated laser\/radar detectors were down due to the company's decision to limit its purchases of certain models to better assist in controlling inventory, which resulted in lower 1994 sales. Also, the prior year sales benefited from large closeout sales of three-band radar detectors that coincided with the introduction of two new integrated detector models. Besides an overall increase in demand for CB radios compared to the prior year, the current period benefited from sales of the company's new weather- alert CBs, which were introduced in the second quarter of 1994.\nTelecommunication product sales were down approximately $5 million, mainly because of lower phone answering system sales. Sales of phone answering systems declined because of the company's strategy to refocus the product line to offer only all-digital models, which would not be available in meaningful quantities until early 1995. Sales of the company's ten-channel INTENNA cordless phones fell slightly from the prior year because of product shortages during the peak sales season. These temporary product shortages were the result of production delays for several new models and the company's underestimate of demand for several existing models when it placed orders with its vendors earlier in the year.\nCombined unit sales for both telecommunication products and mobile electronics products declined approximately 7% in 1994. The remaining sales decline was attributable to reduced sales of Lloyd's clock radios and the elimination of sales from the company's former Professional Products Group, which was sold in late 1993.\nGross margins for 1994 increased to 17.6% from 14.1% a year ago. The margin improvement reflected a better customer mix and an improved product mix because of more sales of high-margin CB Radios and improved margins on cordless phones and integrated laser\/radar detector sales. Also, 1993's margin was depressed because of sizable closeout sales of discontinued cordless phones and detectors, which were minimized in 1994 through better inventory control. The margin improvement, as a result of better sales mix, was partially offset by costs associated with the 1994 expansion of the company's consumer hotline, (1-800-COBRA22). This expansion was implemented to enable the company to answer all of its calls from consumers for installation and operational assistance--to partially offset the lack of skilled sales personnel in many retail stores--as well as for information on where to purchase company products.\nDuring the second quarter of 1993, the company recorded a one-time charge of $1.1 million to cover the estimated costs of a restructuring program. Approximately 40% of the charge was for severance and termination costs related to a significant downsizing of the company's workforce, which was carried out during the third quarter of 1993. The remaining portion of the restructuring charge was to cover additional one-time costs to be incurred as a result of the lower staffing levels. As of December 31, 1993, all restructuring costs had been incurred. Annualized savings from this workforce reduction in payroll-related expenses were estimated to be approximately $2.1 million. Because the workforce reduction was implemented in mid-1993, payroll-related savings approximated $1.2 million in 1994 compared to 1993.\nSelling, general and administrative expense declined $1.1 million during 1994 and, as a percent of sales, increased to 17.8% from 15.9% a year ago. Approximately two-thirds of the decline was due to the elimination of expenses for the Professional Products Group, which was sold in late 1993. The remaining decline was realized because of reduced payroll-related expenses in connection with the workforce reduction, reduced variable selling costs because of lower sales and lower bad debt expense. The expense for bad debts declined due to a reduction in receivable balances, an improvement in the quality of the receivable portfolio and favorable collections experience. Expenses as a percent of sales increased in the current year because the fixed portion of such expenses was spread over a smaller sales volume.\nInterest expense for 1994 declined 16% compared to the prior year because of reduced working capital requirements, which resulted in lower borrowings under the company's line-of-credit agreement.\n1993 Compared to 1992 - - ---------------------\nSales for 1993 were $99 million compared to $118 million in 1992. The loss before cumulative effect of a change in accounting principle in 1993 was $4.4 million, or $.70 per share, compared to a loss of $8.7 million, or $1.39 per share in 1992. Approximately $9 million of the decrease in sales is directly attributable to reduced sales of Lloyd's products. This was due to management's decision in 1992 to contract the Lloyd's product line to focus on clock radios. Sales of mobile electronics products (including CB radios, integrated laser\/radar detectors and single unit laser and radar detectors) declined $7 million in 1993 compared to 1992. Sales of CB radios increased slightly during 1993 but were more than offset by a drop in sales of detectors, primarily because of the large sale of discontinued two-band radar detectors in 1992 and weakness in consumer demand for non-integrated laser\/radar detectors during 1993. Telecommunication product sales were down approximately $2 million, mainly because of lower answering machine sales. Management decided in 1992 to narrow the line to focus on higher-margin cordless phone answering systems. The decline in answering system sales was offset in part by stronger sales of the company's ten-channel INTENNA cordless phones. Unit sales for both telecommunication products and mobile electronics products declined 19% in 1993.\nGross profit and gross margin in 1993 were $13.9 million and 14.1%, respectively, compared to $14.9 million and 12.7%, respectively, 1992. The increase in margin was due primarily to lower 1993 sales of discontinued products sold at or below cost, partially offset by reduced detector margins resulting from weak demand for non-integrated radar and laser detectors.\nSelling, general and administrative expense declined by $3.7 million during 1993 and, as a percent of sales, declined to 15.9% from 16.5% in 1992. Besides reduced variable selling costs because of lower sales, the company's ongoing efforts to streamline its operations reduced payroll-related costs approximately $1.6 million during 1993.\nDuring the second quarter of 1993, the company recorded a one-time charge of $1.1 million to cover the estimated costs of a restructuring program. Approximately 40% of the charge was for severance and termination costs related to a significant downsizing of the company's workforce, which was carried out during the third quarter of 1993. Annualized savings from this workforce reduction in payroll-related expenses were estimated to be approximately $2.1 million. The remaining portion of the restructuring charge was to cover additional one-time costs to be incurred because of the lower staffing levels. As of December 31, 1993, all restructuring costs had been incurred.\nFourth quarter results for 1992 included a non-cash charge of $1.2 million for the write-off of the remaining excess of cost over net assets of businesses acquired. The company's decision to contract the Lloyd's product line, and uncertainties surrounding the longevity of the rights to distribute audio products under the Marantz brand, made the future realization of these assets uncertain.\nOther, net expenses were $220,000 in 1993 compared to $1.7 million in 1992. The expenses for 1992 included $462,000 for the closure of the company's Tokyo office, while expenses for 1993 reflected the elimination of the costs associated with the operation of this office.\nCUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE\nThe company adopted Financial Accounting Standards Board Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\", as of the beginning of 1992 and recorded a charge of $835,000, or $.13 per share for the cumulative effect of a change in accounting principle. This charge, which represents a net decrease to the deferred tax asset, resulted because previously recognized tax benefits did not satisfy the recognition criteria set forth in SFAS No. 109 and because current enacted tax rates were applied to temporary differences between the financial statement and tax bases of assets and liabilities. As a result, the first quarter of 1992 was restated for the $835,000 cumulative effect and a $922,000 reversal of a tax benefit previously recorded. The second and third quarters of 1992 did not require restatement.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1994, the company had a $30 million secured credit facility that included a fixed term loan of $2.6 million. In January, 1995, the agreement for this credit facility was extended to January 10, 1997. Borrowings and letters of credit issued under this agreement are collateralized by the company's assets, and usage of the non-term loan portion is limited to certain percentages of accounts receivable and inventory balances. The fixed term loan, which was increased to $3.7 million at the time of the credit agreement's extension, is secured by the company's buildings and equipment and requires both monthly principal payments of $43,000 and a balloon payment of $2.6 million due when the agreement expires.\nThe credit agreement specifies that the company may not pay cash dividends and contains a material adverse change clause, which, under certain circumstances, can accelerate the payment of the debt. Because of this clause, and the company's recent history of losses, the company classified the debt as short- term for financial reporting purposes. The company does not believe a material adverse change is likely and does not believe that repayment of the debt will be accelerated. At December 31, 1994, the company had approximately $3 million of unused credit line.\nCash flows provided by operating activities were $3.7 million, $1.9 million and $1.1 million for the years ended December 31, 1994, 1993 and 1992, respectively; losses from operations before cumulative effect of a change in accounting principle of $1.5 million, $4.4 million and $8.7 million, respectively, were more than offset by non-cash expenses of depreciation and amortization and reduced working capital requirements. Cash provided by the reduction in receivables during 1994 was primarily the result of reduced sales during the fourth quarter compared to the prior year. The reduction in accrued liabilities was due to a decrease in the cost of estimated future product warranty obligations.\nInvesting activities required cash of $1.5 million, $788,000 and $1.4 million for the years ended December 31, 1994, 1993 and 1992, respectively. Most of the cash outflows during these years related to the purchase of tooling and equipment. During 1993, the company sold the assets of its Professional Products Group. The purchase price, which exceeded the net book value of the assets sold, amounted to $1.3 million and consisted of $867,000 of cash and the assumption of certain liabilities.\nCash flows from financing activities for the three years ending December 31, 1994, 1993 and 1992 primarily reflect changes in the company's borrowing requirements under its line-of-credit agreement. Because of management's continuing effort to strengthen the balance sheet, the company reduced debt by $2.2 million during 1994.\nAt December 31, 1994, the company had no material commitments, other than approximately $23.2 million in outstanding purchase orders for products compared with $20.1 million at the end of the prior year.\nThe company believes that cash generated from operations and from borrowings under its credit agreement will be sufficient in 1995 to fund its working capital needs. In addition, the majority of any taxable income in 1995 will be offset by tax net operating loss carryforwards that totaled $46.6 million at December 31, 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:\nFinancial Statements and quarterly financial data are included in this Annual Report on Form 10-K, as indicated in the index on page 30.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:\nDuring 1994, the company changed independent accountants. The change was previously reported on the company's Current Reports on Form 8-K dated July 19, 1994, as amended, and August 15, 1994, and are hereby incorporated by reference.\nCONSOLIDATED STATEMENTS OF OPERATIONS Cobra Electronics Corporation\nThe accompanying notes to consolidated financial statements are an integral part of these financial statements.\nCONSOLIDATED BALANCE SHEETS Cobra Electronics Corporation\nThe accompanying notes to consolidated financial statements are an integral part of these financial statements.\nCONSOLIDATED BALANCE SHEETS Cobra Electronics Corporation\nThe accompanying notes to consolidated financial statements are an integral part of these financial statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS Cobra Electronics Corporation\nThe accompanying notes to consolidated financial statements are an integral part of these financial statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Cobra Electronics Corporation\nThe accompanying notes to consolidated financial statements are an integral part of these financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Cobra Electronics Corporation\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS -- The company designs and markets consumer electronics products, a majority of which are purchased from overseas suppliers. The consumer electronics market is characterized by rapidly changing technology and certain products may have limited life cycles. The company believes that it maintains strong relationships with its current suppliers and, if necessary, other suppliers could be found. Production delays or a change in suppliers, however, could cause a delay in obtaining inventories and a possible loss of sales, which could adversely affect operating results.\nPRINCIPLES OF CONSOLIDATION -- The consolidated financial statements include the accounts of the company.\nINVENTORIES -- Inventories are recorded at the lower of cost, on a first-in, first-out basis, or market.\nDEPRECIATION -- Depreciation of buildings, improvements, tooling and equipment is computed using the straight-line method and the following estimated useful lives:\nRESEARCH, ENGINEERING AND PRODUCT DEVELOPMENT EXPENDITURES -- Research, engineering and product development expenditures are expensed as incurred and amounted to $1.1 million in 1994, $1.0 million in 1993 and $1.4 million in 1992.\nEXCESS OF COST OVER NET ASSETS OF BUSINESSES ACQUIRED -- In 1992, because of the decision to de-emphasize the Lloyd's and Marantz brand names, the remaining unamortized excess of cost over net assets of these businesses was charged against income.\nREVENUE RECOGNITION -- Revenue from the sale of goods is recognized at the time of shipment. Obligations for sales returns and allowances and product warranties are recognized on an accrual basis.\nINCOME TAXES -- Income taxes are accounted for under Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" which requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events included in the financial statements or tax returns at different amounts. 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. SFAS No. 109 also requires a valuation allowance when it is more likely than not that all or some of the deferred tax asset will not be realized.\nEffective January 1, 1992, the company changed its accounting for income taxes by adopting prospectively SFAS No. 109. Income taxes were previously accounted for under Accounting Principles Board Opinion No. 11. This resulted in a cumulative effect of a change in accounting principle which increased the 1992 net loss by $835,000.\nRECLASSIFICATIONS -- Certain reclassifications have been made to the 1993 and 1992 consolidated financial statements to conform to the 1994 classifications.\n(2) TAXES ON INCOME\nDeferred tax assets (liabilities) by component, at December 31, 1994 and 1993 were:\nThe tax lease income resulted from several 1983 tax lease agreements to acquire tax benefits under the provisions of the Economic Recovery Tax Act of 1981. The total cash price paid by the company was $12.4 million. The economic value of these leases was not impaired by the Tax Reform Act of 1986. The company realized temporary tax savings from accelerated depreciation and permanent tax savings from credits associated with the leases, subject to statutory limitations. These savings offset current taxes payable which would otherwise have been due on income from normal operations.\nThe statutory Federal income tax rates are reconciled to the effective income tax rates as follows:\nAt December 31, 1994, the company has net operating loss carryforwards available to offset future taxable income, and both investment tax credit and alternative minimum tax credit carryforwards to offset future income tax payments. The alternative minimum tax credit carryforwards, amounting to $885,000, do not expire.\nThe net operating loss and investment tax credit carryforwards expire as follows (in thousands):\n(3) FINANCING ARRANGEMENTS\nAt December 31, 1994, the company had a $30 million secured credit facility that included a fixed term loan of $2.6 million. In January, 1995, the agreement for this credit facility was extended to January 10, 1997. Borrowings and letters of credit issued under this agreement are collateralized by the company's assets, and usage of the non-term loan portion is limited to certain percentages of accounts receivable and inventory balances. The fixed term loan, which was increased to $3.7 million at the time of the credit agreement's extension, is secured by the company's buildings and equipment and requires both monthly principal payments of $43,000 and a balloon payment of $2.6 million due when the agreement expires.\nThe credit agreement specifies that the company may not pay cash dividends and contains a material adverse change clause, which, under certain circumstances, can accelerate the payment of the debt. Because of this clause, and the company's recent history of losses, the company classified the debt as short-term for financial reporting purposes. The company does not believe a material adverse change is likely and does not believe that repayment of the debt will be accelerated.\nMaximum borrowings outstanding at any month-end were $13.3 million, $17.0 million and $17.6 million in 1994, 1993 and 1992, respectively. Aggregate average borrowings outstanding were $11.3 million, $15.5 million and $16.2 million during 1994, 1993 and 1992, respectively, with weighted average interest rates thereon of 9.4%, 8.1% and 8.1%, respectively. The maximum value of letters of credit outstanding at any month-end were $7.1 million, $11.8 million and $11.8 million in 1994, 1993 and 1992, respectively. At December 31, 1994, the company had approximately $3 million of unused credit line.\nDuring 1994, 1993 and 1992, the company made interest payments of $1.1 million, $1.3 million and $1.2 million, respectively.\n4) LEASE TRANSACTIONS\nThe company leases facilities and equipment under noncancellable operating leases with remaining terms of one year or less. The terms of these agreements provide that the company pay certain operating expenses. Some of these lease agreements also provide the company with the option to purchase the related assets at the end of the respective initial lease terms. Rental expense for these operating leases for 1994, 1993 and 1992 was $215,000, $256,000 and $360,000, respectively.\nAt December 31, 1994, the future minimum lease payments under operating leases for continuing and discontinued operations, excluding $96,000 minimum rentals under a noncancellable sublease, are $412,000 for 1995.\n5) SHAREHOLDERS' EQUITY\nPREFERRED STOCK -- Preferred stock is issuable from time to time in one or more series, which series may have such voting powers, and such designations, preferences, and relative participating, optional or other special rights, and qualifications, limitations or restrictions thereof, as shall be stated and expressed in the resolution or resolutions providing for the issue of such stock adopted by the Board of Directors. No preferred stock has been issued.\nEARNINGS PER SHARE -- Earnings per share are calculated using the treasury stock method and giving effect to common share equivalents. Weighted average common shares outstanding used in the calculation were 6,226,648 in 1994, 6,229,813 in 1993, and 6,246,919 in 1992.\n(6) STOCK OPTION PLANS\nThe company has five Stock Option Plans--1988, 1987, 1986, 1985 and 1981 (\"the Plans\"). A summary of certain provisions and amounts related to the Plans follows:\nActivity under the Plans is summarized as follows:\nUnder the terms of the Plans, the consideration received by the company upon exercise of the options may be paid in cash or by the surrender and delivery to the company of shares of its common stock, or by a combination thereof. The optionee is credited with the fair market value of any stock surrendered and delivered as of the exercise date.\nOptions granted under the 1985 nonqualified plan may include provisions that are similar to stock appreciation rights in that they entitle the holder to additional compensation at the date of exercise or, if later, at the date when the exercise transaction becomes taxable. The anticipated cost is recognized over the vesting period of the options, which ranges from one to five years. Currently there are no options outstanding that include these provisions.\n(7) RETIREMENT BENEFITS\nThe only qualified retirement plan for employees is the Cobra Electronics Corporation Profit Sharing and 401(k) Incentive Savings Plan (the \"Plan\"). The company may make a discretionary annual profit sharing contribution that is allocated among accounts of persons employed by the company for more than one year, prorated based on the compensation paid to such persons during the year. In 1992, the company made a profit sharing contribution to the Plan of approximately $277,000. There were no profit sharing contributions in 1994 or 1993.\nDeferred compensation of $1.6 million and $1.5 million is included in the balances of accrued salaries and commissions at December 31, 1994 and 1993, respectively. Deferred compensation obligations arise pursuant to outstanding key executive employment agreements.\n(8) RELATED PARTY TRANSACTIONS\nDuring 1993, the company sold the assets of its Professional Products Group to its division president, who was an officer of the company. The purchase price, which exceeded the net book value of the assets sold, amounted to $1.3 million and consisted of $867,000 of cash and the assumption of $393,000 in liabilities.\nDuring 1990, pursuant to an employment agreement, the company lent an officer $1.25 million for the exercise of options on 375,000 shares of common stock. The officer signed a promissory note with recourse, which is secured by the related shares. The promissory note was amended during 1994 to extend the due date to December 30, 1997 and to change the interest rate to the appropriate Applicable Federal Rate, to be adjusted monthly. The interest rate was retroactively changed to conform the promissory note to the variable interest rate specified in the employment agreement. The amount of the note is shown as a reduction of shareholders' equity. From the inception of the loan through December 31, 1994, accrued interest of $362,804 has been added to the loan balance reflecting an average interest rate of 6.6%.\n(9) COMMITMENTS\nAt December 31, 1994 and 1993, the company had outstanding inventory purchase orders committed with suppliers totaling approximately $23.2 million and $20.1 million, respectively.\n(10) RESTRUCTURING COSTS\nDuring the second quarter of 1993, the company recorded a one-time charge of $1.1 million to cover the estimated costs of a restructuring program. Approximately 40% of the charge was for severance and termination costs related to a significant downsizing of the company's workforce, which was carried out during the third quarter of 1993. The remaining portion of the restructuring charge was to cover additional one-time costs to be incurred as a result of the lower staffing levels. As of December 31, 1993, all restructuring costs had been incurred.\n(11) INDUSTRY SEGMENT INFORMATION\nThe company operates in only one business segment--consumer electronics. Excluding company-owned tooling at suppliers with a net book value of $1.1 million at December 31, 1994, assets located outside the United States not material. Foreign sales were $11.7 million, $9.3 million and $6.3 million in 1994, 1993 and 1992, respectively. For 1994, sales to one customer totaled 10.2% of consolidated net sales. There were no sales in excess of 10% of consolidated net sales to a single customer or a group of entities under common control for either 1993 or 1992. The company does not believe that the loss of any one customer would have a material adverse effect on its business.\n(12) ADVERTISING BARTER CREDITS\nDuring 1992, the company received $3.8 million of advertising credits in exchange for certain discontinued products. These credits can be used to reduce the cost of a variety of media services (by 40 to 50 percent) prior to their expiration in December 1998. The company has developed marketing plans to utilize these credits and is also exploring opportunities to exchange a portion of the credits for various goods and services used by the company as well as the outright sale of the credits to third parties. In 1994, the company recorded a charge of $300,000 to reduce the credits to their estimated net realizable value. Although realization is not assured, management believes that all of the recorded credits will be utilized or sold prior to their expiration. The net book value of these credits at December 31, 1994 and 1993 was $2.8 million and $3.2 million, respectively. The noncurrent portion of advertising barter credits included in other assets was $2.1 million and $2.2 million at December 31, 1994 and 1993, respectively.\n(13) OTHER ASSETS\nIn addition to the advertising barter credits, other assets at December 31, 1994 and 1993 included the cash value on officer life insurance policies of $2.5 million and $2.3 million, respectively. The cash value of officer life insurance policies is pledged as collateral for the company's secured lending agreement and is maintained to fund deferred compensation obligations (see Notes 3 and 7).\nQuarterly Financial Data (Unaudited) (In thousands, except per share amounts)\nINDEPENDENT AUDITORS' REPORT ----------------------------\nTo the Board of Directors and Shareholders of Cobra Electronics Corporation:\nWe have audited the accompanying consolidated balance sheet of Cobra Electronics Corporation and subsidiaries as of December 31, 1994, and the related consolidated statements of income, shareholders' equity and cash flows for the year then ended. Our audit also included the financial statement schedules for the year ended December 31, 1994 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 financial statement schedules based on our audit. The financial statements and financial statement schedules of the company for the years ended December 31, 1993 and 1992 were audited by other auditors whose report, dated March 7, 1994, expressed an unqualified opinion on those statements and included an explanatory paragraph with respect to the change in accounting for income taxes in 1992.\nWe conducted our audit in accordance with generally accepted accounting 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 1994 consolidated financial statements present fairly, in all material respects, the financial position of Cobra Electronics Corporation and subsidiaries at December 31, 1994, and the results of their operations and their cash flows for the year then ended in conformity with generally accepted accounting principles. Also, in our opinion, such 1994 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. The 1993 and 1992 financial statement schedules were subjected to auditing procedures by other auditors whose report dated March 7, 1994, referred to above, stated that such schedules 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.\nDELOITTE & TOUCHE LLP\nChicago, Illinois March 2, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ----------------------------------------\nTo the Shareholders and Board of Directors of Cobra Electronics Corporation:\nWe have audited the accompanying consolidated balance sheets of Cobra Electronics Corporation (a Delaware corporation) and Subsidiaries as of December 31, 1993 and 1992, and the related consolidated statements of income, shareholders' equity 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 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 Cobra Electronics 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.\nAs discussed in Notes 1 and 2 to the consolidated financial statements, effective January 1, 1992, the company changed its method of accounting for income taxes.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. Schedule II is the responsibility of the company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states 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 LLP\nChicago, Illinois, March 7, 1994\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation in response to this item is set forth in the company's definitive proxy statement filed pursuant to Regulation 14A under \"Directors and Nominees,\" which information is hereby incorporated by reference. The information under \"Section 16(a) Reports\" included in the definitive proxy statement is hereby incorporated by reference.\nThe executive officers of the Registrant are as follows:\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation in response to this item will be set forth in a definitive proxy statement to be filed by the company pursuant to Regulation 14A within 120 days after the close of the company's 1994 fiscal year, and such information, other than the information required by Item 402(k) (\"Board Compensation Committee Report on Executive Compensation\") and Item 402(l) (\"Performance Graph\") under Regulation S-K adopted by the Securities and Exchange Commission, is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation in response to this item will be set forth in a definitive proxy statement to be filed by the company pursuant to Regulation 14A within 120 days after the close of the company's 1994 fiscal year, and such information is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation in response to this item will be set forth in a definitive proxy statement to be filed by the company pursuant to Regulation 14A within 120 days after the close of the company's 1994 fiscal year, and such information is hereby incorporated by reference.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nIndex to Consolidated Financial Statements and Schedules --------------------------------------------------------\nSchedule II\nCOBRA ELECTRONICS CORPORATION VALUATION AND QUALIFYING ACCOUNTS FOR THE THREE YEARS ENDED DECEMBER 31, 1994 (in thousands) -------------------------------------------\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15 (d) of the ecurities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCOBRA ELECTRONICS CORPORATION\nBy Gerald M. Laures ---------------- Vice President-Finance, and Corporate Secretary\nDated: March 28, 1995\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 above.\nCarl Korn Director and Chairman of the Board - - --------------------- Carl Korn\nJerry Kalov Director, President and Chief Executive Officer - - --------------------- (Principal Executive Officer) Jerry Kalov\nWilliam P. Carmichael Director - - --------------------- William P. Carmichael\nSamuel B. Horberg Director - - --------------------- Samuel B. Horberg\nGerald M. Laures Director, Vice President-Finance and Corporate - - --------------------- Secretary (Principal Financial and Accounting Gerald M. Laures Officer)\nHarold D. Schwartz Director - - --------------------- Harold D. Schwartz\nINDEX TO EXHIBITS -----------------\nExhibit Number Description of Document - - ------- ------------------------------------------------------------------ 3(i)(a) Articles of Incorporation, as amended February 23, 1990--Filed as exhibit No. 3-1 to the Registrant's Form 10-K for the year ended December 31, 1990 (File No. 0-511), hereby incorporated by reference.\n3(i)(b) Certificate of Ownership and Merger, filed with the Secretary of State of Delaware on March 29, 1993--Filed as exhibit No. 3-2 to the Registrant's Form 10-K for the year ended December 31, 1992 (File No. 0-511), hereby incorporated by reference.\n3(ii) Bylaws, as amended December 6, 1983--Filed as exhibit No. 3-2 to the Registrant's Form 10-K for the year ended December 31, 1990 (File No. 0-511), hereby incorporated by reference.\n10-1 1981 Nonqualified and Incentive Stock Option Plan--Filed as exhibit No. 10-1 to the Registrant's Form 10-K for the year ended December 31, 1992 (File No. 0-511), hereby incorporated by reference.\n10-2 Amendment No. 1 to 1981 Nonqualified and Incentive Stock Option Plan--Filed as exhibit No. 10-2 to the Registrant's Form 10-K for the year ended December 31, 1992 (File No. 0-511), hereby incorporated by reference.\n10-3 1985 Key Employees Nonqualified Stock Option Plan--Filed as exhibit No. 10-6 to the Registrant's Form 10-K for the year ended December 31, 1985 (File No. 0-511), hereby incorporated by reference.\n10-4 Key Executive Employment Agreement dated as of January 1, 1988-- Filed as exhibit No. 10-15 to the Registrant's Form 10-K for the year ended December 31, 1987 (File No. 0-511), hereby incorporated by reference.\n10-5 1986 Key Employees Nonqualified and Incentive Stock Option Plan-- Filed as exhibit No. 10-6 to the Registrant's Form 10-K for the year ended December 31, 1990 (File No. 0-511), hereby incorporated by reference.\n10-6 1987 Key Employees Nonqualified and Incentive Stock Option Plan-- Filed as exhibit No. 10-7 to the Registrant's Form 10-K for the year ended December 31, 1990 (File No. 0-511), hereby incorporated by reference.\n10-7 1988 Key Employees Nonqualified and Incentive Stock Option Plan-- Filed as exhibit No. 10-8 to the Registrant's Form 10-K for the year ended December 31, 1990 (File No. 0-511), hereby incorporated by reference.\n10-8 Lease Agreement dated August 16, 1989 between Registrant and CMD Midwest Eight Limited Partnership for Aurora, Illinois facility-- Filed as exhibit No. 10-9 to the Registrant's Form 10-K for the year ended December 31, 1990 (File No. 0-511), hereby incorporated by reference.\n10-9 Key Executive Pledge Agreement and Term Loan Promissory Note dated December 31, 1990--Filed as exhibit No. 10-12 to the Registrant's Form 10-K for the year ended December 31, 1990 (File No. 0-511), hereby incorporated by reference.\n10-10 Sublease Agreement dated December 1, 1992 between Registrant and Petcare Plus, Inc. for Aurora, Illinois facility--Filed as exhibit No. 10-16 to the Registrant's Form 10-K for the year ended December 31, 1992 (File No. 0-511), hereby incorporated by reference.\n10-11 Lease Agreement dated October 15, 1987, including Amendment Numbers 1, 2 and 3, between Registrant and Maxtec International Corp. for approximately 85% of the Registrant's building located at 6460 West Cortland Street, Chicago, IL--Filed as exhibit No. 10-17 to the Registrant's Form 10-K for the year ended December 31, 1992 (File No. 0-511), hereby incorporated by reference.\n10-12 Loan and Security Agreement dated November 12, 1992, including Amendment No. 1, by and between the Registrant and Congress Financial Corporation (Central)--Filed as exhibit No. 10-18 to the Registrant's Form 10-K for the year ended December 31, 1992 (File No. 0-511), hereby incorporated by reference.\n10-13 Deferred Compensation Plan dated as of December 23, 1992--Filed as exhibit No. 10-19 to the Registrant's Form 10-K for the year ended December 31, 1992 (File No. 0-511), hereby incorporated by reference.\n10-14 Asset Purchase Agreement between Registrant and Superscope Technologies, Inc. dated as of September 30, 1993--Filed as exhibit No. 10-18 to the Registrant's Form 10-K for the year ended December 31, 1993 (File No. 0-511), hereby incorporated by reference.\n10-15 Omnibus Amendment To All Loan Documents between Registrant and Congress Financial Corporation (Central) dated as of March 29, 1993--Filed as exhibit No. 10-19 to the Registrant's Form 10-K for the year ended December 31, 1993 (File No. 0-511), hereby incorporated by reference.\n10-16 Amendment No. 3 to the Loan and Security Agreement between Registrant and Congress Financial Corporation (Central)dated as of August 17, 1993--Filed as exhibit No. 10-20 to the Registrant's Form 10-K for the year ended December 31, 1993 (File No. 0-511), hereby incorporated by reference.\n10-17 Amendment No. 4 to the Loan and Security Agreement between Registrant and Congress Financial Corporation (Central) dated as of December 29, 1993--Filed as exhibit No. 10-21 to the Registrant's Form 10-K for the year ended December 31, 1993 (File No. 0-511), hereby incorporated by reference.\n10-18 Amendment No. 5 to the Loan and Security Agreement between Registrant and Congress Financial Corporation (Central) dated as of February 25, 1994--Filed as exhibit No. 10-22 to the Registrant's Form 10-K for the year ended December 31, 1993 (File No. 0-511), hereby incorporated by reference.\n10-17 Amendment No. 6 to the Loan and Security Agreement between Registrant and Congress Financial Corporation (Central) dated as of November 23, 1994.\n10-18 Amendment No. 7 to the Loan and Security Agreement between Registrant and Congress Financial Corporation (Central) dated as of December 14, 1994.\n10-19 Amendment No. 8 to the Loan and Security Agreement between Registrant and Congress Financial Corporation (Central) dated as of January 20, 1995.\n10-20 Executive Employment Agreement dated as of September 23, 1994.\n10-21 Amendment to the Key Executive Employment Agreement dated as of December 15, 1994.\n10-22 Amended and Restated Term Loan Promissory Note dated as of December 15, 1994.\n21 Subsidiaries of the Registrant.\n23 Consents of Deloitte & Touche LLP, and Arthur Andersen LLP.\n27 Financial data schedule required under Article 5 of Regulation S-X.\n[FN]\nFiled herewith.\nExecutive compensation plan or arrangement. [\/FN]\nEXHIBIT 10.17 AMENDMENT NO. 6 TO LOAN AGREEMENT\nTHIS AMENDMENT NO. 6 TO LOAN AGREEMENT (\"Amendment\"), dated as of November 23, 1994 is entered into between COBRA ELECTRONICS CORPORATION (f\/k\/a Dynascan Corporation), a Delaware corporation (\"Debtor\"), and CONGRESS FINANCIAL CORPORATION (CENTRAL) (\"Congress\"). The capitalized terms used herein without definition shall have the respective meanings assigned thereto in the Loan Agreement (as defined below).\nW I T N E S S E T H:\nWHEREAS, the parties hereto are parties to that certain Loan and Security Agreement dated as of November 12, 1992 as amended by Amendment No. 1 to Loan Agreement dated as of January 13, 1993, Omnibus Amendment to All Loan Documents dated as of March 29, 1993, Amendment No. 3 to Loan Agreement dated as of August 17, 1993, Amendment No. 4 to Loan Agreement dated as of December 29, 1993, and Amendment No. 5 to Loan Agreement dated as of February 25, 1994 (collectively, the \"Existing Agreement\" and as amended by this Amendment, the \"Loan Agreement\") and certain other agreements and documents executed or delivered in connection therewith.\nCapitalized terms used herein without definition shall have the meanings ascribed to such terms in the Loan Agreement.\nWHEREAS, Debtor and Congress desire to amend the Existing Agreement to permit issuance of Post-Termination Letters of Credit and to grant to Congress a security interest in and lien upon certain Cash Collateral to be held in the Cash Collateral Account to secure Debtor's Letter of Credit Outstandings.\nNOW, THEREFORE, in consideration of the premises, the mutual covenants herein contained and other good and valuable consideration (the receipt, adequacy and sufficiency of which are hereby acknowledged), the parties hereto, intending legally to be bound, hereby agree as follows:\n1. Amendment to Existing Agreement.\n1.1 The following terms are inserted into Section 1 of the Existing Agreement in the appropriate place in alphabetical order.\n\"Cancellation Request\" shall have the meaning set forth in Section 4A.2 hereof.\n\"Cash Collateral\" shall have the meaning set forth in Section 4A.2 hereof.\n\"Cash Collateral Account\" shall have the meaning set forth in Section 4A.2 hereof.\n\"Interest Termination Event\" shall have the meaning set forth in Section 4A.3 hereof.\n\"Post Termination Letter(s) of Credit\" shall mean any Letter(s) of Credit issued for the account of the Debtor at the sole discretion of Congress having a final expiry date occurring on or after January 11, 1995 including any replacements, renewals, extensions or modifications thereof.\n1.2 The definition of \"Letters of Credit\" in Section 1.1 of the Existing Agreement is amended and restated in its entirety as follows:\n\"Letter of Credit\" shall mean any guarantees of Congress or letters of credit (standby or commercial) which are now or at any time hereafter guaranteed, issued or caused to be issued by Congress, in either case at the request of and for the account of Debtor and which have not expired or been rescinded, revoked or terminated.\n1.3 The definition of \"In-Transit Inventory\" in Section 1.1 of the Existing Agreement is amended and restated in its entirety as follows:\n\"In-Transit Inventory\" shall mean fist quality finished electronics goods held for sale or resale in the ordinary course of Debtor's business which are (a) evidenced by a Qualifying Bill of Lading and currently in-transit from the supplier thereof and for which (i) the supplier has been paid in full therefor or (ii) the supplier has been issued a Letter of Credit not constituting a Post-Termination Letter of Credit for the full amount of the purchase price thereof or (b) to be acquired by Debtor from a supplier to which a Letter of Credit not constituting a Post-Termination Letter of Credit has been issued for the full amount of the purchase price thereof which contains as a condition to drawing thereunder, the presentation of a Qualifying Bill of Lading.\n1.4 The following Section 4A is added to the Existing Agreement immediately following Section 4.2.5 and preceding Section 5:\n\"SECTION 4A. POST TERMINATION LETTER(S) OF CREDIT\n4A.1 Issuance of Post-Termination Letter(s) of Credit. Although nothing contained in this Agreement or any other Loan Document in any way obligates Congress to do so, Congress may, in its sole discretion, issue or cause to be issued Post-Termination Letter(s) of Credit upon the written request of Debtor which Post- Termination Letter(s) of Credit, in all respects other than the stated expiry date thereof, shall be subject to the same terms and conditions applicable to any Letter of Credit set forth in this Agreement, including, without limitation, the provisions of Section 4.1 hereof.\n4A.2 Cash Collateral. Upon issuance of any Post-Termination Letter of Credit, Congress shall be deemed to be authorized and directed by Debtor to immediately fund an Advance equal to the maximum face amount of such Post-Termination Letter of Credit (all such funds received from time to time, collectively the \"Cash Collateral\") and to place such funds in an account owned and controlled by Congress (the \"Cash Collateral Account\") to cash collateralize the Letter of Credit Outstandings. To secure the full and complete payment and performance when due of the Letter of Credit Outstandings, Debtor hereby pledges and assigns to Congress all of its right, title and interest in, and hereby grants to Congress, a security interest in all Cash Collateral and all proceeds thereof which is deposited or deemed deposited by Congress from time to time in the Cash Collateral Account. If any time Congress receives a draw request or draft, as the case may be, from a beneficiary under any Post Termination Letter of Credit or letter of Credit Outstandings otherwise become due and payable, Congress shall be entitled, without demand upon Debtor, to withdraw from the Cash Collateral Account and retain for its own account an amount of Cash Collateral equal to the amount of the drawing or draft honored by Congress plus the amount of any outstanding L\/C fees and other fees, expenses and amounts payable pursuant to Sections 4.1.1 and 4.1.2 of the Loan Agreement. Congress shall promptly provide notice to Debtor of any withdrawl by Congress from the Cash Collateral Account. If at any time Post-Termination letter of Credit is delivered to Congress for cancellation with a duly executed release from the beneficiary or beneficiaries thereof in form and substance satisfactory to Congress waiving and releasing all rights under such Post-Termination Letter of Credit and requesting that the same be cancelled (a \"Cancellation Request\") and\/or the Post-Termination Letter of Credit shall expire with any available amount thereunder undrawn, Congress shall, within five (5) Business days after receipt of written demand therefor from Debtor, remit to Debtor an amount of Cash Collateral equal to the available undrawn amount of such Post-Termination Letter of Credit immediately prior to cancellation or expiration less the amount of any outstanding L\/C Fees and other fees, expenses and amounts payable pursuant to Sections 4.1.1 and 4.1.2 of the Loan Agreement in respect of such Post-Termination Letter of Credit which L\/C Fees and other fees, expenses and amounts shall thereupon be withdrawn from the Cash Collateral Account by Congress and retained for its own account. If all Post-Termination Letters of Credit have been delivered to Congress for cancellation together with a Cancellation Request and\/or have expired with any available amount thereunder undrawn and all the other Letter of Credit Outstandings have been satisfied or discharged, then Congress shall promptly apply the Cash Collateral then remaining in the Cash Collateral Account against the Obligations. If any Cash Collateral remains after the application of Cash Collateral to the Obligations as described in the prior sentence, Congress shall, within five (5) Business Days after receipt of written demand therefor from Debtor, remit to Debtor the remaining balance of any Cash Collateral held by Congress in the Cash Collateral Account pursuant to this Section 4A.2 less the amount of any outstanding L\/C Fees and other fees, expenses and amounts payable pursuant to Sections 4.1.1 and 4.1.2 of the Loan Agreement in respect of such Post-Termination Letter(s) of Credit which L\/C Fees and other fees, expenses and amounts shall be thereupon withdrawn from the Cash Collateral Account by Congress and retained for its own account. Notwithstanding any depletion of the Cash Collateral Account, Debtor shall continue to be liable to Congress for all Letter of Credit Outstandings and other Obligations which may become due and payable.\n4A.3 Interest on Cash Collateral. Until January 11, 1995 or such earlier date as the Loan Agreement is terminated or the Obligations of Debtor have been declared immediately due and payable (the earlier to occur of such dates, an \"Interest Termination Event\"), the Cash Collateral remaining in the Cash Collateral Account (after any reduction of the amount of such Cash Collateral pursuant to Section 4A.2 hereof) will accrue interest at the same rate and in the same manner as interest accrues on Debtor's loan account balance as provided in Section 3; it being understood and agreed that from and after the occurrence of an Interest Termination Event, no interest will accrue in favor of Debtor in respect of the Cash Collateral. On the first day of each month or such other day as may be provided for in Section 3.1 for the payment of interest to Congress, Congress shall apply the accrued interest from such Cash Collateral for the prior month to reduce the Obligations.\"\n2. Conditions Precedent to Effectiveness of This Amendment. This Amendment shall become effective upon the fulfillment of each of the following conditions to the satisfaction of Congress:\na. All of Debtor's representations and warranties contained in the Loan Agreement and any other agreement executed in connection therewith (other than the representations and warranties that are expressly made as of a certain date, which shall be true and correct in all material respects on and as of such date) shall be true and correct in all material respects; and\nb. Congress shall have received from Debtor fully executed counterparts to the Amendment signed by a duly authorized officer of Debtor, and Congress shall have delivered to Debtor fully executed counterparts to the Amendment signed by a duly authorized officer of Congress;\n3. Absence of Waiver or Setoff.\n3.1 No Waiver. Congress and Debtor agree that the amendment set forth in Section 1 hereof shall be limited precisely as written and expect, as expressly set forth in Section 1 of this Amendment, shall not be deemed to be a consent to any waiver or modification of any other term or condition of the Existing Agreement, the Loan Agreement or any Loan Document.\n3.2 Acknowledgement of Liabilities. Debtor hereby acknowledges and agrees that there is no defense, setoff or counterclaim of any kind, nature or description to the Obligations or the payment thereof when due.\n4. Representations. Debtor hereby represents and warrants to Congress that:\n(i) Debtor is a corporation duly organized, validly existing, and in good standing under the laws of the state of its incorporation;\n(ii) the execution, delivery and performance of this Amendment by Debtor are within its corporate powers and have been duly authorized by all necessary corporate action; and\n(iii) this Amendment is a legal, valid, and binding obligation of Debtor, enforceable against Debtor in accordance with its terms.\n5. References in Other Documents. References to the Existing Agreement in any Loan Document shall be deemed to include a reference to the Loan Agreement, whether or not reference is made to this Amendment.\n6. Miscellaneous.\n(i) Section headings used in this Amendment are for convenience of reference only and shall not affect the construction of this Amendment.\n(ii) This Amendment may be executed in any number of counterparts and by the difference parties on separate counterparts and each such counterpart shall be deemed to be an original, but all such counterparts shall together constitute but one and the same agreement.\n(iii) This Amendment shall be a contract made under and governed by the laws of the State of Illinois, without giving effect to principles of conflicts of laws.\n(iv) All obligations of Debtor and rights of Congress that are expressed herein, shall be in addition to and not in limitation of those provided by applicable law.\n(v) Whenever possible, each provision of this Amendment shall be interpreted in such manner as to be effective and valid under applicable law; but if any provision of this Amendment shall be prohibited by or invalid under application law, such provision shall be ineffective to the extend of such prohibition or invalidity, without invalidating the remainder of such provision of such provision or the remaining provisions of this Amendment.\n(vi) This Amendment shall be binding upon Debtor and Congress and their respective successors and assigns, and shall insure to the benefit of Debtor and Congress and the successors and assigns of Congress.\nIN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized as of the date first above written.\nCOBRA ELECTRONICS CORPORATION, (f\/k\/a Dynascan Corporation), a Delaware corporation\nBy: Gerald M. Laures Name: Gerald M. Laures Title: VP-Finance\nCONGRESS FINANCIAL CORPORATION (CENTRAL)\nBy: Steven Linderman Name: Steven Linderman Title: Assist. Vice President\nEXHIBIT 10-18\nAMENDMENT NO. 7 TO LOAN AGREEMENT\nTHIS AMENDMENT NO. 7 TO LOAN AGREEMENT (\"Amendment\"), dated of December 14, 1994 is entered into between COBRA ELECTRONICS CORPORATION (f\/k\/a\/ Dynascan Corporation), a Delaware corporation (\"Debtor\"), and CONGRESS FINANCIAL CORPORATION (CENTRAL) (\"Congress\"). The capitalized terms used herein without definition shall have the respective meanings assigned thereto in the Loan Agreement (as defined below).\nW I T N E S S E T H:\nWHEREAS, the parties hereto are parties to that certain Loan and Security Agreement dated as of November 12, 1992 as amendment by Amendment No. 1 to Loan Agreement dated as of January 13, 1993, Omnibus Amendment to All Loan Documents dated as of August 17, 1993, Amendment No. 3 to Loan Agreement dated as of December 29, 1993, Amendment No. 5 to Loan Agreement dated as of February 25, 1994, and Amendment No. 6 to Loan Agreement dated as of November 23, 1994 (collectively, the \"Existing Agreement\" and as amended by this Amendment, the \"Loan Agreement\") and certain other agreements and documents executed or delivered in connection therewith.\nCapitalized terms used herein without definition shall have the meanings ascribed to such terms in the Loan Agreement.\nWHEREAS, Debtor and Congress desire to amend the Existing Agreement to extend the termination date of the Loan Agreement to February 28, 1995.\nNOW, THEREFORE, in consideration of the premises, the mutual covenants herein contained and other good and valuable consideration (the receipt, adequacy and sufficiency of which are hereby acknowledged), the parties hereto, intending legally to be bound, hereby agree as follows:\n1. Amendment to Existing Agreement. Section 2.6 of the Existing Agreement is hereby amended by deleting the phrase \"for a term ending January 11, 1995\" and inserting in place thereof the phrase \"for a term ending February 28, 1995\".\n2. Conditions Precedent to Effectiveness of This Amendment. This Amendment shall become effective upon the fulfillment of each of the following conditions to the satisfaction of Congress:\n(a) All of Debtor's representations and warranties contained in the Loan Agreement and any other agreement executed in connection therewith (other than the representations and warranties that are expressly made as of a certain date, which shall be true and correct in all material respects on and as of such date) shall be true and correct in all material respects;\n(b) Debtor shall deliver to Congress a certificate of the Secretary of Debtor, dated as of the effective date of this Amendment and satisfactory in form and substance to Congress, as Congress, in its sole discretion, shall determine, certifying, among other things, (a) the names and true signatures of the officers of Debtor authorized to sign the Amendment and any of the other Loan Documents contemplated thereby to which Debtor is a party; (b) that attached thereto is a true and complete copy of the By-Laws of Debtor as in effect on the date of such certification; and (c) that attached thereto is a true and complete copy of the resolutions of Debtor's Board of Directors approving and authorizing the execution and delivery of the Amendment and the other Loan Documents contemplated thereby to which Debtor is a party;\n(c) Congress shall have received from Debtor fully executed counterparts to the Amendment, the Amended and Restated Promissory Note in the form attached hereto as Exhibit A and each other Loan Document contemplated thereby to which Debtor is a party signed by duly authorized officers of Debtor, and Congress shall have delivered to Debtor fully executed counterparts to the Amendment and each other Loan Document to which Congress is party signed by a duly authorized officer of Congress; and\n(d) No material adverse change in the financial condition, business prospects or value of assets of Debtor shall have occurred since the date of Debtor's quarterly financial statements for the period ending September 30, 1994;.\n3. Absence of Waiver or Setoff.\n3.1 No Waiver. Congress and Debtor agree that the amendment set forth in Section 1 hereof shall be limited precisely as written and except, as expressly set forth in Section 1 of this Amendment, shall not be deemed to be a consent to any waiver or modification of any other term or condition of the Existing Agreement, the Loan Agreement or any Loan Document.\n3.2 Acknowledgement of Liabilities. Debtor hereby acknowledges and agrees that there is no defense, setoff or counterclaim of any kind, nature or description to the Obligations or the payment thereof when due.\n4. Representations. Debtor hereby represents and warrants to Congress that:\n(i) Debtor is a corporation duly organized, validly existing, and in good standing under the laws of the state of its incorporation;\n(ii) the execution, delivery and performance of this Amendment by Debtor are within its corporate powers and have been duly authorized by all necessary corporate action; and\n(iii) this Amendment is a legal, valid, and binding obligation of Debtor, enforceable against Debtor in accordance with its terms.\n5. References in Other Documents. References to the Existing Agreement in any Loan Document shall be deemed to include a reference to the Loan Agreement, whether or not reference is made to this Amendment.\n6. Miscellaneous.\n(i) Section headings used in this Amendment are for convenience of reference only and shall not affect the construction of this Amendment.\n(ii) This Amendment may be executed in any number of counterparts and by the different parties on separate counterparts and each such counterpart shall be deemed to be an original, but all such counterparts shall together constitute but one and the same agreement.\n(iii) This Amendment shall be a contract made under and governed by the laws of the State of Illinois, without giving effect to principles of conflicts of laws.\n(iv) All obligations of Debtor and rights of Congress that are expressed herein, shall be in addition to and not in limitation of those provided by applicable law.\n(v) Whenever possible, each provision of this Amendment shall be interpreted in such manner as to be effective and valid under applicable law; but if any provision of this Amendment shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision of such provision or the remaining provisions of this Amendment.\n(vi) This Amendment shall be binding upon Debtor and Congress and their respective successors and assigns, and shall inure to the benefit of Debtor and Congress and the successors and assigns of Congress.\nIN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed by their respective officers thereunto duly authorized as of the date first above written.\nCOBRA ELECTRONICS CORPORATION (f\/k\/a Dynascan Corporation), a Delaware corporation\nBy: Gerald M. Laures Name: Gerald M. Laures Title: VP-Finance\nCONGRESS FINANCIAL CORPORATION (CENTRAL)\nBy: Steven Linderman Name: Steven Linderman Title: Assist. Vice President\nEXHIBIT A\nSECOND AMENDED AND RESTATED PROMISSORY NOTE\n$2,563,690.50 December 14, 1994\nFOR VALUE RECEIVED, the undersigned (the \"Maker\"), does hereby promise to pay to CONGRESS FINANCIAL CORPORATION (CENTRAL) (the \"Payee\"), at its offices located at 100 South Wacker Drive, Suite 1940, Chicago, Illinois, 60606, or at such other place as the Payee or any holder hereof may from time to time designate, the principal sum of TWO MILLION FIVE HUNDRED SIXTY-THREE THOUSAND SIX HUNDRED NINETY DOLLARS AND FIFTY CENTS ($2,563,690.50) in lawful money of the United States, in monthly installments as provided below (or earlier, as hereinafter referred to) on the 1st day of each month commencing January 1, 1995 of which the first two (2) installments each shall be in the amount of $43,452.38 and the last (i.e. balloon) installment shall be in the amount of $2,476,785.74 and shall be due and payable on February 28, 1995. Maker hereby further promises to pay interest to Payee in like money at said office or place from and after the date the Term Loan is funded on the unpaid principal balance thereof computed at the rate of two percent (2.0%) percent per annum plus the prime commercial interest rate as announced from time to time by The Philadelphia National Bank, incorporated as CoreStates Bank. N.A., Philadelphia, Pennsylvania, whether or not such announced rate is the best rate available at such bank, which interest rate payable hereunder shall increase or decrease in an amount equal to each increase or decrease, respectively, in said prime commercial interest rate as announced by said bank, effective on the first day of the month after any change in said prime commercial interest rate based on the prime commercial interest rate in effect on the last day of the month in which any such change occurs. Interest shall be payable on the 1st day of each month commencing January 1, 1995. Interest after maturity shall be payable at a rate equal to two (2%) percent per annum in excess of the rate otherwise payable hereunder. Interest shall be calculated on the basis of a 360-day year and actual days elapsed. In no event shall the interest charged hereunder exceed the maximum permitted under the laws of the State of Illinois.\nThis Note is issued as evidence of indebtedness arising pursuant to the terms and provisions of the financing agreements, documents and guaranties granting collateral security or evidencing or creating indebtedness, each initially executed and delivered by Maker or related parties in favor of Payee as of November 16, 1992, as amended from time to time (the foregoing, together with all present and future related agreements or instruments with respect thereto, as the same may not exist or hereafter be amended, modified or supplemented are hereafter collectively referred to as the \"Financing Agreements\"). Capitalized terms used herein without definition shall have the meanings ascribed to such terms in the Financing Agreements. This Note is secured by, and is entitled to the benefit of, any and all collateral pledged by Maker or related parties to Payee as more particularly set forth in the Financing Agreements. At the time payment is due hereunder, at is option Payee may charge the amount thereof to any account of the Maker maintained by Payee.\nIf there shall be a default in the payment when due of principal or interest hereunder, or if an Event of Default shall occur for any reason under the Financing Agreements, or if the Financing Agreements shall be terminated or not renewed for any reason whatsoever, then and in any such event, in addition to and not in limitation of all rights and remedies of the Payee under the Financing Agreements, applicable law and otherwise, all such rights and remedies being cumulative, not exclusive and enforceable alternatively, successively and concurrently, the Payee may, at its option, declare all amounts owing under this Note to be due and payable, whereupon the then unpaid balance hereof together with all interest accrued thereon shall forthwith become due and payable, together with interest accruing thereafter at the aforesaid rate payable after maturity until this Note is paid and the costs and expenses of collection hereof, including attorney's fees.\nThe Note is prepayable in whole or in part at any time in accordance with the terms of the Financing Agreements.\nThe Maker hereby waives presentment for payment, demand, notice of nonpayment and dishonor, protest and notice of protest.\nThe provisions of this Note may be changed, modified or terminated orally, but only by an agreement, in writing signed by the party to be charged, not shall any waiver be applicable except in the specific instance for which it is given.\nSection 12.1 of the Loan and Security Agreement dated as of November 12, 1992 between Maker and Payee, as amended, is hereby incorporated by reference, and shall be given full force and effect as if the same were restated herein. This note and the Financing Agreements shall be governed by and construed, and all rights and obligations hereunder determined, in accordance with the laws of the State of Illinois and shall be binding upon the successors and assigns of the Maker and inure to the benefit of the Payee, its successors, endorsers and assigns. If any term or provision of this Note shall be held invalid, illegal or unenforceable, the validity of all other terms and provisions shall in no way be affected thereby.\nThe execution and delivery of this Note has been authorized by the Board of Directors of Maker. The Maker hereby authorizes the Payee to complete this note in any particulars according to the terms of the loan evidenced hereby.\nTHIS NOTE IS NOT A NOVATION OF BUT MERELY RESTATES IN ITS ENTIRETY AND RE-EVIDENCES THAT CERTAIN AMENDED AND RESTATED PROMISSORY NOTE EXECUTED BY THE UNDERSIGNED IN FAVOR OF CONGRESS DATED DECEMBER 29, 1993 (THE \"INITIAL NOTE\") AND NOTHING HEREIN OR IN THE FINANCING AGREEMENTS, AS AMENDED, SHALL DEEM THE INITIAL NOTE TO HAVE BEEN PAID; PROVIDED HOWEVER, THE PRINCIPAL AMOUNT OF THIS NOTE EVIDENCES THE ENTIRE PRINCIPAL AMOUNT NOW OUTSTANDING UNDER THE INITIAL NOTE. INTEREST ACCRUED UNDER THE INITIAL NOTE PRIOR TO THE DATE OF THIS NOTE REMAINS ACCRUED AND UNPAID UNDER THIS NOTE AND DOES NOT CONSTITUTE ANY PART OF THE PRINCIPAL AMOUNT OF THIS NOTE.\nIN WITNESS WHEREOF, the Maker has duly executed and sealed this Note as of the day and year first above written.\nCOBRA ELECTRONICS CORPORATION, a Delaware corporation (f\/k\/a Dynascan Corporation)\nBy: Gerald M. Laures Title: Vice President-Finance\nEXHIBIT 10-19\nAMENDMENT NO. 8 TO LOAN DOCUMENTS\nTHIS AMENDMENT NO. 8 TO LOAN DOCUMENTS (\"Amendment\"), dated as of January 20, 1995 is entered into between COBRA ELECTRONICS CORPORATION (f\/k\/a Dynascan Corporation), a Delaware corporation (\"Debtor\"), and CONGRESS FINANCIAL CORPORATION (CENTRAL) (\"Congress\"). The capitalized terms used herein without definition shall have the respective meanings assigned thereto in the Loan Agreement (as defined below).\nW I T N E S S E T H:\nWHEREAS, the parties hereto are parties to that certain Loan and Security Agreement dated as of November 12, 1992 as amended by Amendment No. 1 to Loan Agreement dated as of January 13, 1993, Omnibus Amendment to All Loan Documents dated as of March 29, 1993, Amendment No. 3 to Loan Agreement dated as of August 17, 1993, Amendment No. 4 to Loan Agreement dated as of December 29, 1993, Amendment No. 5 to Loan Agreement dated as of February 25, 1994, Amendment No. 6 to Loan Agreement dated as of November 23, 1994, and Amendment No. 7 to Loan Agreement dated as of December 14, 1994 (collectively, the \"Existing Agreement\" and as amended by this Amendment, the \"Loan Agreement\") and certain other agreements and documents executed or delivered in connection therewith. Capitalized terms used herein without definition shall have the meanings ascribed to such terms in the Loan Agreement.\nWHEREAS, Debtor and Congress desire to extend the maturity date of the Loan Agreement to January 10, 1997, restructure the Term Loan facility, modify various aspects of the Revolving Loan facility, delete provisions relating to Post-Termination Letters of Credit which were added by Amendment No. 6 to Loan Agreement and make various other amendments to the Loan Agreement and other Loan Documents as set forth herein.\nNOW, THEREFORE, in consideration of the premises, the mutual covenants herein contained and other good valuable consideration (the receipt, adequacy and sufficiency of which are hereby acknowledged), the parties hereto, intending legally to be bound, hereby agree as follows:\n1. Amendments to Existing Loan Documents.\n1.1 The following defined terms are hereby deleted from Section 1 of the Existing Agreement:\n\"Cancellation Request\" shall have the meaning set forth in Section 4A.2 hereof.\n\"Cash Collateral\" shall have the meaning set forth in Section 4A.2 hereof.\n\"Cash Collateral Account\" shall have the meaning set forth in Section 4A.2 hereof.\n\"Interest Termination Event\" shall have the meaning set forth in Section 4A.3 hereof.\n\"Post-Termination Letter(s) of Credit\" shall mean any Letter(s) of Credit issued for the account of Debtor at the sole discretion of Congress having a final expiry date occurring on or after January 11, 1995 including any replacements, renewals, extensions or modifications thereof.\n1.2 The following terms are inserted into Section 1 of the Existing Agreement in the appropriate place in alphabetical order:\n\"Dilution Event\" shall exist whenever the aggregate amount of noncash credits and other discounts reported or accrued by the Debtor in the ordinary course of Debtor's business consistent with Debtor's prior practices and policies represent an amount greater than twenty-two percent (22%) of the initial invoiced amount of all outstanding Accounts as measured on the last day of each month for the immediately preceding three month period.\n\"New Term Loan\" shall mean the loan evidenced by that certain New Term Promissory Note of dated as of January 23, 1995 in the original principal amount of $3,650,000 made by Debtor and payable to Congress for the purpose of refinancing the Term Loan and providing additional funding to Debtor.\n\"Repair Inventory\" shall mean Inventory which has been returned which is being repaired and\/or repackaged for resale and which is located at Debtor's premises or at a third party repair\/service facility which has executed and delivered a bailee waiver letter in favor of and on terms acceptable to Congress.\n\"Seasonal Overadvance Amount\" shall mean (a) during the period commencing March 1 and ending August 31 of each year commencing with 1995, an amount equal to the lessor of (i) $1,250,000 and (ii) the positive difference, if any, of $1,250,000 minus (x) zero so long as no Dilution Event is outstanding or (y) an amount equal to five percent (5%) of the Net Amount of Eligible Accounts at anytime a Dilution Event is outstanding, and (b) during the period commencing September 1 and ending February 28 or 29, as applicable, of each year commencing with 1995, an amount equal to zero.\n1.3 The following definitions in Section 1.1 of the Existing Agreement is amended in its entirety as follows:\n\"Eligible Inventory\" shall mean and include Inventory consisting of first quality finished electronics goods (and Repair Inventory) held for sale or resale in the ordinary course of Debtor's business and raw materials for such finished goods which are acceptable to Congress in all respects exercising its Permitted Discretion and which (i) are located at Debtor's premises or at Permitted Warehouses or (ii) constitute In-Transit Inventory or Repair Inventory. General criteria for Eligible Inventory may be established and revised from time to time by Congress in the exercise of its Permitted Discretion. In determining such acceptability Congress may, but need not, rely on reports and schedules of Inventory furnished to Congress by Debtor, but reliance thereon by Congress from time to time shall not be deemed to limit Congress' right to revise standards of eligibility at any time exercising its Permitted Discretion. In general, except as may be expressly permitted by Congress in Congress' sole discretion, Eligible Inventory shall not include discontinued items other than Discontinued Inventory, work in process, molded components which are not part of finished goods, spare parts, packaging and shipping materials, supplies used or consumed in Debtor's business, Inventory at the premises of third parties other than Inventory located at Permitted Warehouses or In-Transit Inventory, Inventory which is subject to a Lien in favor of any third party, bill and hold goods, Inventory which is not subject to Congress' perfected security interest, Inventory which is purchased on consignment, and except for Inventory constituting Repair Inventory, Inventory being repaired, remanufactured products, defective goods, \"seconds\", and returned goods which are not packaged for resale. In addition, Eligible Inventory must also be Inventory that meets the following requirements in Congress' sole and absolute judgment:\nA. Except for Inventory constituting Repair Inventory, the Inventory is in good condition, meets all standards imposed by any governmental agency, or department or division thereof, having regulatory authority over the Inventory, their use and\/or sale and is either currently usable or currently saleable in the ordinary course of Debtor's business and is not otherwise unacceptable to Congress in the exercise of its Permitted Discretion because of age, type, category, quality and\/or quantity;\nB. The Inventory has not been consigned to a customer of Debtor, has not been used or repossessed, and has not been attached, seized, made subject to a writ or distress warrant, levied upon or brought within the possession of any receiver, trustee, custodian or assignee for the benefit or creditors;\nC. Each of the warranties and representations set forth in this Agreement has been reaffirmed with respect thereto at the time the most recent Availability Report was delivered to Congress; and\nD. The Inventory was not purchased by Debtor in or as part of a \"bulk\" transfer or sale of assets unless Debtor has complied with all applicable bulk sales or bulk transfer laws.\n\"In-Transit Inventory\" shall mean first quality finished electronics goods held for sale or resale in the ordinary course of Debtor's business which are (a) evidenced by a Qualifying Bill of Lading and currently in-transit from the supplier thereof and for which (i) the supplier has been paid in full therefor or (ii) the supplier has been issued a Letter of Credit for the full amount of the purchase price thereof or (b) to be acquired by Debtor from a supplier to which a Letter of Credit has been issued for the full amount of the purchase price thereof which contains as a condition to drawing thereunder, the presentation of a Qualifying Bill of Lading.\n\"Permitted Real Estate Refinancing\" means Debtor's refinancing with a financial institution of all or a portion of its real property; provided that, (i) the Debtor receives cash proceeds in connection with any such refinancing which are equal to or greater than the amount listed opposite such property on Schedule A hereto, (ii) all net cash proceeds are paid to Congress and applied to repayment in full of the New Term Loan and with any balance being applied to repayment of the remaining Obligations, and (iii) any Liens granted by Debtor in connection with such refinancing shall be limited to a senior Lien on the real property, fixtures and improvements associated therewith and be subject to an intercreditor agreement acceptable to Congress in its sole discretion; provided that no Lien of any nature or priority shall be provided in connection with such refinancing on any other property of Debtor without the prior written consent of Congress.\n1.4 Section 2.1 of the Existing Agreement is amended and restated in its entirety to read as follows:\n\"2.1 Revolving Loans. Congress shall, in the exercise of its Permitted Discretion, make Revolving Loans (net of applicable reserves pursuant to Section 4.1 and 4.2 hereof) to Debtor from time to time, at Debtor's request, of (a) seventy percent (70%) of the Net Amount of Eligible Accounts (or such greater or lesser percentage thereof as Congress shall, in the exercise of its Permitted discretion determine from time to time), plus (b) the Seasonal Overadvance Amount, if any, plus (c) the following percentages of Value of the following categories of Eligible Inventory (or such greater of lesser percentages thereof as Congress shall, in the exercise of its Permitted Discretion, determine from time to time):\n(i) 55% of first quality finished goods owned by Debtor which do not constitute In-Transit Inventory or Discontinued Inventory;\n(ii) 55% of In-Transit Inventory;\n(iii) 40% of Discontinued Inventory; and\n(iv) 15% of Repair Inventory\nExcept as may be expressly permitted by Congress in Congress' sole discretion, (i) during the period commencing on March 1 and ending on August 31 of each year, the outstanding aggregate principal amount of Advances by Congress to Debtor hereunder with respect to Eligible Inventory shall not exceed, at any time, the lower of (a) the aggregate amount of the above percentages of Value of Eligible Inventory, or (b) $17,500,000 and (ii) during the period commencing on September 1 and ending on February 28 or 29, as applicable, of each year, the outstanding aggregate principal amount of Advances by Congress to Debtor hereunder with respect to Eligible Inventory shall not exceed, at any time, the lower of (a) the aggregate amount of the above percentages of Value of Eligible Inventory, or (b) $15,000,000. In addition, except as may be expressly permitted by Congress in Congress' sole discretion, (i) the outstanding aggregate principal amount of Advances by Congress to Debtor hereunder in respect to Discontinued Inventory shall not exceed, at any time, the lower of (a) the Value of Discontinued Inventory constituting Eligible Inventory, or (b) $2,000,000 and (ii) the outstanding aggregate principal amount of Advances by Congress to Debtor hereunder in respect of Repair Inventory shall not exceed, at any time, the lower of (a) the Value of Repair Inventory constituting Eligible Inventory, or (b) $1,000,000. In addition to the amount advanced against the value of Eligible Accounts and Eligible Inventory, hereby, Congress may, in its sole discretion, make Revolving Loans to Debtor from time to time, at Debtor's request, which shall not exceed the positive difference, if any, between (a) the Cash Value (as defined in Section 12.3 hereof) on the date of determination less (b) $1,850,000. The Revolving Loans made pursuant to this Section 2.1 shall be repaid in full upon termination of this Agreement in accordance with Section 2.6 hereof. On each day that Debtor shall request an Advance, and on any other day that Congress may request, Debtor shall deliver to Congress an assignment schedule, a remittance report and a report of credit returns and allowances together with such other documents as Congress may reasonably request, including, without limitation, documents setting forth total sales, total non-cash credits and cash collections of Debtor. In addition, Debtor shall furnish to Congress on the first Business day of each week and on any other day that Congress may request, an Availability Report. In no event shall the information set forth in the Availability Report or otherwise delivered to Congress in connection therewith limit Congress' Permitted Discretion to determine the Eligible Accounts, the Eligible Inventory, the Net Amount of Eligible Accounts or the Value of Eligible Inventory.\"\n1.5 The Existing Agreement is amended by adding thereto the following new Section 2.2A immediately following Section 2.2 thereof:\n\"2.2A New Term Loan. Congress shall subject to the terms and conditions of Amendment No. 8 to this Agreement, advance the New Term Loan to Debtor on the date the condition precedent set forth in such Amendment No. 8 have been met to the satisfaction of Congress. Debtor hereby irrevocably directs Congress to apply the proceeds of the New Term Loan to repayment in full of the outstanding principal and all accrued but unpaid interest in respect of the Term Loan with the remaining balance of such New Term Loan proceeds being applied to reduce the outstanding balance of Revolving Loans. The New Term Loan shall be repaid in accordance with the applicable promissory note evidencing such loan and shall be repaid in full upon the termination of this Agreement in accordance with Section 2.6 hereof.\"\n1.6 Section 2.4 of the Existing Agreement is amended and restated in its entirety to read as follows:\n\"2.4 Maximum Loan Amount. Except as may be expressly permitted by Congress in Congress' sole discretion, the outstanding aggregate principal amount of all Advances by Congress to Debtor hereunder or evidenced by any promissory note, shall not exceed the Maximum Credit at any time and the sum of the Revolving Loans plus the Letter of Credit Outstandings plus the B\/A Outstandings, shall not exceed the Maximum Revolving Credit at any time. Without limiting Congress' right to demand payment of the Obligations, or any portion thereof, in accordance with any other terms of this Agreement, in the same event that (i) the outstanding aggregate principal amount of Advances by Congress to Debtor exceeds the Maximum Credit or (ii) the sum of the Revolving Loans plus the Letter of Credit Outstandings plus the B\/A Outstandings exceeds the lesser of the Maximum Revolving Credit and the formula (giving effect to any applicable sublimits) set forth in Section 2.1 hereof, Debtor shall remain liable therefor and the entire amount of such excess(es) shall, at Congress' option, become immediately due and payable, upon Congress' demand and, except to the extent of any amount then due and payable under the New Term Loan, all payments thereof shall be applied to the Revolving Loans or to cash collateralize any outstanding Letter of Credit or Banker's Acceptances.\"\n1.7 Section 2.6 of the Existing Agreement is amended and restated in its entirety to read as follows:\n\"2.6 \"Term of Agreement\". This Agreement shall become effective upon acceptance by you and shall continue in full force and effect for a term ending January 10, 1997, unless sooner terminated pursuant to the terms hereof. Congress shall have the right to terminate this Agreement immediately at any time upon the occurrence of an Event of Default. No termination of this Agreement, however, shall relieve or discharge Debtor of its duties, obligations and covenants hereunder until all Obligations have been paid in full, and Congress' continuing security interest in the Collateral shall remain in effect until such Obligations have been fully discharged.\"\n1.8 Section 3.1 of the Existing Agreement is amended and restated in its entirety to read as follows:\n\"3.1 Interest. Interest shall be payable by Debtor to Congress in arrears on the first day of each month upon the closing daily balances in Debtor's loan account for each day during the immediately preceding month at a rate equal to one and one-half percent (1.5%) per annum in excess of the prime commercial interest rate from time to time publicly announced by the CoreStates Bank, N.A., Philadelphia, Pennsylvania, whether or not such announced rate is the best rate available at such bank (the \"Applicable Prime Rate\"), provided that such monthly interest payments regarding the closing daily balances in Debtor's loan account constituting usage of the Seasonal Overadvance Amount or otherwise reflecting Advances exceeding the amounts permitted in Section 2.4 hereof shall be based on a rate equal to two and one-half percent (2.5%) in excess of the Applicable Prime Rate. The interest rate charged hereunder shall increase or decrease by an amount equal to each increase or decrease, respectively, in said prime loan rate, effective on the first day of the month after any change in said prime loan rate based on the prime loan rate in effect on the last day of the month in which any such change occurs.\"\n1.9 Section 4A of the Existing Agreement appearing immediately following Section 4.2.5 is hereby deleted in its entirety.\n1.10 Section 12.12 of the Existing Agreement is amended and restated in its entirety to read as follows:\n\"12.12 Refinancing of the New Term Loan. In the event Debtor shall present another bank or financial institution to Congress that is willing to refinance the New Term Loan pursuant to a Permitted Real Estate Refinancing, Congress will subordinate its lien on the real estate (but not any Equipment located thereon) which is the subject of such Permitted Real Estate Refinancing on terms and conditions mutually acceptable to Congress and such bank or financial institution.\"\n1.11 Section 12.13 of the Existing Agreement is amended by adding the following language at the end thereof:\n\"Debtor shall use its best efforts to cause the Equitable Variable Life Insurance Company to issue to Congress prior to February 15, 1995 a certificate of insurance or other satisfactory written acknowledgement indicating that Congress is the collateral assignee of Debtor's interests in the Policy No. AA38257996 and confirming that the Insurance Assignment executed by Debtor on November 12, 1992 in favor of Congress relating to policy No. AA38257996 continues to remain in full force and effect notwithstanding that the named insured thereunder has been changed from \"James J. Bode\" to \"Stephen M. Yanklowitz\".\"\n1.12 Section 1 of the Trademark Security Agreement is amended by deleting the word \"Lender's\" and inserting the word \"Borrower's\" in place thereof.\n2. Conditions Precedent to Effectiveness of This Amendment. Solely with respect to the amendment to Section 2.6 of the Existing Agreement described in Section 1.7 to this Amendment and with respect to all provisions of this Amendment set forth in Sections 3, 4, 5, and 6 hereof, this Amendment shall be deemed effective upon the fulfillment of each of the conditions set forth in clauses (a) through and including (d) set forth below. All aspects of this Amendment shall become effective upon the fulfillment of each of the following conditions (including the conditions in clause (e) below) to the satisfaction of Congress:\n(a) All of Debtor's representations and warranties contained in the Loan Agreement and any other agreement executed in connection therewith (other than the representations and warranties that are expressly made as of a certain date, which shall be true and correct in all material respects on and as of such date) shall be true and correct in all material respects;\n(b) Debtor shall deliver to Congress a certificate of the Secretary of Debtor, dated as of the effective date of this Amendment and satisfactory in form and substance to Congress, as Congress, in its sole discretion, shall determine, certifying, among other things, (a) the names and true signatures of the officers of Debtor authorized to sign the Amendment and any of the other Loan Documents contemplated thereby to which Debtor is a party; (b) that attached thereto is a true and complete copy of the By-Laws of Debtor as in effect on the date of such certification; (c) that attached thereto is a true and complete copy of the resolutions of Debtor's Board of Directors approving and authorizing the execution and delivery of the Amendment and the other Loan Documents contemplated thereby to which Debtor is a party; and (d) that the Secretary has reviewed each of the material agreements and written undertakings to which Debtor has become a party since the date of the Initial Advance and the execution, delivery and performance of this Amendment do not violate or conflict with any of the terms or provisions of any such material agreement or written undertaking.\n(c) Congress shall have received from Debtor fully executed counterparts to the Amendment, the New Term Promissory Note in the form attached hereto as Exhibit A, Amendment No. 1 to Illinois Mortgage in the form attached as Exhibit B, Amendment No. 1 to North Carolina Deed of Trust in the form of Exhibit C, and each other Loan Document contemplated thereby to which Debtor is a party signed by duly authorized officers of Debtor, and Congress shall have delivered to Debtor fully executed counterparts to the Amendment and each other Loan Document to which Congress is party signed by a duly authorized officer of Congress;\n(d) Congress shall have received from Debtor an amendment fee equal to $50,000 which shall be deemed earned in full on the date of Congress' execution and delivery of this Amendment, and\n(e) Congress shall have received updated title insurance on each of the Illinois Mortgage and the North Carolina Deed of Trust on terms acceptable to Congress.\n3. Absence of Waiver or Setoff\n3.1 No Waiver. Congress and Debtor agree that the amendment set forth in Section 1 hereof shall be limited precisely as written and except, as expressly set forth in Section 1 of this Amendment, shall not be deemed to be a consent to any waiver or modification of any other term or condition of the Existing Agreement, the Loan Agreement or any Loan Document.\n3.2 Acknowledgement of Liabilities. Debtor hereby acknowledges and agrees that there is no defense, setoff or counterclaim of any kind, nature or description to the Obligations or the payment thereof when due.\n3.3 No Amounts Due on Cash Collateral. Debtor acknowledges that no amounts are due Debtor from Congress or have accrued pursuant to Section 4A.3 of the Existing Agreement (which Section is being deleted from the Existing Agreement by this Amendment).\n4. Representations. Debtor hereby represents and warrants to Congress that:\n(i) Debtor is a corporation duly organized, validly existing, and in good standing under the laws of the state of its incorporation;\n(ii) the execution, delivery and performance of this Amendment by Debtor are within its corporate powers, have been duly authorized by all necessary corporate action and do not violate or conflict with the terms of any agreement or written undertaking to which the Debtor is a party;\n(iii) This Amendment is a legal, valid, and binding obligation of Debtor, enforceable against Debtor in accordance with its terms.\n(iv) attached hereto as Schedule 1 is an accurate and complete listing of all life insurance policies owned by the Debtor which have any Cash Value and each such policy is currently subject to a valid and enforceable Insurance Assignment in favor of Congress.\n5. References in Other Documents. References to the Existing Agreement in any Loan Document shall be deemed to include a reference to the Loan Agreement, whether or not reference is made to this Amendment.\n6. Miscellaneous.\n(i) Section heading used in this Amendment are for convenience of reference only and shall not affect the construction of this Amendment.\n(ii) This Amendment may be executed in any number of counterparts and by the different parties on separate counterparts and each such counterpart shall be deemed to be an original, but all such counterparts shall together constitute but one and the same agreement.\n(iii) This Amendment shall be a contract made under and governed by the laws of the State of Illinois, without giving effect to principles of conflicts of laws.\n(iv) All obligations of Debtor and rights of Congress that are expressed herein, shall be in addition to and not in limitation of those provided by applicable law.\n(v) Whenever possible, each provision of this Amendment shall be interpreted in such manner as to be effective and valid under applicable law; but if any provision of this Amendment shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the reminder of such provision of such provision or the remaining provisions of this Amendment.\n(vi) This Amendment shall be binding upon Debtor and Congress and their respective successors and assigns, and shall inure to the benefit of Debtor and Congress and the successors and assigns of Congress.\nIN WITNESS WHEREOF, the parties hereby have caused this Amendment to be executed by their respective officers thereunto duly authorized as of the date first above written.\nCOBRA ELECTRONICS CORPORATION (f\/k\/a Dynascan Corporation) By: Gerald M. Laures Name: Gerald M. Laures Title: VP-Finance\nCONGRESS FINANCIAL CORPORATION (CENTRAL) By: Steven Linderman Name: Steven Linderman Title: Assist. Vice Pres.\nLISTING OF LIFE INSURANCE POLICIES SCHEDULE 1\nInsurance Policy Insured Company Number Stephen M. Yanklowitz Equitable AA38257996 J. Dennis Burke Equitable AA38257997 Fred N. Hackendahl Equitable AA38257998 Jerry Kalov Equitable AA38257995 Jerry Kalov Equitable AA38257999 Jerry Kalov Guardian 3153023\nEXHIBIT A\nNEW TERM PROMISSORY NOTE\n$3,650,000.00 January 23, 1995\nFOR VALUE RECEIVED, the undersigned (the \"Maker\"), does hereby promise to pay to CONGRESS FINANCIAL CORPORATION (CENTRAL) (the \"Payee\"), at its offices located at 100 South Wacker Drive, Suite 1940, Chicago, Illinois, 60606, or at such other place as the Payee or any holder hereof may from time to time designate, the principal sum of THREE MILLION SIX HUNDRED FIFTY THOUSAND DOLLARS ($3,650,000) in lawful money of the United States, in monthly installments as provided below (or earlier, as hereinafter referred to) on the 1st day of each month commencing February 1, 1995 of which the first twenty-four (24) installments each shall be in the amount of $43,452.38 and the last (i.e.balloon) installment shall be in the amount of $2,607,142.88 and shall be due and payable on January 10, 1997. Maker hereby further promises to pay interest to Payee in like money at said office or place from and after the date the New Term Loan is funded on the unpaid principal balance thereof computed at the rate of one an one-half percent (1.5%) per annum plus the prime commercial interest rate as announced from time to time by CoreStates Bank. N.A., Philadelphia,Pennsylvania, whether or not such announced rate is the best rate available at such bank, which interest rate payable hereunder shall increase or decrease in an amount equal to each increase or decrease, respectively, in said prime commercial interest rate as announced by said bank, effective on the first day of the month after any change in said prime commercial interest rate based on the prime commercial interest rate in effect on the last day of the month in which any such change occurs. Interest shall be payable on the 1st day of each month commencing February 1, 1995. Interest after maturity shall be payable at a rate equal to two percent (2%) per annum in excess of the rate otherwise payable hereunder. Interest shall be calculated on the basis of a 360-day year and actual days elapsed. In no event shall the interest charged hereunder exceed the maximum permitted under the laws of the State of Illinois.\nThis Note is issued as evidence of indebtedness arising pursuant to the terms and provisions of the financing agreements, documents and guaranties granting collateral security or evidencing or creating indebtedness, each initially executed and delivered by Maker or related parties in favor of Payee as of November 16, 1992, as amended from time to time (the foregoing, together with all present and future related agreements or instruments with respect thereto, as the same may not exist or hereafter be amended, modified or supplemented are hereafter collectively referred to as the \"Financing Agreements\"). Capitalized terms used herein without definition shall have the meanings ascribed to such terms in the Financing Agreements. This Note is secured by, and is entitled to the benefit of, any and all collateral pledged by Maker or related parties to Payee as more particularly set forth in the Financing Agreements. At the time payment is due hereunder, at is option Payee may charge the amount thereof to any account of the Maker maintained by Payee.\nIf there shall be a default in the payment when due of principal or interest hereunder, or if an Event of Default shall occur for any reason under the Financing Agreements, or if the Financing Agreements shall be terminated or not renewed for any reason whatsoever, then and in any such event, in addition to and not in limitation of all rights and remedies of the Payee under the Financing Agreements, applicable law and otherwise, all such rights and remedies being cumulative, not exclusive and enforceable alternatively, successively and concurrently, the Payee may, at its option, declare all amounts owing under this Note to be due and payable, whereupon the then unpaid balance hereof together with all interest accrued thereon shall forthwith become due and payable, together with interest accruing thereafter at the aforesaid rate payable after maturity until this Note is paid and the costs and expenses of collection hereof, including attorney's fees.\nThe Note is prepayable in whole or in part at any time in accordance with the terms of the Financing Agreements.\nThe Maker hereby waives presentment for payment, demand, notice of nonpayment and dishonor, protest and notice of protest.\nThe provisions of this Note may be changed, modified or terminated orally, but only by an agreement, in writing signed by the party to be charged, nor shall any waiver be applicable except in the specific instance for which it is given.\nSection 12.1 of the Loan and Security Agreement dated as of November 12, 1992 between Maker and Payee, as amended, is hereby incorporated by reference, and shall be given full force and effect as if the same were restated herein. This note and the Financing Agreements shall be governed by and construed, and all rights and obligations hereunder determined, in accordance with the laws of the State of Illinois and shall be binding upon the successors and assigns of the Maker and inure to the benefit of the Payee, its successors, endorsers and assigns. If any term or provision of this Note shall be held invalid, illegal or unenforceable, the validity of all other terms and provisions shall in no way be affected thereby.\nThe execution and delivery of this Note has been authorized by the Board of Directors of Maker. The Maker hereby authorizes the Payee to complete this note in any particulars according to the terms of the loan evidenced hereby.\nIN WITNESS WHEREOF, the Maker has duly executed and sealed this Note as of the day and year first above written.\nCOBRA ELECTRONICS CORPORATION, a Delaware corporation (f\/k\/a Dynascan Corporation) By: Gerald M. Laures Title: Vice President-Finance\nEXHIBIT B\nThis instrument prepared by and when recorded return to:\nPhilip J. Perzek, Esq. Latham & Watkins 5800 Sears Tower Chicago, Illinois 60606\nFIRST AMENDMENT TO MORTGAGE, SECURITY AGREEMENT AND ASSIGNMENT OF RENTS\nTHIS FIRST AMENDMENT TO MORTGAGE SECURITY AGREEMENT AND ASSIGNMENT OF RENTS (the \"Amendment\") is made as of January 20, 1995, but and between COBRA ELECTRONICS CORPORATION (f\/k\/a Dynascan Corporation), a Delaware corporation (\"Mortgagor\"), and CONGRESS FINANCIAL CORPORATION (CENTRAL) (\"Mortgagee\").\nWHEREAS, Mortgagor executed that certain Mortgage, Security Agreement and Assignment of Rents, dated as of November 12, 1992 and recorded November 16, 1992 in the Office of the Recorder of Cook County, Illinois as Document No. 92858615 (the \"Mortgage\"), for the benefit of Mortgagee relating to that real property located in the County of Cook, State of Illinois and described on Exhibit A hereto. All capitalized terms used herein but not otherwise defined shall have the meanings assigned to them in the Mortgage;\nWHEREAS, Mortgagor and Mortgagee are parties to that certain Loan and Security Agreement dated as of November 12, 1992, as amended from time to time (the \"Loan Agreement\");\nWHEREAS, Mortgagee and Mortgagor have entered into that certain Amendment No. 8 to Loan Agreement of even date herewith, in order to, inter alia, extend the maturity date of the Loan Agreement to January 10, 1997 (the \"Maturity Date\"), which date may be extended by agreement of the parties to the Loan Agreement from time to time; and\nWHEREAS, the parties hereto desire to amend the Mortgage to reflect the new Maturity Date of the indebtedness being secured thereby.\nNOW, THEREFORE, in consideration of the foregoing and the mutual agreements herein contained, each party agrees as follows:\n1. Amendment to Section 1.03 of the Mortgage. Section 1.03 of the Mortgage is hereby amended by deleting the following language in the fifth line therein:\n\"The Obligations shall mature and become due and payable not later than two years from the date hereof.\"\n2. Representations. Mortgagor hereby represents and warrants as of the date hereof that (i) all representations and warranties contained in the Mortgage ar true and correct in all material respects on the date hereof (except for representations and warranties that were expressly made as of a certain date which shall have been true and correct as of such date), (ii) the execution, delivery and performance of this Amendment have been duly authorized by all requisite action by Mortgagor, and (iii) the Mortgage as amended hereby constitutes a legal, valid and binding obligation of Mortgagor enforceable in accordance with its terms.\n3. Ratification. The Mortgage (as amended hereby) shall remain in full force and effect and is hereby ratified and confirmed in all respects.\n4. Execution in Counterparts. This Amendment may be executed in any number of counterparts, and each such counterpart, when so executed and delivered, shall be deemed to be an original and binding upon the party signing such counterpart; all such counterparts taken together shall constitute one and the same instrument.\n5. Entire Agreement. This is the entire agreement among the parties with respect to the matters addressed herein, and may not be modified except by written modification signed by all parties hereto.\n6. Governing Law. This Amendment shall be governed by and construed in accordance with the laws of the State of Illinois.\nIN WITNESS WHEREOF, the parties have executed this Amendment as of the day and year set forth above.\nCOBRA ELECTRONICS CORPORATION, (f\/k\/a Dynascan Corporation), a Delaware corporation By: Gerald M. Laures Name: Gerald M. Laures Title: VP-Finance\nCONGRESS FINANCIAL CORPORATION (CENTRAL) By: Steven Linderman By: Steven Linderman Title: Assist. Vice President\nEXHIBIT C\nThis instrument prepared by and when recorded return to:\nPhilip J. Perzek, Esq. Latham & Watkins 5800 Sears Tower Chicago, Illinois 60606\nFIRST AMENDMENT TO DEED OF TRUST, SECURITY AGREEMENT AND ASSIGNMENT OF RENTS\nTHIS FIRST AMENDMENT TO DEED OF TRUST, SECURITY AGREEMENT AND ASSIGNMENT OF RENTS (the \"Amendment\") is made as of January 20, 1995, by and between COBRA ELECTRONICS CORPORATION, (f\/k\/a\/ Dynascan Corporation), a Delaware corporation (\"Trustor\") and CONGRESS FINANCIAL CORPORATION (CENTRAL) (\"Beneficiary\").\nWHEREAS, Trustor executed that certain Deed of Trust, Security Agreement and Assignment of Rents, dated as of November 12, 1992 and recorded November 18, 1992 in the Office of the Registrar of Deeds, Burke County, North Carolina in Book 800, Pages 97-119 (the \"Deed of Trust\"), for the benefit of Beneficiary relating to that real property located in the County of Burke, State of North Carolina and described on Exhibit A hereto. All capitalized terms used herein but not otherwise defined shall have the meanings assigned to them in the Deed of Trust;\nWHEREAS, Trustor and Beneficiary are parties to that certain Loan and Security Agreement dated as of November 12, 1992, as amended from time to time (the \"Loan Agreement\");\nWHEREAS, Trustor and Beneficiary have entered into that certain Amendment No. 8 to Loan Agreement of even date herewith, in order to, inter alia, extend the maturity date of the Loan Agreement to January 10, 1997 (the \"Maturity Date\"), which date may be extended by agreement of the parties to the Loan Agreement from time to time; and\nWHEREAS, the parties hereto desire to amend the Deed of Trust to reflect the new Maturity Date of the indebtedness being secured thereby.\nNOW, THEREFORE, in consideration of the foregoing and the mutual agreements herein contained, each party agrees as follows:\n1. Amendment to Section 1.01 of the Deed of Trust. Section 1.01 of the Deed of Trust is hereby amended by (i) deleting the following language appearing in the last two sentences of the last paragraph of Section 1.01:\n\"The amount of present indebtedness initially advanced under the Loan Agreement is $20,800,000. All advances under the Loan Agreement will be made within two years of the date hereof.\"\nand (ii) inserting in place thereof the following language:\n\"The amount of present indebtedness initially advanced under the Loan Agreement on the date the Deed of Trust was executed was $20,800,000, and the principal amount outstanding under the Loan Agreement on January 20, 1995 was $16,438,329. All advances under the Loan Agreement will be made during the period commencing on the date hereof and ending on January 10, 1997.\"\n2. Amendment to Section 1.03 of the Deed of Trust. Section 1.03 of the Deed of Trust is hereby amended by deleting the words \"two years from the date hereof\" in the seventh line thereof, and inserting in place thereof the words \"January 10, 1997\".\n3. Amendment to Article VI of the Deed of Trust. Article VI of the Deed of Trust is amended by adding the following Section 6.14:\n\"6.14 Address of Trustee for Notices. Notice to the Trustee under the Deed of Trust should be addressed as follows: Christopher C. Kupec, Moore & Van Allen, NationsBank Corporation Center, 100 North Tryon Street, 47th Floor, Charlotte, North Carolina 28202. Telephone number: (704) 331-1000; Fax number: (704) 331-1159\".\n4. Representations. Trustor hereby represents and warrants as of the date hereof that (i) all representations and warranties contained in the Deed of Trust are true and correct in all material respects on the date hereof (except for representations and warranties that were expressly made as of a certain date which shall have been true and correct as of such date), (ii) the execution, delivery and performance of this Amendment have been duly authorized by al requisite action by Trustor, and (iii) the Deed of Trust as amended hereby constitutes a legal, valid and binding obligation of Trustor enforceable in accordance with its terms.\n5. Ratification. The Deed of Trust (as amended hereby) shall remain in full force and effect and is hereby ratified and confirmed in all respects.\n6. Execution in Counterparts. This Amendment may be executed in any number of counterparts, and each such counterpart, when so executed and delivered, shall be deemed to be an original and binding upon the party signing such counterpart; all such counterparts taken together shall constitute one and the same instrument.\n7. Entire Agreement. This is the entire agreement among the parties with respect to the matters addressed herein, and may not be modified except by written modification signed by all parties hereto.\n8. Governing Law. This Amendment, the debts and obligations secured hereunder, and all other obligations and agreements of the parties hereunder, shall be governed by and construed in accordance with the laws of the State of Illinois subject only to those laws of the State of North Carolina that of necessity must apply to methods of foreclosure directly affecting interests in the Trust Property and the laws of the State of North Carolina that shall apply to Beneficiary's rights against personal property covered by the security interest granted in the Deed of Trust.\nIN WITNESS WHEREOF, the parties have executed this Amendment as of the date and year set forth above.\nCOBRA ELECTRONICS CORPORATION (f\/k\/a Dynascan Corporation), a Delaware corporation\nBy: Gerald M. Laures Name: Gerald M. Laures Title: Vice President\n(SEAL) Attest: By: Karen L. Clement Name: Karen L. Clement Title: Assistant Secretary\nCONGRESS FINANCIAL CORPORATION (CENTRAL)\nBy: James W. Ward Name: James W. Ward Title: Vice President\n(SEAL) Attest: By: George Kalesnik, Jr. Name: George Kalesnik, Jr. Title: Asst. Secretary\nEXHIBIT 10-20\nSeptember 23, 1994\nMr. Stephen M. Yanklowitz 2105 Stirling Road Bannockburn, IL 60015\nDear Steve:\nThis letter is to confirm the terms of your employment with Cobra Electronics Corporation (\"Cobra\").\n1. At the commencement of this agreement on September 19, 1994, you shall be employed as the Chief Operating Officer of Cobra and shall have the normal duties, responsibilities and attendant authorities of a Chief Operating Officer. You shall also have such other duties and responsibilities as may from time to time be assigned to you by the Chief Executive Officer and the Board of Directors.\n2. During your employment hereunder, you shall receive a regular annual salary at the rate of $200,000 per year, payable biweekly. (Your salary will be subject to annual review of the Compensation Committee of the Cobra Board of Directors.)\n3. In addition to your regular annual salary, you also may receive a bonus, without a maximum limitation, pursuant to a bonus plan to be agreed upon between you and the Board of Directors. The criteria for payout will be consistent with our pre-employment discussions, i.e. you will receive a minimum payment of 35% of your base salary for achievement of the approved profit plan with a target of an additional 30% payout of your base salary for major over achievement of the approved profit plan based upon mutually agreeable criteria; provided that the proceeds of any settlement or judgment received by the Company in connection with the Babbitt litigation (\"Babbitt Electronics Inc. v. Dynascan Corporation\") shall not be included as part of the profit calculation for purposes of determining achievement of the approved profit plan.\n4. You shall be reimbursed for all of your reasonable and necessary business expenses incurred in performing your duties for Cobra upon presentation of Cobra's standard forms for expense reimbursement.\n5. You also shall receive $15,000 gross each year to be used for perquisites of your choice, payable monthly.\nMr. Stephen Yanklowitz September 23, 1994\n6. A non-qualified stock option will be granted to you to purchase up to 125,000 shares of the corporation's stock, which will be subject to the terms and conditions of Cobra's existing stock option plan. The exercise price for the stock option will be the fair market value as determined by the closing NASDAQ price on September 19, 1994, which was $2.875 per share. It is the intention (but not an obligation) of the Board of Directors to grant additional options to you of 75,000 shares after your first year of employment, and an additional 50,000 shares after your second year; both grants, should they occur, would be at the fair market value on the grant date.\n7. During the term of this agreement, you shall be entitled to participate in such employee benefits including, but not limited to, life and health insurance and other medical benefits as Cobra makes available generally to individuals serving at senior corporate levels.\n8. If at any time during the term of this agreement, you die or are deemed to be disabled, Cobra may immediately terminate this agreement. For the purpose of this agreement, you shall be deemed to be disabled if you are physically or mentally unable to perform your duties hereunder for a period of 180 consecutive days.\n9. Notwithstanding any other provision of this agreement, except as provided in Paragraph 12, Cobra may immediately terminate your employment for any reason. In the event of such a termination, Cobra shall pay to you an amount equal to your regular annual salary, payable in 12 equal monthly installments and shall continue your then existing medical and health benefits for one year from the date of your termination provided that, if in such one year period you obtain employment elsewhere, an independent contract or any other type of engagement providing you with salary, commission or any other type of compensation or benefits, or both, Cobra's obligation to make such salary payments and benefits to you, as provided in this sentence, shall be reduced by the salary, commission or any other type of compensation and benefits, respectively, payable to you from such employment, contract or engagement. Additionally, you will be paid a pro-rata bonus for the period during the year you were with the Company, the amount to be based upon the actual year-end results. All of your remaining benefits, including the continued vesting of all amounts under your stock option and deferred compensation plans, shall immediately end upon your termination of employment. Notwithstanding any other provision of this Paragraph 9, if your employment is terminated as a result of your death, disability, or for cause, Cobra shall pay to you only such salary or benefits as may be due to you through the date of such termination. After the payment of the amounts set forth in this Paragraph 9, you shall have no further rights to recover any amounts under this agreement. For cause shall mean your engaging in any embezzlement or misappropriation of corporate funds, other acts of dishonesty, activities materially harmful to the reputation of Cobra, willful refusal to perform or substantial disregard of your assigned duties, violation of any statuary or common law duty of loyalty to Cobra, or other material breach of this agreement.\nMr. Stephen M. Yanklowitz September 23, 1994\n10. For a one year period following the termination of your employment by your decision, you shall not for the benefit of yourself or any business or other entity solicit, directly or indirectly, Cobra employees or customers of Cobra for products which are currently marketed or which have been announced by the Company. In addition, at no time following the termination of your employment shall you disclose or in any way use the confidential and proprietary information obtained during the course of your employment with Cobra, including, but not limited to Cobra's financial and product information and information relating to Cobra's customer and supplier relations.\n11. If, at any time of enforcement of any provisions of Paragraph 10, a court holds that the restrictions stated therein are unreasonable under the circumstances then existing, you agree that the maximum period, scope, or geographical area reasonable under such circumstances will be substituted for the stated period, scope, or area.\n12. In the event your employment hereunder is terminated by Cobra within six (6) months prior to, or within thirty-six months following, a \"Change of Control\" (as defined below) of Cobra, for any reason, other than your death, disability, or for cause, Cobra shall, within five business days following such termination, pay to you an amount equal to one hundred fifty percent (150%) of your regular annual salary, plus all other amounts then due and owing to you under this agreement; provided, however, that if such payment pursuant to this Paragraph 12 would result in your incurring excise tax liabilities pursuant to Section 4999 of the Internal Revenue Code, then such payment shall be reduced to the maximum amount which could be paid to you without incurring such excise tax liabilities. In addition, you will be paid a pro-rata bonus for the period of the year you were employed by the Company, the amount to be based upon the actual year end results. After the payment to you of such amount, you shall have no further right to recover any amounts under this agreement.\nFor the purpose of this agreement, a Change of Control shall be deemed to have occurred if: (a) any person, including a \"group\" within the meaning of Section 13 (d)(3) of the Securities Exchange Act of 1934, as amended, acquires the beneficial ownership of, and the right to vote, shares having at least 20 percent of the aggregate voting power of the class or classes of capital stock of Cobra having the ordinary and sufficient voting power (not depending upon the happening of a contingency) to elect at least a majority of the directors of the board of directors of Cobra or (b) as the result of any tender or exchange offer, substantial purchase of Cobra's equity securities, merger consolidation, sale of assets or contested election, or any combination of the foregoing transactions, the persons who were directors of Cobra immediately prior to such transaction or transactions shall not constitute a majority of the board of directors (or of the board of directors of any successor to or assign of Cobra) immediately after the next meeting of stockholders of Cobra (or such successor or assign) following such transaction.\nMr. Stephen M. Yanklowitz September 23, 1994\n13. You acknowledge that the services to be rendered by you hereunder are unique and personal. Accordingly, you may not assign any of your rights or delegate any of your duties or obligations under this agreement. Cobra may assign its rights, duties or obligations under this agreement to a purchaser or transferee of all, or substantially all, of the assets of Cobra.\n14. Cobra's future waiver of any breach by you of any provision of this agreement or failure to enforce any such provision with respect to you shall not operate or be construed as a waiver of any subsequent breach by you of any such provision or of Cobra's right to enforce any such provision with respect to you. No act or omission of Cobra shall constitute a waiver of any of its rights hereunder except for a written waiver signed by an officer of Cobra.\n15. As Chief Operating Officer, you shall be entitled to the benefits, and shall be under the coverage, of Cobra's Directors and Officer Liability and Corporate Reimbursement Insurance Policy. Further, you shall be included within the group of officers entitled to indemnification as provided in Cobra's by-laws.\n16. This agreement embodies the entire agreement and understanding of the parties hereto with respect to the matters described herein and supersedes any and all prior and\/or contemporaneous agreements and understandings, oral or written, between the parties.\n17. This agreement shall be, in all respects, construed in accordance with and governed by the laws of the State of Illinois.\nSteve, we are extremely pleased that you have commenced your employment with Cobra. We believe that the terms outlined in this letter are consistent with that which we have discussed. If you are in agreement, please sign in the appropriate place below and return to me as soon as possible.\nSincerely,\nCOBRA ELECTRONICS CORPORATION\nBy: JERRY KALOV\nPresident and Chief Executive Officer\nBy: STEPHEN M. YANKLOWITZ\nJK\/jb cc: William Carmichael Samuel Horberg Carl Korn Gerry Laures James Marovitz Harold Schwartz\nEXHIBIT 10-21 AMENDMENT TO EMPLOYMENT AGREEMENT\nThis Amendment (this \"Amendment\") to the Employment Agreement dated as of January 1, 1988 (the \"Agreement\") between Cobra Electronics Corporation (formerly known as Dynascan Corporation), a Delaware corporation (the \"Company\"), and Jerry Kalov (the \"Executive\") is entered into as of December 15, 1994. Capitalized terms used and not defined herein shall have the meanings ascribed to them in the Agreement.\nWHEREAS, the Executive has been employed by the Company as its Chief Executive Officer pursuant to the Agreement since January 1, 1988 and prior thereto had been employed by the Company in such capacity pursuant to a predecessor employment agreement;\nWHEREAS, the Executive has voluntarily foregone certain amounts of Base Salary provided for by Section 4(a) of the Agreement for the years 1992 and 1993, as well as for the year 1994 through the date of this Amendment, and is willing to continue to do so for the remaining term of the Agreement; and\nWHEREAS, the Company and the Executive desire to amend the Agreement as provided herein in consideration for the Executive having foregone, and continuing to forego, such amounts of Base Salary.\nNOW, THEREFORE, in consideration of the premises and the agreements and covenants contained herein, the Company and the Executive hereby agree as follows:\n1. Employment and Term. Section 1 of the Agreement is hereby amended by deleting the date \"December 31, 1997\" from the first and third sentences thereof and substituting the date \"January 1, 1998\" therefor.\n2. Basic Compensation. The first sentence of Section 4(a) of the Agreement is hereby amended as follows:\n(a) Such sentence is amended by adding after the date \"January 1, 1989\" the following: \"and ending December 31, 1991\".\n(b) Such sentence is further amended by adding at the end thereof the following: \",and thereafter the Executive's Base Salary shall be: for the year 1992 $345,074 per annum; for the year 1993 $311,519 per annum; and for the years 1994 through 1997, inclusive, $300,000 per annum\".\n3. Bonus Payments. Section 5 of the Agreement is hereby amended as follows:\n(a) The first sentence of Section 5 is amended by adding after the number \".015\" the following: \"for the years 1988 through 1993, inclusive, and .04 for the years 1994 through 1997, inclusive,\".\n(b) The last sentence of Section 5 is amended by adding after the words \"Employment Period\" the following: \"ending prior to January 1, 1994\".\n4. Plan of Deferred Compensation. Section 6 of the Agreement is hereby amended by adding the following two provisos at the end of the second sentence thereof:\n\"; provided, however, that in no event shall the amount payable by the Company pursuant to this Section 6 be less than the amount that would have been payable pursuant to this Section 6 had the Executive's Base Salary for the years 1992, 1993, 1994, 1995, 1996 and 1997 been $358,946, $369,679, $380,954, $396,192, $412,040 and $428,522, respectively, and had the Executive's Bonus been zero for each of the years 1992 through 1997, inclusive; and provided, further, that in no event shall the amount payable by the Company pursuant to this Section 6 be more than the amount that would have been payable pursuant to this Section 6 had the Executive's Base Salary for each of the years 1992 through 1997, inclusive, been equal to the respective amounts set forth in the preceding proviso and had the Executive's Bonus for each of the years 1994 through 1997, inclusive, been 50% of the Executive's Base Salary for each such year.\"\n5. Stock Options. The first paragraph of Section 7(b) of the Agreement is hereby amended by adding after the fifth sentence thereof the following sentence:\n\"In addition, on May 9, 1994, the Executive shall be granted pursuant to the 1988 Stock Option Plan an incentive stock option (within the meaning of Section 422 of the Code) to purchase 100,000 shares of the Company's Common Stock, $.33-1\/3 par value, at a price of $2.625 per share, such price being equal to the closing price of such Common Stock on the Nasdaq National Market on May 9, 1994. Such incentive stock option shall be exercisable with respect to 25,000 shares on May 10, 1994 in accordance with the approval heretofore given by the Board of Directors pursuant to Section 5(f)(i) of the 1988 Stock Option Plan, and shall become exercisable, in cumulative installments, as to an additional 25,000 shares on each of May 10, 1995, May 10, 1996 and May 10, 1997. In the event that the employment of the Executive shall be terminated by the Company for any reason other than for Cause (as such term is defined in Section 9(b) hereof) prior to May 10, 1997, such termination shall be deemed to constitute the retirement of the Executive with the approval of the Company for purposes of Section 5(e) of the 1988 Stock Option Plan, and such incentive stock option shall becomeexercisable, in accordance with the approval heretofore given by the Board of Directors pursuant to Section 5(e) of the 1988 Stock Option Plan, as to all shares subject thereto as of the date of such termination. All other terms of such incentive stock option and all other obligations of the Company with respect thereto, including the obligation of the Company to extend credit upon the exercise of such option, shall be the same as the terms of, and obligations with respect to, the option to purchase 321,000 shares referred to above in this Section 7(b). The Company shall use its best efforts as soon as administratively possible to cause the 100,000 shares of Common Stock subject to the incentive stock option granted on May 9, 1994 to be registered pursuant to an effective registration statement on Form S-8, and the Company shall use its best efforts to enable such shares to be eligible for resale pursuant to Rule 144 under the Securities Act (without regard to the holding period condition of Rule 144(d)).\"\n6. Termination of Employment. The first sentence of Section 9(a) of the Agreement is hereby amended by deleting therefrom the date \"December 31, 1997\" and substituting therefor the date \"January 1, 1998\".\n7. Term Loan Promissory Note. The Company and the Executive shall execute an Amended and Restated Term Loan Promissory Note (\"Amended Note\") in the form attached hereto concurrently with the execution of this Amendment, which Amended Note shall provide (i) that the interest rate from and after the original execution date of the Term Loan Promissory Note between the parties dated December 31, 1990 (\"Original Note\") shall be the appropriate applicable federal rate adjusted and applied on the first day of each calendar month during the term of the Amended Note (including the term of the Original Note) and (ii) the term of the Amended Note shall be extended to December 30, 1997. The Company and the Executive agree and understand that it was the original intent of the parties to applythe appropriate applicable federal rate described in the prior sentence from the original date of the Original Note. The Company and the Executive agree and understand that it is the current intent of the parties to extend the term of the Original Note to December 30, 1997 as described in this Section 7.\n8. Payment of Expenses. The Company acknowledges that this Amendment was initiated by it and is principally for its convenience and agrees to pay the costs and expenses incurred by the Executive in connection with the Executive's review and execution hereof.\nIN WITNESS WHEREOF, the Company has caused this Amendment to be executed by its duly authorized officer and the Executive has executed this Amendment as of the day and year first above written.\nCOBRA ELECTRONICS CORPORATION\nBy GERALD M. LAURES --------------------------\nEXECUTIVE:\nJERRY KALOV --------------------------\nEXHIBIT 10-22\nAMENDED AND RESTATED TERM LOAN PROMISSORY NOTE\n$1,250,000.00 Dated: As of December 31, 1990\nFOR VALUE RECEIVED, the undersigned, JERRY KALOV (the \"Borrower\"), HEREBY UNCONDITIONALLY PROMISES TO PAY to the order of COBRA ELECTRONICS CORPORATION (formerly known as DYNASCAN CORPORATION), a Delaware corporation (the \"Company\"), at its office at 6460 Cortland Street, Chicago, Illinois 60635, or at such other place as the holder of this Amended and Restated Term Loan Promissory Note (\"Term Loan Note\") may from time to time designate in writing, in lawful money of the United States of America and in immediately available funds, the principal sum of ONE MILLION TWO HUNDRED FIFTY THOUSAND AND NO\/100 DOLLARS ($1,250,000.00) (\"Original Principal Amount\"), together with interest on the unpaid principal balance at the rate provided below from the date hereof until the principal amount is paid in full. This Term Loan Note is referred to in, and was executed pursuant to, that certain Employment Agreement dated as of January 1, 1988 (as amended, restated, supplemented or otherwise modified from time to time, the \"Employment Agreement\") between the Company and the Borrower, pursuant to which the Company agrees to extend credit to the Borrower for the purpose of the Borrower's exercising any of the options (the \"Options\") granted under the \"1985 Stock Option Plan\" referred to in the Employment Agreement for an amount equal to the full option exercise price of shares of the common stock of the Company (the \"Common Stock\") received upon the exercise of any of the Options. The Original Principal Amount under this Term Loan Note is based on the Borrower's exercise of each of its 375,000 options to purchase one share of the Common Stock at an exercise price of three dollars and thirty- three and one-third cents per share.\nThe entire principal indebtedness evidenced hereby, together with all accrued but unpaid interest thereon, shall be payable in one installment on December 30, 1997 (the \"Maturity Date\"); provided, however, that the Borrower may, at his option and without penalty or premium, prepay the outstanding principal balance and accrued interest thereon, or any portion thereof, at any time prior to the Maturity Date. Any such prepayment of less than the entire outstanding principal balance hereof shall be applied first to all accrued but unpaid interest hereunder, and second to the unpaid principal balance hereof. Interest shall accrue on the unpaid principal balance hereof from the date hereof set forth above until the principal amount is paid in full at the per annum rate equal to the minimum applicable federal rate required to avoid the imputation of interest under the Internal Revenue Code of 1986, as amended, adjusted and applied on the first day of each calendar month during the term of this Term Loan Note. In the event that the Borrower fails to pay the interest accruing as of December 30 in any year during the term of this Term Loan Note, such unpaid interest shall be added to the outstanding principal balance hereof. The Borrower further agrees to pay all costs and expenses incurred by the Company in connection with the collection or enforcement of the Borrower's obligations hereunder.\nIn order to secure the prompt and complete payment, observance and performance of all of the Borrower's obligations and liabilities hereunder (the \"Obligations\"), the Borrower has executed that certain Pledge Agreement of even date herewith in favor of the Company, pursuant to which the Borrower grants to the Company a continuing security interest in all of the Common Stock of the Company received by the Borrower upon the exercise of any or all of the Options (the \"Common Stock\"). In the event the Borrower disposes of any of the Common Stock received upon the exercise of any of the Options for which credit has been extended by the Company, the Borrower shall pay to the Company an amount equal to the lesser of (i) the total amount of the proceeds of such disposition and (ii) the amount of the unpaid principal hereof and interest accruing thereon multiplied by a fraction, the numerator of which is the number of shares of the Common Stock for which the proceeds are received, and the denominator of which is 375,000, to be applied to the unpaid principal balance hereof and the interest accruing thereon. To the extent the amount of such payment of proceeds is less than the entire outstanding principal balance hereof, such payment of proceeds shall be applied to unpaid principal and interest as specified above.\nEach of the following shall constitute an Event of Default under this Term Loan Note:\n(1) Borrower fails to pay when due, whether by acceleration or otherwise, any payment required under this Term Loan Note;\n(2) Borrower generally fails to pay, or admits in writing his inability to pay, his debts as they mature, or applies for, consents to, or acquiesces in the appointment of a trustee, receiver or other custodian for the Borrower or for a substantial part of the Borrower's property, or makes a general assignment for the benefit of creditors; or, in the absence of such application, consent or acquiescence, a trustee, receiver or other custodian is appointed for the Borrower or for a substantial part of the Borrower's property, or any bankruptcy, debt arrangement or other proceeding under any bankruptcy or insolvency law is instituted by or against the Borrower, or any warrant of attachment or similar legal process is issued against any substantial part of the property of the Borrower, and such trustee, receiver, custodian, proceeding or process, as the case may be, is not discharged, satisfied, dismissed, stayed or lifted, as applicable, within thirty (30) days; and\n(3) There shall be entered against the Borrower one or more judgments or decrees in excess of $500,000.00 in the aggregate at any one time outstanding, excluding those judgments or decrees (a) that shall have been outstanding less than thirty (30) calendar days from the entry thereof or (b) for and to the extent to which the Borrower is insured and with respect to which the insurer has assumed responsibility in writing or for and to the extent to which the Borrower is otherwise indemnified if the terms of such indemnification are satisfactory to the Company.\nIn the event that one or more Events of Default described in (2) above shall occur, the Obligations shall be immediately due and payable without demand, notice or declaration of any kind whatsoever. In the event an Event of Default other than one described in (2) above shall occur, the Company, in its sole discretion, may declare the Obligations due and payable without demand or notice of any kind whatsoever, whereupon all of the Obligations shall be immediately due and payable. The Company shall promptly advise the Borrower of any such declaration, but failure to do so shall not impair the effect of such declaration.\nTo the extent not waived in the preceding paragraph, demand, presentment, protest and notice of nonpayment and protest are hereby waived by the Borrower.\nThis Term Loan Note has been delivered at and shall be deemed to have been made at Chicago, Illinois and shall be interpreted and the rights and liabilities of the parties hereto determined in accordance with the internal laws (as opposed to the conflicts of law provisions) of the State of Illinois. Whenever possible each provision of this Term Loan Note shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Term Loan Note shall be prohibited by or invalid under applicable law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Term Loan Note. THIS TERM LOAN NOTE IS NON-NEGOTIABLE AND UNDER NO CIRCUMSTANCES SHALL THE SAME BE CONSTRUED AS A NEGOTIABLE INSTRUMENT UNDER THE UNIFORM COMMERCIAL CODE, AS ENACTED IN ANY RELEVANT JURISDICTION. Whenever in this Term Loan Note reference is made to the Company or the Borrower, such reference shall be deemed to include, as applicable, a reference to their respective successors and assigns. The provisions of this Term Loan Note shall be binding upon and shall inure to the benefit of said successors and assigns. The Borrower's successors and assigns shall include, without limitation, a receiver, trustee or debtor-in-possession of or for the Borrower, and a legal representative or designated beneficiary under the Employment Agreement.\nThis Term Loan Note amends and restates that Term Loan Promissory Note of the Borrower, dated December 31, 1990, payable to the Company in the principal amount of $1,250,000.\nIN WITNESS WHEREOF, the Borrower has executed this Term Loan Note on December 15, 1994, effective as of December 31, 1990.\nJERRY KALOV ---------------------------- Jerry Kalov\nEXHIBIT 21\nCOBRA ELECTRONICS CORPORATION\nSUBSIDIARIES OF THE REGISTRANT ------------------------------\nState or Other Name Under Which Subsidiary Ownership Jurisdiction Does Business Percentage of Incorporation - - --------------------------- ---------- - - ----------------\nCobra Electronics (HK) Limited 100% Hong Kong\nDynascan Europe Limited 100% England\nEXHIBIT 23\nDELOITTE & TOUCHE LLP\nINDEPENDENT AUDITORS' CONSENT -----------------------------\nWe consent to the incorporation by reference in Registration Statement Nos. 33-25973 and 33-24459 of Cobra Electronics Corporation and subsidiaries of our report dated March 2, 1995, appearing in this Annual Report on Form 10-K of Cobra Electronics Corporation and subsidiaries for the year ended December 31, 1994.\nDELOITTE & TOUCHE LLP\nChicago, Illinois March 24, 1995\nEXHIBIT 23\nARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS -----------------------------------------\nAs independent public accountants, we hereby consent to the incorporation of our report included in this Form 10-K, into the Company's previously filed Registration Statement File Nos. 33-25973 and 33-24459. It should be noted that we have not audited any financial statements of the Company subsequent to December 31, 1993.\nARTHUR ANDERSEN LLP\nChicago, Illinois March 27, 1995\nEXHIBIT 27\nCOBRA ELECTRONICS CORPORATION\nFINANCIAL DATA SCHEDULE -----------------------","section_15":""}
{"filename":"25600_1994.txt","cik":"25600","year":"1994","section_1":"Item 1. Business.\nGENERAL\nAmerican General Finance, Inc. (AGFI) was incorporated under the laws of the State of Indiana in 1974 to become the parent holding company of American General Finance Corporation (AGFC). AGFC was incorporated under the laws of the State of Indiana in 1927 as successor to a business started in 1920. Since 1982, AGFI has been a direct or indirect wholly-owned subsidiary of American General Corporation (American General), the parent of one of the nation's largest consumer financial services organizations. American General was incorporated in the State of Texas in 1980 as the successor to American General Insurance Company, a Texas insurance company incorporated in 1926.\nAGFI is a financial services holding company whose principal subsidiaries are AGFC and American General Financial Center (AGF-Utah). AGFC is also a holding company with subsidiaries that are engaged primarily in the consumer finance and credit insurance business. The credit insurance operations are conducted by Merit Life Insurance Co. (Merit) and Yosemite Insurance Company (Yosemite) as a part of the Company's consumer finance business. AGF-Utah is an industrial loan company engaged primarily in the consumer finance business with funding for its operations including public deposits insured by the Federal Deposit Insurance Corporation. Unless the context otherwise indicates, references to the Company relate to AGFI and its subsidiaries, whether directly or indirectly owned.\nAt December 31, 1994, the Company had 1,305 offices in 41 states, Puerto Rico, and the U.S. Virgin Islands and employed approximately 8,800 persons. The Company's executive offices are located in Evansville, Indiana.\nCertain amounts in the 1993 and 1992 information presented herein have been reclassified to conform to the 1994 presentation.\nItem 1. Continued\nSelected Financial Statistics\nThe following table sets forth certain selected financial information and ratios of the Company and illustrates certain aspects of the Company's business for the years indicated: 1994 1993 1992 (dollars in thousands) Average finance receivables net of unearned finance charges (ANR) $7,096,011 $6,387,044 $5,939,417\nAverage borrowings $6,308,901 $5,693,080 $5,317,836\nFinance charges as a percentage of ANR (yield) 17.58% 16.95% 16.74%\nInterest expense as a percentage of average borrowings (borrowing cost) 6.60% 6.67% 7.49%\nSpread between yield and borrowing cost 10.98% 10.28% 9.25%\nInsurance revenues as a percentage of ANR 2.55% 2.24% 2.01%\nOperating expenses as a percentage of ANR 5.23% 5.17% 5.18%\nAllowance for finance receivable losses as a percentage of net finance receivables 2.86% 2.80% 2.61%\nCharge-off ratio (defined in \"Consumer Finance Operations - Finance Receivable Loss and Delinquency Experience\" in Item 1. herein.) 2.45% 2.21% 2.18%\nDelinquency ratio - 60 days or more (defined in \"Consumer Finance Operations - Finance Receivable Loss and Delinquency Experience\" in Item 1. herein.) 2.89% 2.51% 2.24%\nDebt to equity ratio 5.85 5.26 5.27\nReturn on average assets 3.00% 2.64% 2.34%\nReturn on average assets before deducting cumulative effect of accounting changes 3.00% 2.81% 2.34%\nReturn on average equity 21.27% 18.08% 15.68%\nItem 1. Continued\n1994 1993 1992 Return on average equity before deducting cumulative effect of accounting changes 21.27% 19.04% 15.68%\nRatio of earnings to fixed charges (refer to Exhibit 12 herein for calculations) 1.92 1.86 1.65\nCONSUMER FINANCE OPERATIONS\nThrough its subsidiaries, the Company makes loans directly to individuals, purchases retail sales contract obligations of individuals, and offers credit card services.\nIn its lending operations, the Company generally takes a security interest in real property and\/or personal property of the borrower. Of the loans outstanding at December 31, 1994, 89% were secured by such property. At December 31, 1994, mortgage loans (generally second mortgages) accounted for 50% of the aggregate dollar amount of loans outstanding and 10% of the total number of loans outstanding; compared to 53% and 11%, respectively, at December 31, 1993. Loans secured by real property generally have maximum original terms of 180 months. Loans secured by personal property or that are unsecured generally have maximum original terms of 60 months.\nIn its retail operations, the Company purchases retail sales contracts arising from the retail sale of consumer goods and services, and issues private label credit cards for various business entities. Retail sales contracts are primarily closed-end accounts which consist of a single purchase. Private label are open-end revolving accounts that can be used for repeated purchases. Retail sales contracts are secured by the real property or personal property giving rise to the contract and generally have a maximum original term of 60 months. Private label are secured by a purchase money security interest in the goods purchased and generally require minimum monthly payments based on current balances.\nIn its credit card operations, the Company issues MasterCard and Visa credit cards to individuals through branch and direct mail solicitation programs. Credit cards are unsecured and require minimum monthly payments based on current balances.\nFinance Receivables\nAll finance receivable data in this report (except as otherwise indicated) are calculated on a net basis -- that is, after deduction of unearned finance charges but before deduction of an allowance for finance receivable losses.\nItem 1. Continued\nThe following table sets forth certain information concerning finance receivables of the Company: Years Ended December 31, 1994 1993 1992 Originated, renewed, and purchased:\nAmount (in thousands): Real estate loans $1,173,386 $ 939,769 $ 841,898 Non-real estate loans 2,983,418 2,499,113 1,969,564 Retail sales finance 2,283,561 1,422,851 1,044,549 Credit cards 537,738 546,611 506,176\nTotal originated and renewed 6,978,103 5,408,344 4,362,187 Purchased (net of sales) 60,533 31,501 259,492\nTotal originated, renewed, and purchased $7,038,636 $5,439,845 $4,621,679\nNumber: Real estate loans 70,823 58,163 48,778 Non-real estate loans 1,511,166 1,280,639 915,311 Retail sales finance 1,862,342 1,175,447 846,420\nAverage size (to nearest dollar): Real estate loans $16,568 $16,158 $17,260 Non-real estate loans 1,974 1,951 2,152 Retail sales finance 1,226 1,210 1,234\nBalance at end of period:\nAmount (in thousands): Real estate loans $2,704,929 $2,641,879 $2,782,297 Non-real estate loans 2,660,523 2,318,102 2,054,380 Retail sales finance 2,075,380 1,218,016 986,008 Credit cards 479,480 395,991 377,001\nTotal $7,920,312 $6,573,988 $6,199,686\nNumber: Real estate loans 162,315 153,562 153,621 Non-real estate loans 1,432,054 1,270,167 1,074,511 Retail sales finance 1,524,072 993,058 784,067 Credit cards 403,262 336,837 333,616\nTotal 3,521,703 2,753,624 2,345,815\nAverage size (to nearest dollar): Real estate loans $16,665 $17,204 $18,111 Non-real estate loans 1,858 1,825 1,912 Retail sales finance 1,362 1,227 1,258 Credit cards 1,189 1,176 1,130\nItem 1. Continued\nANR\nThe following table details ANR by type of finance receivable for the years indicated:\n1994 1993 1992 (dollars in thousands)\nLoans $5,099,942 $4,942,508 $4,736,611 Retail sales finance 1,578,521 1,076,550 847,558 Credit cards 417,548 367,986 355,248\nTotal $7,096,011 $6,387,044 $5,939,417\nYield\nThe following table details yield for the years indicated:\n1994 1993 1992\nLoans 17.70% 17.05% 16.63% Retail sales finance 16.20% 15.48% 15.87% Credit cards 21.39% 19.91% 20.30%\nTotal 17.58% 16.95% 16.74%\nGeographic Distribution\nSee Note 3. of the Notes to Consolidated Financial Statements in Item 8. herein for information on geographic distribution of finance receivables.\nItem 1. Continued\nFinance Receivable Loss and Delinquency Experience\nThe finance receivable loss experience for the Company, for the periods indicated, is set forth in the net charge-offs and charge-off ratio(a) information below: Years Ended December 31, 1994 1993 1992 (dollars in thousands) Real estate loans: Net charge-offs $ 15,408 $ 20,325 $ 21,403 Charge-off ratio .58% .74% .76%\nNon-real estate loans: Net charge-offs $ 93,790 $ 79,016 $ 71,052 Charge-off ratio 3.92% 3.74% 4.00%\nTotal loans: Net charge-offs $109,198 $ 99,341 $ 92,455 Charge-off ratio 2.15% 2.01% 1.95%\nRetail sales finance: Net charge-offs $ 38,404 $ 18,651 $ 12,166 Charge-off ratio 2.49% 1.75% 1.45%\nCredit cards: Net charge-offs $ 24,885 $ 22,756 $ 24,459 Charge-off ratio 6.01% 6.20% 6.90%\nTotal: Net charge-offs $172,487 $140,748 $129,080 Charge-off ratio 2.45% 2.21% 2.18% Allowance for finance receivable losses (b) $226,226 $183,756 $161,678 Allowance ratio (b) 2.86% 2.80% 2.61%\n(a) The charge-off ratio represents charge-offs net of recoveries as a percentage of the average of the amount of net finance receivables at the beginning of each month during the period.\n(b) Allowance for finance receivable losses represents the balance at the end of the period. The allowance ratio represents the allowance for finance receivable losses at the end of the period as a percentage of net finance receivables.\nThe allowance for finance receivable losses is maintained at a level based on management's periodic evaluation of the finance receivable portfolio and reflects an amount that, in management's opinion, is adequate to absorb losses in the existing portfolio. In evaluating the portfolio, management takes into consideration numerous factors, including current economic conditions, prior finance receivable loss and delinquency experience, the composition of the finance receivable portfolio, and management's estimate of anticipated finance receivable losses.\nItem 1. Continued\nAGFI's basic policy is to charge off each month loan accounts, except those secured by real estate, on which little or no collections were made in the prior six-month period. Retail sales contracts are charged off when four installments are past due. Private label and credit card accounts are charged off when 180 days past due. In the case of loans secured by real estate, foreclosure proceedings are instituted when four monthly installments are past due. When foreclosure is completed and the Company has obtained title to the property, the real estate is established as an asset valued at market value, and any loan value in excess of that amount is charged off. Exceptions are made to the charge-off policies when, in the opinion of management, such treatment is warranted.\nBased upon contract terms in effect at the respective dates, delinquency(a) was as follows: December 31, 1994 1993 1992 (dollars in thousands)\nReal estate loans $ 46,746 $ 48,426 $ 53,046 % of related receivables 1.64% 1.75% 1.83%\nNon-real estate loans $140,615 $102,855 $ 75,449 % of related receivables 4.54% 3.83% 3.18%\nTotal loans $187,361 $151,281 $128,495 % of related receivables 3.15% 2.77% 2.44%\nRetail sales finance $ 49,259 $ 17,746 $ 11,670 % of related receivables 2.13% 1.27% 1.01%\nCredit cards $ 15,454 $ 12,537 $ 12,373 % of related receivables 3.25% 3.19% 3.31%\nTotal $252,074 $181,564 $152,538 % of related receivables 2.89% 2.51% 2.24%\n(a) Finance receivables any portion of which was 60 days or more past due (including unearned finance charges and excluding deferred origination costs, a fair value adjustment on finance receivables, and accrued interest).\nSources of Funds\nAGFI funds its consumer finance operations principally through net cash flows from operating activities, issuances of long-term debt, short-term borrowings in the commercial paper market, and borrowings from banks. The spread between the rates charged in consumer finance operations and the cost of borrowed funds is one of the major factors determining the Company's earnings. The Company is limited by statute in most states to a maximum rate which it may charge in its lending operations.\nItem 1. Continued\nAverage Borrowings\nThe following table details average borrowings by type of debt for the years indicated: 1994 1993 1992 (dollars in thousands)\nLong-term debt $4,162,229 $3,856,328 $3,181,509 Short-term debt 2,138,324 1,781,165 1,889,874 Investment certificates 8,348 55,587 246,453\nTotal $6,308,901 $5,693,080 $5,317,836\nBorrowing Cost\nThe following table details interest expense as a percentage of average borrowings by type of debt for the years indicated:\n1994 1993 1992\nLong-term debt 7.33% 7.88% 8.68% Short-term debt 5.18% 4.11% 5.64% Investment certificates 5.68% 4.74% 6.31%\nTotal 6.60% 6.67% 7.49%\nContractual Maturities\nContractual maturities of finance receivables and debt as of December 31, 1994 were as follows: Net Finance Receivables Debt (dollars in thousands) Due in: 1995 $3,152,603 $3,681,094 1996 1,468,445 590,897 1997 900,143 1,132,176 1998 455,543 242,492 1999 275,705 533,694 2000 and thereafter 1,667,873 910,643\nTotal $7,920,312 $7,090,996\nSee Note 3. of the Notes to Consolidated Financial Statements in Item 8. herein for further information on principal cash collections of finance receivables.\nItem 1. Continued\nINSURANCE OPERATIONS\nMerit is a life and health insurance company domiciled in Indiana and currently licensed in 43 states and the District of Columbia. Merit writes or assumes (through affiliated and non-affiliated insurance companies) credit life, credit accident and health, and ordinary insurance coverages.\nYosemite is a property and casualty insurance company domiciled in California and licensed in 42 states which principally underwrites credit- related property and casualty coverages.\nBoth Merit and Yosemite market their products through the consumer finance network of the Company. The credit life insurance policies typically cover the life of the borrower in an amount equal to the unpaid balance of the obligation and provide for payment in full to the lender of the insured's obligation in the event of death. The credit accident and health insurance policies provide for the payment of the installments on the insured's obligation to the lender coming due during a period of unemployment or disability due to illness or injury. The credit-related property and casualty insurance is written to protect property pledged as security for the obligation. The purchase by the borrower of credit life, credit accident and health, and credit property and casualty insurance is voluntary with the exception of property damage coverage for automobiles, dwellings, and commercial real estate pledged as collateral. In these instances, property damage coverage is provided under the terms of the lending agreement if the borrower does not provide evidence of coverage with another insurance carrier. Premiums for insurance products are financed as part of the insured's obligation to the lender.\nMerit has from time to time entered into reinsurance agreements with other insurance companies, including certain American General subsidiaries, for assumptions of various shares of annuities and ordinary, group, and credit life insurance on a coinsurance basis. The reserves attributable to this business fluctuate over time and in certain instances are subject to recapture by the ceding company. At December 31, 1994, life reserves on the books of Merit attributable to these reinsurance agreements amounted to $75.9 million.\nItem 1. Continued\nThe following tables set forth information concerning the insurance operations:\nLife Insurance in Force December 31, 1994 1993 1992 (dollars in thousands)\nCredit life $2,899,124 $2,547,784 $2,221,940 Ordinary life 2,773,928 2,373,685 2,208,685\nTotal $5,673,052 $4,921,469 $4,430,625\nPremiums Earned Years Ended December 31, 1994 1993 1992 (dollars in thousands) Insurance premiums earned in connection with affiliated finance and loan activities: Credit life $ 39,398 $ 35,711 $ 30,324 Credit accident and health 51,983 42,978 34,222 Property 37,847 25,686 18,594 Other insurance premiums earned: Ordinary life 26,685 20,823 19,344 Premiums assumed under coinsurance agreements 18,599 12,318 6,984\nTotal $174,512 $137,516 $109,468\nPremiums Written Years Ended December 31, 1994 1993 1992 (dollars in thousands) Insurance premiums written in connection with affiliated finance and loan activities: Credit life $ 47,864 $ 41,036 $ 36,605 Credit accident and health 64,395 56,839 44,029 Property 55,086 47,358 19,344 Other insurance premiums written: Ordinary life 26,685 20,823 23,968 Premiums assumed under coinsurance agreements 18,599 12,318 6,984\nTotal $212,629 $178,374 $130,930\nItem 1. Continued\nInvestments and Investment Results\nThe following table summarizes the investment results of the Company's insurance subsidiaries for the periods indicated:\nYears Ended December 31, 1994 1993 1992 (dollars in thousands)\nNet investment revenue (a) $ 56,795 $ 55,654 $ 54,134\nAverage invested assets $722,117 $666,982 $597,631\nReturn on invested assets (a) 7.87% 8.34% 9.06%\nNet realized investment (losses) gains (b) $ (141) $ 7,101 $ 1,937\n(a) Net investment revenue and return on invested assets are after deduction of investment expense but before net realized investment (losses) gains and provision for income taxes.\n(b) Includes net realized investment (losses) gains on marketable securities and other invested assets before provision for income taxes.\nSee Note 5. of the Notes to Consolidated Financial Statements in Item 8. herein for information regarding investments in marketable securities for all operations of the Company.\nREGULATION\nConsumer Finance\nThe Company operates under various state laws which regulate the consumer lending and retail sales financing businesses. The degree and nature of such regulation varies from state to state. In general, the laws under which a substantial amount of the Company's business is conducted provide for state licensing of lenders; impose maximum term, amount, interest rate, and other charge limitations; and enumerate whether and under what circumstances insurance and other ancillary products may be sold in connection with a lending transaction. In addition, certain of these laws prohibit the taking of liens on real estate except liens resulting from judgments.\nThe Company also is subject to various types of federal regulation, including the Federal Consumer Credit Protection Act (governing disclosure of applicable charges), the Equal Credit Opportunity Act (prohibiting discrimination against credit worthy applicants), the Fair Credit Reporting Act (governing the accuracy and use of credit bureau reports), and certain Federal Trade Commission rules. AGF-Utah, which engages in the consumer\nItem 1. Continued\nfinance business and accepts insured deposits, is subject to regulation by and reporting requirements of the Federal Deposit Insurance Corporation and is subject to regulatory codes in the state of Utah.\nInsurance\nThe operations of the Company's insurance subsidiaries are subject to regulation and supervision by state authorities. The extent of such regulation varies but relates primarily to conduct of business, types of products offered, standards of solvency, payment of dividends, licensing, nature of and limitations on investments, deposits of securities for the benefit of policyholders, the approval of policy forms and premium rates, periodic examination of the affairs of insurers, form and content of required financial reports and establishment of reserves required to be maintained for unearned premiums, losses, and other purposes. Substantially all of the states in which the Company operates regulate the rates of premiums charged for credit life and credit accident and health insurance.\nThe investment portfolio of the Company's insurance subsidiaries is subject to state insurance laws and regulations which prescribe the nature, quality and percentage of various types of investments which may be made by insurance companies.\nCOMPETITION\nConsumer Finance\nThe consumer finance business is highly competitive. The Company competes with other consumer finance companies, industrial banks, industrial loan companies, commercial banks, sales finance companies, savings and loan associations, credit unions, mutual or cooperative agencies, and others. See Competitive Factors in Item 7. herein for more information.\nInsurance\nThe Company's insurance business primarily operates as a supplementary business to the consumer lending operations. As such, the competition for this business is relatively limited.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nDue to the nature of the Company's business, its investment in real estate and tangible property is not significant in relation to its total assets. AGFI and certain of its subsidiaries own real estate on which AGFI and other affiliates conduct business. Branch office operations are generally conducted in leased premises. Leases ordinarily have terms from three to five years.\nThe Company's exposure to environmental regulation arises from its ownership of such properties and properties obtained through foreclosure. The properties are monitored for compliance with federal and local environmental guidelines. Potential costs related to environmental clean- up are estimated to be immaterial.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company is a defendant in various lawsuits and proceedings arising in the normal course of business that are not discussed below. Some of these lawsuits and proceedings arise in jurisdictions such as Alabama that permit punitive damages disproportionate to the actual damages alleged. Although 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 that there are meritorious defenses for all of these claims and is defending them vigorously. The Company also believes that the total amounts that would ultimately be paid, if any, arising from these claims would have no material effect on the Company's consolidated results of operations and consolidated financial position.\nEnvironmental\nIn March 1994, a subsidiary of AGFI and a subsidiary of AGFC were named as defendants in a lawsuit, The People of the State of California (\"California\") V. Luis Ochoa, Skeeters Automotive, Morris Plan, Creditway of America, Inc., and American General Finance, filed in the Superior Court of California, County of San Joaquin, Case No. 271130. California is seeking injunctive relief, a civil penalty of not less than $5,000 per day or not less than $250,000 for violation of its Health and Safety Code in connection with the failure to register and remove underground storage tanks on property acquired through a foreclosure proceeding by a subsidiary of AGFI, and a civil penalty of $2,500 for each act of unfair competition prohibited by its Business and Professions Code, but not less than $250,000, plus costs. The Company believes that the total amounts that would ultimately be paid, if any, arising from this environmental claim would have no material effect on the Company's consolidated results of operations and consolidated financial position.\nPART II\nItem 5.","section_4":"","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThere is no trading market for AGFI's common stock, all of which is owned by American General. The frequency and amount of cash dividends declared on AGFI's common stock for the years indicated were as follows:\nQuarter Ended 1994 1993 (dollars in thousands)\nMarch 31 $ 33,201 $ 26,000 June 30 22,800 42,100 September 30 21,600 52,900 December 31 14,200 48,198\n$ 91,801 $169,198\nSee Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7. herein, as well as Note 13. of Notes to Consolidated Financial Statements in Item 8. herein, with respect to limitations on the ability of AGFI and its subsidiaries to pay dividends.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following selected financial data are derived from the consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.\nYears Ended December 31, 1994 1993(a) 1992 1991 1990 (dollars in thousands)\nTotal revenues $1,491,239 $1,288,777 $1,170,371 $1,141,662 $1,114,068\nNet income (b) 244,988 195,741 161,908 135,020 121,925\nDecember 31, 1994 1993(a) 1992 1991 1990 (dollars in thousands)\nTotal assets $8,980,728 $7,658,775 $7,210,763 $6,906,025 $6,802,524\nLong-term debt 4,312,932 4,018,797 3,604,371 2,819,045 2,239,448\n(a) The Company adopted three new accounting standards through cumulative adjustments as of January 1, 1993, resulting in a one-time reduction of net income of $12.7 million. See Note 2. of the Notes to Consolidated Financial Statements in Item 8. herein for information on the adoption of new accounting standards.\n(b) Per share information is not included because all of the common stock of AGFI is owned by American General.\nItem 7.","section_7":"Item 7. Continued\nANALYSIS OF OPERATING RESULTS\nSee Selected Financial Statistics in Item 1. herein, for information on important aspects of the Company's business and as a frame of reference for the discussion following.\nNet income for the years ended December 31, 1994, 1993, and 1992, was $245.0 million, $195.7 million, and $161.9 million, respectively.\nFactors which specifically affected the Company's operating results are as follows:\nFinance Charges\nChanges in finance charge revenues, the principal component of total revenues, are a function of period to period changes in the levels of ANR and yield. ANR for 1994 and 1993 increased when compared to the respective previous year. Finance receivables increased primarily due to receivables originated or renewed by the Company due to business development efforts. The yield for 1994 and 1993 increased when compared to the respective previous year primarily due to the increased proportion of higher-rate, non-real estate loans in the loan portfolio during 1994 and 1993 and higher yield on retail sales finance and credit cards for 1994.\nInsurance Revenues\nInsurance revenues increased for 1994 and 1993 when compared to the respective previous year primarily due to the increase in earned premiums. Earned premiums increased primarily due to increased written premiums in prior periods and reinsurance assumptions. Written premiums increased primarily due to increased loan activity and insurance product introductions.\nOther Revenues\nOther revenues decreased slightly for 1994 and increased for 1993 when compared to the respective previous year primarily due to the respective decrease and increase in investment revenue. The decrease in investment revenue for 1994 when compared to 1993 resulted from realized investment losses and a decrease in investment portfolio yields, partially offset by an increase in invested assets. The increase in investment revenue for 1993 when compared to 1992 resulted from an increase in invested assets and realized investment gains, partially offset by a decline in investment portfolio yields. Investment portfolio yields declined for 1994 and 1993 when compared to the respective previous year primarily due to prepayments of higher yielding investments and lower reinvestment rates in recent years.\nItem 7. Continued\nInterest Expense\nChanges in interest expense are a function of period to period changes in average borrowings and borrowing cost. Average borrowings for 1994 and 1993 increased when compared to the respective previous year primarily to fund asset growth. The borrowing cost for 1994 decreased when compared to 1993 due to lower long-term borrowing cost, partially offset by an increase in short-term borrowing cost. The borrowing cost for 1993 decreased when compared to 1992 due to lower short-term and long-term borrowing costs.\nOperating Expenses\nOperating expenses increased for 1994 when compared to 1993 primarily due to increases in salaries and data processing expense. The increase in salaries expense was primarily due to operational staffing increases, to support the Company's growth (including over 100 new consumer finance offices), and merit salary increases. The increase in data processing expense was primarily due to equipment expenses resulting from a branch office automation program and an increase in processor fees due to higher private label and credit card activity. Operating expenses increased for 1993 when compared to 1992 primarily due to increases in salaries, benefits, and occupancy costs. These expenses increased in 1993 as a result of the 1992 third quarter increase in the number of consumer finance offices and the additional employees required to operate such offices. Operating expenses also increased for 1993 when compared to 1992 due to the branch office automation program. The increase in operating expenses for 1994 and 1993 when compared to the respective previous year was partially offset by the increase in deferral of finance receivable origination costs.\nProvision for Finance Receivable Losses\nProvision for finance receivable losses for 1994 and 1993 increased when compared to the respective previous year due to an increase in net charge- offs and amounts provided for the allowance for finance receivable losses. Net charge-offs for 1994 increased when compared to 1993 due to the increase in charge-off ratios and ANR. Charge-off ratios increased for 1994 when compared to 1993 due to the increase in the charge-off ratio on retail sales finance and loans partially offset by a decrease in the charge-off ratio for credit cards. The charge-off ratio on loans increased primarily due to the increased proportion of non-real estate loans in the loan portfolio and the increase in the charge-off ratio on such loans. As expected, the increased proportion of non-real estate loans in the loan portfolio has contributed to both higher charge-off ratios and corresponding higher yields. Net charge-offs for 1993 increased when compared to 1992 primarily due to the increase in ANR. The allowance for finance receivable losses for 1994 and 1993 increased when compared to the respective previous year primarily to bring the balance to appropriate levels based upon the balance of finance receivables, portfolio mix, levels of delinquency, net charge-offs, and the economic climate.\nItem 7. Continued\nInsurance Losses and Loss Adjustment Expenses\nInsurance losses and loss adjustment expenses for 1994 and 1993 increased when compared to the respective previous year primarily due to an increase in claims and reserves resulting from the increase in premiums written due to increased loan activity and reinsurance assumptions.\nCumulative Effect of Accounting Changes\nThe adoption of three new accounting standards resulted in a cumulative adjustment effective January 1, 1993 consisting of a one-time charge to earnings of $12.7 million. Other than the cumulative effect, adoption of these new accounting standards did not have a material effect on 1994 or 1993 net income and is not expected to have a material impact in the future.\nANALYSIS OF FINANCIAL CONDITION\nAt December 31, 1994, the Company's assets are distributed primarily as follows: 85.67% in finance receivables, 7.82% in marketable securities, 3.22% in acquisition-related goodwill, 2.70% in other assets, and .59% in cash and cash equivalents.\nAsset Quality\nThe Company believes that its geographic diversification reduces the risk associated with a recession in any one region. An additional indication of asset quality is that of the loans and retail sales finance outstanding at December 31, 1994, 92% are secured by real property or personal property.\nThe delinquency ratio increased for 1994 when compared to 1993 reflecting the increase in the delinquency ratio of loans, primarily due to the increase in the delinquency ratio on non-real estate loans and the increased proportion of such loans in the loan portfolio, and the increase in the delinquency ratio on retail sales finance and credit cards. The charge-off ratio for 1994 increased when compared to 1993 reflecting an increase in the charge-off ratio of retail sales finance and loans partially offset by a decrease in the charge-off ratio of credit cards. The charge-off ratio on loans increased primarily due to the increased proportion of non-real estate loans in the loan portfolio and the increase in the charge-off ratio on such loans. While finance receivables have some exposure to further economic uncertainty, the Company believes that in the present environment, the allowance for finance receivable losses is adequate.\nMarketable securities principally represent the investment portfolio of the Company's insurance operations. The investment strategy is to optimize after-tax returns on invested assets, subject to the constraints of safety, liquidity, diversification, and regulation.\nItem 7. Continued\nThe largest intangible asset is acquisition-related goodwill which is charged to expense in equal amounts, generally over 20 or 40 years. See Note 1. of the Notes to Consolidated Financial Statements in Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Report of Independent Auditors and the related consolidated financial statements are presented on the following pages.\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors American General Finance, Inc.\nWe have audited the accompanying consolidated balance sheets of American General Finance, Inc. (a wholly-owned subsidiary of American General Corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, shareholder's equity and cash flows for each of the three years in the period ended December 31, 1994. Our audit 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of American General Finance, Inc. and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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 2. of the Notes to Consolidated Financial Statements, in 1993 the Company changed its method of accounting for postretirement benefits other than pensions, income taxes, postemployment benefits, reinsurance, loan impairments, and certain investments in debt and equity securities, as a result of adopting promulgated accounting standards governing the accounting treatment for these items.\nERNST & YOUNG LLP\nNashville, Tennessee February 14, 1995\nAmerican General Finance, Inc. and Subsidiaries\nConsolidated Balance Sheets\nDecember 31, Assets 1994 1993 (dollars in thousands) Finance receivables, net of unearned finance charges (Note 3.): Real estate loans $2,704,929 $2,641,879 Non-real estate loans 2,660,523 2,318,102 Retail sales finance 2,075,380 1,218,016 Credit cards 479,480 395,991\nNet finance receivables 7,920,312 6,573,988 Allowance for finance receivable losses (Note 4.) (226,226) (183,756) Net finance receivables, less allowance for finance receivable losses 7,694,086 6,390,232\nMarketable securities (Note 5.) 702,510 699,697 Cash and cash equivalents 52,729 48,374 Goodwill (Note 6.) 289,000 299,653 Other assets (Note 6.) 242,403 220,819\nTotal assets $8,980,728 $7,658,775\nLiabilities and Shareholder's Equity\nLong-term debt (Note 7.) $4,312,932 $4,018,797 Short-term notes payable: Commercial paper (Notes 8. and 9.) 2,609,986 1,643,961 Banks and other (Notes 8. and 10) 161,477 171,000 Investment certificates 6,601 9,406 Insurance claims and policyholder liabilities 466,883 415,488 Other liabilities 191,278 231,737 Accrued taxes 19,831 57,686\nTotal liabilities 7,768,988 6,548,075\nShareholder's equity Common stock (Note 12.) 1,000 1,000 Additional paid-in capital 616,021 616,021 Net unrealized investment (losses) gains (Note 5.) (18,407) 33,740 Retained earnings (Note 13.) 613,126 459,939\nTotal shareholder's equity 1,211,740 1,110,700\nTotal liabilities and shareholder's equity $8,980,728 $7,658,775\nSee Notes to Consolidated Financial Statements.\nAmerican General Finance, Inc. and Subsidiaries\nConsolidated Statements of Income\nYears Ended December 31, 1994 1993 1992 (dollars in thousands) Revenues Finance charges $1,247,727 $1,082,660 $ 994,296 Insurance 180,913 142,856 119,272 Other 62,599 63,261 56,803\nTotal revenues 1,491,239 1,288,777 1,170,371\nExpenses Interest expense 416,233 379,764 398,168 Operating expenses 371,125 330,122 307,782 Provision for finance receivable losses 213,987 162,847 135,102 Insurance losses and loss adjustment expenses 97,893 79,214 66,603\nTotal expenses 1,099,238 951,947 907,655\nIncome before provision for income taxes and cumulative effect of accounting changes 392,001 336,830 262,716\nProvision for Income Taxes (Note 11.) 147,013 128,437 100,808\nIncome before cumulative effect of accounting changes 244,988 208,393 161,908\nCumulative Effect of Accounting Changes (Note 2.) - (12,652) -\nNet Income $ 244,988 $ 195,741 $ 161,908\nSee Notes to Consolidated Financial Statements.\nAmerican General Finance, Inc. and Subsidiaries\nConsolidated Statements of Shareholder's Equity\nYears Ended December 31, 1994 1993 1992 (dollars in thousands)\nCommon Stock Balance at beginning of year $ 1,000 $ 1,000 $ 1,000 Balance at end of year 1,000 1,000 1,000\nAdditional Paid-in Capital Balance at beginning of year 616,021 615,874 615,874 Capital contribution from parent and other - 147 - Balance at end of year 616,021 616,021 615,874\nNet Unrealized Investment (Losses) Gains Balance at beginning of year 33,740 617 655 Change during year (52,147) (318) (38) Effect of accounting change - 33,441 - Balance at end of year (18,407) 33,740 617\nRetained Earnings Balance at beginning of year 459,939 433,396 404,328 Net income 244,988 195,741 161,908 Common stock dividends (91,801) (169,198) (132,840) Balance at end of year 613,126 459,939 433,396\nTotal Shareholder's Equity $1,211,740 $1,110,700 $1,050,887\nSee Notes to Consolidated Financial Statements.\nAmerican General Finance, Inc. and Subsidiaries\nNotes to Consolidated Financial Statements\nDecember 31, 1994\nNote 1. Summary of Significant Accounting Policies\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of American General Finance, Inc. (AGFI) and all of its subsidiaries (the Company) including American General Finance Corporation (AGFC) and American General Financial Center (AGF-Utah). The subsidiaries are all wholly-owned and all intercompany items have been eliminated. AGFI is a wholly-owned subsidiary of American General Corporation (American General).\nCertain amounts in the 1993 and 1992 financial statements have been reclassified to conform to the 1994 presentation.\nFINANCE OPERATIONS\nRevenue Recognition\nRevenue on finance receivables is accounted for as follows:\n(1) Finance charges on discounted finance receivables and interest on interest-bearing finance receivables are recognized as revenue on the accrual basis using the interest method. The accrual of revenue is suspended when the fourth contractual payment becomes past due for loans and retail sales contracts (which are included in retail sales finance) and when the sixth contractual payment becomes past due for private label (which are also included in retail sales finance) and credit cards.\n(2) Extension fees and late charges are recognized as revenue when received.\n(3) Nonrefundable points and fees on loans are recognized on the accrual basis using the interest method over the lesser of the contractual term or the estimated life based upon prepayment experience (50 months for real estate loans and 19 months for non-real estate loans). If a loan liquidates before amortization is completed, any unamortized fees are recognized as revenue at the date of liquidation. Nonrefundable points and fees on retail sales finance and deferred annual fees on credit cards are not material.\nNotes to Consolidated Financial Statements, Continued\nOrigination Costs\nThe Company defers costs associated with the origination of loans, private label, and credit card receivables. Deferred loan origination costs are included in finance receivables and are amortized to finance charges using the interest method over the contractual term or the estimated economic life of the loans (50 months for real estate loans and 19 months for non- real estate loans). If a loan liquidates before amortization is completed, any unamortized costs are charged to revenue at the date of liquidation. Deferred costs for the origination of private label and credit cards are not material.\nAllowance For Finance Receivable Losses\nThe allowance for finance receivable losses is maintained at a level based on management's periodic evaluation of the finance receivable portfolio and reflects an amount that, in management's opinion, is adequate to absorb losses in the existing portfolio. In evaluating the portfolio, management takes into consideration numerous factors, including current economic conditions, prior finance receivable loss and delinquency experience, the composition of the finance receivable portfolio, and management's estimate of anticipated finance receivable losses.\nAGFI's basic policy is to charge off each month loan accounts, except those secured by real estate, on which little or no collections were made in the prior six-month period. Retail sales contracts are charged off when four installments are past due. Private label and credit card accounts are charged off when 180 days past due. In the case of loans secured by real estate, foreclosure proceedings are instituted when four monthly installments are past due. When foreclosure is completed and the Company has obtained title to the property, the real estate is established as an asset valued at market value, and any loan value in excess of that amount is charged off. Exceptions are made to the charge-off policies when, in the opinion of management, such treatment is warranted.\nINSURANCE OPERATIONS\nRevenue Recognition\nThe Company's insurance subsidiaries are engaged in writing credit life and credit accident and health insurance, ordinary life insurance, and property and casualty insurance. Premiums on credit life insurance are recognized as revenue using the sum-of-the-digits or actuarial methods, except in the case of level-term contracts, which are recognized as revenue using the straight-line method over the lives of the policies. Premiums on credit accident and health insurance are recognized as revenue using an average of the sum-of-the-digits and the straight-line methods. Ordinary life insurance premiums are reported as earned when collected but not before their due dates. Premiums on property and casualty insurance are recognized as revenue using the straight-line method over the terms of the policies or appropriate shorter periods.\nNotes to Consolidated Financial Statements, Continued\nPolicy Reserves\nPolicy reserves for credit life and credit accident and health insurance are equal to related unearned premiums, and claim reserves are based on company experience. Liabilities for future life insurance policy benefits associated with ordinary life contracts are accrued when premium revenue is recognized and are computed on the basis of assumptions as to investment yields, mortality, and withdrawals. Annuity reserves are computed on the basis of assumptions as to investment yields and mortality. Reserves for losses and loss adjustment expenses of the property and casualty insurance company are based upon estimates of claims reported plus estimates of incurred but not reported claims. Ordinary life, group annuity, and accident and health insurance reserves assumed under coinsurance agreements are established on the bases of various tabular and unearned premium methods.\nAcquisition Costs\nInsurance acquisition costs, principally commissions, reinsurance fees, and premium taxes, are deferred and charged to expense over the terms of the related policies or reinsurance agreements.\nReinsurance\nThe Company's insurance subsidiaries enter into reinsurance agreements among themselves and other insurers, including insurance subsidiaries of American General. The life reserves attributable to this business with the subsidiaries of American General were $61.6 million and $62.6 million at December 31, 1994 and 1993, respectively. The Company's insurance subsidiaries assumed from other insurers $51.4 million, $42.5 million, and $30.3 million of reinsurance premiums during 1994, 1993, and 1992, respectively. The Company's ceded reinsurance activities were not significant during the last three years.\nGAAP vs. Statutory Accounting\nStatutory accounting practices differ from generally accepted accounting principles, primarily in the following respects: credit life insurance reserves are maintained on the basis of mortality tables; ordinary life and group annuity insurance reserves are based on statutory requirements; insurance acquisition costs are expensed when incurred rather than expensed over the related contract period; deferred income taxes are not recorded on temporary differences in the recognition of revenue and expense for tax versus statutory reporting purposes; certain intangible assets resulting from a purchase and the related amortization are not reflected in statutory financial statements; investments in fixed-maturity marketable securities are carried at amortized cost; and an asset valuation reserve and interest maintenance reserve are required for Merit Life Insurance Co. (Merit), which is a wholly-owned subsidiary of AGFC. The following compares net income and shareholder's equity determined under statutory accounting\nNotes to Consolidated Financial Statements, Continued\npractices with those determined under generally accepted accounting principles:\nNet Income Shareholder's Equity Years Ended December 31, December 31, 1994 1993 1992 1994 1993 (dollars in thousands) Statutory accounting practices $35,466 $31,080 $32,128 $279,231 $245,175\nGenerally accepted accounting principles 46,903 39,363 38,164 381,577 386,821\nMARKETABLE SECURITIES\nValuation\nEffective with the adoption of Statement of Financial Accounting Standards (SFAS) 115 (see Note 2.), management determines the appropriate classification of marketable securities at the time of purchase and re- evaluates such designation at each balance sheet date. All marketable securities are currently classified as available-for-sale and recorded at fair value. After adjusting related balance sheet accounts as if the unrealized investment gains or losses had been realized, the net adjustment is recorded in net unrealized investment gains or losses within shareholder's equity. If the fair value of a marketable security classified as available-for-sale declines below its cost and this decline is considered to be other than temporary, the marketable security is reduced to its net realizable value, and the reduction is recorded as a realized loss.\nRealized Gains or Losses\nRealized gains or losses are recognized using the specific identification method and include declines in fair value of marketable securities below cost that are considered other than temporary. Realized gains or losses are included in other revenues.\nOTHER\nCash Equivalents\nThe Company considers all short-term investments with a maturity at date of purchase of three months or less to be cash equivalents.\nNotes to Consolidated Financial Statements, Continued\nGoodwill\nAcquisition-related goodwill is charged to expense in equal amounts, generally over 20 or 40 years. The carrying value of goodwill is regularly reviewed for indicators of impairment in value, which in the view of management are other than temporary, including unexpected or adverse changes in the following: 1) the economic or competitive environments in which the Company operates, 2) profitability analyses, and 3) cash flow analyses. If facts and circumstances suggest that goodwill is impaired, the Company assesses the fair value of the underlying business and reduces goodwill to an amount that results in the book value of the Company approximating fair value. The Company determines the fair value based on an independent appraisal.\nAt December 31, 1994, the reported value and the remaining life of acquisition-related goodwill are considered appropriate.\nIncome Taxes\nBeginning in 1993, income taxes have been provided in accordance with SFAS 109 (see Note 2.). Under this standard, deferred tax assets and liabilities are established for temporary differences between the financial reporting basis and the tax basis of assets and liabilities, at the enacted tax rates expected to be in effect when the temporary differences reverse. The effect of a tax rate change is recognized in income in the period of enactment.\nA valuation allowance for deferred tax assets is provided if all or some portion of the deferred tax asset may not be realized. An increase or decrease in a valuation allowance that results from a change in circumstances that causes a change in judgement about the realizability of the related deferred tax asset is included in income. A change related to fluctuations in fair value of available-for-sale marketable securities is included in unrealized investment gains or losses in shareholder's equity.\nBefore 1993, the Company recognized deferred taxes on timing differences between financial reporting income and taxable income. Deferred taxes were not adjusted for tax rate changes.\nInterest Conversion Agreements\nThe interest differential to be paid or received on interest conversion agreements is accrued as interest rates change and is recognized over the life of the agreements as an adjustment to interest expense. The related amount payable to or receivable from counterparties is included in other liabilities or other assets.\nNotes to Consolidated Financial Statements, Continued\nFair Value of Financial Instruments\nThe fair values disclosed in Note 17. are based on estimates using discounted cash flows when quoted market prices are not available. 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. The fair value amounts presented can be misinterpreted, and care should be exercised in drawing conclusions from such data.\nNote 2. Accounting Changes\nDuring 1994, the Company adopted two SFAS's issued by the Financial Accounting Standards Board.\nThe Company adopted SFAS 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures,\" and SFAS 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\" SFAS 118 requires disclosures about the recorded investment in certain impaired loans and the recognition of related interest income. SFAS 119 requires additional disclosures about derivative financial instruments and amends existing fair value disclosure requirements. These standards do not impact the Company's consolidated financial statements.\nDuring 1993, the Company adopted six SFAS's issued by the Financial Accounting Standards Board.\nThe Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" through a cumulative adjustment, effective January 1, 1993, resulting in a one-time reduction of net income of $2.9 million ($4.4 million pretax). This standard requires accrual of a liability for postretirement benefits other than pensions.\nThe Company adopted SFAS 109, \"Accounting for Income Taxes,\" through a cumulative adjustment, effective January 1, 1993, resulting in a one-time reduction of net income of $8.6 million. This standard changes the way income tax expense is determined for financial reporting purposes.\nThe Company adopted SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" through a cumulative adjustment, effective January 1, 1993, resulting in a one-time reduction of net income of $1.2 million ($1.8 million pretax). This standard requires the accrual of a liability for benefits provided to employees after employment but before retirement.\nNotes to Consolidated Financial Statements, Continued\nThe Company adopted SFAS 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts,\" effective January 1, 1993. This standard, which does not have a material impact on the consolidated financial statements, requires that reinsurance receivables and prepaid reinsurance premiums be reported as assets, rather than netted against the related insurance liabilities.\nThe Company adopted SFAS 114, \"Accounting by Creditors for Impairment of a Loan,\" effective January 1, 1993. This standard requires that certain impaired loans be reported at the present value of expected future cash flows, the loan's observable market price, or the fair value of underlying collateral. This standard does not have a material impact on the consolidated financial statements.\nThe Company adopted SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" at December 31, 1993. This standard requires that debt and equity securities be carried at fair value unless the Company has the positive intent and ability to hold these investments to maturity. Marketable securities must be classified into one of three categories: 1) held-to-maturity, 2) available-for-sale, or 3) trading securities. At December 31, 1993, the Company classified all marketable securities as available-for-sale and recorded net unrealized investment gains of $33.4 million to shareholder's equity. Rising interest rates during 1994 caused a decrease in the fair value of the Company's available-for-sale marketable securities. As a result, shareholder's equity included net unrealized investment losses on marketable securities affected by SFAS 115 of $18.5 million at December 31, 1994.\nNote 3. Finance Receivables\nLoans collateralized by security interests in real estate generally have maximum original terms of 180 months. Loans collateralized by consumer goods, automobiles or other chattel security, and loans that are unsecured, generally have maximum original terms of 60 months. Retail sales contracts are collateralized principally by consumer goods and automobiles, and generally have maximum original terms of 60 months. Private label are secured by a purchase money security interest in the goods purchased and generally require minimum monthly payments based upon current balances. Credit card receivables are unsecured and require minimum monthly payments based upon current balances. Of the loans and retail sales finance outstanding at December 31, 1994, 92% were secured by the real or personal property of the borrower. At December 31, 1994, mortgage loans (generally second mortgages) accounted for 50% of the aggregate dollar amount of loans outstanding and 10% of the total number of loans outstanding.\nNotes to Consolidated Financial Statements, Continued\nContractual maturities of finance receivables were as follows:\nDecember 31, 1994 Net Receivables Percent of Amount Net Receivables (dollars in thousands)\n1995 $3,152,603 39.80% 1996 1,468,445 18.54 1997 900,143 11.37 1998 455,543 5.75 1999 275,705 3.48 2000 and thereafter 1,667,873 21.06\nTotal $7,920,312 100.00%\nExperience of the Company has shown that a substantial portion of finance receivables will be renewed, converted, or paid in full prior to maturity. Accordingly, the preceding information as to contractual maturities should not be considered as a forecast of future cash collections. Principal cash collections and such collections as a percentage of average net finance receivables were as follows:\n1994 1993 (dollars in thousands) Loans: Principal cash collections $2,436,747 $2,100,565 Percent of average net finance receivables 47.78% 42.50%\nRetail sales finance: Principal cash collections $1,454,419 $1,191,745 Percent of average net finance receivables 92.14% 110.70%\nCredit cards: Principal cash collections $ 431,426 $ 504,529 Percent of average net finance receivables 103.32% 137.11%\nUnused credit limits on private label extended by the Company to its customers were $2.4 billion and $595.0 million at December 31, 1994 and 1993, respectively. Unused credit limits on credit cards extended by the Company to its customers were $1.7 billion and $1.3 billion at December 31, 1994 and 1993, respectively. Unused credit limits on loan and other retail sales finance revolving lines of credit extended by the Company to its customers were $260.2 million and $176.5 million at December 31, 1994 and 1993, respectively. These amounts, in part or in total, can be cancelled at the discretion of the Company, and are not indicative of the amounts expected to be funded.\nNotes to Consolidated Financial Statements, Continued\nGeographic diversification of finance receivables reduces the concentration of credit risk associated with a recession in any one region. The largest concentrations of finance receivables, net of unearned finance charges, are as follows:\nDecember 31, 1994 December 31, 1993 Location Amount Percent Amount Percent (dollars in thousands) (dollars in thousands)\nCalifornia $ 810,562 10.23% $ 750,772 11.42% N. Carolina 638,942 8.07 581,754 8.85 Florida 574,229 7.25 502,977 7.65 Illinois 458,170 5.78 409,032 6.22 Indiana 410,265 5.18 364,706 5.55 Ohio 400,643 5.06 341,179 5.19 Virginia 355,094 4.48 353,397 5.38 Georgia 347,321 4.39 264,260 4.02 Other 3,925,086 49.56 3,005,911 45.72 $7,920,312 100.00% $6,573,988 100.00%\nNote 4. Allowance for Finance Receivable Losses\nThe changes in the allowance for finance receivable losses are detailed below: 1994 1993 1992 (dollars in thousands)\nBalance at beginning of year $183,756 $161,678 $151,091 Provision for finance receivable losses 213,987 162,847 135,102 Allowance related to net acquired receivables and other 970 (21) 4,565 Charge-offs: Finance receivables charged off (209,340) (169,758) (158,781) Recoveries 36,853 29,010 29,701 Net charge-offs (172,487) (140,748) (129,080) Balance at end of year $226,226 $183,756 $161,678\nNotes to Consolidated Financial Statements, Continued\nNote 5. Marketable Securities\nAt December 31, 1994 and 1993, all marketable securities were classified as available-for-sale and reported at fair value. Marketable securities were as follows at December 31:\nFair Value Amortized Cost 1994 1993 1994 1993 (dollars in thousands) Fixed-maturity marketable securities: Bonds: Corporate securities $324,706 $313,174 $338,624 $290,153 Mortgage-backed securities 206,120 234,062 222,788 223,868 States and political subdivisions 123,116 102,438 124,701 94,540 Other 38,561 40,766 34,297 30,736 Redeemable preferred stocks 8,782 7,486 9,334 7,180\nTotal 701,285 697,926 729,744 646,477\nNon-redeemable preferred stocks 1,225 1,771 1,084 1,313\nTotal marketable securities $702,510 $699,697 $730,828 $647,790\nAt December 31, the gross unrealized investment gains and losses were as follows:\nGross Gross Unrealized Gains Unrealized Losses 1994 1993 1994 1993 (dollars in thousands) Fixed-maturity marketable securities: Bonds: Corporate securities $ 3,701 $23,836 $17,619 $ 815 Mortgage-backed securities 781 11,681 17,449 1,487 State and political subdivisions 2,534 8,031 4,119 133 Other 4,539 10,032 275 2 Redeemable preferred stocks - 315 552 9\nTotal 11,555 53,895 40,014 2,446\nNon-redeemable preferred stocks 215 458 74 -\nTotal marketable securities $11,770 $54,353 $40,088 $ 2,446\nNotes to Consolidated Financial Statements, Continued\nDuring the years ended December 31, 1994, 1993, and 1992, marketable securities with a fair value of $81.2 million, $141.4 million, and $127.9 million, respectively, were sold or redeemed. The gross realized investment gains on such sales or redemptions totaled $.3 million, $7.4 million, and $3.1 million, respectively. The gross realized investment losses totaled $.6 million, $.1 million and $.5 million, respectively.\nThe contractual maturities of fixed-maturity securities at December 31, 1994 were as follows: Fair Amortized Value Cost (dollars in thousands) Fixed maturities, excluding mortgage-backed securities: Due in 1 year or less $ 8,732 $ 8,632 Due after 1 year through 5 years 82,417 81,144 Due after 5 years through 10 years 276,186 288,561 Due after 10 years 127,830 128,619\n495,165 506,956 Mortgage-backed securities 206,120 222,788\nTotal $701,285 $729,744\nActual maturities may differ from contractual maturities since borrowers may have the right to call or prepay obligations. Company requirements and investment strategies may result in the sale of investments before maturity.\nCertain of the bonds were on deposit with regulatory authorities. The carrying values of such bonds were $7.5 million and $18.6 million at December 31, 1994 and 1993, respectively.\nNote 6. Costs In Excess of Net Assets Acquired\nGoodwill, resulting from the excess of the purchase price paid over the fair value of separately identified tangible and intangible net assets acquired, amounted to $289.0 million and $299.7 million at December 31, 1994 and 1993, respectively. Accumulated amortization amounted to $59.0 million and $48.4 million at December 31, 1994 and 1993, respectively.\nIncluded in other assets is a customer base valuation of $21.6 million and $23.2 million at December 31, 1994 and 1993, respectively, which is being amortized to operating expenses on a straight-line basis over a 25 year period.\nNotes to Consolidated Financial Statements, Continued\nNote 7. Long-term Debt\nLong-term debt outstanding at December 31, is summarized as follows:\nSenior Maturity Senior Subordinated Total (dollars in thousands)\n1995 $ 753,076 $149,954 $ 903,030 1996 590,897 - 590,897 1997 1,132,176 - 1,132,176 1998 242,492 - 242,492 1999 533,694 - 533,694 2000-2004 612,787 - 612,787 2005-2009 297,856 - 297,856\nTotal $4,162,978 $149,954 $4,312,932\nCertain debt issues of the Company are redeemable prior to maturity at par, at the option of the holders. If these issues were so redeemed, the senior amounts above would increase $148.9 million in 1996 and $149.0 million in 1999 and would decrease $297.9 million in 2009.\nCarrying Value Fair Value Type of Debt 1994 1993 1994 1993 (dollars in thousands)\nSenior $4,162,978 $3,547,244 $4,058,247 $3,776,820 Senior subordinated 149,954 471,553 149,922 486,806\nTotal $4,312,932 $4,018,797 $4,208,169 $4,263,626\nThe weighted average interest rates on long-term debt outstanding by type were as follows: Years Ended December 31, December 31, 1994 1993 1994 1993\nSenior 7.28% 7.63% 7.11% 7.37% Senior subordinated 7.46 8.71 6.34 7.07 Total 7.33 7.88 7.08 7.33\nCertain debt agreements contain restrictions on consolidated retained earnings for certain purposes (see Note 13.).\nNotes to Consolidated Financial Statements, Continued\nNote 8. Short-term Notes Payable and Credit Facilities\nAGFC issues commercial paper with terms ranging from 1 to 270 days. Information concerning short-term notes payable for commercial paper and to banks was as follows: 1994 1993 1992 (dollars in thousands)\nMaximum borrowings at any month end $2,770,886 $1,886,426 $2,096,961 Average borrowings $2,138,124 $1,780,732 $1,887,408 Weighted average interest rate, giving effect to interest conversion agreements and commitment fees 5.18% 4.11% 5.64% Weighted average interest rate, at December 31, 5.85% 3.30% 3.53%\nCredit facilities are maintained to support the issuance of commercial paper and as an additional source of funds for operating requirements. At December 31, 1994 and 1993, the Company had committed credit facilities of $500.0 million and $390.0 million, respectively, and was an eligible borrower under $2.5 billion and $2.1 billion of committed credit facilities, respectively, extended to American General and certain of its subsidiaries. On January 31, 1995, the $2.5 billion of committed credit facilities extended to American General and certain of its subsidiaries were increased by $1.3 billion. The annual commitment fees for all committed facilities range from .070% to .125%. At December 31, 1994 and 1993, the Company also had $611.0 million and $496.0 million, respectively, of uncommitted credit facilities and was an eligible borrower under $195.0 million and $240.0 million, respectively, of uncommitted credit facilities extended to American General and certain of its subsidiaries. Available borrowings under all facilities are reduced by any amounts outstanding thereunder. At December 31, 1994 and 1993, Company short-term borrowings outstanding under all credit facilities were $160.9 million and $171.0 million, respectively, and Company long-term borrowings outstanding under all credit facilities were $168.1 million and $147.0 million, respectively, with remaining availability to the Company of $3.0 billion and $2.4 billion, respectively, in committed facilities and $477.0 million and $461.0 million, respectively, in uncommitted facilities.\nNotes to Consolidated Financial Statements, Continued\nNote 9. Derivative Financial Instruments\nThe Company is neither a dealer nor a trader in derivative financial instruments. On infrequent occasions, the Company has used interest conversion agreements and options on interest conversion agreements to manage the Company's exposure to market interest rate risk associated with debt. Interest rate conversion agreements involve the receipt of floating- rate amounts in exchange for fixed-rate interest payments, or vice versa, over the life of the agreement without an exchange of the underlying principal (or notional) amount.\nThe Company's objective for using interest conversion agreements and options on interest conversion agreements is to synthetically modify a portion of the Company's floating-rate borrowings to fixed rates. Such floating-rate obligations are carried at amortized cost (as opposed to fair value) in the Company's consolidated financial statements.\nFixed interest rates contracted to be paid on interest conversion agreements and options on interest conversion agreements approximated the rates on fixed-rate term debt with maturities similar to the derivative financial instruments at the date of contract. Accordingly, the Company's use of interest conversion agreements and options on interest conversion agreements did not have a material effect on the weighted-average interest rate or reported interest expense in any of the three years ended December 31, 1994.\nInterest conversion agreements in which the Company contracted to pay interest at fixed rates and receive interest at floating rates were $390.0 million, $290.0 million, and $415.0 million in notional amounts at December 31, 1994, 1993, and 1992, respectively. The weighted average interest rate paid was 8.77%, 8.69%, and 8.71% for the year ended December 31, 1994, 1993, and 1992, respectively. The weighted average interest rate received was 4.64%, 3.35%, and 3.91% for the year ended December 31, 1994, 1993, and 1992, respectively. These agreements mature at various dates and have the respective fixed rates at December 31, 1994 as shown in the table below:\nNotional Weighted Average Maturity Amount Interest Rate (dollars in thousands)\n1996 $ 50,000 8.38% 1998 90,000 9.06 1999 50,000 9.39 2000 200,000 9.10\n$390,000 9.03%\nNotes to Consolidated Financial Statements, Continued\nThe rollforward of notional amounts for interest conversion agreements was as follows:\nNotional Amounts 1994 1993 1992 (dollars in thousands)\nBalance at beginning of year $ 290,000 $ 415,000 $ 765,000 New contracts (a) 200,000 50,000 100,000 Expired contracts (100,000) (175,000) (450,000)\nBalance at end of year $ 390,000 $ 290,000 $ 415,000\n(a) Reflects options exercised.\nOptions on interest conversion agreements at December 31, 1993 and 1992, in aggregate notional amounts, were $200.0 million and $250.0 million, respectively. There were no such agreements outstanding as of December 31, 1994. All such option agreements, when exercised by the counterparty, committed the Company to pay interest at fixed rates in exchange for receiving floating-rate interest payments. The related option fees received are being amortized as a reduction of interest expense over the aggregate of the option period and interest conversion period.\nThe Company is exposed to credit risk in the event of non-performance by counterparties to interest conversion agreements. The Company limits its exposure to credit risk by entering into interest conversion agreements with counterparties having high credit ratings and by basing the amount and term of an agreement on these credit ratings. Furthermore, the Company regularly monitors counterparty credit ratings throughout the term of the agreements.\nThe Company's current credit exposure on interest conversion agreements is limited to the fair value of interest conversion agreements that are favorable to the Company. At December 31, 1994, 1993, and 1992, the Company was in a payable position on all outstanding interest conversion agreements. The Company does not expect any counterparty to fail to meet its obligation; however, non-performance would not have a material impact on the consolidated financial statements.\nThe Company's exposure to market risk is mitigated by the offsetting effects of changes in the value of interest conversion agreements and of the underlying liabilities to which they relate.\nNotes to Consolidated Financial Statements, Continued\nNote 10. Short-term Notes Payable - Parent\nBorrowings from American General primarily provide overnight operating liquidity when American General is in a surplus cash position. All such borrowings are made on a due on demand basis at short-term rates based on overnight bank investment rates. At December 31, 1994, 1993 and 1992, AGFI had no borrowings outstanding with American General. Information concerning such borrowings is as follows:\n1994 1993 1992 (dollars in thousands)\nMaximum borrowings at any month end $ - $ 178 $29,200 Average borrowings $ 200 $ 433 $ 2,466 Weighted average interest rate (total interest expense divided by average borrowings) 4.35% 3.22% 3.98%\nNote 11. Income Taxes\nAGFI and all of its subsidiaries file a consolidated federal income tax return with American General and its subsidiaries. AGFI and its subsidiaries provide for federal income taxes as if filing a separate tax return, and pay such amounts to American General in accordance with a tax sharing agreement.\nAs a result of the adoption of SFAS 109, income tax disclosures for 1994 and 1993 are not comparable to 1992.\nProvision for income taxes is summarized as follows:\nYears Ended December 31, 1994 1993 1992 (dollars in thousands) Federal Current $152,968 $124,295 $ 86,942 Deferred (17,020) (7,617) 759\nTotal federal 135,948 116,678 87,701 State 11,065 11,759 13,107\nTotal $147,013 $128,437 $100,808\nNotes to Consolidated Financial Statements, Continued\nThe U.S. statutory federal income tax rate differs from the effective income tax rate as follows: Years Ended December 31, 1994 1993 1992\nStatutory federal income tax rate 35.00% 35.00% 34.00% State income taxes 1.83 2.26 3.29 Amortization of goodwill 1.13 1.17 1.13 Nontaxable investment income (.55) (.56) (.65) Other, net .09 .26 .60\nEffective income tax rate 37.50% 38.13% 38.37%\nThe net deferred tax asset at December 31, 1994 of $13.6 million was net of deferred tax liabilities totalling $97.8 million. The net deferred tax liability at December 31, 1993 of $25.5 million was net of deferred tax assets totalling $80.9 million. The most significant deferred tax assets relate to the provision for finance receivable losses and insurance premiums recorded for financial reporting purposes. No valuation allowance was considered necessary at December 31, 1994 and 1993.\nOn August 10, 1993, the Revenue Reconciliation Act of 1993 was enacted, which increased the corporate tax rate from 34% to 35%, retroactive to January 1, 1993. The additional 1% tax on earnings for first and second quarter 1993 was $1.6 million, and the effect of the 1% increase in the tax rate used to value existing deferred tax liabilities, as required by SFAS 109, was $.6 million. In accordance with SFAS 109, this total one-time charge of $2.2 million was included in provision for income taxes for the quarter ended September 30, 1993.\nNote 12. Capital Stock\nAGFI has two classes of capital stock: special shares (without par value, 25 million shares authorized) which may be issued in series with such dividend, liquidation, redemption, conversion, voting and other rights as the board of directors may determine prior to issuance; and common shares ($.50 par value, 25 million shares authorized). Issued shares were as follows:\nSpecial Shares - As of December 31, 1994 and 1993, there were no shares issued and outstanding.\nCommon Shares - As of December 31, 1994 and 1993, there were 2 million shares issued and outstanding.\nNotes to Consolidated Financial Statements, Continued\nNote 13. Consolidated Retained Earnings\nThe ability of AGFI to pay dividends is substantially dependent on the receipt of dividends or other funds from its subsidiaries. The Company's insurance subsidiaries are restricted by state laws as to the amounts they may pay as dividends without prior notice to, or in some cases prior approval from, their respective state insurance departments. The maximum amount of dividends which can be paid by the Company's insurance subsidiaries in 1995 without prior approval is $35.5 million. The Company's insurance subsidiaries had statutory capital and surplus of $279.2 million at December 31, 1994. The amount of dividends which may be paid by AGFC is limited by provisions of certain of its financing agreements. Under the most restrictive provisions of such agreements, $407.9 million of the consolidated retained earnings of AGFC at December 31, 1994, was free from such restrictions. At that same date, $6.6 million of the retained earnings of AGFI's industrial loan company subsidiaries was unrestricted as to the payment of dividends.\nAt December 31, 1994, Merit had $52.7 million of accumulated earnings for which no federal income tax provisions have been required. Federal income taxes will become payable only to the extent such earnings are distributed as dividends or exceed limits prescribed by tax laws. No distributions are presently contemplated from these earnings. If such earnings were to become taxable at December 31, 1994, the federal income tax would approximate $18.4 million.\nNote 14. Benefit Plans\nRETIREMENT INCOME PLANS\nThe Company participates in the American General Retirement Plans (AGRP), which are noncontributory defined benefit pension plans covering most employees. Pension benefits are based on the participant's average monthly compensation and length of credited service. American General's funding policy is to contribute annually no more than the maximum amount that can be deducted for federal income tax purposes. American General uses the projected unit credit method to compute pension expense.\nThe plans' assets include primarily readily marketable securities.\nPrior to 1994, the pension plans purchased annuity contracts from American General subsidiaries that provide benefits to certain retirees. These annuity contracts provided $2.3 million, $2.3 million, and $2.0 million for benefits to the Company's retirees for the years ended December 31, 1994, 1993, and 1992.\nNotes to Consolidated Financial Statements, Continued\nAGFI's participation in the AGRP is accounted for as if AGFI had its own plan. The following table sets forth AGFI's portion of the plans' funded status:\nDecember 31, 1994 1993 1992 (dollars in thousands) Actuarial present value of benefit obligation: Accumulated benefit obligation $31,591 $35,868 $22,400 Vested benefits (included in accumulated benefit obligation) $30,748 $35,639 $21,985\nProjected benefit obligation $38,778 $43,212 $29,278 Plan assets at fair value 50,247 49,767 44,678 Plan assets in excess of projected benefit obligation 11,469 6,555 15,400 Unrecognized prior service cost (480) (659) (821) Unrecognized net (gain) loss (2,656) 3,485 (4,320) Unrecognized net asset at January 1, net of amortization (1,528) (2,747) (3,925)\nPrepaid pension expense $ 6,805 $ 6,634 $ 6,334\nNet pension expense included the following components for the years ended December 31: 1994 1993 1992 (dollars in thousands)\nService cost $ 2,960 $ 2,375 $ 1,881 Interest on projected benefit obligation 3,084 2,791 3,687 Actual return on plan assets (237) (6,112) (5,000) Amortization of prior service costs (154) (157) (163) Amortization of unrecognized net asset existing at date of initial application (1,190) (1,190) (1,193) Deferral of net asset (loss) gain (4,179) 2,224 (631)\nTotal pension expense (income) $ 284 $ (69) $(1,419)\nAdditional assumptions concerning the determination of net pension costs is as follows: 1994 1993 1992\nWeighted average discount rate 8.50% 7.25% 8.00% Expected long-term rate of return on plan assets 10.00 10.00 10.00 Rate of increase in compensation levels 4.00 4.00 5.00\nNotes to Consolidated Financial Statements, Continued\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Company participates in American General's life, medical, supplemental major medical, and dental plans for certain retired employees. Most plans are contributory, with retiree contributions adjusted annually to limit employer contributions to predetermined amounts. For individuals retiring after December 31, 1992, the cost of the supplemental major medical plan is borne entirely by retirees. American General and its subsidiaries have reserved the right to change or eliminate these benefits at any time.\nAmerican General's life plans are fully insured. A portion of the retiree medical and dental plans are funded through a voluntary employees' beneficiary association (VEBA) established in 1994; the remainder is unfunded and self-insured. All of the retiree medical and dental plans' assets held in the VEBA were invested in readily marketable securities at the plans' most recent balance sheet date.\nAGFI's participation in the plans is accounted for as if AGFI had its own plans. The following table sets forth AGFI's portion of the plans' combined funded status and the accrued postretirement benefit cost included in other liabilities in the Company's Consolidated Balance Sheet:\nDecember 31, 1994 1993 (dollars in thousands)\nRetirees $1,847 $2,223 Fully eligible active plan participants 1,728 1,804 Other active plan participants 2,498 2,341\nAccumulated postretirement benefit obligation 6,073 6,368 Plan assets at fair value (110) -\nAccumulated postretirement benefit obligation in excess of plan assets at fair value 5,963 6,368 Unrecognized net loss (gain) 373 (226)\nAccrued postretirement benefit cost $6,336 $6,142\nNotes to Consolidated Financial Statements, Continued\nPostretirement benefit expense included the following components for the year ended December 31: 1994 1993 (dollars in thousands) Service cost-benefits attributed to service during the period $ 271 $ 184 Interest cost on accumulated postretirement benefit obligation 470 403 Actual return on plan assets (2) - Deferral of net asset gain 2 -\nPostretirement benefit expense $ 741 $ 587\nThe weighted-average discount rate used in determining the accumulated postretirement benefit obligation for the years ended December 31, 1994 and 1993 was 8.50% and 7.25%, respectively. For measurement purposes, a 12% annual rate of increase in the per capita cost of covered health care benefits was assumed in 1995; the rate was assumed to decrease gradually to 6% in 2007 and remain at that level. A 1% increase in the assumed annual rate of increase in per capita cost of health care benefits results in an immaterial increase in the accumulated postretirement benefit obligation and postretirement benefit expense.\nNote 15. Lease Commitments, Rent Expense and Contingent Liabilities\nThe approximate annual rental commitments for leased office space, automobiles and data processing and related equipment accounted for as operating leases, excluding leases on a month-to-month basis, are as follows: 1995, $24.6 million; 1996, $19.8 million; 1997, $14.7 million; 1998, $9.3 million; 1999, $5.0 million; and subsequent to 1999, $11.3 million.\nTaxes, insurance and maintenance expenses are obligations of the Company under certain leases. It is expected that, in the normal course of business, leases that expire will be renewed or replaced by leases on other properties; therefore, it is believed that future minimum annual rental commitments will not be less than the amount of rental expense incurred in 1994. Rental expense incurred for the years ended December 31, 1994, 1993, and 1992, was $32.2 million, $31.4 million, and $25.9 million, respectively.\nThe Company is a defendant in various lawsuits and proceedings arising in the normal course of business. Some of these lawsuits and proceedings arise in jurisdictions such as Alabama that permit punitive damages disproportionate to the actual damages alleged. Although 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 that there are meritorious defenses for all of these claims and is defending them vigorously. The Company also believes that the total amounts that would ultimately be paid, if any, arising from these claims would have no\nNotes to Consolidated Financial Statements, Continued\nmaterial effect on the Company's consolidated results of operations and consolidated financial position.\nNote 16. Interim Financial Information (Unaudited)\nUnaudited interim information for 1994 and 1993 is summarized below:\nTotal Revenues Three Months Ended 1994 1993 (dollars in thousands)\nMarch 31 $ 335,587 $ 310,915 June 30 360,413 322,485 September 30 386,928 328,277 December 31 408,311 327,100\nTotal $1,491,239 $1,288,777\nIncome Before Provision for Income Taxes and Cumulative Effect of Accounting Changes Three Months Ended 1994 1993 (dollars in thousands)\nMarch 31 $ 86,018 $ 77,317 June 30 98,176 89,793 September 30 101,271 86,797 December 31 106,536 82,923\nTotal $ 392,001 $ 336,830\nNet Income Three Months Ended 1994 1993 (dollars in thousands)\nMarch 31 $ 53,162 $ 35,761(a) June 30 61,145 56,391 September 30 63,580 51,642(b) December 31 67,101 51,947\nTotal $ 244,988 $ 195,741\n(a) Includes cumulative charge of $12.7 million due to adoption of accounting changes: SFAS 106, SFAS 109, and SFAS 112. Amounts previously reported in the 1993 first quarter Form 10-Q have been restated above for SFAS 112.\n(b) Includes corporate tax rate increase enacted in the third quarter, retroactive to January 1, 1993 (see Note 11.).\nNotes to Consolidated Financial Statements, Continued\nNote 17. Fair Value of Financial Instruments\nSFAS 107, \"Disclosures about Fair Value of Financial Instruments,\" requires disclosure of the fair value of financial instruments. This standard excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Care should be exercised in drawing conclusions based on fair value, since the fair values presented below do not include the value associated with all the Company's assets and liabilities.\nThe carrying values and estimated fair values of the Company's financial instruments covered by SFAS 107 are as follows:\nDecember 31, 1994 December 31, 1993 Carrying Fair Carrying Fair Value Value Value Value (dollars in thousands) Assets\nNet finance receivables, less allowance for finance receivable losses $7,694,086 $7,694,086 $6,390,232 $6,390,232 Marketable securities 702,510 702,510 699,697 699,697 Cash and cash equivalents 52,729 52,729 48,374 48,374\nLiabilities\nLong-term debt (4,312,932) (4,208,169) (4,018,797) (4,263,626) Short-term notes payable (2,771,463) (2,771,463) (1,814,961) (1,814,961) Investment certificates (6,601) (6,648) (9,406) (9,652)\nOff-Balance Sheet Financial Instruments\nUnused credit limits: Credit cards - - - - Private label - - - - Loan and other retail sales finance revolving lines of credit - - - - Interest conversion agreements - (13,407) - (29,371) Options on interest conversion agreements - - - (33,265)\nNotes to Consolidated Financial Statements, Continued\nVALUATION METHODOLOGIES AND ASSUMPTIONS\nThe following methods and assumptions were used in estimating the fair value of the Company's financial instruments.\nFinance Receivables\nFair value of net finance receivables (which approximates carrying amount less allowance for finance receivable losses) was estimated using discounted cash flows computed by category of finance receivable. Cash flows were based on contractual payment terms adjusted for delinquencies and finance receivable losses, discounted at the weighted-average interest rates currently being offered for similar finance receivables. The fair value estimate does not reflect the value of the underlying customer relationships or the related distribution system.\nMarketable Securities\nFair values for marketable securities are based on quoted market prices, where available. For marketable securities not actively traded, fair values were estimated using values obtained from independent pricing services or, in the case of private placements, by discounting expected future cash flows using a current market rate applicable to yield, credit quality, and average life of the investments.\nCash and Cash Equivalents\nThe carrying amounts reported in the Consolidated Balance Sheets for cash and cash equivalents approximate those assets' fair values.\nLong-term Debt\nThe fair values of the Company's long-term borrowings are estimated using discounted cash flows based on current borrowing rates.\nShort-term Notes Payable\nThe carrying value of short-term notes payable approximates the fair value.\nNotes to Consolidated Financial Statements, Continued\nInvestment Certificates\nFair values for fixed-rate time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on time deposits to a schedule of aggregated expected monthly maturities on time deposits. The carrying amounts for variable-rate time deposits approximate their fair values at the reporting date. The fair values for demand deposits are, by definition, equal to the amount payable on demand at the reporting date.\nUnused Customer Credit Lines\nThe unused credit lines available to the Company's customers are considered to have no fair value. The interest rates charged on these facilities can either be changed at the Company's discretion, such as for credit cards and private label, or are adjustable and reprice frequently, such as for loan and other retail sales finance revolving lines of credit. Furthermore, these amounts, in part or in total, can be cancelled at the discretion of the Company.\nInterest Conversion Agreements\nFair values for the Company's interest conversion agreements are based on estimates, obtained from the individual counterparties, of the cost or benefit of terminating the agreements.\nPART IV\nItem 14.","section_9":"","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) and (2) The following consolidated financial statements of American General Finance, Inc. and subsidiaries are included in Item 8:\nConsolidated Balance Sheets, December 31, 1994 and 1993\nConsolidated Statements of Income, years ended December 31, 1994, 1993, and 1992\nConsolidated Statements of Shareholder's Equity, years ended December 31, 1994, 1993, and 1992\nConsolidated Statements of Cash Flows, years ended December 31, 1994, 1993, and 1992\nNotes to Consolidated Financial Statements\nSchedule I--Condensed Financial Information of Registrant is included in Item 14(d).\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 inapplicable, or the information required therein is included in the consolidated financial statements or notes.\n(3) Exhibits:\nExhibits are listed in the Exhibit Index beginning on page 64 herein.\n(b) Reports on Form 8-K\nNo Current Reports on Form 8-K were filed during the last quarter of 1994.\n(c) Exhibits\nThe exhibits required to be included in this portion of Item 14. are submitted as a separate section of this report.\nItem 14(d).\nSchedule I - Condensed Financial Information of Registrant\nAmerican General Finance, Inc.\nCondensed Balance Sheets\nDecember 31, 1994 1993 Assets (dollars in thousands)\nCash $ 151 $ 217\nFinance receivables, net of unearned finance charges: Credit cards - 336,476 Retail sales finance - 250,928\nNet finance receivables - 587,404 Allowance for finance receivable losses - (26,143) Net finance receivables, less allowance for finance receivables losses - 561,261\nInvestments in subsidiaries 1,348,916 1,268,775 Notes receivable from subsidiaries 3,299 - Other assets 49,145 79,534\nTotal assets $1,401,511 $1,909,787\nLiabilities and Shareholder's Equity\nSenior long-term debt, 5.0% - 13.0%, due 1995-2000 $ 47,706 $ 53,025 Notes payable to banks 141,000 120,000 Notes payable to subsidiaries - 573,256 Other liabilities 1,065 52,806\nTotal liabilities 189,771 799,087\nShareholder's equity: Common stock 1,000 1,000 Additional paid-in capital 616,021 616,021 Other equity (18,407) 33,740 Retained earnings 613,126 459,939\nTotal shareholder's equity 1,211,740 1,110,700\nTotal liabilities and shareholder's equity $1,401,511 $1,909,787\nSee Notes to Condensed Financial Statements.\nSchedule I, Continued\nAmerican General Finance, Inc.\nCondensed Statements of Income\nYears Ended December 31, 1994 1993 1992 (dollars in thousands)\nRevenues Dividends received from subsidiaries $119,145 $152,555 $171,139 Finance charges 151,246 84,367 25,043 Interest and other 13,816 3,517 3,369\nTotal revenues 284,207 240,439 199,551\nExpenses Interest expense 83,070 40,122 22,821 Operating expenses 41,638 24,967 6,569 Provision for finance receivable losses 51,492 24,429 6,868\nTotal expenses 176,200 89,518 36,258\nIncome before income taxes, equity in undistributed net income of subsidiaries, and cumulative effect of accounting changes 108,007 150,921 163,293\nIncome Tax Credit 3,925 584 10,260\nIncome before equity in undistributed net income of subsidiaries and cumulative effect of accounting changes 111,932 151,505 173,553\nEquity in Undistributed Net Income of Subsidiaries 133,056 56,888 (11,645)\nIncome before cumulative effect of accounting changes 244,988 208,393 161,908\nCumulative Effect of Accounting Changes Parent company - 65 - Subsidiaries - (12,717) -\nNet Income $244,988 $195,741 $161,908\nSee Notes to Condensed Financial Statements.\nSchedule I, Continued\nAmerican General Finance, Inc.\nCondensed Statements of Cash Flows\nYears ended December 31, 1994 1993 1992 (dollars in thousands) Cash Flows from Operating Activities Net Income $244,988 $195,741 $161,908 Reconciling adjustments to net cash provided by operating activities: Provision for finance receivable losses 51,492 24,429 6,868 Change in dividends receivable 32,512 (11,239) 14,842 Equity in undistributed net income of subsidiaries (133,056) (44,171) 11,645 Other, net 1,107 10,616 (13,107) Net cash provided by operating activities 197,043 175,376 182,156\nCash Flows from Investing Activities Participation in finance receivables (1,246,417) (677,847) (586,151) Cash collections on participated finance receivables 548,384 487,200 161,853 Sale of participated finance receivables 1,205,945 - - Return of capital from subsidiary 7,435 - 23,537 Capital contribution to subsidiary (6,667) (4,577) (17,267) Preferred stock redemption of subsidiary - - 4,000 Other, net (3,780) (18,040) (8,604) Net cash provided by (used for) investing activities 504,900 (213,264) (422,632)\nCash Flows from Financing Activities Proceeds from issuance of long-term debt 5,664 17,320 16,043 Repayment of long-term debt (12,118) (11,448) (14,108) Change in notes receivable or payable with parent and subsidiaries (576,555) 194,585 254,733 Change in notes payable to banks 21,000 - 120,000 Common stock dividends paid (140,000) (162,600) (124,740) Preferred stock dividends paid - - (12,078) Net cash (used for) provided by financing activities (702,009) 37,857 239,850\nDecrease in cash (66) (31) (626) Cash at beginning of year 217 248 874 Cash at end of year $ 151 $ 217 $ 248\nSee Notes to Condensed Financial Statements.\nSchedule I, Continued\nAmerican General Finance, Inc.\nNotes to Condensed Financial Statements\nDecember 31, 1994\nNote 1. Accounting Policies\nIn the financial statements of the registrant, AGFI's investments in subsidiaries are stated at cost plus the equity in undistributed net income of subsidiaries since the date of the acquisition. The condensed financial statements of the registrant should be read in conjunction with AGFI's consolidated financial statements.\nNote 2. Long-Term Debt\nThe aggregate amounts of long-term senior debt maturities for the five years subsequent to December 31, 1994, are as follows: 1995, $12.6 million; 1996, $8.5 million; 1997, $11.6 million; 1998, $11.0 million; 1999, $3.8 million; and thereafter, $.2 million.\nNote 3. Participation Agreement\nOn May 1, 1992, AGFI entered into a participation agreement whereby AGFI purchased finance receivables from a subsidiary. The servicing fee expense for the participation transaction for the years ended December 31, 1994, 1993, and 1992 was $30.1 million, $18.2 million, and $5.1 million, respectively. On December 31, 1994, the participation agreement was transferred to a subsidiary of AGFI.\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, 1995.\nAMERICAN GENERAL FINANCE, INC.\nBy: \/s\/ Philip M. Hanley Philip M. Hanley (Senior 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 indicated on March 15, 1995.\n\/s\/ Daniel Leitch III \/s\/ James R. Jerwers Daniel Leitch III James R. Jerwers (Chairman and Chief Executive (Director) Officer and Director - Principal Executive Officer) \/s\/ Larry R. Klaholz Larry R. Klaholz \/s\/ Philip M. Hanley (Director) Philip M. Hanley (Senior Vice President and Chief Financial Officer and Director - \/s\/ Jon P. Newton Principal Financial Officer) Jon P. Newton (Director)\n\/s\/ George W. Schmidt George W. Schmidt \/s\/ David C. Seeley (Controller and Assistant Secretary - David C. Seeley Principal Accounting Officer) (Director)\n\/s\/ Wayne D. Baker \/s\/ James R. Tuerff Wayne D. Baker James R. Tuerff (Director) (Director)\n\/s\/ Robert M. Devlin \/s\/ Peter V. Tuters Robert M. Devlin Peter V. Tuters (Director) (Director)\n\/s\/ Bennie D. Hendrix \/s\/ Robert D. Womack Bennie D. Hendrix Robert D. Womack (Director) (Director)\n\/s\/ Harold S. Hook Harold S. Hook (Director)\nSUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE SECURITIES EXCHANGE ACT OF 1934.\nNo annual report to security-holders or proxy material has been sent to security-holders.\nExhibit Index\nExhibits Page\n(3) a. Restated Articles of Incorporation of American General Finance, Inc. (formerly Credithrift Financial, Inc.) dated May 27, 1988 and amendments thereto dated September 7, 1988 and March 20, 1989. Incorporated by reference to Exhibit (3)a filed as a part of the Company's Annual Report on Form 10-K for the year ended December 31, 1988 (File No. 1-7422).\nb. By-laws of American General Finance, Inc. Incorporated by reference to Exhibit (3)b filed as a part of the Company's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 1-7422).\n(4) a. The following instruments are filed pursuant to Item 601(b)(4)(ii) of Regulation S-K, which requires with certain exceptions that all instruments be filed which define the rights of holders of long-term debt of the Company and its consolidated subsidiaries. In the aggregate, the outstanding issuances of debt under each Indenture referred to under items (1) and (2) below exceed 10% of the total assets of the Company on a consolidated basis.\n(1) Senior Indenture dated as of February 1, 1993 from American General Finance Corporation to Citibank, N.A. Incorporated by reference to Exhibit 4(a) filed as a part of American General Finance Corporation's Registration Statement on Form S-3 (Registration No. 33-57910).\n(a) Resolutions and form of note for senior note, 6 3\/8% due March 15, 2003. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated March 4, 1993 (File No. 1-6155).\n(b) Resolutions and form of note for senior note, 5% due June 15, 1996. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated June 10, 1993 (File No. 1-6155).\n(c) Resolutions and form of note for senior note, 5 7\/8% due July 1, 2000. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated June 29, 1993 (File No. 1-6155).\n(d) Resolutions and form of note for senior note, 5.80% due April 1, 1997. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated March 22, 1994 (File No. 1-6155).\nExhibit Index, Continued\nExhibits Page\n(e) Resolutions and form of note for senior note, 6 5\/8% due June 1, 1997. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated May 17, 1994 (File No. 1-6155).\n(f) Resolutions and form of note for senior note, 6 7\/8% due July 1, 1999. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated June 8, 1994 (File No. 1-6155).\n(g) Resolutions and form of note for senior note, 7% due October 1, 1997. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated September 26, 1994 (File No. 1-6155).\n(h) Resolutions and form of note for senior note, 7.70% due November 15, 1997. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated November 10, 1994 (File No. 1-6155).\n(i) Resolutions and form of note for senior note, 8 1\/4% due January 15, 1998. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated January 6, 1995 (File No. 1-6155).\n(2) Senior Indenture dated as of November 1, 1991 from American General Finance Corporation to Citibank, N.A., as successor trustee. Incorporated by reference to Exhibit 4(a) filed as part of American General Finance Corporation's Current Report on Form 8-K dated November 6, 1991 (File No. 1-6155).\n(a) Resolutions and form of note for senior note, 7 3\/8% due November 15, 1996. Incorporated by reference to Exhibits 4(c) and 4(d) filed as part of American General Finance Corporation's Current Report on Form 8-K dated November 6, 1991 (File No. 1-6155).\n(b) Resolutions and form of note for senior note, 7.15% due May 15, 1997. Incorporated by reference to Exhibits 4(a) and 4(b) filed as part of American General Finance Corporation's Current Report on Form 8-K dated May 13, 1992 (File No. 1-6155).\nExhibit Index, Continued\nExhibits Page\n(c) Resolutions and form of note for senior note, 7.45% due July 1, 2002. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated July 2, 1992 (File No. 1-6155).\n(d) Resolutions and form of note for senior note, 5% due September 1, 1995. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated August 20, 1992 (File No. 1-6155).\n(e) Resolutions and form of note for senior note, 7 1\/8% due December 1, 1999. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated December 1, 1992 (File No. 1-6155).\n(f) Resolutions and forms of notes for (senior) Medium- Term Notes, Series C. Incorporated by reference to Exhibits 4(a), 4(b) and 4(c) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated December 10, 1992 (File No. 1-6155).\n(g) Resolutions and form of note for senior note, 6 7\/8% due January 15, 2000. Incorporated by reference to Exhibits 4(a) and 4(b) filed as a part of American General Finance Corporation's Current Report on Form 8-K dated January 11, 1993 (File No. 1-6155).\n(h) Resolutions for (senior) Medium-Term Notes, Series C. Incorporated by reference to Exhibit 4 filed as a part of American General Finance Corporation's Current Report on Form 8-K dated April 6, 1994 (File No. 1- 6155).\nb. In accordance with Item 601(b)(4)(iii) of Regulation S-K, certain other instruments defining the rights of holders of long-term debt of the Company and its subsidiaries have not been filed as exhibits to this Annual Report on Form 10-K because the total amount of securities authorized under each such instrument does not exceed 10% of the total assets of the Company on a consolidated basis. The Company hereby agrees to furnish a copy of each such instrument to the Securities and Exchange Commission upon request therefor.\n(12) Computation of ratio of earnings to fixed charges. 67\n(23) Consent of Ernst & Young LLP 68\n(27) Financial Data Schedule 69","section_15":""}
{"filename":"29917_1994.txt","cik":"29917","year":"1994","section_1":"ITEM 1. BUSINESS - - - - - -----------------\nDow Corning Corporation (Dow Corning or the Company) was incorporated in 1943 by Corning Glass Works (now Corning Incorporated) and The Dow Chemical Company (Dow Chemical) for the purpose of developing and producing polymers and other materials based on silicon chemistry. Corning Incorporated provided the basic silicone technology and Dow Chemical supplied the chemical processing and manufacturing know-how. Both companies provided initial key employees.\nDow Corning built a new business based on silicon chemistry. Silicon is one of the most abundant elements in the world. Most of the Company's products are based on polymers known as silicones which have a silicon-oxygen-silicon backbone. Through various chemical processes, the Company manufactures silicones that have an extremely wide variety of characteristics, in forms ranging from fluids, gels, greases and elastomeric materials to resins and other rigid materials. Silicones combine the temperature and chemical resistance of glass and the versatility of plastics and, regardless of form or application, generally possess such qualities as electrical resistance, resistance to extreme temperatures, resistance to deterioration from aging, water repellency, lubricating characteristics, relative chemical and physiological inertness, and resistance to ultraviolet radiation.\nThe Company currently manufactures over 8,700 products and serves approximately 50,000 customers worldwide, with no single customer accounting for more than three percent of the Company's sales in 1994.\nRaw Materials - - - - - -------------\nThe principal raw material used in the production of Dow Corning products is silicon. The Company purchases chemical grade silicon metal from producers who manufacture the silicon metal from quartz that has been reacted with carbon at high temperatures. The majority of the Company's anticipated annual requirements are satisfied by its silicon supply contracts. The Company believes that it has adequate sources of supply of silicon and believes that adequate supplies of quartz are available to the producers of silicon. The Company considers worldwide production capacity of silicon to be adequate to meet expected demand and does not expect shortages.\nDow Corning also purchases substantial quantities, and believes it has adequate sources of supply, of methanol, methyl chloride, and other raw materials required for its manufacturing operations. The raw materials that the Company uses are equally accessible to all of its competitors. Although from time to time temporary shortages of particular raw materials may exist, Dow Corning believes that adequate sources of raw materials required to maintain its operations exist. Generally, the Company maintains inventory levels of raw materials in quantities sufficient to meet its short-term production requirements.\nForeign Operations - - - - - ------------------\nThe foreign operations of Dow Corning, principally in Europe and Asia, are conducted primarily through wholly-owned subsidiaries and involve sales of substantially all Dow Corning products. These products are manufactured either domestically or by one of the Company's foreign subsidiaries. See Note 18 of Notes to Consolidated Financial Statements included in this report for financial information relating to foreign operations.\nThe Company's international operations are affected by factors normally associated with foreign operations, including exchange controls, fluctuations in currency values, local economic and labor conditions, dividend and payment restrictions, political instability and international credit or financial problems, many of which are beyond the control of the Company. While these conditions associated with foreign business involve risks different from those associated with domestic business activities, Dow Corning does not regard the overall risks of its foreign operations, on the whole, to be materially greater than those of its operations in the United States.\nCompetition - - - - - -----------\nDow Corning is a leader among the various companies that produce silicon-based products throughout the world. The Company faces substantial competition for its products both in the United States and abroad from other manufacturers of silicon-based products. In addition, many of the Company's products compete with non-silicon-based products in specific applications. The risk of product substitution is common to all Dow Corning products. The principal competitive elements in the sale of Dow Corning products are: product quality and performance, responsive customer service, new product development, cost effectiveness, and application expertise.\nResearch and Development - - - - - ------------------------\nSince its inception, Dow Corning has been engaged in a continuous program of basic and applied research on silicon-based materials to develop new products and processes, to improve and refine existing products and processes, and to develop new applications for existing products. The Company also provides a wide variety of technical services to its customers. Research and development expenditures totalled (in millions of dollars) $174.0 in 1994, $163.9 in 1993, and $161.2 in 1992.\nThe Company operates research and development facilities located in the United States, Belgium, Japan, and the United Kingdom. The Company also operates technical service centers in the United States, Australia, Belgium, Brazil, France, Germany, Japan, South Korea, Taiwan, and the United Kingdom.\nPatents and Licenses - - - - - --------------------\nDow Corning regularly applies for United States and foreign patents and owns, directly or indirectly, a substantial number of such patents. The Company is a licensor under a number of patent licenses and technology agreements. While Dow Corning considers its patents and licenses to be valuable assets, it does not regard its business as being materially dependent on any single patent or license or any group of related patents or licenses.\nProtection of the Environment - - - - - -----------------------------\nDow Corning has set a goal to reduce its toxic releases within the United States by 75% in the year 2000 compared to 1987. This goal extends beyond voluntary commitments made by the Company under two programs with the U.S. Environmental Protection Agency - the 33\/50 Voluntary Reduction Program under which the Company has committed to reductions of all of its toxic chemical releases, and the Clean Air Act Early Reduction Credit Program under which the Company has committed to major reductions in methyl chloride releases at its largest U.S. manufacturing facilities. As of December 31, 1994, the Company has met all voluntary commitments under the 33\/50 Voluntary Reduction Program and the Clean Air Act Early Reduction Program. As a member of the Chemical Manufacturers Association, the Company is also committed to and is implementing the Codes of Management Practices specified in the Chemical Manufacturers Association's Responsible Care(R) program, a continuing chemical industry effort to improve the management of chemicals. Responsible Care(R) is a trademark of the Chemical Manufacturers Association.\nDow Corning expends funds consistent with its commitments to reduce the discharge of materials into the environment. The Company expects that its pollution control related expenditures will be partially offset through the recovery of raw materials in the pollution control process. The Company believes that these expenditures should not materially affect Dow Corning's earnings or competitive position.\nThe Company records a charge to earnings for environmental matters when it is probable that a liability has been incurred and the Company's costs can be reasonably estimated. For information concerning environmental liabilities, see Note 2 of Notes to Consolidated Financial Statements.\nEmployees - - - - - ---------\nDow Corning's average employment for 1994 was 8,300 persons.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES - - - - - -------------------\nDow Corning owns or leases extensive property for use in its business and believes that its properties are in good operating condition and are generally suited for the purposes for which they are presently being used.\nPrincipal United States production plants are located in Kentucky, Michigan and North Carolina. Principal foreign manufacturing plants are located in Belgium, Germany, Japan and the United Kingdom. Dow Corning owns substantially all of its manufacturing facilities. Approximately 63% of Dow Corning's aggregate investment in plant and equipment is represented by its United States facilities.\nDow Corning owns its executive and corporate offices, which are located near Midland, Michigan, and certain foreign offices. The Company also owns research and development facilities in the United States, Belgium, Japan, and the United Kingdom. Domestic and foreign sales offices are primarily in leased facilities. For information concerning lease commitments, see Note 17 of Notes to Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS - - - - - --------------------------\nENVIRONMENTAL MATTERS\nThe Company has agreed to participate in the Toxic Substances Control Act Section 8(e) compliance audit program. The Company expects to pay a civil penalty which will exceed $100,000. While the exact amount of the civil penalty is not yet known, the United States Environmental Protection Agency (EPA) has put a limit of $1 million on any civil penalty to be paid.\nBREAST IMPLANT LITIGATION\nBreast Implant Products Liability Class Action Lawsuits - - - - - -------------------------------------------------------\nAs of December 31, 1994, the Company had been named, generally as one of several defendants, in 45 breast implant products liability class action lawsuits filed on behalf of individuals who claim to have or have had silicone gel breast implants. Of these lawsuits, 31 have been brought in various Federal District Courts, 12 have been brought in various state courts, and 2 have been brought in courts in Canada.\nAmong the Federal District Court class action lawsuits, 27 were filed in 1992, 3 were filed in 1993, and 1 was filed in the first quarter of 1994. These cases have been filed in the Federal District Courts for the Northern District of Alabama, the District of Arizona, the Northern District of California (3 cases), the Central District of California, the Southern District of California, the District of Hawaii, the Northern District of Illinois, the Eastern District of Kentucky, the Northern District of Louisiana, the Eastern District of Michigan, the District of Minnesota (2 cases), the Eastern District of New York (2 cases), the Northern District of Ohio (3 cases), the Southern District of Ohio (7 cases), the Eastern District of Pennsylvania, the Western District of Pennsylvania (2 cases), the District of Utah and the Eastern District of Virginia. In the class action case filed in the Federal District Court for the Eastern District of Virginia, all proceedings have been stayed and class certification has been denied. All of these federal breast implant products liability class action lawsuits have been transferred to the Federal District Court for the Northern District of Alabama for discovery purposes (see \"Consolidation of Breast Implant Products Liability Lawsuits\" below).\nIn one of the federal class actions filed in the Southern District of Ohio (later transferred to the Northern District of Alabama), a class action was conditionally certified on behalf of all breast implant recipients in the United States and their spouses. In a case filed in the first quarter of 1994 in the Northern District of Alabama, the Judge has certified a non-mandatory worldwide class action and has given approval to a proposed class action settlement involving certain manufacturers (including the Company) of breast implants and suppliers (see \"Settlement to Resolve Breast Implant Claims\" below). In the class action filed in the District of Utah, a class certification motion has been denied. In the class action filed in the Eastern District of Michigan, that Court was asked to certify a class action on behalf of breast implant recipients residing outside the United States; this motion was denied, but class certification may be sought again in the future.\nAmong the 12 class action lawsuits brought in various state courts, 9 were filed in 1992 and 3 were filed in the first quarter of 1994. These cases have been filed in the following state courts: the Dade County, Florida Eleventh Judicial Circuit Court; the District Court for the Third Judicial District of Utah; the Philadelphia County, Pennsylvania Court of Common Pleas; the Dauphin County, Pennsylvania Court of Common Pleas; the Cook County, Illinois Circuit Court (2 cases); the Marion County, Indiana Superior Court; the Civil District Court for the Parish of Orleans, Louisiana; the District Court for Douglas County, Nebraska; the Second Judicial District Court for the County of Bernalillo, New Mexico; and the Circuit\nCourt for Multnomah County, Oregon (2 cases). In 6 of these cases (the 2 cases in the Cook County, Illinois Circuit Court, the case in the District Court for the Third Judicial District of Utah, the cases in the Philadelphia County and the Dauphin County, Pennsylvania Courts of Common Pleas, and the case in the Second Judicial District Court for the County of Bernalillo, New Mexico), either the class action claims have been dismissed or class certification has been denied. The case filed in Douglas County, Nebraska, and one of the cases filed in Multnomah County, Oregon, were removed from state to federal court and were then transferred to the Federal District Court for the Northern District of Alabama; the class action claims in the Douglas County, Nebraska case have been withdrawn. In the case filed in the Civil District Court for the Parish of Orleans, Louisiana, that Court certified a class of women with silicone breast implants who either reside in or received their implants in the State of Louisiana; this order certifying a class action has been upheld on appeal. State class action cases in Florida, Indiana, Louisiana and Oregon remain pending, with only the Louisiana case having been certified as a class action.\nA class action was filed in Ontario, Canada during 1993 against Dow Corning Canada, Inc., a wholly-owned subsidiary of the Company. The Judge has entered an order certifying a class of breast implant recipients in the Province of Ontario, Canada; the Ontario Court of Appeals has declined to hear an appeal from this class certification order. In 1993, a petition was filed in Montreal, Canada seeking authorization to institute a class action on behalf of a class of breast implant recipients in the Province of Quebec, Canada, against Dow Corning Corporation and Dow Corning Canada, Inc. The court has authorized this class action.\nThe typical alleged factual bases for these lawsuits include allegations that the plaintiffs' breast implants caused specified ailments, including, among other things, autoimmune disease, scleroderma, systemic disorders, joint swelling and chronic fatigue. The Company is sometimes named as the manufacturer of silicone gel breast implants, and other times the Company is named as the supplier of silicone raw materials to other breast implant manufacturers.\nPlaintiffs in these cases typically seek relief in the form of monetary damages, often in unspecified amounts, and have also asked for certain types of equitable relief such as requiring the Company to fund the removal of the breast implants of the class members, to fund medical research into any ailments caused by silicone gel breast implants and to fund periodic medical checkups for the class members. The federal class action in the Federal District Court for the Eastern District of Pennsylvania claims monetary damages of more than $75,000 for each plaintiff. One of the federal class actions in the Federal District Court for the Southern District of Ohio claims monetary damages of more than $50,000 for each plaintiff. One of the federal class actions in the Federal District Court for the District of Minnesota claims an unspecified amount of monetary damages, but claims more than $50,000 for each plaintiff on fraud claims. The federal class action in the Federal District Court for the Southern District of California claims more than $50,000 for each plaintiff. One of the federal class actions in the Federal District Court for the Western District of Pennsylvania claims damages of $50,000 compensatory and $50,000 punitive for each plaintiff. Each other federal class action specifies monetary damages in an unspecified amount except that they claim the minimal jurisdictional amount. The state class action in the Dade County, Florida Eleventh Judicial Circuit Court claims $500 million in punitive damages and unspecified compensatory damages for the class. Each other state class action specifies monetary damages in an unspecified amount except that they claim the minimal jurisdictional amounts. The class action in Ontario, Canada claims $80,000 in monetary damages for each named plaintiff and unspecified monetary damages for other members of the class.\nMonetary damages claimed in these cases in the aggregate are substantial; however, the Company does not consider the monetary damages claimed to be a realistic measure of the Company's ultimate resolution costs.\nIndividual Breast Implant Products Liability Lawsuits - - - - - -----------------------------------------------------\nAs of December 31, 1994, the Company has been named, often along with other defendants, in approximately 19,000 individual breast implant products liability lawsuits filed in federal courts and state courts in many different jurisdictions; many of these cases involve multiple plaintiffs. The typical alleged factual bases for these lawsuits include allegations that the plaintiffs' breast implants caused specified ailments, including, among others, autoimmune disease, scleroderma, systemic disorders, joint swelling and chronic fatigue. The Company is sometimes named as the manufacturer of silicone gel breast implants, and other times the Company is named as the supplier of silicone raw materials to other breast implant manufacturers.\nPlaintiffs in these cases typically seek relief in the form of monetary damages, often in unspecified amounts. In those individual breast implant cases where management is aware that monetary damages are specified, the amount of monetary damages alleged ranges from approximately $100,000 to approximately $140 million. Also, many of these cases only specify as monetary damages an amount in excess of the jurisdictional minimum for the courts in which such cases are filed. Monetary damages claimed in these cases in the aggregate may be substantial; however, the Company does not consider the monetary damages claimed to be a realistic measure of the Company's ultimate resolution costs.\nConsolidation of Breast Implant Products Liability Lawsuits - - - - - -----------------------------------------------------------\nMany of these breast implant products liability cases have been or are in the process of being consolidated for purposes of case management in federal and state courts. As previously reported, on June 25, 1992, the Judicial Panel on Multidistrict Litigation in \"In Re Silicone Gel Breast Implants Products Liability Litigation\" consolidated all federal breast implant cases for discovery purposes in the Federal District Court for the Northern District of Alabama (the \"Court\") under the multidistrict litigation rules \"in order to avoid duplication of discovery, prevent inconsistent pretrial rulings, and preserve the resources of the parties, their counsel and the judiciary.\" Substantially all federal breast implant cases have been consolidated in the Federal District Court for the Northern District of Alabama. A substantial number of breast implant cases originally filed in state courts have been removed to federal court and either have been or are likely to be similarly consolidated. The Company anticipates that any federal breast implant products liability cases filed after June 25, 1992, as well as some state breast implant cases removed to federal courts, will be transferred to the Federal District Court for the Northern District of Alabama for discovery purposes under the multidistrict litigation rules. In addition, the consolidation of many state breast implant products liability cases has proceeded in many jurisdictions where a substantial number of state breast implant lawsuits have been filed; however, this consolidation of state cases has not occurred in all jurisdictions. As of December 31, 1994, substantially more than half of all breast implant cases were consolidated for pretrial purposes at the federal and state levels. The Company views these case consolidation measures as positive steps toward the management of these various lawsuits and anticipates that breast implant lawsuit consolidations will result in a reduction of litigation defense costs. For more information on these matters, see Note 2 of Notes to Consolidated Financial Statements.\nSettlement to Resolve Breast Implant Claims - - - - - -------------------------------------------\nOn September 9, 1993, the Company announced that representatives of plaintiffs and defendants involved with silicone breast implant litigation had developed a \"Statement of Principles for Global Resolution of Breast Implant Claims\" (the \"Statement of Principles\"). The Statement of Principles summarizes a proposed claims based structured resolution of claims arising out of breast implants which have been or could be asserted against various implant manufacturers, suppliers, physicians and hospitals. The Company negotiated with other potential parties to reach a Breast Implant Litigation Settlement Agreement similar in concept to the Statement of Principles.\nOn March 23, 1994, the Company, along with other defendants and representatives of breast implant litigation plaintiffs, entered into a settlement pursuant to a Breast Implant Litigation Settlement Agreement (as amended by the Court, the \"Settlement Agreement\"). The Company's participation in this Settlement Agreement was approved by the Company's Board of Directors on March 28, 1994. Under the Settlement Agreement, industry participants (the \"Funding Participants\") agreed to contribute up to approximately $4.2 billion over a period of more than thirty years to establish several special purpose funds. A related funding agreement (the \"Funding Agreement\") specifies the amount that each Funding Participant would contribute to the settlement fund and the timing of those contributions. The Settlement Agreement provides for a claims based structured resolution of claims arising out of silicone breast implants and defines the circumstances under which payments from the funds would be made. The Settlement Agreement includes provisions for (a) class membership and the ability of plaintiffs to opt out of the class, (b) the establishment of defined funds for medical diagnostic\/evaluation procedures, explantation, ruptures, compensation for specific diseases and administration, (c) payment terms and timing and (d) claims administration.\nThe settlement covers claims of most breast implant recipients, and related claims, brought in the courts of U.S. federal and state jurisdictions. The settlement also covers the claims of breast implant recipients brought in jurisdictions outside of the U.S. if payments received by those potential claimants from the settlement fund, and related releases, serve to preclude them from bringing legal actions in these other jurisdictions. The settlement does not cover claims of breast implant recipients who have affirmatively chosen not to participate in the Settlement Agreement, or whom the Court has specifically excluded from the Settlement Agreement unless these potential claimants affirmatively join the settlement. Breast implant recipients who reside in Ontario or Quebec, Canada, or in Australia have been specifically excluded by the Court. The Settlement Agreement defines various periods during which, upon the occurrence of certain events, breast implant plaintiffs may elect not to settle their claims by way of the Settlement Agreement and pursue their individual breast implant litigation against manufacturers and other defendants (the \"Opt Out Plaintiffs\"). The Settlement Agreement also provides the children of breast implant recipients with the right to opt out of the settlement in certain circumstances. Under the terms of the Settlement Agreement, in certain circumstances, if any defendant who is a Funding Participant considers the number of Opt Out Plaintiffs to be excessive, such defendant may decide to exercise the option to withdraw from participation in the settlement during a number of periods specified in the Settlement Agreement.\nOn April 1, 1994, the Court preliminarily approved the Settlement Agreement. On April 18, 1994, the Court issued notice of the Settlement Agreement to breast implant recipients and others who may be eligible to participate in the settlement (\"Settlement Class Members\"). This notice began a 60-day period, ending June 17, 1994, during which Settlement Class Members had the ability to become initial Opt Out Plaintiffs. This period was extended to July 1, 1994 with respect to certain Settlement Class Members whose Court issued notice was delayed. The Court has afforded initial Opt Out Plaintiffs an opportunity to rejoin the settlement within specified periods which currently end no later than March 1, 1995. A Court hearing to review the fairness of the Settlement Agreement was completed on August 22, 1994. On September 1, 1994, the Court granted final approval to the Settlement Agreement, determining that it is fair, reasonable and adequate, and on September 8, 1994, the Company's Board of Directors approved the Company's continued participation in the Settlement Agreement.\nThe Court's final approval of the Settlement Agreement has been appealed to the U.S. Court of Appeals for the Eleventh Circuit primarily by certain providers of health care indemnity payments or services and by certain foreign claimants.\nThe Settlement Agreement provides that industry participants will contribute a total of $4.2 billion, of which the Company is obligated to contribute up to approximately $2.02 billion, over a period of more than 30 years. The Company's required contributions under the Settlement Agreement cannot be changed without the Company's consent. Under the terms of the Funding Agreement, the Company has made or anticipates making settlement payments in accordance with the following schedule:\n1994 $ 42.50 million 1995 275.00 million 1997 275.00 million 1998 275.00 million 1999 through 2011 51.17 million per year 2012 through 2019 38.38 million per year 2020 through 2026 25.57 million per year\nThe Company's first payment of $275 million under the Funding Agreement is due upon the earlier of (a) a resolution of these appeals which confirms the Court's final approval of the Settlement Agreement or (b) the completion of a second opt out process or the determination that there will be no second opt out process (as described below). The Company has placed $275 million into an escrow account and is required, among other things, to provide a letter of credit in the amount of $275 million to provide financial assurance to the Court of the Company's ability to meet its obligations under the Settlement Agreement. After the third payment of $275 million, the amount of the letter of credit will be reduced to $51.2 million or may be eliminated by order of the Court. The Company is engaged in discussions with certain financial institutions to provide this letter of credit.\nInitial claims for specific disease compensation were required to be filed with the Court in September 1994. After these claims and the supporting medical records have been evaluated by the Court for validity, eligibility, accuracy, and consistency, the Court will determine whether the disease compensation settlement fund is sufficient to pay validated claims. If the disease compensation settlement fund is not sufficient to pay validated claims, and if such insufficiency cannot be resolved through other means, claimants with validated claims may have the ability to opt out during another period as specified in the Settlement Agreement. If any defendant who is a Funding Participant considers the number of new Opt Out Plaintiffs against said defendant to be excessive, such defendant may decide to exercise a second option to withdraw from participation in the settlement.\nSince July 1, 1994, many former Opt Out Plaintiffs have rejoined the settlement. Based on preliminary information received from the Court as of December 1994, approximately 5,000 of the initial U.S. Opt Out Plaintiffs and approximately 2,000 potential foreign claimants (including initial foreign Opt Out Plaintiffs and foreign claimants excluded from the settlement class) have identified the Company as potentially responsible, in whole or in part, with respect to their current or potential future claims. The Court is continuing to collect information relating to the number of Opt Out Plaintiffs and as information is received from the Court the Company will continue to evaluate the nature and scope of its potential exposure with respect to the current or potential future claims of these Opt Out Plaintiffs. Opt Out Plaintiffs may continue to rejoin the settlement until the March 1, 1995 date established by the Court.\nThe Settlement Agreement is in the process of being implemented. The settlement implementation process can be affected by external factors as described above such as the resolution of pending appeals and the number and magnitude of claims filed in the settlement. However, based on its analysis of the most current information, including assessments by knowledgeable third parties who have been directly involved in the negotiation and implementation of the Settlement Agreement, management believes that the aggregate amount of the Company's obligation and the amount and timing of the related cash payments under the Settlement Agreement are reliably determinable. Management also believes that events will not occur which would lead to the Company's withdrawal from the settlement and that the Settlement Agreement will be implemented in the state currently envisioned.\nOTHER LITIGATION\nDue to the nature of its business as a supplier of specialty materials to a variety of industries, the Company, at any particular time, is a defendant in a number of products liability lawsuits for injury allegedly related to the Company's products, and, in certain instances, products manufactured by others. Many of these lawsuits seek damages in substantial amounts. For example, the Company has been named in products liability lawsuits pertaining to materials previously used in connection with temporo-mandibular joint implant applications. The Company has followed a practice of aggressively defending all product liability claims asserted against it. Although the Company intends to continue this practice, currently pending proceedings and any future claims are subject to the uncertainties attendant to litigation and the ultimate outcome of any such proceedings or claims cannot be predicted with certainty. Nonetheless, the Company believes that these products liability claims will not have a material adverse effect on the Company's results of operations or financial condition.\nSECURITIES LAWS AND SHAREHOLDER DERIVATIVE LAWSUITS\nSecurities Laws Class Action Lawsuits - - - - - -------------------------------------\nAs of December 31, 1994, the Company and certain of its directors and officers were named, as defendants with others, in two securities laws class action lawsuits filed by purchasers of stock of Corning Incorporated (Corning) and The Dow Chemical Company (Dow Chemical). These cases were originally filed as several separate cases in the Federal District Court for the Southern District of New York in the first quarter of 1992; these cases were consolidated in the second quarter of 1992 so that there is one case involving claims on behalf of purchasers of stock of Corning and one case involving claims on behalf of purchasers of stock of Dow Chemical. The plaintiffs in these cases allege, among other things, misrepresentations and omissions of material facts and breach of duty with respect to purchasers of stock of Corning and Dow Chemical relative to the breast implant issue. The relief sought in these cases is monetary damages in unspecified amounts. Motions to dismiss both cases have been filed by all defendants.\nShareholder Derivative Lawsuits - - - - - -------------------------------\nAs of December 31, 1994, the Company and\/or certain of its directors and officers were named in three shareholder derivative lawsuits filed by shareholders of Corning and Dow Chemical. The plaintiffs in these cases allege various breaches of fiduciary duties claimed to be owed by the defendants relative to the breast implant issue. The relief sought by the shareholders filing these suits on behalf of Dow Chemical and Corning is monetary damages in unspecified amounts. Motions to dismiss these cases have been filed by all defendants.\nGRAND JURY INVESTIGATION\nOn February 8, 1993, the Company received two federal grand jury subpoenas initiated by the Assistant U.S. Attorney in Baltimore, Maryland seeking documents and information related to silicone breast implants. The Company has provided information in response to the subpoenas and continues to cooperate with the Assistant U.S. Attorney as this grand jury investigation proceeds.\nLAWSUIT AGAINST INSURANCE CARRIERS\nOn June 30, 1993, the Company filed a complaint, which was subsequently amended, in the Superior Court of California against 99 insurance companies which issued occurrence based products liability insurance policies to the Company from 1962 through 1985 (\"Insurers\"). The complaint also names as defendants three state insurance guaranty funds. This action (the \"California Action\") resulted from an inability of some of the Insurers to reach an agreement with the Company on a formula for the allocation among the Insurers of payments of defense and indemnity expenses submitted by the Company related to breast implant products liability lawsuits and claims (\"Insurance Allocation Agreement\"). The California Action was filed to seek, among other things, a judicial enforcement of the obligations of the Insurers under the relevant insurance policies.\nOn September 10, 1993, several of the Company's insurers filed a complaint against the Company and other insurers for declaratory relief in Wayne County Michigan Circuit Court (the \"Michigan Action\"). This complaint named additional insurers, particularly the insurers that provided coverage on a claims-made basis subsequent to 1985, and raised issues similar to those described above for determination by the courts.\nOn September 13, 1993, plaintiff insurers in the Michigan Action brought a motion in the California Action for the California Action to be stayed or dismissed in favor of the Michigan Action on the grounds of inconvenient forum. On October 1, 1993, the California Court dismissed the California Action on the grounds of inconvenient forum. In light of this ruling, the Company has elected to litigate the coverage issues on breast implant products liability lawsuits and claims in the Michigan Action.\nOn March 11, 1994, the court in the Michigan Action ruled that certain of the Company's primary insurers have a duty to defend the Company with respect to breast implant products liability lawsuits. These insurers were also directed to reimburse the Company for certain defense costs previously incurred. On November 16, 1994, the court further ruled in favor of the Company on allocation of defense costs. The court ruled that each primary occurrence insurer is obligated to pay the defense costs for all cases alleging a date of implant either before or during the insurers' policy period and for all cases involving unknown implant dates.\nNotwithstanding this litigation, the Company is continuing its negotiations with the Insurers to obtain an Insurance Allocation Agreement as described above.\nSECURITIES AND EXCHANGE COMMISSION INFORMAL INVESTIGATION\nThe Company received a request, dated July 9, 1993, from the Boston Regional Office of the Securities and Exchange Commission for certain documents and information related to silicone breast implants. The request stated that an informal investigation of the Company and its equity owners is being conducted by the Boston Regional Office. On July 30, 1993, the Company responded to this request enclosing the documents and information requested along with related information. The Company will continue to cooperate with the Boston Regional Office.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - - - - - ------------------------------------------------------------\nItem omitted in accordance with provisions of General Instruction J of Form 10-K.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS - - - - - ---------------------------------------------------------------------\nThe Company's common stock is owned in equal portions by Corning Incorporated and Dow Holdings Inc., a wholly-owned subsidiary of The Dow Chemical Company. None of the Company's common stock has been sold or traded since the Company's inception in 1943.\nThe Company did not pay dividends in 1994 or 1993.\nUnder the provisions of the Revolving Credit Agreement (which is described in Note 10 of Notes to Consolidated Financial Statements), the Company is subject to certain restrictions as to the payment of dividends or distribution of assets for other specified purposes. The amount of the restriction is based on a formula which considers, among other things, the income before income taxes for the most recent fiscal year. Based on the computation completed for the year ended December 31, 1994, the Company is restricted from issuing dividends or distributing assets for other specified purposes in excess of $71.9 million in 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA - - - - - --------------------------------\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S NARRATIVE ANALYSIS - - - - - ----------------------------------------\n(all amounts in millions of dollars)\nResults of Operations - - - - - ---------------------\n1994 Compared to 1993 ---------------------\n1994 net sales increased $160.9 or 7.9% over levels reported for 1993. The increase is principally attributable to higher sales volumes in the United States and Europe and favorable currency effects in Asia and Europe. The increase was offset slightly by lower selling prices.\nManufacturing cost of sales, as a percent of net sales, was 66.7% in 1994 compared to 68.7% in 1993. This decrease is due to lower personnel and depreciation costs.\nMarketing and administrative expenses, as a percent of net sales, were 18.8% in 1994 compared to 19.8% in 1993. This decrease is principally due to lower personnel costs.\nImplant costs of $241.0 in 1994 and $640.0 in 1993 represent provisions for costs associated with breast implant litigation, claims and related matters, as further described in Note 2 of Notes to Consolidated Financial Statements. These costs were reported separately to better identify the Company's profitability from ongoing operations and the financial impact resulting from breast implant litigation.\nOperating income for 1994 was $77.9 compared to an operating loss of $404.1 in 1993. Operating results in both years have been negatively impacted by breast implant related charges as described above.\nInterest expense was $70.3 in 1994 compared to $33.3 in 1993. This increase is principally attributable to the recognition in 1994 of $28.3 in imputed interest on the net discounted implant liability (as further discussed in Note 2 of Notes to Consolidated Financial Statements) and higher average levels of debt.\nImplant costs of $241.0 in 1994 and $640.0 in 1993 were offset by related tax benefits of $89.2 in 1994 and $225.0 in 1993. Excluding the impact of these charges and the related tax benefits, the effective tax rate was 38.0% in 1994 compared to 34.0% in 1993. The higher effective rate in 1994 is due to lower anticipated foreign tax credits.\n1993 Compared to 1992 ---------------------\n1993 net sales increased $88.0 or 4.5% over levels reported for 1992. The increase for 1993 was principally attributable to higher sales volumes, particularly in Asia, offset slightly by lower selling prices, and unfavorable currency effects in Europe.\nManufacturing cost of sales, as a percent of net sales, was relatively unchanged for 1993 as compared to 1992.\nMarketing and administrative expenses, as a percent of net sales, were 19.8% in 1993 compared to 21.0% in 1992. This decrease is attributable to lower freight costs, commissions and allowances.\nImplant costs of $640.0 in 1993 and $69.0 in 1992 represent provisions for costs associated with breast implant litigation, claims and related matters, as further described in Note 2 of Notes to Consolidated Financial Statements. These costs were reported separately to better identify the Company's profitability from ongoing operations and the financial impact resulting from breast implant litigation.\nSpecial items of $40.0 in 1992 relate to provisions for restructuring activities, consisting largely of costs associated with the cessation of manufacturing activities at a subsidiary in Brazil and costs involved in global expense reduction, including elimination of low-priority activities, redeployment of people and reduction in the value of affected facilities.\nThe Company incurred an operating loss in 1993 of $404.1, compared to operating income of $93.1 in 1992. Operating results in both years have been negatively impacted by breast implant related charges of $640.0 in 1993 and $69.0 in 1992. Operating results were also negatively impacted in 1992 due to special items of $40.0 described above.\nOther income was $15.4 in 1993 compared to other expense of $20.6 in 1992. As a result of the turmoil in European financial markets in September 1992, the Company incurred losses in 1992 related to positions taken in several financial instruments. These losses were generated as the market values of these instruments were sensitive to movements in cross-currency exchange rates and interest rates in certain foreign markets. During September 1992, the Company offset these positions and reduced its exposure to the effects of further instability in the European markets.\nImplant costs of $640.0 described above were offset by a related tax benefit of $225.0. Excluding the impact of this charge and the related tax benefit, the effective tax rate was 34.0% in 1993 compared to 20.2% in 1992. The higher effective rate in 1993 is due to lower foreign tax credits.\nDuring 1992, the Company adopted Statements of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, and No. 109, Accounting for Income Taxes. The impact of these changes, as further explained in Notes 13 and 15 of Notes to Consolidated Financial Statements, reduced 1992 net income by $111.9, $100.4 of which represented the cumulative effect of these changes for years prior to 1992.\nCredit Availability - - - - - -------------------\nDuring 1993, the Company terminated a revolving credit agreement which was in place at December 31, 1992, and replaced it with a revolving credit agreement with 16 domestic and foreign banks which provides for borrowings on a revolving credit basis until November, 1997 of up to $400.0. At December 31, 1994, there was $375.0 outstanding under this facility. Availability of credit under this facility may be affected by certain debt restrictions and provisions as described below and in Note 10 of Notes to Consolidated Financial Statements.\nAdditionally, the Company has agreements in place whereby it may sell on an ongoing basis fractional ownership interests in a designated pool of U.S. trade receivables, with limited recourse, in amounts up to $65.0. As of December 31, 1994, the Company had $32.0 outstanding under these agreements. For information concerning receivables sold, see Note 6 of Notes to Consolidated Financial Statements.\nDuring 1994, the Company obtained long-term financing totaling $66.4 ($6.4 of which is denominated in foreign currencies) bearing interest at rates ranging from 5.9% to 6.7% at December 31, 1994 and with maturities ranging from two to three years.\nManagement believes that the Company will generate the financial liquidity required to meet ongoing operational needs, to meet its obligations under the Settlement Agreement, and to resolve breast implant claims not covered by the Settlement Agreement. This belief is based on, among other things, management's estimate of future operational cash flows, its estimate of the cost to resolve breast implant litigation, its assessment that recovery of substantial amounts from the Company's insurance carriers on a timely basis is probable, and its evaluation of current and anticipated future financing arrangements.\nManagement's evaluation of current financing arrangements has considered the fact that the Company's existing Revolving Credit Agreement provides participating banks the right, subject to a vote of a majority in interest, to demand repayment of amounts outstanding prior to maturity in the event that breast implant litigation expenditures, net of insurance recoveries, exceed certain limits.\nAdditional facts and circumstances may develop which could result in a material and adverse effect on the Company's liquidity. In an effort to provide the Company with additional financial flexibility, should such facts and circumstances develop, the Company is currently evaluating alternative financing arrangements. However, there can be no assurance that these alternative financing arrangements will be concluded successfully.\nInflation - - - - - ---------\nThe impact of inflation on the Company's financial position and results of operations has been minimal. The Company expects that future impacts of inflation will be offset by increased prices and productivity gains.\nContingencies - - - - - -------------\nFor information regarding contingencies, including a discussion of breast implant litigation and the Company's environmental liabilities, see Note 2 of Notes to Consolidated Financial Statements.\nManagement Changes - - - - - ------------------\nOn September 16, 1994, Keith R. McKennon, formerly Chairman of the Board, retired from the Board of Directors and was named Director Emeritus. Richard A. Hazleton, formerly President and Chief Executive Officer, was elected Chairman of the Board and will continue as Chief Executive Officer. Gary E. Anderson, formerly Executive Vice President, was elected President.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - - - - - ----------------------------------------------------\nSee the \"Index to Financial Statements\" included in this report, as well as the \"Report of Independent Accountants.\"\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 omitted in accordance with provisions of General Instruction J of Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION - - - - - --------------------------------\nItem omitted in accordance with provisions of General Instruction J of Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - - - - - ------------------------------------------------------------------------\nItem omitted in accordance with provisions of General Instruction J of Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - - - - - --------------------------------------------------------\nItem omitted in accordance with provisions of General Instruction J of Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K - - - - - --------------------------------------------------------------------------\nDocuments filed as part of Form 10-K for the year ended December 31, 1994 are as follows:\n(a) Financial Statements and Financial Statement Schedules:\nSee the \"Index to Financial Statements\" included in this report, as well as the \"Report of Independent Accountants.\"\n(b) Reports on Form 8-K:\nA report on Form 8-K dated January 20, 1995, was filed in connection with a special charge to reflect the Company's best estimate of the costs of resolving breast implant litigation and related matters.\n(c) Exhibits:\nSee the \"Exhibit Index\" which is located on page 50.\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.\nDOW CORNING CORPORATION\nDate January 31, 1995 By R. A. Hazleton ---------------- --------------------------------------- R. A. Hazleton Chairman and Chief Executive Officer\nDate January 31, 1995 By J. W. Churchfield ---------------- --------------------------------------- J. W. Churchfield Vice President for Planning and Finance and Chief Financial Officer\nDate January 31, 1995 By G. P. Callaghan ---------------- --------------------------------------- G. P. Callaghan Corporate Controller\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons (a majority of the Board of Directors) on behalf of the registrant and in the capacities and on the dates indicated.\nDate January 31, 1995 By G. E. Anderson ---------------- --------------------------------------- G. E. Anderson Director, Dow Corning Corporation\nDate January 31, 1995 By V. C. Campbell ---------------- --------------------------------------- V. C. Campbell Director, Dow Corning Corporation\nDate January 31, 1995 By E. C. Falla ---------------- --------------------------------------- E. C. Falla Director, Dow Corning Corporation\nDate January 31, 1995 By R. A. Hazleton ---------------- --------------------------------------- R. A. Hazleton Director, Dow Corning Corporation\nDate January 31, 1995 By J. R. Houghton ---------------- --------------------------------------- J. R. Houghton Director, Dow Corning Corporation\nDate January 31, 1995 By F. P. Popoff ---------------- --------------------------------------- F. P. Popoff Director, Dow Corning Corporation\nDate January 31, 1995 By L. A. Reed ---------------- --------------------------------------- L. A. Reed Director, Dow Corning Corporation\nDate January 31, 1995 By D. R. Weyenberg ---------------- --------------------------------------- D. R. Weyenberg Director, Dow Corning Corporation\nSTATEMENT OF MANAGEMENT RESPONSIBILITY FOR ------------------------------------------\nFINANCIAL STATEMENTS --------------------\nThe management of Dow Corning Corporation is responsible for the preparation, presentation and integrity of the consolidated financial statements and other information included in this annual report on Form 10-K. The financial statements have been prepared in conformity with generally accepted accounting principles appropriate in the circumstances and necessarily include amounts based on management's best estimates and judgments.\nIn meeting its responsibility for the reliability of these financial statements, Dow Corning maintains comprehensive systems of internal accounting control. These systems are designed to provide reasonable assurance at reasonable cost that corporate assets are protected against loss or unauthorized use and that transactions and events are properly recorded. Such systems are reinforced by written policies, selection and training of competent financial personnel, appropriate division of responsibilities and a program of internal audits.\nThe financial statements have been audited by our independent accountants, Price Waterhouse LLP. Their responsibility is to express an independent professional opinion with respect to the consolidated financial statements on the basis of an audit conducted in accordance with generally accepted auditing standards. In addition to the audit performed by the independent accountants, Dow Corning maintains a professional staff of internal auditors whose audit coverage is coordinated with that of the independent accountants.\nThe Board of Directors, through its Audit Committee, is responsible for reviewing and monitoring Dow Corning's financial reporting and accounting practices and recommending annually the appointment of the independent accountants. The Committee, composed of non-management directors, meets periodically with management, the internal auditors and the independent accountants to review and assess the activities of each. Both the independent accountants and the internal auditors meet with the Committee, without management present, to review the results of their audits and their assessment of the adequacy of the system of internal accounting controls and the quality of financial reporting.\nJanuary 20, 1995\nR. A. Hazleton J. W. Churchfield - - - - - ------------------------------ --------------------------------------- R. A. Hazleton J. W. Churchfield Chairman and Vice President for Planning and Finance Chief Executive Officer and Chief Financial Officer\nSuite 3900 Telephone 313 259 0500 200 Renaissance Center Detroit, MI 48243\nPrice Waterhouse LLP\nREPORT OF INDEPENDENT ACCOUNTANTS\nJanuary 20, 1995\nTo the Stockholders and Board of Directors of Dow Corning Corporation\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Dow Corning Corporation and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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.\nAs discussed in Note 2 to the financial statements, the Company is involved in product liability litigation and claims related to breast implants for which it is seeking recovery from insurance carriers. The Company has recorded a liability for its obligations under a settlement agreement and an estimated liability for costs not covered by the settlement agreement. Additionally, the Company has recorded an estimated insurance receivable related to these liabilities. The estimated amounts were recorded based upon all currently available information. However, as additional facts and circumstances develop, it may be necessary for the Company to revise its estimate of the costs not covered by the settlement agreement as well as the estimate of the insurance receivable.\nIn 1992, the Company changed its method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards No. 106 as discussed in Note 13 and its method of accounting for income taxes to conform with Statement of Financial Accounting Standards No. 109 as discussed in Note 15.\nPrice Waterhouse LLP\n(THIS PAGE INTENTIONALLY BLANK)\nDOW CORNING CORPORATION -----------------------\n-----------------------------\nPage ----\nConsolidated balance sheets at December 31, 1994 and 1993 23\nConsolidated statements of operations and retained earnings for the years ended December 31, 1994, 1993 and 1992 25\nConsolidated statements of cash flow for the years ended December 31, 1994, 1993 and 1992 26\nNotes to consolidated financial statements 27\nSupplementary Data for the years ended December 31, 1994 and 1993:\nQuarterly financial information 47\nFinancial Statement Schedules for the years ended December 31, 1994, 1993 and 1992:\nVIII - Valuation and qualifying accounts and reserves 48\nAll other supplementary data and financial statement schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or the accompanying notes.\nDOW CORNING CORPORATION ----------------------- CONSOLIDATED BALANCE SHEETS --------------------------- (in millions of dollars)\nASSETS ------\nDecember 31, -------------------------- 1994 1993 ---- ----\nCURRENT ASSETS: Cash and cash equivalents $ 201.1 $ 263.0 -------- --------\nShort-term investments 0.7 0.9 -------- --------\nAccounts and notes receivable - Trade (less allowance for doubtful accounts of $10.2 in 1994 and $8.4 in 1993) 380.4 318.5 Anticipated implant insurance receivable 157.5 - Other receivables 35.8 54.5 -------- -------- 573.7 373.0 -------- --------\nInventories 308.4 285.6 -------- --------\nOther current assets - Deferred income taxes 252.9 118.4 Implant deposit 275.0 - Other 24.0 28.3 -------- -------- 551.9 146.7 -------- --------\nTotal current assets 1,635.8 1,069.2 -------- --------\nPROPERTY, PLANT AND EQUIPMENT: Land and land improvements 150.8 130.9 Buildings 467.0 436.0 Machinery and equipment 2,181.9 2,011.3 Construction-in-progress 135.2 132.5 -------- -------- 2,934.9 2,710.7 Less - Accumulated depreciation (1,743.0) (1,544.6 -------- --------) 1,191.9 1,166.1 -------- --------\nOTHER ASSETS: Anticipated implant insurance receivable 943.6 663.7 Deferred income taxes 182.7 229.6 Other 139.2 133.7 -------- -------- 1,265.5 1,027.0 -------- --------\n$4,093.2 $3,262.3 ======== ========\nThe Notes to Consolidated Financial Statements are an integral part of these financial statements.\nDOW CORNING CORPORATION ----------------------- CONSOLIDATED BALANCE SHEETS --------------------------- (in millions of dollars except share data)\nLIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------\nDecember 31, -------------------------- 1994 1993 ---- ----\nCURRENT LIABILITIES: Notes payable $ 404.9 $ 233.7 Current portion of long-term debt 41.9 33.5 Trade accounts payable 160.2 147.1 Income taxes payable 42.6 18.6 Accrued payrolls and employee benefits 61.8 60.4 Accrued taxes, other than income taxes 18.3 19.6 Implant reserve 475.4 158.7 Other current liabilities 119.9 99.0 -------- -------- Total current liabilities 1,325.0 770.6 -------- --------\nLONG-TERM DEBT 335.1 314.7 -------- --------\nOTHER LONG-TERM LIABILITIES: Implant reserve 1,286.9 1,100.0 Deferred income taxes 3.4 14.6 Other 348.7 311.2 -------- -------- 1,639.0 1,425.8 -------- --------\nCONTINGENT LIABILITIES (NOTE 2)\nMINORITY INTEREST IN CONSOLIDATED SUBSIDIARIES 117.9 102.8 -------- --------\nSTOCKHOLDERS' EQUITY: Common stock, $5 par value - 2,500,000 shares authorized and outstanding 12.5 12.5 Retained earnings 597.5 604.3 Cumulative translation adjustment 66.2 31.6 -------- -------- Stockholders' equity 676.2 648.4 -------- --------\n$4,093.2 $3,262.3 ======== ========\nThe Notes to Consolidated Financial Statements are an integral part of these financial statements.\nDOW CORNING CORPORATION ----------------------- NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ (in millions of dollars except where noted)\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - - - - - ---------------------------------------------------\nPrinciples of Consolidation - - - - - ---------------------------\nThe accompanying consolidated financial statements include the accounts of Dow Corning Corporation and all of its wholly-owned and majority-owned domestic and foreign subsidiaries (the Company). The Company's interests in 20% to 50% owned affiliates are carried on the equity basis and are included in other assets. Intercompany transactions and balances have been eliminated in consolidation.\nCash Equivalents and Short-Term Investments - - - - - -------------------------------------------\nCash equivalents include all highly liquid investments purchased with an original maturity of ninety days or less. All other temporary investments are classified as short-term investments. The carrying amounts for cash equivalents and short-term investments approximate their fair values.\nInventories - - - - - -----------\nInventories are stated at the lower of cost or market. The cost of the majority of inventories is determined using the last-in, first-out (LIFO) method and the remainder is valued using the first-in, first-out (FIFO) method.\nProperty and Depreciation - - - - - -------------------------\nProperty, plant and equipment are carried at cost and are depreciated principally using accelerated methods over estimated useful lives ranging from 10 to 20 years for land improvements, 10 to 45 years for buildings and 3 to 20 years for machinery and equipment. Upon retirement or other disposal, the asset cost and related accumulated depreciation are removed from the accounts and the net amount, less any proceeds, is charged or credited to income.\nExpenditures for maintenance and repairs are charged against income as incurred. Expenditures which significantly increase asset value or extend useful asset lives are capitalized.\nThe Company follows the policy of capitalizing interest as a component of the cost of capital assets constructed for its own use. Interest capitalized was $14.3 in 1994, $12.0 in 1993, and $11.8 in 1992.\nIntangibles - - - - - -----------\nOther assets include $24.8 and $27.0 of intangible assets at December 31, 1994 and 1993, respectively, representing the excess of cost over net assets of businesses acquired. These intangible assets are being amortized on a straight-line basis over 10 years. Other identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives.\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - - - - - ---------------------------------------------------\nDeferred Investment Grants - - - - - --------------------------\nIncluded in other long-term liabilities are deferred investment incentives (grants) which the Company has received related to certain capital expansion projects in Belgium, Canada and the United Kingdom. Such grants are deferred and recognized in income over the service lives of the related assets. At December 31, 1994 and 1993, gross deferred investment incentives were $89.7 and $84.6 with related accumulated amortization of $72.8 and $62.8, respectively.\nIncome Taxes - - - - - ------------\nThe Company adopted the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes, effective on January 1, 1992. SFAS 109 requires a company to recognize deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in a company's financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference 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 differences are expected to reverse.\nResearch and Development Costs - - - - - ------------------------------\nResearch and development costs are charged to operations when incurred and are included in manufacturing cost of sales. These costs totalled $174.0 in 1994, $163.9 in 1993, and $161.2 in 1992.\nCurrency Translation - - - - - --------------------\nAssets and liabilities of certain foreign subsidiaries are translated into U.S. dollars at end-of-period exchange rates; translation gains and losses, hedging activity and related tax effects from these subsidiaries are reported as a separate component of stockholders' equity. Assets and liabilities of other foreign subsidiaries are remeasured into U.S. dollars using end-of-period and historical exchange rates; remeasurement gains and losses, hedging activity and related tax effects for these subsidiaries are recognized in the statement of operations. Revenues and expenses for all foreign subsidiaries are translated at average exchange rates during the period. Foreign currency transaction gains and losses are included in current earnings.\nInterest and Currency Rate Derivatives - - - - - --------------------------------------\nThe Company enters into a variety of interest rate and currency swaps, interest rate caps and floors, options and forward exchange contracts in its management of interest rate and foreign currency exposures. The differential to be paid or received on interest rate swaps, including interest rate elements in combined currency and interest rate swaps, interest rate caps and floors is recognized over the life of the agreements as an adjustment to interest expense. Gains and losses on terminated interest rate instruments that were entered into for the purpose of changing the nature of underlying debt obligations are deferred and amortized to income as an adjustment to interest expense. Currency option premiums are amortized over the option period. Gains and losses on purchased currency options that are designated and effective as hedges are deferred and recognized in income in the same period as the hedged transaction. Realized and unrealized gains and losses on currency swaps, including currency elements in combined currency and interest rate swaps, and forward exchange contracts are recognized currently in other income and expense, or, if such contracts are effective as net investment hedges, in stockholders' equity.\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) - - - - - ---------------------------------------------------\nNew Accounting Standard - - - - - -----------------------\nIn January 1994, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Post-employment Benefits.\" This new standard requires, among other things, that the expected costs of benefits paid to former or inactive employees after employment but before retirement be recognized when the benefits are earned or become payable when certain conditions are met rather than the previous method which recognized these costs when they were paid. The adoption of this new standard did not materially impact the Company's consolidated financial condition or results of operations.\nReclassifications - - - - - -----------------\nCertain reclassifications of prior year amounts have been made to conform to the presentation adopted in 1994.\nNOTE 2 - CONTINGENCIES - - - - - ----------------------\nBreast Implant Litigation and Claims - - - - - ------------------------------------\nPrior to January 6, 1992, the Company, directly and through its wholly-owned subsidiary, Dow Corning Wright Corporation, was engaged in the manufacture and sale of silicone gel breast implants and the raw material components of these products. As part of a review process initiated in 1991 by the United States Food and Drug Administration (FDA) of Premarket Approval Applications (PMAA) for silicone gel breast implants, on January 6, 1992, the FDA asked breast implant producers and medical practitioners to voluntarily halt the sale and use of silicone gel breast implants pending further review of the safety and effectiveness of such devices, and the Company complied with the FDA's request and suspended shipments of implants. Subsequently, the Company announced that it would not resume the production or sale of silicone gel breast implants and that it would withdraw its PMAA for silicone gel breast implants from consideration by the FDA.\nSince late 1991, there has been considerable publicity associated with the breast implant controversy, and the Company experienced a substantial increase in the number of lawsuits against the Company relating to breast implants. As of December 31, 1994, the Company has been named, often together with other defendants, in approximately 19,000 pending breast implant products liability lawsuits filed by or on behalf of individuals who claim to have or have had silicone gel breast implants. Many of these cases involve multiple plaintiffs. In addition, there were 45 breast implant products liability class action lawsuits which had been filed against the Company as of December 31, 1994. It is anticipated that the Company will be named as a defendant in additional breast implant lawsuits in the future by those breast implant recipients not participating in the Breast Implant Litigation Settlement Agreement (as described below). The typical alleged factual bases for these lawsuits include allegations that the plaintiffs' breast implants caused specified ailments, including, among other things, autoimmune disease, scleroderma, systemic disorders, joint swelling and chronic fatigue. The Company is sometimes named as the manufacturer of silicone gel breast implants, and other times the Company is named as the supplier of silicone raw materials to other breast implant manufacturers. The Company is vigorously defending this litigation asserting, among other defenses, that there is no causal connection between silicone breast implants and the ailments alleged by the plaintiffs in these cases. Once the Breast Implant Litigation Settlement Agreement (as described below) becomes final and binding, it is anticipated that lawsuits brought by those breast implant plaintiffs participating in the settlement will be dismissed.\nNOTE 2 - CONTINGENCIES (Continued) - - - - - ----------------------\nConsolidation of a substantial number of breast implant lawsuits for pretrial purposes has occurred in federal court (U.S. District Court for the Northern District of Alabama, the \"Court\") and various state courts where a substantial number of breast implant lawsuits have been filed. As of December 31, 1994, substantially more than half of all breast implant cases have been consolidated for pretrial purposes at the federal and state levels. The Company anticipates that breast implant lawsuit consolidations and implementation of the Breast Implant Litigation Settlement Agreement will result in a reduction of litigation defense costs.\nOn September 9, 1993, the Company announced that representatives of plaintiffs and defendants involved with silicone breast implant litigation had developed a \"Statement of Principles for Global Resolution of Breast Implant Claims\" (the \"Statement of Principles\"). The Statement of Principles summarizes a proposed claims based structured resolution of claims arising out of breast implants which have been or could be asserted against various implant manufacturers, suppliers, physicians and hospitals. The Company negotiated with other potential parties to reach a Breast Implant Litigation Settlement Agreement similar in concept to the Statement of Principles.\nOn March 23, 1994, the Company, along with other defendants and representatives of breast implant litigation plaintiffs, entered into a settlement pursuant to a Breast Implant Litigation Settlement Agreement (as amended by the Court, the \"Settlement Agreement\"). The Company's participation in this Settlement Agreement was approved by the Company's Board of Directors on March 28, 1994. Under the Settlement Agreement, industry participants (the \"Funding Participants\") agreed to contribute up to approximately $4.2 billion over a period of more than thirty years to establish several special purpose funds. A related funding agreement (the \"Funding Agreement\") specifies the amount that each Funding Participant would contribute to the settlement fund and the timing of those contributions. The Settlement Agreement provides for a claims based structured resolution of claims arising out of silicone breast implants and defines the circumstances under which payments from the funds would be made. The Settlement Agreement includes provisions for (a) class membership and the ability of plaintiffs to opt out of the class, (b) the establishment of defined funds for medical diagnostic\/evaluation procedures, explantation, ruptures, compensation for specific diseases and administration, (c) payment terms and timing and (d) claims administration.\nThe settlement covers claims of most breast implant recipients, and related claims, brought in the courts of U.S. federal and state jurisdictions. The settlement also covers the claims of breast implant recipients brought in jurisdictions outside of the U.S. if payments received by those potential claimants from the settlement fund, and related releases, serve to preclude them from bringing legal actions in these other jurisdictions. The settlement does not cover claims of breast implant recipients who have affirmatively chosen not to participate in the Settlement Agreement, or whom the Court has specifically excluded from the Settlement Agreement unless these potential claimants affirmatively join the settlement. Breast implant recipients who reside in Ontario or Quebec, Canada, or in Australia have been specifically excluded by the Court. The Settlement Agreement defines various periods during which, upon the occurrence of certain events, breast implant plaintiffs may elect not to settle their claims by way of the Settlement Agreement and pursue their individual breast implant litigation against manufacturers and other defendants (the \"Opt Out Plaintiffs\"). The Settlement Agreement also provides the children of breast implant recipients with the right to opt out of the settlement in certain circumstances. Under the terms of the Settlement Agreement, in certain circumstances, if any defendant who is a Funding Participant considers the number of Opt Out Plaintiffs to be excessive, such defendant may decide to exercise the option to withdraw from participation in the settlement during a number of periods specified in the Settlement Agreement.\nNOTE 2 - CONTINGENCIES (Continued) - - - - - ----------------------\nOn April 1, 1994, the Court preliminarily approved the Settlement Agreement. On April 18, 1994, the Court issued notice of the Settlement Agreement to breast implant recipients and others who may be eligible to participate in the settlement (\"Settlement Class Members\"). This notice began a 60-day period, ending June 17, 1994, during which Settlement Class Members had the ability to become initial Opt Out Plaintiffs. This period was extended to July 1, 1994 with respect to certain Settlement Class Members whose Court issued notice was delayed. The Court has afforded initial Opt Out Plaintiffs an opportunity to rejoin the settlement within specified periods which currently end no later than March 1, 1995. A Court hearing to review the fairness of the Settlement Agreement was completed on August 22, 1994. On September 1, 1994, the Court granted final approval to the Settlement Agreement, determining that it is fair, reasonable and adequate, and on September 8, 1994, the Company's Board of Directors approved the Company's continued participation in the Settlement Agreement.\nThe Court's final approval of the Settlement Agreement has been appealed to the U.S. Court of Appeals for the Eleventh Circuit primarily by certain providers of health care indemnity payments or services and by certain foreign claimants.\nThe Settlement Agreement provides that industry participants will contribute a total of $4.2 billion, of which the Company is obligated to contribute up to approximately $2.02 billion, over a period of more than 30 years. The Company's required contributions under the Settlement Agreement cannot be changed without the Company's consent. Under the terms of the Funding Agreement, the Company has made or anticipates making settlement payments in accordance with the following schedule:\n1994 $ 42.50 1995 275.00 1997 275.00 1998 275.00 1999 through 2011 51.17 per year 2012 through 2019 38.38 per year 2020 through 2026 25.57 per year\nThe Company's first payment of $275.0 under the Funding Agreement is due upon the earlier of (a) a resolution of these appeals which confirms the Court's final approval of the Settlement Agreement or (b) the completion of a second opt out process or the determination that there will be no second opt out process (as described below). The Company has placed $275.0 into an escrow account and is required, among other things, to provide a letter of credit in the amount of $275.0 to provide financial assurance to the Court of the Company's ability to meet its obligations under the Settlement Agreement. After the third payment of $275.0, the amount of the letter of credit will be reduced to $51.2 or may be eliminated by order of the Court. The Company is engaged in discussions with certain financial institutions to provide this letter of credit.\nInitial claims for specific disease compensation were required to be filed with the Court in September 1994. After these claims and the supporting medical records have been evaluated by the Court for validity, eligibility, accuracy, and consistency, the Court will determine whether the disease compensation settlement fund is sufficient to pay validated claims. If the disease compensation settlement fund is not sufficient to pay validated claims, and if such insufficiency cannot be resolved through other means, claimants with validated claims may have the ability to opt out during another period as specified in the Settlement Agreement. If any defendant who is a Funding Participant considers the number of new Opt Out Plaintiffs against said defendant to be excessive, such defendant may decide to exercise a second option to withdraw from participation in the settlement.\nNOTE 2 - CONTINGENCIES (Continued) - - - - - ----------------------\nSince July 1, 1994, many former Opt Out Plaintiffs have rejoined the settlement. Based on preliminary information received from the Court as of December 1994, approximately 5,000 of the initial U.S. Opt Out Plaintiffs and approximately 2,000 potential foreign claimants (including initial foreign Opt Out Plaintiffs and foreign claimants excluded from the settlement class) have identified the Company as potentially responsible, in whole or in part, with respect to their current or potential future claims. The Court is continuing to collect information relating to the number of Opt Out Plaintiffs and as information is received from the Court the Company will continue to evaluate the nature and scope of its potential exposure with respect to the current or potential future claims of these Opt Out Plaintiffs. Opt Out Plaintiffs may continue to rejoin the settlement until the March 1, 1995 date established by the Court.\nThe Settlement Agreement is in the process of being implemented. The settlement implementation process can be affected by external factors as described above such as the resolution of pending appeals and the number and magnitude of claims filed in the settlement. However, based on its analysis of the most current information, including assessments by knowledgeable third parties who have been directly involved in the negotiation and implementation of the Settlement Agreement, management believes that the aggregate amount of the Company's obligation and the amount and timing of the related cash payments under the Settlement Agreement are reliably determinable. Management also believes that events will not occur which would lead to the Company's withdrawal from the settlement and that the Settlement Agreement will be implemented in the state currently envisioned.\nThe Company believes that a substantial portion of the indemnity, settlement and defense costs related to breast implant lawsuits and claims will be covered by the Company's products liability insurance. Substantially all of the Company's insurers have reserved the right to deny coverage, in whole or in part, due to differing theories regarding, among other things, when coverage may attach, and their respective obligations relative to other insurers. The Company has a substantial amount of unexhausted claims-made insurance coverage with respect to lawsuits and claims commencing in 1986 and thereafter. For lawsuits and claims involving implant dates prior to 1986, substantial coverage exists under a number of primary and excess occurrence policies having various limits. Because defense costs and disposition of particular breast implant lawsuits and claims may be covered, in whole or in part, both by the claims-made coverage issued from and after 1986, and one or more of the occurrence policies issued prior to 1986, determination of aggregate insurance coverage depends on, among other things, how defense and indemnity costs are allocated among the various policy periods. Also, a number of the breast implant lawsuits pending against the Company request punitive damages and compensatory damages arising out of alleged intentional torts. Depending on policy language, applicable law and agreements with insurers, any such damages which may be awarded pursuant to such lawsuits may or may not be covered, in whole or in part, by insurance.\nDiscussions among the Company and its primary insurers have occurred and are continuing with a view toward reaching an agreement as to the allocation of costs of breast implant litigation among the various insurers issuing products liability insurance policies to the Company relative to breast implants and other products. In 1993, the Company commenced a lawsuit against certain of these insurers seeking, among other things, a judicial enforcement of the obligations of the insurers under certain of these insurance policies. Approximately 85% of the anticipated implant insurance receivable recorded in the financial statements is currently subject to litigation. This litigation principally involves those insurers who provided coverage on an occurrence basis and generally does not involve insurers who provided coverage on a claims made basis.\nManagement continues to believe that it is probable that the Company will recover from its insurers a substantial amount of breast implant related payments which have been or may be made by the Company. In reaching this belief, the Company has analyzed its insurance policies, considered its history of coverage and insurance reimbursement for these types of claims, and consulted with knowledgeable\nNOTE 2 - CONTINGENCIES (Continued) - - - - - ----------------------\nthird parties with significant experience in insurance coverage matters. This belief is further supported by the fact that the Company received insurance recoveries of $71.4 in 1994 and entered into settlements with certain insurers for future reimbursement. These settlements relate to only a small number of the Company's insurers and a small portion of the Company's total insurance program.\nThe Company has recorded an anticipated insurance receivable which is less than the amount for which the Company will seek reimbursement; a substantial portion of this anticipated insurance receivable relates to insurers who provided coverage on an occurrence basis. The principal uncertainties which exist with respect to the ultimate realization of this asset include the method applied in allocating losses between insurers who provided coverage on a claims made basis and insurers who provided coverage on an occurrence basis, the method applied in allocating losses among the insurers who provided coverage on an occurrence basis, potential delays in reimbursement if the insurers fail to pay on a timely basis, and the extent to which insurers may become insolvent in the future. The Company has taken these factors into account when estimating the amount of insurance recovery to record in the financial statements. Specifically, the Company selected a reasonable and legally sound allocation theory which is one of several generally accepted allocation theories in circumstances involving product liability claims; the allocation theory selected is supported by recent developments in the ongoing insurance litigation. The Company also assumed a reasonable delay between the time the Company makes breast implant related payments and the time the Company receives reimbursement from the insurers, and an allowance for insolvent insurers has been provided.\nThe Company has made efforts in the past to reflect anticipated financial consequences to the Company of the breast implant situation. During 1991 and 1992, the Company recorded $25.0 and $69.0, respectively, of pretax costs related to breast implant matters. In 1993 the Company recorded a pretax charge of $640.0. This charge included the Company's best estimate of its potential liability for breast implant litigation based on settlement negotiations, and also included provisions for legal, administrative, and research costs related to breast implants, for a total of $1.24 billion, less anticipated insurance recoveries of $600.0. As discussed below, the Company recorded the liability attributable to the Settlement Agreement and the related insurance receivable on a present value basis.\nOn January 20, 1995, the Company announced a pretax charge of $241.0 ($151.8 after tax) for the fourth quarter of 1994. This charge reflects the Company's best current estimate of additional costs to resolve breast implant litigation and claims outside of the Settlement Agreement, and includes provisions for legal, administrative, and research costs related to breast implants. This pretax charge of $241.0 consists of a $647.0 liability less anticipated insurance recoveries of $406.0. These amounts were recorded on an undiscounted basis.\nAs a result of the provisions described above, as of December 31, 1994 the Company's financial statements reflect a total liability of $1,762.3 and a total anticipated implant insurance receivable of $1,101.1. Of these amounts, a liability of $603.6 and an anticipated implant insurance receivable of $398.3 have been recorded to reflect costs and insurance recoveries, respectively, relevant to breast implant liabilities not covered by the Settlement Agreement; these amounts are recorded on an undiscounted basis. Because the amount and timing of the liability attributable to the Settlement Agreement is reliably determinable, the Company recorded this liability and the related anticipated implant insurance receivable on a present-value basis using a discount rate of 7.0% over a period of more than 30 years. This rate approximated the interest rate on monetary assets that are risk free and that have maturities corresponding with the scheduled cash payments. The Settlement Agreement liability recorded in the financial statements at December 31, 1994 is $1,158.7; this amount is $1,976.2 on an undiscounted basis. The Settlement Agreement anticipated implant insurance receivable recorded in the financial statements at December 31, 1994 is $702.8; this amount is $1,156.2 on an undiscounted basis.\nNOTE 2 - CONTINGENCIES (Continued) - - - - - ----------------------\nDifferences between discounted amounts recorded in the financial statements and undiscounted amounts represent interest to be recorded over the life of the net liability. The net amount of imputed interest recorded in 1994 was $28.3. Amounts recorded in the financial statements related to the Settlement Agreement are adjusted as insurance proceeds are received, as payments are made against reserves and as imputed interest is recorded on discounted amounts.\nImplant reserves less the anticipated implant insurance receivable reflects management's best current estimate of the cost of ultimate resolution of breast implant litigation and claims. The liability under the Settlement Agreement is reliably determinable. However, additional facts and circumstances may develop which could affect the reliability and precision of the estimate of costs not covered by the Settlement Agreement as well as the estimate of the anticipated implant insurance receivable. Those facts and circumstances include, among other things, the ultimate number and extent of claims not covered by the Settlement Agreement, the ultimate cost of resolving those claims, the amount and timing of insurance recoveries, and the allocation of insurance payments among the Company's insurers. Management cannot currently estimate the impact that these factors may have on the current estimate of costs not covered by the Settlement Agreement as well as the estimate of the anticipated implant insurance receivable. As additional facts and circumstances develop, the estimate may be revised, or provisions may be necessary to reflect any additional costs of resolving breast implant litigation and claims not covered by the settlement. Future charges resulting from any revisions or provisions, if required, could have a material adverse effect on Dow Corning's financial position or results of operations in the period or periods in which such charges are recorded.\nOther Litigation - - - - - ----------------\nDue to the nature of its business as a supplier of specialty materials to a variety of industries, the Company, at any particular time, is a defendant in a number of products liability lawsuits for injury allegedly related to the Company's products, and, in certain instances, products manufactured by others. Many of these lawsuits seek damages in substantial amounts. For example, the Company has been named in products liability lawsuits pertaining to materials previously used in connection with temporo-mandibular joint implant applications. The Company has followed a practice of aggressively defending all product liability claims asserted against it. Although the Company intends to continue this practice, currently pending proceedings and any future claims are subject to the uncertainties attendant to litigation and the ultimate outcome of any such proceedings or claims cannot be predicted with certainty. Nonetheless, the Company believes that these products liability claims will not have a material adverse effect on the Company's results of operations or financial condition.\nEnvironmental Matters - - - - - ---------------------\nThe Company has been advised by the United States Environmental Protection Agency (EPA) or by similar state regulatory agencies that the Company, together with others, is a Potentially Responsible Party (PRP) with respect to a portion of the cleanup costs and other related matters involving a number of abandoned hazardous waste disposal facilities. Management believes that there are 13 sites at which the Company may have some liability, although management currently expects to settle the Company's liability for a majority of these sites for de minimis amounts. Based upon preliminary estimates by the EPA or the PRP groups formed with respect to these sites, the aggregate liabilities for all PRPs at these sites at which management currently believes the Company may have more than the de minimis liability is $106.0. Management cannot currently estimate the aggregate liability for all PRPs at those sites at which management expects the Company has a de minimis liability.\nNOTE 2 - CONTINGENCIES (Continued) - - - - - ----------------------\nThe Company records accruals for environmental matters when it is probable that a liability has been incurred and the Company's costs can be reasonably estimated. The amount accrued for environmental matters at December 31, 1994 was $16.2, although possible costs could range up to $32.0. While there are a number of uncertainties with respect to the Company's estimate of its ultimate liability for cleanup costs at these sites, it is the opinion of the Company that the possibility that costs in excess of those accrued or disclosed will have a material adverse impact on the Company's consolidated financial position or results of operations is remote. This opinion is based upon the number of identified PRPs at each site, the number of such PRPs that are believed by management to be financially capable of paying their share of the ultimate liability, and the portion of waste sent to the sites for which management believes the Company might be held responsible based on available records.\nDOW CORNING FIRE STOP(R) - - - - - ------------------------\nIn May, 1993, the Company began communicating additional information and test results to the owners of buildings which contain DOW CORNING FIRE STOP(R) Intumescent Wrap Strip 2002, recommending that the owners conduct a review with a qualified Fire Protection Engineer to determine whether remedial action is warranted, including possible replacement of the product due to uncertainty about its ability to perform consistently and predictably over time. DOW CORNING FIRE STOP(R) Intumescent Wrap Strip 2002 is a non-silicone, resin-based fire stop product which was installed in buildings as a passive fire protection product. The Company ceased the sale of this product in 1992. Management believes that the ultimate resolution of this issue will not have a material adverse effect on the Company's consolidated financial position or results of operations.\nNOTE 3 - SPECIAL ITEMS - - - - - ----------------------\nCharges of $40.0 in 1992 relate to provisions for restructuring activities, consisting largely of costs associated with the cessation of manufacturing activities at a subsidiary in Brazil and costs involved in global expense reduction, including elimination of low-priority activities, redeployment of people and reduction in the value of affected facilities.\nNOTE 4 - SALE OF ASSETS AND ACQUISITIONS - - - - - ----------------------------------------\nOn July 1, 1993, the Company sold the metal orthopedic device assets for approximately $66.3 in cash. The Company's investment in assets was approximately $70.0, most of which represented current assets. The sale of the metal orthopedic device business did not have a material effect on the Company's consolidated net sales, financial position or results of operations.\nOn July 14, 1992, the Company acquired ARA - Werk Kraemer GmbH (ARA), a German supplier of sealants, polyurethane foam products and related application tools. The purchase price included $18.9 of cash and $19.2 in notes to be paid within one year of the acquisition date. The acquisition was accounted for by the purchase method of accounting, and, accordingly, the purchase price has been allocated to the assets acquired and the liabilities assumed based on their estimated fair values at date of acquisition. The excess of purchase price over estimated fair values of the net assets acquired was $25.6 and has been recorded as goodwill, which is being amortized over 10 years. The operating results of ARA are included in the Company's consolidated results from the acquisition date. Consolidated net sales, net income and related per share amounts for the year ended December 31, 1992, would not have been materially different had this acquisition taken place at the beginning of 1992.\nNOTE 4 - SALE OF ASSETS AND ACQUISITIONS (Continued) - - - - - ----------------------------------------\nOn November 2, 1992, the Company acquired for $12.8 an additional 40% interest in Lucky-DC Silicone Co., Ltd., a company in which Dow Corning previously had held a 50% interest. In addition, under the terms of the agreement with the partner, Lucky Ltd., the Company will acquire for $3.2 the remaining 10% interest by November 1995, subject to the approval by the Government of South Korea. Consolidated net sales, net income and related per share amounts for the year ended December 31, 1992, would not have been materially different had this acquisition taken place at the beginning of 1992.\nNOTE 5 - FOREIGN CURRENCY - - - - - -------------------------\nFollowing is an analysis of the changes in the cumulative translation adjustment:\n1994 1993 1992 ---- ---- ----\nBalance, beginning of year $31.6 $28.3 $66.2\nTranslation adjustments and gains (losses) from certain hedges and intercompany balances 31.3 (0.2) (37.5)\nIncome tax effect of current year activity 3.3 3.5 (0.4) ----- ----- -----\nBalance, end of year $66.2 $31.6 $28.3 ===== ===== =====\nNet foreign currency gains (losses) currently recognized in income amounted to $(4.8) in 1994, $(8.1) in 1993, and $(35.2) in 1992.\nNOTE 6 - RECEIVABLES SOLD - - - - - -------------------------\nThe Company sells certain receivables with limited recourse provisions. Dow Corning Corporation sells on an ongoing basis substantially all of its U.S. trade receivables, with limited recourse, to Bay Asset Funding Corporation (\"BAFC\"), a wholly owned but separate corporate entity of the Company. BAFC has agreements in place with third parties whereby it may sell on an ongoing basis fractional ownership interests in such trade receivables, with limited recourse, for a purchase price of up to $65.0. The agreements contemplate that (a) the trade receivables sold to BAFC by the Company are solely the assets of BAFC, (b) the creditors of BAFC are separate from the creditors of the Company, and (c) in the event of a liquidation of BAFC, such creditors would be entitled to satisfy their claims from BAFC's assets prior to any distribution to the Company.\nNet of related reserves, the amount of receivables sold under third party agreements which remained uncollected at December 31, 1994 and 1993 was $32.0 and $63.2, respectively. The sale of such receivables resulted in net proceeds of approximately $62.6 in 1994, $74.7 in 1993, and $73.5 in 1992.\nNOTE 7 - IMPLANT DEPOSIT - - - - - ------------------------\nIn connection with the Settlement Agreement, the Company has entered into an agreement whereby $275.0 in cash and cash equivalents is restricted to use for future breast implant settlement payments. Accordingly, this amount is included in the caption \"Implant deposit\" in the accompanying consolidated balance sheet and statement of cash flows.\nNOTE 8 - INVENTORIES - - - - - --------------------\nFollowing is a summary of inventories by costing method at December 31:\n1994 1993 ---- ----\nRaw material, work-in-process and finished goods: Valued at LIFO $204.7 $197.0 Valued at FIFO 103.7 88.6 ------ ------\n$308.4 $285.6 ====== ======\nUnder the dollar value LIFO method used by the Company, it is impracticable to separate inventory values by classifications. Inventories valued using LIFO at December 31, 1994 and 1993 are stated at approximately $69.5 and $70.9, respectively, less than they would have been if valued at replacement cost.\nNOTE 9 - INVESTMENTS - - - - - --------------------\nExcluding investments accounted for on the equity basis, the carrying amount for investments at December 31, 1994 and 1993 was $27.6 and $24.6, respectively. Carrying amounts approximate fair values. Fair values are determined based on quoted market prices or, if quoted market prices are not available, on market prices of comparable instruments. Investments are included in the captions \"Short-term investments\" and \"Other assets\" in the accompanying consolidated balance sheets.\nNOTE 10 - NOTES PAYABLE AND CREDIT FACILITIES - - - - - ---------------------------------------------\nNotes payable at December 31 consisted of:\n1994 1993 ---- ----\nRevolving Credit Agreement $375.0 $150.0 Other bank borrowings 29.9 83.7 ------ ------\n$404.9 $233.7 ====== ======\nDuring 1993, the Company terminated a revolving credit agreement which was in place at December 31, 1992, and replaced it with a Revolving Credit Agreement with 16 domestic and foreign banks which provides for borrowings on a revolving credit basis until November, 1997, of up to $400.0. At December 31, 1994, the interest rate on amounts outstanding under the Revolving Credit Agreement was 6.8125%. Amounts outstanding under short-term lines of credit are described as \"Other bank borrowings\" in the table above. The carrying amounts of the Company's short-term borrowings approximate their fair value.\nCertain of the Company's debt agreements, including the Revolving Credit Agreement, contain debt restrictions and provisions relating to property liens, sale and leaseback transactions, debt to tangible capital ratio, and funds flow. In addition, the Revolving Credit Agreement provides participating banks the right, subject to a vote of a majority in interest, to demand payment in the event that breast implant litigation expenditures, net of insurance recoveries, exceed certain limits. At December 31, 1994, the Company was in compliance with all debt restrictions and provisions.\nNOTE 10 - NOTES PAYABLE AND CREDIT FACILITIES (Continued) - - - - - ---------------------------------------------\nUnder the provisions of the Revolving Credit Agreement, the Company is subject to certain restrictions as to the payment of dividends or distribution of assets for other specified purposes. The amount of the restriction is based on a formula which considers, among other things, the income before income taxes for the most recent fiscal year. Based on the computation completed for the year ended December 31, 1994, the Company is restricted from issuing dividends or distributing assets for other specified purposes in excess of $71.9 in 1995.\nNOTE 11 - LONG-TERM DEBT - - - - - ------------------------\nLong-term debt at December 31 consisted of:\n1994 1993 ---- ----\n9.625% Sinking Fund Debentures due 2005 $ - $ 4.8 9.375% Debentures due 2008 75.0 75.0 8.15% Debentures due 2029 50.0 50.0 8.125%-9.50% Medium-term Notes due 1995-2001, 8.82% average rate at December 31, 1994 36.5 54.5 5.77% Term Loans, maturing serially 1995-1999 26.6 32.1 Variable-rate Notes due 1995-1998, 5.9%-6.984% at December 31, 1994 123.3 55.2 Variable-rate Note, maturing serially 1997-1999, 6.44% at December 31, 1994 20.0 20.0 5.55%-6.5% Japanese Yen Notes due 1996-1998 33.0 33.4 Other obligations due 1995-1999 12.6 23.2 ------ ------ 377.0 348.2 Less - Payments due within one year 41.9 33.5 ------ ------\n$335.1 $314.7 ====== ======\nThe fair value of the Company's long-term debt was approximately $7.2 higher than book value at December 31, 1994 and $45.0 higher than book value at December 31, 1993. The fair value was based largely on interest rates offered on U.S. Treasury obligations with comparable maturities using discounted cash flow analysis. These rates were not adjusted to reflect the premium that the Company might pay over U.S. Treasury rates. A one percentage point increase in these rates would decrease the fair value by approximately $11.1.\nThe Company has $400.0 of debt securities registered with the Securities and Exchange Commission at December 31, 1994, of which $275.0 had been designated to medium-term note programs and another $125.0 had been issued in debentures. At December 31, 1994, $100.0 had been issued under the medium- term note programs, of which $36.5 was still outstanding.\nThe 9.375% and 8.15% debentures are not redeemable by the Company prior to their maturity; however, the holders of the 8.15% debentures may elect to have all or a portion of their debentures repaid on October 15, 1996, at 100% of the principal amount.\nNOTE 11 - LONG-TERM DEBT (Continued) - - - - - ------------------------\nAggregate annual maturities of long-term debt are: $41.9 in 1995, $27.8 in 1996, $84.0 in 1997, $71.1 in 1998, $17.9 in 1999 and $84.3 thereafter. Excluded from such maturities are $50.0 of 8.15% debentures, due in 2029, which are subject to early redemptions at the holders' option in 1996. Cash paid during the year for interest, net of amounts capitalized, was $40.7 in 1994, $31.8 in 1993, and $20.8 in 1992.\nNOTE 12 - INTEREST AND CURRENCY RATE DERIVATIVES - - - - - ------------------------------------------------\nThe Company utilizes a variety of financial instruments, several with off-balance sheet risks, in its management of current and future interest rate and foreign currency exposures. These financial instruments include interest rate swaps, interest rate caps and floors, interest rate options, currency swaps, currency options, and forward exchange contracts.\nThese instruments involve, to varying degrees, elements of credit and market risk in excess of the amount recognized in the consolidated balance sheet. Methods used by the Company to monitor and control credit risk include limiting counterparties to only major banks and substantial financial institutions, and monitoring the credit-worthiness of these counterparties on an ongoing basis. In the event of default by a counterparty, the risk in these transactions is limited to the cost of replacing the instrument at current market rates. The contract or notional amounts of these instruments are used to measure the volume of these agreements and do not represent exposure to credit loss. Methods used by the Company to monitor and control market risk include entering into offsetting positions that essentially counterbalance with each other, and continued monitoring of market conditions. Although the Company may be exposed to losses in the event of nonperformance by counterparties and interest and currency rate movements, it does not anticipate significant losses due to these financial arrangements.\nThe Company enters into interest rate swaps to exchange fixed and variable interest payment obligations without an exchange of the underlying principal amounts in order to manage interest rate exposures. The Company also enters into interest rate caps and floors, and interest rate options in order to transfer, modify, or reduce interest rate risk. These instruments are used to hedge specific elements of the Company's debt portfolio. Hedge accounting is used to recognize the differential to be paid or received as an adjustment to interest expense over the life of the agreements. Interest rate swaps, interest rate caps and floors, and interest rate options are shown in the following table.\nNOTE 12 - INTEREST AND CURRENCY RATE DERIVATIVES (Continued) - - - - - ------------------------------------------------\nThe Company enters into currency swaps, currency options, and forward exchange contracts primarily to hedge working capital not denominated in functional currencies. Gains and losses on these contracts are recognized concurrent with the gains and losses from the associated exposures. Currency swaps, currency options and forward exchange contracts are shown in the following table. The book values of these instruments approximate fair values.\nThe fair value of interest rate swaps, interest rate caps and floors, interest rate options, currency swaps, and currency options is estimated by obtaining quoted market prices of comparable instruments, adjusted through interpolation where necessary for maturity differences. The fair value of forward exchange contracts is estimated by obtaining quotes from brokers. The fair values shown above represent the amount the Company would receive (or pay, if denoted by brackets) to terminate the agreements at the reporting date.\nNOTE 13 - POST EMPLOYMENT BENEFITS - - - - - ----------------------------------\nThe Company maintains defined benefit employee retirement plans covering most domestic and certain foreign employees. The Company also has various defined contribution and savings plans covering certain employees. Plan benefits for defined benefit employee retirement plans are based primarily on years of service and compensation. The Company's funding policy is consistent with national laws and regulations. Plan assets include marketable equity securities, insurance contracts, corporate and government debt securities, real estate and cash.\nNOTE 13 - POST EMPLOYMENT BENEFITS (Continued) - - - - - ----------------------------------\nThe components of pension expense for the Company's domestic and foreign plans are set forth below.\n1994 1993 1992 ---- ---- ----\nDefined benefit plans: Service cost (benefits earned during the period) $ 20.9 $ 16.1 $ 14.1 Interest cost on projected benefit obligations 43.9 38.0 35.4 Actual return on plan assets 0.2 (73.4) (24.7) Net amortization 4.7 1.6 1.2 Difference between actual and expected return on plan assets (40.2) 35.0 (8.6) ------ ------ ------\n29.5 17.3 17.4 ------ ------ ------\nDefined contribution and savings plans 12.0 10.1 12.6 ------ ------ ------\n$ 41.5 $ 27.4 $ 30.0 ====== ====== ======\nThe following table presents reconciliations of defined benefit plans' funded status with amounts recognized in the Company's consolidated balance sheets as part of other assets and other long-term liabilities. Plans with assets exceeding the accumulated benefit obligation (ABO) are segregated by column from plans with ABO exceeding assets. Assets exceed ABO for all domestic plans.\n1994 1993 ---------------- ---------------- Assets ABO Assets ABO exceed exceeds exceed exceeds ABO assets ABO assets ------ ------- ------ -------\nActuarial present value of benefit obligations: Vested $387.7 $ 35.5 $396.9 $ 32.9 Nonvested 41.9 4.4 25.2 5.3 ------ ------ ------ ------\nAccumulated benefit obligation 429.6 39.9 422.1 38.2 Provision for future salary increases 92.1 12.6 104.3 13.1 ------ ------ ------ ------\nProjected benefit obligation 521.7 52.5 526.4 51.3 Plan assets at fair value 480.3 7.2 484.9 6.4 ------ ------ ------ ------\nPlan assets in excess of (less than) projected benefit obligation (41.4) (45.3) (41.5) (44.9) Unrecognized net loss (gain) 25.1 5.7 20.2 8.9 Unrecognized (negative) prior service costs 40.9 (7.8) 43.7 (5.3) Unrecognized net transition obligation 5.7 1.7 6.5 1.9 ------ ------ ------ ------\nPrepaid (accrued) pension cost $ 30.3 $(45.7) $ 28.9 $(39.4) ====== ====== ====== ======\nNOTE 13 - POST EMPLOYMENT BENEFITS (Continued) - - - - - ----------------------------------\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation for defined benefit plans was 8.1% in 1994 and 7.3% in 1993. The weighted average rate of increase in future compensation levels was determined using an age specific salary scale and was 5.5% in 1994 and 5.6% in 1993. The weighted average expected long-term rate of return on plan assets was 8.5% in 1994 and 8.6% in 1993.\nIn addition to providing pension benefits, the Company, primarily in the United States, provides certain health care and life insurance benefits for most retired employees. In 1992, the Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The Company elected to immediately recognize the cumulative effect of the change in accounting for postretirement benefits of $176.9 ($116.8 net of income tax benefit) which represents the accumulated postretirement benefit obligation existing at January 1, 1992. In addition, the effect of adopting the new rules increased 1992 net periodic postretirement benefit cost by $17.4 ($11.5 net of income tax benefit). Prior to 1992, the cost of retiree health care and life insurance benefits was recognized as an expense as benefits were paid. The cost of providing these benefits to retirees outside the United States is not significant. Net periodic postretirement benefit cost includes the following components:\n1994 1993 1992 ---- ---- ----\nService cost $ 3.4 $ 6.0 $ 6.6 Interest cost 9.3 10.3 15.6 Amortization of negative prior service cost (13.2) (14.3) - ----- ----- -----\n$(0.5) $ 2.0 $22.2 ===== ===== =====\nThe following table presents the plan's funded status reconciled with amounts recognized in the Company's consolidated balance sheets as part of other long-term liabilities:\nDecember 31, December 31, 1994 1993 ------------ ------------\nAccumulated postretirement benefit obligation: Retirees $ 66.3 $ 55.5 Fully eligible, active plan participants 36.2 52.6 Other active plan participants 25.5 37.7 ------ ------\n128.0 145.8 Unrecognized negative prior service cost 67.9 61.5 Unrecognized net loss (9.9) (16.8) ------ ------\nAccrued postretirement benefit cost $186.0 $190.5 ====== ======\nIn December 1992, the Company amended its retiree health care benefit plan to require that, beginning in 1994, employees have a certain number of years of service to be eligible for any retiree health care benefit. The retiree health care plan provides for certain cost-sharing changes which limit the Company's share of retiree health care costs. The Company continues to fund benefit costs on a pay-as-you-go basis with the retiree paying a portion of the costs.\nNOTE 13 - POST EMPLOYMENT BENEFITS (Continued) - - - - - ----------------------------------\nThe health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 10.02% in 1994 and was assumed to decrease gradually to 5.75% in 2005 and remain at that level thereafter. For retirees under age 65, plan features limit the health care cost trend rate assumption to a maximum of 8% for years 1994 and later. 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 increase the accumulated postretirement benefit obligation by 4% and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by 6%.\nThe discount rate used in determining the accumulated postretirement benefit obligation was 8.25% at December 31, 1994 and 7.25% at December 31, 1993.\nNOTE 14 - RELATED PARTY TRANSACTIONS - - - - - ------------------------------------\nThe Company purchased raw materials and services totalling $46.8 in 1994, $39.4 in 1993, and $43.5 in 1992 from The Dow Chemical Company and its affiliates. The Company believes that the costs of such purchases were competitive with alternative sources of supply. Other transactions between the Company and related parties were not material.\nNOTE 15 - INCOME TAXES - - - - - ----------------------\nThe components of income (loss) before income taxes are as follows:\n1994 1993 1992 ---- ---- ----\nU.S. companies $ (47.2) $(516.7) $(20.8) Non-U.S. companies 61.8 94.7 70.8 ------- ------- ------\n$ 14.6 $(422.0) $ 50.0 ======= ======= ======\nThe components of the income tax provision (benefit) are as follows:\n1994 1993 1992 ---- ---- ----\nCurrent U.S. $ 62.6 $ 14.3 $ 4.7 Non-U.S. 47.5 37.9 59.9 ------ ------- ------\n110.1 52.2 64.6 ------ ------- ------\nDeferred U.S. (96.0) (205.4) (26.7) Non-U.S. ( 6.2) 2.3 (27.8) ------ ------- ------\n(102.2) (203.1) (54.5) ------ ------- ------\n$ 7.9 $(150.9) $ 10.1 ====== ======= ======\nNOTE 15 - INCOME TAXES (Continued) - - - - - ----------------------\nThe tax effects of the principal temporary differences giving rise to deferred tax assets and liabilities were as follows:\nDecember 31, December 31, 1994 1993 ------------ ------------\nImplant costs $288.0 $225.0 Accrued expenses 97.2 62.8 Postretirement health care and life insurance 61.7 63.0 Basis in inventories 24.9 24.8 Tax credit and net operating loss carry forwards 2.5 5.6 Other 26.4 20.9 ------ ------ 500.7 402.1 Valuation allowance (1.0) (3.5) ------ ------ 499.7 398.6 ------ ------\nProperty, plant and equipment (66.3) (60.1) Other - (5.8) ------ ------ (66.3) (65.9) ------ ------\nNet deferred tax asset $433.4 $332.7 ====== ======\nAt December 31, 1994, income and remittance taxes have not been recorded on $217.9 of undistributed earnings of foreign subsidiaries, either because any taxes on dividends would be offset substantially by foreign tax credits or because the Company intends to indefinitely reinvest those earnings. Cash paid during the year for income taxes, net of refunds received, was $62.4 in 1994, $72.5 in 1993, and $68.2 in 1992.\nThe effective rates of 54.1% for 1994, (35.8)% for 1993, and 20.2% for 1992 differ from the U.S. federal statutory income tax rate in effect during those years for the following reasons:\nYear ended December 31, -------------------------------- 1994 1993 1992 ---- ---- ----\nIncome tax provision (benefit) at statutory rate $ 5.1 $(147.7) $17.0 Foreign taxes, net 10.6 0.4 (8.2) Foreign sales corporation (3.7) (2.1) (1.0) State income taxes (12.6) 1.7 1.6 Other, net 8.5 (3.2) 0.7 ----- ------- -----\nIncome tax provision (benefit) at effective rate $ 7.9 $(150.9) $10.1 ===== ======= =====\nIn the first quarter of 1992, the Company adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), Accounting for Income Taxes, which requires an asset and liability approach in the measurement of deferred taxes. Financial statements prior to 1992 have not been restated for this change in accounting principle. The cumulative effect of adopting SFAS 109 as of January 1, 1992, increased 1992 net income by $16.4. Except for the cumulative effect, the change did not have a material effect on operating results for the periods presented.\nNOTE 16 - COMMON STOCK - - - - - ----------------------\nThe outstanding shares of the Company's common stock are held in equal portions by Corning Incorporated and Dow Holdings Inc., a wholly-owned subsidiary of The Dow Chemical Company. There were no changes in outstanding shares during 1994, 1993 or 1992.\nNOTE 17 - COMMITMENTS AND GUARANTEES - - - - - ------------------------------------\nThe Company leases certain real and personal property under agreements which generally require the Company to pay for maintenance, insurance and taxes. Rental expense was $45.5 in 1994, $46.2 in 1993, and $48.4 in 1992. The minimum future rental payments required under noncancellable operating leases at December 31, 1994, in the aggregate are $141.8, including the following amounts due in each of the next five years: 1995 - $39.7, 1996 - $28.2, 1997 - $20.8, 1998 - $17.5, and 1999 - $15.1.\nNOTE 18 - INDUSTRY SEGMENT AND FOREIGN OPERATIONS - - - - - -------------------------------------------------\nThe Company's operations are classified as a single industry segment. Financial data by geographic area are presented below:\n1994 1993 1992 ---- ---- ----\nNet sales to customers: United States $ 888.3 $ 830.6 $ 822.6 Europe 554.5 490.9 528.7 Asia 652.0 619.9 500.8 Other 109.8 102.3 103.6 -------- -------- --------\nNet sales $2,204.6 $2,043.7 $1,955.7 ======== ======== ========\nInterarea sales: United States $ 317.6 $ 219.6 $ 228.3 Europe 46.9 54.7 45.1 Asia 9.5 9.2 6.6 Other 0.3 0.3 1.9 -------- -------- --------\nTotal interarea sales $ 374.3 $ 283.8 $ 281.9 ======== ======== ========\nOperating profit: United States $ 338.8 $ 192.3 $ 131.8 Europe 36.0 59.2 23.8 Asia 53.8 68.7 64.4 Other and eliminations 14.2 7.1 9.7 -------- -------- -------- 442.8 327.3 229.7 General corporate expenses (401.7) (703.6) (123.4) Unallocated income (expense), net (26.5) (45.7) (56.3) -------- -------- --------\nIncome (loss) before income taxes $ 14.6 $ (422.0) $ 50.0 ======== ======== ========\nIdentifiable assets: United States $1,083.0 $1,071.2 $1,091.4 Europe 486.4 423.6 455.5 Asia 593.8 498.1 490.0 Other and eliminations 38.9 37.3 64.1 -------- -------- -------- 2,202.1 2,030.2 2,101.0 Corporate assets 1,891.1 1,232.1 89.7 -------- -------- --------\nTotal assets $4,093.2 $3,262.3 $2,190.7 ======== ======== ========\nNOTE 18 - INDUSTRY SEGMENT AND FOREIGN OPERATIONS (Continued) - - - - - -------------------------------------------------\nInterarea sales are made on the basis of arm's length pricing. Interarea sales in 1993 and 1992 for Asia have been restated to reflect the combination of the former Japan and Pacific areas. Operating profit is total sales less certain operating expenses. General corporate expenses, equity in earnings of associated companies, interest income and expense, certain currency gains (losses), minority interests' share in income, and income taxes have not been reflected in computing operating profit.\nGeneral corporate expenses include implant costs, certain research and development costs, and corporate administrative personnel and facilities costs not specifically identified with a geographic area. Identifiable assets are those operating assets identified with the operations in each geographic area. Corporate assets are principally cash and cash equivalents, short-term investments, anticipated implant insurance receivables, intangible assets, investments accounted for on the equity basis, and corporate facilities.\nDOW CORNING CORPORATION ----------------------- SUPPLEMENTARY DATA - QUARTERLY FINANCIAL INFORMATION ---------------------------------------------------- YEARS ENDED DECEMBER 31, 1994 AND 1993 (Unaudited) -------------------------------------------------- (in millions of dollars, except per share amounts)\nQUARTER ENDED: March 31 June 30 September 30 December 31 -------- ------- ------------ -----------\n1994: Net sales $509.1 $552.4 $559.7 $583.4 Gross profit 177.8 192.7 182.7 181.1 Net income (loss) 37.2 40.5 34.7 (119.2) Net income (loss) per share 14.88 16.20 13.88 (47.68)\n1993: Net sales $490.8 $519.9 $512.0 $521.0 Gross profit 161.2 166.9 162.6 149.1 Net income (loss) 30.7 36.3 30.2 (384.2) Net income (loss) per share 12.28 14.52 12.08 (153.68)\n[FN] Includes a pretax charge related to breast implants of $241.0 in 1994 ($151.8 net of income tax benefit) and $640.0 in 1993 ($415.0 net of income tax benefit); see Note 2 of Notes to Consolidated Financial Statements for a discussion of this matter.\nThe Notes to Consolidated Financial Statements are an integral part of these financial statements. [\/FN]\nDOW CORNING CORPORATION ----------------------- SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES -------------------------------------------------------------- YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 -------------------------------------------- (in millions of dollars)\nAdditions charged to Balance at operating Uncollectible Balance beginning costs and accounts SFAS No. 52 at end of year expenses written off adjustments of year ---------- ---------- -------------- ----------- -------\nDescription - - - - - -----------\nAllowance for doubtful accounts - deducted from accounts and notes receivable in the balance sheet\n1994 $ 8.4 $ 3.5 $ 1.5 $(0.2) $10.2 ===== ===== ===== ===== =====\n1993 $ 8.4 $ 0.9 $ 0.9 $ - $ 8.4 ===== ===== ===== ===== =====\n1992 $ 7.7 $ 2.3 $ 1.0 $(0.6) $ 8.4 ===== ===== ===== ===== ===== \/TABLE\n(THIS PAGE INTENTIONALLY BLANK)\nDOW CORNING CORPORATION ----------------------- EXHIBIT INDEX -------------\nThese exhibits are numbered in accordance with the exhibit table of Item 601 of Regulation S-K\nExhibit Number Description Page - - - - - ------- ----------- ----\n3.1 Restated Articles of Incorporation of Dow Corning Corporation dated March 25, 1988 are incorporated by reference from Item 14(c) of Form 10-K for the fiscal year ended December 31, 1993\n3.2 By-Laws of Dow Corning Corporation dated September 16, 1994 51\n4 Dow Corning Corporation agrees to furnish the Securities and Exchange Commission upon its request a copy of any instrument which defines the rights of holders of long-term debt of the registrant and all of its subsidiaries for which consolidated or unconsolidated financial statements are required to be filed.\n10 Breast Implant Litigation Settlement Agreement 90\n12 Computation of ratio of earnings to fixed charges 197\n21 Subsidiaries of the Registrant -- has been omitted in accordance with provisions of General Instruction J of Form 10-K.\n23 Consent of Price Waterhouse LLP 198\nExhibits 3.2, 10, 12, and 23 were appended to the manually signed original and have not been included in this printed copy.","section_15":""}
{"filename":"77776_1994.txt","cik":"77776","year":"1994","section_1":"ITEM 1. BUSINESS GENERAL The Company provides a broad range of integrated management services, expense management programs and mortgage banking services to more than 2,000 clients, including many of the world's largest corporations, as well as governmental agencies and affinity groups. Its primary business service segments consist of vehicle management, relocation and real estate and mortgage banking. Information as to revenues, operating income and identifiable assets by business segment is included in the Business Segments note in the Notes to Consolidated Financial Statements. As of June 30, 1994, the Company and its subsidiaries had approximately 5,000 employees. VEHICLE MANAGEMENT SERVICES Vehicle management services consist primarily of the management, purchase, leasing and resale of vehicles for corporate clients and governmental agencies, including fuel and expense management programs and other fee-based services for clients' vehicle fleets. FLEET MANAGEMENT SERVICES The Company provides fully integrated vehicle management and leasing programs through PHH Vehicle Management Services. These programs were developed to meet the specific needs of companies using large and small numbers of cars and trucks and consist of managerial, leasing and advisory services, aimed at reducing and controlling the cost of operating corporate fleets. The Company's advisory services for automobile fleet management programs include recommendations on the makes and models of cars and accessories best suited to the client's use, the determination of persons eligible for company cars, the method of reimbursing field representatives for actual car expenses, the care and maintenance of cars and the personal use of company cars. Managerial services for automobile fleet programs include purchasing automobiles, arranging for their delivery through new car dealers located throughout the United States, Canada, the United Kingdom and the Republic of Ireland, complying with various local registration, title, tax and insurance requirements, pursuing warranty claims with automobile manufacturers and selling used cars at replacement time. The Company offers similar programs and services for vans and light and heavy-duty truck fleets. Advisory services offered include the determination of the vehicle specifications, makes, models and equipment best suited to perform the functions required by the client. Managerial services include purchasing new vans, light and heavy-duty trucks, trailers, truck bodies and equipment from manufacturers and franchised dealers, the performance of title, registration, tax and insurance functions, arranging for them to be titled, licensed and delivered to locations designated by clients, verifying invoices and selling used vehicles at replacement time. The Company offers various leasing plans for its vehicle leasing programs. Under these plans, the Company provides for the financing primarily through the issuance of commercial paper and medium-term notes and through unsecured borrowings under revolving credit agreements and bank lines of credit. See the Liabilities Under Management Programs note in Notes to Consolidated Financial Statements. The Company leases vehicles for minimum lease terms of twelve months or more under either direct financing or operating lease agreements. The Company's experience indicates that the full term of the leases may vary considerably due to extensions beyond the minimum lease term. Under the direct financing lease agreements, resale of the vehicles upon termination of the lease is generally for the account of the lessee. The Company has two distinct types of operating leases. Under one type, the open-end operating lease, resale of the vehicles upon termination of the lease is for the account of the lessee except for a minimum residual value which the Company has guaranteed. The Company's experience has been that vehicles under this type of lease agreement have consistently been sold for amounts exceeding residual value guarantees. Under the other type of operating lease, the closed-end operating lease, resale of the vehicle on termination of the lease is for the account of the Company.\nThe Company's fleet management services may be the same whether the client owns or leases the vehicles. In either case, the client generally operates the vehicles on a net basis, paying all the actual costs incidental to their operation, including gasoline, oil, repairs, tires, depreciation, vehicle licenses, insurance and taxes. The fee charged by the Company for its services is based upon either a percentage of the original cost of the vehicle or a stated management fee and, in the case of a leasing client, includes the interest cost incurred in financing the vehicle. FUEL AND EXPENSE MANAGEMENT PROGRAMS The Company offers fuel and expense management programs to corporations and governmental agencies for the control of automotive business travel expenses in each of the United States, Canada, United Kingdom, Republic of Ireland and Germany. Through a service card and billing service, a client's traveling representatives are able to purchase various products and services such as gasoline, tires, batteries, glass and maintenance services at numerous outlets. The Company also provides a series of safety-related programs, statistical control reports detailing expenses related to the general operation of vehicles, and a program which monitors and controls the type and cost of vehicle maintenance for individual automobiles. The Company also provides a fuel and expense management program and a centralized billing service for companies operating truck fleets in each of the United States, Canada, United Kingdom, Republic of Ireland and Germany. Drivers of the clients' trucks are furnished with courtesy cards together with a directory listing the names of strategically located truck stops and service stations which participate in this program. Service fees are earned for the billing, collection and record keeping services and for assuming the credit risk. These fees are paid by the truck stop or service stations and\/or the fleet operator and are based upon the total dollar amount of fuel purchased or the number of transactions processed. COMPETITIVE CONDITIONS The principal methods of competition within vehicle management services are service quality and price. In the United States and Canada, an estimated 30% of the market for vehicle management services is served by third-party providers. There are 5 major providers of such services in North America, as well as an estimated several hundred local and regional competitors. The Company shares the market leadership with one other provider. In the United Kingdom, the portion of the fuel card services and vehicle management services markets served by third-party providers is an estimated 37% and 35%, respectively. The Company is the market leader among the 4 major nation-wide providers of fuel card services, and a market leader among the 7 major nation-wide providers of vehicle management services. Numerous local and regional competitors serve each such market element. The following sets forth certain statistics concerning automobiles, vans, light and heavy-duty trucks for which the Company provides managerial, leasing and\/or advisory services in the United States, Canada, the United Kingdom, the Republic of Ireland and Germany at the end of the fiscal years shown:\n(1) The cost of the Canadian and United Kingdom vehicles is stated in United States dollars, translated at the average exchange rate in effect for the year ended April 30, 1994 in order to eliminate the effect of exchange rate fluctuations. (2) Includes the Republic of Ireland.\nRELOCATION AND REAL ESTATE SERVICES EMPLOYEE RELOCATION The Company provides employee relocation services principally to large international corporations, governmental agencies and affinity groups in the United States, Canada, the United Kingdom and the Republic of Ireland through PHH Homequity Corporation and other relocation subsidiaries. Principal services consist of counseling transferred employees of clients and the purchase, management and resale of their homes. The Company's relocation services offer clients the opportunity to reduce employee relocation costs and facilitate employee relocation. The relocation subsidiary pays a transferring employee his\/her equity in a home based upon a value determined by independent appraisals. In certain circumstances the employee's mortgage may be retired concurrently with the purchase of the equity; otherwise the relocation subsidiary normally accepts the administrative responsibility for making payments on any mortgages. Following payment to the employee, the corporate client normally pays the relocation subsidiary an advance billing to cover costs to be incurred during the period the home is held for resale, including debt service on any existing mortgage. These costs are paid by the relocation subsidiary and, after ultimate resale, a settlement is made with the corporate client reconciling the advance billing and the expense payments. Under the terms of the client contracts, the relocation subsidiaries are generally protected against losses from changes in market conditions. Funds to finance the purchase of homes are provided primarily through the issuance of commercial paper and medium-term notes and occasionally through unsecured borrowings under revolving credit agreements and bank lines of credit, or may be provided by the client. Interest costs are billed directly to the Company's clients. See the Liabilities Under Management Programs note in Notes to Consolidated Financial Statements. The Company's relocation subsidiaries also offer programs which provide home marketing, moving services, rental management, spousal career counseling and consulting services for transferred employees to help in selecting their new communities and homes. The destination services operations focus on developing and delivering home-finding and settling-in services for individual customers through local centers. Through its PHH Fantus Corporation subsidiary, the Company provides strategic facilities planning services, site selection and location consulting for corporate clients and governmental agencies. Additionally, the Company provides consulting services in the areas of general business strategy, marketing and management for transnational clients. REAL ESTATE SERVICES The Company provides real estate services through PHH Homequity Corporation and other relocation subsidiaries. These services primarily include the management and resale of homes for financial institutions and governmental agencies in the United Kingdom, the United States and Canada. COMPETITIVE CONDITIONS The principal methods of competition within relocation and real estate services are service quality and price. In the United States, Canada and the United Kingdom, an estimated 25% of the market for relocation and real estate services is served by third-party providers. In each of the United States, Canada and the United Kingdom, there are 4 major national providers of such services. There are an estimated several dozen local and regional competitors in each such country. The Company is the market leader in the United States and Canada, and third in the United Kingdom.\nThe following sets forth certain statistics concerning relocation and real estate services in the United States, Canada and the United Kingdom for the fiscal years shown:\n(1) Revenues for the U.S. relocation services are significantly determined based on the value of homes sold, while revenues for the United Kingdom and Canadian segments are primarily based on fees which are not related to the value of homes sold; therefore, this table only includes the average value of U.S. homes sold. N\/A Information not available. MORTGAGE BANKING SERVICES The Company provides residential mortgage banking services through PHH US Mortgage Corporation. These services consist of the origination, sale and servicing of residential first mortgage loans. A variety of first mortgage products as well as casualty insurance-related products are marketed to consumers through relationships with corporations, affinity groups, real estate brokerage firms and other mortgage banks. PHH US Mortgage is a centralized mortgage lender conducting business in all 50 states. It utilizes its computer system and an extensive telemarketing operation to allow the consumer to complete the entire mortgage transaction over the telephone. Through its own network of appraisers, title companies and closing attorneys, the Company can effectively administer its products and services anywhere in the nation. The mortgage unit customarily sells all mortgages it originates to investors (which include a variety of institutional investors) either as individual loans, as mortgage-backed securities or as participation certificates issued or guaranteed by the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC), or the Government National Mortgage Association (GNMA) while generally retaining mortgage servicing rights. The guarantees provided by FNMA and FHLMC are on a non-recourse basis to the Company. Guarantees provided by GNMA are non-recourse to the extent recoverable from certain government insurance programs. Mortgage servicing consists of collecting loan payments, remitting principal and interest payments to investors, holding escrow funds for payment of mortgage-related expenses such as taxes and insurance, and otherwise administering the Company's mortgage loan servicing portfolio. COMPETITIVE CONDITIONS The principal methods of competition in mortgage banking services are service quality and price. There are an estimated 22,000 national, regional or local providers of mortgage banking services across the United States. The Company ranked twenty-third among loan originators for calendar year 1993 and twenty-fourth for the three months ended March 31,1994. The following sets forth certain statistics concerning mortgage banking services for the fiscal years shown:\nSIGNIFICANT CUSTOMERS No customer purchased services totaling 10% or more of consolidated revenues in 1994, 1993, or 1992. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The corporate offices of the Company are located at 11333 McCormick Road, Hunt Valley, Maryland in an eight-story building which is owned by the Company and contains approximately 163,000 square feet of office space. The offices of PHH Vehicle Management Services North American operations are located throughout the US and Canada as follows: (Bullet) A six-story, 200,000 square foot office building in Hunt Valley, Maryland leased until September 2003 (Bullet) Office space totaling 17,500 square feet in five cities leased as full service branch offices for fleet management activities for various terms to April 2003 (Bullet) A dealership in Williamsburg, Virginia, having 101,000 square feet, leased until March 1998 (Bullet) A dealership in Edenton, North Carolina, having 337,100 square feet, leased until December 1998 (Bullet) Offices in Fort Worth, Texas, having 75,500 square feet, leased until March 2002 (Bullet) Administrative offices in Mississauga, Canada, having 59,400 square feet, leased until February 1998 (Bullet) Regional offices located in Montreal, Calgary, Vancouver, Mississauga & Quebec, Canada, having a total of 43,100 square feet, leased for various terms to December 2002 The offices of PHH Relocation and Real Estate Services North American operations are located throughout the US and Canada as follows: (Bullet) Offices located in Wilton, Connecticut, having 40,000 square feet, leased until January 1996 (Bullet) Offices in Danbury, Connecticut, having 92,500 square feet, leased until January 2000 (Bullet) Field office space leased in fourteen cities as follows: 56,500 square feet in Irving, Texas until November 1998; 54,000 square feet in Oak Brook, Illinois until April 2003; 52,800 square feet in Concord, California until October 1998; and 55,500 square feet in eleven other cities for various terms to June 2002 (Bullet) Offices located in Florham Park, New Jersey, where 14,200 square feet are leased until May 1996 (Bullet) Offices in Chicago, Illinois, having 8,800 square feet, leased until September 2004 (Bullet) Office space totaling 35,300 square feet in Toronto, Montreal, Vancouver, Ottawa and Nova Scotia, leased for various terms to May 2004 The offices of Mortgage Banking Services are located as follows: (Bullet) A 127,000 square foot building in Mount Laurel, New Jersey which is owned by the Company (Bullet) In Englewood, Colorado in a building having 27,900 square feet leased until June 1997 (Bullet) In two other locations totaling 16,300 square feet for various terms to June 1995. The offices of Vehicle Management Services and Relocation and Real Estate Management Services operations located in the United Kingdom and Europe are as follows: (Bullet) A 129,000 square foot building which is owned by the Company located in Swindon, United Kingdom (Bullet) Field offices having 47,800 square feet located in Swindon and Manchester, United Kingdom, Munich, Germany and Dublin, Ireland are leased for various terms to February 2016. The Company considers that its properties are generally in good condition and well maintained and are generally suitable and adequate to carry on the Company's business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS The Company is party to various litigation arising in the ordinary course of business and is plaintiff in several collection matters which are not considered material either individually or in the aggregate. ITEM 4.","section_4":"ITEM 4. RESULTS OF VOTES OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended April 30, 1994. PART II ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS The Company's common stock is publicly traded on the New York Stock Exchange under the symbol \"PHH\". The common stock is entitled to dividends when and as declared by the Board of Directors. The payment of future dividends will depend upon earnings, the financial condition of the Company and other relevant factors. At June 30, 1994 there were 1,975 holders of common stock. The dividends and high and low prices for each quarter during the Company's 1994 and 1993 fiscal years were as follows:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS\nRESULTS OF OPERATIONS\nAll comparisons within the following discussion are to the previous year, unless otherwise stated.\nConsolidated results: Net income increased 14% to $64.6 million in fiscal 1994. Net income per share increased 12% to $3.64. The increase in net income was due to increases in the mortgage banking services and vehicle management services business segments, partially offset by a decrease in the relocation and real estate services business segment. In fiscal 1993, net income increased 13% to $56.4 million and net income per share increased 11% to $3.25, reflecting increases in all three of the Company's business segments, though primarily in mortgage banking services.\nConsolidated revenues increased 6% to $2.1 billion in fiscal 1994 and 5% to $2.0 billion in fiscal 1993.\nThe provision for income taxes reflects effective tax rates of 41.2%, 40.1% and 39.9% in fiscal 1994, 1993 and 1992, respectively. The fiscal 1994 rate reflects the increase in the US federal corporate income tax rate from 34% to 35%. The additional tax accrued to adjust the Company's deferred tax assets and liabilities for the effect of the increased income tax rate was offset by an adjustment of tax accruals based upon the completion of certain tax examinations.\nVehicle Management Services Vehicle management services primarily consist of the management, purchase, leasing and resale of vehicles for corporate clients and governmental agencies, including fuel and expense management programs and other fee-based services for clients' vehicle fleets.\nLeasing revenues increased 8% to $968 million in fiscal 1994 and 8% to $895 million in fiscal 1993. The increases were primarily due to a reduced amount, in comparison to prior years, of leases and leased vehicles sold or transferred to third parties for which management and servicing responsibility is retained. Had these assets not been sold or transferred, the related rental payments would have been included in revenues and the related depreciation on vehicles under operating leases and interest would have been included in expenses. On a pro forma basis, the result would have been a decrease in leasing revenues of 6% for fiscal 1994 and 3% for fiscal 1993. The decreases in pro forma leasing revenues were primarily due to a lower rental interest component charged on certain leases and leased vehicles due to reduced interest rates and a decrease in the number of leased vehicles under management.\nOther revenues increased 11% to $194 million in fiscal 1994 and 6% to $175 million in fiscal 1993. The increases were primarily due to growth in domestic fee-based services such as vehicle maintenance management programs and a favorable resale market for disposition of vehicles under closed-end leases.\nVehicle management services operating income increased 9% to $46.2 million in fiscal 1994. The increase was primarily due to increases from the continuing positive effects of a favorable resale market for disposition of vehicles under closed-end leases, higher management fees resulting from increases in the average cost of vehicles managed, growth in domestic fee-based vehicle services as reflected in the number of fuel and service card transactions and gallons processed (see key operating factors) as well as the favorable effect of productivity efforts. Partially offsetting the increase were decreased revenues resulting from a slight decrease in the number of vehicles under management as well as increased selling, general and administrative costs including costs related to certain information technology improvements.\nIn fiscal 1993, operating income increased 4% to $42.3 million. The increase was primarily due to growth in fee-based vehicle management services as well as improvements in fuel and expense management programs in the UK. These improvements were partially offset by a decrease in domestic fuel and expense management programs, a decrease in the number of vehicles under management, continued investment toward expansion into Continental Europe, and a reduction due to the effect of foreign currency translation.\nThe Company's profitability from vehicle management services is affected by the number of vehicles managed and related services provided for clients. Profitability can also be affected as corporate clients exercise a higher degree of caution by decreasing the size of their vehicle fleets or by extending the service period of existing fleet vehicles. Operating results should be positively affected as clients choose to outsource their vehicle management services and as the Company expands into new markets, further enhances its product diversity, broadens its client base and continues its productivity and quality improvement efforts.\nRelocation and Real Estate Services Relocation and real estate services primarily consist of the purchase, management and resale of homes for transferred employees of corporate clients, governmental agencies and affinity groups. Other programs include fee-based services which provide assistance to the transferring employee and real estate services to financial institutions as well as other consulting services.\nRelocation and real estate services revenues decreased 2% to $816 million in fiscal 1994. Revenue decreases were primarily due to a reduction in the number of transferee homes sold in the US and UK and a reduction in interest rates and other direct costs of carrying and reselling homes, which are charged to the Company's clients. These decreases were partially offset by revenue increases due to an increase in the number of homes sold in Canada resulting from an acquisition in fiscal 1994; an increase in domestic fee-based relocation services such as home marketing programs, group move planning and household goods moving; and an increase in the average value of transferee homes sold in the US.\nIn fiscal 1993, revenues decreased 2% to $829 million. The decrease was primarily due to a reduction in interest rates and other direct costs of carrying and reselling homes, which are passed through to the Company's clients, partially offset by an increase in the number of transferee homes sold in the US and favorable results in the US from other fee-based relocation services.\nCosts of carrying and reselling homes and interest decreased 3% to $718 million in fiscal 1994 and 3% to $739 million in fiscal 1993. The decreases were primarily due to a decrease in interest expense caused by a reduction in interest rates as noted above, as well as a reduction in other direct costs of carrying and reselling homes due to a reduction in the number of days homes were held for resale. In fiscal 1994, increased costs were incurred due to an increase in the number of homes sold resulting from the Company's acquisition in Canada and to enhance the Company's global information technology.\nRelocation and real estate services operating income decreased 19% to $21.5 million in fiscal 1994. The decrease was primarily due to costs incurred by the Company to broaden its worldwide consulting business, enhance its global information technology and consolidate office space in North America, as well as integration costs from its acquisition in Canada. The decrease was partially offset by improvement in the results of other fee-based relocation and real estate services and an increase in the value of transferee homes sold in the US.\nIn fiscal 1993, operating income increased 1% to $26.6 million. The increase was primarily due to increases in the number of transferee homes sold in the US as well as improvement in other fee-based services in the US. Partially offsetting the increase were decreases in the number of homes sold and a reduction of real estate services provided in the UK and Canada, as well as the minor effect of a change in the application of revenue recognition accounting policies in the UK to more closely align policies for similar product lines on a worldwide basis.\nThe Company is generally not at risk on its carrying value of homes should there be a downturn in the housing market. Management anticipates that, as businesses continue to reassess their relocation plans as part of cost control measures, the results of the relocation services segment may be impacted. However, operating results should be positively affected as the Company expands into new markets, enhances its product diversity, broadens its client base and continues its productivity and quality improvement efforts.\nMortgage Banking Services\nMortgage banking services primarily consist of the origination, sale and servicing of residential first mortgage loans. A variety of first mortgage products are marketed to consumers through relationships with corporations, affinity groups, real estate brokerage firms and other mortgage banks.\nMortgage banking services revenues increased 28% to $156 million in fiscal 1994. The increase was primarily due to a large percentage increase in loan closing volume as well as a 51% increase in the servicing portfolio. The value of loan closings increased 44% due to growth in volume from established customer relationships, increased market penetration, as well as volume generated from residential mortgage refinancings. Similarly, in fiscal 1993, revenues increased 37% to $122 million.\nDirect costs and interest increased 23% to $86 million in fiscal 1994 and 25% to $70 million in fiscal 1993. The increases were primarily due to increased costs to support increased loan closings and a larger servicing portfolio partially offset by reduced interest rates. Additionally, direct costs include unscheduled amortization of excess mortgage servicing fees of $11.3 million and $11.9 million in fiscal 1994 and 1993, respectively.\nKey Operating Factors 1994 1993 1992\nMortgage loan closings (in millions) $ 8,074 $ 5,618 $ 3,797 Percent change 44% 48% 63% Ending mortgage servicing portfolio (in millions) $ 16,645 $ 11,047 $ 7,517 Percent change 51% 47% 50% Delinquency rate 1.2% 1.1% 1.8%\nMortgage banking services operating income increased 66% to $42.1 million in fiscal 1994 and 58% to $25.4 million in fiscal 1993. The increase reflects increases in revenues as discussed above, partially offset by higher costs incurred due to increased loan closings as well as higher costs of managing the larger servicing portfolio.\nThe Company's profitability from mortgage banking services will be affected by such external factors as the level of interest rates, the strength of the various segments of the economy, and the condition of residential real estate markets. The Company is experiencing a slowdown in refinancing activity due to a rise in interest rates. Management believes the Company's broad-based marketing strategies and continuous quality improvement efforts, as well as its focus on building and maintaining a high quality servicing portfolio, should continue to positively affect operating results.\nNEW ACCOUNTING PRONOUNCEMENTS\nIn fiscal 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". Additionally, in November 1992, the Financial Accounting Standards Board (FASB) issued SFAS No. 112, effective in fiscal 1995, \"Employers' Accounting for Postemployment Benefits\". Application of this statement will require the Company to change from the cash basis to the accrual basis of recording the costs of benefits provided to former or inactive employees after employment but before retirement. The effect of this statement has been estimated and will not significantly affect the consolidated financial statements of the Company.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company manages its funding sources to ensure adequate liquidity for servicing of existing liabilities and by obtaining longer-term funds required to meet the Company's strategic growth objectives. The mix of funding sources depends on market conditions at the time, the characteristics of the assets of the Company, and the management of diverse international funding sources for the greatest long-term financial flexibility.\nThe sources of liquidity fall into three general areas: ongoing liquidation of assets under management, international money and capital markets, and committed credit agreements with various high-quality domestic and international banks. In the ordinary course of business, the liquidation of assets under management programs, as well as cash flows generated from operating activities, provide the cash flow necessary for the repayment of existing liabilities. (See Operating Activities and Investing Activities in the Company's Consolidated Statements of Cash Flows.)\nBased upon historical information, the Company projects the time period that a client's vehicle will be in service or the length of time that a home will be held in inventory before being sold on behalf of a client. Within mortgage banking services, the asset characteristics reflect the length of time from commitment to the sale of mortgages to unrelated investors. Once the asset characteristics are projected, the Company generally matches the projected dollar amount, interest rate and maturity characteristics of the assets within the overall funding program. This is accomplished through stated debt terms or effectively modifying such terms through other instruments, primarily interest rate swap agreements and revolving credit agreements. Interest rate risk on mortgages originated for sale is managed through the use of forward delivery contracts, financial futures and options.\nTo maintain the integrity of its assets under management, the Company maintains rigorous client credit standards to minimize credit risk and the potential for losses.\nDomestic and international financial markets provide a variety of sources of funding. The Company has consciously managed these sources to ensure broad access to major money and capital markets. Depending upon asset growth and financial market conditions, the Company utilizes the United States, Euro, Canadian and Sterling commercial paper markets, as well as other cost effective short-term instruments. In addition, the Company utilizes the public and private debt markets to issue unsecured senior corporate debt. Augmenting these sources, the Company has reduced outstanding debt by the sale or\ntransfer of managed assets to third parties while retaining fee-related servicing responsibility. The Company's aggregate commercial paper outstanding totaled $2.1 and $1.9 billion at April 30, 1994 and April 30, 1993, respectively. At April 30, 1994, $1.2 billion in medium-term notes and $185 million in other debt securities were outstanding compared to $1.1 billion and $390 million, respectively, in fiscal 1993. (See Financing Activities in the Company's Consolidated Statements of Cash Flows.) From a risk management standpoint, borrowings not in the local currency of the business unit are converted to the local currency through the use of foreign currency forward contracts.\nTo provide additional financial flexibility, the Company's current policy is to ensure that minimum committed bank facilities aggregate 80% of the average amount of outstanding commercial paper. Committed revolving credit agreements totaling $2.4 billion and uncommitted lines of credit aggregating $330 million are currently in place with 31 domestic and international banks. Management closely evaluates not only the credit quality of the banks but the maturity of the various agreements to ensure ongoing availability. Of the Company's $2.4 billion in committed facilities at April 30, 1994, the full amount was undrawn and available. Management believes that its current policy provides adequate protection should financial stress occur in the commercial paper or medium-term note markets.\nThese established means of effectively matching floating and fixed interest rate and maturity characteristics of funding to related assets, the variety of short- and long-term domestic and international funding sources, and the committed banking facilities enable the Company to service its debt and offer a broad spectrum of service products to its clients.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA REPORT AND CONSENT OF INDEPENDENT AUDITORS The Stockholders and Board of Directors PHH Corporation: We have audited the consolidated financial statements of PHH Corporation and subsidiaries as listed in the accompanying index on page 27. In connection with our audits of the consolidated financial statements, we have also audited the 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 schedules 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 financial position of PHH Corporation and subsidiaries at April 30, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended April 30, 1994, 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. KPMG PEAT MARWICK Baltimore, Maryland May 23, 1994 To the Stockholders and Board of Directors PHH Corporation: We consent to incorporation by reference in the Registration Statements on Form S-3 (No. 33-48125, No. 33-52669 and No. 33-59376) and Form S-8 (No. 33-38309 and No. 33-53282) of PHH Corporation of our report dated May 23, 1994, relating to the consolidated balance sheets of PHH Corporation and subsidiaries as of April 30, 1994 and 1993, and the related consolidated statements of income, stockholders' equity and cash flows for each of the years in the three-year period ended April 30, 1994, and all related schedules, which report appears in the April 30, 1994 annual report on Form 10-K of PHH Corporation. KPMG PEAT MARWICK Baltimore, Maryland July 29, 1994\nConsolidated Statements of Income\nSee Notes to Consolidated Financial Statements.\nConsolidated Balance Sheets\nSee Notes to Consolidated Financial Statements.\nConsolidated Statements of Cash Flows\nSee Notes to Consolidated Financial Statements.\nConsolidated Statements of Stockholders' Equity\nOTHER ASSETS Other assets at April 30 consisted of the following:\nThe unamortized mortgage servicing fees represent the value of purchased servicing rights and excess servicing fees which are deferred. Such servicing rights and fees are charged to income over the estimated effective life of the related mortgages, estimated to average 6 years. The fair value of excess servicing fees, estimated using discounted cash flows, approximates the carrying amount which was $74,200 and $58,500 at April 30, 1994 and 1993, respectively. Mortgage loans serviced were $16,644,730 and $11,047,284 at April 30, 1994 and 1993, respectively. Intangible assets recognized from acquisitions of relocation services companies are being amortized by the straight-line method over periods ranging from 5 to 10 years. Residential properties held for resale are located primarily in the US and are carried at the lower of cost or resale value. Mortgage-related notes receivable are loans secured by real estate.\nASSETS UNDER MANAGEMENT PROGRAMS\nNet Investment in Leases and Leased Vehicles\nThe net investment in leases and leased vehicles at April 30 consisted of the following:\nThe Company leases vehicles for initial periods of twelve months or more under either direct financing or operating lease agreements. The Company's experience indicates that the full term of the leases may vary considerably due to extensions beyond the minimum lease term. Lessee repayments of investments in leases and leased vehicles for 1994 and 1993 were $1,358,156 and $1,173,994, respectively; and the ratios of such repayments to the average net investment in leases and leased vehicles were 49% in 1994 and 46% in 1993.\nThe Company has two types of operating leases. Under one type, open-end operating leases, resale of the vehicles upon termination of the lease is generally for the account of the lessee except for a minimum residual value which the Company has guaranteed. The Company's experience has been that vehicles under this type of lease agreement have consistently been sold for amounts exceeding the residual value guarantees. Maintenance and repairs of vehicles under these agreements are the responsibility of the lessee. The original cost of vehicles under this type of operating lease at April 30, 1994 and 1993, was $3,538,000 and $3,184,000, respectively.\nUnder the other type of operating lease, closed-end operating leases, resale of the vehicles on termination of the lease is for the account of the Company. The lessee generally pays for or provides maintenance, vehicle licenses and servicing. The original cost of vehicles under these agreements at April 30, 1994 and 1993, was $367,000 and $484,000, respectively. The Company believes adequate reserves are maintained in the event of loss on vehicle disposition.\nUnder the direct financing lease agreements, resale of the vehicles upon termination of the lease is generally for the account of the lessee. Maintenance and repairs of these vehicles are the responsibility of the lessee.\nLeasing revenues are included in revenues from vehicle management services. Following is a summary of leasing revenues for years ended April 30:\nOther managed vehicles are subject to leases serviced by the Company for others, and neither the vehicles nor the leases are included as assets of the Company. The Company receives a financial spread under such agreements which covers or exceeds its cost of servicing. The agreements are made in various ways, some of which entail some risks of accounting loss to the Company, and all of which has been included in its consideration of related reserves.\nThe Company has transferred existing managed vehicles and related leases to unrelated investors and has retained servicing responsibility. Credit risk for such agreements is retained by the Company to a maximum extent in one of two forms: excess assets transferred which were $12,836 and $42,120 at April 30, 1994 and 1993, respectively; or guarantees to a maximum extent of $2,749 and $3,475 at April 30, 1994 and 1993, respectively. All such credit risk has been included in the Company's consideration of related reserves. The outstanding balances under such agreements aggregated $189,480 and $392,642 at April 30, 1994 and 1993, respectively.\nOther managed vehicles with balances aggregating $206,740 and $181,296 at April 30, 1994 and 1993, respectively, are included in special-purpose entities whose ownership is deemed unrelated to the Company and whose credit and residual value risk characteristics are ultimately not the Company's responsibility.\nEquity Advances on Homes\nEquity advances on homes represent advances paid to transferring employees of clients for their equity based on an appraised value of their homes.\nThe Company manages the resale of homes for unrelated investors under its real estate management program in the UK. The Company receives a financial spread under this agreement which covers or exceeds its cost of servicing. The outstanding balance under such agreements aggregated $1,848 and $10,237 at April 30, 1994 and 1993, respectively. The Company retains credit risk to the extent of excess assets sold totaling $1,419 and $3,041 in 1994 and 1993, respectively, which has been included in the Company's consideration of related reserves.\nOther Assets Under Management Programs\nOther assets under management programs represent mortgage-related loans receivable originated by the Company on behalf of corporate clients and secured by real estate. Based on contracts with corporate clients, the Company is generally protected against loss after taking into account all related costs.\nOTHER DEBT\nOther debt at April 30 consisted of the following:\n1994 1993 Commercial paper $ 619,822 $ 411,128 Medium-term note 100,000 100,000 $ 719,822 $ 511,128\nAs more fully described in the Note for Liabilities Under Management Programs, commercial paper is primarily supported by committed one-year and three-year revolving credit agreements. The weighted average interest rate on commercial paper, all of which matures within ninety days, was 4.0% and 3.3% at April 30, 1994 and 1993, respectively. The medium-term note represents an unsecured obligation having a fixed interest rate of 6.5% with interest payable semi-annually and a term of 7 years payable in full in fiscal 2000. At April 30, 1994 and 1993, respectively, the fair value of the medium-term note, estimated from quotes from brokers, was $95,930 and $101,180, respectively.\nINCOME TAXES\nProvisions (credits) for income taxes for the years ended April 30, were comprised as follows:\n1994 1993 1992 Current income taxes: Federal $ 24,316 $ 34,300 $ 24,298 State and local 11,905 9,643 6,233 Foreign 6,663 9,612 11,387 42,884 53,555 41,918\nDeferred income taxes: Federal 7,686 (8,000) (1,280) State and local (3,000) (2,873) (653) Foreign (2,332) (4,861) (6,847) 2,354 (15,734) (8,780) $ 45,238 $ 37,821 $ 33,138\nDeferred income taxes are recorded based upon differences between the financial statements and the tax bases of assets and liabilities and available tax credit carryforwards. There was no valuation allowance relating to deferred tax assets.\nDeferred tax assets (liabilities) as of April 30 were comprised as follows:\n1994 1993 Alternative minimum tax credit carryforwards $ 8,310 $ 43,268 Depreciation (137,602) (167,217) Unamortized mortgage servicing fees (3,033) (6,013) Accrued liabilities and deferred income 38,725 38,716 $ (93,600) $ (91,246)\nThe portions of the 1994 income tax liability and provision classified as current and deferred are subject to final determination based on the actual 1994 income tax returns. The liability and provision amounts for 1993 have been reclassified to reflect the final determination made in filing the 1993 income tax returns.\nThe Company paid income taxes of $35,739 in 1994, $50,092 in 1993, and $42,011 in 1992.\nThe US federal statutory tax rate for the Company was 35% in 1994, and 34% in 1993 and 1992. The effective tax rates on income were 41.2% in 1994, 40.1% in 1993 and 39.9% in 1992. A summary of the reasons for differences between the statutory rate and the Company's effective rate follows:\n1994 1993 1992 Federal income tax statutory rate 35.0% 34.0% 34.0% Increase (decrease) resulting from: State income taxes, net of federal tax effect 5.3 4.7 4.4 Amortization of goodwill 0.7 0.8 0.8 Rate increase - deferred taxes 3.0 - - Adjustment of tax accruals due to completed tax examinations (3.0) - - Foreign tax rates higher than US federal income tax statutory rate - 0.4 0.8 Other 0.2 0.2 (0.1) Effective tax rate 41.2% 40.1% 39.9%\nThe Company's US federal income tax returns have been examined by the Internal Revenue Service through April 30, 1991.\nLIABILITIES UNDER MANAGEMENT PROGRAMS\nBorrowings to fund assets under management programs are classified as \"liabilities under management programs\" and, at April 30, consisted of the following: 1994 1993 Commercial paper $1,513,897 $1,479,671 Medium-term notes 1,143,235 1,031,085 Eurobond - 76,000 Limited recourse debt 9,819 54,693 Secured notes payable on vehicles under lease 34,621 35,893 Other unsecured debt 140,333 223,592 $2,841,905 $2,900,934\nCommercial paper, all of which matures within ninety days, is supported by committed revolving credit agreements described below and short-term lines of credit. The weighted average interest rates on commercial paper were 4.0% and 3.3% at April 30, 1994 and 1993, respectively.\nMedium-term notes represent unsecured loans which mature as follows: $1,043,235 in 1995 and $100,000 in 1997. The weighted average interest rates on medium-term notes were 4.1% and 4.0% at April 30, 1994 and 1993, respectively. At April 30, 1994 and 1993, respectively the fair value of medium-term notes, estimated by obtaining quotes from brokers, was $1,145,800 and $1,041,047.\nLimited recourse debt and secured notes payable on vehicles under lease primarily consist of secured loans arranged for certain clients for their convenience. The lenders hold a security interest in the lease payments and the clients' leased vehicles. The debt and notes payable mature concurrently with the related lease payments. The aggregate lease payments due from the lessees exceed the loan repayment requirements. The weighted average interest rates on secured debt were 4.2% and 3.7% at April 30, 1994 and 1993, respectively.\nThe Company has unsecured committed credit agreements with various banks totaling $2,400,000. These agreements have both fixed and evergreen maturities ranging from June 15, 1994 to April 28, 1997. The evergreen revolving credit agreements require a notice of termination of one to three years. Interest rates under all revolvers are either at fixed rates or vary with prime or the London Interbank Offered Rate. Under these agreements, the Company is obligated to pay annual commitment fees which were $3,975 and $3,954 in 1994 and 1993, respectively. The Company has other unused lines of credit with various banks of $223,000 and $121,000 at April 30, 1994 and 1993, respectively.\nOther unsecured debt, all of which matures in 1995, includes other borrowings under short-term lines of credit and other bank facilities. The weighted average interest rates on unsecured debt were 5.2% and 5.3% at April 30, 1994 and 1993, respectively.\nThe Company employs interest rate swap agreements to match effectively the fixed or floating rate nature of liabilities to the assets funded. The notional amount of outstanding swap agreements is not indicative of the degree of risk of accounting loss. At April 30, 1994 and 1993, the notional amount of swap agreements with commercial and investment banks which effectively converts outstanding short-term, floating rate debt to medium-term, fixed rate debt was $708,368 and $938,624, respectively. The notional amount of swap agreements with commercial and investment banks which effectively converts outstanding medium- term fixed rate debt to short-term floating rate debt was $100,000 and $385,000, at April 30, 1994 and 1993, respectively. The notional amount of swap agreements with commercial and investment banks which effectively converts floating rate debt to floating rate debt based on a different index was $1,040,000 and $713,000 at April 30, 1994 and 1993, respectively. Additionally, the Company has entered into interest rate swap agreements with unrelated investors to whom it has transferred certain managed leases and leased vehicles to effectively convert fixed rate leases into floating rate leases. The notional amount of such swaps is $64,131 and $108,238 at April 30, 1994 and 1993, respectively, against which the Company has in place interest rate swap agreements with commercial and investment banks as discussed above. The fair value of interest rate swaps (used for hedging purposes) is the estimated amount the Company would receive or pay to terminate the swap agreements at April 30,1994 and 1993, respectively, taking into account current interest rates and the current creditworthiness of the swap counterparties. The estimated fair values of the Company's interest rate swaps at April 30, 1994 and 1993, respectively, in a gain position aggregated $5,929 and $15,693, respectively, and in a loss position aggregated $6,064 and $29,854, respectively. 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 Company manages such risk by periodically evaluating the financial condition of counterparties and spreading its positions among multiple counterparties.\nThe Company has entered into foreign exchange contracts as hedges against currency fluctuation on certain intercompany loans. Such contracts effectively offset the currency risk applicable to approximately $85,852 and $231,944 of obligations at April 30, 1994 and 1993, respectively. Market value gains and losses are recognized, and the resulting gains and losses offset foreign exchange gains or losses on such loans. At April 30, 1994 and 1993, respectively, the fair value of the Company's foreign exchange contracts, estimated by obtaining quotes from financial institutions, is a loss position aggregating $260 and $8,587, respectively.\nAlthough the period of service for a vehicle is at the lessee's option, and the period a home is held for resale varies, management estimates, by using historical information, the rate at which vehicles will be disposed and the rate at which homes will be resold. These projections of estimated liquidations of assets under management programs and the related estimated repayment of liabilities under management programs as of April 30, 1994, as set forth in the table below, indicate that the actual repayments of liabilities under management programs will be different than required by contractual maturities.\nAssets Under Liabilities Under Management Programs Management Programs 1995 $ 1,705,609 $ 1,613,423 1996 916,369 743,275 1997 414,997 323,567 1998 132,702 107,523 1999 43,976 34,501 2000-2004 29,361 19,616 $ 3,243,014 $ 2,841,905\nSTOCK OPTION, INVESTMENT AND INCENTIVE PLANS\nThe Company's employee stock option plans allow for options to be granted to key employees for the purchase of common stock at prices not less than fair market value on the date of grant. Either incentive stock options or non- statutory stock options may be granted under the plans. The Company's Directors' stock option plan allows for options to be granted to outside Directors of the Company for the purchase of common stock at prices not less than fair market value on the date of grant. Options become exercisable after one year from date of grant on a vesting schedule provided by the plan and expire either eight or ten years after the date of the grant. Option transactions during 1994, 1993, and 1992 were as follows:\nNumber of Option Price Shares per Share Outstanding April 30, 1991 1,826,925 $18.13 to $39.00 Granted 362,460 $26.25 to $35.88 Exercised (77,148) $18.13 to $34.25 Canceled (159,399) $23.38 to $39.00 Outstanding April 30, 1992 1,952,838 $18.13 to $37.75 Granted 440,500 $33.63 to $39.63 Exercised (372,203) $19.88 to $37.75 Canceled (49,565) $23.38 to $37.75 Outstanding April 30, 1993 1,971,570 $18.13 to $39.63 Granted 199,450 $39.00 to $42.00 Exercised (305,062) $18.13 to $37.75 Canceled (97,785) $27.00 to $39.63 Outstanding April 30, 1994 1,768,173 $19.88 to $42.00 Exercisable April 30, 1994 1,575,723 $19.88 to $41.88\nAt April 30, 1994, there were 1,218,241 shares of common stock reserved, including 889,827 shares for issuance under the employee stock option plans, 265,914 shares for issuance under the employee investment plan and 62,500 shares for issuance under the Directors' stock option plan.\nUnder provisions of the Company's employee investment plan, a qualified retirement plan, eligible employees may generally have up to 10% of their base salaries withheld and placed with an independent custodian and elect to invest in common stock of the Company, an index equity fund, a growth equity fund, an international equity fund, a fixed income fund, an asset allocation fund and\/or a money market fund. The Company's contributions vest proportionately in accordance with an employee's years of vesting service, with an employee being 100% vested after three years of vesting service. For 1991 and prior years, the Company matched, in common stock of the Company, employees' contributions to 6% of their base salaries. Beginning in 1992 and thereafter, the Company matches, in common stock of the Company, employee contributions to 3%, with an additional 3% match available at the end of the year based on the Company's operating results. In 1994 and 1993, the Company made an additional match of 50% of employee contributions greater than 3% up to 6%. The additional match, initially invested in a money market fund, can be redirected by the employee into any of the investment elections noted above. No additional match was made in 1992. The Company's expenses for contributions included in selling, general and administrative expenses were $4,020, $3,662, and $2,450 for the years ended April 30, 1994 and the two preceding years, respectively.\nThe Company has incentive compensation plans for certain key employees. The plans provide for the payment of cash bonuses or, in some instances, stock incentives, based upon the achievement of predetermined performance objectives. The related expense included in selling, general and administrative expenses for 1994, 1993 and 1992 was $6,086, $5,659 and $1,861, respectively.\nSTOCK RIGHTS\nOn March 17, 1986, the Company declared a dividend of one preferred share purchase right for each share of common stock outstanding on April 11, 1986. The Company adopted an amendment to its rights agreement January 16, 1989. Each right entitles the holder to purchase 1\/100th of a share of series A Junior Participating Preferred Stock at an exercise price of $120. The rights become exercisable in the event any party acquires or announces an offer to acquire 20% or more of the Company's common stock. The rights expire April 10, 1996, and are redeemable at $.05 per right prior to the time any party owns 20% or more of the Company's outstanding common stock. In the event the Company enters into a consolidation or merger after the time rights are exercisable, the rights provide that the holder will receive, upon exercise of the right, shares of common stock of the surviving company having a market value of twice the exercise price of the right. Until the earlier of the time the rights become exercisable, are redeemed or expire, the Company will issue one right with each new share of common stock issued. The Company has designated 200,000 shares of the authorized preferred shares as series A Junior Participating Preferred Stock for issuance upon exercise of the rights.\nPENSION AND OTHER EMPLOYEE BENEFIT PLANS\nPension Plans\nThe Company has a non-contributory defined benefit pension plan covering substantially all US employees of the Company and its subsidiaries. The Company's subsidiary located in the UK has a contributory defined benefit pension plan, with participation at the employee's option. Under both the US and UK plans, benefits are based on an employee's years of credited service and a percentage of final average compensation. The Company's policy for both plans is to contribute amounts sufficient to meet the minimum requirements plus other amounts as the Company deems appropriate from time to time.\nPension cost for both plans for 1994, 1993, and 1992 included the following components:\n1994 1993 1992 Service cost--benefits earned $ 4,514 $ 3,760 $ 3,477 Interest cost on projected benefit obligation 5,259 4,559 4,126 Actual return on assets (2,049) (3,959) (4,250) Net amortization and deferral (2,620) (377) 207 Net pension cost $ 5,104 $ 3,983 $ 3,560\nThe following table provides a reconciliation of the actuarial present value of projected benefit obligation for the plans in 1994 and 1993 and the Company's recorded pension liability recognized in the Consolidated Balance Sheets at April 30, 1994 and 1993:\n1994 1993 Accumulated benefit obligation: Vested $ 40,681 $ 36,035 Unvested 7,072 6,073 $ 47,753 $ 42,108\nProjected benefit obligation $ 71,571 $ 63,199 Funded assets, at fair value (53,177) (48,212) Unrecognized net loss from past experience different from that assumed and effects of changes in assumptions (11,528) (7,082) Unrecognized prior service cost 129 (882) Unrecognized net (obligation) asset (29) 19 Recorded liability $ 6,966 $ 7,042\nPlan assets are primarily invested in marketable securities.\nSupplemental Retirement Plans\nThe Company also sponsors two unfunded supplemental retirement plans to provide certain key executives with benefits in excess of limits under the federal tax law and to include annual incentive payments in benefit calculations.\nThe cost of these plans in 1994, 1993 and 1992 included the following components:\n1994 1993 1992 Service cost--benefits earned $ 90 $ 44 $ 7 Interest cost on projected benefit obligation 922 824 781 Net amortization and deferral 570 445 409 $ 1,582 $ 1,313 $ 1,197\nThe following table provides a reconciliation of the actuarial present value of projected benefit obligation for the plans and the Company's recorded liability as reported in the Consolidated Balance Sheets at April 30, 1994 and 1993:\n1994 1993 Accumulated benefit obligation Vested $ 8,202 $ 7,407 Unvested 1,445 1,077 $ 9,647 $ 8,484\nProjected benefit obligation $ 13,466 $ 10,656 Unrecognized net obligation (1,856) (2,088) Unrecognized prior service cost (2,941) (1,034) Minimum liability adjustment 2,562 2,464 Unrecognized net loss (1,584) (1,514) Recorded liability $ 9,647 $ 8,484\nIn accordance with SFAS No. 87, $2,562 and $2,464 of additional minimum liability is included in the recorded liability in 1994 and 1993, respectively, to provide a total liability that is at least equal to the unfunded accumulated benefit obligation. The Company recorded an intangible asset of the same amount which is included in the Consolidated Balance Sheets.\nAssumptions\nCertain assumptions were used in determining the cost and related obligations under the US pension and unfunded supplemental retirement plans as follows:\n1994 1993 1992 Percent Pension Cost: Discount rate 8.25 8.75 9.00 Rate of increase in compensation 5.00 5.00 5.50 Long-term rate of return on assets 10.00 10.00 10.00 Pension Obligation: Discount rate 8.25 8.25 8.75 Rate of increase in compensation 5.00 5.00 5.00 Postretirement Benefits Other Than Pensions\nEffective May 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires accrual accounting for postretirement benefits other than pensions. The Company provides healthcare and life insurance benefits for certain retired employees up to the age of 65. Prior to adoption of SFAS No. 106, the Company recognized the costs of these benefits by expensing the benefits as paid. The aggregate costs of such benefits did not exceed $500 in 1993 or 1992.\nThe Company has elected to recognize the cost of its transition obligation (the accumulated postretirement benefit obligation as of May 1, 1993) by amortizing it on a straight-line basis over 20 years. The Company's SFAS No. 106 obligation and cost are based on a discount rate of 8.25%. The assumed rate of increase in healthcare costs (healthcare cost trend rate) was 12% in 1994, decreasing to 10% in 1995 and gradually decreasing to 4.75% by 2004. Increasing the healthcare cost trend rates of future years by one percentage point would increase the accumulated postretirement benefit obligation by $560 and would increase annual aggregate service and interest costs by $161.\nNet periodic postretirement benefits costs for 1994 included the following components:\nService cost - benefits earned during period $ 788 Interest cost on accumulated postretirement benefit obligation 469 Amortization of the unrecognized transition obligation 294 Net periodic postretirement benefit cost $ 1,551\nStatus of Plan Accumulated postretirement benefit obligation: Active employees fully eligible for benefits $ 5,361 Current retirees 1,599 6,960 Unrecognized transition obligation (5,583) Recorded liability $ 1,377\nLEASE COMMITMENTS\nTotal rental expenses relating to office facilities and equipment were $27,264, $25,368, and $25,994 for 1994, 1993 and 1992, respectively. Minimum rental commitments under non-cancelable leases with remaining terms in excess of one year are as follows:\n1995 $ 15,037 1998 $ 7,970 1996 $ 13,004 1999 $ 4,703 1997 $ 9,303 2000-2004 $ 13,942 2005 & thereafter $ 1,863\nThese leases provide for additional rentals based on the lessors' increased property taxes, maintenance and operating expenses.\nACQUISITION\nIn 1994 the Company purchased all of the outstanding stock of a Canadian relocation company. The acquisition was accounted for as a purchase and is not material to the consolidated financial statements.\nCONTINGENT LIABILITIES\nThe Company and its subsidiaries are involved in pending litigation of the usual character incidental to the business transacted by them. In the opinion of management, such litigation will not have a material effect on the Company's consolidated financial statements.\nThe Company is contingently liable under the terms of an agreement involving its discontinued aviation services segment for payment of Industrial Revenue Bonds issued by local governmental authorities operating at three airports, as well as guarantor on a note associated with the buyer of one office closed as part of its disposition of its facilities management services segment. The Company believes its allowance for disposition loss is sufficient to cover all potential liability.\nBUSINESS SEGMENTS\nThe Company operations are classified into three business segments: vehicle management services, relocation and real estate services and mortgage banking services. In the selected information by business segment and geographic area which follows, previously reported operating income has been replaced by income before income taxes to reflect the retroactive reclassification of \"Other expense, net\" to \"Selling, general and administrative\" expenses. Further, Canadian information has been combined with that of the United States to reflect the Company's North American management structure. Additionally, minor adjustments have been made to the methodology applied in allocating certain income and expense items. None of these changes had a significant effect on the information presented.\nBusiness Segments\nQUARTERLY FINANCIAL DATA (UNAUDITED)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information with respect to the Directors is contained on pages 2 through 6 of the Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders, which information is hereby incorporated by reference. EXECUTIVE OFFICERS OF THE REGISTRANT\nOfficers are elected by the Board of Directors to serve at the pleasure of the Board. There is no family relationship between any of such persons. Each of the persons named above has been employed by the Company or one of its subsidiaries for more than the past five years except Mr. Mitchell, who was Vice President, Finance for Household International Corporation and Vice President and Treasurer for Household Finance Corporation. ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION Information with respect to executive compensation is contained on pages 9 through 17 of the Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders, which information is hereby incorporated by reference. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information with respect to security ownership of certain beneficial owners and management is contained on pages 7, 8 and 9 of the Registrant's Proxy Statement for its 1994 Annual Meeting of Stockholders, which information is hereby incorporated by reference. ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(b) Reports on Form 8-K--There were no filings on Form 8-K during the fourth quarter of fiscal 1994.\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. PHH CORPORATION By ROBERT D. KUNISCH Robert D. Kunisch Chairman of the Board, Chief Executive Officer 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 dates indicated: Principal Executive Officer:\nPrincipal Financial Officer:\nPrincipal Accounting Officer:\nMajority of the Board of Directors: Robert D. Kunisch, James S. Beard, Andrew F. Brimmer, George L. Bunting, Jr., Barbara S. Feigin, Paul X. Kelley, Thomas V. King, L. Patton Kline, Francis P. Lucier, Kent C. Nelson, Alexander B. Trowbridge\nPHH CORPORATION AND SUBSIDIARIES SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED APRIL 30, 1994, 1993 AND 1992\nNOTES:(a) Amounts relate to acquisitions, divestitures and reclassifications of prior year amounts. (b) Deductions from reserves represent accounts charged off, less recoveries, and foreign translation gains and losses.\nPHH CORPORATION AND SUBSIDIARIES SCHEDULE IX--SHORT-TERM BORROWINGS FOR THE YEARS ENDED APRIL 30, 1994, 1993, AND 1992 (THOUSANDS OF DOLLARS)\n(a) The average amount outstanding during the period is the average of the daily balances. The weighted average interest rate during the period is determined by dividing interest expense related to short-term borrowings by the average of the daily balances. (b) Commercial paper is supported by long-term revolving credit agreements and short-term lines of credit.","section_15":""}
{"filename":"26058_1994.txt","cik":"26058","year":"1994","section_1":"Item 1. Business\nINTRODUCTION AND GENERAL DEVELOPMENT OF BUSINESS\nThe registrant, CTS Corporation (CTS or Company), is an Indiana corporation incorporated in 1929 as a successor to a company started in 1896. CTS' principal executive offices are located at 905 West Boulevard North, Elkhart, Indiana 46514, telephone number (219) 293-7511.\nCTS designs, manufactures and sells electronic components. The engineering and manufacturing of CTS products is performed at 16 facilities worldwide. CTS products are sold through sales engineers, sales representatives, agents and distributors.\nIn March 1987, a settlement was announced between CTS and Dynamics Corporation of America (DCA), terminating the sale process of the Company and resolving all disputes between CTS and DCA. Subsequently, the United States Supreme Court held that the Control Share Acquisition Chapter of the Indiana Business Corporation Law was constitutional. As a result of the Court's decision, the issue of voting rights of 1,020,000 shares of CTS common stock acquired by DCA in 1986 was submitted to a vote of CTS stockholders at the 1987 annual meeting. The affirmative vote of the majority of all shares eligible to vote was necessary to grant voting rights. DCA was not eligible to vote on the issue. The stockholders voted not to grant voting rights to DCA on these shares. The Court's decision did not have an impact on the voting rights in additional shares of CTS common stock previously or subsequently acquired by DCA. In May 1988, the settlement agreement expired pursuant to its terms. At the end of 1994, DCA owned 2,222,100 shares (42.9%) of CTS common stock, including the 1,020,000 shares without voting rights.\nIn January 1990, the Company formally announced the closing of its Switch Division located in Paso Robles, California. The Paso Robles manufacturing operations were relocated to the Company's facilities in Taiwan and Bentonville, Arkansas. During 1992, the Company completed the sale of the Paso Robles manufacturing plant and most of the associated real estate for $1.9 million. A pretax-tax gain of $0.9 was realized from the sale. The manufacturing operations for certain variable resistor and selector switch products, which formerly were performed in Elkhart, Indiana, were also transferred to Bentonville in 1990, to take advantage of any efficiencies to be gained in consolidating such operations in Bentonville. The buildings located in Elkhart which housed the plastics molding, and element production, were vacated, with these manufacturing operations being consolidated into the main Elkhart plant.\nCTS announced in July 1990 that its facility near Glasgow, Scotland, would be expanded in order to manufacture and sell additional electronic products in Europe. The total capital investment has been approximately $11 million as of December 31, 1994. Automotive throttle position sensors and precision and clock oscillators were added to the product lines already manufactured in Scotland. The decision to expand the Scottish facility was based on several factors, including the excellent business climate and skills base in Scotland and the anticipated full participation of the United Kingdom in the European Economic Community. The expansion of the Scotland facility represents a major effort by CTS to serve the large and rapidly growing European market on a direct basis.\nIn November 1991, construction was completed on a 53,000 square foot manufacturing facility in Bangkok, Thailand. During 1992, the Company idled operations at this facility. During 1994, a three- year lease was finalized with an international computer peripheral manufacturer for this property. The annual rental amount is approximately U.S. $345,000.\nAlso during 1991, the Company significantly reduced the operating activities at its Brownsville, Texas, facility and plans to sell this property. A portion of the Brownsville facility is currently under a leasing arrangement which expires in 1999, at an annual rental amount of approximately $60,000.\nThe manufacturing space owned by CTS in Hong Kong, which consisted of two floors in a multi-story building, was sold in March 1991. One floor was leased back by CTS for the continuation of its manufacturing operations in Hong Kong. During 1992, the Company terminated this lease and discontinued its manufacturing operations in Hong Kong.\nDuring 1994, the Company purchased the assets of AT&T Microelectronics' light emitting diode based optic data link products business. The transaction also included sales contracts, backlog, intellectual property, trademarks, and the design and manufacturing technology. These products will be manufactured in the Microelectronics West Lafayette, Indiana, facility.\nFINANCIAL INFORMATION ON INDUSTRY SEGMENTS\nAll of the Company's products are considered one industry segment. Sales to unaffiliated customers, operating profit and identifiable assets, by geographic area, are contained in \"Note I - Business Segment and Non-U.S. Operations,\" pages 21-23, of the CTS Corporation 1994 Annual Report, and is incorporated herein by reference.\nPRINCIPAL BUSINESS AND PRODUCTS OF CTS\nCTS is primarily in the business of developing, manufacturing and selling a broad line of electronic components principally serving the electronic needs of original equipment manufacturers (OEMs).\nThe Company sells classes of similar products consisting of the following:\nAutomotive control devices Loudspeakers Electronic connectors Programmable switches Frequency control devices Resistor networks Hybrid microcircuits Selector switches Industrial electronics Variable resistors\nMost products within these product classes are manufactured by CTS from purchased raw materials or subassemblies. Some products sold by CTS are purchased and resold under the Company's name.\nDuring the past three years, five classes of similar product lines accounted for 10% or more of consolidated revenue during one or more years, as follows:\nPercent of Consolidated Revenue Class of Similar Products 1994 1993 1992\nAutomotive Control Devices 30 26 20 Electronic Connectors 17 14 17 Frequency Control Devices 15 15 17 Resistor Networks 11 14 16 Hybrid Microcircuits 10 14 11 Other 17 17 19\nTotal 100% 100% 100%\nMARKETS\nCTS estimates that its products have been sold in the following segments of the electronics OEM and distribution markets and in the following percentages during the preceding three fiscal years:\nPercent of Consolidated Revenue Markets 1994 1993 1992\nAutomotive 38 32 25 Data Processing 17 22 20 Communications Equipment 17 17 18 Defense and Aerospace 11 12 17 Instruments and Controls 9 9 12 Distribution 5 4 5 Consumer Electronics 3 4 3\nTotal 100% 100% 100%\nProducts for the automotive market include throttle position sensors, switch assemblies for operator interface, exhaust gas recirculation subsystems, variable resistors and switches for automotive entertainment systems and other applications, and loudspeakers.\nProducts for the data processing market include resistor networks, frequency control devices, programmable switches and hybrid microcircuits. Products for this market are principally used in computers and computer peripheral equipment.\nIn the communications equipment market, CTS products include frequency control devices, hybrid microcircuits, switches and resistor networks. Products for this market are principally used in telephone equipment and in telephone switching systems.\nCTS products for the defense and aerospace market, usually procured through government contractors or subcontractors, are electronic connectors, hybrid microcircuits, backpanels, frequency control devices and programmable key storage devices.\nProducts for the instruments and controls market include hybrid microcircuits, variable resistors and switches. Principal end uses are medical electronic devices and electronic testing, measuring and servicing instruments.\nIn the distribution market, CTS' primary products include program- mable switches, resistor networks and frequency control devices. In this market, standard CTS products are sold for a wide variety of applications.\nProducts for the consumer electronics market, primarily variable resistors and switches, are principally used in home entertainment equipment and appliances.\nMARKETING AND DISTRIBUTION\nSales of CTS electronic components to original equipment manufacturers are principally by CTS sales engineers and manufacturers' representatives. CTS maintains sales offices in Elkhart, Indiana; Detroit, Michigan; and in the United Kingdom, Hong Kong, Taiwan and Japan. Various regions of the United States are serviced by sales engineers working out of their homes. The sale of electronic components is relatively integrated such that most of the product lines of CTS are sold through the same field sales force. Approximately 40% of net sales in 1994 were attributable to coverage by CTS sales engineers.\nGenerally, CTS sales engineers service the Company's largest customers with application specific products. CTS sales engineers work closely with major customers in determining customer require- ments and in designing CTS products to be provided to such customers.\nCTS uses the services of independent sales representatives and distributors in the United States and other countries for customers not serviced by CTS sales engineers. Sales representatives receive commissions from CTS. During 1994, about 55% of net sales were at- tributable to coverage by sales representatives. Independent distributors purchase products from CTS for resale to customers. In 1994, independent distributors accounted for about 5% of net sales.\nRAW MATERIALS\nGenerally, CTS' major raw materials are steel, copper, brass, certain precious metals, resistive and conductive inks, passive components and semiconductors, used in several CTS products; ceramic materials used particularly in resistor networks and hybrid microcircuits; synthetic quartz used in frequency control devices; and laminate material used in printed circuit boards. These raw materials are purchased from several vendors, and except for certain semiconductors, CTS does not believe that it is dependent on one or on a very few vendors. In 1994, all of these materials were available in adequate quantities to meet CTS' production demands.\nThe Company does not presently anticipate any raw material short- ages which would significantly affect production. However, the lead times between the placement of orders for certain raw mater- ials and actual delivery to CTS are quite variable, and the Company may from time to time be required to order raw materials in quantities and at prices less than optimal to compensate for the variability of lead times for delivery.\nPrecious metals prices have a significant effect on the manufactur- ing cost and selling prices of many CTS products, particularly some programmable switches, electronic connectors and resistor networks. CTS has continuing programs to reduce the precious metals content of several products, when consistent with customer specifications.\nWORKING CAPITAL\nCTS does not usually buy inventories or manufacture products without actual or reasonably anticipated customer orders, except for some standard, off-the-shelf distributor products. The Company is not generally required to carry significant amounts of inven- tories to meet rapid delivery requirements because most customer orders are for custom products. CTS has entered into \"just-in- time\" arrangements with certain major customers in order to meet customers' just-in-time delivery needs.\nCTS carries raw materials, including certain semiconductors, and certain work-in-process and finished goods inventories which are unique to a particular customer or to a small number of customers, and in the event of reductions in or cancellations of orders, some inventories are not useable or cannot be returned to vendors for credit. CTS generally imposes charges for the reduction or cancellation of orders by customers, and these charges are usually sufficient to cover the financial exposure of CTS to inventories which are unique to a customer. CTS does not customarily grant special return privileges or payment privileges to customers, although CTS' distributor program permits certain returns. CTS' working capital requirements are generally cyclical but not seasonal.\nWorking capital requirements are generally dependent on the overall business level. During 1994, working capital increased significantly to $65.9 million, as receivables and inventories increased in response to the greater sales. Also, short-term debt was reduced, generally being replaced by long-term obligations at relatively more favorable borrowing rates. Cash represents a significant part of the Company's working capital. Cash of various non-U.S. subsidiaries was held in U.S.-denominated cash equivalents at December 31, 1994. The cash, other than approximately $4.6 million, is generally available to the parent Company.\nPATENTS, TRADEMARKS AND LICENSES\nCTS maintains a program of obtaining and protecting U.S. and non- U.S. patents and trademarks. CTS believes that the success of its business is not materially dependent on the existence or duration of any patent, group of patents or trademarks.\nCTS licenses the manufacture of several electronic products to companies in the United States and non-U.S. countries. In 1994 license and royalty income was less than 1% of net sales. CTS believes that the success of its business is not materially dependent upon any licensing arrangement where CTS is either the licensor or licensee.\nMAJOR CUSTOMERS\nCTS' 15 largest customers represented about 62%, 62% and 58% of net sales in 1994, 1993 and 1992, respectively.\nOf the net sales to unaffiliated customers, approximately $49.4 million, $40.1 million and $30.7 million were derived from sales to General Motors Corporation in 1994, 1993 and 1992, respectively. During 1993 and 1992, $24.0 million and $19.3 million were derived from sales to International Business Machines Corporation. However, during 1994 sales to this customer decreased to $4.4 million. CTS is dependent upon these and other customers for a significant percentage of its sales and profits, and the loss of one or more of these customers or reduction of orders by one or more of these customers could have a materially adverse effect upon the Company.\nBACKLOG OF ORDERS\nBacklog of orders does not necessarily provide an accurate indica- tion of present or future business levels for CTS. For many electronic products, the period between receipt of orders and delivery is relatively short. For large orders from major customers that may constitute backlog over an extended period of time, production scheduling and delivery are subject to change or cancellation by the customers on relatively short notice. At the end of 1994, the Company's backlog of orders was $82.7 million, compared with $70.5 million at the end of 1993. This increase was primarily attributable to increased demand from automotive and microelectronics customers.\nThe backlog of orders at the end of 1994 will generally be filled during the 1995 fiscal year.\nGOVERNMENT CONTRACTS\nCTS believes that about 11% of its net sales are associated with purchases by the U.S. Government or non-U.S. governments, principally for defense and aerospace applications. Because most CTS products procured through government contractors and subcontractors are for military end uses, the level of defense and aerospace market sales by CTS is dependent upon government budgeting and funding of programs utilizing electronic systems.\nAlmost all CTS sales involving government purchases are to primary government contractors or subcontractors. CTS is usually subject to contract provisions permitting termination of the contract, usually with penalties payable by the government; maintenance of specified accounting procedures; limitations on and renegotiations of profits; priority production scheduling; and possible penalties or fines against CTS for late delivery or substandard quality. Such contract provisions have not previously resulted in material uncertainties or disruptions for CTS.\nCOMPETITION\nCTS competes with many domestic and non-U.S. manufacturers prin- cipally on the basis of product features, price, engineering, quality, reliability, delivery and service. Most product lines of CTS encounter significant competition. The number of significant competitors varies from product line to product line. No single competitor competes with CTS in every product line, but many com- petitors are larger and more diversified than CTS. Some com-\npetitors are divisions or affiliates of customers. CTS is subject to competitive risks typical in the electronics industry such as shorter product life cycles and new products causing existing products to become obsolete.\nSome customers have reduced or plan to reduce the number of suppliers while increasing the volume of purchases from independent suppliers. Most customers are demanding higher quality, reliability and delivery standards from CTS as well as competitors. These trends may create opportunities for CTS while also increasing the risk of loss of business to competitors.\nThe Company believes that it competes most successfully in custom products manufactured to meet specific applications of major original equipment manufacturers.\nCTS believes that it has some advantages over certain competitors because of its ability to apply a broad range of technologies and materials capabilities to develop products for the special require- ments of customers. CTS also believes that it has an advantage over some competitors in its capability to sell a broad range of products manufactured to relatively consistent standards of quality and delivery. CTS believes that the relative breadth of its product lines and relative consistency in quality and delivery across product lines is an advantage to CTS in selling products to customers.\nCTS believes that it is one of the largest manufacturers of automotive throttle position sensors.\nFINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES\nInformation about revenue from sales to unaffiliated customers, operating profit and identifiable assets, by geographic area, is contained in \"Note I - Business Segment and Non-U.S. Operations,\" pages 21-23, of the CTS Corporation 1994 Annual Report, and is incorporated herein by reference.\nIn 1994, approximately 34% of net sales to unaffiliated customers, after eliminations, were attributable to non-U.S. operations. This represents an increase from 28% of net sales attributable to non- U.S. operations in 1993. About 32% of total CTS assets, after eliminations, are non-U.S. Except for cash and equivalents, a substantial portion of these assets cannot readily be liquidated. CTS believes that the business risks attendant to its present non- U.S. operations, though substantial, are normal risks for non-U.S. businesses, including expropriation, currency controls and changes in currency exchange rates and government regulations.\nRESEARCH AND DEVELOPMENT ACTIVITIES\nIn 1994, 1993 and 1992, CTS spent $7.1, $5.7 and $6.1 million, respectively, for research and development. Most CTS research and development activities relate to new product and process develop- ments or the improvement of product materials. Many such research and development activities are for the benefit of one or a limited number of customers or potential customers.\nDuring 1994, except for the purchase of the light emitting diode based optic data link products assets, the Company did not enter into any new, significant product lines, but continued to introduce additional versions of existing products in response to present and future customer requirements.\nENVIRONMENTAL PROTECTION LAWS\nIn complying with federal, state and local environmental protection laws, CTS has modified certain manufacturing processes and expects to continue to make additional modifications. Such modifications that have been performed have not materially affected the capital expenditures, earnings or competitive position of CTS.\nCertain processes in the manufacture of the Company's current and past products create hazardous waste by-products as currently defined by federal and state laws and regulations. The Company has been notified by the U.S. Environmental Protection Agency, state environmental agencies and, in some cases, generator groups, that it is or may be a Potentially Responsible Party (PRP) regarding hazardous waste remediation at several non-CTS sites. The factual circumstances of each site are different; the Company has determined that its role as a PRP with respect to these sites, even in the aggregate, will not have a material adverse effect on the Company's business or financial condition, based on the following: 1) the Company's status as a de minimis party; 2) the large number of other PRPs identified; 3) the identification and participation of many larger PRPs who are financially viable; 4) defenses concerning the nature and limited quantities of materials sent by the Company to certain of the sites; and 5) the Company's experience to-date in relation to the determination of its allocable share. In addition to these non-CTS sites, the Company has an ongoing practice of providing reserves for probable remediation activities at certain of its manufacturing locations and for claims and proceedings against the Company with respect to other environmental matters. In the opinion of management, based upon presently available information, either adequate provision for probable costs has been made, or the ultimate costs resulting will not materially affect the consolidated financial position or results of operations of the Company.\nThere are claims against the Company with respect to environmental matters which the Company contests. In the opinion of management, based upon presently available information, either adequate provision for potential costs has been made, or the costs which ultimately might result will not materially affect the consolidated financial position or results of operations of the Company.\nEMPLOYEES\nCTS employed an average of 4,056 persons during 1994. About 45% of these persons were employed outside the United States at the end of 1994. Approximately 370 employees in the United States were covered by collective bargaining agreements as of December 31, 1994. One of the two collective bargaining agreements covering these employees will expire in 1995. The other agreement will expire in 1999.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nCTS operations or facilities are at the following locations. The owned properties are not subject to material liens or encumbrances.\nLocation\nElkhart, IN 521,813 Owned - Berne, IN 248,726 Owned - Singapore 158,926 Owned* - Kaohsiung, Taiwan 132,887 Owned* - Streetsville, Ontario, Canada 111,740 Owned - West Lafayette, IN 105,983 Owned - Sandwich, IL 94,173 Owned - Brownsville, TX 84,679 Owned - Bentonville, AR 72,000 Owned - Glasgow, Scotland 75,000 Owned - New Hope, MN 55,000 Leased December (Science Center Dr.) 1998 Bangkok, Thailand 53,000 Owned - Matamoros, Mexico 50,590 Owned* - Baldwin, WI 39,050 Owned - Cokato, MN 36,000 Owned - Burlington, WI 5,000 Leased March\nTOTAL 1,844,567\n* Buildings are located on land leased under renewable leases.\nThe Company is currently seeking to sell some, or all, of the Streetsville, Ontario, Canada, facility and related property, and the Brownsville, Texas, manufacturing building. A portion of the Brownsville facility is currently under a leasing arrangement which expires in 1999. The annual rental income is approximately $60,000. Also, a portion of the New Hope, Minnesota, facility is currently under a sublease arrangement, which expires in 1998. The annual rental income is approximately $88,400.\nThe Company constructed the Bangkok, Thailand, facility during 1991. This facility was idled during 1992 and was idle for all of 1993. During 1994, the Company entered a three-year lease on this property at an annual rental amount of approximately U.S. $345,000.\nThe Company regularly assesses the adequacy of its manufacturing facilities for manufacturing capacity, available labor and location to the markets and major customers for the Company's products. CTS also reviews the operating costs of its facilities and may from time to time relocate facilities or certain manufacturing activities in order to achieve operating cost reductions and improved asset utilization and cash flow.\nItem 3.","section_3":"Item 3. Legal Proceedings\nContested claims involving various matters, including environmental claims brought by government agencies, are being litigated by CTS, both in legal and administrative forums. In the opinion of management, based upon currently available information, adequate provision for potential costs has been made, or the costs which might ultimately result from such litigation or administrative proceedings will not materially affect the consolidated financial position of the Company or the results of operations.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of 1994, no issue was submitted to a vote of CTS stockholders.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe principal market for CTS common stock is the New York Stock Exchange. Information relative to the high and low trading prices for CTS Common Stock for each quarter of the past two years and the frequency and amount of dividends declared during the previous two years can be located in \"Stockholder Information,\" page 10, of the CTS Corporation 1994 Annual Report, incorporated herein by reference. On March 10, 1995, there were approximately 1,120 holders of record of CTS common stock.\nThe Company intends to continue a policy of considering dividends on a quarterly basis. The declaration of a dividend and the amount of any such dividend are subject to earnings, anticipated working capital, capital expenditure and other investment requirements, the financial condition of CTS and such other factors as the Board of Directors deems relevant.\nItem 6.","section_6":"Item 6. Selected Financial Data\nA summary of selected financial data for CTS, for each of the previous five fiscal years, is contained in the \"Five-Year Summary,\" page 11, of the CTS Corporation 1994 Annual Report, incorporated herein by reference.\nCertain divestitures and closures of businesses and certain accounting changes affect the comparability of information con- tained in the \"Five-Year Summary.\"\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nInformation about liquidity, capital resources and results of operations, for the three previous fiscal years, is contained in \"Management's Discussion and Analysis of Financial Condition and Results of Operations (1992-1994),\" pages 25-27, of the CTS Corporation 1994 Annual Report, incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nConsolidated financial statements, meeting the requirements of Regulation S-X, and the Report of Independent Accountants, are contained in pages 12-24 of the CTS Corporation 1994 Annual Report, incorporated herein by reference. Quarterly per share financial data is provided in \"Stockholder Information,\" under the subheadings, \"Quarterly Results of Operations\" and \"Per Share Data,\" on page 10 of the CTS Corporation 1994 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\nThere were no disagreements.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nInformation responsive to Items 401(a) and 401(e) of Regulation S-K pertaining to directors of CTS is contained in the 1995 Proxy Statement under the caption \"Election of Directors,\" page 6, filed with the Securities and Exchange Commission, and is incorporated herein by reference.\nInformation responsive to Item 405 of Regulation S-K pertaining to compliance with Section 16(a) of the Securities Exchange Act of 1934 is contained in the 1995 Proxy Statement under the caption \"Compliance with Section 16(a) of the Securities Exchange Act of 1934,\" page 7, filed with the Securities and Exchange Commission, and is incorporated herein by reference.\nThe individuals listed were elected as executive officers of CTS at the annual meeting of the Board of Directors on April 29, 1994, and are expected to serve as executive officers until the next annual meeting of the Board of Directors, scheduled on April 28, 1995, at which time the election of officers will be considered again by the Board of Directors.\nName Age Position and Offices\nJoseph P. Walker 56 Director, Chairman, President and Chief Executive Officer Philip T. Christ 63 Group Vice President Stanley J. Aris 54 Vice President Finance and Chief Financial Officer Jeannine M. Davis 46 Vice President, Secretary and General Counsel James L. Cummins 39 Vice President Human Resources George T. Newhart 52 Corporate Controller Gary N. Hoipkemier 40 Treasurer James N. Hufford 55 Vice President Research, Development and Engineering Donald R. Schroeder 46 Vice President Sales and Marketing\nJoseph P. Walker has served as Chairman of the Board, President and Chief Executive Officer of CTS since 1988. Mr. Walker is a Director of NBD Bank, N.A.\nPhilip T. Christ has served as Group Vice President since 1990. Mr. Christ served as a Senior Vice President at Simplex Time Recorder from 1976-1986.\nStanley J. Aris has served as Vice President, Finance and Chief Financial Officer since May 18, 1992. Prior to joining CTS, Mr. Aris worked for two years as a business consultant. From 1989 to 1990 Mr. Aris served as Vice President, Finance of Hypres Corporation.\nJeannine M. Davis has served as Vice President, General Counsel and Secretary since 1988. Between 1980 and 1988, she served as legal counsel, Assistant Secretary, Assistant General Counsel and General Counsel of the Corporation.\nJames L. Cummins was elected Vice President Human Resources on February 25, 1994. Prior to this appointment, he served as Director, Human Resources, CTS Corporation from 1991-1994. From 1990-1991, Mr. Cummins served as Human Resources Director, CTS Corporation Electromechanical Group and in 1991 was appointed Assistant Human Resources Director, CTS Corporation.\nGeorge T. Newhart has served as Corporate Controller since 1989. Prior to joining the Company in June 1989, he was Chief Financial and Administrative Officer of the Chelsea Electronic Distribution Group from 1987-1989.\nGary N. Hoipkemier has served as Treasurer since 1989. He served as Chief Financial Officer of Riblet Products Corporation from 1988-1989.\nJames N. Hufford was elected Vice President Research, Development and Engineering on February 17, 1995. During the four years prior to this appointment, Mr. Hufford served as Manager and then Director of Corporate Research, Development and Engineering for the Corporation. From 1981 through 1991, Mr. Hufford held key engineering positions at the Corporation's Elkhart manufacturing facility.\nDonald R. Schroeder was elected Vice President Sales and Marketing on February 17, 1995. During the six years prior to this appointment, Mr. Schroeder served as Business Development Manager for innovative and new technology for the CTS Microelectronics business unit in West Lafayette, Indiana. Prior to 1989, Mr. Schroeder held several other management and marketing positions with various operating units of the Corporation.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation responsive to Item 402 of Regulation S-K pertaining to management remuneration is contained in the 1995 Proxy Statement in the captions \"Executive Compensation,\" pages 8-9 and \"Director Compensation,\" page 14, filed with the Securities and Exchange Commission, and is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation responsive to Item 403 of Regulation S-K pertaining to security ownership of certain beneficial owners and management is contained in the 1995 Proxy Statement in the caption \"Securities Beneficially Owned by Principal Stockholders and Management,\" pages 3-5 filed with the Securities and Exchange Commission, and is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nDynamics Corporation of America (DCA) owned 2,222,100 (42.9%) of the Company's outstanding common stock as of December 31, 1994. CTS purchased products from DCA totalling about $233,000 in 1994, $145,000 in 1993 and $93,000 in 1992, principally consisting of certain component parts used by CTS in the manufacture of frequency control devices. CTS had minimal sales to DCA in 1994, and no sales in 1993 and 1992.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) (1) and (2)\nThe list of financial statements and financial statement schedules required by Item 14 (a)(1) and (2) is contained on page S-1 herein.\n(a)(3) Exhibits\n(3)(a) Articles of Incorporation, as amended April 16, 1973, previously filed as exhibit (3)(a) to the Company's Form 10-K for 1987, and incorporated herein by reference.\n(3)(b) Bylaws, as amended and effective June 25, 1992, previously filed as exhibit (3)(b) to the Company's Form 10-K for 1992, and incorporated herein by reference.\n(10)(a) Employment agreement dated June 24, 1994, between CTS and Joseph P. Walker, filed as exhibit (10)(a) to the Company's Form 10-K for 1994, and incorporated herein by reference.\n(10)(b) Prototype indemnification agreement, with Lawrence J. Ciancia, Patrick J. Dorme, Gerald H. Frieling, Jr., Andrew Lozyniak, Joseph P. Walker, Philip T. Christ, Stanley J. Aris, Jeannine M. Davis, James L. Cummins, George T. Newhart and Gary N. Hoipkemier, previously filed as exhibit (10)(b) to the Company's Form 10-K for 1991, and incorporated herein by reference.\n(10)(c) CTS Corporation 1982 Stock Option Plan, as amended February 24, 1989, was previously filed as exhibit (10)(d) to the Company's Form 10-K for 1989, and is incorporated herein by reference.\n(10)(d) CTS Corporation 1986 Stock Option Plan, approved by the stockholders at the reconvened annual meeting on May 30, 1986. The CTS Corporation 1986 Stock Option Plan is contained in Exhibit 4 to Registration Statement No. 33-27749, effective March 23, 1989, and is incorporated herein by reference.\n(10)(e) CTS Corporation 1988 Restricted Stock and Cash Bonus Plan, as adopted by the CTS Board of Directors on December 16, 1988, and approved by stockholders at the 1989 annual meeting of stock- holders on April 28, 1989. The CTS Corporation 1988 Restricted Stock and Cash Bonus Plan is contained in Appendix A, pages 11-15, of the 1989 Proxy Statement for the annual meeting of stockholders held April 28, 1989, under the caption \"CTS Corporation 1988 Restricted Stock and Cash Bonus Plan,\" previously filed with the Securities and Exchange Commission, and is incorporated herein by reference.\n(13) CTS Corporation 1994 Annual Report.\n(21) Subsidiaries of CTS Corporation.\n(23) Consent of Price Waterhouse to incorporation by reference of this Annual Report on Form 10-K for the fiscal year 1994 to Registration Statement 2- 84230 on Form S-8 and Registration Statement 33- 27749 on Form S-8.\nIndemnification Undertaking\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. 2-84230 (filed June 13, 1983) and 33-27749 (filed March 23, 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 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.\nANNUAL REPORT ON FOR 10-K\nITEM 14(a) (1) AND (2) AND ITEM 14(d)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nFINANCIAL STATEMENT SCHEDULES\nYEAR ENDED DECEMBER 31, 1994\nCTS CORPORATION AND SUBSIDIARIES\nELKHART, INDIANA\nFORM 10-K - ITEM 14(a) (1) AND (2)\nCTS CORPORATION AND SUBSIDIARIES\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of CTS Corporation and subsidiaries included in the annual report of the registrant to its shareholders for the year ended December 31, 1994, are incorpo- rated by reference in Item 8:\nConsolidated balance sheets - December 31, 1994, and December 31, 1993\nConsolidated statements of earnings - Years ended December 31, 1994, December 31, 1993, and December 31,\nConsolidated statements of stockholders' equity - Years ended December 31, 1994, December 31, 1993, and Decem- ber 31, 1992\nConsolidated statements of cash flows - Years ended December 31, 1994, December 31, 1993, and December 31,\nNotes to consolidated financial statements\nThe following consolidated financial statement schedules of CTS Corporation and subsidiaries, are included in item 14(d):\nPage\nSchedule II - Valuation and qualifying accounts S-3\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 inapplicable, not required or the information is included in the consolidated financial state- ments or notes thereto.\nS-1\nEXHIBIT 22\nCTS CORPORATION AND SUBSIDIARIES\nCTS Corporation (Registrant), an Indiana corporation\nSubsidiaries\nCTS Corporation, a Delaware corporation\nCTS Singapore, Pte. Ltd., a Republic of Singapore corporation\nCTS of Panama, Inc., a Republic of Panama corporation\nCTS Components Taiwan, Ltd.,1 a Taiwan, Republic of China\ncorporation\nCTS de Mexico S.A.,1 a Republic of Mexico corporation\nCTS Export Corporation, a Virgin Islands corporation\nCTS of Canada, Ltd., a Province of Ontario (Canada) corporation\nCTS Manufacturing (Thailand) Ltd.,1 a Thailand corporation\nCTS Electronics Hong Kong Ltd.,1 a Republic of Hong Kong corpora-\ntion\nCTS Corporation U.K. Ltd., a United Kingdom corporation\nCTS Printex, Inc., a California corporation\nCTS Micro Peripherals, Inc., a California corporation\nMicro Peripherals Singapore (Private) Limited, a Republic of Singapore corporation\nCorporations whose names are indented are subsidiaries of the preceding non-indented corporations. Except as indicated, each of the above subsidiaries is 100% owned by its parent company. Operations of all subsidiaries and divisions are consolidated in the financial statements filed.\n1 Less than 1% of the outstanding shares of stock is owned of record by nominee shareholders pursuant to national laws regarding resident or nominee ownership.\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 17, 1995 By \/S\/ Stanley J. Aris Stanley J. Aris Vice President Finance 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 dates indicated.\nDate March 17, 1995 By \/S\/ Lawrence J. Ciancia Lawrence J. Ciancia, Director\nDate March 17, 1995 By \/S\/ Patrick J. Dorme Patrick J. Dorme, Director\nDate March 17, 1995 By \/S\/ Gerald H. Frieling, Jr. Gerald H. Frieling, Jr., Director\nDate March 17, 1995 By \/S\/ Andrew Lozyniak Andrew Lozyniak, Director\nDate March 17, 1995 By \/S\/ Joseph P. Walker Joseph P. Walker, Director\nDate March 17, 1995 By \/S\/ George T. Newhart George T. Newhart, Corporate Controller and principal accounting officer\nDate March 17, 1995 By \/S\/ Jeannine M. Davis Jeannine M. Davis, Vice President, Secretary and General Counsel\nCTS CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (In thousands of dollars)\n(a) Recoveries. (b) Uncollectible accounts written off.\nS-3 EXHIBIT 23\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 2-84230 and No. 33- 27749) of CTS Corporation of our report dated February 2, 1995, appearing within the 1994 CTS Corporation Annual Report to Stockholders which is incorporated in the Annual Report on Form 10-K. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page S-2 of this Form 10-K.\nPRICE WATERHOUSE LLP\nSouth Bend, Indiana March 17, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of CTS Corporation\nOur audits of the consolidated financial statements referred to in our report dated February 2, 1995, appearing within the CTS Corporation 1994 Annual Report to Stockholders, (which report and consolidated financial statements are incorporated by reference in the Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule listed in item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nSouth Bend, Indiana February 2, 1995","section_15":""}
{"filename":"83053_1994.txt","cik":"83053","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nReliance Insurance Company ('Reliance Insurance Company' or 'Registrant') and its property and casualty insurance subsidiaries (such subsidiaries, together with Reliance Insurance Company, the 'Reliance Property and Casualty Companies') and its title insurance subsidiaries (collectively, the 'Reliance Insurance Group') underwrite a broad range of commercial lines of property and casualty insurance, as well as title insurance. Reliance Insurance Company has conducted business since 1817, making it one of the oldest property and casualty insurance companies in the United States.\nThe Reliance Property and Casualty Companies consist of four principal operations: Reliance National, Reliance Insurance, Reliance Reinsurance and Reliance Surety. Established in 1987, Reliance National offers, through national and regional brokers, a broad range of commercial property and casualty insurance products and services for large companies and specialty line customers. Reliance National selects market segments where it can provide specialized coverages and services, and it conducts business nationwide and in certain international markets. In 1994, Reliance National accounted for 50% of the net premiums written by the Reliance Property and Casualty Companies. Reliance Insurance offers commercial property and casualty insurance coverages for mid-sized companies throughout the United States. Reliance Insurance also offers traditional and specialized coverages for more complex risks as well as insurance programs for groups with common insurance needs. Reliance Reinsurance primarily provides property and casualty treaty reinsurance for small to medium sized regional and specialty insurance companies located in the United States. Reliance Surety is a leading writer of surety bonds and fidelity bonds in the United States. The Reliance Property and Casualty Companies accounted for $1,777.3 million (67%) of the Reliance Insurance Group's 1994 net premiums earned.\nThe Reliance Insurance Group's title insurance business consists of Commonwealth Land Title Insurance Company ('Commonwealth') and Transamerica Title Insurance Company ('Transamerica Title', together with Commonwealth and their respective subsidiaries, 'Commonwealth\/Transamerica Title'). Commonwealth\/Transamerica Title is the third largest title insurance operation in the United States, in terms of 1993 total premiums and fees. Commonwealth\/Transamerica Title accounted for $856.8 million (33%) of the Reliance Insurance Group's 1994 net premiums earned.\nBusiness segment information for the years ended December 31, 1994, 1993 and 1992 is set forth in Note 17 to the Company's consolidated financial statements (the 'Consolidated Financial Statements'), which segment information is included in the Company's 1994 Annual Report and incorporated herein by reference. All financial information in this Annual Report on Form 10-K is presented in accordance with generally accepted accounting principles ('GAAP') unless otherwise specified.\nReliance Financial Services Corporation ('Reliance Financial') owns all of\nthe common stock of Reliance Insurance Company. The common stock of Reliance Insurance Company, which represents approximately 98% of the combined voting power of all Reliance Insurance Company stockholders, is pledged to secure certain indebtedness. Reliance Financial is a wholly-owned subsidiary of Reliance Group Holdings, Inc. ('Reliance Group Holdings'). Approximately 47% of the common stock of Reliance Group Holdings, the only class of voting security outstanding, is owned by Saul P. Steinberg, members of his family and affiliated trusts.\nOPERATING UNITS\nProperty and Casualty Insurance. The Reliance Property and Casualty Companies consist of four principal operations: Reliance National, Reliance Insurance, Reliance Reinsurance and Reliance Surety. The following table sets forth the amount of net premiums written in each line of business by Reliance National, Reliance Insurance, Reliance Reinsurance and Reliance Surety for the years ended December 31, 1994, 1993 and 1992.\nThe following table sets forth underwriting results for the Reliance Property and Casualty Companies for the years ended December 31, 1994, 1993 and 1992.\n------------------ (1) Includes catastrophe losses for the years ended December 31, 1994, 1993 and 1992 of $50.1 million, $39.3 million and $61.1 million, respectively.\nThe following table sets forth certain financial information of the Reliance Property and Casualty Companies based upon statutory accounting practices and common shareholder's equity of Reliance Insurance Company based upon GAAP, in thousands:\n------------------ * Includes Reliance Insurance Company's investment in title insurance operations of $180.8 million at December 31, 1994.\nThe Reliance Property and Casualty Companies write insurance in every state of the United States, the District of Columbia, Puerto Rico, Guam and The Virgin Islands. The Reliance Property and Casualty Companies also write insurance in the European Community through offices in the United Kingdom, the Netherlands and Spain, and in the Americas through offices in Canada, Mexico and Argentina. In 1994, California, New York, Texas, Pennsylvania and Florida accounted for approximately 18%, 9%, 7%, 6% and 5%, respectively, of direct premiums written. No other state accounted for more than 5% of direct premiums written by the Reliance Property and Casualty Companies. The Reliance Property and Casualty Companies write insurance through independent agents, program agents and brokers. No single insurance agent or broker accounts for 10% or more of the direct premiums written by the Reliance Property and Casualty Companies.\nThe Reliance Property and Casualty Companies ranked 32nd among property and casualty insurance companies and groups in terms of net premiums written during 1993, according to Best's Insurance Management Reports. A. M. Best & Company, Inc. ('Best'), publisher of Best's Insurance Reports, Property-Casualty, has assigned an A- (Excellent) rating to the Reliance Property and Casualty Companies. Best's ratings are based on an analysis of the financial condition and operations of an insurance company as they relate to the industry in general. An A- (Excellent) rating is assigned to those companies which have demonstrated excellent overall performance when compared to the norms of the property and casualty industry. Standard & Poor's ('S&P') rates the claims-paying ability of the Reliance Property and Casualty Companies A. S&P's ratings are based on quantitative and qualitative analysis including consideration of ownership and support factors, if applicable. An A rating is assigned to those companies which have good financial security, but capacity to meet policyholder obligations is somewhat susceptible to adverse economic and underwriting conditions. Best's ratings are not designed for the protection of investors and do not constitute recommendations to buy, sell or hold any security. Although the Best and S&P ratings of the Reliance Property and Casualty Companies are lower than those of many of the insurance companies with which the Reliance Property and Casualty Companies compete, management believes that the current ratings are adequate to enable the Reliance Property and Casualty Companies to compete successfully.\nReliance National. Established in 1987, Reliance National offers a broad range of commercial insurance products and services to selected segments of the property and casualty market which do not lend themselves to traditional insurance products and services. Reliance National selects market segments where it can provide specialized coverages and services. In 1994, Reliance National accounted for 50% of the net premiums written by the Reliance Property and Casualty Companies. Reliance National, which conducts business nationwide, is headquartered in New York City and has regional offices in seven states. Reliance National also conducts business in the European Community through offices located in the United Kingdom, the Netherlands and Spain and in the Americas through offices in Canada, Mexico and Argentina. In 1994, Reliance National completed its acquisition of a Mexican insurance company and purchased an Argentinean insurance company. Reliance National distributes its products primarily through national insurance brokers. Reliance National maintains an underwriting staff in the United States, the United Kingdom, Canada and Mexico, an actuarial staff in the United States and makes extensive use of third party administrators and technical consultants for certain claims and loss control services. Net premiums written by Reliance National were $889.7 million, $872.2 million and $828.6 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nReliance National is organized into eight major divisions. Each division is comprised of individual departments, each focusing on a particular type of business, program or market segment. Each department makes use of underwriters, actuaries and other professionals to market, structure and price its products. Reliance National's eight major divisions are:\no Risk Management Services, Reliance National's largest division, targets Fortune 1,000 companies and multinationals with a broad array of coverages and services. Its use of risk financing techniques such as retrospectively rated policies, self-insured retentions, deductibles, captives, alternative risk funding and fronting arrangements all help clients to reduce costs and\/or manage cash flow more efficiently. It provides workers' compensation, commercial automobile, general liability and pollution coverages. In 1994, this division had net premiums written of $290.8 million.\no Special Operations provides coverages for construction, transportation and ocean marine risks and offers non-standard personal automobile insurance for drivers unable to obtain insurance in the standard market. In 1994, this division had net premiums written of $181.4 million.\no Excess and Surplus Lines provides professional liability insurance to architects and engineers, lawyers, healthcare providers and other professions, and markets excess and umbrella coverages. It also provides employment practices liability insurance and develops and provides insurance products to certain markets requiring specialized underwriting, such as the entertainment industry market. In 1994, this division had net premiums written of $121.6 million.\no International writes predominantly commercial property and casualty insurance products, including specialized coverages such as excess casualty, directors and officers liability, and fidelity insurance, in the European Community, Canada, Mexico and Argentina. It also provides\ncertain risk management services for foreign subsidiaries of United States multinational corporations. In 1994, this division had net premiums written of $86.4 million.\no Financial Products provides directors and officers liability insurance and, for financial institutions, errors and omissions insurance. In 1994, this division had net premiums written of $70.7 million.\no Financial Specialty Coverages provides aviation and space satellite risk coverages on an assumed and direct basis, and also underwrites complex non-traditional insurance and reinsurance products, including finite risk transactions. In 1994, this division had net written premiums of $53.9 million.\no Accident and Health provides high limit disability, group accident, blanket special risk and medical excess of loss programs. In 1994, this division had net premiums written of $48.1 million.\no Property provides commercial property coverage focusing on excess and specialty commercial property. In 1994, this division had net premiums written of $23.0 million.\nReliance National attempts to limit its exposure to losses through the use of certain methods such as claims-made policies, retrospectively rated policies, high deductible policies and reinsurance. Approximately 23% of Reliance National's net premiums written during 1994 were written on a 'claims-made' basis which provides\ncoverage only for claims reported during the policy period or within an established reporting period, as opposed to 'occurrence' basis policies which provide coverage for events during the policy period without regard for when the claim is reported. Claims-made policies mitigate the 'long tail' nature of the risks insured.\nApproximately 13% of Reliance National's net premiums written during 1994 were written on a retrospectively rated or loss sensitive basis, whereby the insured effectively pays for a large portion or, in many cases, all of its losses. Approximately 6% of Reliance National's net premiums written during 1994 were written on a high deductible basis, whereby the insured pays for all of its losses up to the deductible amount. The use of high deductible policies results in lower premiums and losses for Reliance National as loss payments made by an insured under a high deductible policy are not considered premium or losses to an insurer. With retrospectively rated and high deductible policies Reliance National provides insurance and loss control management services, while reducing its underwriting risk. Reliance National assumes a credit risk in connection with retrospectively rated and high deductible policies and, therefore, accounts with such policies undergo extensive credit analysis by a centralized credit department. Collateral in the form of bank letters of credit, trust accounts or cash collateral is generally provided by the insured to cover a significant portion of Reliance National's credit exposure.\nTo further limit exposures, approximately 91% of Reliance National's net\npremiums written during 1994 were for policies with net retentions equal to or lower than $1.5 million per risk. By reinsuring a large proportion of its business, Reliance National seeks to limit its exposure to losses on each line of business it writes. Its largest single exposure, net of reinsurance, at December 31, 1994, was $2.3 million per occurrence.\nReliance Insurance. Reliance Insurance offers commercial lines property and casualty insurance products, primarily focusing on the diverse needs of mid-sized companies nationwide. Reliance Insurance distributes its products through approximately 2,800 independent agents, program agents and brokers. Reliance Insurance's customers are primarily closely held companies with 25 to 1,000 employees and annual sales of $5 million to $300 million. Reliance Insurance underwrites a variety of commercial insurance coverages, including property, general liability, commercial automobile and workers' compensation (the majority of which is written on a loss sensitive or retrospectively rated basis). Reliance Insurance is headquartered in Philadelphia and operates in 50 states and the District of Columbia. Net written premiums by Reliance Insurance were $631.0 million (including $20.7 million of personal lines premiums), $668.2 million (including $45.4 million of personal lines premiums) and $510.8 million (including $8.8 million of personal lines premiums) for the years ended December 31, 1994, 1993 and 1992, respectively.\nReliance Insurance is organized into the Commercial Insurance Division, comprised of the Standard Commercial department and the Large Accounts department, and the Custom Underwriting Facility, comprised of the Special Risk department and the Program department. The Commercial Insurance Division provides its products and services through a decentralized network of regional and branch offices. This organization allows it to place major responsibility and accountability for underwriting, sales, claims, and customer service close to the insured. The Custom Underwriting Facility's Special Risk department has three regional offices and the Program department has one central office.\nThe Commercial Insurance Division's Standard Commercial department focuses on accounts with annual premiums of up to $1 million. This department offers a broad range of traditional commercial coverages, primarily written on a guaranteed cost basis. The Standard Commercial department had net written premiums of $312.8 million in 1994. The Commercial Insurance Division's Large Accounts department focuses on casualty exposures of accounts with annual premiums in excess of $1 million, where it is able to offer more flexible coverages through the use of retrospectively rated and high deductible policies. The Large Accounts department primarily provides workers' compensation insurance and approximately 85% of its business was written on a loss sensitive basis. Accounts with retrospectively rated and high deductible policies undergo extensive credit analysis by a centralized credit department and collateral is generally provided by the insured to cover a significant portion of Reliance Insurance's credit exposure. The Large Accounts department wrote $115.7 million of net premiums in 1994.\nThe Custom Underwriting Facility's Special Risk department provides underwriting of excess and surplus coverages (generally with lower net retentions than for other commercial lines written by Reliance Insurance) for risks with unique exposures. The Special Risk department had net written premiums of $109.5 million in 1994.\nThe Custom Underwriting Facility's Program department provides property and liability insurance programs, targeting homogeneous groups of insureds with particular insurance needs, such as auto rental companies, day care centers and municipalities. These programs are administered by independent program agents, with Reliance Insurance retaining authority for all underwriting and pricing decisions. Program agents market the programs, gather the initial underwriting data and, if authorized by Reliance Insurance, issue the policies. All claims and other services are handled by Reliance Insurance. The Program department had net written premiums of $73.4 million in 1994.\nReliance Insurance has substantially withdrawn from personal lines, where it has had unfavorable experience and does not perceive a potential for long-term profitability. The Reliance Property and Casualty Companies derived 1.2% of their net premiums written from personal lines in 1994, compared with 2.6% in 1993.\nReliance Reinsurance. Reliance Reinsurance provides property reinsurance on a treaty basis and casualty reinsurance on a treaty and facultative basis. All treaty business is marketed through reinsurance brokers who negotiate contracts of reinsurance on behalf of the primary insurer or ceding reinsurer, while facultative business is produced both directly and through reinsurance brokers. While Reliance Reinsurance's treaty clients include all types and sizes of insurers, Reliance Reinsurance typically targets treaty reinsurance for small to medium sized regional and specialty insurance companies, as well as captives, risk retention groups and other alternative markets, providing both pro rata and excess of loss coverage. Reliance Reinsurance believes that this market is subject to less competition and provides Reliance Reinsurance an opportunity to develop and market innovative programs where pricing is not the key competitive factor. Reliance Reinsurance typically avoids participating in large capacity reinsurance treaties where price is the predominant competitive factor. It generally writes reinsurance in the 'lower layers,' the first $1 million of primary coverage, where losses are more predictable and quantifiable. The assumed reinsurance business of the Reliance Property and Casualty Companies is conducted nationwide and is headquartered in Philadelphia. Net written premiums by Reliance Reinsurance were $125.6 million, $123.6 million and $107.9 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nReliance Surety. Reliance Surety is a leading writer of surety bonds and fidelity bonds in the United States. Reliance Surety concentrates on writing performance and payment bonds for contractors of public works projects, commercial real estate and multi-family housing. It also writes financial institution and commercial fidelity bonds. Reliance Surety performs extensive credit analysis on its clients, and actively manages the claims function to minimize losses and maximize recoveries. Reliance Surety has enjoyed long relationships with the major contractors it has insured. Reliance Surety has established an operation targeting smaller contractors, an area traditionally less fully serviced by national surety companies and one providing potential growth for Reliance Surety. Reliance Surety is headquartered in Philadelphia and conducts business nationwide through 43 branch offices and approximately 3,200 independent agents and brokers. Net written premiums by Reliance Surety were $118.0 million, $106.7 million and $94.3 million for the years 1994, 1993 and 1992, respectively.\nSurety bonds guarantee the payment or performance of one party (called the principal) to another party (called the obligee). This guarantee is typically evidenced by a written agreement by the surety (e.g., Reliance Insurance Company) to discharge the payment or performance obligations of the principal pursuant to the underlying contract between the obligee and the principal. Fidelity bonds insure against losses arising from employee dishonesty. Financial institution fidelity bonds insure against losses arising from employee dishonesty and other specifically named theft and fraud perils.\nTitle Insurance. Through Commonwealth\/Transamerica Title, the Company writes title insurance for residential and commercial real estate nationwide and provides escrow and settlement services in connection with real estate closings. The National Title Services division of Commonwealth\/Transamerica Title provides title services for large and multi-state commercial transactions. Through the Commonwealth OneStop(Trademark) program, Commonwealth\/Transamerica Title provides national lenders with a full range of residential closing services, including title insurance through its National Residential Title Services division, appraisal management through its CLT Appraisal Services, Inc. subsidiary, and other real estate related services. Commonwealth\/Transamerica Title is the third largest title insurance operation in the United States, based on 1993 total premiums and fees. Commonwealth\/Transamerica Title had premiums and fees (excluding Commonwealth Mortgage Assurance\nCorporation, its mortgage insurance subsidiary which was sold in the fourth quarter of 1992) of $856.8 million, $893.4 million and $770.5 million for the years 1994, 1993 and 1992, respectively.\nCommonwealth\/Transamerica Title is organized into six regions with more than 325 offices covering all 50 states, as well as Puerto Rico and the Virgin Islands. In 1994, Texas, California, Florida, Pennsylvania, New York, Washington and Michigan accounted for approximately 11%, 10%, 10%, 8%, 7%, 6% and 6%, respectively, of revenues for premiums and services related to title insurance. No other state accounted for more than 5% of such revenues. Commonwealth\/Transamerica Title is committed to increasing its market share through a carefully developed plan of expanding its direct and agency operations, including selective acquisitions.\nA title insurance policy protects the insured party and certain successors in interest against losses resulting from title defects, liens and encumbrances existing as of the date of the policy and not specifically excepted from the policy's provisions. Generally, a title policy is obtained by the buyer, the mortgage lender or both at the time real property is transferred or refinanced. The policy is written for an indefinite term for a single premium which is due in full upon issuance of the policy. The face amount of the policy is usually either the purchase price of the property or the amount of the loan secured by the property. Title policies issued to lenders insure the priority position of the lender's lien. Many lenders require title insurance as a condition to making loans secured by real estate. Title insurers, unlike other types of insurers, seek to eliminate future losses through the title examination process and the closing process, and a substantial portion of the expenses of a title insurer\nrelate to those functions.\nConsulting and Technical Services. RCG International, Inc. ('RCG'), a subsidiary of the Reliance Insurance Group, and its subsidiaries provide consulting and technical services to industry, government and nonprofit organizations, principally in the United States and Europe, and also in Canada, Asia, South America, Africa and Australia. The services provided by RCG include consulting in two principal areas: information technology, which provides computer-related professional services to large corporate clients, and energy\/environmental services. RCG and its subsidiaries had revenues of $141.6 million, $116.8 million and $109.1 million for 1994, 1993 and 1992, respectively.\nSALE OF NON-CORE OPERATIONS\nThe Company has realigned its operations to emphasize commercial property and casualty insurance, particularly specialized insurance products and complex risks of larger accounts, and title insurance. In July 1993, the Company completed the sale of its life insurance subsidiary, United Pacific Life Insurance Company ('UPL'). In the fourth quarter of 1992, the Company sold substantially all of the operating assets and insurance brokerage, employee benefits consulting and related services businesses of its insurance brokerage subsidiary, Frank B. Hall & Co. Inc. ('Hall'). Also in the fourth quarter of 1992, the Company sold its mortgage insurance subsidiary, Commonwealth Mortgage Assurance Corporation ('CMAC'), through a public offering of 100% of the common stock of CMAC Investment Corporation ('CMAC Investment'). For a further description of the above referenced transactions, see Notes 12 and 15 to the Consolidated Financial Statements.\nINSURANCE CEDED\nAll of the Reliance Insurance Group's insurance operations purchase reinsurance to limit the Company's exposure to losses. Although the ceding of insurance does not discharge an insurer from its primary legal liability to a policyholder, the reinsuring company assumes a related liability and, accordingly, it is the practice of the industry, as permitted by statutory regulations, to treat properly reinsured exposures as if they were not exposures for which the primary insurer is liable. The Reliance Insurance Group enters into reinsurance arrangements that are both facultative (individual risks) and treaty (blocks of risk). Limits and retentions are based on a number of factors, including the previous loss history of the operating unit, policy limits and exposure data, industry studies as to potential severity, and market terms, conditions and capacity, and may change over time. Reliance National and Reliance Insurance limit their exposure to individual risks by purchasing excess of loss and quota share reinsurance, with treaty structures and net retentions varying with the specific requirements of the line of business or program being reinsured. In many cases, Reliance National and Reliance Insurance purchase additional facultative reinsurance to further reduce their retentions below the treaty levels.\nDuring 1994, the highest net retention per occurrence for casualty risk was\n$2.2 million for Reliance National and $3.0 million for Reliance Insurance. In addition, both Reliance National and Reliance Insurance purchase 'casualty clash' coverage to provide protection in the event of losses incurred by multiple coverages on one occurrence.\nDuring 1994, the highest net retention per occurrence for property risk was $2.3 million for Reliance National and $3.2 million for Reliance Insurance. In addition, during 1994, Reliance National and Reliance Insurance together had reinsurance for 95% of net retained property catastrophe losses in excess of $15 million and up to $107 million. Thus, for all net retained losses attributable to a single catastrophe of $107 million, Reliance National and Reliance Insurance together retained a maximum exposure of $19.6 million. Any net retained loss from a single catastrophe beyond $107 million is not reinsured and is retained by Reliance National and Reliance Insurance together. Renewal of catastrophe coverage during the term of the treaty is provided by a provision for one automatic reinstatement of the original coverage at a contractually determined premium. The Company believes that the limit of $107 million of net retained losses per occurrence is sufficient to cover its probable maximum loss in the event of a catastrophe.\nCatastrophe losses, including losses incurred by Reliance Reinsurance on insurance assumed, were $50.1 million in 1994 ($134.0 million before insurance ceded), which included $44.9 million ($127.0 million before insurance ceded) arising from the January 1994 California earthquake, compared to $39.3 million in 1993 ($88.5 million before insurance ceded). Catastrophe losses, including losses incurred by Reliance Reinsurance on insurance assumed, were $61.1 million in 1992 ($119.2 million before insurance ceded), which included $45.6 million ($94.1 million before insurance ceded) arising from Hurricane Andrew.\nA catastrophic event can cause losses in lines of insurance other than property. Both Reliance National and Reliance Insurance purchase workers' compensation reinsurance coverage up to $200 million to provide protection against losses under workers' compensation policies which might be caused by catastrophes. Such workers' compensation reinsurance applies after retentions by Reliance National of up to $500,000 and Reliance Insurance of up to $1 million. For Reliance Insurance, any such losses over $200 million would be covered by the property catastrophe treaty to the extent of available capacity. For Reliance National, any such losses over $200 million and up to $255 million would be covered by Reliance National's casualty clash coverage.\nReliance National and Reliance Insurance have also purchased reinsurance to cover aggregate retained catastrophe losses in the event of multiple catastrophes in any one year. This reinsurance agreement provides coverage for up to 93% of aggregate catastrophe losses between $12.5 million and $31.0 million, after applying a deductible of $3.8 million per catastrophe.\nReliance Surety retains 100% of surety bond limits up to $2 million. For surety bonds in excess of $2 million, up to $40 million, Reliance Surety obtains 50% quota share reinsurance. For surety bonds between $40 million and $50 million, Reliance Surety obtains 60% quota share reinsurance. In addition, Reliance Surety has excess of loss protection, with a net retention of up to $4.3 million, for losses up to $30 million on any one principal insured. For fidelity business, Reliance Surety retains 100% of each loss up to $1.5 million. Reliance Surety has obtained reinsurance above that retention up to a maximum of\n$8.5 million on each loss.\nReliance Reinsurance writes treaty property and casualty reinsurance and facultative casualty reinsurance with limits of $1.5 million per program. Facultative property reinsurance, which was discontinued in February 1994, was written with limits of $10 million per risk, of which the Company retained $500,000 after the purchase of reinsurance. Reliance Reinsurance purchases catastrophe protection for its property treaty and facultative insurance assumed of $5.0 million in excess of a $2.5 million per occurrence retention, with a contractual provision for a reinstatement. In 1994, Reliance Reinsurance also wrote a specific catastrophe book of business with an aggregate limit of $17.7 million for any one event, not subject to the above protection. In 1994, losses and expenses of $12.5 million incurred under this specific catastrophe program were offset by premiums of $11.0 million. As of December 31, 1994, Reliance Reinsurance no longer writes a specific catastrophe book of business.\nCommonwealth\/Transamerica Title generally retains no more than $60 million on any one risk, although it often retains significantly less than this amount, with reinsurance placed with other title companies. Commonwealth\/Transamerica Title also purchases reinsurance from Lloyd's of London which provides coverage\nfor 80% of losses between $20 million and $60 million, on any one risk. The largest net loss paid by Commonwealth or, since its acquisition, Transamerica Title on any one risk was approximately $5 million.\nPremiums ceded by the Reliance Insurance Group to reinsurers were $1.2 billion and $1.1 billion in 1994 and 1993, respectively. The Reliance Insurance Group is subject to credit risk with respect to its reinsurers, as the ceding of risk to reinsurers does not relieve the Reliance Insurance Group of its liability to insureds. At December 31, 1994, the Reliance Insurance Group had reinsurance recoverables of $2.9 billion, representing estimated amounts recoverable from reinsurers pertaining to paid claims, unpaid claims, claims incurred but not reported and unearned premiums. In order to minimize losses from uncollectible reinsurance, the Reliance Insurance Group places its reinsurance with a number of different reinsurers, and utilizes a security committee or a credit department to approve in advance the reinsurers which meet its standards of financial strength and are acceptable for use by Reliance Insurance Group. The Reliance Insurance Group holds substantial amounts of collateral, consisting of letters of credit, trust accounts and cash collateral, to secure recoverables from unauthorized reinsurers. The Company had $8.2 million reserved for potentially unrecoverable reinsurance at December 31, 1994. The Company is not aware of any impairment of the creditworthiness of any of the Reliance Insurance Group's significant reinsurers. While the Company is aware of financial difficulties experienced by certain Lloyd's of London syndicates, the Company has not experienced deterioration of payments from the Lloyd's of London syndicates from which it has reinsurance. The Company has no reason to believe that the Lloyd's of London syndicates from which it has reinsurance will be unable to satisfy claims that may arise with respect to ceded losses.\nIn 1994, the Reliance Property and Casualty Companies did not cede more than 5.1% of direct premiums to any one reinsurer and no one reinsurer accounted\nfor more than 10.9% of total ceded premiums. The Reliance Insurance Group's ten largest reinsurers, based on 1994 ceded premiums, are as follows:\n------------------\n(1) Individual Lloyd's of London syndicates are not rated by Best. (2) An unrated captive reinsurer that is not affiliated with the Company. Recoverables from such reinsurer are fully collateralized. (3) Assigned a Best's Rating of NA-3 (Insufficient Operating Experience) as the reinsurer has not accumulated five years of representative operating experience. (4) Reinsurer is not rated by Best. The S&P Rating for such reinsurer is A.\nThe Reliance Insurance Group maintains no 'Funded Cover' reinsurance agreements. 'Funded Cover' reinsurance agreements are multi-year retrospectively rated reinsurance agreements which may not meet relevant accounting standards for risk transfer and under which the reinsured must pay additional premiums in subsequent years if losses in the current year exceed levels specified in the reinsurance agreement.\nPROPERTY AND CASUALTY LOSS RESERVES\nAs of March 15, 1995, the Reliance Insurance Group maintains a staff of 101 actuaries, of whom 17 are fellows of the Casualty Actuarial Society and one is a fellow of the Society of Actuaries. This staff regularly performs comprehensive analyses of reserves and reviews the pricing and reserving methodologies of the Reliance Insurance Group. Although the Company believes, in light of present facts and current legal interpretations, that the Reliance Insurance Group's overall property and casualty reserve levels are adequate\nto meet its obligations under existing policies, due to the inherent uncertainty and complexity of the reserving process, the ultimate liability may be more or less than such reserves.\nThe following tables present information relating to the liability for unpaid claims and related expenses ('loss reserves') for the Reliance Property and Casualty Companies. The table below provides a reconciliation of beginning and ending liability balances for the years ended December 31, 1994, 1993 and 1992.\n------------------ * Loss reserves exclude the loss reserves of title operations of $228.1 million, $204.7 million and $173.3 million at December 31, 1994, 1993 and 1992,\nrespectively.\nPolicy claims and settlement expenses includes a provision for insured events of prior years of $22.4 million, $40.2 million and $31.5 million for the years 1994, 1993 and 1992, respectively. The 1994 provision includes $17.0 million of adverse development related to prior year asbestos-related and environmental pollution claims. Development in asbestos-related and environmental pollution claims primarily affects general liability and multiple peril lines of business. The 1994 provision also includes $14.7 million of adverse development from other general liability lines. This development was partially offset by $13.3 million of favorable development in workers' compensation. The 1993 provision includes $21.1 million of adverse development from workers' compensation reinsurance pools and $35.2 million of adverse development related to prior-year asbestos-related and environmental pollution claims. This development was partially offset by favorable development in other lines of business, including other general liability lines. The 1992 provision includes $55.6 million of adverse development from workers' compensation and automobile reinsurance pools. This development was partially offset by favorable development of $11.9 million from two general liability claims and favorable development of $10.7 million related to unallocated loss adjustment expenses.\nThe table below summarizes the development of the estimated liability for loss reserves (net of reinsurance recoverables) as of December 31 of each of the prior ten years. The amounts shown on the top line of the table represent the estimated liability for loss reserves (net of reinsurance recoverables) for claims that are unpaid at the particular balance sheet date, including losses that had been incurred but not reported to the Reliance Property and Casualty Companies. The upper portion of the table indicates the loss reserves as they are reestimated in subsequent periods as a percentage of the originally recorded reserves. These estimates change as losses are paid and more accurate information becomes available about remaining loss reserves. A redundancy exists when the original loss reserve estimate is greater, and a deficiency exists when the original loss reserve estimate is less, than the reestimated loss reserve at December 31, 1994. A redundancy or deficiency indicates the cumulative percentage change, as of December 31, 1994, of originally recorded loss reserves. The lower portion of the table indicates the cumulative amounts paid as of successive periods as a percentage of the original loss reserve liability. In calculating the percentage of cumulative paid losses to the loss reserve liability in each year, unpaid losses of General Casualty Company of Wisconsin, a former wholly-owned subsidiary, and its subsidiaries ('General Casualty') at April 30, 1990 (the date of sale of General Casualty), relating to 1984 to 1989, were deducted from the original liability in each year. Each amount in the following table includes the effects of all changes in amounts for prior periods. The table does not present accident or policy year development data. For the years 1984 through 1993, the Company has experienced deficiencies in its estimated liability for loss reserves. Included in these deficiencies were provisions of $156.0 million in 1991 and $100.0 million in 1986 specifically made to strengthen prior-years' loss reserves. The Company's loss reserves during this period have been adversely affected by a number of factors beyond the Company's control as follows: (i) significant increases in claim settlements reflecting, among other things, inflation in medical costs; (ii) increases in the costs of settling claims, particularly legal expenses; (iii) more frequent\nresort to litigation in connection with claims; and (iv) a widening interpretation of what constitutes a covered claim.\n------------------ (1) The gross liability for unpaid claims and related expenses was $5.6 billion at December 31, 1994. The gross liability for unpaid claims and related expenses for years 1993 and prior was redundant by $144.4 million at December 31, 1994.\nThe difference between the property and casualty liability for loss reserves at December 31, 1994 and 1993 reported in the Company's consolidated financial statements (net of reinsurance recoverables) and the liability which would be reported in accordance with statutory accounting practices is as follows:\nThe difference between the property and casualty liability for loss reserves at December 31, 1994 and 1993 reported in the Company's consolidated financial statements and the liability which would be reported in accordance with statutory accounting practices is as follows:\nProperty and casualty loss reserves are based on an evaluation of reported claims, in addition to statistical projections of claims incurred but not reported and loss adjustment expenses. Estimates of salvage and subrogation are deducted from the liability for unpaid claims. Also considered are other factors such as the promptness with which claims are reported, the history of the ultimate liability for such claims compared with initial and intermediate estimates, the type of insurance coverage involved, the experience of the property and casualty industry and other economic indicators, when applicable.\nThe establishment of loss reserves requires an estimate of the ultimate liability based primarily on past experience. The Reliance Property and Casualty Companies apply a variety of generally accepted actuarial techniques to determine the estimates of ultimate liability. The techniques recognize, among other factors, the Reliance Insurance Group's and the industry's experience with similar business, historical trends in reserving patterns and loss payments, pending level of unpaid claims, the cost of claim settlements, the Reliance Insurance Group's product mix, the economic environment in which property and casualty companies operate and the trend toward increasing claims and awards. Estimates are continually reviewed and adjustments of the probable ultimate liability based on subsequent developments and new data are included in operating results for the periods in which they are made. In general, reserves are initially established based upon the actuarial and underwriting data utilized to set pricing levels, and are reviewed as additional information, including claims experience, becomes available. The Reliance Property and Casualty Companies regularly analyze their reserves and review their pricing and\nreserving methodologies, using Reliance Insurance Group actuaries, so that future adjustments to prior year reserves can be minimized. From time to time, the Reliance Property and Casualty Companies consult with independent actuarial firms concerning reserving practices and levels. The Reliance Property and Casualty Companies are required by state insurance regulators to file, along with their statutory reports, a statement of actuarial reserve opinion setting forth an actuary's assessment of their reserve status and, in 1994, the Reliance Property and Casualty Companies used an independent actuarial firm to meet such requirements. However, given the complexity of this process, reserves require continual updates. The process of estimating claims is a complex task and the ultimate liability may be more or less than such estimates indicate.\nSince 1989, the Reliance Property and Casualty Companies have increased their premium writings in long tail lines of business. Estimation of loss reserves for these lines of business is more difficult than for short tail lines because claims may not become apparent for a number of years, and a relatively higher proportion of ultimate losses are considered incurred but not reported. As a result, variations in loss development are more likely in these lines of business. The Reliance Property and Casualty Companies attempt to reduce these variations in certain of its long tail lines, primarily directors and officers liability, professional liability and general liability, by writing policies on a claims-made basis, which mitigates the long tail nature of the risks. The Reliance Property and Casualty Companies also seek to limit the loss from a single event through the use of reinsurance.\nIn calculating the liability for loss reserves, the Reliance Property and Casualty Companies discount workers' compensation pension claims which are expected to have regular, periodic payment patterns. These claims are discounted for mortality and for interest using statutory annual rates ranging from 3.5% to 6%. In addition, the reserves for claims assumed through the participation of the Reliance Property and Casualty Companies in workers' compensation reinsurance pools are discounted. The discounting of all claims (net of reinsurance recoverables) resulted in a decrease in the liability for loss reserves of $245.7 million, $284.7 million and $289.5 million at December 31, 1994, 1993 and 1992, respectively. The discount in 1994 was reduced by $27.3 million plus discount amortization of $11.7 million, resulting in a reduction in pre-tax income of $39.0 million. The discount in 1993 was increased by $7.9 million, which was more than offset by discount amortization resulting in a decrease in pre-tax income of $4.8 million. The discount in 1992 was increased by $54.1 million which was partially offset by discount amortization, resulting in an increase in pre-tax income of $45.7 million.\nThe liability for loss reserves includes provisions for inflation in several ways, depending on how the reserve is established. An explicit provision for inflation is used where estimates of ultimate loss are based on pricing. A provision for inflation is also included for certain discounted workers' compensation claims. In these cases, the provision for inflation is based on factors supplied by the respective workers' compensation rating bureaus which have jurisdiction for states which provide for cost-of-living increases in indemnity benefits. In other reserves, the analysis reflects the effect of inflationary trends as part of the overall effect on claim costs, as well as changes in marketing, underwriting, reporting and processing systems, claims\nsettlement and coverages purchased.\nIncluded in the liability for loss reserves at December 31, 1994 are $182.2 million ($130.1 million net of reinsurance recoverables) of loss reserves pertaining to asbestos-related and environmental pollution claims. The following table presents information relating to the liability for unpaid claims and related expenses pertaining to asbestos-related and environmental pollution claims (such information is for the years 1994 and 1993 only as certain 1992 information is not available):\nIncluded in the December 31, 1994 net liability for unpaid claims and related expenses for asbestos-related and environmental pollution claims are $36.5 million of loss costs for claims incurred but not reported, $49.4 million of loss costs for reported claims and $44.2 million of related expenses. The Company continues to receive claims asserting injuries from hazardous materials and alleged damages to cover various clean-up costs. Asbestos-related and environmental pollution claims primarily result from the Company's general liability and multiple peril lines of business. Loss and loss expense reserves for asbestos-related and environmental pollution claims are established using standard actuarial techniques as well as management's judgment. Coverage and claim settlement issues, related to policies written in prior years, such as the determination that coverage exists and the definition of an occurrence, may cause the actual loss development for asbestos-related and environmental pollution claims to exhibit more variation than the remainder of the Company's book of business.\nThe Company's net paid losses and related expenses for asbestos-related and environmental pollution claims have not been material in relation to the Company's total net paid losses and related expenses. Net paid losses and related expenses relating to these claims were $20.2 million (including $7.9 million of related expenses), $24.8 million (including $8.1 million of related expenses) and $16.1 million (including $6.2 million of related expenses) for the years ended December 31, 1994, 1993 and 1992, respectively. Related expenses consist primarily of legal costs. Total payments for all property and casualty insurance policy claims and related expenses were $1.1 billion, $1.0 billion and\n$961.1 million for the years ended December 31, 1994, 1993 and 1992, respectively. The following table presents information related to the number of insureds with asbestos-related and environmental pollution claims outstanding:\nThe average net paid loss per insured for asbestos-related and environmental pollution claims was $34,200 and $28,200 for the years 1994 and 1993, respectively. As of December 31, 1994, the Company was involved in approximately 45 coverage disputes (where a motion for declaratory judgment had been filed, the resolution of which will require a judicial interpretation of an insurance policy) related to asbestos or environmental pollution claims. The Company is not aware of any pending litigation or pending claim which will result in significant contingent liabilities in these areas. The Company believes it has made reasonable provisions for these claims, although the ultimate liability may be more or less than such reserves. The Company believes that future losses associated with these claims will not have a material adverse effect on its financial position, although there is no assurance that such losses will not materially affect the Company's results of operations for any period.\nAlthough the Company believes, in light of present facts and current legal interpretations, that the overall loss reserves of the Reliance Property and Casualty Companies are adequate to meet their obligations under existing policies, due to the inherent uncertainty and complexity of the reserving process, the ultimate liability may be more or less than such reserves.\nPORTFOLIO INVESTMENTS\nInvestment activities are an integral part of the business of the Reliance Insurance Group. The Reliance Insurance Group believes that the investment objectives of safety and liquidity, while seeking the best available return, can be achieved by active portfolio management and intensive monitoring of investments. Reference is made to 'Financial Review--Investment Portfolio' on page 30 of the Company's 1994 Annual Report, which section is incorporated herein by reference, and Note 2 to the Consolidated Financial Statements.\nAt December 31, 1994, the Company's investment portfolio was $3.8 billion\n(at cost) with 87.4% in fixed maturities and short-term securities (including redeemable preferred stock) and 12.6% in equity securities, approximately half of which were convertible preferred stock. The following table details the distribution of the Company's investments at December 31, 1994:\n------------------ (1) Does not include investment in Zenith National Insurance Corp. which is accounted for by the equity method and which, as of December 31, 1994, had a carrying value of $147.5 million and a market value of $149.6 million. See '--Investee Company.' (2) In the Company's Consolidated Financial Statements, mortgage loans are included in other accounts and notes receivable.\nThe Company seeks to maintain a diversified and balanced fixed maturity portfolio representing a broad spectrum of industries and types of securities. The Company holds virtually no investments in commercial real estate mortgages and has no exposure to derivative securities (other than through its ownership of any option, warrant or convertible security with an exercise or conversion price related to an equity security). Purchases of fixed maturity securities are researched individually based on in-depth analysis and objective predetermined\ninvestment criteria and are managed to achieve a proper balance of safety, liquidity and investment yields. The Reliance Insurance Group primarily invests in investment grade securities (those rated 'BBB' or better by S&P), and, to a lesser extent, non-investment grade and non-rated securities.\nAt December 31, 1994, the aggregate carrying value and market value of fixed maturities (other than short-term investments and cash) that either have been rated by S&P in the following categories or are non-rated were as follows:\nSubstantially all of the non-investment grade fixed maturities are classified as 'available for sale' and, accordingly, are carried at quoted market value. All publicly traded investment grade securities are priced using the Merrill Lynch Matrix Pricing model, which model is one of the standard methods of pricing such securities in the industry. All publicly traded non-investment grade securities, except as indicated below, are priced from broker-dealers who make markets in these and other similar securities. For fixed maturities not publicly traded, prices are estimated based on values obtained from independent third parties or quoted market prices of comparable instruments. Upon sale, such prices may not be realized when the size of a particular investment in an issue is significant in relation to the total size of such issue. Non-investment grade securities that are thinly traded are priced using internally developed calculations. Such securities represent less than 1% of the Reliance Insurance Group's fixed maturities portfolio.\nEquity investments are made after in-depth analysis of individual companies' fundamentals by the Reliance Insurance Group's staff of investment professionals. They seek to identify equities of large capitalization companies with strong growth prospects and equities that appear to be undervalued relative to the issuer's business fundamentals, such as earnings, cash flows, balance sheet and future prospects. Subsequent to purchase, the business fundamentals of each equity investment are carefully monitored.\nAs of March 15, 1995, the Reliance Insurance Group owned 3,568,634 shares of common stock of Symbol Technologies, Inc. ('Symbol'), representing 13.9% of the then outstanding common stock of Symbol. Symbol is the nation's largest manufacturer of bar code-based data capture systems. As of March 15, 1995, the market value of the Reliance Insurance Group's investment in Symbol was $105,274,703 (based upon the closing price on such date as reported by the NYSE), with a cost basis of $26,890,000.\nAt December 31, 1994, the Company's real estate holdings had a carrying value of $284.0 million, which includes 11 shopping centers with an aggregate carrying value of $138.0 million, office buildings and other commercial properties with an aggregate carrying value of $90.7 million, and undeveloped land with a carrying value of $55.3 million.\nThe following table presents the investment results of the Reliance Insurance Group's investment portfolio for each of the years ended December 31, 1994, 1993, and 1992:\n------------------ (1) The average is computed by dividing the total market value of investments at the beginning of the period plus the individual quarter-end balances by five for the years ended December 31, 1994, 1993 and 1992. (2) Does not include investment in Zenith National Insurance Corp. See '--Investee Company.' (3) The impact on the overall rate of return of a one percent increase or decrease in the December 31, 1994 fixed maturity portfolio market value would be approximately 0.78%.\nThe carrying value and market value at December 31, 1994 of fixed maturities for which interest is payable on a deferred basis was $114.0 million.\nINVESTEE COMPANY\nAs of March 15, 1995, the Reliance Insurance Group owned 6,574,445 shares of common stock of Zenith National Insurance Corp. ('Zenith'), representing 34.7% of the outstanding common stock of Zenith, a California-based insurance company with significant workers' compensation and standard commercial and personal lines business. As of March 15, 1995 the market value of the Reliance Insurance Group's investment in Zenith was $129,023,483 (based upon the closing price on such date as reported by the NYSE), with a carrying value of $147,513,000.\nThe board of directors of Zenith includes certain executive officers of the Company. The Company's investment in Zenith is accounted for by the equity method. See Note 3 to the Consolidated Financial Statements.\nREGULATION\nThe businesses of the Reliance Insurance Group, in common with those of other insurance companies, are subject to comprehensive, detailed regulation in the jurisdictions in which they do business. Such regulation is primarily for the protection of policyholders rather than for the benefit of investors. Although their scope varies from place to place, insurance laws in general grant broad powers to supervisory agencies or officials to examine companies and to enforce rules or exercise discretion touching almost every significant aspect of the conduct of the insurance business. These include the licensing of companies and agents to transact business, the imposition of monetary penalties for rules violations, varying degrees of control over premium rates (particularly for property and casualty companies), the forms of policies offered to customers, financial statements, periodic reporting, permissible investments and adherence to financial standards relating to surplus, dividends and other criteria of solvency intended to assure the satisfaction of obligations to policyholders. Other legislation obliges the Reliance Property and Casualty Companies to offer policies or assume risks in various markets which they would not seek if they were acting solely in their own interest. While such regulation and legislation is sometimes burdensome, inasmuch as all insurance companies similarly situated are subject to such controls, the Company does not believe that the competitive position of the Reliance Insurance Group is adversely affected.\nState holding company acts also regulate changes of control in insurance holding companies and transactions and dividends between an insurance company and its parent or affiliates. Although the specific provisions vary, the holding company acts generally prohibit a person from acquiring a controlling interest in an insurer incorporated in the state promulgating the act or in any other controlling person of such insurer unless the insurance authority has approved the proposed acquisition in accordance with the applicable regulations. In many states, including Pennsylvania, where Reliance Insurance Company is domiciled, 'control' is presumed to exist if 10% or more of the voting securities of the insurer are owned or controlled by a party, although the insurance authority may find that 'control' in fact does or does not exist where a person owns or controls either a lesser or a greater amount of securities. The holding company acts also impose standards on certain transactions with related companies, which generally include, among other requirements, that all transactions be fair and reasonable and that certain types of transactions receive prior regulatory approval either in all instances or when certain regulatory thresholds have been exceeded.\nOther states, in addition to an insurance company's state of domicile, may regulate affiliated transactions and the acquisition of control of licensed insurers. The State of California, for example, presently treats certain insurance subsidiaries of the Company which are not domiciled in California as though they were domestic insurers for insurance holding company purposes and such subsidiaries are required to comply with the holding company provisions of\nthe California Insurance Code, certain of which provisions are more restrictive than the comparable laws of the states of domicile of such subsidiaries.\nThe Insurance Law of Pennsylvania, where Reliance Insurance Company is domiciled, limits the maximum amount of dividends which may be paid without approval by the Pennsylvania Insurance Department. Under such law, Reliance Insurance Company may pay dividends during the year equal to the greater of (a) 10% of the preceding year-end policyholders' surplus or (b) the preceding year's statutory net income, but in no event to exceed the amount of unassigned funds, which are defined as 'undistributed, accumulated surplus including net income and unrealized gains since the organization of the insurer.' In addition, the Pennsylvania law specifies factors to be considered by the Pennsylvania Insurance Department to allow it to determine that statutory surplus after the payment of dividends is reasonable in relation to an insurance company's outstanding liabilities and adequate for its financial needs. Such factors include the size of the company, the extent to which its business is diversified among several lines of insurance, the number and size of risks insured, the nature and extent of the company's reinsurance, and the adequacy of the company's reserves. The maximum dividend permitted by law is not indicative of an insurer's actual ability to pay dividends, which may be constrained by business and regulatory considerations, such as the impact of dividends on surplus, which could affect an insurer's ratings, competitive position, the amount of premiums that can be written and the ability to pay future dividends. Furthermore, the Pennsylvania Insurance Department has broad discretion to limit the payment of dividends by insurance companies.\nIn addition, under California Insurance law, Reliance Insurance Company is deemed to be a 'commercially domiciled' California insurer and therefore subject to the dividend payment laws of California. The California\nlaws that limit the maximum amount of dividends which may be paid without approval by the California Insurance Department and specify the factors to be considered by the California Insurance Department to determine if the payment of the dividend is reasonable in relation to an insurance company's outstanding liabilities and financial needs are substantially the same as the laws of Pennsylvania. As in Pennsylvania, the California Insurance Department has broad discretion to limit the payment of dividends by insurance companies.\nTotal common and preferred stock dividends paid by Reliance Insurance Company during 1994, 1993 and 1992 were, $114.1 million ($111.5 million for common stock), $133.7 million ($130.6 million for common stock) and $143.7 million ($140.4 million for common stock), respectively. During 1995, $124.5 million would be available for dividend payments by Reliance Insurance Company under Pennsylvania and California law.\nThere is no assurance that Reliance Insurance Company will meet the tests in effect from time to time under Pennsylvania or California law for the payment of dividends without prior Insurance Department approvals or that any requested approvals will be obtained. However, Reliance Insurance Company has been advised by the California Insurance Department that any required prior approval will be based on the financial stability of the Company. Reliance Insurance Company has also been advised by the Pennsylvania Insurance Department that any required\nprior approval will be based upon a solvency standard and will not be unreasonably withheld.\nThe National Association of Insurance Commissioners (the 'NAIC') has adopted a 'risk-based capital' requirement for the property and casualty insurance industry which became effective in 1995 based on annual statements as of December 31, 1994. 'Risk-based capital' refers to the determination of the amount of statutory capital required for an insurer based on the risks assumed by the insurer (including, for example, investment risks, credit risks relating to reinsurance recoverables and underwriting risks) rather than just the amount of net premiums written by the insurer. A formula that applies prescribed factors to the various risk elements in an insurer's business is used to determine the minimum statutory capital requirement for the insurer. An insurer having less statutory capital than the formula calculates would be subject to varying degrees of regulatory intervention, depending on the level of capital inadequacy. All of the Company's statutory insurance companies have policyholders' surplus in excess of the minimum required risk-based capital. Management cannot predict the ultimate impact of risk-based capital requirements on the Company's competitive position.\nMaintaining appropriate levels of statutory surplus is considered important by the Company's management, state insurance regulatory authorities, and the agencies that rate insurers' claims-paying abilities and financial strength. Failure to maintain certain levels of statutory capital and surplus could result in increased scrutiny or, in some cases, action taken by state regulatory authorities and\/or downgrades in an insurer's ratings.\nThe Company's principal property and casualty insurance subsidiary, Reliance Insurance Company, has operated outside of the NAIC financial ratio range concerning liabilities to liquid assets (the 'NAIC liquidity test'). This ratio is intended only as a guideline for an insurance company to follow. The Company believes that it has sufficient marketable assets on hand to make timely payment of claims and other operating requirements.\nOn November 8, 1988, voters in California approved Proposition 103, which requires a rollback of rates for property and casualty insurance policies issued or renewed after November 8, 1988 of 20% from November 1987 levels and freezes rates at such lower levels until November 1989. Proposition 103 also requires that subsequent rate changes be justified to, and approved by, an elected insurance commissioner.\nIn 1989, the California Department of Insurance directed to United Pacific Insurance Company, one of the Company's California subsidiaries which writes business in California, a notice to reduce its current rates and make refunds to its policyholders by approximately $10.0 million. In January 1991, the regulations which formed the basis of the notice were repealed by the newly elected Insurance Commissioner. Subsequently, there were several administrative hearings on rate rollback and several different sets of regulations were issued. The regulations were subject to ongoing administrative and legal challenges. In February 1993, a Los Angeles Superior Court issued a decision declaring several sections of the regulations invalid and enjoined the enforcement of the regulations. On August 18, 1994, the California Supreme Court issued a decision reversing the Superior Court and upholding the validity of the regulations issued by the Insurance Commissioner. A petition filed with the United States\nSupreme Court seeking review of the California Supreme Court decision was denied on February 21, 1995. On November 28, 1994, Reliance Insurance Company and several of its affiliates received an order from the outgoing Insurance Commissioner ordering refunds totaling $44.8 million plus interest of $27.5 million. The Company believes that the refund order is based on incomplete and erroneous data.\nFurthermore, the Company believes that it did not earn a fair rate of return on its California business during the year at issue, 1989. Consequently, it intends to contest the order vigorously. The Company is entitled to a hearing to present evidence to establish what it believes to be an appropriate rollback or refund amount, if any. In the fourth quarter of 1994, the Company recorded a pre-tax charge of $11.6 million related to Proposition 103. While this charge reflects the Company's assessment of the impact of potential refunds to policyholders under Proposition 103, the Company nevertheless intends to contest the imposition of any refund on the basis of the matters set forth above. The Company does not believe that it is probable that it will be subject to a refund in an amount which will have a material adverse effect on the Consolidated Financial Statements.\nFrom time to time, other states have considered adopting legislation or regulations which could adversely affect the manner in which the Company sets rates for policies of insurance, particularly as they relate to personal lines. No assurance can be given as to what effect the adoption of any such legislation or regulation would have on the ability of the Company to raise its rates. However, since the Company is transferring or running off its personal lines business and, as a result, has substantially withdrawn from personal lines, the Company believes that these initiatives will not have a material adverse effect on its on-going business.\nCOMPETITION\nAll of the Company's businesses are highly competitive. The property and casualty insurance business is fragmented and no single company dominates any of the markets in which the Company operates. The Reliance Property and Casualty Companies compete with individual companies and with groups of affiliated companies with greater financial resources, larger sales forces and more widespread agency and broker relationships. Competition in the property and casualty insurance industry is based primarily on price, product design and service. In addition, because the Reliance Property and Casualty Companies sell policies through independent agents and insurance brokers who are not obligated to choose the policies of the Reliance Property and Casualty Companies over those of another insurer, the Reliance Property and Casualty Companies must compete for agents and brokers and for the business they control. Such competition is based upon price, product design, policyholder service, commissions and service to agents and brokers.\nCommonwealth\/Transamerica Title compete with large national title insurance companies and with smaller, locally established businesses which may possess distinct competitive advantages. Competition in the title insurance business is based primarily on the quality and timeliness of service. In some market areas, abstracts and title opinions issued by attorneys are used as an alternative to\ntitle insurance and other services provided by title companies. In addition, certain jurisdictions have title registration systems which can lessen the demand for title insurance.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company and its consolidated subsidiaries own and lease offices in various locations primarily in the United States. None of these properties is material to the Company's business. At December 31, 1994, the Company and its consolidated subsidiaries employed approximately 9,075 persons in approximately 440 offices.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company and its subsidiaries are involved in certain litigation arising in the course of their businesses, some of which involve claims of substantial amounts. Although the ultimate outcome of these matters cannot be ascertained at this time, and the results of legal proceedings cannot be predicted with certainty, the Company is contesting the allegations of the complaints in each pending action and believes, based on current knowledge and after consultation with counsel, that the resolution of these matters will not have a material adverse effect on the Consolidated Financial Statements. In addition, the Company is subject to the litigation set forth below.\nIn June 1989, Hall, the predecessor corporation of Prometheus Funding Corp., a subsidiary of the Company ('Prometheus'), entered into a settlement agreement, which is subject to court approval, with the Superintendent of Insurance of the State of New York (the 'Superintendent'), arising out of the insolvency of Union Indemnity Insurance Company of New York, Inc. ('Union Indemnity'). The settlement agreement was submitted to the court for approval in October 1989 and objections were filed by various parties. In March 1994, the Superintendent informed Prometheus that he did not intend to pursue court approval of the settlement until the resolution of appellate proceedings in a pending litigation between the Superintendent and certain of Union\nIndemnity's reinsurers. Prometheus has advised the Superintendent that this position is in breach of the settlement agreement's requirement that the parties diligently make every effort to obtain court approval of the settlement, and Prometheus has reserved all of its rights with respect thereto. There is no assurance that such approval will be obtained. The settlement agreement will not become effective until final approval by the court.\nThirty-one employers doing business in Texas have brought two actions in the District Court of Dallas County, Texas, against, among others, approximately 200 individual insurance companies, including Reliance Insurance Company and several of its subsidiaries. The plaintiffs in the actions, which were commenced against the Reliance parties in April 1992 and February 1995 respectively (and the second of which has been stayed in light of the pendency of the first), assert that they were overcharged for workers' compensation insurance and multiple line retrospectively rated casualty insurance between 1987 and 1992. In August 1994, the plaintiffs in the first action moved for certification of a purported plaintiff class consisting of all employers who purchased Texas\nworkers' compensation insurance from the insurance company defendants during the years in question. Plaintiffs seek monetary damages, with interest and attorneys' fees, against all defendants jointly and severally, together with a release of all purported class members from liability for payment of unlawful premiums, and injunctive relief. The Company has filed answers denying the allegations and is contesting the actions vigorously. The Company does not believe that it is probable that its liability, if any, in excess of what the Company has provided for in respect of this matter will have a material adverse effect on the Consolidated Financial Statements.\nSee Note 16 to the Consolidated Financial Statements for additional information concerning the above referenced legal proceedings affecting the Company and its subsidiaries.\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 in the fourth quarter of the fiscal year covered by this Annual Report on Form 10-K.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nSet forth below is the name, age and position of each of the executive officers of the Company:\nEach director of the Company is also a director of Reliance Group Holdings and Reliance Financial.\nMr. Robert M. Steinberg has been a Director of Reliance Insurance Company since 1978, served as Vice Chairman of the Board from March 1984 until October 1984, and became Chairman of the Board and Chief Executive Officer in October 1984. Mr. Steinberg has been President and Chief Operating Officer of Reliance Group Holdings since 1982. He has held various positions with predecessors of Reliance Group Holdings since 1965. He is a Director of Zenith National Insurance Corp. He is the brother of Saul P. Steinberg.\nMr. Saul P. Steinberg has been a Director of Reliance Insurance Company since 1968 and Chairman of its Executive and Finance Committee since October 1976. Mr. Steinberg founded and has been the Chief Executive Officer and a Director of Reliance Group Holdings and predecessors of Reliance Group Holdings since 1961. Mr. Steinberg is a Director of Symbol Technologies, Inc. and Zenith National Insurance Corp. He is the brother of Robert M. Steinberg.\nMr. Dean W. Case became the Vice Chairman of the Board of Reliance Insurance Company in October 1994 and a Director of Reliance Insurance Company and Reliance Group Holdings in January 1986. From July 1988 until October 1994, he was President and Chief Operating Officer of Reliance Insurance Company and from July 1988 until March 1995 he was President and Chief Executive Officer of United Pacific Insurance Company, a subsidiary of Reliance Insurance Company. From June 1981 until April 1990, Mr. Case was Chief Executive Officer of General Casualty Company of Wisconsin, a subsidiary of Reliance Insurance Company until April 1990. Prior thereto he held various offices with Reliance Insurance Company since 1973. Mr. Case is a member of the Board of Governors of the National Association of Independent Insurers.\nMr. Robert C. Olsman was elected President and Chief Operating Officer of Reliance Insurance Company and President and Chief Executive Officer of United Pacific Insurance Company, a subsidiary of Reliance Insurance Company, in March 1995. He was Senior Vice President of Reliance Insurance Company from January 1986 to March 1995. Prior thereto, he held various positions with Travelers Insurance Company, including Regional Vice President from 1983 to 1984 and Second Vice President from 1984 to 1985.\nMr. Dennis A. Busti became a Director of Reliance Insurance Company and Reliance Group Holdings in August 1991. He has been Chairman of the Board of Reliance National since October 1993 and President and Chief Executive Officer of Reliance National since June 1987. From January 1987 to June 1987 he was President of Columbia Insurance Company. From 1983 to January 1987 he was President of American Home Insurance Company.\nMr. Jerome H. Carr joined Reliance Insurance Company as Corporate Senior Vice President and Chief Financial Officer in May 1981. For over ten years prior thereto, he was Vice President of Finance and Chief Financial Officer of Alexander & Alexander Services, Inc., an international insurance broker.\nMr. Kenneth R. Frohlich has been Corporate Senior Vice President and Chief Actuarial Officer of Reliance Insurance Company since March 1988 and Corporate\nSenior Vice President and Chief Actuarial Officer of Reliance Insurance Group, Inc., an affiliate of Reliance Insurance Company, since June 1987. From June 1982 to June 1987 he was a Senior Vice President of CIGNA P\/C Companies, a group of insurance companies.\nMr. Dennis C. Costello has been Senior Vice President--Claims of Reliance Insurance Company since June 1988. From 1973 to June 1988 he was Vice President of Chubb & Son, Inc., an insurance management company.\nMr. Wesley D. Dingman became Senior Vice President--Marketing and Agency Relations of Reliance Insurance Company in January 1990. From July 1986 to December 1989 he was a Regional Vice President of Reliance Insurance Company. Prior thereto he was a Regional Vice President of Crum & Forster Insurance Companies from 1983 to June 1986.\nMr. Bruce Farbman has been Senior Vice President--Human Resources and Administration of Reliance Insurance Company since April 1989. From April 1988 to April 1989 he was Senior Vice President--Human Resources of Reliance Insurance Company and from July 1987 to April 1988 he was Vice President--Human Resources of Reliance Insurance Company.\nMr. Lowell C. Freiberg has been Senior Vice President of Reliance Insurance Company since December 1985. He has been Senior Vice President and a Director of Reliance Group Holdings since 1982 and Chief Financial Officer of Reliance Group Holdings since 1985. He also served as Treasurer of Reliance Group\nHoldings from 1982 until March 1994 and has held various positions with predecessors of Reliance Group Holdings since 1969. He is a Director of Symbol Technologies, Inc.\nMr. George T. Holbrook has been Senior Vice President of Reliance Insurance Company since December 1979.\nMr. Robert J. Joyce has been Senior Vice President of Reliance Insurance Company since September 1991. Prior thereto he was Senior Vice President--Personal Division of Reliance Insurance Company since October 1987 and Senior Vice President--Finance and Administration of United Pacific Insurance Company, a subsidiary of Reliance Insurance Company, from January 1985 until October 1987. From March 1984 to January 1985 he was Senior Vice President of United Pacific Life Insurance Company, a subsidiary of Reliance Insurance Company until July 1993.\nMr. Robert Krisowaty has been Senior Vice President and Controller of Reliance Insurance Company since October 1988. Prior thereto he was Senior Vice President and General Claims Manager of Reliance Insurance Company since March 1985. From March 1982 to March 1985 he was General Auditor of Reliance Insurance Company.\nMr. Richard B. Root has been Senior Vice President of Reliance Insurance Company since September 1991. From March 1989 to September 1991, he was Vice\nPresident--Commercial Division of Reliance Insurance Company. He was Vice President of United Pacific Insurance Company, a subsidiary of Reliance Insurance Company, from December 1986 to March 1989. Prior thereto, he was Executive Vice President of United Pacific Special Risk, Inc., a subsidiary of United Pacific Insurance Company, from January 1980.\nMr. James E. Yacobucci became a Director and Senior Vice President--Investments of Reliance Insurance Company in May 1989 and Senior Vice President--Investments of Reliance Group Holdings in December 1990. From January 1982 through April 1989, he was a general partner of Cumberland Associates, a private investment manager.\nOfficers are not elected for a fixed term of office but serve at the discretion of the Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAs of March 15, 1995, all outstanding shares of common stock of Reliance Insurance Company are held of record by Reliance Financial and are not publicly traded. A discussion of dividends paid by Reliance Insurance Company is included in Item 1 of this report under the caption 'Regulation.'\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSee the information in 'Reliance Insurance Company and Subsidiaries Selected Financial Data' on pages 23 and 24 of the Reliance Insurance Group's 1994 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.\nSee the information in 'Reliance Insurance Company and Subsidiaries Financial Review' on pages 26 through 32 of the Reliance Insurance Group's 1994 Annual Report, which information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements of the Company and its consolidated subsidiaries, included on pages 1 through 22 of the Reliance Insurance Group's 1994 Annual Report, which information is incorporated herein by reference, are listed in Item 14 below.\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 the executive officers of the Company is included in Part I of this report under the caption 'Executive Officers of the Registrant.'\nInformation regarding the directors of the Company is incorporated herein by reference from its Definitive Information Statement for the Annual Meeting of Stockholders to be held May 31, 1995, under the caption 'Nominees for Election as Directors.'\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nSee the information in the Definitive Information Statement for the Annual Meeting of Stockholders to be held May 31, 1995, under the captions 'Nominees for Election as Directors--Compensation of Directors' and 'Executive Compensation,' which information (other than the information under the caption 'Executive Compensation--Report of Compensation Committees of the Board') is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nSee the information in the Definitive Information Statement for the Annual Meeting of Stockholders to be held May 31, 1995 under the captions 'Voting Securities and Principal Holders' and 'Security Ownership of Management,' which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nSee the information in the Definitive Information Statement for the Annual Meeting of Stockholders to be held May 31, 1995, under the captions 'Executive Compensation--Compensation Committee Interlocks and Insider Participation' and 'Related Party Transactions,' 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) 1. FINANCIAL STATEMENTS.\nThe consolidated financial statements of Reliance Insurance Company and Subsidiaries, which appear on pages 1 through 22 of the Reliance Insurance Group's 1994 Annual Report, are incorporated herein by reference.\n2. FINANCIAL STATEMENT SCHEDULES\nPursuant to Rule 1-02(v) of Regulation S-X, Reliance Insurance Group's investment in Zenith National Insurance Corp. meets the definition of a 'significant subsidiary.' Zenith National Insurance Corp. files financial statements with the Securities and Exchange Commission which should be referred to for additional information.\n3. EXHIBITS\n------------------ * Neither Reliance Insurance Company nor its subsidiaries is a party to any instrument relating to long-term debt under which the securities authorized exceed 10% of the total consolidated assets of Reliance Insurance Company and its subsidiaries. Copies of instruments relating to long-term debt of lesser amounts will be provided to the Securities and Exchange Commission upon request.\n+ Management contract or compensatory plan or arrangement required to be filed as an Exhibit to this Form 10-K pursuant to Item 14(c).\n------------------ + Management contract or compensatory plan or arrangement required to be filed as an Exhibit to this Form 10-K pursuant to Item 14(c).\n------------------ ++ Schedule P from the statutory reports of Zenith National Insurance Corp., 34.7% of the outstanding common stock of which is owned by the Company, is omitted herefrom as such Schedule P is filed directly with the Securities and Exchange Commission.\n** To be filed by Amendment.\n(B) REPORTS ON FORM 8-K\nDuring the last quarter of the period for which this report is filed, the Company filed a Report on Form 8-K, dated (date of earliest event reported) November 28, 1994, reporting an Item 5 matter regarding an order of the insurance commissioner of California.\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 30TH DAY OF MARCH, 1995.\nRELIANCE INSURANCE COMPANY\nBy: ROBERT M. STEINBERG ---------------------------------- ROBERT M. STEINBERG 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\nREGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Reliance Insurance Company Philadelphia, Pennsylvania\nWe have audited the consolidated financial statements of Reliance Insurance Company (a subsidiary of Reliance Group Holdings, Inc.) and subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 22, 1995 (which report includes an explanatory paragraph concerning the adoption of Statement of Financial Accounting Standards No. 109); such financial statements and report are included in your 1994 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedules of Reliance Insurance Company, 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.\n\/s\/ DELOITTE & TOUCHE LLP Philadelphia, Pennsylvania February 22, 1995\nA-1\nSCHEDULE I ITEM 14(A)2\nRELIANCE INSURANCE COMPANY AND SUBSIDIARIES SUMMARY OF INVESTMENTS--OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1994\n(1) In the consolidated financial statements, mortgage loans are included in other accounts and notes receivable.\nA-2\nSCHEDULE II ITEM 14(A)2 RELIANCE INSURANCE COMPANY (PARENT COMPANY)\nSTATEMENT OF INCOME\nA-3\nSCHEDULE II ITEM 14(A)2 RELIANCE INSURANCE COMPANY (PARENT COMPANY)\nBALANCE SHEET\nA-4\nSCHEDULE II ITEM 14(A)2 RELIANCE INSURANCE COMPANY (PARENT COMPANY)\nSTATEMENT OF CASH FLOWS\nA-5\nSCHEDULE III ITEM 14(A)2 RELIANCE INSURANCE COMPANY AND SUBSIDIARIES\nSUPPLEMENTARY INSURANCE INFORMATION\nA-6\nSCHEDULE IV ITEM 14(A)2 RELIANCE INSURANCE COMPANY AND SUBSIDIARIES\nREINSURANCE\nA-7\nSCHEDULE VI ITEM 14(A)2 RELIANCE INSURANCE COMPANY AND SUBSIDIARIES\nSUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\n(a) Liabilities for unpaid claims and related expenses for short-duration contracts which are expected to have fixed, periodic payment patterns are discounted to present values using statutory annual rates ranging from 3 1\/2% to 6% in 1994 and 3% to 6% in 1993 and 1992.\nA-8\nEXHIBITS TO FORM 10-K\nANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED COMMISSION FILE NUMBER DECEMBER 31, 1994 1-7577\nRELIANCE INSURANCE COMPANY (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)\nRELIANCE INSURANCE COMPANY\nEXHIBIT INDEX\n------------------ * Neither Reliance Insurance Company nor its subsidiaries is a party to any instrument relating to long-term debt under which the securities authorized exceed 10% of the total consolidated assets of Reliance Insurance Company and its subsidiaries. Copies of instruments relating to long-term debt of lesser amounts will be provided to the Securities and Exchange Commission upon request.\n+ Management contract or compensatory plan or arrangement required to be filed as an Exhibit to this Form 10-K pursuant to Item 14(c).\n------------------\n+ Management contract or compensatory plan or arrangement required to be filed as an Exhibit to this Form 10-K pursuant to Item 14(c).\n------------------ ++ Schedule P from the statutory reports of Zenith National Insurance Corp., 34.7% of the outstanding common stock of which is owned by the Company, is omitted herefrom as such Schedule P is filed directly with the Securities and Exchange Commission.\n** To be filed by Amendment.","section_15":""}
{"filename":"75042_1994.txt","cik":"75042","year":"1994","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business\nOshKosh B'Gosh, Inc.(together with its subsidiaries, the \"Company\") was founded in 1895 and was incorporated in the state of Delaware in 1929. The\nCompany designs, manufactures, sources and sells apparel for the children's wear, youth wear, and men's wear markets. While its heritage is in the men's workwear market, the Company is currently best known for its line of high quality children's wear. The children's wear and youth wear business represented approximately 94% of consolidated Company revenues for 1994. The success of the children's wear business can be attributed to the Company's core themes: quality, durability, style, trust and Americana. These themes have propelled the Company to the position of market leader in the branded children's wear industry. The Company also leverages the economic value of the OshKosh B'Gosh name via both domestic and international licensing agreements.\nThe Company's long-term strategy is to provide high quality, high value clothing for the entire family. Toward this end the Company continues to expand its business lines and avenues for marketing its products. In 1990, the Company acquired Essex Outfitters, Inc. (\"Essex\"), a vertically integrated children's and youth wear retailer marketed under the Boston Trader label through a licensing agreement with Boston Trader Ltd. In 1994, the Company merged the operations of Essex into OshKosh B'Gosh, Inc. and created a new brand name, Genuine Kids , for the line of children's and youth wear formerly marketed under the Boston Trader label. The Genuine Kids line of apparel is sourced from third party manufacturers, primarily offshore, and sold primarily through a chain of 77 domestic retail stores.\nOshKosh B'Gosh International Sales, Inc. was created in 1985 for the sale of OshKosh B'Gosh products to foreign distributors. In 1990, the Company formed OshKosh B'Gosh Europe, S.A. in conjunction with a joint venture with Poron Diffusion, S.A. to provide further access to European markets. In 1992 the Company acquired Poron's 49% interest in OshKosh B'Gosh Europe, S.A. During 1993 OshKosh B'Gosh made moves to strategically position itself for International expansion. OshKosh B'Gosh\/Asia Pacific Ltd. was created in Hong Kong to oversee licensees and distributors in the Pacific Rim, to assist international licensees with the sourcing of product, and to expand the Company's presence in that region. OshKosh B'Gosh U.K. Ltd. and OshKosh B'Gosh Deutschland GmbH, incorporated in the United Kingdom and Germany respectively, were established to increase sales emphasis in those countries.\nThe Company's chain of 60 domestic OshKosh B'Gosh factory outlet stores sells irregular and first quality OshKosh B'Gosh merchandise throughout the United States. In 1994, the Company opened an OshKosh B'Gosh showcase store in New York City bringing total domestic stores to 61. In addition, Oshkosh B'Gosh Europe opened showcase stores in London and Paris during 1994. The showcase stores are designed to reinforce awareness and demand for OshKosh B'Gosh as a global brand. In 1993, the Company distributed its first children's wear mail order catalog, further expanding its channels of distribution.\nThe Company has been expanding its utilization of off-shore sourcing as a cost-effective means to produce its products and to this end leased a production facility in Honduras in 1990 under its wholly owned subsidiary Manufacturera International Apparel S.A.\n(b) Financial Information About Industry Segments\nThe Company is engaged in only one line of business, namely, the apparel industry.\n(c) Narrative Description of Business\nProducts\nThe Company designs, manufactures, sources and markets a broad range of children's clothing as well as lines of youth wear and men's casual and work wear clothing under the OshKosh , OshKosh B'Gosh , Baby B'Gosh , Genuine Kids or OshKosh Men's Wear labels. In 1994, the Company created the Our Stuff by OshKosh B'Gosh brandname (initial sales of the product are scheduled for the fall 1995 season). The products are distributed primarily through better quality department and specialty stores, 138 of the Company's own stores, direct mail catalogs and foreign retailers. The children's wear and youth wear business, which is the largest segment of the business, accounted for approximately 94% of 1994 sales compared to approximately 94% and 96% of such sales in 1993 and 1992, respectively.\nThe children's wear and youth wear business is targeted to reach the middle to upper middle segment of the sportswear market. Children's wear is in size ranges from newborn\/infant to girls 6X and boys 7. Youth wear is in size ranges girls 7 to 14 and boys 8 to 20.\nThe Company's children's wear and youth wear business include a broad range of product categories organized primarily in a collection format whereby the products in that collection share a primary design theme which is carried out through fabric design, screenprint, embroidery, and trim applications. The Company also offers basic denim products with multiple wash treatments. The product offerings for each season will typically consist of a variety of clothing items including bib overalls, pants, jeans, shorts, and shortalls (overalls with short pant legs), shirts, blouses and knit tops, skirts, jumpers, sweaters, dresses, playwear and fleece.\nThe men's wear line is the original business that started the Company in 1895. The current line comprises the traditional bib overalls, several styles of waistband-work, carpenter, and painters-pants, five pocket jeans, work shirts and flannel shirts as well as coats and jackets. The line is designed with a full array of sizes up to and including size 60 inch waists and 5x size shirts.\nMost products are designed by an in-house staff. Product design requires long lead times, with products generally being designed a year in advance of the time they actually reach the retail market. In general, the Company's products are traditional in nature and not intended to be \"designer\" items. In designing new products and styles, the Company attempts to incorporate current trends and consumer preferences in its traditional product offerings.\nIn selecting fabrics and prints for its products, the Company seeks, where possible, to obtain exclusive rights to the fabric design from its suppliers in order to provide the Company with some protection from imitation by competitors for a limited period of time.\nRaw Materials, Manufacturing and Sourcing\nAll raw materials used in the manufacture of Company products are purchased from unaffiliated suppliers. In 1994, approximately 78% of the Company's direct expenditures for raw materials (fabric) were from its five largest suppliers, with the largest such supplier accounting for approximately 29% of total raw material expenditures. Fabric and various non-fabric items,\nsuch as thread, zippers, rivets, buckles and snaps are purchased from a variety of independent suppliers. The fabric and accessory market in which OshKosh B'Gosh purchases its raw materials is composed of a substantial number of suppliers with similar products and capabilities, and is characterized by a high degree of competition. As is customary in its industry, the Company has no long-term contracts with its suppliers. To date, the Company has experienced little difficulty in satisfying its requirements for raw materials, considers its sources of supply to be adequate, and believes that it would be able to obtain sufficient raw materials should any one of its product suppliers become unavailable.\nProduction administration is primarily coordinated from the Company's headquarters facility in Oshkosh with most production taking place in its one Wisconsin, eight Tennessee, and five Kentucky plants. Overseas labor is also accessed through a leased sewing plant in Honduras, where cut apparel pieces are received from the United States and are reimported by OshKosh B'Gosh as finished goods. In addition, product is produced by contractors in 11 countries and imported into the United States.\nThe majority of the product engineering and sample making, allocation of production among plants and independent suppliers, material purchases and invoice payments is done through the Company's Oshkosh headquarters. All designs and specifications utilized by independent manufacturers are provided by the Company. While no long-term, formal arrangements exist with these manufacturers, the Company considers these relationships to be satisfactory. The Company believes it could obtain adequate alternative production capacity if any of its independent manufacturers become unavailable.\nBecause higher quality apparel manufacturing is generally labor intensive (sewing, pressing, finishing and quality control), the Company has continually sought to upgrade its manufacturing and distribution facilities. Economies are therefore realized by technical advances in areas like computer-assisted design, computer-controlled fabric cutting, computer evaluation and matching of fabric colors, automated sewing processes, and computer-assisted inventory control and shipping. In order to realize economies of operation within the domestic production facilities, cutting operations are located in three of the Company's fourteen plants, with all product washing, pressing and finishing done in one facility in Tennessee and all screenprint and embroidery done in one facility in Kentucky. Quality control inspections of both semi-finished and finished products are required at each plant, including those of independent manufacturers, to assure compliance.\nCustomer orders for fashion products are booked from three to six months in advance of shipping. Because most Company production of styled products is scheduled to fill orders already booked, the Company believes that it is better able to plan its production and delivery schedules than would be the case if production were in advance of actual orders. In order to secure necessary fabrics on a timely basis and to obtain manufacturing capacity from independent suppliers, the Company must make substantial advance commitments, sometimes as much as five to seven months prior to receipt of customer orders. Inventory levels therefore depend on Company judgment of market demand.\nTrademarks\nThe Company utilizes the OshKosh , OshKosh B'Gosh , Baby B'Gosh or Genuine Kids trademarks on most of its products, either alone or in conjunction with a white triangular background. In addition, \"The Genuine Article \" is embroidered on the small OshKosh B'Gosh patch to signify apparel\nthat is classic in design and all-but-indestructible in quality construction. The Company currently uses approximately 21 registered and unregistered trademarks in the United States. These trademarks and universal awareness of the OshKosh B'Gosh name are significant in marketing the products.\nSeasonality\nProducts are designed and marketed primarily for three principal selling seasons:\nRETAIL SALES SEASON PRIMARY BOOKING PERIOD SHIPPING PERIOD Spring\/Summer August-September January-April Fall\/Back-to-School January-February May-August Winter\/Holiday April-May September-December\nThe Company's business is increasingly seasonal, with highest sales and income in the third quarter which is the Company's peak retail selling season at its retail outlet stores. The Company's second quarter sales and income are the lowest both because of relatively low domestic wholesale unit shipments and relatively modest retail outlet store sales during this period. The Company anticipates this seasonality trend to continue to impact 1995 quarterly sales and income.\nWorking Capital\nWorking capital needs are affected primarily by inventory levels, outstanding accounts receivable and trades payable. In June 1994, the Company entered into a credit agreement with a number of banks which provides a $60 million three year revolving credit facility and a $40 million revocable demand line of credit for cash borrowings, issuance of commercial paper and letters of credit. The agreement expires in June 1997. The Company also has a $12.5 million unsecured credit facility available at December 31, 1994 for issuance of letters of credit. There were no outstanding borrowings against these credit arrangements at December 31, 1994. Letters of credit of approximately $26 million were outstanding at December 31, 1994.\nInventory levels are affected by order backlog and anticipated sales. Accounts receivable are affected by payment terms offered. It is general practice in the apparel industry to offer payment terms of ten to sixty days from date of shipment. The Company offers net 30 days terms only.\nThe Company believes that its working capital requirements and financing resources are comparable with those of other major, financially sound apparel manufacturers.\nSales and Marketing\nCompany products are sold primarily through better quality department and specialty stores, although sales are also made through direct mail catalog companies, foreign retailers and other outlets, including 137 Company operated domestic retail factory stores and one retail showcase store, and the Company's proprietary mail order catalog. No one customer accounted for more than 10% of the Company's 1994 sales. The Company's largest ten and largest 100 customers accounted for approximately 43% and 68% of 1994 sales, respectively. In 1994, the Company's products were sold to approximately 3,300 wholesale customers (approximately 10,600 stores) throughout the United States, and a sizeable number of international accounts.\nProduct sales to better quality department and specialty stores are primarily by an employee sales force with the balance of sales made through manufacturer's representatives or to in-house accounts. In addition to the central sales office in Oshkosh, the Company maintains regional sales offices and product showrooms in Dallas and New York. Most members of the Company's sales force are assigned to defined geographic territories, with some assigned to specific large national accounts. In sparsely populated areas and new markets, manufacturer's representatives represent the Company on a non- exclusive basis.\nDirect advertising in consumer and trade publications is the primary method of advertising used. The Company also offers a cooperative advertising program, paying half of its customers' advertising expenditures for their products, generally up to two percent of the higher of the customer's prior or current year's gross purchases from the Company.\nBacklog\nThe dollar amount of backlog of orders believed to be firm as of the end of the Company's fiscal year and as of the preceding fiscal year is not material for an understanding of the business of the Company taken as a whole.\nCompetitive Conditions\nThe apparel industry is highly competitive and consists of a number of domestic and foreign companies. Some competitors have assets and sales greater than those of the Company. In addition, the Company competes with a number of firms that produce and distribute only a limited number of products similar to those sold by the Company or sell only in certain geographic areas being supplied by the Company.\nA characteristic of the apparel industry is the requirement that a marketer recognize fashion trends and adequately provide products to meet such trends. Competition within the apparel industry is generally in terms of quality, price, service, style and, with respect to branded product lines, consumer recognition and preference. The Company believes that it competes primarily on the basis of quality, style, and consumer recognition and to a lesser extent on the basis of service and price. The Company is focusing attention on the issue of price and service and has taken and will continue to take steps to reduce costs, become more competitive in the eyes of value conscious consumers and deliver the service expected by its customers.\nThe Company's share of the overall children's wear market is quite small. This is due to the diverse structure of the market where there is no truly dominant producer of children's garments across all size ranges and garment types. In the Company's channel of distribution, department and specialty stores, it holds the largest share of the branded children's wear market.\nEnvironmental Matters\nThe Company's compliance with Federal, State, and local environmental laws and regulations had no material effect upon its capital expenditures, earnings, or competitive position. The Company does not anticipate any material capital expenditures for environmental control in either the current or succeeding fiscal years.\nEmployees\nAt December 31, 1994, the Company employed approximately 6,600 persons. Approximately 52% of the Company's personnel are covered by collective bargaining agreements with the United Garment Workers of America.\nThe Company considers its relations with its personnel to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's principal executive and administrative offices are located in Oshkosh, Wisconsin. Its principal office, manufacturing and distribution operations are conducted at the following locations:\nApproximate Location Floor Area in Principal Square Feet Use\nAlbany, KY 20,000 Manufacturing Byrdstown, TN 32,000 Manufacturing Celina, TN 100,000 Manufacturing Celina, TN 90,000 Laundering\/Pressing Columbia, KY 78,000 Manufacturing Columbia, KY 23,000 Manufacturing Dallas, TX (1) 1,995 Sales Offices\/Showroom Gainesboro, TN 61,000 Manufacturing Gainesboro, TN 29,000 Warehousing Hermitage Springs, TN 52,000 Manufacturing Jamestown, TN 43,000 Manufacturing Liberty, KY 218,000 Manufacturing\/Warehousing Liberty, KY (2) 32,000 Warehousing Los Angeles, CA (3) 667 Sales Offices\/Showroom Marrowbone, KY 27,000 Manufacturing McEwen, TN (4) 29,000 Manufacturing New York City, NY (5) 18,255 Sales Offices\/Showrooms Oshkosh, WI 99,000 Exec. & Operating Co. Offices Oshkosh, WI 88,000 Manufacturing Oshkosh, WI 128,000 Distribution\/Warehousing Red Boiling Springs,TN 41,000 Manufacturing White House, TN 284,000 Distribution\/Warehousing\nAll properties are owned by the Registrant with the exception of: (1) Lease expiration date - 1995, (2) Lease expiration date - 1999, (3) Lease expiration date -1997, (4) Lease expiration date - 1997, (5) Lease expiration date - 2007. The Company believes that its properties are well maintained and its manufacturing equipment is in good operating condition and sufficient for current production.\nSubstantially all of the Company's retail stores occupy leased premises. For information regarding the terms of the leases and rental payments thereunder, refer to the \"Leases\" note to the consolidated financial statements on page 26 of this Form 10-K.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company and its subsidiaries are not parties to any material pending legal proceedings.\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.\nQuarterly Common Stock Data\n1994 1993 Stock Price Dividends Stock Price Dividends High Low Per Share High Low Per Share\nClass A common stock 1st 21-3\/4 14-1\/2 $0.1025 22-1\/2 14-1\/2 $0.1025 2nd 15 12-1\/4 0.1025 19 14-1\/2 0.1025 3rd 15-1\/2 13-1\/2 0.1025 18-1\/4 13-1\/2 0.1025 4th 15-1\/4 13 0.07 20-1\/2 16-1\/4 0.205\nClass B common stock 1st 22 16-3\/4 $0.09 18 12 $0.09 2nd 17 13-3\/4 0.09 18-1\/4 15-1\/4 0.09 3rd 15-1\/2 14 0.09 18 13-3\/4 0.09 4th 15-1\/4 13-1\/2 0.06 20-3\/4 17 0.18\nThe Company's Class A common stock and Class B common stock trade on the Over-The-Counter market and is quoted on NASDAQ under the symbols GOSHA and GOSHB, respectively. The table reflects the last price quotation on the NASDAQ National Market System and does not reflect mark-ups, mark-downs, or commissions and may not represent actual transactions.\nThe Company has paid cash dividends on its common stock each year since 1936. The Company's Certificate of Incorporation requires that when any dividend (other than a dividend payable solely in shares of the Company's stock) is paid on the Company's Class B Common Stock, a dividend equal to 115% of such amount per share must concurrently be paid on each outstanding share of Class A Common Stock.\nAs of March 17, 1995, there were 1,939 Class A common stock shareholders of record and 194 Class B common stock shareholders of record.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFinancial Highlights (Dollars in thousands, except per share amounts)\nYear Ended December 31, 1994 1993 1992 1991 1990\nFinancial Results Net sales $363,363 $340,186 $346,206 $365,173 $323,377 Net income 7,039 4,523 15,135* 23,576 29,552 Return on sales 1.9% 1.3% 4.4% 6.5% 9.1%\nFinancial Condition Working capital $102,463 $111,794 $111,075 $106,803 $103,063 Total assets 217,211 229,131 226,195 214,963 192,196 Long-term debt (less current maturities) 517 757 1,293 2,379 3,459 Shareholders equity 158,814 171,998 175,153 167,380 151,166\nData Per Common Share Net income $ .50 $ .31 $ 1.04* $ 1.62 $ 2.03 Cash dividends declared Class A .3775 .5125 .5125 .5125 .49 Class B .33 .45 .45 .45 .43 Shareholders equity 11.76 11.79 12.01 11.48 10.36\n* After a charge of $601 or $.04 per share to reflect cumulative effect of change in accounting for nonpension postretirement benefits. See Note 10 to consolidated financial statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nNet sales in 1994 were $363.4 million, an increase of $23.2 million (6.8%) over 1993 sales of $340.2 million. The Company's 1994 domestic wholesale business of approximately $234 million was 9% less than 1993 sales of approximately $257 million, with a corresponding decline in unit shipments of approximately 6.7%. The decrease in domestic wholesale unit shipments related primarily to the effects of the competitive environment in the children's wear business combined with the effects of prior years poor shipping performance and perceived weakness in product design. The Company's Spring, 1995 children s fashion offering has been well received. Company initiatives undertaken during 1994 resulted in significantly improved shipping performance to customers. In addition, improved product design contributed to better sell-thrus and margins for a majority of our wholesale customers. The Company currently anticipates that unit shipments of its Spring, 1995 wholesale product offering will exceed Spring, 1994 by over 10%. Early indications of acceptance of the Company's Fall, 1995 children's fashion offering have also been promising.\nCompany retail sales at its OshKosh B'Gosh branded outlet stores and Genuine Kids stores were approximately $99.4 million for 1994, a 52.5% increase over 1993 retail sales of approximately $65.2 million. This retail sales increase was primarily driven by the opening of an additional 46 retail stores during 1994. In addition, the Company's comparable store sales for 1994 were up approximately 3.6%. At year end the Company operated 61 OshKosh B'Gosh branded stores and 77 Genuine Kids stores. The Company anticipates continued expansion of its retail business through the opening of approximately 35 additional retail stores during 1995.\nThe Company's gross profit margin as a percent of sales improved to 28.6% in 1994, compared with 28.0% in 1993. This gross profit margin improvement was due primarily to the impact of the Company's increased retail sales at higher gross margins relative to its domestic wholesale business. The favorable impact of the Company's retail gross margins was offset in part by the domestic wholesale gross margin, which was down in 1994 primarily as a result of the adverse impact of reduced unit volume on our manufacturing operations and slightly lower pricing to wholesale customers. As a result of capacity reduction initiatives implemented during 1994 and early 1995, along with increased utilization of contracted manufacturing resources outside of the United States, the Company anticipates further improvement in its gross profit margins during 1995.\nSelling, general and administrative expenses for 1994 increased $16.5 million over 1993. As a percent of net sales, selling, general and administrative expenses were 26.1% in 1994, up from 23.1% in 1993. The primary reason for the increased selling, general and administrative expenses is the Company's aggressive expansion of its retail business. In addition, the Company's increasing focus on its international operations resulted in an increase in 1994's selling, general and administrative expenses of approximately $2.7 million. Also, the Company's catalog division, initiated in the second half of\n1993, added approximately $1.6 million to selling, general and administrative expenses in 1994. Continued expansion of the Company's retail business, along with further development of its foreign business and catalog division, will result in higher selling, general and administrative expenses in relation to its net sales in 1995.\nDuring the fourth quarter of 1993, the Company recorded a pretax restructuring charge of $10.8 million. Restructuring costs (net of income tax benefit) reduced net income by $7.1 million ($.49 per share) in 1993. The restructuring charge included approximately $3.3 million for facility closings, write-down of the related assets and severance costs pertaining to work force reductions. The restructuring charge also reflected the Company's decision to market its Trader Kids line of children's apparel under the new name Genuine Kids and the resulting costs of the Company's decision not to renew its Boston Trader license arrangement beyond 1994, as well as expenses to consolidate its retail operations. Accordingly, the restructuring charge also included approximately $7.5 million for write-off of unamortized trademark rights and expenses relating to consolidating the Company's retail operations.\nDuring 1994, the Company implemented its restructuring plan. The Company closed its McKenzie, Tennessee facility and announced plans to close its Dover, Tennessee facility, which was completed in early 1995. Closing of the Dover facility in 1995 will reduce the Company's work force by approximately 270 employees. The Company was able to sell both operating facilities, and reached satisfactory agreements with all affected employees concerning severance arrangements. The Company began to market a portion of its children's wear line under the Genuine Kids label, discontinuing the Trader Kids line of children's apparel. The Company also consolidated the operations of its retail business into its Oshkosh office. As of December 31, 1994, the Company estimates that remaining restructuring costs are sufficiently provided for in the residual restructuring liability. Remaining costs include charges for facility closings, including disposal of the real estate and severance costs pertaining to work force reductions. This plan should be substantially completed during 1995.\nThe Company's effective tax rate for 1994 was 45.7% compared to 51.3% in 1993. The relatively high effective tax rates for both years result primarily from the Company's foreign operating losses, which provide no tax benefit. In addition, the high 1993 effective tax rate was the result of substantially lower income before income taxes in 1993 (which resulted in part from the restructuring charge). Company management believes that the $11.5 million deferred tax asset at December 31, 1994 can be fully realized through reversals of existing taxable temporary differences and the Company's history of substantial taxable income which allows the opportunity for carrybacks of current or future losses.\nIn November of 1992, the Financial Accounting Standards Board issued its Statement No. 112 entitled Employers Accounting for Post Employment Benefits. This standard had no significant impact on the Company's 1994 financial statements.\nYEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992\nNet sales in 1993 were $340.2 million, down 1.7% from 1992 sales of $346.2 million. The Company's domestic wholesale business of approximately $257 million in 1993 was 9.3% less than 1992 sales, due primarily to a decline in unit shipments of approximately 10% in 1993 from 1992. The decrease in domestic wholesale unit shipments related primarily to the effects of the competitive pricing environment in the children's wear business, the Company's difficulty in meeting the delivery requirements of its wholesale customers as well as perceived weakness in its product design.\nCompany retail sales at its OshKosh B'Gosh branded outlet stores and its Trader Kids stores (now marketed under the Genuine Kids name) expanded to approximately $65.2 million in 1993, a 49.9% increase over 1992 retail sales of approximately $43.5 million. Retail sales increases resulted primarily from the opening of an additional 38 retail stores during 1993.\nGross profit margin as a percent of sales improved to 28.0% in 1993, compared with 25.1% in 1992. During 1993, the Company experienced a slight improvement in its domestic wholesale gross margins. Increased retail store sales, at higher gross profit margins, had a significant impact on improved overall gross margin performance. Gross margins for 1992 were unfavorably impacted by manufacturing inefficiencies resulting from the restructuring of production lines and increasing workers compensation insurance and employee health care costs.\nSelling, general and administrative expenses increased $12.1 million in 1993 from 1992. As a percent of net sales, selling, general and administrative expenses were 23.1% in 1993, up from 19.2% in 1992. The primary reason for the increased selling, general and administrative expenses was the Company's increased focus on its retail business. In addition, the Company initiated a catalog division in the second half of 1993 which added approximately $1.2 million to its selling, general and administrative expenses. Increased emphasis on foreign sales opportunities, including the start-up cost associated with the opening of sales offices, also added to the Company's selling, general and administrative expenses during 1993.\nDuring the fourth quarter of 1993, the Company recorded a pretax restructuring charge of $10.8 million. Restructuring costs (net of income tax benefit) reduced net income by $7.1 million ($.49 per share) in 1993.\nDuring 1992, the Company reduced its estimate of the Absorba line restructuring costs originally recorded in 1991 by $2.8 million, due to the efficient and orderly wind down of operations and favorable settlement of lease obligations. This adjustment to restructuring costs (net of income taxes) increased 1992 net income by $1.8 million ($.12 per share).\nRoyalty income, net of expenses, was $3.4 million in 1993, as compared to $2.6 million in 1992. The increase in net royalty income resulted primarily from additional foreign license agreements.\nThe effective tax rate for 1993 was 51.3% compared to 39.8% in 1992. The higher 1993 effective tax rate resulted from the Company's foreign operating losses, which provide no tax benefit, combined with\nthe Company's substantially lower income before income taxes in 1993 (which resulted in part from the restructuring charge). The Company's early adoption of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, in 1992 had no material impact on 1992's results of operations.\nThe Company elected early adoption of the Statement of Financial Accounting Standards No. 106, Employers Accounting for Post Retirement Benefits Other Than Pensions, in 1992. The Company elected to record the entire transition obligation in 1992, which resulted in a net $.6 million after tax ($.04 per share) reduction in net income.\nSEASONALITY\nThe Company's business is increasingly seasonal, with highest sales and income in the third quarter which is the Company's peak retail selling season at its retail outlet stores. The Company's second quarter sales and income are the lowest both because of relatively low domestic wholesale unit shipments and relatively modest retail outlet store sales during this period. The Company anticipates this seasonality trend to continue to impact 1995 quarterly sales and income.\nFINANCIAL POSITION, CAPITAL RESOURCES AND LIQUIDITY\nThe Company's financial position remained strong throughout 1994. At December 31, 1994, the Company's cash and cash equivalents were $10.5 million, compared to $17.9 million at the end of 1993 and $21.1 million at the end of 1992. Net working capital at the end of 1994 was $102.5 million, compared to $111.8 million at 1993 year end and $111.1 million at 1992 year end. Cash provided by operations was approximately $22.1 million in 1994, compared to $21.6 million in 1993 and $22.9 million in 1992.\nAccounts receivable at December 31, 1994 were $23.9 million compared to $19.5 million at December 31, 1993. Inventories at the end of 1994 were $93.9 million, down $6.1 million from 1993. Management believes that year end 1994 inventory levels are generally appropriate for anticipated 1995 business activity.\nCapital expenditures were approximately $9.9 million in 1994 and $9 million in 1993. Capital expenditures for 1995 are currently budgeted at approximately $12 million.\nOn June 14, 1994, the Company announced a stock repurchase program for up to 1,500,000 shares of its Class A common stock in open market transactions at prevailing prices. Through December 31, 1994, the Company has repurchased approximately 1,084,000 shares of its Class A common stock for approximately $15 million.\nIn June 1994, the Company finalized a credit agreement with participating banks. This arrangement provides a $60 million, three year revolving credit facility and a $40 million revocable demand line of credit for cash borrowings, issuance of commercial paper and letters of credit. The agreement expires in June 1997. The Company believes that these credit facilities, along with cash generated from operations, will be sufficient to finance the Company's stock repurchase program as well as its capital expenditure, seasonal\nworking capital, remaining restructuring and business development needs.\nDividends on the Company's Class A and Class B common stock totaled $.3775 per share and $.33 per share, respectively, in 1994, compared to $.5125 per share and $.45 per share on the Company's Class A and Class B common stock, respectively, in 1993. The dividend payout rate was 75% of net income in 1994 and 163% in 1993. The Company's lower earnings from operations in 1993 combined with the fourth quarter 1993 restructuring charge resulted in the unusually high 1993 payout rate.\nINFLATION\nThe effects of inflation on the Company's operating results and financial condition were not significant.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Financial Statements:\nReports of Independent Auditors 16\nConsolidated Balance Sheets - December 31, 1994 and 1993 18\nConsolidated Statement of Income - years ended December 31, 1994, 1993, and 1992 19\nConsolidated Statements of Changes in Shareholders Equity - years ended December 31, 1994, 1993, and 1992 20\nConsolidated Statements of Cash Flows - years ended December 31, 1994, 1993, and 1992 21\nNotes to Consolidated Financial Statements 22\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors OshKosh B'Gosh, Inc. and Subsidiaries\nWe have audited the accompanying consolidated balance sheets of OshKosh B'Gosh, Inc. and subsidiaries (the Company) as of December 31, 1994 and 1993, and the related consolidated statements of income, changes in shareholders' equity and cash flows for the years then ended. Our audit also included the 1994 and 1993 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 Oshkosh B'Gosh, Inc. and Subsidiaries at December 31, 1994 and 1993, 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 1994 and 1993 financial statements 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 1 and 10 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for income taxes and nonpension postretirement benefits.\nMilwaukee, Wisconsin ERNST & YOUNG LLP February 6, 1995\nREPORT OF SCHUMAKER, ROMENESKO & ASSOCIATES, S.C. INDEPENDENT AUDITORS\nThe Board of Directors OshKosh B'Gosh, Inc. and Subsidiaries\nWe have audited the accompanying consolidated statements of income, changes in shareholders' equity and cash flows of OshKosh B'Gosh, Inc. and Subsidiaries for the year ended December 31, 1992. Our audit also included the 1992 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 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 OshKosh B'Gosh, Inc. and Subsidiaries for the year ended December 31, 1992 in conformity with generally accepted accounting principles. Also, in our opinion, the related 1992 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 1 and 10 to the consolidated financial statements, effective January 1, 1992, the Company changed its method of accounting for income taxes and nonpension postretirement benefits.\nOshkosh, Wisconsin SCHUMAKER, ROMENESKO & ASSOCIATES, S.C. February 15, 1993\nConsolidated Balance Sheets OshKosh B'Gosh, Inc. (Dollars in thousands, except share and per share amounts) and Subsidiaries\nDecember 31, 1994 1993 ASSETS Current assets Cash and cash equivalents $ 10,514 $ 17,853 Accounts receivable, less allowances of $3,700 in 1994 and $3,310 in 1993 23,857 19,477 Inventories 93,916 99,999 Prepaid expenses and other current assets 2,510 3,810 Deferred income taxes 11,510 10,716 Total current assets 142,307 151,855 Property, plant and equipment, net 69,829 71,755 Other assets 5,075 5,521\nTotal assets $217,211 $229,131\nLIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities Current maturities of long-term debt $ 240 $ 536 Accounts payable 9,436 9,720 Accrued liabilities 30,168 29,805 Total current liabilities 39,844 40,061 Long-term debt 517 757 Deferred income taxes 2,869 3,040 Employee benefit plan liabilities 15,167 13,275 Commitments - - Shareholders' equity Preferred stock, par value $.01 per share: Authorized - 1,000,000 shares; Issued and outstanding - None - - Common stock, par value $.01 per share: Class A, authorized - 30,000,000 shares; Issued and outstanding - 12,233,787 shares in 1994, 13,280,572 shares in 1993 122 133 Class B, authorized - 3,750,000 shares; Issued and outstanding - 1,267,713 shares in 1994, 1,305,228 shares in 1993 13 13 Additional paid-in capital - 2,971 Retained earnings 158,933 169,182 Cumulative foreign currency translation adjustments (254) (301) Total shareholders' equity 158,814 171,998 Total liabilities and shareholders' equity $217,211 $229,131\nSee notes to consolidated financial statements.\nConsolidated Statements of Income OshKosh B'Gosh, Inc. (Dollars and shares in thousands, except per share amounts) and Subsidiaries\nYear Ended December 31, 1994 1993 1992\nNet sales $363,363 $340,186 $346,206 Cost of products sold 259,416 244,926 259,344\nGross profit 103,947 95,260 86,862\nSelling, general and administrative expenses 94,988 78,492 66,414 Restructuring - 10,836 (2,800)\nOperating income 8,959 5,932 23,248\nOther income (expense): Interest expense (1,034) (626) (797) Interest income 1,048 1,114 1,022 Royalty income, net of expenses 3,442 3,417 2,562 Miscellaneous 543 (545) 91\nOther income - net 3,999 3,360 2,878\nIncome before income taxes and cumulative effect of accounting change 12,958 9,292 26,126 Income taxes 5,919 4,769 10,390\nIncome before cumulative effect of accounting change 7,039 4,523 15,736 Cumulative effect of change in accounting for nonpension postretirement benefits - - (601)\nNet income $ 7,039 $ 4,523 $ 15,135\nWeighted average common shares outstanding 14,144 14,586 14,586\nIncome per share before cumulative effect of accounting change $.50 $.31 $1.08 Change in accounting for nonpension postretirement benefits - - (.04)\nNet income per common share $.50 $.31 $1.04\nSee notes to consolidated financial statements.\nConsolidated Statements of Changes in Shareholders' Equity Oshkosh B'Gosh, Inc. (Dollars and shares in thousands, except per share amounts) and Subsidiaries\nCumulative Foreign Common Stock Additional Currency Class A Class B Paid-In Retained Translation Shares Amount Shares Amount Capital Earnings Adjustments Balance - December 31, 1991 12,777 $128 1,809 $18 $2,971 $164,263 $ - Net income - - - - - 15,135 - Dividends - Class A ($.5125 per share) - - - - - (6,548) - - Class B ($.45 per share) - - - - - (814) -\nBalance - December 31, 1992 12,777 128 1,809 18 2,971 172,036 - Net income - - - - - 4,523 - Dividends - Class A ($.5125 per share) - - - - - (6,667) - - Class B ($.45 per share) - - - - - (710) - Foreign currency translation adjustments - - - - - - (301) Conversions of common shares 504 5 (504) (5) - - -\nBalance - December 31, 1993 13,281 133 1,305 13 2,971 169,182 (301) Net income - - - - - 7,039 - Dividends - Class A ($.3775 per share) - - - - - (4,886) - - Class B ($.33 per share) - - - - - (425) - Foreign currency translation adjustments - - - - - - 47 Conversions of common shares 37 - (37) - - - - Repurchase of common shares (1,084) (11) - - (2,971) (11,977) -\nBalance - December 31, 1994 12,234 $122 1,268 $13 $ - $158,933 $(254)\nSee notes to consolidated financial statements.\nConsolidated Statements of Cash Flows OshKosh B'Gosh, Inc. (Dollars in thousands) and Subsidiaries\nYear Ended December 31, 1994 1993 1992 Cash flows from operating activities Net income $ 7,039 $ 4,523 $15,135 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 10,692 9,233 8,375 (Gain) loss on disposal of assets (185) 63 85 Minority interest in loss of consolidated subsidiary - - (108) Provision for deferred income taxes (965) (5,537) 35 Pension expense, net of contributions 979 1,852 1,753 Cumulative effect of accounting change - - 1,001 Restructuring - 10,836 (2,800) Changes in operating assets and liabilities: Accounts receivable (4,380) 4,948 (643) Inventories 6,083 (7,247) 1,478 Prepaid expenses and other current assets1,300 (1,624) (252) Accounts payable (284) (1,376) (2,522) Accrued liabilities 1,863 5,940 1,313 Net cash provided by operating activities 22,142 21,611 22,850\nCash flows from investing activities Additions to property, plant and equipment (9,914) (8,990) (12,563) Proceeds from disposal of assets 1,425 1,159 625 Investments in subsidiaries - - (900) Additions to other assets (186) (1,783) (1,602) Net cash used in investing activities (8,675) (9,614) (14,440)\nCash flows from financing activities Proceeds from long-term borrowings - - 7,000 Payments of long-term debt (536) (7,896) (1,270) Dividends paid (5,311) (7,377) (7,362) Repurchase of common stock (14,959) - - Net cash used in financing activities (20,806) (15,273) (1,632)\nNet increase (decrease) in cash and cash equivalents (7,339) (3,276) 6,778 Cash and cash equivalents at beginning of year 17,853 21,129 14,351\nCash and cash equivalents at end of year $10,514 $17,853 $21,129\nSupplementary disclosures Cash paid for interest $ 638 $ 1,030 $ 823 Cash paid for income taxes $ 3,937 $12,194 $ 9,877\nSee notes to consolidated financial statements.\nOSHKOSH B'GOSH, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements (Dollars in thousands, except share and per share amounts)\nNote 1. Significant accounting policies\nBusiness - OshKosh B'Gosh, Inc. and its wholly-owned subsidiaries (the Company) are engaged primarily in the design, manufacture and marketing of apparel to wholesale customers and through Company owned retail stores.\nPrinciples of consolidation - The consolidated financial statements include the accounts of all wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nCash equivalents - Cash equivalents consist of highly liquid debt instruments such as money market accounts and commercial paper with original maturities of three months or less. The Company's policy is to invest cash in conservative instruments as part of its cash management program and to evaluate the credit exposure of any investment. Cash and cash equivalents are stated at cost, which approximates market value.\nInventories - Inventories are stated at the lower of cost or market. Inventories stated on the last-in, first-out (LIFO) basis represent 95.7% of total 1994 and 90.6% of total 1993 inventories. Remaining inventories are valued using the first-in, first-out (FIFO) method.\nProperty, plant and equipment - Property, plant and equipment are carried at cost. Depreciation and amortization for financial reporting purposes is calculated using the straight line method based on the following useful lives:\nYears Land improvements 10 to 15 Buildings 10 to 40 Leasehold improvements 5 to 10 Machinery and equipment 5 to 10\nIncome taxes - Effective January 1, 1992, the Company accounts for income taxes under the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\". This Statement requires recognition of deferred tax assets and liabilities for all temporary differences between the financial reporting and income tax basis of the Company's assets and liabilities. The effect of this accounting change at January 1, 1992 was not material.\nForeign currency translation - The functional currency for certain foreign subsidiaries is the local currency. Accordingly, assets and liabilities are translated at year end exchange rates, and income statement items are translated at average exchange rates prevailing during the year. Such translation adjustments are recorded as a separate component of shareholders' equity.\nRevenue recognition - Revenue within wholesale operations is recognized at the time merchandise is shipped to customers. Retail store revenues are recognized at the time of sale.\nIncome per common share - Income per common share amounts are computed by dividing income by the weighted average number of shares of common stock outstanding. There are no common stock equivalents.\nAdvertising - Advertising costs are expensed as incurred and totaled $9,858, $11,209, and $10,180 in 1994, 1993, and 1992, respectively.\nNote 2. Restructuring\nDuring 1993, the Company recorded a pretax restructuring charge of $10,836. The restructuring charge included approximately $3,300 for facility closings, write-down of the related assets and severance costs pertaining to work force reductions. The restructuring charge also reflected the Company's decision to market its Trader Kids line of children's apparel under the new name Genuine Kids and the resulting costs of the Company's decision not to renew its Boston Trader license arrangement beyond 1994, as well as expenses to consolidate its retail operations. Accordingly, the restructuring charge included approximately $7,500 for write-off of unamortized trademark rights and expenses related to consolidating the Company's retail operations. Restructuring costs (net of income tax benefit) reduced net income by $7,100 ($.49 per share) in 1993.\nDuring 1994, the Company implemented its restructuring plan. The Company closed its McKenzie, Tennessee facility, and announced plans to close its Dover, Tennessee facility, which was completed in early 1995. The Company was able to sell both operating facilities, and reached satisfactory agreements with all affected workforce concerning severance arrangements. The Company also began to market a portion of its childrenswear line under the Genuine Kids label, discontinuing the Trader Kids line of childrens' apparel. The Company also successfully consolidated the operations of its retail business into its OshKosh office. As of December 31, 1994, the Company estimates that remaining restructuring costs are sufficiently provided for in the residual restructuring liability. Remaining costs include charges for facility closings, including disposal of the real estate and severance costs pertaining to workforce reductions. This plan should be substantially completed in early 1995.\nDuring 1992, the Company reduced its estimate of the Absorba line restructuring costs originally recorded in 1991 by $2,800, due to the efficient and orderly wind down of operations and favorable settlement of lease obligations. This adjustment to restructuring costs (net of income taxes) increased 1992 net income by $1,800 ($.12 per share).\nNote 3. Inventories\nA summary of inventories follows:\nDecember 31, 1994 1993\nFinished goods $75,187 $82,737 Work in process 7,410 5,008 Raw materials 11,319 12,254\nTotal $93,916 $99,999\nThe replacement cost of inventory exceeds the above LIFO costs by $16,122 and $14,716 at December 31, 1994 and 1993, respectively.\nNote 4. Property, plant and equipment\nA summary of property, plant and equipment follows:\nDecember 31, 1994 1993\nLand and improvements $ 4,139 $ 4,172 Buildings 37,442 37,640 Leasehold improvements 7,862 5,268 Machinery and equipment 70,498 67,026 Construction in progress 9 291\nTotal 119,950 114,397\nLess: accumulated depreciation and amortization 50,121 42,642\nProperty, plant and equipment, net $69,829 $71,755\nDepreciation and amortization expense on property, plant and equipment for the years ended December 31, 1994, 1993, and 1992 amounted to approximately $9,972, $8,425, and $7,909, respectively.\nNote 5. Lines of Credit\nIn June 1994, the Company entered into a credit agreement with a number of banks which provides a $60,000 three year revolving credit facility and a $40,000 revocable demand line of credit for cash borrowings, issuance of commercial paper, and letters of credit. The agreement expires in June 1997.\nUnder the terms of the agreement, interest rates are determined at the time of borrowing and are based on London Interbank Offered Rates plus .625% or the prime rate. Commitment fees of .125% are required on the $100,000 credit facilities. The Company is required to maintain certain financial ratios in connection with this agreement.\nThe Company also has a $12,500 unsecured credit facility available at December 31, 1994 for issuance of letters of credit.\nThere were no outstanding borrowings against these credit arrangements at December 31, 1994. Letters of credit of approximately $26,150 were outstanding at December 31, 1994, with $23,774 of the unused revocable demand line of credit available for borrowing.\nNote 6. Accrued liabilities\nA summary of accrued liabilities follows: December 31, 1994 1993 Compensation $ 8,491 $ 4,701 Group health insurance - 1,700 Worker's compensation 10,800 8,600 Income taxes 1,729 640 Restructuring costs 2,381 8,186 Other 6,767 5,978\nTotal $30,168 $29,805\nNote 7. Long-term debt\nThe Company's long-term debt is summarized as follows:\nDecember 31, 1994 1993\nObligation under industrial development revenue bonds $200 $ 666 Other mortgage notes and loans with interest at varying rates 557 627\nTotal 757 1,293\nLess current maturities 240 536\nTotal long-term debt $517 $757\nThe final payment on the industrial development revenue bond is due October 1, 1995. The interest rate on the bond is approximately 80% of prime rate (prime rate was 8.5% at December 31, 1994).\nAnnual total maturities of principal on long-term debt are as follows:\nYear ending December 31,\n1995 $240 1996 42 1997 43 1998 45 1999 47 Thereafter 340\nTotal $757\nNote 8. Leases\nThe Company leases certain property and equipment including retail sales facilities and regional sales offices under operating leases. Certain leases provide the Company with renewal options. Leases for retail sales facilities provide for minimum rentals plus contingent rentals based on sales volume.\nMinimum future rental payments under noncancellable operating leases are as follows:\nYear ending December 31,\n1995 $10,202 1996 9,148 1997 8,452 1998 7,608 1999 6,151 Thereafter 17,034\nTotal minimum lease payments $58,595 Total rent expense charged to operations for all operating leases is as follows:\nYear Ended December 31, 1994 1993 1992\nMinimum rentals $11,139 $7,718 $5,921 Contingent rentals 196 167 179\nTotal rent expense $11,335 $7,885 $6,100\nNote 9. Income taxes\nIncome tax expense (credit) is comprised of the following:\nYear Ended December 31, 1994 1993 1992 Current: Federal $5,653 $ 8,571 $ 8,155 State and local 1,231 1,735 1,800 6,884 10,306 9,955 Deferred (965) (5,537) 435\nTotal $5,919 $4,769 $10,390\nThe components of the Company's deferred tax asset and deferred tax liability include:\nDecember 31, 1994 1993 [Assets (Liabilities)] Current deferred taxes: Accounts receivable allowances $ 1,402 $ 1,272 Inventory valuation 2,835 2,129 Accrued liabilities 5,994 3,714 Restructuring costs 834 3,204 Other 445 397\nTotal net current deferred tax asset $11,510 $10,716\nNon-current deferred taxes: Depreciation $(8,497) $(8,266) Deferred employee benefits 5,234 4,419 Trademark 394 807 Foreign loss carryforwards 2,418 1,807 Valuation allowance (2,418) (1,807)\nTotal net long-term deferred tax liability $(2,869) $(3,040)\nFor financial reporting purposes, income before income taxes and cumulative effect of accounting change includes the following components:\nYear Ended December 31, 1994 1993 1992 Pretax income (loss): United States $14,319 $11,704 $27,574 Foreign (1,361) (2,412) (1,448)\nTotal $12,958 $9,292 $26,126\nA reconciliation of the federal statutory income tax rate to the effective tax rates reflected in the consolidated statements of income follows:\nYear Ended December 31, 1994 1993 1992 Federal statutory tax rate 35.0% 35.0% 34.0% Differences resulting from: State and local income taxes, net of federal income tax benefit 4.5 4.1 4.2 Foreign losses with no tax benefit 3.7 9.1 1.9 Other 2.5 3.1 (.3)\nTotal 45.7% 51.3% 39.8%\nNote 10. Retirement plans\nThe Company has defined contribution and defined benefit pension plans covering substantially all employees. Charges to operations by the Company for these pension plans totaled $4,309, $4,621, and $4,477 for 1994, 1993 and 1992, respectively.\nDefined benefit pension plans - The Company sponsors several qualified defined benefit pension plans covering certain hourly and salaried employees. In addition, the Company maintains a supplemental unfunded salaried pension plan to provide those benefits otherwise due employees under the salaried plan's benefit formulas, but which are in excess of benefits permitted by the Internal Revenue Service.\nThe benefits provided are based primarily on years of service and average compensation. The pension plans' assets are comprised primarily of listed securities, bonds, treasury securities, commingled equity and fixed income investment funds and cash equivalents. Plan assets included 7,000 shares of OshKosh B'Gosh, Inc. Class A common stock at December 31, 1993 and 9,500 and 5,000 shares of OshKosh B'Gosh, Inc. Class B common stock at December 31, 1994 and 1993, respectively, with a total market value of approximately $128 and $236 at December 31, 1994 and 1993, respectively.\nThe Company's funding policy for qualified plans is to contribute amounts which are actuarially determined to provide the plans with sufficient assets to meet future benefit payment requirements consistent with the funding requirements of federal laws and regulations.\nThe actuarial computations utilized the following assumptions.\nDecember 31, 1994 1993 1992\nDiscount rate 7.5% 7.0% 7.0-7.5% Expected long-term rate of return on assets 8.0% 7.0% 7.5-8.0% Rates of increase in compensation levels 0-4.5% 0-4.5% 0-5.5%\nNet periodic pension cost was comprised of:\nDecember 31, 1994 1993 1992 Service cost - benefits earned during the period $2,212 $2,318 $2,309 Interest cost on projected benefit obligations 1,888 1,808 1,601 Actual return on plan assets (1,118) (1,708) (1,037) Net amortization and deferral 552 1,259 636\nNet periodic pension cost $3,534 $3,677 $3,509\nThe following table sets forth the funded status of the Company's defined benefit plans and the amount recognized in the Company's consolidated balance sheets. The funded status of plans with assets exceeding the accumulated benefit obligation (ABO) is segregated by column from that of plans with the ABO exceeding assets.\nDecember 31, 1994 1993 Assets ABO Assets ABO Exceed Exceeds Exceed Exceeds ABO Assets ABO Assets Actuarial present value of benefit obligations: Vested benefits $ 9,365 $ 6,599 $ 9,051 $ 6,308 Nonvested benefits 916 313 1,604 449\nTotal accumulated benefit obligation $10,281 $ 6,912 $10,655 $ 6,757\nProjected benefit obligation $19,334 $ 7,244 $22,299 $ 6,835\nPlan net assets at fair value 12,451 2,980 12,070 2,777\nProjected benefit obligation in excess of plan net assets (6,883) (4,264) (10,229) (4,058)\nUnamortized transition asset (1,382) (20) (1,535) (23)\nUnrecognized prior service cost 2,586 3,022 2,821 2,867\nUnrecognized net (gain) loss (604) (679) 3,546 (592)\nAdjustment to recognize minimum liability - (2,000) - (2,200)\nAccrued pension liability at December 31 $(6,283) $(3,941) $(5,397) $(4,006)\nDefined contribution plan - The Company maintains a defined contribution retirement plan covering certain salaried employees. Annual contributions are discretionary and are determined by the Company's Executive Committee. Charges to operations by the Company for contributions under this plan totaled $531, $565 and $658 for 1994, 1993 and 1992, respectively.\nThe Company also has a supplemental retirement program for designated employees. Annual provisions to this unfunded plan are discretionary and are determined by the Company's Executive Committee. Charges to operations by the Company for additions to this plan totaled $244, $379 and $310 for 1994, 1993 and 1992, respectively.\nDeferred employee benefit plans - The Company has deferred compensation and supplemental retirement arrangements with certain key officers.\nPostretirement health and life insurance plan - The Company sponsors an unfunded defined benefit postretirement health insurance plan that covers eligible salaried employees. Life insurance benefits are provided under the plan to qualifying retired employees. The postretirement health insurance plan is offered, on a shared cost basis, only to employees electing early retirement. This coverage ceases when the employee reaches age 65 and becomes eligible for medicare. Retiree contributions are adjusted periodically.\nIn 1992, the Company adopted the provisions of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" In applying this pronouncement, the Company elected to immediately recognize the accumulated postretirement benefit obligation as of the beginning of 1992 of approximately $1 million in the first quarter of 1992 as a change in accounting principle. The charge, net of an income tax benefit of $400, was $601 or $.04 per share.\nThe following table sets forth the funded status of the plan and the postretirement benefit cost recognized in the Company's consolidated balance sheets:\nDecember 31, 1994 1993\nAccumulated postretirement benefit obligation: Retirees $ 159 $ 119 Fully eligible active plan participants 169 216 Other active plan participants 523 670\n851 1,005 Plan assets - - Unrecognized net gain 497 281\nAccrued postretirement benefit cost $1,348 $1,286\nNet periodic postretirement benefit cost was comprised of:\nYear Ended December 31, 1994 1993 1992\nService cost - benefits attributed to employee service during the year $ 67 $ 98 $119 Interest cost on accumulated postretirement benefit obligation 53 61 75 Net amortization and deferral (38) (18) -\nNet periodic postretirement benefit cost $82 $141 $194\nThe discount rate used in determining the accumulated postretirement benefit obligation was 7% in 1994 and 1993. The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 12%, declining gradually to 6% by 2012 and then declining further to an ultimate rate of 4% by 2022.\nThe health care cost trend rate assumption has a significant impact on the amounts reported. Increasing the assumed health care cost trend rate by one percentage point would increase the accumulated postretirement benefit obligation at December 31, 1994 by approximately $108 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by approximately $13.\nNote 11. Common stock\nIn May, 1993 shareholders of the Company approved a stock conversion plan whereby shares of Class B common stock may be converted to an equal number of Class A common shares.\nThe Company's common stock authorization provides that dividends be paid on both the Class A and Class B common stock at any time that dividends are paid on either. Whenever dividends (other than dividends of Company stock) are paid on the common stock, each share of Class A common stock is entitled to receive 115% of the dividend paid on each share of Class B common stock.\nThe Class A common stock shareholders are entitled to receive a liquidation preference of $7.50 per share before any payment or distribution to holders of the Class B common stock. Thereafter, holders of the Class B common stock are entitled to receive $7.50 per share before any further payment or distribution to holders of the Class A common stock. Thereafter, holders of the Class A common stock and Class B common stock share on a pro-rata basis in all payments or distributions upon liquidation, dissolution or winding up of the Company.\nNote 12. Business and credit concentrations\nThe Company provides credit, in the normal course of business, to department and specialty stores. The Company performs ongoing credit evaluations of its customers and maintains allowances for potential credit losses.\nThe Company's customers are not concentrated in any specific geographic region. In 1993, sales to a customer, as a percentage of total sales, amounted to approximately 10%. In 1992, sales to two customers, as a percentage of total sales, amounted to approximately 12% each.\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 is incorporated by reference to the definitive Proxy Statement of OshKosh B'Gosh, Inc. for its annual meeting to be held on May 5, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this item is incorporated by reference to the definitive Proxy Statement of OshKosh B'Gosh, Inc. for its annual meeting to be held on May 5, 1995.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this item is incorporated by reference to the definitive Proxy Statement of OshKosh B'Gosh, Inc. for its annual meeting to be held on May 5, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this item is incorporated by reference to the definitive Proxy Statement of OshKosh B'Gosh, Inc. for its annual meeting to be held on May 5, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) Financial Statements Financial statements for OshKosh B'Gosh, Inc. listed in the Index to Financial Statements and Supplementary Data on page 17 are filed as part of this Annual Report.\n(2) Financial Statement Schedules: Schedule II - Valuation and Qualifying Accounts\nSchedules not included have been omitted because they are not applicable or the required information is included in the consolidated financial statements and notes thereto.\n(3) Index to Exhibits\n(b) Reports on Form 8-K None.\n(3) Exhibits\n3.1 Certificate of Incorporation of OshKosh B'Gosh, Inc., as restated, October 20, 1988, previously filed as Exhibit 3.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1988, Commission File Number 0-13365, is incorporated herein by reference.\n3.2 By-laws of OshKosh B'Gosh, Inc., as amended through the date hereof.\n*10.1 Employment Agreement dated July 7, 1980, between OshKosh B'Gosh, Inc. and Charles F. Hyde as extended by \"Request For Later Retirement\" dated April 15, 1986 and accepted by Board of Directors' resolution on May 2, 1986, previously filed as Exhibit 10.1 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1986, Commission File Number 0-13365, is incorporated herein by reference.\n*10.2 Employment Agreement dated July 7, 1980, between OshKosh B'Gosh, Inc. and Thomas R. Wyman, previously filed as Exhibit 10.2 to the Registrant's Registration Statement No. 2-96586 on Form S-1, is incorporated herein by reference.\n*10.3 OshKosh B'Gosh, Inc. Pension Plan as amended, previously filed as Exhibit 10.3 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 0-13365, is incorporated herein by reference.\n*10.4 OshKosh B'Gosh, Inc. Profit Sharing Plan, as amended on August 5, 1985, previously filed as Exhibit 10.4 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985, Commission File Number 0-13365, is incorporated herein by reference.\n*10.5 OshKosh B'Gosh, Inc. Restated Excess Benefit Plan as amended, previously filed as Exhibit 10.5 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 0-13365, is incorporated herein by reference.\n*10.6 OshKosh B'Gosh, Inc. Executive Deferred Compensation Plan as amended, previously filed as Exhibit 10.6 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, Commission File Number 0-13365, is incorporated herein by reference.\n*10.7 OshKosh B'Gosh, Inc. Officers Medical and Dental Reimbursement Plan, as amended.\n10.8 Lease Agreement between OshKosh B'Gosh, Inc. and City of Oshkosh, Wisconsin, dated as of March 1, 1975, previously filed as Exhibit 10.13 to the Registrant's Registration Statement No. 2-96586 on Form S-1, is incorporated herein by reference.\n*Represents a plan that covers compensation, benefits and\/or related arrangements for executive management.\n10.9 Acknowledgement and Guaranty Agreement between City of Liberty, Casey County, Kentucky and OshKosh B'Gosh, Inc., dated October 4, 1984, and related Contract of Lease and Rent dated as of November 26, 1968, previously filed as Exhibit 10.14 to the Registrant's Registration Statement No. 2-96586 on Form S-1, is incorporated herein by reference.\n10.10 Loan Agreement between OshKosh B'Gosh, Inc. and City of Oshkosh, Wisconsin, dated as of October 1, 1985, previously filed as Exhibit 10.15 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1985, Commission File Number 0-13365, is incorporated herein by reference.\n10.11 Indemnity Agreement between OshKosh B'Gosh, Inc. and William P. Jacobsen (Vice President and Treasurer of OshKosh B'Gosh, Inc.) dated as of June 8, 1987, previously filed as Exhibit 10.16 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1987, Commission File Number 0-13365, is incorporated herein by reference. (Note: Identical agreements have been entered into by the Company with each of the following officers: Charles F. Hyde, Thomas R. Wyman, John F. Beckman, Anthony S. Giordano, Douglas W. Hyde, Michael D. Wachtel, and Kenneth H. Masters).\n*10.12 Employment agreement dated December 14, 1989 and effective February 1, 1990, between OshKosh B'Gosh, Inc. and Harry M. Krogh, previously filed as Exhibit 10.17 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, Commission File Number 0-13365, is incorporated herein by reference.\n*10.13 OshKosh B'Gosh, Inc. Executive Non-Qualified Profit Sharing Plan effective as of January 1, 1989, previously filed as Exhibit 10.18 to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, Commission File Number 0-13365, is incorporated herein by reference.\n10.14 Employment agreement dated and effective May 1, 1994, by and among OshKosh B'Gosh, Inc., Essex Outfitters, Inc. and Barbara Widder-Lowry.\n10.15 Employment agreement dated and effective May 1, 1994 by and among OshKosh B'Gosh, Inc., Essex Outfitters, Inc. and Paul A. Lowry.\n10.16 Credit agreement between Oshkosh B'Gosh, Inc. and Firstar Bank Milwaukee, N.A. and participating banks as amended, dated as of June 24, 1994.\n*10.17 OshKosh B'Gosh, Inc. 1994 Incentive Stock Plan.\n10.18 OshKosh B'Gosh, Inc. 1995 Outside Directors' Stock Option Plan.\n*Represents a plan that covers compensation, benefits and\/or related arrangements for executive management.\n21. The following is a list of the subsidiaries of the Company as of December 31, 1994. The consolidated financial statements reflect the operations of all subsidiaries as they existed on December 31, 1994.\nState or Other Jurisdiction of Name of Incorporation or Subsidiary Organization\nTerm Co. (formerly Absorba, Inc.) Delaware\nGrove Industries, Inc. Delaware\nManufacturera International Apparel, S.A. Honduras\nOshKosh B'Gosh Europe, S.A. France\nOshKosh B'Gosh International Sales, Inc. Virgin Islands\nOshKosh B'Gosh Asia\/Pacific Ltd. Hong Kong\nOshKosh B'Gosh U.K. Ltd. United Kingdom\nOshKosh B'Gosh Deutschland GmbH Germany\n27. Financial Data Schedule\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.\nOSHKOSH B'GOSH, INC.\nBy: \/s\/ DOUGLAS W. HYDE Chairman of the Board, President and Chief Executive Officer\nBy: \/s\/ DAVID L. OMACHINSKI Vice President, Treasurer 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 dates indicated.\nSignature Title\n\/S\/ DOUGLAS W. HYDE Chairman of the Board, President, Chief Executive Officer and Director\n\/S\/ MICHAEL D. WACHTEL Executive Vice President, Chief Operating Officer and Director\n\/S\/ DAVID L. OMACHINSKI Vice President, Treasurer, Chief Financial Officer and Director\n\/S\/ STEVEN R. DUBACK Secretary and Director\n\/S\/ THOMAS R. WYMAN Director\nOSHKOSH B'GOSH, INC. AND SUBSIDIARIES Schedule II\nValuation and Qualifying Accounts (Dollars in Thousands)\nYears Ended December 31, 1994 1993 1992\nAccounts Receivable - Allowances: Balance at Beginning of Period $ 3,310 $2,265 $2,335 Charged to Costs and Expenses 6,508 5,979 4,500 Deductions - Bad Debts Written off, Net of Recoveries and Other Allowances (6,118) (4,934) (4,570)\nBalance at End of Period $ 3,700 $3,310 $2,265\nYears Ended December 31, 1994 1993 1992\nRestructuring Costs - Allowances: Balance at Beginning of Period $ 8,186 $ 422 $ 5,600 Charged to Cost and Expenses - 10,836 (2,800) Actual Restructuring Costs Incurred (5,805) (3,072) (2,378)\nBalance at End of Period $ 2,381 $ 8,186 $ 422","section_15":""}
{"filename":"24011_1994.txt","cik":"24011","year":"1994","section_1":"Item 1. Business General Information\nThe Continental Corporation (\"Continental\"), a New York corporation incorporated in 1968, is an insurance holding company. Its best known subsidiary, The Continental Insurance Company, was organized in 1853. The principal business of Continental is the ownership of a group of property and casualty insurance companies. Continental's other principal subsidiaries and affiliates provide investment management, claims adjusting and risk management services. In 1993, Continental sold its premium financing operations; in 1992, Continental instituted a plan to withdraw from the traditional assumed reinsurance and marine reinsurance businesses and the indigenous international and international marine insurance businesses. The results of these operations are reported as discontinued and previously reported information has been restated accordingly.\nOn December 6, 1994, Continental entered into an Agreement and Plan of Merger (the \"Merger Agreement\") under which CNA Financial Corporation (\"CNA\") will acquire Continental through a merger of a wholly-owned CNA subsidiary with and into Continental (the \"CNA Merger\"). Under the Merger Agreement, each share of Continental common stock outstanding prior to the Merger (other than certain shares held by Continental and its subsidiaries), will be converted into the right to receive $20.00 in cash, without interest, upon consummation of the Merger. The proposed CNA Merger is subject to satisfaction of certain conditions, including approval by Continental's shareholders and various regulatory authorities, and is required to be consummated prior to December 31, 1995. Consummation of the proposed CNA Merger is expected in the first half of 1995.\nRe-engineering Strategy\nContinental's results over the past several years have been adversely affected by a variety of factors, including a downturn in the insurance industry, a number of severe catastrophic losses and a high expense structure. In the first quarter of 1994, Continental experienced a substantial increase in weather-related losses not officially designated as catastrophic and a substantial increase in large losses. The cumulative effect of these factors resulted in a significant reduction in statutory surplus of Continental's insurance company subsidiaries, and Continental's shareholders' equity. In 1994, Continental also experienced a reduction in the value of its investment portfolio resulting from increased interest rates, which also affected shareholders' equity.\nIn early 1994, Continental began reviewing all aspects of its operations in order to develop a plan to address these concerns. Following its review, Continental began to implement a restructuring plan designed to increase the profitability of its underwriting businesses, shift the focus of its business to more profitable lines, reduce its expense structure, reduce its exposure in catastrophe-prone areas, reduce its premium to surplus ratio, strengthen its balance sheet and improve its capital position.\nAs part of its re-engineering efforts, Continental has taken several steps that it believes will enhance the profitability of its insurance underwriting operations. In June 1994, Continental began to curtail its property writings of commercial and personal package business, especially in catastrophe-prone areas, and to alter the scope and breadth of its property coverages and exposures. Continental has also increased rates in catastrophe-prone areas. Continental also began shifting the mix of its business towards those areas in which management believes Continental can achieve an underwriting profit without a pre-determined target for business mix. As part of those efforts, Continental restructured its Agency & Brokerage Group and formed in its place two new, more focused operating groups -- Commercial Lines and Personal Lines. These two groups compete in separate arenas and require different sets of resources. They are now structured on a product management basis, which Continental believes will provide enhanced customer service and operating efficiencies. Continen- tal's Special Operations Group will remain focused on specialty commercial lines. This will allow Continental to focus more clearly on underwriting profit by product and industry.\nContinental is also focusing on increasing its profitability through changes in its distribution system by raising the standards for its agents. Continental is taking steps to increase the level of business that is distributed through agents that maintain the lowest loss ratios, decrease the level of business distributed through non-key agents and terminate unprofitable agents.\nTo reduce its operating expenses, in March 1994, Continental's senior management approved a definitive plan (the \"First Quarter Plan\") to re-engineer, as noted above, the operations of Continental's Agency & Brokerage division (including home office, field claims and underwriting), selected operations of Continental's Special Operations Group, particularly its multinational unit and several corporate staff divisions, including Human Resources, Corporate Claims, Actuarial, Finance and Legal. The locations identified for re-engineering were Cranbury, New Jersey; New York, New York; Duluth, Georgia; Chicago, Illinois; Dallas, Texas; Glens Falls, New York; Overland Park, Kansas; Rancho Cordova, California; Columbus, Ohio; York, Pennsylvania and certain overseas locations. The First Quarter Plan provided for the elimination of 680 positions (net of new hires and transfers and resulting from approximately 1,200 terminations), from a total workforce of 12,255 at year end 1993, within one year from approval of the plan, as well as the achievement of business-related expense savings by the first quarter of 1995. During 1994, substantially all of the employees identified for termination in the First Quarter Plan were notified that their positions had been eliminated. The First Quarter Plan included severance packages for all affected employees, as well as extended benefits and outplacement counseling for many of them.\nThe First Quarter Plan re-engineering efforts also included vacating leased space at 27 locations. As of December 31, 1994, all of these locations had been effectively vacated. Continental's underwriting results for 1994 included a $45 million restructuring charge (the \"Restructuring Charge\") relating to the First Quarter Plan, which included $29 million for expected severance and related benefit costs and $16 million in expected lease vacation and other associated costs.\nAlso, to further reduce its operating expenses, Continental reconsidered its staffing needs in the second quarter and developed a plan in the third quarter (the \"Third Quarter Plan\") that would result in a further net reduction of approximately 1,100 positions (in addition to the terminations of approximately 1,200 under the First Quarter Plan). Continental's 1994 underwriting results include a $14 million additional staff reduction charge (the \"Additional Staff Reduction Charge\"), which included expected severance and related benefit costs. During 1994, substantially all employees identified for termination in the Third Quarter Plan were notified that their positions had been eliminated. Management believes that the re-engineering actions taken under the First Quarter Plan and the Third Quarter Plan will create annual pre-tax savings of about $120 million, compared with Continental's reported 1993 expenses.\nContinental has also taken steps to strengthen its balance sheet by eliminating dividends on its common stock and raising additional equity capital. In addition, in order to strengthen the capital base of its domestic insurance subsidiaries, during 1994, Continental deployed $510 million of capital to its domestic insurance subsidiaries from non-domestic insurance subsidiaries, investments held at the holding company level and capital raised by Continental.\nIn August 1994, Continental's Board of Directors, citing the need to further strengthen the Corporation's capital base, eliminated the quarterly cash dividend of $.25 per share on the Corporation's common stock. Continental will be prohibited under certain provisions of its preferred stock instruments from paying common stock dividends for three years and will be restricted from paying common stock dividends thereafter under certain circumstances.\nPursuant to a separate agreement (the \"CNA Securities Purchase Agreement\") executed at the time of entering into the Merger Agreement, CNA and its affiliate Continental Casualty Company (\"CCC\") acquired for $275 million in cash (i) $200 million in aggregate liquidation value of two\nseries of 9.75% non-convertible preferred stock, redeemable under certain circumstances at the liquidation value plus an additional amount reflecting any increase in the per share price of Continental's common stock over $15.75 based on an average market price during a period relating to the notice of redemption; (ii) an option, which is exercisable only after termination of the Merger Agreement, to acquire $125 million in liquidation value of another series of 9.75% non-convertible preferred stock; and (iii) $75 million in liquidation value of a series of 12% non-convertible preferred stock, maturing in ten years and redeemable under certain circumstances. The option and its underlying preferred stock will be redeemable under certain circumstances at an additional amount reflecting any increase in the per share price of the common stock over $17.75 based on an average market price during a period relating to the notice of redemption and, in the case of the underlying preferred stock, the liquidation value. The 9.75% preferred stock will mature in forty years, with a right of the holders to require redemption in 15 years, and may be redeemed by Continental under certain circumstances. If the CNA Merger is not completed, CNA may, subject to regulatory approvals, exchange approximately $166 million of the $200 million liquidation value 9.75% preferred stock for another series of preferred stock that would be convertible into approximately 19% of Continental's currently outstanding common shares (approximately 16% on a fully diluted basis) at an initial conversion price, subject to adjustment, of $15.75. Following such exchange, CNA would be entitled to nominate up to four members of Continental's Board of Directors. CNA would also be subject to certain standstill agreements and restrictions on transfer. (For a more detailed description of the securities purchased by CNA see Continental's Proxy Statement, filed with the Securities and Exchange Commission and mailed to shareholders on March 29, 1995, in connection with a May 9, 1995 Special Meeting of Shareholders (the \"Proxy Statement\") at pages 36 - 43.)\nThe capital investment by CNA, which was completed on December 9, 1994, took the place of a proposed $200 million investment in Continental by Insurance Partners L.P. (\"IP\"). In connection with the execution of the Merger Agreement and the CNA Securities Purchase Agreement, Continental terminated a securities purchase agreement with IP (the \"IP Securities Purchase Agreement\") and an agreement under which an affiliate of IP was to purchase Continental Asset Management Corp., Continental's asset management subsidiary. (See the Proxy Statement at pages 13 - 14.)\nOf the $275 million CNA capital investment, $235 million was contributed by Continental to its domestic insurance companies, as part of the $510 million deployment of capital. $25 million was used to fund termination fees (including $7 million of expenses) payable to IP upon termination of the IP Securities Purchase Agreement, and $10 million was used to pay severance benefits to Richard M. Haverland, former director and Vice Chairman of Continental, pursuant to his employment agreement with Continental, upon his resignation upon termination of the IP Securities Purchase Agreement. The remainder of such proceeds was used to pay certain expenses in connection with Continental's capital infusion efforts and the CNA Merger.\nContinental has also sold non-strategic businesses. In 1994, Continental sold The Continental Insurance Company of Canada (\"CI\") and its wholly-owned subsidiaries (\"CI Canada\"), a major property and casualty insurer in Canada, which wrote $320 million of premiums in 1994. (See pages 6 - 7 herein.) In 1995, Continental sold Casualty Insurance Company and its wholly-owned subsid- iary (\"Casualty\"), the leading writer of workers' compensation insurance in Illinois, which wrote $385 million of premiums in 1994. (See page 9 herein.)\nIn mid-1994, Continental also entered into a quota-share agreement (the \"Quota Share Cession\") to reinsure a portion of its domestic personal lines with a major U.S. reinsurer. From July 1, 1994 through December 31, 1995, the quota share participation is 50% of the covered lines. Continental ceded written premiums of $325 million in 1994, and expects to cede premiums related to this agreement of approximately $300 million in 1995. The Quota Share Cession will help Continental lower its premium-to-surplus ratio and further reduce its exposure to catastrophes subject to the agreement's catastrophe coverage limits.\nThese actions have already had the following results: Continental's work force has been reduced by 2,898 employees (including 2,300 from planned reductions in force), from 12,255 employees at December 31, 1993 to 9,357 at December 31, 1994; more selective underwriting has reduced net premiums written by approximately $435 million as at December 31, 1994 from 1993 levels; the Quota Share Cession has reduced net premiums written by $325 million as at December 31, 1994 from 1993 levels; sales of businesses are expected to reduce net premiums written by an additional approximately $705 million from 1994 levels; the capital position of Continental's domestic insurance subsidiaries has been strengthened by the deployment of $510 million of capital to such insurance subsidiaries from non-domestic insurance subsidiaries, investments held at the holding company level and capital raised by Continental; and Continental's capital position has been improved by the elimination of dividends on Common Stock. Continental expects that these and similar actions, if continued, would, barring unexpected adverse events such as have occurred in the past, result in a significant improvement in its financial condition and profitability. Continental's restructuring efforts have not, however, been fully implemented, and there can be no assurance that implementation of such efforts would result in future profitability or a significant improvement in Continental's financial condition.\nUnder the Merger Agreement, Continental is required to conduct its business in the ordinary course and use all reasonable efforts to preserve intact its business organizations and relationships with third parties and to keep available the services of the present officers and key employees. (See Proxy Statement at pages 25 - 26.) As a result, Continental will not implement further premium reduction or other restructuring efforts pending the CNA merger.\nIf the CNA Merger is not approved by Continental's shareholders, the Board of Directors of Continental would consider what action should be taken in the interests of Continental's shareholders, including implementing further restructuring efforts, as well as continuing as an independent company, or exploring the sale of Continental or of an additional minority interest in Continental. If restructuring efforts were resumed, there can be no assurance that the financial condition and profitability of Continental would improve to the same extent as anticipated when the Merger Agreement was executed. If the CNA Merger is not approved by Continental's shareholders, CCC will continue to own Continental's preferred stock and will be entitled to seek the necessary regulatory approvals to convert certain of those shares into shares that would give it voting and other rights. CNA will retain its option to purchase certain other preferred stock of Continental. Continental would seek to raise an additional $100 million in capital through the sale of either non-convertible preferred stock or senior notes. (See \"Miscellaneous\" commencing on page 35 herein.) Even with further restructuring efforts and the additional investments, Continental would likely continue to have little surplus cushion available for adverse events, such as additional high catastrophe losses, adverse loss development or further reductions in the value of its investment portfolio, and a high debt to capital ratio. Continental would also be subject to any adverse market consequences resulting from a failure of the CNA Merger to be consummated.\nFinancial Information Relating to Business Segments\nContinental's revenues from insurance operations accounted for approximately 98% of Continental's consolidated revenues for the year ended December 31, 1994, and approximately 97% and 98% of consolidated revenues for each of the years ended December 31, 1993 and 1992, respectively. The following table sets forth certain information with respect to Continental's business segments for each of the last three years:\n____________________\n(1) Distinct investment portfolios are not maintained for each insurance segment, and, accordingly, allocation of assets, net investment income and realized capital gains to each insurance segment is not performed.\n(2) Certain reclassifications have been made to the prior years' financial information to conform to the 1994 presentation.\nGeneral Information Relating to Business Segments\nContinental's insurance operations (the \"Insurance Operations\") are comprised of three segments: Agency & Brokerage Commercial, Agency & Brokerage Personal and Specialized Commercial. These operations are conducted by Continental's property and casualty insurance subsidiaries. One or more of these companies is licensed or admitted to conduct business in each state or territory of the United States and in each province or territory of Canada. The Insurance Operations generated 98% of consolidated revenues for 1994, including 87% from premiums earned and 11% from investment activities (net investment income and realized capital gains). Continental's other segment is Corporate & Other Operations, which principally includes investment management, claims adjusting and risk management services.\nAgency & Brokerage Commercial\nContinental's Agency & Brokerage Commercial segment focuses on the production of property and casualty insurance coverage in the United States and Canada through independent insurance agents and brokers, almost all of whom also represent other companies. In 1994, the Agency & Brokerage Commercial segment included: (1) the new Commercial Lines group; (2) Continental Risk Management Services operations; (3) Continental Canada's commercial lines operations; and (4) commercial lines operations of First Insurance Company of Hawaii, Ltd., a 60%-owned Continental subsidiary (\"First of Hawaii\"). For the fiscal year ended December 31, 1994, the Agency & Brokerage Commercial segment produced 49.8% of Continental's consolidated written premiums. In 1994, premiums on its com- mercial multi-peril policies represented 57.8% of the segment's written premi- ums. Other principal lines written by the Agency & Brokerage Commercial segment include workers' compensation, commercial automobile, general liability, boiler and machinery, and fire & allied lines.\nContinental's Agency & Brokerage Commercial segment is structured on a product management basis. Agency & Brokerage Commercial operations consist of five regional offices containing underwriters and support personnel and a network of approximately 30 territorial offices responsible for sales and underwriting.\nContinental Risk Management Services operations market custom-tailored casualty coverages to Continental's large commercial accounts, including primary and excess coverage for workers' compensation, general liability and commercial automobile risks. Such operations also provide claims management, loss control and actuarial services for its clients.\nContinental's Canadian operations, which are considered part of North American operations and which write commercial and personal property and casualty coverages in Canada, included the following during 1994: (1) CI Canada, which was sold as of December 31, 1994; and (2) branch offices of two of Continental's U.S. property and casualty companies. In October 1994, Continental entered into an agreement to sell CI Canada to Fairfax Financial Holdings Limited, a Canadian financial services company (\"Fairfax\"), for 130 million Canadian dollars, debt securities of Fairfax with a face value of 25 million Canadian dollars and a contingent payment of up to 10 million Canadian dollars based on the performance of CI Canada through December 31, 1999. The approximate U.S. dollar equivalents at the exchange rate on December 31, 1994, are $95 million, $18 million and $7 million, respectively. Due to the uncertainty of future performance, no provision has been made in Continental's Consolidated Financial Statements for any potential gain from the contingent payment from Fairfax to Continental. Continental provided a guarantee of up to 40 million Canadian dollars for adverse loss development on accident years 1993 and prior, which, based on current actuarial reviews, is not expected to be utilized. The entities sold accounted for 10.3% of Agency &\nBrokerage Commercial's written premiums in 1994. The sale was closed as of December 31, 1994, and Continental recognized a $10 million loss on the transaction. Subsequent to that sale, Continental's Canadian operations consist of its two remaining branch offices in Canada.\nFirst of Hawaii is a property and casualty insurer in the Hawaiian Islands. As of December 31, 1994, The Tokio Marine and Fire Insurance Company, Ltd., a Japanese insurance company, owns the remaining 40% of the outstanding shares of First of Hawaii.\nThe Agency & Brokerage Commercial segment's 1994 underwriting results decreased $619 million from 1993, primarily due to the segment's $269 million share of a $480 million charge to establish, for the first time, loss and loss expense reserves and a reinsurance recoverable charge related to incurred but not reported asbestos-related, other toxic tort and environmental pollution claims (the \"Environmental IBNR Charge\"); its $70 million share of a $200 million charge to strengthen Continental's commercial multi-peril and workers' compensation reserves (the \"Reserve Strengthening Charge\") (see \"Reserves for Unpaid Losses and Loss Expenses\" commencing on page 22 herein); a $31 million charge for an additional provision for uncollectible premiums receivable (the \"Premiums Receivables Charge\"); increases in non-catastrophe weather-related losses and large losses; its $29 million share ($17 million in loss expenses and $12 million in insurance operating expenses) of the Restructuring Charge; its $21 million share of a $73 million provision for other assets; its $9 million share ($1 million in loss expenses and $8 million in insurance operating expenses) of the Additional Staff Reduction Charge; and a $35 million increase in net reported environmental losses and loss expenses. The segment's premiums earned increased $43 million from 1993, primarily due to increases in premiums from growth in certain non-package standard commercial lines, partially offset by the Premiums Receivable Charge. The segment's losses and loss expenses in- creased $619 million, primarily due to the Environmental IBNR Charge; the Reserve Strengthening Charge; increases in non-catastrophe weather-related losses and large losses; the Restructuring Charge; the increase in net reported environmental losses and loss expenses; and inflation in loss costs. Insurance operating expenses increased $43 million, primarily due to the Restructuring Charge, Additional Staff Reduction Charge, the provision for other assets and a $21 million decrease in servicing carrier income, partially offset by expense savings realized as a result of Continental's 1994 re-engineering.\nAgency & Brokerage Personal\nContinental's Agency & Brokerage Personal segment also focuses on the production of property and casualty insurance coverage in the United States and Canada through independent insurance agents and brokers, almost all of whom also represent other companies. The Agency & Brokerage Personal segment includes: (1) the new Personal Lines group, including employee accounts; (2) Continental's Canadian personal lines operations; and (3) personal lines operations of First of Hawaii, each of which is discussed above. For the fiscal year ended Decem- ber 31, 1994, the Agency & Brokerage Personal segment produced 12.8% of Continental's consolidated written premiums. Premiums on its personal package policies represented 48.5% of the segment's written premiums. Other principal lines written by the Agency & Brokerage Personal segment include automobile, homeowners, and fire & allied lines.\nAgency & Brokerage Personal operations consist of five regional offices, four of which are shared with Agency & Brokerage Commercial, and an automated business center that handles underwriting and processing of its personal lines.\nCI Canada, which was sold as of December 31, 1994, accounted for 20% of Agency & Brokerage Personal's written premiums in 1994.\nThe Agency & Brokerage Personal segment's 1994 underwriting results decreased $18 million from 1993, primarily due to a $25 million increase in catastrophe- related charges, the segment's $13 million share ($9 million in loss expenses and $4 million in insurance operating expenses) of the Restructuring Charge, its $10 million share of the provision for other assets and its $5 million share ($1 million in loss expenses and $4 million in insurance operating expenses) of the Additional Staff Reduction Charge, partially offset by better loss experience (excluding catastrophe losses) and a decrease in relative underwriting expenses. The segment's premiums earned decreased $158 million from 1993, primarily due to the cession of $170 million of domestic personal lines business under a quota share agreement with General Reinsurance Corporation (the \"Quota Share Cession\") and a decrease in the amount of risk accepted, partially offset by price increases. The segment's losses and loss expenses decreased $89 million, primarily due to the Quota Share Cession and the decrease in the amount of risk accepted, partially offset by the increase in catastrophe losses, the Restructuring Charge and inflation in loss costs. The segment's insurance operating expenses improved $51 million, primarily due to a $61 million decrease in commission expenses resulting from the Quota Share Cession and expense savings realized as a result of the re-engineering, partially offset by the Restructuring Charge, the Additional Staff Reduction Charge and the provision for other assets.\nSpecialized Commercial\nContinental's Specialized Commercial segment provides specialized commercial coverages, principally in marine and aviation, workers' compensation, fidelity & surety, excess and specialty, accident and health, medical malpractice, customized financial coverage and multinational lines. This segment accounted for 37.4% of Continental's consolidated written premiums for the 1994 fiscal year. The Specialized Commercial segment included during 1994: (1) Marine Office of America Corporation, a Continental subsidiary (\"MOAC\"); (2) a 37% participation in the operations of Associated Aviation Underwriters (\"AAU\"), which was reduced to a 25% participation by March 1995; (3) Continental Excess & Select and other specialty operations; (4) Casualty Insurance Company, a Continental subsidiary sold in February 1995 (\"Casualty\"); (5) Continental Financial Institutions operations; (6) Continental Guaranty operations; (7) Continental Credit operations; (8) Continental Insurance HealthCare opera- tions; (9) The Continental Insurance Company of Puerto Rico (\"Continental Puerto Rico\"); (10) The Continental Insurance Company (Europe) Limited, a Continental subsidiary (\"Continental Insurance (Europe)\") and (11) Lombard Insurance Company Limited and its subsidiary Lombard General Insurance Limited (together, the \"Lombard Entities\"), which were sold in January 1995.\nMOAC underwrites and manages ocean and inland marine insurance coverages, automobile warranty coverages and service repair warranty coverages for technical equipment through branch offices located throughout the United States. It also concentrates on developing package policies for the transportation, distribution and manufacturing industries. MOAC supports all of these coverages with specialized claims handling, surveying, loss control and recovery services.\nAAU writes insurance for many segments of the aviation industry through branch offices located throughout the United States. Associated Aviation Underwriters, Inc., in which Continental has a 50% interest, manages AAU.\nContinental Excess & Select and other specialty operations are active in the excess and specialty lines markets. Their principal types of coverage are stop- loss protection on group health insurance programs, professional liability insurance for lawyers, accountants and other classes of professionals, excess liability insurance, directors' and officers' liability insurance and industry targeted programs of liability insurance for the railroad, mining, skiing, biotechnology and pharmaceutical industries.\nContinental Excess & Select operations also provide support services to Continental's other excess liability and specialty lines operations.\nCasualty and its subsidiary, Workers' Compensation and Indemnity Company of California, were Continental subsidiaries engaged in writing certain preselected classes of workers' compensation exposures in Illinois, Wisconsin, Indiana, Michigan and southern California. In February 1995, Continental sold the stock of Casualty to Fremont General Corporation for $225 million in cash and a $25 million note. In 1995, Continental will recognize a pre-tax gain of approximately $50 million from the sale of Casualty. The entities sold accounted for 24.7% of the Specialized Commercial segment's written premiums in 1994.\nContinental Financial Institutions operations provide highly specialized coverages for financial institutions, from fidelity bonds to directors' and officers' liability and professional liability insurance, as well as a range of fidelity products for commercial businesses. Continental Guaranty operations are a major provider of surety coverages. Continental Credit operations provide credit insurance. The financial institutions, guaranty and credit operations were previously divisions of a Continental subsidiary, Continental Guaranty & Credit Corporation, which is no longer doing business as a separate corporate entity.\nContinental Insurance HealthCare operations primarily provide medical malpractice insurance. Such operations also provide claims and risk management services to insureds and other clients.\nContinental Puerto Rico assumes business in Puerto Rico, primarily by way of a quota-share reinsurance agreement with an unaffiliated entity, Puerto-Rican American Insurance Company (\"PRAICO\"). In 1994, the quota-share participation of Continental Puerto Rico was 8.1% of the net premiums written by PRAICO.\nContinental Insurance (Europe) services some U.S. multinational companies.\nIn January 1995, pursuant to an agreement with Carlingford Gibbs Holdings Limited, Continental sold the Lombard Entities, which were primarily engaged in the business of writing business in Hong Kong. Proceeds from the sale approximated $48 million, comprised of a $17 million dividend from Lombard to Continental, and $31 million in cash at the closing. Continental does not expect that this sale will have a significant impact on its results of operations, financial condition or liquidity.\nThe Specialized Commercial segment's 1994 underwriting results decreased $383 million from 1993, primarily due to the segment's $211 million share of the Environmental IBNR Charge and its $130 million share of the Reserve Strengthening Charge, partially offset by a $13 million decrease in catastrophe losses. The segment's 1994 premiums earned increased $128 million from 1993 due to price increases and acceptance of new risks in certain lines. Premiums earned increased $69 million in domestic marine, $60 million in specialty casualty, $41 million in workers' compensation in selected markets and $11 million in aviation. These increases were partially offset by a $68 million decrease in customized financial coverages and a $29 million decrease in multinational business. The segment's losses and loss expenses increased $457 million, despite the $13 million decrease in net catastrophe losses, primarily due to the Environmental IBNR Charge; the Reserve Strengthening Charge; inflation in loss costs and the increase in the amount of risk accepted. Insurance operating expenses increased $54 million, primarily due to growth in business written.\nCorporate & Other Operations\nThe Corporate & Other Operations segment includes Continental's corporate operating expenses and the operations of Continental's non-insurance subsidiaries. Continental's non-insurance subsidiaries primarily include: (1) Continental Asset Management Corp. (\"CAM\"); (2) Continental Loss Adjusting Services, Inc. (\"CLAS\"); (3) Continental Rehabilitation Resources, Inc. (\"CRR\"); (4) Ctek, Inc. (\"Ctek\"); (5) California Central Trust Bank Corporation (\"CalTrust\"); and (6) Settlement Options, Inc. (\"Settlement Options\").\nCAM, a Continental subsidiary registered under the Investment Advisers Act of 1940, as amended, provides investment advisory services to Continental, its subsidiaries, its employee benefit plans, certain affiliates and unrelated parties under investment advisory agreements. Continental has had preliminary discussions relating to a possible sale of CAM. Continental does not expect the sale of CAM to have a significant impact on its financial position, results of operations or liquidity.\nCLAS provides claims services for Continental's subsidiaries and other customers. Its wholly-owned subsidiary, CRR, provides case management and vocational rehabilitation for injured employees of insureds and other clients.\nCtek engages in risk evaluation and improvement activities designed to help insureds and other clients reduce or control losses to property, equipment, materials and human resources.\nCalTrust is a limited service bank whose activities are restricted to the acceptance of deposits, investment of depository funds and acting as trustee and\/or third party administrator for employee benefit plans. Continental and CNA have determined, in order that CNA not become subject to regulation under the Bank Holding Company Act, as amended (the \"BHC Act\"), to dispose of CalTrust and, if a sale is not completed prior to the Merger, to transfer ownership of CalTrust to an independent trustee (the \"Trustee\") subject to an irrevocable voting trust agreement. A change in control of CalTrust requires prior notice to and approval of the Board of Governors of the Federal Reserve System (the \"Board\") and of the California Superintendent of Banks (the \"Superintendent\"). Continental has requested and received confirmation from the Board Staff that, if Continental proceeds in the manner described above, the Staff would not recommend that the Board require the prior approval of the Board to effect the Merger nor that the Board take any action against CNA under the BHC Act as a result of the Merger. Continental has submitted to the Superintendent an application for exemption of the transfer of CalTrust to the voting trust from the notice and approval requirements. Continental intends to sell CalTrust whether or not the Merger is consummated. Continental does not expect the sale of CalTrust to have a significant impact on its financial position, results of operations or liquidity.\nThe following table sets forth certain information with respect to CalTrust's deposit liabilities for each of the last three years ended December 31:\nSettlement Options is a general insurance agency which consults with property and casualty claim organizations on personal injury losses to reduce settlement costs by arranging structured claim settlements, and purchases annuities to fund these future periodic payment obligations.\nCorporate and Other Operations generated a loss, before income tax benefits, of $150 million for 1994, an increase in loss of $109 million from 1993. This increase in losses was primarily due to a $43 million charge for fees and expenses paid in connection with Continental's capital infusion efforts and the Merger Agreement (see \"Re-engineering Strategy\" commencing on page 1 herein); Corporate and Other Operations' $36 million share of the provision for other assets; a $30 million decrease in investment results (a $15 million decrease in net investment income and a $15 million decrease in realized capital gains); and higher corporate operating expenses, partially offset by an $8 million decrease in corporate interest expense.\nDiscontinued Operations\nIn 1993, Continental completed the sale of its premium financing subsidiaries, AFCO Credit Corporation, AFCO Acceptance Corporation and CAFO Inc. (collectively, \"AFCO\"), to Mellon Bank Corporation (\"Mellon\"). Proceeds from the sale approximated $220 million, comprised of a $120 million dividend from AFCO to Continental and $100 million in cash from Mellon Bank. In addition, the sale agreement provides for a contingent payment to Continental based on AFCO's premium finance growth through December 31, 1998, for a potential maximum payment to Continental of up to $78 million. No provision has been made in Continental's Consolidated Financial Statements for any potential gain from this contingent payment from Mellon Bank. Continental realized a 1993 gain from the sale of approximately $36 million, net of income taxes. Also in 1993, Continental had an additional $15 million of income, net of income taxes, from its discontinued premium financing operations and a loss of $2 million, net of income tax benefits, from its discontinued insurance operations.\nIn 1993, results and net assets of the premium financing operations, which were previously reported in the Corporate & Other Operations segment, were classified in Continental's Consolidated Financial Statements as discontinued. Previously reported information has been restated accordingly.\nIn 1994, Continental recognized an additional after-tax gain of $3.5 million, relating to the sale of its premium financing operations, as a result of final tax elections made for 1993. In addition, in 1994, Continental reduced various tax liabilities related to previously discontinued insurance operations and realized $36 million in additional income. The reduction in the various tax liabilities\nis a direct result of a recent review of Continental's tax position and the development of the discontinued operations over the last two years.\nThe following table sets forth certain information with respect to operating results of the discontinued premium financing operations for each of the last three years:\nDuring 1992, Continental instituted a program to withdraw from the traditional assumed reinsurance and marine reinsurance businesses, as well as the indigenous international and international marine insurance businesses. Continental has been accomplishing this withdrawal by running off the insurance reserves of certain of these discontinued operations and selling the remaining operations (all of which were sold by September 30, 1993). The results and net assets of the aforementioned operations have been classified in Continental's Consolidated Financial Statements as discontinued.\nContinental's subsidiaries, Continental Reinsurance Corporation International Limited (\"CRC-I\") and East River Insurance Company (Bermuda) Ltd. (\"ERIC\"), both of which are continuing entities, manage a substantial portion of the assets and reserves of the discontinued operations, except reserves which were recorded in foreign operations as a requirement of law. In 1992, substantially all of the business of Continental's reinsurance subsidiary, Continental Reinsurance Corporation, was discontinued, and substantially all of its insurance reserves, along with an equivalent amount of assets, were transferred to CRC-I and ERIC.\nThe traditional assumed reinsurance and marine reinsurance businesses were autonomous from Continental's primary Insurance Operations. The product, customer base and distribution system also varied significantly from Continental's primary Insurance Operations. Before discontinuance, these businesses generally included proportional and non-proportional, facultative and treaty, and property and casualty insurance and reinsurance. The primary method of reinsurance distribution was through the broker market and the customer base consisted of other insurance and reinsurance companies. With the exception of a portion of the indigenous international insurance business, the discontinued insurance operations were comprised of separate legal entities. The discon- tinued insurance operations maintained distinct investment portfolios since the companies were domiciled in jurisdictions outside the United States and were required by local law to have separately maintained and managed portfolios.\nIndigenous international insurance was comprised of risks that are located in countries outside the\nUnited States and Canada, underwritten by companies domiciled or branches licensed outside the United States or Canada, where the insured is a person or company located outside the United States or Canada. This business was generally written and reported on a monoline basis. In contrast, Continental's United States and Canadian operations generally had focused on package business, and Continental's multinational operations (now included in the Specialized Commercial segment) wrote monoline coverage. Continental's United States and Canadian operations and multinational operations (other than Casualty) write monoline coverages, such as workers' compensation insurance, generally as an accommodation to obtain package business or as specialized coverages like excess liability and surety.\nMonoline personal lines coverages, such as secure home policies, were usually distributed and marketed by savings institutions as part of a mortgage package. Thus, it was only through prearranged participation, or brokered after mortgage sales, that such a product was sold.\nFor commercial risks, the distribution and marketing of indigenous international insurance was primarily on a co-insurance basis taking a participation percentage from a lead underwriter. Due to this standard overseas distribution system, the nature of selling this product was vastly different from the domestic practice of more direct links to insureds. Therefore, Continental's focus was on developing relationships with the various underwriters and brokers, rather than directly marketing to the insureds' agents. The servicing of the business was also substantially different, as the claims adjusting services were not administered directly by Continental.\nThe international marine business was underwritten by companies domiciled or branches licensed outside the United States and Canada. The international marine business had a different class of customer and marketing structure, which relied upon the syndication procedures used by the Institute for London Underwriting (\"ILU\"). The distribution and servicing of such business was also unique. The international marine operations consisted of a small group of underwriters and a collection group using third-party claims services. The ILU is an underwriting center as well as a funds clearing house for claims processing and settlement. Continental acted as a participant in part of a layer of each policy, rather than as a direct underwriter and claims servicer. Thus, systems needs and direct expenses associated with the production of business are different from Continental's domestic marine business. This difference in the method of marketing and distribution for international marine insurance substantially reduces Continental's records keeping requirements. In contrast, domestic marine insurance is underwritten in a similar manner to other domestic lines of business and has similar reporting requirements.\nThe following table sets forth certain information with respect to operating results of the discontinued insurance operations for each of the last three years:\nYear Ended December 31,\n1994 1993 1992 ---- ---- ---- (millions)\nTotal Revenues . . . . . . . . $ 62.7 $282.2 $549.8\nTotal Expenses . . . . . . . . 62.7 285.5 740.0 ------ ------ ------ Loss before Income Tax Benefits -- (3.3) (190.2)\nIncome Tax Benefits . . . . . . (36.0) (0.7) (9.7)\nLoss on Disposal of Discontinued Insurance Operations, Net of Income Tax Benefits . . . . . -- -- (13.0) ------ ------ ------ Net Income (Loss) from Discontinued Insurance Operations . . . . . . . . . $ 36.0 $ (2.6) $(193.5) ====== ====== ======\nThe following table sets forth certain information with respect to net assets of the discontinued insurance operations for each of the last two years:\nDecember 31,\n1994 1993 ---- ---- (millions)\nAssets:\nCash and Investments . . . $ 733.5 $1,166.5 Other Assets . . . . . . . 806.7 528.4 ------- ------- 1,540.2 1,694.9 ------- -------\nLiabilities: Outstanding Losses and Loss Expenses . . . . . . . . . 1,154.6 1,346.0 Unearned Premiums . . . . . 1.4 3.0 Other Liabilities . . . . . 296.0 261.3 ------- ------- 1,452.0 1,610.3 ------- ------- Net Assets: . . . . . . . . . $ 88.2 $ 84.6 ======= =======\nOf the $1,155 million in Gross Outstanding Losses and Loss Expenses at December 31, 1994, Continental currently plans the following: (1) $973 million of Gross Outstanding Losses and Loss Expenses are recorded by ERIC and CRC-I (Continental intends to run off these insurance reserves, and to support the reserves, which are carried at economic value in accordance with Bermuda law (the jurisdiction in which such reserves are reinsured), with an equal amount of reinsurance assets and earning assets held in trust by ERIC and CRC-I); and (2) $182 million of Gross Outstanding Losses and Loss Expenses, which Continental intends to run off, are recorded in foreign operations as a requirement of local regulations (these reserves are carried at their nominal amounts, in accordance with the regulations of the countries where such reserves are recorded).\nAdditional Business Information\nEach of Continental's insurance segments principally provides its own claims service through internal loss-adjusting operations. Designated employees of these operations have authority to settle claims, subject to limits on authority and, in large cases, to review by senior officers.\nContinental's Insurance Operations purchase reinsurance on certain risks which they insure, principally to (1) reduce liability on individual risks; (2) protect against catastrophe losses; (3) enable them to write additional insurance in order to diversify risks; and (4) reduce their total liability in relation to statutory surplus. The costs of reinsurance, including catastrophe coverages, are generally increased by adverse loss experience in prior periods. (For additional information concerning Continental's reinsurance arrangements, see \"Reinsurance\" commencing on page 30 herein.)\nThe industry as a whole has experienced underwriting losses for the past several years. These losses are generally attributable to price competition, which has prevented premium rate increases from keeping pace with losses and loss expenses, and an unusually high level of catastrophe losses. According to A.M. Best Company's (\"A.M. Best\") Review and Preview, which follows and reports on the industry's financial results, the industry's aggregate underwriting loss for 1993 was $23 billion.\nThe underwriting profitability of property and casualty insurers is affected by many factors, including price competition; the cost and availability of reinsurance; administrative and other expenses; the incidence of natural disasters; and insurance regulators' willingness to grant increases in those rates which they control. Loss frequency and severity trends are influenced by economic factors, such as a company's business mix; inflation rates; medical cost inflation; employment levels; crime rates; general business conditions; regulatory measures; and court decisions that define and expand the risks and damages covered by insurance. The incidence of natural disasters has adversely affected the underwriting profitability primarily of multi-peril, homeowners, and fire & allied lines of business. The underwriting profitability of workers' compensation and commercial and personal automobile business is adversely affected by (1) lower price levels and higher assumed risks due to mandated participation in state involuntary programs by companies writing such business; and (2) the medical cost inflation rate, which, though decreasing, is still higher than the overall inflation rate.\nA key component of underwriting profitability is controlling costs. The Insurance Operations have attempted to control their discretionary and loss costs by (1) implementing technological advances; (2) changing their distribution systems and marketing methods; (3) instituting policies designed to increase employees' productivity; (4) changing the mix of agency and brokerage relationships; (5) reducing writings of certain less profitable classes of risks; and (6) becoming more selective in the acceptance of risks.\nAn indicator of underwriting profitability of property and casualty insurers is a company's \"combined ratio\". The combined ratio is the sum, expressed as a percentage, of (i) the ratio of incurred losses and loss expenses to premiums earned (the \"loss ratio\"); and (ii) the ratio of sales commissions, premium taxes, and administrative and other underwriting expenses to premiums written (the \"expense ratio\"). When the combined ratio is below 100%, underwriting results are generally considered profitable; when the ratio is over 100%, underwriting results are generally considered unprofitable. Because the combined ratio does not reflect net investment income, which is a significant component of an insurance company's operating results, an insurance company's operating results for a line of business may be profitable even though the combined ratio for that line of business exceeds 100%. (For information concerning net investment income, see \"Investment and Finance\" commencing on page 32 herein.)\nThe following table sets forth certain information (presented in accordance with statutory accounting practices) with respect to the underwriting results of the Insurance Operations for the commercial and personal lines of insurance written by them for each of the last three years. Information as to premiums written includes premiums on insurance policies directly written and on policies assumed from other insurers, pools and associations, in each case net of premiums ceded to others in connection with reinsurance purchased.\n(1) The comparable GAAP loss, expense and combined ratios for the years ended December 31, 1994, 1993 and 1992 were 99.4%, 32.8% and 132.2%; 77.3%, 31.9% and 109.2%; and 81.1%, 33.8% and 114.9%, respectively. The difference between the GAAP loss ratio for Continental's Insurance Operations and the statutory loss ratio at December 31, 1994 largely resulted from establishing an $80 million asset relating to Environmental Claims for GAAP purposes and fully reserving that amount as not recoverable.\nApproximately 61.3% of direct premiums written by the Insurance Operations during 1994 were written in nine states and Canada. Canada accounted for 10.2% of direct written premiums; New York, 10.3%; California, 8.1%; Illinois, 8.8%; New Jersey, 5.6%; Texas, 5.1%; Pennsylvania, 4.1%; Ohio, 3.9%; Michigan, 2.7%; and Hawaii, 2.5%. No other state, country or political subdivision accounted for more than 2.5% of such premiums. The percentages do not reflect premiums received or paid in connection with reinsurance transactions.\nContinental is taking steps to shift its business mix towards those areas in which management believes Continental can achieve an underwriting profit without a predetermined target for business mix in order to increase profitability. Continental is significantly reducing the level of new business in its personal lines and standard commercial lines groups, which are focusing instead on their renewal business. Continental is also taking steps to curtail renewal business in unprofitable lines and industries. In 1994, the loss and expense ratios for the Insurance Operations increased 17.1 and 0.5 percentage points, respectively, from the prior year, primarily as a result of the Environmental IBNR Charge, the Reserve Strengthening Charge and the Restructuring Charge. Underwriting results for the Insurance Operations produced statutory combined ratios for their personal and commercial lines of 112.8% and 128.6%, respectively, in 1994, compared with 108.8% and 108.4%, respectively, in 1993.\nMany states require property and casualty insurers to participate in \"plans\", \"pools\" or \"facilities\" which provide coverages for defined risks at rates required by regulators which insurers otherwise would be unwilling to underwrite in view of the nature of the risks and the claims experience of the insureds or the insurance classes of which they are members. Continental provides for its share from its participation in these pools and associations, as well as its participation in voluntary pools and associations, based upon results reported to it by these organizations. In 1994, these involuntary writings totaled approximately $236 million, or approximately 5.7% of the Insurance Operations' total written premiums. The statutory underwriting loss on this business was $30 million during 1994, accounting for approximately 2.8% of Insurance Operations' statutory underwriting loss. In 1994, 35.5%, and 62.0% of these writings were attributable to automobile and workers' compensation businesses, respectively. (For additional information concerning such pools and associations, see \"Regulation\" commencing on page 20 herein.)\nCompetition\nThe property and casualty insurance industry is highly competitive. Continental's Insurance Operations compete with other stock companies, specialty insurance organizations, mutual insurance companies, and other underwriting organizations. As reported by the Insurance Information Institute in 1994, an educational, fact-finding and communications organization, the property and casualty industry in the United States is comprised of approximately 900 leading insurance organizations, none of which has a market share larger than 12% and the top ten of which account in the aggregate for less than 45% of the market. Companies in the United States also face competition from foreign insurance companies and from \"captive\" insurance companies and \"risk retention\" groups (i.e., entities established by insureds to provide insurance for themselves). In the future, the industry, including Continental's Insurance Operations, may face increasing insurance underwriting competition from banks and other financial institutions.\nBased upon the 1994 edition of Best's Aggregates and Averages for the calendar year 1993, Continental's domestic property and casualty companies collectively ranked eleventh in overall premium volume among United States property and casualty insurers. In addition, such companies are among the leading twenty in such categories as commercial multi-peril, aircraft, farmowners, homeowners, fire & allied lines, ocean marine and inland marine lines, and among the leading twenty-five in commercial automobile lines. Because of the relatively large size and underwriting capacity of Continental's property and casualty companies, many opportunities are available to them that are not available to smaller companies.\nThe competitive focus of Continental's Insurance Operations is to (1) offer combinations of superior products, services and premium rates; (2) distribute their products efficiently; and (3) market\nthem effectively. Reliance upon these factors varies from line to line of insurance and from product to product within lines of insurance. Rates are not uniform for all insurers and vary according to the respective types of insurers and methods of operation. Continental's Insurance Operations have traditionally marketed their products principally through independent agents and brokers. This system of marketing is facing increased competition from financial institutions and other companies that market their insurance products directly to the consumer. In response to this competition, Continental has implemented several programs designed to develop a more concentrated and productive agency and brokerage force by eliminating duplication of functions, shifting its mix of business towards those areas in which management believes it can achieve underwriting profit without a pre-determined target for business mix, terminat- ing producers of unprofitable business, reducing its exposure to catastrophes and providing added incentives and improved support to its more productive producers. Such incentives include assurances of continuing representation; expanded promotional and marketing assistance; specialized account handling; training; and, in certain cases, financial assistance in connection with agency and brokerage expansion. Consequently, Continental's Insurance Operations have, over the past several years, placed computer terminals with many of their most productive producers, which permit producers to transmit information directly to Continental's computer centers and to receive policies, endorsements and other personal lines services overnight. In response to market conditions, Continental has also developed package personal and commercial policies for customers having standard risk exposures, customized products for certain classes of business and industries, and a strong distribution network comprised largely of selected producers with professional sales skills and product knowledge in Continental's targeted markets.\nRegulation\nContinental's property and casualty companies are subject to regulation by government agencies in the states and foreign jurisdictions in which they do business. The nature and extent of such regulation vary from jurisdiction to jurisdiction, but typically involve the establishment of premium rates for many lines of insurance; standards of solvency and minimum amounts of capital and surplus which must be maintained; limitations on types of investments; restrictions on the size of risks which may be insured by a single company; licensing of insurers and their agents; deposits of securities for the benefit of policyholders; approval of policy forms; methods of accounting; mandating reserves for losses and loss expenses; and filing of annual and other reports with respect to financial condition and other matters. In addition, state regulatory examiners perform periodic examinations of insurance companies. Such regulation is generally intended for the protection of policyholders rather than security holders.\nMost states also require property and casualty insurers to become members of insolvency associations or guaranty funds, which generally protect policyholders against the insolvency of an insurer writing insurance in the state. Members of the associations must contribute to the payment of certain claims made against insolvent insurers. Maximum contributions required by law in any one year vary generally between 1% and 2% of annual premiums written by a member in that state.\nContinental's domestic insurance subsidiaries are subject to various state statutory and regulatory restrictions, applicable generally to each insurance company in its state of incorporation, that limit the amount of dividends and other distributions that those subsidiaries may pay to Continental. Each of the states in which one or more of these subsidiaries is domiciled has enacted a formula that governs the maximum amount of dividends that such subsidiaries may pay without prior regulatory approval. These formulas, which are substantially similar, limit such dividends on such factors as policyholders' surplus, net income, net investment income and\/or unassigned surplus. These restrictions will, under certain circumstances, significantly reduce the maximum amount of dividends and other distributions\npayable to Continental by its domestic insurance subsidiaries without approval by state regulatory authorities. Some restrictions require that dividends, loans, and advances in excess of stated levels be approved by state regulatory authorities. During 1994, Continental's domestic insurance subsidiaries paid it $70 million in dividends. To the extent that its insurance subsidiaries do not generate amounts available for distribution sufficient to meet Continental's cash requirements without regulatory approval, Continental would seek approval for additional distributions. As of December 31, 1994, under the restrictions currently in effect, the maximum amount available for payment of dividends to Continental by its domestic insurance subsidiaries during the year ending December 31, 1995 without regulatory approval is estimated to be $71 million. (See Note 18 to Consolidated Financial Statements included in the Proxy Statement at page.) Continental anticipates that dividends from its domes- tic insurance subsidiaries, together with cash from other sources, will enable it to meet its obligations for interest and principal payments on debt, corporate expenses, declared shareholder dividends and taxes in 1995.\nAlthough the federal government does not directly regulate the business of insurance, federal initiatives often affect the insurance business in a variety of ways. For example, pollution liability for insurers could be affected by federal initiatives relating to environmental pollution liability issues. In addition, the significant costs of natural catastrophes may prompt responsive legislation to expand the federal role in the funding of amelioration of future catastrophes. Other current proposals that may affect insurers are tort reform initiatives, where legislation aimed at tightening standards for suit, limiting punitive damages and reducing the liability of product sellers could have a positive impact in reducing costs associated with litigation in the claims handling process; legislation related to the availability and affordability of insurance products in certain areas; initiatives relating to the ability of banks to provide insurance products; and proposals relating to health care reform or change.\nThe National Association of Insurance Commissioners (\"NAIC\") has developed several model initiatives to strengthen the existing state regulatory system, including uniform accreditation of state insurance regulatory systems; limitations on the payment of dividends by property and casualty insurance companies; adoption of risk-based capital standards; actuarial certification of reserves; and independent audits of insurer financial statements. Adoption of such initiatives will be on a state-by-state basis. Continental favors stronger solvency standards, but recognizes that more regulation, at either the state or federal level, will increase the cost of providing insurance coverage. In the fourth quarter of 1993, the NAIC adopted a risk based capital (\"RBC\") standard for use by state insurance regulators. RBC is intended to be a \"tool\" for regulators to assess the capital adequacy of property and casualty insurers and to take action when capital under the standard is judged to be inadequate. The NAIC developed a model law which has been adopted by various states, including several of Continental's domiciliary states. Each state that adopts the model law will provide certain additional enforcement powers to its insurance regulators. As of December 31, 1994 and the date of this report, Continental believes that its domestic insurance subsidiaries have sufficient levels of capital for their respective operations based upon the RBC standards in effect and as applied by relevant state authorities and as applied to Continental's 1994 statutory financial statements.\nInsurance companies, including Continental's property and casualty companies, are also affected by a variety of state and federal legislative and regulatory measures and judicial decisions that define and extend the risks and benefits for which insurance is sought and provided. These include redefinitions of risk exposure in areas such as product liability; environmental damage; and employee benefits, including pensions, workers' compensation and disability benefits. In addition, individual state insurance departments may prevent premium rates for some classes of insureds from reflecting the level of risk assumed by the insurer for those classes. Such developments may result in short-term adverse effects on the profitability of various lines of insurance. Longer-term adverse effects on\nprofitability can be minimized, when possible, only through repricing of coverages or limitation or cessation of the affected business.\nReinsurers and international insurance companies are subject to licensing requirements and other regulation in the jurisdictions in which they do business. United States regulation of licensed reinsurers is similar to the regulation of domestic property and casualty insurers, except that regulation of reinsurers does not extend to rates, policy forms, or, generally, participation in insolvency funds. Countries outside of the United States have varying levels of regulation of insurance and reinsurance companies.\nReserves for Unpaid Losses and Loss Expenses\nContinental's insurance subsidiaries establish reserves to cover their estimated liability for losses and loss expenses with respect to reported and unreported claims incurred (including for the first time, in 1994, unreported \"Environmental Claims,\" as defined below) as of the end of each accounting period, after taking into effect salvage and subrogation claims. In establishing such reserves with respect to the period then ended, loss reserves recorded in prior periods are updated to reflect improved estimates of losses and loss expenses as actual experience develops and payments are made.\nThe losses and loss expense reserves of Continental's insurance subsidiaries are estimates of the liability determined by using individual case-basis estimates on reported claims and statistical projections and industry measurement techniques for unreported claims. The statistical projection models used to estimate non-environmental unreported claims reflect changes in the volume of business written, as well as claim frequency and severity. Adjustments to these models are also made for changes in the mix of business, claims processing and other items which affect the development patterns over time. Such statistical projections of ultimate net costs are used to adjust the amount estimated for individually established non-environmental case reserves, as well as to establish estimates for the amount needed for non-environmental unreported claims. (For a discussion of the techniques used for unreported Environmental Claims, see discussion at page 24 herein.)\nFor more mature accident years, inflation is implicitly considered in such projections based on actual patterns of reported claims, loss payments and case-basis reserves. For relatively immature accident years, in addition to actual loss patterns, explicit assumptions are made for changes in claim severity and frequency based on the type of claims, nature of the related risks, industry trends and related cost indices.\nContinental conducts an annual fourth quarter in-depth review of its core (non-environmental) reserves using loss and loss adjustment expense information. Its 1994 fourth quarter review was completed in December 1994 on loss and loss adjustment information updated as of September 30, 1994. Upon completion of the annual fourth quarter review and a special review of workers' compensation reserves conducted in connection with the sale of Casualty, Continental strengthened its reserves by $200 million. Of the $200 million in additional loss and loss adjustment reserves, $100 million of the reserves was primarily due to a higher than anticipated number of claims and adverse loss development in case reserves in multi-peril and various smaller programs (primarily auto) and an increase in the number of large cases and adverse loss development in case reserves in the surety program. The other $100 million of additional loss and loss adjustment expense reserves were established in workers' compensation as a result of the annual fourth quarter review, the review conducted in connection with the sale of Casualty and negotiations with respect to such sale.\nContinental's reserves for losses and loss adjustment expenses include reserves for \"Environmental Claims.\" Continental employs what it believes to be a broad definition of \"Environmental Claims.\" \"Environmental Claims\" include reported and unreported claims or lawsuits, for which coverage is or may be alleged, arising from exposure to hazardous substances or materials originating from a site that is the subject of an investigation or cleanup pursuant to state or federal environmental legislation; claims or lawsuits involving allegations of bodily injury or property damage arising out of the discharge or escape of a pollutant or contaminant; and claims or lawsuits alleging bodily injury or property damage as a result of exposure over a period of time to products or substances alleged to be harmful or toxic. Based upon reviews of claim frequency, exposure trends and relevant legal issues relating to types of claims, Continental periodically revises the definition of Environmental Claims. In 1994, Continental broadened the definition of Environmental Claims to include claims arising from certain railroad exposures involving asbestos-related claims and other toxic tort claims, including repetitive stress and noise-induced hearing loss claims. Railroad exposure claims involving environmental pollution claims had previously been classified as Environmental Claims. The classification of asbestos-related and other toxic tort railroad exposure claims as Environmental Claims resulted in the reclassification of reserves relating to such claims to the gross reserves for Environmental Claims and gave rise to the increase in reserves for asbestos-related and other toxic tort claims from December 31, 1993 to January 1, 1994. (See the table entitled \"Asbestos- Related, Other Toxic Tort and Environmental Pollution Claims\" on page 26.) Claims falling under the above categories are classified into two general claim types: (1) asbestos-related and other toxic torts; and (2) environmental pollution. The table on page 26 sets forth information regarding the amounts of the reserves for Environmental Claims at December 31, 1994, 1993 and 1992 and payments of losses and loss expenses on such claims in each of those years. These reserves represent Continental's current best estimates of the probable cost to resolve such reported and unreported claims, either through settlement, litigation or alternative dispute resolution. The amounts in the table reflect the gross and net undiscounted estimated liability. (For information concerning reinsurance relating to Environmental Claims, see \"Reinsurance\" commencing on page 30 herein.) Such reserves incorporate factors specifically relevant to Environmental Claims, including the nature and scope of policy coverage; the number of claimants, defendants and co-insurers; the timing and severity of injuries or damage; and the relevant jurisdiction and case law. Continental has managed its reported Environmental Claims from its centralized Environmental Claims Department since 1981. Continental believes that its centralized approach to handling reported Environmental Claims gives Continental the best practicable ability to determine its liability.\nPrior to the third quarter of 1994, Continental did not establish reserves for incurred but not reported Environmental Claims (\"Environmental IBNR Claims\") because the existence of significant uncertainties (including difficulties in determining the frequency and severity of potential claims and in predicting the outcome of judicial decisions as case law evolves regarding liability exposure, insurance coverage and interpretation of policy language) and the absence of standard techniques to measure exposure did not allow ultimate liabilities to be reasonably estimated in accordance with accepted actuarial standards.\nWhile Continental continues to believe that it is not possible to reasonably estimate ultimate liabilities for Environmental IBNR Claims, it has concluded that different measurement techniques, based on industry averages, for estimating a reserve for Environmental IBNR Claims have been sufficiently developed, and accepted in the insurance industry, to permit Continental to determine a reasonable gross estimate for Environmental IBNR Claims. However, due to the continuing level of uncertainty involved with environmental exposures, Continental may incur future charges for Environmental IBNR Claims, which may be material to Continental's financial position, results of operations or liquidity.\nIncluded in Continental's liability for outstanding losses and loss expenses are gross undiscounted reserves of $834 million for Environmental Claims. At December 31, 1994, the gross undiscounted reserves for losses and loss expenses were $354 million ($264 million at December 31, 1993) for reported Environmental Claims, and a gross undiscounted reserve of $480 million was established for losses and loss expenses for Environmental IBNR Claims ($0 million at December 31, 1993). The $354 million represents Continental's current best estimate for reported Environmental Claims. The $480 million represents Continental's best estimate for its Environmental IBNR Claims, using a measurement technique believed to be reasonable, based upon information currently available. However, it is not possible at this time to estimate the amount of additional liability related to Environmental IBNR Claims that is at least reasonably possible to exist.\nIncluded in Continental's reinsurance assets are amounts due for reported Environmental Claims of $175 million at December 31, 1994 ($105 million at December 31, 1993). A reinsurance asset of $80 million was recorded in conjunction with the establishment of the reserves for Environmental IBNR Claims, but was fully reserved for as not recoverable due to the degree of uncertainty in the collectibility of such amounts.\nThe technique utilized by Continental involves measuring total net reserves for reported Environmental Claims and Environmental IBNR Claims in terms of the number of years such reserves could fund the net annual payments for these claims. Such technique is consistent with that utilized by an insurance rating agency and by the actuarial profession in some of its discussion papers for its preliminary work with respect to such liabilities. At the end of 1992, the industry was at a net environmental reserve to net environmental paid ratio (\"Survival Ratio\") of six times such paid losses, which had been increasing and was expected to increase further. At December 31, 1994, Continental's net Environmental Claims reserves would comprise approximately nine times its historical average net paid losses and loss expenses for these claims.\nNet losses and loss expenses incurred include charges for reported Environmental Claims and Environmental IBNR Claims of $573 million, $56 million and $81 million for 1994, 1993 and 1992, respectively. The 1994 increase is primarily related to the establishment of the reserves for the Environmental IBNR Claims.\nContinental has not marketed nor been in the business of providing environmental pollution coverages, with the exception of a program which was in effect from 1981 to 1985, which provided such coverage on a claims-made basis. There are currently two claims pending under policies written under this program for which Continental has established case reserves which reflect Continental's estimate of the probable ultimate cost of these claims. The allowable reporting period under all policies written under this program has expired.\nThe 1980 enactment of the Comprehensive Environmental Response, Compensation, and Liability Act, as amended by the Superfund Amendments and Reauthorization Act of 1986, as well as similar state statutes, resulted in environmental pollution claims brought thereafter under standard form general liability policies. While most environmental pollution claims have arisen out of policyholders' obligations under federal and state regulatory statutes, claims have also been brought against policyholders by private third-parties alleging pollution-related property damage and\/or bodily injury. Consistent with the broad range of entities which may become subject to designation as \"Potentially Responsible Parties\" under state and federal environmental statutes, insureds presenting such claims for coverage under general liability policies span a broad spectrum of commercial policyholders. Most of Continental's environmental pollution claims result from general liability policies written prior to 1986. Certain provisions of Continental's, and the industry's, standard form general liability policies written prior to 1986 have been subject to wide-ranging challenges by policyholders and\/or differing interpretations by courts in various jurisdictions, with inconsistent conclusions as to the applicability of coverage for environmental pollution claims. Policies written after 1986 have not been subject to such wide-ranging challenges by policyholders and\/or differing\ninterpretations by the courts. Continental has consistently maintained during coverage litigation that its general liability policies did not provide coverage for environmental pollution liability.\nAsbestos-related claims have generally arisen out of product liability and railroad exposure coverage provided by Continental under general liability policies written prior to 1986. Thereafter, asbestos-product exclusions were included in general liability policies. Asbestos-related bodily injury litigation developed during the late 1970's. Initially, the majority of defendant-insureds making claims under general liability policies were involved in the mining, processing, distribution and sale of raw asbestos. By 1985, the category of defendants grew to include companies which produced a variety of products containing asbestos, including roofing materials, tile, refractory products, asbestos-containing clothing, and brake and clutch friction products. Continental had written primary general liability coverage for only two major asbestos manufacturers, and had settled all liabilities under those policies by 1989. Continental had written excess insurance coverage for several other asbestos manufacturers. In addition, Continental had written primary general liability coverage for companies which produce products containing asbestos.\nClaims which fall in the other toxic tort category have generally arisen out of product liability and railroad exposure coverage under general liability policies. These claims involve a variety of allegations of bodily injury as a result of exposure over a period of time to products alleged to be harmful or toxic, such as silica, lead-based paint, pesticides, dust, acids, gases, noise, chemicals, silicone breast implants and pharmaceutical products, as well as repetitive stress and noise-induced hearing loss claims.\nTypically, the coverage provided by Continental for all of the above claim- types represents a portion of the total insurance coverage available to a policyholder for such claims. Whenever appropriate, Continental actively seeks out opportunities to participate in cost-sharing agreements with other insurance carriers, stipulating an equitable allocation of expenses and indemnity pay- ments. Cost-sharing agreements are presently in effect with respect to litigation concerning a large majority of Continental's asbestos-related and other toxic tort litigation.\nAs of December 31, 1994, there were approximately 2,311 pending environmental pollution claims involving approximately 892 policyholders, and environmental pollution-related coverage disputes involving approximately 329 policyholders in 421 actions. Approximately 1,465 environmental pollution claims closed or settled during 1994. Continental defines a \"claim\" as the potential financial exposure to a policy year based on an analysis of relevant factors, and which arises out of a policyholder's potential liability at a single site or multiple sites.\nA three-year asbestos-related, other toxic tort and environmental pollution loss reserve activity analysis is set forth below:\n___________________________\n(1) The increase in gross reserves from December 31, 1993 to January 1, 1994, resulted from a reclassification of reserves to this category as a result of Continental's broadening, in 1994, of the definition of Environmental Claims to include claims arising from certain railroad exposures involving asbestos-related and other toxic tort claims.\nAs of December 31, 1994, Continental's $834 million gross loss and loss adjustment expense reserve for reported and unreported Environmental Claims included gross loss adjustment expense reserves of $318 million, or 38% of such total reserves (as of December 31, 1993, $54 million, or 21% of such total reserves). The amount of Continental's gross loss adjustment expense reserves for reported Environmental Claims and Environmental IBNR Claims as of December 31, 1994, constituted 26% of Continental's total gross loss adjustment expense reserves.\nIn accordance with individual state insurance laws, certain of Continental's property and casualty subsidiaries discount certain workers' compensation pension reserves. The rate of discount varies by\njurisdiction and ranges from 3.0% to 5.0%. The statutory discount on workers' compensation reserves at December 31, 1994, 1993 and 1992 is $509 million, or 7.1% of statutory reserves; $525 million, or 7.9% of statutory reserves; and $522 million, or 8.0% of statutory reserves, respectively. The discount includes an additional discount on the reserves at December 31, 1994, 1993 and 1992 for incurred but not reported claims of $143 million, $127 million and $187 million, respectively, for losses reported to Continental through its participation in joint reinsurance pools. In 1994, individual state insurance laws changed to restrict the discount on certain workers' compensation pension reserves. In addition, for the purpose of reporting on a generally accepted accounting principles (\"GAAP\") basis, these subsidiaries have discounted workers' compensation pension reserves since 1984 at a rate of 7% to reflect as- sumed market yields. Discounting at a rate of 7% in 1994, 1993 and 1992 reduced total reserves for losses at the end of such years by $680 million, or 9.3%; $696 million, or 10.5%; and $693 million, or 10.6%, respectively.\nAs a result of the discounting of workers' compensation reserves, the ultimate net cost of the losses would, without taking other factors into account, be projected to exceed the amount of the carried reserves by the amount of the discount. The total amount of this excess will emerge as current year incurred losses develop over many years. If such excess had been reflected in the table on page 28 as development of prior year reserves, it would have added $34 million, or 0.6%; $39 million, or 0.7%; and $52 million, or 0.9%, respectively, to the 1993, 1992 and 1991 cumulative deficiencies as of December 31, 1994. However, the yields on these subsidiaries' investment portfolios have historically been greater than the discount rate, and any deficiency due to the discounting of such reserves should be more than offset by investment income.\nThe table on page 28 shows the annual adjustment to historical reserves for each year since 1984. The reserves for unpaid losses and loss expenses are set forth on a cumulative basis for the year specified and all prior years. Although amounts paid for any year are reflected in the re-estimated ultimate net loss at the end of such year, there is no direct correlation in the development patterns between the two portions of the table because the re- estimated ultimate net loss includes adjustments for unpaid losses and loss expenses as well. Finally, an adjustment to an unpaid claim for a prior year will also be reflected in the adjustments for all subsequent years. For example, an adjustment made in 1990 for 1984 loss reserves will be reflected in the re-estimated ultimate net loss as a subsequent development for each of the years 1984 through 1989.\n--------------- (1) Information for each year from 1984 - 1991 has been restated to reflect accounting for Continental's traditional assumed reinsurance and marine reinsurance businesses and indigenous international and international marine insurance businesses as discontinued operations. See \"Discontinued Operations\" commencing on page 11 herein.\n(2) The reserves of foreign subsidiaries are translated into United States dollars at the exchange rates as of each year-end. Foreign exchange factors tend to improve or adversely affect the reserve development (ultimate loss as compared to initial estimated liability) of foreign subsidiaries depending upon the relative movement of the exchange rates.\n(3) The gross reserves include direct written business and assumed business. In 1993, Continental commuted a reinsurance agreement, which had the effect of decreasing assumed business and reinsurance receivables by $208 million, but did not affect net reserves. This commutation pertains to certain business arising in 1992 and prior years.\nThe following table shows the changes in the last three years in Continental's estimates of its liability for insured events of prior years, including the extent to which such changes relate to asbestos- related, other toxic tort and environmental pollution claims:\nThe increase in Continental's estimate of its liabilities for insured events of prior years for total Environmental Claims during each of the years 1994, 1993 and 1992 was 13.0%, 1.6% and 2.6%, respectively, of Continental's net incurred losses and loss expenses for such years.\nAs a result of insured events in prior years, the provision for claims and claim adjustment expenses (net of reinsurance recoveries of $3,670 million and $3,153 million in 1994 and 1993, respectively) increased by $853 million in 1994, primarily due to a $573 million increase in asbestos-related, other toxic tort and environmental pollution claims (including $480 million for establishment of reserves for Environmental IBNR Claims in the third quarter of 1994); an $80 million increase resulting from higher than anticipated number of claims and adverse loss development in case reserves in multi-peril and various smaller programs (primarily auto) and an increase in the number of large cases and adverse loss development in case reserves in the surety program; and $100 million of additional loss and loss adjustment expense reserves established in workers' compensation, primarily as a result of Continental's annual fourth quarter review of reserves and reviews conducted in connection with the sale of Casualty and negotiations with respect to such sale.\nThe $55 million reduction for the provision for claims and claim adjustment expenses other than asbestos-related and other toxic tort and environmental pollution claims in 1993 was primarily due to a decrease in the medical cost inflation rate trends in comparison to prior years, which was anticipated to primarily benefit the provision for claims and claim adjustment expenses relating to Continental's workers' compensation business, which is most affected by medical costs.\nReinsurance\nIn the ordinary course of business, Continental cedes business, on both a pro rata and excess of loss basis, to other insurers and reinsurers. Purchasing reinsurance enables Continental to limit its exposure to catastrophic events and other concentrations of risk. However, purchasing reinsurance does not relieve Continental of its obligations to its insureds. Continental assumes business from other reinsurance organizations, primarily through its participation in voluntary and involuntary risk-sharing pools.\nFor a table showing premiums written, premiums earned and losses and loss expenses information (direct, assumed and ceded) for the years ended December 31, 1994, December 31, 1993 and December 31, 1992 see the Proxy Statement at page.\nContinental reviews the creditworthiness of its reinsurers on an ongoing basis. To minimize potential problems, Continental's policy is to purchase reinsurance only from carriers who meet its credit quality standards. It has also taken and is continuing to take steps to settle existing reinsurance arrangements with reinsurers which do not meet its credit quality standards. Continental does not believe that there is a significant solvency risk concerning its reinsurers. In addition, Continental regularly evaluates the adequacy of its reserves for uncollectible reinsurance. Continental believes that it makes adequate provisions for the ultimate collectibility of its reinsurance claims and therefore believes these net recoveries to be probable. During 1994, Continental charged $135 million to earnings for uncollectible reinsurance (which includes an $80 million charge for the reinsurance asset recorded in conjunction with the establishment of the reserve for Environmental IBNR Claims that was fully reserved for as not recoverable), compared with $15 million in 1993 and $41 million in 1992. Continental has not incurred any significant reinsurance write-offs associated with its corporate catastrophe reinsurance program.\nContinental has in place various reinsurance arrangements with respect to its current operations. These arrangements are subject to retention, coverage limits and other policy terms. Some of the principal treaty arrangements which are presently in effect are: (1) an excess-of-loss treaty reducing Continental's liability on individual property losses; (2) a blanket casualty program reducing Continental's liability on third party liability losses; (3) a clash casualty program reducing Continental's liability on multiple insured\/single event losses; and (4) a property catastrophe program, with a net retention of $50 million in both 1994 and 1993, reducing its liability from catastrophic events. Continental also uses individual risk facultative and other facultative agreements to further reduce its liabilities.\nContinental also has in place an aggregate excess-of-loss reinsurance contract with a limit of $400 million. This agreement was purchased in 1992 from National Indemnity Insurance Company. It covers losses and allocated loss expenses for 1991 and prior policy years. The business covered includes all lines of business written by Continental's domestic property and casualty insurance subsidiaries, with specific exclusions for nuclear exposure, war risks, business written through the Workers' Compensation Reinsurance Bureau and involuntary market pools, insolvency and guarantee fund assessments, taxes, unallocated loss adjustment expenses, and extra-contractual obligations.\nEffective July 1, 1994, Continental entered into a quota share agreement (previously referred to as the Quota Share Cession) to reinsure a portion of its domestic personal lines business with General Reinsurance Corporation. From July 1, 1994 through December 31, 1995, the quota share participation is 50% of covered lines. Continental ceded premiums related to the Quota Share Cession of $325 million in 1994 and expects to cede written premiums of approximately $300 million in 1995. This arrangement will help Continental lower its premium-to-surplus ratio and further reduce its exposure to catastrophes subject to the agreement's catastrophe coverage limits.\nContinental does not maintain any reinsurance arrangements whose coverage is limited solely to reported and unreported Environmental Claims, as defined above. The amounts of reinsurance receivables and recoverables that are reflected in Continental's Consolidated Financial Statements arose under a variety of reinsurance arrangements put in place generally from 1963 through 1986, which generally are the years in which Continental's general liability policies were alleged to provide coverage for those types of claims. As most of Continental's reserves for asbestos-related, other toxic\ntort and environmental pollution claims have arisen out of general liability policies written prior to 1986 (after which such policies have not generally been subject to wide-ranging challenges by policyholders and\/or differing interpretations by courts in various jurisdictions), a majority of reinsurance receivables and recoverables arising out of such claims in 1992, 1993 and 1994 related to reinsurance arrangements put into place prior to 1986. These reinsurance arrangements include primary casualty treaty arrangements, excess of loss and umbrella casualty treaty arrangements, property treaty arrangements and various facultative agreements.\nInvestment and Finance\nReserves and surplus balances constitute a pool of funds which are invested by insurance companies. Investment results combined with underwriting results produce operating income or losses. Continental's overall operating results in the insurance business are significantly affected by the performance of its investment portfolio.\nThe following table sets forth the investment results of Continental and its subsidiaries for each of the past three years:\n(1) Average of investments at beginning and end of calendar year, excluding operating cash, but including cash equivalents. Bonds and redeemable preferred stocks are reported at fair value, except for those investments intended to be held to maturity, which are reported at cost. (2) Net investment income after deduction of investment expenses, but before realized capital gains and applicable income taxes.\nThe following table sets forth the amortized cost and estimated fair value of Continental's investment portfolio as at December 31 of the years indicated:\nThe value of Continental's investment portfolio has been negatively impacted by recent increases in interest rates, which resulted in a reduction in the fair value of Continental's fixed income securities.\nContinental is shifting its investment focus from an objective of total return to an objective to maximize pre-tax investment income and minimize volatility of shareholders' equity. Accordingly, Continental is continuing to reduce the equity and non-investment grade bond components of its portfolio and reduce the average maturity of the taxable fixed income investments. Presently, Continental also intends to enter into derivative investments primarily as economic hedges against the fixed income portfolio.\nAll investments are made in accordance with applicable state investment laws; further, Continental employs strict internal guidelines limiting its investments in any particular issue and in any particular industry. Continental also maintains short- term investments and cash equivalents for the current and anticipated near-term liquidity needs of its operations.\nFixed maturities available-for-sale consist of certain bonds and redeemable preferred stocks that management may not hold until maturity and which have an average Moody's rating of Aa1, Moody's second highest of ten investment grade ratings (or its Standard & Poor's equivalent). Continental's fixed maturities available-for-sale had a balance sheet fair value of $5,795 million at December 31, 1994 (compared with a fair value of $6,916 million at December 31, 1993) and included mortgage-backed securities with a fair value of $1,432 million and an amortized cost of $1,516 million at December 31, 1994 (compared with a fair value of $1,270 million and an amortized cost of $1,255 million at December 31, 1993). Continental's mortgage-backed securities have an average Moody's rating of Aaa, Moody's highest rating (or its Standard & Poor's equivalent), and an average life of 7 years. Continental has an insignificant investment in col- lateralized mortgage obligations which put the return of principal at risk if interest rates or prepayment patterns fluctuate.\nAt December 31, Continental's fixed maturities available-for- sale portfolio classified by Moody's rating was as follows:\nAt December 31, 1994, the fixed maturities portfolio included an immaterial amount of securities, the fair value of which is expected to be lower than its carrying value for more than a temporary period; such investments have been recorded in Conti- nental's Consolidated Balance Sheets (see the Proxy Statement at p.) at their net realizable value.\nAt December 31, 1994, Continental's equity securities had a fair value of $121 million, which represented a $608 million decrease from the fair value at September 30, 1994, primarily due to sales, in the fourth quarter, of $615 million of Continental's appreciated equity securities. As a result of those fourth quarter sales, Continental recognized $102 million of realized capital gains.\nIn 1994, Continental held derivative financial investments for the purposes of enhancing income and total return and\/or hedging long-term investments. Presently, it is Continental's intent to enter into derivative financial investments primarily as economic hedges against the fixed income portfolio. At December 31, 1994, the total notional value of Continental's derivative financial investments amounted to $184 million, and included futures contracts, interest rate swap agreements, options and foreign currency forward contracts. The notional amounts of such instruments as of December 31, 1994 and 1993, respectively, were as follows: foreign currency forward contracts of $3 million and $0 million; interest rate swaps of $33 million and $208 million; options of $25 million and $0 million; and futures contracts of $123 million and $123 million. Continental does not participate in these types of financial instruments as an intermediary, and believes it limits its credit risk of non-performance by any counterparty to an insignificant amount.\nContinental has forward contracts in place to hedge the cash proceeds from the sale of CI Canada. These forward contracts expire in 1995 and at December 31, 1994 had an unrealized gain of $1 million with respect to them.\nAt December 31, 1994, Continental also had a $109 million investment in privately-placed direct mortgages, which are included in \"Other Long-Term Investments at Fair Value\" in Continental's Consolidated Balance Sheets (see the Proxy Statement at page).\nThe NAIC is currently developing an Investments of Insurers Model Act, which, if adopted by state regulatory authorities, would establish uniform limitations upon the type and amounts of investments insurers may hold. Based upon the current proposals of this Model Act, which are subject to review and change, Continental does not believe a uniform standard would significantly affect the current investment mix or operations of its insurance subsidiaries.\nUnrealized appreciation on investments available-for-sale decreased $731 million, before income taxes, from December 31, 1993 primarily as a result of a loss in value due to increased interest rates\nand sales of equity securities. Unrealized appreciation on fixed maturities decreased $595 million. Unrealized appreciation on common stocks decreased $128 million, while unrealized appreciation on nonredeemable preferred stocks decreased $7 million. Unrealized appreciation on other long-term assets decreased $1 million. In addition, unrealized appreciation on investments held by discontinued operations decreased $44 million, before income taxes, from December 31, 1993.\nIn recent years, a small portion of Continental's investment funds has been committed to alternative areas of investment (i.e., other than Continental's traditional areas). Continental currently invests in alternative areas including limited partnerships, venture capital partnerships and international diversification investments. As of December 31, 1994, the total investment in these areas represented approximately 5% of Continental's investment portfolio.\nContinental, through its former participation in the Municipal Bond Insurance Association, issued guarantees of financial obligations. During 1986, this association was reorganized as a corporation named MBIA, Inc. Continental's net par value exposure at December 31, 1994 on guarantees issued before the reorganization was $1.1 billion (1993 - $1.4 billion), all of which has been reinsured by MBIA, Inc. In addition, Continental has issued financial guarantees of limited partners' obligations, municipal lease obligations, industrial development bonds and other obligations. Continental's net par value exposure on these guarantees at December 31, 1994 was $133 million (1993 - $151 million). The maturity dates of these obligations range between one and twelve years. Continental continually monitors its exposure relating to financial guarantees. Continental does not believe that its exposures relating to financial guarantees are material.\nMiscellaneous\nDuring 1994, Continental extended the maturity on its revolving credit facility from December 30, 1994 to December 31, 1995. In addition, the revolving credit facility was increased by $60 million and provides for borrowings of up to $210 million from a syndicate of banks. Funds borrowed through the facility may be used for general corporate purposes, but Continental has used and intends to use the facility primarily as an alternative to traditional sources of short-term borrowings. At December 31, 1994, Continental had a $205 million balance outstanding under the facility. Under the revolving credit agreement, Continental is required, among other things, not to exceed a modified debt to capital ratio (debt plus shareholders' equity, excluding net unrealized appreciation\/(depreciation) of investments, plus redeemable preferred stocks) of 45%, for the period through June 29, 1995, and 40%, thereafter, and to maintain a minimum level of statutory surplus for its domestic insurance subsidiaries of $1,400 million, for the period through June 29, 1995, and $1,465 million, thereafter. At December 31, 1994 (the most recent date of compliance calculations), Continental's modified debt to capital ratio was approximately 40.1% and statutory surplus for its domestic insurance subsidiaries was $1,468 million.\nIn March 1993, Continental sold a total of $150 million of a total of $350 million of Notes (which provided $148 million of a total of $346 million in cash, net of offering and underwriting costs) outstanding under its shelf registration of up to $400 million of debt securities with the Securities and Exchange Commission. During 1993, Continental used $282 million of net proceeds from these sales to retire its outstanding 9 3\/8% Notes due July 1, 1993 and $50 million of net proceeds from these sales to reduce corporate short-term borrowings. As described above (see \"Re-engineering Strategy\" commencing on page 1), during 1994, Continental sold preferred stock and an option for $275 million in cash. Pursuant to its obligations under the CNA Securities Purchase Agreement, Continental will endeavor to raise additional capital of approximately $100 million, through the issuance of either preferred stock or notes, if the CNA Merger is not consummated. If such addition-\nal funds are not raised within 360 days after termination of the Merger Agreement or if the annual dividend rate or interest rate on such securities exceeds 13%, then the annual rate of cumulative cash dividends on Continental's 9.75% preferred stock will be increased to a rate of 10.75%. Continental does not currently contemplate incurring additional borrowings other than for the purpose of reducing amounts outstanding under its revolving credit facility.\nDuring the first quarter of 1995, Continental redeemed its Series A and Series B Preferred Stock. Continental will pay a total of $2.1 million in connection with that redemption.\nAs of December 31, 1994, Continental and its subsidiaries had approximately 9,357 employees, compared with 12,255 at December 31, 1993. Continental and its subsidiaries consider their em- ployee relations to be satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nContinental's subsidiaries lease office space in various cities throughout the United States and in other countries. The following table sets forth certain information with respect to the principal office buildings owned or leased by Continental's subsidiaries:\n(1) Represents the amount of space owned, occupied by or leased to Continental or its subsidiaries. To the extent not occupied by Continental or its subsidiaries, such space is or is intended to be subleased to third parties.\n(2) Represents property owned in fee by Continental's subsidiaries and held subject to mortgages. (See Note 12 to Consolidated Financial Statements included at pages -F-34 of the Proxy Statement.)\nItem 3.","section_3":"Item 3. Legal Proceedings\nContinental's subsidiaries are routinely party to litigation incidental to their business, as well as other litigation of a nonmaterial nature. Management regularly evaluates the liability of Continental and its subsidiaries associated with such litiga- tion. The status of such litigation is reviewed in consultation with Continental's in-house legal staff, Corporate Claims Depart- ment and Environmental Claims Department, and their respective outside counsel, all of whom have extensive experience in handling such matters. Based upon the foregoing evaluative process, Continental makes a determination as to the effect that such litigation may have upon its financial condition on a consolidated basis. In the opinion of Continental, no individual item of litigation, or group of related items of litigation (including asbestos-related, other toxic tort and environmental pollution matters), taken net of claims reserves established therefore and giving effect to reinsurance, is likely to result in judgments for amounts material to the financial condition of Continental and its subsidiaries on a consolidated basis. In light of Continental's recent operating results, it is possible that litigation judgments or settlements may have a material impact on results of operations and liquidity.\nA Continental subsidiary and other workers' compensation carriers are involved in the Maine Workers' Compensation --------------------------- Assessment Litigation, which is currently pending in Maine State --------------------- Superior Court. This litigation is a collection of various appeals and proceedings from the Maine Bureau of Insurance, and involves the statutory reconciliation of the residual market pool for workers' compensation. The impacted policy years are 1988 through 1992 which are to be re-examined annually through 1999. For each of those years, the Bureau of Insurance is to conduct a \"Fresh Start\" proceeding, in which a determination is to be made as to whether the residual market was operating at a deficit for the policy year in question and if so, which portion of the deficit is to be paid by surcharges to the employers\/insureds and which portion of the deficit is to be assessed to the servicing and other insurance carriers. The statute requires the Maine Superintendent of Insurance to determine whether the carriers used \"good faith best efforts\" to depopulate the residual market in order to allocate a percentage (up to 50%) of the deficit against the carriers. 90% of the portion allocated to the carriers will be assessed to the approximately twelve (12) servicing carriers (which includes Continental subsidiary) on a roughly per capita basis subject to possible exceptions and adjustments for which new rules are being promulgated by the Superintendent in another proceeding.\nIn several decisions beginning in October 1994, a Maine court (the state Superior Court) in the first judicial appellate review ruling on the validity of any of the underlying administrative proceedings, upheld a significant portion of the Superintendent's methodology and dollar deficit determinations, while invalidating certain other findings challenged by the carriers. Thus far the Commissioner has found deficits for the policy years 1989, 1990, and 1991. No deficit for policy year 1992 has been found, and policy year 1993 will not be considered until the 1995 \"Fresh Start\" proceedings. For the years 1989 through 1991, the Superintendent ruled that based upon insufficient depopulation efforts, the maximum permitted 50% of the deficit was to be allocated to carriers, with the other 50% being surcharged to employers\/insureds. Each of the separate \"Fresh Start\" decisions, which form the basis of the Superintendent's allocations, have been appealed. In addition, the Superintendent's allocation of $40 million of the combined 1988 through 1991 deficit, servicing carrier performance and investment yield issues has been challenged.\nThose decisions all are currently pending on appeal to the Maine Law Court. The amount of the deficit for prior years 1989-1992 is still being litigated, and remains to be determined. The Continental subsidiary will be liable for a certain percentage of any such deficit, which percentage will be determined in a separate proceeding and is dependent on a combination of residual and voluntary workers' compensation market shares. In light of Continental's recent operating results, an adverse decision in this action may have a material impact on results of operations and liquidity.\nIn May 1994 and subsequently, a purported class action entitled Weatherford Roofing et al. v. Employers National ------------------------------------------------ Insurance Company, et al. and related actions, were instituted in ------------------------- state court in Dallas, Texas. They involve alleged assigned risk overburden (\"ARO\") and other over-charges levied by insurance carriers writing workers compensation business in the State of Texas from May 15, 1987 through April 1, 1992. During that period, the residual market pool for workers' compensation generated deficits which were assessed to carriers in relation to their voluntary written workers' compensation premium. Continental subsidiaries had a total Texas workers' compensation premium volume of approximately $530 million during that period.\nThe action seeks to certify a class of all commercial insureds who were allegedly overcharged on workers' compensation policies and in some cases, other casualty insurance policies, purchased during said period. The fourteenth amended complaint currently names some 260 insurance carrier defendants who wrote such coverage in the State of Texas during that same time. Two defendant groups, Hartford and St. Paul, have entered into settlements totalling about $25 million. Nine (9) Continental companies are named as defendants. Plaintiff's claim breach of contract and fraud as well as violations of the Texas Deceptive Trade Practices Act (\"DTPA\"), the\ndeceptive practices and other provisions of the Texas Insurance Code, and the state antitrust act. Plaintiffs' seek actual damages, enhanced and\/or treble damages and attorneys fees, as well as injunctive relief. At the present time the complaints have been served and answers and other defenses interposed. The plaintiff's motion for class certification is being opposed.\nAlthough, Continental intends to defend this action vigorously, in light of Continental's recent operating results, an adverse result in this action may have a material impact on results of operations and liquidity.\nBeginning on December 7, 1994, five purported class actions were filed in New York State Supreme Court, New York County, against Continental and directors of Continental by persons claiming to be stockholders of Continental. The plaintiffs in these actions allege that directors of Continental breached their fiduciary duties when they approved the Merger Agreement with CNA and its affiliate, Chicago Acquisition Corp., by, among other things, agreeing to the Merger at an unfair and inadequate price, failing to adequately \"shop\" Continental and failing to maximize value for Continental's shareholders. The plaintiffs in two of these actions have also named CNA as a defendant, and allege that CNA aided and abetted the breaches of fiduciary duty. The plaintiff in another of these actions alleges that directors of Continental also violated Sections 715 and 717 of the NYBCL (which relate to the duties of officers and directors). The plaintiffs in one or more of these purported class actions seek, among other relief, an injunction prohibiting the Merger, other injunctive relief and unspecified monetary damages. Counsel for the plaintiffs in these actions have advised counsel for Continental that they intend to serve a single, consolidated amended complaint.\nContinental does not believe that this litigation is likely to have a material adverse effect on the financial condition or results of operations of Continental because, based on its review of the complaints that have been filed, the underlying facts and the applicable law, Continental believes that the claims against it and its directors have no merit and that it is highly unlikely that an injunction will be issued or that damages will be awarded against Continental or its directors in an amount that would have a material adverse effect on the financial conditions or results of operations of Continental.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of 1994, no matter was submitted to a vote of Continental's shareholders.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters\nContinental's Common Stock has traded on the New York Stock Exchange since May 27, 1968 (symbol: CIC). The Common Stock also trades on the Midwest Stock Exchange and the Pacific Stock Exchange.\nThe following table sets forth, for the calendar periods indicated, the high and low sale prices per share of Continental's Common Stock as reported by the NYSE.\nCommon Stock ------------ High Low ---- ---\nCalendar 1993 First Quarter 29-1\/2 24-3\/4 Second Quarter 31-1\/4 24-3\/8 Third Quarter 34-5\/8 30-3\/8 Fourth Quarter 33 27-1\/2\nCalendar 1994\nFirst Quarter 28-1\/2 22-1\/8 Second Quarter 23-5\/8 14-1\/8 Third Quarter 19-7\/8 13-3\/8 Fourth Quarter 19-1\/8 12\nOn October 12, the day prior to the announcement of the IP Securities Agreement, the closing sales price of the Common Stock on the New York Stock Exchange was $13.50 per share. On December 5, 1994, the day prior to the announcement of the proposed CNA Merger, the high, low and closing sales prices of the Common Stock on the New York Stock Exchange were $14.375, $14.125 and $14.375 per share, respectively.\nAs of March 27, 1995, there were approximately 11,750 registered holders of Continental's Common Stock.\nContinental paid $0.50, $1.00 and $2.20 per share in dividends in the first nine months of 1994 and in 1993 and 1992, respectively. In August 1994, the Board of Directors, citing the need to further strengthen Continental's capital base, eliminated the quarterly cash dividend on the Common Stock. Continental is prohibited under certain provisions of its preferred stock from paying Common Stock dividends until December 9, 1997, and will be restricted from paying Common Stock dividends thereafter under certain circumstances.\nMaterial appearing under the captions \"Summarized Consolidated Quarterly Financial Data (Unaudited)\", \"Selected Consolidated Financial Information\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Financial Resources and Liquidity\", and Notes 16 and 18 to Consolidated Financial Statements included in Continental's Proxy Statement is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data\nMaterial appearing under the caption \"Selected Consolidated Financial Information\" included in the Proxy Statement is incorporated herein by reference.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nMaterial appearing under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included in the Proxy Statement is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nConsolidated Financial Statements and related Notes, and material appearing under the captions \"Independent Auditors' Re- port\", \"Report on Financial Statements\" and \"Summarized Consolidated Quarterly Financial Data (Unaudited)\" included in the Proxy Statement are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nWithin the 24 months prior to the date of its most recent financial statements, Continental did not file a report on Form 8-K reporting a change of accountants.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n(a) Directors of the Registrant\nAll Directors of Continental are elected to serve for terms to expire at the meeting of the Board of Directors following the next Annual Meeting of Shareholders and until their successors shall have been elected.\nIvan Burns is a former Executive Vice President-Administration and Director (1989-90) of CPC International Inc., and was President of its Corn Wet Milling Division (1985-87). From 1983 to 1985 he had been Chairman of the Board and Chief Executive Officer of ACF Industries, Inc. He has been a Continental Director since 1983. Committees: Compensation and Nominating.\nAlec Flamm is a former Vice Chairman (1985-86), President and Chief Operating Officer (1982-85) and Director (1981-86) of Union Carbide Corporation. Mr. Flamm has been a Continental Director since 1983. He is also a director of Imcera Group, formerly the International Minerals and Chemicals Corporation. Committees: Compensation (Chair), Executive and Public Affairs.\nIrvine O. Hockaday, Jr. has been President and Chief Executive Officer of Hallmark Cards, Inc. since 1986, and a Director since 1978. Prior to joining Hallmark Cards, Inc., he was President and Chief Executive Officer of Kansas City Southern Industries, Inc. Mr. Hockaday has been a Continental Director since 1989. He also is a Director of The Ford Motor Company and Dow Jones Inc. Committees: Audit and Investment.\nJohn E. Jacob has been Executive Vice President and Chief Communications Officer of Anheuser Busch Companies, Inc. since 1994. From 1982 to 1994, he was President and Chief Executive Officer of the National Urban League. He has been a Continental Director since 1985. Mr. Jacob also is a Director of Coca Cola Enterprises, Inc., Anheuser-Busch Companies, Inc. and LTV Corporation. Committees: Audit (Chair), Executive and Public Affairs.\nJohn P. Mascotte has been Chairman and Chief Executive Officer of Continental since 1982. From 1992 through 1994, he also acted as President, a position he held during the period 1981-1984. Mr. Mascotte is also the chief executive officer and director of several subsidiaries of the Corporation. Mr. Mascotte has been a Continental Director since 1981. He also is a Director of Hallmark Cards, Inc., Chemical Banking Corporation, Chemical Bank, Business Men's Assurance Company of America and American Home Products Corporation. Committee: Executive (Chair).\nJohn F. McGillicuddy is the retired Chairman of the Board and Chief Executive Officer of Chemical Banking Corporation and Chemical Bank. Prior to the merger on January 1, 1992 of Manufacturers Hanover Corporation and Chemical Banking Corporation, Mr. McGillicuddy had been Chairman and Chief Executive Officer of Manufacturers Hanover Corporation and Manufacturers Hanover Trust Company, positions he had held since 1979. Mr. McGillicuddy is a Director of Chemical Banking Corporation and Chemical Bank. He has been a Continental Director since 1975. Mr. McGillicuddy also is a Director of UAL Corporation, USX Corporation, Empire Blue Cross and Blue Shield and Kelso & Company. Committees: Audit, Executive, Investment and Nominating (Chair).\nRichard de J. Osborne has been Chairman, Chief Executive Officer and President of ASARCO Incorporated since 1985. He has been a Continental Director since 1992. Mr. Osborne is a Director of ASARCO and Schering-Plough Corporation, Chairman and a Director of American Mining Congress, a Director and former Chairman of International Copper Association, Chairman and a Director of Copper Development Association, and a Director of the United States Chamber of Commerce, the Americas Society and the Council of the Americas. He also is President and a Director of the American-Australian Association and a member of the Council on Foreign Relations, the Economic Club of New York and The Conference Board. Committees: Audit, Executive and Investment.\nJohn W. Rowe, M.D., has been President of Mount Sinai Medical Center and Mount Sinai School of Medicine since 1988. He was formerly a Professor of Medicine at Harvard Medical School (1974- 1988). He has been a Continental Director since 1993. Dr. Rowe is a member of the Board of Directors of the American Board of Internal Medicine and the New York Academy of Medicine. He is a past President of the Gerontological Society of America and the American Federation for Aging Research, and a member of the Institute of Medicine of the National Academy of Sciences. Committees: Compensation and Public Affairs.\nPatricia Carry Stewart is a former Vice President of The Edna McConnell Clark Foundation (1974-1992). She has been a Continental Director since 1976. Ms. Stewart is also a Director of Bankers Trust Company, Bankers Trust N.Y. Corporation, and Melville Corporation. She serves as a Trustee and Vice Chairman of the Board of Cornell University, a member of the Council on Foreign Relations and a director and Vice Chairman of the Board of the Community Foundation for Palm Beach and Martin Counties. Committees: Investment (Chair) and Nominating.\nAdrian M. Tocklin has been a Director, President and Chief Operating Officer of Continental since July 1994. Prior to that time, she served as Executive Vice President of Continental and President, Continental Risk Management Services, since November 1992, and as Senior Vice President, Corporate Claims, of Continental (July 1988-November 1992).\nFrancis T. Vincent, Jr. is a former Commissioner of Major League Baseball (1989-1992). From 1979 to 1989, he served as Executive Vice President of The Coca-Cola Company and Chief Executive Officer, Chairman of the Board and President of Columbia Pictures Industries, Inc., formerly a subsidiary of The Coca-Cola Company. Mr. Vincent has been a Continental Director since 1992. He also is a Director of Time-Warner Corp., Culbro Corp. and Oakwood Homes Corp. Committees: Compensation and Nominating.\nMichael Weintraub is a private investor. He has been a Continental Director since 1976. Mr. Weintraub also is a Director of NationsBank Corporation and IVAX Corporation and a trustee of the Miami Heart Research Institute. Committees: Audit and Investment.\nAnne Wexler has been Chairman of The Wexler Group, a Washington, D.C., government relations consulting firm, 1981. She has been a Continental Director since 1990. Ms. Wexler is also a Director of American Cyanamid Corporation, Comcast Corporation, Dreyfus Index Funds and the New England Electric System. She is a member of the I.B.M. Public Responsibility Committee, the Board of Visitors of the University of Maryland School of Public Affairs, the Carter Center of Emory University, the Council on Foreign Relations and the Visiting Committee of the JFK School of Government at Harvard University. Committees: Compensation and Public Affairs (Chair).\nThe Continental Board of Directors has established six Committees, described below. With the exception of the Executive Committee, all Board Committees are comprised entirely of independent Directors of Continental.\nThe Executive Committee is authorized, to the extent permitted by New York law, to exercise powers of the Board during intervals between Board meetings. The Executive Committee has five members: Messrs. Mascotte (Chair), Flamm, Jacob, McGillicuddy and Osborne. The Committee met three times in 1994.\nThe Audit Committee consists of five members: Messrs. Jacob (Chair), Hockaday, McGillicuddy, Osborne and Weintraub. The Audit Committee reviews the annual financial statements of Continental, reviews the adequacy of its system of internal accounting controls and procedures, reviews the plan and scope of the annual audit of Continental, and considers other matters in relation to the internal and external auditing of Continental. The Audit Committee meets with Continental's independent certified public accountants, internal auditors and financial and legal personnel in connection with the Committee's reviews. It recommends to the Board of Directors the appointment of the independent certified public accountants. The Audit Committee met five times in 1994.\nThe primary function of the Investment Committee is to review and evaluate Continental's investment policies and to recommend to the Board of Directors such changes as may be appropriate. The Investment Committee has five members: Ms. Stewart (Chair) and Messrs. Hockaday, McGillicuddy, Osborne and Weintraub. It met four times in 1994.\nThe Compensation Committee is responsible for remuneration arrangements for Directors and senior management, for awards and other matters under Continental's Annual Management Incentive Plan and Long Term Incentive Plan and for compensation and benefit plans for Continental employees generally. The Compensation Committee has five members: Messrs. Flamm (Chair), Burns and Vincent, Dr. Rowe and Ms. Wexler. It met eleven times in 1994.\nThe Nominating Committee recommends as nominees for election as Directors of Continental at the Annual Meeting of Shareholders. The Nominating Committee consists of four members: Messrs. McGillicuddy (Chair), Burns and Vincent and Ms. Stewart. It met one time in 1994.\nThe Public Affairs Committee has four members: Ms. Wexler (Chair) and Messrs. Flamm, Jacob and Dr. Rowe. Its function is to review Continental's policies on public issues relating to its business, and to report to the Board of Directors on the Committee's findings. The Public Affairs Committee met three times in 1994.\nEach Director who is not an executive officer of the Corporation receives an annual retainer of $25,000 and 100 shares of Continental common stock, and a meeting fee of $1,000 for each Board and Committee meeting which he or she attends (except that in 1995, each such director received cash in lieu of shares). Chairpersons of Committees receive additional annual retainers as follows: Audit Committee -- $6,000; Compensation, Investment, Nominating and Public Affairs Committees -- $5,000. Directors who are also Continental executive officers receive no fees for serving as Directors of the Corporation. Each Director (who is not an executive officer) who retires from the Board after attaining the age of 70, or by reason of disability, with a minimum of five years' service as director receives thereafter, annually for the same number of years as the Director served on the Board, subject to a maximum of ten years, the annual retainer at the time such Director retires or is disabled.\nItem 10(b). Executive Officers of the Registrant\nAll Executive Officers of Continental are elected to serve for terms to expire at the meeting of the Board of Directors follow- ing the next Annual Meeting of Shareholders and until their successors shall have been elected.\nJohn P. Mascotte has been a Director since February 1981 and Chairman of the Board and Chief Executive Officer of Continental since December 1982. From 1992 through 1994, he also acted as President, a position he held during 1981 - 1984.\nAdrian M. Tocklin has been a Director, President and Chief Operating Officer of Continental since July 1994. Prior to that time, she served as Executive Vice President of Continental and President, Continental Risk Management Services, since November 1992, and as Senior Vice President, Corporate Claims, of Continental (July 1988 - November 1992).\nWayne H. Fisher has been a Senior Executive Vice President of Continental since July 1994 and has been President, Special Operations Group, since January 1988. Before that time, he was an\nExecutive Vice President (December 1990 - July 1994) and a Senior Vice President of Continental (December 1988 - December 1990).\nSteven J. Smith has been an Executive Vice President, Office of the Chairman, of Continental since February 1985.\nBruce B. Brodie has been Senior Vice President and Chief Information Officer of Continental since October 1993. Before that time, he served as Chief Financial Officer for the Special Operations Group (April 1990 - October 1993) and Vice President, Office of the Chairman, of Continental (January 1989 - April 1990).\nJ. Heath Fitzsimmons has been Senior Vice President and Chief Financial Officer of Continental since January 1990. Before that time, he was Vice President, Finance, of Continental (February 1989 - December 1989).\nJames P. Flood has been Senior Vice President, Corporate Claims, of Continental since November 1992. Before that time, he served as Vice President, Environmental Claims, of Continental (March 1988 - October 1992).\nWilliam F. Gleason, Jr. has been Senior Vice President, General Counsel and Secretary of Continental since January 1983.\nJohn F. Kirby has been a Senior Vice President of Continental since January 1990 and a Senior Vice President of The Continental Insurance Company since March 1987.\nArthur J. O'Connor has been Senior Vice President, Corporate Communications and Investor Relations, of Continental since November 1992 and served as Vice President, Corporate Communica- tions and Investors Relations, of Continental (January 1988 - November 1992).\nSheldon Rosenberg has been Senior Vice President and Chief Actuary of Continental since February 1994. Before that time, he served as Vice President and Chief Actuary of The Continental Insurance Company (April 1992 - February 1994), Vice President and Actuary of The Continental Insurance Company (April 1990 - March 1992) and Vice President and Chief Financial Officer of the Special Operations Group (April 1988 - March 1990).\nKenneth B. Zeigler has been Senior Vice President, Human Resources, of Continental since December 1991. Before that time, he served as Senior Vice President and President of the Marine and International Group (January 1990 - November 1991). Previously, he had been President of Continental International (July 1988 - December 1990).\nFrancis M. Colalucci has been Vice President and Treasurer of Continental since May 1991. Before that time, he was Vice Presi- dent and Controller of The Continental Insurance Company (November 1980 - May 1991).\nWilliam A. Robbie has been Vice President and Chief Accounting Officer since June 1992 and served as Vice President, Financial Reporting (June 1990 - June 1992). Before that time, he served as Vice President and Treasurer of Monarch Life Insurance Co. and Vice President and Corporate Controller of Monarch Capital Corp. (August 1988 - June 1990).\nTimothy P. Mitchell has been Senior Vice President and Chief Underwriting Officer of Continental since August 1994. Prior to that time, he was Executive Vice President of Underwriting and\nProduction, Continental Risk Management Services (November 1992 - August 1994), Chief Underwriter, Special Operations Group (February 1991 - November 1992) and President, Continental Health Care (June 1986 - February 1991).\nSalvadore J. Ricciardone has been a Senior Vice President of Continental since September 1994 and the President of Continental's Commercial Lines Group since August 1994. Prior to that time, he was Senior Vice President for the Product Management Division of Continental's Agency & Brokerage Group (May 1994-August 1994), Vice President and Manager of the Midwest Region (1992-1994) Vice President and Regional Manager of Continental's North Atlantic Region (N.J., N.Y.C. and Long Island) (1991 - 1992) and Regional Vice President of Garden State Region (N.J.) (1989-1991).\nItem 11.","section_11":"Item 11. Executive Compensation\nThe Summary Compensation Table, which appears below, provides information concerning all forms of compensation for the three- year period 1992-1994 for the CEO and the four other most highly compensated Continental executive officers for services to Continental and its subsidiaries in all capacities. The three tables following the Summary Compensation Table provide further detail regarding compensation earned by these executive officers in 1994.\n(a) Includes tax gross-ups for the taxable value of unreimbursed personal use of company cars and chauffeur services on behalf of named executives, which, in 1994, were as follows: Mr. Mascotte: $15,130; Mr. Parker: $18,750; Ms. Tocklin: $16,022; Mr. Fisher: $22,532; and Mr. Smith: $6,491. (b) Represents Continental's contributions to Incentive Savings Plan and Supplemental Savings Plan, respectively, on behalf of named executives which, in 1994, were as follows: Mr. Mascotte: $6,923 and $26,804; Mr. Parker: $6,923 and $14,262; Ms. Tocklin: $6,923 and $7,782; Mr. Fisher: $6,923 and $8,835; and Mr. Smith: $6,923 and $8,095. (c) Includes $940,000 separation pay paid in February 1995. See page 51 herein.\nContinental did not grant any Incentive or Non-Qualified stock options after February 18, 1994. The grants made on February 18, 1994 were reported in Continental's Annual Report to Shareholders for the Year 1993.\n(a) Calculated at $19.00 closing price for 12\/30\/94.\nThe table below shows estimated annual retirement benefits payable under Continental's Retirement and Supplemental Retirement Plans as a straight life annuity at age 65 to persons in specified compensation and years-of- service classifications.\nPlease note that the final five-year average covered compensation includes incentive compensation as well as base salary. The compensation included in calculating pension benefits takes into account the compensation listed in the Summary Compensation Table, but is generally less than such amounts due to the use of a five year average. The benefits listed in the preceding table are not subject to deduction for Social Security or other offset amount.\nFor the executive officers named in the preceding compensation tables, the respective years of service at the end of 1994 are as follows: Mr. Mascotte: 23.9 years; Mr. Parker: 24.75 years; Ms. Tocklin: 20 years; Mr. Fisher: 12.3 years; and Mr. Smith: 18.6 years. The years of credited service stated for such executive officers include eleven years, nine years, zero years, zero years and seven years, respectively, credited by employment arrangements; supplemental benefits with respect to those years are to be paid from Continental's general funds.\nThe Executive Severance Plan was established by the Board in 1988 to help assure a continuing dedication by certain senior executives of Continental to their duties notwithstanding any occurrence of a tender offer or other takeover bid. The Compensation Committee of the Board determines the senior executives who participate in the Plan. Presently, 15 executive officers are participants in the Plan.\nIf a change in control of Continental occurs and a participant's employment terminates within two years after such change of control for any reason other than retirement, disability, death or\ncertain criminal convictions, under The Executive Severance Plan the participant shall receive a payment equal to 299.9% of the average of his or her annual compensation paid during the five preceding years minus the amount of benefits to which such participant is entitled under The Long Term Incentive Plan, the Annual Management Incentive Plan, the Executive Termination Program or any other plan or agreement of Continental, which are accelerated by, or contingent on, a change of control. The amount of such accelerated or contingent benefits for any participant could be determined only after any change of control. The average annual compensation paid during the five preceding years to the named executive officers is as follows: Mr. Mascotte: $885,405; Mr. Parker: $517,255; Ms. Tocklin: $286,095; Mr. Fisher: $355,890; and Mr. Smith: $377,816. The Board may not amend or terminate the Plan to relieve the Corporation of its obligation to pay any amounts to which a participant has become entitled. No amendment or termination may become effective, without the consent of all the participants, within two years after a change of control of Continental or at any time after the Board has reason to believe a change of control may occur.\nThe Executive Termination Program (the \"Program\"), adopted by the Board of Directors effective September 22, 1994, codified Continental's severance policies and its policies relating to reductions in work force and other involuntary terminations as they applied to senior executives. The Program provides severance benefits to participants in the event of the involuntary termination of their employment other than for cause or upon retirement before a change in control such as the CNA Merger. Under the Program, a participant will receive a payment equal to twice the annualized base pay the executive is receiving on the date he or she began participation in the Program or on the date of termination of employment, if greater, if the participant's employment is terminated by Continental other than by reason of willful misconduct, normal retirement or disability or by the participant following a reduction in grade level responsibilities or base salary by more than 15%. The Program may not be amended or terminated until January 1, 1997.\nUnder Continental's Annual Management Incentive Plan, each participant who is involuntarily terminated in the year in which a change of control occurs (but following the change of control) will receive a prorated bonus in respect of his services for that year based on a percentage of the midpoint of his salary grade established by the compensation committee of the Board of Directors under that plan.\nIn connection with the voluntary early retirement of Mr. Charles A. Parker, Mr. Parker and Continental entered into a Separation Agreement, effective as of December 30, 1994 (the \"Separation Agreement\"). Pursuant to the Separation Agreement, Mr. Parker and Continental agreed among other things that Mr. Parker would receive the amount he would have been entitled to in accordance with the Program ($940,000 or twice his annualized base pay) as if he continued to be a participant in the Program and, upon a change in control prior to September 30, 1995, the difference between (x) the amount he would have been entitled to receive pursuant to the Plan, if he had remained a participant in the Plan on and after such change of control, and (y) $940,000.\nNo executive officers of Continental served on the Compensation Committee in 1994.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nSECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSecurity Ownership of Directors and Executive Officers\nThe following table sets forth information regarding beneficial ownership, as of March 27, 1995, of Common Stock of Continental by directors of Continental, Continental's five most highly compensated executive officers and Continental's directors and executive officers as a group.\n(a) The numbers of Continental's shares shown as beneficially owned by Messrs. Mascotte, Parker, Fisher and Smith and Ms. Tocklin and all directors and executive officers as a group include 156,400, 85,050, 74,150, 67,200, 52,300 and 749,650 stock options, respectively, granted under Continental's Long Term Incentive Plan to such executive officers and all executive officers as a group, which are exercisable or become exercisable prior to May 26, 1995.\n(b) Mr. Parker retired effective February 1, 1995.\n(c) The number of the Common Shares shown includes 1,915,344 shares held by the Continental Incentive Savings and Retirement Plans, for which a subsidiary of Continental shares investment power.\n* Less than 1% of Continental's outstanding shares of Common Stock.\nOther Ownership of Continental Common Stock\nThe following table sets forth information, as of December 31, 1994, concerning persons known to Continental to be the beneficial owners of more than 5% of the outstanding shares of Continental's voting stock.\n_______________\n(a) CNA reports that 100,000 of such shares are held by CCC, a subsidiary of CNA, and that 10,516,566 of such shares are issuable upon the exchange of the Series T preferred shares held by CCC into shares of Series E Preferred Stock and the conversion thereof. CNA also reports that CCC has acquired shares of Series F Preferred Stock and an option to acquire Series G Preferred Stock. Shares of such New Preferred are redeemable at prices that reflect any increase in the per share market price of the Common Stock over $15.75 and $17.75, respectively. CNA reports that Loews Corporation (\"Loews\"), 667 Madison Avenue, New York, New York, owns approximately 84% of CNA and is a \"controlling\" person of CNA under the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"). CNA reports that CNA, CCC and Loews share voting authority and investment authority with respect to all such Common Shares. CNA reports that Laurence A. Tisch and Preston B. Tisch, Co-Chairmen of the Board and Co-Chief Executive Officers of Loews, together own approximately 31.5% of Loews and may be deemed to be \"controlling\" persons of Loews under the Exchange Act. At the Effective Time, each Preferred Share that is issued and outstanding immediately prior to the Effective Time shall be converted, at CNA's option, into either (a) the right to receive a cash payment equal to the liquidation preference of such share, plus any accrued and unpaid dividends on such share, at the Effective Time or (b) one share of preferred stock of CNA or its affiliate, having the same terms, designations, preferences, limitations, privileges and relative rights as the Preferred Shares, except that in the case of convertible Preferred Shares, if any, the shares shall be convertible into such consideration as would have been received by the holder of such stock had such stock been converted into Common Stock immediately prior to the Effective Time. At CNA's option and sole dis- cretion, effective immediately prior to the Effective Time, any or all Preferred Shares owned by or held in treasury of Continental or CNA or any subsidiary thereof may be cancelled and extinguished in lieu of the conversion referred to above.\n(b) The Prudential Insurance Company of America reports that it has sole voting authority with respect to 28,812 shares, shared voting authority with respect to 6,441,300 shares, sole investment authority with respect to 28,812 shares and shared investment authority with respect to 6,442,700 shares.\n(c) Norwest Corporation reports that it has sole voting authority with respect to 4,390,680 shares, shared voting authority with respect to 21,256 shares, sole investment authority with respect to 4,661,590 shares and shared investment authority with respect to 6,026 shares.\nContinental's management knows of no other beneficial owner of more than 5% of any class of voting security of Continental.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nMr. Osborne, a director of Continental, is Chairman, Chief Executive Officer and President of ASARCO Incorporated. ASARCO rents office space from Continental under a lease expiring April 30, 2002, with an annual rent of $3,063,117.\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) The following items, all of which have been incorporated herein by reference to the material in the Proxy Statement as described under Item 8 of this Report.\nConsolidated Statements of Income for the years ended December 31, 1994, 1993 and 1992\nConsolidated Balance Sheets at December 31, 1994 and 1993\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Shareholders' Equity for the years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nIndependent Auditors' Report\nSelected Consolidated Financial Information\nSummarized Consolidated Quarterly Financial Data (Unaudited)\n(2) The following items are filed with this Report:\nIndependent Auditors' Report\nConsolidated:\n(3) The following is a list of exhibits hereto required to be filed by Item 601 of Regulation S-K of the Securities and Exchange Commission (the \"SEC\"), each of which is attached as an Exhibit or incorporated by reference from the document or documents indicated.\n(b) Continental filed three Reports on Form 8-K during the last quarter of the period covered by this Report. The Report on Form 8-K dated October 18, 1994 (the \"October Report\"), reported that, on October 13, 1994, Continental had entered into a definitive agreement to sell $200 million in preferred stock, convertible into about 19.9% of its then currently outstanding common stock, to Insurance Partners, L.P. (\"IP\"); in connection with that proposed transaction, Continental's board of directors had elected Richard M. Haverland vice chairman and a director of Continental Corporation; upon completion of the proposed transaction, Mr. Haverland would be named chairman and chief executive officer, succeeding John P. Mascotte, who would resign; and Continental had entered into a separate agreement to sell IP the operations of Continental Asset Management Corp., Continental's investment management subsidiary. The October Report reported that Continental had announced that it would strengthen its reserves by $400 million pre-tax by establishing, for the first time, loss reserves for incurred but not reported asbestos-related, environmental pollution and other toxic-tort claims; and that Continental would take an additional pre-tax charge of $164 million for reinsurance recoverables and other assets.\nThe October Report also reported that on October 11, 1994, Continental entered into an agreement in principle with Fremont General Corporation (\"FGC\") to sell Casualty to Fremont for $250 million; and on October 12, 1994, Continental entered into an agreement with Fairfax Financial Holdings Limited relating to the sale of certain Continental subsidiaries in Canada. Finally, the October Report reported that, on September 22, 1994, Continental adopted an Executive Termination Program.\nThe Report on Form 8-K, dated December 9, 1994, reported that, on December 6, 1994, Continental entered into a merger agreement under which CNA Financial Corporation (\"CNA Financial\") will acquire Continental through a merger with a wholly-owned CNA subsidiary and that, under a separate agreement, CNA has agreed to invest $275 million in Continental.\nThe Report on Form 8-K, dated December 16, 1994 (the \"December 16 Report\"), reported that, on December 9, 1994, Continental consummated the sale of certain Continental securities to Continental Casualty Company (\"CCC\"), a subsidiary of CNA, for a cash purchase price of $275 million, pursuant to a previously announced securities purchase agreement, dated as of December 6, 1994, with CNA. The December 16 Report reported that CCC acquired approximately $165 million in liquidation value of Continental's 9.75% Cumulative Preferred Stock, Series T (the \"Series T Stock\"), and approximately $34 million in liquidation value of Continental's 9.75% Cumulative Preferred Stock, Series F. Each of the Series F Stock and the Series T Stock is redeemable under certain circumstances at a price reflecting any increase in the per share price of Continental's common\nstock over $15.75. CCC also received an option to acquire $125 million in liquidation preference of another series of Continental's 9.75% Cumulative Preferred Stock, Series G. The option and its underlying preferred stock will be redeemable under certain circumstances at a price reflecting any increase in the per share price of the common stock over $17.75. The 9.75% preferred stock will mature in 40 years, with a right of the holders to require redemption in 15 years, and may be redeemed by Continental under certain circumstances. In addition, CCC acquired $75 million in liquidation value of Continental's 12% Cumulative Preferred Stock, Series H, maturing in 10 years and redeemable under certain circumstances.\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 30, 1995 THE CONTINENTAL CORPORATION\nBy \/s\/ John P. Mascotte ---------------------- (John P. Mascotte) 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.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders THE CONTINENTAL CORPORATION:\nUnder date of February 16, 1995, we reported on the consolidated balance sheets of The Continental Corporation and subsidiaries as of December 31, 1994 and 1993, 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, 1994 as contained in the Proxy Statement. These consolidated financial statements and our report thereon are incorporated by reference in the 1994 annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedules as listed in 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.\nAs discussed in Note 2 to the consolidated financial statements, The Continental Corporation and subsidiaries changed their methods of accounting for multiple-year retrospectively rated reinsurance con- tracts and for the adoption of the provisions of the Financial Accounting Standards Board's Statements of Financial Accounting Standards (\"SFAS\") No. 112, \"Employers' Accounting for Postemployment Benefits,\" No. 113, \"Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts,\" and No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" in 1993. SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and No. 109, \"Accounting for Income Taxes\" were adopted in 1992.\n\/s\/ KPMG PEAT MARWICK LLP\nKPMG Peat Marwick LLP\nNew York, New York February 16, 1995\n_____________________\n(1) All fixed maturities are carried at fair value.\n_______________________\n(1) See Notes to Consolidated Financial Statements included in Continental's Proxy Statement, first filed with the Securities and Exchange Commission and mailed to shareholders on March 29, 1995, in connection with a May 9, 1995 Special Meeting of Shareholders (the \"Proxy Statement\").\n(2) Represents Income Taxes (Benefits) for continuing operations.\n__________________\n(1) See Notes to Consolidated Financial Statements included in the Proxy Statement.\n______________________ (1) See Notes to Consolidated Financial Statements included in Continental's Proxy Statement.\n(2) Certain reclassifications have been made to the prior year's financial information to conform to the 1994 presentation.\n______________________\n(1) Distinct investment portfolios are not maintained for individual insurance segments; accordingly, insurance segments results are shown in the aggregate.\n____________________________\n(1) Represents write-offs of amounts determined to be uncollectible, net of recoveries. (2) Includes the establishment of an $80 million reinsurance GAAP asset for environmental claims fully reserved for as not recoverable.\n______________________________\n(1) Distinct investment portfolios are not maintained for individual segments; accordingly, insurance segments results are shown in the aggregate.\nEXHIBIT INDEX\n(h) Credit Agreement dated as of December 30, 1993 (the \"Credit Agreement\"), among Continental, the Several Lenders from Time to Time Parties Hereto, Chemical Bank (\"Chemical\") and Citibank, as Co-Agents and Chemical, as Administrative Agent.\n(i) Amendment dated March 30, 1994, to the Credit Agreement among Continental, the Several Lenders from Time to Time Parties Hereto, Chemical and Citibank, as Co-Agents and Chemical, as Administrative Agent.\n(j) Second Amendment to the Credit Agreement, dated as of June 30, 1994, among Continental, the Several Lenders from Time to Time Parties Hereto, Chemical and Citibank, as Co- Agents and Chemical, as Administrative Agent.\n(k) Third Amendment to the Credit Agreement, dated as of September 29, 1994, among Continental, the Several Lenders from Time to Time Parties Hereto, Chemical and Citibank, as Co-Agents and Chemical, as Administrative Agent.\n(l) Fourth Amendment to the Credit Agreement, dated as of November 23, 1994, among Continental, the Several Lenders from Time to Time Parties Hereto, Chemical and Citibank, as Administrative Agent.\n(m) Fifth Amendment to Credit Agreement, dated as of December 22, 1994 among Continental, certain lenders and Chemical and Citibank as Administrative Agent.\n(n) Agreement, dated as of July 1, 1994, between Fidelity and General Reinsurance Corporation.\n(o) Stock Purchase Agreement, dated December 16, 1994, among FCIC, FGC, Buckeye and Continental.\n(p) Stock Purchase Agreement dated as of June 30, 1993, among Continental, Continental Insurance, Continental Re and Mellon as filed under Exhibit 10(f) to the 1993 Form 10-K.\n(q) Share Purchase Agreement dated as of June 30, 1993 (the \"Unionamerica Stock Purchase Agreement\"), among Unionamerica Acquisition Company Ltd. (\"Unionamerica\"), Unionamerica Holdings Ltd. (\"Unionamerica Holdings\") and Continental as filed under Exhibit 10(g) to the 1993 Form 10-K.\n(r) Amendment dated September 1, 1993 to the Unionamerica Share Purchase Agreement, among Unionamerica, Unionamerica Holdings and Continental as filed under Exhibit 10(h) to the 1993 Form 10-K.\n(s) Stock Purchase Agreement dated as of July 28, 1993 (the \"Alleghany Stock Purchase Agreement\"), among Alleghany Corporation (\"Alleghany\"), Continental, Goldman, Sachs & Co. (\"Goldman\") and certain funds which Goldman either controls or of which it is a general partner (together, the \"GS Investors\"; Continental and the GS Investors together referred to as the \"URHC Stockholders\"), Underwriters Re Holdings Corp. (\"Underwrit-","section_15":""}
{"filename":"67727_1994.txt","cik":"67727","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL - INDUSTRY SEGMENTS: The Montana Power Company (the Company) and its subsidiaries conduct a number of diversified, but related businesses. The Company's principal business, which is conducted through its Utility Division, includes regulated utility operations involving the generation, purchase, transmission and distribution of electricity and the production, purchase, transportation and distribution of natural gas. The Company, through its wholly-owned subsidiary, Entech, Inc. (Entech), engages in nonutility operations principally involving the mining and sale of coal and exploration for, and the development, production, processing and sale of oil and natural gas and the sale of telecommunication equipment and services. The Company, through its Independent Power Group (IPG) manages long-term power sales, and develops and invests in nonutility power projects and other energy- related businesses. See Item 8, Note 10 to the Consolidated Financial Statements for further information. A group of officers and employees of the Company constitute the Office of the Corporation. The Office of the Corporation provides strategic direction and policy, approves the allocation of capital and provides financial, legal and other services to all of the operating units. The Company was incorporated in 1961 under the laws of the State of Montana, where its principal business is conducted, as the successor to a New Jersey corporation incorporated in 1912.\nUTILITY DIVISION:\nSERVICE AREA AND SALES: The Utility Division's service territory comprises 107,600 square miles or approximately 73% of Montana. Within its service territory, 86% of the state's population resides. The Division serves approximately 593,000 residents, or 81% of the population within the service territory. Additionally, energy is provided to cooperatives that serve approximately 72,000 residents. Dominant factors in Montana's diversified economy are agriculture and livestock, which constitute Montana's largest industry, tourism and recreation, coal and metals mining, oil and gas production, and the forest products industry which embraces the production of pulp and paper, plywood and lumber.\nElectric service is provided to 191 communities, the rural areas surrounding them and Yellowstone National Park, and natural gas service is provided to 109 communities. Firm electric power is sold at wholesale to two rural electric cooperatives. Natural gas is sold at wholesale or transported to distribution companies in Great Falls, Cut Bank, Shelby, Kevin, Sweetgrass and Sunburst, Montana.\nWeather is a factor which can significantly affect electric and natural gas revenues. The Company's sales generally increase as a result of colder weather with customer demand peaking during the winter months.\nCOMPETITIVE ENVIRONMENT: The electric and natural gas industries are currently in a transition to a more competitive market environment. Federal legislation, including the National Energy Policy Act, is intended to promote competition and reduce the level of regulation in the energy supply industry. The Utility Division's electric and natural gas businesses currently are substantially free from direct competition with other suppliers for residential and commercial customers. The Utility Division is subject to, in certain circumstances, increased competition for large industrial loads and with other energy suppliers for large wholesale loads. Because of the absence of competing transmission pipelines in its natural gas service territory, the Utility Division is less subject to bypass by its large industrial and wholesale natural gas customers.\nIn February 1995, the Company became a charter member of the Western Regional Transmission Association (WRTA). WRTA is a Regional Transmission Group (RTG), certified by the Federal Energy Regulatory Commission (FERC), formed by its members \"to foster the efficient, equitable and reliable use of existing and future transmission facilities and the expeditious and fair resolution of disputes related to transmission access.\" The Company has also been involved in the formation of another RTG, the Northwest Regional Transmission Association (NRTA). The Company expects that NRTA will be certified by FERC in 1995 and that it will become a member.\nREGULATION AND RATES: The Company's public utility business in Montana is subject to the jurisdiction of the Public Service Commission of Montana (PSC). The PSC has jurisdiction over the issuance of securities by the Company. FERC also has jurisdiction over the Company, under the Federal Power Act, as a licensee of hydroelectric projects and as a public utility engaged in interstate commerce. The importation of natural gas from Canada requires approval by the Alberta Energy Resources Conservation Board, the National Energy Board of Canada and the United States Department of Energy.\nThe PSC issued an order approving electric and natural gas rate increases for the Company totaling $13,500,000 annually effective April 28, 1994. This order allowed the Company a $7,800,000 annual electric rate increase, down from the interim increase of $8,800,000 and an annual natural gas rate increase of $5,700,000, up from the interim increase of $4,000,000. In its updated application, the Company had requested general rate increases of $37,600,000 annually for electricity and natural gas based upon a 12.25% return on common equity.\nThe order reduced the Company's authorized return on common equity from 12.1% to 11.0% for both the electric and natural gas utilities. Of the $24,100,000 difference between the requested amount and allowed increases, $11,100,000 is attributable to the lower return on common equity. Another $7,000,000 of the difference is attributable to the disallowance of certain fuel expense on coal sales from the Company's subsidiary, Western Energy Company, to the Utility Division. The remaining differences relate primarily to the denial of the Company's request to begin recovery of previously flowed through tax timing differences and does not affect net income.\nOn June 17, 1994, the Company filed a complaint requesting the District Court, Butte-Silver Bow County, to set aside that portion of the PSC's decision disallowing the portion of the fuel expense and remand the coal cost issue to the PSC for a redetermination. On December 29, 1994, the District Court ruled that the PSC is entitled to choose the method by which coal costs are determined for inclusion in rates. Legislation was introduced into the 1995 session of the Montana Legislature to require the PSC to use a market price approach for determining the amount of coal costs to be included in rates. On March 17, 1995, the bill was signed into law by the Governor.\nIn August 1993, the Company filed an allocated cost of service and rate design docket with the PSC requesting that the portion of total electric revenues collected from various customer classifications be changed to more appropriately reflect the cost of providing service to these customers. The filing proposed an 8.16% reduction in average industrial rates, which would be offset by increased revenues collected from other customer classifications. In its final order dated June 17, 1994, the PSC refrained from deciding several contested issues central to the allocation of costs to customer classes. Instead, the PSC strongly encouraged the parties to come together in a collaborative effort to settle, or at least narrow, their differences. That collaborative effort is in progress, and is expected to be completed in time for the results to be used in a new allocated cost of service and rate design filing expected in the fourth quarter of 1995. In the interim, rate designs remain largely unchanged.\nOn August 22, 1994, the Company filed with the PSC, and has since updated, a request for an increase in annual electric revenues of $24,700,000 representing a 7.4% increase. The request is based upon a 12.75% return on common equity and continues to seek a market price approach for determining the amount of coal costs allowed to be collected in rates. A 1% change in the return allowed on common equity would result in a change of approximately $7,000,000 in annual electric revenues. The Company's interim rate increase request of $16,700,000 was considered by the PSC in November and an interim rate increase of $7,700,000 was granted effective November 28. The interim increase was based on an 11% return on common equity and included a $5,700,000 coal cost disallowance. A proposed settlement between the Company and the Montana Consumer Counsel, which would provide a $13,800,000 annual increase was reached on March 8, 1995. The settlement is now under consideration by the PSC. Final orders are anticipated no later than May 1995.\nNatural gas rates changed on December 13, 1994, reflecting a net increase of $4,000,000 in annual revenues. This net increase reflected: 1) The Company's annual deferred gas cost accounting filing. The Company, on an annual basis, is allowed to submit its actual natural gas supply costs and related revenues as a basis for rate adjustments: and 2) The Gas Transportation Adjustment Clause (GTAC) net balance. The GTAC mechanism tracks the difference between estimated interruptible transportation (IT) revenues and the actual IT revenues received. The bulk of the $4,000,000 increase was created by the completion of the deferred gas cost balance and GTAC net balance amortizations from the 12-month tracking period ending in August, 1993, as approved in last year's gas tracking filing in November, 1993, for amortization in the subsequent 12 months. This rate change did not affect the Company's overall net income.\nCentral Montana Electric Power Cooperative, Inc. (Central) manages the contract for purchases of power from the Utility Division by a group of Montana coops. During 1994, Central purchased 4% of the total energy sold by the Utility Division. On an annual basis the Company prepares and analyzes the cost of service associated with providing this wholesale service to Central. During 1994, the Company prepared a cost of service based on 1993 FERC Form 1 actual data, modified for known and measurable changes. Following presentation of the 1993 data, the Company and Central Montana negotiated a zero rate adjustment for the 1994 rate period and agreed to continue the annual rate review\/adjustment process.\nELECTRIC UTILITY OPERATIONS: The maximum demand on the resources in 1994 was 1,468,000 kW on February 7, 1994. Total firm capability of the Utility's electric system for 1994 was 1,601,000 kW. Of this capability, 1,186,000 kW was provided by the Utility's generating facilities, and 415,000 kW was provided by firm Electric Utility power purchases and exchange arrangements. The Electric Utility's 1994 reserve margin, as a percentage of maximum demand, was 9%.\nIncreases in peak capability will be met with a combination of resources including upgrades to hydroelectric and thermal facilities, both short- and long-term purchase contracts and Demand Side Management. New electric capacity will be required in the late 1990s to meet load growth and the expiration of two power purchase contracts totalling approximately 150 megawatts. Pursuant to a Request for Proposal (RFP), a variety of projects, including some proposed by the Company have been evaluated under a least cost planning process. To date, the bid resources that have been acquired include the extension to 2003 of an existing 50,000 Kw exchange contract with the Idaho Power Company, the purchase of a 15 year 98,000 kW winter season power purchase starting in November 1996 from Basin Electric Power Cooperative, and construction has commenced on a 41,000 kW upgrade to the Utility's hydroelectric facility at Thompson Falls. In addition, the Utility is continuing to decrease energy and peak demand by investing in demand-side management programs. In 1994, the Company went out for its second RFP for resources. Evaluation of the responses is ongoing and will be complete during the first half of 1995. The results of this analysis will be part of the Electric Utility's 1995 integrated least cost plan filing with the Montana Public Service Commission. ITEM 1. BUSINESS (Continued)\nDuring the year ended December 31, 1994, the sources of the Utility Division electric supply were: hydro, 27%; coal, 44%; and purchased power, 29%. Hydroelectric generation decreased 16% due to lower stream flows in 1994, partially offset by an 8% increase in steam generation. The cost of coal burned has been as follows:\nYear Ended December 31 1994 1993 1992\nAverage cost per million Btu's. . . . . . $ 0.66 $ 0.65 $ 0.65 Average cost per ton (delivered). . . . . 11.24 11.16 11.30\nThe Company's electric system forms an integral part of the Northwest Power Pool consisting of the major electric suppliers in the United States, Pacific Northwest and British Columbia, and parts of Alberta, Canada. The Company also is a party to the Pacific Northwest Coordination Agreement which integrates electric and hydroelectric operations of the 18 parties associated with generating facilities in the Columbia River Basin; is a member of the Western Systems Coordinating Council, organized by 68 member systems and 10 affiliates in the 14 western states, British Columbia, Alberta and Mexico to assure reliability of operations and service to their customers; is one of 64 members of the Western Systems Power Pool, organized to enhance the economics of power production and reliability of service among the western states power systems; and is a party to the Intercompany Pool Agreement for the coordination of load, resource and transmission planning, operations and reserve requirements among eight utilities in Washington, Oregon, Idaho, Montana, Wyoming, Nevada and Utah. The Company participates in an interconnection agreement with The Washington Water Power Company, Idaho Power Company, and PacifiCorp, providing for the sharing of transmission capacity of certain lines on their respective interconnected systems. The Company also operates, in coordination with its own transmission lines and facilities, the transmission lines and facilities which are jointly owned by the utility owners of the four Colstrip generating units. The Company and the Western Area Power Administration have transmission interconnection and agreements which provide for the mutual use of excess capacity of certain lines on each party's system for the transmission of power east of the Continental Divide in Montana and for the firm use of certain of the Company's transmission lines to deliver government power.\nNATURAL GAS UTILITY OPERATIONS: Natural gas supply requirements in 1994 totaled 19,594 Mmcf, of which 12,537 Mmcf were from Montana and 7,057 Mmcf from Canada. The Gas Utility produced 40% of the Montana natural gas and its Canadian subsidiaries produced 62% of the Canadian natural gas.\nThe Company implemented open access gas transportation on November 1, 1991. As of September 1993, substantially all eligible customers were acquiring 100% of their gas supplies directly from other suppliers. The Gas Utility transports gas supplies for these customers. The total volumes of natural gas transported were 23,700 Mmcf, 17,900 Mmcf and 15,100 Mmcf for 1994, 1993 and 1992, respectively.\nTotal 1995 natural gas requirements, estimated to be 21,600 Mmcf, are anticipated to be supplied from existing reserves and purchase contracts. Approximately 13,100 Mmcf of these requirements are expected to be obtained in the United States and 8,500 Mmcf from Canada. The Gas Utility expects to produce 45% of the Montana natural gas. Its Canadian subsidiaries are expected to produce 60% of the Canadian natural gas. The 1995 transportation volumes are anticipated to be 28,961 Mmcf.\nExportation of natural gas from Canada is controlled by the Canadian provincial and federal governments. The Company has a long-term export license which entitles it to export up to 10,000 Mmcf, after losses, annually through October 2006.\nENTECH:\nGENERAL: Entech, Inc. (Entech) conducts its businesses through various subsidiaries, all of which, with immaterial exceptions, are wholly-owned. It also owns a passive investment in a gold mine in Brazil. Its coal and lignite business is conducted through several subsidiaries. Western Energy Company (Western) holds leases and rights on coal properties in Montana and Wyoming and operates the Rosebud Mine. Western's subsidiary, Western SynCoal Company (SynCoal), owns 75% of a patented coal enhancement process and a subsidiary of Northern States Power owns 25% of this patented coal enhancement process and each own 50% of the Rosebud SynCoal Partnership. The Partnership owns and operates a coal enhancement process demonstration plant at the Rosebud Mine. Northwestern Resources Company (Northwestern) holds leases on coal and lignite properties in Texas and Wyoming and operates the Jewett Mine. Basin Resources, Inc. (Basin) operates the Golden Eagle Mine, and North Central Energy Company (North Central) owns and holds leases on coal properties, in Colorado. Horizon Coal Services, Inc. (Horizon) markets coal and lignite, and holds leases and rights on lignite properties in Montana, Texas and Alabama. Approximately 94% of total annual coal and lignite production is sold under long-term contracts. Entech's oil and natural gas business is conducted in the United States through North American Resources Company (NARCO) and in Canada through both Altana Exploration Company (Altana) and Roan Resources, Ltd. (Roan). Entech's telecommunication business is conducted through TRI Touch America, Inc. Entech's other businesses are conducted by various subsidiaries, none of which is a significant subsidiary.\nCOAL OPERATIONS: Western's Rosebud Mine is at Colstrip, Montana, in the northern Powder River Basin, where coal is surface-mined and, after crushing, sold without further preparation, principally for use by electric utilities in steam-electric generating plants. The mine's principal customers are the owners of the four mine-mouth Colstrip units and the Utility Division's Corette Plant located at Billings, Montana. These customers purchased approximately 71% of the 1994 production. Most of the remainder is sold to Midwestern customers located in Michigan, Minnesota, North Dakota and Wisconsin.\nDuring 1994, Western mined and sold 13,717,418 tons, of which 3,787,318 tons were sold to the Company. Western's Colstrip production is estimated to be 12,300,000 tons in 1995 and 10,300,000 tons in 1996. Future production is reduced as a result of the non-renewal of a contract with a Midwestern customer at year-end 1994 and the anticipated non-renewal of contracts with another Midwestern customer and the Corette Plant at year-end 1995. Western has experienced strong competition from southern Powder River Basin producers, primarily those in Wyoming, for its Midwestern coal sales, which represent approximately 23% of Western's total sales. In December 1994, Western lost a contract with a Midwestern customer because of a market price reopener. While Western has a per-ton rail rate advantage to some of the upper Midwest markets, Wyoming producers generally experience lower stripping ratios, royalties and production taxes. In addition, Western produces coal containing higher, noncompliance levels of sulfur than southern Powder River Basin Mines.\nNorthwestern's Jewett Mine is located in central Texas about midway between Dallas and Houston. Northwestern supplies lignite under a long-term contract to the two electric generating units, located adjacent to the mine, that are owned by Houston Lighting and Power Company. Total deliveries during 1994, a record production year, were 8,627,923 tons. The estimated production for 1995 and 1996 is 8,100,000 and 7,700,000 tons, respectively. Future production is reduced as a result of the two generating units returning to normal levels of demand plus planned maintenance outages.\nBasin's underground Golden Eagle Mine is located in southern Colorado near Trinidad. The coal is processed through an on-site wash plant to reduce the ash content prior to sale. Total deliveries from the mine, which has a current capacity to produce 2,000,000 tons annually, were 1,076,321 tons during 1994. In July 1994, Basin began delivering coal under a long-term contract to supply up to 1,200,000 tons annually to a southeastern utility. A portion of Basin's production supplies short-term sales to industrial and utility customers. The mine experienced unanticipated production problems in both the mining and the wash plant operations during 1994. These production problems are being addressed and management expects resolution of them in 1995. Estimated production for 1995 and 1996 is 1,400,000 and 1,900,000 tons, respectively. For further discussion of Basin's production problems, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operation\" under \"Entech Coal Operations.\"\nOIL AND GAS OPERATIONS: NARCO's producing oil and natural gas properties are principally located in the states of Wyoming, Colorado, Kansas, Oklahoma and Montana. Altana and Roan's properties are principally located in the Province of Alberta, Canada.\nNARCO has entered into agreements to supply 138,000 Mmcf of natural gas to four cogeneration facilities over periods of 10 to 16 years with performance guaranteed by Entech. NARCO has sufficient proven, developed and undeveloped reserves to supply all of the remaining natural gas required by those agreements. None of the reserves are dedicated to supply these agreements. For information on another subsidiary's participation in an investment in these cogeneration projects, See Item 1 \"Independent Power Group.\"\nNatural gas production in both the United States and Canada is currently sold pursuant to short-term, spot market and long-term contracts. Approximately 30,000 Mmcf, or one-third of Altana and Roan's natural gas reserves, are dedicated to long-term contracts expiring at various times through 2005.\nThrough its subsidiary Entech Altamont, Inc., (a single purpose subsidiary), Entech owns a minority interest in a joint venture to construct the proposed Altamont pipeline. In 1991, Altamont received FERC approval to construct a 620 mile pipeline running from the Alberta-Montana border to Muddy Creek, Wyoming. The decision to proceed with the construction of this pipeline will depend upon obtaining the necessary regulatory approval and shipper commitments.\nINDEPENDENT POWER GROUP:\nGENERAL: The Independent Power Group (IPG), which consists of Continental Energy Services, Inc. (CES) and Colstrip 4 Lease Management Division, manages sales of the Company's 210 megawatt share of Colstrip Unit 4 generation to the Los Angeles Department of Water and Power and to Puget Sound Power & Light Company (Puget) under contracts which are coextensive with the Company's leasehold interest in the Unit. See Item 3, \"Legal Proceedings\" for additional information pertaining to the Puget Contract.\nThrough CES, the IPG has invested in six operating, natural gas fired, independent power projects located in Texas, New York, Washington and the United Kingdom, two independent power projects under construction in Texas and Washington and another under development in China. CES also participates with several partners in several nonutility electric generation development efforts and peak shaving facilities by providing funding and project development expertise. This participation includes domestic as well as foreign projects.\nIn August 1994, CES sold 50% of its wholly-owned subsidiary, North American Energy Services Company (NAES), which it acquired in November 1992, to Illinova Generating Company. NAES provides energy-related support services including the operation and maintenance of power plants for private power generating companies and provides maintenance services for power plants owned and operated by electric utilities.\nENVIRONMENT:\nThe information required in this section is contained in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" under \"Environmental Issues.\"\nEMPLOYEES:\nAt December 31, 1994, the Company and its subsidiaries employed 3,686 persons of which 2,290 were utility and Office of the Corporation employees (including 569 employees at the jointly owned Colstrip Units 1-4), 9 Independent Power Group employees and 1,387 Entech employees.\nFOREIGN AND DOMESTIC OPERATIONS:\nSee Item 2, \"Utility Natural Gas Properties,\" for information on the Company's Canadian and domestic utility natural gas properties. See Item 2, \"Entech Oil and Natural Gas Properties\" for information on Entech's Canadian and domestic oil and natural gas properties.\nEXECUTIVE OFFICERS:\nCorporate Officers:\nIn 1992, D. T. Berube, 61, was elected Chairman of the Board and Chief Executive Officer. He served as President and Chief Operating Officer, Entech, Inc., 1988-1991.\nIn 1991, J. P. Pederson, 52, was elected Vice President and Chief Financial Officer. He served as Vice President Corporate Finance 1990-1991.\nIn 1993, P. K. Merrell, 42, was elected Vice President and Secretary. She served as Staff Attorney 1981-1991, Assistant Secretary 1991-1992, and Secretary 1992-1993.\nIn 1991, M. E. Zimmerman, 46, was elected Vice President and General Counsel. He served as General Counsel from 1989-1991.\nUtility Division Officers:\nIn 1990, R. P. Gannon, 50, was elected President and Chief Operating Officer - Utility Division.\nIn 1993, A. K. Neill, 57, was elected Executive Vice President - Generation and Transmission. He had previously served as Executive Vice President - Utility Services since 1987.\nIn 1993, J. D. Haffey, 49, was elected Vice President - Administration and Regulatory Affairs. He had previously served as Vice President - Regulatory Affairs for the Utility Division since 1987.\nIn 1993, D. A. Johnson, 50, was elected Vice President - Utility Services. He had previously served as Vice President - Gas Supply and Transportation for the Utility Division since 1984.\nIn 1993, C. D. Regan, 58, was elected Vice President - Natural Gas Supply and Transportation. He had previously served as Vice President - Energy Services for the Utility Division since 1986.\nIn 1988, G. A. Thorson, 60, was elected Vice President - Colstrip Project Division for the Utility Division.\nIn 1993, W. C. Verbael, 57, was elected Vice President - Accounting, Finance and Information Services. He had previously served as Vice President - Accounting and Finance for the Utility Division since 1984.\nIn 1993, P. J. Cole, 37, was elected Treasurer for the Utility Division. He served as Manager, Corporate Financial Planning and Analysis 1986-1992, and as Assistant Treasurer 1992-1993.\nIn 1990, J. S. Miller, 51, was elected Controller for the Utility Division.\nEntech Officers:\nIn 1992, J. J. Murphy, 56, was elected President and Chief Operating Officer - Entech, Inc. He served as President and Chief Operating Officer, Western Energy and Northwestern Resources Co., 1988-1991.\nIn 1985, E. M. Senechal, 45, was elected Vice President and Treasurer - Entech, Inc.\nIndependent Power Group Officer:\nIn 1992, R. F. Cromer, 49, was elected President and Chief Operating Officer - Continental Energy Services, Inc. He served as Vice President and General Manager, Continental Energy Services 1989-1992.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nUTILITY DIVISION:\nELECTRIC PROPERTIES: The Company's Utility Division electric system extends through the western two-thirds of Montana. Generating capability is provided by four coal-fired thermal generation units, with total net capability available to the Utility of 697,000 kW, and 12 hydroelectric projects, with total net capability of 489,000 kW. The thermal units are (1) Colstrip Unit 3, which has a net capability of 727,000 kW, of which the Company owns 218,000 kW, (2) Colstrip Units 1 and 2, with a combined net capability of 638,000 kW, of which the Utility owns 319,000 kW, and (3) the 160,000 kW Corette Plant. Substantially all of the Utility's coal requirements are supplied by Western Energy Company under long-term contracts. Reliability of service is enhanced by the location of hydroelectric generation on two separate watersheds with different precipitation characteristics and by diverse sources of thermal generation.\nIn addition to the Utility's hydroelectric and thermal resources, it currently receives power through 21 power contracts totaling 415,000 kW of firm winter peak capacity. These contracts vary in type, size, seller and ending dates. The Utility has one energy contract ending in 1995 for the delivery of up to 10,000 kW of power to the Utility during the off-peak hours.\nHydroelectric projects are licensed by the FERC under licenses which expire on varying dates from 1995 to 2035. The Company is in the process of relicensing its nine dams located on the Missouri and Madison rivers. See Item 8, \"Note 2 to the Consolidated Financial Statements.\"\nAt December 31, 1994, the Utility owned and operated 6,890 miles of transmission lines and 15,073 miles of distribution lines.\nNATURAL GAS PROPERTIES: The Utility produces natural gas from fields in Montana and Wyoming and through its subsidiary, Canadian-Montana Gas Company, from fields in southeastern Alberta, Canada. Natural gas is also purchased from independent producers in Montana and Alberta.\nAll of the Utility's natural gas customers are served from its transmission system which extends through the western two-thirds of Montana. System reliability is enhanced by four natural gas storage fields which enable the Utility to store natural gas in excess of system load requirements during the summer for delivery during winter periods of peak demand.\nAt December 31, 1994, the Gas Utility and its subsidiaries owned and operated 2,034 miles of natural gas transmission lines and 3,075 miles of distribution mains.\nAll natural gas volumes are at a pressure base of 14.73 psia at 60 degrees Fahrenheit, except for those volumes used to compute the average revenues by customer classification.\nFor information pertaining to the Company's net recoverable utility natural gas reserves, see Item 8, \"Supplementary Data.\"\nIn addition to owned reserves, the Utility at December 31, 1994, controlled under purchase contracts, 60,604 Mmcf of proven reserves in the United States and 36,190 Mmcf in Canada. No significant change has occurred and no event has taken place since December 31, 1994, that would materially affect the magnitude of the Utility's reserve estimates.\nUtility natural gas reserve estimates have not been filed with any other federal or any foreign governmental agency during the past twelve months. Certain lease and well data, with respect only to owned wells, are filed with the Internal Revenue Service for tax purposes.\nTotal produced, royalty and purchased natural gas volumes in Mmcf during the last three years were as follows:\nUnited States Canada Produced Royalty Purchased Produced Royalty Purchased\n1992 . . . . 5,724 561 8,713 2,951 916 3,443 1993 . . . . 5,587 539 8,554 3,927 1,186 2,824 1994 . . . . 4,742 230 7,565 3,350 998 2,709\nThe following table presents information as of December 31, 1994, concerning the Utility natural gas wells and the owned or leased acreages in which they are located.\nUnited States Canada\nGross productive wells. . . . . . . . . . 610 173 Net productive wells. . . . . . . . . . . 499 162 Gross wells with multiple completions . . 18 11 Net wells with multiple completions . . . 12.8 10.5\nGross producing acres . . . . . . . . . . 457,145 194,392 Net producing acres . . . . . . . . . . . 296,759 171,798 Gross undeveloped acres . . . . . . . . . 63,344 45,280 Net undeveloped acres . . . . . . . . . . 53,227 44,320\nThese acreages are located primarily in Montana and Alberta, Canada.\nThe Company anticipates that during 1995 total exploration and development expenditures (expense and capital) will be approximately $2,114,000 in the United States and approximately $1,735,000 in Canada.\nThe following table presents information on utility natural gas exploratory and development wells drilled during 1994, 1993 and 1992.\nUnited States Canada 1994 1993 1992 1994 1993 1992\nNet productive exploratory wells. . . . . . . . . . . . - - - - - - Net dry exploratory wells. . . - - - - - - Net productive development wells. . . . . . . . . . . . 14.38 12.25 6.38 6.00 3.00 - Net dry development wells. . . 4.00 2.00 3.00 1.00 1.00 -\nThe following table presents average revenues received per Mcf by customer classification for natural gas from all sources for the years 1994, 1993 and 1992. Revenues per Mcf are computed based on volumes at varying pressure bases as billed.\nYear Ended December 31 Customer Classification 1994 1993 1992\nResidential. . . . . . . . . . . . . . . $ 4.64 $ 4.35 $ 4.22 Commercial . . . . . . . . . . . . . . . 4.43 4.20 3.91 Industrial . . . . . . . . . . . . . . . 4.25 4.02 3.76 Other gas utilities. . . . . . . . . . . 3.72 3.38 3.33\nThe following table presents the average production cost per Mcf for produced utility natural gas, in U. S. dollars, for the three years 1994, 1993 and 1992.\nUnited States Canada\n1992. . . . . . $ 0.84 $ 0.38 1993. . . . . . 0.97 0.36 1994. . . . . . 1.07 0.40\nProduction cost per unit fluctuated over the three-year period primarily as a result of expensing fixed costs over varying levels of production.\nENTECH:\nCOAL PROPERTIES: Western leases and produces coal from Montana and Wyoming properties. Northwestern leases and produces lignite from properties in Texas and leases coal properties in Wyoming. Basin produces coal from properties in Colorado that North Central owns and leases. Horizon leases lignite properties in Montana, Texas and Alabama. Western SynCoal owns a 50% partnership interest in a coal enhancement demonstration plant at Colstrip, Montana.\nWestern has coal mining leases covering approximately 551,000,000 proved and probable, and recoverable tons of surface-minable coal reserves averaging less than 0.9 pounds of sulfur per million Btu (low-sulfur quality) at Colstrip. Approximately 264,000,000 tons of these reserves are committed to present contracts, including requirements of the Colstrip Units.\nNorthwestern has lignite mining leases in central Texas at the Jewett Mine covering approximately 237,000,000 proved and probable, and recoverable tons of surface-minable lignite reserves. Northwestern has contracted all of these reserves to Houston Lighting and Power Company, which owns two electric generating units located adjacent to the mine.\nIn 1990, Northwestern acquired surface rights and coal leases which contain approximately 628,000,000 proved and probable, and recoverable tons of surface-minable, coal reserves, averaging less than 0.6 pounds of sulfur per million Btu (compliance quality), in the southern Powder River coal region located at Rocky Butte, Wyoming. In January 1993, Northwestern acquired an adjacent federal lease which contains approximately 56,000,000 proved and probable, and recoverable tons of compliance quality, surface minable, coal reserves. Northwestern's application with the Department of Interior to combine these leases into one logical mining unit, which was granted in December 1993, requires the property to be developed by January 1, 2003. A permit application was submitted to the Wyoming Department of Environmental Quality on November 7, 1994. Northwestern expects to receive a mine permit by the second quarter of 1996. No definite plans for mine development have been made.\nNorth Central owns and leases lands containing approximately 98,600,000 tons of proved and probable, and recoverable, compliance quality underground-minable coal reserves near Trinidad, Colorado. Approximately 32,000,000 tons of these reserves are dedicated to a long-term contract.\nHorizon has undeveloped mining leases covering lands in three different states. Properties in eastern Montana contain approximately 31,000,000 proved and probable, and recoverable tons of low-sulfur surface-minable lignite, under lease. Those in southeastern Alabama contain approximately 97,000,000 proved and probable, and recoverable tons of surface-minable lignite (averaging greater than 1.25 pounds of sulfur per million Btu). Those in central Texas contain approximately 177,000,000 proved and probable, and recoverable tons of surface-minable lignite.\nOIL AND NATURAL GAS PROPERTIES: No significant change has occurred and no event has taken place since December 31, 1994, which would materially affect the estimated quantities of proved reserves. For information pertaining to net recoverable Entech oil and natural gas reserves, see Item 8, \"Supplementary Data.\"\nEntech's oil and natural gas volumes are at a pressure base of 14.73 psia at 60 degrees Fahrenheit.\nEntech's oil and natural gas reserve estimates have not been filed with any other federal or any foreign government agency during the past 12 months. Certain lease information and well data, only with respect to owned wells, is filed with the Internal Revenue Service for tax purposes.\nThe following table presents information on produced oil and natural gas average sales prices and production costs in U.S. dollars for 1994, 1993 and 1992.\nNatural gas production was converted to barrel of oil equivalents based on a ratio of 6 Mcf to 1 barrel of oil.\nEntech's oil, natural gas and natural gas liquids production was sold under both short- and long-term contracts at posted prices or under forward market arrangements. From 1993 to 1994, Entech's average sale prices changed due to fluctuations in market prices and currency exchange rates. In the U.S., Entech's average production cost changed reflecting lower production taxes per barrel of oil equivalent due to lower revenues received and lower operating expenses.\nInformation on Entech's natural gas and oil wells and the owned or leased acreages in which they are located, as of December 31, 1994, is presented below.\nUnited States Canada\nGross productive natural gas wells 379 184 Net productive natural gas wells 232.03 121.31 Gross productive oil wells 247 209 Net productive oil wells 160.56 119.08\nGross producing acres 127,675 191,439 Net producing acres 58,752 96,805 Gross undeveloped acres 260,410 202,764 Net undeveloped acres 126,028 125,288\nThe wells located in Canada include multiple completions of 12 gross productive natural gas wells and 9.81 net productive gas wells.\nThe foregoing acreages located in the United States and Canada are primarily in the Rocky Mountain states and Alberta.\nIt is anticipated that during 1995 total exploration, acquisition and development expenditures (expense and capital) will be approximately $26,895,000 in the United States and approximately $10,814,000 in Canada.\nThe following table presents information on Entech's oil and natural gas exploratory and development wells drilled during 1994, 1993 and 1992.\nFor information on properties acquired, see Item 8, \"Supplementary Data.\"\nINDEPENDENT POWER GROUP:\nThe IPG manages the sale of power from the Company's 210 MW Colstrip 4 leased interest and associated common and transmission facilities. The IPG also has ownership or contract rights in a number of nonutility power generation projects:\nProjects in Operation:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company, through the IPG, sells 94 MW of electricity to Puget Sound Power & Light Company (Puget) under a 25-year agreement which expires in 2010 (the Agreement). On February 27, 1995, Puget notified the Company of its intention to terminate the Agreement, effective the next day, alleging the Company had failed to satisfy a requirement to secure firm contractual rights to transmission paths for the delivery of the electricity.\nIf Puget establishes its right to terminate the Agreement, the Company would be at risk for the difference between the power purchase price under the Agreement, approximately 4.6 cents\/kWh ($29,000,000 in revenue) for the current contract year and escalating annually thereafter, and the prices it might receive from future sales of the electricity. In addition, the Company would be obligated to reimburse Puget approximately $37,000,000 for the amount by which Puget's payments for the electricity have exceeded its projection of avoided costs. This reimbursement obligation would peak at approximately $47,000,000 by the end of 1995 and would be reduced to zero by the end of the Agreement's term in 2010. The Company also may be required to make a non-cash adjustment to its accounting records reducing an asset related to the Agreement by an amount currently estimated to be approximately $20,000,000, pre-tax.\nThe Company believes that is has performed its obligations under the Agreement and that Puget has no basis for termination. On February 28, 1995, the Company obtained, from a Montana district court, a temporary restraining order enjoining Puget from terminating the Agreement. A hearing has been set for March 15, 1995 to determine whether a preliminary injunction should be issued. The Company also has filed with that court a complaint for a declaratory ruling that it has complied with the Agreement and that Puget has no basis for termination. The Company will seek to enforce the Agreement and to obtain damages for any breach; however, it cannot predict the outcome of this controversy.\nRefer to Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Environmental Issues\" for additional information pertaining to legal proceedings.\nRefer to Item 8, \"Financial Statements and Supplementary Data - Note 2 to the Consolidated Financial Statements\" for additional information pertaining to legal proceedings.\nThe Company and its subsidiaries are party to various other legal claims, actions and complaints arising in the ordinary course of business. Management does not expect disposition of these matters to have a material adverse effect on the Company's consolidated 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 THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nCommon Stock Information\nThe Common Stock of the Company is listed on the New York and Pacific Stock Exchanges. The following table presents the high and low sale prices of the common stock of the Company as well as dividends declared for the years 1994 and 1993. The number of common shareholders of record on December 31, 1994, was 40,956.\nDividends Declared per 1994 High Low Share\n1st quarter $ 25.875 $ 23.250 $ 0.40 2nd quarter 25.000 22.125 0.40 3rd quarter 24.625 21.750 0.40 4th quarter 24.000 22.250 0.40\nDividends Declared per 1993 High Low Share\n1st quarter $ 27.875 $ 25.125 $ 0.395 2nd quarter 27.750 25.500 0.395 3rd quarter 28.125 26.375 0.395 4th quarter 27.500 24.500 0.400\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 6. SELECTED FINANCIAL DATA\nIncome Statement Items (000) 1994 1993 1992\nIncome Statement Items (000) 1991 1990 1989\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations:\nThe Company's net income available for common stock increased to $106,365,000 in 1994 compared to $102,858,000 and $103,275,000 in 1993 and 1992, respectively. The following discussion presents significant events or trends which have had an effect on the operations of the Company during the years 1992 through 1994. Also presented are factors which are expected to have an impact on operating results in the future.\nNet Income Per Share of Common Stock:\nAlthough net income available for common stock increased $3,507,000, the net income per share increase was moderated by additional outstanding shares. The following table shows the sources of consolidated net income on a per share basis.\n1994 1993 1992\nUtility Operations $ 0.91 $ 1.07 $ 0.97 Entech 0.90 0.91 0.98 Independent Power Group 0.19 - 0.07\n$ 2.00 $ 1.98 $ 2.02\nConsolidated net income per share for 1994 increased due to sharply higher Independent Power Group (IPG) earnings resulting from power project development revenues and improved performance by the Colstrip units. Despite higher revenues resulting from rate increases, growth in the number of customers, increased industrial electric loads and improved Colstrip units performance, Utility Division earnings were lower due to less favorable hydroelectric generation and wholesale market conditions, increased property taxes, an increased regulatory disallowance on coal purchases and warmer weather. Entech earnings were comparable to 1993. A 1993 non-recurring gain on the sale of an Entech Oil Division's non-strategic asset and continuing losses at Entech's underground mine in Colorado, where production problems are being addressed, were offset by increased coal sales from mines in Montana and Texas.\nColder weather and increased hydroelectric generation combined to increase the earnings of the Utility Division for 1993. The Utility increase offset reduced earnings of Entech and the IPG. Entech earnings decreased primarily due to reduced coal sales resulting from an extended outage at a Colstrip generating unit. The IPG earnings decrease resulted primarily from a decrease in independent power project development revenues.\nUtility Operations:\nWeather can significantly affect revenues and net income, and should be considered when determining trends. The Company's sales increase as a result of colder weather in the winter months. As measured by heating degree days, the weather in 1994 in the Company's service territory was 13% warmer than 1993 and 6% warmer than normal. The weather in 1993 was 17% colder than 1992 and 8% colder than normal.\nElectric Utility:\nThe following table shows year-to-year changes for the previous two years, in millions of dollars, in the various classifications of electric revenues (excluding intersegment revenues) and the related percentage changes in volumes sold and prices received:\n1994 1993\nGeneral business - revenue $ 11 $ 9 - volume 3% 3% - price\/kWh - -\nOther utilities - revenue $ (9) $ 11 - volume (6%) 5% - price\/kWh (5%) 10%\nMiscellaneous - revenue $ (1) $ 4\n1994 Compared to 1993\nIncome from electric operations decreased $14,500,000 due primarily to the less favorable hydroelectric generation and wholesale market conditions partially offset by higher rates and growth in customers.\nRevenues:\nElectric sales from general business customers increased $11,500,000 including an increase of $5,800,000 in revenues from industrial customers. Industrial revenues increased due to a 5% increase in volumes sold, primarily the result of additional equipment installed by several customers and demand for irrigation because of dry summer weather. Growth in residential and commercial customers and higher rates also contributed to the increase in revenues. These increases were moderated by volume decreases resulting from the warmer winter weather.\nElectric revenues from sales to other utilities decreased $5,100,000 due to a reduction in volumes and $4,300,000 due to a decrease in average price. The decreases resulted from wholesale market conditions returning to near- normal compared with better than average conditions experienced during the first and fourth quarters of 1993.\nMiscellaneous electric revenues decreased $1,100,000 primarily due to reduced wheeling revenues resulting from the previously discussed change in wholesale market conditions.\nIntersegment revenues decreased $1,600,000 due primarily to lower volumes sold to the IPG.\nExpenses:\nThe following table shows the Company's sources of electricity and power supply expenses (Operation, Fuel for electric generation, and Maintenance) for 1994 and 1993.\n1994 1993 Sources Megawatt Hours\nHydroelectric. . . . . . . . . . . . . . . 2,999,396 3,560,915 Steam. . . . . . . . . . . . . . . . . . . 4,909,852 4,542,100 Purchases. . . . . . . . . . . . . . . . . 3,193,522 3,186,025\nTotal Power Supply . . . . . . . . . . . 11,102,770 11,289,040\nExpenses Thousands of Dollars\nHydroelectric. . . . . . . . . . . . . . . $ 18,395 $ 18,092 Steam. . . . . . . . . . . . . . . . . . . 61,385 57,876 Purchases. . . . . . . . . . . . . . . . . 99,147 96,222\nTotal Power Supply Expenses. . . . . . . $ 178,927 $ 172,190\nCents per Kilowatt-Hour. . . . . . . . . 1.612 1.525\nSteam generation and related fuel expense increased as a result of improved performance at the Colstrip units which experienced outages in 1993. Purchased power costs increased as a result of a 3% increase in average price paid. Total power supply cost increased as a result of this price increase and a change in the mix of the Utility's sources of energy. In 1994, a larger portion of power supply was provided by steam generation which is incrementally more expensive than hydroelectric generation.\nThe increase in selling, general and administrative results primarily from a $1,800,000 increase associated with the recognition of postretirement benefit expense in accordance with SFAS No. 106 commensurate with the approval of rate treatment for this expense by the PSC in April 1994, a $500,000 increase related to insurance for postemployment disability-related benefits and a $600,000 increase due to the costs associated with Colstrip housing damages.\nThe $3,200,000 increase in taxes - other than income taxes is principally due to increased property taxes resulting from property additions and higher mill levies.\nDepreciation and amortization expense increased $1,500,000 as a result of depreciation of additional plant and property in service.\n1993 Compared to 1992\nIncome from electric operations increased $8,000,000 primarily as a result of increased sales to other utilities resulting from better than normal market conditions, increased sales to general business customers due to colder weather and increased hydroelectric generation caused by higher stream flows.\nRevenues:\nElectric revenues from general business customers increased due to a 3% increase in volumes sold. Weather, which was 17% colder than 1992, and a 2% increase in the number of customers, combined to increase revenues $8,600,000.\nElectric revenues from sales to other utilities increased revenues $11,400,000. Volumes increased 5% and unit prices increased 10% providing additional revenues of $4,000,000 and $7,400,000, respectively. The increases occurred primarily during the first and fourth quarters as a result of improved regional market conditions during those periods. In spite of reduced steam generation resulting from outages at a Colstrip generating unit, volumes sold increased due to a 27% increase in hydroelectric generation for the year and increased power purchases.\nThe $4,300,000 increase in miscellaneous electric revenues resulted primarily from a $2,500,000 increase in wheeling revenues and a $2,300,000 increase due to recording the SFAS No. 87 pension cost funding difference which is explained further in the expense discussion below.\nIntersegment revenues increased due to increased sales to the IPG resulting from the reduction in the IPG's steam generation at Colstrip due to the outages.\nExpenses:\nThe following table shows the Company's sources of electricity and power supply expenses (Operation, Fuel for electric generation, and Maintenance) for 1993 and 1992.\n1993 1992 Sources Megawatt Hours\nHydroelectric. . . . . . . . . . . . . . . 3,560,915 2,793,974 Steam. . . . . . . . . . . . . . . . . . 4,542,100 5,176,130 Purchases. . . . . . . . . . . . . . . . . 3,186,025 2,833,388\nTotal Power Supply . . . . . . . . . . . 11,289,040 10,803,492\nExpenses Thousands of Dollars\nHydroelectric. . . . . . . . . . . . . . . $ 18,092 $ 17,384 Steam. . . . . . . . . . . . . . . . . . . 57,876 59,563 Purchases. . . . . . . . . . . . . . . . . 96,222 89,748\nTotal Power Supply Expenses. . . . . . . $ 172,190 $ 166,695\nCents per Kilowatt-Hour. . . . . . . . . 1.525 1.543\nThe Company's hydroelectric output increased as a result of improved stream flows, offsetting a decline in generation from the Company's coal-fired plants. Purchased power volumes were increased to meet higher sales to general business and wholesale customers.\nIncreases in purchased power costs were partially offset by a $2,900,000 decrease in the amortization of previously deferred costs. Fuel for electric generation decreased $4,900,000 as a result of outages at a Colstrip generating unit. The decrease in fuel was partially offset by a $3,000,000 increase in maintenance of steam plants resulting from scheduled maintenance and unscheduled repairs due to the outages.\nTransmission and distribution expense increased $4,200,000 primarily as a result of increased wheeling expense associated with higher volumes of out- of-state sales and increased maintenance of the transmission and distribution system.\nThe $4,600,000 increase in selling, general and administrative resulted principally from a $2,600,000 increase in pension costs and expenses of $1,600,000 related to property damages to homes at Colstrip. The Utility recovers pension expense for regulatory purposes on a funding basis. In 1993, pension costs funded were less than SFAS No. 87 pension expense and the difference of $1,900,000 was recorded as miscellaneous operating revenue.\nThe $2,800,000 increase in taxes - other than income taxes is principally due to increased property taxes resulting from property additions and higher mill levies.\nDepreciation and amortization expense increased $2,000,000 as a result of depreciation of additional plant and property in service.\nNatural Gas Utility:\nThe following table shows year-to-year changes for the previous two years, in millions of dollars, in the various classifications of natural gas revenues (excluding intersegment revenues) and the related percentage changes in volumes sold and prices received:\n1994 1993 Revenues (other than gas supply cost revenues) Full requirement Customers -revenue $ (3) $ 7 -volume (13%) 4% -price\/Mcf 11% 6%\nTransportation -revenue $ 3 $ 2 -volume 32% 19% -price\/Mcf 26% 35%\nMiscellaneous -revenue $ 1 $ 1\n1994 Compared to 1993\nIncome from natural gas operations decreased $1,400,000 primarily due to decreased volumes resulting from warmer weather and increases in expenses other than gas supply costs the effects of which were moderated by higher rates.\nRevenues:\nEffective September 1, 1993 natural gas customers who consume more than 60,000 Mcfs annually (non full-requirements customers) are no longer required to purchase any portion of their natural gas supply from the Company. All but one eligible customer have chosen to convert their volumes to transportation service only and have secured their own supply. The resulting decline in natural gas revenue has been offset by revenues from transportation fees and lower purchased gas costs.\nNatural gas revenues (other than gas supply cost) increased $1,300,000. Growth in the number of residential and commercial customers, higher rates and increased transportation fees contributed $13,200,000. This increase was mostly offset by an approximately $11,800,000 decrease due to warmer weather and the previously discussed switch by eligible customers to transportation service only.\nGas supply cost revenues consist of the amount authorized by the PSC to be collected in rates from full requirement customers to cover the cost of supplying the gas. The $4,900,000 decrease in gas supply cost revenues is the result of reduced volumes sold due to warmer weather and a supply cost rate reduction for overcollections of supply costs in prior years. Gas supply cost revenues and gas supply cost expenses are always equal due to rate and accounting procedures adopted by the PSC in January 1980.\nExpenses:\nThe decrease in gas supply costs results from the reasons mentioned in the gas supply cost revenue discussion.\nAs presented in the electric expense discussion, the $900,000 increase in selling, general and administrative results primarily from increased costs associated with the recognition of postretirement benefit expense in accordance with SFAS No. 106 and insurance for postemployment disability- related benefits.\nAlso as previously discussed, the $1,000,000 increase in taxes - other than income taxes is principally due to increased property taxes resulting from property additions and higher mill levies.\n1993 Compared to 1992\nThe $8,600,000 increase in income from natural gas operations results primarily from increased volumes sold to full requirement general business customers due to colder weather and an increase in the number of customers.\nRevenues:\nNatural gas revenues (other than gas supply cost revenues) increased $10,300,000. Volumes sold to residential and commercial customers increased 19% primarily as a result of 17% colder weather and a 4% increase in the number of customers. The volume increases along with higher rates and increased transportation fees increased revenues approximately $14,600,000. These increases were partially offset by the decrease resulting from a 53% reduction in volumes sold to industrial, government and municipal and other utility customers who switched to transportation service only.\nThe $2,900,000 increase in gas supply revenues resulted from the increase in volumes delivered to full requirement customers resulting from colder weather and more customers.\nExpenses:\nThe increase in gas supply costs results from the reasons mentioned in the above gas supply cost revenue discussion.\nOther production, gathering and exploration expense decreased $2,000,000 due to decreased operation and maintenance costs and the capitalization of future use gas well expenses.\nThe $1,100,000 increase in selling, general and administrative resulted principally from an increase in labor costs.\nThe $1,300,000 increase in taxes - other than income taxes is principally due to increased property taxes resulting from property additions and higher mill levies.\nInterest Expense and Other Income, and Income Taxes:\nThe decreases in interest expense from 1992 to 1994 are primarily a result of refinancing of long-term debt at lower interest rates. The average cost of debt was 7.84%, 8.34% and 8.48% for 1994, 1993 and 1992, respectively.\nOther (income) deductions - net increased $3,100,000 in 1994 due primarily to a non-recurring increase in investment income.\nIncome taxes changed due primarily to changes in pre-tax income.\nIndependent Power Group Operations:\nIn November 1992, the IPG acquired 100% of North American Energy Services Company (NAES) and their operations were included in the Company's financial statements on a consolidated basis throughout the remainder of 1992 and 1993. In August 1994, the IPG sold a 50% interest in NAES and, as a result of the sale, NAES has been included in the Company's operations on the equity basis of accounting as of January 1, 1994.\n1994 Compared to 1993\nIncome from IPG operations increased $14,300,000 primarily due to increased revenues from independent power project development activity, a gain on the sale of NAES and improved performance by the Colstrip generating units. Earnings from development activities in 1995 are not expected to maintain the 1994 levels.\nRevenues:\nIPG revenues decreased $43,600,000 due to the accounting change for the IPG's investment in NAES as mentioned above. The decrease was partially offset by increases in independent power project development revenues of $12,600,000, management fees of $500,000 and a $4,900,000 increase in revenues from long-term power sales from the Colstrip units due to a 13% increase in volumes sold.\nThe decrease in earnings from unconsolidated investments results primarily from lower earnings from operating projects. The decrease in intersegment revenues results primarily from the sale of NAES and the resulting change in accounting.\nExpenses:\nThe NAES sale and corresponding accounting change resulted in decreases of $41,500,000 in operation and maintenance expense and $5,300,000 in selling, general and administrative. Operation and maintenance expense was also impacted by a $2,100,000 decrease in wheeling expense, a $2,100,000 decrease in purchased power costs and a $3,000,000 increase in fuel costs due to increased generation at the Colstrip units. Expenses associated with project development increased by $1,600,000 primarily due to the development of two power projects.\nInterest Expense and Other Income:\nOther (income) deductions - net increased $3,700,000 due principally to increases in interest income and the gain on the sale of 50% of NAES.\n1993 Compared to 1992\nIncome from IPG operations decreased $5,800,000 primarily due to decreased revenues from independent power project development activity and reduced generation from the Colstrip generating units due to outages.\nRevenues:\nTotal IPG revenues increased $30,400,000. The acquisition of NAES resulted in increased revenues of $39,300,000 and income from investments in independent power projects increased $1,300,000. The increases were partially offset by a $6,000,000 reduction in independent power project development revenues and a $3,800,000 decrease resulting from a change in the amount of amortization of the loss on long-term sales.\nA $3,800,000 increase in intersegment revenues resulting from the acquisition mentioned previously was partially offset by a $900,000 decrease in sales from the Colstrip generating units.\nExpenses:\nIPG operation and maintenance expense increased $30,000,000 primarily as a result of a $34,400,000 increase resulting from the acquisition of NAES mentioned above and a $3,000,000 increase in purchased power costs resulting from outages at a Colstrip generating unit. The increases were offset by a $3,500,000 reduction in fuel expense resulting from the Colstrip outages and a $3,000,000 decrease in independent power project development expenses.\nSelling, general and administrative expense rose primarily due to a $4,200,000 increase resulting from the acquisition mentioned previously and a $1,000,000 increase due to the accrual of Colstrip housing damage claims.\nLiquidity and Capital Resources:\nNet cash provided by operating activities was $203,886,000 in 1994 compared to $185,809,000 in 1993 and $227,988,000 in 1992. Cash from operating activities less dividends paid provided 54% of capital expenditures in 1994, 54% in 1993 and 91% in 1992.\nThe Company's long-term debt as a percentage of capitalization was 36%, 36% and 39% in 1994, 1993 and 1992, respectively. The Company also has entered into long-term lease arrangements and other long-term contracts for sales and purchases that are not reflected on its balance sheet. See Item 8, \"Financial Statements and Supplementary Data - Note 3 to the Consolidated Financial Statements\" for additional information.\nCapital expenditures during the prior three years are as follows:\nYears Utility Entech IPG Total Thousands of Dollars\n1992 $ 96,352 $ 44,662 $ 19,489 $ 160,503 1993 112,178 66,832 4,542 183,552 1994 150,903 50,253 6,154 207,310\nThe following table sets forth the Company's estimated capital expenditures for the years 1995-1999:\nYears Utility Entech IPG Total Thousands of Dollars\n1995 $128,000 $ 81,000 $ 27,000 $ 236,000 1996 158,000 98,000 31,000 287,000 1997 161,000 78,000 25,000 264,000 1998 134,000 70,000 29,000 233,000 1999 135,000 114,000 26,000 275,000\nIn addition, $153,677,000 of long-term debt will mature during the years 1995-1999. See Item 8, \"Financial Statements and Supplementary Data - Note 7 to the Consolidated Financial Statements\" for details on maturities of long- term debt.\nFor the years 1995-1999, the Company estimates that approximately 61% of its utility construction program, 81% of Entech capital expenditures and 37% of IPG investments will be financed from funds generated internally and that the balance, as well as the repayment of maturing long-term debt, will be financed through the incurrence of short- and long-term debt and the sales of equity securities, the timing and amounts of which will depend upon future market conditions. The Company anticipates that it will have adequate sources of external capital to meet its financing needs.\nDividends on common and preferred stock increased to $92,009,000 in 1994 from $85,823,000 in 1993 and $82,343,000 in 1992. The Company paid dividends of $1.60 per share of outstanding common stock during 1994, up 1.27% from 1993. In an effort to move toward the Company's target payout ratio for dividends of 70% of earnings, the Board of Directors voted in December to continue the regular quarterly dividend at 40 cents per share of common stock, $1.60 on an annual basis.\nThe Company and Entech have Revolving Credit and Term Loan Agreements in the amount of $60,000,000 and $75,000,000, respectively. These businesses also have short-term borrowing facilities with commercial banks that provide both committed and uncommitted lines of credit, and the ability to sell commercial paper. See Item 8, \"Financial Statements and Supplementary Data - Notes 7 and 8 to the Consolidated Financial Statements.\"\nIn January 1994, the Company sold $5,000,000 of Secured Medium-Term Notes, 7.25% series due 2024. The proceeds were used to repay short-term debt incurred to complete the refinancing of $80,000,000 of the 10% and 10-1\/8% series Pollution Control Revenue Bonds in December 1993.\nIn June 1994, the Company sold $20,000,000 of Secured Medium-Term Notes, 7.2% series due 2000, the proceeds of which were used to retire other long- term debt.\nIn November 1994, the Company sold $10,000,000 of Secured Medium-Term Notes, 7.6% series due 1997 and $10,000,000 of Secured Medium-Term Notes, 7.85% series due 1998, the proceeds of which were used to retire three series of unsecured Medium-Term Notes, $9,000,000 of the 8.78% series due November 1994, $5,000,000 of the 8.57% series due December 1994 and $5,000,000 of the 8.78% series due December 1994.\nThe Company's Mortgage and Deed of Trust contains certain restrictions upon the issuance of additional First Mortgage Bonds. At December 31, 1994, the unfunded net property additions and retired bonds test, which is the most restrictive test, would have permitted the issuance of approximately $514,000,000 additional First Mortgage Bonds. There are no restrictions upon issuance of short-term debt or preferred stock in the Company's Restated Articles of Incorporation, its Mortgage and Deed of Trust or its Sinking Fund Debenture Agreement.\nSEC Ratio of Earnings to Fixed Charges:\nFor the twelve months ended December 31, 1994, the Company's ratio of earnings to fixed charges was 3.05 times. Fixed charges include interest, the implicit interest of Unit 4 rentals and one-third of all other rental payments.\nInflation:\nCapital intensive businesses, such as the Company's electric and natural gas utility operations, are significantly and adversely affected by long-term inflation as neither depreciation nor the ratemaking process reflect the replacement cost of utility plant. Although prices for natural gas may fluctuate, earnings of the Gas Utility are not impacted because a gas cost tracking procedure annually balances gas costs collected from customers with the costs of supplying gas.\nEntech's long-term coal contracts and the IPG's long-term power sales contracts provide for the adjustment of prices either through indices, fixed escalations and\/or direct pass-through of costs.\nThe Company believes that the effects of inflation, at currently anticipated levels, will not significantly affect results of operations.\nEnvironmental Issues:\nThe Company is committed to do its part to protect and maintain the environment. A management function is in place which monitors compliance and keeps management informed regarding the status of compliance.\nThe Clean Air Act Amendments of 1990 should have no major effects on the Company's electric generation facilities. The Company's coal-fired generating plants meet the 1995 Phase I requirements of the Act. Low-sulfur coal and state-of-the-art scrubbers already result in sulfur dioxide emissions from the Colstrip units well below the new requirements. Either fuel switching or the use of allowances, or both, would permit the Corette Plant to meet the Phase II requirements of the Act in 2000. The Company has agreed to a new State Implementation Plan required by the Federal Environmental Protection Agency to reduce sulfur dioxide emissions in Billings, Montana. Under the Plan, the Company will reduce its emissions at the Corette Plant from an average of 7,800 tons in 1987-93 to less than 5,000 tons annually. This reduction is expected to be obtained by changing the Plant's fuel to low-sulphur, compliance coal.\nModifications will be required at three units in the late 1990's to meet the nitrogen oxide emission standards of the Act. Phase II rules implementing the Act are subject to legal appeal, challenging their adoption. The Company, therefore, does not yet know what requirements may result from the Phase II Rules. Consequently, the capital costs associated with the modifications to meet the nitrogen oxide standards of the Act have not yet been determined. However, capital improvements that may be required are expected to be recovered through rates, and therefore, the costs are not expected to have a material impact on earnings.\nIn 1988, the United States Environmental Protection Agency advised the Company that it, along with certain other parties, is a potentially responsible party (PRP) for the release of certain toxic substances which have come to rest behind the dam at the Company's Milltown Hydroelectric Plant. Because of federal legislation specifically relating to Milltown, the Company believes it has no responsibility for any of the alleged releases. If the Company should have some responsibility, it would have to share, together with other responsible parties, the costs related to the handling of these toxic substances. While these costs have not been determined, the Company believes that any portion which it might bear would not have a significant impact upon its earnings.\nThe Company, along with others, has been named a PRP with respect to the Silver Bow Creek\/Butte Area Superfund Site. The alleged contamination is soil and groundwater contamination, for the most part, associated with decades of copper mining in the area. The PRPs have cooperated to summarize the data that currently exists, to evaluate the useability of this existing data and to determine additional data needs. Studies to determine the extent of the alleged contamination, and a proposal for removal or remediation of the alleged contamination are not complete.\nRegarding this superfund site, the Company has focused on its property ownership and alleged contamination that may be attributed to that ownership. It has spent approximately $650,000 to investigate its property within the site, collect data, evaluate studies and monitor its property. Costs to clean up this contamination, including sums spent in the studies mentioned above, are not expected to exceed $1,000,000.\nOther contamination at the Company's property within the site involves heavy metals and substances which may be attributed to mining and activities of others within the greater area of the site. Consultants employed by the PRPs to compile and analyze previously prepared study data regarding the greater area of this superfund site have made preliminary estimates indicating that clean-up costs could range from $20,000,000 to $60,000,000. While the Company denies any responsibility for costs associated with this contamination, if the Company should have some responsibility, it would have to share a portion of the costs ultimately related to the handling of the contamination.\nThe Company was also a PRP at another site of soil contamination in Montana, alleged to have resulted from the salvage of electric transformers by a third party or parties who obtained the transformers from the Company. The Company completed clean-up work at this site in 1994 and has received acceptance of the clean-up from the state agency with jurisdiction over this site. Costs incurred by the Company were approximately $610,000.\nThe Company is a PRP at two sites in the State of Washington where electric transformers were sent for salvage. At one of the sites, the Company is an extremely small contributor and liability will be de minimis. At the second site, pursuant to the terms of a Consent Decree, the Company has paid approximately $360,000. Clean-up at this site is near completion.\nMercury has been used in measurement devices used to measure natural gas production at the Company's properties. The Company has gathered information regarding mercury content in the surrounding wellhead sites and, with the appropriate state agency, is preparing a response strategy. Preliminary estimates indicate the Company may incur costs ranging from $250,000 to $750,000 to clean approximately 120 sites.\nA subsidiary of the Company operating oil and gas properties in Canada has notified regulatory authorities with jurisdiction over environmental matters of potential contamination that may have been caused by a leaking condensate tank. Contamination is contained at the site of the plant where the tank was situated and estimated clean-up costs are $250,000 in Canadian dollars. The Company's subsidiary owns 60% of the facility.\nThe Company has accrued the estimated minimum costs associated with these matters. The Company does not expect these costs to materially impact the results of its operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAND SUPPLEMENTARY DATA\nPage\nManagement's Responsibility for Financial Statements 50\nReport of Independent Accountants 51\nConsolidated Financial Statements:\nConsolidated Statements of Income for the Years Ended December 31, 1994, 1993 and 1992 52\nConsolidated Balance Sheets as of December 31, 1994 and 1993 53-54\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 55\nConsolidated Statements of Common Shareholders' Equity for the Years Ended December 31, 1994, 1993 and 1992 56\nNotes to Consolidated Financial Statements 57-83\nSupplementary Data (Unaudited) 84-92 Financial Statement Schedules for the Years Ended December 31, 1994, 1993 and 1992:\nSchedule VIII - Valuation and Qualifying Accounts and Reserves 97\nFinancial 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 in the Consolidated Financial Statements or notes thereto.\nMANAGEMENT'S RESPONSIBILITY FOR FINANCIAL STATEMENTS\nThe management of The Montana Power Company is responsible for the preparation and integrity of the consolidated financial statements of the Corporation. These financial statements have been prepared in accordance with generally accepted accounting principles which are consistently applied, and appropriate in the circumstances. In preparing the financial statements, management makes appropriate estimates and judgements based upon available information. Management also prepared the other financial information in the annual report and is responsible for its accuracy and consistency with the financial statements.\nManagement maintains systems of internal accounting control which are adequate to provide reasonable assurance that the financial statements are accurate, in all material respects. The concept of reasonable assurance recognizes that there are inherent limitations in all systems of internal control in that the costs of such systems should not exceed the benefits to be derived. Management believes the Company's systems provide this appropriate balance.\nThe Company maintains an internal audit function that independently assesses the effectiveness of the systems and recommends possible improvements. Price Waterhouse LLP, the Company's independent public accountants, also considered the systems in connection with its audit. Management has considered the internal auditors' and Price Waterhouse LLP's recommendations concerning the systems and has taken cost-effective actions to respond appropriately to these recommendations.\nThe Board of Directors, acting through an Audit Committee composed entirely of directors who are not employees of the Company, is responsible for determining that management fulfills its responsibilities in the preparation of the financial statements. The Audit Committee recommends, and the Board of Directors appoints, the independent public accountants. The independent accountants and internal auditors are assured of full and free access to the Audit Committee and meet with it to discuss their audit work, the Company's internal controls, financial reporting and other matters. The Committee is also responsible for determining that there is adherence to the Company's Code of Business Conduct (Code). The Code addresses, among other things, potential conflicts of interests and compliance with laws, including those relating to financial disclosure and the confidentiality of proprietary information.\nThe financial statements have been examined by Price Waterhouse LLP, which is responsible for conducting its examination in accordance with generally accepted auditing standards.\n\/s\/ Daniel T. Berube \/s\/ J. P. Pederson Daniel T. Berube J. P. Pederson Chairman of the Board and Vice President and Chief Executive Officer Chief Financial Officer\nReport of Independent Accountants\nTo the Board of Directors and Shareholders of The Montana Power Company\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of The Montana Power Company and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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 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, 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 Company is party to a long-term supply contract price dispute subject to arbitration. The outcome of the arbitration is final and binding on all parties to the contract retroactive to August 1, 1991. The ultimate outcome of the arbitration cannot be determined at present. No provision for any liability that may result upon completion of arbitration has been made in the accompanying consolidated financial statements.\nAs discussed in Note 9 to the consolidated financial statements, the Company changed its method of accounting for postretirement benefits other than pensions in 1993.\nPRICE WATERHOUSE LLP\nPortland, Oregon February 10, 1995 CONSOLIDATED STATEMENT OF INCOME The Montana Power Company and Subsidiaries\nCONSOLIDATED BALANCE SHEET The Montana Power Company and Subsidiaries ASSETS\nCONSOLIDATED STATEMENT OF CASH FLOWS The Montana Power Company and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - Summary of significant accounting policies:\nThe Company's accounting policies conform to generally accepted accounting principles. With respect to utility operations, such policies are in accordance with the accounting requirements and ratemaking practices of the regulatory authorities having jurisdiction.\nPrinciples of consolidation:\nThe Consolidated Financial Statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. The Independent Power Group (IPG) includes the Company's Colstrip Unit 4 operations. All material intercompany sales and purchases between the Utility, Entech and the IPG have been eliminated from revenues and expenses in the Consolidated Statement of Income. All other significant intercompany items have also been eliminated. See Note 10 for details.\nPlant and property:\nAdditions to and replacement of plant and property are recorded at original cost, which includes material, labor, overhead and contracted services. Cost includes interest capitalized and, with respect to utility plant, also includes an allowance for funds used during construction. Gas in underground storage is included in natural gas utility plant. Maintenance and repairs of plant and property, and replacements and renewals of items determined to be smaller than established units of plant, are charged to operating expenses. The cost of units of utility plant retired or otherwise disposed of, adjusted for removal costs and salvage, is charged to the accumulated provision for depreciation and depletion, and the cost of related replacements and renewals is added to utility plant. Gain or loss is recognized upon the sale or other disposition of Entech property, Independent Power Group property and Utility land.\nProvisions for depreciation and depletion are recorded at amounts substantially equivalent to calculations made on straight-line and unit-of-production methods by application of various rates based on useful lives of properties determined from engineering studies. The provisions for utility depreciation and depletion approximated 2.7% for 1994, 1993, and 1992 of the depreciable and depletable utility plant at the beginning of the year.\nThe Company and its subsidiaries have adopted two methods of accounting for oil and gas exploration and development costs. Entech's Oil Division uses the successful efforts method. The regulated natural gas utility capitalizes all costs associated with the successful development of a natural gas well and expenses those costs incurred on an unsuccessful well.\nThe Company is a joint-owner of Colstrip Units 1, 2, and 3 and of transmission facilities serving these Units. At December 31, 1994, the Company's joint ownership percentage and investment in these Units and transmission facilities were:\nUnits Transmission 1 & 2 Unit 3 Facilities Thousands of Dollars\nOwnership. . . . . . . . . . . . 50% 30% 30%* Plant in service . . . . . . . . 180,725 280,791 50,046 Plant under construction . . . . 248 1,028 6 Accumulated depreciation . . . . 80,576 85,700 10,959\n*This is an approximate ownership percentage. The ownership percentages are generally based on capacity rights on the various segments of the transmission system.\nThe Company also owns $36,321,000 and $33,024,000 of the Colstrip Unit 4 share of common production plant and transmission plant that had related accumulated depreciation of $11,755,000 and $5,786,000, respectively.\nEach joint-owner provides its own financing. The Company's share of direct expenses associated with the operation and maintenance of these joint facilities is included in the corresponding operating expenses in the Consolidated Statement of Income.\nUtility revenue and expense recognition:\nOperating revenues are recorded on the basis of service rendered. Costs of service are recognized on the accrual basis and charged to expense currently except for natural gas costs deferred pursuant to PSC-approved deferred gas accounting procedures and other costs deferred pursuant to regulatory decisions which are discussed in the following paragraph of this note.\nIn 1985, the Public Service Commission of Montana (PSC) approved an annual electric rate increase in the amount of $80,400,000 to be collected in accordance with a rate-moderation plan. During 1992, cash collected under this plan exceeded revenues recorded by $12,462,000. As of October 1992, all deferred revenues under the plan had been collected.\nRegulatory assets:\nIn the ratemaking process, tax costs and benefits related to certain temporary differences are recovered in rates on an as paid or \"flow-through\" basis. Financial Accounting Standards No. 109 \"Accounting for Income Taxes,\" (SFAS No. 109) requires that tax assets and liabilities be reflected on the Balance Sheet on an accrual basis. This timing difference requires the Company to recognize a regulatory asset for taxes accrued but not yet recovered in rates. That regulatory asset was $146,844,000 and $143,447,000 as of December 31, 1994 and 1993 respectively.\nIncluded in other regulatory assets are costs related to the Company's Demand Side Management (DSM) programs in the amounts of $27,521,000 and $17,987,000 for 1994 and 1993, respectively. The amounts are included in the Company's rate base and are being charged to income over a ten-year period. Certain other costs have also been deferred pursuant to PSC orders of which significant amounts will also be charged to income within the next ten years.\nCash and cash equivalents:\nFor the purposes of these financial statements, the Company considers all liquid investments with original maturities of three months or less to be cash equivalents.\nAllowance for funds used during construction:\nThe Company capitalizes, as a part of the cost of utility plant, an allowance for the cost of equity and borrowed funds required to finance construction work in progress. The rate used to compute the allowance is determined in accordance with a formula established by the FERC and was an average of 7.9% for 1994, 6.5% for 1993, and 7.3% for 1992. The Company capitalized an allowance for borrowed funds used during construction of $2,405,000, $1,372,000, and $1,255,000 for 1994, 1993, and 1992, respectively.\nAllowance for funds used for conservation expenditures:\nThe Company has been allowed by the PSC to capitalize, as part of its conservation expenditures, an allowance for the cost of equity and borrowed funds required to finance Demand Side Management expenditures. The rate used to capitalize the allowance is the Company's overall rate of return allowed by the PSC. The Company capitalized an allowance for borrowed funds used to finance DSM expenditures of $635,000, $561,000 and $290,000 for 1994, 1993 and 1992, respectively.\nIncome taxes:\nThe Company and its U.S. subsidiaries file a consolidated U.S. income tax return. Consolidated U.S. income taxes are allocated to Utility, Entech, and IPG operations as if separate U.S. income tax returns were filed. Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. For further information on income taxes see \"Regulatory Assets\" in this note and also Note 4 - \"Income Taxes.\"\nNet income per share of common stock:\nNet income per share of common stock is computed for each year based upon the weighted average number of common shares outstanding. The effect of options outstanding under the Company's Long-Term Incentive Plan is not significant (see Note 5).\nFinancial instruments:\nIn October 1994, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments,\" effective for fiscal years ending after December 15, 1994. This statement requires disclosure about derivative financial instruments - futures, forwards, swap and option contracts, and other financial instruments with similar characteristics.\nEntech uses derivative financial instruments to manage the price risk associated with its oil and natural gas operations. Entech is authorized to use swaps, collars and options (caps and floors) as approved by a committee of its officers, to hedge up to 75% of its estimated production of oil and natural gas. At December 31, 1994, Entech held no derivative financial instruments.\nThe Independent Power Group (IPG) has investments in independent power partnerships, some of which have entered into derivative financial instruments to hedge against interest rate exposure on floating rate debt and foreign currency and gas price fluctuations.\nStatement of Financial Accounting Standards No. 107, \"Disclosure About Fair Value of Financial Instruments,\" requires disclosure of the fair value of certain financial instruments. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgement is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and\/or estimation methodologies could result in different estimated fair value amounts.\nCash and temporary cash investments, accounts receivable, current assets, short-term borrowings, accounts payable and accrued liabilities are reflected in the financial statements at fair value because of the short-term maturity of these instruments.\nThe carrying amounts and estimated fair value of the Company's other significant financial instruments at December 31, 1994 are as follows:\nEstimated Carrying Fair Amount Value Thousands of Dollars\nAssets: Independent Power Investments. . . . . . $ 9,566 $ 5,482 Other Investments. . . . . . . . . . . . 31,690 31,875\nLiabilities: Long-Term Debt . . . . . . . . . . . . . $ 585,157 $ 544,639\nThe following methods and assumptions were used to estimate fair value:\nIndependent Power Investments - The fair value represents the Company's assessment of the present value of net future cash flows embodied in these investments, discounted to reflect current market rates of return. This represents only those investments accounted for on the cost basis. The investments accounted for on the equity basis are not presented.\nOther Investments - The carrying value of most of the investments approximates fair value as the investments have short maturities or the carrying value equals their cash surrender value. Other investments' fair value was estimated based on the discounted value of the future cash flows expected to be received using a rate of return expected on similar current investments.\nLong-Term Debt - The fair value was estimated using quoted market rates for the same or similar instruments. Where quotes were not available the fair value was estimated using the Company's year-end incremental borrowing rate.\nReclassifications:\nCertain reclassifications have been made to the prior year amounts to make them comparable to the 1994 presentation. These changes had no impact on previously reported results of operations or shareholders' equity.\nNOTE 2 - Contingencies:\nThe Company's hydroelectric projects are operated under licenses issued by the FERC, which expire on varying dates from 1995 to 2035. When a license expires, it may be reissued to the Company, issued to a new licensee or the facility may be taken over by the United States. In either of the last two events, the Company would be entitled to compensation equivalent to its net investment in the project plus severance damages. In determining net investment in the project, the licenses provide that there may be deducted the amount contained in an appropriated retained earnings account, which shall be accumulated from a portion of the amount earned in excess of a specified reasonable rate of return after 20 years of operation under the license. At December 31, 1994, the amount of these appropriated retained earnings relating to the Company's hydroelectric projects as computed by the Company is estimated to be $6,238,000. The Board of Directors has appropriated retained earnings in the same amount for this purpose, thereby restricting their availability for dividend purposes.\nUnder a joint 50-year license with the Confederated Salish and Kootenai Tribes (Tribes), the Company will own and operate the 180 megawatt Kerr Hydroelectric project until September 2015. The Tribes may take over the project anytime between 2015 and 2025 on one year's written notice in return for payment equal to the Company's remaining net investment. The Company pays the Tribes an annual rental fee that is adjusted yearly to reflect changes in the Consumer Price Index.\nIn 1990, the Company filed with the FERC a plan (the Plan), prepared pursuant to the joint license issued by the FERC to the Company and the Tribes, to mitigate damages to, and to manage fish and wildlife habitat impacted by the operation of the Kerr Hydroelectric Project. The Plan provides for a one-time payment by the Company of $15,418,000 and annual payments of $965,000 which would be adjusted annually to reflect the effects of inflation and which are to be allocated between the Tribes and various groups.\nAs part of its review of the Plan, FERC is preparing a draft environmental impact statement which is expected to suggest modifications to the Plan. In addition, the Department of Interior, pursuant to its authority under the Federal Power Act, has proposed certain conditions, requiring changes in the operation of the project, as well as non-operational measures which would be funded by an initial payment, annual payments based on a calculation of the Project's value as a base-load facility and further capital investments.\nWhile it cannot predict when or in what form the Plan finally will be approved, the Company expects that the cost of mitigation measures will be recovered through rates or from the Tribes if they exercise their right to take over the project and will not have a materially adverse effect on the Company's financial condition or results of operations.\nIn November 1992, the Company filed with FERC its application to relicense nine Madison and Missouri River hydroelectric facilities with electric generating capacity totaling 292 megawatts. The application, in preparation since 1989, proposes an additional 74 megawatts of generation. The total capital investment of relicensing, including physical improvements, environmental protection, mitigation and enhancement measures, is estimated at $173,000,000. Additional costs for operational changes, as well as annual payments for environmental protection, mitigation and enhancement, are estimated to be about $5,400,000 per year. The Company expects that the relicensing costs will be recovered through rates and, therefore, will not have a materially adverse effect on the Company's financial condition or results of operations.\nThe coal supply agreement for Colstrip Units 1 and 2 between Puget Sound Power & Light Company (Puget) and the Company's Utility Division, as co-owners of the units, and Western Energy Company, as coal supplier, provides for periodic price redeterminations over the life of the contract, commencing in 1991. Negotiations with respect to the 1991 redetermination were unsuccessful and an arbitration proceeding was held in January 1995. A decision is expected in late March 1995. Based upon the positions of the parties, the estimated effect on pretax net income at December 31, 1994 would range from an increase of approximately $4,000,000 to a decrease of approximately $12,000,000 on coal sold to Puget and, in addition, an increase of approximately $2,000,000 to a decrease of $12,000,000 on coal sold to the Company's Utility Division. The Company believes Western presented a convincing position in the arbitration. Further, the Company believes because its electric rates have been adjusted by a coal cost disallowance, they should not be subject to further adjustment. The Company, however, cannot predict the outcome of the arbitration nor any related rate proceeding.\nNOTE 3 - Commitments:\nThe Company purchases approximately 600 million kWh annually under an Exchange Agreement with the Washington Public Power Supply System and the Bonneville Power Administration which expires in 1996. The rate is 4.7 cents per kWh in the contract year which began in July 1994 and will increase to approximately 4.8 cents per kWh in the final contract year beginning July 1995. In 1993, the Company entered into a contract to purchase 98 megawatts of seasonal capacity from Basin Electric Power Cooperative beginning in 1996. Based upon projected deliveries, the rate, including the capacity charge, will be approximately 3.3 cents per kWh in the contract year beginning in November 1996 and will increase each subsequent year to approximately 7.1 cents per kWh in the final contract year which begins in November 2009.\nThe Company also has long-term purchase contracts with certain independent power producers and natural gas producers. The purchased power contracts provide for capacity payments subject to a facility meeting certain operating standards, and payments based on energy received. The purchased gas contracts provide for take-or-pay payments. The Entech Oil Division has various natural gas transportation contracts with terms that expire beginning in 1998.\nTotal payments under these contracts for the prior three years were as follows:\nThousands of Dollars\nYears Electric Natural Gas Entech 1992. . . . . . . $ 18,143 $ 12,496 $ 1,938 1993. . . . . . . 18,434 11,633 2,260 1994. . . . . . . 19,242 11,072 2,993\nThe present value of future minimum payments, at an assumed discount rate of 8%, under the above agreements are estimated as follows:\nThousands of Dollars\nYears Electric Natural Gas Entech 1995. . . . . . . $ 4,609 $ 9,032 $ 2,411 1996. . . . . . . 8,169 7,001 1,889 1997. . . . . . . 11,143 5,810 1,727 1998. . . . . . . 11,109 2,907 1,598 1999. . . . . . . 10,916 2,450 1,406 Remainder. . . .. 151,979 6,156 6,643 Total . . . . . $ 197,925 $ 33,356 $ 15,674\nIn 1993, the Company entered into contracts for the construction of a second powerhouse at the Thompson Falls Hydroelectric Plant. Expenditures for the project to date have been $28,300,000, while the total costs for the next two years are expected to be $20,600,000.\nAn Entech Coal Division coal lease purchase agreement requires minimum annual payments, beginning in 1991 in the amount of $1,125,000 escalated quarterly by the Gross National Product implicit price deflator. The payments will continue until the equivalent of $18,750,000, in 1986 dollars, has been paid. At December 31, 1994, the remaining payments under this agreement were $13,991,000. A similar agreement requires minimum annual payments of $1,000,000 through 1995. Under current mine plans, these payments should be recovered through coal sales.\nIn 1990, a patented coal enhancement process developed by the Entech Coal Division was selected for funding under the U.S. Department of Energy (DOE) Clean Coal Technology Program. The Coal Division and a subsidiary of Northern States Power are partners in a five-year, $69,000,000 coal enhancement demonstration project at Colstrip, Montana. DOE is funding 50% and the partners share equally in the remaining 50% of the cost of the project. The Division's remaining commitment at December 31, 1994, was $2,809,000.\nThe Entech Oil Division has agreed to supply approximately 138,000 Mmcf of natural gas to four cogeneration facilities over 10 to 16 years. The Oil Division has proven, developed and undeveloped reserves sufficient to supply all of the remaining natural gas required by these agreements.\nRental expense for the prior three years was as follows:\n1994 1993 1992 Thousands of Dollars\nColstrip Unit 4. . . . $ 32,226 $ 32,226 $ 32,226 Kerr project . . . . . 12,172 11,837 11,486 Other. . . . . . . . . 12,530 11,917 11,985 $ 56,928 $ 55,980 $ 55,697\nIn addition, operating expenses include delay rentals paid by the Company to retain mineral rights before development of leased acreage. Delay rentals were $1,015,000, $1,021,000, and $999,000 in 1994, 1993, and 1992, respectively.\nLeases:\nThe Company classifies leases as operating or capitalized leases. Capitalized leases are not material and are included in other long-term debt. On December 30, 1985, the Company sold its 30% share of Colstrip Unit 4 and is leasing back this share under a net lease. The transaction has been accounted for as an operating lease with semiannual lease payments of approximately $16,113,000 over the remaining term of the 25-year lease.\nAt December 31, 1994, the Company's future minimum operating lease payments are as follows:\nThousands of Year Dollars\n1995. . . . . . . . . . . . . . $ 35,265 1996. . . . . . . . . . . . . . 34,317 1997. . . . . . . . . . . . . . 34,022 1998. . . . . . . . . . . . . . 33,831 1999. . . . . . . . . . . . . . 33,781 Remainder . . . . . . . . . . . 356,260 Total . . . . . . . . . . . $ 527,476\nNOTE 4 - Income tax expense:\nIncome before income taxes for the years ended December 31, 1994, 1993 and 1992 was as follows:\n1994 1993 1992 Thousands of Dollars\nUnited States. . . . . . . . . . . . . $ 155,978 $ 150,290 $ 143,298\nCanada . . . . . . . . . . . . . . . . 9,144 8,791 6,047\nBrazil . . . . . . . . . . . . . . . . 3,696 2,250 3,359\n$ 168,818 $ 161,331 $ 152,704\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:\n1994 1993 1992 Thousands of Dollars\nComputed \"expected\" income tax expense . . $ 59,086 $ 56,466 $ 51,919\nAdjustments for tax effects of:\nStatutory depletion in coal mining operations . . . . . . . (4,983) (3,775) (5,920) General business and nonconventional fuel tax credits . . . . . . . . . . (5,130) (4,496) (3,723) State income tax, net . . . . . . . . . 4,772 4,704 3,332 Reversal of excess of U.S. utility income tax depreciation over financial accounting depreciation on utility plant additions. . . . . . . . . . . . . . 3,236 2,281 1,987\nOther . . . . . . . . . . . . . . . . . (1,755) (1,060) (1,956)\nActual income tax expense. . . . . . . . . $ 55,226 $ 54,120 $ 45,639\nIncome tax expense as shown in the Consolidated Statement of Income consists of the following components:\n1994 1993 1992 Thousands of Dollars\nCurrent\nUnited States. . . . . . . . . . . . $ 38,519 $ 31,039 $ 38,252\nCanada . . . . . . . . . . . . . . . 3,093 3,235 3,162\nBrazil . . . . . . . . . . . . . . . 1,080\nState. . . . . . . . . . . . . . . . 7,742 3,522 8,307\n50,434 37,796 49,721\nDeferred\nUnited States. . . . . . . . . . . . 4,426 13,664 (2,646)\nCanada . . . . . . . . . . . . . . . 850 374 (200)\nState. . . . . . . . . . . . . . . . (484) 2,286 (1,236)\n4,792 16,324 (4,082)\n$ 55,226 $ 54,120 $ 45,639\nDeferred tax liabilities (assets) are comprised of the following at December 31: 1994 1993 Thousands of Dollars\nPlant Related. . . . . . . . . . . . . . . . . . . $ 379,401 $ 372,236 Investment in nonutility generation projects . . . 21,752 16,370 Other. . . . . . . . . . . . . . . . . . . . . . . 21,309 16,260\nGross deferred tax liabilities . . . . . . . . . . 422,462 404,866\nCoal reclamation . . . . . . . . . . . . . . . . . (40,509) (37,321) Amortization of gain on sale\/leaseback . . . . . . (17,026) (18,090) Investment tax credit amortization . . . . . . . . (31,665) (32,801) Other. . . . . . . . . . . . . . . . . . . . . . . (20,392) (14,937)\nGross deferred tax assets. . . . . . . . . . . . . (109,592) (103,149) Net deferred tax liabilities (assets). . . . . . . 312,870 301,717\nPlus current deferred tax assets-net . . . . . . . 9,965 8,063\nTotal noncurrent deferred tax liabilities (assets) . . . . . . . . . . . . . . . . . . . . $ 322,835 $ 309,780\nThe change in net deferred liabilities differs from current year deferred tax expense as a result of the following:\nThousands of Dollars Increase (decrease) in total noncurrent deferred tax liabilities (assets) . . . . . . . . . . . . . . . . $ 13,055 Regulatory assets related to income taxes. . . . . . . (3,397) Current deferred tax asset-net . . . . . . . . . . . . (1,902) Amortization of investment tax credits . . . . . . . . (1,748) Other. . . . . . . . . . . . . . . . . . . . . . . . . (1,216) Deferred tax expense . . . . . . . . . . . . . . . . $ 4,792\nNOTE 5 - Common stock:\nAt December 31, 1994 and 1993, the Company had 120,000,000 shares of authorized common stock. The Company has a Shareholder Protection Rights Plan which provides one preferred share purchase right (Right) on each outstanding common share of the Company. Each Right entitles the registered holder, upon the occurrence of certain events, to purchase from the Company one one-hundredth of a share of Participating Preferred Shares, A Series, without par value. If it should become exercisable, each Right would have economic terms similar to one share of common stock of the Company. The Rights trade with the underlying shares and will, except under certain circumstances described in the Plan, expire on June 6, 1999, unless earlier redeemed or exchanged by the Company.\nThe Company's Dividend Reinvestment and Stock Purchase Plan allows owners of common and preferred stock, as well as Montana utility customers, to reinvest the dividends paid on their common and preferred stock to purchase shares of common stock. Participants in the plan may also elect to invest by purchasing up to $15,000 per quarter of common stock.\nThe Company has a Deferred Savings and Employee Stock Ownership Plan (Plan) that covers all regular eligible employees. The Company, on behalf of the employee, contributes a percentage of the amount contributed to the Plan by the employee. In 1990, the Company borrowed $40,000,000 at an interest rate of 9.2% to be repaid in equal annual installments over 15 years. The proceeds of the loan were lent on similar terms to the Plan Trustee, which purchased 1,922,297 shares of Company common stock. The loan, which is reflected as long-term debt, is offset by a similar amount in common shareholders' equity as unallocated stock. Company contributions plus the dividends on the shares held under the Plan are used to meet principal and interest payments on the loan. Shares acquired with loan proceeds are allocated to Plan participants. As principal payments on the loans are made, long-term debt and the offset in common shareholders' equity are both reduced. At December 31, 1994, 610,379 shares had been allocated to the participants' accounts.\nExpense for the Plan is recognized using the Shares Allocated Method, and consists of the following for the three years ended December 31, 1994:\n1994 1993 1992\nThousands of Dollars\nPrincipal allocated.................... $ 2,663 $ 2,663 $ 2,663 Interest incurred...................... 3,114 3,275 3,422 Dividends.............................. (3,046) (3,028) (3,014) Additional contribution................ 2,952 2,310 1,766\nTotal Expense..................... $ 5,683 $ 5,220 $ 4,837\nThe Company's amount of Plan costs funded, which currently is less than the aforementioned expense amounts, is included in utility rates. Accordingly, the difference of $968,000, $758,000 and $694,000 for the years ending December 31, 1994, 1993 and 1992, respectively, were recorded as a reduction of Plan expense.\nUnder the Long-Term Incentive Plan, options have been issued to Company employees. Options issued to Utility employees are not reflected in balance sheet accounts until exercised, at which time (i) authorized, but unissued shares are issued to the employee, (ii) the capital stock account is credited with the proceeds, and (iii) no charges or credits to income are made. Options issued to Entech and IPG employees are not reflected in balance sheet accounts. Rather, upon exercise, outstanding shares are purchased at current market prices and compensation expense is charged with the excess of the market price over the option price.\nOption activity is summarized below.\nNumber Option Price Of Shares Per Share\nOutstanding December 31, 1991 657,447 $11.4375 - 26.50 Granted - Exercised (116,905) 11.4375 - 22.125 Cancelled (4,457) 11.4375 - 22.125\nOutstanding December 31, 1992 536,085 $14.25 - 26.50 Granted - Exercised (118,243) 14.25 - 26.50 Cancelled (5,532) 14.25 - 26.50\nOutstanding December 31, 1993 412,310 $14.25 - 26.50 Granted 117,100 22.625 - 25.625 Exercised (43,884) 14.25 - 26.50 Cancelled (4,540) 14.25 - 26.50\nOutstanding December 31, 1994 480,986 $17.25 - 26.50\nOptions Exercisable at December 31, 1994 480,986\nOptions were granted at 100% of the closing price on the New York Stock Exchange on the date granted, and expire ten years from that date. Options granted prior to January 1, 1987 must be exercised in the order granted.\nIn 1994, 64,235 restricted stock awards were issued to certain Entech employees under the Long-Term Incentive Plan. Upon the achievement of performance and passage of time constraints, restrictions will be lifted and participants will retain, at no cost, the unrestricted shares. As they are earned, the awards are reflected as common stock and compensation expense on the Balance Sheet and Income Statement, respectively.\nNOTE 6 - Preferred stock:\nThe number of authorized shares of preferred stock is 5,000,000. No dividends may be declared or paid on common stock while cumulative dividends have not either been declared and set apart or paid on any of the preferred stock.\nPreferred stock, as shown in the Consolidated Balance Sheet, is in four series as detailed in the following table:\nShares Amount Issued and Thousands of Series Outstanding Dollars\n$6.875 500,000 $ 50,000 6.00 159,589 15,959 4.20 60,000 6,025 2.15 1,200,000 30,000 1,919,589 $ 101,984\nThe stated value and liquidation price of preferred shares is $100 for the $6.875 series, the $6.00 series and the $4.20 series and $25 for the $2.15 series, plus accumulated dividends. The preferred stock is redeemable at the option of the Company upon the written consent or affirmative vote of the holders of a majority of the common shares on thirty days notice at $110 per share for the $6.00 series, $103 per share for the $4.20 series and $25.25 per share for the $2.15 series, plus accumulated dividends. The $6.875 series is redeemable in whole or in part, at anytime on or after November 1, 2003 for a price beginning at $103.438 per share with annual decrements through the year 2013, after which the redemption price is $100 per share. At the annual meeting of shareholders in May 1994, shareholders approved a proposal permitting the redemption of the $2.15 series.\nNOTE 7 - Long-term debt:\nLong-term debt consists of the following: December 31 1994 1993 Thousands of Dollars First Mortgage Bonds: 7.7% series, due 1999...................... $ 55,000 $ 55,000 7 1\/2% series, due 2001.................... 25,000 25,000 7% series, due 2005........................ 50,000 50,000 8 1\/4% series, due 2007.................... 55,000 55,000 8.95% series, due 2022..................... 50,000 50,000 Secured Medium-Term Notes.................. 88,000 43,000 Pollution Control Revenue Bonds: City of Forsyth, Montana 6 1\/8% series, due 2023.............. 90,205 90,205 5.9% series, due 2023................ 80,000 80,000 Sinking Fund Debentures: 7 1\/2%, due 1998........................... 17,000 17,500 ESOP Notes Payable, due 2004................... 31,943 33,850 Unsecured Medium-Term Notes, Series A.......... 48,250 67,250 Long-Term Commercial Paper..................... 20,000 Other.......................................... 19,847 15,144 Unamortized Discount and Premium.......... (4,389) (3,880) 605,856 598,069 Less: Portion due within one year............. 16,980 26,199 $ 588,876 $ 571,870\nFirst Mortgage Bonds:\nThe Company's Mortgage and Deed of Trust imposes a first mortgage lien on all physical properties owned, exclusive of subsidiary company assets, and certain property and assets specifically excepted. The obligations collateralized are First Mortgage Bonds, including those First Mortgage Bonds securing Pollution Control Revenue Bonds set forth above, in the aggregate principal amount of $493,205,000 at December 31, 1994.\nSecured Medium-Term Notes:\nAt December 31, 1994 and 1993, the Company had outstanding $88,000,000 and $43,000,000 principal amount of Secured Medium-Term Notes, respectively, maturing from 3 to 30 years with interest rates varying between 7.20% and 8.11%.\nIn January 1994, the Company sold $5,000,000 of Secured Medium-Term Notes, 7.25% series due 2024. The proceeds were used to repay short-term debt incurred to complete the refinancing of $80,000,000 of the 10% and 10-1\/8% series Pollution Control Revenue Bonds in December 1993.\nIn June 1994, the Company sold $20,000,000 of Secured Medium-Term Notes, 7.2% series due 2000, the proceeds of which were used to retire other long- term debt.\nIn November 1994, the Company sold $10,000,000 of Secured Medium-Term Notes, 7.6% series due 1997 and $10,000,000 of Secured Medium-Term Notes, 7.85% series due 1998, the proceeds of which were used to retire three series of unsecured Medium-Term Notes, $9,000,000 of the 8.78% series due November 1994, $5,000,000 of the 8.57% series due December 1994 and $5,000,000 of the 8.78% series due December 1994.\nESOP Notes Payable:\nIn 1990, the Company borrowed $40,000,000 at an interest rate of 9.2% in a 15-year loan to be repaid in equal annual installments. The proceeds of the loan were used to purchase shares of the Company's stock to pre-fund a portion of the Company's matching requirements under the Deferred Savings and Employee Stock Ownership Plan. See Note 5 for further information.\nUnsecured Medium-Term Notes, Series A:\nAt December 31, 1994 and 1993, the Company had outstanding $48,250,000 and $67,250,000 principal amount of Medium-Term Notes, respectively, maturing from 1 to 28 years with interest rates varying between 8.68% and 8.90%.\nDuring 1994 the following Medium-Term Notes matured; on November 15, 1994, $9,000,000 of the 8.78% series due 1994, on December 15, 1994, $5,000,000 of the 8.57% series due 1994, on December 20, 1994, $5,000,000 of the 8.78% series due 1994. As previously mentioned, the Company retired these notes with the proceeds from the sale of Secured Medium-Term Notes.\nRevolving Credit Agreements:\nThe Company has a Revolving Credit and Term Loan Agreement that allows it to borrow up to $60,000,000, all of which was unused at December 31, 1994. Under the agreement, borrowings outstanding at October 31, 1995, must be repaid in eight quarterly installments beginning in January 1996.\nEntech has a Revolving Credit and Term Loan Agreement with a group of banks that allows it to borrow up to $75,000,000, all of which was unused at December 31, 1994. Under the agreement, borrowings outstanding at September 30, 1997 must be repaid at maturity.\nFixed or variable interest rate options are available under the facilities, with commitment fees on the unused portions.\nDuring the period 1995 through 1999, the Company is required to make the following maturity and sinking fund payments on long-term debt:\n1995 1996 1997 1998 1999 Thousands of Dollars\n7.7% First Mortgage Bonds.. $ 55,000 Secured Medium-Term Notes.. $ 10,000 $ 10,000 7 1\/2% Sinking Fund Debentures............... $ 500 $ 500 500 15,500 ESOP Notes Payable......... 2,082 2,274 2,483 2,712 2,961 Unsecured Medium-Term Notes.................... 10,000 8,750 7,500 2,500 2,500 Other...................... 4,398 12,613 303 301 300 $ 16,980 $ 24,137 $ 20,786 $ 31,013 $ 60,761\nNOTE 8 - Short-term borrowing:\nThe Company is currently authorized by the PSC to incur short-term debt not to exceed $150,000,000. The Company and Entech have short-term borrowing facilities with commercial banks that provide both committed, as well as uncommitted, lines of credit, and the ability to sell commercial paper. Bank borrowings either bear interest at the lender's floating base rate and may be repaid at any time, or have fixed rates of interest and maturities. Commercial paper has fixed rates of interest and maturities.\nAt December 31, 1994, the Company had lines of credit consisting of $65,000,000 committed and $75,400,000 uncommitted, and Entech had lines of credit consisting of $15,000,000 committed and $25,000,000 uncommitted. There is a commitment fee on the unused portion of some of these facilities which is not significant. The Company has the ability, subject to the previously mentioned PSC limitation, to issue up to $125,000,000 of commercial paper and Entech up to $50,000,000 of commercial paper based on the total of unused committed lines of credit and revolving credit agreements.\nAt December 31, 1994 and 1993, the Company's and Entech's short-term borrowing included the following:\n1994 1993 Thousands of Dollars\nNotes payable to banks MPC.......................... $ 90,000 $ 43,900 Entech....................... 14,000 8,000 Commercial paper Entech....................... 9,989 16,965 $ 113,989 $ 68,865\nNOTE 9 - Retirement plans:\nThe Company maintains trusteed, noncontributory retirement plans covering substantially all employees. Retirement benefits are based on salary, years of service and social security integration levels.\nIn 1994 and 1993, pension costs funded were less than SFAS No. 87 pension expense by $2,770,000 and $1,887,000, respectively and the difference was recorded as a reduction of unearned revenue. The amount of utility pension costs funded are included in rates. In 1992, pension costs funded exceeded SFAS No. 87 pension expense by $969,000 and the differences were recorded as unearned revenue. At December 31, 1994, the cumulative amount by which SFAS No. 87 pension expense exceeded pension costs funded was $1,408,000.\nThe assets of the plans consist primarily of domestic and foreign corporate stocks, domestic corporate bonds and U.S. Government securities.\nThe Company also has an unfunded, nonqualified benefit plan for senior management executives and directors that provides for defined benefit payments upon retirement over the life of the participant or to their beneficiary for a minimum fifteen-year period. Life insurance payable to the Company is carried on plan participants as an investment. Utility nonqualified benefit plan expense is not included in rates.\nNet pension and benefit expense includes the following components:\n1994 1993 1992 Thousands of Dollars\nService cost benefits earned during the period.......................... $ 8,442 $ 6,746 $ 5,287\nInterest cost on projected benefit obligation.......................... 13,430 12,077 9,978\nActual return market value of assets.. (13,051) (18,701) (12,688) Net amortization and deferral......... 3,788 10,891 4,642\nTotal net periodic pension and benefit expense................... $ 12,609 $ 11,013 $ 7,219\nThe funded status of the pension and benefit plans is as follows:\nDecember 31 1994 1993 Thousands of Dollars\nActuarial present value of accumulated plan benefits Vested...................................... $ 119,298 $ 120,550 Nonvested................................... 13,066 10,861\nAccumulated benefit obligation.................. 132,364 131,411 Effect of projected future compensation levels.. 40,474 62,278\nProjected benefit obligation.................... 172,838 193,689 Plan assets at fair value....................... 153,916 150,913\nPlan assets less than projected benefit obligation............................ (18,922) (42,776)\nUnrecognized net loss (gain) from past experience different from that assumed and effects of changes in assumptions............. (9,402) 16,675 Prior service cost not yet recognized in net periodic pension expense...................... 11,498 14,567 Unrecognized initial obligation................. 3,261 3,703\nPrepaid (Accrued) benefits expense............ $ (13,565) $ (7,831)\nThe following assumptions were used in the determination of actuarial present values of the projected benefit obligations:\nDecember 31 1994 1993\nAssumed discount rates: Active service and vested terminations........ 8.25% 7.00% Retired employees............................. 8.25% 7.00%\nLong-term rate of average compensation increase. 4.25%-5.20% 4.90%-5.45%\nLong-term rate on plan assets................... 8.50% 8.50%\nIn addition to providing pension benefits, the Company and its subsidiaries provide certain health care and life insurance benefits for eligible retired employees. Until 1993, the cost of retiree health care and life insurance benefits was recognized as expense on a pay-as-you-go (cash) basis. The cost of these benefits in 1993 and 1992 was $1,387,000 and $1,267,000, respectively.\nIn 1994, the Company established a pre-funding plan for postretirement benefits for utility employees retiring after January 1, 1993. Funding costs for the plan for 1994 were $1,487,000. The assets of the plan consist primarily of domestic and foreign corporate stocks, domestic corporate bonds and U.S. Government securities.\nThe Company adopted SFAS No. 106 effective January 1, 1993. SFAS No. 106 requires accrual of the expected cost of these postretirement benefits during the employees' years of service rather than when the costs are paid.\nIn accordance with an Accounting Order issued by the PSC in 1992, the Company recorded as a deferred expense $600,000 and $2,100,000 representing the increased costs in 1994 and 1993, respectively, from adopting SFAS No. 106 for the Utility Division. In its April 28, 1994 Order, the PSC allowed the Company to include in rates the full OPEB cost on the accrual basis provided by SFAS No. 106, including the amortization of the amounts previously deferred under a PSC Accounting Order from January 1, 1993 to April 27, 1994. Consequently, as of April 28, 1994, the Company commenced recognition of these utility postretirement benefits in expense in accordance with SFAS No. 106. The incremental increase in 1994 consolidated expenses due to the utility SFAS No. 106 expense recognition was approximately $1,500,000.\nThe cost of SFAS No. 106 adoption for the years ended December 31, 1994 and 1993, portions of which have been deferred or capitalized, includes the following components:\nDecember 31 1994 1993 Thousands of Dollars\nService cost on benefits earned during the year. . . . . . . . . . . . . $ 1,455 $ 1,356\nInterest cost on projected benefit obligation . . . . . . . . . . . . . . . 2,323 2,296\nActual return market value of assets. . . . (38)\nAmortization of transition obligation . . . 1,535 1,492\nTotal postretirement benefit cost . . . . . $ 5,275 $ 5,144\nThe funded status of the postretirement benefit plans other than pensions is as follows:\nDecember 31 1994 1993 Thousands of Dollars\nAccumulated benefit obligation: Fully eligible active employees . . . . . . $ 2,253 $ 1,920 Other active employees. . . . . . . . . . . 19,857 20,195 Retirees. . . . . . . . . . . . . . . . . . 8,751 12,298 Accumulated benefit obligation. . . . . . . 30,861 34,413 Plan assets at fair value . . . . . . . . . . 1,479 0 Plan assets less than projected benefit obligation. . . . . . . . . . . . . (29,382) (34,413) Unrecognized net transition obligation. . . . 25,560 27,519 Unrecognized net loss (gain) from past experience different from that assumed and effects of changes in assumptions. . . . . . . . . . . . . . . (2,417) 3,113 Prepaid (Accrued) benefits expense. . . . . . $ (6,239) $ (3,781)\nThe assumed 1994 health care cost trend rates used to measure the expected cost of benefits covered by the plans are 8.75% and 11% for the utility and non-utility operations, respectively. The utility trend rate decreases through 2002 to 6%. The nonutility trend rate decreases through 2004 to 5%. The trend rates are for pre-65 benefits since most of the plans provide a fixed dollar annual benefit for retirees over age 65. One Entech subsidiary's plan used a trend rate of 9% decreasing through 2003 to an ultimate rate of 5% for post-65 benefits. The effect of a 1% increase in each future year's assumed health care cost trend rates increases the service and interest cost from $3,800,000 to $4,200,000 and the accumulated postretirement benefit obligation from $29,400,000 to $32,300,000.\nOn January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" (SFAS No. 112) with respect to disability related benefits up to age 65. SFAS No. 112 requires the accrual of a liability or loss contingency for the estimated obligation for postemployment benefits. At December 31, 1993, the postemployment benefit liability for regulated utility operations was estimated to be $9,300,000, of which $2,400,000 had been accrued and included in rates. The remaining $6,900,000 was recorded in 1994 as a deferred charge and will be expensed and included in rates over the next ten years. The estimated December 31, 1993 postemployment benefit liability of $1,300,000 for non-utility operations has been charged to income in 1994. The Company is no longer self-insured for disability-related benefits resulting from claims occurring after December 31, 1993. Therefore, SFAS No. 112 will not apply to benefits after that date, except workman's compensation claims which are accrued and recovered in rates as previously discussed.\nNOTE 10 - Information on industry segments:\nThe Company's principal business includes regulated utility operations involving the generation, purchase, transmission and distribution of electricity and the production, purchase, transportation and distribution of natural gas. The Company, through Entech, engages in nonutility operations principally involving the mining and sale of coal, exploration for, and the development, production, processing and sale of oil and natural gas and the sale of telecommunication equipment and services. The Company, through its Independent Power Group (IPG), manages long-term power sales, develops and invests in independent power projects, and other energy-related businesses.\nSubstantially all of the natural gas produced by the Company's Canadian utility operations has been sold to the Company's United States utility operations.\nPre-tax operating income for the Utility, Entech, and IPG segments represents revenues excluding earnings from unconsolidated investments less all costs and expenses except interest and other (income) deductions-net. Immaterial intersegment sales are not disclosed.\nIdentifiable assets of each industry segment are those assets used in the Company's operations in such industry segments. Corporate assets are principally miscellaneous special funds, cash and temporary cash investments, other investments and unallocable property. The assets of the Company's Canadian operations were $79,337,000, $80,553,000 and $84,202,000 at December 31, 1994, 1993 and 1992, respectively.\nOperations Information:\nOperations Information:\nOperations Information:\nSUPPLEMENTARY DATA Oil and Natural Gas Producing Activities (Cont.)\nAs determined by engineers, utility natural gas reserves were revised during 1994, 1993 and 1992 due to a change in projected performance or a change in the Company's ownership interest in specific fields.\nIn 1994, Entech's U.S. oil and natural gas reserves increased as a result of the acquisition of oil interests in Kansas and the drilling of 25 development wells and 6 exploratory wells in Colorado, Montana, Oklahoma, and Wyoming. Natural gas liquid reserves decreased due to a lower liquid recovery factor experienced at the Fort Lupton, Colorado, gas processing plant. Higher oil market prices contributed to an upward revision in U.S. reserves. The Canadian companies participated in 21 development wells and 7 exploratory wells. Significant natural gas and natural gas liquid reserves were added as a result of exploratory well discoveries in the Grand Prairie and Saddle Lake areas of Alberta. A development well in the Caroline area in Alberta extended the new pool discovery from 1993. Significant oil reserves were added at Manyberries because of a new pool discovery and development drilling in 1994.\nIn 1993, Entech's U.S. oil and natural gas reserves increased as a result of the drilling of 55 development wells and 10 exploratory wells in Colorado, North Dakota, Wyoming, Oklahoma and Kansas. Natural gas liquid reserves increased due to the startup of the Fort Lupton, Colorado, gas processing plant in September 1993. Lower oil market prices contributed to downward revisions in U.S. reserves. The Canadian companies participated in 26 development and 13 exploratory wells. Significant gas reserves were added from discoveries in the exploratory wells. Additions in oil reserves were the result of two successful secondary recovery schemes completed in the Manyberries area in Southern Alberta during 1993. Revisions due to price and performance resulted in a net increase in natural gas liquid reserves and a net decrease in oil reserves.\nIn 1992, the drilling of 43 development wells and one exploratory well in Colorado, Wyoming, and Oklahoma, resulted in additions to Entech's oil and gas reserves in the United States. Price changes also added to the reserves of existing properties. The Canadian companies participated in 59 development and two exploratory wells, resulting in the addition of significant oil and gas reserves. Revisions due to price and improved performance provided a net increase in oil and gas reserves. Natural gas liquid reserves decreased due to a downward revision in unit working interest in the recently developed Shell Caroline area in Alberta.\nThe following table presents information for 1994, 1993 and 1992 on the capitalized costs relating to utility natural gas producing activities, costs incurred in utility natural gas property acquisition, exploration and development activities and certain utility natural gas production costs reflected in results of operations. As a regulated public utility, the Company is authorized to earn a rate of return on its utility natural gas plant rate base. The Company's cost of acquiring utility natural gas reserves and the net cost of natural gas in underground storage are included in the natural gas plant which is a part of the utility rate base. Due to the commingling of produced natural gas with purchased and royalty natural gas for sale to utility customers and application of the ratemaking process to the utility natural gas producing activities, the Company is unable to identify revenues resulting solely from utility natural gas producing activities. Accordingly, the information on revenues, income taxes, results of operations and estimated future net cash flows and changes therein relating to proved utility natural gas reserves are not presented for the Company's utility natural gas producing activities.\nThe following table presents information for 1994, 1993 and 1992 on the capitalized costs relating to Entech oil and natural gas producing activities, costs incurred in Entech oil and natural gas property acquisition, exploration and development activities and results of Entech operations for oil and natural gas producing activities:\nSUPPLEMENTARY DATA Oil and Natural Gas Producing Activities (Cont.)\nEstimated future cash flows are computed by applying year-end prices and contract prices, when appropriate, of oil and natural gas to year-end quantities of proved reserves. Estimated future development and production costs are determined by estimating the expenditures to be incurred in developing and producing the proved oil and natural gas reserves at the end of the year, based on year-end costs. Estimated future income tax expenses are calculated by applying year-end statutory tax rates to estimated future pretax net cash flows related to proved oil and natural gas reserves, less the tax basis of the properties involved. The future income tax expenses give effect to permanent differences, tax credits and deferred taxes relating to proved oil and natural gas reserves.\nThese estimates are furnished and calculated in accordance with requirements of the Financial Accounting Standards Board and the Securities and Exchange Commission (SEC). Management believes the usefulness of these projections is limited because of the unpredictable variances in expenses, capital forecasts and crude oil and natural gas prices. Estimates of future net cash flows presented do not represent management's assessment of future profitability or future cash flow to the Company. Management's investment and operating decisions are based upon reserve estimates that include proved reserves prescribed by the SEC as well as probable reserves, and upon different price and cost assumptions from those used here.\nStandardized Measure of Discounted Future Net Cash Flows and Changes Therein Relating to Proved Oil and Natural Gas Reserves\nQuarterly Financial Data\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS\nSee Item 1. Business - \"Executive Officers.\"\nInformation on Directors is incorporated by reference from the Company's Notice of 1995 Annual Meeting of Shareholders and Proxy Statement, pages 1-3.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference from Notice of 1995 Annual Meeting of Shareholders and Proxy Statement, pages 5-8.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference from Notice of 1995 Annual Meeting of Shareholders and Proxy Statement, pages 3-4.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated by reference from Notice of 1995 Annual Meeting of Shareholders and Proxy Statement, page 14.\nPART IV\nITEM 14.","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) The Company filed the following reports on Form 8-K:\nDate Subject\nNone\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n3. Exhibits Incorporation by Reference Previous Previous Exhibit Filing Designation\n3(a) Restated Articles of Incorporation 33-42882 4(a) 3(a)(1) Restated Articles of Incorporation 33-56739 3(a) 3(a)(2) Amendments to the Restated Articles of Incorporation 33-56739 3(a) 3(b) By-laws, as amended 33-42882 4(b) 3(b)(1) Amendments to By-laws 4(a) Mortgage and Deed Trust 2-5927 7(e) 4(b) First Supplemental Indenture 2-10834 4(e) 4(c) Second Supplemental Indenture 2-14237 4(d) 4(d) Third Supplemental Indenture 2-27121 2(a)-5 4(e) Fourth Supplemental Indenture 2-36246 2(a)-6 4(f) Fifth Supplemental Indenture 2-39536 2(a)-7 4(g) Sixth Supplemental Indenture 2-49884 2(a)-8(a) 4(h) Seventh Supplemental Indenture 2-52268 2(a)-9 4(i) Eighth Supplemental Indenture 2-53940 2(a)-10 4(j) Ninth Supplemental Indenture 2-55036 2(a)-11 4(k) Tenth Supplemental Indenture 2-63264 2(a)-12 4(l) Eleventh Supplemental Indenture 2-86500 2(a)-13 4(m) Twelfth Supplemental Indenture 33-42882 4(c) 4(n) Thirteenth Supplemental Indenture 33-55816 4(a)-14 4(o) Fourteenth Supplemental Indenture 33-64576 4(c) 4(p) Fifteenth Supplemental Indenture 33-64576 4(d) 4(q) Sixteenth Supplemental Indenture 33-50235 99(a) 4(r) Seventeenth Supplemental Indenture 33-56739 99(a) 4(s) Eighteenth Supplemental Indenture 33-56739 99(b)\nInstruments defining the rights of holders of long-term debt which are not required to be filed with the Commission will be furnished to the Commission upon request.\nIncorporation by Reference\nPrevious Previous Exhibit Filing Designation\n4(t) Rights Agreement dated as of 33-42882 4(d) June 6, 1989, between The Montana Power Company and First Chicago Trust Company of New York, as Rights Agent\n10(a)(i) Benefit Restoration Plan for 33-42882 10(a)(i) Senior Management Executives and Board of Directors\n10(a)(ii) Deferred Compensation Plan for 33-42882 10(a)(ii) Non-Employee Directors\nIncorporation by Reference\nPrevious Previous Exhibit Filing Designation\n10(a)(iii) Long-Term Incentive Stock 1-4566 10(a)(iii) Ownership Plan 1992 Form 10-K\n10(a)(iv) The Montana Power Company 33-28096 4(c) Employee Stock Ownership Plan (Revised)\n10(a)(v) Termination Compensation 1-4566 10(a)(v) Agreements with Senior 1992 Management Executives Form 10-K\n10(a)(v)(1) Amendments to Termination Compensation Agreements with Senior Management Executives\n10(c) Participation Agreements among 33-42882 10(c) United States Trust Company of New York, Burnham Leasing Corporation, and SGE (New York) Associates, Certain Institutions, The Montana Power Company and Bankers Trust Company\n12 Statement re computation of ratio of earnings to Fixed Charges\n21 Subsidiaries of the registrant\n27 Financial Data Schedule\nTHE MONTANA POWER COMPANY AND SUBSIDIARIES SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES Thousands of Dollars\nCOLUMN A COLUMN B COLUMN C COLUMN D COLUMN E Balance Additions at Charged to Charged to Balance beginning costs and other at close Description of period expenses accounts Deductions of period\n(Note a)\nYear Ended:\nDecember 31, 1994 Reserves deducted in balance sheet from assets to which they apply: Doubtful accounts Utility $ 748 $ 781 $ $ 721 $ 808 Entech 643 156 (9) 174 616\nTotal $ 1,391 $ 937 $ (9) $ 895 $ 1,424\nDecember 31, 1993 Reserves deducted in balance sheet from assets to which they apply: Doubtful accounts Utility $ 688 $ 764 $ $ 704 $ 748 Entech 529 391 17 294 643\nTotal $ 1,217 $ 1,155 $ 17 $ 998 $ 1,391\nDecember 31, 1992 Reserves deducted in balance sheet from assets to which they apply: Doubtful accounts Utility $ 628 $ 1,361 $ $ 1,301 $ 688 Entech 387 345 3 206 529\nTotal $ 1,015 $ 1,706 $ 3 $ 1,507 $ 1,217\nNOTES: (a) Deductions are of the nature for which the reserves were created. In the case of the reserve for doubtful accounts, deductions from this reserve are reduced by recoveries of amounts previously written off. \/TABLE\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 MONTANA POWER COMPANY\nBy \/s\/ Daniel T. Berube Daniel T. Berube (Chairman of the Board)\nDate March 21, 1995\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\/ Daniel T. Berube Principal Executive Daniel T. Berube Officer and Director March 21, 1995 (Chief Executive Officer)\n\/s\/ J. P. Pederson Principal Financial J. P. Pederson and Accounting Officer March 21, 1995 (Vice President and Chief and Director Financial Officer)\n\/s\/ Alan F. Cain Director March 21, 1995 Alan F. Cain\n\/s\/ R. D. Corette Director March 21, 1995 R. D. Corette\n\/s\/ Kay Foster Director March 21, 1995 Kay Foster\n\/s\/ Robert P. Gannon Director March 21, 1995 Robert P. Gannon\n\/s\/ Beverly D. Harris Director March 21, 1995 Beverly D. Harris\n\/s\/ Chase T. Hibbard Director March 21, 1995 Chase T. Hibbard\n\/s\/ Daniel P. Lambros Director March 21, 1995 Daniel P. Lambros\n\/s\/ Carl Lehrkind, III Director March 21, 1995 Carl Lehrkind, III\n\/s\/ James P. Lucas Director March 21, 1995 James P. Lucas\n\/s\/ Arthur K. Neill Director March 21, 1995 Arthur K. Neill\n\/s\/ George H. Selover Director March 21, 1995 George H. Selover\n\/s\/ N. E. Vosburg Director March 21, 1995 N. E. Vosburg\nConsent of Independent Accountants\nWe hereby consent to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 No. 33-56739, to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 No. 33-64922, to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 No. 33-43655, to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-8 No. 33-64576, to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-8 No. 33-24952, to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-8 No. 33-28096, to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 No. 33-32275 and to the incorporation by reference in the Prospectus constituting part of the Registration Statement on Form S-3 No. 33-55816 of our report dated February 10, 1995 appearing on page 51 of The Montana Power Company's Annual Report on Form 10-K for the year ended December 31, 1994.\nPRICE WATERHOUSE LLP\nPortland, Oregon March 23, 1995\nEXHIBIT INDEX\nExhibit (3)(b)(1) Amendments to By-laws\nExhibit 10(a)(v)(1) Amendments to Termination Compensation Agreements with Senior Management Executives\nExhibit 12 Statement re computation of ratio earnings to Fixed Charges\nExhibit 21 Subsidiaries of the registrant\nExhibit 27 Financial Data Schedule","section_15":""}
{"filename":"354952_1994.txt","cik":"354952","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nSeagate Technology, Inc. (herein \"Seagate Technology\", \"Seagate\" or the \"Company\") designs, manufactures and markets a broad line of rigid magnetic disc drives for use in computer systems ranging from notebook computers and desktop personal computers to workstations and supercomputers as well as in multimedia applications such as digital video and video-on-demand. The Company's products include over 100 rigid disc drive models with form factors from 2.5 to 5.25 inches and capacities from 130 megabytes to 9 gigabytes. The Company sells its products to original equipment manufacturers (\"OEMs\") for inclusion in their computer systems or subsystems, and to distributors, resellers and dealers. The Company has pursued a strategy of vertical integration and accordingly designs and manufactures rigid disc drive components including recording heads, discs, substrates, motors and custom integrated circuits. It also assembles certain of the key subassemblies for use in its products including printed circuit board and head stack assemblies. The Company's products are currently manufactured primarily in the Far East with limited production in the United States.\nIn addition to pursuing its core rigid disc drive business, the Company is broadening its business strategy as a data technology company to more fully address the markets for storage, retrieval and management of data. In this regard, the Company has implemented a strategy to sell selected magnetic recording components including thin-film heads, head stack assemblies and motors to other manufacturers. The Company is also investigating various opportunities to invest in software activities in which software might be sold together with the Company's products or marketed separately to third parties. Finally, the Company's broadened strategy may include expanding its traditional rigid disc drive business to include other forms of data storage and retrieval, such as flash memory, where the Company has made a significant investment in SunDisk Corporation (\"SunDisk\"), a flash memory company. The Company anticipates that this broadened strategy may include acquisitions of, investments in and strategic alliances regarding complementary businesses, products and technologies. Neither the components business, the software business nor the investment in SunDisk was material to the Company's results of operations for fiscal 1994.\nSOFTWARE EXPANSION\nThe Company is seeking to leverage its name recognition, existing presence in international markets, distribution channels and OEM relationships with software products directed towards the client\/server environment.\nThe Company anticipates that users of computer systems will increasingly rely upon client\/server network computing environments. Seagate believes that as this reliance increases, users will demand software that more efficiently and securely manages data across computer networked environments. As such, the Company is attempting to broaden its core competencies to include software products to meet these requirements.\nIn October 1993 Seagate completed its purchase of Caltex Software, Inc., a development stage company located in Dallas, Texas. Caltex is developing an application development system and database management product for the Macintosh and Windows platforms.\nIn May 1994 Seagate acquired Crystal Computer Services, Inc., a Vancouver, Canada based developer and marketer of data access and reporting software for the Windows platform. These products are sold as Crystal Reports, Crystal Reports Pro and Crystal Reports Server.\nIn August 1994 the Company acquired Palindrome Corporation, an Illinois based developer of data production and management software for NetWare based networks and enterprise LANs.\nSeagate intends to continue its expansion into software by actively pursuing discussions with companies that fit with its strategy. Key to the Company's software expansion success is acquiring companies that possess\ntechnology, development personnel and management providing long-term growth potential. However, implementation of this broadened strategy entails risks of entering markets in which the Company may have limited or no experience. In addition, such broadened strategy could result in the diversion of management's attention from the core rigid disc drive business which could adversely impact the core business. The broadened strategy has entailed and may continue to entail acquisitions of, or investments in, businesses, products and technologies. Acquisitions involve numerous risks, including difficulties in the assimilation of the operations and products of the acquired businesses and the potential loss of key employees or customers of the acquired businesses.\nRIGID DISC DRIVE TECHNOLOGY\nMagnetic disc drives are used in computer systems to record, store and retrieve digital information. Most computer applications require access to a greater volume of data than can economically be stored in the random access memory of the computer's central processing unit (commonly known as \"semiconductor\" memory). This information can be stored on a variety of storage devices, including rigid disc drives, flexible disc drives, magnetic tape drives, optical disc drives and semiconductor memory. Rigid disc drives provide access to large volumes of information faster than optical disc drives, flexible disc drives or magnetic tape drives and at substantially lower cost than high-speed semiconductor memory.\nAlthough products vary, all rigid disc drives incorporate the same basic technology. Inside a sealed housing, one or more rigid discs are attached to a spindle assembly that rotates the discs at a high constant speed around a hub. The discs, or media, are the components on which data is stored and from which it is retrieved. Each disc typically consists of a substrate of finely machined aluminum or glass with a magnetic layer of a \"thin-film\" metallic material.\nRead\/write heads, mounted on an arm assembly similar in concept to that of a record player, fly extremely close to each disc surface, and record data on and retrieve it from concentric tracks in the magnetic layers of the rotating discs.\nAreal density is a measure of storage capacity per square inch on the recording surface of a disc. It represents the number of bits of information on a linear inch of the recording track (called bits per inch or bpi) multiplied by the number of recording tracks on a radial inch of the disc. With the proliferation of multimedia applications, the demand for increased areal densities has and continues to increase at an accelerating rate since sound and moving pictures require many times the storage capacity of simple text. The Company is aggressively pursuing a range of technologies to increase areal densities across the entire range of its products including the use of advanced signal processing techniques such as PRML (Partial Response Maximum Likelihood) read\/write channels, advanced servo systems, higher precision mechanics and a more advanced head technology. Today, all Seagate drives use inductive thin-film heads, which are based on semiconductor processing technology. However, to attain greater areal densities, the Company currently has under development magneto-resistive (\"MR\") thin-film heads to be incorporated into future products. MR heads have discrete read and write structures which take advantage of special magnetic properties in certain metals to achieve significantly higher storage capacities. There can be no assurance that the Company's development efforts will be successful. See \"Product Development.\"\nUpon instructions from the drive's electronic circuitry, a head positioning mechanism (an \"actuator\") guides the heads to the selected track of a disc where the data will be recorded or retrieved. The disc drive communicates with the host computer through an internal controller. Disc drive manufacturers may use one or more of several industry standard interfaces, such as IPI (Intelligent Peripheral Interface), SCSI (Small Computer System Interface), ATA (AT Attachment), PCMCIA (Personal Computer Memory Card International Association) or proprietary interfaces, such as EISA (Extended Industry Standard Architecture).\nRigid disc drive performance is commonly measured by four key characteristics: average seek time (commonly expressed in milliseconds), which is the time needed to position the heads over a selected track on the disc surface; internal data transfer rate (commonly expressed in Megabits per second), which is the rate at which data is transferred to and from the disc; storage capacity (commonly expressed in Megabytes), which is\nthe amount of data that can be stored on the disc; and spindle rotational speed (commonly expressed in revolutions per minute), which has an effect on average latency or access to data.\nMARKET OVERVIEW\nRigid disc drives are used in a broad range of computer systems as well as multimedia applications such as digital video and video-on-demand. The Company defines the major computer system markets to include mobile computers, personal computers, mid-range systems and high-end applications. Users of computer systems are increasingly demanding additional data storage capacity with higher performance in order to (i) use more sophisticated applications software, including database management, CAD\/CAM\/CAE, desktop publishing and enhanced graphics applications, and (ii) operate in multiuser, multitasking and multimedia environments.\nPersonal and Mobile Computers\nDesktop and portable personal computers are used in a number of environments, ranging from homes to businesses and multiuser networks. Software applications are primarily word processing, spreadsheet, desktop publishing, database management, multimedia and other related applications. The Company believes the minimum storage requirements in the past year for entry-level personal computers were generally 130 megabytes (\"MB\") to 500 MB of formatted capacity with average seek times of 15 milliseconds (\"msec\") or less. As the personal computer market has matured, users of personal computers have become increasingly price sensitive. The Company's objective for the desktop and portable personal computer market is to design drives for high-volume, low-cost manufacture.\nSmaller footprint microcomputers, such as portable, laptop, notebook and sub-notebook computers require rigid disc drives in form factors of 2.5 inches or less that emphasize durability and low power consumption in addition to capacity and other performance characteristics found in their desktop functional equivalents. Personal digital assistants, handheld and pen-based computers may use 1.8 or 2.5 inch hard disc drives or flash memory in the form of a PCMCIA card for additional memory. These applications also emphasize low power consumption as well as very high degrees of durability.\nMid-Range Systems\nMid-range systems include high performance microcomputers, technical workstations, servers and departmental minicomputers. Applications are characterized by compute-and data-intensive solutions, such as CAD\/CAM\/CAE, network management, larger database management systems, scientific applications and small to medium-sized business applications such as materials requirement planning, payroll, general ledger systems and related management reports. Mid-range systems typically require rigid disc drive storage capacities from 400 MB to 2.5 gigabytes (\"GB\") per drive and average seek times of less than 12 msec. Mid-range systems typically use 3.5 and 5.25 inch disc drives. Due to the leading edge characteristics required by end-users of mid-range systems, manufacturers of such systems emphasize performance as well as price as the key selling points.\nHigh-End Applications\nLarge systems include mainframes and supercomputers. Typical applications are medium and large business management systems, transaction processing, parallel processing applications and other applications requiring intensive data manipulation. Also inclusive in high-end applications are systems designed for video-on-demand and near-line storage.\nUsers of these systems generally require capacities of 1.0 GB to 9 GB per drive with average seek times of less than 12 msec. End-users of large systems are less concerned than users of smaller systems with the size, weight, power consumption and absolute cost of the drive. As with mid-range systems, disc drive products are typically designed into these systems by the OEM with emphasis on performance, reliability and capacity. In this arena, data storage subsystems are used containing large numbers of spindles. Data integrity is paramount,\nso high device reliability and maintainability are key features. Mainframe, supercomputer and digital video systems also benefit from very high device data rates (up to ten times that in small computer systems).\nPRODUCTS\nThe Company's products include over 100 rigid disc drive models with form factors from 2.5 to 5.25 inches and capacities from 130 megabytes to 9 gigabytes. The Company provides more than one product at some capacity points and differentiates products on a price\/performance and form factor basis. The Company believes that its broad range of rigid disc drives is particularly appealing to customers, such as large OEMs, which require a wide variety of drive capacities, performance levels and interfaces. Producing for several market segments also broadens the Company's customer base and reduces the Company's reliance on any one segment of the computer market. The Company continues to devote its resources to developing products with industry leading performance characteristics and to being among the first to introduce such products to market. The Company continuously seeks to enhance its market presence in emerging segments of the rigid disc drive market by drawing on its established capabilities in high-volume, low-cost production. The Company believes it offers the broadest range of disc storage products available.\nMobile Computing\n2.5 INCH DISC DRIVES\nAnnouncement of the Company's first 2.5 inch family of drives was made in November 1990 with the ST9096 family. The Company has continued to expand its 2.5 inch family with two different form factors, the 19mm high form factor which is designed to address the highest capacity segment of the mobile computing market, and the 12.5mm high form factor which is designed to address the sub-notebook market. In November 1992 the Company introduced a patented shock sensing technology called SafeRite(TM). SafeRite technology allows for a much higher specification of operating shock and helps to prevent the drive from writing data \"off track\". This technology has been implemented in all of the Company's 2.5 inch drives.\nIn October 1993 the Company announced its ST9550 family. This 19mm height family is available in 455 and 341 MB versions. Volume production began in the third quarter of fiscal 1994. In January 1994 the 12.5mm high ST9300 family was announced with 262, 210 and 131 MB versions. Volume production began in the fourth quarter of fiscal 1994. Future plans for the 2.5 inch family of drives include continued higher capacities and lower cost designs.\n1.8 INCH DISC DRIVES\nSystems manufacturers are producing a variety of products which can utilize the 1.8 inch form factor. However, the Company believes it will be some time before there is a demand for large volumes of these drives. Although the Company has discontinued production of its initial 1.8 inch products, it plans to continue its efforts to design and produce higher capacity 1.8 inch products with interface and power management enhancements to meet the new market demands. Certain of the Company's competitors have been much more active in the development and marketing of less than 2.5 inch form factor products. Consequently, there can be no assurance that the Company's efforts will be successful.\nEntry-Level PC Computing\nIn October 1993 the Company announced the ST3491 family of 3.5 inch low-profile cost-effective disc drives. The family features capacity points ranging from 214 to 428 MB of formatted capacity. The design was leveraged from the earlier ST3290 and ST3144 products that had been shipping in volume in 1993. The ST3491 family, later named the Medalist XE family, began volume shipments in the third quarter of fiscal 1994.\nAlso in October 1993 the Company announced the Decathlon family of disc drives. The Decathlon family features a 3.5 inch, 19mm high profile which targets the emerging ultra-low profile PCs. This family also enables a mini-array package whereby up to six drives can be mounted in the space of one 5.25 inch full height\ndrive. In addition to its unique form factor, the Company believes the Decathlon family offers the most energy efficient design in its class, providing advanced power savings for \"Green PCs\" and Energy Star systems. Volume production of the first product in this family, the ST5660 with 545 MB of formatted capacity, commenced in the first quarter of fiscal 1995.\nIn May 1994 the Company announced the expansion of the Medalist family to include a higher performance series of products with 1 GB and 720 MB formatted capacities. These products are directed to the growing capacity and cost-effective requirements of the PC market. They are expected to go into volume production in the first quarter of fiscal 1995.\nMid-Range Systems\nIn October 1992 the Company expanded its low-profile 3.5 inch mid-range product line with the ST31200, a high performance drive with 1 GB of formatted capacity that began production during the first quarter of fiscal 1994. In October 1993 the Company expanded that product family to a 2 GB formatted capacity platform with the family name of Hawk. The Hawk 2 went into production the fourth quarter of fiscal 1994. In January 1994 the Hawk 4, 3.5 inch half-height 4 GB formatted capacity drive, was announced. Volume production is expected to begin the first quarter of fiscal 1995. The Company plans to continue designing and manufacturing for the higher capacity, high performance and cost sensitive requirements of this market.\nHigh-End Computing\nHigh-end applications range from digital video, video-on-demand, high-end file servers, mainframes and minicomputers to supercomputers. Two new product families have been introduced by the Company to address this wide range of applications. The Barracuda family of 3.5 inch drives, first introduced in October 1992, had the highest rotational speed of any drives produced at that time. Since then three additional products have been added to the family. The Barracuda 4 and Barracuda 2-2HP were introduced in October 1993. The Barracuda 4 is a 4 GB formatted capacity, 7200 RPM drive in the half-height form factor. Volume production is expected in the first quarter of fiscal 1995. The Barracuda 2-2HP is a 2 GB formatted capacity high-performance drive in the half-height form factor featuring the 2 head parallel design which doubles the data transfer rate. Volume production of this product began in the first quarter of fiscal 1995.\nIn January 1994 the Company announced the Barracuda 2, a 3.5 inch low-profile, one-inch high, 2 GB formatted capacity disc drive. Volume production of this product also began in the fourth quarter of fiscal 1994.\nAddressing the high-end 5.25 inch market the Company has continued to leverage its Elite product line. The Elite 3, with 2.9 GB of formatted capacity began volume shipments in August 1992 and has continued to supply the mainframe, enterprise and departmental server market. To address the emerging digital video and near-line storage applications the Company introduced the Elite 9 in October 1993. The Elite 9 leverages the established design of the Elite family to an expanded 9 GB of formatted capacity. Volume production began in the fourth quarter of fiscal 1994.\nOther Products\nThe Company markets solid-state flash memory devices designed and manufactured by SunDisk. These devices are designed for both integrated (embedded) applications and removable applications. The flash devices range from 1.8 MB to 41.9 MB and are best suited for highly rugged, power-sensitive environments. The Company plans to continue to market, sell and, in the future, jointly design and manufacture flash memory devices with SunDisk.\nThe Company offers warranty and out-of-warranty repair service to users of its disc drives. The Company also designs and manufactures disc drive components, primarily thin-film heads, principally for use in its own products but also for sale to other disc drive manufacturers.\nMARKETING AND CUSTOMERS\nThe Company sells its products to OEMs and distributors. OEM customers incorporate Seagate disc drives into computer systems for resale. OEMs either manufacture and assemble computer system components into computer systems; purchase components to build their systems; or purchase complete computer systems and integrate the hard disc drives and other hardware and software. Distributors typically resell Seagate disc drives to small OEMs, dealers and other resellers. Certain resellers to which the Company directly sells its products also resell Seagate drives as part of enhanced packages (e.g., an add-on kit for a computer or as part of their own computers). Shipments to OEMs were 68%, 70% and 56% of net sales in fiscal 1994, 1993 and 1992, respectively. No customer accounted for 10% or more of consolidated net sales in 1994 and 1992. During fiscal 1993 sales to Sun Microsystems, Inc. accounted for approximately 11% of the Company's consolidated net sales. No other customer accounted for 10% or more of consolidated net sales in 1993.\nOEMs -- OEM customers typically enter into purchase agreements with the Company. These agreements provide for pricing, volume discounts, order lead times, product support obligations and other terms and conditions, usually for periods of 12 to 24 months, although product support obligations generally extend substantially beyond this period. These master agreements typically do not commit the customer to buy any minimum quantity of products. Deliveries are scheduled only after receipt of purchase orders. In addition, with limited lead time, customers may cancel or defer most purchase orders without significant penalty. Anticipated orders from many of Seagate's customers have in the past failed to materialize or OEM delivery schedules have been deferred as a result of changes in their business needs. Such order fluctuations and deferrals have had a material adverse effect on the Company's operations in the past, and there can be no assurance that the Company will not experience such effects in the future.\nDistributors -- The Company's distributors, located throughout the world, generally enter into non-exclusive agreements for the redistribution of the Company's products. Distributors typically furnish the Company with a non-binding indication of their near-term requirements. Product deliveries are generally scheduled based on a weekly confirmation by the distributor of its requirements for that week. The agreements typically provide the distributors with price protection with respect to their inventory of Seagate drives at the time of a reduction by Seagate in its selling price for the drives, and also provide limited rights to return the product.\nService and Warranty -- Seagate warrants its products against defects in design, materials and workmanship by the Company generally for two to five years depending upon the capacity category of the disc drive, with the higher capacity products being warranted for the longer periods. Warranty periods for disc drives have been increasing and may continue to increase. The Company's products are refurbished or repaired at facilities located in the United States, Singapore and Thailand.\nSales Offices -- The Company maintains sales offices throughout the United States and in Australia, England, France, Hong Kong, Ireland, Italy, Japan, Singapore, South Korea, Taiwan, Thailand, Germany and Sweden. Foreign sales are subject to certain controls and restrictions, including, in the case of certain countries, approval by the office of Export Administration of the United States Department of Commerce.\nBACKLOG\nIn view of customers' rights to cancel or defer orders with little or no penalty, the Company believes backlog in the disc drive industry can be misleading.\nThe Company's backlog includes only those orders for which a delivery schedule has been specified by the customer. Substantially all orders shown as backlog at July 1, 1994 were scheduled for delivery within six months. Because many customers place large orders for delivery throughout the year, and because of the possibility of customer cancellation of orders or changes in delivery schedules, the Company's backlog as of any particular date is not indicative of the Company's potential sales for any succeeding fiscal period. The Company's order backlog at July 1, 1994 was approximately $739,000,000 compared with $261,000,000 at July 2, 1993.\nMANUFACTURING\nThe Company's business objectives require it to establish manufacturing capacity in anticipation of market demand. The key elements of the Company's manufacturing strategy are: high-volume, low-cost assembly and test; vertical integration of selected components; and key vendor relationships. The highly competitive disc drive industry requires that the Company manufacture significant volumes of high-quality drives at low unit cost. To do this, the Company must achieve high manufacturing yields and obtain uninterrupted access to high-quality components in required volumes at competitive prices.\nThe Company is currently in the early stages of automating its manufacturing processes. Over the next two years it expects such processes to become substantially automated. The Company believes its competitors' level of automation is significantly greater than its own.\nManufacturing of the Company's rigid disc drives is a complex process, requiring a \"clean room\" environment, the assembly of precision components within narrow tolerances and extensive testing to ensure reliability. The first step in the manufacturing of a rigid disc drive is the assembly of the actuator mechanism, heads, discs, and spindle motor in a housing to form the head-disc assembly (the \"HDA\"). The assembly of the HDA involves a combination of manual and semiautomated processes. After the HDA is assembled and servo writing has been completed, automated testing equipment subjects the HDA to several tests aimed at ensuring that it meets all of the Company's specifications for quality and performance. Upon completion of assembly and testing, circuit boards are added to the HDA and the completed unit is again tested prior to packaging and shipment. The Company uses statistical process control in an effort to continually improve its manufacturing processes. Final assembly and test operations of the Company's disc drives take place primarily at facilities located in Singapore, Thailand, Minnesota and Oklahoma. Subassembly and component operations are performed at the Company's facilities in Singapore, Thailand, Minnesota, California, Malaysia, Scotland and Northern Ireland. In addition, independent entities manufacture or assemble components for the Company in the United States, Europe and various Far East countries including Hong Kong, Japan, Korea, China, the Philippines, Singapore, Taiwan and Thailand.\nThe cost, quality and availability of certain components including head, media, spindle motors, actuator motors, printed circuit boards and custom semiconductors are critical to the successful production of disc drives. The Company's design and vertical integration have allowed it to internally manufacture substantial percentages of its critical components. The Company's objectives of vertical integration are to maintain control over component technology, quality and availability, and to reduce costs. The Company believes that its strategy of vertical integration gives it an advantage over other disc drive manufacturers. However, this strategy entails a high level of fixed costs and requires a high volume of production to be successful. During periods of decreased production, these high fixed costs in the past have had and in the future could have a material adverse effect on the Company's results of operations.\nThin-film sliders are fabricated and assembled into head gimbal assemblies at the Company's facilities. Spindle motors are sourced principally from outside vendors in the Far East, although the Company is increasing its internal motor manufacturing capabilities. Actuator motors are sourced both from outside vendors and internally. The vast majority of the high-volume surface-mount printed circuit assemblies are assembled internally. The Company evaluates the need for second sources on a case-by-case basis and, where it is deemed desirable and feasible to do so, secures multiple sources for components. The Company has experienced production delays when unable to obtain sufficient quantities of certain components or assembly capacity. The Company maintains component inventory levels adequate for its short-term needs. However, an inability to obtain essential components, if prolonged, would adversely affect the Company's business.\nBecause of the significant fixed costs associated with the production of its products and components and the industry's history of declining prices, the Company must continue to produce and sell its disc drives in significant volume, continue to lower manufacturing costs and carefully monitor inventory levels. Toward these ends, the Company continually evaluates its components and manufacturing processes as well as the desirability of transferring volume production of disc drives and related components between facilities, including transfer overseas to countries where labor costs and other manufacturing costs are significantly lower than in the U.S., principally Singapore, Thailand and Malaysia. In addition, the Company is considering\nexpanding its manufacturing operations into other third world countries, including China. Frequently, transfer of production of a product to a different facility requires qualification of such new facility by certain of the Company's OEM customers. There can be no certainty that such changes and transfers will be implemented on a cost-effective basis without delays or disruption in the Company's production and without adversely affecting the Company's results of operations.\nAlthough offshore operations are subject to certain inherent risks, including delays in transportation, changes in governmental policies, tariffs, import\/export regulations, and fluctuations in currency exchange rates in addition to geographic limitations on management controls and reporting, the Company has not had any significant adverse experience in this regard and has significant experience in the offshore production of its products. Certain of the Far East countries in which the Company operates have experienced political unrest and the Company's operations have been adversely affected for short periods of time.\nPRODUCT DEVELOPMENT\nThe Company's strategy for new products emphasizes developing and introducing on a timely basis products that offer functionality and performance equal to or better than competitive product offerings. The rigid disc drive industry is characterized by ongoing, rapid technological change, relatively short product life cycles and rapidly changing user needs. The Company believes that its future success will depend upon its ability to develop, manufacture and market products which meet changing user needs, and which successfully anticipate or respond to changes in technology and standards on a cost-effective and timely basis. Accordingly, the Company is committed to the development of new component technologies, new products, and the continuing evaluation of alternative technologies. The Company is presently concentrating its product development efforts on new disc drives and improved disc dive components as described below.\nThe Company develops new disc drive products and the processes to produce them at four locations: Scotts Valley and Simi Valley, California; Oklahoma City, Oklahoma; and Bloomington, Minnesota. Generally speaking, Scotts Valley and Simi Valley are responsible for development of 3.5 inch, 2.5 inch and smaller form factor drives intended for desktop, laptop, notebook and sub-notebook personal computer systems; Oklahoma City is responsible for development of 3.5 inch disc drives with capacities and interfaces intended for use in minicomputers, supermicrocomputers, workstations and file servers; and Bloomington is responsible for 3.5 inch and 5.25 inch products principally intended for use in systems ranging from workstations and superminicomputers to mainframe and supercomputers as well as new markets such as digital video and video-on-demand.\nThe Company has focused its components research and development efforts in four main areas: Motors, heads, media and ASICs (application specific integrated circuits). The major emphasis of this R&D is reduced size and power consumption, improved performance and reliability, and reduced cost. Disc drive customers require new products to have greater reliability with ever decreasing defective parts per million (\"DPPMs\") and ever increasing mean time between failures (\"MTBFs\").\nThe principal areas of research and development relating to motors are improved bearings, smaller form factors, lower power requirements, quieter operation, higher reliability, improved magnets and lower cost.\nThe Company's head research and development efforts are focused on increasing recording densities, reducing the size and mass of the slider, developing suspensions and assembly technology for reduced head size, reducing the cost and increasing the reliability. This research and development includes substantial effort to develop and manufacture magneto-resistive (\"MR\") heads and advanced air bearing sliders for high areal density and small form factor products. There can be no assurance that the Company's MR head development effort will be successful and a failure of the Company to successfully manufacture and market products incorporating MR head technology in a timely manner could have a material adverse effect on the Company's business and results of operations. Moreover, International Business Machines Corporation (\"IBM\") has initiated a lawsuit against the Company alleging misappropriation of IBM trade secrets, including trade secrets related to IBM's MR head technology. The Company believes that IBM's claims are without merit, is vigorously defending this suit and is continuing development and preparation for commercial manufacture of MR heads. However, if IBM prevails in this suit, the Company could be enjoined from manufacturing MR\nheads or commercializing disc drives containing such heads and could also be held liable for damages, any of which could have a material adverse effect on the Company's business and results of operations.\nMedia research and development efforts are focused on higher performance materials for increased areal density and better substrate and surface topographies for lower flying height applications, improved head\/disc separation margin and increased reliability.\nASIC development has been and will continue to be focused on optimizing the architecture for system performance, cost and reliability. In addition, the focus has been and will continue to be on reducing the number of parts, the amount of power consumption, and the size, and increasing areal densities by use of advanced signal processing techniques such as PRML (Partial Response Maximum Likelihood) read\/write channels. The Company designs nearly all of its ASICs for motor and actuator control and manufactures some of these circuits. It designs many of the other ASICs in the drive such as interface and read\/write, and procures these from third parties.\nIn addition to developing new products and components, the Company devotes significant resources to product engineering aimed at improving manufacturing processes, lowering manufacturing costs and increasing volume production of new and existing products. Process engineering groups are located with the disc drive development groups and the reliability engineering groups in locations listed above; however, most of the Company's volume production is done in locations remote from these groups and the development of the volume processes are completed at the volume manufacturing sites.\nNo assurance can be given that the Company will be able to successfully complete the design or introduction of new products in a timely manner, that the Company will be able to manufacture new products in volume with acceptable manufacturing yields, or successfully market these products, or that these products will perform to specifications on a long-term basis.\nDuring the fiscal years ended July 1, 1994, July 2, 1993 and June 30, 1992 the Company's product development expenses were $171,907,000, $154,005,000 and $132,926,000, respectively.\nPATENTS AND LICENSES\nThe Company has been issued over 395 U.S. patents and approximately 226 foreign patents relating to certain of its disc drive components and manufacturing processes. The Company also has approximately 173 U.S. and 272 foreign patent applications pending. Due to the rapid technological change that characterizes the rigid disc drive industry, the Company believes that the improvement of existing products, reliance upon trade secrets and unpatented proprietary know-how and development of new products are generally more important than patent protection in establishing and maintaining a competitive advantage. Nevertheless, the Company believes that patents are of value to its business and intends to continue its efforts to obtain patents, when available, in connection with its research and development program. There can be no assurance that any patents obtained will provide substantial protection or be of commercial benefit to the Company, or that their validity will not be challenged.\nBecause of rapid technological development in the disc drive industry, it is possible that certain of the Company's products could involve infringement of existing patents. The rigid disc drive industry has been characterized by significant litigation relating to patent and other intellectual property rights. From time to time, the Company receives claims that certain of its products infringe patents of third parties. Although the Company has been able to resolve some such claims or potential claims by obtaining licenses or rights under the patents in question without a material adverse affect on the Company, other such claims are pending which if resolved unfavorably to the Company could have a material adverse effect on the Company's business. For a description of current disputes see the \"Litigation\" note to the Company's consolidated financial statements. In addition, the costs of engaging in intellectual property litigation may be substantial regardless of outcome. The Company has patent cross licenses with Areal Technology, Hewlett-Packard Company, NEC Corporation, Toshiba Corporation, Hitachi, Ltd., Quantum Corporation, Western Digital Corporation, and Ceridian Corporation (formally Control Data Corporation), has the benefit of a now expired cross license with IBM, and is licensed under certain Unysis, Bull and Bull SA disc drive and controller\npatents by virtue of such companies' former ownership of Magnetic Peripherals Inc., now merged into the Company. Additionally, the Company has agreements in principle with other major disc drive companies.\nCOMPETITION\nThe rigid disc drive industry is intensely competitive, with manufacturers competing for a limited number of major customers. The principal competitive factors in the rigid disc drive market include product quality and reliability, form factor, storage capacity, price per unit, price per megabyte, product performance, production volume capability and responsiveness to customers. The relative importance of these factors varies with different customers and for different products. The Company believes that it is generally competitive as to these factors.\nThe Company has experienced and expects to continue to experience intense competition from a number of domestic and foreign companies, some of which have far greater resources than the Company. In addition to independent rigid disc drive manufacturers, the Company also faces competition from present and potential customers, including IBM, Hewlett-Packard, Digital Equipment Corporation, NEC and Fujitsu Limited who continually evaluate whether to manufacture their own drives or purchase them from outside sources. These manufacturers also sell drives to third parties which results in direct competition with the Company.\nProduct life cycles are relatively short in the disc drive industry. The Company expects its competitors to offer new and existing products at prices necessary to gain or retain market share and customers. To remain competitive, the Company believes it will be necessary to continue to reduce its prices and aggressively enhance its product offerings. In addition to the foregoing, the ability of the Company to compete successfully will also depend on its ability to provide timely product introductions and to continue to reduce production costs. The Company's establishment and ongoing expansion of production facilities in Singapore, Thailand and Malaysia are directed toward such cost reductions. The Company's four development centers and market-focused design strategies are structured for time-to-market product introductions.\nThe introduction of products using alternative technologies could be a significant source of competition. For example, optical recording and high-speed semiconductor memory could compete with the Company's products in the future. Although optical disc technologies are attractive for certain archival and imaging applications, they have lower performance and are more costly than magnetic disc drives and the Company does not believe that they will be competitive with magnetic disc drives in the near future in markets requiring on-line, random access, non-volatile mass storage. Semiconductor memory (SRAM and DRAM) is much faster than magnetic disc drives, but currently is volatile (i.e., subject to loss of data in the event of power failure) and much more costly. Flash EE prom, a nonvolatile semiconductor memory, is currently much more costly and, while it has higher read performance than disc drives, it has lower write performance. Flash EE prom could become competitive in the near future for applications requiring less storage capacity (i.e., less that 40 MB) than is required in the Company's more traditional computer related market place.\nENVIRONMENTAL MATTERS\nThe United States Environmental Protection Agency (EPA) and\/or similar state agencies have identified the Company as a potentially responsible party with respect to environmental conditions at several different sites to which hazardous wastes had been shipped or from which they were released. These sites were acquired by the Company from Control Data Corporation (CDC) in fiscal 1990. Other parties have also been identified at certain of these sites as potentially responsible parties. Many of these parties either have shared or likely will share in the costs associated with the sites. Investigative and\/or remedial activities are ongoing at such sites.\nThe estimated cost of investigation and remediation of known contamination at the sites to be incurred after July 1, 1994 was approximately $15,200,000. At July 1, 1994 the Company had recovered $1,500,000 from CDC through its indemnification and cost sharing agreements with CDC and, in addition, expects to recover approximately $10,400,000 over the next 30 years. After deducting the expected recoveries from CDC, the expected aggregate undiscounted liability was approximately $4,800,000 with payments expected to begin in 1998. The total liability recorded by the Company after discounting was $3,000,000 at July 1, 1994.\nThe Company believes that the indemnification and cost-sharing agreement entered into with CDC and the reserves that the Company has established with respect to its future environmental costs are such that, based on present information available to it, future environmental costs related to currently known contaminations will not have a material adverse effect on its financial condition or results of operations.\nEMPLOYEES\nFrom July 2, 1993 to July 1, 1994, the number of persons employed worldwide by the Company increased from approximately 43,000 to approximately 53,000. Approximately 43,000 of the Company's employees were located in the Company's Far East operations as of July 1, 1994. In addition, the Company makes use of supplemental employees, principally in manufacturing, who are hired on an as-needed basis. Management believes that the future success of the Company will depend in part on its ability to attract and retain qualified employees at all levels, of which there can be no assurance. The Company believes that its employee relations are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSeagate's executive offices are located in Scotts Valley, California. Principal manufacturing facilities are located in Singapore, Thailand, Minnesota, Oklahoma, California, Malaysia, Scotland and Northern Ireland. A major portion of the Company's facilities are occupied under leases which expire at various times through 2005. The following is a summary of square footage owned or leased by the Company:\nFACILITIES (SQUARE FEET)\n- - - - - - - - - ---------------\n(1) Includes approximately 202,800 square feet owned by the Company on leased land.\n(2) Excludes approximately 225,800 square feet leased to others and 33,100 square feet unoccupied.\n(3) Excludes approximately 178,900 square feet owned by the Company on leased land which is currently unoccupied. Includes approximately 297,000 square feet owned by the Company on leased land.\n(4) The aggregate of Scotts Valley facilities includes approximately 365,600 square feet owned by the Company. Of this amount approximately 144,200 square feet is on leased land. Excludes approximately 10,000 square feet unoccupied.\n(5) Excludes approximately 232,500 square feet currently unoccupied and under contract for sale.\n(6) Excludes approximately 70,900 square feet owned by the Company and unoccupied.\n(7) Excludes approximately 55,700 square feet leased to others and 12,300 square feet unoccupied.\n(8) Excludes approximately 130,400 square feet currently unoccupied and 16,000 square feet leased to others.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe information required by this item is incorporated by reference to pages 18-19 and 20-22 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\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 STOCK AND RELATED SHAREHOLDER MATTERS\nThe information required by this Item is incorporated by reference to pages 1-2 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this Item is incorporated by reference to pages 1-2 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\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 incorporated by reference to pages 3-6 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is incorporated by reference to pages 1-2 and 7-24 of the Annual Report to Shareholders, filed as Exhibit 13.1 hereto.\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 present directors and executive officers of the Company are as follows:\nAll directors hold office until the annual meeting of shareholders of the Company following their election, or until their successors are duly elected and qualified. Officers are elected annually by the Board of Directors and serve at the discretion of the Board.\nMr. Shugart was Chairman of the Board and Chief Executive Officer of the Company from its inception in 1979 until 1991. From 1979 until 1983 he also served as the Company's President. He now serves as Chairman of the Board, President, Chief Executive Officer and Chief Operating Officer. He was re-appointed Chairman of the Board in October 1992. Mr. Shugart is also currently a Director of Valence Technology, Inc.\nMr. Carballo was General Manager, Product Line Management for the Company's Oklahoma City operations at the time of the Company's acquisition of Imprimis in 1989. In 1990 he was promoted to Vice President, Product Line Management, Oklahoma City operations and in September 1991 he was promoted to Senior Vice President, Sales, Marketing and Product Line Management. Prior to joining the Company, Mr. Carballo had seventeen years with Control Data\/Imprimis.\nMr. Greenspan joined the Company in September 1987 as Vice President, Process Development. In 1991 he was made Vice President, Manufacturing Operations for Singapore and California operations. He was promoted to Senior Vice President, Quality and Customer Service in November 1991. Prior to joining the Company, Mr. Greenspan had over twenty years experience in computer-related industries, including nineteen years with IBM.\nDr. Hegarty joined Control Data\/Imprimis in 1988 as Vice President, Thin-Film Heads. In October 1989 he was named Seagate's Vice President of Component Operations in Bloomington, Minnesota, and in August 1990 was promoted to Senior Vice President and Chief Technical Officer. From October 1990 to\nOctober 1993 Dr. Hegarty was also a Director of the Company. Prior to joining Control Data\/Imprimis, Dr. Hegarty had twenty-one years with IBM in the U.K., Netherlands and the U.S.\nMr. Kundtz joined the Company in 1988 as Vice President, Administration. In January 1992 he was promoted to Senior Vice President, Administration.\nMr. Luczo joined the Company in October 1993. Prior to joining the Company he was Senior Managing Director of the Global Technology Group of Bear, Stearns & Co. Inc., an investment banking firm, from September 1993 to October 1993. He served as Co-Head of the Global Technology Group of Bear, Stearns & Co. Inc. from February 1992 to October 1993. Prior to joining Bear, Stearns & Co. Inc., Mr. Luczo was with Salomon Brothers Inc., an investment banking firm, from 1984 to February 1992, most recently as Vice President and Head of West Coast Technology.\nDr. Moghadam was Vice President, Engineering of Control Data\/Imprimis from December 1986 until October 1989 when he became Vice President, Engineering at Seagate concurrent with the Company's acquisition of Imprimis Technology. Dr. Moghadam was promoted to Senior Vice President and Chief Technical Officer, Data Storage Products in August 1993.\nMr. Sandie joined the Company in 1983 as Vice President, Materials. He was promoted to Senior Vice President, Corporate Materials in November 1991.\nMr. Verdoorn joined the Company in 1983. From 1987 to 1991 he was Vice President, Far East Manufacturing and in November 1991 he was promoted to Senior Vice President, Manufacturing Operations.\nMr. Waite joined the Company in 1983 as Vice President of Finance and Chief Financial Officer, and was promoted to Senior Vice President, Finance in 1984.\nMr. Filler is a consultant and private investor. From February 1994 until June 1994 he served as Executive Vice President and Chief Financial Officer at ASK Group, Inc. From December 1989 to May 1993 he served as Chairman of the Board of Directors and Chief Executive Officer of Burke Industries, a manufacturer of rubber products for military and industrial usage. Mr. Filler was Chairman of the Board of Seagate from September 1991 until October 1992. From October 1990 until September 1991 Mr. Filler served as Vice Chairman of the Board of Directors of the Company.\nDr. Haughton is an engineering consultant. He was a Vice President of Engineering at DaVinci Graphics, a plotter manufacturer, from May 1990 until August 1991. Prior to that he was a consultant from May 1989 to May 1990. From August 1988 to May 1989 Dr. Haughton was Professor of Mechanical Engineering at Santa Clara University. Dr. Haughton is also a Director of Solectron Corporation.\nMr. Kleist has been President, Chief Executive Officer and a Director of Printronix, Inc., a manufacturer of computer printers, since 1974.\nMr. Perlman presently holds the position of Chairman of the Board of Directors and Chief Executive Officer of Ceridian Corporation (formerly Control Data Corporation), an information services and defense electronics company. He previously held several executive positions at Control Data Corporation including President and CEO of Imprimis. Prior to Control Data Corporation, he was in the private practice of law and at Medtronic, where he served as Executive Vice President for U.S. Pacemaker Operations. He also serves on a number of other corporate boards including Inter-Regional Financial Group, Inc., Computer Network Technology Corporation and the Valspar Corporation.\nGeneral Stafford, a former astronaut, has been Vice Chairman of Stafford, Burke and Hecker, Inc., a consulting firm based in Alexandria, Virginia since 1982. He also serves as a Director for the following companies: Allied-Signal Corporation, Pacific Scientific, Inc., Tremont, Inc., CMI, Inc., Fisher Scientific International, Inc., Wackenhut, Inc. and Wheelabrator Technologies, Inc.\nDr. Wilkening has served as Chancellor of the University of California, Irvine since July 1, 1993. From September 1988 to June 30, 1993 she was Provost and Vice President of Academic Affairs at the University of Washington. From 1991 to 1993 Dr. Wilkening also served as Chairwoman of the Space Policy Advisory Board of the National Space Council.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission within 120 days of the end of the Registrant's fiscal year pursuant to General Instruction G(3) to Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission within 120 days of the end of the Registrant's fiscal year pursuant to General Instruction G(3) to Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference to the Company's Proxy Statement to be filed with the Commission within 120 days of the end of the Registrant's fiscal year pursuant to General Instruction G(3) to Form 10-K.\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. The following Consolidated Financial Statements of Seagate Technology, Inc. and subsidiaries and Report of Independent Auditors are incorporated by reference in Item 8:\nReport of Independent Auditors\nConsolidated Balance Sheets -- July 1, 1994 and July 2, 1993.\nConsolidated Statements of Income -- Years Ended July 1, 1994, July 2, 1993 and June 30, 1992.\nConsolidated Statements of Shareholders' Equity -- Years Ended July 1, 1994, July 2, 1993 and June 30, 1992.\nConsolidated Statements of Cash Flows -- Years Ended July 1, 1994, July 2, 1993 and June 30, 1992.\nNotes to Consolidated Financial Statements.\nSeparate financial statements of Seagate Technology, Inc. have not been presented because it is primarily an operating company and its subsidiaries included in the Consolidated Financial Statements are wholly-owned.\n2. Financial Statement Schedules. The following consolidated financial statement schedules of Seagate Technology, Inc. and subsidiaries are filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Seagate Technology, Inc. and subsidiaries:\nSchedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto.\n3. Exhibits:\n- - - - - - - - - ---------------\n(A) Incorporated by reference to exhibits filed in response to Item 16, \"Exhibits,\" of the Company's Registration Statement on Form S-3 (File No. 33-13430) filed with the Securities and Exchange Commission on April 14, 1987.\n(B) Incorporated by reference to exhibits filed in response to Item 14 (a), \"Exhibits,\" of the Company's Form 10-K, as amended, for the year ended June 30, 1990.\n(C) Incorporated by reference to exhibits filed in response to Item 2, \"Exhibits,\" of the Company's Registration Statement on Form 8-A, as amended, filed with the Securities and Exchange Commission on November 23, 1988.\n(D) Incorporated by reference to exhibits filed in response to Item 30(b), \"Exhibits,\" of the Company's Registration Statement on Form S-1 and Amendment No. 1 thereto (File No. 2-73663), as declared effective by the Securities and Exchange Commission on September 24, 1981.\n(E) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K for the year ended June 30, 1983.\n(F) Incorporated by reference to exhibits filed in response to Item 20, \"Exhibits,\" of the Company's Registration Statement on Form S-8\/S-3 (file No. 2-98486) filed with the Securities and Exchange Commission on June 19, 1985.\n(G) Incorporated by reference to exhibits filed in response to Item 16(a), \"Exhibits,\" of the Company's Registration Statement on Form S-1 (File No. 2-78672) filed with the Securities and Exchange Commission on August 3, 1982.\n(H) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's 10-K for the year ended June 30, 1985.\n(I) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K for the year ended June 30, 1988.\n(J) Incorporated by reference to exhibits filed in response to Item 7(c), \"Exhibits,\" of the Company's Current Report on Form 8-K dated October 2, 1989.\n(K) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K for the year ended June 30, 1991.\n(L) Incorporated by reference to exhibits filed in response to Item 7(c), \"Exhibits,\" of the Company's Current Report on Form 8-K dated December 17, 1993.\n(M) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K for the year ended July 2, 1993.\n(b) Reports on Form 8-K. No reports on Form 8-K were filed by the Company during the quarter ended July 1, 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.\nSEAGATE TECHNOLOGY, INC.\nBy: ALAN F. SHUGART ----------------------------------- (Alan F. Shugart, Chairman of the Board, President, Chief Executive Officer and Chief Operating Officer)\nDated: August 4, 1994\nPOWER OF ATTORNEY\nKnow All Men By These Presents, that each person whose signature appears below constitutes and appoints Alan F. Shugart and Donald L. Waite, jointly and severally, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may 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 REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nSEAGATE TECHNOLOGY, INC. SCHEDULE I -- MARKETABLE SECURITIES -- OTHER INVESTMENTS\nSEAGATE TECHNOLOGY, INC.\nSCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\n- - - - - - - - - ---------------\n(1) All such debtors are employees of the Company.\nSEAGATE TECHNOLOGY, INC.\nSCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\n- - - - - - - - - --------------- (1) All such debtors are employees of the Company.\nSEAGATE TECHNOLOGY, INC.\nSCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES\n- - - - - - - - - ---------------\n(1) All such debtors are employees of the Company.\nSEAGATE TECHNOLOGY, INC.\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS\n- - - - - - - - - ---------------\n(1) $17,775,000 uncollectible accounts written off, net of recoveries.\n(2) $25,748,000 uncollectible accounts written off, net of recoveries, $2,526,000 reclassification to notes receivable.\n(3) $9,925,000 uncollectible accounts written off, net of recoveries, $(72,000) due to foreign exchange rates.\nEXHIBIT 11.1 SEAGATE TECHNOLOGY, INC.\nCOMPUTATION OF NET INCOME PER SHARE\n- - - - - - - - - ---------------\n(a) This calculation is submitted in accordance with Regulation S-K Item 601 (b)(11) although it is contrary to paragraph 40 of APB Opinion #15 because it produces an anti-dilutive result.\nSEAGATE TECHNOLOGY, INC. INDEX TO EXHIBITS\n- - - - - - - - - ---------------\n(A) Incorporated by reference to exhibits filed in response to Item 16, \"Exhibits,\" of the Company's Registration Statement on Form S-3 (File No. 33-13430) filed with the Securities and Exchange Commission on April 14, 1987.\n(B) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K, as amended, for the year ended June 30, 1990.\n(C) Incorporated by reference to exhibits filed in response to Item 2, \"Exhibits,\" of the Company's Registration Statement on Form 8-A, as amended, filed with the Securities and Exchange Commission on November 23, 1988.\n(D) Incorporated by reference to exhibits filed in response to Item 30(b), \"Exhibits,\" of the Company's Registration Statement on Form S-1 and Amendment No. 1 thereto (File No. 2-73663), as declared effective by the Securities and Exchange Commission on September 24, 1981.\n(E) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K for the year ended June 30, 1983.\n(F) Incorporated by reference to exhibits filed in response to Item 20, \"Exhibits,\" of the Company's Registration Statement on Form S-8\/S-3 (file No. 2-98486) filed with the Securities and Exchange Commission on June 19, 1985.\n(G) Incorporated by reference to exhibits filed in response to Item 16(a), \"Exhibits,\" of the Company's Registration Statement on Form S-1 (File No. 2-78672) filed with the Securities and Exchange Commission on August 3, 1982.\n(H) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's 10-K for the year ended June 30, 1985.\n(I) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K for the year ended June 30, 1988.\n(J) Incorporated by reference to exhibits filed in response to Item 7(c), \"Exhibits,\" of the Company's Current Report on Form 8-K dated October 2, 1989.\n(K) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K for the year ended June 30, 1991.\n(L) Incorporated by reference to exhibits filed in response to Item 7(c), \"Exhibits,\" of the Company's Current Report on Form 8-K dated December 17, 1993.\n(M) Incorporated by reference to exhibits filed in response to Item 14(a), \"Exhibits,\" of the Company's Form 10-K for the year ended July 2, 1993.","section_15":""}
{"filename":"7286_1994.txt","cik":"7286","year":"1994","section_1":"ITEM 1. BUSINESS\nThe Company\nThe Company was incorporated in 1920 under the laws of Arizona and is engaged principally in serving electricity in the State of Arizona. The principal executive offices of the Company are located at 400 North Fifth Street, Phoenix, Arizona 85004 (telephone 602-250-1000). The Company currently employs approximately 6,535 people, which includes employees assigned to joint projects where the Company is project manager.\nThe Company serves approximately 681,000 customers in an area that includes all or part of 11 of Arizona's 15 counties. During 1994, no single purchaser or user of energy accounted for more than 3% of total electric revenues.\nPinnacle West owns all of the outstanding shares of the Company's common stock. Pursuant to a Pledge Agreement, dated as of January 31, 1990, between Pinnacle West and Citibank, N.A., as Collateral Agent (the \"Pledge Agreement\"), and as part of a restructuring of substantially all of its outstanding indebtedness, Pinnacle West granted certain of its lenders a security interest in all of the Company's outstanding common stock. Until the Collateral Agent and Pinnacle West receive notice of the occurrence and continuation of an Event of Default (as defined in the Pledge Agreement), Pinnacle West is entitled to exercise or refrain from exercising any and all voting and other consensual rights pertaining to the common stock. As to matters other than the election of directors, Pinnacle West agreed not to exercise or refrain from exercising any such rights if, in the Collateral Agent's judgment, such action would have a material adverse effect on the value of the common stock. After notice of an Event of Default, the Collateral Agent would have the right to vote the common stock.\nIndustry and Company Issues\nThe utility industry continues to experience a number of challenges. Depending on the circumstances of a particular utility, these may include (i) competition in general from numerous sources (see \"Competition\" below); (ii) difficulties in meeting government imposed environmental requirements; (iii) the necessity to make substantial capital outlays for transmission and distribution facilities; (iv) uncertainty regarding projected electrical demand growth; (v) controversies over electromagnetic fields; (vi) controversies over the safety and use of nuclear power; (vii) issues related to spent fuel and low-level waste (see \"Generating Fuel\" below); and (viii) increasing costs of wages and materials.\nCompetition\nCertain territory adjacent to or within areas served by the Company is served by other investor-owned utilities (notably Tucson Electric Power Company serving electricity in the Tucson area, Southwest Gas Corporation serving gas throughout the state, and Citizens Utilities Company serving electricity and gas in various locations throughout the state) and a number of cooperatives, municipalities, electrical districts, and similar types of governmental organizations (principally SRP serving electricity in various areas in and around Phoenix).\nElectric utilities have historically operated in a highly-regulated environment that provides limited opportunities for direct competition in providing electric service to their customers. The National Energy Policy Act of 1992 (the \"Energy Act\") has far-reaching implications for the Company by moving utilities toward a more competitive environment. The Energy Act is designed, among other things, to promote competition among utility and non- utility generators by amending the Public Utility Holding Company Act of 1935 (the \"1935 Act\") to exempt a new class of independent power producers that are not subject to regulation under the 1935 Act. The Energy Act also amends the Federal Power Act to allow the FERC to order electric utilities to transmit, or \"wheel,\" wholesale power for others. The FERC is prohibited under the Energy Act from requiring utilities to provide transmission access to retail customers, and there remains uncertainty about a state's ability to authorize such transmission access to and for retail electric customers.\nOne of the issues that must be addressed responsibly is the recovery in a more competitive environment of the carrying value of assets (including those referred to in Note 1a of Notes to Financial Statements) acquired or recorded under the existing regulatory environment. Pursuant to a 1994 rate settlement (see Note 2 of Notes to Financial Statements), the Company and the ACC staff will develop certain procedures that are responsive to the competitive forces in larger customer segments, with the objective of making joint recommendations to the ACC in 1995. A separate ACC proceeding on competition was opened in mid-1994 and is expected to continue for some months.\nAs the forces of competition continue to impact the industry, it will become clearer as to what customer sectors and what regions will be most affected and what strategies are best to deal with those forces. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Competition\" in Item 7 for a discussion of some of the Company's strategies.\nCapital Structure\nThe capital structure of the Company (which, for this purpose, includes short-term borrowings and current maturities of long-term debt) as of December 31, 1994 is tabulated below.\nAmount Percentage ---------- ---------- (Thousands of Dollars) Long-Term Debt Less Current Maturities: First mortgage bonds................................ $1,740,071 Other............................................... 441,761 ---------- Total long-term debt less current maturities...... 2,181,832 52.5% ---------- Non-Redeemable Preferred Stock........................ 193,561 4.7 ---------- Redeemable Preferred Stock............................ 75,000 1.8 ---------- Common Stock Equity: Common stock, $2.50 par value, 100,000,000 shares authorized; 71,264,947 shares outstanding......... 178,162 Premiums and expenses............................... 1,039,303 Retained earnings................................... 353,655 ---------- Total common stock equity......................... 1,571,120 37.8 ---------- Total capitalization............................ 4,021,513 Current Maturities of Long-Term Debt.................. 3,428 .1 Short-Term Borrowings................................. 131,500 3.1 ---------- --------\nTotal........................................... $4,156,441 100.0% ---------- -------- ---------- -------- See Notes 3, 4, and 5 of Notes to Financial Statements in Item 8.\nOn January 12, 1995, the Company issued $75 million of its 10% junior subordinated deferrable interest debentures, Series A (MIDS), due 2025, and applied the net proceeds to the repayment of short-term borrowings incurred for the redemption of preferred stock in 1994. On March 2, 1995, the Company redeemed $49.15 million in aggregate principal amount of the Company's First Mortgage Bonds, 10.25% Series due 2000 (the \"10.25% Bonds\").\nSo long as any of the Company's first mortgage bonds are outstanding, the Company is required for each calendar year to deposit with the trustee under its Mortgage cash in a formularized amount related to net additions to the Company's mortgaged utility plant; however, the Company may satisfy all or any part of this \"replacement fund\" requirement by utilizing redeemed or retired bonds, net property additions, or property retirements. For 1994, the replacement fund requirement amounted to approximately $125 million. Many, though not all, of the bonds issued by the Company under the Mortgage are redeemable at their par value plus accrued interest with cash deposited by the Company in the replacement fund, subject in many cases to a period of time after the original issuance of the bonds during which they may not be so redeemed and\/or to other restrictions on any such redemption. The cash deposited with the trustee by the Company in partial satisfaction of its 1994 replacement fund requirements was used to redeem the 10.25% Bonds at their principal amount plus accrued interest.\nRates\nState. The ACC has regulatory authority over the Company in matters relating to retail electric rates and the issuance of securities. See Note 2 of Notes to Financial Statements in Item 8 for a discussion of the 1994 retail rate settlement agreement between the Company and the ACC.\nFederal. The Company's rates for wholesale power sales and transmission services are subject to regulation by the FERC. During 1994, approximately 6% of the Company's electric operating revenues resulted from such sales and charges. For most wholesale transactions regulated by the FERC, a fuel adjustment clause results in monthly adjustments for changes in the actual cost of fuel for generation and in the fuel component of purchased power expense.\nArizona Corporation Commission Petition\nPinnacle West and its subsidiaries, including the Company, are currently exempt from registration under the 1935 Act; however, the SEC has the authority to revoke or condition an exemption if it appears that any question exists as to whether the exemption may be detrimental to the public interest or the interest of investors or consumers. In May 1990, the ACC filed a petition with the SEC requesting the SEC to revoke or modify the Pinnacle West's exemption under the 1935 Act. To date, the SEC has not taken any action with respect to the ACC petition. The Company cannot predict what action, if any, the SEC may take with respect to such petition. The Company does not believe that the revocation or modification of the Pinnacle West exemption under the 1935 Act, if acted on by the SEC, would have a material adverse effect on the operations or financial position of the Company.\nConstruction Program\nPresent construction plans exclude any major baseload generating plants. Utility construction expenditures for the years 1995 through 1997 are therefore expected to be primarily for expanding transmission and distribution capabilities to meet customer growth, upgrading existing facilities and for environmental purposes. Construction expenditures, including expenditures for environmental control facilities, for the years 1995 through 1997 have been estimated as follows:\n(Millions of Dollars) By Year By Major Facilities ----------------- ---------------------------------------------------- 1995 $300 Electric generation $278 1996 257 Electric transmission 59 1997 236 Electric distribution 367 ---- General facilities 89 $793 ---- ==== $793 ====\nThe amounts for 1995 through 1997 exclude capitalized interest costs and capitalized property taxes. These amounts include about $27 million each year for nuclear fuel expenditures. The Company conducts a continuing review of its construction program. This program and the above estimates are subject to periodic revisions based upon changes in projections as to system reliability, system load growth, rates of inflation, the availability and timing of environmental and other regulatory approvals, the availability and costs of outside sources of capital, and changes in project construction schedules. During the years 1992 through 1994, the Company incurred approximately $728 million in construction expenditures and approximately $31 million in additional capitalized items.\nEnvironmental Matters\nPursuant to the Clean Air Act, the EPA has adopted regulations, applicable to certain federally-protected areas, that address visibility impairment that can be reasonably attributed to specific sources. In September 1991, the EPA issued a final rule that would limit sulfur dioxide emissions at NGS. Compliance with the emission limitation becomes applicable to NGS Units 1, 2, and 3 in 1997, 1998, and 1999, respectively. SRP, the NGS operating agent, has estimated a capital cost of $500 million, most of which will be incurred from 1995 through 1998, and annual operations and maintenance costs of approximately $14 million for all three units, for NGS to meet these requirements. The Company will be required to fund 14% of these expenditures.\nThe Clean Air Act Amendments of 1990 (the \"Amendments\") became effective on November 15, 1990. The Amendments address, among other things, \"acid rain,\" visibility in certain specified areas, toxic air pollutants, and the nonattainment of national ambient air quality standards. With respect to \"acid rain,\" the Amendments establish a system of sulfur dioxide emissions \"allowances.\" Each existing utility unit is granted a certain number of \"allowances.\" On March 5, 1993, the EPA promulgated rules listing allowance allocations applicable to Company-owned plants, which allocations will begin in the year 2000. Based on those allocations, the Company will have sufficient allowances to permit continued operation of its plants at current levels without installing additional equipment. In addition, the Amendments require the EPA to set nitrogen oxides emissions limitations which would require certain plants to install additional pollution control equipment. On March 22, 1994, the EPA issued rules for nitrogen oxides emissions limitations; however, on November 29, 1994, the United States Court of Appeals for the District of Columbia Circuit vacated the rules and remanded them to the EPA for further consideration. The EPA has not yet proposed revised rules.\nWith respect to protection of visibility in certain specified areas, the Amendments require the EPA to complete a study by November 1995 concerning visibility impairment in those areas and identification of sources contributing to such impairment. Interim findings of this study have indicated that any beneficial effect on visibility as a result of the Amendments would be offset by expected population and industry growth. The EPA has established a \"Grand Canyon Visibility Transport Commission\" to complete a study by November 1995 on visibility impairment in the \"Golden Circle of National Parks\" in the Colorado Plateau. NGS, Cholla, and Four Corners are located near the \"Golden Circle of National Parks.\" Based on the recommendations of the Commission, the EPA may require additional emissions controls at various sources causing visibility impairment in the \"Golden Circle of National Parks\" and may limit economic development in several western states. The Company cannot currently estimate the capital expenditures, if any, which may be required as a result of the EPA studies and the Commission's recommendations.\nWith respect to hazardous air pollutants emitted by electric utility steam generating units, the Amendments require two studies. The results of the first study indicated an impact from mercury emissions from such units in certain unspecified areas; however, the EPA has not yet stated whether or not emissions limitations will be imposed. Next, the EPA will complete a general study by November 1995 concerning the necessity of regulating such units under the Amendments. Due to the lack of historical data, and because the Company cannot speculate as to the ultimate requirements by the EPA, the Company cannot currently estimate the capital expenditures, if any, which may be required as a result of these studies.\nCertain aspects of the Amendments may require related expenditures by the Company, such as permit fees, none of which the Company expects to have a material impact on its financial position.\nGenerating Fuel\nCoal, nuclear, gas, and other contributions to total net generation of electricity by the Company in 1994, 1993, and 1992, and the average cost to the Company of those fuels (in dollars per MWh), were as follows:\nOther includes oil and hydro generation.\nThe Company believes that Cholla has sufficient reserves of low sulfur coal committed to that plant for the next five years, the term of the existing coal contract. Sufficient reserves of low sulfur coal are available to continue operating Cholla for its useful life. The Company also believes that Four Corners and NGS have sufficient reserves of low sulfur coal available for use by those plants to continue operating them for their useful lives. The current sulfur content of coal being used at Four Corners, NGS, and Cholla is approximately 0.8%, 0.6%, and 0.4%, respectively. In 1994, average prices paid for coal supplied from reserves dedicated under the existing contracts were relatively stable, although applicable contract clauses permit escalations under certain conditions. In addition, major price adjustments can occur from time to time as a result of contract renegotiation.\nNGS and Four Corners are located on the Navajo Reservation and held under easements granted by the federal government as well as leases from the Navajo Tribe. See \"Properties\" in Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's present generating facilities have an accredited capacity aggregating 4,022,410 kW, comprised as follows:\nCapacity(kW) ------------ Coal: Units 1, 2, and 3 at Four Corners, aggregating........... 560,000 15% owned Units 4 and 5 at Four Corners, representing.... 222,000 Units 1, 2, and 3 at Cholla Plant, aggregating........... 590,000 14% owned Units 1, 2, and 3 at the Navajo Plant, representing........................................... 315,000 ----------- 1,687,000 ===========\nGas or Oil: Two steam units at Ocotillo, two steam units at Saguaro, and one steam unit at Yucca, aggregating............... 468,400(1) Eleven combustion turbine units, aggregating............. 500,600 Three combined cycle units, aggregating.................. 253,500 ----------- 1,222,500 ===========\nNuclear: 29.1% owned or leased Units 1, 2, and 3 at Palo Verde, representing........................................... 1,108,710 =========== Other........................................................ 4,200 =========== ---------- (1) West Phoenix steam units (96,300 kW) are currently mothballed.\n--------------\nThe Company's peak one-hour demand on its electric system was recorded on June 29, 1994 at 4,214,000 kW, compared to the 1993 peak of 3,802,300 kW recorded on August 2. Taking into account additional capacity then available to it under purchase power contracts as well as its own generating capacity, the Company's capability of meeting system demand on June 29, 1994, computed in accordance with accepted industry practices, amounted to 4,514,300 kW, for an installed reserve margin of 8.1%. The power actually available to the Company from its resources fluctuates from time to time due in part to planned outages and technical problems. The available capacity from sources actually operable at the time of the 1994 peak amounted to 4,193,500 kW, for a margin of -0.5%. Firm purchases from neighboring utilities totaling 550 MW were in place at the time of the 1994 peak, ensuring the Company's ability to meet the load requirement.\nNGS and Four Corners are located on land held under easements from the federal government and also under leases from the Navajo Tribe. The risk with respect to enforcement of these easements and leases is not deemed by the Company to be material. The Company is dependent, however, in some measure upon the willingness and ability of the Navajo Tribe to honor its commitments. Certain of the Company's transmission lines and almost all of its contracted coal sources are also located on Indian reservations. See \"Generating Fuel\" in Item 1.\nOn August 18, 1986 and December 19, 1986, the Company entered into a total of three sale and leaseback transactions under which it sold and leased back approximately 42% of its 29.1% ownership interest in Palo Verde Unit 2. The leases under each of the sale and leaseback transactions have initial lease terms expiring on December 31, 2015. Each of the leases also allows the Company to extend the term of the lease and\/or to repurchase the leased Unit 2 interest under certain circumstances at fair market value. The leases in the aggregate require annual payments of approximately $40 million through 1999, approximately $46 million in 2000, and approximately $49 million through 2015 (see Note 7 of Notes to Financial Statements in Item 8).\nSee \"Water Supply\" in Item 1 with respect to matters having possible impact on the operation of certain of the Company's power plants, including Palo Verde.\nThe Company's construction plans are susceptible to changes in forecasts of future demand on its electric system and in its ability to finance its construction program. Although its plans are subject to change, present construction plans exclude any major baseload generating plants. Important factors affecting the Company's ability to delay the construction of new major generating units are continuing efforts to upgrade and improve the reliability of existing generating stations, system load diversity with other utilities, and continuing efforts in customer demand-side conservation and load management programs.\nIn addition to that available from its own generating capacity, the Company purchases electricity from other utilities under various arrangements. One of the most important of these is a long-term contract with SRP which may be canceled by SRP on three years' notice and which requires SRP to make available, and the Company to pay for, certain amounts of electricity that are based in large part on customer demand within certain areas now served by the Company pursuant to a related territorial agreement. The Company believes that the prices payable by it under the contract are fair to both parties. The generating capacity available to the Company pursuant to the contract was 304,000 kW until May, 1994, at which time the capacity increased to 313,000 kW. In 1994, the Company received approximately 887,650 MWh of energy under the contract and paid approximately $40 million for capacity availability and energy received.\nIn September 1990, the Company and PacifiCorp entered into certain agreements relating principally to sales and purchases of electric power and electric utility assets, and in July 1991, after regulatory approvals, the Company sold Cholla 4 to PacifiCorp for approximately $230 million. As part of the transaction, PacifiCorp agreed to make a firm system sale to the Company for thirty years during the Company's summer peak season in the amount of 175 megawatts for the first five years, increasing thereafter, at the Company's option, up to a maximum amount equal to the rated capacity of Cholla 4. After the first five years, all or part of the sale may be converted to a one-for-one seasonal capacity exchange. PacifiCorp has the right to purchase from the Company up to 125 average megawatts of energy per year for thirty years. PacifiCorp and the Company also entered into a 100 megawatt one-for-one seasonal capacity exchange to be effective upon the latter of January 1, 1996 or the completion of certain new transmission projects. In addition, PacifiCorp agreed to pay the Company (i) $20 million upon commercial operation of 150 megawatts of peaking capacity constructed by the Company and (ii) $19 million ($9.5 million of which has been paid) in connection with the construction of transmission lines and upgrades that will afford PacifiCorp 150 megawatts of northbound transmission rights. In addition, PacifiCorp secured additional firm transmission capacity of 30 megawatts, for which approximately $0.5 million was paid during 1994. In 1994, the Company received 389,110 MWh of energy from PacifiCorp under these transactions and paid approximately $18 million for capacity availability and the energy received, and PacifiCorp paid approximately $0.5 million for approximately 32,000 MWh.\nSee \"El Paso Electric Company Bankruptcy\" in Note 10 of Notes to Financial Statements in Item 8 for a discussion of the filing by EPEC of a voluntary petition to reorganize under Chapter 11 of the Bankruptcy Code. EPEC has a joint ownership interest with the Company and others in Palo Verde and Four Corners Units 4 and 5.\nSee Notes 4 and 7 of Notes to Financial Statements in Item 8 with respect to property of the Company not held in fee or held subject to any major encumbrance.\nGRAPHIC -------\nIn accordance with Item 304 of Regulation S-T of the Securities Exchange Act of 1934, the Company's Service Territory map contained in this Form 10-K is a map of the state of Arizona showing the Company's service area, the location of its major power plants and principal transmission lines, and the location of transmission lines operated by the Company for others. The major power plants shown on such map are the Navajo Generating Station located in Coconino County, Arizona; the Four Corners Power Plant located near Farmington, New Mexico; the Cholla Power Plant, located in Navajo County, Arizona; the Yucca Power Plant, located near Yuma, Arizona; and the Palo Verde Nuclear Generating Station, located about 55 miles west of Phoenix, Arizona (each of which plants is reflected on such map as being jointly owned with other utilities), as well as the Ocotillo Power Plant and West Phoenix Power Plant, each located near Phoenix, Arizona, and the Saguaro Power Plant, located near Tucson, Arizona. The Company's major transmission lines shown on such map are reflected as running between the power plants named above and certain major cities in the state of Arizona. The transmission lines operated for others shown on such map are reflected as running from the Four Corners Plant through a portion of northern Arizona to the California border.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nProperty Taxes\nOn June 29, 1990, a new Arizona state tax law was enacted, effective as of December 31, 1989, which adversely impacted the Company's earnings in tax years 1990 through 1994 by an aggregate amount of approximately $21 million per year, before income taxes. On December 20, 1990, the Palo Verde participants, including the Company, filed a lawsuit in the Arizona Tax Court, a division of the Maricopa County Superior Court, against the Arizona Department of Revenue, the Treasurer of the State of Arizona, and various Arizona counties, claiming, among other things, that portions of the new tax law are unconstitutional. (Arizona Public Service Company, et al. v. Apache County, et al., No. TX 90-01686 (Consol.), Maricopa County Superior Court). In December 1992, the court granted summary judgment to the taxing authorities, holding that the law is constitutional. The Company has appealed this decision to the Arizona Court of Appeals. The Company cannot currently predict the ultimate outcome of this matter.\nSee \"Water Supply\" and \"Palo Verde Nuclear Generating Station\" in Item 1 and \"El Paso Electric Company Bankruptcy\" in Note 10 of Notes to Financial Statements in Item 8 in regard to pending or threatened litigation and other disputes.\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 the fiscal year covered by this report, through the solicitation of proxies or otherwise.\nSUPPLEMENTAL ITEM. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Company's executive officers are as follows:\nAge at Name March 1, 1995 Position(s) at March 1, 1995 ---- ------------- ---------------------------- Richard Snell 64 Chairman of the Board of Directors (1) O. Mark DeMichele 60 President and Chief Executive Officer(1) William J. Post 44 Senior Vice President and Chief Operating Officer(1) Jaron B. Norberg 57 Executive Vice President and Chief Financial Officer(1) Shirley A. Richard 47 Executive Vice President, Customer Service, Marketing and Corporate Relations William L. Stewart 51 Executive Vice President, Nuclear Jan H. Bennett 47 Vice President, Customer Service Jack E. Davis 48 Vice President, Generation and Transmission Armando B. Flores 51 Vice President, Human Resources James M. Levine 45 Vice President, Nuclear Production Richard W. MacLean 48 Vice President, Environmental, Health and Safety E. C. Simpson 46 Vice President, Nuclear Support Jack A. Bailey 41 Vice President, Nuclear Engineering and Projects William J. Hemelt 41 Controller Nancy C. Loftin 41 Secretary and Corporate Counsel Nancy E. Newquist 43 Treasurer ---------- (1) Member of the Board of Directors.\n----------------------------------------\nThe executive officers of the Company are elected no less often than annually and may be removed by the Board of Directors at any time. The terms served by the named officers in their current positions and the principal occupations (in addition to those stated in the table and exclusive of directorships) of such officers for the past five years have been as follows:\nMr. Snell was elected to his present position as of February 1990. He was also elected Chairman of the Board, President, and Chief Executive Officer of Pinnacle West at that time. Previously, he was Chairman of the Board (1989- 1992) and Chief Executive Officer (1989-1990) of Aztar Corporation and Chairman of the Board, President, and Chief Executive Officer of Ramada Inc. (1981-1989).\nMr. DeMichele was elected President in September 1982 and became Chief Executive Officer as of January 1988.\nMr. Post was elected to his present position in September 1994. Prior to that time he was Senior Vice President, Planning, Information and Financial Services (since June 1993), and Vice President, Finance & Rates (since April 1987).\nMr. Norberg was elected to his present position in July 1986.\nMs. Richard was elected to her present position in January 1989.\nMr. Stewart was elected to his present position in May 1994. Prior to that time he was Senior Vice President -- Nuclear for Virginia Power (since 1989).\nMr. Bennett was elected to his present position in May 1991. Prior to that time he was Director, Customer Service (September 1990 to May 1991), and Manager, State Region -- Customer Service (January 1988 to September 1990).\nMr. Davis was elected to his present position in June 1993. Prior to that time he was Director, Transmission Systems (January 1993-June 1993); Director, Fossil Generation (June 1992-December 1992); Director, System Development and Power Operations (May 1990-May 1992); and Manager, Power Contracts (March 1979-May 1990).\nMr. Flores was elected to his present position in December 1991. Prior to that time, he was Director -- Human Resources (1990 to 1991) and Manager -- Employment (1989 to 1990) of GENCORP, Propulsion Division, Aerojet Group.\nMr. Levine was elected to his present position in September 1989.\nMr. MacLean was elected to his present position in December 1991. Prior to that time he held the following positions at General Electric (Corporate Environmental Programs): Manager, EHS Resource Development (January to December 1991); and Manager, Environmental Protection (February 1986 to January 1991).\nMr. Simpson was elected to his present position in February 1990.\nMr. Bailey was elected to his present position in April 1994. Prior to that time he was Assistant Vice President, Nuclear Engineering and Projects (July 1993-April 1994); Director, Nuclear Engineering (1991-1993); and, Assistant Plant Manager (1989 to 1991) at Palo Verde.\nMr. Hemelt was elected to his present position in June 1993. Prior to that time he was Treasurer and Assistant Secretary (since April 1987).\nMs. Loftin was elected Secretary in April 1987 and became Corporate Counsel in February 1989.\nMs. Newquist was elected to her present position in June 1993. Prior to that time she was Assistant Treasurer (since October 1992). She is also Treasurer (since June 1990) and Vice President (since February 1994) of Pinnacle West. From May 1987 to June 1990, Ms. Newquist served as Pinnacle West's Director of Finance.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nThe Company's common stock is wholly-owned by Pinnacle West and is not listed for trading on any stock exchange. As a result, there is no established public trading market for the Company's common stock. See \"The Company\" in Part I, Item 1 for information regarding the Pledge Agreement to which the common stock is subject.\nThe chart below sets forth the dividends declared on the Company's common stock for each of the four quarters for 1994 and 1993.\nCommon Stock Dividends (Thousands of Dollars)\n------------------------------------------------- Quarter 1994 1993 ------------------------------------------------- 1st Quarter $42,500 $42,500 2nd Quarter 42,500 42,500 3rd Quarter 42,500 42,500 4th Quarter 42,500 42,500 -------------------------------------------------\nAfter payment or setting aside for payment of cumulative dividends and mandatory sinking fund requirements, where applicable, on all outstanding issues of preferred stock, the holders of common stock are entitled to dividends when and as declared out of funds legally available therefor. See Notes 3 and 4 of Notes to Financial Statements in Item 8 for restrictions on retained earnings available for the payment of dividends.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1994 Compared with 1993\nEarnings in 1994 were $218.2 million compared with $219.5 million in 1993. Electric operating revenues increased primarily due to strong customer growth and significantly warmer weather in 1994, partially offset by lower interchange sales and the 1994 rate reduction. Substantially offsetting the earnings effect of the 1994 rate reduction was a one-time depreciation reversal, also occasioned by the 1994 rate settlement. (See Note 2 of Notes to Financial Statements for information regarding the 1994 rate settlement.) Interest expense declined due to the Company's refinancing efforts in 1994 and 1993. The Company's effort to refinance high-cost debt, started in 1992, was substantially completed at the end of 1994.\nSubstantially offsetting these positive factors were the completion in May 1994 of the recording of non-cash income related to a 1991 rate settlement (see Note 1 of Notes to Financial Statements); increased operations and maintenance expense due primarily to employee severance costs related to various cost-reduction efforts; and increased nuclear decommissioning costs reflecting the most recent site-specific study (see Note 1 of Notes to Financial Statements).\nFuel and purchased power expenses remained relatively unchanged in 1994 compared with 1993. Higher costs to meet increased retail sales were about offset by lower fuel costs for reduced interchange sales. The Company does not have a fuel adjustment clause as part of its retail rate structure; therefore, changes in fuel and purchased power expenses are reflected currently in earnings.\n1993 Compared with 1992\nEarnings in 1993 were $219.5 million compared with $214.3 million in 1992. The primary factor that contributed to this increase was lower interest expense due to refinancing debt at lower rates, lower average debt balances and lower interest rates on the Company's variable-rate debt. Partially offsetting the lower interest expense were increased taxes and higher operating expenses.\nOperating revenue increased significantly due to customer growth. Offsetting customer growth were the effects of milder weather and increased fuel and purchased power costs due to Palo Verde outages and reduced power levels related to steam generator tube problems (see Note 10 of Notes to Financial Statements).\nOperations and maintenance expense for 1993 increased over 1992 levels primarily due to the implementation of new accounting standards for postemployment benefits and postretirement benefits other than pensions, which added $17.0 million to expense in 1993 (see Note 9 of Notes to Financial Statements). Partially offsetting these factors were lower power plant operating costs, lower rent expense and lower costs for an employee cost-saving incentive plan.\nOperating Revenues\nOperating revenues reflect changes in both the volume of units sold and price per kilowatt-hour of electric sales. An analysis of the changes in 1994 and 1993 electric operating revenues compared with the prior year follows (in millions of dollars):\n1994 1993 ------ ------ Volume variance ................................. $ 86.7 $22.3 1994 rate reduction ............................. (27.4) -- Interchange sales ............................... (19.5) (7.2) Reversal of refund obligation ................... (12.1) -- Other operating revenues ........................ (3.9) (.3) ------ ------ Total change ................................... $ 23.8 $14.8 ====== ======\nThe volume increase in 1994 primarily reflects the effects on retail sales of customer growth ($56 million) and warmer weather ($42 million). The volume increase in 1993 was primarily due to customer growth ($41 million), partially offset by milder weather ($20 million reduction). Other factors affecting volumes include changes in usage, unbilled revenue and firm sales for resale for a net total of $11 million reduction in 1994 and $1 million increase in 1993.\nOther Income\/Rate Settlement Impacts\nNet income reflects accounting practices required for regulated public utilities and represents a composite of cash and non-cash items, including AFUDC, accretion income on Palo Verde Unit 3 and the reversal of a refund obligation arising out of the 1991 rate settlement (see Statements of Cash Flows and Note 1 of Notes to Financial Statements). The accretion and refund reversals, net of income taxes, totaled $25.9 million, $58.2 million and $53.6 million in 1994, 1993 and 1992, respectively. The Company has now recorded all of the Palo Verde Unit 3 accretion income and refund obligation reversals related to the 1991 settlement. Also in 1994 was a one-time Palo Verde depreciation reversal of $15 million, net of income tax, which is included in \"Other -- net\" in the Statements of Income (see Note 2 of Notes to Financial Statements).\nThe retail rate settlement which was approved by the ACC in May 1994 did not significantly affect 1994 earnings as previously discussed, and is not expected to significantly affect earnings for the years 1995 through 1999 because the rate reduction will be substantially offset by accelerated amortization of deferred investment tax credits (see Note 2 of Notes to Financial Statements).\nCAPITAL NEEDS AND RESOURCES\nThe Company's capital needs consist primarily of construction expenditures and optional and mandatory repayments or redemptions of long-term debt and preferred stock. The capital resources available to meet these requirements include funds provided by operations and external financings.\nPresent construction plans do not include any major baseload generating plants. In general, most of the construction expenditures are for expanding transmission and distribution capabilities to meet customer growth, upgrading existing facilities and for environmental purposes. Construction expenditures are anticipated to be approximately $300 million, $257 million and $236 million for 1995, 1996 and 1997, respectively. These amounts include about $27 million each year for nuclear fuel expenditures.\nIn the period 1992 through 1994, the Company funded all of its construction expenditures and capitalized property taxes with funds provided by operations, after the payment of dividends. For the period 1995 through 1997, the Company estimates that it will fund substantially all such expenditures in the same manner.\nDuring 1994, the Company repurchased or redeemed approximately $587 million of long-term debt and preferred stock, of which approximately $518 million was optional. Refunding obligations for preferred stock, long-term debt, a capitalized lease obligation and certain anticipated early redemptions are expected to total approximately $106 million, $4 million and $164 million for the years 1995, 1996 and 1997, respectively. On March 2, 1995, the Company redeemed all of its outstanding first mortgage bonds, 10.25% Series due 2000 (the 10.25% Bonds) for approximately $50 million.\nThe Company currently expects to issue up to $175 million of debt in 1995. Of this amount, on January 12, 1995, the Company issued $75 million of 10% junior subordinated deferrable interest debentures (MIDS) due 2025, and applied the net proceeds to the repayment of short-term debt that had been incurred for the redemption of preferred stock in 1994. The Company expects that substantially all of the net proceeds of the remaining financing activity in 1995 will be used for the retirement of outstanding debt.\nProvisions in the Company's mortgage bond indenture and articles of incorporation require certain coverage ratios to be met before the Company can issue additional first mortgage bonds or preferred stock. In addition, the bond indenture limits the amount of additional first mortgage bonds which may be issued to a percentage of net property additions, to the amount of certain first mortgage bonds that have been redeemed or retired, and\/or to cash deposited with the mortgage bond trustee. After giving proforma effect to the redemption of the 10.25% Bonds as of December 31, 1994, the Company estimates that the bond indenture and the articles of incorporation would then have allowed it to issue up to approximately $1.33 billion and $768 million of additional first mortgage bonds and preferred stock, respectively.\nThe ACC has authority over the Company with respect to the issuance of long-term debt and equity securities. Existing ACC orders allow the Company to have up to approximately $2.6 billion in long-term debt and approximately $501 million of preferred stock outstanding at any one time.\nManagement does not expect any of the foregoing restrictions to limit the Company's ability to meet its capital requirements.\nAs of December 31, 1994, the Company had credit commitments from various banks totaling approximately $300 million, which were available either to support the issuance of commercial paper or to be used as bank borrowings. There were no bank borrowings outstanding at the end of 1994. Commercial paper borrowings totaling $131.5 million were then outstanding.\nCOMPETITION\nA significant challenge for the Company will be how well it is able to respond to increasingly competitive conditions in the electric utility industry, while continuing to earn an acceptable return for its shareholders. Strategies emphasize managing costs, stabilizing electric rates, negotiating long-term contracts with large customers and capitalizing on the growth characteristics of the Company's service territory.\nOne of the issues that must be addressed responsibly is the recovery in a more competitive environment of the carrying value of assets (including those referred to in Note 1a of Notes to Financial Statements) acquired or recorded under the existing regulatory environment.\nPursuant to the 1994 rate settlement, APS and the ACC staff will develop certain procedures that are responsive to the competitive forces in larger customer segments, with the objective of making joint recommendations to the ACC in 1995. A separate ACC proceeding on competition was opened in mid-1994 and is expected to continue for some months.\nAs the forces of competition continue to impact the industry, it will become clearer as to what customer sectors and what regions will be most affected and what strategies are best to deal with those forces.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage ----\nReport of Management ...................................................... 20\nIndependent Auditors' Report .............................................. 21\nStatements of Income for each of the three years in the period ended December 31, 1994 .................................... 23\nBalance Sheets -- December 31, 1994 and 1993 .............................. 24\nStatements of Retained Earnings for each of the three years in the period ended December 31, 1994 ........................ 26\nStatements of Cash Flows for each of the three years in the period ended December 31, 1994 .............................. 27\nNotes to Financial Statements ............................................. 28\nSee Note 11 of Notes to Financial Statements for the selected quarterly financial data required to be presented in this Item.\nREPORT OF MANAGEMENT\nThe primary responsibility for the integrity of the Company's financial information rests with management, which has prepared the accompanying financial statements and related information. Such information was prepared in accordance with generally accepted accounting principles appropriate in the circumstances, based on management's best estimates and judgments and giving due consideration to materiality. These financial statements have been audited by independent auditors and their report is included.\nManagement maintains and relies upon systems of internal accounting controls. A limiting factor in all systems of internal accounting control is that the cost of the system should not exceed the benefits to be derived. Management believes that the Company's system provides the appropriate balance between such costs and benefits.\nPeriodically the internal accounting control system is reviewed by both the Company's internal auditors and its independent auditors to test for compliance. Reports issued by the internal auditors are released to management, and such reports, or summaries thereof, are transmitted to the Audit Committee of the Board of Directors and the independent auditors on a timely basis.\nThe Audit Committee, composed solely of outside directors, meets periodically with the internal auditors and independent auditors (as well as management) to review the work of each. The internal auditors and independent auditors have free access to the Audit Committee, without management present, to discuss the results of their audit work.\nManagement believes that the Company's systems, policies and procedures provide reasonable assurance that operations are conducted in conformity with the law and with management's commitment to a high standard of business conduct.\nO. MARK DEMICHELE JARON B. NORBERG\nO. Mark DeMichele Jaron B. Norberg President and Executive Vice President and Chief Executive Officer Chief Financial Officer\nWILLIAM J. POST\nWilliam J. Post Senior Vice President and Chief Operating Officer\nINDEPENDENT AUDITORS' REPORT\nArizona Public Service Company:\nWe have audited the accompanying balance sheets of Arizona Public Service Company as of December 31, 1994 and 1993 and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. 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, 1994 and 1993 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nDELOITTE & TOUCHE LLP Phoenix, Arizona March 3, 1995\n[This page intentionally left blank]\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\na. Accounting Records -- The accounting records are maintained in accordance with generally accepted accounting principles applicable to rate-regulated enterprises. The Company is regulated by the ACC and the FERC and the accompanying financial statements reflect the rate-making policies of these commissions.\nThe Company prepares its financial statements in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation\". SFAS No. 71 requires a cost-based rate-regulated enterprise to reflect the impact of regulatory decisions in its financial statements.\nThe Company's major regulatory assets are Palo Verde cost deferrals (see Note 1j) and deferred taxes (see Note 8). These items, combined with miscellaneous other items and regulatory liabilities, amounted to approximately $1.1 billion at December 31, 1994 and 1993, most of which are included in \"Deferred Debits\" on the Balance Sheets.\nb. Common Stock -- All of the outstanding shares of common stock of the Company are owned by Pinnacle West.\nc. Cash and Cash Equivalents -- For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an initial maturity of three months or less to be cash equivalents.\nd. Utility Plant and Depreciation -- Utility plant represents the buildings, equipment and other facilities used to provide electric service. The cost of utility plant includes labor, materials, contract services, other related items and an allowance for funds used during construction. The cost of retired depreciable utility plant, plus removal costs less salvage realized, is charged to accumulated depreciation.\nDepreciation on utility property is recorded on a straight-line basis. The applicable rates for 1992 through 1994 ranged from 0.84% to 15.00%, which resulted in an annual composite rate of 3.43% for 1994.\ne. Nuclear Decommissioning Costs -- In 1994, the Company recorded $11.9 million for decommissioning expense. The Company estimates it will cost approximately $2.1 billion ($425 million in 1994 dollars), over a thirteen-year period beginning in 2023, to decommission its 29.1% interest in Palo Verde. Decommissioning costs are charged to expense over the respective unit's operating license term and are included in the accumulated depreciation balance until each Palo Verde unit is fully decommissioned. Nuclear decommissioning costs are currently recovered in rates.\nThe Company is utilizing a 1992 site-specific study for Palo Verde, prepared for the Company by an independent consultant, that assumes the prompt removal\/dismantlement method of decommissioning. The study is updated every three years.\nAs required by the ACC, the Company has established external trust accounts into which quarterly deposits are made for decommissioning. As of December 31, 1994, the Company had deposited a total of $45.0 million. The trust accounts are included in \"Investments and Other Assets\" on the Balance Sheets at a market value of $55.2 million on December 31, 1994. The trust funds are invested primarily in fixed-income securities and domestic stock and are classified as available for sale. Gains and losses are reflected in accumulated depreciation.\nIn 1994, FASB added a project to its agenda on accounting for nuclear decommissioning obligations. Only preliminary views have been discussed at this time; however, there is some indication the FASB may require the estimated present value of the cost of decommissioning to be recorded as a liability along with an offsetting plant asset. The Company is unable to determine what, if any, impact these deliberations may have on its financial position or results of operations.\nf. Revenues -- Operating revenues are recognized on the accrual basis and include estimated amounts for service rendered but unbilled at the end of each accounting period.\nIn 1991 the Company recorded a refund obligation of $53.4 million ($32.3 million after tax) as a result of a 1991 rate settlement. The refund obligation was used to reduce the amount of a 1991 rate increase granted rather than require specific customer refunds and was reversed over the thirty months ended May 1994. The after-tax refund\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nobligation reversals that were recorded as electric operating revenues by the Company amounted to $5.6 million in 1994 and $12.9 million in each of the years 1993 and 1992.\nConsistent with the 1994 presentation, prior years' electric operating revenues and other taxes have been restated to exclude sales tax on electric revenue.\ng. Allowance for Funds Used During Construction -- AFUDC represents the cost of debt and equity funds used to finance construction of utility plant. Plant construction costs, including AFUDC, are recovered in authorized rates through depreciation when completed projects are placed into commercial operation. AFUDC does not represent current cash earnings.\nAFUDC has been calculated using composite rates of 7.70% for 1994; 7.20% for 1993; and 10.00% for 1992. The Company compounds AFUDC semiannually and ceases to accrue AFUDC when construction is completed and the property is placed in service.\nh. Reacquired Debt Costs -- The Company amortizes gains and losses on reacquired debt over the remaining life of the original debt, consistent with ratemaking.\ni. Nuclear Fuel -- Nuclear fuel is charged to fuel expense using the unit-of-production method under which the number of units of thermal energy produced in the current period is related to the total thermal units expected to be produced over the remaining life of the fuel.\nUnder federal law, the DOE is responsible for the permanent disposal of spent nuclear fuel. The DOE assesses $.001 per kWh of nuclear generation. This amount is charged to nuclear fuel expense and recovered through rates.\nj. Palo Verde Cost Deferrals -- As authorized by the ACC, the Company deferred operating costs (excluding fuel) and financing costs for Palo Verde Units 2 and 3 from the commercial operation date (September 1986 and January 1988, respectively) until the date the units were included in a rate order (April 1988 and December 1991, respectively). The deferrals are being amortized and recovered in rates over thirty-five year periods.\nk. Palo Verde Accretion Income -- In 1991, the Company discounted the carrying value of Palo Verde Unit 3 to reflect the present value of lost cash flows resulting from a 1991 rate settlement agreement deeming a portion of the unit to temporarily be excess capacity. In accordance with generally accepted accounting principles, the Company recorded accretion income over a thirty-month period ended May 1994 in the aggregate amount of the original discount. The after-tax accretion income recorded in 1994, 1993 and 1992 was $20.3 million, $45.3 million and $40.7 million, respectively.\n2. Regulatory Matters\nIn May 1994, the ACC approved a retail rate settlement agreement which was jointly proposed by the Company and the ACC staff. The major provisions of the settlement include:\n* A net annual rate reduction of approximately $32.3 million ($19 million after tax), or 2.2% on average, effective June 1, 1994.\n* A moratorium on filing for permanent rate changes, except under certain circumstances, prior to the end of 1996 for both the Company and the ACC staff.\n* A joint APS-ACC study to develop rate principles allowing the Company greater flexibility to deal with market conditions and increasing competition in the electric industry.\n* All of Palo Verde Unit 3 included in rate base.\n* An incentive rewarding reduction in fuel and operating and maintenance cost per kWh below established targets.\nAs part of the settlement, the Company reversed approximately $20 million of depreciation ($15 million after tax) which related to the portion of Palo Verde which was written off as a result of a 1991 rate settlement. The settlement also provided for the accelerated amortization of substantially all deferred ITCs over a five-year period beginning in 1995. Overall, the settlement is not expected to materially affect the Company's financial position or results of operations for the years 1995-1999.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nIf there were to be any arrearage in dividends on any of the Company's preferred stock or in the sinking fund requirements applicable to any of its redeemable preferred stock, the Company could not pay dividends on its common stock or acquire any shares thereof for consideration.\nThe redemption requirements for the above issues for the next five years are: $0 in 1995 and 1996, and $10.0 million in each of the years 1997 through 1999.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nAggregate annual principal payments due on long-term debt and for sinking fund requirements through 1999 are as follows: 1995, $3.4 million; 1996, $3.5 million; 1997, $153.8 million; 1998, $109.1 million; and 1999, $109.4 million. See Note 3 for redemption and sinking fund requirements of redeemable preferred stock of the Company.\nOn January 12, 1995, the Company issued $75 million of 10% junior subordinated deferrable interest debentures (MIDS) due 2025.\nSubstantially all utility plant (other than nuclear fuel, transportation equipment, and the combined cycle plant) is subject to the lien of the mortgage bond indenture. The mortgage bond indenture includes provisions which would restrict the payment of common stock dividends under certain conditions which did not exist at December 31, 1994.\n5. Lines of Credit\nThe Company had committed lines of credit with various banks of $300 million at December 31, 1994, and $302 million at December 31, 1993, which were available either to support the issuance of commercial paper or to be used for bank borrowings. The commitment fees on these lines were 0.25% per annum through June 30, 1994, 0.20% per annum on $200 million and 0.15% per annum on $100 million thereafter, through December 31, 1994. The Company had commercial paper borrowings outstanding of $131.5 million at December 31, 1994, and $148.0 million at December 31, 1993. The weighted average interest rate on commercial paper borrowings was 6.25% on December 31, 1994, and 3.48% on December 31, 1993. By Arizona statute, the Company's short-term borrowings cannot exceed 7% of its total capitalization without the consent of the ACC.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\n7. Leases\nIn 1986, the Company entered into sale and leaseback transactions under which it sold approximately 42% of its share of Palo Verde Unit 2 and certain common facilities. The gain of approximately $140.2 million has been deferred and is being amortized to operations expense over the original lease term. The leases are being accounted for as operating leases. The amounts paid each year approximate $40.1 million through December 1999, $46.3 million through December 2000, and $49.0 million through December 2015. Options to renew for two additional years and to purchase the property at fair market value at the end of the lease terms are also included. Consistent with the ratemaking treatment, an amount equal to the annual lease payments is included in rent expense. A regulatory asset (totaling approximately $52.8 million at December 31, 1994) has been established for the difference between lease payments and rent expense calculated on a straight-line basis. Lease expense for 1994, 1993 and 1992 was $42.2 million, $41.8 million and $45.8 million, respectively.\nThe Company has a capital lease on a combined cycle plant which it sold and leased back. The lease requires semiannual payments of $2.6 million through June 2001, and includes renewal and purchase options based on fair market value. This plant is included in plant in service at its original cost of $54.4 million; accumulated amortization at December 31, 1994, was $40.3 million.\nIn addition, the Company also leases certain land, buildings, equipment and miscellaneous other items through operating rental agreements with varying terms, provisions and expiration dates. Rent expense for 1994, 1993 and 1992 was approximately $10.1 million, $11.1 million and $14.7 million, respectively. Annual future minimum rental commitments, excluding the Palo Verde and combined cycle leases, for the period 1995 through 1999 range between $11 million and $12 million. Total rental commitments after 1999 are estimated at $122 million.\n8. Income Taxes\nThe Company is included in the consolidated income tax returns of Pinnacle West. Income taxes are allocated to the Company based on its separate company taxable income or loss. Approximately $1.8 million of income tax overpayments were due from Pinnacle West at December 31, 1994. Investment tax credits were deferred and are being amortized to other income over the estimated lives of the related assets as directed by the ACC. Beginning in 1995, the ACC portion of the unamortized investment tax credits will be amortized over a five-year period in accordance with the 1994 rate settlement agreement (see Note 2).\nEffective January 1, 1993, the Company adopted the provisions of SFAS No. 109, which requires the use of the liability method of accounting for income taxes. Upon adoption the Company recorded deferred income taxes related to the equity component of AFUDC; the debt component of AFUDC recorded net-of-tax; and other temporary differences for which deferred income taxes had not been provided. Deferred tax balances were also adjusted for changes in tax rates. The adoption of SFAS No. 109 had no material effect on net income but increased net deferred income tax liabilities by $585.3 million at December 31, 1993. Historically the FERC and the ACC have allowed revenues sufficient to pay for these deferred tax liabilities and, in accordance with SFAS No. 109, a regulatory asset was established in a corresponding amount.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\n9. Pension Plan and Other Benefits\nPension Plan\nThe Company sponsors a defined benefit pension plan covering substantially all employees. Benefits are based on years of service and compensation utilizing a final average pay benefit formula. The plan is funded on a current basis to the extent deductible under existing tax regulations. Plan assets consist primarily of domestic and international common stocks and bonds and real estate. Pension cost, including administrative cost, for 1994, 1993 and 1992 was approximately $25.4 million, $14.0 million and $14.0 million, respectively, of which approximately $11.9 million, $6.5 million and $3.9 million, respectively, was charged to expense. The remainder was either capitalized or billed to others.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nIn addition to the defined benefit pension plan described above, the Company also sponsors qualified defined contribution plans. Collectively, these plans cover substantially all employees. The plans provide for employee contributions and partial employer matching contributions after certain eligibility requirements are met. The cost of these plans for 1994, 1993 and 1992 was $6.8 million, $6.3 million and $5.3 million, respectively, of which $3.2 million, $3.0 million and $2.5 million, respectively, was charged to expense.\nPostretirement Plans\nThe Company provides medical and life insurance benefits to its retired employees. Employees may become eligible for these retirement benefits based on years of service and age. The retiree medical insurance plans are contributory; the retiree life insurance plan is noncontributory. In accordance with the governing plan documents, the Company retains the right to change or eliminate these benefits.\nDuring 1993, the Company adopted SFAS No. 106, which requires the cost of postretirement benefits be accrued during the years employees render service. Prior to 1993, the costs of retiree benefits were recognized as expense when claims were paid. This change had the effect of increasing 1994 and 1993 retiree benefit costs from approximately $6 million in each year to $28 million and $34 million, respectively. The amount charged to expense for 1994 increased from about $3 million to $13 million, and for 1993 increased from about $2 million to $17 million. The balance was either capitalized or billed to others. The above amounts include the amortization (over 20 years) of the initial postretirement benefit obligation estimated at January 1, 1993, to be $183 million. Funding is based upon actuarially determined contributions that take tax consequences into account. Plan assets consist primarily of domestic stocks and bonds.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nThe components of the net periodic postretirement benefit costs are as follows:\n1994 1993 -------- -------- (Thousands of Dollars)\nService cost -- benefits earned during the period ..... $ 8,785 $ 9,510 Interest cost on accumulated benefit obligation ....... 14,026 15,630 Return on plan assets ................................. (6,459) -- Net amortization and deferral ......................... 11,619 9,146 -------- -------- Net periodic postretirement benefit cost .............. $ 27,971 $ 34,286 ======== ========\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nAssuming a one percent increase in the health care cost trend rate, the 1994 cost of postretirement benefits other than pensions would increase by approximately $5 million and the accumulated benefit obligation as of December 31, 1994, would increase by approximately $31 million.\nIn 1993, the Company adopted SFAS No. 112. This standard required a change from a cash method to an accrual method in accounting for benefits (such as long-term disability) provided to former or inactive employees after employment but before retirement. The adoption of this standard resulted in an increase in 1993 postemployment benefit expense of approximately $2 million.\n10. Commitments and Contingencies\nLitigation\nThe Company is a party to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the operations or financial position of the Company.\nPalo Verde Nuclear Generating Station\nThe Company has encountered tube cracking in steam generators and has taken, and will continue to take, remedial actions that it believes have slowed further tube problems to manageable levels. The Company believes that the Palo Verde steam generators are capable of operating for their designed life of 40 years, although at some point, long-term economic considerations may make steam generator replacement desirable. All of the Palo Verde units were operating at full power at December 31, 1994.\nThe Palo Verde participants have insurance for public liability payments resulting from nuclear energy hazards to the full limit of liability under federal law. This potential liability is covered by primary liability insurance provided by commercial insurance carriers in the amount of $200 million and the balance by an industry-wide retrospective assessment program. The maximum assessment per reactor under the retrospective rating program for each nuclear incident is approximately $79 million, subject to an annual limit of $10 million per incident. Based upon the Company's 29.1% interest in the three Palo Verde units, the Company's maximum potential assessment per incident for all three units is approximately $69 million, with an annual payment limitation of approximately $9 million.\nThe Palo Verde participants maintain \"all risk\" (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.78 billion, a substantial portion of which must first be applied to stabilization and decontamination. The Company has also secured insurance against portions of any increased cost of generation or purchased power and business interruption resulting from a sudden and unforeseen outage of any of the three units. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.\nEl Paso Electric Company Bankruptcy\nEl Paso Electric Company (EPEC), one of the joint owners of Palo Verde and Four Corners, has been operating under Chapter 11 of the Bankruptcy Code since 1992. A plan whereby EPEC would become a wholly-owned subsidiary of Central and South West Corporation (CSW) has been confirmed by the bankruptcy court, but cannot become fully effective until several other approvals are obtained. Under the plan, certain issues, including EPEC allegations regarding the 1989-90 Palo Verde outages, would be resolved, and EPEC would assume the joint facilities operating agreements. CSW has stated that several matters have arisen which may impede completion of the merger. If the plan is not approved, the Company does not expect that there would be a material adverse effect on its operations or financial position.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nConstruction Program\nTotal construction expenditures in 1995 are estimated at $300 million, excluding capitalized property taxes and capitalized interest.\nFuel and Purchased Power Commitments\nThe Company is a party to various fuel and purchased power contracts with terms expiring from 1995 through 2020 that include required purchase provisions. The Company estimates its 1995 contract requirements to be approximately $127 million. However, this amount may vary significantly pursuant to certain provisions in such contracts which permit the Company to decrease its required purchases under certain circumstances.\n11. Selected Quarterly Financial Data (Unaudited)\nQuarterly financial information for 1994 and 1993 is as follows:\nElectric Operating Operating Net Earnings for Quarter Revenues(a) Income(b) Income Common Stock ------- ----------- --------- -------- ------------- (Thousands of Dollars)\nFirst ........... $346,049 $ 67,147 $ 38,468 $ 30,958 Second .......... 397,156 83,607 65,851 58,879 Third ........... 540,883 155,115 116,267 110,359 Fourth .......... 342,080 62,564 22,900 18,016\nFirst ........... $353,891 $ 79,441 $ 47,166 $ 39,277 Second .......... 387,871 92,264 61,364 53,716 Third ........... 497,282 132,639 102,911 95,617 Fourth .......... 363,369 68,144 38,945 30,936\n(a) Consistent with the presentation for the quarter ended December 31, 1994, prior quarters' electric operating revenues and other taxes have been restated to exclude sales tax on electric revenues.\n(b) The Company's operations are subject to seasonal fluctuations primarily as a result of weather conditions. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.\n12. Fair Value of Financial Instruments\nThe Company estimates that the carrying amounts of its cash equivalents and commercial paper are reasonable estimates of their fair values at December 31, 1994 and 1993 due to their short maturities. The December 31, 1994 and 1993 fair values of debt and equity investments, determined by using quoted market values or by discounting cash flows at rates equal to its cost of capital, approximate their carrying amounts. Investments in debt and equity securities are held for purposes other than trading.\nOn December 31, 1994, the carrying amount of long-term debt (excluding $26 million of capital lease obligations) was $2.16 billion and its estimated fair value was approximately $1.99 billion. On December 31, 1993, the carrying amount of long-term debt (excluding $30 million of capital lease obligations) was $2.10 billion and its estimated fair value was approximately $2.26 billion. The fair value estimates were determined by independent sources using quoted market rates where available. Where market prices were not available, the fair values were based on market values of comparable instruments.\nITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nReference is hereby made to \"Election of Directors\" in the Company's Proxy Statement relating to the annual meeting of shareholders to be held on May 16, 1995 (the \"1995 Proxy Statement\") and to the Supplemental Item -- \"Executive Officers of the Registrant\" in Part I of this report.\nITEM 11. EXECUTIVE COMPENSATION\nReference is hereby made to the fourth paragraph under the heading \"The Board and its Committees,\" and to \"Executive Compensation\" in the 1995 Proxy Statement.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nReference is hereby made to \"Principal Holders of Voting Securities\" and \"Ownership of Pinnacle West Securities by Management\" in the 1995 Proxy Statement.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is hereby made to the last paragraph under the heading \"The Board and its Committees\" in the 1995 Proxy Statement.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFinancial Statements\nSee the Index to Financial Statements in Part II, Item 8 on page 19.\nIn addition to those Exhibits shown above, the Company hereby incorporates the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation ss201.24 by reference to the filings set forth below:\nReports on Form 8-K\nDuring the quarter ended December 31, 1994, and the period ended March 29, 1995, the Company filed the following Reports on Form 8-K:\nReport filed January 11, 1995 comprised of exhibits to the Company's Registration Statements (Registration Nos. 33-61228 and 33-55473) relating to the Company's offering of $75 million of its Junior Subordinated Deferrable Interest Debentures.\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.\nARIZONA PUBLIC SERVICE COMPANY (Registrant)\nDate: March 29, 1995 O. MARK DEMICHELE -------------------------------- (O. Mark DeMichele, 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.\nSignature Title Date --------- ----- ----\nO. MARK DEMICHELE Principal Executive Officer March 29, 1995 ------------------------------- and Director (O. Mark DeMichele, President and Chief Executive Officer)\nWILLIAM J. POST Principal Accounting Officer March 29, 1995 ------------------------------- and Director (William J. Post, Senior Vice President and Chief Operating Officer)\nJARON B. NORBERG Principal Financial Officer March 29, 1995 ------------------------------- and Director (Jaron B. Norberg, Executive Vice President and Chief Financial Officer)\nKENNETH M. CARR Director March 29, 1995 ------------------------------- (Kenneth M. Carr)\nMARTHA O. HESSE Director March 29, 1995 ------------------------------- (Martha O. Hesse)\nMARIANNE MOODY JENNINGS Director March 29, 1995 ------------------------------- (Marianne Moody Jennings)\nROBERT G. MATLOCK Director March 29, 1995 ------------------------------- (Robert G. Matlock)\nJOHN R. NORTON III Director March 29, 1995 ------------------------------- (John R. Norton III)\nDONALD M. RILEY Director March 29, 1995 ------------------------------- (Donald M. Riley)\nHENRY B. SARGENT Director March 29, 1995 ------------------------------- (Henry B. Sargent)\nWILMA W. SCHWADA Director March 29, 1995 ------------------------------- (Wilma W. Schwada)\nVERNE D. SEIDEL Director March 29, 1995 ------------------------------- (Verne D. Seidel)\nRICHARD SNELL Director March 29, 1995 ------------------------------- (Richard Snell)\nDIANNE C. WALKER Director March 29, 1995 ------------------------------- (Dianne C. Walker)\nBEN F. WILLIAMS, JR. Director March 29, 1995 ------------------------------- (Ben F. Williams, Jr.)\nTHOMAS G. WOODS, JR. Director March 29, 1995 ------------------------------- (Thomas G. Woods, Jr.)\nCommission File Number 1-4473 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- EXHIBITS TO FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1994 -------------- Arizona Public Service Company (Exact name of registrant as specified in charter) ------------------------------------------------------------------------------ ------------------------------------------------------------------------------\nINDEX TO EXHIBITS\nExhibit No. Description ----------- ----------- 3.1 -- Bylaws, amended as of November 19, 1991\n3.2 -- Resolution of Board of Directors temporarily suspending Bylaws in part\n10.1 -- Amendment No. 1 to Decommissioning Trust Agreement (PVNGS Unit 1) dated as of December 1, 1994\n10.2 -- Amendment No. 1 to Decommissioning Trust Agreement (PVNGS Unit 3) dated as of December 1, 1994\n10.3 -- Amendment No. 2 to Amended and Restated Decommissioning Trust Agreement (PVNGS Unit 2) dated as of November 1, 1994\n10.4a -- 1995 Key Employee Variable Pay Plan\n10.5a -- 1995 Officers Variable Pay Plan\n10.6a -- Letter Agreement dated December 21, 1993, between the Company and William L. Stewart\n10.7a -- Pinnacle West Capital Corporation and Arizona Public Service Company Directors' Retirement Plan\n10.8ac -- Second revised form of Key Executive Employment and Severance Agreement between the Company and certain key employees of the Company\n10.9ac -- Second revised form of Key Executive Employment and Severance Agreement between the Company and certain executive officers of the Company\n23.1 -- Consent of Deloitte & Touche LLP\n27.1 -- Financial Data Schedule ----------\na Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\nb An additional document, substantially identical in all material respects to this Exhibit, has been entered into, relating to an additional Equity Participant. Although such additional document may differ in other respects (such as dollar amounts, percentages, tax indemnity matters, and dates of execution), there are no material details in which such document differs from this Exhibit.\nc Additional agreements, substantially identical in all material respects to this Exhibit have been entered into with additional officers and key employees of the Company. Although such additional documents may differ in other respects (such as dollar amounts and dates of execution), there are no material details in which such agreements differ from this Exhibit.\nFor a description of the Exhibits incorporated in this filing by reference, see Part IV, Item 14.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1994 Compared with 1993\nEarnings in 1994 were $218.2 million compared with $219.5 million in 1993. Electric operating revenues increased primarily due to strong customer growth and significantly warmer weather in 1994, partially offset by lower interchange sales and the 1994 rate reduction. Substantially offsetting the earnings effect of the 1994 rate reduction was a one-time depreciation reversal, also occasioned by the 1994 rate settlement. (See Note 2 of Notes to Financial Statements for information regarding the 1994 rate settlement.) Interest expense declined due to the Company's refinancing efforts in 1994 and 1993. The Company's effort to refinance high-cost debt, started in 1992, was substantially completed at the end of 1994.\nSubstantially offsetting these positive factors were the completion in May 1994 of the recording of non-cash income related to a 1991 rate settlement (see Note 1 of Notes to Financial Statements); increased operations and maintenance expense due primarily to employee severance costs related to various cost-reduction efforts; and increased nuclear decommissioning costs reflecting the most recent site-specific study (see Note 1 of Notes to Financial Statements).\nFuel and purchased power expenses remained relatively unchanged in 1994 compared with 1993. Higher costs to meet increased retail sales were about offset by lower fuel costs for reduced interchange sales. The Company does not have a fuel adjustment clause as part of its retail rate structure; therefore, changes in fuel and purchased power expenses are reflected currently in earnings.\n1993 Compared with 1992\nEarnings in 1993 were $219.5 million compared with $214.3 million in 1992. The primary factor that contributed to this increase was lower interest expense due to refinancing debt at lower rates, lower average debt balances and lower interest rates on the Company's variable-rate debt. Partially offsetting the lower interest expense were increased taxes and higher operating expenses.\nOperating revenue increased significantly due to customer growth. Offsetting customer growth were the effects of milder weather and increased fuel and purchased power costs due to Palo Verde outages and reduced power levels related to steam generator tube problems (see Note 10 of Notes to Financial Statements).\nOperations and maintenance expense for 1993 increased over 1992 levels primarily due to the implementation of new accounting standards for postemployment benefits and postretirement benefits other than pensions, which added $17.0 million to expense in 1993 (see Note 9 of Notes to Financial Statements). Partially offsetting these factors were lower power plant operating costs, lower rent expense and lower costs for an employee cost-saving incentive plan.\nOperating Revenues\nOperating revenues reflect changes in both the volume of units sold and price per kilowatt-hour of electric sales. An analysis of the changes in 1994 and 1993 electric operating revenues compared with the prior year follows (in millions of dollars):\n1994 1993 ------ ------ Volume variance ................................. $ 86.7 $22.3 1994 rate reduction ............................. (27.4) -- Interchange sales ............................... (19.5) (7.2) Reversal of refund obligation ................... (12.1) -- Other operating revenues ........................ (3.9) (.3) ------ ------ Total change ................................... $ 23.8 $14.8 ====== ======\nThe volume increase in 1994 primarily reflects the effects on retail sales of customer growth ($56 million) and warmer weather ($42 million). The volume increase in 1993 was primarily due to customer growth ($41 million), partially offset by milder weather ($20 million reduction). Other factors affecting volumes include changes in usage, unbilled revenue and firm sales for resale for a net total of $11 million reduction in 1994 and $1 million increase in 1993.\nOther Income\/Rate Settlement Impacts\nNet income reflects accounting practices required for regulated public utilities and represents a composite of cash and non-cash items, including AFUDC, accretion income on Palo Verde Unit 3 and the reversal of a refund obligation arising out of the 1991 rate settlement (see Statements of Cash Flows and Note 1 of Notes to Financial Statements). The accretion and refund reversals, net of income taxes, totaled $25.9 million, $58.2 million and $53.6 million in 1994, 1993 and 1992, respectively. The Company has now recorded all of the Palo Verde Unit 3 accretion income and refund obligation reversals related to the 1991 settlement. Also in 1994 was a one-time Palo Verde depreciation reversal of $15 million, net of income tax, which is included in \"Other -- net\" in the Statements of Income (see Note 2 of Notes to Financial Statements).\nThe retail rate settlement which was approved by the ACC in May 1994 did not significantly affect 1994 earnings as previously discussed, and is not expected to significantly affect earnings for the years 1995 through 1999 because the rate reduction will be substantially offset by accelerated amortization of deferred investment tax credits (see Note 2 of Notes to Financial Statements).\nCAPITAL NEEDS AND RESOURCES\nThe Company's capital needs consist primarily of construction expenditures and optional and mandatory repayments or redemptions of long-term debt and preferred stock. The capital resources available to meet these requirements include funds provided by operations and external financings.\nPresent construction plans do not include any major baseload generating plants. In general, most of the construction expenditures are for expanding transmission and distribution capabilities to meet customer growth, upgrading existing facilities and for environmental purposes. Construction expenditures are anticipated to be approximately $300 million, $257 million and $236 million for 1995, 1996 and 1997, respectively. These amounts include about $27 million each year for nuclear fuel expenditures.\nIn the period 1992 through 1994, the Company funded all of its construction expenditures and capitalized property taxes with funds provided by operations, after the payment of dividends. For the period 1995 through 1997, the Company estimates that it will fund substantially all such expenditures in the same manner.\nDuring 1994, the Company repurchased or redeemed approximately $587 million of long-term debt and preferred stock, of which approximately $518 million was optional. Refunding obligations for preferred stock, long-term debt, a capitalized lease obligation and certain anticipated early redemptions are expected to total approximately $106 million, $4 million and $164 million for the years 1995, 1996 and 1997, respectively. On March 2, 1995, the Company redeemed all of its outstanding first mortgage bonds, 10.25% Series due 2000 (the 10.25% Bonds) for approximately $50 million.\nThe Company currently expects to issue up to $175 million of debt in 1995. Of this amount, on January 12, 1995, the Company issued $75 million of 10% junior subordinated deferrable interest debentures (MIDS) due 2025, and applied the net proceeds to the repayment of short-term debt that had been incurred for the redemption of preferred stock in 1994. The Company expects that substantially all of the net proceeds of the remaining financing activity in 1995 will be used for the retirement of outstanding debt.\nProvisions in the Company's mortgage bond indenture and articles of incorporation require certain coverage ratios to be met before the Company can issue additional first mortgage bonds or preferred stock. In addition, the bond indenture limits the amount of additional first mortgage bonds which may be issued to a percentage of net property additions, to the amount of certain first mortgage bonds that have been redeemed or retired, and\/or to cash deposited with the mortgage bond trustee. After giving proforma effect to the redemption of the 10.25% Bonds as of December 31, 1994, the Company estimates that the bond indenture and the articles of incorporation would then have allowed it to issue up to approximately $1.33 billion and $768 million of additional first mortgage bonds and preferred stock, respectively.\nThe ACC has authority over the Company with respect to the issuance of long-term debt and equity securities. Existing ACC orders allow the Company to have up to approximately $2.6 billion in long-term debt and approximately $501 million of preferred stock outstanding at any one time.\nManagement does not expect any of the foregoing restrictions to limit the Company's ability to meet its capital requirements.\nAs of December 31, 1994, the Company had credit commitments from various banks totaling approximately $300 million, which were available either to support the issuance of commercial paper or to be used as bank borrowings. There were no bank borrowings outstanding at the end of 1994. Commercial paper borrowings totaling $131.5 million were then outstanding.\nCOMPETITION\nA significant challenge for the Company will be how well it is able to respond to increasingly competitive conditions in the electric utility industry, while continuing to earn an acceptable return for its shareholders. Strategies emphasize managing costs, stabilizing electric rates, negotiating long-term contracts with large customers and capitalizing on the growth characteristics of the Company's service territory.\nOne of the issues that must be addressed responsibly is the recovery in a more competitive environment of the carrying value of assets (including those referred to in Note 1a of Notes to Financial Statements) acquired or recorded under the existing regulatory environment.\nPursuant to the 1994 rate settlement, APS and the ACC staff will develop certain procedures that are responsive to the competitive forces in larger customer segments, with the objective of making joint recommendations to the ACC in 1995. A separate ACC proceeding on competition was opened in mid-1994 and is expected to continue for some months.\nAs the forces of competition continue to impact the industry, it will become clearer as to what customer sectors and what regions will be most affected and what strategies are best to deal with those forces.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nPage ----\nReport of Management ...................................................... 20\nIndependent Auditors' Report .............................................. 21\nStatements of Income for each of the three years in the period ended December 31, 1994 .................................... 23\nBalance Sheets -- December 31, 1994 and 1993 .............................. 24\nStatements of Retained Earnings for each of the three years in the period ended December 31, 1994 ........................ 26\nStatements of Cash Flows for each of the three years in the period ended December 31, 1994 .............................. 27\nNotes to Financial Statements ............................................. 28\nSee Note 11 of Notes to Financial Statements for the selected quarterly financial data required to be presented in this Item.\nREPORT OF MANAGEMENT\nThe primary responsibility for the integrity of the Company's financial information rests with management, which has prepared the accompanying financial statements and related information. Such information was prepared in accordance with generally accepted accounting principles appropriate in the circumstances, based on management's best estimates and judgments and giving due consideration to materiality. These financial statements have been audited by independent auditors and their report is included.\nManagement maintains and relies upon systems of internal accounting controls. A limiting factor in all systems of internal accounting control is that the cost of the system should not exceed the benefits to be derived. Management believes that the Company's system provides the appropriate balance between such costs and benefits.\nPeriodically the internal accounting control system is reviewed by both the Company's internal auditors and its independent auditors to test for compliance. Reports issued by the internal auditors are released to management, and such reports, or summaries thereof, are transmitted to the Audit Committee of the Board of Directors and the independent auditors on a timely basis.\nThe Audit Committee, composed solely of outside directors, meets periodically with the internal auditors and independent auditors (as well as management) to review the work of each. The internal auditors and independent auditors have free access to the Audit Committee, without management present, to discuss the results of their audit work.\nManagement believes that the Company's systems, policies and procedures provide reasonable assurance that operations are conducted in conformity with the law and with management's commitment to a high standard of business conduct.\nO. MARK DEMICHELE JARON B. NORBERG\nO. Mark DeMichele Jaron B. Norberg President and Executive Vice President and Chief Executive Officer Chief Financial Officer\nWILLIAM J. POST\nWilliam J. Post Senior Vice President and Chief Operating Officer\nINDEPENDENT AUDITORS' REPORT\nArizona Public Service Company:\nWe have audited the accompanying balance sheets of Arizona Public Service Company as of December 31, 1994 and 1993 and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. 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, 1994 and 1993 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nDELOITTE & TOUCHE LLP Phoenix, Arizona March 3, 1995\n[This page intentionally left blank]\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\na. Accounting Records -- The accounting records are maintained in accordance with generally accepted accounting principles applicable to rate-regulated enterprises. The Company is regulated by the ACC and the FERC and the accompanying financial statements reflect the rate-making policies of these commissions.\nThe Company prepares its financial statements in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation\". SFAS No. 71 requires a cost-based rate-regulated enterprise to reflect the impact of regulatory decisions in its financial statements.\nThe Company's major regulatory assets are Palo Verde cost deferrals (see Note 1j) and deferred taxes (see Note 8). These items, combined with miscellaneous other items and regulatory liabilities, amounted to approximately $1.1 billion at December 31, 1994 and 1993, most of which are included in \"Deferred Debits\" on the Balance Sheets.\nb. Common Stock -- All of the outstanding shares of common stock of the Company are owned by Pinnacle West.\nc. Cash and Cash Equivalents -- For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with an initial maturity of three months or less to be cash equivalents.\nd. Utility Plant and Depreciation -- Utility plant represents the buildings, equipment and other facilities used to provide electric service. The cost of utility plant includes labor, materials, contract services, other related items and an allowance for funds used during construction. The cost of retired depreciable utility plant, plus removal costs less salvage realized, is charged to accumulated depreciation.\nDepreciation on utility property is recorded on a straight-line basis. The applicable rates for 1992 through 1994 ranged from 0.84% to 15.00%, which resulted in an annual composite rate of 3.43% for 1994.\ne. Nuclear Decommissioning Costs -- In 1994, the Company recorded $11.9 million for decommissioning expense. The Company estimates it will cost approximately $2.1 billion ($425 million in 1994 dollars), over a thirteen-year period beginning in 2023, to decommission its 29.1% interest in Palo Verde. Decommissioning costs are charged to expense over the respective unit's operating license term and are included in the accumulated depreciation balance until each Palo Verde unit is fully decommissioned. Nuclear decommissioning costs are currently recovered in rates.\nThe Company is utilizing a 1992 site-specific study for Palo Verde, prepared for the Company by an independent consultant, that assumes the prompt removal\/dismantlement method of decommissioning. The study is updated every three years.\nAs required by the ACC, the Company has established external trust accounts into which quarterly deposits are made for decommissioning. As of December 31, 1994, the Company had deposited a total of $45.0 million. The trust accounts are included in \"Investments and Other Assets\" on the Balance Sheets at a market value of $55.2 million on December 31, 1994. The trust funds are invested primarily in fixed-income securities and domestic stock and are classified as available for sale. Gains and losses are reflected in accumulated depreciation.\nIn 1994, FASB added a project to its agenda on accounting for nuclear decommissioning obligations. Only preliminary views have been discussed at this time; however, there is some indication the FASB may require the estimated present value of the cost of decommissioning to be recorded as a liability along with an offsetting plant asset. The Company is unable to determine what, if any, impact these deliberations may have on its financial position or results of operations.\nf. Revenues -- Operating revenues are recognized on the accrual basis and include estimated amounts for service rendered but unbilled at the end of each accounting period.\nIn 1991 the Company recorded a refund obligation of $53.4 million ($32.3 million after tax) as a result of a 1991 rate settlement. The refund obligation was used to reduce the amount of a 1991 rate increase granted rather than require specific customer refunds and was reversed over the thirty months ended May 1994. The after-tax refund\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nobligation reversals that were recorded as electric operating revenues by the Company amounted to $5.6 million in 1994 and $12.9 million in each of the years 1993 and 1992.\nConsistent with the 1994 presentation, prior years' electric operating revenues and other taxes have been restated to exclude sales tax on electric revenue.\ng. Allowance for Funds Used During Construction -- AFUDC represents the cost of debt and equity funds used to finance construction of utility plant. Plant construction costs, including AFUDC, are recovered in authorized rates through depreciation when completed projects are placed into commercial operation. AFUDC does not represent current cash earnings.\nAFUDC has been calculated using composite rates of 7.70% for 1994; 7.20% for 1993; and 10.00% for 1992. The Company compounds AFUDC semiannually and ceases to accrue AFUDC when construction is completed and the property is placed in service.\nh. Reacquired Debt Costs -- The Company amortizes gains and losses on reacquired debt over the remaining life of the original debt, consistent with ratemaking.\ni. Nuclear Fuel -- Nuclear fuel is charged to fuel expense using the unit-of-production method under which the number of units of thermal energy produced in the current period is related to the total thermal units expected to be produced over the remaining life of the fuel.\nUnder federal law, the DOE is responsible for the permanent disposal of spent nuclear fuel. The DOE assesses $.001 per kWh of nuclear generation. This amount is charged to nuclear fuel expense and recovered through rates.\nj. Palo Verde Cost Deferrals -- As authorized by the ACC, the Company deferred operating costs (excluding fuel) and financing costs for Palo Verde Units 2 and 3 from the commercial operation date (September 1986 and January 1988, respectively) until the date the units were included in a rate order (April 1988 and December 1991, respectively). The deferrals are being amortized and recovered in rates over thirty-five year periods.\nk. Palo Verde Accretion Income -- In 1991, the Company discounted the carrying value of Palo Verde Unit 3 to reflect the present value of lost cash flows resulting from a 1991 rate settlement agreement deeming a portion of the unit to temporarily be excess capacity. In accordance with generally accepted accounting principles, the Company recorded accretion income over a thirty-month period ended May 1994 in the aggregate amount of the original discount. The after-tax accretion income recorded in 1994, 1993 and 1992 was $20.3 million, $45.3 million and $40.7 million, respectively.\n2. Regulatory Matters\nIn May 1994, the ACC approved a retail rate settlement agreement which was jointly proposed by the Company and the ACC staff. The major provisions of the settlement include:\n* A net annual rate reduction of approximately $32.3 million ($19 million after tax), or 2.2% on average, effective June 1, 1994.\n* A moratorium on filing for permanent rate changes, except under certain circumstances, prior to the end of 1996 for both the Company and the ACC staff.\n* A joint APS-ACC study to develop rate principles allowing the Company greater flexibility to deal with market conditions and increasing competition in the electric industry.\n* All of Palo Verde Unit 3 included in rate base.\n* An incentive rewarding reduction in fuel and operating and maintenance cost per kWh below established targets.\nAs part of the settlement, the Company reversed approximately $20 million of depreciation ($15 million after tax) which related to the portion of Palo Verde which was written off as a result of a 1991 rate settlement. The settlement also provided for the accelerated amortization of substantially all deferred ITCs over a five-year period beginning in 1995. Overall, the settlement is not expected to materially affect the Company's financial position or results of operations for the years 1995-1999.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nIf there were to be any arrearage in dividends on any of the Company's preferred stock or in the sinking fund requirements applicable to any of its redeemable preferred stock, the Company could not pay dividends on its common stock or acquire any shares thereof for consideration.\nThe redemption requirements for the above issues for the next five years are: $0 in 1995 and 1996, and $10.0 million in each of the years 1997 through 1999.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nAggregate annual principal payments due on long-term debt and for sinking fund requirements through 1999 are as follows: 1995, $3.4 million; 1996, $3.5 million; 1997, $153.8 million; 1998, $109.1 million; and 1999, $109.4 million. See Note 3 for redemption and sinking fund requirements of redeemable preferred stock of the Company.\nOn January 12, 1995, the Company issued $75 million of 10% junior subordinated deferrable interest debentures (MIDS) due 2025.\nSubstantially all utility plant (other than nuclear fuel, transportation equipment, and the combined cycle plant) is subject to the lien of the mortgage bond indenture. The mortgage bond indenture includes provisions which would restrict the payment of common stock dividends under certain conditions which did not exist at December 31, 1994.\n5. Lines of Credit\nThe Company had committed lines of credit with various banks of $300 million at December 31, 1994, and $302 million at December 31, 1993, which were available either to support the issuance of commercial paper or to be used for bank borrowings. The commitment fees on these lines were 0.25% per annum through June 30, 1994, 0.20% per annum on $200 million and 0.15% per annum on $100 million thereafter, through December 31, 1994. The Company had commercial paper borrowings outstanding of $131.5 million at December 31, 1994, and $148.0 million at December 31, 1993. The weighted average interest rate on commercial paper borrowings was 6.25% on December 31, 1994, and 3.48% on December 31, 1993. By Arizona statute, the Company's short-term borrowings cannot exceed 7% of its total capitalization without the consent of the ACC.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\n7. Leases\nIn 1986, the Company entered into sale and leaseback transactions under which it sold approximately 42% of its share of Palo Verde Unit 2 and certain common facilities. The gain of approximately $140.2 million has been deferred and is being amortized to operations expense over the original lease term. The leases are being accounted for as operating leases. The amounts paid each year approximate $40.1 million through December 1999, $46.3 million through December 2000, and $49.0 million through December 2015. Options to renew for two additional years and to purchase the property at fair market value at the end of the lease terms are also included. Consistent with the ratemaking treatment, an amount equal to the annual lease payments is included in rent expense. A regulatory asset (totaling approximately $52.8 million at December 31, 1994) has been established for the difference between lease payments and rent expense calculated on a straight-line basis. Lease expense for 1994, 1993 and 1992 was $42.2 million, $41.8 million and $45.8 million, respectively.\nThe Company has a capital lease on a combined cycle plant which it sold and leased back. The lease requires semiannual payments of $2.6 million through June 2001, and includes renewal and purchase options based on fair market value. This plant is included in plant in service at its original cost of $54.4 million; accumulated amortization at December 31, 1994, was $40.3 million.\nIn addition, the Company also leases certain land, buildings, equipment and miscellaneous other items through operating rental agreements with varying terms, provisions and expiration dates. Rent expense for 1994, 1993 and 1992 was approximately $10.1 million, $11.1 million and $14.7 million, respectively. Annual future minimum rental commitments, excluding the Palo Verde and combined cycle leases, for the period 1995 through 1999 range between $11 million and $12 million. Total rental commitments after 1999 are estimated at $122 million.\n8. Income Taxes\nThe Company is included in the consolidated income tax returns of Pinnacle West. Income taxes are allocated to the Company based on its separate company taxable income or loss. Approximately $1.8 million of income tax overpayments were due from Pinnacle West at December 31, 1994. Investment tax credits were deferred and are being amortized to other income over the estimated lives of the related assets as directed by the ACC. Beginning in 1995, the ACC portion of the unamortized investment tax credits will be amortized over a five-year period in accordance with the 1994 rate settlement agreement (see Note 2).\nEffective January 1, 1993, the Company adopted the provisions of SFAS No. 109, which requires the use of the liability method of accounting for income taxes. Upon adoption the Company recorded deferred income taxes related to the equity component of AFUDC; the debt component of AFUDC recorded net-of-tax; and other temporary differences for which deferred income taxes had not been provided. Deferred tax balances were also adjusted for changes in tax rates. The adoption of SFAS No. 109 had no material effect on net income but increased net deferred income tax liabilities by $585.3 million at December 31, 1993. Historically the FERC and the ACC have allowed revenues sufficient to pay for these deferred tax liabilities and, in accordance with SFAS No. 109, a regulatory asset was established in a corresponding amount.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\n9. Pension Plan and Other Benefits\nPension Plan\nThe Company sponsors a defined benefit pension plan covering substantially all employees. Benefits are based on years of service and compensation utilizing a final average pay benefit formula. The plan is funded on a current basis to the extent deductible under existing tax regulations. Plan assets consist primarily of domestic and international common stocks and bonds and real estate. Pension cost, including administrative cost, for 1994, 1993 and 1992 was approximately $25.4 million, $14.0 million and $14.0 million, respectively, of which approximately $11.9 million, $6.5 million and $3.9 million, respectively, was charged to expense. The remainder was either capitalized or billed to others.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nIn addition to the defined benefit pension plan described above, the Company also sponsors qualified defined contribution plans. Collectively, these plans cover substantially all employees. The plans provide for employee contributions and partial employer matching contributions after certain eligibility requirements are met. The cost of these plans for 1994, 1993 and 1992 was $6.8 million, $6.3 million and $5.3 million, respectively, of which $3.2 million, $3.0 million and $2.5 million, respectively, was charged to expense.\nPostretirement Plans\nThe Company provides medical and life insurance benefits to its retired employees. Employees may become eligible for these retirement benefits based on years of service and age. The retiree medical insurance plans are contributory; the retiree life insurance plan is noncontributory. In accordance with the governing plan documents, the Company retains the right to change or eliminate these benefits.\nDuring 1993, the Company adopted SFAS No. 106, which requires the cost of postretirement benefits be accrued during the years employees render service. Prior to 1993, the costs of retiree benefits were recognized as expense when claims were paid. This change had the effect of increasing 1994 and 1993 retiree benefit costs from approximately $6 million in each year to $28 million and $34 million, respectively. The amount charged to expense for 1994 increased from about $3 million to $13 million, and for 1993 increased from about $2 million to $17 million. The balance was either capitalized or billed to others. The above amounts include the amortization (over 20 years) of the initial postretirement benefit obligation estimated at January 1, 1993, to be $183 million. Funding is based upon actuarially determined contributions that take tax consequences into account. Plan assets consist primarily of domestic stocks and bonds.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nThe components of the net periodic postretirement benefit costs are as follows:\n1994 1993 -------- -------- (Thousands of Dollars)\nService cost -- benefits earned during the period ..... $ 8,785 $ 9,510 Interest cost on accumulated benefit obligation ....... 14,026 15,630 Return on plan assets ................................. (6,459) -- Net amortization and deferral ......................... 11,619 9,146 -------- -------- Net periodic postretirement benefit cost .............. $ 27,971 $ 34,286 ======== ========\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nAssuming a one percent increase in the health care cost trend rate, the 1994 cost of postretirement benefits other than pensions would increase by approximately $5 million and the accumulated benefit obligation as of December 31, 1994, would increase by approximately $31 million.\nIn 1993, the Company adopted SFAS No. 112. This standard required a change from a cash method to an accrual method in accounting for benefits (such as long-term disability) provided to former or inactive employees after employment but before retirement. The adoption of this standard resulted in an increase in 1993 postemployment benefit expense of approximately $2 million.\n10. Commitments and Contingencies\nLitigation\nThe Company is a party to various claims, legal actions and complaints arising in the ordinary course of business. In the opinion of management, the ultimate resolution of these matters will not have a material adverse effect on the operations or financial position of the Company.\nPalo Verde Nuclear Generating Station\nThe Company has encountered tube cracking in steam generators and has taken, and will continue to take, remedial actions that it believes have slowed further tube problems to manageable levels. The Company believes that the Palo Verde steam generators are capable of operating for their designed life of 40 years, although at some point, long-term economic considerations may make steam generator replacement desirable. All of the Palo Verde units were operating at full power at December 31, 1994.\nThe Palo Verde participants have insurance for public liability payments resulting from nuclear energy hazards to the full limit of liability under federal law. This potential liability is covered by primary liability insurance provided by commercial insurance carriers in the amount of $200 million and the balance by an industry-wide retrospective assessment program. The maximum assessment per reactor under the retrospective rating program for each nuclear incident is approximately $79 million, subject to an annual limit of $10 million per incident. Based upon the Company's 29.1% interest in the three Palo Verde units, the Company's maximum potential assessment per incident for all three units is approximately $69 million, with an annual payment limitation of approximately $9 million.\nThe Palo Verde participants maintain \"all risk\" (including nuclear hazards) insurance for property damage to, and decontamination of, property at Palo Verde in the aggregate amount of $2.78 billion, a substantial portion of which must first be applied to stabilization and decontamination. The Company has also secured insurance against portions of any increased cost of generation or purchased power and business interruption resulting from a sudden and unforeseen outage of any of the three units. The insurance coverage discussed in this and the previous paragraph is subject to certain policy conditions and exclusions.\nEl Paso Electric Company Bankruptcy\nEl Paso Electric Company (EPEC), one of the joint owners of Palo Verde and Four Corners, has been operating under Chapter 11 of the Bankruptcy Code since 1992. A plan whereby EPEC would become a wholly-owned subsidiary of Central and South West Corporation (CSW) has been confirmed by the bankruptcy court, but cannot become fully effective until several other approvals are obtained. Under the plan, certain issues, including EPEC allegations regarding the 1989-90 Palo Verde outages, would be resolved, and EPEC would assume the joint facilities operating agreements. CSW has stated that several matters have arisen which may impede completion of the merger. If the plan is not approved, the Company does not expect that there would be a material adverse effect on its operations or financial position.\nARIZONA PUBLIC SERVICE COMPANY NOTES TO FINANCIAL STATEMENTS (continued)\nConstruction Program\nTotal construction expenditures in 1995 are estimated at $300 million, excluding capitalized property taxes and capitalized interest.\nFuel and Purchased Power Commitments\nThe Company is a party to various fuel and purchased power contracts with terms expiring from 1995 through 2020 that include required purchase provisions. The Company estimates its 1995 contract requirements to be approximately $127 million. However, this amount may vary significantly pursuant to certain provisions in such contracts which permit the Company to decrease its required purchases under certain circumstances.\n11. Selected Quarterly Financial Data (Unaudited)\nQuarterly financial information for 1994 and 1993 is as follows:\nElectric Operating Operating Net Earnings for Quarter Revenues(a) Income(b) Income Common Stock ------- ----------- --------- -------- ------------- (Thousands of Dollars)\nFirst ........... $346,049 $ 67,147 $ 38,468 $ 30,958 Second .......... 397,156 83,607 65,851 58,879 Third ........... 540,883 155,115 116,267 110,359 Fourth .......... 342,080 62,564 22,900 18,016\nFirst ........... $353,891 $ 79,441 $ 47,166 $ 39,277 Second .......... 387,871 92,264 61,364 53,716 Third ........... 497,282 132,639 102,911 95,617 Fourth .......... 363,369 68,144 38,945 30,936\n(a) Consistent with the presentation for the quarter ended December 31, 1994, prior quarters' electric operating revenues and other taxes have been restated to exclude sales tax on electric revenues.\n(b) The Company's operations are subject to seasonal fluctuations primarily as a result of weather conditions. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.\n12. Fair Value of Financial Instruments\nThe Company estimates that the carrying amounts of its cash equivalents and commercial paper are reasonable estimates of their fair values at December 31, 1994 and 1993 due to their short maturities. The December 31, 1994 and 1993 fair values of debt and equity investments, determined by using quoted market values or by discounting cash flows at rates equal to its cost of capital, approximate their carrying amounts. Investments in debt and equity securities are held for purposes other than trading.\nOn December 31, 1994, the carrying amount of long-term debt (excluding $26 million of capital lease obligations) was $2.16 billion and its estimated fair value was approximately $1.99 billion. On December 31, 1993, the carrying amount of long-term debt (excluding $30 million of capital lease obligations) was $2.10 billion and its estimated fair value was approximately $2.26 billion. The fair value estimates were determined by independent sources using quoted market rates where available. Where market prices were not available, the fair values were based on market values of comparable instruments.\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\nReference is hereby made to \"Election of Directors\" in the Company's Proxy Statement relating to the annual meeting of shareholders to be held on May 16, 1995 (the \"1995 Proxy Statement\") and to the Supplemental Item -- \"Executive Officers of the Registrant\" in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nReference is hereby made to the fourth paragraph under the heading \"The Board and its Committees,\" and to \"Executive Compensation\" in the 1995 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nReference is hereby made to \"Principal Holders of Voting Securities\" and \"Ownership of Pinnacle West Securities by Management\" in the 1995 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nReference is hereby made to the last paragraph under the heading \"The Board and its Committees\" in the 1995 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nFinancial Statements\nSee the Index to Financial Statements in Part II, Item 8 on page 19.\nIn addition to those Exhibits shown above, the Company hereby incorporates the following Exhibits pursuant to Exchange Act Rule 12b-32 and Regulation ss201.24 by reference to the filings set forth below:\nReports on Form 8-K\nDuring the quarter ended December 31, 1994, and the period ended March 29, 1995, the Company filed the following Reports on Form 8-K:\nReport filed January 11, 1995 comprised of exhibits to the Company's Registration Statements (Registration Nos. 33-61228 and 33-55473) relating to the Company's offering of $75 million of its Junior Subordinated Deferrable Interest Debentures.\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.\nARIZONA PUBLIC SERVICE COMPANY (Registrant)\nDate: March 29, 1995 O. MARK DEMICHELE -------------------------------- (O. Mark DeMichele, 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.\nSignature Title Date --------- ----- ----\nO. MARK DEMICHELE Principal Executive Officer March 29, 1995 ------------------------------- and Director (O. Mark DeMichele, President and Chief Executive Officer)\nWILLIAM J. POST Principal Accounting Officer March 29, 1995 ------------------------------- and Director (William J. Post, Senior Vice President and Chief Operating Officer)\nJARON B. NORBERG Principal Financial Officer March 29, 1995 ------------------------------- and Director (Jaron B. Norberg, Executive Vice President and Chief Financial Officer)\nKENNETH M. CARR Director March 29, 1995 ------------------------------- (Kenneth M. Carr)\nMARTHA O. HESSE Director March 29, 1995 ------------------------------- (Martha O. Hesse)\nMARIANNE MOODY JENNINGS Director March 29, 1995 ------------------------------- (Marianne Moody Jennings)\nROBERT G. MATLOCK Director March 29, 1995 ------------------------------- (Robert G. Matlock)\nJOHN R. NORTON III Director March 29, 1995 ------------------------------- (John R. Norton III)\nDONALD M. RILEY Director March 29, 1995 ------------------------------- (Donald M. Riley)\nHENRY B. SARGENT Director March 29, 1995 ------------------------------- (Henry B. Sargent)\nWILMA W. SCHWADA Director March 29, 1995 ------------------------------- (Wilma W. Schwada)\nVERNE D. SEIDEL Director March 29, 1995 ------------------------------- (Verne D. Seidel)\nRICHARD SNELL Director March 29, 1995 ------------------------------- (Richard Snell)\nDIANNE C. WALKER Director March 29, 1995 ------------------------------- (Dianne C. Walker)\nBEN F. WILLIAMS, JR. Director March 29, 1995 ------------------------------- (Ben F. Williams, Jr.)\nTHOMAS G. WOODS, JR. Director March 29, 1995 ------------------------------- (Thomas G. Woods, Jr.)\nCommission File Number 1-4473 ------------------------------------------------------------------------------ ------------------------------------------------------------------------------ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- EXHIBITS TO FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1994 -------------- Arizona Public Service Company (Exact name of registrant as specified in charter) ------------------------------------------------------------------------------ ------------------------------------------------------------------------------\nINDEX TO EXHIBITS\nExhibit No. Description ----------- ----------- 3.1 -- Bylaws, amended as of November 19, 1991\n3.2 -- Resolution of Board of Directors temporarily suspending Bylaws in part\n10.1 -- Amendment No. 1 to Decommissioning Trust Agreement (PVNGS Unit 1) dated as of December 1, 1994\n10.2 -- Amendment No. 1 to Decommissioning Trust Agreement (PVNGS Unit 3) dated as of December 1, 1994\n10.3 -- Amendment No. 2 to Amended and Restated Decommissioning Trust Agreement (PVNGS Unit 2) dated as of November 1, 1994\n10.4a -- 1995 Key Employee Variable Pay Plan\n10.5a -- 1995 Officers Variable Pay Plan\n10.6a -- Letter Agreement dated December 21, 1993, between the Company and William L. Stewart\n10.7a -- Pinnacle West Capital Corporation and Arizona Public Service Company Directors' Retirement Plan\n10.8ac -- Second revised form of Key Executive Employment and Severance Agreement between the Company and certain key employees of the Company\n10.9ac -- Second revised form of Key Executive Employment and Severance Agreement between the Company and certain executive officers of the Company\n23.1 -- Consent of Deloitte & Touche LLP\n27.1 -- Financial Data Schedule ----------\na Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of Form 10-K.\nb An additional document, substantially identical in all material respects to this Exhibit, has been entered into, relating to an additional Equity Participant. Although such additional document may differ in other respects (such as dollar amounts, percentages, tax indemnity matters, and dates of execution), there are no material details in which such document differs from this Exhibit.\nc Additional agreements, substantially identical in all material respects to this Exhibit have been entered into with additional officers and key employees of the Company. Although such additional documents may differ in other respects (such as dollar amounts and dates of execution), there are no material details in which such agreements differ from this Exhibit.\nFor a description of the Exhibits incorporated in this filing by reference, see Part IV, Item 14.","section_15":""}
{"filename":"101778_1994.txt","cik":"101778","year":"1994","section_1":"ITEM 1. BUSINESS\nUSX CORPORATION\nUSX Corporation was incorporated in 1901 and is a Delaware corporation. Executive offices are located at 600 Grant Street, Pittsburgh, PA 15219-4776. The terms \"USX\" and \"Corporation\" when used herein refer to USX Corporation or USX Corporation and its subsidiaries, as required by the context.\nINDUSTRY SEGMENTS\nFor consolidated reporting purposes, USX's reportable industry segments correspond with its three groups. A description of the groups and their products and services is as follows:\n- The Marathon Group is engaged in worldwide exploration, production, transportation and marketing of crude oil and natural gas; and domestic refining, marketing and transportation of petroleum products.\n- The U. S. Steel Group includes U. S. Steel, the largest integrated steel producer in the United States, which is primarily engaged in the production and sale of steel mill products, coke, and taconite pellets. The U. S. Steel Group also includes the management of mineral resources, domestic coal mining, engineering and consulting services and technology licensing. Other businesses that are part of the U. S. Steel Group include real estate development and management, and leasing and financing activities.\n- The Delhi Group is engaged in the purchasing, gathering, processing, transporting and marketing of natural gas. Data with respect to the Delhi Group for periods prior to October 2, 1992, represent the historical financial data of the businesses included in the Delhi Group. Such data for periods prior to that date are included in the Marathon Group.\nThe total number of active USX Headquarters employees not assigned to a specific group at year-end was 276 in 1994, 292 in 1993 and 364 in 1992.\nBelow is a three-year summary of financial highlights for the groups.\nMARATHON GROUP\nThe Marathon Group includes Marathon Oil Company (\"Marathon\") and certain other subsidiaries of USX which are engaged in worldwide exploration, production, transportation and marketing of crude oil and natural gas; and domestic refining, marketing and transportation of petroleum products. Marathon Group sales (excluding sales from businesses now included in the Delhi Group) as a percentage of USX consolidated sales were 66% in each of 1994 and 1993 and 69% in 1992. Prior to October 2, 1992, the Marathon Group also included the businesses of Delhi Gas Pipeline Corporation and certain other subsidiaries of USX engaged in the purchasing, gathering, processing, transporting and marketing of natural gas which are now included in the Delhi Group. The Marathon Group financial data for the periods prior to October 2, 1992, include the combined historical financial position, results of operations and cash flows for the businesses of the Delhi Group. Beginning October 2, 1992, the financial statements of the Marathon Group do not include the financial position, results of operations and cash flows for the businesses of the Delhi Group except for the financial effects of the Retained Interest. For further\ndiscussion of the Retained Interest, see \"Financial Statements and Supplementary Data - Notes to Financial Statements - 3. Corporate Activities - Common stock transactions\" for the Marathon Group.\nThe following table summarizes Marathon Group sales for each of the last three years:\nThe oil and gas industry is characterized by a large number of companies, none of which is dominant within the industry, but a number of which have greater resources than Marathon. Marathon must compete with these companies for the rights to explore for oil and gas. Acquiring the more attractive exploration opportunities frequently requires competitive bids involving substantial front-end bonus payments or commitments to work programs. Based on worldwide liquid hydrocarbon and natural gas production for 1993, the most recent year for which such information has been compiled by Oil & Gas Journal, Marathon ranked 13th among U.S. based petroleum corporations. Marathon believes it has 28 primary U.S. based exploration and production competitors, and a much larger number worldwide. Marathon must also compete with these and many other companies to acquire crude oil for refinery processing and in the distribution and marketing of a full array of petroleum products. Based on the U. S. Department of Energy's Petroleum Supply Annual for 1993, which is the most recent year for which such information is available, Marathon ranked eighth among U. S. petroleum corporations on the basis of crude oil refining capacity. In addition, based on 1993 data published by National Petroleum News, Marathon ranked ninth in refined product sales volumes. Marathon competes in three distinct markets for the sale of refined products in the Midwest and Southeast, and believes that its primary competitors in these markets include 43 companies in the wholesale distribution of petroleum products to private brand marketers and large commercial and industrial consumers; nine refiner\/marketers in the supply of branded petroleum products to dealers and jobbers; and over 1,000 petroleum product retailers in the retail sale of petroleum products. Marathon also competes in the convenience store industry through its retail outlets.\nThe Marathon Group's operating results are affected by price changes in crude oil, natural gas and petroleum products as well as changes in competitive conditions in the markets it serves. Generally, operating results from production operations benefit from higher crude oil and natural gas prices while refining and marketing margins may be adversely affected by crude oil price increases. Market conditions in the oil industry are cyclical and subject to global economic and political events.\nThe following table sets forth the number of active Marathon Group employees at year-end for each of the last three years:\nNUMBER OF ACTIVE EMPLOYEES AT YEAR-END\nThe reduction in the total number of employees between 1992 and 1994 primarily reflected implementation of work force reduction programs, the sale of the assets of a propane marketing subsidiary, the temporary idling of Marathon's Indianapolis refinery, the sale of the assets of a convenience store distribution warehouse facility and the closing of a lubricants and accessory supply facility. These factors were partially offset by the addition of employees staffing retail marketing outlets acquired during 1993 and 1994.\nCertain Marathon hourly employees at two of its four operating refineries and various other locations are represented by labor unions. On November 16, 1994, concurrent with the expiration of a labor agreement, 239 Detroit refinery and terminal employees represented by the International Brotherhood of Teamsters (\"Teamsters\") went on strike. On March 4, 1995, these employees ratified a new five-year labor agreement expiring on February 1, 2000. During the strike, the refinery and terminal were operated by salaried personnel, with no adverse effect on operations or on Marathon's ability to supply products to associated marketing areas. Certain hourly employees at the Texas City refinery are represented by the Oil, Chemical and Atomic Workers Union under a labor agreement which expires on March 31, 1996.\nOIL AND NATURAL GAS EXPLORATION AND DEVELOPMENT\nMarathon is currently conducting exploration and development activities in 17 countries, including the United States. Principal exploration activities are in the United States, the United Kingdom, Ireland, Bolivia, China, Gabon, Egypt, Tunisia, the Netherlands and Argentina. Principal development activities are in the United States, the United Kingdom, Indonesia, the Netherlands, Ireland, Norway and Egypt. Marathon is also pursuing potential long-term development opportunities in Russia and Syria.\nExploration activities during 1994 resulted in discoveries in the United Kingdom and the United States (both onshore and in the Gulf of Mexico).\nThe following table sets forth, by geographic area, the number of net productive and dry development and exploratory wells completed in each of the last three years (references to \"net\" wells or production indicate Marathon's ownership interest or share as the context requires):\nUnited States\nIn the United States Marathon completed 38 gross wildcat and delineation (\"exploratory\") wells (24 net wells) during 1994, including 8 gross wells (5 net wells) on which drilling began in prior years. Principal domestic exploration and development activities were in the U. S. Gulf of Mexico and the states of Texas, Louisiana, Oklahoma and Wyoming.\nExploration expenses during the three years ended December 31, 1994, totaled $224 million in the United States, of which $84 million was incurred in 1994. Development expenditures during the three years ended December 31, 1994, totaled $623 million in the United States, of which $276 million was incurred in 1994.\nThe following is a summary of recent, significant exploration and development activity in the United States including discussion, as deemed appropriate, of completed wells, drilling wells and wells under evaluation.\nThe Ewing Bank 873 discovery well was drilled in the Gulf of Mexico in early 1991. Installation of the Ewing Bank platform is complete, and production began in August 1994 and is expected to peak at 45,000 gross barrels per day (\"bpd\") of 21.5 degree American Petroleum Institute (\"API\") gravity crude oil and 30 gross million cubic feet per day (\"mmcfd\") of gas. The development is expected to ultimately produce an estimated 66 million gross barrels of oil and 45 gross billion cubic feet (\"bcf\") of gas. Marathon is the operator and holds a 66.67% working interest in this development which is located in 775 feet of water.\nIn the South Pass Block 89 Field, delineation wells drilled in 1994 from the South Pass 87 template to bottom hole locations on West Delta Block 128 and South Pass Block 88 encountered gas\/condensate pay. Fabrication of \"platform D\" began in 1994, and first production is planned for mid-\n1995. Marathon is the operator and holds a 33.3% working interest in South Pass 87, which is located offshore Louisiana in 375 feet of water, and a 50% working interest in West Delta 128 and South Pass 88.\nIn 1994, the Green Canyon 244 No. 1 discovery well encountered over 350 feet of net oil and gas pay, with most of the net oil pay in a single sand. Fluid samples indicated a 36.5 degree API gravity crude oil. Marathon is the operator and holds a 33.3% working interest in this discovery which is located offshore Louisiana in 2,800 feet of water. Appraisal activity began in 1994 and will continue into 1995.\nIn 1992, Marathon announced that a discovery well drilled on South Marsh Island Block 192, offshore Louisiana, encountered 65 feet of net gas pay. Development is scheduled to begin in 1995. Marathon holds a 33.3% working interest in this block which is located in 394 feet of water.\nDevelopment options are being evaluated for a 1993 exploratory well drilled in 1,900 feet of water at Ewing Bank 1006, located ten miles south of Ewing Bank 873. The well encountered 77 feet of oil sand and tested at a rate of 1,200 gross bpd of oil and 0.7 gross mmcfd of natural gas. Marathon is the operator and holds a 33.3% working interest in the well.\nDuring 1994, the Nash No. 1 exploratory well encountered a 300 foot reef section of the Cotton Valley formation in east Texas. A subsequent well, which reached total depth in 1995, encountered a reef section in a separate structure and is being evaluated. Marathon holds a 100% working interest in these wells. The Cotton Valley program is expected to continue through 1995 with the drilling of up to five additional exploratory wells.\nContract Drilling-FWA Drilling Company, Inc. owns 28 onshore rotary drilling rigs operating in the state of Texas.\nInternational\nOutside the United States during 1994, Marathon completed 14 gross exploratory wells (7 net wells) in 6 countries, including 8 gross wells (4 net wells) on which drilling began in prior years. Marathon drilled to total depth 8 gross exploratory wells (4 net wells) in 4 countries during 1994. Of the 8 wells, 2 wells in the United Kingdom encountered hydrocarbons and 6 were completed, plugged and abandoned.\nMarathon's expenses for international oil and natural gas exploration activities during the three years ended December 31, 1994, totaled $250 million, of which $73 million was incurred in 1994. Marathon's international development expenditures during the three years ended December 31, 1994, totaled $912 million, of which $146 million was incurred in 1994. Development expenditures during this three-year period included $718 million of the total $1.109 billion expended by Marathon for the development of the East Brae Field and construction of the Scottish Area Gas Evacuation (\"SAGE\") system. Marathon plans continued expenditures on international projects.\nThe following is a summary of recent, significant exploration and development activity outside the United States, including discussion, as deemed appropriate, of completed wells, drilling wells and wells under evaluation.\nUnited Kingdom-Marathon is continuing its development of the Brae area in the United Kingdom sector of the North Sea where it is the operator and owns a 41.6% revenue interest in the South, Central and North Brae Fields and a 38.5% revenue interest in the East Brae Field (as a result of a redetermination of East Brae unit interest ownership, Marathon's net revenue interest in East Brae was reduced from 39.1%). Marathon has interests in 24 blocks in the U.K. North Sea and other offshore areas.\nFormal U.K. Government approval to develop the Beinn Field was received in February 1994. Production before that time had been subject to a government approved extended test of a 1992 delineation\nwell. A second delineation well was drilled, completed and began production in 1993. Also during 1993, Marathon began drilling a third delineation well which was completed and began production during 1994. The latest delineation well commenced drilling in December 1994 and is scheduled for completion in the first quarter of 1995. Marathon owns a 41.6% revenue interest in this field.\nEast Brae is a gas condensate field and the largest field yet discovered by Marathon in the Brae area. Liquid hydrocarbon production began in late December 1993 and reached rates of up to 115,000 gross bpd during 1994. Gross estimated reserves exceed 300 million barrels of liquids and 1.5 trillion cubic feet (\"tcf\") of natural gas. East Brae platform commissioning was completed in August 1994. Including completion of the development drilling program, total investment, excluding capitalized interest, is estimated at $1.5 billion, of which Marathon's share is $620 million. See \"Oil and Natural Gas Production - International - North Sea\" for a description of Brae production operations.\nParticipation in the SAGE system provides pipeline transportation for Brae gas. The Brae group owns 50% of SAGE, which has a total wet gas capacity of 1.2 gross bcf per day. The other 50% is owned by the Beryl group which operates the system. The 30-inch pipeline connects the Brae, Beryl and Scott Fields to a gas processing terminal at St. Fergus in northeast Scotland. Gross project costs, excluding capitalized interest, approximated $1.2 billion, of which Marathon's share was approximately $280 million. Commissioning of the gas processing facilities was concluded in June 1994, and contractual sales began in October. Marathon, along with its Brae Group co-venturers, has entered into agreements for the sale of more than 1.1 gross tcf of Brae area gas. Marathon's share is 615 bcf. This includes approximately 205 gross mmcfd (112 net mmcfd ) under two separate 15-year supply contracts to U.K. utilities.\nDuring 1994, Marathon commenced drilling three wildcat wells, including one well in Block 103\/1 in the St. George's Channel near the U.K.\/Irish offshore boundary which tested oil and gas in two intervals of the Jurassic reservoirs below 7,500 feet. Additional seismic work and appraisal drilling will be required to more fully assess whether the reservoirs contain commercial quantities of oil and gas. A three- dimensional seismic program is in progress, and a delineation well is planned for 1995. Marathon has a 60% interest in this block which is located in 380 feet of water. The remaining two wildcat wells commenced in the U.K. during 1994 have been completed, plugged and abandoned.\nIreland-Marathon continues to work toward completion of a seven-well exploratory drilling program required by a 1991 agreement between Marathon and the Irish Government. Wells four and five are planned for 1995. None of the wells drilled to date encountered commercial quantities of hydrocarbons. In the first quarter of 1995, Marathon was awarded a license covering a total of approximately 450,000 acres in seven blocks in the Porcupine Basin off the west coast of Ireland. Marathon holds a 33.3% working interest in the license.\nIndonesia-Activity continues in the Kakap KRA and KG oil fields in the South China Sea to develop an estimated 40 million gross barrels of oil through existing infrastructure. A contract was awarded in November 1993 for the engineering, construction and installation of the platforms, facilities and pipelines along with connection to existing production facilities in the Kakap Block. First oil is anticipated in mid-1995, and production is expected to peak at an estimated 50,000 gross bpd of oil later that year. Marathon is the operator and holds a 37.5% working interest in this development.\nEgypt-Marathon has completed a three-well drilling program in the Nile Delta. The first of these wells was an exploratory well drilled and tested in 1993 on the Abu Madi West Development Lease seven miles northwest of Marathon's joint-interest El Qar'a Gas Field. The well's production potential and opportunities for delineation are being evaluated. Marathon has a 25% working interest in the El Qar'a Northwest discovery. The remaining two wells in the program were completed, plugged and abandoned in 1994. Also in the Nile Delta area, Marathon was awarded the 840,000 acre El Manzala Block, pending Egyptian Parliamentary ratification. Marathon has completed contract negotiations calling for a one-well exploratory drilling program, planned for 1995. Marathon holds a 100% working interest in this area. Marathon has successfully tested a well drilled in January 1995 in the Gebel El Zeit concession. The well\nencountered hydrocarbons in the Matulla and Nubia Formations. A delineation well in the Nubia formation is planned for 1995. Marathon holds a 100% interest in this concession.\nTunisia-Marathon has executed a farmout agreement requiring the drilling of three exploratory wells, two on the Grombalia permit and one on the Cap Bon permit. Drilling began in the fourth quarter of 1994, and the first well was completed, plugged and abandoned in February 1995. Marathon is drilling a 1995 delineation well on the Zarat Permit in the Gulf of Gabes in Southern Tunisia. Marathon holds a 66.67% exploration working interest on this permit and would retain an undivided 30% working interest in the development, subsequent to full participation by the Tunisian National Oil Company.\nNetherlands-Marathon, through its 50% equity interest in CLAM Petroleum Company (\"CLAM\"), drilled one exploratory well (a gas discovery) and two development wells in the Netherlands North Sea. Drilling activity planned for 1995 consists of an exploratory well on Block E18 and two development wells in the K8 block. Also during 1995, a plan of development (\"POD\") for two fields in the K11 Block will be initiated. This development is ultimately expected to include the drilling of four wells.\nRussia-In June 1994, Sakhalin Energy Investment Company Ltd. (\"Sakhalin Energy\"), a joint venture company in which Marathon has a 30% interest, joined with members of the Russian Government in the signing of the Sakhalin II Production Sharing Contract (\"PSC\") for the development of the Lunskoye gas field and the Piltun-Astokhskoye (\"P-A\") oil field located offshore Sakhalin Island in the Russian Far East Region. The Sakhalin II PSC is the first executed Russian PSC. Subsequent efforts during the year focused on working with the Russian parliament to finalize legislation to ensure the stabilization of laws complementary to the Sakhalin II PSC. This is necessary before Sakhalin Energy commits to undertaking appraisal period activities. These appraisal period activities include the finalizing of the development plan and efforts to secure liquefied natural gas (\"LNG\") markets and financing arrangements. According to estimates by Russian experts, the P-A and Lunskoye fields contain combined proven reserves of 750 million barrels of oil and condensate and 14 tcf of natural gas.\nSyria-Marathon is awaiting approval of a POD submitted to the Syria Petroleum Company in May 1993, for the development of Marathon's gas reserves in the Palmyra Block. Negotiation of a gas sales agreement would be required following approval of the POD.\nChina-In January 1995, Marathon signed a production sharing contract covering Kaiping Block 27\/35 in the South China Sea. The 1.2 million acre block is located 180 miles south of Hong Kong. Marathon holds a 100% working interest. The first exploratory well is scheduled for 1995.\nBolivia-Marathon holds a 50% working interest in a six million acre concession. An exploratory well is scheduled for the first half of 1995.\nGabon-Marathon continues exploration work on the Kowe permit (offshore block) awarded in 1992. The first well in this permit is scheduled to be drilled in the second half of 1995. Marathon holds a 75% working interest in this block which is located approximately 90 miles southeast of Port Gentil.\nArgentina-An exploratory well is planned for 1995 in the Rio Desaguardero Block located approximately 500 miles west of Buenos Aires. Marathon holds a 100% working interest in this concession.\nAustralia-During 1994, Marathon closed its Perth office and discontinued activities in blocks in which it held operating interest, but continues to hold non-operating interests in Blocks WA-191-P and WA-8-1, offshore northwestern Australia.\nThe following table sets forth, by geographic area, the developed and undeveloped oil and gas acreage held as of December 31, 1994:\nGROSS AND NET ACREAGE\nReserves\nThe table below sets forth estimated quantities of net proved oil and gas reserves at the end of each of the last three years. Reports have been filed with the U. S. Department of Energy (\"DOE\") for the years 1993 and 1992 disclosing the year-end estimated oil and gas reserves. A similar report will be filed for 1994. The year-end estimates reported to the DOE are the same as the estimates reported herein. For additional information regarding oil and gas reserves, see \"Consolidated Financial Statements and Supplementary Data - Supplementary Information on Oil and Gas Producing Activities - Estimated Quantities of Proved Oil and Gas Reserves.\"\nESTIMATED QUANTITIES OF NET PROVED OIL AND GAS RESERVES AT DECEMBER 31\nAt December 31, 1994, the Marathon Group's estimated quantities of combined net proved liquid hydrocarbons and natural gas reserves totaled 1.4 billion barrels of oil equivalent, of which 86% were\nproved developed reserves and 14% were proved undeveloped reserves. (Natural gas reserves are converted to barrels of oil equivalent using a conversion factor of six thousand cubic feet (\"mcf\") of natural gas to one barrel of oil.) Net proved reserves are located principally in the United States, the U.K. North Sea, the Irish Celtic Sea, the Norwegian North Sea, North Africa and Southeast Asia. Liquid hydrocarbons represented 57% of combined net proved reserves.\nOIL AND NATURAL GAS PRODUCTION\nThe following tables set forth daily average net production of crude oil, condensate and natural gas liquids, and natural gas by geographic area for each of the last three years:\nMarathon is currently producing crude oil and\/or natural gas in eight countries, including the United States. Marathon's worldwide liquid hydrocarbon production averaged 172,400 net bpd in 1994, up 16,400 bpd, or 10%, from 1993, due mainly to production from the East Brae Field in the U.K. North Sea which began in late December 1993. Marathon's worldwide liquid hydrocarbon production is expected to increase to an estimated 211,000 net bpd in 1995, primarily reflecting increased production from the East Brae Field in the U.K. North Sea, production from projects in the U.S. Gulf of Mexico (including a full year of production from Ewing Bank 873) and new production from the Kakap KRA and KG fields, offshore Indonesia.\nMarathon's worldwide sales of equity natural gas production, including Marathon's equity share of CLAM's production, averaged over 1 billion cubic feet per day in 1994, up 77 net mmcfd, or 8%, from 1993. Average sales of equity natural gas production in the U.S. increased by 45 net mmcfd, or 9%, in 1994 and is expected to increase by an additional 19% in 1995, as natural production declines are more than offset by the effects of successful drilling programs in Wyoming, Oklahoma and Texas. Average\nsales of equity natural gas production outside the U.S. increased by 32 net mmcfd, or 8%, with further increases expected in 1995, primarily due to Brae area gas sales which began in October 1994.\nUnited States\nApproximately 64% of Marathon's 1994 worldwide liquid hydrocarbon production and equity liftings and 57% of worldwide natural gas production were from domestic operations. The principal domestic producing areas are located in Texas, Wyoming, the U.S. Gulf of Mexico and Alaska.\nTexas-Marathon owns a 49.63% working interest in, and is the operator of, the Yates Field Unit, one of the largest fields in the United States. Marathon's 23,400 net bpd of 1994 liquid hydrocarbon production from the Yates Field and Gas Plant accounted for 21% of Marathon's total U.S. production. The field's average annual production increased by 7% in 1994, compared with declines of 3% in 1993, 9% in 1992, 8% in 1991 and 19% in 1990.\nWyoming-Since operations began in 1912, Marathon has produced over one billion gross barrels of liquid hydrocarbons in the state. Production for 1994 averaged 24,300 net bpd, representing 22% of Marathon's total U.S. liquid hydrocarbon production. Production in 1993 averaged 27,200 net bpd.\nMarathon continues to apply enhanced recovery and reservoir management programs and cost containment efforts to maximize liquid hydrocarbon recovery and profitability in maturing fields such as Yates and Oregon Basin.\nGulf of Mexico-During 1994, Marathon produced 11,800 net bpd of liquid hydrocarbons and 79 net mmcfd of natural gas in the U.S. Gulf of Mexico. Liquid hydrocarbon production increased by 20% from the prior year, as production from Ewing Bank 873 began in August, following platform installation. Natural gas production decreased by 19% from the prior year, reflecting a full-year effect of 1993 dispositions. At year-end 1994, Marathon held working interests in 12 fields producing from 29 platforms, 18 of which Marathon operates.\nAlaska-Marathon has interests in seven of the 15 drilling and production platforms in the Cook Inlet. In December 1994, a property exchange and realignment of operations designed to improve performance and efficiencies of Marathon and the other joint-interest owners were completed. Marathon acquired additional working interests in the Beaver Creek, Kenai and Cannery Loop fields and now operates each of the fields. Marathon relinquished working interest in the Swanson River Field and operatorship of the Trading Bay Unit, which includes the Steelhead and Dolly Varden platforms and the onshore Trading Bay Production Facility. Marathon's production from Alaska averaged 9,400 net bpd of liquid hydrocarbons and 123 net mmcfd of natural gas in 1994, compared with 8,800 net bpd and 118 net mmcfd in 1993. Average production in 1995 is expected to increase slightly from 1994 levels.\nInternational\nInterests in liquid hydrocarbon and\/or natural gas production are held in the U.K. North Sea, Ireland, the Norwegian North Sea, Tunisia, Indonesia and Egypt. In addition, Marathon has an equity interest in the Netherlands North Sea.\nNorth Sea-The following table sets forth Marathon's average net liquid hydrocarbon liftings for the Brae area, in each of the last three years:\nMarathon's liquid hydrocarbon liftings from the East, North, South and Central Brae Fields averaged 45,900 net bpd in 1994, compared with 23,300 net bpd in 1993. The increase was due mainly to liftings from East Brae. Production from East Brae commenced in late December 1993, and continued to increase throughout 1994. Liftings averaged 23,400 net bpd in 1994 (38,700 net bpd in December 1994).\nNorth Brae is a gas condensate field and continues to be produced using the gas cycling technique. This technique separates natural gas liquids and returns the dry gas to the reservoir for pressure maintenance, increasing the overall liquids recovery. Liftings include production from the previously mentioned Beinn Field, processed by North Brae facilities.\nThe South Brae platform serves as a vital link in generating third-party pipeline tariff revenue. To date, production from eight third-party fields is contracted to the Brae pipeline system. Six of the fields are currently onstream, one is expected to be brought onstream in 1995, and another is scheduled to be brought onstream in 1996.\nCentral Brae is a multi-well subsea development tied to South Brae facilities.\nMarathon's total U.K. gas sales from all sources averaged 39 mmcfd in 1994. Contractual sales of Brae area gas through the SAGE pipeline system began in October and averaged 82 net mmcfd for the fourth quarter of 1994.\nMarathon owns an overall 6.14% revenue interest in the V-Fields gas development in the Southern Basin of the U.K. North Sea. Marathon's sales from the V-Fields averaged 13 net mmcfd in 1994, compared with 22 net mmcfd in 1993 and 18 net mmcfd in 1992. The changes in sales primarily reflected fluctuations in customer demand.\nIn the Norwegian North Sea, Marathon holds a 24% working interest in the Heimdal Field with sales of 81 net mmcfd of natural gas and 1,700 net bpd of condensate in 1994. On June 11, 1994, Marathon issued notice of termination on the two original gas sales agreements for the evacuation of Heimdal gas. Marathon issued notice of termination based upon low gas prices and high pipeline tariffs associated with the original agreements. Negotiations are ongoing to raise prices and lower tariffs for current and post-June 1996 sales. Unless otherwise agreed, the effective date of termination under the original gas sales agreements is June 11, 1996.\nMarathon's 50% equity interest in CLAM, a natural gas and gas liquids producer in the Netherlands North Sea, provides a 7% entitlement in the production of 16 gas fields which provided sales of 40 net mmcfd of natural gas in 1994.\nIreland-Marathon owns a 100% working interest in the Kinsale Head and Ballycotton Fields in the Celtic Sea. Combined sales of natural gas averaged 263 net mmcfd, 258 net mmcfd and 227 net\nmmcfd in 1994, 1993 and 1992, respectively. Four compressors were installed at Kinsale Head, two in each of 1992 and 1993, to increase the deliverability from the fields.\nTunisia-Marathon holds a 50% working interest in the Belli Field located 30 miles southeast of Tunis and a 31% interest in the Ezzaouia Field, located 220 miles south of Tunis. Liquid hydrocarbon liftings averaged 2,600 net bpd from these fields in 1994, compared with 8,200 net bpd in 1993 and 10,700 net bpd in 1992. The decreases primarily reflected natural declines.\nIndonesia-Marathon holds a 37.5% working interest in two producing fields (KH and KF) in the Kakap Block in the Natuna Sea. The fields produce into a floating production, storage and off-loading vessel. Liquid hydrocarbon liftings from Marathon's Kakap Block averaged 3,600 net bpd in 1994, compared with 3,300 net bpd in 1993 and 5,100 net bpd in 1992. The decrease from 1992 reflected natural declines. Production in the KG and KRA Fields is expected to begin in mid-1995.\nEgypt-Marathon holds interests in three fields in Egypt. During 1994, liquid hydrocarbon liftings from the Ashrafi Field, in which Marathon holds a 50% working interest, averaged 6,200 net bpd. Natural gas sales and liquid hydrocarbon liftings from the El Qar'a Gas Field, in which Marathon holds a 25% interest, averaged 18 net mmcfd and 500 net bpd, respectively. Liquid hydrocarbon liftings from the Gazwarina Field, in which Marathon holds a 50% working interest, averaged 200 net bpd.\nThe following tables set forth productive wells and drilling wells as of December 31, 1994, and average production costs and sales prices per unit of production for each of the last three years:\nGROSS AND NET WELLS\n(Footnotes presented on the following page)\n(a) Production costs are as defined by the Securities and Exchange Commission and include property taxes, severance taxes and other costs, but exclude depreciation, depletion and amortization of capitalized acquisition, exploration and development costs. Prior year production costs have been restated to conform to 1994 classifications and such costs exclude administrative costs and costs associated with reorganization efforts. Natural gas volumes were converted to barrels of oil equivalent using a conversion factor of six mcf of natural gas to one barrel of oil. (b) Production costs in 1992 were favorably affected by $1.50 per equivalent barrel for the settlement of prior years' production taxes but excluded the effect of a $115 million restructuring charge relating to the disposition of certain domestic exploration and production properties.\nREFINING, MARKETING AND TRANSPORTATION\nMarathon's refining, marketing and transportation (\"RM&T\") operations are geographically concentrated in the Midwest and Southeast. This regional focus allows Marathon to achieve operating efficiencies between its integrated refining and distribution systems and its marketing operations.\nRefining\nMarathon is a leading domestic petroleum refiner with 620,000 bpd of combined crude oil refining capacity. Marathon's refining system operated at 86% of its in-use capacity in 1994.\nThe following table sets forth the location and throughput capacity of each of Marathon's refineries at December 31, 1994:\nMarathon's refineries are integrated via pipelines and barges to maximize operating efficiency. The transportation links that connect the refineries allow the movement of intermediate products to optimize operations and the production of higher margin products. For example, naphtha is moved from Texas City to Robinson where excess reforming capacity is available. Gas oil is moved from Robinson to Detroit, which allows the Detroit refinery to upgrade diesel fuel to gasoline, using excess fluid catalytic cracking unit capacity. Light cycle oil is moved from Texas City to Robinson for sulfur removal to produce low-sulfur diesel fuel.\nIn December 1994, in order to comply with provisions of the 1990 Amendments to the Clean Air Act (\"CAA\"), Marathon began selling reformulated gasoline at wholesale distribution terminals serving ozone non-attainment areas that require reformulated gasoline. In January 1995, Marathon's retail outlets in these areas began selling reformulated gasoline. Of the nine metropolitan areas requiring reformulated gasoline under the 1990 Amendments to the CAA, only two, Chicago and Milwaukee, are in Marathon's marketing territory. In addition, Louisville subsequently opted into the program. These markets are supplied with reformulated gasoline or reformulated gasoline blend stocks produced at Marathon's Robinson and Texas City refineries. Marathon blends ethanol with reformulated gasoline blend stocks to supply the Chicago area. Annual demand for Marathon reformulated gasoline is expected to average approximately 50,000 bpd. As a result, an estimated 10-15% of Marathon's gasoline yield will be\nreformulated. Marathon has the ability to produce additional volumes of reformulated gasoline for sale should the opportunity arise. An insignificant share of Marathon's sales are in carbon monoxide non-attainment areas where oxygenated fuels were required effective November 1992.\nMarathon's Detroit and Robinson refineries have oxygenate units capable of producing the oxygenated ether which can be a primary component of reformulated gasoline. Depending on the economics, the unit at Robinson can be configured to use either methanol or ethanol as a feedstock to produce methyl tertiary butyl ether (\"MTBE\") or ethyl tertiary butyl ether (\"ETBE\"), respectively.\nDuring 1993, Marathon completed installation of distillate desulfurization facilities at its Detroit, Garyville and Robinson refineries, which enable Marathon to meet the United States Environmental Protection Agency's (\"EPA\") standards limiting the sulfur content of highway transportation diesel fuels. Marathon's total capital investment in these facilities was $339 million, including expenditures of $111 million in 1993 and $184 million in 1992. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of Marathon's products and services, operating results will be adversely affected. During 1994, total U.S. production of low-sulfur diesel fuels exceeded demand by an average of approximately 200,000 bpd, putting downward pressure on the spread between low- and high-sulfur fuel prices and limiting the ability of refiner\/marketers to recoup capital investments in desulfurization facilities. For further discussion of environmental regulations, see \"Environmental Matters.\"\nIn October 1993, Marathon temporarily idled its 50,000 bpd Indianapolis refinery due to unfavorable plant economics and increased environmental spending requirements. The costs related to the idling did not have a material effect on Marathon's 1993 operating results. The idling had no adverse impact on Marathon's supply of transportation fuels to its various classes of trade in Indiana or the Midwest marketing area. The status of the refinery is periodically reviewed. This includes consideration of economic as well as regulatory matters. As of February 28, 1995, the refinery remained temporarily idled.\nMarketing\nIn 1994, Marathon had refined product sales volumes (excluding matching buy\/sell transactions) of 10.3 billion gallons (670,000 bpd). Excluding sales related to matching buy\/sell transactions, the wholesale distribution of petroleum products to private brand marketers and to large commercial and industrial consumers, primarily located in the Midwest and Southeast, accounted for about 58% of Marathon's refined product sales volumes in 1994. Approximately 41% of Marathon's gasoline volumes and 72% of its distillate volumes were sold on a wholesale basis to independent unbranded customers in 1994.\nThe following table sets forth the volume of consolidated refined product sales by product group for each of the last three years:\nAs of December 31, 1994, Marathon supplied petroleum products to 2,356 Marathon branded retail outlets located primarily in Ohio, Michigan, Indiana, Kentucky and Illinois. Substantially all Marathon branded petroleum products are sold to independent dealers and jobbers. In addition, Marathon branded operations are being expanded into areas in proximity to Marathon's existing terminal and transportation system where new accounts can be supplied at minimal incremental cost. At December 31, 1994, Marathon supplied 212 stations in states outside its traditional branded marketing territory including Virginia, Tennessee, West Virginia, Wisconsin, North Carolina and Pennsylvania.\nRetail sales of gasoline and diesel fuel are also made through limited and self-service stations and truck stops operated in 15 states by a wholly owned subsidiary, Emro Marketing Company (\"Emro\"). As of December 31, 1994, this subsidiary had 1,659 retail outlets which sold petroleum products, primarily under the brand names \"Speedway,\" \"Starvin' Marvin,\" \"United\" and \"Bonded,\" as well as convenience-store merchandise. Revenues from the sale of convenience-store merchandise totaled $843 million, $757 million and $741 million in 1994, 1993 and 1992, respectively. Profits generated from these sales serve as a buffer against the price volatility experienced in the retail sale of refined products. The selection of merchandise varies among outlets--1,183 of Emro's 1,659 outlets at December 31, 1994, had convenience stores which sold a variety of food and merchandise, and the remaining outlets sold selected convenience-store items such as cigarettes, candy and beverages.\nIn recent years, Emro has made substantial progress in streamlining its operations, reducing costs and concentrating on its core businesses. To enhance profitability, Emro closed 123 marginal outlets during the three-year period ended December 31, 1994. In addition, Emro sold certain of its non-core businesses. In 1993, Emro sold the assets of a subsidiary, Bosart Co., which consisted primarily of a convenience store distribution warehouse facility. In 1994, Emro sold the assets of Emro Propane Company, a wholly owned subsidiary. Emro Propane Company was a distributor of propane to residential heating and industrial consumers in several midwestern states.\nEmro has recently expanded its core business through several acquisitions. In 1993, Emro acquired the remaining interest in Wake Up Oil Co. which included 36 retail outlets marketing under the name \"Wake Up.\" In May 1994, Emro completed the acquisition of 36 retail outlets in the Greater Chicago and northern Indiana areas. Also during 1994, Emro acquired 38 retail outlets in Florida, 36 retail outlets and a truck stop in Tennessee, 20 retail outlets in Michigan, one retail outlet in Kentucky and a truck stop in South Carolina.\nCertain Marathon branded and Emro retail outlets feature on-premises brand-name restaurants (\"branded food service\") as a means of increasing overall unit profitability. Typically, Emro or the independent Marathon jobber or dealer becomes a restaurant franchisee\nat these locations, although some sites are leased for food-service management under different ownership. Both Marathon and Emro plan additional branded food service locations in the future.\nSupply and Transportation\nMarathon obtains nearly 60% of its crude oil feedstocks from North and South America and the balance primarily from the Middle East, the North Sea and West Africa. In 1994, Marathon was a net purchaser of 380,000 bpd of crude oil from both domestic and international sources, including approximately 145,000 bpd obtained from the Middle East.\nMarathon's strategy in acquiring raw materials for its refineries is to obtain supply from secure, long-term sources. Marathon generally sells its international equity production into local markets, but has the ability to satisfy about 75% of its requirements from a combination of its international equity crude and current supply arrangements in the Western Hemisphere.\nMarathon operates a system of terminals and pipelines to provide crude oil to its refineries and refined products to its marketing areas. Fifty-one terminals, including 45 light product and 6 asphalt terminals, are strategically located throughout the Midwest and Southeast. In addition, Marathon operates a fleet of trucks to deliver petroleum products to retail marketing outlets.\nDuring late 1993 and early 1994, Marathon installed automated fuel dye-injection equipment at 30 of its terminals in order to facilitate the sale of low-sulfur fuel oils for tax-exempt uses. The dye injection equipment was installed in connection with a January 1, 1994 requirement that terminal operators collect and remit federal excise taxes on all fuels suitable for use as on-highway diesel fuel, unless the fuel is dyed to indicate its tax-exempt status. Computerized in-line blenders installed during 1994 at Marathon's Chicago-area terminals allow the blending of virtually any grade of gasoline from three base inventory components--ethanol, and low- and high- octane reformulated gasoline blend stocks. As a result, existing tankage will be sufficient to handle demands for reformulated gasoline in the Chicago area.\nIn late 1994, Marathon began construction of a new asphalt terminal in Mt. Vernon, Ind. which will allow Marathon to take advantage of favorable winter asphalt production economics at its Garyville refinery. The terminal will be completed in early 1995, prior to the summer asphalt sales season.\nAlso during 1994, Marathon reached agreement with a third party to blend and package lubricants for sale through Marathon branded and company-operated retail outlets. This resulted in the closing of Marathon's Lubricants and Tires, Batteries and Accessories supply facility in Robinson, Ill.\nMarathon, through a wholly owned subsidiary, Marathon Pipe Line Company (\"MPLC\"), owns and operates, as a common carrier, approximately 1,100 miles of crude oil gathering lines; 1,500 miles of crude oil trunk lines; and 1,500 miles of products trunk lines. MPLC also owns interests in various pipeline systems, including 11.06% of the Capline system, a large diameter crude pipeline extending from St. James, La. to Patoka, Ill., and a 66.67% partnership interest in Block 873 Pipeline Company, which owns a 60-mile pipeline connected to the Ewing Bank 873 production platform in the Gulf of Mexico. Additionally, MPLC owns 32.1% of LOOP INC., which is the owner and operator of the only U.S. deepwater oil port. LOOP is located 18 miles off the coast of Louisiana. Marathon holds equity interests in a number of pipeline companies, including 17.36% of the Explorer Pipeline Company, which operates a light products pipeline system extending from the Gulf Coast to the Midwest, and 2.5% of the Colonial Pipeline Company, which operates a light products pipeline system extending from the Gulf Coast to the East Coast.\nDomestic Natural Gas Marketing and Transportation\nIn addition to the sale of equity production of natural gas, Marathon purchases gas from third-party producers and marketers for resale in order to offer customers secure and source-flexible supplies.\nMarathon also manufactures LNG at a Kenai, Alaska gas liquefication plant, in which Marathon holds a 30% interest. Feedstock is supplied to the plant from a portion of Marathon's natural gas production in Alaska. LNG is delivered via tankers to two Japanese utilities under a contract which was renewed in April 1989 for a 15-year period. Marathon has a 30% participation in this contract which calls for the sale of more than 900 gross bcf over the contract life. During 1993, the LNG tankers used since deliveries began under the original contract in 1969 were replaced by two new tankers with 22% greater capacity. During 1994, LNG deliveries totaled 63.3 gross bcf (19.0 net bcf), up from 56.5 gross bcf (17.2 net bcf) in 1993. The increased capacity of the new tankers was not fully utilized in 1994, their first full year of operation, as demand growth was constrained by high inventory levels resulting from mild weather and a weak Japanese economy and by maintenance downtime at customer power generation facilities.\nNatural Gas Utilities\nCarnegie Natural Gas Company (\"Carnegie\") is an interstate pipeline company engaged in the transportation and sale-for-resale of natural gas in interstate commerce. In addition, Carnegie functions as a local distribution company serving residential, commercial and industrial customers in West Virginia and western Pennsylvania. Carnegie is a supplier and transporter of natural gas for U. S. Steel's Mon Valley Works near Pittsburgh. Apollo Gas Company (\"Apollo\") is engaged in the distribution of natural gas to residential, commercial and industrial customers in western Pennsylvania.\nBoth Carnegie and Apollo are regulated as public utilities by state commissions within their service areas. Carnegie is also regulated by the Federal Energy Regulatory Commission as an interstate pipeline. Total natural gas throughput for Carnegie and Apollo was 28 bcf in 1994, 37 bcf in 1993 and 33 bcf in 1992.\nHEDGING ACTIVITIES\nThe Marathon Group engages in hedging activity to help protect against adverse market price changes related to the purchase or production and sale of crude oil, natural gas and refined products. Although crude oil and refined product prices generally move in tandem, futures contracts, commodity swaps and options are used to supplement the natural marketplace in protecting overall profitability. While hedging activities are generally used to reduce risks from unfavorable price movements, they also may limit the opportunity to benefit from favorable movements. The Marathon Group's hedging activities have not been significant in relation to its overall business activity. For additional information regarding hedging activity, see \"Financial Statements and Supplementary Data - Notes to Financial Statements - 2. Summary of Principal Accounting Policies - Hedging Transactions and - 24. Derivative Financial Instruments and Management's Discussion and Analysis of Cash Flows - Hedging Activity\" for the Marathon Group.\nPROPERTY, PLANT AND EQUIPMENT ADDITIONS\nThe following table sets forth property, plant and equipment additions for the Marathon Group for each of the last three years:\nProperty, plant and equipment additions, including capital leases and assets acquired by issuing stock or debt securities, have been primarily for the replacement, modernization and expansion of facilities and production capabilities including: development of the Brae Fields and the related SAGE pipeline system in the U. K. North Sea; refinery modifications at Robinson, Garyville and Detroit (including the construction of facilities required to meet federal low-sulfur diesel requirements); expansion of Emro Marketing Company's network of retail outlets; and environmental controls. For information concerning capital expenditures for environmental controls in 1992, 1993 and 1994 and estimated capital expenditures for such purposes in 1995 and 1996, see \"Environmental Matters.\"\nDepreciation, depletion and amortization costs for the Marathon Group were $721 million, $727 million and $793 million in 1994, 1993 and 1992, respectively.\nRESEARCH AND DEVELOPMENT\nThe research and development activities of the Marathon Group are conducted mainly at Marathon's Petroleum Technology Center in Littleton, Colorado. Expenditures by Marathon for research and development were $16 million in 1994 and $19 million in each of 1993 and 1992.\nActivities at the Petroleum Technology Center are devoted primarily to assisting Marathon's operating organizations in finding, producing and processing oil and gas efficiently and economically. Current efforts include new concepts in regional geological interpretation, enhanced seismic interpretation, development of computer-based techniques for reservoir description and performance modeling, methods to improve production and injection well performance and enhanced oil recovery techniques. The staff at the Petroleum Technology Center also provides a broad range of technical assistance and consultation to Marathon's RM&T operating organizations, including refinery process optimization.\nENVIRONMENTAL MATTERS\nThe Marathon Group maintains a comprehensive environmental policy overseen by the Public Policy Committee of the USX Board of Directors. The Environmental Affairs, Health and Safety organization has the responsibility to ensure that the Marathon Group's operating organizations maintain environmental compliance systems that are in accordance with applicable laws and regulations. The Health, Environmental and Safety Management Committee, which is comprised of officers of the group, is charged with reviewing its overall performance with various environmental compliance programs. Also,\nthe Marathon Group has formed the Emergency Management Team, composed of senior management, which will oversee the response to any major emergency environmental incident throughout the group.\nThe businesses of the Marathon Group are subject to numerous federal, state and local laws and regulations relating to the protection of the environment. These environmental laws and regulations include the Clean Air Act (\"CAA\") with respect to air emissions, the Clean Water Act (\"CWA\") with respect to water discharges, the Resource Conservation and Recovery Act (\"RCRA\") with respect to solid and hazardous waste treatment, storage and disposal, the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") with respect to releases and remediation of hazardous substances, and the Oil Pollution Act of 1990 (\"OPA-90\") with respect to oil pollution and response. In addition, many states where the Marathon Group operates have similar laws dealing with the same matters. These laws are constantly evolving and becoming increasingly stringent. The ultimate impact of complying with existing laws and regulations is not always clearly known or determinable due in part to the fact that certain implementing regulations for laws such as RCRA and the CAA have not yet been promulgated or in certain instances are undergoing revision. These environmental laws and regulations, particularly the 1990 Amendments to the CAA and new water quality standards, could result in substantially increased capital, operating and compliance costs. For a discussion of environmental expenditures, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Management's Discussion and Analysis of Environmental Matters, Litigation and Contingencies\" and \"Legal Proceedings\" for the Marathon Group.\nThe Marathon Group has incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. Expenditures during 1992 and 1993 included substantial amounts for product reformulation and process changes to meet CAA requirements, in addition to ongoing compliance costs. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of the Marathon Group's products and services, operating results will be adversely affected. The Marathon Group believes that substantially all of its competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities, marketing areas, production processes and whether or not it is engaged in the petrochemical business or the marine transportation of crude oil.\nAir\nThe 1990 Amendments to the CAA impose more stringent limits on air emissions, establish a federally mandated operating permit program and allow for enhanced civil and criminal enforcement sanctions. The principal impact of the 1990 Amendments to the CAA on the Marathon Group is on RM&T operations. The amendments establish attainment deadlines and control requirements based on the severity of air pollution in a geographical area. For example, the amendments required a reduction in the amount of sulfur in diesel fuel produced for highway transportation use, effective October 1993, and the introduction of reformulated gasoline in the nine metropolitan areas classified as severe or extreme for ozone non-attainment, and other areas opting into the program, effective January 1995.\nMarathon has the capability of producing about 25% of its gasoline output as reformulated fuels -- well above the estimated 10-15% required to meet demand within Marathon's marketing area. A major cost of reformulation is the mandated use of oxygenates in gasoline. As discussed under Refining, Marketing and Transportation above, Marathon has constructed oxygenate units at its Detroit and Robinson refineries.\nIn addition to the foregoing, refueling controls are required on fuel dispensers (so called Stage II Recovery) at gasoline stations located in ozone non-attainment areas classified as moderate, serious, severe and extreme. As of December 31, 1994, Marathon had installed refueling controls at approximately 500 of the potential 600 retail outlets requiring them, at an estimated average cost of $40,000 per outlet.\nWater\nThe Marathon Group maintains numerous discharge permits as required under the National Pollutant Discharge Elimination System program of the CWA, and has implemented systems to oversee its compliance efforts. In addition, the Marathon Group is regulated under OPA-90 which amended the CWA. Among other requirements, OPA-90 requires the owner or operator of a tank vessel or a facility to maintain an emergency plan to respond to discharges of oil or hazardous substances. Also, in case of such spills, OPA-90 requires responsible companies to pay removal costs and damages caused by them, provides for substantial civil penalties, and imposes criminal sanctions for violations of this law. Unlike many of its competitors within the oil industry, Marathon does not operate tank vessels, and therefore, has significantly less exposure under OPA-90 than competitors who do operate tank vessels. However, it does operate facilities at which spills of oil and hazardous substances could occur. Furthermore, several coastal states in which Marathon operates have passed or are expected to pass state laws similar to OPA-90, but with expanded liability provisions, including provisions for cargo owners as well as shipowners. Marathon has implemented approximately 50 emergency oil response plans for all its components and facilities covered by OPA-90, and it is an active member, along with other oil companies, in the Marine Preservation Association, which funds the Marine Spill Recovery Corporation, a major oil spill response organization covering a number of U.S. coastal areas.\nSolid Waste\nThe Marathon Group continues to seek methods to minimize the generation of hazardous wastes in its operations. RCRA establishes standards for the management of solid and hazardous wastes. Besides affecting current waste disposal practices, RCRA also addresses the environmental effects of certain past waste disposal operations, the recycling of wastes and the regulation of underground storage tanks (\"USTs\") containing regulated substances. Since the EPA has not yet promulgated implementing regulations for all provisions of RCRA and has not yet made clear the practical application of all the implementing regulations it has promulgated, the ultimate cost of compliance cannot be accurately estimated. In addition, new laws are being enacted and regulations are being adopted by various regulatory agencies on a continuing basis, and the costs of compliance with these new rules can only be broadly appraised until their implementation becomes more accurately defined. Corrective action under RCRA related to past waste disposal activities is discussed under \"Remediation.\"\nRemediation\nThe Marathon Group operates certain retail outlets where, during the normal course of operations, releases of petroleum products from USTs have occurred. Federal and state laws require that contamination caused by such releases at these sites be assessed and remediated to meet applicable standards. The enforcement of the UST regulations under RCRA has been delegated to the states which administer their own UST programs. The Marathon Group's obligation to remediate such contamination varies, depending upon the extent of the releases and the stringency of the laws and regulations of the states in which it operates. A portion of these remediation costs may be recoverable from state UST reimbursement funds once the applicable deductibles have been satisfied. Accruals for remediation expenses are established for sites where contamination has been determined to exist and the amount of associated costs is reasonably determinable.\nThe Marathon Group is involved with a potential corrective action at its Robinson, Ill. refinery where the remediation costs have been estimated at between $4 million and $18 million over 20 to 30 years. Remediation activities might also be required at other Marathon Group sites under RCRA.\nUSX is also involved in a number of remedial actions under CERCLA and similar state statutes related to the Marathon Group. It is possible that additional matters relating to the Marathon Group may come to USX's attention which may require remediation. For a discussion of remediation matters relating to the Marathon Group, see \"Legal Proceedings - Environmental Proceedings.\"\nCapital Expenditures\nThe Marathon Group's capital expenditures for environmental controls were $70 million, $123 million and $240 million in 1994, 1993 and 1992, respectively. The declines in 1994 and 1993 primarily reflected the Marathon Group's multi-year capital spending program for diesel fuel desulfurization which began in 1990 and was substantially completed by year-end 1993. The Marathon Group expects expenditures for environmental controls to approximate $40 million in 1995. This projection includes amounts reflecting management's latest estimate of expenditures for implementation of CAA requirements for production of reformulated gasoline. Predictions beyond 1995 can only be broad-based estimates which have varied, and will continue to vary, due to the ongoing evolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified projects, the Marathon Group anticipates that environmental capital expenditures will be approximately $45 million in 1996; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed.\nU. S. STEEL GROUP\nThe U. S. Steel Group includes U. S. Steel, the largest integrated steel producer in the United States (referred to hereinafter as \"U. S. Steel\"), which is primarily engaged in the production and sale of steel mill products, coke and taconite pellets. The U. S. Steel Group also includes the management of mineral resources, domestic coal mining, engineering and consulting services and technology licensing (together with U. S. Steel, the \"Steel and Related Businesses\"). Other businesses that are part of the U. S. Steel Group include real estate development and management, and leasing and financing activities. The U. S. Steel Group also participates in a number of joint ventures and other investments. U. S. Steel Group sales as a percentage of USX consolidated sales were 31% in each of 1994 and 1993 and 28% in 1992.\nThe following table sets forth the total sales of the U. S. Steel Group for each of the last three years. Such information does not include sales by joint ventures and other affiliates of USX accounted for by the equity method.\nThe total number of active U. S. Steel Group employees at year-end was 20,711 in 1994, 21,892 in 1993 and 21,183 in 1992. The reduction in the number of active employees in 1994 from 1993 primarily reflected the exclusion of RMI Titanium Company (\"RMI\") employees (in August 1994, USX adopted the equity method of accounting for RMI), the idling of operations at Maple Creek coal mine and the integration of operations at Shawnee coal mine with the No. 50 coal mine. Most hourly and certain salaried employees are represented by the United Steelworkers of America (\"USWA\").\nU. S. Steel entered into a new five and one-half year contract with the USWA, effective February 1, 1994, covering approximately 15,000 employees. The agreement will result in higher labor and benefit costs for the U. S. Steel Group each year throughout the term of the agreement. Management believes that this agreement is competitive with labor agreements reached by U. S. Steel's major domestic integrated competitors and thus does not believe that U. S. Steel's competitive position with regard to such other competition will be materially affected.\nIn January 1994, U. S. Steel Mining Co., Inc. (\"U. S. Steel Mining\") entered into a five-year agreement with the United Mine Workers of America covering approximately 1,700 employees.\nSTEEL INDUSTRY BACKGROUND AND COMPETITION\nThe domestic steel industry is cyclical and highly competitive. Despite significant reductions in raw steel production capability by major domestic producers over the last decade, the domestic industry continues to be adversely affected by excess world capacity. In certain years over the last decade, extensive downsizings have necessitated costly restructuring charges which, when combined with highly competitive market conditions, resulted in substantial losses for most domestic integrated producers.\nU. S. Steel is the largest integrated steel producer in the United States and competes with many domestic and foreign steel producers. Domestic competitors include integrated producers which, like U. S. Steel, use iron ore and coke as primary raw materials for steel production, and minimills which use steel scrap as a primary raw material. Minimills generally produce a narrower range of steel products than integrated producers, but typically enjoy certain competitive advantages such as lower capital expenditures for construction of facilities and non-unionized work forces with lower employment costs and more flexible work rules. One minimill company is currently operating facilities which utilize thin slab casting technology to produce flat-rolled products. A number of companies have announced plans for constructing similar facilities having the additional capability to produce in excess of 10 million tons of flat-rolled products by 1998. Depending on market conditions, the additional production generated from minimills could have an adverse effect on U. S. Steel's prices and shipment levels.\nThe domestic steel industry has, in the past, been adversely affected by unfairly traded imports, and high levels of imported steel may ultimately have an adverse effect on product prices and shipment levels. Steel imports to the United States accounted for an estimated 25%, 19% and 17% of the domestic steel market in 1994, 1993 and 1992, respectively.\nOil country tubular goods (\"OCTG\") accounted for 3.6% of U. S. Steel Group shipments in 1994. On June 30, 1994, in conjunction with six other domestic producers, USX filed antidumping and countervailing duty cases with the U.S. Department of Commerce (\"Commerce\") and the International Trade Commission (\"ITC\") asserting that seven foreign nations have engaged in unfair trade practices with respect to the export of OCTG. On August 15, 1994, the ITC unanimously issued a preliminary ruling that there is a reasonable indication that domestic OCTG producers may have been injured by illegal subsidies and dumping. In December 1994 and January 1995, Commerce issued its preliminary affirmative determinations of the applicable margins of dumping and subsidies in the OCTG cases against producers in four countries. In June 1995, Commerce is scheduled to make final determinations, and in July 1995 it is anticipated that the ITC will render its final determinations as to whether the domestic industry has been materially injured by these imports. USX will file additional antidumping and countervailing duty petitions if unfairly traded imports adversely impact, or threaten to adversely impact, the results of the U. S. Steel Group.\nIn addition to competition from other domestic and foreign steel producers, U. S. Steel faces competition from producers of materials such as aluminum, cement, composites, glass, plastics and wood in many markets.\nThe U. S. Steel Group's businesses are subject to numerous federal, state and local laws and regulations relating to the storage, handling, emission and discharge of environmentally sensitive materials. U. S. Steel believes that its major domestic integrated steel competitors are confronted by substantially similar conditions and thus does not believe that its relative position with regard to such other competitors is materially affected by the impact of environmental laws and regulations. However, the costs and operating restrictions necessary for compliance with environmental laws and regulations may have an adverse effect on U. S. Steel's competitive position with regard to domestic minimills and some foreign steel producers and producers of materials which compete with steel, which may not be required to undertake equivalent costs in their operations. For further information, see \"Environmental Matters.\"\nBUSINESS STRATEGY\nU. S. Steel's raw steel production facilities are Gary Works in Indiana, Mon Valley Works in Pennsylvania and Fairfield Works in Alabama.\nOver the last ten years, U. S. Steel has responded to competition resulting from excess steel industry capability by eliminating less efficient facilities, modernizing those that remain and entering into joint ventures, all with the objective of focusing production on higher value-added products, where superior quality and special characteristics are of critical importance. These products include bake hardenable steels and coated sheets for the automobile industry, laminated sheets for the manufacture of motors and electrical equipment, improved tin mill products for the container industry and oil country tubular goods. In addition, U. S. Steel intends to pursue lower manufacturing cost objectives through continuing cost improvement programs. These initiatives include, but are not limited to, reduced production cycle time, improved yields, continued customer orientation and improved process control. For example, a Pulverized Coal Injection project at Gary Works has resulted in reduced dependence on higher cost coke.\nSince 1982, the number of U. S. Steel raw steel production facilities has been reduced from ten to the three mentioned above, and annual raw steel capability has been reduced from 33.0 million to 12.5 million tons. Steel employment has been reduced from approximately 89,000 in 1982 to about 19,000 in 1995. As a result of downsizing its operations, the U. S. Steel Group recognized restructuring charges aggregating $2.8 billion since 1982 as its less efficient facilities have been shut down. During that period, U. S. Steel also invested approximately $3.4 billion in capital facilities for its steel operations. U. S. Steel believes that these expenditures have made its remaining steel operations among the most modern, efficient and competitive in the world. In both 1994 and 1993, U. S. Steel continuously cast nearly 100% of its raw steel production. This method of producing steel has resulted in higher quality steel at a lower cost than the previously used ingot method.\nIn addition to the modernization of its production facilities, USX has entered into a number of joint ventures with domestic and foreign partners to take advantage of market or manufacturing opportunities in the sheet, tin plate, tubular, bar and plate consuming industries. See \"Joint Ventures and Other Investments.\"\nSTEEL AND RELATED BUSINESSES\nU. S. Steel operates plants which produce steel mill products in a variety of forms and grades. Gary Works, Mon Valley Works and Fairfield Works accounted for 58%, 23% and 19%, respectively, of U. S. Steel's 1994 raw steel production of 11.7 million tons. The annual raw steel production capability in 1994 of 12.0 million tons was increased through operating efficiencies to 12.5 million tons for 1995, including Gary Works - 7.4 million, Mon Valley Works - 2.8 million and Fairfield Works - 2.3 million.\nThe following tables set forth significant U. S. Steel shipment data by major market and product for each of the last three years. Such data do not include shipments by joint ventures and other affiliates of USX accounted for by the equity method.\nSTEEL SHIPMENTS BY MARKET AND PRODUCT\nUSX and its wholly owned subsidiary, U. S. Steel Mining Co., Inc. (\"U.S. Steel Mining\") have domestic coal properties with demonstrated bituminous coal reserves of approximately 928 million net tons at year-end 1994 compared with approximately 945 million net tons at year-end 1993. The reserves are of metallurgical and steam quality in approximately equal proportions. They are located in Alabama, Pennsylvania, Virginia, West Virginia, Illinois and Indiana. Approximately 80% of the reserves are owned, and the rest are leased. Of the leased properties, 85% are renewable indefinitely and the balance are covered by a lease which expires in 2005. U. S. Steel Mining's Maple Creek coal mine and a related preparation plant located in Pennsylvania were idled in January 1994, because unforeseen and\nunpredictable geologic conditions made continued mining economically infeasible. Reserves associated with the Maple Creek coal mine were 21 million net tons at December 31, 1994. In December 1994, the U. S. Steel Group signed a letter of intent for the sale of the coal mine and preparation plant. The sale, which is contingent on certain conditions, including financing and government approval of the transfer of permits, is expected to be completed in the second quarter of 1995. In September 1994, the Shawnee coal mine located in West Virginia was integrated with the No. 50 coal mine for operational efficiencies.\nUSX controls domestic iron ore properties having demonstrated iron ore reserves in grades subject to beneficiation processes in commercial use by U. S. Steel of approximately 746 million tons at year-end 1994, substantially all of which are iron ore concentrate equivalents available from low-grade iron-bearing materials, and the rest are higher grade ore. All of these demonstrated reserves are located in Minnesota. Approximately 40% of these reserves are owned and the remaining 60% are leased. Most of the leased reserves are covered by a lease expiring in 2058 and the remaining leases have expiration dates ranging from 1996 to 2007. U. S. Steel's iron ore operations at Mt. Iron, Minn. (\"Minntac\") produced 16.0 million net tons of taconite pellets in each of 1994 and 1993 and 14.7 million net tons in 1992.\nUSX's Resource Management administers the remaining mineral lands and timber lands of the U. S. Steel Group, and is responsible for the lease or sale of these lands and their associated resources, which encompass approximately 300,000 acres of surface rights and 1,500,000 acres of mineral rights in 18 states.\nUSX Engineers and Consultants, Inc. sells technical services worldwide to the steel, mining, chemical and related industries. Together with its subsidiary companies, it provides engineering and consulting services for facility expansions and modernizations, operating improvement projects, integrated computer systems, coal and lubrication testing and environmental projects.\nThe following tables set forth significant production data for Steel and Related Businesses for each of the last five years and products and services by facility:\nPRINCIPAL PRODUCTS AND SERVICES\nOTHER BUSINESSES\nIn addition to the Steel and Related Businesses, the U. S. Steel Group includes various other businesses, the most significant of which are described below in this section. Other businesses also included RMI prior to the adoption of equity accounting in 1994. The other businesses that are included in the U. S. Steel Group accounted for 2% of the U. S. Steel Group's sales in 1994 and 3% in 1993 and 1992.\nUSX Realty Development develops real estate for sale or lease and manages retail and office space, business and industrial parks and residential and recreational properties.\nUSX Credit operates in the leasing and financing industry, managing a portfolio of real estate and equipment loans. Those loans are generally secured by the real property or equipment financed, often with additional security. USX Credit's portfolio is diversified as to types and terms of loans, borrowers, loan sizes, sources of business and types and locations of collateral. USX Credit is not actively making new loan commitments.\nIn March 1995, Cyclone Fence was sold.\nJOINT VENTURES AND OTHER INVESTMENTS\nUSX participates directly and through subsidiaries in a number of joint ventures included in the U. S. Steel Group. All of the joint ventures are accounted for under the equity method. Certain of the joint ventures and other investments are described below, all of which are at least 50% owned except Transtar, Inc. (\"Transtar\"). For financial information regarding joint ventures and other investments see \"Financial Statements and Supplementary Data - - Notes to Financial Statements - 14. Long-term Receivables and Other Investments\" for the U. S. Steel Group.\nUSX and Pohang Iron & Steel Co., Ltd. (\"POSCO\") of South Korea participate in a joint venture (\"USS-POSCO Industries\") which owns and operates the former U. S. Steel Pittsburg, Cal. Plant. The joint venture markets high quality sheet and tin products, principally in the western United States market area. USS-POSCO Industries produces cold-rolled sheets, galvanized sheets, tin plate and tin-free steel. USS-POSCO Industries' annual shipment capacity is approximately 1.4 million tons. Total shipments were approximately 1.4 million tons in 1994.\nUSX and Kobe Steel Ltd. (\"Kobe\") of Japan participate in a joint venture (\"USS\/Kobe Steel Company\") which owns and operates the former U. S. Steel Lorain, Ohio Works. The joint venture produces raw steel for the manufacture of bar and tubular products. Bar products are sold by USS\/Kobe Steel Company while U. S. Steel retains sales and marketing responsibilities for tubular products. Total shipments in 1994 were 1.6 million tons. USS\/Kobe Steel Company entered into a new five and one-half year labor contract with the USWA, effective February 1, 1994, covering approximately 2,300 employees. USS\/Kobe Steel Company's annual raw steel capability is approximately 2.6 million tons. Raw steel production was approximately 2.1 million tons in 1994.\nUSX and Kobe participate in a joint venture (\"PRO-TEC Coating Company\") which owns and operates a hot dip galvanizing line in Leipsic, Ohio. The facility commenced operations in early 1993. Capacity is approximately 600,000 tons per year with substrate coils provided by U. S. Steel. PRO-TEC Coating Company produced approximately 570,000 tons of galvanized steel in 1994.\nUSX and Worthington Industries Inc. participate in a joint venture known as Worthington Specialty Processing which operates a steel processing facility in Jackson, Mich. The plant is operated by Worthington Industries, Inc. and is dedicated to serving U. S. Steel customers. The facility contains state-of-the-art technology capable of processing master steel coils into both slit coils and sheared first operation blanks including rectangles, trapezoids, parallelograms and chevrons. It is designed to meet specifications for the automotive, appliance, furniture and metal door industries. The joint venture processes material\nsourced by U. S. Steel, with a processing capacity of 600,000 tons annually. In 1994, Worthington Specialty Processing processed approximately 425,000 tons.\nUSX and Rouge Steel Company participate in Double Eagle Steel Coating Company (\"DESCO\"), a joint venture which operates an electrogalvanizing facility located in Dearborn, Mich. This facility enables U. S. Steel to further participate in the expanding automotive demand for steel with corrosion resistant properties. The facility can coat both sides of sheet steel with zinc or alloy coatings and has the capability to coat one side with zinc and the other side with alloy. Capacity was 700,000 tons of galvanized steel annually, with availability of the facility shared by the partners on an equal basis. In 1994, DESCO produced 745,000 tons of galvanized steel. The increase over capacity was due to improved operating efficiencies. The effective capacity is being increased in 1995 to 900,000 tons.\nNational-Oilwell, a joint venture between a subsidiary of USX and National Supply Company, Inc., a subsidiary of Armco Inc., operates in the oil field service industry and has 3 manufacturing plants in the United States and abroad that produce a broad line of drilling equipment and pumping units. In the United States and abroad, it also operates 118 oil field supply stores, 6 service centers and 21 sales offices where it sells tubular goods, oil field operating supplies manufactured by others and its own manufactured equipment. The foreign manufacturing location is scheduled for closure in 1995.\nUSX owns a 46% interest in Transtar, which in 1988 purchased the former domestic transportation businesses of USX including railroads, a dock company, USS Great Lakes Fleet, Inc. and Warrior & Gulf Navigation Company. Blackstone Transportation Partners, L.P. and Blackstone Capital Partners L.P., both affiliated with The Blackstone Group, together own 53% of Transtar, and the senior management of Transtar owns the remaining 1%. For a discussion of litigation related to Transtar, see \"Legal Proceedings - U. S. Steel Group.\"\nUSX has an economic interest of 54% in RMI, a leading producer of titanium metal products. In 1994, the U. S. Steel Group's voting interest in RMI was reduced to 46%, and the investment is accounted for under the equity method. RMI is a publicly traded company listed on the New York Stock Exchange.\nIn October 1994, the U. S. Steel Group entered into a letter of intent with Nucor Corporation and Praxair, Inc. for the establishment of a joint venture to develop a new technology to produce steel directly from iron carbide. The parties would initially conduct a feasibility study of the iron carbide to steel process. If the feasibility study proves successful, the joint venture company would construct a demonstration plant to develop and evaluate the commercial feasibility of the steelmaking process.\nHEDGING ACTIVITY\nThe U. S. Steel Group engages in hedging activities in the normal course of its business. Commodity swaps are used to hedge exposure to price fluctuations relevant to the purchase of natural gas. While hedging activities are generally used to reduce risks from unfavorable price movements, they also may limit the opportunity to benefit from favorable movements. The U. S. Steel Group's hedging activities have not been significant in relation to its overall business activity. For additional information regarding hedging activity, see \"Financial Statements and Supplementary Data - Notes to Financial Statements - 2. Summary of Principal Accounting Policies - Hedging Transactions and 24. Derivative Financial Instruments and Management's Discussion and Analysis of Cash Flows - Hedging Activity\" for the U. S. Steel Group.\nPROPERTY, PLANT AND EQUIPMENT ADDITIONS\nDuring the years 1992-1994, the U. S. Steel Group made property, plant and equipment additions, including capital leases, aggregating $764 million, including $248 million, $198 million and $318 million in 1994, 1993 and 1992, respectively. The additions have been primarily for the completion of the continuous caster at Mon Valley Works in 1992, modernization of the hot-strip mill and pickle line at Gary\nWorks and environmental controls associated with steel production and other facilities. Significant expenditures in 1994 included expenditures to complete environmental projects, hot-strip mill and pickle line improvements and various blast furnace improvements at Gary Works; and initial expenditures for a blast furnace reline project and hot-strip mill improvements at Mon Valley Works. Capital expenditures for 1995 are expected to be approximately $300 million and will include spending on a degasser at Mon Valley Works, a granulated coal injection facility at Fairfield Works' blast furnace, a galvanizing line in the southern United States, as well as additional environmental expenditures. Capital expenditures in 1996 and 1997 are currently expected to remain at a level similar to that planned in 1995.\nDepreciation, depletion and amortization costs for the U. S. Steel Group were $314 million in each of 1994 and 1993 and $288 million in 1992.\nRESEARCH AND DEVELOPMENT\nThe research and development activities of the U. S. Steel Group are conducted mainly at the U. S. Steel Technical Center in Monroeville, Pa. Expenditures for steel research and development were $23 million, $22 million and $23 million in 1994, 1993 and 1992, respectively.\nSteel research is devoted to developing new or improved processes for the mining and beneficiation of raw materials such as coal and iron ore and for the production of steel; developing new and improved products in steel and other product lines; developing technology for meeting environmental regulations and for achieving higher productivity in these areas; and serving customers in the selection and use of U. S. Steel's products. Steel research has contributed to current business performance through expanded use of on-site plant improvement teams. In addition, several collaborative research programs with technical projects directed at mid- to long-range research opportunities have been continued at universities and in conjunction with other domestic steel companies through the American Iron and Steel Institute and cooperative research and development agreements.\nENVIRONMENTAL MATTERS\nThe U. S. Steel Group maintains a comprehensive environmental policy overseen by the Public Policy Committee of the USX Board of Directors. The Environmental Affairs organization has the responsibility to ensure that the U.S. Steel Group's operating organizations maintain environmental compliance systems that are in accordance with applicable laws and regulations. The Executive Environmental Committee, which is comprised of officers of the group, is charged with reviewing its overall performance with various environmental compliance programs. Also, the U. S. Steel Group, largely through the American Iron and Steel Institute, continues its involvement in the negotiation of various air, water, and waste regulations with federal, state and local governments to assure the implementation of cost effective pollution reduction strategies, such as the innovative regulatory-negotiation activities for coke plants, which are regulated under the Clean Air Act (\"CAA\").\nThe U. S. Steel Group has voluntarily participated in the Environmental Protection Agency (\"EPA\") 33-50 program to reduce toxic releases and the EPA Greenlights program to promote energy efficiency. The U. S. Steel Group has also developed an award winning environmental education program (the Continuous Improvement to the Environment program), a corporate program to reduce the volume of wastes the U. S. Steel Group generates, and wildlife management programs certified by the Wildlife Habitat Council at U. S. Steel Group operating facilities. Additionally, over the past 5 years, it has reduced the volume of toxic releases reported under the Superfund Amendments and Reauthorization Act of 1986 (Section 313) by 75%, primarily through recycling and process changes.\nThe businesses of the U. S. Steel Group are subject to numerous federal, state and local laws and regulations relating to the protection of the environment. These environmental laws and regulations include the CAA with respect to air emissions, the Clean Water Act (\"CWA\") with respect to water discharges, the Resource Conservation and Recovery Act (\"RCRA\") with respect to solid and hazardous\nwaste treatment, storage and disposal, and the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") with respect to releases and remediation of hazardous substances. In addition, all states where the U. S. Steel Group operates have similar laws dealing with the same matters. These laws are constantly evolving and becoming increasingly stringent. The ultimate impact of complying with existing laws and regulations is not always clearly known or determinable due in part to the fact that certain implementing regulations for laws such as RCRA and the CAA have not yet been promulgated or in certain instances are undergoing revision. These environmental laws and regulations, particularly the 1990 Amendments to the CAA and new water quality standards, could result in substantially increased capital, operating and compliance costs. For a discussion of environmental expenditures, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Management's Discussion and Analysis of Environmental Matters, Litigation and Contingencies\" and \"Legal Proceedings\" for the U. S. Steel Group.\nThe U. S. Steel Group has incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. In recent years, these expenditures have been mainly for process changes in order to meet CAA obligations, although ongoing compliance costs have also been significant. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of the U. S. Steel Group's products and services, operating results will be adversely affected. The U. S. Steel Group believes that all of its domestic competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities and its production methods.\nAir The 1990 Amendments to the CAA impose more stringent limits on air emissions, establish a federally mandated operating permit program and allow for enhanced civil and criminal enforcement sanctions. The principal impact of the 1990 Amendments to the CAA on the U. S. Steel Group is on the coke-making operations of U. S. Steel, as described below in this section. The coal mining operations and sales of U. S. Steel Mining may also be affected.\nThe 1990 Amendments to the CAA specifically address the regulation and control of hazardous air pollutants, including emissions from coke ovens. Generally, emissions for existing coke ovens must comply with technology-based limits by the end of 1995 and comply with a health risk-based standard by the end of 2003. However, a coke oven will not be required to comply with the health risk-based standard until January 1, 2020, if it complied with the technology-based standard at the end of 1993 and also complies with additional technology-based standards, by January 1, 1998, and by January 1, 2010. USX believes that it met the 1993 requirement and will be able to meet the 1998 and 2010 compliance dates.\nThe 1990 Amendments to the CAA also mandate the nationwide reduction of emissions of acid rain precursors (sulfur dioxide and nitrogen oxides) from fossil fuel-fired electrical utility plants. Specified emission reductions are to be achieved by 2000. Phase I begins on January 1, 1995, and applies to 110 utility plants specifically listed in the law. Phase II, which begins on January 1, 2000, will apply to other utility plants which may be regulated under the law. U. S. Steel, like all other electricity consumers, will be impacted by increased electrical energy costs that are expected as electric utilities seek rate increases to comply with the acid rain requirements.\nIn 1994, 100% of the coal production of U. S. Steel Mining was metallurgical coal, which is primarily used in coke production. While USX believes that the new environmental requirements for coke ovens will not have an immediate effect on U. S. Steel Mining, the requirements may encourage development of steelmaking processes that reduce the usage of coke.\nWater The U. S. Steel Group maintains the necessary discharge permits as required under the National Pollutant Discharge Elimination System program of the CWA and it is in compliance with such permits. U. S. Steel is currently negotiating with the EPA to develop a sediment remediation plan for the section of the Grand Calumet River that runs through Gary Works. The U. S. Steel Group expects to reach a final agreement with the EPA concerning this sediment remediation plan in 1995. As proposed, this project would require 5 to 6 years to complete after approval and would be followed by an environmental recovery validation. The estimated program cost, which has been accrued, is approximately $30 million.\nSolid Waste The U. S. Steel Group continues to seek methods to minimize the generation of hazardous wastes in its operations. RCRA establishes standards for the management of solid and hazardous wastes. Besides affecting current waste disposal practices, RCRA also addresses the environmental effects of certain past waste disposal operations, the recycling of wastes and the regulation of underground storage tanks containing regulated substances. Since the EPA has not yet promulgated implementing regulations for all provisions of RCRA and has not yet made clear the practical application of all the implementing regulations it has promulgated, the ultimate cost of compliance cannot be accurately estimated. In addition, new laws are being enacted and regulations are being adopted by various regulatory agencies on a continuing basis and the costs of compliance with these new rules can only be broadly appraised until their implementation becomes more accurately defined. Corrective action under RCRA related to past waste disposal activities is discussed below under \"Remediation.\"\nRemediation A significant portion of the U. S. Steel Group's currently identified environmental remediation projects relate to the dismantlement and restoration of former and present operating locations. These projects include continuing remediation at an in situ uranium mining operation, the dismantling of former coke-making facilities and the closure of permitted hazardous waste landfills.\nThe U. S. Steel Group is also involved in a number of remedial actions under CERCLA, RCRA and other federal and state statutes, and it is possible that additional matters may come to its attention which may require remediation. For a discussion of remedial actions related to the U. S. Steel Group, see \"Legal Proceedings - U. S. Steel Group Environmental Proceedings.\"\nCapital Expenditures The U. S. Steel Group's capital expenditures for environmental controls were $57 million, $53 million and $52 million in 1994, 1993 and 1992, respectively. The U. S. Steel Group currently expects such expenditures to approximate $60 million in 1995. These amounts will primarily be spent on projects at Gary Works. Predictions beyond 1995 can only be broad-based estimates which have varied, and will continue to vary, due to the ongoing evolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified projects, the U. S. Steel Group anticipates that environmental capital expenditures will be approximately $70 million in 1996; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed.\nDELHI GROUP\nThe Delhi Group (\"Delhi\") consists of Delhi Gas Pipeline Corporation (\"DGP\") and certain other subsidiaries of USX which are engaged in the purchasing, gathering, processing, transporting and marketing of natural gas. Prior to establishment of the Delhi Group on October 2, 1992, these businesses were included in the Marathon Group. Sales from the businesses included in the Delhi Group as a percentage of USX consolidated sales were 3% in each of 1994, 1993 and 1992. See \"Financial Statements and Supplementary Data - Notes to Financial Statements - 1. Basis of Presentation\" for the Delhi Group.\nDelhi is an established natural gas merchant engaged in the purchasing, gathering, processing, transporting and marketing of natural gas. It uses its extensive pipeline systems to provide gas producers with a ready purchaser for their gas or transportation to other pipelines and markets, and to provide customers with an aggregated, reliable gas supply. Delhi has the ability to offer a complete package of services to customers, relieving them of the need to locate, negotiate for, purchase and arrange transportation of gas. As a result, margins realized by Delhi, when providing premium supply services, are generally higher than those realized when providing separate gathering, processing or transporting services or those realized from short-term, interruptible (\"spot\") market sales. Delhi provides premium supply services to customers, such as local distribution companies (\"LDCs\") and utility electric generators (\"UEGs\"). These services include providing reliable supplies tailored to meet the peak demand requirements of customers. Premium supply services range from standby service, where the customer has no obligation to take any volumes but may immediately receive gas from Delhi upon an increase in the customer's demand, to baseload firm service where delivery of continuous volumes is assured by Delhi and the customer is obligated to take the gas provided. Delhi attempts to structure its gas sales to balance the peak demand requirements of LDCs during the winter heating season and of UEGs during the summer air conditioning season. Gas supplies not sold under premium service contracts are generally sold in the spot market.\nDelhi also extracts and markets natural gas liquids (\"NGLs\") from natural gas gathered on its pipeline systems. Delhi sells NGLs to a variety of purchasers, including petrochemical companies, refiners, retailers, resellers and trading companies. At February 28, 1995, Delhi owned interests in 17 natural gas processing facilities including 21 gas processing plants, 11 of which were 50% owned and the remainder of which were wholly owned. Fifteen of the plants were operating as of February 28, 1995. These facilities straddle Delhi's pipelines and have been located to maximize utilization. During 1994, four plants were written down to estimated net realizable value in accordance with a plan for the disposition of certain non-strategic assets. As of February 28, 1995, one of these plants had been sold.\nDelhi faces competition in all of its businesses, including obtaining additional dedicated gas reserves and providing premium supply services and gas transportation services. Delhi's competitors include major integrated oil and gas companies, more than 100 major intrastate and interstate pipelines, and national and local gas gatherers, brokers, marketers, distributors and end-users of varying size, financial resources and experience. Based on 1993 data published in the September 1994 Pipeline & Gas Journal, Delhi ranked sixteenth among domestic pipeline companies in terms of total miles of gas pipeline operated and third in terms of miles of gathering line operated. With respect to competition in Delhi's gas processing business, Delhi estimates there are approximately 400 gas processing plants in Texas and Oklahoma. Certain competitors, including major integrated oil companies and some intrastate and interstate pipeline companies, have substantially greater financial resources and control larger supplies of gas than Delhi. Competition for premium supply services varies for individual customers depending on the number of other potential suppliers capable of providing the level of service required by such customers.\nThe following tables set forth the distribution of the Delhi Group's sales and gross margin for each of the last three years:\nThe total number of Delhi employees at year-end was 681 in 1994, 805 in 1993 and 810 in 1992. The reduction in 1994 from 1993 reflected the effects of a work force reduction program initiated in the second quarter of 1994 to realign the organization with current business conditions. Delhi employees are not represented by labor unions.\nNATURAL GAS GATHERING AND SUPPLY\nDelhi provides a valuable service to producers of natural gas by providing a direct market for the sale of their natural gas. Following discovery of commercial quantities of natural gas, producers generally must either build their own gathering lines or negotiate with another party, such as Delhi, to have gathering lines built to connect their wells to a pipeline for delivery to market. Delhi typically aggregates natural gas production from several wells in a gathering system where it may also provide additional services for the producers by compressing and dehydrating the gas. Depending on the quality of the gas stream, the gas may be treated to make it suitable for market. Delhi's ability to offer producers treating services and its willingness to purchase untreated gas give it an advantage in acquiring gas supplies, particularly in east Texas, where much of the gas produced is not pipeline quality gas. After processing, the residue gas flows through pipelines for ultimate delivery to market.\nDelhi owns and operates extensive gathering systems which are strategically located primarily in the major gas producing areas of Texas and Oklahoma, including east Texas, south Texas, the Permian Basin in west Texas and the Anadarko Basin in Oklahoma. Delhi's principal intrastate natural gas pipeline systems total approximately 6,900 miles and interconnect with other intrastate and interstate pipelines at more than 110 points. Interests in two partnerships, one of which operates a Federal Energy Regulatory Commission (\"FERC\") regulated interstate pipeline system, bring total systems miles to approximately 7,400 at December 31, 1994, compared with approximately 8,100 miles at December 31, 1993. Total\nthroughput, including Delhi's share of partnership volumes, was 334 billion cubic feet (\"bcf\") in 1994, 327 bcf in 1993 and 314 bcf in 1992.\nPipeline systems comprised of approximately 1,500 miles of gas pipeline in Arkansas, Kansas, Louisiana, Oklahoma and Texas were written down to net realizable value in June 1994 in accordance with a plan for the disposition of certain non-strategic assets. Systems comprised of approximately 800 miles of pipeline were sold during 1994 and systems comprised of approximately 200 miles were sold in January 1995. Agreements were signed in early 1995 for the sale of substantially all of the remaining pipeline systems included in the plan of disposition, including Delhi's partnership interest in the previously mentioned FERC regulated interstate pipeline company. For further discussion of the partnership interest, see \"FERC Regulation.\"\nThe following table sets forth the pipeline mileage for pipeline systems, including partnerships, owned and operated by Delhi at December 31, 1994, and natural gas throughput volumes for pipeline systems operated during 1994:\nPIPELINE MILEAGE AND THROUGHPUT VOLUMES\nDelhi obtains gas supplies from various sources, including major oil and gas companies, other pipelines and independent producers. It offers competitive prices for gas, a full range of pipeline services and stable, year-round takes of production. Stable takes are particularly important to small producers who may not have the financial capacity to withstand significant variations in cash flow.\nThe services Delhi provides to producers include gathering, dehydration, treating, compression, blending, processing and transportation. Delhi's ability to provide this wide range of services, together with the location of its gathering systems within major gas-producing basins, has allowed it to build a large, flexible gas supply base.\nDelhi generally buys gas from producers at prices based on a market index. Gas purchase contracts generally include provisions for periodically renegotiable prices. The majority of Delhi's contracts with producers are \"take-or-release\" contracts under which Delhi has the right to purchase the gas or, if it does not purchase minimum volumes of gas over a specified period, the producer has the right to sell the gas to another party and may have it transported on Delhi's system for a fee. Take-or-release contracts present less risk to Delhi than the formerly prevalent take-or-pay contracts, while affording producers an opportunity to protect their cash flow by selling to other buyers. Delhi believes that its liability on take-or-pay contracts, if any, is not material.\nDelhi must add dedicated gas reserves in order to offset the natural declines in production from existing wells on its systems and to meet any increase in demand. In the past, Delhi has successfully connected new sources of supply to its pipeline systems. Management attributes this past success to the strategic location of Delhi's gathering systems in major producing basins, the quality of its service and its ability to adjust to changing market conditions. Delhi's future ability to contract for additional dedicated gas reserves also depends in part on the level and success of drilling by producers in the areas in which Delhi operates.\nThe following table sets forth information concerning Delhi's dedicated gas reserves for each of the last three years:\nNATURAL GAS SALES\nDelhi sells natural gas nationwide to LDCs, UEGs, pipeline companies, various industrial end-users and marketers under both long- and short-term contracts. As a result of Delhi's ability to offer a complete package of services to customers, relieving them of the need to locate, negotiate for, purchase and arrange transportation and processing of gas, margins realized by Delhi when providing premium supply services are generally higher than those realized when providing separate gathering, processing or transportation services or those realized from spot market sales. In 1994, gas sales represented approximately 70% of Delhi's total systems throughput and 71% of Delhi's total gross margin. Delhi sells gas under both firm and interruptible contracts at varying volumes, and in 1994 sold gas to over 180 customers.\nWhen negotiating sales to customers directly connected to its pipeline systems (\"on system\"), Delhi principally targets LDCs and UEGs. LDCs and UEGs generally are willing to pay higher prices to gas suppliers who can provide reliable gas supplies and adjust to rapid changes in their demand for gas service. Fluctuations in demand for natural gas by LDCs and UEGs are influenced by the seasonal requirements of purchasers using gas for space heating and the generation of electricity for air conditioning. LDCs require maximum deliveries during the winter heating season, while UEGs require maximum deliveries during the summer air-conditioning season. Delhi serves over 43 LDCs and UEGs, and total sales to these customers in 1994 exceeded 108 bcf. Delhi also sells gas to industrial end-users. These customers are generally more price-sensitive, but diversify Delhi's customer base and provide a stable market for natural gas.\nDelhi primarily uses the spot market to balance its gas supply with the demands for premium services. It attempts to sell all of its available gas each month. Delhi typically estimates sales to its premium market, then places the rest of its supply on the spot market. If the estimated premium load does not materialize, spot market sales are increased. If the actual premium load is greater than expected, spot market sales are interrupted to divert additional gas to the premium market. Spot market sales allow Delhi to balance its gas supply with its sales and to maximize throughput on its systems.\nIn order to increase flexibility for supplying gas to premium customers, and in balancing its gas supply, Delhi has an arrangement with a large LDC in Texas to store up to 2.5 bcf of natural gas in an east\nTexas storage facility, and continues to evaluate other storage options. As of January 31, 1995, Delhi had 1.1 bcf of natural gas in storage pursuant to this arrangement.\nBecause of prevailing industry conditions, most recent sales contracts are for periods of one year or less, and many are for periods of 30 days or less. Pricing mechanisms under Delhi's contracts result in gas sales primarily at market sensitive prices with the unit margin fluctuating based on the sales price and the cost of gas. Various contracts permit the customer or Delhi to interrupt the gas purchased or sold, under certain circumstances. Other contracts provide Delhi or the customer the right to renegotiate the gas sales price at specified intervals, often monthly or annually. Sales under these contracts may be terminated if the parties are unable to agree on a new price. These contract provisions may make the specified term of a contract less meaningful.\nDelhi's four largest customers accounted for 30% of total sales in each of 1994 and 1993 and 26% in 1992. In 1994, Delhi's four largest customers were Oklahoma Natural Gas Company (\"ONG\"), the largest LDC in Oklahoma; Central and Southwest, which includes UEGs primarily serving locations in Oklahoma, Texas, Louisiana and Arkansas; Lone Star Gas Company (\"Lone Star\"), the largest LDC in Texas, serving the north central part of the state; and Noram Energy Corp., which includes Entex, the second largest LDC in Texas. Central and Southwest includes Central Power and Light Company (\"CP&L\") and Southwestern Electric Power Company (\"SWEPCO\"), which operate in different geographical areas, but centralized their purchasing functions in 1994. For the years 1993 and 1992, Delhi's four largest customers were ONG, SWEPCO, CP&L and Lone Star. Natural gas sales to Delhi's four largest customers accounted for 25%, 18% and 14% of total systems throughput and 41%, 45% and 39% of total gross margin in 1994, 1993 and 1992, respectively. Sales to two customers, ONG and Central and Southwest, accounted for an aggregate of 31% of total gross margin in 1994. Aggregate sales to two customers, ONG and SWEPCO, accounted for 34% and 30% of total gross margin in 1993 and 1992, respectively. During each of these years, one customer, ONG (discussed below), accounted for 10% or more of the Delhi Group's total revenues. Sales to Central and Southwest aggregated $54.7 million, or just under 10% of total revenues, in 1994, $66.3 million, or 12%, in 1993 and $63.2 million, or 14%, in 1992. In the event that one or more of Delhi's large premium supply service customers reduce volumes taken under an existing contract or choose not to renew such contract, Delhi would be adversely affected to the extent it is unable to find alternative customers to buy gas at the same level of profitability.\nDelhi has maintained long-term sales relationships with many of its customers and has done business with ONG since 1971. ONG accounted for 13%, 14% and 12% of total sales in 1994, 1993 and 1992, respectively. During 1992, Delhi executed a 10-year contract with ONG which provides for annual negotiation of contract prices. Delhi is currently in the third year of this contract which includes specific pricing provisions for the 1995 and 1996 contract years.\nSales to SWEPCO accounted for 5% of total sales in 1994 and 7% in each of 1993 and 1992. Sales to SWEPCO pursuant to one contract (\"original contract\") were at prices substantially above spot market prices and, as a result, this contract accounted for more than 10% of Delhi's total gross margin in each of the year's 1990 through 1993. On January 26, 1994, a settlement agreement was executed between DGP and SWEPCO, resolving litigation which began in 1991 related to the original contract which was due to expire in April 1995. The settlement agreement provided that SWEPCO pay Delhi the price under the original contract through January 1994. Concurrent with the execution of the settlement agreement, Delhi executed a new four-year agreement with SWEPCO enabling Delhi to supply increased volumes of gas to two SWEPCO power plants in east Texas, at market sensitive prices and premiums commensurate with the level of service provided. The agreement provides for swing service and does not require any minimum gas purchase volumes. Delhi's 1994 operating income and cash flow were adversely affected by an estimated $16.2 million of premiums lost under the original contract.\nDelhi continues to pursue opportunities for long-term gas sales to LDCs and UEGs. Delhi can sell gas to customers which are not directly connected to its pipeline systems (\"off-system\") because of its numerous interconnections with other pipelines and the availability of transportation service from other\npipelines. These interconnections give Delhi access to virtually every significant interstate pipeline in the United States and permit it to take advantage of regional pricing differentials. As a shipper, Delhi has both firm and interruptible transportation agreements with certain of these pipelines, including firm agreements that obligate Delhi to pay for transportation services for periods of up to one year, regardless of whether or not Delhi uses these services.\nIn a typical off-system sale transaction, Delhi sells gas to a customer at an interconnection point with another pipeline, and the customer arranges further pipeline transportation of the gas to the point of consumption. Delhi's off-system sales in 1994 included sales to LDCs in Arkansas, California, Indiana, Illinois, Kansas and Louisiana; UEGs in California, Illinois, Kansas, Louisiana, Mississippi, Pennsylvania and Tennessee; and industrial end-users in many of these same states. Margins realized from off-system sales to LDCs and UEGs have traditionally been lower than those realized from on-system sales to such customers, reflecting increased competition and the lower level of service typically received by the off-system customers. However, firm off-system sales to LDCs and UEGs generally provide a premium over off-system industrial and spot market sales. During 1994, Delhi negotiated four firm sales of gas moving to off-system markets.\nIn 1994, Delhi initiated natural gas trading activity involving the purchase of natural gas from sources other than wells directly connected to Delhi's systems, and the subsequent sale of like volumes. Unit margins earned in the trading business are significantly less than those earned from on-system premium sales. The volume of trading activity in 1995 is expected to expand significantly from 1994 levels.\nThe following table sets forth the distribution of Delhi's natural gas volumes for each of the last three years:\nTRANSPORTATION\nDelhi transports natural gas on its pipeline systems for third parties at negotiated fees. When transporting gas for others, Delhi does not take title but delivers equivalent amounts to designated locations. The core of Delhi's transportation business is moving gas for on-system producers who market their own gas. Delhi's transportation business complements its sales and gas processing businesses by generating incremental revenues and margins. Transportation volumes also may be available for purchase by Delhi during periods of peak demand to increase Delhi's supply base. Delhi's more than 110 points of interconnection with both intrastate and interstate pipeline systems facilitate its transportation business. Transportation services accounted for approximately 30% of Delhi's total systems throughput and 12% of its total gross margin in 1994, compared with 37% and 10%, in 1993.\nHEDGING ACTIVITY\nDelhi uses pricing mechanisms built into its natural gas purchase and sales contracts or commodity based derivative instruments such as exchange traded futures contracts and options to hedge exposure to changes in market prices on its natural gas margins. While hedging activities are generally used to reduce risks from unfavorable price movements, they also may limit the opportunity to benefit\nfrom favorable movements. Delhi does not hedge against all such exposure, depending on management's overall view of market conditions. Operating results are thus subject to management's assessment of and response to changing market prices. For additional information regarding hedging activity, see \"Financial Statements and Supplementary Data - Notes to Financial Statements - 2. Summary of Principal Accounting Policies - Hedging Transactions and Management's Discussion and Analysis of Cash Flows - Hedging Activity\" for the Delhi Group.\nGAS PROCESSING AND NGLS MARKETING\nNatural gas processing involves the extraction of NGLs (ethane, propane, isobutane, normal butane and\/or natural gasoline) from the natural gas stream, thereby removing some of the British thermal units (\"Btus\") from the gas. Delhi processes most of the gas moved on its pipeline systems in its own plants, which straddle its pipelines, and processes a smaller portion at third-party plants. Delhi has the processing rights under a substantial majority of its contracts with producers. By processing gas, Delhi captures the differential between the price obtainable for the Btus if sold as NGLs and the price obtainable for the Btus if left in the gas. Delhi has the ability to take advantage of such price differentials by utilizing additional processing capacity at operating plants, by choosing not to extract certain NGLs from the gas stream or, to a lesser extent, by starting up or idling processing plants. Delhi monitors the economics of removing NGLs from the gas stream for processing on an ongoing basis to determine the appropriate level of each plant's operation and the viability of starting up or idling individual plants. At February 28, 1995, 15 of Delhi's 21 plants were operating. Four plants were written down to estimated net realizable value in June 1994 in accordance with a plan for the disposition of certain non-strategic assets. One of these plants was sold during 1994. Delhi expanded its facilities in Custer County, Okla. with the relocation, redesign and installation of the idled Cimmaron processing plant and the installation of a two-mile pipeline. The plant (renamed Panther Creek) began operations in March 1994. Delhi has a 50% interest in the plant project. In 1994, Delhi completed a 21-mile system expansion to provide additional system capacity to this plant.\nThe following table sets forth the location, capacity and type of Delhi's processing plants at December 31, 1994:\nPROCESSING PLANTS\nDelhi retains the rights to the NGLs on more than 90% of the gas it processes. The remainder is shared with either producers or other pipelines. For certain 50% owned plants, Delhi shares the retained NGLs equally with the joint owner. Delhi pursues incremental processing business from third parties with unprocessed gas accessible to Delhi's pipeline systems to take advantage of excess capacity when processing economics are favorable.\nDelhi also receives fees for providing treating services for producers whose gas requires the removal of various impurities to make it marketable. The impurities may include water, carbon dioxide or hydrogen sulfide. Delhi owns and operates its own treating facilities, including six sulfur plants, and also has contracts to treat gas at third-party plants. The ability to offer treating services to producers gives Delhi a competitive advantage in acquiring gas supplies in east Texas, where much of the gas produced is not pipeline-quality gas.\nDelhi markets NGLs either at the two major domestic marketing centers for NGLs, Mont Belvieu, Texas and Conway, Kansas, or at the processing plant sites. Delhi also markets NGLs for third parties for a fee. Condensate (free liquids in the gas stream before processing) is very similar to crude oil and is\nmarketed to crude oil purchasers at various separation or collection facilities located throughout Delhi's pipeline systems. Prices for NGLs and condensates are closely related to the price of crude oil.\nDelhi has transportation, fractionation and exchange agreements for the movement of NGLs to market. Delhi sells NGLs to a variety of purchasers including petrochemical companies, refiners, retailers, resellers and trading companies. In 1994, Delhi marketed 276 million gallons (\"mmgal\") of NGLs to over 53 different customers at spot market prices. In the past, Delhi has entered into agreements with third parties to store NGLs, in order to provide the flexibility to delay NGLs sales until demand and prices are higher.\nDelhi's NGLs sales volumes totaled 276 mmgal, 282 mmgal and 261 mmgal in 1994, 1993 and 1992, respectively. In addition, NGLs volumes which Delhi processed for third parties for a fee totaled 30 mmgal, 46 mmgal and 41 mmgal in 1994, 1993 and 1992, respectively. Gas processing unit margins averaged 6 cents per gallon in 1994 (10 cents per gallon in the fourth quarter), compared with 6 cents per gallon in 1993 (1 cent per gallon in the fourth quarter) and 10 cents per gallon in 1992 (6 cents per gallon in the fourth quarter). Average unit margins improved over the last half of 1994, reflecting improved NGLs prices and lower feedstock (natural gas) costs.\nPROPERTY, PLANT AND EQUIPMENT ADDITIONS\nThe following table sets forth property, plant and equipment additions and dedicated natural gas reserve additions for the Delhi Group for each of the last three years:\nDuring the three years 1992-1994, expenditures were primarily related to the connection of new dedicated natural gas reserves, the purchase of new facilities and the improvement and upgrading of existing facilities. Expenditures in 1994 included amounts for a pipeline construction project in western Oklahoma and the purchase and upgrade of three gas treating facilities in east and west Texas. For information concerning capital expenditures for environmental controls in 1992, 1993 and 1994 and estimated capital expenditures for such purposes in 1995 and 1996, see \"Environmental Matters.\"\nCapital expenditures in 1995 are expected to be in the range of $35 million to $45 million as Delhi continues to pursue opportunities at attractive prices to connect dedicated gas reserves by the expansion or acquisition of gas gathering, processing and transmission assets, including those made available as a result of current industry conditions and regulatory initiatives.\nDepreciation, depletion and amortization costs for Delhi were $30.1 million, $36.3 million and $40.2 million in 1994, 1993 and 1992, respectively. The decline in 1994 from 1993 primarily reflected effects of 1994 restructuring activity.\nREGULATORY MATTERS\nDelhi's facilities and operations are subject to regulation by various governmental agencies.\nState Regulation\nThe Texas Railroad Commission (\"RRC\") has the authority to regulate natural gas sales and transportation rates charged by intrastate pipelines in Texas. The RRC requires tariff filings for certain of Delhi's transactions and, under limited circumstances, could propose changes in such filed tariffs. Rates\ncharged for pipeline-to-pipeline transactions and rates charged to transportation, industrial and other similar large volume contract customers (other than LDCs) are presumed by the RRC to be just and reasonable where (i) neither the supplier nor the customer had an unfair advantage during negotiations, (ii) the rates are substantially the same as rates between the gas utility and two or more of these customers for similar service or (iii) competition does or did exist for the market with another supplier of natural gas or an alternative form of energy. Competition generally exists in the markets Delhi serves and rate cases have been infrequent.\nDelhi's Texas pipeline systems are subject to the \"ratable take rules\" of the RRC. Under ratable take rules, each purchaser of gas is generally required first to take ratably certain high-priority gas (i.e., principally casinghead gas from oil wells) produced from wells from which it purchases gas and, if its sales volumes exceed available amounts of such high-priority gas, thereafter to take gas well gas from wells from which it purchases gas on a ratable basis, by categories, to the extent of demand. Under other RRC regulations, large industrial customers are subject to curtailment or service interruption during periods of peak demand. Certain Delhi customers in Texas and Oklahoma may also be subject to state ratable take rules. Such rules have affected purchases of gas from Delhi in the past and may affect such purchases in the future.\nThe RRC has promulgated Statewide Rules which streamline the process for determining gas demand and gas allowables in Texas. By setting allowables to meet market demand, Delhi believes the RRC rules will foster more accurate pricing signals between the wellhead and the burnertip. Although the ultimate impact of these changes to the proration rules is uncertain, Delhi believes it is well positioned to benefit from the new pricing structure.\nDelhi generally does not engage in the type of sales or transportation transactions that would subject it to cost of service regulation in the states where it does business. Louisiana exercises limited jurisdiction over certain facilities constructed in that state by Delhi.\nFERC Regulation\nAs a gas gatherer and an operator primarily of intrastate pipelines, Delhi is generally exempt from regulation under the Natural Gas Act of 1938 (\"NGA\"). Delhi operates and owns a 25% interest in Ozark Gas Transmission System (\"Ozark\"), an interstate pipeline providing transportation services in western Arkansas and eastern Oklahoma. Ozark is subject to FERC regulation under the NGA and the Natural Gas Policy Act of 1978 (\"NGPA\"). In February 1995, Delhi signed an agreement to sell its 25% interest in Ozark. The sale of Ozark is expected to be completed in the second quarter of 1995, subject to certain closing conditions and other government agency approvals. FERC also exercises jurisdiction over transportation services provided by Delhi under Section 311 of the NGPA. This jurisdiction is limited to a review of the rates, terms and conditions of such services.\nIn April 1992, FERC issued Order No. 636, which makes significant changes to the regulatory schedule applicable to the services provided by interstate natural gas pipelines. The changes are intended to ensure that pipelines provide transportation service that is equal in quality for all gas supplies, whether the customer purchases the gas from the pipeline or from another supplier.\nENVIRONMENTAL MATTERS\nThe Delhi Group maintains a comprehensive environmental policy overseen by the Public Policy Committee of the USX Board of Directors. The Safety and Environmental Affairs organization has the\nresponsibility to ensure that the Delhi Group's operating organizations maintain environmental compliance systems that are in accordance with applicable laws and regulations.\nThe businesses of the Delhi Group are subject to numerous federal, state and local laws and regulations relating to the protection of the environment. These environmental laws and regulations include the Clean Air Act (\"CAA\") with respect to air emissions, the Clean Water Act (\"CWA\") with respect to water discharges, the Resource Conservation and Recovery Act (\"RCRA\") with respect to solid and hazardous waste treatment, storage and disposal, and the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") with respect to releases and remediation of hazardous substances. In addition, many states where the Delhi Group operates have similar laws dealing with the same matters. These laws are constantly evolving and becoming increasingly stringent. The ultimate impact of complying with existing laws and regulations is not always clearly known or determinable due in part to the fact that certain implementing regulations for laws such as RCRA and the CAA have not yet been promulgated or in certain instances are undergoing revision. These environmental laws and regulations, particularly the 1990 Amendments to the CAA, could result in increased capital, operating and compliance costs. For a discussion of environmental expenditures, see \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Management's Discussion and Analysis of Environmental Matters, Litigation and Contingencies\" for the Delhi Group.\nThe Delhi Group has incurred and will continue to incur capital and operating and maintenance expenditures as a result of environmental laws and regulations, although such expenditures have historically not been material. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of the Delhi Group's products and services, operating results will be adversely affected. The Delhi Group believes that substantially all of its competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities and its production processes.\nAir The 1990 Amendments to the CAA impose more stringent limits on air emissions, establish a federally mandated operating permit program and allow for enhanced civil and criminal enforcement sanctions. The principal impact of the 1990 Amendments to the CAA on the Delhi Group is on its compressor stations and its processing plants. The amendments establish attainment deadlines and control requirements based on the severity of air pollution in a geographical area. All facilities that are major sources as defined by the CAA will require Title V permits. Delhi anticipates that such permits will be required on 15 processing and treating plants by June 1996. The issuance of permits is currently scheduled to begin in June 1995.\nWater The Delhi Group maintains the necessary discharge permits as required under the National Pollutant Discharge Elimination System program of the CWA and it is in compliance with such permits.\nSolid Waste The Delhi Group continues to seek methods to minimize the generation of hazardous wastes in its operations. RCRA establishes standards for the management of solid and hazardous wastes. Besides affecting current waste disposal practices, RCRA also addresses the environmental effects of certain past waste disposal operations, the recycling of wastes and the regulation of underground storage tanks containing regulated substances. Since the EPA has not yet promulgated implementing regulations for all provisions of RCRA and has not yet made clear the practical application of all the implementing regulations it has promulgated, the ultimate cost of compliance cannot be accurately estimated. In addition, new laws are being enacted and regulations are being adopted by various regulatory agencies on a\ncontinuing basis, and the costs of compliance with these new rules can only be broadly appraised until their implementation becomes more accurately defined.\nRemediation Minor remediation projects are done on a routine basis and related expenditures have not been material.\nCapital Expenditures The Delhi Group's capital expenditures for environmental controls were $4.6 million, $4.5 million and $3.0 million in 1994, 1993 and 1992, respectively. The Delhi Group currently expects such expenditures to approximate $5 million in 1995. Predictions beyond 1995 can only be broad-based estimates which have varied, and will continue to vary, due to the ongoing evolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified projects, the Delhi Group anticipates that environmental capital expenditures will be about $5 million in 1996; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed. Expenditures for environmental controls include amounts for projects which, while benefitting the environment, also enhance operating efficiencies.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe location and general character of the principal oil and gas properties, plants, mines, pipeline systems and other important physical properties of USX are described in the Item 1. BUSINESS section of this document. Except for oil and gas producing properties, which generally are leased, or as otherwise stated, such properties are held in fee. The plants and facilities have been constructed or acquired over a period of years and vary in age and operating efficiency. At the date of acquisition of important properties, titles were examined and opinions of counsel obtained, but no title examination has been made specifically for the purpose of this document. The properties classified as owned in fee generally have been held for many years without any material unfavorably adjudicated claim.\nSeveral steel production facilities and interests in two liquefied natural gas tankers are leased. See \"Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 15. Leases.\"\nThe basis for estimating oil and gas reserves is set forth in \"Consolidated Financial Statements and Supplementary Data - Supplementary Information on Oil and Gas Producing Activities - Estimated Quantities of Proved Oil and Gas Reserves.\"\nUSX believes that its surface and mineral rights covering reserves are adequate to assure the basic legal right to extract the minerals, but may not yet have obtained all governmental permits necessary to do so.\nUnless otherwise indicated, all reserves shown are as of December 31, 1994.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nUSX is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments related to the Marathon Group, the U. S. Steel Group and the Delhi Group involving a variety of matters, including laws and regulations relating to the environment. Certain of these matters are included below in this discussion. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the consolidated financial statements and\/or to the financial statements of the applicable group. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably.\nMARATHON GROUP\nEnvironmental Proceedings\nThe following is a summary of proceedings attributable to the Marathon Group that were pending or contemplated as of December 31, 1994, under federal and state environmental laws. Except as described herein, it is not possible to accurately predict the ultimate outcome of these matters; however, management's belief set forth in the first paragraph under \"Item 3. LEGAL PROCEEDINGS \" above takes such matters into account.\nClaims under the Comprehensive Environmental Response, Compensation, and Liability Act (\"CERCLA\") and related state acts have been raised with respect to the cleanup of various waste disposal and other sites. CERCLA is intended to expedite the cleanup of hazardous substances without regard to fault. Potentially responsible parties (\"PRPs\") for each site include present and former owners and operators of, transporters to and generators of the substances at the site. Liability is strict and can be joint and several. Because of the ambiguity of the regulations, the difficulty of identifying the responsible parties for any particular site, the complexity of determining the relative liability among them, the uncertainty as to the most desirable remediation techniques and the amount of damages and cleanup costs and the time period during which such costs may be incurred, USX is unable to reasonably estimate its ultimate cost of compliance with CERCLA.\nAt December 31, 1994, USX had been identified as a PRP at a total of 17 CERCLA sites related to the Marathon Group. Based on currently available information, which is in many cases preliminary and incomplete, USX believes that its liability for cleanup and remediation costs in connection with each of these sites will be under $1 million per site and most will be under $100,000.\nIn addition, there are 7 sites related to the Marathon Group where USX has received information requests or other indications that USX may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability.\nThere are also 70 additional sites, excluding retail marketing outlets, related to the Marathon Group where remediation is being sought under other environmental statutes, both federal and state. Based on currently available information, which is in many cases preliminary and incomplete, the Marathon Group believes that its liability for cleanup and remediation costs in connection with 32 of these sites will be under $100,000 per site, another 29 sites have potential costs between $100,000 and $1 million per site and 7 sites may involve remediation costs between $1 million and $5 million per site.\nThere is one location which involves a remediation program in cooperation with the Michigan Department of Natural Resources at a closed and dismantled refinery site located near Muskegon, Mich. The Marathon Group anticipates spending between $9 million and $12 million over the next 10 to 20 years at this site. Anticipated expenditures for 1995 are $1.6 million.\nAdditionally, the Marathon Group is involved with a potential corrective action at its Robinson, Ill. refinery where the remediation costs have been estimated at between $4 million and $18 million over 20 to 30 years. Anticipated expenditures for 1995 are $3.8 million.\nIn January 1994, the U.S. Environmental Protection Agency (\"EPA\") (Region 5, Chicago) served Marathon with a Complaint and Compliance Order for Resource Conservation and Recovery Act (\"RCRA\") violations at the Robinson refinery seeking a penalty of $298,990. The Complaint alleges that the refinery violated RCRA for failure to properly characterize the waste water from a truck rinse pad and to maintain records of such characterization and failure to file a Class I permit modification and to implement the Contingency Plan. Marathon has filed its Answer denying liability.\nOn February 9, 1995, the EPA notified Marathon that it proposed to assess penalties in the amount of $526,100 for violating the Clean Water Act general NPDES Permit for the Cook Inlet, Alaska. This amount is based primarily on clerical reporting errors and minor permit exceedances during the period of 1990 through 1994. Before the EPA proposed to assess the fine, Marathon conducted a comprehensive and voluntary self-evaluation of its permit compliance status for the 1990-1994 period for all of its Cook Inlet discharges. All findings were reported to the EPA along with actions taken or planned by Marathon. There is no evidence that these permit exceedances have harmed the environment. Marathon is negotiating with the EPA concerning these penalties.\nU. S. STEEL GROUP\nB&LE Litigation\nIn 1994, judgments against the Bessemer & Lake Erie Railroad (\"B&LE\") in the amount of approximately $498 million, plus interest, in the Lower Lake Erie Iron Ore Antitrust Litigation were upheld. In connection with that litigation, claims of two plaintiffs for retrial of their damage awards remain to be heard (Toledo World Terminal, Inc. v. B&LE). At trial these plaintiffs asserted claims of approximately $8 million, but were awarded only nominal damages by the jury. A new trial date has not been set. Any damages awarded in a new trial may be more or less than $8 million and would be subject to trebling.\nA further related lawsuit (Pacific Great Lakes Corporation v. B&LE) filed under the Ohio Valentine Act has been set for trial in the Cuyahoga County (Ohio) Court of Common Pleas in September 1995. Formal discovery commenced in late 1994, following unsuccessful efforts to reach settlement. Plaintiffs unsubstantiated claims are approximately $21.6 million and are subject to doubling under the Valentine Act.\nThe B&LE was a wholly owned subsidiary of USX throughout the period the conduct occurred. It is now a subsidiary of Transtar, Inc. (\"Transtar\") in which USX has a 46% equity interest. USX is obligated to reimburse Transtar for judgments paid by the B&LE.\nFairfield Agreement Litigation\nIn 1989, USX and two former officials of the USWA were indicted by a federal grand jury in Birmingham, Ala. which alleged that USX granted leaves of absence and pensions to the union officials with intent to influence their approval, implementation and interpretation of the 1983 Fairfield labor agreement which resulted in reopening USX's Fairfield Works. In 1990, USX and the union officials were convicted, and the District Court imposed a $4.1 million fine on USX and ordered restitution to the U. S. Steel and Carnegie Pension Fund of approximately $300,000. The verdicts were affirmed by the Court of Appeals for the 11th Circuit on May 10, 1994, and a petition for Writ of Certiorari to the U. S. Supreme Court was denied on March 6, 1995. A former executive officer of USX who was also subsequently indicted has pleaded not guilty and has not yet been tried. A related civil action (Cox v. USX), which was dismissed by the trial court, was reversed by the U. S. Court of Appeals for the 11th Circuit on April 5, 1994 and has been returned to the trial court for further proceedings. The plaintiffs' complaint asserted five causes of action arising out of conduct relating to the negotiation of the 1983 Fairfield labor agreement. The causes of action include claims asserted under the Racketeer Influenced and Corrupt Organization Act and Employee Retirement Income Security Act based on allegations that union negotiators had agreed to concessions in the agreement in exchange for pension payments to which they were not entitled.\nPickering Litigation\nOn November 3, 1992, the United States District Court for the District of Utah Central Division issued a Memorandum Opinion and Order in Pickering v. USX relating to pension and compensation claims by approximately 1,900 employees of USX's former Geneva Utah Works. Although the court dismissed a number of the claims by the plaintiffs, it found that USX had violated the Employee Retirement Income Security Act by interfering with the accrual of pension benefits of certain employees and amending a benefit plan to reduce the accrual of future benefits without proper notice to plan participants. Further proceedings were held to determine damages and, pending the court's determinations, USX may appeal. Plaintiffs' counsel has been reported as estimating plaintiffs' recovery to be in excess of $100 million. USX believes any such damages will likely be substantially less than the plaintiff's estimate. In 1994, USX entered into settlement agreements with 227 plaintiffs providing for releases of liability against USX and the aggregate payment by USX of approximately $1 million.\nAloha Stadium Litigation\nA jury trial commenced in late June 1993, in a case filed in the Circuit Court of the First Circuit of Hawaii by the State of Hawaii alleging, among other things, that the weathering steel, including USS COR-TEN Steel, which was incorporated into the Aloha Stadium was unsuitable for the purpose used. The State sought damages of approximately $97 million for past and future repair costs and also sought treble damages and punitive damages for deceptive trade practices and fraud, respectively. On October 1, 1993, the jury returned a verdict finding no liability on the part of U. S. Steel. In January 1994, the State appealed the decision to the Supreme Court of Hawaii.\nInland Steel Patent Litigation\nIn July 1991, Inland Steel Company (\"Inland\") filed an action against USX and another domestic steel producer in the U. S. District Court for the Northern District of Illinois, Eastern Division, alleging defendants had infringed two of Inland's steel-related patents. Inland seeks monetary damages of up to approximately $50 million and an injunction against future infringement. USX in its answer and counterclaim alleges the patents are invalid and not infringed and seeks a declaratory judgment to such effect. In May 1993, a jury found USX to have infringed the patents. The District Court has yet to rule on the validity of the patents. In July 1993, the U. S. Patent Office rejected the claims of the two Inland patents upon a reexamination at the request of USX and the other steel producer. A further request was submitted by USX to the Patent Office in October 1993, presenting additional questions as to patentability which was granted and consolidated for consideration with the original request. In 1994, the Patent Office issued a decision rejecting all claims of the Inland patents. Inland has appealed this decision to the Patent Office Board of Appeals.\nSecurities Litigation\nIn July 1993, a class action was filed in the U.S. District Court for the Western District of Pennsylvania (Finkel v. Lehman Brothers, et al.) naming as defendants USX, Messrs. C.A. Corry, R.M. Hernandez and L.B. Jones, officers of the Corporation, and the underwriters in a public offering of 10 million shares of Steel Stock completed on July 29, 1993. The complaint alleges that the Corporation's prospectus and registration statement was false and misleading with respect to the effect of unfairly traded imports on the domestic steel industry and the then pending ITC proceedings and seeks as damages the difference between the public offering price and the value of the shares at the time the action was brought or the price at which shares were disposed of prior to filing the suit. Two additional actions (Snyder v. USX, et al. and Erenberg v. USX, et al.) involving essentially the same issues were filed in August 1993 in the same court and added Mr. T.J. Usher, also an officer, as a defendant. These cases have been consolidated, and discovery is proceeding.\nEnvironmental Proceedings\nThe following is a summary of the proceedings attributable to the U. S. Steel Group that were pending or contemplated as of December 31, 1994, under federal and state environmental laws. Except as described herein, it is not possible to accurately predict the ultimate outcome of these matters; however, management's belief set forth in the first paragraph under \"Item 3. LEGAL PROCEEDINGS\" above takes such matters into account.\nClaims under CERCLA and related state acts have been raised with respect to the cleanup of various waste disposal and other sites. CERCLA is intended to expedite the cleanup of hazardous substances without regard to fault. PRP's for each site include present and former owners and operators of, transporters to and generators of the substances at the site. Liability is strict and can be joint and several. Because of the ambiguity of the regulations, the difficulty of identifying the responsible parties for any particular site, the complexity of determining the relative liability among them, the uncertainty as to the most desirable remediation techniques and the amount of damages and cleanup costs and the time period during which such costs may be incurred, USX is unable to reasonably estimate its ultimate cost of compliance with CERCLA.\nAt December 31, 1994, USX had been identified as a PRP at a total of 28 CERCLA sites related to the U. S. Steel Group. Based on currently available information, which is in many cases preliminary and incomplete, USX believes that its liability for cleanup and remediation costs in connection with 12 of these sites will be between $100,000 and $1 million per site and ten will be under $100,000. At one site, U. S. Steel's former Duluth, Minn. Works, USX has spent approximately $5.4 million and currently estimates that it will spend another $1.6 million. However, USX was directed in 1993 to develop alternative methods of remediation for this site, the cost of which is presently unknown and indeterminable\nand, as a result, future costs may be more or less than previously estimated. At the remaining five sites, USX has no reason to believe that its share in the remaining cleanup costs at any single site will exceed $5 million, although it is not possible to accurately predict the amount of USX's share in any final allocation of such costs. Following is a summary of the status of the five sites:\nIn 1988, USX and three other PRPs agreed to the issuance of an administrative order by the EPA to undertake emergency removal work at the Municipal & Industrial Disposal Co. site in Elizabeth, Pa. The cost of such removal, which has been completed, was approximately $3 million, of which USX paid $2.5 million. The EPA has indicated that further remediation of this site may be required in the future, but it has not conducted any assessment or investigation to support what remediation would be required. In October 1991, the Pennsylvania Department of Environmental Resources (\"PaDER\") placed the site on the Pennsylvania State Superfund list and began a Remedial Investigation and Feasibility Study (\"RI\/FS\") which is expected to be completed in 1995. It is not possible to estimate accurately the cost of any remediation or USX's share in any final allocation formula; however, based on presently available information, USX may have been responsible for approximately 70% of the waste material deposited at the site. The EPA has demanded reimbursement for approximately $400,000 in past costs. USX is negotiating with the agency.\nIn 1989, a consent decree negotiated between the EPA and USX was entered in the U.S. District Court of New Jersey requiring USX to undertake remedial work at the Tabernacle Drum Dump site in Tabernacle, N.J. USX has expended $3.5 million in completing the remedial design and in constructing the treatment system. Additionally, the Department of Justice filed a complaint in 1990 against USX and a waste disposal firm seeking recovery of $1.7 million expended by the EPA in conducting a RI\/FS for the site. USX cross claimed against the waste disposal firm, and its successor in ownership, which improperly disposed of the waste material. On June 14, 1994, a settlement was reached with the codefendant waste disposal firm requiring it to pay $1.7 million to settle the EPA's cost claims and to pay USX $300,000. The EPA has not released USX from future liability.\nUSX participated with thirty-five other PRPs in performing removal work at the Ekotek\/Petrochem site in Salt Lake City, Utah under the terms of a 1991 administrative order negotiated with the EPA. The removal work was completed in 1992 at a cost of over $9 million. In July 1992, the PRP Remediation Committee negotiated an administrative order on consent to perform a RI\/FS of the site. It is expected the RI\/FS will be completed in early 1995 and a Record of Decision issued by the end of 1995. USX has contributed approximately $550,000 through 1994 towards completing the removal work and performing the RI\/FS. USX's proportionate share of costs presently being used by the PRP Remediation Committee is approximately 5% of the participating PRPs, but a final determination has not yet been made and it is expected that the percentage may decrease as a result of the participation of additional PRPs. The PRP Remediation Committee has commenced cost recovery litigation against approximately 1,100 non-participating PRPs.\nUSX has a 54% economic interest in RMI Titanium Company (\"RMI\") which has been identified as a PRP (together with 31 other companies) at the Fields Brook Superfund site in Ashtabula, Ohio. In 1986, the EPA estimated the cost of remediation at $48 million. However, recent studies show the volume of sediment to be substantially lower than projected in 1986. These studies, together with improved remediation technology and redefined cleanup standards have resulted in a more recent estimate of the remediation cost of approximately $25 million. The actual cost of remediation may vary from the estimate depending upon any number of factors. The EPA, in March 1989, ordered 22 of the PRP's to conduct a design phase study for the sediment operable unit and a source control study, which studies are currently estimated to cost $19 million. RMI, working cooperatively with fourteen others in accordance with two separate agreements, is complying with the order. RMI has accrued and has been paying its\nportion of the cost of complying with the EPA's order, which includes the studies. It is anticipated that the studies will be completed no earlier than mid 1996. Actual cleanup would not commence prior to that time. It is not possible to determine accurately RMI's cost or share of any final allocation formula with respect to the actual cleanup; however, based on the results of the allocation of the study costs which have been agreed to by the fifteen cooperating companies, RMI believes its share of the cleanup costs will be approximately 10%.\nThe Buckeye Reclamation Landfill, near St. Clairsville, Ohio, has been used at various times as a disposal site for coal mine refuse and municipal and industrial waste. USX is one of fifteen PRPs that have indicated a willingness to enter into an agreed order with the EPA to perform a remediation of the site. Until there is a final determination of each PRP's proportionate share at the site, USX has agreed to accept a share of 9.26% under an interim allocation agreement among all fifteen PRPs. Since 1992, USX has spent approximately $250,000 at the site, primarily on remedial design work estimated to total $2.5 million. Implementation of the remedial design plan, resulting in a long-term cleanup of the site, is expected to cost approximately $21.5 million. One of the PRPs filed suit against the EPA, the Ohio EPA, and 13 PRPs including USX. The EPA, in turn, has filed suit against the PRPs to recover $1.3 million in oversight costs.\nAt the Arrowhead Refinery site in Hermantown, Minn., USX was one of 17 defendants named in a complaint filed by the EPA in 1989 in which the agency was seeking to recover past and future clean-up costs. A settlement agreement was reached between the EPA and the PRP's which was embodied in a consent decree entered by the court in 1994. USX's liability under the agreement was $444,000, which has been paid.\nIn addition, there are 24 sites related to the U. S. Steel Group where USX has received information requests or other indications that USX may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability.\nThere are also 44 additional sites related to the U. S. Steel Group where remediation is being sought under other environmental statutes, both federal and state. Based on currently available information, which is in many cases preliminary and incomplete, the U. S. Steel Group believes that its liability for cleanup and remediation costs in connection with nine of these sites will be under $100,000 per site, another ten sites have potential costs between $100,000 and $1 million per site, and seven sites may involve remediation costs between $1 million and $5 million. Potential costs associated with remediation at sixteen of the sites are not presently determinable.\nTwo sites, USX's Gary Works and Clairton Works, are expected to have costs of cleanup and remediation in excess of $5 million.\nGary\nIn 1988, the United States filed an action in the United States District Court, Northern District of Indiana, for alleged violations of its National Pollutant Discharge Elimination System (\"NPDES\") permit effluent limitations and proposed including Gary Works on the EPA's List of Violating Facilities under Section 508 of the Clean Water Act based upon the EPA's allegations of continuing or recurring noncompliance with clean water standards at the facility. A consent decree signed by USX and approved by the court in 1990 requires USX to pay a civil penalty of $1.6 million, to spend up to $7.5 million to study and implement a program to remediate the sediment in a portion of the Grand Calumet River and to comply with specified wastewater control requirements entailing up to $25 million for new control equipment. In addition, the EPA withdrew the proposal to include Gary Works on the List of Violating Facilities. USX is currently negotiating with the EPA to develop a sediment remediation plan for the section of the Grand Calumet River that runs through Gary Works. USX expects to reach a final agreement with the EPA concerning this sediment remediation plan in 1995. As proposed, this\nproject would require five to six years to complete after approval and would be followed by an environmental recovery validation. The estimated program cost, which has been accrued, is approximately $30 million. In September 1994, the EPA informed USX of its intent to demand civil penalties of $12 million for alleged violations of the Clean Water Act at Gary Works. USX is negotiating a consent decree which will provide for the expanded sediment remediation program and will resolve alleged violations of the prior consent decree and NPDES permit since 1990.\nIn 1990, USX received a Notice of Violation issued by the Indiana Department of Environmental Management (\"IDEM\") alleging the violation of regulations concerning hazardous wastes at Gary Works. After several unsuccessful discussions with the agency in an attempt to resolve the issues raised in the Notice of Violation, including the amount of any penalty, the agency issued an Order assessing a civil penalty of $180,225. USX and IDEM have entered into a settlement of the matters alleged in the Order which requires USX to implement a plant-wide ground water assessment at Gary Works, consistent with the possibility of a future RCRA corrective action by EPA. In addition, USX paid the penalty amount in October 1994. USX expects to enter into an agreement with the EPA in 1995 concerning the initiation of a RCRA facility investigation and a corrective measure study at Gary Works.\nOn November 16, 1994, USX received a Notice of Violation from IDEM alleging violations of regulations concerning the management of hazardous wastes at USX's Gary Works. With the Notice of Violation, IDEM included a proposed settlement agreement which would require Gary Works to initiate certain remediation and study programs and pay a civil penalty of $1.8 million. USX submitted a detailed response in rebuttal of the allegations and has requested an opportunity to meet with IDEM.\nThe IDEM has issued Notices of Violation to USX's Gary Works alleging violations of air pollution requirements, including allegations that one source was not in compliance from 1982 to 1994. USX and IDEM have been involved in negotiations since the fall of 1994 in an attempt to resolve these matters. Those discussions are continuing. At a meeting between USX and IDEM in November 1994, the IDEM representatives orally conveyed an initial penalty demand of $52 million which reflects their calculation of the economic benefit that IDEM alleges USX received by not complying with the statutory requirements. USX has entered into discussions with IDEM in an attempt to resolve these issues, including the amount of any penalty. It is USX's expectation that a significant portion of any agreed to penalty amount would be resolved through additional environmental capital projects at Gary Works.\nClairton\nIn 1987, USX and the PaDER entered into a consent order to resolve an incident in January 1985 involving the alleged unauthorized discharge of benzene and other organic pollutants from Clairton Works in Clairton, Pa. That consent order required USX to pay a penalty of $50,000 and a monthly payment of $2,500 for five years. In 1990, USX and the PaDER reached agreement to amend the consent order. Under the amended order, USX has agreed to continue paying the prior $2,500 monthly penalty until February 1997; to cleanup and close a former coke plant waste disposal site over a period of 15 years; to pay a penalty of $300,000; and to pay a monthly penalty of up to $1,500 each month until the former disposal site is closed. A study is underway to determine cleanup and closure requirements which are currently estimated to cost $5.3 million.\nOn October 5, 1994, USX received an administrative complaint issued by the EPA alleging that USX's Clairton Works and Mon Valley Works were in violation of regulations requiring the installation and operation of Continuous Emission Monitoring (\"CEM\") equipment on certain air emission sources. USX has reached an agreement in principle with the EPA to resolve the allegations. The agreement requires USX to install, maintain, and operate CEM equipment which USX is already in the process of installing. In addition, USX will be required to pay a civil penalty of $125,000.\nOther Sites\nIn January 1992, USX commenced negotiations with the EPA regarding the terms of an administrative order on consent, pursuant to the RCRA, under which USX would perform a RCRA Facility Investigation (\"RFI\") and a Corrective Measure Study (\"CMS\") at USX's Fairless Works. During 1993, USX commenced the RFI\/CMS which will require over three years to complete at an approximate cost ranging from $2 million to $3 million. The RFI\/CMS will determine whether there is a need for, and the scope of, any remedial activities at Fairless Works.\nOn October 9, 1992, the EPA filed a complaint against RMI alleging certain RCRA violations at RMI's closed sodium plant in Ashtabula, Ohio. The EPA's determination is based on information gathered during inspections of the facility in 1991. Under the complaint, the EPA proposed to assess a civil penalty of approximately $1.4 million for alleged failure to comply with RCRA. RMI is contesting the complaint. It is RMI's position that it has complied with the provisions of RCRA and that the EPA's assessment of penalties is inappropriate. A formal hearing has been requested and informal discussions with the EPA to settle this matter are ongoing. Based on the preliminary nature of the proceedings, RMI is currently unable to determine the ultimate liability, if any, that may arise from this matter.\nDELHI GROUP\nEnvironmental Regulation\nDelhi is subject to federal, state and local laws and regulations relating to the environment. Based on procedures currently in place, including routine reviews of existing and proposed environmental laws and regulations and unannounced environmental inspections performed periodically at company facilities, and the associated expenditures for environmental controls, Delhi believes that its facilities and operations are in general compliance with environmental laws and regulations. However, because some of these requirements presently are not fixed, Delhi is unable to accurately predict the eventual cost of compliance.\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\nThe principal market on which Marathon Stock, Steel Stock and Delhi Stock are traded is the New York Stock Exchange. Information concerning the high and low sales prices for the common stocks as reported in the consolidated transaction reporting system and the frequency and amount of dividends paid during the last two years is set forth in \"Consolidated Financial Statements and Supplementary Data - Selected Quarterly Financial Data (Unaudited).\"\nAs of February 28, 1995, there were 109,148 registered holders of Marathon Stock, 80,514 registered holders of Steel Stock and 157 registered holders of Delhi Stock.\nThe Board of Directors intends to declare and pay dividends on Marathon Stock, Steel Stock and Delhi Stock based on the financial condition and results of operations of the Marathon Group, the U. S. Steel Group and the Delhi Group, respectively, although it has no obligation under Delaware law to do so. In determining its dividend policy with respect to Marathon Stock, Steel Stock and Delhi Stock, the Board will rely on the separate financial statements of the Marathon Group, the U. S. Steel Group and the Delhi Group, respectively. The method of calculating earnings per share for Marathon Stock, Steel Stock and Delhi Stock reflects the Board's intent that separately reported earnings and the surplus of the Marathon Group, the U. S. Steel Group and the Delhi Group, as determined consistent with the Certificate of Incorporation, are available for payment of dividends to the respective classes of stock, although legally available funds and liquidation preferences of these classes of stock do not necessarily correspond with these amounts. Dividends on all classes of preferred stock and USX common stock are limited to legally available funds of USX, which are determined on the basis of the entire Corporation. Distributions on Marathon Stock, Steel Stock and Delhi Stock would be precluded by a failure to pay dividends on any series of preferred stock of USX. In addition, net losses of any group, as well as dividends or distributions on any class of USX common stock or series of preferred stock and repurchases of any class of USX common stock or preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on the three classes of USX common stock as well as any preferred stock.\nDividends on Steel Stock are further limited to the Available Steel Dividend Amount. Net losses of the Marathon Group and the Delhi Group and distributions on Marathon Stock, Delhi Stock and on any preferred stock attributed to the Marathon Group or the Delhi Group will not reduce the funds available for declaration and payment of dividends on Steel Stock unless the legally available funds of USX are less than the Available Steel Dividend Amount. Dividends on Delhi Stock are further limited to the Available Delhi Dividend Amount. Net losses of the Marathon Group and the U. S. Steel Group and distributions on Marathon Stock, Steel Stock and on any preferred stock attributed to the Marathon Group or the U. S. Steel Group will not reduce the funds available for declaration and payment of dividends on Delhi Stock unless the legally available funds of USX are less than the Available Delhi Dividend Amount. See \"Financial Statements and Supplementary Data - Notes to Consolidated Financial Statements - 20. Dividends.\"\nThe Board has adopted certain policies with respect to the Marathon Group, the U. S. Steel Group and the Delhi Group, including, without limitation, the intention to: (i) limit capital expenditures of the U. S. Steel Group over the long term to an amount equal to the internally generated cash flow of the U. S. Steel Group, including funds generated by sales of assets of the U. S. Steel Group, (ii) sell assets and provide services between any of the Marathon Group, the U. S. Steel Group and the Delhi Group only on an arm's-length basis and (iii) treat funds generated by sales of Marathon Stock, Steel Stock or Delhi Stock (except for sales of Delhi Stock deemed to represent the Retained Interest) and securities convertible into such stock as assets of the Marathon Group, the U. S. Steel Group, or the Delhi Group, as the case may be, and apply such funds to acquire assets or reduce liabilities of the Marathon Group, the U. S. Steel Group or the Delhi Group, respectively. These policies may be modified or rescinded by action of the Board, or the\nBoard may adopt additional policies, without the approval of holders of the three classes of USX common stock, although the Board has no present intention to do so.\nFiduciary Duties of the Board; Resolution of Conflicts\nUnder Delaware law, the Board must act with due care and in the best interest of all the stockholders, including the holders of the shares of each class of USX common stock. The interests of the holders of any class of USX common stock may, under some circumstances, diverge or appear to diverge. Examples include the determination of whether shares of Delhi Stock offered for sale will be deemed to represent either part of the Retained Interest or an additional equity interest in the Delhi Group; the optional exchange of Steel Stock for Marathon Stock at the 10% premium or of Delhi Stock for Marathon Stock or Steel Stock at the 10% premium or 15% premium, as the case may be, the determination of the record date of any such exchange or for the redemption of any Steel Stock or Delhi Stock; the establishing of the date for public announcement of the liquidation of USX and the commitment of capital among the Marathon Group, the U. S. Steel Group and the Delhi Group.\nBecause the Board owes an equal duty to all common stockholders regardless of class, the Board is the appropriate body to deal with these matters. In order to assist the Board in this regard, USX has formulated policies to serve as guidelines for the resolution of matters involving a conflict or a potential conflict, including policies dealing with the payment of dividends, limiting capital investment in the U. S. Steel Group over the long term to its internally generated cash flow and allocation of corporate expenses and other matters. The Board has been advised concerning the applicable law relating to the discharge of its fiduciary duties to the common stockholders in the context of the separate classes of USX common stock and has delegated to the Audit Committee of the Board the responsibility to review matters which relate to this subject and report to the Board. While the classes of USX common stock may give rise to an increased potential for conflicts of interest, established rules of Delaware law would apply to the resolution of any such conflicts. Under Delaware law, a good faith determination by a disinterested and adequately informed Board with respect to any such matter would be a defense to any claim of liability made on behalf of the holders of any class of USX common stock. USX is aware of no precedent concerning the manner in which such rules of Delaware law would be applied in the context of its capital structure.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA USX - CONSOLIDATED\n(Footnotes presented on the following page.)\nSELECTED FINANCIAL DATA (CONTD.) USX - CONSOLIDATED (CONTD.)\nSELECTED FINANCIAL DATA (CONTD.) USX - MARATHON GROUP\nSELECTED FINANCIAL DATA (CONTD.) USX - U. S. STEEL GROUP\nSELECTED FINANCIAL DATA (CONTD.) USX - DELHI GROUP (a)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIndexes to Financial Statements, Supplementary Data and Management's Discussion and Analysis of USX Consolidated, the Marathon Group, the U. S. Steel Group and the Delhi Group, are presented on pages U-1, M-1, S-1 and D-1, respectively.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndexes to Financial Statements, Supplementary Data and Management's Discussion and Analysis for USX Consolidated, the Marathon Group, the U. S. Steel Group and the Delhi Group, are presented on pages U-1, M-1, S-1 and D-1, respectively.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nTHIS PAGE IS INTENTIONALLY LEFT BLANK\nUSX\nIndex to Consolidated Financial Statements, Supplementary Data and Management's Discussion and Analysis\nU-1 USX\nExplanatory Note Regarding Financial Information\nAlthough the financial statements of the Marathon Group, the U. S. Steel Group and the Delhi Group separately report the assets, liabilities (including contingent liabilities) and stockholders' equity of USX attributed to each such group, such attribution of assets, liabilities (including contingent liabilities) and stockholders' equity among the Marathon Group, the U. S. Steel Group and the Delhi Group for the purpose of preparing their respective financial statements does not affect legal title to such assets or responsibility for such liabilities. Holders of USX - Marathon Group Common Stock, USX - U. S. Steel Group Common Stock and USX - Delhi Group Common Stock are holders of common stock of USX, and continue to be subject to all the risks associated with an investment in USX and all of its businesses and liabilities. Financial impacts arising from one Group that affect the overall cost of USX's capital could affect the results of operations and financial condition of other groups. In addition, net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock.\nU-2 Management's Report\nThe accompanying consolidated financial statements of USX Corporation and Subsidiary Companies (USX) are the responsibility of and have been prepared by USX in conformity with generally accepted accounting principles. They necessarily include some amounts that are based on best judgments and estimates. The consolidated financial information displayed in other sections of this report is consistent with these consolidated financial statements.\nUSX seeks to assure the objectivity and integrity of its financial records by careful selection of its managers, by organizational arrangements that provide an appropriate division of responsibility and by communications programs aimed at assuring that its policies and methods are understood throughout the organization.\nUSX has a comprehensive formalized system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that financial records are reliable. Appropriate management monitors the system for compliance, and the internal auditors independently measure its effectiveness and recommend possible improvements thereto. In addition, as part of their audit of the consolidated financial statements, USX's independent accountants, who are elected by the stockholders, review and test the internal accounting controls selectively to establish a basis of reliance thereon in determining the nature, extent and timing of audit tests to be applied.\nThe Board of Directors pursues its oversight role in the area of financial reporting and internal accounting control through its Audit Committee. This Committee, composed solely of nonmanagement directors, regularly meets (jointly and separately) with the independent accountants, management and internal auditors to monitor the proper discharge by each of its responsibilities relative to internal accounting controls and the consolidated financial statements.\nCharles A. Corry Robert M. Hernandez Lewis B. Jones Chairman, Board of Directors Vice Chairman Vice President & Chief Executive Officer & Chief Financial Officer & Comptroller\nReport of Independent Accountants\nTo the Stockholders of USX Corporation:\nIn our opinion, the accompanying consolidated financial statements appearing on pages U-4 through U-28 present fairly, in all material respects, the financial position of USX Corporation and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of USX'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 1, page U-11, in 1993 USX adopted new accounting standards for postemployment benefits and for retrospectively rated insurance contracts. As discussed in Note 8, page U-16, and Note 9, page U-17, in 1992 USX adopted new accounting standards for postretirement benefits other than pensions and for income taxes, respectively.\nPrice Waterhouse LLP 600 Grant Street, Pittsburgh, Pennsylvania 15219-2794 February 14, 1995\nU-3\nConsolidated Statement of Operations\nThe accompanying notes are an integral part of these consolidated financial statements.\nU-4\nIncome Per Common Share\nSee Note 21, page U-24, for a description of net income per common share. The accompanying notes are an integral part of these consolidated financial statements.\nU-5\nConsolidated Balance Sheet\nThe accompanying notes are an integral part of these consolidated financial statements.\nU-6\nConsolidated Statement of Cash Flows\nSee Note 17, page U-22, for supplemental cash flow information. The accompanying notes are an integral part of these consolidated financial statements.\nU-7\nConsolidated Statement of Stockholders' Equity\nUSX has three classes of common stock, being USX - Marathon Group Common Stock (Marathon Stock), USX - U. S. Steel Group Common Stock (Steel Stock), and USX - Delhi Group Common Stock (Delhi Stock), which are intended to reflect the performance of the Marathon Group, the U. S. Steel Group, and the Delhi Group, respectively. (See Note 6, page U-13 for a description of the three groups.)\nThe USX Certificate of Incorporation was amended on September 30, 1992, to authorize a new class of common stock. On October 2, 1992, USX sold 9,000,000 shares of Delhi Stock to the public.\nOn all matters where the holders of Marathon Stock, Steel Stock and Delhi Stock vote together as a single class, Marathon Stock has one vote per share, and Steel Stock and Delhi Stock each have a fluctuating vote per share based on the relative market value of a share of Steel Stock or Delhi Stock, as the case may be, to the market value of a share of Marathon Stock. In the event of a disposition of all or substantially all the properties and assets of either the U. S. Steel Group or the Delhi Group, USX must either distribute the net proceeds to the holders of the Steel Stock or Delhi Stock, as the case may be, as a special dividend or in redemption of the stock, or exchange the Steel Stock or Delhi Stock, as the case may be, for one of the other remaining two classes of stock. In the event of liquidation of USX, the holders of the Marathon Stock, Steel Stock and Delhi Stock will share in the funds remaining for common stockholders based on the relative market capitalization of the respective Marathon Stock, Steel Stock or Delhi Stock to the aggregate market capitalization of all classes of common stock.\n(Table continued on next page)\nU-8\nThe accompanying notes are an integral part of these consolidated financial statements.\nU-9\nNotes to Consolidated Financial Statements\n- ------------------------------------------------------------------------------- 1. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES\nPRINCIPLES APPLIED IN CONSOLIDATION - The consolidated financial statements include the accounts of USX Corporation and its majority-owned subsidiaries (USX).\nInvestments in unincorporated oil and gas joint ventures, undivided interest pipelines and jointly-owned gas processing plants are accounted for on a pro rata basis.\nInvestments in other entities in which USX has significant influence in management and control are accounted for using the equity method of accounting and are carried in the investment account at USX's share of net assets plus advances. The proportionate share of income from equity investments is included in other income. In 1994, USX reduced its voting interest in RMI Titanium Company (RMI) to less than 50% and began accounting for its investment using the equity method.\nInvestments in marketable equity securities are carried at lower of cost or market and investments in other companies are carried at cost, with income recognized when dividends are received.\nCASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on hand and on deposit and highly liquid debt instruments with maturities generally of three months or less.\nINVENTORIES - Inventories are carried at lower of cost or market. Cost of inventories is determined primarily under the last-in, first-out (LIFO) method.\nHEDGING TRANSACTIONS - USX engages in hedging activities within the normal course of its businesses (Note 26, page U-27). Management has been authorized to manage exposure to price fluctuations relevant to the purchase or sale of crude oil, natural gas, refined products and nonferrous metals through the use of a variety of derivative financial and nonfinancial instruments. Derivative financial instruments require settlement in cash and include such instruments as over-the-counter (OTC) commodity swap agreements and OTC commodity options. Derivative nonfinancial instruments require or permit settlement by delivery of commodities and include exchange-traded commodity futures contracts and options. Changes in the market value of derivative instruments are deferred and subsequently recognized in income, as sales or cost of sales, in the same period as the hedged item. OTC swaps are off-balance-sheet instruments; therefore, the effect of changes in the market value of such instruments are not recorded until settlement. The margin accounts for open commodity futures contracts, which reflect daily settlements as market values change, are recorded as accounts receivable. Premiums on all commodity-based option contracts are initially recorded based on the amount paid or received; the options' market value is subsequently recorded as accounts receivable or accounts payable, as appropriate.\nForward currency contracts are primarily used to manage currency risks related to anticipated revenues and operating costs, firm commitments for capital expenditures and existing assets or liabilities denominated in a foreign currency. Gains or losses related to firm commitments are deferred and included with the hedged item; all other gains or losses are recognized in income in the current period as sales, cost of sales, interest income or expense, or other income, as appropriate. For balance sheet reporting, net contract values are included in receivables or payables, as appropriate.\nRecorded deferred gains or losses are reflected within other noncurrent assets or deferred credits and other liabilities. Cash flows from the use of derivative instruments are reported in the same category as the hedged item in the statement of cash flows.\nEXPLORATION AND DEVELOPMENT - USX follows the successful efforts method of accounting for oil and gas exploration and development.\nGAS BALANCING - USX follows the sales method of accounting for gas production imbalances.\nPROPERTY, PLANT AND EQUIPMENT - Except for oil and gas producing properties, depreciation is generally computed on the straight-line method based upon estimated lives of assets. USX's method of computing depreciation for steel producing assets modifies straight-line depreciation based on the level of production. The modification factors range from a minimum of 85% at a production level below 81% of capability, to a maximum of 105% for a 100% production level. No modification is made at the 95% production level, considered the normal long-range level.\nU-10\nDepreciation and depletion of oil and gas producing properties are computed using predetermined rates based upon estimated proved oil and gas reserves applied on a units-of-production method.\nDepletion of mineral properties, other than oil and gas, is based on rates which are expected to amortize cost over the estimated tonnage of minerals to be removed.\nWhen an entire property, plant, major facility or facilities depreciated on an individual basis are sold or otherwise disposed of, any gain or loss is reflected in income. Proceeds from disposal of other facilities depreciated on a group basis are credited to the depreciation reserve with no immediate effect on income.\nENVIRONMENTAL REMEDIATION - USX provides for remediation costs and penalties when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. Generally, the timing of remediation accruals coincides with completion of a feasibility study or the commitment to a formal plan of action. Estimated abandonment and dismantlement costs of offshore production platforms are accrued based upon estimated proved oil and gas reserves on a units-of-production method.\nINSURANCE - USX is insured for catastrophic casualty and certain property exposures, as well as those risks required to be insured by law or contract. Costs resulting from noninsured losses are charged against income upon occurrence.\nIn 1993, USX adopted Emerging Issues Task Force (EITF) Consensus No. 93-14, \"Accounting for Multiple-Year Retrospectively Rated Insurance Contracts\". EITF No. 93-14 requires accrual of retrospective premium adjustments when the insured has an obligation to pay cash to the insurer that would not have been required absent experience under the contract. The cumulative effect of the change in accounting principle determined as of January 1, 1993, reduced net income $6 million, net of $3 million income tax effect.\nPOSTEMPLOYMENT BENEFITS - In 1993, USX adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (SFAS No. 112). SFAS No. 112 requires employers to recognize the obligation to provide postemployment benefits on an accrual basis if certain conditions are met. USX is affected primarily by disability-related claims covering indemnity and medical payments. The obligation for these claims is measured using actuarial techniques and assumptions including appropriate discount rates. The cumulative effect of the change in accounting principle determined as of January 1, 1993, reduced net income $86 million, net of $50 million income tax effect. The effect of the change in accounting principle reduced 1993 operating income by $23 million.\nRECLASSIFICATIONS - Certain reclassifications of prior years' data have been made to conform to 1994 classifications.\n- -------------------------------------------------------------------------------- 2. SALES\nThe items below were included in both sales and operating costs, resulting in no effect on income:\n(a) Reflected the gross amount of purchases and sales associated with crude oil and refined product buy\/sell transactions which are settled in cash.\nU-11\n- -------------------------------------------------------------------------------- 3. OTHER ITEMS\n(a) Gains resulted primarily from the sale of the assets of a retail propane marketing subsidiary and certain domestic oil and gas production properties. (b) Gains resulted primarily from the sale of the Cumberland coal mine, an investment in an insurance company and the realization of a deferred gain resulting from collection of a subordinated note related to the 1988 sale of Transtar, Inc. (Transtar). The collection also resulted in interest income of $37 million. (c) Included a $177 million favorable adjustment related to interest income from a refund of prior years' production taxes. (d) Reflected $164 million related to the B&LE litigation (Note 5, page U-12). (e) Included a $35 million favorable adjustment related to interest and other financial costs from the settlement of various state tax issues. (f) Excludes financial income and costs of finance operations, which are included in operating income.\n- -------------------------------------------------------------------------------- 4. RESTRUCTURING CHARGES\nIn mid-1994, the planned disposition of certain nonstrategic gas gathering and processing assets and other investments resulted in a $37 million charge to operating income and a $3 million charge to other income for the write-downs of assets to their estimated net realizable value. Disposition of these assets is expected to be completed in 1995.\nIn 1993, the planned closure of a Pennsylvania coal mine resulted in a $42 million charge, primarily related to the write-down of property, plant and equipment, contract termination, and mine closure cost. In December 1994, a letter of intent for the sale of this coal mine was entered into, subject to certain conditions. This transaction, if concluded, will close in 1995.\nIn 1992, restructuring actions resulted in a $125 million charge, of which $115 million was for the write-down of assets related to the planned disposition of nonstrategic domestic exploration and production properties, and $10 million for the completion of the 1991 restructuring plan related to steel operations. The disposal of the exploration and production properties was completed in 1993.\n- -------------------------------------------------------------------------------- 5. B&LE LITIGATION\nPretax income (loss) in 1993 included a $506 million charge related to the Lower Lake Erie Iron Ore Antitrust Litigation against a former USX subsidiary, the Bessemer & Lake Erie Railroad (B&LE) (Note 25, page U-25). Charges of $342 million were included in cost of sales and $164 million included in interest and other financial costs. The effect on 1993 net income (loss) was $325 million unfavorable ($5.04 per share of Steel Stock). At December 31, 1993, accounts payable included $376 million for this litigation, which was substantially settled in 1994.\nU-12\n- -------------------------------------------------------------------------------- 6. SEGMENT INFORMATION\nUSX has three classes of common stock: Marathon Stock, Steel Stock and Delhi Stock, which are intended to reflect the performance of the Marathon Group, the U. S. Steel Group and the Delhi Group, respectively. The segments of USX conform to USX's group structure. A description of each group and its products and services is as follows:\nMARATHON GROUP - The Marathon Group is involved in worldwide exploration, production, transportation and marketing of crude oil and natural gas; and domestic refining, marketing and transportation of petroleum products.\nU. S. STEEL GROUP - The U. S. Steel Group, which consists primarily of steel operations, includes the largest domestic integrated steel producer and is primarily engaged in the production and sale of steel mill products, coke and taconite pellets. The U. S. Steel Group also includes the management of mineral resources, domestic coal mining, and engineering and consulting services and technology licensing. Other businesses that are part of the U. S. Steel Group include real estate development and management, fencing products, leasing and financing activities, and RMI prior to the adoption of equity accounting in 1994.\nDELHI GROUP - The Delhi Group is engaged in the purchasing, gathering, processing, transporting and marketing of natural gas. The Delhi Group amounts prior to October 2, 1992, represent the historical financial data of the businesses included in the Delhi Group which were also included in the amounts of the Marathon Group.\nIntergroup sales and transfers were conducted on an arm's-length basis. Assets include certain assets attributed to each group that are not used to generate operating income. Export sales from domestic operations were not material.\nINDUSTRY SEGMENT:\n(a) Operating income (loss) included the following: a $342 million charge related to the B&LE litigation for the U. S. Steel Group in 1993 (Note 5, page U-12); restructuring charges of $42 million and $10 million for the U. S. Steel Group in 1993 and 1992, respectively; restructuring charges of $115 million for the Marathon Group in 1992 (Note 4, page U-12); restructuring charges of $37 million for the Delhi Group in 1994 (Note 4, page U-12); and inventory market valuation charges (credits) for the Marathon Group of $(160) million, $241 million and $(62) million in 1994, 1993 and 1992, respectively (Note 16, page U-22).\nU-13\nThe information below summarizes the operations in different geographic areas. Transfers between geographic areas are at prices which approximate market.\nU-14\n- -------------------------------------------------------------------------------- 7. PENSIONS\nUSX has noncontributory defined benefit plans covering substantially all employees. Benefits under these plans are based upon years of service and final average pensionable earnings, or a minimum benefit based upon years of service, whichever is greater. In addition, contributory pension benefits, which cover certain participating salaried employees, are based upon years of service and career earnings. The funding policy for defined benefit plans provides that payments to the pension trusts shall be equal to the minimum funding requirements of ERISA plus such additional amounts as may be approved from time to time.\nUSX also participates in multiemployer plans, most of which are defined benefit plans associated with coal operations.\nPENSION COST (CREDIT) - The defined benefit cost for major plans for 1994, 1993 and 1992 was determined assuming an expected long-term rate of return on plan assets of 9%, 10% and 11%, respectively.\n(a) The curtailment loss in 1994 resulted from work force reduction programs in the Marathon and Delhi Groups.\nFUNDS' STATUS - The assumed discount rate used to measure the benefit obligations of major plans was 8% and 6.5% at December 31, 1994, and December 31, 1993, respectively. The assumed rate of future increases in compensation levels was 4% and 3% at December 31, 1994 and December 31, 1993, respectively.\nU-15\n- -------------------------------------------------------------------------------- 8. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nUSX has defined benefit retiree health and life insurance plans covering most employees upon their retirement. Health benefits are provided, for the most part, through comprehensive hospital, surgical and major medical benefit provisions subject to various cost sharing features. Life insurance benefits are provided to nonunion and certain union represented retiree beneficiaries primarily based on employees' annual base salary at retirement. For other union retirees, benefits are provided for the most part based on fixed amounts negotiated in labor contracts with the appropriate unions. Except for certain life insurance benefits paid from reserves held by insurance carriers, benefits have not been prefunded. In 1994, USX agreed to establish a Voluntary Employee Beneficiary Association Trust to prefund a portion of health care and life insurance benefits for retirees covered under the United Steelworkers of America (USWA) union agreement. In early 1995, USX funded the initial $25 million contribution and will be required to fund a minimum of $10 million more in 1995 and each succeeding contract year.\nIn 1992, USX adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS No. 106), which requires accrual accounting for all postretirement benefits other than pensions. USX elected to recognize immediately the transition obligation determined as of January 1, 1992, which represented the excess accumulated postretirement benefit obligation (APBO) for current and future retirees over the fair value of plan assets and recorded postretirement benefit cost accruals. The cumulative effect of the change in accounting principle reduced net income $1,306 million, consisting of the transition obligation of $2,070 million, net of $764 million income tax effect.\nPOSTRETIREMENT BENEFIT COST - Postretirement benefit cost for defined benefit plans for 1994, 1993 and 1992 was determined assuming a discount rate of 6.5%, 7% and 8%, respectively, and an expected return on plan assets of 9% for 1994 and 10% for both 1993 and 1992.\n(a) Payments are made to a multiemployer benefit plan created by the Coal Industry Retiree Health Benefit Act of 1992 based on assigned beneficiaries receiving benefits. The present value of this unrecognized obligation is broadly estimated to be $160 million, including the effects of future medical inflation, and this amount could increase if additional beneficiaries are assigned. (b) In 1994, curtailment gains resulted from a work force reduction program in the Marathon Group. In 1993, other income (Note 3, page U-12) included a settlement gain resulting from the sale of the Cumberland coal mine.\nFUNDS' STATUS - The following table sets forth the plans' funded status and the amounts reported in USX's consolidated balance sheet:\nThe assumed discount rate used to measure the APBO was 8% and 6.5% at December 31, 1994, and December 31, 1993, respectively. The assumed rate of future increases in compensation levels was 4% at both year ends. The weighted average health care cost trend rate in 1995 is approximately 7%, declining to an ultimate rate in 1997 of approximately 6%. A one percentage point increase in the assumed health care cost trend rates for each future year would have increased the aggregate of the service and interest cost components of the 1994 net periodic postretirement benefit cost by $34 million and would have increased the APBO as of December 31, 1994, by $268 million.\nU-16\n- -------------------------------------------------------------------------------- 9. INCOME TAXES\nIn 1992, USX adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), which requires an asset and liability approach in accounting for income taxes. Under this method, deferred income tax assets and liabilities are established to reflect the future tax consequences of carryforwards and differences between the tax bases and financial bases of assets and liabilities.\nProvisions (credits) for estimated income taxes:\nIn 1993, the cumulative effect of the change in accounting principles for postemployment benefits and for retrospectively rated insurance contracts included deferred tax benefits of $50 million and $3 million, respectively (Note 1, page U-11). In 1992, the cumulative effect of the change in accounting principle for other postretirement benefits included a deferred tax benefit of $764 million (Note 8, page U-16).\nReconciliation of federal statutory tax rate (35% in 1994 and 1993, and 34% in 1992) to total provisions (credits):\n(a) Included incremental deferred tax benefit of $64 million in 1993 resulting from USX's ability to credit, rather than deduct, certain foreign income taxes for federal income tax purposes when paid in future periods. (b) Included favorable effects in 1994 resulting from the settlement of various state tax issues.\nDeferred tax assets and liabilities resulted from the following:\n(c) The decrease in valuation allowances reflected $52 million related to a previously consolidated subsidiary now accounted for using the equity method, of which $26 million related to federal tax loss carryforwards.\nThe consolidated tax returns of USX for the years 1988 through 1991 are under various stages of audit and administrative review by the IRS. USX believes it has made adequate provision for income taxes and interest which may become payable for years not yet settled.\nPretax income (loss) included $14 million, $(53) million and $55 million attributable to foreign sources in 1994, 1993 and 1992, respectively.\nU-17\n- -------------------------------------------------------------------------------- 10. LONG-TERM RECEIVABLES AND OTHER INVESTMENTS\nThe following financial information summarizes USX's share in investments accounted for by the equity method:\nUSX purchases from equity affiliates totaled $431 million, $390 million and $348 million in 1994, 1993 and 1992, respectively. USX sales to equity affiliates totaled $681 million, $547 million and $283 million in 1994, 1993 and 1992, respectively.\nU-18\n- -------------------------------------------------------------------------------- 11. SALES OF RECEIVABLES\nACCOUNTS RECEIVABLE - USX has entered into agreements to sell certain accounts receivable subject to limited recourse. Payments are collected from the sold accounts receivable; the collections are reinvested in new accounts receivable for the buyers; and a yield based on defined short-term market rates is transferred to the buyers. Collections on sold accounts receivable will be forwarded to the buyers at the end of the agreements in 1995, in the event of earlier contract termination or if USX does not have a sufficient quantity of eligible accounts receivable to reinvest in for the buyers. The balance of sold accounts receivable averaged $737 million, $733 million and $703 million for years 1994, 1993 and 1992, respectively. At December 31, 1994, the balance of sold accounts receivable that had not been collected was $750 million. Buyers have collection rights to recover payments from an amount of outstanding receivables for 115% to 120% of the outstanding receivables purchased on a nonrecourse basis; such overcollateralization cannot exceed $133 million. USX does not generally require collateral for accounts receivable, but significantly reduces credit risk through credit extension and collection policies, which include analyzing the financial condition of potential customers, establishing credit limits, monitoring payments and aggressively pursuing delinquent accounts. In the event of a change in control of USX, as defined in the agreements, USX may be required to forward payments collected on sold accounts receivable to the buyers.\nLOANS RECEIVABLE - Prior to 1993, USX Credit, a division of USX, sold certain of its loans receivable subject to limited recourse. USX Credit continues to collect payments from the loans and transfer to the buyers principal collected plus yield based on defined short-term market rates. In 1994, 1993 and 1992, USX Credit net repurchases of loans receivable totaled $38 million, $50 million and $24 million, respectively. At December 31, 1994, the balance of sold loans receivable subject to recourse was $131 million. USX Credit is not actively seeking new loans at this time. USX Credit is subject to market risk through fluctuations in short-term market rates on sold loans which pay fixed interest rates. USX Credit significantly reduces credit risk through a credit policy, which requires that loans be secured by the real property or equipment financed, often with additional security such as letters of credit, personal guarantees and committed long-term financing takeouts. Also, USX Credit diversifies its portfolio as to types and terms of loans, borrowers, loan sizes, sources of business and types and locations of collateral. As of December 31, 1994, and December 31, 1993, USX Credit had outstanding loan commitments of $26 million and $29 million, respectively. In the event of a change in control of USX, as defined in the agreement, USX may be required to provide cash collateral in the amount of the uncollected loans receivable to assure compliance with the limited recourse provisions.\nEstimated credit losses under the limited recourse provisions for both accounts receivable and loans receivable are recognized when the receivables are sold consistent with bad debt experience. Recognized liabilities for future recourse obligations of sold receivables were $3 million at December 31, 1994, and December 31, 1993.\n- -------------------------------------------------------------------------------- 12. SHORT-TERM CREDIT AGREEMENTS\nUSX had short-term credit agreements totaling $175 million at December 31, 1994. These agreements are with two banks, with interest based on their prime rate or London Interbank Offered Rate (LIBOR), and carry a commitment fee of .25%. Certain other banks provide short-term lines of credit totaling $165 million which require maintenance of compensating balances of 3%. No amounts were outstanding under these agreements at December 31, 1994.\nU-19\n- ------------------------------------------------------------------------------- 13. LONG-TERM DEBT\n(a) An agreement which terminates in August 1999, provides for borrowing under a $2,325 million revolving credit facility. Interest is based on defined short-term market rates. During the term of this agreement, USX is obligated to pay a facility fee of .20% on total commitments and a commitment fee of .05% on the unused portions. The commercial paper and Zero Coupon Convertible Senior Debentures were supported by the $2,325 million in unused and available credit at December 31, 1994, and, accordingly, were classified as long-term debt. (b) Foreign currency exchange agreements were executed in connection with the Swiss franc and European currency unit (ECU) obligations, which effectively fixed the principal repayment at $210 million and interest in U.S. dollars, thereby eliminating currency exchange risks (Note 26, page U-27). (c) The Zero Coupon Convertible Senior Debentures have a principal at maturity of $920 million. The original issue discount is being amortized recognizing a yield to maturity of 7-7\/8% per annum. The carrying value represents the principal at maturity less the unamortized discount. Each debenture of $1,000 principal at maturity is convertible into a unit consisting of 8.207 shares of Marathon Stock and 1.6414 shares of Steel Stock subject to adjustment or, at the election of USX, cash equal to the market value of the unit. At the option of the holders, USX will purchase debentures at the carrying value of $430 million and $625 million on August 9, 1995, and August 9, 2000, respectively; USX may elect to pay the purchase price in cash, shares of Marathon and Steel stocks or notes. USX may call the debentures for redemption at the issue price plus amortized discount beginning on August 9, 1995, or earlier if the market value of one share of Marathon Stock and one-fifth of a share of Steel Stock equals or exceeds $57.375 for 20 out of 30 consecutive trading days. (d) The debentures are convertible into one share of Marathon Stock and one-fifth of a share of Steel Stock subject to adjustment for $62.75 and are redeemable at USX's option. Sinking fund requirements for all years through 1995 have been satisfied through repurchases. (e) The debentures are convertible into one share of Marathon Stock and one-fifth of a share of Steel Stock subject to adjustment for $38.125 and may be redeemed by USX. The sinking fund begins in 1997. (f) At December 31, 1994, USX had outstanding obligations relating to short-term maturity Environmental Improvement Bonds in the amount of $203 million, which were supported by long-term credit arrangements. (g) The notes may be redeemed at par by USX on or after March 1, 1996. (h) The guaranteed loan was used to fund a portion of the costs in connection with the development of the East Brae Field and the SAGE pipeline in the North Sea. A portion of proceeds from a long-term gas sales contract is dedicated to loan service under certain circumstances. Prepayment of the loan may be required under certain situations, including events impairing the security interest. (i) Required payments of long-term debt, excluding commercial paper, Zero Coupon Convertible Senior Debentures, and short-term maturity Environmental Improvement Bonds, for the years 1996-1999 are $475 million, $275 million, $521 million and $274 million, respectively. (j) In the event of a change in control of USX, as defined in the related agreements, debt obligations totaling $3,833 million may be declared immediately due and payable. The principal obligations subject to such a provision are Senior Notes - $100 million; Notes payable - $2,548 million; Zero Coupon Convertible Senior Debentures - $409 million; Guaranteed Loan - $300 million; and 9-3\/4% Guaranteed Notes - $161 million. In such event, USX may also be required to either repurchase the leased Fairfield slab caster for $115 million or provide a letter of credit to secure the remaining obligation. (k) At December 31, 1994, $82 million of 4-5\/8% Sinking Fund Subordinated Debentures due 1996, which have been extinguished by placing securities into an irrevocable trust, were still outstanding.\nU-20\n- -------------------------------------------------------------------------------- 14. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment included gross assets acquired under capital leases (including sale-leasebacks accounted for as financings) of $155 million at December 31, 1994, and $156 million at December 31, 1993; related amounts included in accumulated depreciation, depletion and amortization were $82 million and $73 million, respectively.\n- -------------------------------------------------------------------------------- 15. LEASES\nFuture minimum commitments for capital leases (including sale-leasebacks accounted for as financings) and for operating leases having remaining noncancelable lease terms in excess of one year are as follows:\nOperating lease rental expense:\nUSX leases a wide variety of facilities and equipment under operating leases, including land and building space, office equipment, production facilities and transportation equipment. Contingent rental includes payments based on facility production and operating expense escalation on building space. Most long-term leases include renewal options and, in certain leases, purchase options. In the event of a change in control of USX, as defined in the agreements, or certain other circumstances, operating lease obligations totaling $180 million may be declared immediately due and payable.\nU-21\n- -------------------------------------------------------------------------------- 16. INVENTORIES\nAt December 31, 1994, and December 31, 1993, the LIFO method accounted for 88% and 87%, respectively, of total inventory value. Current acquisition costs were estimated to exceed the above inventory values at December 31 by approximately $260 million and $280 million in 1994 and 1993, respectively.\nThe inventory market valuation reserve reflects the extent that the recorded cost of crude oil and refined products inventories exceeds net realizable value. The reserve is decreased to reflect increases in market prices and inventory turnover and increased to reflect decreases in market prices. Changes in the inventory market valuation reserve resulted in charges (credits) to operating income of $(160) million, $241 million and $(62) million in 1994, 1993 and 1992, respectively.\nCost of sales was reduced and operating income was increased by $13 million, $11 million and $24 million in 1994, 1993 and 1992, respectively, as a result of liquidations of LIFO inventories.\n- -------------------------------------------------------------------------------- 17. SUPPLEMENTAL CASH FLOW INFORMATION\n- -------------------------------------------------------------------------------- 18. PREFERRED STOCK\nUSX is authorized to issue 40,000,000 shares of preferred stock, without par value. The following series were outstanding as of December 31, 1994:\nADJUSTABLE RATE CUMULATIVE PREFERRED STOCK - As of December 31, 1994, a total of 2,099,970 shares (stated value $50 per share) were outstanding. Dividend rates vary within a range of 7.50% to 15.75% per annum in accordance with a formula based on various U.S. Treasury security rates. In 1994, dividend rates on an annualized basis ranged from 7.50% to 8.15%. This stock is redeemable, at USX's sole option, at a price of $50 per share.\n6.50% CUMULATIVE CONVERTIBLE PREFERRED STOCK (6.50% CONVERTIBLE PREFERRED STOCK) - - As of December 31, 1994, 6,900,000 shares (stated value of $1.00 per share; liquidation preference of $50.00 per share) were outstanding. The 6.50% Convertible Preferred Stock is convertible at any time, at the option of the holder, into shares of Steel Stock at a conversion price of $46.125 per share of Steel Stock, subject to adjustment in certain circumstances. On and after April 1, 1996, this stock is redeemable at USX's sole option, at a price of $52.275 per share, and thereafter at prices declining annually on each April 1 to an amount equal to $50.00 per share on and after April 1, 2003.\nU-22\n- ------------------------------------------------------------------------------- 19. STOCK PLANS\nThe 1990 Stock Plan, as amended, authorizes the Compensation Committee of the Board of Directors to grant the following awards to key management employees; no further options will be granted under the predecessor plans.\nOPTIONS - the right to purchase shares of Marathon Stock, Steel Stock or Delhi Stock at not less than 100 percent of the fair market value of the stock at date of grant.\nSTOCK APPRECIATION RIGHTS - the right to receive cash and\/or common stock equal to the excess of the fair market value of a share of common stock, as determined in accordance with the plan, over the fair market value of a share on the date the right was granted for a specified number of shares.\nRESTRICTED STOCK - stock for no cash consideration or for such other consideration as determined by the Compensation Committee, subject to provisions for forfeiture and restricting transfer. Restriction may be removed as conditions such as performance, continuous service and other criteria are met.\nSuch employees are generally granted awards of the class of common stock intended to reflect the performance of the group in which they work. Up to .5 percent of the outstanding Marathon Stock and .8 percent of each of the outstanding Steel Stock and Delhi Stock, as determined on December 31 of the preceding year, are available for grants during each calendar year the 1990 Plan is in effect. In addition, awarded shares that do not result in shares being issued are available for subsequent grant in the same year, and any ungranted shares from prior years' annual allocations are available for subsequent grant during the years the 1990 Plan is in effect. As of December 31, 1994, 4,873,031 Marathon Stock shares, 1,490,147 Steel Stock shares and 75,510 Delhi Stock shares were available for grants in 1995.\nThe following table presents a summary of option and stock appreciation right transactions:\n(a) All outstanding options and stock appreciation rights are exercisable.\nDeferred compensation is charged to stockholders' equity when the restricted stock is granted and is expensed over the balance of the vesting period if conditions of the restricted stock grant are met. The following table presents a summary of restricted stock transactions:\nU-23\n- -------------------------------------------------------------------------------- 20. DIVIDENDS\nIn accordance with the USX Certificate of Incorporation, dividends on the Marathon Stock, Steel Stock and Delhi Stock are limited to the legally available funds of USX. Net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Subject to this limitation, the Board of Directors intends to declare and pay dividends on the Marathon Stock, Steel Stock and Delhi Stock based on the financial condition and results of operations of the related group, although it has no obligation under Delaware law to do so. In making its dividend decisions with respect to each of the Marathon Stock, Steel Stock and Delhi Stock, the Board of Directors considers, among other things, the long-term earnings and cash flow capabilities of the related group as well as the dividend policies of similar publicly traded companies.\nDividends on the Steel Stock and Delhi Stock are further limited to the Available Steel Dividend Amount and the Available Delhi Dividend Amount, respectively. At December 31, 1994, the Available Steel Dividend Amount was at least $2.170 billion, and the Available Delhi Dividend Amount was at least $104 million. The Available Steel Dividend Amount and Available Delhi Dividend Amount, respectively, will be increased or decreased, as appropriate, to reflect the respective group's separately reported net income, dividends, repurchases or issuances with respect to the related class of common stock and preferred stock attributed to the respective groups and certain other items.\n- -------------------------------------------------------------------------------- 21. NET INCOME PER COMMON SHARE\nThe method of calculating net income (loss) per share for the Marathon Stock, Steel Stock and Delhi Stock reflects the USX Board of Directors' intent that the separately reported earnings and surplus of the Marathon Group, the U. S. Steel Group and the Delhi Group, as determined consistent with the USX Certificate of Incorporation, are available for payment of dividends on the respective classes of stock, although legally available funds and liquidation preferences of these classes of stock do not necessarily correspond with these amounts. The financial statements of the Marathon Group, the U. S. Steel Group and the Delhi Group, taken together, include all accounts which comprise the corresponding consolidated financial statements of USX.\nThe USX Board of Directors has designated 14,003,205 shares of Delhi Stock to represent 100% of the common stockholders' equity value of USX attributable to the Delhi Group as of December 31, 1994. The Delhi Fraction is the percentage interest in the Delhi Group represented by the shares of Delhi Stock that are outstanding at any particular time and, based on 9,437,891 outstanding shares at December 31, 1994, is approximately 67%. The Marathon Group financial statements reflect a percentage interest in the Delhi Group of approximately 33% (Retained Interest) at December 31, 1994. Income per share applicable to outstanding Delhi Stock is presented for the periods subsequent to the October 2, 1992, initial issuance of Delhi Stock.\nPrimary net income (loss) per share is calculated by adjusting net income (loss) for dividend requirements of preferred stock and, in the case of Delhi Stock, for the income applicable to the Retained Interest; and is based on the weighted average number of common shares outstanding plus common stock equivalents, provided they are not antidilutive. Common stock equivalents result from assumed exercise of stock options and surrender of stock appreciation rights associated with stock options where applicable.\nFully diluted net income (loss) per share assumes conversion of convertible securities for the applicable periods outstanding and assumes exercise of stock options and surrender of stock appreciation rights, provided, in each case, the effect is not antidilutive.\nU-24\n- -------------------------------------------------------------------------------- 22. FOREIGN CURRENCY TRANSLATION\nExchange adjustments resulting from foreign currency transactions generally are recognized in income, whereas adjustments resulting from translation of financial statements are reflected as a separate component of stockholders' equity. For 1994, 1993 and 1992, respectively, the aggregate foreign currency transaction gains (losses) included in determining net income were $(6) million, $(3) million and $14 million. An analysis of changes in cumulative foreign currency translation adjustments follows:\n- -------------------------------------------------------------------------------- 23. STOCKHOLDER RIGHTS PLAN\nUSX's Board of Directors has adopted a Stockholder Rights Plan and declared a dividend distribution of one right for each outstanding share of Marathon Stock, Steel Stock and Delhi Stock referred to together as \"Voting Stock.\" Each right becomes exercisable, at a price of $120, when any person or group has acquired, obtained the right to acquire or made a tender or exchange offer for 15 percent or more of the total voting power of the Voting Stock, except pursuant to a qualifying all-cash tender offer for all outstanding shares of Voting Stock, which is accepted with respect to shares of Voting Stock representing a majority of the voting power other than Voting Stock beneficially owned by the offeror. Each right entitles the holder, other than the acquiring person or group, to purchase one one-hundredth of a share of Series A Junior Preferred Stock or, upon the acquisition by any person of 15 percent or more of the total voting power of the Voting Stock, Marathon Stock, Steel Stock or Delhi Stock (as the case may be) or other property having a market value of twice the exercise price. After the rights become exercisable, if USX is acquired in a merger or other business combination where it is not the survivor, or if 50 percent or more of USX's assets, earnings power or cash flow are sold or transferred, each right entitles the holder to purchase common stock of the acquiring entity having a market value of twice the exercise price. The rights and exercise price are subject to adjustment, and the rights expire on October 9, 1999, or may be redeemed by USX for one cent per right at any time prior to the point they become exercisable. Under certain circumstances, the Board of Directors has the option to exchange one share of the respective class of Voting Stock for each exercisable right.\n- -------------------------------------------------------------------------------- 24. PREFERRED STOCK OF SUBSIDIARY\nUSX Capital LLC, a wholly owned subsidiary of USX, sold 10,000,000 shares (carrying value of $250 million) of 8-3\/4% Cumulative Monthly Income Preferred Shares (MIPS) (liquidation preference of $25 per share) in 1994. Proceeds of the issue were loaned to USX. USX has the right under the loan agreement to extend interest payment periods for up to 18 months, and as a consequence, monthly dividend payments on the MIPS can be deferred by USX Capital LLC during any such interest payment period. In the event that USX exercises this right, USX may not declare dividends on any share of its preferred or common stocks. The MIPS are redeemable at the option of USX Capital LLC and subject to the prior consent of USX, in whole or in part from time to time, for $25 per share on or after March 31, 1999, and will be redeemed from the proceeds of any repayment of the loan by USX. In addition, upon final maturity of the loan, USX Capital LLC is required to redeem the MIPS. The financial costs are included in interest and other financial costs.\n- -------------------------------------------------------------------------------- 25. CONTINGENCIES AND COMMITMENTS\nUSX is the subject of, or party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment. Certain of these matters are discussed below. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the consolidated financial statements. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably.\nLEGAL PROCEEDINGS - B&LE litigation\nIn 1994, USX paid $367 million to satisfy substantially all judgments against the B&LE in the Lower Lake Erie Iron Ore Antitrust Litigation. Two remaining plaintiffs in this case have had their damage claims remanded for retrial. A new trial may result in awards more or less than the original asserted claims of $8 million and would be subject to trebling.\nIn a separate lawsuit brought by Armco Steel, settlement was reached in 1994 with immaterial financial impact.\nU-25\n- -------------------------------------------------------------------------------- 25. CONTINGENCIES AND COMMITMENTS (CONTINUED)\nPickering litigation\nIn 1992, the United States District Court for the District of Utah Central Division issued a Memorandum Opinion and Order in Pickering v. USX relating to pension and compensation claims by approximately 1,900 employees of USX's former Geneva (Utah) Works. Although the court dismissed a number of the claims by the plaintiffs, it found that USX had violated the Employee Retirement Income Security Act by interfering with the accrual of pension benefits of certain employees and amending a benefit plan to reduce the accrual of future benefits without proper notice to plan participants. Further proceedings were held to determine damages for a sample group and, pending the court's determinations, USX may appeal. Plaintiffs' counsel has been reported as estimating plaintiffs' anticipated recovery to be in excess of $100 million. USX believes actual damages will be substantially less than plaintiffs' estimates. In 1994, USX entered into settlement agreements with 227 plaintiffs providing for releases of liability against USX and the aggregate payment of approximately $1 million by USX.\nENVIRONMENTAL MATTERS -\nUSX is subject to federal, state, local and foreign laws and regulations relating to the environment. These laws generally provide for control of pollutants released into the environment and require responsible parties to undertake remediation of hazardous waste disposal sites. Penalties may be imposed for noncompliance. At both December 31, 1994, and December 31, 1993, accrued liabilities for remediation totaled $186 million. It is not presently possible to estimate the ultimate amount of all remediation costs that might be incurred or the penalties that may be imposed.\nFor a number of years, USX has made substantial capital expenditures to bring existing facilities into compliance with various laws relating to the environment. In 1994 and 1993, such capital expenditures totaled $132 million and $181 million, respectively. USX anticipates making additional such expenditures in the future; however, the exact amounts and timing of such expenditures are uncertain because of the continuing evolution of specific regulatory requirements.\nAt December 31, 1994, and December 31, 1993, accrued liabilities for platform abandonment and dismantlement totaled $127 million and $126 million, respectively.\nLIBYAN OPERATIONS -\nBy reason of Executive Orders and related regulations under which the U.S. Government is continuing economic sanctions against Libya, USX was required to discontinue performing its Libyan petroleum contracts on June 30, 1986. In June 1989, the Department of the Treasury authorized USX to resume performing under those contracts. Pursuant to that authorization, USX has engaged the Libyan National Oil Company and the Secretary of Petroleum in continuing negotiations to determine when and on what basis they are willing to allow USX to resume realizing revenue from USX's investment of $107 million in Libya. USX is uncertain when these negotiations can be completed.\nGUARANTEES -\nGuarantees by USX of the liabilities of affiliated and other entities totaled $190 million at December 31, 1994, and $227 million at December 31, 1993. In the event that any defaults of guaranteed liabilities occur, USX has access to its interest in the assets of most of the affiliates to reduce losses resulting from these guarantees. As of December 31, 1994, the largest guarantee for a single affiliate was $87 million.\nAt December 31, 1994, and December 31, 1993, USX's pro rata share of obligations of LOOP INC. and various pipeline affiliates secured by throughput and deficiency agreements totaled $197 million and $206 million, respectively. Under the agreements, USX is required to advance funds if the affiliates are unable to service debt. Any such advances are prepayments of future transportation charges.\nCOMMITMENTS -\nAt December 31, 1994, and December 31, 1993, contract commitments for capital expenditures for property, plant and equipment totaled $283 million and $389 million, respectively.\nUSX has entered into a 15-year take-or-pay arrangement which requires USX to accept pulverized coal each month or pay a minimum monthly charge. In 1994 and 1993, charges for deliveries of pulverized coal totaled $24 million and $14 million (deliveries began in 1993), respectively. In the future, USX will be obligated to make minimum payments of approximately $16 million per year. If USX elects to terminate the contract early, a maximum termination payment of $126 million, which declines over the duration of the agreement, may be required.\nUSX is a party to a transportation agreement with Transtar for Great Lakes shipments of raw materials required by steel operations. The agreement cannot be canceled until 1999 and requires USX to pay, at a minimum, Transtar's annual fixed costs related to the agreement, including lease\/charter costs, depreciation of owned vessels, dry dock fees and other administrative costs. Total transportation costs under the agreement were $70 million in 1994 and $68 million in 1993, including fixed costs of $21 million in each year. The fixed costs are expected to continue at approximately the same level over the duration of the agreement.\nU-26\n- -------------------------------------------------------------------------------- 26. DERIVATIVE FINANCIAL INSTRUMENTS\nUSX uses derivative financial instruments, such as OTC commodity swaps, to hedge exposure to price fluctuations relevant to the anticipated purchase or production and sale of crude oil, natural gas and refined products. USX also uses exchange-traded commodity contracts as a part of its overall hedging activities. The use of derivative instruments helps to protect against adverse market price changes for products sold and volatility in raw material costs.\nUSX uses forward currency contracts to reduce exposure to currency price fluctuations when transactions require settlement in a foreign currency (principally Swiss franc, ECU, U.K. pound and Irish punt) rather than U.S. dollars.\nUSX remains at risk for possible changes in the market value of the derivative instrument; however, such risk should be mitigated by price changes in the underlying hedged item. USX is also exposed to credit risk in the event of nonperformance by counterparties. The credit worthiness of counterparties is subject to continuing review, including the use of master netting agreements to the extent practical, and full performance is anticipated.\nThe following table sets forth quantitative information by class of derivative financial instrument:\n(a) The fair value amounts are based on exchange-traded index prices and dealer quotes. (b) Contract or notional amounts do not quantify risk exposure, but are used in the calculation of cash settlements under the contracts. The contract or notional amounts do not reflect the extent to which positions may offset one another. (c) The OTC swap arrangements vary in duration with certain contracts extending into early 1997. (d) The fair value amount includes fair value assets of $11 million and fair value liabilities of $(11) million. (e) The forward currency contracts mature in 1995-1998.\nU-27\n- ------------------------------------------------------------------------------- 27. FAIR VALUE OF FINANCIAL INSTRUMENTS\nFair value of the financial instruments disclosed herein is not necessarily representative of the amount that could be realized or settled, nor does the fair value amount consider the tax consequences of realization or settlement. The following table summarizes financial instruments, excluding derivative financial instruments disclosed in Note 26, page U-27, by individual balance sheet account:\nFair value of financial instruments classified as current assets or liabilities approximate carrying value due to the short-term maturity of the instruments. Fair value of long-term receivables and other investments was based on discounted cash flows or other specific instrument analysis. Fair value of long-term debt instruments was based on market prices where available or current borrowing rates available for financings with similar terms and maturities.\nIn addition to certain derivative financial instruments, USX's unrecognized financial instruments consist of receivables sold subject to limited recourse, commitments to extend credit and financial guarantees. It is not practicable to estimate the fair value of these forms of financial instrument obligations because there are no quoted market prices for transactions which are similar in nature. For details relating to sales of receivables and commitments to extend credit see Note 11, page U-19. For details relating to financial guarantees see Note 25, page U-26.\nU-28\nSelected Quarterly Financial Data (Unaudited)\n(a) Composite tape.\n(a) Primary and fully diluted earnings per share are computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings per share in 1994 and 1993 does not equal the total computed for the year due primarily to the effect of the 6.50% Convertible Preferred Stock on the quarterly calculations during 1994, and stock transactions which occurred during 1993. (b) Composite tape.\n(a) Composite tape.\nU-29\nPrincipal Unconsolidated Affiliates (Unaudited)\n(a) Economic interest as of December 31, 1994.\nSupplementary Information on Mineral Reserves (Unaudited)\nMINERAL RESERVES (OTHER THAN OIL AND GAS)\n(a) Commercially recoverable reserves include demonstrated (measured and indicated) quantities which are expressed in recoverable net product tons. Coal reserves of 284 million tons for 1992, were included in the Marathon Group; the remaining coal reserves and all iron reserves, as well as related production, were included in the U. S. Steel Group. (b) In 1994, iron ore reserves were reduced 28 million tons as a result of lease activity. (c) In 1994, coal reserves were reduced 9 million tons as a result of lease activity. In 1993, 320 million tons of reserves were sold, including all the Marathon Group reserves and 36 million tons associated with the Cumberland coal mine.\nU-30\nSupplementary Information on Oil and Gas Producing Activities (Unaudited)\nRESULTS OF OPERATIONS FOR OIL AND GAS PRODUCING ACTIVITIES, EXCLUDING CORPORATE OVERHEAD AND INTEREST COSTS(a)\n(a) Certain reclassifications of prior years' data have been made to conform to 1994 reporting practices. (b) Other expenses include administrative costs and costs associated with reorganization efforts in 1994. (c) U.S. production costs included a $119 million refund of prior years' production taxes and excluded a $115 million restructuring charge relating to planned disposition of certain domestic exploration and production properties.\nCAPITALIZED COSTS AND ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION\nU-31\nSUPPLEMENTARY INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED) CONTINUED\nCOSTS INCURRED FOR PROPERTY ACQUISITION, EXPLORATION AND DEVELOPMENT - INCLUDING CAPITAL EXPENDITURES(a)\n(a) Certain restatement of prior years' data has been made to conform to 1994 reporting practices.\nESTIMATED QUANTITIES OF PROVED OIL AND GAS RESERVES\nThe following estimates of net reserves have been determined by deducting royalties of various kinds from USX's gross reserves. The reserve estimates are believed to be reasonable and consistent with presently known physical data concerning size and character of the reservoirs and are subject to change as additional knowledge concerning the reservoirs becomes available. The estimates include only such reserves as can reasonably be classified as proved; they do not include reserves which may be found by extension of proved areas or reserves recoverable by secondary or tertiary recovery methods unless these methods are in operation and are showing successful results. Undeveloped reserves consist of reserves to be recovered from future wells on undrilled acreage or from existing wells where relatively major expenditures will be required to realize production. Liquid hydrocarbon production amounts for international operations principally reflect tanker liftings of equity production. USX did not have any quantities of oil and gas reserves subject to long-term supply agreements with foreign governments or authorities in which USX acts as producer.\n(a) Excluded reserves located in Libya. See Note 25, page U-26, for current status.\nU-32\nSUPPLEMENTARY INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED) CONTINUED\nESTIMATED QUANTITIES OF PROVED OIL AND GAS RESERVES (CONTINUED)\n(a) Excluded reserves located in Libya. See Note 25, page U-26, for current status.\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND CHANGES THEREIN RELATING TO PROVED OIL AND GAS RESERVES\nEstimated discounted future net cash flows and changes therein were determined in accordance with Statement of Financial Accounting Standards No. 69. Certain information concerning the assumptions used in computing the valuation of proved reserves and their inherent limitations are discussed below. USX believes such information is essential for a proper understanding and assessment of the data presented.\nFuture cash inflows are computed by applying year-end prices of oil and gas relating to USX's proved reserves to the year-end quantities of those reserves. Future price changes are considered only to the extent provided by contractual arrangements in existence at year-end.\nThe assumptions used to compute the proved reserve valuation do not necessarily reflect USX's expectations of actual revenues to be derived from those reserves nor their present worth. Assigning monetary values to the estimated quantities of reserves, described on the preceding page, does not reduce the subjective and ever-changing nature of such reserve estimates.\nAdditional subjectivity occurs when determining present values because the rate of producing the reserves must be estimated. In addition to uncertainties inherent in predicting the future, variations from the expected production rate also could result directly or indirectly from factors outside of USX's control, such as unintentional delays in development, environmental concerns, changes in prices or regulatory controls.\nThe reserve valuation assumes that all reserves will be disposed of by production. However, if reserves are sold in place or subjected to participation by foreign governments, additional economic considerations also could affect the amount of cash eventually realized.\nFuture development and production costs, including abandonment and dismantlement costs, are computed 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.\nFuture income tax expenses are computed by applying the appropriate year-end statutory tax rates, with consideration of future tax rates already legislated, to the future pretax net cash flows relating to USX's proved oil and gas reserves. Permanent differences in oil and gas related tax credits and allowances are recognized.\nDiscount was derived by using a discount rate of 10 percent a year to reflect the timing of the future net cash flows relating to proved oil and gas reserves.\nU-33\nSUPPLEMENTARY INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED) CONTINUED\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND CHANGES THEREIN RELATING TO PROVED OIL AND GAS RESERVES (CONTINUED)\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVES\nSUMMARY OF CHANGES IN STANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS RELATING TO PROVED OIL AND GAS RESERVES(a)\n(a) Certain reclassifications of prior years' data have been made to conform to 1994 reporting practices.\nU-34\nFive-Year Operating Summary - Marathon Group\n(a) Excludes the Indianapolis Refinery which was temporarily idled in October 1993.\nU-35\nFIVE-YEAR OPERATING SUMMARY - U. S. STEEL GROUP\n(a) In July 1991, U. S. Steel closed all iron and steel producing operations at Fairless (PA) Works. In April 1992, U. S. Steel closed South (IL) Works. (b) In June 1993, U. S. Steel sold the Cumberland coal mine. In 1994, U. S. Steel permanently closed the Maple Creek coal mine. (c) U. S. Steel ceased production of structural products when South Works closed in April 1992.\nU-36\nFIVE-YEAR OPERATING SUMMARY - DELHI GROUP\n(a) In January 1993, the Delhi Group sold its 25% interest in Red River Pipeline. (b) In 1993, the Delhi Group sold its pipeline systems located in Colorado. (c) In 1994, the Delhi Group sold certain pipeline systems associated with the planned disposition of nonstrategic assets.\nU-37 USX CORPORATION Management's Discussion and Analysis\nManagement's Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF INCOME\nSALES were $19.3 billion in 1994, compared with $18.1 billion in 1993 and $17.8 billion in 1992. The increase in 1994 primarily reflected increased sales for the Marathon Group and U. S. Steel Group. Marathon Group sales increased mainly due to higher excise taxes and higher volumes of worldwide liquid hydrocarbons and refined product matching buy\/sell transactions, partially offset by lower worldwide liquid hydrocarbon prices. U. S. Steel Group sales increased primarily due to higher steel shipment volumes and prices and increased commercial shipments of coke, partly offset by lower commercial shipments of coal. The increase in 1993 primarily reflected increased sales for the U. S. Steel Group due mainly to higher steel shipment volumes and prices, and increased commercial shipments of taconite pellets and coke. These were partially offset by lower sales for the Marathon Group (excluding the effect of the businesses of the Delhi Group which were included in the Marathon Group for periods prior to October 2, 1992). The decrease in Marathon Group sales was mainly due to lower worldwide liquid hydrocarbon volumes and prices and lower refined product prices, partially offset by increased excise taxes and higher refined product sales volumes, excluding matching buy\/sell transactions. Matching buy\/sell transactions and excise taxes are included in both sales and operating costs of the Marathon Group, resulting in no effect on operating income. Higher excise taxes were the predominant factor in the increase in taxes other than income taxes during 1994 and 1993 primarily resulting from the fourth quarter 1993 increase in the federal excise tax rate and a change in the collection point on distillates from third-party locations to the Marathon Group's terminals.\nOPERATING INCOME increased by $805 million in 1994, following a $14 million decrease in 1993. Results in 1994 included a $160 million favorable noncash effect resulting from a decrease in the inventory market valuation reserve, partially offset by charges of $37 million related to the planned disposition of certain Delhi Group nonstrategic gas gathering and processing assets. Results in 1993 included a $342 million charge for the Lower Lake Erie Iron Ore Antitrust Litigation against the Bessemer & Lake Erie Railroad (\"B&LE litigation\") (which also resulted in $164 million of interest costs) (see Note 5 to the Consolidated Financial Statements), a $241 million unfavorable noncash effect resulting from an increase in the inventory market valuation reserve and restructuring charges of $42 million related to the planned closure of the Maple Creek coal mine and preparation plant. Excluding the effect of these items, operating income increased $57 million in 1994 primarily due to higher results for the U. S. Steel Group and Marathon Group, partially offset by lower results for the Delhi Group.\nResults in 1992 included a favorable impact of $119 million for the settlement of a tax refund claim related to prior years' production taxes and a $62 million favorable noncash effect resulting from a decrease in the inventory market valuation reserve, partially offset by charges of $125 million primarily related to the planned disposition of certain domestic exploration and production properties. Excluding the effects of these items and the 1993 items previously discussed, operating income increased $667 million in 1993 mainly due to improved results for the U. S. Steel Group, as well as the Marathon Group. The adoption of Statement of Financial Accounting Standards No.112 - Employers' Accounting for Postemployment Benefits (\"SFAS No.112\") resulted in a $23 million increase in operating costs in 1993, principally for the U. S. Steel Group.\nNet pension credits included in operating income totaled $116 million in 1994, compared to $211 million in 1993 and $260 million in 1992. The decrease over the three-year period primarily reflects decreases in the expected long-term rate of return on plan assets. In 1995, net pension credits are expected to remain at approximately the same level as in 1994. See Note 7 to the Consolidated Financial Statements.\nOTHER INCOME was $261 million in 1994, compared with income of $257 million in 1993 and a loss of $2 million in 1992. The slight increase in 1994 was mainly due to increased income from equity affiliates, partly offset by lower gains from the disposal of assets. The increase in 1993 primarily resulted from higher gains from the disposal of assets, including the sale of the Cumberland coal mine, the realization of a $70 million deferred gain resulting from the collection of a subordinated note related to the 1988 sale of Transtar, Inc. (\"Transtar\") (which also resulted in $37 million of interest income) and the sale of an investment in an insurance company. The increase in 1993 also reflected the absence of a $19 million impairment of an investment recorded in 1992.\nU-38 Management's Discussion and Analysis continued\nINTEREST AND OTHER FINANCIAL INCOME was $24 million in 1994, compared with $78 million in 1993 and $228 million in 1992. The 1993 amount included $37 million of interest income resulting from collection of the Transtar note while the 1992 amount included $177 million of interest income resulting from the settlement of a tax refund claim related to prior years' production taxes. Excluding these items, interest and other financial income was $24 million in 1994, compared with $41 million in 1993 and $51 million in 1992.\nINTEREST AND OTHER FINANCIAL COSTS were $461 million in 1994, compared with $630 million in 1993 and $485 million in 1992. The 1994 amount included a $35 million favorable effect resulting from settlement of various state tax issues. Excluding this item, the decrease from 1993 mostly reflected the absence of $164 million of interest expense related to the adverse decision in the B&LE litigation recorded in 1993, partially offset by lower capitalized interest in 1994 due mainly to the completion of the East Brae platform and SAGE system in the United Kingdom (\"U.K.\") sector of the North Sea. Excluding the $164 million of interest expense previously mentioned, the decrease in 1993 primarily resulted from an increase in capitalized interest.\nInterest and other financial costs in 1995 are expected to increase by approximately $35 million because of lower capitalized interest due to the completion of the aforementioned international projects.\nTHE PROVISION FOR ESTIMATED INCOME TAXES in 1994 was $184 million, compared with credits of $72 million in 1993 and $29 million in 1992. The 1994 provision included a one-time $32 million deferred tax benefit related to an excess of tax over book basis in an equity affiliate. The 1994 income tax provision also included a $24 million credit for the reversal of a valuation allowance related to deferred tax assets. The 1993 income tax credit included an incremental deferred tax benefit of $64 million resulting from USX Corporation's (\"USX\") ability to elect to credit, rather than deduct, certain foreign income taxes for U.S. federal income tax purposes when paid in future years. The anticipated use of the U.S. foreign tax credit reflects the Marathon Group's improving international production profile. The 1993 income tax credit also included a $29 million charge associated with an increase in the federal income tax rate from 34% to 35%, reflecting remeasurement of deferred federal income tax assets and liabilities as of January 1, 1993. See Note 9 to the Consolidated Financial Statements.\nNET INCOME of $501 million was recorded in 1994, compared with a net loss of $259 million in 1993 and a net loss of $1.826 billion in 1992. Excluding the unfavorable cumulative effect of changes in accounting principles, which totaled $92 million and $1.666 billion in 1993 and 1992, respectively, net income increased $668 million in 1994 from 1993, compared with a decrease of $7 million in 1993 from 1992. The changes in net income primarily reflect the factors discussed above.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION\nCURRENT ASSETS increased $183 million from year-end 1993 primarily reflecting higher trade receivables and inventories, partially offset by a reduction in cash and cash equivalent balances. The increase in trade receivables primarily resulted from higher Marathon Group sales of refined products and crude oil and higher U. S. Steel Group sales of flat-rolled steel products. The increase in inventories was mainly due to an increase in inventory values, which reflected a $160 million decrease in the inventory market valuation reserve. This reserve reflects the extent to which the recorded costs of crude oil and refined product inventories exceed net realizable value. Subsequent changes to the inventory market valuation reserve are dependent upon changes in future crude oil and refined product price levels and inventory turnover. The $220 million decrease in cash and cash equivalent balances from year-end 1993 primarily reflects cash applied to debt reduction.\nCURRENT LIABILITIES were $459 million lower at year-end 1994 mainly due to decreases in accounts payable and accrued taxes, partially offset by an increase in long-term debt due within one year. The decrease in accounts payable primarily resulted from payments against B&LE litigation accruals while the decrease in accrued taxes mainly reflected the settlement of various state tax issues.\nTOTAL LONG-TERM DEBT AND NOTES PAYABLE at December 31, 1994, was $5.6 billion. The $371 million decrease from year-end 1993 reflected, in part, a reduction of cash and cash equivalent balances. The remaining decrease primarily resulted from other financing activities. For a discussion of these activities, see Management's Discussion and Analysis of Cash Flows below.\nU-39 Management's Discussion and Analysis continued\nSTOCKHOLDERS' EQUITY of $4.3 billion at year-end 1994 increased by $438 million from the end of 1993 mainly reflecting 1994 net income and the issuance of additional common equity, partially offset by dividend payments.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF CASH FLOWS\nNET CASH PROVIDED FROM OPERATING ACTIVITIES totaled $782 million in 1994, compared with $944 million in 1993 and $920 million in 1992. The 1994 period was negatively affected by payments of $367 million to satisfy substantially all judgments from the B&LE litigation and payments of $124 million to settle various state tax issues. The 1993 period was negatively affected by payments of $314 million related to partial settlement of the B&LE litigation and settlement of the Energy Buyers litigation. Excluding these items, net cash provided from operating activities was $1.273 billion in 1994, compared with $1.258 billion in 1993.\nThe 1992 period included $296 million associated with the refund of prior years' production taxes. Excluding this item and 1993 items discussed above, net cash provided from 1993 operating activities improved $634 million from 1992. The increase primarily reflected improved operations for the U. S. Steel Group, improved refined product margins for the Marathon Group and a $103 million favorable effect from the use of available funds from previously established insurance reserves to pay for certain active and retired employee insurance benefits.\nCAPITAL EXPENDITURES were $1.033 billion in 1994, compared with $1.151 billion in 1993 and $1.505 billion in 1992. The $118 million decrease in 1994 was primarily due to lower expenditures for the Marathon Group, partially offset by higher expenditures for the U. S. Steel Group. The $157 million decline for the Marathon Group mainly reflected decreased expenditures resulting from the substantial completion of the East Brae Field and SAGE system in the U.K. and the distillate hydrotreater complex at the Robinson, Illinois refinery. The $50 million increase for the U. S. Steel Group primarily reflected hot-strip mill and pickle line improvements at Gary Works, a coke oven gas transmission line replacement from Clairton to Mon Valley and the preparation for a blast furnace reline project at Mon Valley Works. The $354 million decrease in 1993 was due primarily to lower expenditures for the Marathon Group and the U. S. Steel Group. Contract commitments for capital expenditures at year-end 1994 were $283 million, compared with $389 million at year-end 1993.\nIn addition to the capital expenditures discussed above, USX's noncash investment activities during 1994 included the issuance of $58 million of debt instruments and $11 million (619,168 shares) of USX - Marathon Group Common Stock (\"Marathon Stock\") related to acquisitions of 89 gasoline outlets\/convenience stores from independent petroleum retailers.\nCapital expenditures in 1995 are expected to total approximately $1.1 billion. The U. S. Steel Group's capital expenditures are expected to increase approximately $50 million to $300 million and will include spending on a degasser at Mon Valley Works and installation of a granulated coal injection facility at Fairfield Works' blast furnace and a galvanizing line in the southern United States. The Marathon Group's capital expenditures are expected to remain at approximately the same level as 1994 at $750 million.\nCASH FROM THE DISPOSAL OF ASSETS was $293 million in 1994, compared with $469 million in 1993 and $117 million in 1992. The 1994 proceeds mainly resulted from the sales of the assets of a retail propane marketing subsidiary and certain domestic oil and gas production properties. The 1993 amount primarily reflected the realization of proceeds from a subordinated note related to the 1988 sale of Transtar, the sale of the Cumberland coal mine, the sale\/leaseback of interests in two LNG tankers, and the sales of various domestic oil and gas production properties and of an investment in an insurance company. No individually significant sales transactions occurred in 1992.\nFINANCIAL OBLIGATIONS decreased by $217 million in 1994, compared with a decrease of $458 million in 1993 and a decrease of $240 million in 1992. These amounts represent changes in balances outstanding of commercial paper, revolving credit agreements, lines of credit, preferred stock of subsidiary, other debt and production financing and other agreements. The decrease in 1994 primarily reflected a reduction in cash and cash equivalent balances.\nDuring 1994, USX issued $300 million in aggregate principal amount of 7.20% Notes Due 2004 and $150 million in aggregate principal amount of LIBOR-based Floating Rate Notes Due 1996. In addition, an aggregate principal amount of $57 million of Marathon's 7% Monthly Interest Guaranteed Notes Due 2002 (\"7% Notes\") was issued in exchange for an equivalent principal amount of its 9-1\/2%\nU-40 Management's Discussion and Analysis continued\nGuaranteed Notes Due 1994 (\"Marathon 9-1\/2% Notes\"). The $642 million balance of Marathon 9-1\/2% Notes was paid in March 1994. USX also issued $55 million of 6.70% Environmental Improvement Revenue Refunding Bonds due 2020 and 2024 to refinance Environmental Improvement Bonds.\nDuring 1993, USX issued an aggregate principal amount of $800 million of fixed rate debt through its medium-term note program and three separate series of unsecured, noncallable debt securities in the public market. Maturities ranged from 5 to 30 years, and interest rates ranged from 6-3\/8% to 8-1\/2% per annum. In addition, an aggregate principal amount of $77 million of Marathon 9-1\/2% Notes was tendered in exchange for the 7% Notes. During 1992, USX issued an aggregate principal amount of $748 million of fixed rate debt through its medium-term note program and three separate series of unsecured, noncallable debt securities in the public market. Maturities ranged from 5 to 30 years, and interest rates ranged from 6.65% to 9.375% per annum.\nPreferred stock of a subsidiary generated proceeds, net of issue costs, of $242 million in 1994. This amount reflected the sale of 10,000,000 shares of 8-3\/4% Cumulative Monthly Income Preferred Stock (\"MIPS\") of USX Capital LLC, a wholly owned subsidiary of USX. MIPS is classified in the liability section of the consolidated balance sheet, and the financial costs are included in interest and other financial costs on the consolidated statement of operations. See Note 24 to the Consolidated Financial Statements.\nIn August 1994, USX entered into a $2.325 billion revolving credit agreement which terminates in August 1999. Interest is based on defined short-term market rates. This agreement replaced the $2.0 billion in revolving credit agreements entered into in October 1992. At December 31, 1994, USX had no outstanding borrowings against long-term credit agreements, leaving $2.325 billion of available unused committed credit lines. In addition, USX had $340 million of available unused short-term lines of credit, of which $175 million requires a commitment fee and the other $165 million generally requires maintenance of compensating balances.\nUSX currently has three active shelf registration statements with the Securities and Exchange Commission aggregating slightly more than $1.2 billion, of which $750 million is dedicated to offer and issue debt securities, only. The balance allows USX to offer and issue debt and equity securities.\nIn the event of a change of control of USX, debt and guaranteed obligations totaling $5.0 billion at year-end 1994 may be declared immediately due and payable or required to be collateralized. See Notes 11,12,13 and 15 to the Consolidated Financial Statements.\nPREFERRED STOCK ISSUED totaled $336 million in 1993. This amount reflected the sale of 6,900,000 shares of 6.50% Cumulative Convertible Preferred Stock ($50.00 liquidation preference per share) (\"6.50% Convertible Preferred\"). The 6.50% Convertible Preferred is convertible at any time into shares of USX - U. S. Steel Group Common Stock (\"Steel Stock\") at a conversion price of $46.125 per share of Steel Stock.\nCOMMON STOCK ISSUED, net of repurchases, totaled $223 million in 1994, compared with $371 million in 1993 and $942 million in 1992. The 1994 amount mainly resulted from the sale of 5,000,000 shares of Steel Stock to the public for net proceeds of $201 million. In 1993, USX sold 10,000,000 shares of Steel Stock to the public for net proceeds of $350 million. The 1992 amount primarily reflected sales to the public of all three classes of common stock, including 25,000,000 shares of Marathon Stock for net proceeds of $541 million, 8,050,000 shares of Steel Stock for net proceeds of $198 million and 9,000,000 shares of USX - Delhi Group Common Stock for net proceeds of $136 million.\nDIVIDEND PAYMENTS increased slightly in 1994 primarily due to the first quarter sale of additional shares of Steel Stock. Dividend payments decreased in 1993 from 1992 mainly reflecting a decrease in the dividend rate on Marathon Stock in the fourth quarter of 1992, partially offset by increased dividends due primarily to the sale in 1993 of additional shares of Steel Stock and of the 6.50% Convertible Preferred.\nPENSION PLAN ACTIVITY\nIn accordance with USX's long-term funding practice, which is designed to maintain an appropriate funded status, USX will resume funding the U. S. Steel Group's principal pension plan in amounts of approximately $100 million per year commencing with the 1994 plan year. The funding for the 1994 plan year and possibly the 1995 plan year will take place in 1995.\nU-41 Management's Discussion and Analysis continued\nRATING AGENCY ACTIVITY\nIn September 1993, Standard & Poor's Corp. lowered its ratings on USX's and Marathon's senior debt to below investment grade (from BBB- to BB+) and on USX's subordinated debt, preferred stock and commercial paper. In October 1993, Moody's Investors Services, Inc. (\"Moody's\") confirmed its Baa3 investment grade ratings on USX's and Marathon's senior debt. Moody's also confirmed its ratings on USX's subordinated debt and commercial paper, but lowered its ratings on USX's preferred stock from ba1 to ba2. The ratings described above remain unchanged.\nHEDGING ACTIVITY\nUSX engages in hedging activities in the normal course of its businesses. Futures contracts, commodity swaps and options are used to hedge exposure to price fluctuations relevant to the purchase or sale of crude oil, natural gas, refined products and nonferrous metals. Forward currency contracts have been used to manage currency risks related to anticipated revenues and operating costs, firm commitments for capital expenditures and existing assets or liabilities denominated in a foreign currency. While hedging activities are generally used to reduce risks from unfavorable commodity price and currency rate movements, they also may limit the opportunity to benefit from favorable movements. USX's hedging activities have not been significant in relation to its overall business activity. Based on risk assessment procedures and internal controls in place, management believes that its use of hedging instruments will not have a material adverse effect on the financial position, liquidity or results of operations of USX. See Notes 1 and 26 to the Consolidated Financial Statements.\nLIQUIDITY\nUSX believes that its short-term and long-term liquidity is adequate to satisfy its obligations as of December 31, 1994, and to complete currently authorized capital spending programs. Future requirements for USX's business needs, including the funding of capital expenditures and debt maturities for the years 1995 to 1997 are expected to be financed by a combination of internally generated funds, proceeds from the sale of stock, future borrowings and other external financing sources. Long-term debt of $78 million matures within one year. In addition, at the option of the holders, USX may be obligated to repurchase zero coupon convertible debentures at a carrying value of $430 million on August 9, 1995. If tendered, USX may elect to pay the purchase price in cash, shares of Marathon Stock and Steel Stock, notes or a combination thereof. See Note 13 to the Consolidated Financial Statements.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF ENVIRONMENTAL MATTERS, LITIGATION AND CONTINGENCIES\nUSX has incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. In recent years, these expenditures have increased primarily due to required refined product reformulation and process changes in order to meet Clean Air Act obligations, although ongoing compliance costs have also been significant. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of USX's products and services, operating results will be adversely affected. USX believes that integrated domestic competitors of the U. S. Steel Group and substantially all the competitors of the Marathon Group and the Delhi Group are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities, marketing areas, production processes and the specific products and services it provides.\nU-42 Management's Discussion and Analysis continued\nThe following table summarizes USX's environmental expenditures for each of the last three years(a):\n(a) Estimated for the Marathon Group and Delhi Group based on American Petroleum Institute survey guidelines and for the U. S. Steel Group based on U.S. Department of Commerce survey guidelines.\n(b) These amounts do not include noncash provisions recorded for environmental remediation, but include spending charged against such reserves.\nUSX's environmental capital expenditures accounted for 13%, 16%, and 20% of total consolidated capital expenditures in 1994, 1993 and 1992, respectively. The decline over the three-year period was primarily the result of the Marathon Group's multi-year capital spending program for diesel fuel desulfurization which began in 1990 and was substantially completed in 1993.\nDuring 1992 through 1994, compliance expenditures averaged 2% of total consolidated operating costs. Remediation spending during this period was primarily related to retail gasoline stations which incur ongoing clean-up costs for soil and groundwater contamination associated with underground storage tanks and piping, and dismantlement and restoration activities at former and present operating locations.\nUSX has been notified that it is a potentially responsible party (\"PRP\") at 45 waste sites under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") as of December 31, 1994. In addition, there are 31 sites where USX has received information requests or other indications that USX may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability. There are also 114 additional sites, excluding retail gasoline stations, where remediation is being sought under other environmental statutes, both federal and state. At many of these sites, USX is one of a number of parties involved and the total cost of remediation, as well as USX's share thereof, is frequently dependent upon the outcome of investigations and remedial studies. USX accrues for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required. See Note 25 to the Consolidated Financial Statements.\nNew or expanded environmental requirements, which could increase USX's environmental costs, may arise in the future. USX intends to comply with all legal requirements regarding the environment, but since many of them are not fixed or presently determinable (even under existing legislation) and may be affected by future legislation, it is not possible to accurately predict the ultimate cost of compliance, including remediation costs which may be incurred and penalties which may be imposed. However, based on presently available information, and existing laws and regulations as currently implemented, USX does not anticipate that environmental compliance expenditures (including operating and maintenance and remediation) will materially increase in 1995. USX expects environmental capital expenditures to approximate $105 million in 1995 or approximately 10% of total estimated consolidated capital expenditures. Predictions beyond 1995 can only be broad-based estimates which have varied, and will continue to vary, due to the ongoing\nU-43 Management's Discussion and Analysis continued\nevolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified projects, USX anticipates that environmental capital expenditures in 1996 will total approximately $120 million; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed.\nUSX is the subject of, or party to, a number of pending or threatened legal actions, contingencies and commitments involving a variety of matters, including laws and regulations relating to the environment, certain of which are discussed in Note 25 to the Consolidated Financial Statements. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the consolidated financial statements. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably. See Management's Discussion and Analysis of Cash Flows.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS BY INDUSTRY SEGMENT\nTHE MARATHON GROUP\nThe Marathon Group includes Marathon Oil Company and certain other subsidiaries of USX, which are engaged in worldwide exploration, production, transportation and marketing of crude oil and natural gas; and domestic refining, marketing and transportation of petroleum products. The Marathon Group financial data for the periods prior to the creation of the Delhi Group on October 2, 1992, include the combined historical financial position, results of operations and cash flows for the businesses of the Delhi Group.\nSales of $12.8 billion in 1994 increased $795 million from 1993 mainly due to higher excise taxes and higher volumes of worldwide liquid hydrocarbons and refined product matching buy\/sell transactions, partially offset by lower worldwide liquid hydrocarbon prices. Sales of $12.0 billion in 1993 declined $820 million from 1992 primarily due to lower worldwide liquid hydrocarbon volumes and prices, lower refined product prices and the absence of sales from the Delhi Group. These decreases were partially offset by increased excise taxes and higher refined product sales volumes, excluding matching buy\/sell transactions. Matching buy\/sell transactions and excise taxes are included in both sales and operating costs, resulting in no effect on operating income. Higher excise taxes were the predominant factor in the increase in taxes other than income taxes during 1994 and 1993. Excise taxes increased mainly due to the fourth quarter 1993 increase in the federal excise tax rate and a change in the collection point on distillates from third-party locations to Marathon's terminals.\nThe Marathon Group reported operating income of $584 million in 1994, compared with $169 million in 1993 and $304 million in 1992. Results included a $160 million favorable effect in 1994, a $241 million unfavorable effect in 1993 and a $62 million favorable effect in 1992 resulting from noncash adjustments to the inventory market valuation reserve. The 1992 results also included a favorable impact of $119 million for the settlement of a tax refund claim related to prior years' production taxes and a restructuring charge of $115 million related to the planned disposition of certain domestic exploration and production properties. Excluding the effects of these items, operating income was $424 million in 1994, $410 million in 1993 and $238 million in 1992. The increase in 1994 mainly reflected reduced worldwide operating expenses and higher international liquid hydrocarbon volumes and worldwide natural gas volumes, largely offset by lower refined product margins, lower liquid hydrocarbon prices and $42 million of employee reorganization charges. The increase in 1993 was mainly due to increased refined product margins and increased domestic natural gas prices, partially offset by lower worldwide liquid hydrocarbon prices and volumes.\nWorldwide liquid hydrocarbon volumes are expected to increase approximately 20% in 1995, primarily reflecting increased production from the East Brae Field, a full year of production from Ewing Bank 873 in the Gulf of Mexico and new production from the Kakap KRA and KG Fields, offshore Indonesia. Worldwide natural gas volumes are also expected to increase approximately 20% in 1995, resulting from a successful 1994 domestic drilling program and a full year of contractual Brae area gas sales, which commenced in October 1994. Contractual sales volumes of Brae area gas through the SAGE pipeline system for the fourth quarter of 1994 averaged approximately 80 million cubic feet per day, which was less than originally anticipated due to unseasonably warm weather in the U.K. In 1995, contractual gas sales volumes through the SAGE system should exceed the level experienced in the fourth quarter of 1994.\nU-44 Management's Discussion and Analysis continued\nThe Marathon Group expects to realize annual cost structure reductions of approximately $80 million from work force reduction programs completed during 1994. These reductions will impact salary and related benefits expenses, capitalized costs and billings to joint venture partners.\nThe outlook regarding prices and costs for the Marathon Group's principal products is largely dependent upon world market developments for crude oil and refined products. Market conditions in the petroleum industry are cyclical and subject to global economic and political events.\nTHE U. S. STEEL GROUP\nThe U. S. Steel Group includes U. S. Steel, which is primarily engaged in the production and sale of steel mill products, coke and taconite pellets. The U. S. Steel Group also includes the management of mineral resources, domestic coal mining, engineering and consulting services and technology licensing. Other businesses that are part of the U. S. Steel Group include real estate development and management, and leasing and financing activities.\nSales were $6.1 billion in 1994, compared with $5.6 billion in 1993 and $4.9 billion in 1992. The $454 million increase in 1994 from 1993 was mainly the result of higher steel shipment volumes and prices and increased commercial shipments of coke, partially offset by lower commercial shipments of coal. The $693 million increase in 1993 from 1992 primarily reflected higher steel shipment volumes and prices, and increased commercial shipments of taconite pellets and coke.\nThe U. S. Steel Group reported operating income of $313 million in 1994, compared with an operating loss of $149 million in 1993 and an operating loss of $241 million in 1992. The 1993 operating loss included a $342 million charge for the B&LE litigation and restructuring charges of $42 million related to the planned closure of the Maple Creek coal mine and preparation plant. The 1992 operating loss included a charge of $10 million for completion of a restructuring plan related to steel facilities. Excluding the effects of these items, operating income increased $78 million in 1994, compared with an increase of $466 million from 1992 to 1993. The improvement in 1994 was primarily due to higher steel prices and shipment volumes. These were partially offset by higher pension, labor and scrap metal costs, the absence of a $39 million favorable effect in 1993 related to employee insurance benefits, the adverse effects of utility curtailments and other severe winter weather complications, a caster fire at Mon Valley Works and planned outages for modernization at Gary Works. The increase in 1993 was mainly due to higher steel shipment volumes and prices, improved operating efficiencies and lower accruals for environmental and legal contingencies, other than the B&LE litigation mentioned above. In addition, 1993 results benefited from a $39 million favorable effect from the utilization of funds from previously established insurance reserves to pay for certain employee insurance benefits, lower provisions for loan losses by USX Credit and the absence of a 1992 unfavorable effect of $28 million resulting from market valuation provisions for foreclosed real estate assets. These were partially offset by higher hourly steel labor costs, unfavorable effects associated with pension and other employee benefits, lower results from coal operations and a $21 million increase in operating costs related to the adoption of SFAS No. 112.\nBased on strong recent order levels and favorable steel market conditions, the U. S. Steel Group anticipates that steel demand will remain strong in 1995, although domestic industry shipments for 1995 may decrease slightly from the 1994 level of 95 million tons. Market prices for steel products have generally remained firm because of strong demand. Price increases for most steel products were implemented effective January 1, 1995, including increases in long-term contract prices with several major customers. Additional price increases for sheet products have been announced effective July 2, 1995.\nSteel imports to the United States accounted for an estimated 25%, 19% and 17% of the domestic steel market in 1994, 1993 and 1992, respectively. The domestic steel industry has, in the past, been adversely affected by unfairly traded imports, and higher levels of imported steel may ultimately have an adverse effect on product prices and shipment levels.\nU. S. Steel Group shipments in the first quarter of 1995 are expected to be lower than the previous quarter as some customers increased purchases prior to the January 1, 1995 price increases, and there may be some weakness in shipments to automotive companies which have recently announced some reductions in build schedules. During the first quarter of 1995, raw steel production will be reduced by planned blast furnace outages at Gary Works and Fairfield Works.\nTHE DELHI GROUP\nThe Delhi Group includes Delhi Gas Pipeline Corporation and certain related companies which are engaged in the purchasing, gathering, processing, transporting and marketing of natural gas.\nU-45 Management's Discussion and Analysis continued\nSales of $567 million in 1994 increased $32 million from 1993 primarily reflecting increased volumes from its trading business and from spot market sales, partially offset by decreased revenues from Southwestern Electric Power Company (\"SWEPCO\") and other customers and lower average prices for natural gas and natural gas liquids (\"NGLs\"). Sales of $535 million in 1993 increased $77 million from 1992, mainly due to increased revenues from premium services and higher average natural gas sales prices.\nThe Delhi Group reported an operating loss of $36 million in 1994, compared with operating income of $36 million in 1993 and operating income of $33 million in 1992. The 1994 operating loss included charges of $37 million for the planned disposition of certain nonstrategic assets, expenses of $2 million related to a workforce reduction program, other employment-related costs of $2 million and a $2 million favorable effect of the settlement of litigation related to a prior-year take-or-pay claim. Operating income in 1993 included favorable effects of $2 million for the reversal of a prior-period accrual related to a natural gas contract settlement, $1 million related to gas imbalance settlements and a net $1 million for a refund of prior years' taxes other than income taxes. Excluding the effects of these items, operating income in 1994 was $3 million, down $29 million from 1993, mainly reflecting a decline in gas sales premiums from SWEPCO and lower margins from other customers, partially offset by higher natural gas throughput volumes and lower depreciation expense due to the previously mentioned asset disposition plan. Operating income in 1992 included favorable effects totaling $2 million relating to the settlement of various lawsuits and third-party disputes. Excluding the effect of this item and 1993 special items previously discussed, 1993 operating income improved by $1 million, primarily as a result of higher gas sales margins and lower operating and other expenses, partially offset by a 34% decline in gas processing margins from the sale of NGLs.\nDuring 1995, the Delhi Group expects to complete the restructuring plan begun in the second quarter of 1994, allowing a more concentrated focus on the management of core assets in western Oklahoma and east, west and south Texas. The benefits of the restructuring plan and the 1994 work force reduction program, such as reduced depreciation, operating and other expenses, are expected to continue in 1995.\nThe levels of gas sales margin for future periods are difficult to accurately project because of systemic fluctuations in customer demand for premium services, competition in attracting new premium customers and the volatility of natural gas prices. However, continued mild weather in the Delhi Group's core service areas during January 1995 reduced demand for premium services, and gas sales margin in the summer of 1995 could be unfavorably affected by the expiration in August 1994 of the Delhi Group's premium service contract with Central Power and Light Company, a utility electric generator serving south Texas. If the mild weather persists, high natural gas inventory levels may continue to put pressure on prices during 1995, as wellhead deliveries compete with storage withdrawals for market share. The volume of trading sales is expected to expand significantly during 1995, although margins earned on trading sales are usually significantly less than those earned on system premium sales.\nThe levels of gas processing margin for future periods are also difficult to project, due to fluctuations in the price and demand for NGLs and the volatility of natural gas prices (feedstock costs). However, management can reduce the volume of NGLs extracted and sold during periods of unfavorable economics by curtailing the extraction of certain NGLs.\nOUTLOOK\nThe Financial Accounting Standards Board intends to issue \"Accounting for the Impairment of Long-Lived Assets\" in the near future. This standard, which is expected to be effective for 1996, requires that operating assets be written down to fair value whenever an impairment review indicates that the carrying value cannot be recovered on an undiscounted cash flow basis. After any such noncash write-down of operating assets, results of operations would be favorably affected by reduced depreciation, depletion and amortization charges. USX will be initiating an extensive review to implement the anticipated standard and, at this time, cannot provide an assessment of either the impact or the timing of adoption, although it is likely that it may be required to recognize certain charges upon adoption. Under current accounting policy, USX generally has only impaired property, plant and equipment under the provisions of Accounting Principles Board Opinion No. 30 and its interpretations.\nU-46 MARATHON GROUP\nIndex to Financial Statements, Supplementary Data and Management's Discussion and Analysis\nM-1 MARATHON GROUP\nExplanatory Note Regarding Financial Information\nAlthough the financial statements of the Marathon Group, the U. S. Steel Group and the Delhi Group separately report the assets, liabilities (including contingent liabilities) and stockholders' equity of USX attributed to each such group, such attribution of assets, liabilities (including contingent liabilities) and stockholders' equity among the Marathon Group, the U. S. Steel Group and the Delhi Group for the purpose of preparing their respective financial statements does not affect legal title to such assets or responsibility for such liabilities. Holders of USX - Marathon Group Common Stock, USX - U. S. Steel Group Common Stock and USX - Delhi Group Common Stock are holders of common stock of USX, and continue to be subject to all the risks associated with an investment in USX and all of its businesses and liabilities. Financial impacts arising from one Group that affect the overall cost of USX's capital could affect the results of operations and financial condition of other groups. In addition, net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Accordingly, the USX consolidated financial information should be read in connection with the Marathon Group financial information.\nM-2\nManagement's Report\nThe accompanying financial statements of the Marathon Group are the responsibility of and have been prepared by USX Corporation (USX) in conformity with generally accepted accounting principles. They necessarily include some amounts that are based on best judgments and estimates. The Marathon Group financial information displayed in other sections of this report is consistent with these financial statements.\nUSX seeks to assure the objectivity and integrity of its financial records by careful selection of its managers, by organizational arrangements that provide an appropriate division of responsibility and by communications programs aimed at assuring that its policies and methods are understood throughout the organization.\nUSX has a comprehensive formalized system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that financial records are reliable. Appropriate management monitors the system for compliance, and the internal auditors independently measure its effectiveness and recommend possible improvements thereto. In addition, as part of their audit of the financial statements, USX's independent accountants, who are elected by the stockholders, review and test the internal accounting controls selectively to establish a basis of reliance thereon in determining the nature, extent and timing of audit tests to be applied.\nThe Board of Directors pursues its oversight role in the area of financial reporting and internal accounting control through its Audit Committee. This Committee, composed solely of nonmanagement directors, regularly meets (jointly and separately) with the independent accountants, management and internal auditors to monitor the proper discharge by each of its responsibilities relative to internal accounting controls and the consolidated and group financial statements.\nCharles A. Corry Robert M. Hernandez Lewis B. Jones Chairman, Board of Directors Vice Chairman Vice President & Chief Executive Officer & Chief Financial Officer & Comptroller\nReport of Independent Accountants\nTo the Stockholders of USX Corporation:\nIn our opinion, the accompanying financial statements appearing on pages M-4 through M-21 present fairly, in all material respects, the financial position of the Marathon Group at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of USX'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, page M-8, in 1993 USX adopted new accounting standards for postemployment benefits and for retrospectively rated insurance contracts. As discussed in Note 10, page M-14, and Note 11, page M-15, in 1992 USX adopted new accounting standards for postretirement benefits other than pensions and for income taxes, respectively.\nThe Marathon Group is a business unit of USX Corporation (as described in Note 1, page M-7); accordingly, the financial statements of the Marathon Group should be read in connection with the consolidated financial statements of USX Corporation.\nPrice Waterhouse LLP 600 Grant Street, Pittsburgh, Pennsylvania 15219-2794 February 14, 1995\nM-3\nStatement of Operations\nIncome Per Common Share of Marathon Stock\nSee Note 21, page M-19, for a description of net income per common share. The accompanying notes are an integral part of these financial statements.\nM-4\nBalance Sheet\nThe accompanying notes are an integral part of these financial statements.\nM-5\nStatement of Cash Flows\nSee Note 7, page M-11, for supplemental cash flow information. The accompanying notes are an integral part of these financial statements.\nM-6 Notes to Financial Statements\n- -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION\nUSX Corporation (USX) has three classes of common stock: USX - Marathon Group Common Stock (Marathon Stock), USX - U. S. Steel Group Common Stock (Steel Stock) and USX - Delhi Group Common Stock (Delhi Stock), which are intended to reflect the performance of the Marathon Group, the U. S. Steel Group and the Delhi Group, respectively.\nThe financial statements of the Marathon Group include the financial position, results of operations and cash flows for the businesses of Marathon Oil Company and certain other subsidiaries of USX, and a portion of the corporate assets and liabilities and related transactions which are not separately identified with ongoing operating units of USX. The Marathon Group is involved in worldwide exploration, production, transportation and marketing of crude oil and natural gas; and domestic refining, marketing and transportation of petroleum products. The Marathon Group financial statements are prepared using the amounts included in the USX consolidated financial statements.\nThe Delhi Group was established October 2, 1992; the Marathon Group financial data for the periods presented prior to this date included the combined historical financial position, results of operations and cash flows for the businesses of the Delhi Group. Beginning October 2, 1992, the financial statements of the Marathon Group do not include the financial position, results of operations and cash flows for the businesses of the Delhi Group except for the financial effects of the Retained Interest (Note 3, page M-9).\nAlthough the financial statements of the Marathon Group, the U. S. Steel Group and the Delhi Group separately report the assets, liabilities (including contingent liabilities) and stockholders' equity of USX attributed to each such group, such attribution of assets, liabilities (including contingent liabilities) and stockholders' equity among the Marathon Group, the U. S. Steel Group and the Delhi Group for the purpose of preparing their respective financial statements does not affect legal title to such assets or responsibility for such liabilities. Holders of Marathon Stock, Steel Stock and Delhi Stock are holders of common stock of USX and continue to be subject to all the risks associated with an investment in USX and all of its businesses and liabilities. Financial impacts arising from one Group that affect the overall cost of USX's capital could affect the results of operations and financial condition of other groups. In addition, net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Accordingly, the USX consolidated financial information should be read in connection with the Marathon Group financial information.\n- -------------------------------------------------------------------------------- 2. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES\nPRINCIPLES APPLIED IN CONSOLIDATION - These financial statements include the accounts of the businesses comprising the Marathon Group. The Marathon Group, the U. S. Steel Group and the Delhi Group financial statements, taken together, comprise all of the accounts included in the USX consolidated financial statements.\nInvestments in unincorporated oil and gas joint ventures, undivided interest pipelines and jointly-owned gas processing plants are accounted for on a pro rata basis.\nInvestments in other entities in which the Marathon Group has significant influence in management and control are accounted for using the equity method of accounting and are carried in the investment account at the Marathon Group's share of net assets plus advances. The proportionate share of income from equity investments is included in other income.\nThe proportionate share of income represented by the Retained Interest in the Delhi Group is included in other income.\nInvestments in marketable equity securities are carried at lower of cost or market and investments in other companies are carried at cost, with income recognized when dividends are received.\nCASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on hand and on deposit and highly liquid debt instruments with maturities generally of three months or less.\nINVENTORIES - Inventories are carried at lower of cost or market. Cost of inventories is determined primarily under the last-in, first-out (LIFO) method.\nM-7\nHEDGING TRANSACTIONS - The Marathon Group engages in commodity and currency hedging within the normal course of its activities (Note 24, page M-19). Management has been authorized to manage exposure to price fluctuations relevant to the purchase or sale of crude oil, natural gas and refined products through the use of a variety of derivative financial and nonfinancial instruments. Derivative financial instruments require settlement in cash and include such instruments as over-the-counter (OTC) commodity swap agreements and OTC commodity options. Derivative nonfinancial instruments require or permit settlement by delivery of commodities and include exchange-traded commodity futures contracts and options. Changes in the market value of derivative instruments are deferred and subsequently recognized in income, as sales or cost of sales, in the same period as the hedged item. OTC swaps are off-balance-sheet instruments; therefore, the effect of changes in the market value of such instruments are not recorded until settlement. The margin accounts for open commodity futures contracts, which reflect daily settlements as market values change, are recorded as accounts receivable. Premiums on all commodity-based option contracts are initially recorded based on the amount paid or received; the options' market value is subsequently recorded as accounts receivable or accounts payable, as appropriate.\nForward currency contracts are primarily used to manage currency risks related to anticipated revenues and operating costs, firm commitments for capital expenditures and existing assets or liabilities denominated in a foreign currency. Gains or losses related to firm commitments are deferred and included with the hedged item; all other gains or losses are recognized in income in the current period as sales, cost of sales, interest income or expense, or other income, as appropriate. For balance sheet reporting, net contract values are included in receivables or payables, as appropriate.\nRecorded deferred gains or losses are reflected within other noncurrent assets or deferred credits and other liabilities. Cash flows from the use of derivative instruments are reported in the same category as the hedged item in the statement of cash flows.\nEXPLORATION AND DEVELOPMENT - The Marathon Group follows the successful efforts method of accounting for oil and gas exploration and development.\nGAS BALANCING - The Marathon Group follows the sales method of accounting for gas production imbalances.\nPROPERTY, PLANT AND EQUIPMENT - Depreciation and depletion of oil and gas producing properties are computed using predetermined rates based upon estimated proved oil and gas reserves applied on a units-of-production method. Other items of property, plant and equipment are depreciated principally by the straight-line method.\nWhen an entire property, major facility or facilities depreciated on an individual basis are sold or otherwise disposed of, any gain or loss is reflected in income. Proceeds from disposal of other facilities depreciated on a group basis are credited to the depreciation reserve with no immediate effect on income.\nENVIRONMENTAL REMEDIATION - The Marathon Group provides for remediation costs and penalties when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. Generally, the timing of remediation accruals coincides with completion of a feasibility study or the commitment to a formal plan of action. Estimated abandonment and dismantlement costs of offshore production platforms are accrued based upon estimated proved oil and gas reserves on a units-of-production method.\nINSURANCE - The Marathon Group is insured for catastrophic casualty and certain property exposures, as well as those risks required to be insured by law or contract. Costs resulting from noninsured losses are charged against income upon occurrence.\nIn 1993, USX adopted Emerging Issues Task Force (EITF) Consensus No. 93-14, \"Accounting for Multiple-Year Retrospectively Rated Insurance Contracts\". EITF No. 93-14 requires accrual of retrospective premium adjustments when the insured has an obligation to pay cash to the insurer that would not have been required absent experience under the contract. The cumulative effect of the change in accounting principle determined as of January 1, 1993, reduced net income $6 million, net of $3 million income tax effect.\nPOSTEMPLOYMENT BENEFITS - In 1993, USX adopted Statement of Finacial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (SFAS No. 112). SFAS No. 112 requires employers to recognize the obligation to provide postemployment benefits on an accrual basis if certain conditions are met. The Marathon Group is affected primarily by disability-related claims covering indemnity and medical payments. The obligation for these claims is measured using actuarial techniques and assumptions including appropriate discount rates. The cumulative effect of the change in accounting principle determined as of January 1, 1993, reduced net income $17 millon, net of $10 million income tax effect. The effect of the change in accounting principle reduced 1993 operating income by $2 million.\nRECLASSIFICATIONS - Certain reclassifications of prior years' data have been made to conform to 1994 classifications.\nM-8\n- -------------------------------------------------------------------------------- 3. CORPORATE ACTIVITIES\nFINANCIAL ACTIVITIES - As a matter of policy, USX manages most financial activities on a centralized, consolidated basis. Such financial activities include the investment of surplus cash; the issuance, repayment and repurchase of short-term and long-term debt; the issuance, repurchase and redemption of preferred stock; and the issuance and repurchase of common stock. Transactions related primarily to invested cash, short-term and long-term debt (including convertible debt), related net interest and other financial costs, and preferred stock and related dividends are attributed to the Marathon Group, the U. S. Steel Group and the Delhi Group based upon the cash flows of each group for the periods presented and the initial capital structure of each group. Most financing transactions are attributed to and reflected in the financial statements of all three groups. See Note 5, page M-10, for the Marathon Group's portion of USX's financial activities attributed to all three groups. However, transactions such as leases, certain collaterized financings, production payment financings, financial activities of consolidated entities which are less than wholly owned by USX and transactions related to securities convertible solely into any one class of common stock are or will be specifically attributed to and reflected in their entirety in the financial statements of the group to which they relate.\nCORPORATE GENERAL & ADMINISTRATIVE COSTS - Corporate general and administrative costs are allocated to the Marathon Group, the U. S. Steel Group and the Delhi Group based upon utilization or other methods management believes to be reasonable and which consider certain measures of business activities, such as employment, investments and sales. The costs allocated to the Marathon Group were $29 million, $28 million and $30 million in 1994, 1993 and 1992, respectively, and primarily consist of employment costs including pension effects, professional services, facilities and other related costs associated with corporate activities.\nCOMMON STOCK TRANSACTIONS - The USX Certificate of Incorporation was amended on September 30, 1992, to authorize a new class of common stock, Delhi Stock, which is intended to reflect the performance of the Delhi Group. On October 2, 1992, USX sold 9,000,000 shares of Delhi Stock to the public. The businesses of the Delhi Group were previously included in the Marathon Group. The USX Board of Directors has designated 14,003,205 shares of Delhi Stock to represent 100% of the common stockholders' equity value of USX attributable to the Delhi Group as of December 31, 1994. The Delhi Fraction is the percentage interest in the Delhi Group represented by the shares of Delhi Stock that are outstanding at any particular time and, based on 9,437,891 outstanding shares at December 31, 1994, is approximately 67%. The Marathon Group financial statements reflect a percentage interest in the Delhi Group of approximately 33% (Retained Interest) at December 31, 1994. Beginning October 2, 1992, the financial position, results of operations and cash flows of the Delhi Group were reflected in the financial statements of the Marathon Group only to the extent of the Retained Interest. The shares deemed to represent the Retained Interest are not outstanding shares of Delhi Stock and cannot be voted by the Marathon Group. As additional shares of Delhi Stock deemed to represent the Retained Interest are sold, the Retained Interest will decrease. When a dividend or other distribution is paid or distributed in respect to the outstanding Delhi Stock, or any amount paid to repurchase shares of Delhi Stock generally, the Marathon Group financial statements are credited, and the Delhi Group financial statements are charged, with the aggregate transaction amount times the quotient of the Retained Interest divided by the Delhi Fraction.\nINCOME TAXES - All members of the USX affiliated group are included in the consolidated United States federal income tax return filed by USX. Accordingly, the provision for federal income taxes and the related payments or refunds of tax are determined on a consolidated basis. The consolidated provision and the related tax payments or refunds have been reflected in the Marathon Group, the U. S. Steel Group and the Delhi Group financial statements in accordance with USX's tax allocation policy. In general, such policy provides that the consolidated tax provision and related tax payments or refunds are allocated among the Marathon Group, the U. S. Steel Group and the Delhi Group, for group financial statement purposes, based principally upon the financial income, taxable income, credits, preferences and other amounts directly related to the respective groups.\nFor tax provision and settlement purposes, tax benefits resulting from attributes (principally net operating losses), which cannot be utilized by one of the three groups on a separate return basis but which can be utilized on a consolidated basis in that year or in a carryback year, are allocated to the group that generated the attributes. However, if such tax benefits cannot be utilized on a consolidated basis in that year or in a carryback year, the prior years' allocation of such consolidated tax effects is adjusted in a subsequent year to the extent necessary to allocate the tax benefits to the group that would have realized the tax benefits on a separate return basis.\nThe allocated group amounts of taxes payable or refundable are not necessarily comparable to those that would have resulted if the groups had filed separate tax returns; however, such allocation should not result in any of the three groups paying more income taxes over time than it would if it filed separate tax returns and, in certain situations, could result in any of the three groups paying less.\nM-9\n- -------------------------------------------------------------------------------- 4. SALES\nThe items below were included in both sales and operating costs, resulting in no effect on income:\n(a)Reflected the gross amount of purchases and sales associated with crude oil and refined product buy\/sell transactions which are settled in cash.\n- -------------------------------------------------------------------------------- 5. FINANCIAL ACTIVITIES ATTRIBUTED TO ALL THREE GROUPS\nThe following is Marathon Group's portion of USX's financial activities attributed to all groups based on their respective cash flows as described in Note 3, page M-9. These amounts exclude debt amounts specifically attributed to a group as disclosed in Note 6, page M-11.\n(a)For details of USX long-term debt, preferred stock of subsidiary and preferred stock, see Notes 13, page U-20; 24, page U-25; and 18 page U-22, respectively, to the USX consolidated financial statements. (b)Primarily reflects forward currency contracts used to manage currency risks related to USX debt and interest denominated in a foreign currency. (c)The Marathon Group's net interest and other financial costs reflect weighted average effects of all financial activities attributed to all three groups.\nM-10\n6. LONG-TERM DEBT\nThe Marathon Group's portion of USX's consolidated long-term debt is as follows:\n(a)See Note 13, page U-20, to the USX consolidated financial statements for details of interest rates, maturities and other terms of long-term debt.\n(b)As described in Note 3, page M-9, certain financial activities are specifically attributed only to the Marathon Group, the U. S. Steel Group or the Delhi Group.\n(c)Most long-term debt activities of USX Corporation and its wholly owned subsidiaries are attributed to all three groups (in total, but not with respect to specific debt issues) based on their respective cash flows (Notes 3, page M-9; 5, page M-10; and 7, page M-11).\n- -------------------------------------------------------------------------------- 7. SUPPLEMENTAL CASH FLOW INFORMATION\nM-11\n- -------------------------------------------------------------------------------- 8. OTHER ITEMS\n(a) Gains resulted primarily from the sale of the assets of a retail propane marketing subsidiary and certain domestic oil and gas production properties. (b) Gains resulted primarily from the sale of two product tug\/barge units and the sale of assets of a convenience store wholesale distributor subsidiary. (c) Delhi Group's loss included restructuring charges. (d) See Note 3, page M-9, for discussion of USX net interest and other financial costs attributable to the Marathon Group. (e) Included a $177 million favorable adjustment related to interest income from a refund of prior years' production taxes. (f) Included a $34 million favorable adjustment related to interest and other financial costs from the settlement of various state tax issues.\nM-12\n- -------------------------------------------------------------------------------- 9. PENSIONS\nThe Marathon Group has noncontributory defined benefit plans covering substantially all employees. Benefits under these plans are based primarily upon years of service and the highest three years earnings during the last ten years before retirement. Certain subsidiaries provide benefits for employees covered by other plans based primarily upon employees' service and career earnings. The funding policy for all plans provides that payments to the pension trusts shall be equal to the minimum funding requirements of ERISA plus such additional amounts as may be approved from time to time.\nPENSION COST (CREDIT) - The defined benefit cost for major plans for 1994, 1993 and 1992 was determined assuming an expected long-term rate of return on plan assets of 9%, 10% and 11%, respectively.\n(a)The curtailment loss resulted from a work force reduction program.\nFUNDS' STATUS - The assumed discount rate used to measure the benefit obligations of major plans was 8% and 6.5% at December 31, 1994, and December 31, 1993, respectively. The assumed rate of future increases in compensation levels was 5% at both year-ends.\nM-13\n- -------------------------------------------------------------------------------- 10. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe Marathon Group has defined benefit retiree health and life insurance plans covering most employees upon their retirement. Health benefits are provided, for the most part, through comprehensive hospital, surgical and major medical benefit provisions subject to various cost sharing features. Life insurance benefits are provided to nonunion and most union represented retiree beneficiaries primarily based on employees' annual base salary at retirement. Benefits have not been prefunded.\nIn 1992, USX adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS No. 106), which requires accrual accounting for all postretirement benefits other than pensions. USX elected to recognize immediately the transition obligation determined as of January 1, 1992, which represents the excess accumulated postretirement benefit obligation (APBO) for current and future retirees over the recorded postretirement benefit cost accruals. The cumulative effect of the change in accounting principle for the Marathon Group reduced net income $147 million, consisting of the transition obligation of $233 million, net of $86 million income tax effect.\nPOSTRETIREMENT BENEFIT COST - Postretirement benefit cost for defined benefit plans for 1994, 1993 and 1992 was determined assuming a discount rate of 6.5%, 7% and 8%, respectively.\n(a) The curtailment gain resulted from a workforce reduction program.\nOBLIGATIONS - The following table sets forth the plans' obligations and the amounts reported in the Marathon Group's balance sheet:\nThe assumed discount rate used to measure the APBO was 8% and 6.5% at December 31, 1994, and December 31, 1993, respectively. The assumed rate of future increases in compensation levels was 5.0% at both year ends. The weighted average health care cost trend rate in 1995 is approximately 7%, gradually declining to an ultimate rate in 1999 of approximately 5.5%. A one percentage point increase in the assumed health care cost trend rates for each future year would have increased the aggregate of the service and interest cost components of the 1994 net periodic postretirement benefit cost by $6 million and would have increased the APBO as of December 31, 1994, by $37 million.\nM-14\n- ------------------------------------------------------------------------------- 11. INCOME TAXES\nIncome tax provisions and related assets and liabilities attributed to the Marathon Group are determined in accordance with the USX group tax allocation policy (Note 3, page M-9).\nIn 1992, USX adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), which requires an asset and liability approach in accounting for income taxes. Under this method, deferred income tax assets and liabilities are established to reflect the future tax consequences of carryforwards and differences between the tax bases and financial bases of assets and liabilities.\nProvisions (credits) for estimated income taxes:\nIn 1993, the cumulative effects of the changes in accounting principles for postemployment benefits and for retrospectively rated insurance contracts included deferred tax benefits of $10 million and $3 million, respectively (Note 2, page M-8). In 1992, the cumulative effect of the change in accounting principle for other postretirement benefits included a deferred tax benefit of $86 million (Note 10, page M-14).\nReconciliation of federal statutory tax rate (35% in 1994 and 1993, and 34% in 1992) to total provisions (credits):\n(a)Included incremental deferred tax benefit of $64 million in 1993 resulting from USX's ability to credit, rather than deduct, certain foreign income taxes for federal income tax purposes when paid in future periods. (b)Included favorable effects in 1994 resulting from the settlement of various state tax issues. Deferred tax assets and liabilities resulted from the following:\nThe consolidated tax returns of USX for the years 1988 through 1991 are under various stages of audit and administrative review by the IRS. USX believes it has made adequate provision for income taxes and interest which may become payable for years not yet settled.\nPretax income (loss) included $14 million, $(55) million and $54 million attributable to foreign sources in 1994, 1993 and 1992, respectively.\nM-15\n- -------------------------------------------------------------------------------- 12. RESTRUCTURING CHARGES\nIn 1992, the write-down of assets related to the planned disposition of nonstrategic domestic exploration and production properties resulted in a $115 million charge. The disposal of these assets was completed in 1993.\n- -------------------------------------------------------------------------------- 13. LONG-TERM RECEIVABLES AND OTHER INVESTMENTS\nThe following financial information summarizes the Marathon Group's share of investments accounted for by the equity method, except for the Retained Interest in the Delhi Group:\nMarathon Group purchases from equity affiliates totaled $71 million, $77 million and $75 million in 1994, 1993 and 1992, respectively. Marathon Group sales to equity affiliates totaled $1 million, $21 million and $34 million in 1994, 1993 and 1992, respectively.\nThe following financial information summarizes the Marathon Group's Retained Interest of 33% in the Delhi Group which is accounted for using the principles of equity accounting (Note 3, page M-9):\n(a) For period from October 2, 1992 to December 31, 1992. (b) Delhi Group's loss included restructuring charges of $40 million.\nM-16\n- ------------------------------------------------------------------------------- 14. INTERGROUP TRANSACTIONS\nSALES AND PURCHASES - Marathon Group sales to the U. S. Steel Group totaled $2 million, $10 million and $16 million in 1994, 1993 and 1992, respectively. Marathon Group sales to the Delhi Group totaled $42 million in 1994, $30 million in 1993 and $8 million from October 2 through December 31, 1992. Marathon Group purchases from the Delhi Group totaled $4 million in both 1994 and 1993 and $2 million from October 2 through December 31, 1992. These transactions were conducted on an arm's-length basis. See Note 18, page M-18 for purchases of Delhi Group accounts receivable.\nPAYABLE TO THE OTHER GROUPS - These amounts represent payables for income taxes determined in accordance with the tax allocation policy described in Note 3, page M-9. Tax settlements between the groups are generally made in the year succeeding that in which such amounts are accrued.\n- ------------------------------------------------------------------------------- 15. LEASES\nFuture minimum commitments for capital leases and for operating leases having remaining noncancelable lease terms in excess of one year are as follows:\nOperating lease rental expense:\nThe Marathon Group leases a wide variety of facilities and equipment under operating leases, including land and building space, office equipment, production facilities and transportation equipment. Most long-term leases include renewal options and, in certain leases, purchase options. In the event of a change in control of USX, as defined in the agreements, or certain other circumstances, operating lease obligations totaling $116 million may be declared immediately due and payable.\n- ------------------------------------------------------------------------------- 16. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment included gross assets acquired under capital leases of $39 million at both year ends; related amounts included in accumulated depreciation, depletion and amortization were $33 million and $32 million, respectively.\nM-17 - ------------------------------------------------------------------------------- 17. INVENTORIES\nInventories of crude oil and refined products are valued by the LIFO method. The LIFO method accounted for 90% and 87% of total inventory value at December 31, 1994, and December 31, 1993, respectively.\nThe inventory market valuation reserve reflects the extent that the recorded cost of crude oil and refined products inventories exceeds net realizable value. The reserve is decreased to reflect increases in market prices and inventory turnover and increased to reflect decreases in market prices. Changes in the inventory market valuation reserve resulted in charges (credits) to operating income of $(160) million, $241 million and $(62) million in 1994, 1993 and 1992, respectively.\n- ------------------------------------------------------------------------------- 18. SALES OF RECEIVABLES\nThe Marathon Group has entered into an agreement, subject to limited recourse, to sell certain accounts receivable including accounts receivable purchased from the Delhi Group. Payments are collected from the sold accounts receivable; the collections are reinvested in new accounts receivable for the buyers; and a yield based on defined short-term market rates is transferred to the buyers. Collections on sold accounts receivable will be forwarded to the buyers at the end of the agreement in 1995, in the event of earlier contract termination or if the Marathon Group does not have a sufficient quantity of eligible accounts receivable to reinvest in for the buyers. The balance of sold accounts receivable averaged $400 million, $400 million and $393 million for the years 1994, 1993 and 1992, respectively. At December 31, 1994, the balance of sold accounts receivable that had not been collected was $400 million. Buyers have collection rights to recover payments from an amount of outstanding receivables equal to 120% of the outstanding receivables purchased on a nonrecourse basis; such overcollateralization cannot exceed $80 million. The Marathon Group does not generally require collateral for accounts receivable, but significantly reduces credit risk through credit extension and collection policies, which include analyzing the financial condition of potential customers, establishing credit limits, monitoring payments and aggressively pursuing delinquent accounts. In the event of a change in control of USX, as defined in the agreement, the Marathon Group may be required to forward payments collected on sold accounts receivable to the buyers.\n- ------------------------------------------------------------------------------- 19. STOCKHOLDERS' EQUITY\n(a) Reflected the proceeds received from the sale of Delhi Stock to the public of $136 million, net of the Delhi Fraction multiplied by the USX common stockholders' equity of $191 million attributed to the Delhi Group as of October 2, 1992 (Note 3, page M-9).\nM-18\n- ------------------------------------------------------------------------------- 20. DIVIDENDS\nIn accordance with the USX Certificate of Incorporation, dividends on the Marathon Stock, Steel Stock and Delhi Stock are limited to the legally available funds of USX. Net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Subject to this limitation, the Board of Directors intends to declare and pay dividends on the Marathon Stock based on the financial condition and results of operation of the Marathon Group, although it has no obligation under Delaware law to do so. In making its dividend decisions with respect to Marathon Stock, the Board of Directors considers among other things, the long-term earnings and cash flow capabilities of the Marathon Group as well as the dividend policies of similar publicly traded companies.\n- -------------------------------------------------------------------------------- 21. NET INCOME PER COMMON SHARE\nThe method of calculating net income (loss) per share for the Marathon Stock, Steel Stock and Delhi Stock reflects the USX Board of Directors' intent that the separately reported earnings and surplus of the Marathon Group, the U. S. Steel Group and the Delhi Group, as determined consistent with the USX Certificate of Incorporation, are available for payment of dividends to the respective classes of stock, although legally available funds and liquidation preferences of these classes of stock do not necessarily correspond with these amounts.\nPrimary net income (loss) per share is calculated by adjusting net income (loss) for dividend requirements of preferred stock and is based on the weighted average number of common shares outstanding plus common stock equivalents, provided they are not antidilutive. Common stock equivalents result from assumed exercise of stock options and surrender of stock appreciation rights associated with stock options, where applicable.\nFully diluted net income (loss) per share assumes conversion of convertible securities for the applicable periods outstanding and assumes exercise of stock options and surrender of stock appreciation rights, provided, in each case, the effect is not antidilutive.\n- ------------------------------------------------------------------------------- 22. FOREIGN CURRENCY TRANSLATION\nExchange adjustments resulting from foreign currency transactions generally are recognized in income, whereas adjustments resulting from translation of financial statements are reflected as a separate component of stockholders' equity. For 1994, 1993 and 1992, respectively, the aggregate foreign currency transaction gains (losses) included in determining net income were $(7) million, $1 million and $16 million. An analysis of changes in cumulative foreign currency translation adjustments follows:\n- -------------------------------------------------------------------------------- 23. STOCK PLANS AND STOCKHOLDER RIGHTS PLAN\nUSX Stock Plans and Stockholder Rights Plan are discussed in Note 19, page U-23, and Note 23, page U-25, respectively, to the USX consolidated financial statements.\n- -------------------------------------------------------------------------------- 24. DERIVATIVE FINANCIAL INSTRUMENTS\nThe Marathon Group uses derivative financial instruments, such as OTC commodity swaps, to hedge exposure to price fluctuations relevant to the anticipated purchase or production and sale of crude oil, natural gas and refined products. The Marathon Group also uses exchange-traded commodity contracts as a part of its overall hedging activities. The use of derivative instruments helps to protect against adverse market price changes for products sold and volatility in raw material costs.\nThe Marathon Group uses forward currency contracts to reduce exposure to currency price fluctuations when transactions require settlement in a foreign currency (principally U.K. pound and Irish punt) rather than U. S. dollars. USX has used forward currency contracts to hedge debt denominated in Swiss francs and European currency units, a portion of which has been attributed to the Marathon Group.\nThe Marathon Group remains at risk for possible changes in the market value of the hedging instrument; however, such risk should be mitigated by price changes in the underlying hedged item. The Marathon Group is also exposed to credit risk in the event of nonperformance by counterparties. The credit worthiness of counterparties is subject to continuing review, including the use of master netting agreements to the extent practical, and full performance is anticipated.\nM-19\nThe following table sets forth quantitative information by class of derivative financial instrument:\n(a) The fair value amounts are based on exchange-traded index prices and dealer quotes. (b) Contract or notional amounts do not quantify risk exposure, but are used in the calculation of cash settlements under the contracts. The contract or notional amounts do not reflect the extent to which positions may offset one another. (c) The OTC swap arrangements vary in duration with certain contracts extending into early 1997. (d) The fair value amount includes fair value assets of $11 million and fair value liabilities of $(1) million.\n- -------------------------------------------------------------------------------- 25. FAIR VALUE OF FINANCIAL INSTRUMENTS\nFair value of the financial instruments disclosed herein is not necessarily representative of the amount that could be realized or settled, nor does the fair value amount consider the tax consequences of realization or settlement. As described in Note 3, page M-9, the Marathon Group's specifically attributed financial instruments and the Marathon Group's portion of USX's financial instruments attributed to all groups are as follows:\nFair value of financial instruments classified as current assets or liabilities approximate carrying value due to the short-term maturity of the instruments. Fair value of long-term receivables and other investments was based on discounted cash flows or other specific instrument analysis. Fair value of long-term debt instruments was based on market prices where available or current borrowing rates available for financings with similar terms and maturities.\nIn addition to certain derivative financial instruments disclosed in Note 24, page M-19, the Marathon Group's unrecognized financial instruments consist of accounts receivables sold subject to limited recourse and financial guarantees. It is not practicable to estimate the fair value of these forms of financial instrument obligations because there are no quoted market prices for transactions which are similar in nature. For details relating to sales of receivables see Note 18, page M-18. For details relating to financial guarantees see Note 26, page M-21.\nM-20\n- -------------------------------------------------------------------------------- 26. CONTINGENCIES AND COMMITMENTS\nUSX is the subject of, or party to, a number of pending or threatened legal actions, contingencies and commitments relating to the Marathon Group involving a variety of matters, including laws and regulations relating to the environment. Certain of these matters are discussed below. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the Marathon Group financial statements. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably to the Marathon Group.\nENVIRONMENTAL MATTERS -\nThe Marathon Group is subject to federal, state, local and foreign laws and regulations relating to the environment. These laws generally provide for control of pollutants released into the environment and require responsible parties to undertake remediation of hazardous waste disposal sites. Penalties may be imposed for noncompliance. At December 31, 1994, and December 31, 1993, accrued liabilities for remediation totaled $45 million and $35 million, respectively. It is not presently possible to estimate the ultimate amount of all remediation costs that might be incurred or the penalties that may be imposed.\nFor a number of years, the Marathon Group has made substantial capital expenditures to bring existing facilities into compliance with various laws relating to the environment. In 1994 and 1993, such capital expenditures totaled $70 million and $123 million, respectively. The Marathon Group anticipates making additional such expenditures in the future; however, the exact amounts and timing of such expenditures are uncertain because of the continuing evolution of specific regulatory requirements.\nAt December 31, 1994, and December 31, 1993, accrued liabilities for platform abandonment and dismantlement totaled $127 million and $126 million, respectively.\nLIBYAN OPERATIONS -\nBy reason of Executive Orders and related regulations under which the U.S. Government is continuing economic sanctions against Libya, the Marathon Group was required to discontinue performing its Libyan petroleum contracts on June 30, 1986. In June 1989, the Department of the Treasury authorized the Marathon Group to resume performing under those contracts. Pursuant to that authorization, the Marathon Group has engaged the Libyan National Oil Company and the Secretary of Petroleum in continuing negotiations to determine when and on what basis they are willing to allow the Marathon Group to resume realizing revenue from the Marathon Group's investment of $107 million in Libya. The Marathon Group is uncertain when these negotiations can be completed.\nGUARANTEES -\nGuarantees by USX of the liabilities of affiliated and other entities of the Marathon Group totaled $19 million and $18 million at December 31, 1994, and December 31, 1993, respectively.\nAt December 31, 1994, and December 31, 1993, the Marathon Group's pro rata share of obligations of LOOP INC. and various pipeline affiliates secured by throughput and deficiency agreements totaled $197 million and $206 million, respectively. Under the agreements, the Marathon Group is required to advance funds if the affiliates are unable to service debt. Any such advances are prepayments of future transportation charges.\nCOMMITMENTS -\nAt December 31, 1994, and December 31, 1993, contract commitments for the Marathon Group's capital expenditures for property, plant and equipment totaled $158 million and $284 million, respectively.\nM-21\nSELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\n(a) Composite tape.\nPRINCIPAL UNCONSOLIDATED AFFILIATES (UNAUDITED)\n(a) Economic interest as of December 31, 1994.\nSUPPLEMENTARY INFORMATION ON OIL AND GAS PRODUCING ACTIVITIES (UNAUDITED)\nSee the USX consolidated financial statements for Supplementary Information on Oil and Gas Producing Activities relating to the Marathon Group, pages U-31 through U-34.\nM-22\nFIVE-YEAR OPERATING SUMMARY\n(a) Excludes the Indianapolis Refinery which was temporarily idled in October 1993.\nM-23\nTHE MARATHON GROUP Management's Discussion And Analysis\nThe Marathon Group includes Marathon Oil Company (\"Marathon\") and certain other subsidiaries of USX Corporation (\"USX\"), which are engaged in worldwide exploration, production, transportation and marketing of crude oil and natural gas; and domestic refining, marketing and transportation of petroleum products. Management's Discussion and Analysis should be read in conjunction with the Marathon Group's Financial Statements and Notes to Financial Statements.\nPrior to October 2, 1992, the Marathon Group also included the businesses of Delhi Gas Pipeline Corporation and certain other USX subsidiaries engaged in the purchasing, gathering, processing, transporting and marketing of natural gas which are now included in the Delhi Group. The Marathon Group financial data for the periods prior to October 2, 1992, include the combined historical financial position, results of operations and cash flows for the businesses of the Delhi Group. Beginning October 2, 1992, the financial statements of the Marathon Group do not include the financial position, results of operations and cash flows for the businesses of the Delhi Group except for the financial effects of the Retained Interest. See Note 3 to the Marathon Group Financial Statements.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF INCOME\nSALES increased $795 million in 1994 from 1993, following an $820 million decrease in 1993 from 1992. The increase in 1994 from 1993 was mainly due to higher excise taxes and higher volumes of worldwide liquid hydrocarbons and refined product matching buy\/sell transactions, partially offset by lower worldwide liquid hydrocarbon prices. The 1993 decline primarily reflected lower worldwide liquid hydrocarbon volumes and prices, lower refined product prices and the absence of sales from the Delhi Group. These decreases were partially offset by increased excise taxes and higher refined product sales volumes, excluding matching buy\/sell transactions. Matching buy\/sell transactions and excise taxes are included in both sales and operating costs, resulting in no effect on operating income. Higher excise taxes were the predominant factor in the increase in taxes other than income taxes in 1994 and 1993 largely resulting from the fourth quarter 1993 increase in the federal excise tax rate and a change in the collection point on distillates from third-party locations to Marathon's terminals.\nOPERATING INCOME increased $415 million in 1994, following a $135 million decline in 1993 from 1992. Results included a $160 million favorable effect in 1994, a $241 million unfavorable effect in 1993 and a $62 million favorable effect in 1992 for noncash adjustments to the inventory market valuation reserve. The 1992 results also included a favorable impact of $119 million for the settlement of a tax refund claim related to prior years' production taxes, partially offset by a $115 million charge related to the planned disposition of certain domestic exploration and production properties. Excluding the effects of these items, operating income increased $14 million in 1994 from 1993, following an increase of $172 million in 1993 from 1992. The increase in 1994 was primarily due to reduced worldwide operating expenses and higher international liquid hydrocarbon and worldwide natural gas volumes, predominantly offset by lower refined product margins, lower liquid hydrocarbon volumes and $42 million of employee reorganization charges. The increase in 1993 was mainly due to increased refined product margins and domestic natural gas prices, partially offset by lower worldwide liquid hydrocarbon prices and volumes.\nOTHER INCOME was $177 million in 1994, compared with income of $46 million in 1993 and a loss of $7 million in 1992. The increase in 1994 mainly resulted from a gain on the sale of the assets of a retail propane marketing subsidiary. In addition to the absence of a $19 million impairment of an investment recorded in 1992, other income in 1993 increased primarily due to gains from disposal of assets totaling $34 million, which mainly reflected the sale of assets of a convenience store wholesale distributor, two tug\/barge units and various domestic oil and gas production properties.\nM-24\nManagement's Discussion and Analysis continued\nINTEREST AND OTHER FINANCIAL INCOME was $15 million in 1994, compared with $22 million in 1993 and $210 million in 1992. The 1992 amount included $177 million of interest income resulting from the settlement of a tax refund claim related to prior years' production taxes.\nINTEREST AND OTHER FINANCIAL COSTS were $300 million in 1994, compared with $292 million in 1993 and $306 million in 1992. The 1994 amount included a $34 million favorable effect resulting from settlement of various state tax issues. Excluding the effect of this item, the increase in 1994 was primarily due to lower capitalized interest resulting from the completion of the East Brae platform and SAGE system in the United Kingdom (\"U.K.\") sector of the North Sea. The decrease in 1993 from 1992 mainly reflected higher capitalized interest for international projects, predominantly offset by higher interest costs related to increased levels of debt.\nInterest and other financial costs in 1995 are expected to increase by approximately $35 million because of lower capitalized interest due to the completion of the aforementioned international projects.\nTHE PROVISION FOR ESTIMATED INCOME TAXES in 1994 was $155 million, compared to a credit of $49 million in 1993 and a provision of $92 million in 1992. The 1994 income tax provision included a $24 million credit for the reversal of a valuation allowance related to deferred tax assets. The 1993 income tax credit included an incremental deferred tax benefit of $64 million resulting from USX's ability to elect to credit, rather than deduct, certain foreign income taxes for U.S. federal income tax purposes when paid in future years. The anticipated use of the U.S. foreign tax credit reflected the Marathon Group's improving international production profile. The 1993 income tax credit also included a $40 million charge associated with an increase in the federal income tax rate from 34% to 35%, reflecting remeasurement of deferred federal income tax assets and liabilities as of January 1, 1993.\nNET INCOME of $321 million was recorded in 1994, compared with a net loss of $29 million in 1993 and a net loss of $222 million in 1992. Excluding the unfavorable cumulative effect of changes in accounting principles, which totaled $23 million and $331 million in 1993 and 1992, respectively, net income increased $327 million in 1994 from 1993, compared with a decrease of $115 million in 1993 from 1992. The changes in net income primarily reflect the factors discussed above.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION\nCURRENT ASSETS increased $165 million from year-end 1993 primarily due to higher inventories and receivables, partially offset by a decrease in cash and cash equivalents. The increase in inventories was mainly due to an increase in inventory values, which reflected a $160 million decrease in the inventory market valuation reserve. This reserve reflects the extent to which the recorded costs of crude oil and refined product inventories exceed net realizable value. Subsequent changes to the inventory market valuation reserve are dependent upon changes in future crude oil and refined product price levels and inventory turnover. The increase in accounts receivable primarily resulted from higher sales of refined products and crude oil. The $157 million decrease in cash balances mainly reflects cash applied to debt reduction.\nCURRENT LIABILITIES increased $69 million in 1994, mostly due to increases in deferred income tax liabilities and accounts payable, partially offset by a decrease in accrued taxes. The increase in deferred income tax liabilities is mainly attributable to the federal tax impact of the settlement of various state tax issues and the decrease in the inventory market valuation reserve. The decrease in accrued taxes primarily reflected the settlements of various state tax issues.\nTOTAL LONG-TERM DEBT AND NOTES PAYABLE at December 31, 1994, was $4.0 billion. The $259 million decrease from year-end 1993 reflected, in part, a reduction of cash and cash equivalent balances. The remaining decrease primarily resulted from other financing activities. The amount of total long-term debt, as well as the amount shown as notes payable, principally represented the\nM-25\nManagement's Discussion and Analysis continued\nMarathon Group's portion of USX debt attributed to all three groups. Virtually all of the debt is a direct obligation of, or is guaranteed by, USX. For a discussion of financial obligations, see Management's Discussion and Analysis of Cash Flows below.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF CASH FLOWS\nTHE MARATHON GROUP'S NET CASH PROVIDED FROM OPERATING ACTIVITIES totaled $719 million in 1994, compared with $827 million in 1993 and $995 million in 1992. The 1994 amount reflected payments of $123 million related to the settlement of various state tax issues. Excluding this item, net cash provided from operating activities increased $15 million from 1993. Cash flows in 1992 included $296 million associated with the refund of prior years' production taxes. Excluding the impact of this item, net cash provided from operating activities in 1993 improved $128 million mainly due to the impact of improved refined product margins on operating results.\nCAPITAL EXPENDITURES were $753 million in 1994, down $157 million from 1993, following a $283 million decrease from 1992. The decrease in 1994 was largely due to the substantial completion of the East Brae Field and SAGE system in the U.K. and the distillate hydrotreater complex at the Robinson, Illinois refinery. Contract commitments for capital expenditures at year-end 1994 were $158 million, compared with $284 million at year-end 1993.\nIn addition to the capital expenditures discussed above, the Marathon Group's noncash investment activities during 1994 included the issuance of $58 million of debt instruments and $11 million (619,168 shares) of USX - Marathon Group Common Stock (\"Marathon Stock\") related to acquisitions of 89 gasoline outlets\/convenience stores from independent petroleum retailers.\nCapital expenditures in 1995 are expected to remain at approximately the same level as 1994 at $750 million.\nCASH FROM DISPOSAL OF ASSETS was $263 million in 1994, compared with $174 million in 1993 and $77 million in 1992. The 1994 proceeds mainly resulted from the sales of the assets of a retail propane marketing subsidiary and certain domestic oil and gas production properties. The 1993 proceeds primarily reflected the sale\/leaseback of interests in two LNG tankers and the sales of various domestic oil and gas production properties, assets of a convenience store wholesale distributor and two tug\/barge units. No individually significant sales transactions occurred in 1992.\nFINANCIAL OBLIGATIONS decreased $196 million, compared with an increase of $261 million in 1993, and a decrease of $426 million in 1992. The decrease in 1994 primarily reflected a reduction in cash and cash equivalent balances. These obligations consist of the Marathon Group's portion of USX debt and preferred stock of a subsidiary attributed to all three groups as well as debt and production financing and other agreements that are specifically attributed to the Marathon Group. For a discussion of USX financing activities attributed to all three groups, see USX Consolidated Management's Discussion and Analysis of Cash Flows.\nMARATHON STOCK ISSUED, net of repurchases, totaled $595 million in 1992, mainly reflecting the sale of 25,000,000 shares of Marathon Stock to the public for net proceeds of $541 million, which were reflected in their entirety in the Marathon Group financial statements.\nDIVIDEND PAYMENTS were $201 million in both 1994 and 1993 and $340 million in 1992. The $139 million decline in 1993 was primarily due to a decrease in the Marathon Stock dividend rate in the fourth quarter of 1992. The annualized rate of dividends per share for the Marathon Stock based on the most recently declared quarterly dividend is $.68.\nM-26\nManagement's Discussion and Analysis continued\nRATING AGENCY ACTIVITY\nIn September 1993, Standard & Poor's Corp. lowered its ratings on USX's and Marathon's senior debt to below investment grade (from BBB- to BB+) and on USX's subordinated debt, preferred stock and commercial paper. In October 1993, Moody's Investors Services, Inc. (\"Moody's\") confirmed its Baa3 investment grade ratings on USX's and Marathon's senior debt. Moody's also confirmed its ratings on USX's subordinated debt and commercial paper, but lowered its ratings on USX's preferred stock from ba1 to ba2. The ratings described above remain unchanged.\nHEDGING ACTIVITY\nThe Marathon Group engages in hedging activities in the normal course of its business. Futures contracts, commodity swaps and options are used to hedge exposure to price fluctuations relevant to the purchase or sale of crude oil, natural gas and refined products. Forward currency contracts have been used to manage currency risks related to anticipated revenues and operating costs, firm commitments for capital expenditures and existing assets or liabilities denominated in a foreign currency. While hedging activities are generally used to reduce risks from unfavorable commodity price and currency rate movements, they also may limit the opportunity to benefit from favorable movements. The Marathon Group's hedging activities have not been significant in relation to its overall business activity. Based on risk assessment procedures and internal controls in place, management believes that its use of hedging instruments will not have a material adverse effect on the financial position, liquidity or results of operations of the Marathon Group. See Notes 2 and 24 to the Marathon Group Financial Statements.\nLIQUIDITY\nFor discussion of USX's liquidity and capital resources, see USX Consolidated Management's Discussion and Analysis of Cash Flows.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF ENVIRONMENTAL MATTERS, LITIGATION AND CONTINGENCIES\nThe Marathon Group has incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. In recent years, these expenditures have increased primarily due to required refined product reformulation and process changes in order to meet Clean Air Act obligations, although ongoing compliance costs have also been significant. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of the Marathon Group's products and services, operating results will be adversely affected. The Marathon Group believes that substantially all of its competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities, marketing areas, production processes and whether or not it is engaged in the petrochemical business or the marine transportation of crude oil and refined products.\nMarathon Group environmental expenditures for each of the last three years were(a):\n(a) Estimated based on American Petroleum Institute survey guidelines. (b) These amounts do not include noncash provisions recorded for environmental remediation, but include spending charged against such reserves.\nM-27\nManagement's Discussion and Analysis continued\nThe Marathon Group's environmental capital expenditures accounted for 9%, 14% and 20% of total capital expenditures in 1994, 1993 and 1992, respectively. The decline in environmental capital expenditures over the three-year period mainly reflected lower expenditures for the Marathon Group's multi-year capital spending program for diesel fuel desulfurization which began in 1990 and was substantially completed by the end of 1993.\nDuring 1992 through 1994, compliance expenditures represented 1% of the Marathon Group's total operating costs. Remediation spending during this period was primarily related to retail gasoline stations which incur ongoing clean-up costs for soil and groundwater contamination associated with underground storage tanks and piping.\nUSX has been notified that it is a potentially responsible party (\"PRP\") at 17 waste sites related to the Marathon Group under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") as of December 31, 1994. In addition, there are 7 sites related to the Marathon Group where USX has received information requests or other indications that USX may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability. There are also 70 additional sites, excluding retail gasoline stations, related to the Marathon Group where remediation is being sought under other environmental statutes, both federal and state. At many of these sites, USX is one of a number of parties involved and the total cost of remediation, as well as USX's share thereof, is frequently dependent upon the outcome of investigations and remedial studies. The Marathon Group accrues for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required. See Note 26 to the Marathon Group Financial Statements.\nNew or expanded environmental requirements, which could increase the Marathon Group's environmental costs, may arise in the future. USX intends to comply with all legal requirements regarding the environment, but since many of them are not fixed or presently determinable (even under existing legislation) and may be affected by future legislation, it is not possible to accurately predict the ultimate cost of compliance, including remediation costs which may be incurred and penalties which may be imposed. However, based on presently available information, and existing laws and regulations as currently implemented, the Marathon Group does not anticipate that environmental compliance expenditures (including operating and maintenance and remediation) will materially increase in 1995. The Marathon Group's capital expenditures for environmental controls are expected to be approximately $40 million in 1995. Predictions beyond 1995 can only be broad-based estimates which have varied, and will continue to vary, due to the ongoing evolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified projects, the Marathon Group anticipates that environmental capital expenditures will be approximately $45 million in 1996; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed.\nUSX is the subject of, or party to, a number of pending or threatened legal actions, contingencies and commitments relating to the Marathon Group involving a variety of matters, including laws and regulations relating to the environment, certain of which are discussed in Note 26 to the Marathon Group Financial Statements. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the Marathon Group financial statements. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably to the Marathon Group. See USX Consolidated Management's Discussion and Analysis of Cash Flows.\nM-28\nManagement's Discussion and Analysis continued\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS\nThe Marathon Group had operating income of $584 million in 1994, compared with $169 million in 1993 and $304 million in 1992. Excluding the effects of noncash adjustments to the inventory market valuation reserve and other items, operating income was $424 million in 1994, $410 million in 1993 and $238 million in 1992 (see Management's Discussion and Analysis of Income).\nOPERATING INCOME (LOSS)\n*Includes the portion of the Marathon Group's administrative costs not allocated to the operating components and the portion of USX corporate general and administrative costs allocated to the Marathon Group.\nAVERAGE VOLUMES AND SELLING PRICES\n*Includes Crude Oil, Condensate and Natural Gas Liquids.\nUPSTREAM operating income increased $130 million in 1994, following a $92 million decrease in 1993. The increase in 1994 primarily reflected reduced worldwide operating expenses, higher international liquid hydrocarbon volumes and worldwide natural gas volumes, partially offset by lower worldwide liquid hydrocarbon prices and employee reorganization charges. Operating income in 1992 included a $20 million gain recognized as a result of a settlement of a natural gas contract. Excluding this settlement, the decline in 1993 was mostly due to significant decreases in worldwide liquid hydrocarbon prices and volumes and lower international natural gas prices, partially offset by increased domestic natural gas prices.\nM-29\nManagement's Discussion and Analysis continued\nDomestic upstream operating income in 1994 increased $34 million from 1993, following a $6 million decrease in 1993 from 1992. The increase in 1994 mainly reflected reduced operating expenses and higher natural gas volumes, partially offset by lower liquid hydrocarbon prices, higher dry well expenses and $18 million of employee reorganization charges. Excluding the previously mentioned contract settlement, the increase in 1993 was primarily due to increased natural gas prices and reduced dry well expenses, partially offset by reduced liquid hydrocarbon prices and volumes. In addition, operating income in 1993 reflected ongoing cost reduction efforts and reduced depletion expenses.\nInternational upstream operating income increased $96 million in 1994, following an $86 million decline in 1993. The increase in 1994 was mainly due to increased liquid hydrocarbon liftings, reduced operating and exploration expenses and increased natural gas volumes, partially offset by lower liquid hydrocarbon prices and $9 million of employee reorganization charges. The decrease in 1993 was primarily due to lower liquid hydrocarbon prices, reduced liftings primarily from the U.K. sector of the North Sea as a result of natural production declines, lower natural gas prices, and a $17 million charge for the relinquishment of Marathon's interest in the Arzanah Oil Field, Abu Dhabi. The decrease was partially offset by reduced pipeline and terminal expenses and reduced dry well expenses.\nIn June 1994, Sakhalin Energy Investment Company Ltd. (\"Sakhalin Energy\"), a joint venture company in which Marathon has a 30% interest, joined with representatives of the Russian Government in the signing of the Sakhalin II Production Sharing Contract (\"PSC\") for the development of the Lunskoye gas field and the Piltun-Astokhskoye oil field located offshore Sakhalin Island in the Russian Far East Region. Subsequent efforts during the year focused on working with the Russian Parliament to finalize legislation to ensure the stabilization of laws complementary to the Sakhalin II PSC. This is necessary before Sakhalin Energy commits to undertaking appraisal period activities, which include the finalizing of the development plan and efforts to secure natural gas liquid markets and financing arrangements.\nMarathon has a 24% working interest in the Heimdal Field located in the Norwegian North Sea. On June 11, 1994, Marathon issued notice of termination on the two original gas sales agreements entered into for the evacuation of Heimdal gas. Marathon issued notice of termination based upon low gas prices and high pipeline tariffs associated with the original contracts. Negotiations are ongoing to raise prices and lower tariffs for current and post-June 1996 sales. Unless otherwise agreed, the effective date of termination under the original gas sales agreements is June 11, 1996.\nDOWNSTREAM operating income decreased $120 million in 1994, after increasing $279 million in 1993. The decrease in 1994 was predominantly due to lower refined product margins from refining and wholesale marketing, and $14 million of employee reorganization charges. The increase in 1993 was primarily due to increased refined product margins from refining and wholesale marketing which nearly doubled from 1992 as a result of decreased crude oil costs and lower maintenance costs for refinery turnaround activities, partially offset by decreased refined product prices in 1993. Also contributing to the increase in operating income were higher margins from refined products and convenience store merchandise at Emro Marketing Company, a Marathon subsidiary. Downstream operating income in 1993 also included a $17 million charge for environmental remediation.\nIn late 1993, Marathon temporarily idled its 50,000 barrels-per-day Indianapolis refinery to enhance the efficiency of downstream operations. Idling of the Indianapolis facility had no impact on Marathon's supply of transportation fuels to its various classes of trade in Indiana or the Midwest marketing area. The costs related to the idling did not have a material effect on Marathon's 1993 operating results. The status of the refinery is periodically reviewed. This includes consideration of economic as well as regulatory matters. As of February 28, 1995, the refinery remained temporarily idled.\nM-30\nManagement's Discussion and Analysis continued\nOn November 16, 1994, 239 employees at the Detroit refinery and terminal represented by the International Brotherhood of Teamsters (\"Teamsters\") went on strike. On March 4, 1995, these employees ratified a new five-year labor agreement expiring on February 1, 2000. During the strike, the refinery and terminal were operated by salaried personnel, so the strike had virtually no impact on refinery and terminal operations or on Marathon's supply of products to associated marketing areas.\nOUTLOOK\nWorldwide liquid hydrocarbon volumes are expected to increase approximately 20% in 1995, primarily reflecting increased production from the East Brae Field, a full year of production from Ewing Bank 873 in the Gulf of Mexico and new production from the Kakap KRA and KG Fields, offshore Indonesia. Worldwide natural gas volumes are also expected to increase approximately 20% in 1995, resulting from a successful 1994 domestic drilling program and a full year of contractual Brae area gas sales, which commenced in October 1994. Contractual sales volumes of Brae area gas through the SAGE pipeline system for the fourth quarter of 1994 averaged approximately 80 million cubic feet per day, which was less than originally anticipated due to unseasonably warm weather in the U.K. In 1995, contractual gas sales volumes through the SAGE system should exceed the level experienced in the fourth quarter of 1994.\nThe Marathon Group expects to realize annual cost structure reductions of approximately $80 million from work force reduction programs completed during 1994. These reductions will impact salary and related benefits expenses, capitalized costs and billings to joint venture partners.\nThe outlook regarding prices and costs for the Marathon Group's principal products is largely dependent upon world market developments for crude oil and refined products. Market conditions in the petroleum industry are cyclical and subject to global economic and political events.\nThe Financial Accounting Standards Board intends to issue \"Accounting for the Impairment of Long-Lived Assets\" in the near future. This standard, which is expected to be effective for 1996, requires that operating assets be written down to fair value whenever an impairment review indicates that the carrying value cannot be recovered on an undiscounted cash flow basis. After any such noncash write-down of operating assets, results of operations would be favorably affected by reduced depreciation, depletion and amortization charges. USX will be initiating an extensive review to implement the anticipated standard and, at this time, cannot provide an assessment of either the impact or the timing of adoption, although it is likely that the Marathon Group may be required to recognize certain charges upon adoption. Under current accounting policy, USX generally has only impaired property, plant and equipment under the provisions of Accounting Principles Board Opinion No. 30 and its interpretations.\nM-31\nTHIS PAGE IS INTENTIONALLY LEFT BLANK\nM-32 U.S. STEEL GROUP\nINDEX TO FINANCIAL STATEMENTS, SUPPLEMENTARY DATA AND MANAGEMENT'S DISCUSSION AND ANALYSIS\nS-1\nU.S. STEEL GROUP\nEXPLANATORY NOTE REGARDING FINANCIAL INFORMATION\nAlthough the financial statements of the U. S. Steel Group, the Marathon Group and the Delhi Group separately report the assets, liabilities (including contingent liabilities) and stockholders' equity of USX attributed to each such group, such attribution of assets, liabilities (including contingent liabilities) and stockholders' equity among the U. S. Steel Group, the Marathon Group and the Delhi Group for the purpose of preparing their respective financial statements does not affect legal title to such assets or responsibility for such liabilities. Holders of USX - U. S. Steel Group Common Stock, USX - Marathon Group Common Stock and USX - Delhi Group Common Stock are holders of common stock of USX, and continue to be subject to all the risks associated with an investment in USX and all of its businesses and liabilities. Financial impacts arising from one Group that affect the overall cost of USX's capital could affect the results of operations and financial condition of other groups. In addition, net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Accordingly, the USX consolidated financial information should be read in connection with the U. S. Steel Group financial information.\nS-2\nMANAGEMENT'S REPORT\nThe accompanying financial statements of the U. S. Steel Group are the responsibility of and have been prepared by USX Corporation (USX) in conformity with generally accepted accounting principles. They necessarily include some amounts that are based on best judgments and estimates. The U. S. Steel Group financial information displayed in other sections of this report is consistent with these financial statements.\nUSX seeks to assure the objectivity and integrity of its financial records by careful selection of its managers, by organizational arrangements that provide an appropriate division of responsibility and by communications programs aimed at assuring that its policies and methods are understood throughout the organization.\nUSX has a comprehensive formalized system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that financial records are reliable. Appropriate management monitors the system for compliance, and the internal auditors independently measure its effectiveness and recommend possible improvements thereto. In addition, as part of their audit of the financial statements, USX's independent accountants, who are elected by the stockholders, review and test the internal accounting controls selectively to establish a basis of reliance thereon in determining the nature, extent and timing of audit tests to be applied.\nThe Board of Directors pursues its oversight role in the area of financial reporting and internal accounting control through its Audit Committee. This Committee, composed solely of nonmanagement directors, regularly meets (jointly and separately) with the independent accountants, management and internal auditors to monitor the proper discharge by each of its responsibilities relative to internal accounting controls and the consolidated and group financial statements.\nCharles A. Corry Robert M. Hernandez Lewis B. Jones Chairman, Board of Directors Vice Chairman Vice President & Chief Executive Officer & Chief Financial Officer & Comptroller\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders of USX Corporation:\nIn our opinion, the accompanying financial statements appearing on pages S-4 through S-20 present fairly, in all material respects, the financial position of the U. S. Steel Group at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of USX'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, page S-8, in 1993 USX adopted a new accounting standard for postemployment benefits. As discussed in Note 11, page S-13, and Note 12, page S-14, in 1992 USX adopted new accounting standards for postretirement benefits other than pensions and for income taxes, respectively.\nThe U. S. Steel Group is a business unit of USX Corporation (as described in Note 1, page S-7); accordingly, the financial statements of the U. S. Steel Group should be read in connection with the consolidated financial statements of USX Corporation.\nPrice Waterhouse LLP 600 Grant Street, Pittsburgh, Pennsylvania 15219-2794 February 14, 1995\nS-3\nSTATEMENT OF OPERATIONS\nINCOME PER COMMON SHARE OF STEEL STOCK\nSee Note 21, page S-18, for a description of net income per common share. The accompanying notes are an integral part of these financial statements.\nS-4\nBALANCE SHEET\nThe accompanying notes are an integral part of these financial statements.\nS-5 STATEMENT OF CASH FLOWS\nSee Note 9, page S-11, for supplemental cash flow information. The accompanying notes are an integral part of these financial statements.\nS-6\nNOTES TO FINANCIAL STATEMENTS\n- -------------------------------------------------------------------------------- 1. BASIS OF PRESENTATION\nUSX Corporation (USX) has three classes of common stock: USX - U. S. Steel Group Common Stock (Steel Stock), USX - Marathon Group Common Stock (Marathon Stock) and USX - Delhi Group Common Stock (Delhi Stock), which are intended to reflect the performance of the U. S. Steel Group, the Marathon Group and the Delhi Group, respectively.\nThe financial statements of the U. S. Steel Group include the financial position, results of operations and cash flows for all businesses of USX other than the businesses, assets and liabilities included in the Marathon Group or the Delhi Group, and a portion of the corporate assets and liabilities and related transactions which are not separately identified with ongoing operating units of USX. The U. S. Steel Group, which consists primarily of steel operations, includes the largest domestic integrated steel producer and is primarily engaged in the production and sale of steel mill products, coke and taconite pellets. The U. S. Steel Group also includes the management of mineral resources, domestic coal mining, and engineering and consulting services and technology licensing. Other businesses that are part of the U. S. Steel Group include real estate development and management, fencing products, and leasing and financing activities. The U. S. Steel Group financial statements are prepared using the amounts included in the USX consolidated financial statements.\nAlthough the financial statements of the U. S. Steel Group, the Marathon Group and the Delhi Group separately report the assets, liabilities (including contingent liabilities) and stockholders' equity of USX attributed to each such group, such attribution of assets, liabilities (including contingent liabilities) and stockholders' equity among the U. S. Steel Group, the Marathon Group and the Delhi Group for the purpose of preparing their respective financial statements does not affect legal title to such assets or responsibility for such liabilities. Holders of Steel Stock, Marathon Stock and Delhi Stock are holders of common stock of USX, and continue to be subject to all the risks associated with an investment in USX and all of its businesses and liabilities. Financial impacts arising from one Group that affect the overall cost of USX's capital could affect the results of operations and financial condition of other groups. In addition, net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Accordingly, the USX consolidated financial information should be read in connection with the U. S. Steel Group financial information.\n- -------------------------------------------------------------------------------- 2. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES\nPRINCIPLES APPLIED IN CONSOLIDATION - These financial statements include the accounts of the U. S. Steel Group. The U. S. Steel Group, the Marathon Group and the Delhi Group financial statements, taken together, comprise all of the accounts included in the USX consolidated financial statements.\nInvestments in other entities in which the U. S. Steel Group has significant influence in management and control are accounted for using the equity method of accounting, and are carried in the investment account at the U. S. Steel Group's share of net assets plus advances. The proportionate share of income from equity investments is included in other income. In 1994, the U. S. Steel Group reduced its voting interest in RMI Titanium Company (RMI) to less than 50% and began accounting for its investment using the equity method.\nInvestments in marketable equity securities are carried at lower of cost or market and investments in other companies are carried at cost, with income recognized when dividends are received.\nCASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on hand and on deposit and highly liquid debt instruments with maturities generally of three months or less.\nINVENTORIES - Inventories are carried at lower of cost or market. Cost of inventories is determined primarily under the last-in, first-out (LIFO) method.\nS-7\nHEDGING TRANSACTIONS - The U. S. Steel Group engages in commodity hedging within the normal course of its activities (Note 24, page S-18). Management has been authorized to manage exposure to price fluctuations relevant to the purchase of natural gas and nonferrous metals through the use of a variety of derivative financial and nonfinancial instruments. Derivative financial instruments require settlement in cash and include such instruments as over-the-counter (OTC) commodity swap agreements and OTC commodity options. Derivative nonfinancial instruments require or permit settlement by delivery of commodities and include exchange-traded commodity futures contracts and options. Changes in the market value of derivative instruments are deferred and subsequently recognized in income as cost of sales in the same period as the hedged item. OTC swaps are off-balance-sheet instruments; therefore, the effect of changes in the market value of such instruments are not recorded until settlement. The margin accounts for open commodity futures contracts, which reflect daily settlements as market values change, are recorded as accounts receivable. Premiums on all commodity-based option contracts are initially recorded based on the amount paid or received; the options' market value is subsequently recorded as accounts receivable or accounts payable, as appropriate.\nForward currency contracts are used to manage currency risks related to USX attributed debt denominated in a foreign currency. Gains or losses related to firm commitments are deferred and included with the hedged item; all other gains or losses are recognized in income in the current period as interest income or expense, as appropriate. For balance sheet reporting, net contract values are included in receivables or payables, as appropriate.\nRecorded deferred gains or losses are reflected within other noncurrent assets or deferred credits and other liabilities. Cash flows from the use of derivative instruments are reported in the same category as the hedged item in the statement of cash flows.\nPROPERTY, PLANT AND EQUIPMENT - Depreciation is generally computed using a modified straight-line method based upon estimated lives of assets and production levels. The modification factors range from a minimum of 85% at a production level below 81% of capability, to a maximum of 105% for a 100% production level. No modification is made at the 95% production level, considered the normal long-range level.\nDepletion of mineral properties is based on rates which are expected to amortize cost over the estimated tonnage of minerals to be removed.\nWhen an entire plant, major facility or facilities depreciated on an individual basis are sold or otherwise disposed of, any gain or loss is reflected in income. Proceeds from disposal of other facilities depreciated on a group basis are credited to the depreciation reserve with no immediate effect on income.\nENVIRONMENTAL REMEDIATION - The U. S. Steel Group provides for remediation costs and penalties when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. Generally, the timing of remediation accruals coincides with completion of a feasibility study or the commitment to a formal plan of action.\nINSURANCE - The U. S. Steel Group is insured for catastrophic casualty and certain property and business interruption exposures, as well as those risks required to be insured by law or contract. Costs resulting from noninsured losses are charged against income upon occurrence.\nPOSTEMPLOYMENT BENEFITS - In 1993, USX adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (SFAS No. 112). SFAS No. 112 requires employers to recognize the obligation to provide postemployment benefits on an accrual basis if certain conditions are met. The U. S. Steel Group is affected primarily by disability-related claims covering indemnity and medical payments. The obligation for these claims is measured using actuarial techniques and assumptions including appropriate discount rates. The cumulative effect of the change in accounting principle determined as of January 1, 1993, reduced net income $69 million, net of $40 million income tax effect. The effect of the change in accounting principle reduced 1993 operating income by $21 million.\nRECLASSIFICATIONS - Certain reclassifications of prior years' data have been made to conform to 1994 classifications.\nS-8\n- -------------------------------------------------------------------------------- 3. CORPORATE ACTIVITIES\nFINANCIAL ACTIVITIES - As a matter of policy, USX manages most financial activities on a centralized, consolidated basis. Such financial activities include the investment of surplus cash; the issuance, repayment and repurchase of short-term and long-term debt; the issuance, repurchase and redemption of preferred stock; and the issuance and repurchase of common stock. Transactions related primarily to invested cash, short-term and long-term debt (including convertible debt), related net interest and other financial costs, and preferred stock and related dividends are attributed to the U. S. Steel Group, the Marathon Group and the Delhi Group based upon the cash flows of each group for the periods presented and the initial capital structure of each group. Most financing transactions are attributed to and reflected in the financial statements of all three groups. See Note 7, page S-10, for the U. S. Steel Group's portion of USX's financial activities attributed to all three groups. However, transactions such as leases, certain collateralized financings, production payment financings, financial activities of consolidated entities which are less than wholly owned by USX and transactions related to securities convertible solely into any one class of common stock are or will be specifically attributed to and reflected in their entirety in the financial statements of the group to which they relate.\nCORPORATE GENERAL & ADMINISTRATIVE COSTS - Corporate general and administrative costs are allocated to the U. S. Steel Group, the Marathon Group and the Delhi Group based upon utilization or other methods management believes to be reasonable and which consider certain measures of business activities, such as employment, investments and sales. The costs allocated to the U. S. Steel Group were $36 million in 1994, and $33 million in both 1993 and 1992, and primarily consist of employment costs including pension effects, professional services, facilities and other related costs associated with corporate activities.\nINCOME TAXES - All members of the USX affiliated group are included in the consolidated United States federal income tax return filed by USX. Accordingly, the provision for federal income taxes and the related payments or refunds of tax are determined on a consolidated basis. The consolidated provision and the related tax payments or refunds have been reflected in the U. S. Steel Group, the Marathon Group and the Delhi Group financial statements in accordance with USX's tax allocation policy. In general, such policy provides that the consolidated tax provision and related tax payments or refunds are allocated among the U. S. Steel Group, the Marathon Group and the Delhi Group, for group financial statement purposes, based principally upon the financial income, taxable income, credits, preferences and other amounts directly related to the respective groups.\nFor tax provision and settlement purposes, tax benefits resulting from attributes (principally net operating losses), which cannot be utilized by one of the three groups on a separate return basis but which can be utilized on a consolidated basis in that year or in a carryback year, are allocated to the group that generated the attributes. However, if such tax benefits cannot be utilized on a consolidated basis in that year or in a carryback year, the prior years' allocation of such consolidated tax effects is adjusted in a subsequent year to the extent necessary to allocate the tax benefits to the group that would have realized the tax benefits on a separate return basis.\nThe allocated group amounts of taxes payable or refundable are not necessarily comparable to those that would have resulted if the groups had filed separate tax returns; however, such allocation should not result in any of the three groups paying more income taxes over time than it would if it filed separate tax returns, and in certain situations, could result in any of the three groups paying less.\n- -------------------------------------------------------------------------------- 4. RESTRUCTURING CHARGES\nIn 1993, the planned closure of a Pennsylvania coal mine resulted in a $42 million charge, primarily related to the writedown of property, plant and equipment, contract termination, and mine closure cost. In December 1994, a letter of intent for the sale of this coal mine was entered into, subject to certain conditions. This transaction, if concluded, will close in 1995. In 1992, the completion of the 1991 restructuring plan related to steel operations resulted in a $10 million charge.\n- -------------------------------------------------------------------------------- 5. B&LE LITIGATION CHARGES\nPretax income (loss) in 1993 included a $506 million charge related to the Lower Lake Erie Iron Ore Antitrust Litigation against a former USX subsidiary, the Bessemer & Lake Erie Railroad (B&LE) (Note 26, page S-20). Charges of $342 million were included in cost of sales and $164 million included in interest and other financial costs. The effect on 1993 net income (loss) was $325 million unfavorable ($5.04 per share of Steel Stock). At December 31, 1993, accounts payable included $376 million for this litigation, which was substantially settled in 1994.\nS-9\n- -------------------------------------------------------------------------------- 6. OTHER ITEMS\n(a) Gains resulted primarily from the sale of the Cumberland coal mine, an investment in an insurance company and the realization of a deferred gain resulting from collection of a subordinated note related to the 1988 sale of Transtar, Inc. (Transtar). The collection also resulted in interest income of $37 million.\n(b) See Note 3, page S-9, for discussion of USX net interest and other financial costs attributable to the U. S. Steel Group.\n(c) Excludes financial income and costs of finance operations, which are included in operating income.\n- -------------------------------------------------------------------------------- 7. FINANCIAL ACTIVITIES ATTRIBUTED TO ALL THREE GROUPS\nThe following is U. S. Steel Group's portion of USX's financial activities attributed to all groups based on their respective cash flows as described in Note 3, page S-9. These amounts exclude debt amounts specifically attributed to a group as described in Note 8, page S-11.\n(a) For details of USX long-term debt, preferred stock of subsidiary and preferred stock, see Notes 13, page U-20; 24, page U-25; and 18, page U-22, respectively, to the USX consolidated financial statements.\n(b) Primarily reflects forward currency contracts used to manage currency risks related to USX debt and interest denominated in a foreign currency.\n(c) The U. S. Steel Group's net interest and other financial costs reflect weighted average effects of all financial activities attributed to all three groups.\nS-10\n- -------------------------------------------------------------------------------- 8. LONG-TERM DEBT\nThe U. S. Steel Group's portion of USX's consolidated long-term debt is as follows:\n(a) See Note 13, page U-20, to the USX consolidated financial statements for details of interest rates, maturities and other terms of long-term debt.\n(b) As described in Note 3, page S-9, certain financial activities are specifically attributed only to the U. S. Steel Group, the Marathon Group or the Delhi Group.\n(c) Most long-term debt activities of USX Corporation and its wholly owned subsidiaries are attributed to all three groups (in total, but not with respect to specific debt issues) based on their respective cash flows (Notes 3, page S-9, 7, page S-10, and 9, page S-11).\n- -------------------------------------------------------------------------------- 9. SUPPLEMENTAL CASH FLOW INFORMATION\nS-11\n- -------------------------------------------------------------------------------- 10. PENSIONS\nThe U. S. Steel Group has noncontributory defined benefit plans covering substantially all employees. Benefits under these plans are based upon years of service and final average pensionable earnings, or a minimum benefit based upon years of service, whichever is greater. In addition, contributory pension benefits, which cover participating salaried employees, are based upon years of service and career earnings. The funding policy for defined benefit plans provides that payments to the pension trusts shall be equal to the minimum funding requirements of ERISA plus such additional amounts as may be approved from time to time. Certain of these plans provide benefits to USX corporate employees, and the related costs or credits for such employees are allocated to all three groups (Note 3, page S-9).\nThe U. S. Steel Group also participates in multiemployer plans, most of which are defined benefit plans associated with coal operations.\nPENSION COST (CREDIT) - The defined benefit cost for major plans for 1994, 1993 and 1992 was determined assuming an expected long-term rate of return on plan assets of 9%, 10%, and 11%, respectively. The total pension credit is primarily included in selling, general and administrative expenses.\nFUNDS' STATUS - The assumed discount rate used to measure the benefit obligations of major plans was 8% and 6.5% at December 31, 1994, and December 31, 1993, respectively. The assumed rate of future increases in compensation levels was 4% and 3% at December 31, 1994, and December 31, 1993, respectively.\nS-12\n- -------------------------------------------------------------------------------- 11. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nThe U. S. Steel Group has defined benefit retiree health and life insurance plans covering most employees upon their retirement. Health benefits are provided, for the most part, through comprehensive hospital, surgical and major medical benefit provisions subject to various cost sharing features. Life insurance benefits are provided to nonunion retiree beneficiaries primarily based on employees' annual base salary at retirement. For union retirees, benefits are provided for the most part based on fixed amounts negotiated in labor contracts with the appropriate unions. Except for certain life insurance benefits paid from reserves held by insurance carriers, benefits have not been prefunded. In 1994, the U. S. Steel Group agreed to establish a Voluntary Employee Beneficiary Association Trust to prefund a portion of health care and life insurance benefits for retirees covered under the United Steelworkers of America (USWA) union agreement. In early 1995, USX funded the initial $25 million contribution and will be required to fund a minimum of $10 million more in 1995 and each succeeding contract year. These plans provide benefits to USX corporate employees, and the related costs for such employees are allocated to all three groups (Note 3, page S-9).\nIn 1992, USX adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS No. 106), which requires accrual accounting for all postretirement benefits other than pensions. USX elected to recognize immediately the transition obligation determined as of January 1, 1992, which represented the excess accumulated postretirement benefit obligation (APBO) for current and future retirees over the fair value of plan assets and recorded postretirement benefit cost accruals. The cumulative effect of the change in accounting principle for the U. S. Steel Group reduced net income $1,159 million, consisting of the transition obligation of $1,837 million, net of $678 million income tax effect.\nPOSTRETIREMENT BENEFIT COST - Postretirement benefit cost for defined benefit plans for 1994, 1993 and 1992 was determined assuming a discount rate of 6.5%, 7% and 8%, respectively, and an expected return on plan assets of 9% for 1994 and 10% for both 1993 and 1992:\n(a) Payments are made to a multiemployer benefit plan created by the Coal Industry Retiree Health Benefit Act of 1992 based on assigned beneficiaries receiving benefits. The present value of this unrecognized obligation is broadly estimated to be $160 million, including the effects of future medical inflation, and this amount could increase if additional beneficiaries are assigned.\n(b) In 1993, other income (Note 6, page S-10) included a settlement gain resulting from the sale of the Cumberland coal mine.\nFUNDS' STATUS - The following table sets forth the plans' funded status and the amounts reported in the U. S. Steel Group's balance sheet:\nThe assumed discount rate used to measure the APBO was 8% and 6.5% at December 31, 1994, and December 31, 1993, respectively. The assumed rate of future increases in compensation levels was 4% and 3% at December 31, 1994, and December 1993, respectively. The weighted average health care cost trend rate in 1995 is approximately 7%, declining to an ultimate rate in 1997 of approximately 6%. A one percentage point increase in the assumed health care cost trend rates for each future year would have increased the aggregate of the service and interest cost components of the 1994 net periodic postretirement benefit cost by $28 million and would have increased the APBO as of December 31, 1994, by $231 million.\nS-13\n- -------------------------------------------------------------------------------- 12. INCOME TAXES\nIncome tax provisions and related assets and liabilities attributed to the U. S. Steel Group are determined in accordance with the USX group tax allocation policy (Note 3, page S-9).\nIn 1992, USX adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), which requires an asset and liability approach in accounting for income taxes. Under this method, deferred income tax assets and liabilities are established to reflect the future tax consequences of carryforwards and differences between the tax bases and financial bases of assets and liabilities.\nProvisions (credits) for estimated income taxes:\nIn 1993, the cumulative effect of the change in accounting principle for postemployment benefits included a deferred tax benefit of $40 million (Note 2, page S-8). In 1992, the cumulative effect of the change in accounting principle for other postretirement benefits included a deferred tax benefit of $678 million (Note 11, page S-13).\nReconciliation of federal statutory tax rate (35% in 1994 and 1993, and 34% in 1992) to total provisions (credits):\nDeferred tax assets and liabilities resulted from the following:\n(a) The decrease in valuation allowances reflected $52 million related to a previously consolidated subsidiary now accounted for using the equity method, of which $26 million related to federal tax loss carryforwards.\nThe consolidated tax returns of USX for the years 1988 through 1991 are under various stages of audit and administrative review by the IRS. USX believes it has made adequate provision for income taxes and interest which may become payable for years not yet settled.\nS-14 - -------------------------------------------------------------------------------- 13. INTERGROUP TRANSACTIONS\nPURCHASES - U. S. Steel Group purchases from the Marathon Group totaled $2 million, $10 million and $16 million in 1994, 1993 and 1992, respectively. These transactions were conducted on an arm's length basis.\nRECEIVABLES FROM THE OTHER GROUPS - These amounts represent receivables for income taxes determined in accordance with the tax allocation policy described in Note 3, page S-9. Tax settlements between the groups are generally made in the year succeeding that in which such amounts are accrued.\n- -------------------------------------------------------------------------------- 14. LONG-TERM RECEIVABLES AND OTHER INVESTMENTS\nThe following financial information summarizes U. S. Steel Group's share in investments accounted for by the equity method:\nU. S. Steel Group purchases of transportation services and semi-finished steel from equity affiliates totaled $360 million, $313 million and $273 million in 1994, 1993, and 1992, respectively. At December 31, 1994 and 1993, U. S. Steel Group payables to these affiliates totaled $22 million and $17 million, respectively. U. S. Steel Group sales of steel and raw materials to equity affiliates totaled $680 million, $526 million and $249 million in 1994, 1993, and 1992, respectively. At December 31, 1994 and 1993, U. S. Steel Group receivables from these affiliates was $198 million and $168 million, respectively. Generally, these transactions were conducted under long-term, market-based contractual arrangements.\n- -------------------------------------------------------------------------------- 15. INVENTORIES\nAt December 31, 1994, and December 31, 1993, the LIFO method accounted for 86% and 89% of total inventory value. Current acquisition costs were estimated to exceed the above inventory values at December 31 by approximately $260 million and $280 million in 1994 and 1993, respectively.\nCost of sales was reduced by $13 million in 1994, $11 million in 1993 and $24 million in 1992 as a result of liquidations of LIFO inventories.\nS-15\n- -------------------------------------------------------------------------------- 16. LEASES\nFuture minimum commitments for capital leases (including sale-leasebacks accounted for as financings) and for operating leases having remaining noncancelable lease terms in excess of one year are as follows:\nOperating lease rental expense:\nThe U. S. Steel Group leases a wide variety of facilities and equipment under operating leases, including land and building space, office equipment, production facilities and transportation equipment. Contingent rental includes payments based on facility production and operating expense escalation on building space. Most long-term leases include renewal options and, in certain leases, purchase options. In the event of a change in control of USX, as defined in the agreements, or certain other circumstances, lease obligations totaling $64 million may be declared immediately due and payable.\n- -------------------------------------------------------------------------------- 17. PROPERTY, PLANT AND EQUIPMENT\nAmounts included in accumulated depreciation, depletion and amortization for assets acquired under capital leases (including sale-leasebacks accounted for as financings) were $49 million and $41 million at December 31, 1994, and December 31, 1993, respectively.\n- -------------------------------------------------------------------------------- 18. SALES OF RECEIVABLES\nACCOUNTS RECEIVABLE - The U. S. Steel Group has entered into an agreement to sell certain accounts receivable subject to limited recourse. Payments are collected from the sold accounts receivable; the collections are reinvested in new accounts receivable for the buyers; and a yield based on defined short-term market rates is transferred to the buyers. Collections on sold accounts receivable will be forwarded to the buyers at the end of the agreement in 1995, in the event of earlier contract termination or if a sufficient quantity of eligible accounts receivable is not available to reinvest in for the buyers. The balance of sold accounts receivable averaged $337 million, $333 million and $310 million for the years 1994, 1993 and 1992, respectively. At December 31, 1994, the balance of sold accounts receivable that had not been collected was $350 million. Buyers have collection rights to recover payments from an amount of outstanding receivables equal to 115% of the outstanding receivables purchased on a nonrecourse basis; such overcollateralization cannot exceed $53 million. The U. S. Steel Group does not generally require collateral for accounts receivable, but significantly reduces credit risk through credit extension and collection policies, which include analyzing the financial condition of potential customers, establishing credit limits, monitoring payments and aggressively pursuing delinquent accounts. In the event of a change in control of USX, as defined in the agreement, the U. S. Steel Group may be required to forward payments collected on sold accounts receivable to the buyers.\nS-16\nLOANS RECEIVABLE - Prior to 1993, USX Credit, a division of USX, sold certain of its loans receivable subject to limited recourse. USX Credit continues to collect payments from the loans and transfer to the buyers principal collected plus yield based on defined short-term market rates. In 1994, 1993 and 1992, USX Credit net repurchases of loans receivable totaled $38 million, $50 million and $24 million, respectively. At December 31, 1994, the balance of sold loans receivable subject to recourse was $131 million. USX Credit is not actively seeking new loans at this time. USX Credit is subject to market risk through fluctuations in short-term market rates on sold loans which pay fixed interest rates. USX Credit significantly reduces credit risk through a credit policy, which requires that loans be secured by the real property or equipment financed, often with additional security such as letters of credit, personal guarantees and committed long-term financing takeouts. Also, USX Credit diversifies its portfolio as to types and terms of loans, borrowers, loan sizes, sources of business and types and locations of collateral. As of December 31, 1994, and December 31, 1993, USX Credit had outstanding loan commitments of $26 million and $29 million, respectively. In the event of a change in control of USX, as defined in the agreement, the U. S. Steel Group may be required to provide cash collateral in the amount of the uncollected loans receivable to assure compliance with the limited recourse provisions.\nEstimated credit losses under the limited recourse provisions for both accounts receivable and loans receivable are recognized when the receivables are sold consistent with bad debt experience. Recognized liabilities for future recourse obligations of sold receivables were $3 million and $3 million at December 31, 1994, and December 31, 1993, respectively.\n- -------------------------------------------------------------------------------- 19. STOCKHOLDERS' EQUITY\n(a) For details of 6.50% Cumulative Convertible Preferred Stock, which was sold in 1993 for net proceeds of $336 million and attributed entirely to the U.S. Steel Group, see Note 18, page U-22 to the USX consolidated financial statements.\n- -------------------------------------------------------------------------------- 20. DIVIDENDS\nIn accordance with the USX Certificate of Incorporation, dividends on the Steel Stock, Marathon Stock and Delhi Stock are limited to the legally available funds of USX. Net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Subject to this limitation, the Board of Directors intends to declare and pay dividends on the Steel Stock based on the financial condition and results of operations of the U. S. Steel Group, although it has no obligation under Delaware law to do so. In making its dividend decisions with respect to Steel Stock, the Board of Directors considers, among other things, the long-term earnings and cash flow capabilities of the U. S. Steel Group as well as the dividend policies of similar publicly traded steel companies.\nDividends on the Steel Stock are further limited to the Available Steel Dividend Amount. At December 31, 1994, the Available Steel Dividend Amount was at least $2.170 billion. The Available Steel Dividend Amount will be increased or decreased, as appropriate, to reflect U. S. Steel Group net income, dividends, repurchases or issuances with respect to the Steel Stock and preferred stock attributed to the U. S. Steel Group and certain other items.\nS-17\n- -------------------------------------------------------------------------------- 21. NET INCOME PER COMMON SHARE\nThe method of calculating net income (loss) per share for the Steel Stock, Marathon Stock and Delhi Stock reflects the USX Board of Directors' intent that the separately reported earnings and surplus of the U. S. Steel Group, the Marathon Group and the Delhi Group, as determined consistent with the USX Certificate of Incorporation, are available for payment of dividends to the respective classes of stock, although legally available funds and liquidation preferences of these classes of stock do not necessarily correspond with these amounts.\nPrimary net income (loss) per share is calculated by adjusting net income (loss) for dividend requirements of preferred stock and is based on the weighted average number of common shares outstanding plus common stock equivalents, provided they are not antidilutive. Common stock equivalents result from assumed exercise of stock options and surrender of stock appreciation rights associated with stock options, where applicable.\nFully diluted net income (loss) per share assumes conversion of convertible securities for the applicable periods outstanding and assumes exercise of stock options and surrender of stock appreciation rights, provided, in each case, the effect is not antidilutive.\n- -------------------------------------------------------------------------------- 22. FOREIGN CURRENCY TRANSLATION\nExchange adjustments resulting from foreign currency transactions generally are recognized in income, whereas adjustments resulting from translation of financial statements are reflected as a separate component of stockholders' equity. For 1994, 1993 and 1992, respectively, the aggregate foreign currency transaction gains (losses) included in determining net income were $1 million, $(4) million and $(2) million. An analysis of changes in cumulative foreign currency translation adjustments follows:\n- -------------------------------------------------------------------------------- 23. STOCK PLANS AND STOCKHOLDER RIGHTS PLAN\nUSX Stock Plans and Stockholder Rights Plan are discussed in Note 19, page U-23, and Note 23, page U-25, respectively, to the USX consolidated financial statements.\n- -------------------------------------------------------------------------------- 24. DERIVATIVE FINANCIAL INSTRUMENTS\nThe U. S. Steel Group uses derivative financial instruments, such as commodity swaps, to hedge the cost of natural gas used in steel operations.\nUSX has used forward currency contracts to manage currency risks related to debt denominated in Swiss francs and European currency units, a portion of which has been attributed to the U. S. Steel Group.\nThe U. S. Steel Group remains at risk for possible changes in the market value of the hedging instrument; however, such risk should be mitigated by price changes in the underlying hedged item. The U. S. Steel Group is also exposed to credit risk in the event of nonperformance by counterparties. The credit worthiness of counterparties is subject to continuing review, including the use of master netting agreements to the extent practical, and full performance is anticipated.\nS-18\nThe following table sets forth quantitative information by class of derivative financial instrument:\n(a) The fair value amounts are based on exchange-traded index prices and dealer quotes.\n(b) Contract or notional amounts do not quantify risk exposure, but are used in the calculation of cash settlements under the contracts.\n(c) The OTC swap arrangements vary in duration with certain contracts extending up to one year.\n- -------------------------------------------------------------------------------- 25. FAIR VALUE OF FINANCIAL INSTRUMENTS\nFair value of the financial instruments disclosed herein is not necessarily representative of the amount that could be realized or settled, nor does the fair value amount consider the tax consequences of realization or settlement. As described in Note 3, page S-9, the U. S. Steel Group's specifically attributed financial instruments and the U. S. Steel Group's portion of USX's financial instruments attributed to all groups are as follows:\nFair value of financial instruments classified as current assets or liabilities approximate carrying value due to the short-term maturity of the instruments. Fair value of long-term receivables and other investments was based on discounted cash flows or other specific instrument analysis. Fair value of long-term debt instruments was based on market prices where available or current borrowing rates available for financings with similar terms and maturities.\nIn addition to certain derivative financial instruments disclosed in Note 24, page S-18, the U. S. Steel Group's unrecognized financial instruments consist of receivables sold subject to limited recourse, commitments to extend credit and financial guarantees. It is not practicable to estimate the fair value of these forms of financial instrument obligations because there are no quoted market prices for transactions which are similar in nature. For details relating to sales of receivables and commitments to extend credit see Note 18, page S-16. For details relating to financial guarantees see Note 26, page S-20.\nS-19\n- -------------------------------------------------------------------------------- 26. CONTINGENCIES AND COMMITMENTS\nUSX is the subject of, or party to, a number of pending or threatened legal actions, contingencies and commitments relating to the U. S. Steel Group involving a variety of matters, including laws and regulations relating to the environment. Certain of these matters are discussed below. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the U. S. Steel Group financial statements. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably to the U. S. Steel Group.\nLEGAL PROCEEDINGS -\nB&LE litigation In 1994, USX paid $367 million to satisfy substantially all judgments against the B&LE in the Lower Lake Erie Iron Ore Antitrust Litigation. Two remaining plaintiffs in this case have had their damage claims remanded for retrial. A new trial may result in awards more or less than the original asserted claims of $8 million and would be subject to trebling.\nIn a separate lawsuit brought by Armco Steel, settlement was reached in 1994 with immaterial financial impact.\nPickering litigation In 1992, the United States District Court for the District of Utah Central Division issued a Memorandum Opinion and Order in Pickering v. USX relating to pension and compensation claims by approximately 1,900 employees of USX's former Geneva (Utah) Works. Although the court dismissed a number of the claims by the plaintiffs, it found that USX had violated the Employee Retirement Income Security Act by interfering with the accrual of pension benefits of certain employees and amending a benefit plan to reduce the accrual of future benefits without proper notice to plan participants. Further proceedings were held to determine damages for a sample group and, pending the court's determinations, USX may appeal. Plaintiffs' counsel has been reported as estimating plaintiffs' anticipated recovery to be in excess of $100 million. USX believes actual damages will be substantially less than plaintiffs' estimates. In 1994, USX entered into settlement agreements with 227 plaintiffs providing for releases of liability against USX and the aggregate payment of approximately $1 million by USX.\nENVIRONMENTAL MATTERS -\nThe U. S. Steel Group is subject to federal, state, and local laws and regulations relating to the environment. These laws generally provide for control of pollutants released into the environment and require responsible parties to undertake remediation of hazardous waste disposal sites. Penalties may be imposed for noncompliance. Accrued liabilities for remediation totaled $141 million and $151 million at December 31, 1994 and December 31, 1993, respectively. It is not presently possible to estimate the ultimate amount of all remediation costs that might be incurred or the penalties that may be imposed.\nFor a number of years, the U. S. Steel Group has made substantial capital expenditures to bring existing facilities into compliance with various laws relating to the environment. In 1994 and 1993, such capital expenditures totaled $57 million and $53 million, respectively. The U. S. Steel Group anticipates making additional such expenditures in the future; however, the exact amounts and timing of such expenditures are uncertain because of the continuing evolution of specific regulatory requirements.\nGUARANTEES -\nGuarantees by USX of the liabilities of affiliated entities of the U. S. Steel Group totaled $171 million at December 31, 1994, and $209 million at December 31, 1993. In the event that any defaults of guaranteed liabilities occur, USX has access to its interest in the assets of the affiliates to reduce U. S. Steel Group losses resulting from these guarantees. As of December 31, 1994, the largest guarantee for a single affiliate was $87 million.\nCOMMITMENTS -\nAt December 31, 1994, and December 31, 1993, contract commitments for the U. S. Steel Group's capital expenditures for property, plant and equipment totaled $125 million and $105 million, respectively.\nUSX has entered into a 15-year take-or-pay arrangement which requires the U. S. Steel Group to accept pulverized coal each month or pay a minimum monthly charge. In 1994 and 1993, such charges for deliveries of pulverized coal totaled $24 and $14 million (deliveries began in 1993), respectively. In the future, the U. S. Steel Group will be obligated to make minimum payments of approximately $16 million per year. If USX elects to terminate the contract early, a maximum termination payment of $126 million, which declines over the duration of the agreement, may be required.\nThe U. S. Steel Group is a party to a transportation agreement with Transtar for Great Lakes shipments of raw materials required by the U. S. Steel Group. The agreement cannot be canceled until 1999 and requires the U. S. Steel Group to pay, at a minimum, Transtar's annual fixed costs related to the agreement, including lease\/charter costs, depreciation of owned vessels, dry dock fees and other administrative costs. Total transportation costs under the agreement were $70 million in 1994 and $68 million in 1993, including fixed costs of $21 million in each year. The fixed costs are expected to continue at approximately the same level over the duration of the agreement.\nS-20\nSELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\n(a) Primary and fully diluted earnings per share are computed independently for each of the quarters presented. Therefore the sum of the quarterly earnings per share in 1994 and 1993 does not equal the total computed for the year due primarily to the effect of the 6.50% Convertible Preferred Stock on the quarterly calculations during 1994, and stock transactions which occurred during 1993.\n(b) Composite tape.\nPRINCIPAL UNCONSOLIDATED AFFILIATES (UNAUDITED)\n(a) Economic interest as of December 31, 1994.\nSUPPLEMENTARY INFORMATION ON MINERAL RESERVES (UNAUDITED)\nSee the USX consolidated financial statements for Supplementary Information on Mineral Reserves relating to the U. S. Steel Group, page U-30.\nS-21\nFIVE-YEAR OPERATING SUMMARY\n(a) In July 1991, U. S. Steel closed all iron and steel producing operations at Fairless (PA) Works. In April 1992, U. S. Steel closed South (IL) Works.\n(b) In June 1993, U. S. Steel sold the Cumberland coal mine. In March 1994, U. S. Steel closed the Maple Creek coal mine.\n(c) U. S. Steel ceased production of structural products when South Works closed in April 1992.\nS-22 THE STEEL GROUP Management's Discussion and Analysis\nThe U. S. Steel Group includes U. S. Steel, which is primarily engaged in the production and sale of steel mill products, coke and taconite pellets. The U. S. Steel Group also includes the management of mineral resources, domestic coal mining, engineering and consulting services and technology licensing (together with U. S. Steel, the \"Steel and Related Businesses\"). Other businesses that are part of the U. S. Steel Group include real estate development and management, and leasing and financing activities. Management's Discussion and Analysis should be read in conjunction with the U. S. Steel Group's Financial Statements and Notes to Financial Statements.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF INCOME\nTHE U. S. STEEL GROUP'S SALES increased by $454 million in 1994 from 1993, following an increase of $693 million in 1993 from 1992. The increase in 1994 primarily reflected an increase in steel shipment volumes of approximately 0.6 million tons, higher average steel prices and increased commercial shipments of coke, partially offset by lower commercial shipments of coal. The increase in 1993 relative to 1992 primarily reflected an increase in steel shipment volumes of approximately 1.1 million tons, higher average steel prices and increased commercial shipments of taconite pellets and coke.\nTHE U. S. STEEL GROUP REPORTED OPERATING INCOME of $313 million in 1994, compared with an operating loss of $149 million in 1993 and an operating loss of $241 million in 1992. The 1993 operating loss included a $342 million charge for the Lower Lake Erie Iron Ore Antitrust Litigation against the Bessemer & Lake Erie Railroad (\"B&LE litigation\") (which also resulted in $164 million of interest costs) (see Note 5 to the U. S. Steel Group Financial Statements) and restructuring charges of $42 million related to the planned closure of the Maple Creek coal mine and preparation plant. Excluding these items, operating results in 1994 improved by $78 million over 1993 primarily due to higher steel prices and shipment volumes. These were partially offset by higher pension, labor and scrap metal costs, the absence of a $39 million favorable effect from the utilization of funds from previously established insurance reserves to pay for certain employee insurance benefits, the adverse effects of utility curtailments and other severe winter weather complications, a caster fire at Mon Valley Works and planned outages for modernization of the Gary Works hot strip mill and pickle line.\nThe operating loss in 1992 included a charge of $10 million for completion of the portion of the 1991 restructuring plan related to steel facilities. Excluding the effect of this item and the 1993 items previously discussed, operating results increased by $466 million from 1992 to 1993. The increase in 1993 was primarily due to higher steel shipment volumes and prices, improved operating efficiencies and lower accruals for environmental and legal contingencies, other than the B&LE litigation mentioned above. In addition, 1993 results benefited from a $39 million favorable effect from the utilization of funds from previously established insurance reserves, as discussed above, lower provisions for loan losses by USX Credit and the absence of a 1992 unfavorable effect of $28 million resulting from market valuation provisions for foreclosed real estate assets. These were partially offset by higher hourly steel labor costs, unfavorable effects associated with pension and other employee benefits, lower results from coal operations and a $21 million increase in operating costs related to the adoption of Statement of Financial Accounting Standards No. 112 - Employers' Accounting for Post Employment Benefits (\"SFAS No. 112\").\nOTHER INCOME was $75 million in 1994, compared with $210 million in 1993 and $5 million in 1992. Results in 1993 included higher gains from the disposal of assets, including the sale of the Cumberland coal mine, the realization of a $70 million deferred gain resulting from the collection of a subordinated note related to the 1988 sale of Transtar, Inc. (\"Transtar\") (which also resulted in $37 million of interest income) and the sale of an investment in an insurance\nS-23 Management's Discussion and Analysis continued\ncompany. Excluding these items, results in 1994 improved by $50 million over 1993 mainly due to increased income from equity affiliates.\nINTEREST AND OTHER FINANCIAL INCOME was $12 million in 1994, compared with $59 million in 1993 and $18 million in 1992. The 1993 amount included $37 million of interest income resulting from the collection of the Transtar note, as previously mentioned.\nINTEREST AND OTHER FINANCIAL COSTS were $152 million in 1994, compared with $330 million in 1993 and $176 million in 1992. The 1993 amount included $164 million of interest expense related to the B&LE litigation.\nTHE PROVISION FOR ESTIMATED INCOME TAXES in 1994 was $47 million, compared with credits of $41 million in 1993 and $123 million in 1992. The provision for 1994 included a one-time $32 million deferred tax benefit related to an excess of tax over book basis in an equity affiliate (see Note 12 to the U. S. Steel Group Financial Statements). The credit for 1993 included a $15 million favorable effect associated with an increase in the federal income tax rate from 34% to 35%, reflecting remeasurement of deferred federal income tax assets as of January 1, 1993, offset by adjustments for prior years' Internal Revenue Service examinations.\nNET INCOME in 1994 was $201 million, compared with a net loss of $238 million in 1993 and a net loss of $1.606 billion in 1992. Excluding the unfavorable cumulative effect of changes in accounting principles, which totaled $69 million and $1.335 billion in 1993 and 1992, respectively, net income increased $370 million in 1994 from 1993, compared with an increase of $102 million in 1993 from 1992. The changes in net income primarily reflect the factors discussed above.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION\nCURRENT ASSETS at year-end 1994 increased $218 million from year-end 1993 primarily due to an increase in deferred income tax benefits and trade receivables partially offset by a decrease in cash and cash equivalent balances. The U. S. Steel Group financial statements reflect current and deferred tax assets and liabilities that relate to tax attributes utilized and recognized on a consolidated basis and attributed in accordance with the USX Corporation (\"USX\") group tax allocation policy. See Notes 3 and 12 to the U. S. Steel Group Financial Statements.\nCURRENT LIABILITIES in 1994 decreased $356 million from 1993 primarily due to a decrease in accounts payable that principally resulted from payments of $367 million in 1994 relative to the B&LE litigation.\nTOTAL LONG-TERM DEBT AND NOTES PAYABLE at December 31, 1994 was $1.453 billion. The $109 million decrease from year-end 1993 reflected, in part, a reduction of cash and cash equivalent balances. An additional decrease resulted from the U. S. Steel Group's adoption of the equity method of accounting for RMI Titanium Company. The amount of total long-term debt, as well as the amount shown as notes payable, principally represented the U. S. Steel Group's portion of USX debt attributed to all three groups. Virtually all of the debt is a direct obligation of, or is guaranteed by, USX. For a discussion of financial obligations and the issuance of Steel Stock, see Management's Discussion and Analysis of Cash Flows below.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF CASH FLOWS\nTHE U. S. STEEL GROUP'S NET CASH PROVIDED FROM OPERATING ACTIVITIES in 1994 was $44 million, compared with $86 million in 1993. The 1994 and 1993 periods reflect payments of $367 million and $219 million, respectively, to satisfy substantially all judgments from the B&LE litigation. In addition, the 1993 period was negatively affected by payments of $95 million related\nS-24\nManagement's Discussion and Analysis continued\nto the settlement of the Energy Buyers litigation offset by a $103 million favorable effect from the use of available funds from previously established insurance reserves to pay for certain active and retired employee insurance benefits. Excluding these items, net cash provided from operating activities improved by $114 million in 1994.\nThe U. S. Steel Group's net cash provided from operating activities in 1993, excluding the previously mentioned items, was $297 million compared with net cash used in operating activities of $89 million in 1992. The increase mainly reflected improved profitability.\nCAPITAL EXPENDITURES totaled $248 million in 1994, compared with $198 million in 1993 and $298 million in 1992. Spending over this period included completion of the continuous caster at Mon Valley Works and modernization of the hot strip mill and electrogalvanizing line at Gary Works. Increased spending in 1994 compared with 1993 reflected modernization of the pickle line at Gary Works, replacement of a coke oven gas transmission line from Clairton to Mon Valley and the preparation for a blast furnace reline at Mon Valley Works. Contract commitments for capital expenditures at year-end 1994 were $125 million, compared with $105 million at year-end 1993. Capital expenditures for 1995 are expected to be approximately $300 million and will include spending on a degasser at Mon Valley Works, a granulated coal injection facility at Fairfield Works' blast furnace, a galvanizing line in the southern United States, as well as additional environmental expenditures. Capital expenditures in 1996 and 1997 are currently expected to remain at about the same level as in 1995.\nCASH FROM DISPOSAL OF ASSETS totaled $19 million in 1994, compared with $291 million in 1993 and $39 million in 1992. The 1993 amount primarily reflected the realization of proceeds from a subordinated note related to the 1988 sale of Transtar and the sales of the Cumberland coal mine and investments in an insurance company and a foreign manganese mining affiliate.\nFINANCIAL OBLIGATIONS decreased by $20 million in 1994, compared with a decrease of $730 million in 1993 and an increase of $203 million in 1992. The decrease in 1994 primarily reflected the effects of proceeds from the issuance of USX - U. S. Steel Group Common Stock (\"Steel Stock\") and a reduction of cash and cash equivalent balances, partially offset by the net effects of cash from operating, investing and other financing activities. These obligations consist of the U. S. Steel Group's portion of USX debt and preferred stock of a subsidiary attributed to all three groups as well as debt and financing agreements specifically attributed to the U. S. Steel Group. For a discussion of USX financing activities attributed to all three groups, see USX Consolidated Management's Discussion and Analysis of Cash Flows.\nPREFERRED STOCK ISSUED totaled $336 million in 1993. This amount was due to the sale of 6,900,000 shares of 6.50% Convertible Preferred ($50.00 liquidation preference per share) to the public for net proceeds of $336 million which were reflected in their entirety in the U. S. Steel Group financial statements. The 6.50% Convertible Preferred is convertible at any time into shares of Steel Stock at a conversion price of $46.125 per share of Steel Stock.\nSTEEL STOCK ISSUED totaled $221 million in 1994, $366 million in 1993 and $212 million in 1992. This included public offerings of 5,000,000 shares in 1994 for net proceeds of $201 million, 10,000,000 shares in 1993 for net proceeds of $350 million and 8,050,000 shares in 1992 for net proceeds of $198 million. These amounts were reflected in their entirety in the U. S. Steel Group financial statements.\nPENSION PLAN ACTIVITY\nIn accordance with USX's long-term funding practice, which is designed to maintain an appropriate funded status, USX will resume funding the U. S. Steel Group's principal pension plan in amounts of approximately $100 million per year commencing with the 1994 plan year. The funding for the 1994 plan year and possibly the 1995 plan year will take place in 1995.\nS-25\nManagement's Discussion and Analysis continued\nRATING AGENCY ACTIVITY\nIn September 1993, Standard & Poor's Corp. lowered its ratings on USX's and Marathon Oil Company's (\"Marathon\") senior debt to below investment grade (from BBB- to BB+) and on USX's subordinated debt, preferred stock and commercial paper. In October 1993, Moody's Investors Services, Inc. (\"Moody's\") confirmed its Baa3 investment grade ratings on USX's and Marathon's senior debt. Moody's also confirmed its ratings on USX's subordinated debt and commercial paper, but lowered its ratings on USX's preferred stock from ba1 to ba2. The ratings described above remain unchanged.\nHEDGING ACTIVITY\nThe U. S. Steel Group engages in hedging activities in the normal course of its business. Commodity swaps are used to hedge exposure to price fluctuations relevant to the purchase of natural gas. While hedging activities are generally used to reduce risks from unfavorable price movements, they also may limit the opportunity to benefit from favorable movements. The U. S. Steel Group's hedging activities have not been significant in relation to its overall business activity. Based on risk assessment procedures and internal controls in place, management believes that its use of hedging instruments will not have a material adverse effect on the financial position, liquidity or results of operations of the U. S. Steel Group. See Notes 2 and 24 to the U. S. Steel Group Financial Statements.\nLIQUIDITY\nFor discussion of USX's liquidity and capital resources, see USX Consolidated Management's Discussion and Analysis of Cash Flows.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF ENVIRONMENTAL MATTERS, LITIGATION AND CONTINGENCIES\nThe U. S. Steel Group has incurred and will continue to incur substantial capital, operating and maintenance, and remediation expenditures as a result of environmental laws and regulations. In recent years, these expenditures have been mainly for process changes in order to meet Clean Air Act obligations, although ongoing compliance costs have also been significant. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of the U. S. Steel Group's products and services, operating results will be adversely affected. The U. S. Steel Group believes that all of its domestic competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities and its production methods.\nThe U. S. Steel Group's environmental expenditures for the last three years were:\n(a) Based on U.S. Department of Commerce survey guidelines. (b) These amounts do not include noncash provisions recorded for environmental remediation, but include spending charged against such reserves.\nThe U. S. Steel Group's environmental capital expenditures accounted for 23%, 27% and 17% of total capital expenditures in 1994, 1993 and 1992, respectively.\nS-26\nManagement's Discussion and Analysis continued\nCompliance expenditures represented 4% of the U. S. Steel Group's total operating costs in 1994, and 3% in both 1993 and 1992. Remediation spending during 1992 to 1994 was mainly related to dismantlement and restoration activities at former and present operating locations.\nUSX has been notified that it is a potential responsible party (\"PRP\") at 28 waste sites related to the U. S. Steel Group under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") as of December 31, 1994. In addition, there are 24 sites related to the U. S. Steel Group where USX has received information requests or other indications that USX may be a PRP under CERCLA but where sufficient information is not presently available to confirm the existence of liability. There are also 44 additional sites related to the U. S. Steel Group where remediation is being sought under other environmental statutes, both federal and state. At many of these sites, USX is one of a number of parties involved and the total cost of remediation, as well as USX's share thereof, is frequently dependent upon the outcome of investigations and remedial studies. The U. S. Steel Group accrues for environmental remediation activities when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable. As environmental remediation matters proceed toward ultimate resolution or as additional remediation obligations arise, charges in excess of those previously accrued may be required. See Note 26 to the U. S. Steel Group Financial Statements.\nNew or expanded environmental requirements, which could increase the U. S. Steel Group's environmental costs, may arise in the future. USX intends to comply with all legal requirements regarding the environment, but since many of them are not fixed or presently determinable (even under existing legislation) and may be affected by future legislation, it is not possible to accurately predict the ultimate cost of compliance, including remediation costs which may be incurred and penalties which may be imposed. However, based on presently available information, and existing laws and regulations as currently implemented, the U. S. Steel Group does not anticipate that environmental compliance expenditures (including operating and maintenance and remediation) will materially increase in 1995. The U. S. Steel Group's capital expenditures for environmental controls are expected to be approximately $60 million in 1995. These amounts will primarily be spent on projects at Gary Works. Predictions beyond 1995 can only be broad-based estimates which have varied, and will continue to vary, due to the ongoing evolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified projects, the U. S. Steel Group anticipates that environmental capital expenditures will be approximately $70 million in 1996; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed.\nUSX is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments relating to the U. S. Steel Group involving a variety of matters, including laws and regulations relating to the environment, certain of which are discussed in Note 26 to the U. S. Steel Group Financial Statements. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the U. S. Steel Group financial statements. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably to the U. S. Steel Group.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS\nThe U. S. Steel Group reported operating income of $313 million in 1994, compared with operating losses of $149 million in 1993 and $241 million in 1992. The operating loss for 1993 included a $342 million charge for the B&LE litigation. The 1993 and 1992 operating losses\nS-27\nManagement's Discussion and Analysis continued\nincluded restructuring charges of $42 million and $10 million, respectively, which are discussed below.\n* Certain reclassifications have been made to conform to 1994 classifications.\nSTEEL AND RELATED BUSINESSES recorded operating income of $239 million in 1994, compared with operating income of $123 million in 1993 and an operating loss of $140 million in 1992. Results in 1993 benefited from a $39 million favorable effect from the utilization of funds from previously established insurance reserves to pay for certain employee insurance benefits. Excluding this item, operating results for 1994 improved by $155 million over 1993 primarily due to higher steel shipment volumes and prices. These positive factors were partially offset by higher pension, labor and scrap metal costs, the adverse effects of utility curtailments and other severe winter weather complications, a caster fire at the Mon Valley Works and planned outages for modernization of the Gary Works hot strip mill and pickle line.\nThe improvement in 1993 compared with 1992, excluding the item mentioned above, was mainly due to higher steel shipment volumes and prices, improved operating efficiencies and lower accruals for environmental and legal contingencies. These benefits were partially offset by higher hourly steel labor costs, unfavorable effects associated with pension and other employee benefits, including higher costs following the adoption of SFAS No. 112 and lower results from coal operations.\nAverage realized steel prices improved $19 per ton in 1994, compared with an $8 per ton improvement in 1993.\nSteel shipments were 10.6 million tons in 1994, compared with 10.0 million tons in 1993 and 8.8 million tons in 1992. U. S. Steel Group shipments comprised approximately 11% of the domestic steel market in 1994. Exports accounted for approximately 4% of U. S. Steel Group shipments in 1994, compared with 4% in 1993 and 7% in 1992.\nRaw steel production was 11.7 million tons in 1994, compared with 11.3 million tons in 1993 and 10.4 million tons in 1992. Raw steel produced was nearly 100% continuous cast in 1994 and 1993 versus 83% in 1992. U. S. Steel completed its continuous cast modernization program with the start-up of the Mon Valley Works continuous caster in August 1992. Raw steel production averaged 97% of capability in 1994, compared with 96% of capability in 1993 and 86% of capability in 1992. As a result of improvements in operating efficiency, U. S. Steel has increased its stated annual raw steel production capability by 0.5 million tons to 12.5 million tons for 1995.\nOil country tubular goods (\"OCTG\") accounted for 3.6% of U. S. Steel Group shipments in 1994. On June 30, 1994, in conjunction with six other domestic producers, USX filed antidumping and countervailing duty cases with the U.S. Department of Commerce (\"Commerce\") and the International Trade Commission (\"ITC\") asserting that seven foreign nations have engaged in unfair trade practices with respect to the export of OCTG. On August 15, 1994, the ITC unanimously issued a preliminary ruling that there is a reasonable indication that domestic OCTG producers may have been injured by illegal subsidies and dumping. By the end of January 1995, Commerce had issued its preliminary determinations of the applicable margins of dumping and subsidies in the OCTG cases. Total margins ranging from 44.2% to 51.2% were found against producers in Austria, Italy and Japan. The total margin against Union Steel of Korea was 12.17% and against producers in Argentina was 0.61%. No margins were found for producers in Mexico\nS-28\nManagement's Discussion and Analysis continued\nand Spain as well as for Hyundai of Korea. Commerce is scheduled to make final determinations of applicable margins in June, and it is anticipated that the ITC will render its final determinations of injury to the domestic industry in July. USX will file additional antidumping and countervailing duty petitions if unfairly traded imports adversely impact, or threaten to adversely impact, the results of the U. S. Steel Group. For additional information regarding levels of imported steel, see Outlook below.\nThe U. S. Steel Group depreciates steel assets by modifying straight-line depreciation based on the level of production. Depreciation charges for 1994, 1993 and 1992 were 102%,100% and 91%, respectively, of straight-line depreciation based on production levels for each of the years. The U. S. Steel Group does not expect that depreciation charges in 1995 will be materially impacted as a result of the increase in raw steel production capability discussed above. See Note 2 to the U. S. Steel Group Financial Statements.\nThe U. S. Steel Group entered into a five and one-half year contract with the United Steelworkers of America, effective February 1, 1994, covering approximately 15,000 employees. The agreement will result in higher labor and benefit costs for the U. S. Steel Group each year throughout the term of the agreement. The agreement also provided for the establishment of a Voluntary Employee Benefit Association Trust to prefund health care and life insurance benefits for retirees covered under the agreement. A payment of $25 million was made in the first quarter of 1995 relative to the 1994 contract year, with additional funding of $10 million expected later in 1995 and $10 million per year thereafter for the duration of the contract. The funding of the trust will have no immediate effect on income of the U. S. Steel Group. Management believes that this agreement is competitive with labor agreements reached by U. S. Steel's major domestic integrated competitors and thus does not believe that U. S. Steel's competitive position with regard to such other competitors will be materially affected by this agreement.\nThe U. S. Steel Group has certain profit sharing plans in place that will require payments of approximately $10 million to be made in 1995 based on 1994 results. Improved financial results in 1995 could increase costs associated with these plans, with payments required in 1996.\nIn October 1994, the U. S. Steel Group entered into a letter of intent with Nucor Corporation and Praxair, Inc. for the establishment of a joint venture to develop a new technology to produce steel directly from iron carbide. The parties would initially conduct a feasibility study of the iron carbide to steel process. If the feasibility study proves successful, the joint venture company would construct a demonstration plant to develop and evaluate the commercial feasibility of the steelmaking process.\nADMINISTRATIVE AND OTHER BUSINESSES includes the portion of pension credits, postretirement benefit costs and certain other expenses principally attributable to the former businesses of the U. S. Steel Group as well as USX corporate general and administrative costs allocated to the U. S. Steel Group. Administrative and Other Businesses recorded operating income of $74 million in 1994, compared with operating losses of $230 million in 1993 and $91 million in 1992. The 1993 operating loss included a $342 million charge for the B&LE litigation (see Note 5 to the U. S. Steel Group Financial Statements). Excluding this item, operating results decreased $38 million in 1994 and increased $203 million in 1993 primarily due to a charge incurred in 1992 to cover the amount of the award in the Energy Buyers litigation and a credit in 1993 as a result of the settlement of all claims in the case. In addition, 1992 results included a $28 million charge resulting from market valuation provisions for foreclosed real estate assets and as well as provisions for loan losses by USX Credit. Loan losses were $11 million in 1994, $11 million in 1993 and $42 million in 1992.\nThe pension credits referred to in Administrative and Other Businesses, combined with pension costs for ongoing operating units of the U. S. Steel Group, resulted in net pension credits (which are primarily noncash) of $120 million, $202 million and $231 million in 1994, 1993 and 1992, respectively. The decrease over the three-year period was primarily due to a lower expected long-term rate of return on plan assets. In 1995, net pension credits are expected to remain at\nS-29\nManagement's Discussion and Analysis continued\napproximately the same level as in 1994. See Note 10 to the U. S. Steel Group Financial Statements.\nThe U. S. Steel Group's 1993 operating loss included restructuring charges of $42 million related to the planned closure of the Maple Creek coal mine and preparation plant. The 1992 loss included a charge of $10 million for completion of the portion of the 1991 restructuring plan related to steel facilities.\nIn December 1994, the U. S. Steel Group and Maple Creek Mining, Inc. entered into a letter of intent for the sale of the Maple Creek Mine and Preparation Plant. The parties intend to close the sale in April 1995 contingent on certain conditions, including financing and governmental approvals. Completion of the sale is not expected to have a material effect on the U. S. Steel Group's financial statements.\nOUTLOOK\nBased on strong recent order levels and favorable steel market conditions, the U. S. Steel Group anticipates that steel demand will remain strong in 1995, although domestic industry shipments for 1995 may decrease slightly from the 1994 level of 95 million tons. Market prices for steel products have generally remained firm because of strong demand. Price increases for most steel products were implemented effective January 1, 1995, including increases in long-term contract prices with several major customers. Additional price increases for sheet products have been announced effective July 2, 1995.\nSteel imports to the United States accounted for an estimated 25%, 19% and 17% of the domestic steel market in 1994, 1993 and 1992, respectively. The domestic steel industry has, in the past, been adversely affected by unfairly traded imports, and higher levels of imported steel may ultimately have an adverse effect on product prices and shipment levels.\nU. S. Steel Group shipments in the first quarter of 1995 are expected to be lower than the previous quarter as some customers increased purchases prior to the January 1, 1995 price increases, and there may be some weakness in shipments to automotive companies which have recently announced some reductions in build schedules. During the first quarter of 1995, raw steel production will be reduced by planned blast furnace outages at Gary Works and Fairfield Works.\nThe Financial Accounting Standards Board intends to issue \"Accounting for the Impairment of Long-Lived Assets\" in the near future. This standard, which is expected to be effective for 1996, requires that operating assets be written down to fair value whenever an impairment review indicates that the carrying value cannot be recovered on an undiscounted cash flow basis. After any such noncash writedown of operating assets, results of operations would be favorably affected by reduced depreciation, depletion and amortization charges. USX will be initiating an extensive review to implement the anticipated standard and, at this time, cannot provide an assessment of either the impact or the timing of adoption, although it is possible that the U. S. Steel Group may be required to recognize certain charges upon adoption. Under current accounting policy, USX generally has only impaired property, plant and equipment under the provisions of Accounting Principles Board Opinion No. 30 and its interpretations.\nS-30 DELHI GROUP\nIndex to Financial Statements, Supplementary Data and Management's Discussion and Analysis\nD-1\nDELHI GROUP\nExplanatory Note Regarding Financial Information\nAlthough the financial statements of the Delhi Group, the Marathon Group and the U. S. Steel Group separately report the assets, liabilities (including contingent liabilities) and stockholders' equity of USX attributed to each such group, such attribution of assets, liabilities (including contingent liabilities) and stockholders' equity among the Delhi Group, the Marathon Group and the U. S. Steel Group for the purpose of preparing their respective financial statements does not affect legal title to such assets or responsibility for such liabilities. Holders of USX - Delhi Group Common Stock, USX - Marathon Group Common Stock and USX - Steel Group Common Stock are holders of common stock of USX, and continue to be subject to all the risks associated with an investment in USX and all of its businesses and liabilities. Financial impacts arising from one Group that affect the overall cost of USX's capital could affect the results of operations and financial condition of other groups. In addition, net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Accordingly, the USX consolidated financial information should be read in connection with the Delhi Group financial information.\nD-2 Management's Report\nThe accompanying financial statements of the Delhi Group are the responsibility of and have been prepared by USX Corporation (USX) in conformity with generally accepted accounting principles. They necessarily include some amounts that are based on best judgments and estimates. The Delhi Group financial information displayed in other sections of this report is consistent with these financial statements.\nUSX seeks to assure the objectivity and integrity of its financial records by careful selection of its managers, by organizational arrangements that provide an appropriate division of responsibility and by communications programs aimed at assuring that its policies and methods are understood throughout the organization.\nUSX has a comprehensive formalized system of internal accounting controls designed to provide reasonable assurance that assets are safeguarded and that financial records are reliable. Appropriate management monitors the system for compliance, and the internal auditors independently measure its effectiveness and recommend possible improvements thereto. In addition, as part of their audit of the financial statements, USX's independent accountants, who are elected by the stockholders, review and test the internal accounting controls selectively to establish a basis of reliance thereon in determining the nature, extent and timing of audit tests to be applied.\nThe Board of Directors pursues its oversight role in the area of financial reporting and internal accounting control through its Audit Committee. This Committee, composed solely of nonmanagement directors, regularly meets (jointly and separately) with the independent accountants, management and internal auditors to monitor the proper discharge by each of its responsibilities relative to internal accounting controls and the consolidated and group financial statements.\nCharles A. Corry Robert M. Hernandez Lewis B. Jones Chairman, Board of Directors Vice Chairman Vice President Chief Executive Officer & Chief Financial Officer & Comptroller\nReport of Independent Accountants\nTo the Stockholders of USX Corporation:\nIn our opinion, the accompanying financial statements appearing on pages D-4 through D-18 present fairly, in all material respects, the financial position of the Delhi Group at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of USX'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 11, page D-13, in 1992 USX adopted a new accounting standard for income taxes.\nThe Delhi Group is a business unit of USX Corporation (as described in Note 1, page D-7); accordingly, the financial statements of the Delhi Group should be read in connection with the consolidated financial statements of USX Corporation.\nPrice Waterhouse LLP 600 Grant Street, Pittsburgh, Pennsylvania 15219-2794 February 14, 1995\nD-3 Statement of Operations\nIncome Per Common Share of Delhi Stock\n(a) For period from October 2, 1992, to December 31, 1992. See Note 1, page D-7, for basis of presentation and Note 19, page D-16, for a description of net income per common share.\nPro Forma Income Per Common Share of Delhi Stock (Unaudited)\nSee Note 24, page D-18, for a description of pro forma income per common share. The accompanying notes are an integral part of these financial statements.\nD-4\nBalance Sheet\nThe accompanying notes are an integral part of these financial statements.\nD-5\nStatement of Cash Flows\nSee Note 7, page D-11, for supplemental cash flow information. The accompanying notes are an integral part of these financial statements.\nD-6\nNotes to Financial Statements\n1. BASIS OF PRESENTATION\nOn October 2, 1992, USX Corporation (USX) publicly sold 9,000,000 shares of a new class of common stock, USX - Delhi Group Common Stock (Delhi Stock), which is intended to reflect the performance of the Delhi Group. As a result, USX has three classes of common stock, the others being USX - Marathon Group Common Stock (Marathon Stock) and USX - U. S. Steel Group Common Stock (Steel Stock), which are intended to reflect the performance of the Marathon Group and the U. S. Steel Group, respectively. The Delhi Group includes the businesses of the Delhi Gas Pipeline Corporation (DGP) and certain other subsidiaries of USX. The Delhi Group is engaged in the purchasing, gathering, processing, transporting and marketing of natural gas.\nThe financial data for the periods presented prior to October 2, 1992, reflected the combined historical financial position, results of operations and cash flows for the businesses of the Delhi Group which were included in the financial statements of the Marathon Group. Beginning October 2, 1992, the financial statements of the Delhi Group include the financial position, results of operations and cash flows for the businesses of the Delhi Group; the effects of the capital structure of the Delhi Group determined by the Board of Directors in accordance with the USX Certificate of Incorporation; and a portion of the corporate assets and liabilities and related transactions which are not separately identified with ongoing operating units of USX. Pro forma data is reported for the year 1992 to reflect the results of operations as if the capital structure of the Delhi Group was in effect beginning January 1, 1992 (Note 24, page D-18). The Delhi Group financial statements are prepared using the amounts included in the USX consolidated financial statements.\nThe USX Board of Directors has designated 14,003,205 shares of Delhi Stock as the total number of shares of Delhi Stock which it deemed to represent 100% of the common stockholders' equity value of USX attributable to the Delhi Group as of December 31, 1994. The Delhi Fraction is the percentage interest in the Delhi Group represented by the shares of Delhi Stock that are outstanding at any particular time and, based on 9,437,891 outstanding shares at December 31, 1994, is approximately 67%. The Marathon Group financial statements reflect a Retained Interest in the Delhi Group of approximately 33% at December 31, 1994. The Retained Interest is subject to reduction as shares of Delhi stock attributed to the Retained Interest are sold. (See Note 3, page D-9, for a description of common stock transactions.)\nAlthough the financial statements of the Delhi Group, the Marathon Group and the U. S. Steel Group separately report the assets, liabilities (including contingent liabilities) and stockholders' equity of USX attributed to each such group, such attribution of assets, liabilities (including contingent liabilities) and stockholders' equity among the Delhi Group, the Marathon Group and the Steel Group for the purpose of preparing their respective financial statements does not affect legal title to such assets or responsibility for such liabilities. Holders of Delhi Stock, Marathon Stock and Steel Stock are holders of common stock of USX, and continue to be subject to all the risks associated with an investment in USX and all of its businesses and liabilities. Financial impacts arising from one Group that affect the overall cost of USX's capital could affect the results of operations and financial condition of other groups. In addition, net losses of any Group, as well as dividends and distributions on any class of USX Common Stock and series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Accordingly, the USX consolidated financial information should be read in connection with the Delhi Group financial information.\nDuring 1994, 1993 and 1992 sales to one customer who accounted for 10 percent or more of the Delhi Group's total revenues totaled $71.7 million, $76.4 million and $55.4 million, respectively. In addition, sales to several customers having a common parent aggregated $54.7 million, $66.3 million and $63.2 million during 1994, 1993 and 1992, respectively.\nD-7\n- ------------------------------------------------------------------------------- 2. SUMMARY OF PRINCIPAL ACCOUNTING POLICIES\nPRINCIPLES APPLIED IN CONSOLIDATION - These financial statements include the accounts of the businesses comprising the Delhi Group. Beginning October 2, 1992, the Delhi Group, the Marathon Group and the U. S. Steel Group financial statements, taken together, comprise all of the accounts included in the USX consolidated financial statements.\nInvestments in jointly-owned gas processing plants are accounted for on a pro rata basis.\nInvestments in other entities in which the Delhi Group has significant influence in management and control are accounted for using the equity method of accounting and are carried in the investment account at the Delhi Group's share of net assets plus advances. The proportionate share of income from equity investments is included in other income. Investments in marketable equity securities are carried at lower of cost or market.\nCASH AND CASH EQUIVALENTS - Cash and cash equivalents includes cash on hand and on deposit and highly liquid debt instruments with maturities generally of three months or less.\nINVENTORIES - Inventories are carried at lower of average cost or market.\nHEDGING TRANSACTIONS - The Delhi Group engages in commodity hedging within the normal course of its activities (Note 21, page D-16). Management has been authorized to manage exposure to price fluctuations relevant to the purchase or sale of natural gas through the use of a variety of derivative financial and nonfinancial instruments. Derivative financial instruments require settlement in cash and include such instruments as over-the-counter (OTC) commodity swap agreements and OTC commodity options. Derivative nonfinancial instruments require or permit settlement by delivery of commodities and include exchange-traded commodity futures contracts and options. Changes in the market value of derivative instruments are deferred and subsequently recognized in income, as sales or cost of sales, in the same period as the hedged item. OTC swaps are off-balance-sheet instruments; therefore, the effect of changes in the market value of such instruments are not recorded until settlement. The margin accounts for open commodity futures contracts, which reflect daily settlements as market values change, are recorded as accounts receivable. Premiums on all commodity-based option contracts are initially based on the amount paid or received; the options' market value is subsequently recorded as accounts receivable or accounts payable, as appropriate.\nForward currency contracts are used to manage currency risks related to USX attributed debt denominated in a foreign currency. Gains or losses related to firm commitments are deferred and included with the hedged item; all other gains or losses are recognized in income in the current period as interest income or expense, as appropriate. For balance sheet reporting, net contract values are included in receivables or payables, as appropriate.\nRecorded deferred gains or losses are reflected within other noncurrent assets or deferred credits and other liabilities. Cash flow from the use of derivative instruments are reported in the same category as the hedged item in the statement of cash flows.\nPROPERTY, PLANT AND EQUIPMENT - Depreciation is generally computed on a straight-line method based upon estimated lives of assets.\nWhen an entire pipeline system, plant, major facility or facilities depreciated on an individual basis are sold or otherwise disposed of, any gain or loss is reflected in income. Proceeds from disposal of other facilities depreciated on a group basis are credited to the depreciation reserve with no immediate effect on income.\nINSURANCE - The Delhi Group is insured for catastrophic casualty and certain property exposures, as well as those risks required to be insured by law or contract. Costs resulting from noninsured losses are charged against income upon occurrence.\nPOSTEMPLOYMENT BENEFITS - In 1993, USX adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (SFAS No. 112). SFAS No. 112 requires employers to recognize the obligation to provide postemployment benefits on an accrual basis if certain conditions are met. The Delhi Group is affected primarily by disability-related claims covering indemnity and medical payments. The obligation for these claims is measured using actuarial techniques and assumptions including appropriate discount rates. The effects in 1993 were not material.\nRECLASSIFICATIONS - Certain reclassifications of prior years' data have been made to conform to 1994 classifications.\nD-8\n- ------------------------------------------------------------------------------- 3. CORPORATE ACTIVITIES\nBeginning October 2, 1992, the following corporate activities were reflected in the Delhi Group financial statements.\nFINANCIAL ACTIVITIES - As a matter of policy, USX manages most financial activities on a centralized, consolidated basis. Such financial activities include the investment of surplus cash; the issuance, repayment and repurchase of short-term and long-term debt; the issuance, repurchase and redemption of preferred stock; and the issuance and repurchase of common stock. The initial capital structure of the Delhi Group determined by the Board of Directors pursuant to the USX Certificate of Incorporation as of June 30, 1992, reflects the Delhi Group's portion of USX's financial activities attributed to each of the three groups. Subsequent to June 30, 1992, transactions related primarily to invested cash, short-term and long-term debt (including convertible debt), related net interest and other financial costs, and preferred stock and related dividends are attributed to the Delhi Group, as well as to the Marathon Group and the U. S. Steel Group, based upon the cash flows of each group for the periods presented. Most financing transactions are attributed to and reflected in the financial statements of all three groups. See Note 5, page D-10 for the Delhi Group's portion of USX's financial activities attributed to all three groups. However, transactions such as leases, certain collateralized financings, production payment financings, financial activities of consolidated entities which are less than wholly owned by USX and transactions related to securities convertible solely into any one class of common stock are or will be specifically attributed to and reflected in their entirety in the financial statements of the group to which they relate.\nCORPORATE GENERAL & ADMINISTRATIVE COSTS - Corporate general and administrative costs are allocated to the Delhi Group, the Marathon Group and the U. S. Steel Group based upon utilization or other methods management believes to be reasonable and which consider certain measures of business activities, such as employment, investments and sales. Such costs were also reflected in the historical financial data of the businesses of the Delhi Group. The costs allocated to the Delhi Group were $1.7 million, $1.4 million and $1.5 million in 1994, 1993 and 1992, respectively, and primarily consist of employment costs including pension effects, professional services, facilities and other related costs associated with corporate activities.\nCOMMON STOCK TRANSACTIONS - The proceeds from issuances of Delhi Stock representing shares attributable to the Retained Interest will be reflected in the financial statements of the Marathon Group (Note 1, page D-7). All proceeds from issuances of additional shares of Delhi Stock not deemed to represent the Retained Interest will be reflected in their entirety in the financial statements of the Delhi Group. When a dividend or other distribution is paid or distributed in respect to the outstanding Delhi Stock, or any amount paid to repurchase shares of Delhi Stock generally, the Marathon Group financial statements are credited, and the Delhi Group financial statements are charged, with the aggregate transaction amount times the quotient of the Retained Interest divided by the Delhi Fraction.\nINCOME TAXES - All members of the USX affiliated group are included in the consolidated United States federal income tax return filed by USX. Accordingly, the provision for federal income taxes and the related payments or refunds of tax are determined on a consolidated basis. The consolidated provision and the related tax payments or refunds will be reflected in the Delhi Group, the Marathon Group and the U. S. Steel Group financial statements in accordance with USX's tax allocation policy. In general, such policy provides that the consolidated tax provision and related tax payments or refunds are allocated among the Delhi Group, the Marathon Group and the U. S. Steel Group, for financial statement purposes, based principally upon the financial income, taxable income, credits, preferences and other amounts directly related to the respective groups.\nFor tax provision and settlement purposes, tax benefits resulting from attributes (principally net operating losses), which cannot be utilized by one of the three groups on a separate return basis but which can be utilized on a consolidated basis in that year or in a carryback year, are allocated to the group that generated the attributes. However, if such tax benefits cannot be utilized on a consolidated basis in that year or in a carryback year, the prior years' allocation of such consolidated tax effects is adjusted in a subsequent year to the extent necessary to allocate the tax benefits to the group that would have realized the tax benefits on a separate return basis.\nThe allocated group amounts of taxes payable or refundable are not necessarily comparable to those that would have resulted if the groups had filed separate returns; however, such allocation should not result in any of the three groups paying more taxes over time than it would if it filed separate tax returns and, in certain situations, could result in any of the three groups paying less.\nD-9\n- ------------------------------------------------------------------------------- 4. RESTRUCTURING CHARGES\nIn mid-1994, the planned disposition of certain nonstrategic gas gathering and processing assets and other investments resulted in a $37.4 million charge to operating income and a $2.5 million charge to other income for the write-down of assets to their estimated net realizable value. Disposition of these assets is expected to be completed in 1995. - -------------------------------------------------------------------------------\n5. FINANCIAL ACTIVITIES ATTRIBUTED TO ALL THREE GROUPS\nThe following is Delhi Group's portion of USX's financial activities attributed to all groups based on their respective cash flows as described in Note 3, page D-9.\n(a) For details of USX long-term debt, preferred stock of subsidiary and preferred stock, see Notes 13, page U-20; 24, page U-25; and 18, page U-22, respectively, to the USX consolidated financial statements. (b) Primarily reflects forward currency contracts used to manage currency risks related to USX debt and interest denominated in a foreign currency. (c) The Delhi Group's net interest and other financial costs reflect weighted average effects of all financial activities attributed to all three groups. The costs reported for 1992 are for the period October 2, 1992, to December 31, 1992.\n- -------------------------------------------------------------------------------- 6. LONG-TERM DEBT\nThe Delhi Group's portion of USX's consolidated long-term debt is as follows:\n(a) See Note 13, page U-20, to the USX consolidated financial statements for details of interest rates, maturities and other terms of long-term debt. (b) Most long-term debt activities of USX Corporation and its wholly owned subsidiaries are attributed to all three groups (in total, but not with respect to specific debt issues) based on their respective cash flows (Notes 3, page D-9; 5, page D-10; and 7, page D-11).\nD-10\n- -------------------------------------------------------------------------------- 7. SUPPLEMENTAL CASH FLOW INFORMATION\n- ------------------------------------------------------------------------------- 8. OTHER ITEMS\n(a) Gain includes the sale of Red River Pipeline partnership. (b) See Note 3, page D-9, for discussion of USX interest and other financial costs attributable to the Delhi Group.\nD-11\n- ------------------------------------------------------------------------------- 9. INTERGROUP TRANSACTIONS\nSALES AND PURCHASES - Delhi Group sales to the Marathon Group totaled $4.1 million, $4.3 million and $4.3 million in 1994, 1993 and 1992, respectively. Delhi Group purchases from the Marathon Group totaled $41.6 million, $30.3 million and $31.2 million in 1994, 1993 and 1992, respectively. These transactions were conducted on an arm's-length basis. See Note 16, page D-14, for sales of Delhi Group receivables to the Marathon Group.\nRECEIVABLE FROM\/PAYABLE TO OTHER GROUPS - These amounts represent receivables or payables for income taxes determined in accordance with the tax allocation policy described in Note 11, page D-13. Tax settlements between the groups are generally made in the year succeeding that in which such amounts are accrued.\n- ------------------------------------------------------------------------------- 10. PENSIONS\nThe Delhi Group has a noncontributory defined benefit plan covering all employees over 21 years of age who have one or more years of continuous service. Benefits are based primarily on years of service and compensation during the later years of employment. The funding policy for the plan provides that payments to the pension trust shall be equal to the minimum funding requirements of ERISA plus such additional amounts as may be approved from time to time. The plan also provides benefits to certain employees of the Marathon Group which are not part of the Delhi Group.\nPENSION COST (CREDIT) - The defined benefit cost for 1994, 1993 and 1992 was determined assuming an expected long-term rate of return on plan assets of 9%, 10% and 11%, respectively.\n(a) The curtailment loss in 1994 resulted from a work force reduction program.\nFUNDS' STATUS - The assumed discount rate used to measure the benefit obligations was 8% and 6.5% at December 31, 1994, and December 31, 1993, respectively. The assumed rate of future increases in compensation levels was 4.5% at both year ends.\nD-12\n- -------------------------------------------------------------------------------- 11. INCOME TAXES\nIncome tax provisions and related assets and liabilities attributed to the Delhi Group are determined in accordance with the USX group tax allocation policy (Note 3, page D-9).\nIn 1992, USX adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), which requires an asset and liability approach in accounting for income taxes. Under this method, deferred income tax assets and liabilities are established to reflect the future tax consequences of carryforwards and differences between the tax bases and financial bases of assets and liabilities.\nProvisions (credits) for estimated income taxes:\nReconciliation of federal statutory tax rate (35% in 1994 and 1993, and 34% in 1992) to total provisions (credits):\nDeferred tax liabilities primarily relate to property, plant and equipment:\nThe consolidated tax returns of USX for the years 1988 through 1991 are under various stages of audit and administrative review by the IRS. USX believes it has made adequate provision for income taxes and interest which may become payable for years not yet settled.\n- -------------------------------------------------------------------------------- 12. LEASES\nFuture minimum commitments for operating leases having remaining noncancelable lease terms in excess of one year are as follows:\nOperating lease rental expense:\nThe Delhi Group leases a wide variety of facilities and equipment under operating leases, including building space, office equipment and production equipment. Contingent rental includes payments for the lease of a pipeline system owned by an affiliate; payments to the lessor are based on the volume of gas transported through the pipeline system less certain operating expenses. Most long-term leases include renewal options and, in certain leases, purchase options.\nD-13\n- -------------------------------------------------------------------------------- 13. LONG-TERM RECEIVABLES AND OTHER INVESTMENTS\n(a) The 25% interest in Ozark Gas Transmission System (Ozark) was written down in mid-1994 in connection with the planned disposition of assets (Note 4, page D-10), and recording of equity income was suspended. The sale of Ozark is expected to be completed in the second quarter of 1995, subject to certain government approvals.\nThe following financial information summarizes the Delhi Group's share in investments accounted for by the equity method:\n- -------------------------------------------------------------------------------- 14. INVENTORIES\n- -------------------------------------------------------------------------------- 15. PROPERTY, PLANT AND EQUIPMENT\n16. SALES OF RECEIVABLES\nCertain of the Delhi Group accounts receivables are sold in combination with the Marathon Group receivables under a limited recourse agreement. Payments are collected from the sold accounts receivable; the collections are reinvested in new accounts receivable for the buyers; and a yield, based on short-term market rates, is transferred to the buyers. Collections on sold accounts receivable will be forwarded to the buyers at the end of the agreement in 1995, in the event of earlier contract termination or if the Delhi Group does not have a sufficient quantity of eligible accounts receivable to reinvest in for the buyers. The balance of sold accounts receivable averaged $72.5 million, $69.1 million and $56.9 million for the years 1994, 1993 and 1992, respectively. At December 31, 1994, the balance of the Delhi Group's sold accounts receivable that had not been collected was $68.3 million. A substantial portion of the Delhi Group's sales are to local distribution companies and electric utilities. This could impact the Delhi Group's overall exposure to credit risk inasmuch as these customers could be affected by similar economic or other conditions. The Delhi Group does not generally require collateral for accounts receivable, but significantly reduces credit risk through credit extension and collection policies, which include analyzing the financial condition of potential customers, establishing credit limits, monitoring payments and aggressively pursuing delinquent accounts. In the event of a change in control of USX, as defined in the agreement, the Delhi Group may be required to forward payments collected on sold Delhi Group accounts receivable to the buyers.\nD-14\n- ------------------------------------------------------------------------------- 17. EQUITY\n(a) Transactions with USX included cash management, intergroup sales and purchases (Note 9, page D-12), settlement of federal income taxes with USX (Note 3, page D-9) and allocation of corporate general and administrative costs (Note 3, page D-9). Cash management reflected net distributions to USX of $65.5 million in 1992. (b) Pursuant to the USX Certificate of Incorporation and the capital structure of the Delhi Group determined by the Board of Directors, the USX equity investment in the Delhi Group was eliminated on October 2, 1992, in conjunction with the attribution of the Delhi Group's portion of USX's financial activities attributed to all groups (Note 3, page D-9) and the USX common stockholders' equity value, attributed to the 14,000,000 shares of Delhi Stock initially deemed to represent 100% of the initial common stockholders' equity in the Delhi Group.\n- ------------------------------------------------------------------------------- 18. DIVIDENDS\nIn accordance with the USX Certificate of Incorporation, dividends on the Delhi Stock, Marathon Stock and Steel Stock are limited to the legally available funds of USX. Net losses of any Group, as well as dividends and distributions on any class of USX Common Stock or series of preferred stock and repurchases of any class of USX Common Stock or series of preferred stock at prices in excess of par or stated value, will reduce the funds of USX legally available for payment of dividends on all classes of Common Stock. Subject to this limitation, the Board of Directors intends to declare and pay dividends on the Delhi Stock based on the financial condition and results of operations of the Delhi Group, although it has no obligation under Delaware law to do so. In making its dividend decisions with respect to Delhi Stock, the Board of Directors considers among other things, the long-term earnings and cash flow capabilities of the Delhi Group as well as the dividend policies of similar publicly traded companies.\nDividends on the Delhi Stock are further limited to the Available Delhi Dividend Amount. At December 31, 1994, the Available Delhi Dividend Amount was at least $104.6 million. The Available Delhi Dividend Amount will be increased or decreased, as appropriate, to reflect Delhi Net Income, dividends, repurchases or issuances with respect to the Delhi Stock and preferred stock attributed to the Delhi Group and certain other items.\nD-15\n- ------------------------------------------------------------------------------- 19. NET INCOME PER COMMON SHARE\nThe method of calculating net income (loss) per share for the Delhi Stock, Marathon Stock and Steel Stock reflects the USX Board of Directors' intent that the separately reported earnings and surplus of the Delhi Group, the Marathon Group and the U. S. Steel Group, as determined consistent with the USX Certificate of Incorporation, are available for payment of dividends to the respective classes of stock, although legally available funds and liquidation preferences of these classes of stock do not necessarily correspond with these amounts.\nNet income per share applicable to outstanding Delhi Stock is presented for periods subsequent to the October 2, 1992, initial issuance of Delhi Stock. (See Note 24, page D-18, for pro forma income per common share.)\nPrimary net income per share is calculated by adjusting net income for dividend requirements of preferred stock and income applicable to the Retained Interest and is based on the weighted average number of common shares outstanding plus common stock equivalents, provided they are not antidilutive. Common stock equivalents result from assumed exercise of stock options and surrender of stock appreciation rights associated with stock options, where applicable.\nFully diluted net income (loss) per share assumes exercise of stock options and surrender of stock appreciation rights, provided, in each case, the effect is not antidilutive.\n- ------------------------------------------------------------------------------- 20. STOCK PLANS AND STOCKHOLDER RIGHTS PLAN\nUSX Stock Plans and Stockholder Rights Plan are discussed in Note 19, page U-23 and Note 23, page U-25, respectively, to the USX consolidated financial statements.\n- ------------------------------------------------------------------------------- 21. DERIVATIVE FINANCIAL INSTRUMENTS\nUSX has used forward currency contracts to manage currency risks related to debt denominated in Swiss francs and European currency units, a portion of which has been attributed to the Delhi Group.\nThe Delhi Group also has used derivative nonfinancial instruments such as exchange-traded commodity contracts to help protect its natural gas margins.\nThe Delhi Group remains at risk for possible changes in the market value of the hedging instrument; however, such risk should be mitigated by price changes in the underlying hedged item. The Delhi Group is also exposed to credit risk in the event of nonperformance by counterparties. The credit worthiness of counterparties is subject to continuing review, including the use of master netting agreements to the extent practical, and full performance is anticipated.\nThe following table sets forth quantitative information for the attributed forward currency contracts:\n(a) The fair value amounts are based on dealer quoted market prices. (b) Contract amounts do not quantify risk exposure.\nD-16\n- -------------------------------------------------------------------------------- 22. FAIR VALUE OF FINANCIAL INSTRUMENTS\nFair value of the financial instruments disclosed herein is not necessarily representative of the amount that could be realized or settled, nor does the fair value amount consider the tax consequences of realization or settlement. As described in Note 3, page D-9, the Delhi Group's specifically attributed financial instruments and the Delhi Group's portion of USX's financial instruments attributed to all groups are as follows:\nFair value of financial instruments classified as current assets or liabilities approximate carrying value due to the short-term maturity of the instruments. Fair value of long-term receivables and other investments was based on discounted cash flows or other specific instrument analysis. Fair value of long-term debt instruments was based on market prices where available or current borrowing rates available for financings with similar terms and maturities.\nIn addition to certain derivative financial instruments disclosed in Note 21, page D-16, the Delhi Group's unrecognized financial instruments consist of accounts receivables sold subject to limited recourse. It is not practicable to estimate the fair value of this form of financial instrument obligation because there are no quoted market prices for transactions which are similar in nature. For details relating to sales of receivables see Note 16, page D-14.\n- ------------------------------------------------------------------------------- 23. CONTINGENCIES\nUSX is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments relating to the Delhi Group involving a variety of matters, including laws and regulations relating to the environment as discussed below. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the Delhi Group financial statements. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably to the Delhi Group.\nENVIRONMENTAL MATTERS -\nThe Delhi Group is subject to federal, state and local laws and regulations relating to the environment. These laws generally provide for control of pollutants released into the environment and require responsible parties to undertake remediation of hazardous waste disposal sites. Penalties may be imposed for noncompliance. Expenditures for remediation and penalties have not been material.\nFor a number of years, the Delhi Group has made capital expenditures to bring existing facilities into compliance with various laws relating to the environment. In 1994 and 1993, such capital expenditures totaled approximately $4.6 million and $4.5 million, respectively. The Delhi Group anticipates making additional such expenditures in the future; however, the exact amounts and timing of such expenditures are uncertain because of the continuing evolution of specific regulatory requirements.\nD-17\n- -------------------------------------------------------------------------------- 24. PRO FORMA INCOME PER COMMON SHARE (UNAUDITED)\nIncome per share data applicable to outstanding Delhi Stock is reported on a pro forma basis for the year 1992 to reflect the per share income as if the capital structure of the Delhi Group was in effect beginning January 1, 1992. The capital structure of the Delhi Group as of June 30, 1992, was determined by the Board of Directors pursuant to the USX Certificate of Incorporation. Historical income before the cumulative effect of the change in accounting principle was adjusted for the attribution of certain corporate activities (Note 3, page D-9). The pro forma data are not necessarily indicative of the results that would have occurred if the capital structure of the Delhi Group was in effect for the period indicated.\n(a) The adjustment for net interest and other financial costs reflects the weighted average effects of all USX financial activities assumed to be attributed to the Delhi Group for the period prior to October 2, 1992. The adjustment for the provision for estimated income taxes reflects the change in total income before taxes due to recognition of these adjustments. The adjustment to dividends on preferred stock reflects the assumed effects of attributed preferred stock.\n(b) Pro forma income applicable to Retained Interest represents the pro forma income before the cumulative effect of the change in accounting principle less dividends on preferred stock, multiplied by the initial Retained Interest of approximately 36%.\n(c) Pro forma income per share before the cumulative effect of the change in accounting principle applicable to outstanding Delhi Stock is calculated by dividing the pro forma income before the cumulative effect of the change in accounting principle applicable to outstanding Delhi Stock by the pro forma average number of shares outstanding, which assumes 9,000,000 shares initially sold were outstanding for the period.\nPrincipal Unconsolidated Affiliates (Unaudited)\n(a) Economic interest as of December 31, 1994.\nD-18\nSelected Quarterly Financial Data (Unaudited)\n(a) Includes a $4.1 million unfavorable effect associated with an increase in the federal income tax rate from 34% to 35%, reflecting remeasurement of deferred income tax liabilities as of January 1, 1993.\n(b) Composite tape.\nD-19\nFive-Year Operating Summary\n(a) In January 1993, the Delhi Group sold its 25% interest in Red River Pipeline. (b) In 1993, the Delhi Group sold its pipeline systems located in Colorado. (c) In 1994, the Delhi Group sold certain pipeline systems associated with the planned disposition of nonstrategic assets.\nD-20 THE DELHI GROUP Management's Discussion and Analysis\nThe Delhi Group includes Delhi Gas Pipeline Corporation (\"DGP\") and certain other subsidiaries of USX Corporation (\"USX\"), which are engaged in the purchasing, gathering, processing, transporting and marketing of natural gas. Management's Discussion and Analysis should be read in conjunction with the Delhi Group's Financial Statements and Notes to Financial Statements. The financial data presented for the periods prior to October 2, 1992, (with the exception of pro forma data) reflected the combined historical financial position, results of operations and cash flows for the businesses of the Delhi Group. Beginning October 2, 1992, the financial statements of the Delhi Group include the financial position, results of operations and cash flows for the businesses of the Delhi Group and the effects of the capital structure of the Delhi Group which includes a portion of the corporate assets and liabilities and related transactions which are not separately identified with the ongoing operations of USX.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF INCOME\nDelhi Group sales for each of the last three years were:\nTOTAL SALES in 1994 increased by 6% from 1993, mainly due to increased volumes from the Delhi Group's trading business and from short-term interruptible (\"spot\") market sales, partially offset by decreased revenues from Southwestern Electric Power Company (\"SWEPCO\") and other customers, and lower average prices for natural gas and natural gas liquids (\"NGLs\"). Total sales in 1993 increased by 17% from 1992, mainly due to increased revenues from premium services and higher average natural gas sales prices.\nThe OPERATING LOSS for the Delhi Group was $35.8 million in 1994, compared with operating income of $35.6 million in 1993 and $32.6 million in 1992. The operating loss in 1994 included charges of $37.4 million for the planned disposition of certain non-strategic assets, expenses of $1.7 million related to a work force reduction program, other employment-related costs of $2.0 million and a $1.6 million favorable effect of the settlement of litigation related to a prior-year take-or-pay claim. Operating income in 1993 included favorable effects of $1.8 million for the reversal of a prior-period accrual related to a natural gas contract settlement, $0.8 million related to gas imbalance settlements and a net $0.6 million for a refund of prior years' sales taxes. Excluding the effects of these items, operating income in 1994 was $3.7 million, down $28.7 million from 1993 operating income of $32.4 million. This decrease was due particularly to a decline in gas sales premiums from SWEPCO, as well as lower margins from other customers, partially offset by higher natural gas throughput volumes, and lower depreciation expense due to the previously mentioned asset disposition plan.\nD-21 Management's Discussion and Analysis continued\nOperating income in 1992 included favorable effects totaling $1.5 million relating to the settlement of various lawsuits and third-party disputes. Excluding the effects of the items noted, operating income in 1993 improved by $1.3 million from 1992, primarily as a result of higher gas sales margin and lower operating and other expenses, partially offset by a 34% decline in gas processing margin from the extraction and sale of NGLs. See Management's Discussion and Analysis of Operations below for further discussion of operating income.\nOTHER LOSS of $0.9 million in 1994 included a $2.5 million restructuring charge, partially offset by a $0.8 million pretax gain on disposal of assets. Other income of $5.2 million in 1993 included a pretax gain of $2.9 million on disposal of assets and a $0.9 million favorable pretax effect recognizing the expiration of certain obligations related to an asset acquisition. The disposal of assets in 1993 included pretax gains of $0.8 million on the sale of non-strategic Colorado gas gathering systems and $1.6 million on the sale of the Delhi Group's interest in a natural gas transmission partnership. The 1993 U.S. income tax provision included a $2.9 million unfavorable tax effect associated with the sale of the transmission partnership interest, which resulted in a $1.3 million net loss on the transaction.\nINTEREST AND OTHER FINANCIAL COSTS increased by $1.3 million in 1994 and $5.9 million in 1993. The increase in 1994 primarily reflected higher expense associated with the sale of certain of the Delhi Group's accounts receivables, as the yield paid to the buyer increased with market interest rates. Interest and other financial costs in 1994 and 1993 included $8.3 million and $7.7 million, respectively, representing the Delhi Group's portion of USX's financial activities attributable to all three groups. Interest and other financial costs in 1992 included interest expense of $2.1 million, representing the Delhi Group's portion of USX's financial activities attributable to all three groups for the period October 2, 1992, through December 31, 1992.\nTHE CREDIT FOR ESTIMATED INCOME TAXES was $17.6 million in 1994, compared with provisions of $18.1 million and $11.1 million in 1993 and 1992, respectively. In addition to the previously mentioned $2.9 million unfavorable tax effect associated with the sale of the Delhi Group's interest in a natural gas transmission partnership, the income tax provision for 1993 included a $4.1 million charge associated with an increase in the federal income tax rate from 34% to 35%, reflecting remeasurement of deferred federal income tax liabilities as of January 1, 1993.\nThe Delhi Group had a NET LOSS of $30.9 million in 1994, compared with NET INCOME of $12.2 million in 1993 and $36.5 million in 1992. The 1994 net loss primarily reflected second quarter charges for the asset disposition plan and lower premiums from natural gas sales. Excluding the $17.9 million favorable cumulative effect of the 1992 adoption of Statement of Financial Accounting Standards No. 109, net income decreased by $6.4 million in 1993 from 1992. Net income presented for the portion of 1992 relating to the period prior to October 2, 1992, reflected the historical income for the businesses of the Delhi Group. Net income for this period does not reflect interest costs and related income tax amounts of the Delhi Group as it was capitalized in accordance with the USX Certificate of Incorporation effective October 2, 1992. However, pro forma income before the cumulative effect of the change in accounting principle of $13.8 million in 1992 is presented as if the capital structure of the Delhi Group was in effect beginning January 1, 1991. See Note 24 to the Delhi Group Financial Statements.\nD-22 Management's Discussion and Analysis continued\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION\nCURRENT ASSETS of $25.8 million at year-end 1994 were $14.6 million lower than the year-end 1993 balance due primarily to a decrease in receivables reflecting, in part, the collection in 1994 of amounts for gas sold to SWEPCO during 1993, related to a natural gas contract dispute which was settled in January 1994. The dispute precluded collection of these receivables in 1993.\nCURRENT LIABILITIES were $89.4 million at year-end 1994, $13.4 million lower than at year-end 1993 due primarily to a decline in accounts payable, mainly reflecting the timing of payments.\nTOTAL LONG-TERM DEBT AND NOTES PAYABLE at December 31, 1994, was $107.5 million. The $3.0 million decrease from year-end 1993 reflected, in part, a reduction of cash and cash equivalent balances. The amount of total long-term debt represented the Delhi Group's portion of USX debt attributed to all three groups. All of the debt is a direct obligation of, or is guaranteed by, USX. For a discussion of financial obligations, see Management's Discussion and Analysis of Cash Flows below.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF CASH FLOWS\nNET CASH PROVIDED FROM OPERATING ACTIVITIES of $19.9 million in 1994 declined $13.3 million from 1993, primarily reflecting the decrease in income, partially offset by favorable working capital changes. These changes mainly reflected the payment of income taxes of $0.5 million in 1994 versus $22.7 million in 1993 and the collection of receivables relating to a natural gas contract dispute with SWEPCO. Cash provided from operating activities in 1993 declined $42.6 million from 1992, primarily reflecting the payment of income taxes totaling $22.7 million in 1993 versus $12.3 million in 1992, an increase in interest paid, a decline in cash realized from the sale of receivables and the delay in collection of receivables mentioned above.\nCAPITAL EXPENDITURES of $32.1 million in 1994 declined by 25% from 1993, following an increase of 60% in 1993 from 1992. Expenditures were primarily for the expansion of existing systems and the acquisition of pipeline systems enabling the Delhi Group to connect additional new dedicated natural gas reserves. Additions to the Delhi Group's dedicated gas reserves totaled 431 billion cubic feet (\"bcf\"), 382 bcf and 273 bcf in 1994, 1993 and 1992, respectively. Expenditures in all three years included amounts for improvements to and upgrades of existing facilities. Expenditures in 1994 included amounts for a pipeline construction project in western Oklahoma and the purchase of three gas treating facilities in east and west Texas, but were substantially below anticipated levels, primarily due to the termination of negotiations for the purchase of gathering and treating facilities in west Texas. Expenditures in 1993 included amounts for a multi-pipeline interconnection and compression project in the Carthage area of east Texas, the acquisition and connection of a 65-mile gas gathering system in west Texas and the purchase, connection and upgrade of a 30 million cubic feet per day (\"mmcfd\") cryogenic gas processing facility near existing systems in south Texas.\nD-23 Management's Discussion and Analysis continued\nCapital expenditures in 1995 are expected to be in the range of $35 million to $45 million. During 1995, the Delhi Group will continue to make capital expenditures to add new dedicated gas reserves, expand existing facilities and acquire new facilities as opportunities arise.\nCASH PROVIDED FROM DISPOSAL OF ASSETS in 1994 totaled $11.8 million, an increase of $7.6 million from 1993, primarily reflecting proceeds of $10.6 million from the sale of non-strategic assets (including the North Louisiana, Denton and Wharton systems) authorized for disposition in 1994. Cash provided from the disposal of assets in 1993 was $4.2 million, an increase of $3.3 million from 1992, primarily reflecting proceeds from the sale of the Delhi Group's interest in a natural gas transmission partnership and the sale of non-strategic gas gathering systems in Colorado.\nFINANCIAL OBLIGATIONS decreased by $0.8 million in 1994. These obligations consist of the Delhi Group's portion of USX debt and preferred stock of a subsidiary attributed to all three groups. The decrease in 1994 primarily reflected a reduction of cash and cash equivalent balances. For discussion of USX financing activities attributed to all three groups, see USX Consolidated Management's Discussion and Analysis of Cash Flows.\nPENSION PLAN ACTIVITY\nDuring 1994, the Delhi Group resumed funding of its pension plan in amounts totaling $0.2 million; funding in 1995 is expected to total approximately $1.1 million.\nRATING AGENCY ACTIVITY\nIn September 1993, Standard and Poor's Corporation lowered its ratings on USX's and Marathon's senior debt to below investment grade (from BBB- to BB+) and on USX's subordinated debt, preferred stock and commercial paper. In October 1993, Moody's Investors Service, Inc. (\"Moody's\") confirmed its Baa3 investment grade ratings on USX's and Marathon's senior debt. Moody's also confirmed its ratings on USX's subordinated debt and commercial paper, but lowered its ratings on USX's preferred stock from ba1 to ba2. The ratings described above remain unchanged.\nHEDGING ACTIVITY\nThe Delhi Group engages in hedging activities in the normal course of its businesses. New York Mercantile Exchange futures contracts and options are used to hedge exposure to price fluctuations relevant to the purchase or sale of natural gas. While hedging activities are generally used to reduce risks from unfavorable price movements, they may also limit the opportunity to benefit from favorable movements. The Delhi Group's hedging activities have not been significant in relation to its overall business activity. However, depending on management's ongoing assessment of market conditions and the associated exposure to price fluctuations, the level of hedging activity could increase in the future. Based on risk assessment procedures and internal controls in place, management believes that its use of hedging instruments will not have a material adverse effect on the financial position, liquidity or results of operations of the Delhi Group. See Notes 2 and 21 to the Delhi Group Financial Statements.\nD-24 Management's Discussion and Analysis continued\nLIQUIDITY\nFor discussion of USX's liquidity and capital resources, see USX Consolidated Management's Discussion and Analysis of Cash Flows.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF ENVIRONMENTAL MATTERS, LITIGATION AND CONTINGENCIES\nThe Delhi Group has incurred and will continue to incur capital and operating and maintenance expenditures as a result of environmental laws and regulations. To the extent these expenditures, as with all costs, are not ultimately reflected in the prices of the Delhi Group's products and services, operating results will be adversely affected. The Delhi Group believes that substantially all of its competitors are subject to similar environmental laws and regulations. However, the specific impact on each competitor may vary depending on a number of factors, including the age and location of its operating facilities and its production processes.\nDelhi Group environmental expenditures for each of the last three years were(a):\n(a) Estimated based on American Petroleum Institute survey guidelines.\nThe Delhi Group's environmental capital expenditures accounted for 14% of total capital expenditures in 1994 and 11% in both 1993 and 1992. Compliance expenditures represented 1% of the Delhi Group's total operating costs in each of the last three years. Remediation expenditures were not material. Some environmental related expenditures, while benefiting the environment, also enhance operating efficiencies.\nNew or expanded environmental requirements, which could increase the Delhi Group's environmental costs, may arise in the future. USX intends to comply with all legal requirements regarding the environment, but since many of them are not fixed or presently determinable (even under existing legislation) and may be affected by future legislation, it is not possible to accurately predict the ultimate cost of compliance, including remediation costs which may be incurred and penalties which may be imposed. However, based on presently available information, and existing laws and regulations as currently implemented, management does not anticipate that environmental compliance expenditures (including operating and maintenance and remediation) will materially increase in 1995. The Delhi Group's capital expenditures for environmental controls are expected to be approximately $5 million in 1995. Predictions beyond 1995 can only be broad-based estimates which have varied, and will continue to vary, due to the ongoing evolution of specific regulatory requirements, the possible imposition of more stringent requirements and the availability of new technologies, among other matters. Based upon currently identified projects, the Delhi Group anticipates that environmental capital expenditures will be approximately $5 million in 1996; however, actual expenditures may vary as the number and scope of environmental projects are revised as a result of improved technology or changes in regulatory requirements and could increase if additional projects are identified or additional requirements are imposed.\nD-25 Management's Discussion and Analysis continued\nUSX is the subject of, or a party to, a number of pending or threatened legal actions, contingencies and commitments relating to the Delhi Group involving a variety of matters, including laws and regulations relating to the environment, certain of which are discussed in Note 23 to the Delhi Group Financial Statements. The ultimate resolution of these contingencies could, individually or in the aggregate, be material to the Delhi Group financial statements. However, management believes that USX will remain a viable and competitive enterprise even though it is possible that these contingencies could be resolved unfavorably to the Delhi Group. See USX Consolidated Management's Discussion and Analysis of Cash Flows.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF OPERATIONS\nRESTRUCTURING AND REORGANIZATION ACTIVITY\nIn June 1994, following a management review of the Delhi Group's overall cost structure and asset base, a plan was approved for the disposition of certain non-strategic assets in Arkansas, Kansas, Louisiana, Oklahoma and Texas, including pipeline systems comprised of approximately 1,500 miles of gas pipeline and four gas processing plants. The Delhi Group recorded noncash pretax restructuring charges totaling $39.9 million in the second quarter of 1994 for the write-down of these assets to estimated net realizable value. Charges of $37.4 million were included in operating costs and a charge of $2.5 million was included in other income (loss). Depreciation expense reductions related to the restructuring totaled $3.1 million in each of the third and fourth quarters of 1994; reductions are expected to total approximately $7.4 million in the year 1995. Proceeds from the sale of restructured assets totaled $10.6 million in 1994. The Delhi Group intends to complete the remaining asset disposals during 1995. At year-end 1994, actual proceeds exceeded estimated amounts by approximately $4.8 million; however, this potential favorable adjustment was not recognized, pending completion of the remaining disposals.\nIn addition to the restructuring charges, the Delhi Group recorded pretax employee reorganization expenses of $1.7 million in the second quarter of 1994, primarily reflecting employee severance and relocation costs associated with a work force reduction program designed to realign the organization with current business conditions. The program resulted in a 15% work force reduction and affected regional and headquarters employees in various job functions. The program resulted in employment cost reductions of approximately $1.8 million during the last six months of 1994 and is expected to result in an annual cost reduction of approximately $5 million, following full implementation.\nOVERVIEW OF OPERATIONS\nThe Delhi Group's operating results are affected by fluctuations in natural gas prices and demand levels in the markets that it serves. The level of gas sales margin is greatly influenced by the demand for premium services and the volatility of natural gas prices. Because the strongest demand for gas and the highest gas sales unit margins generally occur during the winter heating season, the Delhi Group has historically recognized the greatest portion of income from its gas sales business during the first and fourth quarters of the year.\nD-26 Management's Discussion and Analysis continued\nThe Delhi Group buys natural gas from producers connected to its systems, often at prices based on market index prices. The Delhi Group attempts to sell all of the natural gas available on its systems each month. Natural gas volumes not sold to its premium markets are typically sold on the spot market, generally at lower average unit margins than those realized from premium sales. The Delhi Group's four largest customers accounted for 41%, 45% and 39% of its total gross margin and 25%, 18% and 14% of its total systems throughput in 1994, 1993 and 1992, respectively. In situations where one or more of the Delhi Group's largest customers reduce volumes taken under an existing contract, or choose not to renew such contract, the Delhi Group is adversely affected to the extent it is unable to find alternative customers to buy gas at the same level of profitability. Gas sales margin in 1994 declined from 1993 due mainly to lower premiums from SWEPCO, lower margins from Oklahoma Natural Gas Company, declining natural gas prices (which led to lower unit margins from other customers) and warm winter weather in the Delhi Group's prime service areas which shifted volumes normally sold to local distribution customers into the lower-margin spot market. Premiums from SWEPCO declined by $16.2 million in 1994 as compared with 1993, reflecting the renegotiation of a natural gas purchase agreement with provisions for market sensitive prices beginning in February 1994. The downward trend in natural gas prices during 1994 stemmed from the unseasonably mild weather, which led to a softening of demand. This trend could continue as natural gas wellhead deliveries compete with storage withdrawal for market share.\nNatural gas volumes from trading sales averaged 94.7 mmcfd in 1994 (148.5 mmcfd in the fourth quarter). The Delhi Group anticipates continued expansion of its trading business in the future. The trading business involves the purchase of natural gas from sources other than wells directly connected to the Delhi Group's systems, and the subsequent sale of like volumes. Unit margins earned in the trading business are significantly less than those earned on system premium sales.\nThe Delhi Group monitors the economics of removing NGLs from the gas stream for processing on an ongoing basis to determine the appropriate level of each gas plant's operation. Unit margins from gas processing are a function of the sales prices for NGLs, which tend to fluctuate with changes in the price of crude oil, and the cost of natural gas feedstocks from which NGLs are extracted. Due to unfavorable economics in late 1993 and early 1994, the Delhi Group chose to curtail gas processing, resulting in a 22% decline in first quarter 1994 NGLs sales volumes as compared with the first quarter of 1993. During the final three quarters of 1994, average NGLs prices, sales volumes and gas processing gross margins improved significantly from the depressed first quarter 1994 levels. Despite this improvement, average gas processing gross margin in 1994 was 10% lower than in 1993.\nOPERATING INCOME (LOSS)\nThe Delhi Group recorded an operating loss of $35.8 million in 1994 (which included a $37.4 million restructuring charge), compared with operating income of $35.6 million in 1993 and $32.6 million in 1992. The following discussion provides analyses of gross margin (by principal service) and operating expenses for each of the last three years.\nD-27 Management's Discussion and Analysis continued\nGAS SALES AND TRADING MARGIN, GAS SALES THROUGHPUT AND TRADING SALES VOLUMES for each of the last three years were:\nGas sales and trading margin decreased by 33% in 1994 from 1993, following an increase of 9% in 1993 from 1992. The decrease in 1994 mainly reflected a decline in premiums due to the renegotiation of a gas purchase agreement with SWEPCO, reduced demand from local distribution customers induced by mild weather in the Delhi Group's core service areas, and a downward trend in natural gas prices during 1994 which led to lower average unit margins. The improvement in 1993 mainly reflected increased sales to higher-margin customers. Margins on spot sales were affected by fluctuations in natural gas prices throughout most of 1994 and 1993 although overall average prices increased in 1993 from the prior year. Additions to dedicated natural gas reserves in 1994, 1993 and 1992 contributed to the increases in gas sales throughput.\nTRANSPORTATION MARGIN and THROUGHPUT for each of the last three years were:\nTransportation margin decreased by 18% to $11.7 million in 1994 and by 4% to $14.2 million in 1993. The decrease in 1994 was due primarily to lower throughput volumes, reflecting increased competition and natural declines in production on third-party wells. The decrease in 1993 was due primarily to lower average rates, which more than offset the favorable effect of higher average throughput volumes. The changes in transportation volumes and rates during 1993 and 1992 reflected a strategy of offering producers transportation rate incentives in order to increase the Delhi Group's dedicated natural gas reserve base and the supply of gas to its plants. The aggregation of transportation and processing services increased the Delhi Group's overall gross margin during these years, although the transportation rate was lower than the normal rate charged for transportation as a separate service. This rate incentive strategy was temporarily abandoned during much of 1994, due to the downturn in the economics for gas processing.\nGAS PROCESSING MARGIN, NGLS SALES VOLUME AND NGLS SALES PRICE for each of the last three years were:\nThe 10% decline in gas processing margin in 1994 resulted primarily from lower average NGLs prices, partially offset by a decline in average plant feedstock (natural gas) costs. The 34% decline in gas processing margin in 1993 resulted from higher average plant feedstock costs, primarily in the first nine months of 1993, and lower NGLs prices which trended downward with\nD-28 Management's Discussion and Analysis continued\ncrude oil prices in the last half of 1993. NGLs volumes for 1993 increased by 8% from the prior year as the Delhi Group continued to add dedicated natural gas reserves, with the associated gas processing rights, to its systems. However, fourth quarter 1993 NGLs volumes declined by 17% from the third quarter of 1993 as the Delhi Group chose to curtail the extraction of certain NGLs due to a decline in NGLs prices. NGLs volumes declined further in the first quarter of 1994, but rebounded as prices improved during the last three quarters of the year. The Delhi Group will continue to monitor the economics of removing NGLs from the gas stream for processing on an ongoing basis to determine the appropriate level of each gas plant's operation.\nOTHER OPERATING COSTS (not included in gross margin) for each of the last three years were:\nOperating expenses of $29.4 million in 1994 increased by $1.4 million from 1993, due mainly to expenses associated with new gas treating facilities; 1994 operating expenses related to the work force reduction program were mostly offset by associated cost savings. Operating expenses of $28.0 million in 1993 declined by $1.1 million from 1992, due mainly to cost control procedures.\nSelling, general and administrative expenses of $28.7 million in 1994 reflected increased employment-related costs as compared with the prior year, partially offset by net cost savings associated with the work force reduction program and other cost control procedures.\nDepreciation, depletion and amortization of $30.1 million in 1994 declined from 1993 primarily due to the asset disposition plan implemented during the second quarter of 1994. Depreciation, depletion and amortization of $36.3 million in 1993 declined from 1992, mainly due to certain assets becoming fully depreciated during the prior year.\nTaxes other than income taxes in 1993 included a $0.8 million refund of prior-years' sales taxes.\nRestructuring charges reflected the previously mentioned write-down of certain non-strategic assets to estimated net realizable value in the second quarter of 1994 in connection with the asset disposition plan.\nOUTLOOK\nDuring 1995, the Delhi Group expects to complete the restructuring plan begun in the second quarter of 1994, allowing a more concentrated focus on the management of core assets in western Oklahoma and east, west and south Texas. The benefits of the restructuring plan and the 1994 work force reduction program, such as reduced depreciation, operating and other expenses, are expected to continue in 1995.\nD-29 Management's Discussion and Analysis continued\nThe levels of gas sales margin for future periods are difficult to accurately project because of systemic fluctuations in customer demand for premium services, competition in attracting new premium customers and the volatility of natural gas prices. However, continued mild weather in the Delhi Group's core service areas during January 1995 reduced demand for premium services and gas sales margin in the summer of 1995 could be unfavorably affected by the expiration in August 1994 of the Delhi Group's premium service contract with Central Power and Light Company, a utility electric generator serving south Texas. If the mild weather persists, high natural gas inventory levels may continue to put pressure on prices during 1995, as wellhead deliveries compete with storage withdrawals for market share. The volume of trading sales is expected to expand significantly during 1995, although margins earned on trading sales are significantly less than those earned on system premium sales.\nThe levels of gas processing margin for future periods are also difficult to project, due to fluctuations in the price and demand for NGLs and the volatility of natural gas prices (feedstock costs). However, management can reduce the volume of NGLs extracted and sold during periods of unfavorable economics by curtailing the extraction of certain NGLs.\nThe Financial Accounting Standards Board intends to issue \"Accounting for the Impairment of Long-Lived Assets\" in the near future. This standard, which is expected to be effective for 1996, requires that operating assets be written down to fair value whenever an impairment review indicates that the carrying value cannot be recovered on an undiscounted cash flow basis. After any such noncash write-down of operating assets, results of operations would be favorably affected by reduced depreciation, depletion and amortization charges. USX will be initiating an extensive review to implement the anticipated standard and, at this time, cannot provide an assessment of either the impact or the timing of adoption, although it is possible that the Delhi Group may be required to recognize certain charges upon adoption. Under current accounting policy, USX generally has only impaired property, plant and equipment under the provisions of Accounting Principles Board Opinion No. 30 and its interpretations.\nD-30 PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation concerning the directors of USX required by this item is incorporated by reference to the material appearing under the headings \"Election of Directors\" in USX's Proxy Statement for the 1995 Annual Meeting of Stockholders.\nThe executive officers of USX and their ages as of February 1, 1995 are as follows:\nAll of the executive officers have held responsible management or professional positions with USX or its subsidiaries for more than the past five years.\nITEM 11.","section_11":"ITEM 11. MANAGEMENT REMUNERATION\nInformation required by this item is incorporated by reference to the material appearing under the heading \"Executive Compensation and Other Information\" in USX's Proxy Statement dated March 10, 1995, for the 1995 Annual Meeting of Stockholders.\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 material appearing under the headings, \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Directors and Executive Officers\" in USX's Proxy Statement dated March 10, 1995, for the 1995 Annual Meeting of Stockholders.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this item is incorporated by reference to the material appearing under the heading \"Transactions\" in USX's Proxy Statement dated March 10, 1995, for the 1995 Annual Meeting of Stockholders.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K A. DOCUMENTS FILED AS PART OF THE REPORT 1. Financial Statements Financial Statements filed as part of this report are listed on the Index to Financial Statements, Supplementary Data and Management's Discussion and Analysis of USX Consolidated on page U-1, of the Marathon Group on Page M-1, of the U. S. Steel Group on page S-1 and of the Delhi Group on Page D-1.\n2. Financial Statement Schedules and Supplementary Data Financial Statement Schedules are omitted because they are not applicable or the required information is contained in the applicable financial statements or notes thereto.\nSupplementary Data - Summarized Financial Information of Marathon Oil Company . . 73\nB. REPORTS ON FORM 8-K 1.1 None\nC. EXHIBITS Exhibit No.\n12.1 Computation of Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends\n12.2 Computation of Ratio of Earnings to Fixed Charges\n21. List of Significant Subsidiaries\n23. Consent of Independent Accountants\n27. Financial Data Schedule\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 capacity indicated on March 20, 1995.\nUSX CORPORATION\nBy \/s\/ Lewis B. Jones ----------------------------- LEWIS B. JONES VICE PRESIDENT & COMPTROLLER\nSignature Title --------- ----- Chairman of the Board of Directors, \/s\/ Charles A. Corry Chief Executive Officer and Director - ------------------------------------ CHARLES A. CORRY Vice Chairman & Chief Financial Officer \/s\/ Robert M. Hernandez and Director - ------------------------------------ ROBERT M. HERNANDEZ\n\/s\/ Lewis B. Jones Vice President & Comptroller - ------------------------------------ LEWIS B. JONES\n\/s\/ Neil A. Armstrong - ------------------------------------ Director NEIL A. ARMSTRONG\n\/s\/ Victor G. Beghini Director - ------------------------------------ VICTOR G. BEGHINI\n\/s\/ Jeanette G. Brown Director - ------------------------------------ JEANETTE G. BROWN\n\/s\/ James A. D. Geier Director - ------------------------------------ JAMES A. D. GEIER\n\/s\/ Charles R. Lee Director - ------------------------------------ CHARLES R. LEE\n\/s\/ Paul E. Lego Director - ------------------------------------ PAUL E. LEGO\n\/s\/ Ray Marshall Director - ------------------------------------ RAY MARSHALL\n\/s\/ John F. McGillicuddy Director - ------------------------------------ JOHN F. MCGILLICUDDY\n\/s\/ John M. Richman Director - ------------------------------------ JOHN M. RICHMAN\n\/s\/ Seth E. Schofield Director - ------------------------------------ SETH E. SCHOFIELD\n\/s\/ John W. Snow Director - ------------------------------------ JOHN W. SNOW\n\/s\/ Thomas J. Usher Director - ------------------------------------ THOMAS J. USHER\n\/s\/ Douglas C. Yearley Director - ------------------------------------ DOUGLAS C. YEARLY\nSUPPLEMENTARY DATA SUMMARIZED FINANCIAL INFORMATION OF MARATHON OIL COMPANY\nIncluded below is the summarized financial information of Marathon Oil Company, a wholly owned subsidiary of USX Corporation.","section_15":""}
{"filename":"819939_1994.txt","cik":"819939","year":"1994","section_1":"ITEM 1. BUSINESS\nINTRODUCTION\nCytocare, Inc. (the \"Company\" or \"Cytocare\"), a Delaware corporation formed in October 1984, develops, manufactures, markets and services medical devices and therapeutic procedures primarily to treat urologic diseases.\nThe Company exercises active and substantial management and operational controls over the two business units reporting to corporate Cytocare - Medstone International, Inc. and Endocare, Inc.\nMEDSTONE - Cytocare's wholly-owned manufacturing subsidiary, Medstone International, Inc., performs engineering, manufacturing, marketing and field service for its proprietary shockwave lithotripters as well as supplies lithotripter services directly to providers on a fee-for-service basis. Shockwave lithotripsy is the preferred therapy for kidney stone disease.\nENDOCARE - Cytocare's wholly-owned subsidiary, Endocare, Inc., develops, manufactures and markets proprietary laser catheters. It also developed a proprietary surgical diode laser and cryosurgical tools for urological and general surgical use.\nThe Company's current business plan is to separate its operating business units and revenue streams into independent public companies. Management hopes that such a restructuring will benefit shareholders by bringing about operational advantages as well as a more discriminating and favorable valuation of Cytocare.\nMARKETS\nUrological diseases, particularly enlarged prostates, prostate cancer and kidney stones, are major medical afflictions. The average urologist spends about 35% of his time managing prostate diseases and 15% of his time in stone management. The following are estimates of the number of procedures or patients in each of these categories of urological diseases initially identified by the Company as its target markets. The share of the target markets that the Company will obtain will be dependent on successful development of new products, obtaining appropriate regulatory agency approvals, market acceptance of the products, the Company's ability to market, the alternative sources of equivalent products and future developments.\nENLARGED PROSTATES - A majority of males will eventually suffer from enlargement of the prostate, an affliction that progresses with age. It is estimated that 75% of the men over the age of 50 years have symptoms arising from an enlarged prostate and up to 30% of the men who live to age 80 require surgical intervention.\nOf the estimated 10 million men in the U.S. displaying symptoms of enlarged prostate, approximately 5 million avoid seeing a doctor, 4.5 million visit a doctor and are treated by \"watchful waiting\", 34,000 are treated with 5-alpha reductase inhibitor drugs, 100,000 are treated with alpha blocker drugs and 400,000 are treated by surgery. Currently the most common surgical procedure is transurethral resection of the prostate (\"TURP\"). This prostatectomy is the most common surgical procedure performed by urologists. Annually an estimated 400,000 men in the U.S. or 1.2 million men worldwide undergo this procedure to reduce the size of the prostate.\nPROSTATE CANCER - Prostate cancer is the most common cancer in men, being diagnosed in 14% - 16% of males over 50 years of age. Approximately 20% of these become lethal through widespread metastasis resulting in prostate cancer being the third most frequent cause of cancer death in males. In the United States, more than 130,000 men are diagnosed with, and more than 33,000 die from, prostate cancer annually. This translates to approximately 1 in every 11 men developing this disease in their lifetime.\nKIDNEY STONES - In the United States, it is estimated that over 600,000 persons per year suffer from kidney stones and an estimated 300,000 patients per year are hospitalized with a primary kidney stone. Historically, approximately 170,000 of these patients have been treated with shockwave lithotripsy each year.\nPRODUCTS\nCytocare's current and future pipeline of products includes devices, and therapeutics for the treatment of prostate and kidney diseases. The Company has regulatory approval to commercialize five devices including the Medstone STS with a pre-market approval (\"PMA\") and the ProLase II, the ProLase I, the CryoCare Surgical System and the DioLase 60 with a 510(k) notifications. See \"Government Regulation.\"\nSTATUS OF PRODUCTS\nMEDSTONE STS - The Medstone STS (\"System\") is presently being used to treat kidney stones, without invasive surgery, in the U.S. and foreign locations. The Company received a PMA from the United States Food and Drug Administration (\"FDA\") in 1988 authorizing commercial use of the device for treating patients with kidney stones.\nA series of shockwaves are created outside the patient's body and focused to travel through water-based fluids until they enter the body and disintegrate the stone. Each successive shockwave serves to further break apart the stone into smaller particles until, in the case of kidney stones, they are small enough to be passed in the patient's urine. A treatment typically requires 1200-1600 shockwaves in a procedure which lasts 45 to 60 minutes.\nIn addition to the shockwave generator, the Medstone STS's components include a customized X-ray table on which the patient lies horizontally with his or her kidney positioned above the shockwave generator, a computer, an X-ray system, an ultrasound system, and an electrocardiogram (\"ECG\") monitor. The computer generates information regarding the treatment and monitors the patient's condition. The X-ray\/ultrasound system produces images that are converted and analyzed by the computer and then used by the physician for proper positioning and to determine when the kidney stone has been sufficiently disintegrated to terminate the treatment. The ECG monitor supplies the data that allows the computer to synchronize the shockwaves with phases of the patient's heartbeat.\nThe Company has developed and copyrighted all the software that controls the Medstone STS. This software, an integral part of the system and therefore subject to review by regulatory agencies, is licensed for use on a per procedure basis.\nThe Company also has developed and manufactures its own disposable components for use with the Medstone STS. Electrodes manufactured by the Company are used to produce electrical sparks in the shockwave generator part of the device. A disposable coupling bag containing fluid for transmission of the shockwave is placed between the shockwave generator and the patient's back or stomach during the treatment. One complete set of the supplies is normally used in each patient procedure.\nPROLASE I - The Endocare Prolase I side-firing disposable laser catheter is sold under a 510(k) exemption from the FDA authorizing commercial use of the device in conjunction with a Nd:YAG (neodymium) laser or equivalent to deliver higher energy for quicker vaporization of tissue and allows physician to apply high wattage therapy in direct contact to tissue for extended periods of time. See \"Government Regulation.\" The Company's general sales of the device began in July 1994.\nPROLASE II - The Endocare Prolase II side-firing disposable laser catheter is sold under a 510(k) exemption from the FDA authorizing commercial use of the device in conjunction with a Nd:YAG (neodymium) laser or equivalent to deliver energy for incision, excision, ablation and coagulation of urological tissues. See \"Government Regulation.\" The Company's general sales of the device began in January 1993.\nCRYOCARE SURGICAL SYSTEM - The cryosurgical delivery system is designed for the treatment of prostate tumors and other organ confined tumors. The delivery system is a reusable cryoprobe that is introduced transperennially using ultrasound guidance. The cryo system has received a 510(k) exemption and may be released for general sale in 1995 or early 1996.\nDIOLASE 60 - Cytocare's fiber-coupled diode laser system is a compact, air cooled unit designed for surgical laser applications. The diode laser system has received a 510(k) exemption and will be marketed in 1995.\nDISEASES AND TREATMENTS\nENLARGED PROSTATE AND TREATMENT - Enlargement of the prostate, commonly called benign prostatic hyperplasia (\"BPH\"), is the noncancerous enlargement of the innermost part of the prostate and is more accurately a true hyperplastic process in that there is an actual increase in the number of cells. This enlargement of the prostate gland appears to occur with aging in combination with certain pathophysiologic influences. Such enlargement frequently results in a gradual squeezing of the urethra where it runs through the prostate, and becomes symptomatic when it obstructs the outflow of urine from the bladder. Side firing laser catheters, such as ProLase I and ProLase II, are used in a procedure called visual laser ablation prostatectomy (\"VLAP\"). This technique is just one of many therapies urologists use to treat BPH.\nKIDNEY STONES AND TREATMENT - A kidney stone develops when the salt and mineral substances in urine form crystals that stick together and grow in size. In most cases, these crystals are removed from the body by the flow of urine, but they sometimes stick to the lining of the kidney or settle in places where the urine flow fails to carry them away. These crystals may gather and grow into a stone ranging in size from that of a grain of sand to a golf ball. Most stones start to form in the kidney. Some may travel to other parts of the urinary system, such as the ureter or bladder, and grow there.\nStones vary in size, composition, and the ease with which they can be dissolved. In some cases, certain medications may be used to lower the amount of acidity or alkalinity in the urine, thereby dissolving the stones. At present, stones that contain calcium cannot be dissolved. Most stones can be treated with conservative methods.\nThis includes increased fluid intake, changes in diet, and medications. About 90 percent of stones that leave the kidney will pass through the ureter within three to six weeks. Stones that do not pass through the ureter may be removed with the aid of a grasping device (basket). The device is passed through a telescopic instrument (cystoscope) that the doctor inserts into the bladder or ureter (urethroscope). In some cases, the stones are removed whole, but sometimes they must be broken into smaller pieces with ultrasound before they can be removed with the basket.\nThe Medstone STS is a minimally invasive nonsurgical treatment for stones in the kidney and ureter called extracorporeal shockwave lithotripsy. In this method, X-rays are used to target the stone, and then, high energy shockwaves are used to break down the stones into gravel which passes out with urine within a few weeks.\nAlthough most stones can be treated with nonsurgical methods, certain stones still require conventional surgery, particularly when there is internal scarring and obstruction. With conventional surgery, an incision is made over the stone site. The hospital stay and recovery period are several weeks longer than when more conservative techniques are used. Therefore, stones are treated with nonsurgical methods when possible.\nPRODUCTION\nCytocare manufactures, under FDA mandated Good Manufacturing Practice (\"GMP\") requirements, its devices at its plant in Aliso Viejo, California. The Company moved into a new facility in March 1994. Subsequent to that move the Company was audited by the FDA and has received notification from the FDA enabling it to manufacture and market devices in the new facility. The Company has existing capacity to produce sufficient quantities of its shockwave lithotripters and side firing laser catheters to support commercial needs for the foreseeable future.\nPRODUCT DEVELOPMENT\nThe Company has focused its research and development on the products believed to have significant commercial potential in the treatment of urological diseases, as well as developments intended to improve performance and convenience of the lithotripter system and side- firing laser catheter. In addition, the engineering staff is developing a diode laser and cryosurgical products. The Company devotes significant resources to research and development, and will continue to invest significantly in proprietary products. During the years ended December 31, 1992, 1993, and 1994, the Company's expenditures for research and development totalled $2,192,756, $2,333,421, and $1,076,033 respectively.\nPRODUCT LIABILITY AND INSURANCE\nThe Company currently has in force commercial liability insurance, with coverage limits of $1 million per incident, and $2 million on an annual aggregate basis. It also has general umbrella liability insurance with coverage limits of $4 million per incident for a total aggregate amount of $5,000,000 per incident. The Company's insurance policies provide coverage on a claims-made basis and are subject to annual renewal.\nGOVERNMENT REGULATION\nGovernmental regulations in the United States and other countries are a significant factor affecting the research and development, manufacture and marketing of the Company's products. In the United States, the FDA has broad authority under the Federal Food, Drug and Cosmetic Act and the Public Health Service Act to regulate the distribution, manufacture and sale of drugs, including biologics, and medical devices. Foreign sales of drugs and medical devices are subject to foreign governmental regulation and restrictions which vary from country to country.\nDEVICES - Medical devices intended for human use in the United States are classified into three categories, depending upon the degree of regulatory control to which they will be subject. Such devices are classified by regulation into either class I (general controls), class II (performance standards) or class III (pre-market approval) depending upon the level of regulatory control required to provide reasonable assurance of the safety and effectiveness of the device. A class III product, such as the Medstone STS, and class I and II devices for which a PMA is necessary generally require initial Investigational Device Exemption (\"IDE\") approval by the FDA. An IDE permits limited clinical evaluation of the product under controlled conditions. Extensive reporting and monitoring of patient treatments made pursuant to the IDE are required. After the PMA is obtained, the product may be marketed to an unrestricted number of users in the United States, but general medical device regulations regarding FDA inspection of facilities, Good Manufacturing Practices, labeling, maintenance of records and filings with the FDA continue to be applicable.\nA subset of medical devices categorized as class I or II and classified as \"old\" devices, that is, commercially distributed before March 28, 1976 or substantially equivalent to a device that was in commercial distribution before that date, may be marketed after the acceptance of the premarket notification under a 510(k) exemption. The 510(k) section of the Federal Food, Drug and Cosmetic Act allows an exemption from the requirement of premarket notification.\nCytocare has obtained from the California Department of Health Services a license to manufacture medical devices and is subject to periodic inspections and other regulation by that agency.\nCertificate of Need (\"CON\") laws and regulations are in effect in many states. Under such laws, a CON issued by a governmental agency is generally required before the introduction of certain new health care services or before a hospital or other provider can acquire certain new medical equipment or facilities having values exceeding specified amounts. Failure to obtain a required CON may prohibit the purchase of desired equipment or cause the denial of Medicare or other governmental reimbursements or payments for patient treatments. In recent years several states have repealed their CON laws and many other states have made or are considering possible amendments to the laws. Most of the revisions involve raising the thresholds for review, eliminating certain types of facilities or services from review or streamlining the review process.\nPATENTS, COPYRIGHTS, TRADE SECRETS AND LICENSES\nThe Company's policy is to secure and protect intellectual property rights relating to its technology. While Cytocare believes that the protection of patents or licenses is important to its business, it also relies on trade secrets, know-how and continuing technological innovation to maintain its competitive position. The Company has received or filed for certain patents or copyrights for some of the products described under \"Products.\"\nThe Company seeks to preserve the confidentiality of its technology by entering into confidentiality agreements with its employees, consultants, customers, and key vendors and by other means. No assurance can be given, however, that these measures will prevent the unauthorized disclosure or use of such technology.\nCOMPETITION\nThe Company's products currently marketed and under development will be competing with many existing products and therapies for market share. The Company competes with fully integrated device companies, many of which have substantially more experience, financial and other resources and superior expertise in research and development, manufacturing, testing, obtaining regulatory approvals, marketing and distribution.\nProducts under development by the Company are expected to address the urological market. The Company's competition will be determined in part by the particular urological disease to which the Company's\npotential products relate. An important factor in competition may be the timing of market introduction of its or competitive products. Accordingly, the relative speed with which Cytocare can develop products, complete the clinical trials and approval processes and supply commercial quantities of the products to the market are expected to be important competitive factors. The Company expects that competition among products approved for sale will be based on, among other things, product efficacy, safety, reliability, availability, price, patent position and sales, marketing and distribution capabilities. The development by others of new treatment methods could render the Company's products under development non-competitive or obsolete.\nThe Company's competitive position also depends upon its ability to attract and retain qualified personnel, obtain patent protection or otherwise develop proprietary products or processes and secure sufficient capital resources for the often substantial period between technological conception and commercial sales.\nSHOCKWAVE LITHOTRIPTERS - The Company's two principal competitors in shockwave lithotripsy are Dornier, which is part of the Daimler Benz group of German companies, and Siemens GmbH, a German electronic company. In addition, a number of other companies, both in the U.S. and foreign countries, have PMAs to sell their lithotripters for the treatment of kidney stones in the U.S. or are conducting clinical studies on the use of lithotripters for the treatment of kidney stones.\nThe Company believes that, in addition to the obtaining of FDA and other governmental approvals, important competitive factors in the markets for shockwave lithotripters include the reliability, effectiveness in treating patients and pricing of particular systems. The Company believes the Medstone System compares favorably with other lithotripters presently being offered by competitors with respect to the precision of its imaging systems, its ease of patient handling, its simplicity of operation design, its safety features and its success rate in treating patients.\nDISPOSABLE CATHETERS - No less than eight companies are currently marketing or seeking approval to market laser based delivery systems for surgical intervention to release bladder obstructive disease. The principal competitors are C.R. Bard\/Trimedyne, Coherent, Intra- Sonix, Laser Sonics\/Circon Acmi, Laserscope and Surgical Laser Technologies. Key differences among the competing products include visualization (direct or ultrasound), control (balloon, surface contact, hand-guided standoff), power and clinical results (safety and efficacy).\nThe Company believes that its side-firing laser catheters with direct visualization, hand guided placement, up to 100 watts of power and a 510(k) exemption provide a good combination of features available in the market.\nSALES AND MARKETING\nThe Company's current products and pipeline of products are targeted at the urology market. Cytocare has a small, direct sales force, as well as independent sales representatives within the United States. Outside the United States, the Company uses a network of distributors.\nThe Company generates revenue from the sale of equipment, and also from the sale of software licenses, disposable supplies, procedure fees and service contracts to hospitals, physicians, and other health care providers.\nMarketing for the Company's products is accomplished through advertisement in medical journals, direct mail, direct physician contact, company participation in various associations, product exhibition and telephonic marketing.\nBACKLOG - SHOCKWAVE LITHOTRIPSY\nThe Company's lithotripsy equipment sale backlog was $440,000 as of March 20, 1995 and $1,375,000 as of March 7, 1994. Due to the high per unit price of the Medstone Systems, equipment backlog can vary significantly from period to period based upon the number of systems on order. Backlog consists only of orders evidenced by signed contracts for equipment scheduled for delivery and installation within 12 months and does not include revenues for maintenance and per procedure charges, or ProLase II orders.\nWith the maturity of Medstone's lithotripsy business, recurring revenues from fee for service and procedure fees and maintenance services have become a major source of Medstone's revenue stream. Maintenance services are generally provided under annual service contracts, and procedure and fee for service fees are earned based upon usage of the System.\nHUMAN RESOURCES\nAs of March 3, 1995, Cytocare had 60 employees. Of the 60 employees, 6 are engaged directly in research and development activities, 12 are engaged in manufacturing, 14 are engaged in field service, 14 are engaged in sales and marketing and 14 are employed in general and administrative positions.\nAlthough Cytocare conducts most of its research and development using its own employees, the Company has funded, and plans to continue to fund, research using consultants. Consultants provide services under written agreements and are paid based on the amount of time spent on Company matters. Under their consulting agreements, Cytocare's consultants are required to disclose and assign to the Company any ideas, discoveries and inventions developed by them in the course of providing consulting services.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nIn March 1994, the Company took occupancy of new office, manufacturing, engineering, and warehouse space, and research and development laboratories, located in Aliso Viejo, California, under an operating lease with an initial term of two years. The monthly lease rate is $12,500. Upon expiration of the initial two-year term of the above lease in March 1996, the Company has the option to extend the lease in one year segments through March 1999 for modest price increases.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company does not carry director and officer liability insurance, but does have indemnification agreements with its officers and directors and reciprocal indemnifications with the underwriter for its initial public offering.\nIn October 1989 and January 1990, two lawsuits were filed by two shareholders of the Company in the United States District Court for the Central District of California. These lawsuits were filed against the Company, certain current and former officers and the underwriter for the initial public offering in June 1988. The complaints, which seek unspecified amounts in damages, allege principally that adverse material information was not disclosed at the time of the initial public offering and in subsequent periods. Both of the suits were consolidated by the District Court in February, 1990 under the case name Kaplan v. Freeman Rose, et al. (\"Kaplan Action\"). On May 4, 1992, the district court granted summary judgment in favor of the Company on all claims. Plaintiffs filed an appeal of the summary judgment to the Ninth Circuit Court of Appeals.\nThere is a related shareholder class action alleging claims virtually identical to those pled in the Kaplan Action discussed above. In this action entitled Kramer v. Freeman Rose, et al. (\"Kramer Action\"), however,\nplaintiff alleged an additional claim under Section 12(2) of the 1933 Securities Act, 15 U.S.C.S. Section 771(2). The Company sought and obtained a dismissal of the Kramer Action on October 7, 1991, on the ground that the claims were barred by the applicable statute of limitations. Plaintiffs filed a First Amendment Complaint on March 17, 1992. On July 9, 1992, the district court granted the Company's motion to dismiss the First Amended Complaint in the Kramer Action. Plaintiffs filed a notice of appeal to the Ninth Circuit Court of Appeals. The Kramer Action and the Kaplan Action have been consolidated for purposes of appeal only. The Company has opposed the appeal of this litigation of the Kramer action as well.\nIn October 1994, the Company received the opinion of the Ninth Circuit Court of Appeals affirming in part and reversing in part the United States District Court's decision granting summary judgment in favor of the Company and several officers. The Company views this lawsuit as an abusive securities suit diverting resources that could otherwise be used for technical innovation, capital investment and job creation. The Company intends to appeal the Ninth Circuit Court of Appeals opinion to the U.S. Supreme Court.\nIn connection with their manufacture and marketing of the Medstone STS and the ProLase II, the Company is subject to legal actions and claims for personal injuries or property damage related to patients who use its products. The Company has obtained a liability insurance policy providing coverage for product liability and other claims. Management does not believe that the resolution of any such current proceedings will have a material financial impact on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company's annual meeting of shareholders was held on June 22, 1994. At the meeting Errol G. Payne, Frank R. Pope and Paul D. Quadros were elected directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPrior to January 24, 1991, the Company's common stock was traded on the NASDAQ Stock Market under the symbol MSHK. On January 24, 1991, the Company changed its name to Cytocare, Inc. and began trading on the Company's common stock on the NASDAQ Stock Market under the symbol CYTI. The following table sets forth the high and low sales prices of the Company's common stock for the two years ended December 31, 1993 and December 31, 1994 as reported in the NASDAQ National Market System for the quarter indicated.\nAt March 9, 1995, there were 445 stockholders of record of the Company's Common Stock.\nThe Company has not paid any cash dividends on its Common Stock. The future payment by the Company of such dividends, if any, rests within the discretion of the Board of Directors and will depend upon the Company's earnings, capital requirements and financial condition, applicable legal restrictions and other factors deemed relevant by the Board.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCONSOLIDATED STATEMENTS OF OPERATIONS DATA: (in thousands, except per share amounts)\nCONSOLIDATED BALANCE SHEET DATA: (in thousands)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nCytocare has transitioned from a company solely in the medical capital equipment business to one offering devices and therapeutics for urological diseases. While Endocare is focused on prostate diseases, Medstone continues to manufacture, market and maintain lithotripters, and expand its Fee-for-Service Program to supply lithotripsy equipment to providers on per procedure basis. To date, the Company's consolidated revenues have come primarily from Medstone's lithotripsy business.\nDuring 1994, the Company received 510(k) notification for the ProLase I, the CryoCare Surgical System, and the Diolase 60 allowing the Company to manufacture and sell these products in the United States. ProLase I has already started contributing to revenue while both the CryoCare Surgical System and Diolase 60 are expected to go to market in 1995.\nIn March of 1994, the Company moved into a smaller, more efficient facility at a substantial cost saving. This move did require a PMA supplement to be filed with the FDA and an audit from the FDA. The Company has received notification from the FDA that the PMA Supplement was approved for manufacturing at the new facility. The Company expects to receive the benefit of a full year of cost savings in 1995 as a result of this move.\nThe Company as a manufacturer of a capital medical devices has been vertically integrating by offering its medical devices directly to the provider on a per procedure basis. Medstone, the Company's wholly-owned subsidiary, currently offers mobile lithotripsy procedures using five mobile systems in the Western United States on a per procedure basis. With the ability to offer quality equipment at reasonable prices, Medstone intends to continue the growth of this manufacturer direct business.\nBy most financial indicators the Company is in a strong position. The Company has just completed 1994 reporting revenue increased, expenses decreased and net income increased compared to 1993. With a positive cash flow, stable inventories, a conservative asset acquisition strategy, and no long-term debt, the balance sheet ratios have improved.\nThe Company began the year with approximately $11.6 million in cash and marketable securities, no debt, inventories of $1.6 million, and total assets of $17.7 million. The Company ended the year with approximately $14.4 million in cash and marketable securities, no debt, inventories of $1.6 million, total assets of $22.3 million as well as four consecutive profitable years.\nThrough its continuing research and development, management of the Company is putting in place the scientific and engineering base it believes is necessary to carry it through the next phases of its growth plans.\nASSETS\nCash and equivalents and short-term investments increased by $2,848,000 at December 31, 1994 from December 31, 1993 due to the Company's increased sales and efforts to streamline operations and its move into a new, lower-cost facility. All of the Company's invested cash balance is invested in U.S. Treasury Bills at rates of 3.45% to 6.7% with staggered maturities through February of 1996.\nAccounts receivable increased by $208,000 from December 31, 1993 to December 31, 1994 due to the increase in the revenue from the mobile lithotripsy operations and the resulting higher number of customers with receivable balances.\nDeferred tax assets increased by $1,005,000 in the current year due to the Company's acknowledgement of the probability of continued profitability and the utilization of these assets in future periods. The recognition of this deferred tax asset resulted in an extremely low tax provision for 1994.\nPrepaid expenses decreased by $147,000 in the current year due to the utilization of an equipment deposit with a mobile van manufacturer as the Company completed the purchase of two additional vans in 1994.\nFixed assets, cost, increased by $1,300,000 from December 31, 1993 to December 31, 1994 primarily as a result of additions of mobile vans used in the mobile lithotripsy operations.\nOther assets decreased by $110,000 in the current year due to the refund of several deposits held by state taxation agencies and a building landlord of the facility vacated in March 1994.\nLIABILITIES\nAccounts payable at December 31, 1994 decreased by $136,000 compared to December 31, 1993 due to lower spending levels for operating expenses.\nAccrued income taxes decreased $227,000 in the current year due to the recognition of the current year tax provision less prepayments.\nAccrued payroll expenses at December 31, 1994 increased by $102,000 compared to December 31, 1993 due to an increased bonus pool established as a result of profits for the current year.\nDeferred revenue increased $140,000 in the current year due to the increased number of sites under maintenance contract and one two year maintenance agreement.\nCustomer deposits at December 31, 1994 decreased by $141,000 compared to December 31, 1993 due to the recognition of revenue in 1994.\nDeferred tax liabilities increased by $225,000 in the current year due to the Company's recording of its deferred tax assets and liabilities. This amount represents the Company's book\/tax depreciation timing differences.\nSHAREHOLDERS' EQUITY\nAdditional paid-in-capital increased $139,000 in the current year due to the exercise of common stock options held by employees.\nRESULTS OF OPERATIONS\nYear Ended December 31, 1994 Compared to Year ended December 31, 1993\nTotal revenue increased to $16.3 million for the year ended December 31, 1994, a 19% increase from the 1993 revenue of $13.7 million. The increased net equipment sales resulted from an increase in both lithotripsy systems shipped, and an increase in the average lithotripter unit selling price. This equipment revenue gain was slightly offset by a decline in 1994 of upgrades in the Company's installed base of lithotripters from 1993 levels.\nRevenue from procedure and maintenance fees, or recurring revenue, increased in 1994 by $1.7 million, or 15%, from 1993 levels due to the continued expansion of the Company's mobile lithotripsy services and increased revenue from the procedure fees on third-party owned equipment. The volume on mobile lithotripsy services in the Company's vans increased by 81% in 1994 compared to the number of patients treated in 1993. Procedure revenue increased by 18% in 1994 as the utilization for the Company's equipment owned by third parties continues to increase. The number of procedures performed on third party-owned lithotripters in the United States increased\nby 27% from 1993 to 1994. A 16% decrease in 1994 revenues from the laser catheters was due to lower unit prices.\nInterest income in 1994 increased by 33% from 1993 levels due to increases in both average invested cash balances due to higher cash flow from operations, and higher yields due to the interest rate increases as a result of market conditions.\nCost of equipment sales in 1994 decreased by 31% from 1993 due to the shipment of lower cost content foreign lithotripsy units. Gross margins on equipment and equipment upgrades increased due to the combination of lower cost units and higher average unit selling prices.\nCost of recurring revenues increased in 1994 by $1,015,000 from 1993 due to the Company's expansion of its mobile lithotripsy services and the requisite equipment investment and expenses related to their operations. Maintenance expenses also increased by 33% as more sites were under maintenance contract in 1994.\nResearch and development costs decreased in 1994 compared to the same period in 1993 due to the scaling back of the biochemical research.\nSelling expenses decreased in 1994 compared to the same period in the prior year, due to the decreased costs in the sales and marketing effort for the laser catheter products as the product's introductory stage in the marketplace has been completed.\nGeneral and administrative expenses decreased in 1994 compared to the same period in 1993 due to the reduced bad debt expenses for the funding of Cardiac Science advances in the current year.\nOther expenses decreased primarily due to the expenses in 1993 for the write-down to market value of the Company's holdings in a mutual fund and expenses relating to the class action lawsuit against the Company.\nAs a result of recognizing deferred tax assets and the utilization of net operating loss carryforwards, the provision for taxes was minimal in 1994. The Company expects the tax provision in 1995 to approximate the statutory rates.\nYear Ended December 31, 1993 Compared to Year ended December 31, 1992\nThe Company recognized revenue of $13.7 million for 1993 compared to $13.6 million for 1992, a 1% increase. The increase in revenue was the result of several changes in the Company's revenue streams. Shipments of lithotripters decreased to four systems in 1993 from eight systems in 1992. Shipment of system upgrades to the Company's installed base of lithotripters increased by 21% from 1992 levels.\nThe Company recognized interest and dividend income of $481,000 during 1993 compared to $631,000 in 1992, a 24% decline. Although average investable balances remained relatively constant during the periods, the revenues decreased as the economy continued to push interest rate yields lower throughout 1993.\nEquipment cost of sales decreased by 39% in 1993 compared to 1992, reflecting the lower equipment sales volume. Gross margins on equipment sales and equipment upgrades decreased to 28% in 1993 from 50% in 1992 as a direct result of lower average unit selling prices.\nThe cost of sales related to recurring revenues decreased to 35% in 1993 from 43% in 1992 due to increased volume of recurring revenues from the Prolase product and increased Medstone patient volume.\nResearch and development expenses increased by $141,000, or 6%, in 1993 compared to the same period in 1992 due to additional headcount as the Company continued its efforts to expand its product line offerings for the treatment of urological diseases.\nSelling expenses increased by $1,055,000, or 65%, as the Company introduced its laser catheter product line with the associated expenses of advertising, headcount additions, and sales commissions necessary to successfully launch its effort to attract new customers and retain current users with new applications.\nGeneral and administrative expenses increased by $644,000, or 41%, as the Company established its separate Divisions and the respective management teams to increase focus on these increasing efforts. Specifically, increases in expenses came in the areas of headcount additions, travel, and legal expenses.\nOther expenses decreased by approximately $530,000 primarily due to the expenses in 1992 for both the class action lawsuit and the settlement of the litigation with a former distributor.\nLIQUIDITY AND CAPITAL RESOURCES\nAt December 31, 1994, the Company had cash and short-term investments of approximately $14.4 million. These funds were generated from operating activities and from the Company's initial public offering in June 1988, in which 1,150,000 shares of common stock were issued for net proceeds of approximately $12.9 million. Cash generated from the offering and from operations financed substantial increases in levels of inventory, capital assets and was used to retire debt.\nThe Company's long-term capital expenditure requirements will depend upon numerous factors, including the progress of the Company's research and development programs, the time required to obtain regulatory approvals, the resources that the Company devotes to the development of self-funded products, proprietary manufacturing methods and advanced technologies, the length and outcome of its existing securities litigation, the ability of the Company to obtain additional licensing arrangements and to manufacture products under those arrangements, and the demand for its products if and when approved and possible acquisitions of products, technologies and companies.\nThe Company believes that its existing working capital and funds anticipated to be generated from operations will be sufficient to meet the cash needs for continuation of its present operations during 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Item 14. \"Exhibits, Financial Statement Schedules, and Reports on Form 8-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\nDIRECTORS The following are the directors of the Company:\nMr. Payne has served as a director of the Company since November 1984 and as its Chairman of the Board and Chief Executive Officer since January 1991. He served as a consultant to the Company from July 1988 through July 1989. He was also the Company's Chairman of the Board and Chief Executive Officer from October 1985 to July 1988.\nMr. Pope is a general partner and officer of the Technology Funding venture capital management firms. Before joining Technology Funding in March 1981, he was a Tax Manager with the accounting firm of Coopers and Lybrand. Mr. Pope is a C.P.A. and a member of the California Bar.\nMr. Quadros has served as a Director of the Company since June 1988. He has been the Senior Vice President and Chief Financial Officer of Thermatrix, Inc. from June 1994 to the present. From January 1985 until May 1994 he was a general partner and officer of the Technology Funding venture capital management firms. Prior to joining Technology Funding in January 1985, he was Executive Vice President of AMREAL Securities Corporation, a real estate affiliate of Home Federal Savings and Loan. Mr. Quadros is a director of Cardiac Science, Inc., a publicly-owned corporation.\nEXECUTIVE OFFICERS\nThe names, ages and positions of all the executive officers of the Company as of March 1995 are listed below, followed by a brief account of their business experience during the past five years. Officers are normally appointed annually by the Board of Directors at a meeting of the directors immediately following the Annual Meeting of Shareholders. There are no family relationships among these officers nor any arrangements or understandings between any officer and any other person pursuant to which an officer was selected. None of these officers has been involved in any court or administrative proceeding within the past five years adversely reflecting on his or her ability or integrity.\nMr. Payne has served as a director of the Company since November 1984 and as its Chairman of the Board and Chief Executive Officer since January 1991. He served as a consultant to the Company from July 1988 through July 1989. He was also the Company's Chairman of the Board and Chief Executive Officer from October 1985 to July 1988.\nMr. Radlinski is currently the President of Medstone International, Inc. and Chief Financial Officer and Secretary of the Company. He had been the Company's Executive Vice President of Finance, Chief Financial Officer and Secretary from July 1987 until January 1991. From 1984 to 1987, he was Vice President of Finance and Chief Financial Officer of Printronix, Inc., a publicly-owned company which manufactures computer printers.\nMr. Gardner served as the President of the Company's Medical Biology Division from March 1, 1993 to January 1995, at which time he was appointed President of Endocare, Inc., a position he currently holds. He had been a Vice President of Domestic Sales for the Company from November 1990 until February 1993. Prior to that he had served as the Vice President of Sales since November 1984.\nCOMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934\nThe Company is not aware of any director, officer, or 10% shareholder who during 1994 failed to file on a timely basis any report regarding the Company's securities required by Section 16(a) of the Securities Exchange Act of 1934.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nEXECUTIVE COMPENSATION\nThe following table sets forth certain information regarding compensation paid by the Company during each of the Company's last three fiscal years to the Company's Chief Executive Officer and to each of the Company's executive officers who received salary and bonus payments in excess of $100,000 during fiscal 1994.\nSUMMARY OF COMPENSATION TABLE\n_____________________\n(1) In addition to the cash compensation shown in the table, executive officers of the Company may receive indirect compensation in the form of perquisites and other personal benefits. For each of the named executive officers, the amount of this indirect compensation in 1990, 1991 and 1992 did not exceed the lesser of $50,000 or 10% of the executive officer's total salary and bonus for that year.\n(2) Options to acquire shares of Common Stock.\n(3) Subsequent to December 31, 1994, Mr. Cherney resigned as President of Endocare, Inc. Mr. Gardner has been appointed President of Endocare, Inc.\nSTOCK OPTION EXTENSIONS DURING 1994\nNo new stock options were granted to the named executives officers during the year ended December 31, 1994. The following table provides information related to the stock options in March 1993 that had their expiration date extended one year until April 2, 1994 at the original exercise price. In March 1994, the expiration date of such options was again extended until April 2, 1995.\n(1) Subsequent to December 31, 1994, Mr. Cherney resigned from the Company.\nSTOCK OPTIONS HELD AT END OF FISCAL YEAR\nThe following table provides information related to options held by the named executive officers at December 31, 1994. No options were exercised by such officers during 1994.\n(1) The closing price for the Company's Common Stock as reported by the National Association of Securities Dealers (NASD) on December 31, 1994 was $5.88. Value is calculated on the basis of the difference between the option exercise price and $5.88, multiplied by the number of shares of Common Stock underlying the option.\n(2) Subsequent to December 31, 1994, Mr. Radlinski and Mr. Gardner exercised 100,000 and 50,000 options, respectively.\n(3) Subsequent to December 31, 1994, Mr. Cherney resigned from the Company and exercised all of his exercisable options.\nCOMPENSATION OF DIRECTORS\nThe Company currently does not compensate Messrs. Quadros and Pope for their services, but they are reimbursed for expenses incurred by them in connection with the Company's business.\nUnder the Nonemployee Director Stock Option Plan, each new nonemployee director is automatically granted an option to purchase up to 5,000 shares as of the effective date of his or her first appointment to the Board or first\nelection to the Board by the shareholders, whichever is earlier. Subject to acceleration of the option exercises in the event of certain events specified in the plan, each such option becomes exercisable with respect to 1\/60 of the shares issuable for each elapsed full month during the five-year period after its grant date, but will not be initially exercisable until six months after the grant date. The exercise price of each option will equal the fair market value of the underlying Common Stock on the date the option is granted. Each option will expire six years after its grant, except that the expiration will be extended until one year after the optionee's death if it occurs less than one year before the option's expiration date. An option granted under the plan is not transferrable during the grantee's lifetime and must be exercised within one year following his or her death, or within 90 days after the grantee ceases to be a member of the Board for any other reason, and will only be exercisable to the extent it is exercisable on the date the grantee leaves the Board. Under this plan, Mr. Pope was granted 5,000 shares in January 1992.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the number of shares of the Company's Common Stock known to the Company to be beneficially owned as of March 9, 1995 by each person who owns beneficially more than 5 percent of the outstanding shares of Common Stock, by each of the present directors and nominees for director, by each of the executive officers named in the Executive Compensation table above and by all executive officers and directors of the Company as a group, and the percentage of the total outstanding shares of Common Stock such shares represented as of March 9, 1995.\n- ---------------\n(1) All such shares were held of record with sole voting and investment power, subject to applicable community property laws, by the named individual and\/or by his wife, except as indicated in the following footnotes.\n(2) Director of the Company.\n(3) Includes 211,351 shares held by Technology Funding Partners I and 211,351 shares held by Technology Funding Partners II. Technology Funding, Inc. and Technology Funding Ltd. (together, \"Technology Funding\"), of which Frank R. Pope is an officer or general partner, are the managing general partners of Technology Funding Partners I and Technology Funding Partners II. Technology Funding and Mr. Pope are entitled to exercise voting and investment power with respect to all shares owned by Technology Funding Partners I and Technology Funding Partners II and therefore are deemed to be beneficial owner of such shares.\n(4) Includes 3,917 shares issuable upon exercise of presently outstanding stock options under the Company's Non-employee Director Stock Option Plan.\n(5) Executive officer of the Company.\n(6) Includes 216,667 shares issuable upon exercise of presently outstanding stock options.\n(7) Includes 61,000 shares issuable upon exercise of presently outstanding stock options.\n(8) Includes 35,000 shares issuable upon exercise of presently outstanding stock options.\n(9) Percentage information is omitted because the beneficially owned shares represent less than 1% of the outstanding shares of the Company's Common Stock\n(10) Includes 316,584 shares issuable upon exercise of presently outstanding stock options.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nDuring 1991, the Company was a party to the formation of Cardiac Science, Inc., for which the Company purchased 5,353,031 shares of common stock, for a cash payment of $.0016 per share. This purchase represented 77.3% of the outstanding stock. As of July 8, 1991, the Company distributed a dividend to its shareholders of record on that date, one share of Cardiac Science, Inc. stock for each share of Cytocare stock held. The Company retained 629,768 shares of common stock of Cardiac Science, Inc.\nIn June 1991, the Company agreed to loan Cardiac Science, Inc. up to $220,000 to provide working capital pursuant to the terms of a revolving note agreement. The unpaid principal amount of the loan, together with interest accrued thereon at the rate of 10% per annum, was due and payable to Cytocare in December 1991. Cytocare then agreed to extend this note and to loan additional amounts to Cardiac Science, Inc. As of April 30, 1992, the Company had loaned Cardiac Science, Inc. approximately $310,000. In April 1992, the Company agreed to extend its initial loan to Cardiac Science, Inc. and to loan Cardiac Science, Inc. an additional $200,000. These loans bear interest at a rate of 8% per annum, payable quarterly, are secured by Cardiac Science's assets and mature on the earlier of April 1, 1995 or the closing of the initial public offering of Cardiac Science's common stock. Cardiac Science, Inc. has the option to pay the interest on the notes in either cash or shares of its common stock valued at $.15 per share. To pay such interest, Cardiac Science, Inc. had issued 419,054 shares of its common stock to the Company as of December 31, 1994. In connection with such loan extension and the agreement to make additional loans, Cardiac Science issued to Cytocare 3,400,000 warrants to purchase shares of its common stock at $.15 per share for an aggregate exercise price of up to $510,000.\nIn September 1994, Cardiac Science reached an agreement with Cytocare pursuant to which, and concurrently with the closing of a Private Placement of Cardiac Science's Common Stock (i) Cytocare exercised the warrants to the extent of 2,720,000 shares, (ii) Cardiac Science utilized the proceeds therefrom ($408,000) to pay an equivalent portion of the note, (iii) the due date for the remaining principal balance on the note ($102,000) was extended to April 1, 1996, (iv) Cytocare maintains its current lien on the assets of the Company until the balance of the note is paid, (v) the expiration date for the remaining warrants to purchase 680,000 shares of Cardiac Science common stock was changed to March 31, 1996, and (vi) all outstanding unsecured obligations owing by Cardiac Science to Cytocare (approximately $270,000) were satisfied by the issuance to Cytocare of 1,800,000 shares of common stock and a ten year warrant to purchase 1,000,000 shares of common stock at $.001 per share.\nAs of December 31, 1994, Cardiac Science's outstanding note balance was $104,335, including accrued interest. A reserve of $104,335 has been provided for non-payment of the note.\nSeparately, the Company advanced amounts to Cardiac Science for accounting, operational expenses, payroll and health insurance of employees working part-time on Cardiac Science projects. These amounts were to be repaid by Cardiac Science on a month-to-month basis. As of December 31, 1994, $8,948 had been advanced to Cardiac Science. A reserve of $4,023 has been provided for non-payment of the advances.\nIn September 1994, Cardiac Science received additional financing and effective October 7, 1994, all Cardiac Science business is conducted at a location completely independent of Cytocare.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) INDEX TO CONSOLIDATED FINANCIAL STATEMENT\n(B) REPORTS ON FORM 8-K\nThere were no reports on Form 8-K filed with the Commission during the quarter ended December 31, 1994.\n(C) EXHIBITS\n----------------------------------- (1) Previously filed with the same exhibit number with the Company's Registration Statement on Form S-1 under the Securities Act of 1933, Reg. No 33-16340 and with the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, and incorporated herein by reference. (2) Previously filed with the same exhibit number with the Company's Registration Statement on Form S-1 under the Securities Act of 1933, Reg. No. 33-16340 and incorporated herein by reference. (3) Previously filed with the same exhibit number with the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference. (4) Compensatory plan or arrangement. (5) Previously filed with the same exhibit number with the Company's annual report on Form 10-K for the year ended December 31, 1993. (6) Previously filed with the same exhibit number with the Company's current report on Form 8-K dated June 26, 1991, and incorporated herein by reference.\nReport of Independent Auditors\nThe Board of Directors Cytocare, Inc.\nWe have audited the accompanying consolidated balance sheets of Cytocare, Inc. as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 Cytocare, Inc. at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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 the first paragraph of Note 8 to the financial statements, the Company is a defendant in a class action lawsuit. Management of the Company believes that the allegations are without merit and intends to continue to vigorously defend against this action. The ultimate outcome of the litigation cannot presently be determined. Accordingly, no provision for any liability that may result, if any, has been made in the financial statements.\nERNST & YOUNG LLP Orange County, California February 15, 1995\nCYTOCARE, INC.\nCONSOLIDATED BALANCE SHEETS\nLIABILITIES AND STOCKHOLDERS' EQUITY\nSee accompanying notes\nCYTOCARE, INC.\nCONSOLIDATED STATEMENTS OF INCOME\nSee accompanying notes\nCYTOCARE, INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSee accompanying notes\nCYTOCARE, INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee accompanying notes\nCYTOCARE, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994\n1. ORGANIZATION AND OPERATIONS OF THE COMPANY\nCytocare, Inc. (formerly Medstone International, Inc. prior to renaming and reorganization of the Company in January 1991) was incorporated in Delaware in October 1984. The Company's wholly-owned subsidiary Medstone International, Inc. (\"Medstone\") designs, manufactures and markets the Medstone STS(TM) Shockwave Therapy System (the \"System\") for the noninvasive disintegration of kidney stones in human patients. In addition to sales of the System, Medstone generates recurring revenue from procedure fees and fee for service arrangements for use of the System and from repairs and maintenance of the Systems.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of consolidation ---------------------------\nThe consolidated financial statements include the accounts of the Company, Medstone International, Inc. and Medstone Sales Corporation, a foreign sales corporation.\nReclassifications -----------------\nCertain prior period balances have been reclassified to conform with the December 31, 1994 presentation.\nStatement of cash flows -----------------------\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nThe Company had net non-cash transfers of inventory into fixed assets of $630,000, $168,000 and $468,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nShort-term Investments ----------------------\nEffective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" The adoption did not have a significant impact on the Company's consolidated financial statements. Management determines the appropriate classification of such securities at the time of purchase and reevaluates such classification as of each balance sheet date. Based on its intent, the Company's investments are classified as available-for-sale and are carried as fair value, with unrealized gains and losses, net of tax, reported as a separate component of\nstockholders' equity. The investments are adjusted for amortization of premiums and discounts to maturity and such amortization is included in interest income. Realized gains and losses and declines in value judged to be other than temporary are determined based on the specific identification method and are reported in the consolidated statements of operations.\nThe Company invests primarily in U.S. government securities, and corporate obligations. As of December 31, 1994 and December 31, 1993, investments are summarized as follows:\nGross realized gains and losses were $0 and $331,817, respectively in 1994.\nThe amortized cost and estimated fair value of investments at December 31, 1994 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because the issuer of the securities may have the right to repurchase such securities.\nConcentrations of credit risk\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist principally of cash equivalents, marketable securities and accounts receivable. The Company's marketable securities consist principally of U.S. Treasury Bills.\nThe Company sells its products primarily to hospitals worldwide. Credit is extended based on an evaluation of the customer's financial condition and collateral generally is not required. The Company's ten largest customers accounted for approximately 47% of accounts receivable at December 31, 1994.\nInventories\nInventories are stated at the lower of cost (first-in, first-out) or market and consist of the following:\nProperty and equipment ----------------------\nProperty and equipment are carried at cost. Depreciation and amortization are computed on the straight-line method over the following estimated useful lives:\nRevenue recognition -------------------\nRevenues are recognized in accordance with the underlying contractual terms of each sale. Typically, revenue recognition requires the transfer of title upon shipment, customer acceptance, receipt of specified down payments and performance of all significant contractual obligations. All foreign sales contracts are negotiated with payment terms in U.S. dollars so the Company has no exposure to foreign currency price fluctuations.\nService and maintenance contract revenues are deferred and amortized over the terms of the related contracts.\nThe results for the year ended December 31, 1992 include two systems shipped in November 1990 to a foreign customer in the amount of $1.4 million. This revenue, with related costs of $324,000, was recognized in December 1992 upon resolution of a dispute with a distributor.\nPer share information ---------------------\nPer share information is presented in the accompanying consolidated statements of income based upon the weighted average number of common and common equivalent shares outstanding. Common equivalent shares result from the assumed exercise of outstanding dilutive securities when applying the treasury stock method. Fully diluted per share information is not presented for periods in which the effect is antidilutive.\n3. COMMITMENTS\nIn March 1994, the Company took occupancy of new office, manufacturing, engineering, warehouse space, and research and development laboratories under an operating lease with an initial term of two years. The monthly lease rate is $12,500. Upon expiration of the initial two- year term, the Company has the option to extend the lease in one year segments through March 1999 for modest price increases. The future minimum lease payments under the initial non-cancelable term of the lease are as follows:\nTotal net rent expense under all operating leases for the years ended December 31, 1994, 1993 and 1992 was $237,000, $495,000, and $328,000, respectively.\n4. INCOME TAXES\nThe provision for income taxes consists of the following:\nThe following is a reconciliation of the provision for income taxes at the federal statutory rate compared to the Company's effective tax rate:\nThe tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities are as follows:\nAt December 31, 1994, the Company has a California net operating loss carryforward of approximately $950,000 and a California research and development credit carryforward of approximately $50,000. These net operating losses and credits expire in 1997 through 2008. As a result of continued profitability, the Company recognized all of its deferred tax assets in the current year as management believes it is more likely than not that such deferred tax assets will be realized.\nThe Tax Reform Act of 1986 contains provisions which could substantially limit the availability of the net operating loss carryforward as well as the research and development credit carryforward if there is a greater than 50% change of ownership during a three-year period. As of December 31, 1994, the Company has experienced less than a 5% ownership change.\n5. STOCK OPTIONS\nIn 1987, the Company adopted the 1987 Stock Option Plan (1987 Plan) under which options could be granted to key employees or directors of the Company by a committee appointed by the Company's Board of Directors (the Committee) to purchase up to 476,323 shares of the Company's common stock. The exercise prices for options granted under the 1987 Plan were equal to the fair market value of the common stock on the date of grant. During 1988 and 1989, the Committee granted options which generally become exercisable with respect to 1\/60th of the issuable shares for each elapsed month during the five-year period commencing with dates determined by the Committee. All options granted in 1988 and 1989 terminate one year after the end of the five-year period. In June 1989, the Company terminated the 1987 Plan as to the granting of additional options. In April 1994, the termination date of the remaining 76,250 options exercisable under this Plan was extended for an additional year from the previously extended termination date.\nIn June 1989, the Company's stockholders approved the 1989 Stock Incentive Plan which provides for the granting of a variety of stock- related securities, including shares of common stock, stock options and stock appreciation rights to employees and other selected individuals. In May 1991, the Company's stockholders amended the Plan to increase the number of shares issuable to 1,593,783 and eliminated the provision for an automatic increase in the number of shares issuable on January 1 of each year by one percent of the then outstanding shares. As of December 31, 1994, 753,698 options for shares of common stock had been granted and are outstanding under this plan.\nIn June 1989, the Company's stockholders also approved the Nonemployee Director Stock Option Plan. This plan provides for the issuance of up to 50,000 shares of the Company's common stock upon exercise of options granted under the plan. As of December 31, 1994, 10,000 options for shares of common stock had been granted under this plan.\nStock option activity under the Company's plans is summarized as follows:\nAt December 31, 1994, 1993 and 1992, the number of unoptioned shares reserved and available for issuance under the plans was 880,085, 776,782 and 674,367, respectively. Outstanding options for 677,539 shares were exercisable at December 31, 1994.\nEffective March 2, 1990, the Company changed the exercise price of all outstanding options granted with exercise prices exceeding the closing market value of the stock on that date. Accordingly, the exercise price of these options was reduced to $5.00 per share.\n6. EMPLOYEE BENEFIT PLAN\nIn January 1990, the Company established a defined contribution profit sharing 401(k) plan for all eligible employees. The plan provides for the deferral of up to 15% of an employee's qualifying compensation under Section 401(k) of the Internal Revenue Code.\nContributions by the Company may be made to the plan at the discretion of the Board of Directors. No such contributions were made to the plan during the years ended December 31, 1994, 1993 and 1992.\n7. MAJOR CUSTOMERS AND FOREIGN SALES\nDuring the year ended December 31, 1994, one foreign customer accounted for 10% of total revenue of the Company and the Company derived 13% of its total revenues from sales to foreign customers. During the year ended December 31, 1993, no single customer accounted for 10% or more of the total revenue and the Company derived 8% of its total revenues from sales to foreign customers. During the year ended December 31, 1992, the Company recorded revenues from two customers, one domestic and one foreign, each greater than 10% of the total revenue and derived 25% of its total revenue from sales to foreign customers.\n8. CONTINGENCIES\nThe Company is a defendant in two related class action lawsuits filed by two shareholders of the Company alleging that adverse material information was not disclosed at the time of the initial public offering and in subsequent periods. On May 4, 1992, the district court granted summary judgment in one of the actions in favor of the Company on all claims. On July 9, 1992, the district court granted the Company's motion to dismiss the second action. In October 1994, the Company received the opinion of the Ninth Circuit of Appeals affirming in part and reversing in part the United States District Court's decision granting summary judgment in favor of the Company and several officers. The complaints allege principally that adverse material information was not disclosed at the time of the initial public offering in June 1988. The Company intends to proceed to trial on any remaining matters. The ultimate outcome of the litigation cannot presently be determined. Accordingly, no provision for any liability that may result, if any, has been made in the financial statements.\nFrom time to time, the Company is subject to legal actions and claims for personal injuries or property damage related to patients who use its products. The Company has obtained a liability insurance policy providing coverage for product liability and other claims. Management does not believe that the resolution of any current proceedings will have a material financial impact on the Company.\n9. RELATED PARTY TRANSACTIONS\nDuring 1991, the Company was a party to the formation of Cardiac Science, Inc., for which the Company purchased 5,353,031 shares of common stock, for a cash payment of $.0016 per share. This purchase represented 77.3% of the outstanding stock. As of July 8, 1991, the Company distributed a dividend to its shareholders of record on that date, one share of Cardiac Science, Inc. stock for each share of Cytocare stock held. The Company retained 629,768 shares of common stock of Cardiac Science, Inc.\nIn June 1991, the Company agreed to loan Cardiac Science, Inc. up to $220,000 to provide working capital pursuant to the terms of a revolving note agreement. The unpaid principal amount of the loan, together with interest accrued thereon at the rate of 10% per annum, was due and payable to Cytocare in December 1991. Cytocare then agreed to extend this note and to loan additional amounts to Cardiac Science, Inc. As of April 30, 1992, the Company had loaned Cardiac Science, Inc. approximately $310,000. In April 1992, the Company agreed to extend its initial loan to Cardiac Science, Inc. and to loan Cardiac Science, Inc. an additional $200,000. These loans bore interest at a rate of 8% per annum, payable quarterly, are secured by Cardiac Science's assets and were to mature on the earlier of April 1, 1995 or the closing of the initial public offering of Cardiac Science's common stock.\nIn September 1994, Cardiac Science completed a private placement offering, and in conjunction with that offering, the Company exercised warrants to purchase 2,720,000 shares of Cardiac Science Common Stock at $.15 per share. The proceeds of $408,000 were used to pay down a portion of the loans described above. The due date for the remaining principal balance of $102,000 has been extended to April 1, 1996. The expiration date for the remaining warrants was changed to March 31, 1996. In addition, the Company was issued 1,800,000 shares of Cardiac Science Common Stock and a ten year warrant to purchase 1,000,000 shares at $.001 per share in full payment of unsecured obligations of approximately $176,000. At December 31, 1994, $104,335, which includes accrued interest, has been loaned to Cardiac Science. A reserve of $104,335 has been provided for non-payment of the loan.\nAs of December 31, 1994, the Company held warrants to purchase 680,000 shares of Cardiac Science's common stock at $.15 per share which expire March 31, 1996 and warrants to purchase 1,000,000 shares at $.001 per share, which expire September 10, 2004.\nSeparately, the Company advanced amounts to Cardiac Science for some operational expenses including (but not limited to) accounting services and health insurance. These amounts were to be repaid by Cardiac Science on a month-to-month basis. As of December 31, 1994, $8,947 had been advanced to Cardiac Science. A reserve of $4,023 has been provided for non-payment of the advances.\nEffective March 15, 1994, all Cardiac Science business is conducted at a location completely independent of Cytocare. This will insure that Cardiac Science cannot be perceived as lacking autonomy over its own business and technical operations.\nCYTOCARE, INC.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(a) Write-off of inventory (b) Write-off of bad debt including $642,000 for one significant customer (c) Reserve transferred from loan provision to investment provision due to restructuring.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nCYTOCARE, INC.\nBy: \/s\/ Errol Payne ------------------------------------- Errol Payne Chief Executive Officer\nDated: March 22, 1995\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 22, 1994.\nSIGNATURE TITLE --------- -----\nEXHIBIT INDEX\n----------------------------------- (1) Previously filed with the same exhibit number with the Company's Registration Statement on Form S-1 under the Securities Act of 1933, Reg. No 33-16340 and with the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, and incorporated herein by reference. (2) Previously filed with the same exhibit number with the Company's Registration Statement on Form S-1 under the Securities Act of 1933, Reg. No. 33-16340 and incorporated herein by reference. (3) Previously filed with the same exhibit number with the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1989, and incorporated herein by reference. (4) Compensatory plan or arrangement. (5) Previously filed with the same exhibit number with the Company's annual report on Form 10-K for the year ended December 31, 1993. (6) Previously filed with the same exhibit number with the Company's current report on Form 8-K dated June 26, 1991, and incorporated herein by reference.","section_15":""}
{"filename":"41091_1994.txt","cik":"41091","year":"1994","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 the State 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, Communications, Southern Nuclear, SCS (the system service company), SDIG 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. Communications, beginning in mid-1995, will provide digital wireless communications services -- over the 800-megahertz frequency band -- to SOUTHERN's subsidiaries and also will market these services to the public within the Southeast. Southern Nuclear provides services to the Southern electric system's nuclear plants. SDIG develops new business opportunities related to energy products and services.\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\nI-1\nand 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 and 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 SOUTHERN, 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, 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. SEI, SDIG and Communications have also secured from the operating affiliates certain services which are furnished at cost.\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 and development of generation facilities in the international market. SEI currently operates three domestic independent power production projects totaling 280 megawatts and is one-third owner of one of these (which produces 180 megawatts). SEI (through subsidiaries) has a contract to sell electric energy to Virginia Electric and Power Company from a facility it is constructing in King George, Virginia. Upon completion, currently planned for 1996, SEI will operate the 220 megawatt coal-fired plant. SOUTHERN owns 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 1993, SOUTHERN completed the purchase of a 38% interest in Edelnor for the purchase price of $73 million. In December 1994, SOUTHERN purchased an additional 27% interest in Edelnor for $80 million. Edelnor is a utility located in Northern Chile that owns and operates a transmission grid and 96 megawatts of generating facilities and is building an additional 150 megawatt facility.\nI-2\nAlso in December 1994, SOUTHERN completed the acquisition of a 39% interest in a partnership that acquired the generation operations of the T&TEC, comprising approximately 1,178 megawatts of generating capacity for a purchase price of $85.6 million. Additionally, SOUTHERN purchased a 100% interest in an energy and recovery complex from Scott Paper Company for a purchase price of $350 million, which included the assumption of $85 million of outstanding tax-exempt debt. This complex is used to generate substantially all of the steam and electricity requirements of Scott's integrated pulp and paper mill located in Mobile, Alabama and has a generating capacity of 105 megawatts. Most of the facility's fuel needs are met from waste and by-products generated by Scott's pulping and woodlands operations.\nSEI and SDIG render consulting services and market SOUTHERN system expertise in the United States and throughout the world. They contract with other public utilities, commercial concerns and government agencies for the rendition of services and the licensing of intellectual property. In addition, SDIG engages in energy management-related services and activities.\nAt year-end, the SEC authorized SOUTHERN to form a new subsidiary, Communications, and to invest up to $179 million in Communications. Communications has contracted with a prime vendor for the installation and construction of a wireless communications system in order to provide services to the general public, including SOUTHERN subsidiaries. The technology selected is new and still under development. Communications will be subject to both market and technology risks. It is anticipated that the operations of Communications, at least in its early years, will negatively affect earnings and cash flow. Furthermore, there can be no assurance that Communications will ultimately recover the cost of constructing its wireless communications system.\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, these activities also involve a higher degree of risk. SOUTHERN expects to make substantial investments over the period 1995-1997 in these and other new businesses.\nCertain Factors Affecting the Industry\nVarious factors are currently affecting the electric utility industry in general, including increasing competition, costs required to comply with environmental regulations, and the potential for new business opportunities (with their associated risks) outside of traditional rate-regulated operations. The effects of these and other factors on the SOUTHERN system are described herein; particular reference is made to Item 1 - BUSINESS - \"New Business Development,\"- - \"Competition\" and -- \"Environmental Regulation\".\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 1995 through 1997 by the operating affiliates, SEGCO, SCS and Southern Nuclear are estimated as follows: (in millions)\n=========================================================== 1995 1996 1997 ---------------------------- ALABAMA $ 604 $ 500 $ 502 GEORGIA 579 626 724 GULF 62 76 84 MISSISSIPPI 78 73 72 SAVANNAH 34 27 26 SEGCO 10 11 11 SCS 26 19 14 Southern Nuclear 2 2 1 ---------------------------------------------------------- SOUTHERN system* $1,395 $1,267 $1,362 ==========================================================\n*System totals for years 1996 and 1997 are less than the sum of the subsidiaries due to changes made in GEORGIA's construction budget subsequent to approval of the SOUTHERN system construction budget. However, GEORGIA's management has adopted an initiative to reduce its 1996 and 1997 construction expenditures by approximately 10% from currently estimated amounts. There can be no assurance that such reductions will be achieved.\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 do not include amounts which may be spent by Communications or 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.) I-3\nEstimated construction costs in 1995 are expected to be apportioned approximately as follows: (in millions)\n*SCS and Southern Nuclear plan capital additions to general plant in 1995 of $26 million and $2 million, respectively, while SEGCO plans capital additions of $10 million to generating facilities.\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; and cost of capital. Also, the SOUTHERN system construction estimates do not reflect expenditures by Communications or the possibility of SEI securing a contract(s) to buy or build additional generating facilities.\nThe operating affiliates do not have any baseload generating plants under construction. However, within the service area, the construction of combustion turbine peaking units with an aggregate capacity of approximately 1,100 megawatts is planned to be completed by 1997. In addition, significant construction will continue related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants.\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, 1994, 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.\n============================================================ Nameplate Generating Station Location Capacity ------------------------------------------------------------ (Kilowatts) Fossil Steam Gadsden Gadsden, AL 120,000 Gorgas Jasper, AL 1,221,250 Barry Mobile, AL 1,525,000 Chickasaw Chickasaw, AL 40,000 Greene County Demopolis, AL 300,000 (1) Gaston Unit 5 Wilsonville, AL 880,000 Miller Birmingham, AL 2,532,288 (2) --------- ALABAMA Total 6,618,538 ---------\nArkwright Macon, GA 160,000 Atkinson Atlanta, GA 180,000 Bowen Cartersville, GA 3,160,000 Branch Milledgeville, GA 1,539,700 Hammond Rome, GA 800,000 McDonough Atlanta, GA 490,000 McManus Brunswick, GA 115,000 Mitchell Albany, GA 170,000 Scherer Macon, GA 886,303 (3) Wansley Carrollton, GA 925,550 (4) Yates Newnan, GA 1,250,000 --------- GEORGIA Total 9,676,553 ---------\nCrist Pensacola, FL 1,045,000 Lansing Smith Panama City, FL 305,000 Scholz Chattahoochee, FL 80,000 Daniel Pascagoula, MS 500,000 (5) Scherer Unit 3 Macon, GA 204,500 (3) --------- GULF Total 2,134,500 ---------\nEaton Hattiesburg, MS 67,500 Sweatt Meridian, MS 80,000 Watson Gulfport, MS 1,012,000 Daniel Pascagoula, MS 500,000 (5) Greene County Demopolis, AL 200,000 (1) --------- MISSISSIPPI Total 1,859,500 --------- ============================================================\n============================================================ Nameplate Generating Station Location Capacity ------------------------------------------------------------ (Kilowatts)\nMcIntosh Effingham County, GA 163,117 Kraft Port Wentworth, GA 281,136 Riverside Savannah, GA 102,278 ----------- SAVANNAH Total 546,531 ----------\nGaston Units 1-4 Wilsonville, AL (SEGCO) 1,000,000 (6) ---------- Total Fossil Steam 21,835,622 ----------\nNuclear Steam Farley Dothan, AL (ALABAMA) 1,720,000 ---------- Hatch Baxley, GA 816,630 (7) Vogtle Augusta, GA 1,060,240 (8) ---------- GEORGIA Total 1,876,870 ---------- Total Nuclear Steam 3,596,870 ----------\nCombustion Turbines Arkwright Macon, GA 30,580 Atkinson Atlanta, GA 78,720 Bowen Cartersville, GA 39,400 McDonough Atlanta, GA 78,800 McIntosh Units 3, 4, 7, 8 Effingham County, GA 320,000 McManus Brunswick, GA 481,700 Mitchell Albany, GA 118,200 Wilson Augusta, GA 354,100 Wansley Carrollton, GA 26,322 (4) ---------- GEORGIA Total 1,527,822 ----------\nLansing Smith Unit A (GULF) Panama City, FL 39,400 ----------\nChevron Cogenerating Station Pascagoula, MS 147,292 (9) Sweatt Meridian, MS 39,400 Watson Gulfport, MS 39,360 ---------- MISSISSIPPI Total 226,052 ----------\nBoulevard Savannah, GA 59,100 Kraft Port Wentworth, GA 22,000 McIntosh Units 5&6 Effingham County, GA 160,000 ---------- SAVANNAH Total 241,100 ---------- ============================================================\nI-18\n============================================================ Nameplate Generating Station Location Capacity ------------------------------------------------------------ (Kilowatts)\nGaston (SEGCO) Wilsonville, AL 19,680 (6) ---------- Total Combustion Turbines 2,054,054 ----------\nHydroelectric Facilities Weiss Leesburg, AL 87,750 Henry Ohatchee, AL 72,900 Logan Martin Vincent, AL 128,250 Lay Clanton, AL 177,000 Mitchell Verbena, AL 170,000 Jordan Wetumpka, AL 100,000 Bouldin Wetumpka, AL 225,000 Harris Wedowee, AL 135,000 Martin Dadeville, AL 154,200 Yates Tallassee, AL 32,000 Thurlow Tallassee, AL 58,000 Lewis Smith Jasper, AL 157,500 Bankhead Holt, AL 45,125 Holt Holt, AL 40,000 ---------- ALABAMA Total 1,582,725 ----------\nBarnett Shoals (Leased) Athens, GA 2,800 Bartletts Ferry Columbus, GA 173,000 Goat Rock Columbus, GA 26,000 Lloyd Shoals Jackson, GA 14,400 Morgan Falls Atlanta, GA 16,800 North Highlands Columbus, GA 29,600 Oliver Dam Columbus, GA 60,000 Sinclair Dam Milledgeville, GA 45,000 Tallulah Falls Clayton, GA 72,000 Terrora Clayton, GA 16,000 Tugalo Clayton, GA 45,000 Wallace Dam Eatonton, GA 321,300 Yonah Toccoa, GA 22,500 6 Other Plants 18,080 (10) ---------- GEORGIA Total 862,480 ----------\nTotal Hydroelectric Facilities 2,445,205 ---------- Total Generating Capacity 29,931,751 ========== ============================================================\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 16.55% for Unit 4 of total plant capacity. See Item 2 - PROPERTIES - \"Proposed Sale 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. (10) Includes 5,400 megawatts of capacity for the Flint River Project damaged by flooding. See Item 1 - BUSINESS - \"Regulation - Federal Power Act\" herein.\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 MEAG and Dalton and excludes demand associated with power purchased from OPC and 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.\nI-19\nThe reserve margin for the Southern electric system at that time was 13.2%. The SOUTHERN system's maximum demand for 1994 of 24,545,700 kilowatts occurred in August. For information on the other registrant's 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 - \"Regulations - Atomic Energy Act of 1954\" and Note 1 to SOUTHERN's, ALABAMA's and GEORGIA's financial statements in Item 8 herein.)\nI-20\nOther Electric Generation Facilities\nThrough special purpose subsidiaries, SOUTHERN owns interests in or operates independent power production facilities and foreign utility companies. 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, 1994, was as follows:\nNotes: (1) Represents megawatts of capacity under a concession agreement expiring in the year 2023. (2) Cogeneration facility.\nI-21\nJointly-Owned Facilities\nALABAMA and GEORGIA have sold and GEORGIA has purchased undivided interests in certain generating plants and other related facilities to or from non-affiliated parties. The percentages of ownership resulting from these transactions 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 and Intercession City, as described below) as agent for the joint owners. See \"Proposed Sale 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 1996 for Unit 2 and, with regard to a portion of a 5% interest 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.\nIn 1994, GEORGIA and FPC entered into a joint ownership agreement regarding the Intercession City combustion turbine unit. The unit is scheduled to be in commercial operation in early 1996, and will be constructed, operated, and maintained by FPC. GEORGIA will have a one-third interest in the 150-megawatt unit, with retention of 100% of the capacity from June through September. FPC will have the capacity the remainder of the year. GEORGIA's investment in the unit at completion is estimated to be $14 million. Also, GEORGIA entered into a separate four-year purchase power contract with FPC. Beginning in 1996, GEORGIA will purchase 400 megawatts of capacity. In 1998, this amount will decline to 200 megawatts for the remaining two years.\nI-22\nProposed Sale of Property\nGEORGIA has completed three of four separate transactions to sell Unit 4 of Plant Scherer to FP&L and JEA for a total price of approximately $808 million, including any gains on these transactions. FP&L would eventually own approximately 76.4% of this unit, with JEA owning the remainder. GEORGIA will continue to operate the unit.\nThe completed and scheduled remaining transactions are as follows:\n======================================================== Percentage Closing of Sales Date Capacity Ownership Price -------------------------------------------------------- (Megawatts) (in millions) July 1991 290 35.46% $291 June 1993 258 31.44 253 June 1994 135 16.55 133 June 1995 135 16.55 131 -------------------------------------------------------- Total 818 100.00% $808 ========================================================\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, 1990, to December 31, 1994, the operating affiliates, SEGCO, and others (i.e. SCS, Southern Nuclear and, beginning in 1993, various of the special purpose subsidiaries) recorded gross property additions and retirements as follows:\n============================================================ Gross Property Additions Retirements -------------- ----------- (in millions) ALABAMA (1) $2,182 $ 336 GEORGIA (2) 2,928 2,030 GULF 349 118 MISSISSIPPI 415 69 SAVANNAH 173 15 SEGCO 81 12 Other (3) 262 87 ------------------------------------------------------------ SOUTHERN system $6,390 $2,667 ============================================================\n(1) Includes approximately $62 million attributable to property sold to AEC in 1992. (2) Includes approximately $612 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\nI-23\nforegoing 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 SOUTHERN board of directors' refusal of an earlier demand by the plaintiffs was wrongful. In April 1994, the U. S. Court of Appeals for the Eleventh Circuit reversed the dismissal and remanded the case to the trial court, finding that allegations by the plaintiffs created a reasonable doubt that the board validly exercised its business judgment in refusing the earlier demand. This action is still pending.\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) In January 1995, GEORGIA and four other unrelated entities were notified by the EPA that they have been designated as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act with respect to a site in Brunswick, Georgia. While GEORGIA believes that the total amount of costs required for the cleanup of this site may be substantial, it is unable at this time to estimate either such total or the portion for which GEORGIA may be ultimately responsible.\nThe final outcome of this matter cannot now be determined; however, in management's opinion, based on the nature and extent of GEORGIA's activities relating to the site, the final outcome will not have a material adverse effect on SOUTHERN's or GEORGIA's financial statements.\n(4) In June 1994, a tax deficiency notice was received from the IRS for the years 1984 through 1987 with regard to the tax accounting by GEORGIA for the sale in 1984 of an interest in Plant Vogtle and related capacity and energy buyback commitments. The potential tax deficiency and interest arising from this issue currently amount to approximately $28 million and $32 million, respectively. The tax deficiency relates to a timing issue as to when taxes are paid; therefore, only the interest portion could affect future income. Management believes that the IRS position is incorrect, and GEORGIA has filed a petition with the U. S. Tax Court challenging the IRS position. In order to minimize additional interest charges should the IRS's position prevail, GEORGIA made a payment to the IRS related to the potential tax deficiency in September 1994.\nI-24\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 GEORGIA'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, SEI, SCS, Southern Nuclear, SDIG and Communications 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-25\nEXECUTIVE OFFICERS OF SOUTHERN\n(Inserted in Part I in accordance with Regulation S-K, Item 401(b), Instruction 3)\nA. W. Dahlberg Chairman, President and Chief Executive Officer Age 54 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. He was elected Chairman and Chief Executive Officer effective March 1995.\nPaul J. DeNicola Executive Vice President and Director Age 46 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 50 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 Chief Executive Officer of GEORGIA effective January 1994.\nElmer B. Harris Executive Vice President and Director Age 55 Elected in 1989; President and Chief Executive Officer of ALABAMA since 1989 and, beginning 1991, Executive Vice President of SOUTHERN.\nDavid M. Ratcliffe Senior Vice President Age 46 Elected in 1995; President and Chief Executive Officer of MISSISSIPPI since 1991. He also serves as Executive Vice President of SCS beginning in 1995 and previously held that position from 1989 to 1991.\nW. L. Westbrook Financial Vice President and Chief Financial Officer Age 55 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 61 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 25, 1994) for one year until the next annual meeting or until his successor is elected and qualified.\nI-26\nPART 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:\n=================================================== High Low ------ ----- First Quarter $22 $18-1\/2 Second Quarter 20-1\/2 17-3\/4 Third Quarter 20 17 Fourth Quarter 21 18-1\/4\nFirst Quarter $21-3\/8 $18-3\/8 Second Quarter 22-1\/2 19-3\/8 Third Quarter 23 20-1\/2 Fourth Quarter 23-5\/8 20-3\/4 ---------------------------------------------------\nThere is no market for the other registrants' common stock, all of which is owned by SOUTHERN. On February 28, 1995, the closing price of SOUTHERN's common stock was $20-5\/8.\n(b) Number of SOUTHERN's common stockholders at December 31, 1994: 234,927\nEach of the other registrants have one common stockholder, SOUTHERN.\n(c) Dividends on each registrant's common stock are payable at the discretion of their respective board of directors. The dividends on common stock paid and\/or declared by SOUTHERN and the operating affiliates to their stockholder(s) for the past two years were as follows: (in thousands)\n==================================================== Registrant Quarter 1994 1993 ----------------------------------------------------\nSOUTHERN First $191,262 $180,381 Second 191,262 180,948 Third 191,475 181,892 Fourth 192,758 182,351\nALABAMA First 66,500 62,900 Second 67,000 63,100 Third 66,900 63,400 Fourth 67,600 63,500\nGEORGIA First 106,600 100,100 Second 107,200 100,400 Third 107,200 100,800 Fourth 108,300 101,100\nGULF First 10,900 10,400 Second 11,000 10,400 Third 11,000 10,500 Fourth 11,100 10,500\nMISSISSIPPI First 8,500 7,200 Second 8,500 7,200 Third 8,500 7,300 Fourth 8,600 7,300\nSAVANNAH First 4,100 4,500 Second 4,100 5,500 Third 4,100 5,500 Fourth 4,000 5,500 -----------------------------------------------------\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 28.5(cent) for each quarter of 1993 and 29.5(cent) for each quarter of 1994. The dividend paid on SOUTHERN's common stock for the first quarter of 1995 was raised to 30.5(cent) per share.\nThe amount of dividends on their common stock 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, 1994, were as follows:\n======================================================== Retained Restricted Earnings Amount ---------- ----------- (in millions) ALABAMA $1,085 $ 807 GEORGIA 1,413 742 GULF 169 101 MISSISSIPPI 144 94 SAVANNAH 99 57 Consolidated 3,191 1,805 --------------------------------------------------------\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-79 through II-92.\nGEORGIA. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II-127 through II-141.\nGULF. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II-170 through II-183.\nMISSISSIPPI. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II-210 through II-223.\nSAVANNAH. Reference is made to information under the heading \"Selected Financial and Operating Data,\" contained herein at pages II-247 through II-260.\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-59.\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-96 through II-103.\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-145 through II-151.\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-187 through II-193.\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-227 through II-232.\nII-2\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO 1994 FINANCIAL STATEMENTS\nII-3\nII-4\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES\nFINANCIAL SECTION\nII-5\nMANAGEMENT'S REPORT The Southern Company and Subsidiary Companies 1994 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 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 consolidated financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of The Southern Company and its subsidiary companies 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 a regulatory review is completed. 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\/ A. W. Dahlberg A. W. Dahlberg Chairman, President, and Chief Executive Officer\n\/s\/ W. L. Westbrook W. L. Westbrook Financial Vice President and Chief Financial Officer\nII-6\nREPORT 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 subsidiary companies as of December 31, 1994 and 1993, 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, 1994. 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 11-16 through II-37) referred to above present fairly, in all material respects, the financial position of The Southern Company and subsidiary companies as of December 31, 1994 and 1993, 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 a regulatory review is completed. 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 LLP\nAtlanta, Georgia February 15, 1995\nII-7\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION The Southern Company and Subsidiary Companies 1994 Annual Report\nRESULTS OF OPERATIONS\nEarnings and Dividends\nThe Southern Company's 1994 earnings were $989 million or $1.52 per share, a decrease of $13 million or 5 cents per share from the year 1993. Earnings were significantly affected in 1994 by efforts related to the company's strategy to remain a low-cost producer of electricity and a high-quality investment. These efforts included work force reduction programs in 1994 and additional investments in companies related to the core business of electricity. These investments have put downward pressure on earnings and return on equity, and that trend will continue in the near term. However, the investments should support growth and strength in the financial condition of the company as it emerges into a more competitive and global environment.\nCosts related to the work force reduction programs decreased earnings by $61 million or 9 cents per share. These costs should be recovered through future savings in about two years. Additional non-operating or non-recurring items affected earnings in 1994 and 1993. After excluding these items in both years, 1994 earnings from operations of the ongoing business of selling electricity were $1.0 billion -- or $1.58 per share -- an increase of $11 million compared with 1993. The non-operating items that affected earnings were as follows:\nConsolidated Earnings Net Income Per Share ----------------- ----------------- 1994 1993 1994 1993 ----------------- ----------------- (in millions)\nEarnings as reported $ 989 $1,002 $1.52 $1.57 ----------------------------------------------------------------- Work force reduction programs in 1994 61 - .09 - Sale of facilities (28) (18) (.04) (.03) Environmental cleanup 5 25 .01 .04 Transportation fleet reduction - 13 - .02 Gulf States related - (6) - (.01) ----------------------------------------------------------------- Total non-operating 38 14 .06 .02 ----------------------------------------------------------------- Earnings from operations $1,027 $1,016 $1.58 $1.59 ================================================================= Amount and percent change $11 1.1% $(0.01) (0.6)% -----------------------------------------------------------------\nIn 1994, non-operating items -- both positive and negative -- had an impact on earnings, which resulted in a net reduction of $38 million. These items were: (1) Costs associated with work force reduction programs implemented in 1994 decreased earnings. (2) The third in a series of four separate transactions to sell Plant Scherer Unit 4 to two Florida utilities and the sale of a 50 percent interest in a cogeneration facility in Virginia increased earnings. (3) Environmental cleanup costs decreased earnings.\nItems not discussed above that affected 1993 earnings were: (1) Costs associated with a transportation fleet reduction program decreased earnings. (2) Transactions related to a 1991 settlement agreement with Gulf States Utilities Company increased earnings.\nIn January 1994, The Southern Company board of directors approved a two-for-one common stock split in the form of a stock distribution. All common stock data reported reflect the stock distribution. Dividends paid on common stock during 1994 were $1.18 per share or 29 1\/2 cents per quarter. During 1993 and 1992, dividends paid per share were $1.14 and $1.10, respectively. In January 1995, The Southern Company board of directors raised the quarterly dividend to 30 1\/2 cents per share or an annual rate of $1.22 per share.\nRevenues\nOperating revenues decreased in 1994 and increased in 1993 and 1992 as a result of the following factors:\nIncrease (Decrease) From Prior Year ---------------------------- 1994 1993 1992 ---------------------------- (in millions) Retail -- Change in base rates $ 3 $ 3 $ 137 Sales growth 153 104 138 Weather (177) 198 (113) Fuel recovery and other (107) 199 (55) --------------------------------------------------------------- Total retail (128) 504 107 --------------------------------------------------------------- Sales for resale -- Within service area (87) 38 (8) Outside service area (108) (184) (87) --------------------------------------------------------------- Total sales for resale (195) (146) (95) Other operating revenues 131 58 11 --------------------------------------------------------------- Total operating revenues $(192) $416 $ 23 ============================================================== Percent change (2.3)% 5.2% 0.3% --------------------------------------------------------------\nRetail revenues of $7.1 billion in 1994 decreased 1.8 percent from last year, compared with an increase of 7.4 percent in 1993. Under fuel cost recovery\nII-8\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nprovisions, fuel revenues generally equal fuel expense -- including the fuel component of purchased energy -- and do not affect net income.\nRevenues from sales for resale within the service area were $360 million in 1994, down 19 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. Sales 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.\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:\n1994 1993 1992 -------------------------------- (in millions) Capacity $276 $350 $457 Energy 176 230 330 ----------------------------------------------------- Total $452 $580 $787 =====================================================\nCapacity revenues decreased in 1994 and 1993 because the amount of capacity under contract declined by some 400 megawatts and 500 megawatts, respectively. In 1995, the contracted capacity will decline another 100 megawatts. Additional declines in capacity are not scheduled until after 1999.\nChanges in revenues are influenced heavily by the amount of energy sold each year. Kilowatt-hour sales for 1994 and the percent change by year were as follows:\n(billions of Amount Percent Change kilowatt-hours) ------ ------------------------ 1994 1994 1993 1992 ---- ------------------------ Residential 35.8 (2.6)% 9.5% 0.0% Commercial 34.1 3.8 5.9 2.1 Industrial 50.3 3.2 1.9 3.8 Other 0.9 3.8 4.6 (4.8) ----- Total retail 121.1 1.6 5.3 2.1 Sales for resale -- Within service area 8.1 (38.5) 9.5 (1.7) Outside service area 10.8 (13.5) (25.2) (16.2) ----- Total 140.0 (3.4) 2.1 (0.7) =================================================================\nThe rate of increase in 1994 retail energy sales was suppressed by the impact of weather. Residential energy sales registered the first annual decrease in more than a decade as a result of milder-than-normal summer weather in 1994, compared with the extremely hot summer of 1993. Commercial and industrial sales continue to show moderate gains in excess of the national average. This reflects the strength of business and economic conditions in The Southern Company's service area. Energy sales to retail customers are projected to increase at an average annual rate of 1.9 percent during the period 1995 through 2005.\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 continue to decrease, primarily as a result of the scheduled decline in megawatts of capacity under contract.\nExpenses\nTotal operating expenses of $6.6 billion for 1994 declined 2.1 percent compared with the prior year. The costs to produce and deliver electricity in 1994 declined by $297 million, primarily as a result of less energy being sold and continued effective cost controls. However, certain other expenses in 1994 increased compared with expenses in 1993. Depreciation expenses and property taxes increased by $41 million as a result of additional utility plant being placed into service. The work force reduction programs in 1994 increased expenses by $100 million. The amortization of deferred expenses related to Plant Vogtle increased by $39 million in 1994 when compared with the prior year. For additional information concerning Plant Vogtle, see Note 1 to the financial statements under \"Plant Vogtle Phase-In Plans.\"\nIn 1993, operating expenses of $6.7 billion were up 6.5 percent compared with 1992. 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. The transportation fleet reduction program and environmental cleanup 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.\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\nII-9\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nnuclear generating units. The amount and sources of generation and the average cost of fuel per net kilowatt-hour generated were as follows:\n1994 1993 1992 ---------------------- Total generation (billions of kilowatt-hours) 142 144 140 Sources of generation (percent) -- Coal 75 78 77 Nuclear 19 17 17 Hydro 5 4 5 Oil and gas 1 1 1 Average cost of fuel per net kilowatt-hour generated (cents) -- Coal 1.80 1.90 1.86 Nuclear 0.56 0.54 0.54 Oil and gas 3.99 4.34 4.81 Total 1.56 1.67 1.62 ------------------------------------------------------------\nFuel and purchased power costs of $2.3 billion in 1994 decreased $266 million or 10 percent compared with 1993, primarily because 3.1 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. Fuel 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 a slightly higher average cost of fuel per net kilowatt-hour generated.\nFor 1994, income taxes rose $8 million or 1.3 percent above the amount reported for 1993. The increase resulted primarily from the sale of interests in generating plant facilities discussed earlier. For 1993, income taxes increased $69 million compared with the prior year. The increase was primarily attributable to a 1 percent increase in the corporate federal income tax rate effective January 1993, and the increase in taxable income from operations.\nTotal gross interest charges and preferred stock dividends continued to decline from amounts reported in the previous year. The declines are attributable to lower interest rates and significant refinancing activities in 1993 and 1992. In 1994, these costs were $765 million -- down $66 million or 8.0 percent. These costs for 1993 decreased $21 million. As a result of favorable market conditions, $1.0 billion in 1994, $3.0 billion in 1993, and $2.4 billion in 1992 of senior securities were issued for the primary purpose of retiring higher-cost securities.\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 a less regulated, more competitive environment.\nGeorgia Power has completed three of four separate transactions to sell Unit 4 of Plant Scherer to two Florida utilities. The remaining transaction is scheduled to take place in 1995 with the after-tax gain currently estimated to total approximately $12 million. See Note 7 to the financial statements for additional information.\nIn 1994, work force reduction programs were implemented, reducing earnings by $61 million. These actions will assist in efforts to control growth in future operating expenses.\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 scheduled to be in commercial operation in 1995.\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) is beginning to have a dramatic effect on the future of the electric utility industry. The Energy Act promotes energy efficiency, alternative fuel use, and increased competition for electric\nII-10\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nutilities. The Southern Company is positioning the business to meet the challenge of this major change in the traditional practice 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. 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, retail wheeling initiatives are rapidly evolving and becoming very prominent issues in several states. In order to address these initiatives, numerous questions must be resolved with the most complex ones relating to transmission pricing and recovery of stranded investments. As the initiatives become a reality, the structure of the utility industry could radically change. Therefore, unless The Southern Company remains a low-cost producer and provides quality service, the company's retail energy sales growth could be limited, and this could significantly erode earnings. Conversely, being the low-cost producer could provide significant opportunities to increase market share and profitability.\nThe Energy Act amended the Public Utility Holding Company Act of 1935 (PUHCA). The amendment allows holding companies to form exempt wholesale generators and foreign utility companies to sell power largely free of regulation under PUHCA. These 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 1994, additional investments were made in entities that own and operate generating facilities in domestic and various international markets. At December 31, 1994, Southern Electric's investment in these facilities amounted to $436 million. In the near term, Southern Electric is expected to have minimal effect on earnings, but the potential exists that it could be a prime contributor to future earnings growth.\nSouthern Communications Services is constructing a wireless communications system to provide services beginning in 1995 to Southern Company subsidiaries and to other parties. It is anticipated that the operations of this new subsidiary, at least in its early years, will negatively affect earnings and cash flow.\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 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. Besides promoting energy efficiency, another benefit of these programs could be the ability to defer the need to construct costly baseload generating facilities further into the future.\nThe ability to defer major construction projects in conjunction with regulatory precertification approval processes for both new plant additions and purchase power contracts should minimize the possibility of not being able to fully recover additional costs.\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 retail and wholesale regulatory matters.\nThe Southern Company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. In the event that a portion of the company's operations is no longer subject to these provisions, the company would be required to write off related regulatory assets and liabilities. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities\" for additional information.\nThe staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry -- including the company -- regarding the recognition, measurement, and classification of decommissioning costs for nuclear generating facilities in the financial statements. In response to these questions, the FASB has decided to review the accounting for nuclear decommissioning. If current electric utility industry accounting practices for decommissioning are changed: (1) Annual provisions for decommissioning could increase. (2) The estimated cost for decommissioning may be required to be recorded as a liability in the Consolidated Balance Sheets. In\nII-11\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nmanagement's opinion -- should these changes be required -- the changes would not have a significant adverse effect on results of operations because of the company's current and expected future ability to recover decommissioning costs through rates. See Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning\" for additional information.\nThe company is involved in various matters being litigated. See Note 3 to the financial statements for information regarding material issues that could possibly affect future earnings.\nCompliance costs related to the Clean Air Act Amendments of 1990 (Clean Air Act) could affect earnings if such costs are not fully recovered. The Clean Air Act and other important environmental items are discussed later under \"Environmental Matters.\"\nFINANCIAL CONDITION\nOverview\nThe Southern Company's financial condition continues to remain at the strongest level since the mid-1980s. Earnings from operations continued to increase in 1994 and exceeded $1 billion. Based on this performance, in January 1995, The Southern Company board of directors increased the common stock dividend for the fourth consecutive year.\nAnother major change in The Southern Company's financial condition was gross property additions of $1.5 billion to utility plant. The majority of funds needed for gross property additions since 1991 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.\nThe Southern Company has a policy that financial derivatives are to be used only to mitigate business risks and not for speculative purposes. Derivatives have been used by the company on a very limited basis. At December 31, 1994, the credit risk for derivatives outstanding was not material.\nCapital Structure\nThe company achieved a ratio of common equity to total capitalization -- including short-term debt -- of 44.4 percent in 1994, compared with 43.8 percent in 1993 and 42.8 percent in 1992. The company's goal is to maintain the common equity ratio generally within a range of 40 percent to 45 percent.\nDuring 1994, the operating companies sold $185 million of first mortgage bonds and, through public authorities, $749 million of pollution control revenue bonds. Preferred securities of $100 million were issued in 1994. The operating companies continued to reduce financing costs by retiring higher-cost bonds. Retirements, including maturities, of bonds totaled $973 million during 1994, $2.5 billion during 1993, and $2.8 billion during 1992. Retirements of preferred stock totaled $1 million during 1994, $516 million during 1993, and $326 million during 1992. As a result, the composite interest rate on long-term debt decreased from 8.8 percent at December 31, 1991, to 7.2 percent at December 31, 1994. During this same period, the composite dividend rate on preferred stock declined from 7.7 percent to 6.7 percent.\nIn 1994, The Southern Company raised $159 million from the issuance of new common stock under the company's various stock plans. An additional $120 million of new common stock was issued through a public offering in early 1994. At the close of 1994, the company's common stock had a market value of $20.00 per share, compared with a book value of $12.47 per share. The market-to-book value ratio was 160 percent at the end of 1994, compared with 184 percent at year-end 1993 and 168 percent at year-end 1992.\nCapital Requirements for Construction\nThe construction program of the operating companies is budgeted at $1.4 billion for 1995, $1.3 billion for 1996, and $1.3 billion for 1997. The total is $4.0 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. In addition, there can be no assurance that costs related to capital expenditures will be fully recovered.\nII-12\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\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 service area, the construction of combustion turbine peaking units of approximately 1,100 megawatts of capacity is planned to be completed by 1997 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 $718 million will be required by the end of 1997 for present sinking fund requirements and maturities of long-term debt. Also, the operating subsidiaries will continue to retire higher-cost debt and preferred stock and replace these obligations with lower-cost capital if market conditions permit.\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 began in 1995 and affected 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.\nIn 1995, the Environmental Protection Agency (EPA) began issuing annual sulfur dioxide emission allowances through the allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for issuing 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 Southern Company's sulfur dioxide compliance strategy is designed to use allowances as a compliance option.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, which has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures were required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment will be installed on all fossil-fired units. Construction expenditures for Phase I compliance are estimated to total approximately $300 million through 1995.\nFor Phase II 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, current compliance strategy could require total estimated construction expenditures of approximately $150 million. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the continuing 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 2 percent in revenue requirements from customers could be necessary to fully recover the cost of compliance for both Phase I and Phase II of Title IV of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\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 -- affecting sources of nitrogen oxides and volatile organic compounds -- to achieve attainment by 1999. As the required first step, the state has issued\nII-13\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nrules 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 Georgia Power plants. Final attainment rules, based on modeling studies, could require installation of additional controls for nitrogen oxide emissions to meet the 1999 deadline. A decision on new requirements is expected in 1996. Compliance with any new rules could result in significant additional costs. The actual 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 EPA is scheduled to submit a report to Congress on the results of this study by November 1995. The report will include 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.\nA significant portion of costs related to the acid rain provision of the Clean Air Act is expected to be recovered through existing ratemaking provisions. However, there can be no assurance that all Clean Air Act costs will be recovered.\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 issued proposed rules in November 1994 and is required to take final action on this issue in 1996. 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 1995, the EPA may 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 subsidiaries must comply with other environmental laws and regulations that cover the handling and disposal of hazardous waste. Under these various laws and regulations, the subsidiaries could incur substantial costs to clean up properties. The subsidiaries conduct studies to determine the extent of any required cleanup costs and have recognized in their respective financial statements costs to clean up known sites. These costs for The Southern Company amounted to $8 million, $41 million, and $3 million in 1994, 1993, and 1992, respectively. Additional sites may require environmental remediation for which the subsidiaries may be liable for a portion or all required cleanup costs. See Note 3 to the financial statements for information regarding Georgia Power's potentially responsible party status at a site in Brunswick, Georgia.\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; the Resource Conservation and Recovery Act; the Toxic Substances Control Act; and the Endangered Species 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.\nII-14\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nCompliance with possible additional 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 exists for liability as the result of lawsuits alleging damages caused by electromagnetic fields.\nSources of Capital\nIn early 1995, The Southern Company sold -- through a public offering -- common stock with proceeds totaling $103 million. The company may require additional equity capital during the remainder of 1995. The amount and timing of additional equity capital to be raised in 1995 -- 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 1995 for the company's 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, which was primarily from internal sources. However, the type and timing of any financings -- if needed -- will depend on market conditions and regulatory approval.\nCompleting the sale of Unit 4 of Plant Scherer in 1995 will provide some $130 million of cash.\nTo meet short-term cash needs and contingencies, the system companies had approximately $139 million of cash and cash equivalents and $1.4 billion of unused credit arrangements with banks at the beginning of 1995.\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. Currently, each of the operating companies expects to have adequate coverage ratios for anticipated requirements through at least 1997.\nII-15\nCONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 1994, 1993, and 1992 The Southern Company and Subsidiary Companies 1994 Annual Report\nII-16\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1994, 1993, and 1992 The Southern Company and Subsidiary Companies 1994 Annual Report\nII-17\nCONSOLIDATED BALANCE SHEETS At December 31, 1994 and 1993 The Southern Company and Subsidiary Companies 1994 Annual Report\nII-18\nCONSOLIDATED BALANCE SHEETS (continued) At December 31, 1994 and 1993 The Southern Company and Subsidiary Companies 1994 Annual Report\nII-19\nCONSOLIDATED STATEMENTS OF CAPITALIZATION At December 31, 1994 and 1993 The Southern Company and Subsidiary Companies 1994 Annual Report\nII-20\nCONSOLIDATED STATEMENTS OF CAPITALIZATION (continued) At December 31, 1994 and 1993 The Southern Company and Subsidiary Companies 1994 Annual Report\nCONSOLIDATED STATEMENTS OF PAID-IN CAPITAL For the Years Ended December 31, 1994, 1993, and 1992\nII-21\nNOTES TO FINANCIAL STATEMENTS The Southern Company and Subsidiary Companies 1994 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 Communications Services (Southern Communications), Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear), and The Southern Development and Investment Group (SDIG). 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 subsidiary companies. Southern Communications, beginning in mid-1995, will provide digital wireless communications services -- over the 800-megahertz frequency band -- to The Southern Company's subsidiaries and also will market these services to the public within the Southeast. 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. SDIG develops new business opportunities related to energy products and services.\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, 1994, include $2.8 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.\nRegulatory Assets and Liabilities\nThe Southern Company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. Regulatory assets represent probable future revenues to the company associated with certain costs that are expected to be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited to customers through the ratemaking process. Regulatory assets and (liabilities) reflected in the Consolidated Balance Sheets at December 31 relate to:\n1994 1993 ---------------- (in millions) Deferred income taxes $1,454 $1,546 Deferred Plant Vogtle costs 432 507 Premium on reacquired debt 298 288 Demand-side programs 97 49 Department of Energy assessments 79 87 Vacation pay 70 73 Deferred fuel charges 51 83 Postretirement benefits 41 22 Work force reduction costs 15 5 Deferred income tax credits (987) (1,051) Storm damage reserve (53) (22) Other, net 108 91 ------------------------------------------------------------- Total $1,605 $1,678 =============================================================\nIn the event that a portion of the company's operations is no longer subject to the provisions of Statement No. 71, the company would be required to write off related regulatory assets and liabilities. In addition, the company would be required to determine any impairment to other assets, including plant, and write down the assets to their fair value.\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.\nThe company has a diversified base of customers. No single customer or industry comprises 10 percent or more of revenues. In 1994, uncollectible accounts continued to average less than 1 percent of revenues.\nII-22\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\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 $152 million in 1994, $137 million in 1993, and $132 million in 1992. 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. Alabama Power and Georgia Power -- based on its ownership interests -- estimate their remaining liability at December 31, 1994, under this law to be approximately $43 million and $33 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 3.2 percent in 1994 and 3.3 percent in both 1993 and 1992. 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.\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. Alabama Power and Georgia Power have external trust funds to comply with the NRC's regulations. Amounts previously recorded in internal reserves are being transferred into the external trust funds over set periods of time as approved by the respective state public service commissions. 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.\nSite study cost is the estimate to decommission the facility as of the site study year, and ultimate cost is the estimate to decommission the facility as of retirement date. The estimated costs of decommissioning -- both site study costs and ultimate costs -- at December 31, 1994, for Alabama Power's Plant Farley and Georgia Power's ownership interests in plants Hatch and Vogtle were as follows:\nPlant Plant Plant Farley Hatch Vogtle -------------------------- Site study basis (year) 1993 1994 1994\nDecommissioning periods: Beginning year 2017 2014 2027 Completion year 2029 2027 2038 -------------------------------------------------------------- (in millions) Site study costs: Radiated structures $409 $241 $193 Non-radiated structures 75 34 43 Other 94 60 49 -------------------------------------------------------------- Total $578 $335 $285 ============================================================== (in millions) Ultimate costs: Radiated structures $1,258 $641 $ 843 Non-radiated structures 231 91 190 Other 289 160 215 -------------------------------------------------------------- Total $1,778 $892 $1,248 ==============================================================\nII-23\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nPlant Plant Plant Farley Hatch Vogtle --------------------------- (in millions)\nAmount expensed in 1994 $18 $6 $6\nAccumulated provisions: Balance in external trust funds $ 71 $33 $22 Balance in internal reserves 51 29 10 ---------------------------------------------------------------- Total $122 $62 $32 ================================================================\nAssumed in ultimate costs: Inflation rate 4.5% 4.4% 4.4% Trust earning rate 7.0 6.0 6.0 ----------------------------------------------------------------\nAnnual provisions for nuclear decommissioning are based on an annuity -- sinking fund -- method as approved by the respective state public service commissions. The decommissioning costs approved for ratemaking are $578 million for Plant Farley, $184 million for Plant Hatch, and $155 million for Plant Vogtle. These amounts for Georgia Power are the costs to decommission the radioactive portions of the plants based on 1990 site studies. Georgia Power's estimated ultimate costs, based on the 1990 studies, were $872 million and $1.4 billion for plants Hatch and Vogtle, respectively. Georgia Power expects the GPSC to periodically review and adjust, if necessary, the amounts collected in rates for the anticipated cost of decommissioning.\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 changes in the assumed date of decommissioning, changes in regulatory requirements, changes in technology, and changes in costs of labor, materials, and equipment.\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.\nEffective 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.\nPlant Vogtle Phase-In Plans\nIn 1987 and 1989, the 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 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. 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:\n1994 1993 1992 ------------------------------- (in millions) Deferred capacity buybacks $ 10 $ 38 $100 Amortization of deferred costs (85) (74) (69) Income taxes - - (23) ------------------------------------------------------------------- Net (amortization) deferred (75) (36) 8 Effect of adoption of FASB Statement No. 109 - 160 - Deferred costs at beginning of year 507 383 375 ------------------------------------------------------------------ Deferred costs at end of year $432 $507 $383 ==================================================================\nEach GPSC order called 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.\nAFUDC\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\nII-24\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\ndepreciation expense. The composite rates used by the operating companies to calculate AFUDC during the years 1992 through 1994 ranged from a before-income-tax rate of 5.0 percent to 11.3 percent. AFUDC, net of income tax, as a percent of consolidated net income was 2.3 percent in 1994, 1.7 percent in 1993, and 1.8 percent in 1992.\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, The Southern Company's only financial instrument that the carrying amount did not approximate fair value at December 31 was as follows:\nLong-Term Debt ----------------------- Carrying Fair Year Amount Value ---- -------- ----- (in millions) 1994 $7,674 $7,373 1993 7,321 7,729 ----------------------------------------------------------------\nThe fair value of long-term debt was based on either closing market price or closing price 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 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 regulatory asset representing the future recoverability of this cost. The amount was $70 million and $73 million at December 31, 1994 and 1993, respectively. In 1995, an estimated 69 percent of the 1994 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 trusts 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. Qualified trusts are funded to the extent deductible under federal income tax regulations or to the extent required by the operating companies' respective regulatory commissions. Amounts funded are primarily invested in debt and equity securities.\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\nII-25\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nusing 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. For the other operating companies, the cost of postretirement benefits is reflected in rates on a current basis.\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 those 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 were $42 million.\nFunded Status 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. The funded status of the plans at December 31 was as follows:\nPension -------------------- 1994 1993 -------------------- (in millions) Actuarial present value of benefit obligation: Vested benefits $1,593 $1,534 Non-vested benefits 68 76 ---------------------------------------------------------------------- Accumulated benefit obligation 1,661 1,610 Additional amounts related to projected salary increases 638 558 ---------------------------------------------------------------------- Projected benefit obligation 2,299 2,168 Less: Fair value of plan assets 3,171 3,337 Unrecognized net gain (789) (1,060) Unrecognized prior service cost 64 72 Unrecognized transition asset (139) (152) ---------------------------------------------------------------------- Prepaid asset recognized in the Consolidated Balance Sheets $ 8 $ 29 ======================================================================\nPostretirement Medical ----------------------- 1994 1993 ----------------------- (in millions) Actuarial present value of benefit obligation: Retirees and dependents $293 $243 Employees eligible to retire 40 48 Other employees 367 389 ------------------------------------------------------------------- Accumulated benefit obligation 700 680 Less: Fair value of plan assets 128 95 Unrecognized net loss (gain) 22 76 Unrecognized transition obligation 394 419 ------------------------------------------------------------------- Accrued liability recognized in the Consolidated Balance Sheets $156 $ 90 ===================================================================\nPostretirement Life -------------------- 1994 1993 -------------------- (in millions) Actuarial present value of benefit obligation: Retirees and dependents $ 82 $ 75 Employees eligible to retire - - Other employees 92 96 ------------------------------------------------------------------- Accumulated benefit obligation 174 171 Less: Fair value of plan assets 12 2 Unrecognized net loss (gain) (19) (13) Unrecognized transition obligation 106 113 ------------------------------------------------------------------- Accrued liability recognized in the Consolidated Balance Sheets $ 75 $ 69 ===================================================================\nThe weighted average rates assumed in the actuarial calculations were:\n1994 1993 1992 -------------------------------------- Discount 8.0% 7.5% 8.0% Annual salary increase 5.5 5.0 6.0 Long-term return on plan assets 8.5 8.5 8.5 --------------------------------------------------------------------\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 10.5 percent for 1994 decreasing gradually to 6.0 percent through the year 2000 and remaining at that level thereafter. An annual increase in the assumed\nII-26\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nmedical care cost trend rate of 1 percent would increase the accumulated medical benefit obligation at December 31, 1994, by $130 million and the aggregate of the service and interest cost components of the net retiree medical cost by $18 million.\nComponents of the plans' net costs are shown below:\nPension ----------------------- 1994 1993 1992 ------------------------ (in millions) Benefits earned during the year $ 77 $ 76 $ 75 Interest cost on projected benefit obligation 160 156 146 Actual (return) loss on plan assets 75 (432) (135) Net amortization and deferral (351) 186 (85) ---------------------------------------------------------------- Net pension cost (income) $ (39) $ (14) $ 1 ================================================================\nOf the above net pension amounts, pension income of $29 million in 1994 and $9 million in 1993, and pension expense of $2 million in 1992, were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nPostretirement Medical ---------------------- 1994 1993 ---------------------- (in millions) Benefits earned during the year $ 26 $ 21 Interest cost on accumulated benefit obligation 51 43 Amortization of transition obligation 21 22 Actual (return) loss on plan assets 2 (12) Net amortization and deferral (10) 5 ----------------------------------------------------------------- Net postretirement cost $ 90 $ 79 =================================================================\nPostretirement Life --------------------- 1994 1993 -------------------- (in millions) Benefits earned during the year $ 5 $ 6 Interest cost on accumulated benefit obligation 13 13 Amortization of transition obligation 6 6 Actual (return) loss on plan assets - - Net amortization and deferral - - ----------------------------------------------------------------- Net postretirement cost $24 $25 =================================================================\nOf the above net postretirement medical and life insurance costs recorded in 1994 and 1993, $77 million and $64 million were charged to operating expenses, $18 million and $21 million were deferred, and the remainder was charged to construction and other accounts, respectively.\nWork Force Reduction Programs\nThe system companies have incurred additional costs for work force reduction programs. The costs related to these programs were $112 million, $35 million, and $37 million for the years 1994, 1993, and 1992, 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 million at December 31, 1994.\n3. LITIGATION AND REGULATORY MATTERS\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. In April 1994, the U.S. Court of Appeals for the 11th Circuit reversed the dismissal and remanded the case to the trial court, finding that allegations by the plaintiffs created a reasonable doubt that the board validly exercised its business judgment in refusing the earlier demand. This action is still pending.\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\nII-27\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nengage 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.\nGeorgia Power Potentially Responsible Party Status\nIn January 1995, Georgia Power and four other unrelated entities were notified by the EPA that they have been designated as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act with respect to a site in Brunswick, Georgia. While Georgia Power believes that the total amount of costs required for the cleanup of this site may be substantial, it is unable at this time to estimate either such total or the portion for which Georgia Power may be ultimately responsible.\nThe final outcome of this matter cannot now be determined; however, in management's opinion -- based on the nature and extent of Georgia Power's activities relating to the site -- the final outcome will not have a material adverse effect on the company's financial statements.\nGeorgia Power Tax Litigation\nIn June 1994, a tax deficiency notice was received from the Internal Revenue Service (IRS) for the years 1984 through 1987 with regard to the tax accounting by Georgia Power for the sale in 1984 of an interest in Plant Vogtle and related capacity and energy buyback commitments. The potential tax deficiency and interest arising from this issue currently amount to approximately $28 million and $32 million, respectively. The tax deficiency relates to a timing issue as to when taxes are paid; therefore only the interest portion could affect future income. Management believes that the IRS position is incorrect, and Georgia Power has filed a petition with the U. S. Tax Court challenging the IRS position. In order to minimize additional interest charges should the IRS's position prevail, Georgia Power made a payment to the IRS related to the potential tax deficiency in September 1994.\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 last rate adjustment was effective in January 1992. 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.\nIn 1994, the APSC issued an order -- at Alabama Power's request -- allowing Alabama Power to establish a natural disaster reserve not to exceed $32 million and to change the procedure for estimating the accrual of revenues for service rendered but unbilled at the end of each month. This change increased unbilled revenues for September 1994 by $28 million, which offset the initial accrual for the natural disaster reserve for the same amount. Additional monthly accruals of $250 thousand will be made until the reserve maximum is attained. In addition, a moratorium on rate increases through the third quarter of 1995 was approved.\nThe ratemaking procedures will remain in effect until the APSC votes to modify or discontinue them.\nGeorgia Power 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\nII-28\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nsuch 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 filed a petition for review of the accounting order in superior court.\nIn July 1994, the Georgia Court of Appeals upheld the legality of the rate riders. In November 1994, the Supreme Court of Georgia denied petitions for review of this ruling. As a result, Georgia Power resumed collection under the rate riders in December 1994. In early 1995, the GPSC initiated a true-up proceeding to review Georgia Power's demand-side conservation program costs both incurred and expected to be incurred during 1995 in order to adjust rate riders accordingly. The proceeding will also address a plan for recovery of costs deferred under the accounting order. Georgia Power's costs related to these conservation programs through 1994 were $115 million, of which $18 million has been collected and the remainder deferred.\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 January 1994, the Mississippi Public Service Commission (MPSC) approved PEP-2. Under PEP-2, Mississippi Power's rate of return is measured on retail net investment. Also, three indicators are used to evaluate Mississippi Power's performance 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. PEP-2 will remain in effect until the MPSC modifies or terminates the plan.\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 change in the rate of return on common equity that may require refunds as a result of this proceeding would be substantially for the period beginning in July 1991 and ending in October 1992.\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.\nIn August 1994, the FERC instituted another proceeding based on substantially the same issues as in the 1991 proceeding. The second period under review for possible refunds began in October 1994 and is scheduled to continue until January 1996.\nIf the rates of return on common equity recommended by the FERC staff were applied to all of the schedules and contracts involved in both proceedings, and refunds were ordered, the amount of refunds could range up to approximately $77 million at December 31, 1994. Although the final outcome of this matter cannot now be determined, in management's opinion, the final outcome will not result in\nII-29\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nchanges that would 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 $1.4 billion in 1995, $1.3 billion in 1996, and $1.3 billion in 1997. These estimates include AFUDC of $40 million in 1995, $30 million in 1996, and $33 million in 1997. 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, 1994, 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 1,100 megawatts is planned to be completed by 1997. 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 as then planned 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 costs and the disposition of the project's capacity output. In the event the GPSC does not allow full recovery of the project costs, then the portion not allowed may have to be written off. 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 $200 million. The plant is scheduled to be in commercial operation in 1995.\nThe ultimate outcome of this matter cannot now be determined.\n5. FINANCING, INVESTMENT, AND COMMITMENTS\nGeneral\nIn early 1995, The Southern Company sold -- through a public offering -- 5 million shares of common stock with proceeds totaling $103 million. The company may require additional equity capital during the remainder of 1995. The amount and timing of additional equity capital to be raised in 1995 -- 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.\nThe operating companies' construction programs are expected to be financed primarily from internal sources. Short-term debt will be utilized if 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 if market conditions permit.\nSouthern Electric Investments\nSouthern Electric's investments in generating facilities in domestic and various foreign markets were approximately $436 million at December 31, 1994. The consolidated financial statements reflect these investments in majority-owned or controlled subsidiaries on a consolidated basis and other investments on an equity basis.\nII-30\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nBank Credit Arrangements\nAt the beginning of 1995, unused credit arrangements with banks totaled $1.4 billion, of which approximately $875 million expires at various times during 1995 and 1996; $41 million expires at May 1, 1997; $25 million expires at May 31, 1997; $400 million expires at June 30, 1997; and $40 million expires at December 1, 1997.\nGeorgia Power's revolving credit agreements of $60 million, of which $41 million remained unused as of December 31, 1994, expire May 1, 1997. 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.\nGulf Power has $25 million of revolving credit agreements expiring May 31, 1997. These agreements allow short-term and\/or term borrowings with various terms and conditions regarding repayment. In connection with these credit arrangements, Gulf 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, 1997, 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 $40 million of revolving credit agreements expiring December 1, 1997. 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's revolving credit arrangements of $20 million, of which $11 million remained unused as of December 31, 1994, expire December 31, 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 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.\nA portion of the $1.4 billion unused credit arrangements with banks -- discussed earlier -- is dedicated to provide liquidity support to the companies' variable rate pollution control bonds. The amount of credit lines dedicated at December 31, 1994, was $293 million.\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.\nII-31\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\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 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 $16 billion at December 31, 1994. 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.\nOperating Leases\nThe operating companies have entered into coal rail car rental agreements with various terms and expiration dates. These expenses totaled $15 million, $11 million, and $9 million for 1994, 1993, and 1992, respectively. At December 31, 1994, estimated minimum rental commitments for noncancelable operating leases were as follows:\nYear Amounts --- ----------- (in millions) 1995 $ 18 1996 17 1997 17 1998 17 1999 17 2000 and thereafter 242 ------------------------------------------------------- Total minimum payments $328 =======================================================\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 three 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 joint ownership agreements with OPC for the Rocky Mountain project and with Florida Power Corporation (FPC) for a combustion turbine unit at Intercession City, Florida, both of which are discussed later.\nAt December 31, 1994, 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:\nJointly Owned Facilities ------------------------ Percent Amount of Accumulated Ownership Investment Depreciation ---------- ----------- ------------ Plant Vogtle (in millions) (nuclear) 45.7% $3,289 $628 Plant Hatch (nuclear) 50.1 842 346 Plant Miller (coal) Units 1 and 2 91.8 708 264 Plant Scherer (coal) Units 1 and 2 8.4 112 36 Unit 4 16.6 119 18 Plant Wansley (coal) 53.5 287 129 Rocky Mountain (pumped storage) 25.0* 199 - ------------------------------------------------------------- *Estimated ownership at date of completion.\nGeorgia Power and OPC have 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\nII-32\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nPower 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. The plant is scheduled to be in commercial operation in 1995.\nIn 1994, Georgia Power and FPC entered into a joint ownership agreement regarding the Intercession City combustion turbine unit. The unit is scheduled to be in commercial operation in early 1996, and will be constructed, operated, and maintained by FPC. Georgia Power will have a 33 percent interest in the 150-megawatt unit, with retention of 100 percent of the capacity from June through September. FPC will have the capacity the remainder of the year. Georgia Power's investment in the unit at completion is estimated to be $14 million. Also, Georgia Power entered into a separate four-year purchase power contract with FPC. Beginning in 1996, Georgia Power will purchase 400 megawatts of capacity. In 1998, this amount will decline to 200 megawatts for the remaining two years.\nAlabama Power and Georgia Power have contracted to operate and maintain the jointly owned facilities -- except for the Rocky Mountain project and Intercession City -- 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 $129 million, $183 million, and $289 million for 1994, 1993, and 1992, respectively. Projected capacity payments for the next five years are as follows: $77 million in 1995; $70 million in 1996; $59 million in 1997; $59 million in 1998; and $59 million in 1999. 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 and $100 million in 1992. In 1994, the amount deferred was exceeded by the amortization of amounts previously deferred by almost $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. SALES OF INTERESTS IN PLANT SCHERER\nGeorgia Power has completed three 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 $808 million, including any gains on these transactions. FP&L would 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:\nClosing Percent Date Capacity Ownership Amount ------ -------- --------- ------- (megawatts) (in millions) July 1991 290 35.46% $291 June 1993 258 31.44 253 June 1994 135 16.55 133 June 1995 135 16.55 131 ------------------------------------------------------------- Total 818 100.00% $808 =============================================================\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\nThe operating subsidiaries of The Southern Company 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. The\nII-33\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nagreements for non-firm capacity expired in 1994. Other agreements -- expiring at various dates discussed below -- 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:\nUnit Other Year Power Long-Term Total ---- ---------------------------------- (in millions) 1994 $257 $19 $276 1993 312 38 350 1992 435 22 457\nIn 1994, long-term non-firm power of 200 megawatts was sold to FPC under a contract that expired at year-end. In January 1995, the amount of unit power sales to FPC increased by 200 megawatts.\nUnit power from specific generating plants is currently being sold to FP&L, FPC, JEA, and the city of Tallahassee, Florida. Under these agreements, approximately 1,700 megawatts of capacity is scheduled to be sold during 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.\n9. INCOME TAXES\nEffective January 1, 1993, The Southern Company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption resulted in the recording of additional deferred income taxes and related regulatory assets and liabilities. At December 31, 1994, the tax- related regulatory assets and liabilities were $1.5 billion and $1.0 billion, respectively. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits.\nDetails of the federal and state income tax provisions are as follows:\n1994 1993 1992 ------------------------- (in millions) Total provision for income taxes: Federal -- Currently payable $603 $424 $343 Deferred -- current year 67 224 225 -- reversal of prior years (75) (51) (41) Deferred investment tax credits - (20) (6) ------------------------------------------------------------------- 595 577 521 ------------------------------------------------------------------- State -- Currently payable 86 64 50 Deferred -- current year 15 39 46 -- reversal of prior years (11) (3) (9) ------------------------------------------------------------------- 90 100 87 ------------------------------------------------------------------- Total 685 677 608 Less income taxes charged (credited) to other income (26) (57) (39) ------------------------------------------------------------------- Federal and state income taxes charged to operations $711 $734 $647 ===================================================================\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:\n1994 1993 ----------------------- (in millions) Deferred tax liabilities: Accelerated depreciation $2,637 $2,496 Property basis differences 1,647 1,741 Deferred plant costs 141 161 Other 271 289 ------------------------------------------------------------------ Total 4,696 4,687 ------------------------------------------------------------------ Deferred tax assets: Federal effect of state deferred taxes 104 102 Other property basis differences 278 292 Deferred costs 79 69 Pension and other benefits 63 46 Other 225 210 ------------------------------------------------------------------ Total 749 719 ------------------------------------------------------------------ Net deferred tax liabilities 3,947 3,968 Portion included in current assets, net 60 11 ------------------------------------------------------------------ Accumulated deferred income taxes in the Consolidated Balance Sheet $4,007 $3,979 ==================================================================\nII-34\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 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 $42 million in 1994, $36 million in 1993, and $41 million in 1992. At December 31, 1994, 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:\n1994 1993 1992 --------------------------- Federal statutory rate 35.0% 35.0% 34.0% State income tax, net of federal deduction 3.3 3.7 3.4 Non-deductible book depreciation 1.8 1.9 2.2 Difference in prior years' deferred and current tax rate (1.5) (1.3) (1.5) Other 0.3 (1.1) (1.6) --------------------------------------------------------------- Effective income tax rate 38.9% 38.2% 36.5% ===============================================================\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 reflect the stock distribution.\nShares Reserved\nAt December 31, 1994, a total of 15 million shares was reserved for issuance pursuant to the Dividend Reinvestment and Stock Purchase Plan, the Employee Savings Plan, Outside Directors Stock 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, 36 employees are eligible to participate in the plan. As of December 31, 1994, 42 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. Options outstanding will expire no later than 10 years after the date of grant, unless terminated earlier by the board of directors in accordance with the plan. Stock option activity in 1993 and 1994 is summarized below:\nShares Average Subject Option Price To Option Per Share --------------------------- Balance at December 31, 1992 1,189,122 $15.02 Options granted 359,492 21.22 Options canceled -- -- Options exercised (183,804) 14.14 -------------------------------------------------------------------- Balance at December 31, 1993 1,364,810 16.77 Options granted 446,443 18.88 Options canceled - - Options exercised (74,649) 14.81 -------------------------------------------------------------------- Balance at December 31, 1994 1,736,604 $17.39 ==================================================================== Shares reserved for future grants: At December 31, 1992 4,073,936 At December 31, 1993 3,714,444 At December 31, 1994 3,268,001 -------------------------------------------------------------------- Options exercisable: At December 31, 1993 475,795 At December 31, 1994 793,989 --------------------------------------------------------------------\nCommon Stock Dividend Restrictions\nThe income of The Southern Company is derived primarily from equity in earnings of its operating subsidiaries. At December 31, 1994, $1.8 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.\nII-35\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\n11. OTHER LONG-TERM DEBT\nDetails of other long-term debt at December 31 are as follows:\n1994 1993 ----------------- (in millions)\nObligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds: Collateralized -- 5.375% to 9.375% due 2004-2024 $1,179 $ 708 Variable rate (5% to 6.25% at 1\/1\/95) due 2011-2024 412 63 Non-collateralized -- 7.2 % to 12.25% due 2003-2014 1 650 6.75% to 10.6% due 2015-2017 828 890 5.8% due 2022 10 10 Variable rate (2.95% to 3.7% at 1\/1\/94) due 2011-2022 - 92 ----------------------------------------------------------------- 2,430 2,413 ----------------------------------------------------------------- Capitalized lease obligations 148 247 ----------------------------------------------------------------- Notes payable: 4.15% to 9.75% due 1994-1998 153 144 8.375% to 10% due 1997-1999 196 - Adjustable rates (14.04% at 1\/1\/95) due 1995 26 - Adjustable rates (4% to 7.8% at 1\/1\/95) due 1994-1996 133 115 Adjustable rates (5.5% to 8.14% at 1\/1\/95) due 1998-2019 175 43 ----------------------------------------------------------------- 683 302 ----------------------------------------------------------------- Total $3,261 $2,962 =================================================================\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 $126 million and $217 million at December 31, 1994 and 1993, respectively. At December 31, 1994, the composite interest rates for buildings and other were 9.7 percent and 10.7 percent, respectively. Sinking fund requirements and\/or serial maturities through 1999 applicable to other long-term debt are as follows: $97 million in 1995; $166 million in 1996; $46 million in 1997; $29 million in 1998; and $23 million in 1999.\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 at December 31 is as follows:\n1994 1993 ------------- (in millions) Bond improvement fund requirements $ 48 $ 51 Less: Portion to be satisfied by certifying property additions 46 3 Reacquired bonds - 25 ---------------------------------------------------------------- Cash sinking fund requirements 2 23 First mortgage bond maturities and redemptions 130 44 Other long-term debt maturities (Note 11) 97 89 ---------------------------------------------------------------- Total $229 $156 ================================================================\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.\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 provides funds up to $8.9 billion for 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\nII-36\nNOTES (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\ntaxes, for Alabama Power and Georgia Power -- based on its ownership and buyback interests -- is $159 million and $163 million, respectively, per incident but not more than an aggregate of $20 million and $21 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 assessment in the event that losses exceed accumulated reserve funds. Alabama Power's and Georgia Power's maximum annual assessments are limited to $12 million and $15 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.\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 $2.8 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 $27 million and $25 million, respectively. The maximum replacement power assessments are $10 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 approximately $6 million each.\nAll retrospective assessments -- whether generated for liability, property, or replacement power -- may be subject to applicable state premium taxes.\n14. QUARTERLY FINANCIAL INFORMATION (Unaudited)\nSummarized quarterly financial data for 1994 and 1993 are as follows:\nEarnings for 1994 declined by $61 million or 9 cents per share as a result of work force reduction programs primarily recorded in the first quarter. *Common stock data reflect a two-for-one stock split in the form of a stock distribution for each share held as of February 7, 1994. The company's business is influenced by seasonal weather conditions.\nII-37\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA The Southern Company and Subsidiary Companies 1994 Annual Report (See Note Below)\nII-38\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA The Southern Company and Subsidiary Companies 1994 Annual Report (See Note Below)\nII-39A\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA The Southern Company and Subsidiary Companies 1994 Annual Report (See Note Below)\nII-39B\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA The Southern Company and Subsidiary Companies 1994 Annual Report (See Note Below)\nII-39C\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nII-40\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nII-41A\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nII-41B\nSELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA (continued) The Southern Company and Subsidiary Companies 1994 Annual Report\nII-41C\nCONSOLIDATED STATEMENTS OF INCOME The Southern Company and Subsidiary Companies\nII-42\nCONSOLIDATED STATEMENTS OF INCOME The Southern Company and Subsidiary Companies\nII-43A\nCONSOLIDATED STATEMENTS OF INCOME The Southern Company and Subsidiary Companies\nII-43B\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-45A\nCONSOLIDATED STATEMENTS OF CASH FLOWS The Southern Company and Subsidiary Companies\nII-45B\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-46\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-47A\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-47B\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-48\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-49A\nCONSOLIDATED BALANCE SHEETS The Southern Company and Subsidiary Companies\nII-49B\nALABAMA POWER COMPANY FINANCIAL SECTION\nII-50\nMANAGEMENT'S REPORT Alabama Power Company 1994 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, 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 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 Elmer B. Harris President and Chief Executive Officer\n\/s\/ William B. Hutchins, III William B. Hutchins, III Executive Vice President 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, 1994 and 1993, and the related statements of income, retained earnings, and cash flows for each of the three years in the period ended December 31, 1994. 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-60 through II-78) referred to above present fairly, in all material respects, the financial position of Alabama Power Company as of December 31, 1994 and 1993, 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, the company changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\n\/s\/ Arthur Andersen LLP\nBirmingham, Alabama February 15, 1995\nII-52\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Alabama Power Company 1994 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nAlabama Power Company's 1994 net income after dividends on preferred stock was $356 million, representing a $10 million (2.8 percent) increase from the prior year. This improvement can be attributed to lower operating expenses which decreased 3.0 percent from the previous year as a result of the company's strategy to remain a low-cost producer of electricity. This improvement was partially offset by reduced capacity sales to nonterritorial utilities. Net income was also impacted by the mild weather in 1994.\nIn 1993, earnings were $346 million, representing a 2.3 percent increase over the prior year. This increase was due to higher retail energy sales and lower financing costs. These positive factors were partially offset by higher operating costs and a scheduled reduction in capacity sales to non-affiliated utilities.\nThe return on average common equity for 1994 was 13.86 percent compared to 13.94 percent in 1993, and 14.02 percent in 1992.\nRevenues\nThe following table summarizes the principal factors that affected operating revenues for the past three years:\n=============================================================== Increase (Decrease) From Prior Year ------------------------------------- 1994 1993 1992 ------------------------------------- (in thousands) Retail -- Change in base rates $ -- $ -- $ 36,348 Unbilled adjustment 28,000 -- -- Sales growth 45,304 24,960 36,237 Weather (39,964) 58,536 (42,709) Fuel cost recovery and other (84,344) 96,437 (31,318) ---------------------------------------------------------------- Total retail (51,004) 179,933 (1,442) ---------------------------------------------------------------- Sales for Resale -- Non-affiliates (9,345) (43,686) (121) Affiliates (17,213) 23,887 (1,287) ---------------------------------------------------------------- Total sales for resale (26,558) (19,799) (1,408) Other operating revenues 5,095 635 2,896 ---------------------------------------------------------------- Total operating revenues $(72,467) $160,769 $ 46 ================================================================ Percent change (2.4)% 5.6% -- % ================================================================\nRetail revenues of $2.4 billion in 1994 decreased $51 million (2.1 percent) from the prior year, compared with an increase of $180 million (8.0 percent) in 1993. The mild weather during the summer of 1994 and lower fuel cost recovery were the primary reasons for the decrease in retail revenues from 1993. The extreme weather during 1993 and sales growth contributed to the increase in retail revenues over 1992. Fuel revenues, which decreased substantially in 1994, generally represent the direct recovery of fuel expense, including the fuel component of purchased energy, and therefore have no effect on net income. In September 1994, the company recorded an additional $28 million (679 million kilowatt-hours) in estimated unbilled revenues due to a change in the estimating procedure for unbilled kilowatt-hours (KWHs) and associated revenues. For additional information concerning unbilled revenues and an offsetting expense, see Note 3 under \"Retail Rate Adjustment Procedures.\"\nII-53\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1994 Annual Report\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. These capacity and energy components, as well as the components of the sales to affiliated companies, were:\n============================================================ 1994 1993 1992 ------------------------------------------ (in thousands)\nCapacity $165,063 $187,062 $216,113 Energy 222,579 233,253 239,622 ------------------------------------------------------------ Total $387,642 $420,315 $455,735 ============================================================\nCapacity revenues from non-affiliates remained relatively constant in 1994 but decreased in 1993 due to a scheduled reduction in capacity dedicated to unit power sales customers for the first five months of the year. Capacity revenues from sales to affiliates decreased $22 million in 1994. Sales to affiliated companies within the Southern electric system will vary from year to year depending on demand, the availability, and the variable production cost of generating resources at each company.\nKWH sales for 1994 and the percent change by year were as follows:\n=============================================================== KWH Percent Change ----------------------------------------- 1994 1994 1993 1992 ----------------------------------------- (millions)\nResidential 12,955 (1.7)% 9.2% (2.1)% Commercial 9,495 3.4 6.4 1.2 Industrial 19,181 3.2 1.8 4.3 Unbilled adjustment 679 - - - Other 184 1.1 2.8 1.2 --------- Total retail 42,494 3.3 5.1 1.6 Sales for resale - Non-affiliates 6,775 (5.2) (14.8) (4.9) Affiliates 8,433 4.3 12.1 (7.4) --------- Total 57,702 2.4% 3.0% (0.7)% ===============================================================\nExpenses\nTotal operating expenses of $2.3 billion for 1994 were down 3.0 percent compared with the prior year. The decrease was mainly due to less coal-fired generation and a lower average cost of fuel consumed. Coal-fired generation decreased because it was displaced with lower cost nuclear and hydro generation.\nTotal operating expenses for 1993 were up 7.0 percent over those recorded in 1992. The increase was mainly attributable to higher production expenses of $95 million to meet increased energy demands.\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 decreased in 1994 by $75 million (8.6 percent) from the previous year. This decrease is attributable to the increase in availability of nuclear and hydro generation and a decrease in the cost of fuel. Fuel expense increased in 1993 as a result of increased energy demands during the summer. Fuel cost per KWH generated was 1.56 cents in 1994, 1.73 cents in 1993 and 1.64 cents in 1992.\nPurchased power consists primarily of purchases from the affiliates of the Southern electric system. Purchased power transactions among the company and its affiliates will vary from period to period depending on demand, the availability, and the variable production cost of generating resources at each company. Purchased capacity from affiliates increased $5 million in 1994. KWH purchases from affiliates decreased 27 percent from the prior year.\nOther operation expenses decreased 2.5 percent in 1994 following a 5.6 percent increase in 1993. The increase in 1993 was 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.\nMaintenance expenses increased 3.8 percent in 1994 over the previous year due to the establishment of a Natural Disaster Reserve. For additional information concerning the Natural Disaster Reserve, see Note 3 under \"Retail Rate Adjustment Procedures.\"\nDepreciation and amortization expense remained virtually unchanged from the previous year. This is the result of lower average depreciation rates effective January 1994 offset by growth in depreciable plant in service. Depreciation and\nII-54\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1994 Annual Report\namortization expense increased 3.4 percent in 1993 due principally to growth in depreciable plant in service.\nIncome taxes increased in 1994 by $17 million (8.2 percent). This is due to higher taxable income. The increase in income tax expense of 2.6 percent for 1993 was primarily attributable to a one percent increase in the corporate federal income tax rate effective January 1, 1993.\nThe company contributed $13.5 million to the Alabama Power Foundation, Inc. in 1994, which represents an increase of $10.5 million from the previous year. The Foundation makes distributions to qualified entities which are organized exclusively for charitable, educational, literary, and scientific purposes.\nTotal net interest charges and preferred stock dividends continued to decline from amounts reported in the previous year. The declines reflect the significant refinancing activities in 1993 and 1992. In 1994, these costs were $236 million -- down $23 million (9.0 percent). These costs decreased $7.5 million (2.8 percent) in 1993.\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 a less regulated, more competitive environment.\nFuture earnings in the near term will 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. However, the Energy Policy Act of 1992 (Energy Act) is beginning to have a dramatic 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 posturing the business to meet the challenge of this major change in the traditional practice 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. 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, retail wheeling initiatives are rapidly evolving and becoming very prominent issues in several states. In order to address these initiatives, numerous questions must be resolved with the most complex ones relating to transmission pricing, recovery of stranded investments, and developing rate structures for different market segments that reflect the economic costs of serving that market. As the initiatives become a reality, the structure of the utility industry could radically change. Therefore, unless the company remains a low-cost producer and provides quality service, the company's retail energy sales growth could be limited, and this could significantly erode earnings. Conversely, being the low-cost producer could provide significant opportunities to increase market share and profitability.\nThe scheduled addition of five combustion turbine generating units in 1995 and four more in 1996 will increase related operation and maintenance expenses and depreciation expenses. These additions are to ensure reliable service to its customers during critical peak times.\nRates to retail customers served by the company are regulated by the Alabama Public Service Commission (APSC). Rates for the company can be adjusted\nII-55\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1994 Annual Report\nperiodically 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 company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. In the event that a portion of the company's operations is no longer subject to these provisions, the company would be required to write off related regulatory assets and liabilities. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities\" for additional information.\nThe staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry -- including the company -- regarding the recognition, measurement, and classification of decommissioning costs for nuclear generating facilities in the financial statements. In response to these questions, the FASB is currently reviewing the accounting for nuclear decommissioning. If current electric utility industry accounting practices for decommissioning are changed: (1) Annual provisions for decommissioning could increase. (2) The estimated cost for decommissioning may be required to be recorded as a liability in the Balance Sheets. In management's opinion -- should these changes be required -- the changes would not have a significant adverse effect on results of operations because of the company's current and expected future ability to recover decommissioning costs through rates. See Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning\" for additional information.\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 affect earnings if such costs are not fully recovered. The Clean Air Act and other important environmental items are discussed later under \"Environmental Matters.\"\nFINANCIAL CONDITION\nOverview\nThe company's financial condition remained stable in 1994. This stability is the continuation over recent years of growth in energy sales and cost control measures 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.\nThe company had gross property additions of $537 million in 1994. The majority of funds needed for gross property additions since 1991 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.\nCapital Structure\nThe company's ratio of common equity to total capitalization was 47.4 percent in 1994 and 1993, compared to 47.6 percent in 1992.\nIn 1994, the company issued $150 million of first mortgage bonds and through public authorities, $180 million of pollution control revenue refunding bonds. Composite financing rates as of year-end for 1992 through 1994 were as follows:\n================================================================ 1994 1993 1992 ------------------------------ Composite interest rate on long-term debt 7.39% 7.35% 8.00% Composite dividend rate on preferred stock 6.23% 5.80% 6.76% ================================================================\nThe company's current securities ratings are as follows:\n============================================================== Duff & Standard Phelps Moody's & Poor's --------------------------------- First Mortgage Bonds A+ A1 A Preferred Stock A- a2 A- ==============================================================\nII-56\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1994 Annual Report\nCapital Requirements\nCapital expenditures are estimated to be $604 million for 1995, $500 million for 1996, and $502 million for 1997. The total is $1.6 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; the cost and efficiency of construction labor, equipment, and materials; and the cost of capital. In addition, there can be no assurance that costs related to capital expenditures will be fully recovered.\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.\nOther Capital Requirements\nIn addition to the funds needed for the capital budget, approximately $60 million will be required by the end of 1997 for maturities of first mortgage bonds. Also, the company will continue to retire higher-cost debt and preferred stock and replace these obligations with lower-cost capital, as market conditions permit.\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 began in 1995 and affected 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.\nIn 1995, the Environmental Protection Agency (EPA) began issuing annual sulfur dioxide emission allowances through the allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for issuing 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 Southern Company's sulfur dioxide compliance strategy is designed to use allowances as a compliance option.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, which has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures were required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment will be installed on all fossil-fired units. Construction expenditures for Phase I compliance are estimated to total approximately $300 million through 1995 for The Southern Company, of which the company's portion is approximately $30 million.\nFor Phase II 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 estimated construction expenditures of $150 million for The Southern Company, of which the company's portion is approximately $80 million. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the continuing development of a market for emission allowances, the completion of EPA regulations, and the possibility of new emission reduction technologies.\nII-57\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1994 Annual Report\nAn average 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 Title IV of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The EPA is scheduled to submit a report to Congress on the results of this study by November 1995. The report will include 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.\nA significant portion of costs related to the acid rain provision of the Clean Air Act is expected to be recovered through existing ratemaking provisions. However, there can be no assurance that all Clean Air Act costs will be recovered.\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 issued proposed rules in November 1994 and is required to take final action on this issue in 1996. 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 1995, the EPA may 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 cleanup costs and has recognized in the financial statements costs to clean up known sites.\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; the Resource Conservation and Recovery Act; and the Endangered Species 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 additional 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 exists for liability as the result of lawsuits alleging damages caused by electromagnetic fields.\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\nII-58\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Alabama Power Company 1994 Annual Report\ncorporate 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. In 1994, the company also established an external trust fund for postretirement benefits as ordered by the APSC. 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-59\nII-60\nII-61\nII-62\nII-63\nII-64\nII-65\nNOTES TO FINANCIAL STATEMENTS Alabama Power Company 1994 Annual Report\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nGeneral\nAlabama Power Company (the company) is a wholly owned subsidiary of The Southern Company, which is the parent company of five operating companies, a system service company, Southern Communications Services (Southern Communications), Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear), and The Southern Development and Investment Group (SDIG). 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 Communications, beginning in mid-1995, will provide digital wireless communications services -- over the 800-megahertz frequency band -- to The Southern Company's subsidiaries and also will market these services to the public within the Southeast. 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. SDIG develops new business opportunities related to energy products and services.\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 regulatory commissions.\nCertain prior years' data presented in the financial statements have been reclassified to conform with current year presentation.\nRegulatory Assets and Liabilities\nThe company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. Regulatory assets represent probable future revenues to the company associated with certain costs that are expected to be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited to customers through the ratemaking process. Regulatory assets and (liabilities) reflected in the Balance Sheets at December 31 relate to:\n================================================================ 1994 1993 -------------------- (in thousands) Deferred income taxes $451,886 $469,010 Premium on reacquired debt 101,620 102,216 Department of Energy assessments 42,996 45,554 Vacation pay 20,442 22,680 Work force reduction costs 3,664 5,468 Deferred income tax credits (405,256) (440,945) Natural disaster reserve (28,750) - Other, net 45,956 26,824 ---------------------------------------------------------------- Total $232,558 $230,807 ================================================================\nIn the event that a portion of the company's operations are no longer subject to the provisions of Statement No. 71, the company would be required to write off related regulatory assets and liabilities. In addition, the company would be required to determine any impairment to other assets, including plant, and write down the assets to their fair value.\nRevenues and Fuel Costs\nThe company accrues revenues for services rendered but unbilled at the end of each fiscal period. For additional information concerning unbilled revenues, see Note 3 under \"Retail Rate Adjustment Procedures.\"\nThe company has a diversified base of customers. No single customer or industry comprises 10 percent or more of revenues. In 1994, uncollectible\nII-66\nNOTES (continued) Alabama Power Company 1994 Annual Report\naccounts continued to average less than 1 percent of revenues.\nFuel 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 $65 million in 1994, $62 million in 1993, and $48 million in 1992. 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 estimates its remaining liability at December 31, 1994, under this law to be approximately $43 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 3.2 percent in 1994 and 3.3 percent in both 1993 and 1992. 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.\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. The company has established external trust funds to comply with the NRC's regulations. Amounts previously recorded in internal reserves are being transferred into the external trust funds over set periods of time as approved by the APSC. Earnings on the trust fund are considered in determining decommissioning expense. 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 amounts prescribed by the NRC.\nSite study cost is the estimate to decommission the facility as of the site study year, and ultimate cost is the estimate to decommission the facility as of retirement date. The estimated cost of decommissioning -- both site study costs and ultimate costs -- at December 31, 1994, for Plant Farley were as follows:\n============================================================== Plant Farley ------------- Site study basis (year) 1993\nDecommissioning periods: Beginning year 2017 Completion year 2029 -------------------------------------------------------------- (in millions) Site study costs: Radiated structures $409 Non-radiated structures 75 Other 94 -------------------------------------------------------------- Total $578 ============================================================== (in millions) Ultimate costs: Radiated structures $1,258 Non-radiated structures 231 Other 289 -------------------------------------------------------------- Total $1,778 ==============================================================\nII-67\nNOTES (continued) Alabama Power Company 1994 Annual Report\n(in millions) Amount expensed in 1994 $18 -------------------------------------------------------------- Accumulated provisions: Balance in external trust funds $ 71 Balance in internal reserves 51 -------------------------------------------------------------- Total $122 ==============================================================\nAssumed in ultimate costs: Inflation rate 4.5% Trust earning rate 7.0 --------------------------------------------------------------\nAnnual provisions for nuclear decommissioning are based on an annuity -- sinking fund -- method as approved by the APSC. The decommissioning costs approved for ratemaking are $578 million for Plant Farley.\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 changes in the assumed date of decommissioning, changes in 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.\nEffective 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.\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 was 7.9 percent in 1994, 7.8 percent in 1993, and 7.9 percent in 1992. AFUDC, net of income tax, as a percent of net income after dividends on preferred stock was 1.5 percent in both 1994 and 1993 and 1.1 percent in 1992.\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.\nFinancial Instruments\nIn accordance with FASB Statement No. 107, Disclosure About Fair Value of Financial Instruments, the company's only financial instrument that the carrying amount did not approximate fair value at December 31 was as follows:\n============================================================== Long-Term Debt ------------------------- Carrying Fair Year Amount Value ------------- ---------- (in millions)\n1994 $2,446 $2,323 1993 2,315 2,439 ==============================================================\nThe fair value for long-term debt was based on either closing market price or closing price 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\nII-68\nNOTES (continued) Alabama Power Company 1994 Annual Report\nan allowable expense only when paid. Consistent with this ratemaking treatment, the company accrues a current liability for earned vacation pay and records a current regulatory asset representing future recoverability of this cost. The amount was $20 million and $23 million at December 31, 1994 and 1993, respectively. In 1995, an estimated 64 percent of the 1994 deferred vacation cost will be expensed and the balance will be charged to construction and other accounts.\nNatural Disaster Reserve\nIn September 1994, in response to a request by the company, the APSC issued an order allowing the company to establish a Natural Disaster Reserve. As of December 31, 1994, the accumulated provision amounted to $28.8 million. Regulatory treatment by the APSC allows the company to accrue $250 thousand per month until the maximum accumulated provision of $32 million is attained. For additional information concerning the Natural Disaster Reserve, see Note 3 under \"Retail Rate Adjustment Procedures.\"\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 trusts 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. Qualified trusts are funded to the extent deductible under federal income tax regulations. Amounts funded are primarily invested in debt and equity securities. In December 1993, the APSC issued an accounting policy statement which requires the company to externally fund net annual postretirement benefits.\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.\" Because 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 were $15.2 million.\nFunded Status 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. The funded status of the plans at December 31 was as follows:\n============================================================ Pension ------------------ 1994 1993 ------------------ (in millions) Actuarial present value of benefit obligations: Vested benefits $ 522 $ 523 Non-vested benefits 18 20 ------------------------------------------------------------ Accumulated benefit obligation 540 543 Additional amounts related to projected salary increases 174 153 ------------------------------------------------------------ Projected benefit obligation 714 696 Less: Fair value of plan assets 1,059 1,121 Unrecognized net gain (251) (349) Unrecognized prior service cost 23 25 Unrecognized transition asset (51) (56) ============================================================ Prepaid asset recognized in the Balance Sheets $ 66 $ 45 ============================================================\nII-69\nNOTES (continued) Alabama Power Company 1994 Annual Report\n=========================================================== Postretirement Medical ------------------- 1994 1993 ------------------- (in millions)\nActuarial present value of benefit obligation: Retirees and dependents $ 69 $ 67 Employees eligible to retire 22 21 Other employees 90 95 ----------------------------------------------------------- Accumulated benefit obligation 181 183 Less: Fair value of plan assets 56 39 Unrecognized net loss 6 18 Unrecognized transition obligation 96 102 ----------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 23 $ 24 ===========================================================\n=========================================================== Postretirement Life ------------------ 1994 1993 ------------------ (in millions) Actuarial present value of benefit obligation: Retirees and dependents $ 27 $ 27 Other employees 29 29 ----------------------------------------------------------- Accumulated benefit obligation 56 56 Less: Fair value of plan assets 5 1 Unrecognized net gain (6) (4) Unrecognized transition obligation 24 26 ----------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 33 $ 33 ===========================================================\nThe weighted average rates assumed in the actuarial calculations were:\n=========================================================== 1994 1993 1992 ---------------------------- Discount 8.0% 7.5% 8.0% Annual salary increase 5.5 5.0 6.0 Long-term return on plan assets 8.5 8.5 8.5 ===========================================================\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 10.5 percent for 1994, 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 of 1.0 percent would increase the accumulated medical benefit obligation as of December 31, 1994, by $33 million and the aggregate of the service and interest cost components of the net retiree medical cost by $4 million.\nComponents of the plans' net income are shown below:\n================================================================== Pension ------------------------------------------------------------------ 1994 1993 1992 ----------------------------- (in millions) Benefits earned during the year $ 20.8 $ 20.6 $ 20.6 Interest cost on projected benefit obligation 51.2 50.4 48.2 Actual (return) loss on plan assets 23.5 (146.3) (45.8) Net amortization and deferral (116.2) 63.3 (29.3) ------------------------------------------------------------------ Net pension cost (income) $ (20.7)$ (12.0) $ (6.3) ==================================================================\nOf the above net pension amounts, $(15.7) million in 1994, $(8.9) million in 1993, and $(5.1) million in 1992 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\n============================================================ Postretirement Medical ------------------ 1994 1993 ------------------ (in millions)\nBenefits earned during the year $ 6 $ 5 Interest cost on accumulated benefit obligation 14 12 Amortization of transition obligation 5 5 Actual (return) loss on plan assets 1 (5) Net amortization and deferral (4) 2 ------------------------------------------------------------ Net postretirement cost $22 $19 ============================================================\nII-70\nNOTES (continued) Alabama Power Company 1994 Annual Report\n============================================================= Postretirement Life ------------------ 1994 1993 ------------------ (in millions)\nBenefits earned during the year $2 $2 Interest cost on accumulated benefit obligation 4 4 Amortization of transition obligation 1 1 ------------------------------------------------------------- Net postretirement cost $7 $7 =============================================================\nOf the above net postretirement medical and life insurance costs recorded in 1994 and 1993, $23 million and $22 million, respectively, were charged to operating expenses and the remainder was charged to construction and other accounts.\nWork Force Reduction Programs\nThe company has incurred additional costs for work force reduction programs. The costs related to these programs were $8.2 million, $16.1 million and $13.4 million for the years 1994, 1993 and 1992, 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 $3.7 million at December 31, 1994.\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 last rate adjustment was effective in January 1992. 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.\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.\nAlso, in 1994, the APSC issued an order - at the company's request - allowing the company to establish a natural disaster reserve not to exceed $32 million and to change the estimating procedure for unbilled kilowatt-hours and associated revenues for service rendered but unbilled at the end of each month. This change in estimate resulted in an increase in unbilled revenues for September 1994 of $28 million, which offset the initial accrual for the natural disaster reserve for the same amount. Additional monthly accruals of $250 thousand will be made until the reserve maximum is attained. In addition, a moratorium on rate increases through the third quarter of 1995 was approved.\nThe ratemaking procedures will remain in effect until the APSC votes to modify or discontinue them.\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 persons 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\nII-71\nNOTES (continued) Alabama Power Company 1994 Annual Report\ncompany'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 require refunds as a result of this proceeding would be substantially for the period beginning in July 1991 and ending in October 1992.\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.\nIn August 1994, the FERC instituted another proceeding based on substantially the same issues as in the 1991 proceeding. The second period under review for possible refunds began in October 1994 and is scheduled to continue until January 1996.\nIf the rates of return on common equity recommended by the FERC staff were applied to all of the schedules and contracts involved in both proceedings, and refunds were ordered, the amount of refunds could range up to approximately $34 million at December 31, 1994. Although the final outcome of this matter cannot now be determined; 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 $604 million in 1995, $500 million in 1996, and $502 million in 1997. The estimates include AFUDC of $10 million in 1995 and $9 million in both 1996 and 1997. The estimates for property additions for the three-year period includes $42.5 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, 1994, 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 at appropriate levels. The amounts available are discussed below. The company may issue additional long-term debt and preferred stock for the purposes of debt maturities, redeeming higher-cost securities, and meeting additional capital requirements.\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 company's primary sources of external financing are sales of first mortgage bonds and preferred stock to the public and receipt of additional paid-in capital from The Southern Company. 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\nII-72\nNOTES (continued) Alabama Power Company 1994 Annual Report\nleast 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. The company's coverages are at a level that would permit any necessary amount of security sales at current interest and dividend rates.\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, 1997. 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 $349 million which expire at various times during 1995 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.\nAt December 31, 1994, the company had regulatory approval to have outstanding up to $530 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 year 2013 were approximately $9.4 billion at December 31, 1994. 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. At December 31, 1994, estimated minimum rental commitments for noncancellable operating leases were as follows:\n============================================================ Year Amounts ---- --------------- (in millions) 1995 $ 0.5 1996 2.8 1997 2.8 1998 2.8 1999 2.8 2000 and thereafter 59.5 ------------------------------------------------------------ Total minimum payments $71.2 ============================================================\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 which, in substance, requires payments sufficient to provide for the operating expenses, taxes, interest expense and a return on equity, whether or not SEGCO has any capacity and energy available. The company's share of expenses totaled $74 million in 1994, $86 million in 1993 and $73 million in 1992, and is included in \"Purchased power from affiliates\" in the Statements of Income.\nII-73\nNOTES (continued) Alabama Power Company 1994 Annual Report\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, 1994, the capitalization of SEGCO consisted of $54 million of equity and $78 million of long-term debt on which the annual interest requirement is $5.1 million. SEGCO paid dividends totaling $11.6 million in 1994, $11.3 million in 1993, and $12.0 million in 1992, of which one-half of each was paid to the company. SEGCO's net income was $7.2 million, $8.3 million, and $9.3 million for 1994, 1993 and 1992, respectively.\nThe company's percentage ownership and investment in jointly-owned generating plants at December 31, 1994, follows:\n================================================================ Total Megawatt Company Facility (Type) Capacity Ownership --------------------- -------- --------- Greene County 500 60.00% (1) (coal) Plant Miller Units 1 and 2 1,320 91.84% (2) (coal) ================================================================ (1) Jointly owned with an affiliate, Mississippi Power Company. (2) Jointly owned with Alabama Electric Cooperative, Inc.\n================================================================ Company Accumulated Facility Investment Depreciation ---------------------- ---------- ------------- (in millions) Greene County $ 89 $ 39 Plant Miller Units 1 and 2 $708 $264 ----------------------------------------------------------------\n7. LONG-TERM POWER SALES AGREEMENTS\nGeneral\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 area. The agreements for non-firm capacity expired in 1994. Other agreements -- expiring at various dates discussed below -- 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 capacity revenues have been as follows:\n================================================================ Unit Other Year Power Long-Term Total ---------------------------------------------------------------- (in millions) 1994 $152 $ 7 $159 1993 144 15 159 1992 177 9 186 ================================================================\nUnit power from Plant Miller is being sold to Florida Power Corporation (FPC), Florida Power & Light Company (FP&L), Jacksonville Electric Authority (JEA) and the City of Tallahassee, Florida. Under these agreements, approximately 1,200 megawatts of capacity, a slight increase over 1994, is scheduled to be sold during 1995 and will 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.\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\nII-74\nNOTES (continued) Alabama Power Company 1994 Annual Report\nwholesale 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, 1994, $146 million of such bonds was 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 resulted in the recording of additional deferred income taxes and related regulatory assets and liabilities. At December 31, 1994, the tax-related regulatory assets and liabilities were $452 million and $405 million, respectively. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits.\nDetails of the federal and state income tax provisions are as follows:\n================================================================= 1994 1993 1992 ------------------------------- (in thousands) Total provision for income taxes: Federal -- Currently payable $219,494 $149,680 $152,481 Deferred -- current year (48,153) 9,636 27,760 reversal of prior years 15,932 19,653 (7,827) Deferred investment tax credits (1) (2,106) - ----------------------------------------------------------------- 187,272 176,863 172,414 ----------------------------------------------------------------- State -- Currently payable 20,565 14,297 16,983 Deferred -- current year (4,067) 1,898 6,387 reversal of prior years 3,676 3,913 (2,806) ----------------------------------------------------------------- 20,174 20,108 20,564 ----------------------------------------------------------------- Total 207,446 196,971 192,978 Less income taxes credited to other income (16,834) (10,239) (8,947) ----------------------------------------------------------------- Federal and state income taxes charged to operations $224,280 $207,210 $201,925 =================================================================\nII-75\nNOTES (continued) Alabama Power Company 1994 Annual Report\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:\n=============================================================== 1994 1993 -------------------- (in millions) Deferred tax liabilities: Accelerated depreciation $ 734 $ 697 Property basis differences 513 536 Premium on reacquired debt 38 38 Fuel clause underrecovered 4 11 Other 26 17 --------------------------------------------------------------- Total 1,315 1,299 --------------------------------------------------------------- Deferred tax assets: Capacity prepayments 36 44 Other deferred costs 27 8 Postretirement benefits 24 15 Accrued nuclear outage costs 7 7 Unbilled revenue 13 7 Other 44 39 --------------------------------------------------------------- Total 151 120 --------------------------------------------------------------- Net deferred tax liabilities 1,164 1,179 Portion included in current assets (liabilities), net 17 (14) --------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $1,181 $1,165 ===============================================================\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 1994 and 1993 and $18 million in 1992. At December 31, 1994, 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:\n============================================================== 1994 1993 1992 -------------------------- Federal statutory rate 35.0% 35.0% 34.0% State income tax, net of federal deduction 2.2 2.3 2.4 Non-deductible book depreciation 1.6 1.6 1.6 Differences in prior years' deferred and current tax rates (2.9) (1.6) (1.9) Other (0.7) (2.9) (2.0) -------------------------------------------------------------- Effective income tax rate 35.2% 34.4% 34.1% ==============================================================\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.\n9. OTHER LONG-TERM DEBT\nDetails of other long-term debt at December 31 are as follows:\n============================================================== 1994 1993 -------------------------- (in thousands) Obligations incurred in connection with the sale of tax-exempt pollution control revenue bonds by public authorities- 2003-2013--6% to 9.375% $ 1,000 $ 27,050 2014-2024--3.05% to 10.875% 475,140 449,090 -------------------------------------------------------------- 476,140 476,140 -------------------------------------------------------------- Capitalized lease obligations: Nuclear fuel - 95,943 Office buildings 7,312 7,710 Street light 2,442 2,761 -------------------------------------------------------------- 9,754 106,414 -------------------------------------------------------------- Total $485,894 $582,554 ==============================================================\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 $312.8 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.\nII-76\nNOTES (continued) Alabama Power Company 1994 Annual Report\nThe company has capitalized certain office building leases and a street light lease. Monthly principal payments plus interest are required, and at December 31, 1994, the interest rate was 9.5 percent for office buildings and 13.0 percent for street lights. In December 1994, the company discontinued capital leases pertaining to nuclear fuel.\nThe net book value of capitalized leases included in utility plant in service was $6.2 million and $94.7 million at December 31, 1994 and 1993, respectively. The estimated aggregate annual maturities of other long-term debt through 1999 are as follows: $0.8 million in 1995, $0.9 million in 1996, $1.0 million in 1997, $1.0 million in 1998 and $1.2 million in 1999.\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 at December 31 is as follows:\n================================================================= 1994 1993 ------------------------ (in thousands) Bond improvement fund requirements $20,047 $20,135 Less: Portion to be satisfied by certifying property additions 20,047 - ----------------------------------------------------------------- Cash sinking fund requirements - $20,135 Other long-term debt maturities (Note 9) 796 38,863 ----------------------------------------------------------------- Total $ 796 $58,998 =================================================================\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 1995 requirement of $20.0 million was satisfied by certification of property additions. In addition, maturing in 1995 are other long-term debt of $796 thousand consisting primarily of capitalized office building leases and a street light lease.\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 provides funds up to $8.9 billion for 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 assessment in the event that losses exceed accumulated reserve funds. The company's maximum annual assessment per incident is limited to $12 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.\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 $2.8 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\nII-77\nNOTES (continued) Alabama Power Company 1994 Annual Report\nthat policy. The maximum annual assessments per incident under current policies for the company would be $27 million for excess property damage and $10 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.\nAll retrospective assessments, whether generated for liability, property or replacement power may be subject to applicable state premium taxes.\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, 1994, $807 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 1994 and 1993 are as follows:\n================================================================== Net Income After Dividends Quarter Operating Operating on Preferred Ended Revenues Income Stock ------------------- --------- --------- -------------- (in thousands)\nMarch 1994 $686,847 $128,623 $ 72,031 June 1994 759,399 162,696 98,668 September 1994 838,927 199,736 141,214 December 1994 649,969 104,949 44,425\nMarch 1993 $635,559 $124,356 $ 57,856 June 1993 733,589 159,023 91,448 September 1993 919,934 205,151 150,818 December 1993 718,527 106,582 46,372 ==================================================================\nThe company's business is influenced by seasonal weather conditions.\nII-78\nII-79\nII-80A\nII-80B\nII-80C\nII-81\nII-82A\nII-82B\nII-82C\nII-83\nII-84A\nII-84B\nII-85\nII-86A\nII-86B\nII-87\nII-88A\nII-88B\nII-89\nII-90A\nII-90B\nALABAMA POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1994\nFirst Mortgage Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity -------------------------------------------------------------------------- (Thousands) (Thousands) 1993 $ 60,000 4-1\/2% $ 60,000 3\/1\/96 1993 50,000 5-1\/2% 50,000 2\/1\/98 1992 170,000 6-3\/8% 170,000 8\/1\/99 1993 100,000 6% 100,000 3\/1\/00 1992 100,000 6.85% 100,000 8\/1\/02 1993 125,000 7% 125,000 1\/1\/03 1993 175,000 6-3\/4% 175,000 2\/1\/03 1992 175,000 7-1\/4% 175,000 8\/1\/07 1991 100,000 9-1\/4% 98,748 5\/1\/21 1991 150,000 8-3\/4% 148,500 12\/1\/21 1992 200,000 8-1\/2% 198,000 5\/1\/22 1992 100,000 8.30% 99,608 7\/1\/22 1993 100,000 7-3\/4% 100,000 2\/1\/23 1993 150,000 7.45% 150,000 7\/1\/23 1993 100,000 7.30% 100,000 11\/1\/23 1994 150,000 9% 150,000 12\/1\/24 ---------- ---------- $2,005,000 $1,999,856 ========== ==========\nPollution Control Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity -------------------------------------------------------------------------- (Thousands) (Thousands) 1978 $ 5,600 7-1\/4% $ 1,000 5\/1\/03 1985 50,000 9-3\/8% 50,000 6\/1\/15 1985 81,500 9-1\/4% 81,500 12\/1\/15 1986 21,000 7.40% 21,000 11\/1\/16 1993 12,100 Variable 12,100 8\/1\/17 1993 12,000 Variable 12,000 8\/1\/17 1993 12,000 Variable 12,000 8\/1\/17 1993 96,990 6.05% 96,990 5\/1\/23 1993 9,800 5.80% 9,800 6\/1\/22 1994 24,400 5-1\/2% 24,400 1\/1\/24 1994 53,700 Variable 53,700 6\/1\/15 1994 101,650 6-1\/2% 101,650 9\/1\/23 ---------- ---------- $ 480,740 $ 476,140 ========== ==========\nPreferred Stock\nShares Dividend Amount Series Outstanding Rate Outstanding -------------------------------------------------------------------------- (Thousands) 1946-1952 364,000 4.20% $ 36,400 1950 100,000 4.60% 10,000 1961 80,000 4.92% 8,000 1963 50,000 4.52% 5,000 1964 60,000 4.64% 6,000 1965 50,000 4.72% 5,000 1966 70,000 5.96% 7,000 1968 50,000 6.88% 5,000 1988 500,000 Auction 50,000 1992 4,000,000 7.60% 100,000 1992 2,000,000 7.60% 50,000 1993 1,520,000 6.80% 38,000 1993 2,000,000 6.40% 50,000 1993 200 Auction 20,000 1993 2,000,000 Adjustable 50,000 ---------- ---------- 12,844,200 $ 440,400 ========== ==========\nII-91\nALABAMA POWER COMPANY\nSECURITIES RETIRED DURING 1994\nFirst Mortgage Bonds Principal Interest Series Amount Rate ---------------------------------------------------- (Thousands) 1987 $ 15,243 10-5\/8% 1991 1,252 9-1\/4% 1991 1,500 8-3\/4% 1992 2,000 8-1\/2% 1992 392 8.30% -------- $ 20,387 ========\nPollution Control Bonds Principal Interest Series Amount Rate --------------------------------------------------- (Thousands) 1974 $ 18,550 6% 1976 2,900 7.20% 1978 4,600 7-1\/4% 1984 100,000 10-7\/8% 1989 35,000 7.20% 1989 18,700 7.20% -------- $179,750 ========\nII-92\nGEORGIA POWER COMPANY FINANCIAL SECTION\nII-93\nMANAGEMENT'S REPORT Georgia Power Company 1994 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, in all material respects, 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 a regulatory review is completed. 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 H. Allen Franklin President and Chief Executive Officer\n\/s\/ Warren Y. Jobe Warren Y. Jobe Executive Vice President, Treasurer and Chief Financial Officer\nII-94\nREPORT 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 and wholly owned subsidiary of The Southern Company) as of December 31, 1994 and 1993, 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, 1994. 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-104 through II-126) referred to above present fairly, in all material respects, the financial position of Georgia Power Company as of December 31, 1994 and 1993, 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 recoverability of the Company's investment in the Rocky Mountain pumped storage hydroelectric project. The outcome of this uncertainty cannot be determined until a regulatory review is completed. 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 LLP\nAtlanta, Georgia February 15, 1995\nII-95\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Georgia Power Company 1994 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nGeorgia Power Company's 1994 earnings totaled $526 million, representing a $44 million (7.8 percent) decrease from the prior year. This decline is primarily the result of a $55 million after-tax charge associated with the 1994 work force reduction programs. The Company had lower operating expenses and financing costs in 1994, partially offset by lower retail revenues due to the mild weather. Also, during the period, the Company had an $11 million after-tax gain on the sale of a portion of Plant Scherer Unit 4 compared to an $18 million after-tax gain on the sale of a portion of the plant in the prior year.\nEarnings for 1993 increased over the prior year primarily as a result of higher retail revenues due to the exceptionally hot summer weather during 1993 and lower financing costs. Also, as previously discussed, 1993 earnings included an $18 million after-tax gain on the sale of a portion of Plant Scherer. These positive events were partially offset by higher operating expenses.\nRevenues\nThe following table summarizes the factors impacting operating revenues for the 1992-1994 period:\n========================================================== Increase (Decrease) From Prior Year ---------------------------------------------------------- 1994 1993 1992 -------------------------- Retail - (in millions) Change in base rates $ - $ - $ 95 Sales growth 67 45 76 Weather (128) 126 (58) Fuel cost recovery (35) 76 (26) Demand-side programs (12) 15 - ---------------------------------------------------------- Total retail (108) 262 87 ---------------------------------------------------------- Sales for resale - Non-affiliates (183) (106) (96) Affiliates (1) (6) 2 ---------------------------------------------------------- Total sales for resale (184) (112) (94) ---------------------------------------------------------- Other operating revenues 3 4 3 ---------------------------------------------------------- Total operating revenues $(289) $ 154 $ (4) ========================================================== Percent change (6.5)% 3.6% (0.1)% ----------------------------------------------------------\nRetail revenues of $3.7 billion in 1994 decreased $108 million (2.8 percent) from the prior year, compared with an increase of $262 million (7.4 percent) in 1993. The milder-than-normal weather during the summer of 1994, compared to the hot summer of 1993, was the primary reason for the decrease in retail revenues. The hot weather during the summer of 1993 was the primary factor affecting the increase in retail revenues over 1992. 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 option programs generally represent the direct recovery of program costs. See Note 3 to the financial statements under \"Demand-Side Conservation Programs\" for further information on these programs.\nRevenues from sales to non-affiliated utilities decreased in both 1994 and 1993. Sales to municipalities and cooperatives in Georgia decreased in 1994 as these customers retained more of their own generation at jointly owned facilities, and as a result of a new agreement with territorial wholesale customers.\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:\n============================================================== 1994 1993 1992 -------------------------- (in millions) Capacity $84 $152 $233 Energy 82 113 168 -------------------------------------------------------------- Total $166 $265 $401 ==============================================================\nContractual unit power sales to Florida utilities for 1994 and 1993 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 June 1994 and June 1993. The amount of capacity under these contracts declined by 427 megawatts and 533 megawatts in 1994 and 1993, respectively. In 1995, the contracted capacity will decline another 155 megawatts.\nII-96\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1994 Annual Report\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.\nKilowatt-hour (KWH) sales for 1994 and the percent change by year were as follows:\n======================================================================= Percent Change ---------------------------------- KWH 1994 1993 1992 ------ ---------------------------------- (in billions) Residential 15.7 (5.8)% 11.5% 0.8% Commercial 18.7 2.5 5.9 2.2 Industrial 24.3 3.0 2.9 3.1 Other 0.5 5.0 5.7 1.7 ------ Total retail 59.2 0.4 6.1 2.2 ------ Sales for resale - Non-affiliates 8.0 (44.3) (9.8) (15.2) Affiliates 3.1 0.9 (8.8) (14.6) ------ Total sales for resale 11.1 (36.4) (9.7) (15.1) ------ Total sales 70.3 (8.0) 2.1 (2.9) ====== -----------------------------------------------------------------------\nThe sales decline in the residential class was primarily the result of milder-than-normal summer weather in 1994, compared to the extremely hot summer of 1993. Industrial and commercial sales were positively impacted by continued improvement in economic conditions. Residential and commercial energy sales growth in 1993 reflected hot summer weather. Industrial sales growth in 1993 is attributable to improved economic conditions which also positively influenced commercial sales. Assuming normal weather, sales to retail customers are projected to grow approximately 2 percent annually on average during 1995 through 1997.\nEnergy sales to non-affiliated utilities reflect reductions in contractual unit power sales and energy sales to municipalities and cooperatives, as discussed earlier.\nExpenses\nFuel costs constitute 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. The amount and sources of generation and the average cost of fuel per net kilowatt-hour generated were as follows:\n=============================================================================== 1994 1993 1992 ---------------------------------- Total generation (billions of kilowatt-hours) 62 64 63 Sources of generation (percent) -- Coal 74.8 76.9 75.9 Nuclear 21.9 20.0 20.9 Hydro 3.1 2.8 3.1 Oil and gas 0.2 0.3 0.1 Average cost of fuel per net kilowatt-hour generated (cents) -- Coal 1.67 1.75 1.75 Nuclear 0.63 0.58 0.63 Oil and gas * * * Total 1.44 1.52 1.52 -------------------------------------------------------------------------------\n* Not meaningful because of minimal generation from fuel source.\nFuel expense decreased 8.5 percent in 1994 due to lower fuel costs, lower generation, and the displacement of coal-fired generation with lower cost nuclear generation. In 1993, fuel expense increased 2.3 percent due to higher generation, which was partially offset by lower nuclear fuel costs.\nPurchased power expense has decreased significantly since 1992, reflecting declining contractual capacity purchases from the co-owners of plants Vogtle and Scherer. Purchased power expense decreased $156 million in 1994 and $88 million in 1993. The decline in 1994 also results from decreased purchases from affiliated companies and energy purchases from territorial wholesale customers. The declines in Plant Vogtle contractual capacity purchases did not have a significant impact on earnings in 1994 or 1993 since 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 under \"Plant Vogtle Phase-In Plans\" for additional information.\nII-97\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1994 Annual Report\nOther Operation and Maintenance (O & M) expenses, excluding the provision for separation benefits, decreased 4.5 percent in 1994. The decrease is primarily due to environmental remediation costs at various sites of $32 million in 1993, compared to $8 million in 1994, recognition in 1993 of the one-time cost of an automotive fleet reduction program, and lower maintenance expenses and pension costs during 1994. Other O & M expenses increased 9.0 percent in 1993 primarily as a result of environmental remediation costs and the 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 under \"Postretirement Benefits\" for additional information concerning the new accounting rules. Also, during 1993, O & M expenses reflected costs associated with new demand-side option programs. These program costs were offset by increases in retail revenues. See Note 3 to the financial statements under \"Demand-Side Conservation Programs\" for additional information on the recovery of these program costs.\nTaxes other than income taxes increased 1.0 percent in 1994 and 7.4 percent in 1993, reflecting primarily higher ad valorem taxes. The 1993 increase also includes higher franchise taxes paid to municipalities as a result of increased sales.\nIncome tax expense decreased $24 million in 1994 primarily due to lower earnings and the recognition of $17 million in tax expense associated with the sale of a portion of Plant Scherer Unit 4 in 1994, compared to $27 million in tax expense associated with the sale of a portion of the plant in the prior year. The sales resulted in after-tax gains of $11 million in 1994 and $18 million in 1993. Income tax expense increased $62 million in 1993 due primarily to higher earnings, the effect of a one percent increase in the federal tax rate effective January, 1993, and as previously discussed, the sale of a portion of Plant Scherer Unit 4.\nInterest expense and dividends on preferred stock decreased $63 million (13.7 percent) and $19 million (4.0 percent) in 1994 and 1993, respectively. These reductions are primarily due to refinancing of long-term debt and preferred stock. The Company refinanced $510 million and $1.5 billion of securities in 1994 and 1993, respectively. The Company also retired $386 million of long-term debt with the proceeds from the 1994 and 1993 Plant Scherer Unit 4 sales. Other interest charges in 1993 include interest related to the settlement of an Internal Revenue Service (IRS) audit. The settlement had no 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 including energy sales and 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 1995 through 1997.\nThe scheduled addition of four combustion turbine generating units and the Rocky Mountain pumped storage hydroelectric project in 1995 and one jointly owned combustion turbine unit in 1996, will increase related O & M and\nII-98\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1994 Annual Report\ndepreciation expenses. In addition, the Company has entered into a four-year purchase power agreement to meet peaking needs. Beginning in 1996, the Company will purchase 400 megawatts of capacity. In 1998, this amount will decline to 200 megawatts for the remaining two years. Capacity payments are projected to be $6 million in 1996 and 1997 and $3 million in 1998 and 1999. These costs will be recorded in purchased power expenses in the Statements of Income. The Company has also reached an agreement on major terms and conditions of a purchase power arrangement whereby the Company would buy electricity during peak periods from a proposed 200 megawatt cogeneration facility, starting in June 1998. A final agreement is expected to be completed and filed with the GPSC for certification during 1995.\nIn 1994, work force reduction programs were implemented, reducing earnings by $55 million. These reductions will assist in efforts to control growth in future operating expenses.\nAs discussed in Note 4 to the financial statements, regulatory uncertainties exist related to the Rocky Mountain pumped storage hydroelectric project. In the event the GPSC does not allow full recovery of the project's costs, then the portion not allowed may have to be written off. The Company's total investment in the project at completion is estimated to be approximately $200 million.\nSee Note 3 to the financial statements for information regarding proceedings with respect to the Company's recovery of demand-side conservation program costs and litigation currently pending in the U. S. Tax Court.\nThe Company has completed three in a series of four separate transactions to sell Unit 4 of Plant Scherer to two Florida utilities. The remaining transaction is scheduled to take place in 1995. If the sale takes place as planned, the Company would realize an additional after-tax gain estimated to total approximately $12 million. This transaction coincides with scheduled reductions in capacity revenues from Florida utilities under contractual unit power sales contracts of approximately $18 million in 1995 and an additional $10 million in 1996. Additionally, the expiration in 1994 of the contract for the sale of long-term non-firm power to Florida Power Corporation will result in a $9 million decrease in capacity revenues in 1995. See Notes 5 and 6 to the financial statements for additional information.\nDuring 1994, Oglethorpe Power Corporation (OPC) gave the Company notice of its intent to decrease its purchases of capacity under a power supply agreement. As a result, the Company's capacity revenues from OPC will decline approximately $8 million in 1996 and an additional $16 million in 1997.\nOPC and the Municipal Electric Authority of Georgia (MEAG) have filed joint complaints in two separate venues seeking to recover from the Company approximately $16.5 million in alleged overcharges, plus approximately $6.3 million in interest. See Note 3 to the financial statements under \"Wholesale Litigation\" for further discussion of this matter.\nThe Clean Air Act and other environmental issues are discussed later under \"Environmental Issues.\"\nThe Energy Policy Act of 1992 (Energy Act) is beginning to have a dramatic 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 posturing the business to meet the challenge of this major change in the traditional practice 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. 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, retail wheeling initiatives are rapidly evolving and becoming very prominent issues in several states. In order to address these initiatives, numerous questions must be resolved with the most complex ones relating to transmission pricing and recovery of stranded investments. As the initiatives become a reality, the structure of the utility industry could radically change. Therefore, unless the Company remains a low-cost producer and provides quality service, the Company's retail energy sales growth could be limited, and this could significantly erode earnings. Conversely, being the low-cost producer could provide significant opportunities to increase market share and profitability.\nThe Company continues to compete with other electric suppliers within the state. In Georgia, most new retail customers with at least 900 kilowatts of\nII-99\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1994 Annual Report\nconnected 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.\nThe Company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. In the event that a portion of the Company's operations is no longer subject to these provisions, the Company would be required to write off related regulatory assets and liabilities. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities\" for additional information.\nThe staff of the Securities and Exchange Commission has questioned certain of the current accounting practices of the electric utility industry -- including the Company -- regarding the recognition, measurement, and classification of decommissioning costs for nuclear generating facilities in the financial statements. In response to these questions, the FASB has decided to review the accounting for nuclear decommissioning. If current electric utility industry accounting practices for decommissioning are changed: (1) annual provisions for decommissioning could increase, and (2) the estimated cost for decommissioning may be required to be recorded as a liability in the Balance Sheets. In management's opinion -- should these changes be required -- the changes would not have a significant adverse effect on results of operations because of the Company's current and expected future ability to recover decommissioning costs through rates. See Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning\" for additional information.\nFINANCIAL CONDITION\nOverview\nThe principal changes in the Company's financial condition in 1994 were gross utility plant additions of $638 million and the lowering of the cost of capital achieved through the refinancing or retirement of $654 million of long-term debt.\nThe funds needed for gross property additions are currently provided from operations. The Statements of Cash Flows provide additional details.\nFinancing Activities\nIn 1994, the Company continued to lower its financing costs by refinancing higher-cost issues. New issues during 1992 through 1994 totaled $3.5 billion and retirement or repayment of securities totaled $4.1 billion. The retirements included the redemption of $133 million and $253 million in 1994 and 1993, respectively, of first mortgage bonds with the proceeds from the Plant Scherer Unit 4 sales. Composite financing rates for the years 1992 through 1994, as of year-end, were as follows:\n============================================================== 1994 1993 1992 ---------------------------------- Composite interest rate on long-term debt 7.14% 7.86% 8.49% Composite preferred stock dividend rate 7.11% 6.76% 7.52% ==============================================================\nThe Company's current securities ratings are as follows:\n============================================================== Duff & Standard & Phelps Moody's Poor's First Mortgage Bonds A+ A2 A Preferred Stock A- a3 A- Unsecured Bonds A A3 A- Commercial Paper D1 P1 A1 ==============================================================\nLiquidity and Capital Requirements\nCash provided from operations decreased by $128 million in 1994, primarily due to lower retail sales, higher tax payments, and the receipt in 1993 of cash payments from Gulf States as partial settlement of litigation.\nII-100\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1994 Annual Report\nThe Company estimates that construction expenditures for the years 1995 through 1997 will total $579 million, $626 million and $724 million, respectively. The Company will continue to invest in transmission and distribution facilities and enhance existing generating plants. These expenditures also include amounts for five combustion turbine generating units and equipment that will be required to comply with the provisions of the Clean Air Act.\nThe Company's annual contractual capacity purchases will decline by $70 million over the next three years. Cash requirements for sinking fund requirements, redemptions announced, and maturities of long-term debt are expected to total $360 million during 1995 through 1997.\nAs a result of requirements by the Nuclear Regulatory Commission, the Company has established external trust funds for the purpose of funding nuclear decommissioning costs. For 1995 through 1997, the amount to be funded totals $16 million annually. For additional information concerning nuclear decommissioning costs, see Note 1 to the financial statements under \"Depreciation and Nuclear Decommissioning.\"\nAs a result of the Energy Policy Act of 1992, the Company is required to pay a special assessment over a 15-year period beginning in 1993 into a fund which will be used by the U. S. Department of Energy for the decontamination and decommissioning of its nuclear enrichment facilities. The Company estimates its remaining liability to be approximately $33 million as of December 31, 1994. See Note 1 to the financial statements under \"Revenues and Fuel Costs\" for additional information.\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 $709 million of unused credit arrangements with banks at the beginning of 1995. See Note 8 to the financial statements for additional information.\nCompleting the remaining transaction for the sale of Plant Scherer Unit 4 will generate approximately $131 million in 1995.\nGeorgia Power Capital, a limited partnership, was formed on November 10, 1994, for the purpose of issuing preferred securities and subsequently lending the proceeds to the Company. In December 1994, Georgia Power Capital issued four million shares of preferred securities at 9 percent and subsequently loaned the proceeds of $100 million to the Company. This subordinated debt of the Company is due December 19, 2024.\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 began in 1995 and affected 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.\nIn 1995, the Environmental Protection Agency (EPA) began issuing 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 issuing 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 Southern Company's sulfur dioxide compliance strategy is\nII-101\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1994 Annual Report\ndesigned to use allowances as a compliance option.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, which has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures were required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment will be installed on all fossil-fired units. Under this Phase I compliance approach, Georgia Power's construction expenditures are estimated to total approximately $175 million through 1995.\nFor Phase II 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. During the period 1996 to 2000, current compliance strategy could require total estimated Georgia Power construction expenditures of approximately $20 million. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the continuing 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 Title IV of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\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 -- 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 of the Company's plants. Final attainment rules, based on modeling studies, could require installation of additional controls for nitrogen oxide emissions to meet the 1999 deadline. A decision on new requirements is expected in 1996. Compliance with any new rules could result in significant additional costs. The actual 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 EPA is scheduled to submit a report to Congress on the results of this study by November 1995. The report will include 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 issued proposed rules in November 1994 and is required to take final action on this issue in 1996. 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 1995, the EPA may 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.\nII-102\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Georgia Power Company 1994 Annual Report\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. These costs for the Company amounted to $8 million, $32 million, and $3 million in 1994, 1993, and 1992, respectively. Additional sites may require environmental remediation for which the Company may be liable for a portion or all required cleanup costs. See Note 4 to the financial statements under \"Certain Environmental Contingencies\" for information regarding the Company's potentially responsible party status at a site in Brunswick, Georgia and another environmental matter.\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; the Resource Conservation and Recovery Act; and the Endangered Species 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 exists for liability as the result of lawsuits alleging damages caused by electromagnetic fields.\nII-103\nII-104\nII-105\nII-106\nII-107\nII-108\nII-109\nNOTES TO FINANCIAL STATEMENTS Georgia Power Company 1994 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), a system service company, Southern Communications Services (Southern Communications), Southern Electric International (Southern Electric), and Southern Nuclear Operating Company (Southern Nuclear), and The Southern Development and Investment Group (SDIG). 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 Communications, beginning in mid-1995, will provide digital wireless communications services to The Southern Company's subsidiaries and also will market these services to the public within the Southeast. 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. SDIG develops new business opportunities related to energy products and services.\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.\nRegulatory Assets and Liabilities\nThe Company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. Regulatory assets represent probable future revenues to the Company associated with certain costs that are expected to be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited to customers through the ratemaking process. Regulatory assets and (liabilities) reflected in the Company's Balance Sheets at December 31 relate to the following:\n=============================================================== 1994 1993 -------------------- (in millions) Deferred income taxes $ 920 $ 993 Deferred income tax credits (433) (453) Deferred Plant Vogtle costs 432 507 Premium on reacquired debt 165 153 Demand-side program costs 97 49 Corporate building lease 48 47 Postretirement benefits 41 22 Vacation pay 41 42 Inventory conversions (39) (47) Department of Energy assessments 36 41 Other, net 52 61 --------------------------------------------------------------- Total $1,360 $1,415 ===============================================================\nIn the event that a portion of the Company's operations is no longer subject to the provisions of Statement No. 71, the Company would be required to write off related regulatory assets and liabilities. In addition, the Company would be required to determine any impairment to other assets, including plant, and write down the assets to their fair value.\nII-110\nNOTES (continued) Georgia Power Company 1994 Annual Report\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 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. Fuel costs were under recovered by $23 million and $79 million at December 31, 1994, and 1993, 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 Company has a diversified base of customers. No single customer or industry comprises 10 percent or more of revenues. In 1994, uncollectible accounts continued to average less than 1 percent of revenues.\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 $87 million in 1994, $75 million in 1993, and $84 million in 1992. 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 2003 at Plant Hatch and into 2009 at Plant Vogtle.\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 fund will be used by the DOE for the decontamination and decommissioning of its nuclear fuel enrichment facilities. The assessment will be paid over a 15-year period, which began in 1993. The law provides that utilities will recover these payments in the same manner as any other fuel expense. The Company -- based on its ownership interests -- estimates its remaining liability under this law to be approximately $33 million. This obligation is recognized in the accompanying Balance Sheets and is being recovered through the fuel cost recovery provisions.\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 3.1 percent in 1994, 1993, and 1992. 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.\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. The Company has established external trust funds to comply with the NRC's regulations. Amounts previously recorded in internal reserves are being transferred into the external trust funds over a set period of time as approved by the GPSC. Earnings on the trust funds are considered in determining decommissioning expense. 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 amounts prescribed by the NRC.\nII-111\nNOTES (continued) Georgia Power Company 1994 Annual Report\nSite study cost is the estimate to decommission the facility as of the site study year, and ultimate cost is the estimate to decommission the facility as of retirement date. The estimated costs of decommissioning -- both site study costs and ultimate costs at December 31, 1994, -- based on the Company's ownership interests -- were as follows:\n=========================================================== Plant Plant Hatch Vogtle -------------------- Site study basis (year) 1994 1994\nDecommissioning periods: Beginning year 2014 2027 Completion year 2027 2038 -----------------------------------------------------------\nSite study costs: (in millions) Radiated structures $241 $193 Non-radiated structures 34 43 Other 60 49 ----------------------------------------------------------- Total $335 $285 ===========================================================\nUltimate costs: (in millions) Radiated structures $641 $ 843 Non-radiated structures 91 190 Other 160 215 ----------------------------------------------------------- Total $892 $1,248 ===========================================================\n(in millions) Amount expensed in 1994 $6 $6\nAccumulated provisions: Balance in external trust funds $33 $22 Balance in internal reserves 29 10 ----------------------------------------------------------- Total $62 $32 ===========================================================\nAssumed in ultimate costs: Inflation rate 4.4% 4.4% Trust earning rate 6.0 6.0 -----------------------------------------------------------\nAnnual provisions for nuclear decommissioning are based on an annuity -- sinking fund -- method as approved by the GPSC. The decommissioning costs approved for ratemaking are $184 million for Plant Hatch and $155 million for Plant Vogtle. These amounts are based on costs to decommission the radioactive portions of the plants based on 1990 site studies. The estimated ultimate costs based on the 1990 studies were $872 million and $1.4 billion for plants Hatch and Vogtle, respectively. The Company expects the GPSC to periodically review and adjust, if necessary, the amounts collected in rates for the anticipated cost of decommissioning.\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 changes in assumed date of decommissioning, changes in regulatory requirements, changes in technology, and changes in costs of labor, materials, and equipment.\nPlant Vogtle Phase-In Plans\nIn 1987 and 1989, the GPSC ordered that the allowed costs of Plant Vogtle Units 1 and 2 be phased into rates under plans that meet the requirements of 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.\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.\nEffective 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-112\nNOTES (continued) Georgia Power Company 1994 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. For the years 1994, 1993 and 1992, the average AFUDC rates were 6.18 percent, 4.96 percent and 7.16 percent, respectively. The reduction in the average AFUDC rate in 1993 reflects the Company's greater use of lower cost short-term debt. The increase in 1994 is primarily the result of the higher short-term borrowing rates.\nAFUDC, net of taxes, as a percentage of net income after dividends on preferred stock, was less than 2.5 percent for 1994, 1993 and 1992, 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 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 replacement of property (exclusive of minor items of property) is charged to utility plant.\nThe Company's investment in generating plant, based on its ownership interests and net of the accumulated provision for depreciation, by type of generation as of December 31 was as follows:\n================================================================== Nameplate Type of Generation Net Investment Capacity -------------------- ----------------- ---------------- 1994 1993 1994 1993 ----------------- ---------------- (in millions) (megawatts)\nSteam $1,674 $1,718 9,676 9,812 Nuclear 3,113 3,215 1,877 1,877 Hydro 335 338 862 862 Other 123 18 1,528 1,208 ----------------------------------------------------------------- Total $5,245 $5,289 13,943 13,759 =================================================================\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, the Company's financial instruments for which the carrying amounts did not approximate fair value at December 31 are as follows:\n============================================================= Long-Term Debt ------------------------- Carrying Fair Amount Value ------------------------ Year (in millions) 1994 $3,838 $3,697 1993 3,954 4,197\nThe 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\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 regulatory asset representing the future recoverability of this cost. This amount was $41 million at December 31, 1994, and $42 million at December 31, 1993. In 1995, approximately 70 percent of the 1994 deferred vacation costs will be expensed, and the balance will be charged to construction and other accounts.\nII-113\nNOTES (continued) Georgia Power Company 1994 Annual Report\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 trusts 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. Qualified trusts are funded to the extent deductible under federal income tax regulations and to the extent required by the GPSC and FERC. During 1994, the Company funded $22 million to the qualified trusts. Amounts funded are primarily invested in debt and equity securities.\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 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 costs on a cash basis as payments were made. The total costs of such benefits recognized by the Company in 1992 were $13 million.\nFunded Status 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. The funded status of the plans at December 31 was as follows:\nPension =============================================================== 1994 1993 --------------------- Actuarial present value of (in millions) benefit obligations: Vested benefits $ 689 $ 655 Non-vested benefits 32 35 --------------------------------------------------------------- Accumulated benefit obligation 721 690 Additional amounts related to projected salary increases 294 257 --------------------------------------------------------------- Projected benefit obligation 1,015 947 Less: Fair value of plan assets 1,419 1,495 Unrecognized net gain (371) (490) Unrecognized prior service cost 28 31 Unrecognized transition asset (58) (62) --------------------------------------------------------------- Prepaid asset recognized in the Balance Sheets $ 3 $ 27 ===============================================================\nII-114\nNOTES (continued) Georgia Power Company 1994 Annual Report\nPostretirement Medical =============================================================== 1994 1993 -------------------- (in millions) Actuarial present value of benefit obligation: Retirees and dependents $168 $136 Employees eligible to retire 7 12 Other employees 191 206 --------------------------------------------------------------- Accumulated benefit obligation 366 354 Less: Fair value of plan assets 46 30 Unrecognized net loss 7 40 Unrecognized transition obligation 236 251 --------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 77 $ 33 ===============================================================\nPostretirement Life =============================================================== 1994 1993 --------------- (in millions) Actuarial present value of benefit obligation: Retirees and dependents $35 $32 Employees eligible to retire - - Other employees 38 40 --------------------------------------------------------------- Accumulated benefit obligation 73 72 Less: Fair value of plan assets 6 1 Unrecognized net gain (8) (6) Unrecognized transition obligation 65 69 --------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $10 $ 8 ===============================================================\nWeighted average rates used in actuarial calculations:\n============================================================= 1994 1993 1992 ------------------------------ Discount 8.0% 7.5% 8.0% Annual salary increase 5.5 5.0 6.0 Long-term return on plan assets 8.5 8.5 8.5 -------------------------------------------------------------\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 10.5 percent for 1994, decreasing gradually to 6 percent through the year 2000 and remaining at that level thereafter. An annual increase in the assumed medical care cost trend rate of 1.0 percent would increase the accumulated medical benefit obligation as of December 31, 1994, by $68 million and the aggregate of the service and interest cost components of the net retiree medical cost by $10 million.\nThe components of the plans' net costs are shown below:\nPension ============================================================================== 1994 1993 1992 ---------------------------- (in millions) Benefits earned during the year $ 34 $ 33 $ 34 Interest cost on projected benefit obligation 71 69 65 Actual (return) loss on plan assets 35 (194) (61) Net amortization and deferral (160) 84 (38) ------------------------------------------------------------------------------ Net pension cost $ (20) $ (8) $ - ==============================================================================\nNet pension costs were negative in 1994 and 1993. Of net pension costs recorded, $15 million in 1994 and $6 million in 1993, were recorded as a reduction to operating expense, with the balance being recorded as a reduction to construction and other accounts.\nPostretirement Medical =============================================================================== 1994 1993 -------------- (in millions) Benefits earned during the year $ 13 $ 11 Interest cost on accumulated benefit obligation 27 23 Amortization of transition obligation over 20 years 12 12 Actual (return) loss on plan assets 1 (4) Net amortization and deferral (3) 2 ------------------------------------------------------------------------------- Net postretirement cost $ 50 $ 44 ===============================================================================\nPostretirement Life =============================================================================== 1994 1993 ----------- (in millions) Benefits earned during the year $ 2 $ 3 Interest cost on accumulated benefit obligation 6 6 Amortization of transition obligation over 20 years 3 3 Actual return on plan assets - - Net amortization and deferral - - ------------------------------------------------------------------------------- Net postretirement cost $11 $12 ===============================================================================\nII-115\nNOTES (continued) Georgia Power Company 1994 Annual Report\nOf the above net postretirement medical and life insurance costs recorded in 1994, $28 million was charged to operating expenses, $18 million was deferred, and the remainder was charged to construction and other accounts. In 1993, $21 million was charged to operating expenses, $21 million was deferred, and the remainder was charged to construction and other accounts.\nWork Force Reduction Programs\nThe Company has incurred additional costs for work force reduction programs. The costs related to the Company's programs were $82 million and $10 million for the years 1994 and 1992, respectively. Additionally, in 1994, the Company recognized $8 million for its share of costs associated with SCS's work force reduction program.\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 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 superior court's decision is reversed or until the next general rate case proceedings. An association of industrial customers filed a petition for review of the accounting order in superior court.\nIn July 1994, the Georgia Court of Appeals upheld the legality of the rate riders. In November 1994, the Supreme Court of Georgia denied petitions for review of this ruling. As a result, the Company resumed collection under the rate riders in December 1994. In February 1995, the GPSC initiated a true-up proceeding to review program costs which have been incurred by the Company and costs expected to be incurred during 1995 in order to adjust the rate riders accordingly. The proceeding will also address a plan for recovery of costs deferred under the accounting order. The Company's costs related to these conservation programs through 1994 were $115 million, of which $18 million has been collected and the remainder deferred.\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.\nTax Litigation\nIn June 1994, a tax deficiency notice was received from the Internal Revenue Service (IRS) for the years 1984 through 1987 with regard to the tax accounting by the Company for the sale in 1984 of an interest in Plant Vogtle and related capacity and energy buyback commitments. The potential tax deficiency and interest arising from this issue currently amount to $28 million and $32 million, respectively. The tax deficiency relates to a timing issue as to when taxes are paid; therefore, only the interest portion could affect future income. Management believes that the IRS position is incorrect, and the Company has filed a petition with the U. S. Tax Court challenging the IRS position. In order to minimize additional interest charges should the IRS's position prevail, the Company made a payment to the IRS related to the potential tax deficiency for the years 1984 through 1987 in September 1994.\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.\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 change in the rate of return on common equity that could potentially require refunds as a result of this proceeding would be substantially for the period beginning in July 1991 and ending in October 1992.\nII-116\nNOTES (continued) Georgia Power Company 1994 Annual Report\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.\nIn August 1994, the FERC instituted another proceeding based on substantially the same issues as in the 1991 proceeding. The second period under review for possible refunds began in October 1994 and is scheduled to continue until January 1996.\nIf the rates of return on common equity recommended by the FERC staff were applied to all the schedules and contracts involved in both proceedings and refunds were ordered, the amount of refunds could range up to approximately $35 million at December 31, 1994. Although the final outcome of this matter cannot now be determined, in management's opinion, the final outcome will not result in changes that would have a material adverse effect on the Company's financial statements.\nWholesale Litigation\nIn July 1994, Oglethorpe Power Corporation (OPC) and the Municipal Electric Authority of Georgia (MEAG) filed a joint complaint with the FERC seeking to recover from the Company an aggregate of approximately $16.5 million in alleged partial requirements rates overcharges, plus approximately $6.3 million in interest. OPC and MEAG claimed that the Company improperly reflected in such rates costs associated with capacity that had previously been sold to Gulf States pursuant to a unit power sales contract or, alternatively, that they should be allocated a portion of the proceeds received by the Company as a result of a settlement with Gulf States of litigation arising out of such contract. The Company's response sought dismissal of the complaint by the FERC. Dismissal was ordered in November 1994. OPC and MEAG filed a request for rehearing in December 1994, and such request is pending before the FERC. In August 1994, OPC and MEAG also filed a complaint in the Superior Court of Fulton County, Georgia, urging substantially the same claims and asking the court to hear the matter in the event the FERC declines jurisdiction. Such court proceeding was subsequently stayed pending resolution of the FERC filing.\nWhile the outcome of this matter cannot be determined, in management's opinion, it 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 amortized these costs (as recovered through rates) as follows:\n============================================================= 1994 1993 1992 --------------------------- (in millions) Deferred costs at beginning of year $507 $383 $375 -------------------------------------------------------------- Deferred capacity buyback expenses 10 38 100 Amortization of previously deferred costs (85) (74) (69) Less income taxes - - (23) -------------------------------------------------------------- Net (amortization) deferral (75) (36) 8 -------------------------------------------------------------- Effect of adoption of FASB Statement No. 109 - 160 - -------------------------------------------------------------- Deferred costs at end of year $432 $507 $383 ==============================================================\nII-117\nNOTES (continued) Georgia Power Company 1994 Annual Report\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 percent 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. At December 31, 1994, the remaining amount to be collected was $5 million.\n4. COMMITMENTS AND CONTINGENCIES\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 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. However, full recovery of the Company's costs depends on the GPSC's treatment of the project's costs and disposition of the project's capacity output. In the event the GPSC does not allow full recovery of the project's costs, then the portion not allowed may have to be written off. 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 estimated total investment in the project at completion would be approximately $200 million. The plant is scheduled to begin commercial operation in 1995.\nThe ultimate outcome of this matter cannot now be determined.\nConstruction Program\nWhile the Company has no new baseload generating plants under construction, the construction of five combustion turbine peaking units is planned to be completed by 1996. In addition, significant construction of transmission and distribution facilities, and projects to upgrade and extend the useful life of generating plants will continue. The Company currently estimates property additions to be approximately $579 million in 1995, $626 million in 1996 and $724 million in 1997. These estimated additions include AFUDC of $27 million in 1995, $17 million in 1996, and $22 million in 1997. The estimates for property additions for the three-year period include $92 million committed to meeting the requirements of the Clean Air Act.\nThe 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.\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 commitments were approximately $4.6 billion at December 31, 1994. Additional commitments for coal and for nuclear fuel will be required in the future to supply the Company's fuel needs.\nII-118\nNOTES (continued) Georgia Power Company 1994 Annual Report\nOperating Leases\nThe Company has entered into coal rail car rental agreements with various terms and expiration dates. These expenses totaled $13 million, $8 million, and $7 million for 1994, 1993, and 1992, respectively. At December 31, 1994, estimated minimum rental commitments for noncancelable operating leases were as follows:\n====================================================== Amounts -------------- Year (in millions) ---- 1995 $ 12 1996 11 1997 10 1998 10 1999 10 2000 and thereafter 136 ------------------------------------------------------ Total minimum payments $189 ======================================================\nCertain Environmental Contingencies\nIn January 1995, the Company and four other unrelated entities were notified by the EPA that they have been designated as potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act with respect to a site in Brunswick, Georgia. While the Company believes that the total amount of costs required for the clean up of this site may be substantial, it is unable at this time to estimate either such total or the portion for which the Company may ultimately be responsible.\nThe final outcome of this matter cannot now be determined. In management's opinion, however, based upon the nature and extent of the Company's activities relating to the site, the final outcome will not have a material adverse effect on the Company's financial statements.\nIn compliance with the recently enacted Georgia Hazardous Site Response Act, the State of Georgia was required to compile an inventory of all known or suspected sites where hazardous wastes, constituents or substances have been disposed of or released in quantities deemed reportable by the State. In developing this list, the State identified several hundred properties throughout the State, including 24 sites which may require environmental remediation by the Company. The majority of these 24 sites are electrical power substations and power generation facilities. The Company has recognized $4 million in expenses for the anticipated clean-up cost for two sites that the Company plans to remediate. The Company will conduct studies at each of the remaining sites to determine the extent of remediation and associated clean-up costs, if any, that may be required. The Company has recognized $3 million in expenses for the anticipated cost of completing such studies. Any cost of remediating the remaining sites cannot presently be determined until such studies are completed for each site, and the State of Georgia determines whether remediation is required. If all sites were required to be remediated, the Company could incur expenses of up to approximately $25 million in additional clean-up costs, and construction expenditures of up to $100 million to develop new waste management facilities or install additional pollution control devices.\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.\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 provides funds up to $8.9 billion for 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 $163 million per incident but not more than an aggregate of $21 million to be paid for each incident in any one year.\nII-119\nNOTES (continued) Georgia Power Company 1994 Annual Report\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 assessment in the event that losses exceed accumulated reserve funds. The Company's maximum annual assessment is limited to $15 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 Insurance Limited (NEIL), a mutual insurance company.\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 $2.8 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 the current policies for the Company would be $25 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 $6 million.\nAll retrospective assessments, whether generated for liability, property or replacement power may be subject to applicable state premium taxes.\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; 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 three 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 $808 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:\n============================================================= Closing Percent After-Tax Date Capacity Ownership Amount Gain ------------------------------------------------------------- (in megawatts) (in millions) July 1991 290 35.46% $291 $14 June 1993 258 31.44 253 18 June 1994 135 16.55 133 11 June 1995 135 16.55 131 12 ------------------------------------------------------------- Total 818 100.00% $808 $55 =============================================================\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\nII-120\nNOTES (continued) Georgia Power Company 1994 Annual Report\nfinance 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 percent of the project (194 megawatts of capacity) at completion.\nThe Company will own six of eight 80 megawatt combustion turbine generating units and 75 percent of the related common facilities being jointly constructed at Plant McIntosh with Savannah Electric, an affiliate. The Company's investment in the project at December 31, 1994, was $149 million and is expected to total approximately $182 million when the project is completed. Four of the Company's six units began commercial operation during 1994, and the remaining two units are expected to be completed by June, 1995. Savannah Electric will operate these units.\nIn 1994, the Company and FPC entered into a joint ownership agreement regarding a 150 megawatt combustion turbine unit to be constructed near Orlando, Florida. The unit is scheduled to be in commercial operation in early 1996, and will be constructed, operated, and maintained by FPC. The Company will have a one-third interest in the unit, with use of 100 percent of the unit's capacity from June through September. FPC will have the capacity the remainder of the year. The Company's investment in the project is expected to be approximately $14 million at completion.\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 $129 million, $183 million and $289 million in 1994, 1993 and 1992, respectively. The Plant Scherer buyback agreements ended in 1993. The current projected Plant Vogtle capacity payments for the next five years are as follows: $77 million in 1995, $70 million in 1996, $59 million in 1997, $59 million in 1998, and $59 million in 1999. 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, 1994, the Company's percentage ownership and investment (exclusive of nuclear fuel) in jointly owned facilities in commercial operation, were as follows:\n================================================================ Total Nameplate Company Facility (Type) Capacity Ownership ---------------------------------------------------------------- (megawatts)\nPlant Vogtle (nuclear) 2,320 45.7% Plant Hatch (nuclear) 1,630 50.1 Plant Wansley (coal) 1,779 53.5 Plant Scherer (coal) Units 1 and 2 1,636 8.4 Unit 3 818 75.0 Unit 4 818 16.6 Plant McIntosh Common Facilities N\/A 75.0 (combustion-turbine)\n=================================================================\nAccumulated Facility (Type) Investment Depreciation ----------------------------------------------------------------- (in millions) Plant Vogtle (nuclear) $3,289* $628 Plant Hatch (nuclear) 842 346 Plant Wansley (coal) 287 129 Plant Scherer (coal) Units 1 and 2 112 36 Unit 3 540 121 Unit 4 119 18 Plant McIntosh Common Facilities (combustion-turbine) 17 ** -----------------------------------------------------------------\n* Investment net of write-offs. ** Less than $1 million.\nII-121\nNOTES (continued) Georgia Power Company 1994 Annual Report\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 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. The term of the contract extends automatically for two year periods, subject to either 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 Income, is as follows:\n============================================================ 1994 1993 1992 ------------------------------------------------------------ (in millions) Energy $43 $60 $47 Capacity 33 30 28 ------------------------------------------------------------ Total $76 $90 $75 ============================================================ Kilowatt-hours 2,429 3,352 2,664 ------------------------------------------------------------\nAt December 31, 1994, the capitalization of SEGCO consisted of $54 million of equity and $78 million of long-term debt on which the annual interest requirement is $5 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 non-affiliated utilities located outside the system's service territory. These agreements consist of firm unit power sales pertaining to capacity from specific generating units and non-firm sales based on the capacity of the Southern system. Because energy is generally sold at cost under these agreements, it is primarily the capacity revenues that affect the Company's profitability.\nThe Company's capacity revenues have been as follows:\n============================================================== Year Unit Power Sales Non-firm Sales -------------------------------------------------------------- (in millions) (megawatts) (in millions) (megawatts) 1994 $ 75 403 $ 9 101 1993 135 830 17 200 1992 223 1,363 10 124\nLong-term non-firm power of 200 megawatts was sold by the Southern electric system in 1994 to FPC, of which the Company's share was 101 megawatts, under a contract that expired 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 403 megawatts of capacity in 1994 and is scheduled to sell approximately 248 megawatts of capacity in 1995. Thereafter, these sales will decline to an estimated 172 megawatts in 1996 then will remain at an approximate level of 158 megawatts through 1999. After 2000, capacity sales will decline to approximately 102 megawatts -- unless reduced by FPL, FPC, and JEA -- until the expiration of the contracts in 2010.\nII-122\nNOTES (continued) Georgia Power Company 1994 Annual Report\n7. INCOME TAXES\nEffective January 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption resulted in the recording of additional deferred income taxes and related regulatory assets and liabilities. At December 31, 1994, the tax-related regulatory assets were $920 million and the tax-related regulatory liabilities were $433 million. The assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. The liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits.\nDetails of the federal and state income tax provisions are as follows:\n============================================================== 1994 1993 1992 --------------------------- Total provision for income taxes: (in millions) Federal: Currently payable $306 $223 $139 Deferred - Current year 86 181 170 Reversal of prior years (57) (40) (6) Deferred investment tax credits (1) (18) (6) -------------------------------------------------------------- 334 346 297 -------------------------------------------------------------- State: Currently payable 52 41 24 Deferred - Current year 15 31 35 Reversal of prior years (10) (3) (3) -------------------------------------------------------------- 57 69 56 -------------------------------------------------------------- Total 391 415 353 -------------------------------------------------------------- Less: Income taxes charged (credited) to other income (8) (37) (25) -------------------------------------------------------------- Federal and state income taxes charged to operations $399 $452 $378 ==============================================================\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:\n=============================================================== 1994 1993 ----------------- (in millions) Deferred tax liabilities: Accelerated depreciation $1,541 $1,458 Property basis differences 1,085 1,163 Deferred Plant Vogtle costs 141 161 Premium on reacquired debt 68 63 Deferred regulatory costs 48 24 Fuel clause underrecovered 9 32 Other 23 38 --------------------------------------------------------------- Total 2,915 2,939 --------------------------------------------------------------- Deferred tax assets: Other property basis differences 250 263 Federal effect of state deferred taxes 94 92 Other deferred costs 79 61 Disallowed Plant Vogtle buybacks 26 29 Accrued interest 10 24 Other 13 12 --------------------------------------------------------------- Total 472 481 --------------------------------------------------------------- Net deferred tax liabilities 2,443 2,458 Portion included in current assets 35 22 --------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $2,478 $2,480 ===============================================================\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 $25 million in 1994, $19 million in 1993, and $19 million in 1992. At December 31, 1994, all investment tax credits available to reduce federal income taxes payable had been utilized.\nII-123\nNOTES (continued) Georgia Power Company 1994 Annual Report\nA reconciliation of the federal statutory tax rate to the effective income tax rate is as follows:\n============================================================= 1994 1993 1992 ------------------------ Federal statutory rate 35% 35% 34% State income tax, net of federal deduction 4 4 4 Non-deductible book depreciation 3 3 3 Difference in prior years' deferred and current tax rate (1) (1) (1) Other - (1) (2) ------------------------------------------------------------- Effective income tax rate 41% 40% 38% =============================================================\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, 1994, $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, 1994, the ratio as defined was 47.3 percent.\nPreferred Securities\nGeorgia Power Capital, a limited partnership, was formed November 10, 1994, for the purpose of issuing preferred securities and subsequently lending the proceeds to the Company. In December 1994, Georgia Power Capital issued four million shares of preferred securities at 9 percent and subsequently loaned the proceeds of $100 million to the Company. This subordinated debt of the Company is due December 19, 2024.\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 $1 billion 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 $651 million 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:\n============================================================ Maturity Interest Rates 1994 1993 ------------------------------------------------------------ (in millions) 2004 5.70% $ 39 $ 39 2005-2008 5.375% to 6.75% 59 59 2011-2014 11.75% & Variable 10 477 2015-2019 6.00% to 10.60% & Variable 786 830 2021-2024 5.40% to 7.25% & Variable 784 256 ------------------------------------------------------------ Total pollution control bonds $1,678 $1,661 ============================================================\nBank Credit Arrangements\nAt the beginning of 1995, the Company had unused credit arrangements with banks totaling $709 million, of which $268 million expires at various times during 1995, $41 million expires at May 1, 1997, and $400 million expires at June 30, 1997.\nII-124\nNOTES (continued) Georgia Power Company 1994 Annual Report\nThe $400 million expiring June 30, 1997, 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 1997, 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.\nOf the Company's total $709 million in unused credit arrangements, a portion of the lines are dedicated to provide liquidity support to variable rate pollution control bonds. The credit lines dedicated as of December 31, 1994, is $219 million. In connection with all other lines of credit, the Company has the option of paying fees or maintaining compensating balances. These balances are not legally restricted from withdrawal.\nIn addition, the Company borrows under uncommitted lines of credit with banks and through a $225 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 1994.\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, 1994 and 1993, the Company had a capitalized lease obligation for its corporate headquarters building of $88 million with an interest rate of 8.1 percent. The maturity of this capital lease obligation through 1999 is approximately as follows: $310 thousand in 1995, $336 thousand in 1996, $365 thousand in 1997, $395 thousand in 1998, and $429 thousand in 1999.\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 payments 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, 1994, and 1993, the interest and lease amortization deferred on the Balance Sheets are $48 million and $47 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================================================================ 1994 1993 -------------- (in millions) First mortgage bond maturity $130 $ - Other long-term debt 37 11 ---------------------------------------------------------------- Total $167 $11 ================================================================\nThe Company's first mortgage bond indenture includes an improvement fund requirement that 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 June 1 of each year by depositing cash or reacquired bonds, or by pledging additional property equal to 1 2\/3 times the requirement. The 1994 requirement was funded in December 1993. The 1995 requirement of $23 million\nII-125\nNOTES (continued) Georgia Power Company 1994 Annual Report\nwill be satisfied by pledging additional property.\nRedemption of Securities\nThe Company plans to continue a program of redeeming or replacing debt and preferred stock in cases where opportunities exist to reduce financing costs. 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 through 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 1994 and 1993 is as follows:\n================================================================== Net Income After Dividends on Operating Operating Preferred Quarter Ended Revenues Income Stock ------------------------------------------------------------------ (in millions) March 1994 $ 992 $157 $ 58 June 1994 1,030 227 140 September 1994 1,213 331 233 December 1994 927 179 95\nMarch 1993 $1,004 $221 $108 June 1993 1,096 219 141 September 1993 1,376 356 245 December 1993 975 176 76 ------------------------------------------------------------------\nEarnings in 1994 declined by $55 million as a result of work force reduction programs. Of this amount, $52 million was recorded in the first quarter of 1994.\nThe Company's business is influenced by seasonal weather conditions.\nII-126\nII-127\nII-128A\nII-128B\nII-128C\nII-129\nII-130A\nII-130B\nII-130C\nII-131\nII-132A\nII-132B\nII-133\nII-134A\nII-134B\nII-135\nII-136A\nII-136B\nII-137\nII-138A\nII-138B\nGEORGIA POWER COMPANY\nOUTSTANDING SECURITIES AT DECEMBER 31, 1994\nFirst Mortgage Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity ------------------------------------------------------------------- (Thousands) (Thousands) 1992 $ 130,000 5-1\/8% $ 130,000 9\/1\/95 1993 150,000 4-3\/4% 150,000 3\/1\/96 1993 100,000 5-1\/2% 100,000 4\/1\/98 1992 195,000 6-1\/8% 195,000 9\/1\/99 1993 100,000 6% 100,000 3\/1\/00 1992 100,000 7% 100,000 10\/1\/00 1992 150,000 6-7\/8% 150,000 9\/1\/02 1993 200,000 6-5\/8% 200,000 4\/1\/03 1993 75,000 6.35% 75,000 8\/1\/03 1993 50,000 6-7\/8% 50,000 4\/1\/08 1989 250,000 9.23% 36,157 12\/1\/19 1992 100,000 8-3\/4% 100,000 4\/1\/22 1992 100,000 8-5\/8% 100,000 6\/1\/22 1993 160,000 7.95% 160,000 2\/1\/23 1993 100,000 7-5\/8% 100,000 3\/1\/23 1993 75,000 7-3\/4% 75,000 4\/1\/23 1993 125,000 7.55% 125,000 8\/1\/23 1992 100,000 Variable 100,000 4\/1\/32 1992 100,000 Variable 100,000 7\/1\/32 ---------- ---------- $2,360,000 $2,146,157 ========== ==========\nPollution Control Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity ------------------------------------------------------------------- (Thousands) (Thousands) 1992 $ 38,800 5.70% $ 38,800 9\/1\/04 1993 46,790 5-3\/8% 46,790 3\/1\/05 1976 40,800 6-3\/4% 1,940 11\/1\/06 1977 24,100 6.40% 1,960 6\/1\/07 1978 21,600 6-3\/8% 8,130 4\/1\/08 1991 10,450 Variable 10,450 7\/1\/11 1985 150,000 10-1\/8% 148,535 6\/1\/15 1985 200,000 10-1\/2% 156,580 9\/1\/15 1985 100,000 10.60% 100,000 10\/1\/15 1985 100,000 10-1\/2% 99,585 11\/1\/15 1986 56,400 8% 56,400 10\/1\/16 1987 90,000 8-3\/8% 90,000 7\/1\/17 1987 50,000 9-3\/8% 50,000 12\/1\/17 1993 26,700 6% 26,700 3\/1\/18 1989 50,000 6.35% 50,000 5\/1\/19 1991 8,500 Variable 8,500 7\/1\/19 1991 51,345 7.25% 51,345 7\/1\/21 1991 10,125 Variable 10,125 7\/1\/21 1992 13,155 Variable 13,155 5\/1\/22 1992 75,000 6.20% 75,000 8\/1\/22 1992 35,000 6.20% 35,000 9\/1\/22 1993 11,935 5-3\/4% 11,935 9\/1\/23 1993 60,000 5-3\/4% 60,000 9\/1\/23 1994 28,065 5.40% 28,065 1\/1\/24 1994 175,000 Variable 175,000 7\/1\/24 1994 125,000 6.60% 125,000 7\/1\/24 1994 60,000 6-3\/8% 60,000 8\/1\/24 1994 43,420 6-3\/4% 43,420 10\/1\/24 1994 20,000 Variable 20,000 10\/1\/24 1994 20,000 Variable 20,000 10\/1\/24 1994 38,725 6-5\/8% 38,725 10\/1\/24 1994 10,000 Variable 10,000 12\/1\/24 1994 7,000 Variable 7,000 12\/1\/24 ---------- ---------- $1,797,910 $1,678,140 ========== ==========\nII-139\nGEORGIA POWER COMPANY\nOUTSTANDING SECURITIES AT DECEMBER 31, 1994 (Continued)\nPreferred Securities (1)\nPreferred Securities Interest Amount Series Outstanding Rate Outstanding --------------------------------------------------------------- (Thousands) 1994 4,000,000 9% $100,000\nPreferred Stock\nShares Dividend Amount Series Outstanding Rate Outstanding --------------------------------------------------------------- (Thousands) (2) 14,090 $5.00 $ 1,409 1953 100,000 $4.92 10,000 1954 433,775 $4.60 43,378 1961 70,000 $4.96 7,000 1962 70,000 $4.60 7,000 1963 70,000 $4.60 7,000 1964 50,000 $4.60 5,000 1965 60,000 $4.72 6,000 1966 90,000 $5.64 9,000 1967 120,000 $6.48 12,000 1968 100,000 $6.60 10,000 1971 300,000 $7.72 30,000 1972 750,000 $7.80 75,000 1991 4,000,000 $2.125 100,000 1992 2,000,000 $1.90 50,000 1992 2,200,000 $1.9875 55,000 1992 2,400,000 $1.9375 60,000 1992 1,200,000 $1.925 30,000 1993 3,000,000 Adjustable 75,000 1993 4,000,000 Adjustable 100,000 ---------- -------- 21,027,865 $692,787 ========== ========\n(1)Issued by Georgia Power Capital, L.P., and unconditionally guaranteed by GEORGIA. (2)Issued in exchange for $5.00 preferred outstanding at the time of company formation.\nII-140\nGEORGIA POWER COMPANY\nSECURITIES RETIRED DURING 1994\nFirst Mortgage Bonds\nPrincipal Interest Series Amount Rate ----------------------------------------------------- (Thousands) 1986 $ 69,716 10.00% 1989 63,843 9.23% -------- $133,559 ========\nPollution Control Bonds\nPrincipal Interest Series Amount Rate ----------------------------------------------------- (Thousands) 1976 $ 20 6-3\/4% 1977 20 6.40% 1978 70 6-3\/8% 1984 28,065 11-5\/8% 1984 113,745 12-1\/4% 1984 123,175 11-5\/8% 1984 126,735 12% 1984 75,070 11-3\/4% 1985 43,420 10-1\/2% -------- $510,320 ========\nII-141\nGULF POWER COMPANY FINANCIAL SECTION\nII-142\nMANAGEMENT'S REPORT Gulf Power Company 1994 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 five 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\/ Travis J. Bowden Travis J. Bowden President and Chief Executive Officer\n\/s\/ Arlan E. Scarbrough Arlan E. Scarbrough Chief Financial Officer\nII-143\nREPORT 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, 1994 and 1993, 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, 1994. 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-152 through II-169) referred to above present fairly, in all material respects, the financial position of Gulf Power Company as of December 31, 1994 and 1993, 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 LLP\nAtlanta, Georgia February 15, 1995\nII-144\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Gulf Power Company 1994 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nGulf Power Company's net income after dividends on preferred stock for 1994 totaled $55.2 million, representing a $0.9 million increase from the prior year. Major factors affecting earnings were a decrease in interest charges on long-term debt as a result of security refinancings and an increase in customers. These positive factors were offset by lower revenues primarily due to mild summer weather, and an increase in other operation expenses and taxes. Also, earnings decreased approximately $3.0 million, reflecting the first full year of decreased industrial sales due to the Company's largest industrial customer, Monsanto, installing its own cogeneration facility in August, 1993. Earnings for 1994 increased from the 1993 level, even though 1993 earnings included $4.0 million of unusual items pertaining to the gain on sale of Gulf States Utilities Company (Gulf States) stock and the reversal of a wholesale rate refund discussed below.\nIn 1993, earnings were $54.3 million, representing a $0.2 million increase compared to the prior year. This increase resulted primarily from a $2.3 million gain on the sale of Gulf States' stock and the reversal of a $1.7 million wholesale rate refund as the result of a court order. 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. These positive events were offset by higher operation and maintenance expense and decreased industrial sales, reflecting the loss of Monsanto, which is discussed above.\nThe Company's return on average common equity was 13.15 percent for 1994, a slight decrease from the 13.29 percent return earned in 1993.\nRevenues\nChanges in operating revenues over the last three years are the result of the following factors:\n=========================================================== Increase (Decrease) From Prior Year ------------------------------- 1994 1993 1992 ------------------------------- (in thousands) Retail -- Change in base rates $ 0 $ 1,571 $ 722 Sales growth 7,126 7,671 12,965 Weather (4,631) 4,049 (6,448) Regulatory cost recovery and other 8,938 (3,079) (1,839) ----------------------------------------------------------- Total retail 11,433 10,212 5,400 ----------------------------------------------------------- Sales for resale-- Non-affiliates (6,098) 2,131* 442 Affiliates (5,813) (909) (5,268) ----------------------------------------------------------- Total sales for resale (11,911) 1,222 (4,826) ----------------------------------------------------------- Other operating revenues (3,851) 806 5,121 ----------------------------------------------------------- Total operating revenues $(4,329) $12,240 $ 5,695 =========================================================== Percent change (0.7)% 2.1% 1.0% -----------------------------------------------------------\n* Includes the non-interest portion of the wholesale rate refund reversal discussed in \"Earnings.\"\nRetail revenues of $483.1 million in 1994 increased $11.4 million or 2.4 percent from last year, compared with an increase of 2.2 percent in 1993 and 1.2 percent in 1992. Revenues increased in the residential and commercial classes primarily due to customer growth and favorable economic conditions, partially offset by the effect of milder weather. Revenues in the industrial class declined in 1994 and 1993 primarily due to the loss of Monsanto as discussed in \"Earnings.\" Also, in 1994, industrial sales decreased due to an unexpected six month plant shutdown -- which ended in October 1994 -- by another major industrial customer. The change in base rates for 1993 and 1992 reflects the expiration of a retail rate penalty in September 1992.\nThe increase in regulatory cost recovery and other retail revenue is primarily attributable to the first year of recovery under the Environmental Cost Recovery (ECR) clause. Regulatory cost recovery and other primarily includes recovery provisions for fuel expense and the energy component of purchased power costs; energy conservation costs; purchased power capacity\nII-145\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1994 Annual Report\ncosts; and environmental compliance costs. The recovery provisions equal the related expenses and have no material effect on net income. See Notes 1 and 3 to the financial statements under \"Revenues and Regulatory Cost Recovery Clauses\" and \"Environmental Cost Recovery,\" respectively, for further information.\nSales for resale were $83.5 million in 1994, decreasing $11.9 million or 12.5 percent from 1993. 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 fixed costs and return on investment. Energy is sold at its variable cost. The capacity and energy components under these long-term contracts were as follows:\n=========================================================== 1994 1993 1992 ------------------------------------ (in thousands) Capacity $30,926 $33,805 $34,180 Energy 18,456 21,202 22,933 ----------------------------------------------------------- $49,382 $55,007 $57,113 ===========================================================\nCapacity revenues decreased in 1994, reflecting the decline in capacity under long-term contracts.\nSales to affiliated companies 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.\nThe changes in other operating revenues for 1994 and 1993 are primarily due to adjustments of regulatory cost recovery clauses for differences between recoverable costs and the amounts actually reflected in revenues. See Notes 1 and 3 to the financial statements under \"Revenues and Regulatory Cost Recovery Clauses\" and \"Environmental Cost Recovery,\" respectively, for further discussion.\nKilowatt-hour sales for 1994 and percent changes in sales since 1992 are reported below.\n============================================================= (millions of Amount Percent Change kilowatt-hours) ------ ---------------------- 1994 1994 1993 1992 ------ ---------------------- Residential 3,752 1.1% 3.2% 4.1% Commercial 2,549 4.8 2.7 4.2 Industrial 1,847 (9.0) (6.9) 2.9 Other 17 - - (2.7) ------ Total retail 8,165 (0.3) 0.4 3.8 Sales for resale Non-affiliates 1,419 (2.8) 2.0 (7.7) Affiliates 874 (15.2) (14.8) (2.2) ------ Total 10,458 (2.1) (1.1) 1.4 =============================================================\nRetail sales decreased in 1994 primarily due to mild summer weather and a decline in sales in the industrial class, which reflects the loss of Monsanto and a lengthy shutdown of another major customer. The decline in sales was partially offset by a 2.4 percent increase in residential customers, a 2.9 percent increase in commercial customers, and an improving economy. Retail sales were relatively flat in 1993.\nIn 1994, energy sales for resale to non-affiliates decreased 2.8 percent and are predominantly related to 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 previously.\nExpenses\nTotal operating expenses for 1994 decreased $4.0 million or 0.8 percent from 1993. The decrease is primarily due to decreased fuel and purchased power expenses, offset by an increase in other operation expenses and taxes. In 1993, total operating expenses increased $16.6 million or 3.5 percent from 1992 primarily due to increased operation and maintenance expenses and higher taxes.\nFuel and purchased power expenses for 1994 declined $13.4 million or 6.5 percent from 1993. The decline reflects the decrease in generation due to the mild weather experienced in 1994 and the lower cost of fuel. In 1993, fuel and purchased power expenses decreased $3.8 million or 1.8 percent from 1992, reflecting the lower cost of fuel.\nII-146\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1994 Annual Report\nIn 1994, other operation expenses increased $4.7 million or 4.3 percent from the 1993 level. The increase is primarily attributable to additional costs of $6.4 million related to the buyouts and renegotiation of coal supply contracts and $1.3 million for the Company's pro rata share of affiliated companies' workforce reduction costs. These costs are further discussed in Notes 2 and 5 to the financial statements under \"Work Force Reduction Programs\" and \"Fuel Commitments,\" respectively. The increase in coal buyouts and workforce reductions costs were partially offset by a decrease in various administrative and general expenses. In 1993, other operation expenses increased $11.9 million or 12.2 percent from the previous year, reflecting $7.4 million of additional costs related to the buyouts and renegotiation of coal supply contracts. In addition, in 1993, other operation expenses increased $3.5 million due to higher employee benefit costs, the Company's pro rata share of the Southern electric system's environmental cleanup costs of a research facility site, and costs related to an automotive fleet reduction program.\nMaintenance expense remained relatively flat in 1994 reflecting no major changes in the scheduling of maintenance of production facilities. In 1993, maintenance expense increased $4.1 million or 9.7 percent over 1992 due to scheduled maintenance of production facilities.\nFederal and state income taxes increased $1.2 million or 3.8 percent in 1994 primarily due to an increase in taxable income. Other taxes increased $1.5 million or 3.7 percent due to higher property taxes, gross receipt taxes, and franchise fee collections. In 1993, federal income taxes increased $0.7 million primarily due to a corporate federal income tax rate increase from 34 percent to 35 percent. Taxes other than income taxes increased $2.3 million in 1993, an increase of 6.1 percent over the 1992 expense primarily due to increases in property and gross receipt taxes. Changes in gross receipt taxes and franchise fee collections, which are collected from customers, have no impact on earnings.\nIn 1994, interest expense decreased $3.8 million or 10.5 percent under the prior year. Interest expense in 1993 decreased $3.2 million or 8.1 percent from the 1992 level. The decrease in both years is primarily attributable to the refinancing of 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 ranging from growth in energy sales to the effects of a less regulated, more competitive environment.\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) is beginning to have a dramatic 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 posturing the business to meet the challenge of this major change in the traditional practice 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. This may enhance the incentive for IPPs to build cogeneration plants for industrial and commercial customers and sell excess energy generation to utilities. Presently, Florida law does not permit retail wheeling. Although the Energy Act does not require transmission access to retail customers, retail wheeling initiatives are rapidly evolving and becoming very prominent issues in several states. In order to address these initiatives, numerous questions must be resolved, with the most complex ones\nII-147\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1994 Annual Report\nrelating to transmission pricing and recovery of stranded investments. As the initiatives become a reality, the structure of the utility industry could radically change. Therefore, unless the Company remains a low-cost producer and provides quality service, the Company's retail energy sales growth could be limited and this could significantly erode earnings. Conversely, being the low-cost producer could provide significant opportunities to increase market share and profitability.\nThe future effect of cogeneration and small-power production facilities cannot be fully determined at this time. One effect of cogeneration which the Company has experienced is the loss of its largest industrial customer, Monsanto, which is discussed in \"Earnings.\" The Company's strategy is to identify and pursue profitable cogeneration projects in Northwest Florida.\nThe Florida Public Service Commission (FPSC) has set conservation goals for the Company to reduce 148 megawatts of peak demand by the year 2003. The Company will file conservation programs in 1995 to accomplish these goals. In response to these goals and seeking to remain competitive with other electric utilities, the Company has developed initiatives which emphasize price flexibility and competitive offering of energy efficiency products and services. These initiatives will enable customers to lower or alter their peak energy requirements. Besides promoting energy efficiency, another benefit of these initiatives could be the ability to defer the need to construct some generating facilities further into the future.\nThe Company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. In the event that a portion of the Company's operations is no longer subject to these provisions, the Company would be required to write off related regulatory assets and liabilities. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities\" for additional information.\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.\" Also, state of Florida legislation adopted in 1993 that provides for recovery of prudent environmental compliance costs is discussed in Note 3 to the financial statements under \"Environmental Cost Recovery.\"\nFINANCIAL CONDITION\nOverview\nThe principal changes in the Company's financial condition during 1994 were gross property additions of $78.9 million and an increase of $47.4 million in notes payable. Funds for the property 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.\nFinancing Activities\nThe Company continued to lower its financing costs by issuing new securities and other debt, and retiring higher-cost issues in 1994. The Company sold through public authorities, $42 million of pollution control revenue bonds and obtained $32.1 million of long-term bank notes. Retirements, including maturities during 1994, totaled $48.9 million of first mortgage bonds, $42.1 million of pollution control bonds, $24.2 million of bank notes and other long-term debt, and $1 million of preferred stock. (See the Statements of Cash Flows for further details.)\nII-148\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1994 Annual Report\nComposite financing rates for the years 1992 through 1994 as of year end were as follows:\n=========================================================== 1994 1993 1992 ------------------------- Composite interest rate on long-term debt 6.5% 7.1% 8.0% Composite preferred stock dividend rate 6.6% 6.5% 7.3% ===========================================================\nThe continued decrease in the composite interest rate on long-term debt reflects the Company's continued efforts to refinance higher-cost debt, which is discussed above. The slight increase in the composite preferred dividend rate is primarily due to an increase in dividends on the Company's adjustable rate preferred stock, reflecting the recent rise in interest rates.\nCapital Requirements for Construction\nThe Company's gross property additions, including those amounts related to environmental compliance, are budgeted at $222 million for the three years beginning 1995 ($62 million in 1995, $76 million in 1996, and $84 million in 1997). The estimates of property additions for the three-year period include $13 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. The Company does not have any baseload generating plants under construction. However, significant construction related to maintaining and upgrading transmission and distribution facilities and generating plants will continue.\nOther Capital Requirements\nIn addition to the funds needed for the construction program, approximately $74.3 million will be required by the end of 1997 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 as market conditions and terms of the instruments permit.\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 began 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 by 2000, and all fossil-fired generating plants in the Southern electric system will be affected.\nIn 1993, the Florida Legislature adopted legislation that allows a utility to petition the FPSC for recovery of prudent environmental compliance costs that are not being recovered through base rates or any other rate-adjustment clause. The legislation is discussed in Note 3 to the financial statements under \"Environmental Cost Recovery.\" Substantially all of the costs for the Clean Air Act and other new legislation discussed below is expected to be recovered through the Environmental Cost Recovery clause.\nIn 1995, the Environmental Protection Agency (EPA) will begin issuing annual sulfur dioxide emission allowances through the allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for issuing 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 Southern Company's sulfur dioxide compliance strategy is designed to use allowances as a compliance option.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, which has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction\nII-149\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1994 Annual Report\nexpenditures are required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment has been installed on all fossil-fired units. Construction expenditures for Phase I are estimated to total approximately $300 million for The Southern Company through 1995. Through 1994, the Company's construction expenditures for Phase I were approximately $51 million.\nFor Phase II 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, the current compliance strategy could require total construction expenditures of approximately $150 million for The Southern Company, including approximately $19 million for the Company. However, the full impact of Phase II compliance cannot be determined with certainty, pending the continuing 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 FPSC 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 the Company's customers could be necessary to fully recover the cost of compliance for both Phase I and Phase II of Title IV of the Clean Air Act. Compliance costs include construction expenditures, increased costs for switching to low-sulfur coal, and costs related to emission allowances.\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The EPA is scheduled to submit a report to Congress on the results of this study by November 1995. The report will include 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 issued proposed rules in November 1994 and is required to take final action on this issue in 1996. 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 1995, the EPA may 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 cleanup costs and has recognized in the financial statements costs to clean up known sites. For additional information, see Note 3 to the financial statements under \"Environmental Cost Recovery.\"\nII-150\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Gulf Power Company 1994 Annual Report\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; the Resource Conservation and Recovery Act; and the Endangered Species 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.\nSources of Capital\nAt December 31, 1994, the Company had $0.9 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; bank notes; 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-151\nII-152\nII-153\nII-154\nII-155\nII-156\nII-157\nII-158\nNOTES TO FINANCIAL STATEMENTS At December 31, 1994, 1993, and 1992 Gulf Power Company 1994 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, a system service company, Southern Communications Services (Southern Communications), Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear) and The Southern Development and Investment Group (SDIG). 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 subsidiary companies. Southern Communications, beginning in mid-1995, will provide digital wireless communications services -- over the 800-megahertz frequency band--to The Southern Company's subsidiaries and also will market these services to the public within the Southeast. 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. SDIG develops new business opportunities related to energy products and services.\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 the FPSC.\nCertain prior years' data presented in the financial statements have been reclassified to conform with current year presentation.\nRegulatory Assets and Liabilities\nThe Company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. Regulatory assets represent probable future revenues to the Company associated with certain costs that are expected to be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited to customers through the ratemaking process. Regulatory assets and (liabilities) reflected in the Balance Sheets at December 31 relate to:\n=========================================================== 1994 1993 ----------------------- (in thousands) Current & deferred fuel charges $ 40,690 $ 65,419 Deferred income taxes 30,433 31,334 Premium on reacquired debt 18,494 17,554 Environmental remediation 7,800 - Vacation pay 4,172 4,022 Regulatory clauses under (over) recovery, net 1,042 2,404 Deferred income tax credits (71,964) (76,876) Accumulated provision for property damage (11,522) (10,509) Other, net (2,691) (1,697) ----------------------------------------------------------- Total $ 16,454 $ 31,651 ===========================================================\nIn the event that a portion of the Company's operations are no longer subject to the provisions of Statement No. 71, the Company would be required to write off related regulatory assets and liabilities. In addition, the Company would be required to determine any impairment to other assets, including plant, and write down the assets to their fair value.\nII-159\nNOTES (continued) Gulf Power Company 1994 Annual Report\nRevenues and Regulatory Cost Recovery Clauses\nThe Company accrues revenues for service rendered but unbilled at the end of each fiscal period. The Company's electric rates include provisions to periodically adjust billings for fluctuations in fuel and the energy component of purchased power costs; purchased power capacity costs; energy conservation costs; and environmental compliance costs. Revenues are adjusted monthly for differences between recoverable costs and amounts actually reflected in current rates.\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 3.8 percent in 1994, 1993, and 1992. 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.\nEffective 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.\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 FPSC-approved composite rate used to calculate AFUDC was 7.27 percent for 1994 and the second half of 1993, and 8.03 percent for the first half of 1993 and all of 1992. AFUDC amounts for 1994, 1993, and 1992 were $1.1 million, $966 thousand, and $60 thousand, respectively. The increase in 1994 and 1993 is primarily 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.\nII-160\nNOTES (continued) Gulf Power Company 1994 Annual Report\nFinancial Instruments\nIn accordance with FASB Statement No. 107, Disclosure About Fair Values 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:\n============================================================ ----------------------- Carrying Fair Amount Value ----------------------- (in thousands) Long-term debt $369,832 $355,019 Preferred stock subject to mandatory redemption 1,000 1,030 ============================================================\n============================================================ ----------------------- Carrying Fair Amount Value ----------------------- (in thousands) Long-term debt $410,811 $431,251 Preferred stock subject to mandatory redemption 2,000 2,040 ============================================================\nThe 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 $4.2 million and $4.0 million at December 31, 1994, and 1993, respectively. In 1995, an estimated 81.3 percent of the 1994 deferred vacation cost will be expensed and the balance will be charged to construction and other accounts.\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 provides 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 $2.5 million and $2.2 million at December 31, 1994, and 1993, 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, 1994, and 1993, the accumulated provision for property damage amounted to $11.5 million and $10.5 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.\nII-161\nNOTES (continued) Gulf Power Company 1994 Annual Report\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 is funded to the extent deductible under federal income tax regulations. Amounts funded are primarily invested in debt and equity securities.\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.\" The costs of such benefits recognized by the Company in 1994 and 1993 were $4.3 million and $3.9 million, respectively.\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 cost of such benefits recognized by the Company in 1992 was $3.1 million.\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. The funded status of the plans at December 31 was as follows:\n================================================================= Pension ------------------------- 1994 1993 ------------------------- (in thousands) Actuarial present value of benefit obligation: Vested benefits $ 73,552 $ 73,925 Non-vested benefits 3,016 3,217 ----------------------------------------------------------------- Accumulated benefit obligation 76,568 77,142 Additional amounts related to projected salary increases 29,451 25,648 ----------------------------------------------------------------- Projected benefit obligation 106,019 102,790 Less: Fair value of plan assets 151,337 159,192 Unrecognized net gain (36,599) (49,376) Unrecognized prior service cost 2,802 3,152 Unrecognized transition asset (8,034) (8,765) ----------------------------------------------------------------- Prepaid asset recognized in the Balance Sheets $ 3,487 $ 1,413 =================================================================\n================================================================= Postretirement Medical ------------------------- 1994 1993 ------------------------- (in thousands) Actuarial present value of benefit obligation: Retirees and dependents $ 7,768 $ 7,857 Employees eligible to retire 4,043 4,054 Other employees 14,598 14,927 ----------------------------------------------------------------- Accumulated benefit obligation 26,409 26,838 Less: Fair value of plan assets 5,655 5,638 Unrecognized net loss (gain) 615 2,653 Unrecognized transition obligation 12,714 13,420 ----------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 7,425 $ 5,127 =================================================================\nII-162\nNOTES (continued) Gulf Power Company 1994 Annual Report\n================================================================= Postretirement Life -------------------- 1994 1993 -------------------- (in thousands) Actuarial present value of benefit obligation: Retirees and dependents $3,032 $2,929 Employees eligible to retire - - Other employees 5,041 5,058 ----------------------------------------------------------------- Accumulated benefit obligation 8,073 7,987 Less: Fair value of plan assets 85 52 Unrecognized net loss (gain) (1,073) (641) Unrecognized transition obligation 2,806 2,954 ----------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $6,255 $5,622 =================================================================\nThe weighted average rates assumed in the actuarial calculations were:\n================================================================= 1994 1993 1992 --------------------------- Discount 8.0% 7.5% 8.0% Annual salary increase 5.5% 5.0% 6.0% Long-term return on plan assets 8.5% 8.5% 8.5% ================================================================= An additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 10.5 percent for 1994, 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 of 1 percent would increase the accumulated medical benefit obligation at December 31,1994, by $4.8 million and the aggregate of the service and interest cost components of the net retiree medical cost by $660 thousand.\nComponents of the plans' net costs are shown below: ================================================================= Pension ----------------------------------- 1994 1993 1992 ----------------------------------- (in thousands) Benefits earned during the year $ 3,775 $ 3,710 $ 3,550 Interest cost on projected benefit obligation 7,484 7,319 6,939 Actual (return) loss on plan assets 3,721 (20,672) (6,431) Net amortization and deferral (17,054) 8,853 (4,054) ----------------------------------------------------------------- Net pension cost (income) $ (2,074) $ (790) $ 4 =================================================================\nOf the above net pension amounts, pension expense\/(income) of $(1.5) million in 1994, $(601) thousand in 1993, and $3 thousand in 1992, were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\n================================================================= Postretirement Medical ----------------------- 1994 1993 ----------------------- (in thousands) Benefits earned during the year $1,092 $ 874 Interest cost on accumulated benefit obligation 1,952 1,714 Amortization of transition obligation 706 706 Actual (return) loss on plan assets 117 (726) Net amortization and deferral (575) 309 ----------------------------------------------------------------- Net postretirement cost $3,292 $2,877 =================================================================\n================================================================= Postretirement Life ----------------------- 1994 1993 ----------------------- (in thousands) Benefits earned during the year $270 $ 292 Interest cost on accumulated benefit obligation 583 625 Amortization of transition obligation 148 148 Actual (return) loss on plan assets 12 (5) Net amortization and deferral (16) 1 ----------------------------------------------------------------- Net postretirement cost $997 $1,061 =================================================================\nII-163\nNOTES (continued) Gulf Power Company 1994 Annual Report\nOf the above net postretirement medical and life insurance amounts, $3.1 million in 1994 and $3.0 million in 1993, were charged to operating expenses, and the remainder was recorded in construction and other accounts.\nWork Force Reduction Programs\nThe Company has not had a work force reduction program but has incurred its pro rata share of affiliated companies' costs. The costs related to these programs were $1.3 million, $109 thousand, and $138 thousand for the years 1994, 1993, and 1992, respectively.\n3. LITIGATION AND REGULATORY MATTERS\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 change in the rate of return on common equity that may require refunds as a result of this proceeding would be substantially for the period beginning in July 1991 and ending in October 1992.\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.\nIn August 1994, the FERC instituted another proceeding based on substantially the same issues as in the 1991 proceeding. The second period under review for possible refunds began in October 1994 and is scheduled to continue until January 1996.\nIf the rates of return on common equity recommended by the FERC staff were applied to all of the schedules and contracts involved in both proceedings and refunds were ordered, the amount of refunds could range up to approximately $5.4 million at December 31, 1994. Although the final outcome of this matter cannot now be determined, in management's opinion, the final outcome will not result in changes that would have a material adverse effect on the Company's financial statements.\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.\nOn January 12, 1994, the FPSC approved the Company's initial petition under the ECR clause for recovery of environmental costs that were projected to be incurred from July 1993 through September 1994. After this initial period, recovery under the ECR clause is determined semi-annually and includes a true-up of the prior period and a projection of the ensuing six month period. During 1994 and 1993, the Company recorded $7.2 million and $2.6 million, respectively, of ECR revenues net of over\/under recovery true-up amounts.\nIn 1994, the Company accrued a liability of $7.8 million for the estimated costs of environmental remediation projects for known sites. These estimated costs are expected to be expended during the period 1995 to 1999. These projects have been approved by the FPSC for recovery through the ECR clause discussed above. Therefore, the Company recorded $2.1 million in current assets and $5.7 million in deferred charges representing the future recoverability of these costs.\n4. CONSTRUCTION PROGRAM\nThe Company is engaged in a continuous construction program, the cost of which is currently estimated to total $62 million in 1995, $76 million in 1996, and $84 million in 1997. 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. At December 31, 1994, significant purchase commitments were outstanding in connection with the construction program. The Company does not have any new\nII-164\nNOTES (continued) Gulf Power Company 1994 Annual Report\nbaseload generating plants under construction. However, 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 and preferred stock; bank notes; 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. If the attractiveness of current short-term interest rates continues, the Company may maintain a higher level of short-term indebtedness than has historically been true.\nBank Credit Arrangements\nAt December 31, 1994, the Company had $25 million in revolving credit lines subject to renewal June 1, 1997, and $22 million of lines of credit with banks subject to renewal June 1 of each year. In connection with these credit lines, 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. The Company had $19 million of these lines of credit committed at December 31, 1994. In addition, the Company has bid-loan facilities with fourteen major money center banks that total $275 million, of which $34.5 million was committed at December 31, 1994.\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 $1.1 billion at December 31, 1994. 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 this payment was $60 million. This amount is being amortized to expense on a per ton basis over a nine-year period ending in 1995. The remaining unamortized amount was $10.1 million at December 31, 1994.\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 was $30.5 million at December 31, 1994.\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 was amortized to expense on a per ton basis during 1993 and 1994, with a remainder of $118 thousand to be amortized to expense in the first quarter of 1995.\nThe amortization expense of these contract buyouts and renegotiations is being recovered through the fuel cost recovery clause discussed under \"Revenues and Regulatory Cost Recovery Clauses\" in Note 1.\nII-165\nNOTES (continued) Gulf Power Company 1994 Annual Report\nLease Agreements\nIn 1989, the Company and Mississippi Power Company jointly entered into a twenty-two year operating lease agreement for the use of 495 aluminum railcars. In 1995, a second lease agreement for the use of 250 additional aluminum railcars will begin and continue for twenty-two years. Both of these leases are for the transportation of coal to Plant Daniel. The Company, as a joint owner of Plant Daniel, is responsible for one half of the lease costs. The lease costs are charged to fuel inventory and are allocated to fuel expense as the fuel is used. The Company's share of the lease costs charged to fuel inventory were $1.2 million in 1994, 1993, and 1992. For the year 1995, the Company's annual lease payments associated with both leases will be approximately $2.6 million. The Company's annual lease payments for 1996 through 1999 will be approximately $1.7 million and after 1999, lease payments total approximately $26.0 million. The Company has the option after three years from the date of the original contract on each lease to purchase the respective number of railcars at the greater of the termination value or the fair market value. Additionally, at the end of each 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, 1994, the Company's percentage ownership and its amount of investment in these jointly owned facilities were as follows:\n================================================================ Plant Scherer Plant Unit No. 3 Daniel (coal-fired) (coal-fired) ---------------------------- (in thousands) Plant-In Service $185,339(1) $220,125 Accumulated Depreciation $45,814 $93,110 Construction Work in Progress $941 $1,163\nNameplate Capacity (2) (In megawatts) 205 500 Ownership 25% 50% ================================================================\n(1) Includes net plant acquisition adjustment. (2) Total megawatt nameplate capacity: Plant Scherer Unit No. 3: 818 Plant Daniel: 1,000\n7. LONG-TERM POWER SALES AGREEMENTS\nGeneral\nThe Company and the other operating affiliates of The Southern Company 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. The agreements for non-firm capacity expired in 1994. Other agreements, expiring at various dates discussed below, 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 capacity revenues have been as follows:\n================================================================ Other Unit Long- Year Power Term Total ---- ----------------------------------------- (in thousands) 1994 $29,653 $1,273 $30,926 1993 31,162 2,643 33,805 1992 32,679 1,501 34,180 ================================================================\nII-166\nNOTES (continued) Gulf Power Company 1994 Annual Report\nIn 1994, long-term non-firm power of 200 megawatts was sold to Florida Power Corporation (FPC) under a contract that expired at year-end. Capacity and energy sales under these long-term non-firm power sales agreements were made from available power pool capacity, and the revenues from the sales were 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, 210 megawatts of net dependable capacity were sold by the Company during 1994, and sales will remain at that 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 $29.3 million in 1994, $39.5 million in 1993, and $46.2 million in 1992, or 5.1 percent, 6.8 percent, and 8.1 percent of operating revenues, respectively.\n8. INCOME TAXES\nEffective January 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption resulted in the recording of additional deferred income taxes and related regulatory assets and liabilities. At December 31, 1994, the tax-related regulatory assets to be recovered from customers were $30.4 million. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. At December 31, 1994, the tax-related regulatory liabilities to be refunded to customers were $72.0 million. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits.\nDetails of the federal and state income tax provisions are as follows:\n================================================================= 1994 1993 1992 ----------------------------- (in thousands) Total provision for income taxes: Federal-- Currently payable $34,941 $24,354 $24,287 Deferred--current year 18,556 26,396 18,173 --reversal of prior years (24,787) (22,102) (15,506) ----------------------------------------------------------------- 28,710 28,648 26,954 ----------------------------------------------------------------- State-- Currently payable 5,907 3,950 4,282 Deferred--current year 2,549 3,838 2,662 --reversal of prior years (3,304) (2,785) (2,007) ----------------------------------------------------------------- 5,152 5,003 4,937 ----------------------------------------------------------------- Total 33,862 33,651 31,891 Less income taxes charged (credited) to other income (95) 921 (187) ----------------------------------------------------------------- Federal and state income taxes charged to operations $33,957 $32,730 $32,078 =================================================================\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:\n===================================================================== 1994 1993 ----------------------- (in thousands) Deferred tax liabilities: Accelerated depreciation $146,686 $146,657 Property basis differences 18,468 15,140 Coal contract buyout 6,896 15,427 Other 11,846 6,724 --------------------------------------------------------------------- Total 183,896 183,948 --------------------------------------------------------------------- Federal effect of state deferred taxes 9,732 10,136 Postretirement benefits 4,383 3,406 Property insurance 5,200 4,730 Other 7,566 6,500 --------------------------------------------------------------------- Total 26,881 24,772 --------------------------------------------------------------------- Net deferred tax liabilities 157,015 159,176 Portion included in current liabilities, net 5,334 7,433 --------------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $151,681 $151,743 =====================================================================\nII-167\nNOTES (continued) Gulf Power Company 1994 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 Statements of Income. Credits amortized in this manner amounted to $2.3 million in 1994, 1993 and 1992. At December 31, 1994, 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:\n============================================================= 1994 1993 1992 -------------------------- Federal statutory rate 35% 35% 34% State income tax, net of federal deduction 4 3 4 Non-deductible book depreciation 1 1 1 Difference in prior years' deferred and current tax rate (2) (2) (2) Other (2) (1) (2) ------------------------------------------------------------- Effective income tax rate 36% 36% 35% =============================================================\nThe 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.\n9. POLLUTION CONTROL OBLIGATIONS AND OTHER LONG-TERM DEBT\nDetails of long-term debt are as follows:\n============================================================== December 31, 1994 1993 ---------------------- (in thousands) Obligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds: Collateralized 6% due 2006* $ 12,200 $ 12,300 8.25% due 2017 32,000 32,000 7.125% due 2021 21,200 21,200 6.75% due 2022 8,930 8,930 5.70% due 2023 7,875 7,875 5.80% due 2023 32,550 32,550 6.20% due 2023 13,000 13,000 6.30% due 2024 22,000 - Variable Rate Remarketed daily 20,000 - Non-collateralized 10.50% due 2014 - 42,000 -------------------------------------------------------------- $169,755 $169,855 -------------------------------------------------------------- Notes payable: 5.39% due 1995 4,500 - 5.72% due 1995 4,500 - 4.69% due 1996 25,000 25,000 6.44% due 1994-1998 16,388 - 8.25% due 1995 - 17,520 -------------------------------------------------------------- 50,388 42,520 -------------------------------------------------------------- Total $220,143 $212,375 ==============================================================\n* Sinking fund requirement applicable to the 6 percent pollution control bonds is $125 thousand for 1995 with increasing increments thereafter through 2005, with the remaining balance due in 2006.\nPollution control obligations represent installment purchases of pollution control facilities financed by funds derived from sales by public authorities of revenue bonds. With 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.\nII-168\nNOTES (continued) Gulf Power Company 1994 Annual Report\nThe 5.39 percent and 5.72 percent notes payable are the Company's portion of notes payable issued in connection with the termination of Plant Daniel coal contracts (see Note 5 under \"Fuel Commitments\" for further information). These notes refinanced the remaining balance of the 8.25 percent note payable. The proceeds from the 6.44 percent note were used to refinance the remaining balance of the 9.2 percent first mortgage bond, which was redeemed in June, 1994. The estimated annual maturities of the notes payable through 1998 are as follows: $13.3 million in 1995, $29.6 million in 1996, $4.9 million in 1997, and $2.6 million in 1998.\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:\n============================================================== December 31 1994 1993 -------------------- (in thousands) Bond improvement fund requirement $ 1,750 $ 2,370 Less: Portion to be satisfied by cash or certifying property additions 1,750 - -------------------------------------------------------------- Cash sinking fund requirement - 2,370 Maturities of first mortgage bonds - 3,676 Redemptions of first mortgage bonds - 27,000 Current portion of notes payable 13,314 8,406 (Note 9) Pollution control bond maturity 125 100 (Note 9) -------------------------------------------------------------- Total $13,439 $41,552 ==============================================================\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.\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, 1994, $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 of 12 months 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, 1994, the ratio was 47.2 percent.\n12. QUARTERLY FINANCIAL DATA (Unaudited)\nSummarized quarterly financial data for 1994 and 1993 are as follows:\n================================================================= Net Income After Dividends Operating Operating on Preferred Quarter Ended Revenues Income Stock ----------------------------------------------------------------- (in thousands) March 31, 1994 $138,088 $19,154 $10,117 June 30, 1994 146,769 19,957 8,886 Sept. 30, 1994 162,143 31,123 21,831 Dec. 31, 1994 131,813 21,979 14,395\nMarch 31, 1993 $127,036 $17,646 $10,426 June 30, 1993 138,863 19,562 7,312 Sept. 30, 1993 175,964 32,783 22,366 Dec. 31, 1993 141,279 22,596 14,207 =================================================================\nThe Company's business is influenced by seasonal weather conditions and the timing of rate changes, among other factors.\nII-169\nII-170\nII-171A\nII-171B\nII-171C\nII-172\nII-173A\nII-173B\nII-173C\nII-174\nII-175A\nII-175B\nII-176\nII-177A\nII-177B\nII-178\nII-179A\nII-179B\nII-180\nII-181A\nII-181B\nGULF POWER COMPANY\nOUTSTANDING SECURITIES AT DECEMBER 31, 1994\nFirst Mortgage Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity ---------------------------------------------------------------- (Thousands) (Thousands) 1992 $ 25,000 5-7\/8% $ 25,000 8\/1\/97 1993 15,000 5.55% 15,000 4\/1\/98 1993 30,000 5% 30,000 7\/1\/98 1993 30,000 6-1\/8% 30,000 7\/1\/03 1978 25,000 9% 2,680 9\/1\/08 1991 50,000 8-3\/4% 50,000 12\/1\/21 --------- -------- $ 175,000 $152,680 ========= ========\nPollution Control Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity ---------------------------------------------------------------- (Thousands) (Thousands) 1976 $ 12,500 6% $ 12,200 10\/1\/06 1987 32,000 8-1\/4% 32,000 6\/1\/17 1991 21,200 7-1\/8% 21,200 4\/1\/21 1992 8,930 6-3\/4% 8,930 3\/1\/22 1993 13,000 6.20% 13,000 4\/1\/23 1993 32,550 5.80% 32,550 6\/1\/23 1993 7,875 5.70% 7,875 11\/1\/23 1994 22,000 6.30% 22,000 9\/1\/24 1994 20,000 Variable 20,000 9\/1\/24 --------- -------- $ 170,055 $169,755 ========= ========\nPreferred Stock\nShares Dividend Amount Series Outstanding Rate Outstanding ---------------------------------------------------------------- (Thousands) 1950 51,026 4.64% $ 5,102 1960 50,000 5.16% 5,000 1966 50,000 5.44% 5,000 1969 50,000 7.52% 5,000 1972 50,000 7.88% 5,000 1980 (1) 10,000 11.36% 1,000 1992 580,000 7% 14,500 1992 600,000 7.30% 15,000 1993 800,000 6.72% 20,000 1993 600,000 Adjustable 15,000 --------- -------- 2,841,026 $ 90,602 ========= ======== (1) The outstanding balance of $1 million was redeemed on February 1, 1995.\nII-182\nGULF POWER COMPANY\nSECURITIES RETIRED DURING 1994\nFirst Mortgage Bonds\nPrincipal Interest Series Amount Rate ----------------------------------------------------- (Thousands) 1964 $12,000 4-5\/8% 1966 15,000 6% 1978 2,370 9% 1988 19,486 9.20% ------- $48,856 =======\nPollution Control Bonds\nPrincipal Interest Series Amount Rate ----------------------------------------------------- (Thousands) 1976 $ 100 6% 1984 42,000 10-1\/2% ------- $42,100 =======\nPreferred Stock\nPrincipal Dividend Series Amount Rate ----------------------------------------------------- (Thousands) 1980 $ 1,000 11.36%\nII-183\nMISSISSIPPI POWER COMPANY\nFINANCIAL SECTION\nII-184\nMANAGEMENT'S REPORT Mississippi Power Company 1994 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 in any system of internal controls, however, 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\/ Michael W. Southern Michael W. Southern Vice President, Secretary, Treasurer and Chief Financial Officer\nII-185\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, 1994 and 1993, 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, 1994. 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-194 through II-209) referred to above present fairly, in all material respects, the financial position of Mississippi Power Company as of December 31, 1994 and 1993, 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, Mississippi Power changed its methods of accounting for postretirement benefits other than pensions and for income taxes.\n\/S\/ ARTHUR ANDERSEN LLP\nAtlanta, Georgia February 15, 1995\nII-186\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Mississippi Power Company 1994 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nMississippi Power Company's net income after dividends on preferred stock for 1994 totaled $49.2 million, an increase of $6.7 million over the prior year. This improvement is attributable primarily to increased energy sales and rate increases. A retail rate increase under the Company's Performance Evaluation Plan (PEP) of $6.4 million annually became effective in July 1993. Under the Environmental Compliance Overview Plan (ECO Plan), retail rates increased by $7.6 million annually effective April 1994. Also, effective in April 1994 was a $3.6 million wholesale rate increase.\nA comparison of 1993 to 1992 reflects an increase in 1993 earnings of $5.6 million. As was the case in 1994, earnings in 1993 increased because of higher energy sales and retail rate increases.\nRevenues\nThe following table summarizes the factors impacting operating revenues for the past three years:\n================================================================ Increase (Decrease) from Prior Year ----------------------------------- 1994 1993 1992 ----------------------------------- (in thousands) Retail -- Change in base rates $ 9,314* $ 5,079* $ 6,605 Sales growth 9,560 5,606 7,181 Weather 1,752 4,735 (3,915) Fuel cost recovery and other 6,594 15,028 (2,743) ---------------------------------------------------------------- Total retail 27,220 30,448 7,128 ---------------------------------------------------------------- Sales for resale -- Non-affiliates 4,611 3,298 1,387 Affiliates (5,981) 5,464 (7,989) ---------------------------------------------------------------- Total sales for resale (1,370) 8,762 (6,602) Other operating revenues (1,571) 1,226 1,535 ---------------------------------------------------------------- Total operating revenues $ 24,279 $ 40,436 $ 2,061 ================================================================ Percent change 5.1% 9.3% 0.5% ----------------------------------------------------------------\n*Includes the effect of the retail rate increases approved under the ECO Plan.\nRetail revenues of $395 million in 1994 increased 7.4 percent over the prior year, compared with increases of 9.0 percent and 2.2 percent in 1993 and 1992, respectively. The increase in retail revenues for 1994 was a result of growth in energy sales and customers and retail rate increases. Changes in base rates reflect rate changes made under PEP and the ECO Plan as approved by the Mississippi Public Service Commission (MPSC).\nUnder 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-187\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1994 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 increased 7.8 percent in 1994 and 9.0 percent in 1993 with the related revenues rising 14.0 percent and 14.1 percent, respectively. 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. Under these long-term contracts, the capacity and energy components were:\n============================================================= 1994 1993 1992 ---------------------------------------- (in thousands) Capacity $ 1,965 $ 4,191 $ 3,573 Energy 8,473 12,120 19,538 ------------------------------------------------------------- Total $10,438 $16,311 $23,111 =============================================================\nCapacity revenues for Mississippi Power varied due to changes in the contracts and 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.\nBelow is a breakdown of kilowatt-hour sales for 1994 and the percent change for the last three years:\n================================================================== Amount Percent Change (millions of -------- ----------------------------- kilowatt-hours 1994 1994 1993 1992 -------- -----------------------------\nResidential 1,922 (0.4)% 6.9 % (1.5)% Commercial 2,101 8.6 6.8 2.4 Industrial 3,847 6.2 2.5 7.3 Other 38 (0.5) 0.3 (57.2) ----- Total retail 7,908 5.1 4.7 2.9 Sales for resale -- Non-affiliates 2,556 0.4 (5.3) (0.7) Affiliates 174 (59.2) 52.2 (54.6) ------ Total 10,638 1.3% 3.3% (1.5)% ==================================================================\nTotal retail energy sales in 1994 increased, compared to the previous year, due primarily to the improvement in the economy. The most notable factor that increased commercial energy sales was the recent establishment of casinos within the Company's service area. It is expected that the establishment of new casinos should slow appreciably. However, growth in ancillary services (lodging, food, transportation, etc.) should continue. Also, energy demand is expected to grow as a result of a larger and more fully employed population. The improvement in the economy also carried over to the industrial sector. Retail energy sales in 1993 increased due to an improving economy and weather influences. Industrial sales increased in 1992 as a result of new contracts with two large industrial customers.\nIn addition to the previously discussed long-term contracts, energy sales to non-affiliates include economy sales and amounts sold under short-term contracts. 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 1994 were higher than the previous year because of higher taxes and an increase in maintenance expenses and depreciation and amortization. Additionally, included in other operation expenses are increased costs associated with work force reduction programs. (See Note 2 to the financial statements for information on these programs.) Expenses in 1993 were higher than 1992 primarily because of higher production expenses stemming from\nII-188\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1994 Annual Report\nincreased demand, an increase in the federal income tax rate, and higher employee related costs.\nFuel costs constitute the single largest expense for Mississippi Power. These costs decreased in 1994 due to a 5.5 percent decrease in generation, which reflects lower demand on the rest of the Southern electric system and, hence, the availability of lower cost generation from affiliates. Fuel expenses in 1993, compared to 1992, were higher because of increased generation reflecting higher demand.\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.\nThe increase in depreciation and amortization is primarily the result of the commercial operation of a 75 megawatt combustion turbine unit in May 1994.\nTaxes other than income taxes increased in 1994 because of higher ad valorem taxes, which are property based, and municipal franchise taxes, which are revenue based.\nThe change in income taxes for 1994 reflected the change in operating income. Income 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.\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 to a less regulated, more competitive environment. 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 managing the construction budget. Operating revenues will be affected by any changes in rates under the PEP, the Company's performance based ratemaking plan. PEP has proven 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 (Clean Air Act) regulations. The ECO Plan is operated independently of PEP. The Clean Air Act and other important environmental items are discussed later under \"Environmental Matters.\"\nThe Federal Energy Regulatory Commission (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.\nFurther discussion of PEP, the ECO Plan, and proceedings before the FERC is made in Note 3 to the financial statements herein.\nII-189\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1994 Annual Report\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 Policy Act of 1992 (Energy Act) is beginning to have a dramatic 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 Southern Company is positioning the business to meet the challenge of this major change in the traditional practice 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. This may enhance the incentive of IPPs to build cogeneration plants for a utility's large industrial and commercial customers and sell excess generation to other utilities. Although the Energy Act does not require transmission access to retail customers, retail wheeling initiatives are rapidly evolving and becoming very prominent issues in several states. In order to address these initiatives, numerous questions must be resolved with the most complex ones relating to transmission pricing and recovery of stranded investments. As the initiatives become a reality, the structure of the utility industry could radically change. Therefore, unless Mississippi Power remains a low-cost producer and provides quality service, the Company's retail energy sales growth could be limited, and this could significantly erode earnings. Conversely, being the low-cost producer could provide significant opportunities to increase market share and profitability.\nMississippi Power is subject to the provisions of Financial Accounting Standards Board Statement No. 71, Accounting for the Effects of Certain Types of Regulation. In the event that a portion of the Company's operations is no longer subject to these provisions, the Company would be required to write off related regulatory assets and liabilities. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities,\" for additional information.\nFINANCIAL CONDITION\nOverview\nThe principal changes in Mississippi Power's financial condition during 1994 were gross property additions to utility plant of $104 million, including the commercial operation of a 75 megawatt capacity combustion turbine unit. Funding for gross property additions and other capital requirements came primarily from capital contributions from The Southern Company, the sale of first mortgage bonds, the issuance of long-term notes payable, 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 1994 by issuing new debt securities and retiring high-cost issues. The Company sold $35 million of first mortgage bonds and issued $85 million in term notes. Retirements, including maturities during 1994, totaled some $42 million of such securities. (See the Statements of Cash Flows for further details.) Composite financing rates for the years 1992 through 1994 as of year-end were as follows:\n=========================================================== 1994 1993 1992 --------------------------- Composite interest rate on long-term debt 6.44% 6.57% 6.91%\nComposite preferred stock dividend rate 6.58% 6.58% 7.29%\n===========================================================\nCapital Structure\nAt year-end 1994, the Company's ratio of common equity to total capitalization was 48.7 percent, compared to 49.8 percent in 1993 and 47.3 percent in 1992. The lower equity ratio in 1994 can be attributed primarily to additional long-term debt.\nCapital Requirements for Construction\nThe Company's projected construction expenditures for the next three years total $223 million ($78 million in 1995, $73 million in 1996, and $72 million in 1997). The major emphasis within the construction program will be on upgrading existing facilities. Also included in the estimates for property additions for\nII-190\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1994 Annual Report\nthe three-year period is $2.9 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 $96 million will be required by the end of 1997 for present sinking fund requirements and maturities of long-term debt. Mississippi Power plans to continue, when economically feasible, 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 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 began 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.\nIn 1995, the Environmental Protection Agency (EPA) began issuing annual sulfur dioxide emission allowances through the allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for issuing 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 Southern Company's sulfur dioxide compliance strategy is designed to take advantage of allowances as a compliance option.\nThe Southern Company expects to achieve Phase I sulfur dioxide compliance at the eight affected plants by switching to low-sulfur coal, which has required some equipment upgrades. This compliance strategy is expected to result in unused emission allowances being banked for later use. Additional construction expenditures were required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment will be installed on all fossil-fired units. Under this Phase I compliance approach, additional construction expenditures are estimated to total approximately $300 million through 1995 for The Southern Company, of which Mississippi Power's portion is approximately $65 million.\nFor Phase II 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, current compliance strategy for The Southern Company could require total construction expenditures of approximately $150 million, of which Mississippi Power's portion is approximately $5 million. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the continuing 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 2 percent in revenue requirements from customers could be necessary to fully recover the Company's cost of compliance for both Phase I and II of Title IV 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\nII-191\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1994 Annual Report\nthe 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 provides 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 EPA is scheduled to submit a report to Congress on the results of this study by November 1995. The report will include 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 issued proposed rules in November 1994 and is required to take final action on this issue in 1996. 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 1995, the EPA may 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. Upon identifying potential sites, the Company conducts studies, when possible, to determine the extent of any required cleanup costs. Should remediation be determined to be probable, reasonable estimates of costs to clean up such sites are developed and recognized in the financial statements. A currently owned site where manufactured gas plant operations were located prior to the Company's ownership is under investigation for potential remediation, but no prediction can presently be made regarding the extent, if any, of contamination or possible cleanup. Results of this investigation are expected to be available in early 1995. If this site were required to be remediated, industry studies show the Company could incur cleanup costs ranging from $1.5 million to $10 million before giving consideration to possible recovery of clean-up costs from other parties. Accordingly, no accrual has been made for remediation in the accompanying 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 Resource Conservation and Recovery Act; the Comprehensive Environmental Response, Compensation, and Liability Act; and the Endangered Species 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-192\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Mississippi Power Company 1994 Annual Report\nSources of Capital\nAt December 31, 1994, the Company had $70 million of committed credit in revolving credit agreements and also had $27 million of committed short-term credit lines. The Company had no short-term notes payable outstanding at year end 1994.\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-193\nSTATEMENTS OF INCOME For the Years Ended December 31, 1994, 1993, and 1992 Mississippi Power Company 1994 Annual Report\nII-194\nSTATEMENTS OF CASH FLOWS For the Years ended December 31, 1994, 1993, and 1992 Mississippi Power Company 1994 Annual Report\nII-195\nBALANCE SHEETS At December 31, 1994 and 1993 Mississippi Power Company 1994 Annual Report\nII-196\nBALANCE SHEETS At December 31, 1994 and 1993 Mississippi Power Company 1994 Annual Report\nII-197\nSTATEMENTS OF CAPITALIZATION At December 31, 1994 and 1993 Mississippi Power Company 1994 Annual Report\nII-198\nSTATEMENTS OF RETAINED EARNINGS For the Years Ended December 31, 1994, 1993, and 1992 Mississippi Power Company 1994 Annual Report\nII-199\nNOTES TO FINANCIAL STATEMENTS Mississippi Power Company 1994 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 Communications Services (Southern Communications), Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear), and The Southern Development and Investment Group (SDIG). 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 Communications, beginning in mid-1995, will provide digital wireless communications services--over the 800-megahertz frequency band--to The Southern Company's subsidiaries and also will market these services to the public within the Southeast. 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. SDIG develops new business opportunities related to energy products and services.\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.\nCertain prior years' data presented in the financial statements have been reclassified to conform with current year presentation.\nRegulatory Assets and Liabilities\nMississippi Power is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. Regulatory assets represent probable future revenues to the Company associated with certain costs that are expected to be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited to customers through the ratemaking process. Regulatory assets and (liabilities) reflected in the Balance Sheets as of December 31 relate to: (in thousands)\n=============================================================== 1994 1993 ------------------------ Deferred income taxes $25,036 $25,267 Vacation pay 4,588 4,797 Work force reduction costs 11,286 - Deferred fuel charges 10,068 17,960 Premium on reacquired debt 9,571 10,563 Property damage reserve (10,905) (10,538) Deferred income tax credits (45,832) (48,228) Other, net (3,383) (3,653) --------------------------------------------------------------- Total $ 429 $(3,832) ===============================================================\nIn the event that a portion of the Company's operations is no longer subject to the provisions of Statement No. 71, the Company would be required to write off the related regulatory assets and liabilities. In addition, the Company would be required to determine any impairment to other assets, including plant, and write down the assets to their fair value.\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 and certain qualifying environmental\nII-200\nNOTES (continued) Mississippi Power Company 1994 Annual Report\ncosts. Revenues are adjusted for differences between actual allowable amounts and the amounts included in rates.\nThe Company has a diversified base of customers. No single customer or industry comprised 10 percent or more of revenues. In 1994, uncollectible accounts continued to average less than 1 percent of revenues.\nDepreciation\nDepreciation of the original cost of depreciable utility plant in service is provided by using composite straight-line rates which approximated 3.2 percent in 1994, 3.1 percent in 1993, and 3.3 percent in 1992. 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.\nEffective 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 8 to the financial statements 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 rates used to capitalize the cost of funds devoted to construction were 6.9 percent in 1994, 6.8 percent in 1993, and 8.2 percent in 1992. AFUDC (net of income taxes), as a percent of net income after dividends on preferred stock, was 3.5 percent in 1994 and 1993 and 2.7 percent in 1992.\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, repairs, 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, must be disclosed. At December 31, 1994, the fair value of long-term debt was $331 million and the carrying amount was $348 million. At December 31, 1993, the fair value of long-term debt was $278 million and the carrying amount was $270 million. The fair value for long-term debt was based on either closing market price or closing price 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.\nII-201\nNOTES (continued) Mississippi Power Company 1994 Annual Report\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 $4.6 million and $4.8 million at December 31, 1994 and 1993, respectively. In 1995, an estimated 78 percent of the 1994 deferred vacation cost will be expensed, and the balance will be charged to construction and other accounts.\nProvision for Property Damage\nMississippi Power is self-insured for the cost of storm, fire and other uninsured casualty damage to its property, including transmission and distribution facilities. As permitted by regulatory authorities, the Company provided for such costs by charges to income of $1.1 million in 1994 and $1.5 million in 1993 and 1992. 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, 1994, the accumulated provision amounted to $10.9 million, the maximum allowed for 1994. Effective January 1995, regulatory treatment by the MPSC allows a maximum accumulated provision of $18 million.\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 trust 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. Qualified trusts are funded to the extent required by the Company's regulatory commissions. Amounts funded are primarily invested in debt and equity securities.\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.\" The cost of postretirement benefits is reflected in rates on a current basis.\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 cost of such benefits recognized by the Company was $3.6 million in 1992.\nFunded Status 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. The funded status of the plans at December 31 was as follows:\nII-202\nNOTES (continued) Mississippi Power Company 1994 Annual Report\n=============================================================== Pension ------------------- 1994 1993 ------------------- (in thousands) Actuarial present value of benefit obligation: Vested benefits $80,603 $73,735 Non-vested benefits 2,966 3,245 -------------------------------------------------------------- Accumulated benefit obligation 83,569 76,980 Additional amounts related to projected salary increases 27,292 24,434 --------------------------------------------------------------- Projected benefit obligation 110,861 101,414 Less: Fair value of plan assets 145,598 154,224 Unrecognized net gain (37,485) (49,239) Unrecognized prior service cost 3,109 3,590 Unrecognized transition asset (6,635) (7,188) --------------------------------------------------------------- Prepaid asset (accrued liability) recognized in the Balance Sheets $(6,274) $ (27) ===============================================================\nPostretirement Medical ------------------------ 1994 1993 ------------------------ (in thousands) Actuarial present value of benefit obligation: Retirees and dependents $18,106 $10,408 Employees eligible to retire 774 3,752 Other employees 19,124 19,389 --------------------------------------------------------------- Accumulated benefit obligation 38,004 33,549\nLess: Fair value of plan assets 6,460 6,271 Unrecognized net loss (gain) 2,301 3,500 Unrecognized transition obligation 15,319 16,540 --------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $13,924 $ 7,238 ===============================================================\nPostretirement Life ---------------------- 1994 1993 ---------------------- (in thousands) Actuarial present value of benefit obligation: Retirees $4,727 $3,315 Other employees 3,727 4,596 ----------------------------------------------------------- Accumulated benefit obligation 8,454 7,911 Less: Fair value of plan assets 148 84 Unrecognized net loss (gain) (550) (632) Unrecognized transition obligation 3,349 3,606 ----------------------------------------------------------- Accrued liability recognized in the Balance Sheets $5,507 $4,853 ===========================================================\nThe weighted average rates assumed in the above actuarial calculations were:\n========================================================== 1994 1993 1992 ---------------------------- Discount 8.0% 7.5% 8.0% Annual salary increase 5.5 5.0 6.0 Long-term return on plan assets 8.5 8.5 8.5 ----------------------------------------------------------\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 10.5 percent for 1994 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 of 1 percent would increase the accumulated medical benefit obligation as of December 31, 1994, by $6.7 million and the aggregate of the service and interest cost components of the net retiree medical cost by $1.1 million.\nII-203\nNOTES (continued) Mississippi Power Company 1994 Annual Report\nComponents of the plans' net cost are shown below:\n================================================================ Pension ------------------------------ 1994 1993 1992 ------------------------------ (in thousands) Benefits earned during the year $ 3,780 $ 3,792 $ 3,595 Interest cost on projected benefit obligation 7,503 7,296 6,886 Actual (return) loss on plan assets 3,244 (20,017) (5,812) Net amortization and deferral (16,048) 8,741 (4,265) ---------------------------------------------------------------- Net pension cost (income) $(1,521) $ (188) $ 404 ================================================================\nOf the above net pension amounts recorded, $(1.1) million in 1994, $(170) thousand in 1993, and $269 thousand in 1992, and were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\nPostretirement Medical --------------------------- 1994 1993 --------------------------- (in thousands) Benefits earned during the year $1,486 $1,149 Interest cost on accumulated benefit obligation 2,666 2,187 Amortization of transition obligation over 20 years 864 871 Actual (return) loss on plan assets 127 (808) Net amortization and deferral (562) 343 ---------------------------------------------------------------- Net postretirement cost $4,581 $3,742 ================================================================\nPostretirement Life --------------------- 1994 1993 --------------------- (in thousands) Benefits earned during the year $ 274 $ 299 Interest cost on accumulated benefit obligation 585 624 Amortization of transition obligation over 20 years 179 180 Actual (return) loss on plan assets 5 (6) Net amortization and deferral (13) - --------------------------------------------------------------- Net postretirement cost $1,030 $1,097 ===============================================================\nOf the above net postretirement medical and life insurance costs recorded, $4.4 million in 1994 and $3.9 million in 1993 was charged to operating expense and the remainder was charged to construction and other accounts.\nWork Force Reduction Programs\nDuring 1994, Mississippi Power and SCS instituted work force reduction programs. The costs of the SCS work force reduction program were apportioned among the various entities that form the Southern electric system, with the Company's portion amounting to $1.4 million. The Company instituted an early retirement incentive program in April 1994 and deferred the related costs of approximately $12.9 million. The Company received authority from the MPSC to defer these costs, as well as its portion of the costs of the SCS program, and to amortize over a period not to exceed 60 months, beginning no later than January 1995. During 1994, the Company expensed $3.0 million of the cost of these programs.\n3. LITIGATION AND REGULATORY MATTERS:\nRetail Rate Adjustment Plans\nMississippi Power's retail base rates are set under a Performance Evaluation Plan (PEP). The current version, PEP-2 was approved by the MPSC in January 1994. PEP-2 was designed with the MPSC objectives that the plan would reduce the impact of rate changes on the customer and provide incentives for Mississippi Power to keep customer prices low. PEP-2 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 indicators that emphasize price and service to the customer. PEP-2 provides for semiannual evaluations of Mississippi's performance-based return on investment. Any change in rates is limited to 2 percent of retail revenues per evaluation period. PEP-2 will remain in effect until the MPSC modifies or terminates the plan. During 1994, there was no increase under PEP-2.\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 has resulted in annual retail rate increases, the latest being a $7.6 million increase effective April 1994. On\nII-204\nNOTES (continued) Mississippi Power Company 1994 Annual Report\nJanuary 31, 1995, the Company filed the ECO Plan with the MPSC requesting an annual retail rate increase of $3.7 million, which included $1.6 million of 1994 carryover.\nMississippi Power conducts studies, when possible, to determine the extent of any required clean-up costs. Should remediation be determined to be probable, reasonable estimates of costs to clean up such sites are developed and recognized in the financial statements. See \"Environmental Matters\" in the Management's Discussion and Analysis for information on a manufactured gas plant site.\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 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 5 under \"Lease Agreements.\" Any changes in the rate of return on common equity that may require refunds as a result of this proceeding would be substantially for the period beginning in July 1991 and ending in October 1992.\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.\nIn August 1994, the FERC instituted another proceeding based on substantially the same issues as in the 1991 proceeding. The second period under review for possible refunds began in October 1994 and is scheduled to continue until January 1996.\nIf the rates of return on common equity recommended by the FERC staff were applied to all of the schedules and contracts involved in both proceedings and refunds were ordered, the amount of refunds could range up to approximately $0.6 million at December 31, 1994. Although the final outcome of this matter cannot now be determined, in management's opinion, the final outcome will not result in changes that would have a material adverse effect on the Company's financial statements.\n4. CONSTRUCTION PROGRAM:\nMississippi Power is engaged in continuous construction programs, the costs of which are currently estimated to total some $78 million in 1995, $73 million in 1996, and $72 million in 1997. These estimates include AFUDC of $1.7 million in 1995, $2.2 million in 1996, and $1.5 million in 1997.\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 generating plants under construction. However, significant construction will continue related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants.\nSee \"Environmental Matters\" in Management's Discussion and Analysis for information on the impact of the Clean Air Act Amendments of 1990 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 \"Sources of Capital\" in Management's Discussion and Analysis for information regarding the Company's coverage requirements.\nAt December 31, 1994, Mississippi Power had unused committed credit agreements with banks for $27 million. Additionally, Mississippi Power had $70 million of unused committed credit agreements in the form of revolving credit\nII-205\nNOTES (continued) Mississippi Power Company 1994 Annual Report\nagreements expiring at various dates during 1995 and in 1997. The agreements expiring December 31, 1997, for $40 million 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. The Company had no short-term borrowings outstanding at year-end 1994.\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.\nLease Agreements\nIn 1984, Mississippi Power and Gulf States Utilities Company (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. For the three years ended 1994 use fees collected under this agreement, net of related expenses, amounted to $3.9 million each year, and are included with other income, net, in the Statements of Income. For other information see Note 3 under \"FERC Reviews Equity Returns.\"\nIn 1989, Mississippi Power entered into a twenty-two year lease agreement for the use of 495 aluminum railcars. In 1994, a second lease agreement for the use of 250 additional aluminum railcars was also entered into for twenty-two years. Both of these leases, totaling 745 railcars, were for the transport of coal at Plant Daniel. Gulf Power, as joint owner of Plant Daniel, is responsible for one half of the lease cost. The Company's share (50%) of the leases is charged to fuel inventory and allocated to fuel expense as the fuel is consumed. The lease cost charged to inventory was $1.2 million in each of the past three years. For the year 1995, the Company's annual lease payment will be $2.6 million, of which $1.2 million was charged to inventory in 1994. Lease payments will be approximately $1.7 million per year for the years 1996 through 1999. Lease payments after 1999 total approximately $26.1 million. The Company has the option to purchase the 745 railcars at the greater of the termination value or the fair market value, or to renew the leases at the end of the lease term.\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 $393 million at December 31, 1994. 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 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 totaled $10.1 million at December 31, 1994.\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, 1994, Mississippi Power's percentage ownership and investment in these jointly owned facilities were as follows:\n========================================================================== Company's Generating Total Percent Gross Accumulated Plant Capacity Ownership Investment Depreciation ---------- --------- --------- ----------- ------------- (Megawatts) (in thousands) Greene County 500 40% $ 57,567 $29,742\nDaniel 1,000 50% 219,870 90,908 --------------------------------------------------------------------------\nII-206\nNOTES (continued) Mississippi Power Company 1994 Annual Report\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. The agreements for non-firm capacity expired in 1994. 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 1989. However, the Company continues to participate in transmission and energy sales under the unit power sales agreements. 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:\n============================================================ Other Year Unit Power Long-Term Total ------------------------------------------------------------ (in thousands) 1994 $ 660 $1,305 $1,965 1993 1,571 2,620 4,191 1992 2,168 1,405 3,573 ------------------------------------------------------------\nIn 1994, long-term non-firm power of 200 megawatts was sold by the Southern electric system to Florida Power Corporation until the contract expired at year-end.\n8. INCOME TAXES:\nEffective January 1, 1993, Mississippi Power adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption resulted in the recording of additional deferred income taxes and related regulatory assets and liabilities. At December 31, 1994, the tax-related regulatory assets to be recovered from customers were $25 million. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. At December 31, 1994, the tax-related regulatory liabilities to be refunded to customers were $46 million. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and unamortized investment tax credits.\nDetails of the federal and state income tax provisions are shown below:\n================================================================== 1994 1993 1992 ------------------------------ (in thousands) Total provision for income taxes Federal -- Currently payable $26,072 $15,842 $20,286 Deferred --current year 6,313 5,158 (1,578) --reversal of prior years (5,161) (820) (3,931) ------------------------------------------------------------------ 27,224 20,180 14,777 ------------------------------------------------------------------ State -- Currently payable 3,978 2,945 2,992 Deferred --current 1,669 1,339 218 --reversal of prior years (1,258) (638) (182) ------------------------------------------------------------------ 4,389 3,646 3,028 ------------------------------------------------------------------ Total 31,613 23,826 17,805 Less income taxes charged to other income 227 1,158 1,427 ------------------------------------------------------------------ Federal and state income taxes charged to operations $31,386 $22,668 $16,378 ==================================================================\nThe tax effects of temporary differences between the carrying amounts of assets and liabilities in the financial statements and their respective tax\nII-207\nNOTES (continued) Mississippi Power Company 1994 Annual Report\nbases, which give rise to deferred tax assets and liabilities are as follows:\n=============================================================== 1994 1993 ------------------------- (in thousands) Deferred tax liabilities: Accelerated depreciation $138,281 $130,299 Basis differences 11,645 11,332 Coal contract buyouts 3,851 6,870 Other 17,908 18,719 --------------------------------------------------------------- Total 171,685 167,220 --------------------------------------------------------------- Deferred tax assets: Other property basis differences 27,375 28,779 Pension and other benefits 5,386 4,625 Property insurance 4,171 4,031 Unbilled fuel 3,649 4,205 Other 7,009 5,562 -------------------------------------------------------------- Total 47,590 47,202 -------------------------------------------------------------- Net deferred tax liabilities 124,095 120,018 Portion included in current assets, net 5,410 4,316 -------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $129,505 $124,334 ==============================================================\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. This tax rate differential has been 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 both 1994 and 1993 and $1.4 million in 1992. At December 31, 1994, 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:\n============================================================= 1994 1993 1992 ---------------------------- Total effective tax rate 37% 33% 30% State income tax, net of federal income tax benefit (3)% (3) (3) Tax rate differential 1 4 6 Other - 1 1 ------------------------------------------------------------- Statutory federal tax rate 35% 35% 34% =============================================================\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.\n9. OTHER LONG-TERM DEBT:\nDetails of other long-term debt are as follows:\n==============================================================\nDecember 31, 1994 1993 ------------------- (in thousands) Obligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds: 5.80% due 2007 $ 980 $ 990 Variable rate due 2020 6,550 6,550 Variable rate due 2022 16,750 16,750 6.20% due 2023 13,000 13,000 5.65% due 2023 25,875 25,875 -------------------------------------------------------------- 63,155 63,165 -------------------------------------------------------------- Notes payable: 8.25% due 1994-1995 - 17,520 7.50% due 1994-1995 1,689 2,158 5.39% to 5.72% due 1995 9,000 - 4.15% to 5.89% due 1995-1996 50,000 - 6.0375% due 1996 35,000 - -------------------------------------------------------------- 95,689 19,678 -------------------------------------------------------------- Total $158,844 $82,843 ==============================================================\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\nII-208\nNOTES (continued) Mississippi Power Company 1994 Annual Report\nmortgage 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 annually in 1998 and 1999.\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:\n=============================================================== 1994 1993 ------------------- (in thousands) Bond improvement fund requirements $ 1,931 $ 1,902\nLess: Portion to be satisfied by certifying property additions 1,431 1,402 --------------------------------------------------------------- Cash improvement fund requirements 500 500 First mortgage bond maturities and redemptions - 10,000 Pollution control bond cash sinking fund requirements (Note 9) 10 10 Current portion of notes payable (Note 9) 40,689 8,835 --------------------------------------------------------------- Total $41,199 $19,345 ===============================================================\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.\n11. COMMON STOCK DIVIDEND RESTRICTIONS:\nMississippi Power's first mortgage bond indenture and the corporate charter contain various common stock dividend restrictions. At December 31, 1994, $94 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 corporate charter.\n12. QUARTERLY FINANCIAL DATA (UNAUDITED):\nSummarized quarterly financial data for 1994 and 1993 are as follows:\n=================================================================== Net Income After Dividends Quarter Operating Operating On Ended Revenues Income Preferred Stock ------- ------------------------------------------------\nMarch 1994 $114,134 $12,910 $ 8,266 June 1994 131,792 19,891 13,744 September 1994 142,340 26,212 21,357 December 1994 110,896 14,062 5,790\nMarch 1993 $101,552 $ 9,529 $ 4,424 June 1993 117,764 18,147 11,852 September 1993 148,102 22,377 16,560 December 1993 107,465 13,333 9,600\nMississippi Power's business is influenced by seasonal weather conditions and the timing of rate changes.\nII-209\nSELECTED FINANCIAL AND OPERATING DATA Mississippi Power Company 1994 Annual Report\nII-210\nSELECTED FINANCIAL AND OPERATING DATA (continued) Mississippi Power Company 1994 Annual Report\nII-211A\nSELECTED FINANCIAL AND OPERATING DATA (continued) Mississippi Power Company 1994 Annual Report\nII-211B\nSELECTED FINANCIAL AND OPERATING DATA (continued) Mississippi Power Company 1994 Annual Report\nII-211C\nSELECTED FINANCIAL AND OPERATING DATA (continued) Mississippi Power Company 1994 Annual Report\nII-212\nSELECTED FINANCIAL AND OPERATING DATA (continued) Mississippi Power Company 1994 Annual Report\nII-213A\nSELECTED FINANCIAL AND OPERATING DATA (continued) Mississippi Power Company 1994 Annual Report\nII-213B\nSELECTED FINANCIAL AND OPERATING DATA (continued) Mississippi Power Company 1994 Annual Report\nII-213C\nSTATEMENTS OF INCOME Mississippi Power Company\nII-214\nSTATEMENTS OF INCOME Mississippi Power Company\nII-215A\nSTATEMENTS OF INCOME Mississippi Power Company\nII-215B\nSTATEMENTS OF CASH FLOWS Mississippi Power Company\nII-216\nSTATEMENTS OF CASH FLOWS Mississippi Power Company\nII-217A\nSTATEMENTS OF CASH FLOWS Mississippi Power Company\nII-217B\nBALANCE SHEETS Mississippi Power Company\nII-218\nBALANCE SHEETS Mississippi Power Company\nII-219A\nBALANCE SHEETS Mississippi Power Company\nII-219B\nBALANCE SHEETS Mississippi Power Company\nII-220\nBALANCE SHEETS Mississippi Power Company\nII-221A\nBALANCE SHEETS Mississippi Power Company\nII-221B\nMISSISSIPPI POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1994\nFirst Mortgage Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity ---------------------------------------------------------------- (Thousands) (Thousands) 1993 $ 35,000 5-3\/8% $ 35,000 3\/1\/98 1992 40,000 6-5\/8% 40,000 8\/1\/00 1994 35,000 6.60% 35,000 3\/1\/04 1991 50,000 9-1\/4% 47,072 5\/1\/21 1993 35,000 7.45% 35,000 6\/1\/23 -------- -------- $195,000 $192,072 ======== ========\nPollution Control Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity ---------------------------------------------------------------- (Thousands) (Thousands) 1977 $ 1,000 5.80% $ 980 10\/1\/07 1992 6,550 Variable 6,550 12\/1\/20 1992 16,750 Variable 16,750 12\/1\/22 1993 13,000 6.20% 13,000 4\/1\/23 1993 25,875 5.65% 25,875 11\/1\/23 -------- -------- $ 63,175 $ 63,155 ======== ========\nPreferred Stock\nShares Dividend Amount Series Outstanding Rate Outstanding ---------------------------------------------------------------- (Thousands) 1947 20,099 4.60% $ 2,010 1956 40,000 4.40% 4,000 1965 50,000 4.72% 5,000 1968 50,000 7.00% 5,000 1992 350,000 7.25% 35,000 1993 150,000 6.32% 15,000 1993 84,040 6.65% 8,404 ------- -------- 744,139 $ 74,414 ======= ========\nII-222\nMISSISSIPPI POWER COMPANY\nSECURITIES RETIRED DURING 1994\nFirst Mortgage Bonds\nPrincipal Interest Series Amount Rate ----------------------------------------------------------------------------- (Thousands) 1964 $10,000 4-5\/8% 1965 11,000 4-3\/4% 1966 10,000 6% 1991 1,628 9-1\/4% ------- $32,628 =======\nPollution Control Bonds\nPrincipal Interest Series Amount Rate ----------------------------------------------------------------------------- (Thousands) 1977 $ 10 5.80%\nII-223\nSAVANNAH ELECTRIC AND POWER COMPANY\nFINANCIAL SECTION\nII-224\nMANAGEMENT'S REPORT Savannah Electric and Power Company 1994 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. Arthur M. Gignilliat, Jr. President and Chief Executive Officer\n\/s\/ K. R. Willis K. R. Willis Vice-President Treasurer and Chief Financial Officer\nII-225\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS Savannah Electric and Power Company 1994 Annual Report\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 and a wholly owned subsidiary of The Southern Company) as of December 31, 1994 and 1993, 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, 1994. 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-233 through II-246) referred to above present fairly, in all material respects, the financial position of Savannah Electric and Power Company as of December 31, 1994 and 1993, 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 LLP\nAtlanta, Georgia February 15, 1995\nII-226\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Savannah Electric and Power Company 1994 Annual Report\nRESULTS OF OPERATIONS\nEarnings\nSavannah Electric and Power Company's net income after dividends on preferred stock for 1994 totaled $22.1 million, representing a $0.6 million (3.0 percent) increase over the prior year. This increase was primarily due to a decrease in operating expenses, offset somewhat by an increase in interest expense.\nIn 1993, earnings were $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.\nRevenues\nTotal revenues for 1994 were $211.8 million, reflecting a 3.0 percent decrease compared to 1993. The revenue impact of an expanding customer base was offset by moderate weather, reduced industrial energy sales, and an associated decrease in fuel cost recovery revenues.\nThe following table summarizes revenue increases and decreases compared to prior years:\n============================================================== Increase (Decrease) From Prior Years -------------------------------- 1994 1993 1992 -------------------------------- Retail -- (in thousands) Change in base rates $ - $(1,450) $(1,350) Sales growth 7,884 5,980 5,467 Weather (6,589) 4,567 (3,116) Fuel cost recovery and other (9,214) 12,404 7,270 -------------------------------------------------------------- Total retail (7,919) 21,501 8,271 -------------------------------------------------------------- Sales for resale-- Non-affiliates (1,235) (1,800) 8 Affiliates 4,013 928 75 -------------------------------------------------------------- Total sales for resale 2,778 (872) 83 -------------------------------------------------------------- Other operating revenues (1,516) 52 (239) -------------------------------------------------------------- Total operating revenues $(6,657) $20,681 $ 8,115 ============================================================== Percent change (3.0)% 10.5% 4.3% --------------------------------------------------------------\nRetail revenues decreased 3.8 percent in 1994, compared to an increase of 11.5 percent in 1993. The decrease in 1994 retail revenues is attributable to milder summer weather, reduced industrial energy sales, and substantially lower fuel cost recovery revenues, offset somewhat by customer growth. Industrial energ y sales turned down in the fourth quarter of 1994 when operations of a large industrial customer were temporarily curtailed due to a mechanical failure of a machine which was a major part of the customer's manufacturing operation. Under the Company's fuel cost recovery provisions, fuel revenues --including purchased energy-- generally equal fuel expense and have no effect on earnings. The $1.5 million decrease in other operating revenues reflects deferral of over recovery of demand-side management rider revenues during 1994. Revenues from demand-side management riders (included in retail revenues) recover demand-side management program costs and have little impact on earnings.\nThe increase in 1993 retail revenues resulted from customer growth and an increase in the average annual kilowatt-hour use per customer which was substantially increased due to hot summer weather.\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. Capacity and energy revenues decreased in 1994 due to reductions in sales to Florida Power Corporation. The capacity and energy components were as follows:\n========================================================\n1994 1993 1992 -------------------------------------------------------- (in thousands) Capacity $ 448 $ 978 $ 537 Energy 3,052 4,262 7,040 -------------------------------------------------------- Total $3,500 $5,240 $7,577 ========================================================\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.\nII-227\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1994 Annual Report\nKilowatt-hour sales for 1994 and the percent change by year were as follows:\n=============================================================== Percent Change ------------------------- KWH 1994 1993 1992 ---------- ------------------------ (in millions) Residential 1,298 (2.3)% 9.2% 1.8% Commercial 1,046 2.9 6.5 3.0 Industrial 800 (6.4) (0.8) 4.3 Other 119 3.1 5.2 3.4 ------ Total retail 3,263 (1.6) 5.5 2.9 Sales for resale - Non-affiliates 202 (18.4) (32.7) (1.3) Affiliates 93 23.4 100.3 15.5 ------ Total 3,558 (2.2)% 2.6% 2.6% ====== ===============================================================\nExpenses\nTotal operating expenses for 1994 were $175.6 million, reflecting an $8.6 million decrease from 1993. This decrease includes a $5.8 million reduction in fuel and purchased power expenses, reflecting a decrease in total energy requirements. The $4.9 million reduction in 1994 in other operation and maintenance expenses reflects the $4.5 million work force reduction charge in 1993 and a $1.1 million reduction in power generation expenses in 1994. This was offset by an increase in depreciation expense because of additions to utility plant, principally two combustion turbine units. Interest expense increased $1.9 million primarily due to the sale in June 1993 of $45 million of first mortgage bonds.\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 summer weather and the higher cost of fuel. The increase in other operation expenses reflects $4.5 million associated with the work force reduction program. The Company also recognized higher employee benefit costs under new accounting rules adopted in 1993. See Note 2 to the financial statements for additional information on these new rules.\nFuel and purchased power costs constitute the single largest expense for the Company. The 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, the average cost of fuel per net kilowatt-hour generated, and the total average cost of energy supply (including purchased power) were as follows:\n=============================================================== 1994 1993 1992 ----------------------- Total energy supply (millions of kilowatt-hours) 3,768 3,863 3,764 Sources of energy supply (percent) Coal 18 21 12 Oil 1 2 1 Gas 1 3 2 Purchased Power 80 74 85 Average cost of fuel per net kilowatt-hour generated (cents) Coal 2.19 2.02 2.28 Oil 3.89 4.11 2.40 Gas 5.19 4.87 4.28 Total average cost of energy supply 2.02 2.12 1.78\n===============================================================\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.\nII-228\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1994 Annual Report\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 a less regulated, more competitive environment.\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) is beginning to have a dramatic 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 posturing the business to meet the challenge of this major change in the traditional practice of selling electricity. 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, retail wheeling initiatives are rapidly evolving and becoming very prominent issues in several states. In order to address these initiatives, numerous questions must be resolved with the most complex ones relating to transmission pricing and recovery of stranded investments. As the initiatives become a reality, the structure of the utility industry could radically change. Therefore, unless the Company remains a low-cost producer and provides quality service, the Company's retail energy sales growth could be limited, and this could significantly erode earnings. Conversely, being the low-cost producer could provide significant opportunities to increase market share and profitability.\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. Besides promoting energy efficiency, another benefit of these programs could be the ability to defer the need to construct costly baseload generating facilities further into the future. The ability to defer major construction projects in conjunction with regulatory precertification approval processes for both new plant additions and purchase power contracts should minimize the possibility of not being able to fully recover additional costs.\nThe Company is subject to the provisions of Financial Accounting Standards Board (FASB) Statement No. 71, Accounting for the Effects of Certain Types of Regulation. In the event that a portion of the Company's operations is no longer subject to these provisions, the Company would be required to write off related regulatory assets and liabilities. See Note 1 to the financial statements under \"Regulatory Assets and Liabilities\" 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.\"\nRates to retail customers served by the Company are regulated by the Georgia Public Service Commission (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 included 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.\nFINANCIAL CONDITION\nOverview\nThe principal change in the Company's financial condition in 1994 was the addition of $30 million to utility plant. The majority of funds needed for gross property additions since 1992 have been provided from operating activities,\nII-229\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1994 Annual Report\nprincipally 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, 1994, the Company's capital structure consisted of 45.8 percent common equity, 9.9 percent preferred stock and 44.3 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 $5 million in 1994, $4 million in 1993 and $53 million in 1992.\nThe composite interest rates and dividend rates for the years 1992 through 1994 as of year-end were as follows:\n=================================================================== 1994 1993 1992 ----------------------------- Composite interest rates on long-term debt 8.0% 8.0% 8.5% Composite preferred stock dividend rate 6.6% 6.6% 9.5% ===================================================================\nThe Company's current securities ratings are as follows:\n=================================================================== Standard Moody's & Poor's ------------------------ First Mortgage Bonds A1 A Preferred Stock \"a2\" A- -- -- ===================================================================\nCapital Requirements for Construction\nThe Company's projected construction expenditures for the next three years total $87 million ($34 million in 1995, $27 million in 1996, and $26 million in 1997). 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. In addition, there can be no assurance that costs related to capital expenditures will be fully recovered.\nOther Capital Requirements\nIn addition to the funds needed for the construction program, approximately $2.9 million will be needed by the end of 1997 for present sinking fund requirements and a capital lease buyout.\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 --may 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 began 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.\nIn 1995, the Environmental Protection Agency (EPA) began issuing annual sulfur dioxide emission allowances through the allowance trading program. An emission allowance is the authority to emit one ton of sulfur dioxide during a calendar year. The method for issuing 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 Southern Company's sulfur dioxide compliance strategy is designed to use allowances as a compliance option.\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\nII-230\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1994 Annual Report\nconstruction expenditures are required to install equipment for the control of nitrogen oxide emissions at these eight plants. Also, continuous emissions monitoring equipment has been installed on all fossil-fired units. Construction expenditures for Phase I compliance are estimated to total approximately $300 million through 1995 for The Southern Company, of which the Company's portion is approximately $2 million.\nFor Phase II 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, current compliance strategy could require total estimated construction expenditures of approximately $150 million. No construction expenditures are expected to be required of the Company to comply with Phase II requirements. However, the full impact of Phase II compliance cannot now be determined with certainty, pending the continuing 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 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.\nTitle III of the Clean Air Act requires a multi-year EPA study of power plant emissions of hazardous air pollutants. The EPA is scheduled to submit a report to Congress on the results of this study by November 1995. The report will include 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.\nA significant portion of costs related to the acid rain provision of the Clean Air Act is expected to be recovered through existing ratemaking provisions. However, there can be no assurance that all Clean Air Act costs will be recovered.\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 issued proposed rules in November 1994 and is required to take final action on this issue in 1996. 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 1995, the EPA may 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\nII-231\nMANAGEMENT'S DISCUSSION AND ANALYSIS (continued) Savannah Electric and Power Company 1994 Annual Report\nregulations, the Company could incur substantial costs to clean up properties currently or previously owned. The Company conducts studies to determine the extent of any required cleanup costs and will recognize in the financial statements any costs to clean up known sites.\nSeveral major pieces of environmental legislation are being considered for reauthorization or amendment by Congress. These include: the Clean Water Act; the Comprehensive Environmental Response, Compensation, and Liability Act; the Resource Conservation and Recovery Act; and the Endangered Species 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 exists for liability as the result of lawsuits alleging damages caused by electromagnetic fields.\nSources of Capital\nAt December 31, 1994, the Company had $1.6 million of cash and $18 million of unused credit arrangements with banks to meet its short-term cash needs. The Company had $2.5 million of short-term bank borrowings at December 31, 1994. In December 1994, the Company renegotiated a two-year revolving credit arrangement with three of its existing 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 construction program.\nIt is anticipated that the funds required for construction and other purposes, including compliance with environmental regulations, will also 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-232\nSTATEMENTS OF INCOME For the Years Ended December 31, 1994, 1993, and 1992 Savannah Electric and Power Company 1994 Annual Report\nII-233\nSTATEMENTS OF CASH FLOWS For the Years Ended December 31, 1994, 1993, and 1992 Savannah Electric and Power Company 1994 Annual Report\nII-234\nBALANCE SHEETS At December 31, 1994 and 1993 Savannah Electric and Power Company 1994 Annual Report\nII-235\nBALANCE SHEETS At December 31, 1994 and 1993 Savannah Electric and Power Company 1994 Annual Report\nII-237\nSTATEMENTS OF RETAINED EARNINGS For the Years Ended December 31, 1994, 1993, and 1992 Savannah Electric and Power Company 1994 Annual Report\nII-238\nNOTES TO FINANCIAL STATEMENTS Savannah Electric and Power Company 1994 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 Communications Services (Southern Communications), Southern Electric International (Southern Electric), Southern Nuclear Operating Company (Southern Nuclear), and The Southern Development and Investment Group (SDIG). 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 subsidiary companies. Southern Communications, beginning in mid-1995, will provide digital wireless communications services -- over the 800-megahertz frequency band -- to The Southern Company's subsidiaries and also will market these services to the public within the Southeast. 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. SDIG develops new business opportunities related to energy products and services.\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.\nRegulatory Assets and Liabilities\nThe Company is subject to the provisions of FASB Statement No. 71, Accounting for the Effects of Certain Types of Regulation. Regulatory assets represent probable future revenues to the Company associated with certain costs that are expected to be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future reductions in revenues associated with amounts that are to be credited to customers through the ratemaking process. Regulatory assets and (liabilities) reflected in the Balance Sheets at December 31 relate to:\n=============================================================== 1994 1993 -------------------- (in thousands) Deferred income taxes $23,521 $24,890 Premium on reacquired debt 3,295 3,792 Deferred income tax credits (25,487) (26,173) --------------------------------------------------------------- Total $ 1,329 $ 2,509 ===============================================================\nIn the event that a portion of the Company's operations is no longer subject to the provisions of Statement No. 71, the Company would be required to write off related regulatory assets and liabilities. In addition, the Company would be required to determine any impairment to other assets, including plant, and write down the assets to their fair value.\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 the fuel is used. The Company's electric rates include provisions to adjust billings for fluctuations in fuel and purchased power costs. Revenues are adjusted for differences between recoverable fuel and demand-side management program costs and amounts actually recovered in current rates.\nThe Company has a diversified base of customers. No single customer or industry comprises 10 percent or more of revenues. In 1994, uncollectible accounts continued to average less than 1 percent of revenues.\nII-239\nNOTES (continued) Savannah Electric and Power Company 1994 Annual Report\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 1994, 2.9 percent in 1993, and 3.2 percent in 1992. The decrease in rates following 1992 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.\nEffective 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.\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 8.04 percent in 1994, 8.77 percent in 1993, and 11.27 percent in 1992.\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, the Company's only financial instrument that the carrying amount did not approximate fair value at December 31 was as follows:\n================================================================ Long-Term Debt ----------------------- Carrying Fair Year Amount Value ---- ----------------------- (in millions) 1994 $157 $153 1993 154 164 ================================================================\nThe 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.\nII-240\nNOTES (continued) Savannah Electric and Power Company 1994 Annual Report\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 \"projected unit credit\" actuarial method for funding purposes, subject to limitations under federal income tax regulations. Amounts funded to the pension trust 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 is funded to the extent deductible under federal income tax regulations. Amounts funded are primarily invested in debt and equity securities.\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.\" The cost of postretirement benefits is reflected in rates on a current basis.\nPrior to 1993, consistent with regulatory treatment, the Company recognized costs on a cash basis as payments were made. The total cost of such benefits recognized by the Company in 1992 was $375 thousand.\nFunded Status 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. The funded status of the plans at December 31 was as follows:\n================================================================== Pension ------------------- 1994 1993 ------------------- (in thousands) Actuarial present value of benefit obligation: Vested benefits $35,227 $35,818 Non-vested benefits 2,069 1,992 ------------------------------------------------------------------ Accumulated benefit obligation 37,296 37,810 Additional amounts related to projected salary increases 7,393 5,974 ------------------------------------------------------------------ Projected benefit obligation 44,689 43,784 Less: Fair value of plan assets 27,165 26,446 Unrecognized net loss 10,950 9,449 Unrecognized prior service cost 1,510 1,685 Unrecognized net transition obligation 621 710 Adjustment required to recognize additional minimum liability 5,688 5,871 ------------------------------------------------------------------ Accrued pension cost recognized in the Balance Sheets $10,131 $11,365\n===================================================================\nThe weighted average rates assumed in the actuarial calculations for the pension plan were:\n================================================================== 1994 1993 1992 ------------------------------ Discount 8.00% 7.50% 8.00% Annual salary increase 5.25 4.75 5.00 Long-term return on plan assets 9.00 9.25 9.25\n===================================================================\nIn accordance with Statement No. 87, an additional liability related to under-funded accumulated benefit obligations was reflected at December 31, 1994 and December 31, 1993. Corresponding net-of-tax balances of $0.5 million and $2.1 million were recognized as separate components of Common Stock Equity in the 1994 and 1993 Statements of Capitalization.\nII-241\nNOTES (continued) Savannah Electric and Power Company 1994 Annual Report\n================================================================\nPostretirement Medical --------------------- 1994 1993 --------------------- (in thousands) Actuarial present value of benefit obligation: Retirees and dependents $ 8,480 $ 8,632 Employees eligible to retire 825 898 Other employees 6,840 6,489 ----------------------------------------------------------------- Accumulated benefit obligation 16,145 16,019 Less: Fair value of plan assets 393 - Unrecognized net loss 3,106 4,124 Unrecognized transition obligation 9,817 10,362 ----------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 2,829 $ 1,533 =================================================================\nPostretirement Life ---------------------- 1994 1993 ---------------------- (in thousands) Actuarial present value of benefit obligation: Retirees and dependents $2,514 $2,536 Employees eligible to retire 59 - Other employees 1,645 1,577 ------------------------------------------------------------------- Accumulated benefit obligation 4,218 4,113 Less: Fair value of plan assets - - Unrecognized net loss 91 262 Unrecognized transition obligation 3,204 3,382 ------------------------------------------------------------------- Accrued liability recognized in the Balance Sheets $ 923 $ 469 ===================================================================\nThe weighted average rates assumed in the actuarial calculations for the postretirement medical and life plans were:\n======================================================= 1994 1993 ------------------ Discount 8.00% 7.50% Annual salary increase 5.50 5.00 Long-term return on plan assets 8.50 8.50\n=======================================================\nAn additional assumption used in measuring the accumulated postretirement medical benefit obligation was a weighted average medical care cost trend rate of 10.5 percent for 1994, 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 of 1 percent would increase the accumulated medical benefit obligation at December 31, 1994, by $2.3 million and the aggregate of the service and interest cost components of the net retiree medical cost by $0.3 million.\nComponents of the plans' net costs are shown below:\n=================================================================== Pension --------------------------- 1994 1993 1992 --------------------------- (in thousands) Benefits earned during the year $ 1,192 $1,188 $1,053 Interest cost on projected benefit obligation 3,279 2,741 2,429 Actual (return) loss on plan assets 27 (2,199) (1,266) Net amortization and deferral (1,474) 716 (227) ------------------------------------------------------------------- Net pension cost $ 3,024 $2,446 $1,989 ===================================================================\nOf the above net pension amounts, $2.6 million in 1994, $2.0 million in 1993 and $1.7 million in 1992 were recorded in operating expenses, and the remainder was recorded in construction and other accounts.\n================================================================ Postretirement Medical ------------------ 1994 1993 ------------------ (in thousands) Benefits earned during the year $ 528 346 Interest cost on accumulated benefit obligation 1,185 855 Amortization of transition obligation 545 545 Actual (return) loss on plan assets 6 - Net amortization and deferral 111 - ---------------------------------------------------------------- Net postretirement cost $2,375 $1,746 ================================================================\n==================================================================\nPostretirement Life ---------------------- 1994 1993 ---------------------- (in thousands) Benefits earned during the year $104 $ 97 Interest cost on accumulated benefit obligation 307 279 Amortization of transition obligation 178 178 ------------------------------------------------------------------ Net postretirement cost $589 $554 ==================================================================\nII-242\nNOTES (continued) Savannah Electric and Power Company 1994 Annual Report\nOf the above net postretirement medical and life insurance costs, $2.4 million in 1994 and $1.8 million in 1993 were charged to operating expenses, and the remainder was recorded in construction and other accounts.\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 1994, 1993 and 1992 were $377 thousand, $980 thousand and $316 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\nIn 1993, the Company 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\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 $34 million in 1995, $27 million in 1996 and $26 million in 1997. The estimates include AFUDC of $0.7 million in 1995 and 1996, and $0.6 million in 1997. 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 changes in cost of capital. The construction of two combustion turbine peaking units totaling 160 megawatts was completed during 1994. In addition, construction will continue related to transmission and distribution facilities and the upgrading and extension of the useful lives of generating plants.\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 1995, unused credit arrangements with five banks totaled $18 million and expire at various times during 1995 and 1996.\nThe Company's revolving credit arrangements of $20 million, of which $11.5 million remained unused as of December 31, 1994, expire in December 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\nII-243\nNOTES (continued) Savannah Electric and Power Company 1994 Annual Report\nthe first calendar quarter after the applicable termination date or at an earlier date at the Company's option.\nIn connection with these credit arrangements, the Company agrees to pay commitment fees based on the unused portions of the commitments.\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 for 1994, 1993, and 1992. At December 31, 1994, estimated future minimum lease payments for non-cancelable operating leases were as follows:\n======================================================== Amounts --------- (in millions) 1995 $1.1 1996 0.9 1997 0.7 1998 0.5\n========================================================\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. The agreements for non-firm capacity expired in 1994. Other agreements--expiring at various dates discussed below-- are firm and pertain to capacity related to specific generating units. Because 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:\n================================================================= Unit Other Year Power Long-Term Total ---- ----------------------------------- (in thousands) 1994 $3 $445 $448 1993 2 976 978 1992 3 534 537\n=================================================================\n7. INCOME TAXES\nEffective January 1, 1993, the Company adopted FASB Statement No. 109, Accounting for Income Taxes. The adoption resulted in the recording of additional deferred income taxes and related regulatory assets and liabilities. At December 31, 1994, the tax-related regulatory assets and liabilities were $24 million and $25 million, respectively. These assets are attributable to tax benefits flowed through to customers in prior years and to taxes applicable to capitalized AFUDC. These liabilities are attributable to deferred taxes previously recognized at rates higher than current enacted tax law and to unamortized investment tax credits.\nDetails of the federal and state income tax provisions are as follows:\n=============================================================== 1994 1993 1992 ---------------------------- (in thousands) Total provision for income taxes Federal -- Currently payable $11,736 $11,663 $ 6,630 Deferred - current year 2,106 1,906 7,407 - reversal of prior years (755) (1,383) (2,347) --------------------------------------------------------------- 13,087 12,186 11,690 --------------------------------------------------------------- State -- Currently payable 2,064 2,049 1,231 Deferred - current year 188 119 1,079 - reversal of prior years 86 (35) (192) --------------------------------------------------------------- 2,338 2,133 2,118 --------------------------------------------------------------- Total 15,425 14,319 13,808 Less income taxes charged (credited) to other income (864) (1,117) (758) --------------------------------------------------------------- Federal and state income taxes charged to operations $16,289 $15,436 $14,566 ===============================================================\nII-244\nNOTES (continued) Savannah Electric and Power Company 1994 Annual Report\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:\n================================================================ 1994 1993 ----------------- (in thousands) Deferred tax liabilities: Accelerated depreciation $57,830 $53,585 Property basis differences 12,956 13,871 Other 2,449 3,922 ---------------------------------------------------------------- Total 73,235 71,378 --------------------------------------------------------------- Deferred tax assets: Pension and other benefits 4,816 4,237 Other 3,959 4,616 ---------------------------------------------------------------- Total 8,775 8,853 ---------------------------------------------------------------- Net deferred tax liabilities 64,460 62,525 Portions included in current assets, net 6,326 4,422 ---------------------------------------------------------------- Accumulated deferred income taxes in the Balance Sheets $70,786 $66,947 ================================================================\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 1994, 1993, and 1992. At December 31, 1994, 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:\n=============================================================== 1994 1993 1992 ----------------------------- Statutory federal tax rate 35% 35% 34% State income tax, net of federal income tax benefit 4 4 4 Other - (1) - --------------------------------------------------------------- Total effective tax rate 39% 38% 38% ===============================================================\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. CUMULATIVE PREFERRED STOCK\nIn 1993, the Company issued 1,400,000 shares of 6.64% Series Preferred Stock which has redemption provisions of $26.66 per share plus accrued dividends if on or prior to November 1, 1998, and redemption provisions of $25 per share plus accrued dividends thereafter.\nIn December 1993, the Company redeemed all 800,000 shares outstanding of its 9.5% 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.\nIn April 1994, the Company retired the remaining outstanding principal amount of $3.7 million of its 4 5\/8 percent series First Mortgage Bonds due April 1994.\nThe sinking fund requirements of first mortgage bonds were satisfied by certification of property additions in 1993 and by cash redemption in 1994. See Note 10 \"Long-Term Debt Due Within One Year\" for details.\nDetails of pollution control obligations and other long-term debt at December 31 are as follows:\n================================================================= 1994 1993 ------------------ (in thousands) Collateralized obligations incurred in connection with the sale by public authorities of tax-exempt pollution control revenue bonds -- Variable rate (5.65% at 1\/1\/95) due 2016 $ 4,085 $ 4,085 6 3\/4% due 2022 13,870 13,870 ----------------------------------------------------------------- Total pollution control obligations $17,955 $17,955 ----------------------------------------------------------------- Capital lease obligations -- Combustion turbine equipment $ 980 $ 1,403 Transportation fleet 508 908 Notes Payable: 6.04% due 1995 3,500 - 6.035% due 1995 5,000 - ----------------------------------------------------------------- Total other long-term debt $ 9,988 $ 2,311 =================================================================\nII-245\nNOTES (continued) Savannah Electric and Power Company 1994 Annual Report\nSinking fund requirements and\/or maturities through 1999 applicable to long-term debt are as follows: $2.6 million in 1995; $0.2 million in 1996; $0.1 million in 1997; and no requirement is needed in 1998 and 1999.\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 December 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.\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 at December 31 is as follows:\n================================================================= 1994 1993 -------------------- (in thousands) Bond sinking fund requirements $1,350 $1,350 Less: Portion to be satisfied by certifying property additions - 1,350 ----------------------------------------------------------------- Cash sinking fund requirements 1,350 - Other long-term debt maturities 1,229 4,499 ----------------------------------------------------------------- Total $2,579 $4,499 =================================================================\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 preferred and common stocks. At December 31, 1994, approximately $57 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 1994 and 1993 are as follows (in thousands):\n================================================================== Net Income After Operating Operating Dividends on Quarter Ended Revenue Income Preferred Stock ------------------------------------------------------------------ March 1994 $46,717 $ 7,130 $ 3,898 June 1994 56,377 9,555 6,051 September 1994 63,674 13,495 9,547 December 1994 45,017 5,989 2,614\nMarch 1993 $42,873 $ 6,123 $ 3,019 June 1993 52,875 9,301 6,211 September 1993 74,420 13,326 10,214 December 1993 48,274 5,484 2,015\n==================================================================\nThe Company's business is influenced by seasonal weather conditions and a seasonal rate structure, among other factors.\nII-246\nSELECTED FINANCIAL AND OPERATING DATA Savannah Electric and Power Company 1994 Annual Report\nII-247\nSELECTED FINANCIAL AND OPERATING DATA Savannah Electric and Power Company 1994 Annual Report\nII-248A\nSELECTED FINANCIAL AND OPERATING DATA Savannah Electric and Power Company 1994 Annual Report\nII-248B\nSELECTED FINANCIAL AND OPERATING DATA Savannah Electric and Power Company 1994 Annual Report\nII-248C\nSELECTED FINANCIAL AND OPERATING DATA (continued) Savannah Electric and Power Company 1994 Annual Report\nII-249\nSELECTED FINANCIAL AND OPERATING DATA (continued) Savannah Electric and Power Company 1994 Annual Report\nII-250A\nSELECTED FINANCIAL AND OPERATING DATA (continued) Savannah Electric and Power Company 1994 Annual Report\nII-250B\nSELECTED FINANCIAL AND OPERATING DATA (continued) Savannah Electric and Power Company 1994 Annual Report\nII-250C\nSTATEMENTS OF INCOME Savannah Electric and Power Company\nII-251\nSTATEMENTS OF INCOME Savannah Electric and Power Company\nII-252A\nSTATEMENTS OF INCOME Savannah Electric and Power Company\nII-252B\nSTATEMENTS OF CASH FLOWS Savannah Electric and Power Company\nII-253\nSTATEMENTS OF CASH FLOWS Savannah Electric and Power Company\nII-254A\nSTATEMENTS OF CASH FLOWS Savannah Electric and Power Company\nII-254B\nBALANCE SHEETS Savannah Electric and Power Company\nII-255\nBALANCE SHEETS Savannah Electric and Power Company\nII-256A\nBALANCE SHEETS Savannah Electric and Power Company\nII-256B\nBALANCE SHEETS Savannah Electric and Power Company\nII-257\nBALANCE SHEETS Savannah Electric and Power Company\nII-258A\nBALANCE SHEETS Savannah Electric and Power Company\nII-258B\nSAVANNAH ELECTRIC AND POWER COMPANY OUTSTANDING SECURITIES AT DECEMBER 31, 1994\nFirst Mortgage Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity ------------------------------------------------------------- (Thousands) (Thousands) 1993 $ 20,000 6-3\/8% $ 20,000 7\/1\/03 1989 30,000 9-1\/4% 28,950 10\/1\/19 1991 30,000 9-3\/8% 29,700 7\/1\/21 1992 30,000 8.30% 30,000 7\/1\/22 1993 25,000 7.40% 25,000 7\/1\/23 -------- -------- $135,000 $133,650 ======== ========\nPollution Control Bonds\nAmount Interest Amount Series Issued Rate Outstanding Maturity ------------------------------------------------------------- (Thousands) (Thousands) 1993 $ 4,085 Variable $ 4,085 1\/1\/16 1992 13,870 6-3\/4% 13,870 2\/1\/22 -------- -------- $ 17,955 $ 17,955 ======== ========\nPreferred Stock\nShares Dividend Amount Series Outstanding Rate Outstanding ------------------------------------------------------------- (Thousands) 1993 1,400,000 6.64% $ 35,000\nII-259\nSAVANNAH ELECTRIC AND POWER COMPANY\nSECURITIES RETIRED DURING 1994\nFirst Mortgage Bonds\nPrincipal Interest Series Amount Rate --------------------------------------------------------------------- (Thousands) 1964 $3,715 4-5\/8% 1989 1,050 9-1\/4% 1991 300 9-3\/8% ------ $5,065 ======\nII-260\nPART 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 1995 annual meeting of stockholders.\nItem 10.","section_9":"","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 55 Served as Director since 3-1-89\nBill M. Guthrie Executive Vice President of ALABAMA Age 61 Served as Director since 12-16-88\nWhit Armstrong (2) Age 47 Served as Director since 9-24-82\nPhilip E. Austin (2) Age 53 Served as Director since 1-25-91\nMargaret A. Carpenter (2) Age 70 Served as Director since 2-26-93\nA. W. Dahlberg (2) Age 54 Served as Director since 4-22-94\nPeter V. Gregerson, Sr. (2) Age 66 Served as Director since 10-22-93\nCrawford T. Johnson, III (2) Age 70 Served as Director since 4-18-69\nCarl E. Jones, Jr. (2) Age 54 Served as Director since 4-22-88\nWallace D. Malone, Jr. (2) Age 58 Served as Director since 6-22-90\nWilliam V. Muse (2) Age 55 Served as Director since 2-26-93\nJohn T. Porter (2) Age 63 Served as Director since 10-22-93\nGerald H. Powell (2) Age 68 Served as Director since 2-28-86\nRobert D. Powers (2) Age 45 Served as Director since 1-24-92\nJohn W. Rouse (2) Age 57 Served as Director since 4-22-88\nWilliam J. Rushton, III (2) Age 65 Served as Director since 9-18-70\nJames H. Sanford (2) Age 50 Served as Director since 8-1-83\nJohn C. Webb, IV (2) Age 52 Served as Director since 4-22-77\nJohn W. Woods (2) Age 63 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 22, 1994) for one year until the next annual meeting or until a successor is elected and qualified.\nIII-1\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 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 55 Served as Executive Officer since 3-1-89\nBanks H. Farris Executive Vice President Age 60 Served as Executive Officer since 12-3-91\nWilliam B. Hutchins, III Executive Vice President and Chief Financial Officer Age 51 Served as Executive Officer since 12-3-91\nCharles D. McCrary Executive Vice President Age 43 Served as Executive Officer since 1-1-91\nT. Harold Jones Senior Vice President Age 64 Served as Executive Officer since 12-1-91\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 22, 1994) 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.\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.\nA. W. Dahlberg - Chairman, President and Chief Executive Officer of SOUTHERN effective March 1, 1995. He previously served as President of SOUTHERN from 1994 to 1995 and President and Chief Executive Officer of GEORGIA from 1988 through 1993. Director of SOUTHERN, GEORGIA, Trust Company Bank, Trust Company of Georgia, Protective Life Corporation and Equifax, Inc.\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 Emeritus 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.\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 Senior Vice President from 1991 to 1994 and Vice President - Human Resources from 1989 to 1991.\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 Senior Vice President and Chief Financial Officer from 1991 to 1994 and Vice President and Treasurer from 1983 to 1991.\nCharles D. McCrary - Elected in 1991; responsible for the External Relations Department, Operating Services and Corporate Services. He previously served as Senior Vice President from 1991 to 1994 and Vice President of Administrative Services - Nuclear of SCS from 1988 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.\n(f)(1) Involvement in certain legal proceedings. None.\nIII-3\nGEORGIA\n(a)(2) Identification of directors of GEORGIA.\nH. Allen Franklin President and Chief Executive Officer. Age 50 Served as Director since 1-1-94.\nWarren Y. Jobe Executive Vice President, Treasurer and Chief Financial Officer. Age 54 Served as Director since 8-1-82\nBennett A. Brown (1) Age 65 Served as Director since 5-15-80\nA. W. Dahlberg (1) Age 54 Served as Director since 6-1-88\nWilliam A. Fickling, Jr. (1) Age 62 Served as Director since 4-18-73\nL. G. Hardman III (1) Age 55 Served as Director since 6-25-79\nJames R. Lientz, Jr. (1) Age 51 Served as Director since 7-1-93\nWilliam A. Parker, Jr. (1) Age 67 Served as Director since 5-19-65\nG. Joseph Prendergast (1) Age 49 Served as Director since 1-20-93\nHerman J. Russell (1) Age 64 Served as Director since 5-18-88\nGloria M. Shatto (1) Age 63 Served as Director since 2-20-80\nWilliam Jerry Vereen (1) Age 54 Served as Director since 5-18-88\nCarl Ware (1) (2) Age 51 Served as Director since 2-15-95\nThomas R. Williams (1) Age 66 Served as Director since 3-17-82\n(1) No position other than Director. (2) Previously served as Director of GEORGIA from 1980 to 1991.\nEach of the above is currently a director of GEORGIA, serving a term running from the last annual meeting of GEORGIA's stockholder (May 18, 1994) for one year until the next annual meeting or until a successor is elected and qualified, except for Mr. Ware whose election was effective on the date indicated.\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 50 Served as Executive Officer since 1-1-94\nWarren Y. Jobe Executive Vice President, Treasurer, Chief Financial Officer and Director Age 54 Served as Executive Officer since 5-19-82\nDwight H. Evans Executive Vice President - External Affairs Age 46 Served as Executive Officer since 4-19-89\nIII-4\nW. G. Hairston, III Executive Vice President - Nuclear Age 50 Served as Executive Officer since 6-1-93\nGene R. Hodges Executive Vice President - Customer Operations Age 56 Served as Executive Officer since 11-19-86\nWayne T. Dahlke Senior Vice President - Power Delivery Age 54 Served as Executive Officer since 4-19-89\nJames K. Davis Senior Vice President - Corporate Relations Age 54 Served as Executive Officer since 10-1-93\nRobert H. Haubein Senior Vice President - Fossil\/Hydro Power Age 55 Served as Executive Officer since 2-19-92\nGale E. Klappa Senior Vice President - Marketing Age 44 Served as Executive Officer since 2-19-92\nFred D. Williams Senior Vice President - Bulk Power Markets Age 50 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 18, 1994) 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 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 Corporation.\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 services, corporate secretary and treasury operations.\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 Cousins Properties.\nA. W. Dahlberg - Chairman, President and Chief Executive Officer of SOUTHERN effective March 1, 1995. He previously served as President of SOUTHERN from 1994 to 1995 and President and Chief Executive Officer of GEORGIA from 1988 through 1993. Director of SOUTHERN, ALABAMA, Trust Company Bank, Trust Company of Georgia, Protective Life Corporation and Equifax, Inc.\nWilliam A. Fickling, Jr. - Co-Chairman of the Board and Chief Executive Officer of Beech Street Corporation (provider of managed care services).\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, Inc. 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.\nIII-5\nWilliam A. Parker, Jr. - Chairman of the Board, Seminole Investment Co., L.L.C. (private investments), Atlanta, Georgia. Director of SOUTHERN, Genuine Parts Company, Life Insurance Company of Georgia, Atlantic Realty Company, ING North America Insurance Company, Post Properties, Inc. and Haverty Furniture Companies, Inc.\nG. Joseph Prendergast - Chairman Wachovia Bank of Georgia, N.A. since April 1994. He previously served as President and Chief Executive Officer, Wachovia Corporation of Georgia and Wachovia Bank of Georgia, N.A. from 1993 to 1994 and from 1988 to 1993 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.\nWilliam Jerry Vereen - President, Treasurer and Chief Executive Officer of Riverside Manufacturing Company (manufacture and sale of uniforms), Moultrie, Georgia. Director of Gerber Scientific, Inc., Textile Clothing Technology Group and Blue Cross\/Blue Shield of Georgia.\nCarl Ware - President, Africa Group, Coca-Cola International; Senior Vice President, The Coca-Cola Co.\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., American Software, Inc. and The Fidelity Group of Funds.\nDwight H. Evans - Executive Vice President - External Affairs since 1989.\nW. G. Hairston, III - Executive Vice President - Nuclear since 1993. Also, he has served as President and Chief Operating Officer of Southern Nuclear since May 1993 and Chief Executive Officer since December 1993. Executive Vice President of Southern Nuclear from 1992 to 1993 and Senior Vice President of Southern Nuclear from 1990 to 1992.\nGene R. Hodges - Executive Vice President - Customer Operations since 1992. Senior Vice President - Region\/Land Operations from 1990 to 1992.\nWayne T. Dahlke - Senior Vice President - Power Delivery since 1992. Senior Vice President - Marketing from 1989 to 1992.\nJames K. Davis - Senior Vice President - Corporate Relations since 1993. Vice President of Corporate Relations from 1988 to 1993.\nRobert H. Haubein - Senior Vice President - Fossil\/ Hydro Power since June 1994. Senior Vice President - Administrative Services from 1992 to 1994 and Vice President - Northern Region from 1990 to 1992.\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.\nTravis J. Bowden President and Chief Executive Officer Age 56 Served as Director since 2-1-94\nReed Bell, Sr., M.D. (1) Age 68 Served as Director since 1-17-86\nPaul J. DeNicola (1) Age 46 Served as Director since 4-19-91\nFred C. Donovan (1) Age 54 Served as Director since 1-18-91\nW. D. Hull, Jr. (1) Age 62 Served as Director since 10-14-83\nC. W. Ruckel (1) Age 67 Served as Director since 4-20-62\nJ. K. Tannehill (1) Age 61 Served as Director since 7-19-85\n(1) 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 28, 1994) 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 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.\nTravis J. Bowden President, Chief Executive Officer and Director Age 56 Served as Executive Officer since 2-1-94\nF. M. Fisher, Jr. Vice President - Employee and External Relations Age 46 Served as Executive Officer since 5-19-89\nJohn E. Hodges, Jr. Vice President - Customer Operations Age 51 Served as Executive Officer since 5-19-89\nG. Edison Holland, Jr. (1) Vice President - Power Generation\/ Transmission and Corporate Counsel Age 42 Served as Executive Officer since 4-25-92\nEarl B. Parsons, Jr. (2) Vice President - Power Generation and Transmission Age 56 Served as Executive Officer since 4-14-78\nA. E. Scarbrough Vice President - Finance Age 58 Served as Executive Officer since 9-21-77\n(1) Effective March 13, 1995.\n(2) Resigned effective March 11, 1995, to assume the position of Senior Vice President - Fossil and Hydro Generation at ALABAMA.\nEach of the above is currently an executive officer of GULF, serving a term running from the last annual meeting of the directors (July 22, 1994) for one year until the next annual meeting or until his successor is elected and qualified.\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.\nTravis J. Bowden - Elected President effective February 1994 and, effective May 1994, Chief Executive Officer. He previously served as Executive Vice President of ALABAMA from 1985 to 1994.\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 1992.\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.\nFred C. Donovan - 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 Florida First Federal Savings Bank, Panama City, Florida.\nF. M. Fisher, Jr. - Elected Vice President - Employee and External Relations in 1989.\nJohn E. Hodges, Jr. - Elected Vice President - Customer Operations in 1989. Director of Barnett Bank of West Florida, Pensacola, Florida.\nG. Edison Holland, Jr. - Elected Vice President and Corporate Counsel in 1992 and Vice President - Power Generation\/Transmission and Corporate Counsel in March 1995; responsible for generation and transmission of electric energy, all legal matters associated with GULF and serves as compliance officer. Also serves, 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.\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 46 Served as Director since 4-24-91\nPaul J. DeNicola (1) Age 46 Served as Director since 5-1-89\nEdwin E. Downer (1) Age 63 Served as Director since 4-24-84\nRobert S. Gaddis (1) Age 63 Served as Director since 1-21-86\nWalter H. Hurt, III (1) Age 59 Served as Director since 4-6-82\nAubrey K. Lucas (1) Age 60 Served as Director since 4-24-84\nGerald J. St. Pe (1) Age 55 Served as Director since 1-21-86\nDr. Philip J. Terrell (1) Age 41 Served as Director since 2-22-95\nN. Eugene Warr (1) Age 59 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 5, 1994) for one year until the next annual meeting or until a successor is elected and qualified, except for Dr. Terrell whose election was effective on the date indicated.\nThere 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 (1) President, Chief Executive Officer and Director Age 46 Served as Executive Officer since 4-24-91\nH. E. Blakeslee Vice President - Customer Services and Marketing Age 54 Served as Executive Officer since 1-25-84\nF. D. Kuester Vice President - Power Generation and Delivery Age 44 Served as Executive Officer since 3-1-94\nDon E. Mason Vice President - External Affairs and Corporate Services Age 53 Served as Executive Officer since 7-27-83\nMichael W. Southern Vice President, Secretary, Treasurer and Chief Financial Officer Age 42 Served as Executive Officer since 1-1-95\n(1) Elected Senior Vice President of SOUTHERN in March 1995, however, Mr. Ratcliffe will maintain his present position until his successor is elected.\nEach of the above is currently an executive officer of MISSISSIPPI, serving a term running from the last annual meeting of the directors (April 27, 1994) for one year until the next annual meeting or until a successor is elected and qualified, except for Mr. Southern whose election was effective on the date indicated.\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.\nIII-9\n(c)(4) Identification of certain significant employees. None.\n(d)(4) Family relationships. None.\n(e)(4) Business experience.\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.\nGerald J. St. Pe - President of Ingalls Shipbuilding and Senior Vice President of Litton Industries, Inc. since 1985. Director of Merchants and Marine Bank, Pascagoula, Mississippi.\nDr. Philip J. Terrell - Superintendent of Pass Christian Public School District and adjunct professor at William Carey College.\nN. Eugene Warr - Retailer (Biloxi and Gulfport, Mississippi). Vice chairman of the Board of SouthTrust Bank of Mississippi, formerly The Jefferson Bank, 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.\nF. D. Kuester - Elected Vice President in 1994. Primarily responsible for generating plants, environmental quality, fuel services, power generation technical services, distribution, transmission, system planning, bulk power contracts, system operations and control, system protection and real estate. He previously served as Manager of Business and New Project Design\/Development of SCS from 1993 to 1994 and Vice President of SCS from 1990 to 1993.\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.\nMichael W. Southern - Elected Vice President, Secretary, Treasurer and Chief Financial Officer in 1995, responsible primarily for accounting, treasury, finance, information resources and risk management. He previously served as Director of Corporate Finance of SCS from 1994 to 1995 and Director of Financial Planning of SCS from 1990 to 1994.\n(f)(4) Involvement in certain legal proceedings. None.\nIII-10\nSAVANNAH\n(a)(5) Identification of directors of SAVANNAH.\nArthur M. Gignilliat, Jr. President and Chief Executive Officer Age 62 Served as Director since 9-1-82\nHelen Quattlebaum Artley (1) Age 67 Served as Director since 5-17-77\nPaul J. DeNicola (1) Age 46 Served as Director since 3-14-91\nBrian R. Foster (1) Age 45 Served as Director since 5-16-89\nWalter D. Gnann (1) Age 59 Served as Director since 5-17-83\nRobert B. Miller, III (1) Age 49 Served as Director since 5-17-83\nJames M. Piette (1) Age 70 Served as Director since 6-12-73\nArnold M. Tenenbaum (1) Age 58 Served as Director since 5-17-77\nFrederick F. Williams, Jr. (1) Age 67 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 17, 1994) 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 62 Served as Executive Officer since 2-15-72\nW. Miles Greer Vice President - Marketing and Customer Services Age 51 Served as Executive Officer since 11-20-85\nLarry M. Porter Vice President - Operations Age 50 Served as Executive Officer since 7-1-91\nKirby R. Willis Vice President, Treasurer and Chief Financial Officer Age 43 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 17, 1994) 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 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 1984. Director of Savannah Foods and Industries, Inc.\nIII-11\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 and Chief Executive Officer 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.\nRobert B. Miller, III - President of American Builders of Savannah.\nJames M. Piette - Retired Vice Chairman, Board of Directors, Union Camp Corporation.\nArnold M. Tenenbaum - President and Director 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 1994. Formerly served as Vice President - Economic Development and Corporate Services from 1989 through 1993.\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 since 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.\nGEORGIA's Mr. Thomas R. Williams failed to file on a timely basis a single report disclosing one transaction on Forms 4 and 5 as required by Section 16 of the Securities Exchange Act of 1934. Mr. William G. Hairston, III also failed to file on a timely basis a Form 3 as required by Section 16 of the Securities Act of 1934.\nIII-12\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n(a) Summary Compensation Tables. The following tables set forth information concerning any Chief Executive Officer and the four most highly compensated executive officers whose total annual salary and bonus exceeded $100,000 during 1994 for each of the operating affiliates (ALABAMA, GEORGIA, GULF, MISSISSIPPI and SAVANNAH).\nIII-13\nIII-14\nIII-15\nIII-16\nIII-17\nIII-18\nSTOCK OPTION GRANTS IN 1994\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, 1994.\nIII-19\nIII-20\nIII-21\nIII-22\nIII-23\nIII-24\nDEFINED BENEFIT OR ACTUARIAL PLAN DISCLOSURE\n(e)(1) Pension Plan Table. The following table sets forth the estimated combined annual pension benefits under the pension and supplemental defined benefit plans in effect during 1994 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, 1994, 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 1994 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 both Mr. Bowden and Mr. Holland pursuant to individual supplemental pension agreements.\nIII-26\nAs of December 31, 1994, the applicable compensation levels and years of accredited service are 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 SAVANNAH, 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------------------------------- 1 The plan benefits are subject to the maximum benefit limitations set forth in Section 415 of the Internal Revenue Code.\nIII-27\n(f) Compensation of Directors. -------------------------\n(1) Standard Arrangements. The following table presents compensation paid to the directors, during 1994 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, 1994 in addition to or in lieu of that specified by the standard arrangements specified above.\n(g) Employment Contracts and Termination of Employment and Change in Control Arrangements.\nNone.\nIII-28\n(h) Report on Repricing of Options. ------------------------------\nNone.\n(i) Additional Information with Respect to Compensation Committee Interlocks and Insider Participation in Compensation Decisions.\nALABAMA\nElmer B. Harris serves on the Compensation Committee of AmSouth Bancorporation. John W. Woods, a director of ALABAMA, is Chairman and Chief Executive Officer of AmSouth Bancorporation.\nIII-29\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\n(a) Security ownership of certain beneficial owners. ----------------------------------------------- SOUTHERN 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, 1994. 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, 1994.\nIII-30\nIII-31\nIII-32\nIII-33\nIII-34\nIII-35\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nALABAMA\n(a) Transactions with management and others.\nDuring 1994, ALABAMA, in the ordinary course of business, paid premiums amounting to approximately $584,358 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 served as Chairman.\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.\nMr. G. Joseph Prendergast is Chairman of Wachovia Bank of Georgia, N.A., and Mr. James R. Lientz, Jr. is President of NationsBank of Georgia. During 1994, these banks furnished a number of regular banking services in the ordinary course of business to GEORGIA. GEORGIA intends to maintain normal banking relations with all the aforesaid banks in the future.\nIn 1994, GEORGIA leased a building from Riverside Manufacturing Co. for approximately $73,000. Mr. William J. Vereen is Chief Executive Officer, President, Treasurer and Director of Riverside Manufacturing Co.\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 $1,095,340 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) Transactions with management and others.\nDuring 1994, MISSISSIPPI was indebted in a maximum amount of $9 million to Hancock Bank, of which Mr. Leo W. Seal, Jr. serves as Chairman of the Board and Chief Executive Officer. Mr. Seal retired from MISSISSIPPI's board of directors effective September 6, 1994.\n(b) Certain business relationships. None.\n(c) Indebtedness of management. None.\n(d) Transactions with promoters. None.\nIII-36\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 1994, 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. None.\n(c) Indebtedness of management. None.\n(d) Transactions with promoters. None.\nIII-37\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 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 1994 only the following registrant filed a Current Report on Form 8-K:\nALABAMA filed a Form 8-K dated November 30, 1994 to facilitate a security sale.\nIV-1\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.\nTHE SOUTHERN COMPANY\nBy: A. W. Dahlberg, Chairman, President and Chief Executive Officer\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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.\nA. W. Dahlberg Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)\nW. L. Westbrook Financial Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)\nDirectors: W. P. Copenhaver Elmer B. Harris. A. D. Correll Earl D. McLean, Jr. Paul J. DeNicola William A. Parker, Jr. Jack Edwards William J. Rushton, III H. Allen Franklin Gloria M. Shatto Bruce S. Gordon Herbert Stockham L. G. Hardman III\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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 and Chief Executive Officer\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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)\nWilliam B. Hutchins, III Executive Vice President (Principal Financial Officer)\nDavid L. Whitson Vice President and Comptroller (Principal Accounting Officer)\nDirectors: Whit Armstrong Wallace D. Malone, Jr. Philip E. Austin William V. Muse Margaret A. Carpenter Gerald H. Powell A. W. Dahlberg 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. John W. Woods\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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 and Chief Executive Officer\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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: Bennett A. Brown Herman J. Russell A. W. Dahlberg William Jerry Vereen L. G. Hardman III Carl Ware James R. Lientz, Jr. Thomas R. Williams G. Joseph Prendergast\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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: Travis J. Bowden, President and Chief Executive Officer\nBy: \/s\/Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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.\nTravis J. Bowden President, Chief Executive Officer and Director (Principal Executive Officer)\nA. E. Scarbrough Vice President - Finance (Principal Financial and Accounting Officer)\nDirectors: Reed Bell W. D. Hull, Jr. Paul J. DeNicola C. W. Ruckel Fred C. Donovan J. K. Tannehill\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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 and Chief Executive Officer\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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)\nMichael W. Southern Vice President, Secretary, Treasurer and Chief Financial Officer (Principal Financial and Accounting Officer)\nDirectors: Paul J. DeNicola Aubrey K. Lucas Edwin E. Downer Gerald J. St. Pe' Robert S. Gaddis N. Eugene Warr Walter H. Hurt, III\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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 and Chief Executive Officer\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\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 Robert B. Miller, III Paul J. DeNicola James M. Piette Brian R. Foster Arnold M. Tenenbaum Walter D. Gnann Frederick F. Williams, Jr.\nBy: \/s\/ Wayne Boston (Wayne Boston, Attorney-in-fact)\nDate: March 23, 1995\nIV-4\nExhibit 21. Subsidiaries of the Registrants.\nIV-5\nARTHUR ANDERSEN LLP\nExhibit 23(a)\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 15, 1995 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, 33-51433, 33-54415, and 33-57951.\n\/s\/ ARTHUR ANDERSEN LLP Atlanta, Georgia March 23, 1995\nIV-6\nExhibit 23(b)\nARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 15, 1995 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 LLP Birmingham, Alabama March 23, 1995\nIV-7\nExhibit 23(c)\nARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 15, 1995 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 LLP Atlanta, Georgia March 23, 1995\nIV-8\nExhibit 23(d)\nARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 15, 1995 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 LLP Atlanta, Georgia March 23, 1995\nIV-9\nExhibit 23(e)\nARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 15, 1995 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 LLP Atlanta, Georgia March 23, 1995\nIV-10\nExhibit 23(f)\nARTHUR ANDERSEN LLP\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated February 15, 1995 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 LLP Atlanta, Georgia March 23, 1995\nIV-11\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 15, 1995. 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 through S-4) 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 LLP Atlanta, Georgia February 15, 1995\nIV-12\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 15, 1995. 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-5 through S-7) 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 LLP Birmingham, Alabama February 15, 1995\nIV-13\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 15, 1995. 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-8 through S-10) 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 LLP Atlanta, Georgia February 15, 1995\nIV-14\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 15, 1995. 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-11 through S-13) 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 LLP Atlanta, Georgia February 15, 1995\nIV-15\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 15, 1995. 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-14 through S-16) 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 LLP Atlanta, Georgia February 15, 1995\nIV-16\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 15, 1995. 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-17 through S-19) 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 LLP Atlanta, Georgia February 15, 1995\nIV-17\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nS-1\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1994 (Stated in Thousands of Dollars)\nS-2\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1993 (Stated in Thousands of Dollars)\nS-3\nTHE SOUTHERN COMPANY AND SUBSIDIARY COMPANIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1992 (Stated in Thousands of Dollars)\nS-4\nALABAMA POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1994 (Stated in Thousands of Dollars)\nS-5\nALABAMA POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1993 (Stated in Thousands of Dollars)\nS-6\nALABAMA POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1992 (Stated in Thousands of Dollars)\nS-7\nGEORGIA POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1994 (Stated in Thousands of Dollars)\nS-8\nGEORGIA POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1993 (Stated in Thousands of Dollars)\nS-9\nGEORGIA POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1992 (Stated in Thousands of Dollars)\nS-10\nGULF POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1994 (Stated in Thousands of Dollars)\nS-11\nGULF POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1993 (Stated in Thousands of Dollars)\nS-12\nGULF POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1992 (Stated in Thousands of Dollars)\nS-13\nMISSISSIPPI POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1994 (Stated in Thousands of Dollars)\nS-14\nMISSISSIPPI POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1993 (Stated in Thousands of Dollars)\nS-15\nMISSISSIPPI POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1992 (Stated in Thousands of Dollars)\nS-16\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1994 (Stated in Thousands of Dollars)\nS-17\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1993 (Stated in Thousands of Dollars)\nS-18\nSAVANNAH ELECTRIC AND POWER COMPANY SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED DECEMBER 31, 1992 (Stated in Thousands of Dollars)\nS-19\nEXHIBIT 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 thereto through January 5, 1994. (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 October 14, 1994. (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), in Form 8-K dated November 16, 1993, File No. 1-3164, as Exhibit 4(a) and in Certificate of Notification, File No. 70-8191, as Exhibit A.)\n(b) 2 - By-laws of ALABAMA as amended effective July 23, 1993, and as presently in effect. (Designated in Form U-1, File No. 70-8191, as Exhibit A-2.)\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\n(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. (Designated in GULF's Form 10-K for the year ended December 31, 1993, as Exhibit 3(d)2.)\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. (Designated in SAVANNAH's Form 10-K for the year ended December 31, 1993, as Exhibit 3(f)2.)\nE-2\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 December 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 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), in Certificate of Notification, File No. 70- 8069, as Exhibits A and B, in Certificate of Notification, File No. 70-8069, as Exhibit A, in Certificate of Notification, File No. 70-8069, as Exhibit A and in Form 8- K dated November 30, 1994, File No. 1-3436, as Exhibit 4.)\nGEORGIA\n(c) 1 - 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 December 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, in Certificate of Notification, File No. 70-7832, as Exhibit C, in Certificate of Notification, File No. 70- 7832, as Exhibits K and L, in Certificate of Notification, File No. 70-8443, as Exhibit C, in Certificate of Notification, File No. 70-8443, as Exhibit C, in Certificate of Notification, File No. 70-8443, as Exhibit E, in Certificate of Notification, File No. 70-8443, as Exhibit E and in Certificate of Notification, File No. 70- 8443, as Exhibit E.)\nE-3\n* (c) 2 - Supplemental Indenture dated as of June 1, 1994, between GEORGIA and Chemical Bank, as Trustee.\n* (c) 3 - Supplemental Indenture dated as of September 1, 1994, between GEORGIA and Chemical Bank, as Trustee.\n(c) 4 - Indenture dated as of December 1, 1994, between GEORGIA and Trust Company Bank, as Trustee. (Designated in Certificate of Notification, File No. 70-8461, as Exhibit E.)\n(c) 5 - First Supplemental Indenture dated as of December 15, 1994, between GEORGIA and Trust Company Bank, as Trustee. (Designated in Certificate of Notification, File No. 70- 8461, as Exhibit F.)\nGULF\n(d) - Indenture dated as of September 1, 1941, between GULF and The Chase Manhattan Bank (National Association), as Trustee, and indentures supplemental thereto through September 1, 1994. (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, in Certificate of Notification, File No. 70-8229, as Exhibit A and in Certificate of Notification, File No. 70-8229, as Exhibits E and F.)\nMISSISSIPPI\n(e) - Indenture dated as of September 1, 1941, between MISSISSIPPI and Bankers Trust Company, as Successor Trustee, and indentures supplemental thereto through March 1, 1994. (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, in Certificate of Notification, File No. 70-8127, as Exhibit A and in Form 8- K dated March 8, 1994, File No. 0-6849, as Exhibit 4.)\nE-4\nSAVANNAH\n(f) - 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).)\n(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).)\nE-5\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).)\n(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).)\nE-6\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, Amendment No. 3 dated as of August 1, 1988 and Amendment No. 4 dated as of December 31, 1990, 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 No. 1-3526, as Exhibit 10(o)(2), in SOUTHERN's Form 10-K for the year ended December 31, 1989, File No. 1- 3526, as Exhibit 10(n)(2) and in SOUTHERN's Form 10-K for the year ended December 31, 1993, File No. 1-3526, as Exhibit 10(a)54.)\n(a) 25 - Plant Robert W. Scherer Units Number One and Two Operating Agreement dated as of May 15, 1980, Amendment No. 1 dated as of December 3, 1985 and Amendment No. 2 dated as of December 31, 1990, among GEORGIA, OPC, MEAG and Dalton. (Designated in Form U-1, File No. 70-6481, as Exhibit B-4, in SOUTHERN's Form 10-K for the year ended December 31, 1987, File No. 1-3526, as Exhibit 10(o)(4) and in SOUTHERN's Form 10-K for the year ended December 31, 1993, File No. 1-3526, as Exhibit 10(a)55.)\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.)\nE-7\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 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).)\nE-8\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).)\n(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.)\nE-9\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. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1993, File No. 1- 3526, as Exhibit 10(a)49.)\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).)\n(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.)\nE-10\n(a) 54 - Plant Scherer Managing Board Agreement dated as of December 31, 1990 among GEORGIA, OPC, MEAG, Dalton, GULF, FP&L and JEA. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1993, File No. 1-3526, as Exhibit 10(a)56.)\n(a) 55 - Plant McIntosh Combustion Turbine Purchase and Ownership Participation Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1993, File No. 1-3526, as Exhibit 10(a)57.)\n(a) 56 - Plant McIntosh Combustion Turbine Operating Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992. (Designated in SOUTHERN's Form 10-K for the year ended December 31, 1993, File No. 1-3526, as Exhibit 10(a)58.)\n(a) 57 - Power Purchase Agreement dated as of December 3, 1993 between GEORGIA and FPC. (Designated in SOUTHERN's Form 10- K for the year ended December 31, 1993, File No. 1-3526, as Exhibit 10(a)59.)\n* (a) 58 - Service Contract dated as of December 12, 1994, between SCS and Mobile Energy Services Company, Inc.\n(a) 59 - The Southern Company Outside Directors Stock Plan. (Designated in Registration No. 33-54415 as Exhibit 4(c).)\n* (a) 60 - Amendment No. 1 dated as of June 15, 1994, to the Plant Robert W. Scherer Unit Number Four Amended and Restated Purchase and Ownership Participation Agreement.\n* (a) 61 - Amendment No. 1 dated as of June 15, 1994, to the Plant Robert W. Scherer Unit Number Four Operating Agreement.\n(a) 62 - Operating Agreement for the Joseph M. Farley Nuclear Plant between ALABAMA and Southern Nuclear dated as of December 23, 1991. (Designated in Form U-1, File No. 70-7530, as Exhibit B-7.)\n(a) 63 - Nuclear Services Agreement between Southern Nuclear and GEORGIA dated as of October 31, 1991. (Designated in Form U-1, File No. 70-7530, as Exhibit B-6.)\n(a) 64 - Nuclear Managing Board Agreement among GEORGIA, OPC, MEAG and Dalton 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(ee).)\n* (a) 65 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1994.\n* (a) 66 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1994.\nE-11\n(a) 67 - The Southern Company Employee Savings Plan, Amended and Restated effective January 1, 1989. (Designated in Registration No. 33-23152 as Exhibit 4(c).)\n(a) 68 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective January 1, 1989. (Designated in Form U-1, File No. 70-7654, as Exhibit B-1 and in Form U-1, File No. 70-8435, as Exhibit B-4(b).)\n* (a) 69 - Pension Plan For Employees of ALABAMA, Amended and Restated effective as of January 1, 1989.\n* (a) 70 - Pension Plan For Employees of GEORGIA, Amended and Restated effective as of January 1, 1989.\n* (a) 71 - Pension Plan For Employees of SCS, Amended and Restated effective as of January 1, 1989.\n* (a) 72 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993.\n* (a) 73 - Supplemental Benefit Plan for ALABAMA.\n* (a) 74 - Supplemental Benefit Plan for GEORGIA.\n* (a) 75 - Supplemental Benefit Plan for SCS and SEI.\n* (a) 76 - The Deferred Compensation Plan for the Directors of The Southern Company.\n* (a) 77 - The Southern Company Outside Directors Pension Plan.\n* (a) 78 - The Deferred Compensation Plan for the Southern Electric System.\nALABAMA\n(b) 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(b) 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(b) 3 - 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) 4 - 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-12\n(b) 5 - 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) 6 - 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) 7 - 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) 8 - 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) 9 - 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) 10 - 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) 11 - 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) 12 - Firm Power Purchase Contract between ALABAMA and AMEA. (Designated in Certificate of Notification, File No. 70- 7212, as Exhibit B.)\n(b) 13 - 1991 Firm Power Purchase Contract between ALABAMA and AMEA. (Designated in Form U-1, File No. 70-7873, as Exhibit B-1.)\n(b) 14 - 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) 15 - 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) 16 - 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-13\n(b) 17 - Long Term Transmission Service Agreement between Entergy Power, Inc. and ALABAMA, MISSISSIPPI and SCS. See Exhibit 10(a)53 herein.\n* (b) 18 - Amendment No. 2 dated November 4, 1993 and effective June 1, 1994, to Agreement dated January 27, 1959, among SEGCO, ALABAMA and GEORGIA.\n(b) 19 - Operating Agreement for the Joseph M. Farley Nuclear Plant between ALABAMA and Southern Nuclear dated as of December 23, 1991. See Exhibit 10(a)62 herein.\n* (b) 20 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1994. See Exhibit 10(a)65 herein.\n* (b) 21 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1994. See Exhibit 10(a)66 herein.\n(b) 22 - The Southern Company Employee Savings Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)67 herein.\n(b) 23 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)68 herein.\n* (b) 24 - Pension Plan For Employees of ALABAMA, Amended and Restated effective as of January 1, 1989. See Exhibit 10(a)69 herein.\n* (b) 25 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)72 herein.\n* (b) 26 - Supplemental Benefit Plan for ALABAMA. See Exhibit 10(a)73 herein.\n* (b) 27 - The Deferred Compensation Plan for the Southern Electric System. See Exhibit 10(a)78 herein.\n* (b) 28 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)77 herein.\nGEORGIA\n(c) 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(c) 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.\nE-14\n(c) 3 - 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) 4 - Joint Committee Agreement dated as of August 27, 1976, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)7 herein.\n(c) 5 - 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) 6 - 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) 7 - 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) 8 - 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) 9 - Plant Hal Wansley Operating Agreement dated as of March 26, 1976, between GEORGIA and OPC. See Exhibit 10(a)12 herein.\n(c) 10 - 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) 11 - Edwin I. Hatch Nuclear Plant Operating Agreement dated as of August 27, 1976, between GEORGIA, MEAG and Dalton. See Exhibit 10(a)14 herein.\n(c) 12 - 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) 13 - 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) 14 - 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) 15 - Plant Hal Wansley Purchase and Ownership Participation Agreement dated as of August 27, 1976, between GEORGIA and MEAG. See Exhibit 10(a)18 herein.\nE-15\n(c) 16 - Plant Hal Wansley Operating Agreement dated as of August 27, 1976, between GEORGIA and MEAG. See Exhibit 10(a)19 herein.\n(c) 17 - Integrated Transmission System Agreement dated as of August 27, 1976, between GEORGIA and Dalton. See Exhibit 10(a)20 herein.\n(c) 18 - Integrated Transmission System Agreement dated as of August 27, 1976, between GEORGIA and MEAG. See Exhibit 10(a)21 herein.\n(c) 19 - 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) 20 - Plant Hal Wansley Operating Agreement dated as of April 19, 1977, between GEORGIA and Dalton. See Exhibit 10(a)23 herein.\n(c) 21 - 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, Amendment No. 3 dated as of August 1, 1988 and Amendment No. 4 dated as of December 31, 1990, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)24 herein.\n(c) 22 - Plant Robert W. Scherer Units Number One and Two Operating Agreement dated as of May 15, 1980, Amendment No. 1 dated as of December 3, 1985 and Amendment No. 2 dated as of December 31, 1990, among GEORGIA, OPC, MEAG and Dalton. See Exhibit 10(a)25 herein.\n(c) 23 - 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) 24 - Plant Robert W. Scherer Purchase and Sale Agreement dated as of May 16, 1980, between GEORGIA and Dalton. See Exhibit 10(a)27 herein.\n(c) 25 - 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) 26 - 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) 27 - 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) 28 - 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.\nE-16\n(c) 29 - 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) 30 - 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) 31 - 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) 32 - 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) 33 - 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) 34 - 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) 35 - Power Purchase Agreement dated as of December 3, 1993 between GEORGIA and FPC. See Exhibit 10(a)57 herein.\n(c) 36 - Transition Energy Agreement dated December 31, 1990, between JEA and ALABAMA, GEORGIA, GULF, MISSISSIPPI, SAVANNAH and SCS. See Exhibit 10(a)39 herein.\n(c) 37 - 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) 38 - 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) 39 - Rocky Mountain Pumped Storage Hydroelectric Project Operating Agreement dated November 18, 1988, between OPC and GEORGIA. See Exhibit 10(a)42 herein.\n(c) 40 - 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-17\n(c) 41 - Block Power Sale Agreement between GEORGIA and OPC dated as of November 12, 1990. See Exhibit 10(a)47 herein.\n(c) 42 - Coordination Services Agreement between GEORGIA and OPC dated as of November 12, 1990. See Exhibit 10(a)48 herein.\n(c) 43 - 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) 44 - 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) 45 - 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) 46 - 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) 47 - 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)54 herein.\n(c) 48 - Plant McIntosh Combustion Turbine Purchase and Ownership Participation Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992. See Exhibit 10(a)55 herein.\n(c) 49 - Plant McIntosh Combustion Turbine Operating Agreement between GEORGIA and SAVANNAH dated as of December 15, 1992. See Exhibit 10(a)56 herein.\n(c) 50 - Certificate of Limited Partnership of Georgia Power Capital. (Designated in Certificate of Notification, File No. 70-8461, as Exhibit B.)\n(c) 51 - Amended and Restated Agreement of Limited Partnership of Georgia Power Capital, dated as of December 1, 1994. (Designated in Certificate of Notification, File No. 70- 8461, as Exhibit C.)\n(c) 52 - Action of General Partner of Georgia Power Capital creating the Series A Preferred Securities. (Designated in Certificate of Notification, File No. 70-8461, as Exhibit D.)\n(c) 53 - Guarantee Agreement of GEORGIA dated as of December 1, 1994, for the benefit of the holders from time to time of the Series A Preferred Securities. (Designated in Certificate of Notification, File No. 70-8461, as Exhibit G.)\nE-18\n* (c) 54 - Amendment No. 1 dated as of June 15, 1994, to the Plant Robert W. Scherer Unit Number Four Amended and Restated Purchase and Ownership Participation Agreement. See Exhibit 10(a)60 herein.\n* (c) 55 - Amendment No. 1 dated as of June 15, 1994, to the Plant Robert W. Scherer Unit Number Four Operating Agreement. See Exhibit 10(a)61 herein.\n* (c) 56 - Amendment No. 2 dated November 4, 1993 and effective June 1, 1994, to Agreement dated as of January 27, 1959, among SEGCO, ALABAMA and GEORGIA. See Exhibit 10(b)18 herein.\n(c) 57 - Nuclear Services Agreement between Southern Nuclear and GEORGIA dated as of October 31, 1991. See Exhibit 10(a)63 herein.\n(c) 58 - Nuclear Managing Board Agreement among GEORGIA, OPC, MEAG and Dalton dated as of November 12, 1990. See Exhibit 10(a)64 herein.\n* (c) 59 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1994. See Exhibit 10(a)65 herein.\n* (c) 60 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1994. See Exhibit 10(a)66 herein.\n(c) 61 - The Southern Company Employee Savings Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)67 herein.\n(c) 62 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)68 herein.\n* (c) 63 - Pension Plan For Employees of GEORGIA, Amended and Restated effective as of January 1, 1989. See Exhibit 10(a)70 herein.\n* (c) 64 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)72 herein.\n* (c) 65 - Supplemental Benefit Plan for GEORGIA. See Exhibit 10(a)74 herein.\n* (c) 66 - The Deferred Compensation Plan for the Southern Electric System. See Exhibit 10(a)78 herein.\n* (c) 67 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)77 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.\nE-19\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.\n(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.\nE-20\n* (d) 14 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1994. See Exhibit 10(a)65 herein.\n* (d) 15 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1994. See Exhibit 10(a)66 herein.\n(d) 16 - The Southern Company Employee Savings Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)67 herein.\n(d) 17 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)68 herein.\n* (d) 18 - Pension Plan For Employees of GULF, Amended and Restated effective as of January 1, 1989.\n* (d) 19 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)72 herein.\n* (d) 20 - Supplemental Benefit Plan for GULF.\n* (d) 21 - The Deferred Compensation Plan for the Southern Electric System. See Exhibit 10(a)78 herein.\n* (d) 22 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)77 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.\nE-21\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.\n(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.\n* (e) 14 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1994. See Exhibit 10(a)65 herein.\n* (e) 15 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1994. See Exhibit 10(a)66 herein.\n(e) 16 - The Southern Company Employee Savings Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)67 herein.\n(e) 17 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)68 herein.\n* (e) 18 - Pension Plan For Employees of MISSISSIPPI, Amended and Restated effective as of January 1, 1989.\n* (e) 19 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)72 herein.\nE-22\n* (e) 20 - Supplemental Benefit Plan for MISSISSIPPI.\n* (e) 21 - The Deferred Compensation Plan for the Southern Electric System. See Exhibit 10(a)78 herein.\n* (e) 22 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)77 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.\n(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)55 herein.\n(f) 10 - Plant McIntosh Combustion Turbine Operating Agreement between GEORGIA and SAVANNAH dated December 15, 1992. See Exhibit 10(a)56 herein.\nE-23\n* (f) 11 - The Southern Company Productivity Improvement Plan, Amended and Restated effective January 1, 1994. See Exhibit 10(a)65 herein.\n* (f) 12 - The Southern Company Executive Productivity Improvement Plan, effective January 1, 1994. See Exhibit 10(a)66 herein.\n(f) 13 - The Southern Company Employee Savings Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)67 herein.\n(f) 14 - The Southern Company Employee Stock Ownership Plan, Amended and Restated effective January 1, 1989. See Exhibit 10(a)68 herein.\n* (f) 15 - Employees' Retirement Plan of SAVANNAH, Amended and Restated effective January 1, 1989.\n* (f) 16 - Supplemental Executive Retirement Plan of SAVANNAH.\n* (f) 17 - Deferred Compensation Plan for Key Employees of SAVANNAH.\n* (f) 18 - The Southern Company Performance Pay Plan, Amended and Restated effective January 1, 1993. See Exhibit 10(a)72 herein.\n* (f) 19 - The Southern Company Outside Directors Pension Plan. See Exhibit 10(a)77 herein.\n* (f) 20 - Deferred Compensation Plan for Directors of SAVANNAH.\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 LLP is contained herein at page IV-6.\nALABAMA\n* (b) - The consent of Arthur Andersen LLP is contained herein at page IV-7.\nGEORGIA\n* (c) - The consent of Arthur Andersen LLP is contained herein at page IV-8.\nGULF\n* (d) - The consent of Arthur Andersen LLP is contained herein at page IV-9.\nE-24\nMISSISSIPPI\n* (e) - The consent of Arthur Andersen LLP is contained herein at page IV-10.\nSAVANNAH\n* (f) - The consent of Arthur Andersen LLP is contained herein at page IV-11.\n(24) Powers of Attorney and Resolutions\nSOUTHERN\n* (a) - Power of Attorney and resolution.\nALABAMA\n* (b) - Power of Attorney and resolution.\nE-25\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.\n(27) Financial Data Schedule\nSOUTHERN\n(a) - Financial Data Schedule. (Designated in Form 8-K dated February 15, 1995, File No. 1-3526, as Exhibit 27.)\nALABAMA\n(b) - Financial Data Schedule. (Designated in Form 8-K dated February 15, 1995, File No. 1-3164, as Exhibit 27.)\nGEORGIA\n(c) - Financial Data Schedule. (Designated in Form 8-K dated February 15, 1995, File No. 1-6468, as Exhibit 27.)\nGULF\n(d) - Financial Data Schedule. (Designated in Form 8-K dated February 15, 1995, File No. 0-2429, as Exhibit 27.)\nMISSISSIPPI\n(e) - Financial Data Schedule. (Designated in Form 8-K dated February 15, 1995, File No. 0-6849, as Exhibit 27.)\nSAVANNAH\n(f) - Financial Data Schedule. (Designated in Form 8-K dated February 15, 1995, File No. 1-5072, as Exhibit 27.)","section_15":""}
{"filename":"92472_1994.txt","cik":"92472","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral Development of Business\nSouthwest Water Company (hereafter together with its consolidated subsidiaries referred to as \"Registrant\" unless the context otherwise indicates) was incorporated under the laws of the State of California on December 10, 1954. The Registrant reincorporated in the State of Delaware effective June 30, 1988. The Registrant and its subsidiaries are engaged in a single line of business, the provision of water and water-related services in the water services industry. Such business is conducted entirely through Registrant's subsidiaries. The Registrant provides service to customers located throughout California; the City of Albuquerque and Bernalillo County, New Mexico; the greater Houston, Austin and Rio Grande, Texas, areas; and various cities in Mississippi. All water utility operations of the Registrant are conducted through Suburban Water Systems (\"Suburban\") and New Mexico Utilities, Inc. (\"NMU\"). The Registrant, located in West Covina, California, had 12 employees at December 31, 1994. These employees perform support services for the Registrant's subsidiaries as well as corporate administrative functions.\nIn 1985, the Registrant diversified into the management and operation of water and wastewater treatment systems owned by others. In carrying out this strategy, on September 30, 1985, the Registrant acquired all of the outstanding common shares of ECO Resources, Inc. (\"ECO\") in Houston, Texas. From September 30, 1985 through 1994, the Registrant expanded its service business operations of water and wastewater treatment systems through various acquisitions and by internal growth. On August 31, 1993, ECO purchased all of the common stock of Southern Municipal Services, Inc. (\"SMS\"). SMS provided contract operations and maintenance services for municipal utility districts in the greater Houston, Texas, area.\nThe following discussion describes the products and services provided by each of the Registrant's subsidiaries, all of which are wholly owned by the Registrant.\nSUBURBAN WATER SYSTEMS\nProduct and Business\nSuburban is a public utility water company engaged in the business of producing and supplying water for residential, business, industrial and public authorities use, and for private and public fire protection service under the regulation of the California Public Utilities Commission (the \"CPUC\"). Suburban's service areas are located within Los Angeles County and Orange County, California. These service areas include portions of the communities of Glendora, Covina, West Covina, La Puente, City of Industry, Hacienda Heights, Whittier, La Mirada and Buena Park, as well as unincorporated areas of Los Angeles and Orange Counties.\nSuburban or its predecessor entities have been engaged in supplying water since approximately 1907. From the mid 1950s to the late 1960s, Suburban's operations rapidly expanded as the transition from agricultural land use to residential, business and industrial use occurred throughout its service areas. Suburban has experienced moderate growth since the late 1960s, due to the population saturation of existing service areas. Minor growth has also come from the extension of water service into new residential subdivisions along the periphery of these service areas.\nSuburban provides water service in two general service areas, designated as the San Jose Hills Service Area, and the Whittier\/La Mirada Service Area. These areas contain an aggregate population of approximately 230,000.\nThe San Jose Hills Service Area is located in Los Angeles County. The Whittier\/La Mirada Service Area covers portions of both Los Angeles and Orange Counties. The two service areas are separated by the Puente Hills and cover approximately 38 square miles, consisting of predominantly residential communities. At December 31, 1994, Suburban served 33,648 and 31,989 customers in the San Jose Hills Service Area and the Whittier\/La Mirada Service Area, respectively. Suburban is franchised, as required in each of the areas it serves, by the respective counties or cities in which it operates and has been issued Certificates of Public Convenience and Necessity by the CPUC.\nAt December 31, 1994, Suburban served 65,637 customers, including 62,193 residential customers, 2,606 business and industrial customers, 276 public authorities customers and 562 fire service customers. During 1994, Suburban's operating revenues were 74% from sales to residential customers and 18% from sales to business and industrial customers. No single customer accounts for a material part of Suburban's sales, and there are no individual customers whose loss would have a material adverse effect on Suburban's operations.\nSuburban is engaged in the water utility service business and supplies a single product: water. There has been no significant change in Suburban's services or method of distribution since the beginning of its fiscal year. Suburban's business is subject to material fluctuations resulting, in large measure, from seasonal temperature and rainfall variations. As a result, most of Suburban's revenue is obtained during the warm, dry months of each year.\nCalifornia Water Availability\nOver 70% of the water produced by Suburban is pumped from local underground water basins using Suburban-owned wells. These local underground water basins are currently at levels sufficient to eliminate any drought concerns. This conclusion is subject to change depending on future weather patterns. Supplementing this water supply is more expensive water purchased from external sources. A new water well drilled in Suburban's Whittier\/La Mirada Service Area in November 1994 will increase the local groundwater component of total water \"mix\" when the well is fully operational in 1995. It will also further reduce Suburban's reliance on expensive purchased water from external sources.\nWells and Other Water Sources\nSuburban supplies its customers from 18 wells it owns, and from purchases of water produced from wells of one mutual water company and treated surface water from another mutual water company. Through Suburban's ownership of shares in each of these mutual water companies, and by leasing additional shares from other stockholders of these companies and from other parties with pumping entitlements in the two water basins from which Suburban pumps water, Suburban has been able to increase its water entitlement, and accordingly reduce its cost of water. Suburban has a connection to the \"Lower Feeder\" of the Metropolitan Water District of Southern California (\"MWD\") through which it purchases water to supplement the supply to its Whittier\/La Mirada Service Area. Additionally, Suburban has access to another MWD connection which serves to supplement the supply of water in its San Jose Hills Service Area. Suburban also has interconnections with other water purveyors which can be used as supplemental and emergency sources of supply. Water purchased from MWD and other water purveyors is more expensive to Suburban than water pumped from its owned wells. Occasionally, Suburban can purchase water from MWD at lower prices when MWD has a surplus of water in\nstorage. No such water was purchased by Suburban from MWD in 1994.\nSuburban's wells produce water from two of the major water basins in the Southern California coastal watershed, the Central Basin and the Main San Gabriel Basin. The rights to produce water from these basins, which are managed by Watermaster Boards (\"Boards\"), have been fully adjudicated under the laws of the State of California. These adjudications have established Suburban's rights to produce water from its wells at the levels prescribed each year by the Boards. When Suburban produces water from either basin in excess of prescribed levels, an additional payment is required to provide for the replenishment of the water supply. As the water levels in the Main San Gabriel Basin increase or decrease, the Board adjusts the amount of water Suburban and other producers can pump from this basin without paying an additional charge. There is no assurance that the current allowable pumping level will continue in the future.\nWater supplied by Suburban is subject to regulation as to quality by the United States Environmental Protection Agency (the \"EPA\") acting pursuant to the Federal Safe Drinking Water Act (the \"US Act\"), and by the Office of Drinking Water of the California Department of Health Services (the \"Health Department\") acting pursuant to the California Safe Drinking Water Act (the \"Cal Act\"). The US Act provides for establishment of uniform minimum national water quality standards, as well as governmental authority to specify the type of treatment processes to be used for public drinking water. Moreover, the EPA has an ongoing directive to issue regulations under the US Act and to require disinfection of drinking water, specification of maximum contaminant levels (\"MCLS\") and filtration of surface water supplies. The Cal Act and the mandate of the Health Department are similar to the US Act and the mandate of the EPA, and in many instances MCLS and other requirements of the Health Department are more restrictive than those promulgated by the EPA.\nBoth the EPA and the Health Department have promulgated regulations and other pronouncements which require various testing and sampling of water and inspections by producers such as Suburban and which set MCLS for numerous contaminants. These include: (a) 1991 EPA proposed regulations relating to permissible levels of radionuclides (including radon), (b) 1991 final EPA regulations governing lead and copper and mandating corrosion control studies and sampling and (c) regulations, which became final in 1993, relating to permissible levels of volatile organic compounds (\"VOCs\"), herbicides, pesticides and inorganic parameters.\nSuburban's water quality assurance department regularly monitors and samples the quality of water being distributed. The corrosion control studies related to sampling included in the lead and copper regulations were not required to be conducted by Suburban because of acceptable water quality parameters. Samples of water from throughout Suburban's system are tested regularly by independent, state-certified laboratories for bacterial contamination, chemical contaminant content and for the presence of pollutants and contaminants for which MCLS have been promulgated. In addition, sampling and testing for certain pollutants such as VOCs is conducted by independent engineers retained by the Boards of the Central Basin and the Main San Gabriel Basin. The results of such sampling and testing are made available to all producers, with the cost of such sampling and testing covered by Board assessments to the producers, including Suburban. Testing, sampling and inspections are conducted at the intervals, locations and frequencies required by EPA and Health Department regulations.\nWater supplied by Suburban meets all current requirements of the US Act, the Cal Act and the regulations promulgated under such legislation, and Suburban anticipates no significant capital expenditures to comply with current requirements. There can be no assurance, however, that water supplied by Suburban will meet future EPA or Health Department requirements or that such requirements will not require capital expenditures by Suburban. Chlorination is currently performed only to provide a chlorine residual required by the Health Department.\nIn late 1979, VOCs were discovered in the Main San Gabriel Basin. Subsequently, underground water sampling resulted in the discovery of four large areas of groundwater VOC contamination. The areas include Suburban's Bartolo Well Field, which contains four of Suburban's producing wells and from which Suburban produces approximately 25% of its total water production. In 1984, these areas were designated as \"Superfund\" sites eligible for funding under the Federal Superfund program. Most of the contamination located in the Main San Gabriel Basin was found in the cities of Baldwin Park and El Monte, areas not within Suburban's service areas. Costs associated with resolving past problems affecting Suburban have been minimal and the CPUC has allowed Suburban to pass such costs on to its customers. Suburban has experienced no shortage of water sources as the result of these problems and there has been no material adverse effect on the financial condition of Suburban to date.\nBetween 1984 and 1991, the EPA conducted numerous studies of underground water in the Main San Gabriel Basin (including the Bartolo Well Field). The Main San Gabriel Basin represents the source of approximately 70% of Suburban's total water supply and is the main source of supply for the Whittier\/La Mirada Service Area. The actual amount of water pumped from the Main San Gabriel Basin is dependent upon various factors including the amount of water available. Separately, Suburban conducted similar studies and developed a design for a facility to remove VOCs from water pumped from the Bartolo Well Field at a rate of 10,000 gallons per minute, thus assuring Suburban an adequate potable water supply. The EPA reviewed Suburban's proposal and assumed responsibility for creating and developing a treatment facility. The EPA anticipated that it would begin operating such a plant in mid-1992; numerous delays have substantially extended this schedule. The EPA is currently evaluating relative contamination levels in the Bartolo Well Field compared to other Superfund sites, and Suburban does not know if an EPA treatment facility will be constructed. The EPA is also attempting to identify parties in the Main San Gabriel Basin who are responsible as sources of VOC contamination. The EPA has named as potentially responsible parties (\"PRPs\") a few large industrial companies that allegedly caused the contamination. Suburban's facilities are not sources of VOCs or other contamination in any portion of the Main San Gabriel Basin (i.e., Suburban's operations do not discharge VOCs into the ground or groundwater). It is expected that the EPA will continue for several years to identify these sources of contamination in order to establish legal responsibility for clean-up costs. Currently, neither the EPA nor any governmental agency has targeted Suburban or other water producers as PRPs.\nTo date, water produced from the Bartolo Well Field and other wells maintained by Suburban in the Main San Gabriel Basin meets all applicable governmental requirements. The treatment proposed by the EPA, and other measures taken by or available to Suburban, are intended to ensure that Suburban continues to have an adequate supply of water which meets all applicable governmental standards. While technology exists to remove VOC contaminants from basin water, there can be no assurance that either (i) such technology will in the future be adequate to reduce the amounts of VOCs and other contaminants in water produced by Suburban in the Main San Gabriel Basin to acceptable levels or (ii) the costs of such removal will be fully recoverable from Suburban's customers. To date, Suburban has been permitted to recover all expenses associated with water quality maintenance.\nSome commentators have suggested that the Main San Gabriel Basin water producers have clean-up liability with respect to contaminants in the Main San Gabriel Basin under applicable environmental statutes on various theories by virtue of their pumping operations. Certain PRPs (i.e., alleged source dischargers of VOCs) have espoused this view, however, water producers have rejected any validity of these theories. Suburban is not aware of any governmental or court decision which resolves this issue, and no governmental authority, including the EPA, is currently seeking to recover any clean-up costs from the Main San Gabriel Basin water producers. Instead, as described above, the EPA is focusing on a few large industrial companies. In the cities of Baldwin Park and El Monte, these industrial companies are working with their water producers to build treatment facilities.\nSuburban believes that the combined efforts of the responsible parties and the water producers will ultimately result in cleaning up portions of the Main San Gabriel Basin, providing benefits to all water producers.\nThere can be no assurance that governmental authorities will not seek in the future to recover clean-up costs from Suburban or that source polluters will not seek contribution from water producers for clean-up costs which they may be required to pay. If Suburban is required to pay any such clean-up costs, Suburban will seek to recover such costs, and costs incurred in removing contaminants from water produced, through increased rates to its customers as has been permitted by the CPUC in the past. Moreover, there are over 100 water producers in the Main San Gabriel Basin and Registrant believes that Suburban's share of any clean up costs assessed against the producers would be only a fraction of the total. Due to the potential recovery of the clean-up costs through higher rates, the costs are not expected to have a material adverse effect on Suburban's financial condition and results of operation.\nSince 1984, Suburban has voluntarily chosen to stop pumping water from 10 older, shallower and\/or less efficient wells because of the presence of nitrates and certain VOCs. These wells have been replaced by four new, deeper and more efficient wells. In the past, Suburban has been successful in replacing lost production capacity by shutting down certain old wells, by introducing new, deeper wells and by blending water produced from different wells. However, no assurance can be given that Suburban will be able to do so in the future.\nDuring 1992, a statute (HR 1679) was passed by the State of California establishing a Water Quality Authority (the \"WQA\") to clean up the water in the Main San Gabriel Basin. Assessments are levied against those who own prescriptive pumping rights in the Main San Gabriel Basin, including Suburban. The amount of Suburban's annual assessment is approximately $348,000. To date, Suburban has been permitted to recover all costs related to such water quality maintenance and preservation. Pursuant to a contract with the WQA, Suburban will operate a WQA constructed water treatment facility and the third party well to which such facility is connected. Treated water from such facility will be distributed to Suburban's customers in lieu of pumping from Suburban's wells. There will be no additional cost to Suburban for operation of such treatment facility, and operation by Suburban of the facility is expected to commence by late 1995.\nTo date, Suburban has experienced no material effects upon its operations or capital expenditures resulting from compliance with governmental regulations relating to protection of the environment. Suburban believes that the water available from its wells and other sources is and will continue to be sufficient for it to adequately serve its customers.\nCompetition, Regulation and Future Development\nSuburban operates under long-term franchises and certificates of indefinite duration granted by the CPUC and other governmental authorities having jurisdiction over water service. The success of Suburban's water service business is dependent upon maintaining these franchises and certificates and upon various contracts and governmental and court decisions affecting Suburban's water rights and service areas. Suburban has no patents, trademarks or licenses.\nUnder the CPUC's practices, rates may be increased by two methods: general rate increases and offsets for certain expense increases. General rate increases typically are for three years and include \"step\" increases in rates for the second and third years. General rate increases are authorized after formal proceedings in which the overall rate structure, expenses and rate base (i.e., utility plant investment) of the service area are examined by CPUC staff, and public hearings are held. Because of delays occasioned by the administrative process required for approval of rate increases, Suburban must anticipate future operating costs well in advance and regularly apply\nfor rate increases. Formal general rate proceedings require approximately 12 months from the filing of an application to the authorization of new rates by the CPUC. Rates are based on estimated expenses and capital costs for a forward two-year period and are established for each of the two years based on these estimates, as approved by the CPUC. A major feature of the proceedings is the use of an attrition mechanism for setting rates for the third year of the three- year rate period by assuming that costs and expenses will increase in the same proportion over the second year as the increase projected for the second year over the first. The step rate increases for the second and third years are allowed to compensate for the projected cost increases, but are subject to later demonstration that earnings levels in the service area do not exceed the rate of return authorized at the general rate proceeding. Suburban anticipates filing a general rate increase application with the CPUC in 1995. The general rate increase, if filed and approved, would be effective early in 1996. Suburban expects to file a joint general rate application covering both of its service areas based upon recent suggestions by the CPUC.\nRate increases to offset increases in certain expenses such as cost of purchased water and energy costs to pump water are accomplished through an abbreviated \"offset\" proceeding that requires approximately two months from the time of filing a request for rate increases to the authorization of new rates. Effective January 1, 1994, the CPUC granted Suburban two annual \"step\" adjustments for its San Jose Hills and Whittier\/La Mirada District customers. Effective January 1, 1995, the CPUC granted Suburban an annual \"step\" adjustment for its Whittier\/La Mirada District customers. Suburban has been, and believes that it will continue to be, permitted to increase its rates as necessary to achieve a reasonable rate of return. However, any inability to do so will adversely affect Suburban's results of operations.\nDuring 1993, Suburban elected to record production cost balancing accounts due to increased variability in the costs of water. As permitted by the CPUC, Suburban records the difference between actual and CPUC-adopted production costs in balancing accounts in the income statement, with a corresponding liability or asset on the balance sheet, until the differences are refunded to or recovered from utility customers through CPUC-authorized rate adjustments. The production cost balancing accounts include such items as purchased water, production assessments and power costs.\nIn recent years, Suburban's growth has been limited to minor extensions into new subdivisions along the periphery of its service areas. Further material expansion of Suburban's service areas is believed to be unlikely, since Suburban's service areas are largely surrounded by those of other water purveyors. Because there is little area available for new business and industrial construction and because of recent low levels of residential growth, no significant increases in business and industrial customers are projected for the near future.\nThe laws of the State of California provide that no public agency can install facilities within the service area of a public utility in order to compete with it, except upon payment of just compensation for all damages incurred by the public utility. Under California law, municipalities and certain other public bodies have the right to acquire private water utility plants and systems within their territorial limits by condemnation after proof of necessity is shown. Registrant is not aware of any impending proceeding relating to the condemnation of any portion of Suburban's facilities.\nThe water utility business requires substantial amounts of capital for the construction, extension and replacement of water distribution facilities. This capital is generated from Suburban's operations; from periodic debt financings by Suburban; from contributions in aid of construction received from developers, governmental agencies, municipalities or individuals; and from advances (i.e., loans) from developers which are repaid in accordance with a formula prescribed by the CPUC. During 1994 and 1993, capital expenditures approximated $3,647,000 and $4,876,000, respectively. Suburban may draw upon two revolving lines of credit of the Registrant which Registrant believes are sufficient for Suburban's anticipated short-term needs. If necessary, and\nsubject to its availability and approval by the CPUC, long-term financing is arranged to fund capital expenditures. Registrant conducts no significant research and development activities.\nEmployees\nAt December 31, 1994, Suburban had a total of 98 full-time employees at Suburban's offices in Covina, La Puente and La Mirada, California. None of Suburban's employees is a member of a union. Suburban considers its relations with its employees to be satisfactory.\nNEW MEXICO UTILITIES, INC.\nProduct and Business\nIn 1969, Suburban purchased NMU. On June 1, 1987, the New Mexico Public Utility Commission (\"NMPUC\") authorized Suburban to transfer by stock dividend all of the stock of NMU to the Registrant and, effective on that date, NMU became a wholly owned subsidiary of the Registrant. NMU is a New Mexico public water utility engaged in the business of producing and supplying water for residential, commercial, irrigation and private fire protection customers under the jurisdiction of the NMPUC. It also provides sewage collection in its service area, located in the northwest part of the City of Albuquerque and in the northern portion of Bernalillo County, New Mexico.\nSince 1969, NMU has grown from approximately 800 water customers to approximately 3,375 water customers. Most growth has come from extension of water and sewer services into new residential subdivisions and the development of commercial property. NMU has adequate capacity to service its current customers.\nNMU provides water and sewer services in one general service area, designated as the NMU service area. This area contains a population of approximately 11,000 persons who are served through various service connections to NMU's distribution mains and collector lines. The service area covers approximately 17 square miles, of which approximately 19% has been developed. The developed area is predominantly residential.\nAt December 31, 1994, NMU provided water service to 3,375 customers including 3,057 residential customers, 291 commercial and industrial customers, one golf course with five service connections and 22 private fire protection customers. NMU also provided sewer collection service at December 31, 1994, to 3,121 customers including 2,942 residential customers and 179 commercial and industrial customers. During 1994, NMU's operating revenues were 45% from sales to residential customers and 55% from sales to commercial and industrial customers. There are no individual customers whose loss would have a material adverse effect on Registrant's operations. NMU's water operation is subject to material fluctuations from seasonal temperature and rainfall variations. As a result, most of NMU's revenue is obtained during the summer months of each year. The sewer operation revenues remain relatively constant throughout the year.\nWells and Other Water Sources\nNMU supplies its customers from three wells which are owned by NMU. An additional well was constructed in 1994, which will be equipped and operational in the spring of 1995. A new, two-million gallon water storage reservoir will be constructed at this new well site in 1995. The total estimated cost of the well and reservoir is approximately $2,335,000. As customer growth continues in NMU's service area, NMU may have to increase its water supply capability through additional well construction. To ensure the availability of an emergency supply of water, NMU has one interconnection with another water purveyor which can be used only as an\nemergency source of supply for part of the developed area.\nNMU's wells produce water from the Rio Grande Underground Water Basin. Well water produced by NMU is of good quality. Chlorination is performed by NMU to provide an allowable chlorine residual as a safeguard against bacteriological contamination. Samples of water from throughout the system are tested regularly by independent, state-certified laboratories, and the results are sent to the State of New Mexico Environmental Improvement Division. To date, NMU has experienced no material effects upon its operations or capital expenditures resulting from compliance with governmental regulations relating to protection of the environment.\nCompetition, Regulation and Future Development\nNMU operates under a Certificate of Public Convenience and Necessity granted by the NMPUC and is regulated by other state and local governmental authorities having jurisdiction over water and wastewater service and other aspects of its business. NMU has no patents, trademarks or licenses.\nRequests for rate increases may be submitted to the NMPUC as required, with the test year typically being the last year's actual results. NMU has been, and, although no assurance can be given, believes that it will continue to be, permitted to increase its rates as necessary to offset its operating costs and achieve a reasonable rate of return. NMU anticipates filing a general sewer rate increase application in 1995, with new rates effective early in 1996.\nSince 1969, NMU has grown in customers, utility plant and its capacity to service its customers. Because there is a large area available for residential, commercial and industrial development and because of recent increased levels of activity in the area, increases in residential and commercial customers are projected for the near future. It should be noted, however, that as the City of Albuquerque (the \"City\") has expanded to the northwest, it has annexed most of NMU's service area. NMU has to date continued to serve the customers located in the annexed areas. Certain representatives of the City have indicated on a continuing basis over a number of years that the City may have an interest in acquiring NMU's assets and merging them with water and sewer systems currently operated by the City. To date, no formal action has commenced or been approved by the City, and NMU does not know when or if such action will be taken by the City.\nThe laws of the State of New Mexico provide that no public agency can install facilities within the service area of a public utility in order to compete with it, except upon payment of just compensation for all damages incurred by the public utility. Under New Mexico law, municipalities and certain other public bodies have the right to acquire private water utility plants and systems within their territorial limits by condemnation. NMU is not aware of any impending proceeding relating to the condemnation of any portion of NMU's facilities.\nNMU's operations are capital intensive. Capital for construction and extension of water distribution facilities is provided from operations, from Registrant, from contributions in aid of construction and from advances from developers. Advances from developers are repaid under the main line extension rules as promulgated by the NMPUC. During 1994 and 1993, capital expenditures approximated $4,295,000 and $927,000, respectively. NMU may draw upon its own $2,500,000 line of credit or may draw upon two revolving lines of credit of Registrant. Registrant believes these lines of credit are sufficient for NMU's short-term anticipated needs. NMU conducts no significant research and development activities.\nEmployees\nNMU employs 12 individuals at the NMU office which is located in NMU's service area. None of NMU's employees is a member of a union. NMU considers its relations with its employees to be satisfactory.\nECO RESOURCES, INC.\nProduct and Business\nOn September 30, 1985, the Registrant purchased all of the outstanding common shares of ECO, a Texas corporation headquartered in the Houston, Texas, metropolitan area. ECO is engaged in providing management and operating services to 79 active governmental and quasi-governmental districts which operate water and wastewater treatment systems in the greater Houston, Texas, area. At December 31, 1994, these systems served 52,286 water and wastewater service connections. ECO also performs associated specialized services for the districts, including equipment maintenance and repair, sewer pipeline cleaning, billing and collection, and state-certified laboratory analysis.\nIn addition, ECO operates water distribution systems and wastewater collection systems under contracts with six cities and water districts in Mississippi. These systems served 29,178 water service connections and 27,617 wastewater service connections at December 31, 1994. ECO also operates 23 water and wastewater service systems in the Austin, Texas, area that served 14,294 water service connections and 7,986 wastewater service connections at December 31, 1994. In 1994, ECO began operating a water and wastewater service system in the Rio Grande area of Southern Texas, serving 3,353 water and wastewater service connections at December 31, 1994. ECO is also engaged in providing operating and maintenance services to six cities or private entities in California. ECO served 6,400 water connections and 11,200 wastewater service connections in California at December 31, 1994.\nAssets held by ECO consist primarily of contracts with water and wastewater districts, 245 vehicles and other equipment used in daily operations.\nCompetition, Regulation and Future Development\nECO operates in an unregulated and competitive market. On August 31, 1993, ECO purchased all of the common stock of SMS, a competitor in the contract operations and maintenance services market in the greater Houston, Texas, area. There is one company in the Houston area that is a significant competitor to ECO and five smaller companies that compete with ECO. There are also four larger competitors that ECO may compete with on an occasional basis. Additionally, there are a number of cities which operate their own water and wastewater facilities. ECO intends to continue to operate in Texas, Mississippi and California, and expand into other areas in the western, southwestern and southeastern United States. ECO will attempt to expand such services to other customers through competitive bidding and negotiated contracts. This expansion may influence the Registrant's liquidity and may also affect the Registrant's results of operations. ECO may draw upon two revolving lines of credit of the Registrant. The Registrant believes these lines of credit are sufficient for ECO's anticipated needs.\nAs the City of Houston and other surrounding cities develop, the water and wastewater treatment facilities currently owned by municipal utility districts and operated by ECO may be condemned by the cities and annexed to the cities' water and wastewater systems. Moreover, all of the contracts with water and wastewater municipal utility districts in the greater Houston, Texas, area and the majority of contracts in the Austin, Texas, area are short-term contracts, which are cancelable on either 30 or 60 days' notice by either party. ECO's operating\ncontracts with cities in Mississippi and California and certain contracts in the Austin and Houston, Texas, areas tend to average three to five years in duration and are generally cancelable only upon breach of contract by either party. In 1994, two contracts were canceled for competitive reasons, two contracts were canceled due to annexation and 12 new contracts were added.\nECO uses certain equipment and commodities in its daily operations, such as chemicals and supplies, which are available in large supply from a number of suppliers, and no significant amounts of such items are required to be carried in inventory. Additionally, ECO's business in Texas is subject to material fluctuations resulting in large measure from seasonal weather variations. ECO holds no patents, trademarks, licenses, franchises or other intangible property believed to be material to its operations. Clients of ECO are, as described above, governmental and quasi-governmental districts, cities or private entities which own water distribution, wastewater collection or wastewater treatment systems. There is no single customer of ECO whose loss would have a material adverse effect on Registrant's operations. ECO conducts no significant research and development activities. To date, ECO has experienced no material adverse effects upon its operations or capital expenditures resulting from compliance with governmental regulations relating to protection of the environment.\nEmployees\nECO employs 314 individuals in management, operations, maintenance and administrative positions. Except for 62 employees in Mississippi, 21 employees in the Rio Grande area of Texas and 23 employees in California, all employees are employed at the offices of ECO in the greater Houston and Austin, Texas, areas. None of its employees is a member of a union. ECO considers its relations with its employees to be satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSUBURBAN WATER SYSTEMS\nThroughout its service areas, Suburban owns and operates water production and distribution systems consisting of well pumping plants, booster pumping stations, reservoir storage facilities, transmission and distribution mains, and service connections to individual customers. In its service areas, Suburban also has rights-of-way or easements necessary to provide its water services. At December 31, 1994, Suburban owned approximately 704 miles of transmission and distribution mains, 26 storage reservoirs with a total capacity of approximately 53 million gallons and 18 wells with a total pumping capacity of approximately 31,000 gallons per minute. These facilities vary as to age and quality, but each is believed by Suburban to be adequate for current operations and in good condition. Suburban is currently revising its master plan which evaluates the adequacy of system operations. In accordance with this master plan, Suburban will continue its capital expenditure program and construct and replace reservoirs, wells, and transmission and distribution lines in future years, as needed.\nNormal maintenance and construction work on these facilities is performed by employees of Suburban, and major construction projects are performed by outside contractors chosen through competitive bidding. Ongoing maintenance and repair is performed by Suburban and constitutes a significant portion of its expenses ($1,365,000 in 1994).\nVirtually all property of Suburban, other than 11.4 acres of vacant land in La Puente, California, is subject to the lien of an Indenture of Mortgage and Deed of Trust dated October 1, 1986 (the \"Indenture\"), as amended February 7, 1990, and January 24, 1992, securing Suburban's first mortgage bonds. The Indenture contains certain restrictions regarding the disposition of property and includes various covenants and restrictions common\nto such types of instruments, including limitations on the amount of cash dividends which Suburban may pay to the Registrant. See Notes 3 and 6 of Notes to Consolidated Financial Statements in the Registrant's 1994 Annual Report to Stockholders, which information is hereby incorporated by reference.\nSuburban's headquarters are located in Covina, California. Suburban is leasing an office building of approximately 14,600 square feet. These administrative offices are adequate for Suburban's headquarters. During 1988, Suburban established a district office in La Mirada of approximately 3,300 square feet to handle customer service activities. This office is in a building owned by Suburban and is believed to be adequate for the Whittier\/La Mirada district office operations. In January 1990, Suburban established a district office in La Puente of approximately 3,600 square feet to handle customer service activities. The office is in a building owned by Suburban and is believed to be adequate for the San Jose Hills district office operations.\nSuburban leases most of its vehicles. Maintenance of such vehicles is performed by outside service garages. Each vehicle used in field or service operations is equipped with two-way radio equipment owned by Suburban. A wholly owned subsidiary of Suburban, Water Suppliers Mobile Communication Service, leases and operates the base station and various other facilities necessary for the operation of the two-way radio communication system.\nNEW MEXICO UTILITIES, INC.\nNMU owns and operates a water production and distribution system consisting of well pumping plants, reservoir storage facilities, booster pumping stations, transmission and distribution mains, and service connections to individual customers. At December 31, 1994, NMU owned approximately 80 miles of transmission and distribution mains and two storage reservoirs with a total capacity in excess of five million gallons. The three wells operated by NMU have a total pumping capacity in excess of 5,325 gallons per minute. In addition, NMU owns and operates a sewer collection system consisting of one lift station and approximately 64 miles of interceptor and collector lines. These facilities vary as to age, and each is believed by NMU to be adequate for current and foreseeable operations. Normal maintenance and construction work on these facilities is performed by employees of NMU or outside contractors. Maintenance and repair expenses approximated $138,000 in 1994. NMU also holds rights-of-way or easements in its service area necessary for its water and sewer services.\nVirtually all of NMU's property is subject to the lien of an Indenture of Mortgage dated February 14, 1992, securing NMU's first mortgage bonds. The bonds are subject to certain restrictions regarding the disposition of such property, and include various covenants and other restrictions, including limitations on the amount of cash dividends which NMU may pay to the Registrant. See Notes 3 and 6 of Notes to Consolidated Financial Statements in the Registrant's 1994 Annual Report to Stockholders, which information is hereby incorporated by reference.\nNMU's administrative office, operating and system control headquarters are all located in one building which is leased by NMU. NMU owns a warehouse building of approximately 2,400 square feet that houses NMU's field supplies and equipment. NMU believes these facilities are adequate for the operation of its business. NMU owns its vehicles, and vehicle maintenance is performed by outside service garages. All vehicles used in the field are equipped with two- way radios owned by NMU.\nECO RESOURCES, INC.\nECO leases approximately 34,000 square feet of office, warehouse and lab space in eight facilities in the greater Houston, Texas, area; the Rio Grande, Texas, area; Mississippi; and California. In 1987, the Registrant purchased the land (4.3 acres) and building (17,000 square feet) that houses ECO's fleet and maintenance department in the Houston, Texas, area. During 1993, ECO purchased land (10 acres) and a building (10,000 square feet) in Austin, Texas. This facility houses ECO's office and fleet and maintenance department that serves the Austin, Texas, area. These facilities are believed to be adequate for the conduct of its business. ECO owns 245 vehicles and other equipment which are used in daily operations. Maintenance on these vehicles is performed by personnel employed by ECO, or by outside service garages.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs described in Registrant's Form 10-K Reports for the years ended December 31, 1992 and 1993, in its Form 8-K Report filed in January 1994, and its Form 10-Q Reports filed March 31, June 30, and September 30, 1994, Suburban was a defendant in three lawsuits arising from a chlorine gas leak that occurred in October 1990 at a Suburban water distribution facility. In two of the actions, the plaintiffs were, respectively, five employees and 22 employees (and some spouses) of a manufacturing plant located adjacent to a water production facility owned and operated by Suburban. In the third action, the plaintiff was the workers' compensation carrier for the operator of the adjacent manufacturing plant. The plaintiffs in the three actions sought general damages in excess of $3.8 million, and the plaintiffs in the action involving 22 employee plaintiffs sought unspecified punitive damages.\nAs earlier reported, in January 1994 Suburban settled with all of the plaintiffs for aggregate cash payments of approximately $1.5 million. These settlements included releases of all claims against Suburban and dismissals with prejudice of the actions and are the last known claims arising out of this incident.\nAt the time of the chlorine gas incident, Registrant and Suburban maintained liability insurance coverage of $20 million. However, the Registrant's primary and excess liability insurance carrier declined to defend or indemnify Suburban on the basis of allegedly applicable exclusions in the policies. Suburban believes it is entitled to defense and indemnity under these policies and filed a lawsuit against the carrier to obtain reimbursement for the full settlement amounts and all associated defense costs. On May 3, 1994, in the U.S. District Court, Central District of California, the insurance carrier was granted a summary judgment dismissing Suburban's action. On May 31, 1994, Suburban appealed this judgment, and the appeal is pending. Suburban is also authorized by the CPUC to seek recovery of defense expenses through future rate proceedings. There is no assurance that recovery of such costs will be allowed. Suburban will not recognize income on these potential recoveries until amounts, if any, are received. Additionally, this litigation will have no future material adverse effect on the Registrant's financial condition or results of operations.\nAs described in the Registrant's Form 10-Q Reports filed March 31, June 30, and September 30, 1994, ECO was named as a defendant in a lawsuit filed on April 15, 1992, in Houston, Texas, by certain homeowners and Pulte Home Corporation of Texas (Pulte). The plaintiffs allege that in 1989 ECO, as an independent contractor for Municipal Utility District #81 (MUD #81) in Houston, Texas, failed to change the treatment of the water supplied to plaintiffs after the plaintiffs made MUD #81 and ECO aware of highly corrosive elements in the water supplied. Plaintiffs additionally allege that this resulted in accelerated corrosion of residential plumbing pipes. The original complaint requested unspecified special damages and reasonable attorneys' fees.\nOn April 24, 1994, the plaintiffs filed an amended complaint which alleges additional causes of action against\nECO. The amended complaint alleges that plaintiffs have sustained more than $838,000 in repair damages and will incur future expenses for home repairs in the sum of $1,000,000 if the water remains untreated. Plaintiffs also allege mental pain and anguish as a result of plumbing failures, loss of home values and that ECO's conduct constitutes gross negligence. Plaintiffs are seeking at least $1,000,000 in exemplary damages. Pulte now also claims that defendant MUD #81 failed to require its agent, ECO, to change the treatment of the water to eliminate accelerated corrosion of pipes and has included MUD #81 as a direct defendant in the amended complaint.\nAs of the date when damages are first alleged to have occurred (1989) and thereafter, the Registrant and ECO maintained liability insurance coverage of $20 million. ECO's primary liability carrier is providing a defense for the primary cause of action against ECO, but has reserved all rights as to allegations that ECO knowingly committed intentional acts constituting \"deceptive trade practices\" and \"negligence.\" The Registrant believes the ultimate resolution of this matter will not have a material adverse effect on its consolidated financial condition or results of operations.\nAs described in the Registrant's Form 10-Q Reports filed June 30, 1994, and September 30, 1994, ECO and Southbend Municipal Utility District (Southbend) were named as defendants in a lawsuit filed on February 15, 1993, in Harris County, Texas, by a homeowner customer. The plaintiffs alleged that ECO, as an independent contractor for Southbend in Houston, Texas, failed to adequately test the water delivered to residents to detect contaminants that would cause harm to persons in the Southbend subdivision. Plaintiffs also alleged physical and mental personal injuries resulting from defendants' alleged negligence. ECO vigorously defended the case and defense counsel discovered facts indicating that the action was barred by res judicata resulting from a settlement in an earlier similar action. Such counsel made an appropriate demand upon plaintiffs and, on January 13, 1995, the plaintiffs filed a motion requesting dismissal of this action against ECO. Such motion was granted without prejudice as to all plaintiffs on January 20, 1995. As a result, the Registrant believes the ultimate resolution of this matter will not have a material adverse effect on its consolidated financial condition or its results of operations. A second independent lawsuit by another Southbend customer was filed in March 1993 with substantially the same allegations as to ECO's performance. No specific damages were claimed in that action. The Registrant applied the successful defense strategy used in the first litigation to this second litigation. In March 1995, the plaintiffs filed a motion for non-suit of all plaintiffs' claims against ECO which, if granted, will result in a dismissal of this action as to ECO. The Registrant believes the ultimate resolution of this matter will not have a material adverse effect on its consolidated financial condition or results of operations. As of the dates of the alleged damages, the Registrant and ECO maintained liability insurance coverage of $20 million. ECO's primary liability carrier is providing a defense for these lawsuits.\nSuburban is a defendant and cross defendant in two actions filed in, respectively, March 1994 and June 1994 in the Superior Court of Los Angeles County and arising out of a slope slide or failure in 1992 in a hilly, residential development in West Covina, California. One of the plaintiffs, Dr. Mendoza, is the owner of a residence located below the failed slope. The other plaintiff, South Hills Home Partnership, is a developer of a tract of lots, including one lot adjacent to the failed slope. Defendants in the actions include the owners of the lot above and containing the failed slope, Suburban and an engineer and contractor who directed and conducted repair work to the slope after a prior failure in 1978.\nThe two actions have been consolidated for all purposes and allege causes of action for strict liability, negligence, nuisance, willful and negligent trespass and intentional and negligent interference with prospective economic advantage. Damages are unspecified as to amount and, in addition, the plaintiffs request unspecified punitive damages and injunctive relief. As against Suburban, the plaintiffs allege improper construction of a water line maintained by Suburban in an easement on the failed slope, damage from breakage of the line in 1978 and improper repair of the slope after the 1978 slope failure. Certain of the defendants have also cross-complained against Suburban for indemnity and contribution.\nAs of the date of the 1992 slope failure, the Registrant and Suburban maintained liability insurance coverage of $20 million. Suburban's primary liability carrier is providing a defense in the consolidated action, and Suburban is vigorously defending all claims. At the initiation of Suburban's defense counsel, Dr. Mendoza dismissed his action against Suburban in March 1995 and defense counsel is discussing with South Hills Home Partnership a similar dismissal as to Suburban. Suburban believes that it has meritorious defenses to all claims in the consolidated action and that if Suburban were determined to have any liability in the action such liability would be fully covered by the liability insurance maintained by Suburban and the Registrant. Accordingly, the Registrant believes that the ultimate resolution of this matter will not have a material adverse effect on its consolidated financial condition or results of operations.\nIn June 1994, the Registrant received a written request for information from the Enforcement Division of the Securities and Exchange Commission (the \"Commission\") concerning trading in the common stock of the Registrant from July 1993 to August 1993. The Registrant voluntarily responded to such request in July 1994. In October 1994, the Registrant was again contacted by the Commission to arrange for oral depositions of the Registrant's directors, its three officers and one employee of the Registrant. Concurrently, the Commission served subpoenas requesting documents and records of the deponents. The individual deponents responded to such subpoenas, and the depositions were taken in late 1994. Legal counsel for the Registrant was present at all depositions.\nThe Registrant believes that the Commission's inquiry is focused upon several small sales of the Registrant's stock. These sales occurred prior to the public announcement of a dividend reduction on August 13, 1993. The Registrant's management believes that the Commission's inquiry is directed at whether such sales were made on the basis of inside information concerning that dividend reduction.\nThe Registrant has had a written policy for a number of years prohibiting its officers, directors and employees both from trading on the basis of inside information and from providing such information to others. This policy has been communicated to all officers and directors as well as key employees. The Registrant is not aware of any officer, director or employee who provided any inside information to any person making the sales being examined by the Commission.\nTo date, no formal action has been initiated by the SEC. Moreover, the Registrant is aware of no allegation of any improper conduct by the Registrant, its officers or directors. Because of the written policy of the Registrant on insider trading described above, the absence of facts suggesting improper use of inside information, and the absence of any formal charge to date, the Registrant believes that should the SEC initiate a formal action, the Registrant would have meritorious defenses and ultimately prevail.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Registrant are elected each year by the Board of Directors at its first meeting following the Annual Meeting of Stockholders, to serve during the ensuing year and until their respective successors are elected and qualify. There are no family relationships between any of the executive officers of the Registrant, nor are there any agreements or understandings between any such officer and another person pursuant to which he or she was elected an officer. There are no legal proceedings involving any executive officer of the types required to be disclosed pursuant to the instructions to this item. The executive officers of the Registrant and its subsidiaries are as follows:\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation with respect to the market for and number of holders of the Registrant's common shares and quarterly market and dividend information is set forth under the caption \"Market and Dividend Information\" in the Registrant's 1994 Annual Report to Stockholders and is hereby incorporated by reference. Portions of such Report are included as Exhibit 13.1 to this filing. The number of holders of record of the Registrant's Common Shares was computed by a count of record holders as of December 31, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information included under the caption \"Selected Financial Data\" of the Registrant's 1994 Annual Report to Stockholders is hereby incorporated by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRegistrant incorporates by reference the information set forth under the caption \"Management's Discussion and Analysis\" in the Registrant's 1994 Annual Report to Stockholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated balance sheets indicating the financial position of the Registrant at December 31, 1994 and 1993, and consolidated financial statements reflecting the results of its operations and changes in its cash flows for the three-year period ended December 31, 1994, together with the notes thereto and the report thereon of KPMG Peat Marwick LLP, independent auditors, as well as selected quarterly financial information under the caption \"Unaudited Quarterly Financial Information,\" are contained in the Registrant's 1994 Annual Report to Stockholders, which statements, notes and report are hereby incorporated by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES\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 Registrant is set forth in the Registrant's definitive Proxy Statement, dated March 20, 1995, and filed with the Commission, under the captions \"Proposal 1: Election of Directors\" and \"Information Regarding the Board of Directors,\" and is hereby incorporated by reference.\nInformation relating to the executive officers of the Registrant appears in Item 4A of this Form 10-K Annual Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation relating to management remuneration is contained in the Registrant's definitive Proxy Statement, dated March 20, 1995, and filed with the Commission, under the captions \"Executive Compensation and Other Information\" and \"Information Regarding the Board of Directors,\" and is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation with respect to beneficial ownership of the Registrant's voting securities by each director and by all officers and directors as a group, and by any person known to beneficially own five percent or more of any class of voting security of the Registrant, is set forth in the Registrant's definitive Proxy Statement, dated March 20, 1995, and filed with the Commission, under the caption \"Beneficial Ownership of the Company's Securities,\" and is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to certain relationships and related transactions is set forth in the Registrant's definitive Proxy Statement, dated March 20, 1995, and filed with the Commission, under the caption \"Executive Compensation and Other Information,\" and is hereby incorporated by reference.\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a)(1) The financial statements listed below are incorporated from Registrant's 1994 Annual Report to Stockholders included as Exhibit 13.1 to this filing:\nConsolidated Statements of Income for the years ended December 31, 1994, 1993 and 1992 Consolidated Balance Sheets at December 31, 1994 and 1993 Consolidated Statements of Changes in Common Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992 Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 Notes to Consolidated Financial Statements Independent Auditors' Report\n(a)(2) The supplementary financial statement schedules required to be filed with this report are as follows:\nPage ----\nIndependent Auditors' Report on Supplementary Note to Consolidated Financial Statements and supporting schedule..................................... 19\nSupplementary Note to Consolidated Financial Statements... 20\nSchedule VIII - Valuation and Qualifying Accounts......... 21\nSchedules not listed above are omitted because of the absence of conditions under which they are required, or because the information required by such omitted schedules is included in the financial statements or notes thereto.\n(a)(3) Exhibit Index.................................................. 22-24\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed for the three months ended December 31, 1994.\nINDEPENDENT AUDITORS' REPORT\nThe Stockholders and Board of Directors Southwest Water Company:\nUnder date of January 23, 1995, we reported on the consolidated balance sheets of Southwest Water Company and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, changes in common stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1994, as contained in the 1994 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 1994. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related supplementary note and financial statement schedule as listed in the accompanying index. The supplementary note and financial statement schedule is the responsibility of the Registrant's management. Our responsibility is to express an opinion on the supplementary note and financial statement schedule based on our audits.\nIn our opinion, such supplementary note and financial statement schedule, 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 LLP\nLos Angeles, California January 23, 1995\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES\nSUPPLEMENTARY NOTE TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nNOTE 14. OPERATING REVENUES AND DIRECT OPERATING EXPENSES\nIncluded in operating revenues and direct operating expenses are the following:\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES EXHIBIT INDEX\nSOUTHWEST WATER COMPANY AND SUBSIDIARIES SIGNATURES\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 by the undersigned thereunto duly authorized:\nSOUTHWEST WATER COMPANY\nFebruary 21, 1995 By: \/s\/ ANTON C. GARNIER -------------------------------- Anton C. Garnier Director and President (Principal 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\/ DIANE CASTELLO PITTS ------------------------------ Diane Castello Pitts, 2\/21\/95 Corporate Controller and Treasurer (Principal Financial and Accounting Officer)\nDirectors: ----------\n\/s\/ MICHAEL J. FASMAN \/s\/ DONOVAN D. HUENNEKENS ------------------------------ -------------------------------- Michael J. Fasman, 2\/21\/95 Donovan D. Huennekens, 2\/21\/95 Director Director\n\/s\/ MONROE HARRIS \/s\/ RICHARD G. NEWMAN ------------------------------ -------------------------------- Monroe Harris, 2\/21\/95 Richard G. Newman, 2\/21\/95 Director Director\n\/s\/ RICHARD KELTON ------------------------------ Richard Kelton, 2\/21\/95 Director","section_15":""}
{"filename":"795185_1994.txt","cik":"795185","year":"1994","section_1":"ITEM 1. BUSINESS.\nA. General Development of Business.\na.\tGeneral\nOn September 28, 1994, O'Brien Environmental Energy, Inc., the parent company, filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code. See \"Business -- General Development of Business -- Significant Factors -- Liquidity; Chapter 11 Bankruptcy Filing\". The Company was originally formed in Florida in 1981 and subsequently merged with a Delaware corporation in 1984. Prior to the merger, the Company was part of a group of several other companies owned by members of the family of Frank L. O'Brien III, Chairman of the Board, Chief Executive Officer and controlling shareholder of the Company, which had served the power generation market since 1915. On July 1, 1991, the Company changed its name from O'Brien Energy Systems, Inc. to O'Brien Environmental Energy, Inc.\nThe Company is mainly in the business of developing cogeneration, waste heat recovery and biogas projects which produce electricity and thermal energy for sale under long-term contracts with industrial and commercial users and public utilities. In its role as a developer of energy projects the Company has developed the following projects, which it currently has an ownership interest in:\n(a)\tThe 32 megawatt California Milk Producers Project (in which the Company has a 3% general partnership interest) began operations in February 1990;\n(b) The 52 megawatt Newark Boxboard Project (which is owned 100% by the Company) began operations in November 1990;\n(c) The 122 megawatt E.I. du Pont Parlin Project (which is owned 100% by the Company) began operations in June 1991;\n(d) Totalling 9.2 megawatts, the Company currently owns 100% of and operates four biogas projects in Pennsylvania and California;\n(e) During 1993, the Company expanded into the area of standby\/peak shaving projects which utilize the Company's power generation equipment as a backup source of electricity for large customers and has developed and operates a 22 megawatt project in Pennsylvania (which is owned 83% by the Company).\nCurrently the Company has in excess of 140 megawatts of cogeneration, biogas and standby\/peak shaving projects in the stage of development where certain key contracts and permits are already in place. The Company also has in excess of 200 megawatts of projects which it is currently evaluating or bidding on.\nIn addition to the portfolio of projects which it currently has an ownership percentage in, the Company has developed in excess of 200 megawatts of other projects which it has since sold or divested of in various stages of the development process.\nThe Company expanded its equipment sales, rentals and services business by acquiring Puma Power Plant Limited (\"Puma\"), a United Kingdom company, in 1988 and Mobile Power Rental Company (now operating under the name O'Brien Energy Services Company) (\"O'Brien Energy Services\") in 1990.\nIn 1989, the Company acquired American Hydrotherm Corporation (\"American Hydrotherm\") and a related company to engineer, manufacture, install and service waste heat recovery systems based upon patented technology for industrial processing applications.\nReferences in this Report to the \"Company\" mean O'Brien Environmental Energy, Inc. and, where relevant, its wholly-owned subsidiaries.\nb. Significant Factors\nThe items discussed in this \"Significant Factors\" section have had a negative impact on the Company's cash flow, its ability to meet current obligations and its ability to finance operations and ongoing development activities, and should be carefully considered:\n(i) Liquidity; Chapter 11 Bankruptcy Filing\nOn September 28, 1994, O'Brien Environmental Energy, Inc., the parent company, filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code with the U.S. Bankruptcy Court for the District of New Jersey to pursue financial restructuring efforts under the protection afforded by the U.S. bankruptcy laws. The decision to seek Chapter 11 relief was based on the conclusion that action had to be taken to preserve its relationships and maintain the operational strength and assets of the Company, and to restructure its debt and utilize its assets in a manner consistent with the interests of all creditors and shareholders rather than liquidate to satisfy the demands of a particular group of creditors. The Company expects to continue its normal activities, including project development and the sale and\/or refinancing of existing projects.\n\t Subsequent to September 28, 1994, the Company is operating as debtor-in-possession under the Bankruptcy Code. As such, the Company is authorized to operate its business, but may not engage in transactions outside the ordinary course of business without approval, after notice and hearing, of the Bankruptcy Court. There can be no assurance that the Company will be able to obtain such approval to continue its normal operations and restructure its debt and otherwise engage in project development and the sale or refinancing of existing projects.\nAs a result of this action, pending litigation against the Company (but not its subsidiaries) will be stayed and consolidated with this bankruptcy proceeding. The Company has also been advised that its securities are being delisted from the American Stock Exchange, however, the Common Stock continues to be listed on the Philadelphia Stock Exchange. The Company intends to have its Debentures included in either the OTC Bulletin Board or the \"pink sheets.\" There can be no assurance that a trading market will develop for any of the Company's securities even if they are listed on any of the foregoing exchanges or quotation systems. See \"Market for Registrant's Common Equity and Related Stockholder Matters.\"\n(ii) Defaults Under Indentures; Proposed Exchange Offer\nOn August 22, 1994, the trustees for each of the 1987 Debentures, 1990 Debentures and 1991 Debentures delivered acceleration notices to the Company, notifying the Company that the total principal amount of $49,174,000 and past due interest in the amount of $5,243,000 as of September 20, 1994, is due and payable by the Company immediately based on the following factors:\nThe Board of Directors elected not to make the March 15, 1994 or the September 15, 1994 semi-annual required interest payments on the Debentures which total $5,037,000. Each semi-annual required interest payment consists of $442,000, $632,500 and $1,444,000 for the 1987 Debentures, 1990 Debentures and 1991 Debentures, respectively.\nAs a result of the losses experienced by the Company, the Company's Consolidated Stockholders' Equity (as defined in the 1987 Indenture, 1990 Indenture and 1991 Indenture) was $136,000 and $8,066,000 at June 30, 1994 and March 31, 1994, respectively. As a result, the covenant in the 1990 Indenture and 1991 Indenture requiring the Company to purchase 7.5% of the outstanding 1990 Debentures and 1991 Debentures if the Company's Consolidated Stockholders' Equity is less than $10,000,000 at the end of each of any two consecutive fiscal quarters has been triggered. Additionally, there is a covenant in the 1987 Indenture which requires the Company to purchase 7.5% of the outstanding 1987 Debentures if the Company's Consolidated Stockholders' Equity is less than $7,500,000 at the end of each of any two consecutive fiscal quarters. Purchasing Debentures pursuant to these covenants would cause severe liquidity problems for the Company. The Company does not presently expect to be in a position to comply with these covenants.\nThe Company is currently in default under the 1987 Indenture's Funded Indebtedness covenant (as defined in the 1987 Indenture). Such covenant prohibits the Company from incurring or creating any Funded Indebtedness if after giving effect to such incurrence or creation, the total outstanding Funded Indebtedness of the Company on a consolidated basis would exceed 75% of the sum of Consolidated Stockholders' Equity and Funded Indebtedness.\nIn May 1994, the Company filed a Registration Statement on Form S-4 (the \"Registration Statement\") with the Securities and Exchange Commission relating to (a) an exchange offer of 40 shares of Series A Cumulative Senior Preferred Stock, 120 Warrants to purchase Class A Common Stock and 20 shares of Class A Common Stock for each $1,000 principal amount of 1987 Debentures, 1990 Debentures and 1991 Debentures outstanding and (b) a solicitation of consents to certain proposed amendments to the indentures (the \"Indentures\") governing each of the 1987 Debentures, 1990 Debentures and 1991 Debentures as well as the waiver of all defaults under each of the Indentures. In June 1994, an amendment to the Registration Statement was filed. Subsequent to such amendment, the Company began discussions with an ad hoc committee (the \"Ad Hoc Committee\") of debentureholders representing holders of the 1987 Debentures, 1990 Debentures and 1991 Debentures. The Company entered into a standstill agreement with the Ad Hoc Committee pursuant to which the Company agreed, among other things, to assist the Ad Hoc Committee in its due diligence efforts. The failure to reach an agreement with the Ad Hoc Committee was one of the factors upon which the Company's decision to file for protection under the Bankruptcy Code was based.\nCertain of the Company's loan agreements require the Company to comply with the terms of all other loan agreements. As a result of the Company's defaults under the Indentures, defaults were triggered under certain of the Company's recourse debt loan agreements. At June 30, 1994, $5,320,000 of the Company's long term debt was reclassified as a current liability solely because of these cross-defaults. Additionally, it is an Event of Default under the 1987 Indenture, 1990 Indenture and 1991 Indenture if the Company defaults on any indebtedness which results in the acceleration of the maturity of at least an aggregate of $1,000,000, $2,000,000 and $2,000,000, respectively, of indebtedness which is not cured within 60 days, 90 days and 90 days, respectively, after notice to the Company. See \"Defaults under Recourse Debt\".\n(iii) Losses\nThe Company has incurred losses in the amounts of $16,501,000 and $13,711,000 for the fiscal years ended June 30, 1994, and June 30, 1993, respectively. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The Company may continue to incur losses from operations for the fiscal year ending June 30, 1995.\n(iv) Capital Requirements\nThe Company's business is capital intensive. The long-term growth of the Company, which involves the development and acquisition of additional projects, will require the Company to seek substantial funds through various forms of financing. There can be no assurance that the Company will be able to arrange the financing needed for these additional projects. If the Company is unable to secure financing, its business would be materially adversely affected. See \"Business--Energy Segment.\"\n(v) Energy Price Fluctuations and Fuel Supply\nThe Company's power purchase agreements with utilities typically contain price provisions which in part are linked to the utility's cost of generating electricity. In addition, the Company's fuel supply prices may be fixed in some cases or may be linked to fluctuations in energy prices. As a result, in the event of significant fluctuations in energy prices, the operating margins of certain projects may be reduced or increased depending upon the terms of the project agreements. In addition, in the event of a significant continuing decline or increase in energy prices, there can be no assurance that the Company's existing customers or suppliers will not attempt to renegotiate existing power purchase or supply agreements on terms less favorable to the Company. To date, renegotiation of the Company's agreements has had no material adverse impact on its operations. In addition, the Company seeks to enter into long-term gas supply arrangements for certain of its cogeneration projects under development. To date, the Company has not obtained long-term supply arrangements that directly track project revenue. The operation of the Company's projects may be more vulnerable to interruption in times of fuel shortage. While it is impossible to predict how such developments will affect the Company's overall business, the Company's profit margins on certain of its projects may be reduced if the increased cost of fuel used to operate those projects exceeds the adjustment to the amounts received by the Company from the utilities pursuant to the related power purchase agreements. Fuel risk may be reduced by entering into a long-term gas supply arrangement or hedge which the Company has explored from time to time. However, there can be no assurance that any of the foregoing will improve or maintain gross profit margins in the future. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Costs and Expenses.\"\n(vi) Defaults Under Recourse Debt\nAs a result of defaults, consisting of defaults in the payment of interest under each of the Indentures as well as defaults under certain of the Company's loan agreements, including the filing for bankruptcy, the Company reclassified $21,914,000 out of a long- term to a current classification resulting in a total of $39,042,000 of its recourse debt as a current liability. Of this amount, approximately $5,320,000 was triggered solely by defaults under the Indentures, $3,066,000 by cross defaults and the non payment of principal subsequent to year end and the remainder, $13,528,000 was solely reclassified because of the bankruptcy filing. The Company was having discussions with its various lenders regarding the defaults and was developing a program to restructure this debt. The program was intended to provide, among other things, an extended amortization of the debt and the sale of equipment which is not currently being utilized in an operating project or which has not been designated for a project under development. Also, as a result of this program, the Company recorded a non-cash charge of $6,250,000 in the fourth quarter of 1994 to adjust the carrying value of these collateralized assets to an estimated sales value. Prior to the filing of the Chapter 11 Bankruptcy, the program had been met with approval by several of the Company's lenders and no lender had accelerated the payment of the loans. As a result of the Chapter 11 Bankruptcy filing, there can be no assurance that the program will continue to be accepted by the Company's lenders.\n(vii) Defaults Under Non-Recourse Debt\nAt June 30, 1994, both the Newark and Parlin projects were in default of the covenant which requires the maintenance of positive working capital. On September 26, 1994, the project lenders agreed to waive this covenant through July 1, 1995, for the Parlin Project only, provided that during the period that this waiver is in effect no distribution of any nature whatsoever will be made to the Company. This waiver will cease to be effective in the event that the Parlin Project is in compliance with the requirement to maintain positive working capital at any time prior to June 30, 1995. The lenders were not willing to provide a similar waiver for the Newark project. As a result of the Newark project not getting the waiver, $25,010,000 of non-recourse debt has been reclassified from long-term to short-term debt.\n(viii) Fire\nIn December 1992, a fire occurred at the Company's Newark cogeneration plant. The damage to the plant caused by the fire has been repaired. The plant returned to partial operation in August 1993 and resumed full operation in October 1993. The Company received the sum of $36,000,000 which covered a substantial majority of the Company's cost of repair and loss of net profits due to business interruption. In addition, the Company has the right to receive up to an additional $1,400,000 upon the recovery by the insurance carrier of its claims against third parties. See \"Business--Energy Segment--Projects in Operation\" and \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\n(ix) Audit Report - Uncertainty\nDuring the years ended June 30, 1994 and June 30, 1993, the Company experienced significant operating problems and setbacks which have contributed significantly to the Company's losses and liquidity problems in fiscal 1994 and fiscal 1993. Additionally, O'Brien Environmental Energy, Inc., the parent company, filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code on September 28, 1994. All of these have had a negative impact on the Company's cash flow and its ability to finance operations and ongoing development activities. Therefore, the Company's independent accountants have included an explanatory paragraph relative to a going concern uncertainty in their audit report. See Note 1 to the Company's Consolidated Financial Statements.\n(x) III Enterprises, Inc. Bankruptcy\nIn October 1993, III Enterprises, Inc., (\"III Enterprises\") which owns the controlling voting interest in the Company, filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. III Enterprises is wholly owned by Frank L. O'Brien III, Chairman of the Board and Chief Executive Officer of the Company. In connection with any reorganization of III Enterprises, the stock ownership of III Enterprises which owns the controlling shares of Class B Common Stock of the Company may be sold to a third party. III Enterprises has advised the Company that improper actions by one of III Enterprises' lenders forced III Enterprises to seek protection under the Federal Bankruptcy Code. In April 1994, III Enterprises and its creditors entered into a stipulation which set forth certain key dates for implementing a plan of reorganization. The debtor sought and obtained an extension of certain time periods in the stipulation to September 30, 1994. The debtor has since filed motions to extend the time periods in the stipulation. On October 6, 1994, the bankruptcy court ordered that the matter be converted to a proceeding under Chapter 7 of the Federal Bankruptcy Code. On October 7, 1994, the debtor appealed this order.\nIn addition, such proceeding could cause a change in control of the Company, which could, among other things, significantly affect the direction of the management of the Company and limit the utilization of the Company's net operating loss carryforwards available at June 30, 1994 in accordance with IRS regulations. See Note 23 to the Consolidated Financial Statements.\n(xi) Stock Price\nFor the fiscal quarter ended June 30, 1994, the high and low sale prices for the Company's Class A Common Stock as reported on the American Stock Exchange were $13\/8 and $7\/16, respectively, as compared to $415\/16 and $311\/16, respectively, for the fiscal quarter ended June 30, 1993. The Company was notified on October 4, 1994 that its securities would be delisted by the American Stock Exchange. See \"Market for Registrant's Common Equity and Related Stockholder Matters.\"\nc. Recent Developments\nThe following are certain of the Company's recent developments:\n(i) Hackensack Meadowlands Project\nIn September 1993, the Company was awarded (pursuant to a competitive bidding process) gas recovery rights by the Hackensack Meadowlands Development Commission for two landfill sites located in New Jersey. The Company is considering alternatives including developing and producing the landfill gas from this project to supply fuel for the Newark Boxboard project. Development of this project is not expected to be completed until 1996, at the earliest. See \"Business--Energy Segment--Projects in Development.\"\n(ii) Philadelphia Water Department Project\nOn August 5, 1994, the Company repurchased an 83% interest in the Philadelphia Water Department project from an unrelated private investor for $5,000,000. This repurchase was funded by a loan from a third party. The Company is negotiating to resell this project to a third party in fiscal 1995. The Company sold its interest in this project for a price of $5,000,000 in November 1993 and retained the right to repurchase an 83% interest in the project for $5,000,000. In connection with the November 1993 sale, the Company issued a total of 5,500,000 warrants to purchase the Company's Class A Common Stock including 2,500,000 warrants having an exercise price of $4.00 per share and are exercisable through November 10, 1995; 2,000,000 warrants having an exercise price of $5.00 per share and are exercisable through November 10, 1996; and the balance of such warrants (1,000,000) have an exercise price of $6.00 per share and are exercisable through November 10, 1997. Following the issuance of the warrants, the private investor filed a Schedule 13D with the SEC disclosing the acquisition of the warrants. See \"Business--Energy Segment-- Projects in Operation--Standby\/Peak Shaving.\" See Note 31 to the Company's Consolidated Financial Statements for a discussion of these transactions.\n(iii) Stewart & Stevenson Credit Facility\nIn November 1993, the Company entered into a letter of intent and then in March 1994, the Company entered into a $7,000,000 subordinated loan agreement with Stewart & Stevenson, a major equipment supplier and operation and maintenance company. The first disbursement of $1,000,000 was funded on January 13, 1994. The second disbursement of $3,500,000 was funded on March 16, 1994. The availability of a third disbursement of $2,500,000 has expired. This third disbursement was intended to be utilized for prepayment of debt at the Newark Boxboard project level and to satisfy the $1,000,000 million note between the Company and Stewart & Stevenson. The Company currently intends to repay the proceeds of the Stewart & Stevenson credit facility upon the refinancing of the Newark Boxboard term loan. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Capital Resources--Working Capital Requirements.\"\n(iv) Tinicum Project\nIn December 1993, the Company executed an energy service agreement with the City of Philadelphia for a 14 megawatt standby electric facility project at the Philadelphia International Airport. On September 27, 1994, the Company sold its rights to this project for net cash proceeds of $1,652,000. See \"Business-- Energy Segment--Sale of Projects in Development.\"\n(v) SmithKline Project\nIn February 1994, the Company executed an energy service agreement with SmithKline Beecham Corporation for a 21 megawatt standby electric facility project in Montgomery County, Pennsylvania. On June 30, 1994 the Company entered into an Amended Energy Service Agreement Transaction with SmithKline Beecham Corporation and PECO Energy Company whereby the Company sold its rights in the 21 megawatt facility to PECO. The amended agreement also includes provisions for the Company to construct an 8 megawatt standby power facility for SmithKline Beecham. The Company will be paid $2,500,000 in installments through June 1995, for the 8 megawatt facility which must be completed no later than December 31, 1995. See \"Business--Energy Segment--Projects in Development.\"\nB. Financial Information About Industry Segments.\nDuring the fiscal year ended June 30, 1994, the Company operated principally in two industry segments: (i) energy - the development, ownership and operation of biogas projects and the development and ownership of cogeneration and waste heat recovery projects through wholly-owned subsidiaries and limited partnerships; and (ii) equipment sales, rentals and service - the selling and renting of power generating, cogenerating and standby\/peak shaving equipment and services. Fees recognized in connection with the development and construction of cogeneration projects formed as limited partnerships are related to energy projects.\nSee Note 25 to the Consolidated Financial Statements of the Company for financial information with respect to industry segments.\nC. Narrative Description of Business.\nGeneral\nThe Company develops, owns and operates cogeneration, waste heat recovery and biogas projects which produce electricity and thermal energy for sale under long-term contracts with industrial and commercial users and public utilities. Cogeneration involves the sequential production of two or more forms of usable energy (i.e. electricity and thermal energy) using a single fuel source, thereby substantially increasing fuel efficiency. A waste heat recovery project utilizes heat resulting from industrial processes as the energy source for the simultaneous production of steam and electricity in a manner similar to cogeneration. Biogas projects such as the Company's landfill and sewage digester gas projects collect otherwise wasted and unproductive methane gas and convert it into usable energy. These projects offer an industrial user potential cost savings and, where electricity is sold to the user, increased reliability and added security against power failures.\nAs a project developer, the Company serves as a single source responsible for the evaluation, design, installation and operation of a project. The Company also assumes the responsibility for evaluating project alternatives; obtaining financing, insurance, all necessary licenses, permits and certifications; conducting contract negotiations with local utilities and arranging turnkey construction. In connection with obtaining financing, the Company may negotiate for credit support facilities with equipment suppliers, large turnkey construction firms and financial institutions. Potential project structures include sole ownership, general partnerships, limited partnerships, sale leaseback arrangements and other forms of joint ventures or debt arrangements. To date, other than the limited partnership substantially owned by a subsidiary of Chrysler Capital Corporation, the Company's projects in operation have been structured as wholly-owned subsidiaries.\nThe Company sells the electricity produced by its projects pursuant to long-term contracts either on a \"wholesale\" basis to local public utilities or on a \"retail\" basis directly to specific industrial and commercial users. Presently, substantially all of the electricity produced by the Company's projects in operation is sold on a wholesale basis. The mix of future energy sales may differ based upon future economic conditions and other circumstances.\nA large portion of the Company's business relates to design and assembly of power generation systems for sale and rental, electrical control and distribution subsystems, and high temperature heat transfer equipment and subsystems.\nDuring 1993, the Company expanded into the area of standby\/peak shaving projects which utilize the Company's power generation equipment as a back-up source of electricity for large customers. These projects are intended to fill a need between large electrical users and the requirements of local utilities. The availability of an alternative energy source allows these customers to benefit from significantly discounted interruptible energy tariffs. The standby\/peak shaving generators typically will be required to provide a limited amount of electricity during peak periods.\nAt present, the Company has eight projects in operation totalling approximately 237 megawatts of electric generating capacity including seven wholly-owned projects developed by the Company totalling approximately 205 megawatts and one approximately 32 megawatt project which was developed by the Company and is presently owned substantially by a subsidiary of Chrysler Capital Corporation.\nIndependent Power Market\nThe independent power market (the market for power generated by companies other than traditional utilities) has evolved and is expected by the Company to continue to expand as a result of the growing need for new and replacement power capacity by electric utilities and industrial customers. Historically, regulated utilities in the United States have been the only producers of electric power intended primarily for sale to third parties. The increase in oil prices during the late 1970s and the increasing cost of constructing and financing large coal-fired or nuclear generating facilities along with the enactment in 1978 of the Public Utilities Regulatory Policies Act (\"PURPA\"), created a favorable regulatory environment and favorable market conditions for the development of energy projects by companies other than electric utilities. The basic policy judgment behind the encouragement of the development of biogas and cogeneration facilities is that the United States' dependence on oil and natural gas resources should be reduced and that the very high incremental costs of large centralized power production facilities should be avoided. However, economic considerations remain the central issue affecting a decision to install a cogeneration project.\nPURPA provided significant incentives to developers of qualifying facilities. It designated certain small power production (those utilizing renewable fuels and having a capacity of less than 80 megawatts) and cogeneration facilities as qualifying facilities exempt from many of the regulatory requirements applicable to electric utilities and eligible for various benefits under federal law. In accordance with PURPA, the Company's projects are exempt, and its proposed projects are intended to be exempt, from rate, financial and similar regulation as a utility as long as they meet the requirements of a qualifying facility. These projects also benefit from regulations that require public utilities to purchase power generated by qualifying projects either at the utilities' \"avoided cost\" (determined in accordance with a formula which varies from state to state but which is generally calculated based upon what the cost to the utility would be to generate the power itself or to purchase it from another source). Power purchase contracts generally must be approved by state public utility commissions. Since the Company benefits from PURPA, the Company's business could be adversely affected by a significant change in PURPA and could otherwise be materially impacted by decisions of federal, state and local legislative, judicial and regulatory bodies. See \"Business--Regulation.\"\nThe Company believes that independent power producers will become increasingly more important to electric utilities as alternative long-term sources of electric power. According to the North American Electric Reliability Council's 1991-2000 Electricity Supply and Demand Report, electric utilities have forecasted that they will need an additional 87,700 megawatts of new generating capacity between 1991 and the year 2000 to meet peak demand. The U.S. Department of Energy's Spring 1991 \"National Energy Strategy\" projects this need at up to 200,000 megawatts between 1991 and the year 2010. According to this report, $100 billion to $200 billion in new capital investment will be needed to meet the nation's growing electricity needs during the period from 1991 to 2001. Since the independent development and ownership of cogeneration projects requires little, if any, capital investment by those public utilities utilizing this power, and requires these public utilities to pay only for capacity and energy actually produced and delivered, utilities may avoid the cost and risk of building new plants as demand grows by purchasing needed power from independent power producers.\nMany organizations, including equipment manufacturers and subsidiaries of utilities and contractors, as well as other organizations similar to the Company, have entered the market of the ownership and operation of cogeneration and biogas projects. Many of these companies have substantially greater resources than the Company. In addition, obtaining power contracts with utilities has become more competitive with the increased use of competitive bidding procedures. This increased competition may make it more difficult for the Company to secure future projects, may increase project development costs and may reduce the Company's operating margins on any future projects.\nProducts and Markets\nCogeneration. Cogeneration involves the sequential production of two or more forms of usable energy (i.e. electricity and thermal energy) using a single fuel source, thereby substantially increasing fuel efficiency. The key elements of a cogeneration project are permit applications, contracts for sales of electricity and thermal energy, contracts or arrangements for fuel supply, and project financing and construction. The Company attempts to design and develop its projects so that they qualify for the benefits of PURPA, which exempts qualifying projects from rate, financial and similar utility regulation and requires public utilities to purchase power generated by these projects. Electricity may be sold to utilities and end users of electrical power, including large industrial facilities. Thermal energy from cogeneration plants may be sold to commercial enterprises and other institutions. Large industrial users of thermal energy include plants in the chemical processing, food processing, pharmaceuticals and paper industries.\nStandby\/Peak Shaving. Standby\/Peak Shaving projects utilize the Company's power generation equipment as a back-up source of electricity for large electrical demand customers. The availability of an alternative energy source allows these customers to benefit from significantly discounted interruptible energy tariffs. The standby\/peak shaving generators typically will be required to provide a limited amount of electricity during peak periods.\nWaste Heat Recovery. A waste heat recovery project utilizes heat resulting from industrial processes as the energy source for the simultaneous production of steam and electricity in a manner similar to cogeneration. The Company believes that waste heat recovery projects, which do not rely on a traditional fuel source, will allow the Company to reduce or eliminate the cost of fuel to the project. While the recovery of continuously released waste heat is not a new process, the Company's patented heat storage technology developed by its subsidiary, American Hydrotherm enables it to capture waste heat released intermittently and convert it into continuous usable energy. These projects are well suited to steel, glass, paper, cement and other industries which generate high quantities of intermittent waste heat from their industrial processes.\nBiogas. Biogas projects use a renewable non-fossil fuel as their fuel source. The Company's biogas projects retrieve otherwise unproductive and environmentally harmful methane gas generated by landfills or sewage digester processes and convert it into usable energy. Landfill gas production will generally continue as long as suitable anaerobic (oxygen-deficient) conditions exist or until the organic components of the refuse placed at the site are entirely decomposed. This process may continue for approximately 20 years after the closing of a landfill site. Sewage digester gas is produced continuously during the sewage treatment process. The key elements of biogas projects are permit applications, contracts for gas rights, sales of gas and electricity, and thermal energy if appropriate, and project financing and construction.\nEquipment Sales, Rentals and Services. The Company sells and rents power generation and cogeneration equipment. The Company provides related services, including the design, assembly, repair and maintenance of permanent or standby power generation equipment. In addition, the Company sells equipment manufactured by others to turnkey contractors in connection with the construction of the Company's projects. The Company also sells equipment purchased by it for projects unrelated to those being developed by the Company. From time to time, it purchases equipment for reconditioning and sale. In its rental business the Company serves the construction, industrial, military, transportation, mining, utility and entertainment markets.\nThe Company also designs and manufactures custom electrical control and distribution subsystems. These include medium voltage cubicle switchboards, main distribution systems, control instrumentation panels and packaged substations. This equipment receives and distributes power through a building, ship or other self-contained structure.\nThe Company, through its American Hydrotherm subsidiary, is also in the business of custom designing, engineering, constructing, installing and servicing high temperature liquid heat transfer systems for industrial processing applications. Each system is designed by American Hydrotherm to meet precise temperature and other specifications for processing equipment. These systems are used in various industries such as steel, plastics, wood, rubber, paper, chemical, petrochemical and electronics.\nEnergy Segment\nProjects in Operation. Set forth below are descriptions of the Company's eight projects currently in operation. Each of these projects is currently producing revenues through the sale of energy under long-term contracts. In connection with the obtaining of financing for its three cogeneration projects in operation, the Company has obtained business interruption insurance and performance guarantees by the operators of its cogeneration projects. These arrangements are negotiated and secured prior to commencement of operations of a project. Taken as a whole, these arrangements reduce the risks associated with any past and future equipment problems or unscheduled plant shutdowns. For example in the event of an unscheduled breakdown, the Company is entitled, pursuant to its business interruption policy, to the net profit which it is prevented from earning from the particular project, including all charges and expenses which continue during the period of interruption, less the applicable deductible amounts. There can be no assurance that such insurance or guarantees will sufficiently mitigate the risk of unforeseen contingencies.\nCogeneration\nE.I. du Pont--Parlin. This 122 megawatt project, which commenced operation in June 1991, is 100%-owned by a subsidiary of the Company. This project is designed to operate continuously and to provide up to 120,000 lbs.\/hr. of steam to a photochemical manufacturing plant in Parlin, New Jersey owned by E.I. du Pont de Nemours and Company (\"E.I. du Pont\"), under a 30-year agreement, and 92 megawatts of electricity to Jersey Central Power & Light (\"JCP&L\"), under a 20-year agreement. In addition to providing up to 9 megawatts of electricity to E.I. du Pont under a 20-year agreement, the Company sells additional electricity to JCP&L on an \"as requested\" basis under the contract's dispatch agreement. See Note 16 to the Company's Consolidated Financial Statements for a discussion of this project's nonrecourse financing.\nFor the fiscal year ended June 30, 1994, this project accounted for approximately $38 million in gross revenues, representing approximately 36% of the Company's consolidated gross revenues.\nDuring the fiscal year ended June 30, 1994, this project experienced two unscheduled outages. In September 1993 a blade on the first stage of one of the two gas turbines (Gas Turbine #2) in the project, broke off at the base sending pieces of metal through the remaining rows of blades. The cause of this failure was due to a manufacturers' defect in the strength of the blade. All of the damaged blading has been repaired or replaced. The turbine went back into service in mid December 1993 and has been performing at satisfactory levels since the repair. In May 1994, the gear connecting Gas Turbine #1 to its generator failed, due to a metallurgical weakness. A new gear was installed and the turbine was brought back on-line in mid August 1994. The failed gear is being repaired, and will be used as a spare for both the Newark and Parlin plants.\nNatural gas is provided by Public Service Electric & Gas Company (\"PSE&G\") under a 15-year service contract. The project is operated and maintained under agreement with a third party who is responsible for the care, custody and control of the facility. The Company and a subsidiary of Stewart & Stevenson, Inc. (\"Stewart & Stevenson\") executed an Operation and Maintenance Contract, which became effective in April 1994 and has a term lasting through June 30, 2002.\nIn May 1994, the Company and the turnkey contractor settled certain litigation regarding delays in project completion. See \"Legal Proceedings.\"\nNewark Boxboard. This 52 megawatt project, which commenced operation in November 1990, is 100%-owned by a subsidiary of the Company. This project is designed to operate continuously and to provide up to 75,000 lbs.\/hr. of steam to a recycled paper boxboard manufacturing plant owned by Newark Boxboard Company, a subsidiary of the Newark Group, Inc., and 52 megawatts of electricity to JCP&L, each under 25-year agreements. See Note 16 to the Company's Consolidated Financial Statements for a discussion of this project's nonrecourse financing.\nFor the fiscal year ended June 30, 1994, this project accounted for approximately $23 million in gross revenues, representing approximately 22% of the Company's consolidated gross revenues.\nOn December 25, 1992, a fire occurred at this project's facility in Newark, New Jersey. The fire resulted in the death of three workers employed by the operator of the project and in damage to the plant. The facility returned to partial operation in August 1993 and resumed full operation in October 1993. The fire has been classified by the local fire commissioner as accidental. As a result of lost revenues, the Company's 1994 and 1993 Income from Operations has been adversely affected. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" The Company carries both property damage and business interruption insurance. The Company received the sum of $36,000,000 which covered a substantial majority of the Company's costs of repair and loss of net profits due to business interruption. In addition, the Company has the right to receive up to an additional $1,400,000 upon recovery by the insurance carrier of its claims against third parties. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations-- Capital Resources--Working Capital Requirements.\"\nNatural gas is provided by PSE&G under a 15-year service contract. Although it is uncertain at this time, the Company may use the landfill gas obtained in connection with its Hackensack Meadowlands project, which is currently in development, to supply fuel for this project in the future. See \"Business--Energy Segment--Projects in Development.\"\nThe project is operated and maintained under agreement with a third party who is responsible for the care, custody and control of the project. In January 1994, the Company and a subsidiary of Stewart & Stevenson executed an Operation and Maintenance Contract, replacing the current operator of the project, which became effective in April 1994. The term of the new Operation and Maintenance Contract goes through June 30, 2002.\nIn November 1993, the Company entered into a letter of intent and then in March 1994, the Company entered into a $7,000,000 subordinated loan agreement with Stewart & Stevenson. The first disbursement of $1,000,000 was funded on January 13, 1994. The second disbursement of $3,500,000 was funded on March 16, 1994. The availability of a third disbursement of $2,500,000 has expired. This third disbursement was intended to be utilized for prepayment of debt at the Newark Boxboard project level and to satisfy the $1,000,000 note between the Company and Stewart & Stevenson. All outstanding principal and interest on the credit facility is to be satisfied by a percentage of all distributions made by O'Brien Newark. The Company currently intends to repay the proceeds of the Stewart & Stevenson credit facility upon the refinancing of the Newark Boxboard term loan.\nIn April 1994, the Company and NatWest Advisory Services, a subsidiary of NatWest Markets (\"NatWest\") executed an engagement letter pursuant to which NatWest was engaged as financial advisor to the Company and O'Brien Newark in connection with identifying and assisting the Company and O'Brien Newark in negotiating and entering into agreements to refinance this project and sell equity therein.\nIn May 1993, the Company and the turnkey construction contractor settled certain litigation regarding delays in project completion. See \"Legal Proceedings.\"\nCalifornia Milk Producers. This 32 megawatt project, which commenced operation in February 1990, was developed and structured by the Company as a limited partnership in which a subsidiary of the Company is the general partner. This project is designed to operate principally during peak demand periods and to provide up to 60,000 lbs.\/hr. of steam to California Milk Producers, Artesia, California and 32 megawatts of electricity to Southern California Edison (\"SCE\"), each under 30-year agreements. The Company has an initial partnership interest of 3% (subject to adjustment to 50% based upon future investment returns of the limited partner). A wholly-owned subsidiary of Chrysler is the limited partner of the partnership and has an initial interest in partnership distributions of 97%. It is not anticipated that there will be any increase in the percentage interest in partnership distributions of the general partner for the foreseeable future.\nFor the fiscal year ended June 30, 1994, the Company received a management fee as a general partner of approximately $130,000. No partnership distributions were received. Until the occurrence of a major increase in the percentage interest in partnership distributions of the general partner, the Company does not expect its share of profits or losses of the partnership to be significant.\nNatural gas is provided by the Company and is purchased from independent brokers. Through a fuel management agreement with Chrysler, the Company is entitled to receive a percentage of any price savings between certain mandated gas price rates and the prices obtained by the Company. Under the agreement, the Company's earnings during the fiscal year ended June 30, 1994 were nominal. The project is operated and maintained under agreement with Stewart & Stevenson which agreement provides for certain performance guarantees.\nBiogas\nMazzaro. This landfill methane gas project produces approximately 1.8 megawatts of electricity which the Company sells to Duquesne Light Company under a 20-year contract expiring in 2009.\nDuarte. This landfill methane gas project generates 0.8 megawatts of electricity for sale to SCE under an agreement which expires in 1997. An extra generator is fueled with natural gas to produce up to .54 megawatts during the summer months to take advantage of the special peak demand rates.\nSmithKline Beecham. The Company uses landfill methane gas to fuel a cogeneration plant which provides up to 1.5 megawatts of electricity and 3,600 lbs.\/hr. of steam for sale to SmithKline Beecham Corporation under an agreement which expires in 2004.\nCorona. The Company uses landfill methane gas to fuel two generators which currently provide approximately 1.2 megawatts of electricity to the SCE under a 20-year contract. An additional generator fueled with natural gas produces approximately 2.0 megawatts during summer months to take advantage of special peak demand rates.\nStandby\/Peak Shaving\nPhiladelphia Water Department. This 22 megawatt project commenced operations in May 1993. Pursuant to a 20-year energy service agreement, the Philadelphia Municipal Authority (the \"Authority\") has the right to be supplied with 20 megawatts of electricity from the project at any time on one hour's notice. In addition, the project is required to use excess digester gas collected at the Authority's northeast and southwest Philadelphia plants to generate up to an approximate 2 megawatts of electricity which is sold to the Authority pursuant to a 10-year power generation agreement. The Company rents facilities and all related generation and associated equipment to the project. The annual rent is approximately $2,350,000. The Company also operates and maintains the project for an annual fee of approximately $250,000, subject to adjustment. In November 1993, the Company sold its interest in this project for a price of $5,000,000 and retained the right to repurchase an 83% interest in it for $5,000,000. On August 5, 1994, the Company repurchased an 83% interest in this project from an unrelated private investor for $5,000,000, subject to certain rights of such investor.\nProjects in Development\nDevelopment of cogeneration, biogas, standby\/peak shaving and waste heat recovery projects often require many months or years to complete and involve a high degree of risk that any given single project will not be completed. To reduce this risk, the Company has since its inception sought to simultaneously develop multiple projects in anticipation that some projects added to its development portfolio will not be completed.\nAmong the principal items involved in developing projects are the selecting of a site, the obtaining of commitments from others to purchase electrical power and steam, negotiating fuel supply arrangements, obtaining environmental and other governmental permits and approvals, arranging project financing and turnkey construction. These items are often obtained independently of one another and success in obtaining one item does not necessarily result in success in obtaining any others. There is no assurance that the Company will be able to obtain satisfactory project agreements, construction contracts, necessary licenses and permits or satisfactory financing commitments and, therefore, that any of the projects discussed below will ultimately be completed. If a project is not completed the Company may neither generate revenue from the project nor be able to recover its investment in the project.\nThe Company has secured some project agreements for certain projects discussed below. Unless otherwise indicated, no definitive agreements have been executed in connection with these projects.\nSchuylkill\/Grays Ferry (cogeneration). The Company has executed a partnership agreement with an affiliate of the Philadelphia Electric Company (the \"Affiliate\") to jointly develop and own this proposed 118 megawatt project. The partnership intends to develop this project in two phases, Phase 1 of which will consist of approximately 40 megawatts. On August 12, 1994, the partnership received a commitment letter for a $62,000,000 loan from Canadian Imperial Bank of Commerce to finance Phase I of this project. The Company expects that the expiration date of the commitment letter will be extended beyond October 30, 1994, although there can be no assurance that such extension will be granted or that if granted, will provide sufficient time to close. The commitment letter also provides for the Company's reduction of its ownership interest in the project from 50% to 25%. The partnership has executed a 25-year agreement with the Trigen-Philadelphia Thermal Energy Corporation for the sale of steam and a 20-year agreement for the sale of electric output with PECO Energy Company, formerly the Philadelphia Electric Company.\nEdgeboro (biogas). In February 1989 the Company executed a gas rights agreement with the owners of the landfill. The landfill is capable of fueling a 15 megawatt generating facility. In April 1992, the Company entered into a 15-year power purchase agreement with PSE&G for the purchase of 9.5 megawatts of electricity. The Company is currently reviewing this project with other potential investors for the purpose of a sale of the project or as equity investors.\nHackensack Meadowlands (Biogas). In September 1993 the Company was awarded (pursuant to a competitive bidding process) gas recovery rights by the Hackensack Meadowlands Development Commission (the \"Development Commission\") for two landfill sites located in North Arlington and Lyndhurst, New Jersey, respectively. The Company and the Development Commission have executed a Gas Rights Agreement. The Company intends to utilize the gas recovered from these sites to supplement natural gas at its Newark Boxboard project.\nOther potential projects. The Company has identified and is considering potential opportunities to develop additional projects as well as to acquire projects in operation or under development and owned by third parties. If these projects are not completed the Company may neither generate revenue from the projects nor be able to recover its investment in the projects.\nSale of Projects in Operation\nIn June 1992, the Company sold its Hamms and Amity biogas projects, exclusive of certain equipment, for an aggregate of $2,048,000, of which $1,725,000 was being paid pursuant to a promissory note. See Notes 6 and 20 of the Consolidated Financial Statements. In addition, the Company is entitled to receive $.01 for each kilowatt hour of electricity sold in excess of the respective projects' target production as long as the projects remain in commercial operation. Pursuant to the contracts of sale, the Company has a right of first refusal for the operation and maintenance of each project on the buyers' behalf if the buyers' present contracts concerning the operation and maintenance of the project are terminated. The Company also entered into equipment rental agreements that provide for removal of power generation equipment if gas from the landfill decreases. The annual rent is $75,000 and $110,000, respectively, for initial terms extending through December 31, 2002 but may be reduced if power generation equipment is removed from the site.\nSale of Projects in Development\nIn September 1994, the Company sold its rights to the Tinicum (Philadelphia Airport) project for net cash proceeds of $1,652,000. The Company executed an energy service agreement with the City of Philadelphia in December 1993 for a 14 megawatt standby electrical facility project at the Philadelphia International Airport.\nIn June 1994, the Company sold its rights to develop a standby project with SmithKline Beecham in Montgomery County, Pennsylvania. See Note 20 to the Consolidated Financial Statements.\nIn August 1993, the Company sold its rights to develop coal-bed methane reserves at a 15,000 acre site in Indiana County, Pennsylvania together with other assets relating to the site for $6,500,000. See Notes 6 and 7 to the Consolidated Financial Statements and Legal Proceedings regarding BBC\/DRI Blacklick Joint Venture.\nIn December 1992, the Company sold its Rowley biogas project for $821,000, of which $331,000 was being paid pursuant to a promissory note. The promissory note was paid in full in October 1993, subject to a discount for early payment offered by the Company. See Notes 6 and 20 to the Consolidated Financial Statements.\nIn December 1992, the Company and a utility entered into an agreement pursuant to which the electric contract previously entered into by the parties was terminated in consideration of the payment by the utility of $4,000,000 payable over five years (commencing on June 29, 1993) and secured by a standby letter of credit. See Notes 6 and 20 to the Consolidated Financial Statements.\nIn September 1992, the Company sold a 50% interest in its SPSA biogas project pursuant to a stock purchase agreement. The remaining 50% interest was sold on June 30, 1993. The aggregate purchase price was $625,000, of which $555,000 is being paid pursuant to a promissory note. During 1994, the promissory note was paid in full, subject to a discount for early payment offered by the Company. See Notes 6 and 20 to the Consolidated Financial Statements.\nEquipment Sales, Rentals and Services Segment\nIn addition to the energy business, the Company sells and rents power generation and cogeneration equipment. A significant portion of the Company's equipment rental business is attributable to the operations of its subsidiary, O'Brien Energy Services. The Company provides related services, including the design, assembly, repair and maintenance of permanent or standby power generation equipment. In addition, the Company sells equipment manufactured by others to turnkey contractors in connection with the construction of the Company's projects. The Company also sells equipment purchased by it for projects unrelated to those being developed by the Company. From time to time, it purchases equipment for reconditioning and sale. In its rental business the Company serves the construction, industrial, military, transportation, mining, utility and entertainment markets. On a national level the Company competes principally with one other company. In addition there are numerous local competitors in each of the geographic areas in which the Company operates. The Company competes on the basis of experience, service, price and depth of its rental fleet.\nPuma, a wholly-owned United Kingdom subsidiary, designs and assembles diesel and gas fueled power generation systems ranging in size from 5 kilowatts to 5 megawatts. These products are engineered and sold for use in prime power base load applications as well as for standby or main failure emergency situations. Major markets for these products include commercial buildings, governmental institutions such as schools, hospitals and public facilities, industrial manufacturing or production plants, shipyards, the entertainment industry and offshore drilling operations. The Company exports many of its products primarily through established distributors and dealers in local areas for delivery to markets such as the Far East, including Hong Kong and mainland China, together with the Middle East and South America.\nThe Company also designs and manufactures custom electrical control and distribution subsystems. These include medium voltage cubicle switchboards, main distribution systems, control instrumentation panels and packaged substations. This equipment receives and distributes power through a building, ship or other self-contained structure.\nThe Company, through its American Hydrotherm subsidiary, is also in the business of custom designing, engineering, constructing, installing and servicing high temperature liquid heat transfer systems for industrial processing applications. Each system is designed by American Hydrotherm to meet precise temperature and other specifications for processing equipment. These systems are used in various industries such as steel, plastics, wood, rubber, paper, chemical, petrochemical and electronics.\nRegulation\nIn connection with the development and operation of its projects, the Company is substantially affected by federal, state and local energy and environmental laws and regulations.\nThe enactment in 1978 of PURPA and the adoption of regulations thereunder by Federal Energy Regulatory Commission (\"FERC\") provided incentives for the development of small power production facilities (those utilizing renewable fuels and having a capacity of less than 80 megawatts) and cogeneration facilities (collectively referred to as \"Qualifying Facilities\"). Electric utilities are required to purchase power from such facilities at rates based on the incremental cost of electrical energy (so-called \"avoided cost\"). Under regulations adopted by FERC and upheld by the United States Supreme Court, such rates are based upon \"the incremental cost to an electric utility of electrical energy or capacity or both which, but for the purchase from the qualifying facility or qualifying facilities, such utility would generate itself or purchase from another source.\" Avoided cost is generally a function of the cost of fuel required to generate electricity and of the cost of capital required to construct a power plant to supply such capacity.\nAll of the Company's existing electric generating facilities are designed to be qualifying small power production facilities or qualifying cogeneration facilities, as these terms are defined in PURPA. Pursuant to authority granted to FERC under PURPA, FERC has promulgated regulations which at present exempt most of these facilities from the Federal Power Act, the Public Utility Holding Company Act of 1935 and, except under certain circumstances, state laws respecting the rates charged by electric utilities.\nIn order to qualify for the benefits provided by PURPA, the Company's facilities must meet certain size, efficiency, fuel and ownership requirements. For its major cogeneration projects, it is the Company's practice to obtain an order from FERC confirming the qualification of its facilities. For its biogas projects, the Company's practice is to utilize the self-certification procedure authorized by PURPA and FERC regulation. However, the standards for qualification and the regulations described above are subject to amendment. If the regulations were to be amended, the Company cannot predict the effect of any such amendment on the extent of regulation to which the Company may thereby become subject. The Company is not currently aware of any proposed amendments to PURPA or regulations promulgated by FERC thereunder to materially alter the standards for qualification.\nIn the event that one of the Company's cogeneration facilities failed to meet the requirements of being a \"Qualified Facility,\" that entity would be materially adversely impacted.\nThe Company is also subject to the Powerplant and Industrial Fuel Use Act of 1978 (\"FUA\"), which limits the ability of power producers to burn natural gas in new generation facilities unless such facilities also have the capability to use coal or any other alternate fuel as a primary energy source. All of the Company's existing cogeneration projects are designed to qualify for permanent exemption from FUA.\nIn addition to the regulations described above, the Company's projects must comply with applicable federal, state and local environmental regulations, including those related to water and air quality. These laws and regulations in many cases require a lengthy and complex process of obtaining licenses, permits and approvals from federal, state and local agencies. The environmental regulations under which the Company's projects operate are subject to amendment. The Company cannot predict what effect compliance with such amendments may have on the Company's business or operations. Compliance could require modification of a project and thereby increase its costs, extend its completion date or otherwise adversely affect a project.\nAll projects in operation and under development are believed to be operating in substantial compliance with or designed to meet currently applicable environmental requirements. To date, compliance with these environmental regulations has not had a material effect on the Company's earnings nor has it required the Company to expend significant capital expenditures.\nEmployees\nAs of September 20, 1994, the Company had approximately 176 full- time employees, including executive officers of the Company. Of these, approximately 69 are involved with the Company's overseas equipment sales, rental and service operations. The Company has reduced its staff of employees for the purpose of reducing overhead expenses. None of the Company's employees are members of a union or are subject to a collective bargaining agreement. The Company considers its employee relations to be satisfactory.\nThe Company expects that as each of its projects is constructed and becomes operational, it will either have to hire additional employees to staff these projects or enter into operation and maintenance agreements with unrelated third parties. The Company believes that these project personnel will be readily available.\nCompetition\nMany organizations, including equipment manufacturers and subsidiaries of utilities and contractors, as well as other organizations similar to the Company, have entered the cogeneration and biogas market. Many of these organizations have substantially greater resources than the Company. In addition, obtaining power contracts with utilities has become more competitive with the increased use of competitive bidding procedures. This increased competition may make it more difficult for the Company to secure future projects, may increase project development costs and may reduce the Company's operating margins. Even though many of its potential competitors have substantially greater resources than the Company, the Company believes that its experience, particularly if combined with a strategic alliance with a third party with regard to larger projects, will enable it to compete effectively.\nSignificant Customers\nThe Company derived 53%, 65% and 67% of its revenues in fiscal 1994, 1993 and 1992, respectively, from JCP&L as a result of the operation of the Newark, Parlin and Hamms projects. (The Hamms project was sold on June 30, 1992.)\nPatents\nThe Company owns patents and trademarks relating to its waste heat storage technology which are expected to contribute to the business activities of the Company.\nBacklog\nThe order backlog of Puma as of March 31, 1994 was approximately $2,611,000, compared with approximately $6,000,000 as of March 31, 1993. The order backlog for American Hydrotherm at June 30, 1994 and 1993 was $1,024,000 and $1,300,000, respectively. The order backlog for O'Brien Energy Services, in regard to its equipment sales operations, at June 30, 1994 was $2,051,000. There was no significant backlog for O'Brien Energy Services at June 30, 1993 during its startup period in its equipment sales operations. Management expects that the backlog amounts will be delivered during each of Puma's and American Hydrotherm's and O'Brien Energy Services' current fiscal years, as applicable. There is no significant seasonal influence to the order backlog. See \"Business--Energy Segment--Projects in Development.\"\nD. Financial Information About Foreign and Domestic Operations and Export Sales.\n\t\t\t\t1994\t\t1993\t\t1992 \t\t\t\t----\t\t----\t\t---- \t\t\t\t\t (In thousands) Revenues: United States\t\t$ 93,090 \t$ 83,797\t$ 84,560 United Kingdom\t\t 13,499\t 13,895 \t 15,555 \t\t\t\t--------\t--------\t--------- \t\t\t\t$106,589\t$ 97,692\t$ 100,115 \t\t\t\t========\t========\t=========\nNet Income (Loss): United States\t\t$(14,570) $(13,350)\t$ 1,535 United Kingdom\t\t (1,931)\t (361)\t (123) \t\t\t\t-------- \t--------\t--------- \t\t\t\t$(16,501) $(13,711)\t$ 1,412 \t\t\t\t========\t========\t=========\nIdentifiable Assets: United States\t\t$230,343\t$252,863\t$ 249,544 United Kingdom\t\t 7,473\t 9,666\t 9,510 \t\t\t\t--------\t--------\t--------- \t\t\t\t$237,816\t$262,529\t$ 259,054 \t\t\t\t========\t========\t=========\nThe revenues and operations of the Company's foreign operations in the United Kingdom disclosed above are attributable solely to the equipment sales and services segment of the Company's business. The revenues from such operations accounted for in excess of 50% of that particular segment's revenue in 1994.\nThe Company's foreign operations are subject to the additional risks inherent in doing business in foreign countries, including changes in currency exchange rates, currency restrictions, political changes and expropriation. Although it is impossible to predict the likelihood of such occurrences or their effect on the Company, management believes these risks to be acceptable and, in view of the fact that the Company's foreign activities historically have been largely concentrated in Europe and not in any single country and the fact that the Company attempts to secure payment for export sales with commercial letters of credit or other secured means, does not consider them a factor materially adverse to its operations as a whole.\n[The remainder of this page is intentionally blank.]\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's offices located at 225 and 231 South Eighth Street, Philadelphia, which cover approximately 16,000 square feet, are leased from Pennsport Partnership, a Pennsylvania partnership in which Frank L. O'Brien III has a 50% ownership interest. The lease term expires in November 1999 with an option to renew for a five- year term at the option of the Company. The rental expense for the premises was approximately $289,000 in 1994. The Company also leases office and warehouse space from Christiana River Holdings, Ltd., an entity owned by Frank L. O'Brien III. Rental expense for 1994 was $150,000, plus real estate taxes.\nIn September 1993, Puma purchased its executive offices and its principal manufacturing facility located in Ash, Canterbury, Kent, United Kingdom from III Enterprises, Limited, an entity owned by Frank L. O'Brien III for approximately $800,000. Rental expense for the five months prior to the purchase in fiscal 1994 was approximately $66,000. See Note 24 to the Consolidated Financial Statements.\nThe executive and engineering offices of American Hydrotherm are located in New York City. American Hydrotherm leases this 8,000 square foot facility under the terms of a ten-year lease executed in 1990. Burr Controls, Inc. leases approximately 10,000 square feet for its assembly and manufacturing operations on Long Island, New York.\nThe headquarters of O'Brien Energy Services are located on approximately 4 acres in Wilmington, Delaware. The premises are owned, subject to a mortgage, in fee simple and include an approximately 55,000 square foot building. In addition, O'Brien Energy Services owns, subject to a mortgage, office and warehouse space in Houston, Texas, on approximately two acres of land. O'Brien Energy Services leases space for similar purposes in each of Bakersfield and Benecia, California. The office and warehouse space in Texas and in the California locations range from approximately 5,000 to 10,000 square feet.\nThe Company leases, typically for a nominal fee, property on the site of its proposed cogeneration facilities from the commercial user of thermal energy. The term of the lease equals or exceeds that of each respective thermal supply agreement. The Company believes that the leased premises are suitable and adequate for the Company's projects.\n[The remainder of this page is intentionally blank.]\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nCHAPTER 11 REORGANIZATION PROCEEDINGS\nOn September 28, 1994, O'Brien Environmental Energy, Inc., the parent company, filed a voluntary petition (No. 94-26723(RG)) for reorganization under Chapter 11 of the United States Bankruptcy Code with the U.S. Bankruptcy Court for the District of New Jersey to pursue financial restructuring efforts under the protection afforded by the U.S. bankruptcy laws. The decision to seek Chapter 11 relief was based on the conclusion that action had to be taken to preserve its relationships and maintain the operational strength and assets of the Company, and to restructure its debt and utilize its assets in a manner consistent with the interests of all creditors and shareholders rather than liquidate to satisfy the demands of a particular group of creditors. The Company expects to continue its normal activities, including project development and the sale and\/or refinancing of existing projects. There can be no assurance that the Company, in ;the future, will ahve adequate cash flow to finance operations and ongoing development activities or to meet current obligations.\nAs a result of this action, pending litigation against the Company (but not its subsidiaries) will be stayed and consolidated with this bankruptcy proceeding. The Company has also been advised that its securities are being delisted from the American Stock Exchange, however, the Common Stock continues to be listed on the Philadelphia Stock Exchange. The Company intends to have its Debentures included in either the OTC Bulletin Board or the \"pink sheets.\" There can be no assurance that a trading market will develop for any of the Company's securities even if they are listed on any of the foregoing exchanges or quotation systems. See \"Market for Registrant's Common Equity and Related Stockholder Matters.\"\nAlthough the Company cannot give definitive assurance regarding the ultimate resolution of the various remaining claims described below, the Company does not presently believe the resolution will have a material adverse impact on the Company's consolidated financial statements. However, attorney costs of defending against these litigations have impacted the Company's financial statements in 1994 and 1993.\nHAWKER SIDDELEY PROCEEDINGS\nIn May 1994, actions entitled (i) Hawker Siddeley Power Engineering Inc. v. O'Brien (Parlin) Cogeneration, Inc. (the \"Parlin Action\"), and (ii) Hawker Siddeley Power Engineering Inc. v. O'Brien California Cogen Limited, a California Limited Partnership, O'Brien Cogeneration, Inc. II and O'Brien Energy Systems Inc. (the \"Salinas Action\") were settled pursuant to an agreement entered into by the parties (the \"Hawker Settlement Agreement\"). Pursuant to the Hawker Settlement Agreement, other than the Company issuing a promissory note for $1,500,000 to Hawker Siddeley (the \"Note\"), no money was exchanged; O'Brien (Parlin) Cogeneration, Inc. was not required to pay the approximately $5,100,000 contract price withheld and all parties dismissed their claims related to the Parlin action. Pursuant to the Hawker Settlement Agreement, the Salinas Action, prior to being dismissed, required that the first payment under the Note be paid by October 6, 1994. Therefore, as the payment was not made, the Salinas Action remains open. See Note 29 to the Consolidated Financial Statements.\nIn May 1993, actions entitled (i) O'Brien (Newark) Cogeneration, Inc. v. Hawker Siddeley Power Engineering Inc. and Hawker Siddeley Group, P.L.C. and (ii) Hawker Siddeley Power Engineering Inc. v. O'Brien (Newark) Cogeneration, Inc. and O'Brien Newark Supply Corporation were settled pursuant to an agreement entered into by the parties (the \"Newark Settlement Agreement\"). Pursuant to the Newark Settlement Agreement, no money was exchanged, O'Brien (Newark) Cogeneration, Inc. was not required to pay the $3,800,000 contract price withheld and all parties dismissed their claims.\nAs of September 1993, actions entitled (i) Hawker Siddeley Power Engineering Inc. v. O'Brien Cogeneration (Hartford), Inc., (ii) O'Brien Cogeneration (Hartford), Inc. and O'Brien (Hartford) Cogeneration Limited Partnership v. Hawker Siddeley Power Engineering Inc. and Hawker Siddeley Group, P.L.C. and (iii) Hawker Siddeley Power Engineering, Inc. v. Energy Networks, Inc., O'Brien (Hartford) Cogeneration Limited Partnership and Connecticut National Bank were settled pursuant to an agreement entered into by the parties (the \"Hartford Settlement Agreement\"). Pursuant to the Hartford Settlement Agreement, the Company relinquished its interest in the project and its general partner responsibilities, paid Hawker Siddeley $250,000 and issued a promissory note for $250,000 to the succeeding general partner, which resulted in a total charge of $1,121,000 for fiscal 1993. See Note 21 to the Consolidated Financial Statements.\nOTHER PROCEEDINGS\nIn September 1993, an action entitled Gulfgen Limited and TransAndean International, S.A. v. O'Brien Environmental Energy, Inc. was commenced in the United States District Court, District of Delaware. The complaint alleged the Company repudiated its obligation to close a proposed transaction which, among other things, involved a proposed transfer by Gulfgen Limited (\"Gulfgen\") and TransAndean International, S.A. (\"TransAndean\") of an interest in a pipeline project to the Company (and an agreement to contract for project development services from the Company in connection therewith) in exchange for certain stock of the Company and an option to purchase additional stock of the Company. No closing documents were negotiated or executed. Gulfgen and TransAndean, however, claim that an officer of the Company with authority to bind the Company sent the agreement with a transmittal letter dated July 30, 1993 containing a statement that constituted an agreement by the Company. The complaint also alleges that the Company is now obligated to pay a break-up fee of $200,000 and that the Company has repudiated its alleged contractual obligation to pay such $200,000 break-up fee. The Company has settled the action by paying Gulfgen $25,000.\nIn December 1993, an action entitled Pueblo Chemical, Inc. v. O'Brien Environmental Energy, Inc. was commenced in the Court of Chancery of the State of Delaware - New Castle County. The Complaint alleges that Pueblo (allegedly, the owner of record of 100 shares of the Class A Common Stock of the Company) has the right to inspect the Company's stock ledger, list of stockholders and certain books and records. This action was settled by the Company providing the information requested.\nIn January 1994, an action entitled Pueblo Chemical, Inc. v. O'Brien Environmental Energy, Inc., Frank L. O'Brien, III, Joel D. Cooperman, William Forman and Charles L. Andes was commenced in the Court of Chancery of the State of Delaware - New Castle County. The Complaint alleges, among other things, fraud and breach of fiduciary duties in connection with a certain agreement allegedly entered into by Pueblo and an affiliate of Frank L. O'Brien III. The Company believes that these allegations are without merit and intends to vigorously contest them. In a decision rendered in U.S. Bankruptcy Court on February 4, 1994, in a companion case involving the aforementioned affiliate of Frank L. O'Brien III, the Judge has determined that these claims are without merit and no contract existed between the parties. Pueblo appealed the decision to the United States District Court, which Court denied the appeal and reaffirmed the decision of the Bankruptcy Court which, in effect, terminated the plaintiff's cause of action in the case, although the case remains on the docket as dormant.\nBy letter dated September 20, 1993, the Securities and Exchange Commission (the \"SEC\") commenced an informal inquiry into trading in the securities of the Company. The SEC requested information from the Company for the period of March 1, 1993 to September 20, 1993. The SEC has indicated that this inquiry should not be construed as an indication by the SEC or its staff that any violations have occurred, or as an adverse reflection upon any person, entity or security. The Company sent an initial written response to the SEC on October 21, 1993, and a subsequent response on November 12, 1993. Since such time, the SEC has not contacted the Company for any additional information with respect to the inquiry.\nIn June 1993, the Company received a Citation and Notification of Penalty (the \"Citations\") under the Occupational Safety and Health Act of 1970 from the United States Department of Labor (\"DOL\") for each of its Newark and Parlin Cogeneration plants. The penalties listed for the Newark and Parlin plants are $44,650 and $10,000, respectively. In September 1994, the Company entered into a settlement agreement with the DOL in which the Company, citing responsibility of the turnkey contractor of the plants to Hawker Siddeley Power Engineering Inc. and the Operations and Maintenance Contractor of the plants to John Brown Engineering, accepted a single citation at the Newark and Parlin plants and accepted penalties in the amount of $7,000 and $5,000, respectively.\nIn September 1993, October 1993 and November 1993, respectively, actions entitled (i) BRIDGET E. McLOUGHLIN, Individually and as Administrator of the estate of MICHAEL A. McLOUGHLIN, deceased, et al., v. O'BRIEN COGENERATION INC., HAWKER SIDDELEY CONSTRUCTION CO., et al.; (ii) GEORGIE ANN ELEY, Individually and as Administratrix on behalf of the Estate of JOSEPH ELEY, JR., deceased, et al. v. O'BRIEN COGENERATION INC., HAWKER SIDDELEY, JOHN BROWN INC. (for discovery purposes only), et al.; and (iii) KELLY ANN MOTICHKA, Individually and as Administrator on behalf of the Estate of Andrew Motichka, deceased, et al. v. O'BRIEN COGENERATION INC., HAWKER SIDDELEY, JOHN BROWN INC., (for discovery purposes only), et al. were commenced in the Superior Court of New Jersey Law Division - Essex County. These actions were filed by the survivors of three employees of John Brown Power Limited, the operator of the Company's Newark Cogeneration facility, who were killed as the result of a fire which occurred at the facility in December 1992. The actions seek the recovery of damages in an unspecified amount. Insurance counsel estimates that each of the pending claims could have a value in excess of $1,000,000. The amount allocable to the Company, if any, is not determinable at this time. The Company's insurer has recently disputed the maximum amounts of coverage under the Company's policies. If a satisfactory resolution of this dispute cannot be reached, the Company may be required to file an action in court to obtain an adjudication of its rights under its insurance policies. The Company believes that these claims will not have a material adverse financial effect on the Company because (i) the Company has sufficient liability insurance coverage and (ii) the operator of the facility has agreed to indemnify the Company for any liability arising out of the operator's operation and maintenance of the facility.\nIn January 1993, an action entitled Resolution Trust Corporation as receiver for Atlantic Financial Savings, F.A. v. Clarence J. O'Brien, II, Frank L. O'Brien III, O'Brien Energy Systems, Inc., O'Brien Mobile Power Rental Company, III Enterprises, Inc., III Enterprises, Inc. I, Puma Manufacturing, Ltd., Puma Power Plant, Ltd., O'Brien Power Equipment, Inc. and Powerhouse Contractors, Inc. was commenced in the District Court for the Eastern District of Pennsylvania. The Complaint alleges that certain transactions between the Company and a separate group of individuals and companies jeopardized and harmed the ability of the second group of companies to repay loans to their creditor, Atlantic Financial Savings, F.A., an entity which had fallen into Resolution Trust Corporation (\"RTC\") receivership. The plaintiffs sought damages in excess of $75,000. In May 1993, the case was dismissed without prejudice and the parties entered into an agreement whereby the Company would pay a total of $930,000 to the RTC in installments including a final payment in the amount of $590,000 on January 15, 1995, unless otherwise extended, in exchange for the RTC's position in certain collateralized assets.\nIn May 1994, BBC\/DRI Blacklick Joint Venture (the \"Joint Venture\") filed a complaint for arbitration against O'Brien Methane Production Inc. with the American Arbitration Association in Philadelphia, Pennsylvania. The complaint alleges, among other things, breach of contract, fraud and conversion in connection with an agreement between the parties concerning the sale by the Company of rights to develop coalbed methane properties in Indiana County, Pennsylvania. The Joint Venture seeks damages in the amount of approximately $550,000 and the cancellation of all remaining payments due under a promissory note in favor of the Company in the current outstanding amount of $4,500,000. In its answer, the Company has denied the allegations and counterclaimed against the Joint Venture for breach of contract in such amount as is necessary to repay the balance of the promissory note with interest. The Company has, further, requested that a receiver be appointed to ensure the performance of the Joint Venture with regard to its contractual obligations to the Company.\nDavid B. Zlotnick, individually and on behalf of himself and all persons similarly situated v. O'Brien Environmental Energy, Inc., Court of Common Pleas, Philadelphia County, April Term 1994, No. 3224. This Complaint alleges that the defendants did not pay interest that was due March 15, 1994 or September 15, 1994 to the three series of bondholders of the 7 3\/4% of Convertible Senior Subordinated Debentures due March 15, 2002, the 11% Convertible Senior Subordinated Debentures due on March 15, 2010 and the 11% Convertible Senior Subordinated Debentures due on March 15, 2011.\nAllan G. Stevens, on behalf of himself and all persons similarly situated v. O'Brien Environmental Energy, Inc., Frank L. O'Brien, III, Joel D. Cooperman, William Forman, Bruce L. Levy, Sanders D. Newman and Morgan Guaranty Trust Co. This Complaint was served on August 10, 1994. The Complaint alleges that the defendants other than Frank L. O'Brien, III, sold stock while in possession of material adverse, non-public information and all defendants participated in disseminating misleading information to artificially inflate the value of the Company's stock. The Company believes these allegations to be totally without merit.\nJames M. Blackman and Virginia Frantz v. O'Brien Environmental Energy, Inc., Frank L. O'Brien, III, Joel D. Cooperman, William Forman, Bruce L. Levy, and Sanders Newman. On September 15, 1994 a class action suit was filed against the Company and others by a class allegedly consisting of all persons who purchased the Company's debentures from September 28, 1992 through April 12, 1994. The Complaint alleges that the defendants made misleading statements and omitted to state material facts in certain public disclosures made by the Company. The Company believes these allegations to be totally without merit.\nSee Notes 7, 21 and 29 to the Company's Consolidated Financial Statements.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nNone.\n[The remainder of this page is intentionally blank.]\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's Class A Common Stock is principally traded on the AMEX under the symbol \"OBS\" and is also listed on the Philadelphia Stock Exchange. As of September 28, 1994, the AMEX halted trading in the Company's securities due to, among other things, the Company's filing of a voluntary petition for protection under the U.S. Bankruptcy Code. On October 4, 1994, the AMEX advised the Company that it had initiated proceedings to delist the Company's securities therefrom.\nThe following table sets forth, for each of the quarterly periods indicated, the high and low sale prices for the Class A Common Stock as reported on the AMEX.\nOn September 20, 1994, the closing sale price of the Company's Class A Common Stock on the AMEX was $11\/16 per share and there were 13,055,597 shares of Class A Common Stock outstanding.\nThe approximate number of stockholders of record of the Class A Common Stock of the Company at September 20, 1994 was 1,471 not including beneficial owners whose shares are held by banks, brokers and other nominees. Frank L. O'Brien III, through his ownership of III Enterprises, Inc., is the owner of all of the outstanding voting shares of Class B Common Stock of the Company. In October 1993, III Enterprises filed for bankruptcy protection under Chapter 11 of the Federal Bankruptcy Code. In April 1994, III Enterprises and its creditors entered into a Stipulation which set forth certain key dates for implementing a Plan of Reorganization. The Debtor sought and obtained an extension of certain time period in the Stipulation to September 30, 1994. The debtor has since filed motions to extend the time periods in the Stipulation. On October 6, 1994, the bankruptcy court ordered that the matter be converted to a proceeding under Chapter 7 of the Federal Bankruptcy Code. On October 7, 1994, the debtor appealed this order.\nIn addition, this proceeding could cause a change of control of the Company, which could, among other things, significantly affect the direction of the management of the Company and limit the utilization all the Company's net operating loss carryforwards available at June 30, 1994 in accordance with IRS regulations. See Note 23 to the Consolidated Financial Statements.\nThe Company presently intends to retain all earnings for the operation and expansion of its business and does not anticipate paying cash dividends on its common stock in the foreseeable future. Any future determination as to the payment of dividends on the common stock will depend upon future earnings, results of operations, capital requirements, the financial condition of the Company and any other factors the Board of Directors of the Company may consider.\nSome of the Company's commercial bank lines of credit restrict the payment of dividends.\nIn addition, the Indenture governing the Company's 7 3\/4% Convertible Senior Subordinated Debentures due March 15, 2002 (the \"1987 Indenture\") restricts the Company from declaring or paying any dividend or making any distribution on its capital stock or to its stockholders other than dividends and distributions payable solely in shares of its capital stock (such dividends being referred to as \"Stock Payments\"), unless (a) at the time of such Stock Payments no Event of Default under the 1987 Indenture (as defined therein) has occurred and is continuing, and (b) after giving effect thereto the aggregate amount expended for all Stock Payments subsequent to December 31, 1986 does not exceed the sum of: (i) 25% of the Consolidated Net Income (as defined in the 1987 Indenture) accrued on a cumulative basis subsequent to December 31, 1986 (or, in case such Consolidated Net Income shall be a deficit, minus 100% of such deficit); (ii) the aggregate net proceeds received by the Company from the issue or sale subsequent to December 31, 1986 of its capital stock (including capital stock issued upon the conversion of Indebtedness (as defined in the 1987 Indenture)); and (iii) $500,000.\nThe indentures governing the Company's 11% Convertible Senior Subordinated Debentures due March 15, 2010 (the \"1990 Indenture\") and 11% Convertible Senior Subordinated Debentures due March 15, 2011 (the \"1991 Indenture\") impose similar restrictions on the payment of dividends by the Company. The reference dates used for the 1990 and 1991 Indentures are December 31, 1989 and December 31, 1990, respectively. With respect to the 1990 and 1991 Indentures, the parenthetical information in (b)(i) above is qualified to indicate that in the event that the Company's Consolidated Stockholders' Equity (as defined in the 1990 and 1991 Indentures, respectively) is $60,000,000 or more, such percentage shall be 50%. The amount set forth in (b)(iii) above for each of the 1990 and 1991 Indentures is $2,000,000.\nThe Company's project subsidiaries may declare and pay dividends to the Company only to the extent of surplus cash flow and subject to certain other restrictions.\n[The remainder of this page is intentionally blank.]\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe consolidated selected financial data as of and for each of the five years in the period ended June 30, 1994 have been derived from the audited financial statements of the Company. Due to the uncertainty concerning the Company's ability to continue as a going concern and the outcome of certain pending litigation, no provision has been made for any liabilities which may result from these uncertainties. This data should be read in conjunction with, and is qualified in its entirety by reference to, the related financial statements and notes included elsewhere in this Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nOn September 28, 1994, O'Brien Environmental Energy, Inc., the parent company, filed a voluntary petition (No. 94-26723(RG)) for reorganization under Chapter 11 of the United States Bankruptcy Code with the U.S. Bankruptcy Court for the District of New Jersey to pursue financial restructuring efforts under the protection afforded by the U.S. bankruptcy laws. The decision to seek Chapter 11 relief was based on the conclusion that action had to be taken to preserve its relationships and maintain the operational strength and assets of the Company, and to restructure its debt and utilize its assets in a manner consistent with the interests of all creditors and shareholders rather than liquidate to satisfy the demands of a particular group of creditors. The Company expects to continue its normal activities, including project development and the sale and\/or refinancing of existing projects. There can be no assurance that the Company, in the future, will have adequate cash flow to finance operations and ongoing development activities or to meet current obligations. Subsequent to September 28, 1994, the Company is operating as debtor-in-possession under the Bankruptcy Code. As such, the Company is authorized to operate its business, but may not engage in transactions outside the ordinary course of business without approval, after notice and hearing, of the Bankruptcy Court. There can be no assurance that the Company will be able to obtain such approval to continue its normal operations and restructure its debt and otherwise engage in project development and the sale or refinancing of existing projects. In addition, the bankruptcy of an affiliate of the Company's principle stockholder may cause a change of control of the Company. Any discussion herein respecting the plans of management concerning the Company's business is accordingly qualified. See \"Significant Factors--Liquidity; Chapter 11 Bankruptcy Filings\" and \"-- III Enterprises, Inc. Bankruptcy.\"\nThe Company develops cogeneration, waste heat recovery and biogas projects (\"Energy business\"). In addition, the Company sells and rents power generation equipment (\"Equipment sales, rental and services business\"). Included in the Equipment sales, rentals and services business is the Company's demand-side management business, through which the Company provides standby power equipment to a customer for a fee.\nAt present, the Company has eight projects in operation totalling approximately 237 megawatts of electric generating capacity, including seven wholly-owned projects developed by the Company totalling approximately 205 megawatts and one 32 megawatt project developed by the Company but presently owned substantially by a subsidiary of Chrysler Capital Corporation.\nThe Company's energy revenues and gross profits are subject to seasonal variations as a result of power sales agreements which contain peak and off-peak energy pricing provisions and fuel costs which fluctuate based upon seasonal demand and other factors.\nThe Board of Directors elected not to make the March 15, 1994 or the September 15, 1994 interest payments due on the 1987, 1990 and 1991 Indentures. The Company is also in default of certain other debt. See \"Recent Developments\" and \"Liquidity and Capital Resources\".\nIn December 1992, a fire disabled the Company's Newark Boxboard cogeneration plant. The damage to the plant has been repaired. The plant returned to partial operation in August 1993 and full operation in October 1993. The Company received $36,000,000 from its insurance carrier which covered a substantial majority of the Company's cost of repair and loss of net profits due to business interruption. See \"Results of Operations for the Years ended June 30, 1994, 1993 and 1992\" and \"Liquidity and Capital Resources\" for further discussion and analysis of the impact of the fire.\nDuring May 1993, operations commenced at the Company's initial demand side management facilities (collectively, the \"Philadelphia Water Department project\"). The Philadelphia Water Department project consists of two ten megawatt standby power generating plants. In November 1993, the Company entered into a transaction under which it sold its interest in the Philadelphia Water Department project to entities controlled by an unrelated private investor. The Company continued to rent facilities and all related generation and associated equipment to the project. The Company repurchased the project on August 5, 1994 subject to a minority interest retained by the private investor. See \"Recent Developments\", \"Results of Operations for the Years ended June 30, 1994, 1993 and 1992\" and \"Liquidity and Capital Resources\".\nIn January 1994, the Company ceased operations at one of its of United Kingdom subsidiaries which was in the business of manufacturing low voltage switchgear. Pretax losses associated with this United Kingdom subsidiary in fiscal 1994 were $1,200,000 which includes costs of $319,000 associated with the closure of the business.\nIn May 1994, actions entitled (i) Hawker Siddeley Power Engineering v. O'Brien (Parlin) Cogeneration, Inc. (the \"Parlin Action\") and (ii) Hawker Siddeley Power Engineering, Inc. v. O'Brien California Cogen Limited, a California Limited Partnership, O'Brien Cogeneration, Inc. II and O'Brien Energy Systems, Inc. (the \"Salinas Action\") were settled pursuant to an agreement entered into by the parties (the \"Hawker Settlement Agreement\"). Pursuant to the Hawker Settlement Agreement, other than the Company issuing a promissory note for $1,500,000 to Hawker Siddeley, no money was exchanged. O'Brien (Parlin) Cogeneration, Inc. was not required to pay the approximately $5,100,000 contract price withheld and all parties dismissed their claims related to the Parlin Action. Pursuant to the Hawker Settlement Agreement, the Salinas Action, prior to being dismissed, required that the first payment under the notes be made by October 6, 1994. Therefore, as the payment was not made, the Salinas Action remains open. See \"Recent Developments\" and \"Liquidity and Capital Resources\".\nIn September 1993, the Company reached an agreement to settle the Hartford Steam project litigation with the project's turnkey contractor, Hawker Siddeley Power Engineering, Inc. Under the terms of the settlement, the Company relinquished its interest in the project and its general partner responsibilities. As the Company's interest in the project was only 5%, management does not believe the settlement will have a significant impact on the Company's future results of operations. See \"Results of Operations for the Years ended June 30, 1994, 1993 and 1992\".\nResults of Operations for the Years ended June 30, 1994, 1993 and\nRevenues\nEnergy revenues for the years ended June 30, 1994, 1993 and 1992 were $62,647,000, $65,136,000 and $71,638,000, respectively. Energy revenues primarily reflect billings associated with the Company's Newark Boxboard and du Pont Parlin cogeneration projects as well as the Company's biogas facilities. The decrease in energy revenues from 1993 to 1994 was primarily attributable to two separate mechanical failures at the Company's du Pont Parlin Project while the decrease in energy revenues from 1992 to 1993 was primarily attributable to the December 25, 1992 fire at the Newark Boxboard facility, each of which is separately discussed below.\nRevenues recognized at the du Pont Parlin Project were $37,910,000, $43,729,000 and $40,915,000 for the fiscal years ended June 30, 1994, 1993 and 1992, respectively. In late September 1993, a gas turbine generator was shut down for unscheduled repairs until mid-December 1993. In late May 1994, a gas turbine was also shut down for unscheduled repairs until mid-August 1994. The Company estimates that these shut downs resulted in lost revenues of approximately $3,300,000 and $2,300,000 for the fiscal 1994 second and fourth quarters, respectively. Fiscal 1994 revenues include business interruption proceeds of $726,000 for the second quarter period. No amounts are recognized for the fourth quarter interruption because of a 30 day deductible period before insurance coverage applies.\nRevenues at the Newark Boxboard project were $23,082,000, $19,629,000 and $27,532,000 for the fiscal years ended June 30, 1994, 1993 and 1992, respectively. A fire at the Newark Boxboard project on December 25, 1992 disabled the plant until full operations resumed in October 1993. Fiscal 1994 revenues consisted of business interruption insurance proceeds of $980,000, partial operations from August to September 1993 and from full operations beginning in October 1993 through June 30, 1994. In comparison, fiscal 1993 revenues consist of full operations from July 1992 through December 1992 and $5,880,000 of business interruption proceeds through June 30, 1993.\nIn February 1994, the Company and its insurance carrier for the Newark project reached an agreement concerning the property damage and business interruption insurance claims submitted in connection with the fire. Under the terms of the agreement, the insurance carrier agreed to a minimum settlement of $36,000,000 which covered a substantial majority of the Company's costs of repair and loss of net profits due to business interruption. In addition, the Company has the right to receive up to an additional $1,400,000 upon the recovery by the insurance carrier of its claims against third parties. As a result of the insurance property settlement and the subsequent repairs made to the project, the Company recognized an involuntary conversion gain of $6,066,000 in the fiscal year ending June 30, 1994, representing the amount by which the replacement cost (insurance proceeds) exceeded the net book value of assets lost.\nEnergy revenues from the Company's biogas projects for the fiscal year ended June 30, 1994, 1993 and 1992 were $1,655,000, $1,679,000 and $2,825,000, respectively. Fiscal 1992 revenues included the Orange County, Amity, Hamms and Republic projects, each of which was sold or affected by termination of contracts in June 1992.\nEquipment sales and services for the years ended June 30, 1994, 1993 and 1992 were $24,304,000, $18,955,000 and $21,854,000, respectively. Equipment sales and services principally reflect the operations of O'Brien Energy Services, Puma and American Hydrotherm. O'Brien Energy Services revenues for the years ended June 30, 1994, 1993 and 1992 were $7,789,000, $3,067,000 and $144,000, respectively. The increases are primarily attributable to the Company expanding its domestic business in the design and assembly of generator sets and switchgear.\nEquipment sales of Puma in the years ended June 30, 1994, 1993 and 1992 were $13,499,000, $12,971,000 and $15,119,000, respectively. Revenues from 1992 to 1993 decreased primarily as a result of substantial utilization of Puma's production facilities in 1993 for internal projects such as the design and assembly of the standby power systems used in the Philadelphia Water Department project. Dollar-denominated revenues also declined as a result of a strengthening of the dollar versus the pound sterling. Fiscal 1994 revenues remain depressed from 1992 levels because of continued recessionary pressures and increased competition in the European market.\nEquipment sales and services for the years ended June 30, 1994, 1993 and 1992 by American Hydrotherm were $2,990,000, $2,912,000 and $5,742,000, respectively. The decrease in revenues from 1992 levels was primarily due to recessionary pressures and a change in product mix towards smaller projects.\nThe balance of equipment sales and services for the years ended June 30, 1994, 1993 and 1992 consisted of nonproject-related equipment activities and operation and maintenance activities with third parties.\nRental revenues were $5,372,000, $3,636,000 and $3,191,000 for the years ended June 30, 1994, 1993 and 1992, respectively. The increase in rental revenues in 1994 and 1993 was attributable to the completion in May 1993 of the Philadelphia Water Department project. The Company sold its interest in the Philadelphia Water Department project in November 1993 but continued to own and lease power generation equipment to the project which in fiscal 1994 amounted to approximately $2,187,000.\nRevenues from related parties for the years ended June 30, 1993 and 1992 were $515,000 and $378,000, respectively. These revenues consisted principally of equipment sales and services. Management does not anticipate significant revenues from related parties in the future.\nDevelopment fees and other revenues were $14,266,000, $9,450,000 and $3,054,000 for the years ended June 30, 1994, 1993 and 1992, respectively. Development fees and other revenues for fiscal 1994 include $5,121,000 of revenues recognized in connection with the sale of the Company's contractual rights to develop certain coalbed methane reserves. The selling price consisted of a $2,000,000 cash payment and a production note of $4,500,000. The Company discounted the note to reflect its estimated net realizable value in consideration of the Company's plan to monetize certain assets and accelerate cash flow. Most significantly, included in development fees and other revenues, in June 1994, the Company sold its recently acquired rights to develop a standby electric facility project for $5,000,000. The costs associated with the development of these rights were insignificant.\nDevelopment fees and other revenues for 1993 and 1992 consist of the sale of certain contractual rights associated with various projects either under development ($4,866,000 in 1993) or in operation ($2,048,000 in 1992). Development fees and other revenues also increased in 1994 and 1993 as a result of the Company supplying $4,015,000 and $3,989,000 in fiscal 1994 and 1993, respectively, of fuel under a fuel management contract to the California Milk Producers project at a negligible profit. In addition, the Company recognized $480,000 and $779,000 of revenues for equipment supply agreements associated with the Hartford Steam project for the years ended June 30, 1993 and 1992, respectively. The balance of development fees and other consists primarily of revenues recognized in connection with management fee agreements associated with the California Milk Producers and Hartford Steam projects.\nCosts and Expenses\nCost of sales for the years ended June 30, 1994, 1993 and 1992 include direct costs associated with the operation of projects of $49,961,000, $44,889,000 and $46,101,000, respectively. Cost of energy revenues increased in 1994 versus 1993 as a result of the Newark Boxboard project resuming full operations in October 1993 after completing repairs caused by the December 1992 fire. The project operated over nine months in fiscal 1994 as compared to six months in fiscal 1993. Energy cost increases in 1994 over 1993 were also impacted by gas swap and futures contract gains recognized in the 1993 fiscal year.\nIn fiscal 1993, the Company entered into a short term gas swap agreement intending to levelize the cost of natural gas for the three month period ended December 31, 1992 (fiscal 1993) and the three month period ended September 30, 1993 (fiscal 1994). The Agreement covered approximately 100% of the natural gas consumed by the Newark Boxboard and du Pont Parlin projects and established a fixed unit price for contracts in each period. The Company realized a $1,000,000 gain on the December 1992 contracts and credited fuel costs for the $1,000,000 cash proceeds received from the broker. Actual market prices then increased slightly above the fixed gas swap prices for the September 1993 quarter contracts thereby eliminating any potential obligation pursuant to the gas swap agreements for the September 1993 quarter.\nA Gas Swap Agreement was also negotiated for the fiscal 1994 second and third quarter fuel costs which resulted in a reduction of fuel costs of approximately $157,000. Presently, the Company has no active gas swaps or hedges.\nThe Company further hedged its gas position against price increases on a portion of its gas requirements for the remainder of the fiscal 1993 year through the use of gas futures which resulted in gains of $510,000 also recognized as an offset to fuel expense in fiscal 1993.\nApproximately seventy percent of the operating costs of the Newark Boxboard and du Pont Parlin projects consist of natural gas fuel costs. The Company continues to evaluate strategies to reduce the risk associated with the volatile nature of natural gas prices and their impact on gross profit levels. Cost of energy revenues in fiscal 1994 also increased because the Newark and Parlin projects were required to operate on an alternative (more expensive) fuel source for a portion of the third quarter because of natural gas shortages caused by severe winter conditions.\nCost of equipment sales and services for the years ended June 30, 1994, 1993 and 1992 were $21,890,000, $16,431,000 and $17,746,000, respectively. Cost of equipment sales and services increased in 1994 primarily as a result of the increase in sales volume at O'Brien Energy Services. Fiscal 1993 cost of equipment sales and services increased as a percentage of sales as a result of the previously discussed change in American Hydrotherm's product mix as well as the utilization of Puma's facilities for internal projects such as the Philadelphia Water Department.\nCost of rental revenues for the years ended June 30, 1994, 1993 and 1992 was $2,730,000, $2,458,000 and $1,421,000, respectively. The increase in fiscal 1994 cost of rental revenues is attributable to costs associated with a full year's rental to the Philadelphia Water Department. The Company sold the project to a private investor in November 1993 but continued to own and lease the facilities and generation equipment to the project. Cost of rental revenues increased as a percentage of revenue in 1993 primarily as a result of depreciation charges on equipment idled while being modified for use in the Philadelphia Water Department project, as well as depreciation charges associated with equipment recently placed in service.\nCost of revenues from related parties for the years ended June 30, 1993 and 1992 was $452,000 and $320,000, respectively. These costs consist principally of costs associated with equipment sales and services.\nCost of development and other fee revenue was $9,593,000, $7,520,000 and $1,408,000, in the years ended June 30, 1994, 1993 and 1992, respectively. These costs consist principally of costs associated with the sale of various projects either under development or in operation, costs associated with a gas supply agreement with the California Milk Producers project, and costs associated with equipment supply agreements for the Hartford Steam project and costs of management agreements for the Hartford Steam and California Milk Producers projects.\nProvision for Loss on Equipment Held For Sale\nAs part of the Company's debt restructuring program and its efforts to improve both short-term and long-term liquidity, the Company has actively begun seeking buyers for specific energy equipment not currently being used in an operating project nor critical to the completion of any projects in development. These assets, consisting mainly of gas and steam turbines are being held for sale in order to raise cash and reduce debt levels. The value of these assets sold in a secondary market is less than if they were incorporated into an internally developed operating project. Accordingly, the Company recorded a non-cash charge against earnings in the fourth quarter of $6,250,000 to write down the carrying value of these assets to an estimated resale value of $8,458,000 based upon appraisals made by the Company.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses for the years ended June 30, 1994, 1993 and 1992 were $19,680,000, $21,872,000 and $13,133,000, respectively. Selling, general and administrative expenses increased substantially in fiscal 1994 and 1993 over 1992 primarily as a result of increased litigation costs and other professional services. Total professional fees were $4,955,000, $4,934,000 and $1,788,000 for 1994, 1993 and 1992 respectively. Fiscal 1994 and 1993 also included the expensing of certain project development costs (See Note 8 to the Company's Consolidated Financial Statements). Additionally, in fiscal 1993, a $1,121,000 charge associated with the Company's relinquishing general partner responsibilities at the Hartford Steam Project was included in selling, general and administrative expenses.\nInvoluntary Conversion Gain\nIn fiscal 1994, the Company recognized an involuntary conversion gain of $6,066,000 from the property settlement with the insurance carrier resulting from the December 25, 1992 fire at the Newark project. The gain represents the amount by which the insurance proceeds (replacement cost) exceeded the net book value of the equipment lost in the fire.\nOther Income\nOther income for the years ended June 30, 1994, 1993 and 1992 was $874,000, $993,000 and $1,204,000, respectively. Fluctuations in other income were primarily attributable to interest income earned on escrow accounts established in connection with the Newark Boxboard and du Pont Parlin projects.\nInterest and Debt Expense\nInterest and debt expense for the years ended June 30, 1994, 1993 and 1992 was $18,013,000, $15,696,000 and $17,340,000, respectively. The increase in fiscal 1994 interest expense is attributable to a full year's impact from additional borrowings in fiscal 1993 as well as from new borrowings in fiscal 1994 incurred primarily in connection with the Philadelphia Water Department project. The decrease in interest and debt expense in 1993 was primarily the result of interest rate decreases on the Company's floating rate debt as well as debt amortization on the Newark Boxboard and du Pont Parlin projects. For the years ended June 30, 1994, 1993 and 1992, interest and debt expense includes $8,211,000, $9,145,000 and $11,284,000, respectively, associated with the nonrecourse financing on the Newark Boxboard and du Pont Parlin projects.\nInterest Swap\nA 1988 non-recourse project loan required that the Company enter into an Interest Swap Agreement to reduce the risk associated with a floating interest rate. As required, the Company negotiated an interest swap agreement with a third party in 1988 fixing the interest rate at 11% on 65% of the outstanding loan balance. At June 30, 1994 the floating rate was approximately 5.75%. Interest expense include costs associated with the interest swap of approximately $3,253,000, $3,544,000 and $2,912,000 in fiscal 1994, 1993 and 1992, respectively.\nIncome Taxes\nIncome tax expense for the years ended June 30, 1994, 1993 and 1992 resulted primarily from not recognizing the future benefit of net operating losses (\"NOLs\"). As the Company continues to generate tax losses due mainly to excess tax over book depreciation, future utilization of these NOLs is not anticipated and therefore, these NOLs are not currently being recognized as deferred tax assets.\nLiquidity and Capital Resources\nCash and cash equivalents at June 30, 1994 totalled approximately $5,681,000 as compared to $5,213,000 at June 30, 1993. Cash and cash equivalents consist primarily of short-term money market instruments. However, as described in Note 3 to the Consolidated Financial Statements, not all such cash balances were available to the Company due to provisions of the Newark Boxboard and du Pont Parlin financing agreements.\nRestricted cash at June 30, 1994 was $4,594,000 compared to $5,064,000 at June 30, 1993.\nThe Company's working capital deficiency at June 30, 1994 was approximately $125,683,000 as compared to $11,119,000 at June 30, 1993. The substantial increase in the Company's working capital deficiency is primarily due to the reclassification to current liabilities of the $49,174,000 balance of all outstanding Debentures as a result of the Company not making its March 15, 1994 interest payment on its Debentures, $25,010,000 of nonrecourse debt because of a working capital default and $21,914,000 of recourse debt because of defaults attributable to cross defaults and the filing of bankruptcy on September 28, 1994. See \"Business--General Development of Business\" and \"Legal Proceedings\".\nAs a result of defaults, consisting of defaults in the payment of interest under each of the Company's three bond Indentures, as well as defaults under certain of the Company's loan agreements and the bankruptcy filing the Company reclassified an additional $21,914,000 for a total of $39,042,000 of its recourse debt as a current liability. Of this amount, approximately $5,320,000 was triggered solely by defaults under the Indentures, $3,066,000 by cross defaults and the non-payment of principal subsequent to year end and the remainder, $13,528,000, was reclassified because of the bankruptcy filing on September 28, 1994. The Company was having discussions with its various lenders regarding the defaults and was developing a program to restructure this debt. The program was intended to provide, among other things, an extended amortization of the debt and the sale of equipment, which is not currently being utilized in an operating project or which has not been designated for a project under development. No lender had accelerated the payment of its loans with Company. The program had met with approval by several of the Company's lenders. See Note 5 to the Company's Consolidated Financial Statements.\nAt June 30, 1994, both the Newark and Parlin projects were in default of the covenant which requires the maintenance of positive working capital. On September 26, 1994, the project lenders agreed to waive this covenant through July 1, 1995, for the Parlin Project only, provided that during the period that this waiver is in effect no distribution of any nature whatsoever will be made to the Company. This waiver will cease to be effective in the event that the Parlin Project is in compliance with the requirement to maintain positive working capital at any time prior to June 30, 1995. The lenders were not willing to provide a similar waiver for the Newark project. As a result of the Newark project not getting the waiver, $25,010,000 of non-recourse debt has been reclassified from long-term to short-term debt.\nWorking Capital Requirements--Capital Resources\nDuring the years ended June 30, 1994 and June 30, 1993, the Company has suffered significant setbacks. Among these were the Newark Boxboard project fire, the expenses and significant diversion of management focus required to repair the Newark Boxboard plant, the intensification of the Hawker Siddeley litigation and the Debenture defaults. All of these have made it difficult for the Company to refinance or sell equity in its Newark Boxboard project and thus deprived the Company of access to significant capital which would otherwise have been available for project development. Additionally, the Indenture governing one series of the Company's Debentures restricts the ability of the Company to incur new long-term indebtedness under certain circumstances.\nIn response to these developments, the Board of Directors of the Company initiated a plan to address the short, intermediate and long-term working capital needs of the Company. Management expects the short-term (fiscal 1995) needs of the Company to be met through the monetization of assets or other means of accelerating cash flow, for example, the sale of operating projects and\/or projects in development.\nIn order to further enhance short-term cash flow, management has also offered discounts to certain debtors of the Company for early payment. In the aggregate, during the period July 1, 1993 through June 1994, the Company has received $1,400,000 in early satisfaction of notes receivable of $1,695,000. Under the terms of the notes, cash would not have been received until periods ranging from three months to over two years from the date of actual funding.\nIn November 1993, the Company entered into a letter of intent and then in March 1994, the Company entered into a $7,000,000 subordinated loan agreement with Stewart & Stevenson Services, Inc., a major equipment supplier and operation and maintenance company to be disbursed upon the completion of certain milestones. The first disbursement of $1,000,000 was funded January 13, 1994. The second disbursement of $3,500,000 was funded on March 16, 1994. Of this amount, $2,300,000 was disbursed to the Company and $1,200,000 remained in the Newark Boxboard project to prepay project debt, pay certain expenses of the project and create a capital improvement fund. The availability of a third disbursement of $2,500,000 has expired. This third disbursement was intended to be utilized for prepayment of debt at the Newark Boxboard project level and to satisfy a $1,000,000 note between the Company and Stewart & Stevenson. All outstanding principal and interest on the credit facility is to be satisfied by a percentage of all distributions made by O'Brien Newark. The Company currently intends to repay the proceeds of the Stewart & Stevenson credit facility upon the refinancing or sale of the Newark Project term loan.\nNatWest Markets has been retained to evaluate and market a partial sale, together with a concurrent or subsequent refinancing of the Newark Boxboard project term loan. The current debt outstanding on this project is approximately $29,580,000. In addition, management is currently evaluating a partial sale of the Company's du Pont Parlin project. Management's objective is to complete these transactions in the near future in order to generate additional cash flow, and to enter into a strategic alliance with a project \"partner\" to enhance refinancing efforts. There can be no assurance that the above mentioned transactions will occur. In order to facilitate these financing arrangements, or other financing alternatives, the Company reacquired in January 1994, a twelve and one-half percent equity interest in the Newark Boxboard project which it had previously sold in March 1993.\nFurthermore, the Company retained an investment banking firm to develop plans to enhance shareholder value, including an evaluation of the merits of selling or merging the Company or forming a strategic alliance. Subsequently, the Company engaged Jefferies & Company, Inc. to complete the implementation of the Company's plans to maximize shareholder value. Although the Company has received indications of interest, the Company's efforts to implement a restructuring plan (\"Restructuring Plan\") have been hampered by, among other things, the ongoing litigation with the Company's previous principal project turnkey construction contractor (the \"Hawker Siddeley litigation\"), the Newark fire, the defaults in the Debentures and the Company's liquidity problems, and most recently the filing under Chapter 11 of the Federal Bankruptcy Code.\nThere can be no assurance that the Company, in the future, will have adequate cash flow to finance operations and ongoing development activities or to meet current obligations.\nCogeneration and Waste Heat Recovery Projects - Capital Resources\nThe Company has previously and expects to continue to arrange for the construction and permanent funding of its projects through long-term nonrecourse debt. Depending upon the specifics of the project and the economic alternatives available, the Company either retains all of the ownership of a project or participates in project finance structures involving leases, corporate joint ventures, and limited partnerships. In the latter instances, the Company sells all or a portion of a project during its development or construction stage to third parties, and then participates in the various profit centers of such projects throughout the construction stage as well as the life of the project.\nAlternatively, the Company may use a debt\/equity structure, whereby the Company retains 100% ownership of the project. In such instances, the Company's equity position in the project funded either internally, from borrowings or the sale of securities, or from financial arrangements with other parties, will enable it to retain all of the revenues of the project.\nCapital Resources - Other Capital Requirements\nIn addition to the development and construction of projects, the Company's principal nonoperating expenditures over the next twelve months are expected to consist of the repayment of various short- term and long-term debt instruments primarily associated with equipment activities. In such instances, management anticipates that the sale of the underlying equipment or the refinancing of such equipment will provide the funds for repayment.\nStandby\/Peak Shaving and Biogas Fuel Projects - Capital Resources\nGenerally, because the capital requirements of standby\/peak shaving and biogas fuel projects are substantially less than those required by most industrial cogeneration and waste heat recovery projects, the Company finances the construction and permanent funding of these standby\/peak shaving and biogas projects primarily through the use of recourse lines of credit or loans with commercial banks and other lending institutions. Financing terms generally extend from one to seven years. Project assets are also leased by the Company on a medium to long-term basis. In most cases, wholly-owned subsidiaries are established for each project. Projects may also be structured in such a fashion as to allow the Company, or other participants, to take advantage of various tax credits that continue to exist.\nAt June 30, 1994, the Company had nominal availability under existing lines of credit. Although the Company had refinanced over $6,000,000 of debt subsequent to June 30, 1993, there can be no assurance that the Company will be successful in extending its current lines of credit or obtaining new lines of credit.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPage\nFinancial Statements\n(i) Consolidated Financial Statements of O'Brien Environmental Energy Inc.\nIndex to Consolidated Financial Statements. . . . . . . . . . . .\nReport of Independent Accountants . . . . . . . . . . . . . . . .\nConsolidated Balance Sheets as of June 30, 1994 and 1993. . . . .\nConsolidated Statements of Operations for the years ended June 30, 1994, 1993 and 1992. . . . . . . .\nConsolidated Statements of Stockholders' Equity for the years ended June 30, 1994, 1993 and 1992. . . . . . . .\nConsolidated Statements of Cash Flows for the years ended June 30, 1994, 1993 and 1992. . . . . . . .\nNotes to Consolidated Financial Statements. . . . . . . . . . . .\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 for this item is incorporated by reference to the Company's 1994 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to June 30, 1994.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required for this item is incorporated by reference to the Company's 1994 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to June 30, 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 the Company's 1994 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to June 30, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required for this item is incorporated by reference to the Company's 1994 Definitive Proxy Statement which the Company will file with the Securities and Exchange Commission no later than 120 days subsequent to June 30, 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 report.\n1. Financial Statements\nIndex to Consolidated Financial Statements\nReport of Independent Accountants\nConsolidated Balance Sheets as of June 30, 1994 and 1993\nConsolidated Statements of Operations for the years ended June 30, 1994, 1993 and 1992\nConsolidated Statements of Stockholders' Equity for the years ended June 30, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the years ended June 30, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nIndex to Financial Statement Schedules\nSchedule II--Amounts Receivable from Related Parties and Underwriters, Promoters and Employees other than Related Parties\nSchedule III -- Condensed Financial Information of Registrant \t (to be filed by amendment)\nSchedule V--Property, Plant and Equipment\nSchedule VI--Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment\nSchedule IX--Short-Term Borrowings\n3. Exhibits\n\t 1.1(20) Form of Letter to Debentureholders 3.1(14) Restated Certificate of Incorporation of the Company and \t \t amendments thereto \t 3.2(19) Amended Bylaws of the Company \t 4.1(1) Loan and Security Agreement with First Pennsylvania Bank N.A. dated August 5, 1985 4.1.1(10) Amendments to Loan and Security Agreement with First \t\t Pennsylvania Bank N.A. \t 4.2(2) Loan and Security Agreement with Fidelity Bank dated \t\t December 31, 1986 \t 4.3(6) Revolving Credit and Security Agreement with Carteret Savings Bank, F.A. dated February 3, 1989 4.4(6) Revolving Term Loan Commitment Letter from First Peoples Bank of New Jersey dated February 16, 1989 4.4.1(6) Amendment to Commitment Letter from First Peoples Bank of New Jersey dated April 21, 1989 4.4.2(18) Amendment No. 2 to Commitment Letter from First Peoples Bank of New Jersey dated January 21, 1992 4.4.3(18) Equipment Credit Facility Commitment Letter from Heller Financial, Inc. dated February 6, 1992 4.5(13) Loan and Security Agreement with Barclays Bank of New York, N.A. dated July 30, 1990 4.5.1(18) Amendment to Loan and Security Agreement with Barclays Bank of New York, N.A. dated February 24, 4.6(19) Letter of Credit Agreement with Meridian Bank dated as of January 21, 1993 4.6.1(19) Loan and Security Agreement with Meridian Bank dated as of September 29, 1992 4.8(19) Term Loan Agreement dated as of February 26, 1993 with The Bank of New York 4.10(19) Master Security Agreement dated as of December 23, 1992 with General Electric Capital Corporation 4.13(2) Indenture under which the Company's 7 3\/4% Convertible Senior Subordinated Debentures due March 15, 2002 are issued 4.13.1(6) Indenture under which the Company's 11% Convertible Senior Subordinated Debentures due March 15, 2010 are issued 4.13.2(13) Indenture under which the Company's 11% Convertible Senior Subordinated Debentures due March 15, 2011 are issued 4.14(2) Specimen of Debenture Certificate relating to Indenture dated as of March 15, 1987 4.14.1(6) Specimen of Debenture Certificate relating to Indenture dated as of March 15, 1990 4.14.2(12) Specimen of Debenture Certificate relating to Indenture dated as of March 14, 1991 4.15(21) Subordinated Loan Agreement with Stewart & Stevenson Services, Inc. dated as of March 11, 1994 10.1 Gas Rights Agreements 10.1.1(1) Gas Rights Agreement between City of Corona and Watson Biogas Systems (\"Watson\") dated December 31, 1981 (Corona Project) 10.1.2(1) Assignment of Gas Rights Agreement between Watson and O'Brien Energy Products, Inc. (\"OEP\") dated December 20, 1983 (Corona Project) 10.1.3(1) Assignment of Gas Rights Agreement between Watson and the Company dated December 31, 1984 (Corona Project) 10.1.4(1) Methane Gas Agreement between SmithKline Beckman Corporation, Montgomery County and OEP dated October 13, 1983 (SmithKline Project) 10.1.5(1) Landfill Gas Lease between FR&S Landfill, AVM Nursery Corporation (\"AVM\") and OEP dated December 11, 1982 (Atochem Project-Phase I) 10.1.6(1) Gas Rights Agreement between the Redevelopment Agency of the City of Duarte and Watson dated November 11, 1980 (Duarte Project) 10.1.7(1) Assignment of Gas Rights Agreement between Watson and the Company dated December 30, 1985 (Duarte Project) 10.1.8(1) Permit Agreement between the City of New York and Wehran Energy Corporation (\"Wehran\") dated September 1, 1981 with attached Amendment dated January 10, 1986 (Pelham Bay Project) 10.1.9(1) Subpermit Agreement between the Company and Wehran dated January 10, 1986 (Pelham Bay Project) 10.1.10(1) Assignment Agreement between Wehran and the Company dated January 10, 1986 (Pelham Bay Project) 10.1.11(2) Landfill Gas Agreement between SCA Disposal Services of New England, Inc. (\"SCA\") and the Company dated March 1986 (Amesbury Project) 10.1.12(1) Landfill Gas Purchase and Sales Agreement between Manus Corporation and the Company dated April 2, 1986 (Mazzaro Project) 10.1.13(2) Amendment to Landfill Gas Purchase and Sales Agreement dated November 5, 1986 (Mazzaro Project) (See 10.1.12) 10.1.14(2) Landfill Gas Rights Agreement between the County of Volusia and the Company dated April 1986 (Volusia Project) 10.1.15(2) Landfill Gas Agreement between Joseph R. Amity & the Company dated September 4, 1986 (Amity Project) 10.1.16(2) Landfill Gas Agreement between Northwest Jersey Development Company and the Company dated September 2, 1986 (Hamms Project) 10.1.17(3) Amended and Restated Landfill Gas Agreement between SCA and the Company dated March 27, 1987 (Amesbury Project) 10.1.18(6) Landfill Gas Agreement between Harold Herbert and the Company dated February 8, 1989 (Edgeboro Project) 10.1.19(6) Landfill Gas Agreement among Nuodex, Inc., Industrial Land Reclaiming, Incorporated and the Company dated February 25, 1988 (ILR-Edison Project) 10.1.20(18) Landfill Gas Agreement between Southwestern Public Service Authority of Virginia (\"SPSA\") and the Company dated October 23, 1991 (SPSA Project) 10.1.21(18) Gas Supply Agreement between The Philadelphia Municipal Authority (\"PMA\") and the Company dated June 30, 1992 regarding the NE Plant (Philadelphia Water Project) 10.1.22(18) Gas Supply Agreement between the PMA and the Company dated June 30, 1992 regarding the SW Plant (Philadelphia Water Project) 10.2 Thermal Supply Agreements 10.2.1(1) Steam Supply Agreement between the Hartford Steam Company and the Company dated September 19, 1985 (Hartford Steam Project) 10.2.2(18) Steam Purchase Agreement among Philadelphia Thermal Energy Corporation, Adwin Equipment Corporation, Grays Ferry Cogeneration Partnership and the Company dated November 11, 1991 (Schuylkill Project) 10.3 Power Purchase Agreements 10.3.1(1) Power Purchase Contract between Southern California Edison Company (\"SCE\") and the Company dated October 2, 1984 (Corona Project) 10.3.2(1) Parallel Generation Agreement between Watson and SCE dated December 31, 1981 (Duarte Project) 10.3.3(1) Amendment to Power Purchase Agreement between SCE and Watson dated May 20, 1985 (Duarte Project) 10.3.3.2(19) Amendment No. 3 to Power Purchase Agreement between SCE and the Company dated June 16, 1993 (Duarte Project) 10.3.4(1) Assignment between Watson and the Company dated December 30, 1985 (Duarte Project) (See 10.1.7) 10.3.5(1) Purchased Power Contract between the Company and Unitil Power Corp. dated December 17, 1985 (Amesbury Project) 10.3.6(1) Electricity Purchase Agreement between the Connecticut Light and Power Company and the Company dated September 18, 1985 (Hartford Steam Project) 10.3.7(1) Power Purchase Agreement between the Company and SCE dated June 14, 1985 (California Milk Project) 10.3.8(1) Power Purchase Agreement between the Company and Pacific Gas and Electric Company (\"PG&E\") dated June 18, 1985 (Salinas Project) 10.3.9(1) First Amendment to Power Purchase Agreement between the Company and PG&E dated January 2, 1986 (Salinas Project) 10.3.10(2) Power Purchase Agreement between County Sanitation District No. 1 and the Company dated October 1, 1986 (Orange County Project) 10.3.11(2) Long Term Power Purchase Contract for Cogeneration and Small Power Production between the Company and Jersey Central Power and Light (\"JCP&L\") dated March 10, 1986 (Newark Boxboard Project) 10.3.12(2) Agreement for Purchase and Sale of Electric Power between the Company and JCP&L dated October 20, 1986 (E.I. du Pont Parlin Project) 10.3.13(2) Agreement for Purchase and Sale of Electric Power between the Company and JCP&L dated January 15, 1987 (Hamms Project) 10.3.14(3) Amended and Restated Power Purchase Agreement between the Company and SCE dated April 15, 1987 (California Milk Project) 10.3.14.1(6) Amendment No. 1 to the Amended and Restated Power Purchase Contract between SCE and the Company dated October 4, 1988 (California Milk Project) 10.3.15(3) Agreement between Pennsylvania Power & Light Company (\"PP&L\") and the Company dated April 15, 1987 (Amity Project) 10.3.15.1(7) Agreement between PP&L and the Company dated July 20, 1989 (Amity Project) 10.3.16(6) Parallel Generation Agreement between the Company and Long Island Lighting Company dated February 2, 1990 (Ruco Polymer Project) 10.3.17(18) Power Purchase and Interconnection Agreement between Public Service Electric and Gas (\"PSE&G\") and the Company dated April 9, 1992 (ILR-Edison Project) 10.3.18(18) Power Purchase and Interconnection Agreement between PSE&G and the Company dated April 9, 1992 (Edgeboro Project) 10.3.19(18) Agreement for the Sale of Electrical Output to Virginia Electric and Power Company (\"VEPC\") between VEPC and the Company dated April 15, 1992 (SPSA Project) 10.3.20(18) Energy Service Agreement between PMA and the Company dated June 30, 1992, regarding the NE Plant (Philadelphia Water Project) 10.3.21(18) Energy Service Agreement between PMA and the Company dated June 30, 1992 regarding the SW Plant (Philadelphia Water Project) 10.3.22(18) Agreement for Purchase of Electric Output between Philadelphia Electric Company and Grays Ferry Cogeneration Partnership dated July 28, 1992 (Schuylkill Project) 10.3.23(18) Power Purchase Agreement among Non-Fossil Purchasing Agency Limited, Norweb plc and the Company dated November 6, 1991 10.3.24(19) Energy Service Agreement dated December 24, 1993 between the City of Philadelphia and O'Brien (Tinicum) Standby Power, Inc. (Tinicum Project) 10.3.25(19) Energy Service Agreement dated February 28, 1994 between SmithKline Beecham Corporation and O'Brien Standby Power Energy, Inc. (SmithKline Project) 10.4 Employment Agreements 10.4.1(14) Employment Agreement with Sanders D. Newman, dated January 1, 1985 and amendment thereto 10.4.2(6) Employment Agreement with Robert Shinn dated May 25, 1989 10.5 Stock Option Plans 10.5.1(1) 1984 Stock Option Plan 10.5.2(4) 1987 Stock Option Plan 10.5.3(16) 1991 Stock Option Plan 10.6 Leases 10.6.1(1) Lease Agreement for premises located at 225 South Eighth Street, Philadelphia, Pennsylvania dated August 14, 1984 10.6.2(6) Lease Agreement for premises located at 231 South Eighth Street, Philadelphia, Pennsylvania dated March 17, 1989 10.6.3(13) Lease Agreement for premises located at 470 Park Avenue South, New York, New York dated May 1, 1990 10.6.4(13) Lease Agreement for premises located at 37 Sandwich Road, Ash, Canterbury, Kent dated June 1, 1990 10.6.5(14) Lease Agreement for premises located in Indiana County, Pennsylvania dated January 30, 1991 10.8 Construction and Term Loan Agreements 10.8.1(6) Construction and Term Loan Agreement between the CIT Group\/Equipment Financing, Inc. and O'Brien California Cogen Limited dated March 1, 1988 (California Milk Project) 10.8.2(6) Construction and Term Loan Agreement between the CIT Group\/Equipment Financing, Inc. and O'Brien California Cogen II Limited dated June 30, 1988 (Salinas Project) 10.8.3(6) Construction and Term Loan Agreement between National Westminster Bank PLC and O'Brien (Newark) Cogeneration, Inc. dated July 18, 1988 (Newark Boxboard Project) 10.8.3.1(13) Amendment No. 1 to Construction and Term Loan Agreement between National Westminster Bank PLC and O'Brien (Newark) Cogeneration, Inc. dated April 1, 1989 (Newark Boxboard Project) 10.8.3.2(21) Amendment No. 2 to Construction and Term Loan Agreement between National Westminster Bank PLC and O'Brien (Newark) Cogeneration, Inc. dated as of June 1, 1989 (Newark Boxboard Project) 10.8.3.3(21) Amendment No. 3 to Construction and Term Loan Agreement between National Westminster Bank PLC and O'Brien (Newark) Cogeneration, Inc. dated as of March 11, 1994 (Newark Boxboard Project) 10.8.4(6) Construction and Term Loan Agreement between National Westminster Bank PLC and O'Brien (Parlin) Cogeneration, Inc., dated December 1, 1988 (E.I. du Pont Parlin Project) 10.8.4.1(13) Amendment No. 1 to Construction and Term Loan Agreement between National Westminster Bank PLC and O'Brien (Parlin) Cogeneration, Inc. dated March 1, 1989 (E.I. du Pont Parlin Project) 10.8.4.2(13) Amendment No. 2 to Construction and Term Loan Agreement between National Westminster Bank PLC and O'Brien (Parlin) Cogeneration, Inc. dated January 1, 1990 (E.I. du Pont Parlin Project) 10.8.5(14) Term Loan and Working Capital Agreement between The Mitsui Bank, Limited, New York Branch and O'Brien California Cogen Limited dated March 29, 1990 (California Milk Project) 10.9 Turnkey Construction Agreements 10.9.1(6) Turnkey Construction Agreement between Hawker Siddeley Power Engineering Inc. and O'Brien California Cogen Limited Partnership dated February 18, 1988 (California Milk Project) 10.9.2(6) Turnkey Construction Agreement between Hawker Siddeley Power Engineering Inc. and O'Brien California Cogen II Limited dated June 23, 1988 (Salinas Project) 10.9.3(6) Turnkey Construction Agreement between Hawker Siddeley Power Engineering Inc. and O'Brien (Newark) Cogeneration, Inc. dated July 8, 1988 (Newark Boxboard Project) 10.9.4(6) Turnkey Construction Agreement between Hawker Siddeley Power Engineering Inc. and O'Brien (Parlin) Cogeneration, Inc. dated November 30, 1988 (E.I. du Pont Parlin Project) 10.9.5(13) Turnkey Construction Agreement between Century Contractors West Inc. and O'Brien California Cogen II Limited dated August 14, 1990 and Amendment thereto dated October 26, 1990 (Salinas Project) 10.10 Operation and Maintenance Contracts 10.10.1(6) Operation and Maintenance Contract between California Cogeneration Operators Inc. and O'Brien California Cogen Limited dated April 6, 1988 (California Milk Project) 10.10.2(6) Operation and Maintenance Contract between California Cogeneration Operators Inc. and O'Brien Cogeneration, Inc. I dated June 1, 1988 (Salinas Project) 10.10.3(6) Operation and Maintenance Contract between John Brown Power Limited and O'Brien (Newark) Cogeneration, Inc. dated October 24, 1988 (Newark Boxboard Project) 10.10.4(6) Operation and Maintenance Contract between John Brown Power Limited and O'Brien (Parlin) Cogeneration, Inc. dated October 24, 1988 (E.I. du Pont Parlin Project) 10.10.5 Operation and Maintenance Contract between John Brown Power Limited and O'Brien (Hartford) Cogeneration Limited Partnership dated October 12, 1988 (Hartford Project) 10.10.6(18) Partnership Agreement of Grays Ferry Cogeneration Partnership dated October 29, 1991 (Schuylkill Project) 10.10.7(21) Operation and Maintenance Contract between Stewart & Stevenson Operations, Inc. and O'Brien (Parlin) Cogeneration, Inc. dated April 1, 1994 (E.I. du Pont Parlin Project) 10.11 Agreements for the Sale of Project Assets or Stock 10.11.1(18) Agreement for the Sale and Purchase of Certain Assets of Westwanda Energy, Inc. (\"Westwanda\") among Westwanda, Lafayette Energy Partners, L.P. and the Company dated June 30, 1992 (Hamms Project) 10.11.2(18) Agreement for the Sale and Purchase of Certain Assets of O'Brien Environmental Energy, Inc. between Taylor Energy Partners, L.P. and the Company dated June 30, 1992 (Amity Project) 10.11.3(19) Supplemented and Restated Agreement between O'Brien Methane Production, Inc. and BBC\/DRI Blacklick Joint Venture dated August 27, 1993 (Coalbed Methane) 10.11.4(19) Exclusive Option Agreement dated as of December 16, 1993 with Zahren Financial Corporation and Memorandum of Understanding related thereto dated January 31, 1994 10.11.5(19) Stock Purchase Agreement dated November 12, 1993 by and among OPC Acquisition, Inc., BioGas Acquisition, Inc. and the Company (Philadelphia Water Department Project) 10.11.6(19) Stock Purchase Agreement dated September 30, 1992 with Zahren Financial Corporation (SPSA Project) 10.11.7(19) Stock Purchase Agreement dated June 30, 1993 with ZFC Energy, Inc. (SPSA Project) 10.11.8(19) Agreement of Sale and Purchase dated December 31, 1992 between O'Brien Energy Europe Limited, Combined Landfill Projects Limited and the Company (Rowley Project) 10.12 Miscellaneous 10.12.1(6) Amended and Restated Agreement between Atochem, Inc. and the Company dated October 12, 1987 10.12.2(21) Rights Assignment Agreement dated as of March 31, 1993 between the Company and Bradley Resources Company 10.12.3(21) Repurchase Agreement dated January 18, 1994 between the Company and Bradley Resources Company 10.12.4(21) Master Equipment Lease Agreement dated as of November 19, 1992 between O'Brien Energy Services Company and Financing For Science and Industry 10.12.5(21) Equipment Lease dated July 28, 1993 between the Company and BLT Leasing Corp. 10.12.6(21) Fairbanks Purchase Agreement dated June 30, 1994 between the Company and SmithKline Beecham Corporation 18.1(6) Letter re change in accounting principles 21.1(19) List of Subsidiaries of Registrant 23.1(21) Consent of Coopers & Lybrand \t 27.1(21) Financial Data Schedule _____________________________\n(1) Incorporated by reference to the Company's Registration Statement (File No. 33-6463) ordered effective by the Commission on July 25, 1986. (2) Incorporated by reference to the Company's Registration Statement (File No. 33-11789) ordered effective by the Commission on March 19, 1987. (3) Incorporated by reference to the Company's Annual Report on Form 10-K filed for the fiscal year ended June 30, 1987. (4) Incorporated by reference to the Company's Annual Report on Form 10-K filed for the fiscal year ended June 30, 1988. (5) Incorporated by reference to the Company's Current Report on Form 8-K filed on September 22, 1989. (6) Incorporated by reference to the Company's Annual Report on Form 10-K filed for the fiscal year ended June 30, 1989. (7) Incorporated by reference to the Company's Registration Statement (File No. 33-32338) ordered effective by the Commission on March 14, 1990. (8) Incorporated by reference to Amendment No. 1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1990. (9) Incorporated by reference to the Company's Annual Report on Form 10-K filed for the fiscal year ended June 30, 1990. (10) Incorporated by reference to Amendment No. 3 to the Company's Registration Statement (File No. 33-38940) ordered effective by the Commission on March 7, 1991. (11) Incorporated by reference to the Company's Registration Statement (File No. 33-38940) filed with the Commission on February 7, 1991. (12) Incorporated by reference to Amendment No. 1 to the Company's Registration Statement (File No. 33-38940) filed with the Commission on February 12, 1991. (13) Incorporated by reference to Amendment No. 2 to the Company's Registration Statement (File No. 33-38940) filed with the Commission on March 1, 1991. (14) Incorporated by reference to the Company's Annual Report on Form 10-K filed for the fiscal year ended June 30, 1991. (15) Incorporated by reference to the Company's Registration Statement (File No. 33-43733) filed with the Commission on November 1, 1991. (16) Incorporated by reference to Amendment No. 2 to the Company's Registration Statement (File No. 33-43733) filed with the Commission on December 17, 1991. (17) Incorporated by reference to Amendment No. 1 to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1991. (18) Incorporated by reference to the Company's Annual Report on Form 10-K filed for the fiscal year ended June 30, 1992. (19) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended June 30, 1993. (20) Incorporated by reference to Amendment No. 1 to the Company's Registration Statement (File No. 33-53631) filed with the Commission on June 7, 1994. (21) Filed herewith.\n(b) Reports on Form 8-K\nThe Company did not file a Current Report on Form 8-K 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 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 10th day of October, 1994.\nO'BRIEN ENVIRONMENTAL ENERGY, INC.\nBy: \/s\/ FRANK L. O'BRIEN III \t\t\t\t ---------------------------------- Frank L. O'Brien III Chairman of the Board and Chief Executive Officer\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 --------- ----- ----\ns\/ FRANK L. O'BRIEN III Chairman of the Board, October 10, 1994 - - ---------------------------- Chief Executive Officer, Frank L. O'Brien III Class B Director\n\/s\/ ROBERT J. SMALLACOMBE President, October 10, 1994 - - ---------------------------- Chief Operating Officer Robert Smallacombe Class A Director\n\/s\/ RONALD R. ROMINIECKI Vice President\/Finance and October 10, 1994 - - ---------------------------- Chief Financial Officer Ronald R. Rominiecki\n\/s\/ JOEL D. COOPERMAN Vice President, Treasurer October 10, 1994 - - ---------------------------- Class B Director Joel D. Cooperman\n\/s\/ GEORGE L. BERNSTEIN Class B Director October 10, 1994 - - ---------------------------- George Bernstein\n\/s\/ SANDERS D. NEWMAN Class A Director October 10, 1994 - - ---------------------------- Sanders D. Newman\nO'BRIEN ENVIRONMENTAL ENERGY, INC.\nIndex to Consolidated Financial Statements . . . . . . . . . .F-1\nIndependent Accountants Report . . . . . . . . . . . . . . . .F-2\nConsolidated Balance Sheets as of June 30, 1994 and 1993 . . .F-3\nConsolidated Statements of Operations for the years ended June 30, 1994, 1993, and 1992. . . . . . . . . . . . . . . .F-5\nConsolidated Statements of Stockholders' Equity for the years ended June 30, 1994, 1993 and 1992 . . . . . . . . . .F-6\nConsolidated Statements of Cash Flows for the years ended June 30, 1994, 1993 and 1992 . . . . . .F-9\nNotes to Consolidated Financial Statements . . . . . . . . .\nINDEPENDENT ACCOUNTANTS REPORT\nThe Board of Directors and Stockholders O'Brien Environmental Energy, Inc.\nWe have audited the consolidated financial statements and the financial statement schedules of O'Brien Environmental Energy, Inc. and subsidiaries (\"Company\") listed in the indexes on pages and S-1, respectively. 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of O'Brien Environmental Energy, Inc. and subsidiaries as of June 30, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1994 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 29 to the consolidated financial statements, the Company is a defendant in several lawsuits. The ultimate outcome of the litigations cannot presently be determined. Accordingly, no provisions for any liabilities that may result has been made in the accompanying consolidated statements.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has experienced significant operating problems and setbacks which have contributed to its losses and liquidity problems. Further, O'Brien Environmental Energy, Inc. filed a voluntary petition for reorganization under Chapter 11 of the Federal Bankruptcy Code in the United States Bankruptcy Court on September 28, 1994. These events and circumstances, including the Company's highly leveraged capital structure, raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are described in Note 1 to the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.\nCOOPERS & LYBRAND L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania October 7, 1994\n\t\tO'BRIEN ENVIRONMENTAL ENERGY, INC. \t\t CONSOLIDATED BALANCE SHEETS \t\t June 30, 1994 and 1993 (Dollars in thousands)\n\t\t\t ASSETS\n\t 1994 1993\nCurrent assets: Cash and cash equivalents \t $ 5,681 \t $ 5,213 Restricted cash and cash equivalents \t\t4,594 5,064 Accounts receivable, net 12,100 12,394 Receivable from related parties 633 1,175 Notes receivable, current 780 2,564 Inventories 3,241 4,196 Insurance claims receivable -- 5,255 Other current assets 3,167 1,631 \t\t\t\t\t ------ \t ------- Total current assets 30,196 37,492\nProperty, plant and equipment, net 176,514 194,217\nEquipment held for sale 8,458 --\nCoalbed methane gas properties held for sale \t\t\t\t\t -- 4,464\nProject development costs 5,126 5,136\nNotes receivable, noncurrent 5,026 9,315\nNotes receivable from officers 238 246\nInvestments in equity affiliates 3,175 2,515\nExcess of cost of investment in subsidiaries over net assets at date of acquisition, net 1,987 2,085\nDeferred financing costs, net 5,269 5,728\nOther assets 1,827 1,331 \t\t\t\t\t -------- -------- $237,816 $262,529 \t\t\t\t\t ======== ========\nSee accompanying notes to consolidated financial statements.\n\t\t\tO'BRIEN ENVIRONMENTAL ENERGY, INC. \t\t\t CONSOLIDATED BALANCE SHEETS \t\t\t June 30, 1994 and 1993 \t\t\t (Dollars in thousands)\n\t\t\tLIABILITIES AND STOCKHOLDERS' EQUITY\n\t 1994 \t 1993\nCurrent liabilities: Accounts payable \t \t\t$ 18,358 \t$ 19,175 Convertible senior subordinated debentures\t\t\t\t 49,174 -- Current portion of recourse long-term debt 39,042 10,419 Current portion of nonrecourse project financing 35,830 10,758 Accrued interest payable 5,145 2,314 Short-term borrowings 2,386 2,199 Other current liabilities 5,944 3,746 \t\t\t\t\t\t ------- ------ Total current liabilities 155,879 48,611\nRecourse long-term debt, net of current portion 7,073 28,012 Convertible senior subordinated debentures -- 49,174 Nonrecourse project financing, net of current portion 60,310 97,140 Construction costs payable -- 5,100 Deferred income taxes 12,808 10,895 Other liabilities 1,610 7,922 \t\t\t\t\t\t ------- ------- 237,680 246,854 \t\t\t\t\t\t ------- ------- Commitments and contingencies\nStockholders' equity: Preferred stock, par value $.01; shares authorized, 10,000,000; none issued Class A common stock, par value $.01, one vote per share; 40,000,000 shares authorized; issued 13,055,597; outstanding - 12,965,397 in 1994 and 1993 130 130\nClass B common stock, par value $.01, ten votes per share; 10,000,000 shares authorized; issued 4,070,770; outstanding - 3,905,770 in 1994 and 1993 39 39 Additional paid-in capital 41,353 40,053 Accumulated deficit (40,735) (23,932) Other (651) (615) \t\t\t\t\t\t-------- ------- Total stockholders' equity 136 15,675 \t\t\t\t\t\t-------- ------- Total liabilities and stockholders' equity $237,816 $262,529 \t\t\t\t\t\t======== ========\nSee accompanying notes to consolidated financial statements.\n\t\t\tO'BRIEN ENVIRONMENTAL ENERGY, INC. \t\t CONSOLIDATED STATEMENTS OF OPERATIONS \t\tfor the years ended June 30, 1994, 1993 and 1992 \t (Dollars and shares in thousands, except per share data)\n\t \t 1994 1993 1992\nEnergy revenues \t $62,647 $ 65,136 $ 71,638 Equipment sales and services \t\t 24,304 18,955 21,854 Rental revenues \t\t 5,372 3,636 3,191 Revenues from related parties \t\t -- 515 378 Development fees and other \t 14,266 9,450 3,054 \t\t\t\t\t ------- -------\t ------- \t 106,589 97,692 100,115 \t\t\t\t\t ------- -------\t ------- Cost of energy revenues \t 49,961 44,889 46,101 Cost of equipment sales and services 21,890 16,431 17,746 Cost of rental revenues \t 2,730 2,458 1,421 Cost of revenues from related parties -- 452 320 Cost of development fees and other \t 9,593 7,520 1,408 \t\t\t\t\t ------- ------- ------- \t 84,174 71,750 66,996 \t\t\t\t\t ------- -------\t ------- Gross profit \t 22,415 25,942 33,119\nProvision for loss on equipment held for sale \t 6,250 -- -- Selling, general and administrative expenses \t\t\t 19,680 21,872 13,133 \t\t\t\t\t ------- ------- ------- Income (loss) from operations \t (3,515) 4,070 19,986\nInvoluntary conversion gain \t 6,066 -- -- Interest and other income \t 874 993 1,204 Interest and debt expense (18,013) (15,696) (17,340) \t\t\t\t\t ------- ------- ------- Income (loss) before income taxes (14,588) (10,633) 3,850\nProvision for income taxes \t 1,913 3,078 2,438 \t\t\t\t\t -------- ------- ------ Net income (loss) \t\t $ (16,501) $(13,711) $1,412 \t\t\t\t\t ======== ======= ====== Net income (loss) per share \t $ (.98) $ (.82) $ .09 \t\t\t\t\t ======== ======= ====== Weighted average shares outstanding \t 16,871 16,821 14,911 \t\t\t\t\t ======== ======= ======\nSee accompanying notes to consolidated financial statements.\n\t\t\tO'BRIEN ENVIRONMENTAL ENERGY, INC. \t\tCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY \t\tfor the years ended June 30, 1994, 1993 and 1992 \t\t\t (Dollars in thousands)\nSee accompanying notes to consolidated financial statements.\n\t\t\tO'BRIEN ENVIRONMENTAL ENERGY, INC. \t\tCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY \t\tfor the years ended June 30, 1994, 1993 and 1992 \t\t\t\t(Dollars in thousands)\n\t See accompanying notes to consolidated financial statements.\n\t\t\t O'BRIEN ENVIRONMENTAL ENERGY, INC. \t\t\tCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY \t\t\tfor the years ended June 30, 1994, 1993 and 1992 \t\t\t\t\t(Dollars in thousands)\n\t See accompanying notes to consolidated financial statements.\n\t\t\tO'BRIEN ENVIRONMENTAL ENERGY, INC. \t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS \t (Dollars in thousands, except per share data)\n1. Business; Liquidity and Capital Resources:\nO'Brien Environmental Energy, Inc. and its subsidiaries (the \"Company\") develop, own and operate biogas projects and develops and owns cogeneration, and waste-heat recovery projects which produce electricity and thermal energy for sale to industrial and commercial users and public utilities. In addition, the Company sells and rents power generation cogeneration and standby\/peak shaving equipment and services.\nOn September 28, 1994, O'Brien Environmental Energy, Inc., the parent company, filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code with the U.S. Bankruptcy Court for the District of New Jersey to pursue financial restructuring efforts under the protection afforded by the U.S. bankruptcy laws. The decision to seek Chapter 11 relief was based on the conclusion that action had to be taken to preserve its relationships and maintain the operational strength and assets of the Company, and to restructure its debt and utilize its assets in a manner consistent with the interests of all creditors and shareholders rather than liquidate to satisfy the demands of a particular group of creditors. The Company expects to continue its normal activities, including project development and the sale and\/or refinancing of existing projects.\nSubsequent to September 28, 1994, the Company is operating as debtor-in-possession under the Bankruptcy Code. As such, the Company is authorized to operate its business, but may not engage in transactions outside the ordinary course of business without approval, after notice and hearing, of the Bankruptcy Court. There can be no assurance that the Company will be able to obtain such approval to continue its normal operations and restructure its debt and otherwise engage in project development and the sale or refinancing of existing projects.\nThere is negative working capital of $125,683 at June 30, 1994. Furthermore, the Company is severely restricted in accessing the cash flows of its major operating wholly-owned subsidiaries (Newark and Parlin) because of certain restrictive debt covenants and technical and legal requirements, including an adequate level of distributable reserves, that arise from these subsidiaries having non- recourse project financing.\nThere can be no assurance that the Company's restructuring efforts will be successful, or that the Company can present a plan of reorganization which will be accepted by the bankruptcy court and creditors, consistent with the Company's requirements in restructuring the obligations. Furthermore, there can be no assurance that sales of assets can be successfully accomplished on terms acceptable to the Company. Under current circumstances, the Company's ability to continue as a going concern depends upon the successful restructuring of the Company's obligations and the further redeployment of assets.\n2. Summary of Significant Accounting Policies:\nBasis of Presentation:\nThe consolidated financial statements include the accounts of the Company and all significant subsidiaries which are more than 50 percent owned and controlled. Intercompany transactions and unrealized intercompany profits and losses on transactions with equity method investees have been eliminated in consolidation. Foreign subsidiaries with fiscal years ending on March 31 are included in the consolidated financial statements. If events occurred between March 31 and June 30 which materially affect the consolidated financial position or results of operations, they would be reflected in the consolidated financial statements. Investments in less than majority-owned entities are recorded at cost plus equity in their undistributed earnings or losses since acquisition.\nCertain reclassifications have been made to conform prior years' data to the current presentation.\nRevenue Recognition:\nEnergy revenues from cogeneration and biogas projects are recognized as billed over the term of the contract. Profits and losses from sales and rental of power generation equipment, including sales to projects in which the Company retains less than a 100% interest, are recognized as the equipment is sold or over the term of the rental. Development fee revenue is recognized on a cost recovery basis as cash is received (without future lending provisions), or equity interest in the partnership increases, whereby revenues are recognized subsequent to the recovery of all project development costs.\nInventories:\nInventories, consisting principally of power generation equipment and related parts held for sale, are valued at the lower of cost (determined primarily by the specific identification method) or market.\nProperty, Plant and Equipment:\nProperty, plant and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful lives of the assets which range from five to thirty years. Depreciation on equipment held for future projects is not provided until the equipment is placed in service. For income tax purposes, the Company uses accelerated depreciation methods.\nCost of maintenance and repairs is charged to expense as incurred. Renewals and improvements are capitalized. Upon retirement or other disposition of items of plant and equipment, cost of items and related accumulated depreciation are removed from the accounts and any gain or loss is included in operations.\nEquipment Held For Sale:\nEquipment held for sale consists of power generation equipment not currently being used in an operating project and is valued at the lower of cost or net realizable value.\nProject Development Costs:\nProject development costs consist of fees, licenses and permits, site testing, bids and other charges, including salary and interest charges, incurred by the Company in developing projects. For wholly-owned projects, these costs are transferred to property, plant and equipment upon commencement of construction and depreciated over the contract term upon commencement of operations. For projects structured as partnerships, these costs may be recovered through development cost reimbursements from the partnership or third parties, or may be transferred to an investment in the partnership. It is the Company's policy to expense these costs in any period in which management determines the costs to be unrecoverable.\nDeferred Financing Costs:\nDeferred financing costs are being amortized on a straight-line basis over the terms of the related financing.\nRecourse Long-term Debt and Nonrecourse Project Financing:\nRecourse long-term debt consists of collateralized long-term debt for which repayment is a general obligation of the Company. Nonrecourse project financing consists of long-term debt for which repayment obligations are limited to specific project subsidiaries.\nIncome Taxes:\nIncome Taxes are provided based upon the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" which requires the recognition of deferred income taxes for the tax consequences of \"temporary differences\" by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities. Under SFAS No. 109, the effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment date.\nGas Swap Agreements:\nThe Company enters into gas swap agreements from time to time to reduce the impact of changes in gas prices on its operating income. The differentials to be paid or received under such agreements are accrued and are recorded as increments or decrements to gas expense.\nInterest Rate Swap Agreement:\nThe Company has entered into an interest rate swap agreement to reduce the impact of changes in interest rates on certain of its variable rate nonrecourse debt. The differentials to be paid or received under such agreements are accrued and are recorded as increments or decrements to interest and debt expense.\nAmortization of Excess Cost:\nExcess of cost of investment in subsidiaries over net assets at date of acquisition is being amortized by charges to operations on a straight-line basis over twenty-five years.\nNet Income (Loss) per Share:\nNet Income (Loss) per share is calculated by dividing net income (loss) by the weighted average shares of Common Stock and Common Stock equivalents outstanding. Fully diluted net income (loss) per share is not presented because conversion of the convertible senior subordinated debentures and other Common Stock equivalents would be antidilutive.\nForeign Currency Accounting:\nThe financial statements of foreign subsidiaries have been translated in accordance with Statement of Financial Accounting Standards No. 52, whereby assets and liabilities are translated at year-end rates of exchange and statements of operations are translated at the average rates of exchange for the year. Currency translation adjustments are accumulated in the other component of stockholders' equity until the entity is substantially sold or liquidated.\nTransaction gains and losses associated with foreign activities are reflected in operations.\nStatements of Cash Flows:\nFor purposes of the consolidated statements of cash flows, the Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.\nConcentration of Credit Risk:\nThe Company primarily sells electricity and steam to public utilities and corporations on the east and west coasts of the United States under long-term contractual agreements. Also, the Company services, sells and rents equipment to various entities worldwide. The Company performs ongoing credit evaluations of its customers and generally does not require collateral. The Company maintains reserves for potential credit losses and such losses have been within management's expectations.\nThe Company invests its excess cash in deposits with financial institutions. Those securities typically mature within ninety days and, therefore, bear minimal risk. The Company has not experienced any losses on these deposits.\n3. Cash and Restricted Cash:\nDue to restrictions in the Newark and Parlin project financing agreements, $2,346 and $2,822 of cash and cash equivalents at June 30, 1994 and 1993, respectively, is generally available for use only by those projects.\nAdditionally, the Company has classified certain cash and cash equivalents that are not fully available for use in its operations as restricted. The restricted cash and cash equivalents relate to debt service reserve accounts for O'Brien (Newark) Cogeneration, Inc. and O'Brien (Parlin) Cogeneration, Inc. (See Note 16), and compensating balances maintained by the Company at financial institutions in connection with lines of credit extended to its United Kingdom subsidiaries (See Note 13).\nDepreciation expense was $9,717, $9,643 and $8,561 in 1994, 1993 and 1992, respectively.\nEquipment related to energy revenues includes the property and equipment of the Newark and Parlin cogeneration plants and the biogas projects.\nThe Newark project consists of a 52 megawatt cogeneration power plant in Newark, New Jersey which commenced operations in November 1990 and is supplying electricity and steam pursuant to 25-year supply contracts. The facility was financed utilizing nonrecourse project financing.\nThe Parlin project consists of a 122 megawatt cogeneration power plant in Parlin, New Jersey which commenced operations on June 26, 1991 and is supplying 101 megawatts of electricity pursuant to a 20-year electric supply contracts and steam pursuant to a 30-year supply contract. The facility was financed utilizing nonrecourse project financing.\n5. Equipment Held for Sale:\nAs part of the Company's debt restructuring program and its efforts to improve both short-term and long-term liquidity, it has actively begun seeking buyers for specific energy equipment not currently being used in an operating project nor critical to the completion of any projects in development. These assets, consisting mainly of gas and steam turbines are being held for sale in order to raise cash and reduce debt levels.\nThe value of these assets sold in a secondary market is less than if they were incorporated into an internally developed operating project. Accordingly, the Company recorded a noncash charge in the fourth quarter in the amount of $6,250 to adjust the carrying value of these assets to an estimated resale value of $8,458 based upon appraisals made by the Company.\n6. Notes Receivable\nNotes receivable consist of the following:\n(a) Note receivable associated with the sale of coalbed methane properties in August 1993. Principal and interest payments are due monthly only to the extent of a percentage of net revenues generated from the properties until the earlier of (1) the note is paid in full or (2) 10 years. The Company discounted the note to its estimated net realizable value in consideration of the Company's plans to monetize the note and accelerate cash flow. During 1994, the Company did not recognize interest income or amortize the discount due to disputes with the other party. (See Notes 7 and 20). At June 30, 1994, the note has a face value of $4,500 and has been discounted by $1,379.\n(b) Note receivable associated with the sale of a 12.5% interest in O'Brien (Newark) Cogeneration, Inc. The note was used to repurchase the 12.5% interest in O'Brien (Newark) Cogeneration, Inc. in January 1994. (See Note 28).\n(c) Note receivable associated with the termination of a power purchase contract (See Note 20). The note is collateralized by an irrevocable letter of credit. At June 30, 1994, face value and discount are $2,400 and $263, respectively, assuming an interest rate of 5.95%\n(d) Notes receivable associated with the sale of two biogas projects in 1992. (See Note 20). In January 1994, these notes were satisfied with a payment based on an offer by the Company to discount the notes by $186 for early repayment.\n(e) Notes receivable associated primarily with a direct finance lease relating to power generation equipment and with the sale of two biogas projects in development in 1993 (See Note 20). In October 1993, a $331 note receivable was satisfied with a payment of $265 based on an offer by the Company to discount the notes for early repayment.\n7. Coalbed Methane Gas Properties Note:\nIn August 1993, the Company entered into an agreement with an unrelated third party joint venture to sell substantially all proved and unproved coalbed methane gas properties for $6,500. The Company received $2,000 in cash and a production payment note receivable of $4,500. In addition, the Company has agreed to contribute up to $800 to complete non-producing wells into commercial wells which is included in other current liabilities at June 30, 1994. The production payment note receivable will be paid from a percentage of net revenues from the coalbed methane properties until the earlier of (1) the note is paid in full or (2) 10 years. The Company discounted the note to its estimated net realizable value in consideration of the Company's plans to monetize the note and accelerate cash flow. (See Note 6). Development fees and other includes $5,121 of revenues recognized in connection with this sale. (See Note 20).\nIn May 1994, the joint venture to which the Company sold its coalbed methane properties, filed a complaint with the American Arbitration Association. The complaint alleges, among other things, breach of contract, fraud and conversion in connection with the agreement between the parties. The joint venture seeks damages in the amount of approximately $550 and the cancellation of all remaining payments due under the promissory note in favor of the Company in the amount of $4,500. In its answer, the Company has denied the allegations and counterclaimed against the Joint Venture for breach of contract in such amount as is necessary to repay the balance of the promissory note with interest. The Company has, further, requested that a receiver be appointed to ensure the performance of the Joint Venture with regard to its contractual obligations to the Company. The Company does not feel that a settlement of this arbitration will impair the net book value of the note receivable.\n8. Project Development Costs:\nDuring the years ended June 30, 1994, 1993 and 1992, the Company determined that certain project development costs should be expensed. The resulting charges, net of any recoveries, of $539, $1,782 and $125 for 1994, 1993 and 1992, respectively, are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.\n9. Notes Receivable from Officers:\nAt June 30, 1994 and 1993, the Company had notes receivable totalling $238 and $246, respectively, from an officer of the Company. The notes are unsecured, and bear interest at 8.25% per annum.\n10. Investments in Equity Affiliates:\nInvestment in equity affiliates consist of the following:\n\t\t\t\t\t1994\t\t1993 \t\t\t\t\t----\t\t----\n\tGray's Ferry\t\t\t$ 2,293\t\t$ 1,590\n\tArtesia\t\t\t\t 337\t\t 356\n\tPoweRent Limited\t\t 438\t\t 342\n\tIntrag, Joing Venture\t\t 107\t\t 227 \t\t\t\t\t-------\t\t------- \t\t\t\t\t$ 3,175\t\t$ 2,515 \t\t\t\t\t=======\t\t======= Gray's Ferry:\nIn October 1991, O'Brien (Schuylkill) Cogeneration, Inc., (O'Brien Schuylkill) a wholly-owned subsidiary, executed a partnership agreement with Adwin Equipment Company (Adwin) to develop a qualifying cogeneration facility located in Philadelphia, Pennsylvania. The partnership will be known as Grays Ferry Cogeneration Partnership and will develop, own and operate the cogeneration facility. The partnership intends to develop this project in two phases, Phase 1 of which will consist of approximately 40 megawatts. The partnership has a 25-year steam supply contract and a 20-year electric supply contract. On August 12, 1994, the partnership received a commitment letter for a $62,000 loan from Canada Imperial Bank at Commerce to finance Phase I. The Company expects that the expiration date of the commitment letter will be extended beyond October 30, 1994, although there can be no assurance that such extension will be granted or that if granted, will provide sufficient time to close.\nArtesia:\nThe Artesia project consists of a 32 megawatt cogeneration facility in Artesia, California which commenced operations in 1990 and is supplying electricity and steam pursuant to 30 year supply contracts. The project is owned and operated by O'Brien California Cogen Limited, a limited partnership. O'Brien Cogeneration, Inc. II, a wholly-owned subsidiary of the Company, is the managing general partner. The Company's initial equity interest of 3% can increase to a maximum of 50% on the basis of project performance and returns to the limited partner. In addition to its share of the limited partnership's operations, the Company receives annual management fees of approximately $130 and participates in a fuel supply partnership.\nPoweRent Limited:\nPoweRent Limited, an entity in which a subsidiary of the Company owns a 50% interest, is a United Kingdom company that sells and rents power generation equipment. The remaining 50% of PoweRent is owned by an officer of a wholly-owned United Kingdom subsidiary.\nIntrag, Joint Venture:\nIntrag, Joint Venture was formed for the purpose of developing power generation projects in Pakistan; and the manufacture, sale and\/or rental of power generation equipment in Pakistan. The joint venture agreement expires in June 1995.\nThe Company's investment in the equity affiliates has been accounted for using the equity method.\n11. Cost in Excess of Net Assets Acquired:\nExcess of cost of investment in subsidiaries over net assets at date of acquisition consists of the following:\n\t\t\t\t\t\t1994\t\t1993 \t\t\t\t\t\t----\t\t----\n\tExcess of investment in subsidiaries \t over net assets at date of acquisition\t\t\t\t$ 2,466\t\t$ 2,466\n\tAccumulated amortization\t\t (479)\t (381) \t\t\t\t\t\t-------\t\t------- \t\t\t\t\t\t$ 1,987\t\t$ 2,085 \t\t\t\t\t\t=======\t\t=======\nAmortization expense amounted to $98 in each of 1994, 1993 and 1992, respectively.\n12. Deferred Financing Costs:\nDeferred financing costs relate to the Subordinated Debentures and nonrecourse debt and consist of the following:\n\t\t\t\t\t\t1994\t\t1993 \t\t\t\t\t\t----\t\t----\n\tDeferred financing costs\t\t$ 7,080\t\t$ 7,087\n\tAccumulated amortization\t\t (1,811)\t (1,359) \t\t\t\t\t\t-------\t\t------- \t\t\t\t\t\t$ 5,269\t\t$ 5,728 \t\t\t\t\t\t=======\t\t=======\nAmortization expense amounted to $452 in each fiscal year ending June 30, 1994, 1993 and 1992 and is included in interest and debt expense in the accompanying consolidated statements of operations.\n13. Short-term Borrowings:\nAs of June 30, 1994 and 1993 short-term borrowings consist of foreign lines of credit payable to financial institutions bearing interest at foreign (U.K.) short term rates. Collateral for the lines of credit consists primarily of certain restricted cash balances.\n14. Recourse Long-Term Debt:\nRecourse long-term debt consist of the following:\n\t\t\t\t\t\t\t1994\t\t1993 \t\t\t\t\t\t\t----\t\t----\n\t Notes payable to financial \t institutions, due in monthly \t installments of principal plus \t interest at floating rates ranging \t from 1% to 4.5% over the prime \t rate (prime rate at June 30, 1994 \t was 7.25%) maturing at various \t dates through December 1999, \t collateralized by certain energy \t equipment having a net book value \t of $32,182 at June 30, 1994\t\t\t$30,481\t\t$27,113\n\t Note payable to unrelated third party, \t due in monthly installments with \t interest at 12% (a)\t\t\t\t 5,000\n\t Capital lease obligations, due in \t monthly installments at rates up to \t 13.25%, maturing at various dates \t through December 2000, \t collateralized by certain energy \t and rental equipment having a net \t book value of $12,067 at June 30, \t 1994\t\t\t\t\t 9,134\t\t 10,828\n\t Other\t\t\t\t\t\t 1,500 490 \t\t\t\t\t\t\t-------\t\t------- \t\t\t\t\t\t\t 46,115\t\t 38,431 \t Less amount classified as current (b) \t(39,042)\t(10,419) \t\t\t\t\t\t\t-------\t\t------- \t\t\t\t\t\t\t$ 7,073\t\t$28,012 \t\t\t\t\t\t\t=======\t\t=======\n(a) The Company has reclassified a $5,000 current liability to long-term debt at June 30, 1994. The $5,000 repurchase option for the Philadelphia Water Department project reacquired on August 5, 1994 was funded by long-term financing from an unrelated third party subsequent to year end. The loan is collateralized by the common stock of the reacquired subsidiary.\n(b) As a result of defaults, consisting of defaults in the payment of interest under each of the Indentures as well as defaults under certain of the Company's loan agreements, the Company reclassified $21,914 out of a long-term classification for a total of $39,042 of its recourse debt as a current liability. Of this amount, approximately $5,320 was triggered solely by defaults under the Indentures, $3,066 by cross defaults and by the non-payment of principal subsequent to year end and the remainder, $13,528 was reclassified because of the Chapter 11 Bankruptcy filing on September 28, 1994.\nScheduled maturities, including the impact of defaults, of recourse long-term debt and capital lease obligations, including interest, for the next five years and thereafter are as follows:\nThe components of the net deferred income tax liabilities are as follows:\nThe increase in the valuation allowance from June 30, 1993 to June 30, 1994 is due primarily to the uncertainty of realizing the benefit of loss carry- forwards generated in 1994.\nA reconciliation between the U.S. Federal statutory tax rate and the effective tax rate follows:\nAt June 30, 1994, the Company has tax basis net operating loss carryforwards available to offset future regular taxable income, and investment tax credit carryforwards available to offset future regular or alternative minimum federal income taxes payable. The amount of these carryforwards available for future utilization could be significantly limited based on a change in control of the Company in accordance with IRS regulations. (See Notes 1 and 17). These carryforwards expire as follows:\n\t \t\t Net Operating\t\tInvestment Tax Credit \t \t\tLoss Carryforwards Carryforwards \t \t\t------------------\t--------------------- \t1998\t\t\t --\t\t\t 58\n\t1999\t\t\t --\t\t\t 138\n\t2000\t\t\t 400\t\t\t 255\n\t2001\t\t\t 792\t\t\t 240\n\t2002\t\t\t 2,325\t\t\t 409\n\t2003\t\t\t 3,733\t\t \t 82\n\t2004\t\t\t 2,071\t\t\t 174\n\t2005\t\t\t 5,022\t\t\t 52\n\t2006\t \t\t 12,677\t\t\t 215\n\t2007\t\t\t 4,002\t\t\t --\n\t2008\t\t\t 16,430\t\t\t --\n\t2009\t\t\t 18,356\t\t\t -- \t\t\t\t-------\t\t\t------ \t\t\t\t$65,808\t\t\t$1,623 \t\t\t\t=======\t\t\t======\nIn addition, the Company has $1,685 of unused net operating loss carryforwards for United Kingdom income tax purposes. These credits can be carried forward for United Kingdom tax purposes indefinitely.\nAn alternative minimum tax is imposed at a 20% rate on the Company's alternative minimum taxable income which is determined by making statutory adjustments to the Company's regular taxable income. Net operating loss carryforwards may be used to offset only 90% of the Company's alternative minimum taxable income. The net operating loss carryforwards for alternative minimum tax purposes are approximately $34,458 for income tax purposes at June 30, 1994. The Company is subject to the alternative minimum tax resulting in an alternative minimum tax expense of $100 in 1992. This amount will be allowed as a credit carryover against regular tax in the future in the event the regular tax expense exceeds the alternative minimum tax expense.\n24. Transactions with Related Parties:\nPoweRent Limited is 50% owned by the Company and 50% by an officer of a wholly-owned subsidiary. Amounts receivable from or payable to related parties are noninterest-bearing and are classified as current, as settlement is expected to occur within one year.\nA summary of activity with related parties is as follows:\n(1) The Company leases office space from Pennsport Partnership, a Pennsylvania partnership in which the Chief Executive Officer and Principal Stockholder (CEO) of the Company has a 50% ownership interest. Rental expense for 1994, 1993 and 1992 was $289, $293 and $290, respectively. The Company also leases office space from Christiana River Holdings, Ltd., an entity owned by the CEO of the Company. Rental expense for 1994 was $150.\n(2) In 1993 and 1992, the Company recognized $156 and $143, respectively, of revenue by selling equipment and related services to PoweRent. The cost of the equipment and related services was $130 and $96, respectively.\n(3) The Company also was charged commissions by O'Brien Power Systems, Inc. of $647 in 1994 in connection with equipment sales and services provided to third parties. In 1993 and 1992, the Company recognized $346 and $235, respectively, of revenue by selling equipment and related services to O'Brien Power Systems, Inc., a company controlled by a relative of the CEO of the Company. The cost of the equipment and related services was $322 and $224, respectively.\n(4) In September 1993, Puma purchased its executive offices and its principal facility located in Ash, Canterbury, Kent, United Kingdom from III Enterprises Limited, an entity owned by the CEO of the Company for approximately $800. The Company has estimated a fair value of these facilities indicating a value of approximately $1,100. However, predecessor cost of $498 has been used to record the assets purchased and the excess of the purchase price over III Enterprises Limited's historical net book value of these facilities has been reflected as an increase in the accumulated deficit. Prior to September 1993, Puma leased the facility from III Enterprises Limited with rental expense amounting to $66, $156 and $155 in 1994, 1993 and 1992, respectively.\nIn addition, the Company has had transactions with projects structured as partnerships in which the Company had or retains a general partnership interest (Note 10).\n25. Segment Information and Major Customers:\nThe Company operates principally in two industry segments: the developing, owning and operating biogas projects and the development and ownership of cogeneration and waste heat recovery projects (energy) and the selling and renting of power generation, cogeneration and standby\/peak shaving equipment and services (equipment sales, rental and services). Information with respect to the segments of the business is as follows:\n\t\t\t\t1994\t\t1993\t\t1992 \t\t\t\t----\t\t----\t\t----\nRevenues: Energy \t\t$ 76,913 \t$ 74,587\t$ 74,692 Equipment sales, rental and services 29,676 23,105 25,423 \t\t\t\t--------\t--------\t--------- \t\t\t\t$106,589\t$ 97,692\t$ 100,115 \t\t\t\t========\t========\t=========\nIdentifiable assets: Energy\t\t\t$180,329\t$224,352\t$ 222,070 Equipment sales, rental and services 47,329\t 29,557\t 26,722 Corporate assets\t\t 10,158\t 8,620\t 10,262 \t\t\t\t--------\t--------\t--------- \t\t\t\t$237,816\t$262,529\t$ 259,054 \t\t\t\t========\t========\t=========\nOperating income (loss): Energy\t\t\t$ 10,280\t$ 14,468\t$ 24,520 Equipment sales, rental and services\t (4,874)\t (1,799)\t 1,283 General corporate expenses\t\t\t (8,921)\t (8,599)\t (5,817) \t\t\t\t--------\t--------\t--------- \t\t\t\t$ (3,515)\t$ 4,070\t$ 19,986 \t\t\t\t======== \t========\t=========\nDepreciation and amortization expense: Energy\t\t\t$ 7,345 \t$ 8,008 \t$ 8,106 Equipment sales, rental and services\t 2,171 \t 1,446 \t 751 Not allocable\t\t 1,486 \t 1,096 \t 591 \t\t\t\t-------- \t-------- \t-------- \t\t\t\t$ 11,002\t$ 10,550\t$ 9,448 \t\t\t\t======== ========\t========\nRevenue by segment consists of sales to unaffiliated customers; intersegment sales are not significant. For the purposes of this presentation, development and other fees are considered revenues of the energy segment.\nIdentifiable assets by segment are those assets that are used in the operations of each segment. Corporate assets are those assets not used in the operations of a specific segment and consist primarily of cash, notes receivable from officers and deferred financing costs. Investments in limited partnerships are included in the identifiable assets of the energy segment.\nSelling, general and administrative expenses have been allocated to the individual segments on the basis of segment revenues and geographical location.\nCapital expenditures for 1994 and 1993 are primarily associated with the equipment sales, rental and services segment. Capital expenditures for 1992 are primarily associated with the energy segment.\nInformation with respect to the Company's geographical areas of business is as follows:\n\t\t\t\t1994\t\t1993\t\t1992 \t\t\t\t----\t\t----\t\t----\nRevenues: United States\t\t$ 93,090 \t$ 83,797\t$ 84,560 United Kingdom\t\t 13,499\t 13,895 \t 15,555 \t\t\t\t--------\t--------\t--------- \t\t\t\t$106,589\t$ 97,692\t$ 100,115 \t\t\t\t========\t========\t=========\nNet income (loss): United States\t\t$(14,570) $(13,350)\t$ 1,535 United Kingdom\t\t (1,931)\t (361)\t (123) \t\t\t\t-------- \t--------\t--------- \t\t\t\t$(16,501) $(13,711)\t$ 1,412 \t\t\t\t========\t========\t=========\nIdentifiable assets: United States\t\t$230,343\t$252,863\t$ 249,544 United Kingdom\t\t 7,473\t 9,666\t 9,510 \t\t\t\t--------\t--------\t--------- \t\t\t\t$237,816\t$262,529\t$ 259,054 \t\t\t\t========\t========\t=========\nRevenues from one energy customer accounted for 53%, 65% and 67% of 1994, 1993 and 1992 revenues, respectively.\n26. Operating Leases:\nThe Company leases equipment and primarily conducts its operations in leased facilities which expire on various dates through the year 2000. Under the terms of most of the lease agreements, the Company is required to pay taxes, insurance, maintenance and other operating costs of the facilities. The total minimum annual lease payments under non-cancellable operating lease agreements are as follows:\n\t\t\tYear ending June 30,\n\t\t\t\t1995\t\t\t$ 848\n\t\t\t\t1996\t\t 789\n\t\t\t\t1997\t\t 788\n\t\t\t\t1998\t\t\t 640\n\t\t\t\t1999\t\t\t 518\n\t\t\t Thereafter\t\t\t 528 \t\t\t\t\t\t\t------ \t\t\t\t\t\t\t$4,111 \t\t\t\t\t\t\t======\n\tTotal rental expense under various operating leases was approximately \t$1,308, $1,434 and $1,182, in 1994, 1993 and 1992.\n27.\tStatements of Cash Flows:\n\tSupplemental disclosure of cash flow information:\n\t\t\t\t\t1994\t\t1993\t\t1992 \t\t\t\t\t----\t\t----\t\t----\n\t Interest paid during the \t year, net of amounts \t capitalized\t \t $13,027 \t$ 15,287\t$16,898\n\t Income taxes paid\t\t - -\t 63\n\tSupplemental schedule of noncash investing and financing activities:\n\t\t\t\t\t1994\t\t1993\t\t1992 \t\t\t\t\t----\t\t----\t\t----\n\t Transfer of project \t development costs to \t property, plant and \t equipment\t\t $ 176 \t -\t\t$ 230\n\t Capital expenditures \t included in accounts \t payable and \t construction costs \t payable\t\t 875 $ 6,986\t\t (74)\n\t Project development costs \t recovered by receipt \t of equipment\t\t - -\t\t 1,501\n\t Other assets included in \t accounts payable and \t other liabilities\t\t - -\t\t 719\n\t Conversion of 7 3\/4% \t convertible \t subordinated debentures - -\t 80\n\t Reduction of property, \t plant and equipment \t resulting from the \t settlement of \t litigation\t\t 2,400\t\t 3,232\t\t -\n\t Notes receivables in \t connection with the \t sale of projects\t 3,121 \t 3,590\t -\n\t Capital expenditures \t acquired by capital \t leases\t\t\t - 4,546\t\t -\n\t Exchange of note \t receivable for note \t payable\t\t\t - 655\t\t -\n(1) Revenues for the quarters ended March 31, 1993, June 30, 1993 and September 30, 1993 were negatively impacted by the Newark Boxboard Project fire which occurred on December 25, 1992. The plant returned to partial operation in August 1993 and full operation in October 1993. (2) Includes $5,121 of revenues recognized in connection with the sale of the Company's contractual rights to develop certain coalbed methane reserves. (3) Revenues were negatively impacted by an unscheduled turbine outage at the du Pont Parlin project which lasted from September 1993 through mid-December 1993. (4) Revenues include $5,000 from the sale of rights to develop a standby electric facility project. The costs associated with this sale were insignificant. Revenues were negatively impacted by an unscheduled outage at the du Pont Parlin project which lasted from late May 1994 to mid-August 1994. (5) Includes the impact of a $6,250 non-cash charge resulting from a market valuation of equipment being held for sale in connection with the Company's restructuring of its recourse debt. (6) During the quarter ended March 31, 1993, the Company recognized a net gain of $4,583 in connection with the sale of a 12 1\/2% interest in the Newark Cogeneration project. On January 18, 1994, Company repurchased the 12 1\/2% interest and recorded a charge of $4,583 in the quarter ended June 30, 1993 to defer the net gain previously recognized on the sale. (7) Includes charges for $1,782 for certain project development costs, $1,121 associated with the Hartford litigation settlement with Hawker Siddeley and $600 associated with bad debt expense.\n29. Litigation:\nHawker Siddeley:\nThe Company was involved in litigation with Hawker Siddeley Power Engineering, Inc. (\"Hawker\"), the turnkey contractor for the Parlin (the \"Parlin Action\") and former Salinas projects (the \"Salinas Action\"). In the aggregate, Hawker's lawsuits, as amended, sought compensatory damages of $15,000 and $3,000 from the Parlin and former Salinas Projects, respectively. In May 1994, O'Brien (Parlin) Cogeneration, Inc., O'Brien Cogeneration Inc. II, wholly owned subsidiaries, and O'Brien Energy Systems, Inc., entered into a settlement agreement with Hawker Siddeley Power Engineering, Inc.; the \"Hawker Settlement Agreement\". Other than a $1,500 Promissory Note (\"the Note\") issued by the Company to Hawker Siddeley, no money was exchanged and O'Brien (Parlin) Cogeneration, Inc. was not obligated to pay the $5,100 contract price withheld and all parties dismissed their claims related to the Parlin Action. Pursuant to the Hawker Settlement Agreement, the Salinas Action, prior to being dismissed, required that the first payment under the note be paid by October 6, 1994. Therefore, as payment was not made, the Salinas Action remains open.\nOther Proceedings:\nDuring September 1993 to November 1993, three actions were filed against O'Brien (Newark) Cogeneration, Inc., a wholly-owned subsidiary, by survivors of three employees of the operator of the Newark Cogeneration facility who were killed as the result of a fire which occurred at the facility in December 1992. The actions seek the recovery of damages in an unspecified amount. Insurance counsel estimates that each of the pending claims could have a value in excess of $1,000. The amount allocable to the Company, if any, is not determinable at this time. The Company's insurer has recently disputed the maximum amounts of coverage under the Company's policies. If a satisfactory resolution of this dispute cannot be reached, the Company may be required to file an action in court to obtain an adjudication of its rights under its insurance policies. The Company believes that these claims will not have a material adverse financial effect on the Company because (1) the Company has sufficient undisputed liability insurance coverage and (2) the operator of the Facility has agreed to indemnify the Company for any liability arising out of the operator's operation and maintenance of the facility.\nOn July 27, 1994, an alleged stockholder of O'Brien Environmental Energy, Inc. filed suit seeking money damages in an amount allegedly sustained by the stockholder. On September 15, 1994, two alleged debentureholders filed suit seeking money damages in an amount allegedly sustained by debentureholders who purchased debentures from September 28, 1992 through April 12, 1994. The complaints name as defendants O'Brien Environmental Energy, Inc. and certain of its officers and directors. The complaints allege that O'Brien Environmental Energy, Inc. and the other defendants violated the Securities Exchange Act of 1934 and disseminated or were responsible for the disseminating of a series of false and misleading statements concerning the Company's business, results of operations and future prospects. The suits purport to be class actions on behalf of all stockholders and debentureholders, respectively. The Company and other defendants believe the suits to be without merit and intend to defend them vigorously.\nAlthough the Company cannot give definitive assurance regarding the ultimate resolution of the various claims described above, the Company does not presently believe the matters described above or the resolution thereof will have a material adverse impact on the Company's financial statements.\n30. Disclosures about Fair Value of Financial Instruments\nThe Company has adopted Statement of Financial Accounting Standards No. 107 \"Disclosures about Fair Value of Financial Instruments\" which requires certain disclosures concerning the estimated fair value of financial instruments. The following disclosures of the estimated fair value amounts have been determined based on the Company's assessment of available market information and appropriate valuation methodologies.\n\t\t\t\t \t\t Carrying Fair \tJune 30, 1994\t\t \t\t\tAmount \t Value \t-------------\t\t\t \t --------\t ----- \tAssets:\nCash and cash equivalents (1)\t \t $ 5,681\t $ 5,681 \t Restricted cash and cash \t equivalents (1)\t\t\t 4,594\t\t 4,594 \t Accounts receivable (1)\t \t 12,100\t\t12,100 \t Receivable from related parties (1)\t 633\t\t 633 \t Notes receivable (1)\t\t\t 5,806 5,806 \t Notes receivable from officers (1)\t\t 238\t\t 238\n\tLiabilities:\n\t Accounts payable (1)\t\t\t 12,737\t\t12,737 \t Short-term borrowings (1)\t\t 2,386\t\t 2,386 \t Recourse long-term debt (1)\t\t 46,115\t\t46,115 \t Non-recourse long-term debt (1) 96,140\t 94,140 \t Convertible senior subordinated \t debentures (2)\t\t\t 49,174\t\t21,996\n\tOff-balance Sheet \t Financial Instruments:\n\t Interest Rate Swap (3)\t\t\t --\t\t 4,889\n(1) The carrying amount of these items are a reasonable estimate of their value as of June 30, 1994.\n(2) The fair value of convertible senior subordinated debentures are determined based on market quotes as of June 30, 1994. The fair value of the Company's convertible senior subordinated debentures as of September 20, 1994 was $19,981.\n(3) The fair value of interest rate swap in the amount at which it could be settled based on an estimate obtained from the dealer.\nFair value estimates are made at a specific point in time, based on relevant market information about the financial instruments. These estimates are subjective in nature and involve uncertainties and matter of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates, including the bankruptcy filing of O'Brien Environmental Energy, Inc., the parent company, on September 28, 1994. (See Note 1).\n31. Sale of Philadelphia Water Department Project:\nOn November 12, 1993, the Company sold the capital stock of O'Brien (Philadelphia) Cogeneration, Inc. (\"OPC\") and Philadelphia BioGas Supply, Inc. (\"Biogas\"), wholly-owned subsidiaries and issued 5.5 million warrants for Class A Common Stock to entities controlled by an unrelated private investor for $5,000 in cash. The warrants are exercisable at prices ranging from $4.00 to $6.00 per share, and have been assigned a value of $1,300 which has been reflected in additional paid in capital. The primary assets of OPC and Biogas consist of a 20-year energy service agreement and a digester gas supply agreement with the Philadelphia Municipal Authority (\"Authority\"). The Company continues to own and rent to OPC and Biogas the facilities and all related generation and associated equipment for the project. Fiscal 1994 revenues were approximately $2,187. On August 5, 1994, the Company exercised its option to repurchase 83% of OPC and Biogas for $5,000. The Company is negotiating to resell this project to a third party in 1995.\nO'BRIEN ENVIRONMENTAL ENERGY, INC. INDEX TO FINANCIAL STATEMENT SCHEDULES\nIndex to Financial Statement Schedules . . . . . . . . . . . . S-1\nSchedule II - Amounts Receivable From Related Parties and Underwriters, Promoters and Employees Other Than Related Parties. . . . . . . . . . . . . . . . . . . . . . . . . . . S-2\nSchedule III - Condensed Financial Information of Registrant S-3 \t (to be filed by amendment)\nSchedule V - Property, Plant and Equipment . . . . . . . . . . S-4\nSchedule VI - Accumulated Depreciation, Depletion and Amortization of Property, Plant and Equipment. . . . . . S-5\nSchedule IX - Short-Term Borrowings. . . . . . . . . . . . . . S-6\n\t\tCONDENSED FINANCIAL INFORMATION OF THE REGISTRANT SCHEDULE III \t\t (To be filed by Amendment)","section_15":""}
{"filename":"837227_1994.txt","cik":"837227","year":"1994","section_1":"Item 1. Business.\nFormation\nML Oklahoma Venture Partners, Limited Partnership (the \"Partnership\" or the \"Registrant\") was organized under the Revised Uniform Limited Partnership Act of the State of Oklahoma on July 15, 1988. MLOK Co., Limited Partnership (the \"Managing General Partner\") and four individuals (the \"Individual General Partners\") are the general partners of the Partnership. The Managing General Partner is an Oklahoma limited partnership in which Merrill Lynch Venture Capital Inc. (the \"Management Company\") is the general partner. The Management Company is an indirect subsidiary of Merrill Lynch & Co., Inc. and an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"MLPF&S\").\nThe Partnership operates as a business development company under the Investment Company Act of 1940. The Partnership's investment objective is to seek long-term capital appreciation by making venture capital investments in new and developing companies which the Managing General Partner believes offer significant long-term growth potential. The Partnership considers this activity to constitute the single industry segment of venture capital investing.\nThe Partnership was organized as a \"qualified venture capital company\" under Oklahoma law and, therefore, invested over 55% of its capitalization in companies which constitute \"Oklahoma business ventures\", as that term is defined under Oklahoma law. Accordingly, in 1989, the Partnership's limited partners (the \"Limited Partners\") were entitled to a credit against their Oklahoma state income tax equal to 20% of the amount of their original investment in the Partnership. From its inception through December 31, 1994, the Partnership had invested $8.9 million in 18 portfolio investments of which approximately 63% represents investments in Oklahoma business ventures.\nThe Partnership publicly offered, through MLPF&S, 25,000 units of limited partnership interest at $1,000 per unit (the \"Units\"). The Units were registered under the Securities Act of 1933 pursuant to a Registration Statement on Form N-2 (File No. 33-24547), which was declared effective on December 1, 1988. The Partnership completed its offering on August 14, 1989. A total of 10,248 Units were sold to the Limited Partners. Gross capital contributions to the Partnership total $10,355,556; $10,248,000 from the Limited Partners, $103,556 from the Managing General Partner and $4,000 from the Individual General Partners.\nThe information set forth under the captions \"Risk and Other Important Factors\" (pages 11 through 18), \"Investment Objective and Policies\" (pages 21 through 26) and \"Oklahoma Considerations\" (pages 26 through 28) in the Prospectus of the Partnership dated December 1, 1988 filed with the Securities and Exchange Commission pursuant to Rule 497(b) under the Securities Act of 1933, as supplemented by a supplement dated April 25, 1989 filed pursuant to Rule 497(d) under the Securities Act of 1933 (the \"Prospectus\"), is incorporated herein by reference.\nThe Venture Capital Investments\nDuring 1994, the Partnership purchased venture capital investments totaling $1.1 million: $225,000 in two new portfolio companies and $896,000 in seven existing portfolio companies. From August 14, 1989 (commencement of operations) to December 31, 1994, the Partnership had invested $8.9 million in 18 portfolio companies, representing 97% of the $9.2 million of net proceeds from the offering of Units. At December 31, 1994, the Partnership's investment portfolio consisted of 14 active investments with a cost basis of $6.6 million and a fair value of $10.5 million. From its inception to December 31, 1994, the Partnership had liquidated investments with an aggregate cost basis of $2.3 million. These liquidated investments returned $435,000 for a cumulative net realized loss of $1.9 million as of December 31, 1994.\nThe descriptions of the Partnership's initial investment in Americo Publishing, Inc. and the Partnership's follow-on investments in Excel Energy Technologies, Ltd., Great Outdoors Publishing, Inc. and Data Critical Corp. set forth in Item 5 of Part II of the Partnership's quarterly report on Form 10-Q for the quarter ended March 31, 1994 are incorporated herein by reference.\nThe descriptions of the Partnership's follow-on investments in Data Critical Corp. and Silverado Foods, Inc. set forth in Item 5 of Part II of the Partnership's quarterly report on Form 10-Q for the quarter ended June 30, 1994 are incorporated herein by reference.\nThe descriptions of the Partnership's follow-on investments in Americo Publishing, Inc., Diagnetics, Inc., Independent Gas Company Holdings, Inc. and Data Critical Corp. set forth in Item 5 of Part II of the Partnership's quarterly report on Form 10-Q for the quarter ended September 30, 1994 are incorporated herein by reference.\nIn January 1994, Symex Corp. ceased operations and transferred its intellectual property to its senior secured creditor. As a former junior secured creditor of Symex, the Partnership was entitled to purchase shares of ZymeTx, Inc., a company formed to advance the intellectual property previously owned by Symex. In August 1994, the Partnership purchased 21,052 common shares of ZymeTx at par value, or $211.\nCompetition\nThe Partnership encounters competition from other entities having similar investment objectives, including other entities affiliated with Merrill Lynch & Co., Inc. Primary competition for venture capital investments has been from venture capital partnerships, venture capital affiliates of large industrial and financial companies, small business investment companies and wealthy individuals.\nEmployees\nThe Partnership has no employees. The Managing General Partner, subject to the supervision of the Individual General Partners, manages and controls the Partnership's venture capital investments. The Management Company performs, or arranges for others to perform, the management and administrative services necessary for the operation of the Partnership and is responsible for managing the Partnership's short-term investments.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Partnership does not own or lease physical properties.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Partnership is not a party to any material pending legal proceedings.\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 covered by this report to a vote of security holders.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe information with respect to the market for the Units set forth under the subcaption \"Substituted Limited Partners\" on page 40 of the Prospectus, is incorporated herein by reference. There is no established public trading market for the Units as of March 17, 1995. The approximate number of holders of Units as of March 17, 1995 is 1,150. The Managing General Partner and the four Individual General Partners of the Partnership also hold interests in the Partnership.\nBeginning with December 1994 client account statements, Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"MLPF&S\") implemented new guidelines for valuing limited partnerships and other direct investments reported on client account statements. As a result, MLPF&S no longer reports general partner estimates of limited partnership net asset value on its client account statements, although the Partnership's managing general partner may continue to provide its estimate of net asset value in quarterly reports to unit holders. Pursuant to the new guidelines, estimated values for limited partnership investments will be provided annually to MLPF&S by independent valuation services. The estimated values will be based on financial and other information available to the independent services on the prior August 15th. MLPF&S clients may contact their Merrill Lynch Financial Consultants or telephone the number provided to them on their account statements to obtain a general description of the methodology used by the independent valuation services to determine their estimates of value. The estimated values provided by the independent services are not market values and unit holders may not be able to sell their units or realize the amounts shown on their MLPF&S statements upon a sale. In addition, unit holders may not realize the amount shown on their account statements upon the liquidation of the Registrant over its remaining life.\nThe Partnership has not made any cash distributions to its Partners during the period from August 14, 1989 (commencement of operations) to December 31, 1994. In March 1995, the General Partners approved a cash distribution to the Limited Partners totaling $2 million, or $200 per Unit. The distribution will be paid in April 1995 to Limited Partners of record on March 31, 1995. The information under the heading \"Distributions\" contained in the section entitled \"Partnership Distributions and Allocations\" on pages 35 and 36 of the Prospectus is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected Financial Data.\n($ in thousands, except for per Unit information)\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, 1994, the Partnership held $889,000 in cash and short-term investments: $598,000 in short-term investments with maturities of less than one year and $292,000 in an interest-bearing cash account. Interest earned on such investments for the years ended December 31, 1994, 1993 and 1992, was $40,000, $93,000 and $201,000, respectively. Interest earned from short-term investments in future periods is subject to fluctuations in short-term interest rates and changes in amounts available for investment in such securities.\nDuring 1994, the Partnership purchased venture capital investments totaling $1.1 million: $225,000 in two new portfolio companies and $896,000 in seven existing portfolio companies. From August 14, 1989 (commencement of operations) to December 31, 1994, the Partnership had invested $8.9 million in 18 portfolio companies, representing 97% of the original net proceeds to the Partnership.\nThe Partnership will not purchase any new portfolio investments. Funds needed to cover the Partnership's future operating expenses and follow-on investments in existing companies is expected to be obtained from existing cash reserves, interest and other investment income and proceeds from the sale of portfolio investments.\nResults of Operations\nFor the years ended December 31, 1994, 1993 and 1992, the Partnership had a net realized loss from operations of $415,000, $1.2 million and $110,000, respectively. Net realized gain or loss from operations is comprised of 1) net realized gains or losses from portfolio investments and 2) net investment income or loss (interest and dividend income less operating expenses).\nRealized Gains and Losses from Portfolio Investments - For the year ended December 31, 1994, the Partnership had a $272,000 net realized loss from portfolio investments. In June 1994, the Partnership sold 10,000 common stock warrants of Envirogen, Inc. in the public market for $6,000, realizing a gain of $6,000. Additionally during June 1994, the Partnership's warrants to purchase common stock of C.R. Anthony Company expired, resulting in a realized loss of $2,175. During 1994, Sports Tactics International, Inc. ceased operations. In connection with the liquidation of the company, the Partnership received payments totaling $19,000, resulting in a realized loss of $81,000. Also during 1994, Symex Corp. ceased operations resulting in the write-off of the Partnership's remaining $146,000 debt investment in the company. In December 1994, the Partnership sold its investment in QuanTem Laboratories, Inc. in a private transaction for $26,000, realizing a loss of $49,000.\nFor the year ended December 31, 1993, the Partnership had a $1 million realized loss from portfolio investments. During 1993, the Partnership wrote-off its $693,000 equity investment in Symex Corp. and wrote-off $350,000 of its $450,000 equity investment in Sports Tactics International, Inc. due to business and financial difficulties at these companies.\nThe Partnership had no realized gains or losses from portfolio investments for the year ended December 31, 1992.\nInvestment Income and Expenses - For the years ended December 31, 1994, 1993 and 1992, the Partnership had a net investment loss of $143,000, $159,000 and $110,000, respectively. The $16,000 decrease in net investment loss for 1994 compared to 1993 primarily was the result of a $39,000 decline in operating expenses for 1994, primarily professional fees, partially offset by a $24,000 decline in investment income for 1994. Professional fees declined $25,000 for 1994, from $78,000 in 1993 to $53,000 in 1994, due to a reduction in the Partnership's legal expenses for 1994. Investment income declined $24,000 for 1994 compared to 1993. Interest earned on short-term investments for 1994 declined $53,000, from $93,000 in 1993 to $40,000 in 1994. This decrease was offset by a $29,000 increase in interest and other income from portfolio investments for 1994, from $126,000 in 1993 to $155,000 in 1994. The decrease in interest earned from short-term investments primarily was a result of a decline in the amount available for investments in such securities during the 1994 period. The increase in interest and other income from portfolio investments for 1994 primarily was the result of an increase in the amount invested in interest bearing debt securities of portfolio investments during 1994 compared to 1993.\nThe $49,000 increase in net investment loss for 1993 compared to 1992 primarily was a result of a $67,000 decline in investment income for 1993 partially offset by a $19,000 decline in operating expenses for 1993. The $67,000 decline in investment income was comprised of a $108,000 decrease in interest earned from short-term investments for 1993 partially offset by a $41,000 increase in interest and other income from portfolio investments for 1993. The decrease in short-term investment income for 1993 was due to a decline in short-term interest rates and a decline in funds invested in such securities for 1993 compared to 1992. The increase in portfolio income for 1993 was due to an increase in dividends received from Diagnetics, Inc. during 1993 and an increase in the amount invested in interest bearing debt securities of other portfolio investments during 1993 compared to 1992.\nThe Management Company performs, or arranges for others to perform, the management and administrative services necessary for the operation of the Partnership. The Management Company receives a management fee of 2.5% of the gross capital contributions to the Partnership, reduced by selling commissions and organizational and offering expenses paid by the Partnership, capital distributed and realized losses, with a minimum fee of $200,000 annually. Such fee is determined and paid quarterly. The management fee for the years ended December 31, 1994, 1993 and 1992, was $200,000, $204,000 and $215,000, respectively. To the extent possible, the management fee and other expenses incurred directly by the Partnership are paid with funds provided from operations.\nUnrealized Gains and Losses and Changes in Unrealized Appreciation of Portfolio Investments - For the year ended December 31, 1994, the Partnership had a $3.1 million net unrealized gain primarily resulting from the upward revaluation of its investments in Silverado Foods, Inc., resulting from the company's initial public offering completed in August 1994, and BACE Manufacturing, Inc. Additionally during 1994, a net $297,000 was transferred from unrealized loss to realized loss relating to portfolio investments sold and written-off during 1994, as discussed above. The $3.1 million unrealized gain and the $297,000 transfer from unrealized loss to realized loss resulted in a $3.4 million increase to net unrealized appreciation of investments for 1994.\nFor the year ended December 31, 1993, the Partnership had a net unrealized loss of $928,000 resulting from the net downward revaluation of certain portfolio investments. Additionally during 1993, the Partnership transferred $540,000 from unrealized loss to realized loss relating to portfolio investments written-off in 1993, as discussed above. The $928,000 unrealized loss less the $540,000 transfer from unrealized loss to realized loss resulted in a $388,000 decrease to net unrealized appreciation of investments for 1993.\nFor the year ended December 31, 1992, the Partnership had a $1.2 million net unrealized gain resulting from the net upward revaluation of certain portfolio investments.\nNet Assets - Changes to net assets resulting from operations are comprised of 1) net realized gains and losses from operations and 2) changes to net unrealized appreciation or depreciation of portfolio investments.\nAt December 31, 1994, the Partnership's net assets were $11.4 million, up $3 million from $8.4 million at December 31, 1993. The increase in net assets from operations was comprised of the $3.4 million increase to net unrealized appreciation of investments partially offset by the $415,000 net realized loss from operations for 1994.\nAt December 31, 1993, the Partnership's net assets were $8.4 million, down $1.6 million from $10 million at December 31, 1992. The decrease in net assets from operations resulted from the $1.2 million net realized loss from operations and the $388,000 decrease to net unrealized appreciation of investments for 1993.\nAt December 31, 1992, the Partnership's net assets were $10 million, up $1.1 million from $8.9 million at December 31, 1991. The increase in net assets from operations resulted from the $1.2 million net unrealized gain from portfolio investments partially offset by the $110,000 net realized loss from operations for 1992.\nGains or losses from investments are allocated to the Partners' capital accounts when realized in accordance with the Partnership Agreement (see Note 3 of Notes to Financial Statements). However, for purposes of calculating the net asset value per unit of limited partnership interest, net unrealized appreciation or depreciation of investments has been included as if the net appreciation or depreciation had been realized and allocated to the Limited Partners in accordance with the Partnership Agreement. Pursuant to such calculation, the net asset value per $1,000 Unit at December 31, 1994, 1993 and 1992 was $1,098, $807 and $961, respectively.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP INDEX\nIndependent Auditors' Report\nBalance Sheets as of December 31, 1994 and 1993\nSchedule of Portfolio Investments as of December 31, 1994 Schedule of Portfolio Investments as of December 31, 1993\nStatements of Operations for the years ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows for the years ended December 31, 1994, 1993 and 1992\nStatements of Changes in Partners' Capital for the years ended December 31, 1992, 1993 and 1994\nNotes to Financial Statements\nNOTE - All other schedules are omitted because of the absence of conditions under which they are required or because the required information is included in the financial statements or the notes thereto.\nINDEPENDENT AUDITORS' REPORT\nML Oklahoma Venture Partners, Limited Partnership:\nWe have audited the accompanying balance sheets of ML Oklahoma Venture Partners, Limited Partnership (the \"Partnership\"), including the schedules of portfolio investments, as of December 31, 1994 and 1993, 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, 1994. 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. Our procedures included confirmation of securities owned at December 31, 1994 and 1993 by correspondence with the custodian; where confirmation was not possible, we performed other audit procedures. 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, 1994 and 1993, and the results of its operations, its cash flows and the changes in its partners' capital for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs explained in Note 2, the financial statements include securities valued at $10,296,209 and $6,563,579 at December 31, 1994 and 1993, respectively, representing 91% and 79% of net assets, respectively, whose values have been estimated by the Managing General Partner in the absence of readily ascertainable market values. We have reviewed the procedures used by the Managing General Partner in arriving at its estimate of value of such securities and have inspected underlying documentation, and, in the circumstances, we believe the procedures are reasonable and the documentation appropriate. However, because of the inherent uncertainty of valuation, those estimated values may differ significantly from the values that would have been used had a ready market for the securities existed, and the differences could be material.\nDeloitte & Touche LLP\nNew York, New York March 7, 1995, except for Note 8, as to which the date is March 16, 1995\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP BALANCE SHEETS December 31,\nSee notes to financial statements.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP SCHEDULE OF PORTFOLIO INVESTMENTS December 31, 1994\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP SCHEDULE OF PORTFOLIO INVESTMENTS - continued December 31, 1994\n(A) Public company\n(B) Qualifies as an \"Oklahoma business venture\" under Oklahoma law.\n(C) In February 1995, the Partnership sold its investment in BACE Manufacturing, Inc. for $2.2 million of which approximately $300,000 will be held in escrow. The release of the escrow is contingent upon certain future events.\n(D) During June 1994, the Partnership's warrants to purchase 48,045 shares of common stock of C.R. Anthony Company expired, resulting in a realized loss of $2,175.\n(E) During 1994, the Partnership purchased 8% and 10% promissory notes of Data Critical Corp. totaling $350,000 and a warrant to purchase 17,500 shares of Data Critical common stock at $5 per share. Subsequently, in connection with the restructuring of the company's outstanding debt, the Partnership exchanged such notes and warrant for a $350,000 8% promissory note and a warrant to purchase 87,500 shares of common stock at $4 per share.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP SCHEDULE OF PORTFOLIO INVESTMENTS - continued December 31, 1994\n(F) On July 22, 1994, the Partnership converted its Diagnetics, Inc. promissory notes aggregating $250,000 in face value, including a $50,000 note purchased in July 1994, and accrued interest of $12,812 into 189,073 preferred shares of the company. In addition, the Partnership exchanged its warrants to purchase 418,000 preferred shares of Diagnetics and accrued preferred stock dividends totaling $35,770 into 25,734 preferred shares of Diagnetics.\n(G) In June 1994, the Partnership sold 10,000 Envirogen, Inc. common stock warrants for $6,000, realizing a gain of $6,000.\n(H) In April 1994, the Partnership converted its demand notes of Excel Energy Technologies, Ltd. totaling $500,000, including $100,000 of notes purchased in March 1994, into 16,304 shares of preferred stock of the company.\n(I) On August 5, 1994, Silverado Foods, Inc. completed its initial public offering. In connection with the offering, the Partnership converted its preferred shares into common shares of the company and the company effected a 2.25-for-1 split of its outstanding stock. As a result, the Partnership exchanged its 267,144 preferred shares for 638,181 common shares of the company. The Partnership also exchanged its $20,000 subordinated note for 45,000 common shares of the company. Additionally, the $180,000 9% note and a $100,000 9% promissory note purchased by the Partnership during 1994, were repaid with interest.\n(J) During 1994, CytoDiagnostics, Inc. changed its name to UroCor, Inc. In March 1994, the Partnership converted its $100,000 note due from UroCor and $3,596 of accrued interest into 24,092 shares of preferred stock of the company.\n(K) In January 1994, Symex Corp. ceased operations and transferred its intellectual property to its senior secured creditor. As a former junior secured creditor of Symex, the Partnership was entitled to purchase shares of ZymeTx, Inc., a company formed to advance the intellectual property previously owned by Symex. In August 1994, the Partnership purchased 21,052 common shares of ZymeTx at par value, or $211.\n(L) In December 1994, the Partnership sold its investment in QuanTem Laboratories, Inc. for $26,000, realizing a loss of $49,000.\n* May be deemed an affiliated person of the Partnership as defined in the Investment Company Act of 1940.\nSee notes to financial statements.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP SCHEDULE OF PORTFOLIO INVESTMENTS December 31, 1993\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP SCHEDULE OF PORTFOLIO INVESTMENTS - continued December 31, 1993\n(A) Public company\n(B) Qualifies as an \"Oklahoma business venture\" under Oklahoma law.\n* Company may be deemed an affiliated person of the Partnership as defined in the Investment Company Act of 1940.\nSee notes to financial statements.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP STATEMENTS OF OPERATIONS For the Years Ended December 31,\nSee notes to financial statements.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP STATEMENTS OF CASH FLOWS For the Years Ended December 31,\nSee notes to financial statements.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP STATEMENTS OF CHANGES IN PARTNERS' CAPITAL For the Years Ended December 31, 1992, 1993 and 1994\n(A) The net asset value per unit of limited partnership interest, including an assumed allocation of net unrealized appreciation or depreciation of investments, was $961, $807 and $1,098 at December 31, 1992, 1993 and 1994, respectively.\nSee notes to financial statements.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS\n1. Organization and Purpose\nML Oklahoma Venture Partners, Limited Partnership (the \"Partnership\") was formed on July 15, 1988 under the Revised Uniform Limited Partnership Act of the State of Oklahoma. The Partnership's operations commenced on August 14, 1989. MLOK Co., Limited Partnership, the managing general partner of the Partnership (the \"Managing General Partner\"), is an Oklahoma limited partnership formed on July 15, 1988, the general partner of which is Merrill Lynch Venture Capital Inc. (the \"Management Company\"), an indirect subsidiary of Merrill Lynch & Co., Inc.\nThe Partnership's objective is to achieve long-term capital appreciation by making venture capital investments in new or developing companies, primarily Oklahoma companies, and other special investment situations. The Partnership does not engage in any other business or activity. The Partnership will terminate on December 31, 1998, subject to the right of the Individual General Partners to extend the term for up to two additional two-year periods.\n2. Significant Accounting Policies\nValuation of Investments - Short-term investments are carried at amortized cost which approximates market. Portfolio investments are carried at fair value as determined quarterly by the Managing General Partner under the supervision of the Individual General Partners. The Managing General Partner determines the fair value of its portfolio investments by applying consistent guidelines. The fair value of public securities is adjusted to the average closing public market price for the last five trading days of the quarter less an appropriate discount for sales restrictions, the size of the Partnership's holdings and the public market trading volume. Private securities are carried at cost until significant developments affecting a portfolio investment provide a basis for change in valuation. The fair value of private securities is adjusted 1) to reflect meaningful third-party transactions in the private market or 2) to reflect significant progress or slippage in the development of the company's business such that cost is no longer reflective of fair value. As a venture capital investment fund, the Partnership's portfolio investments involve a high degree of business and financial risk that can result in substantial losses. The Managing General Partner considers such risks in determining the fair value of the Partnership's portfolio investments.\nInvestment Transactions - Investment transactions are recorded on the accrual method. Portfolio investments are recorded on the trade date, the date the Partnership obtains an enforceable right to demand the securities or payment therefor. Realized gains and losses on investments sold are computed on a specific identification basis.\nIncome Taxes - No provision for income taxes has been made since all income and losses are allocable to the Partners for inclusion in their respective tax returns. The Partnership's net assets for financial reporting purposes differ from its net assets for tax purposes. Net unrealized appreciation of $3.9 million at December 31, 1994, which was recorded for financial statement purposes, was not recognized for tax purposes.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS\nAdditionally, from inception to December 31, 1994, other timing differences totaling $1.2 million relating to the original sales commissions paid and other costs of selling the Units have been recorded on the Partnership's financial statements but have not yet been deducted for tax purposes.\nStatements of Cash Flows - The Partnership considers its interest-bearing cash account to be cash equivalents.\nOrganizational Costs - Organizational costs of $47,718 were amortized over a sixty-month period which commenced August 14, 1989.\n3. Allocation of Partnership Profits and Losses\nPursuant to the Partnership Agreement, profits from venture capital investments are allocated to all Partners in proportion to their capital contributions until all Partners have been allocated a 10% Priority Return from liquidated investments. Profits in excess of this amount are allocated 30% to the Managing General Partner and 70% to all Partners in proportion to their capital contributions until the Managing General Partner has been allocated 20% of the total profits from venture capital investments. Thereafter, profits from venture capital investments are allocated 20% to the Managing General Partner and 80% to all Partners in proportion to their capital contributions. Profits from other sources are allocated to all Partners in proportion to their capital contributions.\nLosses are allocated to all Partners in proportion to their capital contributions. However, if profits had been previously allocated in the 70-30 or 80-20 ratios as discussed above, then losses will be allocated in the reverse order in which profits were allocated.\n4. Related Party Transactions\nThe Management Company performs, or arranges for others to perform, the management and administrative services necessary for the operation of the Partnership. The Management Company receives a management fee at an annual rate of 2.5% of the gross capital contributions to the Partnership, reduced by selling commissions and organizational and offering expenses paid by the Partnership, capital distributed and realized losses, with a minimum annual fee of $200,000. Such fee is determined and paid quarterly.\nOn May 29, 1992, the SEC issued an exemptive order permitting the Partnership to acquire 11,916 shares of class A common stock of EDS Holdings Inc. from an affiliate of the Management Company subject to certain conditions, including review and approval by the Independent General Partners. On July 22, 1992, the Partnership purchased these shares for $160,796, representing original cost of $142,992 plus interest expense of $17,804.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP NOTES TO FINANCIAL STATEMENTS\n5. Limitation on Operating Expenses\nThe Management Company has undertaken to the Partnership that it will reduce its management fee or otherwise reimburse the Partnership in order to limit the annual operating expenses of the Partnership, exclusive of the management fee, to an amount equal to $203,720.\n6. Independent General Partners' Fees\nAs compensation for services rendered to the Partnership, each of the three Independent General Partners receives $16,000 annually in quarterly installments, $1,000 for each meeting of the General Partners attended, $1,000 for each committee meeting attended ($500 if a committee meeting is held on the same day as a meeting of the General Partners) and $500 for meetings held by telephone conference.\n7. Short-Term Investments\nAt December 31, 1994 and 1993, the Partnership had investments in short-term securities as detailed below.\n8. Subsequent events\nIn March 1995, the General Partners approved a cash distribution to the Limited Partners totaling $2 million, or $200 per Unit. The distribution will be paid in April 1995 to Limited Partners of record on March 31, 1995.\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 Partnership\nGENERAL PARTNERS\nThe five General Partners of the Partnership are responsible for the management and administration of the Partnership. The General Partners consist of the four Individual General Partners and the Managing General Partner. As required by the Investment Company Act of 1940 (the \"Investment Company Act\"), a majority of the General Partners must be individuals who are not \"interested persons\" of the Partnership as defined in the Investment Company Act. In 1989, the Securities and Exchange Commission issued an order declaring that the independent general partners of the Partnership (the \"Independent General Partners\") are not \"interested persons\" of the Partnership as defined in the Investment Company Act solely by reason of their being general partners of the Partnership. The Managing General Partner and the four Individual General Partners will serve as the General Partners until successors have been elected or until their earlier resignation or removal.\nThe Individual General Partners have full authority over the management of the Partnership and provide overall guidance and supervision with respect to the operations of the Partnership and perform the various duties imposed on the directors of business development companies by the Investment Company Act. In addition to general fiduciary duties, the Individual General Partners, among other things, supervise the management arrangements of the Partnership and supervise the activities of the Managing General Partner.\nThe Managing General Partner has exclusive power and authority to manage and control the Partnership's venture capital investments subject to the supervision of the Individual General Partners. Additionally, subject to the supervision of the Individual General Partners, the Managing General Partner is authorized to make all decisions regarding the Partnership's venture capital investment portfolio including, among other things, find, evaluate, structure, monitor and liquidate such investments and to provide, or arrange for the provision of, managerial assistance to the portfolio companies in which the Partnership invests.\nIndividual General Partners\nWilliam C. Liedtke, III (1) P.O. Box 54369 Oklahoma City, OK 73154 Age 43 Individual General Partner since 1988 0 Units of the Partnership beneficially owned at March 17, 1995 (3) Energy consultant since 1991; Assistant to the Governor of the State of Oklahoma from 1989 to 1991; an independent natural gas marketing consultant since 1984; an oil and gas marketing manager for Trigg Drilling Company, Inc.; a member of the State Bar of Texas; a trustee of the Casady School.\nRichard P. Miller (1) 7500 N. Mockingbird Lane Paradise Valley, AZ 85253 Age 67 Individual General Partner since 1988 0 Units of the Partnership beneficially owned at March 17, 1995 (3) Since1988 Director and Chief Financial Officer of Techlaw, Inc.; from 1983 to 1990, Executive Vice President of Private Sector Counsel; in 1983 and 1984, Vice President, Corporate Finance, Union Bank of California; from 1968 to 1983, founder and Chief Executive Officer of Systems Control Inc.\nGeorge A. Singer (1) 2222 E. 25th Place Tulsa, OK 74114 Age 47 Individual General Partner since 1995 0 Units of the Partnership beneficially owned at March 17, 1995 (3) Since1978 General Partner of Singer Bros. and several related family entities; Executive Vice President, Pedestal Oil Company, Inc.; Director of Manchester Pipeline Corporation; a member of the Independent Petroleum Association of America.\nBruce W. Shewmaker (2) 12 Briarwood Drive Short Hills, NJ 07078 Age 49 Individual General Partner since 1988 0 Units of the Partnership beneficially owned at March 17, 1995 (3) Since1992 President of New Century Management Inc., a venture capital management and advisory firm; since 1991, a self-employed business consultant; from 1990 to 1991, venture investment advisor with Vector Securities International Inc., an investment banking firm specializing in health care companies; from 1984 to 1990, President of Merrill Lynch R&D Management Inc.; from 1982 to 1983 and from 1988 to 1990, Vice President of Merrill Lynch Venture Capital Inc.\n(1) Member of Audit Committee.\n(2) Interested person, as defined in the Investment Company Act, of the Partnership.\n(3) Each Individual General Partner has contributed $1,000 to the capital of the Partnership. Mr. Shewmaker is a limited partner of the Managing General Partner of the Partnership. The Managing General Partner contributed $103,556 to the capital of the Partnership. George A. Singer succeeded to the interest of a prior Independent General Partner who contributed $1,000 to the capital of the Partnership.\nThe Managing General Partner\nMLOK Co., Limited Partnership (the \"Managing General Partner\") is a limited partnership organized on July 15, 1988 under the laws of the State of Oklahoma. The Managing General Partner maintains its legal address at Meridian Tower, 5100 East Skelly Drive, Suite 1060, Tulsa, OK 74135. The Managing General Partner has acted as the managing general partner of the Partnership since the Partnership commenced operations on August 14, 1989. The Managing General Partner is engaged in no other activities at the date hereof. The Managing General Partner has contributed $103,556 to the capital of the Partnership, equal to 1% of the aggregate capital contributions of all Partners of the Partnership.\nThe general partner of the Managing General Partner is Merrill Lynch Venture Capital Inc. (the \"Management Company\") and the limited partners of the Managing General Partner include Joe D. Tippens and C. James Bode, independent contractors to the Management Company. Information concerning the Management Company is set forth below.\nThe Management Company\nMerrill Lynch Venture Capital Inc. (the \"Management Company\") has served as the management company for the Partnership since the Partnership commenced operations. The Management Company performs, or arranges for others to perform, the management and administrative services necessary for the operation of the Partnership pursuant to a Management Agreement between the Partnership and the Management Company.\nThe Management Company is an indirect subsidiary of Merrill Lynch & Co., Inc. The Management Company, which was incorporated under Delaware law on January 25, 1982, maintains its principal office at North Tower, World Financial Center, New York, New York 10281-1327. Listed below is information concerning the directors and officers of the Management Company. Unless otherwise noted, the address of each such person is in North Tower, World Financial Center, New York, New York 10281.\nKevin K. Albert, Age 42, Director, President Officer or Director since 1990 Managing Director of Merrill Lynch & Co. Investment Banking Division (\"MLIBK\") since 1988; Vice President of MLIBK from 1983 to 1988.\nRobert F. Aufenanger, Age 41, Director and Executive Vice President Officer or Director since 1990 Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research and Director of the Partnership Management Group since 1991; Director of MLIBK from 1990 to 1991; Vice President of MLIBK from 1984 to 1990.\nSteven N. Baumgarten, Age 39, Vice President Officer or Director since 1993 Vice President of MLPF&S since 1986.\nRobert W. Seitz, Age 48, Director, Vice President Officer or Director since 1993 FirstVice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research and a Managing Director within the Corporate Credit Division of Merrill Lynch since 1987.\nJoseph W. Sullivan, Age 37, Treasurer Officer or Director since 1993 Vice President of MLIBK since 1994; Controller in the Partnership Analysis and Management Department of MLIBK from 1990 to 1993; Assistant Vice President of Standard & Poors Corporation from 1988 to 1990.\nThe directors of the Management Company will serve as directors until the next annual meeting of stockholders and until their successors are elected and qualify. The officers of the Management Company will hold office until the next annual meeting of the Board of Directors of the Management Company and until their successors are elected and qualify.\nThere are no family relationships among any of the Individual General Partners of the Partnership and the officers and directors of the Management Company.\nItem 11.","section_11":"Item 11. Executive Compensation.\nCompensation - The Partnership pays each Independent General Partner an annual fee of $16,000 in quarterly installments, $1,000 per meeting of the Individual General Partners attended and $500 for participating in each special meeting of the Individual General Partners conducted by telephone conference call and pays all non-interested Individual General Partners' actual out-of-pocket expenses relating to attendance at meetings. The Independent General Partners receive $1,000 for each meeting of the Audit Committee attended unless such committee meeting is held on the same day as a meeting of the Individual General Partners. In such case, the Independent General Partners receive $500 for each meeting of the Audit Committee attended. The aggregate fees and expenses paid by the Partnership to the Independent General Partners for the years ended December 31, 1994, 1993 and 1992, totaled $52,826, $57,230 and $55,364, respectively.\nAllocations and Distributions - The information with respect to the allocation and distribution of the Partnership's profits and losses to the Managing General Partner set forth under the caption \"Partnership Distributions and Allocations\" on pages 35 - 37 of the Prospectus is incorporated herein by reference.\nFor the years ended December 31, 1994, 1993 and 1992, the Partnership had a net realized loss from operations of $414,829, $1,201,565 and $109,997, respectively. In accordance with the Partnership's allocation procedure, the Managing General Partner was allocated $4,149, $12,016 and $1,100 of such losses. Since the inception of the Partnership, there have been no cash distributions paid to Partners. In March 1995, the General Partners approved a cash distribution to the Limited Partners totaling $2 million, or $200 per Unit. The distribution will be paid in April 1995 to Limited Partners of record on March 31, 1995.\nManagement Fee - The Management Agreement provides that as compensation for its services to the Partnership, the Management Company will receive a fee at the annual rate of 2.5% of the amount of the partners' gross capital contributions (net of selling commissions and organizational and offering expenses paid by the Partnership), reduced by capital distributed and realized capital losses, with a minimum annual fee of $200,000. Such fee is determined and payable quarterly on the basis of the amount of the partners' capital contributions at the end of the preceding calendar quarter. For the years ended December 31, 1994, 1993 and 1992, the management fee was $200,000, $204,256 and $215,104, respectively.\nLimitation on Operating Expenses - The Management Company has undertaken to the Partnership that it will reduce its management fee or otherwise reimburse the Partnership in order to limit the annual operating expenses of the Partnership, exclusive of the management fee, to an amount equal to $203,720.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe information concerning the security ownership of the Individual General Partners set forth in Item 10 under the subcaption \"Individual General Partners\" is incorporated herein by reference. As of March 17, 1995, no person or group is known by the Partnership to be the beneficial owner of more than 5 percent of the Units.\nThe Partnership is not aware of any arrangement which may, at a subsequent date, result in a change of control of the Partnership.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nKevin K. Albert, a Director and President of the Management Company and a Managing Director of Merrill Lynch Investment Banking Group (\"ML Investment Banking\"), joined Merrill Lynch in 1981. Robert F. Aufenanger, a Director and Executive Vice President of the Management Company, a Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research and a Director of the Partnership Management Department, joined Merrill Lynch in 1980. Steven N. Baumgarten, a Vice President of the Management Company and MLPF&S, joined Merrill Lynch in 1986. Messrs. Albert, Aufenanger and Baumgarten are involved with certain other entities affiliated with Merrill Lynch or its affiliates. Robert W. Seitz, a Director and Vice President of the Management Company, a First Vice President of Merrill Lynch & Co. Corporate Strategy, Credit and Research and a Managing Director within the Corporate Credit Division of Merrill Lynch, joined Merrill Lynch in 1981. Joseph W. Sullivan, a Treasurer of the Management Company and a Vice President of ML Investment Banking, joined Merrill Lynch in 1990. From 1988 to 1990, Mr. Sullivan was an Assistant Vice President with Standard & Poor's Debt Rating Group.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K.\n(a) 1. Financial Statements\nIndependent Auditors' Report\nBalance Sheets as of December 31, 1994 and 1993\nSchedule of Portfolio Investments as of December 31, 1994 Schedule of Portfolio Investments as of December 31, 1993\n* Incorporated by reference to the Partnership's Annual Report on Form 10-K for the fiscal year ended December 31, 1988 filed with the Securities and Exchange Commission on April 3, 1989.\n** Incorporated by reference to the Partnership's Quarterly Report on Form 10-Q for the quarter ended September 30, 1989 filed with the Securities and Exchange Commission on November 14, 1989.\n*** Incorporated by reference to the Partnership's Quarterly Report on Form 10-Q for the quarter ended March 31, 1989 filed with the Securities and Exchange Commission on May 15, 1989.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) 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 27th day of March, 1995.\nML OKLAHOMA VENTURE PARTNERS, LIMITED PARTNERSHIP\nBy: MLOK Co. Limited Partnership its Managing General Partner\nBy: Merrill Lynch Venture Capital Inc. its General Partner\nBy: \/s\/ Kevin K. Albert Kevin K. Albert President (Principal 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 indicated on the 27th day of March 1995.\nBy: MLOK Co., Limited Partnership its Managing General Partner\nBy: Merrill Lynch Venture Capital Inc. its General Partner","section_15":""}
{"filename":"40518_1994.txt","cik":"40518","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral DataComm Industries, Inc. (the \"Corporation\") was incorporated in 1969 under the laws of the State of Delaware. The Corporation's principal executive offices are located at 1579 Straits Turnpike, Middlebury, Connecticut, and its telephone number is (203) 574-1118. Unless the context otherwise requires, the term \"Corporation\" as used here and in the following pages means General DataComm Industries, Inc. and its subsidiaries.\nGENERAL\nThe Corporation is a leading worldwide provider of wide area networking and telecommunications products. The Corporation designs, assembles, markets, installs and maintains products and services that enable telecommunications common carriers, corporations and governments to build, upgrade and better manage their global telecommunications networks. Products and services include multiplexers and internetworking equipment, digital data sets, analog modems, Asynchronous Transfer Mode (\"ATM\") cell switches, network management systems and comprehensive support services.\nThe Corporation's customer base includes: Local Exchange Carriers including all seven Regional Bell Operating Companies, Bell Canada and GTE; Competitive Access Providers including MFS Datanet; Interexchange Carriers, including AT&T, MCI and Sprint; corporate end users such as American Airlines, Citicorp, EDS, Harris and Hongkong & Shanghai Bank; and government entities including the British Ministry of Defence, the French Ministry of State, NASA, the U.S. Department of State and many state and local governments.\nBy offering ATM solutions to its customers, the Corporation believes it has enhanced its position as a leading supplier of wide area networking and telecommunications products. The Corporation's strategy of providing integrated networking solutions to its customers is based upon the following:\nCapitalizing on ATM technology. The Corporation believes it has a leading position in the ATM switch market. The following entities have deployed or announced their intention to deploy the Corporation's ATM cell switches in their proposed ATM networks: Ameritech, Bell Canada, MCI, MFS Datanet, Telecom Finland and Australia's Defence, Science and Technology Organisation. As of September 30, 1994, the Corporation, along with Netcomm Limited, had shipped 238 ATM switches to a variety of customers in 15 countries (76 for customer trial and 162 sold). The Corporation also believes that growing market awareness of its ATM switch technology has increased customer exposure to its other products.\nProviding cost-effective flexible product solutions. The Corporation's product families are designed with architectures that scale to most network sizes and cost requirements. Customers can select the products that are most appropriate for their needs and then migrate to higher capacity products over time.\nImproving performance of customer networks. The Corporation's products are designed to improve network efficiency by increasing transmission speed, compressing and consolidating voice and data communication and providing dynamic bandwidth allocation.\nLeveraging global customer base, distribution and support. The Corporation has a worldwide customer base of corporate and government users and telecommunications carriers. With a sales and marketing organization of 471 employees, the Corporation has global distribution capabilities in nearly 60 countries around the world. The Corporation's ability to provide international customer service and support is critical to customers that run mission-critical applications over their networks.\nMARKETING, SALES AND BACKLOG\nThe Corporation's products and networks are marketed throughout the world. The Corporation's sales and marketing force is organized on a worldwide basis to address three market segments: (1) corporate and government end-users; (2) common carriers (PTTs); and (3) indirect sales through value-added resellers (VARs) and distributors. In the United States, the Corporation sells, leases and services its equipment primarily through its own sales and service groups, which include separate geographic support organizations for the corporate and government end-users and common carrier markets. Internationally, the Corporation maintains full subsidiary operations in Canada (sales and service), the United Kingdom (sales and service), Mexico (sales and service), France (sales and service), Australia (sales), Singapore (sales) and Russia (sales), and sales and technical support offices in Japan, Hong Kong, Germany, China, Brazil and Spain. These sales offices manage a worldwide distribution network with representatives in more than 48 countries. International operations represented 37% of the Corporation's revenues in fiscal 1994. The Corporation's foreign operations are subject to all the various risks inherent in operating outside the United States.\nWhile the majority of the Corporation's products are sold on an outright basis, the Corporation also leases its equipment through a wholly-owned consolidated subsidiary under a versatile selection of leasing programs designed to meet the specific needs and objectives of its customers. At September 30, 1994, the Corporation's leasing subsidiary had agreements in place with financial institutions whereby certain finance lease receivables can be transferred with full recourse. Each request for financing is subject to the approval of the financing institution.\nThe Corporation's order backlog, while one of several useful financial statistics, is, however, a limited indicator of the Corporation's future revenues. Because of normally short delivery requirements, the Corporation's sales in each quarter primarily depend upon orders received and shipped in that same quarter. In addition, since product shipments are historically heavier in the last month of each quarter, quarterly revenues can be adversely or beneficially impacted by several events: unforeseen delays in product shipments; large sales that close at the end of the quarter; sales order changes or cancellations; changes in product mix; new product announcements by the Corporation or its competitors; and the capital spending trends of customers.\nIndustry and geographic area information is hereby included in Note 9 of \"Notes to Consolidated Financial Statements\". See \"Index to Financial Statements and Schedules\" on page in this report.\nRESEARCH, ENGINEERING AND PRODUCT DEVELOPMENT\nIn order to develop and implement new technology in the data, voice and video communications industry and to broaden the applications for its products, the Corporation has significant ongoing engineering programs for product improvement and new product development. At September 30, 1994, 331 people were engaged in research and development activities. The Corporation conducts research and development activities in three locations. Development for all transmission products, multiplexer and internetworking products, enhancements to the APEX-ATM switch products and continuation engineering activities occur in the Technology Research Center in Middlebury, Connecticut. The Multimedia Research Center in Montreal, Quebec, focuses on ATM-based applications and solutions, and the Advanced Research Centre in Basildon, England, focuses on next-generation ATM hardware and software.\nThe combination of research, development and capitalized software spending amounted to 15.7%, 14.1% and 12.7% of revenues in fiscal 1994, 1993 and 1992, respectively. In order to support its commitment to new products and technologies, the Corporation expects to continue or to increase these levels of spending on research and product and software development.\nCOMPETITION\nEach of the segments of the telecommunications and networking industries is intensely competitive. Many of the Corporation's current and prospective competitors have greater name recognition, a larger installed base of networking products, more extensive engineering, manufacturing, marketing, distribution and support capabilities and greater financial, technological and personnel resources.\nMany of the participants in the networking industry, including, among others, ADC Telecom- munications, Bay Networks, Cascade Communications, Cisco, ECI Telecom, FORE Systems, Lightstream, Newbridge Networks and StrataCom, and certain participants in the computer industry, including among others, DEC and IBM, have introduced, or announced their intention to develop, ATM networking products. Other companies are expected to follow. In addition, traditional suppliers of central office switching equipment such as Alcatel, AT&T Network Systems, Fujitsu, Hitachi, LM Ericsson, Northern Telecom and Siemens, are expected to offer ATM-based switches for central offices. Companies may also develop alternative network solutions to ATM. Even though certain of these ATM competitors currently offer or plan to offer ATM products in markets in which the Corporation does not plan to compete, it is possible that such competitors will develop ATM technology that does compete with the Corporation's products. This competition could result in the same intense price competition that is present in the broader networking market.\nPATENTS AND RELATED RIGHTS\nThe Corporation presently owns approximately 59 domestic patents and has approximately 10 additional applications pending. In addition, all of these patents and applications have been filed in Canada; most have also been filed in other various foreign countries. Most of those filed outside the United States have been allowed while the remainder are pending. The Corporation believes that certain features relating to its equipment for which it has obtained patents or for which patent applications have been filed are important to its business, but does not believe that its success is dependent upon its ability to obtain and defend such patents. Because of the extensive patent coverage in the data communications industry and the rapid issuance of new patents, certain equipment of the Corporation may involve infringement of existing patents not known to the Corporation.\nEMPLOYEE RELATIONS\nAt September 30, 1994, the Corporation employed 1,824 persons, of whom 331 were research and development personnel, 537 were manufacturing personnel, 471 were employed in various selling and marketing activities, 307 were in field services and 178 were in general and administrative activities. No Corporation employees are covered by collective bargaining agreements. The Corporation has never experienced a work stoppage and considers its relations with its employees to be good.\nSOURCES OF MATERIAL\nThe Corporation's products use certain components, such as microprocessors, memory chips and pre-formed enclosures that are acquired or available from one or a limited number of sources. The Corporation has generally been able to procure adequate supplies of these components in a timely manner from existing sources. The Corporation's inability to obtain a sufficient quantity of these components as required, or to develop alternative sources at acceptable prices and within a reasonable time, could result in delays or reductions in product shipments which could materially affect the Corporation's operating results in any given period.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe principal facilities of the Corporation are as follows:\nIn addition, the Corporation leases sales and service offices throughout the United States and in international locations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nNot applicable.\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\nCOMMON STOCK PRICES\nGeneral DataComm Industries, Inc.'s Common Stock is listed on the New York Stock Exchange and trades under the symbol \"GDC.\" The table below shows the intra-day high and low and closing sales prices as reported during each quarter of the last two fiscal years.\nNo cash dividends have ever been paid on the Common or Class B Stock. The Corporation's principal loan agreement does not allow payment of cash dividends. In the event this would change, it is still management's intention to reinvest future earnings in the business to support growth plans.\nThe Corporation had approximately 1,953 shareholders of record at September 30, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE-YEAR SELECTED FINANCIAL DATA\nIn thousands except per share, ratio and employee data\n(* - Fiscal 1994 net income (loss) includes: (i) after-tax charges totaling $(433), or ($0.03) per share, resulting from the adoption of Financial Accounting Standards Nos. 106 and 112 effective October 1, 1993, and (ii) an income tax benefit of $1,700, or $0.10 per share, relating to the resolution of a foreign tax issue.\n(** - Fiscal 1993 includes the purchase of the Corporation's principal manufacturing facility and corporate headquarters for $14,473.\n- 9 -\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nGENERAL SUMMARY DISCUSSION\nAlthough revenues were essentially unchanged in fiscal 1994 when compared to fiscal 1993, there were significant differences in both the revenue trends within the years and in the types of products sold in each year. Revenues declined 4.9% in the fiscal 1993 second half compared to the first half, whereas fiscal 1994 second half revenues exceeded the first half by 19.6%. The Corporation's fiscal 1994 fourth quarter revenues were the highest in its history. The upward trend in the second half was driven by demand for the Corporation's ATM (Asynchronous Transfer Mode) and digital transmission products, offset in part by a continuing decline in demand for the Corporation's traditional analog products.\nThe Corporation has made incremental investments in research and development, marketing, production engineering and inventories (including ATM trial units) in preparation for the roll-out of its ATM products. The Corporation also continues to expand its international sales operations. As a result, operating expenses grew by $7.6 million to 47.4% of fiscal 1994 revenues compared to 43.6% of fiscal 1993 revenues and contributed to the losses in the first three quarters of fiscal 1994.\nNet income in the fiscal 1994 fourth quarter of $1.3 million, or $0.07 per share, reduced the net loss for the fiscal 1994 year to $(2.3 million), or $(0.14) per share, compared to net income of $6.1 million, or $0.36 per share, in fiscal 1993. The fiscal 1994 loss included: (i) after-tax charges of $(433,000), or $(0.03) per share, as a result of adopting Statements of Financial Accounting Standards Nos. 106 and 112 relating to post-retirement and post-employment benefits, respectively, and (ii) an income tax benefit of $1.7 million, or $0.10 per share, resulting from the resolution of a foreign tax issue.\nIn November 1993 the Corporation acquired Netcomm Limited (\"Netcomm\"), a developer of ATM technology, and, accordingly, Netcomm's results of operations were included in the Corporation's financial data beginning at that time. Netcomm has been renamed General DataComm Advanced Research Centre Limited, and its charter is to develop next-generation ATM equipment.\nIn the third quarter of fiscal 1994, the Corporation raised $14.6 million, after expenses, through a private offering of 1,250,000 shares of Common Stock.\nRESULTS OF OPERATIONS\nThe following table sets forth selected consolidated financial data stated as a percentage of total revenues:\n1994 COMPARED WITH 1993\nRevenues for fiscal 1994 were slightly lower (0.4%) than fiscal 1993. However, fiscal 1994 fourth quarter revenues rose $8.0 million, or 15.4%, over the fourth quarter of fiscal 1993. Growth markets in the fiscal 1994 fourth quarter included both the domestic carriers and many international areas. New products, such as ATM cell switches, V.F 28.8 modems and additions to digital data sets and multiplexer lines, sold higher volumes compared to the prior quarters of fiscal 1994, offset in part by a reduction in traditional analog modem shipments. For the 1994 fiscal year, net product sales were down $1.5 million, or 0.1%, service revenues were up $1.4 million, or 4.2%, and leasing revenues were down $737,000, or 9.8%.\nGross margin (which includes amortization of capitalized software development costs) declined slightly (0.2%) to 47.7% in fiscal 1994 from 47.9% in fiscal 1993. Amortization of capitalized software development costs charged to cost of product sales increased to $9.7 million in fiscal 1994 from $8.3 million in fiscal 1993 and had the effect of reducing gross margins by 0.5%. High technology products in particular are subject to sales price pressures as competition grows. The Corporation works to offset these effects by negotiating lower material component prices, improving manufacturing cost and efficiencies and introducing new-generation products.\nSelling, general and administrative expenses increased $6.8 million, or 9.2%, in fiscal 1994, principally due to strategic investments made in ATM marketing operations and in international selling organizations. Since there was no corresponding growth in revenue until the second half of the fiscal year, selling, general and administrative expenses rose to 37.9% of revenues from 34.6% in fiscal 1993.\nResearch and product development spending, before consideration of capitalized software development costs, increased to $33.2 million, or 15.7% of revenues, from $29.8 million, or 14.1% of revenues, in fiscal 1993. This increase, 11.3% year-over-year, reflects the acquisition of Netcomm and its\nsubsequent conversion to a dedicated ATM research facility, the start-up of a new ATM product development facility in Quebec, Canada, and the strategic repositioning of the domestic product development organization. The increase in capitalized software development costs to $13.1 million, or 39.5% of total spending, from $10.6 million, or 35.4% of total spending in fiscal 1993, is directly related to the increasing software content within the Corporation's products.\nInterest expense in fiscal 1994 increased $1.8 million, nearly double the fiscal 1993 level. The Corporation purchased and concurrently mortgaged two of its principal facilities in September 1993, adding $630,000 to interest expense, which was offset by lower rent expense. Also, the higher interest levels reflected an increase in borrowing levels attributable to the acquisition cost of Netcomm in November 1993, the related investments since made to support the ATM product line and investments in international sales organizations.\nThe fiscal 1994 income tax benefit of $975,000 is comprised of a $1.7 million favorable resolution of a foreign tax issue offset by $725,000 in provisions for state and foreign income taxes. The Corporation has significant net operating loss carryforwards (approximately $35 million at September 30, 1994) available to offset future federal income taxes. These net operating losses begin to expire in the year 2002.\n1993 COMPARED WITH 1992\nRevenues for fiscal 1993 rose $14.0 million, or 7.1%, over fiscal 1992. The increase in net product sales of $12.7 million was principally due to improvements in sales into domestic markets while foreign sales results were mixed. Service revenue increased 3.7%, or $1.2 million, while leasing revenue remained constant on a year-to-year basis.\nGross margin rose to 47.9% in fiscal 1993 from 45.6% in fiscal 1992. Product margins increased 2.3%, from 47.0% to 49.3%, mainly attributable to higher volumes and manufacturing productivity improvements. Amortization of capitalized software development costs charged to cost of product sales increased to $8.3 million in fiscal 1993 from $7.2 million in fiscal 1992. Excluding the impact of this amortization, product margins rose to 54.1% in fiscal 1993 from 51.5% in fiscal 1992.\nSelling, general and administrative expenses increased $4.4 million, or 6.4%, in fiscal 1993. The higher spending levels reflected the impact of headcount additions in the international and domestic sales forces, regular salary increases, higher commissions and increased costs associated with the launch of new products.\nResearch and product development expenditures increased $4.6 million to 14.1% of revenue in fiscal 1993 due to increased investments in new product development and enhancements. As a result, the capitalization of software development costs rose from $9.3 million in fiscal 1992 to $10.6 million in fiscal 1993. On a net basis, research and development expense increased $3.4 million, or 21.2%, from the prior fiscal year.\nInterest expense declined 26.4% from $2.7 million in fiscal 1992 to $2.0 million in fiscal 1993 mostly due to lower levels of borrowings during the fiscal year. Foreign currency exchange gains of $54,000 and $122,000 were reported in other income in fiscal 1993 and 1992, respectively.\nThe Corporation provided $1.0 million and $554,000 in fiscal 1993 and 1992, respectively, for federal, state and foreign income taxes, with the increase principally attributable to higher taxable income in foreign operations.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Corporation's cash and cash equivalents were $2.9 million at September 30, 1994, compared to $2.6 million at September 30, 1993.\nOPERATING\nNon-debt working capital, excluding cash and cash equivalents, increased $19.6 million in fiscal 1994 to $58.7 million at September 30, 1994. This increase resulted primarily from increases in current receivables and inventories, which were partially offset by increases in accounts payable and accrued liabilities and deferred income on maintenance contracts. Current receivables increased $13.9 million in fiscal 1994 to $49.6 million at September 30,1994, due in part to the revenue growth in the fourth quarter. Inventory grew $7.6 million to $42.2 million in anticipation of increasing shipments of ATM and other new products.\nINVESTING\nInvesting activities during fiscal year 1994 included net additions to property, plant and equipment of $11.3 million, additions to capitalized software development costs of $13.1 million and costs of $5.9 million associated with the Netcomm acquisition. Any future product growth will increase capital requirements for manufacturing and development equipment. As a result, the Corporation anticipates that fiscal 1995 capital requirements should equal or exceed 1994 capital expenditures.\nFINANCING\nFinancing activities during the year ended September 30, 1994, added $34.2 million in cash, representing $16.5 million from long-term borrowings and $3.1 million from the issuance of Common Stock pursuant to employee stock programs and net proceeds of $14.6 million in conjunction with a private placement of 1,250,000 shares of Common Stock in the fiscal 1994 third quarter.\nIn November 1993, the Corporation entered into an amended revolving credit agreement expiring on November 30, 1996, that provides for borrowings of up to $25.0 million, reduced by the value of outstanding letters of credit issued by the lenders on behalf of the Corporation up to $2.5 million. Interest is charged at 0.75% over the prime rate, or, at the Corporation's option, 2.625% over selected LIBOR terms. The agreement imposes various financial covenants, requires that most assets be pledged as collateral and limits the permitted amount of borrowing through an asset-based formula. The loan balance outstanding at September 30, 1994, was $16.2 million. In June 1994, this agreement was further amended to provide an $8.0 million term loan ($7.5 million outstanding at September 30, 1994), the proceeds of which the Corporation used to reduce in full other maturing indebtedness.\nIn September 1993, the Corporation purchased its corporate headquarters and manufacturing facilities and concurrently entered into mortgages to partially finance these purchases. The mortgage balances outstanding at September 30, 1994, totaled $11.4 million. Interest is charged at LIBOR (90-day) plus 2%, principal payments are $100,000 per quarter and the mortgages mature in the year 2003.\nNotes payable and capitalized lease obligations, both used to finance capital equipment purchases, totaled $11.8 million at September 30, 1994 and have five-year maturities.\nThe Corporation believes that its existing cash balances and future cash flow from operations, combined with available funds under its revolving credit facility will be adequate to support the Corporation's growth for the foreseeable future.\nThe Corporation also considers its ability to offer for sale its Common Stock as a viable alternative source of funds. Accordingly, during fiscal 1994, the Corporation completed a 1,250,000 share private placement offering, as described above. Additionally, on October 28, 1994, a registration statement was filed with the Securities and Exchange Commission relating to a proposed public offering of 1,800,000 shares of Common Stock and 270,000 shares of Common Stock subject to an over-allotment option. It is anticipated that the proceeds of this offering would be used for debt reduction, working capital needs and other general corporate purposes, including expenditures related to the development and expansion of the Corporation's ATM products and potential acquisitions. The registration statement has not yet, and may not, become effective.\nLEASE FINANCING AGREEMENTS\nThe Corporation's principal leasing subsidiary has agreements in place with financial institutions whereby lease receivables can be transferred with full recourse. Each request for financing is subject to the approval of the financing institution.\nOPERATING LEASE OBLIGATIONS\nSee Note 7 of the \"Notes to Consolidated Financial Statements\" for discussion of the Corporation's operating lease obligations.\nTRADE RECEIVABLE CONCENTRATION\nApproximately $15.2 million, or 28.5%, of consolidated accounts receivable at September 30, 1994 ($9.3 million, or 22.9%, at September 30, 1993) were concentrated in telephone companies in North America and Europe. These receivables are not collateralized due to the high credit ratings and the extensive financial resources available to such telephone companies.\nIMPACT OF INFLATION AND CHANGING PRICES\nIn management's opinion, the impact of inflation and changing prices for the three most recent fiscal years is not significant to the financial statements as reported.\nADOPTION OF FINANCIAL ACCOUNTING STANDARDS NOS. 106, 109 AND 112\nEffective October 1, 1993, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employer's Accounting for Post-Retirement Benefits Other Than Pensions\", requiring the use of an accrual method of accounting for post-retirement benefits. The Corporation elected to recognize the transition obligation as a one-time cumulative after-tax charge to income of ($117,000), or $(.01) per share. The increase in annual expense for retiree health care is not material.\nEffective October 1, 1993, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes\". SFAS 109 is an asset and liability approach that requires recognition of deferred tax assets and liabilities for the expected\nfuture tax consequences of events that have been recognized in the Corporation's financial statements or tax returns. In estimating future tax consequences, SFAS 109 generally considers all expected future events other than enactments of changes in the tax law or rates. Previously, the Corporation 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 effect of adoption was not material to the Corporation's results of operations.\nEffective October 1, 1993, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Post-Employment Benefits\", requiring the use of an accrual method of accounting for post-employment benefits. The Corporation elected to recognize the transition obligation as a one-time cumulative after-tax charge to income of ($316,000), or $(.02) per share. The increase in annual expense for post-employment costs is not material.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nGENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these consolidated financial statements.\n- 16 - GENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS AND EARNINGS REINVESTED\nThe accompanying notes are an integral part of these consolidated financial statements.\n- 17 - GENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(1 - Excluded from the fiscal 1994 Consolidated Statements of Cash Flows is the issuance of common stock with a fair market value of $1,846 related to the acquisition of a company. Excluded from the fiscal 1993 and 1992 cash flows are the acquisitions of capital equipment in the amounts of $701 and $1,175, respectively, financed in their entirety with capital leases. Also excluded from the fiscal 1993 cash flows is the acquisition of property financed with mortgages in the amount of $11,925.\n(2 - The Corporation considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\n- 18 - NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Corporation and its majority-owned subsidiary companies. Intercompany accounts, transactions and profits have been appropriately eliminated in consolidation.\nINVENTORIES\nInventories are stated at the lower of cost or market, using a first-in, first-out method.\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at cost and depreciated or amortized using the straight-line method over their estimated useful lives. The cost of internally constructed assets includes manufacturing labor and related overhead costs. Depreciation expense amounted to $8,776,000, $7,985,000 and $8,686,000 in fiscal 1994, 1993 and 1992, respectively.\nCAPITALIZED SOFTWARE DEVELOPMENT COSTS\nSoftware development costs are capitalized for those products that have met the requirements of technological feasibility. These costs are amortized on a product-by-product basis using a straight-line method over the estimated economic life of the product, not to exceed three years.\nREVENUE RECOGNITION\nRevenue from equipment sales is recognized at the date of shipment. Service revenue is recognized when the service is performed or, in the case of maintenance contracts, on a straight-line basis over the term of the contract.\nRevenue from sales-type leases is recognized at the date of shipment. Revenue from operating leases is recognized ratably over the lease term, and the related equipment is depreciated using the straight-line method over its estimated useful life which approximates four years. The average length of initial lease terms in fiscal 1994 was approximately 31 months. Leasing revenue includes income from the transfer of certain finance lease receivables with full recourse. Such income amounted to $842,000, $1,354,000 and $871,000 in fiscal 1994, 1993 and 1992, respectively.\nINCOME TAXES\nThe Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes\", which requires the use of the liability method of accounting for deferred income taxes effective October 1, 1993. The financial effect of adoption on the results of operations was not material. However, adoption changed the classification of deferred income tax accounts on the balance sheet.\nThe provision for income taxes includes federal, foreign, state and local income taxes currently payable and deferred taxes resulting from temporary differences between the financial statement and tax basis of assets and liabilities. The Corporation intends to permanently reinvest the undistributed earnings of foreign subsidiaries ($1,279,000). Accordingly, no federal income taxes have been provided on such earnings.\nEARNINGS PER SHARE\nEarnings per share are computed using the weighted average number of common (including Class B Stock) and common equivalent shares outstanding. Common equivalent shares consist of dilutive stock options and warrants.\nFOREIGN CURRENCY\nAssets and liabilities of the Corporation's foreign subsidiaries are translated using fiscal year-end exchange rates, and revenue and expenses are translated using average exchange rates prevailing during the year. The effects of translating foreign subsidiaries' financial statements are recorded as a separate component of stockholders' equity.\nIn addition, included in other income are net realized foreign currency exchange gains (losses) of ($188,000), $54,000 and $122,000 for fiscal 1994, 1993 and 1992, respectively.\nPOST-RETIREMENT BENEFITS\nEffective October 1, 1993, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employer's Accounting for Post-Retirement Benefits Other Than Pensions\", requiring the use of an accrual method of accounting for post-retirement benefits. The Corporation elected to recognize the transition obligation as a one-time cumulative after-tax charge to income of ($117,000), or $(.01) per share. The increase in annual expense for retiree health care is not material.\nPOST-EMPLOYMENT BENEFITS\nEffective October 1, 1993, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Post-Employment Benefits\", requiring the use of an accrual method of accounting for post-employment benefits. The Corporation elected to recognize the transition obligation as a one-time cumulative after-tax charge to income of ($316,000), or $(.02) per share. The increase in annual expense for post-employment costs is not material.\nFAIR VALUES OF FINANCIAL INSTRUMENTS\nCash and cash equivalents - The carrying amount reported in the consolidated balance sheet for cash and cash equivalents approximates its fair value due to their short-term nature.\nLong-term debt - The carrying amounts of the Corporation's long-term borrowings, including current maturities, approximate fair value based on current rates available to the Corporation for debt of the same remaining maturities.\nRECLASSIFICATIONS\nCertain reclassifications were made to prior years' financial statements to conform to the current year's presentation.\n2. BUSINESS ACQUISITION\nEffective November 24, 1993, the Corporation acquired Netcomm Limited (\"Netcomm\"), a leader in Asynchronous Transfer Mode (ATM) technology, located in England. Under the terms of the acquisition, the Corporation issued 184,647 shares of common stock valued at $1.8 million and committed to pay cash of $5.5 million in return for all the outstanding common stock of Netcomm. The acquisition was accounted for as a purchase and, accordingly, the results of operations of the acquired business have been included in the Corporation's consolidated financial statements commencing on November 24, 1993. Approximately $6.5 million of the purchase price was allocated to goodwill, which is being amortized on a straight-line basis over fifteen years.\n3. PRODUCT DEVELOPMENT AND PURCHASE AGREEMENTS\nQUEBEC R&D PROJECT\nIn fiscal 1993, the Corporation's Canadian subsidiary entered into an agreement with the Quebec, Canada, government to establish a research and development facility in Quebec for the development of an ATM hub product. The Corporation has committed to spend approximately $9.0 million over a three-year period. Up to 50% of the costs of this facility will be reimbursed through tax credits and grants from the Quebec government. Such tax credits and grants, which amounted to $320,000 and $355,000, respectively, for the year ended September 30, 1994, are recorded as a reduction to research and product development expense.\nCROSSCOMM\nIn 1992, the Corporation entered into a joint development agreement with CrossComm Corporation (\"CrossComm\") pursuant to which the Corporation and CrossComm will jointly develop certain new products that will integrate CrossComm's Token Ring Local Area Network (LAN) technology into the Corporation's Wide Area Network (WAN) products. CrossComm will receive $1,250,000 in payments for software license fees based upon the Corporation's profits recorded on the sales of certain of the new products over a four-year term commencing upon the Corporation's future receipt and acceptance of the new products.\n4. INVENTORIES\nInventories consist of (in thousands):\n5. LONG-TERM DEBT\nLong-term debt consists of the following (in thousands):\nREVOLVING CREDIT LOAN\nOn June 1, 1994, the Corporation, for the purpose of providing a term loan (see Notes Payable), entered into an amended agreement with The Bank of New York, as lender and agent for other institutions that are also lenders, to provide a revolving credit facility maturing on November 30, 1996 in the amount of $25,000,000. The amended agreement provides for interest on outstanding borrowings to be charged at .75% plus the higher of either (1) the prime rate, or (2) the federal funds rate plus 1\/2 of 1% (on September 30, 1994, the prime rate was 7.75% and the federal funds rate was 5.44%). Alternately, the Corporation may elect to borrow at 2.625% over LIBOR for terms of 1, 2, 3 or 6 months (on September 30, 1994, these LIBOR rates ranged from 4.94% to 5.69%).\nThe agreement also requires conformity with various financial covenants, the most restrictive of which include minimum tangible net worth and a fixed charge coverage ratio. Certain assets of the Corporation, including most accounts receivable and inventories, are pledged as collateral. The amount of borrowing is predicated on satisfying a borrowing base formula related to levels of certain accounts receivable and inventories.\nNOTES PAYABLE\nThe Corporation has entered into five-year note and installment purchase agreements collateralized by certain machinery, test equipment and furniture and fixtures. The outstanding balance of $10,818,000 at September 30, 1994, which approximates the net book value of the underlying equipment, bears interest depending upon the agreement, either at fixed rates ranging from 6.5% to 11.22%, at prime rate, at prime plus 1% or at the 30-day commercial paper rate plus 3.75%. Individual notes mature between fiscal 1995 and fiscal 1999.\nThe following is a schedule of future minimum payments on such notes at September 30, 1994 (in thousands):\nOn June 1, 1994, the Corporation refinanced $8,000,000 of a note payable, previously maturing January 2, 1995, with The Bank of New York as lender and agent for other institutions by incorporating term loan provisions and additional collateral into the previous revolving credit agreement. Quarterly principal payments of $250,000, $375,000 and $500,000 are required in the first, second and third (partial) years, respectively, with the final payment due November 30, 1996. Interest is payable either at 3.25% over LIBOR terms of 1, 2, 3 or 6 months or at 1.25% over the prime rate, at the Corporation's election. At September 30, 1994, the outstanding balance on this note was $7,500,000.\nMORTGAGES PAYABLE\nIn September 1993, the Corporation purchased its corporate headquarters and manufacturing facilities with financing provided by the seller's banks. Interest is payable at 90-day LIBOR (5.44% at 9\/30\/94) plus 2%, and quarterly principal payments of $100,000 are required until these mortgages mature in the year 2003.\nCAPITAL LEASE OBLIGATIONS\nThe Corporation has acquired the use of certain machinery and equipment by entering into capital leases. The outstanding balance of $1,029,000 at September 30, 1994 bears interest, depending upon the agreement, at fixed rates ranging from 6.66% to 10.75%.\n6. INCOME TAXES\nIncome (loss) before income taxes and cumulative effect of accounting changes consists of both domestic and foreign income (loss) as follows (in thousands):\nThe provision for (benefit from) income taxes consists of the following amounts (in thousands):\nDue to the Corporation's net operating loss carryforward position, no tax benefit was recorded for the cumulative effect of adopting SFAS Nos. 106 and 112 (see Note 1).\nThe following reconciles the U.S. statutory income tax rate to the Corporation's effective rate:\nFor regular tax reporting purposes at September 30, 1994, tax credit and net operating loss carryforwards amounted to $4,118,000 and $43,509,000, respectively. Domestic federal loss carryforwards of $35,051,000 expire between 2002 and 2009, of which approximately $4,100,000 relate to items which will be credited to stockholders' equity when applied; state loss carryforwards of $4,882,000 expire between 1995 and 2009. Foreign loss carryforwards of $3,576,000 expire beginning in 1996. Tax credit carryforwards expire between 1995 and 2009.\nFor federal alternative minimum tax purposes at September 30, 1994, net operating loss carryforwards amounted to $35,966,000.\nThe nature of temporary differences for prior periods were consistent with those of September 30, 1994. The tax effects of the significant temporary differences comprising the deferred tax assets and liabilities at September 30, 1994 follow (in thousands):\nDuring fiscal 1994 the valuation allowance increased by $754,000.\n7. OPERATING LEASES\nThe Corporation has certain non-cancelable operating leases on automobiles, subsidiary locations, sales offices and service facilities, which expire within one to five years. These leases generally contain renewal options and provisions for payment by the lessee of executory costs (taxes, maintenance and insurance). In addition, the Corporation has entered into a non-cancelable operating lease with scheduled rent increases for its engineering facility which expires in the year 2003. The Corporation also has a non-cancelable operating lease for an industrial facility which expires December 31, 1995. This facility was vacated as part of a cost reduction program in 1988 (see Note 12).\nThe following is a schedule of the future minimum payments on such leases at September 30, 1994 (in thousands):\nNet rental expense for the three most recent fiscal years was (in thousands):\n8. STOCKHOLDERS' EQUITY\nAuthorized: 35,000,000 shares of Common Stock - par value $.10 per share; 35,000,000 shares of Class B Stock - par value $.10 per share; 3,000,000 shares of Preferred Stock - par value $.10 per share (of which no shares have been issued):\nTransactions in capital stock during fiscal 1992, 1993 and 1994 were as follows (in thousands except share amounts):\nClass B Stock, under certain circumstances, has greater voting power in the election of directors. However, Common Stock is entitled to cash dividends, if and when paid, 11.11% higher per share than Class B Stock. The Corporation has never paid cash dividends, and dividends are not permitted by the Corporation's revolving credit and term loan agreement. Class B Stock has limited transferability and is convertible into Common Stock at any time on a share-for-share basis. At September 30, 1994, 1993 and 1992, 2,271,780, 2,466,231 and 2,705,670 shares, respectively, of Class B Stock were outstanding.\nOn May 27, 1994, the Corporation completed the sale of 1,250,000 shares of comon stock through a private placement offering. The sales price was $12.375 per common share. Net proceeds of $14.6 million were used to reduce debt and to provide additional working capital.\n- 26 - 9. INDUSTRY AND GEOGRAPHIC AREA INFORMATION\nThe Corporation operates solely in the data communications industry, where it designs, assembles, markets, installs and services products that enable users to build global, multimedia communications networks. These products include network management systems, multiplexers and data sets for a wide range of industrial, commercial and service corporations, government agencies, and domestic and international communications common carriers.\nGeographic area information for 1994, 1993 and 1992 is presented below (in thousands):\n(1) Includes export sales by domestic operations of $25,126 ,$21,793 and $23,315 for fiscal 1994, 1993 and 1992, respectively.\nApproximately $15.2 million, or 28.5%, of consolidated accounts receivable at September 30, 1994 ($9.3 million, or 22.9%, at September 30, 1993) were concentrated in telephone companies located in North America and Europe. These receivables are not collateralized due to the high credit ratings and the extensive financial resources available to such telephone companies.\n10. EMPLOYEE INCENTIVE PLANS\nSTOCK OPTION PLANS\nOfficers and key employees may be granted incentive stock options at an exercise price equal to or greater than the market price on the date of grant and non-qualified stock options at an exercise price equal to or less than the market price on the date of grant. Once granted, options become exercisable in whole or in part after the first year and generally expire within ten years. Under the terms of these stock option plans, the Corporation has reserved a total of 2,997,837 shares of Common Stock in 1994 (2,832,096 in 1993).\nThe following summarizes activity in fiscal 1992, 1993 and 1994 under these stock option plans:\nSTOCK PURCHASE PLAN\nThe Corporation has a stock purchase plan to encourage employees to participate in the Corporation's future growth. At September 30, 1994, 553,691 shares were reserved for purchase by employees through payroll deductions regularly accumulated over six-month payment periods. At the end of each payment period, Common Stock is purchased at 85% of the market value of the stock on the first or last day of the payment periods, whichever is lower. However, the purchase of Common Stock under this plan is prohibited if 85% of the market value of the Common Stock is less than the book value per share. Note 8, \"Stockholders' Equity,\" presents the historical activity under this plan.\n* * * * *\nNo charges are made to income for stock purchases or incentive stock options granted or exercised under the stock purchase and stock option plans. When shares are purchased under the stock purchase plan or issued upon exercise of incentive stock options, the excess of amounts paid over par value is credited to capital in excess of par value.\nEMPLOYEE RETIREMENT SAVINGS AND DEFERRED PROFIT SHARING PLAN\nUnder the retirement savings provisions of the Corporation's retirement plan, established under Section 401(k) of the Internal Revenue Code, employees are generally eligible to contribute to the plan after six months of continuous service, in amounts determined by the plan. The Corporation contributes an additional 50% of the employee contribution up to certain limits (not to exceed 1.5% of total eligible compensation). Employees become fully vested in the Corporation's contributions after five years of continuous service, death, disability or upon reaching age 65. The amounts charged to expense for the years ended September 30, 1994, 1993 and 1992 were $838,800, $808,800 and $601,400, respectively.\nThe deferred profit sharing provisions of the plan include retirement and other related benefits for substantially all of the Corporation's full-time employees. Contributions under the plan are funded annually and are based, at a minimum, upon a formula measuring profitability in relation to revenues. Additional amounts may be contributed at the discretion of the Corporation. There was no contribution for fiscal 1994. The Corporation's contributions for fiscal 1993 and 1992 were $357,050 and $156,600, respectively.\n11. LEASING SUBSIDIARY\nThe Corporation's consolidated financial statements include the accounts of its wholly-owned leasing subsidiary, DataComm Leasing Corporation. The leasing subsidiary purchases equipment for lease to others from General DataComm, Inc., its sole supplier.\nThe following represents the condensed financial information of DataComm Leasing Corporation (in thousands):\nLEASE FINANCING PROGRAMS\nDataComm Leasing Corporation maintains agreements with financial institutions whereby certain finance lease receivables are transferred with full recourse. The underlying equipment is retained as collateral by DataComm Leasing Corporation. Proceeds received by the leasing subsidiary from the transfer of such receivables amounted to $3,618,000, $4,193,000 and $3,751,000 for fiscal 1994, 1993\nand 1992, respectively. The balance of all transferred receivables which were due to be paid by the original lessees under the remaining lease terms as of September 30, 1994 and 1993 amounted to $6,836,000 and $7,129,000, respectively.\n12. RESTRUCTURING OF OPERATIONS\nThe Corporation remains obligated for a leased industrial facility, located in Connecticut, which was vacated in 1988 as part of a cost reduction program. The Corporation anticipates that reserves, in the total amount of $2,848,250 at September 30, 1994, of which $2,256,189 are classified as a current liability, are adequate to cover the estimated future costs to carry the facility through the end of its lease term, December 31, 1995.\n13. QUARTERLY FINANCIAL DATA (UNAUDITED)\nIn thousands except per share data\n(1) First quarter 1994 net loss includes charges totaling $(433), resulting from the adoption of Financial Accounting Standards Nos. 106 and 112, effective October 1, 1993. As originally reported, net loss for the first quarter was $(1,993), or $(0.12) per share.\n(2) Earnings (loss) per share amounts for each quarter are required to be computed independently and, in 1994, did not equal the full-year loss-per-share amounts.\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 with respect to directors is incorporated by reference from the section entitled \"ELECTION OF DIRECTORS\" in the Corporation's Proxy Statement for 1995 Annual Meeting of Stockholders, which Proxy Statement will be filed within 120 days after the end of the Corporation's fiscal year ended September 30, 1994.\nMr. Charles P. Johnson, Chairman of the Board and Chief Executive Officer, founded the Corporation in 1969.\nMr. Ross A. Belson, President and Chief Operating Officer, has served in his present capacity since joining the Corporation in August 1987. Before joining the Corporation, Mr. Belson held executive positions at Adage and Lexidata.\nMr. Frederick R. Cronin, Vice President, Technology, has served in executive capacities since the founding of the Corporation.\nMr. Robert S. Smith, Vice President, Business Development, has held positions of major responsibility within the Corporation since its formation and has served in executive capacities since February 1973.\nMr. William S. Lawrence, Vice President, Finance and Chief Financial Officer, has served in his present capacity since joining the Corporation in April 1977.\nMr. James R. Arcara, Vice President, Corporate Operations, has held positions of major responsibility within the Corporation since its formation and has served in executive capacities since September 1978.\nMr. Dennis J. Nesler, Vice President and Treasurer since May 1987 and Treasurer since July 1981, joined the Corporation in 1979 as Vice President of the Corporation's wholly owned leasing subsidiary, a capacity in which he still serves.\nMr. Rick L. Mantz, Vice President, Engineering, has served in this capacity since joining the Corporation in 1988. From October 1985, Mr. Mantz served as Assistant Vice President of Engineering at Timeplex, Inc.\nMr. Michael C. Thurk, Senior Vice President, Marketing, joined the Corporation in January 1994. Before that time, Mr. Thurk held various positions within the networking business of Digital Equipment Corporation over a period of fourteen years. Mr. Thurk's most recent position at Digital was Vice President of the Telecommunications Business segment.\nMr. William G. Henry, Corporate Controller, has served in this capacity since joining the Corporation in 1984.\nMr. August J. Hof, Vice President, Manufacturing Operations since June 1989, joined the Corporation in 1985 as Printed Circuit Board Plant Manager.\nMr. Eric A. Amster, Vice President, U.S. Federal and Commercial Sales, was elected officer of the Corporation in August 1993. He joined the Corporation in the sales organization in 1981 and has held positions of increasing responsibility since that time.\nMr. V. Jay Damiano, Vice President, U.S. Telecomm Sales, was elected officer of the Corporation in August 1993. He joined the Corporation in the sales organization in 1984 and has held positions of increasing responsibility since that time.\nMr. Howard S. Modlin, Secretary, an attorney and partner of the firm of Weisman, Celler, Spett & Modlin, has been Secretary and counsel to the Corporation since its formation.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION AND OTHER TRANSACTIONS WITH MANAGEMENT\nTo be filed by amendment.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nTo be filed by amendment.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nLOANS\nDuring the period October 1, 1987 through September 30, 1991, the Corporation granted unsecured loans to Messrs. Charles P. Johnson (Chairman of the Board), Frederick R. Cronin (Vice President, Technology) and Robert S. Smith (Vice President, Business Development) in the amounts of $453,045, $100,000 and $200,000, respectively, which were due January 31, 1995, April 14, 1994 and April 14, 1994, respectively. During fiscal 1994, Messrs. Johnson, Cronin and Smith repaid their respective balances in full and were not indebted to the Corporation at September 30, 1994. All loans were made for the personal needs of the respective executive officers.\nDuring fiscal 1989, Mr. Rick L. Mantz (Vice President, Engineering) was granted a secured loan by the Corporation in the maximum amount of $75,000. Mr. Mantz's loan was secured by a third mortgage on a property located in Southbury, Connecticut and bore interest at the rate of 9% per annum, payable bi-weekly. During fiscal 1994, Mr. Mantz's final principal balance of $18,750 was forgiven in accordance with the loan terms. The loan was made for the personal needs of Mr. Mantz pursuant to employment negotiations at the time he was hired by the Corporation.\nBUSINESS RELATIONSHIPS WITH DIRECTORS\nDuring the fiscal year ended September 30, 1994, $700,000 in fees were paid to the law firm of which Howard S. Modlin is a partner.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(1) Incorporated by reference from Form 10-Q for quarter ended June 30, 1988, Exhibit 3.1. Amendments thereto are filed as Exhibit 3.1 to Form 10-Q for quarter ended March 31, 1990. (2) Incorporated by reference from Exhibit 3.2 to Form 10-K for year ended September 30, 1987. (3) Incorporated by reference from Exhibit 10.2 to Form 10-Q for quarter ended June 30, 1989. (4) Incorporated by reference from Exhibit 10.1 to Form 10-Q for quarter ended June 30, 1989.\n(5) 1979 Employee Stock Purchase Plan is incorporated by reference from Part II of prospectus dated September 30, 1991, contained in Form S-8, Registration Statement No. 33-43050. (6) Incorporated by reference from Exhibit 1(c) to Form S-8, Registration Statement No. 2-92929.Amendments thereto are filed as Exhibit 10.3 to Form 10-Q for quarter ended December 31, 1987 and as Exhibit 10.3.1 to Form 10-Q for quarter ended June 30, 1991. (7) Incorporated by reference from Exhibit 1(a), Form S-8, Registration Statement No. 2-92929. Amendment thereto is filed as Exhibit 10.2 to Form 10-Q for quarter ended June 30, 1991. (8) Incorporated by reference from Exhibit 10a, Form S-8, Registration Statement No. 33-21027. Amendments thereto are incorporated by reference from Part II of prospectus dated August 21, 1990, contained in Form S-8, Registration Statement No. 33-36351 and as Exhibit 10.3.2 to Form 10-Q for quarter ended June 30, 1991. (9) Incorporated by reference from Exhibit 10.19 to Form 10-K for year ended September 30, 1987. (10) Incorporated by reference from Exhibit 10.2 to Form 10-Q for quarter ended December 31, 1987. (11) Incorporated by reference from Form S-8, Registration Statement No. 33-37266. (12) Incorporated by reference from Exhibit 10.2 to Form 10-Q for quarter ended December 31, 1991 and Exhibit 28.2 to Form 10-Q for quarter ended March 31, 1992. (13) Incorporated by reference from Exhibit 28.3 to Form 10-Q for quarter ended March 31, 1992 and from Exhibit 28.3 to Form 10-Q for quarter ended June 30, 1992. (14) Incorporated by reference from Exhibit 28.4 to Form 10-Q for quarter ended June 30, 1992 and from Exhibit 28.4 to Form 10-Q for quarter ended December 31, 1992. (15) Incorporated by reference from Form S-8, Registration Statement No. 33-53150, from Form S-8, Registration Statement No. 33-62716 and from Form S-8, Registration Statement No. 33-53201. (16) Incorporated by reference from Exhibit 10.21 to Form 10-K for the year ended September 30, 1993. (17) Incorporated by reference from Exhibit 28.1 to Form 10-Q for the quarter ended June 30, 1994.\n(b) Reports on Form 8-K. No reports on Form 8-K were 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 Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nGENERAL DATACOMM INDUSTRIES, INC.\nBy: WILLIAM S. LAWRENCE ---------------------------------- William S. Lawrence Vice President, Finance and Principal Financial Officer\nDated: November 4, 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:\nGENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES ITEM 14(A)\nFINANCIAL STATEMENTS AND SCHEDULED OMITTED\nFinancial statements and schedules other than those included herein are omitted because they are not required or because the required information is presented elsewhere in the financial statements or notes thereto.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF GENERAL DATACOMM INDUSTRIES, INC.\nWe have audited the consolidated financial statements and financial statement schedules of General DataComm Industries, 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 Corporation's management. Our responsibility is to express an opinion on these financial statements and financial statement schedules based upon 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 General DataComm Industries, Inc. And Subsidiaries as of September 30, 1994 and 1993, and the consolidated results of their operations and their cash flows for the years ended September 30, 1994, 1993 and 1992, 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 1 and 6 to the consolidated financial statements, effective October 1, 1993 the Corporation changed its methods of accounting for post-retirement benefits other than pensions, post-employment benefits and income taxes.\nCoopers & Lybrand L.L.P. Stamford, Connecticut October 19, 1994\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the Registration Statements of General Datacomm Industries, Inc. and Subsidiaries on Form S-8 (File Nos. 2-92929, 33-21027, 33-36351, 33-37266, 33-43050, 33-53150, 33-62716 and 33-53201) and on Form S-3 (File No. 33-54417) of our report, which includes an explanatory paragraph for certain accounting changes, dated October 19, 1994, on our audits of the consolidated financial statements and financial statement schedules of General Datacomm Industries, Inc. and Subsidiaries as of September 30, 1994 and 1993 and for the years ended September 30, 1994, 1993, and 1992, which report is included in this Annual Report on Form 10-K.\nCoopers & Lybrand L.L.P. Stamford, Connecticut November 4, 1994\nGENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nSCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992\n(a) Represents seven individual $50,000 and one $103,045 unsecured notes receivable, each of which bears interest at the rate of 7.65% per annum as of September 30, 1991, and September 30, 1992. These loans were scheduled to mature at dates ranging from December 1993 through February 1995.\n(b) Represents one unsecured note receivable, which bears interest at the rate of 5.81% per annum at September 30, 1993. The loan, which was due January 31, 1995, was paid in full in February 1994.\n(c) Represents one unsecured note receivable, which bears interest at the rate of 7.65% per annum at September 30, 1993. The loan, which was due in April 1994, was paid in full in March 1994.\nGENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (IN THOUSANDS)\n(a) Reflects property, plant and equipment at cost associated with the November 1993 acquisition of Netcomm Limited.\n(b) Includes the purchase of the Company's principal manufacturing facility and corporate headquarters in September 1993 for $14,473, which was partially financed by mortgages in the amount of $11,925.\nGENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nSCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (IN THOUSANDS)\n(a) Reflects accumulated depreciation and amortization associated with the November 1993 acquisition of Netcomm Limited.\nNote: Depreciation and amortization is computed on the straight-line method over the following estimated useful lives: Buildings and improvements - 3 to 30 years Test equipment, fixtures and field spares - 3 to 10 years Machinery and equipment - 2 to 10 years\nGENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992 (IN THOUSANDS)\n- - -------------------- (a) Deducted from asset accounts.\n(b) Uncollectible accounts written off, net of recoveries.\nGENERAL DATACOMM INDUSTRIES, INC. AND SUBSIDIARIES\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1993 AND 1992\nAmounts for maintenance and repairs, depreciation and amortization of intangible assets, taxes other than income or payroll taxes and royalties are not presented, as such amounts are presented elsewhere in the financial statements or notes thereto, or were less than 1% of total revenues in each of the three periods presented.\nEXHIBIT INDEX -------------\n(1) Incorporated by reference from Form 10-Q for quarter ended June 30, 1988, Exhibit 3.1. Amendments thereto are filed as Exhibit 3.1 to Form 10-Q for quarter ended March 31, 1990. (2) Incorporated by reference from Exhibit 3.2 to Form 10-K for year ended September 30, 1987. (3) Incorporated by reference from Exhibit 10.2 to Form 10-Q for quarter ended June 30, 1989. (4) Incorporated by reference from Exhibit 10.1 to Form 10-Q for quarter ended June 30, 1989.\n(5) 1979 Employee Stock Purchase Plan is incorporated by reference from Part II of prospectus dated September 30, 1991, contained in Form S-8, Registration Statement No. 33-43050. (6) Incorporated by reference from Exhibit 1(c) to Form S-8, Registration Statement No. 2-92929.Amendments thereto are filed as Exhibit 10.3 to Form 10-Q for quarter ended December 31, 1987 and as Exhibit 10.3.1 to Form 10-Q for quarter ended June 30, 1991. (7) Incorporated by reference from Exhibit 1(a), Form S-8, Registration Statement No. 2-92929. Amendment thereto is filed as Exhibit 10.2 to Form 10-Q for quarter ended June 30, 1991. (8) Incorporated by reference from Exhibit 10a, Form S-8, Registration Statement No. 33-21027. Amendments thereto are incorporated by reference from Part II of prospectus dated August 21, 1990, contained in Form S-8, Registration Statement No. 33-36351 and as Exhibit 10.3.2 to Form 10-Q for quarter ended June 30, 1991. (9) Incorporated by reference from Exhibit 10.19 to Form 10-K for year ended September 30, 1987. (10) Incorporated by reference from Exhibit 10.2 to Form 10-Q for quarter ended December 31, 1987. (11) Incorporated by reference from Form S-8, Registration Statement No. 33-37266. (12) Incorporated by reference from Exhibit 10.2 to Form 10-Q for quarter ended December 31, 1991 and Exhibit 28.2 to Form 10-Q for quarter ended March 31, 1992. (13) Incorporated by reference from Exhibit 28.3 to Form 10-Q for quarter ended March 31, 1992 and from Exhibit 28.3 to Form 10-Q for quarter ended June 30, 1992. (14) Incorporated by reference from Exhibit 28.4 to Form 10-Q for quarter ended June 30, 1992 and from Exhibit 28.4 to Form 10-Q for quarter ended December 31, 1992. (15) Incorporated by reference from Form S-8, Registration Statement No. 33-53150, from Form S-8, Registration Statement No. 33-62716 and from Form S-8, Registration Statement No. 33-53201. (16) Incorporated by reference from Exhibit 10.21 to Form 10-K for the year ended September 30, 1993. (17) Incorporated by reference from Exhibit 28.1 to Form 10-Q for the quarter ended June 30, 1994.\n(b) Reports on Form 8-K. No reports on Form 8-K were filed during the last quarter of the period covered by this report.","section_15":""}
{"filename":"46989_1994.txt","cik":"46989","year":"1994","section_1":"ITEM 1. BUSINESS: Hercules Incorporated (\"Hercules\" or the \"Company\") is a diversified, worldwide producer of chemicals and related products. The Company was incorporated in Delaware in 1912. In March 1995, Hercules completed the sale of a substantial portion of its Aerospace segment (which produced solid fuel systems for aerospace applications) to Alliant Techsystems Incorporated. Hercules now holds a 30% ownership interest in Alliant and two of the eight nonemployee seats on the Alliant Board of Directors. Hercules' 30% interest in Alliant will be accounted for on the equity method, and is not expected to be material to Hercules' consolidated financial statements. Accordingly, information related to the Aerospace segment has been omitted in this Form 10-K, except where relevant.\nINDUSTRY SEGMENTS\nHercules operates, both domestically and throughout the world, in two industry segments: Chemical Specialties and Food & Functional Products. The financial information regarding Hercules' industry segments, which includes net sales and profit from operations for each of the three years in the period ended December 31, 1994 and identifiable assets as of December 31, 1994, 1993 and 1992, is provided in Note 24 to the Consolidated Financial Statements.\nInformation regarding principal products produced and sold by each industry segment and principal markets served by each segment is presented in the columns so designated in the segment table presented below. These products are sold directly to customers from plants and warehouses, as well as being sold in some cases (particularly in markets outside the United States) to and through distributors.\nIn general, Hercules does not produce against a backlog of firm orders; production is geared primarily to the level of incoming orders and the projections of future demand. Significant inventories of finished products, work in process and raw materials are maintained to meet delivery requirements of customers and Hercules' production schedules. The businesses of each of the segments are not seasonal to any significant extent.\nRAW MATERIALS AND ENERGY Raw materials and supplies are purchased from a variety of industry sources, including agricultural, forestry, mining, petroleum and chemical industries.\nThe important raw materials for the Chemical Specialties segment are d-limonene, turpentine, crude tall oil, rosin, pine wood stumps, aromatic and aliphatic resin formers, ketones, cumene, catalysts, alcohols, pure monomers, toluene, clay, phenol, adipic acid, epichlorohydrin, fumaric acid, process oils, stearic acid, diethylenetriamine, phosphorus trichloride, wax, casein, starch, polypropylene resin, pigments, and antioxidants.\nRaw materials important to the Food & Functional Products segment are acetaldehyde, fatty acids, chemical cotton, woodpulp, ethyl chloride, alcohols, chlorine, ethylene oxide, propylene oxide, monochloroacetic acid, methyl chloride, caustic, inorganic acids, fruit and floral extracts, guar splits, seaweed, terpenes, and citrus peel.\nMajor requirements for key raw materials and fuels are typically purchased pursuant to multi-year contracts. Hercules is not dependent on any one supplier for a material amount of its raw material or fuel requirements, but certain important raw materials are obtained from sole-source or a few major suppliers.\nWhile temporary shortages of raw materials and fuels may occur occasionally, these items are currently readily available. However, their continuing availability and price are subject to domestic and world market and political conditions as well as to the direct or indirect effect of United States Government regulations. The impact of any future raw material and energy shortages on Hercules' business as a whole or in specific world areas cannot be accurately predicted. Operations and products may, at times, be adversely affected by legislation, shortages or international or domestic events.\nCOMPETITION Hercules encounters substantial competition in each of its two industry segments. This competition, from other manufacturers of the same products and from manufacturers of different products designed for the same uses, is expected to continue in both the United States and markets outside the United States. Some of Hercules' competitors, such as companies engaged in petroleum operations, have more direct access to raw materials, and some have greater financial resources than Hercules.\nThe number of Hercules' principal competitors varies from product to product. It is not practicable to estimate the number of all competitors because of the large variety of Hercules' products, the markets served and the world-wide business interests of Hercules.\nPATENTS AND TRADEMARKS Patents covering a variety of products and processes have been issued to Hercules and its assignees. In addition, Hercules is licensed under certain other patents covering the products and processes. Taken as a whole, the rights of Hercules under these patents and licenses, which expire from time to time, are considered by Hercules to constitute a valuable asset. However, Hercules does not consider any single patent or license, or any group thereof related to a specific product or process, to be of material importance to its business as a whole.\nHercules also has registered trademarks for a number of its products. Some of the more significant trademarks include: AQUAPEL(R) sizing agent, HERCON(R) sizing emulsions, KYMENE(R) resin, MAGNAMITE(R) graphite fiber, MERIGRAPH(R) photopolymer resin, NANOCHEM(R) synthetic resin, REGALREZ(R) resin, SYCAR(R) resin, HERCULON(R) olefin fiber, SLENDID(R) fat replacer, NATROSOL(R) hydroxyethylcellulose, CULMINAL(R) methylcellulose, KLUCEL(R) hydroxypropylcellulose, NATROSOL FPS(R) water-soluble polymer suspension, AQUA MER(R) dry film photoresists, and PRECIS(TM) sizing agent.\nRESEARCH AND DEVELOPMENT Research and development, which is directed toward the discovery and development of new products and processes, the improvement and refinement of existing products and processes and development of new applications for existing products, is primarily company-sponsored. Hercules spent $64,780,000 on research activities during 1994, as compared to $76,121,000 in 1993 and $70,208,000 in 1992. During the three-year period, research and development expenditures for the Chemical Specialties and Food & Functional Products segments were between 1.8% and 2.6% of sales.\nENVIRONMENTAL MATTERS Hercules believes that it is in compliance in all material respects with applicable federal, state and local environmental laws and regulations. Expenditures relating to environmental cleanup costs have not and are not expected to materially affect capital expenditures or competitive position. Additional information regarding environmental matters is provided in Notes 15 and 23(c) to the Consolidated Financial Statements.\nEMPLOYEES As of December 31, 1994, Hercules had 11,989 employees worldwide (of which 3,741 were in the areospace business). Approximately 8,895 were located in the United States, and of these employees about 30% were represented by various local or national unions.\nINTERNATIONAL OPERATIONS Information on net sales, profit from operations, identifiable assets by geographic areas, and the amount of export sales, for each of the last three years appear in Note 24 to the Consolidated Financial Statements. Hercules' operations outside the United States are subject to the usual risks and limitations related to investments in foreign countries, such as fluctuations in currency values, exchange control regulations, wage and price controls, employment regulations, effects of foreign investment laws, governmental instability (including expropriation or confiscation of assets) and other potentially detrimental domestic and foreign governmental policies affecting United States companies doing business abroad.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES: The Company's corporate headquarters and major research center are located in WiImington, Delaware. Information as to Hercules' principal manufacturing facilities and the industry segment served by each is presented below.\nAll principal properties are owned by Hercules except for the Company's corporate headquarters, which is leased to the Company.\nThe following are Hercules' major worldwide plants:\nChemical Specialties - Aberdeen, Scotland; Beringen, Belgium; Brunswick, Georgia; Burlington, Ontario, Canada; Busnago, Italy; Chicopee, Massachusetts; Franklin, Virginia; Gibbstown, New Jersey; Hattiesburg, Mississippi; Iberville, Quebec, Canada; Jefferson, Pennsylvania; Kalamazoo, Michigan; Kim Cheon, Korea; Lilla Edet, Sweden; Mexico City, Mexico; Middelburg, the Netherlands; Milwaukee, Wisconsin; Nant'ou, Taiwan; Oxford, Georgia; Pandaan, Indonesia; Paulinia, Brazil; Pendlebury, England; Portland, Oregon; St.-Jean, Quebec, Canada; Sandarne, Sweden; Savannah, Georgia; Sobernheim, Germany; Tampere, Finland; Tarragona, Spain; Traun, Austria; Uruapan, Mexico; Voreppe, France; Zwijndrecht, the Netherlands. Food & Functional Products - Alizay, France; Barneveld, the Netherlands; Doel, Belgium; Grossenbrode, Germany; Hopewell, Virginia; Kenedy, Texas; Lille Skensved, Denmark; Louisiana, Missouri; Middletown, Delaware; Parlin, New Jersey; Sao Paulo, Brazil; Tarragona, Spain; Zwijndrecht, the Netherlands.\nHercules plants and facilities, which are continually added to and modernized, are generally considered to be in good condition and adequate for business operations. From time to time Hercules discontinues operations at, or disposes of, facilities that have for one reason or another become unsuitable.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS: For discussion of legal proceedings see Note 23(d) to the Hercules Financial Statements.\nIn September 1993, Hercules and the U.S. Environmental Protection Agency (EPA) Region 1 reached an agreement in principle which, when effectuated, will settle the EPA's claims that Hercules violated its wastewater permit with the City of Chicopee and the federal pretreatment standard for industrial users of\npublicly owned treatment works at its Chicopee, MA facility. Hercules has signed a Consent Decree (the \"Decree\") based on this agreement requiring supplemental environmental projects (at a cost of approximately $375,000), compliance with permit limits in the future, and $250,000 in fines. Hercules expects the Decree to be finalized in the first quarter of 1995.\nOn February 17, 1994, Hercules received an Administrative Order and Notice of Civil Administrative Penalty Assessment (the \"Order\") for alleged violations of Hercules' water discharge (NPDES) permit at its Kenvil, New Jersey facility. The fine identified in the Order is $141,750. Although Hercules has requested an administrative hearing on this matter, negotiations with the State of New Jersey Department of Environmental Protection (\"NJDEP\") are ongoing. Hercules expects that the ultimate penalty amount to be paid to NJDEP under the terms of the Order will exceed $100,000.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS: No matter was submitted to a vote of security holders during the fourth quarter of 1994, through the solicitations of proxies or otherwise.\nEXECUTIVE OFFICERS OF THE REGISTRANT:\nThe name, age and current position of each executive officer (as defined by Securities and Exchange Commission rules) of the Company as of February 27, 1995, are listed below. Each of the officers, except for R. Keith Elliott, Herbert K. Pattberg, and Vikram Jog, have during the past five years, served in one or more executive capacities with the Company and\/or its affiliates. Mr. Elliott served with Engelhard Corporation as Vice President of Finance, Chief Financial Officer and Director from 1985 to 1988 and as Senior Vice President, Chief Financial Officer and Director from 1988 to 1990. Since joining Hercules in 1991, Mr. Elliott has held the positions of Sr. Vice President and Chief Financial Officer and most recently Executive Vice President and Chief Financial Officer. Herbert Pattberg was employed by Henkel KgaA for 22 years, most recently as group vice president, Oleochemicals. Mr. Pattberg joined Hercules in 1993 in his present position of president, S.A. Hercules Europe N.V., Brussels, Belgium. Vikram Jog has been with Hercules since 1992, as director, Corporate Reporting, director, Corporate Analysis and now his current position as Controller. Prior to joining Hercules, Mr. Jog was employed at Price Waterhouse, LLP and Coopers & Lybrand L.L.P. There are no family relationships among executive officers.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS:\nHercules Incorporated common stock is listed on the New York Stock Exchange (ticker symbol HPC), The Stock Exchange, London, and the Swiss Stock Exchange. It is also traded on the Philadelphia, Midwest, and Pacific Stock Exchanges.\nOn December 8, 1994, the company announced a three-for-one split of its common stock effected in the form of a 200% tax-free stock dividend distributed on January 30, 1995, to shareholders of record as of January 8, 1995. The information presented below reflects the three-for-one stock split.\nThe approximate number of holders of record of common stock ($25\/48 stated value) as of January 31, 1995, was 19,665.\nOn December 31, 1994, the closing price of the common stock was $38 1\/2.\nThe company has paid quarterly cash dividends as follows:\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA: A summary of selected financial data for Hercules for the years and year ends specified is set forth in the table below.\nPer-share amounts for all periods presented have been restated to give retroactive recognition to the three-for-one stock split distributed January 30, 1995.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:\nThis discussion should be read in connection with the information contained in the Consolidated Financial Statements and Notes thereto.\nIn March 1995, Hercules completed the sale of a substantial portion of its Aerospace segment to Alliant Techsystems Incorporated (Alliant), at a gain, for approximately $300 million in cash and 3.86 million shares of newly issued Alliant common stock. Included in the transaction were Aerospace units with combined revenues and operating profits of $657 million and $110 million, respectively in 1994, $688 million and $110 million, respectively in 1993, and $745 million and $62 million, respectively in 1992. Hercules now holds a 30% ownership interest in Alliant and two of the eight nonemployee seats on the Alliant Board of Directors. After funding the needs of the business, cash proceeds from the sale will be used primarily to repurchase Hercules shares. This transaction has no effect on the 1994 finanical statements; Hercules' 30% interest in Alliant will be accounted for on the equity method. Additionally during 1994, the company completed previously announced divestitures of its Packaging Films and Liquid Molding Resins business units in April 1994 and October 1994, respectively, for $173 million in cash, subject to post-closing adjustments. See Note 22 to the financial statements.\nOn December 8, 1994, the company announced a three-for-one split of its common stock effected in the form of a 200% tax-free stock dividend distributed on January 30, 1995, to shareholders of record as of January 9, 1995.\nRESULTS OF OPERATIONS All comparisons within the following discussion are to the previous year, unless otherwise stated.\nConsolidated net sales: Chemical businesses (Chemical Specialties and Food & Functional Products segments) sales increased 10% in 1994 on increased volumes and prices, reflecting improvement in western economies. However, the divestiture of the Packaging Films unit in April 1994 and reduced Aerospace revenues resulted in consolidated net sales remaining relatively flat. In 1993, sales declined approximately 3% mostly in the Aerospace and Chemical Specialties segments, reflecting continued cutbacks in defense budgets, weaker European currencies, and recessionary conditions in Europe.\nProfit from operations increased 36%, or $111 million, in 1994. Gross profit improved approximately $55 million, or 7%, and gross profit margins increased to 32% from 30% a year ago primarily on the strength of the chemical businesses. This gross profit improvement, resulting from the aforementioned volume and price increases, coupled with manufacturing cost improvements, was partially offset by the sale of Packaging Films and lower Aerospace margins. Selling, general and administrative (SG&A) expenses remained relatively flat while research and development (R&D) expenses declined. Cost savings from previous restructurings and the continuation of cost-management programs were offset by increased expense for employee incentive compensation programs (primarily related to performance above target levels) and increased manufacturing support and marketing expenses. The lower R&D expenses relate primarily to lower spending in the Aerospace segment and other divested businesses. Other operating expenses (Note 15 to the financial statements) declined $48 million. Lower 1994 environmental expenses and severance costs, coupled with 1993 restructuring charges related to the disposition of Liquid Molding Resins and a company-wide reduction in personnel, account for the favorable change. Environmental expenses declined from $35 million to $20 million as no significant new sites requiring recognition of environmental expenditures were identified. Environmental expenses are discussed further below and in Note 23 to the financial statements.\nIn 1993, profit from operations increased 26%, or $63 million. Contract changes and settlements related to the Titan IV solid rocket motor upgrade (SRMU) program in the Aerospace segment aggregated approximately $60 million. Increased gross margins were offset by higher R&D expenses. SG&A expenses were unchanged. Cost savings from previous restructurings and divestitures, and the continuation of cost-management programs, were offset by increased expenses for employee incentive compensation programs. Other operating expenses were also unchanged. Lower environmental expenses were offset by higher restructuring and other charges. Environmental costs were higher in 1992 compared with 1993 pursuant to a court decision giving wider latitude to the U.S. Environmental Protection Agency in selecting the remediation methods for cleanup at the Jacksonville, Arkansas, site (see Note 23 to the financial statements).\nChemical Specialties: Net sales increased 11%, or $105 million, in 1994. Higher pricing for resins in adhesives, chewing gum, construction, and graphic arts markets along with overall resins volume increases accounted for the sales improvement. In addition, strong polypropylene nonwoven fiber volume in the diaper coverstock market and increased volumes of rosin size and emulsion products due to higher utilization rates in the paper industry added to the sales increase. Profit from operations increased 32%, or $48 million, in 1994, primarily due to the increased revenues. Additionally, reduced manufacturing cost per unit derived from higher production volume added to the operating profit improvement.\nIn 1993, net sales declined by 5%, or $47 million. Weaker European currencies were a significant factor in the sales decline. While overall volumes were relatively stable, recessionary conditions in Europe resulted in pricing pressures. Profit from operations declined by 8%, or $13 million, in 1993, primarily due to the decline in revenues. Manufacturing cost improvements, lower raw material costs, and cost savings from the rationalization of worldwide administration and support functions were largely offset by asset writeoffs, higher incentive compensation, and R&D expenses.\nIn 1995, strong market demand is expected to continue in the Americas and Europe. Manufacturing cost improvements will continue to be important, especially as raw material prices continue to increase.\nFood & Functional Products: Net sales increased 9%, or $78 million, in 1994. Water-soluble polymer sales increased reflecting volume and price improvements due to strong demand in the paint, construction, and regulated markets. This improvement was partially offset by lower volumes in the oil and gas markets along with declines in coatings due to continued pricing pressures from foreign manufacturers on furniture coating applications. Additionally, volume improvements in food gums and printing product applications added to the revenue improvement. Profit from operations increased 31%, or $35 million, in 1994, primarily due to the aforementioned price and volume improvements. Additionally, lower manufacturing costs and higher yield from process improvements and better utilization of capacity added to the operating profit improvement.\nIn 1993, net sales were relatively flat. Although overall volumes increased, particularly in food gums, revenues were adversely affected by weaker European currencies, partially offset by higher water-soluble\npolymer prices. Profit from operations increased by 4%, or $4 million, principally due to higher yield from process improvements and better utilization of capacity.\nIn 1995, demand in major markets is expected to remain strong. Successful implementation of incremental capacity projects and manufacturing cost improvements will continue to be important.\nAerospace: Net sales declined 1%, or $11 million, in 1994. The sales decrease relates primarily to decline in production volumes, lower flight incentives, overall defense budget cuts, reduced number of new programs, program cancellations, and funding delays. Sales (and operating profit) were favorably affected by $48 millon related to a re-evaluation of the Titan IV SRMU contract deferral established in 1993. This resulted from diminished program risk coincident with progress in 1994 toward program completion and a second favorable contract modification in 1994, the final portion of which was negotiated in the fourth quarter. In 1993, Titan IV SRMU contract modifications and settlements had a $28 million favorable effect on sales. The basis for the deferral and subsequent adjustment thereof is based on management's evaluation and quantification of risks inherent in the program, prior difficulties with this contract, and the effects of contract modifications and restructurings. Additionally, 1994 sales (and operating profit) benefited $8 million from a one-time sale of a technology license. Profit from operations declined $7 million, or 7%, as a result of the following: lower profit related to the Titan IV SRMU contract deferrals and settlements ($48 million in 1994 compared with $60 million in 1993); manufacturing problems in the Ordnance business unit resulting in a $13 million decline in operating profits; lower flight incentives of $15 million; and lower margins in composite materials as a result of defense reductions. Partially offsetting these unfavorable effects were improved Titan operating performance, realization of past cost reduction actions, the one-time sale of technology, and improved performance in the tactical missiles business unit.\nNet sales declined by 5%, or $43 million, in 1993 principally because of overall defense budget cuts, funding delays, and program terminations and cancellations. Additionally, the 1992 results were favorably affected by ordnance replenishment sales resulting from the 1991 Gulf War. Despite the reduction in sales, profit from operations increased by 102%, or $52 million, as a result of the following: Titan IV SRMU contract modifications and settlements of $60 million ($28 million favorable effect on net sales); incentive and award fees (a normal part of successful government contracting) of $21 million; continued cost management; the phaseout of several loss programs; and favorable resolution of contractual issues. Offsetting these favorable effects were increased charges approximating $16 million, principally related to incentive compensation plans, severance costs, and the 1992 favorable settlement of a cost-allowability issue on Government contracts.\nBoth declines in new program opportunities and cancellations or stretch-outs of existing programs are possible in the continued budget-reduction environment of the Department of Defense. In addition, accelerating industry-wide excess capacity is likely to increase price competition. Although aggressive cost-reduction efforts will continue to be a focus, the occurrence of these events may adversely affect Aerospace segment results in the future.\nCorporate and other: Net sales declined $124 million in 1994 primarily due to the divestiture of the Packaging Films business in April 1994. Operating losses declined $35 million principally reflecting restructuring charges taken in 1993 coupled with lower environmental expenses.\nIn 1993, net sales were relatively flat. Operating losses declined by $20 million, reflecting lower losses in Liquid Molding Resins (before restructuring charges) and lower environmental expenses. The 1993 restructuring charges for planned asset dispositions did not vary significantly from 1992 charges related to rationalization of worldwide administration and support functions.\nEquity in income of affiliated companies increased by $2 million. The improvement reflects improved earnings in Tastemaker, the 50%-owned flavors joint venture, partially offset by the sale of Hercules' interest in several affiliates in 1993. In 1993, income increased $8 million reflecting improved Tastemaker earnings.\nInterest and debt expense decreased by 22% and 12% in 1994 and 1993, respectively, principally because of reduced levels of average debt and increased capitalized interest related to higher capital spending.\nOther income (expense) net, (see Note 17) showed an unfavorable change of $24 million in 1994. The decline primarily reflects 1993 favorable litigation settlements of $29 million. In 1993, other income (expense) net, decreased by $30 million. The decline principally reflects lower net gains on dispositions and lower interest income offset by favorable litigation settlements, lower foreign currency losses, and 1992 shutdown costs.\nThe provision for income taxes reflects effective tax rates of 33% in 1994 and 1993, and 37% in 1992. Both the 1994 and the 1993 rates have been favorably affected by research and experimentation tax credits of $4 million and $10 million, respectively. The 1993 rate was offset by a relatively high tax rate on the sale of Hercules' investment in a foreign affiliate. Without these unusual items, effective tax rates would have been 35% in both 1994 and 1993. See Note 18 to the financial statements for further information.\nFINANCIAL CONDITION\nLiquidity and financial resources: Net cash flow from operations was $298 million, $659 million, and $305 million in 1994, 1993, and 1992, respectively. The substantial increase in 1993 and subsequent decrease in 1994 were due principally to Titan IV SRMU recoveries in 1993 of approximately $262 million. Additionally, cash flow from operations in 1994 reflected higher tax payments associated with the Titan settlement and the sale of the Packaging Films business, while 1993 reflected cash proceeds from favorable litigation settlements. Also in 1994 working capital requirements were higher. Overall cash flow in 1994 was favorably affected by the proceeds from asset disposals of $202 million, primarily related to the sale of the Packaging Films business.\nIn the three-year period ended December 31, 1994, the company satisfied its cash requirements for capital expenditures, other investing activities, and dividends entirely from operating cash flows.\nIn addition to internally generated cash, various credit sources are available to the company. These include short-term lines of credit, of which $66 million was available at December 31, 1994, and revolving credit agreements with several banks providing $380 million ($280 million of which was available at December 31, 1994). In addition, the company has a shelf registration in the amount of $50 million available, subject to market conditions.\nWorking capital has increased in 1994 primarily reflecting the recognition of previously deferred revenue associated with the Titan IV SRMU of $48 million.\nWorking capital decreased in 1993 largely reflecting recoveries of accounts receivable, resulting from the restructuring of the Titan IV SRMU contract. In addition, water-soluble polymer inventories were managed downward.\nCapital expenditures increased in 1994 to $164 million from $150 million in both 1993 and 1992. The increase primarily reflects spending on a new methylcellulose facility in Doel, Belgium, which was completed in late 1994.\nCommitments and Capital Structure: Total capitalization (stockholders' equity plus total debt) of $1.8 billion at December 31, 1994, remained unchanged from December 31, 1993. Stockholders' equity declined $73 million while total debt increased $15 million. As a result, total debt as a percentage of capitalization increased to 28% from 26%.\nConcurrent with the three-for-one split of common stock, the Board also increased the quarterly dividend 12.5% to $.21 per share on a post-split basis. Also, at December 31, 1994, 12,774,600 shares of common stock on a post-split basis remained authorized for repurchase.\nFluctuations in interest and foreign currency exchange rates affect the company's financial position and results of operations. The company uses several strategies to actively hedge foreign currency exposure and minimize the effect of such fluctuations in reported earnings. (See \"Foreign Currency Translation\" and \"Financial Instruments and Hedging\" in the Summary of Significant Accounting Policies and Notes 17 and 20\nto the financial statements.) There are presently no significant restrictions on the remittance of funds generated by the company's operations outside the United States.\nHercules has been identified as a potentially responsible party (PRP) by Federal and State authorities for environmental cleanup at numerous sites. The estimated range of the reasonably possible costs of remediation is between $64 million and $244 million. The company does not anticipate that its financial condition will be materially affected by environmental remediation costs in excess of amounts accrued, although quarterly or annual operating results could be materially affected. Additional details regarding environmental matters are provided in Note 23 to the financial statements.\nEnvironmental remediation expenses for nonoperating and operating sites have been funded from internal sources of cash. Such expenses are not expected to have a significant effect on the company's ongoing liquidity. Environmental cleanup costs, including capital expenditures for ongoing operations, are a normal, recurring part of operations and are not significant in relation to total operating costs or cash flows.\nA quarterly dividend has been paid without interruption since 1913, the company's first year of operation. The quarterly dividend of $.56 per share, during 1994 (pre-split basis), represents a total payout for the year of $89 million.\nDuring 1994, about 43% of capital expenditures pertained to production-capacity increases, compared with 35% in 1993 and 30% in 1992. Most of the remainder relates to cost-savings projects, regulatory requirements, and research facilities. Capital expenditures are expected to approximate $146 million during 1995. This amount includes funds for continuation and\/or completion of ongoing projects as well as resins upgrade and modernization at Jefferson, Pennsylvania, and a new polypropylene fiber plant in Mexico.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND REQUIRED SUPPLEMENTARY DATA HERCULES INCORPORATED\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and the Board of Directors of Hercules Incorporated Wilmington, Delaware\nWe have audited the consolidated financial statements of Hercules Incorporated and subsidiary companies listed in the index on page 12 of this Form 10-K. 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 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 Hercules Incorporated and subsidiary companies as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flow for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Notes 14 and 18 to the financial statements, in 1993, the company changed its methods of accounting for postemployment benefits, postretirement benefits other than pensions, and income taxes.\nCoopers & Lybrand, L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania 19103 January 30, 1995\nHercules Incorporated\nThe accompanying accounting policies and notes are an integral part of the consolidated financial statements.\nHercules Incorporated\nThe accompanying accounting policies and notes are an integral part of the consolidated financial statements.\nHercules Incorporated\nThe accompanying accounting policies and notes are an integral part of the consolidated financial statements.\nHercules Incorporated\nThe accompanying accounting policies and notes are an integral part of the consolidated financial statements.\nHercules Incorporated SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of Hercules Incorporated and all wholly owned subsidiaries. Investments in affiliated companies owned 20% or more are accounted for on the equity method and, accordingly, consolidated income includes Hercules' share of their income.\nRECLASSIFICATIONS On December 8, 1994, the company's Board of Directors authorized a three-for-one stock split effected in the form of a 200% tax-free stock dividend distributed on January 30, 1995, to stockholders of record as of January 9, 1995. Stockholders' equity at December 31, 1994, has been adjusted to give retroactive effect to the stock split by reclassifying from retained earnings to common stock the par value of the additional shares arising from the split. In addition, all references in the financial statements to per-share amounts, number of shares at December 31, 1994, and stock option data of the company's common stock have been restated. Equity in income of affiliated companies is reported before applicable income taxes and included in income before income taxes and effect of changes in accounting principles. Previously, equity in income of affiliated companies was reported net of applicable income taxes and included in income before effect of changes in accounting principles. Management believes that the current presentation is more meaningful. The effect on income before income taxes is $25,605, $24,108, and $15,984 for the years ended December 31, 1994, December 31, 1993, and December 31, 1992, respectively. The effect on the provision for income taxes is $8,700, $6,881, and $8,601 for the comparable periods. Financial statements for 1993 and 1992 have been reclassified to conform with the 1994 presentation.\nLONG-TERM CONTRACTS Aerospace segment sales are principally under long-term contracts and include cost-reimbursement and fixed-price contracts. Sales under cost-reimbursement contracts are recognized as costs are incurred and include a proportion of the fees expected to be realized equal to the ratio of costs incurred to date to total estimated costs. Sales under fixed-price contracts are recognized as the actual cost of work performed relates to the estimate at completion. Cost or performance incentives, which are incorporated in certain contracts, are recognized when realization is assured and amounts can be reasonably estimated. Estimated amounts for contract changes and claims are included in contract sales only when realization is probable. Assumptions used for recording sales and earnings are adjusted in the period of change to reflect revisions in contract value and estimated costs. In the period in which it is determined that a loss will be incurred on a contract, the entire amount of the estimated loss is charged to income.\nENVIRONMENTAL EXPENDITURES Environmental expenditures that pertain to current operations or relate to future revenues are expensed or capitalized consistent with the company's capitalization policy. Expenditures that result from the remediation of an existing condition caused by past operations that do not contribute to current or future revenues are expensed. Liabilities are recognized for remedial activities when the cleanup is probable and the cost can be reasonably estimated.\nCASH AND CASH EQUIVALENTS Cash in excess of operating requirements is invested in short-term, income-producing instruments. In accordance with company policy, cash equivalents include commercial paper and other securities with original maturities of 90 days or less. The book value approximates fair value because of the short maturity of those instruments.\nINVENTORIES Inventories are stated at the lower of cost or market. Domestic inventories are valued predominantly on the last-in, first-out (LIFO) method. Foreign inventories and certain domestic inventories, which in the aggregate represent approximately 53% of total inventories, are valued principally on the average cost method. Inventoried costs relating to long-term contracts are stated at actual production cost.\nPROPERTY AND DEPRECIATION Property, plant and equipment are stated at cost. The company changed to the straight-line method of depreciation, effective January 1, 1991, for newly acquired processing facilities and equipment. Assets acquired before the effective date of the change continue to be depreciated principally by accelerated methods. The company believes that straight-line depreciation provides for a better matching of costs and revenues over the lives of the assets. Maintenance, repairs, and minor renewals are charged to income; major renewals and betterments are capitalized. Upon normal retirement or replacement, the cost of property (less proceeds of sale or salvage) is charged to income.\nINCOME TAXES Income taxes for 1994 and 1993 are determined in accordance with Statement of Financial Accounting Standards (SFAS) No. 109, which requires an asset and liability approach for financial accounting and reporting of income taxes. Changes in enacted tax rates are reflected in the tax provision as they occur. A valuation allowance is recorded to reduce deferred tax assets when realization of a tax benefit is unlikely. For years prior to 1993, the provision for income taxes was determined under Accounting Principles Board Opinion 11 (APB 11), whereby the income tax provision was calculated under the deferred method. The company provides taxes on undistributed earnings of subsidiaries and affiliates included in consolidated retained earnings to the extent such earnings are planned to be remitted and not reinvested permanently.\nFOREIGN CURRENCY TRANSLATION With the exception of operations in countries with highly inflationary economies, the financial statements of Hercules' non-U.S. entities are translated into U.S. dollars using current rates of exchange, with gains or losses resulting from translation included in the foreign currency translation adjustment account in the stockholders' equity section of the balance sheet. The related allocation for income taxes is not significant. For foreign operations in countries with highly inflationary economies, financial statements are translated at either current or historical exchange rates, as appropriate. These currency adjustments, along with gains and losses on foreign currency transactions (denominated in currencies other than local currency), are reflected in net income. The translation loss of the inflationary component of interest income related to holding marketable securities in highly inflationary economies is classified as a reduction in interest income.\nFINANCIAL INSTRUMENTS AND HEDGING Derivative financial instruments are used to hedge risk caused by fluctuating currency and interest rates. The company enters into forward exchange and foreign currency option contracts and currency swaps to hedge foreign currency exposure. Realized and unrealized gains and losses on these contracts are included in net income, except for gains and losses on contracts to hedge specific foreign currency commitments, which are deferred and accounted for as part of the transaction. Gains or losses on contracts used to hedge the value of investments in certain foreign subsidiaries are included in the foreign currency translation adjustment account. The company does not hold or issue financial instruments for trading purposes. In addition, the company uses interest rate swap agreements to manage interest costs and risks associated with changing interest rates. The differential to be paid or received is accrued as interest rates change and is recognized in interest expense over the life of the agreements. Counterparties to the forward exchange, currency swap and interest rate swap contracts are major financial institutions. Credit loss from counterparty nonperformance is not anticipated.\nHercules Incorporated NOTES TO FINANCIAL STATEMENTS (Dollars in thousands, except per share)\n1. ACCOUNTS RECEIVABLE, NET\nTrade accounts receivable include amounts under long-term contracts and subcontracts (principally with the U.S. Government or U.S. Government contractors) of $171,705 at December 31, 1994, and $196,465 at December 31, 1993, net of progress payments of $297,200 and $373,132, respectively. Included in these amounts are unbilled accounts receivable (work in progress and claims) of $94,369 and $113,282, respectively, representing recoverable costs and accrued profits, which will be billed in accordance with contract terms and delivery schedules. Receivables that will not be collected within one year are $31,496 at December 31, 1994, and $15,144 at December 31, 1993. Long-term U.S. Government contracts and subcontracts are subject to termination by the Government; however, in these circumstances, an equitable settlement of work performed is negotiated unless in the unlikely event it is determined to be a termination for default. Additionally, certain contracts are subject to final cost submissions and rate settlements. At December 31, 1994, there were no significant receivables subject to litigation. Additionally at December 31, 1994, net accounts receivable from customers located in the United States, Europe and other regions were $396,764, $160,798, and $31,289, respectively.\n2. INVENTORIES\nThe components of inventories are as follows:\nInventories valued on the LIFO method were lower than if valued under the average cost method, which approximates current cost by $34,171 and $35,273 at December 31, 1994 and 1993, respectively.\n3. INVESTMENTS\nTotal equity investments in affiliated companies were $133,810 and $142,917 at December 31, 1994 and 1993, respectively. Dividends received from affiliated companies were $11,281 in 1994, $18,381 in 1993, and $10,222 in 1992.\nOther investments, at cost or less, were $90,950 and $89,160, for the years ended December 31, 1994 and 1993, respectively. Included in these amounts are noncurrent marketable securities aggregating $53,242 and $52,264 for the corresponding years. The company's investments in equity and debt securities covered under the scope of Statement of Financial Accounting Standards (SFAS), No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" are classified as \"available for sale\". The value of these investments, based on market quotes, approximates book values.\n4. CONTRACT DEFERRALS AND PROVISIONS\nHercules entered into a Supplemental Agreement with the Titan IV SRMU prime contractor effective October 15, 1993. Contemporaneously with this agreement, which called for contract changes related to production, delivery, and launch schedules, the prime contractor entered into a Supplemental Agreement to its Titan IV\nprime contract with the Air Force, which was also effective October 15, 1993. As a result, Hercules dismissed its lawsuit against the prime contractor and received payments of $215,000 in November 1993, primarily for amortized investment in development and tooling costs and increased risk associated with the contract changes. Additional agreements between the parties provided for Hercules to receive payments for settlements of contract claims aggregating $84,000, of which $21,700 and $47,000 were received for 1994 and 1993, respectively. Estimated costs at completion for the Titan IV SRMU program and other contracts are reviewed quarterly and consider the progress of the contracts, changes in contract terms and conditions, and other contingencies. Year-end deferrals and provisions are considered adequate to complete the contracts and amounted to $63,097 and $118,321 at December 31, 1994 and 1993, respectively. The decrease in the deferrals and provisions principally reflects diminished program risk relating to the Titan IV SRMU program coincident with 1994 progress toward program completion and a favorable contract modification, the final portion of which was negotiated in the fourth quarter of 1994.\n5. SHORT-TERM DEBT\nA summary of short-term debt follows:\nCommercial paper is issued or renewed for varying periods, with interest at prevailing market rates. Bank borrowings represent primarily foreign overdraft facilities and short-term lines of credit, which are generally payable on demand with interest at various rates. Book values of commercial paper and bank borrowings approximate market value because of their short maturity period. At December 31, 1994, Hercules had $66,376 of unused lines of credit that may be drawn as needed, with interest at a negotiated spread over lenders' cost of funds. Lines of credit in use at December 31, 1994, were $28,783.\n6. LONG-TERM DEBT\nA summary of long-term debt follows:\n(a) The term loans are with several banks and bear interest at various rates at an agreed-upon spread over lenders' cost of funds.\n(b) The subordinated debentures are convertible into common stock at $11.67 per share and are redeemable at the option of the company at varying rates.\n(c) Par value of $125,000 issued June 1993.\n(d) The subordinated debentures are convertible into common stock at $14.90 per share and are redeemable at the option of the company at varying rates. Beginning in 1996, the debentures require an annual sinking fund of $5,000.\n(e) Debentures were redeemed in first quarter 1994. In December 1993, the company notified the holders of its intention to redeem the debentures in January 1994. An extraordinary charge of $3,578 (net of a tax benefit of $2,288), or $.03 per share, was recorded, principally for redemption premiums and unamortized issuance costs. 1993 \"Current maturities of long-term debt\" included these debentures.\n(f) Uncollateralized bank borrowings with average maturities of 400 days, with interest at a negotiated spread over lenders' cost of funds.\nThe company has entered into a revolving credit and competitive advance facility agreement with various banks providing for commitments that terminate in 1995 and 1998. Under the agreement, Hercules may borrow up to a total of $380,000 (of which $280,000 was available at December 31, 1994) at an agreed-upon spread over London Interbank Offered Rate (LIBOR). This agreement requires the maintenance of certain financial ratios.\nLong-term debt maturities during the next five years are $52,747 in 1995, $78,067 in 1996, $1,763 in 1997, $895 in 1998, and $4,414 in 1999.\n7. SERIES PREFERRED STOCK\nThe series preferred stock is without par value and is issuable in series. There are 2,000,000 shares authorized for issuance, of which none have been issued.\n8. COMMON STOCK\nHercules common stock has a stated value of $25\/48, and 150,000,000 shares are authorized for issuance. At December 31, 1994, a total of 18,020,784 shares were reserved for issuance for the following purposes: 879,999 shares for sales to the Savings Plan Trustee; 8,102,250 shares for the exercise of awards under the Stock Option Plan; 2,527,713 shares for awards under incentive compensation plans; 4,854,609 shares for conversion of debentures and notes; and 1,656,213 shares for employee stock purchases. Under the company's stock repurchase program started in 1991 through the year ended December 31, 1994, the Board of Directors had authorized the repurchase of up to 47,850,000 shares of company common stock, 4,350,000 shares of which was intended to satisfy requirements of various employee benefit programs. During this period, a total of 35,075,400 shares of common stock was purchased in the open market at an average price of $26.16 per share.\n9. PREFERRED STOCK PURCHASE RIGHTS\nEach outstanding share of common stock carries one preferred stock purchase right. The right may be exercised, under certain conditions, to purchase one three-thousandth of a share of new Series A Junior Participating Preferred Stock (no par) for $180. The rights are not exercisable or transferable apart from the common stock until 10 days after a public announcement that a person or group has acquired 20% or more, or intends to commence a tender offer for 30% or more, of the common stock of Hercules. The rights, which expire on July 13, 1995, do not have voting rights, are subject to adjustment to prevent dilution, and may be redeemed (under certain conditions) by the company at a price of $.007 per right at any time prior to an\nacquisition of 20% or more of the company's common stock, and, if no change of control of the company's Board of Directors has occurred, for 10 days thereafter. In the event that the company is acquired in a merger, or other business combination transaction of 50% or more of its consolidated assets or earning power are sold, each right will entitle its holder to purchase from the surviving or acquiring corporation, for the exercise price, common stock having a market value of twice the exercise price of the right. Alternatively, if a 20% holder were to acquire the company by means of a reverse merger in which the company and its stock survive, or were to engage in certain \"self-dealing\" transactions, each right not owned by the 20% holder would become exercisable for the number of common shares which, at that time, would have a market value of two times the exercise price of the right. At December 31, 1994, 150,000 shares of Series A Junior Participating Preferred Stock were reserved for issuance at certain terms upon the exercise of the Preferred Stock Purchase Rights. The voting, dividend, and liquidation rights of each three-thousandth of a share are generally equivalent to rights enjoyed by one share of common stock, subject to certain minimum preferences.\n10. STOCK-BASED INCENTIVE PLANS\nThe incentive compensation plans provide for the grant of stock options and the award of common stock and other market-based units to certain key employees and nonemployee directors. Shares of common stock awarded under these plans normally are either restricted stock (shares subject to restrictions on transfer and subject to risk of forfeiture until earned by continued employment) or performance shares (shares subject to the same restrictions and risk of forfeiture, whose ultimate distribution is contingent on performance as measured against predetermined objectives over a specified period of time). During the restriction period, award holders have the rights of stockholders, including the right to vote and receive cash dividends, except for the right to transfer ownership. Shares are forfeited and revert to the company as a result of employment termination, except in the case of death, disability, retirement, or other specified events. The number of awarded shares outstanding was 3,269,250, 2,863,341, and 1,420,095 at December 31, 1994, 1993, and 1992, respectively. The cost of stock awards and other market-based units, which is charged to income over the period during which the restrictions lapse or over the performance period, amounted to $41,256, $36,606, and $12,304 during 1994, 1993, and 1992, respectively. At December 31, 1994, there were 2,527,713 shares of common stock available for award under the plans. Under the company's stock option plans, options are granted at the market price on the date of grant, are exercisable at various periods from one to five years after date of grant, and expire 10 years after date of grant. A summary of the status of the company's stock option plans for the three years ended December 31, 1994, follows:\nOptions exercisable at December 31, 1994, 1993, and 1992 were 2,242,950, 1,834,878, and 2,461,095, respectively.\n11. EMPLOYEE STOCK PURCHASE PLAN\nIn April 1993, the company approved a qualified, noncompensatory, Employee Stock Purchase Plan, which allows eligible employees to acquire shares of common stock through systematic payroll deductions. The plan consists of three-month subscription periods starting on July 1, 1993. The purchase price for each share is 85% of the lower of the fair market value of the common stock on either the first or last day of that subscription period. Purchases are limited from 2% to 15% of an employee's base salary each pay period, subject to certain limitations. Currently, 1,800,000 shares of Hercules common stock are registered for offer and sale under the plan. Shares issued at December 31, 1994, and December 31, 1993, were 143,787 and 36,288, respectively.\n12. ADDITIONAL BALANCE SHEET DETAIL\n13. PENSION BENEFITS\nHercules and its consolidated subsidiaries maintain various defined benefit pension plans covering substantially all employees. Benefits for the majority of plans are based on average final pay and years of service, while benefits for certain represented locations are based on stated amounts and years of service. The company's funding policy, consistent with statutory requirements and tax considerations, is based on actuarial computations utilizing the Entry Age Normal method of calculation.\nNet periodic pension cost includes the following components:\nThe company's pension plans have assets in excess of the accumulated benefit obligation. Plan assets include equity and fixed income securities and real estate. The following table presents a reconciliation of the funded status of the pension plans to prepaid pension expense.\nSignificant assumptions used in determining pension obligations and the related pension expense include a weighted-average discount rate of 8.6% at December 31, 1994, and 7.25% at December 31, 1993, and an assumed rate of increase in future compensation of 4.5% at both dates. The 1994 discount rate was changed from 7.25% to 8.6% on October 1, 1994, based upon an interim valuation performed by the company's actuaries due to the pending sale of the Aerospace business. The increase in the discount rate reflects the significant increase in interest rates in 1994. The expected long-term rate of return on plan assets was 9.0% for 1994 and 1993. The change in assumptions noted above decreased the accumulated benefit obligation and the projected benefit obligation by approximately $142,600 and $186,300 respectively.\n14. OTHER POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS\nHercules provides certain defined benefit postretirement health care and life insurance benefits to retired employees. Substantially all employees are covered and become eligible for these benefits upon satisfying the appropriate age and service requirements necessary for receipt of these benefits. Effective January 1, 1993, Hercules adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions.\" SFAS No. 106 requires the recognition of these benefit costs on an accrual basis. Prior to January 1, 1993, the costs of retiree health care and life insurance were expensed as incurred. The effect of adopting this accounting standard was recognized immediately as the effect of a change in accounting principle and resulted in a charge of $187,860 (net of a tax benefit of $115,140) or $1.46 per share against 1993 net income. This represented the accumulated postretirement benefit obligation existing at January 1, 1993. This amount excluded approximately $60,000 related to employees of Government-owned, contractor-operated plants. Based on opinion of company counsel, management believes that postretirement benefits for these employees are the obligation of the United States Government. The new accounting standard would have increased periodic benefit expenses; however, modifications to the Hercules benefit plans announced in February 1993 have more than offset the increase. The following provides a reconciliation of the accumulated postretirement benefit obligation (APBO) to the liabilities reflected in the company's balance sheet at December 31, 1994 and 1993:\nThe postretirement plans are contributory. In August 1993, the company established a Voluntary Employees' Beneficiary Association (VEBA) Trust and contributed $10,000 to fund postretirement benefits for eligible employees. Benefits for retirees not eligible under the Trust continue to be paid by the company. The company will periodically seek reimbursement from the Trust for claims paid by the company that are eligible for reimbursement. During 1994, $2,004 in reimbursements was obtained from the Trust. The plan assets are invested primarily in equity funds. The weighted average of the expected long-term rate of return on plan assets is 9%. In January 1994, Hercules implemented managed care and managed care pharmacy programs for retirees. These programs reduced the accumulated postretirement benefit obligation by $8,205. In February 1993, the company modified its health care benefits. The changes provided for increased cost-sharing by current and future retirees. The plan modifications reduced the accumulated postretirement benefit obligation by $61,832. These amounts are being amortized over the average remaining service lives of the company's active employees. In addition, the components of net periodic benefit costs have been reduced by $9,950 and $8,600 in 1994 and 1993, respectively, as a result of these changes. The net periodic postretirement benefit costs for 1994 and 1993 are as follows:\nIn 1992, the annual costs of these benefits were expensed as paid and totaled $22,550. The weighted-average discount rate used to estimate the accumulated postretirement benefit obligation was 8.6% and 7.25% at December 31, 1994 and 1993, respectively. The 1994 discount rate was changed from 7.25% to 8.6% on October 1, 1994 based upon an interim valuation performed by the company's actuaries due to the pending sale of the Aerospace business. The increase in the discount rate reflects the significant increase in interest rates in 1994. The assumed health care cost trend rate at December 31, 1994, was 9% grading down to 5% in 1998 and thereafter. The assumed health care cost trend rate at December 31, 1993, was 10% grading down to 5% in 1998 and thereafter. At December 31, 1994 and 1993, the assumed compensation increases for life insurance were based on graded scales averaging 4.4% for salaried employees and 3.4% for wage employees. The change in the assumptions noted above did not have a material effect on the accumulated postretirement benefit obligation. A one-percentage-point increase in the assumed health care cost trend rate would have increased the accumulated postretirement benefit obligation as of December 31, 1994, and the net periodic postretirement benefit cost for 1994 by $17,000 and $1,800, respectively, and $19,500 and $1,800, respectively, as of December 31, 1993. Hercules provides certain disability and workers' compensation benefits to former or inactive employees. Effective January 1, 1993, Hercules adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\". This statement requires recognition of these benefits on an accrual basis. Prior to January 1, 1993,\ndisability benefits and workers' compensation benefits were expensed as claims were reported. The company's accrued liability under SFAS No. 112 at December 31, 1994, and December 31, 1993, was approximately $19,000. The effect of adopting SFAS No. 112 was recognized immediately in 1993 as the effect of a change in accounting principle and resulted in a charge of $12,400 (net of a tax benefit of $7,600) or $.10 per share against 1993 net income. Adoption of this standard did not materially affect 1993 results of operations.\n15. OTHER OPERATING EXPENSES, NET\nOther operating expenses, net, include environmental cleanup costs, principally for nonoperating sites of $20,366 in 1994, $34,744 in 1993, and $45,152 in 1992. Other operating expenses, net, in 1994 also included employee separation costs from a corporate-wide early retirement incentive option and involuntary terminations and writeoffs of $18,738. Net restructuring and other writeoffs in 1993 were $52,168 including $25,000 of estimated operating losses, shutdown costs and loss on sale related to the disposition of the Liquid Molding Resins business, $20,654 of severance costs related to involuntary terminations, and $4,600 of asset writedowns associated with an idle manufacturing facility. 1992 restructuring charges and other writeoffs of $44,998 were principally severance costs including rationalization of worldwide administrative and support functions.\n16. INTEREST AND DEBT EXPENSE\nInterest and debt costs are summarized as follows:\n17. OTHER INCOME (EXPENSE), NET\nOther income (expense), net, consists of the following:\nNet gains on dispositions primarily reflect the sale of the company's interests in affiliated companies. Gain from litigation settlements in 1993 substantially relates to businesses acquired in the 1980s. Investment writeoffs in 1992 primarily reflect the termination of a joint venture to supply paraxylene for an exclusive purchase and resale contract. Owing to market conditions, this contract was in a loss position and the termination caused immediate recognition of the estimated losses associated with the remaining obligations under the contract. Miscellaneous expense, net, includes net foreign currency gains (losses) of $(8,557), $(1,132) and $(8,055) in 1994, 1993, and 1992, respectively.\n18. INCOME TAXES\nEffective January 1, 1993, Hercules adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" (See \"Income Taxes\" under Summary of Significant Accounting Policies.) Deferred tax balances at January 1, 1993, were remeasured in accordance with SFAS No. 109, resulting in a charge of $37,958, or $.29 per share, against net income. The charge primarily represents the effect of adjusting deferred taxes to reflect recognition of foreign tax credits on a tax rather than book basis. The effect of adopting this standard was recognized immediately as the effect of a change in accounting principle and financial statements for years prior to 1993 were not restated. Information shown below for those prior years was determined under the provisions of Accounting Principles Board (APB) Opinion 11.\nThe domestic and foreign components of income before taxes on income are presented below.\nA summary of the components of the tax provision follows:\nIncluded in the SFAS No. 109 adoption at January 1, 1993, were valuation allowances of $35,629. The decrease in the valuation allowance in 1994 and 1993 relates principally to utilization of foreign tax credit carryforwards. Under the provisions of APB 11, deferred taxes for 1992 relate to the following timing differences between financial and taxable income:\nIn the fourth quarter of 1993, based upon clarification of certain tax law provisions concerning research and experimentation (R&E) credits, the company recognized an R&E credit of $9,700. Upon further clarification, the company recognized an additional $4,000 of R&E credit in 1994. The tax credit relates to research and development expenditures incurred on certain Government contracts. Additional amounts of R&E credit may be recorded in future years as clarifications of the R&E credit provisions continue to occur. A reconciliation of the U.S. statutory income tax rate to the effective rate (excluding extraordinary item and effect of changes in accounting principles) follows:\nThe undistributed earnings of subsidiaries and affiliates on which no provision for foreign withholding or U.S. income taxes has been made amounted to $246,833 at December 31, 1994. U.S. and foreign income taxes that would be payable if such earnings were distributed may be lower than the amount computed at the U.S. statutory rate because of the availability of tax credits.\n19. EARNINGS PER SHARE\nPrimary earnings per share are calculated on the basis of the average number of common and common equivalent shares, using net income adjusted to reflect the elimination of interest expense, net of taxes, on the 6.5% convertible debentures. Shares (post- split basis) and interest expense used in the calculation are as follows:\nFully diluted earnings per share, which additionally assumes conversion of the 8% convertible subordinated debentures, are not materially different from primary earnings per share or are anti-dilutive. Equivalent shares are increased by an additional 4,900,548 in 1994, 6,843,036 in 1993, and 7,711,332 in 1992, and net income is further adjusted to eliminate interest expense, net of taxes, of $3,855 for 1994, $5,287 for 1993, and $6,066 for 1992.\n20. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT\na. Notional Amounts and Credit Exposure of Derivatives The notional amounts of derivatives summarized below do not represent amounts exchanged by the parties and, thus, are not a measure of the exposure of the company through its use of derivatives. The amounts exchanged are calculated on the basis of the notional amounts and the other terms of the derivatives, which relate to interest rates or exchange rates. b. Interest Rate Risk Management\nIn April 1992, the company entered into a three-year amortizing interest rate swap agreement whereby 5.52% per annum fixed-rate debt has been effectively converted to floating-rate debt. Beginning in March 1993, the company entered into another agreement effectively converting floating-rate debt into debt with a fixed rate of 7.52% per annum. In March 1994, the company entered into two additional agreements effectively converting floating-rate debt into debt with a fixed rate of 4.92% and 4.923% per annum, respectively. For the years 1994 and 1993, these contracts resulted in an (increase) reduction in the effective interest rate of (.6%) and 0.7% per annum, respectively, on the weighted-average notional principal amounts outstanding. The aggregate notional principal amounts at the end of the corresponding periods were $160,000 and $150,000, respectively. These agreements mature through the first quarter of 1996.\nThe following table indicates the types of swaps used and their weighted-average interest rates.\nc. Foreign Exchange Risk Management The company enters into forward exchange contracts and purchased options to hedge certain firm purchase and sale commitments denominated in foreign currencies (principally Danish kroner, Dutch guilder, Belgian franc, British pound sterling, and German mark). Some of the contracts involve the exchange of two foreign currencies, according to local needs in foreign subsidiaries. The term of the currency derivatives is rarely more than one year. The purpose of the company's foreign currency hedging activities is to protect the company from the risk that the eventual net cash flows resulting from the sale of products to foreign customers and purchases from foreign suppliers will be adversely affected by changes in exchange rates. Foreign exchange contracts do not expose the company to accounting risk due to exchange rate movements as gains and losses on the contracts offset gains and losses on the underlying exposures being hedged. At December 31, 1994 and 1993, the company had outstanding forward exchange contracts to purchase foreign currencies aggregating $50,946 and $24,251 and to sell foreign currencies aggregating $283,782 and $271,869, respectively. Non-U.S. dollar cross-currency trades aggregated $401,756 and $258,530, respectively. The forward exchange contracts mature during 1995. No currency swap agreements were outstanding at December 31, 1994 or 1993. Additionally, there were no deferrals of gains or losses on forward exchange contracts at December 31, 1994. d. Fair Values The following table presents the carrying amounts and fair values of the company's financial instruments at December 31, 1994 and 1993.\n*The carrying amount represents the net unrealized gain (loss) or net interest receivable (payable) associated with the contracts at the end of the period.\nFAIR VALUE DISCLOSURES The following methods and assumptions were used to estimate the fair value of each class of financial instrument: Investment securities Valued at quoted market prices. Long-term debt Present value of expected cash flows related to existing borrowings discounted at rates currently available to the company for long- term borrowings with similar terms and remaining maturities. Foreign exchange contracts Year-end exchange rates. Interest rate swap contracts Bank or market quotes or discounted cash flows using year-end interest rates.\n21. PENDING DIVESTITUTE\nIn March 1995, Hercules expects to complete the sale of a substantial portion of its Aerospace segment to Alliant Techsystems Incorporated (Alliant), at a gain, for approximately $300 million in cash and 3.86 million shares of newly issued Alliant common stock. Net sales for the business units to be divested were $657,393, $687,955 and $745,600 for the years ended December 31, 1994, 1993 and 1992, respectively. Operating profits were $110,427, $110,224 and $61,709 for the corresponding periods.\n22. DIVESTITURES\nDuring 1994, the company completed the divestiture of its Packaging Films and Liquid Molding Resins business units for $172,600 in cash, subject to post-closing adjustments. The effect of the divestitures on the results of operations is not significant. Net sales of these units were $46,825, $164,229, and $170,353 for the years ended December 31, 1994, 1993, and 1992. Operating losses for the corresponding periods were $0, $27,816 (including restructuring charges of $25,000), and $11,900.\n23. COMMITMENTS AND CONTINGENCIES\n(A) LEASES: Hercules has certain operating leases, including office space and transportation and data processing equipment, expiring at various dates. Rental expense relating to these leases was $40,579 in 1994, $46,005 in 1993, and $48,090 in 1992. At December 31, 1994, minimum rental payments under non-cancelable leases aggregated $336,666 with subleases of $9,616. A significant portion of the lease payments relate to a long-term operating lease for corporate office facilities. The net minimum payments over the next five years are $25,345 in 1995, $17,028 in 1996, $15,715 in 1997, $18,207 in 1998, and $20,257 in 1999.\n(B) CAPITAL EXPENDITURES: Capital expenditures are expected to approximate $146,000 in 1995.\n(C) ENVIRONMENTAL: Hercules has been identified as a potentially responsible party (PRP) by U.S. Federal and State authorities for environmental cleanup at numerous sites. The estimated range of the reasonably possible costs of remediation is between $64,000 and $244,000. The actual costs will depend upon numerous factors, including the number of parties found liable at each environmental site and their ability to pay, the actual method of remediation, outcome of negotiations with regulatory authorities, outcome of litigation, changes in environmental laws and regulations, technological developments, and the years of remedial activity required, which could range up to 30 years. Hercules becomes aware of sites in which it may be but has not yet been named a PRP principally through its knowledge of investigation of sites by the U.S. Environmental Protection Agency (EPA) or other Government agency or through correspondence with previously named PRPs requesting information of Hercules' activities at sites under investigation. Hercules brought suit in late 1992 against its insurance carriers for past and future costs for remediation of certain environmental sites. Hercules has not included any insurance recovery in the estimates set forth above.\nHercules has established procedures for identification of environmental issues at Hercules plant sites. Hercules designates an environmental coordinator at all operating facilities. Environmental coordinators are familiar with environmental laws and regulations and are a resource for identification of environmental issues. Hercules also has an environmental audit program which is designed to identify environmental issues at operating plant sites. Through these programs, Hercules identifies potential environmental, regulatory, and remedial issues. Litigation over liability at Jacksonville, Arkansas, the most significant site, has been pending since 1980. As a result of a pretrial court ruling in October 1993, Hercules has been held jointly and severally liable for costs incurred and for future remediation costs at the Jacksonville site by the District Court, Eastern District of Arkansas (the Court). Appeal of the Court's ruling with respect to the finding of Hercules being jointly and severally liable will be filed promptly after issuance of a final court order. In mid-November 1993, an advisory jury found Uniroyal Chemical, Ltd., liable for the Jacksonville site, but also found that Uniroyal had proven a reasonable basis for allocation of responsibility. That same advisory jury found that Standard Chlorine of Delaware is not a liable party for the Jacksonville site. The Court may take the jury's findings into consideration when reaching its decision regarding these parties. The Court has not entered its ruling on the liability of Uniroyal and Standard Chlorine. Appeals of the Court's expected rulings with respect to Uniroyal and Standard Chlorine are probable. Other defendants in this litigation have either settled with the Government or, in the case of the Department of Defense, have not been held liable. Hercules appealed the Court's order finding the Department of Defense not liable. On January 31, 1995 the 8th Circuit Court of Appeals upheld the Court's order holding the Department of Defense not liable. Hercules intends to petition the U.S. Supreme Court on this ruling. Hercules' potential costs for remediation of the Jacksonville site are presently estimated between $23,000 and $149,000. Hercules' potential costs are based on its assessment of potential liability, the level of participation by other PRPs and upon current estimates of the costs to remediate the Jacksonville site. The costs to remediate will vary as Records of Decision are issued on each operable unit of the site and as remediation methods are approved by the EPA. At December 31, 1994, the accrued liability for environmental remediation represents management's best estimate of the probable and reasonably estimable costs related to environmental remediation. The extent of liability is evaluated quarterly. The measurement of the liability is evaluated quarterly based on currently available information, including the progress of remedial investigation at each site and the current status of negotiations with regulatory authorities regarding the method and extent of apportionment of costs among other PRPs. The company does not anticipate that its financial condition will be materially affected by environmental remediation costs in excess of amounts accrued, although quarterly or annual operating results could be materially affected.\n(D) LITIGATION:\nHercules is a defendant in numerous lawsuits that arise out of, and are incidental to, the conduct of its business. In these legal proceedings, no director, officer, or affiliate is a party or a named defendant. These suits concern issues such as product liability, contract disputes, labor-related matters, patent infringement, environmental proceedings, and personal injury matters. Hercules also is a defendant in one Federal Administrative Law Proceeding and two Qui Tam (\"Whistle Blower\") lawsuits brought by former employees. Under the terms of the agreements relating to the sale of a substantial portion of the Aerospace segment, all litigation and legal disputes arising in the ordinary course of the operation of the business sold will be assumed by Alliant Techsystems Inc. except for a few specific lawsuits and disputes including the two Qui Tam lawsuits referred to above. Although Hercules will remain responsible for the Qui Tam actions, Alliant has agreed to reimburse Hercules for a portion of all litigation costs incurred, and a portion of damages, if any, awarded in these suits. The Qui Tam suits were brought by former employees who had been terminated by Hercules in Reduction-in-Force programs. The first Qui Tam suit involves allegations relating to submission of false claims and records, delivery of defective products, and a deficient quality control program. The second Qui Tam suit involves allegations of mischarging of work performed under Government contracts, misuse of Government equipment, other acts of financial mismanagement and wrongful termination claims. The subject matter of both of these Qui Tam suits was investigated by the U.S. Department of Justice. As a result of these investigations, the Government declined to intervene, i.e., prosecute Hercules in either of these suits.\nHercules denies the allegations made in these suits and intends to vigorously defend these allegations in Court. While it is not feasible to predict the outcome of all pending suits and claims, management does not anticipate that the ultimate resolution of these matters will have a material effect upon the consolidated financial position of Hercules, although the resolution of any of the matters during a specific period could have a material effect on the quarterly or annual operating results for that period.\n24. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA (Dollars in millions)\nIn the Operations by Industry Segment and Geographic Area table that follows, sales to the U.S. Government and other customers under Government contracts, principally by the Aerospace segment, aggregate $602, $633, and $696 in 1994, 1993 and 1992, respectively. Intersegment sales are eliminated and are insignificant. Operating results and other financial data are prepared on an \"entity basis,\" which means that net sales, profit (loss) from operations, and assets of a legal entity are included in the geographic area where the legal entity is located. For example, a direct sale from the United States to an unaffiliated customer in Europe is reported as a U.S. sale. Interarea sales between Hercules locations are made at transfer prices that approximate market price and have been eliminated from consolidated net sales. Operating profit for the individual area does not include the full profitability generated by sales of Hercules products imported from other geographic areas. Identifiable assets include net trade accounts receivable, inventories, and net property, plant and equipment. Consolidated foreign subsidiaries had net assets (including translation adjustment) of $574 at December 31, 1994, $520 at December 31, 1993, and $552 at December 31, 1992, and net income excluding the extraordinary item and effect of changes in accounting principles of $117 in 1994, $95 in 1993, and $91 in 1992. Direct export sales from the United States to unaffiliated customers were $286, $256, and $260 for 1994, 1993, and 1992, respectively.\n24. OPERATIONS BY INDUSTRY SEGMENT AND GEOGRAPHIC AREA (Dollars in millions) continued\n(1) Includes worldwide rationalization of $23, principally related to administration and support functions that supplied services to the Chemical Specialties and Food & Functional Products segments.\nHercules Incorporated Summary of Quarterly Results (Unaudited) (Dollars in millions, except per share)\nPrincipal Consolidated, Wholly Owned Subsidiaries (Directly or Indirectly)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE: Not Applicable.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT: Information regarding directors and nominees for directors of the Company is included under the caption entitled \"Election of Three Directors (Proxy Item No. 1)\" on pages 3 through 4 of the Proxy Statement and is incorporated herein by reference. Information regarding executive officers is contained on pages 18 through 20 of that report.\nDisclosure of information for directors, officers, and other persons not meeting the timely reporting requirements under section 16(a) of the Exchange Act is contained in the Proxy Statement under the caption entitled \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" on page 12 and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION:\nInformation regarding executive compensation of Hercules' directors and executive officers is included in the Proxy Statement under the caption entitled \"Corporate Governance-Directors and Executives\" on pages 9 through 11, and the caption entitled \"Executive Compensation\" on pages 12 through 14, respectively, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT: Information regarding beneficial ownership of the Common Stock by certain beneficial owners and by management of the Company is included under the caption entitled \"Security Ownership of Certain Beneficial Owners\" on pages 8 and 9 of the Proxy Statement and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS: Information regarding certain relationships and related transactions with management is included under the caption entitled \"Certain Relationships and Related Transactions\" on page 9 of 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) Documents filed as part of this Report:\n1. Financial Statements\nThese documents are listed in the Index to Consolidated Financial Statements. See Item 8.\n2. Financial Statement Schedules:\nAll schedules are omitted because they are not applicable, not required, or the information required is either presented in the Notes to Financial Statements or has not changed materially from that previously reported.\n3. Exhibits:\nA complete listing of exhibits required is given in the Exhibit Index which precedes the exhibits filed with this Report.\n(b) Reports on Form 8-K.\nHercules was not required to file any reports on Form 8-K for the quarter ended December 31, 1994.\nHowever, an optional filing (Item 5 event) 8-K filing was made on October 28, 1994 related to the acquisition by Alliant Techsystems of a substantial portion of the Aerospace segment and included the Purchase and Sale Agreement between Hercules Incorporated and Alliant Techsystems dated October 28, 1994 and press release from Hercules Incorporated dated October 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 on March 24, 1995.\nHERCULES INCORPORATED\nBy R. KEITH ELLIOTT ---------------------------------------------------------- R. Keith Elliott, 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 in the capacities indicated on March 24, 1995.\nEXHIBIT INDEX\nEXHIBIT INDEX (CONT'D)\n* Previously filed as indicated and incorporated herein by reference. Exhibits incorporated by reference should be located in SEC File No. 1-496.\nEXHIBIT 23-A. CONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statements of Hercules Incorporated and subsidiary companies on Form S-8 [Registration No. 33-37279 (which includes Registration No. 33-21668), No. 33-14912, No. 33-15052, No. 33-21667, No. 33-47664, No. 33-51178, No. 33-52621, No. 33-66136 and No. 33-65352] and on Form S-3 (Registration No. 33-15104 and No. 33-33768) of our report dated January 30, 1995 on our audits of the consolidated financial statements of Hercules Incorporated and subsidiary companies as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, which report is included in this Annual Report on Form 10-K.\nCoopers & Lybrand, L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania 19103 March 27, 1995\nEXHIBIT 23-B. CONSENT OF COMPANY COUNSEL\nI hereby consent to the reference to Company Counsel in Notes 23(c) and 23(d) of Notes to the Consolidated Financial Statements.\nWilmington, Delaware Michael B. Keehan March 27, 1995 Vice President and General Counsel Hercules Incorporated","section_15":""}
{"filename":"813828_1994.txt","cik":"813828","year":"1994","section_1":"Item 1. Business.\nBackground\nViacom Inc. (together with its subsidiaries and divisions, unless the context otherwise requires, the \"Company\") is a diversified entertainment and publishing company with operations in five segments: (i) Networks and Broadcasting, (ii) Entertainment, (iii) Video and Music\/Theme Parks, (iv) Publishing, and (v) Cable Television. Through the Networks and Broadcasting segment, the Company operates MTV: MUSIC TELEVISION (R), SHOWTIME (R), NICKELODEON(R)\/NICK AT NITE (R) and VH1 MUSIC FIRST (TM), among other program services, and 12 broadcast television and 12 radio stations. Through the Entertainment segment, which includes PARAMOUNT PICTURES (TM) and the Company's approximately 77%- owned subsidiary Spelling Entertainment Group Inc., the Company produces and distributes theatrical motion pictures and television programming. Through the Video and Music\/Theme Parks segment, which includes the BLOCKBUSTER(R) family of businesses and PARAMOUNT PARKS (TM), the Company is the leading worldwide owner, operator and franchisor of videocassette rental and sales stores and a leading owner and operator of music stores in the U.S. In addition, PARAMOUNT PARKS owns and operates five theme parks located in the U.S. and Canada. Through the Publishing segment, which includes SIMON & SCHUSTER(R), MACMILLAN PUBLISHING USA(TM) and PRENTICE HALL(R), the Company publishes and distributes educational, consumer, business, technical and professional books, and audio-video software products. Through the Cable Television segment, the Company operates cable television systems serving approximately 1.1 million customers.\nThe Company was organized in Delaware in 1986 for the purpose of acquiring Viacom International Inc. (\"Viacom International\"). On March 11, 1994, the Company acquired a majority of outstanding shares of Paramount Communications Inc. (\"Paramount Communications\") by tender offer; on July 7, 1994, Paramount Communications became a wholly owned subsidiary of the Company, and, on January 3, 1995, Paramount Communications was merged into Viacom International. On September 29, 1994, Blockbuster Entertainment Corporation merged with and into the Company (the \"Blockbuster Merger\"). On January 20, 1995, the Company agreed to sell its cable television systems to a partnership of which Mitgo Corp., a company wholly owned by Frank Washington, is the general partner, for approximately $2.3 billion, subject to certain conditions, including receipt of a tax certificate from the Federal Communications Commission (\"FCC\") and the availability of certain federal tax consequences of the sale advantageous to the Company. The U.S. House of Representatives and the U.S. Senate have each approved a similar version of legislation that would eliminate such tax consequences. The House of Representatives has also approved a compromise version of the bill, which is awaiting Senate approval. The Company has announced that it will not proceed with the agreed transaction in the event that such tax consequences are unavailable. (see \"Business -- Regulation\"). The Company has also announced that it is considering other options with respect to the disposition of its cable systems and that it intends to proceed with such disposition. On March 10, 1995, the Company sold Madison Square Garden Corporation for closing proceeds of approximately $1.009 billion, representing the sale price of approximately $1.075 billion, less an approximately $66 million working capital adjustment. The net after-tax proceeds of the sale were used to repay indebtedness.\nAs of March 1, 1995, National Amusements, Inc. (\"NAI\"), a closely held corporation that owns and operates more than 900 movie screens in the U.S. and the U.K., owned approximately 61% of the Company's voting Class A Common Stock (\"Class A Common Stock\"), and approximately 26% of the Company's outstanding Class A Common Stock and non-voting Class B Common Stock (\"Class B Common Stock\") on a combined basis. NAI is not subject to the informational filing requirements of the Securities Exchange Act of 1934, as amended. Sumner M. Redstone, the controlling shareholder of NAI, is the Chairman of the Board of the Company.\nThe Company's principal offices are located at 1515 Broadway, New York, New York 10036 (telephone 212\/258-6000). At December 31, 1994, the Company and its affiliated companies employed approximately 70,000 people, of which approximately 30,700 were full-time salaried employees.\nI-1\nBusiness\nNetworks and Broadcasting\nNetworks. The Company, through MTV Networks (\"MTVN\"), operates three advertiser-supported basic cable television program services in the U.S.: MTV: MUSIC TELEVISION(R) (\"MTV\") (including the U.S feed of MTV LATINO(TM)), VH1 MUSIC FIRST(TM) (\"VH1\") and NICKELODEON(R)\/NICK AT NITE(R). The Company also operates three premium subscription services in the U.S.: SHOWTIME(R), THE MOVIE CHANNEL(TM) and FLIX(TM). Additionally, the Company participates as a joint venture partner in four additional advertiser-supported basic cable program services in the U.S.: USA NETWORK(TM) and the SCI-FI CHANNEL(TM) (both of which are operated by USA Networks), COMEDY CENTRAL(TM), and ALL NEWS CHANNEL(TM). Internationally, the Company owns and operates MTV EUROPE(TM), MTV LATINO(TM), VH-1(TM) in the U.K. and VH-1(TM) in Germany, and participates as a joint venture partner in NICKELODEON U.K. The Company plans to launch MTV ASIA(TM) in the second quarter of 1995, NICKELODEON AUSTRALIA(TM), a premium subscription television service, also in 1995, and VH-1(TM) in Latin America in 1996. The Company has also entered into a joint venture agreement for the development and launch of MTV SOUTH AFRICA(TM) in 1996, and has entered into a joint venture with Ravensburger Film & TV GmbH, which has received a license to launch NICKELODEON(TM) in Germany. The Company also packages satellite-delivered program services for distribution to home satellite dish owners in the U.S. through SHOWTIME SATELLITE NETWORKS(TM).\nMTV Networks. Each of MTV, MTV EUROPE, MTV LATINO, NICKELODEON\/NICK AT NITE and VH1 (including VH-1 in the U.K.) is a 24-hours-a-day, seven-days-a- week program service transmitted via satellite for distribution by cable television operators and other distributors.\nMTV targets young adult viewers from the ages of 12 to 34 with programming that consists primarily of music videos and concerts, music and general lifestyle information, comedy and dramatic series, news specials, interviews, documentaries and other youth-oriented programming. Additionally, international MTV program services are regionally customized to suit the local tastes of their young adult viewers by the inclusion of local music, programming, language content and on-air personalities.\nMTV has expanded its business opportunities based on its programming to include, among other enterprises, an MTV line of home videos, merchandise, interactive products and books, and electronic retailing programs. MTV also pursues broadcast network and first-run syndication television opportunities and motion picture development and production through its MTV Productions operation.\nMTV was licensed to approximately 54.2 million domestic cable subscribers at December 31, 1994 (based on subscriber counts provided by each cable system). According to the December 1994 sample reports issued by the A.C. Nielsen Company (the \"Nielsen Report\"), MTV reached approximately 58.7 million domestic subscriber households.\nMTV EUROPE is designed to communicate with Europe's youth in their language by providing a high percentage of European-sourced youth programming, including music videos, and focusing on fashion, movies, news, trends and social issues. MTV EUROPE is distributed via cable systems, direct-to-home satellite transmission and terrestrial re-broadcast of the satellite transmission in Europe and certain countries in the former Soviet Union and the Middle East. According to Pan European Television Audience Research, MTV EUROPE reached approximately 59.1 million subscribers at December 31, 1994.\nMTV LATINO, launched in October 1993, reaches subscribers to cable, multichannel, multidistribution systems (\"MMDS\") and satellite master antenna television systems (\"SMATV\") and direct-to-home satellite viewers in approximately 20 countries in Latin America and in the U.S. MTV LATINO was distributed to approximately 4.8 million subscribers at December 31, 1994 (based on subscriber counts provided by each distributor of the service).\nMTV ASIA, which is expected to launch in the second quarter of 1995, will reach subscribers throughout Asia via cable, terrestrial MMDS, SMATV and direct-to-home satellite dishes. MTV ASIA will consist of two separate satellite feeds, one primarily in Mandarin, the other primarily in English.\nI-2\nMTVN has licensing arrangements covering the distribution of regionally-specific program services in Brazil and Japan. MTVN also licenses worldwide MTV programs, merchandise and format rights.\nNICKELODEON combines acquired and originally produced programs in a pro-social, non-violent format comprising two distinct program units tailored to age-specific demographic audiences. NICKELODEON, targeted to audiences ages 2 to 14 (which includes NICK JR., a program block designed for 2 to 5 year olds), features live-action, animation and original kid game shows. NICK AT NITE primarily attracts an audience ages 18 to 49 and offers \"Classic TV(TM)\" shows from various eras, including THE DICK VAN DYKE SHOW, THE MARY TYLER MOORE SHOW and TAXI. At December 31, 1994, NICKELODEON was licensed to approximately 55.6 million cable subscribers and NICK AT NITE was licensed to approximately 55.2 million cable subscribers (based on subscriber counts provided by each cable system for each program unit). According to the Nielsen Report, NICKELODEON and NICK AT NITE each reached approximately 60.9 million subscriber households. In 1994, NICKELODEON expanded its brand and character licensing programs in the U.S. and international markets by entering into merchandise agreements throughout the world and by producing audio and video product in the U.S. and Canada for distribution under its agreement with Sony Music Entertainment, Inc. (\"Sony Music\"). Additionally, NICKELODEON has commenced publication of NICKELODEON books with Simon & Schuster and has introduced \"The Big Help\" campaign to encourage volunteerism among young people and \"U to U\", a fully interactive television program.\nNICKELODEON in the U.K. is a joint venture of the Company and British Sky Broadcasting Limited and is a 12-hours-a-day, seven-days-a-week satellite- delivered children's programming service which includes original programming produced by NICKELODEON and the joint venture.\nVH1 presents music videos, long-form music-based series, original concerts, music-based news segments, fashion, comedy and promotions and targets an audience from the ages of 25 to 44. On October 17, 1994, VH1 was relaunched as VH1 MUSIC FIRST in the U.S. At December 31, 1994, VH1 was licensed to approximately 47.2 million domestic cable subscribers (based on subscriber counts provided by each cable system). According to the Nielsen Report, VH1 reached approximately 49.8 million domestic subscriber households. VH-1 in the U.K. was launched in September 1994 and is distributed to approximately 3.1 million viewers in the U.K. and Ireland via cable systems and direct-to-home satellite transmission as of December 31, 1994 (based on subscriber counts provided by each distributor of the service). VH-1 in Germany was launched in March 1995. The Company has announced plans to launch VH-1 in Latin America in 1996.\nMTVN, in exchange for cash and advertising time or promotional consideration only, licenses from record companies the availability of music videos for exhibition on MTV and on MTVN's other basic cable networks. The agreements generally provide that the videos are available for debut by MTVN and that certain videos are subject to exclusive exhibition periods on MTV. In October 1994, MTVN entered into a music video licensing agreement with Sony Music which licenses to MTVN international exhibition rights in key territories. MTVN's ability to continue to obtain music videos on favorable terms is material to MTVN. (See \"Business -- Competition\")\nMTVN derives revenues principally from two sources: the sale of time on its own networks to advertisers and the license of the services to cable television operators and other distributors. The sale of MTVN advertising time is affected by viewer demographics, viewer ratings and market conditions for advertising time. Adverse changes in general market conditions for advertising may affect MTVN's revenues. MTVN also derives revenues from the license fees paid by cable operators and other distributors which deliver programming by non- cable technologies. In 1994, MTVN derived approximately 59% of its revenues from music programming and approximately 41% of its revenues from children's and other programming.\nShowtime Networks Inc. Showtime Networks Inc. (\"SNI\") operates three 24-hours-a-day, seven-days-a-week commercial-free, premium subscription services: SHOWTIME, offering theatrically released feature films, dramatic series, comedy specials, boxing events, and original movies; THE MOVIE CHANNEL, offering feature films and related programming including film festivals; and FLIX, an added-value premium subscription service featuring movies, primarily from the 1960s, 70s and 80s. SHOWTIME, THE MOVIE CHANNEL and FLIX are offered to cable television operators and other distributors under affiliation agreements which for SHOWTIME and THE MOVIE CHANNEL are generally for a term of three to five years, and in each case are distributed to the systems they serve by means of domestic communications satellites. SHOWTIME, THE MOVIE CHANNEL and FLIX are also offered to distributors for subscription by home satellite dish owners, including United States Satellite Broadcasting Inc., a subsidiary of Hubbard Broadcasting, Inc., which uses high-powered Ku-Band direct broadcast satellite technology. At December 31, 1994, SHOWTIME, THE MOVIE CHANNEL and FLIX, in the aggregate, had approximately 13.5 million cable and other subscribers in approximately 8,800 cable systems as well as other distribution systems in 50 states and certain U.S. territories. In January 1995, SNI and Robert Redford announced plans to launch, in late 1995, the Sundance Film Channel, designed to be a commercial-free 24-hours-a-day, seven-days-a-week premium subscription service featuring independent and foreign language films and documentaries.\nI-3\nSNI also provides special events, such as sports events, and feature films to licensees on a pay-per-view basis through its operation of SET PAY PER VIEW. For example, SNI recently announced an exclusive multi-year agreement among former heavyweight champion Mike Tyson, Don King Productions, Inc., SNI and SET PAY PER VIEW for the pay-per-view marketing and exhibition of all of Mike Tyson's fights over three years. SNI, through its subsidiary, Showtime Satellite Networks Inc., packages for distribution to home satellite dish owners the Company's wholly owned program services as well as COMEDY CENTRAL, USA NETWORK, the SCI-FI CHANNEL, and certain third-party program services.\nIn order to exhibit theatrical motion pictures on premium subscription television, SNI enters into commitments to acquire rights, with an emphasis on acquiring exclusive rights for SHOWTIME and THE MOVIE CHANNEL, from major or independent motion picture producers and other distributors. SNI's exhibition rights always cover the U.S. and may, on a contract-by-contract basis, cover additional territories. Theatrical motion pictures are generally exhibited first on SHOWTIME and THE MOVIE CHANNEL after an initial period for theatrical, home video and pay-per-view exhibition and before the period has commenced for standard broadcast television and basic cable television exhibition. Many of the motion pictures which appear on FLIX have been previously available for standard broadcast and other exhibitions.\nSNI also arranges for the development, production and, in many cases, distribution of original programs and motion pictures. These original programs and motion pictures premiere on SHOWTIME and certain of such programming is exploited in various media worldwide.\nThe cost of acquiring premium television rights to programming is the principal expense of SNI. At December 31, 1994, in addition to program acquisition commitments reflected in the Company's financial statements, SNI had commitments to acquire programming rights at an aggregate cost of approximately $1.9 billion, most of which is payable over the next seven years as part of SNI's normal programming expenditures. These commitments are contingent upon delivery of motion pictures which are not yet available for premium television exhibition and, in many cases, have not yet been produced.\nJoint Ventures. USA Networks, a joint venture of the Company and MCA, Inc. (\"MCA\"), operates two national advertiser-supported basic cable television networks: USA NETWORK, a general entertainment and sports channel, and the SCI- FI CHANNEL, a science fiction channel. COMEDY CENTRAL, a joint venture of the Company, through MTVN, and Home Box Office (\"HBO\"), is an advertiser-supported basic cable television comedy service. ALL NEWS CHANNEL, a joint venture of a subsidiary of the Company and Conus Communications Company Limited Partnership, a limited partnership whose managing general partner is Hubbard Broadcasting, Inc., consists of national and international news, weather, sports and business news. Each of USA NETWORK, the SCI-FI CHANNEL, COMEDY CENTRAL and ALL NEWS CHANNEL is a 24-hours-a-day, seven-days-a-week service.\nBroadcasting. The Company owns and operates 12 television stations and 12 radio stations. All of the television and radio stations operate pursuant to the Communications Act of 1934, as amended (the \"Communications Act\"), and licenses granted by the FCC, which are renewable every five years in the case of television stations and every seven years in the case of radio stations.\nThe Company's strategy has been to acquire independent television stations in the top 20 U.S. markets to the extent advantageous in conjunction with the Company's formation of the United Paramount Network (\"UPN\") (See \"Business -- Entertainment\"). The Company acquired WSBK-TV, serving Boston, Massachusetts, on March 7, 1995 and has entered into agreements to acquire WGBS- TV, serving Philadelphia, Pennsylvania and WBFS-TV, serving Miami, Florida. The Company sold WLFL-TV, serving Raleigh\/Durham, North Carolina, on January 17, 1995 and has entered into agreements to sell WTXF-TV, serving Philadelphia, Pennsylvania and KRRT-TV, serving San Antonio, Texas. The table below sets forth a list of the 12 television properties owned and operated by the Company at March 31, 1995.\nI-4\n*The Company has entered into agreements to sell these television stations.\nThe Company owns and operates the following 12 radio stations: WLTW- FM, serving New York, New York (Adult Contemporary), KYSR-FM and KXEZ-FM, each serving Los Angeles, California (Adult Contemporary), WLIT-FM, serving Chicago, Illinois (Adult Contemporary), WLTI-FM, serving Detroit, Michigan (Adult Contemporary), WMZQ-AM\/FM (Country), WJZW-FM (Jazz) and WCPT-AM (CNN Headline News), each serving Washington, D.C., KBSG-AM\/FM, serving Tacoma\/Seattle, Washington (Oldies), and KNDD-FM, serving Seattle, Washington (New Rock\/AOR). The Company has undertaken to divest two stations in the Washington, D.C. market as a result of multiple ownership issues arising from the acquisition of Paramount Communications (See \"Business -- Regulation\"). On March 22, 1995, the Company sold KSOL-FM, serving San Francisco, California, and KYLZ-FM, serving Santa Cruz\/San Jose, California.\nI-5\nEntertainment\nThe Entertainment segment's principal businesses are the production and distribution of motion pictures and television programming as well as movie theater operations and new media and interactive services.\nTheatrical Motion Pictures. Through PARAMOUNT PICTURES(TM), the Company produces, finances and distributes feature motion pictures. Motion pictures are produced by PARAMOUNT PICTURES, produced by independent producers and financed in whole or in part by PARAMOUNT PICTURES, or produced by others and acquired by PARAMOUNT PICTURES. Each picture is a separate and distinct product with its financial success dependent upon many factors, among which cost and public response are of fundamental importance. Feature motion pictures are produced or acquired for distribution, normally for exhibition in U.S. and foreign theaters followed by videocassettes and discs, pay-per-view television, premium subscription television, network television, and basic cable television and syndicated television exploitation. During 1994, PARAMOUNT PICTURES released 16 feature motion pictures, including FORREST GUMP, winner of six Academy Awards including \"Best Picture\", STAR TREK: GENERATIONS, NOBODY'S FOOL, and CLEAR AND PRESENT DANGER. PARAMOUNT PICTURES plans to release approximately 16 to 18 films in 1995. In seeking to maximize PARAMOUNT PICTURES' output, while decreasing its financial exposure, the Company has entered into agreements to distribute films produced and\/or financed by other parties. For example, entities associated with the Company have agreements with companies with which Michael Douglas and Steven Reuther are associated, for the production and\/or financing of 12 films over four years. PARAMOUNT PICTURES also has an agreement with Lakeshore Entertainment Corporation (\"Lakeshore\") for the distribution by PARAMOUNT PICTURES of 15 films to be produced by Lakeshore over five years. In addition, PARAMOUNT PICTURES entered into an agreement with Columbia Pictures for PARAMOUNT PICTURES' upcoming feature film THE INDIAN IN THE CUPBOARD, which will be co-financed by the studios and for which they will divide distribution rights and revenues.\nPARAMOUNT PICTURES distributes its motion pictures for theatrical release outside the U.S. and Canada through United International Pictures (\"UIP\"), a company owned by entities associated with the Company, MGM and MCA. PARAMOUNT PICTURES distributes its motion pictures on videocassette and disc in the U.S. and Canada through Paramount Home Video and outside the U.S. and Canada, through Cinema International B.V., a joint venture of entities associated with the Company and MCA. PARAMOUNT PICTURES has an exclusive premium subscription television agreement with HBO for exhibition of PARAMOUNT PICTURES' new releases on domestic premium subscription television, which includes new PARAMOUNT PICTURES motion pictures released theatrically through December 1997. PARAMOUNT PICTURES also distributes its motion pictures for premium subscription television release outside the U.S. and Canada through UIP and is a joint venture partner in HBO Pacific Partners C.V., Latin American Pay Television Service, VOF, Telecine Programacao de Filmes Ltda., and Pay-TV Movies Australia, which are premium television services in Asia, Spanish-speaking Latin America, Brazil and Australia, respectively. PARAMOUNT PICTURES also licenses its motion pictures to home and hotel\/motel pay-per-view, airlines, schools and universities. UIP and United Cinemas International (\"UCI\", as described below) are the subject of various governmental inquiries by the Commission of the European Community (\"EC\") and Monopolies and Mergers Commission of the U.K. Such inquiries are not expected to have a material effect on the Company (See \"Business -- Competition\"). Most motion pictures are also licensed for exhibition on television, including basic cable television, with fees generally collected in installments.\nAll of the above license fees for television exhibition (including international and domestic premium television and basic cable television) are recorded as revenue in the year that the films are available for such exhibition, which, among other reasons, may cause substantial fluctuation in PARAMOUNT PICTURES' operating results. At December 31, 1994, the unrecognized revenues attributable to such licensing of completed films from PARAMOUNT PICTURES' license agreements were approximately $574.7 million. PARAMOUNT PICTURES has over 900 motion pictures in its library.\nTelevision Production and Syndication. The Company also produces and distributes series, miniseries, specials and made-for-television movies for network television, first-run syndication, premium subscription and basic cable television, videocassettes and video discs, and live television programming. As a result of the Blockbuster Merger, the Company acquired approximately 77% of Spelling Entertainment Group Inc. (\"Spelling\"), which includes Spelling Television, Republic Pictures and Worldvision Enterprises (\"Worldvision\").\nI-6\nThe Company's current network programming includes FRASIER, WINGS, THE MOMMIES, THE MARSHAL, SISTER, SISTER, DIAGNOSIS: MURDER and MATLOCK, and through Spelling, BEVERLY HILLS, 90210 and MELROSE PLACE. Generally, a network will license a specified number of episodes for exhibition on the network in the U.S. during the license period. All other distribution rights, including foreign and off-network syndication rights, are retained by the Company. The episodic license fee is normally less than the Company's and Spelling's respective costs of producing each series episode; however, in many cases, the Company has been successful in obtaining international sales through its and Spelling's respective syndication operations. Foreign sales are generally concurrent with U.S. network runs. Generally, a series must have a network run of at least four years to be successfully sold in syndication.\nThe Company produces television programming for first-run syndication which programs are sold directly to television stations in the U.S. on a market- by-market basis. The Company sells its programs to television stations for cash, advertising time or a combination of both. Where a product is licensed in exchange for advertising time, through what are known as \"barter agreements\", a broadcaster agrees to give the Company a specified amount of advertising time, which the Company subsequently sells. The Company's first-run syndicated programming includes such shows as STAR TREK: DEEP SPACE NINE, ENTERTAINMENT TONIGHT, HARD COPY, SIGHTINGS, THE MAURY POVICH SHOW, THE MONTEL WILLIAMS SHOW and THE JON STEWART SHOW. PARAMOUNT PICTURES recently entered into an agreement with Procter & Gamble Productions, Inc. (\"P&G\") pursuant to which P&G will co- finance certain network and first-run syndicated programming produced by PARAMOUNT PICTURES during the term of the agreement.\nThe Company produces original programming, including STAR TREK: VOYAGER, PLATYPUS MAN, PIGSTY and THE WATCHER, for UPN. UPN launched on January 16, 1995 in more than 95 U.S. television markets and currently provides to its affiliates four hours per week of primetime programming. UPN is currently 100% owned by subsidiaries of BHC Communications, Inc. (\"BHC\"), an affiliate of Chris Craft Industries, Inc. The Company has an option exercisable through January 15, 1997 to acquire an interest in UPN equal to that of BHC and its subsidiaries for a price equivalent to approximately one-half of BHC's aggregated cash contributions to UPN through the exercise date, plus market-based interest.\nThe Company distributes or syndicates television series, feature films, made-for-television movies, miniseries and specials for television exhibition in domestic and\/or international broadcast, cable and other marketplaces. Feature film and television properties distributed by the Company are produced by the Company and\/or Spelling or acquired from third parties. Third party agreements for the acquisition of distribution rights are generally long-term and exclusive in nature; such agreements frequently guarantee a minimum recoupable advance payment to such third parties and generally provide for periodic payment to such third parties based on the amount of revenues derived from distribution activities after deduction of the Company's percentage distribution fee, recoupment of distribution expenses and recoupment of any advance payments. The Company and Worldvision together control the rights to distribute substantially all of the pre-1971 libraries of CBS, NBC and ABC.\nThe receipt and recognition of revenues for license fees for completed television programming in syndication and on basic cable is similar to that of feature films exhibited on television and, consequently, operating results are subject to substantial fluctuation. At December 31, 1994, the unrecognized revenues attributable to television program license agreements were approximately $486.4 million.\nTheatrical Exhibition. The Company's movie theater operations consist primarily of Famous Players in Canada, UCI and Films Paramount in Europe, and Cinamerica in the Western U.S. Famous Players operates 465 screens in 109 theaters throughout Canada. UCI, a 50%-owned joint venture of entities associated with the Company and MCA, operates 247 screens in 26 theaters in the U.K. and Ireland, 51 screens in four theaters in Germany, nine screens in one theater in Austria and 81 screens in 25 theaters in Spain. UCI also manages in six countries, 31 screens in 17 theaters which are owned by Cinema International Corporation, a joint venture with MCA. Films Paramount operates seven screens in one theater in France. Cinamerica, a 50%-owned joint venture of entities associated with the Company and Time Warner Inc., includes Mann and Festival Theaters and operates 349 screens in 65 theaters in California, Colorado, Arizona and Alaska.\nI-7\nNew Media and Interactive Services. Viacom Interactive Media is comprised of Viacom New Media and Viacom Interactive Services. Viacom New Media develops, produces, publishes, markets and distributes interactive software on a wide variety of platforms. Viacom New Media derives its content from brands and franchises developed by Viacom's business units, including PARAMOUNT PICTURES, MTV Networks and Paramount Television, and also secures outside licenses and acquisitions. In 1994, Viacom New Media released 12 titles, some of which were released for multiple platforms; the titles represent 16 stock keeping units (\"sku's\"). In 1995, Viacom New Media expects to release 12 new titles, representing 29 sku's. Viacom Interactive Services collaborates with the Company's various business units to develop their respective on-line and interactive television environments. The Company, through Spelling, also owns 90% of Virgin Interactive Entertainment Ltd. (\"Virgin\"), a leading video game producer with a library of more than 100 titles which distributes video games in approximately 30 countries. In 1994, Virgin released 54 titles, some of which were released for multiple platforms; the titles represent 90 sku's. In 1995, Virgin expects to release 71 new titles, representing 130 sku's.\nVideo and Music\/Theme Parks\nThe Company operates in the home video retailing and rental business, music retailing business, and theme parks business through its Blockbuster Entertainment Group (\"Blockbuster\").\nHome Video Retailing. Blockbuster is the leading worldwide owner, operator and franchisor of videocassette rental and sales stores. BLOCKBUSTER VIDEO (R) stores range in size from approximately 3,800 square feet to 11,500 square feet, and generally carry a comprehensive selection of 7,000 to 13,000 prerecorded videocassettes, consisting of more than 5,000 titles.\nAt December 31, 1994, there were 4,069 video stores in Blockbuster's system, of which 3,067 were Blockbuster-owned and 1,002 were franchise-owned. Blockbuster-owned video stores at December 31, 1994 included 711 stores operating under the \"Ritz\" and \"Blockbuster Video Express\" trade names in Europe. At December 31, 1994, the BLOCKBUSTER VIDEO system operated in all 50 states and 13 foreign countries. The Company expects to add approximately 650 stores systemwide in 1995. Also in 1995, the Company entered into franchise agreements pursuant to which BLOCKBUSTER VIDEO stores will be opened in Columbia, Peru and Thailand, and the Company formed a joint venture with Burda, one of Germany's largest publishers, to develop BLOCKBUSTER VIDEO stores in Germany. During the first quarter of 1995, 132 small video stores operating under the \"Ritz\" trade name in the U.K. were closed in connection with the Company's conversion of \"Ritz\" stores to \"Blockbuster Video Express\" stores.\nThe Company's home video business may be affected by a variety of factors, including but not limited to, general economic trends, acquisitions made by the Company, additional and existing competition, marketing programs, weather, special or unusual events, variations in the number of store openings, the quality of new release titles available for rental and sale, and similar factors that may affect retailers in general. As compared to other months of the year, revenue from BLOCKBUSTER VIDEO stores in the U.S. has been, and the Company believes will continue to be, subject to decline during the months of April and May, due in part to the change to Daylight Savings Time, and during the months of September, October and November, due in part to the start of school and the introduction of new television programs.\nMusic Retailing. Through music stores operating under the \"Blockbuster Music\" trade name, Blockbuster is among the largest specialty retailers of prerecorded music in the United States. At December 31, 1994, Blockbuster owned and operated 542 music stores in 34 states. These music stores range in size from 900 to 24,600 square feet and generally carry a comprehensive selection of 25,000 to 135,000 compact discs and audio cassettes consisting of up to 60,000 titles.\nThe Company's music business may be affected by a variety of factors, including but not limited to, general economic trends and conditions in the music industry, including the quality of new titles and artists, existing and additional competition, changes in technology, and similar factors that may affect retailers in general. The Company's music business is seasonal, with higher than average monthly revenue experienced during the Thanksgiving and Christmas seasons, and lower than average monthly revenue experienced in September and October.\nTheme Parks. The Company, through PARAMOUNT PARKS (TM), owns and operates five regional theme parks in the U.S. and Canada: Paramount's Carowinds, in Charlotte, North Carolina; Paramount's Great America, in Santa Clara, California; Paramount's Kings Dominion located near Richmond, Virginia; Paramount's Kings Island located near Cincinnati, Ohio; and Paramount Canada's Wonderland located near Toronto, Ontario. Substantially all of the theme parks' operating income is generated from May through September. In December 1994, PARAMOUNT PARKS and Hilton Hotels Corporation agreed to launch STAR TREK: THE EXPERIENCE, a futuristic-themed, interactive environment within the Las Vegas Hilton which is expected to open in late 1996.\nOther Entertainment. At December 31, 1994, the Company owned approximately 49.6% of the outstanding common stock of Discovery Zone, Inc. (\"Discovery Zone\") (approximately 36.7% on a fully diluted basis). Discovery Zone owns, operates and franchises large indoor recreational spaces known as FunCenters, and operates Leaps and Bounds indoor entertainment and fitness facilities. Blockbuster is also a partner in a joint venture with Discovery\nI-8\nZone to develop up to 10 FunCenters in the U.K. The Company accounts for its interest in Discovery Zone as an equity interest. Through joint ventures with Sony Music and PACE Entertainment Corporation, the Company operates seven amphitheaters in the U.S., with plans to open an eighth amphitheater in mid- 1995. Through PARAMOUNT PARKS, the Company owns five additional amphitheaters. Through PARAMOUNT PARKS, the Company owns and operates BLOCK PARTY (TM) entertainment centers in Indianapolis, Indiana and Albuquerque, New Mexico, each of which were opened in January 1995. The Company also owns an approximately 35% interest in Catapult Entertainment, Inc., a company which has established a service enabling multiple video game players to compete against one another from different locations in \"real time\" by modem without requiring modification to either hardware or software.\nPublishing\nThe Company, principally through Simon & Schuster and affiliated companies, publishes and distributes hardcover and paperback books, educational textbooks, supplemental educational materials and multimedia products, and provides information and reference services for business and professions. In February 1994, Simon & Schuster completed the acquisition of the U.S. publishing assets of Macmillan, Inc. for approximately $553 million. Simon & Schuster's well-known imprints include SIMON & SCHUSTER, THE FREE PRESS, POCKET BOOKS, MACMILLAN PUBLISHING USA, PRENTICE HALL, SCRIBNER, SILVER BURDETT GINN, ALLYN AND BACON, COMPUTER CURRICULUM CORPORATION and EDUCATIONAL MANAGEMENT GROUP, among others. Simon & Schuster distributes its books directly and through third parties on a retail and wholesale basis.\nEducational Publishing. The Elementary, Secondary, Higher Education and Educational Technology divisions publish elementary, secondary and college textbooks and related materials, computer-based educational products, audiovisual products and vocational and technical materials under such imprints as PRENTICE HALL, SILVER BURDETT GINN and ALLYN AND BACON, among others. In February 1995, Simon & Schuster acquired all of the outstanding stock of Educational Management Group Inc., an interactive telecommunications company that develops and distributes customized instructional materials and live interactive television services to schools and reaches more than one million students in 3,500 schools. Computer Curriculum Corporation delivers multimedia coursework to more than 1.5 million students in approximately 8,000 schools in six countries. The educational marketplace is subject to seasonal fluctuations in its business which correlate to the traditional school year. Sales to elementary and secondary schools are dependent, in part, on the \"adoption\" or selection of instructional materials by designated state agencies. 22 states and some localities limit the textbooks that may be purchased with state funds to those books that have been approved by the adoption authority.\nConsumer Publishing. The Consumer division publishes and distributes hardcover, trade paperback and mass market books under imprints including SIMON & SCHUSTER, POCKET BOOKS, SCRIBNER, THE FREE PRESS, SIMON & SCHUSTER TRADE PAPERBACK, which includes FIRESIDE, TOUCHSTONE, SCRIBNER PAPERBACK FICTION and SIMON & SCHUSTER LIBROS AGUILAR ESPANOL as well as SIMON & SCHUSTER CHILDREN'S PUBLISHING, which includes ALADDIN PAPERBACKS, ATHENEUM BOOKS FOR YOUNG READERS, LITTLE SIMON, MARGARET K. McELDERRY BOOKS, and SIMON & SCHUSTER BOOKS FOR YOUNG READERS. In 1994, the Consumer division announced the formation of Simon & Schuster New Media, combining Simon & Schuster Audio, the world's largest publisher of audio books, with the newly created Simon & Schuster Interactive, which has 15 CD-ROM titles scheduled for publication in 1995. The consumer marketplace is subject to increased periods of demand in the summer months and during the end-of-year holiday season.\nBusiness, Training and Healthcare Publishing. Through a wide variety of imprints, Simon & Schuster publishes a full range of business, professional training, and medical healthcare information products, including books, newsletters, journals, seminars, videos, loose-leaf series and multimedia programs. Operating units include The New York Institute of Finance, Appleton & Lange, Jossey-Bass, The Bureau of Business Practice, and Prentice Hall Direct.\nReference Publishing - Macmillan Publishing USA. Macmillan Publishing USA, the umbrella identity of Simon & Schuster's reference publishing operations, is the industry leader in computer book publishing and a leader in home\/library reference publishing. The unit's imprints include MACMILLAN\nI-9\nCOMPUTER PUBLISHING USA (QUE, SAMS, HAYDEN BOOKS, NEW RIDERS PUBLISHING, BRADY GAMES), MACMILLAN GENERAL REFERENCE USA (ARCO, BETTY CROCKER, BURPEE, FROMMER'S TRAVEL GUIDES, HARRAP'S BILINGUAL DICTIONARIES, HOWELL BOOK HOUSE, MONARCH NOTES, J.K. LASSER, THE PLACES RATED ALMANAC, THE UNOFFICIAL GUIDES, WEBSTER'S NEW WORLD), MACMILLAN LIBRARY REFERENCE USA (CHARLES SCRIBNER'S SONS, G.K. HALL, MACMILLAN REFERENCE USA) and MACMILLAN DIGITAL USA, which publishes computer books and reference content in electronic formats.\nInternational. The International Group publishes approximately 650 titles each year, primarily in the areas of academic, computer, English language training, and professional publishing in 10 languages and 34 countries outside North America. The International Group also maintains co-publishing partnerships in 14 countries, such as Japan (Toppan and Impress) and Hungary (Novotrade), whose operations include distribution of U.S. product, local language translation and adaptation of U.S. product, and indigenous publishing. In January 1995, the Company acquired German computer book publisher Markt & Technik, enhancing the Company's position as the world's largest computer book publisher and providing greater opportunities for expansion into other European markets, particularly Eastern Europe.\nCable Television\nCable Operations. At December 31, 1994, the Company, through Viacom Cable Television (\"Viacom Cable\"), was approximately the 12th largest multiple cable television system operator in the U.S. with approximately 1.1 million subscribers. On January 20, 1995, the Company agreed to sell its cable television systems to a partnership of which Mitgo Corp., a company wholly owned by African American businessman Frank Washington, is the general partner, for approximately $2.3 billion, subject to certain conditions, including receipt of a tax certificate from the FCC and the availability of certain federal tax consequences of the sale advantageous to the Company. The U.S. House of Representatives and the U.S. Senate have approved a similar version of legislation that would eliminate such tax consequences. The House of Representatives has also approved a compromise version of the bill, which is awaiting Senate approval. The Company has announced that it will not proceed with the agreed transaction in the event that such tax consequences are unavailable (see \"Business -- Regulation\"). The Company has also announced that it is considering other options with respect to the disposition of its cable systems and that it intends to proceed with such disposition. Viacom Cable's systems are operated pursuant to non-exclusive franchises granted by local governing authorities.\nIn most of its systems, Viacom Cable offers two tiers of primary (i.e, non-premium) service: \"Limited Service\", which consists generally of local and distant broadcast stations and all public, educational and governmental (\"PEG\") channels required by local franchise authorities; and the \"Satellite Value Package\", which provides additional channels of satellite-delivered cable networks. Monthly service fees for these two levels of primary service constitute the major source of the systems' revenue. In addition, Viacom Cable has introduced a third tier of non-premium service which qualifies as a non- regulated \"new product tier\" under the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\") in its Nashville, Tennessee, Pittsburg, California, Puget Sound South and most of its Puget Sound North and Central systems. Each such tier consists of five channels of advertiser- supported cable networks.\nThe monthly service fees for Limited Service and the Satellite Value Package are regulated under the 1992 Cable Act (See \"Business -- Regulation\"). The Company offers customers the Company's own basic program services (including joint venture program services) as well as third-party services. None of Viacom Cable's systems is presently exempt from rate regulation under the 1992 Cable Act. The new product tiers mentioned above are not rate regulated at the present time, but the FCC has reserved the right to reopen the issue of rate regulation for new product tiers in the future.\nViacom Cable offers premium cable television programming, including the Company's premium subscription television services, to its customers for an additional monthly fee of up to $11.95 per premium service. At December 31, 1994, the Company's cable television systems had approximately 875,000 subscriptions to premium cable television program services.\nI-10\nViacom Cable also derives revenues from the lease of certain fiber optic capacity in three of its markets to partnerships engaged in competitive access telephone services and in all of its markets from advertising sales and sharing of revenues from sales of products on home shopping services offered by Viacom Cable to its customers.\nCable operators require substantial capital expenditures to construct systems and significant annual expenditures to maintain, rebuild and expand systems. System construction and operation and quality of equipment used must conform with federal, state and local electrical and safety codes and certain regulations of the FCC. Viacom Cable, like many other cable operators, is analyzing potential business applications for its broadband network, including interactive video, video on demand, data services and telephony. These applications, either individually or in combination, may require technological changes such as fiber optics and digital compression. Although management believes the equipment used in the cable operations is in good operating condition, except for ordinary wear and tear, the Company invests significant amounts each year to upgrade, rebuild and expand its cable systems. During the last five years, Viacom Cable's capital expenditures were as follows: 1990: $46 million; 1991: $45 million; 1992: $55 million; 1993: $79 million; and 1994: $100 million. The Company expects that Viacom Cable's capital expenditures in 1995 will be approximately $135 million. A substantial amount of the capital expenditures for 1995 will be reimbursed by the buyer if the proposed sale of Viacom Cable is consummated.\nViacom Cable has constructed a fiber optic cable system in Castro Valley, California to provide more channels with significantly better picture quality, and to accommodate testing of new services including an interactive on- screen programming guide known as StarSight (in which consolidated affiliates of the Company currently have an approximately 25% equity interest on a combined basis), other interactive programs with Viacom Interactive Media, video-on- demand services, multiplexed services, and advanced interactive video and data services.\nIntellectual Property\nIt is the Company's practice to maintain U.S. and foreign legal protection for its theatrical and television product, software, publications and its other original and acquired works. The following logos and trademarks are among those strongly identified with the product lines they represent and are significant assets of the Company: VIACOM (R), the BLOCKBUSTER (R) family of marks, MACMILLAN (R), MTV: MUSIC TELEVISION (R), NICK AT NITE (R), NICKELODEON (R), the PARAMOUNT (R) family of marks, POCKET BOOKS (TM), SIMON & SCHUSTER (R), SHOWTIME (R) and VH1 MUSIC FIRST (TM).\nCOMPETITION\nNetworks\nMTVN. MTVN services are in competition for available channel space on existing cable systems and for fees from cable operators and alternative media distributors, with other cable program services, and nationally distributed and local independent television stations. MTVN also competes for advertising revenue with other cable and broadcast television programmers, and radio and print media. For basic cable television programmers, such as MTVN, advertising revenues derived by each programming service depend on the number of households subscribing to the service through local cable operators and other distributors. I-11\nAt December 31, 1994, there were 31 principal cable program services and superstations, each with over 10 million subscribers, under contract with A.C. Nielsen Company, including MTV, VH1, NICKELODEON (including NICKELODEON and NICK AT NITE program segments), USA NETWORK and the SCI-FI CHANNEL. The Nielsen Report ranked USA NETWORK fourth, NICKELODEON\/NICK AT NITE seventh, MTV twelfth, VH1 sixteenth and the SCI-FI CHANNEL twenty-sixth, in terms of subscriber households.\nCertain major record companies have announced plans to launch music- based program services in the U.S. and internationally. Major worldwide record companies have attempted to license their music videos to MTV EUROPE only on a collective basis, the lawfulness of which is being challenged by MTV EUROPE (See \"Item 3. Legal Proceedings\").\nSNI. Competition among premium subscription television program services is primarily dependent on: (1) the acquisition and packaging of an adequate number of recently released quality motion pictures; and (2) the offering of prices, marketing and advertising support and other incentives to cable operators and other distributors so as to favorably position and package SNI's premium subscription television program services to subscribers. HBO is the dominant company in the premium subscription television category, offering two premium subscription television program services, the HBO service and Cinemax. SNI is second to HBO with a significantly smaller share of the premium subscription television category. In addition, in February 1994, Encore Media Corp. (an affiliate of Tele-Communications, Inc.) launched Starz!, a premium subscription television program service featuring recently released motion pictures, in competition with SNI's premium program services.\nGeneral. The Company's antitrust suit against Tele-Communications, Inc., et al., which is pending in the Southern District of New York, is currently suspended pending satisfaction of certain conditions, which, if satisfied, would lead to settlement of the action. (See \"Item 3. Legal Proceedings\")\nThe potential exists that one or more telephone companies (\"telcos\"), either individually or in groups, will enter the business of creating and distributing program services, both inside and outside their respective service areas (See \"Cable Television -- Video Dialtone Regulations\" below). The Company cannot predict the impact that telco entry into those businesses may have on the Company's program services.\nBroadcasting\nThe principal methods of competition in the television and radio broadcasting field are the development of audience interest through programming and promotions. Unlike broadcast station owners which seek network affiliates, the Company's strategy has been to seek to acquire independent stations each of which will be primarily affiliated with UPN. At this time, UPN has very limited programming and, to the extent that the Company acquires independent affiliates, there will be a need for those stations to acquire additional programming. Television and radio stations also compete for advertising revenues with other stations in their respective coverage areas and with all other advertising media. They also compete with various other forms of leisure time activities, such as cable television systems and audio players and video recorders. These competing services, which may provide improved signal reception and offer an increased home entertainment selection, have been in a period of rapid development and expansion. Technological advances and regulatory policies will have an impact upon the future competitive broadcasting environment. In particular, recent FCC liberalization of its radio station ownership limits will allow for increased group ownership of stations. However, the Company is unable to predict what impact these rule changes will have on its businesses in their markets. (\"See Business -- Regulation\")\nDirect broadcast satellite (\"DBS\") distribution of programs commenced in 1994. Additionally, the FCC has issued rules which may significantly increase the number of multipoint distribution service systems (i.e., the distribution of video services on microwave frequencies which can only be received by special microwave antennas). The FCC has also authorized video uses of certain frequencies which have not traditionally been used or permitted for commercial video services and has issued rules which will increase the number of FM and AM stations. The FCC is also considering authorizing digital audio broadcasts, which could ultimately permit increased radio competition by satellite delivery of audio stations directly to the home (or to cars) and result in an increased spectrum being used for digital delivery of radio signals, and it has authorized and is in the process of licensing low-power television stations (\"LPTV stations\") that may serve various communities with coverage areas smaller than those served by full conventional television stations. Because of their coverage limitations, LPTV stations may be allocated to communities which cannot accommodate a full-power television station because of technical requirements. I-12\nEntertainment\nThe Company's entertainment businesses compete with all forms of entertainment. The Company competes intensely with other major studios and independent film producers in the production and distribution of motion pictures and video cassettes. Similarly, as a producer and distributor of television programs, the Company competes with other studios and independent producers in the licensing of television programs to both networks and independent television stations. PARAMOUNT PICTURES' competitive position primarily depends on the quality of the product produced, public response and cost. The Company also competes to obtain creative talents and story properties which are essential to the success of all of the Company's entertainment businesses. UIP and UCI are the subject of various governmental inquiries by the EC and the Monopolies and Mergers Commission of the U.K. Such inquiries are not expected to have a material effect on the Company's businesses.\nIn addition to the competitive factors applicable to all areas of the entertainment industry, the marketplace for interactive entertainment is also characterized by the rapid evolution of distribution technologies.\nVideo\nThe home video retail business is highly competitive. The Company believes that the principal competitive factors in the business are title selection, number of copies of titles available, the quality of customer service and, to a lesser extent, pricing. The Company believes that it has generally addressed the selection and service demands of consumers more adequately than most of its competitors.\nThe Company and its franchise owners compete with video retail stores, as well as supermarkets, drug stores, convenience stores, book stores, mass merchandisers and others. The Company believes that the success of its business depends in part on its large and attractive Company-owned and franchise-owned BLOCKBUSTER VIDEO stores offering a wider selection of titles and larger and more accessible inventory than its competitors, in addition to more convenient store locations, faster and more efficient computerized check-in\/check-out procedures, extended operating hours, effective customer service and competitive pricing.\nThe Company's business is also dependent on the pricing of videocassettes by distributors since such pricing significantly influences whether a title is marketed by retailers primarily for rental or sale (or \"sell- thru\") to consumers. Since the Company has a larger share of the rental market than the sell-thru market and since its margins are generally higher for rental product than for sell-thru market, an increase in the number of sell-thru titles may have an adverse impact on the Company's business.\nIn addition to competing with other home video retailers, the Company and its franchise owners compete with all other forms of entertainment and recreational activities including, but not limited to, movie theaters, network television and other events, such as sporting events. The Company also competes with cable television, which includes pay-per-view television. Currently, pay- per-view television provides less viewing flexibility to the consumer than videocassettes, and the more popular movies are generally available on videocassette prior to appearing on pay-per-view television. However, technological advances could result in greater viewing flexibility for pay-per- view or in other methods of electronic delivery, and such developments could have an adverse impact on the Company and its franchise owners' businesses.\nSeveral consumer product companies have recently announced plans to introduce a new product to exhibit prerecorded filmed entertainment products on television. The product, the digital video disc player, is to be based on digital technology and would permit a film that is recorded in digital format on a compact disc to be exhibited on a standard television set. This new technology is said to offer significant benefits to consumers by enabling distributors to produce a lower cost, higher quality product than videocassettes. The Company is unable to determine at this time whether and, if so, when, this new format will be introduced into the marketplace, whether it will gain significant consumer acceptance generally or among the Company's customers. As a result, the Company is unable to determine the impact this new format will have on the Company's business.\nI-13\nMusic\nThe retail sale of prerecorded music and related products is highly competitive among numerous chain and department stores, discount stores, mail order clubs and specialty music stores. Some mail order clubs are affiliated with major manufacturers of prerecorded music and may have advantageous marketing arrangements with their affiliates. As music stores generally serve individual or local markets, competition is fragmented and varies substantially from one location or geographic area to another. The Company believes that its ability to compete successfully in the music retailing business depends on its ability to secure and maintain attractive and convenient locations, manage merchandise efficiently, offer broad merchandise selections at competitive prices and provide effective service to its customers.\nThe retailing of certain prerecorded music products has changed during the past year. A large number of mass merchandisers have begun to sell new releases at or, in certain cases, below cost in order to attract customers into their stores and generate sales of other products. In an attempt to remain competitive, the Company has reduced the price at which it sells these products, resulting in lower revenue. The Company believes that this practice may continue for a period of time as mass merchandisers continue to open stores and build their customer base.\nTheme Parks\nThe Company's theme parks compete with other theme parks in their respective geographic regions as well as with other forms of leisure entertainment. The profitability of the leisure-time industry is influenced by various factors which are not directly controllable, such as economic conditions, amount of available leisure time, oil and transportation prices and weather patterns. The Company believes that its intellectual properties will enhance existing attractions and facilitate the development of new attractions to encourage visitors to PARAMOUNT PARKS.\nPublishing\nCompetition in the elementary, secondary and higher education textbook and the trade and paperback book fields is intense, with a number of strong competitors. In addition, the acquisition of publication rights to important book titles is highly competitive and the Company competes with numerous other book publishers. In the field of elementary and secondary school textbooks, 22 states and some local jurisdictions limit the textbooks that may be bought by school systems with state funds to those books that have been approved by adoption or listing. In the higher education textbook field, new books compete with used books. In addition, book piracy affects sales in certain foreign markets. A large portion of annual sales of educational textbooks is made during the June to September period. In certain areas of publishing, books are usually sold on a fully-returnable basis resulting in significant product returns to publishers. In the field of information services to businesses and professionals, there are numerous organizations that provide competitive materials and services.\nCable Television\nThe Company's cable systems operate pursuant to non-exclusive franchises granted by local governing authorities (either municipal or county) and compete for viewers with other distribution systems which deliver programming by microwave transmission (MDS or MMDS) and SMATV or directly to subscribers via either \"TVRO\" or DBS technology. The strength of competition depends upon the reliability, programming and pricing of such alternative distribution systems. Digital compression may allow cable systems to significantly increase the number of channels of programming they deliver and thereby help cable systems meet competition from these other distribution systems.\nThe Company views the future success of the cable business as being dependent on supplying additional programming and new services to its customers and increasing primary and premium subscriber penetrations.\nI-14\nAs the Company's cable television systems are franchised on a non- exclusive basis, other cable operators have been franchised and may continue to apply for franchises in certain areas served by the Company's cable systems. In addition, the 1992 Cable Act prohibits a franchisor from granting exclusive franchises and from unreasonably refusing to award additional competitive franchises.\nThe entry of telcos into the cable television business may provide additional competition to the cable industry. Current prohibitions against telcos engaging in the cable television business within their local service areas have been held by some courts to be unconstitutional and, although these decisions are being appealed, the FCC, on March 17, 1995, issued a public notice announcing that it will no longer enforce its cross-ownership rules in the Fourth and Ninth Circuits. A significant number of the Company's cable franchise areas are in the Ninth Circuit. In addition, the FCC has adopted video dialtone (\"VDT\") regulations which allow delivery of video programming over telephone lines without the requirement to obtain a franchise and the FCC has proposed substantial revisions to such regulations (See \"Business -- Regulation\"). The Company is a general partner in three partnerships providing commercial competitive access services which link business customers to long distance carriers via private networks owned by the cable television company partners and leased to the partnerships. These interests will be sold if the proposed sale of the Company's cable systems is consummated.\nREGULATION\nThe Company's networks, broadcasting, entertainment, video and music distribution, publishing, and cable television businesses are subject to regulation by federal, state and local governmental authorities, and its broadcast television, production and distribution operations are affected thereby. The rules, regulations, policies and procedures affecting these businesses are constantly subject to change. The descriptions which follow are summaries and should be read in conjunction with the texts of the statutes, rules and regulations described herein. The descriptions do not purport to describe all present and proposed federal, state and local statutes, rules and regulations affecting the Company's businesses.\nIntellectual Property\nThe Company conducts many of its businesses through the control and exploitation of the numerous copyrights and trademarks underlying its products and licenses; therefore, domestic and international laws affecting intellectual property have significant importance to the Company. Congress is currently considering revisions to the Copyright Act of 1976 (the \"Copyright Act\"), including extension of the protection term by 20 years, and the creation of a performance right for digital performances of sound recordings. Congress may also consider legislation to update the Copyright Act to take into account new technological developments relating to the distribution of copyrighted materials.\nCOMPULSORY COPYRIGHT. Cable television systems are subject to the Copyright Act which provides a compulsory license for carriage of distant broadcast signals at prescribed rates (the proceeds are divided among the various copyright holders of the programs contained in such signals). No license fee is payable to any program copyright holder for retransmission of broadcast signals which are \"local\" to the communities served by the cable system (see \"Regulation -- Cable Television\").\nThe Copyright Act also provides a similar compulsory license for satellite services. Legislation adopted in the 104th Congress extended the satellite compulsory license for five years, raised the fees paid to carry broadcast signals, and, beginning in 1996, requires the fees to be set through negotiations and binding arbitration rather than by law, taking into account fair market value. The law also includes a provision eliminating the requirement that cable operators pay compulsory license fees for stations located more than 35 miles away but within the same \"Area of Dominant Influence\".\nFIRST SALE DOCTRINE. The \"First Sale\" provision of the Copyright Act provides that the owner of a legitimate copy of a copyrighted work may rent or otherwise use or dispose of that copy in such a manner as the owner sees fit. The First Sale doctrine does not apply to sound recordings or computer software (other than software made for a limited purpose computer, such as a video game platform), for which the Copyright Act vests a rental right (i.e., the right to control the rental of the copy) in the copyright holder. The repeal or limitation of the First Sale doctrine (or conversely, the creation of a rental right) for audiovisual works or for computer software made for limited purpose computers would have an adverse impact on the Company's home video business; however, no such legislation is pending in Congress at the present time.\nI-15\nNetworks and Broadcasting\nNetworks\nMODIFICATION OF FINAL JUDGMENT. The Modification of Final Judgment (the \"MFJ\") is the consent decree pursuant to which AT&T was reorganized and was required to divest its local telephone service monopolies. As a result, seven regional holding companies (\"RHCs\") were formed (including NYNEX) comprised of operating companies within their regions (Bell Operating Companies, or \"BOCs\"). In addition, that portion of the continental United States served by the BOCs was divided into geographical areas termed Local Access and Transport Areas (\"LATAs\"). The MFJ restricts the RHCs, the BOCs and their affiliates from engaging in inter-LATA telecommunications services and from manufacturing telecommunications products. As a result of NYNEX's investment in the Company, the Company could arguably be considered an affiliate of an RHC for MFJ purposes. As a result, the Company transferred certain of its Networks and Broadcasting and other operations and properties to an affiliated entity which will be consolidated into the Company for financial reporting purposes. Neither the transfer nor the operations of the affiliate as an entity separate from the Company will have a material effect on the financial condition or the results of operations of the Company. Should the MFJ restrictions be modified or waived, the affiliate intends to retransfer such assets and operations to the Company. In March 1995, a U.S. District Court ruled that Bell Atlantic Corporation (\"Bell Atlantic\"), which is a BOC and therefore is subject to the MFJ, may deliver movies and television programming via satellite nationally, and cleared the way for Bell Atlantic to buy radio and television stations, as well as to own cable systems outside its service area.\n1992 CABLE ACT. (See \"Cable Television\" below)\nBroadcasting\nTelevision and radio broadcasting are subject to the jurisdiction of the FCC pursuant to the Communications Act.\nTHE COMMUNICATIONS ACT. The Communications Act authorizes the FCC to issue, renew, revoke or modify broadcast licenses; to regulate the radio frequency, operating power and location of stations; to approve the transmitting equipment used by stations; to adopt rules and regulations necessary to carry out the provisions of the Communications Act; and to impose certain penalties for violations of the Communications Act and the FCC's regulations governing the day-to-day operations of television and radio stations.\nBROADCAST LICENSES. Broadcast station licenses (both television and radio) are ordinarily granted for the maximum allowable period of five years in the case of television and seven years in the case of radio, and are renewable for additional five-year or seven-year periods upon application and approval. Such licenses may be revoked by the FCC for serious violations of its regulations. Petitions to deny renewal of a license or competing applications may be filed for the frequency used by a renewal applicant. If a petition to deny is filed, the FCC will determine whether renewal is in the public interest based upon presentations made by the licensee and the petitioner. On March 23, 1995, the Senate Committee on Commerce, Science and Transportation approved legislation (the \"Commerce Committee Bill\") which, among other things, would lengthen television and radio station license terms to 10 years and relax ownership restrictions with respect to aliens to the extent U.S. ownership of broadcast stations is permitted in the alien's home country. It is impossible at this time to predict whether the Commerce Committee Bill will become law or what form it will take.\nThe licenses for the Company's television stations expire as follows: WDCA-TV on October 1, 1996; KSLA-TV on June 1, 1997; WKBD-TV on October 1, 1997; KMOV-TV on February 1, 1998; each of KRRT-TV, KTXA-TV and KTXH-TV on August 1, 1998; each of WVIT-TV and WSBK-TV on April 1, 1999; each of WNYT-TV and WHEC-TV on June 1, 1999; and WTXF-TV on August 1, 1999. The Company's licenses for its radio stations expire as follows: WMZQ- AM\/FM, WCPT-AM and WJZW-FM on October 1, 1995; WLTI-FM on October 1, 1996; WLIT-FM on December 1, 1996; KYSR-FM and KXEZ-FM on December 1, 1997; each of KBSG-AM\/FM and KNDD-FM on February 1, 1998; and WLTW-FM on June 1, 1998. The Company will apply for renewal of and expects that the licenses which expire in 1995 will be renewed.\nI-16\nThe Communications Act prohibits the assignment of a license or the transfer of control of a license without prior approval of the FCC. The Communications Act also provides that no license may be held by a corporation if (1) any officer or director is an alien or (2) more than 20% of the voting stock is owned of record or voted by aliens or is subject to control by aliens. In addition, no corporation may hold the voting stock of another corporation owning broadcast licenses if any of the officers or directors of such parent corporation are aliens or more than 25% of the voting stock of such parent corporation is owned of record or voted by aliens or is subject to control by aliens, unless specific FCC authorization is obtained. The FCC is currently reviewing these regulations and legislation, such as the Commerce Committee Bill, has been introduced to relax the foreign ownership restrictions. The outcome of the FCC review and the legislative proposal is uncertain.\nMUST CARRY\/RETRANSMISSION CONSENT. The 1992 Cable Act contains provisions which grant certain \"Must Carry\" rights to commercial broadcast television stations that are \"local\" to communities served by a cable system, including the right to elect either to require a cable operator to carry the station pursuant to the Must Carry provisions of the Act or to require that the cable operator secure the station's \"Retransmission Consent\" on a negotiated basis before the station can be carried (i.e., retransmitted) on the cable system. (See \"Cable Television\" below)\nRESTRICTIONS ON BROADCAST ADVERTISING. In past Congressional sessions, committees of Congress examined proposals for legislation that would eliminate or severely restrict advertising of beer and wine either through direct restrictions on content or through elimination or reduction of the deductibility of expenses for such advertising under federal tax laws. Such proposals generated substantial opposition, but it is possible that similar proposals will be reintroduced in Congress. The elimination of all beer and wine advertising would have an adverse effect on the revenues of the Company's television and radio stations.\nOWNERSHIP LIMITATIONS. The FCC has placed limits on the number of radio and television stations in which one entity can own an \"attributable interest\". The Company currently owns radio stations below those ownership limits and owns the maximum permitted number of television stations. The FCC has adopted a number of rules designed to prevent monopoly or undue concentration of control of the media of mass communications. In 1994, FCC regulations which permitted a single entity to have an \"attributable\" ownership or management interest in up to 18 AM and 18 FM stations nationwide were increased to 20 AM and 20 FM stations, including multiple AM and\/or FM stations licensed to serve the same market. Minority-controlled broadcasters can own an additional three AM and three FM stations. The limit on the number of such multiple stations in a particular market which a single entity may own or control depends upon the total number of AM and\/or FM stations in that market; provided that, at the time of purchase, the combined audience share of such multiple stations does not exceed 25%. With respect to television, the FCC's rules limit the maximum number of stations nationwide in which one entity can have an \"attributable\" ownership or management interest, to that number which serves up to 25% of U.S. television households, provided, however, that (except in limited circumstances) the total number of stations will not exceed 12. The FCC also permits radio stations to broker the programming and sales inventories of their stations to other radio stations within the same area, subject to various restrictions, so long as ultimate operational control and ownership is retained and exercised by the licensee. Such brokerage agreements function, as a practical matter, to effect a consolidation of competitive radio broadcast stations within a market in much the same manner as multiple ownership of radio facilities by one entity. Similar brokerage agreements among television stations are being implemented in a smaller number of markets than in radio and are not now subject to any explicit FCC regulations.\nI-17\nThe FCC's ownership limitations also prohibit a single entity from owning multiple \"same service\" (e.g., TV, AM or FM) stations licensed to serve different markets if the broadcast signals of such stations overlap to a specified measurable degree. The maximum number of commonly owned stations serving neighboring markets whose signals can overlap is the same as that maximum number of commonly owned stations which an entity can own or control in a single market. Additional ownership prohibitions preclude common ownership in the same market of (i) television stations and cable systems; (ii) television or radio stations and newspapers of general circulation; and (iii) radio and television stations. Radio-television cross-ownership prohibitions are subject to waiver by the FCC on a case-by-case basis. The Company operates two AM and two FM stations as well as a television station serving Washington, D.C. Ownership of the television station (WDCA) was obtained when the Company acquired majority ownership of Paramount Communications on March 11, 1994. Pursuant to the FCC's order consenting to the transfer of control of the broadcast licenses of Paramount Communications to the Company, the Company has undertaken to dispose of one AM and one FM radio station serving Washington, D.C. no later than September 11, 1995. The FCC's previous prohibition on a national television network's (ABC, CBS, and NBC) owning or operating cable systems has been repealed but with certain limits as to the number of homes which network-owned cable systems can pass on a national and local basis.\nThe FCC is currently reviewing the broadcast ownership regulations, and the Commerce Committee Bill proposes to increase the audience share ceiling from 25% to 35%. The extent to which these regulations will be repealed or modified is uncertain.\nHDTV. In 1993, the FCC adopted a technological standard for the transmission of high definition television (\"HDTV\"), an advanced television system which enhances picture and sound quality, as well as the methods and timetable for implementation of an HDTV transmission standard by broadcasters. The means by which that transmission standard will be implemented and the development of technologies such as digital compression will have an economic and competitive impact on broadcasting and cable operations. The Company cannot predict the effect of implementation of these technologies on its operations. The FCC has stated its intention not to disadvantage broadcasters and it is expected that any HDTV standard which is ultimately adopted will be fashioned so as to accommodate the needs of broadcasters vis-a-vis competitive video delivery technologies. The FCC has already determined that TV stations will be given up to six years to implement HDTV from commencement of the transition period and that stations which do not convert to the HDTV standard will lose their licenses to broadcast at the end of a proposed 15-year period from commencement of the transition period. The cost of converting to HDTV will not have a material effect on the Company. Broadcasters have asked Congress and the FCC for permission to use broadcast stations' respective forthcoming HDTV spectrum assignments for some non-broadcasting purposes, such as advanced paging and data delivery. The Commerce Committee Bill includes some expanded spectrum use authority, provided that broadcasters compensate the FCC.\nEntertainment\nThe Company's first-run, network and other production operations and its distribution of off-network, first-run and other programs in domestic and foreign syndication are not directly regulated by legislation. However, existing and proposed rules and regulations of the FCC applicable to broadcast networks, individual broadcast stations and cable could affect the Company's Entertainment businesses.\nFINANCIAL INTEREST AND SYNDICATION RULES. The financial interest and syndication rules (\"finsyn rules\") were adopted by the FCC in 1970. These rules significantly limited the role of broadcast television networks in broadcast television program syndication. The financial interest rule prohibited a network from acquiring a financial or proprietary right or interest in the exhibition (other than its own broadcast network exhibition), distribution or other commercial use in connection with the broadcasting of any television program of which it is not the sole producer. The syndication rule prohibited a network from syndicating programming domestically to television stations for non-network exhibition and precluded a network from reserving any rights to participate in income derived from domestic broadcast syndication or from foreign broadcast syndication where the network was not the sole producer. For the purposes of these rules, a broadcast network was defined as any entity which offers an interconnected program service on a regular basis for 15 or more hours per week to at least 25 affiliated television stations in 10 or more states.\nI-18\nIn 1993, the FCC modified the finsyn rules effective as of June 5, 1993, although ABC, CBS, and NBC could not commence operating under the modified finsyn rules until November 10, 1993 when the antitrust consent decrees to which they are subject were modified to eliminate certain restrictions by an order of the U.S. District Court for the Central District of California. The modified rules will expire in November 1995, absent an affirmative FCC action retaining or further modifying them. The FCC is to initiate a final review of the modified rules six months prior to their November 1995 expiration date and proponents of their continuation have the burden of proving that the public interest requires their continued retention. The Company is unable to predict what action the FCC will take when it reviews the rule. Elimination of the rule may have an adverse affect on the Company's distribution and production of network prime time programming.\nPRIME TIME ACCESS RULE. The Prime Time Access Rule (\"PTAR\") prohibits network affiliates in the top 50 markets (designated by the FCC based on survey data) from exhibiting network or off-network programming during more than three out of the four prime time hours, with certain limited exceptions. The Decision provided that first-run programming produced by a network will be considered network programming for this purpose.\nIn October 1994, the FCC began a review on whether PTAR should be modified, repealed, or retained. Certain programmers have sought repeal while others are seeking modification to permit only the exhibition of off-network programming.\nThe Company strongly supports PTAR and has launched an aggressive campaign, along with other parties, to retain PTAR intact. The Company believes that PTAR will play an important role in helping emerging networks, including UPN, and enables independent producers and television stations to compete with the networks. Modification or elimination of PTAR could affect the Company's first-run and other distribution activities and hamper the development of UPN.\nANTITRUST. The Company, through PARAMOUNT PICTURES, is subject to a consent decree, entered in 1948, which contains restrictions on certain motion picture trade practices in the United States.\nEUROPEAN UNION DIRECTIVE. In October 1989, the European Union (\"EU\", then the EC and sometimes referred to as the EC) directed each of the 12 European Community member countries to adopt broadcast quota regulations based on its guidelines by October 3, 1991. The EU is currently considering amendments to its Television Without Frontiers directive. In March 1995, the Executive Commision of the EU approved revisions to the directive, which will increase the discrimination against non-European programming; however, at this time, it is impossible to predict what changes will be adopted by the EU, or to predict their impact on the Company's theatrical distribution and television syndication businesses. Each of MTV EUROPE, NICKELODEON U.K. and VH-1 in the U.K are in compliance with the EU broadcast quotas and the Company does not believe that these businesses would be affected by the adoption of such proposals.\nVideo and Music Distribution\nFRANCHISING. Certain states, the United States Federal Trade Commission and certain foreign jurisdictions require a franchisor to transmit specified disclosure statements to potential owners before issuing a franchise. Additionally, some states and foreign jurisdictions require the franchisor to register its franchise before its issuance. The Company believes the offering circulars used to market its franchises comply with the Federal Trade Commission guidelines and all applicable laws of states in the United States and foreign jurisdictions regulating the offering and issuance of franchises. The Company's home video and music retailing businesses, other than the franchising aspect thereof, are not generally subject to any government regulation other than customary laws and local zoning and permit requirements.\nI-19\nCable Television\nFederal Regulation\n1992 CABLE ACT. On October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), substantially amending the regulatory framework under which cable television systems have operated since the Communications Act was amended by the Cable Communications Policy Act of 1984 (the \"1984 Act\"). The FCC, through its rules and regulations, began implementing the requirements of the 1992 Cable Act in 1993. The following is a summary of certain significant issues:\nRate Regulation. Rate regulations adopted in April 1993 by the FCC (the \"April 1993 Regulations\") established a \"benchmark\" formula used to set a cable operator's \"initial permitted rate\" for regulated tiers of cable service. Cable systems whose rates exceeded the applicable benchmark were required to reduce their rates either to the benchmark or by 10% from those charged on September 30, 1992, whichever reduction was less. These regulations also established the prices that an operator may charge for subscriber equipment and installation services, based on the operator's actual cost plus an 11.25% return.\nOn February 22, 1994, the FCC adopted additional rules (the \"February 1994 Regulations\") that: (1) replaced the April 1993 Regulations' 10% rollback provision with a 17% reduction of regulated tier rates; (2) adopted interim standards governing \"cost-of service\" proceedings pursuant to which a cable operator may attempt to prove that its costs of providing regulated service justify initial permitted rates that are higher than those produced under the benchmark approach; and (3) established a regulatory scheme to adjust initial permitted rates on a going- forward basis for certain \"external\" cost increases exceeding inflation, providing (among other things) a pass-through of and 7.5% mark-up for increases in an operator's programming expenses. The February 1994 Regulations also adopted an elaborate multi-factor test for determining whether collective offerings of \"a la carte\" channels (which channels may be sold individually on an unregulated basis) are to be treated as regulated tiers. The February 1994 Regulations govern rates in effect as of May 15, 1994, while the April 1993 Regulations remain applicable to rates that were in effect between September 1, 1993 and May 14, 1994.\nOn November 10, 1994, the FCC adopted new \"going forward\" rules (\"November 1994 Regulations\") that increased the mark-up for channels added to regulated tiers (other than the basic tier), established a more permissively regulated new product tier (\"NPT\"), and otherwise tightened FCC regulation of collective offerings of a la carte channels. These new rules allow operators to pass through to subscribers the costs, plus a 20-cent per channel mark-up, for channels newly added to regulated tiers (other than the basic tier). Through 1996, however, operators are subject to an aggregate cap of $1.50 (no more than $1.20 of which may be mark-up) on the amount that they may increase their retail rates for cable program service tier rates due to channel additions. In 1997, operators will be entitled to an additional 20-cent per channel mark-up and will no longer be subject to a license fee cap. The FCC also established NPTs to provide operators broad pricing and packaging flexibility so long as operators preserve the fundamental nature of their preexisting regulated tiers. At the same time, the FCC reversed its policy with respect to collective a la carte offerings (that do not qualify for unregulated NPT treatment) and generally held that such collective offerings would be treated as regulated tiers (other than NPTs). In addition, the FCC proposed to eliminate the current 7.5 % operator mark-up on increases in a program service's license fees. The Company, along with other cable industry interests, has opposed this proposal.\nSeveral parties, including the Company and other cable industry interests, have continued to challenge other elements of the FCC's rate regulations. The Commerce Committee Bill would eliminate rate regulation of (i) all regulated tiers (other than the basic tier) except for those cable operators whose rates substantially exceed the national average, and (ii) all cable systems which are subject to telco video competition. The Company is unable to predict the timing or outcome of any such pending reconsideration petitions, judicial appeals or proposed legislation.\nI-20\nThe implementation of the April 1993 and February 1994 Regulations has had a negative effect on the Cable Television segment's revenues and earnings from operations. The reduction in revenues in 1994 was partially offset by customer growth and subsequent permitted rate increases. On a going forward basis, the November 1994 Regulations will mitigate a portion of the adverse impact of any reduction in revenues of the Cable Television segment, although the Company cannot predict the effect of these rules or any reconsideration proceedings regarding these rules on the license fees paid to, or the penetration of, program services such as those owned by the Company. For example, in those systems that have been rebuilt to expand channel capacity, one or two programming services added subsequent to the February 1994 Regulations have supported rate increases for the Satellite Value Package tier; in addition, Viacom Cable has launched five channel NPTs in various systems (see \"Business -- Cable Television -- Cable Operations\"). Further, Viacom Cable has made cost-of- service filings in two systems. While the Company cannot predict the outcome of these filings, it believes that both cost-of-service proceedings justify rates in excess of those calculated using the April 1993 Regulations and the February 1994 Regulations.\nVertical Integration. Certain pricing and other restrictions are imposed on vertically integrated cable programmers (such as the Company) with respect to their dealings with multichannel distributors of programming, such as cable systems, SMATV systems, MMDS operators and TVRO and DBS distributors (as defined in \"Business--Competition-- Cable Television\"). The FCC's implementing regulations governing access by multichannel distributors to the programming of vertically integrated cable programmers limit the extent to which a vertically integrated cable programmer can differentiate in pricing or other terms and conditions of carriage between and among multichannel distributors. Multichannel distributors may file a complaint with the FCC if they believe that a vertically integrated cable programmer has not complied with these regulations. To date, no complaints have been filed against the Company. The FCC's implementing regulations also limit the number of channels on a cable system which may be used to carry the programming of such system's affiliated (vertically integrated) cable programmers. These regulations provide generally that no more than 40% of such a system's channels can be used to carry the programming of the system's affiliated cable programmers. These channel occupancy limits apply only up to 75 channels of a given system. The FCC also considered whether limits should be placed on a multichannel distributor's right to participate in the production or creation of programming, and concluded that no such limits are appropriate at this time. The FCC's implementing regulations regarding channel occupancy limits are subject to pending petitions for reconsideration at the FCC.\nMust Carry\/Retransmission Consent. Commercial television stations which are \"local\" to communities served by a cable system can elect to require either Must Carry or Retransmission Consent. In addition, a cable system may not carry any commercial non-satellite-delivered television station which is \"distant\" to communities served by such system or any radio station without obtaining the consent of such station for such retransmission; however, such television and radio stations do not have Must Carry rights. Such stations may require payment in consideration for Retransmission Consent. The Company has negotiated retransmission rights for a number of commercial stations which it carries. Some of these agreements are on an interim basis and may be canceled by the stations. The Company carries other stations pursuant to their exercise of their Must Carry rights. Local non-commercial television stations have Must Carry rights, but may not elect Retransmission Consent. The Must Carry Rules were challenged by cable program services and cable system operators. In April 1993, a District of Columbia three-judge court upheld the rules against a First Amendment attack. In June 1994, the U.S. Supreme Court held that the rules were content-neutral rather than unconstitutional, vacating the District Court's decision and remanding the case back to the District Court for determination of the impact of such rules on the broadcast and cable industries. The rules remain in effect pending the decision of the District Court on remand. (See \"Broadcasting\" above)\nBuy Through to Premium Services. Pursuant to the 1992 Cable Act, a cable system may not require subscribers to purchase any tier of service other than the basic service tier in order to obtain other tiers of service or services offered by the cable operator on a per channel (e.g., premium services) or pay-per-view basis. A cable system which is not now fully addressable and which cannot utilize other means to facilitate access to all of its programming will have up to 10 years to fully comply with this provision through the implementation of fully addressable technology. The Company's cable systems have already begun to implement compliance.\nAmong other things, the 1992 Cable Act and the FCC's implementing regulations also: (i) with certain exceptions, require a three-year holding period before the resale of cable systems; (ii) provide that franchising authorities cannot unreasonably refuse to grant competing franchises (all of the Company's current franchises are non-exclusive); (iii) require that the FCC study the cost and benefits of issuing regulations with respect to compatibility between cable system equipment and consumer electronics such as VCRs and issue such regulations as may be appropriate; and (iv) facilitate the manner in which third parties can lease channel capacity from cable systems and provide that the maximum rates which a cable system can charge for leased channel capacity may be set by the FCC. Pursuant to the 1992 Cable Act, the FCC adopted minimum customer service standards and also determined the circumstances under which local franchising authorities may impose higher standards.\nI-21\nLawsuits have been filed challenging various provisions of the 1992 Cable Act including the provisions relating to rate regulation, Must Carry, Retransmission Consent, the pricing and other restrictions imposed on vertically integrated cable programmers with respect to their dealings with multichannel programming distributors, and the mandated availability of cable channels for leased access and PEG programming. If enacted, the Commerce Committee Bill may affect the status of such lawsuits.\nVIDEO DIALTONE REGULATIONS. A series of recent U.S. district court decisions in Alabama, the District of Columbia, Illinois, Washington and Virginia have declared unconstitutional and have enjoined the Communications Act's ban on the direct provision of video programming by a telco in its local service area. The U.S. Court of Appeals for the Fourth and Ninth Circuits have affirmed the district court rulings brought before them on appeal. Even prior to these court rulings, the FCC had reinterpreted this statutory ban in its 1992 \"video dialtone\" decision, authorizing a broadened role for telco participation in video distribution. The VDT policy is being challenged in court by cable interests as violating the Communications Act. It is also being challenged by telephone interests as not being liberal enough. The policy permits in-service- area delivery of video programming by a telco and exempts telcos from the Communications Act's franchising requirements so long as their facilities are capable of two-way video and are used for transmission of video programming on a common carrier basis, i.e., use of the facilities must be available to all programmers and program packagers on a non-discriminatory, first-come first- served basis. Telcos are also permitted to provide to facilities users additional \"enhanced\" services such as video gateways, video processing services, customer premises equipment and billing and collection. These can be provided on a non-common carrier basis. In January 1995, in response to the court rulings discussed above striking down the underlying statutory ban, the FCC issued a Notice of Proposed Rulemaking seeking to craft rules to govern telco provision of video programming directly to subscribers. The FCC's pending proceeding addresses the extent to which regulations applicable to common carriers and\/or regulations applicable to cable operators should govern telcos that provide video programming directly to subscribers over their own VDT systems. The FCC has already approved several VDT construction applications for market trials and\/or limited commercial deployment and has granted, in part, the first tariff filed to govern the rates and terms of a VDT offering. In response to the court rulings noted above, the FCC's more recent VDT authorizations have also allowed telcos to serve as program packagers on their VDT platforms. The Commerce Committee Bill also contemplates a relatively permissive framework for telco entry into cable. It is expected that bills will be formally introduced later this year. At present, state and\/or local laws do not prohibit cable television companies from engaging in certain kinds of telephony business in many states. The Commerce Committee Bill proposes to generally eliminate state and local entry barriers which currently either prohibit or restrict an entity's (including a cable operator's) capacity to offer telecommunications services (including telephone exchange service) in competition with telcos and to interconnect on a non-discriminatory basis with telcos and utilize certain telco facilities in order to provide service in competition with a telco after the date of enactment of such legislation. The Company cannot predict the outcome or impact of these legislative and regulatory efforts although the Company anticipates that its program services could benefit from the increased distribution opportunities afforded by broadened telco entry into multichannel video distribution. If the pending legislation does not become law, and the various appellate courts uphold the unconstitutionality of the Communications Act's restrictions on telco video programming, the telcos have stated their intention to immediately enter the video programming business.\nFCC MINORITY TAX CERTIFICATE On January 20, 1995, the Company agreed to sell its cable television systems to a partnership which is minority-owned. Under the minority-ownership tax deferral rules adopted by the FCC in 1978, the Company is entitled to receive a tax certificate pursuant to which the Company would be able to defer capital gains tax on the gain from the sale, provided the Company reinvests the net proceeds of the sale in qualifying media properties within two years of closing or reduces its tax basis in existing assets. The U.S. House of Representatives and the U.S. Senate have each approved a similar version of legislation that would eliminate such tax consequences retroactive to January 17, 1995. The Company's current agreement to sell its cable systems is contingent upon receipt of the FCC tax certificate.\nI-22\nState and Local Regulation.\nState and local regulation of cable is exercised primarily through the franchising process under which a company enters into a franchise agreement with the appropriate franchising authority and agrees to abide by applicable ordinances. The 1992 Cable Act permits the FCC to broaden the regulatory powers of the state and local franchising authorities, particularly in the areas of rate regulation and customer service standards. (See \"Cable Television-- Federal Regulation\" above)\nUnder the 1984 Act, franchising authorities may control only cable- related equipment and facilities requirements and may not require the carriage of specific program services. However, federal law (as implemented by FCC regulations) mandates the carriage of both commercial and non-commercial television broadcast stations \"local\" to the area in which a cable system is located. (see \"Cable Television -- Must Carry\/Retransmission Consent\" above)\nThe 1984 Act, as amended, guarantees cable operators due process rights in franchise renewal proceedings and provides that franchises will be renewed unless the cable operator fails to meet one or more enumerated statutory criteria. The Company's current franchises expire on various dates through 2017. During the five-year period 1995 through 1999, franchises having an aggregate of approximately 369,420 customers (at December 31, 1994) will expire unless renewed. The Company expects its franchises to be renewed.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company maintains its world headquarters at 1515 Broadway, New York, New York, where it rents approximately one million square feet for executive offices and certain of its operating divisions. The lease runs to 2010, with four renewal options for five years each. The lease also grants the Company options for additional space and a right of first negotiation for other available space in the building. The Company also leases approximately 484,000 square feet of office space at 1633 Broadway, New York, New York, which lease runs to 2010, and approximately 237,000 square feet of office space at 1230 Avenue of the Americas, New York, New York, which lease runs to 2009, which leases contain options to renew, among other terms. The Company owns the PARAMOUNT PICTURES studio at 5555 Melrose Avenue, Los Angeles, California, which consists of approximately 63 acres containing sound stages, administrative, technical and dressing room structures, screening theatres, machinery and equipment facilities, plus a back lot and parking lot. PARAMOUNT PARKS' operations in the U.S. include approximately 1,640 acres owned and 295 acres leased and in Canada include approximately 200 acres owned and 97 acres leased. The Company owns the Blockbuster Entertainment Group headquarters at 200 South Andrews Avenue, Fort Lauderdale, Florida, which consists of approximately 148,000 square feet of office space and regional and district offices. The BLOCKBUSTER retail and distribution operations consist of approximately 55 owned properties, aggregating approximately 361,000 square feet, and approximately 2,833 leased locations, aggregating approximately 19.4 million square feet. Facilities within the Publishing segment (other than executive offices at 1230 Avenue of the Americas described above) include approximately 7,653,000 square feet of space, of which approximately 5,070,000 square feet are leased. The facilities are used for warehouse, distribution and administrative functions. The Company's cable television systems include a combination of owned and leased premises in California, Ohio, Oregon, Tennessee and Washington (the location of Viacom Cable's franchises) and each system's electronic distribution equipment.\nThe Company also owns and leases office, studio and warehouse space in various cities in the U.S., Canada and several countries around the world for its businesses. The Company considers its properties adequate for its present needs. The Company also owns approximately 1,770 acres of undeveloped land in Southeast Florida.\nI-23\nItem 3.","section_3":"Item 3. Legal Proceedings\nOn August 18, 1994, the District Court in and for Dallas County, Texas entered a judgment in favor of the plaintiffs in the action Howell v. Blockbuster Entertainment Corporation et al. (Cause No. 91-10193-M, now pending on appeal before the Dallas Court of Appeals as Cause No. 05-94-01823). The defendants include Blockbuster Entertainment Corporation (\"BEC\"), which has been merged into the Company, and Video Superstores Master Limited Partnership, a dissolved limited partnership that was indirectly controlled by BEC at the time of its dissolution. The judgment is based upon plaintiffs' claims of breach of fiduciary duty, fraud, conspiracy, breach of contract and tortious interference with contract and claims under Texas partnership law in connection with the defendants' treatment, and ultimate acquisition, of plaintiff's interest in a limited partnership which owned three Blockbuster stores. The court entered judgment against all defendants, jointly and severally in the amount of $10,884,003 as compensatory damages, $3,791,172 as pre-judgment interest and attorneys' fees in the amount of $175,000. In addition, the Court entered judgment totaling $108,840,030 for exemplary damages and ordered that the plaintiffs recover post-judgment interest at the rate of 10% per annum on all amounts awarded from the date of judgment until paid. The Company believes that substantial grounds exist for the vacation of the judgment or its substantial reduction and is vigorously prosecuting an appeal.\nOn September 27, 1994, an action captioned Murphy, et al. v. Blockbuster Entertainment Corporation, et al. (Cause No. 94-10051-M) was filed in the District Court in and for Dallas County, Texas by plaintiffs representing the two other limited partners of the plaintiff in the Howell litigation described above. Plaintiffs assert the same basic causes of action as in Howell and have claimed they are entitled to actual damages in excess of $240 million and punitive damages in excess of $1 billion. The Company believes that it has substantial defenses to these claims, including, among others, that the claims are barred by the statute of limitations and by releases entered into by the plaintiffs, and intends to vigorously defend the claims. Discovery in the Murphy action has been stayed pending the outcome of the appeal in the Howell action.\nStockholder Litigation. Four putative class actions were filed by alleged Spelling shareholders in November 1994. By Order dated February 15, 1995, the four actions were consolidated under the caption In re Spelling Shareholder Litigation, Master File 94-8764 (AH), Circuit Court, Palm Beach County, Florida. Defendants in all actions include Spelling, the Company and the members of the Board of Directors of Spelling. All complaints alleged that the Company intends to acquire the 23% shares of Spelling it does not currently hold for inadequate consideration and in breach of the defendants' fiduciary duties. Two of the actions also alleged that the acquisition of the Company's 77% interest in Spelling was done improperly so as to avoid payment of a control premium to the shareholders. Plaintiffs sought declaratory and injunctive relief preventing the alleged acquisition plan and damages. The Company believes that plaintiffs' allegations are speculative and without merit and intends to defend the claims vigorously. The plaintiffs have been directed to serve a single consolidated class action complaint to supersede all existing complaints and to move for class certification on or before May 18, l995.\nAntitrust Matters. On September 23, 1993, the Company filed an action in the United States District Court for the Southern District of New York styled Viacom International Inc. v. Tele-Communications, Inc. et al., Case No. 93 Civ 6658. The complaint (as amended on November 9, 1993) alleges violations of Sections 1 and 2 of the Sherman Act, Section 7 of the Clayton Act, Section 12 of the Cable Act, and New York's Donnelly Act, and tortious interference, against all defendants, and a breach of contract claim against certain defendants, including Tele-Communications, Inc. (\"TCI\"). The claims for relief in the complaint are based in significant part on allegations that defendants exert monopoly power in the U.S. cable industry through their control over approximately one in four of all cable households in the U.S. In addition to other relief, the Company seeks injunctive relief against defendants' anticompetitive conduct and damages in an amount to be determined at trial, including trebled damages and attorneys' fees.\nOn January 20, 1995, the Company announced that it had provisionally agreed to settle this action, subject to certain conditions, including, among other things, the effectiveness of a new affiliation agreement covering TCI's long-term carriage of SHOWTIME and THE MOVIE CHANNEL and the consummation of the sale of the Company's cable television systems (See \"Business -- Cable Television\"). The action is currently suspended pending satisfaction of certain conditions which, if satisfied, would lead to settlement of the action.\nI-24\nMTV EUROPE is engaged in a number of related litigations in Europe contesting the legality of certain joint licensing activities by the major worldwide record companies (See \"Business -- Competition -- Networks\"). In 1992, MTV EUROPE initiated a proceeding before the EC, seeking the dissolution, under Articles 85 and 86 of the Treaty of Rome, of the record companies' joint licensing organizations -- Video Performance Limited (\"VPL\") and International Federation of Phonogram and Videogram Producers (\"IFPI\") -- through which the record companies exclusively license rights to exhibit music video clips on television in Europe and elsewhere. In 1994, the EC issued a Statement of Objections which stated that the collective licensing negotiations of VPL and IFPI, and their major record company members, constituted an unlawful restriction of trade under Article 85, and reserved its right to address abuse of monopoly power under Article 86. The VPL\/IFPI and major labels were afforded an opportunity to respond at a hearing in June 1994, and it is anticipated that in 1995 the EC will issue a decision or take steps toward alternative resolution of these issues. MTV EUROPE has been licensed to continue to exhibit music video clips during the EC proceeding under an EC-assisted interim agreement with VPL and IFPI, which expires in July 1995.\nIn December 1993, MTV EUROPE commenced a separate proceeding before the EC, challenging the operation of Viva, a German language music service owned by four of the five major record companies, as an example of illegal cartel activity.\nIn a separate U.K. high court action, MTV EUROPE is seeking reimbursement of license fees paid to VPL and IFPI and\/or damages on the grounds that these fees were unlawfully extracted by the record companies' cartel organizations.\nCertain subsidiaries of the Company from time to time receive claims from federal and state environmental regulatory agencies and other entities asserting that they are or may be liable for environmental cleanup costs and related damages arising out of former operations. While the outcome of these claims cannot be predicted with certainty, on the basis of its experience and the information currently available to it, the Company does not believe that the claims it has received will have a material adverse effect on its financial condition or results of operations (See \"Item 6. Selected Financial Data\" and \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\").\nThe Company and various of its subsidiaries are parties to certain other legal proceedings. However, in the opinion of counsel, these proceedings are not likely to result in judgments that will have a material adverse effect on its financial condition or results of operations.\nFinancial Information About Industry Segments\nThe contribution to revenues and earnings from operations of each industry segment and the identifiable assets attributable to each industry segment for each of the last three years ending December 31, are set forth in Note 12 to the Consolidated Financial Statements of the Company included elsewhere herein.\nFinancial Information About Foreign and Domestic Operations\nFinancial information relating to foreign and domestic operations for each of the last three years ending December 31, is set forth in Notes 11 and 12 to the Consolidated Financial Statements of the Company included elsewhere herein.\nI-25\nExecutive Officers of the Company\nSet forth below is certain information concerning the current executive officers of the Company, which information is hereby included in Part I of this report.\n* effective April 1, 1995 ** through March 31, 1995\nNone of the executive officers of the Company is related to any other executive officer or director by blood, marriage or adoption except that Brent D. Redstone and Shari Redstone, Directors of the Company, are the son and daughter, respectively, of Sumner M. Redstone.\nI-26\nMr. Redstone has been a Director of the Company since 1986 and Chairman of the Board since 1987. Mr. Redstone has served as President, Chief Executive Officer of NAI since July 1967, and continues to serve in such capacity; he has also served as the Chairman of the Board of NAI since 1986. Mr. Redstone became a Director of Spelling in 1994. He served as the first Chairman of the Board of the National Association of Theater Owners, and is currently a member of the Executive Committee of that organization. During the Carter Administration, Mr. Redstone was appointed a member of the Presidential Advisory Committee on the Arts for the John F. Kennedy Center for the Performing Arts and, in 1984, he was appointed a Director of the Kennedy Presidential Library Foundation. Since 1982, Mr. Redstone has been a member of the faculty of Boston University Law School, where he has lectured in entertainment law, and in 1994, he accepted a proposal from Harvard Law School to lecture, as well as a Visiting Professorship from Brandeis University. In 1944, Mr. Redstone graduated from Harvard University and, in 1947, received an L.L.B. from Harvard University School of Law. Upon graduation, he served as Law Secretary with the United States Court of Appeals, and then as a Special Assistant to the United States Attorney General.\nMr. Huizenga has been Vice Chairman of the Board since September 1994 and a Director of the Company since October 1993. He served as Chairman of the Board and Chief Executive Officer of Blockbuster from April 1987 to September 1994, having been elected a director of Blockbuster in February 1987. Mr. Huizenga also served as President of Blockbuster from April 1987 to June 1988. He is Chairman of the Board of Spelling and a Director of Discovery Zone. From May 1984 to present, Mr. Huizenga has been an investor in other businesses and is the sole stockholder and Chairman of the Board of Huizenga Holdings, Inc., a holding and management company with various business interests. In connection with these business interests, Mr. Huizenga has been actively involved in strategic planning for and executive management of these businesses. He also has a majority ownership interest in Florida Marlins Baseball, Ltd., a Major League Baseball sports franchise, and owns the Florida Panthers Hockey Club, Ltd., a National Hockey League sports franchise, the Miami Dolphins, Ltd., a National Football League sports franchise, and Joe Robbie Stadium in South Florida.\nMr. Biondi has been President, Chief Executive Officer and a Director of the Company since July 1987. He became a Director of Spelling in 1994. From November 1986 to July 1987, Mr. Biondi was Chairman, Chief Executive Officer of Coca-Cola Television and, from 1985, Executive Vice President of the Entertainment Business Sector of The Coca-Cola Company. Mr. Biondi joined HBO in 1978 and held various positions there until his appointment as President, Chief Executive Officer in 1983. In 1984, he was elected to the additional position of Chairman and continued to serve in such capacities until October 1984.\nMr. Dauman has been a Director of the Company since 1987. In March 1994, he was elected Executive Vice President, General Counsel, Chief Administrative Officer and Secretary of the Company. From February 1993 to March 1994, he served as Senior Vice President, General Counsel and Secretary of the Company. Prior to that, Mr. Dauman was a partner in the law firm of Shearman & Sterling in New York, which he joined in 1978. Mr. Dauman became a Director of National Amusements, Inc. in 1992 and a Director of Spelling in 1994.\nMr. Dooley has been an executive officer of the Company since January 1987. In March 1994, he was elected Executive Vice President -- Finance, Corporate Development and Communications of the Company. From July 1992 to March 1994, Mr. Dooley served as Senior Vice President, Corporate Development of the Company. From August 1993 to March 1994, he also served as President, Interactive Television. Prior to that, he served as Vice President, Treasurer of the Company since 1987. In December 1990, he was named Vice President, Finance of the Company. Mr. Dooley joined Viacom International Inc. in 1980 in the corporate finance area and has held various positions in the corporate and divisional finance areas.\nMr. Clarke was elected Senior Vice President, Treasurer of the Company in July 1994, having joined the Company as Vice President, Treasurer in April 1993. Prior to that, he spent 12 years at Gannett Co., Inc., where he held various management positions, most recently as Assistant Treasurer.\nI-27\nMr. Folta was elected Senior Vice President, Corporate Relations of the Company in November 1994. Prior to that, he served as Vice President, Corporate Relations of the Company from April 1994 to November 1994. From 1984 until joining the Company in April 1994, Mr. Folta held various Corporate Communications positions at Paramount, serving most recently as Senior Director, Corporate Communications.\nMr. Fricklas was elected Senior Vice President, Deputy General Counsel of the Company in March 1994. From June 1993 to March 1994, he served as Vice President, Deputy General Counsel of the Company. He served as Vice President, General Counsel and Secretary of Minorco (U.S.A.) Inc. from 1990 to 1993. Prior to that, Mr. Fricklas was an attorney in private practice at the law firm of Shearman & Sterling.\nMs. Gordon was elected Vice President, Controller and Chief Accounting Officer effective April 1, 1995. Prior to that, she served as Vice President, Internal Audit of the Company since October 1986. From June 1985 to October 1986, Ms. Gordon served as Controller of Viacom Broadcasting. She joined the Company in 1981 and held various positions in the corporate finance area.\nMr. Hertlein was elected Senior Vice President of the Company in July 1994. Prior to that, he served as Senior Vice President and Controller of Paramount from September 1993 to July 1994 and as Senior Vice President, Internal Audit and Special Projects of Paramount from September 1992 to September 1993 and, before that, as Vice President, Internal Audit and Special Projects of Paramount.\nMr. Horowitz has been an executive officer of the Company since April 1989. In March 1994, he was elected Senior Vice President, Technology of the Company and Chairman, Chief Executive Officer of Viacom Interactive Media. Prior to that, he served as Senior Vice President of the Company from April 1989 and as Chairman, Chief Executive Officer of Viacom Broadcasting from July 1992 to March 1994. From 1974 to April 1989, Mr. Horowitz held various positions with HBO, most recently as Senior Vice President, Technology and Operations. Mr. Horowitz held several other management positions with HBO, including Senior Vice President, Network Operations and New Business Development and Vice President, Affiliate Sales.\nMr. Lavan has been an executive officer of the Company since December 1987. In July 1994, he was elected Senior Vice President, Controller and Chief Accounting Officer and will serve in such capacity until March 31, 1995. Prior to that he served as Vice President, Controller and Chief Accounting Officer since May 1989, having served as Controller, Chief Accounting Officer since December 1987. In December 1990, he assumed the added responsibilities of oversight of Company tax matters. From 1991 to 1992, he also served as Senior Vice President and Chief Financial Officer of Viacom Pictures. Mr. Lavan joined the Company in 1984 as Assistant Controller of the Company. Mr. Lavan will become Chief Financial Officer of MTV Networks effective April 1, 1995.\nMr. Leingang was elected Senior Vice President, Chief Information Officer in May 1993. Prior to that, he served as Vice President, Chief Information Officer upon joining the Company in 1990. Mr. Leingang was Vice President, Information Services of the Trian Group (formerly Triangle Industries) from 1984 to 1990. From 1982 to 1984, he served as Corporate Director, MIS, and Manager, MIS Planning and Control for Interpace Corporation. Prior to that he held positions with Touche Ross & Company, McGraw- Hill Book Company and General Electric Credit Corp.\nI-28\nMr. Roskin has been an executive officer of the Company since April 1988 when he became Vice President, Human Resources and Administration. In July 1992, Mr. Roskin was elected Senior Vice President, Human Resources and Administration of the Company. From May 1986 to April 1988, he was Senior Vice President, Human Resources at Coleco Industries, Inc. From 1976 to 1986, he held various executive positions at Warner Communications, Inc., serving most recently as Vice President, Industrial and Labor Relations.\nMr. Smith has been an executive officer of the Company since May 1985. In November 1987, he was elected Senior Vice President, Chief Financial Officer of the Company and he continues to serve in such capacities. In May 1985, Mr. Smith was elected Vice President, Controller and, in October 1987, he was elected Vice President, Chief Financial Officer of the Company. From 1983 until May 1985, he served as Vice President, Finance and Administration of the Viacom Broadcasting and from 1981 until 1983, he served as Controller of Viacom Radio. Mr. Smith joined the Company in 1977 in the Corporate Treasurer's office and until 1981 served in various financial planning capacities.\nMr. Weinstein has been an executive officer of the Company since January 1986. In February 1993, he was elected Senior Vice President, Government Affairs of the Company. Prior to that, Mr. Weinstein served as Senior Vice President, General Counsel and Secretary of the Company since the fall of 1987. In January 1986, Mr. Weinstein was appointed Vice President, General Counsel of the Company. From 1976 through 1985, he was Deputy General Counsel of Warner Communications Inc. and in 1980 became Vice President. Previously, Mr. Weinstein was an attorney in private practice at the law firm of Paul, Weiss, Rifkind, Wharton & Garrison.\nI-29\nPART II\nItem 5.","section_4":"","section_5":"Item 5. Market for Viacom Inc.'s Common Equity and Related Security Holder Matters.\nViacom Inc. voting Class A Common Stock and Viacom Inc. non- voting Class B Common Stock are listed and traded on the American Stock Exchange (\"AMEX\") under the symbols \"VIA\" and \"VIA B\", respectively.\nThe following table sets forth, for the calendar period indicated, the per share range of high and low sales prices for Viacom Inc.'s Class A Common Stock and Class B Common Stock, as reported on the AMEX Composite Tape.\nViacom Inc. has not declared cash dividends on its common equity and has no present intention of so doing.\nAs of March 27, 1995 there were approximately 14,878 holders of Viacom Inc. Class A Common Stock, and 25,738 holders of Viacom Inc. Class B Common Stock.\nII-1\nItem 6.","section_6":"Item 6. Selected Financial Data.\nVIACOM INC. AND SUBSIDIARIES (Millions of dollars, except per share amounts)\nSee Notes to Consolidated Financial Statements for information on transactions and accounting classifications which have affected the comparability of the periods presented above. Viacom Inc. has not declared cash dividends on its common equity for any of the periods presented above.\nII-2\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition.\nGeneral\nManagement's discussion and analysis of the combined results of operations and financial condition of Viacom Inc. (the \"Company\") should be read in conjunction with the Consolidated Financial Statements and related Notes. Descriptions of all documents incorporated by reference herein or included as exhibits hereto are qualified in their entirety by reference to the full text of such documents so incorporated or included.\nDuring 1994, the Company made two significant acquisitions of large and diversified businesses. Where appropriate the Company has merged, or is in the process of merging, the operations of previously existing and acquired businesses. Comparisons of results of operations have been significantly affected by such acquisitions and merging of operations. On March 11, 1994, the Company acquired a majority of the outstanding shares of Paramount Communications Inc. (\"Paramount Communications\") by tender offer; on July 7, 1994, Paramount Communications became a wholly owned subsidiary of the Company (the \"Paramount Merger\"); and on January 3, 1995, Paramount Communications was merged into Viacom International. On September 29, 1994, Blockbuster Entertainment Corporation (\"Blockbuster\") merged with and into the Company (the \"Blockbuster Merger\"). Paramount Communications' and Blockbuster's results of operations are included as of March 1, 1994 and October 1, 1994, respectively.\nThe Company's consolidated statements of operations reflect five operating segments:\nNetworks and Broadcasting - Basic Cable and Premium Television Networks, Television and Radio Stations.\nEntertainment - Production and distribution of motion pictures and television programming as well as movie theater operations, and new media and interactive services.\nVideo and Music\/Theme Parks - Home Video and Music Retailing, and Theme Parks.\nPublishing - Educational; Consumer; Business, Training and Health Care; Reference; and International Groups.\nCable Television - Cable Television Systems. (See Note 3 of Notes to Consolidated Financial Statements.)\nThe following tables set forth revenues, earnings from continuing operations before depreciation and amortization (\"EBITDA\"), depreciation and amortization, earnings (loss) from continuing operations, equity in pre-tax earnings (loss) of affiliated companies and earnings (loss) from continuing operations plus equity in pre-tax earnings (loss) by business segment for the periods indicated. Prior period presentations have been reclassified to conform to the current presentation.\nII-3\nBusiness Segment Information ----------------------------\n(a) Earnings from continuing operations before depreciation and amortization.\n(b) Paramount Communications' and Blockbuster's results of operations are included as of March 1, 1994 and October 1, 1994, respectively.\nII-4\nResults of Operations ---------------------\n1994 versus 1993 ----------------\nRevenues increased to $7.36 billion for 1994 from $2.0 billion for 1993 (or 267%). EBITDA increased to $1.07 billion for 1994 from $538.1 million for 1993 (or 100%). Earnings from continuing operations increased to $608.3 million for 1994 from $385.0 million for 1993 (or 58%). The foregoing increases in results of operations are principally attributable to the acquisitions of Paramount Communications and Blockbuster, partially offset by the merger-related charges described below.\nEBITDA and earnings from continuing operations for 1994 include merger-related charges, reflecting the integration of the Company's pre-merger businesses with similar Paramount units, and related management and strategic changes. Such amounts relate principally to adjustments of programming assets based upon new management strategies and additional programming sources resulting from the Paramount Merger and, with respect to Corporate, the combination of the employees of the Company and Paramount Communications.\nWhile many in the financial community consider EBITDA to be an important measure of comparative operating performance, it should be considered in addition to, but not as a substitute for or superior to, earnings from operations, net income, cash flow and other measures of financial performance.\nThe comparability of results of operations for 1994 and 1993 has been affected by (i) the Paramount Merger, (ii) the Blockbuster Merger, and (iii) the merger-related charges all of which are non-recurring charges. The following discussion of results of operations is exclusive of merger-related charges and includes an analysis of changes in EBITDA, which does not reflect the effect of significant amounts of amortization of goodwill related to the Paramount Merger, the Blockbuster Merger and other business combinations accounted for by the purchase method of accounting.\nII-5\nNetworks and Broadcasting\nThe constituents of Networks and Broadcasting are MTV Networks (\"MTVN\"), Showtime Networks Inc. (\"SNI\"), television stations and radio stations. Revenues increased to $1.86 billion for 1994 from $1.40 billion for 1993 (or 32%). EBITDA increased to $544.0 million for 1994 from $382.6 million for 1993 (or 42%). Earnings from operations increased to $447.8 million for 1994 from $314.4 million for 1993 (or 42%). The increase in revenues, EBITDA and earnings from operations resulted from increased advertising revenues of MTVN, modest increases in operating results of SNI and the Company's previously existing television and radio stations, and the acquisition of the Paramount television stations. MTVN revenues of $852.2 million, EBITDA of $326.8 million and earnings from operations of $284.5 million increased 26%, 20% and 19%, respectively. The increase in MTVN's revenues was principally attributable to increased advertising revenues due to rate increases. The increase in MTVN's EBITDA was driven by increased advertising revenues partially offset by increased operating costs, as well as aggregate losses of $15.0 million associated with the development of MTV Latino, Nickelodeon Magazine and VH-1 U.K. The Paramount television stations reported revenues of $210.4 million, EBITDA of $83.1 million and earnings from operations of $65.8 million for the period subsequent to their acquisition.\nEntertainment\nThe primary constituents of Entertainment are Paramount Pictures, Spelling Entertainment Group (\"Spelling\"), which was acquired as part of the Blockbuster Merger, and the former Viacom Entertainment. Revenues increased to $2.29 billion in 1994 from $209.1 million in 1993. EBITDA increased to $230.0 million for 1994 from $42.0 million for 1993. Earnings from operations increased to $135.6 million in 1994 from $32.5 million in 1993. The increase in revenues, EBITDA and earnings from operations resulted primarily from the acquisitions of Paramount Pictures and Spelling. Theatrical feature film and television programming results reflect revenues of $1.9 billion, EBITDA of $227.8 million and earnings from operations of $157.7 million. The Entertainment segment's earnings from operations were partially offset by Viacom Interactive Media's loss from operations of $28.6 million, including start-up costs associated with the development of new businesses. Results of operations primarily reflect theatrical feature film revenues, including the domestic and foreign box office success of FORREST GUMP and CLEAR AND PRESENT DANGER, as well as television programming revenues including network and syndication sales. Earnings from operations benefited from a lower cost base and efficiencies associated with the Paramount Merger.\nVideo and Music\/Theme Parks\nThe constituents of Video and Music\/Theme Parks are Blockbuster Video and Music, and Paramount Parks. Revenues, EBITDA and earnings from operations were $1.07 billion, $289.9 million and $199.5 million, respectively. Video and Music revenues, EBITDA and earnings from operations were $735.7 million, $220.3 million and $167.8 million, respectively, reflecting results of operations beginning October 1, 1994 and the continued expansion of video and music stores. Theme Parks revenues, EBITDA and earnings from operations were $334.7 million, $69.6 million and $31.7 million, respectively, reflecting the full 1994 operating season (May through September) of the theme parks.\nII-6\nPublishing\nPublishing represents Simon & Schuster which includes imprints such as Simon & Schuster, Pocket Books, Prentice Hall and Macmillan Publishing USA. Publishing revenues, EBITDA and earnings from operations were $1.79 billion, $296.9 million and $193.9 million, respectively, subsequent to its acquisition in March 1994. Results of operations reflect the Simon & Schuster's Higher Education, Consumer and International groups, and the U.S. publishing assets of Macmillan, Inc.\nCable Television\nCable Television revenues decreased to $406.2 million for 1994 from $416.0 million for 1993 (or 2%), primarily attributable to a decrease in primary revenues. EBITDA decreased to $155.2 million for 1994 from $181.7 million for 1993 (or 15%). Earnings from operations decreased to $78.8 million for 1994 from $110.2 million for 1993 (or 28%). The results reflect a 10% decrease in average rates for primary services, partially offset by a 3% increase in average primary customers. Total revenue per primary customer per month decreased 5% to $30.30 for 1994 from $32.03 for 1993. The revenue variances reflect the effect of the FCC rate regulations pursuant to the 1992 Cable Act governing rates in effect as of September 1, 1993 and as of May 15, 1994. The decrease in EBITDA and earnings from operations principally reflect the decreased revenues attributable to the above rate regulations and increased operating, general and administrative expenses.\nAs of December 31, 1994, Viacom Cable served approximately 1,139,000 primary customers subscribing to approximately 875,000 premium units, representing an increase of 4% and 22%, respectively, since December 31, 1993.\nCorporate Expenses\nCorporate expenses including depreciation increased 60% to $115.2 million in 1994 from $72.1 million in 1993 reflecting overall increased expenses attributable to the mergers.\nOther Income and Expense Information\nInterest Expense Net interest expense of $494.1 million for 1994 compared to $145.0 million for 1993 reflects increased bank borrowing, the issuance of the 8% exchangeable subordinated debentures and debt acquired as part of the Mergers. The Company had approximately $10.4 billion and $2.5 billion principal amount of debt outstanding as of December 31, 1994 and December 31, 1993 at weighted average interest rates of 7.5% and 5.3%, respectively. (See Note 5 of Notes to Consolidated Financial Statements.)\nOther Items, Net For 1994, \"Other items, net\" primarily reflects the pre-tax gain of $267.4 million, which resulted from the sale of the Company's one-third partnership interest in Lifetime for $317.6 million in April 1994. Proceeds from the sale were used to reduce outstanding debt.\nII-7\nFor 1993, \"Other items, net\" reflects the pre-tax gain of approximately $55 million from the sale of the stock of the Wisconsin cable system, a pre-tax gain of $17.4 million in the aggregate from sales of a portion of an investment held at cost, partially offset by an increase of $9.1 million to previously established non-operating litigation reserves and other items.\nProvision for Income Taxes The provision for income taxes represents federal, state and foreign income taxes on earnings before income taxes.\nThe annual effective tax rates of 74% for 1994 and 43% for 1993 were both adversely affected by amortization of acquisition costs which are not deductible for tax purposes. The 1993 effective tax rate was favorably affected as a result of reductions of certain prior year tax reserves of $22.0 million. The reductions were based on management's view concerning the outcome of several tax issues based upon the progress of federal, state and local audits.\nDuring the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" on a prospective basis and recognized an increase in earnings of $10.4 million in 1993 as the cumulative effect of a change in accounting principle.\nEquity in Earnings (Loss) of Affiliates \"Equity in earnings (loss) of affiliated companies, net of tax\" was $18.6 million for 1994 as compared to a loss of $2.5 million for 1993, primarily reflecting the inclusion of the net earnings of affiliated companies that were acquired as part of the Mergers, improved operating results of Comedy Central, partially offset by the absence of Lifetime's earnings due to the sale of the Company's one-third partnership interest. (See Note 1 of Notes to Consolidated Financial Statements.)\nMinority Interest Minority interest primarily represents the minority ownership of Paramount Communications' outstanding common stock, for the period March through June 1994, and the 23% minority ownership of Spelling's common stock for fourth quarter 1994.\nDiscontinued Operations Discontinued operations reflect the results of operations of Madison Square Garden Corporation (\"MSG\"), which was sold March 10, 1995. The Company acquired MSG during March 1994 as part of the Paramount Merger. (See Note 3 of Notes to Consolidated Financial Statements.)\nExtraordinary Losses During 1994, the Company refinanced its existing credit facilities and therefore recognized an after-tax extraordinary loss from the extinguishment of debt of $20.4 million, net of a tax benefit of $11.9 million.\nOn July 15, 1993, Viacom International redeemed all of the $298 million principal amount outstanding of the 11.80% Senior Subordinated Notes at a redemption price equal to 103.37% of the principal amount plus accrued interest to July 15, 1993. Viacom International recognized an after-tax extraordinary loss of $8.9 million, net of a tax benefit of $6.1 million. Viacom International borrowed the funds necessary for the redemption under bank credit agreements existing at the time.\nII-8\n1993 versus 1992 ----------------\nRevenues increased to $2.0 billion in 1993 from $1.9 billion in 1992 (or 8%). EBITDA increased to $538.1 million for 1993 from $492.7 million for 1992 (or 9%). Earnings from continuing operations increased to $385.0 million in 1993 from $347.9 million in 1992 (or 11%). Explanations of variances in revenues, EBITDA and earnings from continuing operations for each segment follow.\nThe comparability of results of operations for 1993 and 1992 has been affected by (i) the change in estimate of copyright royalty revenues during 1992 in the Entertainment segment and (ii) the sale of the Wisconsin cable television system, effective January 1, 1993. (See \"Entertainment\" and \"Cable Television\" for additional information.)\nNetworks and Broadcasting\nRevenues increased to $1.40 billion for 1993 from $1.23 billion for 1992 (or 14%). EBITDA increased to $382.6 million for 1993 from $303.8 million for 1992 (or 26%). Earnings from operations increased to $314.4 million from $237.5 million (or 32%). The increase in revenues and earnings from operations resulted primarily from increased advertising sales of MTVN. MTVN revenues of $677.9 million, EBITDA of $272.7 million, and earnings from operations of $239.7 million increased 27%, 33% and 39%, respectively. The increase in MTVN's advertising revenues was principally attributable to rate increases. The increase in MTVN's EBITDA reflects the increased revenues, partially offset by increased programming and marketing expenses at each of the networks and other costs of operating the networks, including start-up losses of MTV Latino and Nickelodeon Magazine aggregating $6.5 million. The increase in programming and marketing expenses at each of the networks (including animated programming on Nickelodeon and MTV) was to a large extent responsible for the Company's ability to increase advertising rates. Revenues of the television stations, radio stations and SNI each increased modestly. EBITDA and earnings from operations of the television stations and radio stations increased, and SNI's EBITDA and earnings from operations were constant.\nEntertainment\nEntertainment revenues decreased to $209.1 million for 1993 from $248.3 million for 1992 (or 16%). EBITDA decreased to $42.0 million for 1993 from $66.5 million for 1992 (or 37%). Earnings from operations decreased to $32.5 million for 1993 from $59.7 million for 1992 (or 46%). The revenue variance was principally due to lower syndication revenues, lower copyright revenues resulting from a change in estimate which increased revenue by approximately $10 million in 1992, and decreased network production revenues. Lower sales to the broadcast, cable and other market places reflect lower syndication revenues for The Cosby Show and softness in the syndication market place due to a decrease in the number of independent broadcast television stations because of new network affiliations. Revenues from the domestic broadcast syndication of The Cosby Show were approximately 12% and 18% of Entertainment revenues during 1993 and 1992, respectively. The decrease was due to the ending of the first domestic syndication cycle of The Cosby Show during the third quarter of 1993. Network license fees were lower because fewer shows were produced for network television; however, the decrease did not have a significant impact on Entertainment EBITDA. The EBITDA variance reflects the decreased revenues and $6.1 million of start-up losses associated with Viacom New Media.\nII-9\nCable Television\nCable Television revenues increased to $416.0 million in 1993 from $411.1 million in 1992 (or 1%). EBITDA decreased to $181.7 million for 1993 from $190.5 million for 1992 (or 5%). Earnings from operations decreased to $110.2 million in 1993 from $122.0 million in 1992 (or 10%).\nOn a comparable basis with the 1992 results (excluding the Wisconsin cable system, which was sold effective January 1, 1993), Cable Television revenues increased to $416.0 million in 1993 from $393.6 million in 1992 (or 6%); EBITDA decreased to $181.7 million in 1993 from $182.5 million in 1992; and earnings from operations decreased to $110.2 million for 1993 from $117.6 million for 1992 (or 6%). The results reflect a 4% increase in average rates for primary services and a 2% increase in average primary customers. Total revenue per primary customer per month increased 3% to $32.03 in 1993 from $31.04 in 1992. The decrease in EBITDA reflects increased operating expenses (which included non-recurring costs associated with the implementation of FCC rate regulations) partially offset by increased revenues.\nAs of December 31, 1993, the Company operated systems serving approximately 1,094,000 primary customers subscribing to approximately 718,000 premium units. Excluding the Wisconsin cable system customers in 1992, primary customers and premium units increased 2% and decreased 5%, respectively, since December 31, 1992. Including the Wisconsin cable system customers in 1993, primary customers and premium units decreased 2% and 9%, respectively, since December 31, 1992.\nCorporate Expenses\nCorporate expenses increased to $72.1 million in 1993 from $71.3 million in 1992 (or 1%), reflecting increased overall expenses offset by decreased compensation expense associated with the Long-Term Incentive Plans (the \"Plans\"), which consist of the Long-Term Incentive Plan (\"LTIP\") and the Long-Term Management Incentive Plan (\"LTMIP\"). The Plans provide for grants of phantom shares and stock options. The value of phantom shares issued under the Plans is determined by reference to the fair market value of Viacom Class A Common Stock and Viacom Class B Common Stock (collectively, \"Common Stock\"). The Plans also provide for subsequent cash payments with respect to such phantom shares based on appreciated value, subject to certain limits, and vesting requirements. As a result of the fluctuation in the market value of its Common Stock, the Company recorded compensation expense associated with the Plans of $3.9 million in 1993 and $8.2 million in 1992. During December 1992, a significant portion of the liability associated with the LTIP was satisfied by the cash payment of $68.6 million and the issuance of 177,897 shares of Viacom Class B Common Stock valued at $6.9 million.\nII-10\nOther Income and Expense Information\nInterest Expense, Net Net interest expense decreased to $145.0 million in 1993 from $194.1 million in 1992 (or 25%), reflecting improvements made to the capital structure (as described below) and reduced interest rates, including rates associated with the credit agreement. The Company had approximately $2.5 billion principal amount of debt outstanding as of December 31, 1993 and December 31, 1992 at weighted average interest rates of 5.3% and 6.5%, respectively. On July 15, 1993, the Company redeemed all $298 million principal amount outstanding of 11.80% Senior Subordinated Notes (\"11.80% Notes\"). During 1992, the following changes to the capital structure were made: a) on March 4, 1992, the Company issued $150 million principal amount of 9.125% Senior Subordinated Notes due 1999; b) on March 10, 1992, the Company redeemed all $193 million of the outstanding 11.5% Senior Subordinated Extendible Reset Notes (\"11.5% Reset Notes\") due 1998; c) on May 28, 1992, the Company issued $100 million principal amount of 8.75% Senior Subordinated Reset Notes due 2001; and d) on June 18, 1992, the Company redeemed all $356.5 million of the outstanding 14.75% Senior Subordinated Discount Debentures (\"Discount Debentures\") due 2002.\nOther Items, Net The settlement of the Time Warner antitrust lawsuit resulted in various business arrangements, which have a positive effect on the Company currently and are expected to continue to have a favorable effect on a prospective basis. \"Other items, net\" reflects a gain of $35 million recorded in the third quarter of 1992; representing payments received in the third quarter of 1992 relating to certain aspects of the settlement of the lawsuit, net of the Company's 1992 legal expenses related to this lawsuit. \"Other items, net\" also reflects a reserve for litigation of $33 million during the second quarter of 1992 related to a summary judgment against the Company in a dispute with CBS Inc. arising under the 1970 agreement associated with the spin-off of Viacom International Inc. by CBS Inc. On July 30, 1993, the Company settled all disputes arising under that litigation.\nIncome Taxes The provision for income taxes represents federal, state and foreign income taxes on earnings before income taxes.\nThe annual effective tax rates of 43% for 1993 and 54.5% for 1992 were adversely affected by amortization of acquisition costs which are not deductible for tax purposes. The 1993 and 1992 effective tax rates were favorably affected as a result of reductions of certain prior year tax reserves of $22.0 million and $20.0 million, respectively. The reductions were based on management's view concerning the outcome of several tax issues based upon the progress of federal, state and local audits.\nEquity in Earnings (Loss) of Affiliates \"Equity in earnings (loss) of affiliated companies, net of tax\" decreased 46% to $2.5 million in 1993 from $4.7 million in 1992, primarily reflecting improved operating results at Lifetime and Comedy Central, partially offset by net losses on equity investments made in 1993.\nII-11\nExtraordinary Losses On June 18, 1992, the Company redeemed all of the $356.5 million principal amount outstanding of the Discount Debentures at a redemption price equal to 105% of the principal amount plus accrued interest to June 18, 1992. On March 10, 1992, the Company redeemed all of the $193 million principal amount outstanding of its 11.50% Reset Notes at a redemption price equal to 101% of the principal amount plus accrued interest to the redemption date. The Company recognized an extraordinary loss of $17.1 million, net of a tax benefit of $11.3 million. The Company borrowed the funds necessary for each of these redemptions under its bank credit facilities existing in the respective periods.\nAcquisitions ------------\nOn March 11, 1994, the Company acquired a majority of the shares of Paramount Communications' common stock outstanding at a price of $107 per share in cash. On July 7, 1994, Paramount Communications became a wholly owned subsidiary of the Company. The total cost to acquire Paramount Communications of $9.9 billion was financed through $3.7 billion of borrowing from banks, $3.1 billion of cash and $3.1 billion of securities. (See Note 2 of Notes to Consolidated Financial Statements.) Such cash was obtained through the issuance of $1.8 billion of Preferred Stock (of which $600 million and $1.2 billion were issued to Blockbuster and NYNEX Corporation, respectively) and $1.25 billion of Viacom Class B Common Stock to Blockbuster. The securities issued to Blockbuster were canceled upon consummation of the Blockbuster Merger.\nOn September 29, 1994, Blockbuster was merged with and into the Company. The total cost to acquire Blockbuster of $7.6 billion was financed through the issuance of equity securities to Blockbuster shareholders. (See Note 2 of Notes to Consolidated Financial Statements.)\nLiquidity and Capital Resources -------------------------------\nThe Company expects to fund its anticipated cash requirements (including the anticipated cash requirements of its capital expenditures, joint ventures, commitments and payments of principal, interest and dividends on its outstanding indebtedness and preferred stock) with internally generated funds and from various external sources, which may include the Company's existing Credit Agreements, co-financing arrangements by the Company's various divisions, additional financings and the sale of non-strategic assets as opportunities may arise.\nThe Company's scheduled maturities of long-term debt, through December 31, 1999 assuming full utilization of the credit agreements (after giving effect to the reduction in commitments resulting from the sale of MSG), are $1.9 billion (1996), $163 million (1997), $1.0 billion (1998) and $1.5 billion (1999). (See Note 5 of Notes to Consolidated Financial Statements.) The Company's Preferred Stock dividend requirement is $60 million per year.\nThe Company's joint ventures are expected to require estimated net cash contributions of approximately $20 million to $40 million in 1995. Planned capital expenditures, including information systems costs, are approximately $600 million to $700 million in 1995. Capital expenditures are primarily related to capital additions for new and existing video and music stores and theme parks, and additional construction and equipment upgrades for the Company's existing cable franchises.\nII-12\nThe Company was in compliance with all debt covenants and had satisfied all financial ratios and tests as of December 31, 1994 under its Credit Agreement and the Company expects to remain in compliance and satisfy all such financial ratios and tests during 1995.\nDebt as a percentage of total capitalization of the Company was 47% at December 31, 1994 and 48% at December 31, 1993.\nSee Note 2 of Notes to Consolidated Financial Statements for a description of the Company's commitments related to the contingent value rights and variable common rights. See Note 10 of Notes to Consolidated Financial Statements for a description of the Company's future minimum lease commitments.\nThe commitments of the Company for program license fees, which are not reflected in the balance sheet as of December 31, 1994 and are estimated to aggregate approximately $2.0 billion, principally reflect commitments under SNI's exclusive arrangements with several motion picture companies. This estimate is based upon a number of factors. A majority of such fees are payable over several years, as part of normal programming expenditures of SNI. These commitments are contingent upon delivery of motion pictures which are not yet available for premium television exhibition and, in many cases, have not yet been produced.\nThere are various lawsuits and claims pending against the Company. Management believes that any ultimate liability resulting from those actions or claims will not have a material adverse effect on the Company's results of operations or financial position.\nCertain subsidiaries and affiliates of the Company from time to time receive claims from Federal and state environmental regulatory agencies and other entities asserting that they are or may be liable for environmental cleanup costs and related damages, principally relating to discontinued operations conducted by its former mining and manufacturing businesses (acquired as part of the mergers). The Company has recorded a liability at approximately the mid- point of its estimated range of environmental exposure. Such liability was not reduced by potential insurance recoveries and reflects management's estimate of cost sharing at multiparty sites. The estimated range of the potential liability was calculated based upon currently available facts, existing technology and presently enacted laws and regulations. On the basis of its experience and the information currently available to it, the Company believes that the claims it has received will not have a material adverse effect on its results of operations or financial position.\nNet cash flow from operating activities increased 130% to $339.2 million in 1994 from $147.6 million for 1993 principally due to the inclusion of Paramount Communications' and Blockbuster's results of operations since the effective time of the respective mergers and increased earnings from operations of Viacom's pre-merger businesses, prior to merger-related charges. Net cash expenditures from investing activities of $6.3 billion for 1994, principally reflect the acquisition of the majority of the shares of Paramount Communications and capital expenditures, partially offset by proceeds from the sale of the Company's one-third partnership in Lifetime. Net cash expenditures from investing activities of $128.4 million for 1993 principally reflect capital expenditures, acquisitions, an additional investment in StarSight Telecast, Inc. and advances to Comedy Central, partially offset by proceeds from the sale of the Wisconsin cable system, proceeds related to the radio station swap and proceeds from the sale of an investment held at cost. Financing activities reflect borrowings and repayment of debt under the credit agreements during each period presented; the issuance of Viacom Class B Common Stock to Blockbuster during 1994 and the redemption of the 11.80% Notes and the issuance of the Preferred Stock during 1993.\nII-13\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Viacom Inc.\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of cash flows and of shareholders' equity present fairly, in all material respects, the financial position of Viacom Inc. and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the management of Viacom Inc.; 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 LLP\n1177 Avenue of the Americas New York, New York 10036 February 10, 1995\nII-14\nMANAGEMENT'S STATEMENT OF RESPONSIBILITY FOR FINANCIAL REPORTING\nManagement has prepared and is responsible for the consolidated financial statements and related notes of Viacom Inc. They have been prepared in accordance with generally accepted accounting principles and necessarily include amounts based on judgments and estimates by management. All financial information in this annual report is consistent with the consolidated financial statements.\nThe Company maintains internal accounting control systems and related policies and procedures designed to provide reasonable assurance that assets are safeguarded, that transactions are executed in accordance with management's authorization and properly recorded, and that accounting records may be relied upon for the preparation of consolidated financial statements and other financial information. The design, monitoring, and revision of internal accounting control systems involve, among other things, management's judgment with respect to the relative cost and expected benefits of specific control measures. The Company also maintains an internal auditing function which evaluates and reports on the adequacy and effectiveness of internal accounting controls, policies and procedures.\nViacom Inc.'s consolidated financial statements have been audited by Price Waterhouse LLP, independent accountants, who have expressed their opinion with respect to the presentation of these statements.\nThe Audit Committee of the Board of Directors, which is comprised solely of directors who are not employees of the Company, meets periodically with the independent accountants, with our internal auditors, as well as with management, to review accounting, auditing, internal accounting controls and financial reporting matters. The Audit Committee is also responsible for recommending to the Board of Directors the independent accounting firm to be retained for the coming year, subject to stockholder approval. The independent accountants and the internal auditors have full and free access to the Audit Committee with and without management's presence.\nVIACOM INC.\nBy: \/s\/Frank J. Biondi, Jr. ----------------------------------- Frank J. Biondi, Jr. President, Chief Executive Officer\nBy: \/s\/George S. Smith, Jr. ----------------------------------- George S. Smith, Jr. Senior Vice President, Chief Financial Officer\nBy: \/s\/ Kevin C. Lavan ----------------------------------- Kevin C. Lavan Senior Vice President, Controller and Chief Accounting Officer\nII-15\nVIACOM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS -------------------------------------- (In millions, except per share amounts)\nII-16\nVIACOM INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In millions) ----------------------------\nII-17\nVIACOM INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ---------------------------- (In millions, except per share amounts)\nSee notes to consolidated financial statements.\nII-18\nII-19\nVIACOM INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EOUITY (In millions)\nSee notes to consolidated financial statements.\nII-20\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1) SUMMARY OF ACCOUNTING POLICIES\nBasis of Presentation - The Company is a diversified entertainment and publishing company with operations in five segments: (i) Networks and Broadcasting, (ii) Entertainment, (iii) Video and Music\/Theme Parks, (iv) Publishing and (v) Cable Television. Paramount Communications Inc. (\"Paramount Communications\") and Blockbuster Entertainment Corporation (\"Blockbuster\") results of operations are included in the Company's consolidated results of operations effective March 1, 1994 and October 1, 1994, respectively. (See Note 2).\nCertain amounts reported on the balance sheet and statements of cash flows for prior years have been reclassified to conform with the current presentation.\nPrinciples of Consolidation - The consolidated financial statements include the accounts of the Company and all investments of more than 50% in subsidiaries and other entities. Investments in affiliated companies over which the Company has a significant influence or ownership of more than 20% but less than or equal to 50% are accounted for under the equity method. All significant intercompany transactions have been eliminated. Investments of 20% or less are accounted for under the cost method. In 1993, the fiscal year end for certain foreign operations was changed from October 31 to December 31.\nCash Equivalents - Cash equivalents are defined as short-term (3 months or less) highly liquid investments.\nInventories - Publishing related inventories are generally determined using the lower of cost (first-in, first-out method) or net realizable value. Prerecorded music and videocassette inventories costs are determined using the moving weighted average method, the use of which approximates the first-in, first-out basis. Videocassette rental inventory is recorded at cost and amortized over its estimated economic life with no provision for salvage value. Videocassettes which are considered base stock are amortized over 36 months on a straight-line basis. Videocassettes which are considered new release feature films are frequently ordered in large quantities to satisfy initial demand (\"hits\"). For each store, the fifth and any succeeding copies of hit titles purchased are amortized over six months on a straight-line basis.\nTheatrical and Television Inventories - Inventories related to theatrical and television product (which include direct production costs, production overhead, capitalized interest, acquisition costs, prints and certain exploitation costs) are stated at the lower of amortized cost or net realizable value. Inventories, residuals and participations are amortized on an individual product basis based on the proportion that current revenues bear to the estimated remaining total lifetime revenues. Domestic syndication and basic cable revenue estimates are not included in the estimated lifetime revenues of network series until such sales are probable. Estimates of total lifetime revenues and expenses are periodically reviewed. The costs of feature and television films are classified as\nII-21\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\ncurrent assets to the extent such costs are expected to be recovered through their respective primary markets. Other costs related to film production are classified as noncurrent. A portion of the cost to acquire Paramount Communications and Blockbuster was allocated to theatrical and television inventories based upon estimated revenues from certain films less related costs of distribution and a reasonable profit allowance for the selling effort. The cost allocated to films is being amortized over their estimated economic lives not to exceed 20 years.\nThe Company estimates that approximately 66% of unamortized film costs (including amounts allocated under purchase accounting) at December 31, 1994 will be amortized within the next three years.\nProgram Rights - The Company acquires rights to exhibit programming on its broadcast stations or cable networks. The costs incurred in acquiring programs are capitalized, to the extent they are estimated to be recovered from future revenues, and amortized over the license period. Program rights and the related liabilities are recorded at the gross amount of the liabilities when the license period has begun, the cost of the program is determinable, and the program is accepted and available for airing.\nProperty and Equipment - Property and equipment is stated at cost. Depreciation is computed principally by the straight-line method over estimated useful lives ranging from 3 to 40 years. Depreciation expense, including capitalized lease amortization, was $215.9 million (1994), $92.8 million (1993) and $81.5 million (1992).\nIntangible Assets - Intangible assets, which primarily consist of the cost of acquired businesses in excess of the market value of tangible assets and liabilities acquired, are generally amortized by the straight-line method over estimated useful lives of up to 40 years. The Company evaluates the amortization period of intangibles on an ongoing basis in light of changes in any business conditions, events or circumstances that may indicate the potential impairment of intangible assets. Accumulated amortization of intangible assets at December 31 was $663.2 million (1994) and $412.5 million (1993).\nRevenue Recognition - Subscriber fees for Networks and Cable Television are recognized in the period the service is provided. Advertising revenues for Networks and Broadcasting are recognized in the period during which the spots are aired. Revenues from the Company owned video and music stores are recognized at the time of rental or sale. The publishing segment recognizes revenue when merchandise is shipped and billed.\nTheatrical and Television Revenues - Feature motion pictures are produced or acquired for distribution, normally, for exhibition in U.S. and foreign theaters followed by videocassettes and discs, pay-per-view, premium subscription television, network television, basic cable television and syndicated television exploitation. On average, the length of the initial revenue cycle for feature films approximates four to seven years. Theatrical revenues from domestic and foreign markets are recognized as films are exhibited; revenues from the sale of videocassettes are recognized upon delivery of the merchandise; and revenues from all television sources are recognized upon availability of the film for telecast.\nII-22\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nTelevision series initially produced for the networks and first-run syndication are generally licensed to domestic and foreign markets concurrently. The more successful series are later syndicated in domestic markets and in certain foreign markets. The length of the revenue cycle for television series will vary depending on the number of seasons a series remains in active production. Revenues arising from television license agreements are recognized in the year that the films or television series are available for telecast.\nInterest - Costs associated with the refinancing or issuance of debt, as well as with debt discount, are expensed as interest over the term of the related debt. The Company enters into interest rate exchange agreements; the amount to be paid or received under such agreements is accrued as interest rates change and is recognized over the life of the agreements as an adjustment to interest expense. Amounts paid for purchased interest rate cap agreements are amortized into interest over the term of the agreement (See Note 6).\nEquity In Earnings (Loss) of Affiliated Companies - Equity in earnings (loss) of affiliated companies in the Consolidated Statement of Operations is primarily comprised of the Company's interest in Lifetime (33% owned), Comedy Central (50% owned), Nickelodeon (UK) (50% owned) and All News Channel (50% owned), as well as, in 1994, investments that were acquired as part of the Mergers (as defined in Note 2). Such investments were USA Networks (50% owned), Cinamerica (50% owned), United Cinemas International Multiplex B.V. (49% owned), Cinema International Corporation N.V. (49% owned) and Discovery Zone (50% owned). The Company's interest in Lifetime was sold in 1994 (See Note 14).\nThe Company, through the normal course of business, is involved in transactions with affiliated companies that have not been material in any of the periods presented.\nForeign Currency Translation and Transactions - The Company's foreign subsidiaries' assets and liabilities are translated at exchange rates in effect at the balance sheet date, while results of operations are translated at average exchange rates for the respective periods. The resulting translation gains or losses are included as a separate component of shareholders' equity. Foreign currency transaction gains and losses have been included in results of operations and have not been material in any of the years presented.\nProvision for Doubtful Accounts - The provision for doubtful accounts charged to expense was $61.6 million (1994), $16.7 million (1993) and $9.4 million (1992).\nNet Earnings per Common Share - Primary net earnings per common share is calculated based on the weighted average number of common shares outstanding during each period and for 1994, the effects of common shares potentially issuable in connection with the contingent value rights (\"CVRs\"), variable common rights (\"VCRs\"), stock options and warrants. For 1993 and 1992, the effect of contingently issuable common shares from stock options was immaterial and, therefore, the effect is not reflected in primary net earnings per common share for those periods. For 1994 and 1993, the effect of the assumed conversion of Preferred Stock is antidilutive and, therefore, not reflected in fully diluted net earnings per common share.\nII-23\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n2) PARAMOUNT MERGER, BLOCKBUSTER MERGER AND RELATED TRANSACTIONS\nOn March 11, 1994, the Company acquired a majority of the shares of Paramount Communications common stock outstanding at a price of $107 per share in cash. On July 7, 1994, Paramount Communications became a wholly owned subsidiary of the Company (the \"Paramount Merger\"). Each share of Paramount Communications common stock outstanding at the time of the Paramount Merger (other than shares held in the treasury of Paramount Communications or owned by the Company and other than shares held by any stockholders who demanded and perfected appraisal rights) was converted into the right to receive (i) 0.93065 of a share of Class B Common Stock, (ii) $17.50 principal amount of 8% exchangeable subordinated debentures (\"8% Merger Debentures\"), (iii) 0.93065 of a CVR (iv) 0.5 of a warrant to purchase one share of Viacom Class B Common Stock at any time prior to the third anniversary of the Paramount Merger at a price of $60 per share, and (v) 0.3 of a warrant to purchase one share of Viacom Class B Common Stock at any time prior to the fifth anniversary of the Paramount Merger at a price of $70 per share.\nEach CVR represents the right to receive the amount, if any, by which the Target Price exceeds the greater of the Current Market Value or the Minimum Price (see defined terms in following paragraph). The CVRs will mature on the first anniversary of the Paramount Merger (the \"Maturity Date\"), provided, however, that the Company may, at its option, (i) extend the Maturity Date to the second anniversary of the Paramount Effective Time (the \"First Extended Maturity Date\") or (ii) extend the First Extended Maturity Date to the third anniversary or the Paramount Effective Time (the \"Second Extended Maturity Date\"). The Company, at its option, may pay any amount due under the terms of the CVRs in cash or in the equivalent value of registered securities of the Company, including, without limitation, common stock, preferred stock, notes or other securities.\nThe \"Minimum Price\" means (a) at the Maturity Date, $36, (b) at the First Extended Maturity Date, $37 and (c) at the Second Extended Maturity Date, $38. \"Target Price\" means (a) at the Maturity Date, $48, (b) at the First Extended Maturity Date, $51, and (c) at the Second Extended Maturity Date, $55. The \"Current Market Value\" means the average market price of Viacom Class B Common Stock for a specified period prior to the respective maturity dates.\nOn September 29, 1994, Blockbuster was merged with and into the Company (the \"Blockbuster Merger\"). Each share of Blockbuster Common Stock outstanding at the time of the Blockbuster Merger (other than shares held in the treasury of Blockbuster or owned by the Company) was converted into the right to receive (i) 0.08 of a share of Viacom Class A Common Stock, (ii) 0.60615 of a share of Viacom Class B Common Stock, and (iii) one VCR.\nThe VCRs represent the right to receive a fraction of a share of Viacom Class B Common Stock, with the exact fraction dependent on the market price of Viacom Class B Common Stock during the year following the effective time of the Blockbuster Merger. The VCRs mature on the first anniversary date of the Blockbuster Merger. Based upon the market price of Viacom Class B Common Stock, following the Blockbuster Merger the maximum fraction of a share issuable pursuant to the VCRs was reduced from 0.13829 of a share of Viacom Class B Common Stock to 0.05929 of a share of Viacom Class B Common Stock, or a maximum issuable potential of approximately 16.7 million shares of Viacom Class B Common Stock.\nII-24\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe Paramount Merger and the Blockbuster Merger (collectively, the \"Mergers\") have been accounted for under the purchase method of accounting. Accordingly, the total cost to acquire Paramount Communications of $9.9 billion and Blockbuster of $7.6 billion has been allocated to the respective assets and liabilities acquired based on their fair values at the time of the Mergers with the aggregate excess cost over the fair value of net tangible assets acquired of $7.9 billion and $6.8 billion, respectively, allocated to goodwill.\nThe unaudited condensed pro forma results of operations data presented below assumes that the Mergers and related transactions, the sale of the one-third partnership interest in Lifetime and the sale of MSG (as defined in Note 3) occurred at the beginning of each period presented. The unaudited condensed pro forma results of operations data was prepared based upon the historical consolidated results of operations of the Company for the years ended December 31, 1994 and 1993, Paramount for the two months ended February 28, 1994 and year ended December 31, 1993, and Blockbuster for the nine months ended September 30, 1994 and year ended December 31, 1993, adjusted to exclude the non-recurring merger-related charges of $332.1 million (as described below). Financial information for Paramount Communications and Blockbuster subsequent to the date of acquisition is included in the Company's historical information. Intangible assets are amortized principally over 40 years on a straight-line basis. The following unaudited pro forma information is not necessarily indicative of the combined results of operations of the Company, Paramount Communications and Blockbuster that would have occurred if the completion of the transactions had occurred on the dates previously indicated nor are they necessarily indicative of future operating results of the combined company.\nPro forma earnings from continuing operations for the year ended December 31, 1994 exclude $332.1 million of non-recurring merger-related charges reflecting the integration of the Company's pre-merger businesses with similar Paramount Communications units, and related management and strategic changes principally related to the merger with Paramount Communications.\nII-25\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nDuring each of the three years presented, the Company has also acquired or sold certain other businesses. The contributions of these businesses in the aggregate were not significant to the Company's results of operations for the periods presented, nor are they expected to have a material effect on the Company's results on a continuing basis.\n3) SUBSEQUENT EVENTS\nOn January 20, 1995, the Company agreed to sell its cable television systems to a partnership of which Mitgo Corp., a company wholly owned by Frank Washington, is a general partner, for approximately $2.3 billion, subject to certain conditions, including, receipt of a tax certificate from the Federal Communications Commission and the availability of certain federal tax consequences of the sale advantageous to the Company. The U. S. House of Representatives and U. S. Senate have each approved a similar version of legislation that would eliminate such tax consequences. The House of Representatives has also approved a compromise version of the bill, which is awaiting Senate approval. The Company has announced that it will not proceed with the agreed transaction in the event that such tax consequences are unavailable. The Company has also announced that it is considering other options with respect to the disposition of its cable systems and that it intends to proceed with such disposition. Until a formal plan for the disposition is established, operating results for Cable Television will be included in earnings from continuing operations.\nDuring March 1995, the Company sold Madison Square Garden Corporation (which includes the Madison Square Garden Arena, The Paramount theater, the New York Knickerbockers, the New York Rangers and the Madison Square Garden Network, collectively \"MSG\") to a joint venture of ITT Corporation and Cablevision Systems Corporation for closing proceeds of $1.009 billion, representing the sale price of approximately $1.075 billion, less approximately $66 million in working capital adjustments. The sale of MSG resulted in no after-tax book gain. Proceeds from the sale were used to pay down notes payable to banks. The Company acquired MSG as part of the Paramount Merger.\nMSG has been accounted for as a discontinued operation and, accordingly, its operating results and net assets have been separately disclosed in the Consolidated Financial Statements.\nII-26\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nSummarized results of operations for the year ended December 31, 1994 and financial position data as of December 31, 1994 for MSG are as follows (millions of dollars).\nResults of operations: Revenues $273.4 Loss from operations before income tax benefit $(25.4) Income tax benefit $ 4.9 Net loss $(20.5)\nFinancial position: Current assets $107.8 Net property, plant and equipment 312.9 Other assets 409.4 Total liabilities (132.7) ------ Net assets of discontinued operations $697.4 ======\nII-27\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n5) BANK FINANCING AND DEBT\n* Issues of Viacom International guaranteed by the Company.\n(a) -- On July 1, 1994, the Company entered into an aggregate $6.489 billion credit agreement (the \"Viacom Credit Agreement\"), and Viacom International Inc. (\"Viacom International\") and certain of its subsidiaries (the \"Subsidiary Obligors\") entered into a $311 million credit agreement (the \"Viacom International Credit Agreement,\" together with the Viacom Credit Agreement, collectively the \"Credit Agreements\") each with certain banks, the proceeds of which were used to refinance debt related to the Paramount Merger and the previously existing bank debt of the Company, Viacom International and Paramount. On September 29, 1994, the Company entered into an aggregate $1.8 billion credit agreement (the \"$1.8 billion Credit Agreement\") with certain banks, the proceeds of which were used to refinance the previously existing bank debt of Blockbuster.\nThe Company guarantees the Viacom International Credit Agreement and notes and debentures issued by Viacom International. Viacom International guarantees Viacom's Credit Agreement, the $1.8 billion Credit Agreement and notes and debentures issued by the Company.\nII-28\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe following is a summary description of the credit agreements. The description does not purport to be complete and should be read in conjunction with each of the credit agreements.\nThe Viacom Credit Agreement is comprised of (i) a $2.5 billion senior unsecured 2-1\/2 year revolving short term loan (the \"Short-Term Loan\") maturing December 31, 1996, (ii) a $1.8 billion senior unsecured 8 year reducing revolving loan (the \"Revolving Loan\") maturing July 1, 2002 and (iii) a $2.189 billion 8 year term loan maturing July 1, 2002 (the \"Term Loan\"). The Viacom International Credit Agreement is comprised of a $311 million 8-year term loan to Viacom International and certain of its subsidiaries maturing July 1, 2002. The $1.8 billion Credit Agreement is comprised of a $1.8 billion senior unsecured reducing revolving loan to the Company maturing July 1, 2002.\nThe interest rate on all loans made under the three facilities is based upon Citibank, N.A.'s base rate or the London Interbank Offered Rate and is affected by the Company's credit rating. At December 31, 1994, the London Interbank Offered Rates (\"LIBOR\") (upon which the Company's borrowing rate was based) for borrowing periods of one month and two months were 6.0% and 6.25%, respectively. At December 31, 1993, LIBOR for borrowing periods of one and two months were 3.25% and 3.3125%, respectively.\nThe Company may prepay the loans and reduce commitments under the Viacom Credit Agreement and the $1.8 billion Credit Agreement in whole or in part at any time. The Company is required, subject to certain conditions, to make prepayments under the Short-Term Loan resulting from receipt of the first $2.5 billion in the aggregate of net cash proceeds from asset sales other than in the ordinary course of business or from capital market transactions. In the event that a Subsidiary Obligor ceases to be a wholly owned subsidiary of the Company or Viacom International, the loans of such Subsidiary Obligor shall be due and payable on the date on which such subsidiary ceases to be a wholly owned subsidiary. If such event occurs prior to December 31, 1996 or the repayment in full of all Short-Term Loans, the Company may elect to convert any outstanding portion of the Short-Term Loan into additional Term Loans in an amount equal to the principal amount of such Subsidiary Obligor's loan.\nThe credit agreements contain certain covenants which, among other things, require that the Company maintain certain financial ratios and impose on the Company and its subsidiaries certain limitations on substantial asset sales and mergers with any other company in which the Company is not the surviving entity.\nThe credit agreements contain certain customary events of default and provide that it is an event of default if National Amusements, Inc. (\"NAI\") fails to own at least 51% of the outstanding voting stock of the Company.\nThe Company is required to pay a commitment fee based on the aggregate daily unborrowed portion of the loan commitments. As of December 31, 1994, the Company had $957 million of available loan commitments. The credit agreements do not require compensating balances.\nII-29\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(b) -- The $100 million aggregate principal amount of 8.75% Senior Subordinated Reset Notes (\"8.75% Reset Notes\") are due on May 15, 2001. On May 15, 1995 and May 15, 1998, unless a notice of redemption of the 8.75% Reset Notes on such date has been given by the Company, the interest rate on the 8.75% Reset Notes will, if necessary, be adjusted from the rate then in effect to a rate to be determined on the basis of market rates in effect on May 5, 1995 and on May 5, 1998, respectively, as the rate the 8.75% Reset Notes should bear in order to have a market value of 101% of principal amount immediately after the resetting of the rate. In no event will the interest rate be lower than 8.75% or higher than the average three year treasury rate (as defined in the indenture) multiplied by two. The interest rate reset on May 15, 1995 will remain in effect on the 8.75% Reset Notes through and including May 15, 1998 and the interest rate reset on May 15, 1998 will remain in effect on the 8.75% Reset Notes thereafter. The 8.75% Reset Notes are redeemable at the option of the Company, in whole but not in part, on May 15, 1995 or May 15, 1998, at a redemption price of 101% of principal amount plus accrued interest to, but not including, the date of redemption.\n(c) -- The Company issued an aggregate principal amount of $1,069.9 million of 8% Merger Debentures as part of the Paramount Merger consideration. The balance sheet reflects the fair value of the 8% Merger Debentures plus amortization of the related discount. _____________________\nExtraordinary Losses\nDuring 1994, the proceeds from the Viacom Credit Agreement were used to refinance the previously existing bank debt of the Company. The Company recognized an extraordinary loss from the extinguishment of debt of $20.4 million, net of a tax benefit of $11.9 million.\nOn July 15, 1993, Viacom International redeemed all of the $298 million principal amount outstanding of the 11.80% Senior Subordinated Notes at a redemption price equal to 103.37% of the principal amount plus accrued interest to July 15, 1993. Viacom International recognized an extraordinary loss from the extinguishment of debt of $8.9 million, net of a tax benefit of $6.1 million.\nOn June 18, 1992, the Company redeemed all of the $356.5 million principal amount outstanding of the 14.75% Senior Subordinated Discount Debentures at a redemption price equal to 105% of the principal amount plus accrued interest to June 18, 1992. On March 10, 1992, the Company redeemed all of the $193 million principal amount outstanding of its 11.50% Senior Subordinated Extendible Reset Notes at a redemption price equal to 101% of the principal amount plus accrued interest to the redemption date. The Company recognized an extraordinary loss of $17.1 million, net of a tax benefit of $11.3 million.\nThe Company borrowed the funds necessary for each of these redemptions under its bank credit facilities existing in the respective periods.\nII-30\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nInterest costs incurred, interest income and capitalized interest are summarized below:\nYear Ended December 31, ---------------------------------- (Millions of dollars) 1994 1993 1992 ---- ---- ---- Interest Incurred $ 536.3 $154.5 $195.7 Interest Income $ 32.6 $ 9.1 $ 1.1 Capitalized Interest $ 9.6 $ .4 $ .5\nScheduled maturities of long-term debt of the Company through December 31, 1999, assuming full utilization of the commitments under the credit agreements (after giving effect to the reduction in commitments resulting from the sale of MSG), are $1.9 billion (1996), $163 million (1997), $1.0 billion (1998) and $1.5 billion (1999).\n6) FINANCIAL INSTRUMENTS\nThe Company's carrying value of the financial instruments approximates fair value, except for differences with respect to the senior subordinated debt and certain differences related to other financial instruments which are not significant. The carrying value of the senior and senior subordinated debt is $2.5 billion and the fair value, which is estimated based on quoted market prices, is approximately $2.4 billion.\nThe Company enters into interest rate exchange agreements with off-balance sheet risk in order to reduce its exposure to changes in interest rates on its variable rate long-term debt and\/or take advantage of changes in interest rates. These interest rate exchange agreements include interest rate swaps and interest rate caps. At December 31, 1994, the Company had $2.1 billion of interest rate exchange agreements outstanding with commercial banks. $1.6 billion of these agreements, which expire over the next three years, effectively change the Company's interest rate on an equivalent amount of variable rate borrowings to a fixed rate of 6.8%. The remaining $500 million of interest rate exchange agreements, which expire during 1995, effectively convert $500 million of its debt from an average fixed rate of 7.9% to a variable rate (8.0% at December 31). The Company is exposed to credit loss in the event of nonperformance by the counterparties to the agreements. However, the Company does not anticipate nonperformance by the counterparties.\nThe Company enters into foreign currency exchange contracts in order to reduce its exposure to changes in foreign currency exchange rates. To date, the hedges have been purchased options and forward contracts. A forward contract is an agreement between parties to purchase and sell a foreign currency, for a price specified at the contract date, with delivery and settlement in the future. An option contract provides the right, but not the obligation, to buy or sell currency at a fixed rate on a future date. At December 31, 1994, the Company had outstanding contracts with a notional value of approximately $36 million, which hedge the European Currency Unit and Japanese Yen, and expire in 1995 and 1996. Realized gains and losses on contracts that hedge expected future cash flows are recognized in \"Other Items, Net\" and were not material in the current period.\nII-31\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n7) SHAREHOLDERS' EQUITY\nOn July 7, 1994 and September 29, 1994, the Company issued equity securities to holders of Paramount Communications and Blockbuster common stock, respectively (See Note 2).\nDuring March 1994, Blockbuster purchased 22.7 million shares of Viacom Class B Common Stock at a price of $55 per share. The common stock was canceled upon consummation of the Blockbuster Merger.\nOn October 22, 1993, Blockbuster purchased 24 million shares of cumulative convertible preferred stock, par value $.01 per share, of the Company (\"Series A Preferred Stock\") for $600 million. The Preferred Stock purchased by Blockbuster was canceled upon consummation of the Blockbuster Merger. On November 19, 1993, NYNEX Corporation (\"NYNEX\") purchased 24 million shares of cumulative convertible preferred stock, par value $.01 per share, of the Company (\"Series B Preferred Stock,\" collectively with the Series A Preferred Stock, \"Preferred Stock\") for $1.2 billion. Series B Preferred Stock has a liquidation preference of $50 per share, an annual dividend rate of 5%, is convertible into shares of Viacom Class B Common Stock at a conversion price of $70 and does not have voting rights other than those required by law. The Series B Preferred Stock is redeemable by the Company at declining premiums after five years.\nNAI holds approximately 26% and the public holds approximately 74% of the Company's outstanding Common Stock as of December 31, 1994. NAI owns 61% of the outstanding Viacom Class A Common Stock as of December 31, 1994.\nLong-Term Incentive Plans - The purpose of the Long-Term Incentive Plans (the \"Plans\") is to benefit and advance the interests of the Company by rewarding certain key employees for their contributions to the financial success of the Company and thereby motivating them to continue to make such contributions in the future. The Plans provide for grants of equity-based interests pursuant to awards of phantom shares, stock options, stock appreciation rights, restricted shares or other equity-based interests (\"Awards\"), and for subsequent payments of cash with respect to phantom shares or stock appreciation rights based, subject to certain limits, on their appreciation in value over stated periods of time.\nDuring December 1992, a significant portion of the liability associated with the phantom shares was satisfied through the cash payment of $68.6 million and the issuance of 177,897 shares of Viacom Class B Common Stock valued at $6.9 million.\nIn addition to the 25.0 million stock option Awards outstanding under various plans, as of December 31, 1994 there are phantom shares for 643,098 shares of common stock all of which are vested, at an average grant price of $29 and vest over a three year period from the date of grant. The stock options generally vest over a four to six year period from the date of grant and expire 10 years after the date of grant. II-32\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nEach of the unexercised stock options to purchase Paramount or Blockbuster common stock that was outstanding at the time of the respective mergers, automatically became options to purchase the merger consideration applicable to the stock option under the same price and terms, except that, for employees of Paramount Communications who were employees on the date of the Paramount Merger, additional Viacom Class B Common Stock valued July 1995, will be issued on exercise of such options as consideration for the cash portion of the blended purchase price per share of Paramount Communications that was not reflected in the Merger consideration because of the transaction structure. These options generally became vested upon the effective date of the Merger, and are exercisable over a three to five year period and expire 10 years after the date of grant.\nThe following table summarizes the stock activity under the various plans:\nThe Company has reserved 1,847,302 shares of Viacom Class A Common Stock and 57,577,294 shares of Viacom Class B Common Stock principally for exercise of stock options and warrants, the conversion of the Preferred Stock, CVRs and VCRs. Such shares are based on the average market value of Viacom Class B Common Stock as of March 27, 1995.\nII-33\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n8) INCOME TAXES\nThe provision for income taxes shown below for the years ended December 31, 1994, 1993 and 1992 represents federal, state and foreign income taxes on earnings before income taxes. Earnings (loss) accounted for under the equity method of accounting are shown net of tax on the Company's Statement of Operations. The tax provision (benefit) relating to earnings (loss) from equity investments in 1994, 1993 and 1992 are $9.8 million, $(.6) million and $(2.2) million, respectively. See Note 3 and 5 for tax benefits relating to the Discontinued Operations and Extraordinary Losses.\nDuring the first quarter of 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") on a prospective basis and recognized an increase to earnings of $10.4 million in 1993 as the cumulative effect of a change in accounting principle. SFAS 109 mandates the liability method for computing deferred income taxes.\nEarnings before income taxes are attributable to the following jurisdictions:\nYear Ended December 31, 1994 1993 1992 ------ ------ ------ (Millions of dollars)\nUnited States $179.4 $267.8 $138.2 Foreign 197.3 34.0 17.4 ------ ------ ------ Total $376.7 $301.8 $155.6 ------ ------ ------ ------ ------ ------\nComponents of the provision for income taxes on earnings before income taxes are as follows:\nYear Ended December 31, 1994 1993 1992 ------ ------ ------ (Millions of dollars) Current: Federal $139.1 $89.5 $47.3 State and local 78.3 10.4 17.9 Foreign 65.8 5.6 4.6 ------ ------ ------ 283.2 105.5 69.8\nDeferred (3.5) 24.3 15.0 ------ ------ ------ $279.7 $129.8 $84.8 ------ ------ ------ ------ ------ ------\nII-34\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nA reconciliation of the U.S. Federal statutory tax rate to the Company's effective tax rate on earnings before income taxes is summarized as follows:\nYear Ended December 31, 1994 1993 1992 ------ ------ ------ Statutory U.S. tax rate 35.0% 35.0% 34.0% State and local taxes, net of federal tax benefit 6.6 5.7 4.7 Effect of foreign operations .2 .5 1.9 Amortization of intangibles 25.9 7.1 18.2 Divestiture tax versus book 1.5 (3.2) -- Property and equipment basis difference -- -- 7.2 Income tax reserve adjustment -- (5.0) (12.9) Effect of changes in statutory rate -- .5 -- Other, net 5.1 2.4 1.4 ---- ---- ---- Effective tax rate 74.3% 43.0% 54.5% ===== ===== =====\nThe annual effective tax rate of 43% for 1993 and 54.5% for 1992 includes a reduction of certain prior year tax reserves in the amount of $22 million and $20 million, respectively. The reduction is based on management's view concerning the outcome of several tax issues based upon the progress of federal, state and local audits.\nII-35\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe following is a summary of the deferred tax accounts in accordance with SFAS 109 for the year ended December 31, 1994 and 1993.\nAs of December 31, 1994 and December 31, 1993, the Company had total non-current deferred net tax assets (liabilities) of $605.4 million and ($85.2) million, and current deferred net tax assets of $193.8 million and $16.3 million, respectively. The 1994 net deferred tax assets include a valuation allowance of $75.7 million, principally relating to acquired net operating loss and tax credit carryforwards which are subject to statutory limitations.\nAs of December 31, 1994, the Company had net operating loss carryforwards of approximately $239 million, capital loss carryforwards of approximately $10 million and tax credit carryforwards of approximately $12 million, which were acquired by the Company as a result of its 1994 mergers with Paramount Communications and Blockbuster. The carryforwards are subject to statutory limitations which resulted from a change of ownership. The carryforward periods expire in years 1995 through 2009.\nII-36\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe Company's share of the undistributed earnings of foreign subsidiaries not included in its consolidated Federal income tax return that could be subject to additional income taxes if remitted, was approximately $881 million at December 31, 1994. No provision has been made for additional U.S. or foreign taxes that could result from the remittance of such undistributed earnings since the Company intends to reinvest these earnings indefinitely, and it is not practicable to estimate the amount of any such additional taxes.\nThe following table identifies the deferred tax items which were part of the Company's tax provision under previously applicable accounting principles for the year ended December 31, 1992 (millions of dollars):\nDeferred compensation $22.7 Depreciation 7.6 Syndication advance payments 4.1 Litigation accrual (13.3) Sale of cable system (6.9) Other, net .9 ----- $15.1 ----- -----\n9) PENSION PLANS, OTHER POSTRETIREMENT BENEFITS AND POSTEMPLOYMENT BENEFITS\nThe Company and certain of its subsidiaries have non-contributory pension plans covering specific groups of employees. The Company continues to maintain the pension plans of the former Paramount Communications. The benefits for these plans are based primarily on an employee's years of service and pay near retirement. Participant employees are vested in the plans after five years of service. The Company's policy for all pension plans is to fund amounts in accordance with the Employee Retirement Income Security Act of 1974. Plan assets consist principally of common stocks, marketable bonds and United States government securities.\nNet periodic pension cost consists of the following components:\nYear Ended December 31, ---------------------------- 1994 1993 1992 ---- ---- ---- (Millions of dollars) Service cost - benefits earned during the period $ 22.1 $ 5.4 $ 4.6 Interest cost on projected benefit obligation 33.4 4.1 3.3 Return on plan assets: Actual 2.9 (1.8) (1.4) Deferred (37.7) (1.1) (.8) Net amortizations .6 .5 .5 -------- ------ ------ Net pension cost $ 21.3 $ 7.1 $ 6.2 -------- ------ ------ -------- ------ ------ II-37\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe funded status of the pension plans for the periods indicated is as follows:\nThe following assumptions were used in accounting for the pension plans:\nIn addition, during 1994, certain of the Company's employees participated in multiemployer pension plans, for which the Company had other pension expense of $10.9 million.\nThe Company sponsors a welfare plan which provides certain postretirement health care and life insurance benefits to substantially all of the Paramount Communications employees and their covered dependents who generally have worked 10 years and are eligible for early or normal retirement under the provisions of the Paramount Communications retirement plan. The welfare plan is contributory and contains cost-sharing features such as deductible and coinsurance which are adjusted annually. The plan is not funded. The Company continues to fund these benefits as claims are paid. II-38\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe components of the amount recognized as of December 31, 1994 are as follows (in millions):\nAccumulated postretirement benefit obligation attributable to: Current retirees $ 88.9 Fully eligible active plan participants 17.8 Other active plan participants 35.1 Unrecognized net gain 21.4 ------- Accumulated postretirement benefit obligation $ 163.2 ------- ------- The components of net periodic postretirement benefit cost for the year ended December 31, 1994 are as follows (in millions):\nService costs-benefits earned $ 4.4 Interest cost on accumulated postretirement benefit obligation 9.5 ------ Net periodic postretirement benefit cost $13.9 ------ ------\nFor purposes of valuing the accumulated postretirement benefit obligation, the discount rate was 8.5%, the assumed weighted average health care cost trend rates are 12% grading down to 5.5% over 8 years for retired both over and under age 65, and 10% grading down to 5.5% over 7 years for managed care under age 65. A one percentage point increase in each year of these health care cost trend rates would increase the accumulated postretirement benefit obligation at December 31, 1994 by $19.9 million, and increase the sum of the service and interest cost components of net period postretirement benefit cost by $2.6 million.\nIn addition the Company contributed to multiemployer plans which provide health and welfare benefits to active as well as retired employees. The Company had costs of $10.0 million related to these benefits during 1994.\nIn 1994, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting For Postemployment Benefits\" (\"SFAS 112\"). SFAS 112 did not have a significant effect on the Company's consolidated financial position or results of operations.\n10) COMMITMENTS AND CONTINGENCIES\nThe Company has long-term noncancellable lease commitments for office space and equipment, transponders, studio facilities and vehicles.\nII-39\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nAt December 31, 1994, minimum rental payments under noncancellable leases are as follows:\nOperating Capital Leases Leases ------ ------ (Millions of dollars)\n1995 $ 487.1 $ 28.9 1996 407.9 23.7 1997 367.7 21.4 1998 323.6 23.1 1999 270.6 20.6 2000 and thereafter 1,373.9 65.0 --------- -------- Total minimum lease payments $ 3,230.8 182.7 Less amounts representing interest ========= 55.2 -------- Present value of net minimum payments $127.5 ========\nThe Company has also entered into capital leases for transponders with future minimum commitments commencing in future periods of approximately $207.9 million payable over the next eleven years Such commitments are contingent upon the successful operation of satellites. Future minimum capital lease payments have not been reduced by future minimum sublease rentals of $23.7 million. Rent expense amounted to $240.2 million (1994), $74.2 million (1993), and $67.9 million (1992).\nThe commitments of the Company for program license fees, which are not reflected in the balance sheet as of December 31, 1994 and are estimated to aggregate approximately $2.0 billion, principally reflect commitments under Showtime Networks Inc.'s (\"SNI's\") exclusive arrangements with several motion picture companies. This estimate is based upon a number of factors. A majority of such fees are payable over several years, as part of normal programming expenditures of SNI. These commitments are contingent upon delivery of motion pictures which are not yet available for premium television exhibition and, in many cases, have not yet been produced.\nThere are various lawsuits and claims pending against the Company. Management believes that any ultimate liability resulting from those actions or claims will not have a material adverse effect on the Company's results of operations or financial position.\nCertain subsidiaries and affiliates of the Company from time to time receive claims from Federal and state environmental regulatory agencies and other entities asserting that they are or may be liable for environmental cleanup costs and related damages, principally relating to discontinued operations conducted by its former mining and manufacturing businesses (acquired as part of the Mergers). The Company has recorded a liability at approximately the mid- point of its estimated range of environmental exposure. Such liability was not reduced by potential insurance recoveries and reflects management's estimate of cost sharing at multiparty sites. The estimated range of the potential liability was calculated based upon currently available facts, existing technology and presently enacted laws and regulations. On the basis of\nII-40\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nits experience and the information currently available to it, the Company believes that the claims it has received will not have a material adverse effect on its results of operations or financial position.\n11) FOREIGN OPERATIONS\nThe consolidated financial statements include the following amounts applicable to foreign subsidiaries:\nYear Ended December 31, ----------------------- 1994 1993 1992 ---- ---- ---- (Millions of dollars)\nRevenues $ 1,223.2 $122.2 $68.2 Earnings before income taxes $ 197.3 $ 34.0 $17.4 Net earnings $ 170.9 $ 33.7 $16.4 Current assets $ 1,021.3 $ 54.2 $47.8 Total assets $ 2,397.6 $115.7 $73.9 Total liabilities $ 784.9 $ 68.7 $57.4\nTotal export revenues were $137.4 million (1994), $25.2 million (1993) and $34.9 million (1992).\nForeign currency transaction gains and losses were immaterial in each period presented. II-41\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n(1) The first quarter of 1994 reflects Paramount Communications' results of operations commencing March 1, 1994 and merger-related charges of $332.1 million. Results of operations of MSG have been restated to discontinued operations. The fourth quarter of 1994 reflects Blockbuster's results of operations commencing October 1, 1994. (See Notes 2 and 3.) (2) The second quarter of 1994 reflects the pre-tax gain on the sale of the one-third partnership interest in Lifetime of $267.4 million. (See Note 14.) (3) The first quarter of 1993 reflects a pre-tax gain of $55 million related to the sale of the stock of Viacom Cablevision of Wisconsin, Inc. (See Note 14.)\nII-43\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n14) OTHER ITEMS, NET\nOn April 4, 1994, Viacom International sold its one-third partnership interest in Lifetime for approximately $317.6 million, which resulted in a pre-tax gain of approximately $267.4 million in the second quarter of 1994. Proceeds from the sale were used to reduce outstanding debt of Viacom International.\nAs part of the settlement of the Time Warner antitrust lawsuit, the Company sold all the stock of Viacom Cablevision of Wisconsin, Inc. to Warner Communications Inc. (\"Warner\"). This transaction was effective on January 1, 1993. As consideration for the stock, Warner paid the sum of $46 million plus repayment of debt under the Credit Agreement in the amount of $49 million, resulting in a pre-tax gain of approximately $55 million reflected in \"Other items, net.\" Also reflected in this line item is the net gain on the sale of a portion of an investment held at cost and adjustments to previously established non-operating litigation reserves, and other items.\n\"Other items, net\" reflects a gain of $35 million recorded in the third quarter of 1992; representing payments received in the third quarter relating to certain aspects of the settlement of the Time Warner antitrust lawsuit, net of the Company's 1992 legal expenses related to this lawsuit. \"Other items, net\" also reflects a reserve for litigation of $33 million during the second quarter of 1992 related to a summary judgment against the Company in a dispute with CBS Inc. arising under the 1970 agreement associated with the spin-off of Viacom International Inc. by CBS Inc. On July 30, 1993, the Company settled all disputes arising under such litigation.\n15) SUPPLEMENTAL CASH FLOW INFORMATION\nII-44\nVIACOM INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n16) CONDENSED CONSOLIDATING FINANCIAL STATEMENTS\nViacom International is a wholly owned subsidiary of Viacom. Viacom's guarantees of the Viacom International debt securities are full and unconditional (See Note 5). Viacom has determined that separate financial statements and other disclosures concerning Viacom International are not material to investors. On January 3, 1995, Paramount Communications was merged into Viacom International and, therefore, the net assets of Paramount Communications (reflected in non-guarantor affiliates) which includes approximately $1.0 billion of issuances of long-term debt became obligations of Viacom International.\nThe following condensed consolidating financial statements present the results of operations, financial position and cash flows of Viacom, Viacom International (carrying any investments in non-guarantor affiliates under the equity method), and non-guarantor affiliates of Viacom, and the eliminations necessary to arrive at the information for the Company on a consolidated basis. Financial statements of Viacom International for 1993 and 1992 as previously filed on Form 10-K are incorporated by reference herein.\nII-45\nVIACOM INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nII-46\nVIACOM INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure - Not applicable.\nII-47\nVIACOM INC. AND SUBSIDIARIES\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULE\nThe following consolidated financial statements and schedule of the registrant and its subsidiaries are submitted herewith as part of this report:\nAll other Schedules are omitted since the required information is not present.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Viacom Inc.\nOur audits of the consolidated financial statements referred to in our report dated February 10, 1995,appearing on page II-14 of this annual report on Form 10-K also included an audit of the Financial Statement Schedule listed in Item 14(a) of this Form 10-K. In our opinion, the Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\n1177 Avenue of the Americas New York, New York 10036 February 10, 1995\nVIACOM INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nNotes: (A) Primarily represents adjustments made as part of the Mergers. (B) Represents balance sheet reclassifications related to certain entertainment receivables. (C) Includes amounts written off, net of recoveries.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers.\nThe information contained in the Viacom Inc. Definitive Proxy Statement under the caption \"Information Concerning Directors and Nominees\" is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nThe information contained in the Viacom Inc. Definitive Proxy Statement under the captions \"Directors' Compensation\" and \"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 Viacom Inc. Definitive Proxy Statement under the caption \"Security Ownership of Certain Beneficial Owners and Management\" is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nThe information contained in the Viacom Inc. Definitive Proxy Statement under the caption \"Related Transactions\" is incorporated herein by reference.\nIII-1\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n(a) and (d) Financial Statements and Schedules (see Index on Page)\n(b) Reports on Form 8-K\nCurrent Report on Form 8-K of Viacom Inc. with a report date of October 18, 1994 relating to the commencement of a litigation concerning Blockbuster's acquisition of the plaintiffs' interests in a limited partnership.\nCurrent Report on Form 8-K of Viacom Inc. with a report date of December 15, 1994 relating to the institution of cross-guarantees by each of Viacom Inc., Viacom International Inc. and Paramount Communications Inc.\n(c) Exhibits (see index on Page E-1)\nIV-1\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(D) of the Securities Exchange Act of 1934, Viacom Inc. has duly caused this report to be signed on its behalf by the undersigned, thereto duly authorized.\nVIACOM INC.\nBy \/s\/ Frank J. Biondi, Jr. ------------------------------ Frank J. Biondi, Jr., President, Chief Executive Officer\nBy \/s\/ George S. Smith, Jr. ------------------------------ George S. Smith, Jr., Senior Vice President, Chief Financial Officer\nBy \/s\/ Kevin C. Lavan ------------------------------ Kevin C. Lavan, Senior Vice President, Controller, Chief Accounting Officer\nDate: March 31, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of Viacom Inc. and in the capacities and on the dates indicated:\nBy * March 31, 1995 ------------------------------------- George S. Abrams, Director\nBy * March 31, 1995 ------------------------------------- Steven R. Berrard, Director\nBy \/s\/ Frank J. Biondi, Jr . March 31, 1995 ------------------------------------- Frank J. Biondi, Jr., Director\nBy \/s\/ Philippe P. Dauman March 31, 1995 ------------------------------------- Philippe P. Dauman, Director\nBy * March 31, 1995 ------------------------------------- William C. Ferguson, Director\nBy * March 31, 1995 ------------------------------------- H. Wayne Huizenga, Director\nBy * March 31, 1995 ------------------------------------- George D. Johnson, Jr., Director\nBy * March 31, 1995 ------------------------------------- Ken Miller, Director\nBy * March 31, 1995 ------------------------------------- Brent D. Redstone, Director\nBy * March 31, 1995 ------------------------------------- Sumner M. Redstone, Director\nBy * March 31, 1995 ------------------------------------- Shari Redstone, Director\nBy * March 31, 1995 ------------------------------------- Frederic V. Salerno, Director\nBy * March 31, 1995 ------------------------------------- William Schwartz, Director\n* By \/s\/ Philippe P. Dauman March 31, 1995 --------------------------------------- Philippe P. Dauman Attorney-in-Fact for the Directors\nVIACOM INC. AND SUBSIDIARIES INDEX TO EXHIBITS ITEM 14(C)\nEXHIBIT NO. DESCRIPTION OF DOCUMENT PAGE NO.\n(2) Plan of Acquisition\n(a) Agreement and Plan of Merger dated as of January 7, 1994, as amended as of June 15, 1994, between Viacom Inc. and Blockbuster Entertainment Corporation (incorporated by reference to Exhibit 2 1 to the Registration Statement on Form S-4 filed by Viacom Inc.) (File No. 33- 55271).\n(b) Amended and Restated Agreement and Plan of Merger dated as of February 4, 1994 between Viacom Inc. and Paramount Communications Inc., as further amended as of May 26, 1994, among Viacom, Viacom Sub Inc. and Paramount Communications Inc. (incorporated by reference to Exhibit 2.1, included as Annex I, to the Registration Statement on Form S-4 filed by Viacom Inc.) (File No. 33- 53977).\n(3) Articles of Incorporation and By-laws\n(a) Restated Certificate of Incorporation of Viacom Inc. (incorporated by reference to Exhibit 3(a) to the Annual Report on Form 10-K of Viacom Inc. for the fiscal year ended December 31, 1992, as amended by Form 10-K\/A Amendment No. 1 dated November 29, 1993 and as further amended by Form 10-K\/A Amendment No. 2 dated December 9, 1993) (File No. 1-9553).\n(b) Amendment to Restated Certificate of Incorporation of Viacom Inc. (incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-4 filed by Viacom Inc. (File No. 33-55271).\n(c) Certificate of Merger merging Blockbuster Entertainment Corporation with and into Viacom Inc. (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-3 filed by Viacom Inc. ) (File No. 33-55785).\nE-1\n(d) Certificate of the Designations, Powers, Preferences and Relative, Participating or other Rights, and the Qualifications, Limitations or Restrictions thereof, of Series B Cumulative Convertible Preferred Stock ($0.01 par value) of Viacom Inc. (incorporated by reference to Exhibit 4.1 to the Quarterly Report on Form 10-Q of Viacom Inc. for the quarter ended September 30, 1993) (File No. 1- 9553)\n(e) By-laws of Viacom Inc. (incorporated by reference to Exhibit 3.3 to the Registration Statement on Form S-4 filed by Viacom Inc.) (File No. 33-13812).\n(4) Instruments defining the rights of security holders, including indentures:\n(a) Specimen certificate representing the Viacom Inc. Voting Common Stock (currently Class A Common Stock) (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-4 filed by Viacom Inc. ) (File No. 33-13812).\n(b) Specimen certificate representing Viacom Inc. Class B Non-Voting Common Stock (incorporated by reference to Exhibit 4(a) to the Quarterly Report on Form 10-Q of Viacom Inc. for the quarter ended June 30, 1990) (File No. 1-9553).\n(c) Specimen certificate representing Viacom Inc. Series B Cumulative Convertible Preferred Stock of Viacom Inc. (incorporated by reference to Exhibit 4(d) to the Annual Report on Form 10-K of Viacom Inc. for the fiscal year ended December 31, 1993, as amended by Form 10- K\/A Amendment No. 1 dated May 2, 1994) (File No. 1- 9533).\n(d) Form of Contingent Value Rights Agreement between Viacom Inc. and Harris Trust and Savings Bank, as Trustee (including the Form of Contingent Value Right) (incorporated by reference to Exhibit 4.6 to the Registration Statement on Form S-4 filed by Viacom Inc. ) (File No. 33- 53977).\n(e) Form of Warrant Agreement between Viacom Inc. and Harris Trust and Savings Bank, as Warrant Agent with respect to the Warrants expiring July 1, 1997 of Viacom Inc. (including the Form of Warrant expiring July 1, 1997) (incorporated by reference to Exhibit 4.7 to the Registration Statement on Form S-4 filed by Viacom Inc.) (File No. 33- 53977).\nE-2\n(f) Form of Warrant Agreement between Viacom Inc. and Harris Trust and Savings Bank, as Warrant Agent with respect to the Warrants expiring July 1, 1999 of Viacom Inc. (including the Form of Warrant expiring July 1, 1999) (incorporated by reference to Exhibit 4.8 to the Registration Statement on Form S-4 filed by Viacom Inc.) (File No. 33- 53977).\n(g) Form of Certificate representing the Variable Common Rights of Viacom Inc. (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-4 filed by Viacom Inc.) (File No. 33-55271).\n(h) Credit Agreement dated as of July 1, 1994 among Viacom Inc.; the Bank parties thereto; The Bank of New York (\"BNY\"), Citibank N.A. (\"Citibank\"), Morgan Guaranty Trust Company of New York and Bank of America NT&SA, as Managing Agents; BNY, as Documentation Agent; Citibank, as Administrative Agent: JP Morgan Securities Inc., as Syndication Agent: and the Agents and Co-Agents named therein (incorporated by reference to Exhibit 4.1 to the Current Report on Form 8-K of Viacom Inc. dated July 22, 1994) (File No. 1-9553).\n(i) Credit Agreement dated as of September 29, 1994, among Viacom Inc., the Banks parties thereto, the Bank of New York, as a Managing Agent and as the Documentation Agent, Citibank, N.A, as a Managing Agent and as the Administrative Agent, Morgan Guaranty Trust Company of New York, as a Managing Agent, JP Morgan Securities Inc., as the Syndication Agent, The Bank of America NT&SA, as a Managing Agent, and the Banks named as Agents therein (incorporated by reference to Exhibit 99.2 to the Current Report on Form 8-K of Viacom Inc. dated September 29, 1994) (File No. 1-9553).\n(j) The instruments defining the rights of holders of the long-term debt securities of Viacom Inc. and its subsidiaries are omitted pursuant to section (b)(4)(iii)(A) of Item 601 of Regulation S-K. Viacom Inc. hereby agrees to furnish copies of these instruments to the Securities and Exchange Commission upon request.\nE-3\n(10) Material Contracts\n(a) Viacom Inc. 1989 Long-Term Management Incentive Plan (as amended and restated through April 23, 1990) (incorporated by reference to Exhibit A to Viacom Inc.'s Definitive Proxy Statement dated April 27. 1990).\n(b) Viacom Inc. 1994 Long-Term Management Incentive Plan (incorporated by reference to Exhibit B to Viacorn Inc.'s Proxy Statement\/Prospectus dated June 6, 1994). *\n(c) Viacom Inc. Senior Executive Short-Term Incentive Plan (incorporated by reference to Exhibit A to Viacom Inc.'s Proxy Statement\/Prospectus dated June 6, 1994). *\n(d) Viacom Inc. Long-Term Incentive Plan (incorporated by reference to Exhibit A to Viacom Inc.'s Definitive Proxy Statement dated April 29, 1988), and amendment thereto (incorporated by reference to Exhibit 10(d) to the Annual Report on Form 10-K of Viacom Inc. for the fiscal year ended December 21, 1991 ) (File No. 1 - 9553), and as further amended by amendment dated December 17, 1992 (incorporated by reference to Exhibit 10(d) to the Annual Report on Form 10-K of Viacom Inc. for the fiscal year ended December 31, 1992, as amended by Form 10-K\/A Amendment No. 1 dated November 29, 1993 and as further amended by Form 10-K\/A Amendment No. 2 dated December 9, 1993) (File No. 1-9553).*\n(e) Viacom Inc. Long-Term Incentive Plan (Divisional) (incorporated by reference to Exhibit 10.2 to the Quarterly Reports on Form 10-Q of Viacom Inc. for the quarter ended June 30, 1993) (File No. 1-9553).*\n(f) Viacom International Inc. Deferred Compensation Plan for Non-Employee Directors (as amended and restated through December 17, 1992) (incorporated by reference to Exhibit 10(e) to the Annual Report on Form 10-K of Viacom Inc. for the fiscal year ended December 31, 1992, as amended by Form 10-K\/A Amendment No. 1 dated November 29, 1993 and as further amended by Form 10-K\/A Amendment No. 2 dated December 9, 1993) (File No. 1-9553).*\n(g) Viacom Inc. and Viacom International Inc. Retirement Income Plan for Non-Employee Directors (incorporated by reference to Exhibit 10(f) to the Annual\n---------------\n* Management contract or compensatory plan required to be filed as an exhibit to this form pursuant to Item 14(c).\nE-4\nReports on Form 10-K of Viacom Inc. for the fiscal year ended December 31, 1989) (File No. 1-9553).*\n(h) Viacom Inc. Stock Option Plan for Non-Employee Directors (incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q of Viacom Inc. for the quarter ended June 30, 1993)(File No. 1-9553).\n(i) Viacom Inc. 1994 Stock Option Plan for Non-Employee Directors (filed herewith). *\n(j) Excess Benefits Investment Plan for Certain Key Employees of Viacom International Inc. (effective April 1, 1984 and amended as of January 1, 1990) (incorporated by reference to Exhibit 10(h) to the Annual Report on Form 10-K of Viacom Inc. for the fiscal year ended December 31, 1990) (File No. 1-9553).*\n(k) Excess Pension Plan for Certain Key Employees of Viacom International Inc. (incorporated by reference to Exhibit 10(i) to the Annual Reports on Form 10-K of Viacom Inc. and Viacom International Inc. for the fiscal year ended December 31, 1990) (File Nos. 1-9553\/1- 9554).*\n(l) Employment Agreement, dated as of August 1, 1994, between Viacom Inc. and Frank J. Biondi, Jr. (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of Viacom Inc. for the quarter ended September 30, 1994) (File No. 1-9533). Agreement under the Viacom Inc. 1994 Long-Term Management Incentive Plan, dated as of August 18, 1994, between Viacom Inc. and Frank J. Biondi, Jr. (incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q of Viacom Inc. for the quarter ended September 30, 1994) (File No. 1-9533)*\n(m) Agreement, dated as of August 1, 1990, between Viacom International Inc. and Mark M. Weinstein (incorporated by reference to Exhibit 10(p) to the Annual Reports on Form 10-K of Viacom Inc. and Viacom International Inc. for the fiscal year ended December 31, 1990) (File Nos. 1-9553\/1-9554), as amended by an Agreement dated as of February 1, 1993 (incorporated by reference to Exhibit 10(n) to the Annual Report on Form 10-K of Viacom Inc. for the fiscal year ended December 31,\n----------------------\n* Management contract or compensatory plan required to be filed as an exhibit to this form pursuant to Item 14(c).\nE-5\n1992, as amended by Form 10-K\/A Amendment No. 1 dated November 29. 1993 and as further amended by Form 10-K\/A Amendment No. 2 dated December 9. 1993) (File No. 1-9553), and as further amended by an Agreement dated February 7, 1995 (filed herewith). *\n(n) Agreement, dated as of April 1, 1994, between Viacom Inc. and Thomas E. Dooley (filed herewith)*. Letter Agreement, dated as of April 1, 1994, between Viacom Inc. and Thomas E. Dooley (filed herewith).*\n(o) Agreement, dated as of July 1, 1994, between Viacom Inc. and Edward D. Horowitz (filed herewith).* Letter Agreement, dated as of July 1, 1994, between Viacom Inc. and Edward D. Horowitz (filed herewith). *\n(p) Agreement, dated as of February 1, 1993. between Viacom International Inc. and Philippe P. Dauman (incorporated by reference to Exhibit 10(q) to the Annual Report on Form 10-K of Viacom Inc. for the fiscal year ended December 31, 1992, as amended by Form 10-K\/A Amendment No. 1 dated December 29. 1993 and as further amended by Form 10-K\/A Amendment No. 2 dated December 9, 1993) (File No. 1-9553), as amended by an Agreement, dated as of April 1, 1994, between Viacom Inc., Viacom International Inc. and Philippe P. Dauman (filed herewith). * Letter Agreement, dated as of April 1, 1994, between Viacom Inc. and Philippe P. Dauman (filed herewith). *\n(q) Service Agreement, dated as of March 1. 1994. between George S. Abrams and Viacom Inc. (filed herewith). *\n(r) Blockbuster Entertainment Corporation (\"BEC\") stock option plans* assumed by Viacom Inc. after the Blockbuster Merger consisting of the following:\n(i) BEC's 1989 Stock Option Plan (incorporated by reference to BEC's Proxy Statement dated March 31, 1989)\n(ii) Amendments to BEC's 1989 Stock Option Plan (incorporated by reference to BEC's Proxy Statement dated April 3, 1991 )\n--------------------\n* Management contract or compensatory plan required to be filed as an exhibit to this form pursuant to Item 14(c).\nE-6\n(iii) BECs 1990 Stock Option Plan (incorporated by reference to BEC's Proxy Statement dated March 29. 1990)\n(iv) Amendments to BEC's 1990 Stock Option Plan (incorporated by reference to BEC's Proxy Statement dated April 15.1991 )\n(v) BEC's 1991 Employee Director Stock Option Plan (incorporated by reference to BEC's Proxy Statement dated April 15.1991 )\n(vi) BEC's 1991 Non-Employee Director Stock Option Plan (incorporated by reference to BEC's Proxy Statement dated April 15, 1991 )\n(vii) BEC's 1994 Stock Option Plan (incorporated by reference to Exhibit 10.35 to the Annual Report on Form 10-K of BEC for the fiscal year ended December 31, 1993)(File No. 0-12700)\n(s) Asset Purchase Agreement dated as of January. 20, 1995 among Tele-Vue Systems, Inc., Viacom International Inc., Intermedia Partners, IV. L.P. and RCS Pacific, L.P. (filed herewith).\n(11) Statements re Computation of Net Earnings Per Share\n(21) Subsidiaries of Viacom Inc.\n(23) Consents of Experts and Counsel\n(a) Consent of price Waterhouse\n(24) Powers of Attorney\n(27) Financial Data Schedule\nE-7","section_15":""}
{"filename":"708819_1994.txt","cik":"708819","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. LEGAL PROCEEDINGS\nDue to the nature of its business, McDermott International is, from time to time, involved in litigation. It is management's opinion that none of this litigation will have a material adverse effect on the consolidated financial position of McDermott International.\nFor a discussion of McDermott International's potential liability for non-employee products liability asbestos claims see Item 1F and Note 1 to the consolidated financial statements.\n- 17 -\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 covered by this report to a vote of security holders, through the solicitation of proxies or otherwise.\n- 18 - PART II\nItem 5.","section_5":"Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nInternational's Common Stock is traded on the New York Stock Exchange. High and low stock prices and dividends declared for the years ended March 31, 1994 and 1993 follow:\nAs of March 31, 1994, the approximate number of record holders of Common Stock was 7,005.\n- 19 - Item 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\n- 20 - In fiscal year 1994, Net Income (Loss) includes a cumulative effect of an accounting change of $100,750,000 due to the adoption of Emerging Issues Task Force Issue No. 93-5 which resulted in a provision for estimated future costs resulting from possible gaps in insurance coverage with respect to non-employee products liability asbestos claims. Inherent in the estimate of such future costs are assumptions which may vary significantly as claims are filed and settled, and accordingly, the ultimate loss may differ materially from the amount provided. In fiscal year 1993, Net Income (Loss) includes a cumulative effect of an accounting change of $249,351,000 due to the adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 106. See Note 1 to the consolidated financial statements regarding the above and the adoption of SFAS No. 109 in fiscal year 1993, Note 2 regarding the acquisition of Northern Ocean Services Limited and Delta Catalytic Corporation, and Note 13 regarding discontinued operations.\nIn fiscal years 1993 and 1992, Income (Loss) from Continuing Operations before Extraordinary Items and Cumulative Effect of Accounting Changes includes after tax gains from the sale of McDermott International's interests in its two commercial nuclear joint ventures of $15,667,000 and $35,436,000, respectively (see Note 3 to the consolidated financial statements).\n- 21 - Item 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nFISCAL YEAR 1994 VS FISCAL YEAR 1993\nPower Generation Systems and Equipment's revenues increased $90,730,000 to $1,614,206,000. This was primarily due to higher revenues from fabrication and erection of fossil fuel steam and environmental control systems, replacement nuclear steam generators, repair and alteration of existing fossil fuel steam systems, and nuclear fuel assemblies and reactor components for the U. S. Government. These increases were partially offset by lower revenues from extended scope of supply and fabrication of industrial boilers, defense and space-related products other than nuclear fuel assemblies and reactor components, and air cooled heat exchangers.\nPower Generation Systems and Equipment's segment operating income decreased $6,526,000 to $49,941,000. This was primarily due to lower volume and margins on extended scope of supply and fabrication of industrial boilers as well as defense and space-related products other than nuclear fuel assemblies and reactor components. There were also lower margins on plant enhancements, replacement parts, and repair and alteration of existing fossil fuel steam systems, as well as higher royalty income recorded in the prior year. These decreases were partially offset by higher volume and margins on replacement nuclear steam generators, nuclear fuel assemblies and reactor components for the U. S. Government and higher volume on fabrication and erection of fossil fuel steam and environmental control systems. There were also lower general and administrative expenses, and lower warranty expense primarily due to net favorable warranty reserve adjustments (See Note 15 to the consolidated financial statements).\nPower Generation Systems and Equipment's equity in income of investees increased $3,341,000 to $12,032,000 primarily due to improved results in a foreign joint venture and in three domestic joint ventures which own and operate a cogeneration plant and two small power plants, partially offset by unfavorable results in another foreign joint venture.\nBacklog for this segment at March 31, 1994 was $2,398,285,000 compared to $2,614,708,000 at March 31, 1993. At March 31, 1994, this segment's backlog with the U.S. Government was $775,909,000 (of which $17,055,000 had not been funded). These amounts reflect the impact of Congressional budget reductions on the advanced solid rocket motor and super conducting super collider projects. Also, additional U. S. Government budget reductions have negatively affected this segment's other government operations. The current competitive economic environment has also negatively affected demand for other industrial related product lines and these markets are expected to remain very competitive.\nThe current competitive economic environment and uncertainties created by the passage of the Energy Policy Act of 1992 and the Clean Air Act Amendments of 1990 have caused U.S. utilities to defer repairs and refurbishments on existing plants. However, the Clean Air Act has created demand for environmental control equipment and related plant enhancements. Most electric utilities have already purchased equipment to comply with\n- 22 - Phase I of the Clean Air Act, and they will purchase equipment to comply with Phase II deadlines in a gradual manner, spread out over the next several years as various deadlines approach. Electric utilities in Asia are active purchasers of large, new baseload generating units, due to the rapid growth of the Pacific Rim economies and to the small existing stock of electrical generating capacity in most developing countries.\nMarine Construction Services' revenues decreased $197,156,000 to $1,452,497,000, primarily due to lower volume in worldwide fabrication and engineering operations, foreign marine operations and procured materials. These decreases were partially offset by the acquisition of Delta Catalytic Corporation (\"DCC\").\nMarine Construction Services' segment operating income decreased $23,258,000 to $44,394,000, primarily due to lower volume in worldwide fabrication and engineering operations and lower volume in procured materials. These decreases were partially offset by the acquisition of DCC, higher margins in foreign marine operations, the accelerated depreciation and write-off of certain fabrication facilities and marine construction equipment in the prior year, and reduced operating costs.\nMarine Construction Services' equity in income of investees increased $22,461,000 to $107,828,000. This increase was principally due to improved operating results of the HeereMac joint venture. In 1995, this segment anticipates that its joint ventures will perform at significantly lower levels.\nBacklog for this segment at March 31, 1994 was $1,054,142,000 (including $233,299,000 from DCC and $57,373,000 from NOS). Excluding DCC and NOS, backlog of $763,470,000 at March 31, 1994 was down from backlog of $1,129,577,000 at March 31, 1993, but remains above the levels experienced during most of the 1980's. Not included in backlog at March 31, 1994 and 1993, was backlog relating to contracts to be performed by unconsolidated foreign joint ventures of approximately $840,000,000 and $900,000,000, respectively. This segment's markets are expected to be at a low level in the U. S. during 1995 while international markets are varied. In all areas, the overcapacity of marine equipment will continue to result in a competitive environment and put pressure on profit margins.\nInterest income decreased $1,640,000 to $38,751,000. This decrease was primarily due to lower interest rates on investments in government securities and other long-term investments.\nInterest expense decreased $26,365,000 to $63,975,000, primarily due to changes in debt obligations and interest rates prevailing thereon. The decrease reflects the redemption of high coupon debt during April and June 1993, and a reduction in accrued interest on proposed tax deficiencies.\nMinority interest expense decreased $2,952,000 to $15,251,000 primarily due to minority shareholder participation in the losses of the McDermott-ETPM East joint venture in the current year and income in the prior year, partially offset by participation in the results of DCC since its acquisition in June 1993 (See Note 2 to the consolidated financial statements).\n- 23 - Other-net decreased $14,562,000 to a loss of $4,365,000 from income of $10,197,000. This decrease was primarily due to gains on the sale of interests in two commercial nuclear joint ventures (See Note 3 to the consolidated financial statements), a foreign marine asset casualty gain and gains on the sale of nineteen tugboats, all in the prior period.\nProvision for income taxes decreased $15,101,000 to $24,998,000, while income from continuing operations before provision for income taxes, extraordinary items, and cumulative effect of accounting changes increased $7,532,000 to $114,954,000. The decrease in the provision for income taxes is primarily due to a reduction in a provision of taxes due to the settlement of outstanding issues and higher non-taxable earnings.\nNet loss decreased $177,938,000 to $10,794,000 reflecting the cumulative effect of the change in accounting for non-employee products liability asbestos claims of $100,750,000 in the current year and the cumulative effect of the adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" of $249,351,000 in the prior year, in addition to other items described above.\nFISCAL YEAR 1993 VS FISCAL YEAR 1992\nPower Generation Systems and Equipment's revenues decreased $70,025,000 to $1,523,476,000. This was primarily due to lower revenues from nuclear fuel assemblies and reactor components for the U. S. Government and plant enhancements. Additionally, the segment's controlling interest in its commercial nuclear fuel joint venture was sold during December 1991, and revenue from this activity is no longer included in this segment's revenues. These decreases were partially offset by higher revenues from fabrication and erection of fossil fuel steam and environmental control systems and extended scope of supply and fabrication of industrial boilers.\nPower Generation Systems and Equipment's segment operating income decreased $53,307,000 to $56,467,000. This was primarily due to non-recurring items which benefitted 1992's results. These items included a Department of Energy grant for decommissioning and restoration of an inactive nuclear facility, a favorable adjustment to workers' compensation costs related to prior years, the inclusion of the commercial nuclear fuel joint venture's results through December 1991, and the reduction of a provision to relocate a manufacturing plant. The decrease was also due to lower volume and margins on plant enhancements and lower volume from nuclear fuel assemblies and reactor components for the U. S. Government. This decrease was partially offset by higher volume and margins on fabrication and erection of fossil fuel steam and environmental control systems and higher margins on defense and space-related products other than nuclear fuel assemblies and reactor components.\nMarine Construction Services' revenues decreased $286,965,000 to $1,649,653,000 primarily due to the December 1991 deconsolidation of the McDermott-ETPM West joint venture. There was lower volume in domestic fabrication and offshore operations and in fabrication operations in Scotland. There was higher volume on foreign turnkey projects.\nMarine Construction Services' segment operating income increased $11,744,000 to $67,652,000 primarily due to improved margins on domestic offshore operations and on foreign turnkey projects, and contract loss provisions in 1992. These were partially offset\n- 24 - by the deconsolidation of the McDermott-ETPM West joint venture. There was also lower volume in domestic fabrication and offshore operations and lower margins on domestic fabrication operations.\nEquity in income of investees increased $86,816,000 to $94,058,000. This increase was principally due to improved operating results of the HeereMac joint venture and both improved operating results and foreign currency transaction gains in the McDermott-ETPM West joint venture.\nInterest income decreased $13,377,000 to $40,391,000. This decrease was principally due to lower interest rates on short-term investments and investments in government securities and other long-term investments.\nInterest expense decreased $11,981,000 to $90,340,000, resulting from a reduction in the provision for interest on proposed tax deficiencies, lower interest expense resulting from interest rate swap agreements, and changes in debt obligations and interest rates prevailing thereon.\nMinority interest decreased $862,000 to $18,203,000 due to the deconsolidation of the McDermott-ETPM West joint venture and the reacquisition of McDermott Scotland's minority shareholder's interest, both in 1991, mostly offset by minority shareholder participation in the improved results of McDermott-ETPM East.\nOther-net decreased $60,172,000 to income of $10,197,000. This decrease was principally due to lower gains on the sale of its interests in two commercial nuclear joint ventures (see Note 3 to the consolidated financial statements), lower marine casualty gains, and gains from the sale of certain marine assets to the HeereMac joint venture in 1992. This was partially offset by a gain of $4,762,000 from the sale of nineteen tugboats in 1993.\nProvision for income taxes decreased $3,170,000 to $40,099,000, while income from continuing operations before provision for income taxes, extraordinary items, and cumulative effect of accounting changes decreased $16,384,000 to $107,422,000. The decrease in the provision for income taxes is due primarily to the decrease in income.\nNet income (loss) decreased $265,901,000 to a loss of $188,732,000 from income of $77,169,000 reflecting the cumulative effect of the adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" of $249,351,000, in addition to other items described above.\nEffect of Inflation and Changing Prices\nMcDermott International's financial statements are prepared in accordance with generally accepted accounting principles, using historical dollar accounting (historical cost). Statements based on historical cost, however, do not adequately reflect the cumulative effect of increasing costs and changes in the purchasing power of the dollar, especially during times of significant and continued inflation.\n- 25 - The management of McDermott International is cognizant of the effects of inflation and, in order to minimize the negative impact of inflation on its operations, attempts to cover the increased cost of anticipated changes in labor, material and service costs, either through an estimation of such changes, which is reflected in the original fixed price, or through price escalation clauses in its contracts.\nLiquidity and Capital Resources\nDuring 1994, McDermott International's cash and cash equivalents decreased $5,713,000 to $133,809,000 and total debt decreased $63,789,000 to $729,610,000. During this period, McDermott International provided cash of $219,524,000 from operating activities; $92,841,000 from the issuance of long-term debt; $16,441,000 from the issuance of common stock; and $140,066,000 from the issuance of Series C convertible preferred stock; and used cash of $56,773,000 for dividends on International's common and preferred stock; $85,894,000 for the acquisitions of Northern Ocean Services Limited (\"NOS\") and Delta Catalytic Corporation (\"DCC\") (See Note 2 to the consolidated financial statements); $222,646,000 for repayment of long-term debt and $76,321,000 for additions to property, plant and equipment.\nLower accounts receivable are primarily due to lower volume and the timing of Marine Construction Services' foreign offshore contract billings and collections, and the acceleration of collections of retainage billings on the Naval Reactors program, partially offset by collection delays on a certain foreign Power Generation Systems and Equipment segment contract. Lower accrued liabilities are primarily due to settlement of subcontract costs on a certain foreign offshore contract. Decreases in net contracts in progress and advance billings are primarily due to lower volume.\nPursuant to an agreement with the majority of its principal insurers, McDermott International negotiates and settles products liability asbestos claims from non-employees and bills these amounts to the appropriate insurers. As a result of collection delays inherent in the process, reimbursement is usually delayed for three months or more. McDermott International has outstanding receivables of $29,079,000 at March 31, 1994 from its insurers for reimbursement of these claims. The number of claims, which management believes peaked in fiscal year 1990, has declined moderately. However, the average amount of these claims (historical average of less than $3,000 per claim) has continued to rise. Claims paid in fiscal year 1994 were $112,271,000, including $7,810,000 applicable to insolvent insurers and $3,315,000 relating to the policy year 1979 (see Note 1 to the consolidated financial statements). Settlement of the estimated liability of $135,053,000 at March 31, 1994 for future costs relating to insolvent insurers and policy year 1979 is expected to occur over the next 30 years. McDermott International's estimated future costs relating to policy year 1979 and certain insolvent insurers are derived from its loss history and constitute management's best estimate of such future costs. Inherent in the estimate of such future costs are assumptions which may vary significantly as claims are filed and settled. Accordingly, the amount ultimately paid may differ materially from the amount provided in the consolidated financial statements. The collection delays, and the amount of claims paid that are related to insolvent insurance carriers and the policy year 1979 have not had a material adverse effect on McDermott International's liquidity, and management believes, based on information currently available, that they will not have a material adverse effect on liquidity in the future.\n- 26 - McDermott International's expenditures for property, plant and equipment decreased $5,713,000 to $76,321,000 in 1994. While the majority of these expenditures were incurred to maintain and replace existing facilities and equipment, $5,000,000 was expended in connection with the purchase of a fabrication yard in Nueces County, Texas and $8,098,000 was expended on the construction a new combustion and emission test facility at its Alliance, Ohio research center. McDermott International has committed to make capital expenditures of approximately $65,692,000 during fiscal 1995. In addition to maintaining McDermott International's existing facilities, these expenditures include $38,560,000 for a new concept steam generator facility for the Naval Reactor Program in Lynchburg, Virginia, the anticipated purchase of a barge currently leased, and the completion of a new combustion and emission facility in Alliance, Ohio.\nDuring April and May 1993, the Delaware Company issued $87,000,000 of Series B Medium Term Notes at maturities ranging from four to twenty-nine years and interest rates ranging from 6.50% to 8.75%. These notes have an average maturity of approximately twenty years and an average interest rate of approximately 7.95%.\nAt March 31, 1994 and 1993, The Babcock & Wilcox Company had sold, with limited recourse, an undivided interest in a designated pool of qualified accounts receivable of approximately $170,000,000 under an agreement with a certain U. S. bank. The maximum sales limit available under this agreement was $225,000,000 at March 31, 1994 (See Note 7 to the consolidated financial statements).\nAt March 31, 1994 and 1993, McDermott International had available to it various uncommitted short-term lines of credit from banks totaling $246,412,000 and $129,734,000, respectively. Borrowings by McDermott International against these lines of credit at March 31, 1994 and 1993 were $37,512,000 and $775,000, respectively. In addition, the Babcock & Wilcox Company had available to it a $128,000,000 unsecured and committed revolving line of credit facility. Loans outstanding under the revolving credit facility may not exceed the banks' commitments thereunder, which commitments are subject to reduction based upon the ratio of the borrower's consolidated net tangible assets to specified indebtedness plus unused commitments. In addition, it is a condition to borrowing under the revolving credit facility that the borrower's consolidated net tangible assets exceed a certain level. There were no borrowings against this facility at March 31, 1994 and 1993. DCC had available from a certain Canadian bank an unsecured and committed revolving credit facility of $14,493,000 which expires on May 31, 1997. No borrowings were outstanding against this facility at March 31, 1994.\nMcDermott International maintains an investment portfolio of government obligations and other investments which is held for long- term investment purposes. The amortized cost of the long-term portfolio at March 31, 1994 was $715,131,000 (market value of $711,036,000). At March 31, 1994, approximately $157,065,000 amortized cost (market value of $158,200,000) of this portfolio was pledged to secure a letter of credit in connection with a long-term loan and reinsurance agreements.\nThe Delaware Company is restricted, as a result of covenants in credit agreements, in its ability to transfer funds to International through cash dividends or through unsecured loans or investments. At March 31, 1994, substantially all of the net assets of the Delaware Company were subject to such restrictions. It is not expected that these restrictions will have any significant effect on International's liquidity.\n- 27 - During July 1993, International sold 2,875,000 shares of Series C Cumulative Convertible Preferred Stock, and received net proceeds of $140,066,000.\nWorking capital decreased $117,486,000, to a deficit of $1,422,000 at March 31, 1994 from $116,064,000 at March 31, 1993. During 1995, McDermott International expects to obtain funds to meet capital expenditure, working capital and debt maturity requirements from operating activities and additional borrowings. Leasing agreements for equipment, which are short-term in nature, are not expected to impact McDermott International's liquidity or capital resources.\nInternational's quarterly dividends of $0.25 per share on its Common Stock and the Delaware Company's quarterly dividends of $0.55 per share on the Series A $2.20 Cumulative Convertible Preferred Stock and $0.65 per share on the Series B $2.60 Cumulative Preferred Stock were at the same rates in 1994 and 1993. At March 31, 1994, International's quarterly dividend rate was $0.71875 per share on its Series C Cumulative Convertible Preferred Stock.\nAt March 31, 1994 the ratio of long-term debt to total common stock and other stockholders' equity was 1.23 as compared with 1.27 at March 31, 1993.\nMcDermott International accounts for income taxes in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\". This standard requires, among other things, recognition of future tax benefits, measured by enacted tax rates, attributable to deductible temporary differences between the financial statement and income tax basis of assets and liabilities and to tax net operating loss carryforwards to the extent that realization of such benefits is more likely than not.\nMcDermott International has provided a valuation allowance ($26,576,000 at March 31, 1994) for deferred tax assets related primarily to net operating loss carryforwards which can not be realized through carrybacks and future reversals of existing taxable temporary differences. Management believes that remaining deferred tax assets ($364,193,000 at March 31, 1994) in all other tax jurisdictions are realizable through carrybacks and future reversals of existing taxable temporary differences and, if necessary, the implementation of tax planning strategies involving sales and sale\/leasebacks of appreciated assets. Major uncertainties that affect the ultimate realization of deferred tax assets include the risks of incurring operating losses in the future and the possibility of declines in value of appreciated assets involved in identified tax planning strategies. These factors have been considered in determining the valuation allowance. Management will continue to assess the adequacy of the valuation allowance on a quarterly basis.\nNew Accounting Standards\nMcDermott International adopted SFAS No. 106 effective April 1, 1992 for all domestic plans. McDermott International plans to adopt SFAS No. 106 for foreign plans during fiscal year 1996, and the adoption is not expected to have a material effect on the consolidated financial statements of McDermott International. The new standard does not have any impact on the cash requirements of any domestic or foreign postretirement health and welfare plan.\n- 28 - In November 1992, the Financial Accounting Standards Board (\"FASB\") issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" effective for fiscal years beginning after December 15, 1993. SFAS No. 112 requires accrual accounting, under certain conditions, for the estimated cost of benefits provided by an employer to former or inactive employees after employment but before retirement. The new standard will have no impact on the cash requirements for any postemployment benefits, and will not have a material effect on the consolidated financial statements of McDermott International.\nIn May 1993, the FASB issued SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective for fiscal years beginning after December 15, 1993. SFAS 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. Based on its current portfolio management practices, McDermott International will report its investments at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. The initial adoption of the new standard will not have a material effect on the consolidated financial statements of McDermott International.\n- 29 - Item 8.","section_7A":"","section_8":"Item 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nCOMPANY REPORT ON CONSOLIDATED FINANCIAL STATEMENTS\nInternational has prepared the consolidated financial statements and related financial information included in this report. International has the primary responsibility for the financial statements and other financial information and for ascertaining that the data fairly reflects the financial position and results of operations of McDermott International. The financial statements were prepared in accordance with generally accepted accounting principles, and necessarily reflect informed estimates and judgments by appropriate officers of McDermott International with appropriate consideration given to materiality.\nMcDermott International believes that it maintains an internal control structure designed to provide reasonable assurance that assets are safeguarded against loss or unauthorized use and that the financial records are adequate and can be relied upon to produce financial statements in accordance with generally accepted accounting principles. The concept of reasonable assurance is based on the recognition that the cost of an internal control structure must not exceed the related benefits. Although internal control procedures are designed to achieve these objectives, it must be recognized that errors or irregularities may nevertheless occur. McDermott International seeks to assure the objectivity and integrity of its accounts by its selection of qualified personnel, by organizational arrangements that provide an appropriate division of responsibility and by the establishment and communication of sound business policies and procedures throughout the organization. McDermott International believes that its internal control structure provides reasonable assurance that errors or irregularities that could be material to the financial statements are prevented or would be detected.\nMcDermott International's accompanying consolidated financial statements have been audited by its independent auditors, who provide McDermott International with expert advice on the application of U. S. generally accepted accounting principles to McDermott International's business and also provide an objective assessment of the degree to which McDermott International meets its responsibility for the fairness of financial reporting. They regularly evaluate the internal control structure and perform such tests and other procedures as they deem necessary to reach and express an opinion on the fairness of the financial statements. The report of the independent auditors appears elsewhere herein.\nThe Board of Directors pursues its responsibility for McDermott International's consolidated financial statements through its Audit Committee, which is composed solely of directors who are not officers or employees of McDermott International. The Audit Committee meets periodically with the independent auditors and management to review matters relating to the quality of financial reporting and internal control structure and the nature, extent and results of the audit effort. In addition, the Audit Committee is responsible for recommending the engagement of independent auditors for McDermott International to the Board of Directors, who in turn submit the engagement to the stockholders for their approval. The independent auditors have free access to the Audit Committee.\nMay 10, 1994\n- 30 - REPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders McDermott International, Inc.\nWe have audited the accompanying consolidated balance sheet of McDermott International, Inc. as of March 31, 1994 and 1993, and the related consolidated statements of income (loss) and retained earnings (deficit) and cash flows for each of the three years in the period ended March 31, 1994. 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 McDermott International, Inc. at March 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, the Company has provided for estimated future costs for non- employee products liability asbestos claims. Inherent in the estimate of such future costs are assumptions which may vary significantly as claims are filed and settled. Accordingly, the ultimate loss may differ materially from the amount provided in the consolidated financial statements.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its methods of accounting for recoveries of products liability claims in 1994 and income taxes and postretirement benefits other than pensions in 1993.\nERNST & YOUNG\nNew Orleans, Louisiana May 9, 1994\n- 31 - McDERMOTT INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEET MARCH 31, 1994 and 1993\nASSETS\nSee accompanying notes to consolidated financial statements.\n- 32 -\nLIABILITIES AND STOCKHOLDERS' EQUITY\n- 33 - McDERMOTT INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF INCOME (LOSS) AND RETAINED EARNINGS (DEFICIT) FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1994\n- 34 - CONTINUED\nSee accompanying notes to consolidated financial statements.\n- 35 - McDERMOTT INTERNATIONAL, INC. CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1994\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\n- 36 - CONTINUED\nINCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS\nSee accompanying notes to consolidated financial statements.\n- 37 - McDERMOTT INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1994\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation\nThe consolidated financial statements are presented in U.S. Dollars in accordance with accounting principles generally accepted in the United States. The consolidated financial statements include the accounts of McDermott International, Inc. and all subsidiaries and controlled joint ventures. Investments in joint venture and other entities in which McDermott International, Inc. has a 20% to 50% interest are accounted for on the equity method. Differences between the cost of equity method investments and the amount of underlying equity in net assets of the investees are amortized systematically to income. All significant intercompany transactions and accounts have been eliminated. Certain amounts previously reported have been reclassified to conform with the presentation at March 31, 1994. The notes to the consolidated financial statements are presented on the basis of continuing operations, unless otherwise stated.\nUnless the context otherwise requires, hereinafter \"International\" will be used to mean McDermott International, Inc., a Panamanian corporation; the \"Delaware Company\" will be used to mean McDermott Incorporated, a Delaware corporation which is a subsidiary of International, and its consolidated subsidiaries (including Babcock & Wilcox Investment Company and its principal subsidiary, The Babcock & Wilcox Company); and \"McDermott International\" will be used to mean the consolidated enterprise.\nChanges in Accounting Policies\nProducts Liability - As a result of the consensus reached on Emerging Issues Task Force (\"EITF\") Issue No. 93-5, a company is no longer permitted to offset, for recognition purposes, reasonably possible recoveries against probable losses which had been McDermott International's practice with respect to estimated future costs for non-employee products liability asbestos claims. During the third quarter of fiscal year 1994, and effective April 1, 1993, McDermott International adopted this provision of EITF Issue No. 93-5 as a change in accounting principle and provided for estimated future costs to the extent that recovery from its insurers is not determined to be probable. McDermott International has an agreement with a majority of its principal insurers concerning the method of allocation of products liability asbestos claim payments to the years of coverage. However, amounts allocable to policy year 1979 are excluded from this agreement, and McDermott International's ability to recover these amounts, and amounts allocable to certain insolvent insurers, is only reasonably possible, thus a provision for these estimated future costs has been recognized. McDermott International's estimated future costs relating to policy year 1979 and certain insolvent insurers are derived from its loss history and constitute management's best estimate of such future costs. As of March 31, 1994, the estimated amount of liabilities arising from all pending and future asbestos claims for non-employees was in excess of $1,100,000,000, of which less than $100,000,000 has been asserted. The estimated amount of future costs allocable to insolvent insurers and the policy year 1979 was $135,053,000. Inherent in the estimate\n- 38 - of such future liabilities and costs are expected trends in claim severity and frequency and other factors, including recoverability from insurers, which may vary significantly as claims are filed and settled. Accordingly, the ultimate loss may differ materially from the amount provided in the consolidated financial statements.\nThe cumulative effect of the accounting change at April 1, 1993 was a charge of $100,750,000 (net of income taxes of $54,250,000), or $1.89 a share, in fiscal year 1994. The adoption of this provision of EITF Issue No. 93-5 resulted in a increase in Income before Cumulative Effect of Accounting Change of $19,947,000, or $0.37 per share, in fiscal year 1994, as costs that would have been recognized under McDermott International's prior practice are included in the cumulative effect of the accounting change. Pro forma amounts reflecting the effect of retroactive application of the accounting change to prior periods are not presented because the amounts are not determinable.\nPostretirement Health Care Benefits - During the fourth quarter of 1993 and effective April 1, 1992, McDermott International adopted Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The Statement requires the accrual method of accounting for the costs of providing postretirement health and welfare benefits and expanded postretirement health and welfare plan disclosures. In accordance with the Statement, McDermott International elected immediate recognition of its transition obligation and recorded $249,351,000 (net of income tax benefit of $136,228,000), or $4.79 per share, as the cumulative effect of an accounting change. In fiscal year 1993, other than the cumulative effect of the accounting change, the adoption of SFAS No. 106 resulted in a decrease in Income before Extraordinary Items and Cumulative Effect of Accounting Changes of $4,688,000, or $0.09 per share. Postretirement benefit cost for prior years has not been restated and was recognized by expensing the insurance programs' premiums, the self-insured program's claims paid, and the estimated unpaid liability for claims incurred by plan participants. The aggregate cost, including discontinued operations, was $25,458,000 in fiscal year 1992.\nIncome Taxes - Effective April 1, 1992, McDermott International adopted SFAS No. 109, \"Accounting for Income Taxes\". This statement establishes new accounting and reporting standards for the effects of income taxes. It continues the liability approach provided by its predecessor standard, SFAS No. 96, which was adopted by McDermott International in fiscal year 1989, but contains new requirements for asset recognition. It also contains new requirements regarding balance sheet classification and prior business combinations. The cumulative effect of the accounting change reflects the impact of the net reduction in enacted tax rates on temporary differences resulting from adjustments of remaining assets and liabilities acquired in the acquisition of The Babcock & Wilcox Company in 1978 from net of tax to pre-tax amounts. The cumulative effect of the accounting change on prior years at April 1, 1992 was $3,727,000, or $0.07 a share. Other than the cumulative effect, the accounting change had no material effect on fiscal year 1993.\n- 39 - Foreign Currency Translation\nAssets and liabilities of foreign operations, other than operations in highly inflationary economies, are translated into U.S. Dollars at current exchange rates and income statement items are translated at average exchange rates for the year. Adjustments resulting from the translation of foreign currency financial statements are recorded in a separate component of equity; an analysis of these adjustments follows:\n(In thousands)\nBalance March 31, 1991 $ (8,869) Translation adjustments for fiscal year 1992 (3,335) - - --------------------------------------------------------------------------------\nBalance March 31, 1992 (12,204) Translation adjustments for fiscal year 1993 (21,581) - - --------------------------------------------------------------------------------\nBalance March 31, 1993 (33,785) Translation adjustments for fiscal year 1994 (14,116) - - --------------------------------------------------------------------------------\nBalance March 31, 1994 $(47,901) ================================================================================\nForeign currency transaction adjustments are reported in income. Included in Other Income (Expense) are transaction losses of $2,260,000, $3,747,000, and $6,744,000 for fiscal years 1994, 1993 and 1992, respectively.\n- 40 - Contracts and Revenue Recognition\nContract revenues and related costs are principally recognized on a percentage of completion method for individual contracts or components thereof based upon work performed or a cost to cost method, as applicable to the product or activity involved. Revenues and related costs so recorded, plus accumulated contract costs that exceed amounts invoiced to customers under the terms of the contracts, are included in Contracts in Progress. Billings that exceed accumulated contract costs and revenues and costs recognized under percentage of completion are included in Advance Billings on Contracts. Most long-term contracts have provisions for progress payments. Contract price and cost estimates are reviewed periodically as the work progresses and adjustments proportionate to the percentage of completion are reflected in income in the period when such estimates are revised. There are no unbilled revenues which will not be billed. Provisions are made currently for all known or anticipated losses. Claims for extra work or changes in scope of work are included in contract revenues when collection is probable. Included in Accounts Receivable and Contracts in Progress are approximately $56,873,000 and $54,668,000 relating to commercial and U.S. Government contracts claims whose final settlement is subject to future determination through negotiations or other procedures which had not been completed at March 31, 1994 and 1993, respectively. International and certain of its subsidiaries keep books and file tax returns on the completed contract method of accounting.\nMcDermott International is usually entitled to financial settlements relative to the individual circumstances of deferrals or cancellations of Power Generation Systems and Equipment contracts. McDermott International does not recognize such settlements or claims for additional compensation until final settlement is reached.\n- 41 - Included in accounts receivable - trade are amounts representing retainages on contracts as follows:\nOf its long-term retainages at March 31, 1994, McDermott International anticipates collection as follows: $18,704,000 in fiscal year 1996, $17,452,000 in fiscal year 1997, $3,214,000 in fiscal year 1998.\nInventories\nInventories are carried at the lower of cost or market. Cost is determined on an average cost basis except for certain materials inventories, for which the last-in first-out (LIFO) method is used. The cost of approximately 21% and 18% of total inventories was determined using the LIFO method at March 31, 1994 and 1993, respectively. Consolidated inventories at March 31, 1994 and 1993 are summarized below:\nWarranty Expense\nEstimated warranty expense which may be required to satisfy contractual requirements, primarily of the Power Generation Systems and Equipment segment, is accrued relative to revenue recognition on the respective contracts. In addition, specific provisions are made where the costs of warranty are expected to significantly exceed such accruals.\n- 42 - Environmental Clean-up Costs\nMcDermott International accrues for future decommissioning and decontamination of its nuclear facilities that will permit the release of these facilities to unrestricted use at the end of each facility's life, which is a condition of its licenses from the Nuclear Regulatory Commission. Such accruals are based on the estimated cost of those activities over the economic useful life of each facility, which is estimated at 40 years. During fiscal year 1992, the provision was reduced $14,900,000 as a result of a Department of Energy grant for one facility.\nResearch and Development\nThe cost of research and development which is not performed on specific contracts is charged to operations as incurred. Such expense was approximately $21,036,000, $19,459,000 and $21,300,000 in fiscal years 1994, 1993 and 1992, respectively. In addition, expenditures on research and development activities of approximately $48,112,000, $42,082,000 and $67,100,000 in fiscal years 1994, 1993 and 1992, respectively, were paid for by customers of McDermott International.\nDepreciation, Maintenance and Repairs and Drydocking Expenses\nExcept for major marine vessels, property, plant and equipment is depreciated on the straight-line method, using estimated economic useful lives of 8 to 40 years for buildings and 2 to 28 years for machinery and equipment.\nMajor marine vessels are depreciated on the units-of-production method based on the utilization of each vessel. Depreciation expense calculated under the units-of-production method may be less than, equal to, or greater than depreciation expense calculated under the straight-line method in any period. The annual depreciation based on utilization of each vessel will not be less than the greater of 25% of annual straight-line depreciation, or 50% of cumulative straight-line depreciation.\nMaintenance, repairs and renewals which do not materially prolong the useful life of an asset are expensed as incurred except for drydocking costs for the marine fleet, which are estimated and accrued over the period of time between drydockings, and such accruals are charged to operations currently.\nAmortization of Excess of Cost Over Fair Value of Net Assets of Purchased Businesses\nExcess of the cost over fair value of net assets of purchased businesses primarily pertains to The Babcock & Wilcox Company, which is being amortized on a straight-line basis over forty years.\n- 43 - Capitalization of Interest Cost\nIn fiscal years 1994, 1993 and 1992, total interest cost incurred was $65,296,000, $92,111,000 and $104,946,000, respectively, of which $1,321,000, $1,771,000 and $2,625,000, respectively, was capitalized.\nEarnings Per Share\nPrimary earnings per share are based on the weighted average number of common and common equivalent shares outstanding during the year. Fully diluted earnings per share include the dilutive effect of stock options and appreciation rights.\nCash Equivalents\nCash equivalents are highly liquid investments, with maturities of three months or less when purchased, which are not held as part of the long-term investment portfolio.\nInvestments\nInvestments in government obligations and other investments (principally debt investments) held as a long-term investment are carried at amortized cost. At March 31, 1994 the market and face values of the government obligations were $393,331,000 and $397,300,000, and other investments were $317,705,000 and $339,016,000, respectively. See Management's Discussion and Analysis of Financial Condition and Results of Operations regarding the future adoption of FASB Statement No. 115, \"Accounting for Investments in Debt and Equity Securities\".\nForward Exchange Contracts\nMcDermott International enters into forward exchange contracts primarily as hedges relating to identifiable currency positions. These financial instruments are designed to minimize exposure and reduce risk from exchange rate fluctuations in the regular course of business. Gains and losses on forward exchange contracts which hedge exposures on firm foreign currency commitments are deferred and recognized as adjustments to the bases of those assets. Gains and losses on forward exchange contracts which hedge foreign currency assets or liabilities are recognized in income as incurred. Such amounts effectively offset gains and losses on the foreign currency assets or liabilities that are hedged.\nAt March 31, 1994, McDermott International had forward exchange contracts to purchase $328,881,000 in foreign currencies (primarily Canadian Dollars and Dutch Guilders), and to sell $281,787,000 in foreign currencies (primarily Canadian Dollars, Japanese Yen, Dutch Guilders, British Pounds, and Saudi Riyals), at varying maturities from fiscal year 1995 through 1998.\n- 44 - NOTE 2 - ACQUISITIONS\nOn February 28, 1994, McDermott International acquired Northern Ocean Services Limited (\"NOS\") for $57,645,000. NOS owns and operates 2 major marine construction vessels and specialized construction equipment for providing subsea and trenching services to industries worldwide; including oil, gas, marine construction and hydrocarbon processing. The purchase has been reflected in the consolidated balance sheet of McDermott International. Results of NOS's operations from the date of acquisition to March 31, 1994 have been included in McDermott International's consolidated results and are included in the Marine Construction Services' segment. Results for the one month ended March 31, 1994 were not material to the consolidated financial statements of McDermott International.\nDuring June 1993, the Delaware Company acquired a controlling interest in Delta Catalytic Corporation (\"DCC\") of Calgary, Alberta, Canada for $28,249,000. This was the first step in a two-step transaction which will be completed during fiscal year 1997, when the Delaware Company intends to acquire the balance of DCC. The purchase price for the second step in fiscal year 1997 will be determined based upon DCC's earnings for the period from November 1992 to October 1996. DCC provides engineering, procurement, construction and maintenance services to industries worldwide; including oil, gas, marine construction and hydrocarbon processing. The purchase has been reflected in the consolidated balance sheet of McDermott International. Results of DCC's operations from the date of acquisition to March 31, 1994 have been included in McDermott International's consolidated results and are included in the Marine Construction Services' segment. Revenues, segment operating income and net income were $228,822,000, $7,207,000, and $182,000, respectively, for the ten months ended March 31, 1994.\nThe following pro forma income statement information for McDermott International is presented as though the acquisitions of NOS and DCC had occurred on April 1, 1992.\nThe pro forma financial information is presented for informational purposes only and is not necessarily indicative of the operating results that would have occurred had the\n- 45 - acquisitions of NOS and DCC been consummated as of the above dates, nor are they necessarily indicative of future operating results.\nThe acquisitions were accounted for under the purchase method. The excess of cost over fair value of net assets of purchased businesses of DCC and NOS is being amortized over a period of 10 years. The purchase price of DCC has been allocated to the underlying assets and liabilities based on fair values at the date of acquisition, while the purchase price of NOS has been allocated to the underlying assets and liabilities based on estimated fair values at the date of acquisition. Such estimates may be revised at a later date. A summary of the purchase price allocation for DCC and NOS is as follows:\n(In thousands) Net Working Capital $ (602) Excess of Cost Over Fair Value of Net Assets of Purchased Businesses 32,832 Net Property, Plant and Equipment 68,003 Other Non-Current Liabilities, Net (14,339) - - ----------------------------------------------------------------------\nTotal $ 85,894 ======================================================================\nNOTE 3 - INVESTMENTS IN JOINT VENTURES AND OTHER ENTITIES\nDuring December 1991, McDermott International reduced its participation in the nuclear fuel assembly and commercial nuclear services business by selling a portion of its interests in B&W Fuel Company (\"BWFC\") and B&W Nuclear Service Company (\"BWNSC\") to a consortium of U. S. subsidiaries of three French companies and the U. S. subsidiary of Framatome S.A. (\"Framatome\"), respectively. McDermott International retained a 25% interest in BWFC and BWNSC. Both joint ventures were accounted for on a cost basis after the sale as McDermott International no longer exercised significant influence over these joint ventures. Prior to the sale, BWFC was part of McDermott International's consolidated financial statements and BWNSC was accounted for as an equity investment. Under the terms of the December 1991 sales agreements, Framatome purchased a 25% interest in BWNSC for $45,000,000 and the three French companies, which included Framatome, purchased a 26% interest in BWFC for $13,800,000. In addition, McDermott International was paid $17,000,000 relating to fees earned from, and the termination of, a management services agreement and received $33,820,000 in loan proceeds. On March 30, 1993, McDermott International sold its remaining interests in BWFC and BWNSC to the same parties for $10,150,000 and $32,440,000, respectively, and loans of $33,820,000 were repaid.\nIncluded in the Consolidated Statement of Income (Loss) and Retained Earnings (Deficit) are revenues of $44,639,000 and a loss of $419,000 applicable to BWFC operations, for the fiscal year ended March 31, 1992. Included in Equity in Income of Investees was income applicable to BWNSC of $5,179,000 for the fiscal year ended March 31, 1992. Included in Other-net were gains on the sales of $23,968,000 and $57,397,000 for the fiscal years ended March 31, 1993 and 1992, respectively, and income from management fees and services applicable to these operations of $8,446,000 for the fiscal year ended March 31, 1992.\n- 46 - During December 1991, McDermott International and ETPM S.A. negotiated the internal reorganization of the ETPM joint venture. As a result of these negotiations, McDermott International's ownership of McDermott-ETPM East increased from 56.8% to 67.2% and ownership of McDermott-ETPM West decreased from 56.8% to 49.9%. McDermott-ETPM East operates in the Middle East and India; McDermott-ETPM West operates in the North Sea, West Africa and South America. Since December 17, 1991, McDermott International's investment in McDermott-ETPM West, has been accounted for on the equity method.\nIncluded in the Consolidated Statement of Income (Loss) and Retained Earnings (Deficit), during fiscal year 1992, are revenues of $302,766,000 and income of $4,104,000 applicable to McDermott-ETPM West operations, prior to deconsolidation in December 1991. After deconsolidation, a loss of $6,058,000 was included in Equity in Income of Investees in fiscal year 1992.\nMcDermott International's investments in joint ventures and other entities, which are accounted for on the equity method, were $128,006,000 and $76,996,000 at March 31, 1994 and 1993, respectively. Transactions with entities for which investments are accounted for by the equity method included sales to ($89,123,000, $91,448,000 and $79,061,000 in fiscal years 1994, 1993 and 1992, respectively), including approximately $49,121,000, $47,535,000 and $33,681,000 attributable to leasing activities in fiscal years 1994, 1993 and 1992, respectively, and purchases from ($137,942,000, $76,396,000, and $35,279,000 in fiscal years 1994, 1993 and 1992, respectively) these entities. Included in Accounts receivable-trade at March 31, 1994 and 1993 are $29,883,000 and $45,954,000 of receivables with unconsolidated investees.\nIn fiscal year 1994, McDermott International recognized revenues of $131,000,000 for work subcontracted to HeereMac. In fiscal year 1992, McDermott International recognized a gain of $5,100,000 on the sale of certain ancillary marine equipment (cost of $14,918,000 and accumulated depreciation of $14,851,000) to HeereMac for $10,267,000. During fiscal year 1992, additional investments of $18,498,000 were made in the HeereMac joint venture. HeereMac subsequently used these funds to settle amounts owed to McDermott International for equipment charters.\nAt March 31, 1994 and 1993, property, plant and equipment included $409,952,000 and $464,101,000, and accumulated depreciation included $221,503,000 and $247,920,000, respectively, of marine equipment that is leased to unconsolidated investees. Dividends received from unconsolidated investees were $65,214,000, $33,202,000 (including a return of capital of $27,402,000), and $12,346,000, in fiscal years 1994, 1993 and 1992, respectively.\n- 47 - Summarized combined balance sheet and income statement information based on the most recent financial information for McDermott International's equity investments in joint ventures and other entities are presented below:\nNOTE 4 - INCOME TAXES\nIncome taxes have been provided based upon the tax laws and rates in the countries in which operations are conducted. All income has been earned outside of Panama and McDermott International is not subject to income tax in Panama on income earned outside of Panama. Therefore, there is no expected relationship between the provision for, or benefit from, income taxes and income, or loss, before income taxes. The major reason for the variations in such relationships is that income is earned within and subject to the taxation laws of various countries, each of which has a regime of taxation which varies from that of any other country (not only with respect to nominal rate but also with respect to the allowability of deductions, credits and other benefits) and because the proportional extent to which income is earned in, and subject to tax by, any particular country or countries varies from year to year.\n- 48 - Deferred income taxes reflect the net tax effects of temporary differences between the financial and tax bases of assets and liabilities. Significant components of deferred tax assets and liabilities as of March 31, 1994 and 1993 were as follows:\n- 49 -\nIncome from continuing operations before provision for income taxes, extraordinary items and cumulative effect of accounting changes was as follows:\nThe current provision for other than U. S. income taxes in 1994 and 1993 includes a reduction of $22,515,000 and $26,606,000, respectively, for the benefit of net operating loss carryforwards.\n- 50 - During fiscal year 1992, a decision was entered in the United States Tax Court concerning the Delaware Company's U.S. income tax liability for the fiscal year ended March 31, 1983 disposing of all significant U.S. federal income tax issues for that year. The IRS has issued notices for fiscal years 1984 through 1988 asserting deficiencies in the amounts of net operating losses and taxes reported. The deficiencies are based on issues substantially similar to those of earlier years. The Delaware Company believes that any income taxes ultimately assessed will not exceed amounts already provided.\nPursuant to a stock purchase and sale agreement (the \"Intercompany Agreement\"), the Delaware Company has the right to sell to International and International has the right to buy from the Delaware Company, 100,000 units, each unit consisting of one share of International Common Stock and one share of International Series A Participating Preferred Stock, at a price based primarily upon the stockholders' equity of McDermott International at the close of the fiscal year preceding the date at which the right to sell or buy, as the case may be, is exercised, and, to a limited extent, upon the price-to-book value of the Dow Jones Industrial Average. At April 1, 1994, the current unit value was $2,039 and the aggregate current unit value for the Delaware Company's 100,000 units was $203,943,000. The net proceeds to the Delaware Company from the exercise of any rights under the Intercompany Agreement would be subject to U. S. federal, state and other applicable taxes. No tax provisions have been established, since there is no present intention by either party to exercise such rights.\n- 51 - NOTE 5 - LONG-TERM DEBT AND NOTES PAYABLE\n- 52 - As defined in the Indenture, the 10.25% Notes due 1995 may be redeemed at the option of the holders upon a change of control of International. The Indenture, and the Indenture for the 9.375% Notes due 2002 and the Series A and B Medium Term Notes, contain certain covenants which restrict the amount of funded indebtedness that the Delaware Company may incur, and place limitations on certain restricted payments, certain transactions between affiliates, the creation of certain liens and the amendment of the Intercompany Agreement.\nPursuant to its right of redemption, on March 31, 1993, the Delaware Company deposited cash into trusts for the purpose of redeeming its 9.625% Sinking Fund Debentures, 10% Subordinated Debentures, and 10.20% Sinking Fund Debentures. These redemptions resulted in an extraordinary loss of $2,429,000 (net of income tax benefit of $1,252,000), in fiscal year 1993. Also on March 31, 1993, pursuant to its redemption option, McDermott International provided for the loss associated with the redemption and subsequent extinguishment of its 12.25% Senior Subordinated Notes due in 1998 resulting in an extraordinary loss of $7,392,000 (net of income tax benefit of $3,808,000). Additionally, during October 1992, the Delaware Company repurchased $10,600,000 aggregate principal amount of its 12.25% Senior Subordinated Notes due 1998 resulting in an extraordinary loss of $610,000 (net of income tax benefit of $314,000).\nIn management of its net interest costs (expense on debt and income on investments), McDermott International entered into interest rate swap agreements with certain banks which effectively change the fixed interest rates on certain long-term notes payable. Net amounts to be paid or received as a result of these agreements are accrued as adjustments to interest expense over the terms of these contracts. Gains realized as a result of terminating agreements in fiscal year 1993 were deferred and were recognized as reductions of interest expense over the original terms of the agreements. Interest rate swaps resulted in a reduction of interest expense of $5,782,000 and $6,961,000 in fiscal year 1994 and 1993, respectively. At March 31, 1994, McDermott International had an interest rate swap outstanding on the current notional principal of $90,400,000 of its 10.375% note payable due 1998. This interest rate swap effectively changes the fixed rate to a variable rate based on the London Interbank Offered Rate and is expected to effectively reduce interest costs on the note over the remaining term to maturity.\nMcDermott International's 10.375% Note payable due 1998 is secured by a letter of credit issued by a U. S. bank. The letter of credit was secured by $100,906,000 amortized cost (market value of $100,160,000) of McDermott International's long term portfolio at March 31, 1994. The outstanding principal is repayable in semi-annual payments with the final installment due June 20, 1998. The letter of credit and collateral amounts decline as the loan principal is repaid.\nMaturities of long-term debt during the five fiscal years subsequent to March 31, 1994 are as follows: 1995 - $25,032,000; 1996 - $174,571,000; 1997 - $26,216,000; 1998 - $73,467,000; 1999 - $42,462,000.\nThe Delaware Company is restricted, as a result of covenants in certain credit agreements, in its ability to transfer funds to International and its subsidiaries through cash dividends or through unsecured loans or investments. At March 31, 1994, substantially all of the net assets of the Delaware Company were subject to such restrictions. It is not expected that these restrictions will have any significant effect on International's liquidity.\n- 53 - At March 31, 1994 and 1993, McDermott International had available to it various uncommitted short-term lines of credit from banks totaling $246,412,000 and $129,734,000, respectively. Borrowings by McDermott International against these lines of credit at March 31, 1994 and 1993 were $37,512,000 and $775,000, respectively. In addition, the Babcock & Wilcox Company had available to it a $128,000,000 unsecured and committed revolving line of credit facility. Loans outstanding under the revolving credit facility may not exceed the banks' commitments thereunder, which commitments are subject to reduction based upon the ratio of the borrower's consolidated net tangible assets to specified indebtedness plus unused commitments. In addition, it is a condition to borrowing under the revolving credit facility that the borrower's consolidated net tangible assets exceed a certain level. There were no borrowings against this facility at March 31, 1994 and 1993. DCC had available from a certain Canadian bank an unsecured and committed revolving credit facility of $14,493,000 which expires on May 31, 1997. No borrowings were outstanding against this facility at March 31, 1994.\n- 54 - NOTE 6 - PENSION PLANS AND POSTRETIREMENT BENEFITS\nPension Plans - McDermott International provides retirement benefits, primarily through non-contributory pension plans, for substantially all of its regular full-time employees, except certain non-resident alien employees of foreign subsidiaries who are not citizens of a European Community country or who do not earn income in the United States, Canada, or the United Kingdom. Salaried plan benefits are based on final average compensation and years of service, while hourly plan benefits are based on a flat benefit rate and years of service. McDermott International's funding policy is to fund applicable pension plans to meet the minimum funding requirements of the Employee Retirement Income Security Act of 1974 (ERISA) and, generally, to fund other pension plans as recommended by the respective plan actuary and in accordance with applicable law. At January 1, 1994 and 1993, approximately one- half of total plan assets were invested in listed stocks and bonds. The remaining assets were held in foreign equity funds, U. S. Government securities and investments of a short-term nature.\nU. S. Pension Plans:\nThe net periodic pension cost (benefit) for fiscal years 1994, 1993 and 1992 included the following components:\nDue to the sale of its welded tubular line of business, the loss from discontinued operations in fiscal year 1992 includes a net after-tax gain of $1,659,000 resulting from the recognition of a curtailment and settlement of a related hourly pension plan.\nDue to the sale of interests in its two nuclear joint ventures, income from continuing operations in fiscal year 1992 includes a net after-tax gain of $1,615,000 resulting from the curtailment and settlement of a related salaried pension plan. The remeasurement of net periodic pension cost increased pre-tax income from continuing operations by $2,074,000.\n- 55 - The following table sets forth the U. S. plans' funded status and amounts recognized in McDermott International's consolidated financial statements:\nThe assumptions used in determining the funded status of the U. S. plans were:\n- 56 - The changes in the discount rate and the rate of increase in future compensation levels for the U. S. plans increased the projected benefit obligation at March 31, 1994. This net increase includes an increase of $101,960,000 due to the change in discount rate and a decrease of $15,233,000 due to the change in the rate of increase in future compensation levels.\nIn accordance with the provisions of SFAS No. 87, \"Employers' Accounting for Pensions,\" McDermott International recorded, during 1994 and 1993, an additional minimum liability for certain of its U. S. plans of $8,414,000 and $11,220,000, respectively. These liabilities resulted in recognition of intangible assets of $7,457,000 and $11,144,000 and reductions in stockholders' equity of $931,000 and $74,000, respectively, in fiscal year 1994 and 1993.\nThe two principal U. S. ERISA pension plans provide that, subject to certain limitations, any excess assets in such plans would be used to increase pension benefits if certain events occurred within a 60 month period following a change in control of International.\nNon-U. S. Pension Plans:\nThe net periodic pension benefit for fiscal years 1994, 1993 and 1992 included the following components:\nDue to a reduction in workforce at one of its foreign subsidiaries, income from continuing operations before cumulative effect of accounting change in fiscal year 1994 includes a net after-tax loss of $1,456,000 resulting from the curtailment of a related plan.\n- 57 - The following table sets forth the non-U. S. plans' funded status (assets exceed accumulated benefits) and amounts recognized in McDermott International's consolidated financial statements:\nThe assumptions used in determining the funded status of the non-U. S. plans were:\nThe changes in the discount rate and the rate of increase in future compensation levels for the non-U. S. plans increased the projected benefit obligation at March 31, 1994. This net increase includes an increase of $40,257,000 due to the change in discount rate and a decrease of $10,767,000 due to the change in the rate of increase in future compensation levels.\n- 58 - Multiemployer Plans - One of McDermott International's subsidiaries contributes to various multiemployer plans. The plans generally provide defined benefits to substantially all unionized workers in this subsidiary. Amounts charged to pension cost and contributed to the plans were $8,367,000, $4,687,000 and $4,886,000 in fiscal years 1994, 1993 and 1992, respectively.\nPostretirement Health Care and Life Insurance Benefits - McDermott International offers postretirement health care and life insurance benefits to substantially all of its retired regular full-time employees, including those associated with discontinued operations, except certain non-resident alien retired employees who are not citizens of a European Community country or who, while employed, did not earn income in the United States, Canada or the United Kingdom. McDermott International shares the cost of providing these benefits with all affected retirees, except for certain life insurance plans. Postretirement health care and life insurance benefits are offered under separate defined benefit postretirement plans to union and non-union employees. The health care plans are contributory and contain cost-sharing provisions such as deductibles and coinsurance; the life insurance plans are contributory and non-contributory. McDermott International does not fund any of its plans.\nThe following table sets forth the amounts recognized in the consolidated financial statements at March 31:\nThe accumulated postretirement benefit obligation in the above table includes $408,675,000 and $362,403,000 for McDermott International's health care plans and $43,026,000 and $35,471,000 for McDermott International's life insurance plans at March 31, 1994 and 1993, respectively. The increase in the unrecognized net loss at March 31, 1994 was primarily attributable to the change in the discount rate.\n- 59 - Net periodic postretirement benefit cost for fiscal years 1994 and 1993 included the following components:\nFor measurement purposes, a weighted-average annual assumed rate of increase in the per capita cost of covered health care claims of 12-1\/2% was assumed for 1994 and 13-1\/2% for 1993. In both years, the rate was assumed to decrease gradually to 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 assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of March 31, 1994 by $26,947,000 and the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for fiscal 1994 by $2,393,000.\nEmployees of McDermott International who are not U.S. citizens and located in certain foreign countries are covered by various foreign postretirement benefit arrangements. McDermott International has not yet adopted SFAS No. 106 for these foreign plans. The effect of initial adoption will be reported as the cumulative effect of an accounting change and is not expected to have a material effect on the consolidated financial statements of McDermott International.\nPostretirement Benefits - See Management's Discussion and Analysis of Financial Condition and Results of Operations regarding future adoption of FASB Statement No. 112, \"Employers' Accounting for Postemployment Benefits.\"\n- 60 - NOTE 7 - SALE OF ACCOUNTS RECEIVABLE\nIn December 1992, The Babcock & Wilcox Company renewed an agreement for an additional period of three years with a certain U.S. bank, whereby it can sell, up to a maximum limit of $225,000,000, with limited recourse, an undivided interest in a designated pool of qualified accounts receivable. Under the terms of the agreement, new receivables are added to the pool as collections reduce previously sold accounts receivable. At March 31, 1994, approximately $170,000,000 of receivables had been sold for cash under this agreement. Included in Other-net income were expenses recorded on the sale of receivables which represent bank fees and discounts of $8,699,000, $7,851,000 and $12,564,000 for the fiscal years ended March 31, 1994, 1993 and 1992, respectively.\nNOTE 8 - SUBSIDIARY'S REDEEMABLE PREFERRED STOCKS\nAt March 31, 1994 and 1993, 13,000,000 shares of Delaware Company Preferred Stock, with a par value of $1 per share, were authorized. Of the authorized shares, 2,818,780 shares of Series A Preferred Stock, and 3,474,652 and 3,724,629 shares of Series B Preferred Stock, respectively, were outstanding (in each case, exclusive of shares owned by the Delaware Company) at March 31, 1994 and 1993. The outstanding shares are entitled to $31.25 per share in liquidation. Preferred dividends of approximately $15,900,000 are classified as minority interest in Other Income (Expense) in each of the fiscal years 1994, 1993 and 1992. Both series of Preferred Stock are entitled to general voting rights of one-half vote for each share. The Board of Directors of the Delaware Company may authorize additional series of Preferred Stock, and may set terms of each new series except that the Delaware Company cannot create any series of stock senior to the existing Series A and Series B Preferred Stock without the consent of the holders of at least 50% of the shares of such Preferred Stock.\nEach share of the outstanding Series A Preferred Stock is convertible into one share of Common Stock of International plus $0.10 cash. Series A and Series B Preferred Stock are redeemable at the option of the Delaware Company at $31.25 per share plus accrued dividends. On March 31, 1995 and each subsequent year through March 31, 2008, the Delaware Company is obligated to redeem, at a redemption price of $31.25 plus accrued dividends, 313,878 shares of Series A Preferred Stock. On March 31, 1995, March 31 of the fiscal years 1996 through 2006, and March 31 of the fiscal years 2007 and 2008, the Delaware Company is obligated to redeem 315,877, 252,702 and 189,526 shares of Series B Preferred Stock, respectively. For the five fiscal years subsequent to March 31, 1994, the obligation to redeem the Series A and B Preferred Stock is $19,680,000 for fiscal year 1995 and $17,706,000 for each of the fiscal years 1996 through 1999. The Delaware Company may apply to the mandatory sinking fund obligations any Series A or B Preferred Stock it has reacquired, redeemed or surrendered for conversion which have not been previously credited against the mandatory sinking fund obligations. The Delaware Company applied 313,878 shares of Series A Preferred Stock and 180,700 shares of Series B Preferred Stock that it owned and redeemed 135,177 shares of Series B Preferred Stock to satisfy the March 31, 1994 mandatory sinking fund obligations. During fiscal year 1994, 114,800 shares of Series B Preferred Stock were purchased on the open market. At March 31, 1994, 49,637 shares of Series A Preferred Stock have been converted to date and the Delaware Company owned 1,575,505 shares of Series A Preferred Stock.\n- 61 - NOTE 9 - CAPITAL STOCK\nCommon Stock - Changes in Common and Series C Preferred Stock during the three years ended March 31, 1994 are summarized below:\nThe Panamanian regulations relating to acquisitions of securities of companies, such as International, registered with the National Securities Commission require, among other matters, that detailed disclosure concerning the offeror, which is subject to review by either the Panamanian National Securities Commission or the Board of Directors of the\n- 62 - subject company, be finalized prior to the beneficial acquisition of more than 5 percent of the outstanding shares of any class of stock. Transfers of securities in violation of these regulations are invalid and cannot be registered for transfer.\nAt March 31, 1994 and 1993, 85,521,703 and 77,823,347 shares of Common Stock, respectively, were reserved for issuance in connection with the conversion and redemption of the Delaware Company's Series A Preferred Stock, the conversion of International's Series C Preferred Stock, the exercise of International Rights, stock options and awards of restricted stock pursuant to the 1992 Officer Stock Program (and its predecessor programs) and the 1992 Director Stock Program, and contributions to the Thrift Plan.\nInternational Preferred Stock - At March 31, 1994 and 1993, 25,000,000 shares of Preferred Stock were authorized. Of the authorized shares, 100,000 shares of Series A Participating Preferred Stock (the \"Participating Preferred Stock\") and 80,000 and 90,000 shares of Series B Non-Voting Preferred Stock (the \"Non-Voting Preferred Stock\"), respectively, were issued and owned by the Delaware Company at March 31, 1994 and 1993. The Non-Voting Preferred Stock is currently callable by International at $275 per share and 10,000 shares are to be redeemed each year by International at $250 per share. The annual per share dividend rates for the Participating Preferred Stock and the Non-Voting Preferred Stock are $10 (but no more than ten times the amount of the per share dividend on International Common Shares) and $20, respectively, payable quarterly, and dividends on such shares are cumulative to the extent not paid. In addition, shares of Participating Preferred Stock are entitled to receive additional dividends whenever dividends in excess of $3.00 per International Share are declared (or deemed to have been declared) in any fiscal year. In 1987, the voting rights of the Participating Preferred Stock were eliminated.\nOf the authorized shares, International issued 2,875,000 shares of Series C Cumulative Convertible Preferred Stock in July 1993. Net cash proceeds to International were $140,066,000. The Series C shares have a par value of $1.00 per share, and a liquidation preference of $50.00 per share, plus an amount equal to accrued and unpaid dividends. Dividends on Series C shares are cumulative at the annual rate of 5.75% per share on the liquidation preference, equal to $2.875 per annum. International may not redeem Series C shares prior to July 1, 1997. On or after July 1, 1997, the Series C shares are redeemable, in whole or in part, at the option of International, either in cash, shares of International common stock, or a combination thereof. Holders of Series C shares may convert them, in whole or in part, at any time, into International common stock shares at a conversion price of $35.25 per share of common stock (equivalent to a conversion rate of 1.4184 shares of common stock for each share of Series C Preferred Stock), subject to certain adjustments.\nThe issuance of additional International Preferred Stock in the future and the specific terms thereof, such as the dividend rights, conversion rights, voting rights, redemption prices and similar matters, may be authorized by the Board of Directors of International without stockholder approval, except to the extent such approval may be required by applicable rules of the New York Stock Exchange or applicable law. If additional Preferred Stock is issued, such additional shares will rank senior to International Common Stock as to dividends and upon liquidation.\n- 63 -\nInternational Rights - On December 30, 1985, each holder of Common Stock received a dividend distribution of one Right for each outstanding share of Common Stock. The Rights currently trade with the Common Stock and at March 31, 1994 and 1993, International had outstanding Rights to purchase 53,544,467 and 52,311,961 shares (including Rights to purchase 100,000 shares held by the Delaware Company at March 31, 1994 and 1993), respectively, of its Common Stock at a price of $50 per share subject to anti-dilution adjustments. The Rights will become exercisable and will detach from the Common Stock 10 days after a person or a group either becomes the beneficial owner of 20 percent or more of the outstanding Common Stock, or commences or announces an intention to commence a tender or exchange offer for 30 percent or more of the outstanding Common Stock. If thereafter the acquiring person or group engages in certain self-dealing transactions, holders of Rights may purchase at the exercise price that number of shares of Common Stock having a market value equal to twice the exercise price. In the event International merges with or transfers 50 percent or more of its assets or earnings to any person after the Rights become exercisable, holders of Rights may purchase at the exercise price that number of shares of Common Stock of the acquiring entity having a market value equal to twice the exercise price. The Rights are redeemable by International and expire on December 30, 1995.\nStock Plans - The following table summarizes activity for McDermott International's stock option plans:\n- 64 - A total of 1,380,090 shares of Common Stock (including 195,230 of approved shares that were not awarded, and rights to shares that have not terminated or expired, under predecessor plans) are available for grants of options under the 1992 Officer Stock Program. Options become exercisable at such time or times as determined at the date of the grant, and expire ten years after the date of grant. Pursuant to the program, eligible employees may be granted rights to purchase shares of Common Stock at par value ($1.00 per share) subject to restrictions on transfer which lapse at such times and circumstances as specified when granted. Substantially all of the shares of Common stock available for award under the 1992 Officer Stock Program may be granted as rights under the program. A total of 789,625 rights have been granted to purchase shares at par value ($1.00 per share) under the 1992 Officer Stock Program (and its predecessor plans) and the 1992 Director Stock Program (described below) at March 31, 1994.\nA total of 25,325 shares of Common Stock are available for grants of options, and rights to purchase shares, to non-employee directors under the 1992 Director Stock Program. Options to purchase 900, 300 and 300 shares will be granted on the first, second, and third years, respectively, of a Director's term at not less than 100% of the fair market value on the date of grant. Options become exercisable, in full, six months after the date of the grant, and expire ten years and one day after the date of grant. Rights to purchase 450, 150 and 150 shares are granted on the first, second and third years, respectively, of a Director's term at par value ($1.00 per share) subject to restrictions on transfer, which lapse at the end of such term.\nUnder the 1992 Senior Management Stock Option plan, senior management employees may be granted options to purchase shares of Common Stock. The total number of shares available for grant is determined by the Board of Directors from time to time. Options to purchase shares are granted at no less that 100% of the fair market value on the date of grant, become exercisable at such time or times as determined when granted, and expire ten years after the date of the grant.\nIn the event of a change in control of McDermott International, all three programs have provisions that may cause restrictions to lapse and accelerate the exercisability of options outstanding.\nThrift Plan - On November 12, 1991, a maximum of 5,000,000 of the authorized and unissued shares of International's common stock was reserved for possible issuance to be used as the employer match for employee contributions to the Thrift Plan for Employees of McDermott Incorporated and Participating Subsidiary and Affiliated Companies. Such employer contributions equal 50% of the first 6% of compensation, as defined in the Plan, contributed by participants, and fully vest and are non-forfeitable after five years of service or upon retirement, death, lay-off or approved disability. During fiscal years 1994, 1993 and 1992, 300,391, 347,054 and 115,787 shares, respectively, were issued as employer contributions pursuant to the Plan. At March 31, 1994, 4,236,768 shares remained available for issuance.\n- 65 - NOTE 10 - CONTINGENCIES AND COMMITMENTS\nLitigation - International and certain of its officers, directors and subsidiaries are defendants in numerous legal proceedings. Management believes that the outcome of these proceedings will not have a material adverse effect upon the consolidated financial position of McDermott International.\nProducts Liability - See Note 1 regarding products liability.\nOperating Leases - Future minimum payments required under operating leases that have initial or remaining noncancellable lease terms in excess of one year at March 31, 1994 are as follows: 1995 -$25,282,000; 1996 - $20,063,000; 1997 - $17,702,000; 1998 - $16,296,000; 1999 - $13,828,000; and thereafter - $52,519,000. Future minimum lease payments and leased property under capital leases are not material. Total rental expense for fiscal years 1994, 1993 and 1992 was $120,515,000, $131,014,000, and $149,140,000, respectively. These expense figures include contingent rentals and are net of sublease income, both of which are not material.\nOther - McDermott International performs significant amounts of work for the U.S. Government under both prime contracts and subcontracts and thus is subject to continuing reviews by governmental agencies.\nMcDermott International maintains liability and property insurance that it considers normal in the industry. However, certain risks are either not insurable or insurance is available only at rates which McDermott International considers uneconomical.\nMcDermott International has been identified as a potentially responsible party at various cleanup sites under the Comprehensive Environmental Response, Compensation and Liability Act, as amended. Whereas, McDermott International has not been determined to be a major contributor of wastes to these sites, each potentially responsible party or contributor may face assertions of joint and several liability. Based on its relative contribution of wastes to the various sites, of which a final determination has not yet been made, McDermott International's share of the ultimate liability is not expected to have a material adverse effect on its consolidated financial position.\nIn addition, remediation projects have been or may be undertaken at certain of McDermott International's current and former plant sites, and B&W is currently evaluating a consent order issued by The Department of Environmental Resources of the Commonwealth of Pennsylvania seeking monetary sanctions, and remedial and monitoring relief, relating to B&W's Parks Facilities in Parks Township, Pennsylvania. Any sanctions ultimately assessed, and any costs ultimately incurred on other remediation projects, are not expected to have a material adverse effect on the consolidated financial statements of McDermott International.\nCommitments for capital expenditures amounted to approximately $65,849,000 (including $38,560,000 for a new concept steam generator facility for the Naval Reactor Program in Lynchburg, Virginia, the anticipated purchase of a barge currently leased and the completion of a new combustion and emission facility in Alliance, Ohio,) at March 31, 1994, of which approximately $65,692,000 relates to fiscal year 1995.\n- 66 - McDermott International is contingently liable under standby letters of credit totaling $428,298,000 (including $72,245,000 issued on behalf of unconsolidated foreign joint ventures) at March 31, 1994, issued in the normal course of business. McDermott International has guaranteed $10,450,000 of loans to and $23,179,000 of standby letters of credit issued by certain unconsolidated foreign joint ventures at March 31, 1994. At March 31, 1994, McDermott International had pledged approximately $56,159,000 amortized cost (market value of $58,040,000) of government obligations to secure payments under and in connection with certain reinsurance agreements.\nNOTE 11 - FINANCIAL INSTRUMENTS WITH CONCENTRATIONS OF CREDIT RISK\nMcDermott International's Power Generation Systems and Equipment customers are principally the electric power generation industry (including government-owned utilities and independent power producers), the U.S. Government (including its contractors), and the pulp and paper and other process industries, such as oil refineries and steel mills. The principal customers of the Marine Construction Services segment are the offshore oil, natural gas and hydrocarbon processing industries and other marine construction companies. These concentrations of customers may impact McDermott International's overall exposure to credit risk, either positively or negatively, in that the customers may be similarly affected by changes in economic or other conditions. However, McDermott International's management believes that the portfolio of receivables is well diversified and that such diversification minimizes any potential credit risk. Receivables are generally not collateralized.\nMcDermott International believes that its provision for possible losses on uncollectible accounts receivable is adequate for its credit loss exposure. At March 31, 1994 and 1993, the allowance for possible losses deducted from Accounts receivable-trade on the balance sheet was $7,289,000 and $4,879,000, respectively.\n- 67 - NOTE 12 - FAIR VALUES OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used by McDermott International 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 its fair value.\nInvestment securities: The fair values of investments are estimated based on quoted market prices. For investments for which there are no quoted market prices, fair values are derived from available yield curves for investments of similar quality and terms.\nLong and short-term debt: The fair value of McDermott International's debt instruments are based on quoted market prices or where quoted prices are not available, on the present value of cash flows discounted at estimated borrowing rates for similar debt instruments or on estimated prices based on current yields for debt issues of similar quality and terms.\nRedeemable preferred stocks: The fair values of the redeemable preferred stocks of the Delaware Company are based on quoted market prices.\nForeign currency exchange contracts: The fair values of foreign currency forward exchange contracts are estimated by obtaining quotes from brokers. At March 31, 1994 and 1993, McDermott International had forward exchange contracts outstanding to purchase and sell foreign currencies with a net notional value of $47,094,000 and $194,125,000 and a fair value of $35,288,000 and $193,409,000, respectively.\nInterest rate swap agreements: The fair values of interest rate swaps are the amounts at which they could be settled and are estimated by obtaining quotes from brokers. At March 31, 1994, McDermott International had an interest rate swap outstanding on current notional principal of $90,400,000 with a fair value of ($1,853,000), which represents the estimated amount McDermott International would have to pay to terminate the agreement.\nThe estimated fair values of McDermott International's financial instruments at March 31, 1994 and 1993 are as follows:\n- 68 - NOTE 13 - DISCONTINUED OPERATIONS\nWelded Tubular Line of Business\nIn fiscal year 1992, McDermott International sold its welded tubular line of business (\"Welded\") for $30,217,000, consisting of $20,368,000 in cash and receivables of $9,849,000. Revenues applicable to Welded operations were $57,428,000 in fiscal year 1992. Loss from discontinued operations in fiscal year 1992 included income from operations of $182,000 (net of income tax benefit of $114,000) and a loss on disposal of $4,790,000 (net of income tax benefit of $2,936,000), including loss from operations of $1,159,000 during the phase out period.\nSeamless Tubular Line of Business\nDuring fiscal year 1991, McDermott International sold its previously discontinued seamless tubular line of business. A gain of $1,240,000 (net of income taxes of $760,000) resulting from price adjustments is included in Loss from discontinued operations in fiscal year 1992.\n- 69 - NOTE 14 - SEGMENT REPORTING\nMcDermott International operates in two industry segments - Power Generation Systems and Equipment, and Marine Construction Services.\nPower Generation Systems and Equipments' principal businesses are the supply of fossil-fuel and nuclear steam generating systems and equipment to the electric power generation industry, and nuclear reactor components to the U. S. Navy.\nMarine Construction Services supplies worldwide services for the offshore oil, natural gas, and hydrocarbon processing industries, and to other marine construction companies. Principal activities include the design, engineering, fabrication and installation of marine pipelines and offshore structures and subsea production systems for development drilling and production; and onshore construction and maintenance services.\nIntersegment sales are accounted for at prices which are generally established by reference to similar transactions with unaffiliated customers. Identifiable assets by industry segment are those assets that are used in McDermott International's operations in each segment. Corporate assets are principally cash and cash equivalents, short-term investments, marketable securities and prepaid pension costs.\nIn the fiscal years 1994, 1993 and 1992, the U. S. Government accounted for approximately 13%, 13% and 15%, respectively, of McDermott International's total revenues. These revenues are principally included in the Power Generation Systems and Equipment segment.\nAt March 31, 1994 and 1993 receivables of $1,142,000 and $10,524,000, respectively, were due from minority shareholders, primarily ETPM S.A., participating in McDermott International's majority-owned joint ventures. Sales to ETPM S.A. were $3,358,000, $31,234,000 and $11,216,000, respectively, for the fiscal years ended March 31, 1994, 1993 and 1992. In fiscal years 1994, 1993 and 1992 equipment charters and overhead expenses of $6,330,000, $6,046,000 and $44,578,000, respectively, were charged by ETPM S.A. to the McDermott-ETPM joint venture. Also, during fiscal year 1992, McDermott International acquired HeereMac's minority interest in a subsidiary of International.\nThe adoption of EITF Issue No. 93-5 in fiscal year 1994 resulted in an increase in the Power Generation Systems and Equipment Segment operating income of $19,947,000. The adoption of SFAS No. 106 in fiscal year 1993 resulted in a net decrease in segment operating income of $6,784,000. This included a decrease of $3,760,000 in the Power Generation Systems and Equipment segment and a decrease of $3,024,000 in the Marine Construction Services segment.\n- 70 - Segment Information for the Three Fiscal Years Ended March 31, 1994.\n1. Information about McDermott International's Operations in Different Industry Segments.\n(1) Segment revenues include intersegment transfers as follows:\n(2) See Note 3 regarding the deconsolidation of B&W Fuel Company to a cost method investment and the change in B&W Nuclear Service Company from an equity method to a cost method investment during fiscal year 1992. (3) See Note 3 regarding the deconsolidation of the McDermott-ETPM West joint venture during fiscal year 1992. (4) See Note 2 regarding the acquisition of NOS and DCC during fiscal year 1994.\n- 71 -\n(1) Includes property, plant and equipment of $79,233,000 of acquired companies in fiscal year 1994, and the purchase of a fabrication yard in Nueces County, Texas financed by a note payable of $16,250,000.\n- 72 - 2. Information about McDermott International's Operations in Different Geographic Areas.\n(1) Net of inter-geographic area revenues in fiscal year 1994 as follows: United States- $38,666,000, Canada - $12,082,000, Europe and West Africa - $15,868,000, Middle and Far East - $3,160,000 and Other Foreign - $25,770,000. (2) Net of inter-geographic area revenues of $71,027,000 and $129,835,000, respectively, in fiscal years 1993 and 1992.\n- 73 - NOTE 15 - QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following tables set forth selected unaudited quarterly financial information for the fiscal years ended March 31,1994 and 1993:\nQuarterly results for June and September 1993 have been restated to reflect the adoption of EITF Issue No. 93-5 (See Note 1). This restatement decreased income before cumulative effect of accounting change and net income by $467,000 and $101,217,000 (or $0.01 and $1.89 per share), respectively, for the quarter ending June 30, 1993; and increased operating income by $10,367,000, and income before cumulative effect of accounting change and net income by $7,980,000 (or $0.14 per share), for the quarter ending September 30, 1993.\nPre-tax results for the quarter ended June 30, 1993 include a favorable warranty reserve adjustment of $11,000,000. Results for the quarter ended December 31, 1993 include a reduction in the provision for worker's compensation and general liability costs resulting from a change in actuarial estimate of $12,001,000. Results for the quarter ended March 31, 1994 include a provision of $8,807,000, including interest, resulting from an unfavorable ruling on a lawsuit relating to a warranty issue; and a reduction in accrued interest on proposed tax deficiencies of $9,400,000. Included in income before cumulative effect of accounting change and net income for the quarter ended March 31, 1994, is a reduction in the provision for taxes of $10,000,000 due to the settlement of outstanding issues.\n- 74 - Continued\nPre-tax results for the quarter ended September 30, 1992 include marine asset casualty gains of $6,782,000. Results for the quarter ended December 31, 1992 include charges for accelerated depreciation and the write-off of certain fabrication facilities and marine construction equipment due to diminished cost-effectiveness and technical obsolescence of $11,708,000 and a reduction in the provision for worker's compensation and general liability costs resulting from a change in actuarial estimate of $17,342,000. Results for the quarter ended March 31, 1993 include the gain on the sale of nineteen tugboats of $4,762,000 and a gain on the sale of the remaining interests in two commercial nuclear joint ventures of $23,968,000.\n- 75 - Item 9.","section_9":"Item 9. DISAGREEMENTS WITH AUDITORS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\n- 76 - PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThere are no family relationships between any of the executive officers, directors or persons nominated to be such, and no executive officer was elected to his position pursuant to any arrangements or understanding between himself and any other person.\nInformation required by this item with respect to directors and executive officers is incorporated by reference to the material appearing under the headings \"Election of Directors\" in the Proxy Statement for the 1994 Annual Meeting of Shareholders.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nInformation required by this item is incorporated by reference to the material appearing under the heading \"Cash Compensation of Executive Officers and Certain Relationships and Related Transactions\" in the Proxy Statement for the 1994 Annual Meeting of Shareholders.\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 material appearing under the heading \"Election of Directors\" in the Proxy Statement for the 1994 Annual Meeting of Shareholders.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this item is incorporated by reference to the material appearing under the heading \"Cash Compensation of Executive Officers and Certain Relationships and Related Transactions\" in the Proxy Statement for the 1994 Annual Meeting of Shareholders.\n- 77 - PART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORT ON FORM 8-K\n- 78 -\n- 79 - FORM 8-K REPORTS\nReport on Form 8-K, Item 2 was filed on March 14, 1994.\n- 80 - EXHIBIT II\nMcDERMOTT INTERNATIONAL, INC. STATEMENT RE COMPUTATION OF PER SHARE EARNINGS (LOSS) FOR THE THREE FISCAL YEARS ENDED MARCH 31, 1994\n(In thousands, except shares and per share amounts)\nPRIMARY AND FULLY DILUTED\n(1) Earnings (loss) per common and common equivalent share assuming full dilution are the same for the fiscal years presented.\n- 81 - EXHIBIT 22\nMcDERMOTT INTERNATIONAL, INC. SIGNIFICANT SUBSIDIARIES OF THE REGISTRANT FISCAL YEAR ENDED MARCH 31, 1994\nThe subsidiaries omitted from the foregoing list do not, considered in the aggregate, constitute a significant subsidiary.\n- 82 - EXHIBIT 24\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statements (Forms S-8 No. 2-83692, No. 33-16680, No. 33-51892, No. 33-51894 and No. 33-63832) of McDermott International, Inc. and the Registration Statement (Form S-3 No. 33-54940) of McDermott Incorporated and in the related Prospectuses of our report dated May 9, 1994 with respect to the consolidated financial statements of McDermott International, Inc. included in this Annual Report (Form 10-K) for the year ended March 31, 1994.\nERNST & YOUNG\nNew Orleans, Louisiana May 12, 1994\n- 83 - SIGNATURES OF THE REGISTRANT\nPursuant to the requirements of Sections 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 May 10, 1994.\nMcDERMOTT INTERNATIONAL, INC. (REGISTRANT)\nBy: \/s\/ Robert E. Howson\nRobert E. Howson Chairman of the Board and Chief Executive Officer\nBy: \/s\/ Brock A. Hattox\nBrock A. Hattox Senior Vice President and Chief Financial Officer\nBy: \/s\/ Daniel R. Gaubert\nDaniel R. Gaubert Vice President and Controller\n- 84 - SIGNATURES OF DIRECTORS\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 May 10, 1994.\n\/s\/ Thomas D. Barrow \/s\/ James A. Hunt Thomas D. Barrow James A. Hunt Director Director\n\/s\/ Theodore H. Black __________________________ Theodore H. Black J. Howard Macdonald Director Director\n\/s\/ John F. Bookout \/s\/ William McCollam, Jr. John F. Bookout William McCollam, Jr. Director Director\n\/s\/ Philip J. Burguieres \/s\/ John A. Morgan Philip J. Burguieres John A. Morgan Director Director\n\/s\/ James L. Dutt \/s\/ William T. Seawell James L. Dutt William T. Seawell Director Director\n\/s\/ Brock A. Hattox \/s\/ John N. Turner Brock A. Hattox John N. Turner Senior Vice President and Director Chief Financial Officer, and Director\n\/s\/ Robert E. Howson Chairman of the Board and Chief Executive Officer, and Director","section_15":""}
{"filename":"14707_1994.txt","cik":"14707","year":"1994","section_1":"ITEM 1 - BUSINESS - -----------------\nThe Corporation was founded in 1878 and incorporated in 1913 and currently operates in the Footwear and Specialty Retailing industry segments. The Footwear segment is engaged in the operation of retail shoe stores and in the manufacture, importing, foreign sourcing, and marketing of women's, men's and children's footwear. The Specialty Retailing segment comprises a chain of retail fabric stores. See Note 13 of Notes to Consolidated Financial Statements on page 29 of the Annual Report to Stockholders for the year ended January 29, 1994, which is incorporated herein by reference, for additional information regarding the Corporation's industry segments.\nFootwear - --------\nThe Footwear segment is engaged in the manufacture, importing, foreign sourcing, and marketing of a wide variety of types and styles of women's, men's and children's dress and casual footwear. During 1993, footwear sales were approximately 66% women's, 21% men's, and 13% children's. This composition has remained relatively constant over the past few years. Approximately 52% of 1993 footwear sales were made at retail compared with 47% in 1992 and 43% in 1991.\nThe major brand names of the Corporation's footwear include the following:\nWomen's: Air Step Brittania (under license from Brittania Sportswear, Ltd.) Connie DeLiso Donnay (under license from Donnay International, S.A.) Dr. Scholl's (under license from Schering-Plough HealthCare Products, Inc.) Fanfares Jordache (under license from Jordache Enterprises, Inc.) Life Stride Naturalizer NaturalSport Penaljo Revelations (under license from Lowell Shoe, Inc.) Waikiki (under license from DDKA, S.A.)\nMen's: Brittania (under license from Brittania Sportswear, Ltd.) Donnay (under license from Donnay International S.A.) Dr. Scholl's (under license from Schering-Plough HealthCare Products, Inc.) Jean Pier Clemente Levi's Shoes and Boots (under license from Levi Strauss & Co.) Reed St. James (under license from Haggar Apparel Co.) Regal\nITEM 1 - BUSINESS (Continued) - -----------------\nChildren's: Aladdin (under license from The Walt Disney Company, Inc.) Bambi (under license from The Walt Disney Company, Inc.) Barbie for Girls (under license from Mattel, Inc.) Beauty and the Beast (under license from The Walt Disney Company, Inc.) Bobby's World (under license from Twentieth Century Fox Licensing and Merchandising) Buster Brown Candie's (under license from Candie's, Inc.) Conan the Adventurer (under license from Hasbro, Inc.) Dinosaurs (under license from The Walt Disney Company, Inc.) Disney (under license from The Walt Disney Company, Inc.) Disney Babies (under license from The Walt Disney Company, Inc.) Donnay (under license from Donnay International, S.A.) The Flintstones (under license from MCA\/Universal Merchandising, Inc. and Turner Home Entertainment) G. I. Joe (under license from Hasbro, Inc.) Jordache (under license from Jordache Enterprises, Inc.) The Lion King (under license from The Walt Disney Company, Inc.) The Little Mermaid (under license from The Walt Disney Company, Inc.) 101 Dalmatians (under license from The Walt Disney Company, Inc.) Playskool (under license from Hasbro, Inc.) Rookie League (under license from Major League Baseball Properties, Inc.) Waikiki (under license from DDKA, S.A.) Wildcats\nThe Corporation's retail footwear operations comprise a large number of retail footwear stores in the United States and Canada including those operated under various names including: Famous Footwear, Naturalizer, F. X. LaSalle, Regal and Connie. A substantial portion of retail sales carry Corporate brand names with the footwear manufactured either by the Corporation in company-owned factories or under contract to its specifications by domestic and foreign suppliers.\nIn retail sales of footwear, the Corporation competes in a highly frag- mented market with many organizations of various sizes operating retail shoe stores. Competitors include general shoe store operators, local and regional shoe store chains, department stores, discount stores and numerous independent retail operators of various sizes. Customer service, store location, product display, merchandise selection and pricing are important components of retail competition.\nA summary of retail footwear stores operated by the Corporation at the prior five fiscal year-ends is as follows:\nITEM 1 - BUSINESS (Continued) - -----------------\nFootwear is distributed by the Corporation's marketing, manufacturing, importing, and foreign sourcing operations in the United States, Canada, Europe, Latin America, and the Far East to approximately 5,000 retailers, including independent and chain operators of shoe and department stores and to affiliates. Certain of these customers also sell shoes bought from competing footwear suppliers. Wholesale footwear sales carry Corporate brand names, brand names licensed by the Corporation, and private label footwear produced for specific customers. This footwear is either manufactured by the Corporation in company-owned factories or under contract to its specifications by domestic and foreign suppliers. The Corporation competes with both domestic manufacturers and importers of foreign-produced footwear.\nThe Corporation's womens domestic shoe manufacturing operations, overall, account for approximately 7% of the total pairs of non-rubber footwear manufactured annually in the United States, and approximately 21% of the women's domestic production. Competition in the shoe manufacturing industry involves style, quality, price, fit and service offered to the customer. The Corporation attempts to meet competition through manufacturing efficiencies, by maintaining emphasis on quality and fit, by its ability to anticipate and create acceptable fashion styles and by manufacturing well-established branded merchandise available for immediate shipment. The principal raw materials used by the Corporation in the manufacture of shoes are leather, man-made materials and fabrics for uppers, and leather, rubber and plastics for soles and heels. The Corporation has experienced no serious difficulty in purchasing its needs of raw materials and manufactured component parts at competitive prices.\nITEM 1 - BUSINESS (Continued) - -----------------\nForeign sourced footwear accounts for approximately 87% of all footwear sold in the United States. Through the sourcing activities of its Pagoda organization, the Corporation is a leading supplier of imported footwear. This organization sources a wide variety of footwear primarily from the Far East and Brazil for other Brown Group divisions and for outside customers. During 1993 this operation was responsible for sourcing approximately 81 million pairs of shoes. Pairs sourced for the U.S. market by Pagoda represent approximately 6% of total pairs imported annually in the United States. These sourcing activities include coordination of the styling, production, and shipment of footwear produced for the Corporation by independent footwear manufacturers in foreign countries. Because Pagoda's sourcing capabilities are diverse and include numerous countries of origin and manufacturing facilities therein and since production can be shifted from country to country, the Corporation does not believe its sourcing arrangements entail significant risks.\nThe nature of the Corporation's wholesale shoe business is such that it does not have a significant backlog of non-cancelable orders. Orders for shoes are solicited by the Corporation's sales force primarily during four selling seasons in each year, with most sales being for the spring and fall retail seasons. Orders placed as a result of these sales efforts are taken before the shoes are manufactured with delivery generally within 10 to 12 weeks thereafter. In addition, the Corporation maintains a stock of the higher volume styles which are available for prompt shipment on reorder. The Corporation maintains adequate reserves for returns and allowances which may occur after sales are recorded.\nThe Corporation's marketing and promotional efforts are carried out through a number of avenues. The footwear wholesaling group maintains a sales force that visits customers periodically, presents its footwear at trade shows throughout the country, and advertises in trade magazines and publications. In addition, direct advertising to consumers is carried out through periodic use of the electronic media, sponsoring of certain sporting events, and in- store presentations and demonstrations. The footwear retailing organization advertises its products in the print and electronic media, as well as with in- store displays and promotions.\nDue to the seasonal nature of retail sales of shoes, the Corporation experiences fluctuations in the components of working capital. Retail footwear sales are seasonal with significant increases in sales experienced in the Christmas, Easter and back-to-school periods.\nSpecialty Retailing - -------------------\nThe Specialty Retailing segment comprises the Cloth World chain of retail fabric stores, one of the nation's largest volume fabric chains. All of Cloth World's 340 stores are leased with more than half having lease renewal options. Each store sells competitively priced craft, home decorating, and sewing fabrics and notions, along with patterns and sewing machines. Cloth World stores are located predominantly in the southern half of the United States extending from coast to coast. Stores are typically located in suburban areas near major metropolitan centers. Most contain between 10,000 and 12,000 square feet of space, enabling them to carry a large selection of merchandise for the home sewer and crafter.\nA summary of retail fabric stores operated by the Corporation at the prior five fiscal year ends is as follows:\nITEM 1 - BUSINESS (Continued) - -----------------\nCloth World purchases its goods from a substantial number of suppliers, and has experienced no difficulty in acquiring merchandise at competitive prices.\nThe Corporation's fabric operation competes with other fabric chains, discount stores operating their own fabric departments and numerous independent retailers. A large selection of \"fashion\" merchandise, in-store customer service, direct mail, newspaper advertising and competitive pricing are the primary methods of competition in fabric operations. Fabric retailing is subject to some seasonal influences, with Easter, back-to-school and the pre-Christmas season being somewhat stronger than other periods.\nDiscontinued Operations - -----------------------\nDuring the fourth quarter of fiscal 1993, the Corporation adopted a formal plan to withdraw from the Wohl Leased Shoe Department business. This business involves the management of over 500 shoe departments in department stores primarily on the West Coast and in the Midwest. Most of the leases are cancelable after a period of notice by either party and the Corporation expects to complete most of the withdrawals by the end of fiscal 1994.\nRestructuring - -------------\nIn January 1994 the Corporation announced restructuring initiatives related to the Footwear Segment which consist of the following:\n* Closing of five manufacturing facilities; * The closing of more than 100 company-owned Regal and Connie shoe stores; and * Reduction of Corporate and Divisional staffing at the St. Louis, Missouri, headquarters.\nIt is expected that these restructuring initiatives will be completed during fiscal 1994 and may extend into the first quarter of fiscal 1995.\nCorporate-wide Business Influences - ----------------------------------\nIn addition to normal and recurring product development, design and styling activities, the Corporation engages in research and development related to new and improved materials for use in its footwear and other products and to the development and adaptation of production techniques.\nThe Corporation is involved in environmental remediation and ongoing compliance at its closed tannery site and two associated landfill locations, and has been identified by various governmental authorities as a potentially responsible party at certain other landfills. See page 15 of the Annual Report to Stockholders for the year ended January 29, 1994, which is incorporated herein by reference, for a discussion of the financial impact of environmental issues on the Corporation. Federal, State, and local provisions for environmental protection have not had, nor are they anticipated to have, a material effect on the Corporation's capital expenditures or competitive position.\nITEM 1 - BUSINESS (Continued) - -----------------\nThe Corporation manufactures and sells certain patented items but does not consider its business to be dependent on patents. In addition, some products are sold under license agreements, such as with Schering-Plough HealthCare Products, Inc., and The Walt Disney Company, Inc. During 1993, sales under these agreements were approximately 13% of the total sales of the footwear segment.\nFrom time to time the Corporation investigates and negotiates for the possible acquisition of other businesses and operations; but at this time, there are no agreements or understandings for acquisition of any significant subsidiaries.\nThe Corporation has approximately 22,000 full and part-time employees including approximately 5,600 in the leased department business, Connie and Regal shoe stores, factories, and Corporate offices which will be terminated as a result of the restructuring and closings previously discussed. Approximately 2,000 employees engaged in the manufacture of footwear are employed under union contracts. Such contracts vary in duration and expire in years between 1994 and 1996.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - PROPERTIES - -------------------\nThe principal executive, sales and administrative offices of the Corporation are located in Clayton (St. Louis), Missouri, and consist of a complex of four adjoining office buildings. As a result of reduction in staffing, the Corporation, subsequent to year end, sold two of the four buildings.\nThe Corporation's footwear manufacturing and warehousing operations are primarily carried out at 10 footwear and component manufacturing plants, two leather cutting facilities, and three warehouses located mainly in smaller towns in the Southern and Midwestern sections of the United States and two manufacturing and one warehouse facility located in Canada. Substantially all of the facilities are owned or are subject to long-term capital leases. In January 1994 the Corporation announced the closing of five domestic production facilities. These closings will be completed in the first and second quarter of 1994. After these closings the Corporation will have annual domestic manufacturing capacity of approximately 7,000,000 pairs.\nThe Corporation's retail footwear operations are conducted throughout the United States and Canada and involve the operation of 1,152 shoe stores, including 102 in Canada. In addition, Famous Footwear has leased office space and a 750,000 square foot distribution center in Madison, Wisconsin. Cloth World has one warehouse\/distribution facility in Amarillo, Texas, and 340 leased retail store locations. All store locations are leased with approximately one-third having renewal options.\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS - --------------------------\nThe Corporation is a party to several uninsured lawsuits arising in the ordinary course of business. While the Corporation is unable to predict the ultimate outcome of these actions, it believes that their final resolution will not result in any materially adverse effect on the Corporation's financial position.\nITEM 3 - LEGAL PROCEEDINGS (Continued) - --------------------------\nThe Corporation is working with Federal and various State Environmental Protection Agencies to resolve clean-up issues at several sites, including the Corporation's closed tannery in New York. The potential financial impact on the Corporation is discussed on page 15 of the Annual Report to Stockholders for the year ended January 29, 1994, which is incorporated herein by reference.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - ------------------------------------------------------------\nNo matter was submitted to a vote of stockholders during the fourth quarter of fiscal 1993.\nEXECUTIVE OFFICERS OF THE REGISTRANT - ------------------------------------\nThe following is a list of the names and ages of the executive officers of the registrant and of the offices held by each such person. There is no family relationship between any of the named persons. The terms of the following executive officers will expire May, 1994.\nName Age Current Position - ---- --- ----------------\nB. A. Bridgewater, Jr. 60 Chairman of the Board, President and Chief Executive Officer and Member of Executive Committee\nJohn B. Biggs, Jr. 50 Senior Vice President\nBrian C. Cook 54 Vice President, Footwear Retailing and President, Famous Footwear\nArthur G. Croci 42 President, Pagoda Trading\nRonald N. Durchfort 40 President, Pagoda International\nRonald A. Fromm 43 Executive Vice President, Famous Footwear\nCurtis R. Johnson 62 Executive Vice President, Brown Shoe Company\nRaymond F. Moseley 54 President, Wohl Shoe Company\nJoseph P. Pearce 48 Executive Vice President, Brown Shoe Company\nRobert D. Pickle 56 Vice President, General Counsel and Corporate Secretary\nGary M. Rich 43 President, Pagoda U.S.A.\nHarry E. Rich 54 Director, Executive Vice President and Chief Financial Officer and Member of Executive Committee\nDonald L. Richey 50 President, Cloth World\nAndrew M. Rosen 43 Vice President and Treasurer\nMary Sylvia Siverts 34 Vice President, Public Affairs\nRichard L. Stonner 50 Senior Vice President, Retail Sales, Famous Footwear\nThomas A. Williams 45 Vice President, Footwear Wholesaling; President, Brown Shoe Company; and Chairman, Pagoda\nE. Lee Wyatt, Jr. 41 Vice President, Planning and Controller\nGeorge J. Zelinsky 45 Senior Vice President and General Merchandise Manager, Famous Footwear\nThe period of service of each officer in the positions listed and other business experience are set forth below.\nEXECUTIVE OFFICERS OF THE REGISTRANT (Continued) - ------------------------------------\nB. A. Bridgewater, Jr., Chairman of the Board and Chief Executive Officer of the registrant since 1985. President of the registrant prior to 1987 and since 1990.\nJohn B. Biggs, Jr., Senior Vice President of the registrant since January 1994. President of Brown Shoe Company from December 1990 to January 1994. Senior Vice President of Brown Shoe Company from 1987 to December 1990.\nBrian C. Cook, Vice President, Footwear Retailing of the registrant since March, 1992; President of Famous Footwear since 1981.\nArthur G. Croci, President of Pagoda Trading since November 1993. President of Brown Group International from December 1990 to November 1993. Vice President of the registrant from December 1990 to March 1993. Executive Vice President of Brown Group International from January 1990 to December 1990 and various positions with the registrant from 1980 through 1989.\nRonald N. Durchfort, President of Pagoda International since March 1993. Managing Director, BGI, SARL-European Operations from 1989 through 1993. International Sales Manager, Sidney Rich Associates, Inc. from 1986 through 1989.\nRonald A. Fromm, Executive Vice President, Famous Footwear since September 1992. Vice President and Chief Financial Officer from 1988 to 1992.\nCurtis R. Johnson, Executive Vice President, Brown Shoe Company since 1992. Executive Vice President - Production and Purchasing, Brown Shoe Company since 1982.\nRaymond F. Moseley, President of Wohl Shoe Company since March 1992; Executive Vice President, Operations of Wohl since 1989; previously Senior Vice President, Operations of Wohl since 1985.\nJoseph P. Pearce, Executive Vice President of Brown Shoe Company since June 1991, with principal responsibility for marketing. Previously, a Group President of the Fisher-Camuto Group, Inc. (a footwear company).\nRobert D. Pickle, Vice President, General Counsel and Corporate Secretary of the registrant since 1985.\nGary M. Rich, President of Pagoda U.S.A. since March 1993. President, Pagoda Trading Company, Inc. from June 1989 through March 1993. Executive Vice President, Sidney Rich Associates, Inc. from December 1980 through June 1989. Account Executive, Sidney Rich Associates, Inc. from August 1975 to December 1980.\nHarry E. Rich, Executive Vice President and Chief Financial Officer of the registrant since 1988. Senior Vice President and Chief Financial Officer of the registrant from 1984 to 1988.\nDonald L. Richey, President of Cloth World since October 1990. Previously, Executive Vice President and a Director of Hancock Fabrics, Inc.\nAndrew M. Rosen, Vice President and Treasurer of the registrant since January 1992. Treasurer of the registrant from 1983 to 1992.\nMary Sylvia Siverts, Vice President of Public Affairs since September 1993. Director of Public Relations from 1988 to 1993.\nEXECUTIVE OFFICERS OF THE REGISTRANT (Continued) - ------------------------------------\nRichard L. Stonner, Senior Vice President, Retail Sales of Famous Footwear since May 1987. Vice President and General Merchandise Manager, Shoe Stores, Wohl Shoe Company from 1985 to 1987.\nThomas A. Williams, Vice President, Footwear Wholesaling; President, Brown Shoe Company; and Chairman, Pagoda since January 1994. Vice President, International Operations of the registrant from March 1993 to January 1994. Chairman of the Board of Pagoda Trading Company from 1990 to January 1994. Vice Chairman and other management positions at Pagoda Trading Company from 1982 to 1990.\nE. Lee Wyatt, Jr., Vice President, Planning and Controller since March 1994. Vice President, Planning and Taxes of the registrant since December 1992. Director, Corporate Planning and Taxes and Assistant Secretary since 1990. Director, Corporate Planning and Analysis since 1989. Manager, Corporate Planning and Analysis since 1986.\nGeorge J. Zelinsky, Senior Vice President and General Merchandise Manager, Famous Footwear since June 1989. Vice President, Women's Better Grade Division, Wohl Shoe Company from 1986 to 1989.\nPART II -------\nITEM 5","section_5":"ITEM 5 -MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS - -------------------------------------------------\nCommon Stock market prices and dividends on page 32 of the annual stockholders report and the number of stockholders on page 34 of the annual stockholders report for the year ended January 29, 1994 are incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA - --------------------------------\nSelected Financial Data on page 16 of the annual stockholders report for the year ended January 29, 1994 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 Operations and Financial Condition on pages 12 through 15 of the annual stockholders report for the year ended January 29, 1994 is incorporated herein by reference.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - ----------------------------------------------------\nThe consolidated financial statements of the Corporation and its subsidiaries on pages 17 through 31, and the supplementary financial information on page 32 of the annual stockholders report for the year ended January 29, 1994 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 - ------------------------------------------------------------\nInformation regarding Directors of the Corporation on pages 3 through 9 of the proxy statement for the annual meeting to be held May 26, 1994, is incorporated herein by reference. Information regarding Executive Officers of the Corporation is included in Part I of this Form 10-K following Item 4.\nITEM 11","section_11":"ITEM 11 - EXECUTIVE COMPENSATION - --------------------------------\nInformation regarding Executive Compensation on pages 10 through 16 and 20 through 24 of the proxy statement for the annual meeting to be held May 26, 1994, is incorporated herein by reference.\nITEM 12","section_12":"ITEM 12 - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT - ---------------------------------------------------------\nSecurity Holdings of Directors and Management on page 3 and 4 of the proxy statement for the annual meeting to be held May 26, 1994, 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) (1) and (2) The response to this portion of Item 14 is submitted as a separate section of this report.\n(a) (3) Exhibits\nExhibit No.:\n3.(a) (i) Certificate of Incorporation of the Corporation as amended through February 16, 1984, incorporated herein by reference to Exhibit 3 to the Corporation's Report on Form 10-K for the fiscal year ended November 1, 1986.\n(a) (ii) Amendment of Certificate of Incorporation of the Corporation filed February 20, 1987, incorporated herein by reference to Exhibit 3 to the Corporation's Report on Form 10-K for the fiscal year ended January 30, 1988.\n(b) Bylaws of the Corporation as amended through December 22, 1993, filed, herewith.\n4. (a) Form of Rights Agreement dated as of March 6, 1986 between the Corporation and Morgan Guaranty Trust Company of New York, which includes as Exhibit A the form of Rights Certificate evidencing the Corporation's Common Stock Purchase Rights, incorporated herein by reference to Exhibits 1 and 2 to the Corporation's Registration Statement on Form 8-A dated March 7, 1986.\n(b) (i) Indenture dated as of April 2, 1986 between the Corporation and Citibank, N.A. as Trustee, incorporated herein by reference to Exhibit 4 to the Corporation's Registration Statement on Form S-3 (No. 33-4500).\n(c) Certain instruments with respect to the long-term debt of the Corporation are omitted pursuant to Item 601(b)(4)(iii) of Regulation S-K since the amount of debt authorized under each such omitted instrument does not exceed 10 percent of the total assets of the Corporation and its subsidiaries on a consolidated basis. The Corporation hereby agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.\n10. (a)* Stock Appreciation, non-qualified Stock Option and Performance Bonus Plan of 1976, incorporated herein by reference to Exhibit 1 to the Corporation's definitive proxy statement dated January 18, 1977.\n(b)* Stock Appreciation, Stock Option and Performance Bonus Plan of 1983, incorporated herein by reference to Exhibit 3 to the Corporation's definitive proxy statement dated January 20, 1984.\n(c)* Stock Option and Restricted Stock Plan of 1987, as amended, incorporated herein by reference to Exhibit 3 to the Corporation's definitive proxy statement dated April 26, 1988.\n11. Computation of earnings per share.\n13. Annual Report to Stockholders of Brown Group, Inc. for the fiscal year ended January 29, 1994. Such report, except for portions incorporated by reference herein, is furnished for the information of the SEC and is not \"filed\" as part of this report.\n21. Subsidiaries of the registrant.\n23. Consent of Independent Auditors.\n24. Power of attorney (contained on signature page).\n(b) Reports on Form 8-K:\nThe Corporation filed a current report on Form 8-K dated January 13, 1994, in response to Item 5, which announced restructuring initiatives, provision for additional environmental monitoring costs and plans to discontinue and withdraw from the Wohl Leased Shoe Department business.\n(c) Exhibits:\nExhibits begin on page 22 of this Form 10-K.\nOn request copies of any exhibit will be furnished to stockholders upon payment of the Corporation's reasonable expenses incurred in furnishing such exhibit.\n(d) Financial Statement Schedules.\n*Denotes management contract or compensatory plan arrangements.\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: April 20, 1994 BROWN GROUP, INC. (Registrant)\nHarry E. Rich \/s\/ Executive Vice President and Principal Financial Officer\nKnow all men by these presents, that each person whose signature appears below constitutes and appoints Harry E. Rich his true and lawful attorney in fact and agent, 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 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, granting unto said attorney in fact and agent, 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 attorney in fact and agent 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 on April 21, 1994, by the following persons on behalf of the Registrant and in the capacities indicated.\nSignatures Title ---------- -----\nB. A. Bridgewater, Jr. \/s\/ Chairman of the Board of Directors President and Chief Executive Officer\nHarry E. Rich \/s\/ Director, Executive Vice President and Chief Financial Officer\nE. Lee Wyatt, Jr. \/s\/ Vice President, Planning and Controller\nSignature Title --------- -----\nJoseph L. Bower \/s\/ Director and Chairman of Compensation Committee\nJoan F. Lane \/s\/ Director and Chairperson of Governance and Nominating Committee\nWilliam E. Maritz \/s\/ Director\nDaniel R. Toll \/s\/ Director and Chairman of Audit Committee\nANNUAL REPORT ON FORM 10-K\nITEM 14 (a) (1) and (2), and (d)\nLIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nYEAR ENDED JANUARY 29, 1994\nBROWN GROUP, INC.\nST. LOUIS, MISSOURI\nFORM 10-K - ITEM 14 (a) (1) and (2) BROWN GROUP, INC. AND SUBSIDIARIES LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of Brown Group, Inc. and subsidiaries included in the annual report of the registrant to stockholders for the year ended January 29, 1994 are incorporated by reference in Item 8:\nConsolidated Balance Sheets - January 29, 1994 and January 30, 1993.\nConsolidated Earnings - Years ended January 29, 1994, January 30, 1993, and February 1, 1992.\nConsolidated Cash Flows - Years ended January 29, 1994, January 30, 1993, and February 1, 1992.\nConsolidated Stockholders' Equity - Years ended January 29, 1994, January 30, 1993, and February 1, 1992.\nNotes to consolidated financial statements.\nReport of Independent Auditors.\nThe following consolidated financial statement schedules of Brown Group, Inc. and subsidiaries are included in Item 14(d):\nSchedule VIII - Valuation and Qualifying Accounts Schedule IX - Short-Term Borrowings\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.\nBROWN GROUP, INC. ANNUAL REPORT TO STOCKHOLDERS ON FORM 10-K INDEX TO EXHIBITS\nExhibit -------\n3.(b) Bylaws as amended through December 22, 1993\n11. Computation of earnings per share\n13. 1993 Annual Report to Stockholders of Brown Group, Inc.\n21. Subsidiaries of the registrant\n23. Consent of Independent Auditors\n24. Power of Attorney (see signature page)","section_15":""}
{"filename":"350066_1994.txt","cik":"350066","year":"1994","section_1":"ITEM 1. BUSINESS\nThe Company\nInter-Tel designs, produces and markets telephone systems, applications and services to businesses and other organizations requiring small to medium size telephone system installations. The Company is a leading supplier to this market, with an installed base estimated at approximately 160,000 systems and 3,300,000 telephones. The Company's products and services include telephone switches and telephones, maintenance, leasing and support services, long distance calling services, and voice processing and other telecommunications applications. The Company's wide range of products support installations of 5 to 500 telephones, with the Company's principal system sales consisting of systems supporting 11 to 200 telephones. Based on information obtained from industry sources, the Company believes that systems supporting 5 to 500 telephones represent approximately 95% of all domestic telephone system installations, and that the market for these systems and related applications in the United States was in excess of $4 billion in 1994.\nThe Company has developed a broad distribution network of direct sales offices and dealers which markets the Company's products to small to medium size organizations and divisions or departments of larger organizations, including Fortune 500 companies, large service organizations and governmental agencies. In the United States, the Company has 23 direct sales offices and a growing network of hundreds of dealers who purchase directly from the Company. The Company also has approximately 20 dealers in the United Kingdom and Europe and is in the process of establishing a dealer network in Japan and Asia.\nThe Company's strategy is to offer to its customers, through a broad distribution network, a single source for their full range of telephony requirements, and to provide to its market segment, on a cost-effective basis, advanced technologies that have achieved acceptance in the market for larger systems.\nTotal Telephony Solution. The Company seeks to differentiate itself from many of its competitors by offering a broad range of products and services that provides customers with a total telephony solution. Inter-Tel couples this solution-oriented approach with a high level of customer service and a commitment to quality throughout the Company's operations. The Company's principal product lines consist of a wide array of telephone switches and telephones. In addition, the Company offers maintenance, leasing and support services, long distance calling services including 800 and WATS services and toll fraud protection software, voice mail, automated attendant and other telecommunications applications, and support for interactive voice response. Because of the modular design of the Company's systems and the high level of software content in its products, customers can readily increase the size and functionality of their systems as their telephony needs change. Through an expanding number of the Company's direct sales offices, customers can acquire and finance all of these products and services under the Company's Totalease program. Expansion of Products and Services. The Company seeks to provide to its market segment, on a cost-effective basis, advanced technologies which have achieved acceptance in the market for larger systems. In many cases, technologies are developed as software upgrades or add-ons to existing products. Ongoing research and development efforts are also directed to the development of new products, applications and services for sale into the Company's extensive customer base and to new customers. The Company commenced commercial shipments of its newest product line, the AXXESS telephone system, in the fourth quarter of 1993. AXXESS is a fully-digital, software-intensive system which incorporates digital signal processing (DSP) components and an open-architecture interface. The DSP components enable the Company to implement full-duplex speakerphones, conferencing and other voice processing functions through upgradable software and a reduced number of hardware components. The interface, AxxessLink, enables the AXXESS telephone system to interact with applications and databases on attached computers. The Company has developed a tightly-integrated voice processing package which operates through AxxessLink. AxxessLink will also permit customers to integrate their telephone systems with computer-based applications such as automatic database look-up, call accounting, call center appalications (ACD--Automatic Call Distribution), facsimile store and forward, and electronic data interchange between customers and vendors. The Company is also increasing the number of sales offices through which it offers its Totalease program and its long distance calling services.\nThrough computer-telephone integration (CTI) and advanced network services, Inter-Tel provides the enabling technology that enhances the way businesses do business. CTI features range from automatic number identification (ANI), which allows for the identification of an incoming call, to screen pops in which a variety of information on a given customer will appear on the screen of a telephony-integrated computer when that customer calls in.\nExpansion of Distribution Channels. The Company continues to expand its distribution channels through a growing network of direct and indirect dealers, expansion of the Company's direct sales force and extension into international markets. Historically, the Company distributed a significant portion of its products through Premier Telecom Products, Inc. (\"Premier\"), an exclusive, private label distributor, and through other distributors, which in turn sold its products through dealers. In April 1993, the Company began to establish direct dealer relationships, while retaining a non-exclusive relationship with Premier. Through December 31, 1994, the Company had established sales relationships with hundreds of direct dealers and continues to expand this network. Sales to Premier are no longer significant. The Company believes that establishment of this network will facilitate expansion of the Company's overall distribution network and enhance the Company's access to end user customers, thereby enabling the Company to better satisfy customer requirements. Sales of the Company's new AXXESS product line are made solely through its direct sales offices, direct dealers and international distribution channels. Internationally, the Company is in the process of establishing dealer networks in Japan and Asia and is expanding its dealer network in the United Kingdom and Europe. The Company has also expanded its direct sales activity in recent periods through strategic acquisitions of resellers of telephony products and services in areas where the Company has existing direct sales offices, and considers additional acquisition opportunities on an ongoing basis.\nIndustry Background\nIn recent years, advances in telecommunications technologies have facilitated the development of increasingly sophisticated telephone systems and applications. Users increasingly rely upon a variety of applications, including conference calls, speakerphones, voice processing, automated attendant and voice processing, to improve communications within their organizations and with customers and vendors. In addition, the integration of telecommunications and computing technologies has made possible new applications that further enhance productivity. Examples are automatic call distribution (which provides for queuing and prioritization of incoming calls), call accounting (which permits accounting for telephone usage and toll calls), facsimile (FAX) storage and forwarding, electronic data interchange between customers and vendors, and the use of ANI (automatic number identification) coupled with \"Database Look-up,\" where customer information is retrieved automatically from a computerized database when the customer calls.\nThe Company believes that the market it serves, telephone systems and applications supporting 5 to 500 telephones, represents approximately 95% of all system installations in the United States and, according to industry surveys, total sales to end users in this market, including new installations, upgrades and enhancements and telephony applications such as voice processing, accounted for more than $4 billion in 1994. These systems and applications are acquired by small to medium size businesses and by small to medium size facilities of large organizations, including Fortune 500 companies, large service organizations and governmental agencies.\nThe market for small to medium size telephone installations has been characterized in recent periods by consolidation among market participants. The breakup of the Bell telephone system in 1984, which removed restrictions on the ability of the regional Bell operating companies to purchase telephone systems and equipment from independent suppliers and to resell such systems and equipment to end user customers, led to an increase in the number of, and the competition among, independent suppliers and distributors. As a result of the competition in recent periods, many of these companies have left the market or been acquired, and a smaller number of firms remain as the principal suppliers and distribution outlets.\nAdvanced features and applications initially have been introduced to the market for large systems. However, small to medium size businesses and other organizations are increasingly requiring advanced features and applications as well as a high level of service and support, at a more effective price-performance point, in order to improve efficiency and enhance competitiveness.\nProducts and Services\nThe Company has a broad range of products designed to support the needs of businesses and other organizations requiring small to medium size telephone system installations. The Company's principal products are telephone systems which support installations of 5 to 500 telephones, with the Company's principal system sales consisting of systems supporting 11 to 200 telephones with suggested retail prices ranging from $1,500 to $200,000 per system depending on configuration. The Company also offers maintenance, leasing and support services, long distance calling services, and voice processing and other telecommunication applications.\nTelephone Systems\nGLX and GLX+\/GMX 48\nThe Company's GLX and GLX+ product lines support up to 12 telephones and 6 outside \"trunk\" lines that connect to the local telephone utility. They are designed for small businesses such as restaurants, shops and professional offices. The GLX and GLX+ systems feature internal speakerphones, call forwarding capability, and an optional data port for modems and data connections. In addition, the GLX+, which began commercial shipments in the third quarter of 1993, has an LCD display and supports voice processing. The Company markets its GLX and GLX+ product lines through dealers.\nThe GMX-48 supports up to 48 telephones and 24 trunk lines. The system is modular and permits expansion in increments of 8 telephones and 4 trunk lines. The GMX product is a cost-effective system that offers many features found on larger systems, including advanced messaging capabilities. The GMX-48 is used by professional offices, manufacturing operations, large retail stores, and financial institutions. The Company sells these systems primarily through dealers and direct sales offices.\nIMX-1224\/2460, IMX-256 and IMX-416\/832\nThe IMX line of products offers a full range of features including extensive call control and system management capabilities. These systems are marketed through the Company's direct sales offices, to direct dealers, and on a private-label basis through Premier. The IMX-1224\/2460 systems support up to 60 telephones and 24 trunk lines, with a modular design that allows capacity to be increased in increments of 6 telephones and 6 trunk lines. The IMX-256 and IMX-416\/832 are the Company's largest systems. The IMX-256 supports as many as 256 ports, which may be allocated by the end user among telephones and trunk lines in order to best meet the end user's needs. IMX-416 supports up to 416 ports and the IMX-832 supports up to 832 ports. Each of the IMX-256, IMX-416 and IMX-832 is expandable using insertable modules (common to each of these platforms) in increments of 8 or 16 telephones, 8 trunk lines, or 24 digital-connection T-1 trunk lines. The suggested retail price per system of the IMX-1224\/2460 ranges from approximately $5,000 to $30,000, the suggested retail price per system of the IMX-256 ranges from approximately $25,000 to $75,000, and the suggested retail price per system of the IMX-416\/832 ranges from approximately $40,000 to $200,000, in each case depending upon configuration.\nAXXESS\nThe Company commenced commercial shipments of its newest product, the AXXESS system in the fourth quarter of 1993. In 1994, the Company released AXXESS version 2.0, a system that supports a total of 12 to 120 telephones and trunk lines, at a suggested retail price ranging from approximately $8,000 to $70,000. The system incorporates fully-digital processing and transmission to the desktop and AxxessLink, an open architecture interface which allows the system to be integrated with and controlled by attached computers such as PCs and workstations. The system incorporates over one million lines of proprietary, object-oriented C++ software developed by the Company, which facilitates upgrades and incorporation of additional features and functionality.\nAXXESS system telephones incorporate user-friendly, 6 by 16 character LCD displays with menu keys that permit the user to select from multiple menu choices or access additional menu screens. AxxessoryTalk, the integrated voice processing application permits push-button selection of voice processing commands appearing on the LCD display, as well as voice-prompted selections through the telephone keypad. The system is multi-lingual, offering English or Japanese voice prompts and LCD displays and allowing the user to switch from one language to the other. Additional languages can be added in the future.\nThe open architecture interface permits tightly integrated connection to a PC or workstation system bus, using several industry standard interfaces, to provide efficient access to voice processing and other applications on the PC or workstation. Potential applications include database look-up (which utilizes called-ID information to retrieve customer information automatically from a computerized database), automated attendant, interactive voice response, automatic call distribution (which queues and prioritizes income calls), and call accounting (which permits the monitoring of telephone usage and toll cost). The AXXESS system is managed through a Microsoft Windows-based interface on a PC, to facilitate installation, system configuration and programming.\nThe AXXESS system utilizes advanced software to configure and utilize real-time digital signal processing (DSP) semiconductor components incorporated into the system hardware. The use of DSPs and related software lowers system costs, permits higher functionality and increases system flexibility. For example, DSPs can be configured by the system manager for different combinations of speakerphones, conference capabilities and other DSP-based facilities. The system's speakerphones incorporate full-duplex technology, which permits speakerphones to transmit in both directions at the same time without the necessity to override one speaker's voice to prevent feedback interference.\nThe AXXESS software is written in a high-level, object oriented language which can operate on many commonly used processors. Accordingly, the software can be readily ported to other hardware platforms. The Company intends to port the AXXESS software to faster micro processors which will permit the AXXESS to grow to a much larger size, in order to enhance the functionality and performance of these larger systems and to permit a migration path from the smaller AXXESS system as a customer's system requirements increase.\nProduct Features\nThe Company's products provide a broad range of features that meets the needs of small to medium size businesses and other organizations. The cost-effective GLX system incorporates a smaller subset of features than the GMX and IMX systems. The new AXXESS system incorporates new, advanced features, as indicated below. Selected features utilized by one or more systems include the following:\nCall Handling. Call handling features are used to establish and administer basic telephone communications. They include the following:\n* Automated attendant. The automated attendant serves as an electronic operator that routes calls to individual telephone stations in accordance with the touch-tone selections of the outside caller.\n* Automatic call distribution (ACD). Calls are distributed evenly over a service group and customers hear pre-recorded announcements telling them they will be handled by the next available agent. ACD supervisor receives real time and historical reports on status of group.\n* Automatic database retrieval (\"Screen Pop\"). Based on calling number, customer's database record \"pops\" to a PC screen during ring-in.\n* Automatic route selection (ARS). The system selects an optimal method to place the call based on the available transmission facilities.\n* Call forward to outside telephone numbers. Provides a means to forward incoming calls to any other telephone number worldwide. Direct inward system access (DISA). Provides a means for outside callers to dial directly into individual phones without connecting to the operator or automated attendant. Local utility access is unlimited for making outside calls, but is controlled by a security procedure.\n* Integrated speakerphone. Each executive telephone has an internal speakerphone standard. Other AXXESS key telephones can be pro- grammed to operate as speakerphones through database programming.\n* Least cost routing (LCR). The system automatically identifies the least cost method for placing a call, among the various local and long distance carriers available to the system.\n* Menu key feature operation. The 6 x 16 character LCD display on the executive version telephone for the AXXESS system displays the multiple options available at any time during the telephone call. Functions may be selected by depressing a single button or key, or alternative menus may be selected in the same manner.\n* Multi-lingual feature operation. The AXXESS system can be readily adapted to other languages by changing the voiced prompts and the menus on the LCD displays. The AXXESS system currently offers English and Japanese versions.\n* Off-hook voice announce (OHVA) calls. Allows outside calls to be announced and either accepted or rejected, even if the called party is on the line.\n* Optional data port module. Modems and data connections may be connected to any phone without adding a special line or additional wiring to the system controller.\n* System forwarding by type of call and status. By adding more intelligence to the call forwarding process, each call can be routed based on a variety of options. This allows calls on the main number and private numbers to be handled separately, day or night.\n* Uniform call distribution. As calls arrive into the system for special services like order desks and \"800\" lines, this feature spreads the call traffic evenly over the service group. In this manner no \"agent\" becomes overloaded while another agent has nothing to do. If all agents are busy, the outside callers hear a pre-recorded announcement and are routed to the next available agent.\nMessaging. Messaging is used to notify telephone users that someone has tried to reach them while out of the office. These messages can range from simple callbacks to voice processing notifications, and include the following:\n* Caller ID. In areas where this service is offered by the telephone utility, called ID displays to the called party the name and telephone number of the calling party using the AXXESS LCD display.\n* Digital voice processing hunt groups. This capability allows multiple conversations to be in progress on the voice processing system using a single extension number via a single wiring connection, without using up telephone ports.\n* Integrated voice processing. Tight integration between the voice processing system and the telephone system allows telephones to display each waiting message and provides a means for the user to randomly select among messages by pressing a single button. Features such as play, record, pause, skip and delete appear on the LCD display of the AXXESS executive telephone for rapid access and instant processing.\n* Off premises notification. Allows callers to leave messages for employees who are off site and then have the system call them periodically at a programmable, pre-selected number to inform them that messages are waiting.\n* Special message notification. Provides telephone users with a light and alphanumeric display when voice processing messages are waiting.\nAdministration. These capabilities are used to manage system resources. Offered features include the following:\n* Attached personal computer programming. Allows service personnel to connect a laptop computer to the system and load the programming information at the end of the session.\n* Day\/night toll restriction by station and trunk. This feature allows a business to toll-restrict individual telephones when the office is locked.\n* Flexible DID ring-in assignments. Dialing information is sent to the system from the telephone company to identify to the system the actual number that was dialed by the caller. This allows the system to provide a large number of direct-dial telephone numbers with a much smaller number of actual telephone lines. Each number, as recognized by the system when the system is called, can be handled in a special manner for greetings, messages or routing to service groups.\n* Integrated administration processor. the system processor is connected to a permanently connected keyboard and computer display for system administration.\n* Integrated SMDR\/SMDA. Systems feature an internal \"Station Detail Message Recording\" report generator which summarizes calling patterns in a variety of ways to assist in management of system usage. Further reports may be generated by transferring call details to a specialized computer using the \"Station Message Detail Recording\" feature.\n* Single database management. Many systems require attached computer applications such as voice processing and call accounting systems to be programmed and administrated separately. The single database management capability of the AXXESS system allows the installer to program a variety of options on both the telephone system and attached computer simultaneously in a single programming session.\n* Tenant groups and departments. The system may be configured to support multiple firms or different departments of the same firm through a single system. The numbering directory can be fully customized and the system can appear to operate as a completely separate system for each separate group.\nApplications and Services\nThe company offers a range of applications and services to its end user customers, including the following:\nVoice Processing Applications\nThe Company has developed its own voice processing product for the new AXXESS system called AxxessoryTalk. This voice processing product is highly integrated with the AXXESS system via the Company's AxxessLink software. It will be able to support up to 500 mailboxes, up to 16 simultaneous voice ports and up to 30 hours of messages. The system will also incorporate a paging application.\nThe Company has also incorporated the features of AxxessoryTalk into its new IVX 500 voice processing platform. This product provides enhanced voice processing capabilities to the GLX\/GMX\/IMX products.\nThe Company's products also support interactive voice response applications through industry-standard protocols.\nLong Distance Calling Services\nThe Company resells a variety of popular long distance calling services, including 1+ domestic and international toll calling, 800 services, WATS services, T-1 transmission services, network switching and toll-fraud protection software. The Company believes that certain of its customers desire the convenience of acquiring long distance calling services through the same vendor that the customer uses to purchase its other telephony equipment and services. The Company is licensed to resell long distance services in approximately 20 states with the intention to become licensed in all 50 states and, by acquiring long distance calling services in bulk for resale, is price competitive in many of these markets. The Company is seeking to increase its number of long distance calling customers and its volume of long distance services, which would enable the Company to become increasingly price competitive in a greater number of markets.\nTotalease Program\nThe Company's Totalease program enables an end user to acquire a full range of telephony systems, applications, maintenance and support services, as well as lease financing, through a single vendor. The Totalease contract provides a total system solution to the customer at a set monthly cost, with system expansion available at predictable additional fees. The typical Totalease contract is 60 months, with the customer entitled to renew at a specified price for an additional 36 to 60 months. The Company intends to introduce single invoice billing, which will enable customers to manage all telephone related payables, including lease payments, maintenance obligations, upgrades, system expansion and long distance calling services through a single monthly bill from Inter-Tel.\nOther Products\nInter-Tel established the Factored Products Division in 1994 to provide \"single sourcing\" of the industry's leading telecommunications products. Factored Products represents products that Inter-Tel has endorsed as the leading communications peripherals needed in many day-to-day functions. Businesses require telecommunications products to provide increased productivity, ease of operations and reliability. Many of these products interface with Inter-Tel telephone systems. Inter-Tel's product selection consists of videoconferencing, battery backup, headsets, surge protection, paging equipment, wireless communications, and data multiplexers. The Company represents leading manufacturers such as Compression Labs, Tandberg, APC, ACS, Ditek, Valcom, ADC Kentrox and other leading telecommunications vendors. Factored Products is providing a value service to our distribution network and additional incremental revenue to the Company.\nSales and Distribution\nThe Company has developed a broad distribution network of direct sales offices and dealers which market the Company's products to small to medium size organizations and divisions or departments of larger organizations. In the United States, the Company has 23 direct sales offices and a growing network of hundreds of dealers who purchase systems directly from the Company. Direct dealers are typically located in geographic areas in which the Company does not maintain direct sales offices. The Company maintains a dealer support office and direct sales office in the United Kingdom and has a network of approximately 20 dealers in the United Kingdom and Europe. In addition, in 1993 the Company opened a dealer support office and direct sales office in Japan and is in the process of establishing dealers in Asia.\nThe Company believes that its success depends in part upon the strength of its distribution channels and the ability of the Company to maintain close access to end user customers. In recent periods, the Company has sought to improve its access to end user customers by effecting strategic acquisitions of resellers of telephony products and services in markets in which the Company has existing direct sales offices and in other strategic markets. The Company has expanded its direct sales office personnel from a total of 282 persons at December 31, 1990 to a total of 473 at December 31, 1994. In addition, the Company restructured its United States distribution organization in 1993 in order to establish a channel of direct dealers for the Company's principal products. From 1987 until 1993, Premier Telecom served as an exclusive private-label distributor for sales of the Company's IMX products to dealers in North America. The Company rendered this arrangement non-exclusive and commenced sales to direct dealers in April 1993. Sales to Premier now represent less than 2% of total revenues. Through December 31, 1994, the Company has established direct dealer relationships with hundreds of dealers.\nThe Company's sales through its direct sales offices have increased from 58.8% of net sales in 1991 to 66.3% of net sales in 1994. Sales to distributors and dealers, including Premier, have decreased from 41.2% of net sales in 1991 to 33.7% of net sales in 1994.\nSales of systems through the Company's direct dealers typically generate lower gross margins than sales through the Company's direct sales organization, although direct sales typically require higher levels of sales, marketing, general and administrative expenses. Accordingly, the Company's margins may vary from period to period depending upon the mix of distributor, dealer and direct sales. Direct dealers typically enter into non-exclusive reseller contracts for a term of one or more years. The Company generally provides support and other services to the reseller pursuant to the terms of the agreement. The agreements often include requirements that the reseller meet or use its best efforts to meet minimum annual purchase quotas. The Company's experience is that dealers maintain low inventories of the Company's products and, accordingly, the Company has experienced insignificant stock rotation returns and price protection credits to date.\nInternational sales, which to date have been made through the Company's United Kingdom and Japan subsidiaries, accounted for approximately 1.5% of net sales in 1994. In order to sell its products to customers in other countries, the Company must comply with local telecommunications standards. The Company's new AXXESS system can be readily altered through software modifications, which the Company believes will facilitate compliance with these local regulations. In addition, the AXXESS system has been designed to support multi-lingual functionality, and currently supports English and Japanese. The Company is presently establishing dealer networks in Japan and Asia and is expanding its dealer network in the United Kingdom and Europe.\nResearch and Development\nThe Company's research and development efforts over the last several years have been focused primarily on development of the Company's new AXXESS system. Current efforts are related to completing the AxxessLink interface, porting AXXESS software to larger versions of the AXESS hardware platform and to industry-standard computer architectures, and the development of additional applications and features. Applications under development for the new AXXESS system and software include a Windows-based system accounting package that will allow end users to manage and monitor system use, and applications which utilize caller-ID information to access computer-based customer databases and enhance the productivity of telephone users. The software-based architecture of the AXXESS system facilitates maintenance and support, upgrades, and incorporation of additional features and functionality.\nThe Company had a total of 63 personnel engaged in research and development as of December 31, 1994. Research and development expenses were $4,536,882; $4,114,385 and $3,928,393 for 1994, 1993 and 1992, respectively.\nManufacturing\nThe Company manufactures substantially all of its systems through third party subcontractors located in the United States, South Korea and the Philippines. These subcontractors use both standard and proprietary integrated circuits and other electronic devices and components to produce telephone switches, telephones and printed circuit boards to the Company's engineering specifications and designs. The suppliers also inspect and test the equipment before delivering them to the Company, which performs systems integration, software loading, final testing and shipment. The Company maintains written agreements with its principal suppliers. The Company provides a forecast schedule to its suppliers and revises the forecast on a periodic basis.\nForeign manufacturing facilities are subject to changes in governmental policies, imposition of tariffs and import restrictions, and other factors beyond the Company's control. Certain of the microprocessors, integrated circuits and voice processing interface cards used in the Company's systems are currently available from a single or limited sources of supply. From time to time, the Company experiences delays in the supply of components and finished goods. Delay or lack of supply from existing sources or the inability to develop alternative sources if and when required in the future could materially and adversely affect operating results.\nCustomer Service and Support\nThe Company believes that customer service and support is a critical component of customer satisfaction and the success of the Company's business. The Company operates a Technical Support \"hotline\" to provide a full range of telephone support to its distributors, dealers and end user customers, free of charge through a toll free number. The Company also provides on-site customer support and, through remote diagnostic procedures, has the ability to detect and correct system problems from its Technical Support facilities.\nInformation taken from customer call records allows feedback into Inter-Tel's Quality First continuous improvement process, thus providing a road map for continuous product and service enhancements. Each direct sales office is given a periodic service activity report summarizing the reasons that technicians are asking for assistance and common issues that give rise to technical inquiries. This allows them to analyze trends in their service operations and provide better customer service.\nQuality\nThe Company believes that the quality of its systems, customer service and support, and other aspects of its organization is a critical element of meeting the needs of its customers. Through its Quality First continuous improvement process initiated in 1991, Inter-Tel implements quality processes throughout its business operations. The Company has established formal procedures to ensure responsiveness to customer requests, to monitor response times and to measure customer satisfaction. The Company has also established means by which all end users, including customers of the Company's resellers, can make product enhancement requests directly to the Company. The Company supports its dealers through an extensive training program at the Company's facility and at dealer sites, a toll free telephone number for sales and technical support, and the provision of end user marketing materials. The Company typically provides a one year warranty on its systems to end users. In manufacturing, the Company continuously monitors the quality of the products produced on its behalf by the Company's manufacturing subcontractors, and is extending the Company's Quality First continuous improvement process to its suppliers.\nCompetition\nThe market for the Company's products is highly competitive and in recent periods has been characterized by pricing pressures and business consolidations. The Company's competitors include AT&T and Northern Telecom, as well as Comdial, Executone, Iwatsu, Mitel, NEC, Nitsuko, Panasonic, ROLM, Toshiba and others. Many of these competitors have significantly greater financial, marketing and technical resources than the Company. The Company also competes against the regional Bell operating companies (RBOCs), which offer systems produced by one or more of the aforementioned competitors and also offer Centrex systems in which automatic calling facilities are provided through equipment located in the telephone company's central office. Competition by the RBOCs could increase significantly if the RBOCs are granted the right by legislative or judicial action (as currently pursued by the RBOCs) to manufacture telephone systems and equipment themselves and\/or to bundle the sale of equipment with telephone calling services, activities which to date they have been restricted from undertaking. In addition, certain of the Company's competitors market systems designed specifically for very small or very large organizations, markets which the Company's current products do not specifically address. In the market for voice processing applications, including voice processing, the Company competes against Centigram Communications Corporation, Octel Corporation, AVT and other competitors, certain of which have significantly greater resources than the Company. In the market for long distance services, the Company competes against AT&T, MCI, US Sprint and other competitors, many of which have significantly greater resources than the Company. Key competitive factors in the sale of telephone systems and related applications include performance, features, reliability, service and support, name recognition, distribution capability and price. The Company believes that it competes favorably in its markets with respect to the performance, features and price of its systems, as well as the level of service and support that the Company provides to its customers. Certain of the Company's competitors have significantly greater name recognition and distribution capabilities than the Company, although the Company believes that it has developed a competitive distribution presence in certain markets, particularly those where the Company has direct sales offices. The Company expects that competition will continue to be intense in the markets addressed by the Company, and there can be no assurance that the Company will be able to continue to compete successfully.\nIntellectual Property Rights\nIn addition to the factors discussed above, the Company's ability to compete successfully depends on its ability to protect the proprietary technology contained in its products. The Company relies principally upon a combination of copyright and trade secret laws and contractual provisions to establish and protect its proprietary rights in its systems. The Company generally enters into confidentiality agreements with its employees and suppliers, and limits access to its proprietary information. There can be no assurance that these protections will be adequate to deter misappropriation of the Company's technologies or independent third party development of similar technologies or product features.\nFrom time to time, the Company is subject to assertions that the Company's products infringe the intellectual property rights of third parties. Such claims could require the Company to expend significant sums in litigation, could require the Company to pay damages, and could require the Company to develop non-infringing technology or to acquire licenses to the technology which is the subject of the claimed infringement.\nEmployees\nAs of December 31, 1994, the Company had a total of 727 employees, of whom 566 were engaged in sales, marketing and customer support, 63 in quality, manufacturing and related operations, 63 in research and development, and 35 in finance and administration. The Company's future success will depend upon its ability to attract, retain and motivate highly qualified employees, who are in great demand. The Company believes that its employee relations are excellent.\nDIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nName Age Position ---- --- ---------- Steven G. Mihaylo 51 Chairman of the Board of Directors and Chief Executive Officer Thomas C. Parise 40 President and Chief Operating Officer Craig W. Rauchle 39 Executive Vice President W. Kris Brown 41 Vice President Michael J. Sargent 45 Vice President Hiroshige Sugihara 35 Vice President Kurt R. Kneip 32 Vice President, Chief Financial Officer, and Secretary\/Treasurer Gary Edens 53 Director Maurice H. Esperseth 69 Director C. Roland Haden 54 Director Norman Stout 37 Director Kathleen R. Wade 41 Director\nMR. MIHAYLO, the founder of the Company, has served as Chairman of the Board of Directors of the Company since September 1983, as President since March 1984, and as Chief Executive Officer of the Company since its formation in July 1969. Mr. Mihaylo also served as President of the Company from July 1969 until September 1983 and as Chairman of the Board of Directors from July 1969 to October 1982. Mr. Mihaylo also is a director of MicroAge, Inc. and Microtest, Inc.\nMR. PARISE was elected President of the Company in December 1994. He has been Senior Vice President of the Company since 1986. He is also President of Inter-Tel Integrated Services, Inc., a wholly owned research and development, manufacturing and distribution subsidiary of the Company. Mr. Parise joined the Company in 1981 and became Branch General Manager of the Phoenix Direct Sales Office in 1982. In 1983, he became the Mountain Regional Vice President, and in January 1985 he was appointed Vice President of Operations and Sales Support.\nMR. RAUCHLE was elected Executive Vice President in December 1994. He had been Senior Vice President of the Company and continues as President of Inter-Tel DataCom, Inc., a wholly owned sales subsidiary of the Company. In addition, he currently serves the Company and all subsidiaries in corporate strategic planning and mergers and acquisitions activities. Mr. Rauchle joined the Company in 1979 as Branch General Manager of the Denver Direct Sales Office and in 1983 was appointed the Central Region Vice President and subsequently the Western Regional Vice President. From 1990 to 1992, Mr. Rauchle served as President of Inter-Tel Communications, Inc.\nMR. BROWN became a Vice President of the Company in December 1994 when he was promoted to President of Inter-Tel Communications, which is one of the Company's Regional Direct Sales Subsidiaries. In 1987, he was promoted to Regional Vice President of the Southeast Region. Mr. Brown joined the Company in 1985 as the General Manager of the Tampa office, the first direct office in Florida, and has expanded the Florida direct offices to include Tallahassee, Ft. Lauderdale and, most recently, North Miami. Mr. Brown obtained a B.A. in Marketing in 1980 from the University of South Florida at Tampa.\nMR. SARGENT was promoted to Vice President, Marketing and Strategic Programs in January 1995. In this position, he will be responsible for business development and strategic analysis of current practices with the goal of attaining substantial corporate growth. Mr. Sargent joined Inter-Tel in 1984 as a software design engineer and progressed through sales engineering and sales management, serving as the Director of Sales and Marketing for the past four years. Mr. Sargent holds a Bachelor of Science Degree in Computer Systems Engineering.\nMR. SUGIHARA has been Vice President of the Company and President of Inter-Tel Japan, Inc. since June 1993. Born in Osaka, Japan, Mr. Sugihara was with Forval Corporation, a publicly traded Japanese company, from 1984 to 1992 and in 1989 established Forval America, Inc., where he served as Vice President\/Secretary\/Treasurer and member of the Board of Directors.\nMR. KNEIP has served as Vice President and Chief Financial Officer of the Company since September 1993. He was elected Secretary and Treasurer in October 1994. He joined the Company in May 1992 as Director of Corporate Tax, after seven years with the accounting firm of Ernst & Young. Mr. Kneip is a certified public accountant, and holds an undergraduate degree in Commercial Economics from South Dakota State University and a Masters Degree in Professional Accountancy from the University of South Dakota.\nMR. EDENS was elected as a director of the Company in October 1994. He has been a broadcasting media executive from 1970 to 1994, serving as Chairman and Chief Executive Officer of Edens Broadcasting, Inc. from 1984 to 1994 when that corporation's nine radio stations were sold. He presently is President of The Hanover Companies, Inc., an investment firm. He is an active leader in various business, civic and philanthropic organizations.\nMR. ESPERSETH has been a director of the Company since October 1986. Mr. Esperseth joined the Company in January 1983 as Senior Vice President-Research and Development, after a 32-year career with GTE, and served as Executive Vice President of Inter-Tel from 1986 to 1988. Mr. Esperseth retired as an officer of the Company on December 31, 1989.\nDR. HADEN has been a director of the Company since 1983. Dr. Haden has been Vice Chancellor and Dean of Engineering of Texas A&M University since 1993. Previously, he served as Vice Chancellor of Louisiana State University from 1991 to 1993, Dean of the College of Engineering and Applied Sciences at Arizona State University from 1989 to 1991, Vice President for Academic Affairs at Arizona State University from 1987 to 1988, and Dean of the College of Engineering and Applied Sciences from 1978 to 1987. Dr. Haden holds a doctoral degree in Electrical Engineering from the University of Texas and has served on the faculties of the University of Oklahoma and Texas A & M University.\nMR. STOUT was elected a director of the Company in October 1994. Mr. Stout has been President of Superlite Block, a manufacturer of concrete block since February 1993. Prior thereto he was employed by Bouhem-Fields, Inc. of Dallas, Texas, a manufacturer of crushed stone, as Chief Executive Officer from 1990 to 1993 and as Chief Financial Officer from 1986 to 1990. Previously, Mr. Stout was a Certified Public Accountant with Coopers & Lybrand.\nMS. WADE was elected a director of the Company in April 1994. Ms. Wade is also a director and Co-Chief Executive Officer of Continental Homes Holding Corporation, having been employed by this multi-market production homebuilder and mortgage company and its predecessor since 1978. Prior thereto, Ms. Wade, a Certified Public Accountant, was employed by Ernst & Ernst, an international accounting firm.\nThe Board of Directors has an Audit Committee and a Compensation Committee. The Audit Committee, consisting of Directors Wade, Stout and Esperseth, is charged with reviewing the Company's annual audit and meets with the Company's independent auditors to review the Company's internal controls and financial management practices. The Compensation Committee, consisting of Messrs. Esperseth, Edens and Haden, recommends to the Board of Directors compensation for the Company's key employees and administers the Company's stock option plans.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company maintains its corporate headquarters in an 85,000 square foot building located in Chandler, Arizona pursuant to a lease that expires in 2008. The Company also leases sales and support offices in a total of 19 locations in the United States and two locations overseas. The Company's aggregate monthly payments under these leases are currently $181,000. The Company believes that its existing facilities are adequate to meet its current needs and that additional or alternative space will be available as necessary in the future on commercially reasonable terms.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company has no legal proceedings in process or pending for which it believes an unfavorable outcome would have a material adverse impact on the financial position 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 STOCK AND RELATED STOCKHOLDER MATTERS\nInter-Tel common stock is traded over-the-counter (symbol INTL) and since February 1983 has been included in the NASD national market system. As of February 1, 1995 there were of record approximately 1,000 shareholders of the Company's common stock. The Company believes there are approximately 2,000 additional beneficial holders of the Company's Common Stock. The following table sets forth high and low closing prices reported by NASDAQ.\nInter-Tel has never paid a cash dividend on its common stock and presently does not intend to do so. Future dividend policy will depend on Company earnings, capital requirements for growth, financial conditions and other factors.\n1994 High Low ---- ---- --- First Quarter 12 1\/8 8 5\/8 Second Quarter 11 8 1\/2 Third Quarter 10 1\/8 7 Fourth Quarter 9 3\/4 6\n1993 High Low ---- ---- --- First Quarter 5 1\/8 4 Second Quarter 8 4 1\/2 Third Quarter 7 3\/8 5 1\/8 Fourth Quarter 12 6\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\nGeneral\nInter-Tel designs, produces and markets business telephone systems, voice processing software, applications software and services to businesses and other organizations requiring small to medium size telephone system installations. Inter-Tel's products and services include telephone switches and telephones, maintenance, leasing and support services, long distance calling services, voice mail and other telecommunications applications. The Company's Common Stock is quoted on the NASDAQ National Market System under the symbol INTL.\nNet sales of the Company have increased substantially in each of the past three years. Such increases were 21%, 14% and 19% in 1994, 1993 and 1992, respectively, over the preceding year.\nThe Company in recent periods has focused on expanding its direct sales capabilities and establishing a direct dealer network. In 1994, the Company completed the transition from Premier Telecom, Inc. as a former, private label distributor to its own network of direct dealers. In 1994, shipments to Premier constituted less than 2% of net sales. In addition, in recent years the Company has effected a number of supporting, strategic acquisitions of resellers of telephony products and integrated these operations with its existing direct sales operations in the same geographic areas and in other strategic markets.\nThe markets served by the Company have been characterized by rapid technological changes and increasing customer requirements. The Company has sought to address these requirements through the development of software enhancements and improvements to existing systems and the introduction of new products and applications. In recent periods, the Company has focused on the development of its new, fully-digital AXXESS telephone software and system. The Company commenced commercial shipments of the AXXESS in the fourth quarter of 1993. An enhanced AXXESS software was released in 1994.\nThe Company offers to its customers a unique package of lease financing and other services under the name Totalease. Totalease provides to customers lease financing, maintenance and support services, long distance services, fixed price upgrades and other benefits. The Company finances this program through the resale of lease rental streams to financial institutions, and formerly through its bank credit facility.\nResults of Operations\nThe following table sets forth certain statement of operations data of the Company expressed as a percentage of net sales:\nYear Ended December 31 1994 1993 1992 ------ ----- ---- Net sales 100.0% 100.0% 100.0% Cost of sales 59.0 60.7 61.6 ---- ---- ---- Gross margin 41.0 39.3 38.4 Research and development 4.1 4.4 4.8 Selling, general and administrative 28.9 27.9 27.4 ---- ---- ---- Operating income 8.0 7.0 6.2 Interest and other income 0.8 0.3 0.8 Interest expense 0.1 0.4 0.9 Income taxes 3.3 2.6 2.3 --- --- --- Net income 5.4% 4.3% 3.8% ---- ---- ----\nYear Ended December 31, 1994 Versus Year Ended December 31, 1993\nNet sales increased 21.2% to $112.2 million in 1994 from $92.5 million in 1993. Sales from direct sales offices accounted for approximately $14.5 million of the increase, with wholesale distribution sales increasing approximately $4.5 million. The remaining increases occurred in long distance sales and other operations. Wholesale shipments to the expanded direct dealer network more than offset decreased shipments to Premier Telecom. Shipments to this former private label distributor are no longer significant.\nGross profit percentages improved to 41.0% in 1994 from 39.3% in 1993. This reflected the transition to the direct dealer network and the expansion of AXXESS software and systems sales.\nResearch and Development expenses increased to $4.5 million in 1994 from $4.1 million in 1993. While this is 4.1% of 1994 total sales, including direct sales office sales, it represents a substantial 9% of wholesale division shipments, including shipments to the direct sales offices. These expenses in both 1994 and 1993 were directed principally to the continued development of the AXXESS software and system. The Company expects that research and development expenses will continue to increase in the future as the Company continues to develop and enhance existing and new technologies and products. These expenses may vary, however, as a percentage of net sales.\nSelling, general and administrative expenses increased to $32.5 million, or 28.9% of net sales in 1994, from $25.8 million or 27.9% of net sales in 1993. This reflected increased incentive and other compensation, additional personnel to support the direct dealer network, and expenses associated with the start up of the Company's Asian subsidiary. The Company expects that selling, general and administrative expenses will increase as the Company continues to invest in expansion of product offerings and its distribution system, but may vary as a percentage of sales.\nInterest and other income increased in 1994 principally from the investment for a full year of the funds received in the 1993 public offering and funds generated through operating cash flow.\nNet income increased 55.1% to $6.1 million or $.58 a share in 1994, from $3.9 million or $.45 a share in 1993. Net income per share in 1994 is based on approximately 2 million more average shares outstanding than in 1993, reflecting the public stock sale in 1993 and the acquisition of Southwest Telephone Systems, Inc.\nYear Ended December 31, 1993 Versus Year Ended December 31, 1992\nFor the year ended December 31, 1993, net sales increased 14.1% to $92.5 million from $81.1 million for 1992. The increase in net sales primarily reflected increased sales through the Company's direct sales offices, including new customer sales and higher sales through the Company's growing Totalease program. Sales to the Company's network of direct dealers following the transition in the distribution channel which commenced in April 1993 offset a decline in sales to Premier. Sales to Premier decreased to $10.1 million, or 10.9% of net sales in 1993 from $17.1 million, or 21.1% of net sales in the corresponding 1992 period.\nIn 1993, gross profit increased to $36.4 million, or 39.3% of net sales, from $31.2 million, or 38.4% of net sales, in 1992. Gross margin improved in 1993 because of higher sales through the Company's direct sales channel and increased sales through the Company's Totalease program, as well as higher gross margins on sales to direct dealers following the Premier transition.\nResearch and development expenses increased to $4.1 million in 1993 from $3.9 million in 1992 and were 4.4% and 4.8% of net sales, respectively. These expenses in both periods were directed principally to continued development of the Company's new AXXESS software and system.\nSelling, general and administrative expenses increased to $25.8 million, or 27.9% of net sales, in 1993, from $22.3 million, or 27.4% of net sales in 1992. This increase reflected increased compensation, additional personnel to support the Company's direct dealer network and a one-time expense associated with the Company's move into its new headquarters. Such increases were partially offset by reductions in key executive incentive compensation.\nOther income in 1993 consisted primarily of interest income. Other income in 1992 was derived principally from a gain on the sale of the Company's headquarters, as well as interest income relating to the refund of import duties. Interest expense during 1993 decreased principally because of lower interest rates and reduced long and short term borrowings.\nNet income in 1993 increased 25.8% to $3.9 million or $.45 per share from $3.1 million or $.37 per share in 1992. This increase reflected the higher level of net sales, improved gross margin and reduced interest expense, offset in part by the cost of the Company's move into a new headquarters facility.\nDiscontinued Operations\nIn 1993, the Company sold a facility related to previously discontinued operations subject to remediation related to fuel tank leakage. The Company had reserved for such remediation approximately $400,000, which management believes is adequate to cover such possible costs.\nAccounting Changes\nDuring the first quarter of 1993, the Company adopted Financial Accounting Standards Board (FASB) Statement 109, \"Accounting for Income Taxes,\" on a prospective basis. This adoption had no material impact on the Company's consolidated financial statements.\nInflation\/Currency Fluctuation\nInflation and currency fluctuations have not previously had a material impact on Inter-Tel's operations. International sales and procurement agreements have traditionally been denominated in U.S. currency. Moreover, a significant amount of contract manufacturing has been or is expected to be moved to domestic sources. The expansion of international operations in the United Kingdom and Europe and anticipated increased sales in Japan and Asia and elsewhere could result in higher international sales as a percentage of total revenues, but international revenues are currently not significant.\nLiquidity and Capital Resources\nDuring the fourth quarter of 1994, the Company executed a $5 million Credit Agreement with Bank One, Arizona, N.A., which is being used primarily to support international letters of credit to suppliers. In the fourth quarter of 1993, the Company prepaid all long and short-term debt from a portion of the net proceeds received from its 1993 public offering. The remaining proceeds were added to working capital.\nThe Company funds its Totalease program in part through the sale to financial institutions of rental income streams under the leases. Totalease rentals resold totaling $19.9 million remain unbilled at December 31, 1994. The Company maintains reserves against potential recourse following the resales based upon loss experience and past due accounts.\nThe Company continues to expand its dealer network, which is expected to require working capital for increased receivables and inventories. During 1994, receivables and inventories increased approximately $4.2 million, which was funded by operating cash flow. At December 31, 1994, the Company had $15.3 million in cash and equivalents.\nThe Company believes that its working capital and credit facilities, together with cash generated from operations will be sufficient to fund purchases of capital equipment, finance any cash acquisitions which the Company may consider and provide adequate working capital for the foreseeable future. However, to the extent that additional funds may be required in the future to address working capital needs and to provide funding for capital expenditures, expansion of the business or additional acquisitions, the Company will consider additional financing.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReport of Ernst & Young LLP, Independent Auditors\nShareholders and Board of Directors Inter-Tel, Incorporated\nWe have audited the accompanying consolidated balance sheets of Inter-Tel, Incorporated and subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 Inter-Tel, Incorporated and subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\n\/s\/ Ernst & Young LLP\nPhoenix, Arizona January 27, 1995\nINTER-TEL, INCORPORATED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE A -- SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation: The consolidated financial statements include the accounts of Inter-Tel, Incorporated and all significant subsidiaries (the Company). Intercompany accounts and transactions have been eliminated in consolidation.\nCash and Equivalents: Cash and equivalents include all highly liquid investments with a remaining maturity of three months or less at date of acquisition.\nInventories: Inventories, consisting principally of telephone systems, computer equipment and related components, are stated at the lower of cost (first-in, first-out method) or market.\nProperty, Plant and Equipment: Property, plant and equipment is stated at cost. Depreciation is computed using the straight-line method over the estimated useful life of the related property. Leasehold improvements are depreciated over the shorter of the related lease terms or the estimated useful lives of the improvements.\nExcess of Purchase Price Over Net Assets Acquired: Purchase prices of acquired businesses that are accounted for as purchases have been allocated to the assets and liabilities acquired based on the estimated fair market values on the respective acquisition dates. Based on these values the excess purchase prices over the fair market value of the net assets acquired are being amortized over 5 to 40 years. Accumulated amortization through December 31, 1994 was $362,196.\nSales-Leases: The discounted present values of minimum rental payments under sales-type leases are recorded as sales, net of provisions for continuing administration and other expenses over the lease period. The costs of systems installed under these sales-leases, net of residual values at the end of the lease periods, are recorded as costs of sales. Gains or losses resulting from the sale of rental income from such leases are recorded as adjustments to the original sales amounts.\nIncome Taxes: Deferred income taxes result from timing differences in the recognition of revenues and expenses for financial reporting and income tax purposes.\nPooling of Interest: The financial statements for periods prior to 1994 have been restated to include the accounts of Southwest Telephone Systems, Inc. (\"Southwest\"), which was acquired by the Company in a pooling of interests transaction in May 1994, in which 161,558 shares of Inter-Tel common stock were issued. Southwest does not constitute a significant subsidiary as defined by the Securities and Exchange Commission. In the consolidated statements of income, net sales and net income were increased as a result of the restatement as follows:\nYear ended December 31, 1993 1992\nNet sales $3,264,387 $2,347,644 Net income 114,104 85,809 Net income per share $0.00 $0.00\nTotal shareholders' equity was increased by $312,000 as of January 1, 1992 as a result of the restatement.\nIncome Per Common Share: Income per common share is based on the weighted average number of common shares outstanding during each year and common stock equivalents.\nReclassifications: Certain reclassifications have been made to the 1993 and 1992 financial statements to conform to the 1994 presentation.\nNOTE B -- NET INVESTMENT IN SALES-LEASES\nNet investment in sales-leases represents the value of sales-leases presently held under the Company's Totalease program. The Company currently sells the rental income from some of the sales-leases. The Company maintains reserves against potential recourse following the resales based upon loss experience and past due accounts. Activity during the years was as follows:\nYear Ended December 31 1994 1993 1992\nSales of rental income ............ $12,423,000 $ 9,586,000 4,500,000 Sold income remaining unbilled at end of year ......... 19,894,000 11,908,000 4,268,000 Allowance for uncollectible minimum lease payments and recourse liability at end of year ..................... 1,198,000 911,000 677,000\nThe Company does not expect any significant losses from the recourse provisions related to the sale of rental income. The Company is compensated for administration and servicing of rental income sold.\nNOTE C -- PROPERTY, PLANT & EQUIPMENT December 31 1994 1993\nComputers and equipment $11,635,742 $8,370,903 Transportation equipment 1,625,397 1,243,488 Furniture and fixtures 2,316,007 2,513,448 Leasehold improvements 657,504 559,059 Land 130,458 130,458 ------- ------- 16,365,108 12,817,356 Less: Accumulated depreciation and amortization 10,650,210 9,740,208 ---------- --------- $5,714,898 $3,077,148 ========== ==========\nNOTE D -- OTHER ASSETS December 31 1994 1993 Long-term 8% note receivable due in 2003 ............................. $1,351,038 $1,363,000 Net investment in sales-leases ............... 4,157,895 1,471,651 Excess of purchase price over net assets acquired, net .................... 1,313,334 1,314,282 Other assets ................................. 639,767 821,728 ---------- ---------- $7,462,034 $4,970,661 ========== ==========\nNOTE E-- OTHER CURRENT LIABILITIES\nDecember 31 1994 1993\nCompensation and employee benefits ........... $4,097,291 $2,790,391 Sundry taxes ................................. 560,102 669,375 Other accrued expenses ....................... 2,149,738 1,908,328 Deferred revenues ............................ 2,000,594 2,014,153 ---------- ---------- $8,807,725 $7,382,247 ========== ==========\nNOTE F -- CREDIT LINE\nAll of the Company's long-term and short-term debt was prepaid in November 1993 upon the issuance and sale of common stock in a public offering. The Company maintains a $5,000,000 unsecured bank credit line at prime rate to cover international letters of credit and for other purposes. The credit agreement matures in May 1996 and contains certain restrictions and financial covenants. At December 31, 1994, $1,473,000 of the credit line was committed under letter of credit arrangements.\nNOTE G -- LEASES\nRental expense amounted to $ 2,178,216, $1,717,770 and $1,187,282 in 1994, 1993 and 1992, respectively.\nNoncancellable operating leases are primarily for buildings. Certain of the leases contain provisions for renewal options and scheduled rent increases. At December 31, 1994, future minimum commitments under noncancellable leases, including a 15 year lease for its headquarters facility, are: 1995 -- $1,894,393; 1996 -- $1,711,856; 1997 -- $1,420,882; 1998 -- $1,297,082; 1999 --- $ 1,086,591; thereafter -- $3,474,055.\nNOTE H -- INCOME TAXES\nEffective January 1, 1993, the Company adopted Financial Accounting Standards Board (FASB) Statement 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 under the provisions of Accounting Principles Board Opinion No. 11. 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 elected not to restate the financial statements of any prior years. The adoption of FASB Statement 109 had no material impact on pretax income from continuing operations for the twelve months ended December 31, 1994 and 1993.\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. Significant components of the Company's deferred tax liabilities and assets as of December 31, are as follows:\n1994 1993 Deferred tax liabilities: Accelerated depreciation .............. $ 29,000 $ 205,000 Lease--sales and reserves ............. 4,466,000 2,621,000 ------------ ------------ Total deferred tax liabilities ............. $ 4,495,000 $ 2,826,000 ------------ ------------\nDeferred tax assets: Inventory basis differences ........... 944,000 $ 798,000 Accounts receivable reserves .......... 409,000 244,000 Maintenance reserve ................... 355,000 353,000 Accrued vacation pay .................. 426,000 349,000 Foreign loss carryforwards ............ 355,000 -- Other -- net .......................... 1,491,000 922,000 ------------ ------------ Deferred tax assets ................... 3,980,000 2,666,000 Less valuation reserve ................ 355,000 -- ------------ ------------ Net deferred tax assets .................... 3,625,000 2,666,000 ------------ ------------ Net deferred tax liabilities ............... $ 870,000 $ 160,000 ------------ ------------\nDuring 1994, the Company incurred a loss carryforward for foreign tax purposes of approximately $830,000 which will begin to expire in 1999.\nThe deferred tax effect of timing differences is as follows:\nInventory basis differences ............................. $ 153,612 Accelerated depreciation ................................ (485,463) Accrued vacation pay .................................... (4,171) State franchise tax ..................................... (8,740) Bad debts ............................................... (10,061) Accrued expenses ........................................ 102,436 Lease - sales ........................................... 545,575 Other ................................................... 106,812 --------- $ 400,000 ---------\nFederal and state income taxes consisted of the following:\nLiability Liability Deferred Method Method Method 1994 1993 1992\nFederal .................. $ 3,365,000 $ 2,068,000 $ 1,477,000 State .................... 365,000 330,000 382,000 ----------- ----------- ----------- $ 3,730,000 $ 2,398,000 $ 1,859,000 ----------- ----------- -----------\nThe principal reasons for the difference between total income tax expense and the amount computed by applying the statutory federal income tax rate to income before taxes are as follows:\n1994 1993 1992\nFederal tax at statutory rates applied to pre-tax income ........... 34% 34% 34% State tax net of federal benefit ......... 3 4 5 Valuation reserve increase for foreign losses .................. 3 -- -- Amortization of goodwill ................. -- -- 1 Other - net .............................. (2) -- (2) --- --- --- 38% 38% 38% --- --- ---\nDuring 1993, the Company disposed of an investment in a hotel and office complex which made available related deferred tax benefits of approximately $2.6 million.\nNOTE I -- EQUITY TRANSACTIONS\nIn a public offering in November and December 1993, the Company sold 1,800,000 shares of previously unissued common stock. During 1992, the Board of Directors authorized cancellation of 3,001,696 shares of common stock held in treasury, reverting such shares to authorized but unissued shares. Common stock and additional paid-in capital accounts were reduced by an amount equal to the cost of treasury stock canceled.\nUnder the Company's Long-Term Incentive Plan, selected officers and key employees are granted options to purchase common stock of the Company at not less than fair market value at date of grant. The options are exercisable at the end of their ten year term, but may become exercisable in annual installments if predetermined performance goals and share market value increases are met. During 1994, previously granted options to 420,000 shares at prices of $7.50 to $9.25 per share were canceled and options to purchase 650,000 shares were granted to an expanded group of optionees at the then fair market value of $6.00 per share.\nUnder other previous stock option plans, directors, officers and key employees may purchase common stock of the Company at amounts not less than the fair market value at the date of grant. These options generally have a term of five years and are exercisable over four years commencing one year from the date of grant.\nOption activity for the past three years under all plans is as follows:\nNumber of Shares 1994 1993 1992\nOutstanding at beginning of year ..... 720,250 322,150 564,000 Granted .............................. 672,000 598,000 87,000 Exercised ............................ (98,750) (193,400) (214,600) Expired or canceled .................. (424,000) (6,500) (114,250) -------- -------- -------- Outstanding at end of year ........... 869,500 720,250 322,150 -------- -------- -------- Exercise price range ................. $1.12-$9.63 $1.12-$9.25 $1.12-$3.00 Exercisable at end of year ........... 75,000 78,750 137,838 -------- -------- --------\nAt December 31, 1994, the Company has reserved 1,499,488 shares of Common Stock for issuance in connection with the stock option plans. In addition, there is an outstanding warrant for the purchase of 50,000 shares of common stock at $4.25 a share, which expires March 25, 1996.\nNOTE J -- RETIREMENT PLANS\nThe Company has two retirement plans for the benefit of all of its employees. Under its 401(k) Retirement Plan, participants may contribute an amount not exceeding 15 percent of compensation received during participation in the Plan. The Company makes voluntary annual contributions to the Plan based on a percentage of contributions made by Plan participants of up to 10 percent of compensation. Contributions to the Plan totaled $248,000; $196,000; and $156,000 in 1994, 1993 and 1992, respectively.\nIn 1992, the Company initiated an Employee Stock Ownership Plan (ESOP), advancing $500,000 to the ESOP Trust for the purpose of purchasing common stock of the Company. The Trust purchased 153,500 shares of the Company's common stock in July 1992. The loan is to be repaid over 5 years with 7.5% interest. As the principal amount of the loan is repaid to the Company through Company annual contributions, the equivalent number of shares released are allocated to employees' accounts to be held until retirement. Total shares so allocated were 30,037; 27,942 and 14,391 in 1994, 1993 and 1992, respectively. Contributions to the ESOP totaled $125,000 in 1994 and 1993 and $62,500 in 1992 and are based upon the historic cost of the shares purchased by the ESOP.\nNOTE L -- QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nCertain information required by Part III is omitted from this report in that the Registrant will file a definitive proxy statement pursuant to Regulation 14A (the \"Proxy Statement\") not later than 120 days after the end of the fiscal year covered by this Report, and the information included therein is incorporated herein by reference.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation with respect to directors and executive officers is included at the end of Part I, Item 1 on Page 20 of this report under the caption \"Directors and Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference to Pages 7 to 14 of the Company's Proxy Statement relating to its 1995 Annual Meeting of Shareholders.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated by reference to Page 5 of the Company's Proxy Statement.\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 documents are filed as part of this Report:\n1. Financial Statements\nThe following consolidated financial statements of Inter-Tel, Incorporated, and subsidiaries, are incorporated by reference to Pages 31 to 44 of this Form 10-K:\nReport of Ernst & Young LLP, Independent Auditors\nConsolidated balance sheets--December 31, 1994 and 1993\nConsolidated statements of income--years ended December 31, 1994, 1993 and 1992\nConsolidated statements of shareholders' equity--years ended December 31, 1994, 1993 and 1992\nConsolidated statements of cash flows--years ended December 31, 1994, 1993 and 1992\nNotes to consolidated financial statements\n2. Financial Statement Schedules\nThe following consolidated financial statement schedules of Inter-Tel, Incorporated, and subsidiaries are filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Inter-Tel, Incorporated and subsidiaries, and the notes thereto.\nSchedules for the three years ended December 31, 1994:\nPage No. ------- Schedule VIII--Valuation and Qualifying Accounts 52 Schedule IX--Short-term Borrowings 53\nSchedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or notes thereto.\n3. Exhibits\n3.1(10) Articles of Incorporation, as amended.\n3.2(1) By-Laws, as amended.\n10.15(1) Registrant's form of standard Distributor Agreement.\n10.16(1) Registrant's form of standard Service Agreement.\n10.34(2) 1984 Incentive Stock Option Plan and forms of Stock Option Agreement.\n10.35(3) Agreement between Registrant and Samsung Semiconductor and Telecommunications Company, Ltd. dated October 17, 1984.\n10.37(3) Tax Deferred Savings Plan.\n10.51(11) 1990 Directors' Stock Option Plan and form of Stock Option Agreement.\n10.53(12) Agreement between Registrant and Maxon Systems, Inc. dated February 27, 1990.\n10.54(12) Agreement between Registrant and Varian Tempe Electronics Center dated February 26, 1991.\n10.55(12) Agreement between Registrant and Jetcrown Industrial Ltd. dated February 18, 1993.\n10.56(13) Employee Stock Ownership Plan.\n10.57(14) Loan and Security Agreement dated December 16, 1994 between Bank One, Arizona, N.A. and Inter-Tel, Incorporated. ---------------------\n(1) Previously filed with Registrant's Registration Statement on Form S-1 (File No. 2-70437).\n(2) Previously filed with Registrant's Registration Statement on Form S-8 (File No. 2-94805).\n(3) Previously filed with Registrant's Annual Report on Form 10-K for the year ended November 30, 1984 (File No. 0-10211).\n(10) Previously filed with Registrant's Annual Report on Form 10-K for the year ended December 31, 1988 (File No. 0-10211).\n(11) Previously filed with Registrant's Registration Statement on Form S-8 (File No. 33-40353).\n(12) Previously filed with Registrant's Registration Statement on Form S-1 (File No. 33-70054).\n(13) Previously filed with Registrant's Registration Statement on Form S-8 (File No. 33-73620).\n(14) Filed herewith\n(b) Reports on Form 8-K. None\n(c) Exhibits.\n11.1 Statement re: Computation of Per Share Earnings. (Page 56)\n13.0 Annual Report to Security Holders\n22.1 List of Subsidiaries. (Page 55)\n23.0 Consent of Independent Auditors. (Page 51)\n24.1 Power of Attorney. (Included on Page 50)\n10.57 Loan Agreement dated December 16, 1994 between Bank One, Arizona, N.A. and Inter-Tel, Incorporated (Page 57)\n27 Financial Data Schedule (page 68)\nSee Item 14(a) (3) also.\n(d) Financial Statement Schedules\nThe response to this portion of Item 14 is submitted as a separate section of this report. See Item 8.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant, Inter-Tel, Incorporated, has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nINTER-TEL, INCORPORATED\nBY: \/S\/ Steven G. Mihaylo ------------------------------------ Steven G. Mihaylo Chairman and Chief Executive Officer\nDated: March 23, 1995\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Steven G. Mihaylo and Kurt R. Kneip, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may 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 Registrant in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/S\/ Steven G. Mihaylo Chairman and Chief March 20, 1995 --------------------- Executive Officer Steven G. Mihaylo\n\/S\/ Kurt R. Kneip Vice President and March 20, 1995 ----------------- Chief Financial Officer Kurt R. Kneip\n\/S\/ Gary D. Edens Director March 20, 1995 ----------------- Gary D. Edens\n\/S\/ Maurice H. Esperseth Director March 20, 1995 ------------------------ Maurice H. Esperseth\n\/S\/ C. Roland Haden Director March 20, 1995 ------------------- C. Roland Haden\n\/S\/ Norman Stout Director March 20, 1995 ------------------- Norman Stout\n\/S\/ Kathleen R. Wade Director March 20, 1995 --------------------- Kathleen R. Wade","section_15":""}
{"filename":"54441_1994.txt","cik":"54441","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nKaneb Services, Inc. (\"Company\"), which was incorporated in the State of Delaware on January 23, 1953, is principally engaged in the business of industrial services (see \"Industrial Services\" below) and pipeline transportation and storage of petroleum products (see \"Pipeline and Terminaling Services\" below).\nOn March 19, 1991, the Company, through a wholly-owned subsidiary, acquired all of the outstanding capital stock of Furmanite PLC (\"Furmanite\") for a combination of cash, preferred stock and the assumption of existing debt totaling approximately $100 million, including transaction costs. Financing for the transaction consisted of approximately $50 million in cash from the Company's own resources and the issuance of $10 million of the Company's 12% preferred stock convertible at $6.00 per share, into shares of the Company's common stock. The Company also arranged about $50 million of non-recourse bank financing, which was used for the acquisition, refinancing of Furmanite's existing debt and working capital requirements. Furmanite is a specialized industrial services company based in Richardson, Texas, providing underpressure leak sealing, on-site machining, valve testing and repair and other engineering products and services, primarily to electric power generating plants, petroleum refineries and other process industries in Western Europe, North America and the Pacific Rim.\nIn February 1995, the Company completed the sale of certain unprofitable Furmanite operations in eastern Germany. These general maintenance projects were acquired in 1991, 1992 and 1993 as the former East Germany was privatized by the German government. As economic conditions in eastern Germany worsened considerably in 1994, the Company elected to close one project and sell the remaining projects. Losses from the operations of these projects and the sale aggregated approximately $3.5 million in 1994.\nIn September 1989, Kaneb Pipe Line Company (\"KPL\"), a wholly owned subsidiary of the Company, formed a master limited partnership, Kaneb Pipe Line Partners, L.P. (\"KPP\"), to own and operate its refined petroleum products pipeline business. In a secondary public offering, the Company sold a total of 5,000,000 senior preference units (\"SPUs\") of KPP for $22 per unit, resulting in net proceeds after transaction costs of approximately $98 million to the Company and a gain on the sale of the SPUs of almost $60 million. In April 1993, an additional 2,250,000 SPUs were issued by KPP for $25.25 per unit, resulting in net proceeds of approximately $53.2 million to KPP and recognition in 1993 of a non-cash gain of approximately $15.1 million to the Company. The SPUs, which trade on the New York Stock Exchange under the ticker symbol \"KPP\", represent an approximate 44% limited partner interest in the partnership operations. The Company owns, indirectly through KPL, approximately 52% in interest as a limited partner, in the form of preference and common units. On March 21, 1995, the Board of Directors of the Company authorized management to pursue the sale of up to 3.5 million of the preference units held by KPL. The proceeds from the sale of the preference units, which will create a substantial gain that will be reflected in the 1995 financial statements, will be used to pay certain long- term debt obligations of the Company that mature in 1995. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources\".\nIn March 1993, KPP acquired, through a series of mergers, all of the capital stock of Support Terminal Services, Inc. (\"ST\"), from an affiliate of W.R. Grace for approximately $65 million, including $2 million in acquisition costs. As used herein, the term \"ST\" refers to such business, as continued by KPP through its subsidiaries. ST has been in business for more than 30 years and is one of the largest independent petroleum products and specialty liquids terminaling companies in the United States. ST operates 23 facilities in sixteen states, with a total storage capacity of approximately 7.7 million barrels.\nIn February 1995, KPP acquired certain refined petroleum pipeline assets from Wyco Pipe Line Company (\"Wyco\"), which is owned by GATX Terminals Corporation and Amoco Pipe Line Company, for $27.1 million. The assets consist of approximately 550 miles of underground pipe in Wyoming, Colorado and South Dakota, four truck loading terminals, numerous pump stations and other related assets. KPP financed the acquisition of the assets by the issuance of 8.37% first mortgage notes due in 2002.\nIn March 1994, the company finalized the terms of an option resulting in the sale of a privatized East German engineering company that was originally acquired by the Company in 1993. The acquisition of Kraftwerks-und Anlagenbau AG (\"Kraftwerks\") from the Berlin Trusteeship Agency (\"Treuhandanstalt\"), the German agency created to privatize former East German state-owned companies was completed in January 1993. A subsidiary of the Company purchased Kraftwerks share capital for DM 1 million ($700,000) and committed to maintain certain employment and investment levels over a three year period, performance of which obligations was to be secured by shares of a new class of the Company's convertible preferred stock to be placed into escrow. Kraftwerks had been engaged in recent years in providing engineering and construction services primarily to the power industry in Germany and eastern Europe. Due to substantial deterioration in the German economy, however, the Company believed that Kraftwerks would have been unlikely to achieve profitability without a corresponding reduction in its work force. Accordingly, in February, 1994, the Company entered into an agreement granting it an option to sell the shares of Kraftwerks to the Treuhandanstalt or its designee. The Company exercised its option, and on March 17, 1994, the Treuhandanstalt repaid the Company's initial acquisition price of DM 1 million, unconditionally discharged the Company from all past and future performance obligations related to Kraftwerks, released the Company's convertible preferred shares from escrow and the capital stock of Kraftwerks was transferred to a designee of the Treuhandanstalt.\nThe Company is also engaged in the transaction information industry through a wholly-owned subsidiary, Viata Corporation, a development-stage company that supplies retail merchants with electronic payment systems and information services. Viata furnishes customers with the means to process alternate forms of payment at the point of sale and to capture information that can be used in focused marketing programs. Through other subsidiaries, the Company also offers products and services that enable financial institutions to monitor the continual insurance coverage of their loan collateral.\nINDUSTRY SEGMENTS\nFinancial information regarding the Company's industry segments and foreign operations is presented under the caption \"Business Segment Data\" in Note 10 to Company's consolidated financial statements. Such information is hereby incorporated by reference into this Item 1.\nINDUSTRIAL SERVICES\nThe Company provides specialized industrial services through its Furmanite subsidiaries to an international client base that includes petroleum refineries, chemical plants, pipelines, offshore drilling and production platforms, steel mills, power generation and other process industries. Furmanite performs underpressure leak sealing, machining, bolting, valve testing and repair and other engineering services, frequently on an emergency response basis, and operates in more than 20 countries world-wide. Furmanite is headquartered in Richardson, Texas, and has offices throughout England and in Scotland, Norway, Germany, Austria, France, Belgium, Holland, Singapore, Hong Kong; U.S. offices in Virginia Beach, Philadelphia, Chicago, Los Angeles, San Francisco, Beaumont, Houston, Salt Lake City, Baton Rouge and Charlotte; and, Canadian offices in Sarnia, Ontario and Edmonton, Alberta. In addition, Furmanite licensees and companies in which it owns a minority interest operate in Sweden, Finland, Mexico, Italy, Portugal, Kuwait, United Arab Emirates, India, Japan, China, Czechoslovakia, Argentina, Puerto Rico, and Trinidad.\nFurmanite was founded in Virginia Beach, Virginia in the early 1920's as a manufacturer of kits that provided customers with the compounds and tools necessary to seal steam leaks. In the mid 1960's, Furmanite began providing leak sealing services in the United Kingdom, and during the 1970's introduced its leak sealing technologies to new markets throughout the world. Furmanite's expansion continued in the 1980's as a result of the development or acquisition of additional engineering services that could be cross-sold to its existing customer base. Over the past sixty years, Furmanite has built a solid reputation for delivering quality service in situations that are often critical. Many of Furmanite's techniques and materials are proprietary and enable it to perform on-stream repair without equipment shutdowns, thereby avoiding costly energy and production losses by the customer.\nSales and operating income of Furmanite were $118.2 million and $1.6 million, respectively, for the year ended December 31, 1994. On-line, underpressure leak sealing represented 26% of revenues, while on-site machining and valve repair accounted for 16% and 9% of revenues, respectively. In addition to valve repair and testing, bolt tightening and other maintenance and engineering services, Furmanite has recently developed a program for monitoring fugitive emissions in U.S. petrochemical plants and refineries which are required to reduce toxic air pollutants under the Clean Air Act of 1990. Geographically, sales for 1994 were divided 29% for the U.S., 31% for the U.K. and 37% for Europe. The information presented in the following tables reflect Furmanite's sales by service and region on an historical basis for the fiscal year ended September 30, 1990, its pro forma results for the calendar year ended December 31, 1991 and its historical results for the three years ended December 31, 1994:\nUnderpressure leak sealing and other specialty services are marketed primarily through direct sales calls on customers by salesmen based at Furmanite's various operating locations, which are situated to facilitate timely customer response, 24 hours a day, seven days a week. Customers are usually billed on a time and materials basis for services usually performed either pursuant to job quotation sheets or purchase orders issued under written customer agreements. Customer agreements generally are short-term in\nduration and specify the range of and rates for services to be performed. Furmanite typically provides various limited warranties, depending on the services furnished, and, to date, has had no significant warranty claims.\nOver 80% of Furmanite's revenues are derived from fossil and nuclear fuel power generation companies, petroleum refiners and chemical producers. Other markets include offshore oil producers and steel manufacturers. As the industrial infrastructure continues to age, additional repair and maintenance expenditures are expected to be incurred requiring specialized services such as those provided by Furmanite. Other factors that may influence the markets served by Furmanite include regulations governing construction of industrial plants, safety and environmental compliance and increased outsourcing in place of full- time staff for specialized services.\nFurmanite competes on the basis of service, product performance and price, generally on a localized basis with smaller companies and the in-house maintenance departments of its customers. In addition to staff reductions and the trend toward outsourcing, Furmanite believes it presently has an advantage over in-house maintenance departments because of its technician's ability to use special techniques to perform quality repairs on a timely basis while customer equipment remains in service.\nMany aspects of Furmanite's operations are subject to governmental regulation. National, state and local authorities of the U.S. and various foreign countries have adopted regulations relating to the use of certain methods, practices and materials in connection with the performance of Furmanite's services. Safety and environmental regulations also affect Furmanite's operations. In addition, because of its international presence, Furmanite is subject to a number of political and economic uncertainties, including expropriation of equipment, taxation policies, labor practices, import and export limitations, foreign exchange restrictions, currency exchange rate fluctuations and local political conditions. Except in certain developing countries, where its contracts usually provide for payment in specified currencies, Furmanite's operations are typically funded in the currencies of the particular country in which its business activities are conducted.\nUnderpressure leak sealing and other Furmanite services are often performed in emergency situations under dangerous circumstances, involving exposure to high temperatures and pressures, potential contact with caustic or toxic materials, fire and explosion hazards and environmental contamination, any of which can cause serious personal injury or property damage. Furmanite manages its operating risks by providing its technicians with extensive classroom and field training and supervision, maintaining a system of technical support through its staff of professionally qualified specialists, establishing and enforcing strict safety and competency requirements, standardizing procedures and evaluating new materials and techniques in connection with its lines of service. Furmanite also maintains insurance coverage for certain risks, although there is no assurance that insurance coverage will continue to be available at rates considered reasonable or that the insurance will be adequate to protect it against liability and loss of revenues resulting from the consequences of a significant accident.\nPIPELINE AND TERMINALING SERVICES\nIn October 1989, the Company's refined petroleum products pipeline business and properties (the \"Pipeline\") were conveyed from KPL to KPP (the \"Partnership\") in connection with the initial public offering discussed above. The pipeline business, which is headquartered in Wichita, Kansas, consists primarily of the transportation, as a common carrier, of refined petroleum products in Kansas, Nebraska, Iowa, South Dakota and North Dakota, as well as related terminaling activities. The acquisition of the assets of Wyco Pipe Line Company in February 1995 increased the Partnership's pipeline business in South Dakota and expanded it into Wyoming and Colorado. None of the results for 1994 include Wyco which is described subsequently. The Pipeline is a 2,075 mile integrated pipeline, ranging between six and sixteen inches in diameter, transporting refined petroleum products, including propane, received from refineries in southeast Kansas, or from other interconnecting pipelines, to terminals in Kansas, Nebraska, Iowa, South Dakota and\nNorth Dakota and to receiving pipeline connections in Kansas. The Pipeline has direct connections to three Kansas refineries. The Pipeline also has direct access by third-party pipelines to four other refineries in Kansas, Oklahoma and Texas and to Gulf Coast suppliers of products through a connecting pipeline which receives products from a pipeline originating on the Gulf Coast. Five connecting pipelines deliver propane from gas processing plants in Texas, New Mexico, Oklahoma and Kansas to the Pipeline for shipment. The Pipeline's operation also includes 16 public truck loading terminals located in five states comprised of a total of 233 tanks with storage capacity of 3,202,795 barrels of product and propane. In addition, the Pipeline has intermediate storage facilities in McPherson and El Dorado, Kansas consisting of 23 tanks with aggregate capacity of 922,176 barrels.\nThe mix of refined petroleum products delivered varies seasonally, with gasoline demand peaking in early summer, diesel fuel demand peaking in late summer and propane demand higher in the fall. In addition, weather conditions in the geographic areas served by the Pipeline affect the demand for and the mix of the refined petroleum products delivered through the Pipeline, although historically any impact on the volumes shipped has been short-term. Most of the refined petroleum products delivered through the Pipeline are ultimately used in agricultural operations, including fuel for farm equipment, irrigation systems, trucks transporting crops and crop drying facilities. The agricultural sector is also affected by governmental policy and crop prices. The Pipeline is also dependent on adequate levels of production of refined petroleum products by refineries connected to the Pipeline. The refineries are, in turn, dependent on adequate supplies of suitable grades of crude oil. If operations at any one refinery were discontinued, the Partnership believes, assuming unchanged demand in markets served by the Pipeline, that the effects thereof would be short-term in nature, and the Partnership's business would not be materially adversely affected over the long term. A substantial reduction of output by several refineries as a group could, however, affect the Pipeline's operations to the extent that a greater percentage of the supply would have to come from refineries outside Kansas via connecting pipelines.\nSubstantially all of the Pipeline's operations constitute common carrier operations that are subject to federal or state tariff regulation. Such common carrier activities are those under which transportation in the Pipeline is available at published tariffs filed with the Federal Energy Regulatory Commission or the Kansas Corporation Commission to any shipper of refined petroleum products who requests such services, provided that each refined petroleum product for which transportation is requested satisfies the conditions and specifications for transportation. Intrastate transportation of refined petroleum products accounted for less than 8% of the Pipeline's revenues in each of the three years ended December 31, 1994.\nBecause pipelines are generally the lowest cost method for intermediate and long-haul overland movement of refined petroleum products, the Pipeline's more significant competitors are common carrier pipelines, proprietary pipelines owned and operated by major integrated and large independent oil companies and other companies in the areas where the Pipeline delivers products. The Pipeline's major competitor is an independent regulated common carrier pipeline system that operates approximately 100 miles east of and parallel with the Pipeline. Competition between common carrier pipelines is based primarily on transportation charges, quality of customer service and proximity to end users. The Partnership believes that high capital costs, tariff regulation, environmental considerations and problems in acquiring rights-of-way make it unlikely that other competing pipeline systems comparable in size and scope to the Pipeline will be built in the near future, provided that the Pipeline has available capacity to satisfy demand and its tariffs remain at reasonable levels. Trucks may competitively deliver products in some of the areas served by the Pipeline. Trucking costs, however, render that mode of transportation uncompetitive for longer hauls or larger volumes. The Partnership does not believe that over the long term, trucks are effective competition to its long- haul volumes.\nEffective February 24, 1995, the Partnership acquired the refined product pipeline assets of Wyco Pipe Line Company for $27.1 million in cash financed by 8.37% first mortgage notes due in 2002 from three insurance companies. The assets consist of approximately 550 miles of pipeline and four truck loading terminals located in Wyoming, South Dakota and Colorado. Unlike the Partnership's service area which is\nlargely agricultural, Wyco serves the growing Denver and northeastern Colorado markets. Wyco also supplies the jet fuel for Ellsworth AFB at Rapid City. Wyco has a relatively small number of shippers, who, with only a few exceptions, are also shippers on the Partnership's system. Wyco is an interstate pipeline and thus subject to regulation by the FERC as well as by Wyoming and Colorado on its intrastate rates. It is subject to the same regulations of other governmental agencies such as the Department of Transportation and the Environmental Protection Agency as the Partnership.\nST is one of the largest independent petroleum products and specialized liquid terminaling companies in the United States. It operates five pipelines and twenty-three terminaling facilities in sixteen states, with a total storage capacity of approximately 7.7 million barrels. ST and its predecessors have been in the terminaling business for over 30 years and handle a wide variety of products from petroleum products to specialty chemicals to edible liquids. ST's terminal facilities provide throughput and storage on a fee basis for petroleum products, specialty chemicals and other liquids. ST's three largest terminal facilities are located in Texas City, Texas, Westwego, Louisiana and Baltimore, Maryland. These facilities accounted for approximately 68% of ST's revenues in 1994 and represent 48% of its current storage capacity. In addition to ST's three major facilities, ST has 20 other terminal sites around the country. In total, these 20 facilities represented approximately 52% of the Company's total storage capacity and approximately 32% of the total revenue for 1994. These inland facilities receive, store and deliver primarily petroleum products for a variety of customers, providing ST with a geographically diverse base of customers and revenue.\nThe terminaling and pipeline transportation of jet fuel for the U.S. Department of Defense is an important part of ST's business. Ten of ST's twenty inland terminal sites are involved in the terminaling or transport (via pipeline) of jet fuel for the Defense Department. Seven of the ten locations are utilized solely by the Defense Department. Five of these locations include pipelines that deliver jet fuel directly to nearby military bases. Revenue is derived from a combination of terminal contracts and tenders for the handling and movement of jet fuel. The terminal contracts provide a fixed monthly revenue for a period of one to four years per contract, with additional revenues generated if specific throughput levels are exceeded. The tenders provide for charges per barrel of throughput and have no minimum guarantees. The base closing list released by the Department of Defense on March 12, 1993 included the closure of the Naval Air Station in Glenview, Illinois which is served by ST's terminal in Peru, Illinois. Additionally, the ST pipeline serving Homestead Air Force Base in Florida has been inactive due to lack of fuel usage at the base since Hurricane Andrew in 1992. It is anticipated that the operation of that pipeline will begin again in 1995. ST does not believe that, in the aggregate, the inland terminals serving the U.S. Department of Defense will experience a significant decrease in cash flows for the foreseeable future as a result of Department of Defense changes in activity. However, the third party pipeline serving the Drumright, Oklahoma terminal reversed the direction of product flow in 1994 causing jet fuel to become unavailable at this location. Jet fuel is the only product handled at Drumright currently and it is possible that it may close sometime in 1995. ST is exploring alternative uses for this terminal. During 1994, revenues of ST from the Defense Department constituted approximately 11% of ST's revenues. The Partnership does not believe that ST's business is dependent on any one or a small group of customers.\nThe independent liquid terminaling industry is fragmented and includes both large, well financed public companies that own many terminal locations and small private companies that may own a single terminal location. In addition to the terminals owned by independent terminal operators, many major energy and chemical companies also own extensive terminal facilities. Although such terminals often have the same capabilities as terminals owned by independent operators, they generally do not provide terminaling services to third parties. In many instances, major energy and chemical companies that own storage facilities are also significant customers of independent terminal operators when independent terminals have more cost effective locations near key transportation links such as deep water ports. Major energy and chemical companies also need independent terminal storage when their captive storage facilities are inadequate, either because of size constraints, the nature of the stored material or specialized handling requirements. Independent terminal owners compete based on the location and versatility of terminals, service and price. A favorably located terminal will have access to varied cost effective transportation both to and from the\nterminal. Terminal versatility is a function of the operator's ability to offer safe handling for a diverse group of products with complex handling requirements. The service function typically provided by the terminal includes, among other things, the safe storage of the product at specified temperature, moisture and other conditions, as well as loading and unloading at the terminal. An increasingly important aspect of versatility and the service function is an operator's ability to offer product handling and storage in compliance with environmental regulations, especially since customers may retain liability for certain acts of non-compliance.\nIn addition to tariff regulation, the operations of the Partnership are subject to federal, state and local laws and regulations relating to construction, maintenance and management of its facilities, the safety of its personnel and the protection of the environment. Although the Partnership believes that the operations of the Pipeline are in general compliance with applicable regulations, risks of substantial costs and liabilities are inherent in pipeline operations, and there can be no assurance that significant costs and liabilities will not be incurred by the Partnership. Contamination resulting from spills or releases of refined petroleum products are not unusual within the petroleum pipeline industry. The Partnership has experienced limited groundwater contamination at three of its sixteen Pipeline terminal sites resulting from spills of refined petroleum products. Regulatory authorities have been notified of these findings and cleanup is underway. The Partnership is also evaluating possible groundwater contamination at a pumping and storage site. The Company will bear the costs associated with identified contamination arising prior to October 3, 1989 and such costs are not believed to be material. During 1994, the Pipeline experienced a seam rupture of its 8\" northbound line in Nebraska in January and another similar rupture on the same line in April. As a result of these ruptures, KPOP reduced the maximum operating pressure on this line to 60% of the Maximum Allowable Operating Pressure (\"MAOP\") and, on May 24, commenced a hydrostatic test to determine the integrity of over 80 miles of that line. The test was completed on the entire 80 miles on May 29, 1994, and the line was authorized to return to approximately 80% of MAOP pending review by the Department of Transportation (\"DOT\") of the hydrostatic test results. On July 29, 1994, the DOT authorized most of the line to return to the historical MAOP. Approximately 30 miles of the line was authorized to return to slightly less than historical MAOP. The amount of remediation expenses that will be required as a result of the ruptures in January and April has not yet been determined but these expenses are not expected to have a material effect upon the results of the Partnership. ST has experienced groundwater contamination at two of its terminal sites. Regulatory authorities have been notified of these findings and cleanup is underway using extraction wells and air strippers. Groundwater contamination also exists at another ST terminal site and in the areas surrounding this site as a result of the past operations of five of the facilities operating in this area. ST has entered into an agreement with three of these other companies to allocate responsibility for the clean up of the contaminated area. In addition, ST is responsible for up to two-thirds of the costs associated with existing groundwater contamination at a formerly owned terminal, which also is being remediated through extraction wells and air strippers. Groundwater contamination that may be the responsibility of third parties has been identified at two additional ST terminal sites, but no remediation has taken place. Also, ST has been named a potentially responsible party for a federally designated and EPA supervised \"Superfund\" site where a small amount of material handled by the former operator was attributed to ST. The Partnership believes that ST will be obligated under the remediation process to pay an aggregate cost of $10,000; however, until a final settlement agreement is signed with the EPA, there is a possibility that the EPA could bring additional claims against ST. For information concerning other potential Superfund liabilities, see \"Legal Proceedings\" below.\nENVIRONMENTAL CONTROLS\nThe Company believes it is in substantial compliance with applicable state, federal and local legislation and regulations relating to environmental controls, and the existence of such laws and regulations has not had, nor at this time is expected to have, any materially restrictive effect on the Company. To date, the Company has not accounted for costs or capital expenditures incurred for environmental control facilities separately from other costs incurred in the operation of its businesses. The Company does not, however,\nbelieve that any such costs or expenditures have been material, and the Company does not expect that under present conditions such costs or expenditures will become material in the foreseeable future.\nEMPLOYEES\nAt December 31, 1994, the Company employed 2,134 persons, approximately 773 of whom were salaried and approximately 1,361 of whom were hourly rate employees.\nThe Partnership has no employees. The Pipeline business of the Partnership is conducted by its general partner, KPL, which at December 31, 1994, employed 144 persons, approximately 50 of whom were salaried and approximately 94 of whom were hourly rate employees. Approximately 94 persons employed by KPL were subject to representation by unions for collective bargaining purposes; however, there were no collective bargaining contracts covering KPL employees in effect at December 31, 1994.\nThe Partnership's liquids terminaling business is conducted through ST subsidiaries, which at December 31, 1994, employed 176 persons, approximately 104 of whom were salaried and approximately 72 of whom were hourly rate employees. Approximately 33 persons employed by ST were subject to representation by the Oil, Chemical and Atomic Workers International Union AFL- CIO (OCAW). ST has an agreement with OCAW regarding conditions of employment for such persons which is in effect through June 28, 1996. This agreement is subject to automatic renewal for successive one-year periods unless ST or OCAW serves written notice to terminate or modify such agreement in a timely manner.\nThe Company's industrial services business is conducted worldwide through its Furmanite subsidiaries, which at December 31, 1994, employed 1,624 persons, approximately 501 of whom were salaried and approximately 1,123 of whom were hourly rate employees. Approximately 894 persons employed by Furmanite were subject to representation by unions or other similar associations for collective bargaining or other similar purposes; however, there were no significant collective bargaining or other similar contracts covering the Furmanite employees in effect at December 31, 1994.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate headquarters of the Company are located in Richardson, Texas, in a modern, sixteen story building pursuant to a five year lease agreement. In addition to properties owned or leased by its industrial services and pipeline transportation and liquids terminaling businesses, the Company also leases office space in Bryan, Texas and San Antonio, Texas.\nDescriptions of other properties owned or utilized by the Company are contained in Item 1 of this report and such descriptions are hereby incorporated by reference into this Item 2. Under the caption \"Commitments and Contingencies\" in Note 9 to the Company's consolidated financial statements, additional information is presented concerning obligations of the Company for lease and rental commitments. Said additional information is hereby incorporated by reference into this Item 2.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn October 1994, the Company settled two lawsuits filed in the 1980's by Kanland Associates and Panance Property Corporation that related to the Company's former office building in Sugar Land, Texas. One of these suits had alleged damages at more than $38 million plus prejudgment interest, legal fees, court costs and punitive damages. The settlement of these lawsuits was adequately reserved.\nIn September 1987, Stephen R. Herbel and other named individuals doing business as Pinnacle Petroleum Company (\"Pinnacle\") filed a lawsuit in Mobile County, Alabama, against the Company and certain of its affiliates, Jim Walter Resources, Inc. and others, seeking damages of $9 million. Pinnacle asserted that\nits rights under a conventional oil and gas lease were violated by the execution of a subsequent coal mining lease covering the same property. In addition to monetary damages, Pinnacle also seeks a judgment from the Trial Court that it is the owner of all the gas under the property described in the conventional oil and gas lease, regardless of its origin, and that a unitization order be declared invalid. On July 28, 1989, the Trial Court ruled in favor of all defendants by granting summary judgment holding that Kaneb and the other defendants, as owners of the coal also own and have the exclusive right to produce the coalbed gas, to the exclusion of the conventional oil and gas lessees. There remained factual disputes as to the characterization of all the gas produced from the property which were to be addressed in future hearings. On October 8, 1993, in a case involving Jim Walter Resources, but not Kaneb, based on similar facts, the Supreme Court of Alabama held that under certain circumstances coalbed methane is the property of the owner of the conventional oil and gas estate. In response thereto, the Trial Court scheduled a further evidentiary hearing to determine the impact of the Supreme Court on the Pinnacle case. In March 1995, all parties in this lawsuit reached an agreement to settle and release their claims against each other. Attorneys for the parties are presently preparing the legal documents related to the settlement, the Company's portion of which was adequately reserved.\nTwo of the Company's former operating subsidiaries have been identified as potentially responsible parties in separate governmental investigations and actions relating to waste disposal facilities which may be subject to remedial action under Superfund. These proceedings are based on allegations that the subsidiaries disposed of hazardous substances at the facilities in question, in one instance prior to acquisition of the subsidiary by the Company. Such proceedings arising under Superfund typically involve numerous waste generators and other waste transportation and disposal companies and seek to allocate or recover costs associated with site investigation and cleanup, which costs could be substantial.\nThe Company or its subsidiaries have been notified that they are potentially responsible parties in connection with 2 locations listed on the Superfund National Priority List. The Company has reviewed its role, if any, with respect to each location, giving consideration to the nature of the Company's alleged connection to the location (e.g., owner, operator, transporter or generator), the amount and nature of waste hauled to the location, the accuracy and strength of evidence connecting the Company to the location, and the number, connection and financial ability of other named and unnamed potentially responsible parties at the location. At one location, the Company has been named in the \"de minimis\" group of generators, who have been negotiating a settlement of their liabilities with the Environmental Protection Agency. However, the Company has joined with others within the group who have elected to contest their liability completely. At the second location, the Company has only recently been notified of its possible involvement and has, therefore, conducted only a limited investigation of its potential exposure, if any. While the Company does not anticipate that the amount of expenditures from its involvement in the above matters will have a material adverse effect on the Company's operations or financial condition, the possibility remains that technological, regulatory or enforcement developments, the results of environmental studies, or other factors could materially alter this expectation at any time.\nIn addition, the Company and certain of its subsidiaries are involved in various litigation and other legal proceedings; however, such litigation or proceedings are not considered to be significant.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company did not hold a meeting of stockholders or otherwise submit any matter to a vote of stockholders in the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nShares of the Company's Common Stock are listed and traded principally on the New York Stock Exchange. At March 17, 1995, there were approximately 5,171 holders of Common Stock of record. The following table sets forth, for the fiscal periods indicated, the quoted high and low sales prices of the shares on the New York Stock Exchange.\nRegular dividends on the Company's reclassified Adjustable Rate Cumulative Class A Preferred Stock were resumed in the third quarter of 1990. In connection with its 1991 acquisition of Furmanite, the Company issued a total of 1,098,373 shares of 12% Convertible Class A Preferred Stock, Series D, stated value of 5.34 Pounds Sterling, of which 989,820 shares were outstanding as of March 17, 1995. Commencing June 30, 1991, an annual dividend of 64 pence has been paid semi-annually to the holders of Series D Preferred Stock. Also, in connection with an executive compensation program, the Company has issued 600 restricted shares of its Adjustable Rate Cumulative Class A Preferred Stock, Series C, to three senior officers, who in 1994 were paid an aggregate dividend of $28,422 previously accrued in 1991. Dividends on the Series C Preferred Stock that are otherwise payable for a year in which the Company has a net loss are not paid until completion of a year in which the Company has a net profit.\nCredit facilities used to acquire Furmanite and ST and KPL's working capital arrangement each contain restrictions on the subsidiaries' ability to pay dividends or distributions to the Company if an event of default exists.\nITEM 6.","section_6":"ITEM 6. SUMMARY HISTORICAL FINANCIAL AND OPERATING DATA\nThe following selected financial data (in thousands, except per share amounts) is derived from the consolidated financial statements of Kaneb Services, Inc. and should be read in conjunction with the consolidated financial statements and related notes included herein. The Company has not declared a dividend on it's common stock for any of the periods presented.\nNotes:\n(a) Represents the cumulative effect of accounting changes from the adoption of new financial accounting standards relating to taxes.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThis discussion should be read in conjunction with the consolidated financial statements of Kaneb Services, Inc. (the \"Company\") and notes thereto included elsewhere in this report.\nRESULTS OF OPERATIONS\nThe Company's revenues increased $10.2 million or 5% over 1993 reflecting growth in the pipeline and terminaling services segment resulting from the inclusion of ST's results for the full year versus the ten month period in 1993 from the March 2, 1993 acquisition date. Net income from continuing operations before the $15.1 million non-cash accounting basis gain resulting from the issuance of additional units by KPP in 1993, increased 100% from $1.0 million in 1993 to $2.0 million in 1994.\nThe Company's revenues increased $21.8 million or 12% over 1992 due to the acquisition by KPP in March 1993 of ST. Operating income increased $14.9 million or 102% over 1992 with substantial improvements in all areas of the Company. Net income, which included a $15.1 million non-cash accounting basis gain resulting from the issuance of additional units by KPP in April 1993, increased $20 million over 1992.\nINDUSTRIAL SERVICES\nThe industrial services segment represents the operations of Furmanite, which was acquired in March 1991.\nRevenues in Germany decreased 18% in 1994 from 1993 as a result of worsening economic conditions in the eastern sector. Furmanite's revenues throughout the rest of the world increased 12% in 1994 over 1993 as some of the downward pressures experienced in the previous year began to relax. Operating losses in Germany in 1994 amounted to $3.5 million, including costs associated with the sale of unprofitable projects in eastern Germany in February 1995, compared to operating profits of $1.4 million in 1993. Furmanite's operations throughout the rest of the world reported operating income of $5.1 million in 1994, a 113% improvement over 1993.\nRevenues declined 7% in 1993 over 1992 primarily as a result of continued pressures from the worldwide recession. Revenues in the U.K. and Western Europe declined 19% in 1993 and United States revenues were 14% lower than in 1992. Operating income increased in 1993 primarily due to improvements throughout Furmanite's operations as a result of the 1992 reorganization. In the third quarter of 1992, the Company recorded a $1.8 million charge for the reorganization of Furmanite. The reorganization was completed in the fourth quarter of 1992 and substantially all of the funds were disbursed from working capital in that period.\nCapital expenditures are primarily related to expansion of manufacturing and shop facilities and the development of new services. Capital expenditures for 1995 are currently estimated to be $2 to $4 million depending on the economic environment and the needs of the business.\nPIPELINE AND TERMINALING SERVICES\nThe pipeline and terminaling services segment includes the operations of Kaneb Pipe Line Partners, L.P. (\"KPP\") which was formed in 1989 to own and operate the refined petroleum products pipeline business started by the Company over 40 years ago. The Company controls the pipeline and terminaling operations through its two percent general partner interest and also owns a 52% limited partner interest in the partnership. Effective March 1, 1993, KPP acquired Support Terminal Services, Inc. (\"ST\"), a petroleum products and specialty liquids storage and terminaling company headquartered in Dallas, Texas for approximately $65 million. KPP borrowed $65 million from a group of banks to fund the acquisition and refinanced its $10 million credit line. In April 1993, KPP completed a secondary public offering of 2.25 million Senior Preference Units at $25.25 per unit and used $50.8 million of the proceeds from the offering to repay a portion of the ST acquisition bank debt. The Company recognized a non- cash accounting basis gain in the amount of $22.4 million resulting from the change in its ownership interest of KPP as a result of this public offering. Consistent with the treatment in 1989 on the initial offering of Senior Preference Units, the Company deferred $7.3 million of this gain and recorded $15.1 million in the statement of income as a gain on the issuance of units by the partnership. Minority interest expense increased $1.6 million and $3.0 million in 1994 and 1993, respectively, as a result of the issuance of the 2.25 additional senior preference units in April 1993. The distributions to the minority interest holders of KPP aggregated approximately $16.2 million, $13.7 million and $11.0 million in 1994, 1993 and 1992, respectively, and were funded by KPP's operations.\nPipeline revenues increased 5% while operating income increased 3% in 1994. The increase in revenues is attributable to an approximate 5.5% tariff increase implemented in April 1994. The effects of the tariff increase were partially offset by an increase in property taxes and unusually high repair and maintenance expenditures. Terminaling revenues and operating income increased $7.5 million and $2.9 million, respectively, over 1993 primarily as a result of the inclusion of the operations of ST for the full year in 1994 versus the ten month period in 1993 from the March 2 acquisition date.\nCapital expenditures, which relate to the expansion of the pipeline and the maintenance of existing operations, for 1994 were $19.5 million. Capital expenditures in 1994 include $12.3 million related to the acquisition of three additional terminaling facilities. Routine capital expenditures for 1995 are currently estimated to be $8 million.\nIn February 1995, KPP, through a wholly-owned subsidiary, acquired the pipeline assets of Wyco Pipe Line Company for $27.1 million. The acquisition was financed by the issuance of $27 million of first mortgage notes that bear interest at 8.37% per annum and mature in 2002.\nOTHER OPERATIONS\nThe Company recorded revenues of $11.8 million, $12.9 million and $8.9 million in 1994, 1993 and 1992, respectively, and operating costs of $10.3 million, $12.3 million and $10.5 million for the same periods related to subsidiaries that provide payment, collection and information services to retail merchants and financial institutions. During 1993, the Company wrote off $.3 million of acquisition costs related to Kraftwerks-und Anlagenbau AG which is included in other expenses. During 1992, the Company offset the release of an excess accrual of $3.5 million in its discontinued operations reserve against the reduction in the carrying value of assets that relate to services no longer actively marketed to retail merchants. The Company recorded income and a gain from the sale of its interests in oil and gas properties of approximately $1.0 million which was included in other income in 1992. The 1992 income tax benefit is due primarily to the favorable settlement of a foreign tax liability. During 1992, the Company recorded a $1.0 million gain from discontinued operations resulting from a cash settlement of a claim in a discontinued subsidiary.\nIn January 1993, the Company completed the acquisition of Kraftwerks-und Anlagenbau AG (\"Kraftwerks\") from the Berlin Trusteeship Agency (\"Treuhandanstalt\"), the German agency created to privatize former East German state-owned companies. A subsidiary of the Company purchased Kraftwerks share capital for DM 1 million ($700,000) and committed to maintain certain employment and investment levels over a three year period, performance of which obligations was to be secured by shares of a new class of the Company's convertible preferred stock to be placed into escrow. Kraftwerks has been engaged in recent years in providing engineering and construction services primarily to the power industry in Germany and eastern Europe. Due to substantial deterioration in the German economy, however, the Company believed that Kraftwerks would have been unlikely to achieve profitability without a corresponding reduction in its work force. Accordingly, in February 1994, the Company entered into an agreement granting it an option to sell the shares of Kraftwerks to the Treuhandanstalt or its designee. The Company exercised its option, and on March 17, 1994, the Treuhandanstalt repaid the Company's initial acquisition price of DM 1 million, unconditionally discharged the Company from all past and future performance obligations related to Kraftwerks, released the Company's convertible preferred shares from escrow and the capital stock of Kraftwerks was transferred to a designee of the Treuhandanstalt.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company has $53.2 million of long-term debt that matures during 1995 which has been included in current liabilities as of December 31, 1994. As a result, the Company's balance sheet shows a working capital deficiency of $42.8 million as of December 31, 1994. After an extensive review of various repayment and refinancing alternatives, the Board of Directors, on March 21, 1995, authorized management of the Company to pursue the sale of up to 3.5 million of the Preference Units it holds in Kaneb Pipe Line Partners, L.P. (\"KPP\"). Management is in discussions with underwriters regarding a public offering of these securities and expects to raise the funds required to repay these obligations prior to their maturity.\nCash provided by operating activities was $25.9 million, $30.9 million and $19.2 million during the years 1994, 1993 and 1992, respectively.\nIn conjunction with the acquisition of Furmanite, a wholly-owned subsidiary obtained a $50 million credit facility, which is without recourse to the Parent Company, with an international banking syndicate. The\nproceeds from the credit facility were applied to the cost of the acquisition and utilized to refinance Furmanite's existing debt. At December 31, 1994, $25.2 million was outstanding under this credit facility.\nA subsidiary of the Company has a $5 million credit line ($3.1 million outstanding at December 31, 1994) which expires in June 1995. In 1994, KPP through a wholly-owned subsidiary, issued $33 million of first mortgage notes to a group of insurance companies. The notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. In 1994, a wholly-owned subsidiary of KPP entered into a Restated Credit Agreement with a group of banks that provides a $15 million revolving credit facility through November 30, 1997. The credit facility bears interest at variable interest rates and has a commitment fee of .2% per annum of the unused credit facility. No amounts were drawn under the credit facility at December 31, 1994. The notes and credit facility are secured by a mortgage on substantially all of the pipeline assets of KPP.\nConsolidated capital expenditures for 1995 have been budgeted at $10 to $12 million. Debt maturities are $60.1 million, $3.8 million, $3.9 million, $19.2 million and $1.6 million for each of the five years ending December 31, 1998. Debt maturities for 1995 are expected to be funded through the sale of Preference Units in KPP as discussed above and anticipated cash flows from operations. Capital expenditures in 1995 are expected to be funded from existing cash and anticipated cash flows from operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and supplementary data of the Company begins on page of this report. Said information is hereby incorporated by reference into this Item 8.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nThe information required by Part III (Items 10, 11, 12 and 13) of Form 10-K is incorporated by reference from portions of the Registrant's definitive proxy statement to be filed with the Securities and Exchange Commission not later than 120 days after the close of the fiscal year covered by this 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) (1) FINANCIAL STATEMENTS\nSet forth below are financial statements appearing in this report.\n(A) (2) FINANCIAL STATEMENT SCHEDULES\nSchedules, other than those listed above, have been 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 or related notes thereto presented in the Annual Report to Stockholders.\n(A) (3) LIST OF EXHIBITS\n3.1 Restated Certificate of Incorporation of the Registrant as restated September 26, 1979, filed as Exhibit 3.1 of the exhibits to the Registrant's registration statement on Form S-16, which exhibit is hereby incorporated by reference.\n3.2 Certificate of Amendment of Certificate of Incorporation of the Registrant, dated April 30, 1981, filed as Exhibit 3.2 of the exhibits to the Registrant's Form 10-K for the year ended December 31, 1981 (1981 Form 10- K), which exhibit is hereby incorporated by reference.\n3.3 Certificate of Amendment of Certificate of Incorporation of the Registrant, dated May 28, 1985, filed as Exhibit 4.1 of the exhibits to the Registrant's quarterly report on Form 10-Q for the quarter ended June 30, 1985, which exhibit is hereby incorporated by reference.\n3.4 Certificate, dated September 17, 1985, amending the Certificate of Incorporation,filed as Exhibit 4.1 of the exhibits to the Registrant's quarterly report on Form 10-Q for the quarter ended September 30, 1985, which exhibit is hereby incorporated by reference.\n3.5 Certificate of Amendment to the Restated Certificate of Incorporation of Registrant dated July 10, 1990, filed as Exhibit 3.5 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1990 (1990 Form 10-K), which exhibit is hereby incorporated by reference.\n3.6 Certificate of Amendment to the Restated Certificate of Incorporation of Registrant dated September 21, 1990, filed as Exhibit 3.5 of the exhibits to Registrant's quarterly report on Form 10-Q for the quarter ended September 30, 1990, which exhibit is hereby incorporated by reference.\n3.7 By-laws of the Registrant, filed as Exhibit 3.5 of the exhibits to the Registrant's report on Form 10-K for year ended December 31, 1985, which exhibit is hereby incorporated by reference.\n4.1 Certificate of Designation related to Registrant's Adjustable Rate Cumulative Class A Preferred Stock, filed as Exhibit 4 of the exhibits to the Registrant's quarterly report of Form 10-Q for the quarter ended September 30, 1983, which exhibit is hereby incorporated by reference.\n4.2 Certificate of Designation, Preferences and Rights of Series B Junior Participating Preferred Stock, filed as Exhibit 1 of the exhibits to the Registrant's report on Form 8-K and registration statement on Form 8-A dated April 5, 1988, which exhibit is hereby incorporated by reference.\n4.3 Certificate of Designation to the Restated Certificate of Incorporation of Registrant relating to the issuance of Series D Preferred Stock dated February 11, 1991, filed as Exhibit 4.3 of Registrant's 1990 Form 10-K, which exhibit is hereby incorporated by reference.\n4.4 Certificate of Designation to the Restated Certificate of Incorporation of Registrant relating to the issuance of Series C Preferred Stock dated April 23, 1991, filed as Exhibit 4.4 of the exhibits to Registrant's report on From 10-K for the year ended December 31, 1991, which exhibit is hereby incorporated herein.\n4.5 Certificate of Designation dated November 2, 1992 relating to the issuance of Series E Preferred Stock, filed as Exhibit 10.2 of the exhibits to Registrant's report on Form 8-K dated January 23, 1993, which exhibit is hereby incorporated by reference.\n4.6 Indenture, dated as of January 1, 1978, between Moran Energy Inc. and First City National Bank of Houston, under which Moran Energy Inc. issued the 11 1\/2% Subordinated Debentures due 1998, filed as Exhibit 2(g) to Moran Energy Inc.'s Registration Statement on Form S-7 (SEC File No. 2-61216), which exhibit is hereby incorporated by reference.\n4.7 First Supplemental Indenture, dated as of March 20, 1984, between the Registrant and First City National Bank of Houston, under which the Registrant assumed obligations under the Indenture listed as Exhibit 4.6 above, filed as Exhibit 4.4 to the exhibits of Registrant's report on Form 10-K for the year ended December 31, 1983 (1983 Form 10-K) which exhibit is hereby incorporated by reference.\n4.8 Indenture, dated as of November 1, 1980, between Moran Energy International N.V., Moran Energy Inc. and First City National Bank of Houston, under which Moran Energy International N.V. issued the 8% Convertible Subordinated Debentures due 1995 of Moran Energy International N.V. guaranteed on a subordinated basis by Moran Energy Inc., filed as Exhibit 4(b) to Moran Energy Inc.'s Form 10-K for the year ended December 1, 1980, which exhibit is hereby incorporated by reference.\n4.9 First Supplemental Indenture, dated as of March 20, 1984, by and among Moran Energy International N.V., the Registrant and First City National Bank of Houston, under which the Registrant assumed Moran Energy Inc.'s obligations under the Indenture listed as Exhibit 4.8 above, filed as Exhibit 4.7 of the 1983 Form 10-K Exhibit 4.7 which exhibit is hereby incorporated by reference.\n4.10 Indenture, dated as of January 15, 1984, between Moran Energy Inc. and First City National Bank of Houston, under which Moran Energy Inc. issued the 8 3\/4% Convertible Subordinated Debentures due 2008, filed as Exhibit 4.1 to Moran Energy Inc.'s registration statement on Form S-3 (SEC File No. 2-81227), which exhibit is hereby incorporated by reference.\n4.11 First Supplemental Indenture, dated as of March 20, 1984, between the Registrant and First City National Bank of Houston, under which the Registrant assumed obligations under the Indenture listed as Exhibit 4.10 above, filed as Exhibit 4.8 of the 1983 Form 10-K Exhibit 4.8 which exhibit is hereby incorporated by reference.\n10.1 Kaneb Services, Inc. 1984 Nonqualified Stock Option Plan, filed as Exhibit 10.26 of the exhibits to Registrant's report on form 10-K for the year ended December 31, 1984, which exhibit is hereby incorporated by reference.\n10.2 Form of Termination Agreement, dated May 22, 1981, entered by the Registrant with certain key employees of the Registrant, filed as Exhibit 10.19 of the 1981 Form 10-K Exhibit 10.19 which exhibit is hereby incorporated by reference.\n10.3 Kaneb Services, Inc. Savings Investment Plan filed as Exhibit 4.10 to the exhibits of Registrant's Form S-8 Registration Statement (S.E.C. File No. 33-41295), which exhibit is hereby incorporated by reference.\n10.4 Form of Indemnification Assurance Agreement entered into by the Registrant with the directors, filed as Exhibit 10.33 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1986, which exhibit is hereby incorporated by reference.\n10.5 Purchase Contract dated November 20, 1992 for the sale of the share capital of KAB between the Treuhandanstalt and Furmanite Holding GmbH together with Kaneb Services, Inc. as a limited guarantor, filed as Exhibit 10.2 to the exhibits of Registrant's report on Form 8-K dated January 29, 1993 which exhibit is incorporated herein by reference.\n10.6 Sale Contract dated February 27, 1994 for the disposition of the share capital of KAB between KAB Holding GmbH (formerly Furmanite Holding GmbH), the Treuhandanstalt and the Registrant, filed as Exhibit 10.6 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1993, which exhibit is hereby incorporated by reference.\n10.7 STS Agreement and Plan of Merger dated December 21, 1992 by and between Grace Energy Corporation, Support Terminal Services, Inc., Standard Transpipe Corp., and Kaneb Pipe Line Operating Partnership, NSTS, Inc. and NSTI, Inc. as amended by Amendment of STS Merger Agreement dated March 2, 1993, filed as Exhibit 10.1 to the exhibits of Registrant's report on Form 8-K dated March 2, 1993, which exhibit is incorporated herein by reference.\n10.8 Amended and Restated Loan Agreement dated May 1, 1991 between Furmanite PLC, Bank of Scotland and certain Banks, filed herewith.\n10.9 Amended and Restated Senior Secured Increasing Rate Promissory Note dated July 2, 1993 between the Registrant and the Bank of Scotland, filed herewith.\n10.10 Pledge and Proxy Agreement dated October 11, 1993, between the Registrant and Texas Commerce Bank, National Association, filed as Exhibit 10.9 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1993, which exhibit is hereby incorporated by reference.\n10.11 Pledge and Security Agreement dated October 11, 1993 between Kaneb Pipe Line Company and Texas Commerce Bank, National Association, filed as Exhibit 10.10 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1993, which exhibit is hereby incorporated by reference.\n10.12 Note Purchase Agreement dated December 22, 1994. Said document is on file as Exhibit 10.2 of the exhibits to Registrant's report on Form 8-K filed on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.13 Restated Credit Agreement dated December 22, 1994 between Kaneb Pipe Line Operating Partnership, L.P., Texas Commerce Bank National Association, and certain Lendors, filed herewith.\n10.14 Agreement for Sale and Purchase of Assets dated February 19, 1995 by and among Wyco Pipe Line Company and Kaneb Pipe Line Operating Partnership, L.P.. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the securities and Exchange Commission on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.15 Kaneb Services, Inc. 1994 Stock Incentive Plan filed as Exhibit 4.12 to the exhibits of Registrant's Form S-8 Registration Statement (S.E.C. File No. 33-54027), which exhibit is hereby incorporated by reference.\n21 List of subsidiaries of the Registrant, filed herewith.\n23 Consent of independent auditors: Price Waterhouse, filed herewith.\n24 Powers of Attorney, filed herewith.\n27 Financial Data Schedule, filed herewith.\nCertain instruments respecting long-term debt of the Registrant have been omitted pursuant to instructions as to Exhibits. The Registrant agrees to furnish copies of any of such instruments to the Commission upon request.\n(B) REPORTS ON FORM 8-K - NONE.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, Kaneb Services, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nKANEB SERVICES, INC.\nBy: JOHN R. BARNES --------------------- (John R. Barnes) President and Chief Executive Officer Date: March 30, 1995\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 Kaneb Services, Inc. and in the capacities and on the date indicated.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Kaneb Services, Inc.\nIn our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) and (2) on page 16 present fairly, in all material respects, the financial position of Kaneb Services, Inc. and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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.\nAs discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for income taxes by adopting Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, effective January 1, 1992.\nPRICE WATERHOUSE LLP\nDallas, Texas March 22, 1995\nF - 1\nKANEB SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME -------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nF - 2\nKANEB SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS ------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nKANEB SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS ------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nF - 4\nKANEB SERVICES, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY --------------------------------------------------------------------------------\nSee notes to consolidated financial statements.\nF - 5\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe following significant accounting policies are followed by Kaneb Services, Inc. (the \"Company\") and its subsidiaries in the preparation of financial statements.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its subsidiaries and Kaneb Pipe Line Partners, L.P. (\"KPP\"). The Company controls the pipeline operations of KPP through its two percent general partner interest and also owns a 52% majority limited partner interest. All significant intercompany transactions and balances are eliminated in consolidation.\nSEGMENT INFORMATION\nThe Company provides specialized industrial services through its industrial services segment to an international client base that includes oil refineries, chemical plants, pipelines, offshore drilling and production platforms, steel mills, food and drink processing facilities, power generation, and other process industries. The Company also provides pipeline and terminaling services through its 2,075 mile integrated pipeline and specialized terminaling and storage facilities.\nCASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS\nThe Company's policy is to invest cash in highly liquid investments with maturities of three months or less, upon acquisition. Accordingly, uninvested cash balances are kept at minimum levels. Such investments are valued at cost, which approximates market, and are classified as cash equivalents. Similar investments with original maturities beyond three months are considered short-term investments and are carried at cost, which approximates market value.\nINVENTORIES\nInventories consist primarily of finished goods of the industrial services segment and are valued at the lower of average cost or market. Cost is determined using the weighted average cost method.\nPROPERTY AND EQUIPMENT\nProperty and equipment are carried at original cost. Certain leases have been capitalized and the leased assets have been included in property and equipment. Additions of new equipment and major renewals and replacements of existing equipment are capitalized. Repairs and minor replacements that do not materially increase values or extend useful lives are expensed.\nDepreciation of property and equipment is provided on the straight-line basis at rates based upon expected useful lives of the various classes of assets. The rates used for pipeline and storage facilities, which are subject to regulation, are the same as those promulgated by the Federal Energy Regulatory Commission.\nF - 6\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\nREVENUE RECOGNITION\nSubstantially all revenues are recognized when services to unaffiliated customers have been rendered. Pipeline transportation revenues are recognized upon receipt of the products into the pipeline system.\nEARNINGS PER SHARE\nEarnings per common share data have been computed by dividing income applicable to common stock by the weighted average number of shares outstanding during each period. The effect of common stock equivalents and other potentially dilutive securities on such computation was anti-dilutive for each period.\nFOREIGN CURRENCY TRANSLATION\nThe Company translates the balance sheets of its foreign subsidiaries using year-end exchange rates and translates income statement amounts using the average exchange rates in effect during the year. The gains and losses resulting from the change in exchange rates from year to year have been reported separately as a component of stockholders' equity. Gains and losses resulting from foreign currency transactions are included in the statements of income.\nEXCESS OF COST OVER FAIR VALUE OF NET ASSETS OF ACQUIRED BUSINESS\nThe excess of the purchase price of Furmanite, PLC over the fair value of the net assets acquired is being amortized over a period of 40 years. Accumulated amortization was $6.6 million and $4.8 million at December 31, 1994 and 1993, respectively.\n2. MANAGEMENT PLANS\nThe Company has $53.2 million of long-term debt that matures during 1995 which has been included in current liabilities as of December 31, 1994. As a result, the Company's balance sheet shows a working capital deficiency of $42.8 million as of December 31, 1994. After an extensive review of various repayment and refinancing alternatives, the Board of Directors, on March 21, 1995, authorized the management of the Company to pursue the sale of up to 3.5 million of the Preference Units it holds in Kaneb Pipe Line Partners, L.P. (\"KPP\"). Management is in discussions with underwriters regarding a public offering of these securities and expects to raise the funds required to repay these obligations prior to their maturity.\nThe Company controls the pipeline and terminaling operations of KPP through its two percent general partner interest and it currently owns a 52% limited partner interest. The sale of 3.5 million Preference Units would reduce the Company's limited partner interest to 31%, but it would not affect the Company's control of the operations of KPP. The excess of the net proceeds from the sale of these Preference Units over their nominal book basis of $4.37 per Preference Unit will be recorded as a gain in the Company's 1995 statement of income.\nF - 7\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\n3. ACQUISITIONS, DISPOSITIONS AND SUBSEQUENT EVENTS\nEffective February 24, 1995, the Company, through KPP, acquired the refined petroleum product pipeline assets of Wyco Pipe Line Company (\"Wyco\") for $27.1 million. The acquisition was financed by the issuance of first mortgage notes to three insurance companies. The notes are due February 24, 2002 and bear interest at the rate of 8.37% per annum. The acquisition will be accounted for as a purchase and, accordingly, the results of operations of Wyco will be included in the Partnership's consolidated statement of income subsequent to the date of acquisition.\nIn February 1995, the Company completed the sale of certain unprofitable Furmanite operations in eastern Germany. These general maintenance projects were acquired in 1991, 1992 and 1993 as the former East Germany was privatized by the German government. As economic conditions in eastern Germany worsened considerably in 1994, the Company elected to close one project and sell the remaining projects. Losses from the operations of these projects and the sale aggregated approximately $3.5 million in 1994.\nEffective March 1, 1993, KPP acquired Support Terminal Services, Inc. (\"ST\"), a petroleum products and specialty liquids storage and terminaling company headquartered in Dallas, Texas, for approximately $65 million. The acquisition was accounted for as a purchase, and accordingly, the Company's consolidated statements of income include the results of operations of ST since March 1, 1993. In connection with the acquisition, KPP borrowed $65 million from a group of banks. In April, 1993 KPP sold 2.25 million Senior Preference Units (\"SPU\") in a secondary public offering at $25.25 per unit and used $50.8 million of the proceeds from this offering to repay a portion of the ST acquisition debt. As a result of KPP issuing additional units to unrelated parties, the Company's pro rata share of the net assets of KPP increased by $22.4 million. The Company recognized a gain of $15.1 million and consistent with the accounting treatment of the initial SPU offering in 1989, deferred $7.3 million of the gain. The unamortized portion of the deferred gains which totaled $6.8 million, $10.4 million and $6.5 million at December 31, 1994, 1993 and 1992, respectively, are included as minority interest on the balance sheet and are being amortized using the straight- line method through 1996.\n4. INCOME TAXES AND ACCOUNTING CHANGE\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 109, Accounting for Income Taxes. The Company adopted this new accounting standard in the first quarter of 1992 and reported the cumulative effect of the change in method of accounting for income taxes as a benefit of $742,000 or $.02 per share. Under SFAS No. 109, the Company has recorded deferred tax assets of approximately $108 million and $113 million as of December 31, 1994 and 1993, respectively, primarily relating to the Company's domestic net operating loss carryforwards and investment tax credit carryforwards, offset by a valuation reserve of the same amount. In 1994 and 1993, the Company reduced its valuation allowance by $4.8 million and $2.7 million, respectively, primarily due to the utilization of domestic net operating loss carryforwards and the expiration of investment tax credit carryforwards.\nF - 8\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\nIncome (loss) from continuing operations before income tax expense is made up of the following components:\nIncome tax expense (benefit) is made up of the following components:\nDeferred income tax provisions (benefits) result from temporary differences between the tax basis of assets (principally fixed assets) and liabilities of foreign subsidiaries and certain domestic subsidiaries not included in the Company's consolidated federal tax return, and their reported amounts in the financial statements that will result in differences between income for tax purposes and income for financial statement purposes in future years.\nF - 9\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS --------------------------------------------------------------------------------\nThe reasons for the differences between the amount of tax expense provided and the amount of tax expense computed by applying the statutory Federal income tax rate to income (loss) from continuing operations before income taxes for the years 1994, 1993 and 1992 were as follows:\nAt December 31, 1994, the Company had the following domestic tax attribute carryforwards expiring in the years indicated:\nThe amounts shown above that expire in the years 1995 through 1998 represent the operating losses and investment tax credits acquired in the acquisition of Moran Energy, Inc. and its subsidiaries and it is unlikely that the Company will be able to utilize these tax carryforwards in the future. If certain substantial changes in the Company's ownership should occur, there would be an annual limitation on the amount of the tax carryforwards which could be utilized.\nF - 10\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\n5. RETIREMENT PLANS\nThe Company has a defined contribution benefit plan which covers substantially all domestic employees and provides for varying levels of employer matching. Company contributions to this plan were $.9 million, $.6 million and $.5 million for 1994, 1993 and 1992, respectively.\nOne of the Company's foreign subsidiaries has a defined benefit pension plan covering substantially all of its United Kingdom employees (the \"U.K. Plan\"). The benefit is based on the average of the employee's salary for the last three years of employment. Generally the employee contributes 5% and the employer contributes up to 12% of pay. Plan assets are primarily invested in unitized pension funds managed by United Kingdom registered funds managers. The valuation of the U.K. Plan was performed as of November 1, 1994. Net pension cost for the U.K. Plan included the following components:\nActuarial assumptions used in the accounting for the U.K. Plan were a weighted average discount rate of 9% for 1994, 7.5% for 1993 and 9% for 1992, an expected long-term rate of return on assets of 9% for 1994, 1993 and 1992 and a rate of increase in compensation levels of 6.0% for 1994, 5.5% for 1993 and 7% for 1992.\nThe funded status of the U.K. Plan is as follows:\nF - 11\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\n6. PROPERTY AND EQUIPMENT\nThe cost of property and equipment is as follows:\nEquipment acquired under capital leases and included in the cost of property and equipment is as follows:\n(a) The capital lease is secured by certain pipeline equipment and the Company has recorded its option to purchase this equipment at the termination of the lease.\nF - 12\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\n7. DEBT\nDebt is summarized as follows:\nIn 1994, KPP, through a wholly-owned subsidiary, issued $33 million of first mortgage notes to a group of insurance companies. The notes bear interest at the rate of 8.05% per annum and are due on December 22, 2001. In 1994, a wholly-owned subsidiary of KPP entered into a Restated Credit Agreement with a group of banks that provides a $15 million revolving credit facility through November 30, 1997. The credit facility bears interest at variable rates and has a commitment fee of .2% per annum of the unused credit facility. No amounts were drawn under the credit facility at December 31, 1994. The notes and credit facility are secured by a mortgage on substantially all of the pipeline assets of KPP and contain certain financial and operational covenants.\nDuring 1991, a wholly-owned subsidiary of the Company obtained a $50.5 million multicurrency credit facility from an international banking syndicate. The proceeds of the loan were applied to the acquisition of Furmanite and to refinance certain Furmanite obligations of approximately $30 million. This credit facility is secured by all of the tangible assets of the industrial services group (except those assets in Germany) without recourse to the Parent Company and bears interest at the Company's option at LIBOR or a \"Base Rate\" (as defined). The credit facility contains a number of financial covenants and restricts the subsidiary from paying dividends to the Parent Company. The credit facility bears a commitment fee equal to one- half of one-percent per annum on unutilized amounts. In December 1994, the subsidiary entered into an agreement with the banking syndicate which extended the maturity date until 2001 and reduced the interest rates. In 1993, the Company entered into a $10 millon term loan with a bank which was used to repay a portion of the multicurrency credit facility of\nF - 13\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\nforeign subsidiaries. The term loan is due in September 1995 and bears interest at prime plus varying margins and is secured by the Company's ownership interest in its industrial services company in Germany.\nThe 8.85% senior note is convertible into shares of the Company's common stock at a conversion price of $6.00 per share. In 1993, a wholly-owned subsidiary of the Company entered into a $5 million revolving credit facility expiring in June 1995. The credit facility is collateralized by a portion of the Company's ownership interest in KPP.\nThe 8% and the 8.75% subordinated debentures are convertible into shares of the Company's Common Stock at a conversion price of $23.32 and $17.54 per share, respectively. The Company has satisfied the sinking fund requirements on its 11.5% and 8.75% subordinated debentures through 1995 and 2000, respectively.\nAnnual sinking fund requirements and debt maturities, including capital leases, are $60.1 million, $3.8 million, $3.9 million, $19.2 million and $1.6 million for each of the five years ending December 31, 1999. The 8.75% and 11.5% subordinated debentures and the 8.85% convertible notes are debts of the Parent Company and the 8% subordinated debentures are guaranteed by the Parent Company. See \"Management Plans\" in Note 2.\n8. CAPITAL STOCK\nThe changes in the number of issued and outstanding shares of the Company's preferred and common stock are summarized as follows:\nF -14\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\nThe Company has stock option plans for officers, directors and key employees. The options granted under these plans generally expire ten years from date of grant. The options were granted at prices greater than or equal to the market price at the date of grant. At December 31, 1994, options on 1,496,436 shares at prices ranging from $1.50 to $8.50 were outstanding, of which 1,170,189 were exercisable at prices ranging from $1.50 to $8.50.\nSERIES A PREFERRED STOCK\nThe Company has 567,950 shares of its Cumulative Class A Adjustable Rate Preferred Stock, Series A (\"Series A Preferred\") with a stated value of $10 per share outstanding at December 31, 1994. Dividends accrue quarterly at the applicable U.S. Treasury rate plus 2.00 percentage points (200 basis points) (\"Applicable Rate\"), but will in no event be less than 7.5% per annum or greater than 14% per annum. If dividends are in arrears for two or more quarters, additional dividends accrue on all dividends in arrears at a rate equal to the Applicable Rate plus 25 basis points for each quarter dividends are in arrears (but not more than the lesser of 14% per annum or 300 basis points more than the Applicable Rate). If unpaid accrued dividends exist with respect to eight or more quarters, the holders of the Series A Preferred may elect individually to require the Company to redeem their shares at a price of $12 per share plus dividends in arrears. No such arrearages existed as of December 31, 1994, 1993 and 1992. The Company, at its option, may redeem shares at any time at a price of $12 per share (reduced ratably to $10 over 15 years unless unpaid accrued dividends exist with respect to eight or more quarters) plus accrued and unpaid dividends thereon.\nSERIES B PREFERRED STOCK\nOn March 26, 1988, the Board of Directors of the Company declared a dividend distribution of one stock purchase right (\"Right\") for each outstanding share of Common Stock to stockholders of record on April 19, 1988. Each Right entitles the holder, upon the occurrence of certain events, to purchase from the Company one one-hundredth of a share of Series B Junior Participating Preferred Stock, no par value, at a price of $10, subject to adjustment. The Rights will not separate from the Common Stock or become exercisable until a person or group either acquires beneficial ownership of 20% or more of the Company's Common Stock or commences a tender or exchange offer that would result in ownership of 30% or more, whichever occurs earlier. The Rights, which expire on April 19, 1998, are redeemable in whole, but not in part, at the Company's option at any time for a price of $0.05 per Right. At December 31, 1994, 1993 and 1992 there were no Series B Preferred shares outstanding.\nSERIES C PREFERRED STOCK\nIn April 1991, the Company authorized 1,000 shares of Adjustable Rate Cumulative Class A Preferred Stock, Series C (\"Series C Preferred\") which has a preference value of $1.00 per share and which is only entitled to a dividend if the value of the Company's Common Stock increases. The Series C Preferred, as an entire class, is entitled to an annual dividend commencing January 1, 1992, equal to 1\/2 of 1% (proportionately reduced for authorized but unissued shares in the class) of the increase in the average per share market value of the Company's Common Stock during the year preceding payment of the dividend, over $4.79 (the average per share market value of the Company's Common Stock during 1990) multiplied by the average number of shares of Common Stock outstanding. The Series C Preferred has\nF - 15\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\nmandatory redemption requirements in the event of certain types of corporate reorganizations and may be redeemed at the option of the Company during the first 60 days of each year commencing 1994. The redemption price is the sum of (i) one divided by the average annual yield of all issues of preferred stock listed on the New York Stock Exchange during the calendar year preceding the date of the redemption period times the average dividend for the two most recent years plus (ii) a pro rata portion of the prior year's dividend based upon the number of elapsed days in the year of redemption plus (iii) any accrued and unpaid dividends. The Company may also repurchase the shares of a holder at such redemption price during the first 60 days following the year in which the holder first ceases to be an employee of the Company. A holder of the Series C Preferred may, at his option, require the Company to redeem his shares at 120% of such redemption price if the Company elects, within 10 days after the most recent dividend payment date, not to pay the accrued dividend. Upon liquidation, holders of the Series C Preferred are entitled to receive $1.00 per share plus accrued and unpaid dividends. The Company granted 600 shares of Series C Preferred to certain officers in April 1991.\nSERIES D PREFERRED STOCK\nIn conjunction with the acquisition of Furmanite, the Company issued 1,098,373 shares of its 12% Convertible Class A Preferred Stock, Series D (\"Series D Preferred\") with a stated value of 5.34 Pound Sterling ($8.36) per share. The Series D Preferred is not redeemable by the holder; however, each share is convertible at the option of the holder into 1.691 shares of the Company's Common Stock. During 1994, 1993 and 1992 10,880 shares, 26,268 shares and 8,789 shares were converted into 18,398 shares, 44,413 shares and 14,862 shares respectively, of the Company's Common Stock. The Company may redeem the Series D Preferred at its option at a price of 5.34 Pound Sterling ($8.36).\n9. COMMITMENTS AND CONTINGENCIES\nThe Company leases vehicles, office space, data processing equipment, office equipment and other items of personal property under leases expiring at various dates. Management expects that, in the normal course of business, leases that expire will be renewed or replaced by other leases. Total rent expense under operating leases was $3.5 million, $3.5 million and $3.4 million for the years 1994, 1993 and 1992, respectively.\nF - 16\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS -------------------------------------------------------------------------------- At December 31, 1994, minimum rental commitments under all capital leases and operating leases for future years are as follows:\nIn October 1994, the Company settled two lawsuits filed in the 1980's by Kanland Associates and Panance Property Corporation that related to the Company's former office building in Sugar Land, Texas. One of these suits had alleged damages at more than $38 million plus prejudgment interest, legal fees, court costs and punitive damages. The settlement of these lawsuits was adequately reserved.\nIn September 1987, Stephen R. Herbel and other named individuals doing business as Pinnacle Petroleum Company (\"Pinnacle\") filed a lawsuit in Mobile County, Alabama, against the Company and certain of its affiliates, Jim Walter Resources, Inc. and others, seeking damages of $9 million. Pinnacle asserted that its rights under a conventional oil and gas lease were violated by the execution of a subsequent coal mining lease covering the same property. In addition to monetary damages, Pinnacle also seeks a judgment from the Trial Court that it is the owner of all the gas under the property described in the conventional oil and gas lease, regardless of its origin, and that a unitization order be declared invalid. On July 28, 1989, the Trial Court ruled in favor of all defendants by granting summary judgment holding that Kaneb and the other defendants, as owners of the coal, also own and have the exclusive right to produce the coalbed gas, to the exclusion of the conventional oil and gas lessees. There remained factual disputes as to the characterization of all the gas produced from the property which were to be addressed in future hearings. On October 8, 1993, in a case involving Jim Walter Resources, but not the Company, based on similar facts, the Supreme Court of Alabama held that under certain circumstances coalbed methane is the property of the owner of the conventional oil and gas estate. In response thereto, the Trial Court scheduled a further evidentionary hearing to determine the impact of the Supreme Court on the Pinnacle case. In March 1995, all parties in this lawsuit reached an agreement to settle and release their claims against each other. Attorneys for the parties are presently preparing the legal documents related to the settlement, the Company's portion of which was adequately reserved.\nKPP makes quarterly distributions of 100% of its Available Cash (as defined in the Partnership Agreement) to holders of limited partnership units and KPL. Available Cash consists generally of all the cash receipts of the Partnership less all of its cash disbursements and reserves. KPP\nF - 17\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\nbelieves it will make distributions of Available Cash for each quarter of not less than $.55 per Senior Preference Unit (\"Minimum Quarterly Distribution\"), or $2.20 per Senior Preference Unit on an annualized basis for the foreseeable future. The Minimum Quarterly Distribution on the Senior Preference Units is cumulative and preferential to the partnership units held by the Company. Based on the 1994 results of KPP, approximately 42% of KPP's cash provided by operations was distributed to the Senior Preference Unitholders. The assets, other than Available Cash, cannot be distributed without a majority vote of the non-affiliated unitholders.\nThe operations of KPP are subject to federal, state and local laws and regulations relating to protection of the environment. Although KPP believes that its operations are in general compliance with applicable environmental regulation, risks of additional costs and liabilities are inherent in its operations, and there can be no assurance that significant costs and liabilities will not be incurred by KPP. Moreover, it is possible that other developments, such as increasingly stringent environmental laws, regulations, enforcement policies thereunder, and claims for damages to property or persons resulting from the operations of KPP, could result in substantial costs and liabilities to KPP.\nThe Company has other contingent liabilities (some of which allege substantial amounts of damages) resulting from litigation, claims and commitments incident to the ordinary course of business. Management believes, based on the advice of counsel, that the ultimate resolution of such contingencies will not have a materially adverse effect on the financial position or results of operations of the Company.\nF - 18\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\n10. BUSINESS SEGMENT DATA\nSelected financial data pertaining to the operations of the Company's business segments is as follows:\nF - 19\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\nSelected financial data pertaining to the operations in geographical areas is as follows:\n11. DISCONTINUED OPERATIONS\nSince 1981, the Company has discontinued numerous business segments to reduce debt, increase cash and concentrate its activities towards ongoing operations. The operations of the offshore and onshore drilling, exploration and production, coal, general contracting, underground storage tank (UST) testing operations and engineering services segments are classified as discontinued operations in the Company's consolidated financial statements and\nF - 20\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\nrelated footnotes. The remaining net liabilities of the discontinued operations have been reclassified in the balance sheet from their traditional classifications to \"Net liabilities of discontinued operations.\"\nDuring 1992, a claim from the discontinued general contracting operation was settled resulting in a $1.0 million gain. The Company also liquidated the remaining assets of the exploration and production operation resulting in a $.9 million gain which was included in other income. In 1992, as a result of the Company's review of the remaining reserves for discontinued operations, the Company determined there were excess reserves relating to the settlement of self-insured workers compensation and general liability claims of the discontinued drilling operations and accordingly, reduced these reserves by approximately $3.5 million. The Company reduced the carrying value of certain assets relating to electronic payment services for retail merchants which are no longer being actively marketed by $3.5 million.\nIn January 1993, the Company completed the acquisition of Kraftwerks-und Anlagenbau AG (\"Kraftwerks\") from the Berlin Trusteeship Agency (\"Treuhandanstalt\"), the German agency created to privatize former East German state-owned companies. A subsidiary of the Company purchased Kraftwerks share capital for DM 1 million ($700,000) and committed to maintain certain employment and investment levels over a three year period, performance of which obligations was to be secured by shares of a new class of the Company's convertible preferred stock to be placed into escrow. Kraftwerks was engaged in providing engineering and construction services primarily to the power industry in Germany and eastern Europe. Due to substantial deterioration in the German economy, however, the Company believed that Kraftwerks would have been unlikely to achieve profitability without a corresponding reduction in its work force. Accordingly, in February 1994, the Company entered into an agreement granting it an option to sell the shares of Kraftwerks to the Treuhandanstalt or its designee. The Company exercised its option, and on March 17, 1994, the Treuhandanstalt repaid the Company's initial acquisition price of DM 1 million, unconditionally discharged the Company from all past and future performance obligations related to Kraftwerks, released the Company's convertible preferred shares from escrow and the capital stock of Kraftwerks was transferred to a designee of the Treuhandanstalt. Kraftwerks reported revenues of $70.7 million in 1993 and its operating losses of $28.6 million were offset by the amortization of the excess of net assets over the purchase price of Kraftwerks, accordingly there was no impact on the Company's income statement in 1993. The Company wrote off $.3 million of related acquisition costs, which is included in other expense on the income statement in 1993.\nF - 21\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\n12. QUARTERLY FINANCIAL DATA (UNAUDITED)\nQuarterly operating results for 1994 and 1993 are summarized as follows:\n13. SUPPLEMENTAL CASH FLOW INFORMATION\nThe Company issued 18,398, 44,413 and 14,862 shares of its common stock upon conversion of 10,880, 26,268 and 8,789 shares of its Series D Preferred Stock in 1994, 1993 and 1992, respectively. The Company contributed 349,942, 197,433 and 62,247 shares of its common stock to its 401(k) Savings Plan in 1994, 1993 and 1992, respectively. The Company contributed 410,000 and 220,000 shares of its common stock to its subsidiary's defined benefit pension plan in 1994 and 1993, respectively.\nSupplemental information on cash paid during the period for:\nF - 22\nKANEB SERVICES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS --------------------------------------------------------------------------------\n14. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair value of cash, cash equivalents, short-term investments and accounts receivable approximate their carrying amount due to the relatively short period to maturity of these instruments. The estimated fair value of all long-term debt (excluding capital leases) as of December 31, 1994 and 1993 was approximately $143 million and $145 million, respectively, as compared to the carrying value of $149 million and $150 million, respectively. These fair values were estimated using discounted cash flow analysis, based on the Company's current incremental borrowing rates for similar types of borrowing arrangements, when quoted market prices were not available. The Company has not determined the fair value of its capital leases as it is not practicable. The estimates presented above are not necessarily indicative of the amounts that would be realized in a current market exchange.\nThe Company does not believe that it has a significant concentration of credit risk at December 31, 1994, as approximately 71% of the Company's accounts receivable are from its industrial services segment located throughout the United States, the United Kingdom and Continental Europe.\nF - 23\nKANEB SERVICES, INC. (PARENT COMPANY) SCHEDULE I\nCONDENSED STATMENTS OF INCOME ------------------------------------------------------------------------------\nSee \"Notes to Consolidated Financial Statements\" of Kaneb Services, Inc. and Subsidiaries included in this report.\nF - 24\nKANEB SERVICES, INC. (PARENT COMPANY) SCHEDULE I\nCONDENSED BALANCE SHEETS --------------------------------------------------------------------------------\nSee \"Notes to Consolidated Financial Statements\" of Kaneb Services, Inc. and Subsidiaries included in this report.\nF - 25\nKANEB SERVICES, INC. (PARENT COMPANY) SCHEDULE I (CONTINUED) CONDENSED STATMENTS OF CASH FLOWS --------------------------------------------------------------------------------\nSee \"Notes to Consolidated Financial Statements\" of Kaneb Services, Inc. and Subsidiaries included in this report.\nF - 26\nKANEB SERVICES, INC. SCHEDULE II\nVALUATIONS AND QUALIFYING ACCOUNTS (IN THOUSANDS) --------------------------------------------------------------------------------\nNotes: (A) Currency translation adjustment. (B) Receivable write-offs and reclassifications, net of recoveries.\nF - 27\nINDEX TO EXHIBITS -----------------\n3.1 Restated Certificate of Incorporation of the Registrant as restated September 26, 1979, filed as Exhibit 3.1 of the exhibits to the Registrant's registration statement on Form S-16, which exhibit is hereby incorporated by reference.\n3.2 Certificate of Amendment of Certificate of Incorporation of the Registrant, dated April 30, 1981, filed as Exhibit 3.2 of the exhibits to the Registrant's Form 10-K for the year ended December 31, 1981 (1981 Form 10-K), which exhibit is hereby incorporated by reference.\n3.3 Certificate of Amendment of Certificate of Incorporation of the Registrant, dated May 28, 1985, filed as Exhibit 4.1 of the exhibits to the Registrant's quarterly report on Form 10-Q for the quarter ended June 30, 1985, which exhibit is hereby incorporated by reference.\n3.4 Certificate, dated September 17, 1985, amending the Certificate of Incorporation,filed as Exhibit 4.1 of the exhibits to the Registrant's quarterly report on Form 10-Q for the quarter ended September 30, 1985, which exhibit is hereby incorporated by reference.\n3.5 Certificate of Amendment to the Restated Certificate of Incorporation of Registrant dated July 10, 1990, filed as Exhibit 3.5 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1990 (1990 Form 10-K), which exhibit is hereby incorporated by reference.\n3.6 Certificate of Amendment to the Restated Certificate of Incorporation of Registrant dated September 21, 1990, filed as Exhibit 3.5 of the exhibits to Registrant's quarterly report on Form 10-Q for the quarter ended September 30, 1990, which exhibit is hereby incorporated by reference.\n3.7 By-laws of the Registrant, filed as Exhibit 3.5 of the exhibits to the Registrant's report on Form 10-K for year ended December 31, 1985, which exhibit is hereby incorporated by reference.\n4.1 Certificate of Designation related to Registrant's Adjustable Rate Cumulative Class A Preferred Stock, filed as Exhibit 4 of the exhibits to the Registrant's quarterly report of Form 10-Q for the quarter ended September 30, 1983, which exhibit is hereby incorporated by reference.\n4.2 Certificate of Designation, Preferences and Rights of Series B Junior Participating Preferred Stock, filed as Exhibit 1 of the exhibits to the Registrant's report on Form 8-K and registration statement on Form 8-A dated April 5, 1988, which exhibit is hereby incorporated by reference.\n4.3 Certificate of Designation to the Restated Certificate of Incorporation of Registrant relating to the issuance of Series D Preferred Stock dated February 11, 1991, filed as Exhibit 4.3 of Registrant's 1990 Form 10-K, which exhibit is hereby incorporated by reference.\n4.4 Certificate of Designation to the Restated Certificate of Incorporation of Registrant relating to the issuance of Series C Preferred Stock dated April 23, 1991, filed as Exhibit 4.4 of the exhibits to Registrant's report on From 10-K for the year ended December 31, 1991, which exhibit is hereby Incorporated herein.\n4.5 Certificate of Designation dated November 2, 1992 relating to the issuance of Series E Preferred Stock, filed as Exhibit 10.2 of the exhibits to Registrant's report on Form 8-K dated January 23, 1993, which exhibit is hereby incorporated by reference.\n4.6 Indenture, dated as of January 1, 1978, between Moran Energy Inc. and First City National Bank of Houston, under which Moran Energy Inc. issued the 11 1\/2% Subordinated Debentures due 1998, filed as Exhibit 2(g) to Moran Energy Inc.'s Registration Statement on Form S-7 (SEC File No. 2- 61216), which exhibit is hereby incorporated by reference.\n4.7 First Supplemental Indenture, dated as of March 20, 1984, between the Registrant and First City National Bank of Houston, under which the Registrant assumed obligations under the Indenture listed as Exhibit 4.6 above, filed as Exhibit 4.4 to the exhibits of Registrant's report on Form 10-K for the year ended December 31, 1983 (1983 Form 10-K) which exhibit is hereby incorporated by reference.\n4.8 Indenture, dated as of November 1, 1980, between Moran Energy International N.V., Moran Energy Inc. and First City National Bank of Houston, under which Moran Energy International N.V. issued the 8% Convertible Subordinated Debentures due 1995 of Moran Energy International N.V. guaranteed on a subordinated basis by Moran Energy Inc., filed as Exhibit 4(b) to Moran Energy Inc.'s Form 10-K for the year ended December 1, 1980, which exhibit is hereby incorporated by reference.\n4.9 First Supplemental Indenture, dated as of March 20, 1984, by and among Moran Energy International N.V., the Registrant and First City National Bank of Houston, under which the Registrant assumed Moran Energy Inc.'s obligations under the Indenture listed as Exhibit 4.8 above, filed as Exhibit 4.7 of the 1983 Form 10-K Exhibit 4.7 which exhibit is hereby incorporated by reference.\n4.10 Indenture, dated as of January 15, 1984, between Moran Energy Inc. and First City National Bank of Houston, under which Moran Energy Inc. issued the 8 3\/4% Convertible Subordinated Debentures due 2008, filed as Exhibit 4.1 to Moran Energy Inc.'s registration statement on Form S-3 (SEC File No. 2-81227), which exhibit is hereby incorporated by reference.\n4.11 First Supplemental Indenture, dated as of March 20, 1984, between the Registrant and First City National Bank of Houston, under which the Registrant assumed obligations under the Indenture listed as Exhibit 4.10 above, filed as Exhibit 4.8 of the 1983 Form 10-K Exhibit 4.8 which exhibit is hereby incorporated by reference.\n10.1 Kaneb Services, Inc. 1984 Nonqualified Stock Option Plan, filed as Exhibit 10.26 of the exhibits to Registrant's report on form 10-K for the year ended December 31, 1984, which exhibit is hereby incorporated by reference.\n10.2 Form of Termination Agreement, dated May 22, 1981, entered by the Registrant with certain key employees of the Registrant, filed as Exhibit 10.19 of the 1981 Form 10-K Exhibit 10.19 which exhibit is hereby incorporated by reference.\n10.3 Kaneb Services, Inc. Savings Investment Plan filed as Exhibit 4.10 to the exhibits of Registrant's Form S-8 Registration Statement (S.E.C. File No. 33-41295), which exhibit is hereby incorporated by reference.\n10.4 Form of Indemnification Assurance Agreement entered into by the Registrant with the directors, filed as Exhibit 10.33 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1986, which exhibit is hereby incorporated by reference.\n10.5 Purchase Contract dated November 20, 1992 for the sale of the share capital of KAB between the Treuhandanstalt and Furmanite Holding GmbH together with Kaneb Services, Inc. as a limited guarantor, filed as Exhibit 10.2 to the exhibits of Registrant's report on Form 8-K dated January 29, 1993 which exhibit is incorporated herein by reference.\n10.6 Sale Contract dated February 27, 1994 for the disposition of the share capital of KAB between KAB Holding GmbH (formerly Furmanite Holding GmbH), the Treuhandanstalt and the Registrant, filed as Exhibit 10.6 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1993, which exhibit is hereby incorporated by reference.\n10.7 STS Agreement and Plan of Merger dated December 21, 1992 by and between Grace Energy Corporation, Support Terminal Services, Inc., Standard Transpipe Corp., and Kaneb Pipe Line Operating Partnership, NSTS, Inc. and NSTI, Inc. as amended by Amendment of STS Merger Agreement dated March 2, 1993, filed as Exhibit 10.1 to the exhibits of Registrant's report on Form 8-K dated March 2, 1993, which exhibit is incorporated herein by reference.\n10.8 Amended and Restated Loan Agreement dated May 1, 1991 between Furmanite PLC, Bank of Scotland and certain Banks, filed herewith.\n10.9 Amended and Restated Senior Secured Increasing Rate Promissory Note dated July 2, 1993 between the Registrant and the Bank of Scotland, filed herewith.\n10.10 Pledge and Proxy Agreement dated October 11, 1993, between the Registrant and Texas Commerce Bank, National Association, filed as Exhibit 10.9 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1993, which exhibit is hereby incorporated by reference.\n10.11 Pledge and Security Agreement dated October 11, 1993 between Kaneb Pipe Line Company and Texas Commerce Bank, National Association, filed as Exhibit 10.10 of the exhibits to Registrant's report on Form 10-K for the year ended December 31, 1993, which exhibit is hereby incorporated by reference.\n10.12 Note Purchase Agreement dated December 22, 1994. Said document is on file as Exhibit 10.2 of the exhibits to Registrant's report on Form 8-K filed on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.13 Restated Credit Agreement dated December 22, 1994 between Kaneb Pipe Line Operating Partnership, L.P., Texas Commerce Bank National Association, and certain Lendors, filed herewith.\n10.14 Agreement for Sale and Purchase of Assets dated February 19, 1995 by and among Wyco Pipe Line Company and Kaneb Pipe Line Operating Partnership, L.P.. Said document is on file as Exhibit 10.1 of the exhibits to Registrant's report on Form 8-K filed with the securities and Exchange Commission on March 13, 1995, and said exhibit is hereby incorporated by reference.\n10.15 Kaneb Services, Inc. 1994 Stock Incentive Plan filed as Exhibit 4.12 to the exhibits of Registrant's Form S-8 Registration Statement (S.E.C. File No. 33-54027), which exhibit is hereby incorporated by reference.\n21 List of subsidiaries of the Registrant, filed herewith.\n23 Consent of independent auditors: Price Waterhouse, filed herewith.\n24 Powers of Attorney, filed herewith.\n27 Financial Data Schedule, filed herewith.","section_15":""}
{"filename":"773136_1994.txt","cik":"773136","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nRamsay Health Care, Inc. (\"RHCI\" or the \"Company\") is one of the leading providers of behavioral health services in the country. RHCI has two business units: a facilities division offering patient care through integrated networks of mental health delivery systems in eleven states principally in the southeast and southwest built around 15 inpatient hospitals with 1,264 beds, day hospitals, subacute units, outpatient centers, and residential treatment centers; and a managed care division providing utilization control and cost management services. The Company also operates mental health programs for public sector and private owners under management contracts.\nFACILITIES DIVISION\nThe following table provides information concerning the 15 inpatient facilities owned and\/or operated by the Company at June 30, 1994.\n(1) A leased hospital facility. See \"Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nInformation relating to the Company's owned and leased hospital facilities, their locations and licensed bed capacity is contained under the caption \"Item 1. Business -- Facilities Division.\" Such information is incorporated herein by reference.\nThe building in which the Company's facility at Houma, Louisiana is located is leased for an initial period ending January 31, 2005 (with an option to renew for 20 years). The Company has entered into a 50-year ground lease for the property on which its 70-bed facility at Morgantown, West Virginia is located. For the Bethany, Oklahoma facility, the Company has one year remaining on a three-year lease with options to renew totaling an additional 9 years.\nThe Company leases its corporate headquarters in New Orleans, Louisiana for a term of five years ending in April 1999, and leases other space for various clinics and regional offices.\nSee Item 1. Business--Acquisitions and Sales.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of such pending legal proceedings will not 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.\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 traded in the over-the-counter market and is quoted on the NASDAQ National Market System under the symbol RHCI. On September 22, 1994 there were 667 holders of record of the Company's Common Stock. No dividends have been declared on the Common Stock since the Company was organized. Under the terms of its current credit agreement, the Company is limited as to the amount of dividends it can pay on its Common Stock unless certain conditions are met. The following table sets forth the range of high and low closing sales prices per share of the Common Stock for each of the quarters during the years ended June 30, 1994 and 1993, as reported on the NASDAQ National Market System:\nOn September 22, 1994, the closing sales price of the Company's Common Stock was $ 7 3\/8 per share.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table sets forth selected consolidated financial information for the periods shown and is qualified by reference to, and should be read in conjunction with, the Consolidated Financial Statements and Notes thereto and \"Item 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nOperating revenues of the facilities are affected by changes in the rates the Company charges or by changes in the number of patient days in the period. Additionally, increases in one factor can offset decreases in the other. Patient days are primarily a function of the number of admissions multiplied by the average length of stay by all patients. Accordingly, increases in admissions can offset, in whole or in part, decreases in average length of stay.\nGenerally, charges for each facility's services are reimbursed under third-party reimbursement programs at the amount billed or at a rate which can be less than the facility's charges. This lower rate can be based on a negotiated per diem amount or based on the facility's costs as audited or projected by the third-party payors. When operating revenues (charges) per patient day are higher than the negotiated per diem rate or the facility's costs, the difference is added to contractual adjustments. Bad debts consist primarily of the uncollectible commercial and self-pay accounts receivable.\nThe Company records amounts due to or from third-party reimbursement sources based on its best estimates of amounts to be ultimately received or paid under cost reports filed with appropriate intermediaries, such as Blue Cross. The final determination of amounts earned under reimbursement programs is subject to review and audit by these intermediaries. Differences between amounts recorded as estimated settlements and the audited amounts are reflected as adjustments to the Company's net revenues in the period the final determination is made. During the years ended June 30, 1992, 1993, and 1994 the Company recorded contractual adjustment benefits of approximately $2,400,000, $2,300,000, and $1,400,000 respectively. The adjustments were made to reflect the combined effects of intermediary audits and the routine evaluation of prior year estimated settlements. There can be no assurances that any future adjustments will be of a favorable nature or of a magnitude comparable to those made in fiscal 1992, 1993, or 1994.\nUnder certain state Medicaid programs, the Company received significant payments pursuant to enhanced reimbursement rates under disproportionate share programs in fiscal 1994, 1993 and 1992. Statutory changes will decrease the level of disproportionate share payments in the future. The Company is investigating certain cost saving and other measures to attempt partially to offset the effects of this decrease. In addition, many state Medicaid programs are seeking to control costs through relationships with managed care organizations. As a result, there can be no assurance as to the amounts or forms of disproportionate share payments or other Medicaid payments in future periods.\nIn recent years, approximately 7% to 17% of the Company's patient revenues have come from CHAMPUS since some of the Company's hospitals are in close proximity to major military installations in the United States. Congress has imposed a reduction in the annual reimbursable length of stay for patients covered by the mental health benefits of CHAMPUS, a federal government health benefit program for the members (active and retired) of all seven uniformed services and their families. Effective October 1, 1991, CHAMPUS began to limit its coverage for hospital psychiatric services to 30 days for adult patients, 45 days for child and adolescent patients and 150 days for RTC services, subject to waivers which will be available under limited circumstances if an extension of the length of stay can be justified. The lengths of stay currently experienced by the Company for adult, child and adolescent hospital programs for CHAMPUS beneficiaries have usually been within the new limits applicable to hospital stays. See \"Item 1. Business -- Sources of Revenue.\"\nThe following table sets forth, for the periods indicated, certain items of the Company's Consolidated Statements of Operations as a percentage of the Company's net revenues.\n1994 COMPARED TO 1993\nNet revenues for fiscal 1994 were $137.0 million compared to $136.4 million in fiscal 1993. Net outpatient revenues increased to $18.2 million for fiscal 1994, an increase of 43% over fiscal 1993, offsetting a decline in inpatient revenues of 9.6% from the prior year. Also, revenues from the managed care division (which began in October 1993) offset the revenues lost from the facilities that were sold during fiscal 1994. See \"Item 1. Business--Acquisitions and Sales.\" Net outpatient revenues comprised 14.2% of total net patient revenues for fiscal 1994 compared to 9.5% for the prior year. Same store admissions increased 5% over the prior year while inpatient average length of stay declined from 18.3 days in fiscal 1993 to 17.6 days for fiscal 1994. Contractual adjustment benefits of approximately $1.4 and $2.3 million were recognized in fiscal 1994 and 1993, respectively, to reflect the combined effects of intermediary audits and the routine evaluation of prior year estimated settlements. There can be no assurances that any future adjustments will be favorable or of a comparable magnitude.\nSalaries, wages and benefits and other operating expenses were 78.6% of net revenues for fiscal 1994 compared to 76.5% for the prior year. Additional costs associated with the managed care operations and the start-up phase of subacute ventures exceeded the cost savings derived from the containment measures at the Company's inpatient facilities.\nThe provision for doubtful accounts was 4.3% of net revenues for fiscal 1994 compared to 6.0% in fiscal 1993. The decrease reflects the shift in payor base toward more Medicaid, fixed rate, negotiated rate and cost-based contracts, as well as the increase in managed care revenues which are less susceptible to uncollectibility.\nDepreciation and amortization was 5.0% of net revenues for fiscal 1994 as compared to 4.8% in fiscal 1993. The increase relates primarily to depreciation and amortization of the preopening costs of the facility opened in January 1993, the amortization of cost in excess of net asset value and other intangibles associated with the acquisition of Florida Psychiatric Management, Inc., offset in part by the effect of the sales of the two facilities in fiscal 1994. See \"Item 1. Business--Acquisitions and Sales.\"\nInterest and other financing charges decreased from 7.0% of net revenues for fiscal 1993 to 6.5% of net revenues for fiscal 1994. The decrease is attributable to reduced levels of debt during fiscal 1994.\nThe Company recorded net charges totaling $802,000 in 1994 relating to the sale of certain inpatient facilities and closure of certain outpatient operations. The Company recorded a loss of $1,109,000 during 1993 from the closure of its leased facility, Oak Grove Hospital, in Concord, California. The loss includes provisions for severance expense and other expenses incurred with the termination of this lease. In addition, the Company recorded a provision for loss at June 30, 1993 for the potential sales of Cumberland Hospital in Fayetteville, NC and Harbor Oaks Hospital in Fort Walton Beach, FL of $6,415,000. The estimated losses were based on a letter of intent relating to the sale of the Cumberland facility and the existence of a lease with an option to purchase for the Harbor Oaks facility. The Cumberland facility was subsequently sold in August 1993. See \"Item 1. Business--Acquisitions and Sales.\"\nThe Company recorded a non-recurring charge of $1,367,000 in 1993 resulting primarily from a decision not to proceed with the development of additional inpatient psychiatric facilities in certain markets.\nMinority interests reflects the limited partners of Three Rivers Hospital's share of income before income taxes at that facility. See \"Item 1. Business--Ownership Arrangements and Operating Agreements.\"\nThe Company recognized an after-tax loss of $155,000 in 1994 from early extinguishment of the industrial revenue bonds in connection with the sale of Atlantic Shores Hospital. The Company recognized a loss of $1,580,000 on early extinguishment of a 16.1% subordinated note in fiscal 1993. These losses are reflected as extraordinary items in the consolidated statements of operations. See \"Liquidity and Capital Resources\" below.\nThe Company had net income of $1,322,000 in fiscal 1994 compared to a net loss of $1,560,000 in fiscal 1993. Excluding the non- recurring charges noted above, the Company's operations continued to be adversely affected by reductions in third party reimbursement levels.\n1993 COMPARED TO 1992\nNet revenues for fiscal 1993 were $136.4 million compared to $136.9 million in fiscal 1992. Same store patient days remained constant during the two years as increases in admissions of 10% were offset by reduced lengths of stay from 19.8 days to 18.3 days. Expanded outpatient and day treatment programs offset the declining reimbursement levels for inpatient care, allowing the Company to maintain approximately the same level of net revenues in 1993 and 1992. Contractual adjustment benefits from prior years totaling $2.3 million and $2.4 million are reflected in net revenues for 1993 and 1992, respectively, to reflect the combined effects of intermediary audits and the routine evaluation of prior year estimated settlements. There can be no assurances that any future adjustments will be favorable or of a comparable magnitude.\nSalaries, wages and benefits and other operating expenses were 76.5% of net revenues for 1993, as compared to 73.6% in 1992. A principal reason for the increase relates to the incremental costs associated with the development of outpatient revenue sources.\nThe provision for doubtful accounts was 6.0% of net revenues for 1993, as compared to 6.3% for 1992. Although higher insurance deductibles and coinsurance levels resulted in increased amounts due from patients, increased emphasis on receivables allowed the Company to control this expense component.\nDepreciation and amortization was 4.8% of net revenues for 1993, as compared to 4.0% for 1992. The increase relates to depreciation of the Company's new management information system and amortization of preopening costs relating to the new facilities opened in the second quarter of fiscal 1992 and the third quarter of fiscal 1993. See \"Item 1. Business--Acquisitions and Sales.\"\nInterest and other financing charges were 7.0% of net revenues for 1993 as compared to 7.6% in 1992. The decrease is attributable to reduced levels of debt during fiscal 1993.\nThe Company recorded a loss of $1,109,000 during 1993 from the closure of its leased facility, Oak Grove Hospital, in Concord, California. The loss includes provisions for severance expense and other expenses incurred with the termination of this lease. In addition, the Company recorded a provision for loss at June 30, 1993 for the\npotential sales of Cumberland Hospital in Fayetteville, NC and Harbor Oaks Hospital in Fort Walton Beach, FL of $6,415,000. The estimated losses were based on a letter of intent relating to the sale of the Cumberland facility and the existence of a lease with an option to purchase for the Harbor Oaks facility. The Cumberland facility was subsequently sold in August 1993. See \"Item 1. Business--Acquisitions and Sales.\"\nThe Company recorded a non-recurring charge of $1,367,000 in 1993 resulting primarily from a decision not to proceed with the development of additional inpatient psychiatric facilities in certain markets. The Company recorded a non-recurring restructuring charge of $2,283,000 during 1992 resulting from the Company's reassessment of its strategic direction to meet the changing demands of both payors and the public. The 1992 charge included provisions for severance packages and for the potentially unrecoverable portion of an investment in a hospital joint venture. See \"Item 1. Business--Ownership Arrangements and Operating Agreements.\"\nMinority interests reflect the limited partners of Three Rivers Hospital's share of income before income taxes at that facility for the 1993 fiscal year.\nThe Company recognized a loss of $1,580,000 on the early extinguishment of a 16.1% subordinated note in fiscal 1993, which is reflected as an extraordinary item in the consolidated statements of operations. In fiscal 1992, the Company wrote off deferred loan costs of $678,000 ($366,000 after applicable income tax benefit) which is reflected as an extraordinary item in the consolidated statements of operations. The write-off resulted from the early retirement of the Company's $34 million bank term debt. See \"Liquidity and Capital Resources\" below. The Company realized income tax benefits of $953,000 in fiscal 1992 relating to the utilization of net operating loss carryovers of prior years, which is also reflected as an extraordinary item in the consolidated statements of operations.\nEffective July 1, 1992, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109, \"Accounting for Income Taxes\". The cumulative effect of adopting Statement No. 109 as of July 1, 1992 was to increase net income for the fiscal year ended June 30, 1993 by $2,353,000.\nThe Company had a net loss of $1,560,000 in fiscal 1993 compared to net income of $5,934,000 in fiscal 1992. In addition to the charges noted above, the decrease resulted from disproportionate increases in salaries and certain operating costs.\nIMPACT OF INFLATION\nThe psychiatric hospital industry is labor intensive, and wages and related expenses increase in inflationary periods. Additionally, suppliers generally seek to pass along rising costs to the Company in the form of higher prices. The Company monitors the operations of its facilities to mitigate the effect of inflation and the increase in costs of health care. To the extent possible, the Company seeks to offset increased costs through increased rates, new programs, and operating efficiencies. However, changes in reimbursement patterns may hinder the Company's ability to realize the full effect of rate increases. To date, inflation has not had a significant impact on operations.\nLIQUIDITY AND CAPITAL RESOURCES\nOn February 10, 1994, the Company sold its Atlantic Shores Hospital for $4.8 million. The $4.3 million outstanding balance of the industrial revenue bonds associated with that facility was repaid with the proceeds from such sale.\nOn August 31, 1993, the Company sold its Cumberland Hospital for $12.3 million. Of the total proceeds, $10.9 million was restricted for the repayment of debt as such amounts become due. At June 30, 1994, $5.3 million was still available and is included in restricted cash on the consolidated balance sheet.\nOn June 30, 1993, the interests in the Company controlled by Paul J. Ramsay, the Company's Chairman, were recapitalized. The Company issued 142,486 shares of Class B Preferred Stock, Series C (the \"Series C Preferred Stock\") in exchange for all outstanding shares of the Company's Class B Preferred Stock, Series 1987, the Company's $2 million 16.1% Subordinated Promissory Note and $500,000 in cash. The Series C Preferred Stock has ten votes per share and is convertible at the option of the holder into ten shares of the Company's common stock. It pays a 5% per annum dividend and has a $50.84 liquidation preference.\nOn May 21, 1993, the Company finalized a credit facility for letters of credit (to support the Company's outstanding variable rate industrial revenue bonds) and working capital (the \"1993 Credit Facility\"). The 1993 Credit Facility includes $27.5 million in letters of credit and a $4 million working capital facility, which replace similar components of the 1990 Credit Facilities described below. The 1993 Credit Facility expires on May 15, 1996. There were no amounts outstanding under the working capital facility at June 30, 1994 or 1993.\nOn July 30, 1991, the Company completed a public offering (the \"Public Offering\") of 2,700,000 shares of Common Stock from which it received net proceeds (after payment of expenses) of $31,038,000 (including proceeds received by the Company from the exercise of certain warrants by certain of the selling stockholders in such offering). The net proceeds from this offering, together with approximately $1,250,000 of the Company's internally generated funds, were used to repay in full the remaining unpaid principal of the Bank Term Debt referred to below.\nOn April 30, 1990, the Company completed the refinancing of its then existing senior debt and a portion of its subordinated debt and entered into new credit agreements (the \"1990 Credit Facilities\") with a group of insurance companies and with a group of banks. The 1990 Credit Facilities included $56,500,000 in senior secured notes, $34,000,000 in bank term debt (the \"Bank Term Debt\"), approximately $31,000,000 in letters of credit (the \"Bank Letters of Credit\"), $3,000,000 in subordinated secured notes and $5,000,000 in a working capital facility (the \"Bank Working Capital Facility\"). The senior secured notes bear interest at 11.6% and are due in semi-annual installments beginning March 31, 1993 and ending on March 31, 2000. The Bank Term Debt bore interest at a variable rate, which at June 30, 1991 was 9.75%, and was due in quarterly installments beginning March 31, 1991 with the balance due on April 30, 1998. The Bank Term Debt was repaid with the Company's net proceeds from the Public Offering and the Company's internally generated funds. The subordinated secured notes bear interest at 15.6% and are due in semi-annual installments beginning March 31, 1994 and ending on March 31, 2000.\nThe Company's current primary cash requirements relate to its normal operating and debt service expenses, routine capital improvements at its facilities and the expansion of its outpatient programs. In addition, at the current time, the Company's specific development projects include ongoing expansion of its subacute ventures, its management contract operations and its network of affiliations with medical\/surgical hospitals and other healthcare providers. At the current time, the Company does not have any commitments to make any material capital expenditures. In connection with any future acquisitions, the Company may determine to make capital improvements at the acquired facilities, although it is the Company's intention to acquire facilities requiring low capital investment. On the basis of its historical experience and projected cash needs, the Company believes that its internally generated funds from operations, together with its $4,000,000 working capital facility and funds derived from any future asset sales will be sufficient to fund its current cash requirements and future identifiable needs. At the present time, the Company does not have any agreement to sell any of its assets.\nThe Company is also considering various options regarding the expansion of its managed care operations. Additional sources of capital would be required to undertake this expansion. There can be no assurances that the Company will expand its managed care operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nFinancial statements of the Company and its consolidated subsidiaries are set forth herein beginning on page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS 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 with respect to the Company's executive officers is contained in Part I under \"Item 1. Business -- Executive Officers of the Registrant.\" The information required by this Item with respect to directors will be contained in the Company's definitive Proxy Statement (\"Proxy Statement\") for its 1994 Annual Meeting of Stockholders to be held on November 28, 1994 and is incorporated herein by reference. Such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days subsequent to June 30, 1994.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required with respect to this Item will be contained in the Proxy Statement, and such information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required with respect to this Item will be contained in the Proxy Statement, and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required with respect to this Item will be contained in the Proxy Statement, and such 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 THE REPORT:\n1. FINANCIAL STATEMENTS\nInformation with respect to this Item is contained on Pages to of this Annual Report on Form 10-K.\n2. FINANCIAL STATEMENT SCHEDULES\nInformation with respect to this Item is contained on Pages S-1 to S-5 of this Annual Report on Form 10-K.\n3. EXHIBITS\nInformation with respect to this Item is contained in the attached Index to Exhibits.\n(B) REPORTS ON FORM 8-K:\nThere were no reports on Form 8-K filed by the Company for the quarter ended June 30, 1994.\n(C) EXHIBITS REQUIRED BY ITEM 601 OF REGULATION S-K:\nExhibits required to be filed by the Company pursuant to Item 601 of Regulation S-K are contained in Exhibits listed in response to Item 14(a)3, and are incorporated herein by reference. The management contracts and compensatory plans and arrangements required to be filed as an Exhibit to this Form 10-K are listed in Exhibits 10.71, 10.72, 10.73, 10.74, 10.75, 10.81, 10.82 and 10.83.\nPOWER OF ATTORNEY\nThe registrant, and each person whose signature appears below, hereby appoints Gregory H. Browne and Thomas M. Haythe as attorneys-in-fact with full power of substitution, severally, to execute in the name and on behalf of the registrant and each such person, individually and in each capacity stated below, one or more amendments to the annual report which amendments may make such changes in the report as the attorney-in-fact acting deems appropriate and to file any such amendment to the report with the Securities and Exchange 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 fully authorized.\nDated:\nRAMSAY HEALTH CARE, INC.\nOCTOBER 3, 1994 By \/s\/ GEREGORY H. BROWNE GREGORY H. BROWNE CHIEF EXECUTIVE OFFICER, PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER AND DIRECTOR\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 SIGNATURE\/TITLE - - - ---- ---------------\nDated:\nOctober 3, 1994 By \/s\/ PAUL J. RAMSAY Paul J. Ramsay Chairman of the Board and Director\nDated:\nOctober 3, 1994 By \/s\/ GREGORY H. BROWNE Gregory H. Browne Chief Executive Officer, Principal Financial and Accounting Officer and Director\nDated:\nOctober 3, 1994 By \/s\/ AARON BEAM, JR. Aaron Beam, Jr. Director\nDATE SIGNATURE\/TITLE - - - ---- ---------------\nDated:\nBy____________________________ Peter J. Evans Director\nDated:\nOctober 3, 1994 By \/s\/ ROBERT E. GALLOWAY Robert E. Galloway Director\nDated:\nOctober 3, 1994 By \/s\/ THOMAS M. HAYTHE Thomas M. Haythe Director\nDated:\nOctober 3, 1994 By \/s\/ STEVEN J. SHULMAN Steven J. Shulman Director\nDated:\nOctober 3, 1994 By \/s\/ MICHAEL S. SIDDLE Michael S. Siddle Director\nDated:\nBy__________________________ Bruce R. Soden Senior Vice President and Director\n(THIS PAGE INTENTIONALLY LEFT BLANK)\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following consolidated financial statements of the Registrant and its subsidiaries are submitted herewith in response to Item 8 and Item 14(a)(1):\nThe following Financial Statement Schedules of the Registrant and its subsidiaries are submitted herewith in response to Item 14(a)(2):\nAll other schedules have been omitted because they are inapplicable or the information is provided in the consolidated financial statements including the notes thereto.\n(THIS PAGE INTENTIONALLY LEFT BLANK)\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors and Stockholders RAMSAY HEALTH CARE, INC.\nWe have audited the accompanying consolidated balance sheets of Ramsay Health Care, Inc. and Subsidiaries as of June 30, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended June 30, 1994. 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 Ramsay Health Care, Inc. and Subsidiaries at June 30, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended June 30, 1994, 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 Note on Income Taxes on page to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1993.\nERNST & YOUNG LLP\nNew Orleans, Louisiana September 1, 1994\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - - - ------------------------------------------\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of the Company and its majority-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.\nINDUSTRY\nThe Company is a provider of a full continuum of behavioral health services. Its facilities division operates private, free-standing acute care psychiatric hospitals as well as outpatient day hospitals, freestanding day treatment centers, subacute units, and residential treatment centers. Its managed care division provides managed mental health care services.\nAFFILIATED COMPANIES\nRamsay Holdings HSA Limited (\"Holdings\") owns approximately 18% of the outstanding Common Stock of the Company and 50% of the outstanding Class B Convertible Preferred Stock, Series C of the Company. Paul Ramsay Holdings Pty. Limited owns the remaining 50% of the outstanding Class B Convertible Preferred Stock, Series C. Together, these two entities affiliated with Paul J. Ramsay own common stock and preferred stock in the Company which in total represents an approximate 31% voting interest.\nMEDICARE AND OTHER CONTRACTED REIMBURSEMENT PROGRAMS\nNet revenues include estimated reimbursable amounts from Medicare and other contracted reimbursement programs. Amounts received by the Company for treatment of patients covered by such programs, which may be based on the cost of services provided or predetermined rates, are generally less than the established billing rates of the Company's hospitals. Final determination of amounts earned under contracted reimbursement programs is subject to review and audit by the appropriate agencies. See Note on Reimbursement from Third-Party Contractual Agencies.\nCHARITY CARE\nThe Company provides care to patients who meet certain criteria under its charity care policy without charge or at amounts less than its established rates. Because the Company does not pursue collection of amounts determined to qualify as charity care, they are not reported as revenue.\nINTANGIBLE ASSETS\nCost in excess of net asset value of purchased businesses is amortized on a straight-line basis, over periods ranging from fifteen to forty years. Other intangible assets, principally the value assigned to acquired clinical protocols and contracts related to the managed care division, are amortized on a straight-line basis over a fifteen year period.\nPreopening costs, principally salaries and other costs incurred prior to opening a new facility or program, are deferred and amortized on a straight-line basis over two years.\nLoan costs are amortized ratably over the life of the loan and are included in interest expense. In fiscal 1994, the Company wrote off $258,000 of deferred loan costs ($155,000 after applicable income tax benefit) in connection with the early retirement of the bonds associated with Atlantic Shores Hospital which was sold in February 1994. In fiscal 1993, the Company incurred approximately $1,573,000 in deferred loan costs in connection with the refinancing of its debt under the 1993 Credit Facilities. In fiscal 1992, the Company wrote off $678,000 of deferred loan costs ($366,000 after applicable income tax benefit) in connection with the early retirement of its $34 million bank term debt.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAccumulated amortization of the Company's intangible assets as of June 30, 1994 and 1993 was $9,896,000 and $10,311,000, respectively.\nPROPERTY AND EQUIPMENT\nProperty and equipment are stated at cost. The Company capitalizes interest, salaries and other costs for site selection and design incurred during the construction period. Upon sale or retirement of property or equipment, the cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in operations.\nDepreciation is computed substantially on the straight-line method for financial reporting purposes and on accelerated methods for income tax purposes. The general range of estimated useful lives is twenty to forty years for buildings and five to twenty years for equipment.\nPROFESSIONAL AND GENERAL LIABILITY INSURANCE\nThe Company maintains a self-insurance program for its hospital professional liability insurance and commercial and general liability insurance. The Company and its facilities are insured for professional and general liability in the aggregate amount of $25 million with self-insured retentions of $500,000 per claim. It is the Company's policy to record the liability for uninsured losses related to asserted and unasserted claims arising from reported incidents and losses related to unreported incidents based upon an actuarial valuation of the Company's past experience and other relevant information.\nINCOME TAXES\nThe Company recognizes deferred income taxes on significant temporary differences between financial statement and income tax reporting. The Company adopted FASB Statement No. 109 as of July 1, 1992 (See note on Income Taxes on page).\nRESTRUCTURING AND OTHER CHARGES\nIn 1993, the Company recorded a non-recurring charge of $1,367,000 resulting primarily from a decision not to develop additional inpatient psychiatric facilities in certain markets. In 1992, the Company recorded a charge against earnings of $2,283,000 reflecting the reassessment of its strategic direction. The 1992 charge included provisions for severance packages and for the potential unrecoverable portion of an investment in a hospital joint venture.\nEARNINGS PER SHARE\nPrimary earnings per share are calculated by dividing income before extraordinary items and cumulative effect of accounting change and net income by the weighted average number of common and dilutive common equivalent shares outstanding during each period. The Company's common stock equivalents include Class A Convertible Preferred Stock, Class B Convertible Preferred Stock, Series C and stock options and warrants to purchase Common Stock. Fully diluted earnings per share are calculated assuming the conversion of the Class B redeemable convertible preferred stock prior to its exchange on June 30, 1993; see note on Related Party Transactions.\nMINORITY INTERESTS\nThe equity of minority shareholders or partners in Company subsidiaries is reported on the balance sheet as minority interests. Minority interests reflect changes for the respective share of income of the subsidiaries attributable to the minority shareholders or partners, the effect of which is also reflected in the results of operations of the Company, and for distributions made to the minority shareholders or partners.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nCASH EQUIVALENTS\nCash equivalents include short-term, highly liquid interest-bearing investments, consisting primarily of certificates of deposit, commercial paper and money market mutual funds. The carrying values of these cash equivalents approximate fair value.\nRESTRICTED CASH\nRestricted cash represents the remaining proceeds from the sale of Cumberland Hospital that are held in trust for the repayment of debt. The carrying value of restricted cash approximates fair value.\nCASH HELD IN TRUST\nCash held in trust is revocable by the Company under certain circumstances and includes cash and short-term investments for payment of self-insurance losses. The carrying value of this cash held in trust approximates fair value.\nACQUISITIONS AND SALES - - - ----------------------\nIn August 1991, the Company purchased a 72-bed hospital facility in San Antonio, Texas and other personal property for a cash purchase price of $2,100,000. After refurbishments and renovations totaling approximately $1,800,000, the facility, Mission Vista Hospital, opened as a 66-bed facility in November 1991.\nIn December 1991, the Company entered into a one-year lease for a 36-bed facility in Concord, California. The Company had an option to purchase this facility for $1,050,000, which expired in December 1992. The Company did not exercise this option, terminated operations at this facility in September 1992, and recognized a loss of $1,109,000 on closure.\nIn November 1992, the Company purchased a 64-bed facility in Covington, Louisiana for $2,000,000. The facility, Three Rivers Hospital, opened in January 1993.\nIn January 1993, the Company terminated operations at its facility in Fort Walton Beach, Florida and subsequently leased that facility to another health care provider. That lease gives the lessee the option to purchase the facility at a fixed price. The Company recognized a provision for loss on potential sale of this facility of approximately $2.8 million in 1993. The cost and accumulated depreciation relating to this facility are approximately $8,900,000 and $4,800,000, respectively, at June 30, 1994.\nIn June 1993, the Company signed a letter of intent to sell its Cumberland Hospital in Fayetteville, North Carolina for approximately $12.3 million. In connection with this sale, the Company wrote off approximately $4 million of costs in excess of net asset value of purchased businesses and recorded an overall provision for loss of approximately $3.6 million in 1993. The sale of the facility was completed in August 1993.\nIn October 1993, the Company purchased the stock of Florida Psychiatric Management, Inc., a regional provider of mental health care cost management services based in Orlando, Florida for a cash payment of $4.0 million, the issuance of an aggregate of $2.5 million of three-year 7% debentures, and contingent consideration based on the attainment of certain earnings and revenue levels over the ensuing two years. In connection with this acquisition, the Company recorded cost in excess of net asset value of purchased businesses and other intangible assets of approximately $3.9 million and $3 million, respectively.\nIn February 1994, the Company sold its 50-bed Atlantic Shores Hospital in Daytona Beach, Florida for $4.8 million.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn June 1994, the Company purchased the assets and assumed certain liabilities of Human Dynamics Institute, a Phoenix Arizona- based managed mental health business for a cash payment of $1.0 million, a three-year, $1.0 million note bearing interest at 8.25%, 172,850 shares of common stock of Ramsay Managed Care, Inc., a subsidiary of the Company, and contingent consideration based upon the attainment of certain revenue levels over the ensuing two years. In connection with this acquisition, the Company recorded cost in excess of net asset value of purchased businesses totalling approximately $3 million.\nThe operations of Florida Psychiatric Management, Inc. and Human Dynamics Institute are included in the consolidated statements of operations from the dates of acquisition. Unaudited pro forma consolidated operating results of the Company as if the acquisitions had occurred as of July 1, 1992, are as follows:\nLONG-TERM DEBT - - - --------------\nThe Company's long-term debt is as follows: . .\nThe aggregate scheduled maturities of long-term debt during the five years subsequent to June 30, 1994 follow: 1995 -- $9,460,000; 1996 -- $10,610,000; 1997 -- $9,383,000; 1998 -- $8,325,000; and 1999 -- $10,443,000.\nThe Company has pledged as collateral substantially all of its real property.\nOn May 21, 1993, the Company finalized a credit facility (the \"1993 Credit Facility\") for letters of credit (to support the variable rate revenue bonds) and working capital with a group of banks. The 1993 Credit Facility includes approximately $27.5 million in letters of credit and $4.0 million in a working capital facility which replaced the $31.0 million in letters of credit and the $5.0 million working capital facility included in the 1990 Credit Facilities. The 1993 Credit Facility expires on May 15, 1996. There were no amounts outstanding under the working capital facility at June 30, 1994 or 1993.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nOn April 30, 1990, the Company entered into credit facilities (the \"1990 Credit Facilities\") with a group of insurance companies and banks. The 1990 Credit Facilities included $56.5 million in Senior Secured Notes, $34.0 million in bank term debt (the \"Bank Term Debt\"), approximately $31.0 million in letters of credit, $3.0 million in Subordinated Secured Notes and $5.0 million in a working capital facility. The Senior Secured Notes bear interest at 11.6% and are due in semi-annual installments through March 31, 2000. The Bank Term Debt was paid out in September 1991 from the proceeds of the Company's stock offering and internally generated funds. The Bank Term Debt bore interest at a variable rate and was due in quarterly installments that began on March 31, 1991 with the balance due on April 30, 1998. The Subordinated Secured Notes bear interest at 15.6% and are due in semi-annual installments through March 31, 2000.\nUnder the 1993 and 1990 Credit Facilities, the Company is required to meet certain covenants, including: (1) the maintenance of a minimum level of consolidated tangible net worth; (2) the maintenance of a working capital ratio; and (3) the maintenance of certain fixed charge coverage and debt service ratios. At June 30, 1994 the Company was in compliance with each such covenant.\nThe Company has entered into loan agreements with various state and local governmental agencies for the purpose of financing or providing reimbursement for the construction costs of certain of the Company's psychiatric hospitals or treatment facilities within respective states. Each state governmental agency funded its loan with proceeds of tax-exempt variable rate demand revenue bonds in the same amount as its loan. These loans, which have a term generally of 30 years, have an outstanding balance at June 30, 1994 totalling $21 million. The interest rate will be the same as the applicable revenue bonds which ranged from 2.5% to 5.5% at June 30, 1994. The Company is required to deliver an irrevocable standby letter of credit for each bond in an amount equal to the total principal payments due under the bond, plus a stipulated number of days interest. Such letters of credit are provided in the 1993 Credit Facility.\nIn December 1992, the Company completed a sale and leaseback of its management information systems, with a cost of $1,857,000 and accumulated depreciation of $185,000 at the time of the transaction, with net proceeds from the transaction approximating $1,857,000. The lease was accounted for as a capital lease.\nFASB Statement No. 107, \"Disclosures about Fair Value of Financial Instruments\", requires disclosure of fair value information about financial instruments. The fair values of the Company's long-term debt (excluding capital lease obligations) are estimated using discounted cash flow analyses, based on the Company's estimated current incremental borrowing rates for similar types of borrowing arrangements. The carrying amounts of all long-term debt are the same as the estimated fair values with the exception of the $48,025,000 and $2,769,000 borrowings. The fair values of these two notes are estimated to be $51,463,000 and $3,227,000, respectively, at June 30, 1994 and $56,319,000 and $3,500,000, respectively, at June 30, 1993.\nINCOME TAXES - - - ------------\nDuring the fourth quarter of fiscal 1993, effective July 1, 1992, the Company changed its method of accounting for income taxes from the deferred method to the liability method required by FASB Statement No. 109, \"Accounting for Income Taxes.\" As permitted under the new rules, prior years' financial statements were not restated. The cumulative effect of adopting Statement No. 109 as of July 1, 1992 was to increase net income in 1993 by $2,353,000.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\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. Significant components of the Company's deferred tax liabilities and assets are as follows:\nThe provision for income taxes consists of the following:\nThe provision for income taxes is reported in the consolidated statements of operations as follows:\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe provision for income taxes included in the consolidated statements of operations differs from the amounts computed by applying the statutory rate to income before income taxes, as follows:\nThe sources of timing differences on which deferred taxes have been provided and the related income tax effects for the year ended June 30, 1992 are as follows:\nAt June 30, 1994, net operating loss carryovers of approximately $17 million, which expire from 2000 to 2003, and alternative minimum tax credit carryovers of approximately $1,668,000, are available to reduce future federal income taxes subject to certain annual limitations.\nSTOCKHOLDERS' EQUITY - - - --------------------\nThe Class A Convertible Preferred Stock is not entitled to receive dividends, is not redeemable, does not have any liquidation preference, has no voting rights and is convertible at any time into Common Stock on a share-for-share basis. The conversion rate of the Class A Convertible Preferred Stock may be adjusted if the Company effects diluting issues such as share dividends, combinations and reclassifications, as well as if the Company sells Common Stock for an effective price of less than $6.06 per share.\nThe Certificate of Incorporation of the Company, as amended, authorizes the issuance of 1,000,000 shares of Class B Convertible Preferred Stock, $1.00 par value.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nIn March 1993, the Board of Directors authorized 152,321 shares of the Class B Convertible Preferred Stock as Class B Preferred Stock, Series C. These shares are entitled to cumulative dividends at a rate of 5% per annum payable quarterly in arrears. These shares are entitled to a liquidation preference of $50.84 per share under certain circumstances. The shares are convertible into that number of fully paid and nonassessable shares of Common Stock that results from dividing the conversion price in effect at conversion into $50.84 and multiplying the quotient obtained by the number of shares of Series C Preferred Stock being converted. The current conversion price is $5.084 per share. Each share of Series C Preferred Stock is entitled to ten (10) votes on all matters put to a vote of the shareholders of the Company and otherwise has voting rights and powers equal to the voting rights and powers of the Common Stock.\nOn June 30, 1993, the Company issued 142,486 shares of Class B Preferred Stock, Series C in a recapitalization of the interests of Paul J. Ramsay, the Company's chairman. (See note on Related Party Transactions.)\nOn July 30, 1991, the Company completed a public offering (the \"Offering\") of 2,700,000 shares of its Common Stock. An additional 405,000 shares of Common Stock were sold by selling stockholders upon the exercise of the underwriters' over-allotment option, including 90,832 shares issued upon the exercise by certain selling stockholders of warrants to purchase Common Stock and 4,590 shares issued upon the conversion of Class A Preferred Stock by a selling stockholder. The net proceeds from the Offering (after expenses and including amounts received from the exercise of warrants by certain selling stockholders) of $31,038,000, together with internally generated funds, were used to pay off the unpaid portion of the Bank Term Debt.\nAt June 30, 1994, an aggregate 1,675,672 options were outstanding under the Company's various option plans. These are set forth below:\nAt June 30, 1994, 1,034,334 shares were exercisable under the terms of the plans. At June 30, 1994, 1,774,338 shares were reserved for issuance under the Company's stock option plans.\nIn connection with a 1988 refinancing, the Company issued to Citibank, N.A. warrants to purchase 166,667 shares of the Company's Common Stock at $10.50 per share. The warrants contain an antidilution provision requiring adjustment to the purchase price and the number of shares upon occurrence of certain transactions. The issuance of the Class B\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nPreferred Stock Series C and the granting and repricing of stock options resulted in an adjustment in the Purchase Price to $9.30. Warrants for a total of 138,417 shares are still outstanding. These warrants are exercisable on or before April 1, 1995. As part of the 1990 refinancing, the Company issued warrants to Aetna Life Insurance Company and Monumental Life Insurance Company to purchase an aggregate of 113,301 shares of the Company's Common Stock at $9.61 per share. As a result of antidilution provision adjustments, the Purchase Price is currently $8.39 per share and warrants for a total of 106,986 shares are still outstanding. These warrants are exercisable on or before March 31, 2000.\nOn January 8, 1992, in consideration of the release of certain rights by the Company's former President and Chief Executive Officer, the Company issued non-transferable five-year warrants to purchase 200,000 shares of Common Stock at an exercise price per share of $9.50. These warrants were surrendered in December, 1992 at a cash amount equal to $2.00 times the number of warrants surrendered.\nUnder the Company's current credit agreements, the Company is presently limited as to the amount of dividends it can pay to the holders of its Common Stock and Class B Convertible Preferred Stock, Series C.\nREIMBURSEMENT FROM THIRD-PARTY CONTRACTUAL AGENCIES - - - ---------------------------------------------------\nThe Company records amounts due to or from third-party contractual agencies based on its best estimates of amounts to be ultimately received or paid under cost reports filed with the appropriate intermediaries. Final determination of amounts earned under contractual reimbursement programs is subject to review and audit by the appropriate intermediaries. Differences between amounts recorded as estimated settlements and the audited amounts are reflected as adjustments to net revenues in the period the final determination is made. During the years ended June 30, 1994, 1993 and 1992, the Company recorded contractual reimbursement benefits of approximately $1,400,000, $2,300,000 and $2,400,000, respectively, for the combined effects of intermediary audits and the routine evaluation of prior year estimated settlements. Management believes that adequate provision has been made for any adjustments that may result from future intermediary reviews or audits.\nLITIGATION - - - ----------\nThe Company is subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of such pending legal proceedings will not have a material adverse effect on the Company's financial position.\nPENSION PLAN - - - ------------\nOn December 1, 1985, the Company established a 401(k) tax deferred savings plan, administered by an independent trustee, covering substantially all employees over age twenty-one meeting a one-year minimum service requirement. The plan was adopted for the purpose of supplementing employees' retirement, death and disability benefits. The Company may, at its option, contribute to the plan through an Employer Matching Account, but is under no obligation to do so. An employee becomes vested in his Employer Matching Account over a four-year period.\nThe Company contributed $160,000, $175,000, and $195,000 to the plan during the years ended June 30, 1994, 1993 and 1992, respectively.\nRELATED PARTY TRANSACTIONS - - - --------------------------\nIn connection with the Paul Ramsay Group's cash investment in 1987, the Company issued 333,333 shares of Class B Convertible Preferred Stock, Series 1987. Dividends were at an annual rate of 6%, were cumulative and payable quarterly in arrears.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nOn June 30, 1993, the interests in the Company controlled by Paul J. Ramsay, the Company's chairman, were recapitalized. The Company issued 142,486 shares of Class B Preferred Stock, Series C in exchange for all outstanding shares of the Company's Class B Convertible Preferred Stock, Series 1987, the Company's $2 million 16.1% subordinated promissory note to affiliate and $500,000 in cash. The early extinguishment of the $2 million 16.1% subordinated promissory note resulted in an extraordinary loss of $1,580,000 in 1993.\nThe Company expensed $698,000, $678,000, and $657,000 in management fees to Holdings during the years ended June 30, 1994, 1993 and 1992, respectively. There were no significant amounts due to or from related parties at June 30, 1994 or 1993.\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nQUARTERLY RESULTS OF OPERATIONS AND OTHER SUPPLEMENTAL INFORMATION (UNAUDITED)\nFollowing is a summary of the Company's quarterly results of operations for the years ended June 30, 1994 and 1993.\n(1) The quarterly earnings per share amounts may not equal the annual amounts due to changes in the average common and dilutive common equivalent shares outstanding during the year.\nIn the quarter ended June 30, 1993, the Company recorded provisions for losses on sales and closure of hospitals and restructuring and other charges totaling $7,782,000.\nFINANCIAL STATEMENT SCHEDULES SCHEDULE IV\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES INDEBTEDNESS OF AND TO RELATED PARTIES--NOT CURRENT\n________________________\n(1) Represents a 16.1% Subordinated Promissory Note due April 1, 2000. The Note was subordinated to bank and investor obligations. On June 30, 1993, the Note was eliminated in conjunction with the recapitalization of the interests of Paul J. Ramsay.\nS-1 SCHEDULE V\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES PROPERTY AND EQUIPMENT\n_______________\n(1) Sale of hospitals. (2) Routine retirements. (3) Purchase of hospital. (4) Write-off of certificate of need (CON) costs.\nS-2\nSCHEDULE VI\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES ACCUMULATED DEPRECIATION, DEPLETION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\n_______________\n(1) Routine retirements. (2) Allowance for loss on potential sale of hospital. (3) Sale of hospitals. (4) Accumulated depreciation on acquisitions.\nS-3 SCHEDULE VIII\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS\n_______________\n(1) Write-offs of uncollectible patient accounts receivable.\nS-4 SCHEDULE X\nRAMSAY HEALTH CARE, INC. AND SUBSIDIARIES SUPPLEMENTARY INCOME STATEMENT INFORMATION\nAmounts for amortization of intangible assets, maintenance and repairs and royalties are not presented, as such amounts are less than 1% of net revenues.\nS-5\nINDEX OF EXHIBITS\nE-1\nE-2\nE-3\nE-4\nE-5\nE-6\nE-7\nE-8\nE-9\nE-10\nCopies of exhibits filed with this Annual Report on Form 10-K or incorporated herein by reference do not accompany copies hereof for distribution to stockholders of the Company. The Company will furnish a copy of any of such exhibits to any stockholder requesting it.\nE-11","section_15":""}
{"filename":"770975_1994.txt","cik":"770975","year":"1994","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\") operating 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 of San Francisco (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 Area, and San Diego County, California and in Las Vegas, and its lending activities are concentrated in the San Francisco, Los Angeles and Las Vegas areas. The San Francisco Bay Area, Los Angeles Area 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, 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 $93,000 net of amortization at December 31, 1994. 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 have been 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, 1994, the Company originated approximately $4.4 billion of loans, of which approximately $1.7 billion were sold to investors.\nThe Company has emphasized the retention of adjustable rate mortgages (\"ARMs\") in its loan portfolio. At December 31, 1994, over 96% 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 period of from one to twelve months 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 over that which was originally advanced. At December 31, 1994, the amount of loans with the potential for negative amortization held by the Company was approximately 9.5% of total loans and the amount of loans which had actually experienced increases in principal balance since origination was approximately 0.6% 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 $1,100,000, 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.\nAt December 31, 1994, single family real estate secured loans, including home equity loans, represented $843,147,000, or 56% of the Company's loan portfolio. Approximately 66% of these loans were in the San Francisco Bay Area, and approximately 26% were in the Los Angeles area. The Company's strategy has been 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. Additionally, the Company offers specific loan programs for first time home buyers and borrowers with low- to moderate-incomes. These are loans secured by single family detached homes, condominiums, cooperative apartments, and two-to-four unit properties. At December 31, 1994, the average single family loan amount, excluding equity lines of credit, was approximately $633,000 and the approximate average loan- to-value ratio was 66%, 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 1,200 for 1994), 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, 1994, loans secured by multifamily properties totaled $367,750,000, or 25% of the Company's loan portfolio. The loans are predominantly on older buildings in the urban neighborhoods of San Francisco and Los Angeles. Approximately 42% of the properties securing the Company's multifamily loans were in the San Francisco Bay Area, approximately 24% 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, 1994, the average multifamily mortgage loan size was approximately $1,100,000 and the approximate average loan-to-value ratio was 65%, using appraised values at the time of origination and current loan balances outstanding.\nThe Company has engaged in commercial real estate lending from its formation in 1985; however, since 1992, in response to economic conditions, the Company originated a limited amount of 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 71% in the San Francisco Bay Area, approximately 11% in Los Angeles County, approximately 4% in other California areas and approximately 12% in Las Vegas. At December 31, 1994, the average loan size was $1,030,000 and the approximate average loan-to-value ratio was 60%, using appraised values at the time of loan origination and current balances outstanding. The total amount of such loans outstanding on December 31, 1994, was $250,369,000, or 17% of the Company's loan portfolio.\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 1994, such loan originations were approximately $135,700,000 and approximately $97,900,000 of such loans were repaid, compared to approximately $146,200,000 of loan originations and $102,400,000 of such loans that were repaid in 1993. Generally, residential construction loans are short-term in nature and are repaid upon completion or ultimate sale of the properties. At December 31, 1994, the outstanding balance of the Company's construction loans was $24,886,000, or 2% of total loans. Construction loans are made 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 $80,465,000 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 24 separate projects were $14,227,000 at December 31, 1994 with total additional committed loan amounts of $25,097,000. The Company also has loans to four separate borrowers on four separate multifamily properties under construction in Las Vegas totalling $9,408,000 and has issued permanent take-out commitments of up to $18,691,000 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\nthat 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 loans, including seasoned performing multifamily and commercial real estate loans. Such loans meet the Company's normal underwriting standards, are generally located in the Company's primary lending areas, and may be purchased at a discount to their face value. Prior to the purchase of loans, management conducts a property visit and applies the Company's underwriting procedures as if a new loan were being originated. Total loans purchased by the Company, including single family real estate loans, were $12,342,000 in 1992, $5,447,000 in 1993, and $8,208,000 in 1994.\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, 1994, the outstanding balance due under home equity lines of credit was $28,137,000 and the unused remaining balance was $45,325,000. 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, 1994, the Company had approximately 100 commercial business loans with an aggregate balance of $5,621,000, 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 $636,000 at December 31, 1994.\nThe following table presents an analysis of the Company's loan portfolio at December 31, 1994 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. 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. From its inception, through December 31, 1994, the Company has sold approximately $1.7 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 ten institutional investors in 1992, to eight institutional investors in 1993, and to eight institutional investors in 1994. 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. Management expects to enter into additional formal and informal commitments in the future as it develops working relationships with additional institutional investors; however, the recent rising interest rate environment has made 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 $843.1 million and $814.5 million at December 31, 1994 and 1993, 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 0.36% for 1994, 0.38% for 1993 and 0.41% for 1992. 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, 1994 approximately 59% were adjustable rate mortgages. The weighted-average mortgage loan note rate of the Company's servicing portfolio at December 31, 1994 was 7.03% for ARMs and 7.68% 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, 1994, this asset (reported as \"premium on sale of loans\" and included in the Company's balance sheet as \"Other Assets\") was $793,000 as compared to $903,000 at December 31, 1993.\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 1994, 1993 or 1992. 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, 1994, the carrying cost of the purchased servicing rights described above was fully amortized. At December 31, 1993, the carrying cost of purchase servicing rights, net of amortization, was $251,000. Amortization of the carrying value of premium on sale of loans and the carrying cost on purchased servicing rights totalled $687,000 in 1994, $1,753,000 in 1993, and $1,960,000 in 1992.\nA declining and relatively low interest rate environment 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, were adversely affected by the low mortgage interest rates of 1992 and 1993, leading to higher loan prepayments and lower income generated from the Company's loan servicing portfolio. This negative effect on the Company's income was offset somewhat by a rise in origination and servicing income attributable to new loan originations, which increased during those years. 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. With the increase in general market rates of interest, including the rates for fixed rate mortgage loans, which occurred throughout 1994, the Company experienced a lower volume of loan originations, loan sales, gain on sale of loans and repayments of loans serviced. 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, 1994, the Company's investment portfolio included the following securities in the proportions listed: U.S. Government--20%; agency MBS--21%; and other MBS--50%.\nAt December 31, 1994, the Company's investment portfolio totalled $129,628,000 (8% of total assets) as compared to $84,208,000 (6% of total assets) at December 31, 1993. The securities in the Company's investment portfolio at December 31, 1994 had contractual maturities generally ranging from six months to thirty years.\nThe following table provides the remaining contractual principal maturities and yields (taxable-equivalent basis) of debt securities within the investment portfolio at December 31, 1994. The remaining contractual principal maturities for mortgage-backed securities were allocated assuming no prepayments. Expected remaining maturities will differ from contractual maturities because borrowers may have the right to prepay obligations with or without penalties. At December 31, 1994, there were no investment securities classified as held to maturity owned by the Company with a contractual principal maturity of after one year but before the end of five years.\nAt December 31, 1994, the Company owned a portfolio of adjustable rate perpetual preferred stocks, which have no stated maturities and therefore are classified as available for sale; these securities, which are considered equity securities, had an original cost of $13,760,000 and a fair value of $11,750,000 at December 31, 1994.\nAt December 31, 1994, all but $15,000 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 contractual maturities.\nThe following summarizes by category the amortized cost and fair market value of investment securities which were classified as held for investment at the dates indicated:\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 full-service checking, safe deposit boxes, money orders, ATM access and other traditional retail services. This limited product operation results in substantial cost savings\nwhich 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, 1994, no individual depositor or source of deposits represented 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.\nSince mid-1992, First Thrift has significantly altered its volatile liability dependency ratio by maintaining a reduced level of larger certificates and a higher level of cash and investments relative to its short-term borrowings. At December 31, 1994, First Thrift's cash and investments exceeded its volatile liabilities by $62,148,000. 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 1994, First Thrift had not accepted brokered deposits for more than five years and the balance of $99,000 of brokered deposits at December 31, 1994, represented 0.01% of total deposits. Management does not plan to renew such deposits upon their scheduled maturity. At December 31, 1994, First Thrift's time certificates $100,000 or more totalled $39,516,000 of which $37,915,000, or 96%, were from retail consumer depositors. At December 31, 1994, First Republic Savings Bank had time certificates over $100,000, totalling $600,000. For the Company, average maturity of all time certificates was 11 months and the average certificate amount per depositor was approximately $35,000 at December 31, 1994.\nThe following table shows the maturity of the Thrifts' certificates of $100,000 or more at December 31, 1994.\nFirst Thrift also utilizes term FHLB advances and, to a lesser extent, repurchase agreements, 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, 1994, total FHLB advances outstanding were $570,530,000. Of this amount, $526,530,000, or 92%, had an original maturity of 10 years or longer. The remaining $44,000,000 is due in 1995. The longer-term advances provide the Company with a stable primarily adjustable rate funding source for assets with longer lives. See \"--Asset and Liability Management.\"\nFirst Republic Savings Bank will apply for FHLB membership in 1995 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\nThe Company seeks to manage its asset and liability portfolios to help reduce any adverse impact on the its 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 asset repricings with short- and intermediate-term investment certificates and adjustable rate borrowings. The Company has established a program to obtain deposits by offering generally 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, 1994. 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 position as of December 31, 1994 for the three months and less and six months and less categories, in accordance with its current 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, 1994.\nASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY MATURING OR ADJUSTING DURING PERIODS SUBSEQUENT TO DECEMBER 31, 1994\n-------- (1) Adjustable rate loans consist principally of real estate secured loans with a maximum term of 30 years. Such loans are generally adjustable monthly, semiannually, or annually 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 (COFI), subject generally to a maximum increase of 2% annually and 5% over the lifetime of the loan. (2) Passbook and MMA account maturities and rate adjustments are allocated based upon management's experience of historical interest rate volatility and erosion rates. However, all passbook and MMA 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.\nAdditional information is provided under the caption \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Asset and Liability Management\" on pages 41 and 42 of the Company's 1994 Annual Report to stockholders.\nFIRST REPUBLIC AND SUBSIDIARIES\nFirst Republic was incorporated in February 1985. First Republic, which owns all of the capital stock of First Thrift, and First Republic Savings Bank, provides executive management to each of its subsidiaries and formulates and directs the implementation of an integrated business strategy for the Company.\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.\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.\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. In 1994, First Republic transferred all operations and employees of First Republic Mortgage Inc. to First Republic Savings Bank and, at December 31, 1994 First Republic Mortgage Inc. had been dissolved.\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 on new ARM loans, especially during a declining period of mortgage loan originations such as experienced in 1994, has resulted in a decrease in the Company's mortgage loan origination volume and 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 has resulted and may continue to 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 borrowers, 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, this limitation has 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.\nUpon 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 dividends; (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. Loans and obligations are considered as having a term of less than seven years if either (1) they are guaranteed or insured by any federal or state agency, or, (2) they are for the purchase or refinance of residential property, salable to qualified institutional buyers as evidenced by irrevocable commitments, and owned by the thrift and loan for 90 days or less. At December 31, 1994, 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, 1994. 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\nsuch 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.\nThe California Industrial Loan Law allows 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.\nIn August 1992, First Thrift agreed pursuant to a Memorandum of Understanding with the FDIC to limit its net loan growth to not more than 2.5% per quarter, to enhance certain operating policies and procedures, including its internal asset review practice, and to provide certain reports to the FDIC. First Thrift fulfilled its obligations under the agreement, which was rescinded by the FDIC in May 1993.\nAlso, First Thrift has enhanced 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 on and 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, 1994, the Tier 2 capital of First Thrift consisted of $10,000,000 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 31, 1994 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, 1994:\nSubsequent to the acquisition of First Republic Savings Bank, First Republic has contributed $6.1 million of additional capital, resulting in Tier 1 capital of that entity equaling $7.0 million on a total asset base of $42.4 million, at December 31, 1994. At such date, 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 paid insurance premiums to the FDIC for 1994 was 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 acquisition 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\nprovisions, \"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, 1994, First Thrift could have paid additional dividends aggregating approximately $14,500,000.\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 thrift 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 action. 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\nextraordinary 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 15 years, also to be financed by insurance premiums. As a result of these provisions, there 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 are charged anywhere from 23 cents to 31 cents for every $100 in insured domestic deposits, based on such institutions' capital levels and supervisory subgroup assignment. The FDIC adopted a permanent risk-based assessment system effective on January 1, 1994, which incorporates the same basic rate structure. The limited changes adopted by the FDIC are those it proposed in December 1992. These amendments clarify the basis on which supervisory subgroup assignments are made by the FDIC, eliminate from the assessment classification review procedure the specific reference to an \"informal hearing\", provide for the assignment of new institutions to the \"well capitalized\" assessment group, and clarify that an institution is to make timely adjustments as appropriate. 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 at this time.\nOn February 16, 1995, the FDIC issued a proposed regulation that would establish a new assessment rate schedule of 4-31 basis points (replacing the current 23-31 basis point schedule) for members of the BIF. The new schedule would apply to the semiannual period in which the reserve ratio of the BIF reaches the FDICIA imposed designated reserve ratio of 1.25% of total estimated insured deposits, and to semiannual periods thereafter. The FDIC currently expects the BIF reserve ratio to reach 1.25% of insured deposits sometime between May 1 and July 31, 1995. The new assessment schedule would retain the risk-based characteristics of the current system. Thus, if the proposed regulation is a adopted and if the BIF reserve ratio reaches 1.25%, then \"well capitalized\" and \"adequately capitalized\" institutions with low risk factors could expect a decrease in their BIF premiums.\nThe FDIC has also issued a Notice of Proposed Rulemaking and solicited comments on whether the deposit insurance assessment base should be redefined. The Notice contains seven proposed definitions: (1) retaining the status quo, (2) retaining the current definition but eliminating assessment base adjustments such as float deductions, (3) expanding the base to include non- deposit secured liabilities, (4) expanding the base to include foreign deposits as well as domestic deposits, (5) expanding the base to include all bank liabilities, (6) limiting the base to insured deposits only, and (7) expanding the base to equal a bank's total assets. Because the FDIC has not yet settled on a single proposed definition, the effect of any future change in the definition of the deposit-insurance assessment base can not be determined at this time.\nFDICIA required insured depository institutions to undergo a full-scope, on- site examination by their primary Federal banking agency as least once very 12 months. A transition rule allowed for examination of certain well capitalized and well managed institutions every 18 months until December 31, 1993. In 1994, the exemption for smaller institutions, which allowed a substitution of an 18 month schedule for the 12 month examination schedule for qualified smaller institutions, was amended to increase the asset threshold from $100 million to $250 million. The cost of examinations of insured depository institutions and any affiliates may be assessed by the appropriate Federal banking agency against each institution or affiliate as it deems necessary or appropriate.\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 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, 1994.\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\nquarters. 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 regulates 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, 1994, the Company had 141 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. 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 and 1994.\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, 1994, 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 or the Company takes possession of the collateral. Real estate collateral obtained by the Company is referred to as \"REO.\"\nSince the inception of operations in 1985 through December 31, 1994, the Company has originated approximately $4.4 billion of loans both for sale and retention in its loan portfolio, on which the Company has experienced $22.9 million of losses. Such losses primarily resulted from the economic recession which affected the California economy commencing in late 1990 and continuing in parts of the state through 1994 and the Northridge earthquake which struck the Los Angeles area in January 1994. At December 31, 1994, management of the Company believes that the effects of the recession have largely diminished with respect to properties securing its mortgage loans. As a result of the Northridge earthquake, which affected primarily the Company's loans secured by multifamily properties in Los Angeles County, the Company has experienced increased loan delinquencies and REO, additional loan loss provisions and a higher level of modified and restructured loans.\nThe Company's loss experience since inception represents an aggregate total of approximately 0.50% of loans originated in over nine years, although the Company's loss experience on single-family mortgage loans has been 0.06% of loans originated in this period. The Company has experienced a higher level of chargeoffs since 1991 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 0.74% for 1992, 0.44% for 1993, and 0.37% for 1994. The Company recorded REO costs and losses related to the disposition of delinquent loans totaling $1,202,000 in 1994 and $3,477,000 in 1993; such costs increased from $309,000 in 1992 because substantially all of these costs were reflected as chargeoffs against the Company's loss reserves prior to 1993.\nAdditional information is provided under the captions \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Asset Quality and--Provisions for Losses and Reserve Activity\" on pages 38 to 40 of the Company's 1994 Annual Report to stockholders.\nThe 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.\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.\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, past 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 44% at December 31, 1994 and 109% at December 31, 1993. While this ratio declined, management considers the $14,355,000 reserve at December 31, 1994 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\nprocedures 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's assessment considers the current status of properties securing loans, the trends in collateral values in each of the Company's geographic markets and the amount of specific reserves previously used to writedown problem or nonaccruing loans. Management's continuing evaluation of the loan portfolio and assessment of economic conditions and collateral values will dictate future reserve levels. Management currently anticipates that it will continue to provide additional reserves so long as, in its judgement, any additional adverse effects of the earthquake on its assets arise. Although the amount of loans that were adversely affected by the earthquake and remain unresolved at December 31, 1994 has been reduced, management anticipates that the ultimate resolution of the remaining loans may require additional reserves in 1995.\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, 1994, management had allocated from its general reserves $5,600,000 to the multifamily loan category, $600,000 to the commercial real estate loan category, $100,000 to the single-family construction category, and $55,000 to other loans, 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.\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 August 1997 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, 1994.\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThis information is incorporated by reference to page 48 of the Company's Annual Report to Stockholders for the year ended December 31, 1994.\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, 1994.\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 36 through 45 of the Company's Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThis information is incorporated by reference to pages 20 through 35 and to page 48 of the Company's Annual Report to Stockholders for the year ended December 31, 1994.\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. (2) Member of the Compensation Committee. (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-deWilde 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-deWilde has served as an officer since July 1985 and as a director since April 1988, while Ms. Moulds has served as an officer since June 1985. Mr. Newton became an officer of First Republic in August 1988.\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 1997. 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 1997, 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 and currently a director 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. He is a member of The Babson Corporation.\nKatherine August-deWilde 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.\nEdward J. Dobranski joined the company in August 1992 as General 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 Officer, 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. Mr. Dougherty is an investor and was previously President of Gill & Duffus International Inc. and Farr Man & Co. Inc., which 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 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 is a partner in the law firm of Rogers & Wells, counsel to the Company. 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 1997. Mr. Joy is Director-European Business Development for CVC Capital Partners Europe Limited, and a non-executive director of Sylvania Lighting International. Formerly, he was Managing Director of Citicorp Venture Capital and Citicorp Corporate Finance from 1989 to 1993. 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\nand 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 1997. 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 27, 1994 on Form 8-K reporting the Company's earnings for the quarter and nine months ended September 30, 1994.\nThe Company filed a report dated January 26, 1995 on Form 8-K reporting the Company's earnings for the quarter and year ended December 31, 1994.\nThe Company filed a report dated March 14, 1995 on Form 8-K reporting that the Company's Board of Director's authorized an increase of 250,000 shares in the Company's common stock repurchase program.\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 (.) are incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1988; Exhibits marked with two diamonds (..) are incorporated by reference to the Registrant's Form 10-K for the year ended December 31, 1989; Exhibits marked with three diamonds (...) 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 sign (+) are incorporated by reference to the Registrant's Registration Statement on Form S-3 (No. 33-60958). Exhibits marked with two dagger signs (++) 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.\n3.1### Certificate of Incorporation, as amended. (3.1)\n3.2+++ By-Laws as currently in effect.\n4.1# Indenture dated as of September 1, 1991 between First Republic Bancorp Inc. and National City Bank of Minneapolis. (10.35)\n4.2## Supplemental Indenture dated as of November 1, 1991 between First Republic Bancorp Inc. and National City Bank of Minneapolis. (10.35)\n4.3### Indenture dated as of December 1, 1992 between First Republic Bancorp Inc. and U.S. Trust Company of California, N.A. (4.1)\n4.4+ Indenture dated as of May 15,1993, between First Republic Bancorp Inc. and United States Trust Company of New York. (4.1)\n4.5++ Indenture dated as of August 4, 1993, between First Republic Bancorp Inc. and United States Trust Company of New York. (4.1)\n10.1+ Employee Stock Ownership Plan. (10.15)\n10.2+ Employee Stock Ownership Trust. (10.16)\n10.3** 1985 Stock Option Plan. (10.3)\n10.4+ Employment offers of James H. Herbert, II, Katherine August- deWilde, and Linda G. Moulds. (10.22)\n10.5++ Continuing Guarantee dated August 3, 1987 of the Registrant. (19.2)\n10.6++ Pledge Agreement dated September 8, 1987 between Pacific Trust Company, as trustee for the First Republic Bancorp Inc. Employee Stock Ownership Plan and the Registrant. (19.6(b))\n10.7+++ Key man life insurance policy on James H. Herbert, II. (10.33)\n10.8. Employment offer of Willis H. Newton, Jr. (10.37)\n10.9. Term Loan Agreement between the Registrant and Imperial Bank. (10.38)\n10.10. Loan and Pledge Agreement by and between the Registrant and the First Republic Bancorp Inc. Employment Stock Ownership Plan and Trust dated November 22, 1988. (10.39)\n10.11. Restated Secured Promissory Note of September 8, 1987, dated November 22, 1988, of First Republic Bancorp Inc. Employee Stock Ownership Trust in favor of the Registrant. (10.40)\n10.12. Restated Secured Promissory Note of December 9, 1987, dated November 22, 1988, of First Republic Bancorp Inc. Employee Stock Ownership Trust in favor of the Registrant. (10.41)\n10.13. Secured Promissory Note dated November 22, 1988 of First Republic Bancorp Inc. Employee Stock Ownership Trust in favor of the Registrant. (10.42)\n10.14... Sublease Agreement dated October 20, 1989 between the Registrant, Wells Fargo Bank and 111 Pine Street Associates with related master lease and amendments thereto attached. (10.44)\n10.15.. Lease Agreement dated January 5, 1990 between the Registrant and Honorway Investment Corporation. (10.45)\n10.16... Agreement re: Executive Bonuses for 1990 and 1991. (10.51)\n10.17** Amendment dated December 29, 1989 to Term Loan Agreement between the Registrant and Imperial Bank. (10.32)\n10.18*** Advances and Security Agreement dated as of June 24, 1991 between the Federal Home Loan Bank of San Francisco (\"FHLB\") and First Republic Thrift & Loan. (10.29)\n10.19### Subordinated Capital Notes by First Republic Thrift & Loan to First Republic Bancorp Inc. outstanding as of October 30, 1992, nos. 1001-1010 and no. 1013. (10.34)\n10.20### Form of 1992 Performance-Based Contingent Stock Option Agreement. (10.35)\n10.21#### Employee Stock Purchase Plan. (10.23)\n11.1 Statement of Computation of Earnings Per Share.\n12.1 Statement of Computation of Ratios of Earnings to Fixed Charges.\n13.1 1994 Annual Report to Stockholders\n22.1 Subsidiaries of First Republic Bancorp Inc.\n23.1 Consent of KPMG Peat Marwick LLP (see page 40).\n27 Financial Data Schedule\nSIGNATURES\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES 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 29, 1995\nPURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRATION AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nEXHIBIT NO. DESCRIPTION ----------- -----------\n11.1 Statement of Computation of Earnings Per Share\n12.1 Statement of Computation of Ratios of Earnings to Fixed Charges\n13.1 1994 Annual Report to Stockholders\n22.1 Subsidiaries of First Republic Bancorp Inc.\n23.1 Consent of KPMG Peat Marwick\n27 Financial Data Schedule","section_15":""}
{"filename":"48305_1994.txt","cik":"48305","year":"1994","section_1":"ITEM 1. BUSINESS\nHoneywell Inc., a Delaware corporation incorporated in 1927, is a Minneapolis-based international controls corporation that supplies automation and control systems, components, software, products and services for homes and buildings, industry, and space and aviation. The purpose of the company is to develop and apply advanced-technology products, systems and services to conserve energy, improve productivity, protect the environment, enhance comfort and increase safety. Development and modification occur continuously in Honeywell's business as new or improved products and services are introduced, new markets are created or entered, distribution methods are revised, and products and services are discontinued.\nINDUSTRY SEGMENT INFORMATION\nHoneywell's products and services are classified by management into three industry segments: (i) Home and Building Control, (ii) Industrial Control, and (iii) Space and Aviation Control. Financial information relating to these industry segments is set forth in Part II, Item 6 at page 10.\nHOME AND BUILDING CONTROL\nHoneywell's Home and Building Control business provides controls and systems for building automation, energy management, fire and security, as well as thermostats, air cleaners and other environmental controls and services for buildings and homes.\nHoneywell manufactures, markets and installs mechanical, pneumatic, electrical and electronic control products and systems for heating, ventilation and air conditioning in homes and commercial, industrial and public buildings. The systems, which may be generic or specifically designed for each application, may include panels and control systems to centralize mechanical and electrical functions.\nHoneywell also produces building management systems for commercial buildings, burner and boiler controls, lighting controls, thermostatic radiator valves, pressure regulators for water systems, thermostats, actuators, humidistats, relays, contactors, transformers, air-quality products, and gas valves and ignition controls for homes and commercial buildings. Sales of these products are made directly to original equipment manufacturers, including manufacturers of heating and air conditioning equipment, through wholesalers, distributors, dealers, contractors, hardware stores and home-care centers, and also through the company's nationwide sales and service organization.\nServices provided include indoor air-quality services, central-station burglary and fire protection services for homes and commercial buildings, video surveillance, access control and entry management services for commercial buildings, contract maintenance services for commercial building mechanical and control systems, automated management of building operations for building complexes, energy management services, energy retrofit services and training.\nINDUSTRIAL CONTROL\nThe Industrial Control business serves the automation and control needs of its worldwide industrial customers as a major supplier of products, systems and services ranging from sensors to integrated systems designed for specific applications.\nHoneywell's Industrial Control segment supplies process control systems and associated software and services to customers in the refining, petrochemical, bulk and fine chemical, pulp-and-paper, electric utility, food and consumer goods, pharmaceutical, metals and transportation markets, as well as other industries. Honeywell also designs and manufactures process instruments, process controllers, recorders, programmers, programmable controllers, transmitters and other field instruments. These products are sold as stand-alone products or integrated into systems. These products are generally used in indicating, recording and automatically controlling process variables.\nUnder the MICRO SWITCH trademark, Honeywell manufactures solid-state sensors (position, pressure, airflow, temperature and current), sensor interface devices, manual controls, explosion-\nproof switches and precision snap-acting switches, as well as proximity, photoelectric and mercury switches and lighted\/unlighted push-buttons. These products are used in industrial, commercial, business equipment, and in consumer, medical, automotive, aerospace and computer applications.\nOther products include solenoid valves, optoelectronic devices, fiber-optic systems and components, as well as microcircuits, sensors, transducers and high-accuracy, noncontact measurement and detection products for factory automation, quality inspection and robotics applications.\nHoneywell also furnishes services, including product and component testing, instrument maintenance, repair and calibration, contract services for industrial control equipment and third-party maintenance for CAD\/CAM and other industrial control equipment, training, applications service and a range of customer support services.\nServices are generally sold directly to users on a monthly or annual contract basis. Products are customarily sold by Honeywell on a delivered, supervised or installed basis directly to end users, to equipment manufacturers and contractors, or through third-party channels such as distributors and systems houses.\nSPACE AND AVIATION CONTROL\nHoneywell's Space and Aviation Control business supplies avionics for the commercial, military and space markets. The company designs, manufactures, services and markets a variety of sophisticated electronic control systems and components that are used on commercial and business aircraft, military aircraft and spacecraft.\nProducts manufactured for aircraft use include ring laser gyro-based inertial reference systems, navigation and guidance systems, flight control systems, flight management systems, inertial sensors, air data computers, radar altimeters, automatic test equipment, cockpit display systems and other communication and flight instrumentation.\nHoneywell products and services have been involved in every major U.S. space mission since the mid-1960s. Products include guidance systems for launch and re-entry vehicles, flight and engine control systems for manned spacecraft, precision components for strategic missiles and on-board data processing. Other products include spacecraft attitude and positioning systems, and precision pointing and isolation systems.\nSpace and Aviation Control products are sold through an integrated international marketing organization, with customer service centers providing international service for commercial and business aviation users.\nOTHER PRODUCTS\nProducts and services not included in the foregoing segment information are described below.\nHoneywell provides systems analysis and applied research and development on systems and products, including, application software, sensors, artificial intelligence and advanced electronics.\nSolid State Electronics Center, a semiconductor facility in Minnesota, designs and manufactures integrated circuits and sensors for Honeywell, government customers and selected external customers.\nHoneywell, through its Aerospace and Defense Group in Germany, develops, markets and sells to European countries, among other things, military avionics and electro-optic devices for flight control and nautical systems, including sonar transducers and echo sounders.\nGENERAL INFORMATION\nRAW MATERIALS\nHoneywell experienced no significant or unusual problems in the purchase of raw materials and commodities in 1994. Although it is impossible to predict what effects shortages or price increases may have in the future, at present management has no reason to believe a shortage of raw materials will cause any material adverse impact during 1995.\nPATENTS, TRADEMARKS, LICENSES AND DISTRIBUTION RIGHTS\nHoneywell owns, or is licensed under, a large number of patents, patent applications and trademarks acquired over a period of many years, which relate to many of its products or improvements thereon and are of importance to its business. From time to time, new patents and trademarks are obtained and patent and trademark licenses and rights are acquired from others. In addition, Honeywell has distribution rights of varying terms in a number of products and services produced by other companies. In the judgment of management, such rights are adequate for the conduct of the business being done by Honeywell. See Item 3 at page 7 for information concerning litigation in which Honeywell is involved relating to patents.\nSEASONALITY\nAlthough Honeywell's business is not seasonal in the traditional sense, revenues and earnings have tended to concentrate to some degree in the fourth quarter of each calendar year, reflecting the tendency of customers to increase ordering and spending for capital goods late in the year.\nMAJOR CUSTOMER\nHoneywell provides products and services to the United States government as a prime contractor or subcontractor, the majority of which are described under the heading \"Space and Aviation Control\" on page 2. Such business is significant because of its volume and its contribution to Honeywell's technical capabilities, but Honeywell's dependence upon individual programs is minimized by the large variety of products and services it provides. Contracts and subcontracts for all of such sales are subject to the standard provisions permitting the government to terminate for convenience or default.\nBACKLOG\nThe total dollar amount of backlog of Honeywell's orders believed to be firm was approximately $3,340 million at December 31, 1994, and $3,128 million at December 31, 1993. All but approximately $813 million of the 1994 backlog is expected to be delivered within the current fiscal year. Backlog is not a reliable indicator of Honeywell's future revenues because a substantial portion of backlog represents the value of orders that are cancelable at the customer's option.\nCOMPETITION\nHoneywell is subject to active competition in substantially all products and services. Competitors generally are engaged in business on a nationwide or an international scale. Honeywell is the largest producer of control systems and products used to regulate and control heating and air conditioning in commercial buildings, and of systems to control industrial processes worldwide. Honeywell is also a leading supplier of commercial aviation, space and avionics systems. Honeywell's automation and control businesses compete worldwide, supported by a strong distribution network with manufacturing and\/or marketing capabilities, for at least a portion of these businesses, in 95 countries.\nCompetitive conditions vary widely among the thousands of products and services provided by Honeywell, and vary as well from country to country. Markets, customers and competitors are becoming more international in their outlook. In those areas of environmental and industrial components and controls where sales are primarily to equipment manufacturers, price\/performance is probably the most significant competitive factor, but customer service and applied technology are also important. Competition is increasingly being applied to government procurements to improve price and product performance. In service businesses, quality, reliability and promptness of service are the most important competitive factors. Service must be offered from many areas because of the localized\nnature of such business. In engineering, construction, consulting and research activities, technological capability and a record of proven reliability are generally the principal competitive factors. Although in a small number of highly specialized products and services Honeywell may have relatively few significant competitors, in most markets there are many competitors.\nRESEARCH AND DEVELOPMENT\nDuring 1994 Honeywell spent approximately $659.5 million on research and development activities, including $340.5 million in customer-funded research, relating to the development of new products or services, or the improvement of existing products or services. Honeywell spent $742.2 million in 1993 and $703.1 million in 1992 on research and development activities, including $404.8 million and $390.5 million, respectively, in customer-funded research.\nENVIRONMENTAL PROTECTION\nCompliance with current federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had, and in the opinion of management will not have, a material effect on Honeywell's financial position, net income, capital expenditures or competitive position. See Item 7 at page 14 for further information concerning environmental matters.\nEMPLOYEES\nHoneywell employed approximately 50,800 persons in total operations as of December 31, 1994.\nGEOGRAPHIC AREAS\nHoneywell engages in material operations in foreign countries. A large majority of Honeywell's foreign business is in Western Europe, Canada and the Asian Pacific Rim.\nAlthough there are risks attendant to foreign operations, such as potential nationalization of facilities, currency fluctuation and restrictions on movement of funds, Honeywell has taken action to mitigate such risks.\nFinancial information related to geographic areas is included in Note 19 to the financial statements in Part II, Item 8 at page 36.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nHoneywell and its subsidiaries operate facilities worldwide comprising approximately 21,331,600 square feet of space for use as manufacturing, office and warehouse space, of which approximately 12,409,100 square feet is owned and approximately 8,922,500 square feet is leased. In the judgment of management, the facilities used by Honeywell are adequate and suitable for the purposes they serve.\nFacilities allocated for corporate use in the United States, including sales offices, comprise approximately 3,405,800 square feet of space, of which approximately 1,683,300 square feet is owned and approximately 1,722,500 square feet is leased. These figures include Honeywell's principal executive offices in Minneapolis, Minnesota which comprise approximately 957,400 square feet, all of which is owned.\nA summary of properties held by each segment of Honeywell is set forth below, showing major plants, their location, size and type of holding. The descriptions include approximately 184,600 square feet of space owned or leased by Honeywell's operations in the United States that has been leased or subleased to third parties. In addition, approximately 4,138,100 square feet of previously leased space in the United States is under assignment to third parties (including 2,417,000 square feet, 441,100 square feet and 102,600 square feet which is assigned to Alliant Techsystems Inc., Federal Systems Inc. and Bull HN Information Systems, Inc., respectively, all of which were formerly affiliates of the company).\nHOME AND BUILDING CONTROL\nHome and Building Control occupies approximately 2,472,100 square feet of space for operations in the United States, of which approximately 1,887,900 square feet is owned and approximately 584,200 square feet is leased.\nOutside the United States, Home and Building Control operations occupy approximately 4,101,100 square feet, of which approximately 1,487,000 square feet is owned and approximately 2,614,100 square feet is leased. Principal facilities operated outside the United States are located in Canada, Germany, The Netherlands, the United Kingdom and Australia.\nFacilities in the United States comprising 300,000 square feet or more are listed below.\nINDUSTRIAL CONTROL\nIndustrial Control occupies approximately 3,191,300 square feet of space for operations in the United States, of which approximately 2,233,200 square feet is owned and approximately 958,100 square feet is leased.\nOutside the United States, Industrial Control operations occupy approximately 2,441,100 square feet, of which approximately 968,800 square feet is owned and approximately 1,472,300 square feet is leased. Principal facilities operated outside the United States are located in the United Kingdom, Australia, Canada, Switzerland, France, Germany, Belgium and The Netherlands.\nFacilities in the United States comprising 300,000 square feet or more are listed below.\nSPACE AND AVIATION CONTROL\nSpace and Aviation Control occupies approximately 5,166,300 square feet of space for operations in the United States, of which approximately 3,819,100 square feet is owned and approximately 1,347,200 square feet is leased.\nOutside the United States, Space and Aviation Control operations occupy approximately 553,900 square feet, of which approximately 329,800 square feet is owned and approximately 224,100 square feet is leased. Principal facilities operated outside the United States are located in Canada, the United Kingdom and Singapore.\nFacilities in the United States comprising 300,000 square feet or more are listed below.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn March 13, 1990, Litton Systems, Inc. filed suit against Honeywell in U.S. District Court, Central District of California, alleging Honeywell patent infringement relating to the process used by Honeywell to coat mirrors incorporated in its ring laser gyroscopes; attempted monopolization by Honeywell of certain alleged markets for products containing ring laser gyroscopes; and intentional interference by Honeywell with Litton's prospective advantage in European markets and with its contractual relationships with Ojai Research, Inc., a California corporation. Honeywell has filed counterclaims against Litton alleging, among other things, violations by Litton of various antitrust laws including attempted monopolization of markets for inertial systems and interference with Honeywell's relationships with suppliers.\nThe trial of the patent infringement and intentional interference claims commenced June 4, 1993, and on August 31, 1993, a federal court jury in U.S. District Court in Los Angeles returned a verdict against Honeywell on each of these claims and awarded damages in the amount of $1.2 billion and concluded that the patent infringement was willful. Honeywell contended that the verdict was unsupported by the facts; that the Litton patent was invalid; and that Honeywell's process differed from Litton's. The judge in the case held a hearing November 22, 1993, on various issues including, among others, Honeywell's claims that the patent was improperly obtained due to alleged \"inequitable conduct\" on the part of Litton; Honeywell's other legal and equitable defenses; and Litton's motion to enhance the damage award. On January 9, 1995, the court issued a decision in favor of Honeywell, ruling that the Litton patent was unenforceable because it was obtained by inequitable conduct and invalid because it was an invention that would have been obvious from combining existing processes. The court further ruled that if the judgment is subsequently vacated or reversed as a result of an appeal of the court's ruling, a new trial on the issue of damages would be held on the ground that the jury's award was inconsistent with the clear weight of the evidence and to permit it to\nstand would constitute a miscarriage of justice. Litton has filed a motion to appeal the court's ruling. The trial for the antitrust claims of Litton and Honeywell is presently scheduled to commence in November 1995.\nHoneywell believes that the court's ruling was correct and continues to believe that Litton's claims are without merit. As a result, no provision has been made in the financial statements with respect to this contingent liability.\nHoneywell is a party to other various claims, legal and governmental proceedings, including claims relating to previously reported environmental matters. It is the opinion of management that any losses in connection with these matters and the resolution of the environmental claims will not have a material effect on net income, financial position or liquidity.\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 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe principal U.S. market for Honeywell's common stock is the New York Stock Exchange. The high and low sales prices for the stock as reported by the consolidated transaction reporting system, of the two most recent fiscal years is set forth in Part II, Item 8 at page 43.\nInformation regarding the frequency and amount of dividends paid by Honeywell on its common stock during the two most recent years is set forth in Note 23 to the financial statements in Part II, Item 8 at page 43. Further information regarding the company's payment of dividends is set forth in Part II, Item 7 at pages 17 and 18.\nIn November 1991, as part of Honeywell's program to enhance shareholder value, the company authorized the repurchase of shares of its common stock in open market transactions during the next five years for an amount not to exceed $600 million. In 1992, 1993 and 1994, $189 million, $240 million and $168 million respectively, of share repurchases were made under this program.\nStockholders of record on March 1, 1995 totaled 31,829, excluding individual participants in security position listings.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nHONEYWELL INC. AND SUBSIDIARIES (DOLLARS AND SHARES IN MILLIONS EXCEPT PER SHARE AMOUNTS)\n(DOLLARS AND SHARES IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOPERATIONS\nSALES\nHoneywell's 1994 sales were $6.057 billion, compared with $5.963 billion in 1993 and $6.223 billion in 1992. Sales in the United States of $3.825 billion were down two percent primarily due to a continuing cyclical downturn in the Space and Aviation Control commercial aviation market and reduced government spending. International sales, which represent 37 percent of total sales, increased eight percent from 1993 to $2.232 billion. The international sales increase was the result of positive sales growth of seven percent measured in local currency, along with positive currency effects as the U.S. dollar weakened an average of one percent against local currencies in countries where Honeywell does business. U.S. export sales, including exports to foreign affiliates, were $780 million in 1994, compared with $769 million in 1993 and $830 million in 1992.\nCOST OF SALES\nCost of sales was $4.082 billion in 1994, or 67.4 percent of sales, compared with $4.020 billion (67.4 percent) in 1993 and $4.195 billion (67.4 percent) in 1992. Cost as a percentage of sales remained flat for 1994 despite highly competitive conditions in all sectors of operation. Honeywell continues to closely monitor all phases of its program to reduce operating costs and improve margins, and margin expansion is anticipated in 1995.\nRESEARCH AND DEVELOPMENT\nHoneywell spent $319 million, or 5.3 percent of sales, on research and development in 1994, compared with $337 million (5.7 percent) in 1993 and $313 million (5.0 percent) in 1992. The higher 1993 percentage reflects significant investments in next-generation technologies. Honeywell expects to return to approximately the same rate of R&D spending in 1995 as in 1992. Honeywell also received $340 million in funds for customer-funded research and development in 1994, compared with $405 million in 1993 and $390 million in 1992.\nOTHER EXPENSES AND INCOME\nSelling, general and administrative expenses were $1.174 billion, or 19.4 percent of sales in 1994, compared with $1.076 billion (18.0 percent) in 1993 and $1.197 billion (19.2 percent) in 1992. Excluding royalties from autofocus licensees (see Note 3 to Financial Statements on page 26), the percent of sales would have been 19.5 percent, 18.6 percent and 19.5 percent in 1994, 1993 and 1992, respectively. The higher percentage in 1994 was primarily due to increased legal costs. The higher percentage in 1992 was due to increased international selling expenses. Royalty income from autofocus licensing agreements is expected to decline to less than $1 million in 1995 as a result of the expiration of the related patents.\nOn April 16, 1993, Honeywell announced the settlement of its lawsuits against the Unisys Corporation and other parties in connection with Honeywell's 1986 purchase of the Sperry Aerospace Group. Honeywell received $70 million in cash and notes, and recorded a gain of $22 million, or $14 million ($0.10 per share) after income taxes, to offset previously incurred costs associated with the matter (see Note 3 to Financial Statements on page 26).\nIn April 1987, Honeywell filed suit against Minolta Camera Co. alleging that Minolta autofocus cameras infringe Honeywell patents. Subsequently, Honeywell filed similar suits against other major camera manufacturers that employ autofocus technology. In March 1992, following a jury award in Honeywell's favor, Minolta agreed to pay Honeywell $127 million in settlement of the damages and Honeywell's claims for interest and legal fees. In addition to the Minolta settlement, agreements were reached with various camera manufacturers for their use of Honeywell's patented automatic focus camera technology. The total of all autofocus settlements recorded, after associated expenses, was $10 million, or $6 million ($0.05 per share) after income taxes, in 1993 and $288 million, or $171 million ($1.24 per share) after income taxes, in 1992 (see Note 3 to Financial Statements on page 26).\nHoneywell remains committed to efforts to reduce operating costs and improve margins. As a result of the identification of additional opportunities to restructure and streamline operations, Honeywell announced on October 19, 1994, its intention to record additional special charges in 1994. In December 1994, Honeywell's management, with the approval of the Board of Directors, committed itself to a plan of action and recorded special charges of $63 million, or $38 million ($0.29 per share) after income taxes. The actions to be undertaken include a continuation of right-sizing the Space and Aviation Control business segment, a worldwide consolidation of manufacturing capacity, a streamlining and realignment of the overhead structure and corporate expense reductions. Special charges of $51 million, or $29 million ($0.22 per share) after income taxes, were recorded in 1993 for productivity initiatives to strengthen the company's competitiveness. In 1992, special charges of $128 million, or $85 million ($0.62 per share) after income taxes, were recorded to right-size the Space and Aviation Control business segment and to reposition the Home and Building Control and Industrial Control business segments to capitalize on emerging market opportunities. Special charges include costs for work force reductions, worldwide facilities consolidation and other cost accruals. Work force reduction costs primarily include severance costs related to involuntary termination programs instituted to improve efficiency and reduce costs. These costs amounted to $53 million in 1994, $44 million in 1993 and $65 million in 1992. As a result of the 1994 plan, approximately 1,500 employees will be terminated. Facilities consolidation costs are primarily associated with consolidations of branch office space and product lines to restructure and streamline Honeywell's operations. These costs amounted to $10 million in 1994, $2 million in 1993 and $43 million in 1992. Other cost accruals include costs of exiting several product lines which were no longer considered complementary to Honeywell's businesses and amounted to $5 million in 1993 and $20 million in 1992.\nThe estimated cost savings of the restructuring actions in 1994 will exceed $30 million annually, when fully realized. Special charge accruals remaining to be paid were $74 million, $79 million and $121 million at December 31, 1994, 1993 and 1992, respectively. Total expenditures amounted to $50 million in 1994, $93 million in 1993 and $8 million in 1992. Cash flows from operating activities have funded and are expected to fund all special charges. Further information about special charges is provided in Note 4 to Financial Statements on page 26.\nNet interest expense was $60 million in 1994, $51 million in 1993 and $59 million in 1992. Net interest expense increased in 1994 as a result of higher market interest rates and higher debt compared with 1993. In 1992, Honeywell reduced total debt by $108 million, including redemption of high-coupon, long-term debt. Information concerning Honeywell's exposure to and management of interest rate risk through the use of derivative financial instruments is provided on page 19 and in Notes 14 and 15 to Financial Statements on pages 31 and 33, respectively.\nEarnings of companies owned 20 percent to 50 percent (primarily Yamatake-Honeywell Co., Ltd.), which are accounted for using the equity method, were $11 million in 1994, $18 million in 1993 and $16 million in 1992. The decline in 1994 primarily resulted from a decline in earnings, the writedown of assets and a bad debt reserve increase.\nINCOME TAXES\nThe provision for income taxes was $91 million in 1994, compared with $156 million in 1993 and $235 million in 1992. The 1994 income tax provision has been reduced by $38 million ($0.29 per share) as a result of a favorable tax settlement. The enactment by Congress of the Omnibus Budget Reconciliation Act of 1993, which raised the U.S. federal statutory income tax rate for corporations from 34 percent to 35 percent retroactive to January 1, 1993, did not have a material impact on the 1993 provision but did result in the recognition of a one-time gain of $9 million ($0.07 per share) in 1993 from the revaluation of deferred tax assets. Further information about income taxes is provided in Note 5 to Financial Statements on page 27.\nEXTRAORDINARY ITEM\nIn 1992, Honeywell recorded an extraordinary loss of $14 million, or $9 million ($0.06 per share) after income taxes, as a result of early debt redemptions that required the payment of premiums and the recognition of unamortized discounts and deferred costs. These redemptions were undertaken as part of Honeywell's efforts to reduce its debt and manage its interest rate exposure.\nACCOUNTING CHANGES\nIn 1992, Honeywell adopted three new Statements of Financial Accounting Standards. Statement of Financial Accounting Standards No. 106 (SFAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" required recognition of the expected cost of providing postretirement benefits over the time employees earn these benefits. Before adopting SFAS 106, Honeywell recognized the costs of providing these benefits on a pay-as-you-go basis by expensing the cost in the year the benefit was provided. The cumulative effect of adopting SFAS 106 at January 1, 1992, was a charge to income of $244 million, or $151 million ($1.09 per share) after income taxes.\nStatement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes,\" allowed consideration of future events in assessing the likelihood that tax benefits will be realized in future tax returns. The cumulative effect of adopting SFAS 109 at January 1, 1992, was an increase in income of $31 million ($0.23 per share) resulting from Honeywell's ability to recognize additional deferred tax assets.\nStatement of Financial Accounting Standards No. 112 (SFAS 112), \"Employers' Accounting for Postemployment Benefits,\" required that the estimated cost of providing postemployment benefits be recognized on an accrual basis. The cumulative effect of adopting SFAS 112 at January 1, 1992, was a charge to income of $40 million, or $25 million ($0.18 per share) after income taxes.\nNET INCOME\nHoneywell's net income was $279 million ($2.15 per share) in 1994, compared with net income of $322 million ($2.40 per share) in 1993 and $247 million ($1.78 per share) in 1992. Net income in 1994 includes an after-tax provision for special charges of $38 million ($0.29 per share) and a reduction of the provision for income taxes of $38 million ($0.29 per share) from a favorable tax settlement. Net income in 1993 includes an after-tax gain from litigation settlements, after associated expenses, of $20 million ($0.15 per share); an after-tax provision for special charges of $29 million ($0.22 per share); and a gain of $9 million ($0.07 per share) from the revaluation of deferred tax assets. Net income in 1992 includes an after-tax gain from litigation settlements, after associated expenses, of $171 million ($1.24 per share); an after-tax provision for special charges of $85 million ($0.62 per share); an extraordinary loss after income taxes of $9 million ($0.06 per share) from the early redemption of long-term debt; and an after-tax reduction of $145 million ($1.04 per share) for the cumulative effect of accounting changes.\nRETURN ON EQUITY AND INVESTMENT\nReturn on equity (ROE) was 15.6 percent in 1994, 18.4 percent in 1993 and 13.8 percent in 1992. Return on investment (ROI) was 12.3 percent in 1994, 14.6 percent in 1993 and 11.8 percent in 1992. The adoption of SFAS 106 and SFAS 112 significantly reduced ROE and ROI in 1992.\nCURRENCY\nThe U.S. dollar weakened an average of one percent in 1994 compared with 1993 in relation to the principal foreign currencies in countries where Honeywell products are sold. A weaker dollar has a positive effect on international results because foreign-exchange denominated profits translate into more U.S. dollars of profit; a stronger dollar has a negative translation effect. Information about Honeywell's exposure to and management of currency risk through the use of derivative financial instruments is provided on page 19 and in Notes 6, 14 and 15 to Financial Statements on pages 28, 31 and 33, respectively.\nINFLATION\nHighly competitive market conditions have minimized inflation's impact on the selling prices of Honeywell's products and the cost of its purchased materials. Productivity improvements and cost-reduction programs have largely offset the effects of inflation on other costs and expenses.\nEMPLOYMENT\nHoneywell employed 50,800 people worldwide at year-end 1994, compared with 52,300 people in 1993 and 55,400 people in 1992. Approximately 31,400 employees work in the United States, with 19,400 employed outside the country, primarily in Europe. Total compensation and benefits in 1994 were $2.7 billion, or 47 percent of total costs and expenses. Sales per employee were $118,600 in 1994, compared with $110,900 in 1993 and $109,600 in 1992.\nENVIRONMENTAL MATTERS\nHoneywell is committed to protecting the environment, a commitment evidenced by both Honeywell's products and manufacturing operations. Honeywell's manufacturing sites generate both hazardous and nonhazardous wastes, the treatment, storage, transportation and disposal of which are subject to various local, state and federal laws relating to protection of the environment. Honeywell is in varying stages of investigation or remediation of potential, alleged or acknowledged contamination at current or previously owned or operated sites and at off-site locations where its wastes were taken for treatment or disposal. In connection with the cleanup of various off-site locations, Honeywell, along with a large number of other entities, has been designated a potentially responsible party (PRP) by the U.S. Environmental Protection Agency under the Comprehensive Environmental Response, Compensation and Liability Act or by state agencies under similar state laws (Superfund), which potentially subjects PRPs to joint and several liability for the costs of such cleanup. In addition, Honeywell is incurring costs relating to environmental remediation pursuant to the federal Resource Conservation and Recovery Act. Based on Honeywell's assessment of the costs associated with its environmental responsibilities, compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had and in the opinion of Honeywell management, will not have a material effect on Honeywell's financial position, net income, capital expenditures or competitive position. Honeywell's opinion with regard to Superfund matters is based on its assessment of the predicted investigation, remediation and associated costs, its expected share of those costs and the availability of legal defenses. Honeywell's policy is to record environmental liabilities when loss amounts are probable and reasonably estimable.\nDISCUSSION AND ANALYSIS BY SEGMENT\nHOME AND BUILDING CONTROL\nSales in Home and Building Control were $2.665 billion in 1994, compared with $2.424 billion in 1993 and $2.394 billion in 1992. Sales in 1994 were up moderately as U.S. sales continued to benefit from an improving economy and growing consumer confidence. International sales were aided by the beginnings of economic recovery internationally. Home Control continued to achieve greater market penetration with original equipment manufacturers worldwide and to broaden its product offerings in key markets such as burner boiler control. Honeywell acquired Metallwerke Neheim Goeke & Co. GmbH, a leading German manufacturer of water heating control products, to complement its current offerings in Europe. In addition, there were a number of new product introductions which included a new line of smart gas valves and integrated boiler and furnace controls. Building Control experienced continued success with its comprehensive energy retrofit and service solutions, particularly in the schools and industrial markets in the United States. Home and Building Control's large worldwide installed product and service base and market strategies will continue to support future sales growth.\nSales in 1993 were up slightly from 1992 as stronger U.S. sales were mostly offset by a stronger U.S. dollar and economic weakness in international markets, driven in large part by the continuing recession in Europe. Home Control gained market share in the United States through new product\nintroductions and greater penetration of the OEM market. TotalHome-Registered Trademark- was introduced outside the United States in 1993. The acquisition of Enviracaire in December 1992 also contributed to the improvement in U.S. sales. Building Control experienced strong U.S. interest in its comprehensive energy retrofit and service solutions for schools and other institutions.\nHome and Building Control operating profit was $236 million in 1994, compared with $233 million in 1993 and $193 million in 1992. Operating profit included special charges of $29 million in 1994, $10 million in 1993 and $43 million in 1992. Excluding the impact of special charges, operating profit increased moderately in 1994 benefiting from increasing volume in an improving U.S. economy and growing consumer confidence. Special charges were incurred in 1994 to consolidate facilities, streamline operations and improve productivity.\nExcluding the impact of special charges, operating profit increased slightly in 1993 despite the deepening European recession, a stronger U.S. dollar, unfavorable intra-European currency fluctuations, additional costs associated with streamlining the U.S. field organization, and costs associated with introducing the new EXCEL 5000-Registered Trademark- building automation platform in the United States. Special charges were incurred in 1993 and 1992 for implementation of programs to consolidate facilities and improve productivity.\nOrders improved moderately in 1994 for both Home Control and Building Control, primarily in the United States. Order activity in the targeted segments of schools and industrial facilities experienced double-digit growth. The backlog of orders also showed a moderate increase for 1994.\nINDUSTRIAL CONTROL\nIndustrial Control sales were $1.835 billion in 1994, compared with $1.692 billion in 1993 and $1.744 billion in 1992. Excluding year-earlier results of the Keyboard Division, which was sold in the third quarter of 1993, sales increased moderately in 1994. Industrial Automation and Control experienced improving sales for TotalPlant-Registered Trademark- Open Solutions as industry continues to focus on improving productivity and meeting stringent environmental and safety regulations worldwide. Sales to the hydrocarbon processing market were strong as companies invested to comply with the U.S. Environmental Protection Agency regulations for reformulated fuels. Honeywell acquired Allied Data Communications, Pepperl & Fuchs Systems, and Profimatics during the year and forged alliances with other companies to expand its TotalPlant Open Solutions portfolio and provide more one-stop shopping and a broader range of services to its industrial customers. Sensing and Control (formerly Control Components) benefited from continued improvements in the U.S. durable goods market, particularly in the automotive, appliance and information technology industries. The business introduced SDS Smart Distributed System, a revolutionary sensor network for distributed machine control. The company expects continued growth for both Industrial Automation and Control's and Sensing and Control's systems and products in 1995.\nSales declined slightly in 1993 due to negative currency translation trends and the divestiture of the Keyboard Division, which was sold to Key Tronic Corporation in the third quarter of 1993. Excluding these items, both Industrial Automation and Control and Sensing and Control grew at moderate rates despite weak conditions in the United States, Europe and Latin America. Industrial Automation and Control reported solid penetration gains in targeted worldwide markets despite a weak capital spending environment in the United States and Europe. Demand for Industrial's systems increased in the Middle East and Asia Pacific. Sales of field instruments showed a strong increase due to broad acceptance of Industrial Automation and Control's smart field products. Sensing and Control experienced significant growth in solid state sensors for on-board automotive and information technology and appliance market segments as demand for durable goods improved.\nIndustrial Control operating profit was $207 million in 1994, $190 million in 1993 and $157 million in 1992. Operating profit included special charges of $14 million in 1994, $9 million in 1993 and $39 million in 1992. Excluding the impact of special charges, operating profit showed a moderate increase as a result of volume increases in Industrial Automation and Control where environmental\nand safety regulations remain key drivers of spending around the world, particularly in the hydrocarbon processing and chemicals markets; and volume increases in Sensing and Control where durable goods markets continued to improve, particularly in the automotive and appliance industries. Special charges were incurred in 1994 to consolidate facilities, streamline operations and improve productivity.\nExcluding the impact of special charges, operating profit showed a slight increase in 1993. Profits were affected by the weak capital spending environment in the United States and Europe, strength of the U.S. dollar and aggressive investments in new technologies, with R&D spending up 26 percent over 1992. Special charges were incurred in 1993 and 1992 for implementation of programs to consolidate facilities and improve productivity.\nIn 1994, on a comparable basis, Industrial Automation and Control experienced strong order activity in both the United States and internationally in such key markets as hydrocarbon and chemical processing. The backlog of orders was up modestly for the year.\nSPACE AND AVIATION CONTROL\nSales in Space and Aviation Control were $1.432 billion in 1994, compared with $1.675 billion in 1993 and $1.933 billion in 1992. Sales continued to decline in 1994 as anticipated, reflecting lower commercial aircraft production rates and reduced government spending. A cyclical recovery of the commercial aircraft industry is expected in 1996. We believe we have seen the worst of the decline, and we anticipate flat sales in 1995.\nSales in 1993 declined as a result of the continuing cyclical decline in commercial aircraft production, weak demand in the business jet market and decreased spending in the military market.\nSpace and Aviation Control operating profit was $81 million in 1994, compared with $148 million in 1993 and $176 million in 1992. Operating profit included special charges of $20 million in 1994, $7 million in 1993 and $35 million in 1992. Excluding the impact of special charges, there was a sharp decline in operating profit resulting from lower sales volume and continued investment in next-generation technology. This was partially offset by favorable warranty performance and termination settlements in the Military and Space businesses. Special charges were incurred in 1994 to consolidate facilities, streamline operations and improve productivity.\nExcluding the impact of special charges, operating profit declined in 1993 due to the sharp volume decline in sales of commercial flight systems and significant investments in next-generation avionics. Special charges were incurred in 1993 and 1992 for implementation of programs to consolidate facilities and improve productivity.\nSpace and Aviation Control orders increased sharply in 1994 as result of contract awards in Space Systems to provide cockpit displays for the space shuttle and supply command and data-handling systems for the International Space Station Alpha, and improved orders in Business and Commuter Aviation driven by a rebound in the business jet market. The backlog of orders increased moderately from 1993 levels.\nOTHER\nSales from other operations were $125 million in 1994, $172 million in 1993 and $152 million in 1992. These sales included the activities of various units, such as the Solid State Electronics and the Honeywell Technology research and development centers, which do not correspond with Honeywell's primary business segments. Other operations broke even in 1994 and incurred operating losses of $2 million in 1993 and $9 million in 1992. The 1993 and 1992 losses included special charges of $16 million and $3 million, respectively, for work force reductions.\nFINANCIAL POSITION\nFINANCIAL CONDITION\nAt year-end 1994, Honeywell's capital structure comprised $361 million of short-term debt, $501 million of long-term debt and $1.855 billion of stockholders' equity. The ratio of debt to total capital was 32 percent, compared with 28 percent at year-end 1993. Honeywell's debt-to-total capital policy range is 30 to 40 percent. Honeywell managed its capital structure at the low end of this range during 1994.\nTotal debt increased $170 million during 1994 to $862 million. The increase was used to finance general corporate requirements, including capital expenditures and working capital, and $105 million of acquisitions.\nStockholders' equity increased $82 million in 1994 to $1.855 billion. The increase was primarily due to an increase in retained earnings of $279 million from net income, offset by dividends of $126 million, a $55 million increase in the accumulated foreign currency translation, and a $7 million reduction in the pension liability adjustment. These increases in stockholders' equity were partially offset by a $148 million increase in treasury stock.\nCASH GENERATION AND DEPLOYMENT\nIn 1994, $470 million of cash was generated from operating activities, compared with $475 million in 1993 and $532 million in 1992. The decrease in 1994 was largely due to lower earnings compared with 1993. In 1994, cash generated from investing and financing activities included $23 million of proceeds from the sale of assets and $6 million of proceeds from employee stock plans. These funds were used to support $262 million of capital expenditures, $126 million of dividend payments and $163 million of share repurchases. Cash balances increased $25 million in 1994.\nWORKING CAPITAL\nCash used for increases in the portion of working capital consisting of trade and long-term receivables and inventories, offset by accounts payable and customer advances, was $9 million in 1994. This portion of working capital as a percentage of sales was 28 percent, which was consistent with 1993. Trade receivables sold at year-end 1994 were $2 million, a reduction of $36 million in 1994. The increases in receivable and payable balances in 1994 were consistent with the increase in fourth quarter sales.\nCAPITAL EXPENDITURES AND ACQUISITIONS\nCapital expenditures for property, plant and equipment in 1994 were $262 million, compared with $232 million in 1993 and $244 million in 1992. The 1994 depreciation charges were $235 million. Honeywell continues to invest at levels believed to be adequate to maintain its technological position in areas providing value-added long-term returns. During 1994, Honeywell invested $105 million in complementary business acquisitions.\nSHARE REPURCHASE PLANS\nIn November 1991, the Board of Directors authorized a five-year program to purchase up to $600 million of Honeywell shares. This program was completed in 1994, two years ahead of schedule. Honeywell repurchased $3 million of shares in 1991, $189 million of shares in 1992, $240 million of shares in 1993, and $168 million of shares in 1994.\nAt year-end 1994, Honeywell had 188 million shares issued, 127 million shares outstanding and 32,025 stockholders of record. At year-end 1993, Honeywell had 188 million shares issued, 132 million shares outstanding and 33,382 stockholders of record.\nDIVIDENDS\nIn November 1993, the Board of Directors approved an 8 percent increase in the regular annual dividend to $0.96 per share, from $0.89 per share, effective in the fourth quarter 1993. In November 1994, the Board of Directors approved an additional 4 percent increase in the regular annual\ndividend to $1.00 per share effective in the fourth quarter 1994. Honeywell paid $0.97 per share in dividends in 1994, compared with $0.9075 in 1993, and $0.84125 in 1992. Honeywell has paid a quarterly dividend since 1932 and has increased the annual payout per share in each of the last 19 years.\nEMPLOYEE STOCK PROGRAM\nHoneywell contributed 634,561 shares of Honeywell common stock to employees under its U.S. employee stock match savings plan in 1994. The number of shares contributed under this program depends on employee savings levels and company performance.\nPENSION CONTRIBUTIONS\nCash contributions to Honeywell's Retirement Plan for U.S. non-union employees were $86 million in 1994, $105 million in 1993 and $79 million in 1992. Cash contributions to the Pension Plan for U.S. union employees were $40 million in 1994, $36 million in 1993 and $27 million in 1992.\nTAXES\nIn 1994, taxes paid were $79 million. Accrued income taxes and related interest decreased $11 million during 1994.\nFUNDING SPECIAL CHARGES\nDuring 1994, 1993 and 1992, the company established reserves for productivity initiatives to strengthen the company's competitiveness (see page 12 and Note 4 to Financial Statements on page 26). Future cash flows from operating activities are expected to be sufficient to fund these accrued costs.\nLIQUIDITY\nShort-term debt at year-end 1994 was $361 million, consisting of $125 million of commercial paper, $102 million of notes payable and $134 million of current maturities of long-term debt. Short-term debt at year-end 1993 totaled $188 million, consisting of $181 million of commercial paper and $7 million of notes payable and current maturities of long-term debt.\nThrough its banks, Honeywell has access to various credit facilities, including committed credit lines for which Honeywell pays commitment fees and uncommitted lines provided by banks on a non-committed, best-efforts basis. Available general purpose lines of credit at year-end 1994 totaled $1.076 billion. This consisted of $737 million of committed credit lines to meet Honeywell's financing requirements, including support of commercial paper and bank note borrowings, and $339 million of uncommitted credit lines available to certain foreign subsidiaries. In addition, Honeywell had a $1.2 billion special purpose credit facility available for an appeal bond that might have been required in the Litton litigation described in Litigation below. The $1.2 billion facility was canceled in February, 1995.\nThis compared with $2.272 billion of available credit lines at year-end 1993, consisting of $675 million of committed credit lines for general financing requirements, $397 million of uncommitted credit lines available to certain foreign subsidiaries and the $1.2 billion special purpose facility.\nIn addition to its committed credit lines, Honeywell has access to the public debt markets as evidenced by its $500 million medium-term note program which was initiated in August 1994. The medium-term note program allows note issuances with maturities ranging from nine months to 30 years. At December 31, 1994, $101 million of notes was outstanding under this program. Long-term debt maturities consist of $133 million in 1995, $185 million in 1996 and $115 million in 1997.\nCash and short-term investments totaled $275 million at year-end 1994 and $256 million at year-end 1993. Management believes its available cash, committed credit lines and access to the public debt markets through its medium-term note program, provide adequate short-term and long-term liquidity.\nDERIVATIVE FINANCIAL INSTRUMENTS\nHoneywell utilizes various foreign currency exchange contracts and interest rate swaps to manage its exposure to exchange rate (see Notes 6, 14 and 15 to Financial Statements on pages 28, 31 and 33, respectively) and interest rate fluctuations and its mix of fixed and floating interest rates (see Notes 14 and 15 to Financial Statements on pages 31 and 33, respectively). At year-end 1994, the notional amount of outstanding foreign exchange contracts was $1.089 billion. The notional amount of outstanding interest rate swaps was $232 million.\nLITIGATION\nOn August 31, 1993, a federal court jury in the U.S. District Court in Los Angeles returned a verdict against Honeywell on patent infringement and intentional interference claims in the amount of $1.2 billion. These claims were part of a lawsuit brought by Litton Systems, Inc. alleging, among other things, Honeywell patent infringement relating to the process used by Honeywell to coat mirrors incorporated in its ring laser gyroscopes. Honeywell contended the verdict was unsupported by the facts; that the Litton patent was invalid; and that Honeywell's process differs from Litton's. The judge in the case held a hearing November 22, 1993, on various issues including, among others, Honeywell's claims that the patent was improperly obtained due to alleged \"inequitable conduct\" on the part of Litton; Honeywell's other legal and equitable defenses; and Litton's motion to enhance the damage award. On January 9, 1995, the court issued a decision in favor of Honeywell, ruling that the Litton patent was unenforceable because it was obtained by inequitable conduct and invalid because it was an invention that would have been obvious from combining existing processes. The court further ruled that if the judgment is subsequently vacated or reversed as a result of an appeal of the court's ruling, a new trial on the issue of damages would be held on the ground that the jury's award was inconsistent with the clear weight of the evidence and to permit it to stand would constitute a miscarriage of justice. Litton has filed a motion to appeal the court's ruling. The trial for the antitrust claims of Litton and Honeywell is currently scheduled to commence in November 1995.\nHoneywell believes that the court's ruling was correct and continues to believe that Litton's claims are without merit. As a result, no provision has been made in the financial statements with respect to this contingent liability.\nCREDIT RATINGS\nHoneywell's credit ratings remained unchanged during 1994. Ratings for long-term and short-term debt are, respectively, A\/A-1 by Standard and Poor's Corporation, A\/Duff1 by Duff and Phelps Corporation and A3\/P-2 by Moody's Investors Service, Inc. On January 10, 1995, Moody's Investors Service, Inc. removed Honeywell from credit watch and affirmed the A3\/P-2 debt ratings. Moody's had placed Honeywell on credit watch status on August 31, 1993, as a result of the jury verdict in the Litton litigation.\nSTOCK PERFORMANCE\nThe market price of Honeywell stock ranged from $36 7\/8 to $28 1\/4 in 1994, and was $31 1\/2 at year end. Book value per common share at year end was $14.57 in 1994 and $13.48 in 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nTo the Stockholders of Honeywell Inc.:\nWe have audited the statement of financial position of Honeywell Inc. and subsidiaries as of December 31, 1994 and 1993, and the related statements of income and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed at Part IV, Item 14(a)2. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.\nWe have 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 Honeywell Inc. and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, such 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 Notes 1, 5 and 21 to the financial statements, in 1992 the Company changed its method of accounting for postemployment benefits, income taxes and postretirement benefits other than pensions.\nDeloitte & Touche LLP Minneapolis, Minnesota February 13, 1995\nINCOME STATEMENT HONEYWELL INC. AND SUBSIDIARIES (DOLLARS AND SHARES IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nSee accompanying Notes to Financial Statements.\nSTATEMENT OF FINANCIAL POSITION HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS)\nASSETS\nSee accompanying Notes to Financial Statements.\nSTATEMENT OF CASH FLOWS HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS)\nSee accompanying Notes to Financial Statements.\nNOTES TO FINANCIAL STATEMENTS HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 1 -- ACCOUNTING POLICIES\nCONSOLIDATION\nThe consolidated financial statements and accompanying data comprise Honeywell Inc. and subsidiaries. All material intercompany transactions are eliminated.\nSALES\nProduct sales are recorded when title is passed to the customer, which usually occurs at the time of delivery or acceptance. Sales under long-term contracts are recorded on the percentage-of-completion method measured on the cost-to-cost basis for engineering-type contracts and the units-of-delivery basis for production-type contracts. Provisions for anticipated losses on long-term contracts are recorded in full when they become evident.\nINCOME TAXES\nIncome taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109 (see Note 5). Interest costs related to prior years' tax issues are included in the provision for income taxes in 1994 and 1993.\nEARNINGS PER COMMON SHARE\nEarnings per common share are based on the average number of common shares outstanding during the year.\nSTATEMENT OF CASH FLOWS\nCash equivalents are all highly liquid, temporary cash investments purchased with a maturity of three months or less.\nCash flows from purchases and maturities of held-to-maturity securities are classified as cash flows from investing activities. Cash flows from contracts used to hedge cash dividend payments from subsidiaries are classified as part of the effect of exchange rate changes on cash.\nINVENTORIES\nInventories are valued at the lower of cost or market. Cost is determined using the weighted-average method. Market is based on net realizable value.\nPayments received from customers relating to the uncompleted portion of contracts are deducted from applicable inventories.\nINVESTMENTS\nInvestments in companies owned 20 to 50 percent are accounted for using the equity method.\nPROPERTY\nProperty is carried at cost and depreciated primarily using the straight-line method over estimated useful lives of 10 to 40 years for buildings and improvements, and three to 15 years for machinery and equipment.\nINTANGIBLES\nIntangibles are carried at cost and amortized using the straight-line method over their estimated useful lives of not more than 40 years for goodwill, four to 17 years for patents, licenses and trademarks, and three to 24 years for software and other intangibles. Intangibles also include the asset resulting from recognition of the defined benefit pension plan minimum liability, which is amortized as part of net periodic pension cost.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 1 -- ACCOUNTING POLICIES (CONTINUED) DERIVATIVES\nIn 1994, Honeywell adopted Statement of Financial Accounting Standards No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments.\" Honeywell uses derivative financial instruments such as foreign currency contracts (forwards, swaps and options) to manage its foreign currency exposure (see Notes 6, 14 and 15) and interest rate swaps to manage its exposure to interest rate fluctuations and its mix of fixed and floating interest rates (see Notes 14 and 15).\nThe carrying amounts of foreign currency contracts purchased to hedge firm foreign currency commitments are deferred and included in the measurement of the related foreign currency transaction. Gains and losses from other foreign currency transactions are included in selling, general and administrative expenses on the income statement and were not material in any year.\nThe amount to be paid or received from interest rate swaps is charged or credited to interest expense over the lives of the interest rate swap agreements.\nFOREIGN CURRENCY\nForeign currency assets and liabilities are generally translated into U.S. dollars using the exchange rates in effect at the statement of financial position date. Results of operations are generally translated using the average exchange rates throughout the period. The effects of exchange rate fluctuations on translation of assets, liabilities and hedges of cash dividend payments from subsidiaries are reported as accumulated foreign currency translation and increased\/(reduced) stockholders' equity $54.5 in 1994, $(3.0) in 1993 and $(74.8) in 1992.\nPOSTEMPLOYMENT BENEFITS\nIn 1992, Honeywell adopted Statement of Financial Accounting Standards No. 112 (SFAS 112), \"Employers' Accounting for Postemployment Benefits.\" The pre-tax cumulative effect of this accounting change to January 1, 1992, was $39.7 and resulted in a reduction in net income of $24.6 ($0.18 per share).\nThe enactment by Congress of the Omnibus Budget Reconciliation Act of 1993, which made Medicare the primary provider of medical benefits for disabled former employees after 29 months of disability, reduced the accumulated benefit obligation for postemployment benefits by $33.4 in 1993. This change in estimate is included in cost of sales on the income statement.\nRECLASSIFICATIONS\nCertain amounts in prior years' income statements have been reclassified to conform to the current year presentation.\nNOTE 2 -- ACQUISITIONS AND SALE OF ASSETS Honeywell acquired 15 companies in 1994, eight companies in 1993 and nine companies in 1992 for $104.6, $14.2 and $83.5 in cash, respectively. These acquisitions were accounted for as purchases, and accordingly, the assets and liabilities of the acquired entities have been recorded at their estimated fair values at the dates of acquisition. The excess of purchase price over the estimated fair values of the net assets acquired, in the amount of $82.4 in 1994, $11.8 in 1993 and $44.2 in 1992, has been recorded as goodwill and is amortized over estimated useful lives. The pro forma results for 1994, 1993 and 1992, assuming these acquisitions had been made at the beginning of the year, would not be significantly different from reported results.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 2 -- ACQUISITIONS AND SALE OF ASSETS (CONTINUED) In 1993, Honeywell sold its Keyboard Division to Key Tronic Corporation for $29.7 in cash, notes and common stock. Proceeds from other asset sales, including the collection of notes receivable and sale of stock received from asset sales made in previous years, amounted to $8.6 in 1994, $22.9 in 1993 and $41.1 in 1992. Gains and losses from asset sales were not material in any year and are included in selling, general and administrative expenses on the income statement.\nNOTE 3 -- LITIGATION SETTLEMENTS On April 16, 1993, Honeywell announced the settlement of its lawsuits against the Unisys Corporation and other parties in connection with Honeywell's 1986 purchase of the Sperry Aerospace Group. Honeywell received $70.0 in cash and notes and recorded a gain of $22.4 in 1993 to offset previously incurred costs associated with the matter. In addition, the portion of the purchase price originally allocated to goodwill and other intangibles was reduced by $47.6.\nHoneywell has reached agreement with various camera manufacturers for their use of Honeywell's patented automatic focus camera technology. The total of all one-time settlements recorded in these matters, after associated expenses, resulted in a gain of $10.2 in 1993 and $287.9 in 1992. Several settlements also included licensing agreements that require the payment of royalties to Honeywell based upon the amount of product manufactured or sold by the licensee. Autofocus royalty income from the licensing agreements amounted to $8.2 in 1994, $31.4 in 1993 and $14.9 in 1992, and is included in selling, general and administrative expenses on the income statement.\nNOTE 4 -- SPECIAL CHARGES In December 1994, Honeywell's management, with the approval of the board of directors, committed itself to a plan of action and recorded special charges of $62.7. Honeywell remains committed to efforts to reduce operating costs and improve margins. The actions to be undertaken include a continuation of right-sizing the Space and Aviation Control business segment, a worldwide consolidation of manufacturing capacity, a streamlining and realignment of the overhead structure and corporate expense reductions. Special charges of $51.2 were recorded in 1993 for productivity initiatives to strengthen the company's competitiveness. In 1992, special charges of $128.4 were recorded to right-size the Space and Aviation Control business segment and to reposition the Home and Building Control and Industrial Control business segments to capitalize on emerging market opportunities. Special charges include costs for work force reductions, worldwide facilities consolidation and other cost accruals.\nWork force reduction costs primarily include severance costs related to involuntary termination programs instituted to improve efficiency and reduce costs. These costs amounted to $52.4 in 1994, $43.7 in 1993 and $65.1 in 1992. As a result of the 1994 plan, approximately 1,500 employees will be terminated. Total expenditures of $36.0 in 1994 included $2.9, $26.4 and $6.7 related to costs incurred in 1994, 1993 and 1992, respectively. Total expenditures of $49.8 in 1993 included $7.8 and $42.0 related to costs incurred in 1993 and 1992, respectively. Total expenditures amounted to $2.3 in 1992. Special charges of $5.9 from 1993 and $3.0 from 1992 remain to be paid out as a result of longer-term agreements.\nFacilities consolidation costs are primarily associated with consolidations of branch office space and product lines to restructure and streamline Honeywell's operations. These costs amounted to $10.3 in 1994, $2.0 in 1993 and $42.7 in 1992. Total expenditures of $8.5 in 1994 included $1.6 and $6.9 related to costs incurred in 1993 and 1992, respectively. Total expenditures of $26.2 in\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 4 -- SPECIAL CHARGES (CONTINUED) related to costs incurred in 1992. Total expenditures amounted to $2.0 in 1992. No expenditures have been made under the 1994 plan. Special charges of $0.4 from 1993 and $4.4 from 1992 remain to be paid out as a result of lease costs associated with vacated facilities.\nOther cost accruals include costs of exiting several product lines which were no longer considered complementary to Honeywell's businesses and amounted to $5.5 in 1993 and $20.6 in 1992. Total expenditures of $5.5 in 1994 related to costs incurred in 1993. Total expenditures of $17.0 in 1993 related to costs incurred in 1992. Total expenditures amounted to $3.6 in 1992.\nCash flows from operating activities have funded and are expected to fund all special charges.\nNOTE 5 -- INCOME TAXES\nThe components of income before income taxes consist of the following:\nThe provision for income taxes on that income is as follows:\nA favorable tax settlement reduced the provision for income taxes by $37.6 ($0.29 per share) in the fourth quarter of 1994.\nThe enactment by Congress of the Omnibus Budget Reconciliation Act of 1993, which raised the U.S. federal statutory income tax rate for corporations from 34 percent to 35 percent retroactive to January 1, 1993, did not have a material impact on the 1993 provision for income taxes; however, the enactment of this legislation did result in a one-time gain of $9.2 ($0.07 per share) in 1993 from the revaluation of deferred tax assets.\nIn 1992, Honeywell adopted Statement of Financial Accounting Standards No. 109 (SFAS 109), \"Accounting for Income Taxes,\" and elected not to restate prior years. The cumulative effect of this accounting change to January 1, 1992, was an increase in net income of $31.4 ($0.23 per share), resulting from the recognition of unrecorded deferred tax assets.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 5 -- INCOME TAXES (CONTINUED) A reconciliation of the provision for income taxes to the amount computed using U.S. federal statutory rates is as follows:\nTaxes paid were $79.4 in 1994, $111.2 in 1993 and $244.0 in 1992.\nDeferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of Honeywell's assets and liabilities. Temporary differences comprising the net deferred taxes shown on the statement of financial position are:\nThe components of net deferred taxes shown on the statement of financial position are:\nProvision has not been made for U.S. or additional foreign taxes on $711.0 of undistributed earnings of international subsidiaries, as those earnings are considered to be permanently reinvested in the operations of those subsidiaries. It is not practicable to estimate the amount of tax that might be payable on the eventual remittance of such earnings.\nAt December 31, 1994, foreign subsidiaries had tax operating loss carryforwards of $14.7.\nNOTE 6 -- FOREIGN CURRENCY Honeywell has entered into various foreign currency exchange contracts (primarily Belgian francs, Deutsche marks and Canadian dollars) designed to minimize its exposure to exchange rate fluctuations on foreign currency transactions. Honeywell only uses foreign currency exchange contracts to hedge underlying exposures such as non-functional currency receivables and payables and foreign currency imports and exports. Company policy prohibits speculation in foreign currency contracts.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 6 -- FOREIGN CURRENCY (CONTINUED) Foreign exchange contracts reduce Honeywell's overall exposure to exchange rate movements, since the gains and losses on these contracts offset losses and gains on the assets, liabilities and transactions being hedged. Honeywell hedges a significant portion of all known foreign exchange exposures. The notional amount of Honeywell's outstanding foreign currency contracts, consisting of forwards, purchased options and swaps, at December 31, 1994, was approximately $1,088.6. The remaining term of the contracts is generally less than one year. The amount of hedging gains and losses deferred was not material at December 31, 1994.\nNOTE 7 -- INVESTMENTS IN DEBT AND EQUITY SECURITIES In 1994, Honeywell adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which specifies certain accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities.\nHoneywell's investments in held-to-maturity securities totaled $144.4 at December 31, 1994, and are reported at amortized cost in the statement of financial position as follows: cash equivalents, $124.9; short-term investments, $6.6; and investments and advances, $12.9. Held-to-maturity securities generally mature within one year and include the following: time deposits with financial institutions, $116.2; commercial paper, $12.0; and other, $16.2. During 1994, Honeywell purchased $233.9 of held-to-maturity securities. Proceeds from maturities of held-to-maturity securities amounted to $233.0. Honeywell has no investments in trading securities, and available-for-sale securities are not material. The estimated aggregate fair value of these securities approximates their carrying amounts in the statement of financial position. Gross unrealized holding gains and losses are not material.\nNOTE 8 -- RECEIVABLES Receivables have been reduced by an allowance for doubtful accounts as follows:\nReceivables include approximately $21.9 in 1994 and $21.1 in 1993 billed to customers but not paid pursuant to contract retainage provisions. These balances are due upon completion of the contracts, generally within one year.\nUnbilled receivables related to long-term contracts amount to $295.9 in 1994 and $275.6 in 1993 and are generally billable and collectible within one year.\nLong-term, interest-bearing notes receivable from the sale of assets have been reduced by valuation reserves of $1.9 in 1994 and $3.6 in 1993 to an amount that approximates realizable value.\nIn 1992, Honeywell entered into a three-year agreement with a large international banking institution, whereby it can sell an undivided interest in a designated pool of trade accounts receivable up to a maximum of $50.0 on an ongoing basis and without recourse. As collections reduce accounts receivable sold, Honeywell may sell an additional undivided interest in new receivables to bring the amount sold up to the $50.0 maximum. Proceeds received from the sale of receivables are included in cash flows from operating activities in the statement of cash flows and amounted to $34.4 in 1994, $193.7 in 1993 and $30.9 in 1992. The uncollected balance of receivables sold amounted to $2.4 and $37.9 at December 31, 1994, and 1993, respectively, and averaged $4.2 and $21.7 during those respective years. The discount recorded on sale of receivables is included in selling, general and\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 8 -- RECEIVABLES (CONTINUED) administrative expenses on the income statement and amounted to $0.4, $0.7 and $0.6 in 1994, 1993 and 1992, respectively. Honeywell, as agent for the purchaser, retains collection and administrative responsibilities for the participating interests sold.\nNOTE 9 -- INVENTORIES\nInventories related to long-term contracts are net of payments received from customers relating to the uncompleted portions of such contracts in the amounts of $32.5 and $36.8 at December 31, 1994, and 1993, respectively.\nNOTE 10 -- PROPERTY, PLANT AND EQUIPMENT\nNOTE 11 -- FOREIGN SUBSIDIARIES The following is a summary of financial data pertaining to foreign subsidiaries:\nInsofar as can be reasonably determined, there are no foreign-exchange restrictions that materially affect the financial position or the operating results of Honeywell and its subsidiaries.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 12 -- INVESTMENTS IN OTHER COMPANIES Following is a summary of financial data pertaining to companies 20 to 50 percent owned. The principal company included is Yamatake-Honeywell Co., Ltd., of which Honeywell owns 24.2 percent of the outstanding common stock.\nNOTE 13 -- INTANGIBLE ASSETS Intangible assets have been reduced by accumulated amortization as follows:\nNOTE 14 -- DEBT\nSHORT-TERM DEBT\nHoneywell had general purpose lines of credit available totaling $1,075.8 at December 31, 1994. Domestic revolving credit lines with 21 banks total $737.0, which management believes is adequate to meet its financing requirements, including support of commercial paper and bank note borrowings. These domestic lines have commitment fee requirements. There were no borrowings on these lines at December 31, 1994. The remaining credit facilities of $338.8 have been arranged by non-U.S. subsidiaries in accordance with customary lending practices in their respective countries of operation. Borrowings against these lines amounted to $3.1 at December 31, 1994. The weighted-average interest rate on short-term borrowings outstanding at December 31, 1994, and 1993, respectively, was as follows: commercial paper, 5.7 percent and 3.3 percent; and notes payable, 5.8 percent and 10.1 percent.\nShort-term debt consists of the following:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 14 -- DEBT (CONTINUED) LONG-TERM DEBT\nThe 8 percent dual-currency yen\/U.S. dollar notes due 1995 are repayable at a fixed exchange rate and are linked to a currency exchange agreement that results in a fixed U.S. dollar interest cost of 10.5 percent.\nThe 6 1\/4 percent Deutsche mark bonds due 1997 are linked to a currency exchange agreement that converts principal and interest payments into fixed U.S. dollar obligations with an interest cost of 8.17 percent.\nIn August 1994, Honeywell initiated a $500.0 medium-term note program whereby it may issue notes with maturities of nine months to 30 years denominated in U.S. dollars or foreign currencies with fixed or variable interest rates. Honeywell issued $100.5 of U.S. dollar fixed-rate medium-term notes in 1994.\nHoneywell utilizes interest rate swaps to manage its interest rate exposures and its mix of fixed and floating interest rates. In 1992, Honeywell entered into interest rate swap agreements effectively converting $100.0 of its 8 5\/8 percent debentures due 2006 from fixed-rate debt to floating-rate debt based on six-month LIBOR rates. During 1993, $50.0 of the $100.0 swap was terminated resulting in a gain of $0.9, which is being amortized over the remaining life of the swap agreement. In 1993, Honeywell entered into interest rate swap agreements effectively converting the 9.6 percent Canadian dollar notes due 1996 to floating-rate debt based on three-month Canadian bankers acceptance rates. In 1994, Honeywell entered into interest rate swap agreements effectively converting $30.0 of medium-term notes due 1998 and $70.5 of medium-term notes due 1999 to floating rate debt based on three-month LIBOR rates. These swap agreements expire in September 1995 for the 8 5\/8 percent debentures, December 1996 for the 9.6 percent Canadian dollar notes, and for the medium-term notes: $10.0 in March 1998, $20.0 in May 1998, $50.0 in August 1999 and $20.5 in September 1999.\nIn 1992, Honeywell redeemed its 9 3\/8 percent debentures due 2005 to 2009, its 8.2 percent debentures due 1996 to 1998, its 9 7\/8 percent debentures due 1998 to 2017, and certain notes due 1993 to 2004, amounting to $9.6 with interest rates ranging from 7.5 percent to 11.75 percent. These early redemptions required the payment of premiums and the recognition of unamortized discounts and\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 14 -- DEBT (CONTINUED) deferred cost resulting in the recording of an extraordinary loss of $13.8, or $8.6 ($0.06 per share) after income taxes. Honeywell redeemed an additional $5.9 of notes due 1993 to 2000 with interest rates ranging from 10 percent to 12.1 percent in 1993 with no additional income statement impact.\nAnnual sinking-fund and maturity requirements for the next five years on long-term debt outstanding at December 31, 1994, are as follows:\nInterest paid amounted to $69.1, $63.9 and $98.5 in 1994, 1993 and 1992, respectively.\nNOTE 15 -- FAIR VALUE OF FINANCIAL INSTRUMENTS All financial instruments are held for purposes other than trading. The estimated fair values of all nonderivative financial instruments approximate their carrying amounts in the statement of financial position with the exception of long-term debt. The estimated fair value of long-term debt is based on quoted market prices for the same or similar issues or on current rates available to Honeywell for debt of the same remaining maturities. The carrying amount of long term debt was $634.9 and $504.3 at December 31, 1994, and 1993, respectively; and the fair value was $630.3 and $569.0 at December 31, 1994, and 1993, respectively.\nThe carrying amount of interest rate swaps was zero and $0.3 at December 31, 1994, and 1993, respectively. The gross unrealized market (loss)\/gain on interest rate swaps was $(7.5) and $2.8 at December 31, 1994, and 1993, respectively. The carrying amount of foreign currency contracts was $18.3 and $10.4 at December 31, 1994, and 1993, respectively. The gross unrealized market gain on foreign currency contracts was $26.6 and $19.9 and the gross unrealized market loss was $28.3 and zero at December 31, 1994, and 1993, respectively. The estimated fair value of interest rate swaps and foreign currency contracts, which is the gross unrealized market gain or loss, is based primarily on quotes obtained from various financial institutions that deal in these types of instruments.\nHoneywell is exposed to credit risk to the extent of nonperformance by the counterparties to the foreign currency contracts and the interest rate swaps discussed above. However, the credit ratings of the counterparties, which consist of a diversified group of financial institutions, are regularly monitored and risk of default is considered remote.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 16 -- LEASING ARRANGEMENTS As lessee, Honeywell has minimum annual lease commitments outstanding at December 31, 1994, with the majority of the leases having initial periods ranging from one to 10 years. Following is a summary of operating lease information.\nRent expense for operating leases was $136.9 in 1994, $134.2 in 1993 and $128.0 in 1992.\nSubstantially all leases are for plant, warehouse, office space and automobiles. A number of the leases contain renewal options ranging from one to 10 years.\nNOTE 17 -- CAPITAL STOCK\nSTOCK SPLIT\nOn November 9, 1992, the board of directors authorized a two-for-one stock split in the form of a stock dividend payable to stockholders of record November 27, 1992. All references in the financial\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 17 -- CAPITAL STOCK (CONTINUED) statements relating to 1992 for average number of shares outstanding and related prices, per share amounts, stock plan data and the 1992 share amounts in the table above have been restated to reflect this split.\nKEY EMPLOYEE PLANS\nIn 1993, the board of directors adopted, and the stockholders approved, the 1993 Honeywell Stock and Incentive Plan. The plan, which terminates December 31, 1998, provides for the award of up to 7,500,000 shares of common stock. The purpose of the plan is to further the growth, development and financial success of Honeywell and its subsidiaries by aligning the personal interests of key employees, through the ownership of shares of common stock and through other incentives, to those of Honeywell stockholders. The plan is further intended to provide flexibility to Honeywell in its ability to compensate key employees and to motivate, attract and retain the services of such key employees who have the ability to enhance the value of Honeywell and its subsidiaries. Awards made under the plan may be in the form of stock options, restricted stock or other stock-based awards. The plan replaced existing similar plans, and awards currently outstanding under those plans were not affected. There were 10,539,718 shares reserved for all key employee plans at December 31, 1994.\nOptions to purchase common stock have been granted to key employees at 100 percent of the market price on the date of grant, pursuant to stockholder-approved plans. The following is a summary of existing stock options under all plans:\nOptions totaling 4,390,382 shares at prices ranging from $15 to $38 were exercisable at December 31, 1994.\nRestricted shares of common stock are issued to certain key employees as compensation. Restricted shares are awarded with a fixed restriction period, usually five years, or with a restriction period that may be shortened dependent on the achievement of performance goals within a specified measurement period. Participants have the rights of stockholders, including the right to receive cash dividends and the right to vote. Restricted shares forfeited revert to Honeywell at no cost. Restricted shares issued totaled 141,376 in 1994, 533,995 in 1993 and 47,812 in 1992. The cost of restricted stock is charged to income over the restriction period and amounted to $5.6 in 1994, $6.3 in 1993 and $6.5 in 1992. At December 31, restricted shares outstanding pursuant to key employee plans totaled 767,209 in 1994, 775,861 in 1993 and 412,872 in 1992.\nEMPLOYEE STOCK MATCH AND STOCK PURCHASE PLANS\nIn 1990, Honeywell adopted Stock Match and Performance Stock Match plans under which Honeywell matches, in the form of Honeywell common stock, certain eligible U.S. employee savings\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 17 -- CAPITAL STOCK (CONTINUED) plan contributions. Shares issued under the stock match plans totaled 634,561 shares in 1994, 643,913 shares in 1993 and 977,716 shares in 1992 at a cost of $20.7, $22.3 and $33.3, respectively. There were 1,713,734 shares reserved for employee stock match plans at December 31, 1994.\nHoneywell has granted to eligible foreign subsidiary employees the right to purchase common stock, principally at the lower of 85 percent of the market price at the time of grant or at the time of purchase. Total shares issued under the foreign stock purchase plans amounted to 49,250 in 1992 at an average price per share of $33. There were no shares issued in 1994 or 1993 under these plans.\nSTOCK PLEDGE\nIn 1993, Honeywell pledged to the Honeywell Foundation a five-year option to purchase 2,000,000 shares of common stock at $33 per share. This option is transferable to charitable organizations and exercisable in whole or in part, subject to certain conditions, from time to time during its term. No shares were purchased under this option in 1994 or 1993 and at December 31, 1994, there were 2,000,000 shares reserved for this pledge.\nPREFERENCE STOCK\nTwenty-five million preference shares with a par value of $1 per share have been authorized. None has been issued at December 31, 1994.\nNOTE 18 -- RETAINED EARNINGS\nIncluded in retained earnings are undistributed earnings of companies 20 to 50 percent owned, amounting to $131.8 at December 31, 1994.\nNOTE 19 -- SEGMENT INFORMATION Honeywell's operations are engaged in the design, development, manufacture, marketing and service of control solutions in three industry segments -- Home and Building Control, Industrial Control and Space and Aviation Control.\nHome and Building Control provides products and services to create efficient, safe, comfortable environments by offering controls for heating, ventilation, humidification and air-conditioning equipment; security and fire alarm systems; home automation systems; energy-efficient lighting controls; and building management systems and services.\nIndustrial Control produces systems for the automation and control of process operations in industries such as oil refining, oil and gas drilling, pulp and paper manufacturing, food processing, chemical manufacturing and power generation; solid-state sensors for position, pressure, air flow, temperature and current; precision electromechanical switches; manual controls; advanced vision-based sensors; fiber-optic components; and solenoid valves used in fluid control and processing industries.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 19 -- SEGMENT INFORMATION (CONTINUED) Space and Aviation Control is a full-line avionics supplier and systems integrator for commercial, military and space applications, providing automatic flight control systems, electronic cockpit displays, flight management systems, navigation, surveillance and warning systems, severe weather avoidance systems and flight reference sensors.\nThe \"other\" category comprises various operations, such as Solid State Electronics Center and Honeywell Technology Center, that are not a significant part of Honeywell's operations either individually or in the aggregate.\nInformation concerning Honeywell's sales, operating profit and identifiable assets by industry segment can be found on page 10. This information for 1994, 1993 and 1992 is an integral part of these financial statements. Sales include external sales only. Intersegment sales are not significant. Corporate and other assets include the assets of the entities in the \"other\" category and cash, short-term investments, investments, property and deferred taxes held by corporate.\nFollowing is additional financial information relating to industry segments:\nHoneywell engages in material operations in foreign countries, the majority of which are located in Europe. Other geographic areas of operation include Canada, Mexico, Australia, South America and the Far East.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 19 -- SEGMENT INFORMATION (CONTINUED) Following is financial information relating to geographic areas:\nHoneywell transfers products from one geographic region for resale in another. These transfers are priced to provide both areas with an equitable share of the overall profit.\nOperating profit is net of provisions for special charges amounting to $62.7, $51.2 and $128.4 in 1994, 1993 and 1992, respectively, (see Note 4) as follows: United States, $23.2, $22.4 and $79.8; Europe, $29.6, $20.3 and $29.7; other areas, $9.9 in 1994 and $9.3 in 1992. General corporate expense includes special charges of $8.5 in 1993 and $9.6 in 1992.\nGeneral corporate expense has been reduced by royalty income of $8.2 in 1994, $31.4 in 1993 and $14.9 in 1992 (see Note 3).\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 20 -- PENSION PLANS Honeywell and its subsidiaries have noncontributory defined benefit pension plans that cover substantially all of their U.S. employees. The plan covering non-union employees provides pension benefits based on employee average earnings during the highest paid 60 consecutive calendar months of employment during the 10 years prior to retirement. The plan covering union employees provides pension benefits of stated amounts for each year of credited service. Funding for these plans is provided solely through contributions from Honeywell determined by the board of directors after consideration of recommendations from the plans' independent actuary. Such recommendations are based on actuarial valuations of benefits payable under the plans.\nThe components of net periodic pension cost for U.S. defined benefit pension plans are as follows:\nFollowing is a summary of assumptions used in the accounting for the U.S. defined benefit plans.\nEmployees in foreign countries who are not U.S. citizens are covered by various retirement benefit arrangements, some of which are considered to be defined benefit pension plans for accounting purposes. The cost of all foreign pension plans charged to income was $1.2 in 1994, $14.2 in 1993 and $9.0 in 1992.\nThe components of net periodic pension cost for foreign defined benefit pension plans are as follows:\nAssumptions used in the accounting for foreign defined benefit plans were:\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 20 -- PENSION PLANS (CONTINUED) The plans' funded status as of September 30 and amounts recognized in Honeywell's statement of financial position for its pension plans are summarized below.\nAdjustments recorded to recognize the minimum liability required for defined benefit pension plans whose accumulated benefits exceed assets amounted to $129.4 in 1994 and $113.0 in 1993. A corresponding amount was recognized as an intangible asset to the extent of unrecognized prior service cost and unrecognized transition obligation. At December 31, 1994, $9.6 of excess minimum liability resulted in a reduction in stockholders equity, net of income taxes, of $5.9. At December 31, 1993, $21.0 of excess minimum liability resulted in a reduction in stockholders equity, net of income taxes, of $12.8.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 20 -- PENSION PLANS (CONTINUED) Plan assets are held by trust funds devoted to servicing pension benefits and are not available to Honeywell until all covered benefits are satisfied after a plan is terminated. The assets held by the trust funds consist of a diversified portfolio of fixed-income investments and equity securities.\nNOTE 21 -- POSTRETIREMENT BENEFITS OTHER THAN PENSIONS In 1992, Honeywell adopted Statement of Financial Accounting Standards No. 106 (SFAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires recognition of the expected cost of providing postretirement benefits over the time employees earn the benefits.\nSubstantially all of Honeywell's domestic and Canadian employees who retire from Honeywell between the ages of 55 and 65 with 10 or more years of service are eligible to receive health-care benefits, until age 65, identical to those available to active employees. Honeywell funds postretirement benefits on a pay-as-you-go basis.\nHoneywell elected to immediately recognize the cumulative effect of this change in accounting for postretirement benefits for both U.S. and Canadian plans, reducing net income by $151.3 ($1.09 per share). The pre-tax cumulative effect of $244.1 represents the accumulated postretirement benefit obligation (APBO) existing at January 1, 1992, less $11.3 related to discontinued product lines recorded in prior years.\nThe components of net periodic postretirement benefit cost are as follows:\nThe amounts recognized in Honeywell's statement of financial position are as follows:\nThe discount rate used in determining the APBO was 8.0 percent in 1994 and 7.0 percent in 1993. The assumed health-care cost trend rate used in measuring the APBO was 10.1 percent in 1995, then declining by 0.6 percent per year to an ultimate rate of 5.5 percent. The health-care cost trend rate assumption has a significant effect on the amounts reported. For example, a 1 percent increase in the health-care trend rate would increase the APBO by 11 percent at December 31, 1994, and the net periodic postretirement benefit cost by 14 percent for 1994.\nNOTE 22 -- CONTINGENCIES\nLITTON LITIGATION\nOn March 13, 1990, Litton Systems, Inc. filed suit against Honeywell in U.S. District Court, Central District of California, alleging Honeywell patent infringement relating to the process used by Honeywell to coat mirrors incorporated in its ring laser gyroscopes; attempted monopolization by\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 22 -- CONTINGENCIES (CONTINUED) Honeywell of certain alleged markets for products containing ring laser gyroscopes; and intentional interference by Honeywell with Litton's prospective advantage in European markets and with its contractual relationships with Ojai Research, Inc., a California corporation. Honeywell has filed counterclaims against Litton alleging, among other things, violations by Litton of various antitrust laws including attempted monopolization of markets for inertial systems and interference with Honeywell's relationships with suppliers.\nThe trial of the patent infringement and intentional interference claims commenced June 4, 1993, and on August 31, 1993, a federal court jury in U.S. District Court in Los Angeles returned a verdict against Honeywell on each of these claims and awarded damages in the amount of $1,200.0 and concluded that the patent infringement was willful. Honeywell contended that the verdict was unsupported by the facts; that the Litton patent was invalid; and that Honeywell's process differed from Litton's. The judge in the case held a hearing November 22, 1993, on various issues including, among others, Honeywell's claims that the patent was improperly obtained due to alleged \"inequitable conduct\" on the part of Litton; Honeywell's other legal and equitable defenses; and Litton's motion to enhance the damage award. On January 9, 1995, the court issued a decision in favor of Honeywell, ruling that the Litton patent was unenforceable because it was obtained by inequitable conduct and invalid because it was an invention that would have been obvious from combining existing processes. The court further ruled that if the judgment is subsequently vacated or reversed as a result of an appeal of the court's ruling, a new trial on the issue of damages would be held on the ground that the jury's award was inconsistent with the clear weight of the evidence and to permit it to stand would constitute a miscarriage of justice. Litton has filed a motion to appeal the court's ruling. The trial for the antitrust claims of Litton and Honeywell is currently scheduled to commence in November 1995.\nHoneywell believes that the court's ruling was correct and continues to believe that Litton's claims are without merit. As a result, no provision has been made in the financial statements with respect to this contingent liability.\nENVIRONMENTAL MATTERS\nHoneywell's manufacturing sites generate both hazardous and nonhazardous wastes, the treatment, storage, transportation and disposal of which are subject to various local, state and national laws relating to protection of the environment. Honeywell is in varying stages of investigation or remediation of potential, alleged or acknowledged contamination at current or previously owned or operated sites and at off-site locations where its wastes were taken for treatment or disposal. In connection with the cleanup of various off-site locations, Honeywell, along with a large number of other entities, has been designated a potentially responsible party (PRP) by the U.S. Environmental Protection Agency under the Comprehensive Environmental Response, Compensation and Liability Act or by state agencies under similar state laws (Superfund), which potentially subjects PRPs to joint and several liability for the costs of such cleanup. In addition, Honeywell is incurring costs relating to environmental remediation pursuant to the federal Resource Conservation and Recovery Act. Based on Honeywell's assessment of the costs associated with its environmental responsibilities, compliance with federal, state and local laws regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had, and in the opinion of Honeywell management, will not have a material effect on Honeywell's financial position, net income, capital expenditures or competitive position. Honeywell's opinion with regard to Superfund matters is based on its assessment of the predicted investigation, remediation and associated costs, its expected share of those costs and the availability of legal defenses. Honeywell's policy is to record environmental liabilities when loss amounts are probable and reasonably estimable.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED) HONEYWELL INC. AND SUBSIDIARIES (DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)\nNOTE 22 -- CONTINGENCIES (CONTINUED) OTHER MATTERS\nHoneywell is a party to a large number of other legal proceedings, some of which are for substantial amounts. It is the opinion of management that any losses in connection with these matters will not have a material effect on Honeywell's net income, financial position or liquidity.\nNOTE 23 -- QUARTERLY DATA (UNAUDITED)\nThe fourth quarter of 1994 includes special charges of $62.7, or $37.6 ($0.29 per share) after income taxes (see Note 4). The fourth quarter of 1994 also includes a reduction of the provision for income taxes of $37.6 ($0.29 per share) related to a favorable tax settlement (see Note 5).\nThe third quarter of 1993 includes a gain of $9.2 from the revaluation of deferred tax assets (see Note 5). The fourth quarter of 1993 benefited from a change in estimate of $33.4 for postemployment benefits (see Note 1) that was partially offset by accruals for facilities closures and other expenses in the amount of $26.9. Following is a summary of other significant items affecting 1993 results.\nStockholders of record on February 1, 1995, totaled 31,940.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNo report on Form 8-K reporting a change in Honeywell's certifying independent accountants has been filed within the 24 months prior to the date of the most recent financial statements.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nPages 3 through 8 and page 22 of the Honeywell Notice of 1995 Annual Meeting and Proxy Statement are incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nPages 12 through 20 of the Honeywell Notice of 1995 Annual Meeting and Proxy Statement are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPage 11 of the Honeywell Notice of 1995 Annual Meeting and Proxy Statement are 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) DOCUMENTS FILED AS A PART OF THIS REPORT\n1. FINANCIAL STATEMENTS The financial statements required to be filed as part of this Annual Report on Form 10-K are listed below with their location in this report.\n2. FINANCIAL STATEMENT SCHEDULES The schedules required to be filed as part of this Annual Report on Form 10-K are listed below with their location in this report.\nAll schedules, other than indicated above, are omitted because of the absence of the conditions under which they are required or because the information required is shown in the financial statements or notes thereto.\n3. EXHIBITS 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 report to be signed on its behalf by the undersigned, thereunto duly authorized.\nHONEYWELL INC.\nBy: \/s\/ SIGURD UELAND, JR.\n----------------------------------- Sigurd Ueland, Jr., Vice President\nDated: March 29, 1995\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 -------------------- --------------------------------------------------------\nM. R. BONSIGNORE Chairman of the Board and Chief Executive Officer and Director\nW. M. HJERPE Vice President and Chief Financial Officer\nP. M. PALAZZARI Vice President and Controller\nA. J. BACIOCCO, JR. Director\nE. E. BAILEY Director\nE. H. CLARK, JR. Director\nW. H. DONALDSON Director\nR. D. FULLERTON Director\nJ. J. HOWARD Director\nB. E. KARATZ Director\nD. L. MOORE Director\nA. B. RAND Director\nS. G. ROTHMEIER Director\nM. W. WRIGHT Director\nBy: \/s\/ SIGURD UELAND, JR.\n----------------------------------- Sigurd Ueland, Jr., ATTORNEY-IN-FACT March 29, 1995\nSCHEDULE II\nHONEYWELL INC. AND SUBSIDIARIES VALUATION RESERVES FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (DOLLARS IN MILLIONS)","section_15":""}
{"filename":"790730_1994.txt","cik":"790730","year":"1994","section_1":"ITEM 1 - BUSINESS\n(a) GENERAL DEVELOPMENT OF BUSINESS.\nAlthough the Company's antecedents date back to 1907, it evolved directly from the merger of two separate firms in 1929, resulting in the incorporation of American Concrete Pipe Co. on April 22, 1929. Various name changes occurred between that time and 1942, at which time the Company's name became American Pipe and Construction Co. By the late 1960s the Company was almost exclusively engaged in manufacturing and had expanded its product lines to include not only concrete and steel pipe but also high-performance protective coatings, ready-mix concrete, aggregates and reinforced thermosetting resin pipe and fittings.\nAt the beginning of 1970, the Company's name was changed to Ameron, Inc. In the meantime, other manufactured products had been added to its product lines. These included concrete and steel poles for street and area lighting, and tapered steel vertical and cantilevered poles for traffic signals. In 1984, the Company acquired a major domestic fiberglass pipe business, including a manufacturing plant in Burkburnett, Texas, and certain trade names and patent rights. In 1988, the Company expanded its ability to serve the water transmission and distribution market through the acquisition of a major steel pipe fabricating facility in Fontana, California.\nFurther details or commentary on the year's operations can be found in the Annual Report, which is Exhibit 13 to this report on Form 10-K, and which should be read in conjunction with this report.\n(b) FINANCIAL INFORMATION AS TO INDUSTRY SEGMENTS.\nThe information contained in Notes (1), (4) and (14) of Notes to Consolidated Financial Statements on pages 42, 43, 48, 50 and 51 of the Annual Report is incorporated herein by reference.\n(c) NARRATIVE DESCRIPTION OF BUSINESS.\n(1) For geographical and operational convenience, the Company is organized into divisions. These divisions are combined into the following groups serving the following-described industry segments.\na) The Protective Coatings Group develops, manufactures and markets high-performance coatings and surfacer systems on a world-wide basis. These products are utilized for the preservation of major structures, such as metallic and concrete facilities and equipment, to prevent their degradation by corrosion, abrasion, marine fouling and other forms of chemical and physical attack. The primary markets served include marine, offshore, petrochemical, power generation, petroleum, chemical, steel, pulp and paper, railroad, bridges, mining, metal processing and original equipment manufacturing. These products are marketed by direct sales, as well as through manufacturers' representatives, distributors and licensees. Competition is based upon\nquality, price and service. Manufacture of these products is carried out in the Company's plant in Arkansas, by a wholly-owned subsidiary in The Netherlands, by jointly-owned operations in Mexico and Saudi Arabia and by various third party licensees. The Company licenses its patents, trademarks, know-how and technical assistance to various of its subsidiary and affiliated companies and to various third party licensees.\nb) The Fiberglass Pipe Group develops, manufactures and markets filament-wound and molded fiberglass pipe and fittings. These products are used by a wide range of process industries, including industrial, petroleum, chemical processing and petrochemical industries, for service station replacement piping systems, aboard marine vessels and on offshore oil platforms, and are marketed as an alternative to metallic piping systems which ultimately fail under corrosive operating conditions. These products are marketed by direct sales, as well as through manufacturers' representatives, distributors and licensees. Competition is based upon quality, price and service. Manufacture of these products is carried out in the Company's plants in Texas and South Carolina, by wholly-owned subsidiaries in The Netherlands and Singapore, and by a jointly-owned affiliate in Saudi Arabia.\nc) The Concrete and Steel Pipe Group supplies products and services used in the construction of pipeline facilities for various utilities. Eight plants are located in three of the continental western states. These plants manufacture concrete cylinder pipe, prestressed concrete cylinder pipe, steel pipe and reinforced concrete pipe for water transmission, storm and industrial waste water and sewage collection. These products are marketed by direct selling using the Company's own personnel and by competitive bidding. Customers include local, state and federal agencies, developers and general contractors. Normally no one customer or group of customers will account for sales equal to or greater than 10 percent of the Company's consolidated revenue. However, occasionally, when more than one unusually large project is in progress, combined sales to all U.S. government agencies and\/or general contractors for those agencies can reach those proportions. Besides competing with several other concrete pipe manufacturers located in the market area, alternative products such as ductile iron, asbestos cement, and clay pipe compete with the Company's concrete and steel pipe products, but ordinarily these other materials do not offer the full diameter range produced by the Company. Principal methods of competition are price, delivery schedule and service. The Company's technology is used in the Middle East through affiliated companies whose activities are not reflected in the amounts reported for this industry segment. This segment also includes the manufacturing and marketing on a world-wide basis through direct sales of polyvinyl chloride sheet lining for the protection of concrete pipe and cast-in-place concrete structures from the corrosive effects of sewer gases, acids and industrial chemicals. Competition is based on quality, price and service. Manufacture of this product is carried out in the Company's plant in California. This segment also includes engineered design, fabrication and direct sale of specialized proprietary equipment which is outside the regular business of the other segments of the Company's businesses. Competition for such work is based upon quality, price and service. Manufacture of such equipment is carried out in the Company's plant in California.\nd) The Construction & Allied Products Group includes the HC&D Division, which supplies ready-mix concrete, crushed and sized basaltic aggregates, dune sand, concrete pipe and box culverts, primarily to the construction industry in Hawaii. These products are marketed through direct sales. Ample raw materials are available locally in Hawaii and, as to rock products, the Company has exclusive rights to a quarry containing many years' reserves. Within the market area there are competitors for each of the segment's products. No single competitor offers the full range of products sold by the Company in Hawaii. The principal methods of competition\nare in price and service, since an appreciable portion of the segment's business is obtained through competitive bidding.\nThis segment also includes the operations of the Pole Products Division, which manufactures and markets concrete and steel poles for highway, street and outdoor area lighting and for traffic signals. Sales are nationwide, but with a stronger concentration in the western states. Marketing is handled by the Company's own sales force and by outside sales agents. Competition for such products is mainly based on price, but with some consideration for service and delivery. Manufacture of these products is carried out in two plants in California, as well as plants in Washington and Oklahoma.\ne) Except as individually shown in the above descriptions of industry segments, the following comments or situations apply to all segments:\n(i) Because of the number of manufacturing locations and the variety of raw materials essential to the business, no critical situations exist with respect to supply of materials. The Company has multiple sources for raw materials. The effects of increases in costs of energy are being mitigated to the extent practical through conservation and through addition or substitution of equipment to manage the use and reduce consumption of energy.\n(ii) The Company owns certain patents and trademarks, both U.S. and foreign, related to its products. It licenses these proprietary items to some extent in the U.S., and to a greater degree abroad. These patents, trademarks, and licenses do not constitute a material portion of the Company's business. No franchises or concessions exist.\n(iii) Many of the Company's products are used in connection with capital goods, water and sewage transmission and construction of capital facilities. Favorable or adverse effects on general sales volume and earnings can result from weather conditions. Normally, sales volume and earnings will be lowest in the first fiscal quarter. Seasonal effects simply accelerate or slow the business volume and normally do not bring about severe changes in full-year activity.\n(iv) With respect to working capital items, the Company does not encounter any requirements which are not common to other companies engaged in the same industries. No unusual amounts of inventory are required to meet seasonal delivery requirements. All of the Company's industry segments turn their inventory between three and eleven times annually. Average days' sales in accounts receivable range between 38 and 120 for all segments.\n(v) The value of backlog orders at November 30, 1994 and 1993 by industry segment is shown below. A substantial portion of the November 30, 1994 backlog is expected to be billed and recorded as sales during the year 1995.\nThe order backlog at November 30, 1994 increased significantly from the prior year's level. The backlog totalled $156.5 million at November 30, 1994, nearly double the $80.8 million level of November 30, 1993. The improvement reflects increased order activity in the Concrete and Steel Pipe segment (up $76.0 million) as a result of a number of large orders for water transmission systems in California that were awarded in 1994. Included in the backlog for Concrete and Steel Pipe is the Los Vasqueros Reservoir System ($38.0 million), which represents the largest single contract received in Ameron's history. The lower backlog in the Protective Coatings Group ($6.2 million) is the result of lower European orders. The increase in the backlog in the Fiberglass Pipe Group ($6.2 million) is due to increased activity in Europe. The backlog in the Construction and Allied Products Group remained essentially equal to last year's level reflecting the generally stable market conditions in Hawaii.\n(vi) There was no significant change in competitive conditions or the competitive position of the Company in the industries and localities in which it operates. There is no knowledge of any single competitive situation which would be material to an understanding of the business.\n(vii) Sales contracts in all of the Company's business segments normally consists of purchase orders, which in some cases are issued pursuant to master purchase agreements. Longer term contracts seldom involve commitments of more than one year by the Company, and exceptions are not deemed material by management. Payment is normally due from 30 to 60 days after shipment, with progress payments prior to shipment in some circumstances. It is the Company's practice to require letters of credit prior to shipment of foreign orders, subject to limited exceptions. The Company does not typically extend long-term credit to purchasers of its products.\n(2) a) Approximate expense during each of the last three fiscal years for Research and Development costs is shown under the caption in Note (1) of Notes to Consolidated Financial Statements on page 42 of the Annual Report, which information is incorporated herein by reference.\nb) The Company's business is not dependent on any single customer or few customers, the loss of any one or more of whom would have a material adverse effect on its business.\nc) For many years the Company has been consistently installing or improving devices to control or eliminate the discharge of pollutants into the environment. Accordingly, compliance with federal, state, and locally enacted provisions relating to protection of the environment is not having, and is not expected to have, a material effect upon the Company's capital expenditures, earnings, or competitive position.\nd) At year-end the Company and its consolidated subsidiaries employed approximately 2,987 persons. Of those, approximately 1,490 were covered by labor union contracts, and there are five separate bargaining agreements subject to renegotiation in 1995. Management does not presently anticipate a strike or other labor disturbance in connection with renegotiation of these agreements that would have a material adverse impact on the Company; however, the possibility of such an occurrence exists.\n(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES.\nThe information contained in Notes (4) and (14) of Notes to Consolidated Financial Statements on pages 43, 48, 50 and 51 of the Annual Report is incorporated herein by reference.\nExport sales in the aggregate from domestic operations during the last three fiscal years were:\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - DESCRIPTION OF PROPERTY\n(a) The location and general character of principal plants and other materially important physical properties used in the Company's operations is tabulated below. Property is owned in fee except where otherwise indicated by footnote. In addition to the property shown, the Company owns vacant land adjacent to or in the proximity of some of its operating locations and holds this property available for use when it may be needed to accommodate expanded or new operations. Property listed does not include any temporary project sites which are generally leased for the duration of the respective projects. With the exception of the Kailua, Oahu property, shown under the Construction & Allied Products industry segment, there are no material leases with respect to which expiration or inability to renew would have any material adverse effect on the Company's operations. The lease term on the Kailua property extends to the year 2012. This is the principal source of quarried rock and aggregates for the Company's operations on Oahu, Hawaii and, in management's opinion, reserves are adequate for its requirements during the term of the lease.\n(b) The Company believes that its existing facilities are adequate for current and presently foreseeable operations. Because of the cyclical nature of certain of the Company's operations, and the substantial amounts involved in some individual orders, the level of utilization of particular facilities may vary significantly from time to time in the normal course of operations.\nINDUSTRY SEGMENT - GROUP - - - - ------------------------ DIVISION - LOCATION DESCRIPTION ------------------- ----------- PROTECTIVE COATINGS GROUP\nProtective Coatings Division - USA Brea, CA Office, Plant, Laboratory Little Rock, AR Office, Plant\nAmeron B.V. Geldermalsen, The Netherlands Office, Plant\nFIBERGLASS PIPE GROUP\nFiberglass Pipe Division - USA Burkburnett, TX Office, Plant Spartanburg, SC Plant\nAmeron B.V. Geldermalsen, The Netherlands Office, Plant\nAmeron (Pte) Ltd. Singapore *Office, Plant\nCONCRETE AND STEEL PIPE GROUP\nSouthern Division Rancho Cucamonga, CA *Office Etiwanda, CA Plant Lakeside, CA Plant South Gate, CA Plant Palmdale, CA Plant Phoenix, AZ Office, Plant\nNorthern Division Tracy, CA Office, Plant Portland, OR Office, Plant\nSteel Fabrication Division Fontana, CA *Office, Plant\nProtective Linings Division Brea, CA Office, Plant\nFabrication Plant South Gate, CA Office, Plant\nAMERICAN PIPE & CONSTRUCTION INTERNATIONAL Bogota, Colombia Office, Plant Cali, Colombia Plant\nCONSTRUCTION & ALLIED PRODUCTS GROUP\nHC&D Division Honolulu, Oahu, HI *Office, Plant Kailua, Oahu, HI *Plant, Quarry Barbers Point, Oahu, HI *Plant Puunene, Maui, HI *Office, Plant, Quarry\nPole Products Division Fillmore, CA Office, Plant Oakland, CA *Plant Everett, WA *Office, Plant Tulsa, OK *Office, Plant\nCORPORATE Corporate Headquarters Pasadena, CA *Office\nCorporate Research & Engineering South Gate, CA Office, Laboratory\n*Leased\nITEM 3","section_3":"ITEM 3 - LEGAL PROCEEDINGS\nOn January 24, 1992, the Central Arizona Water Conservation District (\"CAWCD\") filed an action for damages against several parties, including the Company, in United States District Court, District of Arizona, in connection with six prestressed concrete pipe siphons furnished and installed in the 1970's as part of the Central Arizona Project (\"CAP\"), a federal project to bring water from the Colorado River to Arizona. The CAWCD also filed separate actions against the U.S. Bureau of Reclamation (\"USBR\") in the United States Claims Court and with the Arizona Projects Office of the USBR in connection with the CAP siphons. The CAWCD alleges that the six CAP siphons are defective and that the USBR and the defendants in the U.S. District Court action are liable for the repair or replacement of those siphons at a claimed estimated cost of $146.7 million. The Company has internally, as well as through independent third party consultants, conducted engineering analyses regarding this issue and believes that the siphons were manufactured in accordance with the project specifications and other contract requirements, and therefore it is not liable for any claims relating to the siphons. On September 14, 1994, the U.S. District Court granted the Company's motion to dismiss the CAWCD action and entered judgment against the CAWCD and in favor of the Company and its co-defendants. CAWCD has filed a notice of appeal with the Ninth Circuit Court of Appeals. The Company has recorded reserves that it believes are adequate to cover costs associated with the Company's vigorous defense of its position in this matter. The Company and its legal counsel believe that it has meritorious defenses to this action and that resultant liability, if any, should not have a material adverse effect on the financial position of the Company and its results of operations.\nOn July 22, 1992, the Company was served with a complaint in an action brought by the City and County of San Francisco (\"CCSF\") in Superior Court, County of San Francisco, State of California against the Company and two co-defendants, in connection with a pipeline referred to as San Andreas Pipeline No. 3, a water transmission pipeline that was installed between 1980 and 1982. The Company furnished the pipe used in that pipeline. The plaintiff alleges that the pipeline is defective. The plaintiff originally sought damages of approximately $44 million to replace the entire pipeline, but in June 1994 it filed its third amended complaint which alleges damages according to proof and in excess of the jurisdictional minimum of $25,000. The Company has recorded reserves that it believes are adequate to cover costs associated with the Company's vigorous defense of its position in this matter. The Company believes that it has meritorious defenses to this action and that resultant liability, if any, should not have a material adverse effect on the financial position of the Company and its results of operations.\nIn addition, certain other claims, suits and complaints, which arise in the ordinary course of business, have been filed or are pending against the Company. Management believes that these matters, and the matters discussed above, are either adequately reserved, covered by insurance, or would not have an adverse material effect on the financial position of the Company and its results of operations if disposed of unfavorably.\nThe Company is also subject to federal, state and local laws and regulations concerning the environment and is currently participating in administrative proceedings at several sites under these laws. It is difficult to estimate with any certainty the total cost of remediation, the timing and extent of remedial actions required by governmental authorities, and the amount of the Company's liability, if any, in proportion to that of other potentially responsible parties. While the Company finds it difficult to estimate with any certainty the total cost of remediation at the several sites which are subject to environmental regulatory proceedings, on the basis of currently available information, the Company does not believe it likely that the outcome of such environmental regulatory proceedings will have a material adverse effect on the Company's financial position or its results of operations. This conclusion is based on the location and type of contamination of each site, potential recovery from insurance carriers and existing reserves. When it has been possible to reasonably estimate the Company's liability with respect to these matters, provisions have been made as appropriate.\nITEM 4","section_4":"ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\n(Not Applicable)\nITEM 4A - EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following sets forth information with respect to individuals who served as executive officers as of November 30, 1994 and who are not directors of the Company. All executive officers are appointed by the Board of Directors to serve at the discretion of the Board of Directors.\nAll of the executive officers named above have held high level managerial or executive positions with the Company for more than the past five years except Mr. Wilkie, who joined the Company in 1994 as Vice President, Financial Planning, Analysis and Management Information Systems and has since been named Vice President, Controller. Prior to joining the Company, he was Corporate Director of Information Systems with GenCorp in Akron, Ohio.\nPART II\nITEM 5","section_5":"ITEM 5 - MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Common Stock, $2.50 Par Value, of the Company, its only outstanding class of common equity, is traded on the New York Stock Exchange, the only exchange on which it is presently listed. On February 10, 1995, there were 1,895 stockholders of record of such stock.\nDividends have been paid each quarter during the prior two years and for many years in the past. Information as to the amount of dividends paid during the reporting period and the high and low sales prices of the Company's Common Stock during that period are set out under the caption Per Share Data shown on page 48 of the Annual Report, which information is incorporated herein by reference.\nTerms of lending agreements which place restrictions on cash dividends are discussed in Note (9) of Notes to Consolidated Financial Statements on page 46 of the Annual Report, which is incorporated herein by reference.\nITEM 6","section_6":"ITEM 6 - SELECTED FINANCIAL DATA\nThe information required by this item is contained in the Selected Consolidated Financial Information shown on page 32 of the 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\nThe information required by this item with respect to fiscal years 1994 and 1993 is shown under Ameron 1994 Financial Review on pages 33-36 of the Annual Report, which information is incorporated herein by reference. The information required for 1992 is as follows:\nRESULTS OF OPERATIONS-1992 COMPARED WITH 1991\nSALES. Sales declined $18.7 million in 1992 due principally to lower deliveries of concrete and steel pipe and construction products. Overall, 1992 revenues reflected a higher proportion of sales from foreign operations.\nBecause of the weak U.S. economic situation, sales in 1992 of protective coatings to domestic commercial utility, petrochemical and offshore markets were near 1991 levels. However, shipments from foreign operations to European and Middle Eastern customers and to a project in North African improved significantly over 1991.\nSales of Fiberglass pipe domestically were lower in 1992 then the previous year, mainly due to the shifting of oil exploration and recovery work from the United States to countries abroad and the impact of the sluggish economy of the capital spending plans of the Company's industrial, chemical and petroleum-related customers. However, declines in U.S. markets were entirely offset by improved sales overseas because of increased industrial development in the Far East and parts of Europe, as well as shipments to several large crude oil projects in North Africa.\nConcrete and steel pipe sales declined in 1992 from 1991 largely because of nonrecurring projects in 1991. The concrete and steel pipe business segment was impacted by the decline in public spending for water transmission systems and reduced construction activity in the Company's geographic markets. The Southwest and Pacific Northwest were in cyclical downturns, and California's depressed condition resulted in severe price competition.\nConstruction products sales declined in 1992 from 1991, due to an overall decline in commercial construction activity in Hawaii that resulted in lower demand for the Company's quarry and concrete pipe products. Commercial construction spending in Hawaii declined because of the reduction in available investment capital. Sales of concrete and steel poles remained flat due to slow housing starts and continued delays in public spending in the western United States.\nGROSS PROFIT. The gross profit margin increased from the 1992 rate of 25.5% to 26.5% in 1992. Although operations were impacted by continued price competition and low production levels caused by weak domestic markets, increased sales on more profitable contracts abroad and previously implemented manufacturing cost reduction programs pushed the rate above the 1991 level. These improvements were realized mainly by foreign operations due to increased shipments of fiberglass pipe and protective coatings to Africa, the Middle East and the Far East. In addition, improved profit margins were recognized on deliveries of concrete and welded steel pressure pipe.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses were $7.1 million higher in 1992 than in 1991. The increase can be attributed to higher insurance charges, reserves for assets related to certain affiliated companies and rent on the corporate headquarters facility. The Company also increased spending to escalate research and development efforts and to strengthen worldwide marketing and sales networks.\nENVIRONMENTAL AND LEGAL CLAIMS. Claims expense increased $3.2 million in 1992, above the 1991 level. A large portion of the increase was attributable to legal costs and a $2 million reserve established in connection with a patent infringement lawsuit.\nOTHER INCOME. Royalty and technical fee income increased slightly in 1992 from the prior year as sales activities of the Company's licensees and affiliated companies remained strong. Foreign currency losses were incurred as a result of the devaluation of the British pound and the increased strength of the Dutch guilder. Interest income was higher due to interest earned on short-term investments and a federal income tax refund. In 1991, other income included $770,000 received from a class action legal settlement.\nINTEREST EXPENSE. Interest expense declined because of lower interest rates and a reduction in debt outstanding.\nPROVISION FOR INCOME TAXES. The Company's effective tax rate declined from 37% in 1991 to 30% in 1992. The lower effective rate was attributable to a higher mix of income coming from foreign operations in 1992 as compared to 1991.\nEQUITY IN EARNINGS OF AFFILIATED COMPANIES. Equity earnings of jointly-owned affiliated companies improved $3 million in 1992 over 1991, due largely to strong performances by the Company's protective coatings, fiberglass pipe and concrete pipe affiliates in the Middle East. Ameron Saudi Arabia, Ltd. provided the greatest contribution to the rise in equity income as it benefitted from increased spending for infrastructure development within the Kingdom of Saudi Arabia. However, Gifford-Hill-American, Inc. incurred losses as a result of weak demand in its markets. Tamco reported higher net income in 1992 because of slightly increased shipments of reinforcing bar and favorable material costs. Bondstrand, Ltd. and Oasis-Ameron, Ltd. produced improved operating results.\nITEM 8","section_7A":"","section_8":"ITEM 8 - FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Consolidated Financial Statements, the report thereon of Arthur Andersen LLP dated January 19, 1995, Notes to Consolidated Financial Statements and Quarterly Financial Data, comprising pages 37 through 49 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\n(Not applicable)\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 is contained under the section entitled, \"Election of Directors\" in the Company's Proxy Statement which was filed on February 24, 1995 in connection with the Annual Meeting of Stockholders to be held on March 27, 1995. Such information is incorporated herein by reference.\nInformation with respect to the executive officers of the Company is located in Part I, Item 4A of this report.\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*\n*The information required by Items 11, 12 and 13 is contained in the Company's Proxy Statement which was filed on February 24, 1995 in connection with the 1995 Annual Meeting of Stockholders to be held on March 27, 1995. Such 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) (1) FINANCIAL STATEMENTS:\nThe financial statements to be filed hereunder are cross-referenced, in the index immediately following, to the Annual Report, as to sections incorporated herein by reference.\nPage Reference Statement to Annual Report --------- ---------------- Consolidated Balance Sheets at November 30, 1994 and 1993 38-39\nConsolidated Statements of Operations for the years ended November 30, 1994, 1993 and 1992 37\nConsolidated Statements of Cash Flows for the years ended November 30, 1994, 1993 and 1992 40\nConsolidated Statements of Stockholders' Equity for the years ended November 30, 1994, 1993 and 1992 41\nNotes to Consolidated Financial Statements 42-48\n(i) Summarized information as to the financial condition and results of operations for Gifford-Hill-American, Inc., Ameron Saudi Arabia, Ltd., Bondstrand, Ltd, Oasis-Ameron, Ltd. and Tamco are presented in Note (4) of Notes to Consolidated Financial Statements on page 43 the Annual Report, which information is incorporated herein by reference.\n(a) (2) FINANCIAL STATEMENT SCHEDULES:\nThe following additional financial data should be read in conjunction with the consolidated financial statements in the 1994 Annual Report. Schedules not included with this additional financial data have been omitted because they are either not applicable, not required, not significant, or the required information is provided in the consolidated financial statements or notes thereto.\nPages of Schedule Schedules of Ameron, Inc. and Subsidiaries This Report -------- ------------------------------------------ ----------- Report of Independent Public Accountants 13\nII Valuation and Qualifying Accounts and Reserves 14-16\n(a) (3) EXHIBITS This Report ----------- 3(i) Certificate of Incorporation 18\n3(ii) Bylaws 19\n4 Instrument Defining the Rights of Security Holders, Including Indentures 20\n10 Material Contracts 21\n13 Annual Report 22\n21 Subsidiaries of the Registrant 23\n23 Consent of Independent Public Accountants 24\n(b) REPORTS ON FORM 8-K\nA report on Form 8-K was filed by the Company on September 15, 1994 reporting under Item 5 the dismissal of an action for damages filed by the Central Arizona Water Conservation District against several parties, including the Company. This matter is discussed in more detail under Part I, Item 3 of this report.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and the Board of Directors, Ameron, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in Ameron, Inc.'s Annual Report to Stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated January 19, 1995. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index above is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states 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 LLP\nLos Angeles, California January 19, 1995\nAMERON, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED NOVEMBER 30, 1994 (In thousands)\nAMERON, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED NOVEMBER 30, 1993 (In thousands)\nAMERON, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES FOR THE YEAR ENDED NOVEMBER 30, 1992 (In thousands)\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.\nAMERON, INC.\nBy: -------------------------------------------------- Javier Solis, Senior Vice President & Secretary\nDate: February 27, 1995\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":"59255_1994.txt","cik":"59255","year":"1994","section_1":"ITEM 1. BUSINESS\nValhi, Inc. (NYSE: VHI), based in Dallas, Texas, is engaged in the chemicals, refined sugar, building products, hardware products and fast food industries. Information regarding the Company's business segments and the operating subsidiaries conducting such businesses is set forth below. Business and geographic segment financial information is included in Note 2 to the Company's Consolidated Financial Statements, which information is incorporated herein by reference.\nChemicals NL is the world's fourth-largest NL Industries, Inc. producer of titanium dioxide (53%-owned) pigments (\"TiO2\"), used for imparting whiteness, brightness and opacity to a wide range of products including paints, plastics, paper, fibers and other \"quality-of-life\" products. With annual TiO2 production capacity of 380,000 metric tons, NL has an 11% share of the worldwide market (18% in Europe). NL is also the world's largest producer of rheological additives for solvent-based systems, supplying an estimated 40% of the worldwide market. NL has production facilities throughout Europe and North America.\nRefined Sugar Amalgamated is the second-largest The Amalgamated Sugar U.S. refiner and processor of Company (100%-owned) sugarbeets with annual production of approximately 11\/2 billion pounds of sugar. Sales from Amalgamated's factories in Idaho and Oregon are principally to industrial sugar users.\nBuilding Products Medite is the world's second Medite Corporation largest producer of medium (100%-owned) density fiberboard (\"MDF\"), a wood fiber-based engineered building board product serving as a cost-effective alternative to certain traditional timber products. With MDF plants in the United States and Ireland, Medite has an estimated 13% market share in North America, a 5% share in Europe and offers a wide range of specialty MDF products. Medite also conducts traditional timber products operations in Oregon where it owns 168,000 acres of timberland.\nHardware Products National Cabinet Lock is a National Cabinet Lock, leading North American\nInc. (100%-owned) manufacturer of low and medium security locks, computer keyboard support arms and precision ball bearing drawer slides for furniture and other markets.\nFast Food Sybra is the second-largest Sybra, Inc. franchisee of Arby's restaurants (100%-owned) with approximately 160 stores clustered principally in Texas, Michigan, Pennsylvania and Florida.\nValhi, a Delaware corporation, is the successor of the 1987 merger of The Amalgamated Sugar Company and LLC Corporation. Contran Corporation holds, directly or through subsidiaries, approximately 90% of Valhi's outstanding common stock. Substantially all of Contran's outstanding voting stock is held by trusts established for the benefit of the children and grandchildren of Harold C. Simmons, of which Mr. Simmons is the sole trustee. Mr. Simmons is Chairman of the Board and Chief Executive Officer of Contran, Valhi and Valcor and Chairman of the Board of NL and may be deemed to control each of such companies.\nDuring 1994, Valhi purchased additional NL common shares in market transactions and thereby increased its direct ownership of NL from 49% to more than 50% in mid-December 1994. Accordingly, the Company ceased to report its interest in NL by the equity method and commenced reporting NL as a consolidated subsidiary. The Company consolidated NL's financial position at December 31, 1994 and will consolidate NL's results of operations and cash flows beginning in 1995. See Note 3 to the Consolidated Financial Statements.\nIn December 1994, Valhi's Board of Directors declared a special dividend on its common stock of all of its 48% ownership interest in Tremont Corporation (3.5 million shares). Valhi stockholders received approximately .03 (three one- hundreds) of a share of Tremont for each share of Valhi common stock held as of the record date in a taxable transaction. The Distribution of Tremont common stock was accounted for as a spin-off (recorded at book value, net of tax), and the Company's equity in losses of Tremont's titanium metals operations are reported as discontinued operations for all periods presented. Tremont also holds 18% of NL's outstanding common stock. See Note 3 to the Consolidated Financial Statements.\nIn March 1995, Medite filed a Registration Statement with the Securities and Exchange Commission for a proposed public offering of approximately $100 million of its common stock, which Registration Statement has not yet become effective. If such offering is completed, the Company's ownership of Medite would be reduced by approximately one-third. There can be no assurance that the proposed Medite stock offering will be consummated. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe Company has tentatively agreed to sell Amalgamated's sugar business, for $325 million cash, to an agricultural cooperative comprised of sugarbeet growers in Amalgamated's area of operations. The proposed transaction is subject to significant conditions, including financing, grower commitments and execution of a definitive purchase agreement, and no assurance can be given that any such transaction will be consummated.\nCHEMICALS - NL INDUSTRIES, INC.:\nNL Industries (NYSE: NL) is an international producer and marketer of TiO2 and specialty chemicals to customers in over 100 countries from facilities located throughout Europe and North America. Kronos, Inc., the largest of NL's two principal operating subsidiaries, is the world's fourth-largest TiO2 producer, with an estimated 11% share of the worldwide market. Approximately one-half of Kronos' 1994 sales volume was in Europe, where Kronos is the second- largest producer of TiO2. Specialty chemicals, primarily rheological additives, are produced through NL's Rheox, Inc. subsidiary. In 1994, Kronos accounted for 87% of NL's sales and Rheox accounted for 13%.\nNL's objectives are to (i) focus on continued cost control, (ii) deleverage during the current upturn cycle and (iii) invest in certain cost effective debottlenecking projects to increase TiO2 production capacity.\nTiO2 products and operations. Titanium dioxide pigments are chemical products used for imparting whiteness, brightness and opacity to a wide range of products, including paints, paper, plastics, fibers and ceramics. TiO2 is considered to be a \"quality-of-life\" product with demand affected by the gross domestic product in various regions of the world.\nDemand, supply and pricing of TiO2 have historically been cyclical. The last cyclical peak for TiO2 prices occurred in early 1990, with a cyclical low in the third quarter of 1993. Kronos' average TiO2 selling prices began an upward trend during 1994, and prices at the end of 1994 were about 10% higher than the 1993 low point but were still approximately 26% below those of the 1990 peak.\nThe Company believes the TiO2 industry has significant potential for future earnings improvment from supply\/demand-driven product price changes. During the early 1990's, the TiO2 industry operated at lower capacity utilization levels relative to the high utilization levels prevalent during the late 1980's, in part because of the slow recovery from the worldwide recession but primarily due to the impact of capacity additions since the late 1980's. NL expects that the TiO2 industry will recover more slowly compared with the previous recovery in the late 1980s, primarily because of the more gradual nature of recent growth of the worldwide economy and the impact of capacity additions since the late 1980s. Recent improvements in the economic growth rates have resulted in increased demand for TiO2. Industry capacity utilization, which NL believes was below 90% during 1990 through 1993, was about 92% in 1994 and is continuing to rise due to improved demand.\nKronos has an estimated 18% share of European TiO2 sales and an estimated 9% share of the U.S. market. Consumption per capita in the United States and Western Europe far exceeds that in other areas of the world and these regions are expected to continue to be the largest geographic markets for TiO2 consumption. If the economies in Eastern Europe, the Far East and China continue to develop, a significant market for TiO2 could emerge in those countries and Kronos believes it is well positioned to participate in growth in Eastern European market.\nNL believes that there are no effective substitutes for TiO2. However, extenders such as kaolin clays, calcium carbonate and polymeric opacifiers are used in a number of Kronos' markets. Generally, extenders are used to reduce to some extent the utilization of higher cost TiO2. The use of extenders has not significantly affected TiO2 consumption over the past decade because extenders generally have, to date, failed to match the performance characteristics of TiO2. NL believes that the use of extenders will not materially alter the growth of the TiO2 business in the foreseeable future.\nNL currently produces over 40 different TiO2 grades, sold under the Kronos and Titanox trademarks, which provide a variety of performance properties to meet customers' specific requirements. Major TiO2 customers include international paint, paper and plastics manufacturers. Kronos and its distributors and agents sell and provide technical services for its products to over 5,000 customers with the majority of sales in Europe, the United States and Canada.\nKronos and its predecessors have produced and marketed TiO2 in North America and Europe for over 70 years. As a result, Kronos believes that it has developed considerable expertise and efficiency in the manufacture, sale, shipment and service of its products in domestic and international markets. By volume, about one-half of Kronos' 1994 TiO2 sales were to Europe, with 36% to North America and the balance to export markets. Kronos' international\noperations are conducted through Kronos International, Inc. (\"KII\"), a German- based holding company formed in 1989 to manage and coordinate NL's manufacturing operations in Europe and Canada and its sales and marketing activities in over 100 countries. NL believes the KII structure allows it to capitalize on expertise and technology developed in Germany over a 60-year period.\nKronos is also engaged in the mining and sale of ilmenite ore (a raw material used in the sulfate pigment production process), and the manufacture and sale of iron-based water treatment chemicals (derived from co-products of the pigment production processes). Water treatment chemicals are used as treatment and conditioning agents for industrial effluents and municipal wastewater and in the manufacture of iron pigments.\nTiO2 manufacturing process, properties and raw materials. TiO2 is manufactured by Kronos using either the chloride or sulfate pigment production processes. Although most end-use applications can use pigments produced by either process, chloride process pigments are generally preferred in certain segments of the coatings and plastics applications, and sulfate process pigments are generally preferred for paper, fibers and ceramics applications. Due to environmental factors and customer considerations, the proportion of TiO2 industry sales represented by chloride process pigments has increased relative to sulfate process pigments in the past few years. About two-thirds of Kronos' current production capacity is based on an efficient chloride process technology.\nKronos currently has four TiO2 facilities in Europe (Leverkusen and Nordenham, Germany; Langerbrugge, Belgium; and Fredrikstad, Norway). In North America, Kronos has a facility in Varennes, Quebec and, through a manufacturing joint venture discussed below, a one-half interest in a plant in Lake Charles, Louisiana which commenced production in 1992. Kronos' principal German operating subsidiary leases the land under its Leverkusen production facility pursuant to a lease expiring in 2050. The Leverkusen plant, with approximately one-third of Kronos' current TiO2 production capacity, is located within the lessor's extensive manufacturing complex, and Kronos is the only unrelated party so situated. Under a separate supplies and services agreement, which expired in 1991 and to which an extension through 2011 has been agreed to in principle, the lessor provides some raw materials, auxiliary and operating materials and utilities services necessary to operate the Leverkusen plant. Kronos and the lessor are continuing discussions regarding a definitive agreement for the extension of the supplies and services agreement. Both the lease and supplies and services agreement restrict NL's ability to transfer ownership or use of the Leverkusen plant. Kronos also has a governmental concession with an unlimited term to operate its ilmenite mine in Norway.\nKronos produced 357,000 metric tons of TiO2 in 1994, compared to 352,000 metric tons in 1993 and 358,000 metric tons in 1992. Kronos believes its annual attainable production capacity is approximately 380,000 metric tons, including its one-half interest in the Louisiana plant. Kronos plans to spend approximately $25 million in capital expenditures over the next three years for a debottlenecking project at its Leverkusen, Germany facility that is expected to increase Kronos' worldwide attainable production capacity by 20,000 metric tons to about 400,000 tons in 1997.\nThe primary raw materials used in the TiO2 chloride production process are chlorine, coke and titanium-containing feedstock derived from beach sand ilmenite and rutile. Chlorine and coke are available from a number of suppliers. Titanium-containing feedstock suitable for use in the chloride process is available from a limited number of suppliers around the world, principally in Australia, Africa, India and the United States. Kronos purchases slag refined from beach sand ilmenite from Richards Bay Iron and Titanium (Proprietary) Ltd. (South Africa), approximately 50% of which is owned by Q.I.T. Fer et Titane Inc. (\"QIT\"), an indirect subsidiary of RTZ Corp. Natural rutile ore is purchased from suppliers in Australia and Africa.\nThe primary raw materials used in the TiO2 sulfate production process are sulfuric acid and titanium-containing feedstock derived primarily from rock and beach sand ilmenite. Sulfuric acid is available from a number of suppliers. Titanium-containing feedstock suitable for use in the sulfate process is available from a limited number of suppliers around the world. Currently, the principal active sources are located in Norway, Canada, Australia, India and South Africa. As one of the few vertically-integrated producers of sulfate process pigments, Kronos operates a rock ilmenite mine near Hauge i Dalane, Norway, which provided all of Kronos' feedstock for its European sulfate process pigment plants in 1994. Kronos' mine is also a major commercial source of rock ilmenite for other sulfate process producers in Europe, and NL believes the mine supplies nearly 40% of Western European demand, including NL, for sulfate feedstock. Kronos also purchases sulfate grade ilmenite slag under contracts negotiated annually with QIT and Tinfos Titanium and Iron K\/S.\nKronos believes the availability of titanium-containing feedstock for both the chloride and sulfate processes is adequate in the near-term; however tightening supplies for the chlorine process may be encountered in the late 1990's. Kronos does not anticipate experiencing any interruptions of its raw material supplies.\nTiO2 manufacturing joint venture. In October 1993, Kronos formed a manufacturing joint venture with Tioxide Group, Ltd., a wholly-owned subsidiary of Imperial Chemicals Industries PLC. The joint venture, which is equally owned by subsidiaries of Kronos and Tioxide, owns and operates the Louisiana chloride process TiO2 plant formerly owned by Kronos. Production from the plant is shared equally by Kronos and Tioxide pursuant to separate offtake agreements.\nA supervisory committee, composed of four members, two of whom are appointed by each partner, directs the business and affairs of the joint venture, including production and output decisions. Two general managers, one appointed and compensated by each partner, manage the day-to-day operations of the joint venture acting under the direction of the supervisory committee.\nThe manufacturing joint venture is intended to be operated on a break-even basis, and accordingly Kronos' transfer price for its share of the TiO2 produced is equal to its share of the joint venture's production costs and interest expense. Kronos' share of the production costs are reported as part of its cost of sales as the related TiO2 acquired from the joint venture is sold, and Kronos' share of the joint venture's interest expense is reported as a component of its interest expense.\nSpecialty chemicals products and operations. Rheological additives produced by Rheox control the flow and levelling characteristics of a variety of products, including paints, inks, lubricants, sealants, adhesives and cosmetics. Organoclay rheological additives are clays which have been chemically reacted with organic chemicals and compounds. Rheox produces rheological additives for both solvent-based and water-based systems. Rheox believes that it is the world's largest producer of rheological additives for solvent-based systems, supplying approximately 40% of the worldwide market, and is also a supplier for rheological additives used in water-based systems. Rheological additives for solvent-based systems accounted for 84% of Rheox's sales in 1994, with the remainder principally rheological additives for water-based systems. Rheox has introduced a number of new products during the past three years, many of which are for water-based systems, which currently represent a larger portion of the market than solvent-based systems. As a result, the portion of Rheox's sales representing additives for water-based systems has increased from 10% to 16% during the past few years. Rheox believes water-based additives will account for an increasing portion of the market in the long term. Rheox is also focused on product development for environmental applications with new products introduced for non-volatile additives in both water and solvent-based coatings. Rheox's plants are in Charleston, West Virginia, Newberry Springs, California, St. Louis, Missouri, Livingston, Scotland and Nordenham, Germany.\nThe primary raw materials for rheological additives are bentonite clays, hectorite clays, quaternary amines, polyethylene waxes and castor oil derivatives. Bentonite clays are currently purchased under a three-year contract, renewable through 2004, with a subsidiary of Dresser Industries, Inc.,\nwhich has significant bentonite reserves in Wyoming. This contract assures Rheox the right to purchase its anticipated requirements of bentonite clays for the foreseeable future, and Dresser's reserves are believed to be sufficient for such purpose. Hectorite clays are mined from company-owned reserves in Newberry Springs, California, which NL believes are adequate to supply its needs for the foreseeable future. The Newberry Springs ore body contains the largest known commercial deposit of hectorite clays in the world. Quaternary amines are purchased primarily from a joint venture company 50%-owned by Rheox and are also generally available on the open market from a number of suppliers. Castor oil- based rheological additives are purchased from sources in the United States and abroad. Rheox has a supply contract with a manufacturer of these products, which may not be terminated without 180 days notice by either party.\nCompetition. The TiO2 industry is highly competitive. During the late 1980's worldwide demand approximated available supply and the major producers, including Kronos, were operating at or near available capacity and customers were generally served on an allocation basis. During the early 1990's, supply exceeded demand, primarily due to new chloride process capacity coming on-stream. Relative supply\/demand relationships, which favorably impacted industry-wide prices during the late 1980's, had a negative impact on prices during the recent downward cycle. During 1994, growth in demand resulting from improved economic conditions, coupled with limited capacity increases, improved industry capacity utilization to about 92% and resulted in increases in worldwide TiO2 prices. During the last upturn cycle, which ended in early 1990, peak average TiO2 prices were about 70% higher than the previous trough.\nWorldwide capacity additions in the TiO2 market are slow to develop because of the significant capital expenditures and substantial lead time (typically three to five years in NL's experience) for, among other things, planning, obtaining environmental approvals and construction.\nKronos competes primarily on the basis of price, product quality and technical service, and the availability of high performance pigment grades. Although certain TiO2 grades are considered specialty pigments, the majority of grades and substantially all of Kronos' production are considered commodity pigments with price generally being a most significant competitive factor. Kronos has an estimated worldwide TiO2 market share of 11%, and believes that it is the leading marketer of TiO2 in a number of countries, including Germany and Canada. Kronos' principal competitors are E.I. du Pont de Nemours & Co.; Tioxide; Hanson PLC (SCM Chemicals); Kemira Oy; Ishihara Sangyo Kaisha, Ltd; Bayer AG; Thann et Mulhouse and Kerr-McGee Corporation. These eight competitors have estimated individual worldwide market shares ranging from 4% to 21%, and an aggregate estimated 74% share. Du Pont has over one-half of total U.S. TiO2 production capacity and is Kronos' principal North American competitor.\nKronos has completed a major environmental protection and improvement program commenced in the early 1980's to replace or modify its TiO2 production facilities for compliance with various environmental laws by the respective effective dates. All of Kronos' TiO2 facilities now use either the low-waste yielding chloride process, or the sulfate process with reprocessing or neutralization of waste acid. Although these upgrades increased operating costs, they are expected to reduce future capital expenditures that Kronos would otherwise need to incur as environmental standards are increased. See \"-- Regulatory and environmental matters.\"\nCompetition in the specialty chemicals industry is generally concentrated in the areas of product uniqueness, quality and availability, technical service, knowledge of end-use applications and price. Rheox's principal competitors for rheological additives for solvent-based systems are LaPorte PLC and Sud-Chemie AG. Principal competitors for water-based systems are Rohm and Haas Company, Hercules Incorporated, The Dow Chemical Company and Union Carbide Corporation.\nResearch and development. NL's annual expenditures for research and development and technical support programs have averaged approximately $10 million during the past three years, with Kronos accounting for about three- fourths of the annual totals. TiO2 research and development activities are conducted principally at KII's Leverkusen, Germany facility. Such activities are directed primarily towards improving both the chloride and sulfate production processes, improving product quality and strengthening Kronos' competitive position by developing new pigment applications. Activities relating to rheological additives are conducted primarily in the U.S. and are directed towards the development of new products for water-based systems, environmental applications and new end-use applications for existing product lines.\nPatents and trademarks. Patents held for products and production processes are believed to be important to NL and contribute to the continuing business activities of Kronos and Rheox. NL continually seeks patent protection for its technical developments, principally in the United States, Canada and Europe, and from time to time enters into licensing arrangements with third parties. In connection with the formation of the manufacturing joint venture with Tioxide, Kronos and certain of its subsidiaries exchanged proprietary chloride process and product technologies with Tioxide and certain of its affiliates. Use by each recipient of the other's technology in Europe is restricted until October 1996. NL's major trademarks, including Kronos, Titanox and Rheox, are protected by registration in the United States and elsewhere with respect to those products it manufactures and sells.\nCustomer base and seasonality. NL believes that neither its aggregate sales nor those of any of its principal product groups are concentrated in or materially dependent upon any single customer or small group of customers. Neither NL's business as a whole nor that of any of its principal product groups is seasonal to any significant extent. Due in part to the increase in paint production in the spring to meet spring and summer painting season demand, TiO2 sales are generally higher in the second and third calendar quarters than in the first and fourth calendar quarters. Sales of rheological additives are influenced by the worldwide industrial protective coatings industry, where second calendar quarter sales are generally the strongest.\nEmployees. As of December 31, 1994, NL employed approximately 3,100 persons (excluding the joint venture employees), with 400 employees in the United States and 2,700 at non-U.S. sites. Hourly employees in production facilities worldwide are represented by a variety of labor unions, with labor agreements having various expiration dates. NL believes its labor relations are satisfactory.\nRegulatory and environmental matters. Certain of NL's businesses are and have been engaged in the handling, manufacture or use of substances or compounds that may be considered toxic or hazardous within the meaning of applicable environmental laws. As with other companies engaged in similar businesses, certain past and current operations and products of NL have the potential to cause environmental or other damage. NL has implemented and continues to implement various policies and programs in an effort to minimize these risks. NL's policy is to achieve compliance with applicable environmental laws and regulations at all of its facilities and to strive to improve its environmental performance. It is possible that future developments, such as stricter requirements of environmental laws and enforcement policies thereunder, could affect NL's production, handling, use, storage, transportation, sale or disposal of such substances.\nNL's U.S. manufacturing operations are governed by federal environmental and worker health and safety laws and regulations, principally the Resource Conservation and Recovery Act, the Occupational Safety and Health Act, the Clean Air Act, the Clean Water Act, the Safe Drinking Water Act, the Toxic Substances Control Act, and the Comprehensive Environmental Response, Compensation and Liability Act, as amended by the Superfund Amendments and Reauthorization Act (\"CERCLA\"), as well as the state counterparts of these statutes. NL believes that all of its U.S. plants and the Louisiana plant owned and operated by the joint venture are in substantial compliance with applicable requirements of these laws. From time to time, NL facilities may be subject to environmental regulatory enforcement under such statutes. Resolution of such matters typically involves the establishment of compliance programs. Occasionally, resolution may result in the payment of penalties, but to date such penalties have not involved amounts having a material adverse effect on NL's consolidated financial position, results of operations or liquidity.\nNL's European and Canadian production facilities operate in an environmental regulatory framework in which governmental authorities typically are granted broad discretionary powers which allow them to issue operating permits required for the plants to operate. NL believes all of its European and Canadian plants are in substantial compliance with applicable environmental laws.\nWhile the laws regulating operations of industrial facilities in Europe vary from country to country, a common regulatory denominator is provided by the European Union (\"EU\"). Germany, Belgium and the United Kingdom, members of the EU, follow the initiatives of the EU; Norway, although not a member, generally patterns its environmental regulatory actions after the EU. Kronos believes it is in substantial compliance with agreements reached with European environmental authorities and with an EU directive to control the effluents produced by TiO2 production facilities. Rheox believes it is in substantial compliance with environmental regulations in Germany and the United Kingdom.\nIn order to reduce sulfur dioxide emissions into the atmosphere, Kronos is currently installing off-gas desulfurization systems at its German and Norwegian plants at an estimated cost of approximately $32 million and expects to complete the systems in 1996. The Louisiana manufacturing joint venture installed a $17 million off-gas desulfurization system which commenced operations in early 1995 and Kronos intends to install a $10 million system in Belgium by 1998. In addition, Kronos completed in February 1994 an onshore disposal system to replace offshore disposal of tailings from its ilmenite mine near Hauge i Dalane, Norway and expects to complete an $11 million wastewater treatment chemical purification project at its Leverkusen, Germany facility in 1996.\nThe Quebec provincial government has environmental regulatory authority over Kronos' Canadian TiO2 production facilities, which currently consist of plants utilizing both the chloride and sulfate process technologies. The provincial government regulates discharges into the St. Lawrence River. In May 1992, the Quebec provincial government extended Kronos' right to discharge effluents from its sulfate process TiO2 plant into the St. Lawrence River until June 1994. Kronos completed a new $25 million waste acid neutralization facility and discontinued discharging effluents into the St. Lawrence River in June 1994. Notwithstanding the above-described agreement, in March 1993 Kronos' Canadian subsidiary and two of its directors were charged by the Canadian federal government with five violations of the Canadian Fisheries Act relating to discharges into the St. Lawrence River from the Varennes sulfate TiO2 production facility. The penalty for these violations, if proven, could be up to Canadian $15 million. Additional charges, if brought, could involve additional penalties. NL has moved to dismiss the case, and believes that this charge is inconsistent with the extension granted by provincial authorities referred to above.\nNL's future capital expenditures related to its ongoing environmental protection and improvement programs, including those described above, are currently expected to approximate $57 million, including $33 million in 1995.\nNL has been named as a defendant, potentially responsible party (\"PRP\") or both, pursuant to CERCLA and similar state laws in approximately 80 governmental enforcement and private actions associated with waste disposal sites and facilities currently or previously owned, operated or used by NL, many of which are on the U.S. Environmental Protection Agency's Superfund National Priority List or similar state lists. See Item 3 - \"Legal Proceedings.\"\nREFINED SUGAR - THE AMALGAMATED SUGAR COMPANY:\nAmalgamated is the second-largest U.S. beet sugar producer with approximately 10% of United States annual sugar production. Amalgamated's primary strategic focus is to improve its efficiency in extracting and refining\nsugar in order to increase sugar production, reduce unit production costs and maintain market share. Amalgamated's recent capital investments, and those planned for the next several years, have emphasized extraction and other productivity improvement projects.\nProducts and operations. Refined sugar accounts for approximately 90% of Amalgamated's annual sales. Animal feed in the forms of beet pulp and molasses, by-products of sugarbeet processing, accounts for most of its remaining sales. Each spring, Amalgamated contracts with approximately 1,600 individual farmers to plant a specified number of acres of sugarbeets and to deliver the sugarbeets to Amalgamated upon harvest in the fall. Amalgamated's sugarbeet processing, which consists of extracting sugar from the sugarbeets and refining the sugar, begins upon harvest and usually lasts until February. Approximately one-fourth of the sugarbeet crop is initially processed into a thick syrup, which is stored in Amalgamated's facilities and subsequently processed into refined sugar. Refined sugar is sold throughout the year while by-products are sold primarily in the first and fourth calendar quarters. Amalgamated's profitability is determined primarily by the quantity and quality of the sugarbeets processed, its efficiency in extracting and refining sugar, and the sales price of refined sugar.\nAmalgamated's four factories operate at approximately full capacity during the annual sugarbeet processing campaigns, and annual sugar production has generally averaged 1.5 billion to 1.6 billion pounds over the past few years. Due principally to an abnormally high yield per acre resulting from extremely favorable weather conditions during the 1994 growing season, sugar production from the crop harvested in the fall of 1994 is currently projected to be between 1.7 billion and 1.8 billion pounds. Production from the 1995 crop will likely be more in line with prior crop levels.\nThe price paid to growers for sugarbeets is a function of Amalgamated's average sales price for refined sugar during the contract settlement year, which runs from October through September, and of the sugar content of the sugarbeets. This variable cost feature serves as a partial hedge of selling price changes. The cost of transporting sugarbeets to Amalgamated's factories generally limits the geographic area from which sugarbeets are purchased. The anticipated price of sugar and the price of competing crops influence the number of acres of sugarbeets planted. The available sugarbeet acreage in Amalgamated's geographic area of operations exceeds Amalgamated's processing capacity.\nAmalgamated sells sugar primarily in the North Central and Intermountain Northwest regions of the United States. Approximately 80% of sugar sales are to industrial sugar users and approximately 20% are to wholesalers or retailers in consumer-sized packages. As is customary in the sugar industry, Amalgamated sells sugar to its customers under contract for future delivery, generally within one to six months. Amalgamated does not otherwise engage in the purchase or sale of sugar futures contracts.\nBeet pulp and molasses, by-products of the sugar extraction process, constitute approximately 10% of Amalgamated's sales and are sold primarily to animal feeders in the U.S. Intermountain Northwest region and Japan. The quantity of by-products available for sale is determined principally by the size of the sugarbeet crop. By-product sales prices are influenced by the prices of competing animal feeds and have no direct relation to refined sugar prices.\nCompetitors and competition. Sugar production in the United States has increased in recent years, and the U.S. sugar industry currently produces over 85% of the country's sugar needs from domestically-grown sugarbeets and sugarcane. The remainder of the country's sugar supply is imported, principally as raw sugar that is processed into refined sugar by coastal refiners. There is no difference between domestically-produced sugar, either from sugarbeets or sugarcane, and that produced from imported raw sugar. Amalgamated competes with virtually all processors of either domestically-grown sugar crops or imported raw sugar. Major competitors in Amalgamated's geographic sales area include the American Crystal, C&H, Domino, Imperial Holly, Savannah Foods and Western Sugar companies. Because refined sugar is a commodity product, Amalgamated has little ability to independently establish selling prices.\nTotal and per capita domestic sugar consumption has been increasing slightly during the past ten years after declining during the early 1980's as a result of increased consumption of high fructose corn syrup and non-caloric sweeteners such as aspartame. According to published sources, the percentage of total United States caloric sweetener use attributable to refined sugar has averaged around 43% to 45% during the last five years. Per capita consumption of refined sugar in 1994 is estimated at 64.6 pounds, as compared to actual consumption of 64.5 pounds in 1990, 63.4 pounds in 1985 and 83.6 pounds in 1980.\nAmalgamated does not believe it is dependent upon one or a few customers; however, major food processors are substantial customers and represent an important portion of sales. Amalgamated's ten largest customers accounted for slightly more than one-third of its sales in each of the past three years, with the largest customer accounting for 4% to 7% of sales in each year.\nGovernmental sugar price support program. The Food, Agriculture, Conservation and Trade Act of 1990 (the \"1990 Farm Bill\"), as amended by the Omnibus Budget Reconciliation Act of 1993, continues, through the 1997 crop year ending in September 1998, the sugar price support program for domestically-grown sugarcane and sugarbeets established by the Agriculture and Food Act of 1981. Amalgamated understands that the sugar industry believes sugar will be included as a part of any new 1995 Farm Bill expected to be considered by Congress.\nUnder the sugar price support loan program, Amalgamated is able to obtain, from the federal government, nonrecourse loans on its refined sugar inventories at loan rates based upon a raw sugar support price of no less than 18 cents per pound. The effective net government loan rate applicable to Amalgamated's 1994 crop sugar is 20.69 cents per pound. The 1990 Farm Bill implemented marketing assessments on domestically-produced beet and cane sugars. The marketing assessment cost is shared by the processors and the growers, and results in a net cost to Amalgamated of about 0.08 cents per pound, or approximately $1.5 million per year.\nThe sugar price support loan program is to be operated at no cost to the federal government, which requires the government to take actions to maintain sugar market prices above the price support loan levels in order to prevent defaults on the nonrecourse loans extended under the program. Currently, the government restricts sugar supply to help maintain domestic market prices both by imposing quotas and duties on imported sugar and limiting quantities which domestic producers can sell in the U.S. market.\nThe 1990 Farm Bill guarantees a minimum annual import quota of 1.25 million short tons (1.1 million metric tons) of raw sugar and the United States Department of Agriculture can impose marketing allotments on domestic sugarcane and sugarbeet processors to limit the amount of raw and refined sugar which each domestic processor may market. Marketing allotments were imposed during the 1992 crop year (for the first time in over 20 years) while the 1993 crop was free of allotments. Marketing allotments have been imposed on the current 1994 crop year, which runs through September 30, 1995. Amalgamated's current allotment is approximately 16 million hundredweight (\"cwt\"), or about 1.5 million cwt less than estimated sugar production from the crop. Amalgamated expects to sell a portion of its excess sugar into foreign markets, which are not covered by the allotments, however \"carryover\" sugar quantities into the next crop year are expected to be well above normal carryover levels. See also Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nResearch and development. Amalgamated maintains research and development programs emphasizing processing technology and its annual research and development expense has been around $500,000 to $600,000 during the past three years. Amalgamated has developed various proprietary technologies related to sugar processing and employs these process improvements to reduce its operating costs. Some of these techniques apply to fructose and cane refinery operations\nas well as sugarbeet operations. Amalgamated presently holds patents on certain of its proprietary technology. The loss of any of such patents would not have a material adverse effect on Amalgamated.\nEmployees. Amalgamated employs approximately 2,700 persons at the height of the production season, of which approximately 1,400 are year-round employees. Amalgamated's three-year labor agreement with the American Federation of Grain Millers, which represents production employees through local unions, expires July 1996. Amalgamated believes its labor relations are satisfactory.\nEnergy. Amalgamated's primary fuel is coal, but it can utilize other fuels. The supply of coal is provided under a long-term contract expiring February 1998, subject to extension at Amalgamated's option for three five-year periods. Energy is an important element in the processing of sugarbeets, and the use of coal has historically resulted in lower production costs than if oil, natural gas or electricity were Amalgamated's primary energy source.\nProperties. Amalgamated owns four sugar processing factories, located in Paul, Twin Falls and Nampa, Idaho and Nyssa, Oregon, and also owns its general office facilities in Ogden, Utah, three distribution terminals in three states, and six storage facilities in two states. The Nampa factory, with a daily slice rate approaching 12,000 tons per day, is the largest such facility in the United States. Amalgamated believes the capacity of each of its four factories exceed the U.S. average.\nRegulatory and environmental matters. Amalgamated's operations are governed by federal, state and local laws and regulations relating to production procedures, operating environment, emissions and waste disposal, air and water quality and worker and product safety and protection. Amalgamated believes that it is currently in substantial compliance with existing permits and regulations relating to its facilities; however, federal and state environmental compliance requirements are becoming more stringent in certain respects and are expected to result in expenditures in excess of the relatively nominal amounts spent in recent years. Amalgamated's capital budget for 1995 includes over $1 million in the area of environmental protection and improvement, principally related to air and water treatment facilities at certain of its factories.\nBUILDING PRODUCTS - MEDITE CORPORATION:\nMedite's principal business is the international production and sale of medium density fiberboard. MDF is a fiber-based engineered building board product manufactured primarily from pre-commercial forest thinnings and forest product industry residuals (wood chips, shavings and sawdust) which are bonded together with resins to form a machineable, composite panel. Relative to traditional timber products, MDF has cost-in-use advantages which promote the use of MDF in an increasing variety of applications, including furniture, cabinetry, shop fittings, moulding, millwork and joinery. According to industry sources, furniture currently accounts for approximately 85% of MDF use in Europe and 55% in the United States.\nMedite sells MDF primarily in North America (48% of 1994 MDF sales) and Europe (43%) and believes that Medite is the world's most recognized MDF trademark. In addition to standard Medite, the Company offers a wide range of specialty MDF products which are typically sold for higher prices and result in higher operating margins than standard MDF products.\nMedite's MDF production facilities are located in the Republic of Ireland, Oregon and New Mexico. The Company expects a capacity addition completed in late 1994 at Medite's Irish plant will increase its annual MDF production capacity by 15% (to 580,000 cubic meters) in 1995 and ultimately increase it by 25% (to 635,000 M3) by 1998. With the recently completed capacity addition in Ireland, Medite is the world's second largest MDF producer, in terms of rated capacity.\nThe Company believes MDF is among the world's fastest growing building board products with increased demand during recent years driven primarily by\nincreasing product substitution principally resulting from (i) MDF product characteristics that have expanded the range of MDF applications, (ii) certain cost advantages relative to traditional timber products, (iii) the development of specialty MDF products satisfying specialized customer requirements and (iv) increased environmental awareness.\nMedite's strategy consists of the following components: (i) continue to focus on MDF; (ii) strive to remain at the forefront of developing higher margin specialty MDF products; (iii) continue to focus on developing new commercial uses for MDF, including applications in cabinetry, joinery, millwork and mouldings; (iv) continue to seek to expand its MDF operations through acquisitions, strategic joint ventures and capacity additions; and (v) manage its fee timber resources on a longer-term sustainable basis and seek to maximize the operating contribution of its harvested timber.\nIn addition to its MDF operations, Medite owns 168,000 acres of timberland in Southern Oregon containing approximately 660 million board feet (\"MMBF\") of generally second growth merchantable timber and produces and sells traditional timber products including logs, lumber, veneer and wood chips. Medite actively manages its fee timberlands, which have become an increasingly valuable resource as the volume of timber offered for sale in the Pacific Northwest by U.S. government agencies has declined substantially in recent years.\nIn March 1995, Medite filed a Registration Statement with the Securities and Exchange Commission for a proposed public offering of approximately $100 million of its common stock, which Registration Statement has not yet become effective. If such offering is completed, the Company's ownership of Medite would be reduced by approximately one-third. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nMDF products. Medite's standard MDF product, Medite, was first introduced in 1975 and is produced exclusively for interior applications such as furniture, shelving, door frames, cabinet doors and interior paneling. In 1994, standard Medite accounted for approximately 72% of Medite's total MDF sales dollars with specialty products, described below, accounting for 28%.\nMedex, designed for exterior applications, is used in facade application on storefronts, decorative shop fronts in many areas in Europe, counter tops, doors and window sills. Medite believes that it is currently the leading exterior grade MDF producer in the world. Medex, first produced in 1987, accounted for 8% of 1994 MDF sales.\nMedite 313 is a specialty MDF product designed for interior applications that involve high-humidity environments, such as bathroom and kitchen cabinetry and mouldings. Medite 313 was introduced in 1987 and accounted for 13% of 1994 MDF sales. Principal markets for Medite 313 have been in the U.K. and Ireland.\nMedite FR, developed by Medite primarily to address strict building code requirements in Europe for flame\/fire resistance, meets Class 1 flame-retardant guidelines in France and Germany. Medite FR, first produced in 1989, accounted for 4% of 1994 MDF sales.\nMedite II was developed by Medite in 1991 to meet the market need for a low formaldehyde-content MDF product for use in sensitive interior applications such as schools, museums and hospitals. Medite II is produced without the introduction of formaldehyde based resins (bonding agents) and additives. Medite believes that it is a leader in the production of interior MDF that does not utilize resins containing formaldehyde. Medite II accounted for 3% of 1994 MDF sales.\nMDF production facilities and raw materials. Medite believes it is one of a relatively small number of MDF manufacturers in the world with the technology and expertise to currently produce specialty MDF products, such as exterior grade, moisture resistant and fire retardant MDF. Medite uses two different press technologies in completing its finished MDF products. Multiopening presses, used at all of Medite's facilities, are more efficient in producing thicker MDF (16 to 30 millimeters) while a continuous line press is more efficient in producing thin board MDF (three to 15 millimeters). Medite operates a continuous press at its Irish MDF plant.\nMedite's Clonmel, Republic of Ireland MDF plant produces standard and specialty MDF products under the ISO 9000 quality management certification. A $31 million expansion was completed in the fourth quarter of 1994, raising future production capacity to 300,000 M3. Production during 1994 (excluding the new continuous press production line) amounted to approximately 160,000 M3 (approximately 100% of the capacity of the original production line). Approximately 40% of 1994 Clonmel production consisted of specialty MDF products. Medite believes this plant is the only MDF facility in the world that operates both a multiopening and continuous press in one location, making it unique in its ability to offer to its customers high quality products in the full range of MDF thicknesses (from three to 30 millimeters). Medite has what it considers to be an attractive long-term supply contract with the Irish Forestry Service, pursuant to which Medite has a reliable, fixed price supply of pre-commercial thinnings from Irish forests. These and other private sources of pre-commercial thinnings accounted for approximately one-half of the Clonmel plant's fiber raw materials in 1994. The balance of fiber requirements are provided by wood chips acquired from local sawmill operators, which Medite believes will be available in adequate supply due to the continuing development of the Irish forest products industry. In 1994, approximately 50% of Medite's Irish production was sold in the United Kingdom, with 18% sold within Ireland and the balance sold primarily in other Northern European countries.\nProduction at the Oregon MDF plant during 1994 was approximately 94% of its 175,000 M3 capacity, with standard Medite accounting for approximately 84% of production. The primary fiber sources are wood chips, shavings and sawdust, almost all purchased from sawmills located in close proximity to the plant at spot market prices.\nWhile the Irish and Oregon MDF plants were built by Medite, the New Mexico MDF plant was built by a third party and purchased by Medite in 1989. Production at the New Mexico plant during 1994 was approximately 93% of its 160,000 M3 capacity, substantially all of which was standard Medite product. The primary fiber sources are wood chips, shavings and sawdust produced within a 150-mile radius of the plant, most of which are purchased pursuant to short-term purchase contracts. Increasingly, however, fiber has been acquired from the \"urban forest\" (sawdust and shavings produced from shipping crates, pallets and recycled lumber). In 1994, these \"post-consumer\" fiber sources comprised approximately 14% of the New Mexico plant's fiber supply.\nThrough its Oregon fee timberlands, its long-term wood supply agreements with the Irish Forestry Service and other sources, Medite believes it has access to adequate fiber supplies to meet current and expected operating needs for its existing facilities. However, Medite anticipates increasing competition for wood fiber in future years and, accordingly, there can be no assurance that long-term future fiber supply will be adequate, with respect to quantity and price, to maintain Medite's recent MDF margins or to provide for future capacity expansion.\nMedite purchases urea formaldehyde resins for standard MDF products from suppliers located in close proximity to its plants. Resins for U.S. specialty MDF products are purchased primarily from suppliers in Texas and Louisiana with resins for specialty MDF products produced in Ireland purchased primarily from U.K. suppliers.\nTraditional timber products - products, operations and properties. Medite produces and sells lumber used in residential and commercial construction, and veneer which is used in the production of plywood and laminated veneer lumber (\"LVL\"), and wood chips, which are a basic raw material for the MDF and paper industries. Logs harvested from Medite's fee timberlands are utilized in the production of lumber, veneer and wood chips. Certain sizes and species of logs harvested by Medite that are not used in its manufacturing operations are sold to other mills in the Northwest.\nMedite owns approximately 168,000 acres of timberland, including 77,000 acres added since Medite was acquired by Valhi in 1984. Medite's timberlands contain approximately 660 million board feet of generally second growth merchantable timber. The dominant species is Douglas Fir and the average annual timber growth rate is approximately 4%. Medite's timber holdings are within close proximity to its Oregon production facilities and are in relatively accessible terrain.\nMedite produces veneer in Rogue River, Oregon and stud lumber in White City, Oregon. Annual capacities of these plants are 80,000 square feet (3\/8\" basis) of veneer and 70,000 board feet of lumber plus a combined annual wood chip capacity of 70,000 bone dry units. The Rogue River plant, completed in late 1993 to replace a similar facility destroyed by fire in June 1992, is designed to process cull (defective) logs from throughout the Southern Oregon area and the smaller second-growth timber expected to be available from Company- owned timberlands on a longer-term basis. Veneer from this plant is sold to the LVL industry as well as to traditional soft-wood and hardwood plywood products manufacturers. The White City mill produces primarily 2x4 studs, used in residential construction in California, from small logs and \"peeler cores\", a by-product of veneer conversion facilities.\nDistribution and sale of products. Medite's manufactured products are sold primarily to wholesalers of building materials. Medite's MDF major markets include the United Kingdom, Northern Europe and the Republic of Ireland; West and Central United States; the Pacific Rim and Mexico. In 1994, approximately 48% of Medite's total MDF sales were in North America with 43% in Europe (21% in the United Kingdom). U.S. distribution is primarily by rail and common carrier trucking, while most Irish production is shipped by containerized ocean cargo.\nManufactured traditional timber products are sold primarily in Western U.S. markets. Logs are sold primarily to other Oregon mills. Although logging operations are seasonal due to inclement weather conditions during winter and spring months, the production and sale of manufactured products is not particularly seasonal in nature.\nMedite's operations are not dependent upon one or a few customers, the loss of which would have a material adverse effect on its operations. Medite's ten largest customers accounted for about one-fourth of sales in each of the past three years. Reflecting Medite's evolving MDF focus, six of the ten largest 1994 customers were primarily MDF customers, up from five in 1993 and two in 1992.\nCyclicality. Demand for Medite's MDF products is in part derived from the general level of economic activity in the principal markets served by Medite (North America and Europe). Economic activity in these markets is currently expanding but as recently as 1991 was at one of its lower levels since World War II. In contrast to demand for MDF, demand for Medite's traditional timber products is largely influenced by new U.S. construction, which is highly cyclical in nature. Medite believes that demand for its MDF products is significantly less cyclical than demand for its traditional timber products due to more geographically dispersed production and markets, the wide range and relative diversity of MDF applications, the overall growth in MDF unit demand and Medite's broad range of specialty MDF products. Nonetheless, Medite expects its future operating performance will be affected in part by both general and industry specific economic conditions, some of which are cyclical in nature.\nCompetition. Medite operates in highly competitive industries. Within the MDF segment of its business, Medite competes on the basis of quality, product breadth, customer service and price. In the traditional timber products business, Medite competes primarily on the basis of price. Transportation costs generally limit the geographic markets in which Medite's and its competitors' products are sold.\nMedite's MDF operations compete in North America principally with a number of producers of MDF and other composite board products such as particle board, and in the Pacific Rim with Australian, New Zealand and other U.S.\nmanufacturers. In Europe, Medite competes principally with other European Union producers. The cost of shipping products, which is borne by the customer, is significant and Medite may operate at a competitive disadvantage relative to certain other producers who are located closer to certain markets. In addition, some of Medite's competitors may possess greater financial resources, including in some cases the financial support of the governments of the countries in which such competitors are located. Due to periodic declines in the value of the U.S. dollar relative to other currencies, Medite's operations in Ireland have also experienced periodic competition from North American producers.\nRecently, global demand for MDF has exceeded availability and numerous producers, including Medite, have placed customers on allocation. High MDF operating rates and increasing product prices, coupled with favorable forecasts for increasing MDF demand, are expected to attract additional competition. A survey by Wood Based Panels International, an MDF industry trade publication, projects worldwide capacity increases of 15% through 1996, which could outstrip demand growth and result in excess MDF production capacity in certain regional markets. Historically, due to the technological difficulties traditionally encountered with new MDF manufacturing facilities that generally adversely impact their effective operating rates, announced MDF capacity additions may be delayed or deferred and effective production levels can be significantly below forecasted \"nameplate\" capacity. In addition, Medite believes its specialty MDF products provide it with a certain degree of insulation from the competitive effects of future MDF capacity additions.\nMedite's traditional timber products operations compete primarily with numerous other producers in the Pacific Northwest, Canada and, increasingly, the Southern United States. While Medite's fee timber is a valuable resource which aids its ability to control product costs, other companies with greater supplies of fee timber may have a competitive product cost advantage.\nEnvironmental matters and governmental regulation. Medite's MDF and traditional timber products manufacturing operations are subject to numerous national, state and local laws and regulations relating to, among other things, raw materials handling, production procedures, operating environment, emissions and waste disposal, air and water quality, worker and product safety and protection of the environment generally. As Medite engages in manufacturing activities in the United States and Europe, it must at times contend with differing regulatory standards and requirements. Medite believes that it is in material compliance with all such existing regulations and does not believe that future expenditures to comply with such regulations will be material. There can be no assurance, however, that new or more rigorous regulations affecting Medite's products or manufacturing operations will not be adopted or that future expenditures to comply with any such regulations would not be material.\nMedite's traditional timber products operations are subject to a variety of Oregon and federal laws and regulations dealing with timber harvesting, reforestation and endangered species. The Northern Spotted Owl is currently designated as a threatened species under the Endangered Species Act (\"ESA\"). Generally, habitat for these owls is found in old growth timber stands, and not in Medite's predominantly second growth timber. Consequently, the Northern Spotted Owl's ESA status has not to date had, and, Medite believes, will not in the future have, a material adverse effect on its timber harvesting practices. A 1994 amendment to the Oregon Forest Practices Act imposed more restrictive regulations on the harvest of timber near rivers and streams, including intermittent stream beds. Medite believes that this amendment will not materially impact its ability to harvest timber from its timberlands. There can be no assurance, however, that future legislation or governmental regulations will not adversely affect Medite or its ability to harvest timber and sell logs in the manner currently contemplated.\nUrea formaldehyde resin is used as a binding agent in the production of standard MDF products. Formaldehyde, which also occurs naturally in wood and other natural resources, is listed as a \"suspected\" carcinogen by the U.S. federal government based upon results of laboratory studies performed using maximum tolerated doses. While Medite's MDF products that contain urea formaldehyde resins currently meet applicable regulations, there can be no assurance that the MDF industry, including Medite, will not be compelled to reduce or even eliminate the use of urea formaldehyde resins in the future. As Medite is currently manufacturing a \"formaldehyde-free\" MDF product (Medite II), Medite believes that the adverse impact of any such changes on it would be less than for certain competitors.\nMedite's MDF manufacturing operations also release formaldehyde into the atmosphere as a waste by-product. These emissions have been targeted for increasingly stringent regulation under the U.S. Clean Air Act, although final regulations for emissions are not scheduled to be promulgated by the Environmental Protection Agency until 1997. While Medite currently meets air emission permit requirements at all of its MDF operating facilities, it cannot predict what, if any, future pollution control technology may be required. The cost of any such technology could be significant in the years in which it might, in the future, be required to be installed.\nTrademarks and patents. Medite believes that the patents it holds for MDF products and production processes are important to its MDF business. Medite's major MDF trademarks, Medite and Medex, are protected by registration in the United States and certain other countries. Medite also has a non-exclusive worldwide license relating to application of resins in the manufacture of Medex and a patent on the apparatus and method of manufacture of Medex.\nEmployees. As of December 31, 1994, Medite employed approximately 710 persons including 510 in the U.S. and 200 in Europe. Approximately 30% of U.S. employees and 70% of non-U.S. employees were represented by various labor unions. The collective bargaining agreements related to its veneer plant, its Irish MDF plant and its Oregon MDF plant expire in June 1996, March 1997 and September 1997, respectively. Medite believes that its labor relations are satisfactory.\nRisk of loss from fire or other casualties. Medite assumes substantially all risks of loss from fire and other casualties on its timberlands, as do the owners of most other timber tracts in the United States. Consistent with the past practices of Medite and most other U.S. timber owners, Medite does not maintain fire insurance in respect of standing timber. Medite is a participant with state agencies and other timberland owners in cooperative fire fighting and aerial fire surveillance programs. The extensive roads on Medite's acreage also serve as fire breaks and facilitate implementation of fire control techniques and utilization of fire fighting equipment. Medite's various timber tracts are also somewhat geographically dispersed, which also reduces the possibility of significant fire damage. The only forest fire on Medite's timberlands of any significance during the past five years occurred in July 1994 and resulted in damage to approximately 1,200 acres, which were salvaged with minimal loss.\nMedite's production facilities are susceptible to fire because of the nature of their operations, and in 1992 the Rogue River veneer mill was completely destroyed by fire. To reduce the risk of significant fire damage, Medite's present facilities employ sophisticated fire monitoring and detection systems. The Company also maintains property and business interruption insurance to mitigate potential risk of loss arising from fires or other casualty losses.\nHARDWARE PRODUCTS - NATIONAL CABINET LOCK, INC.:\nProducts, operations and properties. National Cabinet Lock manufactures low and medium-security locks, precision ball bearing drawer slides, computer keyboard support arms and other components for furniture and a variety of other applications. Lock products accounted for approximately 40% of the Company's hardware products sales in 1994 with drawer slides constituting 34% and keyboard arms 26%. Locks are produced by National Cabinet Lock in Mauldin, South Carolina and Mississauga, Ontario. Drawer slides and keyboard support arms are produced in Kitchener, Ontario under the Waterloo Furniture Components name. The Company believes that its hardware products compete in relatively well- defined niche markets and that it is (i) the largest U.S. cabinet lock producer, (ii) the largest Canadian producer of drawer slides and (iii) the largest supplier of computer keyboard support arms to the North American office furniture manufacturing market.\nPurchased components, including zinc castings, are the principal raw materials used in the manufacture of latching and security products. Strip steel is the major raw material used in the manufacture of drawer slides and keyboard arm products. These raw materials are purchased from several suppliers and are readily available. The cost of zinc, copper and steel increased throughout 1994 as general economic activity has increased, and such costs have continued to rise into 1995. There can be no assurance that any future raw material cost increases can be fully recovered through product price increases.\nStrategy. National Cabinet Lock seeks to maintain its relatively high margins through improved manufacturing efficiency and cost control, development of specialty, higher margin products focused on niche markets and engineered to customer specification and by capitalizing on future opportunities that may emerge with targeted original equipment manufacturers. In this regard, the newly developed patented Swinglift work surface arm and ISL (integrated slidelock) drawer slide are expected to be important contributors to future sales volume growth. National Cabinet Lock will also search for synergistic acquisitions or product licensing to expand its product base and seek to expand its established market positions by emphasizing customer service, promoting its distribution programs and seeking greater penetration of the replacement lock market.\nCompetition and customer base. Competition in the Company's hardware products markets is based on product features, customer service, quality, distribution channels, consumer brand preferences and price. Approximately 30% of lock sales are made through National Cabinet Lock's STOCK LOCKS distribution program, a program believed to offer a competitive advantage because delivery generally is made within 72 hours. Most remaining lock sales are to original equipment manufacturers' specifications. Precision ball bearing drawer slides and computer keyboard support arms are produced in Canada under the Waterloo Furniture Components tradename. The primary market for these products are office furniture manufacturers in the United States and Canada. National Cabinet Lock markets its products primarily through its own sales organization as well as select manufacturers' representatives.\nThe Company's major competitors include Chicago Lock, Hudson Lock and Fort Lock (locks), Accuride and Hettich\/Grant (drawer slides) and Weber Knapp and Jacmorr (computer keyboard support arms). National Cabinet Lock also competes with a large number of other manufacturers, and the variety of relatively small competitors generally makes significant price increases difficult. National Cabinet Lock does not believe it is dependent upon one or a few customers, the loss of which would have a material adverse effect on its operations. National Cabinet Lock's ten largest customers accounted for about one-third of its sales in each of the past three years, with the largest customer less than 10% in each year. In 1994, seven of the ten largest customers were located in the U.S. with three in Canada. Of such customers, nine were primarily purchasers of Waterloo Furniture Components' products and one was a U.S. lock customer.\nPatents and trademarks. National Cabinet Lock holds a number of patents relating to its hardware products operations, none of which by itself is considered significant, and owns a number of trademarks, including National Cabinet Lock, STOCK LOCKS and Waterloo Furniture Components, which the Company believes are well recognized in the hardware products industry.\nEmployees. As of December 31, 1994, National Cabinet Lock employed approximately 640 persons, of which 240 were in the United States and 400 were in Canada. Approximately 60% of Canadian employees are covered by a three-year collective bargaining agreement expiring February 1997. National Cabinet Lock believes that its labor relations are satisfactory.\nRegulatory and environmental matters. The Company's hardware products operations are subject to various federal, state, provincial and local provisions regulating, among other things, worker and product safety and protection, the discharge of materials into the environment and other environmental protection matters. National Cabinet Lock believes that it is in substantial compliance with existing permits and regulations and does not believe future expenditures to comply with these regulations will be material.\nFAST FOOD - SYBRA, INC.:\nProducts and operations. Sybra (Arby's spelled backwards) operates approximately 160 Arby's restaurants clustered in four regions, principally in Michigan, Texas, Pennsylvania and Florida, pursuant to licenses with Arby's, Inc. According to information provided by Arby's, Sybra is the second-largest franchisee in the Arby's restaurant system based upon the number of restaurants operated and gross sales. Arby's is a well-established fast food restaurant chain and features a menu that highlights roast beef sandwiches along with a variety of chicken sandwiches and products, deli sandwiches, potato products and soft drinks. Arby's represents a niche segment of the fast food restaurant industry. Arby's current advertising campaign includes the slogan \"Go West...., It's Better Out Here\" and emphasizes the Arby's western hat logo.\nSandwich category items have accounted for over 60% of Sybra's total sales during the past few years. New product development is important to the continued success of a restaurant system, and Sybra has introduced several new menu items in recent years including chicken fingers, chicken, submarine and alternative roast beef sandwiches, curly fried potatoes and desserts. Sybra's menu has evolved whereby roast beef accounts for approximately two-thirds of sandwich sales compared to 80% five years ago.\nSybra's 162 Arby's restaurants at the end of 1994 represent a net increase of 103 stores from the 59 Arby's restaurants Sybra operated when it was acquired in 1979 by a predecessor of Valhi. Sybra has also remodeled over 35 stores during the past five years. Sybra currently expects a net increase of two to three stores in 1995, as it plans to open eight to ten new restaurants within its existing regions and to close five to seven stores. The first new restaurants in 1995 are scheduled to open in March, with five stores closed or to be closed during the first quarter. During the past three years, 13 of the 14 new restaurants opened were free-standing stores as are all of the new stores planned for 1995. Sybra continuously evaluates its individual restaurants and closes unprofitable stores when considered appropriate.\nStrategy. Given the extremely competitive environment in which Sybra operates, Sybra will (i) continue its strong emphasis on operational details, (ii) routinely review the profit contribution of each restaurant with a view toward closing those stores which do not meet expectations; and (iii) continue to follow its \"clustering\" concept in opening new stores in order to capitalize on the economies of scale realized in management and advertising as a result of geographic proximity. Sybra's development rights with Arby's in the Dallas\/Ft. Worth, Texas and Tampa, Florida areas, discussed below, provide future growth opportunities consistent with Sybra's store clustering concept. New stores are likely to be free-standing restaurants, which the Company has found generally to yield a greater rate of return, and most stores likely to be closed will be mall units. Sybra also plans to continue to increase market share in its geographic markets through periodic promotions including the introduction of innovative menu items to complement its main product offerings.\nProperties. At the end of 1994, Sybra operated 162 Arby's restaurants of which 57 were in its Southwestern Region (Texas), 52 in the Northern Region (principally Michigan), 32 in the Eastern Region (Pennsylvania and Maryland\/ Virginia) and 21 in the Southeastern Region (Florida).\nOf the 162 stores operated at the end of 1994, 121 were free-standing stores and the remaining 41 are located within regional shopping malls or strip shopping centers. Sybra leases 109 locations and owns the remainder. Lease terms vary with most leases being on a long-term basis and providing for contingent rents based on sales in addition to base monthly rents. At the end of 1994, approximately 90% of the leases of free-standing locations contain purchase options at fair market values and\/or various renewal options. During the next five years, 29 free-standing leases and 33 mall or food court leases will expire. In most cases, Sybra expects that leases could be renewed or replaced by other leases, although rental rates may increase. Contingent rentals based upon various percentages of gross sales of individual restaurants were less than 10% of Sybra's total rent expense in each of the past three years. Sybra also leases corporate or regional office space in five states.\nSybra has a Consolidated Development Agreement (\"CDA\") with Arby's, Inc. which, as revised in 1994, provides Sybra with exclusive development rights within certain counties in the Dallas\/Fort Worth, Texas area, and provides Sybra and Arby's with joint development rights in the Tampa, Florida area. Sybra is required to open an aggregate of 31 stores in its existing regional markets during the five year term (1993 - 1997) of the CDA. Sybra had opened ten stores pursuant to the CDA through December 31, 1994, is required to open eight more stores in 1995 and is required to open 13 additional stores by various dates through 1997. Sybra currently expects its expansion program will meet or exceed this schedule. Sybra does not have any other territorial or development agreements which would prohibit others from operating an Arby's restaurant in the general geographic markets in which Sybra now operates.\nFood products and supplies. Sybra and other Arby's franchisees are members of ARCOP, Inc., a non-profit cooperative purchasing organization. ARCOP facilitates negotiations of national contracts for food and distribution, taking advantage of the larger purchasing requirements of the member franchisees. Since Arby's franchisees are not required to purchase any food products or supplies from Arby's, Inc., ARCOP facilitates control over food supply costs and avoids franchisor conflicts of interest.\nLicense terms and royalty fees. The 28-year relationship between Sybra and Arby's, Inc. has been governed principally by licenses relating to each restaurant location. Generally, such franchise agreements require that Sybra comply with certain requirements as to business operations and facility maintenance. Currently, Sybra pays an initial franchise fee of $25,000 and a royalty rate of 4% of sales for a standard 20-year license. Because some of Sybra's licenses were issued at times when license terms were perpetual and lower royalty rates were in effect, 44% of Sybra's franchise agreements have no fixed termination date and royalties for all locations aggregated 2.6% to 2.8% of sales in each of the past three years. Sybra's average royalty rate is expected to increase over time as new stores are opened or existing 20-year licenses are renewed at then-prevailing royalty rates. The first of Sybra's 20- year licenses expires in 2003.\nIn 1993, there was a change in ownership of the controlling interest in Triarc Company (formerly DWG Corporation), the parent company of Arby's, Inc. Sybra believes that the new ownership of Triarc is a positive development for the Arby's system.\nAdvertising and marketing. For the past several years, Sybra has directed about 71\/2% of its total restaurant sales toward marketing. All franchisees of Arby's, Inc. must belong to AFA Service Corporation (\"AFA\"), a non-profit association of Arby's restaurant operators, and must contribute a specified portion (up to 1.2%) of their gross revenues as dues to AFA. In return, AFA provides franchisees creative materials such as television and radio commercials, ad mats for newspapers, point-of-purchase graphics and other advertising materials. Although Arby's, Inc., as an operator of Arby's restaurants, is a member of AFA, the direction and management of AFA is principally controlled by the member franchisees. Sybra and other franchisees currently contribute .7% of their gross revenues to AFA. In addition to the AFA contribution, Sybra devotes approximately 3% of its restaurant sales to coupon sales promotions, including the direct cost of discounted food, and newspaper and direct mail inserts, and approximately 3.5% of its restaurant sales to local advertising, including outdoor advertising and electronic media.\nCompetition and seasonality. The fast food industry is extremely competitive and subject to pressures from major business cycles and competition from many established and new restaurant concepts. According to industry data, there is a significant disparity in the revenues and number of restaurants operated by the largest restaurant systems and the Arby's system. As a result, some organizations and franchised restaurant systems have significantly greater resources for advertising and marketing than the Arby's restaurant system and Sybra, which is an important competitive factor. Sybra's response to these competitive factors has been to cluster its stores in certain geographic areas where it can achieve economies of scale in advertising and other activities.\nOperating results of Sybra's restaurants have historically been affected by both retail shopping patterns and weather conditions. Accordingly, Sybra historically has experienced its most favorable results during the fourth calendar quarter (which includes the holiday shopping season) and its least favorable results during the first calendar quarter (which includes winter weather that can be adverse in certain markets).\nEmployees. As of December 31, 1994, Sybra had approximately 4,300 employees, of which 3,700 were part-time employees. Approximately 4,200 employees work in Sybra's restaurants with the remainder in its corporate or regional offices. Employees are not covered by collective bargaining agreements and Sybra believes that its employee relations are satisfactory.\nGovernmental regulation. A significant portion of Sybra's restaurant employees work on a part-time basis and are paid at rates related to the minimum wage rate. Restaurant labor costs currently are approximately 28% of sales. The increase in the minimum wage rate being considered by the current session of Congress and any mandatory medical insurance benefits to part-time employees would increase Sybra's labor costs. Although Sybra's competitors would likely experience similar increases, there can be no assurance that Sybra will be able to increase sales prices to offset future increases, if any, in these costs.\nVarious federal, state and local laws affect Sybra's restaurant business, including laws and regulations relating to minimum wages, overtime and other working conditions, health, sanitation, employment and safety standards and local zoning ordinances. Sybra has not experienced and does not anticipate unusual difficulties in complying with such laws and regulations.\nOTHER:\nForeign operations. The Company has substantial operations and assets located outside the United States, principally chemicals operations in Germany, Belgium, Norway and the United Kingdom, chemicals and hardware products operations in Canada and MDF operations in Ireland. See Note 2 to the Consolidated Financial Statements. Foreign operations are subject to, among other things, currency exchange rate fluctuations and the Company's results of operations have in the past been both favorably and unfavorably affected by fluctuations in currency exchange rates. See Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nThe Company uses multi-currency revolving credit borrowings to mitigate exchange rate risk on certain receivables and also monitors net receivable\/ payable currency positions. While the Company has in the past used currency forward contracts to fix the dollar equivalent of specific commitments, the Company does not generally engage in currency derivative transactions.\nPolitical and economic uncertainties in certain of the countries in which the Company operates may expose the Company to risk of loss. The Company does not believe that there is currently any likelihood of material loss through political or economic instability, seizure, nationalization or similar event. The Company cannot predict, however, whether events of this type in the future could have a material effect on its operations. The Company's manufacturing and mining operations are also subject to extensive and diverse environmental regulation in each of the foreign countries in which they operate, as discussed in the respective business sections elsewhere herein.\nRegulatory and environmental matters. Regulatory and environmental matters are discussed in the respective business sections contained elsewhere herein and in Item 3 - \"Legal Proceedings.\" In addition, the information included in Note 20 to the Consolidated Financial Statements under the captions \"Legal proceedings -- Lead pigment litigation and -- Environmental matters and litigation\" is incorporated herein by reference.\nAcquisition and restructuring activities. The Company routinely compares its liquidity requirements and alternative uses of capital against the estimated future cash flows to be received from its subsidiaries and unconsolidated affiliates, and the estimated sales value of those units. As a result of this process, the Company has in the past and may in the future seek to raise additional capital, refinance or restructure indebtedness, modify its dividend policy, consider the sale of interests in subsidiaries, business units, marketable securities or other assets, or take a combination of such steps or other steps, to increase liquidity, reduce indebtedness and fund future activities. Such activities have in the past and may in the future involve related companies. From time to time, the Company also evaluates the restructuring of ownership interests among its subsidiaries and related companies and expects to continue this activity in the future.\nThe Company and other entities that may be deemed to be controlled by or affiliated with Mr. Harold C. Simmons routinely evaluate acquisitions of interests in, or combinations with, companies, including related companies, perceived by management to be undervalued in the marketplace. These companies may or may not be engaged in businesses related to the Company's current businesses. In a number of instances, the Company has actively managed the businesses acquired with a focus on maximizing return-on-investment through cost reductions, capital expenditures, improved operating efficiencies, selective marketing to address market niches, disposition of marginal operations, use of leverage, and redeployment of capital to more productive assets. In other instances, the Company has disposed of the acquired interest in a company prior to gaining control. The Company intends to consider such activities in the future and may, in connection with such activities, consider issuing additional equity securities and increasing the indebtedness of Valhi, its subsidiaries and related companies.\nOther. Through June 1989, Valmont Insurance Company, a wholly-owned captive insurance subsidiary, reinsured workers' compensation and employers' liability, auto liability, and comprehensive general liability risks of Valhi and certain affiliates. Through April 1989, Valmont assumed certain third-party reinsurance business, primarily property, marine and casualty risks from insurance subsidiaries of other industrial firms, and a small amount of U.S. quota share property and casualty risks. Valmont currently writes certain miscellaneous direct coverages of Valhi and affiliates. All of Valmont's third- party reinsurance risks are on a runoff basis.\nThe Company, through a general partnership, has an interest in certain medical-related research and development activities pursuant to sponsored research agreements. See Note 19 to the Consolidated Financial Statements.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nValhi leases approximately 34,000 square feet of office space for its principal executive offices in a building located at 5430 LBJ Freeway, Dallas, Texas, 75240-2697.\nThe principal properties used in the operations of the Company are described in the applicable business sections of Item 1 - \"Business.\" The Company believes that its facilities are adequate and suitable for their respective uses.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in various legal proceedings. In addition to information that is included below, certain information called for by this Item\nis included in Note 20 to the Consolidated Financial Statements under the caption \"Legal proceedings -- Other litigation,\" which information is incorporated herein by reference.\nLead pigment litigation. NL was formerly involved in the manufacture of lead pigments for use in paint and lead-based paint. NL has been named as a defendant or third party defendant in various legal proceedings alleging that NL and other manufacturers are responsible for personal injury and property damage allegedly associated with the use of lead pigments. NL is vigorously defending such litigation. Considering NL's previous involvement in the lead pigment and lead-based paint businesses, there can be no assurance that additional litigation, similar to that described below, will not be filed. In addition, various legislation and administrative regulations have, from time to time, been enacted or proposed that seek to (a) impose various obligations on present and former manufacturers of lead pigment and lead-based paint with respect to asserted health concerns associated with the use of such products and (b) effectively overturn court decisions in which NL and other pigment manufacturers have been successful. One such bill that would subject lead pigment manufacturers to civil liability for damages caused by lead-based paint on the basis of market share, and that extends certain statutes of limitations, passed the Massachusetts House of Representatives in 1993. The same bill, reintroduced in the Massachusetts legislature in 1994 and defeated in the House of Representatives, was again reintroduced in 1995. No legislation or regulations have been enacted to date which are expected to have a material adverse effect on NL's consolidated financial position, results of operations or liquidity. NL has not accrued any amounts for the pending lead pigment litigation. Although no assurance can be given that NL will not incur future liability in respect of this litigation, based on, among other things, the results of such litigation to date, NL believes that the pending lead pigment litigation is without merit. Liability, if any, that may result is not reasonably capable of estimation.\nIn 1989 and 1990, the Housing Authority of New Orleans (\"HANO\") filed third-party complaints for indemnity and\/or contribution against NL, other alleged manufacturers of lead pigment (together with NL, the \"pigment manufacturers\") and the Lead Industries Association (the \"LIA\") in 14 actions commenced by residents of HANO units seeking compensatory and punitive damages for injuries allegedly caused by lead pigment. The actions in the Civil District Court for the Parish of Orleans, State of Louisiana were dismissed by the district court in 1990. Subsequently, HANO agreed to consolidate all the cases and appealed eleven of them. In March 1992, the Louisiana Court of Appeals, Fourth Circuit, dismissed HANO's appeal as untimely with respect to three of these cases. With respect to the other eight cases included in the appeal, the court of appeals reversed the lower court decision dismissing the cases due to inadequate pleading of facts. These eight cases have been remanded to the district court for further proceedings. In November 1994, the district court granted defendants' motion for summary judgment in one of the eight remaining cases.\nIn December 1991, NL received a copy of a complaint filed in the Civil District Court for the Parish of Orleans seeking indemnification and\/or contribution against NL and eight other defendants for approximately $4.5 million in settlements paid to HANO residents (Housing Authority of New Orleans v. Hoechst Celanese Corp., et al., No. 91-28067). These claims appear to be based upon the same theories which HANO had previously filed. NL has not been served.\nIn June 1989, a complaint was filed in the Supreme Court of the State of New York, County of New York, against the pigment manufacturers and the LIA. Plaintiffs seek damages, contribution and\/or indemnity in an amount in excess of $50 million for monitoring and abating alleged lead paint hazards in public and private residential buildings, diagnosing and treating children allegedly exposed to lead paint in city buildings, the costs of educating city residents to the hazards of lead paint, and liability in personal injury actions against the City and the Housing Authority based on alleged lead poisoning of city residents (The City of New York, the New York City Housing Authority and the New York City Health and Hospitals Corp. v. Lead Industries Association, Inc., et al., No. 89-4617). In December 1991, the court granted the defendants' motion to dismiss claims alleging negligence and strict liability and denied the remainder of the motion. In January 1992, defendants appealed the denial. NL has answered the remaining portions of the complaint denying all allegations of wrongdoing, and the case is in discovery. In December 1992, plaintiffs filed a motion to stay the claims of the City of New York and the New York City Health and Hospitals Corporation pending resolution of the Housing Authority's claim. In May 1993, the Appellate Division of the Supreme Court affirmed the denial of the motion to dismiss plaintiffs' fraud, restitution, conspiracy and concert of action claims. In August 1993, the defendants' motion for leave to appeal was denied. In May 1994, the trial court granted the defendants' motion to dismiss the plaintiffs' restitution and indemnification claims, and plaintiffs have appealed. Defendants have moved for summary judgment on the remaining fraud claim.\nIn March 1992, NL was served with a complaint in Skipworth v. Sherwin- Williams Co., et al. (No. 92-3069), Court of Common Pleas, Philadelphia County. Plaintiffs are a minor and her legal guardians seeking damages from lead paint and pigment producers, the LIA, the Philadelphia Housing Authority and the owners of the plaintiffs' premises for bodily injuries allegedly suffered by the minor from lead-based paint. Plaintiffs' counsel has asserted that approximately 200 similar complaints would be served shortly, but no such complaints have yet been served. In April 1994, the court granted defendants' motion for summary judgment and plaintiffs appealed that decision in June 1994.\nIn August 1992, NL was named as a defendant and served with an amended complaint in Jackson, et al. v. The Glidden Co., et al., Court of Common Pleas, Cuyahoga County, Cleveland, Ohio (Case No. 236835). Plaintiffs seek compensatory and punitive damages for personal injury caused by the ingestion of lead, and an order directing defendants to abate lead-based paint in buildings. Plaintiffs purport to represent a class of similarly situated persons throughout the State of Ohio. The amended complaint identifies 18 other defendants who allegedly manufactured lead products or lead-based paint, and asserts causes of action under theories of strict liability, negligence per se, negligence, breach of express and implied warranty, fraud, nuisance, restitution, and negligent infliction of emotional distress. The complaint asserts several theories of liability including joint and several, market share, enterprise and alternative liability. In October 1992, NL and the other defendants moved to dismiss the complaint with prejudice. In July 1993, the court dismissed the complaint. In December 1994, the Ohio Court of Appeals reversed the trial court dismissal and remanded the case to the trial court.\nIn November 1993, NL was served with a complaint in Brenner, et al. v. American Cyanamid, et al., Supreme Court, State of New York, Erie County alleging injuries to two children purportedly caused by lead pigment. The complaint seeks $24 million in compensatory and $10 million in punitive damages for alleged negligent failure to warn, strict products liability, fraud and misrepresentation, concert of action, civil conspiracy, enterprise liability, market share liability, and alternative liability. In January 1994, NL answered the complaint, denying liability. Discovery is proceeding.\nIn January 1995, NL was served with complaints in Wright (Alvin) and Wright (Allen) v. Lead Industries, et. al., (Nos. 94-363042 and 363043), Circuit Court, Baltimore City, Maryland. Plaintiffs are two brothers (one deceased) who allege injuries due to exposure to lead pigment. Each complaint seeks more than $100 million in compensatory and punitive damages for alleged strict liability, breach of warranty, negligence, conspiracy and fraud claims.\nNL believes that the foregoing lead pigment actions are without merit and intends to continue to deny all allegations of wrongdoing and liability and to defend such actions vigorously.\nNL has filed declaratory judgment actions against various insurance carriers seeking costs of defense and indemnity coverage for certain of its environmental and lead pigment litigation. NL Industries, Inc. v. Commercial Union Insurance Cos., et al., Nos. 90-2124, -2125 (HLS). In May 1990, NL filed an action in the United States District Court for the District of New Jersey against Commercial Union Insurance Company (\"Commercial Union\") seeking to recover defense costs incurred in the City of New York lead pigment case and two other cases which have since been resolved in NL's favor. In July 1991, the court granted NL's motion for summary judgment and ordered Commercial Union to pay NL's reasonable defense costs for such cases. In June 1992, NL filed an amended complaint in the United States District Court for the District of New Jersey against Commercial Union seeking to recover costs incurred in defending four additional lead pigment cases which have since been resolved in NL's favor. In August 1993, the court granted NL's motion for summary judgment and ordered Commercial Union to pay the reasonable costs of defending those cases. In July 1994, the court entered judgment on the order requiring Commercial Union to pay previously-incurred NL costs in defending two lead pigment cases. Commercial Union has appealed. Other than a magistrate's recommendation to grant motions for summary judgment brought by two excess insurance carriers, which contended their policies contained unique pollution exclusion language, and a grant by the court of certain motions regarding policy periods, the court has not made any rulings on defense costs or indemnity coverage with respect to NL's pending environmental litigation or on indemnity coverage in the lead pigment litigation. No trial dates have been set. Other than rulings to date, the issue of whether insurance coverage for defense costs or indemnity or both will be found to exist depends upon a variety of factors, and there can be no assurance that such insurance coverage will exist in other cases. NL has not considered any insurance recoveries for lead pigment or environmental litigation in determining related accruals.\nEnvironmental matters and litigation. NL has been named as a defendant, PRP, or both, pursuant to CERCLA and similar state laws in approximately 80 governmental and private actions associated with waste disposal sites and facilities currently or previously owned, operated or used by NL, or its subsidiaries, or their predecessors, many of which are on the U.S. Environmental Protection Agency's Superfund National Priorities List or similar state lists. These proceedings seek cleanup costs, damages for personal injury or property damage, or both. Certain of these proceedings involve claims for substantial amounts. Although NL may be jointly and severally liable for such costs, in most cases, it is only one of a number of PRPs who are also jointly and severally liable. In addition to the matters noted above, certain current and former facilities of NL, including several divested secondary lead smelter and former mining locations, are the subject of environmental investigations or litigation arising out of industrial waste disposal practices and mining activities.\nThe extent of CERCLA liability cannot be determined until the Remedial Investigation and Feasibility Study (\"RIFS\") is complete, the U.S. EPA issues a record of decision and costs are allocated among PRPs. The extent of liability under analogous state cleanup statutes and for common law equivalents are subject to similar uncertainties. NL believes it has provided adequate accruals for reasonably estimable costs for CERCLA matters and other environmental liabilities. At December 31, 1994, NL had accrued $87 million in respect of those environmental matters which are reasonably estimable. NL determines the amount of accrual on a quarterly basis by analyzing and estimating the range of possible costs to NL. Such costs include, among other things, remedial investigations, monitoring, studies, clean-up, removal and remediation. It is not possible to estimate the range of costs for certain sites. NL has estimated that the upper end of the range of reasonably possible costs to NL for sites for which it is possible to estimate costs is approximately $160 million. No assurance can be given that actual costs will not exceed accrued amounts or the upper end of the range for sites for which estimates have been made, and no assurance can be given that costs will not be incurred with respect to sites as to which no estimate presently can be made. The imposition of more stringent standards or requirements under environmental laws or regulations, new developments or changes respecting site cleanup costs or allocation of such costs among PRPs, or a determination that NL is potentially responsible for the release of hazardous substances at other sites could result in expenditures in excess of amounts currently estimated by NL to be required for such matters. Further, there can be no assurance that additional environmental matters will not arise in the future. More detailed descriptions of certain legal proceedings relating to environmental matters are set forth below.\nNL has been identified as a PRP by the U.S. EPA because of its former ownership of three secondary lead smelters (battery recycling plants) in Pedricktown, New Jersey; Granite City, Illinois; and Portland, Oregon. In all three matters, NL voluntarily entered into administrative consent orders with the U.S. EPA requiring the performance of a RIFS, a study with the objective of identifying the nature and extent of the hazards, if any, posed by the sites, and selecting a remedial action, if necessary.\nAt Pedricktown, the U.S. EPA divided the site into two operable units. Operable unit one covers contaminated ground water, surface water, soils and stream sediments. NL submitted the final RIFS for operable unit one to the U.S. EPA in May 1993. In July 1994, the U.S. EPA issued the Record of Decision for operable unit one. The U.S. EPA estimates the cost to complete operable unit one is $18.7 million. The U.S. EPA has not yet issued a notice or an order requiring implementation of operable unit one. In addition, the U.S. EPA has completed the fifth phase of a removal action on the soils and sediments of a stream at the site, at a U. S. EPA estimated total cost of $2 million. The U.S. EPA issued a Unilateral Administrative Order (Index No. II-CERCLA 20205) with respect to operable unit two in March 1992 to NL and 30 other PRPs directing immediate removal activities including the cleanup of waste, surface water and building surfaces. NL has complied with the order, and the work with respect to operable unit two is nearing completion. NL has paid approximately 50% of operable unit two costs, or $2.5 million.\nAt Granite City, the RIFS is complete, and in 1990 the U.S. EPA selected a remedy estimated to cost approximately $28 million. In July 1991, the United States filed an action in the U.S. District Court for the Southern District of Illinois against NL and others (United States of America v. NL Industries, Inc., et al., Civ. No. 91-CV 00578) with respect to the Granite City smelter. The complaint seeks injunctive relief to compel the defendants to comply with an administrative order issued pursuant to CERCLA, and fines and treble damages for the alleged failure to comply with the order. NL and the other parties did not comply with the order believing that the remedy selected by the U.S. EPA was invalid, arbitrary, capricious and not in accordance with law. The complaint also seeks recovery of past costs of $.3 million and a declaration that the defendants are liable for future costs. Although the action was filed against NL and ten other defendants, there are 330 other PRPs who have been notified by the U.S. EPA. Some of those notified were also respondents to the administrative order. In February 1992, the court entered a case management order directing that the remedy issues be tried before the liability aspects are presented. In August 1994, when the U.S. EPA reinitiated the residential yard soils remediation in Granite City after an agreed-upon stay of the cleanup pending completion of a health study and reopening of the administrative record, the PRPs and the City of Granite City sought an injunction against the U.S. EPA to prevent further cleanup until after the record was reopened for submittal of additional comments on the selected remedy. In October 1994, the U.S. EPA issued its proposed plan for addressing residential yard soils in Granite City. The U.S. EPA presented no estimate of costs for this work. The administrative record was reopened for public comment, and NL, along with other PRPs, submitted extensive comments on the proposed residential soils cleanup plan. In February 1995, the U.S. EPA issued its proposed plan for the Main Industrial Area, the remaining remote fill areas and ground water at the site, which is estimated by the U. S. EPA to cost approximately $9.2 million. The administrative record has been reopened for public comments on this phase of the cleanup.\nHaving completed the RIFS at Portland, NL conducted predesign studies to explore the viability of the U.S. EPA's selected remedy pursuant to a June 1989 consent decree captioned U.S. v. NL Industries, Inc., Civ. No. 89-408, United States District Court for the District of Oregon. Subsequent to the completion of the predesign studies, the U.S. EPA issued notices of potential liability to approximately 20 PRPs, including NL, directing them to perform the remedy, which was initially estimated to cost approximately $17 million, exclusive of administrative and overhead costs and any additional costs, for the disposition of recycled materials from the site. In January 1992, the U.S. EPA issued unilateral administrative orders Docket No. 1091-01-10-106 to NL and six other PRPs directing the performance of the remedy. NL and the other PRPs commenced performance of the remedy and, through December 31, 1994, NL and the other PRPs had spent approximately $18 million. Based upon site operations to date, the remedy is not proceeding in accordance with engineering expectations or cost projections; therefore, NL and the others PRPs have met with the U.S. EPA to discuss alternative remedies for the site. The U.S. EPA authorized NL and other PRPs to cease performing most aspects of the selected remedy. In September 1994, NL and the other PRPs submitted a focused feasibility study (\"FFS\") to the U.S. EPA, which proposes alternative remedies for the site. The U.S. EPA is considering the alternatives proposed in the FFS. Pursuant to an interim allocation, NL's share of remedial costs is approximately 50%. In November 1991, Gould, Inc., the current owner of the site, filed an action, Gould Inc. v. NL Industries, Inc., No. 91-1091, United States District Court for the District of Oregon, against NL for damages for alleged fraud in the sale of the smelter, rescission of the sale, past CERCLA response costs and a declaratory judgment allocating future response costs and $5 million in punitive damages. The court granted Gould's motion to amend the complaint to add additional defendants (adjoining current and former landowners) and third party defendants (generators). The amended complaint deletes the fraud and punitive damages claims asserted against NL; thus, the pending action is essentially one for reallocation of past and future cleanup costs. In March 1993, the parties agreed to a case management order limiting discovery until 1995. In December 1994, Gould amended its complaint adding approximately 15 additional generator defendants and two additional owner\/operator defendants. Discovery is proceeding. A trial date has been tentatively set for September 1996.\nThere are several actions pending relating to alleged contamination at other properties formerly owned or operated by NL or its subsidiaries or their predecessors. In one of those cases, suit was filed in November 1992 against NL asserting claims arising out of the sale of a former business of NL to Exxon Chemical Company (Exxon Chemical Company v. NL Industries, Inc., United States District Court for the Southern District of Texas, No. H-92-3360). The action sought contractual indemnification, contribution under CERCLA for costs associated with the environmental assessment and cleanup at nine properties included in the sale, a declaration of liability for future environmental cleanup costs, and punitive damages for fraud. Plaintiff asserted that past and future cleanup costs, business interruption, and asset value losses and legal and site assessment costs were approximately $25 million. In December 1994, this matter was settled within previously accrued amounts.\nNL and other PRPs entered into an administrative consent order with the U.S. EPA requiring the performance of a RIFS at two sites in Cherokee County, Kansas, where NL and others formerly mined lead and zinc. A predecessor of NL mined at the Baxter Springs subsite, where it is the largest viable PRP. The final RIFS was submitted to the U.S. EPA in May 1993. In August 1994, the U.S. EPA issued its proposed plan for the cleanup of the Baxter Springs and Treece sites in Cherokee County. The proposed remedy is estimated by the U.S. EPA to cost $6 million.\nIn January 1989, the State of Illinois brought an action against NL and several other subsequent owners and operators of the former lead oxide plant in Chicago, Illinois (People of the State of Illinois v. NL Industries, et al., No. 88-CH-11618, Circuit Court, Cook County). The complaint seeks recovery of $2.3 million of cleanup costs expended by the Illinois Environmental Protection Agency, plus penalties and treble damages. In October 1992, the Supreme Court of Illinois reversed the Appellate Division, which had affirmed the trial court's earlier dismissal of the complaint, and remanded the case for further proceedings. In December 1993, the trial court denied the State's petition to reinstate the complaint, and dismissed the case with prejudice. The State's appeal of this ruling is pending.\nIn 1980, the State of New York commenced litigation against NL in connection with the operation of a plant in Colonie, New York formerly owned by NL. Flacke v. NL Industries, Inc., No. 1842-80 (\"Flacke I\") and Flacke v. Federal Insurance Company and NL Industries, Inc., No. 3131-92 (\"Flacke II\"), New York Supreme Court, Albany County. The plant manufactured military and civilian products from depleted uranium and was acquired from NL by the U.S. Department of Energy (\"DOE\") in 1984. Flacke I seeks penalties for alleged violations of New York's Environmental Conservation Law, and of a consent order entered into to resolve these alleged violations. Flacke II seeks forfeiture of a $200,000 surety bond posted in connection with the consent order, plus interest from February 1980. NL denied liability in both actions. The litigation had been inactive from 1984 until July 1993 when the State moved for partial summary judgment for approximately $1.5 million on certain of its claims in Flacke I and for summary judgment in Flacke II. In January 1994, NL cross- moved for summary judgment in Flacke I and Flacke II. All summary judgment motions have been denied and both parties have appealed.\nResidents in the vicinity of NL's former Philadelphia lead chemicals plant commenced a class action allegedly comprised of over 7,500 individuals seeking medical monitoring and damages allegedly caused by emissions from the plant. Wagner, et al v. Anzon and NL Industries, Inc., No. 87-4420, Court of Common Pleas, Philadelphia County. The complaint sought compensatory and punitive damages from NL and the current owner of the plant, and alleged causes of action for, among other things, negligence, strict liability, and nuisance. A class was certified to include persons who reside, owned or rented property, or who work or have worked within up to approximately three-quarters of a mile from the plant from 1960 through the present. NL answered the complaint, denying liability. In November 1994, the jury returned a verdict in favor of NL. Plaintiffs have filed post-trial motions requesting a new trial. Residents also filed consolidated actions in the United States District Court for the Eastern District of Pennsylvania, Shinozaki v. Anzon, Inc. and Wagner and Antczak v. Anzon and NL Industries, Inc. Nos. 87-3441 and 87-3502. The consolidated action is a putative class action seeking CERCLA response costs, including cleanup and medical monitoring, declaratory and injunctive relief and civil penalties for alleged violations of the Resource Conservation and Recovery Act (\"RCRA\"), and also asserting pendent common law claims for strict liability, trespass, nuisance and punitive damages. The court dismissed the common law claims without prejudice, dismissed two of the three RCRA claims as against NL with prejudice, and stayed the case pending the outcome of the state court litigation.\nIn July 1991, a complaint was filed in the United States District Court for the Central District of California, United States of America v. Peter Gull and NL Industries, Inc., Civ. No. 91-4098, seeking recovery of $2 million in costs incurred by the United States in response to the alleged release of hazardous substances into the environment from a facility located in Norco, California, treble damages and $1.75 million in penalties for NL's alleged failure to comply with the U.S. EPA's administrative order No. 88-13. The order, which alleged that NL arranged for the treatment or disposal of materials at the Norco site, directed the immediate removal of hazardous substances from the site. NL carried out a portion of the remedy at the Norco site, but did not complete the ordered activities because it believed they were in conflict with California law. NL answered the complaint denying liability. The government claims it expended in excess of $2.7 million for this matter. Trial was held in March and April 1993. In April 1994, the court entered final judgment in this matter directing NL to pay $6.3 million plus interest. The court ruled that NL was liable for approximately $2.7 million in response costs plus approximately $3.6 million in penalties for failure to comply with the administrative order. Both NL and the government have appealed. In August 1994, this matter was referred to mediation, which is pending.\nAt a municipal and industrial waste disposal site in Batavia, New York, NL and six others have been identified as PRPs. The U.S. EPA has divided the site into two operable units. Pursuant to an administrative consent order entered into with the U.S. EPA, NL is conducting a RIFS for operable unit one, the closure of the industrial waste disposal section of the landfill. NL's RIFS costs to date are approximately $2 million. In August 1994, the U.S. EPA issued the proposed plan for operable unit one, which the U.S. EPA has estimated to cost approximately $12.3 million. NL, along with other PRPs, submitted extensive comments on the proposed plan. With respect to the second operable unit, the extension of the municipal water supply, the U.S. EPA estimated the costs at $1 million plus annual operation and maintenance costs. NL and the other PRPs are performing the work comprising operable unit two. The U.S. EPA has also demanded approximately $.9 million in past costs from the PRPs.\nSee also Item 1 - \"Business - Chemicals - Regulatory and environmental matters\".\nIn addition to the NL matters discussed above, the Company has been named as a PRP pursuant to CERCLA at one Superfund site in Indiana and has also undertaken a voluntary cleanup program approved by state authorities at another Indiana site, both of which involve operations no longer conducted by the Company. The total estimated cost for cleanup and remediation at the Indiana Superfund site is $45 million, of which the Company's share is currently estimated to be approximately $2 million. The Company's estimated cost to complete the voluntary cleanup program at the other Indiana site, which involves both surface and groundwater remediation, is relatively nominal. The Company believes it has adequately provided accruals for reasonably estimable costs for CERCLA matters and other environmental liabilities. At December 31, 1994, the Company had accrued $3 million in respect of such matters, which accrual does not reflect any amounts which the Company could recover from insurers or other third parties and is near the Company's estimate of the upper end of range of possible costs. No assurance can be given that actual costs will not exceed accrued amounts or the upper end of the range. The imposition of more stringent standards or requirements under environmental laws or regulations, new developments or changes respecting site cleanup costs or allocation of such costs among PRPs or a determination that the Company is potentially responsible for the release of hazardous substances at other sites could result in expenditures in excess of amounts currently estimated by the Company to be required for such matters. Furthermore, there can be no assurance that additional environmental matters related to current or former operations will not arise in the future.\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 quarter ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nValhi's common stock is listed and traded on the New York and Pacific Stock Exchanges (symbol: VHI). As of February 28, 1995, there were approximately 6,500 holders of record of Valhi common stock. The following table sets forth the high and low sales prices for Valhi common stock for the years indicated, according to the New York Stock Exchange Composite Tape, and dividends paid during such periods. On February 28, 1995 the closing price of Valhi common stock according to the NYSE Composite Tape was $8.00.\nIn March 1995, the Company's Board of Directors increased the regular quarterly dividend to $.03 per common share. However, declaration and payment of dividends and the amount thereof will be dependent upon the Company's results of operations, financial condition, cash requirements for its businesses, contractual requirements and restrictions and other factors deemed relevant by the Board of Directors. There are currently no contractual restrictions on the ability of Valhi to declare or pay dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following selected financial data should be read in conjunction with the Company's Consolidated Financial Statements and Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS:\nCONTINUING OPERATIONS\nThe Company reported income from continuing operations of $.17 per share in 1994 following per share losses of $.52 in 1993 and $.01 in 1992. The 1994 improvement in earnings from continuing operations over 1993, as well as the 1992 to 1993 decline, was significantly influenced by the Company's equity in losses attributable to NL Industries. During December 1994, Valhi increased its ownership of NL to over 50% and as a result, will consolidate NL's results of operations beginning in 1995. The Company currently expects its consolidated 1995 earnings to be higher than in 1994, in large part due to expected improvements in NL's chemicals earnings.\nCHEMICALS\nSelling prices for TiO2, NL's principal chemical product, increased during 1994 after four consecutive years of declining prices. NL's TiO2 operations are conducted through Kronos while its specialty chemicals operations are conducted through Rheox.\n[FN] * Valhi's purchase accounting adjustments made in conjunction with the acquisitions of its interest in NL result in additional depreciation, depletion and amortization expense beyond amounts separately reported by NL. As a result, 1994 pro forma chemicals operating income is approximately $20 million less than as reported by NL in its separate financial statements.\nThe improvement in Kronos' 1994 results was primarily due to higher average selling prices, higher production and sales volumes for TiO2 and higher technology fee income. In billing currency terms, Kronos' 1994 average TiO2 selling prices were approximately 3% higher than in 1993. At year-end 1994, average TiO2 selling prices were 6% higher than year-earlier levels and were 10% above the low point reached in 1993.\nRecord sales volume of 376,000 metric tons of TiO2 in 1994 represents an increase of 9% over 1993, with increases in Europe, North American and other regions. Due to increasing demand for TiO2 and higher sales volumes, Kronos increased its capacity utilization in 1994 to 94% after having reduced its TiO2 production rates in response to weakened demand in late 1992 and in 1993. Approximately one-half of Kronos' 1994 TiO2 sales, by volume, were attributable to markets in Europe with 36% attributable to North America and the balance to export markets. TiO2 sales volumes increased 3% in 1993 over 1992, as increases in North American sales volumes were partially offset by declining sales volumes in European markets. Average prices in 1993 were 8% lower than in 1992.\nAs a result of Kronos' continued emphasis on cost reduction and containment efforts, TiO2 per-unit production costs were relatively flat during 1992 to 1994 (up slightly in 1993 and down slightly in 1994).\nDemand, supply and pricing of TiO2 have historically been cyclical, with the last cyclical peak for TiO2 prices in early 1990 and the trough in the third quarter of 1993. The average TiO2 selling price index (using 1983 = 100) of 131 for 1994 was 3% above the 1993 level but was still 25% below the TiO2 price index of 175 for 1990. Kronos believes that its operating income and margins for 1995 will be higher than in 1994 due principally to the net effect of higher average TiO2 selling prices and slightly higher sales and production volumes, offset in part by increased raw material costs.\nRheox's operating results improved in 1994 primarily as a result of higher sales volume and lower operating costs. Operating costs increased during 1993 over 1992, contributing to the decline in 1993 operating income. Changes in currency exchange rates had a slightly positive effect on Rheox's sales and earnings in 1994 and a negative effect on 1993 results compared to 1992.\nNL has substantial operations and assets located outside the United States (principally Germany, Norway, Belgium and Canada). The U.S. dollar value of NL's foreign sales and operating results are subject to currency exchange rate fluctuations which may favorably or adversely impact reported earnings and effect the comparability of period to period operating results. A significant amount of NL's sales are denominated in currencies other than the U.S. dollar (67% in 1994), principally major European currencies and the Canadian dollar. Certain raw materials, primarily titanium-containing feedstocks, are purchased in U.S. dollars, while labor and other production costs are denominated primarily in the local currency. Fluctuations in the value of the U.S. dollar relative to other currencies decreased 1994 sales by $2 million compared to 1993 and decreased 1993 sales by $45 million compared to 1992.\nREFINED SUGAR\nSugar sales volume comparisons can be affected by relative timing of sales during the crop year, which runs from October 1 to September 30, and by marketing allotments as well as by the size of the respective crops. Government-imposed marketing allotments, which limit domestic sales volume and are intended to help support prices, are in effect for the crop year ending September 30, 1995.\nAverage sugar selling prices in 1994 were slightly (less than 1%) higher than in 1993 following three years of declines. After continuing to fall during much of 1994, average prices increased 4% in the fourth quarter compared to third quarter averages, in large part due to the effects of the government- imposed marketing allotments on domestic processors. Amalgamated's allotment for the current crop year, which runs through September 30, 1995, is approximately 2% lower than the volume of sugar sold during the previous crop year when no marketing allotments were imposed. However, fourth quarter 1994 volume represented only about 20% of Amalgamated's current crop year marketing allotment of 16 million hundredweight (\"cwt\"). As a result, sugar sales volume for the first nine months of 1995 (the remainder of the crop year) should approximate the cwt volume sold during the same period of 1994.\nSugar sales volume in 1993 was lower than in 1992 in large part as a result of imposition of marketing allotments during the crop year ended September 30, 1993. The marketing allotments, imposed in June 1993, had a positive impact on prices in the third quarter of 1993. Prices weakened during the 1993 fourth quarter following expiration of the allotments and average prices for the year were 3% below those of 1992.\nDue primarily to an abnormally high yield per acre, Amalgamated's sugar production from the crop harvested in the fall of 1994 is currently expected to be at least 10% higher than its previous record crop and exceed its domestic marketing allotment quota by about 1.5 million cwt. Due to the combined effects of record production and marketing allotments, inventories were significantly higher at December 31, 1994 than one year ago and are expected to continue to be above historical norms throughout the remainder of the current crop year. Amalgamated expects to make limited sales into foreign markets (which are excluded from domestic allotments) to help reduce the amount of \"carryover\" sugar into the next crop year, however such sales will likely be at lower prices than domestic sales. Amalgamated currently expects contracted acreage for the crop to be planted in the spring of 1995 will approximate the acreage harvested in 1994. However, the abnormally high yield per acre is unlikely to recur and production is therefore expected to be more in line with historical levels of the past few years.\nRefined sugar historically represents approximately 90% of Amalgamated's annual sales. Fluctuations in the volume of by-products sold, generally sold principally in the first and fourth calendar quarters, approximate those of refined sugar. The selling prices of by-products are affected by the prices of competing animal feeds and are, therefore, independent of the price of sugar. Average selling prices of dried pulp, the principal by-product, rose 5% in 1994 after falling over 10% in 1993.\nSugarbeet purchase cost is the largest cost component of producing refined sugar and the price paid for sugarbeets is, under the terms of contracts with the sugarbeet growers, a function of the average selling price of Amalgamated's refined sugar. As a result, changes in sugar selling prices impact sugarbeet purchase costs as well as revenues and serve as a partial hedge against changing prices. However, related LIFO adjustments can significantly affect operating income and margin comparisons relative to FIFO basis comparisons.\nProcessing costs per hundredweight of refined sugar were lower in 1993 than in either 1992 or 1994 due in part to generally more favorable weather conditions during 1993's sugarbeet processing campaign and a higher sugar content of that year's sugarbeets. Primarily due to the combination of the bumper crop, which extended the current processing campaign into March 1995 (the longest campaign in the Company's history), and relatively adverse weather conditions during the campaign, 1995 per-unit processing costs are currently estimated to be about 7% higher than in 1994. The largest component of Amalgamated's selling, general and administrative expenses is the freight cost of sugar and by-products delivered to customers. Consequently, such expenses vary significantly with the volume of refined sugar and by-products sold.\nThe Company has tentatively agreed to sell its sugar business, for $325 million cash, to an agricultural cooperative comprised of sugarbeet growers in Amalgamated's area of operations. The proposed transaction is subject to significant conditions, including financing, grower commitments and execution of a definitive purchase agreement, and no assurance can be given that any such transaction will be consummated.\nBUILDING PRODUCTS\nResults of operations during the past three years have been affected by Medite's ongoing strategy to expand its emphasis on MDF, to increase the relative proportion of higher margin specialty MDF products and to downsize its commodity-type traditional timber products operations.\nMedium density fiberboard. Medite's MDF plants have been operating at a high rate of capacity and, consequently, Medite's emphasis on the production of higher margin specialty MDF products has displaced production of standard grade MDF. A new production line in Ireland became operational during the fourth quarter of 1994 and is expected to enable Medite to increase both standard and specialty product volumes and to more efficiently produce thin-board MDF. Over the past two years, the increased cost of traditional timber products has led to higher demand for substitute products such as MDF and resulted in MDF operating rates approaching effective capacity. In this environment, MDF prices have increased notably, and Medite's increased emphasis on specialty products has also favorably impacted its average selling prices. At the end of 1994, selling prices of standard MDF products were approximately 27% higher than one year earlier and Medite implemented additional price increases averaging over 4% during the first quarter of 1995. Further 1995 improvement in aggregate MDF prices is currently expected to be influenced primarily by specialty product mix and changes, if any, in raw material costs.\nThe significant improvements in MDF sales, operating income and operating income margins in 1994 were driven by both higher selling prices and higher volumes of specialty MDF products. Overall average MDF selling prices were up 19% in 1994 due to combined effects of a 16% increase in average selling prices of standard MDF products and increased sales of higher-priced\/higher margin specialty products. Average per-unit MDF costs increased approximately 6% in 1994 primarily as a result of higher resin costs (due to increased prices for resins of standard MDF products and the increased use of higher-cost resins associated with specialty MDF products) and higher wood fiber costs. The price of standard MDF resins increased principally due to recent worldwide shortages of methanol, a primary element in resin manufacture. Continued increases in resin costs could hamper margins as there is no assurance that they can continue to be recovered through additional product price increases. Fluctuations in the value of the U.S. dollar relative to other currencies accounted for approximately one percentage point of the increase in average selling prices and less than one percentage point of the increase in per-unit costs.\nMDF sales in 1993, in U.S. dollar terms, were only nominally higher than 1992. The positive effects of higher total volume, higher specialty products volume and selling price increases (in billing currency terms) were substantially offset by fluctuations in currency exchange rates. Average selling prices, in billing currency terms, of standard MDF increased 7% in the U.S. and decreased 3% at the Ireland facility. The decline in average prices in Ireland was due primarily to lower volume of cut-to-size standard products. MDF operating income margins improved, however, as currency fluctuations were also a significant factor in the 4% reduction of per-unit MDF costs. The effect of currency fluctuations, along with moderate improvement in operating efficiency in the U.S., more than offset increased per-unit wood and resin costs resulting primarily from higher production of specialty products.\nThe U.S. dollar value of Medite's foreign sales and operating costs are subject to currency exchange rate fluctuations which, as noted above, may favorably or adversely impact reported earnings and affect the comparability of operating results. Approximately 30% of Medite's 1994 MDF sales were denominated in currencies other than the U.S. dollar, principally the U.K. Pound Sterling and the European Currency Unit. Medite's Irish operations accounted for approximately 35% of its MDF production in 1994. Fiber, labor and most other production costs in Ireland are denominated principally in Irish punts, while Irish resins are purchased primarily in Sterling. The percentage of non- dollar sales and costs are expected to increase as a result of the additional production capacity recently added to the Irish MDF plant and could, therefore, increase the magnitude of the effect of future currency fluctuations.\nTraditional timber products. Traditional timber products operations for the past three years are not, in certain respects, directly comparable due to the January 1993 closure of Medite's plywood operations (in response to the rising cost and declining availability of government timber in recent years) and the fire at its Rogue River chipping and veneer plant in June 1992, as discussed below. Rogue River chipping operations resumed in July 1993 and veneer operations resumed in January 1994. Medite expects to meet its longer-term timber needs from its own lands and other private sources and does not anticipate acquiring any significant amount of new government timber contracts in the foreseeable future.\nMedite's strategy is to maximize the operating contributions from its fee timberlands by allocating its harvested timber between log sales and its traditional timber products conversion facilities depending upon prevailing market conditions. Primarily as a result of market-based volume decisions made by Medite, including a relative reduction in the volume of logs offered for sale and curtailment of veneer and lumber production during a portion of 1994, traditional timber products sales and operating income declined in 1994 relative to 1993. Average sales prices for logs and lumber during 1994 were about 5% higher than during 1993, although year-end 1994 prices were 15% and 25%, respectively, below the averages for the year. Operating income in 1994 was favorably impacted by lower log costs, which on a per unit basis were 18% lower than in 1993. This decrease in average log costs results from the combined effects of log mix (31% of logs obtained from lower cost fee timber in 1994 compared to 22% in 1993) and a $3 million favorable impact of reductions in LIFO log inventories in 1994. The favorable effects of lower log costs on operating income, including the favorable LIFO effect that is not necessarily recurring, were substantially offset by adverse effects of start-up of Rogue River veneer operations in the first half of 1994.\nAverage selling prices increased significantly in 1993 over 1992 levels (lumber up 29%; logs up 46%) due primarily to the combined effects of the continuing Pacific Northwest timber shortage, closure of certain competitor operations and increased demand for building products. These factors also significantly increased Medite's timber costs. The average unit cost of logs used in Medite's traditional timber product operations increased about 24% in 1993 following a 28% increase in 1992 due primarily to increases in the cost of timber from government and other sources. Business interruption insurance from the Rogue River fire recognized as a component of operating income ($3.7 million in 1992 and $1.9 million in 1993) had a significant favorable, non-recurring effect on traditional timber product operating income margins in 1992 and 1993 as this income had no associated cost.\nHARDWARE PRODUCTS\nNational Cabinet Lock reported new highs in both sales and operating income in each of 1993 and 1994 as volumes increased in each of its three major product lines (locks, computer keyboard support arms and drawer slides). Keyboard support arms have been the fastest growing product line and were up 18% in 1994, to about one-fourth of total hardware product sales. The Company's principal production facilities are operating at a high rate of capacity, and overtime was used throughout 1994 in order to meet market demand.\nNational Cabinet Lock continues to add new products to its STOCK LOCKS product line as well as to its Waterloo Furniture Components support arms and drawer slide lines. National Cabinet Lock currently expects more modest growth in 1995 than in the past two years due to production capacity considerations and certain changes in customer mix. A lock contract with a U.S. Government agency that accounted for approximately 5% of 1994 sales will be completed in about March 1995, and the agency has indicated it has an adequate supply of locks for its remaining 1995 requirements. National Cabinet Lock believes it will be able to compensate through increased sales to other customers.\nAlmost two-thirds of National Cabinet Lock's sales are generated by its Canadian operations. About two-thirds of these Canadian-produced sales are denominated in U.S. dollars while substantially all of the related costs are incurred in Canadian dollars. As a result, fluctuations in the value of the U.S. dollar relative to the Canadian dollar favorably impacted operating results in both 1994 and 1993 compared to the respective prior year.\nFAST FOOD\nSales in 1994 were a new Sybra record, with comparable store sales up about 2% in large part because 1994 was a 53-week year. An $800,000 year-to-year increase in store closing costs was a principal factor in the decline in operating income. The fast food industry continues to be very competitive. Despite stable to lower food costs, increased usage of lower-margin value-priced sandwiches and the market responsive introduction of higher cost new menu items have served to dampen operating margins. Any increase in the minimum wage rate would increase labor costs, which currently are about 28% of sales. There is no assurance that any such cost increase could, particularly in the short-term, be recovered through product price increases.\nImproving general economic conditions contributed significantly to a 6% increase in comparable store sales during 1993. Customer traffic increased in part due to certain regional promotions marketed to price-driven consumers with various levels of advertising support.\nSybra expects to open eight to ten new Arby's restaurants in 1995, which is expected to result in a net increase in the number of stores operated of two or three. Sybra continually evaluates the profitability of its individual restaurants and intends to continue to close unprofitable stores when appropriate. In addition to five stores closed during the first quarter of 1995, Sybra may close one to two additional stores later in the year.\nGENERAL CORPORATE AND OTHER ITEMS\nGeneral corporate. Lower securities earnings in 1994 resulted primarily from a first quarter 1994 decline in the market value of the fixed-income investments while average balances available for investment and yields thereon were lower in 1993 than in 1992. General expenses increased in 1994 as higher legal-related expenses were only partially offset by lower environmental-related charges. The increase in general expenses in 1993 resulted in large part from lower net charges to affiliates and additional environmental remediation expenses relating to certain operations no longer conducted by the Company.\nPro forma general corporate and other expenses for 1994 include $45 million attributable to NL. Such NL general corporate expenses include provisions for environmental remediation and litigation costs of approximately $40 million and $15 million, respectively, and a nonrecurring $20 million gain related to settlement of NL's lawsuit against Lockheed Corporation.\nInterest expense. Historical interest expense declined $13 million (25%) in 1993 and further declined $3 million (9%) in 1994 as a result of lower average indebtedness levels and interest rates. The lower average interest rates resulted in part from the prepayment of Valhi 121\/2% Senior Subordinated Notes from the proceeds of lower-rate borrowings. Pro forma interest expense of $119 million for 1994 includes $84 million attributable to NL.\nAt December 31, 1994, approximately $645 million of consolidated indebtedness, principally publicly-traded debt, bears interest at fixed rates averaging 10.9%. The average interest rate on floating rate borrowings outstanding at December 31, 1994 was 7.4%, up from 4.4% on outstanding variable rate borrowings from one year earlier. NL has significant variable interest rate borrowings in Germany (the DM bank credit facility) and, accordingly, NL's interest expense is also subject to currency fluctuations. Periodic cash interest payments are not required on Valhi's 9.25% deferred coupon LYONs, and NL's 13% Discount Notes do not require periodic interest payments until 1998. As a result, current cash interest expense payments are lower than accrual basis interest expense.\nMinority interest. Pro forma minority interest relates to certain partially-owned foreign subsidiaries of NL. At December 31, 1994, NL separately reported a stockholders' deficit of approximately $293 million and, as a result, no minority interest in NL Industries is recorded in the Company's consolidated balance sheet. Accordingly, until such time as NL reports positive stockholders' equity in its separate financial statements, all future changes in NL's equity, including all undistributed earnings or losses, will accrue to the Company for financial reporting purposes.\nPROVISION FOR INCOME TAXES\nThe principal reasons for the difference between the Company's effective income tax rates and the U.S. federal statutory income tax rates are explained in Note 16 to the Consolidated Financial Statements. Income tax rates vary by jurisdiction (country and\/or state), and relative changes in the geographic source of the Company's pre-tax earnings can result in fluctuations in the Company's consolidated effective income tax rate.\nNL's operations are conducted on a worldwide basis and the geographic mix of income can significantly impact NL's effective income tax rate. In each of the past three years, such geographic mix included losses in certain of NL's tax jurisdictions for which no current refund was available and in which recognition of a deferred tax asset was not considered appropriate. This contributed significantly to NL's effective tax rates, and consequently the Company's pro forma 1994 effective tax rate, varying from a normally expected rate. Because NL is not a member of the Contran Tax Group (of which Valhi is a member), Valhi's incremental income taxes on its after-tax earnings or losses attributable to NL also can increase the Company's overall effective tax rate.\nDISCONTINUED OPERATIONS, EXTRAORDINARY ITEMS, AND CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES.\nSee Notes 3, 13 and 17 to the Consolidated Financial Statements.\nEQUITY IN EARNINGS OF NL PRIOR TO CONSOLIDATION\nAs discussed in Note 3 to the Consolidated Financial Statements, the Company's interest in NL was reported by the equity method during 1992 to 1994. As discussed above and in Note 3, the Company will consolidate NL's results of operations beginning January 1, 1995. NL's separately-reported results of operations are summarized below. The Company's equity in NL's results differ from its effective percentage interest in NL's separate results. Amortization of basis differences arising from purchase accounting adjustments made by the Company in conjunction with the acquisition of its interests in NL generally reduces earnings, or increases losses, as reported by the Company compared to amounts separately reported by NL.\nNL's sales and operating income are discussed under \"Chemicals\" above. NL's corporate expenses, net in 1994 were higher than in 1993 as a $20 million gain related to the settlement of a lawsuit against Lockheed was offset primarily by increased provisions for environmental remediation and litigation costs. In 1993, higher environmental remediation costs were more than offset by a $9 million reduction in certain proxy solicitation and litigation settlement expenses. NL's interest expense declined in both 1993 and 1994 principally as a result of lower debt levels. NL's tax provision is discussed under \"Provision for income taxes\" above.\nThe Company periodically evaluates the net carrying value of its long-term assets to determine if there has been any decline in value below their respective net carrying values that is considered to be other than temporary and would, therefore, require a write-down accounted for as a realized loss. As a result of this process, Valhi recorded an $84 million pre-tax charge to earnings for an other than temporary decline in market value of NL common stock in the first quarter of 1993, which charge is reported as a separate item. See Notes 2 and 3 to the Consolidated Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES:\nCONSOLIDATED CASH FLOWS\nOperating activities. As noted above, the Company consolidated NL's financial position at December 31, 1994 and will consolidate NL's results of operations and cash flows beginning in 1995. As historically reported, cash flow from operating activities before changes in assets and liabilities increased from $63 million in 1992 to $69 million in 1993 and to $80 million in 1994 reflecting the Company's improved operating results. Changes in assets and liabilities, which used cash in each of the past three years, result primarily from the timing of production, sales and purchases, generally tend to even out over time and include the impact of significant seasonal fluctuations related to\nrefined sugar operations. Over 80% of the aggregate $48 million net change in assets and liabilities during the past three years related to Amalgamated as year-to-year fluctuations in the size of the sugarbeet crop can have a material impact on working capital levels.\nPro forma cash provided by operating activities for 1994 of $254 million includes $136 million attributable to NL's receipt of German tentative income tax refunds discussed below.\nNoncash interest expense consists of amortization of original issue discount on certain indebtedness and amortization of deferred financing costs. The net deferred income tax benefit relates primarily to the Company's incremental tax benefit on its equity in losses of NL.\nInvesting activities. Capital expenditures during the past three years are disclosed by business segment in Note 2 to the Consolidated Financial Statements and are discussed in the respective individual company sections below. The higher levels of capital expenditures in 1994 relate principally to capacity projects, including Amalgamated's sugar productivity-enhancing equipment, Medite's Irish MDF plant expansion and Sybra's new restaurants.\nAt December 31, 1994, the estimated cost to complete capital projects in process approximated $74 million, most of which relates to environmental protection and improvement programs at NL and productivity-enhancing equipment at both NL and Amalgamated. The Company's total capital expenditures for 1995 are estimated at approximately $126 million compared to 1994 pro forma capital expenditures of $110 million. Such 1995 estimated capital expenditures include $35 million related to environmental protection and improvement programs, principally desulfurization and water treatment chemical purification systems at certain of NL's TiO2 plants and air and water facilities at certain of Amalgamated's factories, $14 million for new productivity-enhancing equipment at Amalgamated, $12 million for new Sybra stores and $7 million for NL TiO2 debottlenecking projects. Other 1995 capital projects are principally of an ongoing normal nature. Capital expenditures in 1995 are expected to be financed primarily from operations or existing cash resources and credit facilities.\nNet sales of securities in 1993 include sales made in conjunction with the redemptions of Valhi's 121\/2% Notes. On a net basis, cash was used to purchase Treasury securities in 1992. Net cash provided in 1992 includes $11 million of insurance proceeds related to the fire at Medite's Rogue River plant.\nFinancing activities. Net repayments of indebtedness in 1994 relate principally to (i) $21 million of project financing related to Medite's Irish MDF plant expansion and (ii) a net $11 increase in term borrowings at Amalgamated for capital expenditures. Pro forma 1994 net repayments of indebtedness include $131 attributable to NL, principally reductions in DM borrowings paid with proceeds of the German tentative tax refunds discussed under \"Chemicals\" below.\nNet repayments of indebtedness in 1993 relate principally to (i) Valhi's redemptions of $235 million principal amount of 121\/2% Notes, (ii) Valcor's issuance of $100 million of 95\/8% Senior Notes, and (iii) net new borrowings of approximately $39 million under Medite's Timber Credit Agreement. Net borrowings in 1992 include $94 million of net proceeds from the issuance of the LYONs and $59 million expended to repurchase 121\/2% Notes in market transactions.\nAt December 31, 1994, unused revolving credit available under the existing facilities aggregated $284 million, including $209 million attributable to NL. Of such NL amount, $80 million is available only for (i) permanently reducing NL's DM term loan or (ii) paying future German income tax assessments, as discussed below. See Note 11 to the Consolidated Financial Statements.\nCHEMICALS - NL INDUSTRIES\nThe TiO2 industry is cyclical, with the previous peak in selling prices in early 1990 and the latest trough in the third quarter of 1993, and NL's operations used significant amounts of cash during such TiO2 downturn cycle. NL operated with a strategy to maintain its competitive position during the past few years and increased its estimated TiO2 worldwide market share from 10% to 11%. NL also implemented cost reduction and control programs which favorably impacted its operating results, and continued its environmental improvement efforts. In 1993, NL formed the TiO2 manufacturing joint venture with Tioxide and refinanced certain debt which, among other things, increased NL's liquidity, reduced its aggregate debt level and extended its debt maturities.\nReflecting the improvement in Kronos' operating results, NL generated $39 million in cash from operating activities in 1994 before changes in assets and liabilities. Relative changes in NL's inventories, receivables and payables (excluding the effect of currency fluctuation) also provided cash in 1994 while receipt of the tentative German income tax refunds, discussed below, significantly increased NL's cash flow from operating activities and was a major factor in NL's improved liquidity.\nNL's capital expenditures during the past three years aggregated $170 million, including $63 million ($17 million in 1994) for NL's ongoing environmental protection and compliance programs, including a Canadian waste acid neutralization facility, a Norwegian onshore tailings disposal system and various off-gas desulfurization systems. NL's estimated 1995 capital expenditures are $66 million and include $33 million in the area of environmental protection and compliance, primarily related to the off-gas desulfurization and water treatment chemical purification systems. NL is planning $25 million in capital expenditures ($7 million in 1995) related to a debottlenecking project at its Leverkusen, Germany chloride process TiO2 facility that is expected to increase NL's annual attainable TiO2 production capacity by 20,000 metric tons to 400,000 tons. The capital expenditures of the TiO2 manufacturing joint venture are not included in NL's capital expenditures.\nNL reduced its \"net debt\" (notes payable and long-term debt less cash, equivalents and securities) by about $90 million during 1994, and currently expects to have sufficient liquidity to meet its obligations including operations, capital expenditures and debt service. In addition to $156 million of cash, equivalents and current securities held by NL and its subsidiaries at December 31, 1994 (30% held by non-U.S. subsidiaries), of which $16 million is restricted, NL had $14 million and $195 million available for borrowing under existing U.S. and non-U.S. credit facilities, respectively, of which $80 million is available only for (i) permanently reducing NL's DM term loan or (ii) paying future German tax assessments, as described below. NL and Kronos have agreed, under certain conditions, to provide KII with up to an additional DM 125 million through January 1, 2001.\nCertain of NL's U.S. and non-U.S. income tax returns, including Germany, are being examined and tax authorities have or may propose tax deficiencies. During 1994, the German tax authorities withdrew certain tax assessment reports which had proposed tax deficiencies of DM 100 million and remitted tax refunds aggregating DM 225 million ($136 million), including interest, on a tentative basis. The examination of NL's German income tax returns is continuing and additional substantial proposed tax deficiency assessments are expected. NL applied DM 174 million of the tentative tax refund to reduce outstanding borrowings under its DM bank credit facility. Although NL believes it will ultimately prevail, NL has granted a DM 100 million ($64 million) lien on its Nordenham, Germany TiO2 plant, and may be required to provide additional security in favor of the German tax authorities until the assessments proposing tax deficiencies are resolved. NL believes that it has adequately provided accruals for additional income taxes and related interest expense which may ultimately result from all such examinations and believes that the ultimate disposition of such examinations should not have a material adverse effect of its consolidated financial position, results of operations or liquidity. Cash received for settlement of prior years' tax examinations aggregated $6 million in 1994 and NL expects to make settlement payments of approximately $20 million in 1995.\nAt December 31, 1994, NL had recorded net deferred tax liabilities of $175 million. NL, which is not a member of the Contran Tax Group, operates in numerous tax jurisdictions, in certain of which it has temporary differences that net to deferred tax assets (before valuation allowance). NL has provided a deferred tax valuation allowance of $165 million, principally related to the U.S. and Germany, offsetting deferred tax assets which NL believes may not currently meet the \"more likely than not\" realization criteria for asset recognition.\nIn addition to the chemicals businesses conducted through Kronos and Rheox, NL also has certain interests and associated liabilities relating to certain discontinued or divested businesses.\nNL has been named as a defendant, PRP, or both, in a number of legal proceedings associated with environmental matters, including waste disposal sites currently or formerly owned, operated or used by NL, many of which disposal sites or facilities are on the U.S. EPA's Superfund National Priorities List or similar state lists. On a quarterly basis, NL evaluates the potential range of its liability at sites where it has been named as a PRP or defendant. NL believes it has provided adequate accruals for reasonably estimable costs of such matters, but NL's ultimate liability may be affected by a number of factors, including changes in remedial alternatives and costs and the allocation of such costs among PRPs. NL is also a defendant in a number of legal proceedings seeking damages for personal injury and property damage arising out of the sale of lead pigments and lead-based paints. NL has not accrued any amounts for the pending lead pigment litigation. Although no assurance can be given that NL will not incur future liability in respect of this litigation, based on, among other things, the results of such litigation to date, NL believes that the pending lead pigment litigation is without merit. Any liability that may result is not reasonably capable of estimation. NL currently believes the disposition of all claims and disputes, individually or in the aggregate, should not have a material adverse effect on its consolidated financial position, results of operations or liquidity. There can be no assurance that additional matters of these types will not arise in the future. See Item 3 - \"Legal Proceedings\" and Note 20 to the Consolidated Financial Statements.\nAs discussed in \"Results of Operations - Chemicals,\" NL has substantial operations located outside the United States for which the functional currency is not the U.S. dollar. As a result, the reported amount of NL's assets and liabilities related to its non-U.S. operations, and therefore NL's consolidated net assets, will fluctuate based upon changes in currency exchange rates. The carrying value of NL's net investment in its German operations is a net liability due principally to its DM bank credit facility, while its net investment in its other non-U.S. operations are net assets.\nNL periodically evaluates its liquidity requirements, capital needs and availability of resources in view of, among other things, debt service requirements, capital expenditure requirements and estimated future operating cash flows. As a result of this process, NL has in the past and may in the future seek to raise additional capital, restructure ownership interests, refinance or restructure indebtedness, sell interests in subsidiaries or other assets, or take a combination of such steps or other steps to increase its liquidity and capital resources.\nREFINED SUGAR - AMALGAMATED\nAmalgamated's cash requirements are seasonal in that a major portion of the total payments for sugarbeets is made, and the costs of processing the sugarbeets are incurred, in the fall and winter of each year. Accordingly, Amalgamated's operating activities use significant amounts of cash in the first and fourth calendar quarters and provide significant cash flow in the second and third quarters of each year. To meet its seasonal cash needs, Amalgamated obtains short-term borrowings pursuant to the Government's sugar price support loan program and bank credit facilities. Borrowings under the Government loan program are secured by refined sugar inventory and are otherwise nonrecourse to Amalgamated. Amalgamated expects to meet its seasonal cash needs for the remainder of the 1994 crop year and for the 1995 crop through borrowings from such sources and internally-generated funds. At December 31, 1994, Amalgamated had $22 million of borrowing availability under the government loan program and existing revolving bank credit facilities. In view of the increase in inventories resulting from the record crop and the imposition of marketing allotments, Amalgamated has obtained an increase in certain of the seasonally adjusted maximum borrowing limits of its $75 million revolving working capital facility.\nThe effective net Government loan rate available to Amalgamated for refined sugar from the 1994 crop is approximately 20.69 cents per pound, down from 20.75 cents per pound for the 1993 crop. Borrowings under the Government loan program are secured by refined sugar inventory and are otherwise nonrecourse to Amalgamated. At December 31, 1994, approximately 3.8 million cwt of refined sugar inventory with a LIFO carrying value of approximately $72 million (18.8 cents per pound) was the sole collateral for $80 million of nonrecourse Government loans.\nAmalgamated's capital expenditures in the past three years, which emphasized equipment to improve productivity, aggregated $51 million and were financed principally from operations and $26 million of term loan borrowings. Estimated 1995 capital expenditures approximate $23 million, including $14 million for sugar extraction enhancing equipment and $1 million for environmental protection and improvement programs, principally air and water treatment facilities.\nBUILDING PRODUCTS - MEDITE\nMedite's capital expenditures over the past three years aggregated $63 million and included $52 million related to its Irish MDF plant expansion and the rebuild of its Rogue River chipping and veneer plant. Medite's MDF plants have been operating at high levels of capacity utilization (approximately 100% in Europe and 92% in the U.S. during 1994) and customers have been served on an allocation basis. The recent completion of a second MDF production line in Ireland is expected to increase Medite's worldwide MDF capacity by approximately 25% by 1998 (by 15% in 1995). This $31 million project was financed in part by a $22 million bank term loan. In connection with the expansion, Medite has obtained $4 million in grants from the Irish government, $3 million of which is expected to be received during 1995 and used to reduce bank borrowings. At December 31, 1994, amounts available for borrowing under Medite's existing bank credit agreements aggregated $12 million.\nMedite intends to add new MDF production capacity during the next two to three years. Although Medite has no plan or arrangement in place with respect to such MDF capacity additions, it is actively exploring expansion opportunities through acquisitions, strategic joint ventures and new construction. Medite recently offered to enter into exclusive negotiations with a third party for the purchase of an existing MDF plant, certain timber resources and certain other assets, which offer was declined. While Medite may renew its efforts at a later date, no assurance can be given that it will be successful in any such acquisition efforts. To the extent it identifies appropriate opportunities to expand its MDF production capacity, Medite could use additional borrowings (including credit availability resulting from the expected paydown of bank debt described below) to fund such expansion opportunities.\nIn February 1995, Medite paid a $50 million non-cash dividend to Valcor by distributing Medite preferred stock bearing a 12% cumulative annual dividend rate. Such preferred stock is redeemable, at Medite's option, for $50 million plus accrued dividends. Valcor currently owns 100% of Medite's outstanding common and preferred stock.\nIn March 1995, Medite filed a Registration Statement with the Securities and Exchange Commission for a proposed public offering of approximately $100 million of its common stock, which Registration Statement has not yet become effective. Medite intends to use a portion of the net proceeds of such proposed stock offering to pay down approximately $40 million of variable interest rate\ndebt and to redeem the $50 million of its preferred stock (plus any accrued dividends) held by Valcor. The remainder of the net proceeds from the proposed offering, along with the borrowing availability discussed below, would be available for Medite's general corporate purposes, including capital expenditures and expansion. In March 1995, Medite also amended its Timber Credit Agreement to, among other things, provide that prepayments of the fixed term portion (Tranche A) of its term loan would increase the reducing revolving term portion (Tranche B) of the facility. Accordingly, the approximately $40 million of bank debt expected to be repaid from proceeds of the proposed common stock offering could be reborrowed subject to reducing availability through 2000. If the Company's ownership of Medite falls below 80%, as is contemplated by the proposed offering, Medite would cease to be a member of the Contran Tax Group and would become a separate U.S. taxpayer. There can be no assurance that any such public offering of Medite common stock will be completed.\nAs a result of the closure of its plywood operations, Medite has a 105 acre site in Medford, Oregon which is believed to have alternative development possibilities and is held for sale.\nHARDWARE PRODUCTS - NATIONAL CABINET LOCK\nNational Cabinet Lock's major plants are operating at a high rate of capacity and capital spending continues to address market demands. In this regard, a new $2 million plating line designed to increase capacity, reduce costs and improve quality in the Canadian drawer slide line was recently completed. The Company continues to explore additional expansion and\/or acquisition opportunities for its high-margin hardware products business.\nAt December 31, 1994, National Cabinet Lock had approximately $6 million of borrowing availability under its existing Canadian credit agreements.\nFAST FOOD - SYBRA\nSybra, like most restaurant businesses, is able to operate with nominal working capital because sales are for cash, inventory turnover is rapid, and payments to trade suppliers are generally not due for 30 days.\nSybra's Consolidated Development Agreement with Arby's, Inc. requires Sybra to open 31 new stores during 1993-1997 in its existing markets, of which ten units had been opened through December 31, 1994 with eight more required to be opened in 1995. The aggregate cost of this expansion during the remaining three years of the CDA is estimated at approximately $25 million, including $12 million in 1995, and is expected to be financed primarily with revolving credit borrowings and internally generated funds. Sybra currently anticipates that its planned expansion program, which includes eight to ten new stores in 1995, will meet or exceed the CDA requirements. Approximately one-fourth of Sybra's 1995 capital budget of $15 million relates to its continuing program to remodel and update existing stores. Approximately 40% of Sybra's capital expenditures in the past three years related to remodeling older stores.\nAt December 31, 1994, Sybra had $16 million of borrowing availability under its existing revolving credit agreements. Sybra is currently negotiating to increase such credit facilities by $5 million for its expansion and remodeling programs.\nGENERAL CORPORATE - VALHI AND VALCOR\nValhi's operations are conducted principally through subsidiaries (NL, Industries, Amalgamated and Valcor). Valcor is an intermediate parent company with operations conducted through its subsidiaries (Medite, National Cabinet Lock and Sybra). Accordingly, Valhi's and Valcor's long-term ability to meet their respective corporate obligations is dependent in large measure on the receipt of dividends or other distributions from their respective subsidiaries, the realization of their investments through the sale of interests in such entities and investment income. Various credit agreements to which subsidiaries are parties contain customary limitations on the payment of dividends, typically\na percentage of net income or cash flow; however, such restrictions have not significantly impacted the Company's ability to service parent company level obligations. Neither Valhi nor Valcor has guaranteed any indebtedness of their respective subsidiaries.\nIn the event Medite's proposed public offering is completed and Medite redeems for cash the $50 million of Medite preferred stock held by Valcor (plus any accrued dividends), availability of such funds for Valcor's general corporate purposes could be influenced in part by the terms of the Indenture governing the Valcor Senior Notes. Under the terms of such Indenture, Medite's sale of common stock to the public would constitute an \"asset disposition\" (as defined) and a portion of the \"available cash\" (as defined) from Medite's offering not used within one year of completing the offering to either (i) repay certain indebtedness of Valcor or certain of Valcor's subsidiaries or (ii) invest in related businesses, could constitute \"excess proceeds\" (as defined) and require Valcor to make an offer to purchase a portion of its Senior Notes, at par. There is no assurance that Medite's offering will be completed, or that if completed there will be any \"excess proceeds\" requiring an offer to purchase the Senior Notes.\nValhi's LYONs do not require current cash debt service. Valhi owns 5.5 million shares of Dresser common stock, which shares are held in escrow for the benefit of holders of the LYONs. The LYONs are exchangeable, at the option of the holder, for the Dresser shares owned by Valhi. Exchanges of LYONs for Dresser stock would result in the Company reporting income related to the disposition of the Dresser stock for both financial reporting and income tax purposes, although no cash proceeds would be generated by such exchanges. Valhi continues to receive regular quarterly Dresser dividends (recently increased to $.17 per quarter) on the escrowed shares.\nDuring the first quarter of 1995 (through March 15, 1995), Valhi purchased additional NL common shares for an aggregate of $11.5 million ($12 per NL share) and had borrowed $20 million on its existing revolving credit facility (none outstanding at December 31, 1994). Valhi has initiated discussions to increase this credit facility to $50 million.\nThe Company has tentatively agreed to sell Amalgamated's sugar business, for $325 million cash, to an agricultural cooperative comprised of sugarbeet growers in Amalgamated's area of operation. The proposed transaction is subject to significant conditions, including financing, grower commitments and execution of a definitive purchase agreement, and no assurance can be given that any such transaction will be consummated. The net proceeds from the proposed sale, if completed, would be available for general corporate purposes, including expansion of Valhi's other businesses.\nThe Company routinely compares its liquidity requirements and alternative uses of capital against the estimated future cash flows to be received from its subsidiaries, and the estimated sales value of those units. As a result of this process, the Company has in the past and may in the future seek to raise additional capital, refinance or restructure indebtedness, modify its dividend policy, consider the sale of interests in subsidiaries, business units, marketable securities or other assets, or take a combination of such steps or other steps, to increase liquidity, reduce indebtedness and fund future activities. Such activities have in the past and may in the future involve related companies. The Company routinely evaluates acquisitions of interests in, or combinations with, companies, including related companies, perceived by management to be undervalued in the marketplace. These companies may or may not be engaged in businesses related to the Company's current businesses. The Company intends to consider such acquisition activities in the future and, in connection with this activity, may consider issuing additional equity securities and increasing the indebtedness of the Company, its subsidiaries and related companies. From time to time, the Company and related entities also evaluate the restructuring of ownership interests among their respective subsidiaries and related companies.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information called for by this Item is contained in a separate section of this Annual Report. See \"Index of Financial Statements and Schedules\" (page).\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 is incorporated by reference to Valhi's definitive Proxy Statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report (the \"Valhi Proxy Statement\").\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference to the Valhi Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated by reference to the Valhi Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference to the Valhi Proxy Statement. See Note 19 to the Consolidated Financial Statements.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) and (d) Financial Statements and Schedules\nThe consolidated financial statements and schedules listed on the accompanying Index of Financial Statements and Schedules (see page ) are filed as part of this Annual Report.\n(b) Reports on Form 8-K\nReports on Form 8-K filed for the quarter ended December 31, 1994 and the months of January and February 1995:\nOctober 26, 1994 - Reported Items 5 and 7. November 10, 1994 - Reported Items 5 and 7. December 27, 1994 - Reported Items 5 and 7. January 31, 1995 - Reported Items 5 and 7.\n(c) Exhibits\nIncluded as exhibits are the items listed in the Exhibit Index. Valhi will furnish a copy of any of the exhibits listed below upon payment of $4.00 per exhibit to cover the costs to Valhi of furnishing the exhibits. Instruments defining the rights of\nholders of long-term debt issues which do not exceed 10% of consolidated total assets will be furnished to the Commission upon request.\nPAGE NUMBER: MANUALLY ITEM NO. SIGNED COPY EXHIBIT INDEX\n3.1 Restated Articles of Incorporation of the Registrant - incorporated by reference to Appendix A to the definitive Prospectus\/Joint Proxy Statement of The Amalgamated Sugar Company and LLC Corporation (File No. 1-5467) dated February 10, 1987.\n3.2 By-Laws of the Registrant as amended - incorporated by reference to Exhibit 3.1 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1992.\n4.1 Form of Indenture between the Registrant and NationsBank of Georgia, N.A., as Trustee, governing Liquid Yield Option Notes due 2007 - incorporated by reference to Exhibit 4.1 to a Registration Statement on Form S-2 (No. 33-49866) filed by the Registrant.\n4.2 Indenture dated November 1, 1993 governing Valcor's 95\/8% Senior Notes due 2003, including form of note - incorporated by reference to Exhibit 4.1 of Valcor's Quarterly Report on Form 10-Q (File No. 33- 63044) for the quarter ended September 30, 1993.\n4.3 Indenture dated October 20, 1993 governing NL's 113\/4% Senior Secured Notes due 2003, including form of note, - incorporated by reference to Exhibit 4.1 of NL's Quarterly Report on Form 10-Q (File No. 1-640) for the quarter ended September 30, 1993.\n4.4 Indenture dated October 20, 1993 governing NL's 13% Senior Secured Discount Notes due 2005, including form of note - incorporated by reference to Exhibit 4.6 of NL's Quarterly Report on Form 10-Q (File No. 1-640) for the quarter ended September 30, 1993.\n10.1 Form of Intercorporate Services Agreement between the Registrant and Contran Corporation - incorporated by reference to Exhibit 10.1 of the Registrant's Annual Report on Form 10-K (File No. 1-5467) for the year ended December 31, 1992.\n10.2 Intercorporate Services Agreement by and between Contran Corporation and NL effective as of January 1, 1994 - incorporated by reference to Exhibit 10.30 to NL's Annual Report on Form 10-K (File No. 1-640) for the year ended December 31, 1993.\n10.3 Stock Purchase Agreement dated October 30, 1991 between the Registrant and Tremont Corporation - incorporated by reference to\nExhibit 28.1 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended September 30, 1991.\n10.4* Valhi, Inc. 1987 Incentive Stock Option - Stock Appreciation Rights Plan, as amended.\n10.5* Valhi, Inc. 1990 Non-Employee Director Stock Option Plan - incorporated by reference to Exhibit 4.1 of a Registration Statement on Form S-8 (No. 33-41508) filed by the Registrant.\n10.6* Description of terms of an executive severance agreement between NL and Joseph S. Compofelice (Executive Vice President of the Registrant) - incorporated by reference to the last paragraph of page 16 entitled \"Employment Agreements\" of NL's definitive proxy statement (File No. 1-640) dated March 30, 1994.\n10.7* 1989 Long Term Performance Incentive Plan of NL Industries, Inc. - incorporated by reference to Exhibit A to NL's Proxy Statement on Schedule 14A (File No. 1-640) for the annual meeting held on May 2, 1989.\n10.8* Supplemental Executive Retirement Plan for Executives and Officers of NL Industries, Inc. effective as of January 1, 1991 - incorporated by reference to Exhibit 10.26 to NL's Annual Report on Form 10-K (File No. 1- 640) for the year ended December 31, 1992.\n10.9 Amended and Restated Loan Agreement dated October 15, 1993 among Kronos International, Inc., the Banks set forth therein and Hypobank International S.A., as Agent, and Banque Paribas, as Co-Agent - incorporated by reference to Exhibit 10.17 of NL's Quarterly Report on Form 10-Q (File No. 1-640) for the quarter ended September 30, 1993.\n10.10 Formation Agreement dated as of October 18, 1993 among Tioxide Americas Inc., Kronos Louisiana, Inc. and Louisiana Pigment Company, L.P. - incorporated by reference to Exhibit 10.2 of NL's Quarterly Report on Form 10-Q (File No. 1-640) for the quarter ended September 30, 1993.\n10.11 Joint Venture Agreement dated as of October 18, 1993 between Tioxide Americas Inc. and Kronos Louisiana, Inc. - incorporated by reference to Exhibit 10.3 of NL's Quarterly Report on Form 10-Q (File No. 1-640) for the quarter ended September 30, 1993.\n10.12 Kronos Offtake Agreement dated as of October 18, 1993 by and between Kronos Louisiana, Inc. and Louisiana Pigment Company, L.P. - incorporated by reference to Exhibit 10.4 of NL's Quarterly Report on Form 10-Q (File No. 1-640) for the quarter ended September 30, 1993.\n10.13 Master Technology and Exchange Agreement dated as of October 18, 1993 among Kronos, Inc., Kronos Louisiana, Inc., Kronos International, Inc., Tioxide Group Limited and Tioxide Group Services Limited - incorporated by reference to Exhibit 10.8 of NL's Quarterly Report on Form 10-Q (File No. 1-640) for the quarter ended September 30, 1993.\n10.14 Allocation Agreement dated as of October 18, 1993 between Tioxide Americas Inc., ICI American Holdings, Inc., Kronos, Inc. and Kronos Louisiana, Inc. - incorporated by reference to Exhibit 10.10 to NL's Quarterly Report on Form 10-Q (File No. 1-640) for the quarter ended September 30, 1993.\n10.15 Lease Contract dated June 21, 1952, between Farbenfabrieken Bayer Aktiengesellschaft and Titangesellschaft mit beschrankter Haftung (German language version and English translation thereof) - incorporated by reference to Exhibit 10.14 of NL's Annual Report on Form 10-K (File No. 1-640) for the year ended December 31, 1985.\n10.16 Contract dated September 9, 1971, between Farbenfabrieken Bayer Aktiengesellschaft and Titangesellschaft mit beschrankter Haftung concerning supplies and services (German language version and English translation thereof) - incorporated by reference to Exhibit 10.15 of NL's Annual Report on Form 10-K (File No. 1-640) for the year ended December 31, 1985.\n10.17 Agreement dated February 8, 1984 between Bayer AG and Kronos Titan GmbH (German language version and English translation thereof) - incorporated by reference to Exhibit 10.16 of NL's Annual Report on Form 10-K (File No. 1-640) for the year ended December 31, 1985.\n10.18 Registration Rights Agreement dated October 30, 1991, by and between NL and Tremont - incorporated by reference to Exhibit 4.3 of NL's Annual Report on Form 10-K (File No. 1- 640) for the year ended December 31, 1991.\n10.19 Insurance Sharing Agreement, effective January 1, 1990, by and between NL, NL Insurance, Ltd. (an indirect subsidiary of Tremont Corporation) and Baroid Corporation - incorporated by reference to Exhibit 10.20 to NL's Annual Report on Form 10-K (File No. 1- 640) for the year ended December 31, 1991.\n21.1 Subsidiaries of the Registrant.\n23.1 Consent of Coopers & Lybrand L.L.P.\n23.2 Consent of KPMG Peat Marwick LLP.\n23.3 Consent of Arthur Andersen LLP.\n27.1 Financial Data Schedule for the year ended December 31, 1994.\n[FN] * Management contract, compensatory plan or agreement.\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.\nVALHI, INC. (Registrant)\nBy: \/s\/ Harold C. Simmons Harold C. Simmons, March 17, 1995 (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:\n\/s\/ Arthur H. Bilger \/s\/ Harold C. Simmons Arthur H. Bilger, March 17, 1995 Harold C. Simmons, March 17, 1995 (Director) (Chairman of the Board, President and Chief Executive Officer)\n\/s\/ Norman S. Edelcup \/s\/ Glenn R. Simmons Norman S. Edelcup, March 17, 1995 Glenn R. Simmons, March 17, 1995 (Director) (Vice Chairman of the Board)\n\/s\/ Robert J. Frame \/s\/ Michael A. Snetzer Robert J. Frame, March 17, 1995 Michael A. Snetzer, March 17, 1995 (Director) (Director)\n\/s\/ J. Walter Tucker, Jr. \/s\/ William C. Timm J. Walter Tucker, Jr., March 17, 1995 William C. Timm, March 17, 1995 (Director) (Vice President-Finance and Treasurer and Chief Financial Officer)\n\/s\/ J. Thomas Montgomery, Jr. J. Thomas Montgomery, Jr., March 17, 1995 (Vice President, Controller and Chief Accounting Officer)\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.\nVALHI, INC. (Registrant)\nBy: Harold C. Simmons, March , 1995 (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:\nArthur H. Bilger, March , 1995 Harold C. Simmons, March , 1995 (Director) (Chairman of the Board, President and Chief Executive Officer)\nNorman S. Edelcup, March , 1995 Glenn R. Simmons, March , 1995 (Director) (Vice Chairman of the Board)\nRobert J. Frame, March , 1995 Michael A. Snetzer, March , 1995 (Director) (Director)\nJ. Walter Tucker, Jr., March , 1995 William C. Timm, March , 1995 (Director) (Vice President-Finance and Treasurer and Chief Financial Officer\nJ. Thomas Montgomery, Jr., March , 1995 (Vice President, Controller and Chief Accounting Officer)\nANNUAL REPORT ON FORM 10-K\nITEMS 8, 14(A) AND 14(D)\nINDEX OF FINANCIAL STATEMENTS AND SCHEDULES\nFINANCIAL STATEMENTS PAGE\nReports of Independent Accountants \/F-5\nConsolidated Balance Sheets - December 31, 1993 and 1994 \/F-7\nConsolidated Statements of Operations - Years ended December 31, 1992, 1993 and 1994 \/F-9\nConsolidated Statements of Cash Flows - Years ended December 31, 1992, 1993 and 1994 \/F-12\nConsolidated Statements of Stockholders' Equity - Years ended December 31, 1992, 1993 and 1994\nNotes to Consolidated Financial Statements \/F-47\nFINANCIAL STATEMENT SCHEDULES\nReport of Independent Accountants S-1\nSchedule I - Condensed financial information of Registrant S-2\/S-9\nSchedule II - Valuation and qualifying accounts S-10\nSchedules III and IV are omitted because they are not applicable.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders and Board of Directors of Valhi, Inc.:\nWe have audited the accompanying consolidated balance sheets of Valhi, Inc. and Subsidiaries as of December 31, 1993 and 1994, and the related consolidated statements of operations, cash flows and stockholders' equity for each of the three years in the period ended December 31, 1994. 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 did not audit the financial statements of certain wholly-owned subsidiaries (The Amalgamated Sugar Company and Medite Corporation) constituting approximately 59% and 25% of consolidated assets as of December 31, 1993 and 1994, respectively, and approximately 80% of consolidated sales for each of the three years in the period ended December 31, 1994 (38% of pro forma sales for 1994). These statements were audited by other auditors whose reports thereon have been furnished to us, and our opinion, insofar as it relates to amounts included for such subsidiaries, is based solely upon their reports.\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 other auditors provide a reasonable basis for our opinion.\nIn our opinion, based upon our audits and the reports of other auditors, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Valhi, Inc. and Subsidiaries as of December 31, 1993 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 17 to the consolidated financial statements, in 1993 the Company changed its method of accounting for certain investments in debt and equity securities in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 115 and in 1992 changed its method of accounting for postretirement benefits other than pensions and income taxes in accordance with SFAS Nos. 106 and 109, respectively.\nCOOPERS & LYBRAND L.L.P.\nDallas, Texas February 28, 1995\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholder of The Amalgamated Sugar Company:\nWe have audited the consolidated balance sheets of The Amalgamated Sugar Company as of December 31, 1993 and 1994, and the related consolidated statements of income and shareholder's equity and cash flows for each of the three years in the period ended December 31, 1994 (not presented separately herein). 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 (not presented separately herein) referred to above present fairly, in all material respects, the financial position of The Amalgamated Sugar Company at December 31, 1993 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 12 to the consolidated financial statements (not presented separately herein), in 1992 the Company changed its method of accounting for postretirement benefits other than pensions and income taxes in accordance with Statements of Financial Accounting Standards Nos. 106 and 109, respectively.\nKPMG PEAT MARWICK LLP\nSalt Lake City, Utah January 27, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholder of Medite Corporation:\nWe have audited the consolidated balance sheets of Medite Corporation as of December 31, 1993 and 1994, 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, 1994 (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, the consolidated financial statements (not presented separately herein) referred to above present fairly, in all material respects, the consolidated financial position of Medite Corporation as of December 31, 1993 and 1994, and the consolidated results of its operations and cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 7 to the consolidated financial statements (not presented separately herein), in 1992 the Company changed its method of accounting for postretirement benefits other than pensions and income taxes in accordance with Statements of Financial Accounting Standards Nos. 106 and 109, respectively.\nARTHUR ANDERSEN LLP\nPortland, Oregon, January 27, 1995\nVALHI, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDECEMBER 31, 1993 AND 1994\n(IN THOUSANDS, EXCEPT PER SHARE DATA)\nVALHI, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS (CONTINUED)\nDECEMBER 31, 1993 AND 1994\n(IN THOUSANDS, EXCEPT PER SHARE DATA)\n[FN] Commitments and contingencies (Notes 16 and 20)\nVALHI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS, EXCEPT PER SHARE DATA)\n[FN] * Assuming the Company had consolidated NL Industries effective at the beginning of 1994. See Notes 1 and 3.\nVALHI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS (CONTINUED)\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS, EXCEPT PER SHARE DATA)\nVALHI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS)\nVALHI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS)\n[FN] * Assuming the Company had consolidated NL Industries effective at the beginning of 1994. See Notes 1 and 3.\nVALHI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS)\nVALHI, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS)\nVALHI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nOrganization. Valhi, Inc. (NYSE: VHI) is a subsidiary of Contran Corporation which holds, directly or through subsidiaries, approximately 90% of Valhi's outstanding common stock. Substantially all of Contran's outstanding voting stock is held by trusts established for the benefit of the children and grandchildren of Harold C. Simmons, of which Mr. Simmons is sole trustee. Mr. Simmons, the Chairman of the Board and Chief Executive Officer of Valhi and Contran, may be deemed to control each of Contran and Valhi.\nPrinciples of consolidation. The consolidated financial statements include the accounts of Valhi and its majority-owned subsidiaries (collectively, the \"Company\"). All material intercompany accounts and balances have been eliminated. Certain prior year amounts have been reclassified to conform to the current year presentation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amount of revenues and expenses during the reporting period. Ultimate actual results may, in some instances, differ from previously estimated amounts.\nPro forma information (unaudited). The accompanying consolidated financial statements include certain pro forma financial information as if the Company's December 31, 1994 consolidation of NL Industries, Inc. (see Note 3) had occurred as of January 1, 1994. All such pro forma information is unaudited.\nTranslation of foreign currencies. Assets and liabilities of subsidiaries whose functional currency is deemed to be other than the U.S. dollar are translated at year-end rates of exchange and revenues and expenses are translated at average exchange rates prevailing during the year. Resulting translation adjustments are accumulated in the currency translation adjustments component of stockholders' equity, net of related deferred income taxes. Currency transaction gains and losses are recognized in income currently.\nNet sales. Sales are recorded when products are shipped (fast food sales at the time of retail sale).\nInventories and cost of sales. Inventories are stated at the lower of cost or market. The last-in, first-out method is used to determine the cost of approximately 55% of total inventories at December 31, 1994 (1993 - 85%). Other inventory costs are generally based on average cost.\nUnder the terms of its contracts with sugarbeet growers, the Company's cost of sugarbeets is based on average sugar sales prices during the beet crop purchase contract year, which begins in October and ends the following September. Any differences between the sugarbeet cost estimated at the end of the fiscal year and the amount ultimately paid is an element of cost of sales in the succeeding year.\nCash and cash equivalents. Cash equivalents include bank time deposits and government and commercial notes and bills with original maturities of three months or less. Cash and cash equivalents at December 31, 1994 include $16 million which is restricted pursuant to outstanding letters of credit and certain indebtedness agreements.\nMarketable securities and securities transactions. Marketable debt and equity securities are carried at market, based upon quoted market prices. Unrealized gains and losses on trading securities are recognized in income currently. Unrealized gains and losses on available-for-sale securities are accumulated in the marketable securities adjustment component of stockholders' equity, net of related deferred income taxes. Realized gains and losses are based upon the specific identification of the securities sold. Prior to the adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" effective December 31, 1993, marketable securities were generally carried at the lower of aggregate market or amortized cost and unrealized net gains were not recognized.\nInvestment in affiliates and joint ventures. Investments in more than 20%- owned but less than majority-owned companies are accounted for by the equity method. Differences between the cost of each investment and the Company's pro rata share of the entity's separately-reported net assets, if any, are allocated among the assets and liabilities of the entity based upon estimated relative fair values. Such differences are charged or credited to income as the entities depreciate, amortize or dispose of the related net assets. At December 31, 1994, the unamortized net difference was nominal.\nNatural resource properties and depletion. Timber and timberlands and mining properties are stated at cost less accumulated depletion. Depletion is computed primarily by the unit-of-production method.\nIntangible assets and amortization. Goodwill, representing the excess of cost over fair value of individual net assets acquired in business combinations accounted for by the purchase method, is amortized by the straight-line method over not more than 40 years. Substantially all goodwill at December 31, 1994 relates to NL Industries. The Company's criteria for evaluating the recoverability of goodwill includes consideration of the fair value of the applicable subsidiary. At December 31, 1994, the quoted market price of NL common stock ($12.63 per share) was substantially in excess of the Company's net investment in NL at that date ($2.37 per NL share held).\nFast food restaurant franchise fees and other intangible assets are amortized by the straight-line method over the periods (10 to 20 years) expected to be benefitted.\nProperty, equipment and depreciation. Property and equipment are stated at cost. Maintenance, repairs and minor renewals are expensed; major improvements are capitalized. Interest costs related to major long-term capital projects capitalized as a component of construction costs were $342,000 in 1992, $420,000 in 1993 and $783,000 in 1994 (pro forma 1994 - $2 million).\nDepreciation is computed principally by the straight-line and unit-of- production methods over the estimated useful lives of eight to 40 years for buildings and three to 20 years for equipment.\nLong-term debt. Long-term debt is stated net of unamortized original issue discount (\"OID\"). OID and deferred financing costs are amortized over the life of the applicable issue by the interest method. Capital lease obligations are stated net of imputed interest.\nIncome taxes. Valhi and its qualifying subsidiaries are members of Contran's consolidated United States federal income tax group (the \"Contran Tax Group\"). The policy for intercompany allocation of federal income taxes provides that subsidiaries included in the Contran Tax Group compute the provision for income taxes on a separate company basis. Subsidiaries make payments to or receive payments from Contran in the amounts they would have paid to or received from the Internal Revenue Service had they not been members of the Contran Tax Group. The separate company provisions and payments are computed using the tax elections made by Contran. NL is a separate U.S. taxpayer and is not a member of the Contran Tax Group.\nDeferred income tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the income tax and financial reporting carrying amounts of assets and liabilities, including investments in the Company's subsidiaries and affiliates not included in the Contran Tax Group.\nEarnings per share. Income (loss) per share of common stock is based upon the weighted average number of common shares outstanding. Common stock equivalents are excluded from the computation because the dilutive effect is either antidilutive or not material.\nOther. Advertising costs, expensed as incurred, aggregated $9.3 million in 1992, $9.9 million in 1993 and $10.1 million in 1994 (pro forma 1994 including NL - $12 million).\nResearch and development costs, expensed as incurred, were $901,000 in 1992, $854,000 in 1993 and $899,000 in 1994 (pro forma 1994 including NL - $11 million).\nDeferred technology fee income of NL is being amortized by the straight line method over three years through October 1996.\nAccounting and funding policies for retirement plans and postretirement benefits other than pensions (\"OPEB\") are described in Note 18.\nNOTE 2 - BUSINESS AND GEOGRAPHIC SEGMENTS: % OWNED AT BUSINESS SEGMENT PRINCIPAL ENTITIES DECEMBER 31, 1994\nChemicals NL Industries, Inc. 52% Refined sugar The Amalgamated Sugar Company 100% Building products Medite Corporation 100% Hardware products National Cabinet Lock, Inc. 100% Fast food Sybra, Inc. 100%\n[FN] (*) Assuming the Company had consolidated NL effective at the beginning of 1994. See Notes 1 and 3.\nNL's chemicals operations are conducted through Kronos, Inc. (titanium dioxide pigments or \"TiO2\") and Rheox, Inc. (specialty chemicals). The Company's building products (Medite), hardware products (National Cabinet Lock) and fast food (Sybra) subsidiaries are owned by Valcor, Inc., a wholly-owned subsidiary of Valhi.\nCapital expenditures include additions to property and equipment and timber and timberlands, excluding amounts attributable to business units acquired in business combinations accounted for by the purchase method.\nCorporate assets consist principally of cash, cash equivalents and marketable securities and, at December 31, 1993, investments in affiliates. At December 31, 1994, about one-third of corporate assets were held by NL. Valhi has a wholly-owned captive insurance company (\"Valmont\") registered in Vermont. Valmont's operations, which are not significant, are included in general expenses and other, net.\nAt December 31, 1994, the net assets of non-U.S. subsidiaries included in consolidated net assets approximated $441 million.\nNOTE 3 - BUSINESS COMBINATIONS AND DISCONTINUED OPERATIONS:\nNL Industries, Inc (NYSE: NL). At the beginning of 1992, Valhi held 48% of NL's outstanding common stock and accounted for its interest in NL by the equity method during the three years in the period ended December 31, 1994. The Company's losses attributable to NL in 1993 include an $84 million first quarter charge for an \"other than temporary\" decline in the market value of NL common stock. Under current accounting rules, a market value writedown of an investment accounted for by the equity method is not reversed if the market value subsequently recovers.\nDuring 1994, Valhi purchased additional NL shares in market transactions for an aggregate of approximately $15 million, and thereby increased its direct ownership of NL to more than 50% in mid-December 1994. The Company accounted for such increase in its interest in NL by the purchase method (step purchase) and, accordingly, consolidated NL's financial position as of December 31, 1994 and will consolidate NL's results of operations and cash flows in 1995. NL's separate financial statements reflect a stockholders' deficit of approximately $293 million at December 31, 1994 and, accordingly, no minority interest in NL is reported in the Company's consolidated financial statements. Until such time as NL reports positive stockholders' equity, all changes in NL's reported stockholders' equity, including all undistributed income or loss, will accrue to the Company for financial reporting purposes.\nTremont Corporation (NYSE: TRE). At the beginning of 1992, Valhi held 44% of Tremont's outstanding common stock and accounted for its interest in Tremont by the equity method during the three years in the period ended December 31, 1994. During 1992, Valhi purchased additional Tremont shares in market transactions for approximately $5 million, increasing its interest in Tremont to 48%. In December 1994, Valhi's Board of Directors declared a special dividend on its common stock of all of its 48% interest in Tremont (3.5 million Tremont shares). Valhi stockholders received approximately .03 (three one-hundreds) of a share of Tremont for each Valhi share held. The Distribution of Tremont common stock was accounted for as a spin-off (recorded at book value, net of tax). The Distribution is currently taxable for federal income tax purposes to both Valhi and Valhi stockholders based upon the aggregate fair market value ($11.19 per Tremont share) of the Tremont common stock distributed. The Company's equity in losses of Tremont's titanium metals operations, net of allocable income tax benefit (see Note 16), are reported as discontinued operations. The 1992 loss from such discontinued operations includes a $22 million pre-tax charge for market value impairment of Tremont common stock.\nContran and certain of its subsidiaries, which hold approximately 90% of Valhi's outstanding common stock, received approximately 3.2 million Tremont shares in the Distribution (44% of Tremont's outstanding common stock), and may be deemed to control Tremont. Tremont holds 18% of NL's outstanding common stock and accounts for its interest in NL by the equity method due to the common control of Contran and certain of its subsidiaries. As discussed above, Valhi continues to own an interest in NL, and, accordingly, the Company's pro rata portion of Tremont's equity in NL is included, for all periods presented, in continuing operations as a component of the Company's equity in losses of NL prior to consolidation.\nNOTE 4 - MARKETABLE SECURITIES AND SECURITIES TRANSACTIONS:\nThe global bond investments consist of fixed income government securities denominated in various currencies, and related currency forward and option contracts obtained to hedge exchange rate risk on the equivalent of approximately $7 million of bond principal amount denominated primarily in Deutsche marks and British pounds. Realized and unrealized gains and losses on trading securities, including related global bond investment currency gains and losses, are reported as a component of securities earnings. The amortized cost of the Company's portfolio of trading securities approximated $28.6 million and $50.4 million at December 31, 1993 and 1994, respectively.\nValhi holds 5.5 million shares of Dresser common stock with a quoted market price of $18.875 at December 31, 1994, or an aggregate market value of $103 million (cost $44 million). The Company's Dresser stock is exchangeable for the Company's LYONs at the option of the LYONs holder, and the carrying value of the Dresser stock is limited to the accreted LYONs obligation. Prior to the January 1994 merger of Dresser and Baroid Corporation, in which each share of Baroid common stock was exchanged for .4 shares of Dresser common stock, Valhi held 13.7 million Baroid shares (quoted market price of $8.25 per share, or an aggregate of $112.8 million, at December 31, 1993). The other available-for- sale common stocks have an aggregate cost basis of $15.4 million at December 31, 1994.\nNOTE 5 - ACCOUNTS AND NOTES RECEIVABLE:\nThe current cost of LIFO inventories exceeded the net carrying value of such inventories by approximately $43 million and $37 million at December 31, 1993 and 1994, respectively. The effect of reductions in certain LIFO inventory quantities increased total operating income by $1.9 million in 1992, $.5 million in 1993 and $3.2 million in 1994.\nNOTE 7 - INVESTMENT IN AFFILIATES AND JOINT VENTURES:\nAffiliates. As a result of increasing its direct ownership of NL to more than 50% in December 1994, the Company now accounts for NL as a consolidated subsidiary. In addition, the Company distributed all of its interest in Tremont to Valhi stockholders in the form of a dividend declared in December 1994. See Note 3. See also Item 7 - \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" of this Annual Report on Form 10-K for summarized financial information of NL prior to consolidation.\nJoint ventures. A Kronos TiO2 subsidiary (Kronos Louisiana, Inc., or \"KLA\") and Tioxide Group, Ltd., a wholly-owned subsidiary of Imperial Chemicals Industries PLC (\"Tioxide\"), are equal owners of a manufacturing joint venture (Louisiana Pigment Company, L.P.) that owns and operates a TiO2 plant in Louisiana. The joint venture has long-term debt which is collateralized by the partnership interests of the partners and substantially all of the assets of the joint venture. The long-term debt consists of two tranches, one attributable to each partner, and each tranche is serviced through (i) the purchase of the plant's TiO2 output in equal quantities by the partners and (ii) cash capital contributions. KLA is required to purchase one-half of the TiO2 produced by the joint venture. The Company's tranche of the joint venture debt is reflected as outstanding indebtedness of the Company because Kronos has guaranteed the purchase obligation relative to the debt service of such tranche. See Note 11.\nThe manufacturing joint venture is intended to be operated on a break-even basis and, accordingly, Kronos' acquisition transfer price for its share of the TiO2 produced is equal to its share of the joint venture's production costs and interest expense. Kronos' share of the production costs are reported as TiO2 cost of sales while Kronos' share of the joint venture's interest expense is reported as a component of NL's interest expense.\nA summary balance sheet of the TiO2 manufacturing joint venture is shown below.\nNOTE 8 - NATURAL RESOURCE PROPERTIES AND OTHER NONCURRENT ASSETS:\nNOTE 9 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES:\nNOTE 10 - OTHER INCOME:\nThe 1992 insurance gain relates to Medite's veneer and chipping plant in Rogue River, Oregon, as insurance proceeds exceeded the net carrying value of the assets destroyed and cleanup costs. The aggregate insurance proceeds of $16.5 million included $10.9 million attributable to property loss and $5.6 million attributable to business interruption insurance, which was recognized as a component of operating income through August 1993. In 1992, Medite accrued a loss on its plywood business and related facilities permanently closed in January 1993, most of which related to the net carrying value of property and equipment in excess of estimated net realizable sales value. In 1993, Medite changed its estimate of the aggregate loss primarily because the auction sale proceeds of certain equipment exceeded the previously estimated net realizable value.\nPro forma other income for 1994 (including NL) of $52.8 million includes $10 million of NL technology fee income and $23 million of NL litigation settlement gains.\nNOTE 11 - NOTES PAYABLE AND LONG-TERM DEBT:\nValhi. The zero coupon Senior Secured LYONs, $379 million principal amount at maturity in October 2007, were issued with significant OID to represent a yield to maturity of 9.25%. No periodic interest payments are required. Each $1,000 in principal amount at maturity of the LYONs is exchangeable, at any time, for 14.4308 shares of Dresser common stock held by Valhi. The LYONs are redeemable at the option of the holder in October 1997 or October 2002 at $404.84 or $636.27, respectively, per $1,000 principal amount (the issue price plus accrued OID through such purchase dates). Such redemptions may be paid, at Valhi's option, in cash, Dresser common stock, or a combination thereof. The LYONs are not redeemable at Valhi's option prior to October 1997 unless the market price of Dresser common stock exceeds $35.70 per share for specified time periods. At December 31, 1993 and 1994, the net carrying value of the LYONs per $1,000 principal amount at maturity was $287 and $314, respectively, and the quoted market price was $330 and $320, respectively.\nThe LYONs are secured by the 5.5 million shares of Dresser common stock held by Valhi, which shares are held in escrow for the benefit of holders of the LYONs. Valhi receives the regular quarterly dividend on the escrowed Dresser shares.\nValhi has a $20 million revolving bank credit facility which matures in October 1996, generally bears interest at LIBOR plus 1% and is collateralized by all of the outstanding common stock of Amalgamated. At December 31, 1994, the full amount of the facility was available for borrowing.\nNL Industries. NL's $250 million principal amount of 11.75% Senior Secured Notes due 2003 and $188 million principal amount at maturity ($100 million proceeds at issuance) of 13% Senior Secured Discount Notes due 2005 (collectively, the \"NL Notes\") are collateralized by a series of intercompany notes from Kronos International, Inc. (\"KII\"), a wholly-owned subsidiary of Kronos, to NL, the terms of which mirror those of the respective NL Notes (the \"NL Mirror Notes\"). The 11.75% Notes are also collateralized by a first priority lien on the stock of Kronos and a second priority lien on the stock of Rheox.\nThe 11.75% Notes and the 13% Discount Notes are redeemable, at NL's option, after October 2000 and October 1998, respectively, except that up to one-third of the aggregate principal amount of the 13% Discount Notes are redeemable (at 113% of the accreted value) upon any NL common stock offering, as defined, prior to October 1996. For redemptions, other than redemptions pursuant to any NL common stock offering, the redemption prices range from 101.5% (starting October 2000) declining to 100% (after October 2001) of the principal amount for the 11.75% Notes and range from 106% (starting October 1998) declining to 100% (after October 2001) of the accreted value of the 13% Discount Notes. In the event of an NL change of control, as defined, NL would be required to make an offer to purchase the NL Notes at 101% of the principal amount of the 11.75% Notes and 101% of the accreted value of the 13% Discount Notes. The NL Notes are issued pursuant to indentures which contain a number of covenants and restrictions which, among other things, restrict the ability of NL and its subsidiaries to incur debt, incur liens, pay dividends or merge or consolidate with, or sell or transfer all or substantially all of its assets to, another entity. The 13% Discount Notes do not require cash interest payments for the first five years. At December 31, 1994, the net carrying value of the 13% Discount Notes per $1,000 principal amount of maturity was $621 (quoted market price - $613) and the quoted market price of the 11.75% Notes was $988 per $1,000 principal amount.\nThe DM credit facility consists of a DM 398 million term loan due from 1997 to 1999 and a DM 250 million revolving credit facility due no later than 2000. Borrowings bear interest at DM LIBOR plus 1.625% (6.9% at December 31, 1994). NL and Kronos have agreed, under certain circumstances, to provide KII with up to DM 125 million through January 1, 2001. The DM credit facility is collateralized by pledges of the stock of certain KII subsidiaries.\nBorrowings under KLA's tranche of the joint venture term loan bear interest at LIBOR plus 1.625% (8.125% at December 31, 1994) and are repayable in quarterly installments through September 2000. See Note 7.\nRheox has a credit agreement providing for a seven-year term loan due in quarterly installments through December 1997 and a $15 million revolving credit\/letter of credit facility due September 1995. Borrowings bear interest, at Rheox's option, at prime rate plus 1.5% or LIBOR plus 2.5% (9.0% at December 31, 1994), and are collateralized principally by the stock of Rheox and its U.S. assets.\nAt December 31, 1994, unused lines of credit available for borrowings under the Rheox U.S. facility and under non-U.S. NL subsidiary credit facilities approximated $14 million and $195 million, respectively. Approximately $80 million (DM 125 million) of such non-U.S. amount is available only to (i) permanently reduce the DM term loan or (ii) pay certain future German income tax assessments.\nAmalgamated. The United States Government loans are made under the sugar price support loan program, which program extends through the 1997 crop year ending September 30, 1998. These short-term nonrecourse loans are collateralized by refined sugar inventories and are payable at the earlier of the date the refined sugar is sold or upon maturity. At December 31, 1994, the weighted average interest rate on Government loans was 6.0% (1993 - 3.4%).\nAmalgamated's principal bank credit agreement (the \"Sugar Credit Agreement\") provides for a revolving credit facility in varying amounts up to $75 million, with advances based upon formula-determined amounts of accounts receivable and inventories, and a term loan. Borrowings under the revolving credit facility bear interest, at Amalgamated's option, at the prime rate or LIBOR plus 1.25% and mature not later than September 30, 1996. The term loan bears interest, at Amalgamated's option, at the prime rate plus .25% or LIBOR plus 1.5% and matures in July 1998. The Sugar Credit Agreement may be terminated by the lenders in the event the sugar price support loan program is abolished or materially and adversely modified, and borrowings are collateralized by substantially all of Amalgamated's assets. Amalgamated also has a $5 million unsecured line of credit with the agent bank for the Sugar Credit Agreement. At December 31, 1994, the weighted average interest rate on Amalgamated's outstanding bank borrowings was 7.7% (1993 - 4.9%).\nAt December 31, 1994, unused credit available to Amalgamated under its bank credit agreements and the sugar price support loan program aggregated approximately $22 million.\nValcor. Valcor's unsecured 9 5\/8% Senior Notes Due November 2003 are redeemable at the Company's option beginning November 1998, initially at 104.813% of principal amount declining to 100% after November 2000. In the event of a change of control of Valcor, as defined, Valcor would be required to make an offer to purchase the Valcor Notes at 101% of principal amount. At December 31, 1994, the quoted market price of the Valcor Notes per $1,000 principal amount was $896 (1993 - $1,008). The indenture governing the Valcor Notes, among other things, limits dividends and additional indebtedness, and prohibits Valcor from co-investing with affiliates.\nMedite. Medite's U.S. bank credit agreement (the \"Timber Credit Agreement\") provides for (i) term loan financing ($67 million at December 31, 1994) due in annual installments of $8 million through 1999 with the balance due in 2000, and (ii) a $15 million revolving working capital facility ($2 million outstanding at December 31, 1994) through September 1996. Borrowings generally bear interest at rates 1.5% to 2% over LIBOR, are collateralized by Medite's timber and timberlands, and borrowings under the working capital facility are also collateralized by Medite's U.S. receivables and inventories. Medite has entered into interest rate swaps to effectively fix the interest rate on $26 million of the term loan due in 1998-2000 that results in a weighted average interest rate of 7.6% for such borrowings. The Company is exposed to interest rate risk in the event of nonperformance by the other parties to the agreements, although it does not anticipate nonperformance by such parties. See Note 15.\nMedite's Irish subsidiary, Medite of Europe Limited, has bank credit agreements providing for (i) a $22.4 million bank term loan repayable in installments from 1995 through 2000 and (ii) a $12 million multi-currency revolving working capital facility through April 1996. Borrowings under both facilities ($29.2 million at December 31, 1994) are collateralized by substantially all of Medite\/Europe's assets. The term loan bears interest at a weighted average fixed rate of 8.4% while borrowings under the revolving facility bear interest at rates based upon LIBOR.\nAt December 31, 1994, the weighted average interest rates on Medite's outstanding U.S. and non-U.S. bank borrowings, including the effect of the interest rate swaps discussed above, were 7.8% and 7.9%, respectively, (6.3% and 6.7%, respectively, at December 31, 1993). Amounts available for borrowing under the existing bank credit facilities aggregated approximately $12 million at December 31, 1994.\nOther Medite indebtedness consists principally of a State of Oregon term loan that matures in monthly installments through March 2008, bears interest at 6.9% and is collateralized by certain property and equipment.\nOther Valcor. Sybra's revolving bank credit agreements provide for unsecured credit facilities aggregating $21 million with interest generally at LIBOR plus 1.25%. Borrowings under these agreements mature July 1996, subject to renewal through July 1997. At December 31, 1993 and 1994, the weighted average interest rate on outstanding revolving borrowings was 4.7% and 7.7%, respectively. Amounts available for borrowing aggregated approximately $15.5 million at December 31, 1994. Future minimum payments under Sybra's capital lease obligations at December 31, 1994, including amounts representing interest, are approximately $1.5 million in each of the next four years and an aggregate of $4.5 million thereafter.\nNational Cabinet Lock has a Canadian bank credit agreement which currently provides for approximately $6 million of U.S. or Canadian dollar borrowings, with interest generally at LIBOR plus .5% and collateralized by substantially all of National Cabinet Lock's Canadian assets. At December 31, 1994, the full amount of these facilities was available for borrowing.\nAggregate maturities of long-term debt at December 31, 1994\nThe LYONs are reflected in the above table as due October 1997, the first of the two dates they are redeemable at the option of the holder, at the aggregate redemption price on such date of $153.5 million ($404.84 per $1,000 principal amount at maturity in October 2007).\nOther. In addition to the NL Notes and the Valcor Notes discussed above, credit agreements of subsidiaries typically require the respective subsidiary to maintain minimum levels of equity, require the maintenance of certain financial ratios, limit dividends and additional indebtedness and contain other provisions and restrictive covenants customary in lending transactions of this type. At December 31, 1994, the restricted net assets of consolidated subsidiaries approximated $125 million.\nNOTE 12 - OTHER NONCURRENT LIABILITIES:\nNOTE 13 - EXTRAORDINARY ITEMS:\nFunds for the prepayment of $235 million principal amount of Valhi 121\/2% Senior Subordinated Notes during 1992 and 1993 were provided in part from net proceeds of the LYONs ($95 million), Medite's Timber Credit Agreement ($60 million) and Valcor's Senior Notes ($50 million).\nNOTE 14 - STOCKHOLDERS' EQUITY:\nCommon stock issued includes 15,500 shares in 1992, 47,800 in 1993 and 20,000 shares in 1994 to pay accrued employee benefits of $87,000, $239,000 and $98,000, respectively.\nTreasury stock includes the Company's proportional interest in 1.2 million Valhi shares held by NL. Under Delaware Corporation Law, all shares held by a majority-owned company are considered to be treasury stock. As a result, shares outstanding for financial reporting purposes differ from those outstanding for legal purposes.\nOptions and restricted stock. Valhi has an incentive stock option plan that provides for the discretionary grant of qualified incentive stock options, nonqualified stock options, restricted stock and stock appreciation rights. Up to nine million shares of Valhi common stock may be issued pursuant to this plan. Options are granted at a price not less than 85% of fair market value on the date of grant, generally vest ratably over a five-year period beginning one year from the date of grant and expire 10 years from the date of grant. Restricted stock, forfeitable unless certain periods of employment are completed, is held in escrow in the name of the grantee until the restriction period expires. At December 31, 1994, approximately 100,000 shares restricted for periods up to 18 months are included in outstanding shares. No stock appreciation rights have been granted.\nPursuant to Valhi's Non-Employee Director Stock Option Plan, options to purchase 2,000 shares of Valhi common stock are automatically granted once a year to each non-employee director of Valhi. Options are granted at a price equal to the fair market value on the date of grant, vest one year from the date of grant and expire five years from the date of grant. Up to 50,000 shares of Valhi common stock may be issued pursuant to this plan.\nAt December 31, 1994, options to purchase 3.4 million Valhi shares were exercisable (1.1 million shares at prices lower than the December 31, 1994 market price of $7.63 per share), options to purchase 1 million shares are scheduled to become exercisable in 1995, and an aggregate of 2.9 million shares were available for future grants. During 1994, options to purchase 1.4 million shares at fixed prices ranging from $5.21 to $6.89 per share were granted in exchange for cancellation of an equal number of options previously granted at prices ranging from $5.00 to $5.50 per share, which prior options contained a formula-based annual exercise price increase.\nNOTE 15 - FINANCIAL INSTRUMENTS:\nFair values of marketable securities and publicly traded debt are based upon quoted market prices. See Notes 4 and 11. The fair value of the 48% minority interest in NL Industries and of Valhi's common stockholders' equity are based upon quoted market prices for NL common stock (1994 - $12.63 per share) and Valhi common stock (1994 - $7.63 per share; 1993 - $4.88 per share).\nThe fair value of debt on which interest rates have been effectively fixed through the use of interest rate swaps is deemed to approximate the book value of the debt plus or minus the fair value of the related swaps. See Note 11. Fair values of Medite's interest rate swaps are estimated to be a $.1 million payable at December 31, 1993 and a $2.7 million receivable at December 31, 1994, representing the estimated amounts Medite would pay or receive if it terminated the swap agreements at those dates, and are based upon quotes obtained from the counter party financial institution. Fair values of other fixed rate debt have been estimated based upon relative changes in the Company's variable borrowing rates since the dates the interest rates were fixed. Fair values of variable interest rate debt are deemed to approximate book value.\nMedite entered into certain forward currency contracts to eliminate exchange rate fluctuation risk on the equivalent of approximately $1 million of equipment purchase commitments denominated principally in Deutsche marks ($4 million at December 31, 1993). Such currency forward contracts effectively fixed the U.S. dollar cost of the related equipment. At December 31, 1993 and 1994, the fair value of such currency contracts, estimated by obtaining quotes from the counter party financial institutions, approximated the contract amount.\nNOTE 16 - INCOME TAXES:\nChanges in deferred income taxes related to adoption of new accounting standards is disclosed in Note 17.\nThe components of the net deferred tax liability are summarized in the following table. At December 31, 1994, all of the deferred tax valuation allowance relates to NL tax jurisdictions, principally the U.S. and Germany.\nThe Contran Tax Group is undergoing examinations of certain of its income tax returns, and tax authorities have or may propose tax deficiencies. The Company believes that it has adequately provided accruals for additional income taxes and related interest expense which may ultimately result from such examinations and believes that the ultimate disposition of all such examinations should not have a material adverse effect on its consolidated financial position, results of operations or liquidity.\nCertain of NL's U.S. and non-U.S. income tax returns, including Germany, are being examined and tax authorities have or may propose tax deficiencies. During 1994, the German tax authorities withdrew certain tax assessment reports which had proposed tax deficiencies of DM 100 million and remitted tax refunds aggregating DM 225 million ($136 million), including interest, on a tentative basis. The examination of NL's German income tax returns is continuing and additional substantial proposed tax deficiency assessments are expected. Although NL believes it will ultimately prevail, NL has granted a DM 100 million ($64 million at December 31, 1994) lien on its Nordenham, Germany TiO2 plant, and may be required to provide additional security in favor of the German tax authorities until any assessments proposing tax deficiencies are resolved. The Company believes that it has adequately provided accruals for additional income taxes and related interest expense which may ultimately result from all such examinations and believes that the ultimate disposition of such examinations should not have a material adverse effect on its consolidated financial position, results of operations or liquidity. NL expects to make examination settlement payments aggregating $20 million in 1995.\nAt December 31, 1994, NL had approximately $300 million of non-U.S. income tax loss carryforwards with no expiration dates, primarily in Germany. As a result of NL's German tentative tax refunds and redetermination of prior year's U.S. tax liabilities, NL does not anticipate having any net operating loss or alternative minimum tax credit carryforwards for U.S. federal income tax purposes at December 31, 1994.\nNOTE 17 - CHANGES IN ACCOUNTING PRINCIPLES:\nMarketable securities (SFAS No. 115). Early compliance with SFAS No. 115 was elected effective December 31, 1993. The amounts attributable to the Company's investment in affiliates consist of the Company's equity in the respective amounts reported by NL and Tremont.\nOPEB (SFAS No. 106) and income taxes (SFAS No. 109). Both SFAS No. 106 and SFAS No. 109 were adopted as of January 1, 1992, SFAS No. 109 was applied prospectively and immediate recognition of the OPEB transition obligation was elected. The amounts attributable to the Company's investments in affiliates consist of the Company's equity in the respective historical amounts reported by NL and Tremont and applicable adjustment of the Company's purchase accounting basis differences originally recorded net-of-tax at rates differing from current rates.\nNOTE 18 - EMPLOYEE BENEFIT PLANS:\nCompany-sponsored plans\nThe Company maintains various defined benefit and defined contribution pension plans covering substantially all full-time employees. Defined pension benefits are generally based on years of service and compensation under fixed dollar, final pay or career average formulas and the related expenses are based on independent actuarial valuations. The funding policies for U.S. defined benefit plans are to contribute amounts satisfying funding requirements of the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\"). Non-U.S. defined benefit plans are funded in accordance with applicable statutory requirements.\nDefined contribution plans. A majority of the Company's full-time U.S. employees are eligible to participate in contributory savings plans with Company contributions based on matching or other formulas, and certain of such employees also participate in Valhi's noncontributory unleveraged Employee Stock Ownership Plan. At December 31, 1994, 186,000 shares of Valhi common stock were held by the ESOP, all of which were allocated to participants. The Company's expense related to the savings plans and the ESOP approximated $2.4 million in 1992, $2.6 million in 1993 and $2.8 million in 1994. Pro forma defined contribution plan expense for 1994 (including NL) was $3 million.\nDefined benefit plans. The funded status of the Company's defined benefit pension plans and the components of net periodic defined benefit pension cost are set forth below. The rates used in determining the actuarial present value of benefit obligations were (i) discount rate - 8.5% (1993 - 7.5%), and (ii) rate of increase in future compensation levels - nil to 6% (1993 - 4% to 5%). The expected long-term rates of return on assets used ranged from 7.5% to 10%. Approximately 10% of the aggregate plan assets at December 31, 1994 (1993 - 50%) consist of units in a combined investment fund for employee benefit plans sponsored by Valhi and its affiliates, including Contran and certain Contran affiliates. Other plan assets are primarily investments in U.S. and non-U.S. corporate equity and debt securities, short-term investments, mutual funds and group annuity contracts. Assets of the combined investment fund are primarily investments in corporate equity and debt securities, short-term cash investments and notes collateralized by residential and commercial real estate. All of the plans for which assets are less than the accumulated benefit obligation at December 31, 1994 relate to NL's plans, approximately 60% of which unfunded amount relates to non-U.S. NL plans.\nSFAS No. 87, \"Employers' Accounting for Pension Costs\" requires that an additional pension liability be recognized when the unfunded accumulated pension benefit obligation exceeds the unfunded accrued pension liability. Variances from actuarially assumed rates, including the rate of return on pension plan assets, will result in additional increases or decreases in accrued pension liabilities, pension expense and funding requirements in future periods. The adjustment required to recognize minimum liability relates to NL's plans.\nPro forma 1994 net periodic pension cost (including NL) approximated $8 million. The 1992 loss related to the permanent closure of the Company's plywood operations (see Note 10) includes a pension curtailment loss of $.6 million.\nPostretirement benefits other than pensions. Certain subsidiaries currently provide certain health care and life insurance benefits for eligible retired employees. Under plans currently in effect, some currently active employees of NL, Amalgamated and Medite may become eligible for postretirement health care benefits if they reach retirement age while working for the applicable subsidiary. In 1989, NL began phasing out such benefits for currently active U.S. employees over a ten-year period. The majority of NL retirees, and substantially all Amalgamated and Medite retirees, are required to contribute a portion of the cost of their benefits. Certain current and future NL retirees are eligible for reduced health care benefits at age 65, and certain current and all future retirees of Amalgamated and Medite either cease to be eligible for health care benefits at age 65 or are thereafter eligible only for limited benefits. Medical claims are funded as incurred, net of any contributions by the retirees.\nThe components of the periodic OPEB cost and accumulated OPEB obligation are set forth below. The rates used in determining the actuarial present value of the accumulated OPEB obligations at December 31, 1994, were (i) discount rate - - 8.5% (1993 - 7.5%), (ii) rate of increase in future compensation levels - 4% to 6% (1993 - 4% to 4.5%), (iii) expected return on plan assets - 9% and (iv) rate of increase in future health care costs - 12.5% to 14% in 1995, gradually declining to 5% to 6% in 2016 and thereafter. If the health care cost trend rate was increased by one percentage point for each year, OPEB expense would have increased $200,000 in 1994, and the actuarial present value of accumulated OPEB obligations at December 31, 1994 would have increased $3.4 million. At December 31, 1994, about 80% of the Company's aggregate accrued OPEB cost relates to NL, and substantially all of the remainder relates to Amalgamated. Pro forma 1994 OPEB cost (including NL) approximated $4 million.\nMultiemployer pension plans\nA small minority of the Company's employees are covered by union-sponsored, collectively-bargained multiemployer pension plans. Contributions to multiemployer plans based upon collectively-bargained agreements were $95,000 in 1992, $53,000 in 1993 and $47,000 in 1994. Based upon information provided by the multiemployer plans' administrators, the Company's share of such plans' unfunded vested benefits is not significant.\nNOTE 19 - RELATED PARTY TRANSACTIONS:\nThe Company may be deemed to be controlled by Harold C. Simmons (see Note 1). Corporations that may be deemed to be controlled by or affiliated with Mr. Simmons sometimes engage in (a) intercorporate transactions such as guarantees, management and expense sharing arrangements, shared fee arrangements, joint ventures, partnerships, loans, options, advances of funds on open account, and sales, leases and exchanges of assets, including securities issued by both related and unrelated parties and (b) common investment and acquisition strategies, business combinations, reorganizations, recapitalizations, securities repurchases, and purchases and sales (and other acquisitions and dispositions) of subsidiaries, divisions or other business units, which transactions have involved both related and unrelated parties and have included transactions which resulted in the acquisition by one related party of a publicly-held minority equity interest in another related party. While no transactions of the type described above are planned or proposed with respect to the Company (except as otherwise set forth in this Annual Report on Form 10-K), the Company continuously considers, reviews and evaluates, and understands that Contran and related entities consider, review and evaluate such transactions. Depending upon the business, tax and other objectives then relevant, it is possible that the Company might be a party to one or more such transactions in the future.\nIt is the policy of the Company to engage in transactions with related parties on terms, in the opinion of the Company, no less favorable to the Company than could be obtained from unrelated parties.\nReceivables from affiliates at December 31, 1994 include $5.3 million of refundable income taxes due from Contran. Payables to affiliates at December 31, 1994 include $6.5 million payable to Louisiana Pigment Company, primarily for the purchase of TiO2 (see Note 7), and $4.8 million payable to Tremont related to NL's Insurance Sharing Agreement discussed below.\nLoans are made between the Company and related parties, including Contran, pursuant to term and demand notes, principally for cash management purposes. Related party loans generally bear interest at rates related to credit agreements with unrelated parties. Interest income on loans to related parties was $405,000 in 1992, $73,000 in 1993 and $398,000 in 1994 and related party interest expense was nil in 1992, $39,000 in 1993 and nil in 1994.\nContran has an $18 million bank credit agreement which includes a $10 million letter of credit facility. Pursuant to such agreement, Contran may authorize the banks to issue letters of credit on behalf of Valmont ($.6 million outstanding at December 31, 1994). Obligations under this Contran credit agreement are collateralized by certain securities held by Contran.\nUnder the terms of Intercorporate Services Agreements (\"ISAs\") with Contran, Contran provides certain management, administrative and aircraft maintenance services to the Company, and the Company provides various administrative and other services to Contran, on a fee basis. The net ISA fees charged to the Company were approximately $1.2 million in each of 1992 and 1993 and $40,000 in 1994. In addition, Contran ISA fees charged to NL and Tremont for 1994 approximated $400,000 and $100,000, respectively. Charges from corporate related parties for services provided in the ordinary course of business were less than $250,000 in each of the past three years. Such charges are principally pass-through in nature and, in the Company's opinion, are not materially different from those that would have been incurred on a stand-alone basis. The Company has established a policy whereby the Board of Directors will consider the payment of additional management fees to Contran for certain financial advisory and other services provided by Contran beyond the scope of the ISAs. No such payments were made in the past three years.\nNL and Tremont are parties to ISAs with Valhi whereby Valhi provides certain management, financial and administrative services to NL and Tremont on a fee basis. Fees charged to NL and Tremont pursuant to these agreements aggregated $1.8 million in 1992, $1.0 million in 1993 and $.4 million in 1994.\nNL and a wholly-owned insurance subsidiary of Tremont that was a subsidiary of NL prior to 1988 (\"TRE Insurance\"), are parties to an Insurance Sharing Agreement with respect to certain loss payments and reserves established by TRE Insurance that (i) arise out of claims against other entities for which NL is responsible and (ii) are subject to payment by TRE Insurance under certain reinsurance contracts. Also, TRE Insurance will credit NL with respect to certain underwriting profits or credit recoveries that TRE Insurance receives from independent reinsurers that relate to retained liabilities.\nIn conjunction with the issuance of the LYONs in October 1992, Valhi purchased 1.7 million shares of Baroid common stock from Contran at the then- current market price of $6.375 per share.\nCOAM Company is a partnership, formed prior to 1991, which has sponsored research agreements with the University of Texas Southwestern Medical Center at Dallas (the \"University\") to develop and commercially market a safe and effective treatment for arthritis (the \"Arthritis Research Agreement\") and to develop and commercially market patents and technology resulting from a cancer research program (the \"Cancer Research Agreement\"). At December 31, 1994, COAM partners are Contran, Valhi and another Contran subsidiary. Harold C. Simmons is the manager of COAM. The Arthritis Research Agreement, as amended, provides for payments by COAM of up to $8 million over the next 10 years and the Cancer Research Agreement, as amended, provides for funds of up to $19 million over the next 16 years. Funding requirements pursuant to the Arthritis and Cancer Research Agreements are without recourse to the COAM partners and the partnership agreement provides that no partner shall be required to make capital contributions. The Company's contributions to COAM were approximately $1.7 million in 1992 and $2 million in each of 1993 and 1994.\nNOTE 20 - COMMITMENTS AND CONTINGENCIES:\nLegal proceedings\nLead pigment litigation. Since 1987, NL, other past manufacturers of lead pigments for use in paint and lead-based paint and the Lead Industries Association have been named as defendants in various legal proceedings seeking damages for personal injury and property damage allegedly caused by the use of lead-based paints. Certain of these actions have been filed by or on behalf of large United States cities or their public housing authorities and certain others have been asserted as class actions. These legal proceedings seek recovery under a variety of theories, including negligent product design, failure to warn, breach of warranty, conspiracy\/concert of action, enterprise liability, market share liability, intentional tort, and fraud and misrepresentation.\nThe plaintiffs in these actions generally seek to impose on the defendants responsibility for lead paint abatement and asserted health concerns associated with the use of lead-based paints, which was permitted for interior residential use in the United States until 1973, including damages for personal injury, contribution and\/or indemnification for medical expenses, medical monitoring expenses and costs for educational programs. Most of these legal proceedings are in various pre-trial stages; several are on appeal.\nNL believes these actions are without merit, intends to continue to deny all allegations of wrongdoing and liability and to defend all actions vigorously. NL has not accrued any amounts for the pending lead pigment litigation. Considering NL's previous involvement in the lead and lead pigment businesses, there can be no assurance that additional litigation similar to that currently pending will not be filed.\nEnvironmental matters and litigation. The Company's operations are governed by various federal, state, local and foreign environmental laws and regulations. The Company's policy is to comply with environmental laws and regulations at all of its plants and to continually strive to improve environmental performance in association with applicable industry initiatives and believes that its operations are in substantial compliance with applicable requirements of environmental laws. From time to time, the Company may be subject to environmental regulatory enforcement under various statutes, resolution of which typically involves the establishment of compliance programs.\nSome of NL's current and former facilities, including several divested secondary lead smelters and former mining locations, are the subject of civil litigation, administrative proceedings or of investigations arising under federal and state environmental laws. Additionally, in connection with past disposal practices, NL has been named a potentially responsible party (\"PRP\") pursuant to CERCLA in approximately 80 governmental enforcement and private actions associated with hazardous waste sites and former mining locations, some of which are on the U.S. EPA's Superfund National Priority List. These actions seek cleanup costs and\/or damages for personal injury or property damage. While NL may be jointly and severally liable for such costs, in most cases, it is only one of a number of PRPs who are also jointly and severally liable. In addition, NL is a party to a number of lawsuits filed in various jurisdictions alleging CERCLA or other environmental claims. At December 31, 1994, NL had accrued $87 million in respect of those environmental matters which are reasonably estimable. It is not possible to estimate the range of costs for certain sites. The upper end of range of reasonably possible costs to NL for sites for which it is possible to estimate costs is approximately $160 million. The imposition of more stringent standards or requirements under environmental laws or regulations, new developments or changes respecting site cleanup costs or allocation of such costs among PRPs, or a determination that NL is potentially responsible for the release of hazardous substances at other sites, could result in expenditures in excess of amounts currently estimated by NL to be required for such matters. No assurance can be given that actual costs will not exceed accrued amounts or the upper end of the range for sites for which estimates have been made, and no assurance can be given that costs will not be incurred with respect to sites as to which no estimate presently can be made. Further, there can be no assurance that additional environmental matters will not arise in the future.\nCertain other information relating to regulatory and environmental matters pertaining to NL is included in Item 1 - \"Business - Chemicals\" of this Annual Report on Form 10-K.\nAt December 31, 1994, the Company has also accrued approximately $3 million in respect of non-NL environmental cleanup matters, principally related to one Superfund site in Indiana where the Company, as a result of former operations, has been named as a PRP. Such accrual does not reflect any amounts which the Company could potentially recover from insurers or other third parties and is near the upper end of the range of the Company's estimate of reasonably possible costs for such matters. The imposition of more strict standards or requirements under environmental laws or regulations, new developments or changes in site cleanup costs or allocations of such costs could result in expenditures in excess of amounts currently estimated to be required for such matters.\nOther litigation. In January 1990, an action was filed in the United States District Court for the Southern District of Ohio against NLO, Inc., a subsidiary of NL, and NL on behalf of a putative class of former NLO employees and their families and former frequenters and invitees of the Feed Materials Production Center (\"FMPC\") in Ohio (Day, et al. v. NLO, Inc., et al., No. C-1- 90-067). The FMPC is owned by the United States Department of Energy (the \"DOE\") and was formerly managed under contract by NLO. The complaint seeks damages for, among other things, emotional distress and damage to personal property allegedly caused by exposure to radioactive and\/or hazardous materials at the FMPC and punitive damages. This action was certified as a class action by the court. In July 1994, the parties reached a settlement agreement pursuant to which the DOE would pay all costs of the settlement and NL and NLO were released.\nDuring 1994, the Company and the plaintiffs in the 1987 pension-related litigation (Holland, et al. v. Valhi, Inc., et al., No. 87-C-968G) agreed to settle the case for $625,000, including attorney fees and interest. The U.S. District Court for the District of Utah has given preliminary approval to the settlement and authorized the sending of a settlement notice to all class members. A final hearing is scheduled for March 24, 1995, at which time the District Court is expected to grant formal approval to the settlement.\nIn November 1992, a complaint was filed in the U.S. District Court for the District of Utah against Valhi, Amalgamated and the Amalgamated Retirement Plan Committee (American Federation of Grain Millers International, et al. v. Valhi, Inc. et al., No. 29-NC-129J). The complaint, a purported class action on behalf of certain current and retired hourly employees of Amalgamated, alleges, among other things, that the defendants breached their fiduciary duties under ERISA by amending certain provisions of a retirement plan for hourly employees maintained by Amalgamated to permit the reversion of excess plan assets to Amalgamated in 1986. The complaint seeks a variety of remedies, including, among other things, orders requiring a return of all reverted funds (alleged to be in excess of $8 million) and any profits earned thereon, a distribution of such funds to the plan participants, retirees and their beneficiaries and enhancement of the benefits under the plan, and an award of costs and expenses, including attorney fees. The hearing on the Company's motion to dismiss and\/or for partial summary judgment has been continued. This litigation is similar in some respects to Holland et al. described above and the Company believes it has adequately accrued for the estimated effect of the ultimate resolution of this matter.\nIn November 1991, a purported derivative complaint was filed in the Court of Chancery of the State of Delaware, New Castle County (Alan Russell Kahn v. Tremont Corporation, et al., No. 12339), in connection with Tremont's agreement to purchase 7.8 million NL common shares from Valhi. In addition to Tremont, the complaint names as defendants the members of Tremont's board of directors and Valhi. The complaint alleges, among other things, that Tremont's purchase of the NL shares constitutes a waste of Tremont's assets and that Tremont's board of directors breached their fiduciary duties to Tremont's public stockholders and seeks, among other things, to rescind Tremont's consummation of the purchase of the NL shares and award damages to Tremont for injuries allegedly suffered as a result of the defendants' wrongful conduct. Valhi believes, and understands that Tremont and the other defendants believe, that the action is without merit. Valhi has denied, and understands that Tremont and the other defendants have denied, all allegations of wrongdoing and liability and intends to defend the action vigorously. The defendants moved to dismiss the complaint on the ground that the plaintiff lacks standing to pursue this action, which motion was denied. Discovery is proceeding and a May 1995 trial date has been set.\nIn addition to the litigation described above, the Company is also involved in various other environmental, contractual, product liability and other claims and disputes incidental to its present and former businesses. The Company currently believes that the disposition of all claims and disputes, individually or in the aggregate, should not have a material adverse effect on its consolidated financial position, results of operations or liquidity.\nConcentrations of credit risk. Sales of TiO2 account for approximately 90% of NL's sales. TiO2 is sold to the paint, paper and plastics industries, which are generally considered \"quality-of-life\" markets whose demand for TiO2 is influenced by the relative economic well-being of the various geographic regions. TiO2 is sold to over 5,000 customers, none of which represents a significant portion of NL's sales. In 1994, approximately 50% of NL's TiO2 sales by volume were to Europe with approximately 36% attributable to North America.\nAmalgamated sells refined sugar primarily in the North Central and Intermountain Northwest regions of the United States. Amalgamated does not believe it is dependent upon one or a few customers; however, major food processors are substantial customers and represent an important portion of refined sugar segment sales. Amalgamated's ten largest customers accounted for about one-third of its sales in each of the past three years.\nMedite's sales are made primarily to wholesalers of building materials located principally in North America and Europe. In each of the past three years, Medite's ten largest customers accounted for approximately one-fourth of its sales with at least seven of such customers in each year located in the U.S.\nNational Cabinet Lock's sales are primarily to original equipment manufacturers in the U.S. and Canada. In each of the past three years, National Cabinet Lock's ten largest customers accounted for approximately one-third of its sales with at least seven of such customers in each year located in the U.S.\nSybra's approximately 160 Arby's restaurants are clustered in four regions, principally Texas, Michigan, Pennsylvania and Florida. All fast food sales are for cash.\nAt December 31, 1994, consolidated cash and cash equivalents includes $80 million invested in U.S. Treasury securities purchased under short-term agreements to resell, of which $73 million are held in trust for the Company by a single U.S. bank.\nOperating leases. Kronos' principal German operating subsidiary leases the land under its Leverkusen TiO2 production facility pursuant to a lease expiring in 2050. The Leverkusen facility, with approximately one-third of Kronos' current TiO2 production capacity, is located within the lessor's extensive manufacturing complex, and Kronos is the only unrelated party so situated. Under a separate supplies and services agreement, which expired in 1991 and to which an extension through 2011 has been agreed in principle, the lessor provides some raw materials, auxiliary and operating materials and utilities services necessary to operate the Leverkusen facility. Kronos and the lessor are continuing discussions regarding a definitive agreement for the extension of the supplies and services agreement. Both the lease and the supplies and services agreements restrict NL's ability to transfer ownership or use of the Leverkusen facility.\nThe Company also leases various fast food retail and other manufacturing facilities and equipment. Most of the leases contain purchase and\/or various term renewal options at fair market values. In most cases the Company expects that, in the normal course of business, such leases will be renewed or replaced by other leases.\nNet rent expense approximated $6 million in each of the last three years (pro forma 1994 including NL - $14 million). Contingent rentals based upon gross sales of individual fast food restaurants were less than 10% of total rent expense in each of the past three years. At December 31, 1994, future minimum payments under noncancellable operating leases having an initial or remaining term of more than one year were as follows:\nCapital expenditures. At December 31, 1994, the estimated cost to complete capital projects in process approximated $74 million, including $56 million related to environmental protection and improvement programs and productivity- enhancing equipment at certain of NL's TiO2 facilities and $14 million for productivity-enhancing equipment at Amalgamated.\nTimber cutting contracts. Deposits are made on timber cutting contracts with public and private sources from which Medite obtains a portion of its timber requirements. Medite records only the cash deposits and advances on these contracts because it does not obtain title to the timber until it has been harvested. At December 31, 1994, timber and log purchase obligations aggregated approximately $10 million under agreements expiring principally in 1995.\nRoyalties. Royalty expense, substantially all of which relates to fast food operations, approximated $4 million in each of the past three years. Fast food royalties are paid to the franchisor based upon a percentage of gross sales, as specified in the franchise agreement related to each individual restaurant.\nSugar marketing allotments. The U.S. Department of Agriculture has imposed marketing allotments on domestic sugar processors, including Amalgamated, for the crop year ending September 30, 1995. The purpose of the allotments is to limit the supply of sugar available for domestic sale and thereby maintain prices at levels sufficient to avoid forfeiture of sugar pledged under the Government's non-recourse sugar price support loan program. Allotments have helped to stabilize sugar prices although they will restrict the volume of sugar which domestic producers, including the Company, can sell in the domestic market during the crop year. The Company's preliminary marketing allotment (which is subject to adjustment) equates to approximately 90% of its estimated record production from the crop harvested in the fall of 1994 and, as a result, will likely result in larger than normal carry-over inventories at the end of the crop year.\nPotential sale. The Company has tentatively agreed to sell Amalgamated's sugar business, for $325 million cash, to an agricultural cooperative comprised of sugarbeet growers in Amalgamated's area of operations. The proposed transaction is subject to significant conditions, including financing, grower commitments and execution of a definitive purchase agreement, and no assurance can be given that any such transaction will be consummated.\nNOTE 21 - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED):\n[FN] (*) Pro forma assuming the Company had consolidated NL's results of operations effective January 1, 1994. See Note 3.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Stockholders and Board of Directors of Valhi, Inc.:\nOur report on the consolidated financial statements of Valhi, Inc. and Subsidiaries as of December 31, 1993 and 1994 and for each of the three years in the period ended December 31, 1994, which report is based in part upon the reports of other auditors, is herein included on this Annual Report on Form 10- K. As discussed in Note 17 to the consolidated financial statements, in 1992 the Company changed its method of accounting for postretirement benefits other than pensions and income taxes in accordance with Statements of Financial Accounting Standards (\"SFAS\") Nos. 106 and 109, respectively, and in 1993 changed its method of accounting for certain investments in debt and equity securities in accordance with SFAS No. 115. 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 Annual Report on Form 10-K. 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, based upon our audits and the reports of other auditors, 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 L.L.P.\nDallas, Texas February 28, 1995\nVALHI, INC. AND SUBSIDIARIES\nSCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nCONDENSED BALANCE SHEETS\nDECEMBER 31, 1993 AND 1994\n(IN THOUSANDS)\nVALHI, INC. AND SUBSIDIARIES\nSCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nCONDENSED STATEMENTS OF OPERATIONS\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS)\nVALHI, INC. AND SUBSIDIARIES\nSCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nCONDENSED STATEMENTS OF CASH FLOWS\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS)\nVALHI, INC. AND SUBSIDIARIES\nSCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nCONDENSED STATEMENTS OF CASH FLOWS (CONTINUED)\nYEARS ENDED DECEMBER 31, 1992, 1993 AND 1994\n(IN THOUSANDS)\nVALHI, INC. AND SUBSIDIARIES\nSCHEDULE I - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nNOTES TO CONDENSED FINANCIAL INFORMATION\nNOTE 1 - BASIS OF PRESENTATION:\nThe Consolidated Financial Statements of Valhi, Inc. and Subsidiaries are incorporated herein by reference. Condensed financial information for all periods presented is classified based on the Company's organizational structure as of December 31, 1994, and certain prior year amounts have been reclassified to conform with the 1994 presentation.\nNOTE 2 - MARKETABLE SECURITIES:\nNOTE 3 - INVESTMENT IN SUBSIDIARIES AND AFFILIATES:\nNOTE 4 - LONG-TERM DEBT:\nLong-term debt consists of Valhi's zero coupon LYONs, $379 million principal amount at maturity in October 2007. The LYONs were issued with significant original issue discount (\"OID\") to represent a yield to maturity of 9.25% and no periodic interest payments are required. The LYONs are secured by the 5.5 million shares of Dresser common stock held by Valhi, which shares are held in escrow for the benefit of holders of the LYONs. Each $1,000 in principal amount at maturity of the LYONs is exchangeable, at any time, for 14.4308 shares of Dresser common stock held by the Company. The LYONs are redeemable at the option of the holder in October 1997 or October 2002 at the issue price plus accrued OID through such purchase date. The aggregate redemption price in October 1997 approximates $154 million. Such redemptions may be paid, at Valhi's option, in cash, Dresser common stock, or a combination thereof. The LYONs are not redeemable at Valhi's option prior to October 1997 unless the market price of Dresser common stock exceeds $35.70 per share for specified time periods.\nValhi also has a $20 million bank revolving credit facility which matures in October 1996, generally bears interest at LIBOR plus 1% and is collateralized by all of Amalgamated's outstanding common stock. At December 31, 1994, no amounts were outstanding and the full amount of the facility was available for borrowing.\nNOTE 5 - DIVIDENDS FROM SUBSIDIARIES AND AFFILIATES:\nDividends from Valcor in 1993 include $135 million from the proceeds of new borrowings. NL and Tremont each suspended dividends during 1992.\nNOTE 6 - INCOME TAXES:\nNL is a separate U.S. taxpayer and is not a member of the Contran Tax Group.\nNOTE 7 - EQUITY IN EARNINGS OF SUBSIDIARIES AND AFFILIATES:\nNOTE 8 - CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES:\nMarketable securities (SFAS No. 115). Early compliance with SFAS No. 115 was elected effective December 31, 1993.\nOPEB (SFAS No. 106) and income taxes (SFAS No. 109). Both SFAS No. 106 and SFAS No. 109 were adopted in 1992, SFAS No. 109 was applied prospectively and immediate recognition of the OPEB transition obligation was elected. Approximately 93% of the amount attributable to the Company's investment in subsidiaries and affiliates relates to NL and Tremont.\nVALHI, INC. AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\n(IN THOUSANDS)\n[FN] (a) Consolidation of NL Industries, Inc. effective December 31, 1994.\n[FN] (a) Consolidation of NL Industries, Inc. effective December 31, 1994.","section_15":""}
{"filename":"812446_1994.txt","cik":"812446","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral\nOne Price Clothing Stores, Inc. (the \"Registrant\" or the \"Company\") operates a growing chain of off-price retail women's and children's specialty stores offering a wide variety of first quality, contemporary, in-season apparel and accessories for the uniform retail price of $7. The Company purchases merchandise at heavily discounted prices in large quantities from a broad mix of manufacturers, jobbers, importers and other suppliers. Items offered in the Company's stores typically sell in department and specialty stores for $15 and up. The Company is able to acquire such merchandise at heavily discounted prices because of its willingness to purchase large quantities and odd lots and to buy goods later in the season than most other retailers. The Company's buyers are able to take advantage of situations such as over-production, order cancellations and manufacturers' needs to liquidate stock. This purchasing strategy allows the Company to obtain a price advantage and to react quickly to seasonal fashion preferences and weather conditions affecting consumer spending. It is the Company's policy to offer only first quality apparel; the Company does not purchase \"seconds\" or irregular merchandise from its suppliers. The Company increased its retail price from $6 to $7 on August 5, 1990, the only price increase since the Company began operations in 1984. At this time, management does not anticipate increasing the retail price in the near future.\nCompany History and Organization\nThe Company opened its first store in August 1984. The Company changed its corporate domicile from South Carolina to Delaware on April 9, 1987 and completed the initial public offering of its Common Stock on May 27, 1987. All information contained herein has been adjusted to reflect the issuance of 10.120811 shares of the Company's Common Stock, $.01 par value, (the \"Common Stock\") in exchange for each share of Common Stock then outstanding in connection with the Company's re- incorporation in Delaware, a 3-for-2 stock split effected in the form of a stock dividend paid on October 15, 1987, and a 3-for-2 stock split effected in the form of a stock dividend paid on April 29, 1994. On February 9, 1994, a wholly-owned subsidiary of the Company, One Price Clothing of Puerto Rico, Inc., was incorporated in Puerto Rico. It commenced operations on May 28, 1994. As used herein, unless the context otherwise indicates, the \"Company\" refers to One Price Clothing Stores, Inc., a Delaware corporation, to its immediate predecessor, a South Carolina corporation of the same name, to the South Carolina corporation's predecessor, a North Carolina corporation organized in 1984 under the name J. K. Apparel, Inc. and to One Price Clothing of Puerto Rico, Inc.\nIndustry Segments\nThe Company operates in only one industry segment. All of the Company's assets and significant revenues and pre-tax earnings relate to retail sales of women's and children's apparel and accessories to the general public through Company-operated stores. At the end of fiscal 1994, 1993 and 1992, the Company's total assets were $67,930,000, $64,201,000 and $50,718,000, respectively. Net sales were $283,326,000 in fiscal 1994, $234,698,000 in fiscal 1993 and $184,149,000 in fiscal 1992. The Company had net income of $4,389,000 in fiscal 1994, $8,724,000 in fiscal 1993 and $6,846,000 in fiscal 1992. Other than operations in Puerto Rico, the Company had no operations outside the continental United States at the end of fiscal 1994 and no export sales. Reference is hereby made to the financial statements included in Part II for more detailed information about the Company's assets.\nOperations\nThe Company operates a chain of off-price retail women's and children's specialty stores offering a wide variety of first quality, contemporary, in-season apparel and accessories for the uniform retail price of $7. The Company registered the trademark \"One Price\" with the United States Patent and Trademark Office on June 5, 1990 for a five year period with the option to renew upon expiration. The Company intends to apply for renewal for this trademark. The Company applied for renewal and permanent registration of the trademark \"Every Day Every Item\" in June, 1994 with the United States Patent and Trademark Office. Approval of the application has not yet been obtained. The Company registered \"Every Day Every Item\", \"Todos Los Dias Todos Los Articulos\", \"One Price\" and \"Un Solo Precio\" in Mexico on June 12, 1993. All Mexican trademarks expire May 14, 2003, with the option to renew them. Management believes that the loss of such trademarks would not have a material adverse effect on the Company's financial position or results of operations.\nThe One Price Store. The Company's typical store has approximately 3,300 square feet, of which approximately 2,400 square feet is devoted to selling space. All of the Company's stores are located in leased facilities with convenient access to adequate parking or public transportation. At December 31, 1994, approximately 93% of the Company's stores were located in strip shopping centers and the remaining stores were located in malls. The Company does not franchise its stores.\nThe Company's stores are primarily located in or near communities with a population of at least 40,000 - 50,000 and above, as well as in large metropolitan areas. Most of the Company's stores are open seven days a week and typical hours of operation are from 10:00 a.m. until 7:00 or 9:00 p.m., Monday through Saturday, with shorter hours on Sunday. A typical store employs a full-time manager and two full-time assistant managers, and most stores employ up to ten additional part-time sales associates.\nThe Company's stores are designed for customer convenience and for attractive presentation of merchandise. All apparel is displayed on hangers and is organized by classification, style and color, promoting a pleasant shopping environment and customer convenience.\nThe Company's store operations department is headed by a Vice President of Stores who is assisted by two Directors of Store Operations and Regional and District Sales Managers. Each Regional Sales Manager is responsible for approximately 9 districts. Each District Sales Manager is responsible for approximately 10 to 12 stores and visits each store in his or her district on a regular or as-needed basis to provide assistance in promoting sales, training, store layout and merchandise presentation, and to monitor adherence to the Company's operational and management policies.\nStore Locations and Expansion. At December 31, 1994, the Company operated 641 stores in 28 states, including states in the southwest, southeast, northeast, midwest and west coast regions of the United States, and in Puerto Rico.\nThe Company opened a net of 101 stores in fiscal 1994. The Company's expansion plans in 1995 include opening a net of approximately 80 stores in new and existing markets. The Company closed 27 underperforming stores in fiscal 1994, and closed 12 such stores in January and February of 1995. The Company anticipates closing additional stores during fiscal 1995 if warranted by the operating performance of such stores.\nPurchasing. The Company's practice is to offer value to its customers by selling desirable women's and children's apparel and accessories at considerably lower prices than generally would be available from department stores and other specialty retailers. The Company purchases its merchandise at heavily discounted prices and on favorable terms from manufacturers, jobbers, importers and other vendors.\nThe Company typically is able to purchase merchandise from vendors at substantially discounted prices as a result of the following circumstances: the inability of a manufacturer or importer to dispose of merchandise through regular channels; the discontinuance of merchandise because of changes in color or style; over-production by manufacturers; cancellation of orders by conventional retail stores; the need of catalog retailers to dispose of inventories of unordered catalog merchandise; and manufacturers' need for liquidity. The Company's ability and willingness to purchase in large quantities and in odd-lot or broken-size assortments and its reputation for reliability in the industry provide the Company with purchasing advantages. Typically, the Company buys the majority of its merchandise close to and during each selling season, later than department stores and other specialty retailers. This purchasing strategy permits the Company to react to fashion trends and opportunistic developments during a selling season. The Company may also purchase selected merchandise in advance of a selling season.\nDuring fiscal 1994, the Company purchased merchandise from approximately 870 vendors, including manufacturers, jobbers, importers and other vendors. No vendor accounted for more than 10% of the Company's total purchases for the year.\nAlthough there can be no assurance that the Company will be able to continue to acquire sufficient quantities of first quality merchandise at such low prices on favorable terms, the Company continues to add new vendors and believes that adequate sources of first quality merchandise exist at appropriate price levels to permit the Company to continue its expansion program. The Company does not maintain long-term or exclusive purchase commitments or arrangements with any vendor.\nCorporate Offices and Distribution Center. The Company's Corporate Offices and Distribution Center are located in Duncan, South Carolina. With the exception of functions performed by certain merchandise buyers, regional directors of real estate, district and regional sales managers, and certain administrative functions performed in Puerto Rico, substantially all purchasing, accounting and other administrative functions are centralized at the Corporate Offices.\nSubstantially all merchandise is shipped directly from vendors to the Company's Distribution Center where the goods are processed and sent to the Company's stores. The majority of shipments to stores are made by common carriers; however, shipments local to the Company's Distribution Center are made in tractor-trailers leased and operated by the Company.\nMerchandising. The Company's merchandising strategy emphasizes contemporary and in-season apparel for juniors, misses, large-sized women and children. The Company's target customers are value- and fashion-conscious women, primarily in lower and middle income brackets. The Company offers only first quality merchandise at the retail price of $7 per item and emphasizes the value of its merchandise compared to similar merchandise sold elsewhere at higher prices. Women's apparel sold by the Company includes contemporary sportswear such as knit tops, pants, blouses, shirts, skirts, sweaters, jackets and shorts. In addition, the Company occasionally sells other types of merchandise such as dresses, swimsuits, jumpsuits, raincoats, lingerie and other related items. The Company also offers selected accessories such as scarves, socks, belts, handbags, jewelry and fragrances, in addition to apparel. Accessory sales as a percentage of net sales were 10.7% in fiscal 1994, 11.6% in fiscal 1993 and 11.7% in fiscal 1992. Sales of children's clothing comprised less than 10% of net sales in each of the last three fiscal years.\nManagement Information System. The Company's management information system, featuring point-of-sale cash registers and a computerized inventory management system, permits management to review each store's inventory on a daily and a weekly basis thereby enabling the Company to tailor its purchasing strategies and merchandise shipments to stores based on customer demand.\nThe Company is currently implementing a new warehouse management system to improve the management of the location and flow of merchandise within the Distribution Center. Implementation of the new system is expected to be completed during the summer of 1995.\nSeasonality\nThe Company's sales and operating results are seasonal, as is typical in the women's retail apparel industry. The Company's sales historically have been lowest during the first quarter (January-March) and the third quarter (July-September) and highest during the second quarter (April-June) and the fourth quarter (October-December). Reduced sales volumes in first and third quarters coincide with the transition of seasonal merchandise. Therefore, increased levels of markdowns generally occur during these transitional periods and operating expenses, when expressed as a percentage of net sales, are typically higher. Management expects this seasonality to continue.\nWorking Capital Requirements\nHistorically, the Company's primary needs for liquidity and capital have been to fund the cost of its new store expansion, the related growth in merchandise inventories, and the expansion of the Corporate Offices and Distribution Center. These needs have been met through cash provided by operations and the Company's available line of credit. The Company had an amended agreement with a bank for a $20,000,000 unsecured line of credit and a $10,000,000 letter of credit facility, expiring April 30, 1995. This agreement was superseded on March 16, 1995 when the Company and the bank executed a credit agreement for a $25,000,000 unsecured line of credit and a $15,000,000 letter of credit facility which will expire May 31, 1996. The agreement contains certain covenants described in Item 7 of this report. The Company has never used long-term debt or capital leases as a source of capital; however, the Company may use such permanent financing, if deemed by management to be in the best interest of the Company.\nMerchandise inventories are typically purchased on credit, including the use of letters of credit. Letters of credit are primarily used to purchase merchandise inventories from foreign suppliers. All such purchases are paid in United States dollars; thus, the Company is not subject to foreign currency risks. As a result of the Company's opportunistic buying strategy and to ensure that an adequate supply of merchandise is available for shipment to its stores, the Company may, at times, invest a significant amount of its working capital in merchandise inventories.\nRevenues from retail sales are recognized at the time of the sale. The Company accepts cash, checks, and, in selected stores, certain major credit cards. All stores offer a liberal exchange and return policy. Merchandise returns are recorded in the period the merchandise is returned by the customer. The amount of unrecorded merchandise returns is not significant to the Company's financial position or results of operations.\nCustomers\nNo material part of the business of the Company is dependent upon a single customer or a few customers.\nCompetition\nThe women's retail apparel industry is highly competitive. In order to compete effectively, the Company is dependent upon its ability to purchase merchandise at substantial discounts. The Company does not know of any direct competition from other specialty apparel retailers having a $7 one-price concept. However, the Company does compete with department stores, specialty stores, discount stores, other off-price retailers and manufacturer-owned outlet stores, many of which are owned by large national or regional chains with substantially greater resources than the Company. There can be no assurance that other retailers with substantially greater financial resources than the Company will not adopt a purchasing and marketing concept similar to that of the Company. Management believes that the primary competitive factors in the retail apparel industry are price, quality, variety of merchandise, good site selection and low cost of operation. The Company believes that it is well positioned in all of these areas to compete in its markets.\nEnvironmental Factors\nThe Company is not aware of any federal, state or local environmental regulations which will materially affect its operations or competitive position or require material capital expenditures. The Company cannot predict, however, the impact of possible future legislation or regulation on its operations.\nEmployees\nAt December 31, 1994, the Company had approximately 4,900 employees, of which approximately 48 percent were full-time employees. The Company, like other retailers, experiences a high turnover rate of part-time store employees but has generally not experienced difficulties in hiring qualified personnel. None of the Company's employees are covered by a collective bargaining agreement, and management believes that the Company's relationship with its employees is good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company leases all of its store locations. At December 31, 1994, the Company had 641 stores operating in 28 states and Puerto Rico. The Company leases its stores under operating leases generally with initial terms of five to ten years and with one to two renewal option periods of five years each. The leases typically contain kickout provisions based on that store's annual sales volume or the shopping center's occupancy. The leases generally provide for increased rents resulting from increases in operating costs and property taxes. Certain of the leases provide contingent or percentage rentals based upon sales volume, and other stores are leased on a month-to-month basis. To date, the Company has not experienced difficulty in obtaining leases for suitable locations for its stores on satisfactory terms. Approximately 64 existing store leases expire or have initial lease terms containing lessee renewal options which may be exercised during fiscal 1995. Management believes that the Company will not experience a significant increase in lease expense as a result of exercising renewal options or negotiating additional lease terms for such locations. The following is a list of store locations by state: \t\t\t\t\t\t\t\t\t\t\nThe Company's Corporate Offices and Distribution Center are located in Duncan, South Carolina on approximately 82 acres which are owned by the Company. In fiscal 1993, the Company completed a 28,000 square foot expansion of its Corporate Offices. The expansion increased the total size of the Corporate Offices and Distribution Center to approximately 390,000 square feet at January 1, 1994. Additionally, the Company is currently expanding the Distribution Center by approximately 90,000 square feet. With the addition of certain equipment and systems in fiscal 1995, the expanded Distribution Center should be able to support the Company's growth over the next several years.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn September 22, 1994, two separate lawsuits making certain securities and common law allegations and seeking unspecified damages were filed in the United States District Court for the District of South Carolina, Columbia Division against the Company and its Chairman and Chief Executive Officer Henry D. Jacobs, Jr. A motion to consolidate these cases is pending. The lawsuits, which seek certification as class actions, allege that the Chairman and Chief Executive Officer and the Company made materially false, misleading and untimely projections and statements on earnings. The plaintiffs in these cases, sought to be consolidated, are Leonard Pitten, Katherine Hogan and Anthony J. Mallozzi. The Company has moved to dismiss the lawsuits, and a ruling on that motion is currently pending. Although the Company cannot predict the outcome of these lawsuits at this time, management intends to vigorously defend these actions and believes that as a result of its legal defenses and insurance arrangements, the final outcome should not have a material adverse effect on the Company's consolidated financial condition or results of operations.\nOccasionally the Company is a defendant in legal actions involving claims arising in the normal course of its business. The Company believes that, as a result of its legal defenses and insurance arrangements, none of these other actions presently pending, if decided adversely, would have a material adverse effect on its financial position and 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 Company's fiscal year.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND \t RELATED SHAREHOLDER MATTERS\nThe Company's common stock is traded under the symbol ONPR in the National Market System of NASDAQ. As of March 23, 1995, there were approximately 430 shareholders of record.\nThe Company has never paid cash dividends since its inception. The Company's credit agreement contains covenants which, among other things, restricts the Company from paying dividends without prior approval. Currently, the Board of Directors intends to continue its policy of retaining earnings for operations and expansion of the business.\nThe quarterly high and low sales prices as quoted by NASDAQ are shown below. Prices have been adjusted to reflect a 3-for-2 stock split effected in the form of a dividend to shareholders of record on April 15, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table presents selected financial data for the Company for each of the five fiscal years ended December 29, 1990 through December 31, 1994. All of the selected financial data are extracted from the Company's audited financial statements and should be read in conjunction with the financial statements and the notes thereto included under Item 8","section_7":"","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of One Price Clothing Stores, Inc. Duncan, South Carolina\nWe have audited the accompanying consolidated balance sheets of One Price Clothing Stores, Inc. and subsidiary as of December 31, 1994 and January 1, 1994, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three fiscal years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14 (d). These consolidated financial statements and financial statement schedule are the responsibility of the Company'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 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 as of December 31, 1994 and January 1, 1994, and the results of its operations and its cash flows for each of the three fiscal years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in 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.\nDELOITTE & TOUCHE LLP Greenville, South Carolina\nFebruary 10, 1995 (February 28, 1995 as to Note B)\n\t\n\t\t ONE PRICE CLOTHING STORES, INC. AND SUBSIDIARY \t\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 31, 1994\nNOTE A - Summary of Significant Accounting Policies\nBusiness: One Price Clothing Stores, Inc. and subsidiary (the \"Company\") operates a chain of off-price retail women's and children's apparel stores in the United States and Puerto Rico. The Company operated 641, 540, and 446 stores at the end of fiscal 1994, 1993 and 1992, respectively.\nPrinciples of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.\nCash and Cash Equivalents: The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents.\nMerchandise Inventories: Merchandise inventories are stated at the lower of average unit cost or market. Average unit cost is determined by the first-in, first-out (FIFO) method.\nDepreciation: Depreciation is computed by the straight-line method, based on estimated useful lives of 10 years for land improvements, 33 to 40 years for buildings, 5 to 10 years for leasehold improvements and 3 to 15 years for fixtures and equipment.\nIncome Taxes: The Company had accounted for income taxes since its inception using the principles of Accounting Principle Board Opinion No. 11. Effective January 3, 1993, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\". The cumulative effect of adopting SFAS No. 109 had no material effect on the consolidated financial statements.\nUnder SFAS No. 109, deferred income taxes represent the future income tax effect of temporary differences between the book and tax bases of the Company's assets and liabilities, assuming they will be realized and settled at the amount reported in the Company's financial statements.\nTrademarks: The cost of trademarks is being amortized over their expected useful lives of 10 years using the straight-line method.\nRevenue Recognition: Revenues from retail sales are recognized at the time of the sale. Merchandise returns are recorded in the period the merchandise is returned by the customer. The amount of unrecorded merchandise returns is not significant to the Company's consolidated financial position or results of operations.\nStore Preopening Costs: Costs associated with the opening of new stores are expensed as incurred.\nStore Closing Costs: At the time management commits to close a store, a provision is made and operations are charged for any remaining store lease obligation, any estimated write-down of property and equipment, and any estimated future operating loss.\nIncome Per Common Share: Net income per common share is computed by dividing net income by the weighted average number of shares of Common Stock and dilutive common stock equivalent shares for stock options (Note E) outstanding during the period.\nFiscal Year: The Company's fiscal year ends on the Saturday nearest December 31. Fiscal years 1994 and 1993 each consisted of 52 weeks, while fiscal year 1992 consisted of 53 weeks.\nReclassifications: Certain amounts included in prior years' financial statements have been reclassified to conform to the fiscal 1994 presentation.\nNOTE B - Credit Facilities\nThe Company has an amended agreement with a bank which provides for a $20,000,000 line of credit and a $10,000,000 letter of credit facility, expiring April 30, 1995. The agreement provides for a 0.20% commitment fee per annum on the line of credit. Borrowings against the line of credit are unsecured and bear interest at the Company's option of the bank's prime interest rate, the adjusted LIBOR rate plus 1.25% or the bank's discount rate for Bankers Acceptances plus 1.00%. The credit facilities contain certain financial covenants which, among other things, have the effect of limiting amounts available for dividends to approximately $9,217,000 at December 31, 1994, and prohibit the Company from encumbering or disposing of a material amount of assets. The Company must also maintain certain ratios regarding net worth, leverage and fixed charges. The maximum amounts outstanding under the line of credit during fiscal 1994 and 1993 were approximately $16,421,000 and $8,616,000, respectively. The average amounts outstanding under the line of credit were $3,165,000 during fiscal 1994 and $2,057,000 during fiscal 1993. The weighted average interest rate was 7.6% in fiscal 1994 and 5.6% in fiscal 1993. There were no amounts outstanding against the Company's line of credit at December 31, 1994 or January 1, 1994. The Company had outstanding letters of credit totaling approximately $7,656,000 at December 31, 1994.\nOn February 28, 1995, the Company and the bank executed a commitment letter which amends and restates their agreement to provide for a $25,000,000 line of credit and a $15,000,000 letter of credit facility. The revised agreement, when executed, will provide for a 0.25% commitment fee per annum on the line of credit and will expire May 31, 1996. Borrowings against the line of credit will be unsecured and will bear interest at the Company's option of a Base Rate (defined as the higher of the bank's prime interest rate or the Federal Funds rate plus 0.50%) or the adjusted LIBOR rate plus 1.50%. The amended credit facilities will contain certain covenants which, among other things, restrict or limit the ability of the Company to incur indebtedness, or encumber or dispose of assets. In addition, the Company will not be able to repurchase its Common Stock or pay dividends without prior approval. The Company must also maintain certain ratios regarding net worth, leverage and fixed charges.\nPresented below are the elements which comprise deferred income tax assets and liabilities:\n\t The net deferred income tax asset is recognized in the accompanying balance sheets as follows:\n\t The Company's subsidiary has a net operating loss carryforward of \t approximately $696,000 which is available to offset future taxable \t income in Puerto Rico through fiscal 2001. Due to the subsidiary's \t short operating history, management cannot be assured that the \t deferred income tax asset related to the operating loss \t carryforward will be realized. Accordingly, a valuation allowance \t for 100% of the deferred income tax asset has been established. \t Otherwise, scheduled reversals of temporary differences and \t anticipated future taxable income should be sufficient to offset \t scheduled losses arising from the net deferred income tax assets.\nNOTE D - Operating Leases The Company generally leases its stores under operating leases with initial terms of five to ten years with one to two renewal option periods of five years each. The leases generally provide for increased rents resulting from increases in operating costs and property taxes. Certain of the leases provide for contingent or percentage rentals based upon sales volume and others are leased on a month-to-month basis.\nIn addition, the Company has operating leases for automobiles, trucks, trailers and certain other equipment with one to ten year terms. The leases for trucks and trailers also provide for contingent rentals based upon miles driven.\nFuture minimum rental commitments as of December 31, 1994 for noncancelable leases, are approximately as follows: \t\t\n\t Total rental expense for operating leases was as follows:\n\t NOTE E - Employee Benefits\n\t Stock Option Plans: The Company has three stock option plans (the \t 1991, 1988, and 1987 Plans) which provide for grants to certain \t officers, directors, and key employees of stock options to purchase \t shares of Common Stock of the Company. Options granted under the \t plans expire ten years from the date of grant and, to date, have \t been granted at prices not less than the fair market value at the \t date of grant. Effective October 27, 1988, the Board of Directors \t retired all unissued options under the Company's 1987 Plan. \t Options cancelled subsequent to October 27, 1988 under the 1987 \t Plan are retired. Options cancelled under the 1991 and 1988 Plans \t are available for reissuance.\n\t Information with respect to the stock option plans is as follows:\n\t At December 31, 1994, a total of 892,000 shares of Common Stock \t were reserved for issuance under the Company's option plans.\n\t Retirement Plan: Effective July 1, 1992, the Company established a \t 401(k) and profit-sharing plan, the One Price Clothing Stores, Inc. \t Retirement Plan (the \"Plan\"). All employees in the United States \t who are 21 years of age or older with at least one year of service \t are eligible to participate in the Plan. In fiscal 1994, the \t Company was obligated under the Plan to make a matching \t contribution of 25% of each participant's contribution with a \t maximum matching contribution of 1.25% of the participant's base \t compensation. Effective January 1995, the Company's contribution \t obligation increased to 50% of each participant's contribution with \t a maximum contribution of 2.5% of the participant's base \t compensation. In addition, the Company may make an annual \t discretionary contribution on behalf of the participants. Employer \t contributions (approximately $132,000, $101,000, and $44,000 in \t fiscal 1994, 1993, and 1992, respectively) vest ratably over five \t years.\n\t Stock Purchase Plan: The Company adopted a Stock Purchase Plan, \t effective March 1995, that allows participating employees to \t purchase, through payroll deductions, shares of the Company's \t Common Stock at prevailing market prices. All full-time associates \t who are 18 years of age or older with at least six months of \t service are eligible to participate in the Stock Purchase Plan. \t The Stock Purchase Plan provides that participants may authorize \t the Company to withhold from net earnings and deposit such amounts \t with an independent custodian. The custodian will purchase Common \t Stock of the Company at prevailing market prices and distribute the \t shares purchased to the participants upon request. The Company \t will pay expenses associated with the purchase of the Common Stock \t and administration of the Stock Purchase Plan.\n\t NOTE F - Related Party Transactions\n\t In fiscal 1992, the Company entered into a deferred compensation \t agreement with a former executive officer who is currently a member \t of the Company's Board of Directors. The agreement provides for \t monthly payments aggregating $75,000 annually (including interest) \t through July 2002. In fiscal 1992, the present value of the \t obligation, approximately $493,000, was charged to selling, general \t and administrative expenses. \t \t NOTE G - Shareholders' Equity\n\t In March 1994, the Company declared a 3-for-2 stock split effected \t in the form of a stock dividend payable April 29, 1994 to \t shareholders of record as of the close of business on April 15, \t 1994. Accordingly, Common Stock outstanding, the weighted average \t number of common and common equivalent shares and per share amounts \t have been retroactively adjusted to give effect to the stock split.\n\t The Company adopted a Shareholder Rights Plan in November 1994. \t Each shareholder of record on November 15, 1994 is entitled to one \t Right for each share of Common Stock held on such date. Each Right \t entitles the registered holder to purchase from the Company one \t half share of Common Stock at a specified price. The Rights become \t exercisable only upon the occurrence of certain conditions set \t forth in the Shareholder Rights Plan relating to the acquisition of \t 20% or more of the outstanding shares of Common Stock.\n\t NOTE H - Commitments and Contingencies \t \t On September 22, 1994, two shareholders filed separate lawsuits \t making certain securities and common law allegations and seeking \t unspecified damages against the Company and its Chairman and Chief \t Executive Officer. The lawsuits, which seek certification as class \t actions, allege that the Chairman and Chief Executive Officer and \t the Company made materially false, misleading and untimely \t projections and statements on earnings. Although the Company \t cannot predict the likely outcome of these lawsuits at this time, \t management intends to vigorously defend these actions and believes \t that as a result of its legal defenses and insurance arrangements, \t the final outcome should not have a material adverse effect on the \t Company's consolidated financial condition or results of \t operations.\n\t At December 31, 1994, the Company had commitments of approximately \t $1,300,000 related to the addition of a new warehouse management \t system and the expansion of the Distribution Center. \t\nITEM 9:","section_9":"ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING \t AND FINANCIAL DISCLOSURE\nThere are no matters which are required to be reported under Item 9.\n\t PART III\n\t ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n\t The information required under this item is incorporated herein \t by reference to the sections entitled \"Election of Directors\" \t and \"Executive Officers of the Company\" of the Company's \t definitive Proxy Statement (the \"Proxy Statement\") filed with \t the Securities and Exchange Commission in connection with the \t Annual Meeting of Shareholders to be held April 19, 1995.\n\t ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n\t The information required under this item is incorporated herein \t by reference to the sections entitled \"Compensation Committee \t Interlocks and Insider Participation\", \"Compensation of \t Executive Officers\", \"Stock Options\", \"Employment Contracts and \t Deferred Compensation Arrangements\", \"Compensation Committee \t Report on Executive Compensation\", \"Performance Graph\" and \t \"Election of Directors - Directors' Fees\" of the Proxy \t Statement.\n\t ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND \t MANAGEMENT \t\t\t\t\t\n\t The information required under this item is incorporated herein \t by reference to the sections entitled \"Security Ownership of Certain \t Beneficial Owners and Management\", \"Election of Directors\" and \t \"Executive Officers of the Company\" of the Proxy Statement.\n\t ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n\t The information required in this item is incorporated herein by \t reference to the section entitled \"Compensation Committee Interlocks \t and Insider Participation\" and \"Employment Contracts and Deferred \t Compensation Arrangements\" of the Proxy Statement.\n\t PART IV\n\t ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND \t\t\t REPORTS ON FORM 8-K \t\t\t\n\t\t (a) 1. Financial Statements\n\t\t\t The following financial statements of One \t\t\t Price Clothing Stores, Inc are included in \t\t\t Part II, Item 8: \t\t\t \t\t\t\t Independent Auditors' Report\n\t\t\t\t Consolidated Balance Sheets as of \t\t\t\t December 31, 1994 and January 1, 1994\n\t\t\t\t Consolidated Statements of Income for \t\t\t\t the years ended December 31, 1994, \t\t\t\t January 1, 1994 and January 2, 1993\n\t\t\t\t Consolidated Statements of \t\t\t\t Shareholders' Equity for the years \t\t\t\t ended December 31, 1994, January 1, \t\t\t\t 1994 and January 2, 1993\n\t\t\t\t Consolidated Statements of Cash Flows \t\t\t\t for the years ended December 31, 1994, \t\t\t\t January 1, 1994 and January 2, 1993\n\t\t\t\t Notes to Consolidated Financial \t\t\t\t Statements\n\t\t (a) 2. Financial Statement Schedule\n\t\t\t The following financial statement schedule of \t\t\t One Price Clothing Stores, Inc. is included in \t\t\t Item 14 (d):\n\t\t\t\t Schedule II -- Valuation and \t\t\t\t Qualifying Accounts.\n\t\t\t\t\n\t\t\t Schedules not listed above have been omitted \t\t\t because they are not applicable or the information \t\t\t is included in the financial statements or notes \t\t\t thereto.\n\t\t (a) 3. Exhibits including those incorporated by \t reference:\n\t\t Exhibit \t\t Number Description\n\t\t 3(a) Certificate of Incorporation of the \t\t\t\t Registrant, as amended through April \t\t\t\t 1987: Incorporated by reference to \t\t\t\t exhibit of the same number in \t\t\t\t Registrant's Registration Statement on \t\t\t\t Form S-1, filed April 10, 1987, (File No. \t\t\t\t 33-13321) (\"the S-1\").\n\t\t 3(a)(1) Certificate of Amendment of Certificate \t\t\t\t of Incorporation of the Registrant: \t\t\t\t Incorporated by reference to exhibit of \t\t\t\t same number in Registrant's Annual Report \t\t\t\t on Form 10-K for the year ended January \t\t\t\t 1, 1994, (File No. 0-15385) (\"the 1993 \t\t\t\t Form 10-K\").\n\t\t 3(b) Restated By-Laws of the Registrant, as of \t\t\t\t July 22, 1992 and amended as of July 20, \t\t\t\t 1994.\n\t\t 4(a) See Exhibits 3(a), 3(a)(1), and 3(b).\n\t\t 4(b) Specimen of Certificate of the \t\t\t\t Registrant's Common Stock: Incorporated \t\t\t\t by reference to Exhibit 1 of the \t\t\t\t Registrant's Registration Statement on \t\t\t\t Form 8-A filed with the Securities and \t\t\t\t Exchange Commission on June 23, 1987, \t\t\t\t (File No. 0-15385).\n\t\t 4(c) One Price Clothing Stores, Inc. and Wachovia Bank of North Carolina, N. A. as \t\t\t\t Rights Agent Shareholder Rights Agreement \t\t\t\t dated November 3, 1994: Incorporated by \t\t\t\t reference to Exhibit 2 to the \t\t\t\t Registrant's Form 8-K filed November 10, \t\t\t\t 1994 (File No. 0-15385).\n\t\t Material Contracts -- Executive Compensation Plans and Arrangements: \t\t 10(a)* Stock Option Plan of the Registrant dated \t\t\t February 20, 1987 and related forms of \t\t\t\t Incentive and Non-qualified Stock Option \t\t\t\t Agreements: Previously filed as exhibit \t\t\t\t 10(d) of the S-1.\n\t\t 10(b)* Stock Option Plan of the Registrant dated \t\t\t\t December 12, 1988 and related forms of \t\t\t\t Incentive and Non-qualified Stock Option \t\t\t\t Agreements: Incorporated by reference to \t\t\t\t exhibit 10(a) in the Registrant's Annual \t\t\t\t Report on Form 10-K for the year ended \t\t\t\t December 31, 1988, (File No. 0-15385) \t\t\t\t (\"the 1988 Form 10-K\").\n\t\t 10(c)* One Price Clothing Stores, Inc. 1991 \t\t Stock Option Plan: Incorporated by \t\t\t\t reference to exhibit 10(b) in the \t\t\t\t Registrant's Annual Report on Form 10-K \t\t\t\t for the year ended December 28, 1991, \t\t\t\t (File No. 0-15385) (\"the 1991 Form 10- \t\t\t\t K\").\n\t\t 10(d)* Summary of Officer Bonus Plan: Previously \t\t\t filed as exhibit of the same number in \t\t\t\t Registrant's Annual Report on Form 10-K \t\t\t\t for the year ended January 2, 1993, (File \t\t\t\t No. 0-15385) (\"the 1992 Form 10-K\").\n\t\t 10(e)* Form of Employment Agreement between \t\t\t\t Registrant and Henry D. Jacobs, Jr.: \t\t\t\t Previously filed as exhibit 10(j) in the \t\t\t\t 1988 Form 10-K.\n\t\t 10(f)* Employment Agreement dated February 1, \t\t\t\t 1991 between the Registrant and Ethan S. \t\t\t\t Shapiro: Incorporated by reference to \t\t\t\t exhibit 10(m) in the Registrant's Annual \t\t\t\t Report on Form 10-K for the year ended \t\t\t\t December 29, 1990, (File No. 0-15385) \t\t\t\t (\"the 1990 Form 10-K\").\n\t 10(g)* Key man term insurance policy, issued \t \t\t\t February 20, 1993, on the life of Henry \t\t\t\t D. Jacobs, Jr.: Previously filed as \t\t\t\t exhibit of the same number in the 1992 \t\t\t\t Form 10-K.\n\t\t 10(h)* Employment Agreement dated January 16, \t\t\t\t 1995 between the Registrant and Stephen \t\t\t A. Feldman.\n\t\t 10(i)* Disability Income Policy for the benefit \t\t\t of Henry D. Jacobs, Jr.: Previously filed \t\t\t\t as exhibit of the same number in the 1992 \t\t\t\t Form 10-K.\n\t\t 10(j)* Disability Income Policy for the benefit \t\t\t\t of Ethan S. Shapiro: Previously filed as \t\t\t\t exhibit of the same number in the 1992 \t\t\t\t Form 10-K.\n\t\t 10(k)* Agreement between the Registrant and Jane \t\t\t\t R. Shapiro, Trustee of the Ethan S. \t\t\t\t Shapiro Life Insurance Trust: Previously \t\t\t\t filed as exhibit of the same number in \t\t\t\t the 1992 Form 10-K.\n\t\t 10(l)* Agreement dated June 24, 1992 between the \t\t\t\t Registrant and Raymond S. Waters: \t\t\t\t Previously filed as exhibit of the same \t\t\t\t number in the 1992 Form 10-K.\n\t\t 10(m)* Proposed Directors' Stock Option Plan to \t\t\t\t be effective April 19, 1995 and submitted \t\t\t\t for shareholders' approval at the Annual \t\t\t\t Shareholders' Meeting to be held April \t\t\t 19, 1995.\n\t\t Material Contracts -- Other:\n\t\t 10(n) The Corporate Plan for Retirement Profit \t\t\t\t Sharing \/ 401 (k) Plan - A Fidelity \t\t\t\t Prototype Plan Non-Standardized Adoption \t\t\t\t Agreement 002, Basic Plan No. 07, as \t\t\t\t amended September 1, 1994\n\t\t 10(o) Letter of agreement for an unsecured \t\t\t $15,000,000 line of credit and \t\t\t\t $15,000,000 letter of credit facility by \t\t\t\t and between the Registrant and \t\t\t\t NationsBank dated April 14, 1994 and \t\t\t\t unsecured Promissory Note of the \t\t\t\t Registrant to NationsBank dated April 14, \t\t\t\t 1994: Incorporated herein by reference to \t\t\t\t exhibit 10 in the Registrant's quarterly \t\t\t\t report on Form 10-Q for the quarter ended \t\t\t\t April 2, 1994, (File No. 0-15385).\n\t\t 10(p) First Amendment to Letter of agreement, \t\t\t\t dated December 31, 1994, by and between \t\t\t\t the Registrant and NationsBank and \t\t\t\t unsecured Promissory Note of the \t\t\t\t Registrant to NationsBank dated February \t\t\t\t 27, 1995.\n\t\t 10(q) Credit Agreement dated March 16, 1995 by \t\t\t\t and between the Registrant and \t\t\t\t NationsBank (as agent) for an unsecured \t\t\t\t $25,000,000 line of credit facility and a \t\t\t\t $15,000,000 letter of credit facility.\n\t\t 11 Statement regarding computation of per \t\t\t\t share earnings.\n\t\t 21 Subsidiary of the Registrant. \t\t \t\t 23 Consent of Deloitte & Touche LLP.\n\t\t 27 Financial Data Schedule (electronic \t\t\t\t filing only).\n\t\t ---------------------------------------\n\t\t * Denotes a management contract or compensatory plan or \t\t agreement.\n(b) Reports on Form 8-K.\n\t On October 21, 1994, the Company filed a report on Form 8-K \t dated September 29, 1994 to report the legal proceedings \t discussed in Item 3.\n\t On November 10, 1994, the Company filed a report on Form 8-K \t dated November 3, 1994 to report the adoption of Shareholder \t Rights Plan by the Board of Directors.\n\t No other reports on Form 8-K were filed during the last \t quarter of the period covered by this report.\n(c) Exhibits.\n\t The response to this portion of Item 14 is submitted as a \t separate section of this report.\n(d) Financial Statement Schedules.\n\t The response to this portion of Item 14 is submitted as a \t separate section of this report.\n\t\t\t ONE PRICE CLOTHING STORES, INC. AND SUBSIDIARY \t\t\t\t EXHIBIT INDEX\n\t\t\t\t\t\nExhibit \t Number Description\n\t 3(a) Certificate of Incorporation of the \t\t\t\t Registrant, as amended through April \t\t\t\t 1987: Incorporated by reference to \t\t\t\t exhibit of the same number in \t\t\t\t Registrant's Registration Statement on \t\t\t\t Form S-1, filed April 10, 1987, (File No. \t\t\t\t 33-13321) (\"the S-1\").\n\t 3(a)(1) Certificate of Amendment of Certificate \t\t\t\t of Incorporation of the Registrant: \t\t\t\t Incorporated by reference to exhibit of \t\t\t\t same number in Registrant's Annual Report \t\t\t\t on Form 10-K for the year ended January \t\t\t\t 1, 1994, (File No. 0-15385) (\"the 1993 \t\t\t\t Form 10-K\").\n\t 3(b) Restated By-Laws of the Registrant, as of \t\t\t\t July 22, 1992 and amended as of July 20, \t\t\t\t 1994.\n\t 4(a) See Exhibits 3(a), 3(a)(1), and 3(b).\n\t \t 4(b) Specimen of Certificate of the \t\t\t\t Registrant's Common Stock: Incorporated \t\t\t\t by reference to Exhibit 1 of the \t\t\t\t Registrant's Registration Statement on \t\t\t\t Form 8-A filed with the Securities and \t\t\t\t Exchange Commission on June 23, 1987, \t\t\t\t (File No. 0-15385).\n\t 4(c) One Price Clothing Stores, Inc. and \t\t\t\t Wachovia Bank of North Carolina, N. A. as \t\t\t\t Rights Agent Shareholder Rights Agreement \t\t\t\t dated November 3, 1994: Incorporated by \t\t\t\t reference to Exhibit 2 to the \t\t\t\t Registrant's Form 8-K filed November 10, \t\t\t\t 1994 (File No. 0-15385).\n\t Material Contracts -- Executive Compensation Plans and \t Arrangements:\n\t 10(a)* Stock Option Plan of the Registrant dated \t\t\t\t February 20, 1987 and related forms of \t\t\t\t Incentive and Non-qualified Stock Option \t\t\t\t Agreements: Previously filed as exhibit \t\t\t\t 10(d) of the S-1.\n\t 10(b)* Stock Option Plan of the Registrant dated \t\t\t\t December 12, 1988 and related forms of \t\t\t\t Incentive and Non-qualified Stock Option \t\t\t\t Agreements: Incorporated by reference to \t\t\t\t exhibit 10(a) in the Registrant's Annual \t\t\t\t Report on Form 10-K for the year ended \t\t\t\t December 31, 1988, (File No. 0-15385) \t\t\t\t (\"the 1988 Form 10-K\").\n\t 10(c)* One Price Clothing Stores, Inc. 1991 \t\t\t\t Stock Option Plan: Incorporated by \t\t\t\t reference to exhibit 10(b) in the \t\t\t\t Registrant's Annual Report on Form 10-K \t\t\t\t for the year ended December 28, 1991, \t\t\t\t (File No. 0-15385) (\"the 1991 Form 10- \t\t\t\t K\").\n\t 10(d)* Summary of Officer Bonus Plan: Previously \t\t\t\t filed as exhibit of the same number in \t\t\t\t Registrant's Annual Report on Form 10-K \t\t\t\t for the year ended January 2, 1993, (File \t\t\t\t No. 0-15385) (\"the 1992 Form 10-K\").\n\t 10(e)* Form of Employment Agreement between \t\t\t\t Registrant and Henry D. Jacobs, Jr.: \t\t\t\t Previously filed as exhibit 10(j) in the \t\t\t\t 1988 Form 10-K.\n\t 10(f)* Employment Agreement dated February 1, \t \t\t\t 1991 between the Registrant and Ethan S. \t\t\t\t Shapiro: Incorporated by reference to \t\t\t\t exhibit 10(m) in the Registrant's Annual \t\t\t\t Report on Form 10-K for the year ended \t\t\t\t December 29, 1990, (File No. 0-15385) \t\t\t\t (\"the 1990 Form 10-K\").\n\t 10(g)* Key man term insurance policy, issued \t\t\t\t February 20, 1993, on the life of Henry \t\t\t\t D. Jacobs, Jr.: Previously filed as \t\t\t\t exhibit of the same number in the 1992 \t\t\t\t Form 10-K.\n\t 10(h)* Employment Agreement dated January 16, \t\t\t\t 1995 between the Registrant and Stephen \t\t\t\t A. Feldman.\n\t 10(i)* Disability Income Policy for the benefit \t\t\t\t of Henry D. Jacobs, Jr.: Previously filed \t\t\t\t as exhibit of the same number in the 1992 \t\t\t\t Form 10-K.\n\t 10(j)* Disability Income Policy for the benefit \t\t\t\t of Ethan S. Shapiro: Previously filed as \t\t\t\t exhibit of the same number in the 1992 \t\t\t\t Form 10-K.\n\t 10(k)* Agreement between the Registrant and Jane \t\t\t\t R. Shapiro, Trustee of the Ethan S. \t\t\t\t Shapiro Life Insurance Trust: Previously \t\t\t\t filed as exhibit of the same number in \t\t\t\t the 1992 Form 10-K.\n\t 10(l)* Agreement dated June 24, 1992 between the \t\t\t\t Registrant and Raymond S. Waters: \t\t\t\t Previously filed as exhibit of the same \t\t\t\t number in the 1992 Form 10-K.\n\t 10(m)* Proposed Directors' Stock Option Plan to \t\t\t\t be effective April 19, 1995 and submitted \t\t\t\t for shareholders' approval at the Annual \t\t\t\t Shareholders' Meeting to be held April \t\t\t\t 19, 1995.\n\t Material Contracts -- Other:\n\t 10(n) The Corporate Plan for Retirement Profit \t\t\t\t Sharing \/ 401(k) Plan - A Fidelity \t\t Prototype Plan Non-Standardized Adoption \t\t\t\t Agreement 002, Basic Plan No. 07, as \t\t\t\t amended September 1, 1994\n\t 10(o) Letter of agreement for an unsecured \t\t\t\t $15,000,000 line of credit and \t\t\t\t $15,000,000 letter of credit facility by \t\t\t\t and between the Registrant and \t\t\t\t NationsBank dated April 14, 1994 and \t\t\t\t unsecured Promissory Note of the \t\t\t\t Registrant to NationsBank dated April 14, \t\t\t\t 1994: Incorporated herein by reference to \t\t\t\t exhibit 10 in the Registrant's quarterly \t\t\t\t report on Form 10-Q for the quarter ended \t\t\t\t April 2, 1994, (File No. 0-15385).\n\t 10(p) First Amendment to Letter of agreement, \t\t\t dated December 31, 1994, by and between \t\t\t\t the Registrant and NationsBank and \t\t\t\t unsecured Promissory Note of the \t\t\t\t Registrant to NationsBank dated February \t\t\t\t 27, 1995.\n\t 10(q) Credit Agreement dated March 16, 1995 by \t\t\t\t and between the Registrant and \t\t\t\t NationsBank (as agent) for an unsecured \t\t\t\t $25,000,000 line of credit facility and a \t\t\t\t $15,000,000 letter of credit facility.\n\t 11 Statement regarding computation of per \t\t\t\t share earnings.\n\t 21 Subsidiary of the Registrant.\n\t 23 Consent of Deloitte & Touche LLP.\n\t 27 Financial Data Schedule (electronic \t\t\t\t filing only).\n\t\t\t\t \t --------------------------------------\n* Denotes a management contract or compensatory plan or agreement.\n(b) Reports on Form 8-K.\n\t On October 21, 1994, the Company filed a report on Form 8-K dated \t September 29, 1994 to report the legal proceedings discussed in \t Item 3.\n\t On November 10, 1994, the Company filed a report on Form 8-K \t dated November 3, 1994 to report the adoption of Shareholder \t Rights Plan by the Board of Directors. No other reports on \t Form 8-K were filed during the last quarter of the period \t covered by this report.\n(c) Exhibits.\n\t The response to this portion of Item 14 is submitted as a \t separate section of this report.\n(d) Financial Statement Schedules.\n\t The response to this portion of Item 14 is submitted as a \t separate section of this report.","section_15":""}
{"filename":"46517_1994.txt","cik":"46517","year":"1994","section_1":"ITEM 1. BUSINESS\nHechinger Company (the \"Company\") is the successor to a business started in 1911 by Sidney L. Hechinger. The Company is a leading specialty retailer providing products and services for the care, repair, remodelling and maintenance of the home and garden. The Company currently serves the home improvement industry through two operating subsidiaries: Hechinger Stores Company, operating 72 home center stores located primarily in the mid-Atlantic region and Home Quarters Warehouse, Inc., operating 56 stores located primarily in the eastern and central parts of the United States.\nHechinger stores are customer-service driven, offering expert advice and a full range of building material and home improvement merchandise in facilities containing on average approximately 70,000 square feet of space under roof. Home Quarters Warehouse stores, with their large-scale merchandise presentation, produce high sales volume by emphasizing low pricing and quality service. Home Quarters Warehouse stores bring a wide assortment of building materials and home improvement merchandise to do-it-yourselfers, and professional contractors in brightly-lit, uncluttered facilities containing on average approximately 90,000 square feet under roof.\nPRODUCTS\nAll of the Company's stores offer for sale a large selection of lumber, building materials, hardware and tools, paint, garden supplies, electrical and plumbing supplies and other items related to the home improvement market.\nThe following table sets forth the percentage of sales accounted for by the merchandise categories:\nMany of the items sold in the Company's stores are nationally advertised, brand name products. The Company also offers some private label items such as garden equipment and supplies, and paint. The Company may add private label items to its merchandise in those areas where there are no major national brands or where management deems it an effective way to meet price competition in a particular product line.\nThe Company's merchandise is purchased from approximately 1000 suppliers. The Company believes it has good relationships with its suppliers and does not consider itself dependent upon any single source for its merchandise.\nMARKETING\nThe Company is continuing its expansion of Home Quarters Warehouse subsidiary. In July 1993, the Company opened a new 115,000 square foot store in Chesapeake, Virginia. This store incorporates many new features, including: a 5,000 square foot greenhouse and garden center, three design centers, installation services for major items and a tool rental program. In addition, the new Home Quarters store has a dedicated Contractor's desk to handle the special needs of professional contractors and commercial property owners, including its own entrance and loading area. The new store also offers\n\"Kids Quarters\", a supervised on-site child care facility for children ages three to eight and a dedicated classroom called \"HQ University\" for how-to clinics. Of the nine new Home Quarters stores opened since July 1993, eight have these new features. The Company is planning to implement these new features in all of its new stores to be opened in 1994 and in its existing Home Quarters stores where possible.\nThe majority of the Company's sales are to individuals. Employees are trained to help the do-it-yourself customer make his or her purchases and solve technical problems related to home repair, maintenance and improvement work.\nThe Company employs an advertising program through the regular use of newspaper and direct mail pieces. A \"catabook\", which is compact enough to carry along as a shopping reference and serves as an \"idea\" book with an index and large type prices, is heavily utilized. Advertisements feature the stores' wide selection and values. The Company also employs television and radio advertising where deemed effective. The Company emphasizes competitive pricing with its policy being to meet or beat the regular or sale prices of all major competitors. In addition, the Company offers its customers a liberal return policy.\nThe Company hosts how-to clinics throughout the year at various stores. At these clinics, trained employees, manufacturers' representatives and, at times, nationally recognized experts, demonstrate products and conduct classes on major home improvement projects.\nThe Company offers a private label credit card program pursuant to which credit is extended to its customers by third party financial institutions. The Company also accepts Visa, MasterCard and Discover in all stores and American Express in its Home Quarters stores. For the fiscal year ended January 29, 1994 credit card sales account for 50% of the Company's total sales.\nEXPANSION PROGRAM\nThe following tables set forth the number of stores operated by the Company and the aggregate amount of square feet of store space in such stores for the specified periods:\nIn 1994, the Company intends to open approximately 11 new Home Quarters Warehouse stores, including two relocations, and approximately two new Hechinger stores, although the precise number will depend upon, among other things, the availability of suitable locations and prevailing economic conditions. In addition, approximately 19 Home Quarters stores and approximately six Hechinger stores are intended to be remodelled.\nCOMPETITION\nThe business of the Company is highly competitive. The Company competes in each of its market areas with other home center chains, national chains of general merchandise stores and local hardware stores, some of which have greater financing resources than the Company.\nThe extent of the Company's competition varies by geographic area. New competitors have entered several of the Company's existing markets and those targeted for future development, and established competitors are expanding in certain of those markets, reflecting the high level of growth anticipated for the industry. The Company's pricing strategy against the introductory pricing of new competition in certain markets may lower gross margins.\nThe Company believes that it is in a strong competitive position. The Company believes that it occupies a leading position in most of its established market areas, reflecting the quality of its trained personnel, breadth and depth of merchandising, pricing, advertising policies and store size, location and condition. The Company believes that its ability to devote substantial capital resources to the operation and expansion of its business will enable it to remain competitive in the industry.\nEMPLOYEES\nThe Company has approximately 18,000 employees, approximately half of whom are employed on a part-time basis. The Company conducts comprehensive employee training programs. These training programs have enabled the Company to promote from within many current area supervisors, store managers and merchandisers. The Company believes its employee relations are satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nHechinger stores currently average approximately 70,000 square feet under roof and an additional 22,000 square\nfeet of outdoor selling and storage space. The Home Quarters Warehouse stores currently average approximately 90,000 square feet under roof and an additional 28,000 square feet of outdoor selling and storage space.\nAs of January 29, 1994, the Company owned 23 stores and leased the remaining stores. The Company believes that all its facilities, both owned and leased, are in good condition and well maintained. Expiration dates of the leases range from 1994 to 2023. Almost all leases contain renewal clauses or continue on a year-to-year basis after their respective expiration dates. Twelve of the store sites are leased from an affiliate.\nHechinger stores are serviced, in part, from the Company's modern warehouse and distribution facility in Landover, Maryland, which has approximately 640,000 square feet under roof. The Landover distribution facility and the Hechinger headquarters office facility in Landover, Maryland together have approximately 177,000 square feet of executive and administrative office space. Home Quarters is serviced directly by their suppliers and as such, requires only limited distribution facilities. Home Quarters has approximately 71,000 square feet of office space in Virginia Beach, Virginia.\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.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nPursuant to General Instruction G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this Report in lieu of being included in its entirety in the Proxy Statement.\nThe following table sets forth certain information regarding the Company's executive officers:\nJohn W. Hechinger Jr. and S. Ross Hechinger are sons of John W. Hechinger.\nExecutive officers are elected by the board of directors of the Company at its first meeting held after each Annual Meeting of Stockholders to serve until their successors are chosen and qualified, or as otherwise provided in the Company's By-laws.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nPursuant to General Instruction G(2) of Form 10-K, the information called for by this item is hereby incorporated by reference from page 23 of the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nPursuant to General Instruction G(2) of Form 10-K, the information called for by this item is hereby incorporated by reference from page 1 of the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1994.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nPursuant to General Instruction G(2) of Form 10-K, the information called for by this item is hereby incorporated by reference from pages 9 through 11 of the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1994.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPursuant to General Instruction G(2) of Form 10-K, the information called for by this item is hereby incorporated by reference from pages 12 through 23 of the Company's Annual Report to Stockholders for the fiscal year ended January 29, 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.\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item regarding directors is hereby incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report. Information regarding the Company's executive officers is set forth above in the unnumbered Item following Item 4 of Part I of this Report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nPursuant to General Instruction G(3) of Form 10-K, the information called for by this item is hereby incorporated by reference from the Company's definitive proxy statement to be filed pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report.\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. The following Consolidated Financial Statements of Hechinger Company and subsidiaries are incorporated by reference to the pages indicated in Annual Report to Stockholders for the fiscal year ended January 29, 1994:\n2. Financial Statement Schedules. The following consolidated financial statement schedules of Hechinger Company and subsidiaries for the year ended January 29, 1994, January 30, 1993 and February 1, 1992 are filed as part of this Report and should be read in conjunction with the Consolidated Financial Statements of Hechinger Company:\nSchedules not listed above have been omitted because they are not applicable or are not required or the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto.\n3. Exhibits.\nEXHIBIT NUMBER DOCUMENT - - -------------- --------\n(b) Reports on Form 8-K.\nThe Current Report on Form 8-K dated October 15, 1993 was to file Ernst & Young's consent to the reference to that firm under the caption \"Experts\" in the Prospectus Supplement dated October 21, 1993 for the issuance of Senior Notes.\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 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.\nHECHINGER COMPANY AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K YEAR ENDED JANUARY 29, 1994\nINDEX TO SCHEDULES AND EXHIBITS\nHECHINGER COMPANY AND SUBSIDIARIES SCHEDULE I - MARKETABLE SECURITIES YEAR ENDED JANUARY 29, 1994 (in thousands)\nHECHINGER COMPANY AND SUBSIDIARIES SCHEDULE I - MARKETABLE SECURITIES YEAR ENDED JANUARY 29, 1994 (in thousands)\nHECHINGER COMPANY AND SUBSIDIARIES SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT (in thousands)\n(a) During the year ended February 1, 1992, the Hechinger Stores Company changed its method of transporting merchandise from its Landover, Maryland distribution facility to its stores, from using its own fleet to utilizing commerial carriers. Dispositions during the year were primarily the result of the Company disposing of this fleet of delivery vehicles. (b) Substantially all additions represent ordinary expenditures for new stores and store remodeling. (c) Sale and leaseback transactions. (d) Substantially all other retirements were primarily the result of store closings. (e) Transfer of construction in progress for assets placed in service.\nDepreciation and amortization are computed using the straight-line method over the estimated useful lives of the various assets, which in general are:\nClassification Estimated Useful Life\nBuildings Generally 30 to 45 years. Leasehold improvements The term of the lease. In some longer term leases, up to 21 years. Furniture, fixtures and equipment 5 to 10 years. Capital leases The term of the lease.\nHECHINGER COMPANY AND SUBSIDIARIES SCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT (in thousands)\nHECHINGER COMPANY AND SUBSIDIARIES SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS (in thousands)\n(a) In 1992, the Company sold the entire Hechinger Stores' accounts receivable.\nHECHINGER COMPANY AND SUBSIDIARIES SCHEDULE IX - SHORT-TERM BORROWINGS (in thousands)\nNotes:\n(a) At February 1, 1992, January 30, 1993 and January 29, 1994 there were no short-term borrowings. (b) The weighted average interest rate during the period was computed by dividing the actual interest expense by average short-term debt outstanding. (c) Note payable to bank represents borrowings under a line of credit borrowing arrangement. (d) There were no short-term borrowings during the year ended January 30, 1993 and January 29, 1994.\nHECHINGER COMPANY AND SUBSIDIARIES SCHEDULE X - SUPPLEMENTARY EARNINGS STATEMENT INFORMATION (in thousands)\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 total sales and revenues.","section_15":""}
{"filename":"59198_1994.txt","cik":"59198","year":"1994","section_1":"ITEM 1. Business.\n(a) TRINOVA Corporation (\"TRINOVA\") is a world leader in the manufacture and distribution of engineered components and systems for industry, sold through its operating companies, Aeroquip Corporation (\"Aeroquip\") and Vickers, Incorporated (\"Vickers\"), to the industrial, automotive, and aerospace and defense markets.\nOn September 22, 1994, Joseph C. Farrell, Chairman of the Board, President and Chief Executive Officer of The Pittston Company, was elected to the Board of Directors of TRINOVA.\nNo business acquisitions were completed in 1994.\nOn February 26, 1994, TRINOVA sold the assets, net of certain liabilities, of its electric motor business located in Wichita, Kansas; Blue Ash, Ohio; and Maysville, Kentucky. The business was sold as part of TRINOVA's ongoing program to eliminate businesses and product lines which do not fit its strategies.\n(b) \"Note 13 - Business Segments\" on pages 80-81 of Exhibit (13) filed hereunder is incorporated herein by reference.\n(c) A description of the business done and intended to be done by TRINOVA and its subsidiaries in each industry segment follows.\n(1) INDUSTRIAL: Aeroquip manufactures and sells all pressure ranges of hose and fittings; adapters; self-sealing couplings; and molded, extruded and co-extruded plastic products.\nVickers manufactures and sells hydraulic, electrohydraulic, pneumatic and electronic control devices; piston and vane pumps and motors; servovalves and controls; hydraulic and pneumatic cylinders; hydraulic power packages; electric motors and drives; hydraulic and lubrication filtration; and fluid- evaluation services.\nPrincipal markets for these products include construction, mining, logging and farm equipment; machine tool; process industries; electrical machinery, air conditioning\/refrigeration; appliances and communications equipment; electronics; lift truck; material handling; plant maintenance; and housing and commercial construction. Sales are dispersed geographically across a broad customer base. Products are sold directly to original equipment manufacturers (\"OEMs\") and through a worldwide network of distributors serving aftermarket and small- and medium-sized OEM customers.\nThe industrial business is highly competitive in terms of price, quality and service. TRINOVA believes that Aeroquip has significant market position worldwide for industrial hose, fittings, couplings and adapters. TRINOVA also believes that Vickers has significant market position worldwide for mobile and industrial vane pumps, solenoid-operated directional valves, mobile hydraulic control valves for forklift trucks, cartridge valve systems, piston pumps for high-horsepower agricultural tractors, hydraulic tilt-train\ntechnology, and utility vehicle hydraulic equipment. TRINOVA serves many customers in the highly diverse and fragmented industrial markets. Due to the diversity of TRINOVA's products, there are a large number of competitors scattered across a wide variety of market segments, with no single competitor competing in each of TRINOVA's product lines.\nThe order backlog for the industrial business was $185 million as of December 31, 1994, compared to $148.4 million as of December 31, 1993. Substantially all of the December 31, 1994, backlog is expected to be filled in 1995.\n(2) AUTOMOTIVE: Aeroquip manufactures and sells air conditioning, power steering, oil and transmission cooler, and fuel line components and assemblies; body side moldings; decorative bumper strips; roof moldings; spoilers; rocker panel claddings; engine components; louvers and trim plates; interior trim; garnish moldings; structural products such as bumper beams; interior engine covers; instrument clusters; radio bezels; and display products.\nThe automotive operations of Aeroquip serve worldwide automobile, light truck and van manufacturers. Products are primarily sold directly to manufacturers. Approximately 52 percent of worldwide sales of TRINOVA's automotive business are made to three major U.S. automobile manufacturers.\nThe automotive industry is highly competitive in terms of price, quality and service. Aeroquip is a preferred supplier to the major U.S. and European automobile manufacturers. Competition for products in the automotive industry is very fragmented.\n(3) AEROSPACE & DEFENSE: Aeroquip manufactures and sells hose, fittings, couplings, swivels, V-band couplings, fuel-handling products and high-pressure tube fittings.\nVickers manufactures and sells fixed- and variable-displacement pumps; fuel pumps; hydraulic motors and motor packages; motor pumps and generator packages; valves and valve packages; electrohydraulic and electromechanical actuators; electric motor packages; and sensors and monitoring devices.\nThe aerospace & defense operations of Aeroquip and Vickers serve worldwide commercial aerospace and military markets including commercial aircraft, air defense, cargo handling, combat and support vehicles, commuter aircraft, engines, marine, military aircraft, military weaponry, missiles and naval machinery. Products are sold directly to OEM businesses and the Government and through a distributor network. Approximately 19 percent of TRINOVA's aerospace & defense business sales are made to two major U.S. airframe manufacturers.\nThe aerospace & defense business is highly competitive in terms of price, quality and service. TRINOVA believes that Aeroquip has significant market position worldwide for aerospace hose, fittings and quick-disconnect couplings. TRINOVA also believes Vickers has significant market position worldwide for aerospace piston pumps and motors, and lube system diagnostics.\nTRINOVA serves a large number of customers in the diverse and fragmented aerospace and defense markets. Due to the diversity of TRINOVA's products, there are a large number of competitors scattered across a wide variety of market segments, with no single competitor competing in each of TRINOVA's product lines.\nThe order backlog for the aerospace & defense business was $267 million as of December 31, 1994, compared to $278.4 million as of December 31, 1993. Approximately 22 percent of the December 31, 1994, backlog is not expected to be filled in 1995 because certain contracts require deliveries after 1995. Approximately 34 percent of the December 31, 1994, backlog represents direct Government contracts or subcontracts on Government programs, which are subject to termination for convenience by the Government.\n(4) OTHER INFORMATION: TRINOVA and its subsidiaries are generally not dependent upon any one source for raw materials or purchased components essential to their businesses, and it is believed that such raw materials and components will be available in adequate quantities to meet anticipated production schedules.\nPatents owned by TRINOVA are considered important to the conduct of its present businesses. TRINOVA is licensed under a number of patents, none of which are considered material to its businesses. TRINOVA is the owner of a number of U.S. and non-U.S. trademark registrations.\nTRINOVA devotes engineering, research and development efforts to new products and improvement of existing products and production processes. During 1994, 1993 and 1992, TRINOVA spent a total of $55.5 million, $55.3 million and $65.3 million, respectively, on these efforts.\nTRINOVA employed 15,024 persons at December 31, 1994.\n(d) \"Note 14 - Non-U.S. Operations\" on page 82 of Exhibit (13) filed hereunder is incorporated herein by reference. TRINOVA believes the risk attendant to non-U.S. operations, which are primarily in developed countries, is not significantly greater than that attendant to its U.S. operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nA description of TRINOVA's principal properties follows. Except as otherwise indicated, all properties are owned by TRINOVA or its subsidiaries.\nTRINOVA's executive offices (leased) are located in Maumee, Ohio.\nINDUSTRIAL: Aeroquip Corporation has executive and administrative offices in Maumee, Ohio (leased); technical centers in Ann Arbor, Michigan (leased) and Maumee, Ohio (leased); and manufacturing facilities throughout the United States and abroad, including plants in Mountain Home, Arkansas; Fitzgerald, Georgia; New Haven, Indiana; Williamsport, Maryland; Forest City and Norwood, North Carolina; Van Wert, Ohio; Gainesboro, Tennessee; Bassett, Virginia; Wausau, Wisconsin; Rio de Janeiro, Brazil; Chambray-Les-Tours, France; Baden- Baden and Hann-Muenden, Germany; Livorno, Italy; and Cardiff, United Kingdom. Aeroquip also owns or leases warehouse, assembly and distribution facilities and sales offices in the United States and abroad.\nVickers, Incorporated has executive and administrative offices in Maumee, Ohio (leased); a technical center in Rochester Hills (leased), Michigan; and manufacturing facilities throughout the United States and abroad, including plants in Decatur, Alabama; Searcy, Arkansas; Carol Stream and Petersburg (leased), Illinois; Grand Blanc and Jackson, Michigan; Omaha, Nebraska; White City, Oregon; Sao Paulo, Brazil; Bad Homburg, Germany; Casella and Vignate (leased), Italy; and Havant and Telford (leased), United Kingdom. Vickers also owns or leases warehouse, assembly and distribution facilities and sales offices in the United States and abroad.\nAUTOMOTIVE: Aeroquip has executive and administrative offices in Maumee, Ohio (leased); technical and administrative offices in Mt. Clemens, Michigan (leased); and manufacturing facilities throughout the United States and abroad, including plants in Atlanta, Georgia; Kendallville, Indiana; Henderson, Kentucky; Clinton Township (leased), Mt. Clemens, Port Huron, Spring Arbor and Sterling Heights, Michigan; Mooresville, North Carolina; Fremont, Ohio; Livingston, Tennessee; Baden-Baden, Beienheim (leased) and Frankfurt (leased), Germany; Chihuahua, Mexico; Alcala de Henares, Spain; and Brierley Hill, United Kingdom. Aeroquip also owns or leases warehouse, assembly and distribution facilities and sales offices in the United States and abroad.\nAEROSPACE & DEFENSE: Aeroquip Corporation has executive and administrative offices in Maumee, Ohio (leased); administrative offices in Jackson, Michigan; and manufacturing facilities throughout the United States and abroad, including plants in Toccoa, Georgia; Jackson, Michigan; Middlesex, North Carolina; Pau, France (leased); and Lakeside, United Kingdom (leased). Aeroquip also owns or leases warehouse, assembly and distribution facilities and sales offices in the United States and abroad.\nVickers, Incorporated has executive and administrative offices in Maumee, Ohio (leased); and manufacturing facilities throughout the United States and abroad, including plants in Los Angeles, California; Grand Rapids, Michigan; Jackson, Mississippi; Hi-Nella, New Jersey; Glenolden, Pennsylvania; Bad Homburg, Germany; and Bedhampton, United Kingdom. Vickers also owns or leases warehouse, assembly and distribution facilities and sales offices in the United States and abroad.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings.\nAs previously reported, on March 26, 1992, the United States Environmental Protection Agency (\"USEPA\") issued an Administrative Order (\"106 Order\") under Section 106 of the Comprehensive Environmental Response, Compensation, and Liability Act (\"CERCLA\") to TRINOVA's subsidiary, Aeroquip Corporation (\"Aeroquip\"), and five other Potentially Responsible Parties (\"PRPs\") relative to the San Fernando Valley Burbank Operable Unit (\"BOU\"), involving groundwater contamination. (Reference is made to Part II, Item 1, of TRINOVA's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.) The 106 Order requires the six PRPs to design and construct a water blending facility at a cost now estimated to be approximately $4.8 million. TRINOVA's portion of any such cost is estimated to be 18.33 percent based on a cost-sharing agreement among the six PRPs which was executed by TRINOVA on July 6, 1992. Construction of the blending facility is expected to be complete in March 1995.\nAlso related to the BOU, on May 15, 1994, USEPA issued to Lockheed Corporation (\"Lockheed\"), Aeroquip and other PRPs a Special Notice of Liability under CERCLA for the remaining 18 years of operation and maintenance (O&M) costs associated with the blending facility, as well as a water treatment facility constructed by Lockheed under its BOU Consent Decree with USEPA. The Special Notice of Liability also covers USEPA's past response costs. The cost of the O&M phase is not known at this time; USEPA past costs claimed against the PRPs are estimated at $12 million for the entire San Fernando Site, which includes other operable units in addition to the BOU. On April 26, 1994, Lockheed filed a complaint against Aeroquip and 105 other PRPs seeking contribution toward costs Lockheed incurred to construct the water treatment facility. Negotiations are under way among the PRPs and Lockheed to arrive at an equitable and reasonable allocation with respect to the BOU costs. Recovery by Lockheed, if any, against Aeroquip is not expected to be significant.\nAs previously reported, on November 13, 1992, the USEPA, Region IX, issued a General Notice of Liability letter to TRINOVA's subsidiary, Sterer Engineering and Manufacturing Company, now known as the Fluid Control and Actuation Division of Vickers, Incorporated (\"Vickers\"). (Reference is made to Part I, Item 3, of TRINOVA's Annual Report on Form 10-K for the year ended December 31, 1993.) The letter notified Vickers of potential liability, as defined by Section 107(a) of CERCLA, that it may incur with respect to the San Fernando Valley Glendale South Operable Unit, involving groundwater contamination. The USEPA issued its Record of Decision (\"ROD\") on June 18, 1993. The interim remedy proposed in the ROD for both the North and South Operable Units is projected by the USEPA to cost approximately $45 million. Twenty-seven PRPs, including Vickers, entered into an Administrative Order on Consent with the USEPA on March 21, 1994, to conduct the Remedial Design (\"RD\") phase of the interim remedy. The estimated cost of the RD phase is $4.7 million. Vickers' portion of the RD costs is estimated to be 2.79 percent based on an interim allocation agreement among the PRPs.\nAs previously reported, on July 31, 1992, the Maine Department of Environmental Protection issued an Administrative Enforcement Order to TRINOVA and its wholly owned subsidiaries, Aeroquip Corporation and Sterling Engineered Products Inc. (\"Sterling\"), as well as one other party, Pioneer Plastics Corporation (\"Pioneer Plastics\"), (collectively the \"respondents\"), pursuant to Title 38, section 1304(12) of the Maine Revised Statutes. (Reference is made to Part I, Item 3, of TRINOVA's Annual Report on Form 10-K for the year ended December 31, 1993.) The Order, which was issued without a prior hearing, required the respondents to conduct a complete Phase II environmental assessment of alleged soil and groundwater contamination at a manufacturing site in Auburn, Maine, which was formerly owned by Sterling and is now owned by Pioneer Plastics. The Order further required the respondents to remediate any environmental contamination identified in the Phase II assessment. On May 5, 1993, a Compliance Order on Consent (\"COC\") was entered into by the State of Maine, Sterling and Pioneer Plastics. The COC replaces and revokes the Order issued July 31, 1992. The COC requires Sterling to conduct a site investigation and to develop and implement a remedial work plan. The cost to Sterling to conduct the COC site investigation and develop the remedial work plan is estimated to be approximately $850,000. Sterling's remediation costs are undetermined at this time because the remedial work plan has not been completed.\nTRINOVA and certain subsidiaries are defendants in various lawsuits. While the ultimate outcome of these lawsuits and the above environmental matters cannot now be predicted, management is of the opinion, based on the facts now known to it, that the liability, if any, in these lawsuits (to the extent not provided for by insurance or otherwise) and the above environmental matters will not have a material adverse effect upon TRINOVA's consolidated financial position.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders.\nNone.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages, positions and recent business experience of the executive officers of TRINOVA as of February 21, 1995, are listed below. Officers of TRINOVA are elected annually in April by the Board of Directors at the organization meeting immediately following the annual meeting of shareholders.\nNAME AND POSITION AGE BUSINESS EXPERIENCE\nDarryl F. Allen, 51 Chairman of the Board, President Chairman of the Board, and Chief Executive Officer of President and Chief TRINOVA since 1991. President and Executive Officer Chief Executive Officer of TRINOVA from 1986 to 1991.\nWilliam R. Ammann, 53 Vice President-Administration Vice President-Administration and Treasurer of TRINOVA since and Treasurer April 1992. Vice President - Administration of TRINOVA from 1983 to April 1992.\nWarren N. Bimblick 40 Vice President-Corporate Vice President-Corporate Communications of TRINOVA since Communications 1990. Director-Investor Relations and Corporate Communications of TRINOVA from 1985 to 1990.\nJames E. Kline, 53 Vice President & General Counsel Vice President and of TRINOVA since 1989. General Counsel\nJames McKee, 63 Executive Vice President of Executive Vice President of TRINOVA since 1989 and President TRINOVA and President of of Vickers, Incorporated since Vickers, Incorporated 1987.\nJames M. Oathout, 50 Secretary and Associate General Secretary and Counsel of TRINOVA since 1988. Associate General Counsel\nNAME AND POSITION AGE BUSINESS EXPERIENCE\nGregory R. Papp, 48 Corporate Controller of TRINOVA Corporate Controller since February 1993. Vice President and Controller of Aeroquip Corporation from July 1991 to February 1993. Vice President Planning and Control - Automotive Products Group of Aeroquip Corporation from January 1991 to July 1991. Group Controller - Garrett Automotive Group of Allied- Signal Corporation from 1987 to 1991.\nDavid M. Risley, 50 Vice President - Finance and Chief Vice President - Finance Financial Officer of TRINOVA since and Chief Financial Officer October 1992. Group Vice President - Administration and Control of Aeroquip Corporation from 1991 to October 1992. Vice President and Controller of Aeroquip Corporation from 1990 to 1991.\nHoward M. Selland, 51 Executive Vice President of Executive Vice President of TRINOVA and President of Aeroquip TRINOVA and President of Corporation since 1989. Aeroquip Corporation\nPhilip G. Simonds, 54 Vice President-Taxation of TRINOVA Vice President-Taxation since 1983.\nThere are no family relationships among the persons named above.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.\n\"Stock Exchanges,\" \"Stock Ownership,\" \"Dividend Information,\" \"Quarterly Common Stock Information\" and \"Dividend Payments per Share of Common Stock\" on page 84 of Exhibit (13) filed hereunder are incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. Selected Financial Data.\n\"11-Year Summary of Selected Financial Data\" on pages 49-51 of Exhibit (13) filed hereunder is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.\n\"Analysis of Operations\" and \"Liquidity, Working Capital and Capital Investment\" on pages 52-58 of Exhibit (13) filed hereunder are incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\n\"Quarterly Results of Operations (Unaudited)\" and the consolidated financial statements of the registrant and its subsidiaries on pages 59-83 of Exhibit (13) filed hereunder 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 Officers of the Registrant.\n\"Election of Directors\" and \"Section 16(a) Reporting Delinquencies\" on pages 1-2 and 9, respectively, of the proxy statement for the annual meeting to be held on April 20, 1995, are incorporated herein by reference. Information regarding executive officers is set forth in Part I of this report under the caption \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. Executive Compensation.\n\"Compensation of Directors\" and \"Executive Compensation\" (excluding material under the captions \"TRINOVA Stock Performance Graph\" and \"Board Compensation Committee Report on Executive Compensation\") on pages 3 and 5-9, respectively, of the proxy statement for the annual meeting to be held on April 20, 1995, are incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management.\n\"Security Ownership\" on page 4 of the proxy statement for the annual meeting to be held on April 20, 1995, 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) The following documents are filed as a part of this report.\n(1) The following consolidated financial statements of TRINOVA and its subsidiaries, included on pages 61-83 of Exhibit (13) filed hereunder are incorporated by reference in Item 8.\nReport of Ernst & Young LLP, Independent Auditors\nStatement of Income - Years ended December 31, 1994, 1993 and 1992\nStatement of Financial Position - December 31, 1994 and 1993\nStatement of Cash Flows - Years ended December 31, 1994, 1993 and 1992\nStatement of Shareholders' Equity - Years ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements - December 31, 1994\n(2) The following consolidated financial statement schedule of TRINOVA and its subsidiaries is filed under Item 14(d):\nSCHEDULE PAGE(S)\nSchedule II - Valuation and qualifying accounts 17-19\nAll other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are either not required under the related instructions or are inapplicable, and therefore have been omitted.\n(3) The following exhibits are incorporated by reference hereunder, and those exhibits marked with an asterisk (*) (together with those exhibits so marked on page 13) are management contracts or compensatory plans or arrangements required to be filed as exhibits pursuant to Item 14(c) of this report:\nEXHIBIT NUMBER\n(3)-1 Amended Code of Regulations (amended April 21, 1988), filed as Exhibit (3) to Form SE filed on March 18, 1993\n(3)-2 Amended Articles of Incorporation (amended January 26, 1989), filed as Exhibit (3) to Form 10-K filed on March 18, 1994\n(4)-1 First Supplemental Indenture, dated as of May 4, 1992, between TRINOVA Corporation and NBD Bank, with respect to the issuance of $75,000,000 aggregate principal amount of TRINOVA Corporation 7.95% Notes Due 1997, filed as Exhibit (4)-1 to Form SE filed on May 6, 1992\n(4)-2 7.95% Notes Due 1997, issued pursuant to the Indenture, dated as of January 28, 1988, between TRINOVA Corporation and NBD Bank\n(formerly National Bank of Detroit), as supplemented by the First Supplemental Indenture, dated as of May 4, 1992, between TRINOVA Corporation and NBD Bank, filed as Exhibit (4)-2 to Form SE filed on May 6, 1992\n(4)-3 Officers' Certificate of TRINOVA Corporation, dated May 4, 1992, pursuant to Section 2.01 of the Indenture, dated as of January 28, 1988, between TRINOVA Corporation and NBD Bank (formerly National Bank of Detroit), as supplemented by the First Supplemental Indenture, dated as of May 4, 1992, between TRINOVA Corporation and NBD Bank, filed as Exhibit (4)-3 to Form SE filed on May 6, 1992\n(4)-4 Rights Agreement, dated January 26, 1989, between TRINOVA Corporation and First Chicago Trust Company of New York filed as Exhibit (2) to Form 8-A filed on January 27, 1989, as amended by the First Amendment to Rights Agreement filed as Exhibit (5) to Form 8 filed on July 1, 1992\n(4)-5 Form of Share Certificate for Common Shares, $5 par value, of TRINOVA Corporation, filed as Exhibit (4)-2 to Form SE filed on July 1, 1992\n(4)-6 Fiscal Agency Agreement, dated as of October 26, 1987, between TRINOVA Corporation, as Issuer, and Bankers Trust Company, as Fiscal Agent, with respect to $100,000,000 aggregate principal amount of TRINOVA Corporation 6% Convertible Subordinated Debentures Due 2002, filed as Exhibit (4)-1 to Form SE filed on March 18, 1993\n(4)-7 Indenture, dated as of January 28, 1988, between TRINOVA Corporation and NBD Bank (formerly National Bank of Detroit), with respect to the issuance of $50,000,000 aggregate principal amount of TRINOVA Corporation 9.55% Senior Sinking Fund Debentures Due 2018, and the issuance of $75,000,000 aggregate principal amount of TRINOVA Corporation 7.95% Notes Due 1997, filed as Exhibit (4)-2 to Form SE filed on March 18, 1993\n*(10)-1 TRINOVA Corporation 1982 Stock Option Plan, filed as Exhibit (10)-1 to Form SE filed on March 18, 1993\n*(10)-2 TRINOVA Corporation 1984 Incentive Compensation Plan, filed as Exhibit (10)-2 to Form SE filed on March 18, 1993\n*(10)-3 TRINOVA Corporation 1987 Stock Option Plan, filed as Exhibit (10)-3 to Form SE filed on March 18, 1993\n*(10)-4 Change in Control Agreement for Officers, filed as Exhibit (10)- 4 to Form SE filed on March 18, 1993 (the Agreements executed by the Company and various executive officers of the Company are identical in all respects to the form of Agreement filed as an Exhibit to Form SE except as to differences in the identity of the officers and the dates of execution, and as to other variations directly necessitated by said differences)\n*(10)-5 Change in Control Agreement for Non-officers, filed as Exhibit (10)-5 to Form SE filed on March 18, 1993 (the Agreements executed by the Company and various non-officer employees of the Company are identical in all respects to the form of Agreement filed as an Exhibit to Form SE except as to differences in the identity of the employees and the dates of execution, and as to other variations directly necessitated by said differences)\n*(10)-6 TRINOVA Corporation 1994 Stock Incentive Plan, filed as Appendix A to the proxy statement for the annual meeting held on April 21, 1994\n*(10)-7 TRINOVA Corporation 1989 Non-Employee Directors' Equity Plan, filed as Exhibit (10) to Form 10-K filed on March 18, 1994\n(99(i))-1 TRINOVA Corporation Directors' Charitable Award Program, filed as Exhibit (99(i)) to Form 10-K filed on March 18, 1994\n(99(i))-2 Credit Agreement, dated as of August 31, 1994, among TRINOVA Corporation (borrower) and The Bank of Tokyo Trust Company; Chemical Bank; Citibank, N.A.; Dresdner Bank AG, New York and Grand Cayman branches; The First National Bank of Chicago; Morgan Guaranty Trust Company of New York; NBD Bank; and Union Bank of Switzerland, Chicago branches (banks) and Citibank N.A. (administrative agent)\nThe following exhibits are filed hereunder, and those exhibits marked with an asterisk (*) (together with those so marked on pages 12-13) are management contracts or compensatory plans or arrangements required to be filed as exhibits pursuant to Item 14(c) of this report:\n*(10)-8 TRINOVA Corporation Plan for Optional Deferment of Directors' Fees (amended and restated effective April 1, 1995)\n*(10)-9 TRINOVA Corporation Directors' Retirement Plan (amended and restated effective January 1, 1990)\n*(10)-10 TRINOVA Corporation Supplemental Benefit Plan (amended and restated effective January 1, 1995)\n*(10)-11 TRINOVA Corporation Voluntary Deferred Compensation Plan (effective April 1, 1995)\n(11) Statement re: Computation of Per Share Earnings\n(13) Portions of the 1994 Annual Report to Security Holders (to the extent incorporated by reference hereunder)\n(21) Subsidiaries of the Registrant\n(23)-1 Consent of Independent Auditors\n(23)-2 Consent of Independent Auditors\n(24) Powers of Attorney\n(27) Financial Data Schedule\n(b) TRINOVA did not file any reports on Form 8-K during the fourth quarter of 1994.\n(c) The exhibits which are listed under Item 14(a)(3) are filed or incorporated by reference hereunder.\n(d) The financial statement schedule which is listed under Item 14(a)(2) is filed hereunder.\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.\nTRINOVA CORPORATION (Registrant)\nBy: \/S\/ DARRYL F. ALLEN Darryl F. Allen Director, Chairman of the Board, President and Chief Executive Officer\nDate: March 20, 1995\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\/ DARRYL F. ALLEN Darryl F. Allen 3\/20\/95 Director, Chairman of the (Date) Board, President and Chief Executive Officer (Principal Executive Officer)\n\/S\/ DAVID M. RISLEY David M. Risley 3\/20\/95 Vice President - Finance (Date) and Chief Financial Officer (Principal Financial Officer)\n\/S\/ GREGORY R. PAPP Gregory R. Papp 3\/20\/95 Corporate Controller (Principal Accounting Officer)\nPURDY CRAWFORD* Purdy Crawford* 3\/20\/95 Director (Date)\nDELMONT A. DAVIS* Delmont A. Davis* 3\/20\/95 Director (Date)\nJOSEPH C. FARRELL* Joseph C. Farrell* 3\/20\/95 Director (Date)\nDAVID R. GOODE* David R. Goode* 3\/20\/95 Director (Date)\nPAUL A. ORMOND* Paul A. Ormond* 3\/20\/95 Director (Date)\nJOHN P. REILLY* John P. Reilly* 3\/20\/95 Director (Date)\nROBERT H. SPILMAN* Robert H. Spilman* 3\/20\/95 Director (Date)\nWILLIAM R. TIMKEN, JR.* William R. Timken, Jr.* 3\/20\/95 Director (Date)\n*By James E. Kline, Attorney-in-fact\n\/S\/ JAMES E. KLINE James E. Kline 3\/20\/95 Vice President and General Counsel (Date)","section_15":""}
{"filename":"793973_1994.txt","cik":"793973","year":"1994","section_1":"Item 1. Business\nPaineWebber Equity Partners Two Limited Partnership (the \"Partnership\") is a limited partnership formed on May 16, 1986, under the Uniform Limited Partnership Act of the State of Virginia to invest in a diversified portfolio of existing, newly- constructed or to-be-built income-producing real properties such as apartments, shopping centers, hotels, office buildings and industrial buildings. The Partnership had authorized the issuance of a maximum of 150,000,000 Partnership Units (the \"Units\") at $1 per Unit, pursuant to a Registration Statement on Form S-11 filed under the Securities Act of 1933 (Registration No. 33-5929). On June 2, 1988, the offering of Units in the Partnership was completed and gross proceeds of $134,425,741 had been received by the Partnership. Limited Partners will not be required to make any additional capital contributions.\nAs of March 31, 1994, the Partnership owned interests in four multi-family apartment complexes, two office\/R&D buildings and two retail shopping centers. The Partnership has acquired all of its operating property investments through joint venture partnerships as set forth in the following table:\nName of Joint Venture Percent Date of Name and Type of Property Leased at Acquisition Type of Location Size 3\/31\/94 of Interest Ownership (1)\nChicago-625 Partnership .38 acres; 82% 12\/16\/86 Fee ownership of land 625 North Michigan Avenue 324,829 net and improvements Office Tower leasable (through joint venture) Chicago, Illinois square feet\nRichmond Gables Associates 224 units 95% 9\/1\/87 Fee ownership of land The Gables at Erin Shades and improvements Apartments (through joint Richmond, Virginia venture)\nDaniel\/Metcalf Associates 19 acres; 96% 9\/30\/87 Fee ownership of land Partnership 142,363 net and improvements Loehmann's Plaza Shopping leasable (through joint venture) Center square feet Overland Park, Kansas\nHacienda Park Associates 12.6 acres; 72% 12\/24\/87 Fee ownership of land Saratoga Center & EG&G 184,905 net and improvements Plaza leasable (through joint Office Buildings square feet venture) Pleasanton, California\nTCR Walnut Creek Limited 160 units 98% 12\/24\/87 Fee ownership of land Partnership and improvements Treat Commons Phase II (through joint venture) Apartments Walnut Creek, California\nPortland Pacific Associates 183 units 98% 1\/12\/88 Fee ownership of land Richland Terrace Apartments and improvements and Richmond Park Apartments (through joint venture) Portland, Oregon\nWest Ashley Shoppes Associates 17.25 66% 3\/10\/88 Fee ownership of land West Ashley Shoppes acres; and improvements Charleston, South Carolina 134,406 net (through joint venture) leasable square feet Atlanta Asbury Partnership 204 units 92% 4\/7\/88 Fee ownership of land Asbury Commons Apartments and improvements Atlanta, GA (through joint venture)\n(1) See Notes to the Financial Statements of the Registrant filed with this Annual Report for a description of the agreements through which the Partnership has acquired these real estate investments.\nOriginally, the Partnership had interests in ten joint venture partnerships, two of which have since been liquidated through sale transactions. On May 31, 1990, the joint venture that owned the Highland Village Apartments sold the property at a gross sales price of $8,450,000. Net proceeds from the sale were split between the Partnership and its co-venture partner, with the Partnership receiving approximately $7,700,000. As a result of the sale, the Partnership no longer owns any interest in the Highland Village Apartments. Also, on November 29, 1989, the Partnership entered into an agreement with Awbrey's Road II Associates Limited Partnership (ARA) to sell the rights to its interest in Ballston Place - Phase II Associates which was to own and operate Ballston Place - Phase II, an apartment complex in Arlington, Virginia. The Partnership received the return of $9,050,000 which had been funded into escrow during the construction phase of the project. In addition, the Partnership received certain other compensation in connection with this transaction. As of March 31, 1994, the Partnership has no remaining interest in the Ballston Place property.\nThe Partnership's investment objectives are to invest in operating properties in order to:\n(1) preserve and protect Limited Partners' capital; (2) provide the Limited Partners with quarterly cash distributions, a portion of which will be sheltered from current federal income tax liability; and (3) achieve long-term capital appreciation in the value of the Partnership's investment properties.\nThrough March 31, 1994, the limited partners had received cumulative cash distributions totalling approximately $67,358,000. This return includes a distribution of $57 per $1,000 investment from the sale of the Highland Village Apartments in May 1990. The remaining cash flow distributions have been from net rental income, and a substantial portion of such distributions has been sheltered from current federal income tax liability. In addition, the Partnership retains its ownership interest in eight of its ten original investment properties. The proceeds from the Ballston Place sale referred to above were retained by the Partnership and have been, or are expected to be, used for capital improvements and leasing costs at the Partnership's other properties in order to preserve and\/or enhance their values. These proceeds have also been used to bolster reserves and to pay off a portion of the zero coupon loans which were used to finance the offering costs and related expenses of the Partnership.\nThe Partnership's success in meeting its capital appreciation objective will depend upon the proceeds received from the final liquidation of the investments. The amount of such proceeds will ultimately depend upon the value of the underlying investment properties at the time of their liquidation, which cannot presently be determined. At the present time, real estate values for commercial office buildings and, to a lesser extent, retail shopping centers, remain depressed nationwide due to an oversupply of competing space in many markets and the lingering effects of the most recent national recession. Management believes that such markets conditions are temporary and will change as certain market corrections are allowed to occur. As discussed further below, the multi-family residential market has generally strengthened in most parts of the country during the last year. Management's plans are presently to hold the majority of the investment property for long-term investment purposes and to direct the management of the operations of the properties to maximize their long-term values.\nAll of the Partnership's investment properties are located in real estate markets in which they face significant competition for the revenues they generate. The apartment complexes compete with numerous projects of similar type generally on the basis of price and amenities. Apartment properties in all markets also compete with the local single family home market for prospective tenants. Over the past 12 months, home mortgage interest rates have remained low, attracting some prospective tenants away from multi-family apartment complexes and into single-family homes. Despite this increased competition, the lack of new construction of multi-family housing has allowed the oversupply which exists in most markets to begin to be absorbed, with the result being a gradual improvement in occupancy levels and effective rental rates and a corresponding increase in property values. Management of the Partnership expects to continue to see improvement in this sector of the real estate market in the near- term as further market corrections occur. The Partnership's shopping centers and office buildings also compete for long-term commercial tenants with numerous projects of similar type generally on the basis of price, location and tenant improvement allowances.\nThe Partnership has no real property investments located outside the United States. The Partnership is engaged solely in the business of real estate investment, therefore presentation of information about industry segments is not applicable.\nThe Partnership has no employees; it has, however, entered into an Advisory Contract with PaineWebber Properties Incorporated (the \"Adviser\"), which is responsible for the day-to- day operations of the Partnership. The Adviser is a wholly-owned subsidiary of PaineWebber Incorporated (\"PWI\"), a wholly-owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\").\nThe General Partners of the Partnership (the \"General Partners\") are Second Equity Partners, Inc., and Properties Associates 1986, L. P. Second Equity Partners, Inc. (the \"Managing General Partner\"), a wholly-owned subsidiary of PaineWebber Group Inc. is the managing general partner of the Partnership. Properties Associates 1986, L.P. (the \"Associate General Partner\"), a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner and the Adviser, is the associate general partner of the Partnership.\nThe terms of transactions between the Partnership and affiliates of the Managing General Partner of the Partnership are set forth in Items 11 and 13 below to which reference is hereby made for a description of such terms and transactions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of March 31, 1994, the Partnership has interests in eight operating properties through joint venture partnerships. These joint venture partnerships and the related properties are referred to under Item 1 above to which reference is made for the name, location and description of each property.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Partnership is not subject to any material pending legal proceedings.\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 the Partnership's Limited Partnership Interests and Related Security Holder Matters\nAt March 31, 1994, there were 9,683 record holders of Units in the Partnership. There is no public market for the Units, and it is not anticipated that a public market for the Units will develop. The Managing General Partner will not redeem or repurchase Units.\nReference is made to Item 6","section_6":"Item 6. Selected Financial Data\nPaineWebber Equity Partners Two Limited Partnership For the years ended March 31, 1994, 1993, 1992, 1991 and 1990 (in thousands, except for per Unit data)\nYears ended March 31, 1994 1993 1992 (1) 1991 1990\nRevenues $ 4,338 $ 4,793 $ 4,628 $ 789 $ 688\nOperating loss $ (2,391) $(1,549) $ (2,658) $(3,128) $ (3,134)\nInvestment income $ 2,313 $ 2,699 $ 2,609 $ 5,593 $ 5,527\nNet income (loss) $ (78) $ 1,150 $ (49) $ 2,465 $ 2,393\nNet income (loss) per 1,000 Limited Partnership Units $ (0.57) $ 8.47 $ (0.36) $ 18.15 $ 17.61\nCash distributions per 1,000 Limited Partnership Units $ 49.52 $ 49.52 $ 49.52 $137.15 $ 82.51\nTotal assets $ 103,391 $107,382 $110,655 $110,496 $128,238\nLong-term debt $ 36,828 $ 33,845 $ 31,041 $ 25,554 $ 27,310\n(1)During fiscal 1992, as further discussed in Note 4 to the accompanying financial statements, the Partnership assumed complete control of the joint ventures which own and operate Saratoga Center and EG&G Plaza and the Asbury Commons Apartments. Accordingly, the joint ventures, which had been accounted for under the equity method in prior years, have been consolidated in the Partnership's financial statements for years subsequent to fiscal 1991.\nThe above selected financial data should be read in conjunction with the financial statements and related notes appearing elsewhere in this Annual Report.\nThe above net income (loss) and cash distributions per 1,000 Limited Partnership Units are based upon the 134,425,741 Limited Partnership Units outstanding during each year.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity and Capital Resources\nThe Partnership commenced an offering to the public on July 21, 1986 for up to 150,000,000 units (the \"Units\") of limited partnership interest (at $1 per Unit) pursuant to a Registration Statement filed under the Securities Act of 1933. The Partnership raised gross proceeds of $134,425,741 between July 21, 1986 and June 2, 1988. As discussed further below, the Partnership also received proceeds of $23 million from the issuance of zero coupon loans. The loan proceeds, net of financing expenses of approximately $908,000, were used to pay the offering and organization costs, acquisition fees and acquisition-related expenses of the Partnership and to fund the Partnership's cash reserves. The Partnership originally invested approximately $132,200,000 (net of acquisition fees) in ten operating properties through joint venture investments. Through March 31, 1994, two of these investments had been sold and a portion of the zero coupon loans had been repaid. The Partnership retains an interest in eight operating properties, which are comprised of four multi-family apartment complexes, two office\/R&D complexes and two retail shopping centers. The Partnership does not have any commitments for additional investments but may be called upon to fund its portion of operating deficits or capital improvement costs of its joint venture investments in accordance with the respective joint venture agreements.\nThe Partnership's focus during fiscal 1994 continued to be on efforts to restructure or refinance the zero coupon loans secured by all of the Partnership's operating investment properties prior to their scheduled maturity dates in May and June of 1995. As noted above, the Partnership originally borrowed $23,000,000 to finance its offering costs and related acquisition expenses in order to invest a greater portion of the initial offering proceeds in real estate assets. During fiscal 1991, principal and interest aggregating approximately $4,250,000 was repaid on these borrowings in connection with the sale of the Ballston Place and Highland Village investments. The outstanding loans are with two different financial institutions, the first of which issued a loan in the initial principal amount of $6,000,000 which is secured by the 625 North Michigan Office Building, and the other of which issued loans which are secured by the seven remaining investment properties. Due to declines in the market value of the 625 North Michigan property over the past several years, management's efforts have been directed toward negotiating a modification and extension agreement with the existing lender on this loan. Such declines in value have mirrored the state of commercial office buildings nationwide, and particularly in major metropolitan areas such as Chicago. Limited sources for the financing of commercial office buildings in general and the stringent loan-to-value ratio requirements for such loans would have made refinancing the 625 North Michigan property by conventional means very difficult.\nThroughout fiscal 1994, management was engaged in negotiations with the 625 North Michigan lender. The terms of the original loan agreement required that if the loan ratio, as defined, exceeded 80%, then the Partnership would be required to deposit additional collateral in an amount sufficient to reduce the loan ratio to 80%. During fiscal 1994, the lender informed the Partnership that, based on an interim property appraisal, the loan ratio exceeded 80% and that a deposit of additional collateral was required. Subsequently, the Partnership submitted an appraisal which demonstrated that the loan ratio exceeded 80% by an amount less than previously demanded by the lender. In December 1993, the Partnership deposited additional collateral of approximately $209,000 in accordance with the higher appraised value. The lender accepted the Partnership's deposit of additional collateral but disputed whether the Partnership had complied with the terms of the loan agreement regarding the 80% loan ratio. Subsequent to year-end, an agreement was reached with the lender on a proposal to refinance the loan and resolve the outstanding disputes. The terms of the agreement call for the Partnership to make a principal paydown on the loan of approximately $801,000, including the application of the additional collateral referred to above. The new loan will have an initial principal balance of approximately $9.7 million and a scheduled maturity date of May 1999. From the date of the formal closing of the modification and extension agreement to the new maturity date of the loan, the loan will bear interest at a rate of 9.125% per annum and will require monthly payments of principal and interest aggregating approximately $81,000. The terms of the loan agreement also require the establishment of an escrow account for real estate taxes, as well as a capital improvement escrow which is to be funded with monthly deposits from the Partnership aggretating approximately $1 million through the scheduled maturity date. Formal closing of the modification and extension agreement occurred on May 31, 1994. Subsequent to the modification agreement, the 625 North Michigan property is expected to generate a small amount of cash flow from operations after debt service, but prior to capital expenditures. However, the majority of such cash flow will likely be required by the joint venture to pay for capital and tenant improvements in order to maintain the property's current occupancy rate in light of the extremely competitive market conditions which continue to adversely affect the market for office space in downtown Chicago.\nThe Partnership is presently involved in negotiations with the other zero coupon note lender regarding a possible modification and extension agreement for the notes secured by the other seven investment properties. Any such agreement would likely involve the conversion of the zero coupon notes to conventional current- pay loans with monthly principal amortization. Such a modification could also require an initial principal paydown similar to the 625 North Michigan transaction described above. There are no assurances that the Partnership and the lender will reach agreement on mutually acceptable terms for a modification and extension of these loans. Consequently, management is also investigating other refinancing options for these obligations. This pool of seven mortgage notes becomes prepayable without penalty at any time after August 1994. Since the pool of properties which secures these loans is comprised primarily of multi-family residential properties, a strong market sector as compared to commercial office buildings, the Partnership should have other viable alternatives in the event that a favorable agreement cannot be reached with the current lender. Consent of certain of the Partnership's co-venture partners may be required in connection with any extension or refinancing transactions. Regardless of whether the Partnership obtains extensions or refinances the outstanding obligations, these transactions are likely to require the current use of cash reserves to make required principal paydowns and\/or to cover transaction costs, in addition to adversely impacting current cash flow due to the commencement of regular debt service payments. Management continues to believe that these outcomes will result in higher overall returns to the Limited Partners than would result from allowing the interest on the zero coupon loans to continue to accrue and compound until their scheduled maturity dates.\nSubsequent to the end of the Partnership's fiscal year, in June 1994, the Board of Directors of the Partnership's Managing General Partner gave approval for the communication to the Limited Partners of a proposed reduction in the Partnership's quarterly distribution rate. Such communication to the Limited Partners is planned for release in August 1994. Formal approval of the proposed distribution rate adjustment, which would be effective for the second quarter of fiscal 1995, will occur in October 1994. The rate reduction is being proposed by management in light of the monthly payment of debt service which will be required under the terms of the loan secured by the 625 North Michigan Office Building and the current debt service expected to be required upon the modification or refinancing of the Partnership's remaining zero coupon loans, as discussed further above. In addition, management anticipates significant cash needs over the next two years to pay for capital and tenant improvements at its commercial office buildings and retail shopping centers as efforts to lease vacant space at these properties continue. The Hacienda Park investment property, which was 72% leased as of March 31, 1994, consists of four separate office\/R&D buildings comprising approximately 185,000 square feet. As previously reported, two of these buildings had been leased to a single tenant, lease payments from which represented approximately 71% of the total rental income from the property for fiscal 1993. The tenant's lease on one of the buildings expired in June of 1993, while its lease on the second building was scheduled to run through March of 1994 and contained a one-year renewal option. Due to corporate reorganization and downsizing measures, this tenant did not renew the lease which expired in June. However, during the current fiscal year, management negotiated the renewal of this tenant's other lease for five years, although at market rents which are substantially lower than the previous lease rental rate. In addition, management has been aggressively pursuing tenants for the vacated building in what is an extremely overbuilt office market. Subsequent to year-end, the Partnership has secured a new tenant, under a seven-year lease, for this 31,000 square foot building. The Partnership has agreed to pay for the tenant improvement costs to modify this space to the needs of the new user. Tenant improvements and leasing commissions related to this lease will total approximately $630,000. At Loehmann's Plaza, management plans to invest between approximately $1.2 and $1.6 million over the next 24 months to complete a general upgrade of the property's exterior, including a 10,000 square foot expansion, which is necessary in order for the property to remain competitive in its market. As discussed further below, significant capital requirements are also expected at West Ashley Shoppes within the next 18-to-24 months.\nIn May 1994, subsequent to the Partnership's year-end, the Partnership and the co-venturer of the West Ashley Shoppes joint venture executed a settlement agreement to resolve their outstanding disputes regarding the net cash flow shortfall contributions owed by the co-venturer under the terms of the joint venture's guaranty agreement. Under the terms of the settlement agreement, the co-venturer assigned 96% of its interest in the joint venture to the Partnership and the remaining 4% of its interest in the joint venture to Second Equity Partners, Inc., the Managing General Partner of the Partnership. Prior to the assignment of its interest, the co- venturer had agreed to retire certain debt in the amount of approximately $400,000 which encumbered certain out-parcels of the West Ashley property. Under the original terms of the venture agreement, the potential future economic value to be realized from these out-parcels would have accrued to the co- venturer's benefit. As a result of the assignment, the future economic value to be realized from the unencumbered out-parcels will accrue solely to the benefit of the Partnership. In return for such assignment, the Partnership agreed to release the co- venturer from all claims regarding net cash flow shortfall contributions owed to the joint venture. In conjunction with the assignment of its interest and withdrawal from the joint venture, the co-venturer agreed to release certain outstanding counter claims against the Partnership. As a result of the settlement agreement, the Partnership has effectively assumed full control over the affairs of the joint venture. The Managing General Partner has engaged a local property management company to oversee the day-to-day operations of the retail center, which was 66% leased as of March 31, 1994. A significant amount of funds may be needed to pay for tenant improvement costs to re-lease the vacant anchor tenant space at West Ashley Shoppes in the near future. As previously reported, Children's Palace closed its retail store at the center in May 1991 and subsequently filed for bankruptcy protection from creditors. Management does not expect to receive any significant proceeds from the bankruptcy liquidation proceedings. Accordingly, funds for tenant improvements required to re-lease this space will have to come from property operations, Partnership advances and\/or short-term borrowings. In addition, Phar-Mor, West Ashley's other major anchor tenant is currently operating under the protection of Chapter 11 of the U. S. Bankruptcy Code. While Phar-Mor has closed a number of its locations nationwide as part of its bankruptcy reorganization, the Phar-Mor drugstore at West Ashley Shoppes is reported to be one of their top performing locations in the southeast. As a result, management is optimistic that its continued operation is likely, assuming Phar-Mor successfully emerges from its current Chapter 11 status. Phar-Mor has approached management seeking concessions on the terms of its lease agreement, but discussions concerning this situation have been deferred pending the release of Phar-Mor's reorganization plan. Phar-Mor is expected to submit a reorganization plan for bankruptcy court approval sometime during the first or second quarter of fiscal 1995.\nDuring fiscal 1994, the Partnership received operating cash flow distributions totalling approximately $7,218,000 from its operating investment properties (including approximately $2,476,000 from the consolidated joint ventures). These property distributions represent the primary source of future liquidity for the Partnership prior to the sales or refinancings of its operating investment properties. At March 31, 1994, the Partnership and its consolidated joint ventures had available cash and cash equivalents of approximately $4,290,000. Such amounts will be utilized for the working capital requirements of the Partnership, as well as for reinvestment in certain of the Partnership's properties (as required), principal payments and refinancing expenses related to the Partnership's zero coupon loans and for distributions to the partners. The source of future liquidity and distributions to the partners is expected to be through cash generated from operations of the Partnership's income-producing investment properties and proceeds received from the sale or refinancing of such properties. Such sources of liquidity are expected to be sufficient to meet the Partnership's needs on both a short-term and long-term basis.\nResults of Operations 1994 Compared to 1993\nThe Partnership reported a net loss of approximately $78,000 for the fiscal year ended March 31, 1994, as compared to net income of approximately $1,150,000 for fiscal 1993. The significant change in net operating results is attributable to an increase in the Partnership's operating loss of approximately $842,000 combined with a decrease in the Partnership's share of unconsolidated ventures' income of approximately $385,000.\nThe increase in the Partnership's operating loss resulted from a combination of a decline in the net income of the consolidated Hacienda Park joint venture and an increase in Partnership interest expense and general and administrative expenses. The net income of the Hacienda Park joint venture declined by approximately $488,000 in comparison with the prior year. The primary reason for this unfavorable change in the venture's operating results was a decline in rental revenues caused by a drop in occupancy. The decline in occupancy during the current fiscal year is a result of the expiration of a major tenant's lease, as discussed further above. In addition, the decline in revenues is also partly attributable to the renewal of another major lease at current market rents, which are substantially below the rates paid under the prior lease agreement, also as discussed further above. Partnership general and administrative expenses increased by approximately $96,000 as a result of certain costs incurred in connection with an independent valuation of the Partnership's operating properties, which is currently in process in conjunction with management's ongoing refinancing efforts. In addition, interest expense on the Partnership's zero coupon loans increased by approximately $282,000. As discussed above, interest on the zero coupon loans continues to compound, resulting in an increased expense, which will continue until the loans are repaid or refinanced.\nThe Partnership's share of unconsolidated ventures' income decreased by approximately $385,000 in fiscal 1994, primarily due to a significant decrease in net income from the 625 North Michigan joint venture. The joint venture's net income decreased due to the combined effects of a decrease in rental income and an increase in property operating expenses. The decline in operating results at 625 North Michigan reflects the extremely competitive market conditions which continue to affect the market for downtown Chicago office space. Similarly, the increase in property expenses is the result of an increase in repairs and maintenance expenses due to the implementation of a general improvement program aimed at improving the property's leasing status.\n1993 Compared to 1992\nThe Partnership reported net income of approximately $1,150,000 for the fiscal year ended March 31, 1993, as compared to a net loss of approximately $49,000 for fiscal 1992. This favorable change resulted from a decrease in the Partnership's operating loss coupled with an increase in the Partnership's share of unconsolidated ventures' income.\nThe decrease in the Partnership's operating loss resulted mainly from a combination of improved operating results of the consolidated Hacienda Park joint venture and a decrease in Partnership general and administrative expenses. The net operating results of the Hacienda Park joint venture improved by approximately $1,002,000 when compared to fiscal 1991. The primary reasons for this favorable change were an increase in rental income, a decline in real estate tax expense and a substantial decrease in non-cash depreciation charges. Hacienda Business Park's rental revenue increased by approximately $225,000, or 10%, mainly due to an increase in average occupancy. As noted above, the Partnership expected to experience a decline in occupancy at Hacienda Business Park in fiscal 1994 upon the expiration of one of the two single-tenant building leases in June of 1993. Real estate tax expense for the Hacienda Business Park decreased by approximately $138,000 in fiscal 1993, mainly as a result of the receipt of refunds totalling approximately $104,000 related to prior years. Finally, depreciation charges for the Hacienda Park joint venture declined by approximately $767,000 in fiscal 1993 as a result of tenant improvement costs totalling approximately $3.7 million having become fully depreciated in the prior year. General and administrative expenses decreased by approximately $148,000 as a result of decreased legal expenses and various other administrative costs. These favorable changes were partially offset by an increase in interest expense on the Partnership's zero coupon loans of approximately $227,000.\nThe Partnership's share of unconsolidated ventures' income increased by approximately $99,000 in fiscal 1993 primarily due to increases in net income from the 625 North Michigan and Loehmann's Plaza joint ventures. The increased net income from the 625 North Michigan joint venture was mainly due to increased rental revenue, resulting from a slight increase in average occupancy, and a decrease in repairs and maintenance expenses due to the completion of a general improvement program implemented during the prior year to enhance the building's appeal. Net income from the Loehmann's Plaza joint venture increased due to increased rental revenue which was partially offset by an increase in real estate tax and insurance expense. These favorable changes were partially offset by a decrease in net income from West Ashley Shoppes resulting from decreased rental revenue due to the anchor store closing of Children's Palace. Despite the fact that the tenant was still liable under the lease agreement, rent was no longer being accrued on this lease due to the uncertainty of its collectibility.\n1992 Compared to 1991\nIn fiscal 1992, the Partnership's operating results include the consolidated results of Saratoga Center & EG&G Plaza and the Asbury Commons Apartments. The Partnership assumed complete control over the affairs of the joint ventures which own these properties during fiscal 1992 as a result of the withdrawals of the respective co-venture partners and the assignments of their remaining interests to Second Equity Partners, Inc., the Managing General Partner of the Partnership.\nThe Partnership reported a net loss of approximately $49,000 for the fiscal year ended March 31, 1992, as compared to net income of approximately $2,465,000 for fiscal 1991. The fiscal 1991 results reflect a gain of approximately $2,068,000 on the sale of the Highland Village Apartments. Excluding the effect of the gain, the Partnership's net operating results declined by approximately $447,000 in fiscal 1992, mainly as a result of a significant decline in interest income earned on cash and cash equivalents and the reserve established against the Ballston Place note receivable due to the payment default referred to above. The decrease in interest earned on cash and cash equivalents is partly a result of a significant decrease in interest rates earned on invested cash reserves during fiscal 1992. In addition, the Partnership had a substantially higher average outstanding cash reserve balance during fiscal 1991 due to the receipt of the proceeds from the sales of the Highland Village Apartments and the Partnership's interest in Ballston Place.\nThe unfavorable changes in net operating results were partially offset by a decrease in management fee expense. No management fees were earned after the first quarter of fiscal 1992 due to the reduction in the rate of quarterly distributions to the Limited Partners from 8.25% to 5.25%. Per the Partnership Agreement, no management fees are paid to the Adviser if the distribution rate to the Limited Partners falls below 7.5%. The Partnership's share of unconsolidated ventures' income, after adjustment for the gain on sale and income from the operations of the Highland Village Apartments, decreased by approximately 19% in fiscal 1992 as compared to the prior year, primarily due to a significant decrease in net income from the Chicago-625 Partnership. The joint venture's net income decreased due to a significant decrease in rental income, an increase in property operating expenses and an increase in real estate taxes. The decline in rental income was reflective of the market conditions in downtown Chicago. Likewise, the increase in property operating expenses resulted from a general improvement program implemented during the year to enhance the building's appeal, as part of management's efforts to retain existing tenants and attract new tenants. Net income of the Partnership's consolidated joint ventures, Hacienda Business Park and Asbury Commons, increased significantly due to increases in rental income from increased occupancy and the first full year of stabilized operations of the Asbury Commons Apartments.\nInflation\nThe Partnership completed its seventh full year of operations in fiscal 1994. The effects of inflation and changes in prices on the Partnership's operating results to date have not been significant.\nInflation in future periods may increase revenues, as well as operating expenses, at the Partnership's operating investment properties. Most of the existing leases with tenants at the Partnership's shopping centers and office buildings contain rental escalation and\/or expense reimbursement clauses based on increases in tenant sales or property operating expenses. Tenants at the Partnership's apartment properties have short-term leases, generally of one year or less in duration. Rental rates at these properties can be adjusted to keep pace with inflation, to the extent market conditions allow, as the leases are renewed or turned over. Such increases in rental income would be expected to at least partially offset the corresponding increases in Partnership and property operating expenses.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and supplementary data are included under Item 14 of this Annual Report.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nNone. PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Partnership\nThe Managing General Partner of the Partnership is Second Equity Partners, Inc., a Virginia corporation, which is a wholly-owned subsidiary of PaineWebber Group, Inc. The Associate General Partner of the Partnership is Properties Associates 1986, L.P., a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner. The Managing General Partner has overall authority and responsibility for the Partnership's operations.\n(a) and (b) The names and ages of the directors and principal executive officers of the Managing General Partner of the Partnership are as follows: Date elected Name Office Age to Office\nLawrence A. Cohen President and Chief Executive Officer 40 5\/15\/91 Albert Pratt Director 83 4\/17\/85 * Clive D. Bull Director 39 6\/29\/93 Eugene M. Matalene, Jr. Director 46 6\/29\/93 Walter V. Arnold Senior Vice President and Chief Financial Officer 46 10\/29\/85 James A. Snyder Senior Vice President 48 7\/6\/92 John B. Watts III Senior Vice President 41 6\/6\/88 Barbara A. Woolhandler Senior Vice President 43 1\/3\/90 David F. Brooks First Vice President and Assistant Treasurer 51 4\/17\/85 * Timothy J. Medlock Vice President and Treasurer 32 6\/1\/88 Thomas W. Boland Vice President 31 12\/1\/91\n* The date of incorporation of the Managing General Partner.\n(c) There are no other significant employees in addition to the directors and executive officers mentioned above.\n(d) There is no family relationship among any of the foregoing directors or executive officers of the Managing General Partner of the Partnership. All of the foregoing directors and executive officers have been elected to serve until the annual meeting of the Managing General Partner.\n(e) All of the directors and officers of the Managing General Partner hold similar positions in affiliates of the Managing General Partner, which are the corporate general partners of other real estate limited partnerships sponsored by PWI, and for which PaineWebber Properties Incorporated serves as the investment adviser. The business experience of each of the directors and principal executive officers of the Managing General Partner is as follows:\nLawrence A. Cohen is President and Chief Executive Officer of the Managing General Partner and President and Chief Executive Officer of the Adviser which he joined in January 1989. He is a also member of the Board of Directors and the Investment Committee of the Adviser. From 1984 to 1988, Mr. Cohen was First Vice President of VMS Realty Partners where he was responsible for origination and structuring of real estate investment programs and for managing national broker-dealer relationships. He is a member of the New York Bar and is a Certified Public Accountant.\nAlbert Pratt is a Director of the Managing General Partner, a Consultant of PWI and a limited partner of the Associate General Partner. Mr. Pratt joined PWI as Counsel in 1946 and since that time has held a number of positions including Director of both the Investment Banking Division and the International Division, Senior Vice President and Vice Chairman of PWI and Chairman of PaineWebber International, Inc.\nClive D. Bull is a Director of the Managing General Partner and is the manager of PaineWebber's Structured Finance Group where he oversees the residential mortgage-backed, commercial mortgage-backed and asset-backed structuring groups. Mr. Bull joined PaineWebber in 1986 and ran futures and options research in the Quantitative Research Group before assuming his current responsibilities. Prior to joining PaineWebber, Mr. Bull was a tenured associate professor in the Economics Department of New York University. During his tenure at NYU, Mr. Bull published articles in economics journals and served on the editorial board of the American Economic Review. Mr. Bull received his B.A. from Oxford University and a Ph.D. in Economics from UCLA.\nEugene M. Matalene, Jr. is a Director of the Managing General Partner and a Director of the Adviser. Mr. Matalene joined PaineWebber in April 1987 as First Vice President in the Private Placement Group. Before joining PaineWebber, Mr. Matalene was First Vice President in the Investment Banking Division at Drexel Burnham Lambert from 1986 to 1987. Prior to Drexel Burnham Lambert, Mr. Matalene was associated with Kidder, Peabody as Vice President in the Investment Banking Division from 1979 to 1986. He holds a B.A. from the University of North Carolina at Chapel Hill and an M.B.A. from Columbia University. He is a member of the Board of Directors of American Bankers Insurance Company.\nWalter V. Arnold is a Senior Vice President and Chief Financial Officer of the Managing General Partner and Senior Vice President and Chief Financial Officer of the Adviser which he joined in October 1985. Mr. Arnold joined PWI in 1983 with the acquisition of Rotan Mosle, Inc. where he had been First Vice President and Controller since 1978, and where he continued until joining the Adviser. Mr. Arnold is a Certified Public Accountant licensed in the state of Texas.\nJames A. Snyder is a Senior Vice President of the Managing General Partner and a Senior Vice President and Member of the Investment Committee of the Adviser. Mr. Snyder re-joined PWPI in July 1992 having served previously as an officer of the Adviser from July 1980 to August 1987. From January 1991 to July 1992, Mr. Snyder was with the Resolution Trust Corporation, most recently as the Vice President of Asset Sales. During the period August 1987 to February 1989, Mr. Snyder was Executive Vice President and Chief Financial Officer of Southeast Regional Management Inc., a real estate development company. From February 1989 to October 1990, he was President of Kan Am Investors, Inc., a real estate investment company.\nJohn B. Watts III is a Senior Vice President of the Managing General Partner and a Senior Vice President of the Adviser which he joined in June 1988. Mr. Watts has had over 15 years of experience in acquisitions, dispositions and finance of real estate. He received degrees of Bachelor of Architecture, Bachelor of Arts and Master of Business Administration from the University of Arkansas.\nBarbara A. Woolhandler is a Senior Vice President of the Managing General Partner and a Senior Vice President of the Adviser. Ms. Woolhandler joined PaineWebber in 1983 with its acquisition of Rotan Mosle, Inc. where she was a First Vice President in the Direct Investments Department. Ms. Woolhandler joined Rotan Mosle, Inc. in 1980.\nDavid F. Brooks is a First Vice President and Assistant Treasurer of the Managing General Partner and a First Vice President and an Assistant Treasurer of the Adviser which he joined in March 1980. From 1972 to 1980, Mr. Brooks was an Assistant Treasurer of Property Capital Advisors, Inc. and also, from March 1974 to February 1980, the Assistant Treasurer of Capital for Real Estate, which provided real estate investment, asset management and consulting services.\nTimothy J. Medlock is a Vice President and Treasurer of the Managing General Partner and Vice President and Treasurer of the Adviser which he joined in 1986. From June 1988 to August 1989, Mr. Medlock served as the Controller of the Managing General Partner and the Adviser. From 1983 to 1986, Mr. Medlock was associated with Deloitte Haskins & Sells. Mr. Medlock graduated from Colgate University in 1983 and received his Masters in Accounting from New York University in 1985.\nThomas W. Boland is a Vice President of the Managing General Partner and a Vice President and Manager of Financial Reporting of the Adviser which he joined in 1988. From 1984 to 1987 Mr. Boland was associated with Arthur Young & Company. Mr. Boland is a Certified Public Accountant licensed in the state of Massachusetts. He holds a B.S. in Accounting from Merrimack College and an M.B.A. from Boston University.\n(f) None of the directors and officers was involved in legal proceedings which are material to an evaluation of his or her ability or integrity as a director or officer.\n(g) Compliance With Exchange Act Filing Requirements: The Securities Exchange Act of 1934 requires the officers and directors of the Managing General Partner, and persons who own more than ten percent of the Partnership's limited partnership units, to file certain reports of ownership and changes in ownership with the Securities and Exchange Commission. Officers, directors and ten-percent beneficial holders are required by SEC regulations to furnish the Partnership with copies of all Section 16(a) forms they file.\nBased solely on its review of the copies of such forms received by it, the Partnership believes that, during the year ended March 31, 1994, all filing requirements applicable to the officers and directors of the Managing General Partner and ten- percent beneficial holders were complied with.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe directors and officers of the Partnership's Managing General Partner receive no current or proposed remuneration from the Partnership.\nThe General Partners are entitled to receive a share of Partnership cash distributions and a share of profits and losses. These items are described in Item 13.\nThe Partnership has paid cash distributions to the Limited Partners on a quarterly basis at a rate of 8.25% per annum on invested capital from April 1, 1989 through the quarter ended December 31, 1990 and at a rate of 5.25% per annum on invested capital from January 1, 1991 to the present. However, the Partnership's Limited Partnership Units are not actively traded on any organized exchange, and no efficient secondary market exists. Accordingly, no accurate price information is available for these Units. Therefore, a presentation of historical unitholder total returns would not be meaningful.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) The Partnership is a limited partnership issuing Units of limited partnership interest, not voting securities. All the outstanding stock of the Managing General Partner, Second Equity Partners Fund, Inc. is owned by PaineWebber. Properties Associates 1986, L.P., the Associate General Partner, is a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner. No limited partner is known by the Partnership to own beneficially more than 5% of the outstanding interests of the Partnership.\n(b) The directors and officers of the Managing General Partner do not directly own any Units of limited partnership interest of the Partnership. No director or officer of the Managing General Partner, nor any limited partner of the Associate General Partner, possesses a right to acquire beneficial ownership of Units of limited partnership interest of the Partnership.\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\nThe General Partners are entitled to receive a share of cash distributions, and a share of profits and losses as described under captions \"Compensation and Fees\" and \"Profits and Losses and Cash Distributions\" of the Prospectus, as supplemented, a copy of which is hereby incorporated herein by reference. The General Partners received cash distributions of $67,242 for the year ended March 31, 1994.\nThe Partnership is permitted to engage in transactions involving affiliates of the General Partners of the Partnership, as described under the captions \"Management Compensation\", \"Conflicts of Interest\" and \"Rights, Powers and Duties of General Partners\" of the Prospectus, as supplemented, a copy of which is hereby incorporated herein by reference. PWI and PaineWebber Properties Incorporated, (\"PWPI\"), a wholly-owned subsidiary of PWI, are reimbursed for their direct expenses relating to the offering of units, the administration of the Partnership and the acquisition of the Partnership's real property investments.\nIncluded in general and administrative expenses for the year ended March 31, 1994 is $268,020, representing reimbursements to an affiliate of the Managing General Partner for providing certain financial, accounting and investor communication services to the Partnership.\nThe Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. (\"Mitchell Hutchins\") for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $7,500 (included in general and administrative expenses) for managing the Partnership's cash assets during fiscal 1994.\nSee Note 3 to the financial statements accompanying this Annual Report for a further discussion of 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) and (2) Financial Statements and Schedules:\nThe response to this portion of Item 14 is submitted as a separate section of this Report. See Index to Financial Statements and Financial Statement Schedules at page.\n(3) Exhibits:\nThe exhibits on the accompanying index to exhibits at page IV-3 are filed as part of this Report.\n(b)No reports on Form 8-K were filed during the last quarter of fiscal 1994.\n(c) Exhibits\nSee (a)(3) above.\n(d) Financial Statement Schedules\nThe response to this portion of Item 14 is submitted as a separate section of this Report. See Index to Financial Statements and Financial Statement Schedules at page.\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.\nPAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nBy: Second Equity Partners, Inc. Managing General Partner\nBy: \/s\/ Lawrence A. Cohen Lawrence A. Cohen President and Chief Executive Officer\nBy: \/s\/ Walter V. Arnold Walter V. Arnold Senior Vice President and Chief Financial Officer\nBy: \/s\/ Thomas W. Boland Thomas W. Boland Vice President\nDated: June 13, 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 Partnership and in the capacities and on the dates indicated.\nBy:\/s\/ Albert Pratt Date: June 13, 1994 Albert Pratt Director\nBy:\/s\/ Clive D. Bull Date: June 13, 1994 Clive D. Bull Director\nBy:\/s\/ Eugene M. Matalene, Jr. Date: June 13, 1994 Eugene M. Matalene, Jr. Director\nANNUAL REPORT ON FORM 10-K Item 14(a)(3)\nPAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nINDEX TO EXHIBITS\nPage Number in the Report Exhibit No. Description of Document Or Other Reference\n(3) and (4) Prospectus of the Partnership Filed with the Commission dated July 21, 1986, as pursuant to Rule 424(c) supplemented, with particular and incorporated herein reference to the Restated by reference. Certificate and Agreement of Limited Partnership\n(10) Material contracts previously Filed with the Commission filed as exhibits to registration pursuant to Section 13 or statements and amendments thereto 15(d) of the Securities of the registrant together with Act of 1934 and incorporated all such contracts filed as herein by reference. exhibits of previously filed Forms 8-K and Forms 10-K are hereby incorporated herein by reference.\n(13) Annual Report to Limited Partners No Annual Report for the fiscal year 1994 has been sent to the Limited Partners. An Annual Report will be sent to the Limited Partners subsequent to this filing.\n(22) List of subsidiaries Included in Item I of Part I of this Report Page I-1, to which reference is hereby made.\nANNUAL REPORT ON FORM 10-K Item 14(a)(1) and (2) and Item 14(d)\nPAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nReference\nPaineWebber Equity Partners Two Limited Partnership:\nReport of independent auditors\nConsolidated balance sheets as of March 31, 1994 and 1993\nConsolidated statements of operations for the years ended March 31, 1994, 1993 and 1992\nConsolidated statements of changes in partners' capital (deficit) for the years ended March 31, 1994, 1993 and 1992\nConsolidated statements of cash flows for the years ended March 31, 1994, 1993 and 1992\nNotes to consolidated financial statements\nSchedule XI - Real Estate and Accumulated Depreciation\nCombined Joint Ventures of PaineWebber Equity Partners Two Limited Partnership:\nReport of independent auditors\nCombined balance sheets as of December 31, 1993 and 1992\nCombined statements of income and changes in ventures' capital for the years ended December 31, 1993, 1992 and 1991\nCombined statements of cash flows for the years ended December 31, 1993, 1992 and 1991\nNotes to combined financial statements\nSchedule XI - Real Estate and Accumulated Depreciation\nOther 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 financial statements, including the notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nThe Partners PaineWebber Equity Partners Two Limited Partnership:\nWe have audited the accompanying consolidated balance sheets of PaineWebber Equity Partners Two Limited Partnership as of March 31, 1994 and 1993, and the related consolidated statements of operations, changes in partners' capital (deficit) and cash flows for each of the three years in the period ended March 31, 1994. 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 Partnership'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 PaineWebber Equity Partners Two Limited Partnership at March 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended March 31, 1994, 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.\nERNST & YOUNG\nBoston, Massachusetts June 13, 1994\nPAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nCONSOLIDATED BALANCE SHEETS\nMarch 31, 1994 and 1993\nASSETS 1994 1993 Operating investment properties: Land $ 5,008,793 $ 5,008,793 Building and improvements 36,514,727 36,423,906 41,523,520 41,432,699 Less accumulated depreciation (8,946,838) (7,722,461) 32,576,682 33,710,238\nInvestments in unconsolidated joint ventures, at equity 65,519,150 68,054,010 Cash and cash equivalents 4,289,661 4,494,420 Escrowed cash 243,660 25,473 Accounts receivable 23,929 126,956 Accounts receivable - affiliates 67,805 57,805 Prepaid expenses 21,680 12,707 Deferred rent receivable 258,190 303,326 Deferred expenses, net of accumulated amortization of $1,227,112 ($977,560 in 1993) 390,504 597,136 $103,391,261 $107,382,071\nLIABILITIES AND PARTNERS' CAPITAL\nAccounts payable - affiliates $ - $ 45,456 Accounts payable and accrued expenses 211,591 185,642 Advances from consolidated ventures 387,859 558,020 Tenant security deposits 85,644 68,150 Bonds payable 2,864,047 2,955,931 Notes payable and accrued interest 33,964,059 30,888,809 Minority interest in net assets of consolidated joint ventures 331,249 331,249 Total liabilities 37,844,449 35,033,257\nPartners' capital: General Partners: Capital contributions 1,000 1,000 Cumulative net income 140,227 141,044 Cumulative cash distributions (619,868) (552,626)\nLimited Partners ($1 per Unit; 134,425,741 Units issued): Capital contributions, net of offering costs 119,746,438 119,746,438 Cumulative net income 13,636,827 13,713,810 Cumulative cash distributions (67,357,812) (60,700,852) Total partners' capital 65,546,812 72,348,814 $103,391,261 $107,382,071\nSee accompanying notes.\nPAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFor the years ended March 31, 1994, 1993 and 1992\n1994 1993 1992 Revenues: Rental income and expense reimbursements $ 4,157,608 $ 4,555,110 $ 4,345,983 Interest and other income 180,584 237,488 281,700 4,338,192 4,792,598 4,627,683 Expenses: Interest expense 3,267,211 2,986,945 2,760,170 Depreciation and amortization 1,473,929 1,477,985 2,240,475 Property operating expenses 929,509 956,877 840,098 Real estate taxes 355,257 312,177 481,813 General and administrative 703,206 607,173 755,120 Provision for possible uncollectible amounts - - 138,136 Management fees - - 69,880 6,729,112 6,341,157 7,285,692\nOperating loss (2,390,920) (1,548,559) (2,658,009)\nInvestment income: Interest income on notes receivable 106,409 106,822 115,917 Partnership's share of unconsolidated ventures' income 2,206,711 2,592,147 2,492,657 2,313,120 2,698,969 2,608,574 Net income (loss) $ (77,800) $ 1,150,410 $ (49,435)\nNet income (loss) per 1,000 Limited Partnership Units $ (0.57) $ 8.47 $ (0.36)\nCash distributions per 1,000 Limited Partnership Units $ 49.52 $ 49.52 $ 49.52\nThe above per Limited Partnership Unit information is based upon the 134,425,741 Limited Partnership Units outstanding during each year.\nSee accompanying notes.\nPAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CHANGES IN PARTNERS' CAPITAL (DEFICIT) For the years ended March 31, 1994, 1993 and 1992\nGeneral Limited Partners Partners Total\nBalance at March 31, 1991 $(286,205) $ 84,983,331 $ 84,697,126\nCash distributions (68,120) (6,656,965) (6,725,085)\nNet loss (519) (48,916) (49,435)\nBalance at March 31, 1992 (354,844) 78,277,450 77,922,606\nCash distributions (67,242) (6,656,960) (6,724,202)\nNet income 11,504 1,138,906 1,150,410\nBalance at March 31, 1993 (410,582) 72,759,396 72,348,814\nCash distributions (67,242) (6,656,960) (6,724,202)\nNet loss (817) (76,983) (77,800)\nBalance at March 31, 1994 $ (478,641) $ 66,025,453 $ 65,546,812\nSee accompanying notes.\nPAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nCONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended March 31, 1994, 1993 and 1992 Increase (Decrease) in Cash and Cash Equivalents\n1994 1993 1992 Cash flows from operating activities: Net income (loss) $ (77,800) $ 1,150,410 $ (49,435) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Partnership's share of unconsolidated ventures' income (2,206,711) (2,592,147) (2,492,657) Interest expense 3,075,250 2,793,630 2,540,953 Depreciation and amortization 1,473,929 1,477,985 2,240,475 Provision for possible uncollectible amounts - - 138,136 Changes in assets and liabilities: Escrowed cash (218,187) 15,422 14,180 Accrued interest receivable - 12,961 11,432 Accounts receivable 103,027 36,561 (12,135) Accounts receivable - affiliates (10,000) (25,305) (1,667) Deferred rent receivable 45,136 (70,882) (8,135) Prepaid expenses (8,973) (3,074) (2,070) Tenant security deposits 17,494 20,777 (6,369) Accounts payable and accrued expenses 25,949 70,553 (183,902) Advances from consolidated ventures (170,161) (513,597) 1,071,617 Accounts payable - affiliates (45,456) (80,396) (461,778) Total adjustments 2,081,297 1,142,488 2,848,080 Net cash provided by operating activities 2,003,497 2,292,898 2,798,645\nCash flows from investing activities: Distributions from unconsolidated ventures 4,741,571 4,611,870 4,701,234 Additional investments in unconsolidated ventures - (168,670) (841,425) Additions to operating investment properties (90,821) (261,317) (902,579) Reductions to operating investment properties resulting from mandatory payments - - 505,486 Payment of leasing commissions (42,920) (139,979) (250,276) Net cash provided by investing activities 4,607,830 4,041,904 3,212,440\nCash flows from financing activities: Distributions to partners (6,724,202) (6,724,202) (6,725,085) District bond assessments - 44,846 - Payments on district bond assessments (91,884) (34,759) (2,429) Net cash used for financing activities (6,816,086) (6,714,115) (6,727,514)\nNet decrease in cash and cash equivalents (204,759) (379,313) (716,429)\nCash and cash equivalents, beginning of year 4,494,420 4,873,733 5,590,162\nCash and cash equivalents, end of year $ 4,289,661 $ 4,494,420 $ 4,873,733\nCash paid during the year for interest $ 191,961 $ 193,315 $ 219,217\nWrite-off of fully depreciated tenant improvements $ - $ 832,336 $ -\nSee accompanying notes.\n1. Organization\nPaineWebber Equity Partners Two Limited Partnership (the \"Partnership\") is a limited partnership organized pursuant to the laws of the State of Virginia on May 16, 1986 for the purpose of investing in a diversified portfolio of existing, newly-constructed or to-be-built income-producing real properties. The Partnership authorized the issuance of a maximum of 150,000,000 Partnership Units (the \"Units\") of which 134,425,741 Units, representing capital contributions of $134,425,741, were subscribed and issued between June 1986 and June 1988.\n2. Summary of Significant Accounting Policies\nThe accompanying financial statements include the Partnership's investment in six unconsolidated joint venture partnerships, each of which owns operating properties. The Partnership accounts for its investments in the unconsolidated joint ventures using the equity method. Under the equity method the ventures are carried at cost adjusted for the Partnership's share of the ventures' earnings or losses and distributions. All of the unconsolidated joint venture partnerships are required to maintain their accounting records on a calendar year basis for income tax reporting purposes. As a result, the Partnership recognizes its share of the earnings or losses from the unconsolidated joint ventures based on financial information which is three months in arrears to that of the Partnership. See Note 5 for a description of the unconsolidated joint venture partnerships.\nAs further discussed in Note 4, the Partnership acquired complete control of Hacienda Park Associates on December 10, 1991. In addition, the Partnership acquired complete control of the Atlanta Asbury Partnership on February 14, 1992. Accordingly, these joint ventures have been presented on a consolidated basis in the accompanying financial statements. As discussed above, these joint ventures also have a December 31 year-end and operations of the ventures continue to be reported on a three-month lag. All material transactions between the Partnership and the joint ventures have been eliminated upon consolidation, except for lag-period cash transfers. Such lag period cash transfers are accounted for as advances from consolidated ventures on the accompanying balance sheet.\nThe consolidated operating investment properties (Saratoga Center and EG&G Plaza and the Asbury Commons Apartments) are carried at the lower of cost, adjusted for certain guaranteed payments from partners and accumulated depreciation, or net realizable value. The net realizable value of a property held for long-term investment purposes is measured by the recoverability of the Partnership's investment from expected future cash flows on an undiscounted basis, which may exceed the property's current market value. The net realizable value of a property held for sale approximates its market value. The Partnership's investments in Saratoga Center and EG&G Plaza and the Asbury Commons Apartments were considered to be held for long-term investment purposes as of March 31, 1994 and 1993. Depreciation expense is computed using the straight-line method over estimated useful lives of five to thirty-one and one-half years. Acquisition fees paid to PaineWebber Properties Incorporated and costs of identifiable improvements, have been capitalized and are included in the cost of the operating investment properties. Maintenance and repairs are charged to expense when incurred.\nRental income is recognized on the straight-line basis over the term of the related lease agreement,taking into consideration scheduled cost increases and free-rent periods offered as inducements to lease the property. Deferred rent receivable represents rental income earned by Hacienda Park Associates which has been recognized on the straight-line basis over the term of the related lease agreement.\nDeferred expenses include legal fees incurred in connection with the organization of the Partnership, which have been amortized using the straight-line method over a sixty-month term and legal fees incurred in connection with the notes payable described in Note 6, which are being amortized using the straight-line basis over the term of the loans. Deferred expenses also include legal fees associated with the organization of the Hacienda Park joint venture, which were amortized on the straight-line basis over a sixty-month term, and deferred commissions and lease cancellation fees of Hacienda Park Associates, which are being amortized on a straight-line basis over the term of the respective lease.\nEscrowed cash includes funds escrowed for the payment of property taxes and tenant security deposits of the Asbury Commons Apartments. At March 31, 1994, escrowed cash also includes funds escrowed as additional collateral under the terms of the loan agreement secured by the 625 North Michigan operating property (see Note 6).\nFor purposes of reporting cash flows, the Partnership considers all highly liquid investments with original maturities of 90 days or less to be cash equivalents.\nCertain fiscal 1993 amounts have been reclassified to conform to the fiscal 1994 presentation.\nNo provision for income taxes has been made as the liability for such taxes is that of the partners rather than the Partnership.\n3. The Partnership Agreement and Related Party Transactions\nThe General Partners of the Partnership are Second Equity Partners, Inc. (the \"Managing General Partner\"), a wholly- owned subsidiary of PaineWebber Group Inc. (\"PaineWebber\") and Properties Associates 1986, L.P. (the \"Associate General Partner\"), a Virginia limited partnership, certain limited partners of which are also officers of the Managing General Partner. Affiliates of the General Partners will receive fees and compensation determined on an agreed-upon basis, in consideration of various services performed in connection with the sale of the Units and the acquisition, management, financing and disposition of Partnership properties.\nAll distributable cash, as defined, for each fiscal year shall be distributed quarterly in the ratio of 99% to the Limited Partners and 1% to the General Partners until the Limited Partners have received an amount equal to a 7.5% noncumulative annual return on their adjusted capital contributions. The General Partners will then receive distributions until they have received an amount equal to 1.01% of total distributions of distributable cash which has been made to all partners and PWPI has received Asset Management Fees equal to 3.99% of all distributions to all partners. The balance will be distributed 95% to the Limited Partners, 1.01% to the General Partners and 3.99% to PWPI as an asset management fee. All sale or refinancing proceeds shall be distributed in varying proportions to the Limited and General Partners, as specified in the amended Partnership Agreement.\nAll taxable income (other than from a Capital Transaction) in each year will be allocated to the Limited Partners and the General Partners in proportion to the amounts of distributable cash distributed to them (excluding the asset management fee) in that year or, if there are no distributions of distributable cash, 98.95% to the Limited Partners and 1.05% to the General Partners. All tax losses (other than from a Capital Transaction) will be allocated 98.95% to the Limited Partners and 1.05% to the General Partners. Taxable income or tax loss arising from a sale or refinancing of investment properties will be allocated to the Limited Partners and the General Partners in proportion to the amounts of sale or refinancing proceeds to which they are entitled; provided that the General Partners shall be allocated at least 1% of taxable income arising from a sale or refinancing. If there are no sale or refinancing proceeds, tax loss or taxable income from a sale or refinancing will be allocated 98.95% to the Limited Partners and 1.05% to the General Partner. Allocations of the Partnership's operations between the General Partners and the Limited Partners for financial accounting purposes have been made in conformity with the allocations of taxable income or tax loss.\nPaineWebber Properties Incorporated (\"PWPI\") received asset management fees of $69,880 for the year ended March 31, 1992, as compensation for providing asset management and advisory services to the Partnership. The payment of management fees to PWPI was suspended after the first quarter of fiscal 1992 due to a reduction in the quarterly distribution rate to the limited partners. Per the terms of the advisory contract, PWPI is not entitled to management fees unless the Limited Partners receive a current cash return of at least 7.5% per annum.\nPWI and PWPI, a wholly-owned subsidiary of PWI, are reimbursed for their direct expenses relating to the offering of units, the administration of the Partnership and the acquisition of the Partnership's real property investments. Accounts payable - affiliates at March 31, 1993 includes reimbursements of out-of-pocket expenses of $10,432, payable to PWPI.\nIncluded in general and administrative expenses for the years ended March 31, 1994, 1993 and 1992 is $268,020, $308,850 and $294,020, respectively, representing reimbursements to an affiliate of the Managing General Partner for providing certain financial, accounting and investor communication services to the Partnership. Accounts payable - affiliates at March 31, 1993 includes $35,024 payable to this affiliate for providing such services.\nThe Partnership uses the services of Mitchell Hutchins Institutional Investors, Inc. (\"Mitchell Hutchins\") for the managing of cash assets. Mitchell Hutchins is a subsidiary of Mitchell Hutchins Asset Management, Inc., an independently operated subsidiary of PaineWebber. Mitchell Hutchins earned fees of $7,500, $8,438 and $7,985 (included in general and administrative expenses) for managing the Partnership's cash assets during fiscal 1994, 1993 and 1992, respectively.\nAccounts receivable - affiliates at March 31, 1994 consists of investor services fees of $52,500 due from the TCR Walnut Creek Limited Partnership and $15,305 due from certain unconsolidated joint ventures for expenses paid by the Partnership on behalf of the joint ventures. Accounts receivable - affiliates at March 31, 1993 consists of investor services fees of $42,500 due from the TCR Walnut Creek Limited Partnership and $15,305 due from certain unconsolidated joint ventures for expenses paid by the Partnership on behalf of the joint ventures.\n4. Operating Investment Properties\nAt March 31, 1994 and 1993, the Partnership owned majority and controlling interests in two joint venture partnerships which own operating investment properties. As discussed further below, the Partnership obtained controlling interests in both of these joint ventures during fiscal 1992. Accordingly, the accompanying financial statements present the financial position and results of operations of these ventures on a consolidated basis. Prior to fiscal 1992, the Partnership's investments in these joint ventures were accounted for on the equity method (see Note 5). The Partnership's policy is to report the operations of these consolidated joint ventures on a three-month lag. Descriptions of the operating properties and the agreements through which the Partnership owns its interests in the properties are provided below:\nHacienda Park Associates\nOn December 24, 1987, the Partnership acquired an interest in Hacienda Park Associates (the \"joint venture\"), a California general partnership organized in accordance with a joint venture agreement between the Partnership and Callahan Pentz Properties (the \"co-venturer\"). The joint venture was organized to own and operate three buildings in the Hacienda Business Park, which is located in Pleasanton, California, consisting of Saratoga Center, a multi-tenant office building and EG&G Plaza, a single tenant facility. Saratoga Center, completed in 1985, consists of approximately 83,000 net rentable square feet located on approximately 5.6 acres of land. Phase I of EG&G Plaza was completed in 1985 and Phase II was completed in 1987. Both phases together consist of approximately 102,000 net rentable square feet located on approximately 7 acres of land. The aggregate cash investment by the Partnership for its interest was $24,930,043 (including an acquisition fee of $890,000 paid to PWPI and certain closing costs of $40,043). These three buildings were 72% leased as of March 31, 1994. Subsequent to year- end, the Partnership executed a lease agreement with a new tenant for 31,000 square feet. The 7-year lease agreement calls for the Partnership to pay for the tenant improvement costs to modify this space to the needs of the new user. Tenant improvements and leasing commissions related to this lease will total approximately $630,000.\nDuring the guaranty period, which was to have run from December 24, 1987 to December 24, 1991, the co-venturer had guaranteed to fund all operating deficits, capital costs and the Partnership's preference return distribution in the event that cash flow from property operations was insufficient. The co-venturer defaulted on the guaranty obligations in fiscal 1990 and negotiations between the Partnership and the co-venturer to reach a resolution of the default were ongoing until fiscal 1992, when the ventures reached a settlement agreement. During fiscal 1992, the co-venturer assigned its remaining joint venture interest to the Managing General Partner of the Partnership. The co-venturer also executed a five-year promissory note in the initial face amount of $300,000 payable to the Partnership without interest. Unless prepaid, the balance of the note escalates as to the principal balance annually up to a maximum of $600,000. In exchange, it was agreed that the co-venturer or its affiliates will have no further liability to the Partnership for any guaranteed preference payments. Due to the uncertainty regarding the collection of the note receivable, such compensation will be recognized as payments are received. Any amounts received will be reflected as reductions to the carrying value of the operating investment properties. No payments have been received to date. Concurrent with the execution of the settlement agreement, the property's management contact with an affiliate of the co- venturer was terminated.\nPer the terms of the joint venture agreement, net cash flow of the joint venture is to be distributed monthly in the following order of priority: (1) the Partnership will receive a cumulative preferred return of 9.25% on its net investment until December 31, 1989, 9.75% for the next two years, and 10% per annum thereafter, (2) to pay any capital expenditures and leasing costs, as defined (3) to the co-venturer in an amount up to their mandatory contribution, (4) to capital reserves (5) to pay interest on accrued preferences and unpaid advances, and (6) the balance will be distributed 75% to the Partnership and 25% to the co-venturer.\nNet proceeds from sales or refinancings shall be distributed as follows: (1) to the Partnership to the extent of any unpaid preferred return and accrued interest thereon; (2) to the Partnership to the extent of its net investment plus $2,400,000 and (3) 75% to the Partnership and 25% to the co- venturer. The co-venturer and the Partnership will also receive pro rata, any outstanding advances, including interest thereon, from proceeds from sales or refinancings prior to a return of capital.\nNet income from operations shall be allocated first to the Partnership to the extent of its preference return and then 75% to the Partnership and 25% to the co-venturer. Net losses from operations shall be allocated 75% to the Partnership and 25% to the co-venturer.\nAtlanta Asbury Partnership\nOn March 12, 1990 the Partnership acquired an interest in Atlanta Asbury Partnership (the \"joint venture\"), a Georgia general partnership organized in accordance with a joint venture agreement between the Partnership and Asbury Commons\/Summit Limited Partnership, an affiliate of Summit Properties (the \"co-venturer\"). The joint venture was organized to own and operate Asbury Commons Apartments, a newly constructed 204-unit residential apartment complex located in Atlanta, Georgia. The aggregate cash investment by the Partnership for its interest was $14,417,791 (including an acquisition fee of $50,649 payable to PWPI and certain closing costs of $67,142). The property was 92% occupied at March 31, 1994.\nDuring the Guaranty Period, from March 13, 1990 to March 15, 1992, as defined, the co-venturer had agreed to unconditionally guarantee to fund any deficits and to ensure that the joint venture could distribute to the Partnership its preference return, (as defined below). The co-venturer was not in compliance with the mandatory payment provisions of the Partnership agreement for the period from November 30, 1990 to February 14, 1992. On February 14, 1992, a settlement agreement between the Partnership and the co- venturer was executed whereby the co-venturer agreed to do the following: 1) pay the Partnership $275,000; (2) release all escrowed purchase price funds, amounting to $230,489, to the joint venture; (3) assign 99% of its joint venture interest to the Partnership and 1% of its joint venture interest to the Managing General Partner and withdraw from the joint venture; and 4) reimburse the Partnership for legal expenses up to $10,000. In return the co-venturer was released from its obligations under the joint venture agreement.\nSubsequent to the withdrawal of the original co-venture partner and the assignments of its interest in the venture to the Partnership and the Managing General Partner, the terms of the venture agreement call for net cash flow from operations of the joint venture to be distributed as follows: (1) to the Partnership in an amount equal to 10% of its net cash investment on an annual basis; (2) next to pay interest on certain additional contributions; and (3) thereafter, any remaining cash is to be distributed 99.75% to the Partnership and .25% to the co-venturer.\nProceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) to the Partnership in the aggregate amount of its cumulative annual preferred return not previously paid; (2) to the Partnership in an amount equal to the Partnership's net investment times 1.10; (3) to the Partnership and co- venturer to repay additional contributions; and (4) thereafter, any remaining proceeds will be distributed 99.75% to the Partnership and .25% to the co-venturer.\nNet income will be allocated as follows: (1) income will be allocated to the Partnership and the co-venturer to the extent of and in the same proportion as cash distributions and (2) thereafter 99.75% to the Partnership and .25% to the co-venturer. Losses will be allocated as follows: (1) losses will be allocated to the partners to the extent of and in proportion to their positive capital accounts, (2) thereafter 99.75% to the Partnership and .25% to the co- venturer.\nThe following is a combined summary of property operating expenses for Saratoga Center and EG&G Plaza and the Asbury Commons Apartments for the years ended December 31, 1993, 1992 and 1991:\n1993 1992 1991\nProperty operating expenses: Utilities $ 186,984 $ 172,330 $ 182,765 Repairs and maintenance 264,438 256,634 167,793 Salaries and related costs 174,733 180,769 165,673 Administrative and other 153,766 166,784 183,593 Insurance 37,144 42,145 44,782 Management fees 112,444 138,215 95,492 $ 929,509 $ 956,877 $ 840,098\n5. Investments in Unconsolidated Joint Ventures\nThe Partnership has investments in six unconsolidated joint venture partnerships which own operating investment properties at March 31, 1994 and 1993. The unconsolidated joint venture partnerships are accounted for on the equity method in the Partnership's financial statements. As discussed in Note 2, these joint ventures report their operations on a calendar year.\nCondensed combined financial statements of these unconsolidated joint ventures, for the periods indicated, are as follows.\nCondensed Combined Balance Sheets December 31, 1993 and 1992 Assets 1993 1992\nCurrent assets $ 3,389,670 $ 3,890,089 Operating investment properties, net 82,290,951 84,904,636 Other assets 3,999,867 4,188,728 $ 89,680,488 $ 92,983,453\nLiabilities and Venturers' Capital\nCurrent liabilities $ 4,457,300 $ 3,661,095 Other liabilities 200,803 203,521 Notes payable 1,000,000 1,700,000 Partnership's share of venturers' capital 63,366,901 65,967,495 Co-venturers' share of venturers' capital 20,655,484 21,451,342 $ 89,680,488 $ 92,983,453\nCondensed Combined Summary of Operations For the years ended December 31, 1993, 1992 and 1991\n1993 1992 1991\nRental revenues and expense reimbursements $13,546,942 $13,507,464 $13,493,322 Interest income 41,192 44,337 68,577 13,588,134 13,551,801 13,561,899\nProperty operating and other expenses 4,486,253 3,830,505 3,989,520 Real estate taxes 3,081,606 2,983,077 3,014,283 Interest expense 161,726 172,855 203,519 Depreciation and amortization 3,573,394 3,591,589 3,614,838 11,302,979 10,578,026 10,822,160\nNet income $ 2,285,155 $ 2,973,775 $ 2,739,739\nNet income: Partnership's share of combined income $ 2,304,661 $ 2,690,097 $ 2,590,607 Co-venturers' share of combined income (loss) (19,506) 283,678 149,132 $ 2,285,155 $ 2,973,775 $ 2,739,739\nReconciliation of Partnership's Investment March 31, 1994 and 1993 1994 1993\nPartnership's share of capital at December 31, as shown above $ 63,366,901 $ 65,967,495 Partnership's share of ventures' current liabilities and long-term debt 1,574,256 1,542,448 Excess basis due to investments in joint ventures, net (1) 2,194,710 2,292,660 Deficit fundings (2) (689,047) (689,047) Timing differences (3) (927,670) (1,059,546) Investments in unconsolidated joint ventures, at equity at March 31 $ 65,519,150 $ 68,054,010\n(1) At March 31, 1994 and 1993, the Partnership's investment exceeds its share of the joint venture partnerships' capital accounts by approximately $2,195,000 and $2,293,000 , respectively. This amount, which relates to certain costs incurred by the Partnership in connection with acquiring its joint venture investments, is being amortized over the estimated useful life of the investment properties (generally 30 years).\n(2) Deficit fundings represent cash contributed to the West Ashley Shoppes joint venture by the Partnership's co-venturer pursuant to a guaranty agreement. The joint venture recorded such contributions as an increase to the Partnership's capital account for financial reporting purposes.\n(3) The timing differences between the Partnership's share of capital account balances and its investments in joint ventures consist of capital contributions made to joint ventures and cash distributions received from joint ventures during the period from January 1 to March 31 in each year. These differences result from the lag in reporting period discussed in Note 2.\nReconciliation of Partnership's Share of Operations For the years ended December 31, 1993, 1992 and 1991\n1993 1992 1991\nPartnership's share of operations, as shown above $ 2,304,661 $ 2,690,097 $ 2,590,607 Amortization of excess basis (97,950) (97,950) (97,950) Partnership's share of unconsolidated ventures' income $ 2,206,711 $ 2,592,147 $ 2,492,657\nInvestments in unconsolidated joint ventures, at equity is the Partnership's net investment in the joint venture partnerships. These joint ventures are subject to Partnership agreements which determine the distribution of available funds, the disposition of the venture's assets and the rights of the partners, regardless of the Partnership's percentage ownership interest in the venture. Substantially all of the Partnership's investments in these joint ventures are restricted as to distributions.\nInvestments in unconsolidated joint ventures, at equity on the balance sheet is comprised of the following investment carrying values:\n1994 1993\nChicago-625 Partnership $ 21,415,404 $ 22,651,836 Richmond Gables Associates 6,037,275 6,394,685 Daniel\/Metcalf Associates Partnership 13,193,783 13,484,487 TCR Walnut Creek Limited Partnership 8,527,132 8,851,862 Portland Pacific Associates 6,261,781 6,499,180 West Ashley Shoppes Associates 9,083,775 9,171,960 64,519,1506 7,054,010 Note receivable: Note receivable from TCR Walnut Creek Limited Partnership (see discussion below) 1,000,000 1,000,000 Investments in unconsolidated joint ventures $ 65,519,150 $ 68,054,010\nThe Partnership received cash distributions from the unconsolidated ventures during the years ended March 31, 1994, 1993 and 1992 as set forth below:\n1994 1993 1992\nChicago-625 Partnership $ 1,252,199 $ 918,285 $ 890,728 Richmond Gables Associates 599,847 564,469 581,588 Daniel\/Metcalf Associates Partnership 1,079,697 1,144,533 1,185,196 TCR Walnut Creek Limited Partnership 769,890 861,841 812,860 Portland Pacific Associates 659,938 699,300 747,862 West Ashley Shoppes Associates 380,000 423,442 483,000 $ 4,741,571$ 4,611,870 $ 4,701,234\nA description of the ventures' properties and the terms of the joint venture agreements are summarized as follows:\na. Chicago - 625 Partnership\nThe Partnership acquired an interest in Chicago - 625 Partnership (the \"joint venture\"), an Illinois general partnership organized on December 16, 1986 in accordance with a joint venture agreement between the Partnership, an affiliate of the Partnership and Michigan-Ontario Limited, an Illinois limited partnership and an affiliate of Golub & Company (the \"co-venturer\"), to own and operate 625 North Michigan Avenue Office Tower (the \"property\"). The property is a 27-story commercial office tower containing an aggregate of 324,829 square feet of leasable space on approximately .38 acres of land. The property is located in Chicago, Illinois.\nThe aggregate cash investment made by the Partnership for its current interest was $26,010,350 (including an acquisition fee of $1,316,600 paid to PWPI and certain closing costs of $223,750). At the same time the Partnership acquired its interest in the joint venture, PaineWebber Equity Partners One Limited Partnership (PWEP1), an affiliate of the Managing General Partner with investment objectives similar to the Partnership's investment objectives, acquired an interest in this joint venture. PWEP1's initial cash investment for its interest was $10,000,000 plus an acquisition fee of $383,400 paid to PWPI. In addition, PWEP1 had an option to purchase from the Partnership $6,880,000 of additional interest in the joint venture. On June 12, 1987, PWEP1 exercised a portion of its option by purchasing an additional interest of $3,500,000 from the Partnership. On May 18, 1988, PWEP1 exercised the remainder of its option by purchasing the remaining interest of $3,380,000 from the Partnership. No gain or loss was recorded on these transactions.\nDuring 1990 the joint venture agreement was amended to allow the Partnership and PWEP1 the option to make contributions to the joint venture equal to total costs of capital improvements, leasehold improvements and leasing commissions (\"Leasing Expense Contributions\") incurred since April 1, 1989, not in excess of the accrued and unpaid Preference Return due to the Partnership and PWEP1. The Partnership made Leasing Expense Contributions in the amounts of $168,670 and $851,451 during fiscal 1993 and 1992, respectively. The Partnership made no Leasing Expense Contributions during fiscal 1994.\nThe joint venture agreement provides for aggregate distributions of cash flow and sale or refinancing proceeds to the Partnership and PWEP1. These amounts are then distributed to the Partnership and PWEP1 based on their respective cash investments in the joint venture exclusive of acquisition fees. As a result of the transfers of the Partnership's interests to PWEP1 as discussed above, cash flow distributions and sale or refinancing proceeds will now be split approximately 59% to the Partnership and 41% to PWEP1.\nNet cash flow will be distributed as follows: First, a preference return, payable monthly, to the Partnership and PWEP1 of 9% of their respective net cash investments, as defined. Second, to the payment of any unpaid accrued interest and principal on all outstanding default notes. Third, to the payment of any unpaid accrued interest and principal on all outstanding operating notes. Fourth, 70% in total to the Partnership and PWEP1 and 30% to the co- venturer. The cumulative unpaid and unaccrued Preference Return due to the Partnership totalled $5,125,199 at December 31, 1993 ($4,039,564 at December 31, 1992).\nProfits for each fiscal year shall be allocated, to the extent that such profits do not exceed the net cash flow for such fiscal year, in proportion to the amount of such net cash flow distributed to the Partners for such fiscal year. Profits in excess of net cash flow shall be allocated 99% in total to the Partnership and PWEP1 and 1% to the co-venturer. Losses shall be allocated 99% in total to the Partnership and PWEP1 and 1% to the co-venturer.\nProceeds from the sale or refinancing of the property shall be allocated as follows:\nFirst, to the payment of all unpaid accrued interest and principal on all outstanding default notes. Second, to the Partnership, PWEP1 and the co-venturer for the payment of all unpaid accrued interest and principal on all outstanding operating notes. Third, 100% to the Partnership and PWEP1 until they have received the aggregate amount of their respective Preference Return not yet paid. Fourth, 100% in total to the Partnership and PWEP1 until they have received an amount equal to their respective net investments. Fifth, 100% to the Partnership and PWEP1 until they have received an amount equal to the PWEP Leasing Expense Contributions less any amount previously distributed, pursuant to this provision. Sixth, 100% to the co-venturer until it has received an amount equal to $6,000,000, less any amount of proceeds previously distributed to the co-venturer, as defined. Seventh, 100% to the co-venturer until it has received an amount equal to any reduction in the amount of net cash flow that it would have received had the Partnership not incurred indebtedness in the form of operating notes. Eighth, 100% in total to the Partnership and PWEP1 until they have received $2,067,500, less any amount of proceeds previously distributed to the Partnership and PWEP1, pursuant to this provision. Ninth, 75% in total to the Partnership and PWEP1 and 25% to the co-venturer until the Partnership and PWEP1 have received $20,675,000, less any amount previously distributed to the Partnership and PWEP1, pursuant to this provision. Tenth, 100% to the Partnership and PWEP1 until the Partnership and PWEP1 have received an amount equal to a cumulative return of 9% on the PWEP Leasing Expense Contributions. Eleventh, any remaining balance will be distributed 55% in total to the Partnership and PWEP1 and 45% to the co-venturer.\nGains resulting from the sale of the property shall be allocated as follows:\nFirst, capital profits shall be allocated to Partners having negative capital account balances, until the balances of the capital accounts of such Partners equal zero. Second, any remaining capital profits up to the amount of capital proceeds distributed to the Partners pursuant to distribution of proceeds of a sale or refinancing with respect to the capital transaction giving rise to such capital profits shall be allocated to the Partners in proportion to the amount of capital proceeds so distributed to the Partners. Third, capital profits in excess of capital proceeds, if any, shall be allocated between the Partners in the same proportions that capital proceeds of a subsequent capital transaction would be distributed if the capital proceeds were equal to the remaining amount of capital profits to be allocated.\nCapital losses shall be allocated as follows:\nFirst, capital losses shall be allocated to the Partners in an amount up to and in proportion to their respective positive capital balances. Then, all remaining capital losses shall be allocated 70% in total to the Partnership and PWEP1 and 30% to the co-venturer.\nThe Partnership has a property management agreement with an affiliate of the co-venturer that provides for management and leasing commission fees to be paid to the property manager. The management fee is 4% of gross rents and the leasing commission is 7%, as defined. The property management contract is cancellable at the Partnership's option upon the occurrence of certain events and is currently cancellable by the co-venturer at any time.\nb) Richmond Gables Associates\nOn September 1, 1987 the Partnership acquired an interest in Richmond Gables Associates (the \"joint venture\"), a Virginia general partnership organized in accordance with a joint venture agreement between the Partnership and Richmond Erin Shades Company Limited Partnership, an affiliate of The Paragon Group (the \"co-venturer\"). The joint venture was organized to own and operate the Gables at Erin Shades, a newly constructed apartment complex located in Richmond, Virginia. The property consists of 224 units with approximately 156,000 net rentable square feet on approximately 15.6 acres of land.\nThe aggregate cash investment by the Partnership for its interest was $9,076,982 (including an acquisition fee of $438,500 paid to PWPI and certain closing costs of $84,716).\nNet cash flow from operations of the joint venture will be distributed in the following order of priority: first, a preference return, payable monthly, to the Partnership of 9% on its net cash investment as defined; second, to pay interest on additional capital contributions; thereafter, 70% to the Partnership and 30% to the co-venturer.\nProceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) the Partnership will receive the aggregate amount of its cumulative annual preferred return not previously paid, (2) the Partnership will receive an amount equal to the Partnership's net investment, (3) $450,000 each to the Partnership and the co-venturer, (4) the Partnership and co- venturer will receive proceeds in proportion to contribution loans made plus accrued interest, (5) 70% to the Partnership and 30% to the co-venturer until the Partnership has received an additional $5,375,000; and (6) thereafter, any remaining proceeds will be distributed 60% to the Partnership and 40% to the co-venturer.\nNet income and loss will be allocated as follows: (1) depreciation will be allocated to the Partnership, (2) income will be allocated to the Partnership and co-venturer in the same proportion as cash distributions. Losses will be allocated in amounts equal to the positive capital accounts of the Partnership and co-venturer and (3) all other profits and losses will be allocated 70% to the Partnership and 30% to the co-venturer.\nDuring the Guaranty Period, which expired in September 1990, the co-venturer agreed to unconditionally guarantee to fund any deficits and to ensure that the joint venture could distribute to the Partnership its preference return. Total mandatory payments contributed by the co-venturer amounted to $152,048 in 1990. At December 31, 1993 there was a cumulative unpaid preferred distribution payable to the Partnership of $740,062. This amount will be paid to the Partnership if and when there is available cash flow.\nThe joint venture has entered into a management contract with an affiliate of the co-venturer which is cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee is 5% of gross rents, as defined.\nc) Daniel\/Metcalf Associates Partnership\nThe Partnership acquired an interest in Daniel\/Metcalf Associates Partnership (the \"joint venture\"), a Virginia general partnership organized on September 30, 1987 in accordance with a joint venture agreement between the Partnership and Plaza 91 Investors, L.P., an affiliate of Daniel Realty Corp., organized to own and operate Loehmann's Plaza, a community shopping center located in Overland Park, Kansas. The property consists of approximately 142,000 net rentable square feet on approximately 19 acres of land.\nThe aggregate cash investment by the Partnership for its interest was $15,488,352 (including an acquisition fee of $689,000 paid to PWPI and certain closing costs of $64,352). As of December 31, 1993, the property was encumbered by a $700,000 nonrecourse mortgage note. The entire principal amount of the mortgage is payable upon maturity on December 1, 1994.\nNet cash flow of the joint venture is to be distributed monthly in the following order of priority: (1) the Partnership will receive a cumulative preferred return (the \"Preferred Return\") of 9.25% on its initial net investment of $14,300,000 from October, 1987 through September, 1989, 9.75% from October, 1989 through September, 1990 and 10% thereafter, (2) to the Partnership and co-venturer for the payment of all unpaid accrued interest and principal on all outstanding notes. Any additional cash flow shall be distributed 75% to the Partnership and 25% to the co- venturer.\nThe co-venturer agreed to contribute to the joint venture all funds that were necessary so the joint venture could distribute to the Partnership its preference return for 36 months from the date of closing (the \"Guaranty Period\"). Contributions for the final 12 months of the Guaranty Period, which ended September 30, 1990, were in the form of mandatory loans. Such loans are non-interest bearing and will be repaid upon sale or refinancing of the Property. The Partnership's cumulative unpaid preferential return as of December 31, 1993 amounted to $1,528,589. If the joint venture requires additional funds after the Guaranty Period, and such funds are not available from third party sources, they are to be provided in the form of operating and capital deficit loans, 75% by the Partnership and 25% by the co- venturer. At December 31, 1993, the co-venturer is obligated to make additional capital contributions of a least $88,644 with respect to cumulative unfunded shortfalls in the Partnership's preferential return through September 30, 1990.\nProceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) to the Partnership and to the co-venturer, to repay any additional capital contributions and loans and unpaid preferential returns, (2) $15,015,000 to the Partnership, (3) $200,000 to the co-venturer and (4) 75% to the Partnership and 25% to the co-venturer.\nTaxable income will be allocated to the Partnership and the co-venturer in any year in the same proportions as actual cash distributions, except to the extent partners are required to make capital contributions, as defined, then an amount equal to such contribution will be allocated to the partners. Profits in excess of net cash flow are allocated 75% to the Partnership and 25% to the co-venturer. Losses are allocated 99% to the Partnership and 1% to the co- venturer. Contributions or loans made to the joint venture by the Partnership or co-venturer will result in a loss allocation to the Partnership or co-venturer of an equal amount.\nThe joint venture has entered into a management contract with an affiliate of the co-venturer cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee is equal to 1.5% of gross rents, as defined. In addition, the affiliate of the co- venturer also earns a subordinated management fee of 2% of gross rents during any year in which the net cash flow of the operating property exceeds the Partnership's preference return. Otherwise the fee is accrued subject to a maximum amount of $50,000 and payable only from the proceeds of a capital transaction.\nd) TCR Walnut Creek Limited Partnership\nThe Partnership acquired an interest in TCR Walnut Creek Limited Partnership (the \"joint venture\"), a Texas limited partnership organized on December 24, 1987 in accordance with a joint venture agreement between the Partnership and Trammell S. Crow (the \"co-venturer\") organized to own and operate Treat Commons Phase II Apartments, an apartment complex located in Walnut Creek, California. The property consists of 160 units on approximately 3.98 acres of land.\nThe aggregate cash investment by the Partnership for its interest was $13,143,079 (including an acquisition fee of $602,400 payable to PWPI and certain closing costs of $40,679). The initial cash investment also includes the sum of $1,000,000 that was contributed in the form of a permanent nonrecourse loan to the venture on which the Partnership receives interest payments at the rate of 10% per annum until the commencement of the guaranty period, 9.5% per annum during the guaranty period and 10% per annum thereafter. The balance of the permanent loan is included in the Partnership's investment in the joint venture on the accompanying balance sheet.\nNet cash flow from operations of the Joint Venture will be distributed quarterly in the following order of priority: (1) first, to repay accrued interest and principal on any optional loans, (2) second, a preference return to the Partnership of an interest rate equal to a rate obtainable on a six-month jumbo certificate of deposit for the period ending six months after the earlier of the date construction commenced or August 15, 1987 on its net cash investment, then 9.5% until the end of the guaranty period and 10% thereafter, and (3) third, the balance, 75% to the Partnership and 25% to the co-venturer. The cumulative unpaid preference return as of December 31, 1993 is $1,320,004.\nProceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) first, to repay accrued interest and principal on any optional loans, (2) second, 100% to the Partnership until the Partnership has received cumulative distributions, as defined, and (3) third, the balance, 75% to the Partnership and 25% to the co-venturer.\nNet income will be allocated to the Partnership to the extent of net cash flow from operations. Any excess income or all net income, in the event there is no net cash flow from operations, will be allocated 75% to the Partnership and 25% to the co-venturer. In general, net loss will be allocated as follows: (i) prior to January 1, 1988, 1% to the Partnership and 99% to the co-venturer, and (ii) subsequent to December 31, 1987, 99% to the Partnership and 1% to the co-venturer.\nDuring the guaranty period, from September 1, 1988 to August 31, 1990, the co-venturer agreed to contribute to the joint venture all funds that were necessary to cover any deficits and to ensure that the joint venture could distribute the Partnership's preference return.\nThe joint venture has entered into a management contract with an affiliate of the co-venturer which is cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee is 5% of gross revenues, as defined.\ne) Portland Pacific Associates\nOn January 12, 1988 the Partnership acquired an interest in Portland Pacific Associates (the \"joint venture\"), a California limited partnership organized in accordance with a joint venture agreement between the Partnership and Pacific Union Investment Corporation (the \"co-venturer\"). The joint venture was organized to own and operate Richland Terrace and Richmond Park Apartments located in Portland, Oregon. The property consists of a total of 183 units located on 9.52 acres of land.\nThe aggregate cash investment by the Partnership for its interest was $8,251,500 (including an acquisition fee of $380,000 paid to PWPI and certain closing costs of $33,500).\nDuring the guaranty period, from January 14, 1988 through February 1, 1991, the co-venturer agreed to unconditionally guarantee to fund any deficits and to ensure that the joint venture could distribute to the Partnership its preference return. The Partnership shall receive a preferred annual return of 9.25% of the Partnership's net investment for the two-year period commencing on the date of closing, 9.75% during the subsequent two years and 10% commencing on the fourth anniversary date and extending until the termination and dissolution of the joint venture. The computation of the preferred return is based upon the Partnership's net investment of $7,700,000, as defined in the joint venture agreement.\nNet cash flow from operations of the joint venture will be distributed in the following order of priority: during the guaranty period 1) to the Partnership until it has received its cumulative preference return, as defined, (2) to the partners to pay any guaranty period operating loans or advances and accrued interest, (3) to the co-venturer to pay guaranty preference loans, (4) to the co-venturer until the co-venturer has received the cumulative amount of $60,000, and (5) then 50% to the Partnership and 50% to the co- venturer. Following the guaranty period, until all guaranty period preference loans and related accrued interest have been paid in full, 50% of the net cash flow is to be distributed to the co-venturer to the extent necessary to repay any principal and accrued interest and 37.5% to the Partnership and 12.5% to the co-venturer. After all guaranty period preference loans and accrued interest have been paid in full, 50% to the Partnership to pay any accrued preference and 37.5% to the Partnership and 12.5% to the co-venturer. Then 50% to the manager for unpaid management fees and 37.5% to the Partnership and 12.5% to the co-venturer, and thereafter 75% to the Partnership and 25% to the co-venturer. The Partnership's cumulative unpaid preference return as of December 31, 1993 is $212,974.\nProceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) the Partnership will receive the aggregate amount of its cumulative annual preferred return not previously paid, (2) to the Partnership and co-venturer in proportion to any guaranty period loans, (3) to the Partnership until it has received an amount equal to its net investment plus $380,000, (4) to the co-venturer until all principal and accrued preference return on guaranty period loans have been repaid (5) to pay any unpaid subordinated management fees and (6) thereafter, any remaining proceeds will be distributed 80% to the Partnership and 20% to the co-venturer.\nNet income and loss will be allocated as follows: (1) income will be allocated to the Partnership and co-venturer in the same proportion as cash distributions (2) then 75% to the Partnership and 25% to the co-venturer. Losses will be allocated in proportion to net cash flow distributed.\nThe joint venture has entered into a management contract with an affiliate of the co-venturer which is cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee is 5% of gross rents.\nf) West Ashley Shoppes Associates\nOn March 10, 1988 the Partnership acquired an interest in West Ashley Shoppes Associates (the \"joint venture\"), a South Carolina general partnership organized in accordance with a joint venture agreement between the Partnership and Orleans Road Development Company, an affiliate of the Leo Eisenberg Company (the \"co-venturer\"). The joint venture was organized to own and operate West Ashley Shoppes, a newly constructed shopping center located in Charleston, South Carolina. The property consists of 134,000 net rentable square feet on approximately 17.25 acres of land. One tenant occupies 55,850 square feet, representing approximately 41% of the total shopping center. This tenant, Phar-Mor, Inc., is in Chapter 11 Bankruptcy Reorganization as of March 31, 1994.\nThe aggregate cash investment by the Partnership for its interest was $10,503,841 (including an acquisition fee of $365,000 paid to PWPI and certain closing costs of $123,841).\nDuring the Guaranty Period, from March 10, 1988 to March 10, 1993, the co-venturer had agreed to unconditionally guarantee to fund any deficits and to ensure that the joint venture could distribute to the Partnership its preference return. During fiscal 1990, the co-venturer defaulted on its guaranty obligation. On April 25, 1990, the Partnership and the co- venturer entered into the second amendment to the joint venture agreement. In accordance with the amendment, the Partnership contributed $300,000 to the joint venture, in exchange for the co-venturer's transfer of rights to certain out-parcel land. The $300,000 was then repaid to the Partnership as a distribution to satisfy the co-venturer's obligation to fund net cash flow shortfalls in arrears at December 31, 1989. Subsequent to the amendment to the joint venture agreement, the co-venturer defaulted on the guaranty obligations again. Net cash flow shortfall contributions of approximately $1,060,000 were in arrears at December 31, 1993. During 1991, the Partnership had filed suit against the co-venturer and the individual guarantors to collect the amount of the cash flow shortfall contributions in arrears. In May 1994, subsequent to the Partnership's year-end, the Partnership and the co-venturer executed a settlement agreement to resolve their outstanding disputes regarding the net cash flow shortfall contributions described above. Under the terms of the settlement agreement, the co-venturer assigned 96% of its interest in the joint venture to the Partnership and the remaining 4% of its interest in the joint venture to Second Equity Partners, Inc. (SEPI), Managing General Partner of the Partnership. In return for such assignment, the Partnership agreed to release the co-venturer from all claims regarding net cash flow shortfall contributions owed to the joint venture. In conjunction with the assignment of its interest and withdrawal from the joint venture, the co-venturer agreed to release certain outstanding counter claims against the Partnership. The Partnership and SEPI intend to continue the operations of the joint venture as a going concern. The settlement agreement effectively gives the Partnership complete control over the affairs of the joint venture. Accordingly, beginning in the first quarter of fiscal 1995, the financial position and results of operations of this joint venture will be presented on a consolidated basis in the Partnership's financial statements.\nSubsequent to the settlement agreement and assignment of joint venture interest described above, the terms of the joint venture agreement calls for net cash flow from operations of the joint venture to be distributed as follows: (1) the Partnership will receive a preference return of 10% per annum on its net cash investment; (2) next to the partners on a pro rata basis to repay unpaid additional contribution returns and return on accrued preference, as defined; (3) net, until all additional contributions, tenant improvement contributions and accrued preference returns have been paid in full, 50% of remaining cash flow to the partners on a pro rata basis to repay such items, 49.5% to the Partnership, and 0.5% to the co-venturer; and (4) thereafter, any remaining cash would be distributed 99% to the Partnership and 1% to the co-venturer.\nProceeds from the sale or refinancing of the property will be distributed in the following order of priority: (1) the Partnership will receive the aggregate amount of its cumulative annual preferred return not previously paid, (2) to the Partnership and co-venturer to pay additional contributions, (3) the Partnership will receive an amount equal to the Partnership's net investment and (4) thereafter, any remaining proceeds will be distributed 99% to the Partnership and 1% to the co-venturer.\nNet income or loss will be allocated to the Partnership and the co-venturer in the same proportion as cash distributions except for certain items which are specifically allocated to the partners, as defined, in the joint venture agreement. Such items include amortization of acquisition fee and organization expenses and allocation of depreciation related to recording of the building at fair value based upon its purchase price.\nThe joint venture originally entered into a management contract with an affiliate of the co-venturer which was cancellable at the option of the Partnership upon the occurrence of certain events. The annual management fee was 4% of gross rents. During fiscal 1992, the Partnership exercised its option to terminate the management agreement and hired third-party management and leasing agents to administer the day-to-day operations of the property.\n6. Notes Payable\nOn April 29, 1988, the Partnership borrowed $6,000,000 in the form of a zero coupon loan which had a scheduled maturity date in May of 1995. The note bears interest at an effective compounded annual rate of 9.8% and is secured by the 625 North Michigan Avenue Office Building. Payment of all interest is deferred until maturity, at which time principal and interest totalling approximately $11,556,000 was to be due and payable. The carrying value on the Partnership's balance sheet at March 31, 1994 of the loan plus accrued interest aggregated approximately $10,404,000. The terms of the loan agreement require that if the loan ratio, as defined, exceeds 80%, the Partnership is required to deposit additional collateral in an amount sufficient to reduce the loan ratio to 80%. During fiscal 1994, the lender informed the Partnership that based on an interim property appraisal, the loan ratio exceeded 80% and that a deposit of additional collateral was required. Subsequently, the Partnership submitted an appraisal which demonstrated that the loan ratio exceeded 80% by an amount less than previously demanded by the lender. In December 1993, the Partnership deposited additional collateral of $208,876 in accordance with the higher appraised value. The lender accepted the Partnership's deposit of additional collateral (included in escrowed cash on the accompanying balance sheet at March 31, 1994) but disputed whether the Partnership had complied with the terms of the loan agreement regarding the 80% loan ratio. Subsequent to the Partnership's year-end, an agreement was reached with the lender of the zero coupon loan on a proposal to refinance the loan and resolve the outstanding disputes. The terms of the agreement call for the Partnership to make a principal pay down of approximately $801,000, including the application of the additional collateral referred to above. The new loan will have an initial principal balance of approximately $9.7 million and a scheduled maturity date of May 1999. From the date of the formal closing of the modification and extension agreement to the new maturity date of the loan, the loan will bear interest at a rate of 9.125% per annum. Monthly payments of principal and interest aggregating approximately $81,000 will be required. The terms of the loan agreement also require the establishment of an escrow account for real estate taxes, as well as a capital improvement escrow which is to be funded with monthly deposits from the Partnership aggregating approximately $1 million through the scheduled maturity date. Formal closing of the modification and extension agreement occurred on May 31, 1994.\nOn June 20, 1988, the Partnership borrowed $17,000,000 from a financial institution in the form of zero coupon loans due in June of 1995. These notes bear interest at an annual rate of 10% compounded annually and are secured by Saratoga Center and EG&G Plaza, Loehmann's Plaza Shopping Center, Richland Terrace and Richmond Park Apartments, West Ashley Shoppes, The Gables at Erin Shades, Treat Commons Phase II Apartments and Asbury Commons Apartments. Payment of all interest is deferred until maturity. During fiscal 1991, the Partnership repaid the portion of the zero coupon loans which had been secured by the Highland Village Apartments, which was sold in May of 1990. The aggregate amount of principal and accrued interest repaid on May 31, 1990 amounted to approximately $1,660,000. Additionally, a paydown of principal and accrued interest, totalling approximately $2,590,000 was made on August 20, 1990. This paydown represented a mandatory repayment of the full amount of the principal and accrued interest which had been secured by the Ballston Place property which was sold in fiscal 1990 and an optional partial prepayment of the principal and accrued interest secured by The Gables Apartments. The remaining balances of these loans and the related accrued interest, aggregating approximately $23,560,000, are reflected on the balance sheet of the Partnership as of March 31, 1994. Based on the current loan balances, principal and interest aggregating approximately $26,419,000 would be due and payable at maturity, in June of 1995. The Partnership is presently involved in negotiations with the lender regarding a possible modification and extension agreement regarding these seven notes. Any such agreement would likely involve the conversion of the zero coupon notes to conventional current- pay loans with monthly principal amortization. Such a modification could also require an initial principal paydown. There are no assurances that a modification and extension agreement will be completed. Management is also investigating other refinancing options for these obligations. Consent of certain of the Partnership's co- venture partners may be required in connection with any extension or refinancing transactions.\n7. Bonds Payable\nBonds payable consist of the Hacienda Park joint venture's share of liabilities for bonds issued by the City of Pleasanton, California for public improvements that benefit Hacienda Business Park and the operating investment property and are secured by liens on the operating investment property. The bonds for which the operating investment property is subject to assessment bear interest at rates ranging from 5% to 7.87%, with an average rate of approximately 7.2%. Principal and interest are payable in semi-annual installments.\nFuture scheduled principal payments on bond assessments are as follows:\nYear ended December 31\n1994 $ 71,859 1995 83,529 1996 91,431 1997 100,597 1998 110,136 Thereafter 2,406,495 $ 2,864,047\nIn the event the operating investment property is sold, the Hacienda Park joint venture will no longer be liable for the bond assessments.\n8. Rental Revenue\nThe buildings owned by Hacienda Park Associates are leased under noncancellable, multi-year leases. Minimum future rentals due under the terms of these leases at December 31, 1993 are as follows:\nFuture Minimum Contractual Payments\n1994 $ 1,482,435 1995 1,235,671 1996 1,057,651 1997 998,311 1998 730,826 Thereafter 104,029 $ 5,608,923\nThe joint venture has one major tenant which paid approximately $1,466,000 in rent for the year ended December 31, 1993, representing 63% of the venture's rental income. At December 31, 1993, monthly rents from this tenant are $97,074 through March 1994 and $41,612 thereafter until the lease expiration in March 1999.\n9. Subsequent Events\nOn May 15, 1994 the Partnership distributed $1,664,240 to the Limited Partners and $16,811 to the General Partners for the quarter ended March 31, 1994.\nIn June 1994, the Board of Directors of the Partnership's Managing General Partner gave approval for the communication to the Limited Partners of a proposed reduction in the Partnership's quarterly distribution rate. Such communication to the Limited Partners is planned for release in August 1994. Formal approval of the proposed distribution rate adjustment, which would be effective for the second quarter of fiscal 1995, will occur in October 1994. The rate reduction is being proposed by management in light of the monthly payment of debt service now required under the terms of the loan secured by the 625 North Michigan Office Building and the current debt service expected to be required upon the modification or refinancing of the Partnership's remaining zero coupon loans (see Note 6). In addition, management anticipates significant cash needs over the next two years to pay for capital and tenant improvements at its commercial office buildings and retail properties.\nSchedule XI - Real Estate and Accumulated Depreciation PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION March 31, 1994\nREPORT OF INDEPENDENT AUDITORS\nThe Partners of PaineWebber Equity Partners Two Limited Partnership:\nWe have audited the accompanying combined balance sheets of the Combined Joint Ventures of PaineWebber Equity Partners Two Limited Partnership as of December 31, 1993 and 1992 and the related combined statements of income and changes in venturers' capital 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 Partnership'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 combined financial position of the Combined Joint Ventures of PaineWebber Equity Partners Two Limited Partnership at December 31, 1993 and 1992, and the combined 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.\nERNST & YOUNG Boston, Massachusetts March 18, 1994, except for Note 9, as to which the date is May 16, 1994, and the second paragraph of Note 8, as to which the date is June 13, 1994\nCOMBINED JOINT VENTURES OF PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nCOMBINED BALANCE SHEETS December 31, 1993 and 1992\nAssets 1993 1992 Current assets: Cash and cash equivalents $ 1,202,805 $ 2,299,439 Investments 729,558 - Accounts receivable, net of allowance for doubtful accounts of $570,533 ($331,228 in 1992) 1,384,275 1,388,735 Accounts receivable - affiliates - 116,306 Prepaid expenses 19,911 35,003 Other current assets 53,121 50,606 Total current assets 3,389,670 3,890,089\nOperating investment properties: Land 24,247,822 24,247,822 Buildings, improvements and equipment 78,105,218 77,488,825 102,353,040 101,736,647 Less accumulated depreciation (20,062,089) (16,832,011) 82,290,951 84,904,636\nEscrow funds 62,405 58,159 Due from affiliates 269,479 269,479 Deferred expenses, net of accumulated amortization of $1,753,360 ($1,444,927 in 1992) 1,789,471 1,912,530 Other assets, net 1,878,512 1,948,560 $ 89,680,488 $ 92,983,453\nLiabilities and Venturers' Capital\nCurrent liabilities: Accounts payable and accrued expenses $ 591,171 $ 590,756 Accounts payable - affiliates 167,881 163,821 Accrued real estate taxes 2,491,992 2,432,070 Distributions payable to venturers 506,256 474,448 Current portion - notes payable 700,000 - Total current liabilities 4,457,300 3,661,095\nTenant security deposits 150,803 153,521\nSubordinated management fee payable to affiliate 50,000 50,000\nNotes payable 1,000,000 1,700,000\nVenturers' capital 84,022,385 87,418,837 $ 89,680,488 $ 92,983,453\nSee accompanying notes.\nCOMBINED JOINT VENTURES OF PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nCOMBINED STATEMENTS OF INCOME AND CHANGES IN VENTURERS' CAPITAL For the years ended December 31, 1993, 1992 and 1991\n1993 1992 1991 Revenues: Rental income and expense reimbursements $13,546,942 $13,507,464 $13,493,322 Interest income 41,192 44,337 68,577 13,588,134 13,551,801 13,561,899\nExpenses: Real estate taxes 3,081,606 2,983,077 3,014,283 Depreciation and amortization 3,573,394 3,591,589 3,614,838 Property operating expenses 809,964 797,255 819,399 Repairs and maintenance 1,169,867 938,488 1,069,211 Management fees 481,996 478,045 484,906 Professional fees 137,392 103,886 117,577 Salaries 764,696 699,633 712,078 Advertising 62,731 66,141 69,650 Interest expense 161,726 172,855 203,519 General and administrative 663,352 529,601 519,287 Bad debt expense 272,855 97,228 10,432 Other 123,400 120,228 186,980 11,302,979 10,578,026 10,822,160\nNet income 2,285,155 2,973,775 2,739,739\nContributions from venturers - 294,450 1,725,000\nDistributions to venturers (5,681,607) (5,181,550) (5,665,441)\nVenturers' capital, beginning of year 87,418,837 89,332,162 90,532,864\nVenturers' capital, end of year $84,022,385 $87,418,837 $89,332,162\nSee accompanying notes.\nCOMBINED JOINT VENTURES OF PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP\nCOMBINED STATEMENT OF CASH FLOWS For the years ended December 31, 1993, 1992 and 1991 Increase (Decrease) in Cash and Cash Equivalents\n1993 1992 1991 Cash flows from operating activities: Net income $ 2,285,155 $ 2,973,775 $ 2,739,739 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 3,573,394 3,591,589 3,614,838 Changes in assets and liabilities: Accounts receivable 4,460 (67,023) 102,780 Accounts receivable - affiliates - - (43,399) Prepaid expenses 15,092 (723) (1,207) Other current assets (2,515) 7,560 (40,746) Escrow funds (4,246) (4,100) (4,352) Other assets 66,864 (123,262) (1,134,301) Accounts payable and accrued expenses (22,634) 203,293 (151,674) Accounts payable - affiliates 4,060 23,049 - Tenant security deposits (2,718) 4,087 1,422 Accrued real estate taxes 59,922 (108,684) 133,819 Total adjustments 3,691,679 3,525,786 2,477,180 Net cash provided by operating activities 5,976,834 6,499,561 5,216,919\nCash flows from investing activities: Additions to operating investment properties (648,092) (513,251) (1,084,784) Increase in deferred expenses (185,374) (273,515) (47,279) Purchase of investment securities (729,558) - - Net cash used for investing activities (1,563,024) (786,766) (1,132,063)\nCash flows from financing activities: Distributions to venturers (5,533,493) (4,964,166) (5,496,292) Proceeds from capital contributions - 281,111 1,714,073 Principal payments under capital lease obligation - (111,639) (89,391) Net cash used for financing activities (5,533,493) (4,794,694) (3,871,610)\nNet increase (decrease) in cash and cash equivalents (1,119,683) 918,101 213,246\nCash and cash equivalents, beginning of year 2,322,488 1,404,387 1,191,141\nCash and cash equivalents, end of year $ 1,202,805 $ 2,322,488 $ 1,404,387\nCash paid during the year for interest $ 148,708 $ 170,066 $ 196,423\nSee accompanying notes.\n1. Organization\nThe accompanying financial statements of the Combined Joint Ventures of PaineWebber Equity Partners Two Limited Partnership (Combined Joint Ventures) include the accounts of Chicago-625 Partnership, an Illinois general partnership; Richmond Gables Associates, a Virginia general partnership; Daniels\/Metcalf Associates Partnership, a Kansas general partnership; TCR Walnut Creek Limited Partnership, a Texas limited partnership; Portland Pacific Associates, a California general partnership and West Ashley Shoppes Associates, a Virginia limited partnership. The financial statements of the Combined Joint Ventures are presented in combined form due to the nature of the relationship between each of the co-venturers and PaineWebber Equity Partners Two Limited Partnership (\"EP2\").\nThe financial statements of the Combined Joint Ventures have been prepared based on the periods that EP2 held an interest in the individual joint ventures. The dates of EP2's acquisition of interests in the joint ventures are as follows: Date of Acquisition Joint Venture of Interest\nChicago-625 Partnership December 16, 1986 Richmond Gables Associates September 1, 1987 Daniel\/Metcalf Associates Partnership September 30, 1987 TCR Walnut Creek Limited Partnership December 24, 1987 Portland Pacific Associates January 12, 1988 West Ashley Shoppes Associates March 10, 1988\n2. Summary of significant accounting policies\nOperating investment properties\nThe operating investment properties are carried at the lower of cost, reduced by accumulated depreciation, or net realizable value. The net realizable value of a property held for long-term investment purposes is measured by the recoverability of the investment from expected future cash flows on an undiscounted basis, which may exceed the property's current market value. The net realizable value of a property held for sale approximates its market value. All of the operating investment properties owned by the Combined Joint Ventures were considered to be held for long-term investment purposes as of December 31, 1993 and 1992. The Combined Joint Ventures capitalized property taxes and interest incurred during the construction period of the projects along with the costs of identifiable improvements. The Combined Joint Ventures also capitalized certain acquisition, construction and guaranty fees paid to affiliates. In certain circumstances the carrying values of the operating properties have been adjusted for mandatory payments received from venture partners (see Note 2). Depreciation expense is computed on a straight-line basis over the estimated useful life of the buildings, improvements and equipment, generally 5 to 31.5 years.\nDeferred expenses\nDeferred expenses consist primarily of organization costs which are being amortized over 5 years and lease commissions and rental concessions which are being amortized over the life of the applicable leases.\nIncome tax matters\nThe Combined Joint Ventures are comprised of entities which are not taxable and, accordingly, the results of their operations are included on the tax returns of the various partners. Accordingly, no income tax provision is reflected in the accompanying combined financial statements.\nCash and cash equivalents\nFor purposes of reporting cash flows, the Combined Joint Ventures consider all highly liquid investments, money market funds and certificates of deposit purchased with original maturities of three months or less to be cash equivalents.\nInvestments\nInvestments consist of United States Treasury Bills with maturities greater than three months from the date of purchase. The fair value approximates cost at December 31, 1993.\nRental revenues\nCertain joint ventures have operating leases with tenants which provide for fixed minimum rents and reimbursements of certain operating costs. Rental revenues are recognized on a straight-line basis over the term of the related lease agreements.\nReclassifications\nCertain 1992 amounts have been reclassified to conform to the 1993 presentation.\n3. Joint Ventures\nSee Note 5 to the financial statements of EP2 included in this Annual Report for a more detailed description of the joint ventures. Descriptions of the ventures' properties are summarized below:\na. Chicago-625 Partnership\nThe joint venture owns and operates 625 North Michigan Avenue, a 325,000 square foot office building located in Chicago, Illinois.\nb. Richmond Gables Associates\nThe joint venture owns and operates The Gables of Erin Shades, a 224-unit apartment complex located in Richmond, Virginia.\nc. Daniel\/Metcalf Associates Partnership\nThe joint venture owns and operates Loehmann's Plaza, a 142,000 square foot shopping center located in Overland Park, Kansas.\nd. TCR Walnut Creek Limited Partnership\nThe joint venture owns and operates Treat Commons Phase II Apartments, a 160-unit apartment complex located in Walnut Creek, California. e. Portland Pacific Associates\nThe joint venture owns and operates two apartment complexes, Richmond Park Apartments and Richland Terrace Apartments, a total of 183 units located in Washington County, Oregon.\nf. West Ashley Shoppes Associates\nThe joint venture owns and operates West Ashley Shoppes, a 134,000 square foot shopping center located in Charleston, South Carolina.\nThe following description of the joint venture agreements provides certain general information.\nAllocations of net income and loss\nExcept for certain items which are specifically allocated to the partners, as defined in the joint venture agreements, the joint venture agreements generally provide that profits up to the amount of net cash flow distributable shall be allocated between EP2 and the co-venturers in proportion to the amount of net cash flow distributed to each partner for such year. Profits in excess of net cash flow shall be allocated between 59% -99% to EP2 and 1% - 41% to the co- venturers. Losses are allocated in varying proportions 59% - 100% to EP2 and 0% - 41% to the co-venturers as specified in the joint venture agreements.\nGains or losses resulting from sales or other dispositions of the projects shall be allocated as specified in the joint venture agreements.\nDistributions\nThe joint venture agreements provide that distributions will generally be paid from net cash flow monthly or quarterly, equivalent to 9% - 10% per annum return on EP2's net investment in the joint ventures. Any remaining cash flow is generally to be distributed first, to repay accrued interest and principal on certain loans and second, to EP2 and the co-venturers until they have received their accrued preference returns. The balance of any net cash flow is to be distributed in amounts ranging from 59% - 75% to EP2 and 25% - 41% to the co-venturers as specified in the joint venture agreements.\nDistributions of net proceeds upon the sale or disposition of the projects shall be made in accordance with formulas provided in the joint venture agreements.\nGuaranty Period\nThe joint venture agreements provided that during the Guaranty Periods (as defined in the joint venture agreements), in the event that net cash flow was insufficient to fund operations including amounts necessary to pay EP2 preferred distributions, the co-venturers were to be required to fund amounts equal to such deficiencies. The co- venturers' obligation to fund such amounts pursuant to their guarantees was generally to be in the form of capital contributions to the joint ventures. For a specified period of time subsequent to the Guaranty Period, one of the joint venture agreements required that mandatory loans be made to the joint venture by the co-venturer to the extent that operating revenues were insufficient to pay operating expenses.\nThe Guaranty and Mandatory Loan Periods of the joint ventures were generally from the date EP2 entered a joint venture for a period ranging from one to five years.\nThe expiration dates of the Guaranty and Mandatory Loan Periods for the joint ventures were as follows:\nMandatory Guaranty Period Loan Period\nChicago-625 Partnership December 15, 1989 N\/A Richmond Gables Associates September 1,1990 N\/A Daniel\/Metcalf Associates Partnership September 30, 1989 September 30, 1990 TCR Walnut Creek Limited Partnership August 31, 1990 N\/A Portland Pacific Associates February 1, 1991 N\/A West Ashley Shoppes Associates March 10, 1993 N\/A\nDuring 1989, the co-venture partner in the West Ashley Shoppes joint venture defaulted on its guaranty obligation. On April 25, 1990, EP2 and the co-venturer entered into the second amendment to the joint venture agreement. In accordance with the amendment, EP2 contributed $300,000 to the joint venture. In exchange for the $300,000 contributed by EP2, the co-venturer transferred to EP2 its rights to certain out-parcel land. Immediately thereon, the co- venturer satisfied its obligations to fund net cash flow shortfall contributions in arrears at December 31, 1989. As a result of this transaction, EP2 will receive an increased preferred return and is entitled to the first $300,000 in proceeds upon sale and\/or refinancing of the out-parcel land described above. Subsequent to the amendment to the joint venture agreement, the co-venturer defaulted on the guaranty obligations again. Net cash flow shortfall contributions owed by the co-venturer pursuant to the guaranty totalled approximately $1,060,000 at December 31, 1993. During 1991, EP2 filed suit against the co-venturer and the individual guarantors to collect the amount of the cash flow shortfall contributions in arrears. As of December 31, 1993, EP2 was negotiating with the co-venturer and the individual guarantors for their removal and the collection of all amounts owed by them to the Partnership. Any uncollected receivable amounts due from the co-venturer are expected to be offset against the co-venturer's capital account at the conclusion of the negotiations (see Note 9).\nAs of December 31, 1993, the co-venturer in the Daniel\/Metcalf Associates Partnership is obligated to make additional capital contributions of at least $88,644 (subject to adjustment pending the venture partners' determination of an additional amount, if any, of working capital reserves to be funded by the co-venturer) with respect to cumulative unfunded shortfalls in EP2's preferred return through September 30, 1990. Such additional capital contributions are not recorded as a receivable in the accompanying financial statements.\n4. Related Party Transactions\nThe Combined Joint Ventures originally entered into property management agreements with affiliates of the co-venturers, cancellable at EP2's option upon the occurrence of certain events. The management fees are equal to 3.5%-5% of gross receipts, as defined in the agreements. During 1992, EP2 exercised its option to terminate the management contract for West Ashley Shoppes and hired third-party management and leasing agents to administer the day-to-day operations of the property. The new property manager was hired for a management fee of 3% of gross receipts, as defined. Affiliates of certain co-venturers also receive leasing commissions with respect to new leases acquired.\nAccounts payable - affiliates at December 31, 1993 includes advances owed to a partner of Richmond Gables Associates of $47,949 for amounts paid to the manager of the venture's operating property for reimbursement of expenses paid on behalf of the joint venture and $15,434 owed to EP2 for organization costs paid in connection with the formation of Portland Pacific Associates. Accounts payable - affiliates at December 31, 1993 also includes advances totalling $85,722 from the venture partners of Portland Pacific Associates and $18,776 payable to related parties of Portland Pacific Associates in connection with services rendered to the venture.\nAccounts payable - affiliates at December 31,1992 includes advances owed to a partner of Richmond Gables Associates of $47,949 for amounts paid to the manager of the venture's operating property for reimbursement of expenses paid on behalf of the joint venture and $15,434 owed to EP2 for organization costs paid in connection with the formation of Portland Pacific Associates. Accounts payable - affiliates at December 31, 1992 also includes advances totalling $85,909 from the venture partners of Portland Pacific Associates in connection with services rendered to the venture.\n5. Capital Reserves\nThe joint venture agreements generally provide that reserves for future capital expenditures be established and administered by affiliates of the co-venturers. The co- venturers are to pay periodically into the reserve (as defined) as funds are available after paying all expenses and the EP2 preferred distribution. No contributions were made to the reserves in 1993 and 1992.\n6. Rental Revenues\nCertain joint ventures have operating leases with tenants which provide for fixed minimum rents and reimbursements of certain operating costs. Rental revenues are recognized on a straight-line basis over the life of the related lease agreements.\nMinimum rental revenues to be recognized on the straight- line basis in the future on noncancellable leases are as follows:\n1994 $ 7,200,428 1995 6,169,042 1996 5,317,377 1997 4,415,874 1998 4,279,934 Thereafter 14,336,350 $41,719,005\nLeases with four tenants of the 625 North Michigan Office Building accounted for approximately $2,231,000 (44%) of the rental revenue generated by that property for 1993. One tenant of West Ashley Shoppes occupies 55,850 square feet, representing approximately 41% of the total shopping center. This tenant, Phar-Mor, Inc., is in Chapter 11 Bankruptcy Reorganization as of December 31, 1993. Base rental income from this tenant for 1993 totalled $348,353. Minimum rents due from this tenant and included in the above amounts are $348,353 annually for 1994 through 1996, $357,070 for 1997, $374,503 for 1998 and $1,498,012 thereafter.\n7. Notes Payable\nNotes payable at December 31, 1993 and 1992 include permanent financing for the Treat Commons joint venture provided by EP2 in the amount of $1,000,000. The nonrecourse permanent loan is secured by a deed of trust and security agreement with an assignment of rents. Interest only payments were 9.5% until the end of the guaranty period (August 31, 1990), and are to be paid at 10% thereafter. Principal is due December 2012. Interest expense on this debt was $100,000 in 1993, 1992 and 1991.\nIn addition, notes payable at December 31, 1993 and 1992 include a nonrecourse mortgage payable arrangement entered into by Daniel\/Metcalf Associates on January 15, 1990 in the principal sum of $700,000. The mortgage payable is secured by the joint venture's operating investment property. The mortgage is due in full December 1, 1994, with interest payable monthly at the prime rate plus 1.5% per annum (7.5% at December 31, 1993).\n8. Encumbrances on Operating Investment Properties\nUnder the terms of the joint venture agreements, EP2 is entitled to use the joint venture operating properties as security for certain borrowings, subject to various restrictions. EP2 (together in one instance with an affiliated partnership) has exercised its options pursuant to this arrangement by issuing certain zero coupon notes. The operating investment properties of all of the Combined Joint Ventures have been pledged as security for these loans which mature in 1995. These borrowings are direct obligations of EP2 and its affiliate and, therefore, are not reflected in the accompanying financial statements. At December 31, 1993, the aggregate indebtedness of EP2 (and its affiliated partnership) under these loan agreements, including accrued interest, was approximately $30,424,000 ($27,682,000 at December 31, 1992). Under these borrowing arrangements, EP2 is required to make all loan payments and has indemnified the joint ventures and the other partners against all liabilities, claims and expenses associated with the borrowings. Based on the loan balances outstanding as of December 31, 1993, principal and interest on the obligations aggregating approximately $45.7 million is scheduled to mature in 1995.\nOne of the zero coupon loans, which is secured by the 625 North Michigan Office Building, requires that if the loan ratio, as defined, exceeds 80%, then EP2, together with its affiliated partnership, shall be required to deposit additional collateral in an amount sufficient to reduce the loan ratio to 80%. During 1993, the lender informed EP2 and its affiliated partnership that based on an interim property appraisal, the loan ratio exceeded 80% and demanded that additional collateral be deposited. Subsequently, EP2 and its affiliated partnership submitted an appraisal which demonstrated that the loan ratio exceeded 80% by an amount less than previously demanded by the lender and deposited additional collateral in accordance with the higher appraised value. The lender accepted the deposit of additional collateral, but disputed whether EP2 and its affiliated partnership had complied with the terms of the loan agreement regarding the 80% loan ratio. Subsequent to year-end, an agreement was reached with the lender on a proposal to refinance the loan and resolve the outstanding disputes. The terms of the agreement, which was formally executed in June 1994, extend the maturity date of the loan to May 1999. The new principal balance of the loan, after a principal paydown to be funded by EP2 and its affiliated partnership, will be approximately $16,225,000. The new loan will bear interest at a rate of 9.125% per annum and will require the current payment of interest and principal on a monthly basis based on a 25-year amortization period. The terms of the loan agreement also require the establishment of an escrow account for real estate taxes, as well as a capital improvement escrow which is to be funded with monthly deposits to be made by EP2 and its affiliated Partnership in the aggregate amount of $1,750,000 thorugh the scheduled maturity date of the loan.\n9. Subsequent Event\nIn May 1994, EP2 and its co-venture partner in the West Ashley Shoppes joint venture executed a settlement agreement to resolve their outstanding disputes, which are described in Note 2. Under the terms of the settlement agreement, the co-venturer assigned 96% of its interest in the joint venture to EP2 and the remaining 4% of its interest to the joint venture to Second Equity Partners, Inc. (SEPI), a Virginia corporation and an affiliate of EP2. In return for such assignment, EP2 agreed to release the co-venturer from all claims regarding net cash flow shortfall contributions owed to the joint venture. In conjunction with the assignment of its interest and withdrawal from the joint venture, the co-venturer agreed to release certain outstanding counter claims against EP2. EP2 and SEPI intend to continue the operations of the joint venture as a going concern. However, the settlement agreement has effectively given EP2 complete control over the affairs of the joint venture. Accordingly, beginning in 1994, the joint venture will be presented on a consolidated basis in the financial statements of EP2.\nSchedule XI - Real Estate and Accumulated Depreciation COMBINED JOINT VENTURES OF PAINEWEBBER EQUITY PARTNERS TWO LIMITED PARTNERSHIP SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1993","section_15":""}
{"filename":"276478_1994.txt","cik":"276478","year":"1994","section_1":"Item 1. Business\nGeneral American Transportation Corporation (GATC) is a wholly-owned subsidiary of GATX Corporation (GATX) and is engaged in the leasing and management of railroad tank cars and specialized freight cars and owns and operates tank storage terminals, pipelines and related facilities.\nIndustry Segments\nRailcar Leasing and Management\nThe Railcar Leasing and Management segment (Transportation) is principally engaged in leasing specialized railcars, primarily tank cars, under full service leases. As of December 31, 1994, its fleet consisted of approximately 59,800 railcars, including 50,700 tank cars and 9,100 specialized freight cars, primarily Airslide covered hopper cars and plastic pellet cars. Transportation has upgraded its fleet over time by adding new larger capacity cars and retiring older, smaller capacity cars. Transportation's railcars have a useful life of approximately 30 to 33 years. The average age of the railcars in Transportation's fleet is approximately 15 years.\nTransportation's customers use its railcars to ship over 700 different commodities, primarily chemicals, petroleum, food products and minerals. For 1994, approximately 54% of railcar leasing revenue was attributable to shipments of chemical products, 21% to petroleum products, 18% to food products and 7% to other products. Many of these products require cars with special features; Transportation offers a wide variety of sizes and types of cars to meet these needs. Transportation leases railcars to over 700 customers, including major chemical, oil, food and agricultural companies. No single customer accounts for more than 5% of total railcar leasing revenue.\nTransportation typically leases new equipment to its customers for a term of five years or longer, whereas renewals or leases of used cars are typically for periods ranging from less than a year to seven years with an average lease term of about three years. The utilization rate of Transportation's railcars as of December 31, 1994 was approximately 95%.\nUnder its full service leases, Transportation maintains and services its railcars, pays ad valorem taxes, and provides many ancillary services. Through its Car Status Service System, for example, the company provides customers with timely information about the location and readiness of their leased cars to enhance and maximize the utilization of this equipment. Transportation also maintains a network of service centers consisting of four major service centers and 24 mobile trucks in 17 locations. Transportation also utilizes independent third-party repair shops.\nTransportation purchases most of its new railcars from Trinity Industries, Inc. (Trinity), a Dallas-based metal products manufacturer, under a contract entered into in 1984 and extended from time to time thereafter, most recently in 1992. Transportation anticipates that through this contract it will continue to be able to satisfy its customers' new car lease requirements. Transportation's engineering staff provides Trinity with design criteria and equipment specifications, and works with Trinity's engineers to develop new technology where needed in order to upgrade or improve car performance or in response to regulatory requirements.\nThe full-service railcar leasing industry is comprised of Transportation, Union Tank Car Company, General Electric Railcar Services Corporation, Shippers Car Line division of ACF Industries, Incorporated, and many smaller companies. Of the approximately 193,000 tank cars owned and leased in the United States at December 31, 1994, Transportation had approximately 50,700. Principal competitive factors include price, service and availability.\nTerminals and Pipelines\nGATX Terminals Corporation (Terminals) is engaged in the storage, handling and intermodal transfer of petroleum and chemical commodities at key points in the bulk liquid distribution chain. All of its terminals are located near major distribution and transportation points and most are capable of receiving and shipping bulk liquids by ship, rail, barge and truck. Many of the terminals are also linked with major interstate pipelines. In addition to storing, handling and transferring bulk liquids, Terminals provides blending and testing services at most of its facilities. Terminals owns and operates 25 terminals in 11 states, two pipeline systems, and eight terminals in the United Kingdom; Terminals also has joint venture interests in 13 international facilities.\nAs of December 31, 1994, Terminals had a total storage capacity of 76 million barrels. This includes 57 million barrels of bulk liquid storage capacity in the United States, 7 million barrels in the United Kingdom, and an equity interest in another 12 million barrels of storage capacity in Europe and the Far East. Terminals' smallest bulk liquid facility has a storage capacity of 100,000 barrels while its largest facility, located in Pasadena, Texas, has a capacity of over 12 million barrels. Capacity utilization at Terminals' wholly-owned facilities was 94% at the end of 1994; throughput for the year was 671 million barrels.\nFor 1994, 76% of Terminals' revenue was derived from petroleum products and 21% from a variety of chemical products. Demand for Terminals' facilities is dependent in part upon demand for petroleum and chemical products and is also affected by refinery output, foreign imports, and the expansion of its customers into new geographical markets.\nTerminals serves approximately 300 customers, including major oil and chemical companies as well as trading firms and larger independent refiners. No single customer accounts for more than 6% of Terminals' revenue. Customer service contracts are both short term and long term.\nTerminals along with two Dutch companies, Paktank N.V. and Van Ommeren N.V., are the three major international public terminalling companies. The domestic public terminalling industry consists of Terminals, Paktank Corporation, International-Matex Tank Terminals, and many smaller independent terminalling companies. In addition to public terminalling companies, oil and chemical companies, which generally do not make their storage facilities available to others, also have significant storage capacity in their own private facilities. Terminals' pipelines compete with rail, trucks and other pipelines for movement of liquid petroleum products. Principal competitive factors include price, location relative to distribution facilities, and service.\nTrademarks, Patents and Research Activities\nPatents, trademarks, licenses, and research and development activities are not material to these businesses taken as a whole.\nCustomer Base\nGATC and its subsidiaries are not dependent upon a single customer or a few customers. The loss of any one customer would not have a material adverse effect on any segment or GATC as a whole.\nEmployees\nGATC and its subsidiaries have approximately 2,000 active employees, of whom 34% are hourly employees covered by union contracts.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nInformation regarding the location and general character of certain properties of GATC is included in Item 1, Business, of this document. The major portion of Terminals' land is owned; the balance is leased.\nItem 3.","section_3":"Item 3. Legal Proceedings\nA railcar owned by Transportation was involved in a derailment near Dunsmuir, California, in July 1991 that resulted in a spill of metam sodium into the Sacramento River. Various lawsuits seeking damages in unspecified amounts have been filed against GATC, or an affiliated company, most of which have been consolidated in the Superior Court of the State of California for the City and County of San Francisco (Nos. 2617 and 2620). GATC has now been dismissed by the class plaintiffs in those cases but remains in the cases with respect to the plaintiffs who have opted out of the class and with respect to indemnity and contribution claims. There is one other case seeking recovery for response costs and natural resource damages: State of California, et al, vs. Southern Pacific, et al, filed in the Eastern District of California (CIV-S-92 1117). All other actions have been consolidated with these two cases. GATC also has been named as a potentially responsible party by the State of California with respect to the assessment and remediation of possible damages to natural resources which claim has also been consolidated in the suit in the Eastern District of California. GATC has entered into provisional settlement agreements with the United States of America, the State of California, Southern Pacific and certain other defendants settling all material claims arising out of the above incident in an amount not material to GATC. Such settlement, however, is conditional on further court action. Further, it is the opinion of management that if damages are assessed and taking into consideration the probable insurance recovery, this matter will not have a material effect on GATC's consolidated financial position or results of operations.\nVarious lawsuits have been filed in the Superior Court for the State of California and served upon Terminals, Calnev Pipe Line Company, or another GATX subsidiary seeking an unspecified amount of damages arising out of the May 1989 explosion in San Bernardino, California. Those suits, all of which were filed in the County of San Bernardino unless otherwise indicated, are: Aguilar, et al, v. Calnev Pipe Line Company, et al, filed February 1990 in the County of Los Angeles (No. 0751026); Alba, et al, v. Southern Pacific Railroad Co., et al, filed November 1989 (No. 252842); Terry, et al, v. Southern Pacific, et al, filed December 1989 (No. 253604); Charles, et al, v. Calnev Pipe Line, Inc., et al, filed May 1990 (No. 256269); Abrego, et al, v. Southern Pacific Transportation Corporation, et al, filed May 1990 in the County of Los Angeles (No. BC 000947); Glaspie, et al, v. Southern Pacific Transportation, et al, filed May 1990 in the County of Los Angeles (No. BC002047); Burney, et al, v. Southern Pacific, et al, filed May 1990 in the County of Los Angeles (BC000876); Ledbetter, et al, v. City of San Bernardino, et al, filed May 1990 (No. 256173); Mary Washington v. Southern Pacific, et al, filed May 1990 and settled February 1995 (No. 256346); Stewart, et al, v. Southern Pacific Railroad Co., et al, filed May 1990 and settled May 1994 (No. 256464); Pearson v. Calnev Pipe Line Company, et al, filed May 1990 in the County of San Bernardino (No. 256206); Pollack v. Southern Pacific Transportation, et al, filed May 1992 (No. 271247); Davis v. Calnev Pipe Line Company, et al, filed May 1990 (No. 256207); J. Roberts, et al, v. Southern Pacific Transportation, et al, filed November 1992 and settled February 1995 (No. 275936); Goldie, et al, v. Southern Pacific, et al, filed May 1990 and settled July 1994; Irby, et al, v. Southern Pacific, et al, filed April 1990 and settled May 1994 (No. 255715); Reese, et al, v. Southern Pacific, et al\nfiled May 1990 and settled April 1994 (No. 256434); Nancy Washington, et al, v. Southern Pacific, et al, filed May 1990 and settled March 1994 (No. 256435); and Zamarripa, et al, vs. Southern Pacific Railroad Company, et al, filed November 1993 (No. 526684). Based upon information known to management, it remains management's opinion that if damages are assessed and taking into consideration probable insurance recovery, the ultimate resolution of the lawsuits arising out of the May 1989 explosion will not have a material effect on GATC's consolidated financial position or results of operations.\nThe San Bernardino County, California, District Attorney has notified Calnev Pipe Line Company that the District Attorney expects to pursue an action against Calnev for the alleged violation of Section 25507 of the California Health & Safety Code by failing to report, until May 23, 1994, a purported release of hazardous materials first discovered in July 1993. According to the District Attorney, violations of that Section are criminal misdemeanors punishable by a fine of $25,000 for each day that the release remained unreported. Calnev does not believe that it violated the reporting requirement of the Code and intends to vigorously defend any action brought by the District Attorney which alleges such a violation.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot required.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters\nGATX Corporation owns all of the outstanding common stock of GATC.\nItem 6.","section_6":"Item 6. Selected Financial Data\nNot required.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nGATC reported record net income of $87 million for 1994 compared to $74 million in 1993 and $66 million in 1992. The improvement was the result of strong operating results at both Transportation and Terminals. Operating results at Transportation improved in 1994 due to significantly more railcars on lease. Terminals reported record earnings in 1994 as the result of increased utilization and throughput. Transportation's 1993 earnings increased as higher revenues and lower ownership costs were somewhat offset by increased fleet repair expenses. Income at Terminals increased in 1993 as a result of higher revenues, reduced interest expense, and improved margins which were partially offset by higher SG&A expense and decreased earnings at its foreign affiliates. The comparison between the years was impacted by the federal income tax rate increase in 1993 and the adoption of two accounting pronouncements in 1992.\nAs a result of new tax legislation which increased the federal income tax rate from 34% to 35% retroactively to January 1, 1993, net income for 1993 included an increase to income taxes of $7 million for the cumulative increase in deferred income taxes and a $1 million increase for the current year. The impact of the tax rate change by segment is shown in a table on page 38.\nIn 1992, GATC adopted Statement of Financial Accounting Standards (SFAS) No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, and SFAS No. 109, Accounting for Income Taxes. SFAS No. 106 changed the method of accounting for postretirement benefits from the pay-as-you-go method to the accrual basis. This resulted in a one-time charge to earnings of $45 million for the transition obligation. SFAS No. 109 revised the method of accounting for deferred income taxes to the liability method which resulted in a $38 million favorable adjustment. These adjustments are shown by segment in a table on page 38.\nGROSS INCOME\nConsolidated gross income for 1994 of $643 million exceeded 1993 revenue of $602 million and 1992 revenue of $579 million.\nTransportation's 1994 gross income of $322 million increased $20 million from 1993. Rental revenues increased 7% attributable to an average of 3,000 additional railcars on lease and slightly higher average fleet rental rates. The level of fleet additions increased in response to improved demand for new tank cars, which is expected to continue in 1995. At the end of 1994, Transportation had 56,500 railcars on lease compared to 51,900 at the end of 1993 and fleet utilization was 95% compared to 93%.\nTerminals' record gross income of $303 million in 1994 was the result of strong performance at a number of individual terminal and pipeline operations. The increase of $22 million or 8% over 1993 was due to high petroleum demand and improved chemical activity which resulted in both increased throughput and higher utilization. Capacity utilization at Terminals' wholly-owned facilities was 94% at the end of 1994 compared to 92% a year earlier. Throughput was 671 million barrels, up 6% from 1993, reflecting the overall improvement in the U.S. economy.\nTransportation's 1993 gross income of $302 million increased $13 million from 1992. Rental revenues increased 4% attributable to an average of 940 additional cars on lease and higher average rental rates. The increased level of additions to the fleet was in anticipation of increased demand for new tank cars. Transportation had approximately 51,900 railcars on lease at December 31, 1993 compared to 50,100 a year earlier and fleet utilization improved to 93% from 92% at the end of 1992.\nTerminals' 1993 gross income of $281 million increased $15 million or 5% from 1992 reflecting continued strong demand for tanks and blending services at domestic petroleum terminals. Capacity utilization at the wholly-owned facilities was 92% at year end, up from 91% a year ago. Throughput from these facilities of 635 million barrels was down 4 million barrels from 1992 reflecting changes in the operating pattern of certain customers.\nCOSTS AND EXPENSES\nOperating expenses in 1994 increased $21 million or 8% over 1993. Transportation's operating expenses of $129 million increased $10 million from 1993 as a result of the increased level of operating lease assets and increased fleet repair costs, partially offset by lower environmental expense. Transportation continues to utilize sale leasebacks to finance its railcar additions. The leaseback is recorded as an operating lease which removes the asset and related liability from the balance sheet; the payments under the operating leases are recorded as operating lease expense. Fleet repair costs increased 10% over 1993 reflecting the increased number of cars repaired. Transportation's commitment to provide its customers with well maintained railcars, coupled with stricter maintenance standards in the industry and mandated inspection programs, will continue to increase repair costs. Transportation has been upgrading its repair facilities to control costs by improving the efficiency and productivity of the repair process and reducing the time a car is out of service. Operating margins were in line with 1993. Pressure on operating margins is expected to continue as higher standards of repair without compensating revenue increases characterize the industry today.\nTerminals' 1994 operating costs of $164 million increased $11 million over the prior year. Operating expenses increased mainly due to higher repair and maintenance spending, higher environmental costs and other costs as a result of expanded operations. Operating margins increased 1% through revenue improvement while controlling costs. Environmental and maintenance spending is expected to continue to grow in keeping with GATX's commitment to improve terminalling assets and to operate environmentally responsible facilities.\nOperating expenses in 1993 increased $16 million over 1992. Transportation's operating expenses of $119 million increased $15 million from 1992 as a result of increased railcar repair costs and higher operating lease expenses which increased due to the increased level of operating lease assets. Fleet repair costs increased 9% over 1992 reflecting higher volumes as a result of regulatory and customer requirements. Operating margins decreased slightly as the increase in fleet repair costs exceeded the growth in revenues. Terminals' operating costs of $153 million increased $1 million over 1992. Even though revenues increased, operating costs were flat with 1992 due to cost controls, resulting in improved operating margins.\nInterest expense decreased slightly in 1994 to $78 million primarily as a result of slightly lower average interest rates, partially offset by a higher average debt balance. A portion of the decrease in interest expense was offset by an increase in the operating lease rent component of operating expenses as a result of the sale leasebacks at Transportation. The increase in interest rates in the last half of 1994 and into 1995 should have minimal effect on results as assets are for the most part match funded. Other assets offer repricing opportunities as contracts are renewed. The company continues to use interest rate swaps to better match the duration of the debt portfolio to the terms of the railcar leases. The effect of the swaps was to reduce interest expense in 1994 and 1993.\nInterest expense of $79 million in 1993 decreased $17 million from 1992 due to lower interest rates, the full-year effect of the 1992 refinancings at lower rates, the effect of interest rate swaps and a reduced debt balance as a result of the sale leasebacks.\nThe provision for depreciation and amortization increased $7 million from 1993 which in turn increased $4 million over 1992. Depreciation expense increased as result of the continued growth in assets.\nSelling, general and administrative expenses of $47 million increased $5 million from 1993 which in turn increased $3 million from 1992 primarily due to expanded operations and higher training and information systems costs at Terminals.\nIncome tax expense of $43 million decreased $2 million from 1993. The effective tax rate for 1994 was 38%. The 1993 effective tax rate of 43% exceeded the statutory rate primarily as the result of the increase in deferred taxes due to the increase in the federal income tax rate from 34% to 35%. Income tax expense of $32 million for 1992 reflected an effective tax rate of 36%. The effective tax rate for all years was higher than the statutory rate because of state taxes and nondeductible items.\nEQUITY IN NET EARNINGS OF AFFILIATED COMPANIES\nEquity in net earnings of affiliated companies of $17 million increased $2 million from 1993 which had in turn decreased $2 million from 1992. The increase in 1994 was primarily due to higher equity earnings from certain European terminals as a result of improved results and favorable foreign exchange rates. Terminals' equity earnings decreased $2 million in 1993 reflecting the weak economies in Europe and Japan, partially offset by favorable results at the Singapore affiliates due to expansion and demand for services.\nCUMULATIVE EFFECT OF ACCOUNTING CHANGES\nThe cumulative effect of accounting changes generated a $7 million reduction in 1992 net income. This adjustment resulted from the recording of a one- time non-cash net accounting charge for postretirement benefits and deferred taxes. SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, requires that certain postretirement benefits, principally health care and life insurance, be recognized in the financial statements on an accrual basis rather than on a pay-as-you-go basis. GATC recorded a one- time aftertax charge of $45 million for the transition obligation related to the implementation of this Standard.\nThe principal change resulting from SFAS No. 109, Accounting for Income Taxes, is the recording of deferred taxes at amounts ultimately considered payable, which resulted in a $38 million favorable adjustment.\nNET INCOME\nConsolidated net income of $87 million in 1994 increased $13 million from 1993 as a result of improved operating performance. In addition, net income for 1993 was reduced by a charge of $7 million for the cumulative increase in deferred income taxes. Transportation's 1994 income from operations increased 6% over 1993 due to significantly more railcars on lease. Increased rental income and lower environmental expense were partially offset by increased fleet repair costs, higher ownership costs and lower investment earnings. Ownership costs, consisting of rental expense, depreciation and interest, increased 9% primarily due to the high level of railcar additions. Terminals' 1994 income from operations increased 11% from 1993 reflecting higher revenues, slightly improved margins and increased earnings by its foreign affiliates which were partially offset by higher SG&A expenses. Overall, the continuing focus on improving physical assets, information systems and people to provide for the long-term success of Terminals may constrain near-term earnings growth.\nConsolidated net income of $74 million in 1993 increased $8 million from 1992 primarily due to improved operating performance. Net income for 1993 was reduced $7 million for the cumulative increase in deferred income taxes and $1 million for the current year impact of the tax rate increase. Net income for 1992 was reduced $7 million for the cumulative effect of accounting changes. Transportation's 1993 income from operations increased 7% over 1992 as higher revenues and lower ownership costs were somewhat offset by increased fleet repair expenses. Ownership costs decreased slightly despite an increased fleet size due to lower interest rates, debt refinancings and interest rate swaps which were executed to more closely match Transportation's debt with the railcar lease terms. Terminals' 1993 income from operations increased 24% from the prior year. Higher revenues, reduced interest expense reflecting lower interest rates and debt refinancings, and improved margins were partially offset by higher SG&A expense and decreased earnings at foreign affiliates.\nASSETS\nTotal assets at year end of $2.5 billion were $251 million higher than 1993.\nProperty, plant and equipment increased $279 million to $3.0 billion. Transportation invested $264 million in new and used railcars and $18 million to upgrade its repair shops, which was partially offset by the sale leaseback of $130 million of such railcar additions. As these leasebacks qualified as operating leases, the assets were removed from the balance sheet. Terminals invested $154 million for tank construction, facility improvements, and terminal acquisitions.\nInvestments in affiliated companies increased $34 million. New investments of $13 million included a European rail joint venture and an increased ownership interest in a Singapore terminal facility. Equity income of $17 million and $7 million of unrealized translation gains and other changes were partially offset by $3 million of cash distributions.\nLIABILITIES AND EQUITY\nTotal debt increased $152 million to fund a portion of the significant volume of capital additions made during the year.\nConsolidated equity increased $60 million attributable to 1994 earnings of $87 million partially reduced by dividends paid to GATX Corporation of $47 million. The balance of the change is attributable to foreign currency translation adjustments.\nLIQUIDITY AND CAPITAL RESOURCES\nGATC generates significant cash from its operating activities. Most of its capital requirements represent additions to the railcar fleet, terminal and pipeline facilities, and joint ventures, and are considered discretionary capital expenditures. However, the non-discretionary level of Terminals' capital program has grown due to the increasing regulatory and environmental requirements of the terminalling business. The level of discretionary capital spending can be adjusted as conditions in the economy or GATC's businesses warrant.\nCash provided by operating activities in 1994 of $201 million decreased $5 million compared to 1993. Net income adjusted for non-cash items generated $209 million of cash, up $16 million from 1993. Other generated $22 million less cash than in 1993 primarily as a result of a decrease in working capital.\nCash provided by operating activities in 1993 of $206 million increased $16 million compared to 1992. Net income adjusted for non-cash items generated $193 million of cash, up $5 million from 1992. Other generated $11 million more cash than in 1992 primarily as the result of the increase in payables.\nCash used in investing activities increased $181 million from 1993. Capital additions of $440 million were up $167 million from 1993. Transportation invested $264 million in the railcar fleet versus $171 million in the prior year; $18 million also was invested in a multi-year program to significantly upgrade its repair facilities versus $24 million in 1993. This program should be completed in 1995. Terminals' capital spending of $154 million increased $77 million from 1993 and included the acquisition of six additional terminal facilities plus the expansion or upgrading of several existing terminal facilities. Proceeds from asset dispositions of $137 million in 1994 included a $130 million sale leaseback of certain railcars at Transportation. GATC has used this method of financing its railcar fleet as an attractive opportunity given GATX's alternative minimum tax position.\nCash used in investing activities increased $10 million in 1993 from the prior year. Capital additions of $273 million were up $80 million from 1992's level of $193 million. Transportation invested $171 million in the railcar fleet, up $63 million from the prior year. In addition, Transportation invested $24 million on its multi-year program to significantly upgrade its repair facilities, up $16 million from 1992. Terminals expended $78 million in 1993, similar to 1992 levels, for tank construction and other modifications and improvements. Proceeds from asset dispositions of $152 million in 1993 included $138 million received on the sale leaseback of railcar additions at Transportation.\nCash provided by financing activities was $104 million in 1994 compared to $79 million of cash used in financing activities in 1993. GATC finances its capital additions through cash generated from operating activities, debt financings, and the sale leasebacks of railcars. During the year $182 million of long-term debt was issued and $56 million of long-term obligations were repaid. Short-term debt increased by $25 million to a balance of $129 million.\nCash used in financing activities was $79 million in 1993, comparable to 1992. During 1993, $63 million of long-term debt was issued and $67 million of long-term obligations were repaid. Short-term debt decreased by $29 million to a balance of $104 million.\nGATC and GATX Terminals have revolving credit facilities. GATC also has a commercial paper program and uncommitted money market lines which are used to fund operating needs. In 1994, GATC amended its credit facility to extend until 1998. Under the covenants of the commercial paper programs and rating agency guidelines, GATC must keep unused revolver capacity at least equal to the amount of commercial paper and money market lines outstanding. At December 31, 1994, GATC and its subsidiaries had available unused committed lines of credit amounting to $196 million.\nGATC has a $650 million shelf registration for debt securities and pass through trust certificates under which $175 million of notes and $93 million of pass through trust certificates have been issued. At year end, GATC had $174 million of commitments to acquire assets, all of which are scheduled to fund in 1995.\nEnvironmental Matters\nCertain of GATC's operations present potential environmental risks principally through the transportation or storage of various commodities. Recognizing that some risk to the environment is intrinsic to its operations, GATC is committed to protecting the environment, as well as complying with applicable environmental protection laws and regulations. GATC, as well as its competitors, is subject to extensive regulation under federal, state and local environmental laws which have the effect of increasing the costs and liabilities associated with the conduct of its operations. In addition, GATC's foreign operations are subject to environmental regulations in effect in each respective jurisdiction.\nGATC's policy is to monitor and actively address environmental concerns in a responsible manner. GATC has received notices from the U.S. Environmental Protection Agency (EPA) that it is a potentially responsible party (PRP) for study and clean-up costs at 11 sites under the requirements of the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980 (Superfund). Under Superfund and comparable state laws, GATC may be required to share in the cost to clean-up various contaminated sites identified by the EPA and other agencies. In all but one instance, GATC is one of a number of financially responsible PRPs and has been identified as contributing only a small percentage of the contamination at each of the sites. Due to various\nfactors such as the required level of remediation and participation in clean- up efforts by others, GATC's total clean-up costs at these sites cannot be predicted with certainty; however, GATC's best estimates for remediation and restoration of these sites have been determined and are included in its environmental reserves.\nFuture costs of environmental compliance are indeterminable due to unknowns such as the magnitude of possible contamination, the timing and extent of the corrective actions that may be required, the determination of the company's liability in proportion to other responsible parties, and the extent to which such costs are recoverable from third parties including insurers. Also, GATC may incur additional costs relating to facilities and sites where past operations followed practices and procedures that were considered acceptable at the time but in the future may require investigation and\/or remedial work to ensure adequate protection to the environment under current or future standards. If future laws and regulations contain more stringent requirements than presently anticipated, expenditures may be higher than the estimates, forecasts, and assessments of potential environmental costs provided below. However, these costs are expected to be at least equal to the current level of expenditures. In addition, GATC has provided indemnities for environmental issues to the buyers of two divested companies for which GATC believes it has adequate reserves.\nGATC's environmental reserve at the end of 1994 was $80 million and reflects GATC's best estimate of the cost to remediate its environmental conditions. Additions to the reserve were $27 million in 1994 and $17 million in 1993; 1994 included $13 million recorded in conjunction with terminal acquisitions. Expenditures charged to the reserve amounted to $12 million and $10 million in 1994 and 1993, respectively.\nIn 1994, GATC made capital expenditures of $15 million for environmental and regulatory compliance compared to $18 million in 1993. These projects included marine vapor recovery, discharge prevention compliance, waste water systems, impervious dikes, tank modifications for emissions control, and tank car cleaning systems. Environmental projects authorized or currently under consideration would require capital expenditures of approximately $30 million in 1995. It is anticipated that GATC will make annual expenditures at a similar annual level over the next five years.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe response to this item is submitted under Item 14 (a)(1) 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\nNot required.\nItem 11.","section_11":"Item 11. Executive Compensation\nNot required.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nNot required.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nNot required.\nPART IV\nItem 14.","section_14":"Item 14. Financial Statement Schedules, Reports on Form 8-K and Exhibits\n(a) (1) Financial Statements PAGE\nThe consolidated financial statements of General American Transportation Corporation and its subsidiaries which are required in Item 8 are listed below:\nStatements of Consolidated Income and Reinvested Earnings-- years ended December 31, 1994, 1993 and 1992.............. 19 Consolidated Balance Sheets--December 31, 1994 and 1993..... 20 Statements of Consolidated Cash Flows-- years ended December 31, 1994, 1993 and 1992.............. 22 Notes to Consolidated Financial Statements.................. 23\n(2) Financial Statement Schedules\nSchedule II Valuation and Qualifying Accounts................40\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.\nItem 14. Financial Statement Schedules, Reports on Form 8-K and Exhibits\n(b) General American Transportation Corporation filed a Current Report on Form 8-K dated December 7, 1994, with respect to the offering of $100 million principal amount of 8-5\/8% Notes due December 1, 2004. Copies of the Note and Underwriting Agreement entered into by GATC as part of this transaction were filed as part of the 8-K Report.\n(c) Exhibit Index\nExhibit Number Exhibit Description Page - ---------- ---------------------------------------------- -----\n3A. Certificate of Incorporation of General American Transportation Corporation, incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1991, file number 2-54754.\n3B. By-Laws of General American Transportation Corporation, as amended and restated as of June 15, 1994, file number 2-54754. Submitted to the SEC along with the electronic submission of this Report on Form 10-K.\n4A. Indenture dated October 1, 1987, incorporated by reference to Exhibit 4.1 to the GATC Registration Statement on Form S-3 filed October 8, 1987, file number 33-17692; Indenture Supplement dated May 15, 1988, incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, file number 2-54754. Second Supplemental Indenture dated as of March 15, 1990, incorporated by reference to GATC Quarterly Report on Form 10-Q for the quarter ended March 30, 1990, file number 2-54754.\n4B. General American Transportation Corporation Notices 1 through 6 dated from November 6, 1987 through April 12, 1988 defining the rights of holders of GATC's Medium-Term Notes Series A issued during that period, incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, file number 2-54754.\n4C. General American Transportation Corporation Notices 1 through 3 dated from October 17, 1988 through October 24, 1988 and 4 through 6 dated from November 7, 1988 through March 3, 1989 defining the rights of holders of GATC's Medium-Term Notes Series B issued during those periods, Notices 1 through 3 incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended September 30, 1988, and Notices 4 through 6 incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1988, file number 2-54754.\nExhibit Number Exhibit Description Page - ---------- ---------------------------------------------- -----\n4D. General American Transportation Corporation Notices 1 and 2 dated from March 30, 1989 through March 31, 1989, Notices 3 through 8 dated from April 4, 1989 through June 29, 1989, Notices 9 through 16 dated from July 19, 1989 through September 29, 1989, and Notices 17 through 21 dated from October 2, 1989 through October 9, 1989 defining the rights of the holders of GATC's Medium-Term Notes Series C issued during those periods. Notices 1 and 2, Notices 3 through 8 and Notices 9 through 16 are incorporated by reference to the GATC Quarterly Reports on Form 10-Q for the quarters ended March 31, 1989, June 30, 1989 and September 30, 1989, respectively, and Notices 17 through 21 incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1989, file number 2-54754.\n4E. General American Transportation Corporation Notices 1 and 2 dated February 27, 1992, Notices 3 through 5 dated from December 7, 1992 through December 14, 1992 and Notices 6 through 10 dated from May 18, 1993 through May 25, 1993 defining the rights of the holders of GATC's Medium-Term Notes Series D issued during those periods. Notices 1 and 2 are incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended March 31, 1992, Notices 3 through 5 are incorporated by reference to the GATC Annual Report on Form 10-K for the fiscal year ended December 31, 1992, and Notices 6 through 10 are incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ending June 30, 1993, file number 2-54754.\n4F. General American Transportation Corporation Notices 1 and 2 dated June 8, 1994, Notices 3 through 6 dated June 17, 1994, and Notices 7 through 11 dated July 18, 1994, defining the rights of the holders of GATC's Medium-Term Notes Series E issued during those periods. Notices 1 through 6 are incorporated by reference to the GATC Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, and Notices 7 through 11 are incorporated herein by reference to the Form 424(b)(5) dated July 18, 1994, file number 2-54754.\n4G. Form of 8-5\/8% Note due December 1, 2004 filed with the SEC on Current Report on Form 8-K on December 7, 1994, file number 2-54754.\nExhibit Number Exhibit Description Page - ---------- ---------------------------------------------- -----\n10A. Third Amended and Restated Revolving Credit Agreement for GATC dated as of March 31, 1994, incorporated by reference to GATC's Quarterly Report on Form 10-Q for the period ended March 31, 1994, file number 2-54754.\n10B. Revolving Credit Facility Agreement for GATX Terminals Limited as borrower and GATC as guarantor dated as of July 13, 1993, incorporated by reference to GATC's Quarterly Report on Form 10-Q for the period ended September 30, 1993, file number 2-54754.\n12. Statement regarding computation of ratios of earnings 41 to fixed charges.\n23. Consent of Independent Auditors 42\n27. Financial Data Schedule for GATC for the fiscal year ended December 31, 1994, file number 1-2328. Submitted to the SEC along with the electronic submission of this report on Form 10-K.\nAny instrument defining the rights of security holders with respect to nonregistered long-term debt not being filed on the basis that the amount of securities authorized does not exceed 10 percent of the total assets of the company and subsidiaries on a consolidated basis will be furnished to the 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.\nGENERAL AMERICAN TRANSPORTATION CORPORATION (Registrant)\n\/s\/D. Ward Fuller ----------------------------------- D. Ward Fuller President, Chief Executive Officer and Director March 22, 1995\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\/s\/D. Ward Fuller ---------------------------------- D. Ward Fuller President, Chief Executive Officer and Director March 22, 1995\n\/s\/Donald J. Schaffer ---------------------------------- Donald J. Schaffer Vice President, Finance and Chief Financial Officer March 22, 1995\n\/s\/James J. Glasser ---------------------------------- James J. Glasser Director March 22, 1995\n\/s\/Ronald H. Zech ---------------------------------- Ronald H. Zech Director March 22, 1995\n\/s\/David M. Edwards ---------------------------------- David M. Edwards Director March 22, 1995\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors General American Transportation Corporation\nWe have audited the consolidated financial statements and related schedule of General American Transportation Corporation (a wholly-owned subsidiary of GATX Corporation) and subsidiaries listed in Item 14(a)(1) and (2) of the Annual Report on Form 10-K of General American Transportation Corporation for the year ended December 31, 1994. These financial statements and related schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and related 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 and related schedule. 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 General American Transportation Corporation and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, it is 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 the notes to the consolidated financial statements, in 1992 the company changed its method of accounting for postretirement benefits other than pensions and income taxes.\nERNST & YOUNG LLP\nChicago, Illinois January 24, 1995\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nSee notes to consolidated financial statements.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nSee notes to consolidated financial statements.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE A--SIGNIFICANT ACCOUNTING POLICIES\nSignificant accounting policies of General American Transportation Corporation (GATC) and its consolidated subsidiaries are discussed below.\nConsolidation: The consolidated financial statements include the accounts of GATC and its majority-owned subsidiaries. Investments in 20 to 50 percent-owned companies and joint ventures are accounted for under the equity method and are shown as investments in affiliated companies. Less than 20 percent-owned affiliated companies are recorded using the cost method.\nCash Equivalents: GATC considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. The carrying amounts reported in the balance sheet for cash and cash equivalents approximate the fair value of those assets.\nProperty, Plant and Equipment: Property, plant and equipment are stated principally at cost. Assets acquired under capital leases are included in property, plant and equipment and the related obligations are recorded as liabilities. Provisions for depreciation include the amortization of the cost of capital leases and are computed by the straight-line method which results in equal annual depreciation charges over the estimated useful lives of the assets. The estimated useful lives of depreciable assets are as follows:\nRailcars 20-33 years Buildings, leasehold improvements, storage tanks, and pipelines 5-45 years Machinery and related equipment 3-20 years\nGoodwill: GATC has classified the cost in excess of the fair value of net assets acquired as goodwill. Goodwill, which is included in other assets, is being amortized on a straight-line basis over 40 years. Goodwill, net of accumulated amortization of $2.2 million and $1.9 million, was $19.5 million and $18.7 million as of December 31, 1994 and 1993, respectively. Amortization expense was $.5 million for 1994, 1993 and 1992.\nIncome Taxes: In February 1992, Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, was issued by the Financial Accounting Standards Board which, among other things, requires that recognition of deferred income taxes be measured by the provisions of enacted tax laws in effect at the date of the financial statements. This Statement was adopted by GATC in the first quarter of 1992. The cumulative effect of the adoption of this Statement was to reduce the deferred tax liability by $37.8 million in 1992. This amount was added to net income and thereby to shareholders' equity.\nUnited States income taxes have not been provided on the undistributed earnings of foreign subsidiaries and affiliates which GATC intends to permanently reinvest in these foreign operations. The cumulative amount of such earnings was $121.3 million at December 31, 1994.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE A--SIGNIFICANT ACCOUNTING POLICIES (CONT'D)\nOther Deferred Items: Other deferred items include the accrual for postretirement benefits other than pensions in addition to environmental, general liability, and workers' compensation reserves, and other deferred credits.\nOff-Balance-Sheet Financial Instruments: GATC uses interest rate and currency swaps and currency forwards to set interest and exchange rates on existing or anticipated transactions. GATC may also, on occasion, use caps, forwards, and other similar contracts. These contracts qualify for hedge accounting. Fair values of GATC's off-balance financial instruments (futures, swaps, forwards, options and purchase commitments) are based on current market prices, settlement values or fees currently charged to enter into similar agreements. The fair values of the hedge contracts are not recognized in the financial statements. Net amounts paid or received on such contracts are recognized over the term of the contract as an adjustment to interest expense or the basis of the hedged financial instrument.\nEnvironmental Liabilities: Expenditures that relate to current or future 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 charged to environmental reserves. Reserves are recorded in accordance with accounting guidelines to cover work at identified sites when GATC's liability for environmental clean-up is both probable and a minimum estimate of associated costs can be made; adjustments to initial estimates are recorded as necessary.\nRevenue Recognition: The majority of GATC's gross income is derived from the rentals of railcars and terminalling and other services.\nForeign Currency Translation: The assets and liabilities of GATC operations located outside the United States are translated at exchange rates in effect at year end, and income statements are translated at the average exchange rates for the year. Gains or losses resulting from the translation of foreign currency financial statements are deferred and recorded as a separate component of consolidated shareholder's equity. Incremental unrealized translation gains (losses) recorded in the cumulative foreign currency translation adjustment account were $19.1 million, $(5.8) million and $(2.8) million during 1994, 1993, and 1992, respectively.\nReclassifications: Certain amounts in the 1993 and 1992 financial statements have been reclassified to conform to the 1994 presentation.\nNOTE B--ACCOUNTING FOR LEASES\nThe following information pertains to GATC as a lessor:\nOperating leases: Railcar and tankage assets included in property, plant and equipment are classified as operating leases.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE B--ACCOUNTING FOR LEASES (CONT'D)\nThe following information pertains to GATC as a lessee:\nCapital leases: Certain railcars are leased by GATC under capital lease agreements. Property, plant and equipment includes cost and related allowances for depreciation of $153.1 million and $70.0 million, respectively, at December 31, 1994 and $153.2 million and $63.5 million, respectively, at December 31, 1993 for these railcars. The cost of these assets is amortized on the straight-line basis with the charge included in depreciation expense.\nOperating leases: GATC has financed railcars through sale leasebacks which are accounted for as operating leases. In addition, GATC leases certain other assets and office facilities. Total rental expense for the years ended December 31, 1994, 1993, and 1992 was $50.3 million, $39.8 million, and $29.8 million, respectively.\nThe above capital lease amounts do not include the cost of licenses, taxes, insurance and maintenance which GATC is required to pay. Interest expense on the above capital lease obligations was $11.3 million in 1994, $11.8 million in 1993, and $12.3 million in 1992.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE C--ADVANCES TO\/FROM PARENT\nInterest income on advances to GATX, which is included in gross income on the income statement, was $17.4 million in 1994, $18.4 million in 1993, and $23.4 million in 1992. Interest income was based on an interest rate which was periodically adjusted in accordance with short-term commercial paper rates and averaged 4.09% in 1994, 4.30% in 1993, and 6.20% in 1992.\nInterest expense on advances from GATX to GATC was $1.8 million in 1994, $2.2 million in 1993, and $2.7 million in 1992. These advances have no fixed maturity date. Interest expense was based on interest rates computed as described in the preceding paragraph.\nNOTE D--INVESTMENTS IN AFFILIATED COMPANIES\nGATC has investments in 20 to 50 percent-owned companies and joint ventures which are accounted for using the equity method. These investments include a Canadian railcar company and foreign tank storage terminals. Distributions received from such jointly-owned companies were $2.6 million in 1994, and $3.1 million in both 1993 and 1992.\nNOTE E--FOREIGN OPERATIONS\nForeign operations were not material to the consolidated gross income or pretax income of GATC for any of the years presented. GATC has investments in affiliated companies which are located in foreign countries. Equity income from these foreign affiliates for 1994, 1993 and 1992 was $16.9 million, $14.6 million and $16.3 million, respectively. The foreign identifiable assets of\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE E--FOREIGN OPERATIONS (CONT'D)\nGATC are investments in affiliated companies and a United Kingdom terminalling operation which is fully consolidated.\nForeign cash flows generated are used to meet local operating needs and for reinvestment. The translation of the foreign balance sheets into U.S. dollars results in an increase or decrease to the unrealized foreign currency translation account.\nNOTE F--SHORT-TERM LINES OF CREDIT\nUnder a revolving credit agreement with a group of banks, GATC may borrow up to $250.0 million. The revolving credit agreement contains various restrictive covenants which include, among other things, minimum net worth, restrictions on additional indebtedness, and requirements to maintain certain financial ratios for GATC. Under the agreement GATC met its requirement to maintain a minimum net worth of $550.0 million at December 31, 1994. While at year end no borrowings were outstanding under the agreement, the available line of credit was reduced by $60.0 million of commercial paper outstanding. GATC had borrowings of $36.5 million under unsecured money market lines. Also, GATX Terminals has a revolving credit agreement of pounds25.0 million of which pounds4.0 million was available at year end.\nInterest expense on short-term debt was $6.2 million in 1994, $4.2 million in 1993, and $3.9 million in 1992.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE G--LONG-TERM DEBT\nInterest cost incurred on long-term debt, net of capitalized interest, was $59.0 million in 1994, $60.5 million in 1993, and $77.1 million in 1992. Interest cost capitalized as part of the cost of acquisition or construction of major assets was $2.7 million in 1994, $2.4 million in 1993, and $2.8 million in 1992. The loss recorded on the early retirement of debt was $.3 million in 1994 and $3.3 million in 1992.\nNOTE H - OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS\nIn the ordinary course of business, GATC enters into various types of transactions that involve contract and financial instruments with off- balance-sheet risk. These instruments are entered into to manage financial market risk, including interest rate and foreign exchange risk.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE H--OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS (CONT'D)\nGATC manages its assets and liabilities using interest rate swaps to better match the duration of its debt portfolio to the lease terms of its railcar assets. Railcar assets are financed with fixed rate long-term debt or through sale leasebacks. Assets are placed on lease with average new lease terms of 5 years; the average renewal term is 3 years. Rents are fixed over these lease terms. In its swaps, GATC agrees to exchange, at specific intervals, the difference between fixed and floating rate interest amounts calculated on an agreed upon notional principal amount. The swaps have in effect converted $100 million of long-term fixed rate debt into floating rate debt and $500 million of long-term fixed rate debt into 1-3 year fixed rate debt. As leases on railcars are renewed, the new lease rate should more closely correlate with the terms of the swapped debt.\nThe net amount payable or receivable from the interest rate swap agreements is accrued as an adjustment to interest expense. The fair value of its interest rate swap agreements is the amount the company would receive or pay to terminate the swap agreement; at year end, GATC would pay $45.2 million if the swaps were terminated. At December 31, 1993, $900.0 million of interest rate swaps were in effect; the fair value of the swap components would have resulted in a net payment to GATC of $7.5 million if the swaps were terminated at that time.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE H--OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS (CONT'D)\nTransportation has a contract to operate and manage a Mexican railcar operation with an advance Peso payment due in January 1995. In December 1994, a forward contract to purchase Pesos was entered into to convert U.S. $6.2 million to 30.375 million pesos. This contract was settled in January and the subsequent loss recorded as an adjustment to the concession cost to be amortized straight line over its life. In conjunction with the financing of the purchase of an interest in a joint venture, Terminals has forward contracts to purchase 14.0 million Singapore dollars in exchange for $9.6 million. These contracts will settle between January and September 1995. Any gain or loss from the settlement will be allocated over the term of the financing.\nIn the event that a counterparty fails to meet the terms of the interest rate swap agreement or a foreign exchange contract, GATC's exposure is limited to the interest rate or currency differential. GATC manages the credit risk of counterparties by dealing only with institutions that the company considers financially sound and by avoiding concentrations of risk with a single counterparty. GATC considers the risk of nonperformance to be remote.\nNOTE I - FAIR VALUE OF OTHER FINANCIAL INSTRUMENTS\nSFAS No. 107, Disclosures about Fair Value of Financial Instruments, defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. The following table presents the carrying amounts and estimated fair values of GATC's financial instruments that are recorded on the balance sheet at year end (in millions):\nThe carrying amounts shown in the table are included in the balance sheet under the indicated captions.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments:\nCash and cash equivalents, trade receivables, trade payables and short-term debt are carried at cost which approximates fair value because of the short maturity of those instruments.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE I - FAIR VALUE OF OTHER FINANCIAL INSTRUMENTS (CONT'D)\nThe carrying amounts reported in the balance sheet for the Due from GATX Corporation approximate fair value.\nThe carrying amounts of variable rate long-term debt reported in the balance sheet approximate fair value. The fair value of fixed rate long-term debt was estimated by aggregating the notes and performing a discounted cash flow calculation using a weighted average note term and market rate based on GATC's current incremental borrowing rates for similar types of borrowing arrangements.\nNOTE J--PENSION BENEFITS\nGATC and its subsidiaries contributed to several pension plans sponsored by GATX which cover substantially all employees. Benefits under the plans are based on years of service and\/or final average salary. The funding policy for all plans is based on an actuarially determined cost method allowable under Internal Revenue Service regulations. Contributions to these plans were $6.6 million in 1994, $6.7 million in 1993, and $5.1 million in 1992.\nCosts pertaining to the GATX plans are allocated to GATC on the basis of payroll costs with respect to normal cost and on the basis of actuarial determinations for prior service cost.\nNet periodic pension cost for 1994, 1993, and 1992 was $2.6 million, $3.4 million, and $3.4 million, respectively. Plan benefit obligations, plan assets, and the components of net periodic cost for individual subsidiaries of GATX have not been determined.\nNOTE K--POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nGATC provides health care, life insurance and other benefits for certain retired employees who meet established criteria. Most domestic employees are eligible for health care and life insurance benefits if they retire from GATC with immediate pension benefits under the GATX pension plan. The plans are either contributory or non-contributory, depending on various factors.\nIn 1992, GATC implemented SFAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, using the immediate recognition transition method, effective as of January 1, 1992. SFAS No. 106 requires recognition of the cost of postretirement benefits during an employee's active service life. GATC's previous practice was to expense these costs as they were paid. GATC recorded a charge of $44.5 million ($68.6 million pretax) in the first quarter of 1992 to reflect the cumulative effect of the change in accounting principle for periods prior to 1992. Aside from the one-time impact of the transition obligation, adoption of SFAS No. 106 was not material to 1992 financial results.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE K--POSTRETIREMENT BENEFITS OTHER THAN PENSIONS (CONT'D)\nThe accrued postretirement benefit liability was determined using an assumed discount rate of 7.75% for 1994 and 1993 and 8.5% for 1992. The effect of the change in the discount rate assumption was a deferred loss of $4.2 million in 1993.\nFor measurement purposes, blended rates ranging from 11% decreasing to 5% over the next three years and remaining at that level thereafter were used for the increase in the per capita cost of covered health care benefits. The health care cost trend rate assumption has a significant effect on the amount of the obligation and periodic cost reported. An increase in the assumed health care cost trend rates by 1% would increase the accumulated postretirement benefit obligation by $4.4 million and would increase aggregate service and interest cost components of net periodic postretirement benefit cost by $.4 million per year.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE L--INCOME TAXES\nEffective January 1, 1992, GATC changed its method of accounting for income taxes from the deferred method to the liability method required by SFAS No. 109, Accounting for Income Taxes. As permitted under the new rules, prior years' financial statements have not been restated. The cumulative effect of adopting this Statement as of January 1, 1992 was to increase net income by $37.8 million. Aside from the one-time impact due to the reassessment of deferred taxes, adoption of SFAS No. 109 was not material to 1992 financial results.\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.\nAt December 31, 1994, GATC had an alternative minimum tax credit of $1.0 million that can be carried forward indefinitely to reduce future regular tax liabilities.\nThe results of operations of GATC and its United States subsidiaries are included in the consolidated federal income tax return of GATX. Current provisions for federal income taxes represent amounts payable to GATX resulting from inclusion of GATC's operations in the consolidated federal income tax return. Amounts shown as currently payable for federal income taxes represent taxes payable due to the alternative minimum tax.\nGATC's sources of income before income taxes and equity in net earnings of affiliated companies were almost entirely domestic.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE L--INCOME TAXES (CONT'D)\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE M--COMMITMENTS, CONTINGENCIES AND CONCENTRATIONS OF CREDIT RISK\nGATC's revenues are derived from a wide range of industries and companies. However, approximately 85% of total revenues are generated from the transportation and storage of products for the chemical and petroleum industries.\nUnder its lease agreements, GATC retains legal ownership of the asset. GATC performs credit evaluations prior to approval of a lease contract. Subsequently, the creditworthiness of the customer is monitored on an ongoing basis. GATC maintains an allowance for possible losses to provide for future losses should customers become unable to discharge their obligations to GATC.\nAt December 31, 1994, GATC had firm commitments to acquire railcars and to upgrade terminal and repair facilities totaling $174 million.\nGATC and its subsidiaries are engaged in various matters of litigation and have a number of unresolved claims pending, including proceedings under governmental laws and regulations related to environmental matters. While the amounts claimed are substantial and the ultimate liability with respect to such litigation and claims cannot be determined at this time, it is the opinion of management that such liability, to the extent not recoverable from third parties including insurers, is not likely to be material to GATC's consolidated financial position or results of operations.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE N--FINANCIAL DATA OF BUSINESS SEGMENTS\nGATC is engaged in the following businesses:\nRailcar Leasing and Management represents General American Transportation Corporation and its foreign subsidiaries and affiliates (Transportation) which lease and manage tank cars and other specialized railcars.\nTerminals and Pipelines represents GATX Terminals Corporation and its domestic and foreign subsidiaries and affiliates, which own and operate tank storage terminals, pipelines and related facilities.\nIntersegment sales are not significant in amount or meaningful to an understanding of GATC's business segments.\nThe following presentation of segment profitability includes the direct costs incurred at the segment's operating level plus expenses allocated by GATX. These allocated expenses represent costs for services provided by GATX which these operations would have incurred otherwise and are determined on a usage basis; management believes that this method is reasonable. Such costs do not include general corporate expense nor interest on debt of GATX.\nInterest costs associated with segment indebtedness are included in the determination of profitability of each segment since interest expense directly influences any investment decision and the evaluation of subsequent operational performance. Interest costs by segment have been shown separately so the reader can ascertain segment profitability before deducting interest expense.\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE N--FINANCIAL DATA OF BUSINESS SEGMENTS (CONT'D)\nGENERAL AMERICAN TRANSPORTATION CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE N--FINANCIAL DATA OF BUSINESS SEGMENTS (CONT'D)\nFEDERAL TAX RATE CHANGE IN 1993\n(A) Effect of tax rate change on pre-1993 deferred taxes.\nACCOUNTING CHANGES IN 1992\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)\nNOTE N--FINANCIAL DATA OF BUSINESS SEGMENTS (CONT'D)\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES (IN MILLIONS)\nEXHIBIT 12\nGENERAL AMERICAN TRANSPORTATION CORPORATION AND SUBSIDIARIES\nEXHIBIT 23\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in Registration Statement No. 33-48475 on Form S-3 filed July 30, 1992 and Registration Statement No. 33-52301 on Form S-3 filed February 16, 1994 of our report dated January 24, 1995 with respect to the consolidated financial statements and schedule of General American Transportation Corporation included in this Annual Report on Form 10-K for the year ended December 31, 1994.\nERNST & YOUNG LLP\nChicago, Illinois March 21, 1995","section_15":""}
{"filename":"732780_1994.txt","cik":"732780","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. LEGAL PROCEEDINGS\nOMI and its subsidiaries are not parties to any material pending legal proceedings for damages, or a related group of such proceedings, other than ordinary routine litigation incidental to the business.\nOMI is a party, as plaintiff or defendant, in a variety of lawsuits for damages arising principally from personal injuries or other casualties in the ordinary course of the maritime business. All such personal injury and casualty claims against OMI are fully covered by insurance (subject to deductibles which are not material).\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 1994.\nEXECUTIVE OFFICERS OF OMI\nSet forth below are the names, ages, position and office, term and year appointed of all of the Company's executive officers as of March 23, 1995.\nThere is no family relationship by blood, marriage or adoption (not more remote than first cousins) between any of the above individuals and any other executive officer or any OMI director.\nThe term of office of each officer is until the first meeting of directors after the annual stockholders' meeting next succeeding his election and until his respective successor is chosen and qualified.\nThere are no arrangements or understandings between any of the above officers and any other person pursuant to which any of the above was selected as an officer.\nMr. Klebanoff has served as Chairman of the Board of the Company since 1983.\nThe following are descriptions of other occupations or positions that the other executive officers of the Company have held during the last five years:\nJack Goldstein was appointed President and Chief Executive Officer of the Company in April 1986.\nCraig H. Stevenson, Jr. was elected Executive Vice President and Chief Operating Officer in November 1994. He was elected Senior Vice President\/Chartering of the Company in August 1993. For five years prior thereto he was President of Ocean Specialty Tankers Corp., a marketing manager for several of the Company's chemical tankers.\nVincent de Sostoa was elected Chief Financial Officer in January, 1994. He was elected Senior Vice President\/Finance of the Company in January 1989.\nFredric S. London was elected Senior Vice President of the Company in December 1991. He was elected Vice President of the Company in December 1988.\nJudith Blackman was elected Vice President of the Company in January, 1995. She was Director of the Office of Cargo Preference for the United States Maritime Administration the three previous years and prior to that time was an employee in the chartering department at the Company.\nKathleen C. Haines was elected Vice President and Controller of the Company in January 1994. She was elected Assistant Vice President and Controller in December 1992. Prior thereto, Ms. Haines was Assistant Controller.\nRichard Halluska was elected Vice President of the Company in July 1993. He was elected Assistant Vice President of the Company in December 1989.\nWilliam A.G. Hogg was elected Vice President of the Company in January 1994. He was elected Assistant Vice President of the Company in June 1987.\nAnthony Naccarato was elected Vice President of Human Resources\/Administration in October, 1993. He was elected Vice President\/Labor Relations of the Company in June 1987.\nWilliam Osmer was elected Vice President of the Company in January 1994. He was elected Assistant Vice President of the Company in December 1986.\nKenneth Rogers was elected Vice President of the Company in January 1994. He was elected Assistant Vice President of the Company in December 1990. Prior thereto, Mr. Rogers was Ship Manager.\nThomas M. Scott was elected Vice President of the Company in February, 1995. He was Ship Manager starting in September, 1991 and was elected Assistant Vice President\/Operations in 1993. Prior thereto he was Port Captain for International Maritime Carriers for one year and prior thereto Marine Superintendent for Marine Transport Lines.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR OMI CORP.'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nCommon Stock\nThe Company listed for trading on the New York Stock Exchange all of its common stock on March 13, 1992 (NYSE-OMM). Previously, the Company's common stock initially traded on the over-the-counter market on January 4, 1984, began trading on the NASDAQ National Market System on February 18, 1986, and on January 27, 1989 was listed for trading on the American Stock Exchange. As of March 23, 1995, the number of holders of OMI common stock was approximately 5,122.\nPayment of Dividends to Stockholders\nOn June 15, 1993, the Board voted to declare special dividends rather than adhere to a regular dividend policy. For the years ended December 31, 1993 and 1994, there were no dividends declared.\nIn 1992 dividends were paid at $0.07 per share on July 23, 1992 and January 21, 1993 to stockholders of record June 26, 1992 and December 28, 1992, respectively.\n1994 Quarter 1st 2nd 3rd 4th ------------ ----- ----- ----- -----\nHigh ........................ 8 7 1\/8 6 7\/8 6 3\/4 Low ......................... 6 1\/4 6 5 3\/4 5 7\/8\n1993 Quarter 1st 2nd 3rd 4th ------------ ----- ----- ----- -----\nHigh ........................ 5 5\/8 6 1\/4 7 7 Low ......................... 3 7\/8 4 3\/4 5 5\/8 6 1\/8\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nSee Notes to Consolidated Financial Statements.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOMI Corp. (\"OMI\" or the \"Company\"), is a highly diversified major bulk shipping company operating in both the U.S. flag and international markets. Its operating fleet currently totals 43 vessels, including nine joint venture vessels and five chartered-in tankers, aggregating approximately 3.7 million deadweight (\"dwt.\"). One Suezmax tanker is currently under construction and scheduled to be delivered mid-1996 to a 49 percent owned joint venture. The Company also has significant investments in other marine related activities, including lightering of large crude carriers in the Gulf of Mexico and workboat supply services.\nResults of operations of OMI include operating activities of the Company's domestic and foreign wholly-owned, leased and chartered-in vessels.\nFISCAL YEARS 1994, 1993 AND 1992\nResults of Operations\nNet voyage revenues is defined as voyage revenue less vessel and voyage expenses. The Company's vessels operate on time charters, short-term time charters, bareboat charters, voyage (or \"spot\") charters, or in accordance with other contractual arrangements involving one of the four mentioned charters. Each type of charter or arrangement connotates a method by which revenue and expenses are recorded. Under a time charter, revenue is usually based on daily or monthly rates, the charterer assumes certain operating expenses, such as bunkers and port charges, and the length of the charter ranges from one to five years. Short-term time charters have similar characteristics as time charters but are usually less than one year. Bareboat charters are similar to time charters but the charterer assumes all operating expenses and the revenue rate may be lower due to the additional costs covered by the charterer. Under a voyage charter, revenues are based on amount of cargo carried, most expenses are for the owner's account and the length of the charter is generally short-term. Revenues may be higher in the spot market as the owner has to cover more costs. As a result of fluctuations in voyage revenues and expenses due to the nature of the charter, the discussion below addresses variations in net voyage revenues to show trends in profitability.\nIn 1991, the majority of OMI's fleet was operating under long-term time charter agreements which provided stable earnings. In 1992, many of the time charters terminated and net voyage revenues declined $41,611,000 or 39 percent in that year. As a result of weak worldwide economic conditions and lower demand for petroleum products, profitable time charters were no longer available, and spot rates were fluctuating. As revenues were reduced as a result of lower rates, costs increased, partially due to regulatory changes, new environmental laws and increased operating costs for vessels and crews. As a result of the Oil Pollution Act of 1990, OMI sustained a substantial increase in insurance costs in 1992, which leveled off in 1993. In 1993, net voyage revenues decreased $10,299,000 or 16 percent from 1992, and continued to decrease in 1994 by $11,841,000 or 21 percent due to market conditions. During the latter part of 1994, rates in the international tanker fleet began improving. Revenue for the domestic fleet, however, has declined from 1993 to 1994 based on changes in both government programs and business available for certain types of vessels. Domestic operations are expected to continue to be uncertain in 1995.\nYEAR ENDED DECEMBER 31, 1994 VERSUS DECEMBER 31, 1993\nNet Voyage Revenues\nNet voyage revenues of $44,217,000 for the year ended December 31, 1994 decreased $11,841,000 or 21 percent as compared to the year ended December 31, 1993. The decrease was primarily attributable to the U.S. flag fleet, which accounted for a $14,364,000 decline in revenues. This decline was offset by $2,523,000 in net increases in the foreign fleet. The majority of the decrease in domestic revenues is attributable to three dry bulk carriers which have been operating under a U.S. government sponsored foreign aid program (\"PL480\") for the distribution of agricultural products. In 1993, there was a large volume of cargo available under this program, especially for shipment to the Commonwealth of Independent States. In fact, there was so much cargo moved under this program that in 1993 and the first few months of 1994, four U.S. flag tankers also participated in this program. As a result of reductions in subsidized cargoes, there was much less tonnage available under this program in 1994 with even less tonnage expected to be available in 1995.\nAlthough the PL480 voyages were profitable in 1994, the rates earned declined due to increased competition for less cargo. As the program decreased in volume the four U.S. flag tankers moved into the vegetable oil trade at lower profit margins and two of the bulkers are currently transporting grain in the commercial market. The four U.S. flag tankers and two of the bulkers share four Operating-Differential Subsidy (\"ODS\") contracts, under which the Company is eligible to receive subsidy on commercial foreign cargoes. The subsidy covers part of the expenses incurred for personal and indemnity insurance, crew and maintenance and repairs.\nAnother reason for the decrease in domestic net revenues was that three vessels built in 1969 were sold in July 1994, resulting in 213 less operating days as compared to 1993.\nThe OMI Columbia, the largest of OMI's domestic vessels, has been operating in the spot market or laid up since its redelivery from a time charter in 1992. In 1993, the OMI Columbia was laid up for 288 days as there was no business for the vessel. There was some improvement in 1994, with net voyage revenues of $636,000 primarily from five spot charters, four consecutive voyages in the Alaskan North Slope trade and one in PL480 trade. During the past few years Alaskan crude oil production has decreased and distribution favors short hauls. Additionally, there is a law\nrestricting exports on Alaskan North Slope oil imposed by Congress. Alaska favors lifting the export ban specifically because sales of crude oil outside the U.S. would get higher prices. Legislation to retain the export ban and the restrictions on exports has been extended until June 30, 1995. Separate legislation has been introduced to Congress to eliminate restrictions on export of Alaskan North Slope oil.\nIncreases in foreign net voyage revenues were primarily the result of purchasing of two crude oil tankers in December 1993. These vessels were on bareboat charters with a steady inflow of revenues when they were purchased until the charters terminated in July and August 1994. At that time the two vessels entered the spot market as crude oil rates began to improve in the international markets. Additional increases in net voyage revenues were from three profitable time charters, one of which continued from 1993 with a higher rate in 1994, and the other two were for vessels previously in the spot market.\nOMI periodically reviews the book value of its vessels and its ability to recover the remaining book value of the vessels using estimated undiscounted cash flows over the remaining life of each vessel. During its last review the Company determined that the carrying value of one of its chemical\/product vessels, operating in coastal trade for liquid chemicals in a marketing pool with a joint venture, exceeded the forecasted estimated undiscounted future net cash flows from operations. An impairment loss of $14,798,000, measured by the excess of the vessel's carrying value over its estimated fair value, based on appraised values from two ship brokers, was recognized and reported as a separate component of operating expenses in the Consolidated Statement of Operations. Additionally, a similar loss was recognized as a separate component of operating expenses, for the forecasted loss from operations of an almost identical vessel chartered-in under an operating lease through 2006, operating in the same marketing pool. The recognized loss of $19,800,000 was based on estimated undiscounted cash flows, excluding from rent expense an amount representative of the interest component of the lease agreement, through the lease expiration date.\nOther Income\nOther income consists primarily of management fees, insurance premiums received from affiliates and\/or other parties and dividend income on investments. During the year ended December 31, 1994, other income increased $740,000 or 16 percent, as compared to 1993. The increase in 1994 comprises dividend income received on a five percent owned investment in a company, insurance premiums collected from affiliates and increased fees from the U.S. government to manage vessels in the Ready Reserve Fleet.\nOther Operating Expenses\nThe Company's operating expenses other than vessel and voyage expenses and provision for losses, consist of depreciation and amortization, operating lease expense and general and administrative expenses. For the year ended December 31, 1994, these expenses increased $4,287,000 or seven percent. Depreciation increased seven percent due to the shortening of lives of six domestic vessels and the purchase of four vessels, offset by the termination of depreciation for the three vessels sold in July 1994. General and administrative expenses increased 13 percent primarily due to costs associated with downsizing international operations and severance agreements.\nOther Income (Expense)\nOther income (expense) consists of gain on disposal of assets-net, provision for writedown of investments, interest expense, interest income, minority interest in subsidiary and other-net. The decrease in net other expense of $435,000 or two percent for the year ended December 31, 1994 over the same period in 1993 is due to the sale of the three domestic vessels in July 1994 for a net gain of $7,178,000, compared with gains from the sale of OMI Petrolink Corp. (\"Petrolink\") workboats and marketable securities in 1993. Interest expense increased in 1994 by $7,020,000 due primarily to the interest accrued at 10.25 percent on Senior Notes (the \"Notes\"), of which $160,650,000 were outstanding at December 31, 1994. Interest income increased $1,105,000 because of interest earned on invested proceeds of the Notes.\nBenefit for Income Taxes\nThe benefit for income taxes of $22,305,000 for the year ended December 31, 1994 varied from statutory rates primarily because deferred taxes are not recorded for the equity in operations of joint ventures other than Amazon Transport, Inc. (\"Amazon\") and White Sea Holdings Ltd. (\"White Sea\"), as management considers such earnings to be permanently invested.\nIn August 1993, Congress passed the Omnibus Budget Reconciliation Act of 1993 (the \"Act\") which increased OMI's corporate tax rate of 34 percent to 35 percent. A retroactive provision of $3,044,000 for deferred income taxes was made in 1993 to comply with the provisions of the Act.\nEquity in Operations of Joint Ventures\nEquity in operations of joint ventures of $5,402,000 was $142,000 or three percent less in 1994 than in 1993. The decline in equity is primarily due to a vessel owned by Amazon which was operating under a time charter until July 1993, at which time it began operating in the spot market at lower rates with idle time between voyages. Additionally, Wilomi, Inc. (\"Wilomi\") and White Sea experienced declines in earnings pertaining to three vessels which operated in the spot market in both years. These declines were offset, in part, by the gain on the sale of a vessel owned by Mosaic Alliance Corporation and operating activity from a vessel delivered in January 1994 to Geraldton Navigation Inc. (\"Geraldton\"). During January 1995, Geraldton sold one of its vessels for a gain.\nBalance Sheet\nThe increase in Marketable securities and the decrease in Long-term securities is due primarily to the reclassification of all Noble Drilling Corporation (\"Noble\") shares to current assets as all shares were sold in March 1995. Fair value of the 2,503,389 common shares in Marketable securities was $14,394,000 at December 31, 1994. The decrease in Long-term securities was offset in part by an increase due to the unrealized gain of $609,000 on 125,000 shares of SEACOR Holdings, Inc.\nYEAR ENDED DECEMBER 31, 1993 VERSUS DECEMBER 31, 1992\nNet Voyage Revenues\nNet voyage revenues of $56,058,000, decreased $10,299,000 or 16 percent, for the year ended December 31, 1993 from the prior year. The decreases in domestic net voyage revenues of $11,609,000 were offset in part by increases in foreign operations of $1,310,000. The net decrease resulted primarily from increased idle time between voyages for five domestic vessels (aggregating 541 more offhire days in 1993 than in 1992) while continuing to incur port expenses and other daily expenses. The net decrease was also attributable to three domestic vessels operating in a profit sharing pool, four vessels operating on time charters that were offhire a total of 144 days for drydocking, loss of revenue for two vessels disposed of, and reduced revenue from Petrolink resulting from reduced volume of its lightering operations in 1993 and the sale of seven workboats.\nOther Income\nDuring the year ended December 31, 1993, other income decreased $986,000, or 17 percent, compared to 1992. The decrease in 1993 resulted primarily from a payment of $1,000,000 from Wilomi during the first quarter of 1992, which was paid in accordance with a contractual agreement relating to the construction contract of a vessel delivered, offset by increases in fees from the U.S. government for the management of vessels in the Ready Reserve Fleet.\nOther Operating Expenses\nFor the year ended December 31, 1993, these expenses decreased a net $992,000 or two percent, as compared to the year ended December 31, 1992. The primary causes of the decrease in 1993 in general and administrative expenses were a change in health insurance coverage for employees, a decrease in other employee benefits and a reduction in legal fees.\nOther Income (Expense)\nFor the year ended December 31, 1993, net other expense decreased $21,633,000, or 55 percent, as compared to 1992. The net decrease resulted primarily from the writedown of $13,094,000 on Chiles Offshore Corporation stock (\"Chiles\") during 1992. In addition, decreases during 1993 also resulted from the $2,190,000 gain from the sale of seven workboats of Petrolink, gain from the sale of Chiles stock of $4,086,000 and the decrease in interest expense resulting from both lower interest rates and a decrease in outstanding principal balance of debt during the year prior to issuing $170,000,000 in Senior Notes in November 1993, offset in part by losses on the sale of a 50 percent owned joint venture and a 25 percent equity investment aggregating approximately $1,554,000.\nEquity in Operations of Joint Ventures\nEquity in operations of joint ventures of $5,544,000 was $3,515,000 or 39 percent less in 1993 than in 1992. Joint venture equity was less in 1993 primarily due to a gain on sale of a vessel owned by Wilomi in April 1992, which increased OMI's equity by approximately $4,826,000. This decline, along with a decline in profits for the vessel owned by Amazon, resulting from the termination of its time charter in 1993 and lower profits being earned in the spot market, were offset by decreases in operating losses in 1993 compared to 1992 incurred by a partnership, Ecomarine USA and increased equity in operating results of White Sea, a joint venture formed during December 1992.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's working capital of $23,161,000 at December 31, 1994 was $9,796,000 or 30 percent less than $32,957,000 at December 31, 1993. Cash and cash equivalents of $31,797,000 decreased $13,524,000 or 30 percent from the balance of $45,321,000 at December 31, 1993. For the year ended December 31, 1994, net cash provided by operating activities was $871,000 which was a decrease of $29,252,000 or 97 percent from net cash provided by operations of $30,123,000 for the year ended 1993.\nDuring 1994, the source of the Company's liquidity was primarily from the proceeds of $23,703,000 received from the sale of the three domestic vessels in July 1994, the issuance of debt of $12,050,000, proceeds received from the sale of Chiles stock of $3,749,000, and a cash distribution of $2,450,000 from Amazon.\nThe primary uses of cash during 1994 were scheduled debt payments of $16,963,000 and prepayments of debt of $19,484,000. OMI repurchased $9,350,000 of the Notes for a gain of $753,000 during 1994, and repurchased an additional $4,100,000 for a gain of $431,000 in the first quarter of 1995. Other uses of cash were the purchase of a foreign flag vessel at a cost of $12,050,000, capital improvements on vessels of $3,268,000, capital contributions of $2,847,000 to joint ventures, and $1,033,000 in proceeds from sales of investments in and interest on the Capital Construction and other restricted funds that was reinvested in the fund.\nOn March 3, 1995, OMI sold all its shares of Noble stock for $12,360,000 and recognized a gain of $7,806,000.\nThe Company anticipates cash from operations in 1995 to improve liquidity and its financial position as it recovers from a depressed market. With its four unused lines of credit aggregating $65,000,000 at December 31, 1994, OMI is in the position to meet its current and future obligations, and to acquire and dispose of vessels as opportunity and need arises.\nCOMMITMENTS\nOMI and a joint venture partner have committed to construct a vessel being built in the Peoples Republic of China for a cost of approximately $54,400,000. The vessel is scheduled to be delivered mid-1996. OMI guarantees 49 percent, through a joint venture subsidiary, of the shipbuilding contract as a backup guarantor to the joint venture partner. OMI acts as a co-guarantor for a portion of the debt incurred by joint ventures with affiliates of two of its joint venture partners. Such debt was approximately $110,697,000 at December 31, 1994, with OMI's share of such guarantees being approximately $54,547,000. OMI also is a guarantor for one of its joint venture's revolving line of credit of up to $4,000,000 at December 31, 1994, with a guarantee to OMI from its joint venture partner of 50 percent of the amount guaranteed by OMI.\nThe Company and its joint ventures partners have committed to fund any working capital deficiencies which may be incurred by their joint venture investments. At December 31, 1994, no such deficiencies have occurred which have required funding.\nEFFECTS OF INFLATION\nThe Company does not consider inflation to be a significant risk to the cost of doing business in the current and foreseeable future. The Company has experienced some additions to the costs of operating the vessels due to price level increases, however, in some cases, the effect has been offset by charter escalation clauses.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nNote 1--Summary of Significant Accounting Policies\nPrinciples of Consolidation--The consolidated financial statements include all domestic and foreign subsidiaries which are more than 50 percent owned by OMI Corp. (\"OMI\" or the \"Company\"). All significant intercompany accounts and transactions have been eliminated in consolidation.\nInvestments in joint ventures, in which the Company's interest is 50 percent or less and where it is deemed that the Company's ownership gives it significant influence over operating and financial policies, are accounted for by the equity method. Accordingly, net income includes OMI's share of the earnings of these companies.\nOperating Revenues and Expenses--Voyage revenues and expenses are recognized on the percentage of completion method of accounting based on voyage costs incurred to date to estimated total voyage costs. Estimated losses on voyages are provided for in full at the time such losses become evident.\nSpecial survey and drydock expenses are accrued and charged to operating expenses over the survey cycle, which is generally a two to three year period.\nAccounting for Investments in Securities--The Company adopted Financial Accounting Standards Board Statement No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS 115\") as of December 31, 1993. In applying SFAS 115, investments in marketable securities have been classified by management as available-for-sale and are carried at fair value. Net unrealized gains or losses are reported as a separate component of stockholders' equity. Upon adoption of SFAS 115, the Company recorded a net unrealized gain of $9,709,000, net of deferred taxes of $5,228,000. Adjustments are made to net income for any impairment in value that is deemed to be other than temporary. Realized gains and losses on the sales of securities are recognized in net income on the specific identification basis.\nCapital Construction and Other Restricted Funds--The Capital Construction Fund (\"CCF\") is restricted to provide for replacement vessels, additional vessels or reconstruction of vessels built in the United States. The other restricted funds are to be used to pay certain of the Company's debt. These funds can be used at the discretion of the Company upon receipt of written approval from the Maritime Administration.\nVessels and Other Property--Vessels and other property are recorded at cost. Depreciation for financial reporting purposes is provided principally on the straight-line method based on the estimated useful lives of the assets up to the assets' estimated salvage value. The useful lives of the vessels range from 20 to 30 years. Salvage value is based upon a vessel's light weight tonnage multiplied by a scrap rate.\nThe Company periodically reviews the book value of its vessels and its ability to recover the remaining book value of the vessels using estimated undiscounted cash flows over the remaining life of each vessel (see Note 11).\nLeasehold improvements are amortized on the straight-line method over the terms of the leases or the estimated useful lives of the improvements as appropriate.\nGoodwill--Goodwill, recognized in business combinations accounted for as purchases, of $17,868,000 before accumulated amortization of $3,260,000 and $2,559,000 at December 31, 1994 and 1993, respectively, is being amortized over 25 years.\nNet Loss per Common Share--Net loss per common share is determined by dividing net loss by the weighted average number of common shares outstanding during the period. Shares issuable upon the exercise of stock options (see Note 8) have not been included in the computation because their effect would be anti-dilutive.\nIncome Taxes--OMI files a consolidated Federal income tax return which includes all its domestic subsidiary companies. Deferred income taxes are recorded under the provisions of SFAS 109, \"Accounting for Income Taxes\" (see Note 5).\nPostemployment Benefits--In 1994, the Company adopted SFAS 112, \"Employers' Accounting for Post-employment Benefits\". Adoption of this statement did not have a material effect on the Company's financial position or results of operations.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nCash Flows--Cash equivalents represent liquid investments which mature within 90 days. The carrying amount approximates fair value.\nDuring the years ended December 31, 1994, 1993 and 1992, interest paid totaled approximately $29,447,000, $20,647,000 and $25,429,000, respectively. For the years ended December 31, 1993 and 1992, income taxes paid were approximately $6,413,000, and $7,628,000, respectively. There were no income taxes paid during 1994.\nReclassifications--Certain reclassifications have been made to the 1993 and 1992 financial statements to conform to the 1994 presentation.\nNote 2--Investments in Joint Ventures\nThe operating results of the joint ventures have been included in the accompanying consolidated financial statements on the basis of ownership as follows:\nPercent of Ownership ----------- Amazon Transport, Inc. (\"Amazon\") .......................... 49.0 Aurora Management Ltd. (\"Aurora\") .......................... 49.9(1) Aurora Tankers Ltd. ........................................ 49.9 Aurora Tankers Pte. Ltd. ................................... 49.9 Aurora Tankers (UK) Ltd. ................................... 49.9 Ecomarine USA .............................................. 49.0 Gainwell Investments Ltd. .................................. 25.0 Geraldton Navigation Company Inc. .......................... 49.9(2) Grandteam Ship Management Ltd. ............................. 50.0 Greeley Management Ltd. (\"Greeley\") ........................ 49.9(1) K\/S Palawan Princess ....................................... 25.0(3) Mosaic Alliance Corporation (\"Mosaic\") ..................... 49.9 Mundogas Orinoco Ltd. ...................................... 50.0(4) Ocean Specialty Tankers Corp. (\"OSTC\") ..................... 50.0 Vanomi Management, Inc. .................................... 50.0 White Sea Holdings Ltd. (\"White Sea\") ...................... 49.0 Wilomi, Inc. (\"Wilomi\") .................................... 49.0 -------------------\n(1) Joint ventures terminated July 1, 1993.\n(2) During January 1995, Geraldton Navigation Company Inc. sold a vessel at a gain.\n(3) The joint venture sold its primary asset in January 1994.\n(4) OMI sold its investment in Mundogas Orinoco Ltd. on May 4, 1993 for $1,363,000.\nOMI has entered into management service agreements with certain of its joint ventures, wherein the Company acts as technical and\/or commercial manager for certain of the ventures' vessels. Management fees relating to services rendered to joint ventures aggregated $820,000, $699,000 and $567,000 for the years ended December 31, 1994, 1993 and 1992, respectively. During 1992, OMI received a $1,000,000 payment from Wilomi, which is included in other income.\nIn 1994, Mosaic owned 893,800 shares of OMI common stock acquired on the open market at an aggregate cost of $4,595,000 and also sold 600,000 of these shares. OMI's equity in these shares is accounted for as treasury stock (see Note 6).\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nSummarized combined financial information pertaining to all affiliated companies accounted for by the equity method is as follows:\nDuring 1994, 1993 and 1992, OMI chartered three vessels to OSTC for $26,689,000, $24,269,000, and $27,260,000, respectively. These amounts are included in revenues of OMI as the operations of OSTC are not consolidated.\nDuring 1994, OMI wrote down its investment in Aurora Tankers Ltd. by $1,250,000 to recognize the estimated loss on exiting the joint venture. The Company has written off its investment in Ecomarine, $1,625,000 in 1993 and $1,982,000 in 1992, and has entered into an agreement to sell its interest in the partnership which is expected to conclude in the second quarter of 1995.\nIn 1994, the Company received distributions from Amazon of $2,450,000 and Greeley of $27,000. In 1993, dividends of $4,410,000 and $258,000 were received from Amazon and Aurora, respectively.\nCertain of the loan agreements to which the Company's joint ventures are party contain restrictive covenants requiring minimum levels of cash or cash equivalents, working capital and net worth, maintenance of specified financial ratios and collateral values, and restrict the ability of the joint ventures to pay dividends to the Company. These loan agreements also contain various provisions restricting the right of the joint ventures to make certain investments, to place additional liens on their property, to incur additional long-term debt, to make certain payments (including in certain instances, dividends), to merge or to undergo a similar corporate reorganization, and to enter into transactions with affiliated companies.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nNote 3--Long-Term Debt and Credit Arrangements\nLong-term debt consists of the following:\nAggregate maturities during the next five years are $18,900,000, $16,703,000, $15,930,000, $20,423,000 and $13,407,000.\nIn November 1993, the Company issued $170,000,000 in unsecured Senior Notes (\"Notes\") due November 1, 2003. The Notes are not redeemable prior to November 1, 1998; thereafter, the Notes are redeemable at the option of the Company at a premium until November 1, 2000 when the Notes will be redeemable at face value, plus accrued interest. During 1994, OMI repurchased $9,350,000 of the Notes for a gain of $753,000. Bonds of a domestic subsidiary of OMI in the amount of $20,013,000 at December 31, 1994 are collateralized by a mortgage on a vessel. Bonds of domestic subsidiaries aggregating $36,390,000, including the amounts due within one year, were collateralized by mortgages on specific vessels at December 31, 1993. Such bonds are guaranteed as to the principal and interest by the U.S. Government under the Title XI program. These security arrangements restrict the subsidiary from, among other things, the withdrawal of capital, the payment of common stock dividends and the extending of loans to affiliated parties.\nAt December 31, 1994, vessels with a net book value of $248,487,000, investments of $12,961,000 (included in Capital Construction and other restricted funds in the accompanying consolidated balance sheets) and shares of a subsidiary and a joint venture with an aggregate carrying value of $21,034,000 have been pledged as collateral on available lines of credit with banks and on long-term debt issues.\nCertain of the loan agreements of the Company's subsidiaries contain restrictive covenants requiring minimum levels of cash or cash equivalents, working capital and net worth, maintenance of specified financial ratios and collateral values, and restrict the ability of the Company's subsidiaries to pay dividends to the Company. These loan agreements also contain various provisions restricting the right of OMI and\/or its subsidiaries to make certain investments, to place additional liens on the property of certain of OMI's subsidiaries, to incur additional long-term debt, to make certain payments, to merge or to undergo a similar corporate reorganization, and to enter into transactions with affiliated companies. As dividend payments are limited to 50 percent of net income earned subsequent to issuance of the Notes, none of the retained earnings at December 31, 1994 were available for payment of dividends.\nAt December 31, 1994, OMI had available and unused a total of $65,000,000 in four lines of credit with banks at variable rates, based on LIBOR.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nOMI has entered into interest rate SWAP agreements to manage interest costs and the risk associated with changing interest rates. At December 31, 1994 and 1993, the Company had outstanding three and four, respectively, interest rate SWAP agreements with commercial banks. These agreements effectively change the Company's interest rate exposure on floating rate loans to fixed rates ranging from 7.83 percent to 9.02 percent. The differential to be paid or received on these interest rate SWAP agreements is recognized as an adjustment to interest expense over the lives of the agreements. The interest rate SWAP agreements have various maturity dates from December 1995 to February 1999. The changes in the notional principal amounts are as follows:\nInterest expense pertaining to interest rate SWAPS for the years ended December 31, 1994, 1993 and 1992 was $2,100,000, $2,914,000 and $4,332,000, respectively.\nThe Company is exposed to credit loss in the event of non-performance by other parties to the interest rate SWAP agreements. However, OMI does not anticipate non-performance by the counter-parties.\nNote 4--Fair Value of Financial Instruments\nThe estimated fair values of the Company's financial instruments at December 31 are as follows:\nThe 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 fair value of interest rate SWAPS (used for purposes other than trading) is the estimated amount the Company would receive or pay to terminate SWAP agreements at the reporting date, taking into account current interest rates and the current credit-worthiness of the SWAP counter-parties.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nSecurities available-for-sale included in Marketable securities, Capital Construction and other restricted funds, and Long-term securities consist of the following components at December 31,\nOn September 15, 1994, Noble merged with Chiles which resulted in the receipt of 0.75 of Noble common stock for each share of Chiles common stock OMI owned. In 1992, OMI recognized a $13,094,000 loss provision as a charge against operations pertaining to the Chiles investment.\nExcluded from the above schedule in 1993 are the 125,000 shares of SEACOR Holdings, Inc., with a carrying value of $1,875,000, which were restricted from sale until February 1995 and were not available-for-sale.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nNote 5--Income Taxes\nA summary of the components of the benefit for income taxes is as follows:\nThe benefit for income taxes varies from the statutory rates due to the following:\nThe components of deferred income taxes relate to the tax effects of temporary differences as follows:\nThe Company has not provided deferred taxes on its equity in the undistributed earnings of foreign corporate joint ventures accounted for under the equity method other than those of Amazon and White Sea. These earnings are considered by management to be permanently invested in the business. If the earnings were not considered permanently invested, approximately $12,094,000 of additional deferred tax liabilities would have been provided at December 31, 1994.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nOn August 2, 1993, Congress passed the Omnibus Budget Reconciliation Act of 1993, (the \"Act\"). The major component of the Act affecting OMI was the retroactive increase in the marginal corporate tax rate from 34 percent to 35 percent, increasing 1993 deferred income taxes by $3,044,000 to comply with the provisions of the Act.\nNote 6--Treasury Stock\nDuring 1994, OMI had 446,006 shares or $2,293,000 in treasury stock representing OMI's proportionate share of Mosaic's ownership in OMI common stock (see Note 2). Mosaic sold 600,000 shares of this stock during the year ended December 31, 1994. OMI's share of this gain, or $767,000, was recorded in capital surplus.\nDuring 1992, OMI purchased 639,000 shares of the Company's common stock at an aggregate price of $2,658,000. In addition, 666,000 shares were repurchased from the ESOP and added to treasury and 1,291,000 shares were retired.\nNote 7--Employee Stock Ownership Plan\nIn 1987, the Company established an Employee Stock Ownership Plan (\"ESOP\"). From November 1987 through February 1990, the ESOP trust purchased a total of 3,404,032 shares of OMI common stock for an aggregate purchase price of $17,558,000. Such purchases were funded through an initial contribution of $400,000 by the Company and $17,158,000 of bank debt, which was repaid with contributions from the Company. Unearned compensation--employee stock ownership trust in the accompanying consolidated balance sheets represents the cost of unallocated shares held by the ESOP trust. Shares are allocated annually to eligible participants based on a percentage of their annual salaries up to the extent allowable by the Internal Revenue Code.\nNote 8--Stock Option and Restricted Stock Plans\nThe Incentive Stock Option Plan (\"ISO\") of 1984 provides for the granting of options to acquire up to 600,000 shares of the Company's common stock. Options under this Plan are exercisable at the rate of 33 1\/3 percent a year, commencing one year from the date of grant and expiring ten years after the date of grant.\nThe Non-Qualified Stock Option Plan of 1986 provides for the granting of up to 500,000 shares at a price not less than fair market value at the date of grant. Options are exercisable at the rate of 20 percent per year, commencing one year from the date of grant, and expiring ten years after the date of grant. Stock Appreciation Rights (\"SARs\") have been granted in tandem with all options under this plan. Such rights offer recipients the alternative of electing to cancel the related stock option, and to receive instead an amount in cash, stock or a combination of cash and stock equal to the difference between the option price and the market price of the Company's stock on the date at which the SAR is exercised.\nProceeds received from the exercise of the options are credited to the capital accounts. Compensation expense is recorded for options based on the difference between market price on the day exercised and option prices. Compensation expense relating to SARs is recorded with respect to the rights based upon the quoted market value of the shares and exercise provisions. Charges (benefits) to net income relating to SARs and\/or options in 1994, 1993 and 1992 were ($36,000), $96,000 and ($126,000), respectively.\nOn June 12, 1990, the Board of Directors of OMI adopted, with shareholders' approval, the 1990 Equity Incentive Plan (the \"1990 Plan\"). The total number of shares that may be optioned or issued as restricted stock under the 1990 Plan was 1,000,000 shares of OMI common stock with the maximum number of issuable restricted stock being 300,000 shares, of which OMI awarded 15,000 shares in 1994, 15,000 shares in 1991, and 254,000 shares in 1990 to eligible key employees under this Plan. On January 27, 1993 and December 18, 1990, OMI granted options to acquire 131,000 and 606,000 shares, respectively, that are not intended to qualify as incentive stock options which are exercisable at a rate of 33 1\/3 percent per year commencing one year from the date of grant, and expiring ten years after the date of grant. Upon issuance of restricted common stock under the 1990 Plan, unearned compensation, equivalent to the\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nmarket value at the date of grant, is charged to stockholders' equity and subsequently amortized over the life of the award.\nA summary of the changes in shares under option for all plans is as follows:\nNumber of Options Option Price --------- ------------ Outstanding at January 1, 1992 ........ 917,679 $2.8125 to 9.875 Exercised ........................... (6,000) 5.125 Forfeited ........................... (4,267) 4.6875 ------- Outstanding at December 31, 1992 ...... 907,412 2.8125 to 9.875 Granted ............................. 131,000 4.50 Exercised ........................... (47,623) 2.8125 to 5.125 Forfeited ........................... (14,300) 5.125 to 9.875 ------- Outstanding at December 31, 1993 ...... 976,489 4.25 to 9.875 Granted ............................. 40,000 6.25 Exercised ........................... (66,834) 4.6875 to 5.125 Forfeited ........................... (34,400) 4.50 to 9.875 ------- Outstanding at December 31, 1994 ...... 915,255 $4.25 to 9.875 =======\nNote 9--Retirement Benefits and Deferred Compensation\nIn June 1993, the Company terminated its non-contributory defined benefit Pension Plan (the \"Plan\"). This termination resulted in a loss of $1,017,000, which was recognized in 1993. All participants of the Plan were fully vested as of the termination date. In April 1994, OMI settled the accumulated benefit obligation through lump-sum payments of $2,950,000 to participants. The net periodic pension costs in 1993 and 1992 were $158,000 and $252,000 respectively.\nThe terminated Plan was replaced by a 401(k) Plan. The 401(k) Plan is available to full-time employees who meet the Plan's eligibility requirements. This Plan is a defined contribution Plan, which permits employees to make contributions up to two percent of their annual salaries. The Company matches 100 percent of the employee's contribution. Company contributions were $160,000 and $91,000 in 1994 and 1993, respectively.\nIn addition, certain domestic subsidiaries make contributions to union sponsored multi-employer pension plans covering seagoing personnel. Contributions to these plans amounted to approximately $1,020,000, $961,000 and $746,000 for 1994, 1993 and 1992, respectively. If these subsidiaries were to withdraw from the plans or the plans were to terminate, the subsidiaries would be liable for a portion of any unfunded plan benefits that might exist. The Company has been advised by the trustees of such plans that it has no withdrawal liability as of December 31, 1994.\nIn December 1991, the Board of Directors adopted the OMI Corp. Key Employees Deferred Compensation Plan which enables key employees of the Company and its subsidiaries to defer the receipt of a portion of their compensation, including salary, bonus and income derived from restricted stock and stock options, until termination of employment or for a certain period of years. The Company has included $303,000 and $134,000 in other accrued liabilities, at December 31, 1994 and 1993, respectively, to reflect its liability under this Plan.\nNote 10--Operating Leases\nTotal rental expense, including contingent rentals, amounted to $49,247,000, $40,350,000 and $42,647,000 for the years ended December 31, 1994, 1993 and 1992, respectively. Leases are primarily for vessels and office space.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nThe future minimum rental payments required, by year, under operating leases subsequent to December 31, 1994, are as follows:\n1995 ........................................................ $ 18,629 1996 ........................................................ 11,879 1997 ........................................................ 12,531 1998 ........................................................ 12,037 1999 ........................................................ 8,619 Thereafter .................................................. 58,613 -------- Total .................................................... $122,308 ========\nTime charters to third parties of the Company's owned and leased vessels are accounted for as operating leases. Minimum future revenues, by year, to be received subsequent to December 31, 1994 on these time charters are as follows:\n1995 ......................................................... $61,193 1996 ......................................................... 23,847 1997 ......................................................... 8,037 ---- ------- Total ..................................................... $93,077(1) =======\n------------------\n(1) Minimum future revenues for later years are not included above due to the charterers' options to continue the lease at such dates.\nNote 11--Impairment and Provision for Loss on Lease Obligation\nAs part of OMI's periodic review of the recoverability of its investment in its vessels, the Company determined that the carrying value of one of its chemical\/product vessels engaged in U.S. domestic shipping operations exceeded the undiscounted forecasted future net cash flows from its operations. This indicated that an impairment loss for this vessel should be recognized. This loss was measured by the excess of the carrying value of the vessel over its estimated fair value which was based on values provided by two ship brokers. The carrying value of the vessel was reduced by $14,798,000, the amount of the impairment loss which is reported as a separate item in the 1994 consolidated statement of operations.\nAs part of this periodic review, the Company also determined that a similar loss should be recognized for the forecasted loss from operations of an almost identical vessel similarly engaged in U.S. domestic shipping operations which is chartered in on an operating lease through 2006. The amount of the loss has been estimated based on forecasted undiscounted cash flows, excluding from rent expense an amount representative of the interest component of the lease agreement, through the lease expiration date. This loss, estimated as $19,800,000, was also reported as a separate item in the 1994 consolidated statement of operations.\nNote 12--Disposal of Assets\nIn July 1994, OMI sold three vessels for $23,750,000 and realized a gain of $7,178,000.\nIn 1992, the Company entered into a sale\/leaseback transaction on a vessel. The Company received $11,500,000 in cash, of which $3,500,000 was used to pay the mortgage on the vessel, a $2,000,000 secured note receivable paid December 1994, and a six-year lease at the current market rate. The gain of approximately $2,001,000 is being amortized over the term of the lease.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nThe Gain (loss) on disposal of assets--net for the years ended December 31, consists of the following:\n1994 1993 1992 -------- -------- -------- Amortization of gain on sale\/leaseback ..... $ 334 $ 334 $ 52 Gain on sale of vessels .................... 7,178 1,802 (1,322) Net loss on disposal of other assets ....... (26) (318) (72) Net (loss) gain on sale of CCF investments . (78) 77 196 Loss on sale of joint venture interests .... (1,554) Gain on sale of marketable securities ...... 2,814 4,060 -------- -------- -------- Total ................................... $ 10,222 $ 4,401 $ (1,146) ======== ======== ========\nNote 13--Financial Information Relating to Domestic and Foreign Operations\nPresented below is certain information relating to OMI's operations:\nYears ended December 31, -------------------------------- 1994 1993 1992 -------- -------- -------- Revenues: Domestic ............................. $173,378 $199,118 $196,804 Foreign .............................. 93,418 71,361 68,725 -------- -------- -------- Total ............................. $266,796 $270,479 $265,529 ======== ======== ======== Operating income (loss): Domestic ............................. $(63,093) $(12,276) $ (2,419) Foreign .............................. 15,009 14,178 14,614 -------- -------- -------- Total ............................. $(48,084) $ 1,902 $ 12,195 Identifiable assets: Domestic ............................. $228,162 $299,860 $271,172 Foreign .............................. 376,970 371,656 373,271 -------- -------- -------- Total ............................. $605,132 $671,516 $644,443 ======== ======== ======== Capital expenditures: Domestic ............................. $ 2,589 $ 15,199 $ 5,920 Foreign .............................. 12,729 21,349 16,704 -------- -------- -------- Total ............................. $ 15,318 $ 36,548 $ 22,624 ======== ======== ======== Depreciation and amortization: Domestic ............................. $ 19,953 $ 20,258 $ 21,170 Foreign .............................. 17,817 15,183 14,313 -------- -------- -------- Total ............................. $ 37,770 $ 35,441 $ 35,483 ======== ======== ========\nThe operating loss pertaining to domestic operations for the year ended December 31, 1994 includes the adjustments for impairment and provision for loss on lease obligation (see Note 11).\nInvestments in and net receivables from foreign subsidiaries amounting to $292,286,000, $395,988,000 and $274,109,000 at December 31, 1994, 1993 and 1992, respectively, have been excluded from domestic assets as they have been eliminated in consolidation.\nOMI CORP. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\n(All tabular amounts are in thousands of dollars)\nVoyage revenues include revenue from major customers as follows:\nYears ended December 31, ----------------------------- 1994 1993 1992 ------- ------- ------- Federal Government Program, PL480 $40,573 $75,017 $28,273 Military Sealift Command 2,188 192 23,942 ------- ------- ------- Total $42,761 $75,209 $52,215 ======= ======= =======\nNote 14--Commitments and Contingencies\nOMI and certain subsidiaries are defendants in various actions arising from shipping operations. Such actions are covered by insurance or, in the opinion of management, after review with counsel, are of such nature that the ultimate liability, if any, would not have a material adverse effect on the consolidated financial statements.\nIn September 1988, the Board of Directors adopted a Separation Allowance Program providing for severance benefits to all non-union employees other than non-resident aliens, leased employees, directors who are not employees of the Company or employees with individual severance plans in the event there is a change of control in OMI and such employees are thereafter terminated without cause or transferred or their position is significantly changed. Severance benefits include a lump-sum payment equal to the employee's average monthly wages immediately prior to the date of termination times the lesser of 24 or one for each year of full-time employment by the Company (but not less than six).\nThe Company has employment agreements with four key officers. Each of the employment agreements provide that if the employee is terminated without cause, voluntarily terminates his employment within 90 days of a relocation or reduction in compensation or responsibilities, dies or is disabled, such employee will continue to receive base salary and other benefits until December 31, 1995 or twelve months from the date of termination, whichever is later. In addition, if any such employee is terminated without cause (other than for reasons of disability) within two years of a Change of Control (as defined in the Company's Separation Allowance Program), the Company will pay such employee an amount equal to three times the sum of his then current base salary and the incentive bonus paid during the previous twelve months. The aggregate commitment for future salaries, excluding bonuses, under these employment agreements is approximately $977,000 at December 31, 1994. The maximum contingent liability for salary and incentive compensation in the event of a change in control is approximately $2,623,000 at December 31, 1994. The Company has recently entered into employment agreements with additional employees.\nOMI and a joint venture partner have contracted to construct a vessel which is being built in the Peoples Republic of China for a cost of approximately $54,400,000. The vessel is scheduled to be delivered in the second quarter of 1996.\nOMI acts as a guarantor for a portion of the debt incurred by joint ventures with affiliates of two of its joint venture partners. Such debt was approximately $110,697,000 at December 31, 1994 with OMI's share of such guarantees being approximately $54,547,000. OMI also is a guarantor for one of its joint venture's revolving line of credit of $4,000,000, with a guarantee to OMI from its joint venture partner of $2,000,000.\nThe Company and its joint venture partners have committed to fund any working capital deficiencies which may be incurred by their joint venture investments. At December 31, 1994, no such deficiencies have been funded.\nNote 15--Subsequent Event\nOn March 3, 1995, the Company sold all of its shares of Noble for $12,360,000 recognizing a gain of $7,806,000.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of OMI Corp.:\nWe have audited the accompanying consolidated balance sheets of OMI Corp. and its subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedules listed in 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 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 companies at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 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.\nDELOITTE & TOUCHE LLP\nNew York, New York February 22, 1995 (March 3, 1995 as to Note 15)\nItem 8. Supplementary Data\nSee notes to condensed financial statements.\nSee notes to condensed financial statements.\nSee notes to condensed financial statements.\nSCHEDULE I\nOMI CORP.\nNOTES TO CONDENSED FINANCIAL STATEMENTS For The Three Years Ended December 31, 1994\n1. The condensed financial statements present the separate financial data (parent only) of OMI Corp. (\"OMI\" or the \"Company\"). All domestic and foreign subsidiaries which are more than 20% owned and investments in joint ventures are accounted for by the equity method.\nSee Notes to Consolidated Financial Statements on pages 20 through 31 of OMI's 1994 Annual Report on Form 10-K.\nCertain reclassifications have been made to the 1993 and 1992 financial statements to conform to the 1994 presentation.\n2. Cash Flows--Cash equivalents represent liquid investments which mature within 90 days. The carrying amount approximates fair value.\nDuring the years ended December 31, 1994, 1993, and 1992, interest paid totaled approximately $19,430,000, 2,305,000 and $2,334,000, respectively. For the years ended December 31, 1993 and 1992, income taxes paid were approximately $6,413,000, and $7,628,000, respectively. There were no income taxes paid during 1994.\n3. Long-Term Debt--Long-term debt as of December 31, 1994 and 1993 consists of the following:\n1994 1993 -------- -------- (dollars in thousands) 10.25% unsecured Senior Notes due 11\/01\/03 ............... $160,650 $170,000 Mortgage note at a variable rate above the London Interbank Offering Rate (\"LIBOR\") in varying installments to 1998(1) ................................ 6,000 7,000 Unsecured notes payable to an affiliate at 5.0% to 1996 .. 7,624 8,881 -------- -------- Total ............................................... 174,274 185,881 Less current portion of long-term debt ................... 6,027 2,350 -------- -------- Long-term debt............................................ $168,247 $183,531 ======== ========\n------------- (1) Rate at December 31, 1994 was 6.6875 percent.\nIn November 1993, the Company issued $170,000,000 in unsecured Senior Notes (\"Notes\") due November 1, 2003. The Notes are not redeemable prior to November 1, 1998; thereafter, the Notes are redeemable at the option of the Company at a premium until November 1, 2000 when the Notes will be redeemable at face value, plus accrued interest. During 1994, OMI repurchased $9,350,000 of the Notes for a gain of $753,000.\n4. Lines of Credit--At December 31, 1994, the Company had available and unused $25,000,000 in two lines of credit with banks at variable rates, based on LIBOR.\nWILOMI, INC. AND SUBSIDIARIES\nPage ---- CONSOLIDATED FINANCIAL STATEMENTS:\nConsolidated Balance Sheets at December 31, 1994 and 1993 ............. 39\nStatements of Consolidated Income and Retained Earnings for the years ended December 31, 1994, 1993 and 1992 .............................. 40\nStatements of Consolidated Cash Flows for the years ended December 31, 1994, 1993 and 1992 .................................... 41\nNotes to Consolidated Financial Statements ............................ 42-43\nINDEPENDENT AUDITORS' REPORT ............................................ 44\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nWILOMI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the Three Years Ended December 31, 1994\n1. Company\nWilomi, Inc. and subsidiaries (the \"Company\" or \"Wilomi\") are jointly-owned by Loire Transport, Inc., a wholly-owned subsidiary of OMI Corp. (\"OMI\"), and K\/S Wilhelmsen Transport and Trading A\/S (\"Wilhelmsen\") with interests of 49 and 51 percent, respectively. The joint venture, incorporated on May 15, 1987, owns and operates commercial vessels.\n2. Summary of Significant Accounting Policies\nBasis of Presentation--The consolidated financial statements include all subsidiaries of the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.\nOperating Revenues and Expenses--Voyage revenues and expenses are recognized on the percentage of completion method of accounting based on voyage costs incurred to date to estimated total voyage costs. Estimated losses on voyages are provided in full at the time such losses become evident.\nSpecial survey and drydock expenses are accrued and charged to operating expenses over the survey cycle, which is generally a three year period.\nVessels and Vessel Under Construction--Vessels are recorded at cost; including interest on funds borrowed to finance the construction of new vessels.\nDepreciation is provided on the straight-line method based on the vessel's estimated useful life of 25 years, up to the vessel's estimated salvage value. Salvage value is based upon the vessel's light weight tonnage, multiplied by a scrap rate.\nThe Company periodically reviews the book value of its vessels and its ability to recover the remaining book value of the vessels using estimated undiscounted cash flow over the remaining life of each vessel.\nFederal Income Taxes--No provision has been made for Federal income taxes. The income of the Company is not generally subject to tax as a result of various provisions of the Internal Revenue Code. Additionally, the country in which the Company is incorporated exempts shipping and maritime operations from taxation.\nCash Flows--Cash equivalents represent liquid investments which mature within 90 days. The carrying amount approximates fair value.\nDuring the years ended December 31, 1994, 1993 and 1992, the Company paid interest of $5,019,256, $4,605,435 and $4,097,261, respectively.\n3. Vessels and Vessels Under Construction\nIn November 1993, the Company entered into an agreement to construct a new vessel at an approximate cost of $54,400,000. As of December 31, 1994, construction costs were $2,719,000. The vessel is expected to be delivered in 1996.\nDuring 1992, the Company took delivery of three vessels which had been under construction in 1991. One vessel, with a cost of $37,681,683, was sold in April, 1992 at a gain of $9,848,317.\n4. Related Party Transactions\nOMI acted as technical and commercial manager for two vessels owned during 1994 and 1993 and three vessels owned during 1992. Management fees to OMI relating to years ended December 31, 1994, 1993 and 1992 were $288,000, $288,000 and $255,827, respectively.\nWILOMI, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) For the Three Years Ended December 31, 1994\nWilhelmsen acted as manager for one vessel owned during 1994 and 1993. Management fees to Wilhelmsen in each of the years ended December 31, 1994 and 1993 were $144,000.\nThe Company declared dividends of $5,102,041 and $1,000,000 in 1992. In 1992, the Company forgave a $2,602,041 note due from Wilhelmsen in lieu of payment of a portion of the dividends.\nNotes due from affiliates are as follows:\n1994 1993 ----------- ----------- Wilhelmsen ......................... $ 8,907,150 $10,284,150 OMI ................................ 7,623,850 8,880,850 ----------- ----------- 16,531,000 19,165,000 Less: current portion .............. 10,535,400 2,755,102 ----------- ----------- Notes due from affiliates .......... $ 5,995,600 $16,409,898 =========== =========== Interest rate ...................... 5% 6.5%\nIncluded in interest income are the following amounts attributable to these notes: $906,000, $1,263,000 and $836,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\n5. Long-Term Debt\nLong-term debt at December 31, 1994 and 1993 consists of the following:\n1994 1993 ----------- ----------- Mortgage notes on vessels at variable rates above LIBOR, payable semi-annually to 2002* ... $90,283,000 $96,347,000 Less current portion of long-term debt ............................. 6,446,000 6,064,000 ----------- ----------- Long-term debt ..................... $83,837,000 $90,283,000 =========== ===========\n-------------- * Rates at December 31, 1994 ranged from 5.9375 percent to 6.9375 percent.\nAggregate maturities during the next five years are $6,446,000, $6,654,000, $6,879,000, $7,122,000 and $7,385,000.\nAt December 31, 1994, the Company had available $10,000,000 in a short-term line of credit with a bank at a variable rate based on LIBOR.\nThe fair value of long-term debt at December 31, 1994 and 1993 approximates its carrying value.\n6. Commitments and Contingencies\nThe Company acts as a guarantor on debt incurred by an affiliated company. Such debt was $3,000,000 at December 31, 1994.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders of Wilomi, Inc. and Subsidiaries:\nWe have audited the accompanying consolidated balance sheets of Wilomi, Inc. and subsidiaries as of December 31, 1994 and 1993 and the related statements of consolidated income and retained earnings and of cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Companies' 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 Companies at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nNew York, New York February 22, 1995\nAMAZON TRANSPORT, INC.\nPage ---- FINANCIAL STATEMENTS:\nBalance Sheets at December 31, 1994 and 1993 ......................... 46\nStatements of Operations and Retained Earnings (Deficit) for the years ended December 31, 1994, 1993 and 1992 .............................. 47\nStatements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 ....................................................... 48\nNotes to Financial Statements ........................................ 49\nINDEPENDENT AUDITORS' REPORT .......................................... 50\nSee notes to financial statements.\nSee notes to financial statements.\nSee notes to financial statements.\nAMAZON TRANSPORT, INC.\nNOTES TO FINANCIAL STATEMENTS For the Three Years Ended December 31, 1994\n1. COMPANY\nAmazon Transport, Inc. (the \"Company\" or \"Amazon\") is jointly owned by a subsidiary of Universal Bulk Carriers, Inc. (\"UBC\"), a wholly-owned subsidiary of OMI Corp. (\"OMI\"), and Bergesen d.y. A\/S (\"Bergesen\") with interests of 49 and 51 percent, respectively. The Company began operating as a joint venture on December 3, 1988 for the purpose of owning and chartering commercial vessels. The Company owned and operated one vessel, the Settebello, for all periods presented.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOperating Revenues and Expenses--Voyage revenues and expenses are recognized on the percentage of completion method of accounting based on voyage costs incurred to date to estimated voyage costs. Estimated losses are provided in full at the time such losses become evident.\nSpecial survey and drydock expenses are accrued and charged to operating expenses over the survey cycle, which is generally a three year period.\nVessel--The vessel is recorded at cost. Depreciation is provided on the straight-line method based on the estimated 25 year useful life of the vessel up to the estimated salvage value. Salvage value is based upon the vessel's light weight tonnage multiplied by a scrap rate.\nThe Company periodically reviews the book value of its vessel and its ability to recover the remaining book value of the vessel using estimated undiscounted cash flows over the remaining life of the vessel.\nFederal Income Taxes--No provision has been made for Federal income taxes. The income of the Company is not generally subject to tax as a result of various provisions of the Internal Revenue Code. Additionally, the country in which the Company is incorporated exempts shipping and maritime operations from taxation.\nCash Flows--Cash equivalents represent liquid investments which mature within 90 days. The carrying amount approximates fair value. The Company paid no interest in 1994, 1993 and 1992.\n3. RELATED PARTY TRANSACTIONS\nThe Company has entered into management service agreements with OMI and Bergesen, who act as technical and commercial managers of the Settebello. The Company paid OMI and Bergesen management fees of $200,000 for each of the years ended December 31, 1994, 1993, and 1992.\nThe following table summarizes balances due to affiliated companies at December 31:\n1994 1993 ------- ------- Payable to affiliates: OMI .............................. $16,980 $14,646 UBC .............................. 61 ------- ------- $16,980 $14,707 ======= =======\nOn December 31, 1992, the Company forgave a $4,590,000 note due from Bergesen and $199,443 of related interest in lieu of payment of a portion of the 1992 dividend.\n4. DIVIDENDS\nDuring 1994, the Company declared and paid a $5,000,000 dividend.\nDuring 1993, the Company declared and paid a $9,000,000 dividend and also paid $4,655,000 of dividends which had been declared in 1992.\nDuring 1992, the Company declared dividends of $9,500,000 of which $55,557 was paid.\nINDEPENDENT AUDITORS' REPORT\nTo the Shareholders of Amazon Transport, Inc.:\nWe have audited the accompanying balance sheets of Amazon Transport, Inc. as of December 31, 1994 and 1993 and the related statements of operations and retained earnings (deficit) and of cash flows for each of the three years in the period ended December 31, 1994. 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 accompanying financial statements present fairly, in all material respects, the financial position of the Company at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nDELOITTE & TOUCHE LLP\nNew York, New York February 22, 1995\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 OMI\nPursuant to General Instruction G(3) the information regarding directors called for by this item is hereby incorporated by reference from OMI's 1994 Proxy Statement to be filed with the Securities and Exchange Commission. Certain information relating to Executive Officers of the Company appears at the end of Part I of this Form 10-K Annual Report.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nPursuant to General Instruction G(3) the information called for by this item is hereby incorporated by reference from OMI's 1994 Proxy Statement to be filed with the Securities and Exchange Commission.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nPursuant to General Instruction G(3) the information called for by this item is hereby incorporated by reference from OMI's 1994 Proxy Statement to be filed with the Securities and Exchange Commission.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nPursuant to General Instruction G(3) the information called for by this item is hereby incorporated by reference from OMI's 1994 Proxy Statement to be filed with the Securities and Exchange Commission.\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\n1. Financial Statements:\nOMI Corp. and Subsidiaries Consolidated Statements of Operations for the three years ended December 31, 1994.\nOMI Corp. and Subsidiaries Consolidated Balance Sheets at December 31, 1994 and 1993.\nOMI Corp. and Subsidiaries Consolidated Statements of Cash Flows for the three years ended December 31, 1994.\nOMI Corp. and Subsidiaries Consolidated Statements of Changes in Stockholders' Equity for the three years ended December 31, 1994.\nOMI Corp. and Subsidiaries Notes to Consolidated Financial Statements for the three years ended December 31, 1994.\nOMI Corp. and Subsidiaries Quarterly Results of Operations for 1994 and 1993.\n2. Financial Statement Schedules:\nI--OMI Corp. (Parent only) Condensed financial information as to financial position as of December 31, 1994 and 1993, and cash flows and results of operations for the years ended December 31, 1994, 1993 and 1992.\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.\nOMI CORP.\nBy \/s\/ JACK GOLDSTEIN --------------------------------------- Jack Goldstein, Chief Executive officer and director\nPursuant to the requirements of the Securities Act of 1933, 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":"50773_1994.txt","cik":"50773","year":"1994","section_1":"ITEM 1. BUSINESS\n(a) General development of business. The Registrant, incorporated in 1963, is a holding company managing and operating a life insurance company, Central Investors Life Insurance Company of Illinois (\"Central\") and a general insurance agency, C I Agency, Inc. (\"CI\"). Substantially all business is conducted through the Registrant's two subsidiaries and these two subsidiaries represent the major assets of the Registrant as follows:\nOn November 28, 1994, Registrant and Central signed a definitive written agreement with Citizens, Inc., a Colorado life insurance holding company based in Austin, Texas for the acquisition of all of the stock of Registrant and Central by Citizens, Inc. The agreement provides that shareholders of Registrant will receive one (1) share of Citizens, Inc. Class A common stock for each eight (8) shares of the Registrant's Class A or B stock owned. Shareholders of Central other than the Parent will receive one (1) share of Citizens, Inc. Class A Common Stock for each four (4) shares of Central stock owned. The companies will continue to operate in their respective locations under a combined management team with the consolidation of computer data processing on Citizens, Inc.'s system. The agreement is subject to the approval of regulatory authorities and stockholders of the Registrant and Central. On March 10, 1995, the Illinois Department of Insurance indicated that the companies could proceed with the merger and Citizens, Inc.'s acquisition of control of Central.\nOther than interest and dividend income from general investments, the Registrant has no source of revenue or income independent from its subsidiaries; therefore, it must rely primarily upon its operating subsidiaries for dividends. The Registrant's subsidiary, C I, has paid to the Registrant seven dividends totaling $90,000 since 1973. The Registrant's subsidiary, Central, has not paid dividends to stockholders to date.\nThe Registrant and its subsidiaries as of December 31, 1994 had in their employment one computer programmer, two data processing and accounting personnel and one part-time and one full-time salaried officers. In addition, four commission agents were licensed for life insurance sales. These agents serviced existing business, but were restricted from writing new business in 1994 because of Central's lack of approved policies and a coinsurance or reinsurance contract for new business. Central continued to be licensed in Illinois, Indiana, Oklahoma and Arizona during the year.\nThe Illinois Legislature passed new Statutory Standard Nonforfeiture and Standard Valuation Laws which took effect January 1, 1989. Since that date, Central has lacked the funds to file any policy revisions with Illinois and does not have any policies currently approved for sale. Between 1974 and 1987, Central's yearly volume of new business primarily came from two policy plans, Modified Whole Life (MWL) and Decreasing Term Life to Age 100 (DTL). Each individual risk insured under either of these two plans was regularly in excess of Central's own risk retention. The excess retention was coinsured with Life Reassurance Corporation (then General Reassurance Co.). Life Reassurance notified Central that it would not coinsure new risk on these plans after February 28, 1987. To date, the efforts to secure another satisfactory coinsurance or reinsurance contract for theses two plans have been delayed by Central's inability to finance the completion of the required policy revisions.\nCentral's inquiries into a new contract were further hampered by a decline in sales of MWL and DTL plans which had started before the cancellation of the contract. Market conditions were changing and independent agents who had been selling these plans were increasingly shifting their business to interest sensitive plans offered by the large brokerage companies. In inquiries with different coinsurance and reinsurance companies, problems arose over commission allowances, which would have made the plans less attractive to agents, and expenses involved in additional revisions to allow male or female, smoker or nonsmoker classifications. The expense of these policy revisions was compounded because two different sets of numerical factors must be actuarially developed for each plan in order to meet the differences in Federal and State reporting requirements.\nThe development of interest sensitive plans was considered, but so far Central has found sales proposals and administrative programs required for interest sensitive plans to be in a price range which would not allow Central a reasonable expectation of profit on projected sales. Recent declines in interest rates on investment grade securities have increased the pricing problem. Initial indications of the cost of interest sensitive plans in 1987 resulted in changing the decision to discontinue the MWL and DTL plans. During 1988, $11,000 was spent with an actuarial firm for the first set of numerical factors. In 1989, there was limited programming done on Central's computer to enable it to print revised DTL policy forms, but increased death claim expenses and general expenses in 1988 and 1989 reduced funds available for revision expenditures. Death claim expenses and general expenses were lower in 1990 and 1991, but during these years concern about the possibility of high death claim expenses and the increased regulatory capital and surplus requirements precluded expenditures for further policy revisions. In 1992, a record high amount of death claim expenses did occur and no funds were available for policy revisions. Death claims were lower in 1993 and 1994, but declining premium and investment income plus increased regulatory requirements did not permit expenditures for policy or market development.\nA 1993 change in the Illinois statutory deposit law requires the Company to maintain a trust deposit of U.S. Government obligations with a market value of $1,200,000. This change required the Company to increase its U.S. Government investments by $900,000 in late 1993, a time of very low interest yields which negatively affected investment income by approximately $25,000 to $30,000 from late 1993 to late 1994. The market value requirement and the Company's small asset base made it necessary to choose short term U. S. Governments to insure less market price volatility, further penalizing yields.\nCentral's statement prepared under statutory accounting practices for state insurance departments reported a loss of $13,337 in 1994 compared to a loss of $12,520 in 1993. A lack of new sales and policy terminations resulted in a premium income decrease of $5,999. Net investment income was down $16,455, as a result of Central being required to purchase $900,000 of short term U. S. Treasury Notes during a period of low interest rates in late 1993. Several of these notes matured and were reinvested during a period of rising interest rates in late 1994. Further decline in investment income is not expected if starting 1995 interest rates do not decline. As a result of a 1992 regulation requiring an interest maintenance reserve liability account (IMR), Central's statutory realized capital gain of $1,081 was reduced to $-0- with the $1,081 to the IMR account, compared to a recognized gain of $18,670 in 1993. The regulation further provided a formula for the yearly amortization of a portion of the IMR. In 1994, $3,288 was treated as income from the IMR. The significant statutory expense changes occurring in 1994, were increases of $27,877 in reserve expense, $1,693 in loading cost and $472 in death claims. The full impact of these changes was reduced by reductions of $25,719 in cash surrender benefits paid, $4,422 in commission expenses less co-insurance allowances, $36,255 in general insurance expenses and $679 in insurance taxes, licenses and fees. Dividends and annual endowment expense declined by $2,436. Since the Company is not selling policies with annual endowments or dividends, these policy benefits decrease from time to time at a rate determined by cash surrenders. In 1994, the Registrant's, and its subsidiary, CI Agency, Inc.'s, expense charges to Central were increased for salaries by $23,000 and for legal fees by $1,376, and reduced for rent by $1,200 from 1993's allocations. Additional allowances were made for accounting fees. Converted to Generally Accepted Accounting Principles (GAAP), Central's 1994 results reflected a loss of $25,698 compared to a gain of $1,736 in 1993. The major changes in GAAP from 1993 to 1994, involved a decrease of $16,050 in premium income, $16,455 in investment income, $35,018 in capital gains and an increase of $30,696 in policyholder reserves for future benefits. The impact of these changes was offset partially by decreases of $36,255 in general expenses and $25,719 in cash surrenders and $8,083 in commission expense.\nCentral's general expenses are high in relation to its size because of varied government reporting requirements. From inception in 1965, Central has been required to report to State Insurance Departments in accordance with Statutory Accounting Practices. In 1973, the Securities and Exchange Commission started requiring reports prepared in accordance with Generally Accepted Accounting Principles (GAAP). Each complex system of accounting represents a significant expense to Central, but GAAP expenses are more readily identified since they were added last. GAAP accounting and quarterly reporting expenses were estimated at $34,150 for 1994, compared to $31,050 in 1993. The 1994 expenditure for GAAP accounting represents approximately 21.2% of Central's general insurance expenses of $154,106 before inter-company allocations in 1994.\nOn a consolidated basis with Central and C I, the Registrant's net loss for 1994 was $125,831 compared to a net loss of $79,465 in 1993 and $103,151 in 1992. Total revenues for 1994 decreased $55,885 as GAAP premium income decreased $16,050, investment income decreased $16,566 and realized investment gain decreased $23,269. Policy benefit expenses decreased $25,270, as cash surrenders decreased by $25,719 and death claims slightly increased by $472. The benefit expenses for annual endowments and dividends were down $2,413 as the block of policies containing these benefits continued to decline. Future life policy benefits increased $30,696 with decreases in cash surrenders and lapses. The overall policy termination ratio improved to 4.9% in 1994 from 18.4% in 1993. The lower rate of policy terminations also reduced the amortization of deferred acquisition cost by $6,185 and deferred premiums by $720.\nIn 1986, the decision was made to have the Registrant's GAAP statements follow Central's statutory accounting practice of not recognizing any agents debit balances as an asset and $49,329 was charged off as an expense. During 1994, recovery of this charge-off, from renewal commissions, was $1,309 making a total recovery to date of $15,592. The amount of recovery is down in 1994 as was expected and will remain so for 1995. The decrease of general insurance expenses of $13,733 was primarily distributed among the accounts for legal fees, group insurance and printing. Actuarial fees rose as regulatory certification requirements increased. Loan expense increased $5,489 from additional loans made in 1994 and 1993. Taxes, licenses and fees decreased by $730, as assessments by State guarantee funds were lower.\n(b) Financial information about industry segments, and\n(c) Narrative description of business, and\n(d) Financial information about foreign and domestic operations and export sales.\nThe Registrant and its subsidiaries are in the life insurance industry, writing ordinary life insurance policies for individuals. All policies are sold within the United States and no one policyholder or agent accounts for more than 10% of premium revenues.\nThe following tables in this section reflect information as to the life insurance business of Central. The presentation of the Registrant's consolidated operations and admitted assets is according to generally accepted accounting principles.\nSubstantially all business of the Registrant is conducted through its two subsidiaries, Central and CI. CI has a non-exclusive Agency Contract with Central to secure, train and supervise life insurance agents to sell policies of Central. CI's efforts to recruit agents were curtailed in 1987 as a result of Central ceasing to issue Modified Whole Life and Decreasing Term Life to Age 100 policy plans. CI has no salaried personnel, but reimburses Central for use of Central's personnel. CI owns IBM, Gateway 2000 and Data General computer equipment. Time on this equipment is leased to the Registrant and Central. Central's personnel operate the equipment. CI also leases other office equipment to Central.\nCentral is licensed to sell life and accident and health insurance; however, Central has not developed any accident and health policies to date. On January 1, 1989, new Illinois Statutory Standard Nonforfeiture and Standard Valuation Laws took effect. Modified Whole Life and Decreasing Term Life to Age 100 are the only policy plans upon which any policy revision work has been started. Each of Central's other policy plans will be reviewed to determine if future sales potential justifies the cost of actuarial and printing revisions. Prior to January 1, 1989, but not after, Central had approval by the Illinois Insurance Department and sold the following ordinary life policies:\nParticipating policies: Life paid up at 63 with annual pure endowments. Life paid up at 75 with 15 year level term and 20 year return of premium benefits.\nNonparticipating policies: Annual Renewable Term. Decreasing Term to Age 100. Modified Whole Life. Ordinary Whole Life. Premium Endowment at 60.\nNonparticipating riders: The following policy riders were also sold according to general underwriting practice of the life insurance industry: Waiver of Premium, Payor Insurance. Double and Triple Indemnity. Family Income Rider (decreasing term) on 10, 15, 20, 25 and 30 year basis. Family Plan.\nBetween 1974 and 1987, Central's yearly volume of new business was basically from two policy plans, Modified Whole Life and Decreasing Term Life to Age 100. The introduction of these two policies marked a change in Central's sales emphasis from high cash value life insurance policies to lower premium policies with little or no cash value. The change was necessitated because increasing interest rates and inflation were detrimental to the starting of savings through high cash value life insurance policies. Before these new policy plans were introduced, first year premium had averaged as high as $35.79 per $1,000 in 1969, but for 1987, the last year of sales, it was $16.89. When Central introduced these plans, it entered into a coinsurance contract with Life Reassurance Corporation to cover risks in excess of its $10,000 retention. The retention limit was changed to\n$20,000 in 1976. Life Reassurance Corporation notified Central in December, 1986 that it would not accept coinsurance on these two plans after February 28, 1987. This action stopped sales efforts of Modified Whole Life and Decreasing Term Life to Age 100.\nPrior to 1973, GAAP accounting and quarterly reporting were not requirements for life insurance companies and an allowance for these expenses was not included in the calculation of Central's earlier life insurance premium rates. The impact of GAAP accounting is significant, and in 1994, it was estimated to be 21.2% of Central's annual general insurance expenses, up from 19.4% in 1993. Central has not been able to adjust premiums for GAAP expenses since premiums on life insurance policies cannot be increased after issue to reflect increased costs. It is difficult to factor GAAP accounting expenses into new premiums since mutual and certain stock life insurance companies are not required to maintain their records in accordance with GAAP accounting or prepare quarterly SEC reports. Further regulatory changes developed additional expenses when Central's state of domicile, Illinois, required certified annual statements in accordance with statutory accounting principles of domestic companies, certain portions of which have been waived for Central.\nCompetition remains strong as there are more than 850 life insurance companies licensed to do business in the State of Illinois. There are also a large number of life insurance companies in Arizona, Indiana, and Oklahoma.\nThe Registrant and its subsidiaries, with limited staff and financial resources, were continuing to experience difficulty in developing their sales programs and computer system because of the workload and expense involved in maintaining separate accounting and reporting processes for Federal and State Regulators. Plans to develop an interest sensitive product were stalled as the Registrant could not locate software to administer the product at a price reasonable to expected sales. As the purchase price and performance of various software packages were investigated, a recurring difficulty was that they were found to be more costly and less complete than initially indicated by their sellers. Time was also diverted from new product development by the Illinois Insurance Department's triennial examination of Central in 1988. Increased death claims in 1988 and 1989 and the requirement to increase capital and surplus by the end of 1990 were additional restrictions on funds available for business development. The Registrant borrowed $40,000 in 1990 to strengthen Central's capital and surplus. An additional $35,000 was borrowed in 1991 for the same purpose and to replace a thirteen year old computer whose repair cost, after a disk drive failure, exceeded replacement cost.\nWhen Central's death claim expenses increased in the latter part of 1992, the Registrant borrowed an additional $47,500 to apply to expenses and preserve Central's capital and surplus position. At the same time, Central began negotiating a reinsurance agreement covering Central's premium paying policies with another life insurance company. The primary purpose of the agreement was to reduce Central's exposure to death claims. The agreement provided for a transfer of reserves to the other company and a payment to Central of $140,000 and a contract to service the premium paying policies. The agreement was finalized in December, 1992, subject to the approval of the Illinois Insurance Department, with an effective date of December 1, 1992. The Illinois Department made additional requests for information, which each time renewed their thirty day review period, until they sent Central a letter dated March 25, 1993, indicating they would not approve the agreement and requested its withdrawal.\nDuring the Spring of 1993, the Illinois Insurance Department conducted an in-house audit of Central's books and records. Their financial examination report confirmed Central's statutory reports, found no regulatory violations and was adopted and filed October 13, 1993. This report is available for public examination at the Illinois Insurance Department's offices in Chicago or Springfield, Illinois.\nLater in 1993, the Registrant increased its borrowings by $58,000 as income declined and expense reductions failed to keep pace. The registrant borrowed $87,400 additional in 1994. On November 28, 1994, the Registrant and Central signed a definitive written agreement with Citizens, Inc., a Colorado life insurance holding company based in Austin, Texas for the acquisition of the stock of the Registrant and Central by Citizens, Inc. The agreement provides that shareholders of Registrant will receive one (1) share of Citizens, Inc. Class A common stock for each eight (8) shares of the Registrant s Class A or B stock owned. Shareholders of Central other than the Parent will receive one (1) share of Citizens, Inc. Class A Common Stock for each four (4) shares of Central stock owned. The companies will continue to operate in their respective locations under a combined management team with consolidation of computer data processing on Citizens, Inc.'s system. The agreement is subject to the approval of regulatory authorities and stockholders of the Registrant and Central. On March 10, 1995, the Illinois Department of Insurance indicated that the companies could proceed with the merger and Citizens, Inc.'s acquisition of control of Central.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant and its two subsidiaries share a common office located at 2512 North Knoxville, Peoria, Illinois. The lease for this office is in the name of Central and the total monthly rental is $800 for approximately 2,900 square feet of space. During 1994, CI reimbursed Central $1,200 for its share of space occupied.\nThe Registrant's general business equipment has been fully amortized. During the year, the Registrant received $400 a month from Central for use of the equipment.\nC I owns miscellaneous data processing equipment and office equipment with a year-end net book value of $921 and $527, respectively. During the year, C I received $6,000 from Central for use of the equipment.\nCentral owns general business equipment which is fully amortized.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is unaware if any pending litigation to which the Registrant or any of its subsidiaries are parties or to which any of their property is subject.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo items were submitted, during the fourth quarter of the fiscal year covered by this report, to a vote of security holders, through the solicitation of proxies or otherwise.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS\nNeither class of the Company's common stock is listed or actively traded through security brokerage firms, and there is virtually no over-the-counter trading activity.\nThere have been no dividends paid since the inception of the Company.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATE\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOn November 28, 1994, the Registrant and its life subsidiary, Central Investors Life Insurance Company of Illinois (Central), signed a definitive written agreement with Citizens, Inc., a Colorado life insurance holding company based in Austin, Texas for the acquisition of the stock of the Registrant and Central by Citizens, Inc. The agreement provides that shareholders of the Registrant will receive one (1) share of Citizens, Inc. Class A common stock for each eight (8) shares of the Registrant's Class A or B stock owned. Shareholders of Central other than the Parent will receive one (1) share of Citizens, Inc. Class A common stock for each four (4) shares of Central stock owned. The companies will continue to operate in their respective locations under a combined management team with consolidation of computer data processing on Citizens, Inc.'s system. The agreement is subject to the approval of regulatory authorities and stockholders of the Registrant and Central. On March 10, 1995, the Illinois Department of Insurance indicated that the companies could proceed with the merger and Citizens, Inc.'s acquisition of control of Central.\nCONSOLIDATED RESULTS OF OPERATIONS\nThe Company's consolidated loss for 1994 was $125,831 compared to losses of $79,465 in 1993 and $103,151 in 1992. A significant part of the changes occurring between each of the years was due to fluctuations in death claims and realized investment gains along with declining premium and investment income. Premium income in 1994 decreased by $16,050 compared to decreases of $3,156 in 1993 and $4,788 in 1992. The premium decline in 1993 was reduced by an unusual number of Modified Whole Life policyholders electing to pay a one time re-entry fee and continue their policies another ten years. Policy lapses and no new sales were the cause of decreasing premium income. The Company's policy lapse ratios were 4.9% in 1994, a significant improvement from 18.4% in 1993, and 17.3% in 1992.\nInvestment income was down $16,566 in 1994 compared to decreases of $24,564 in 1993 and $18,363 in 1992. The 1994 and 1993 decreases in investment income were the result of falling interest rates during the past three years, which lead to the Company experiencing almost all of its bonds with over 7% yield being called in for redemption. Investment income was further affected by a 1993 change in the Illinois statutory deposit law requiring the Company to maintain a trust deposit of U. S. Government obligations with a market value of $1,200,000. This change required the Company to increase its U. S. Government investments by $900,000 in late 1993, a time of very low interest yields which negatively affected investment income, approximately $25,000 to $30,000 from late 1993 to late 1994. The market value requirement and the Company's small asset base made it necessary to choose short term U. S. Governments to insure less market price volatility, further penalizing yields.\nThe realized investment gains of $1,081 in 1994, and $24,350 in 1993 and $20,208 in 1992 were the result of early calls plus adjustments in stock and U. S. Treasury Note holdings. The Company's bond investments have always been limited to investment grade bonds, but two bonds have been reduced by Moody's Investment Service to a rating of Ba1 or lower. These two bonds represent less than 1.2% of total assets and were current with interest payments at the end of the year. The Company has no direct investments in mortgages or real estate.\nThe Financial Accounting Standards Board (FASB) has issued a Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\". In 1994, this required the Company to classify its debt and marketable equity securities in one of three categories: trading, held-to-maturity, or available-for-sale. Securities which qualify for the held-to-maturity category are to be stated at amortized cost. Since the Company's practice has been to purchase U. S. Treasuries and other bonds with the intent to hold-to-maturity, there was no significant change in the stated value of these investments.\nIn 1994, death claim expenses were $30,020, compared to $29,548 in 1993 and $76,617 in 1992. The death claim expense in 1992 was the highest in the Company's history and developed from Modified Whole Life (MWL) policies written in the early \"80's. During 1993, the lapsing of these policies accelerated as a large block of 1983 MWL policies were subject to a premium increase and deposit refund on their tenth anniversary date. The amount of cash surrenders decreased by $25,719 in 1994 compared to an increase of $15,474 in 1993 and a decrease of $8,235 in 1992. Since the Company is not selling policies with annual endowments or dividends, these policy benefits will also decrease from time to time at a rate determined by cash surrenders. As a result of decreased lapses and cash surrenders in 1994, expenses for future life policy benefits and deferred\npremium increased while amortization of deferred acquisition cost decreased. The recovery of $1,309 in uncollectible agents balances was a result of contractual changes in MWL policies which continued into their eleventh year. Recovery of uncollectible agents balances decreased significantly in 1994, as expected, and will remain low in 1995.\nGeneral insurance expenses in 1994 decreased by $13,733 compared to a decrease of $8,792 in 1993 and an increase of $10,527 in 1992. The 1994 change resulted from decreases in expenses for legal fees, group insurance and printing. Actuarial fees rose as regulatory certification requirements increased in 1994. Between 1993 and 1992, the decrease in expenses resulted from lower expenditures for salaries, group insurance, printing, equipment repair and computer programs. Loan expense increased $5,489 from additional loans made in 1994 and 1993. The Company continues to have difficulty developing sales programs and computer programs, because of the growing work load and expense involved in maintaining separate accounting and reporting processes for Federal and State Regulators. Although the rate of inflation has eased over the past few years, the Company was still adversely affected by modest declines in the purchasing power of the dollar since it cannot increase the premiums on present in-force policies. Taxes, licenses and fees decreased in 1994 as assessment by state guarantee funds were lower.\nDuring the Spring of 1993, the Illinois Insurance Department conducted an in-house audit of the books and records of the Company's life insurance subsidiary. Their financial examination report confirmed the subsidiary's statutory reports, found no regulatory violations and was adopted and filed October 13, 1993. This report is available for public examination at the Illinois Insurance Department's offices in Chicago or Springfield, Illinois.\nLater in 1993, the Registrant increased its borrowings by $58,000 as income declined and expense reductions failed to keep pace. The Registrant borrowed $87,400 additional in 1994. On November 28, 1994, the Registrant and Central signed a definitive written agreement with Citizens, Inc., a Colorado life insurance holding company based in Austin, Texas for the acquisition of the stock of the Registrant and Central by Citizens, Inc. The agreement provides that shareholders of the Registrant will receive one (1) share of Citizens, Inc., Class A common stock for each eight (8) shares of the Registrant's Class A or B stock owned. Shareholders of Central, other than the Parent, will receive one (1) share of Citizens, Inc. Class A common stock for each four (4) shares of Central stock owned. The companies will continue to operate in their respective locations under a combined management team with consolidation of computer data processing on Citizens, Inc. system. The agreement is subject to the approval of regulatory authorities and stockholders of the Registrant and Central. On March 10, 1995, the Illinois Department of Insurance indicated that the companies could proceed with the merger and Citizens, Inc.'s acquisition of control of Central.\nLIQUIDITY AND CAPITAL RESOURCES\nFunds from premium income, interest income, bond maturities and redemptions, and a loan increase of $87,400 were used to meet 1994 liquidity and capital requirements. The company's total assets and liabilities decreased between 1994 and 1993 as a result of decreased investment income and premium income. Although the Company has a substantial amount of liquidity in interest earning cash accounts and short term investments totaling $207,500 and anticipates the maturing of $1,038,000 of bonds in 1995, the requirement to maintain $1,200,000 of capital and surplus in the life subsidiary and to maintain two complex accounting systems for different regulatory layers of government has imposed severe limits on the use of these funds. None of the funds can be applied\ntoward loan repayments due in 1995. The Company will need to secure an extension of its loans or a new loan, an effort which will not be enhanced by the Company's record or previous earnings trends unless regulatory and stockholder approval is secured implementing the previously described definitive written agreement between Citizens, Inc. and the Company. Progress on product development continues to be postponed by concern for the rising cost of supporting the regulatory reporting system, claim experience and maintaining the current capital and surplus requirements for the life insurance subsidiary.\nDuring the early part of 1993, the Company sought approval from the Illinois Insurance Department for a reinsurance contract designed to reduce the Company's exposure to claims while injecting additional capital and permitting the Company to earn a fee servicing the business reinsured. In a letter dated March 25, 1993, the Department requested the contract be withdrawn. Once the computer system, which has been adjusted to service the reinsured business, was readjusted, the decision developed reasonably well for the Company. Death claim expense for 1993 and 1994 returned to near average levels, policy terminations in the block of policies generating claims reduced potential claim expense and, in 1994 the lapse rate dropped to 4.9% from 18.4% in 1993 and 17.3% in 1992.\nThe Company, directly and through its life subsidiary, continued to investigate options for raising additional capital and surplus. Options available, as a result of changing regulatory requirements, have become more restricted by the cost of studies, legal fees, actuarial services and audit certifications required to satisfy various regulators. Among options which have been investigated were the redomestication of the life subsidiary, the sale of premium paying policies to reduce exposure to death claims, surplus debentures and sale or merger of the Company or its life subsidiary. A sale of stock by the Company or its life subsidiary was also considered. However, the Company comes under the Securities and Exchange Commission (SEC) rules, which makes it very costly to sell a small block of stock; nor would the Company's history be conducive to selling additional stock. Toward the end of 1994, the previously described definitive written agreement was included in a Form A filing with the Illinois Insurance Department regarding a change of control of a life insurance company. On March 10, 1995, the Illinois Insurance Department indicated the companies could proceed to secure approval from other regulatory agencies and stockholders.\nThe National Association of Insurance Commissioners established new minimum capital requirements in the form of Risk Based Capital. Risk-based capital factors the type of business written by a company, the quality of its assets, and various other factors into account, to develop a minimum level of capital called \"authorized control level risk-based capital\" and compares this level to an adjusted statutory capital that includes capital and surplus as reported under Statutory Accounting Principles, plus certain investment reserves. Should the ratio of adjusted statutory capital to control level risk-based capital fall below 200%, a series of actions by insurance regulators begins. At December 31, 1994, the Company's life subsidiary's ratio was 8,346.7%. This unusual ratio was a result of a high percentage of investments in U.S. Government securities and a low ratio of liabilities to capital and surplus.\nAt the end of 1994 the life subsidiary had $1,202,323 of statutory capital and surplus. This was a decrease of $11,924 compared to an increase of $4,628 in 1993 and a decrease of $24,799 in 1992. The Illinois Legislature established $1,200,000 as the minimum statutory capital and surplus for an Illinois domiciled life insurance company after December 31, 1990. On December 31, 1995, the\nrequirement changes to $1,500,000 capital and surplus. The normal \"grandfather\" provision was not allowed, and life insurance companies which were in existence before the changes were established are required to meet the new minimums as they come into effect.\nThe cost of maintaining and reporting under two complex standards of accounting, GAAP for Federal Regulators and statutory accounting for State Regulators, continues to drain resources from more productive efforts. Statutory accounting has always been required of the Company, but GAAP accounting was not required until 1973. In 1994, GAAP accounting was estimated to have cost $34,150 or 21.2% of 1994 GAAP general insurance expenses. From the start of GAAP accounting in 1973, the Company estimates, exclusive of internal expenses, that $377,518 has been spent with independent actuarial and accounting firms to assist in maintaining the GAAP accounting system. In the opinion of management, statutory accounting will remain the primary accounting method determining the Company's solvency, and ability to make expenditures and pay dividends.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nInsurance Investors & Holding Co. and Subsidiaries:\nIndependent Auditor's Report Consolidated Balance Sheets - December 31, 1994 and 1993 Consolidated Statements of Operations - Three Years Ended December 31, 1994 Consolidated Statements of Changes in Stockholders Equity - Three Years Ended December 31, 1994 Consolidated Statements of Cash Flows - Three Years Ended December 31, 1994 Notes to Consolidated Financial Statements\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\n[KPMG PEAT MARWICK LLP LETTERHEAD]\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Stockholders Insurance Investors & Holding Co.:\nWe have audited the consolidated financial statements of Insurance Investors & Holding Co. and subsidiaries. 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 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 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Insurance Investors & Holding Co. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, 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 LLP \/s\/ KPMG Peat Marwick LLP\nDallas, Texas June 6, 1995\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nConsolidated Balance Sheets\nDecember 31, 1994 and 1993\nSee accompanying notes to consolidated financial statements.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nConsolidated Statements of Operations\nYears ended December 31, 1994, 1993 and 1992\nSee accompanying notes to consolidated financial statements.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nConsolidated Statements of Changes in Stockholders' Equity\nYears ended December 31, 1994, 1993 and 1992\nSee accompanying notes to consolidated financial statements.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nConsolidated Statements of Cash Flows\nSee accompanying notes to consolidated financial statements.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1994, 1993 and 1992 --------------------------------------------------------------------------------\n(1) BASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, C I Agency, Inc. and its 93.0% owned subsidiary, Central Investors Life Insurance Company of Illinois. All significant intercompany balances and transactions have been eliminated in consolidation. The significant accounting policies are as follows:\nThe accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles prescribed for stock life companies for all years presented.\n(a) Premiums Gross premium received in excess of the net premium on limited-payment contracts is deferred and recognized in income over the expected life of the business. Other premium income is recognized as revenue ratably over the terms of the respective policies calculated on the monthly pro rata basis and are stated after deduction for reinsurance with other insurers.\n(b) Deferred Policy Acquisition Costs Policy acquisition costs such as commissions (net of reinsurance), premium taxes, and certain other underwriting and agency expenses which vary with and are directly related to the production of business have been deferred. Such deferred policy acquisition costs are being amortized as premium revenue is recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, losses and loss settlement expenses, and certain other costs expected to be incurred as the premium is earned.\n(c) Future Policy Benefits Liabilities for future life policy benefits and expenses have been computed by a net level premium method based upon estimated future investment yield, mortality and withdrawals.\n(d) Depreciation Furniture and equipment are depreciated over estimated useful lives of 5 to 10 years. Provision for depreciation is computed using the straight-line and accelerated methods.\n(e) Federal Income Taxes Effective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements --------------------------------------------------------------------------------\nrecognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases (temporary differences) and operating loss and tax credit carryforwards. 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.\nThe cumulative effect of the change in accounting for income taxes was $-0- and has therefore not been separately stated in the 1993 consolidated Statement of Operations.\nPrior to January 1, 1993, in accordance with Accounting Principles Board Opinion No. 11 (APB 11), amounts provided for income tax expense by the Company were based on income reported for financial statement purposes rather than amounts currently payable under tax laws. Deferred taxes, which arose from timing differences between the period in which certain income and expenses were recognized for financial accounting purposes and the period in which they affected taxable income, were included in the amounts provided for income taxes.\n(f) Earnings Per Share Earnings per share have been computed using weighted average number of shares of common stock outstanding during each period.\n(g) Accounting Pronouncements 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 115). SFAS 115, requires the classification of debt and equity securities in one of three categories: trading, held-to-maturity, or available-for-sale, based on established criteria.\nHeld-to-maturity securities are stated at amortized cost which represents actual cost adjusted for amortization of premium and accretion of discount using methods that generally approximate the effective interest method. Trading and available-for-sale securities are stated at fair value. Unrealized holding gains and losses, net of related taxes, on available-for-sale securities are excluded from earnings and reported as a separate component of stockholders' equity until realized, while unrealized gains and losses for trading securities are included in earnings. A decline in the market value of any available-for-sale or held-to-maturity security below cost that is deemed other than temporary is charged to earnings resulting in the establishment of a new cost basis for the security.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements --------------------------------------------------------------------------------\nThe Company adopted SFAS 115 effective January 1, 1994 on a prospective basis. There was no impact of adoption of SFAS 115 to the consolidated financial statements as all the debt securities of the Company are classified as held to maturity.\n(2) INVESTMENTS\n(a) Bonds and U.S. Treasury bills are included in the consolidated financial statements at amortized cost, as the Company intends to hold all bond until maturity. The non-redeemable preferred stocks are carried at market.\n(b) Adjustments reflecting the revaluation of stocks at each statement date on the basis described in paragraph (a) above, are carried to the consolidated statements of stockholders equity as unrealized appreciation (depreciation) on investments.\n(c) The fair values of U.S. Treasury securities, bonds and stocks represent quoted market values from published sources.\nThe amortized cost and estimated fair values of investments in debt securities are as follows:\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements --------------------------------------------------------------------------------\nThe amortized cost and estimated market value of debt securities at December 31, 1994 by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nThe following information summarizes the components of investment income and changes in realized and unrealized gains (losses):\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements --------------------------------------------------------------------------------\nGross unrealized gains and gross unrealized losses at December 31 were as follows:\n(c) Net realized gain or loss on investments is determined on the basis of specific identification.\nProceeds from sales of fixed maturity investments were $304,438 in 1993. Gross gains and losses realized on those sales were $25,131 and $781 for 1993. There were no sales of fixed maturities in 1994.\n(d) At December 31, 1994 and 1993, the market value of investments on deposit with government authorities in excess of the legal requirements were $1,245,250 and $1,287,524, respectively.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements --------------------------------------------------------------------------------\n(3) ACTUARIAL ASSUMPTIONS - DEFERRED ACQUISITION COSTS AND FUTURE LIFE POLICY BENEFITS\nINTEREST:\nPolicy reserves for most ordinary policies in force are computed on the basis of interest rates for the first year of 6% graded over 20 years to 4%. Other policies use 4%.\nMORTALITY:\nMortality rates assumed in the computation of most policy reserves are based on the 1955-60 Select and Ultimate Mortality Tables.\nEXPENSES:\nCapitalized expenses include commissions, underwriting and policy issue expenses, but exclude expenses which do not vary with the sales of new business, such as developmental, advertising and sales promotion expenses. Amortization of expenses is accomplished principally by using actuarial techniques incorporating assumptions for interest, mortality and withdrawals.\nWITHDRAWALS:\nWithdrawal rates for most policies in force are based upon Company experience. Other policies use the Linton A Table.\n(4) NOTES PAYABLE\nNotes payable at December 31, 1994 and 1993 are as follows:\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\n5) STOCKHOLDERS EQUITY\nThe holders of each class of common stock are entitled to one vote for each share held, with the right of cumulative voting for directors. In the event of liquidation, Class A common stockholders shall first be paid $2 a share; next, Class B common stockholders shall be paid $.10 a share; thereafter, any remaining distribution would be on a share-for-share basis.\nClass B stockholders are not entitled to a cash dividend in any year until Class A stockholders have been paid $.12 a share. In that event, Class B stockholders are entitled to a dividend up to $.12 a share in that year. Thereafter, any remaining distribution during that year is on a share-for-share basis.\nThe Class B common shares are automatically convertible into Class A common shares if, and when, the Company has had average net earnings of $.12 a share per year (on the total number of Class A and Class B common shares outstanding at time of conversion) for a period of not less than 36, nor more than 60, consecutive months. Such conversion is to be made on a share-for-share basis.\nThe payment of cash dividends by the Company is principally dependent upon the amount of its insurance subsidiary s statutory surplus available for dividend distribution.\nUnder the Illinois Insurance Code, dividends may be paid only from unassigned surplus, as restricted by the provisions of the Code. As defined by the Illinois Insurance Code provisions, no dividends or other distributions can be paid by the insurance subsidiary unassigned surplus reflects a statutory deficit at December 31, 1994, 1993 and 1992 (see note 7).\n(6) Reconciliation Between GAAP and Statutory Financial Statements for Net Earnings (Loss) and Retained Deficit\nThe following reconciles net earnings (loss) and retained earnings (deficit) determined in accordance with statutory accounting practices prescribed or permitted by the Insurance Department of the State of Illinois with such amounts determined in conformity with generally accepted accounting principles:\n(7) Income Taxes\nThe Company and C I Agency, Inc. file a consolidated federal income tax return, while Central Investors Life Insurance Company of Illinois files a separate federal income tax return.\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 was $-0- as of January 1, 1993 and therefore is not reported separately in the consolidated statement of operations for the year ended December 31, 1993. Prior years financial statements have not been restated to apply the provisions of Statement 109.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nTotal income tax benefit is less than the amount computed by applying the applicable federal income tax rate to losses from operations before income taxes for the following reasons:\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1994 and 1993 are presented below:\nThe change in the valuation allowance for deferred taxes for the year ended December 31, 1994 and 1993 was an increase of $33,349 and $15,150, respectively.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements --------------------------------------------------------------------------------\nSubsequently recognized tax benefits relating to the valuation allowance for deferred tax assets as of December 31, 1994 will be allocated to income tax benefit that would be reported in the consolidated statement of operations.\nIn assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. In order to fully realize the deferred tax asset, the Company will need to generate future taxable income of approximately $637,000 in future years.\nFor federal income tax purposes, the Company's life insurance subsidiary at December 31, 1994 had net operating loss carryforwards of approximately $305,000 available to offset future taxable income. These carryforwards expire as follows: $28,000 in 1995, $3,000 in 1996, $38,000 in 1997, $63,000 in 1998, $19,000 in 1999, $9,000 in 2002, $51,000 in 2003, $23,000 in 2004, $5,000 in 2006, $39,000 in 2007, $24,000 in 2008 and $6000 in 2009.\nFor federal income tax purposes, the Company and C I Agency at December 31, 1994 had net operating loss carryforwards of approximately $343,000 available to offset future taxable income. These carryforwards expire as follows: $9,500 in 2003, $56,300 in 2004, $48,600 in 2005, $45,000 in 2006, $73,600 in 2007, $77,000 in 2008 and $33,000 in 2009.\n(8) Dividends to Policyholders\nIn 1994, 1993, and 1992, the Company provided for policyholder dividends of $13,996, $15,135 and $18,422, respectively.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements --------------------------------------------------------------------------------\nCertain of the life policies written by the Company are \"participating policies.\" Dividends on participating policies generally are payable in the second and subsequent years on the basis of 90% of the earnings applicable to the sale of such policies. During 1994 and prior years, based on the allocations of income and expenses to the various lines of business, the participating policies have produced losses. Consequently, the accompanying consolidated financial statements reflect no provision for additional dividends.\n(9) Minority Interest\nMinority interest in the equity of the consolidated subsidiary, Central Investors Life Insurance Company of Illinois, is comprised of the following:\n(10) Segment Information\nThe Company operates primarily through its subsidiaries, Central Investors Life Insurance Company of Illinois and C I Agency, Inc. The life insurance is primarily personal lines sold by agents under contract by C I Agency, Inc. Separate financial statements are not shown in this report for Central Investors Life Insurance Company of Illinois and C I Agency, Inc. since their financial position and results of operations are indicative of the consolidated financial position and results of operations. The following table presents certain information concerning Central Investors Life Insurance Company of Illinois, (in 000's):\nNet income (loss) for each of the years in the three years ended December 31, 1994 was $(25,886), $1,736,and $(37,632), respectively.\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements --------------------------------------------------------------------------------\n(11) Commitments and Contingent Liabilities\nThe Company does not retain more than a $20,000 liability on any one life. To the extent that any reinsuring companies are unable to meet their obligations under the reinsurance agreements, the Company would remain liable.\nThe amounts related to reinsurance ceded are as follows:\nSchedule II\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nINSURANCE INVESTORS & HOLDING CO.\nCondensed Balance Sheets\nDecember 31, 1994, 1993 and 1992\nSee accompanying note to condensed financial information of Registrant.\nSchedule II Continued\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nINSURANCE INVESTORS & HOLDING CO.\nCondensed Statements of Operations\nYears ended December 31, 1994, 1993 and 1992\nSee accompanying note to condensed financial information of Registrant.\nScheduled II Continued\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nINSURANCE INVESTORS & HOLDING CO.\nCondensed Statements of Cash Flows\nYears ended December 31, 1994, 1993 and 1992\nSee accompanying note to condensed financial information of Registrant.\nSchedule II Continued\nCONDENSED FINANCIAL INFORMATION OF REGISTRANT\nINSURANCE INVESTORS & HOLDING CO.\nNote to Condensed Financial Information of Registrant --------------------------------------------------------------------------------\nSummary of Significant Accounting Policies\nThe Company normally prepares consolidated financial statements with its subsidiaries. The Condensed Financial Information of the Registrant (parent only) has been prepared to conform with the requirements of the Securities and Exchange Commission. This information should be read in conjunction with the consolidated financial statements and notes contained elsewhere herein.\n(a) Investment in Subsidiaries\nThe investment in common stock of subsidiaries is reflected at cost, adjusted for equity in operations.\n(b) Income Taxes\nNo Federal income tax expense was incurred in 1994, 1993 and 1992 due to operating losses.\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Under the asset and liability method of SFAS 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 (temporary differences) and operating loss and tax credit carryforwards. 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.\nThe cumulative effect of the change in accounting for income taxes was $-0- and has therefore not been separately stated in the 1993 Condensed Statement of Operations.\nPrior to January 1, 1993, in accordance with Accounting Principles Board Opinion No. 11 (APB 11), amounts provided for income tax expense by the Company were based on income reported for financial statement purposes rather than amounts currently payable under tax laws. Deferred taxes, which arose from timing differences between the period in which certain income and expenses were recognized for financial accounting purposes and the period in which they affected taxable income, were included in the amounts provided for income taxes.\nSchedule III\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nSupplementary Insurance Information\nDecember 31, 1994, 1993 and 1992\n* Not applicable\nSchedule VI\nINSURANCE INVESTORS & HOLDING CO. AND SUBSIDIARIES\nReinsurance\nDecember 31, 1994, 1993 and 1992\n* Not applicable\nItem 9.","section_9":"Item 9. Disagreements on Accounting and Financial Disclosure\nThere have been no disagreements with accountants regarding any matter of accounting principles or practices or financial statement disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nThe following information as of December 31, 1994 is furnished with respect to each director and executive officer.\n(1) Member of Executive and Investment Committees\nFull Board of Directors as Audit Committee\nNote: All directors and officers are elected for a term of one year or until their successors have been elected and qualified.\nItem 10. Directors and Executive Officers of the Registrant, Continued\nFamily Relationships\nFrank J. Wilkins, Director, is the father of Robert D. Wilkins, Director.\nThere are no family relationships among the officers listed, and there are no arrangements or understandings pursuant to which any of them were elected as officers.\nOther\nThere 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 director or executive officer during the past five years.\nItem 11.","section_11":"Item 11. Executive Compensation\nSummary Compensation Table\nCompensation Through Plans and Other Compensation\nAll employees are covered by a group insurance plan. No option has been granted to any employee to purchase securities from the Company or any of its subsidiaries. There are no pension or retirement benefit plans.\nCompensation of Directors\nMr. McCallum and Mr. Robert D. Wilkins received a $250 yearly director's fee from the Company and each of its two subsidiaries. Mr. Robert W. Kreutz received a $750 yearly director's fee from the Company s life subsidiary. Mr. Frank J. Wilkins received no director's fees.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security Ownership of Certain Beneficial Owners\nSet forth below is certain information concerning persons who are known by the Registrant to own beneficially more than 5% of any class of the Company's voting shares on December 31, 1994.\nItem 12. Security Ownership of Certain Beneficial Owners and Management, Continued\n(a) Security Ownership of Certain Beneficial Owners, Continued\n(1) See footnote (1) in Section (b) below. (2) See footnote (2) in Section (b) below.\n(b) Security Ownership of Management\nThe following table sets forth as of December 31, 1994 information concerning the beneficial ownership of each class of equity securities by all directors and all directors and officers of the Company as a group. Class A and Class B shares are those of the Registrant.\n(1) Inclusive of 14,000 Class A shares and 82,800 Class B shares held as co-trustee with the First of America Bank of Peoria, for the benefit of Frank J. Wilkins children; and exclusive of 103,428 Class A shares and 220,886 Class B shares owned by Frank J. Wilkins wife and children.\n(2) Held jointly with wife.\n(c) Changes in Control\nNot applicable.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nRegistrant had no such reportable transaction as described under Item 404 of Regulation S-K.\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 Insurance Investors & Holding Co. and its subsidiaries are included in Part II, Item 8:\n(a) 2. Financial Statement Schedules\nThe following consolidated financial statement schedules of Insurance Investors & Holding Co. and its subsidiaries, which are required under Rule 7 of Regulation S-X, are included in Part II, Item 8:\n(a) 3. Exhibits Required Under Item 601 of Regulation S-K:\n1) Articles of Incorporation and By-Laws (incorporated by reference from Exhibit 3 from Form 10-K previously filed for the year ended December 31, 1981)\n2) Subsidiaries of the Registrant (incorporated by reference to Part I, Item I, (Business) of this Form 10-K\n3) Article III, Section 2, of the By-Laws was amended and a complete copy of the By-Laws as amended was filed as an enclosure with Form 10-K previously filed for the year ended December 31,\n27) Financial Data Schedule\n(b) Reports on Form 8-K:\nOne report on Form 8-K was filed by Insurance Investors and Holding Company, Inc., on December 9, 1994, relating to the proposed acquisition by Citizens, Inc.\nNo other schedules or exhibits are included herein because they are not required or are inapplicable.\nSeparate statements for Central Investors Life Insurance Company have been omitted as their financial position and results of operations are indicative of the consolidated financial position and results of operations.\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.\nINSURANCE INVESTORS & HOLDING CO. Registrant\nBY \/s\/ Frank J. Wilkins -------------------------------------- Frank J. Wilkins, President\nDate: August 16, 1995\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 \/s\/ Frank J. Wilkins ------------------------------------------ Frank J. Wilkins President, Treasurer and Director\nDate: August 16, 1995\nBy \/s\/ Robert W. Kreutz ------------------------------------------ Robert W. Kreutz Vice-President, Secretary and Director\nDate: August 16, 1995\nBy \/s\/ Robert W. McCallum ------------------------------------------ Robert W. McCallum Director\nDate: August 16, 1995\nBy \/s\/ Robert D. Wilkins ------------------------------------------ Robert D. Wilkins Director\nDate: August 16, 1995\nEXHIBIT INDEX\nEXHIBIT NO. EXHIBIT DESCRIPTION PAGE ----------- ------------------- ----\n1) Articles of Incorporation and By-Laws (incorporated by reference from Exhibit 3 from Form 10-K previously filed for the year ended December 31, 1981)\n2) Subsidiaries of the Registrant (incorporated by reference to Part I, Item I, (Business) of this Form 10-K)\n3) Article III, Section 2, of the By-Laws was amended and a complete copy of the By-Laws as amended was filed as an enclosure with Form 10-K previously filed for the year ended December 31, 1990\n27) Financial Data Schedule","section_15":""}
{"filename":"43952_1994.txt","cik":"43952","year":"1994","section_1":"ITEM 1. BUSINESS.\nRegistrant (\"Grey\") and its subsidiaries (collectively with Grey, the \"Company\") have been engaged in the planning, creation, supervision and placing of advertising since the Company's formation in 1917. Grey was incorporated in New York in 1925 and changed its state of incorporation to Delaware in 1974.\nThe Company's principal business activity consists of providing a full range of advertising services to its clients. Typically, this involves developing an advertising and\/or marketing plan after study of a client's business, the distribution or utilization of the client's products or services and the use of various media (e.g., television, radio, newspapers, magazines, direct mail, outdoor billboards) by which desired market performance can best be achieved. The Company then creates advertising, prepares media recommendations and places advertising in the media. The Company's business also involves it in allied areas such as marketing consultation, audio-visual production, cooperative advertising programs, direct marketing, media buying, research, product publicity, public relations and sales promotion.\nThe Company is not engaged in more than one industry segment, and no separate class of similar services contributed 10% or more of the Company's gross income or net income during 1994, 1993 or 1992.\nThe Company serves a diversified client roster in the apparel, automobile, beverage, chemical, community service, computer, corporate, electrical appliance, entertainment, food product, home furnishing, houseware, office product, packaged goods, publishing, restaurant, retailing, toy, travel and other sectors.\nAdvertising is a highly competitive business in which agencies of all sizes and other providers of creative or media services strive to attract new clients or additional assignments from existing clients. Competition for new business, however, is restricted from time to time because large agencies (such as the Company) often are precluded from providing advertising services for products or services that may be viewed as being competitive with those of an existing client. Generally, since advertising agencies charge clients substantially equivalent rates for their services, competitive efforts principally focus on the skills of the competing agencies.\nPublished reports indicate that there are over 500 advertising agencies of all sizes in the United States. In 1994, the Company was the 8th largest United States advertising agency in terms of domestic gross income according to statistics published in Adweek, a trade publication.\nApproximately 52% of the Grey's present domestic advertising clients, representing a significant majority of the Company's 1994 domestic gross income, have been with the Company since 1990. The agreements between the Company and most of its clients are generally terminable by either the Company or the client on 90 days' notice as is the custom in the industry. Clients may also reduce advertising budgets at any time and for any reason.\nDuring 1994, one client (The Procter & Gamble Company) represented more than 10% of the Company's consolidated income from commissions and fees. No other client represented more than 5% of the Company's total consolidated commissions and fees. The loss of such client or other large clients of the Company may be expected to have an adverse effect on net income. Losses of important clients in past years, however, have not had a long-term effect upon the Company's financial condition or its competitive position.\nOn December 31, 1994, Grey and its consolidated subsidiaries employed approximately 5,800 persons, of whom eight were executive officers of Grey.\nAs is generally the case in the advertising industry, the Company's business traditionally has been seasonal, with greater revenues generated in the second and fourth quarters of each year. This reflects, in large degree, the media placement patterns of the Company's clients.\nAdvertising programs created by the Company are placed principally in media distributed within the United States and overseas through its offices in the United States and a number of foreign countries. While the Company operates on a worldwide basis, for the purposes of presenting certain financial information in accordance with Securities and Exchange Commission rules, its operations are deemed to be conducted in three geographic areas. Commissions and fees, and operating profit by each such geographic area for the years ended December 31, 1994, 1993 and 1992, and related identifiable assets at December 31 of each of the years, are summarized in Note N of the Notes to Consolidated Financial Statements, which is incorporated herein by reference.\nWhile the Company has no reason to believe that its foreign operations as a whole are presently jeopardized in any material respect, there are certain risks of operating which do not affect domestic operations but which may affect the Company's foreign operations from time to time. Such risks include the possibility of limitations on repatriation of capital or dividends, political instability, currency devaluation and restrictions on the percentage of permitted foreign ownership.\nEXECUTIVE OFFICERS OF THE REGISTRANT AS OF MARCH 1, 1995\n(a) All executive officers are elected annually by the Board of Directors of Grey. Each executive officer has been with Grey for a period more than five years. There exists no family relationship between any of Grey's directors or executive officers and any other director or executive officer or person nominated or chosen to become a director or executive officer.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nSubstantially all offices of the Company are located in leased premises. The Company's principal office is at 777 Third Avenue, New York, New York, where it now occupies approximately 357,000 square feet of space. The main lease covering the bulk of this space expires in 1999. The Company also has significant leases covering other offices in New York, Los Angeles, Amsterdam, Brussels, Copenhagen, Dusseldorf, Hong Kong, London, Madrid, Melbourne, Milan, Paris, Stockholm and Toronto.\nThe Company considers all space leased by it to be adequate for the operation of its business and does not foresee any significant difficulty in meeting its space requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is not involved in any material pending legal proceedings other than ordinary routine litigation incidental to the business of the Company.\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 during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Common Stock of Grey is traded on The Nasdaq Stock Market's National Market and quoted on the National Market System of NASDAQ under the symbol GREY.\nAs of March 1, 1995, there were 513 holders of record of the Common Stock and 310 holders of record of the Limited Duration Class B Common Stock.\nThe following table sets forth certain information about dividends paid, and the bid prices on the NASDAQ Stock Market during the periods indicated with respect to the Common Stock:\n* Such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\n(a) In 1991, the Company recognized restructuring charges primarily related to the absorption of the Company's subsidiary, Levine Huntley Vick & Beaver, Inc.\n(b) In the fourth quarter of 1994, the Company recorded a charge of $39,944,000 on both a pre-tax and after-tax basis, for a non-cash write-off which related almost exclusively to write-offs of goodwill.\n(c) Gives effect to amounts attributable to (i) redeemable preferred stock, (ii) the assumed exercise of dilutive stock options, (iii) shares issuable pursuant to the Company's Senior Management Incentive Plan and (iv) for fully diluted net income per common share, the assumed conversion of 8-1\/2% Convertible Subordinated Debentures issued December 1983.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nIncome from commissions and fees (\"gross income\") increased 4.6% in 1994 and 0.5% in 1993 as compared to the respective prior years. Absent exchange rate fluctuations, gross income increased 6.0% in 1994 and 5.9% in 1993 as compared to the respective prior years. In 1994, 1993 and 1992, respectively, 46.8%, 47.2% and 42.7% of consolidated gross income was attributable to domestic operations and 53.2%, 52.8% and 57.3%, respectively, to international operations. The increases in gross income in both years primarily resulted from expanded activities from existing clients and the continued growth of the Company's general agency and specialized operations. In 1994, gross income from domestic operations increased 3.5% versus 1993 and was up 11.1% in 1993 versus 1992. Gross income from international operations increased 5.6% in 1994 when compared to 1993 after a decrease of 7.4% in 1993. The decrease in international gross income in 1993 was partially attributable to a general slowdown of advertising activity in certain markets and the relative strength of the United States dollar.\nSalaries and employee-related expenses increased 6.2% in 1994 and less than 1%, in 1993 as compared to the respective prior years. Office and general expenses, absent the goodwill write-off (discussed below), increased 3.3% in 1994 and 2.1% in 1993 versus respective prior years. The increases in expenses are generally in line with the increases in gross income shown for such years.\nIn the fourth quarter of 1994, the Company wrote-off $39,944,000 of goodwill. The non-cash write-off related almost exclusively to international acquisitions made by the Company principally in the 1980's. The carrying value of the Company's goodwill prior to the write-off was approximately $84,000,000 and the write-off was associated with 34 of the almost 100 investments for which the Company had unamortized goodwill. The portion of the write-off relating to advertising agencies was approximately $31,295,000 and $8,649,000 related to public relations agencies. Significant amounts of these write-offs related to operations in the United Kingdom.\nThe widely recognized international recession seriously affected the advertising industry, particularly in Western Europe, where the Company has its largest and most developed international operations. As the recession abated in the latter part of 1994, the Company was able to assess more clearly the long-term prospects of the affected operations. At that point, and in connection with annual business plan meetings which took place in the fourth quarter, it became clear that the goodwill associated with a number of the agencies had become permanently impaired. Management's projections indicated that anticipated future cash flows for these specific operations would not, as would be expected in a normal post-recession environment, recover sufficiently to cover amortization of the associated goodwill. The gross income of the operations for which permanent impairment of goodwill was recognized in 1994 represented approximately 7%, 9% and 12% of the Company's consolidated gross income in 1994, 1993 and 1992, respectively.\nIn reaching its conclusion as to the impairment of goodwill, the Company took into account certain client-related developments, such as client losses or major changes in the business circumstances of clients significant to particular operations, and the departure of key management personnel. In substantially all of the 34 operations for which there were goodwill write-offs, the loss of key clients and\/or key personnel specific to those operations were significant factors leading to management's determination that goodwill was impaired. While indicators of impairment may have been developing during the course of the year, until the recession abated, business planning meetings were held and the annual analysis of recoverability of goodwill was performed, management had not determined whether permanent impairment of goodwill had occurred.\nThe material portion of the goodwill write-off related to ten agencies acquired in the United Kingdom as part of a strategy to develop the Company's representation outside of the London market in the general advertising category and in certain specialized disciplines (such as retail advertising, promotional services and public relations). With the revival of the industry, a review of the Company's local market strategies, and in conjunction with several key management changes, client losses or the inability of these operations to maintain revenues with replacement or new clients, after the analysis referred to above, management concluded that the goodwill associated with these operations had been permanently impaired. While future client losses and management changes could affect the Company's operations in the United Kingdom, the Company has consolidated a number of operations, thereby lessening the likelihood of a negative impact from any instance of client or management turnover. In addition, the unimpaired goodwill balances associated with the United Kingdom operations represents less than 10% of the Company's consolidated unamortized goodwill as of December 31, 1994.\nSeveral of the operations where permanent impairment of goodwill was identified will continue to operate as ongoing businesses; however, management has concluded that such operations will likely continue to experience difficulties. While the Company has no intention of closing any office or terminating employees in these operations other than in the normal course of business, the Company will take prudent and reasonable actions, which may include expense reductions, consolidation of offices and perhaps making selected acquisitions to supplement these operations, as may be necessary to have such operations contribute to the Company's profitable activities.\nIn 1993 and 1992, respectively, the Company wrote-off $1,939,000 and $3,065,000 of goodwill in excess of normal amortization schedules.\nThe Company will continue to assess the carrying value of its goodwill by analyzing non-discounted cash flows and will recognize additional permanent impairments, if any, as they arise.\nNeither inflation nor changing prices had a material effect on revenue or expenses in 1992, 1993 or 1994.\nThe effective tax rate was 1,342.9% in 1994, 52.7% in 1993 and 46.9% in 1992. The increase in the effective tax rate in 1994 as compared to 1993 is due to the goodwill write-off in the fourth quarter, which is a non-deductible expense for tax purposes. Absent the goodwill write-off, the 1994 effective tax rate would have been 52.0%, approximately the same as 1993. The increase in the effective tax rate in 1993 as compared to 1992 is primarily related to an increase in the state and local tax provision which results from a higher portion of income of consolidated companies before taxes on income being derived from domestic\noperations in 1993. In addition, the 1993 effective tax rate increased because the U.S. income tax statutory rate rose to 35% from 34%.\nMinority interest decreased $1,468,000 in 1994 and $3,104,000 in 1993 as compared to the respective prior years. The decreases in 1994 and in 1993 were primarily due to changes in the level of profits of majority-owned companies.\nEquity in earnings of nonconsolidated companies decreased $298,000 in 1994 and increased $1,068,000 in 1993 as compared to the respective prior years. These changes are due primarily to changes in the level of profits attributable to the nonconsolidated companies.\nThe Company reported a loss of $21,378,000 for 1994 as compared to net income of $17,681,000 in 1993; absent the goodwill write-off, net income for 1994 would have been $18,566,000, an increase of 5.0% over 1993. Net income for 1993, increased 11.2% over net income in 1992. Net loss per common share for 1994 was $17.51 as compared to primary earnings per share of $13.46 in 1993. Absent the goodwill write-off, primary net income per share would have been $13.50, an increase of .3% over 1993. Primary net income per share increased 6.2% in 1993 over 1992.\nFor purposes of computing primary net income per common share, the Company's net income was (i) reduced by dividends paid on the Company's Preferred Stock and (ii) reduced or increased by the increase or decrease, respectively, in redemption value of the Preferred Stock.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company continues to maintain a high level of liquidity, as it continued to have high levels of cash and investments in highly marketable liquid United States government securities. Cash and cash equivalents were $170,077,000 and $181,267,000 at December 31, 1994 and 1993, respectively, and the Company's investment in United States government securities was $22,463,000 and $22,425,000 at December 31, 1994 and 1993, respectively. The high level of liquidity reflects the Company's attention to the cash management process.\nDomestically, the Company maintains committed bank lines of credit totalling $40,000,000. These lines of credit were partially utilized during both 1994 and 1993 to secure obligations of selected foreign subsidiaries in the respective year-end amounts of $15,000,000 and $11,100,000.\nOther lines of credit are available to the Company in foreign countries in connection with short-term borrowings and bank overdrafts used in the normal course of business. There were $49,460,000 and $34,751,000 outstanding under such facilities at December 31, 1994 and 1993, respectively.\nHistorically, funds from operations and short-term bank borrowings have been sufficient to meet the Company's dividend, capital expenditure and working capital needs. The Company expects that such sources shall be sufficient to meet its short-term cash requirements in the future.\nWhile the Company has not had to utilize long-term borrowing to fund its operating needs, in January 1993, taking advantage of favorable terms offered, it borrowed $30,000,000, at a fixed interest rate of 7.68%, principal repayable in equal installments in January 1998, 1999 and 2000. The Company does not anticipate any material increased requirement for capital or other expenditures which will adversely affect its liquidity.\nThe Company's business generally has been seasonal with greater commissions and fees earned in the second and fourth quarters, particularly the fourth quarter. As a result, cash, accounts receivable, accounts payable and accrued expenses are typically higher on the Company's year-end balance sheet than at the end of any of the preceding three quarters.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information required by this Item is presented in this report beginning on Page.\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 incorporated herein by reference to the Company's proxy statement (the \"Proxy Statement\") to be sent to its stockholders in connection with its 1995 annual meeting, under the caption \"Election of Directors\". Information with respect to the Company's executive officers is set forth in Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information required by this Item is incorporated herein by reference to the Proxy Statement and will be included under the caption \"Management Remuneration and Other Transactions\".\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information required by this Item is incorporated herein by reference to the Proxy Statement and will be included under the captions \"Election of Directors\" and \"Voting Securities\".\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information required by this Item is incorporated herein by reference to the Proxy Statement and will be included under the captions \"Election of Directors\" and \"Voting Securities\".\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) (1) (2) The information required by this subsection of this Item is presented in the index to Financial Statements on Page.\n(3)The information required by this subsection of this Item is provided in the Index of Exhibits at Page of this report. Such index provides a listing of exhibits filed with this report and those incorporated herein by reference.\n(b) Reports on Form 8-K: The Company filed a report on Form 8-K dated December 13, 1994 and filed with the Commission on December 20, 1994 in which the Company's announcement of a fourth quarter non-cash write-off of goodwill was disclosed. Further information about this transaction can be found in both the Management's Discussion and Analysis of Financial Condition and Results of Operations (Item 7) and Note M to the Consolidated Financial Statements.\nThe undersigned Registrant hereby undertakes as follows, which undertaking shall be incorporated by reference into Registrant's Registration Statements on Form S-8, filed with the SEC pursuant to Section 6(a) of the '33 Act:\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of Registrant pursuant to the foregoing provisions, or otherwise, 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 Registrant of expenses incurred or paid by a director, officer or controlling person of 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, 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.\nGREY ADVERTISING INC.\nBy: \/s\/ Edward H. Meyer ---------------------------- Edward H. Meyer, Chairman, Chief Executive Officer & President\nDated: March 30, 1995\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\/ Mark N. Kaplan Dated: March 30, 1995 ------------------------------------ Mark N. Kaplan, Director\n\/s\/ Edward H. Meyer Dated: March 30, 1995 ------------------------------------ Edward H. Meyer, Director; Principal Executive Officer\n\/s\/ O. John C. Shannon Dated: March 30, 1995 ------------------------------------ O. John C. Shannon, Director; President - Grey International\n\/s\/ Richard R. Shinn Dated: March 30, 1995 ------------------------------------ Richard R. Shinn, Director\n\/s\/ Steven G. Felsher Dated: March 30, 1995 ------------------------------------ Steven G. Felsher, Principal Financial Officer\n\/s\/ William P. Garvey Dated: March 30, 1995 ------------------------------------ William P. Garvey, Principal Accounting Officer\nAnnual Report on Form 10-K\nItem 8, Item 14(a)(1) and (2) and item 14(d)\nFinancial Statements and Supplementary Data\nList of Financial Statements\nYear ended December 31, 1994\nGREY ADVERTISING INC.\nNew York, New York\nForm 10-K - Item 8, Item 14(a)(1) and (2)\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nThe following consolidated financial statements of Grey Advertising Inc. and consolidated subsidiary companies are included in Item 8:\nAll 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.\nSummarized financial information and financial statements for nonconsolidated foreign investee companies accounted for by the equity method have been omitted because such companies, considered individually or in the aggregate, do not constitute a significant subsidiary.\nReport of Independent Auditors\nBoard of Directors Grey Advertising Inc.\nWe have audited the accompanying consolidated balance sheets of Grey Advertising Inc. and consolidated subsidiary companies as of December 31, 1994 and 1993, 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, 1994. 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 Grey Advertising Inc. and consolidated subsidiary companies at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP New York, New York February 8, 1995\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nConsolidated Balance Sheets\nSee notes to consolidated financial statements\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nConsolidated Balance Sheets (continued)\nSee notes to consolidated financial statements.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nConsolidated Statements of Income\n*Antidilutive\nSee notes to consolidated financial statements.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nConsolidated Statements of Common Stockholders' Equity\nYears ended December 31, 1994, 1993 and 1992\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nConsolidated Statements of Common Stockholders' Equity (continued)\nYears ended December 31, 1994, 1993 and 1992\nSee notes to consolidated financial statements.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nConsolidated Statements of Cash Flows\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nConsolidated Statements of Cash Flows (continued)\nSUPPLEMENTAL INFORMATION REGARDING NON-CASH FINANCING ACTIVITIES.\nIn 1992, the Company granted a loan of $3,170,000 in partial payment for the purchase of common stock (see Note I).\nSee notes to consolidated financial statements.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. Material intercompany balances and transactions have been eliminated in consolidation. Certain amounts for years prior to 1994 have been reclassified to conform with the current year classification.\nCOMMISSIONS AND FEES\nIncome derived from advertising placed with media is generally recognized based upon the publication or broadcast dates. Income resulting from expenditures billable to clients is generally recognized when billed. Payroll costs are expensed as incurred.\nCASH EQUIVALENTS\nThe Company considers all highly liquid investments with a maturity of three months or less from the purchase date to be cash equivalents. The carrying amount of cash equivalents approximates fair value because of the short maturities of those instruments.\nINVESTMENTS IN AND ADVANCES TO NONCONSOLIDATED AFFILIATED COMPANIES\nThe Company generally carries its investments in nonconsolidated affiliated companies on the equity method. Certain investments which are not material in the aggregate are carried on the cost method.\nFIXED ASSETS\nDepreciation of furniture, fixtures and equipment is provided for over their estimated useful lives ranging from three to ten years and has been computed principally by the straight-line method. Amortization of leaseholds and leasehold improvements is provided for principally over the terms of the related leases, which are not in excess of the lives of the assets.\nFOREIGN CURRENCY TRANSLATION\nPrimarily all balance sheet accounts of the Company's foreign operations are translated at the exchange rate in effect at each year end and income statement accounts are translated at the average exchange rates prevailing during the year. Resulting translation adjustments are made directly to a separate component of stockholders' equity. Foreign currency transaction gains and losses are reported in income. During 1994, 1993 and 1992, foreign currency transaction gains and losses were not material\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)\nINTANGIBLES\nThe excess of purchase price over underlying net equity of certain consolidated subsidiaries and nonconsolidated affiliated companies at the date of acquisition (\"goodwill\") is being amortized by the straight-line method over periods of up to 20 years. The amounts of goodwill associated with consolidated subsidiaries (included in Other Assets) and nonconsolidated investments (included in Investments in and Advances to Nonconsolidated Affiliated Companies) were $36,603,000 and $7,718,000 in 1994 and $63,965,000 and $6,995,000 in 1993, respectively.\nAnnually, the Company assesses the carrying value of its goodwill and the respective periods of amortization. As part of the evaluation, the Company considers a number of factors including actual operating results, the impact of gains and losses of major local clients, the impact of any loss of key local management staff and any changes in general economic conditions. In 1994, the Company formalized its assessment of goodwill and quantified the recoverability of goodwill based on each agency's estimated future non-discounted cash flows over the applicable remaining amortization periods. This required management to make certain specific assumptions with respect to future revenue and expense levels. Where multiple investments had been made in an agency, a weighted average amortization period is used.\nCharges to reflect permanent impairment are recorded to the extent that the unamortized book value of the goodwill exceeds the future cumulative non-discounted cash flows. If such cash flows are expected to recover less than 10% of the associated goodwill, a full write-off is recorded. No write-off is recorded if the cash flows are expected to recover 90% or more of the associated goodwill.\nINCOME TAXES\nThe Company uses the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company provides appropriate foreign withholding taxes on unremitted earnings of consolidated and nonconsolidated foreign companies.\nMARKETABLE SECURITIES\nEffective December 31, 1993, the Company adopted FAS 115, Accounting for Certain Investments in Debt and Equity Securities. The Company has classified its investments in marketable securities as available-for-sale at the time of purchase and re-evaluates such designation as of each balance sheet date. Available-for-sale securities are carried at fair value, based on publicly quoted market prices, with unrealized gains and losses reported as a separate component of stockholders' equity.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nB. FOREIGN OPERATIONS\nThe following financial data is applicable to consolidated foreign subsidiaries:\nConsolidated retained earnings at December 31, 1994 includes equity in unremitted earnings of nonconsolidated foreign companies of approximately $4,156,000.\nC. OTHER INCOME - NET\nD. FIXED ASSETS\nComponents of fixed assets - at cost are:\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nE. MARKETABLE SECURITIES\nAt December 31, 1994 and 1993, the Company's investments in marketable securities consist of U.S. Treasury obligations with maturities of 11 months to 6 years and a market value of $22,463,000 and $22,425,000, respectively. At December 31, 1994 and 1993, the Company has recorded unrealized losses of $1,492,000 and $147,000, respectively related to these investments.\nF. CREDIT ARRANGEMENTS AND LONG-TERM DEBT\nThe Company maintains committed lines of credit of $40,000,000 with various banks and may draw against the lines on unsecured demand notes at rates below the applicable bank's prime interest rate. These lines of credit were partially utilized during both 1994 and 1993 to secure obligations of selected foreign subsidiaries in the respective year-end amounts of $15,000,000 and $11,100,000. The weighted average interest rate related to the debt associated with the committed lines of credit was 6.25% and 7.7% at December 31, 1994 and 1993 respectively. The Company had $49,460,000 and $34,751,000 outstanding under other uncommitted lines of credit at December 31, 1994 and 1993, respectively. The weighted average interest rate for the borrowings under the uncomitted lines of credit was 7.7% and 10.9%, at December 31, 1994 and 1993, respectively. The carrying amount of the debt outstanding under both the committed and uncommitted lines of credit approximates fair value because of the short maturities of the underlying notes.\nIn January 1993, the Company borrowed $30,000,000 from the Prudential Insurance Company at a fixed interest rate of 7.68% and principal repayable in equal installments of $10,000,000 in January 1998, 1999 and 2000. The terms of the loan agreement require, inter alia, that the Company maintain specified levels of net worth, meet certain cash flow requirements and limit its incurrence of additional indebtedness to certain specified amounts. At December 31, 1994, the Company was in compliance with all of these covenants. The fair value of the Prudential debt is estimated to be $29,900,000 and $31,400,000 at December 31, 1994 and 1993 respectively. This estimate was determined using a discounted cash flow analysis using current interest rates for debt having similar terms and remaining maturities.\nThe remaining balance of long-term debt consists of 8-1\/2% Convertible Subordinated Debentures due December 10, 1996 which are currently convertible into 8.43 shares of Common Stock and an equal amount of Limited Duration Class B Common Stock, subject to certain adjustments, for each $1,000 principal amount of such Debentures. The debt was issued in exchange for cash and a $3,000,000, 9% promissory note, payable\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nF. CREDIT ARRANGEMENTS AND LONG-TERM DEBT (CONTINUED)\nDecember 10,1997 from an officer of the Company that is included in Other Assets at December 31, 1994 and 1993. During each of the years 1994, 1993 and 1992, the Company paid to the officer interest of $257,000 pursuant to the terms of the Debenture and the officer paid to the Company interest of $270,000 pursuant to the terms of the 9% promissory note.\nFor the years 1994, 1993 and 1992, the Company made interest payments of $7,839,000, $6,529,000 and $7,242,000, respectively.\nG. REDEEMABLE PREFERRED STOCK\nAs of December 31, 1994, the Company had outstanding 20,000 shares of Series I Preferred Stock, 5,000 shares each of its Series II and Series III Preferred Stock, and 2,000 shares of Series 1 Preferred Stock. As of December 31, 1993, the Company had outstanding 22,000 shares of Series 1 Preferred Stock and 5,000 shares each of its Series 2 and 3 Preferred Stock which were sold to certain current and former employees, including one senior executive, for a combination of cash and full recourse promissory notes (included in Other Assets). In April 1994, the senior executive entered into an Exchange Agreement pursuant to which he exchanged 20,000 shares of Series 1 Preferred Stock and 5,000 shares each of Series 2 and Series 3 Preferred Stock (collectively, the \"Original Preferred Stock\") for a like number of shares of new Preferred Stock, designated Series I Preferred Stock, Series II Preferred Stock and Series III Preferred Stock (collectively, the \"New Preferred Stock\"). The terms of the New Preferred Stock, including the basic economic terms relating thereto, are essentially the same as the Original Preferred Stock, except that the redemption date of the new Preferred Stock is fixed at April 7, 2004, unless redeemed earlier under the circumstances described below, rather than on a date determined by reference to the senior executive's termination of full-time employment with the Company, as was the case with the Original Preferred Stock. The terms of the New Preferred Stock also give the holder, his estate or legal representative, as the case may be, the option to require the Company to redeem his New Preferred Stock for a period of 12 months following his (i) death, (ii) permanent disability or permanent mental disability, (iii) termination of full-time employment for good reason or (iv) termination of full-time employment by the Company with cause. In addition, the maturity date for the outstanding promissory notes referred to above was extended to April, 2004. The terms of the Series 1 Preferred Stock permits the holder of shares thereof the option to have his shares redeemed upon termination of his employment prior to age 65. The Company is obligated to redeem such shares following the attainment of age 65 by the holder thereof following termination of employment.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nG. REDEEMABLE PREFERRED STOCK (CONTINUED)\nEach share of Preferred Stock is to be redeemed by the Company at a price equal to the book value per share attributable to one share of Common Stock and one share of Class B Common Stock upon redemption (subject to certain adjustments), less a fixed discount established upon the issuance of the Preferred Stock. The holders of each class of Preferred Stock are entitled to receive cumulative preferential dividends at the annual rate of $.25 per share, and to participate in dividends on one share of the Common Stock and one share of the Class B Common Stock to the extent such dividends exceed the per share preferential dividend. In April 1993, the Company, at the option of one holder, after attainment of age 65, redeemed 2,000 shares of Series 1 Preferred Stock at a price of $347,000. The Company discharged its obligation by payment of cash of $300,000 and forgiveness of the holder's promissory note of $47,000. The amount of the full recourse promissory notes included in Other Assets at December 31, 1994 and 1993 was $763,000. The interest paid by the senior employees to the Company in 1994, 1993 and 1992 pursuant to the terms of these notes was $70,000, $70,000 and $77,000, respectively.\nIn accordance with the terms of the respective Certificates of Designation and Terms of each Series of Preferred Stock (\"Certificates\"), the change in redemption value in 1994 does not reflect the write-off of goodwill described in Notes A and M, but rather reflects amortization as if the Company had continued to write-off goodwill in accordance with historical amortization schedules.\nFollowing the distribution of the new class of Common Stock designated Limited Duration Class B Common Stock, the holder of the Preferred Stock became entitled to eleven votes per share on all matters submitted to the vote of stockholders. The holder of the Series I Preferred Stock is entitled, as well, to vote as a single class to elect or remove one-quarter of the Board of Directors, to approve the merger or consolidation of the Company or the sale by it of all or substantially all of its assets, and to approve the authorization or issuance of any other class of Preferred Stock having equivalent voting rights.\nIn the event of the liquidation of the Company, holders of Preferred Stock are entitled to a preferential liquidation distribution of $1.00 per share in addition to all accrued and unpaid preferrential dividends.\nThe total carrying value of the Preferred Stock (applicable to those shares outstanding at each respective year end) increased by $926,000, $468,000 and $415,000 in 1994, 1993 and 1992, respectively. The change in carrying value represents the change in redemption value during those periods. This change is referred to as \"Additional Capital Applicable to Redeemable Preferred Stock\" in the respective Certificates.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nH. COMMON STOCK\nThe Company has authorized and outstanding two classes of common stock, Common Stock and Limited Duration Class B Common Stock (Class B Common Stock), both $1 par value per share.\nThe Class B Common Stock has the same dividend and liquidation rights as the Common Stock and a holder of each share of Class B Common Stock is entitled to ten votes on all matters submitted to stockholders. The shares of Class B Common Stock are restricted as to transferability and upon transfer, except to specified limited classes of transferees, will convert into shares of Common Stock which have one vote per share. The Class B Common Stock will automatically convert to Common Stock on April 30, 1996.\nI. RESTRICTED STOCK AND STOCK OPTION PLANS\nThe Company's 1994 Stock Incentive Plan (\"Stock Incentive Plan\") was adopted in March 1994 subject to stockholder approval which was received in June 1994. The Stock Incentive Plan replaces the Restricted Stock Plan, the Executive Growth Plan, the Incentive Stock Option Plan and the Nonqualified Stock Option Plan (\"Prior Plans\") and any shares available for granting of awards under the Prior Stock Plans are no longer available for such awards. Options granted pursuant to the Prior Plans remain outstanding and in full force and shares reserved remain for such purposes.\nSTOCK INCENTIVE PLAN\nUnder the Stock Incentive Plan, awards in the form of incentive or nonqualified stock options or restricted stock are available to be granted through June 2003 to officers and other key employees. A maximum of 250,000 shares of Common Stock are available for grant under the Stock Incentive Plan and no employee can be granted stock options in excess of 75,000 shares or more than 75,000 shares of restricted stock. Stock options cannot be granted at a price less than 100% of the fair market value of the shares on the date of grant. A committee of the Board of Directors (\"the Committee\") determines the terms and conditions under which the awards may be granted or exercised. Options, however, shall expire not later than ten years from the date of grant. Shares of restricted stock may be sold to participants, at a purchase price determined by the Committee (which may be less than fair market value per share). During 1994, non-qualified options for 3,250 shares of Common Stock were granted a total option price of $530,750. In addition, 1,750 shares of Restricted Stock were issued at prices between $77.50 and $81.50 per share with restrictions as to transferability expiring after five years. No restrictions lapsed during 1994 and no restricted stock or options were forefeited during 1994. At December 31,1994, there were 245,000 shares of Common Stock available for issuance under the Stock Incentive Plan.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nI. RESTRICTED STOCK AND STOCK OPTIONS PLANS (CONTINUED)\nCompensation to employees under the Plan of $134,000 representing the unamortized excess of the market value of restricted stock over any cash consideration received, is carried as a reduction of Paid-In Additional Capital and is charged to income ($7,000 in 1994) over the related required period of service of the respective employees.\nRESTRICTED STOCK PLAN\nShares which have been issued and are now outstanding under the provisions of the Company's Restricted Stock Plan are subject to restrictions as to transferability expiring generally five or six years from the date of issue. In 1990, an additional 100,000 shares of Common Stock were authorized under this Plan. During 1994, the restriction lapsed on 13,800 shares of Common Stock. At December 31, 1994, there were no shares of Common Stock or Class B Common Stock reserved by the Company and available for issuance under this Plan. At December 31, 1993, there were 125,000 shares of Common Stock and 49,900 shares of Class B Common Stock reserved for issuance under this Plan. Compensation to employees under the Plan of $105,000 representing the unamortized excess of the market value of restricted stock over any cash consideration received, is carried as a reduction of Paid-In Additional Capital and is charged to income ($109,000 in 1994, $256,000 in 1993 and $252,000 in 1992) over the related required period of service of the respective employees.\nThis plan was replaced by the Stock Incentive Plan discussed above.\nEXECUTIVE GROWTH PLAN\nUnder the terms of the Company's qualified stock option plan (Executive Growth Plan), options were granted to officers and other key employees at prices not less than 100% of the fair market value of the shares on the date of grant. At December 31, 1994, 1993 and 1992, there were no options outstanding and no options exercisable. At December 31, 1991, there were 25,000 options for Class B Common Stock and 25,000 options for Common Stock outstanding and exercisable under this plan. During 1992, these options were exercised at a total option price of $3,237,000, and were paid for with cash of $67,000 and a note from an officer of the Company in the amount of $3,170,000 due and payable in December 2001 at a fixed interest rate of 6.06%. At December 31, 1994, there were no shares of either Common Stock or Class B Common Stock reserved by the Company for issuance with respect to the Plan. In addition, the holder of the options was entitled to receive an additional amount representing the dividends which would have been paid if the options had been exercised on the date of grant. The holder used this additional amount ($1,153,000) to purchase an additional 8,905 shares of both Common Stock and Class B Common Stock. The additional amount was reflected as compensation expense in 1992 and in years prior to the exercise.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nI. RESTRICTED STOCK AND STOCK OPTIONS PLANS (CONTINUED)\nIn addition, and in accordance with the terms of the option agreement, the holder of the options issued to the Company a promissory note in the principal amount of $2,340,000 bearing interest at the rate of 6.06%, payable in December 2001, to settle his obligation to provide the Company with funds necessary to pay the required withholding taxes due upon the exercise of the options. The Company received a tax benefit of $1,556,000 upon the exercise of the options. A portion of this note equal to the tax benefit and the full amount of the note for $3,170,000 are reflected in a separate component of stockholders' equity at December 31, 1994 and 1993.\nThe interest paid to the Company by the holder pursuant to the terms of the two notes issued in connection with the option exercise was $334,000 in both 1994 and 1993.\nThis plan was replaced by the Stock Incentive Plan discussed above.\nINCENTIVE STOCK OPTION PLAN\nIn 1982, the Company adopted an Incentive Stock Option Plan. Under this plan in which options were available to be granted through May 1992, options were granted to key employees, including officers, at a price not less than 100% of the fair market value of the shares on the date of grant. A Committee of the Board of Directors determined the terms and conditions under which options may be granted or exercised. However, options (i) may not be exercised within twelve months from the date of grant, (ii) may not be granted to Committee members, (iii) expire within ten years from the date of grant and (iv) must be exercised in the order of grant.\nTransactions involving outstanding stock options under this Plan were:\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nI. RESTRICTED STOCK AND STOCK OPTIONS PLANS (CONTINUED)\nAs of December 31, 1994, options to acquire 2,856 shares of Common Stock were exercisable. There are 5,000 shares of Common Stock reserved to be issued with respect to this plan.\nThis plan was replaced by the Stock Incentive Plan discussed above.\nNONQUALIFIED STOCK OPTION PLAN\nOn December 2, 1987, the Company adopted a Nonqualified Stock Option Plan, whereby 100,000 shares of Common Stock were reserved for issuance. In 1990, the number of shares of Common Stock authorized for issuance under this Plan was increased to 200,000. No shares were available for grant after June, 1994. At the discretion of a Committee of the Board of Directors, nonqualified stock options were granted to employees eligible to receive options at prices not less than 100% of the fair market value of the shares on the date of grant, and options must be exercised within 10 years of grant and for only specified limited periods beyond termination of employment.\nTransactions involving outstanding stock options under this Plan were:\nAs of December 31, 1994 and 1993, 27,867 and 19,668 of the outstanding options, respectively, were exercisable, and 33,149 shares were reserved for issuance under this plan.\nThis plan was replaced by the Stock Incentive Plan discussed above.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nJ. COMPUTATION OF NET INCOME PER COMMON SHARE\nThe computation of net income per common share is based on the weighted average number of common shares outstanding, including adjustments for the effect of the assumed exercise of dilutive stock options and shares issuable pursuant to the Company's Senior Management Incentive Plan (see Note L(1)) (1,285,605 in 1994, 1,263,900 in 1993 and 1,205,241 in 1992) and, for fully diluted net income per common share, the assumed conversion of the 8-1\/2% Convertible Subordinated Debentures issued in December 1983. Also, for the purpose of computing net income per common share, the Company's net income is reduced by dividends on the Preferred Stock and is reduced or increased to the extent of an increase or decrease, respectively, in redemption value of the Preferred Stock. Primary net income per common share is computed as if stock options were exercised at the beginning of the period and the funds obtained thereby used to purchase common shares at the average market price during the period. In computing fully diluted net income per common share, the market price at the close of the period or the average market price, whichever is higher, is used to determine the number of shares which are assumed to be repurchased.\nThe effects of the Preferred Stock dividend requirements and the change in redemption values amounted to $.88, $.53 and $.52 per share in 1994, 1993 and 1992, respectively.\nK. INCOME TAXES\nDeferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and amounts used for income tax purposes. At December 31, 1994, 1993 and 1992, the Company had deferred tax assets of $19,651,000, $16,282,000 and $15,334,000 and deferred tax liabilities of $10,459,000, $12,194,000 and $14,517,000, respectively, detailed as follows:\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nK. INCOME TAXES (CONTINUED)\nThe components of income before taxes on income are as follows:\nProvisions (benefits) for Federal, foreign, state and local income taxes consisted of the following:\nThe effective tax rate varied from the statutory Federal income tax rate as follows:\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nK. INCOME TAXES (CONTINUED)\nDuring the years 1994, 1993 and 1992, the Company made net income tax payments of $19,005,000, $18,748,000 and $14,435,000, respectively.\nThe tax benefit resulting from the difference between compensation expense deducted for tax purposes and compensation expense charged to income for restricted stock and nonqualified stock options is recorded as an increase to Paid-In Additional Capital.\nL. RETIREMENT PLANS, DEFERRED COMPENSATION, LEASES AND CONTINGENCIES\n1. The Company's Profit Sharing Plan is available to all employees of the Company and qualifying subsidiaries meeting certain eligibility requirements. The Plan provides for contributions by the Company at the discretion of the Board of Directors, subject to maximum limitations. The Company also operates a noncontributory Employee Stock Ownership Plan covering eligible employees of the Company and qualifying subsidiaries, under which the Company may make contributions (in stock or cash) to an Employee Stock Ownership Trust (\"ESOT\") in amounts each year as determined at the discretion of the Board of Directors. The Company made only cash contributions to the Plan in 1994, 1993 and 1992. The Company and the ESOT have certain rights to purchase shares from participants whose employment has terminated. In addition to the two plans noted above, various subsidiaries maintain separate profit sharing and retirement arrangements. Furthermore, the Company also provides additional retirement and deferred compensation benefits to certain officers and employees.\nThe Company maintains a Senior Management Incentive Plan in which deferred compensation is granted to senior executive or management employees deemed essential to the continued success of the Company. The amount recorded as an expense related to this Plan amounted to $5,434,000, $4,581,000 and $4,340,000 in 1994, 1993 and 1992, respectively. Approximately $4,215,300, $3,343,000 and $1,160,000 of Plan expense incurred in 1994, 1993 and 1992, respectively, will be payable in Company stock in accordance with the terms of the Plan. These awards convert into 28,081, 18,461 and 8,624 equivalent shares of Common Stock in 1994, 1993 and 1992, respectively. The future obligation related to the stock award has been reflected as an increase to Paid-In Additional Capital.\nExpenses related to the foregoing plans and benefits aggregated $24,211,000 in 1994, $21,057,000 in 1993 and $25,002,000 in 1992.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nL. RETIREMENT PLANS, DEFERRED COMPENSATION, LEASES AND CONTINGENCIES (CONTINUED)\nIn December 1990, the Company amended its employment agreement with its Chairman and Chief Executive Officer. Concurrently, the Company also discharged this individual's pension obligation which had been established pursuant to the terms of his long-standing employment agreement. This obligation was partially satisfied by a distribution of approximately $19.8 million from a trust fund previously established by the Company for this purpose. The remainder of the amount necessary to discharge this obligation (approximately $9.5 million) was distributed from general corporate funds. Included in Other Assets at December 31, 1994 and 1993 is approximately $7,100,000 and $9,500,000 respectively, related to this arrangement which is being amortized to expense over the remaining term of the related employment agreement.\nPursuant to an employment agreement, dated December 21, 1990, an executive officer of the Company borrowed $1,000,000 from the Company repayable at December 31, 1995, except that one-fifth of the principal of the loan is forgiven by the Company each December 31, beginning with December 31, 1991, provided that the officer continues to be employed by the Company on those dates. In 1994, the executive officer entered into a new employment agreement. Pursuant to that agreement, the executive officer borrowed an additional $600,000 from the Company repayable at December 31, 1998 except that one-third of the principal of the loan is forgiven by the Company each December 31, beginning with December 31, 1996, provided that the officer continues to be employed by the Company on those dates. In 1994, 1993 and 1992, the Company has included in each year $200,000 of compensation expense, representing the amount of loan forgiven each year. As of December 31, 1994 and 1993, the remaining loan balance was $800,000 and $400,000, respectively (the long-term portion of the loan, $600,000 in 1994 and $200,000 in 1993, is included in Other Assets).\n2. Rental expense amounted to approximately $35,568,000 in 1994, $32,725,000 in 1993 and $33,741,000 in 1992 which is net of sub-lease rental income of $1,263,000 in 1994, $2,016,000 in 1993, and $3,343,000 in 1992. Approximate minimum rental commitments, excluding escalations, under noncancellable operating leases are as follows:\nL. RETIREMENT PLANS, DEFERRED COMPENSATION, LEASES AND CONTINGENCIES (CONTINUED)\n3. The Company is not involved in any pending legal proceedings not covered by insurance or by adequate indemnification or which, if decided adversely, would have a material effect on either the results of operations, liquidity or financial position of the Company.\nM. GOODWILL WRITE-OFF\nIn the fourth quarter of 1994, the Company wrote-off $39,944,000 of goodwill. The non-cash write-off related almost exclusively to international acquisitions made by the Company principally in the 1980's. The carrying value of the Company's goodwill prior to the write-off was approximately $84,000,000 and the write-off was associated with 34 of the almost 100 investments for which the Company had unamortized goodwill. The portion of the write-off relating to advertising agencies was approximately $31,295,000 and $8,649,000 related to public relations agencies. Significant amounts of these write-offs related to operations in the United Kingdom.\nThe widely recognized international recession seriously affected the advertising industry, particularly in Western Europe, where the Company has its largest and most developed international operations. As the recession abated in the latter part of 1994, the Company was able to assess more clearly the long-term prospects of the affected operations. At that point, and in connection with annual business plan meetings which took place in the fourth quarter, it became clear that the goodwill associated with a number of the agencies had become permanently impaired. Management's projections indicated that anticipated future cash flows for these specific operations would not, as would be expected in a normal post-recession environment, recover sufficiently to cover amortization of the associated goodwill.\nThe material portion of the goodwill write-off related to ten agencies acquired in the United Kingdom as part of a strategy to develop the Company's representation outside of the London market in the general advertising category and in specialized disciplines (such as retail advertising, promotional services and public relations). With the revival of the industry, a review of the Company's local market strategies and in conjunction with several key management changes, client losses or the inability of these operations to maintain revenues with replacement or new clients, after the analysis referred to above, management concluded that the goodwill associated with these operations had been permanently impaired. While future client losses and management changes could affect the Company's operation in the United Kingdom, the Company has consolidated a number of operations, thereby lessening the likelihood of a negative impact from any instance of client or management turnover. In addition, the unimpaired goodwill balances associated with the United Kingdom operations represents less than 10% of the Company's consolidated unamortized goodwill as of December 31, 1994.\nIn 1993 and 1992, respectively, the Company wrote-off $1,939,000 and $3,065,000 of goodwill in excess of normal amortization schedules.\nGrey Advertising Inc. and Consolidated Subsidiary Companies\nNotes to Consolidated Financial Statements (continued)\nN. INDUSTRY SEGMENT AND RELATED INFORMATION\nCommissions and fees and operating profit by geographic area for the years ended December 31, 1994, 1993 and 1992, and related identifiable assets at December 31, 1994, 1993 and 1992 are summarized below (000s omitted):\nCommissions and fees from one client amounted to 13.8%, 13.0% and 13.4% of the consolidated total in 1994, 1993 and 1992, respectively.\nINDEX TO EXHIBITS -----------------\nINDEX TO EXHIBITS -----------------\nINDEX TO EXHIBITS -----------------\nINDEX TO EXHIBITS -----------------\nINDEX TO EXHIBITS -----------------\nINDEX TO EXHIBITS -----------------\nINDEX TO EXHIBITS -----------------\nINDEX TO EXHIBITS -----------------\nINDEX TO EXHIBITS -----------------\n*Management contract or compensatory plan or arrangement identified in compliance with Item 14(c) of the rules governing the preparation of this report.\n10K-Exhibits","section_15":""}
{"filename":"79716_1994.txt","cik":"79716","year":"1994","section_1":"ITEM 1. Business\nGeneral\nPotlatch Corporation (the \"company\"), incorporated in 1903, is an integrated forest products company with substantial timber resources. It is engaged principally in the growing and harvesting of timber and the manufacture and sale of wood products, printing papers and other pulp-based products. Its timberlands and all of its manufacturing facilities are located within the continental United States.\nInformation relating to the amounts of revenue, operating profit or loss and identifiable assets attributable to each of the company's industry segments for 1992-1994 is included in Note 12 to the financial statements on pages 31-32 of this report.\nFiber Resources\nThe principal source of raw material used in the company's operations is timber, obtained from its own timberlands and purchased on the open market. The company owns in fee approximately 1.5 million acres of timberland: 497,000 acres in Arkansas, 678,000 acres in Idaho and 345,000 acres in Minnesota. In addition, the company owns and is developing 10,000 acres in Oregon as a hybrid poplar tree farm for pulp fiber. The company plans to acquire an additional 12,000 acres for this purpose in 1995.\nThe amount of timber harvested in any one year from company-owned lands varies according to the requirements of sound forest management, as well as the supply of timber available for purchase on the open market. By continually improving forestry and silviculture techniques and other forest management practices, the company has been able to increase the volume of wood fiber available from its timberlands and to provide for a continuous supply of wood fiber in the future. In most cases, the cost of timber from company land is substantially less than that of timber obtained on the open market.\nThe company's fee lands provided approximately 59 percent of its sawlogs and plywood logs in 1994 and an average of 62 percent over the past five years. Including the raw materials used for pulp and oriented strand board, the percentages decline to 35 percent for 1994 and 38 percent for the past five years. Additional logs were obtained principally under cutting contracts from lands owned by federal, state and local governments and from private purchases. Such cutting contracts cover areas of varying size and generally have terms ranging from a few months to several years. The company enters into many such contracts each year. At December 31, 1994, the market value of uncut timber remaining under timber cutting contracts approximated $60.7 million. The company is not unconditionally obligated for that amount on such contracts and uncut timber values are subject to change depending on the market value at time of harvest.\nAt the present time, timber from the company's own lands, together with outside purchases, is adequate to support manufacturing operations. In recent years the timber supply from federal lands has been increasingly curtailed largely due to environmental pressures that are expected to continue into the foreseeable future. Although this trend has had a favorable effect on\nearnings for the company as a whole, it has had an adverse effect on wood costs. The long-term effect of this trend on company earnings cannot be predicted. However, the company has implemented plans to develop additional fiber supplies, primarily hybrid poplar, for the Lewiston, Idaho, pulp mill and by the year 2000 expects to provide approximately 70 percent of chip fiber requirements for this mill from resources it controls, compared with approximately 40 percent currently.\nThe company assumes substantially all risk of loss from fire and other hazards on the standing timber it owns, as do most owners of timber tracts in the United States.\nWood Products\nThe company manufactures and markets oriented strand board, plywood, particleboard, lumber and other wood products. These products are sold through the company's sales offices primarily to wholesalers for nationwide distribution.\nTo produce these solid wood products, the company owns and operates several manufacturing facilities in Arkansas, Idaho and Minnesota. A description of these facilities is included under Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nThe principal manufacturing facilities of the company, together with their respective 1994 capacities and production are as follows:\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nIn June 1994, the company received a Notice of Violation (\"NOV\") issued by the Idaho Department of Health and Welfare (\"IDHW\") alleging 41 violations of State of Idaho environmental laws relating to air quality at the company's facilities in Lewiston, Idaho. Many of the alleged violations include continuing violations over a period of time. The IDHW also submitted a list of 14 alleged federal New Source Performance Standard violations. The aggregate penalty proposed by the IDHW for settlement of all of the alleged state and federal violations is approximately $2.7 million. The company believes it has legal and equitable defenses to many of the alleged violations and has held settlement discussions with the IDHW and the United States Environmental Protection Agency (\"EPA\"). The company will continue to discuss settlement of all outstanding issues.\nIn August 1993, the company received a NOV from the EPA. The NOV alleged that construction of the company's three oriented strand board plants in Minnesota commenced prior to obtaining proper permits and that particulate emissions from the dryers at one plant exceeded applicable limits. The Minnesota Pollution Control Agency (\"MPCA\") had previously issued NOVs to the company which set forth the same allegations. In early January 1994, the company entered into an agreement with the MPCA which resolved the alleged violations under its NOVs by agreeing to install additional pollution control equipment at all three plants and pay a civil penalty of $300,000. The agreement did not resolve the EPA allegations. In January 1995, the EPA informed the company that it referred the matter to the United States Department of Justice to commence a civil enforcement action against the company. The company believes that it has legal and equitable defenses to the alleged violations.\nThe company believes that adequate provision has been made for any amounts which may be paid as a result of the alleged violations described above.\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 ended December 31, 1994.\nExecutive Officers of the Registrant\nInformation as of March 1, 1995, and for the past five years concerning the executive officers of the company is as follows:\nJohn M. Richards (age 57), first elected an officer in 1972, has served as Chairman of the Board and Chief Executive Officer since May 1994. Prior to May 1994 he was President and Chief Operating Officer. He was elected a director of the company effective January 1991. He is a member of the Finance Committee of the Board of Directors.\nL. Pendleton Siegel (age 52), first elected an officer in 1983, has served as President and Chief Operating Officer since May 1994. From August 1993 to May 1994, he was Executive Vice President, Pulp-Based Operations and Planning. From March 1992 through July 1993, he was Group Vice President, Pulp and Paperboard. Prior to March 1992, he was Group Vice President, Wood Products. In addition, from October 1990 through May 1994, he was also responsible for planning and business development.\nRobert V. Hershey (age 62), first elected an officer in 1993, has served as Vice President, Northwest Paper Division since August 1993. From June 1991 through July 1993, he was an appointed officer serving as Vice President, Manufacturing, Northwest Paper Division. Prior to that he served as Vice President, Manufacturing, for the Northwest Paper Division's Cloquet plant.\nRichard L. Paulson (age 53), first elected an officer in 1992, has served as Vice President, Consumer Products since January 1993. Prior to that he was an appointed officer serving as Vice President, Manufacturing, for the Northwest Paper Division's Brainerd plant.\nGeorge E. Pfautsch (age 59), first elected an officer in 1971, has served as Senior Vice President, Finance since October 1989. From January 1993 through May 1994, he also served as Treasurer.\nCharles R. Pottenger (age 55), first elected an officer in 1991, has served as Group Vice President, Pulp and Paperboard since August 1993. From February 1991 through July 1993, he was Vice President, Northwest Paper Division. Prior to February 1991, he was an appointed officer serving as Northwest Paper Division Vice President, Manufacturing.\nThomas J. Smrekar (age 52), first elected an officer in 1992, has served as Group Vice President, Wood Products since March 1992. Prior to March 1992, he was an appointed officer serving as Minnesota Wood Products Division Vice President.\nNOTE: The aforementioned officers of the company are elected to hold office until the next annual meeting of the Board of Directors. Each officer holds office until the officer's successor has been duly elected and has qualified or until the earlier of the officer's death, resignation, retirement or removal by the board.\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, Chicago and Pacific Stock Exchanges. Quarterly and yearly price ranges were:\nIn general, all holders of Potlatch common stock who own shares 48 consecutive calendar months or longer (\"long-term holders\") are entitled to exercise four votes per share of stock so held, while stockholders who are not long-term holders are entitled to one vote per share. All stockholders are entitled to only one vote per share on matters arising under certain provisions of the company's charter. There were approximately 3,500 common stockholders of record at December 31, 1994.\nQuarterly dividend payments per common share for the past two years were:\nITEMS 6, 7 and 8.\nThe information called for by Items 6, 7 and 8, inclusive, of Part II of this form, is contained in the following sections of this Report at the pages indicated below:\nPage Number\nITEM 6","section_6":"ITEM 6 Selected Financial Data 12\nITEM 7","section_7":"ITEM 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 12-16\nITEM 8","section_7A":"","section_8":"ITEM 8 Financial Statements and Supplementary Data 17-35\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 the directors of the company is set forth under the heading \"Information with Respect to Nominees for Election and Directors Continuing in Office\" on pages 3-5 of the company's definitive proxy statement, dated March 27, 1995, for the 1995 annual meeting of stockholders (the \"1995 Proxy Statement\"), which information is incorporated herein by reference. Information concerning Executive Officers is included in Part I of this report following Item 4.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nInformation set forth under the heading \"Compensation of Directors and the Named Executive Officers\" on pages 9-19 of the 1995 Proxy Statement, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nInformation regarding security ownership of management, included under the heading \"Stock Ownership of Directors and Executive Officers\" on pages 7-8 of the 1995 Proxy Statement, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nInformation set forth under the heading \"Certain Transactions\" on page 19 of the 1995 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\n1. Exhibits are listed in the Exhibit Index on pages 36-38 of this Form 10-K.\n2. Financial statement schedules are listed in the Index to Consolidated Financial Statements and Schedules on page 11 of this Form 10-K.\n3. No reports on Form 8-K were filed for the quarter ended December 31, 1994.\nSIGNATURES\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.\nPOTLATCH CORPORATION (Registrant)\nDate: March 23, 1995 By John M. Richards ---------------------- John M. Richards 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 March 23, 1995, by the following persons on behalf of the company in the capacities indicated.\nBy John M. Richards ----------------------------- John M. Richards RICHARD A. CLARKE* Director and Chairman of Director the Board and Chief KENNETH T. DERR* Executive Officer Director (Principal Executive Officer) ALLEN F. JACOBSON* Director By L. Pendleton Siegel GEORGE F. JEWETT, JR.* ----------------------------- Director L. Pendleton Siegel RICHARD B. MADDEN* President and Chief Director Operating Officer RICHARD M. MORROW* (Principal Operating Officer) Director VIVIAN W. PIASECKI* By George E. Pfautsch Director ----------------------------- TONI REMBE* George E. Pfautsch Director Senior Vice President, REUBEN F. RICHARDS* Finance Director (Principal Financial Officer) RICHARD M. ROSENBERG* Director By Terry L. Carter ROBERT G. SCHWARTZ* ----------------------------- Director Terry L. Carter CHARLES R. WEAVER* Controller Director (Principal Accounting Officer) FREDERICK T. WEYERHAEUSER* Director DR. WILLIAM T. WEYERHAEUSER* Director\n*By Sandra T. Powell ------------------ Sandra T. Powell (Attorney-in-fact)\nPOTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES\nIndex to Consolidated Financial Statements and Schedules\nPage Number\nThe following documents are filed as part of this Report:\nConsolidated Financial Statements:\nSelected Financial Data 12\nManagement's Discussion and Analysis of Financial Condition and Results of Operations 12 - 16\nStatements of Earnings for the years ended December 31, 1994, 1993 and 1992 17\nBalance Sheets at December 31, 1994 and 1993 18\nStatements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 19\nStatements of Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992 20\nSummary of Principal Accounting Policies 21 - 22\nNotes to Financial Statements 23 - 33\nIndependent Auditors' Report 34\nSchedules:\nII. Valuation and Qualifying Accounts 35\nAll other schedules are omitted because they are not required, not applicable or the required information is given in the consolidated financial statements.\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\nLiquidity\nLiquidity of a company can be measured by several factors. Of major importance are: Capability of generating earnings and cash flow Maintenance of a sound financial structure Access to capital markets Maintenance of adequate working capital\nIn 1994, the company's net cash provided by operations, excluding working capital changes, as presented in the Statements of Cash Flows on page 19, totaled $197.9 million, compared with $170.7 million in 1993 and $166.2 million in 1992.\nThe ratio of long-term debt to stockholders' equity was .69 to 1 at December 31, 1994, compared with .77 to 1 at December 31, 1993, and .66 to 1 at December 31, 1992. The improvement in 1994 was largely due to a reduction in outstanding commercial paper classified as long-term debt from $75.0 million at December 31, 1993, to $20.0 million at December 31, 1994. Total commercial paper outstanding at December 31, 1994, was $33.0 million. Also affecting the ratio was the reclassification of $15.0 million of the company's medium-term notes from long-term to current due to the debt maturing within one year.\nAt December 31, 1994, the company had credit lines totaling $150.0 million for general corporate purposes. Of that amount, $50.0 million was in short- term lines and $100.0 million was in a revolving credit and term loan agreement. At December 31, 1994, there were no borrowings by the company under any credit lines; however, the company uses the credit lines to back its issuance of commercial paper. At December 31, 1994, a portion of the revolving credit was being used to back outstanding commercial paper.\nOne of the company's stated objectives is to maintain a sound financial structure. The company's long-term debt to equity ratio of .69 to 1 at December 31, 1994, is somewhat above the range of its targeted financial structure. The company believes that the combination of its internal cash flow and projected levels of dividends and capital spending in 1995 will permit it to return to its targeted range within the next year.\nThe company also believes that debt ratings within investment grade categories are important for long-term access to capital markets. At the end of 1994, the company's senior long-term debt was rated A- by Standard & Poors and Duff and Phelps, and Baa1 by Moody's. With the company's ability to generate cash flow and its access to capital markets, the company believes it is capable of funding capital expenditures, working capital and other liquidity needs for the foreseeable future.\nAt December 31, 1994, working capital was $142.7 million, compared with $129.1 million at December 31, 1993, and $153.5 million at December 31, 1992. The improvement for 1994 was largely due to increases of $26.4 million in short-term investments and $18.8 million in receivables, which were partially offset by increases of $12.9 million in notes payable, $11.8 million in current installments on long-term debt and $5.9 million in accounts payable and accrued liabilities.\nCapital Resources and Funding\nCapital expenditures totaled $104.4 million in 1994, compared with $201.7 million in 1993 and $179.5 million in 1992.\nIn 1994, the company spent $37.9 million in the wood products segment. Significant projects included the completion of the new sawmill in Warren, Arkansas, installation of a new log processing center at the Lewiston, Idaho, sawmill and installation of required pollution control equipment at the Grand Rapids, Minnesota, oriented strand board plant. The Warren sawmill, which is progressing steadily to its designed capabilities, will improve lumber quality and the yield from the available log supply while making more efficient use of manpower. The new log processing center in Lewiston will reduce manufacturing costs as well as increase production and improve yield.\nCapital spending in the printing papers segment totaled $25.2 million, where the first phase of the modernization and expansion of the Cloquet, Minnesota, pulp mill continued during 1994. Also included were expenditures for the rebuild of a paper machine at the Brainerd, Minnesota, facility.\nSpending in the other pulp-based products segment totaled $40.8 million, including two major projects in the Consumer Products Division where an older tissue machine was rebuilt in Lewiston and the warehouse at the North Las Vegas, Nevada, tissue converting facility was expanded. These two projects improve the division's competitive position by improving product quality and service. Other pulp-based products spending also included the continuing development of acreage near Boardman, Oregon, to grow hybrid poplar trees for pulp fiber to be used at the Lewiston pulp mill.\nAuthorized but unexpended appropriations totaled $332.5 million at December 31, 1994. Of that amount, $225.1 million is budgeted to be expended in 1995. Such expenditures will include the continuing modernization and expansion of the Cloquet pulp mill; the continued rebuild of a paper machine in Brainerd; the continued development of the hybrid poplar tree farm in Boardman; the upgrade of the green stacker, planer and kiln at the Prescott, Arkansas, sawmill; and installation of pollution control equipment at the Minnesota oriented strand board plants. As in 1994, the 1995 capital program will be funded primarily from internally generated sources.\nHistorically, the company has spent less on capital expenditures than the annual amount budgeted. In 1994, the company spent $63.8 million less than the $168.2 million budgeted. Spending on projects may be delayed due to acquisition of environmental permits, acquisition of equipment, engineering, weather and other factors. It is likely that the company will again spend less than the budgeted amount in 1995.\nIn December 1994, the company announced a stock repurchase program which authorizes the company to purchase up to 1 million shares of its common stock over several years. Under the program, the company can purchase shares of common stock from time to time through open market and privately negotiated transactions at prices deemed appropriate by management. The purchases of such shares are planned to be accomplished while also maintaining the company's targeted financial structure.\nEnvironment\nThe company is subject to extensive federal and state environmental control regulations at its operating facilities. The company endeavors to comply with all environmental regulations and monitors its activities on a regular basis for such compliance. Compliance with environmental regulations requires capital expenditures as well as additional operating costs. Capital expenditures specifically designated for environmental compliance totaled approximately $17.0 million during 1994 and are budgeted to be $25.0 million in 1995. In addition, the company made expenditures for pollution control facilities as part of major mill modernizations and expansions currently under way.\nIn late 1993, the Environmental Protection Agency published proposed regulations applicable to the pulp and paper industry. This extensive set of regulations is designed to address both air and water emissions. As proposed, the regulations would require modifications to process equipment and procedures. Based on an examination of the capital costs of the proposals, the company estimates that compliance would require capital expenditures in the broad range of $200.0 million. Of this amount, approximately $100.0 million is already included in the planned expansion and modernization project\nunder way at the Cloquet, Minnesota, pulp mill, which is expected to cost in excess of $500.0 million. The company does not expect that such compliance costs would have a material adverse effect on its competitive position.\nResults of Operations Comparison of 1994 with 1993\nPotlatch consolidated net sales of $1.47 billion increased 7 percent from 1993's $1.37 billion. Earnings were $49.0 million, compared with $38.3 million before the one-time effects of accounting changes for 1993. Earnings per common share for 1994 were $1.68, which included a $.21 per share first quarter charge for early retirement programs. Earnings per share for 1993 were $1.31 before the one-time effects of accounting changes.\nMarket improvements in most of the company's pulp-based businesses, along with continued favorable market conditions for wood products, resulted in higher earnings for 1994. The operating difficulties experienced by the Lewiston, Idaho, pulp and paperboard mill in 1993 were reduced in 1994, but some problems continue with the pulp mill washers. Although no reduction of current operating levels is anticipated, the company is planning to replace these washers.\nThe wood products segment reported earnings of $160.3 million, approximately equal to the $160.2 million earned in 1993. Higher net sales realizations for the company's lumber and panel products were offset by startup costs of the new sawmill in Warren, Arkansas, and costs associated with the installation of new log processing equipment at the Lewiston, Idaho, sawmill. Late in the year the company sold two small manufacturing operations: a split-cedar mill in Idaho and a hardwood flooring plant in Arkansas.\nAt the present time, timber from the company's own lands, together with outside purchases, is adequate to support manufacturing operations. In recent years the timber supply from federal lands has been increasingly curtailed largely due to environmental pressures that are expected to continue into the foreseeable future. Although this trend has had a favorable effect on earnings for the company as a whole, it has had an adverse effect on wood costs. The long-term effect of this trend on company earnings cannot be predicted. However, the company has implemented plans to develop additional fiber supplies for the Lewiston, Idaho, pulp mill and by the year 2000 expects to provide approximately 70 percent of chip fiber requirements for this mill from resources it controls, compared with approximately 40 percent currently.\nEarnings for the printing papers segment were $40.2 million, a substantial improvement over 1993's $15.8 million. Higher shipments and net sales realizations, resulting from a strengthening marketplace, along with production improvements at the segment's facilities, were largely responsible for the increase. An improved product mix also contributed to the positive results.\nThe other pulp-based products segment, which includes the Pulp and Paperboard Group and the Consumer Products Division, reported a loss of $53.5 million versus a loss of $40.9 million for 1993. The 1994 results include a first quarter charge for early retirement programs of $10.0 million. The company anticipates annual savings of $10.0 million as a result of the\nprograms. Higher paperboard shipments for the Pulp and Paperboard Group were partially offset by lower paperboard net sales realizations and costs associated with operating problems during the year. Sales of market pulp had been curtailed since late 1993. However, market conditions improved considerably from the beginning of 1994 and resulted in the resumption of market pulp sales during the second quarter. The Consumer Products Division increased product shipments 10 percent in 1994, but higher pulp costs and a very competitive tissue market resulted in a loss for the year.\nComparison of 1993 with 1992\nPotlatch consolidated net sales of $1.37 billion in 1993 increased slightly over 1992's $1.33 billion. Earnings per common share before accounting changes were $1.31 in 1993 compared with $2.71 for 1992. Including a one- time, after-tax net charge of $31.7 million related to new accounting requirements for postretirement benefits and income taxes, the company earned $6.6 million or $.22 per common share in 1993. The results for 1992 include a nonrecurring, net after-tax gain of $14.7 million or $.51 per common share from the sale of the company's packaging operations and a charge related to a litigation settlement.\nDespite very favorable market conditions for wood products, earnings continued to be adversely affected by weak market conditions throughout 1993 for the company's pulp-based products. Operating difficulties at the Lewiston, Idaho, pulp and paperboard mill also negatively affected earnings.\nEarnings for the wood products segment were $160.2 million, an increase of 61 percent over 1992's $99.8 million. Substantially higher net sales realizations for most of the company's wood products were the primary reason for the improved results. Timber supply constraints in the Pacific Northwest continued to have a significant positive influence on product pricing in 1993, as they did in 1992.\nIn 1993 the printing papers segment reported earnings of $15.8 million, down from the $27.3 million earned in 1992. The poor market conditions for printing papers of the past few years continued in 1993. Shipments increased modestly during the year, but realizations were lower than in 1992.\nThe other pulp-based products segment, which includes the Pulp and Paperboard Group and the Consumer Products Division, reported a loss of $40.9 million for 1993, compared with earnings of $33.3 million in 1992. Lower paperboard shipments and sales realizations as a result of very depressed market conditions combined with higher wood costs in Idaho were largely responsible for the decline. Operating difficulties and extended shutdowns at both of the company's pulp and paperboard mills in Lewiston, Idaho, and Cypress Bend, Arkansas, during 1993 also contributed to the disappointing results. The Consumer Products Division also incurred a loss for the year due to very competitive markets and higher operating costs associated with the startup of the new tissue machine in Lewiston and the new converting facility in North Las Vegas, Nevada.\nIncome Taxes\nThe company's effective tax rates for 1994, 1993 and 1992 were 35.5 percent, 41.0 percent and 36.7 percent, respectively.\nPotlatch Corporation and Consolidated Subsidiaries Summary of Principal Accounting Policies\nConsolidation\nThe financial statements include the accounts of Potlatch Corporation and its subsidiaries after elimination of significant intercompany transactions and accounts. There are no significant unconsolidated subsidiaries.\nInventories\nInventories are stated at the lower of cost or market. The last-in, first- out method is used to determine cost of most wood products. The average cost method is used to determine cost of all other inventories.\nEarnings Per Common Share\nEarnings per common share are computed on the weighted average number of common shares outstanding each year. Outstanding stock options are common stock equivalents but are excluded from earnings per common share computations due to immateriality. The weighted average number of common shares used in earnings per common share computations for 1994, 1993 and 1992 were 29,217,261, 29,183,871 and 29,110,179, respectively.\nProperties\nProperty, plant and equipment are valued at cost less accumulated depreciation. Depreciation of buildings, equipment and other depreciable assets is determined by using the straight-line method on estimated useful lives. Estimated useful lives of plant and equipment range from 2 to 40 years.\nTimber, timberlands and related logging facilities are valued at cost net of the cost of fee timber harvested and depreciation or amortization. Logging roads and related facilities are amortized over their useful lives or as related timber is removed. Cost of fee timber harvested is determined annually based on the estimated volumes of recoverable timber and related cost.\nMajor improvements and replacements of property are capitalized. Maintenance, repairs, and minor improvements and replacements are expensed. Amounts expensed in 1994, 1993 and 1992 were $167.7 million, $166.6 million and $155.1 million, respectively. Upon retirement or other disposition of property, applicable cost and accumulated depreciation or amortization are removed from the accounts. Any gains or losses are included in earnings.\nIncome Taxes\nThe provision for taxes on income is based on earnings reported in the financial statements. Deferred income taxes are provided on the temporary differences between reported earnings and taxable income using current tax laws and rates.\nPreoperating and Startup Costs\nPreoperating costs are expensed as incurred except for charges relating to major new facilities. Deferred preoperating costs are amortized over a 60- month period. Startup costs are expensed as incurred.\nPotlatch Corporation and Consolidated Subsidiaries Notes to Financial Statements\nIf the last-in, first-out inventory had been priced at lower of current average cost or market, the values would have been approximately $32.3 million higher at December 31, 1994, and $27.8 million higher at December 31, 1993. In 1994 and 1993, reductions in quantities of LIFO inventories valued at lower costs prevailing in prior years had the effect of increasing earnings, net of income taxes, by approximately $1.6 million ($.06 per common share) and $2.4 million ($.08 per common share), respectively.\nDepreciation charged against income amounted to $119.6 million in 1994 ($108.4 million in 1993 and $95.8 million in 1992).\nAuthorized but unexpended appropriations totaled $332.5 million at December 31, 1994. Of that amount, $225.1 million is budgeted to be expended in 1995.\nTimber, timberlands and related logging facilities are stated at cost less cost of fee timber harvested and amortization. Cost of fee timber harvested amounted to $15.1 million in 1994 ($12.0 million in 1993 and $9.1 million in 1992). Amortization of logging roads and related facilities amounted to $1.1 million in 1994 ($.7 million in 1993 and 1992).\nNote 4. Taxes on Income\nEffective January 1, 1993, the company adopted the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. The statement requires the liability method for recording differences in financial and taxable income. The company recorded the cumulative effect of the accounting change in the first quarter of 1993, which increased income by $43.8 million or $1.50 per share. Prior years' financial statements were not restated.\nSignificant components of the provision for taxes on income:\nThe provision for taxes on income differs from the amount computed by applying the statutory federal income tax rate (35 percent in 1994 and 1993 and 34 percent in 1992) to earnings before taxes on income and cumulative effect of accounting changes due to the following:\nPrincipal current and noncurrent deferred tax assets and liabilities at December 31:\nNoncurrent deferred tax assets at December 31, 1994 and 1993, are net of valuation allowances of $8.9 million and $8.1 million, respectively. Based on the company's history of operating earnings and its expectations for the future, management has determined that operating income will more likely than not be sufficient to recognize fully all other deferred tax assets.\nIn the third quarter of 1993, the company adjusted its current and deferred income tax balances to reflect an increase in the statutory federal tax rate from 34 percent to 35 percent retroactive to January 1, 1993. The provision for taxes on income for 1993 includes $3.2 million of expense for the effect of the tax increase on beginning of the year deferred tax balances.\nThe company's federal income tax returns have been examined and settlements have been reached for all years through 1988, except a petition which has been filed with the U.S. Tax Court regarding the deductibility of certain expenses on the company's 1985 federal income tax return. Assessments made for the years 1989 and 1990 are presently being negotiated at the appellate level. The company believes that adequate provision has been made for possible assessments of additional taxes.\nThe commercial paper is backed by the company's revolving credit agreement, which enables it to refinance these short-term borrowings to a long-term basis should the company choose to do so. Because of this capability and the likelihood of $20.0 million of the commercial paper being outstanding for more than a year, that amount has been classified as long-term debt. The balance of commercial paper outstanding at December 31, 1994, is classified as current notes payable in the Balance Sheets. The weighted average interest rate payable is 6.302 percent.\nThe interest rate payable on the 9.125 percent credit sensitive debentures is subject to adjustment if certain changes in the debt rating of the debentures occur. No such change in the interest rate payable has occurred.\nCertain credit agreements have restrictive covenants. At December 31, 1994, the company was in compliance with such covenants.\nPayments due on long-term debt during each of the five years subsequent to December 31, 1994:\nThe above installments do not include any payments on commercial paper outstanding.\nAt December 31, 1994, the company had credit lines totaling $150.0 million for general corporate purposes. Of that amount, $50.0 million was in short- term lines and $100.0 million was in a revolving credit and term loan agreement. The short-term credit lines are LIBOR based and permit the company to borrow at any time through May 31, 1995. The revolving credit and term loan agreement dated September 1, 1994, contains a 364-day commitment period, is renewable annually and includes a two-year term loan option. At December 31, 1994, there were no borrowings by the company under any credit lines.\nNote 8. 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 SHORT-TERM INVESTMENTS\nFor short-term investments, the carrying amount approximates fair value. Short-term investments include bank certificates of deposit, repurchase agreements, money market preferreds and various other investment grade securities which can be readily purchased or sold using established markets. Short-term investments at December 31, 1994, include $45.3 million for the company's investment in corporate owned life insurance (COLI). COLI does not qualify as a financial instrument and therefore is not included in the fair values stated below.\nCURRENT NOTES PAYABLE\nThe fair value of the company's current notes payable, which consists of commercial paper, is estimated based upon the quoted market prices for the same or similar issues.\nLONG-TERM DEBT\nThe fair value of the company's long-term debt is estimated based upon the quoted market prices for the same or similar debt issues. The amount of long- term debt for which there is no quoted market price is immaterial and the carrying amount approximates fair value.\nEstimated fair values of the company's financial instruments:\nNote 9. Retirement, Incentive and Savings Plans\nSubstantially all employees and directors of the company are covered by noncontributory defined benefit pension plans. These include both company- sponsored and multi-employer plans. Total pension expense was $4.5 million in 1994, $6.3 million in 1993 and $7.3 million in 1992. The 1994 pension expense presented above excludes $4.6 million for early retirement programs which is included in Other income and expense in the Statements of Earnings.\nThe salaried plan provides benefits based on the participants' final average pay and years of service. Plans covering hourly employees generally provide benefits of stated amounts for each year of service. The directors' plan provides a benefit equal to the retainer in effect at the time the participant ceases to be a director if the director has completed five years of service as a nonemployee director. Benefits are paid for the lesser of 10 years or the number of years of service as a nonemployee director.\nPension cost for company-sponsored plans:\nFunded status and related balance sheet amounts for company-sponsored pension plans at December 31:\nThe projected benefit obligation for the company's unfunded, nonqualified plans at December 31, 1994 and 1993, was $16.2 million and $15.2 million, respectively. These amounts are included in the total for Plans Where Accumulated Benefits Exceed Assets.\nAs of December 31, 1994, $20.3 million of minimum pension liabilities for underfunded plans was included in other long-term liabilities, with corresponding intangible assets of $14.8 million and a charge of $3.4 million to retained earnings, which is net of deferred taxes of $2.1 million. As of December 31, 1993, minimum pension liabilities totaled $.7 million, with corresponding intangible assets of the same amount.\nThe projected benefit obligation at December 31, 1994, 1993 and 1992, was determined using an assumed discount rate of 8.25 percent, 7.75 percent and 8.5 percent, respectively, and an assumed long-term rate of salaried\ncompensation increase of 5 percent, 5 percent and 6 percent, respectively. The assumed rate of return on plan assets was 9.5 percent for 1994, 9.5 percent for 1993 and 9 percent for 1992. The actual return on plan assets has averaged approximately 12 percent over the past 17 years.\nFunding of company-sponsored plans is based on accepted actuarial methods in accordance with applicable governmental regulations and is determined separately from the net periodic cost presented above.\nHourly employees at two of the company's manufacturing facilities participate in a multi-employer defined benefit pension plan, the Paper Industry Union-Management Pension Fund. Company contributions were $2.6 million for 1994, $2.7 million for 1993 and $2.6 million for 1992 and equaled the amounts charged to pension expense.\nKey management employees participate in a management performance award plan under which awards are based on certain minimum and standard performance criteria established each year. All company employees are eligible to participate in 401(k) savings plans.\nNote 10. Postretirement Benefits Other Than Pensions\nEffective January 1, 1993, the company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The statement requires accrual basis recognition of the projected future cost of providing postretirement benefits. The company elected immediate recognition of the transition obligation, which amounted to $118.0 million ($75.5 million after income tax benefits or $2.59 per share). The obligation, which is presented in Other long-term obligations in the Balance Sheets, was partially offset by $31.2 million of plan assets.\nThe company provides many of its retired employees with health care and life insurance benefits. Benefits are provided under company-sponsored defined benefit retiree health care and life insurance plans which cover most salaried and certain hourly employees. Employees become eligible for these benefits as they retire from active employment. Most of the retiree health care plans require retiree contributions and contain other cost sharing features such as deductibles and coinsurance. The retiree life insurance plans are primarily noncontributory. The retiree health care plans are partially funded. The retiree life insurance plans are unfunded.\nNet periodic postretirement benefit cost:\nThe 1994 postretirement benefit cost presented above excludes $1.9 million for early retirement programs which is included in Other income and expense in the Statements of Earnings. Postretirement benefit cost on a pay-as-you-go basis totaled $5.7 million for 1992 and has not been restated.\nFunded status and related balance sheet amounts for postretirement health care and life insurance plans at December 31:\nThe discount rate used in determining the accumulated postretirement benefit obligation at December 31, 1994 and 1993, was 8.25 percent and 7.75 percent, respectively. The expected long-term rate of return on plan assets for 1994 and 1993 was 9.5 percent.\nThe health care cost trend rate assumption used in determining the accumulated postretirement benefit obligation at December 31, 1994 and 1993, is based on an initial rate of 10 percent, decreasing incrementally to 5 percent over an 8-year period and remaining at that level thereafter. This assumption has a significant effect on the amounts reported. For example, a 1 percent increase in the health care cost trend rates would have increased the accumulated postretirement benefit obligation at December 31, 1994, to $176.7 million and increased the net periodic cost for 1994 to $15.9 million from the $13.3 million actually recorded.\nFunding of postretirement health care plans is based on accepted actuarial methods in accordance with applicable governmental regulations and is determined separately from the net periodic cost presented above.\nEffective January 1, 1993, the company adopted Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits. The statement requires accrual basis recognition of postemployment benefits provided to former or inactive employees after employment but before retirement. The effect of implementing the new standard was not material.\nNote 11. Stock Options\nUnder the company's stock option plans, options for shares of the company's common stock have been issued to certain key personnel. Options are granted at market value and may include a stock appreciation right. Options may also be issued in the form of restricted stock and other share-based awards, none of which were outstanding at December 31, 1994. Options are fully exercisable after two years and expire not later than 10 years from the date of grant.\nInformation with respect to the company's stock options:\nNote 12. Segment Information\nPotlatch Corporation is an integrated forest products company with substantial timber resources. It is engaged principally in the growing and harvesting of timber and the manufacture and sale of wood products, printing papers and other pulp-based products. Its timberlands and all of its manufacturing facilities are located within the United States.\nFollowing is a tabulation of business segment information for each of the past three years:\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors:\nWe have audited the accompanying balance sheets of Potlatch Corporation and consolidated subsidiaries as of December 31, 1994 and 1993 and the related statements of earnings, stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1994. In connection with our audits of the financial statements, we also have audited the financial statement schedule on page 35. These financial statements and financial statement schedule are the responsibility of the company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\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 Potlatch Corporation and consolidated subsidiaries at December 31, 1994 and 1993 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, 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, present fairly, in all material respects, the information set forth herein.\nAs discussed in the notes to the financial statements, in 1993 the company adopted the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" and Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits.\"\nKPMG Peat Marwick LLP\nPortland, Oregon\nJanuary 25, 1995\nPOTLATCH CORPORATION AND CONSOLIDATED SUBSIDIARIES\nExhibit Index\nExhibit\n*(3)(a) Restated Certificate of Incorporation, restated and filed with the state of Delaware on May 1, 1987, filed as Exhibit (3)(a) to the Annual Report on Form 10-K for the fiscal year ended December 31, 1992 (\"1992 Form 10-K\").\n*(3)(c) By-laws, as amended through May 20, 1993, filed as Exhibit (3)(c) to the Annual Report on Form 10-K for the fiscal year ended December 31, 1993 (\"1993 Form 10-K\").\n(4) See Exhibits (3)(a) and (3)(c). Registrant also undertakes to file with the Securities and Exchange Commission, upon request, any instrument with respect to long-term debt.\n(4)(a) Form of Indenture, dated as of April 1, 1986.\n(4)(b) Form of Debenture for the $100 Million Principal Amount of 9-5\/8% Sinking Fund Debentures due April 15, 2016.\n(4)(c) Form of Debenture for the $100 Million Principal Amount of 9-1\/8% Credit Sensitive Debentures due December 1, 2009.\n(4)(d) Officers' Certificate, dated December 6, 1989.\n*(4)(e) Form of Indenture, dated as of November 27, 1990, filed as Exhibit (4)(e) to the Annual Report on Form 10-K for the fiscal year ended December 31, 1990 (\"1990 Form 10- K\").\n*(4)(f) Officers' Certificate, dated January 24, 1991, filed as Exhibit (4)(f) to the 1990 Form 10-K.\n*(4)(g) Officers' Certificate, dated December 12, 1991, filed as Exhibit (4)(g) to the Annual Report on Form 10-K for the fiscal year ended December 31, 1991 (\"1991 Form 10-K\").\n*(10)(a) Potlatch Corporation Management Performance Award Plan, as amended effective January 1, 1986, filed as Exhibit (10)(a) to the 1990 Form 10-K.\n(10)(a)(i) Amendment, dated May 5, 1989, to the Plan described in Exhibit (10)(a).\n*Incorporated by reference.\n*(10)(b) Potlatch Corporation Severance Program for Executive Employees, as amended and restated as of February 24, 1989, filed as Exhibit (10)(b)(iv) to the 1993 Form 10-K.\n*(10)(c) Letter agreement, dated May 21, 1979, between Potlatch Corporation and George F. Jewett, Jr., regarding consulting services, filed as Exhibit (10)(c) to the 1990 Form 10-K.\n*(10)(c)(i) Amendment, dated February 19, 1986, to agreement described in Exhibit (10)(c), filed as Exhibit (10)(c)(i) to the 1990 Form 10-K.\n*(10)(d) Potlatch Corporation Salaried Employees' Supplemental Benefit Plan (As Amended and Restated Effective January 1, 1988), filed as Exhibit (10)(d)(i) to the 1993 Form 10-K.\n*(10)(d)(i) Amendment, effective as of December 31, 1992, to Plan described in Exhibit (10)(d), filed as Exhibit (10)(d)(ii) to the 1992 Form 10-K.\n*(10)(f) Supplemental Retirement Benefit and Life Insurance Agreement, dated February 19, 1988, together with Amendment to Agreement thereto, dated as of January 1, 1992, between Potlatch Corporation and Richard B. Madden, filed as Exhibit (10)(f)(iii) to the 1992 Form 10-K.\n(10)(f)(i) Description of facilities use by Richard B. Madden.\n*(10)(g) Potlatch Corporation 1983 Stock Option Plan (effective September 24, 1983), together with amendments thereto, dated December 14, 1984, February 24, 1989 and February 22, 1990, filed as Exhibit (10)(r) to the 1993 Form 10-K.\n(10)(g)(i) Form of Stock Option Agreement for the Potlatch Corporation 1983 Stock Option Plan together with the Addendum thereto as used for options granted on December 14, 1989.\n(10)(g)(ii) Form of Amendment to Stock Option Agreement together with the Addendum thereto to add stock appreciation rights to stock option agreements issued under the Potlatch Corporation 1983 Stock Option Plan.\n*(10)(g)(iii) Form of Stock Option Agreement for the Potlatch Corporation 1983 Stock Option Plan together with the Addendum thereto as used for options granted in each December of 1990-1992, filed as Exhibit (10)(s)(v) to the 1990 Form 10-K.\n(10)(h) Potlatch Corporation Deferred Compensation Plan for Directors, as amended and restated as of May 1991.\n*Incorporated by reference.\n(10)(i) Potlatch Corporation Directors' Retirement Plan, effective October 1, 1989.\n*(10)(j) Compensation of Directors, dated May 20, 1993, filed as Exhibit (10)(w)(vi) to the 1993 Form 10-K.\n*(10)(k) Form of Indemnification Agreement with each director of Potlatch Corporation, dated as of the dates set forth on Schedule A and Amendments 1, 2, 3 and 4 to Schedule A, filed as Exhibit (10)(x) to the 1991 Form 10-K.\n*(10)(k)(i) Amendment No. 5 to Schedule A to Exhibit (10)(k), filed as Exhibit (10)(x)(i) to the 1992 Form 10-K.\n*(10)(k)(ii) Amendment No. 6 to Schedule A to Exhibit (10)(k), filed as Exhibit (10)(x)(ii) to the 1993 Form 10-K.\n*(10)(l) Form of Indemnification Agreement with certain officers of Potlatch Corporation identified on Schedule A and Amendments 1, 2, and 3 to Schedule A, filed as Exhibit (10)(y) to the 1991 Form 10-K.\n*(10)(l)(i) Amendment No. 4 to Schedule A to Exhibit (10)(l), filed as Exhibit (10)(y) to the 1992 Form 10-K.\n*(10)(l)(ii) Amendment No. 5 to Schedule A to Exhibit (10)(l), filed as Exhibit (10)(y)(ii) to the 1993 Form 10-K.\n*(10)(m) Potlatch Corporation 1989 Stock Incentive Plan adopted December 8, 1988, and as amended and restated February 24, 1989, filed as Exhibit (10)(z) to the 1993 Form 10-K.\n(10)(m)(i) Form of Stock Option Agreement for the Potlatch Corporation 1989 Stock Incentive Plan together with the Addendum thereto as used for options granted on December 14, 1989.\n*(10)(m)(ii) Form of Stock Option Agreement for the Potlatch Corporation 1989 Stock Incentive Plan together with the Addendum thereto as used for options granted in each December of 1990-1994, filed as Exhibit (10)(z)(ii) to the 1990 Form 10-K.\n*(10)(n) Form of Amendments to Stock Options and Stock Incentive Plans, dated March 30, 1990, filed as Exhibit (10)(aa) to the 1990 Form 10-K.\n(22) Potlatch Corporation Subsidiaries.\n(23) Consent of Independent Auditors.\n(24) Powers of Attorney.\n*Incorporated by reference.","section_15":""}
{"filename":"788329_1994.txt","cik":"788329","year":"1994","section_1":"ITEM 1. BUSINESS\nJohnson Worldwide Associates, Inc. and its subsidiaries (the \"Company\") are engaged in the manufacture and marketing of recreational products. The Company also manufactured and marketed marking systems, but on July 28, 1993 announced its intention to sell its marking systems business. In accordance with this decision, the marking systems business is presented as a discontinued operation in the Company's Consolidated Financial Statements. Additional information regarding the marking systems business is set forth at Note 3 to the Consolidated Financial Statements on page 20 in the Company's 1994 Annual Report, which is incorporated herein by reference. Financial information for the foreign and domestic operations of the Company's recreational business is set forth at Note 13 to the Consolidated Financial Statements on page 25 in the Company's 1994 Annual Report which is incorporated herein by reference.\nThe Company's primary focus is on marketing and product innovation and design to achieve strong brand names and consumer recognition. Research and development activities for each of the Company's principal businesses emphasize new products and innovations to differentiate the Company's products from those of its competitors.\nThe Company and S. C. Johnson & Son, Inc. (\"SCJ\") are controlled by Samuel C. Johnson, members of his family, and related entities.\nRecreational Products\nFishing and Camping Products\nThe Company's fishing and camping products include Minn Kota electric fishing motors, Mitchell reels and rods, Johnson reels, Beetle Spin soft body lures, Johnson spoons, Deckhand electric boat anchor systems, Eureka! and Camp Trails tents and backpacks, Old Town canoes, Carlisle paddles, Silva compasses, and Jack Wolfskin camping tents, backpacks and outdoor clothing.\nThe overall fishing and camping markets in which the Company competes have grown modestly in recent years. The Company believes it has been able to maintain or increase its share of most markets primarily as a result of the Company's emphasis on marketing and product innovation. Research and development emphasizes new products and innovations to provide demonstrable product differentiation and expanded product lines. Consumer advertising and promotion include advertising on regional television and in outdoor, general interest and sports magazines, in-store displays and sponsorship of fishing tournaments. Packaging and point-of-purchase materials are used to increase consumer appeal and sales.\nElectric Fishing Motors. The Company manufactures, under its Minn Kota name, battery powered motors used on fishing boats for quiet trolling power. The Company's Minn Kota motors and related accessories are sold primarily in the United States through large retail store chains such as K-Mart and Wal-Mart.\nRods and Reels. The Company markets Johnson fishing reels, which are primarily closed-face reels, as well as Mitchell reels, which are open-faced reels. Reels are sold individually and in rod and reel combinations, primarily through large retail store chains in the United States and Canada and specialty fishing shops in Europe. The Company's closed-face reels compete in a segment of the U.S. fishing reel market which is dominated by larger manufacturers. Marketing support for the Company's reels is focused on building brand names, emphasizing product features and innovations and on developing specific segments of the reel market through advertising in national outdoor magazines, through trade and consumer support at retail and through sponsorship of fishing tournaments.\nLure Products. The Company's artificial lure products consist of Beetle Spin soft body lures, and Johnson spoons. These products are sold primarily through large retail store chains.\nTents and Backpacks. The Company's Eureka! and Camp Trails tents and backpacks compete primarily in the mid- to high-price range of their respective markets and are sold in the United States through independent sales representatives primarily to sporting goods stores, catalog and mail order houses and camping and backpacking specialty stores. Marketing of the Company's tents and backpacks is focused on building the Eureka! and Camp Trails brand names and establishing the Company as a leader in product design and innovation. The Company's tents and backpacks are produced by off-shore manufacturing sources.\nThe Company markets both Eureka! camping and commercial tents. The Company's camping tents have outside self-supporting aluminum frames allowing quicker and easier set-up, a design approach first introduced by the Company. Most of the Eureka! tents are made from breathable nylon. The Company's commercial tents include party tents and tents for fairs. Party tents are sold primarily to general rental stores while other commercial tents are sold directly to tent erectors. Commercial tents are manufactured by the Company in the United States. In 1994, the Company introduced a line of Camp Trails tents to compete in the promotional product category.\nCamp Trails backpacks consist primarily of internal and external frame backpacks for hiking and mountaineering. The Company's line of Camp Trails backpacks also includes soft back bags, day packs and travel packs. Jack Wolfskin, a German marketer of camping tents, backpacks and outdoor clothing, distributes its products primarily through camping and backpacking specialty stores in Germany with additional distribution in other European countries and Japan. In 1994, the Company introduced a line of Eureka! backpacks to compete in the mid to high performance product category.\nCanoes. The Company's canoes are sold under the Old Town name and consist of whitewater, tripping, touring and general recreational purpose canoes for the high quality and mid-price segments of the canoe market. The Company has developed a proprietary roto-molding process for manufacturing polyethylene canoes to compete in the higher volume mid-priced range of the market. These canoes maintain many of the design and durability characteristics of higher priced canoes. The Company also manufactures canoes from fiberglass, Royalex (ABS) and wood. The Company's canoes are sold primarily to sporting goods stores, catalog and mail order houses such as L. L. Bean, canoe specialty stores and marine dealers in the United States and Europe. The United States' market for canoes is relatively constant, but the Company believes, based on industry data, that it is the leading manufacturer of canoes in the United States in unit and dollar sales. Carlisle Paddles, a manufacturer of composite canoe paddles, supplies certain paddles that are sold with the Company's canoes as well as supplying paddles which are distributed through the same channels as the Company's canoes.\nDiving and Marine Products\nDiving. The Company believes that it is one of the world's largest manufacturers and distributors of underwater diving products which it sells under the Scubapro name. The Company markets a full line of snorkeling and underwater diving equipment including regulators, stabilizing jackets, tanks, depth gauges, masks, fins, snorkels, diving electronics and other accessories. Scubapro products are marketed to the high quality, premium priced segment of the market. The Company maintains a marketing policy of limited distribution and sells primarily through independent specialty diving shops worldwide. These diving shops generally provide a wide range of services to divers, including instruction and repair service. Scubapro products are marketed primarily in the United States, Europe and the Pacific Basin.\nThe Company focuses on maintaining Scubapro as the market leader in innovations and new products. The Company maintains a research and development staff both in the United States and Italy and has obtained several patents on Scubapro products and features. Consumer advertising focuses on building the Scubapro brand name and position as the high quality and innovative leader in the industry. The Company advertises its Scubapro equipment in diving magazines and through in-store displays.\nThe Company maintains manufacturing and assembly facilities in the United States and Italy. The Company procures a number of its rubber and plastic products and components from offshore sources.\nMarine Products. The Company is a leading supplier in Europe of marine products and accessories primarily for sailing, which are sold under the Plastimo name. Plastimo products and accessories include safety products (such as buoyancy vests and inflatable life rafts), mooring products (such as anchors, fenders and ladders), navigational equipment (such as cockpit instruments, automatic pilots and compasses) and jib reefing systems. Plastimo products are also sold in the United States and other markets worldwide.\nThe Company's line of Airguide marine, weather and automotive instruments are distributed primarily in the United States through large retail store chains and original equipment manufacturers.\nSales by Category\nThe following table depicts net sales of continuing operations by major product category:\nYear Ended\nSeptember 30, October 1, October 2, 1994 1993 1992\n(thousands of dollars) Fishing $ 94,363 $ 84,773 $ 81,074\nCamping 87,529 86,118 84,068\nDiving 66,884 66,225 64,382\nMarine 35,567 43,176 46,321 ------ ------ -------- $284,343 $280,292 $275,845 ======= ======= =======\nMarking Systems\nThe Company manufactured and marketed marking systems throughout the world under the Porelon, First Edition, Perma Stamp, Stamp-Ever, Phoenix, Eagle, Trident and other trade names. The Company's primary marking systems products included hand stamps; ink roll and cartridge replacement units for calculators, adding machines and computers; extruded rolls for the printing industry; and liquid ink jets. The hand stamps and replacement units were distributed through office supply retail stores, including the super store segment of the market. The liquid ink jets were sold to original equipment manufacturers primarily for applications in financial institutions and the postal industry.\nOn July 28, 1993, the Company announced its intention to sell its marking systems business. As a result, the marking systems operations have been reclassified as discontinued for financial reporting purposes. The Company completed the divestiture of the marking systems business in the second calendar quarter of 1994.\nInternational Operations\nSee Note 13 to the Consolidated Financial Statements on page 25 of the Company's 1994 Annual Report which is incorporated herein by reference, for financial information comparing the Company's domestic and international operations.\nResearch and Development\nThe Company commits significant resources to research and new product development. The Company expenses research and development costs as incurred. The amounts expended by the Company in connection with research and development activities for each of the last three fiscal years is set forth in the Consolidated Statements of Operations on page 16 of the Company's 1994 Annual Report which is incorporated herein by reference.\nCompetition\nThe markets for most of the Company's products are quite competitive. The Company believes its products compete favorably on the basis of product innovation, product performance and strong marketing support, and to a lesser extent, price.\nEmployees\nAt September 30, 1994, the Company had approximately 1,275 employees working in its businesses. The Company considers its employee relations to be excellent.\nPatents, Trademarks and Proprietary Rights\nThe Company owns no single patent which is material to its business as a whole. However, the Company holds several patents, principally for diving products and roto-molded canoes and has filed several applications for patents. The Company also has numerous trademarks and trade names which the Company considers important to its business.\nSeasonality\nThe Company's business is seasonal. The following table shows total net sales and operating profit of the Company's continuing operations for each quarter, as a percentage of the total year. An inventory writedown of $5.4 million is included as a component of fourth quarter operating loss in 1994. Restructuring charges of $13.0 million and $4.5 million for 1993 and 1992, respectively, are included as a component of the fourth quarter operating loss in those years.\nExecutive Officers of the Registrant\nPursuant to General Instruction of G(3) of Form 10-K, the following list is included as an unnumbered Item in Part I of this report in lieu of being included in the Company's Proxy Statement for the January 25, 1995 Annual Meeting of Shareholders.\nMr. Crabb, age 51, became President and Chief Executive Officer in January 1994. He served as President and Chief Operating Officer of the Company from 1992 to January 1994. Mr. Crabb served as Executive Vice President-Regional Director, Consumer Products, Europe of S.C. Johnson and Son, Inc. (\"SCJ\") from 1990 to 1992 and from 1984 to 1990 was Vice President-Regional Director of Asia\/Pacific of SCJ. Mr. Crabb joined SCJ in 1970. He was previously employed by Lever Bros., Ltd., Toronto, Canada.\nMr. Malone, age 64, retired as Chairman and Chief Executive Officer of the Company in January 1994. He was President and Chief Executive Officer of the Company from 1984 to 1992.\nMr. Blime, age 53, became a Vice President of the Company and President of JWA Europe in 1993. From 1982 to 1993, Mr. Blime was President and Directeur General of Mitchell Sports, S.A., a subsidiary of the Company since 1990.\nMr. Inslee, age 56, became Vice President-Human Resources of the Company in 1991. From 1988 to 1991, Mr. Inslee was Director of Human Resources of the Company. He was Director of Personnel at SCJ from 1981 to 1988. Mr. Inslee joined SCJ in 1960.\nMr. Schmidt, age 38, became Vice President, Chief Financial Officer, Secretary and Treasurer of the Company in July 1994. From 1988 to July 1994 he was a partner in the firm of KPMG Peat Marwick LLP.\nMr. Chilton, age 48, resigned as Vice President-Business Development in July 1994, which position he had held since November 1991. From 1987 to 1991 Mr. Chilton was President of Oregon Farms, Inc.\nMr. Caulk, age 42, resigned as Vice President of the Company and President of JWA North America in October 1994, which positions he had held since July 1993. From 1991 to 1993, Mr. Caulk was Vice President and General Manager of Scubapro USA, a division of the Company. From 1989 to 1991, he was Director of Corporate Acquisitions and Planning for the Company.\nMr. Cahill, age 37, resigned as Vice President, Chief Financial Officer, Secretary and Treasurer of the Company in July 1994, which positions he had held since 1992. He served as Corporate Controller of the Company from 1989 to 1992.\nThere are no family relationships between the above executive officers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company maintains both leased and owned manufacturing, warehousing, distribution and office facilities throughout the world.\nThe Company's manufacturing processes are primarily assembly operations and the Company prefers to lease rather than own facilities to maintain operational flexibility and control the investment of financial resources in property. See Note 6 to the Consolidated Financial Statements on Page 21 of the Company's 1994 Annual Report for a discussion of lease obligations.\nThe Company believes that its facilities are well maintained and have a capacity adequate to meet the Company's current needs.\nThe Company's principal manufacturing locations and distribution centers are:\nAntibes, France Bad Sakingen, Germany Barcelona, Spain Binghamton, New York Bruxelles, Belgium Burlington, Ontario, Canada Chicago, Illinois Eastleigh, Hampshire, England Genoa, Italy Grayling, Michigan Henan, Sweden Henggart, Switzerland Lorient, France Mankato, Minnesota Marignier, France Mitcham, Surrey, England Morfelden-Walldorf, Germany Nykoping, Sweden Old Town, Maine Oslo, Norway Racine, Wisconsin Rancho Dominguez, California Salzburg-Glasenbach, Austria Silverwater, Australia Tokyo (Kawasaki), Japan\nThe Company's Marking Systems' principal locations were:\nBoras, Sweden Brookfield, Connecticut Cookeville, Tennessee Houston, Texas Utica, New York\nThe Company's corporate headquarters is in Mount Pleasant, Wisconsin. The Company's mailing address is Sturtevant, Wisconsin.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is subject to various legal actions and proceedings in the normal course of business, including those related to environmental matters. Although litigation is subject to many uncertainties and the ultimate exposure with respect to these matters cannot be ascertained, management does not believe the final outcome will have a significant effect on the Consolidated Financial Statements.\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 last quarter of the year ended September 30, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nInformation with respect to this item is included on pages 21, 23, 24 and 27 and the inside back cover of the Company's 1994 Annual Report and is incorporated herein by reference.\nThere is no public market for the Registrant's Class B Common Stock. However, the Class B Common Stock is convertible at all times at the option of the holder into shares of Class A Common Stock on a share for share basis. As of November 15, 1994, the Company had 817 Holders of Record of its Class A Common Stock and 75 Holders of Record of its Class B Common Stock.\nThe Company has never paid a dividend on its Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation with respect to this item is included on page 27 of the Company's 1994 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 OPERATION\nInformation with respect to this item is included on pages 12 to 14 of the Company's 1994 Annual Report and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements and supplemental data of the registrant and subsidiaries, included on pages 15 through 27 of the Company's 1994 Annual Report, are herein incorporated by reference:\nConsolidated Balance Sheets - September 30, 1994 and October 1, 1993 Consolidated Statements of Operations - Years ended September 30, 1994, October 1, 1993 and October 2, 1992 Consolidated Statements of Shareholders' Equity - Years ended September 30, 1994, October 1, 1993 and October 2, 1992 Consolidated Statements of Cash Flows - Years ended September 30, 1994, October 1, 1993 and October 2, 1992 Notes to Consolidated Financial Statements Independent Auditors' Report Five Year Financial Summary\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 this item, except for information on the Executive Officers which appears at the end of Part I of this report, is included in the Company's January 25, 1995 Proxy Statement under the headings \"Election of Directors\" and \"Other Matters\" and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation with respect to this item is included in the Company's January 25, 1995 Proxy Statement under the heading \"Executive Compensation\" and 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 is included in the Company's January 25, 1995 Proxy Statement under the heading \"Stock Ownership of Management and Others\" and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation with respect to this item is included in the Company's January 25, 1995 Proxy Statement under the heading \"Certain Transactions\" and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\nA. The following documents are filed as a part of this Form 10-K:\n1. Financial Statements:\nIncluded in Item 8 of Part II of this Form 10-K are the following Consolidated Financial Statements, related notes thereto, and independent auditors' report which are incorporated herein by reference from the 1994 Annual Report:\nConsolidated Balance Sheets - September 30, 1994 and October 1, Consolidated Statements of Operations - Years ended September 30, 1994, October 1, 1993 and October 2, 1992 Consolidated Statements of Shareholders' Equity - Years ended September 30, 1994, October 1, 1993 and October 2, 1992 Consolidated Statements of Cash Flows - Years ended September 30, 1994, October 1, 1993 and October 2, 1992 Notes to Consolidated Financial Statements Independent Auditors' Report Five Year Financial Summary\n2. Financial Statement Schedules and Independent Auditors' Report:\nIncluded in Part IV of this Form 10-K are the following financial statement schedules and independent auditors' report:\nIndependent Auditors' Report Schedule VIII - Valuation and Qualifying Accounts Schedule IX - Short-term Borrowings Schedule X - Supplementary Income Statement Information\nAll other schedules are omitted because they are not applicable, are not required or equivalent information has been included in the Consolidated Financial Statements or notes thereto.\n3. Exhibits\nSee Exhibit Index on page 16.\nB. Reports on Form 8-K:\nNo reports on Form 8-K were filed during the fiscal year ended\nSeptember 30, 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, in the Town of Mount Pleasant and State of Wisconsin, on the 13th day of December, 1994.\nJOHNSON WORLDWIDE ASSOCIATES, INC. (Registrant)\nBy \/s\/ John D. Crabb John D. Crabb President and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, the report has been signed by the following persons in the capacities indicated on the 13th day of December, 1994.\n\/s\/ Samuel C. Johnson Chairman of the Board (Samuel C. Johnson) and Director\n\/s\/ John D. Crabb President and Chief (John D. Crabb) Executive Officer and Director\n\/s\/ Donald W. Brinckman Director (Donald W. Brinckman)\n\/s\/ Raymond F. Farley Director (Raymond F. Farley)\n\/s\/ Helen P. Johnson-Leipold Director (Helen P. Johnson-Leipold)\n\/s\/ Thomas F. Pyle, Jr. Director (Thomas F. Pyle, Jr.)\n\/s\/ Carl G. Schmidt Vice President, Chief (Carl G. Schmidt) Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer)\nINDEPENDENT AUDITORS' REPORT\nShareholders and Board of Directors Johnson Worldwide Associates, Inc.:\nUnder date of November 10, 1994, we reported on the consolidated balance sheets of Johnson Worldwide Associates, Inc. and subsidiaries as of September 30, 1994 and October 1, 1993 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three year period ended September 30, 1994, as contained in the 1994 Annual Report. These consolidated financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for the fiscal year 1994. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedules as listed in Item 14A. 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 LLP Milwaukee, Wisconsin November 10, 1994\nJOHNSON WORLDWIDE ASSOCIATES, INC. AND SUBSIDIARIES\nJOHNSON WORLDWIDE ASSOCIATES, INC. AND SUBSIDIARIES\nJOHNSON WORLDWIDE ASSOCIATES, INC. AND SUBSIDIARIES\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION\n(thousands of dollars)\nCharged to Costs and Expenses Year Ended\nSeptember 30, October 1, October 2, 1994 1993 1992\n5. Advertising costs $12,078 $12,042 $10,854\n(1) Items 1, 3 and 4 have been omitted as the amounts did not exceed one percent of total sales and revenues.\nJOHNSON WORLDWIDE ASSOCIATES, INC.\nEXHIBIT INDEX\nExhibits Title Page No.\n3.1 Articles of Incorporation of the * Company. (Filed as Exhibit 3.1 to the Company's Form S-1 Registration Statement No. 33-16998, and incorporated herein by reference.)\n3.2 Bylaws of the Company as Amended through - January 27, 1994\n4.1 Note Agreement dated May 1, 1991. * (Filed as Exhibit 4 to the Company's Form 10-Q for the quarter ended June 28, 1991 and incorporated herein by reference).\n4.2 Revolving and Term Loan Agreement dated * October 2, 1991. (Filed as Exhibit 4.4 to the Company's Form 10-K for the year ended September 27, 1991 and incorporated herein by reference.)\n4.3 Revolving Loan Agreement dated April 2, * 1993. (Filed as Exhibit 4 to the Company's Form 10-Q for the quarter ended April 2, 1993 and incorporated herein by reference.)\n4.4 Note Agreement dated May 1, 1993. * (Filed as Exhibit 4 to the Company's Form 10-Q for the quarter ended July 2, 1993 and incorporated herein by reference.)\n4.5 Letter Amendment No. 1 dated September * 30, 1993 to Note Agreement dated May 1,\n4.6 Letter Amendment No. 1 dated September * 27, 1993 to Revolving and Term Loan Agreement dated October 2, 1991\n4.7 Letter Amendment No. 1 dated September * 27, 1993 to Revolving Loan Agreement dated April 2, 1993\n4.8 Letter Amendment dated September 30, * 1993 to Note Agreement dated May 1, 1993\n4.9 Letter Amendment No. 2 dated September - 30, 1994 to Revolving and Term Loan Agreement dated October 2, 1991\n4.10 Letter Amendment No. 2 dated August 29, - 1994 to Revolving Loan Agreement dated April 2, 1993\n9. Johnson Worldwide Associates, Inc. Class * B Common Stock Voting Trust Agreement, dated December 30, 1993 (Filed as Exhibit 9 to the Company's Form 10-Q for the quarter ended December 31, 1993 and incorporated herein by reference.)\n10.1 Acquisition Agreement between S. C. * Johnson & Son, Inc. and Johnson Worldwide Associates, Inc. dated December 18, 1985. (Filed as Exhibit 10.1 to the Company's Form S-1 Registration Statement No. 33-16998, and incorporated herein by reference.)\n10.2 Discretionary Bonus Option Plan. (Filed * as Exhibit 10-2 to the Company's Form S-1 Registration Statement No. 33-16998, and incorporated herein by reference.)\n10.3 Johnson Worldwide Associates, Inc. * Amended and Restated 1986 Stock Option Plan. (Filed as Exhibit 10 to the Company's Form 10-Q for the quarter ended July 2, 1993 and incorporated herein by reference.)\n10.4 Registration Rights Agreement regarding * Johnson Worldwide Associates, Inc. Common Stock issued to the Johnson family prior to the acquisition of Johnson Diversified, Inc. (Filed as Exhibit 10.6 to the Company's Form S-1 Registration Statement No. 33-16998, and incorporated herein by reference.)\n10.5 Registration Rights Agreement regarding * Johnson Worldwide Associate, Inc. Class A Common Stock held by Mr. Samuel C. Johnson. (Filed as Exhibit 28 to the Company's Form 10-Q for the quarter ended March 29, 1991 and incorporated herein by reference.)\n10.6 Lease Agreement between Johnson * Worldwide Associates, Inc. and Johnson Redevelopment Corporation (lease relates to the Company's executive office). (Filed as Exhibit 10.6 to the Company's Form 10-K for the year ended October 2, 1992 and incorporated herein by reference.)\n10.7 Form of Restricted Stock Agreement. * (Filed as Exhibit 10.8 to the Company's Form S-1 Registration Statement No. 33-23299, and incorporated herein by reference.)\n10.8 Form of Supplemental Retirement * Agreement of Johnson Diversified, Inc. (Filed as Exhibit 10.9 to the Company's Form S-1 Registration Statement No. 33-16998, and incorporated herein by reference.)\n10.9 Johnson Worldwide Associates Retirement * and Savings Plan. (Filed as Exhibit 10.9 to the Company's Form 10-K for the year ended September 29, 1989 and incorporated herein by reference.)\n10.10 Form of Agreement of Indemnity and * Exoneration with Directors and Officers. (Filed as Exhibit 10.11 to the Company's Form S-1 Registration Statement No. 33-16998, and incorporated herein by reference.)\n10.11 Consulting and administrative agreements * with S. C. Johnson & Son, Inc. (Filed as Exhibit 10.12 to the Company's Form S-1 Registration Statement No.33-16998, and incorporated herein by reference.)\n10.12 Johnson Worldwide Associates, Inc. Stock * Option Plan for Non-Employee Directors. (Filed as Exhibit 4.2 to the Company's Form S-8 Registration Statement No. 33-19805 and incorporated herein by reference.)\n10.13 Sublease Agreement between Johnson * Worldwide Associates, Inc. and S.C. Johnson and Son, Inc. (sublease relates to the Company's former executive office).\n10.14 Lease Agreement between Johnson * Worldwide Associates, Inc. and Johnson Redevelopment Corporation (lease relates to the Company's former executive office).\n10.15 Johnson Worldwide Associates, Inc. 1994 * Long-Term Stock Incentive Plan (Filed as Exhibit 4 to the Company's S-8 Registration Statement No. 33-52073 and incorporated herein by reference.)\n11. Statement regarding computation of per Incorporated by share earnings. reference to Note 14 to the Consolidated Financial Statements on page 25 of the Company's 1994 Annual Report.\n13. Johnson Worldwide Associates, Inc. 1994 - Annual Report. With the exception of the Consolidated Financial Statements, independent auditors' report thereon and certain other information expressly incorporated herein by reference, the Company's 1994 Annual Report is not to be deemed filed as part of this report.\n21. Subsidiaries of the Company as of - September 30, 1994.\n23. Consent of KPMG Peat Marwick LLP. -\n27. Financial Data Schedule -\n28. Definitive Proxy Statement (to be filed * with the Securities and Exchange Commission within 120 days of the end of the Company's fiscal year covered by this Form 10-K pursuant to Instruction (G)3 of this Form 10-K and Regulation 14A of the Securities Exchange Act of 1934).\n* Incorporated by reference.","section_15":""}
{"filename":"23304_1994.txt","cik":"23304","year":"1994","section_1":"Item 1. Business\nOverview\nCone Mills Corporation (\"Cone\", \"Cone Mills\" or the \"Company\") is the largest producer of denim fabrics in the world and is the largest printer of home furnishings fabrics in North America. Net sales were $769 million in 1993 and $705 million in 1992. The Company operates in two business segments: apparel fabrics and home furnishings products, representing 75% and 25%, respectively, of net sales. All wholly owned manufacturing is performed in the United States, with sales and marketing activities conducted through a worldwide distribution network. The Company is the largest domestic exporter of denim fabrics and is a major exporter of printed home furnishings fabrics, with export sales of $132 million for 1993 and $114 million for 1992.\nThe Company's business strategy is to focus on products and services that generate attractive margins and in which the Company believes it is an efficient international competitor. To this end, the Company has been engaged in the process of deemphasizing labor-intensive commodity businesses and in the first quarter of 1994 will conclude an initiative to discontinue its corduroy and other bottomweight continuous piece-dyed fabrics product line, the estimated costs of which were fully provided for in its 1991 financial statements. The Company utilizes its styling and development expertise and management depth and experience, in combination with its versatile manufacturing facilities and technical capabilities, to compete effectively in its worldwide markets.\nCone became a private company in 1984 in a leveraged transaction funded with $445 million of bank debt and other obligations and $20 million of Common Stock and equivalents. Prior to its public offering in June 1992 the Company had reduced its debt and other bank obligations by more than $225 million and had invested more than $160 million in capital improvements. In 1992 the Company raised $63.6 million in net proceeds through its public offering and replaced its bank credit agreement with more flexible facilities. As of January 2, 1994, long-term debt comprised 27% of combined long-term debt and equity capital.\nFORM 10-K Page 3\nItem 1. (continued)\nFORM 10-K Page 4\nItem 1. Business (continued)\nMarket Developments\nThe Company's domestic apparel markets have been affected by changing demographics associated with the maturation of the \"baby-boom\" generation of consumers born between 1946 and 1964. As the baby-boom generation has matured, product trends have evolved away from commodity-type products to higher quality products with more diverse styling. As a result, denim apparel manufacturers desire better fabric quality and styling to meet consumer demand, as well as faster service to reduce the risk of changing fashion trends. The size of the 15-to 24-year-old age category, which accounts for the largest consumption segment of the U.S. population, has become smaller in recent years; but this segment is expected to expand beginning in the mid-1990's when the children of baby boomers begin to reach these ages. Demand for denims is expected to increase as this segment of the U.S. population expands. By virtue of its styling expertise, manufacturing versatility and service capabilities, the Company believes that it has positioned itself to take advantage of the market opportunities presented by these demographic changes.\nInternationally, consumption of denims has increased in industrialized countries, notwithstanding moderate population growth, as these countries continue to adopt U.S. casual fashion trends. In less industrialized countries, the potential market for denim jeans has continued to grow as youth populations expand. The Company believes that these international market trends present opportunities for long- term growth through the Company's international distribution network. Apparel exports have increased sharply in recent years as 1993 apparel export sales were $124.9 million as compared with $105.2 million in 1992 and $81.9 million in 1991. In 1993, the Company entered into agreements with the largest denim manufacturer in Mexico in order to expand both market and manufacturing presence into Latin America. See \"Business - International Operations\".\nThe Company believes that the demographic trends applicable to the U.S. markets for its home furnishings fabrics indicate continued increases in demand as the baby boomers reach ages traditionally associated with high levels of spending on home furnishings. The Company also believes that the outlook for printed home furnishings fabrics is favorable because these products provide high fashion appearance at affordable prices. Additionally, there has been an increased international demand for U.S. styled home furnishings products. Accordingly, the Company's strategy is to continue to expand its home furnishings businesses.\nFORM 10-K Page 5\nItem 1. Business (continued)\nProducts for Apparel Markets\nDenims. Cone markets and manufactures a wide variety of denim apparel fabrics. Denims are generally \"yarn-dyed\", which means that the yarn is dyed before the fabric is woven. The result is a fabric with variations in color that give denim its distinctive appearance. Fabric styling of denims, which the Company believes to be critical to this market, is supported by the Company's experienced stylists and extensive use of computer-aided design and manufacturing systems.\nThe Company is a leader in denim styling and development, and believes that it produces a broader range of fashion denim than any of its competitors. In 1993, Cone sold approximately 400 different styles of denim. The styling process involves the creation of a wide array of fabric colors, shades and patterns in a variety of both traditional and innovative weaves. After weaving, fabrics are processed further in finishing operations that produce different textures and other physical properties. During this process, the Company's product development specialists and stylists generally work in collaboration with customers to assure that fabrics meet customer requirements and can be manufactured efficiently. This creates a strong working relationship that allows Cone to react quickly to its customers' rapidly changing needs.\nAlthough the markets and end uses for denim are very diverse, the Company categorizes the market into heavyweight denims and specialty weight denims. Heavyweight denim is used primarily in jeans and is by far the largest segment of the denim market. Within the heavyweight market, the Company further classifies its denims as \"fashion-forward\", \"fashion-basic\" and \"basic\".\nFashion-forward denims include innovative products and trendsetting styles for use primarily in garments sold through specialty stores and designer sections of department stores. Cone's customers in this group include Ralph Lauren (Polo), Calvin Klein, The Gap, and Stussy.\nCone's fashion-basic denims are stylish but have a broader market than fashion-forward products. The Company's largest customer in this category is Levi Strauss, whose 501 jeans are produced solely from the Company's proprietary fabrics. Other customers include The Gap, Structure and Wrangler.\nFORM 10-K Page 6\nItem 1. Business (continued)\nCone's basic denims, with mass market appeal, are used primarily in garments sold through retail chains, department stores and catalogs. Customers for this product include Wrangler, Sasson, Chic, Faded Glory and Land's End. Although the Company's basic denims are designed for the upscale segment of these markets, the Company also produces basic heavyweight blue denim to service mass market needs of certain customers. While the Company's profit margins from basic heavyweight blue denim are less than those generally applicable to its other denim products, sales of this product constituted approximately 20% of total denim sales in 1993.\nSpecialty weight denims include a variety of weave constructions, stripes, colors and weights, and are used primarily in women's and children's wear. Although these fabrics constitute only a small portion of the denim market, they tend to establish market trends and generally command higher margins because of their use in higher fashion garments. Cone's customers in this group include OshKosh, Oxford, The Gap, Timber Creek, Ruff Hewn, Ralph Lauren (Polo), Guess, Tanner, Woolridge, and Chic.\nSpecialty Sportswear Fabrics. The Company is the largest domestic producer of yarn-dyed plaid flannel and solid shade chamois shirting fabrics. Distribution channels for garments using these fabrics are broadening to include mass merchandising retailers. The Company's manufacturing capability for producing fabrics with a soft texture is essential to its success in this product group. These fabrics are primarily manufactured for use in menswear sold through catalog stores but recently have been used in lighter-weight apparel products for women's and children's wear. Customers in this market include M. Fine, Woolrich, L.L. Bean and Oxford.\nThe Company styles and distributes a line of specialty print fabrics for a wide range of branded apparel customers, which are printed at the Company's Carlisle plant. The markets for these products are primarily fashion women's and children's wear, and Cone's customers for these fabrics include OshKosh, Oxford, Healthtex, M. Fine, and Wrangler.\nThrough its Carlisle plant, the Company also provides fabric printing services to converters of fashion apparel fabrics. These converters purchase unfinished fabrics from weaving mills, utilize outside sources to dye the fabrics and print their designs, and then market the finished fabrics to apparel\nFORM 10-K Page 7\nItem 1. Business (continued)\nmanufacturers. Carlisle is well known for its quality, service and technical capabilities in roller and screen printing.\nCone also serves niche markets for two-ply, polyester\/rayon uniform and sportswear fabrics. Major end uses include uniforms for organizations such as United Parcel Service, the U. S. Postal Service, and police and fire departments. Polyester\/rayon sportswear fabrics are sold primarily for use in women's wear.\nMarketing and Sales. The Company's marketing focus is to serve upper-end and brandname apparel manufacturers through the development of innovative products that are recognized in the marketplace for their distinctive quality and styling. The Company has also placed its apparel fabrics marketing and manufacturing activities under the same management in an effort designed to assure that manufacturing is market driven.\nStyles of the Company's denim and other fabrics vary in color, finish and fabrication, depending upon fashion trends and the needs of the specific customer. The Company's stylists monitor fashion trends by periodically traveling throughout the United States, Europe and the Far East to attend fashion and trade shows, meet with garment manufacturers and retailers and conduct market research. Together with the apparel marketing group, stylists work directly with Cone's customers to create fabrics that respond to rapidly changing fashion trends and customer needs.\nThe Company employs an apparel marketing and sales staff of more than 150 persons. The apparel marketing group is organized around two product lines: denim and specialty sportswear. The Company believes that it has been able to achieve more effective customer service and improved efficiency through the integration of its styling, manufacturing, marketing and customer service functions. The Company's apparel fabrics marketing group is headquartered in Greensboro in proximity to its apparel manufacturing facilities so that customer requirements can be translated more effectively into finished products. In order to provide a more direct working relationship with its customers, the Company also maintains sales offices located in New York, Los Angeles, San Francisco and Dallas. In addition, the Company maintains a marketing support office in Brussels, Belgium.\nThe Company's marketing professionals, together with its stylists and product development personnel, work as early as one year in advance of a retail selling season to develop fabric styles, colors, constructions and finishes. There are\nFORM 10-K Page 8\nItem 1. Business (continued)\nthree annual retail selling seasons: spring, fall (back-to- school) and Christmas holiday. The Company's sales for a particular selling season generally begin six months in advance of that season. The Company's sales force presents each season's line to customers in its showrooms as well as in its customers' offices.\nManufacturing. The Company is the largest manufacturer of denims in the world. Cone bases this conclusion upon capacity and sales information obtained from trade sources. The Company is aware that a large foreign-based competitor is a substantial minority owner in a foreign manufacturing facility and, in reaching its conclusion, the Company has attributed to such competitor only its pro rata ownership in this facility.\nCone believes that it has the most versatile denim manufacturing capabilities in the world. The Company's denim facilities are modern, flexible, vertically integrated, and encompass all manufacturing processes necessary to convert raw fiber into finished fabrics. The Company has extensive flexibility in its yarn spinning operations, with open-end, ring and special stretch-yarn spinning equipment. The Company's denim weaving facilities, which include approximately 1,200 weaving machines, utilize all major cotton weaving technologies, including double-width projectile, air- jet and rapier machines. The Company's dyeing and finishing facilities include a wide range of technologies, with six indigo long-chain dyeing machines, package and beam dyeing, continuous overdye machinery, and raw cotton dyeing equipment. Specialty dyeing and printing processes for apparel fabrics are conducted at the Company's Carlisle plant, which is one of the largest textile printing facilities in the United States.\nCone is recognized internationally as a leader in quality. The Company uses a number of methods to support this process, including classroom training of employees, statistical process quality controls, computer-aided product testing from raw fiber to finished fabric and computer-aided manufacturing control systems.\nThe Company also believes that it is a leader in customer service. The Company's five denim manufacturing facilities are continually scheduled and coordinated to maximize versatility. Approximately 60% of Cone's apparel volume is shipped under its just-in-time quality assurance and delivery\nFORM 10-K Page 9\nItem 1. Business (continued)\nprogram. Cone also is a member of the Textile Apparel Linkage Council and offers electronic data interchange (EDI) to its customers and suppliers.\nProduct and process development is supported by a special manufacturing development group, which has specialists located in each facility. This group works with the Company's stylists and its customers' stylists to produce new products for the marketplace. The Company uses on-line computer aided design systems to increase styling effectiveness.\nRaw Materials. The primary raw material for the Company's fabric manufacturing operations is cotton. In past years, U.S. cotton prices generally exceeded world price levels, which created a competitive disadvantage for U.S. textile manufacturers. Because the Company's customers compete with foreign producers, the Company cannot always pass through increased cotton costs to its customers. The Food, Agriculture, Conservation and Trade Act of 1990 and the regulations promulgated thereunder, which became effective in August 1991 and is scheduled to expire on July 31, 1996 unless extended, established trigger mechanisms to modify the prohibition on cotton imports that has been in effect since 1933 and to implement increased government supply targets. This has resulted in declines in U.S. cotton prices, which, together with certain price equalization payments authorized under this Act, have reduced the Company's effective cotton costs to world levels. While management believes that existing legislation and agricultural policies presently allow U.S. companies to acquire cotton at prices competitive with offshore manufacturers, there can be no assurance that these results will always occur.\nSince cotton is an agricultural product, its supply and quality are subject to the forces of nature. Although the Company has always been able to acquire sufficient supplies of cotton for its operations in the past, any shortage in the cotton supply by reason of weather, disease or other factors could adversely affect the Company's operations. In late 1993 and early 1994, as a result of less favorable supply and demand balance, primarily related to smaller world cotton crops in 1993, cotton prices began to rise throughout the world. See Item 7. \"Management's Discussion and Analysis of Results of Operations and Financial Condition.\" In order to assure a continuous supply of cotton, the Company enters into cotton purchase contracts for several months in advance of delivery. Since prices for such purchases are sometimes fixed in advance of shipment, the Company may benefit from its investments in cotton if prices thereafter rise, or suffer losses if prices subsequently fall.\nFORM 10-K Page 10\nItem 1. Business (continued)\nCone also purchases \"greige goods\" (fabrics that have not been dyed or finished), synthetic fibers and dyes and chemicals. These raw materials have normally been available in adequate supplies through a number of suppliers.\nCompetition. The apparel textile business is highly competitive. No single company dominates the industry and domestic and foreign competitors range from large, integrated enterprises to small niche concerns. There are nine major denim manufacturers in the United States, of which Cone is the largest. Foreign competition in domestic markets is principally in the form of imported garments. Primary competitive factors include price, product styling and differentiation, customer service, quality and flexibility, with the significance of each factor dependent upon the particular needs of the customer and the product involved. Increased competition in the form of imported apparel, more aggressive pricing from domestic companies and the proliferation of newly styled fabrics competing for fashion acceptance have been factors affecting the Company's business environment.\nThe level of import protection in the U.S. for domestic producers of textiles is subject to both domestic political and foreign policy considerations. Proposed rules under GATT would eliminate quota restrictions on imports of textile and apparel after a ten-year transition period. Any significant reduction in import protection for domestic textile manufacturers could adversely affect the Company.\nThe ratification of NAFTA by Canada, Mexico and the U.S. in 1993 has created the world's largest free-trade zone. In its present form, the agreement contains safeguards which were sought by the U.S. textile industry, including a rule of origin requirement that products be processed in one of the three countries in order to benefit from NAFTA. The Company believes that the removal of tariffs on denim and denim jeans in the participating countries and improved access to Mexico's consumer markets are opportunities for growth. However, there can be no assurance that NAFTA will not adversely affect the Company.\nThe Company's domestic strategy is to compete primarily on the basis of quality, styling and service. The Company believes that the historically high quality of its products and manufacturing processes has created a competitive advantage, which it has enhanced by the extensive use of statistical quality control and investment in modern equipment, including manufacturing process controls. The Company also believes\nFORM 10-K Page 11\nItem 1. Business (continued)\nthat its experienced stylists and product development specialists, its use of computer-aided design systems and its manufacturing versatility have created a competitive advantage in styling.\nThe Company's emphasis on customer service is supported by its just-in-time and quick response programs and by electronic data interchange (EDI) with customers.\nThe Company has focused its operations on the manufacture of fabrics for use in garments that are less vulnerable to import penetration. The relatively low labor content of these fabrics and garments, coupled with high levels of demand for quality, styling and service, present barriers to foreign competition. The location of the Company's manufacturing facilities in the U.S. and its emphasis on shortening production and delivery times allow the Company to respond more quickly than foreign producers to changing fashion trends and to its domestic customers' demands for precise production schedules and rapid delivery.\nThe Company believes it effectively competes in foreign markets through export sales. See \"Business - International Operations\".\nSeasonality. Demand for the Company's apparel products and the level of the Company's sales fluctuate moderately during the year. Generally, there is increased consumer demand for garments made of denim and the Company's specialty apparel fabrics during the fall (back-to-school) and Christmas holiday selling seasons. As a result, demand for the Company's apparel fabrics is generally higher during the first half of the calendar year when apparel manufacturers are producing for these selling seasons.\nHome Furnishings Products\nTextile Fabrics. Carlisle Finishing Company is the largest U.S. commission printer of fabrics for decorative upholstery, drapery and other home furnishings applications. As a commission printer, Carlisle prints fabrics owned by customers on a fee basis. Customers for Carlisle's printing services include Waverly Division of F. Schumacher & Co., Ametex, P. Kaufman, Anju\/Woodridge, Covington, Richloom, and Universal.\nFORM 10-K Page 12\nItem 1. Business (continued)\nThe home furnishings fabrics processed at Carlisle are generally used for upper-end upholstery and drapery prints. The Carlisle plant is a modern, one-million square foot facility specializing in rotary screen printing. In recent years, the Company has invested heavily in computerized color- mixing systems and automated process controls in order to support its competitive strategy of focusing on quality and service. Carlisle has completed its planned screen printing building addition and in the first quarter of 1993 added the third of five planned new screen printing machines. Through this expansion Carlisle increased its home furnishings print capacity by approximately 35%.\nCarlisle marketing headquarters are located in New York City. Marketing efforts of the New York sales staff are augmented by close working relationships between Carlisle's production and technical staff and customers' designers and stylists. Carlisle also maintains a customer service center that utilizes electronic data interchange (EDI) with major customers.\nJohn Wolf Decorative Fabrics is a major \"converter\" of printed and solid woven fabrics for upholstery, draperies and bedspreads. A converter designs and markets fabrics, which are manufactured and printed for the converter by others. John Wolf's lines are printed primarily at the Carlisle plant.\nJohn Wolf's fabrics are marketed domestically and internationally through the division's sales staff and sales agents. The division's sales staff handles sales to large customers such as hotels, institutions and furniture manufacturers, as well as \"jobbers\", who resell to decorators, fabric retailers and certain smaller quantity users. International sales and sales to other smaller customers are made primarily through agents.\nCarlisle competes primarily with two large commission printers, the Cherokee division of Spartan Mills and Santee Print Works. John Wolf competes with a large number of domestic and foreign suppliers of decorative fabrics. Both Carlisle and John Wolf compete primarily on the basis of quality and service.\nFoam Products. Olympic Products Company is a supplier of polyurethane foam and related products, primarily to the home furnishings industry. Olympic's polyurethane foams are used in upholstered furniture, mattresses, carpet padding and specialty patient care applications. Related products and\nFORM 10-K Page 13\nItem 1. Business (continued)\nservices include nonwoven fiber batting, specialty fabricated cushions marketed under the Prelude brand, quilting services and distribution of other furniture components. Olympic supplies foam to the automotive market, for use in interior headliners and side panels, which has become the fastest growing portion of its business.\nOlympic markets its products through its own sales force. Customers include Bench Craft, Span America, Henredon, Collins & Aikman, Guilford Mills, Drexel Heritage, Bassett, Bio Clinic and Milliken.\nOlympic has four manufacturing facilities, which are located in the two largest upholstered furniture manufacturing areas in the U.S. Three of these facilities are located near High Point, North Carolina, and one is located in Tupelo, Mississippi.\nCompetition in the foam products market generally occurs on a regional basis as a result of high shipping costs relative to price associated with these products. Olympic competes with several larger and numerous small competitors in its foam products markets. Olympic's strategy is to compete on the basis of quality and service and, to this end, it has adopted statistical process quality control techniques and installed a computerized customer service system.\nRaw materials, which are a significant portion of Olympic's costs, consist primarily of chemicals, dyes and synthetic fibers. Adequate supplies at competitive costs are generally available from a number of large suppliers.\nReal Estate Activities. The Company owns more than 1,000 acres of real estate in the Greensboro area that were purchased originally to support the Company's manufacturing operations. The Company has determined that the land is no longer needed for this purpose, and has adopted a strategy to maximize the value of its real estate holdings through the systematic development and orderly liquidation of this property, much of which is considered prime residential real estate. These activities are conducted through a wholly owned subsidiary, Cornwallis Development Company. Cornwallis' activities include residential and commercial lot development and construction, primarily in the upper-end real estate market. Net sales from real estate activities generally account for less than two percent of the Company's total net revenues and these activities have been profitable.\nFORM 10-K Page 14\nItem 1. Business (continued)\nInternational Operations\nThe Company began development of its international distribution network almost 40 years ago in response to the post World War II growth in the popularity of jeans around the world. Approximately 30% of the Company's current denim production is exported. Historically, the Company's export sales have been primarily to Europe; however, the fastest growing areas of the Company's international sales are now its non-European markets. The Company has sales agents in Europe, Japan, Korea, Hong Kong, Africa, and throughout Central and South America, and it maintains extensive support services in trade financing, traffic and transportation in order to support its international presence. The Company's strategy is to service its international customers with the same degree of commitment to quality, service and fabric development as its domestic customers, and the Company believes this philosophy is responsible for Cone's position as the dominant U.S. exporter of denims. The Company's international customers include: Levi International, Super Rifle, Giorgio Armani and Benetton in Europe; C. Itoh and Shinpo in Japan; licensees for Guess, Calvin Klein and Wrangler in Korea; Aca Joe in Mexico; Ellus and Wrangler in South America.\nPrincipal competitive factors in the international markets for denims are quality, price and styling. The Company believes it has competitive advantages in quality over foreign manufacturers resulting primarily from its denim manufacturing experience and the versatility of its manufacturing facilities. The Company also believes that it is a cost- effective producer in comparison with its foreign competitors, primarily because of the economies of scale resulting from the size of the Company's operations and the low labor content of denim. In addition, denim jeans have an image of being uniquely American products, which complements the Company's strategy of serving the upper-end \"genuine\" jeans market.\nIn 1993 the Company purchased 20% of the voting common stock of Compania Industrial de Parras, S.A. (\"CIPSA\"), and entered into certain commercial marketing agreements as well. The Company also entered into a 50\/50 joint venture arrangement with CIPSA to build and operate a new world class denim manufacturing plant in Mexico. The Company believes that these actions will better position Cone to serve the growing Latin America markets.\nJohn Wolf exports approximately one-sixth of its sales volume. Styling and service are the principal competitive factors affecting John Wolf's position in these markets. The Company\nFORM 10-K Page 15\nItem 1. Business (continued)\nbelieves that there is a growing international preference for U.S. styling and design. This styling and the Company's technical printing expertise are not easily duplicated by foreign competitors and have given John Wolf's products a competitive advantage in international markets.\nTrademarks and Patents\nThe Company owns a registered trademark containing the \"Cone\" name and pine cone design, which it uses as its primary trademark. In addition, the Company holds various other trademarks and tradenames used in connection with its business and products, both domestically and internationally. However, because the Company's business is not dependent upon any trademark or tradename, the loss of any trademark or tradename now held by the Company would not have a material adverse effect upon its business or results of operations.\nCustomers\nThe Company has one unaffiliated customer, Levi Strauss (\"Levi\"), which accounts for more than 10% of consolidated sales. Sales to this customer amounted to 35.3%, 37.9%, and 38.5% of sales from continuing operations in 1993, 1992,and 1991, respectively.\nLevi has been a customer of the Company for more than 75 years and a close, cooperative supplier\/customer relationship has evolved through the development of the Company's proprietary fabrics for use in Levi's 501 family of jeans. In addition to supplying fabrics for Levi's 501 family of jeans, the Company is increasing its sales of other denim fabrics to Levi. Because the Company is Levi's major supplier, Levi initiated discussions with the Company in 1989 concerning ways to assure the continuity of this relationship. As a result of these discussions, Cone and Levi entered into an exclusive Supply Agreement as of March 30, 1992, which confirms that Levi will continue to use only Cone's proprietary denim fabrics in manufacturing Levi's 501 family of jeans, and that Cone will continue to supply such fabrics solely to Levi. The volume of purchases by Levi and the prices charged by Cone will continue to be subject to customary negotiations between the parties.\nIn addition to formalizing the exclusive relationship between the Company and Levi relating to the denim fabrics used in Levi 501 jeans, the Supply Agreement assures Levi of a source of such fabrics in the event that a change in control of the\nFORM 10-K Page 16\nItem 1. Business (continued)\nCompany adversely affects the long-standing working relationship between Levi and the Company. The Supply Agreement provides that, upon a change in control of the Company and at Levi's election, Cone will enter into a three- year supply arrangement with Levi pursuant to which Cone will make available to Levi up to 30 million yards per fiscal quarter of its proprietary denim fabrics used in Levi's 501 family of jeans, and, so long as Levi purchases at least 10 million yards per fiscal quarter, Cone will sell these fabrics exclusively to Levi. If the change in control provision becomes operative, the price for the fabric will be derived from a formula based upon prevailing denim market prices, adjusted to reflect the average differential between the price for the Company's proprietary denim and the market price of certain other denims in the market over the preceding 16 fiscal quarters, plus an additional 1.5% of the total price paid during any quarter for which purchases by Levi are less than 15 million yards. Although the Company believes that the formula price will not materially vary from the price at which the Company could have otherwise sold its proprietary denims, there is no assurance that the formula price will reflect then-current market prices for such denims.\nFor purposes of the Supply Agreement, a \"change in control\" is deemed to occur upon a change in a majority of the directors of the Company excluding persons nominated by the current Board of Directors, or a merger, consolidation or other transaction pursuant to which a third party obtains 50% or more of the Company's outstanding voting shares. In the event of a change in control followed by the Company's failure to supply fabric to Levi in accordance with the three-year supply arrangement, Levi will have the option to lease from Cone its White Oak denim manufacturing plant, which is the Company's largest denim facility, for a period not to exceed four years from the time Levi receives notice that a change of control occurred. The annual rents under such lease would be an amount equal to 115% of Cone's average operating profit on the plant for the immediately preceding three fiscal years.\nThe Supply Agreement expires on March 30, 1998 and is automatically extended on each March 30, for an additional year unless either party gives notice otherwise. Following a change in control, the Supply Agreement would terminate at the end of the three-year supply arrangement or of the lease term, as the case may be. Additionally, Levi may terminate the Supply Agreement upon 30 days' written notice and either party may terminate the Supply Agreement in the event of the other party's insolvency, bankruptcy or occurrence of a similar event.\nFORM 10-K Page 17\nItem 1. Business (continued)\nOther than Levi, no single customer accounted for more than 10% of the Company's net sales in 1993, 1992, and 1991.\nBacklog\nThe Company's apparel and home furnishings order backlog was approximately $163 million, or 53 million yards, at January 2, 1994, as compared to approximately $170 million or 55 million yards at January 3, 1993. Physical deliveries for booked fabric orders in the apparel industry vary in that some products are ordered for immediate delivery only while others are ordered for delivery several months in the future; therefore, orders on hand are not necessarily indicative of total future revenues. It is expected that substantially all of the orders outstanding at January 2, 1994 will be filled within the next 90 days.\nResearch and Development\nThe research and development activities of the Company are directed primarily toward improving the quality, style and performance of its apparel fabrics and other products and services. The Company also is engaged in the development of computer-aided design and manufacturing systems and other methods of improving the interaction between the Company's stylists and its customers. These activities are conducted at various facilities and expenses related to these activities are an immaterial portion of the Company's overall operating costs.\nGovernmental Regulation\nFederal, state and local regulations relating to the work place and the discharge of materials into the environment are continually changing; therefore, it is difficult to gauge the total future impact of such regulations on the Company. However, existing government regulations are not expected to have a material effect on the Company's financial position, operating results or planned capital expenditures. The Company currently has an active Environmental Protection Committee and an active work place safety organization.\nDiscontinued Operations\nAt the end of 1991, the Company determined that continuation of its corduroy and other bottomweight continuous piece-dyed fabrics product line was no longer economically justifiable due to substantial declines in demand and downward pressures on prices and margins caused by imported garments and to the\nFORM 10-K Page 18\nItem 1. Business (continued)\nconfiguration of its fabric finishing plant, which became inefficient due to product mix changes. As a result, the Company implemented a plan to discontinue and dispose of these operations. The Company experienced after-tax operating losses of $17.1 million in 1991 from its discontinued product lines and provided for estimated after-tax costs of $17.9 million in its 1991 Consolidated Financial Statements for expected future operating losses and losses associated with disposal of these operations. The discontinuance of these operations will be completed in first quarter 1994. See Note 18 of Notes to Consolidated Financial Statements. Losses from discontinued operations for 1993 and 1992 were consistent with management's assumptions in formulating the provision. Accordingly, no gain or loss has been recognized on discontinued operations in the 1993 and 1992 Consolidated Financial Statements. Management does not expect to incur any additional loss in 1994 as the discontinuance is completed.\nEmployees\nAt January 31, 1994, the Company employed approximately 7,900 persons, of whom approximately 1,500 were salaried and approximately 6,400 were hourly employees. Of such hourly employees, approximately 2,400 are represented by collective bargaining units and are employed under collective bargaining agreements that provide for annual wage negotiations in the spring of each year. The Company has not suffered any major disruptions in its operations due to strikes or similar events for more than a decade.\nFORM 10-K Page 19\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Property\nThe Company operates 11 manufacturing plants - nine in North Carolina and one each in South Carolina and Mississippi. There are six apparel and five home furnishings plants. The Company also operates several distribution centers and warehouses. All significant manufacturing facilities are held in fee and are substantially free of any significant liens or other encumbrances. The Company's manufacturing facilities total approximately five million square feet of floor space, with buildings generally constructed of brick, steel, concrete or concrete block. All such facilities are maintained in good condition and are suitable for their respective purposes. Although such facilities are substantially fully utilized, the Company believes that it is in a position to respond to opportunities to produce additional higher margin fabrics through changes in product mix and through acquisition of greige goods from outside sources for further processing and finishing by the Company. The Company also has an ongoing capital expenditure program that will increase its production capacity. See \"Item 7. Management's Discussion and Analysis of Results of Operations and Financial Condition\". The Company owns an office building in Greensboro where its executive and administrative offices are located. All of the Company's sales offices are leased from unrelated parties.\nItem 3.","section_3":"Item 3. Legal Proceedings\nIn November 1988, William J. Elmore and Wayne Comer (the \"Plaintiffs\"), former employees of the Company, instituted a class action suit against the Company and Wachovia Bank & Trust Company, N.A. (\"Wachovia\") and certain current and former employees of the Company and Wachovia. The suit was brought on behalf of salaried employees of the Company who were participants in certain Company retirement plans. The Plaintiffs asserted a variety of claims related to actions taken and statements made concerning certain employee benefit plans maintained by the Company. In May 1990, the United States District Court in Greenville, South Carolina, certified a plaintiff class of salaried employees. In August 1990, the District Court granted partial summary judgment in favor of the defendants and significantly narrowed the extent of the Plaintiffs' claims. A trial was held in February 1991, and supplemental proceedings were held on July 24, 1991. At the trial, a witness hired by the Plaintiffs estimated the alleged loss to the Plaintiff class to range from approximately $34 million to approximately $94 million.\nFORM 10-K Page 20\nItem 3. (continued)\nOn March 20, 1992, the District Court entered a judgment finding that the Company had promised to contribute certain surplus funds (or their equivalent in Company stock) relating to the overfunding of the Company's pension plans to the 1983 ESOP by December 23, 1985, that such surplus amounted to $69 million, that the Company's actual contribution totaled approximately $55 million, and that the Company and its Chairman, Dewey L. Trogdon, and its Secretary, Lacy G. Baynes, therefore had breached their fiduciary duties under the Employee Retirement Income Security Act of 1974 (\"ERISA\") to certain participants in the 1983 ESOP. The District Court ordered the Company to pay to the 1983 ESOP for the benefit of plan participants, both salaried and hourly, the sum of $14.2 million in cash or the equivalent in Company stock. In addition, the District Court awarded $3.5 million in attorneys' fees to the Plaintiffs, $2.2 million of which is to be paid from the sum awarded to the 1983 ESOP. Judgment was entered in favor of the defendants on all remaining claims except for claims relating to the ESOP contribution. In accordance with and to the extent permitted by the Company's Articles of Incorporation and Bylaws, the two individual defendants in this litigation are indemnified by the Company for any costs incurred by them in connection with this matter.\nOn March 20, 1992, the Company and the individual defendants appealed the District Court's judgment against them to the United States Court of Appeals for the Fourth Circuit. On April 2, 1992, the Plaintiffs appealed the District Court's judgment to the Court of Appeals insofar as it dismissed certain of their claims. To secure the judgment on appeal, the Company has deposited in escrow with the trustee of the 1983 ESOP an $8 million letter of credit and 75,330 shares of Class A Preferred Stock valued at $7.5 million which has subsequently earned dividends of an additional 5,795 shares valued at $.6 million.\nOn September 22, 1993 a three-judge panel of the United States Court of Appeals for the Fourth Circuit in a two-to-one decision reversed the District Court's decision as to the obligation to contribute additional funds to the 1983 ESOP and affirmed the District Court's dismissal of all remaining claims against the Company and the individual defendants. On October 4, 1993, Plaintiffs petitioned the fourth Circuit for rehearing, with a suggestion for rehearing en banc , and on October 29, 1993 the United States Department of Labor filed a brief in support of Plaintiffs' petition for rehearing. Plaintiffs' petition for rehearing en banc was granted on December 13, 1993, and, consequently, the panel opinion was vacated. Briefs were filed by the Plaintiffs, Department of Labor, and the Company, and an en banc oral argument was heard\nFORM 10-K Page 21\nItem 3. (continued)\nby the Court of Appeals on March 8, 1994. The Company is awaiting a decision. An attorney for the Plaintiffs has contended that, if Plaintiffs prevail on appeal, the judgment could exceed $50 million based on the existing judgment and additional claims relating to alleged unjust enrichment and alleged overvaluation of the Class A Preferred Stock initially contributed to the 1983 ESOP, as well as prejudgment interest.\nThe Company has received an opinion from its lead counsel on appeal, Robinson, Bradshaw & Hinson, P.A., a Charlotte, North Carolina firm, that, while it is not possible to predict the outcome of this lawsuit with certainty, in the opinion of such firm the District Court's decision in Plaintiffs' favor is erroneous and is more likely than not to be reversed or substantially modified by the Court sitting en banc and the dismissal of Plaintiffs' claims was proper and is more likely than not to be affirmed by the en banc Court. However, the Company has been advised by such counsel that an appellate court which votes to rehear a case en banc often reaches a result different from the panel originally designated to hear the appeal, and further, that ERISA law is rapidly changing and decisional law on many ERISA issues is neither unanimous nor fully developed. Because of the foregoing and the uncertainties inherent in the litigation process, there can be no assurance as to the ultimate resolution of this lawsuit. An unfavorable result could have a material adverse effect on the Company's results of operations and, if Plaintiffs' judgment (including the attorneys' fees award) is affirmed on appeal, the Company's management estimates that income, net of taxes, would be reduced by approximately $10 million. It is the opinion of the Company's management that this lawsuit, when finally concluded, will not have a material adverse effect on the Company's financial condition.\nThe Company is a party to various other legal claims and actions incidental to its business. Management believes that none of these claims or actions, either individually or in the aggregate, will have a material adverse effect on the financial condition of the Company.\nFORM 10-K Page 22\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNot applicable.\nItem 4A. Executive Officers of the Registrant.\nAll officers of the Registrant are elected or reelected each year at the Annual Meeting of the Board of Directors or at other times as necessary. All officers serve at the pleasure of the Board of Directors and until their successors are elected and qualified.\nJ. Patrick Danahy joined the Company in 1971; he was named General Manager of the Carlisle Plant in 1978 and President of the Cone Finishing Division in September 1984. He was elected corporate Vice President in May 1986 and director in May 1989. He was named President and Chief Operating Officer in August 1989 and President and Chief Executive Officer in August 1990.\nFORM 10-K Page 23\nItem 4A. (continued)\nJohn L. Bakane joined the Company in 1975 and has served in various administrative and staff positions involving planning, financial management and customer service. He was named corporate Vice President in May 1986, became Chief Financial Officer in November 1988 and was elected to the Board of Directors in May 1989.\nRichard S. Vetack was employed by Otto B. May Co., a former subsidiary of the Company, until 1980. He joined the Company in March 1983 and has served in various management positions in the Textile Products Division. He was elected Vice President of the Company in 1985 and Senior Vice President in May 1987. He was elected to the Board of Directors in May 1988.\nBud W. Willis III was employed by the Company in August 1970 and has served in various management positions in the Textile Products Division. In March 1985 he was named Executive Vice President of the Textile Products Division and in December 1985 was elected corporate Vice President. He was elected to the Board of Directors in May 1988. Since July 1992 he has been the President of the Denim Division of the Textile Products Division.\nJames S. Butner was employed by Celanese Corporation, a synthetic fibers and chemical company, from 1979 to 1984, at which time he became Director of Industrial and Public Relations for the Company. Effective August 1, 1988, he was named corporate Vice President for Industrial and Public Relations.\nNeil W. Koonce was employed by the Company in January 1974 as a staff attorney. He was elected Assistant General Counsel in 1985, General Counsel in August 1987 and Vice President in May 1989.\nLester J. Smith was named Vice President of the Company in August 1978, and has executive responsibility for purchasing, including cotton and synthetic fiber procurement.\nEugene A. Trout was employed by the Company in 1971, and was appointed Vice President of Cone Mills Marketing Co., a division of the Company, in 1980. He was elected Vice President of the Company in December 1985 and also serves as Group Executive Vice President of the Textile Products Division.\nDavid E. Bray was employed in 1977 as Director of Treasury Services. He was elected Assistant Treasurer of the Company in May 1984 and Treasurer in November 1988.\nFORM 10-K Page 24\nItem 4A. (continued)\nJ. D. Holder was employed by the Company in 1954 as a Cost Accountant. He became Manager of the corporate Cost Department in April 1970 and was elected Assistant Controller in 1984. He was named Controller of the Company in August 1987.\nTerry L. Weatherford was Secretary and General Counsel of Blue Bell, Inc., a manufacturer and distributor of wearing apparel, from 1981 to 1987. From 1987 to 1993, he was self- employed as an attorney except for a thirteen month period from June 1988 when he was employed by Manufactured Homes, Inc. as its General Counsel. He was employed by the Company and elected Assistant Secretary in May 1993, and effective December 1993, was elected Secretary.\nFORM 10-K Page 25\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe Company's Common Stock has traded on the New York Stock Exchange under the ticker symbol \"COE\" since June 18, 1992, the date of its public offering. The following table sets forth the high and low sales prices of the Common Stock as reported on the NYSE Composite Tape for the periods indicated.\nThe Company has not declared any dividends on its Common Stock since it became a privately held company in 1984 and anticipates that its earnings for the foreseeable future will be retained for use in its business and to finance growth. Payment of cash dividends in the future will depend upon the Company's financial condition, results of operations, current and anticipated capital requirements, and other factors deemed relevant by the Company's Board of Directors. See Item 7. \"Management's Discussion and Analysis of Results of Operations and Financial Condition\".\nThe approximate number of holders of record of the Company's Common Stock as of March 1, 1994 was 574.\nFORM 10-K Page 26\nItem 6.","section_6":"Item 6. Selected Financial Data\nFORM 10-K Page 27\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nOverview\nThe operating results and financial condition of Cone Mills have been influenced by a number of external factors and company initiatives. The principal influences have been domestic cotton costs, the general business cycle, apparel and fabric imports, and strategic changes in the Company's business and capital structure.\nCotton Costs. Management believes that the most significant factor affecting operating margins has been the price of cotton, the Company's principal raw material. Prices and supply of domestically grown cotton are influenced by U.S. agricultural policy and U.S. companies are generally prohibited by law from importing cotton. Historically, the risk in operating under these cotton market regulations has been that U.S. cotton prices could exceed world price levels, and U.S. companies could, therefore, experience both eroding competitiveness and margins unlike foreign competitors who have access to lower-priced cotton. In 1990 through mid-1991, domestic cotton prices generally exceeded world prices, which contributed to substantial reductions in the Company's operating margins. Provisions under the Food, Agriculture, Conservation and Trade Act of 1990, which became effective in August 1991, resulted in the reduction of the Company's effective cotton costs to world levels.\nCotton prices fluctuate with the balance of supply and demand and, since cotton is an agricultural product its supply and quality are subject to the forces of nature. World cotton prices began to rise in late 1993 and early 1994 as a result of a less favorable balance between supply and demand, primarily related to a smaller world cotton crop in 1993. See \"Financial Outlook and Strategy.\"\nGeneral Business Cycle. The Company's operating results are closely related to the general business cycle of the U.S. economy. In this regard, Cone Mills experienced an unfavorable cyclical economic retrenchment from late 1989 through mid- 1991. Management believes the U.S. economy is currently in a more mature phase of the economic cycle where typically, the demand for home furnishings and consumer durables grows at a higher rate than demand for apparel products which is usually strongest in the earlier phases of a recovery. While demand for denim apparel remains strong at retail, there presently exists an excess of denim inventories in the softgoods pipeline, which suppliers are in process of adjusting.\nFORM 10-K Page 28\nItem 7. (continued)\nThese trends are reflected in the Company's recent quarterly net sales (which are also generally affected by mild seasonal sales declines in the second half of the year). All quarters had 13 weeks except the fourth quarter of 1992 which had 14 weeks.\nImports. The Company's operating results have been influenced by U.S. trade policy, which has allowed gains in market share by foreign-produced, labor-intensive garments over the past decade. This has caused U.S. manufacturers of fabrics used in these labor-intensive garments to have excess capacity, which has resulted in increased competition and reduced margins for U.S. manufacturers of commodity-type goods. In response to this environment, the Company has focused on high-margin and low-labor content businesses in which it believes it is internationally competitive. In addition, the Company believes that the recent passage of the North American Free Trade Agreement (NAFTA) will strengthen garment manufacturing in this hemisphere and generate additional opportunities for Cone Mills.\nStrategic Initiatives. Over the past decade, the Company has been in the process of curtailing its production of low-margin commodity-type products and terminating or disposing of unprofitable operations. In 1991, the Company decided to discontinue its corduroy and other bottomweight continuous piece-dyed fabrics product line as a result of ongoing losses. Estimated costs of this discontinuance were provided for in the Company's 1991 consolidated financial statements. See Note 18 of Notes to Consolidated Financial Statements for a discussion of the financial impact of these actions. Cone Mills will complete the liquidation of its corduroy and other bottomweight continuous piece-dyed fabrics product line in the first quarter of 1994. Actual losses in 1992 and 1993 have been consistent with the original estimate. No additional loss in 1994 is expected as the discontinuance is completed.\nFORM 10-K Page 29\nItem 7. (continued)\nManagement believes that ongoing businesses are interna- tionally competitive and that the restructuring is now substantially complete.\nIn 1992, Cone Mills undertook several initiatives to strengthen its financial position, improve its financial flexibility and increase its ability to raise capital. Cone Mills consummated a public offering of its Common Stock in mid-1992 and received $63.6 million in net proceeds, which were used to repay $42.1 million of long-term debt and redeem $21.5 million of Class A Preferred Stock (including payment of dividend obligations on shares redeemed). Following the consummation of the offering, the Company replaced the existing credit agreement with a $75 million term loan, a $40 million receivables purchase agreement and a $60 million bank revolving credit facility. See \"Liquidity and Capital Resources.\"\nIn 1993, Cone Mills used its strengthened financial resources to fund a $38.7 million capital spending program which included the expansion of denim and home furnishings capacities. In addition, the Company purchased a 20% equity ownership in CIPSA, the largest denim manufacturer in Mexico and began the construction of a new joint venture denim plant in Mexico with CIPSA as its partner. See \"Liquidity and Capital Resources.\"\nSegment Information. Cone Mills operates in two principal business segments, apparel fabrics and home furnishings products. The following table sets forth certain net sales and operating income information (excluding restructuring and general corporate expenses) regarding these segments for 1993, 1992 and 1991.\n(1) Fiscal years 1993 and 1991 contained 52 weeks, and 1992 contained 53 weeks. (2) Percentages reflect operating income as a percentage of segment net sales.\nFORM 10-K Page 30\nItem 7. (continued)\nFifty-two Weeks Ended January 2, 1994 Compared with Fifty- three Weeks Ended January 3, 1993\nFollowing a U.S. cyclical recovery from mid-1991 through the end of 1992, the rate of growth in the domestic softgoods sector began to decline and retailers and softgoods manufacturers began to report mixed results during 1993. Despite these general economic conditions, Cone Mills had record sales and income from continuing operations in 1993. In the apparel segment, sales were up substantially, primarily as a result of growth in denims and flannel shirtings. The Company believes that the strength of these products is largely a result of favorable perception of value by consumers and retailers who are seeking fashion and durability at affordable price points. The Company also benefited from expanding apparel export sales. Home Furnishings segment sales increased because of sales growth at Carlisle Finishing, arising primarily from market share gains, and the Company's real estate division, Cornwallis Development Co.\nNet sales for 1993 were $769.2 million, an increase of $63.8 million, or 9.0% from 1992 net sales of $705.4 million. Gross profit (net sales less cost of sales and depreciation) as a percentage of net sales was 20.7% for both 1993 and 1992. Income from operations increased 9.0% to $85.6 million for 1993. The Company's 1993 net income was $49.6 million, or $1.68 per share, of Common Stock after preferred dividends. Net income for 1993 included $2.4 million of increased taxes resulting from the 1993 change in federal tax rates. The per- share impact of those increased taxes was $.09.\nFor comparison, Cone Mills reported net income of $43.4 million or $1.59 per share for 1992, which included an after tax benefit of $2.2 million related to an income tax refund, a $2.0 million extraordinary expense related to the early extinguishment of debt, and for the first six months of 1992, outstanding shares did not include 6.9 million shares issued in the Company's mid-1992 initial public offering. On a pro- forma basis, adjusted for calculating the per share earnings as if the sale of the new stock in the Company's mid-year public offering and the application of the net proceeds had occurred at the beginning of the year, the Company's net income would have been $1.47 per share for 1992. See Pro Forma Condensed Consolidated Statement of Operations on Page 71a.\nApparel Fabrics. Apparel fabrics segment net sales were $575.8 million for 1993, an increase of 10.7% from 1992. The improved sales resulted from increases in sales\nFORM 10-K Page 31\nItem 7. (continued)\nvolume and, to a lesser extent, higher prices. Average prices adjusted for product mix changes were up approximately three percent.\nApparel export sales for 1993 were up 18.7% to $124.9 million, as compared with $105.2 million for 1992.\nOperating margins for the apparel fabrics segment were 12.0% of net sales for 1993 as compared with 13.0% for 1992. Margins as a percent of sales were down slightly as a result of a shift in mix to lower margin specialty sportswear fabrics and, to a lesser extent, increased depreciation expense. Average cotton costs were up by approximately two percent for 1993 as compared with 1992.\nHome Furnishings. For 1993, net sales of $193.4 million for the home furnishings segment increased $8.0 million, or 4.3.%, and operating income increased $3.2 million, or 19.3% , compared with 1992. All product groups of the home furnishings segment had higher sales in 1993.\nExport sales of home furnishings products were $7.1 million in 1993 compared with $8.6 million in 1992. These export sales were impacted by poor economic conditions in European and Japanese markets.\nIn 1993, operating margins for the home furnishings segment improved to 10.1% of net sales compared with 8.8% for 1992. The increase was primarily the result of improved operating performance at Olympic Products and higher sales and improved sales mix of real estate operations.\nTotal Company selling and administrative expenses increased from $67.6 million, or 9.6% of sales, for 1992 to $73.3 million, 9.5% of sales, for 1993. The increase in expenses was primarily the result of the redeployment of people previously charged to discontinued lines to support expanding sportswear and denim businesses, increases in salaries and benefits costs and, to a lesser extent, expenses associated with the secondary offering in early 1993 of common stock held by certain institutional shareholders of the Company.\nInterest expense for 1993 decreased $4.0 million as compared with 1992 because of reduced borrowing levels and, to a lesser extent, lower interest rates. For 1993 interest income was $2.1 million lower than 1992 levels because of the interest associated with an income tax refund in the first quarter of 1992. Other income in 1993 of $.3 million represented the income from the Company's 20% investment in CIPSA.\nFORM 10-K Page 32\nItem 7. (continued)\nIncome taxes as a percent of taxable income were 37.6% in 1993 compared with 35.3% in 1992. The effective tax rate for 1993 was higher than the previous year primarily because of the 1993 increase in federal statutory tax rates. Both periods reflect tax benefits resulting from operations of the Company's foreign sales corporation.\nFifty-three Weeks Ended January 3, 1993 Compared with Fifty- two Weeks Ended December 29, 1991\nCone experienced more favorable market conditions in 1992 compared with 1991 as the industry continued to recover from the severe U.S. economic cyclical downturn of 1989 through early 1991. The Company realized improved volume, prices and operating results because of this cyclical rebound.\nNet sales for the fifty-three week fiscal year of 1992 were $705.4 million, an increase of $72.5 million or 11.4% from net sales of $633.0 million for the fifty-two week fiscal year of 1991. Operating income for 1992 of $78.5 million and income from continuing operations before extraordinary expense of $45.4 million, or $1.67 per share of Common Stock after preferred dividends, compares favorably with operating income of $34.8 million and income from continuing operations of $10.1 million, or $.22 per common share after preferred dividends for the 1991 period. Gross profit (net sales less cost of sales and depreciation) as a percent of sales was 20.7% for 1992 compared with 14.6% for 1991.\nIncome before extraordinary expense for 1992 was $45.4 million compared with a net loss of $24.8 million for 1991. Net income for 1992, after extraordinary expense, was $43.4 million or $1.59 per share of Common Stock after preferred dividends, and includes an income tax refund and related interest income, received in the first quarter, which together amounted to $.09 per share. The Company recognized an extraordinary expense of $2.0 million in 1992 as a result of the early termination of the existing credit agreement. The 1991 net loss was primarily the result of a $35.0 million after-tax loss associated with the Company's discontinued corduroy and bottomweight continuous piece-dyed fabrics product line.\nApparel Fabrics. Apparel fabrics net sales were $520.0 million for the fifty-three week year of 1992, an increase of 13.5% from 1991. The improved sales resulted from increases in sales volume, primarily basic denims and shirtings, of approximately nine percent and increases in average prices, adjusted for product mix changes, of approximately six percent.\nFORM 10-K Page 33\nItem 7. (continued)\nExport sales for 1992 were $105.2 million, or 20.2% of total apparel fabrics sales, compared with $81.9 million, or 17.9% in 1991.\nOperating margins for the apparel fabrics segment were 13.0% of net sales in 1992 compared with 4.5% in 1991. The increase in margins as a percent of sales resulted from reduced cotton costs, increases in volume and selling prices, and higher operating efficiencies. This included more fully absorbed overhead costs because plants were running full schedules in 1992 compared with curtailed operating schedules in the first half of 1991. Average cotton prices declined by approximately twenty- four percent in 1992 as compared with 1991.\nHome Furnishings. Net sales for 1992 of the home furnishings segment increased $10.4 million, or 6.0%, while operating income was down 14.8% compared with 1991. The increase in net sales primarily resulted from increased sales by Carlisle Finishing and John Wolf Decorative Fabrics. Operating margins in 1992 were adversely affected by higher bad debt expense, a less profitable mix of fabrics sales, higher sample and product development expenses and costs associated with the expansion of the Carlisle plant.\nExport sales of home furnishings products were $8.6 million in 1992 as compared with $9.9 million in 1991, and consisted primarily of export sales by John Wolf Decorative Fabrics. Lower exports resulted primarily from weaker economic conditions in the Company's foreign markets for these products.\nSelling and administrative expense for 1992 was $67.6 million, an increase of $10.8 million from 1991, and primarily reflects higher salary and benefit costs, including incentive compensation associated with improved performance, the addition of an overseas marketing office and higher sample expense. Selling and administrative expenses represented 9.6% of 1992 net sales compared with 9.0% for 1991.\nNet interest expense of $8.3 million for 1992 was down $10.1 million or 54.8% from 1991 levels. The decrease represented lower borrowing levels as a result of the proceeds from the 1992 public offering, cash flow from operations, including the sale of accounts receivable, and the liquidation of working capital associated with discontinued product lines and, to a lesser extent, lower interest rates. Net interest expense for 1992 also included a $2.1 million increase in interest income\nFORM 10-K Page 34\nItem 7. (continued)\nprimarily resulting from interest associated with an income tax refund received in the first quarter of 1992.\nIncome taxes as a percent of income from continuing operations before income taxes were 35.3% in 1992 compared with 38.4% in 1991. The lower effective tax rate in the 1992 period primarily was caused by the first quarter 1992 tax refund, which related to a year in which statutory federal tax rates were higher than 1992 rates.\nEarnings per share comparisons for 1992 are affected by Cone's mid-year public offering of common stock, which increased outstanding shares by 6.9 million and, through use of the net proceeds of the offering, reduced debt and preferred stock outstanding and associated interest expense and preferred dividends. Adjusting as if the offering and the application of the net proceeds therefrom had occurred at the beginning of 1992, the Company's 1992 pro-forma earnings per share was $1.47 after extraordinary item and preferred dividends, which includes a pro forma amount of $.08 per share related to a nonrecurring tax refund and associated interest income in the first quarter of 1992. See Pro Forma Condensed Consolidated Statement of Operations on Page 71a.\nLiquidity and Capital Resources\nThe Company's principal long-term capital sources are a $75 million Note Agreement with The Prudential Insurance Company of America (the \"Term Loan\") and stockholders' equity. Primary sources of liquidity are internally generated funds, a $60 million Credit Agreement with Morgan Guaranty Trust Company of New York (\"Morgan Guaranty\") as Agent Bank (the \"Revolving Credit Facility\"), and a $40 million Receivables Purchase Agreement (the \"Receivables Purchase Agreement\") with Delaware Funding Corporation, an affiliate of Morgan Guaranty.\nDuring 1993, Cone Mills generated $57.2 million in funds from operating activities, including $70.6 million from net income adjusted for non-cash depreciation expenses, partially offset by increased working capital requirements, primarily resulting from reductions of accounts payable and accrued expenses. Major uses of cash during this period included $38.7 million for capital expenditures and $3.1 million for preferred stock dividends. For approximately $24 million, Cone Mills purchased 20% of CIPSA, the largest denim manufacturer in Mexico, and is in the beginning stages of building a joint venture denim plant with CIPSA. The investment in the joint venture was $2.3 million for 1993. Funding for these cash uses came primarily from operating cash flow and cash available at the beginning of the period.\nFORM 10-K Page 35\nItem 7. (continued)\nDuring 1992, Cone Mills generated $115.8 million in funds from operating activities, including $63.3 million from net income adjusted for non-cash depreciation expenses and additional funds resulting from working capital changes which included $24 million from the sale of accounts receivables. In addition, the Company raised $63.6 million in cash from the initial public offering and received $6.4 million in proceeds from the sale of property, plant and equipment primarily as a result of entering into an operating lease of $3.9 million on equipment which had been purchased in December 1991. Major uses of cash during this period included $25.4 million for capital investments, $28.5 million for redemption of preferred stock (including associated dividend obligations) and a net of $127.4 million of long-term and seasonal borrowing repayments.\nOn January 2, 1994, the long-term capital structure of Cone Mills consisted of $77.2 million of long-term debt, including the $75 million Term Loan, and $210.0 million of stockholders' equity. For comparison, at year-end 1992 the Company had $76.6 million of long-term debt and $163.4 million of stockholders' equity. Long-term debt as a percent of long-term debt and stockholders' equity was 27% on January 2, 1994, compared with 32% at year-end 1992.\nOn January 2, 1994, Cone Mills had ample liquidity, with only $.8 million of current maturities of long-term debt and $65.5 million of available liquidity including unused borrowing capacity and cash. The Company had sold $35 million of receivables under the Receivables Purchase Agreement.\nAccounts receivable on January 2, 1994, were $44.2 million, a decline of $13.2 million from January 3, 1993. At year-end 1993, the Company had sold $35 million of accounts receivable compared with $24 million at year-end 1992. In addition, the decrease in year-end 1993 balances was caused by certain customers paying in advance of due date. Receivables at year- end 1993, including those sold pursuant to the Receivables Purchase Agreement, represented 41 days of sales outstanding as compared with 47 days at year-end 1992.\nInventories on January 2, 1994, were $152.1 million, up 4.4% from year-end 1992. The increase resulted from higher greige and finished goods and real estate inventories.\nCapital spending in 1993 was $38.7 million and included an expansion of denim weaving capacity of approximately nine percent and the addition of another screen printing machine at the Carlisle plant. Capital expenditures for 1992 were $25.4 million.\nFORM 10-K Page 36\nItem 7. (continued)\nCapital spending in 1994 is expected to be $36 million and includes expansion and upgrading of yarn preparation facilities, new weaving machines, and a new fiber production line at Olympic Products. In addition, the Company expects to invest a total of approximately $25 million in the Mexican joint venture denim company through 1995. Approximately $5.1 million of the budgeted capital expenditures for 1994 had been committed at year-end 1993.\nFederal, state and local regulations relating to the workplace and the discharge of materials into the environment are continually changing; therefore, it is difficult to gauge the total future impact of such regulations on the Company. Existing government regulations are not expected to have a material effect on the Company's competitive position, operating results or planned capital expenditures. Cone Mills has an active environmental committee which fosters protection of the environment and compliance with laws.\nIn November 1988 certain former employees of the Company instituted a class action suit against the Company and certain other defendants in which the plaintiffs (\"Plaintiffs\") asserted a variety of claims related to the 1983 ESOP and certain other employee benefit plans maintained by the Company. In March 1992 a judgment in the amount of $15.5 million (including an attorneys' fees award) was entered against the Company with respect to an alleged promise to make additional company contributions to the 1983 ESOP and all claims unrelated to the alleged promise were dismissed. The Company, the individual defendants and the Plaintiffs appealed. On September 22, 1993, a three-judge panel of the United States Court of Appeals for the Fourth Circuit in a two-to-one decision reversed the District Court's decision as to the obligation to contribute additional funds to the 1983 ESOP and affirmed the District Court's dismissal of all remaining claims against the Company and individual defendants. On October 4, 1993, Plaintiffs petitioned the Fourth Circuit for rehearing, with a suggestion for rehearing en banc, and on October 29, 1993, the United States Department of Labor filed a brief in support of Plaintiffs' petition for rehearing. Plaintiffs' petition for rehearing en banc, was granted on December 13, 1993, and consequently, the panel opinion was vacated. Briefs were filed by the Plaintiffs, Department of Labor, and Cone Mills, and an en banc, oral argument was heard by the Court of Appeals on March 8, 1994. The Company is awaiting a decision.\nFORM 10-K Page 37\nItem 7. (continued)\nCone Mills has received an opinion from its lead counsel on appeal that, while it is not possible to predict the outcome of this lawsuit with certainty, in the opinion of such firm the District Court's decision in Plaintiffs' favor is erroneous and is more likely than not to be reversed or substantially modified by the Court sitting en banc, and the dismissal of Plaintiffs' claims was proper and is more likely than not to be affirmed by the en banc Court. Therefore, the Company's management has concluded that it is not probable that a liability has been incurred with respect to this suit. However, the Company has been advised by such counsel that an appellate court which votes to rehear a case en banc, often reaches a result different from the panel originally designated to hear the appeal, and further, that Employee Retirement Income Security Act (ERISA) law is rapidly changing and decisional law on many ERISA issues is neither unanimous nor fully developed. Because of the foregoing and the uncertainties inherent in the litigation process, there can be no assurance as to the ultimate resolution of this lawsuit. An unfavorable result could have a material adverse effect on the Company's results of operations and, if Plaintiffs' judgment (including the attorneys' fees award) is affirmed on appeal, the Company's management estimates that income net of taxes, would be reduced by approximately $10 million. Management also believes that the Company's unused borrowing capacity available under the Revolving Credit Facility and its internally generated funds are sufficient to meet its liquidity requirements for the foreseeable future and that it is unlikely that the Company's operations would be materially adversely affected by any cash shortage as a result of the judgement. For these reasons, it is the opinion of the Company's management that this lawsuit, when finally concluded, will not have a material adverse effect on the Company's financial condition. To secure the judgment on appeal from the District Court to the Court of Appeals, the Company has deposited in escrow with the trustee of the 1983 ESOP an $8 million letter of credit and 75,330 shares of Class A Preferred Stock valued at $7.5 million which has subsequently earned dividends of an additional 5,795 shares valued at $.6 million. The letter of credit was substituted for an $8 million cash deposit made in April 1992. To record these escrow transactions, the Company increased outstanding Class A Preferred Stock by $8.1 million and established an offsetting contra stockholders' equity account. These transactions did not have an effect upon net income or stockholders' equity of the Company.\nFORM 10-K Page 38\nItem 7. (continued)\nThe Company is a party to various other legal claims and actions incidental to its business. Management believes that none of these claims or actions, either individually or in the aggregate, will have a material adverse effect on the financial condition of the Company.\nCone Mills adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS 106\") in the first quarter of 1993. The additional noncash charge to earnings resulting from implementation of FAS 106, including amortization of the transition obligation, did not have a material impact on the Company's results of operations. See Note 8 of Notes to Consolidated Financial Statements.\nThe Company provides health care benefits and life insurance benefits for certain disabled employees and health care continuation coverage for former employees as mandated by law. The Company pays a portion of the actual costs of these benefits. SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which is effective in 1994, requires an accrual method of recognizing these benefits rather than recording an expense when paid. Based upon preliminary studies, the Company expects the cumulative effect of this accounting change will reduce first quarter 1994 net income by less than $2 million.\nFinancial Outlook and Strategy\nFor over two years, Cone Mills has benefited from favorable apparel fabric markets characterized by increasing prices and volume in both domestic and international denim markets and the rapid expansion of sportswear fabrics markets. While the Company believes that demographic trends and other market developments continue to present favorable long-term opportunities for growth, Cone is cautious about the near-term balance between growing domestic retail denim apparel sales and domestic, industry-wide denim garment and fabric inventories which have been increasing at a higher rate of growth. As inventory levels are adjusted, prices and volumes could potentially be affected. Sportswear and home furnishings markets should not be directly impacted and are expected to grow over the next year.\nSince November of 1993, the market price of cotton, the Company's principal raw material, has increased significantly. Even though Cone Mills has purchased cotton for future deliveries at favorable prices, continued high spot and forward cotton prices could affect the Company's profit margin\nFORM 10-K Page 39\nItem 7. (continued)\nin 1994, unless prices for denims and specialty sportswear products can be increased accordingly.\nCone Mills actively seeks possible acquisitions and other investment opportunities to which it believes it can add value through application of its manufacturing and marketing expertise. There can be no assurance that any actual transaction will ultimately result, but the consummation of any such transaction could involve a significant financial commitment.\nOn June 25, 1993, the Company purchased a 20% ownership in CIPSA, the largest denim manufacturer in Mexico. This investment cost approximately $24 million and the Company accounts for this investment by the equity method. Third- quarter 1993 earnings from this affiliate were included in the Company's statement of operations for the fourth quarter of 1993.\nCone Mills has also signed agreements dated June 25, 1993, with CIPSA, providing for the formation of a joint venture company to build and operate a world-class denim manufacturing facility in Parras, Mexico. The partners plan to invest a total of approximately $50 million, with each partner providing 50% of this investment. Capital requirements for the joint venture will primarily occur in 1994 and 1995. The joint venture has signed a credit agreement with a Mexican bank for approximately $63 million of debt financing. This debt is not guaranteed by Cone Mills Corporation or CIPSA.\nOn February 17, 1994, the Board of Directors of Cone Mills Corporation authorized the repurchase, from time to time, of up to 2.5 million shares of the Company's outstanding common stock in open market transactions. Repurchase decisions will be based on the Company's expected capital structure, the market price of the common stock, and alternative investment opportunities.\nThe Company believes that its internally generated operating funds and funds available under its credit facilities are sufficient to meet its working capital, capital spending, possible stock repurchases, and financing needs for the foreseeable future, including the investment in the joint venture.\nFORM 10-K Page 40\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nMcGLADREY & PULLEN CERTIFIED PUBLIC ACCOUNTANTS AND CONSULTANTS\nINDEPENDENT AUDITOR'S REPORT\nTo the Board of Directors Cone Mills Corporation Greensboro, North Carolina\nWe have audited the accompanying consolidated balance sheets of Cone Mills Corporation and subsidiaries as of January 2, 1994 and January 3, 1993 and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended January 2, 1994. 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 financial position of Cone Mills Corporation and subsidiaries as of January 2, 1994 and January 3, 1993, and the results of their operations and their cash flows for each of the three years in the period ended January 2, 1994 in conformity with generally accepted accounting principles.\nMcGladrey & Pullen\nGreensboro, North Carolina February 11, 1994 except for Note 17 as to which the date is March 8, 1994\nFORM 10-K Page 41 Item 8. (continued)\nSee Notes to Consolidated Financial Statements.\nFORM 10-K Page 42 Item 8. (continued)\nSee Notes to Consolidated Financial Statements.\nFORM 10-K Page 43 Item 8. (continued)\nSee Notes to Consolidated Financial Statements.\nFORM 10-K\nSee Notes to Consolidated Financial Statements.\nFORM 10-K\nSee Notes to Consolidated Financial Statements.\nFORM 10-K Page 45 Item 8. (continued)\nSee Notes to Consolidated Financial Statements.\nFORM 10-K Page 46\nItem 8. (continued)\nCONE MILLS CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Summary of Significant Accounting Policies\nPrinciples of consolidation:\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany accounts have been eliminated.\nFiscal year:\nThe Company's fiscal year ends on the Sunday nearest December 31. The years ended January 2, 1994, and December 29, 1991, contained 52 weeks. The year ended January 3, 1993, contained 53 weeks.\nInventories (amounts in thousands):\nSubstantially all components of textile inventories are valued at the lower of cost or market using the last-in, first-out (LIFO) method. Nontextile inventories are valued at the lower of average cost or market. If current replacement cost had been used for valuing financial statement inventories, that portion of the inventories based on the LIFO method would have been approximately $20,000 higher at January 2, 1994, and $14,000 higher at January 3, 1993. LIFO inventories valued for financial statement purposes exceed their income tax basis by approximately $86,000 at January 2, 1994, and $84,000 at January 3, 1993.\nInvestments in Unconsolidated Affiliates:\nInvestments in unconsolidated affiliated companies are accounted for by the equity method.\nFORM 10-K Page 47\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nProperty, plant and equipment:\nProperty, plant and equipment is carried at cost except for assets related to discontinued operations, which are carried at estimated net realizable value. Depreciation is computed by the straight-line method for financial reporting purposes.\nCapital stock redeemed:\nRedemption of capital stock is accounted for by the par value method. Excess of redemption price over par value for Class A Preferred Stock is charged to retained earnings. Excess of purchase price over par value for common stock is charged to capital in excess of par applicable to common shares and to retained earnings thereafter.\nDeferred Income Taxes:\nDeferred income taxes are provided on the difference between the financial reporting and the income tax basis of assets and liabilities, principally inventories, and property, plant and equipment. Balance sheet classification of these deferred income taxes is based upon the classification of the related assets or liabilities that created the temporary differences and does not necessarily reflect the expected timing of the reversals.\nPostemployment Benefits:\nThe Company provides health care benefits (in excess of Medicare) and life insurance benefits for certain disabled employees and health care continuation coverage for former employees as mandated by law. Presently, the Company pays a portion of the actual costs of these benefits. SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" which is effective for fiscal years beginning after December 15, 1993, requires an accrual method of recognizing postemployment benefits rather than recording an expense when paid. Based\nFORM 10-K Page 48\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nupon preliminary studies, the Company expects the cumulative effect of this accounting change will reduce first quarter 1994 net income by less than $2 million.\nNote 2. Sale of Accounts Receivables\nOn August 11, 1992, the Company entered into an agreement extendable to August 1995, with the subsidiary of a major financial institution, which allows the sale without recourse of up to $40 million of an undivided interest in eligible trade receivables. The Company acts as an agent for the purchaser by performing record keeping and collections function of receivables sold. The cost of receivables sold by the Company is the commercial paper rate plus 65 basis points calculated for the period of time from the sale of a receivable until its payment date. The resulting cost on the sale of receivables is included in cost of sales. Accounts receivable is shown net of $35 million sold at January 2, 1994 and net of $24 million sold at January 3, 1993 under this agreement. Cash flows provided by operating activities for the years ended January 2, 1994 and January 3, 1993 include the sale of accounts receivable of $11 million and $24 million, respectively.\nNote 3. Inventory Liquidations (amounts in thousands):\nDuring 1993, 1992 and 1991, certain inventory quantities were reduced, resulting in a liquidation of LIFO inventory layers carried at lower costs prevailing in prior years. The effect of these liquidations increased net earnings by $303 in 1993, $1,076 in 1992 and by $2,082 in 1991.\nNote 4. Investments In Unconsolidated Affiliates\nOn June 25, 1993, the Company purchased a 20% ownership in Compania Industrial de Parras S.A., (\"CIPSA\"), the largest denim manufacturer in Mexico. This investment cost approximately $24 million and the Company accounts for this investment by the equity method. Third-quarter 1993 earnings from this affiliate were included in\nFORM 10-K Page 49 Item 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nthe Company's statement of operations for the fourth quarter of 1993. The Company has not received any dividends on this investment.\nThe summarized unaudited financial information of CIPSA (100% basis), as adjusted for purchase accounting, is set forth below:\nThe carrying value of this investment exceeds by approximately $10.4 million the Company's share in CIPSA's net assets calculated using U.S. generally accepted accounting principles before application of purchase accounting. Approximately $2.9 million of the excess relates to differences between historical costs and fair market values of CIPSA's property, plant and equipment. The remainder is goodwill of approximately $7.5 million which is being amortized over 25 years by the straight-line method.\nThe Company has also signed agreements dated June 25, 1993, with CIPSA providing for the formation of a joint venture company to build and operate a world-class denim manufacturing facility in Parras, Mexico. The partners plan to invest a total of approximately $50 million, with each partner providing 50% of this investment. The joint venture has signed a credit agreement with a Mexican bank for approximately $63 million of debt financing. This debt is not guaranteed by Cone Mills Corporation or CIPSA. Expenditures on the joint venture began in the third quarter of 1993 and as of January 2, 1994 the Company has invested $2.3 million.\nFORM 10-K Page 50\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 5. Sundry Accounts Payable and Accrued Expenses\nSundry accounts payable and accrued expenses consist of the following:\nNote 6. Long-Term Debt\nLong-term debt consists of the following:\nFORM 10-K Page 51\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFinancing arrangements effective August 13, 1992 include a ten year $75 million 8% Senior Promissory Note and a three year $60 million Revolving Credit Agreement. Annual principal payments of $10.7 million are required by the Senior Note, beginning August 1996, with the remaining principal amount due August 2002. Borrowings under the Revolving Credit Agreement are at floating rates, determined by either the prime rate, CD Rate, or LIBOR, at the Company's option, plus a margin determined by the Company's capital structure.\nThe financing agreements contain certain covenants regarding the operations and financial condition of the Company. The Company was in compliance with all loan covenants at January 2, 1994. The total amount of unused capacity under the Revolving Credit Agreement at January 2, 1994, was $60 million.\nThe Company's industrial revenue bond obligations are at interest rates ranging from 70% to 86% of prime rate and have maturities through 1999.\nThe Company's other long-term obligations are $187,000 at 7% per annum and $1,521,000 at lender's prime rate plus 1%. These obligations also have maturities through 1999.\nThe fair value of the Company's long-term debt approximates its carrying value.\nAnnual maturities of long-term debt for each of the next five fiscal years are:\nNote 7. Retirement Plans\nThe Company maintains noncontributory defined benefit pension plans covering substantially all employees. The plan covering salaried employees provides pension benefits based on years of service and average compensation for the highest five consecutive years during the last ten years of service. Plans covering hourly employees and long distance drivers provide benefits based on compensation for each year of service.\nFORM 10-K Page 52\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nPension expense related to these plans was $2,445,000 in 1993, $1,807,000 in 1992 and $1,963,000 in 1991. The Company's funding policy is to make annual contributions of amounts that are deductible for income tax purposes. Assets of the pension plans are primarily invested in fixed income securities consisting of bond funds and short-term money market or cash equivalent funds.\nNet periodic pension costs for 1993, 1992 and 1991 included the following components:\nAssumptions used in determining the periodic pension cost of the pension plans are as follows:\nFORM 10-K Page 53\nItem 8(continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFORM 10-K Page 54\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nListed below are the Company's three defined contribution plans which cover substantially all employees.\n1. The 1983 Employee Stock Ownership Plan (\"ESOP\") 2. The Supplemental Retirement Plan (\"SRP\") 3. The Employee Equity Plan (\"EEP\")\nFor the years 1990 through 1992, the Company made ESOP contributions for eligible, nonsalaried employees equal to 1% of compensation, less forfeitures. Contributions to the ESOP were made in cash and Class A Preferred Stock of the Company. The Company discontinued contributions to the ESOP after 1992. The ESOP is subject to a floor offset arrangement in conjunction with the Company's defined benefit plans with respect to pension benefits earned for service after 1983. Under the floor offset arrangement, retirement benefits earned after 1983 under the Company's three defined benefit pension plans are offset by the actuarial equivalent pension value of participants' ESOP accounts.\nThe 401(k) Program (\"Program\"), formerly known as the Supplemental Retirement Program, consists of the EEP and the SRP. Participants of the Program may contribute from 2% to 10% of their annual compensation to the SRP or to the EEP, or their contributions may be divided between the two plans. Starting in 1994, employees may contribute from 2% to 15% of their compensation. The Company makes matching cash contributions of 25% to the SRP, and 50% to the EEP. The Company matches employee contributions up to 6% of the employee's annual compensation.\nBeginning in 1994, there will be two new plans in the Program, the EEP-Hourly and the SRP-Hourly. Salaried participants will remain in the EEP and SRP while hourly participants will go into the two new plans. The two new hourly plans are identical to the original EEP and SRP, except for the employment status of the participants.\nFORM 10-K Page 55\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nExpenses for the three defined contribution plans are shown below:\nThe 1992 EEP and SRP expenses include a special discretionary contribution made by the Company.\nNote 8. Postretirement Benefits Other Than Pensions (amounts in thousands)\nThe Company provides postretirement health care benefits to certain retired employees between the ages of 55 and 65. These employees become eligible for postretirement health care benefits if they retire after age 55 and have completed 15 years of service. The plan is contributory, with retiree contributions and plan design adjusted annually to reflect changes in health care costs. The Company funds a portion of the actual health care costs.\nThe Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" (\"FAS 106\"), as of the beginning of the 1993 fiscal year. FAS 106 requires accrual of the cost of providing postretirement benefits during the employees' active service periods. The Company's accumulated postretirement benefit obligation (\"APBO\") at the time of adoption was $4,598 and is being amortized to expense over a 20-year transition period. Prior to 1993, the Company recognized retiree health care expense when the benefits were paid. The effect of the change in accounting policy was to reduce net income for 1993 by $405.\nFORM 10-K Page 56\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe periodic expense for postretirement benefits included the following components for the year ended January 2, 1994:\nPostretirement benefit cost recognized in 1992 under the Company's prior accounting policy was $277.\nThe actuarial and recorded liabilities for postretirement benefits, none of which have been funded, are as follows at January 2, 1994:\nFor measurement purposes, a 15 percent annual rate of increase in per capita health care costs of covered benefits was assumed for 1994, with such rate of increase gradually declining to 5.5 percent in 2003. Increasing the assumed health care cost trend rate by 1 percentage point would increase the accumulated postretirement benefit obligation at January 2, 1994 by $431 and increase net periodic postretirement benefit expense by approximately $78 in 1993. The accumulated postretirement benefit obligation was computed using an assumed discount rate of 7 percent for 1993.\nFORM 10-K Page 57\nItem 8. (continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 9. Income Taxes\nComponents of Income Tax Expense from Continuing Operations (in thousands)\nFORM 10-K Page 58\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 10. Common Stock Offering and Conversion of Participating Preferred Stock\nOn June 25, 1992, the Company received net proceeds of $55.2 million upon consummation of an underwritten public offering for 6,000,000 shares of Common Stock. Pursuant to exercise by the underwriters of a 900,000 share over- allotment option, the Company received additional net proceeds of $8.3 million on July 22, 1992.\nOn June 18, 1992, the effective date of the Company's registration statement for its public offering, and in accordance with agreements executed by the Company and each of the holders of its Participating Preferred Stock, all outstanding shares of Participating Preferred Stock were converted into an aggregate of 5,118,669 shares of Common Stock and 1,231,327 shares of Nonvoting Common Stock.\nNote 11. Capital Stock\nAll Class A Preferred Stock is held by the Cone Mills Corporation 1983 ESOP except shares held in escrow and shares held by former participants who elected to receive shares in a distribution of account balances. Class A Preferred Stock is nonvoting, except as otherwise required by law, and is senior in dividend preference to all other classes of capital stock. Class A Preferred Stock has a liquidation preference senior to all other classes of capital stock of $100 per share plus accrued and unpaid dividends.\nHolders of Class A Preferred Stock are entitled to receive dividends on the 31st day of March of each year from funds legally available therefor when, as and if declared by the Board of Directors. The dividend rate is established on March 31 for the succeeding dividend period, and is determined by an independent investment bank or appraisal firm selected by the Board of Directors, subject to confirmation by the ESOP trustee. The dividend rate is determined annually, and is that rate required to make the fair market value of Class A Preferred Stock equal to its original par value. The dividend rate cannot exceed 13% per annum or be less than 7% per annum. Dividends on Class A Preferred Stock are cumulative, but accumulated dividends do not bear interest. Dividend rates for Class A Preferred Stock were 7.0% for 1994, 8.0% for 1993 and 9.7% for 1992.\nFORM 10-K Page 59\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDividends on the Class A Preferred Stock are, at the option of the Board of Directors, paid in cash or by delivery of shares of the Company's Class A Preferred Stock, Common Stock or by delivery of other \"qualifying employer securities\" of the Company as that term is used, on the date of such delivery, in Section 407 of the Employee Retirement Income Security Act of 1974, as amended (\"ERISA\") (or the corresponding section of any future law) or by a combination of the foregoing; provided, however, that on the date of delivery the fair market value of any stock or qualifying employer securities used to pay dividends shall be equal to or greater than the amount of dividends paid therewith. All dividends paid to date on the Class A Preferred Stock have been paid in additional shares of Class A Preferred Stock or cash.\nClass A Preferred Stock held by the 1983 ESOP may be redeemed, in whole or in part, at the option of the Company by a vote of the Board of Directors, at a price equal to the greater of $100 per share or the fair market value thereof, plus dividends accrued and unpaid thereon to the date fixed for redemption. The redemption price shall be paid in cash or by delivery of shares of the Company's Class A Preferred Stock, Common Stock or by delivery of other qualifying employer securities or a combination of the foregoing, at the Company's option; provided, however, that on the date of delivery the fair market value of any stock or other qualifying employer securities used to pay the redemption price shall be equal to or greater than the redemption price (or portion thereof) paid therewith. The fair market value of Class A Preferred Stock was determined to be $100.10 per share at January 2, 1994.\nPurchases of Class A Preferred Stock by the ESOP may be necessary to provide all or part of the pension due under the Company's defined benefit plans pursuant to the floor offset arrangement in connection with the ESOP and to make distributions due to retired or terminated employees. The ESOP is obligated to purchase shares of Class A Preferred Stock from participants and former participants of these plans in accordance with the terms and conditions of the plans, the trust agreements and liquidity agreements thereunder. To the extent the ESOP has insufficient liquidity to make these purchases, it may require the Company to repurchase shares of Class A\nFORM 10-K Page 60\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nPreferred Stock. It is within the control of the Company to satisfy the liquidity needs of the ESOP through cash contributions, cash dividends or optional repurchases of the Class A Preferred Stock.\nAll outstanding shares of Nonvoting Common Stock were converted to Common Stock during February, 1993. These shares, owned exclusively by unaffiliated shareholders, were converted at the rate of one share of Common Stock for each share of Nonvoting Common Stock. On May 11, 1993, the shareholders approved an amendment to the Company's Restated Articles of Incorporation which removed Nonvoting Common Stock as authorized capital stock. At the same time, Participating Preferred Stock was removed as authorized capital stock.\nThe Company is authorized to issue Class B Preferred Stock but it has no Class B Preferred Stock outstanding nor does it have present plans to issue such shares. The Restated Articles of Incorporation provide that the Board of Directors may determine the preferences, limitations and relative rights of the Class B Preferred Stock, including voting rights, which could adversely affect the voting rights of holders of Common Stock. Any Class B Preferred Stock which is authorized and issued shall be junior to Class A Preferred Stock in accordance with the terms of the Restated Articles of Incorporation.\nHolders of Common Stock are entitled ratably, share for share, to dividends, when, as and if declared by the Board of Directors, out of funds legally available therefor. Common Stock is junior to Class A Preferred Stock with respect to dividend preference and may be junior to Class B Preferred Stock depending upon the relative preferences, limitations and relative rights the Board of Directors may determine upon issuance of such Class B Preferred Stock.\nThe Common Stock is junior in liquidation preference to the Class A Preferred Stock and may be junior to the Class B Preferred Stock depending upon the relative preferences, limitations and rights the Board of Directors may establish upon issuance of Class B Preferred Stock. After payment in liquidation has been made to the senior capital stock, the remaining assets of the Company would be distributed pro rata among the holders of Common Stock equally on a per share basis.\nFORM 10-K Page 61\nItem 8. (continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nHolders of Common Stock are entitled to one vote per share on all matters submitted to a vote of holders of Common Stock.\nNote 12. Stock Option Plan\nThe Company's 1984 Stock Option Plan provides for the granting of options to purchase 5,000,000 shares of Common Stock; such options may be incentive stock options or nonqualified stock options. All of the options granted have been nonqualified stock options with a term of ten years, and such grants included income tax reimbursement in accordance with the terms of the plan. Options are exercisable on a cumulative basis, at a rate of 20% per year beginning in the year of grant. No additional grants will be made under the 1984 Plan.\nThe Company also has in effect the 1992 Stock Option Plan that permits the granting of options to purchase up to 2,000,000 shares of Common Stock. This plan is substantially identical to the 1984 Stock Option Plan. On February 18, 1993, incentive stock option grants to purchase 500,000 shares of Common Stock at $15.625 per share were made. These options have a term of ten years and are exercisable, on a cumulative basis, at a rate of 20% in each twelve month period, beginning six months after the date of grant.\nA summary of activity under the plans follows:\nFORM 10-K Page 62\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 13. Leases, Commitments and Repairs and Maintenance - Continuing Operations (amounts in thousands)\nThe Company has various leases accounted for as operating\nleases. Rent expense was $5,053, $4,465, and $4,255, for 1993, 1992 and 1991, respectively. Future minimum rental payments required under lease agreements are $4,332 for 1994, $3,625 for 1995, $2,698 for 1996, $1,979 for 1997, $1,077 for 1998, and thereafter $2,217. Aggregate future minimum rental payments total $15,928. Commitments for improvements of and additions to property, plant and equipment approximated $5,105 at January 2, 1994. Operating costs and expenses include repairs and maintenance costs of $34,680, $32,239, and $28,738 for 1993, 1992 and 1991, respectively.\nNote 14. Restructuring Costs (amounts in thousands)\nIn 1991 the Company sold the assets of Ragan Hardware Company, a small wholesale distributor of hardware in the furniture industry. The loss of $767 relating to this disposition is shown as restructuring cost in 1991.\nFORM 10-K Page 63\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFORM 10-K Page 64\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 16. Segment Information and Major Customers\nThe Company operates in two major segments within the textile industry: Apparel Fabrics and Home Furnishings. The Company designs, manufactures and markets Apparel Fabrics including denim in various styles, finishes and weights, yarn-dyed and chamois flannel shirting fabrics, printed fabrics and synthetic sportswear fabrics. The Home Furnishings segment consists of the design and distribution of decorative fabrics for the home furnishings industry, and decorative fabrics commission dyeing, printing and finishing services. This segment also includes polyurethane foam products, batting, cushions, carpet padding, and the distribution of furniture hardware. For reporting purposes, real estate operations are included in the Home Furnishings segment.\nThe Company has no foreign operations. Sales to unaffiliated foreign customers, principally in Europe, were 17.2% of sales from continuing operations in 1993, 16.1% in 1992 and 14.5% in 1991. Cone has one unaffiliated customer which accounted for more than 10% of consolidated sales from the Apparel Fabrics segment. Sales to this customer, as a percentage of sales from continuing operations, were 35.3% in 1993, 37.9% in 1992, and 38.5% in 1991. At January 2, 1994 this customer had an outstanding accounts receivable balance with the Company of approximately $8.6 million. The Company has not incurred any losses in past years related to this customer's accounts receivable.\nOperating profit for each segment is total revenue less operating expenses applicable to that segment. General corporate expenses, interest, income taxes, and losses from discontinued operations are not included in segment operating income. General corporate expenses include certain executive officers salaries, legal expenses, bank fees and charitable contributions. Intersegment sales and transfers are considered insignificant. Corporate assets include cash, administrative facilities, deferred charges, and miscellaneous receivables.\nFORM 10-K Page 65 Item 8 (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSegment Information\nFORM 10-K Page 66 Item 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 17. Litigation and Contingencies\nIn November 1988, William J. Elmore and Wayne Comer (the \"Plaintiffs\"), former employees of the Company, instituted a class action suit against the Company and Wachovia Bank & Trust Company, N.A. (\"Wachovia\") and certain current and former employees of the Company and Wachovia. The suit was brought on behalf of salaried employees of the Company who were participants in certain Company retirement plans. The Plaintiffs asserted a variety of claims related to actions taken and statements made concerning certain employee benefit plans maintained by the Company. In May 1990, the United States District Court in Greenville, South Carolina, certified a plaintiff class of salaried employees. In August 1990, the District Court granted partial summary judgment in favor of the defendants and significantly narrowed the extent of the Plaintiffs' claims. A trial was held in February 1991, and supplemental proceedings were held on July 24, 1991. At the trial, a witness hired by the Plaintiffs estimated the alleged loss to the Plaintiff class to range from approximately $34 million to approximately $94 million.\nOn March 20, 1992, the District Court entered a judgment finding that the Company had promised to contribute certain surplus funds (or their equivalent in Company stock) relating to the overfunding of the Company's pension plans to the 1983 ESOP by December 23, 1985, that such surplus amounted to $69 million, that the Company's actual contribution totaled approximately $55 million, and that the Company and its Chairman, Dewey L. Trogdon, and its Secretary, Lacy G. Baynes, therefore had breached their fiduciary duties under the Employee Retirement Income Security Act of 1974 (\"ERISA\") to certain participants in the 1983 ESOP. The District Court ordered the Company to pay to the 1983 ESOP for the benefit of plan participants, both salaried and hourly, the sum of $14.2 million in cash or the equivalent in Company stock. In addition, the District Court awarded $3.5 million in attorneys' fees to the Plaintiffs, $2.2 million of which is to be paid from the sum awarded to the 1983 ESOP. Judgment was entered in favor of the defendants on all remaining claims except for claims relating to the ESOP contribution. In accordance with and to the extent permitted by the Company's Articles of Incorporation and Bylaws, the two individual defendants in this litigation are indemnified by the Company for any costs incurred by them in connection with this matter.\nFORM 10-K Page 67\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nOn March 20, 1992, the Company and the individual defendants appealed the District Court's judgment against them to the United States Court of Appeals for the Fourth Circuit. On April 2, 1992, the Plaintiffs appealed the District Court's judgment to the Court of Appeals insofar as it dismissed certain of their claims. To secure the judgment on appeal the Company has deposited in escrow with the trustee of the 1983 ESOP an $8 million letter of credit and 75,330 shares of Class A Preferred Stock valued at $7.5 million which has subsequently earned dividends of an additional 5,795 shares valued at $.6 million. To record these escrow transactions, the Company increased outstanding Class A Preferred Stock by $8.1 million. The increase in outstanding Class A Preferred Stock was offset by a contra stockholders' equity account labeled \"Class A Preferred Stock held in escrow.\" These escrow account transactions did not have an effect upon net income or stockholders' equity of the Company.\nOn September 22, 1993 a three-judge panel of the United States Court of Appeals for the Fourth Circuit in a two- to-one decision reversed the District Court's decision as to the obligation to contribute additional funds to the 1983 ESOP and affirmed the District Court's dismissal of all remaining claims against the Company and the individual defendants. On October 4, 1993, Plaintiffs petitioned the Fourth Circuit for rehearing, with a suggestion for rehearing en banc, and on October 29, 1993 the United States Department of Labor filed a brief in support of Plaintiffs' petition for rehearing. Plaintiffs' petition for rehearing en banc was granted on December 13, 1993, and, consequently, the panel opinion was vacated. Briefs were filed by the Plaintiffs, Department of Labor, and the Company, and an en banc oral argument was heard by the Court of Appeals on March 8, 1994. The Company is awaiting a decision. An attorney for the Plaintiffs has contended that, if Plaintiffs prevail on appeal, the judgment could exceed $50 million based on the existing judgment and additional claims relating to alleged unjust enrichment and alleged overvaluation of the Class A Preferred Stock initially contributed to the 1983 ESOP, as well as prejudgment interest.\nFORM 10-K Page 68\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe Company has received an opinion from its lead counsel on appeal, that, while it is not possible to predict the outcome of this lawsuit with certainty, in the opinion of such firm the District Court's decision in Plaintiffs' favor is erroneous and is more likely than not to be reversed or substantially modified by the Court sitting en banc and the dismissal of Plaintiffs' claims was proper and is more likely than not to be affirmed by the en banc Court. Therefore, the Company has concluded that it is not probable that a liability has been incurred with respect to this suit. However, the Company has been advised by such counsel that an appellate court which votes to rehear a case en banc often reaches a result different from the panel originally designated to hear the appeal, and further, that ERISA law is rapidly changing and decisional law on many ERISA issues is neither unanimous nor fully developed. Because of the foregoing and the uncertainties inherent in the litigation process, there can be no assurance as to the ultimate resolution of this lawsuit. If Plaintiffs' judgment (including the attorneys' fees award) is affirmed on appeal, the Company's management estimates that income, net of taxes, would be reduced by approximately $10 million. It is the opinion of the Company's management that this lawsuit, when finally concluded, will not have a material adverse effect on the Company's financial condition.\nNote 18. Discontinued Operations (amounts in thousands)\nAs of December 5, 1991, the Company adopted a plan to discontinue and liquidate its corduroy and other bottomweight continuous piece-dyed fabrics product line. Earlier in 1991, the Company closed its last weaving facility dedicated to corduroy and flat woven fabrics. The operations to dye and finish these fabrics are concentrated at Cone's Haw River, North Carolina facility. The Company began to phase out this product line in early 1992, and continued to accommodate customers, liquidate inventory and collect receivables through the 1993 cutting season and will complete the liquidation of its corduroy and other bottomweight continuous piece-dyed fabrics product line in the first quarter of 1994.\nFORM 10-K Page 69\nItem 8. (continued)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nAn estimated loss on disposal of these discontinued operations of $17,860, net of income tax benefits of $10,777, was recognized in the 1991 fiscal year. This estimate included anticipated operating losses during the phase-out period of $6,952, net of income tax benefits of $4,195. This operating loss included allocated interest of $765, net of income tax benefits of $462. Actual losses from discontinued operations in 1992 and 1993 were consistent with the estimated provision for such years; therefore, no gain or additional loss has been recognized on discontinued operations.\nFORM 10-K Page 70 Item 8. (continued) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nFORM 10-K Page 71\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.\nNone.\nFORM 10-K Page 71a\nPART II - ADDITIONAL DISCLOSURE\nFORM 10-K Page 71b\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant.\nInformation relating to directors of the Company is presented under the heading \"Election of Directors\" in the Company's definitive Proxy Statement dated April 1, 1994, prepared for the Annual Meeting of Shareholders to be held on May 10, 1994, and is hereby incorporated by reference. Information regarding executive officers is included as Item 4A in Part I.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation relating to executive compensation is presented under the heading \"Executive Compensation\" in the Company's definitive Proxy Statement dated April 1, 1994, prepared for the Annual Meeting of Shareholders to be held on May 10, 1994, and is hereby incorporated by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation with respect to beneficial ownership of the Company's voting securities by each director and all officers and directors as a group, and by any person known to beneficially own more than 5% of any class of voting security of the Company is presented under the heading \"Security Ownership of Directors, Nominees and Named Executive Officers\" and \"Security Ownership of Certain Beneficial Owners\" in the Company's definitive Proxy Statement dated April 1, 1994, prepared for the Annual Meeting of Shareholders to be held on May 10, 1994, and is hereby incorporated by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation with respect to certain relationships and related transactions is presented under the headings \"Compensation of Directors\" and \"Compensation Committee Interlocks and Insider Participation\" in the Company's definitive Proxy Statement dated April 1, 1994, prepared for the Annual Meeting of Shareholders to be held on May 10, 1994, and is hereby incorporated by reference.\nFORM 10-K Page 72\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(a)(1) The following financial statements of the Registrant are presented in Item 8 on pages 40 through 70 hereof.\nReport of Independent Auditor\nConsolidated Statements of Operations for the Years Ended January 2, 1994, January 3, 1993 and December 29, 1991\nConsolidated Balance Sheets as of January 2, 1994, and January 3, 1993\nConsolidated Statements of Stockholders' Equity for the Years Ended January 2, 1994, January 3, 1993, and December 29, 1991\nConsolidated Statements of Cash Flows for the Years Ended January 2, 1994, January 3, 1993, and December 29, 1991\nNotes to Consolidated Financial Statements\n(a)(2) The following Financial Statement Schedules are presented on pages 75 through 78 hereto.\nReport of Independent Auditor relating to Schedules V, VI, VIII and IX\nSchedule V - Property, Plant and Equipment\nSchedule VI - Accumulated Depreciation of Property, Plant and Equipment\nSchedule VIII - Valuation and Qualifying Accounts\nSchedule IX - Short-Term Borrowings\nAll other schedules specified under Regulation S-X are omitted because they are not applicable, not required or the information required appears in the Consolidated Financial Statements or Notes thereto.\nFORM 10-K Page 73\nItem 14. (continued)\n(a)(3) Exhibits. Exhibits to this report are listed on the accompanying Index to Exhibits.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter of 1994.\nFORM 10-K Page 74\nMcGLADREY & PULLEN\nCERTIFIED PUBLIC ACCOUNTANTS AND CONSULTANTS\nINDEPENDENT AUDITOR'S REPORT ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors Cone Mills Corporation Greensboro, North Carolina\nOur audit of the consolidated financial statements of Cone Mills Corporation and subsidiaries included schedules V, VI, VIII and IX contained herein, for the years ended January 2, 1994, January 3, 1993 and December 29, 1991.\nIn our opinion, such schedules present fairly the information required to be set forth therein in conformity with generally accepted accounting principles.\nMcGladrey & Pullen\nGreensboro, North Carolina February 11, 1994\nFORM 10-K Page 75\nFORM 10-K Page 76\nFORM 10-K Page 77\nFORM 10-K Page 78","section_15":""}
{"filename":"72741_1994.txt","cik":"72741","year":"1994","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. The System furnishes retail electric service in Connecticut, New Hampshire and western Massachusetts 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]). In addition to their retail electric service, CL&P, PSNH, WMECO and HWP (including its wholly-owned subsidiary, Holyoke Power and Electric Company [HPE]) (the System companies) together furnish firm wholesale electric service to eight municipal electric systems and investor-owned 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 as measured by revenues.\nNorth Atlantic Energy Corporation (NAEC) is a special purpose subsidiary of NU, which sells its share of the capacity and output of the Seabrook nuclear generating facility (Seabrook) in Seabrook, New Hampshire, to PSNH under two life-of-unit, full cost recovery contracts. NU's subsidiary North Atlantic Energy Service Corporation (North Atlantic or NAESCO) has operational responsibility for Seabrook.\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 the Millstone nuclear generating facilities in Connecticut. North Atlantic acts as agent for the System companies and other New England utilities in operating Seabrook. Three 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 other forms of non-utility generation and in exempt wholesale generators (\"EWGs\")(collectively, \"NUGs\") and foreign utility companies (\"FUCOs\") as permitted under the Energy Policy Act of 1992 (Energy Policy Act). HEC provides energy management services for commercial, industrial and institutional electric customers. See \"Nonutility Businesses.\"\nA reorganization of NU entailing realignment into two core business groups became effective on January 1, 1994. The first group, the energy resources group, is devoted to energy resource acquisition and wholesale marketing and focuses on nuclear, fossil and hydroelectric generation and wholesale power marketing. The other 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 is undergoing a corporate reengineering process to assist in identifying opportunities to become more competitive while improving customer service and maintaining a high level of operational performance.\nPUBLIC UTILITY REGULATION\nNU is a registered electric utility holding company under the Public Utility Holding Company Act of 1935 (1935 Act). Accordingly, the Securities and Exchange Commission (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. The 1935 Act limits the System, with certain exceptions, to the business of being an electric utility in the Northeastern region of the country.\nThe System companies are subject to the Federal Power Act as administered by the Federal Energy Regulatory Commission (FERC). The Energy Policy Act amended this act to authorize FERC to order wholesale transmission wheeling services and under certain circumstances to require electric utilities to enlarge transmission capacity necessary to provide such services. 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 laws governing the retail marketing areas of electric utilities.\nIn addition, the Nuclear Regulatory Commission (NRC) has broad jurisdiction over the System's nuclear units and each of the System companies is subject to broad regulation by its respective state and\/or local regulatory authorities with jurisdiction over the service areas in which each company operates. The System incurs substantial capital expenditures and operating expenses to identify and comply with environmental, energy, licensing and other regulatory requirements, including those described herein, and it expects to incur additional costs to satisfy further requirements in these and other areas of regulation. See generally \"Rates,\" \"Electric Operations\" and \"Regulatory and Environmental Matters.\"\nCOMPETITION AND MARKETING\nCompetitive forces within the electric utility industry are continuing to increase due to a variety of influences, including legislative and regulatory actions, technological advances and changes in consumer demands. In response, the System 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. The System also benefits from a diverse retail base. The System has no significant dependence on any one retail customer or industry.\nTHE ECONOMY\nIn 1994, the System experienced its most significant retail sales growth in six years, due in large part to the economic recovery in New England. Employment levels have risen, particularly in New Hampshire, unemployment rates have fallen, and personal income has increased in all three states comprising the System's retail service territory. The System's 1994 retail sales, which comprise 77 percent of all kilowatt-hour sales, rose by a total of 2.9 percent or 867 million kilowatt-hours over 1993. Retail sales growth was consistent across all major customer classes, with residential sales rising by 2.8 percent, commercial sales by 3.2 percent and industrial sales by 2.6 percent. Retail sales growth was strongest for CL&P, which recorded an increase of 3.4 percent, and weakest for WMECO, which experienced a 1.4 percent increase. At PSNH, retail sales rose by 2.0 percent. Overall, weather had little effect on sales volume, with mild weather after mid-August offsetting unusually cold weather in January and hot weather in late June and July.\nIn 1995, the System expects little retail sales growth from 1994, primarily because of the effects of higher interest rates on the regional economy and further cutbacks in defense-related industries in Connecticut. Over the longer term, retail sales growth is expected to be strongest in New Hampshire, which by some measures has the fastest-growing economy in New England. In 1994, many businesses announced plans to expand in New Hampshire. The System estimates that PSNH will have compounded annual sales growth of 1.9 percent from 1994 through 1999, compared with 1.4 percent for CL&P and 0.9 percent for WMECO.\nWholesale sales, which comprised the remaining 23 percent of all sales, rose 0.8 percent or 75 million kilowatt-hours in 1994, due to aggressive marketing efforts and the opening of new wholesale markets as a result of increased wholesale competition, including the addition of Madison, Maine as a wholesale customer.\nRETAIL MARKETING\nRetail sales growth and the System's success in lowering operating costs were the primary reasons for the improvement in NU's financial performance in 1994. Because the System has surplus generating capacity, additional demand can be easily met from existing generation. As a result, the additional costs of serving expanding load--principally the cost of additional fuel--are far less than the revenues received from the additional kilowatt-hour sales.\nThe System companies continue to operate predominantly in state-approved franchise territories under traditional cost-of-service regulation. Retail wheeling, under which a retail customer would be permitted to select an electricity supplier other than its local electric utility and require the local electric utility to transmit the power to the customer's site, is not required in any of the System's jurisdictions. In 1994, Connecticut regulators reviewed the desirability of retail wheeling and determined that it was not in the best interest of the state until new generating capacity is needed, which the System projects to be in 2009. The Connecticut Department of Public Utility Control (DPUC) is presently conducting a generic proceeding studying the restructuring of the electric industry and competition in order to develop findings and recommendations to be presented to policymakers at the legislative level. A decision in this proceeding is expected in mid-1995.\nIn New Hampshire, several bills related to retail wheeling have been introduced in the legislature. The chairman of the New Hampshire Public Utilities Commission (NHPUC) has set up a roundtable discussion with legislators, utilities and large customers on how to deal with a more competitive market. In addition, a new entity, Freedom Electric Power Company (FEPCO), has filed with the NHPUC for permission to do business as an electric utility to serve selected large PSNH customers. PSNH and other New Hampshire utilities are opposing FEPCO's petition before the NHPUC.\nThere also have been several bills introduced in Massachusetts that involve the potential for retail wheeling, electric utility industry restructuring and regulatory reform. To date, none of these bills have been enacted. On February 10, 1995, the Massachusetts Department of Public Utilities (DPU) initiated an investigation into various ways in which the electric utility industry in Massachusetts could be restructured. The DPU has asked interested parties to comment on numerous topics such as competition and customer choice by March 31, 1995. It is not known when the DPU will issue an order in this proceeding.\nWhile retail wheeling is not required in the System's retail service territory, competitive forces nonetheless are influencing retail pricing. These include competition from alternate fuels such as natural gas, competition from customer-owned generation and regional competition for business retention and expansion. The System's retail business group is continuing to work with customers to address their concerns. Since the fall of 1991, the System companies have reached approximately 230 special rate agreements with customers to increase or retain their electricity purchases from the System, including 124 CL&P customers, 54 PSNH customers and 44 WMECO customers through the end of 1994. These agreements include 135 agreements to retain existing customers and 87 agreements for new customers and account for approximately four percent of System 1994 retail revenues.\nIn general, these special rate agreements have terms of approximately five years. Most of CL&P's agreements have been entered pursuant to general rate riders approved by the DPUC. Most of PSNH's special contracts require individual approval from the NHPUC. The DPU requires individual approval of some special contracts, but in 1994 the DPU also authorized WMECO to reduce rates by five percent for all customers whose demand exceeds one megawatt (MW) as long as those customers agree to give WMECO at least five years' notice before generating their own power or purchasing it from an alternative supplier. As of December 31, 1994, ten WMECO customers had signed up for this service extension discount.\nMany of the special rate agreements were reached individually on a customer-by-customer basis. However, three significant groups of customers also entered agreements with certain of the System companies over the past two years. In 1993, HWP entered ten-year contracts with all of its approximately 40 retail industrial customers, which accounted for approximately $7 million of revenue in 1994. PSNH entered into long-term contracts with approximately 30 sawmill operators and nine ski resorts in 1994.\nNegotiated retail rate reductions for System customers under rate agreements in effect for 1994 amounted to approximately $20 million, including $11 million for CL&P, $3 million for PSNH, $4 million for WMECO and $2 million for HWP. Management believes that the aggregate amount of retail rate reductions will increase in 1995, but that such agreements will continue to provide significant benefits to the System including the preservation of approximately four percent of retail revenues.\nSpecial rate agreements represent only a portion of the System's response to the new competitive forces in the energy marketplace. The System spent approximately $46 million in 1994 on demand side management (DSM) programs. Over 60 percent of DSM program costs were targeted to the commercial and industrial sectors. These programs help customers improve the efficiency of their electric lighting, manufacturing, and heating, ventilating and air conditioning systems, making them more competitive in their own markets, which in turn enables them to be more viable employers in the System's service territories. DSM program costs are recovered from customers through various cost recovery adjustment mechanisms. For further information on DSM programs, see \"Rates - Connecticut Retail Rates - Demand Side Management\" and \"Rates - Massachusetts Retail Rates - Demand Side Management.\" System companies also are increasingly working with customers to improve reliability and power quality within commercial and industrial facilities.\nMany of the System's programs for residential customers are targeted at improving the efficiency of lighting and electric space heating, as well as the energy efficiency of new homes. Residential space heating represents approximately five percent of the System's retail electric sales, and suppliers of alternative fuels, such as natural gas, have actively recruited residential customers to convert their heating systems from electric heat. In 1994, an increase in the number of CL&P's space heating customers offset decreases in the numbers of WMECO's and PSNH's space heating customers.\nWHOLESALE MARKETING\nThe System acts as both a buyer and a seller of electricity in the highly competitive wholesale electricity market in the Northeastern United States (Northeast). Many of the sales contracts signed by the System companies in the late 1980's have expired or will expire in the mid-1990's, and much of the revenue produced by such contracts has not been replaced through new wholesale power arrangements. In 1994, wholesale sales, including firm wholesale service and other bulk supply transactions, accounted for approximately $331 million, or approximately 9.2 percent, of System revenues, down from approximately $383 million in 1993, due in large part to the loss of one major customer and the increased competitiveness of the wholesale market. Unless prices on the wholesale market improve, revenues are expected to fall further in 1995 before stabilizing in late 1996 and 1997. Wholesale sales are made primarily to investor-owned utilities and municipal systems or cooperative electric systems in the Northeast. The System will be increasing its efforts to increase wholesale sales through intensified marketing efforts. The System's power marketing efforts benefit from the interconnection of its transmission system with all of the major utilities in New England, as well as with three of the largest electric utilities in New York state.\nThe System's 1994 firm wholesale sales were approximately 1.3 million megawatt-hours. In 1994, firm wholesale electric service accounted for approximately 2.5 percent of the System's revenues (approximately 1.4 percent of CL&P's operating revenue, 6 percent of PSNH's operating revenue and a negligible amount of WMECO's operating revenue).\nIn 1994, the System companies commenced service under six long-term sales contracts with municipal electric systems, including five in Massachusetts and one in Maine. These power sales contracts have terms which range from five to ten years. The related revenues, which amounted to approximately $4 million in 1994, are expected to increase over the coming years. The System also sold an average of approximately 400 MW of power during 1994 in short-term sales to four utilities in New York State. Those sales ranged in duration from a week to six months and accounted for approximately $54 million in System revenues in 1994.\nThe System owns approximately one-half of the 2,000 MW of surplus capacity in New England. This surplus and the resulting competition for business has caused the System to renegotiate some of its arrangements with its existing wholesale customers. For example, in 1994 CL&P began serving the City of Chicopee, Massachusetts under a new ten-year arrangement. Furthermore, CL&P and the Town of Wallingford, Connecticut signed a contract for service of Wallingford's approximate 110 MW load for a ten-year period beginning in 1995. The new arrangement was coordinated through the Connecticut Municipal Electric Energy Cooperative, an organization that assists municipalities with their energy needs, and supersedes CL&P's current firm wholesale contract with Wallingford. In these cases, due to wholesale competition, the customers were able to secure prices lower than those that would have been paid under traditional cost-of-service ratemaking. Similarly, long-term agreements were renegotiated before 1994 with the New Hampshire Electric Cooperative and several other municipal and small investor-owned electric systems in Connecticut, New Hampshire and Massachusetts.\nThe System's transmission system is an open access wholesale transmission system: other parties, either utilities or independent power producers, can use NU's transmission system to move power from a seller to a wholesale buyer at FERC-approved rates, provided adequate capacity across those lines is available and service reliability is not endangered. In 1994, the System companies collected approximately $42 million in transmission revenues for transmission of power sales emanating from either the System or from other generating plants. See \"Electric Operations - Generation and Transmission\" for further information on 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.\"\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. Connecticut 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.\nThe DPUC issued a decision in CL&P's most recent rate case in June 1993 (1993 Decision) approving a multi-year rate plan that provides for annual retail 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 rate increases were implemented as scheduled in 1993 and 1994. For more information regarding the 1993 Decision, see \"Legal Proceedings.\"\nCL&P ADJUSTMENT CLAUSES\nCL&P has a fossil fuel and purchased power adjustment clause pursuant to which CL&P, subject to periodic review by the DPUC, recovers or refunds substantially all prudently incurred expenses and credits applicable to its retail electric rates on a current basis.\nCL&P's current retail rates also assume that the nuclear units in which CL&P has entitlements will operate at a 72 percent composite capacity factor. A generation utilization adjustment clause (GUAC) levels the effect on rates of fuel costs incurred or avoided due to variations in nuclear generation above and below that performance level. Because nuclear fuel is less expensive than any other fuel utilized by the System, 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 each twelve-month period ending July 31, these net variations from the costs reflected in base rates are, with DPUC approval, generally refunded to or collected from customers over the subsequent twelve-month period beginning September 1.\nOn January 5, 1994, the DPUC issued a decision ordering CL&P not to include a GUAC amount in customers' bills through August 1994. The DPUC found that CL&P overrecovered its fuel costs during the 1992-1993 GUAC period and offset the amount of the overrecovery against the unrecovered GUAC balance. The effect of the order was a disallowance of $7.9 million. On March 4, 1994, CL&P appealed this decision to Hartford Superior Court and expects a decision in the spring of 1995.\nIn the most recent GUAC period, which ended July 31, 1994, the actual level of nuclear generating performance was 68.2 percent, resulting in a GUAC deferral of $23.7 million to be collected from customers beginning in September 1994. On December 30, 1994, the DPUC ordered CL&P to collect from customers over the ensuing eight months only $15.9 million of the $23.7 million GUAC deferral accrued during the 1993-1994 GUAC year. The DPUC disallowed $7.8 million of the deferral, finding that CL&P had overrecovered that amount through base rate fuel recoveries. The DPUC further stated that it would follow a similar course in the future. CL&P has also appealed this order.\nFor the GUAC year ended July 31, 1995, CL&P expects to defer in excess of $50 million of GUAC fuel costs for projected nuclear performance below 72 percent. As of December 31, 1994, CL&P has reserved $13 million against this amount based on the methodology applied by the DPUC in previous GUAC decisions.\nThe DPUC has conducted several reviews to examine the prudence of certain costs, including purchased power costs, incurred in connection with outages at various nuclear units located in Connecticut, which occurred during the period October 1990 - February 1992. Three of these prudence reviews are either on appeal or still pending at the DPUC. Approximately $92 million of costs are at issue in these remaining cases, some or all of which may be disallowed. Management believes its actions with respect to these outages have been prudent and does not expect the outcome of the appeals to result in material disallowances. For further information on these prudence reviews, see \"Nuclear Performance\" in the notes to NU's and CL&P's financial statements.\nDEMAND SIDE MANAGEMENT\nCL&P participates in a collaborative process for the development and implementation of DSM programs for its residential, commercial and industrial customers. CL&P is allowed to recover conservation costs in excess of costs reflected in base rates over periods ranging from 3.85 to 10 years.\nIn June 1994, the DPUC issued an order approving a reduction in the amortization period from eight years to 3.85 years for CL&P's 1994 DSM expenditures, which will allow CL&P to recover its total 1994 program budget of $40 million over 3.85 years beginning in 1994.\nOn October 31, 1994, CL&P filed an application with the DPUC regarding CL&P's 1995 DSM expenditures, program designs, performance incentive mechanism and lost fixed-cost recovery. CL&P proposed a budget level of $36.7 million for 1995 DSM expenditures and an amortization period for new expenditures of 3.93 years. The DPUC began hearings on the proposed budget and programs during November 1994. CL&P's unrecovered DSM costs at December 31, 1994, excluding carrying costs, which are collected currently, were approximately $116 million.\nNEW HAMPSHIRE RETAIL RATES\nRATE AGREEMENT AND FPPAC\nPSNH's 1989 Rate Agreement with the State of New Hampshire provides for seven base rate increases of 5.5 percent per year beginning in 1990 and a comprehensive fuel and purchased power adjustment clause (FPPAC). The first five base rate increases went into effect as scheduled and the remaining two base rate increases will be put in effect on June 1, 1995 and June 1, 1996, concurrently with semi-annual adjustments in the FPPAC. Political and economic pressures, caused by historically high retail electric rates in New Hampshire, may inhibit additional rate increases, including FPPAC increases, above 5.5 percent per year during the next two years, may lead to challenges to the Rate Agreement in the future and may limit rate recoveries after the period for the seven 5.5 percent increases has ended. In accordance with the schedule for rate increases under the Rate Agreement, PSNH increased its average retail electric rates by about 5.5 percent in June 1994.\nThe FPPAC provides for the recovery or refund by PSNH, for the ten-year period beginning on May 16, 1991, of the difference between its actual prudent energy and purchased power costs and the estimated amounts of such costs included in base rates established by the Rate Agreement. The FPPAC amount is calculated for a six-month period based on forecasted data and is reconciled to actual data in subsequent FPPAC billing periods.\nFor the period December 1, 1993 through May 31, 1994, the NHPUC approved an increase in the FPPAC rate which resulted in a 1.8% increase in overall base rates. For the period June 1, 1994 through November 30, 1994, the NHPUC approved an increase in the FPPAC rate consistent with an overall increase in base rates of 5.5% For the period December 1, 1994 through May 31, 1995, the NHPUC approved a continuation of the current FPPAC rate. This rate treatment allowed PSNH to limit overall rate increases in 1994 to a level that did not exceed 5.5%, while maintaining an FPPAC rate level sufficient to collect the Seabrook refueling costs over four periods through rates by the end of November 30, 1995. The FPPAC rate is not expected to increase in 1995.\nThe costs associated with purchases by PSNH from certain NUGs at prices over the level assumed in rates and a portion of the payments to New Hampshire Electric Cooperative, Inc. (NHEC) for PSNH's buyback of NHEC's Seabrook entitlement are deferred and recovered through the FPPAC over ten years. As of December 31, 1994, NUG and NHEC deferrals totaled approximately $174 and $20.3 million, respectively.\nUnder the Rate Agreement, PSNH has an obligation to use its best efforts to renegotiate burdensome purchase power arrangements with 13 specified NUGs that were selling their output to PSNH under long term rate orders. In general, PSNH has been attempting to exchange present cash payments for relief from high-cost purchased power obligations to the NUGs, with such payments and an associated return being recoverable from customers over a future amortization period. For more information regarding the Rate Agreement, see \"PSNH Rate Agreement\" in the notes to NU's and PSNH's financial statements.\nOn April 19, 1994, the NHPUC approved new purchase power agreements with five hydroelectric NUGs. These agreements were effective retroactive to January 1993. Management anticipates that the initial decrease in payments to these NUGs during a year with normal water flow will average approximately 14 percent or $1.4 million per year. PSNH will flow the savings resulting from these new agreements through the FPPAC to its customers. The first of these new power purchase agreements will expire in 2022. The NHPUC deferred action on whether PSNH had exercised its best effort to renegotiate the agreements.\nIn addition, PSNH has been involved in negotiations with eight wood-fired NUGs. On September 23, 1994, the NHPUC approved settlement agreements with two wood-fired NUGs covering approximately 20 MW of capacity. Pursuant to the settlement agreements, PSNH paid the owners approximately $40 million in exchange for the cancellation of the rate orders under which these NUGs sold their entire output at rates in excess of PSNH's replacement power costs. These NUGs also agreed not to compete with PSNH or other NU subsidiaries. Under New Hampshire legislation passed in May 1994, PSNH and the remaining six wood-fired NUGs were directed to continue negotiations concerning their power sales arrangements. Absent successful negotiations, the parties were directed to enter into a mediation process to be completed by November 14, 1994. The legislation required the parties to attempt to agree on a settlement under which the payments PSNH made for the NUGs' power would be lowered but the plants would continue to operate. At a January 4, 1995 status hearing, the NHPUC directed further mediation to take place with a representative from the State of New Hampshire assisting the parties. Only one agreement emerged from the mediation process, which calls for a payment of $52 million in return for a substantial reduction in the rates charged to PSNH. This agreement was filed with the NHPUC in February 1995.\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 its non-Seabrook assets and the value assigned to Seabrook. The unrecovered balance of the regulatory asset at December 31, 1994 was approximately $679 million. In accordance with the Rate Agreement, approximately $204 million of the remaining regulatory asset is scheduled to be amortized and recovered through rates by 1998, and the remaining amount, approximately $475 million, is being amortized and recovered through rates by 2011. PSNH earns a return each year on the unamortized portion of the asset. For more information regarding PSNH's recovery of this regulatory asset after 1997, see \"Regulatory Asset-PSNH\" in the notes to NU's financial statements and \"Regulatory Asset\" in the notes to PSNH's financial statements.\nSEABROOK POWER CONTRACT\nPSNH and NAEC entered into the Seabrook Power Contract (Contract) in June 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 1-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. At December 31, 1994, NAEC's net utility plant investment in Seabrook 1 was approximately $718 million.\nIf Seabrook 1 were retired prior to the expiration of its NRC operating license term, NAEC would continue to be entitled under the Contract to recover its remaining Seabrook investment and a return on that investment and its other Seabrook-related costs for 39 years, less the period during which Seabrook 1 has operated.\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 and a portion of the initial investment) is calculated based on NAEC's actual capitalization 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 has increased annually since May 1991 and will reach 100 percent by 1997. As of December 31, 1994, 70 percent of the initial 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, together with a return on it, will be recovered between 1997 and 2001. At December 31, 1994, the amount of this deferred return was $131.5 million. For additional information regarding the Contract and a similar contract, which involves NAEC's acquisition of Vermont Electric Generation and Transmission Cooperative, Inc.'s ownership interest in Seabrook, see \"Seabrook Power Contract\" in the notes to PSNH's financial statements.\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.\nOn May 26, 1994, the DPU approved a settlement offer from WMECO and the Massachusetts Attorney General that, among other things, provided that: (1) all pending WMECO generating unit performance review proceedings regarding unit outages from mid-1987 through mid-1993 would be terminated without findings; (2) WMECO's customers' overall bills will be reduced by approximately $13.3 million over the 20-month period June 1, 1994 to January 31, 1996; (3) WMECO will not file for increased base rates effective before February 1, 1996; (4) WMECO will amortize post-retirement benefits other than pensions costs over a three-year period starting July 1, 1994; and (5) WMECO will offer a five percent rate reduction to its largest customers who agree not to self-generate or take electricity from another provider for five years. The settlement did not have a significant adverse impact on WMECO's 1994 earnings.\nDEMAND SIDE MANAGEMENT\nIn 1992, the DPU established a conservation charge (CC) to be included in WMECO's customers' bills. The CC includes incremental DSM program costs above or below base rate recovery levels, lost fixed cost recovery adjustments, and the provision for a DSM incentive mechanism. On January 21, 1994 the DPU approved a settlement offer from WMECO, the Massachusetts Attorney General, the Massachusetts Division of Energy Resources (DOER), the Conservation Law Foundation (CLF) and the Massachusetts Public Interest Research Group (MASSPIRG) pre-approving DSM funding levels for 1994 and 1995 of $14.2 million and $15.8 million, respectively. The settlement also provides for cost recovery adjustments and an incentive mechanism if certain implementation objectives are met.\nIn a subsequent proceeding, the DPU established a CC for each rate class at least through 1994 (and ordered deferred recovery of conservation-related costs in connection with two rate classes) and examined the level of conservation savings delivered by WMECO programs in prior years (and disallowed certain claimed conservation savings). On January 11, 1995, the DPU initiated hearings to set CCs for 1995, review the claimed level of conservation savings delivered and review the mechanism for determining lost fixed-cost recovery. Recently, in proceedings involving two other utilities, the DPU changed its policy to limit recovery of lost revenues due to implementation of conservation measures to a fixed period. If such a policy is implemented for WMECO, WMECO could lose several millions of dollars of revenues starting in 1996 and possibly as early as 1995. Further hearings for WMECO's docket are scheduled for March 1995. Management cannot predict when the DPU will issue a decision in this case.\nWMECO FUEL ADJUSTMENT CLAUSE AND GENERATING UNIT OPERATING PERFORMANCE\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 on a system-wide basis 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. 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. 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 operating units (the Yankee plants) in which WMECO has ownership interests.\nSubsequent to the May 26, 1994 settlement between WMECO and the DPU, the DPU initiated a review of WMECO's 1993-1994 generating unit performance. Hearings have not begun in that proceeding and it is not known when the DPU may issue a decision.\nRESOURCE PLANS\nCONSTRUCTION\nThe System's construction program expenditures, including allowance for funds used during construction (AFUDC), in the period 1995 through 1999 are estimated to be as follows:\n1995 1996 1997 1998 1999 (Millions)\nCL&P $148 $136 $144 $145 $145\nPSNH 51 36 32 39 39\nWMECO 36 28 29 39 39\nNAEC 5 8 7 6 6\nOTHER 14 10 10 10 10 ---- ---- ---- ---- ----\nTOTAL $254 $218 $222 $239 $239 ==== ==== ==== ==== ====\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. The construction program's main focus is maintaining and upgrading the existing transmission and distribution system, as well as nuclear and fossil-generating facilities.\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 periodically updates its long-range resource needs through its integrated demand and supply planning process. The System does not foresee the need for any new major generating facilities at least until 2009.\nThe System's long-term plans rely, in part, on certain DSM programs. These System company sponsored measures, including installations to date, are projected to lower the System summer peak load in 2009 by over 650 MW. See \"Rates - Connecticut Retail Rates - Demand Side Management\" and \"Rates - Massachusetts Retail Rates - Demand Side Management\" for information about rate treatment of DSM costs.\nIn addition, System companies have long-term arrangements to purchase the output from certain NUGs under federal and state laws, regulations and orders mandating such purchases. NUGs supplied 680 MW of firm capacity in 1994. This is the maximum amount that the System companies expect to purchase from NUGs for the foreseeable future. See \"New Hampshire Retail Rates - Rate Agreement and FPPAC\" for information concerning PSNH's efforts to renegotiate its agreements with thirteen NUGs.\nThe System's long-term resource plan also considers the economic viability of continuing the operation of certain of the System's fossil fuel generating units beyond their current book retirement dates and possibly repowering certain of the System's older fossil plants. Continued operation of existing fossil fuel units past their book retirement dates (and replacing certain critically located peaking units if they fail) is expected to provide approximately 1900 MW of resources by 2009 that would otherwise have been retired. In addition, repowering of some of the System's retired generating plants could provide the System with approximately 900 MW of capacity. The capacity could be brought on line in various increments timed with the year of need.\nThe System's need for new resources may be affected by unscheduled retirements of its existing generating units, regulatory approval of the continued operation of fossil fuel units and nuclear units past scheduled retirement dates and deactivation of plants resulting from environmental compliance or licensing decisions. For information regarding the agreement concerning NOX emissions at the Merrimack units, see \"Regulatory and Environmental Matters - Environmental Regulation - Air Quality Requirements.\" See \"Electric Operations - Nuclear Generation - Nuclear Plant Licensing and NRC Regulation\" and - \"Nuclear Performance\" 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 the 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.\nThe System's long-term resource plan also anticipates that the System's nuclear units will continue to run through the scheduled terms of their respective operating licenses. For information regarding the early retirement of one of the System's nuclear units, see \"Electric Operations - Nuclear Generation - Nuclear Performance\" and - \"Decommissioning.\"\nFINANCING PROGRAM\n1994 FINANCINGS\nIn 1994, CL&P and WMECO issued $535 and $90 million, respectively, of first mortgage bonds. In virtually all cases, new issues of first mortgage bonds were of smaller principal amounts than the issues that were retired with the proceeds of such issuances, with cash derived from operations making up the balance of funds needed to effect the retirements. This was done as part of NU's overall effort to reduce the System companies' debt levels. Total debt, including short-term and capitalized leased obligations, was $4.54 billion as of December 31, 1994, compared with $4.88 billion as of December 31, 1993 and $5.21 billion as of December 31, 1992. For more information regarding 1994 financings, see Notes to Consolidated Statements of Capitalization of NU and \"Long-Term Debt\" in the notes to CL&P's, PSNH's, WMECO's and NAEC's financial statements. 1995 FINANCING REQUIREMENTS\nIn addition to financing the construction requirements described under \"Resource Plans - Construction,\" the System companies are obligated to meet $1.3 billion of long-term debt maturities and cash sinking fund requirements and $124.9 million of preferred stock cash sinking fund requirements in 1995 through 1999. In 1995, long-term debt maturity and cash sinking fund requirements will be $175.8 million, consisting of $11.9 million of cash sinking fund requirements to be met by CL&P, $94 million of cash sinking fund requirements to be met by PSNH, $35.8 million of long-term debt maturities and cash sinking fund requirements to be met by WMECO, $20 million of cash sinking fund requirements to be met by NAEC and $14.1 million of cash sinking fund requirements to be met by other subsidiaries.\nThe System's aggregate capital requirements for 1995, exclusive of requirements under the Niantic Bay Fuel Trust (NBFT), are as follows:\nTotal CL&P PSNH WMECO NAEC Other System (Millions of Dollars) Construction (including AFUDC)..... $148 $51 $36 $ 5 $14 $254 Nuclear Fuel (excluding AFUDC).. 47 1 11 9 - 68 Maturities.............. - - 35 - - 35 Cash Sinking Funds.. 12 94 1 20 14 141 ---- ---- --- --- --- ----\nTotal........... $207 $146 $83 $34 $28 $498 ==== ==== === === === ====\nFor further information on NBFT and the System's financing of its nuclear fuel requirements, see \"Leases\" in the notes to NU's, CL&P's and WMECO's financial statements.\n1995 FINANCING PLANS\nThe System companies currently expect to finance their 1995 requirements through internal cash flow and short-term debt. This estimate excludes the nuclear fuel requirements financed through the NBFT. In addition to financing their 1995 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. On January 23, 1995, CL&P issued, through an affiliate, $100 million of 9.3 percent Monthly Income Preferred Securities, to help finance the retirement of approximately $125 million of preferred stock.\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 1935 Act.\nThe following table shows the amount of short-term borrowings authorized by the SEC for each company as of January 1, 1995 and the amounts of outstanding short-term debt of those companies at the end of 1994.\nMaximum Authorized Short-Term Debt Short-Term Debt Outstanding at 12\/31\/94* (Millions) NU.................. $ 150 $ 104 CL&P ............... 325 179 PSNH ............... 175 - WMECO............... 60 - HWP................. 5 - NAEC................ 50 - NNECO............... 50 6 RRR................. 22 17 Quinnehtuk.......... 8 5 HEC................. 11 2 -----\nTotal $ 313 =====\n----------------- * 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 $190 million at December 31, 1994.\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, 1995, 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, 1994, CL&P's charter would permit CL&P to incur an additional $450.3 million of unsecured debt and WMECO's charter would permit it to incur an additional $145.5 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, 1994, CL&P's common equity ratio was 42.0 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, 1994, NU's common equity ratio was 33.4 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 23 percent of total capitalization (as defined) 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 1.75 to 1 at the end of each fiscal quarter for the remaining term of the agreement. At December 31, 1994, PSNH's common equity ratio was 32.7 percent and its operating income to interest expense ratio for the twelve-month period was 2.69 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, PSNH's and WMECO'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.\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, 1994, 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.\nSEC 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 and 1994, PSNH did not pay dividends, to allow it to build up the common equity portion of its capitalization and to fund the buyout of certain NUGs operating in New Hampshire. See \"Rates - New Hampshire Retail Rates - Rate Agreement and FPPAC.\" NAEC paid dividends of $5 million in each of the third and fourth quarters of 1994. If PSNH does not fund its pro rata share of NU's dividend requirements, NU expects to fund that portion of its dividend requirements with the proceeds of borrowings or the issuance of additional common shares under the dividend reinvestment plan.\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, 1994, CL&P had $225.6 million, WMECO had $90.1 million and PSNH had $125.0 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, 1994, $69.2 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. At December 31, 1994, $162 million was available to be paid under these provisions.\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 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 4.0 million (2.5 million in Connecticut, 959,000 in New Hampshire and 582,000 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 1994, CL&P furnished retail electric service to approximately 1.1 million customers in Connecticut, PSNH provided retail electric service to approximately 400,000 customers in New Hampshire and WMECO served approximately 194,000 retail electric customers in Massachusetts. HWP serves 46 retail customers in Holyoke, Massachusetts.\nThe following table shows the sources of 1994 electric revenues based on categories of customers:\nCL&P PSNH WMECO NAEC Total System Residential........... 41% 35% 38% - 40% Commercial............ 34 28 31 - 33 Industrial ........... 14 18 19 - 16 Wholesale* ........... 9 16 9 100% 9 Other ................ 2 3 3 - 2 ---- ---- ---- ---- ---- Total ................ 100% 100% 100% 100% 100% * Includes capacity sales.\nNAEC's 1994 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, 1994, the all-time maximum demand on the System was 6339 MW, which occurred on July 21, 1994. The System was also selling approximately 896 MW of capacity to other utilities at that time. At the time of the peak, the System's generating capacity, including capacity purchases, was 8948 MW.\nSystem energy requirements were met in 1993 and 1994 as set forth below:\nSource 1994 1993\nNuclear .................................... 54% 62% Oil ........................................ 7 7 Coal ....................................... 8 10 Hydroelectric .............................. 4 3 Natural gas ................................ 3 2 NUGs ....................................... 14 14 Purchased power............................. 10 2 ----- ---\n100% 100%\nThe actual changes in kilowatt-hour sales for the last two years and the forecasted sales growth estimates for the 10-year period 1994 through 2004, in each case exclusive of bulk power sales, for the System, CL&P, PSNH and WMECO are set forth below:\n1994 over 1993 over Forecast 1994-2004 1993 (under) 1992 Compound Rate of Growth\nSystem......... 2.50% 10.9%(1) 1.2% CL&P........... 3.66% (0.3)% 1.1% PSNH........... 1.56% 1.0% 1.5% WMECO....... 1.47% 0.1% 1.2%\n(1) The percent increase in System 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 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 kilowatt-hour 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:\n1994 over (under) 1993 1993 over (under) 1992\nSystem ................... 2.37% 11.8% CL&P ..................... 3.33% 1.2% PSNH ..................... (1.35)% (9.3)% WMECO .................... 5.58% 13.5%\nFor a discussion of trends in bulk power sales, see \"Competition and Marketing.\"\nThe System's total kilowatt-hour sales grew 2.5% in 1994 because of economic growth. The growth was broad-based and was not dominated by any particular industry or sector. Partially offsetting the gains in the economy were continued curtailments in the defense and insurance industries, which particularly affected the CL&P service area. Such curtailments should continue into 1995, which, combined with the efforts of the Federal Reserve to slow the national recovery, have the potential to further thwart New England's recovery. Moreover, 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 more information on the effect of competition on sales growth rates, see \"Competition and Marketing.\"\nIn spite of further defense and insurance curtailments moderate growth is forecasted to resume over the next ten years. The System forecasts a 1.2% growth rate of sales over this period. This growth rate is significantly below historic rates because of anticipated labor force constraints and, in part, because of forecasted savings from System sponsored DSM programs that 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 0.5% higher if the System did not pursue DSM programs at the forecasted levels. See \"Rates - Connecticut Retail Rates\" and \"Rates - Massachusetts Retail Rates\" for information about rate treatment of DSM costs. With the System's generating capacity of 8,241 MW as of January 1, 1995 (including the net of capacity sales to and purchases from other utilities, and approximately 688 MW of capacity purchased from NUGs under existing contracts), the System expects to meet reliably its projected annual peak load growth of 1.2 percent until at least the year 2009.\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. 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 or purchases from other utilities that are not subject to firm commitments, the System's installed reserve is expected to be approximately 1,700 MW in the summer of 1995. For further information on the effect of competition on sales of surplus capacity, see \"Competition and Marketing.\"\nThe System companies operate and dispatch their generation as provided in the New England Power Pool (NEPOOL) Agreement. In 1994, the peak demand on the NEPOOL system was 20,519 MW in July, which was 949 MW above the 1993 peak load of 19,570 MW in July of that year. NEPOOL has projected that there will be a decrease in demand in 1995 and estimates that the summer 1995 peak load could reach 20,425 MW. NEPOOL projects that sufficient capacity will be available to meet this anticipated demand.\nGENERATION AND TRANSMISSION\nThe System companies and most other New England utilities with electric generating facilities are parties to the NEPOOL Agreement. Under the NEPOOL Agreement, planning and operation of the region's generation and transmission facilities are coordinated. 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. NEPOOL's objectives are to assure that the bulk power supply of New England and adjoining areas conforms to proper standards of reliability, to attain maximum practical economy in the bulk power supply system consistent with such reliability standards and to provide for equitable sharing of the resulting benefits and costs.\nThe System companies, except PSNH and NAEC, pool their electric production costs and the costs of their principal transmission facilities under the Northeast Utilities Generation and Transmission Agreement (NUG&T). In addition, a ten-year agreement, expiring in June 2002, 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 January 1992, FERC issued a decision approving NU's acquisition of PSNH, provided that the combined system accord transmission access to other utilities and non-utility generators that need to use the NU-PSNH transmission system to buy or sell electricity. FERC noted that NU system customers should remain harmless from the granting of such access. In accordance with the January 1992 decision, in April and August 1992, NU made compliance filings with FERC, including transmission tariffs implementing such conditions. FERC has made all tariffs effective as of the merger date based on interim rates and terms of service established by FERC pursuant to summary determinations (without hearing). NU 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. For information regarding the appeal of FERC's approval of NU's acquisition of PSNH, see \"Legal Proceedings.\"\nThe terms on which wheeling transactions are to be effected in New England have stimulated a series of negotiations among utilities, regulators, power brokers and marketers and non-utility generators, directed at the possible development of a regional transmission group within New England. Any arrangement would require widespread support by the parties and be subject to approval by FERC.\nFOSSIL FUELS\nThe System's residual oil-fired generation stations used approximately six million barrels of oil in 1994. The System obtained the majority of its oil requirements in 1994 through contracts with two large, independent oil companies. Those contracts allow for some spot purchases when market conditions warrant, but spot purchases represented less than 10 percent of the System's fuel oil purchases in 1994. The contracts expire annually or biennially. The System currently does not anticipate any difficulties in obtaining necessary fuel oil supplies on economic terms.\nThe System converted CL&P's Devon Units 7 and 8 into oil and gas dual-fuel generating units in July 1994. The System now has five generating stations, aggregating approximately 800 MW, which can burn either residual oil or natural gas as economics, environmental concerns or other factors dictate. CL&P, PSNH and WMECO all have contracts with the local gas distribution companies where the dual-fuel generating units are located, under which natural gas is made available by those companies on an interruptible basis. In addition, gas for the Devon units is being purchased directly from producers and brokers on an interruptible basis and transported through the interstate pipeline system and the local gas distribution company. The System expects that interruptible natural gas will continue to be available for its dual-fuel electric generating units on economic terms and will continue to supplement fuel oil requirements.\nSee \"Derivative Financial Instruments\" in the notes to NU's and CL&P's financial statements for information about CL&P's oil and natural gas swap agreements to hedge against fuel price risk on certain long-term fixed-price energy contracts.\nThe System companies obtain their coal through long-term supply contracts and spot market purchases. The System companies currently have an adequate supply of coal. Because of changes in federal and state air quality requirements, the System expects to use lower sulfur coal in its plants in the future. See \"Regulatory and Environmental Matters - Environmental Regulation - Air Quality Requirements.\"\nNUCLEAR GENERATION\nGENERAL\nThe System companies have interests in seven operating nuclear units: Millstone 1, 2 and 3, Seabrook 1 and three other units, Connecticut Yankee (CY), Maine Yankee (MY), and Vermont Yankee (VY), owned by regional nuclear generating companies (the Yankee companies). System companies operate the three Millstone units and Seabrook 1 and have operational responsibility for CY. The System companies also have interests in Yankee Rowe owned by the Yankee Atomic Electric Company (YAEC), 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 52.93 percent, PSNH's ownership interest in the unit is 2.85 percent and WMECO's interest is 12.24 percent. NAEC and CL&P have 35.98 percent and 4.06 percent ownership interests, respectively, in Seabrook. The Millstone 3 and Seabrook joint ownership agreements provide for pro rata sharing by the owners of each unit of the construction and operating costs, the electrical output and the associated transmission costs.\nCL&P and NAEC have been affected at times by the inability of certain 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, began bankruptcy proceedings in February 1991. On November 11, 1994, a final plan of reorganization of GBPC was confirmed by the United States Bankruptcy Court. Under the plan of reorganization's financing agreement, on November 22, 1994 a group of investors purchased 60 percent of the reorganized GBPC's common stock for an investment of $35 million and repaid CL&P $7.3 million for advances which CL&P made to cover GBPC's shortfalls in funding its share of operating costs of Seabrook during the bankruptcy.\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 in the Yankee companies are set forth below:\nCL&P PSNH WMECO System Connecticut Yankee Atomic Power Company (CYAPC) ...... 34.5% 5.0% 9.5% 49.0% Maine Yankee Atomic Power Company (MYAPC) ............ 12.0% 5.0% 3.0% 20.0% Vermont Yankee Nuclear Power Corporation (VYNPC)... 9.5% 4.0% 2.5% 16.0% Yankee Atomic Electric Company (YAEC) ............ 24.5% 7.0% 7.0% 38.5%\nCL&P, PSNH and WMECO are obligated to provide their percentages of any additional equity capital necessary for the Yankee companies, but do not expect to contribute additional equity capital in the future. CL&P, PSNH and WMECO believe that the Yankee companies, excluding YAEC, could require additional external financing in the next several years to finance construction expenditures, nuclear fuel and for other purposes. Although the ways in which each Yankee company would attempt to finance these expenditures, if they are needed, 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. NUCLEAR PLANT LICENSING AND NRC REGULATION\nThe operators of Millstone 1, 2 and 3, CY, MY, VY and Seabrook 1 hold full power operating licenses from the NRC. As holders of licenses to operate nuclear reactors, CL&P, WMECO, NAESCO, 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. The NRC issues 40-year initial operating licenses to nuclear units and NRC regulations permit renewal of licenses for an additional 20 year period.\nIn addition, activities related to nuclear plant operation are routinely inspected by the NRC for compliance with NRC regulations. The NRC has authority to enforce its regulations through various mechanisms which include the issuance of notices of violation (NOV) and civil monetary penalties. Several regulatory enforcement actions, with associated civil monetary penalties aggregating $357,500, were taken by the NRC in 1994 for certain violations which occurred at Millstone Station. However, approximately $270,000 of such amounts related to violations that occurred prior to 1994.\nThe NRC also regularly conducts generic reviews of technical and other issues, a number of which may affect the nuclear plants in which System companies have interests. 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. One such issue that has received considerable attention from the NRC in the last several years concerns the ability and willingness of nuclear plant workers to raise nuclear safety concerns without fear of retaliation for doing so. The NRC has identified the Millstone Station in particular as a site where workers have expressed concern with their ability to raise nuclear safety issues to company supervisors and managers. Management is aware of the NRC's concerns in this area, and is taking steps to ensure that the environment at Millstone is one where workers feel free to raise issues without fear of retaliation.\nNUCLEAR PLANT PERFORMANCE\nCapacity factor is a ratio that compares a unit's actual generating output for a period with the unit's maximum potential output. The average capacity factor for operating nuclear units in the United States was 73.2 percent for January through September 1994, and 67.5 percent for the five nuclear units operated by the System in 1994, compared with 80.8 percent for 1993. The lower 1994 capacity factor was primarily due to extended refueling and maintenance outages at Millstone 1, Millstone 2 and Seabrook and unexpected technical and operating difficulties at Millstone 2, Seabrook and CY.\nThe System anticipates total expenditures in 1995 of approximately $477.5 million for operations and maintenance and $82.2 million in capital improvements for the five nuclear plants that it operates. The Performance Enhancement Program (PEP), initiated in 1992 by the System's nuclear organization, was designed in response to a declining performance trend noted in the early 1990's. Seven PEP action plans were completed in 1994. The System companies spent $25.2 million on PEP in 1994 and have budgeted $21.7 million (included in the 1995 operations and maintenance annual budget) for 1995 PEP action plans. The remaining nine action plans are expected to be completed by the end of 1997.\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 replacement power costs is permitted, subject to prudence reviews, through the GUAC for CL&P, through FPPAC for PSNH and through a retail fuel adjustment clause for WMECO. 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 - New Hampshire Retail Rates\" and \"Rates - Massachusetts Retail Rates.\"\nMILLSTONE UNITS\nFor the twelve months ended December 31, 1994, the three Millstone units' composite capacity factor was 66.4 percent, compared with a composite capacity factor of 79.3 percent for the twelve months ended December 31, 1993 and 53.1 percent for the same period in 1992.\nMillstone 1, a 660 MW boiling water reactor, has a license expiration date of October 6, 2010. In 1994, Millstone 1 operated at a 58.3 percent capacity factor. The unit began a 71 day planned refueling and maintenance outage on January 15, 1994. Millstone 1 returned to service on May 20, 1994, for an outage duration of 125 days. The delay in completing the outage on schedule was primarily attributable to unanticipated work associated with the service water systems, certain system valves and surveillance testing. The next refueling outage is scheduled for October 1995.\nMillstone 2, a 870 MW pressurized water reactor, has a license expiration date of July 31, 2015. In 1994 Millstone 2 operated at a 48.2 percent capacity factor. The unit began a planned 63-day refueling and maintenance outage on October 1, 1994. Subsequent events have added substantially to the duration of the refueling outage and at present, the unit is not expected return to service before mid-April 1995. Earlier in 1994, Millstone 2 experienced a 57-day unplanned maintenance outage which ended on June 18, 1994 and a second unplanned outage to repair the reactor coolant pump oil collection system from July 27, 1994 to September 3, 1994. The recovery of replacement power operation and maintenance costs incurred during these outages are subject to prudence reviews in both Connecticut and Massachusetts.\nA recent report issued by the NRC for the Millstone Station noted significant weaknesses in Millstone 2's operations and maintenance. Subsequently, a senior NRC official expressed disappointment with the continued weaknesses in Millstone 2's performance. The primary cause of the NRC's disappointment with Millstone 2's performance appears to be that, despite significant management attention and action over a period of years, the NRC does not believe it has seen enough objective evidence of improvement in reducing procedural noncompliance and other human errors. Management has acknowledged the basis for the NRC's concern with Millstone 2 and has been devoting increased attention to resolving these issues. Management and the NRC expect to continue to closely monitor performance at Millstone 2.\nMillstone 3, a 1154 MW pressurized water reactor, has a license expiration date of November 25, 2025. In 1994, Millstone 3 operated at a 94 percent capacity factor. The unit had no planned refueling and maintenance outages in 1994. Millstone 3 experienced one unplanned outage in 1994 which lasted from September 8, 1994 to September 22, 1994. The next refueling outage is scheduled to begin on April 14, 1995, with a planned duration of 54 days. SEABROOK\nSeabrook 1, a 1148 MW pressurized water reactor, has a license expiration date of October 17, 2026. The Seabrook operating license expires 40 years from the date of issuance of authorization to load fuel, which was about three and a half years before Seabrook's full power operating license was issued. The System will determine at the appropriate time whether to seek recapture of this period from the NRC and thus add an additional three and a half years to the operating term for Seabrook. In 1994, Seabrook operated at a capacity factor of 61.6 percent. The unit began a scheduled refueling and maintenance outage on April 9, 1994. The unexpected discovery of reactor coolant pump locking cups and a bolt in the reactor vessel contributed substantially to the duration of the outage. The unit returned to service on August 1, 1994 for an outage duration of 114 days. Seabrook experienced one unplanned outage in 1994 which lasted from January 26 to February 17, 1994 when a main steam isolation valve closed during quarterly surveillance testing. The next refueling outage is scheduled for November 1995.\nYANKEE UNITS\nCONNECTICUT YANKEE\nCY, a 582 MW pressurized water reactor, has a license expiration date of June 29, 2007. In 1994 CY operated at a capacity factor of 75.4 percent. CY experienced two unplanned outages with durations greater than two weeks in 1994. The first such outage began in February 1994 and lasted 44 days in order to repair and replace service water piping. On July 11, 1994 the unit began a second forced outage to upgrade the oil collection system for the reactor coolant pumps. The unit returned to service on August 17, 1994. CY began a planned refueling and maintenance outage on January 28, 1995, with a scheduled duration of 51 days.\nMAINE YANKEE\nMY, a 870 MW pressurized water reactor, has a license expiration date of October 21, 2008. MY's operating license expires 40 years from the date of issuance of the construction permit, which was about four years before MY's full power operating license was issued. At the appropriate time, MYAPC will determine whether to seek recapture of this construction period from the NRC and add it to the term of the MY operating license. In 1994, MY operated at a capacity factor of 85.9 percent. The current refueling outage began in January 1995.\nVERMONT YANKEE\nVY, a 514 MW boiling water reactor, has a license expiration date of March 21, 2012. In 1994, VY operated at a capacity factor of 94.4 percent. The current refueling outage began on March 17, 1995.\nYANKEE ROWE\nIn February 1992, YAEC's owners voted to shut down Yankee Rowe permanently 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 certain regulatory requirements. The power contracts between CL&P, PSNH and WMECO and YAEC permit YAEC to recover from each its proportional share of the Yankee Rowe shutdown and decommissioning costs. For more information regarding recovery of decommissioning costs for Yankee Rowe, see \"Electric Operations - Nuclear Generation - Decommissioning.\"\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 rule 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. For more information regarding nuclear insurance, see \"Nuclear Insurance Contingencies\" in the notes of NU's, CL&P's, PSNH's, WMECO's and NAEC's financial statements.\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. The System companies have maintained diversified sources of supply for these materials and services, relying on no single source of supply for any one component of the fuel cycle. The majority of the System companies' uranium enrichment services requirements are provided under a long term contract with the U.S. Enrichment Corporation, a wholly-owned government corporation. The majority of Seabrook 1's uranium enrichment services requirements, however, are furnished by a Russian trading company. 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. commercial nuclear power industry is required to pay to the DOE, via a special assessment for the costs of the decontamination and decommissioning of uranium enrichment plants owned by the U.S. government, no more than $150 million for 15 years beginning in 1993. Each domestic nuclear utility will make a payment based on its pro rata share of all enrichment services received by the U.S. commercial nuclear power industry from the U.S. Government through October 1992. Each year, the U. S. Department of Energy (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 $51 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 a regulatory asset, with a corresponding obligation on its balance sheet.\nCosts associated with nuclear plant operations include amounts for disposal of nuclear waste, 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 FERC-approved wholesale charges. Such provisions include amortization and recovery in rates of previously unrecovered disposal costs of accumulated spent nuclear fuel.\nHIGH-LEVEL RADIOACTIVE WASTE\nThe Nuclear Waste Policy Act of 1982 (NWPA), provides that the federal government is responsible for the permanent disposal of spent nuclear reactor fuel and high-level waste. As required by the NWPA, electric utilities generating spent nuclear fuel and high-level waste are obligated to pay fees into a fund which would be used to cover the cost of siting, constructing, developing and operating a permanent disposal facility for this waste. The System companies have been paying for such services for fuel burned starting in April 1983 on a quarterly basis since July 1983. The DPUC, the NHPUC and the DPU permit the fee to be recovered through rates.\nIn return for payment of the fees prescribed by the NWPA, the federal government is to take title to and dispose of the utilities' high-level wastes and spent nuclear fuel. The NWPA provides that a disposal facility be operational and for the DOE to accept nuclear waste for permanent disposal in 1998. In late 1993 and 1994, DOE indicated that it was not likely to meet its statutory and contractual obligations to accept spent fuel in 1998.\nIn June 1994, the DPUC joined with the Connecticut and Massachusetts Attorneys General and a number of states in a lawsuit filed in federal court against the DOE, seeking a declaratory judgment that the DOE has a statutory obligation to take high-level nuclear waste from utilities in 1998 and to establish judicially administered milestones to enforce that obligation. The State of New Hampshire, among others, subsequently joined in this lawsuit. NU and its affiliates did not join a companion lawsuit filed by fourteen utilities seeking similar relief. Nuclear utilities and state regulators are presently considering additional steps which they might take to ensure that the DOE is able to meet its obligations with regard to nuclear waste disposal as soon as possible.\nUntil the federal government begins accepting nuclear waste for disposal, 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. 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.\nMY'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. On March 15, 1994, the NRC authorized this plan. MYAPC believes that the replacement of the fuel racks will provide adequate storage capacity through MY's current licensed operating life.\nThe storage capacity of the spent fuel pool at VY is expected to be reached in 2005, and the available capacity of the pool is expected to be able to accommodate full-core removal until 2001.\nBecause the Yankee Rowe plant was permanently shut down effective February 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 WASTE\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 low-level radioactive wastes (LLRW) from outside its compact region. On July 1, 1994, the Barnwell, South Carolina LLRW facility ceased accepting LLRW for disposal from states situated outside its compact region. The NU System is currently implementing plans for the temporary on-site storage of LLRW generated at its nuclear facilities. The costs associated with temporary on-site storage of LLRW are not material. The System has plans that will allow for the storage of LLRW until a permanent disposal facility becomes available. The System can manage its Connecticut LLRW by volume reduction, storage or shipment at least through 1999. In addition, an NRC policy memorandum provides additional guidance on interim LLRW storage by removing any time limitations on the on-site storage of LLRW and by allowing for modification and expansion of storage facilities without prior NRC approval. The Millstone units and CY incurred approximately $6.8 million in off-site disposal costs in 1994.\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. On February 1, 1993, the Connecticut legislature approved a 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 through 1996. The Service's activities in this regard are funded by assessments on Connecticut's LLRW generators. Due to the change to a volunteer process, there was no assessment for the 1994-1995 fiscal year and the state projects no assessment for the 1995-1996 and 1996-1997 fiscal years. Management cannot predict whether and when a disposal site will be designated in Connecticut. The Service currently projects that a disposal site will be designated by 2002.\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 $2.0 million in off-site disposal costs in 1994. New Hampshire is pursuing options for out-of-state disposal of LLRW generated at Seabrook. 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 implementing an agreement with Texas to provide access to a LLRW facility that is to be developed in that state.\nDECOMMISSIONING\nBased upon the System's most recent comprehensive site-specific updates of the decommissioning costs for each of the three Millstone units and for Seabrook, the recommended decommissioning method 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, 1994 dollars, and include costs allocable to NAEC's share of Seabrook acquired from VEG&T.\nCL&P PSNH WMECO NAEC System (Millions) Millstone 1 $332.8 $ - $ 78.1 $ - $ 410.9 Millstone 2 267.3 - 62.7 - 330.0 Millstone 3 237.5 12.8 54.9 - 305.2 Seabrook 1* 15.5 - - 137.3 52.8 ------ ----- ------ ------ --------\nTotal $853.1 $12.8 $195.7 $137.3 $1,198.9 ====== ===== ====== ====== ========\n--------------- * The Seabrook decommissioning estimate currently is under review by the New Hampshire Nuclear Decommissioning Finance Committee (NDFC).\nAs of December 31, 1994, the balances (at market) in certain external decommissioning trust funds, as discussed more fully below, were as follows:\nCL&P PSNH WMECO NAEC System (Millions)\nMillstone 1 $ 81.5 $ - $ 27.4 $ - $108.9 Millstone 2 52.1 - 18.5 - 70.6 Millstone 3 37.2 1.8 10.2 - 49.2 Seabrook 1 1.2 - - 10.3 11.5 ------ ---- ------ ----- ------\nTotal $172.0 $1.8 $ 56.1 $10.3 $240.2 ====== ==== ===== ===== ======\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 System cost of decommissioning the Millstone units is approximately $1.05 billion in December 1994 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, collections from customers in future years will need to increase 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 NDFC established approximately $323 million (in 1991 dollars) as the decommissioning cost estimate for immediate and complete dismantlement of Seabrook 1 upon its retirement. North Atlantic prepared a revised decommissioning estimate in 1994. The revised estimate is currently under review by the NDFC. Public hearings were held in the fourth quarter of 1994. Approval of the estimate is expected in late April, 1995. On the basis of North Atlantic's 1994 revised estimate, the total System decommissioning cost for Seabrook 1 is $152.8 million in December 1994 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.\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. The estimates are based on the latest site studies, escalated to December 31, 1994 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 System (Millions)\nVY $ 31.3 $13.2 $ 8.2 $ 52.7 Yankee Rowe* 100.0 28.6 28.6 157.2 CY 124.9 18.1 34.4 177.4 MY 40.6 16.9 10.1 67.6 ------ ----- ----- -----\nTotal $298.8 $76.8 $81.3 $454.9 ====== ===== ===== ======\n--------------- * The costs shown include all decommissioning costs as well as other closing costs associated with the early retirement of Yankee Rowe.\nAs of December 31, 1994, the balances (at market) in the external decommissioning trust funds for the Yankee Units were as follows:\nCL&P PSNH WMECO System (Millions) VY $ 10.8 $ 4.5 $ 2.8 $ 18.1 Yankee Rowe 26.4 7.6 7.6 41.6 CY 51.6 7.5 14.2 73.3 MY 13.0 5.4 3.3 21.7 ------ ----- ----- -----\nTotal $101.8 $25.0 $27.9 $154.7 ====== ===== ===== ======\nIn October 1994, YAEC submitted a decommissioning cost estimate as part of its decommissioning plan with the NRC. Following the receipt of NRC approval, this estimate will be filed with FERC. The estimate increased the system's ownership share of decommissioning YAEC's nuclear facility by approximately $36 million in January 1, 1994 dollars. At December 31, 1994, the estimated remaining costs amounted to $408.2 million, of which the System's share was approximately $157.1 million. Management expects that CL&P, PSNH and WMECO will continue to be allowed to recover such FERC approved costs from their customers.\nYAEC has begun component removal activities related to the decommissioning of its nuclear facility. Based on the revised decommissioning estimate and the remaining decommissioning costs in 1994 dollars, approximately nine percent of such removal activities has been completed. Management believes that, although Yankee Rowe was shut down eight years before the end of the unit's operating license, CL&P, PSNH and WMECO will recover their investments in YAEC, along with any other associated costs.\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 $362.0 million in year-end 1994 dollars. In May 1993, FERC approved a settlement agreement in a CYAPC rate proceeding allowing a revised decommissioning estimate of $294.2 million (in July 1992 dollars) to be recovered in rates beginning on June 1, 1993. This amount will increase by a stated amount each year for inflation.\nMYAPC estimates the cost of decommissioning MY at $338.3 million in December 31, 1994 dollars based on a study completed in July 1993. VYNPC estimates the cost of decommissioning VY at $329.6 million in December 31, 1994 dollars based on a study completed in March 1994.\nFor further information regarding the decommissioning of the System nuclear units, see \"Nuclear Decommissioning\" in the notes to NU's, CL&P's, PSNH's, WMECO's and NAEC's financial statements.\nNON-UTILITY BUSINESSES\nGENERAL In 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 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 EWG and FUCO power projects anywhere in the world. 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.\nCharter Oak has made strategic alliances with several experienced developers to pursue development opportunities nationwide and internationally. Charter 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. Charter Oak also owns 56 MW of the 1,875 MW Teesside natural gas-fired cogeneration facility in the United Kingdom.\nCharter 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, Latin America and the Pacific Rim. Specifically, Charter Oak is engaged in constructing a 114 MW natural gas-fired project located in the Republic of Argentina (Argentina) and plans to begin construction of a 20 MW wind project in Costa Rica in the spring of 1995. Charter Oak's share of these projects is 38 MW and 13 MW, respectively.\nAlthough Charter Oak has no full-time employees, nine NUSCO employees are dedicated to Charter Oak activities on a full-time basis. Other NUSCO employees provide services as required. NU's total investment in Charter Oak was approximately $31.0 million as of December 31, 1994. NU currently is committed to invest an additional $15 million in Charter Oak to fund completion of the natural gas-fired project in Argentina.\nENERGY MANAGEMENT SERVICES\nIn 1990, NU organized a subsidiary corporation, HEC, to acquire 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' energy costs and\/or conserve energy and other 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. NU's initial equity investment in HEC was approximately $4 million and NU has made additional capital contributions of approximately $300,000 through December 31, 1994.\nREGULATORY AND ENVIRONMENTAL MATTERS\nENVIRONMENTAL REGULATION\nGENERAL\nThe System and its subsidiaries are subject to federal, state and local regulations with respect to water quality, air quality, toxic substances, hazardous waste and other environmental matters. Similarly, the System's major generation or transmission facilities may not be constructed or significantly modified without a review by the applicable state agency of the environmental impact of the proposed construction or modification. 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. 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 the U.S. Environmental Protection Agency (EPA) or state environmental agency specifying the allowable quantity and characteristics of its effluent. The System's steam-electric generating plants have all required NPDES permits in effect. Compliance with NPDES and state water discharge permits 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, the Connecticut Department of Environmental Protection (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. On January 14, 1994, CDEP approved the Millstone feasibility report submitted to it in 1993 and required 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 NPDES 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.\nThe Merrimack permit also requires PSNH to perform further biological studies because significant numbers of migratory fish are being restored to lower reaches of the Merrimack River. These studies are in progress and will be completed in 1995. If they 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 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 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 nontransportation-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. The Coast Guard has completed its final review process and issued its approval of these plans. The EPA has issued its approval of all facility plans except PSNH's Schiller Station, where the EPA has authorized continued operation pending its 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\nThe Clean Air Act Amendments of 1990 (CAAA) made extensive revisions and additions to the federal 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.\nNitrogen Oxide. The CAAA identifies NOX emissions as a precursor of ambient ozone for the northeastern region of the United States, which currently exceeds ambient air quality standard for ozone. Pursuant to the CAAA, Connecticut, New Hampshire and Massachusetts must implement plans to address ozone nonattainment. All three states have issued final regulations to implement Phase I (RACT) reduction requirements. The System has developed compliance strategies and estimates of costs. The capital cost to comply with Phase I requirements will cost the System a total of approximately $41 million: $10 million for CL&P, $27 million for PSNH, $1 million for WMECO and $3 million for HWP. Compliance will be achieved using currently available technology and combustion efficiency improvements. Compliance costs for Phase II, effective in 1999, are expected to result in an additional cost of $10 to $15 million. These Phase II costs take into consideration capital expenditures during Phase I and expanded capital costs for available technology.\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 was submitted to the New Hampshire Air Resources Division (NHARD) in the form of proposed regulations. The 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. More stringent emission rate limits equivalent to the range of 0.1 to 0.4 pounds of NOX per million Btu, however, are required for the unit by that date. On May 20, 1994, NHARD promulgated the New Hampshire NOX reduction rule. The System will comply with the requirements of this rule by installing controls on the units. The additional requirements for Merrimack Unit 2 for 1999 will be attained through increased catalytic reduction of NOX at an additional estimated cost of $5 to 7 million.\nSulfur Dioxide. The CAAA mandates reductions in SO2 emissions to control acid rain. These reductions are to occur in two phases. First, certain 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. All Phase I units will be allocated SO2 allowances for the period 1995-1999. 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.\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. The System expects that its allocated allowances will substantially exceed its expected SO2 emissions for 2000 and subsequent years. Current estimates indicate the System will have approximately 25,000 tradeable SO2 allowances available annually at a market value of approximately $150 per allowance. On July 20, 1994 the DPUC issued an order that, with some restrictions, allows CL&P to retain for its shareholders 15 percent of the net proceeds from the sale of SO2 allowances.\nNew Hampshire and Massachusetts have each instituted acid rain control laws that limit SO2 emissions. The System expects to meet the new SO2 limitations by using natural gas and lower sulfur 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. In addition, management believes that Title IV (acid rain) requirements for NOX limitations will not have a significant impact on System costs due to the more stringent state NOX limitations discussed above.\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. The System could incur additional costs to meet these requirements, which costs cannot be estimated at this time.\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.\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.\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. The System disposes of solid wastes containing PCBs in secure chemical waste landfills.\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. Asbestos costs for the System are typically several million dollars annually. These costs are already included in capital and operation and maintenance budgets.\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. 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 is expecting that EPA and DEP will approve clean closure for CL&P's Montville and Middletown Stations' former surface impoundments. For the Norwalk Harbor and Devon sites, CL&P has applied for post-closure permits and is awaiting approval from EPA and DEP. The System estimates that it will incur approximately $2 million in total costs of 30-year maintenance 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. To reduce its environmental and financial liabilities, the System has been permanently removing 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, fuel oils, gasoline and other hazardous materials 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 risks. The System has recorded a liability for what it believes is, based upon currently available information, its estimated environmental remediation costs for waste disposal sites for which the System companies expect to bear legal liability, and 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. At December 31, 1994, the liability recorded by the System for its estimated environmental remediation costs for known sites needing remediation including those sites described below, exclusive of recoveries from insurance or third parties, was approximately $11 million. The costs for these known sites could rise to as much as $16 million if alternative remedies become necessary.\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 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. System companies are in compliance with these reporting and notification requirements.\nThe System currently is involved in one Superfund site in Kentucky and three 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 standards 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.\nThe System is no longer involved with the Beacon Heights, Connecticut Superfund site, at which a coalition of major parties had attempted to join \"Northeast Utilities (Connecticut Light and Power)\" as defendants. In January 1994, the Beacon Heights Coalition filed a response with the federal district court indicating that it would not continue to pursue NU (CL&P) as a defendant in this litigation. Accordingly, it is not likely that CL&P will incur any cleanup costs for this site.\nEPA has issued a notice of potential liability to NNECO and CYAPC as potentially responsible parties (PRPs) at the Maxey Flats nuclear waste disposal site in Fleming County, Kentucky. The System had sent a substantial volume of LLRW from Millstone 1, Millstone 2 and CY to this site. 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 as well as the Commonwealth of Kentucky have reached a tentative settlement with EPA embodied in a consent decree. NUSCO, on behalf of NNECO and CYAPC, signed the consent decree in March 1995. The System has recorded a liability for future remediation costs for this site based on its best estimate of its share of ultimate remediation costs under the tentative agreement. To date, the costs have not been material with respect to System earnings or financial position.\nPSNH has committed approximately $280,000 as its share of the costs to clean up Superfund sites at municipal landfills in Dover and North Hampton, New Hampshire. Some additional costs may be incurred at these sites and at the Somersworth site but they are not expected to be significant.\nAs discussed below, in addition to the remediation efforts for the above- mentioned Superfund sites, the System has been named as a PRP and is monitoring developments in connection with several state environmental actions.\nIn 1987, Connecticut Department of Environmental Protection (CDEP) published a list of 567 hazardous waste disposal sites in Connecticut. The System owns two sites on this list, which are also listed on the EPA's list of hazardous waste sites. The System has spent approximately $600,000 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. The need for site remediation is being evaluated. The level of cleanup will be established in cooperation with CDEP, which 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. These options include institutional controls, excavation and limited removal of contamination, which would reduce the potential environmental and health risks and secure the site. The estimated costs of remediation and institutional controls range from $5 to $13 million.\nThe second site is a 3.5 acre former coal gasification facility that currently serves as an active substation in Rockville, Connecticut. Site investigations have located creosote and other polyaromatic hydrocarbon contaminants which will require remediation. Several options are being evaluated to process surface soils and degrade subsurface contamination to remediate the site. Levels of cleanup will be coordinated with the CDEP.\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). CL&P agreed to accept liability for required cleanup for the three sites it retained. These three sites include Stamford and Rockville (discussed above) and Torrington, Connecticut. At the Torrington site, investigations have been completed and the cost of any remediation, if necessary, is not expected to be material. CL&P and Yankee Gas also share a site in Winsted, Connecticut and any liability for required cleanup there. 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.\nPSNH contacted NHDES in December 1993 concerning possible coal tar contamination in Laconia, New Hampshire in Lake Opechee and the Winnipesaukee River near an area where PSNH formerly owned and operated a coal gasification plant which was sold in 1945. PSNH completed a site investigation in December 1994. Results indicate that off-site coal tar\/creosote contamination is present in the adjacent water bodies. The cost of remediation at this site is estimated at $1.8 million. A second coal gasification facility formerly owned and operated by a predecessor company to PSNH is located in Keene, New Hampshire. The NHDES has been notified of the presence of coal tar contamination and further site investigations are planned in 1995. Other New Hampshire sites include a municipal landfill in Peterborough and the inactive Dover Point site owned by PSNH in Dover, New Hampshire. PSNH's liability at the landfill is not expected to be significant and its liability at the Dover Point site cannot be estimated at this time.\nIn Massachusetts, System companies have been designated by the Massachusetts Department of Environmental Protection (MDEP) as PRPs for twelve sites under MDEP's hazardous waste and spill remediation program. Except for the Holyoke site, the System does not expect that its share of the remaining remediation costs for most of these sites will be material. HWP has been identified by MDEP as one of three PRPs in a coal tar site in Holyoke, Massachusetts. HWP owned and operated the Holyoke Gas Works from 1859 to 1902. 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 designated both the land and river deposit areas as 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. 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 $400,000 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. The estimated costs for remediation of this site range from $2 to $3 million.\nIn the past, the 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 may 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. Most researchers, as well as scientific review panels considering all significant EMF epidemiological and laboratory research to date, agree that current information remains inconclusive, inconsistent and insufficient for risk assessment of EMF exposures. Based on this information management does not believe that a causal relationship has been established or that significant capital expenditures are appropriate to minimize unsubstantiated risks. NU is closely monitoring research and government policy developments.\nThe 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.\nThe Connecticut Interagency EMF Task Force (Task Force) provided a report to the state legislature in January 1995. The Task Force advocates 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. The Connecticut Siting Council previously adopted a set of EMF \"best management practices,\" which are now considered in the justification, siting and design of new transmission lines and substations. The Siting Council also opened a generic docket in 1994 to conduct a life-cycle cost analysis of overhead and underground transmission lines, which was mandated by PA-176. This Act was adopted by the General Assembly in part due to public EMF concerns.\nEMF has become increasingly important as a factor in facility siting decisions in many states. Several bills involving EMF were introduced in Massachusetts in 1994, with no action taken. These bills were similar to ones introduced in previous years, on which no action was taken.\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, are 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. Upon the expiration of a license, any hydroelectric project so licensed is subject to reissuance by FERC to the existing licensee or to others 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.\nThe System companies hold FERC licenses for thirteen hydroelectric projects located in Connecticut, Massachusetts and New Hampshire. Four of the System licenses expired on December 31, 1993 (WMECO's Gardners Falls Project and PSNH's Ayers Island, Smith and Gorham Projects). On August 1, 1994, FERC issued new 30-year licenses to PSNH for the continued operation of the Smith and Gorham Projects. Although rehearing requests on these new licenses are pending with FERC, it is anticipated that it will be economic for PSNH to continue operation of these projects. FERC has issued annual licenses allowing the Gardners Falls and Ayers Island Projects to continue operations pending completion of the relicensing process. It is not known whether FERC will require any substantial changes in the operation or design of these two projects if and when it issues new licenses.\nThe license for HWP's Holyoke Project expires in late 1999. The relicensing process for this project began in 1994.\nAt the time of relicensing and for certain matters during the term of an existing license, FERC can direct changes in hydro project operation, maintenance and design to accommodate environmental, recreational, or navigational needs. At present, the U.S. Fish and Wildlife Service is considering a petition to place the Atlantic Salmon on the endangered species list. If such designation is granted, System hydroelectric projects along the Connecticut River, the Merrimack River and their tributaries may be required to make operational and\/or design changes to mitigate any adverse effects on the Atlantic Salmon. The System cannot estimate the cost of such mitigation actions at this time.\nFERC recently issued a notice indicating that it has authority to order project licensees to decommission projects that are no longer economic to operate. FERC has not required any such project decommissioning to date; the potential costs of decommissioning a project, however, could be substantial. It is likely that this FERC decision will be appealed at an appropriate time.\nEMPLOYEES\nAs of December 31, 1994, the System companies had approximately 9,395 full and part time employees on their payrolls, of which approximately 2,601 were employed by CL&P, approximately 1,390 by PSNH, approximately 619 by WMECO, approximately 112 by HWP, approximately 1,312 by NNECO, approximately 2,456 by NUSCO and approximately 905 by North Atlantic. NU, NAEC and Charter Oak have no employees. Approximately 2,325 employees of CL&P, PSNH, WMECO, North Atlantic and HWP are covered by union agreements, which expire between October 1994 and May 1996. The two union agreements that expired on October 1, 1994 cover 370 employees of WMECO and HWP and are currently under negotiation. Management cannot predict the timing or terms of these new contracts.\nSUBSEQUENT EVENTS\nCOMPETITION AND MARKETING - RETAIL MARKETING\nOn March 23, 1995, the Energy and Technology Committee of the Connecticut General Assembly passed a bill that would create a task force to study restructuring of the electric industry in Connecticut. If enacted, the bill would require a preliminary report to the committee by February 1, 1996, and a final report by January 1, 1997. The bill now goes to the state Senate and House of Representatives where CL&P will be proposing changes.\nRATES\nCONNECTICUT RETAIL RATES\nOn March 22, 1995, the System introduced its plan, entitled \"Path to a Competitive Future,\" for the future of the electric industry and related regulation in Connecticut in a filing submitted to the DPUC in its investigation into the potential restructuring of the electric utility industry initiated earlier this year. The plan is a comprehensive four-phase approach to enhancing CL&P's customer satisfaction and market efficiency in Connecticut. It calls for several significant changes in electricity pricing, in the ability to introduce new products and services, in methods of rate-setting, and in the composition of NEPOOL. The two-year first phase began in early 1995. The second and third phases, which involve the transition to a more efficient market, would each last an estimated four to six years. The final stage--a fully competitive market for electricity--could begin once all issues relating to traditional utility regulation have been thoroughly addressed and relevant transition costs have been recovered from customers. Other similar approaches, tailored to the specific needs of their service territories, are to be introduced this spring by NU's other operating company subsidiaries, PSNH and WMECO, in ongoing restructuring proceedings in New Hampshire and Massachusetts, respectively.\nNEW HAMPSHIRE RETAIL RATES\nOn March 17, 1995 a status conference was held with the NHPUC relating to PSNH's negotiations with the wood-fired NUGs. The parties reported that an agreement in principle had been reached with all but one of the owners of the wood-fired NUGs. It is expected that settlement agreements and purchase power contracts with the settling owners will be drafted, executed and filed with the NHPUC as soon as possible. The NHPUC will consider approval of the settlements in proceedings to begin in the late Spring of 1995. Negotiations are continuing with the nonsettling owner, who owns two plants.\nFINANCING PROGRAM - FINANCING LIMITATIONS\nThe amount, in millions, of short-term debt outstanding as of March 20, 1995 was $91.5 for NU, $88.3 for CL&P, $0 for PSNH, $14.3 for WMECO, $0 for HWP, $0 for NAEC, $0 for NNECO, $17.2 for RRR, $4.5 for Quinnehtuk and $2.2 for HEC, or a total of $218.\nELECTRIC OPERATIONS - NUCLEAR GENERATION\nNUCLEAR PLANT PERFORMANCE\nThe average capacity factor for the operating nuclear units in the United States for calendar 1994 was 72.5 percent.\nMILLSTONE UNITS Management's ongoing evaluation of the current Millstone 2 extended refueling and maintenance outage, which has been under way since October 1, 1994, has concluded that based on currently available information, the unit is now expected to resume operations in May 1995, following an NRC assessment of the unit's readiness to restart.\nCONNECTICUT YANKEE\nThe CY planned refueling and maintenance outage which began on January 28, 1995 has been extended for approximately two weeks due to overall work progress and emergent work. The plant is expected to return to service in early April 1995.\nMAINE YANKEE\nMY, like other pressurized water reactors, has been experiencing degradation of its steam generator tubes, principally in the form of circumferential cracking which, until early 1995, was believed to be limited to a relatively small number of steam generator tubes. In the past the detection of defects has resulted in the plugging of those tubes to prevent their subsequent use. During the refueling and maintenance shutdown that commenced in early February 1995, MYAPC detected an increased rate of degradation of MY's steam generator tubes, in excess of the number expected, and is currently evaluating several courses of action to address the matter. This circumstance is likely to adversely affect the operation of MY and may result in substantial cost to MYAPC. MYAPC cannot now predict what course of action it will choose or to what extent the operation of MY will be affected. See \"Nuclear Generation- General\" for information about the ownership interests of CL&P, PSNH and WMECO in MYAPC.\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 35.98 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 companies' lines are located on or under streets or highways, or on properties either owned or leased, or in which the company has appropriate rights, easements, or permits from the owners.\nCL&P's properties are subject to the lien of its 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 Bonds 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 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' and NAEC's properties are well maintained and are in good operating condition.\nTransmission and Distribution System\nAt December 31, 1994, the System companies owned 103 transmission and 429 distribution substations that had an aggregate transformer capacity of 25,001,996 kilovoltamperes (kVa) and 9,145,129 kVa, respectively; 3,054 circuit miles of overhead transmission lines ranging from 69 kilovolt (kV) to 345 kV, and 194 cable miles of underground transmission lines ranging from 69 kV to 138 kV; 32,507 pole miles of overhead and 1,893 conduit bank miles of underground distribution lines; and 384,367 line transformers in service with an aggregate capacity of 15,625,000 kVa.\nElectric Generating Plants\nAs of December 31, 1994, the electric generating plants of the System companies and NAEC, and the System companies' entitlements in the generating plants of the three operating Yankee regional nuclear generating companies were as follows (See \"Item 1. Business - Electric Operations, Nuclear Generation\" for information on ownership and operating results for the year.):\nClaimed Plant name Year Capability* Owner (location) Type Installed (kilowatts) ----- ---------- ---- --------- ----------- CL&P Millstone(Waterford,CT) Unit 1 Nuclear 1970 524,637 Unit 2 Nuclear 1975 708,345 Unit 3 Nuclear 1986 606,453 Seabrook (Seabrook,NH) Nuclear 1990 46,688 CT Yankee (Haddam,CT) Nuclear 1968 201,204 ME Yankee (Wiscasset,ME) Nuclear 1972 94,832 VT Yankee (Vernon,VT) Nuclear 1972 44,570 --------- Total Nuclear-Steam Plants (7 units) 2,226,729 Total Fossil-Steam Plants (9 units) 1954-73 1,803,000 Total Hydro-Conventional (25 units) 1903-55 98,930 Total Hydro-Pumped Storage (7 units) 1928-73 905,150 Total Internal Combustion (16 units) 1966-86 413,200 --------- Total CL&P Generating Plant (64 units) 5,447,009 =========\nPSNH Millstone(Waterford,CT) Unit 3 Nuclear 1986 32,624 CT Yankee (Haddam,CT) Nuclear 1968 29,160 ME Yankee (Wiscasset,ME) Nuclear 1972 39,514 VT Yankee (Vernon,VT) Nuclear 1972 18,737 --------- Total Nuclear-Steam Plants (4 units) 120,035 Total Fossil-Steam Plants (7 units) 1952-78 1,004,065 Total Hydro-Conventional (20 units) 1917-83 67,510 Total Internal Combustion (5 units) 1968-70 107,050 --------- Total PSNH Generating Plant (36 units) 1,298,660 =========\nClaimed Plant name Year Capability* Owner (location) Type Installed (kilowatts) ----- ---------- ---- --------- ----------- WMECO Millstone(Waterford,CT) Unit 1 Nuclear 1970 123,063 Unit 2 Nuclear 1975 166,155 Unit 3 Nuclear 1986 140,216 CT Yankee (Haddam,CT) Nuclear 1968 55,404 ME Yankee (Wiscasset,ME) Nuclear 1972 23,708 VT Yankee (Vernon,VT) Nuclear 1972 11,741 --------- Total Nuclear-Steam Plants (6 units) 520,287 Total Fossil-Steam Plants (1 unit) 1957 107,000 Total Hydro-Conventional (27 units) 1904-34 110,910** Total Hydro-Pumped Storage(4 units) 1972-73 205,200 Total Internal Combustion (3 units) 1968-69 63,500 --------- Total WMECO Generating Plant (41 units) 1,006,897 =========\nNAEC Seabrook (Seabrook,NH) Nuclear 1990 413,793 =========\nHWP Mt. Tom (Holyoke,MA) Fossil-Steam 1960 147,000 Total Hydro-Conventional (15 units) 1905-83 43,560 --------- Total HWP Generating Plant (16 units) 190,560 =========\nNU Millstone(Waterford,CT) SYSTEM Unit 1 Nuclear 1970 647,700 Unit 2 Nuclear 1975 874,500 Unit 3 Nuclear 1986 779,293 Seabrook (Seabrook,NH) Nuclear 1990 460,481 CT Yankee (Haddam,CT) Nuclear 1968 285,768 ME Yankee (Wiscasset,ME) Nuclear 1972 158,054 VT Yankee (Vernon,VT) Nuclear 1972 75,048 --------- Total Nuclear-Steam Plants (7 units) 3,280,844 Total Fossil-Steam Plants (18 units) 1952-78 3,061,065 Total Hydro-Conventional (87 units) 1903-83 320,910** Total Hydro-Pumped Storage (7 units) 1928-73 1,110,350 Total Internal Combustion (24 units) 1966-86 583,750 --------- Total NU SYSTEM Generating Plant Including Regional Yankees (143 units) 8,356,919 =========\nExcluding Regional Yankees (140 units) 7,838,049 ========= *Claimed capability represents winter ratings as of December 31, 1994. **Total Hydro-Conventional capability includes the Cobble Mtn. plant's 33,960 kW which is leased from the City of Springfield, MA.\nFranchises\nNU's operating subsidiaries hold numerous franchises in the territories served by them.\nCL&P. Subject to the power of alteration, amendment or repeal by the General Assembly of Connecticut and subject to certain approvals, permits and consents of public authority and others prescribed by statute, CL&P has, subject to certain exceptions not deemed material, valid franchises free from burdensome restrictions to sell electricity in the respective areas in which it is now supplying such service.\nIn addition to the right to sell electricity as set forth above, the franchises of CL&P include, among others, rights and powers to manufacture, generate, purchase, transmit and distribute electricity, to sell electricity at wholesale to other utility companies and municipalities and to erect and maintain certain facilities on public highways and grounds, all subject to such consents and approvals of public authority and others as may be required by law. The franchises of CL&P include the power of eminent domain.\nPSNH. Subject to the power of alteration, amendment or repeal by the General Court (legislature) of the State of New Hampshire and subject to certain approvals, permits and consents of public authority and others prescribed by statute, PSNH has, subject to certain exceptions not deemed material, valid franchises free from burdensome restrictions to sell electricity in the respective areas in which it is now supplying such service.\nIn addition to the right to sell electricity as set forth above, the franchises of PSNH include, among others, rights and powers to manufacture, generate, purchase, transmit and distribute electricity, to sell electricity at wholesale to other utility companies and municipalities and to erect and maintain certain facilities on certain public highways and grounds, all subject to such consents and approvals of public authority and others as may be required by law. The franchises of PSNH include the power of eminent domain.\nNNECO. Subject to the power of alteration, amendment or repeal by the General Assembly of Connecticut and subject to certain approvals, permits and consents of public authority and others prescribed by statute, NNECO has a valid franchise free from burdensome restrictions to sell electricity to utility companies doing an electric business in Connecticut and other states.\nIn addition to the right to sell electricity as set forth above, the franchise of NNECO includes, among others, rights and powers to manufacture, generate and transmit electricity, and to erect and maintain facilities on certain public highways and grounds, all subject to such consents and approvals of public authority and others as may be required by law.\nWMECO. WMECO is authorized by its charter to conduct its electric business in the territories served by it, and has locations in the public highways for transmission and distribution lines. Such locations are granted pursuant to the laws of Massachusetts by the Department of Public Works of Massachusetts or local municipal authorities and are of unlimited duration, but the rights thereby granted are not vested. Such locations are for specific lines only, and, for extensions of lines in public highways, further similar locations must be obtained from the Department of Public Works of Massachusetts or the local municipal authorities. In addition, WMECO has been granted easements for its lines in the Massachusetts Turnpike by the Massachusetts Turnpike Authority.\nHWP and Holyoke Power and Electric Company (HP&E). HWP, and its wholly owned subsidiary HP&E, are authorized by their charters to conduct their businesses in the territories served by them. HWP's electric business is subject to the restriction that sales be made by written contract in amounts of not less than 100 horsepower, except for municipal customers in the counties of Hampden or Hampshire, Massachusetts and except for customers who occupy property in which HWP has a financial interest, by ownership or purchase money mortgage. HWP also has certain dam and canal and related rights, all subject to such consents and approvals of public authorities and others as may be required by law. The two companies have locations in the public highways for their transmission and distribution lines. Such locations are granted pursuant to the laws of Massachusetts by the Department of Public Works of Massachusetts or local municipal authorities and are of unlimited duration, but the rights thereby granted are not vested. Such locations are for specific lines only and, for extensions of lines in public highways, further similar locations must be obtained from the Department of Public Works of Massachusetts or the local municipal authorities. The two companies have no other utility franchises.\nNAEC. NAEC is authorized by the NHPUC to own and operate its interest in Seabrook 1.\nItem 3","section_3":"Item 3 - Legal Proceedings\n1. Litigation Relating to Electric and Magnetic Fields\nIn December 1991, NU and CL&P were sued in Connecticut Superior Court by Melissa Bullock, a nineteen-year old woman, and her mother, Suzanne Bullock, both residents of 28 Meadow Street in Guilford, Connecticut. The plaintiffs allege that they have lived in close proximity to CL&P's Meadow Street substation and distribution lines since 1979. The suit claims that Melissa Bullock suffers from a form of brain cancer and related physical and psychological injuries, which were \"brought on as a result of exposure in her home to electromagnetic radiation generated by the defendants.\" Suzanne Bullock claims various physical and psychological injuries, and a diminution in the value of her property. The various counts against NU and CL&P include allegations of negligence, product liability, nuisance, unfair trade practices and strict liability. The suit seeks monetary damages, both compensatory and punitive, in as-yet unspecified amounts, as well as an injunction to cease emission of \"dangerous levels\" of electric and magnetic fields (EMF) into the plaintiffs' home.\nThe plaintiffs are represented in part by counsel with a nationwide emphasis on similar litigation, and management considers this lawsuit to be a test case. The case is presently in the pre-trial discovery process. Trial is not anticipated until 1996 at the earliest.\nIn January 1992, a related lawsuit by two other plaintiffs also alleging cancer from EMF emanating from CL&P's Meadow Street substation and distribution lines was served on CL&P and NU. The plaintiffs are represented by the same counsel as the Bullocks, and the claims are nearly identical to the Bullocks' suit. This case is also in the pretrial discovery process; a trial date is not yet known.\nManagement believes that the allegations that EMF caused or contributed to the plaintiffs' illnesses are not supported by current scientific studies. NU and CL&P intend to defend the lawsuits vigorously. For information on EMF studies and state and federal initiatives, see \"Item 1. Business - Regulatory and Environmental Matters - Electric and Magnetic Fields.\"\n2. Massachusetts Municipal Wholesale Electric Company \/ 30th Amendment to NEPOOL Agreement Settlement\nNU's operating subsidiaries, CL&P, PSNH, WMECO, HWP and HP&E (collectively, the Company) and a number of other utilities that are members of NEPOOL, as defendants, are involved in two pending actions relating to pool planning and future transmission service issues under the NEPOOL Agreement. An action in Suffolk Superior Court in Massachusetts was brought by a number of the Massachusetts electric municipal systems and the Massachusetts Municipal Wholesale Electric Company requesting damages and injunctive relief. FERC subsequently commenced an action when the Company and 26 other participants filed an amendment to the NEPOOL Agreement with FERC that concerns many of the issues raised in the Massachusetts litigation.\nOn February 10, 1995, FERC issued an order accepting a withdrawal of the amendment to the NEPOOL Agreement. The withdrawal was part of a settlement agreement signed by substantially all of the parties and intervenors, which will also result in the withdrawal by the settling plaintiffs of their Superior Court complaint after the FERC action is terminated and no longer subject to appeal. The 30-day period in which to appeal from the FERC order expired without the filing of requests for rehearing, and the order has become final.\n3. Southeastern Connecticut Regional Resources Recovery Authority (SCRRRA) - Application of the Municipal Rate\nThis matter involves three separate disputes over the rates that apply to CL&P's purchases of the generation of the SCRRRA project in Preston, Connecticut.\nMunicipal Rate Litigation: In 1990, CL&P initiated a challenge -------------------------- district court to the DPUC's approval of an electricity purchase contract for the SCRRRA project under Connecticut's so-called \"municipal rate law.\" Under this law, CL&P would be required to purchase a portion of the electricity from the resource recovery facility at a rate equal to the retail rate that CL&P charges municipalities for electricity (\"municipal rate\"), which is significantly higher than CL&P's avoided costs. The district court subsequently ordered the parties to seek FERC's resolution of this matter. On January 11, 1995, FERC ruled that a state cannot require an electric utility to enter into a contract paying a qualifying facility more than the utility's avoided costs. The FERC decision is subject to rehearing and can be appealed to the United States Court of Appeals. In early February 1995, several petitions for rehearing were filed. Should CL&P ultimately prevail, the benefits to CL&P customers would be approximately $13 million.\nNon-Participant Towns: CL&P also contested SCRRRA's claim that CL&P must ---------------------\npay the municipal rate for the portion of the project's electricity that is derived from the trash of towns that are not long-term participants in the project. On April 20, 1994, the DPUC granted SCRRRA's request that the municipal rate be made applicable to the non-participant's portion of electricity.\nOn June 9, 1994, CL&P filed an appeal of the DPUC's ruling in the Hartford Superior Court. A total of approximately $3.5 million is in dispute for the years 1992 through 1994. The rate CL&P would be required to pay would also be substantially higher in later years if the DPUC's ruling is upheld. On February 6, 1995, the Superior Court granted the SCRRRA's motion to stay this proceeding until FERC issues a final decision on the municipal rate law. This case could be moot once the FERC decision is final.\nExcess Capacity: CL&P also contested SCRRRA's claim that CL&P must ---------------\npurchase at the applicable contract rates (each of which is higher than CL&P's current avoided costs) any excess of the project's generation above 13.85 MW per hour. On May 3, 1994, the Connecticut Appellate Court affirmed a Superior Court's ruling that the DPUC should decide this issue. CL&P has answered interrogatories issued by the DPUC and further DPUC proceedings on this dispute are expected. The amount in dispute for the period 1992 through August 1994 is approximately $470,000. However, assuming SCRRRA were permitted to charge the municipal rate for an assumed project generation of 14.5 MW per hour (i.e., 5% greater than 13.85 MW), the amount in dispute could be as much as $4.5 million (cumulative present value) for the remaining term of the contract with SCRRRA. This dispute will not be resolved by the FERC decision on the municipal rate statute because each of the contract rates is greater than CL&P's current avoided costs.\nOn June 20, 1994, the Connecticut General Assembly overrode Governor Weicker's veto of a bill that purportedly resolves the non-participant towns and excess capacity disputes against CL&P. CL&P has a number of options in response to this legislation including challenging its constitutionality in either federal or state court. The law took effect on October 1, 1994, but has not yet been applied against CL&P in either of these proceedings.\n4. CL&P's 1992-1993 Retail Rate Case\nIn June 1993, the DPUC issued a decision approving a multi-year rate plan for CL&P. Two appeals have been filed from the 1993 Decision, one by CL&P and the other by the Connecticut Office of Consumer Counsel (OCC) and the City of Hartford (City). The two appeals were consolidated. On May 9, 1994, the City's appeal was dismissed by the Hartford Superior Court on jurisdictional grounds, and the City appealed that dismissal to the Connecticut Appellate Court. The Supreme Court of Connecticut transferred the jurisdictional issue to itself on August 2, 1994. Oral argument is expected to be scheduled in the spring of 1995, and a decision is expected by September 1995.\n5. Connecticut Indian Land Claims\nNumerous lawsuits asserting land claims in Connecticut have been filed in either state and federal court or threatened by a group called the Golden Hill Paugussett Tribe of Indians (the Paugussetts). These actions could impact the title to certain NU system real estate in the eight affected Connecticut towns. Title to the properties of thousands of other owners, including homeowners, has been similarly threatened. However, the only case to specifically name CL&P as a defendant, a class action suit affecting approximately 1,500 property owners in Southbury, was dismissed by the trial court, and the dismissal was subsequently upheld on appeal by the Connecticut Supreme Court on the grounds that the plaintiff lacked standing to act on behalf of the Paugussetts. The outcome of the present or potential litigation either by the Paugussetts or by other groups claiming to be \"Indian tribes\" cannot be predicted at this time. However, a number of possible defenses exist to Indian land claims in Connecticut, and the Paugussetts' success on the merits appears unlikely.\n6. FERC - PSNH Acquisition Case\nIn 1992, FERC's approval of NU's acquisition of PSNH was appealed to the United States Court of Appeals for the First Circuit. The Court affirmed the decision approving the merger but ordered FERC to address whether, if FERC had applied a more stringent \"public interest standard\" to the Seabrook power contract, any modifications would have been necessary. Purporting to apply this standard, FERC reaffirmed certain modifications to the contract, interpreting the standard liberally to allow it to intervene in contracts on behalf of non-parties to the contract. NU requested rehearing, arguing that FERC had not applied the appropriate standard, which request was denied by FERC on July 8, 1994. On September 6, 1994, NU filed a Petition for Review with the First Circuit Court of Appeals concerning FERC's application of a \"public interest standard\" to the Seabrook Power Contract, which Petition is expected to be heard April 3, 1995.\n7. Other Legal Proceedings\nThe following sections of Item 1 \"Business\" discuss additional legal proceedings: \"Rates\" for information about CL&P's rate and fuel clause adjustment clause proceedings and the Seabrook Power Contract; \"Electric Operations -- Generation and Transmission\" for information about proceedings relating to power transmission issues; \"Electric Operations -- Nuclear Generation\" for information related to Seabrook joint owners, high-level and low-level radioactive waste disposal, decommissioning matters and NRC regulation; \"Regulatory and Environmental Matters\" for information about proceedings involving surface water and air quality, toxic substances and hazardous waste, electric and magnetic fields, licensing of hydroelectric projects, and other matters; and \"FINANCIAL CONDITION -- Property Taxes\" in the NU 1994 Annual Report for information about proceedings involving utility property tax appeal matters.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo Event that would be described in response to this item occurred with respect to NU, CL&P, WMECO, PSNH or NAEC.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrants' Common Equity and Related Shareholder Matters\nNU. The common shares of NU are listed on the New York Stock Exchange. The ticker symbol is \"NU,\" although it is frequently presented as \"Noeast Util\" in various financial publications. The high and low sales prices for the past two years, by quarters, are shown below.\nYear Quarter High Low ---- ------- ---- --- 1994 First $25 3\/4 23 Second 24 7\/8 21 1\/4 Third 24 5\/8 20 3\/8 Fourth 23 3\/8 21 1\/4\n1993 First $28 7\/8 $25 1\/2 Second 28 3\/4 25 1\/4 Third 28 1\/8 26 1\/4 Fourth 27 3\/8 22\nAs of January 31, 1995, there were 137,978 common shareholders of record of NU. As of the same date, there were a total of 134,210,261 common shares issued, including approximately 9.1 million shares held in an ESOP trust.\nNU declared and paid quarterly dividends of $0.44 in 1994 and $0.44 in 1993. On January 24, 1995, the Board of Trustees declared a dividend of $0.44 per share, payable on March 31, 1995 to holders of record on March 1, 1995. The declaration of future dividends may vary depending on capital requirements and income as well as financial and other conditions existing at the time.\nInformation with respect to dividend restrictions for NU and its subsidiaries is contained in Item 1. Business under the caption \"Financing Program--Financing Limitations\" and in Note (b) to the \"Consolidated Statements of Common Shareholders' Equity\" on page 32 of NU's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P, PSNH, WMECO, and NAEC. The information required by this item is not applicable because the common stock of CL&P, PSNH, WMECO, and NAEC is held solely by NU.\nItem 6.","section_6":"Item 6. Selected Financial Data\nNU. Reference is made to information under the heading \"Selected Consolidated Financial Data\" contained on pages 48 and 49 of NU's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the heading \"Selected Financial Data\" contained on page 40 of CL&P's 1994 Annual Report, which information is incorporated herein by reference.\nPSNH. Reference is made to information under the heading \"Selected Financial Data\" contained on pages 37 and 38 of PSNH's 1994 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the heading \"Selected Financial Data\" contained on page 33 of WMECO's 1994 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the heading \"Selected Financial Data\" contained on page 21 of NAEC's 1994 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\nNU. Reference is made to information under the heading \"Management's Discussion and Analysis\" contained on pages 16 through 23 in NU's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 32 through 39 in CL&P's 1994 Annual Report, which information is incorporated herein by reference.\nPSNH. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 29 through 35 in PSNH's 1994 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 27 through 32 in WMECO's 1994 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 18 through 20 in NAEC's 1994 Annual Report, which information is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nNU. Reference is made to information under the headings \"Company Report,\" \"Report of Independent Public Accountants,\" \"Consolidated Statements of Income,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Statements of Income Taxes,\" \"Consolidated Balance Sheets,\" \"Consolidated Statements of Capitalization,\" \"Consolidated Statements of Common Shareholders' Equity,\" \"Notes to Consolidated Financial Statements,\" and \"Consolidated Statements of Quarterly Financial Data\" contained on pages 24 through 47 in NU's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the headings \"Consolidated Balance Sheets,\" \"Consolidated Statements of Income,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Statements of Common Stockholder's Equity,\" \"Notes to Consolidated Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statements of Quarterly Financial Data\" contained on pages 1 through 31 and page 40 in CL&P's 1994 Annual Report, which information is incorporated herein by reference. PSNH. Reference is made to information under the headings \"Balance Sheets,\" \"Statements of Income,\" \"Statements of Cash Flows,\" Statements of Common Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" \"Independent Auditors' Report,\" and \"Statements of Quarterly Financial Data\" contained on pages 1 through 28 and page 39 in PSNH's 1994 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the headings \"Balance Sheets,\" \"Statements of Income,\" \"Statements of Cash Flows,\" \"Statements of Common Stockholder's Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statements of Quarterly Financial Data\" contained on pages 1 through 26 and page 33 in WMECO's 1994 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the headings \"Balance Sheet,\" \"Statement of Income,\" \"Statement of Cash Flows,\" \"Statement of Common Stockholder's Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statement of Quarterly Financial Data\" contained on pages 1 through 17 and page 21 in NAEC's 1994 Annual 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\nNo event that would be described in response to this item has occurred with respect to NU, CL&P, PSNH, WMECO, or NAEC.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nNU.\nIn addition to the information provided below concerning the executive officers of NU, incorporated herein by reference are pages 1 through 13 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 3, 1995 and filed with the Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934 (the Act).\nFirst First Positions Elected Elected Name Held an Officer a Trustee --------------------- --------- ---------- ---------\nWilliam B. Ellis CHB, T 06\/15\/76 04\/26\/77 Bernard M. Fox P, CEO, T 05\/01\/83 05\/20\/86\nCL&P. First First Positions Elected Elected Name Held an Officer a Director --------------------- --------- ---------- ----------\nRobert G. Abair D - 01\/01\/89 Robert E. Busch EVP, CFO, D 06\/01\/87 06\/01\/87 William B. Ellis CH, D 06\/15\/76 06\/15\/76 Bernard M. Fox VC, D 05\/15\/81 05\/01\/83 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, D 06\/01\/91 01\/01\/94 John B. Keane VP, T, D 08\/01\/92 08\/01\/92 Francis L. Kinney SVP 04\/24\/74 - Hugh C. MacKenzie P, D 07\/01\/88 06\/06\/90 John W. Noyes 07\/01\/87 - John F. Opeka D - 06\/10\/85\nPSNH. First First Positions Elected Elected Name Held an Officer a Director ------------------- --------- ---------- ----------\nRobert E. Busch EVP, CFO 06\/05\/92 John C. Collins D - 10\/19\/92 William B. Ellis CH, D 06\/05\/92 06\/05\/92 William T. Frain, Jr. P, COO, D 03\/18\/71 02\/01\/94 Bernard M. Fox VC, CEO, D 06\/05\/92 06\/05\/92 Cheryl W. Grise D 02\/06\/95 Gerald Letendre D - 10\/19\/92 Hugh C. MacKenzie D - 02\/01\/94 Jane E. Newman D - 10\/19\/92 John W. Noyes VP, CONT 06\/05\/92 - Robert P. Wax VP, SEC, GC, D 08\/01\/92 02\/01\/93\nWMECO. First First Positions Elected Elected Name Held an Officer a Director ------------------- --------- ---------- ----------\nRobert G. Abair VP, CAD, D 09\/06\/88 01\/01\/89 Robert E. Busch EVP, CFO, D 06\/01\/87 06\/01\/87 William B. Ellis CH, D 06\/15\/76 06\/15\/76 Bernard M. Fox VC, D 05\/15\/81 05\/01\/83 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, D 06\/01\/91 01\/01\/94 John B. Keane VP, TR, D 08\/01\/92 08\/01\/92 Francis L. Kinney SVP 04\/24\/74 - Hugh C. MacKenzie P, D 07\/01\/88 06\/06\/90 John W. Noyes VP, CONT 04\/01\/92 - John F. Opeka D - 06\/10\/85\nNAEC. First First Positions Elected Elected Name Held an Officer a Director --------------------- --------- ---------- ----------\nRobert E. Busch P, CFO, D 10\/21\/91 10\/16\/91 William B. Ellis CH, D 10\/21\/91 10\/16\/91 Ted C. Feigenbaum SVP, D 10\/21\/91 10\/16\/91 Bernard M. Fox VC, CEO, D 10\/21\/91 10\/16\/91 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, D 10\/21\/91 01\/01\/94 Francis L. Kinney SVP 10\/21\/91 - John B. Keane VP, TR, D 08\/01\/92 08\/01\/92 Hugh C. MacKenzie D - 01\/01\/94 John W. Noyes VP, CONT 10\/21\/91 - John F. Opeka EVP, D 10\/21\/91 10\/16\/91\nKEY: CAO - Chief Administrative Office EVP - Executive Vice President CEO - Chief Executive Officer GC - General Counsel CFO - Chief Financial Officer P - President CH - Chairman SEC - Secretary CHB - Chairman of the Board SVP - Senior Vice President COO - Chief Operating Officer T - Trustee CONT - Controller TR - Treasurer D - Director VC - Vice Chairman VP - Vice President\nName Age Business Experience During Past 5 Years ----------------- --- ---------------------------------------\nRobert G. Abair (1) 56 Elected Vice President and Chief Administrative Officer of WMECO in 1988.\nRobert E. Busch (2) 48 Elected President and Chief Financial Officer of NAEC in 1994; elected Executive Vice President and Chief Financial Officer of NU, CL&P, PSNH, and WMECO in 1992; previously Executive Vice President and Chief Financial Officer of NAEC since 1992; Senior Vice President and Chief Financial Officer of NU, CL&P and WMECO since 1990.\nJohn C. Collins (3) 50 Chief Executive Officer, The Hitchcock Clinic, Dartmouth - Hitchcock Medical Center since 1977.\nWilliam B. Ellis (4) 54 Elected Chairman of the Board of NU in 1993; elected Chairman of CL&P, NAEC, PSNH and WMECO in 1993; previously Chairman of the Board and Chief Executive Officer of NU and Chairman and Chief Executive Officer of CL&P and WMECO since 1987, NAEC since 1991 and PSNH since 1992.\nTed C. Feigenbaum (5) 44 Elected Senior Vice President of NAEC in 1991; previously Senior Vice President and Chief Nuclear Officer of PSNH June, 1992 to August, 1992; previously President and Chief Executive Officer - New Hampshire Yankee Division of PSNH October, 1990 to June, 1992 and Chief Nuclear Production Officer of PSNH January, 1990 to June, 1992; Senior Vice President and Chief Operating Officer - New Hampshire Yankee Division of PSNH (1989-1990).\nBernard M. Fox (6) 52 Elected Vice Chairman of CL&P and WMECO, and Vice Chairman and Chief Executive Officer of NAEC, in 1994; previously Chief Executive Officer of NU, CL&P, PSNH, WMECO and NAEC in 1993; previously President and Chief Operating Officer of NU, CL&P and WMECO in 1990 and NAEC since 1991; Vice Chairman of PSNH since 1992; previously President and Chief Operating and Financial Officer of NU, CL&P and WMECO since 1987.\nWilliam T. Frain, Jr.(7) 53 Elected President and Chief Operating Officer of PSNH in 1994; previously Senior Vice President of PSNH since 1992; previously Treasurer of PSNH since 1991 and Vice President of PSNH since 1982.\nCheryl W. Grise 42 Elected Senior Vice President-Human Resources and Administrative Services of CL&P, WMECO and NAEC in 1994; previously Vice President-Human Resources of NAEC since 1992 and of CL&P and WMECO since 1991.\nJohn B. Keane (8) 48 Elected Vice President and Treasurer of NU, CL&P, PSNH, WMECO and NAEC in 1993; previously Vice President, Secretary and General Counsel- Corporate of NU, CL&P, PSNH, WMECO and NAEC since February 1, 1993; previously Vice President, Assistant Secretary and General Counsel-Corporate of PSNH and NAEC, Vice President, Secretary and General Counsel- Corporate of NU and CL&P, and Vice President, Secretary, Assistant Clerk and General Counsel- Corporate of WMECO since 1992; previously Associate General Counsel of NUSCO since 1985.\nFrancis L. Kinney (9) 62 Elected Senior Vice President-Governmental Affairs of CL&P, WMECO and NAEC in 1994; previously Vice President-Public Affairs of NAEC since 1992 and of CL&P and WMECO since 1978.\nGerald Letendre 53 President, Diamond Casting & Machine Co., Inc. since 1972.\nHugh C. MacKenzie (10) 52 Elected President of CL&P and WMECO in 1994; previously Senior Vice President-Customer Service Operations of CL&P and WMECO since 1990.\nJane E. Newman (11) 49 President, Coastal Broadcasting Corporation since 1992; previously Assistant to the President of the United States for Management and Administration from 1989 to 1991.\nJohn W. Noyes 47 Elected Vice President and Controller of NU, CL&P, PSNH, WMECO and NAEC in 1992; previously Vice President of CL&P and WMECO since 1987.\nJohn F. Opeka (12) 54 Elected Executive Vice President - Nuclear of NAEC in 1991 and of NUSCO in 1986, previously Executive Vice President - Nuclear of CL&P and WMECO from 1986 to 1993.\nRobert P. Wax 46 Elected Vice President, Secretary and General Counsel of PSNH and NAEC in 1994; elected Vice President, Secretary and General Counsel of NU and CL&P and Vice President, Secretary, Assistant Clerk and General Counsel of WMECO in 1993; previously Vice President, Assistant Secretary and General Counsel of PSNH and NAEC since 1993; previously Vice President and General Counsel-Regulatory of NU, CL&P, PSNH, WMECO and NAEC since 1992; previously Associate General Counsel of NUSCO since 1985.\n(1) Trustee of Easthampton Savings Bank. (2) Director Connecticut Yankee Atomic Power Company. (3) Director of Fleet Bank - New Hampshire. (4) Director of Nuclear Electric Insurance Limited, Connecticut Mutual Life Insurance Company, The Hartford Steam Boiler Inspection and Insurance Company and Radian Corporation (a subsidiary of Hartford Steam Boiler) and the Greater Hartford Chamber of Commerce; Chairman of the Board of the Capitol Region Growth Council, Inc.; Director Emeritus of Connecticut Yankee Atomic Power Company; Member of The National Museum of Natural History of The Smithsonian Institution and the Science Advisory Board of The Nature Conservancy. (5) Director of Maine Yankee Atomic Power Company. (6) Director of The Institute of Living, The Institute of Nuclear Power Operations, The Connecticut Business and Industry Association, Mount Holyoke College, Shawmut National Corp., CIGNA Corporation, Connecticut Yankee Atomic Power Company and The Dexter Corporation. (7) Director of Connecticut Yankee Atomic Power Company, the Business and Industry Association of New Hampshire, the Greater Manchester Chamber of Commerce; Trustee of Optima Health, Inc. (8) Director of Maine Yankee Atomic Power Company, Vermont Yankee Nuclear Power Corporation, Yankee Atomic Electric Company and Connecticut Yankee Atomic Power Company. (9) Director of Mid-Conn Bank. (10) Director of Connecticut Yankee Atomic Power Company. (11) Director of Perini Corporation, NYNEX Telecommunications and Consumers Water Company. (12) Director of Connecticut Yankee Atomic Power Company and Yankee Atomic Electric Company.\nThere are no family relationships between any director or executive officer and any other director or executive officer of NU, CL&P, PSNH, WMECO or NAEC.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNU.\nIncorporated herein by reference are pages 8 through 13 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 3, 1995 and filed with the Commission pursuant to Rule 14a-6 under the Act. SUMMARY COMPENSATION TABLE\nThe following table presents the cash and non-cash compensation received by the five highest-paid executive officers of Northeast Utilities, in accordance with rules of the SEC:\nNotes:\n1. Awards under the 1992 short-term program of the Northeast Utilities Executive Incentive Plan (EIP) were paid in 1993 in the form of unrestricted stock. Awards under the 1993 short-term EIP program were paid in 1994 in the form of cash. In accordance with the requirements of the SEC, these awards are included as \"bonus\" in the years earned.\n2. \"All Other Compensation\" consists of employer matching contributions under the 401(k) Plan, generally available to all eligible employees.\n3. Awards under the short-term program of the EIP have typically been made by the 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. Busch, Opeka and MacKenzie 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 - $303,000; Mr. Ellis - $127,000; Mr. Busch - $165,000; Mr. Opeka - $81,000; and Mr. MacKenzie - $108,000.\n4. Mr. Fox served as President and Chief Operating Officer until July 1, 1993, when he became President and Chief Executive Officer. Mr. Ellis served as Chairman of the Board and Chief Executive Officer until July 1, 1993, when he became Chairman of the Board.\n5. The titles for these executive officers are listed by company in \"Item 10. Directors and Executive Officers of the Registrants.\"\nPENSION BENEFITS The following table shows the estimated annual retirement benefits payable to an executive officer of Northeast Utilities 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 Board of Trustees to participate in the target benefit and who remain in the employ of Northeast Utilities companies until at least age 60 (unless the Board of Trustees sets an earlier age). Each of the executive officers of Northeast Utilities 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.\nFINAL YEARS OF CREDITED SERVICE AVERAGE COMPENSATION\n15 20 25 30 35 $200,000 $72,000 $96,000 $120,000 $120,000 $120,000\n250,000 90,000 120,000 150,000 150,000 150,000\n300,000 108,000 144,000 180,000 180,000 180,000\n350,000 126,000 168,000 210,000 210,000 210,000\n400,000 144,000 192,000 240,000 240,000 240,000\n450,000 162,000 216,000 270,000 270,000 270,000\n500,000 180,000 240,000 300,000 300,000 300,000\n600,000 216,000 288,000 360,000 360,000 360,000\n700,000 252,000 336,000 420,000 420,000 420,000\n800,000 288,000 384,000 480,000 480,000 480,000\n900,000 324,000 432,000 540,000 540,000 540,000\n1,000,000 360,000 480,000 600,000 600,000 600,000\n1,100,000 396,000 528,000 660,000 660,000 660,000\n1,200,000 432,000 576,000 720,000 720,000 720,000\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 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 Northeast Utilities and its subsidiaries under long term disability plans and policies.\nAs of December 31, 1994, the five executive officers named in the Summary Compensation Table above had the following years of credited service for retirement compensation purposes: Mr. Fox - 30, Mr. Ellis - 18, Mr. Busch - 21, Mr. Opeka - 24, and Mr. MacKenzie - 29. Assuming that retirement were to occur at age 65 for these officers, retirement would occur with 43, 29, 38, 35 and 41 years of credited service, respectively.\nIn 1992 Northeast Utilities entered into agreements with Messrs. Ellis and Fox to provide for an orderly Chief Executive Officer succession. The agreement with Mr. Ellis calls for him to work with the Board 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 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 Northeast Utilities 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 Northeast Utilities 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 the Committee and the Board in accordance with their customary practices.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNU.\nIncorporated herein by reference are pages 6 through 13 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 3, 1995 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nCL&P, PSNH, WMECO AND NAEC.\nNU owns 100% of the outstanding common stock of registrants CL&P, PSNH, WMECO and NAEC. As of February 28, 1995, the Directors of CL&P, PSNH, WMECO and NAEC, beneficially owned the number of shares of each class of equity securities of NU listed below. No equity securities of CL&P, PSNH, WMECO or NAEC are owned by the Directors and Executive Officers of their respective companies.\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) 5,323 shares NU Common Robert E. Busch(4) 7,301 shares NU Common John C. Collins (5)(6) 25 shares NU Common William B. Ellis (7) 10,360 shares NU Common Ted C. Feigenbaum(8) 299 shares NU Common Bernard M. Fox (9) 19,911 shares NU Common William T. Frain, Jr. 1,108 shares NU Common Cheryl W. Grise 2,291 shares NU Common John B. Keane (4) 1,374 shares NU Common Francis L. Kinney (10) 2,415 shares NU Common Gerald Letendre (5) 0 shares NU Common Hugh C. MacKenzie(11)(12) 5,902 shares NU Common Jane E. Newman (5) 0 shares NU Common John W. Noyes 3,272 shares NU Common John F. Opeka (4)(11)(13) 18,271 shares NU Common Robert P. Wax (5) 1,963 shares\nAmount beneficially owned by Directors and Executive Officers as a group - CL&P 77,528 shares - PSNH 70,404 shares - WMECO 77,528 shares - NAEC 72,504 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, 1995 there were 134,210,358 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) Messrs. Busch, Keane and Opeka are Directors of CL&P, WMECO and NAEC only.\n(5) Messrs. Collins, Letendre and Wax and Ms. Newman are Directors of PSNH only. (6) Mr. Collins shares voting and investment power with his wife for 25 shares.\n(7) Mr. Ellis shares voting and investment power with his wife for 1,208 shares.\n(8) Mr. Feigenbaum is a Director and an Executive Officer of NAEC only.\n(9) 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(10) Mr. Kinney shares voting and investment power with his wife for 525 shares.\n(11) Messrs. MacKenzie and Opeka are not officers of PSNH, but in their capacity as officers (with their stated titles) of NUSCO, an affiliate of PSNH, they perform policy-making functions for PSNH.\n(12) Mr. MacKenzie shares voting and investment power with his wife for 1,361 shares.\n(13) 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 15 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 3, 1995 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 1994 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\"). Report of Independent Public Accountants on Schedules S-1\nConsent of Independent Public Accountants S-2\n2. Schedules:\nFinancial Statement Schedules for NU (Parent), NU and Subsidiaries, CL&P and Subsidiaries, PSNH and WMECO are listed in the Index to Financial Statement Schedules S-3\n3. Exhibits Index E-1\n(b) Reports on Form 8-K:\nDuring the fourth quarter of 1994, the companies filed Form 8-Ks dated December 31, 1994 disclosing the following:\no The primary reasons for lower composite nuclear capacity factors in 1994.\nNORTHEAST UTILITIES 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.\nNORTHEAST UTILITIES ------------------- (Registrant)\nDate: March 23, 1995 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 23, 1995 Trustee and Chairman \/s\/William B. Ellis -------------- of the Board ------------------------- William B. Ellis\nMarch 23, 1995 Trustee, President \/s\/Bernard M. Fox -------------- and Chief Executive ------------------------- Officer Bernard M. Fox\nMarch 23, 1995 Executive Vice \/s\/Robert E. Busch -------------- President and Chief ------------------------- Financial Officer Robert E. Busch\nMarch 23, 1995 Vice President and \/s\/John B. Keane -------------- Treasurer ------------------------- John B. Keane\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller ------------------------- John W. Noyes\nNORTHEAST UTILITIES\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- --------- March 23, 1995 Trustee \/s\/Cotton Mather Cleveland -------------- --------------------------- Cotton Mather Cleveland\nMarch 23, 1995 Trustee \/s\/George David -------------- --------------------------- George David\nMarch 23, 1995 Trustee \/s\/Donald J. Donahue -------------- --------------------------- Donald J. Donahue\nMarch 23, 1995 Trustee \/s\/Eugene D. Jones -------------- --------------------------- Eugene D. Jones\nMarch 23, 1995 Trustee \/s\/Gaynor N. Kelley -------------- --------------------------- Gaynor N. Kelley\nMarch 23, 1995 Trustee \/s\/Elizabeth T. Kennan -------------- --------------------------- Elizabeth T. Kennan\nMarch 23, 1995 Trustee \/s\/Denham C. Lunt, Jr. -------------- --------------------------- Denham C. Lunt, Jr.\nMarch 23, 1995 Trustee \/s\/William J. Pape II -------------- --------------------------- William J. Pape II\nMarch 23, 1995 Trustee \/s\/Robert E. Patricelli -------------- --------------------------- Robert E. Patricelli\nNORTHEAST UTILITIES\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 23, 1995 Trustee \/s\/Norman C. Rasmussen -------------- --------------------------- Norman C. Rasmussen\nMarch 23, 1995 Trustee \/s\/John F. Swope -------------- --------------------------- 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 23, 1995 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 23, 1995 Chairman and Director \/s\/William B. Ellis -------------- -------------------------- William B. Ellis\nMarch 23, 1995 Vice Chairman and \/s\/Bernard M. Fox -------------- Director -------------------------- Bernard M. Fox\nMarch 23, 1995 President and Director \/s\/Hugh C. MacKenzie -------------- -------------------------- Hugh C. MacKenzie\nMarch 23, 1995 Executive Vice \/s\/Robert E. Busch -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller -------------------------- John W. Noyes\nTHE CONNECTICUT LIGHT AND POWER COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 23, 1995 Director \/s\/Robert G. Abair -------------- -------------------------- Robert G. Abair\nMarch 23, 1995 Director \/s\/William T. Frain, Jr. -------------- -------------------------- William T. Frain, Jr.\nMarch 23, 1995 Director \/s\/Cheryl W. Grise -------------- -------------------------- Cheryl W. Grise\nMarch 23, 1995 Director \/s\/John B. Keane -------------- -------------------------- John B. Keane\nMarch 23, 1995 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 23, 1995 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 23, 1995 Chairman and Director \/s\/William B. Ellis -------------- -------------------------- William B. Ellis\nMarch 23, 1995 Vice Chairman, Chief \/s\/Bernard M. Fox -------------- Executive Officer and -------------------------- Director Bernard M. Fox\nMarch 23, 1995 President, Chief \/s\/William T. Frain, Jr. -------------- Operating Officer -------------------------- and Director William T. Frain, Jr.\nMarch 23, 1995 Executive Vice -------------- President and \/s\/Robert E. Busch Chief Financial -------------------------- Officer Robert E. Busch\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller -------------------------- John W. Noyes\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 23, 1995 Director \/s\/John C. Collins -------------- -------------------------- John C. Collins\nMarch 23, 1995 Director \/s\/Cheryl W. Grise -------------- -------------------------- Cheryl W. Grise\nDirector -------------- -------------------------- Gerald Letendre\nMarch 23, 1995 Director \/s\/Hugh C. MacKenzie -------------- -------------------------- Hugh C. MacKenzie\nMarch 23, 1995 Director \/s\/Jane E. Newman -------------- -------------------------- Jane E. Newman\nMarch 23, 1995 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 23, 1995 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 23, 1995 Chairman and Director \/s\/William B. Ellis -------------- -------------------------- William B. Ellis\nMarch 23, 1995 Vice Chairman and \/s\/Bernard M. Fox -------------- Director -------------------------- Bernard M. Fox\nMarch 23, 1995 President and Director \/s\/Hugh C. MacKenzie -------------- -------------------------- Hugh C. MacKenzie\nMarch 23, 1995 Executive Vice \/s\/Robert E. Busch -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller -------------------------- John W. Noyes\nWESTERN MASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- --------- March 23, 1995 Director \/s\/Robert G. Abair -------------- -------------------------- Robert G. Abair\nMarch 23, 1995 Director \/s\/William T. Frain, Jr. -------------- -------------------------- William T. Frain, Jr.\nMarch 23, 1995 Director \/s\/Cheryl W. Grise -------------- -------------------------- Cheryl W. Grise\nMarch 23, 1995 Director \/s\/John B. Keane -------------- -------------------------- John B. Keane\nMarch 23, 1995 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 23, 1995 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 23, 1995 Chairman and Director \/s\/William B. Ellis -------------- -------------------------- William B. Ellis\nMarch 23, 1995 Vice Chairman, Chief \/s\/Bernard M. Fox -------------- Executive Officer and -------------------------- Director Bernard M. Fox\nMarch 23, 1995 President, Chief \/s\/Robert E. Busch -------------- Financial Officer -------------------------- and Director Robert E. Busch\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller -------------------------- John W. Noyes\nNORTH ATLANTIC ENERGY CORPORATION\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 23, 1995 \/s\/Ted C. Feigenbaum -------------- Director -------------------------- Ted C. Feigenbaum\nMarch 23, 1995 Director \/s\/William T. Frain, Jr. -------------- -------------------------- William T. Frain, Jr.\nMarch 23, 1995 Director \/s\/Cheryl W. Grise -------------- -------------------------- Cheryl W. Grise\nMarch 23, 1995 Director \/s\/John B. Keane -------------- -------------------------- John B. Keane\nMarch 23, 1995 Director \/s\/Hugh C. MacKenzie -------------- -------------------------- Hugh C. MacKenzie\nMarch 23, 1995 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 17, 1995. 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, and employee stock ownership plans, if applicable to each company, as described in notes 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 accompanying index 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. These 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 LLP\nARTHUR ANDERSEN LLP\nHartford, Connecticut February 17, 1995\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. 33-55279 of The Connecticut Light and Power Company, No. 33-56537 of CL&P Capital, LP, No. 33-51185 of Western Massachusetts Electric Company, and No. 33-34622, No. 33-44814, and No. 33-40156 of Northeast Utilities.\n\/s\/ ARTHUR ANDERSEN LLP\nARTHUR ANDERSEN LLP\nHartford, Connecticut March 10, 1995\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nSchedule Page -------- ----\nI. Financial Information of Registrant:\nNortheast Utilities (Parent) Balance Sheets 1994 and 1993 S-4\nNortheast Utilities (Parent) Statements of Income 1994, 1993, and 1992 S-5\nNortheast Utilities (Parent) Statements of Cash Flows 1994, 1993, and 1992 S-6 II. Valuation and Qualifying Accounts and Reserves 1994, 1993, and 1992:\nNortheast Utilities and Subsidiaries S-7 -- S-9 The Connecticut Light and Power Company and Subsidiaries S-10 -- S-12 Public Service Company of New Hampshire S-13 -- S-16 Western Massachusetts Electric Company S-17 -- S-19\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.\nSCHEDULE I NORTHEAST UTILITIES (PARENT)\nFINANCIAL INFORMATION OF REGISTRANT\nBALANCE SHEETS\nAT DECEMBER 31, 1994 AND 1993\n(Thousands of Dollars)\nSCHEDULE I NORTHEAST UTILITIES (PARENT)\nFINANCIAL INFORMATION OF REGISTRANT\nSTATEMENTS OF INCOME\nYEARS ENDED DECEMBER 31, 1994, 1993, AND 1992\n(Thousands of Dollars Except Share Information)\nSCHEDULE I NORTHEAST UTILITIES (PARENT) FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, 1994, 1993, 1992 (Thousands of Dollars)\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 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 NU Form 10-K, File No. 1-5324 into the 1994 Annual Reports on Form 10-K for CL&P, PSNH, WMECO and NAEC.\n# - Filed with the 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 NU Form 10-K, File No. 1-5324 into the 1994 Annual Report on Form 10-K for CL&P.\n@ - Filed with the 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 NU Form 10-K, File No. 1-5324 into the 1994 Annual Report on Form 10-K for PSNH.\n** - Filed with the 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 NU Form 10-K, File No. 1-5324 into the 1994 Annual Report on Form 10-K for WMECO.\n## - Filed with the 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 Form 10-K, File No. 1-5324 into the 1994 Annual Report on Form 10-K for NAEC.\nExhibit Number Description 3 Articles of Incorporation and By-Laws\n3.1 Northeast Utilities\n3.1.1 Declaration of Trust of NU, as amended through May 24,\n1988. (Exhibit 3.1.1, 1988 NU Form 10-K, File No. 1-5324)\n3.2 The Connecticut Light and Power Company\n3.2.1 Certificate of Incorporation of CL&P,restated to March 22, 1994. (Exhibit 3.2.1, 1993 NU Form 10-K, File No. 1-\n5324)\n3.2.2 By-laws of CL&P, as amended to March 1, 1982. (Exhibit\n3.2.2, 1993 NU Form 10-K, File No. 1-5324)\n3.3 Public Service Company of New Hampshire\n3.3.1 Articles of Incorporation, as amended to May 16, 1991.\n(Exhibit 3.3.1, 1993 NU Form 10-K, File No. 1-5324)\n3.3.2 By-laws of PSNH, as amended to November 1, 1993. (Exhibit 3.3.2, 1993 NU Form 10-K, File No. 1-5324)\n3.4 Western Massachusetts Electric Company\n** 3.4.1 Articles of Organization of WMECO, restated to February 23, 1995.\n** 3.4.2 By-laws of WMECO, as amended to February 13, 1995.\n3.5 North Atlantic Energy Corporation\n3.5.1 Articles of Incorporation of NAEC dated September 20, 1991. (Exhibit 3.5.1, 1993 NU Form 10-K, File No. 1-5324)\n3.5.2 Articles of Amendment dated October 16, 1991 and June 2, 1992 to Articles of Incorporation of NAEC. (Exhibit 3.5.2, 1993 NU Form 10-K, File No. 1-5324)\n3.5.3 By-laws of NAEC, as amended to November 8, 1993. (Exhibit 3.5.3, 1993 NU Form 10-K, File No. 1-5324)\n4 Instruments defining the rights of security holders, including indentures\n4.1 Northeast Utilities 4.1.1 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)\n4.1.4 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) Supplemental 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 December 1, 1989. (Exhibit 4.1.26, 1989 NU Form 10-K, File No. 1-5324)\n4.2.7 April 1, 1992. (Exhibit 4.30, File No. 33-59430)\n4.2.8 July 1, 1992. (Exhibit 4.31, File No. 33-59430)\n4.2.9 October 1, 1992. (Exhibit 4.32, File No. 33-59430)\n4.2.10 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n4.2.11 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n4.2.12 December 1, 1993. (Exhibit 4.2.14, 1993 NU Form 10-K, File No. 1-5324)\n4.2.13 February 1, 1994. 1(Exhibit 4.2.15, 1993 NU Form 10-K, File No. 1-5324)\n4.2.14 February 1, 1994. (Exhibit 4.2.16, 1993 NU Form 10-K, File No. 1-5324)\n# 4.2.15 June 1, 1994.\n# 4.2.16 October 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) 4.2.18 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)\n4.2.21 Series A (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.2.21, 1993 NU Form 10-K, File No. 1-5324)\n4.2.22 Series B (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.2.22, 1993 NU Form 10-K, File No. 1-5324)\n4.2.23 Series A (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.2.23, 1993 NU Form 10-K, File No. 1-5324)\n4.2.24 Series B (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.2.24, 1993 NU Form 10-K, File No. 1-5324)\n4.2.25 Amended and Restated Limited Partnership Agreement (CL&P Capital, L.P.) among CL&P, NUSCO, and the persons who became limited partners of CL&P Capital, L.P. in accordance with the provisions thereof dated as of January 23, 1995(MIPS). (Exhibit A.1 (Execution Copy), File No. 70-8451)\n4.2.26 Indenture between CL&P and Bankers Trust Company, Trustee (Series A Subordinated Debentures), dated as of January 1, 1995 (MIPS). (Exhibit B.1 (Execution Copy), File No. 70-8451)\n4.2.27 Payment and Guaranty Agreement of CL&P dated as of January 23, 1995 (MIPS). (Exhibit B.3 (Execution Copy), File No. 70-8451)\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)\n4.3.1.1 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)\n4.3.8.1 First Supplement to Series E (Tax Exempt Refunding Issue) PCRB Loan and Trust Agreement dated as of December 1, 1993. (Exhibit 4.3.8.1, 1993 NU Form 10-K, File No. 1-5324)\n4.3.9 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. (Exhibit 4.3.9, 1993 NU Form 10-K, File No. 1-5324)\n4.3.9.1 Amended and Restated Letter of Credit dated December 17, 1992. (Exhibit 4.3.9.1, 1993 NU Form 10-K, File No. 1-5324)\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)\n4.3.10.1 Amended and Restated Letter of Credit dated December 15, 1993. (Exhibit 4.3.10.1, 1993 NU Form 10-K, File No. 1-5324)\n4.4 Western Massachusetts Electric Company\n4.4.1 First Mortgage Indenture and Deed of Trust between WMECO and Old Colony Trust Company, Trustee, dated as of August 1, 1954. (Exhibit 4.4.1, 1993 NU Form 10-K, File No. 1- 5324)\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 September 1, 1990. (Exhibit 4.3.15, 1990 NU Form 10-K, File No. 1-5324.)\n4.4.5 December 1, 1992. (Exhibit 4.15, File No. 33-55772)\n4.4.6 January 1, 1993. (Exhibit 4.5.13, 1992 NU Form 10-K, File No. 1-5324)\n4.4.7 March 1, 1994. (Exhibit 4.4.11, 1993 NU Form 10-K, File No. 1-5324)\n4.4.8 March 1, 1994. (Exhibit 4.4.12, 1993 NU Form 10-K, File No. 1-5324)\n4.4.9 Series A (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and WMECO (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.4.13, 1993 NU Form 10-K, File No. 1-5324)\n4.4.10 Series A (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.4.14, 1993 NU Form 10-K, File No. 1-5324)\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)\n4.5.3 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\n#@** 10.1 Stockholder Agreement dated as of July 1, 1964 among the stockholders of Connecticut Yankee Atomic Power Company (CYAPC).\n#@** 10.2 Form of Power Contract dated as of July 1, 1964 between CYAPC and each of CL&P, HELCO, PSNH and WMECO.\n#@** 10.2.1 Form of Additional Power Contract dated as of April 30, 1984, between CYAPC and each of CL&P, PSNH and WMECO.\n10.2.2 Form of 1987 Supplementary Power Contract dated as of April 1, 1987, between CYAPC and each (Exhibit 10.2.6, 1987 NU Form 10-K, File No. 1-5324)\n#@** 10.3 Capital Funds Agreement dated as of September 1, 1964 between CYAPC and CL&P, HELCO, PSNH and WMECO.\n10.4 Stockholder Agreement dated December 10, 1958 between Yankee Atomic Electric Company (YAEC) and CL&P, HELCO, PSNH and WMECO. (Exhibit 10.4, 1993 NU Form 10-K, File No. 1-5324)\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.) 10.5.1 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)\n10.5.4 Form of Amendment No. 7 to Power Contract, dated February 1, 1992, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.4, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.7.1 Form of Amendment No. 1 to Power Contract dated as of March 1, 1983 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.1, 1993 NU Form 10-K, File No. 1-5324)\n10.7.2 Form of Amendment No. 2 to Power Contract dated as of January 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.2, 1993 NU Form 10-K, File No. 1- 5324)\n#@** 10.7.3 Form of Amendment No. 3 to Power Contract dated as of October 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO.\n10.7.4 Form of Additional Power Contract dated as of February 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.4, 1993 NU Form 10-K, File No. 1-5324)\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)\n#@** 10.8.1 Amendment No. 1 to Capital Funds Agreement, dated as of August 1, 1985, between MYAPC, CL&P, PSNH and WMECO.\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) 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. (Exhibit 10.10.2, 1993 NU Form 10-K, File No. 1-5324)\n#@** 10.10.3 Form of Third Amendment to Power Contract dated as of April 24, 1985 between VYNPC and each of CL&P, PSNH and WMECO.\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. 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)\n10.10.7 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)\n10.10.9 Form of Additional Power Contract dated as of February 1, 1984 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.9, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.11.2 Form of Second Amendment to Capital Funds Agreement dated as of September 1, 1993 between VYNPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 10.11.2, 1993 NU Form 10-K, File No. 1-5324)\n#** 10.12 Amended and Restated Millstone Plant Agreement dated as of December 1, 1984 by and among CL&P, WMECO and Northeast Nuclear Energy Company (NNECO).\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) 10.13.1 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)\n* 10.17 Agreement (composite) for joint ownership, construction and operation of New Hampshire nuclear, as amended through the November 1, 1990 twenty-third amendment.\n10.17.1 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)\n10.17.2 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)\n10.17.2.1 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)\n10.18.2 Form (Composite) of Second Amendment to Exhibit 10.18. (Exhibit 10.18.2, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.20 Form of Service Contract dated as of July 1, 1966 between each of NU, CL&P and WMECO and the Service Company. (Exhibit 10.20, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.20.2 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)\n10.20.3 Form of Annual Renewal of Service Contract. (Exhibit 10.20.3, 1993 NU Form 10-K, File No. 1-5324)\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) 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. (Exhibit 10.21.1, 1993 NU Form 10-K, File No. 1-5324)\n**#10.21.2 Amendment to Memorandum of Understanding between CL&P, HELCO, HP&E, HWP and WMECO dated as of January 1, 1984 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)\n10.22.4 Twenty-ninth Amendment to Exhibit 10.22 dated as of May 1, 1993. (Exhibit 10.22.4, 1993 NU Form 10-K, File No. 1-5324)\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)\n#@**10.25 Simulator Financing Lease Agreement, dated as of February 1, 1985, by and between ComPlan and NNECO.\n#@**10.26 Simulator Financing Lease Agreement, dated as of May 2, 1985, by and between The Prudential Insurance Company of America and NNECO.\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 dated 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)\n10.28 Millstone Technical Building Note Agreement dated as of December 21, 1993 between, by and between The Prudential Insurance Company of America and NNECO. (Exhibit 10.28, 1993 NU Form 10-K, File No. 1-5324)\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)\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) 10.33 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)\n10.35.1 Amendment 1 to Exhibit 10.35, effective as of August 1, 1993. (Exhibit 10.35.1, 1993 NU Form 10-K, File No. 1-5324)\n10.35.2 Amendment 2 to Exhibit 10.35, effective as of January 1, 1994. (Exhibit 10.35.2, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.36.1 First Amendment to Exhibit 10.36 dated February 7, 1992. (Exhibit 10.36.1, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.36.3 Second Amendment to Exhibit 10.36 dated April 9, 1992. (Exhibit 10.36.3, 1993 NU Form 10-K, File No. 1-5324)\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.)\n* 13.1 Portions of the Annual Report to Shareholders of NU (pages 16 - 50) that have been incorporated by reference into this Form 10-K.\n13.2 Annual Report of CL&P. 13.3 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)\n27 Financial Data Schedules (Each Financial Data Schedule is filed only with the Form 10-K of that respective registrant.)\n27.1 Financial Data Schedule of NU.\n27.2 Financial Data Schedule of CL&P.\n27.3 Financial Data Schedule of WMECO.","section_15":""}
{"filename":"41147_1994.txt","cik":"41147","year":"1994","section_1":"ITEM 1. BUSINESS\nGeriatric & Medical Companies, Inc., a Delaware Corporation organized in July, 1968, (hereinafter, together with its subsidiaries, referred to as the 'Company') is a holding company which conducts its business through its principal subsidiaries: Life Support Medical, Inc, (formerly known as the Life Support Medical Group) and Geriatric and Medical Services, Inc. (formerly known as the GeriMed Services Group) as described below.\nLIFE SUPPORT MEDICAL, INC.\nThrough its subsidiaries listed below, Life Support Medical, Inc. (LSM) provides a broad line of healthcare support services to the managed care industry, including long term care facilities, hospitals, health maintenance organizations (HMO's), and physician groups. LSM operates from multiple locations in New Jersey and Pennsylvania.\nLIFE SUPPORT AMBULANCE, INC. (LSA) provides a full range of medical transport services, including basic life support, advanced life support, critical care and coach transportation. LSA is fully accredited by the Commission on Accreditation of Ambulance Services and utilizes state-of-the-art, high-tech computer aided dispatch and a satellite vehicle tracking system to deliver these services on a cost effective basis. UNITED HEALTH CARE SERVICES, INC. (UHCS) provides infusion, parenteral\/enteral nutrition, respiratory therapy, medical equipment and supplies to adult and pediatric patients, primarily in the home care setting. UHCS is accredited by the Joint Commission on the Accreditation of Healthcare Organizations (JCAHO).\nINNOVATIVE PHARMACY SERVICES, INC. (IPS) is a full service institutional pharmacy which provides Prescription and Non-prescription Medications, Infusion, Parenteral\/Enteral Nutritional and Medical Supplies to approximately 6,200 long-term care and residential beds.\nHEALTHCARE HOSPITALITY SERVICES (HCHS) is a provider of contract management services including dietary, housekeeping, laundry, pest control, plant operations and facilities management to approximately 6,600 long term care, residential and independent living beds.\nDIVERSIFIED DIAGNOSTICS, INC. (Diversified) and Rehab Technologies, Inc. (Rehab) provide diagnostic and rehabilitative management services to approximately 6,500 long term care and residential beds. Diversified is a provider of portable x-ray, echocardiograms, Holter Monitor, electrocardiograms, Doppler Studies, pacemaker evaluation and ultrasound. Rehab supplies a comprehensive therapy and management program which includes: occupational therapy, physical therapy and speech therapy services.\nGERIATRIC AND MEDICAL SERVICES, INC.\nThrough its subsidiaries and divisions, Geriatric and Medical Services, Inc. (GMS) owns, operates and provides services to long term care, residential and independent living facilities in Pennsylvania and New Jersey. The services provided include management and consulting, financial and information, and insurance.\nMANAGEMENT AND CONSULTING SERVICES. GMS, through its various subsidiaries, provides management and consulting services to approximately 3,900 beds, principally its owned facilities. Generally, subject to the terms of the specific contractual arrangement, GMS will act as the general manager for the facility and monitor substantial compliance with all licensure and certification requirements applicable to the facility and the operations conducted at the facility. GMS also conducts comprehensive quality assurance reviews and monitors each facility for substantial compliance with Federal and State regulations. As general manager for the facility, GMS has the overall responsibility for the daily operation of the facility in conformity with pre-established budgetary guidelines and monitors the quality of services provided to the facility by other service contractors. The long-term care facilities managed by GMS provide services to patients ranging from subacute rehabilition units,\nto skilled nursing care for bedridden patients to basic nursing care for custodial or ambulatory patients. Services provided include the prescribed type of nursing care, room and board, special diets as needed, occupational, physical and recreational therapy and other services as specified by the patient's physician. Staff size and composition vary depending on the size and location of the facility, acuity or level of care, and state requirements.\nThe residential and independent living facilities operated by GMS are available for rental without regard to age; however, substantially all residents are senior citizens. Services at these facilities include meals, recreation and housekeeping, but generally only limited nursing care. Each of these facilities is subject to various state and local licensing requirements and building codes.\nHEALTHCARE FINANCIAL SERVICES AND INFORMATION SYSTEMS. Through its GMC Financial Services, Inc. subsidiary, GMS provides accounting, financing, management information, health care benefit management and insurance services to approximately 5,300 long term care and residential beds.\nThe following table sets forth pertinent information concerning the long-term care, residential and independent living facilities operated by the Company.\n- ------------------ (1) Includes a long term care facility of 280 beds and a residential facility of 55 beds which are owned by a Company controlled by the Chairman of the Board, President and Chief Executive Officer of the Company. These facilities were managed by the Company as of May 31, 1994. (2) Facilities managed by the Company\nThe Company has obtained Certificates of Need and will add 123 nursing home beds to 3 existing facilities in New Jersey and Pennsylvania during fiscal 1995. In addition, the Company is currently developing a 120 bed facility in Pennsylvania and a 60 bed nursing home and 60 bed residential facility in New Jersey. Certificates of Need have been obtained for both projects with construction anticipated to commence during fiscal 1995.\nOTHER FACTORS MARKETING\nThe Company engages in local marketing efforts to promote and maintain occupancy rates and to improve its quality mix. The Company's marketing activities are conducted primarily by each facility and business unit who seek to establish relationships with referring physicians, hospital discharge planners, social workers, community organizations and other support groups.\nThe Company is increasingly concentrating its market efforts to managed care and insurance companies, as well as hospital executives and discharge planners, thereby developing referral sources for both LSM and GMS.\nTHIRD PARTY PAYOR PROGRAMS\nThe Company derives substantially all its revenues from third party payors, including Medicare, Medicaid and private insurers. The collection of accounts receivable from third party payors is critical to the Company's success and therefore is a high priority for all levels of management. Funds received under Medicare and Medicaid by all companies in the health care industry are subject to audit with respect to the proper application of various regulations and payment formulas. Such audits can result in retroactive adjustments resulting in amounts due to or from the governmental agency. While the Company believes that the charges it has submitted are appropriate, no assurance can be given that such adjustments will not be made, and if made, that they will not be material.\nThe levels of revenues and profitability of the Company, like those of other health care companies, are affected by the continuing efforts of third party payors to contain or reduce the costs of health care by lowering reimbursement rates, increasing case management review of services and negotiating contract pricing. The implementation of managed care programs either mandated by government action or adopted by the industry is expected to continue to bring additional pressures on pricing. Such programs also favor providers who can efficiently deliver a continuum of products and services to a large defined population on a captitated basis. Home health, long term care facilities and other sub-acute care facilities, which are generally less costly to third party payors than hospital-based care, have benefitted from those cost containment objectives. However, as expenditures in these segments continue to grow, initiatives aimed at reducing the costs of health care delivery at non-hospital sites are increasing. Such initiatives have been implemented in the past and have negatively impacted the operating results of LSM. A significant change in coverage or a reduction in payment rates by third party payors would have a material adverse effect upon the Company's business and financial condition.\nAll of the Company's long-term care facilities are currently certified and substantially all of the Company's other business units are qualified to receive payments under Medicare, and all are certified under the Medicaid programs of the Commonwealth of Pennsylvania or the State of New Jersey to provide medical assistance to the 'medically indigent'. Both initial and continuing certification or qualification to participate in such programs is dependent upon many factors including, among others, accommodations, equipment, services, patient care, safety, personnel, physical environment, and adequate policies, procedures and controls.\nThe Company's long-term care facilities are primarily made up of Medicaid, Medicare and private pay patients. During the fiscal year ended May 31, 1994, the total number of patient days at the long-term care facilities owned by the Company were attributable to: 81% Medicaid patients, 5% Medicare patients and 14% private pay and other patients, and the related revenues earned were from: 77% Medicaid patients, 9% Medicare patients and 14% private pay and other patients. Revenues derived with respect to products and services provided by LSM were attributable 20% from Medicaid, 26% from Medicare and 54% from private insurance and private pay.\nThe Company is dependent upon the continuation of the present reimbursement system, or something similar thereto, pursuant to which third-party payors (principally Medicaid and Medicare) pay for the services and products provided by the Company.\nBecause of the significance of Medicaid Reimbursement on the Company's operations, significant increases in costs have an adverse impact on the Company's operating results. This occurs because the Medicaid reimbursement rates set by each state, which are applicable throughout the ensuing year, are established periodically and are based on historical data. Additionally, the Company tends to build up Medicaid receivables due to differences between interim payments and final cost report audits and settlements. Although Pennsylvania Medicaid regulations require audits within one year of the filing of cost reports and the audit of the Medicare home office cost report, audits and settlements thereof may take up to four years after the costs involved are incurred.\nBoth the Medicare and Medicaid programs are subject to statutory and regulatory changes, administrative rulings, interpretations of policy, determinations by the Medicare carrier and\ngovernmental funding restrictions, all of which may materially increase or decrease the rate of program payments to health care providers. Congress is attempting to limit the growth of Federal spending on health care programs, including limitations on payments under the Medicare and Medicaid programs. The Company can give no assurance that payments under such programs will in the future remain at a level comparable to the present level. See 'Healthcare Reform' below.\nGOVERNMENT REGULATION\nThe Federal government and each state in which the Company currently operates regulate various aspects of its business. LSM's pharmacy operations are subject to the Federal laws covering the repackaging and dispensing of drugs. LSM is also subject to Federal laws covering the dispensing of oxygen and interstate motor-carrier transportation, as well as state laws governing pharmacies, nursing services and certain types of home health care activities. The failure to obtain, renew or maintain any of the required regulatory approvals or licenses could adversely affect expansion of the business conducted by the Company and could prevent the delivery of one or more products and services.\nOperation and development of long term care facilities are subject to various federal, state and local statutes and regulations. The states in which the Company operates have statutes which require that prior to the addition or construction of new beds, the addition of new services or certain capital expenditures in excess of defined levels, the Company must obtain a certificate of need ('CON') which certifies that the state has made a determination that a need exists for such new or additional beds, new services or capital expenditures. These state determinations of need or CON programs are designed to comply with certain minimum Federal standards and to enable states to participate in certain federal and state health related programs. Elimination or relaxation of CON requirements may result in increased competition and may also result in increased expansion possibilities.\nSince August 1982, Pennsylvania has refused to reimburse long time care providers for depreciation and interest on facilities built after that date even though the Commonwealth issued a CON for the facility. The Company has received legal counsel opinion that Pennsylvania's position violates various provisions of federal law. The Company is negotiating to receive reimbursement for the beds it has added since August 1982 and if it is not successful, the Company is prepared to litigate the issue. Even if the Company is successful, there is no assurance that the amount of reimbursement will be sufficient to cover all costs incurred.\nThe Company presently has CON applications in Pennsylvania pertaining to 330 beds.\nThe Company's long term care facilities are also subject to licensure regulations. Each of the long term care facilities is licensed as a nursing facility. The Company believes it is in substantial compliance with all material statues and regulations applicable to its long term care, residential and independent living facilities. In addition, all healthcare facilities are subject to various local building codes and other ordinances. It is not possible to predict the content or impact of future legislation and regulations affecting the healthcare industry.\nState and local agencies survey all long term care facilities on a regular basis to determine whether such facilities are in compliance with governmental operating and health standards and conditions for participation in government medical assistance programs. Such surveys include review of patient utilization of healthcare facilities and standards for patient care. The Company endeavors to maintain and operate its facilities in substantial compliance with all such standards and conditions. However, in the ordinary course of business the facilities receive notices of deficiencies for failure to comply with various regulatory requirements. Generally, the facility and the reviewing agency will agree upon the measures to be taken to bring the facility into compliance with the regulatory requirements. In some cases or upon repeat violations, the reviewing agency may take adverse actions against a facility, including the imposition of fines, temporary suspension of admission of new patients to the facility ('bed holds'), suspension or decertification from participation in the Medicare or Medicaid programs, and, in extreme circumstances, revocation of a facility's license. These adverse actions may adversely affect the ability of a facility to operate or to provide certain services and its eligibility to participate in the Medicare or Medicaid programs. In addition, such adverse actions may\nadversely affect other facilities operated by the Company. Certain of the Company's owned or managed facilities have in the past received notices from governmental agencies to the effect that if certain alleged deficiencies are not rectified, such facilities would be decertified from participation in Medicare and Medicaid programs. In all such cases, the alleged deficiencies were rectified before any such facilities were decertified. Enforcement of these regulations is becoming more stringent. As a result the Company has in recent years experienced bed holds in certain facilities and other administrative activities, however, the Company has not had any of its operating licenses revoked. The Company believes that such actions will not have a material impact on its operations or financial condition. See 'Business -- Federal and State Assistance Programs' and 'Business -- Legal Proceedings.'\nAs a provider of services under the Medicare and Medicaid programs, the Company is subject to the Medicare and Medicaid fraud and abuse laws. These laws prohibit any bribe, kickback or rebate in return for the referral of Medicare or Medicaid patients. Violations of these provisions may result in civil and criminal penalties and exclusion from participation in the Medicare and Medicaid programs. In July 1991, the Office of the Inspector General of the United States Department of Health and Human Services promulgated regulations setting forth certain safe harbors under the fraud and abuse laws (the 'Safe Harbors'). These laws and regulations were updated under OBRA'93 and pursuant to clarifying regulations adopted in July, 1994. In addition, certain states in which the Company operates have laws that prohibit certain direct or indirect payments or fee-splitting arrangements between health care providers, if such arrangements are designed to induce or encourage the referral of patients to a particular provider. Possible sanctions for violation of these state-created restrictions include loss of licensure and civil and criminal penalties.\nSuch laws and regulations vary from state to state, often are vague and seldom have been interpreted by the courts or regulatory agencies. Some states enacted laws which, with some exceptions, have the effect of prohibiting a physician from referring to an ancillary service which the physician has either an ownership interest or a contractual arrangement. As a result of the various statutes and interpretations, the Company has reviewed its joint venture and management arrangements and has terminated these arrangements as deemed appropriate. The Company believes that its operations including joint venture and management arrangements with other health care providers substantially comply with applicable laws and regulations; however, there can be no assurance that judicial or administrative interpretation of existing laws, including the fraud and abuse laws, or legislative enactment of new laws will not have a material adverse effect on the Company's business. The Company's subsidiary, United Health Care Services, Inc. ('United') had been involved in certain joint ventures, most of which were in place when the Company purchased United, which were subsequently terminated. In connection with a recent review of such arrangements in the industry, the Company was requested by the Office of the United States Attorney for the Eastern District of Pennsylvania and the Commonwealth of Pennsylvania, Department of Welfare to provide certain information concerning such joint venture arrangements. As a result of such inquiry, the Company has reached a tentative settlement with the Office of the United States Attorney for the Eastern District of Pennsylvania and is discussing a settlement with the Commonwealth of Pennsylvania Department of Public Welfare regarding such joint ventures. (See Item 3 'Legal Proceedings'.)\nThe Medicare program consists of two separate insurance programs: 'Hospital Insurance,' Part A, provides certain benefits covering inpatient hospital, nursing facility, home health and hospice services; and 'Supplementary Medical Insurance,' Part B of the Social Security Act, provides benefits in the areas of outpatient hospital visits, physician services, pertaining to other types of outpatient services, respiratory therapy, infusion therapy, home medical equipment and prosthetic devices. The Company is an authorized supplier eligible to receive direct reimbursement under Medicare Part B. Health care providers must meet 'conditions of participation' to receive Medicare payments. The conditions of participation are Federal requirements intended to insure the quality of the medical services provided. Part A providers such as hospitals and skilled nursing facilities are required to sign a provider agreement to participate in Medicare.\nUnder Part B, there is an annual deductible of $100 that the beneficiary must pay before Medicare will make any payments. After the Part B deductible is satisfied, Medicare will ordinarily pay 80% of the Medicare-approved payment amount, and the beneficiary is responsible for paying the remaining 20%. If a patient or customer is not covered by a medigap policy, the ability of the Company to collect the 20% Part B co-pay is limited.\nOBRA 1987 created six categories for durable medical equipment reimbursement under the Medicare Part B program. OBRA 1987 also defined whether products would be paid for on a rental or sale basis and established fixed payment rates for oxygen service as well as a 15-month rental ceiling on certain medical equipment. The Omnibus Budget Reconciliation Act of 1990 ('OBRA 1990') made new changes to Medicare Part B reimbursement that were implemented in 1991. The substantive changes included a national standardization of Medicare rates for certain equipment categories and reductions in amounts paid for certain durable medical equipment. The changes mandated by OBRA'93 are not expected to have a material effect on the Company.\nQUALITY ASSURANCE\nThe Company maintains quality assurance programs in all of its operating entities. The Quality Review Committee of the Board of Directors reviews and maintains these programs and reports to the Board with respect to compliance with these programs.\nCOMPETITION\nA dramatic growth in the health care market in recent years has attracted a large number of providers, some of which are national in scope and a greater number of which, like the Company, operate only in limited geographic areas. Accordingly, the market for health care service is highly competitive. Competition is encountered from a variety of health care organizations including major national chains which are larger than the Company. Some existing competitors in the home health care business also manufacture their own products and equipment. Other competitors include health care organizations, hospital and health maintenance organizations. Some of the significant competitive factors include reputation, quality and diversity of services offered, family and physician preferences, referral networks and price. The Company's ability to successfully compete in the delivery of health care services is dependent, among other things, on its ability to adjust to a changing regulatory environment, obtain payment from third-party payors, control costs, deliver a consistently high quality of care, adapt to the changing needs of the population it serves and position itself to provide a continuum of cost efficient products and services to the managed care industry.\nThe long-term care, residential and independent living facilities operated by the Company compete with all types of health care facilities, nursing and convalescent centers, extended care centers, retirement facilities and communities, and similar institutions. There are a large number of skilled nursing facilities and other facilities in each of the geographic areas served by the Company's facilities. The degree of success with which the Company's care facilities compete varies from location to location and is dependent on a number of factors. The Company believes that the quality of care provided, reputation and physical appearance of facilities, and in the case of private patients, charges for services, are significant competitive factors. There is limited, if any, competition in price with respect to Medicaid and Medicare patients, since revenues for services to such patients are strictly controlled and based on fixed rates and cost reimbursement principles. See 'Federal and State Assistance Programs', above. Provision of quality care by the Company is dependent in part on its ability to adequately staff its facilities.\nHEALTHCARE REFORM\nThe Clinton Administration has made healthcare reform one of its top priorities. The White House Task Force on Health Care Reform studied the issue of health care reform and presented its report and recommendations to the Administration. The Administration proposed health care reform legislation to Congress. Various other legislative and industry groups continue to study numerous health care issues,\nincluding access, delivery, and financing of long-term health care. These and other groups' recommendations will likely impact the form and content of future health care reform legislation. As a result, the Company is unable to predict the type of legislation or regulations that may be adopted affecting the future of the Health Care Industry and their impact on the Company. There can be no assurance that any health care reform will not adversely affect the Company's financial position or results of operations.\nBills and proposed regulations have been pending in Pennsylvania to substantially change Pennsylvania's Medicaid System. The new System, expected to be implemented no later than July 1, 1994, was not adopted. The Company is not able to determine, at this time, whether or when a new system will be adopted, or, if adopted, the effect on the financial results of the Company.\nLIABILITY INSURANCE\nIn recent years, participants in the health care market have become subject to an increasing number of lawsuits alleging malpractice, product liability or related legal theories, many of which involve large claims and significant defense costs. The Company is from time to time subject to such suits as a result of the nature of its business. The Company currently maintains liability insurance intended to cover such claims. However, there can be no assurance that the coverage limits of the Company's insurance policies will be adequate. While the Company has been able to obtain liability insurance in the past, such insurance varies in cost, is difficult to obtain and may not be available in the future on acceptable terms or at all. A successful claim against the Company in excess of the Company's insurance coverage could have a material adverse effect upon the Company and its financial condition.\nThe Company currently has in force general liability insurance, including professional liability, with an aggregate annual limit of $11,000,000 covering operations at all of its owned long-term care and residential health care facilities and the other operations of the Company other than the ambulance services for which the limit of coverage is $3,000,000. In addition, the ambulance services has in force automobile insurance coverage with an aggregate annual limit of $1,000,000. The Company also currently has in force two general liability policies, with aggregate annual limits of $6,000,000 each, covering the operations of UHCS and IPS, respectively. These insurance policies have no deductibles, are subject to annual renewal, and provide coverage on a claims made basis for professional liability. All other policies provide coverage on an occurrence basis.\nThe Company makes available health plan coverage to certain of its employees under a fully insured program. The Company also maintains retroactively rated workers' compensation insurance with an A+ rated insurance carrier in all states of operation. The Company has implemented and continues to maintain programs to minimize the number and severity of occurrences and to control the costs of existing and future claims. The Company's ultimate liability is limited under the terms of the worker's compensation insurance contracts and by state statute.\nEMPLOYEES\nAs of May 31, 1994, the Company employed approximately 4,150 full and part time employees. The majority of those employees, primarily the service worker employees of GMS, are represented by labor unions. The Company believes that its employee relations are generally satisfactory. However, it cannot predict the effect of organizational activities on its future operations. In the present labor market, the prospect of demands for higher wages or strikes is a possibility.\nThe health care industry is labor intensive and dependent upon skilled personnel. On occasion, a shortage of skilled and entry level healthcare personnel may occur which could adversely affect the operating results of the Company.\nIn the conduct of its business, the Company does not discriminate against any individual on account of his\/her race, color, religion, sex, national origin or physical disability.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nReference is made to Item 1 of this Report for a description of the long-term care, residential and independent living facilities operated by the Company. All owned facilities listed in Item 1 are subject to mortgages. See Note 2 of the Notes to Consolidated Financial Statements. In addition, the Company owns and occupies a 175,000 square foot building in West Philadelphia which houses its management and administrative activities as well as the operations of its pharmacy and durable medical equipment businesses. The Company believes that all of the properties are adequately maintained and are suitable for the purposes intended.\nThe Company also holds various improved and unimproved properties for development which, in the aggregate, are not material.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn September, 1992 a class action law suit was commenced against the Company, GMS Management, Inc., and various current or former officers of the Company in the United States District Court for the Eastern District of Pennsylvania. The Complaint alleges that, among other things, various reports and press releases issued by the Company misrepresented and omitted adverse material facts concerning the quality of care provided at two nursing facilities previously managed by a subsidiary of the Company. The plaintiff did not seek a specified sum other than 'to pay to plaintiff and to all members of the class damages in an amount to be proven at trial, with interest thereon.' Although the outcome cannot be predicted, the Company and the individual defendants deny any wrongdoing and are vigorously defending this action. A trial of this law suit is scheduled to start in October, 1994.\nThe Company's subsidiary UHCS was the subject of an inquiry by the Office of the United States Attorney for the Eastern District of Pennsylvania and the Commonwealth of Pennsylvania, Department of Public Welfare regarding its joint ventures and management arrangements. UHCS reached a tentative agreement with the United States Attorney whereby the Company will be required to pay $320,000 no later than September 30, 1994, $340,000 in September, 1995 and $440,000 in September, 1996. The Company is anticipates settling this matter with the Commonwealth of Pennsylvania.\nThe Company is involved in routine government inquiries, audit surveys and administrative proceedings concerning its activities and operations. The Company is also involved in various claims and legal actions arising in the ordinary course of business. The Company believes that the outcome of all of these matters will not have a material adverse effect on the Company's operations, financial position and cash flows.\nPART II\nITEM 5.","section_4":"","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock is traded in the over-the-counter market and listed on the Automated Quotations System of the National Association of Securities Dealers, Inc. (NASDAQ symbol: GEMC). The following table sets forth, for the fiscal periods indicated, the high and low sale prices of the Company's Common Stock as reported by the National Quotation Bureau, Inc., together with information concerning cash dividends paid per share during those periods. The following quotations represent prices between dealers and do not include retail markup, markdown, or commissions. They do not necessarily represent actual transactions. The high and low sales prices for each quarterly period for the two most recent fiscal years are:\nOn October 6, 1994, the last sale price for the Company's Common Stock was 2 1\/4. As of May 31, 1994, the Company had 1,458 stockholders of record of its Common Stock.\nThe Company did not declare or pay cash dividends in fiscal year 1994 and future dividends will depend, among other things, upon the earnings of the Company, its working capital needs, capital requirements, its debt service requirements, its general financial condition and other factors. Pursuant to a guaranty in connection with the issuance of certain 1992 tax-exempt bonds, the Company has agreed not to pay any dividends or make any distribution which could have the effect of reducing the Company's consolidated tangible net worth and subordinated indebtedness, if the Company's consolidated tangible net worth and subordinated indebtedness is at such time or would be reduced to less than $9,000,000. No assurance can be given that the Company will declare or pay dividends in the future. However, the Company has, in the past, declared and paid stock dividends in the form of stock splits.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED SELECTED FINANCIAL DATA*\n- ------------------\n(a) Includes recognition of deferred and current gains on facilities sold:\n(b) Excludes current portion of long-term debt and subordinated debentures.\n(c) Pertains to owned long-term care facilities only.\n* Reclassified for comparative purposes.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nGeriatric & Medical Companies, Inc. is a holding company which conducts its business through its principal subsidiaries: LIFE SUPPORT MEDICAL, INC. (LSM) (formerly known as the Life Support Medical Group) and GERIATRIC AND MEDICAL SERVICES, INC. (GMS) (formerly known as the GeriMed Services Group) as described below.\nLSM provides ambulance transportation services, home infusion therapy, home respiratory therapy, home medical equipment, pharmaceutical services, medical supplies and related billing services and intravenous therapy. This group also offers portable diagnostic services, speech, occupational and physical therapy, nutritional services, environmental services, facility maintenance, design, construction management services and a full range of health care financial and information services. The Company provides these services to other health care providers, long term care facilities, including its own facilities, health maintenance organizations and the home care health care market.\nGMS owns, operates and provides services to long term care, residential and independent living facilities. The services offered include management and consulting, financial information and insurance.\nLIQUIDITY AND CAPITAL RESOURCES\nOn May 31, 1993, the Company sold its Mount Laurel, New Jersey facilities to Tomahawk Capital Investments, Inc., (Tomahawk) which is controlled by the Chairman of the Board of the Company, for a purchase price of $8.5 million, the fair market value as established by an independent appraisal. The Company received $2.5 million in cash and a $6.0 million note bearing interest at nine percent (9%) per annum. The note is based on a 25-year amortization with a balloon payment due June of 2005. Tomahawk prepaid $1,000,000 of this note in January, 1994.\nDuring fiscal 1994, the Company refinanced approximately $1,315,000 of industrial development bonds, which allowed the Company to replace cash collateralized letters of credit with other property. This resulted in additional working capital of $1,197,000 during fiscal 1994.\nOn November 4, 1993, the Company entered into a $25 million accounts receivables sale agreement, with recourse. This is a three year agreement with program costs charged at 9.84% of the outstanding receivables sold. The Company accounts for this as a sale of receivables. On May 19, 1994 the Company entered into an additional agreement to sell certain receivables due from third party payors. The program cost charged is 9.75% of outstanding amounts sold. The maximum amount to be sold under this agreement will be $5,000,000. The amount sold by the Company at May 31, 1994 under this agreement was $628,000. The agreement expires in November, 1997. The Company has accounted for the transaction as a sale of receivables (See Note 4 to the Notes to Consolidated Financial Statements.)\nThe Company redeemed $2,868,000 of 16% subordinated debentures due December 31, 1994 on February 1, 1994 at par plus accrued interest. The Company funded this redemption through the collection of outstanding accounts receivables and the prepayment of the mortgage due from Tomahawk.\nA substantial part of the Company's revenues consists of reimbursements under the Pennsylvania Medicaid Program, a retrospective cost based program that typically results in the generation of large receivables which are periodically settled. Pennsylvania had planned to switch to a prospective Medicaid reimbursement system effective January, 1994 which did not occur. It is not known whether Pennsylvania will institute a prospective system during fiscal 1995 and the effects of the final plan on the cash flow or operations of the Company are not known. The Company anticipates the State of Pennsylvania increasing its rates as of July, 1994 and also anticipates Pennsylvania will pay tentative settlements on its fiscal 1994 cost reports during fiscal 1995.\nAt May 31, 1994, the Company has restricted cash of approximately $1,733,000 to be used for capital improvements and construction projects. In addition to the capitalized improvements which will be funded from the restricted cash account the Company anticipates commencing construction on two facilities in fiscal 1995 for a total cost of $13,188,000. The Company has tentative commitments for $11,240,000 to finance construction. Of the remaining amount, approximately $1,250,000 has been funded and approximately $700,000 will need to be funded by the Company.\nThe Company reached a tentative settlement with the Office of the United States Attorney for the Eastern District of Pennsylvania regarding the joint venture and management arrangements of its subsidiary United Health Care Services, Inc. whereby the Company will pay $320,000 by September 30, 1994, $340,000 by September 30, 1995 and $440,000 by September 30, 1996.\nThe Company intends to meet its capital commitments and working capital requirements in fiscal 1995 from operations, existing financing arrangements including the $25 million and $5 million receivable funding facilities, or the sale or refinancing of other assets.\nCOMPARISON OF CONSOLIDATED RESULTS OF OPERATIONS FOR FISCAL 1994 AND FISCAL 1993\nThe following table derived from the Company's consolidated statements of operations sets forth for the items listed the respective charges when compared between the periods:\nNet loss was $1,438,000 for the twelve months ended May 31, 1994 compared to net income of $2,434,000 in 1993. Income (loss) before income taxes was a loss of $1,737,000 in 1994 compared to income of $3,246,000 in 1993 which includes $1,576,000 in 1994 and $6,365,000 in 1993 related to a gain on facilities sold and recognition of deferred income.\nOperating revenues increased $13,593,000 in 1994 when compared to 1993. LSM increased its operating revenues in 1994 when compared to 1993, by $4,062,000 principally as a result of increased volume in the ambulance, pharmaceuticals and hospitality businesses. GMS increased its operating revenues, $9,531,000 in 1994 compared with the same period in 1993. The increase resulted from an increase in rates from government and private payors of $9,665,000 and a reduction in the allowance for third party receivables of approximately $1,100,000 resulting from a change in the estimation of the allowance needed for various issues. These increases were offset by a decrease in revenue related to the sale of a facility on May 31, 1993 which was offset by staffing and other services provided to the new owners and 60 new beds added during fiscal, 1994. The net effect of these items was a net loss of revenue of approximately $811,000. In addition, management fees decreased by approximately $423,000 resulting from the termination of substantially all non owned management agreements. These terminations represent a change in business whereby the Company will emphasize providing support services versus general management to long term care facilities. The Company anticipates replacing these revenues in fiscal 1995 through bed additions and an increase in other services.\nOperating expenses increased $15,594,000 in 1994 compared to 1993. LSM operating expenses increased $8,027,000 in 1994 resulting primarily from the Company providing a non cash charge of approximately $4,500,000 for possible uncollectible receivables. The Company completed in 1994 the installation of new billing and collection systems for several of the entities within LSM and has provided for possible uncollectibles related to receivables still outstanding on the replaced systems. In addition LSM recorded its estimate of a tentative settlement of $1,100,000 with the Office of the United States Attorney for the Eastern District of Pennsylvania and its anticipated settlement with the Commonwealth of Pennsylvania regarding joint ventures and management agreements (See Note 17 of the Notes to Consolidated Financial Statements). The remaining expense increase of $2,427,000 relates to increased volume at new and existing customers. GMS had an increase in operating expenses of $7,567,000 in 1994 relating principally to salary and other inflationary increases and the recording of a $700,000 non cash charge relating to a change in estimating workers' compensation expense in 1994.\nDepreciation and amortization increased $238,000 in 1994 as a result of the amortization of costs incurred in connection with bond refinancings in July 1993.\nInterest expense, net, for the year ended May 31, 1994 decreased approximately $488,000 over 1993. The net decrease is principally attributable to the redemption of $2.8 million of subordinated debentures in February 1, 1994 combined with capitalization of interest on construction and development projects.\nCOMPARISON OF CONSOLIDATED RESULTS OF OPERATIONS FOR FISCAL 1993 AND FISCAL 1992\nThe following table derived from the Company's consolidated statements of operations sets forth, for the items listed, the respective changes when compared between the periods:\nNet income was $2,434,000 for the year ended May 31, 1993, as compared to net income of $559,000 for the same period in 1992. Income before income taxes and extraordinary charges for 1993 was $3,246,000 compared to $1,523,000 for 1992. Other revenues in fiscal 1993 included $6,365,000 and fiscal 1992 included $3,175,000 related to recognition of deferred and current gains on facilities sold. During fiscal 1992, the Company recorded extraordinary items of $66,000 reflecting utilization of net operating loss carryforwards and an extraordinary charge of $650,000, net of tax, related to the early repayment and refinancing of its bank group debt.\nOperating revenues, decreased $187,000 in 1993 compared with the same period in 1992. LSM's operating revenues, decreased $2,661,000 resulting from discontinuance of certain product lines as a result of Medicare Part B Reimbursement changes, which totalled $5,096,000, offset by increased volume with new and existing customers totalling $2,435,000. GMS had an increase in operating revenues, of $2,474,000 in 1993 resulting primarily from increases in government reimbursement and\nprivate room rates totaling $5,780,000 offset by decreases in Medicare and Private census of $2,874,000 and decreased miscellaneous other items of $432,000.\nOperating expenses decreased in 1993 by $4,105,000 compared to the same period in 1992. LSM's operating expenses decreased $2,801,000 resulting from cost efficiencies and reductions, costs related to discontinuance of certain product lines offset by costs associated with volume increases. GMS decreased operating expenses by $1,304,000 principally as a result of cost reduction and efficiency programs.\nDepreciation and amortization expense increased $1,295,000 in fiscal 1993 compared to same period in 1992 relating to capital expenditures which were depreciated in 1993 and the amortization of financing costs related to the refinancing which occurred in April, 1992.\nInterest expense, net, for the year ended May 31, 1993 increased approximately $1,914,000 over last year. The net increase is attributed to additional debt combined with an increased weighted average interest rate.\nThe increase in provision for costs on sale of accounts receivable is principally related to increased costs associated with the review, servicing and management of the receivables previously sold. The Company entered into an accounts receivable funding facility in November 1991 and thereby utilized such facility for six months in fiscal 1992 versus the full year in fiscal 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements of the Company for the years ended May 31, 1994, 1993 and 1992, and the report of the Company's independent certified public accountants with respect thereto, are included in this report beginning on the following page.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Board of Directors of Geriatric & Medical Companies, Inc. and Subsidiaries\nWe have audited the consolidated financial statements and the financial statement schedules of Geriatric & Medical Companies, 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 from 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 Geriatric & Medical Companies, Inc. and Subsidiaries as of May 31, 1994 and May 31, 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended May 31, 1994 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 more fully discussed in Note 17, a class action shareholder lawsuit has been brought against the Company. The ultimate outcome of the foregoing cannot presently be determined. Accordingly, no provision for any liability has been made to the accompanying consolidated financial statements.\n2400 Eleven Penn Center Philadelphia, Pennsylvania 19103 October 11, 1994\nCOOPERS & LYBRAND, L.L.P.\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS EXCEPT PAR VALUES AND SHARES)\n- ------------------ * Reclassified for comparative purposes\nSee accompanying notes to consolidated financial statements.\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS ($'S IN THOUSANDS EXCEPT PER COMMON SHARE)\n- ------------------ *Reclassified for comparative purposes.\nSee accompanying notes to consolidated financial statements.\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS ($'S IN THOUSANDS)\n- ------------------ * Reclassified for comparative purposes\nSee accompanying notes to consolidated financial statements.\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT) FOR THE YEARS ENDED MAY 31, 1994, 1993 AND 1992 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (A) PRINCIPLES OF CONSOLIDATION AND PRESENTATION:\nThe consolidated financial statements include the accounts of Geriatric & Medical Companies, Inc., and Subsidiaries and its investments in majority owned joint ventures hereafter referred to as the 'Company'. The Company uses the equity method to account for its ownership interest in other joint ventures. Under the equity method, the Company recognizes its proportionate share of the net income or loss of joint ventures currently, rather than when realized through dividends or disposals. All material intercompany transactions and accounts have been eliminated in consolidation.\n(B) NET PATIENT SERVICE REVENUE:\nThe Company's operations and cash flows are dependent upon the payments for patient services by third-party payors and, in particular, Federal and State administered programs. Reimbursement under these programs is limited to certain expenditures in accordance with Federal and State regulations and is subject to retroactive adjustment upon audit by Federal and State agencies. Accordingly, net patient service revenue is recorded at the estimated realizable amounts due from third-party payors and others.\nDifferences between the amounts accrued and subsequent settlements will be recorded in operations in the year of settlement. Management maintains an allowance that it considers adequate to provide for potential disallowances on its recorded revenues under Federal and State administered programs. This allowance is based on the estimated net realizable value of the Company's revenues. Management periodically evaluates specific past experience and the results of the most recent regulatory examinations, as well as other relevant factors. While management uses the best information available to make such evaluations, no assurance can be given that future adjustments to the allowance may be necessary if regulatory agencies interpret the Company's claims for reimbursement on a basis different than the Company's historical experience with regulatory examinations.\nAlthough receivables due from third-party payors may be outstanding in excess of one year, in accordance with industry practices, such amounts are classified as current.\n(C) CASH AND CASH EQUIVALENTS:\nFor purposes of the statements of cash flows, the Company considers cash and cash equivalents to be cash on hand, cash in banks and overnight investments.\n(D) RESTRICTED CASH:\nRestricted cash represents funds held in trust to be used for construction expenditures and to repay debt obligations.\n(E) PATIENTS' FUNDS:\nPatients' funds represent cash balances which have been deposited by the Company into a separate bank account and are restricted for the use of patients. The related liability is included in accounts payable.\n(F) INVENTORIES:\nInventories, principally consisting of durable medical and respiratory therapy equipment, medical supplies and pharmaceuticals, are stated at the lower of cost or market. Cost is determined principally on the first-in, first-out basis (FIFO).\n(G) PROPERTY, EQUIPMENT AND RELATED DEPRECIATION:\nProperty and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the respective assets using the straight-line method. The annual depreciation rates range from 2.5% to 10% for buildings and improvements and 5% to 33% for equipment and fixtures. Normal maintenance and repair costs are charged to expense as incurred. Major expenditures for renewals and betterments which extend useful lives are capitalized. Upon sale or retirement the costs and related accumulated depreciation are eliminated from the respective accounts and the resulting gain or loss is included in income.\n(H) OTHER NONCURRENT ASSETS:\nGoodwill represents the excess of the cost of purchased businesses over the fair value of their net assets. Goodwill arising after October 31, 1970 is being amortized by the straight-line method over 40 years. Goodwill in the amount of $565,000 relating to acquisitions prior to November 1, 1970 is not being amortized. In the opinion of Management, there has been no impairment of goodwill.\nNotes and other receivables consist primarily of term loans, issuance cost loans and operating deficits advances related to facility sales.\nCosts incurred in obtaining long-term borrowings are amortized over the term of the loan. Pre-opening costs incurred in connection with the expansion of existing or with the construction of new long-term care facilities, are capitalized until the facility nursing units admit the initial patient or are substantially completed and then amortized using the straight-line method over a five-year period which coincides with the amortization period required by government reimbursement regulations.\n(I) INCOME TAXES:\nIn 1993 and 1992, the provision for deferred income taxes is applicable to timing differences between taxable income and income for financial reporting purposes. Beginning in fiscal 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, which provides that income taxes be accounted for under the liability method. Under the liability method, deferred income taxes are recognized by applying enacted statutory tax rates, applicable to future years, to temporary differences between the tax bases and financial statement carrying values of the Company's assets and liabilities. The adoption of SFAS No. 109 did not have a material effect on the Company's consolidated financial statements.\n(J) WORKERS' COMPENSATION INSURANCE:\nThe Company self-insures for certain levels of Workers' Compensation Insurance and estimated costs for the workers' compensation programs are accrued at present values based upon actuarially projected claims. Related workers' compensation expense for 1994, 1993, and 1992 amount to $4,928,000, $4,429,000 and $4,900,000, respectively. During 1994 the Company refined its estimate of its workers' compensation expense which resulted in an additional charge of $700,000. Included in other assets is $3,028,000, and $3,230,000 relating to the future revenue associated with the difference in accounting for workers' compensation expense under third party payor programs which is different than the method used for financial reporting purposes. The accrued workers' compensation expense amounting to $2,623,000 in 1994 and $3,230,000 in 1993 is included in other long term liabilities in the accompanying consolidated financial statements.\n(K) FINANCIAL INSTRUMENTS:\nEffective May 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 107 'Disclosures about Fair Value of Financial Instruments.' The statement requires disclosure of the fair value of certain of the Company's financial instruments for which it is practicable to estimate the\nfair value. Fair value amounts disclosed do not affect financial results and do not necessarily represent the amounts that could be realized in a sale or settlement. See Note 18 of the Notes to Consolidated Financial Statements.\n2. LONG-TERM DEBT AND SUBORDINATED DEBENTURES:\nA summary of long-term debt and subordinated debentures follows:\n(a) On April 24, 1992, the Company completed an agreement with Meditrust Mortgage Investments, Inc. ('Meditrust'), pursuant to which Meditrust extended to the Company and certain of its operating subsidiaries a credit facility of approximately $86,000,000 ('Credit Facility'), collateralized by mortgages on various nursing home facilities located in Pennsylvania and New Jersey (the 'Mortgaged Facilities'). Approximately $72,000,000 of such facility was used by the Company for the payment in full of all of its obligations under its revolvers discussed in (b), which was approximately $55,000,000, the refinancing of certain other outstanding long-term indebtedness totalling approximately $6,500,000 and the placement in restricted cash of approximately $10,500,000 to service debt and cash collateral. Approximately $12,000,000 of such facility was restricted to be used by the Company to provide for various capital improvements and additions to the Mortgaged Facilities, with the remaining $2,000,000 utilized for working capital. As of May 31, 1994, restricted cash includes approximately $5,300,000 to service debt and approximately $1,733,000 for capital improvements.\nThe Credit Facility converted a substantial portion of the Company's current liabilities into long-term indebtedness, payable over ten years based upon a twenty-five year amortization schedule, at an initial interest rate of 11.5% per annum ('Base Rate') which may increase prospectively (based upon revenues) at a maximum rate of .25% ('Additional Interest') over the initial five-year period. At the end of five years, the Base Rate will be reset prospectively at either the higher of 11.5% or the five-year treasury note interest rate plus 4%, or the rate in effect at the end of the initial five-year period. The Additional Interest of .25% will continue through maturity in the second five-year period. At the Company's election, such Credit Facility may be prepaid at 103% of the outstanding principal at the end of the fifth year. The interest rate as of May 31, 1994 was 11.68%.\nIn connection with this agreement the Company may not pay dividends under certain circumstances and is required to comply with certain financial covenants, the most restrictive of which is the debt service coverage ratio, at May 31, 1994. The Company has complied with the\nprovision of the agreement or in instances of non compliance has received waivers or Meditrust has agreed to temporary modifications of the ratios through October 15, 1995.\n(b) In fiscal 1992, the Company made an early retirement of its bank debt which resulted in an extraordinary charge totalling $650,000, net of tax benefit of $290,000, relating to deferred charges associated with the Loan Agreements.\n(c) The Company's facilities are owned and are subject to mortgages. Mortgage loans made through Pennsylvania Industrial Development Authorities bear interest at fixed rates of 7% to 9% payable semi-annually. Pursuant to the Meditrust loans discussed in (a), above, $10,471,000 of economic development authority mortgage loans were collateralized with cash which was held in an irrevocable trust. At May 31, 1992, the Company executed an 'in-substance defeasance' upon depositing $5,981,000 into an irrevocable trust to cover the outstanding principal for certain economic development authority mortgage loans. In July 1992, $5,981,000 of cash in the irrevocable trust was used to satisfy the loans and in August 1992 a scheduled annual principal payment of $325,000 was made. In December 1992, an additional $3,050,000 of cash in the irrevocable trust was used to satisfy the loans. The remaining $1,115,000 is reflected as restricted cash on the May 31, 1993 consolidated balance sheet. Subsequent to May 31, 1993, the $1,115,000 became unrestricted upon the refinancing of the remaining mortgage loan.\n(d) The Company has a mortgage loan insured under Section 232 of the National Housing Act by the United States Department of Housing and Urban Development, Federal Housing Administration. The borrower, Northwest Total Care Associates, Limited Partnership ('LP'), is owned by subsidiaries of the Company. Construction of the LP owned facility ('Care Center of Brakeley Park') was completed during fiscal 1993. The loan had a balance of approximately $8,125,000 as of May 31, 1994 and bears interest at 10.35% per annum. The loan is payable in equal monthly payments over forty years. The obligation is collateralized by the assets of the Limited Partnership without recourse to the partners.\n(e) The Company refinanced on April 1, 1992, $2,025,000 and $850,000 of Demand Revenue Bonds and Demand Revenue Refunding Bonds, respectively, which were issued by the New Jersey Economic Development Authority ('NJEDA'). These bonds had been supported by letters of credit provided by its principal banks. The refinancing was accomplished through a public offering. These bonds bear interest at a fixed rate of 9.625% payable quarterly beginning July 15, 1992. Principal on the $2,025,000 and $850,000 Demand Revenue Bonds is payable quarterly beginning July 15, 2004 and July 15, 1992, respectively. Additionally, at May 31, 1994, the Company had $6,025,000 of Economic Development Refunding Bonds which are secured by a skilled and intermediate care facility. Interest on these bonds is at a fixed rate of 10.5% payable semi-annually over a thirty year period.\nAt May 31, 1991, the Company had $2,660,000 and $3,660,000 of bonds bearing interest at 8.25% and 15.42%, respectively. Pursuant to the Meditrust loan discussed in (a) above, these bonds were collateralized with $6,145,000 in cash which was deposited into an irrevocable trust to cover the outstanding principal of these bonds and the bonds were in-substance defeased. In July, 1992, the $6,145,000 was used to satisfy the bonds it was collateralizing. At May 31, 1994, the Company had $6,160,000 of NJEDA First Mortgage Gross Revenue Bonds. These bonds are collateralized by mortgages on two facilities and bear interest at 9.0% payable semi-annually beginning July 1, 1993.\nThe Company did not meet certain financial ratios as required under the bond issues discussed above at May 31, 1994. In accordance with the agreements the Company will, if required, hire a consultant to review the facilities operations and make changes, as required.\nWith respect to certain Industrial and Economic Development Authority loans, the Company has agreed not to pay any dividends or make any distribution which could have the effect of\nreducing consolidated tangible net worth and subordinated indebtedness, if consolidated tangible net worth and subordinated indebtedness is at such time or would thereby be reduced to less than $9,000,000.\n(f) Other bank loans consist primarily of capitalized leases and promissory notes bearing interest at 5.75% to 12.9%.\n(g) On February 1, 1994, the Company redeemed $2,868,000 of 16% subordinated debentures due December 31, 1994. The debentures were redeemed at par plus accrued interest to the date of redemption. At May 31, 1993, the Company had outstanding $3,279,000 of 16% Subordinated Debentures with interest outstanding payable on June 30 and December 31 of each year. These debentures were subordinated to all current and future indebtedness of the Company and its subsidiaries, except for any indebtedness expressly stated not to be senior indebtedness.\nAmounts due on long-term debt in each of the next five fiscal years are as follows:\nAll assets of Life Support Medical, Inc. (formerly known as the Life Support Medical Group) (excluding property under capital lease and certain accounts receivable) are unencumbered. Substantially all of the Company's property related to Geriatric and Medical Services, Inc. (formerly known as the GeriMed Services Group) is pledged as collateral on borrowings.\n3. ACQUISITIONS AND DISPOSALS:\nConcurrent with the sale of nursing or residential facilities in prior years, the Company entered into long-term agreements to provide management and other services in operating these facilities. All of these management agreements have expired or been terminated as of May 31, 1994.\nUnder the terms of these sales of nursing and residential facilities, the Company was required to lend the purchaser amounts to cover certain issuance costs of bond offerings and to enter into operating deficits agreements under which the Company lends the purchaser, if needed, funds for working capital requirements. These working capital advances, plus related interest, were not payable to the Company until certain conditions were achieved or over a five-year period upon termination or expiration of the management agreements. In conjunction with the expiration or termination of these agreements, the Company has converted the operating deficits advances as well as certain subordinated management fees, as appropriate, into term loans.\nAs of May 31, 1994 and 1993, with respect to the aforementioned facility sales, the Company was owed the following:\nIncluded in noncurrent notes and other receivables are $4,851,000 and $4,619,000 of receivables related to the aforementioned transactions at May 31, 1994 and 1993, respectively.\nThe Company has deferred the recognition of gain on sale of facilities related to guarantees under an operating deficit agreement. As of May 31, 1994, the Company may ultimately recognize as additional gain on sale of facilities $492,000 if certain minimum operating cash flow requirements and other factors are achieved. In fiscal 1994 the Company recognized $1,576,000 of deferred gain on facilities sold in prior years.\nOn February 28, 1993, Tomahawk Capital Investments, Inc., (Tomahawk) which is controlled by Geriatric & Medical Companies, Inc.'s Chairman of the Board, purchased a note receivable from the Company for $773,000, the fair market value of the note as established by an independent appraisal, plus accrued interest of $57,000. This resulted in the recognition of $773,000 of associated deferred gain on facilities sold which is included in other revenue at May 31, 1993.\nOn May 31, 1993, the Company sold its Mt. Laurel, New Jersey facilities to Tomahawk for a purchase price of $8.5 million, the fair market value as established by an independent appraisal. The Company received $2.5 million in cash and a $6.0 million note bearing interest at nine percent (9%) per annum. The note is payable based on a 25-year amortization with a balloon payment due June of 2005. This resulted in the recognition of a $4,678,000 gain on the sale of these facilities which is included in other revenue at May 31, 1993. The Company received a prepayment of $1,000,000 on this mortgage in January, 1994. As of May 31, 1994, the Company has a note receivable balance of $5,000,000 and management\/other fees due from Tomahawk of $2,255,000.\nOn May 20, 1994, the Company acquired all of the outstanding stock of an ambulance transportation company in exchange for the assumption of $782,000 in liabilities. Goodwill of $683,000, was recorded in connection with the acquisition. The transaction has been accounted for as a purchase for financial reporting purposes. The operating results of the acquired company are included in the Company's consolidated results of operations from the date of acquisition and do not have a material effect on the Company's consolidated financial statements.\n4. ACCOUNTS RECEIVABLE:\nEffective November 4, 1993, the Company entered into a three year $25 million accounts receivable sale agreement with recourse with a financial institution, retiring its previous arrangement. The Company may sell, on a continuing basis, up to $25,000,000 of certain qualifying accounts receivable. The Company receives, net of reserves, approximately 80% of accounts receivable submitted. This transaction has been accounted for as a sale under Financial Accounting Standards Board Statement No. 77 guidelines but may be treated as a financing (borrowing) transaction for Medicare\/Medicaid purposes.\nUnder the terms of the agreement, the Company will pay program costs at 9.84% on the outstanding receivables submitted. During fiscal 1994 and 1993, the Company sold approximately\n$92,739,000 and $82,569,000 respectively, of certain qualifying accounts receivables. As of May 31, 1994 and 1993, the balance of the receivables submitted for sale was approximately $16,746,000 and $22,457,000 of which approximately $13,397,000 and $17,555,000 were funded, respectively. The unfunded portion is included in other receivables on the balance sheet.\nIn May 1994, the Company entered into an agreement to sell certain receivables due from third-party payors. The program costs charged are 9.75% of the outstanding receivables sold. The maximum amount of receivables to be sold is $5,000,000. The Company receives, net of reserves, approximately 80% of third-party payor receivables sold. The unfunded portion is included in other receivables on the balance sheet. As of May 31, 1994, the amount of the receivables sold was $628,000.\nAs of May 31, 1994, 1993 and 1992 , the Company has recognized a provision for costs on sale of accounts receivable of $3,531,000, $5,377,000 and $2,912,000 respectively. The provision for costs on sale of accounts receivable consists of: (A) program and other costs incurred on receivables sold and (B) servicing costs relating to the collection of receivables sold. Under the sale agreement, the Company continues and is required to service the accounts receivable sold.\n5. INVENTORIES:\nThe components of inventories are as follows:\n6. CAPITALIZED INTEREST:\nThe Company capitalized interest expense of approximately $1,388,000, $1,485,000, and $450,000 in fiscal 1994, 1993 and 1992, respectively, relating to the cost of additions to existing nursing home facilities and construction of new facilities.\n7. DEFERRED CHARGES AND OTHER:\nThe components of deferred charges and other are as follows:\n8. ACCRUED EXPENSES:\nThe components of accrued expenses are as follows:\n9. INCENTIVE PLANS AND OPTION ARRANGEMENTS:\nThe Company's 401(k) profit sharing plan covers substantially all full-time employees not covered by collective bargaining agreements. 'Highly Compensated Employees,' as defined within IRS Code Section 414(O) (which includes all executive officers), are excluded from the plan.\nContributions under the plan are at the discretion of the Board of Directors. No contributions were made in fiscal 1994, 1993 and 1992.\nEffective November 1989, the Company adopted a 1989 stock option and restricted stock plan, for cert in key employees, whereby eligible employees may be issued up to an aggregate of 281,250 shares of the Company's common stock, subject to certain restrictions, and up to an additional 343,750 shares upon the exercise of incentive and\/or non-qualified stock options granted pursuant to the plan. The restricted share portion of this plan expired as of May 31, 1994. No restricted shares vested during fiscal 1994. As of May 31, 1994, there were 135,565 shares under option under this plan, of which 76,003 were exercisable at an average price of $2.03. During fiscal 1994, 8,500 shares under option under this plan were granted at exercise prices ranging from $1.375 to $1.625 of which 1,500 shares were exercisable. During fiscal 1994, 2,750 shares were exercised at an average exercise price of $1.72 per share. During fiscal 1993, 129,815 shares under option under this plan were granted at exercise prices ranging from $1.375 to $2.4375 of which 47,315 shares are exercisable. None of these options were exercised in fiscal 1993.\nThe Company has a 1982 incentive stock option plan for key executive and management personnel. At May 31, 1994, there were 307,355 shares under option under this plan at exercise prices ranging from $.80 to $2.50 of which 266,823 shares were exercisable at an average price of $1.60. During fiscal 1994, 1993, and 1992, 46,484, 66,060, and 54,738 options were exercised, respectively, at an average price of $1.14, $1.22 and $1.21, respectively. Effective January 28, 1992 additional options cannot be granted under this plan.\nIn April 1985, a stock option plan was approved under which options to purchase 23,438 shares may be granted to nonemployees. At May 31, 1994, there were 6,250 shares under option an exercise price of $2.30, all of which were exercisable.\nThe Company has a 1990 stock option plan for directors under which options to purchase up to a total of 120,313 shares may be granted to outside directors. Under this plan, a total of 100,078 options have been granted to outside directors at exercise prices ranging from $.96 to $2.30 per share. At May 31, 1994, 65,823 shares under this plan were exercisable.\nUnder all stock option plans maintained by the Company, the exercise price of options issued is the same as the market price at the date of grant.\nEffective June 1, 1993, the Company entered into an employment agreement with the Chairman of the Board of Geriatric & Medical Companies, Inc. The term of the agreement is for an initial five year period with a provision for annual extensions. The employment agreement provides for a short-term and long-term incentive plan in addition to a base compensation package. The short-term incentive plan provides for an incentive bonus contingent upon the Company's annual operating results. No short-term incentive bonus was awarded for the fiscal year ended May 31, 1994. The long-term incentive plan provides for long-term compensation based upon the increase in market value of the Company's stock to the shareholders. As of May 31, 1994, the Company accrued $11,000 relating to this plan. The employment agreement, while in effect, also provides for a death benefit of $1,000,000 payable in forty equal quarterly installments. As of May 31, 1994, the Company accrued the present value of the actuarially computed benefit which totaled $27,000.\n10. MEDICARE AND MEDICAID REVENUE:\nThe Company's long-term care facilities, which are located in Pennsylvania and New Jersey, receive reimbursement under the Medicare and Medicaid programs, which is subject to adjustment upon audit by Federal and State agencies (see Note 1b). Revenue from these programs related to the Company's long-term care facilities totaled approximately $98,200,000, $91,600,000, and $84,005,000 for the years ended May 31, 1994, 1993 and 1992, respectively. At May 31, 1994, the Company had a net third-party receivable of approximately $9,314,000. The total amounts due from third-party payors generally are not paid in full until audit issues are resolved. The Company is continually negotiating to resolve the audit findings and accelerate interim payments due under the reimbursement system.\nAt May 31, 1994, approximately $70,847 of appeals pertaining to 1991 were outstanding under the Medicare program.\nOn September 15, 1992, the Company entered into a settlement agreement with the Pennsylvania Department of Public Welfare ('DPW') in which all issues were settled for fiscal years 1986 to 1989, inclusive. With the completion of this settlement, all open issues with DPW from 1989 and prior have been resolved in full. This settlement will not deter the ability of the Company to contest the issues for fiscal years 1990 through 1994 inclusive.\nFor the fiscal years 1990 through 1994, the Company has receivables of approximately $4,310,000 for open issues with DPW. Management believes that any reduction of the amount recorded that results from final settlement of these open issues will not have a material adverse effect on the financial position of the Company. In 1994 the Company reduced its allowance for third party receivables approximately $1,100,000 resulting from a change in the estimation of allowance needed for various issues on appeal.\n11. INCOME TAXES:\nA summary of the components of the tax provision and charge equivalents for fiscal years 1994, 1993 and 1992 is as follows:\nThe effective net income tax rates before the utilization of the Company's operating loss carryforwards are different than the statutory Federal income tax rates of 34% in 1994, 1993 and 1992 as indicated below:\nThe following is a summary of the significant components of the Company's deferred tax assets and liabilities as of May 31, 1994 determined in accordance with the provisions of SFAS No. 109.\nFor financial statement purposes, the Company has unused state net operating loss carryovers of approximately $4,567,000 and Federal tax credit carryovers of approximately $436,000. Differences between state and Federal NOLs for financial statement and tax purposes result from timing differences and utilization of previous years' NOL carryforwards.\n12. REVENUES:\nOperating revenues, net are presented net of contractual allowances of $36,997,000, $33,239,000, and $30,436,000 for the years ended May 31, 1994, 1993 and 1992, respectively. Included in other revenues are deferred and current gains recognized on facilities sold of $1,576,000, $6,365,000 and $3,175,000 for the years ended May 31, 1994, 1993 and 1992, respectively.\n13. INTEREST EXPENSE:\nInterest expense is reflected net of approximately $1,405,000, $844,000, and $785,000 of interest income for the years ended May 31, 1994, 1993, and 1992, respectively. The interest income is principally related to overnight investments, restricted cash and notes receivables.\n14. EARNINGS (LOSS) PER COMMON SHARE:\nEarnings (loss) per common share is based on the weighted average number of shares of common stock outstanding. Potential dilution from common stock equivalents is not material. The weighted average number of shares of common stock outstanding used to compute earnings (loss) per common share are 15,314,000, 15,231,000, and 15,152,000 for the fiscal years ended May 31, 1994, 1993 and 1992, respectively.\n15. QUARTERLY RESULTS (UNAUDITED):\nThe following table summarizes the Company's quarterly results of operations for the fiscal years ending May 31, 1994 and 1993:\n- ------------------ Primary earnings per share were used to calculate net income (loss) per share of common stock.\nPrice range of Common Stock: The Company's common stock is listed on the Automated Quotation System of the National Association of Securities Dealers, Inc. (NASDAQ symbol: GEMC). On October 6, 1994, the last sale price for the Company's Common Stock was 2 1\/4. There were 1,458 stockholders of record of its Common Stock at as of May 31, 1994. The table above sets forth for the periods indicated the range of high and low sale prices of the common stock as reported by The Wall Street Journal.\n(a) Net income includes $773,000 recognition of deferred income related to the sale of a facility.\n(b) The decrease in net income in the fourth quarter of Fiscal 1993 resulted from the increase in the allowance for amounts due from third-party payors based upon an adjustment to the historical reserve percentages based upon recent settlements. In addition, net income includes $4,678,000 gain on sale of a facility and $820,000 recognition of deferred income related to facility sales.\n(c) The net loss in the fourth quarter of Fiscal 1994 resulted primarily from an increase in the provision for uncollectible receivables to provide for potential uncollectibles related to the conversion of billing and collection systems and a charge of $700,000 related to a change in estimating workermans' compensation expense.\n16. BUSINESS SEGMENT INFORMATION:\nGeriatric & Medical Companies, Inc. is a holding company which conducts its business through its principal subsidiaries: LIFE SUPPORT MEDICAL, INC. (LSM) (formerly known as the Life Support Medical Group) and GERIATRIC AND MEDICAL SERVICES, INC. (GMS) (formerly known as the GeriMed Services Group) as described below.\nLSM provides ambulance transportation services, home infusion therapy, home respiratory therapy, home medical equipment, pharmaceutical services, medical supplies and related billing services and intravenous therapy. This group also offers portable diagnostic services, speech, occupational and physical therapy, nutritional services, environmental services, facility maintenance, design, construction management services and a full range of health care financial and information services. The Company provides these services to other health care providers, long term care facilities, including its own facilities, health maintenance organizations and the home care health care market.\nGMS owns, operates and provides services to long term care, residential and independent living facilities. The services offered include contract management, financial and insurance services.\n- ------------------ * Reclassified for comparative purposes.\nNet operating revenues for GMS include contract management revenues of $6,761,000, $8,414,000, and $11,978,000 in fiscal 1994, 1993 and 1992, respectively.\nNet operating revenues for LSM include revenues from equipment rentals of $5,435,000, $5,850,000, and $9,176,000 in fiscal 1994, 1993 and 1992, respectively.\n17. COMMITMENTS AND CONTINGENCIES:\nOn September 1, 1992, GMS Management, Inc., and four of its employees were indicted in connection with the death of two nursing home residents. The charges included involuntary manslaughter and improper Medicaid billing for these two residents, technically constituting Medicaid fraud. Subsequently, one case against two individuals was directed by the Judge in favor of the defendants and the other case against two other individuals was withdrawn. On November 12, 1993, the Company entered into a settlement agreement between GMS Management, Inc. and the Pennsylvania Department of Attorney General by pleading nolo contendere to two misdemeanor counts of involuntary manslaughter and agreeing to pay fines and settlement costs associated with the counts.\nFollowing the initiation of the above described litigation, in September, 1992 a class action law suit was commenced against the Company, GMS Management, Inc., and various current or former officers of the Company in the United States District Court for the Eastern District of Pennsylvania. The Complaint alleges that, among other things, various reports and press releases issued by the Company misrepresented and omitted to state adverse material facts concerning the quality of care given at two of the Company's nursing homes. The plaintiff did not seek a specified sum other than 'to pay to plaintiff and to all members of the class damages in an amount to be proven at trial, with interest thereon.' Although the outcome cannot be predicted, the Company and the individual defendants deny any wrong doing and are vigorously defending this action. Trial in this law suit is scheduled to commence in October, 1994.\nThe Company's subsidiary United Health Care Services, Inc. (UHCS) has been the subject of an inquiry by the Office of the United States Attorney for the Eastern District of Pennsylvania and the Commonwealth of Pennsylvania Department of Public Welfare regarding its joint ventures and management arrangements. UHCS reached a tentative agreement with the United States Attorney whereby the Company will be required to pay $320,000 no later than September 30, 1994, $340,000 in September, 1995 and $440,000 in September, 1996. The Company is anticipating settling this matter with the Commonwealth of Pennsylvania. The Company has recorded its estimated settlement amounts in fiscal, 1994.\nThe Company received an assessment from the New Jersey Division of Taxation totalling $612,000 as a result of an audit of sales, use and corporate business taxes for the years 1986 to 1992. The Company is currently involved with negotiations regarding this matter with the State of New Jersey. The Company has recorded in the accompanying consolidated financial statements its estimate (which is less than the assessment) of the liability to be paid in connection with this assessment.\nThe Company is involved in various routine government inquiries, audit surveys and administrative proceedings concerning its activities and operations.\nThe Company is also involved in various claims and legal actions arising in the ordinary course of business. The Company believes that the ultimate disposition of all of these matters will not have a material adverse effect on the Company's Consolidated Financial Statements.\n18. FAIR VALUE OF FINANCIAL INSTRUMENTS:\nAs of May 31, 1994, the estimated fair values of the Company's financial instruments and significant assumptions made in determining fair values are as follows:\n-- Cash, accounts receivable, accounts payable and accrued expenses: The amounts reported in the balance sheet approximate fair value due to the short-term maturities of these instruments.\n-- Due from third party payors, net: The approximate fair value of the amount reported in the balance sheet is $7,381,000 based upon the Company's current discount rate.\n-- Notes receivable: The amounts reported in the balance sheet were negotiated at May 31, 1993 or are subject to fluctuating market rates of interest and approximate fair value.\n-- Long-term debt: Substantially all of the amounts reported in the balance sheet had been negotiated since April, 1992 and approximate fair value.\n19. OTHER TRANSACTIONS:\nDedicated Staffing Services, Inc. (formerly 'Today's Staffing Services, Inc.'), a Pennsylvania non-profit corporation, provides registered nurses, licensed practical nurses, nursing assistants and other personnel to the Company on a temporary employment basis. Certain officers of the Company are members of Dedicated Staffing's Board of Directors. The Company's subsidiary, Rite Care Resources had previously supplied the Company's owned and managed long-term care facilities with such nursing services. The Company paid Dedicated Staffing Services, Inc. approximately $6,809,000 and $6,655,000 for these services in fiscal 1994 and 1993, respectively. At May 31, 1994 and 1993, the Company owed Dedicated Staffing Services, Inc. a net amount of approximately $389,580 and $442,517 respectively. Dedicated Staffing Services, Inc. and Community Care and Development Corporation (parent corporation of Dedicated Staffing Services, Inc.) has agreed to charge the Company at cost for these services. The Company believes that the amounts charged by Dedicated Staffing Services, Inc. are at or below the fair market value for the services rendered. During fiscal 1994, Dedicated Staffing Services, Inc. leased office space from the Company in Pennsauken, New Jersey for which it paid rent at the rate of $5,167 per month and for which it paid the Company $77,430 in rent. This lease arrangement was terminated effective January 1994. As of May 31, 1994, Dedicated Staffing Services, Inc. owed the Company $36,134 in rent.\nThe Company sold various assets during fiscal 1993. See Note 3 of the Notes to Consolidated Financial Statements for a description of the transactions.\nThe Company provides certain services which are priced at or above projected cost, and include staffing services, dietary, environmental, financial, and other services, to Mount Laurel Convalescent Center and Laurelview Manor which are owned by Tomahawk. The total services rendered during fiscal 1994 were $6,754,000. At May 31, 1994 the Company had a receivable of $2,255,000 due from Tomahawk for these services.\nThe Company receives additional revenues of approximately $1,500,000 related to its provision of ancillary services at the Tomahawk facilities. These services, including provision of ambulance transportation, diagnostics, rehabilitation, pharmacy and medical supplies are provided at market rates.\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 certain information regarding the executive officers of the Company as of May 31, 1994.\nEach executive officer of the Company is elected or appointed by the Board of Directors of the Company and holds office until his or her successor is elected or until the earlier of his or her death, resignation or removal.\nDANIEL VELORIC is a founder of the Company and has been a Director and Executive Officer for more than twenty-five years. Mr. Veloric has been personally named in the class action suit (See Item 3 -- 'Legal Proceedings').\nESTHER PONNOCKS has been Senior Executive Vice President since October 1991, Executive Vice President -- Long Term Care Operations of the Company (April 1990 until October 1991), Senior Vice President -- Operations of the Company (1985 until April 1990) and has been a member of the Company's Management for over twenty-five years. Ms. Ponnocks was elected a Director in 1985.\nARTHUR A. CARR, JR. joined the Company in March 1989 as Assistant to the President and was appointed Executive Vice President in July 1989 and Secretary in August 1992.\nMICHAEL VELORIC (the son of Daniel Veloric) has been a Vice President of the Company since June 1987 and has held the position of Assistant Secretary since October 1984. Mr. Veloric has been a member of the Company's Management for over ten years. Mr. Veloric was elected a Director in August, 1992.\nJAMES J. O'MALLEY joined the Company in April, 1989 as the Chief Financial Officer of its Life Support Group and has held various positions with the Company since that time. Mr. O'Malley was appointed Vice President and Chief Financial Officer in August, 1992.\nJAMES J. WANKMILLER joined the Company in March 1987 and was elected Vice President of Human Resources in February, 1989. He was appointed as Legal Administrator in May, 1991 and promoted to Vice President -- Legal & Human Resources and Assistant Secretary in 1992. Mr. Wankmiller has been personally named in the class action suit (see Item 3 -- 'Legal Proceedings').\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nExcept for the 1990 Stock Option Plan Committee, no compensation committee interlocks nor insider participation exists on the Compensation Committee.\nSUMMARY COMPENSATION TABLE\nThe Summary Compensation Table includes individual compensation information on the Chief Executive Officer and the four most highly paid executive officers of the Company whose salary and bonus exceeded $100,000, for services rendered in all capacities during the fiscal years ended May 31, 1994, 1993 and 1992.\n- ------------------ (1) Promoted to current position in June 1992. (2) Bonuses paid to employee with more than 20 years dedicated service to the Company as an added incentive to Miss Ponnocks to continue her employment. (3) Includes all other compensation reported on IRS Form W-2. (4) Includes Company contribution relating to the Incentive Deferred Compensation Plan. (5) Represents the value at May 31, 1994 of 13,000 phantom shares issued to his Long Term Incentive Plan. (6) Represents the value of 25,000 unregistered shares issued on December 16, 1993 in recognition of 25 years of service. (7) Amount represents the forfeiture as of May 31, 1994 of restricted shares previously granted. (*) Other Annual Comp shows W-2 wages for release of restrictions. This is estimated $ amount of award. NOTE: During fiscal 1994, no executive officer received personal benefits from the Company valued at more than 10% of total Annual Compensation or $50,000, whichever is less.\nEffective June 1, 1993, the Company entered into an Employment Agreement with Daniel Veloric, Chairman and President of the Company, which provides for an annual base compensation of $450,000 per year and an original term of five years (which, until terminated, extends one additional year each year). The Agreement also provides for a death benefit of $1,000,000 as well as benefits under the previously described short term incentive plan and long term incentive plan for Daniel Veloric.\nEffective June 1, 1992, the Company entered into an Employment Agreement with Esther Ponnocks, Senior Executive Vice President, which provides for an annual base compensation of $150,000 for an original term of three years, with annual extensions through not later than May 31, 2002. If a person acquires more than 20% of the outstanding voting stock of the Company without the prior approval of the Company's Board of Directors, or if the Company materially breaches the employment agreement or under certain other circumstances; the Company will owe Ms. Ponnocks the remainder of the compensation due under the agreement through as long as May 31, 2002.\nCOMPENSATION PURSUANT TO PLANS\nThe Company's Profit Sharing Plan was merged into a 401(k) Profit Sharing Plan effective June 1, 1989. Under the 401(k) Plan, eligible employees may contribute up to 15% of their total compensation on a tax-deferred basis subject to maximum annual limitations. 'Highly Compensated Employees', as defined within IRS Code Section 414(O) which included all executive officers of the Company, are excluded from participation in the Plan. Pursuant to the terms of the plan, the Company may make matching contributions at a percentage or amount determined at the sole discretion of the Company. During the fiscal year ended May 31, 1994, no contribution was made by the Company to the plan.\nThe Company's 1989 Stock Option and Restricted Stock Plan ('the 1989 Plan') provides that incentive and non-qualified stock options may be granted to key employees of the Company and its subsidiaries. The 1989 plan is administered by the Compensation Committee which has the discretion to determine those key employees who will receive options and the amount of options to be granted to said employees; to determine when options will be granted and the exercise price of each option, which price cannot, however, be less than the fair market value of the Common Stock on the date of grant; and to determine when each option can be exercised and the term (up to ten years) of each option granted. All options will expire within ten years from the date of grant and no options may be granted after November 9, 1999. If an optionee is terminated other than for wrongful conduct, the optionee may exercise his\/her options within three months (one year for an optionee who ceases to be employed because of permanent and total disability) provided that his\/her right to exercise said options has vested at the date of termination and provided that the exercise of the option is within ten years from the date it was granted (five years for an incentive stock option granted to a 10% stockholder). If optionee dies while in the employ of the Company or within three months (one year in the case of disability) after the termination of employment, and provided that his\/her options have vested at the time of his\/her death and the exercise of the options are within ten years from the date of grant (five years for an incentive stock option granted to a 10% stockholder), then the optionee's personal representative may exercise said options within one year after the optionee's death.\nThe 1989 Plan also provided for the issuance of up to 281,250 shares of the Company's Common Stock, subject to restriction ('Restricted Shares'), to eligible employees of the Company, including the Chairman, President and Chief Executive Officer, Senior Executive and Executive Vice Presidents, Senior Vice Presidents, Vice Presidents, certain Division Presidents and other key employees. The Restricted Shares were held by the Company pending the vesting of such shares in whole or in part upon the achievement by the Company of the following financial performance levels: (1) increases in revenues by 50% over revenues reported for fiscal 1989; (2) earnings before capital gains or losses and before income taxes reaching break-even or higher; (3) said earnings exceeding $4,000,000 for any fiscal year; (4) a reduction in the ratio of debt-to-total capital to 85-100 or less; and (5) an increase in the price of the Company's Common Stock to $5 per share or higher based upon 1989 share level\n(prior to the May 20, 1991 stock split) for any five days during a 30-day period. As of May 31, 1994 255,353 shares were issued of which 67,616 shares vested and 187,737 shares were forfeited.\nIn 1992, the Company implemented an Incentive Deferred Compensation Plan for selected key employees. Under this Plan, the Company makes discretionary awards to such executives, which amount, if any, can vary annually and by participant, and is generally expressed as a percentage of salary. The amounts are credited to a book-entry account established in such participant's name. Such account is also credited with the equivalent of interest and such interest rate is determined annually by the Company. Participants become vested in the amounts credited to the deferred compensation account on a graduated basis. However, full vesting cannot occur prior to attainment of age 65 while actively employed by the Company. Upon retirement at age 65 or later, the vested deferred compensation account is paid out as a 15 year annuity. Participants who terminate employment prior to age 65 will receive a 10 year annuity at retirement based on the vested account balance. In the event of the death of a participant while actively employed, the plan provides to the participant's survivor a continuation of 50% of the final salary for one year, followed by 25% of final salary until the participant would have attained age 65, subject to a minimum of 10 years of total payments. All benefits under the incentive Deferred Compensation Plan are unfunded, unsecured general obligations of the Company. The Company has purchased corporate owned life insurance on the participants estimated to be sufficient to recover the distributions to be made under this Plan.\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES\nThe following table provides information, with respect to the named executive officers, concerning the exercise of options during the last fiscal year and unexercised options held as of the end of the fiscal year, May 31, 1994. There are no outstanding stock appreciation rights.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth information as of October 7, 1994, with respect to the beneficial ownership of the Company's Common Stock by all persons known to the Company to be the beneficial owner of more than five percent of its outstanding Common Stock, by each Director of the Company, by each Executive Officer of the Company, and by all Directors and Executive Officers of the Company as a group. Unless otherwise indicated, each such person has sole voting and dispositive power with respect to the shares listed opposite his\/her name.\n- ------------------\n(1) Includes 18,946 shares which may be purchased pursuant to options that are immediately exercisable or will become exercisable within 60 days under the 1990 Stock Option Plan for Directors.\n(2) Includes 1,000,000 shares held in Trusts of which Mr. Gorman and Mr. Krauss are co-Trustees.\n(3) Includes 69,688 shares which may be purchased pursuant to options that are immediately exercisable or will become exercisable within 60 days under the Company's 1982 and 1989 Stock Option Plans.\n(4) Represents shares which may be purchased pursuant to options that are immediately exercisable or will become exercisable within 60 days under the 1990 Stock Option Plans for Directors.\n(5) Includes 18,947 shares which may be purchased pursuant to options that are immediately exercisable or will become exercisable within 60 days under the 1990 Stock Option Plan for Directors.\n(6) Includes 3,595 shares which may be purchased pursuant to options that are immediately exercisable or will become exercisable within 60 days under the Company's 1982 and 1989 Stock Option Plans.\n(7) Includes 15,469 shares which may be purchased pursuant to options that are immediately exercisable or will become exercisable within 60 days under the Company's 1982 and 1989 Stock Option Plans. Does not include 1000 shares owned by Mr. Carr's wife, beneficial ownership of which he disclaims.\n(8) Represents shares which may be purchased pursuant to options that are immediately exercisable or will become exercisable within 60 days under the Company's 1982 and 1989 Stock Option Plans.\n(9) Includes 176,108 shares which may be purchased pursuant to options that are immediately exercisable or will become exercisable within 60 days under the Company's Stock Option Plans. Also, included is 1,000,000 shares held in Trusts as noted in (3) above.\n(10) Less than 1%.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nOn May 31, 1993, the Company sold its Mount Laurel Convalescent Center and Laurelview Manor facilities in Mount Laurel, New Jersey to Tomahawk Capital Investments, Inc. ('Tomahawk') for a purchase price of $8.5 million, the fair market value as established by an independent appraisal. The Company received $2.5 million in cash and a $6.0 million note bearing interest at nine percent (9%) per annum. The note is payable based on a 25-year amortization with a balloon payment due June of 2005. This resulted in the recognition of a $4,678,000 nonoperating gain on the sale of these facilities. Tomahawk prepaid $1,000,000 of this note in January, 1994.\nIn conjunction with the sale to Tomahawk, the Company entered into various contracts to provide certain services, priced at or above projected cost, to the Tomahawk facilities. These services including staffing, dietary, environmental, financial and management and consulting services generated $6,754,000 of revenues for the Company during 1994. At May 31, 1994, the Company had a receivable of $2,255,000 due from Tomahawk for these services.\nThe Company receives additional revenues of approximately $1,500,000 related to its provision of ancillary services at the Tomahawk facilities. These services, including provision of ambulance transportation, diagnostics, rehabilitation, pharmacy and medical supplies are provided at market rates.\nDuring the fiscal year ended May 31, 1994, various operating subsidiaries and divisions of the Company had business transactions with Community Care and Development Corporation ('CCDC') and\/or its related organization, Dedicated Staffing Services, Inc. ('DSSI'), both of which are Pennsylvania non-profit corporations. The Board of Directors and officers of CCDC and DSSI included Daniel Veloric, Esther Ponnocks and Michael Veloric, who are also directors and officers of the Company. CCDC and DSSI paid Esther Ponnocks and Michael Veloric $55,500 and $12,000 respectively for consulting services in fiscal 1994. No payments were made to Daniel Veloric in fiscal 1994.\nDuring fiscal 1994, the Company purchased from DSSI approximately $6,809,000 of staffing services, including the provision of registered nurses, licensed practical nurses, nursing assistants and other personnel on a temporary employment basis. DSSI has agreed to charge the Company at cost for the services, which the Company believes to be at or below the fair market value for the services rendered. The Company leases office space to DSSI in Pennsauken, New Jersey at the current rate of $5,162 per month and received $61,944 in rent for the fiscal year ended May 31, 1994. The Company also leased-back certain properties previously sold at fair market value to CCDC. The Company paid rent to CCDC at the rate of $5,167 per month, approximately $62,000 for the fiscal year ended May 31, 1994. The Company believes its transactions with CCDC and DSSI have been on terms at least as favorable to the Company as those which would have been available in the general marketplace.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(A) EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.\nSchedules other than those listed above have been omitted because they are not applicable or the required information is shown in or can be derived from the financial statements and notes thereto.\nSCHEDULE II\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES FOR THE YEARS ENDED MAY 31, 1994, 1993, AND 1992 ($ IN THOUSANDS)\n------------------------\n- ------------------ (a) Represents a note receivable from the sale of the Mt. Laurel, New Jersey facilities (See Note 3 of the Notes to Consolidated Financial Statements).\nSCHEDULE V\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED MAY 31, 1994, 1993, AND 1992 ($ IN THOUSANDS)\n------------------------\n- ------------------ (a) Construction in progress completed, transferred to building and fixtures.\n(b) Includes sale of Mt. Laurel, New Jersey facilities.\n(c) Relates to acquisition of ambulance company (see Note 3 of the Notes to Consolidated Financial Statements).\nSCHEDULE VI\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE VI -- ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED MAY 31, 1994, 1993, AND 1992 ($ IN THOUSANDS)\n------------------------\n- ------------------ (a) Includes sale of Mt. Laurel, New Jersey facilities.\n(b) Relates to acquisition of ambulance company (See Note 3 of the Notes to Consolidated Financial Statements).\nSCHEDULE VIII\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED MAY 31, 1994, 1993, AND 1992 ($ IN THOUSANDS)\n------------------------\n- ------------------ (a) Amounts reflected as a reduction of revenues.\n(b) Amounts written off, net of recoveries.\nSCHEDULE X\nGERIATRIC & MEDICAL COMPANIES, INC. AND SUBSIDIARIES SCHEDULE X -- SUPPLEMENTAL INCOME STATEMENT INFORMATION FOR THE YEARS ENDED MAY 31, 1994, 1993, AND 1992 ($ IN THOUSANDS)\n------------------------\n- ------------------ (a) State and local taxes, other than income and payroll taxes increased $149,000 (5.2%) in fiscal 1994. The increase resulted primarily from an increase in use taxes based upon current year purchases and an increase in capital stock taxes.\n(b) Amortization expense increased $233,000 (15.6%) in fiscal 1994 primarily due to costs associated with debt refinancings.\n(c) State and local taxes, other than income and payroll taxes increased 7.0% in fiscal 1993. The increase resulted primarily from an increase in real estate taxes due to increased rates and the addition of a 150 bed nursing facility and related financing charges.\n(d) Amortization expense increased $763,000 (104.8%) in fiscal 1993 primarily due to costs associated with the Company's Credit Facility (see Note 2 of the Notes to Consolidated Financial Statements).\n(e) State and local taxes, other than income and payroll taxes, decreased $83,000 (3.0%) in fiscal 1992 due primarily to reductions in property assessments at several facilities.\n(f) Amortization expense decreased $717,000 (49.6%) in fiscal 1992 due primarily to various intangible assets becoming fully amortized during fiscal 1992.\n3. EXHIBITS\n3(a). Articles of Incorporation of the Registrant, as amended. Incorporated by reference to Exhibit 3(a) to the Registrant's Registration Statement on Form S-1 (File No. 2-94822) (the '1984 Registration Statement') and as amended in the Registrant's Current Report on Form 8-K dated December 31, 1992.\n3(b). By-Laws of the Registrant, as amended. Incorporated by reference to Exhibit 3 (b) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1990.\n4(a). Master Loan Agreement between Registrant and the New Jersey National Bank dated as of October 1, 1983. Incorporated by reference to Exhibit 4(e) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1984.\n4(b). Loan Agreement, dated as of November 1, 1986 between New Jersey Economic Development Authority and Geriatric and Medical Services, Inc. relating to $2,025,000 principal amount New Jersey Economic Development Authority Demand Revenue Bonds and related Trust Indenture. Incorporated by reference to Exhibit 4(b) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1987.\n4(c). Amended and Restated Reimbursement Agreement, dated as of November 1, 1986 by and among Geriatric and Medical Services, Inc., First Pennsylvania Bank N.A. and Mellon Bank, N.A. Incorporated by reference to Exhibit 4(c) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1987.\n4(d). Loan Agreement, dated as of November 1, 1986 between New Jersey Economic Development Authority and Geriatric and Medical Services, Inc. relating to $850,000 principal amount New Jersey Economic Development Authority Demand Revenue Refunding Bonds and related Trust Indenture. Incorporated by reference to Exhibit 4(f) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1987.\n4(e). Amended and Restated Reimbursement Agreement, dated as of November 1, 1986 by and among Geriatric and Medical Services, Inc., First Pennsylvania Bank N.A. and Mellon Bank, N.A. Incorporated by reference to Exhibit 4(g) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1987.\n4(f). Loan Agreement, dated as of May 1, 1990 between New Jersey Economic Development Authority and Geriatric and Medical Services, Inc. relating to $5,000,000 and $1,175,000 of Demand Revenue Bonds and Demand Revenue Refunding Bonds, respectively. Incorporated by reference to Exhibit 4(t) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1990.\n10(a). 1982 Incentive Stock Option Plan as amended. Incorporated by reference to Exhibit 10(a) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1989.\n10(b). 1984 Stock Option Plan Incorporated by reference to Exhibit 10(b) to the 1984 Registration Statement.\n10(c). 1990 Stock Option Plan for Directors. Incorporated by reference to Exhibit 10(c) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1990.\n10(d). 1989 Stock Option and Restricted Stock Plan. Incorporated by reference to Exhibit 4(a) to the Registrant's Registration Statement on Form S-8 (File No. 33-34803).\n10(e)(i). Operating Deficits Agreement, dated February 1, 1988 among the Company and Resource Housing of America, Inc. Incorporated by reference to exhibit 10(c)(iii) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended February 29, 1988.\n10(e)(ii). Revolving Credit and Term Loan Agreement, dated February 1, 1988 by and among the Company and Resource Housing of America, Inc. Incorporated by reference to exhibit 10(c)(v) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended February 29, 1988.\n10(f)(i). $175,000 Purchase Money Note, dated November 30, 1988, given by RHA\/Philadelphia Nursing Homes, Inc. to Geriatric and Medical Services, Inc. Incorporated by reference to exhibit 10(c) to the Registrant's Current Report on Form 8-K, dated November 30, 1988.\n10(f)(ii). Revolving Credit and Term Loan Agreement, dated as of November 1, 1988, by and between RHA\/Philadelphia Nursing Homes, Inc. and Geriatric & Medical Centers, Inc. Incorporated by reference to exhibit 10(f) to the Registrant's Current Report on Form 8-K, dated November 30, 1988.\n10(f)(iii). $2,455,000 Promissory Note dated as of November 1, 1988, given by RHA\/Philadelphia Nursing Homes, Inc. to Geriatric & Medical Centers, Inc. Incorporated by reference to exhibit 10(g) to the Registrant's Current Report on Form 8-K, dated November 30, 1988.\n10(f)(iv). Operating Deficits Agreement, dated as of November 1, 1988, by and between RHA\/Philadelphia Nursing Homes, Inc. and Geriatric & Medical Centers, Inc. Incorporated by reference to exhibit 10(h) to the Registrant's Current Report on Form 8-K, dated November 30, 1988.\n10(f)(v). Second Mortgage and Security Agreement, dated as of November 30, 1988, between RHA\/Philadelphia Nursing Homes, Inc., Geriatric & Medical Centers, Inc., Geriatric and Medical Services, Inc. and Total Care Development Corporation Incorporated by reference to exhibit 10(i) to the Registrant's Current Report on Form 8-K, dated November 30, 1988.\n10(f)(vi). Subordination Agreement, dated as of November 1, 1988, between and among Geriatric & Medical Centers, Inc., Total Care Development Corporation, Geriatric and Medical Services, Inc. and RHA\/Philadelphia Nursing Homes, Inc. Incorporated by reference to exhibit 10(j) to the Registrant's Current Report on Form 8-K, dated November 30, 1988.\n10(g)(i). Term Loan Agreement, dated as of August 1, 1989, by and between RHA\/Pennsylvania Nursing Homes, Inc. and Geriatric & Medical Centers, Inc. Incorporated by reference to the Registrant's Current Report on Form 8-K, dated August 31, 1989.\n10(g)(ii). $724,500 Promissory Note dated as of August 1, 1989 given by RHA\/Pennsylvania Nursing Homes, Inc. to Geriatric & Medical Centers, Inc. Incorporated by reference to the Registrant's Current Report on Form 8-K, dated August 31, 1989.\n10(g)(iii). Operating Deficits Agreement, dated as of August 1, 1989 by and between RHA\/Pennsylvania Nursing Homes, Inc. and Geriatric & Medical Centers, Inc. Incorporated by reference to the Registrant's Current Report on Form 8-K, dated August 31, 1989.\n10(g)(iv). Second Mortgage and Security Agreement, dated as of August 31, 1989, by and among RHA\/ Pennsylvania Nursing Homes, Inc., Geriatric & Medical Centers, Inc., GMS Management, Inc., GMC Financial Services, Inc., Total Care Insurance Corporation, d\/b\/a Rite Care Resources and Total Care Management Inc. Incorporated by reference to the Registrant's Current Report on Form 8-K, dated August 31, 1989.\n10(g)(v). Subordination Agreement, dated as of August 1, 1989, between and among Geriatric & Medical Centers, Inc., GMS Management, Inc., GMC Financial Services, Inc., Total Care Inn Corporation, d\/b\/a Rite Care Resources, RHA\/Pennsylvania Nursing Homes, Inc., and RHA\/Home Office, Inc. Incorporated by reference to the Registrant's Current Report on Form 8-K, dated August 31, 1989.\n10(h)(i). Operating Deficits Agreement, dated as of October 1, 1988 by and among Walnut Park Plaza Associates, Villas Realty & Investments, Inc. and Maryland National Bank, exclusive of exhibits thereto. Incorporated by reference to Exhibit 10(e)(ii) to the Registrant's report on Form 8 dated September 26, 1989.\n10(i)(i). Operating Deficits and Term Loan Agreement, dated as of September 1, 1990, between AHF\/Montgomery, Inc. and Geriatric & Medical Centers, Inc. Incorporated by reference to Exhibit 10(b) to the Registrant's Current Report on Form 8-K dated October 26, 1990.\n10(i)(ii). Subordination Agreement, dated as of September 1, 1990, between and among Montgomery County Higher Education and Health Authority (the 'Authority'), Geriatric & Medical Centers, Inc., GMS Management, Inc., GMC Financial Services, Inc., AHF\/Montgomery, Inc., and AHF\/Home Office, Inc. Incorporated by reference to Exhibit 10(c) to the Registrant's Current Report on Form 8-K dated October 26, 1990.\n10(i)(iii). Loan and Security Agreement, dated as of September 1, 1990, between the Authority, AHF\/Montgomery, Inc., and Assignment of the Authority's Interest to Geriatric & Medical Centers, Inc. as Bondholder. Incorporated by reference to Exhibit 10(d) to the Registrant's Current Report on Form 8-K dated October 26, 1990.\n10(j). Management Incentive Bonus Program. Incorporated by reference to Exhibit 10(i) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1990.\n10(l)(i). Supplemental Loan Agreement, dated as of April 15, 1992 between New Jersey Economic Development Authority and Geriatric and Medical Services, Inc. relating to $2,025,000 and $850,000 of Revenue Bonds and Revenue Refunding Bonds, respectively. Incorporated by reference to Exhibit 10(l)(i) to the Registrant's Current Report on Form 8-K dated May 14, 1992.\n10(l)(ii). Loan Agreement, dated as of April 23, 1992, by and among Meditrust Mortgage Investments, Inc. and Geriatric and Medical Services, Inc., Crestview Convalescent Home, Inc., Burlington Woods Convalescent Center, Inc., Geriatric & Medical Centers, Inc. and Crestview North, Inc. relating to a loan in the amount of $86,003,000. Incorporated by reference to Exhibit 10(l)(ii) to the Registrant's Current Report on Form 8-K dated May 14, 1992.\n10(l)(iii). Loan Agreement, dated as of April 23, 1992, between Geriatric and Medical Services, Inc. and Geriatric & Medical Centers, Inc. and CoreStates Enterprise Fund relating to a loan in the amount of $5,000,000. Incorporated by reference to Exhibit 10(l)(iv) to the Registrant's Current Report on Form 8-K dated May 14, 1992.\n10(m)(i) Loan Agreement, dated as of May 1, 1992 between New Jersey Economic Development Authority and Geriatric and Medical Services, Inc. relating to $6,215,000 of Mortgage Revenue Refunding Bonds.\n10(m)(ii) Loan Agreement, dated as of May 1, 1992 between Montgomery County (Pennsylvania) Industrial Development Authority and Geriatric and Medical Services, Inc., relating to $2,105,000 of Mortgage Revenue Refunding Bonds.\n10(n) Accounts Financing Agreement, dated as of December 6, 1991, between American Insured Receivables Fund, Inc. and Geriatric & Medical Centers, Inc. and certain of its subsidiaries.\n10(o) Master Trust Indenture, dated May 1, 1992, by and between Geriatric and Medical Services, Inc. and Fidelity Bank, National Association.\n10(p)(i) Loan Agreement, dated as of June 1, 1992 between Chester County (Pennsylvania) Industrial Development Authority and Geriatric and Medical Services, Inc., relating to $2,285,000 of Mortgage Revenue Refunding Bonds.\n10(p)(ii) Loan Agreement, dated as of June 1, 1992, between Bucks County (Pennsylvania) Industrial Development Authority and Geriatric and Medical Services, Inc., relating to $2,370,000 of Mortgage Revenue Refunding Bonds.\n10(q) Loan Agreement, dated as of December 1, 1992, between Lancaster (Pennsylvania) Industrial Development Authority and Geriatric and Medical Services, Inc., relating to $855,000 of Mortgage Revenue Refunding Bonds and Loan Agreement, dated as of December 1, 1992, between Montgomery County (Pennsylvania) Industrial Development Authority and Geriatric and Medical Services, Inc., relating to $1,195,000 of Mortgage Revenue Refunding Bonds.\n10(r)(i) Assignment Agreement, dated February 26, 1993, by and between Geriatric & Medical Companies, Inc., and Robert P. Krauss, Esquire, as agent, regarding the assignment of $1,200,000 Subordinated Revenue Bond (AHF\/Montgomery, Inc., Project) - Series 1990B to agent.\n10(r)(ii) Agency Agreement, dated February 26, 1993, by, between and among the Daniel Veloric Individual Retirement Account, Transcorp, Inc., Custodian; Tomahawk Capital Investments, Inc.; and Robert P. Krauss, Esquire, as agent.\n10(s)(i) Agreement of Sale, dated as of May 31, 1993, by and between Geriatric and Medical Services, Inc, and Tomahawk Capital Investments, Inc.\n10(s)(ii) Mortgage Note, dated as of May 31, 1993, given by Tomahawk Capital Investments, Inc., to Geriatric and Medical Services, Inc.\n10(s)(iii) Mortgage and Security Agreement, dated as of May 31, 1993, by and between Tomahawk Capital Investments, Inc, and Geriatric and Medical Services, Inc.\n10(t) Sale and Subservicing Agreement, dated as of November 4, 1993, by and among certain subsidiaries of Geriatric & Medical Companies, Inc. as Seller and Subservicer, NPF-PW, Inc. as Purchaser and National Premier Financial Services, Inc., as Servicer.\n10(u) Sale and Subservicing Agreement, dated as of May 19, 1994, by and among certain subsidiaries of Geriatric & Medical Companies, Inc. as Seller and Subservicer, NPF-PW, Inc. as Purchaser and National Premier Financial Services, Inc, as Servicer.\n10(v) Employment Agreement dated March 4, 1993, effective June 1, 1993 by and between Geriatric & Medical Companies, Inc. and Daniel Veloric - Chairman of the Board, Chief Executive Officer and President.\n22. Subsidiaries of the Registrant.\n28(a). Stipulation and Settlement Agreement (City of Philadelphia). Incorporated by reference to Exhibit 28(a) to the Registrant's Annual Report on form 10-K for the fiscal year May 31, 1990.\n28(b). Stipulation of Settlement in Whole and In Part (Commonwealth of Pennsylvania - Department of Public Welfare). Incorporated by reference to Exhibit 28(b) to the Registrant's Annual Report on Form 10-K for the fiscal year ended May 31, 1990.\n(B) REPORTS ON FORM 8-K\nNone.\nSIGNATURES\nPursuant to 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.\nGERIATRIC & MEDICAL COMPANIES, INC. (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 the registrant and in the capacities and on the dates indicated.\nGERIATRIC & MEDICAL COMPANIES, INC.\nANNUAL REPORT ON FORM 10-K FOR YEAR ENDED MAY 31, 1994 EXHIBIT INDEX\nEMPLOYMENT AGREEMENT\nThis Employment Agreement (the 'Agreement') is made and entered into as of this 4th day of March, 1993, effective June 1, 1993, by and between GERIATRIC & MEDICAL COMPANIES, INC., a Delaware Corporation, (hereinafter the 'Company') and DANIEL VELORIC (hereinafter 'Employee').\nBACKGROUND\nCompany deems it to be in its best interests to secure and retain the services of Employee and Employee desires to work for Company upon the terms and under the conditions hereinafter set forth.\nThe Compensation Committee of the Board of Directors determined, in 1993, that this Employment Agreement would become effective June 1, 1993 notwithstanding the fact that the final terms of the Agreement and the Bonus Plans referred to herein would take several months to finalize. The Compensation Committee engaged an outside consultant to review this Employment Agreement and the Bonus Plans referred to herein to determine that they were fair and reasonable in the marketplace and the Committee approved this Agreement and the Plans at their meetings held on February 3, 1994.\nNOW, THEREFORE, in consideration of the mutual promises and undertakings contained herein and intending to be legally bound hereby, the parties hereto agree as follows:\n1. EMPLOYMENT. The Company hereby employs Employee and Employee hereby accepts such employment, on the terms and under the conditions hereinafter set forth.\n2. TERM. The original term of this Agreement shall begin as of June 1, 1993 and shall continue for five years, ending May 31, 1998 (the 'Term'). This Agreement shall be extended for one additional year until this Agreement terminates in accordance with the provisions of Paragraph 11 hereof so that the Term of this Agreement shall always remain five years.\n3. DUTIES. Employee is engaged hereunder as Chairman and CEO of Company (the 'Position'), and he agrees to perform the duties of the Position, or such other or further duties and services of a similar nature as may be reasonably required of him by the Board of Directors of the Company (the 'Board'). Employee shall have such power and authority as shall reasonably be required to enable him to perform his duties hereunder in an efficient manner; provided that, in exercising such power and authority and performing such duties, Employee shall at all times be subject to the authority and control of the Board. Employee shall perform his duties and services hereunder based at the Company's Philadelphia, Pennsylvania location. Employee shall devote his full business time, attention, energies and best efforts to the performance of all of the duties required of the Position.\n4. COMPENSATION. For all services rendered by Employee during the Term of this Agreement, and any renewal hereof, Company agrees to pay Employee a salary of Four Hundred Fifty Thousand Dollars ($450,000) per annum ('Base Compensation'), which shall be paid in equal installments every two weeks, plus such additional compensation and bonuses as may be awarded from time to time to the Employee by the Board or its Compensation Committee.\n5. FRINGE BENEFITS AND PENSION PLAN. During the term of this Agreement, or so long as compensation is required to be paid by Company to Employee hereunder, Employee shall be entitled to participate in (or to continue his participation in) all the fringe benefit programs provided for executive employees of the Company, including, without limitation, all medical, disability, and life insurance programs and incentive compensation plans now in existence or hereinafter adopted by the Company for its Executive Officers; provided, however, that Employee shall be entitled to and shall receive the benefits provided for in the plans described on Exhibit 'A' and Exhibit 'B' attached hereto (the 'Incentive Plans'), in lieu of, and not in addition to, any retirement or bonus program provided for executive employees of Company.\n6. CAR ALLOWANCE. Company agrees to provide Employee with a Company owned and maintained luxury class vehicle.\n7. VACATIONS. Employee shall be entitled each year to vacation time of four weeks, during which time his Base Compensation shall continue to be paid to him. Each vacation shall be taken by Employee at such time or times as agreed upon by Company and Employee.\n8. REIMBURSEMENT OF EXPENSES. Company shall reimburse Employee for all reasonable expenses incurred by Employee in connection with his employment hereunder in accordance with procedures established by Company, from time to time.\n9. DISABILITY OF EMPLOYEE. If Employee is unable to substantially perform his services by reason of incapacity, either physical or mental, for a period of ninety consecutive days, Company shall have the option of reducing, in whole or in part, the Base Compensation or other compensation thereafter payable to Employee pursuant to this Agreement during the continued period of illness or incapacity, or of declaring at any time thereafter during the continuation of such disability, upon thirty days notice, that Employee's employment hereunder is terminated.\nIn the event this Agreement is terminated due to disability of Employee, Company shall pay to Employee all sums owed to him as Base Compensation, and all earned and accrued bonuses which would otherwise be payable to Employee up to the end of the month in which Employee's employment is terminated hereunder. The Disability Payment shall be made within thirty days of the date of termination. In addition, Company shall pay Employee, as a further Disability Payment, an amount equal to 100% of his Base Compensation at the time any such disability commences each year such disability continues (or having commenced, he does not again become an Employee of the Company) for three years. Company shall have no obligation to Employee upon termination due to disability of Employee, except as expressly provided for in this Paragraph 9.\n10. DEATH. If Employee dies during the term of this Agreement, including any renewals hereof, this Agreement shall terminate immediately and Company shall pay to Employee's Estate (i) all sums owed to Employee as Base Compensation; (ii) all earned and accrued but unpaid bonuses (including payments pursuant to Paragraph 9 hereof), which would otherwise be payable to Employee up to the end of the month in which Employee's death occurs; and a Death Benefit of One Million Dollars ($1,000,000) payable in forty equal quarterly payments commencing on the last day of the third month after the date of Employee's death. Company shall have no obligation to Employee upon termination due to death of Employee, except as expressly provided for in this Paragraph 10.\n11. TERMINATION.\n11.1. Company may terminate this Agreement only (a) with Cause (as hereinafter defined); (b) upon the disability of Employee pursuant to Paragraph 9 hereof; or (c) upon the death of Employee pursuant to Paragraph 10 hereof. Any termination pursuant to (a) or (b) of this Paragraph 11.1 must be preceded by not less than ninety days written notice to Employee.\n11.2. Employee may terminate this Agreement by giving written notice to Company thirty days prior to the expiration of the Term of this Agreement or any extension(s) hereof or at any time upon Company's breach of any material provision hereof upon giving 90 days prior written notice thereof to Company.\n12. CAUSE.\n12.1. Cause, as the term is used herein, shall include only the following: engagement by Employee in willful misconduct, fraud, embezzlement, theft constituting a felony, an act intentionally against the interests of the Company which causes Company material harm, or a final determination by a court of competent jurisdiction that Employee has committed a material breach of the provisions of Paragraph 3 of this Agreement.\n12.2. For the purpose of this Agreement, Company's exercise of its right to terminate Employee shall require a vote of two-thirds of the Board.\n12.3. If Employee is terminated hereunder for Cause, Company shall not be obligated to provide to Employee any compensation or benefits whatsoever, which Employee might otherwise be entitled to hereunder accruing hereunder after the date of a termination for cause.\n13. ETHICS, NON-COMPETITION AND CONFIDENTIALITY. In consideration of the employment of Employee as herein provided, Employee agrees to execute and abide by the Company's standard statements for business ethics, conflicts of interest and confidentiality and any Reaffirmations as from time-to-time are requested. Employee understands and acknowledges that such covenants are required for the fair and reasonable protection of Company and that said covenants shall be construed as an agreement independent of any other provisions of Employee's employment and that they shall survive termination of this Agreement.\n14. NOTICES. Any notice required or permitted to be given under this Agreement shall be sufficient, if delivered in person or if delivered by any nationally recognized overnight delivery service.\n15. BINDING EFFECT. This Agreement shall be binding upon and inure to the benefit of Company and Employee and their respective successors, assigns and legal representatives; provided, however, that neither party shall have the right to assign or otherwise transfer (by operation of law or otherwise) its or his rights or obligations under this Agreement (other than as referred to herein) except with the prior written consent of the other.\n16. GOVERNING LAW. This Agreement shall be deemed to be a contract made and performed under the laws of the Commonwealth of Pennsylvania, and for all purposes it shall be construed in accordance with and governed by the laws of the Commonwealth of Pennsylvania.\n17. SPECIFIC PERFORMANCE. The parties to this Agreement, in addition to all other remedies allowed by law for its enforcement, expressly consent to the enforcement of this Agreement by specific performance or by injunction in any court having competent jurisdiction.\n18. ENFORCEMENT. If Employee seeks to enforce his rights under this Agreement, and Employee prevails, Company shall pay all actual attorneys' fees and attorneys' costs which were reasonably incurred by Employee in enforcing his rights hereunder.\n19. ARBITRATION. In any dispute regarding this Agreement, including its applicability, and the applicability of this Paragraph 19, Employee may require Company to submit the dispute to binding arbitration for resolution ('Arbitration'). If Employee requests Arbitration, Employee and Company shall each choose one arbitrator, and the two arbitrators so chosen shall choose a third arbitrator. The Arbitration shall be according to the rules of the American Arbitration Association, and any final decision reached by the arbitrators shall be final and unappealable. Company agrees to and shall pay all costs of the Arbitration, including all costs incurred in enforcing Employee's rights, if any, pursuant to a final decision of the arbitrators. If Company files an action in any court regarding a matter which the Company was required to submit to arbitration, or if the Company attempts to or does appeal to any court any decision of the arbitrators, Company shall pay all costs of such subsequent action, including those of Employee, regardless of whether or not Company prevails.\n20. SEVERABILITY. Whenever possible, each provision of this Agreement shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of this Agreement shall be prohibited by or invalid under applicable law, such provision shall be ineffective only to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of this Agreement.\n21. MODIFICATION. This Agreement shall not be and shall not be deemed or construed to have been modified, amended, rescinded, canceled, or waived in whole or in part, except by a written instrument signed by the parties hereto.\n22. ENTIRE AGREEMENT. This Agreement constitutes and expresses the entire agreement and understanding between the parties hereto in reference to all the matters referred to herein, and any previous discussions, promises, representations, and understanding relative thereto are merged into the terms of this Agreement and shall have no further force and effect.\nIN WITNESS WHEREOF, the parties hereto have signed this Agreement as of the date first set forth above.\nGERIATRIC & MEDICAL COMPANIES, INC.\nBy: __________________________________ ARTHUR A. CARR, JR., Executive Vice President\nSALE AND SUBSERVICING AGREEMENT\nDated as of May 19, 1994\nby and among\nTHOSE PARTIES LISTED ON SCHEDULE 4 ATTACHED HERETO\nas Seller and as Subservicer,\nNPF III, INC.\nAS PURCHASER,\nAND\nNATIONAL PREMIER FINANCIAL SERVICES, INC.,\nAS SERVICER\nTABLE OF CONTENTS ARTICLE I\nDEFINITIONS\nSALE AND SUBSERVICING AGREEMENT (the 'Agreement'), dated as of May 19, 1994, by and among those corporations identified and set forth on Schedule 4 attached hereto, each of which is incorporated in the state adjacent to its name set forth on Schedule 4 attached hereto, as Seller (as such, together with its successors and permitted assigns, the 'Seller') and as Subservicer hereunder (as such, together with its successors and permitted assigns, the 'Subservicer'), NPF III, INC., an Ohio corporation, as Purchaser (as such, together with its successors and permitted assigns, the 'Purchaser'), and NATIONAL PREMIER FINANCIAL SERVICES, INC., an Ohio corporation, as Servicer (as such, together with its successors and permitted assigns, the 'Servicer').\nWITNESSETH:\nWHEREAS, each Seller desires to sell to the Purchaser certain health care receivables originated by such Seller and, unless otherwise specifically provided herein to the contrary, each Seller constitutes a separate party to this Agreement with respect to each Seller's duties, responsibilities, obligations, representations, warranties and covenants set forth in this Agreement;\nWHEREAS, the Purchaser is a special purpose corporation formed for the purpose of purchasing certain health care receivables and funding such purchases with the proceeds from the issuance of promissory notes;\nWHEREAS, the Seller and the Purchaser intend that the Purchaser will purchase certain health care receivables from the Seller from time to time;\nWHEREAS, the Purchaser has appointed the Servicer to perform certain servicing, administrative and collection functions in respect of the receivables purchased by the Purchaser under this Agreement (the 'Purchased Receivables');\nWHEREAS, in order to effectuate the purposes of this Agreement, the Purchaser and the Servicer desire that a subservicer (the 'Subservicer') be appointed to perform certain servicing, administrative and collection functions in respect of the Purchased Receivables;\nWHEREAS, the Seller has been requested and is willing to act as the Subservicer; and\nWHEREAS, each Seller acknowledges and consents to the Purchaser's anticipated assignment to an affiliate of the Purchaser of all its right, title, interest and obligations with respect to this Agreement.\nNOW, THEREFORE, the parties agree as follows:\nARTICLE I DEFINITIONS\nSECTION 1.01. Certain Defined Terms. Except as otherwise agreed by the parties, as used in this Agreement, the following terms shall have the following meanings:\n'ACCREDITATION' means certification by the JCAHO that a facility fully complies with the standards set by the JCAHO for operation of such facility.\n'ADDITIONAL SUBSERVICER' has the meaning specified in Section 7.02.\n'ADDITIONAL SUBSERVICING AGREEMENT' has the meaning specified in Section 7.02.\n'ADVERSE CLAIM' means any claim of ownership or any lien, security interest or other charge or encumbrance, or other type of preferential arrangement having the effect of a lien or security interest.\n'AFFILIATE' means, as to any Person, any other Person that, directly or indirectly, is in control of, is controlled by, or is under common control with, such Person within the meaning of control under Section 15 of the Securities Act of 1933.\n'BASE RATE' means, as of any Purchase Date a percentage, determined by the Servicer, equal to 9.75% per annum.\n'BILLING DATE' means the date on which the claim with respect to a Receivable was submitted to the related Payor.\n'BLUE CROSS\/BLUE SHIELD CONTRACT' means any and all agreements currently in force between the Seller and any Blue Cross\/Blue Shield plan.\n'BUSINESS DAY' means any day of the year other than a Saturday, Sunday or any day on which banks are required, or authorized, by law to close in the State of Ohio or the State of New York.\n'CHAMPUS' means the Civilian Health and Medical Program of the Uniformed Service, a program of medical benefits covering retirees and dependents of a member or a former member of a uniformed service, provided, financed and supervised by the United States Department of Defense established by 10 USC 1071 et seq.\n'CHAMPUS RECEIVABLE' means a Receivable payable pursuant to CHAMPUS.\n'CHAMPUS REGULATIONS' means collectively, all regulation of the Civilian Health and Medical Program of the Uniformed Services including (a) all federal statutes (whether set forth in 10 USC 1071 or elsewhere) affecting CHAMPUS; and (b) all applicable provisions of all rules, regulations (including 32 CFR 199), manuals, orders, and administrative, reimbursement and other guidelines of all Governmental Authorities (including, without limitation, HHS, the Department of Defense, the Department of Transportation, the Assistant Secretary of Defense (Health Affairs), and the Office of CHAMPUS, or any Person or entity succeeding to the functions of any of the foregoing) promulgated pursuant to or in connection with any of the foregoing (whether or not having the force of law), in each case as may be amended, supplemented or otherwise modified from time to time.\n'CLOSING DATE' means May 19, 1994.\n'COLLECTION ACCOUNT' means the trust account maintained with the Trustee described in Section 2.03(c).\n'COLLECTIONS' means, with respect to any Receivable, all cash collections and other cash proceeds of such Receivable.\n'COMMERCIAL LOCKBOX ACCOUNT' has the meaning specified in Section 2.03(a).\n'CONCENTRATION LIMIT' means: (a) the following expressed as a percentage of the aggregate Net Value of the total outstanding Purchased Receivables:\n(i) Receivables payable by Blue Cross and Blue Shield plans - 20%;\n(ii) Receivables for which any one commercial insurer or HMO\/PPO is Payor during the time such Payor has a long-term rating of A or better but less than AAA from S&P - 8%; and\n(iii) Receivables payable by all commercial insurance Payors and HMO\/PPO Payors which are unrated or which have a long-term rating of below A from S&P - 1%; and\n(b) the following expressed as a dollar amount of the aggregate Net Value of Purchased Receivables:\n(i) Medicare Receivables, Medicaid Receivables and CHAMPUS Receivables - $2,000,000; and\n(ii) Medicare Receivables and Medicaid Receivables for which no DRG Code is assigned - $200,000.\n'CONTRACT' means an agreement (or agreements), pursuant to, or under which, a Payor shall be obligated to pay for services rendered or merchandise sold to patients of the Seller from time to time.\n'CREDIT DEFICIENCY' has the meaning specified in Section 6.02(e).\n'DEBT' of any Person means (a) indebtedness of such Person for borrowed money, (b) obligations of such Person evidenced by bonds, debentures, notes or other similar instruments, (c)\nobligations of such Person to pay the deferred purchase price of property or services, (d) obligations of such Person as lessee under leases which have been or should be, in accordance with generally accepted accounting principles, recorded as capital leases, (e) obligations secured by any lien or other charge upon property or assets owned by such Person, even though such Person has not assumed or become liable for the payment of such obligations, (f) obligations of such Person under direct or indirect guaranties in respect of, and obligations (contingent or otherwise) to purchase or otherwise acquire, or otherwise to assure a creditor against loss in respect of, indebtedness or obligations of others of the kinds referred to in clauses (a) through (e) above, and (g) liabilities in respect of unfunded vested benefits under plans covered by Title IV of the Employee Retirement Income Security Act of 1974, as amended.\n'DEFAULTED AMOUNT' has the meaning specified in Section 6.02(b).\n'DEFAULTED RECEIVABLE' means a Receivable as to which, on any Determination Date (a) any part of the Net Value thereof remains unpaid for more than 150 days from the Discharge Date for such Receivable; or (b) the Payor thereof has taken any action, or suffered any event to occur, of the type described in Section 8.01(c); or (c) the Servicer or the Subservicer otherwise deems any part of the Net Value thereof to be uncollectible.\n'DEFAULTED RECEIVABLES PAYMENTS' has the meaning specified in Section 6.02(f).\n'DETERMINATION DATE' means the Business Day preceding the Purchase Date of each week.\n'DISCHARGE DATE' means, with respect to any Receivable, the date of discharge by a Seller of the related patient, in the case of an in-patient and the date of the provision of services or merchandise to the related patient in the case of an out-patient.\n'DOLLAR' and '$' means lawful money of the United States of America.\n'DRG CODE' means the Diagnosis Related Group code assigned by HCFA.\n'ELIGIBLE PAYOR' means a Payor which is (a) (i) a commercial insurance company, organized under the laws of any jurisdiction in the United States, having its principal office in the United States, (ii) a Blue Cross\/Blue Shield plan, or (iii) during such time as the Seller is the Subservicer hereunder, (A) Medicare, (B) Medicaid plans other than those administered by the states listed on Schedule 1, (C) CHAMPUS or (iv) a HMO or PPO, organized under the laws of any jurisdiction in the United States, having its principal office in the United States;\n(b) not an Affiliate of any of the parties hereto;\n(c) in the case of (a) (i), (ii) and (iv) above, in receipt of a letter substantially in the form of Exhibit A hereto; and\n(d) not subject to bankruptcy or insolvency proceedings at the time of sale of the Receivable to the Purchaser.\n'ELIGIBLE RECEIVABLE' means, at any time, a Receivable; (a) which is a primary liability of an Eligible Payor and is recognized by the Eligible Payor as its primary liability; and\n(b) as to which the representations and warranties of Section 4.02 are true and correct in all respects at the time of Purchase.\n'EQUITY ACCOUNT' means the trust account of the Purchaser maintained with the Trustee titled 'NPF III - Equity Account'.\n'EVENT OF SELLER DEFAULT' has the meaning specified in Section 8.01.\n'GOVERNMENTAL AUTHORITY' means the United States of America, federal, any state, local or other political subdivision thereof and any entity exercising executive, legislative, judicial, regulatory or administrative functions thereof or pertaining thereto.\n'GOVERNMENTAL CONSENTS' has the meaning specified in Section 4.01(i).\n'GROSS LIQUIDATION RATE' means a factor, conclusively determined by the Servicer, with respect to a designated Payor Class based on the Seller's historical experience with respect to Collections for such Payor Class, estimated on the basis of actual Collections which are expected to be received on a Receivable within 180 days of its Discharge Date. The Servicer will notify the Seller and the Purchaser, from time to time (subject to the requirements of Section 2.06), of its determination of such factors, and such determinations shall conclusively bind the Seller and the Purchaser.\n'GROSS RECEIVABLE AMOUNT' means, with respect to any Receivable, the amount billed to the related Payor with respect thereto.\n'HCFA' means the Health Care Financing Administration, an agency of the HHS charged with administering and regulating, inter alia, certain aspects of Medicaid and Medicare.\n'HEALTH FACILITY LICENSE' means a license issued by a state health agency or similar agency or body certifying that the facility has been inspected and found to comply with applicable laws for operating such a health facility.\n'HHS' means the Department of Health and Human Services, an agency of the Federal Government of the United States.\n'HMO' means a health maintenance organization.\n'INDEMNIFIED AMOUNTS' has the meaning specified in Section 9.01(a).\n'INDEMNIFIED PARTY' has the meaning specified in Section 9.01(a).\n'INTERNAL REVENUE CODE' means the Internal Revenue Code of 1986, as amended.\n'INVESTMENT INCOME' means income on Permitted Investments.\n'JCAHO' means the Joint Commission for Accreditation of Health Care Organizations.\n'LOCKBOX ACCOUNT' has the meaning specified in Section 2.03(a).\n'LOCKBOX ACCOUNT AGREEMENT' means an agreement among the Seller, the Purchaser, and a depository institution satisfactory to the Purchaser with respect to either Lockbox Account, (a) providing that all Collections therein shall be remitted directly to the Collection Account within one Business Day of receipt and (b) otherwise satisfactory to the Purchaser.\n'MEDICAID' means the medical assistance program established by Title XIX of the Social Security Act (42 USC SectionSection 1396 et seq.) and any statutes succeeding thereto.\n'MEDICAID CERTIFICATION' means certification of a facility by HCFA or a state agency or entity under contract with HCFA that the facility fully complies with all the conditions of participation set forth in Medicaid Regulations.\n'MEDICAID PROVIDER AGREEMENT' means an agreement entered into between a federal or state agency or other such entity administering the Medicaid program and a health care facility under which the health care facility agrees to provide services or merchandise for Medicaid patients in accordance with the terms of the agreement and Medicaid Regulations.\n'MEDICAID RECEIVABLE' means a Receivable payable pursuant to a Medicaid Provider Agreement.\n'MEDICAID REGULATIONS' means, collectively, (a) all federal statutes (whether set forth in Title XIX of the Social Security Act or elsewhere) affecting Medicaid; (b) all state statutes and plans for medical assistance enacted in connection with such statutes and federal rules and regulations promulgated pursuant to or in connection with such statutes; and (c) all applicable provisions of all rules, regulations, manuals, orders and administrative, reimbursement and other guidelines of all Governmental Authorities (including, without limitation, HHS, HCFA, the office of the Inspector General for HHS, or any Person succeeding to the functions of any of the foregoing) promulgated\npursuant to or in connection with any of the foregoing (whether or not having the force of law), in each case as may be amended, supplemented or otherwise modified from time to time.\n'MEDICARE' means the health insurance program for the aged and disabled established by Title XVIII of the Social Security Act (42 USC 1395 et seq.) and any statutes succeeding thereto.\n'MEDICARE CERTIFICATION' means certification of a facility by HCFA or a state agency or entity under contract with HCFA that the facility fully complies with all the conditions of participation set forth in Medicare Regulations.\n'MEDICARE LOCKBOX ACCOUNT' has the meaning specified in Section 2.03(a).\n'MEDICARE PROVIDER AGREEMENT' means an agreement entered into between a state agency or other such entity administering the Medicare program and a health care facility under which the health care facility agrees to provide services or merchandise for Medicare patients in accordance with the terms of the agreement and Medicare Regulations.\n'MEDICARE RECEIVABLE' means a Receivable payable pursuant to a Medicare Provider Agreement.\n'MEDICARE REGULATIONS' means, collectively, (a) all federal statutes (whether set forth in Title XVIII of the Social Security Act or elsewhere) affecting Medicare; and (b) all applicable provisions of all rules, regulations, manuals, orders and administrative, reimbursement and other guidelines of all Governmental Authorities (including, without limitation, HHS, HCFA, the Office of the Inspector General for HHS, or any Person succeeding to the functions of any of the foregoing) promulgated pursuant to or in connection with the foregoing (whether or not having the force of law), as each may be amended, supplemented or otherwise modified from time to time.\n'NET VALUE' of any Receivable at any time means an amount (not less than zero) equal to (a)(i) its Gross Receivable Amount multiplied by (ii) the Gross Liquidation Rate of the Payor thereof multiplied by (iii) 0.97; minus (b) all payments received from the Payor with respect thereto; provided, that if the Servicer makes a determination that all payments by the Payor with respect to such Receivable have been made, the Net Value shall be zero.\n'NET VALUE AMOUNT' has the meaning specified in Section 6.02(a).\n'NOTES' means the promissory notes issued by the Purchaser the proceeds of which shall be principally used to fund the purchase of Receivables by the Purchaser.\n'OFFICERS' CERTIFICATE' means a certificate delivered to the Trustee or, as specified, the Purchaser or the Servicer signed by two persons, one of whom shall (a) hold the office of the Chairman of the Board, President, Vice President or Treasurer and (b) the second of whom shall hold (i) any of the offices described in the preceding clause (a) or (ii) the office of Assistant Treasurer, Secretary or Assistant Secretary of the Purchaser.\n'OTHER SELLERS' has the meaning specified in Section 2.07.\n'PAID RECEIVABLE' means, as of any Purchase Date, a Purchased Receivable as to which a payment by the Payor with respect to such Receivable has been received.\n'PAID RECEIVABLES AMOUNT' has the meaning specified in Section 6.02(c).\n'PAYOR' means, with respect to any Receivable, the Person primarily obligated to make payments in respect thereto.\n'PAYOR CLASS' means, with respect to any Payor, one of the following: (a) commercial insurance Payors; (b) Medicare Payors; (c) Medicaid Payors; (d) Blue Cross\/Blue Shield Payors; (e) CHAMPUS Payors; and (f) HMO and PPO Payors.\n'PERMITTED INVESTMENTS' means (a) U.S. Government Obligations having a maturity of not more than 180 days from the date of acquisition; (b) marketable obligations directly and fully guaranteed by the United States having a maturity of not more than 180 days from the date of\nacquisition; (c) repurchase agreements on obligations specified in clause (a) maturing not more than two months from the date of acquisition thereof, provided that the long-term unsecured obligations of the party agreeing to repurchase are at the time rated AAA by S&P; (d) federal funds, certificates of deposit and time deposits of any depository institution or trust company incorporated under the laws of the United States or any state, provided that the long-term unsecured obligations of the obligor are at the time rated AAA by S&P or the short-term unsecured obligations of the obligor are at the time rated A-1 + by S&P; (e) commercial paper of any corporation incorporated under the laws of the United States or any state thereof which on the date of acquisition is rated A-1+ by S&P and (f) securities of money market funds rated AAAm or AAAm-G by S&P.\n'PERSON' means an individual, partnership, corporation (including a business trust), joint stock company, trust, voluntary association, joint venture, a government or any agency or political subdivision thereof, or any other entity of whatever nature.\n'PPO' means a preferred provider organization.\n'PRINCIPAL AMORTIZATION EVENT' means the earlier to occur of (a) a default with respect to any interest or principal payment on the Notes; (b) a default with respect to any promissory note in favor of the Purchaser payable by an affiliate of the Purchaser; (c) the Purchaser generally not paying its Debts, the Purchaser admitting in writing its inability to pay its Debts generally, the Purchaser making a general assignment for the benefit of creditors, the institution of any proceeding by or against the Purchaser seeking to adjudicate the Purchaser bankrupt or insolvent or seeking liquidation, winding up, reorganization or other similar official action for it or for any substantial part of its property; (d) the commencement by the Purchaser of a voluntary case or proceeding under any applicable Federal or state bankruptcy, insolvency, reorganization or other similar law or any other case or proceeding to be adjudicated bankrupt or insolvent or consent by it to the entry of a decree or order for relief in respect of the Purchaser in an involuntary case or proceeding; provided that in the event of a proceeding brought by a third party and not consented to by the Purchaser in (c) and (d) above, a Principal Amortization Event shall not be deemed to have occurred until 10 days after the commencement of such proceeding; or (e) a default in the performance or breach of any covenant, representation or warranty of the Purchaser to the Trustee which remains uncured for a period of 30 days. 'PROGRAM FEE' means, (a) as of the first Purchase Date in any month, an amount determined by the Servicer, equal to (i) 1\/12 of the annualized Base Rate multiplied by (ii) the aggregate Net Value of all Purchased Receivables (including those to be purchased on such Purchase Date) other than Defaulted Receivables; and (b) as of any subsequent Purchase Date in any month, an amount determined by the Servicer, equal to (i) 7\/360 of the annualized Base Rate multiplied by (ii) any increase in the aggregate Net Value of all Purchased Receivables (including those to be purchased on such Purchase Date) other than Defaulted Receivables since such first Purchase Date.\n'PURCHASE' means a purchase by the Purchaser of Eligible Receivables from the Seller pursuant to Section 2.02.\n'PURCHASE ACCOUNT' means the trust account of the Purchaser maintained with the Trustee titled 'NPF III - Purchase Account.'\n'PURCHASE ASSIGNMENT' means the assignment of Purchased Receivables entered into between the Seller and the Purchaser on any Purchase Date substantially in the form of Exhibit C.\n'PURCHASE COMMITMENT' means the dollar amount adjacent to each Seller's name set forth on Schedule 5 attached hereto, and in the aggregate an amount not to exceed $7,500,000.\n'PURCHASE DATE' means the Closing Date and thereafter, the day of each week adjacent to each Seller's name set forth on Schedule 7 attached hereto, or the preceding Business Day if such day is not a Business Day.\n'PURCHASE PRICE' has the meaning specified in Section 2.02(b).\n'PURCHASE NOTICE' means a notice in a form of acceptable to the Purchaser, which enables the Purchaser to identify all Eligible Receivables owned on such date by the Seller, and the Required Information with respect thereto, segregated by the Payor Class.\n'PURCHASED RECEIVABLE' means any Receivable which has been purchased by the Purchaser hereunder regardless of whether a Receivable is determined to be an Eligible Receivable as of its Purchase Date. Notwithstanding anything to the contrary herein, Purchased Receivable shall only refer to a Receivable (or part thereof) payable by the primary Payor thereof.\n'PURCHASER' means NPF III, Inc., an Ohio corporation, together with its successors and assigns.\n'RECEIVABLE' means (a) an account receivable billed to a Payor arising from the provision of health care services (and any services or sales ancillary thereto) by the Seller including the right to payment of any interest or finance charges and other obligations of such Payor with respect thereto;\n(b) all security interests or liens and property subject thereto from time to time purporting to secure payment by the Payor;\n(c) all guarantees, indemnities and warranties and proceeds thereof, proceeds of insurance policies, UCC financing statements and other agreements or arrangements of whatever character from time to time supporting or securing payment of such Receivable;\n(d) all Collections with respect to any of the foregoing;\n(e) all Records with respect to any of the foregoing; and\n(f) all proceeds of any of the foregoing.\n'RECORDS' means all Contracts and other documents, books, records and other information (including, without limitation, computer programs, tapes, disks, punch cards, data processing software and related property and rights) prepared and maintained by the Seller or the Subservicer with respect to Receivables (including Purchased Receivables) and the related Payors.\n'REJECTED RECEIVABLE' has the meaning specified in Section 4.03.\n'RELATED DOCUMENTS' means each Purchase Assignment, the Lockbox Account Agreement and all documents required to be delivered thereunder and under this Agreement.\n'REQUIRED INFORMATION' means, with respect to a Receivable, (a) the Payor, (b) the DRG Code, (c) the Gross Receivable Amount, (d) the Billing Date, (e) the patient account number and (f) date on which the patient was discharged by the Seller, if applicable.\n'S & P' means Standard & Poor's Corporation, and its successors and assigns.\n'SELLER' means each of those corporations identified and set forth on Schedule 4 attached hereto, each of which is incorporated in the state adjacent to its name set forth on Schedule 4 attached hereto, together with its successors and permitted assigns.\n'SELLER CREDIT RESERVE ACCOUNT' means the trust account maintained with the Trustee.\n'SELLER EQUITY ACCOUNT REQUIREMENT' means, with respect to the Equity Account, as of any Purchase Date, an amount equal to 5.25% of the Net Value of Purchased Receivables (including Receivables to be purchased as of such Purchase Date) other than Defaulted Receivables.\n'SELLER LIQUIDITY RESERVE ACCOUNT' means the trust account maintained with the Trustee.\n'SERVICER' means National Premier Financial Services, Inc., an Ohio corporation, or any Person designated as the successor Servicer, and its successors and assigns, from time to time.\n'SERVICING OFFICER' means any officer of the Subservicer involved in, or responsible for, the administration and servicing of the Purchased Receivables whose name appears on an Officer's Certificate listing servicing officers furnished to the Purchaser and the Servicer by the Subservicer, as amended, from time to time.\n'SERVICING RECORDS' means all documents, books, records and other information (including, without limitation, computer programs, tapes, disks, punch cards, data processing software and related property and rights) prepared and maintained by the Subservicer or the Servicer with respect to the Purchased Receivables and the related Payors.\n'SERVICING TRANSFER EVENT' means, with respect to any Purchased Receivable, that payment in full of such Purchased Receivables has not been received from the Payor within 150 days of the Discharge Date.\n'SPECIAL SERVICER' means any Person designated as the Special Servicer, from time to time, by the Servicer for the purposes of servicing Purchased Receivables following a Servicing Transfer Event.\n'SPECIFIED CREDIT RESERVE BALANCE' means, as of any Purchase Date, an amount to be deposited with respect to the Seller in the Seller Credit Reserve Account equal to 6.5% of the Net Value of Purchased Receivables (including Receivables to be purchased as of such Purchase Date) other than Defaulted Receivables.\n'SPECIFIED LIQUIDITY RESERVE BALANCE' means, as of any Purchase Date, an amount to be deposited with respect to the Seller in the Seller Liquidity Reserve Account equal to 5.25% of the Net Value of Purchased Receivables (including Receivables to be purchased as of such Purchase Date) other than Defaulted Receivables.\n'SUBSERVICER' means the Seller, or any Person designated as Subservicer, from time to time, hereunder.\n'SUBSERVICING OFFICER' means any officer of the Subservicer involved in, or responsible for, the administration and servicing of the Purchased Receivables whose name appears on an Officer's Certificate listing servicing officers furnished to the Servicer by the Subservicer, as amended, from time to time.\n'SUBSIDIARY' means, as to any Person, any corporation or other entity of which securities or other ownership interests having ordinary voting power to elect a majority of the board of directors or other Persons performing similar functions are at the time directly or indirectly owned by such Person.\n'TERMINATION DATE' means the earlier of (a) July 31, 1995, or (b) the date of declaration or automatic occurrence of the Termination Date pursuant to Section 8.01.\n'TRUSTEE' means Bankers Trust Company, a national banking association, or any successor Trustee properly appointed by a majority of the noteholders to monitor and administer the Purchaser's activities for and on behalf of the noteholders.\n'UCC' means the Uniform Commercial Code as from time to time in effect in the State of the location of the Seller's chief executive office.\nSECTION 1.02. Other Terms. All accounting terms not specifically defined herein shall be construed in accordance with generally accepted accounting principles. All terms used in Article 9 of the UCC, and not specifically defined herein, are used herein as defined in such Article 9.\nARTICLE II\nPURCHASE AND SALE; ESTABLISHMENT OF ACCOUNTS\nSECTION 2.01. Purchase and Sale. The Seller does hereby agree to sell, transfer, assign, set over and convey to the Purchaser, without recourse, all right, title and interest of the Seller in and to the Purchased Receivables sold pursuant to this Agreement and the Purchaser does hereby agree to purchase Eligible Receivables pursuant to the terms of this Agreement; provided, that with respect to each Purchased Receivable which is a Medicare Receivable, a Medicaid Receivable or a CHAMPUS Receivable, the Seller, as Subservicer hereunder, shall retain all rights of collection with respect to such Receivable.\nSECTION 2.02. Conveyance of Receivables. (a) No later than 2:00 p.m. on the fifth Business Day prior to each Purchase Date, the Seller will deliver, or cause to be delivered, to the Servicer a Purchase Notice. In the event that the Seller does not provide such notification, the Purchaser will have no obligation to purchase any Eligible Receivable on such Purchase Date. Upon receipt of a Purchase Notice, the Servicer, in its sole discretion, as agent for the Purchaser, shall determine which, if any, of the Eligible Receivables specified therein the Purchaser shall purchase. In the event the Servicer determines (the determination of the Servicer being conclusive in this regard) that any Receivables identified on such notice are not Eligible Receivables, such Receivables shall not be eligible for sale on such Purchase Date. On each Purchase Date, following its selection, if any, of Eligible Receivables, the Servicer will complete, execute and deliver a Purchase Assignment to the Purchaser and the Seller. The Purchaser and the Seller shall thereupon execute such Purchase Assignment and deliver executed copies thereof to each other and to the Servicer. Notwithstanding the foregoing, the Purchaser shall have no obligation to purchase Receivables from the Seller to the extent the aggregate Net Value of all Purchased Receivables (other than Defaulted Receivables) is in excess of the Purchase Commitment.\n(b) The Purchase Price with respect to Purchased Receivables purchased on any Purchase Date shall be an amount (not less than zero) equal to (i) the aggregate Net Values of such Purchased Receivables; minus (ii) the sum of (A) the Program Fee as of such Purchase Date; (B) the amount, if any, by which the amount in the Seller Credit Reserve Account deposited hereunder (net of withdrawals required hereunder) is less than the Specified Credit Reserve Balance as of such Purchase Date; (C) the amount, if any, by which the amount in the Equity Account deposited hereunder is less than the Seller Equity Account Requirement as of such Purchase Date; and (D) the amount, if any, by which the amount in the Seller Liquidity Reserve Account deposited hereunder (net of withdrawals required hereunder) is less than the Specified Liquidity Reserve Balance as of such Purchase Date. Following delivery of a duly executed Purchase Assignment, subject to the satisfaction of the conditions set forth in Section 3.02, the Purchaser shall, by withdrawal from the Purchase Account, (v) pay to the Seller the Purchase Price for all Purchased Receivables purchased on such Purchase Date, (w) deposit the Program Fee in the Equity Account, (x) make a deposit in the amount set forth in (B) above, if any, in the Seller Credit Reserve Account, (y) make a deposit in the amount set forth in (C) above, if any, in the Equity Account and (z) make a deposit in the amount set forth in (D) above, if any, in the Seller Liquidity Reserve Account. Payment of such Purchase Price shall be made by the Servicer, as agent for the Purchaser, causing the Trustee to effect such payment. In the event the Purchase Price is zero on any Purchase Date, the Purchaser shall only be required to make deposits specified in (w), (x), (y), and (z) above in an amount equal to the Net Value of such Purchased Receivables as of such Purchase Date, with priority being given in the foregoing order. In the event the Net Value of such Purchased Receivables is less than the Program Fee (including where no Receivables are purchased on the relevant Purchase Date), to the extent funds deposited hereunder (net of withdrawals required hereunder) are sufficient, the Servicer shall cause the Trustee to withdraw the difference from the Seller Liquidity Reserve Account on such Purchase Date and deposit such amount in the Equity Account. In the event the Servicer causes the Trustee to withdraw all or a portion of the Program Fee from the Seller Liquidity Reserve Account and as a result thereof there is a deficiency in the Seller Liquidity Reserve Account, the Servicer shall\nnotify the Seller of such deficiency in the Seller Liquidity Reserve Account and the Seller shall cure the deficiency within 10 Business Days of notice thereof.\n(c) Following payment of the Purchase Price on any Purchase Date, ownership of each Purchased Receivable will be vested in the Purchaser. The Seller shall not take any action inconsistent with such ownership and shall not claim any ownership interest in any Purchased Receivable. The Seller shall indicate in its Records that ownership of each Purchased Receivable is held by the Purchaser. In addition, the Seller shall respond to any inquiries with respect to ownership of a Purchased Receivable by stating that it is no longer the owner of such Purchased Receivable and that ownership of such Purchased Receivable is held by the Purchaser. Documents (other than medical records, which shall be retained by the Seller) relating to the Purchased Receivables shall be held in trust by the Seller and the Subservicer, for the benefit of the Purchaser as the owner thereof, and possession of any Required Information or incident relating to the Purchased Receivables so retained is for the sole purpose of facilitating the servicing of the Purchased Receivables. Such retention and possession is at the will of the Purchaser and in a custodial capacity for the benefit of the Purchaser only. To further evidence such sale, at the request of the Purchaser, the Seller shall (i) mark conspicuously each invoice evidencing each Purchased Receivable with a legend, acceptable to the Purchaser, evidencing that the Purchaser has purchased all right and title thereto and interest therein as provided in this Agreement; (ii) mark its master data processing records evidencing such Purchased Receivables with such legend; and (iii) send notification to Payors as to the transfer of such interest in the Purchased Receivables.\nSECTION 2.03. Establishment of Accounts; Conveyance of Interests Therein; Investment.\n(a) Lockbox Account. Prior to the execution and delivery of this Agreement, the Seller shall (i) establish and maintain (A) an account in the name of the Seller with a depository institution satisfactory to the Purchaser (the 'Medicare Lockbox Account') into which all Collections in respect of Medicaid, Medicare and CHAMPUS Receivables shall be deposited and (B) an account in the name of the Trustee into which all Collections from Eligible Payors in respect of other Receivables shall be deposited (the 'Commercial Lockbox Account'; the Medicare Lockbox Account and the Commercial Lockbox Account are referred to collectively in this Agreement as the 'Lockbox Account') and (ii) enter into the Lockbox Account Agreement.\n(b) Seller Credit Reserve Account; Seller Liquidity Reserve Account. The Purchaser has established and shall maintain trust accounts with the corporate trust department of the Trustee titled 'NPF III -- Seller Credit Reserve Account' (the 'Seller Credit Reserve Account') and 'NPF III -- Seller Liquidity Reserve Account' (the 'Seller Liquidity Reserve Account').\n(c) Collection Account. The Purchaser has established and shall maintain a trust account with the corporate trust department of the Trustee titled 'NPF III -- Collection Account' (the 'Collection Account').\n(d) The Seller does hereby sell, transfer, assign, set over and convey to the Purchaser all right, title and interest of the Seller in and to (i) all amounts deposited, from time to time, in the Seller Credit Reserve Account and the Seller Liquidity Reserve Account and (ii) subject to the provisions of Article VI hereunder, all amounts deposited, from time to time, in the Lockbox Account and the Collection Account. Any Collections in respect of Purchased Receivables held by the Seller or the Subservicer pending transfer to the Collection Account as provided in this Agreement, shall be held by the Seller in trust for the benefit of the Purchaser until such amounts are deposited into the Collection Account or the Lockbox Account. In the event Collections in respect of Purchased Receivables held by the Seller (whether in the Lockbox Account or otherwise) shall not be remitted to the Collection Account on the day of receipt or the following Business Day if the day of receipt is not a Business Day in addition to its other remedies hereunder, the Purchaser shall be entitled to receive a late charge (which shall be in addition to the Program Fee) equal to 12% per annum or the maximum rate legally permitted if less than such rate, calculated as of the first Business Day of such delinquency.\n(e) To the extent there are uninvested amounts in the Collection Account, the Seller Credit Reserve Account or the Seller Liquidity Reserve Account, the Servicer shall cause the Trustee to invest all such amounts in Permitted Investments selected by the Trustee.\n(f) Notwithstanding anything to the contrary herein, the Seller may, but shall not be obligated to, make a deposit at any time in the Seller Credit Reserve Account or the Seller Liquidity Reserve Account.\nSECTION 2.04. Grant of Security Interest. It is the intention of the parties hereto that each payment by the Purchaser to the Seller with respect to Purchased Receivables to be made hereunder shall constitute part of the purchase and sale of such Purchased Receivables and not a loan. In the event, however, that a court of competent jurisdiction were to hold that the transaction evidenced hereby constitutes a loan and not a purchase and sale, it is the intention of the parties hereto that this Agreement shall constitute a security agreement under the UCC and any other applicable law, and that the Seller shall be deemed to have granted to the Purchaser a first priority perfected security interest in all of the Seller's right, title and interest in, to and under the Purchased Receivables; all payments of principal of or interest on such Purchased Receivables; all amounts on deposit from time to time in the Seller Credit Reserve Account, the Seller Liquidity Reserve Account; and all amounts on deposit with respect to Purchased Receivables from time to time in the Lockbox Account and the Collection Account, all other rights relating to and payments made in respect of this Agreement, and all proceeds of any of the foregoing.\nSECTION 2.05. Further Action Evidencing Purchases. (a) The Seller agrees that, from time to time, at its expense, it will promptly execute and deliver all further instruments and documents, and take all further action, that may be necessary or appropriate, or that the Purchaser may reasonably request, in order to perfect, protect or more fully evidence the transfer of ownership of the Purchased Receivables or to enable the Purchaser to exercise or enforce any of its rights hereunder or under any Purchase Assignment. Without limiting the generality of the foregoing, the Seller will, upon the request of the Purchaser, execute and file such financing or continuation statements, or amendments thereto or assignments thereof, and such other instruments or notices, as may be necessary or appropriate, or as the Purchaser may request. (b) The Seller hereby authorizes the Purchaser to file one or more financing or continuation statements, and amendments thereto and assignments thereof, relating to all or any of the Purchased Receivables and Collections with respect thereto without the signature of the Seller.\nSECTION 2.06. Eligible Receivables. The Servicer may from time to time unilaterally amend the Gross Liquidation Rate for each Payor Class to reflect, in its reasonable judgment, the historical experience of the Seller, the Purchaser, and the Servicer, with respect to Receivables. Such amendment shall be made solely at the discretion of the Servicer and shall be effected by delivery by the Servicer of a notice to each other party hereto setting forth such amendment. The effective date of such revision shall be five Business Days after such delivery. All determinations of the Servicer under this Agreement including, without limitation, whether Receivables are Eligible Receivables and the Gross Liquidation Rate, shall be conclusive.\nSECTION 2.07. Medicare and Medicaid Offsets. The parties acknowledge that the Purchaser and the Servicer have entered into a series of agreements in substantially the form as this Agreement with other sellers of Receivables ('Other Sellers') and that the Seller Liquidity Reserve Account has been established to provide liquidity to the Purchaser with respect to Medicare Receivables and Medicaid Receivables as to which an offset against payment thereof has occurred, whether such Receivables were sold to the Purchaser by the Seller or by Other Sellers. In the event of an offset against payment with respect to a Medicare Receivable or a Medicaid Receivable purchased by the Purchaser from the Seller or an Other Seller, the Servicer will cause the Trustee to withdraw the amount of such offset from the Seller Liquidity Reserve Account and deposit it in the Purchase Account. If such Receivable was sold to the Purchaser by the Seller, the Seller shall repurchase such Medicare Receivable or Medicaid Receivable in the same manner as set forth in Section 4.03. The amount of the offset by the Seller shall be deposited in the Seller Liquidity Reserve Account. The\nremaining amount of the Net Value of the Receivable shall be deposited in the Purchase Account. In the event such Receivable was sold to the Purchaser by an Other Seller, the Purchaser agrees to enforce the Other Seller's obligation to repurchase such Receivable under the terms of its agreement with such Other Seller and to cause the amount of such repurchase by the Other Seller to be deposited in the Seller Liquidity Reserve Account. The Servicer will maintain a detailed accounting record of all deposits and withdrawals from the Seller Liquidity Reserve Account including whether a withdrawal was made with respect to an offset against payment on a Medicare Receivable or Medicaid Receivable sold to the Purchaser by the Seller or an Other Seller. For purposes of calculating whether the amount in the Seller Liquidity Reserve Account deposited by the Seller (net of withdrawals required hereunder with respect to the Seller) is equal to the Specified Liquidity Reserve Balance, only withdrawals with respect to an offset on a Medicare Receivable or Medicaid Receivable sold to the Purchaser by the Seller will be deemed to be with respect to the Seller.\nSECTION 2.08. Assignment of Agreement. The Seller does hereby acknowledge and consent to the assignment by the Purchaser to an Affiliate of all the Purchaser's right, title, interest and obligations with respect to this Agreement. The Seller does hereby further agree to execute and deliver to the Purchaser all documents and amendments presented to the Seller by the Purchaser in furtherance of this Section 2.08 consistent with the terms and provisions of this Agreement.\nARTICLE III\nCONDITIONS OF PURCHASES\nSECTION 3.01. Conditions Precedent to Effectiveness of Agreement. The effectiveness of this Agreement is subject to the condition precedent that the Purchaser and the Servicer shall have received on or before the Closing Date the following, in form and substance satisfactory to the Purchaser and the Servicer:\n(a) With respect to the Seller:\n(i) the certificate or articles of incorporation of the Seller certified, as of a date no more than ten days prior to the Closing Date, by the Secretary of State of its state of incorporation;\n(ii) a Good Standing Certificate, dated no more than ten days prior to the Closing Date, from the respective Secretary of State of its state of incorporation and each state in which the Seller is required to qualify to do business;\n(iii) a certificate of the Secretary or Assistant Secretary of the Seller (on which certificate the Servicer and the Purchaser may conclusively rely until such time as the Servicer shall receive from the Seller a revised certificate meeting the requirements of this subsection) certifying as of the Closing Date: (A) the names and true signatures of the officers authorized on its behalf to sign this Agreement and the Related Documents, (B) a copy of the Seller's by-laws or code of regulations, and (C) a copy of the resolutions of the board of directors of the Seller approving this Agreement, the Related Documents and the transactions contemplated thereby;\n(iv) an Officer's Certificate in the form of Exhibit D hereto;\n(v) certified copies of Requests for Information or Copies (Form UCC-11) (or a similar search report certified by a party acceptable to the Purchaser), dated a date no more than ten days prior to the Closing Date listing all effective financing statements which name the Seller (under its present name and any previous name) as debtor, together with copies of such financing statements, and searches of applicable federal and state court and agency dockets and lien records showing all judgment liens affecting the Seller or the Eligible Receivables and tax liens; and\n(vi) Acknowledgment copies of proper financing statements (Form UCC-3), if any, necessary to release all security interests and other rights of any Person in Purchased\nReceivables previously granted by the Seller including, without limitation, all such releases specified by the Seller prior to the date hereof;\n(b) Consents required by, or of, any Person or Governmental Authority, if any, to the closing of the transactions contemplated hereby, in form and substance satisfactory to the Purchaser;\n(c) Acknowledgement copies of proper financing statements (Form UCC-1), duly filed, in respect of Purchased Receivables, naming (i) the Seller as the assignor and the Purchaser as the assignee or other, similar instruments or documents, as may be necessary or, in the opinion of the Purchaser or the Servicer, desirable under the UCC of all appropriate jurisdictions or any comparable law to perfect the Purchaser's ownership interests in all Purchased Receivables in which an interest may be assigned hereunder;\n(d) Fully executed copies of the Lockbox Account Agreement;\n(e) The favorable opinion of counsel to the Seller substantially in the form attached hereto as Exhibit E;\n(f) Such other approvals, opinions, documents and instruments, as the Purchaser or the Servicer may reasonably request; and\n(g) The Seller shall have paid such closing costs as have previously been agreed with the Purchaser.\nSECTION 3.02. Conditions Precedent to All Purchases. Each Purchase (including the initial Purchase) from the Seller by the Purchaser shall be subject to the further conditions precedent that:\n(a) On the related Purchase Date, the Seller shall have certified in the related Purchase Assignment that:\n(i) the representations and warranties of the Seller set forth in Sections 4.01 and 4.02 are true and correct on and as of such date, before and after giving effect to such Purchase and to the application of the proceeds therefrom, as though made on and as of such date;\n(ii) no event has occurred, or would result from such Purchase or from the application of the proceeds therefrom, which constitutes an Event of Seller Default or would constitute an Event of Seller Default, but for the requirement that notice be given or time elapse or both; and\n(iii) the Seller is in compliance with each of its covenants set forth herein;\n(b) The Termination Date shall not have occurred;\n(c) Each Receivable submitted by the Seller for purchase is an Eligible Receivable; and\n(d) The Seller shall have taken such other action, including delivery of approvals, opinions or documents to the Purchaser, as the Purchaser may reasonably request.\nARTICLE IV\nREPRESENTATIONS AND WARRANTIES OF THE SELLER\nSECTION 4.01. Representations and Warranties as to the Seller. The Seller (in its capacities as Seller and Subservicer hereunder) represents and warrants to the Purchaser and the Servicer, as of the date hereof and on each subsequent Purchase Date, as follows:\n(a) The Seller is a corporation duly organized, validly existing and in good standing under the laws of its state of incorporation and is duly qualified to do business, and is in good standing in each jurisdiction in which the nature of its business requires it to be so qualified;\n(b) The Seller has the power and authority to own and convey all of its properties and assets and to execute and deliver, this Agreement and the Related Documents and to perform the transactions contemplated hereby and thereby;\n(c) The execution, delivery and performance by the Seller of this Agreement and the Related Documents, and the transactions contemplated thereby, (i) have been duly authorized by all necessary corporate or other action on the part of the Seller, (ii) do not contravene or cause the Seller to be in default under (A) the Seller's certificate or articles of incorporation or by-laws or code of regulations, (B) any contractual restriction contained in any indenture, loan or credit agreement, lease, mortgage, security agreement, bond, note, or other agreement or instrument binding on or affecting the Seller or its property or (C) any law, rule, regulation, order, writ, judgment, award, injunction, or decree applicable to, binding on or affecting the Seller or its property and (iii) do not result in or require the creation of any Adverse Claim upon or with respect to any of the property of the Seller (other than in favor of the Purchaser as contemplated hereunder);\n(d) This Agreement and the Related Documents have each been duly executed and delivered on behalf of the Seller;\n(e) No consent of, or other action by, and no notice to or filing with, any Governmental Authority or any other party, is required for the due execution, delivery and performance by the Seller of this Agreement or any of the Related Documents or for the perfection of or the exercise by the Purchaser or the Servicer of any of their rights or remedies thereunder;\n(f) Each of this Agreement and each other Related Document is (or will be if not executed and delivered as of the date hereof) the legal, valid and binding obligation of the Seller enforceable against the Seller in accordance with its respective terms;\n(g) Except as disclosed by the Seller on Schedule 8 hereto, there is no pending or threatened action, suit or proceeding, of a material nature against or affecting the Seller, its officers or directors, or the property of the Seller, in any court or tribunal, or before any arbitrator of any kind or before or by any Governmental Authority (i) asserting the invalidity of this Agreement or any of the Related Documents, (ii) seeking to prevent the sale and assignment of any Receivable or the consummation of any of the transactions contemplated thereby, (iii) seeking any determination or ruling that might materially and adversely affect (A) the performance by the Seller or the Subservicer of its obligations under this Agreement or any of the Related Documents (B) the validity or enforceability of this Agreement or any of the Related Documents, (C) the Receivables or the Contracts or (D) the federal income tax attributes of the Purchases, or (iv) asserting a claim for payment of money in excess of $100,000 (other than such judgments or orders in respect of which adequate insurance is maintained by the Seller for the payment thereof);\n(h) No injunction, writ, restraining order or other order of any material nature adverse to the Seller or the conduct of its business or which is inconsistent with the due consummation of the transactions contemplated by this Agreement has been issued by a Governmental Authority;\n(i) The Seller has complied in all material respects with all applicable laws, rules, regulations, and orders with respect to it, its business and properties and all Receivables and related Contracts (including without limitation, all applicable environmental, health and safety requirements) and all restrictions contained in any indenture, loan or credit agreement, mortgage, security agreement, bond, note, or other agreement or instrument binding on or affecting the Seller or its property, and has and maintains all permits, licenses, authorizations, registrations, approvals and consents of Governmental Authorities, and all certificates of need for the construction or expansion of or investment in health care facilities, all Health Facility Licenses, Accreditations, Medicaid Certifications and Medicare Certifications necessary for the activities and business of the Seller and each of its Subsidiaries as currently conducted and as proposed to be conducted, the ownership, use, operation and maintenance by each of them of its properties,\nfacilities and assets and the performance by the Seller of this Agreement and the related Documents (hereinafter referred to collectively as 'Governmental Consents');\n(j) Without limiting the generality of the prior representation: (A) each Health Facility License, Medicaid Certification, Medicare Certification, Medicaid Provider Agreement, Medicare Provider Agreement and each of the Blue Cross\/Blue Shield Contracts of the Seller and each of its Subsidiaries is in full force and effect and has not been amended or otherwise modified, rescinded or revoked or assigned, (B) the Seller and each Subsidiary is in compliance with the requirements of Medicaid, Medicare, CHAMPUS and related programs, and the Blue Cross\/Blue Shield Contracts, and (C) no condition exists or event has occurred which, in itself or with the giving of notice or lapse of time or both, would result in the suspension, revocation, impairment, forfeiture, non-renewal of any Governmental Consent applicable to the Seller or any other health care facility owned or operated by the Seller or any of its Subsidiaries, or such facility's participation in any Medicaid, Medicare, CHAMPUS or other similar program, or of any Blue Cross\/Blue Shield Contracts and there is no claim that any such Governmental Consent, participation or contract is not in full force and effect;\n(k) The Seller has filed on a timely basis all tax returns (federal, state, and local) required to be filed and has paid or made adequate provisions for the payment of all taxes, assessments, and other governmental charges due from the Seller;\n(l) The primary business of the Seller is the provision of health care services and\/or equipment;\n(m) Except as set forth on Schedule 6, the Medicaid and Medicare cost reports of each facility and of the home office of each Seller have been examined and audited by (A) as to Medicaid, the state agency, or other HCFA-designated agents or agents of such state agency, charged with such responsibility or (B) as to Medicare, the Medicare intermediary or other HCFA-designated agents charged with such responsibility for the respective cost reporting periods set forth opposite each Seller's name;\n(n) All information heretofore or hereafter furnished by or on behalf of the Seller to the Servicer or the Purchaser in connection with this Agreement or any transaction contemplated hereby is and will be true and complete in all material respects and does not and will not omit to state a material fact necessary to make the statements contained therein not misleading;\n(o) With respect to the Seller or any of its Subsidiaries, there has occurred no event which has or is reasonably likely to have a material adverse effect on the Seller's financial condition, business or operations, including its ability to perform its obligations under this Agreement;\n(p) The Seller is solvent and will not become insolvent after giving effect to the transactions contemplated by this Agreement; the Seller has not incurred Debts beyond its ability to pay; the Seller, after giving effect to the transactions contemplated by this Agreement, will have an adequate amount of capital to conduct its business in the foreseeable future; and the sales of Purchased Receivables hereunder are made in good faith and without intent to hinder, delay or defraud present or future creditors of the Seller;\n(q) The Seller is licensed or otherwise has the lawful right to use all patents, trademarks, servicemarks, tradenames, copyrights, technology, know-how and processes used in or necessary for the conduct of its business as currently conducted which are material to its financial condition, business, operations, assets and prospects, individually or taken as a whole;\n(r) The consolidated balance sheet of Geriatric & Medical Companies, Inc. and its consolidated Subsidiaries as of February 28, 1994, and the related statements of income and shareholders' equity of Geriatric & Medical Companies, Inc. and its consolidated Subsidiaries for the nine month period then ended, prepared internally by Geriatric & Medical Companies, Inc., copies of which have been furnished to the Purchaser and Servicer, fairly present the consolidated financial condition, business and operations of Geriatric & Medical Companies, Inc. and its\nconsolidated Subsidiaries as at such date and the consolidated results of the operations of Geriatric & Medical Companies, Inc. and its consolidated Subsidiaries for the period ended on such date, all in accordance with generally accepted accounting principles consistently applied, and since February 28, 1994 there has been no material adverse change in any such condition, business or operations;\n(s) The Medicare Lockbox Account and the Commercial Lockbox Account are the only lockbox accounts maintained by the Seller;\n(t) The principal place of business and chief executive office of the Seller are located at the address of the Seller set forth under its signature below and there are now no, and during the past four months there have not been, any other locations where the Seller is located (as that term is used in the UCC) or keeps Records except as set forth in the designated space beneath its signature line in this Agreement;\n(u) The legal name of the Seller is as set forth at the beginning of this Agreement and except as set forth in the designated space beneath its signature line in this Agreement the Seller has not changed its name in the last six years, and during such period, the Seller did not use, nor does the Seller now use any tradenames, fictitious names, assumed names or 'doing business as' names;\n(v) No transaction contemplated by this Agreement requires compliance with any bulk sales act or similar law;\n(w) Each pension plan or profit sharing plan to which the Seller is a party has been fully funded in accordance with the obligations of the Seller set forth in such plan;\n(x) Each Payor of an Eligible Receivable has been directed, and is required to, remit all payments with respect to such Receivable for deposit in the Commercial Lockbox Account (other than the Payors of Medicaid, Medicare and CHAMPUS Receivables which has been directed to remit all payments with respect to such Receivables for deposit in the Medicare Lockbox Account);\n(y) The Receivables of the Seller have been and will continue to be adjusted to reflect reimbursement policies of the Payors with respect thereto; in particular, the Gross Receivable Amounts of Receivables relating to such Payors do not and shall not exceed the Net Value with respect thereto which amounts the Seller is entitled to receive under any capitation arrangement, fee schedule, discount formula, cost-based reimbursement, or other adjustment or limitation to the usual charges of the Seller;\n(z) No Payor of an Eligible Receivable being sold on any Purchase Date has any claim of a material nature against or affecting the Seller or the property of the Seller;\n(aa) The Seller has not done and shall not do anything to impede or interfere with the collection by the Purchaser of the Purchased Receivables and shall not amend, waive or otherwise permit or agree to any deviation from the terms or conditions of any Purchased Receivable or any related Contract;\n(bb) The Seller has made and will continue to make all payments to Payors necessary to prevent any Payor from offsetting any earlier overpayment to the Seller against any amounts such Payor owes on a Purchased Receivable;\n(cc) Each Purchase Notice contains a complete and accurate list of all Eligible Receivables of the Seller as of its date;\n(dd) For federal income tax reporting and accounting purposes, the Seller will treat the sale of each Purchased Receivable pursuant to this Agreement as a sale of, or absolute assignment of its full right, title and ownership interest in, such Purchased Receivable to the Purchaser and the Seller has not in any other manner accounted for or treated the transactions in Purchased Receivables by the Seller contemplated hereby;\n(ee) This Agreement and each Purchase Assignment constitute a valid transfer, assignment, set-over and conveyance to the Purchaser of all right, title and interest of the Seller in and to the Purchased Receivables now existing and hereafter created;\n(ff) The Seller has valid business reasons for selling its interests in the Purchased Receivables rather than obtaining a loan with the Purchased Receivables as collateral; and\n(gg) As of the date first above written, the Seller operates the facilities included on Schedule 3 hereto. The Seller is not doing business under any name other than those listed on Schedule 3 hereto. Further, one or more but no more than those names listed on Schedule 3 hereto are payees on the checks received from Eligible Payors under the respective provider numbers included on Schedule 2 hereto.\nSECTION 4.02. Representations and Warranties of the Seller as to Purchased Receivables. With respect to each Purchased Receivable sold pursuant to this Agreement (including, without limitation, claims which may be satisfied by set-off of any amounts due under any Receivable) the Seller (in its capacities as Seller and Subservicer hereunder) represents and warrants, as of the date hereof and on each subsequent Purchase Date, as follows:\n(a) Such Receivable is an Eligible Receivable;\n(b) The Required Information contained in the Purchase Notice is true and correct;\n(c) Such Receivable is not a Defaulted Receivable and has not become a Paid Receivable;\n(d) The Seller has submitted all necessary documentation and supplied all necessary information for payment of such Receivable to the Payor and has fulfilled all its other obligations, in respect thereof, including verification of the eligibility of the Receivable for payment by such Payor;\n(e) Neither the Receivable nor the related Contract has been satisfied, subordinated or rescinded, or except as disclosed in writing to the Purchaser, amended in any manner;\n(f) The Net Value of such Receivable is net of contractual allowances or other modifications and neither the Receivable nor the related Contract has or will be compromised, adjusted, extended, satisfied, subordinated, rescinded, set-off or modified by the Seller, and is not nor will be subject to compromise, adjustment, extension, satisfaction, subordination, rescission, set-off, counterclaim, defense or modification, whether arising out of transactions concerning the Contract or otherwise which would reduce the Net Value of such Receivable;\n(g) Such Receivable is an account receivable created through the provision of medically necessary services or merchandise supplied by the Seller in the ordinary course of its business and the sales prices of such services or merchandise were usual, customary and reasonable in the Seller's community for such services;\n(h) Such Receivable is an 'account' within the meaning of the UCC and is not evidenced by an 'instrument' within the meaning of the UCC;\n(i) Such Receivable has a Net Value which, when added to the Net Value of all other Receivables in such Payor Class and which constitute Purchased Receivables hereunder, does not exceed the Concentration Limit;\n(j) Such Receivable has a Billing Date (A) no earlier than 120 days from its Purchase Date, and (B) with respect to all Purchases following the initial Purchase, no later than 30 days after the Discharge Date of the patient to whom the health care services giving rise to the Receivable were rendered;\n(k) Such Receivable is denominated and payable in Dollars in the United States;\n(l) The related Contract is, and was at the time of the services giving rise to the Receivable, in full force and effect and constitutes the legal, valid and binding obligation of the Payor\nenforceable against such Payor in accordance with its terms, such Receivable was created in accordance with the requirements of the Contract and applicable law, including, without limitation, to the extent the Receivable is subject to limitations imposed by workers' compensation law or a related Contract and is entitled to be paid pursuant to the terms of the related Contract, and a copy of any related Contract to which the Seller is a party has been delivered to the Purchaser, the amount of the Eligible Receivable does not exceed the limitations so imposed, and each Receivable to which the fees are so restricted has been clearly identified as being subject to such restrictions;\n(m) Such Receivable is the primary liability of the applicable Payor;\n(n) Such Receivable is owned by the Seller free and clear of any Adverse Claim, and the Seller has the right to sell, assign and transfer the same and interests therein as contemplated under this Agreement and, subject to Medicaid Regulations, upon such sale, the Purchaser has acquired a valid ownership interest in such Receivable, free and clear of any Adverse Claim;\n(o) No consent from the Payor or any other Person shall be required to effect the sale of any Purchased Receivables;\n(p) The Payor of such Receivable has not been the Payor of any Defaulted Receivables in the past 12 months (other than, for the purpose of this clause, for good faith disputes);\n(q) There are no procedures or investigations pending or threatened before any Governmental Authority (i) asserting the invalidity of such Receivable or such Contract, (ii) asserting the bankruptcy or insolvency of the related Payor, (iii) seeking the payment of such Receivable or payment and performance of such Contract or (iv) seeking any determination or ruling that might materially and adversely affect the validity or enforceability of such Receivable or such Contract;\n(r) Neither such Receivable nor the related Contract contravenes in any material respect any laws, rules or regulations applicable thereto (including, without limitation, laws, rules and regulations relating to usury, consumer protection, truth in lending, fair credit billing, fair credit reporting, equal credit opportunity, fair debt collection practices and privacy) and no party to such related Contract is in violation of any such law, rule or regulation in any material respect;\n(s) Such Receivable complies with such additional criteria and requirements (other than those relating to the collectibility of such Receivables) as the Purchaser may from time to time specify to the Seller following 30 days' notice;\n(t) The Gross Receivable Amount of such Receivable is not in excess of $100,000; and\n(u) The Seller has no knowledge of any fact which should have led it to expect at the time of sale of such Receivable to the Purchaser that the Net Value of such Receivable would not be paid in full.\nThe Seller hereby agrees that the benefits of such representations and warranties of the Seller have been assigned to the Trustee for the benefit of the holders of the Notes. The parties acknowledge that some of the foregoing representations and warranties may have been made only to the best of the Seller's knowledge. Nevertheless, notwithstanding the Seller's lack of knowledge with respect to an inaccuracy of a representation and warranty, the parties agree that any such inaccuracy shall be deemed a breach of the applicable representation or warranty.\nSECTION 4.03. Repurchase Obligations. Upon discovery by any party hereto of a breach of any representation or warranty in this Article IV which materially and adversely affects the value of a Purchased Receivable or the interests of the Purchaser therein, the party discovering such breach shall give prompt written notice to the other parties hereto. Thereafter, upon notice from the Purchaser, the Seller shall (a) cure such breach within 15 days of the date of notice of such breach or (b) substitute one or more Eligible Receivables that are less than 40 days past the Discharge Date and have an aggregate Net Value of not less than that of each such Purchased Receivable. In the event the Seller\ndoes not take either of the actions specified in the foregoing sentence, no later than 15 days succeeding the date of such notice, the Seller shall repurchase such Receivable (each such Receivable, a 'Rejected Receivable') by remitting to the Purchaser the Net Value of such Receivable. Such amount shall be deemed to be Collections of such Rejected Receivable received and shall be deposited in the Collection Account. Any such repurchase shall be made without recourse to, or warranty, express or implied, of, the Purchaser or the Servicer. The Purchaser and the Servicer shall execute and deliver an assignment substantially in the form of Exhibit F hereto to vest ownership of such Rejected Receivable in the entity effecting such repurchase. It is understood and agreed that the obligation of the Seller to repurchase any Rejected Receivable pursuant to this Section 4.03 shall constitute the sole remedy for the breach of any representation or warranty in respect of such Receivable; provided, that the foregoing limitation shall not be construed to limit in any manner the Purchaser's right to (a) in the event the Seller fails to effect a repurchase as set forth hereinabove offset against any amounts it owes the Seller under this Agreement, the Net Value of such Rejected Receivable; or (b) declare the Termination Date to have occurred or to terminate the responsibilities of the Servicer hereunder to the extent that such breaches also constitute an Event of Seller Default. Except as set forth in this Section 4.03, the Seller shall have no right to repurchase any Purchased Receivable from the Purchaser.\nARTICLE V\nGENERAL COVENANTS OF THE SELLER\nSECTION 5.01. Affirmative Covenants of the Seller. The Seller shall, unless the Purchaser shall otherwise consent in writing:\n(a) Comply in all material respects with all applicable laws, rules, regulations and orders with respect to it, its business and properties and all Receivables, related Contracts and Collections with respect thereto;\n(b) Preserve and maintain its corporate existence, rights, franchises and privileges in the jurisdiction of its incorporation;\n(c) Continue to operate its business in the manner set forth in Section 4.01(a);\n(d) Cause to be delivered to the Purchaser on or before September 30 of each year commencing with September 30, 1994 (i) an Officer's Certificate of the Seller in the form of Exhibit D, dated the date of such delivery; and (ii) an opinion of counsel, in form and substance satisfactory to the Purchaser, reaffirming as of the date of its delivery of the opinion of counsel which the Seller delivered to the Purchaser and the Servicer on the Closing Date pursuant to Section 3.01(e);\n(e) Deposit all Collections received in respect of Medicaid, Medicare and CHAMPUS Receivables into the Medicare Lockbox Account within one Business Day of receipt; and\n(f) Make all payments to any Payors necessary to prevent the Payor from offsetting a prior overpayment to the Seller against any amount the Payor owes on a Purchased Receivable.\nSECTION 5.02. Reporting Requirements of the Seller. The Seller shall furnish, or cause to be furnished, to the Purchaser:\n(a) As soon as available and in any event within 45 days after the end of each of the first three quarters of its fiscal year a consolidated balance sheet of Geriatric & Medical Companies, Inc. and its consolidated Subsidiaries as of the end of such quarter, for the period commencing at the end of the previous fiscal year and ending with the end of such quarter, certified by the chief financial officer or chief accounting officer of Geriatric & Medical Companies, Inc.; (b) As soon as available and in any event within 120 days after the end of its fiscal year, a copy of the consolidated financial statements of Geriatric & Medical Companies, Inc. and its consolidated Subsidiaries as of the end of such year and the related consolidated statements of income and retained earnings, and of cash flow, of Geriatric & Medical Companies, Inc. and its consolidated\nSubsidiaries for such year, in each case reviewed by a nationally recognized firm of independent public accountants as is acceptable to the Purchaser and the Servicer;\n(c) Promptly after the sending or filing thereof, copies of all reports which the Seller files with any Governmental Authority as they relate to the Seller's Receivables or sends to any of its security holders and a copy of the annual report (if any) of the Seller;\n(d) As soon as possible and in any event within five days after the occurrence of an Event of Seller Default (including without limitation a material adverse change in the financial condition of the Seller as determined by the Servicer) or each event which, with the giving of notice or lapse of time or both, would constitute an Event of Seller Default, the statement of the chief executive officer of the Seller setting forth complete details of such Event of Seller Default and the action which the Seller has taken, is taking and proposes to take with respect thereto; and\n(e) Promptly, from time to time, such other information, documents, records or reports respecting the Receivables or the Contracts or the condition or operations, financial or otherwise, of the Seller, or the Seller or any of its Subsidiaries, if any, as the Purchaser may, from time to time, reasonably request.\nSECTION 5.03. Negative Covenants of the Seller. The Seller shall not, without the written consent of the Purchaser and the Servicer:\n(a) Sell, assign (by operation of law or otherwise) or otherwise dispose of, or create or suffer to exist any Adverse Claim upon or with respect to, any Eligible Receivable or related Contract with respect thereto, or, upon or with respect to the Lockbox Account, the Seller Credit Reserve Account, the Seller Credit Liquidity Account, the Collection Account, or any other account in which any Collections of any Receivable are deposited, or assign any right to receive income in respect of any Purchased Receivable;\n(b) Extend, amend or otherwise modify the terms of any Purchased Receivable, or amend, modify or waive any term or condition of any Contract related thereto or in any manner impede or interfere with the collection by the Subservicer, Servicer, Special Servicer or Purchaser of such Purchased Receivable;\n(c) Make any material change in the character of its business;\n(d) Make any change in its instructions to Payors regarding payments to be made to the Seller or payments to be deposited to the Lockbox Account;\n(e) To the extent it has a material adverse effect on its business, merge with or into or consolidate with or into, or convey, transfer, lease or otherwise dispose of all or substantially all of its assets (whether now owned or hereafter acquired), or acquire all or substantially all of the assets or capital stock or other ownership interest of, any Person;\n(f) Make any change to (i) the location of its chief executive office or the location of the office where Records are kept or (ii) its corporate name or use any tradenames, fictitious names, assumed names or 'doing business as' names; or\n(g) Prepare any financial statements which shall account for the transactions contemplated hereby in any manner other than as a sale of the Purchased Receivables by the Seller to the Purchaser, and will not in any other respect account for or treat the transactions contemplated hereby (including but not limited to, for accounting, tax and reporting purposes) in any manner other than as a sale of the Purchased Receivables by the Seller to the Purchaser. It is understood and agreed that the obligation of the Seller to comply with the covenants set forth in this Section 5.03 shall be subject to the Seller's obligation to comply with any order or directive of a Governmental Authority of competent jurisdiction and that compliance with such order or directive shall not constitute a breach of such covenant; provided, that the foregoing shall not be construed to limit in any manner the Purchaser's right to declare the Termination Date to have occurred to the extent that such noncompliance with such covenant (whether or not resulting from\nsuch an order or directive) shall constitute, or contribute to the determination of, an Event of Seller Default.\nARTICLE VI\nACCOUNTS ADMINISTRATION\nSECTION 6.01. Collection Account. The Purchaser and the Servicer acknowledge that certain amounts deposited in the Collection Account may relate to Receivables other than Purchased Receivables and that such amounts continue to be owned by the Seller. All such amounts shall be returned to the Seller in accordance with Section 6.03.\nSECTION 6.02. Determinations of the Servicer. On each Determination Date, the Servicer will determine:\n(a) the Net Value of Purchased Receivables, as of the prior Determination Date, as to which payments were received since such Determination Date (the 'Net Value Amount');\n(b) the Net Value of Purchased Receivables which became Defaulted Receivables since the prior Determination Date (the 'Defaulted Amount');\n(c) the amount of payments on Purchased Receivables received since the prior Determination Date (the 'Paid Receivables Amount');\n(d) the Net Value of the Purchased Receivables referred to in (c) above as of the current Determination Date;\n(e) the sum of (i)(a) plus (b) above minus (ii) (c) plus (d) above (but not less than zero) (the 'Credit Deficiency'); and\n(f) the amount of payments on Defaulted Receivables received since the prior Determination Date (the 'Defaulted Receivables Payments').\nThe Servicer's determinations of the foregoing amounts shall be conclusive in the absence of manifest error. The Servicer shall notify the Seller and the Purchaser of such determinations.\nSECTION 6.03. Distributions from Accounts. (a) No later than 11:00 a.m. on each Determination Date, following the determinations set forth in Section 6.02, the Servicer will notify the Trustee of such determinations and will cause the Trustee to withdraw in the following priority:\n(i) (A) the Paid Receivables Amount from the Collection Account; and (B) the Credit Deficiency, if any, from the Seller Credit Reserve Account; and deposit such amounts in the Purchase Account;\n(ii) Investment Income from the Collection Account, the Seller Credit Reserve Account and the Seller Liquidity Reserve Account and deposit it in the Equity Account;\n(iii) the amount of Defaulted Receivables Payments from the Collection Account and deposit it in the Seller Credit Reserve Account; and\n(iv) the remaining amount from the Collection Account and pay such amount by check to the Seller.\n(b) Until the Termination Date on each Purchase Date following the Purchase on such date, the Servicer shall cause the Trustee to withdraw (i) all amounts deposited hereunder (net of withdrawals required hereunder) from the Seller Credit Reserve Account in excess of the Specified Credit Reserve Balance and (ii) all amounts deposited hereunder (net of withdrawals required hereunder) from the Seller Liquidity Reserve Account in excess of the Specified Liquidity Reserve Balance and shall pay such amounts by check to the Seller.\n(c) To the extent that, on any Determination Date, all amounts deposited hereunder (net of withdrawals hereunder) from the Seller Credit Reserve Account by the Seller are less than the\nCredit Deficiency, the withdrawal contemplated by Section 6.03(a)(i) shall only be in amounts of such deposit and the balance of such withdrawal shall be made when next available; and the amount of any deficiency with respect thereto shall be deposited on the next Determination Date when an additional deposit is made in the Seller Credit Reserve Account in such amount by the Seller.\nSECTION 6.04. Allocation of Moneys following Termination Date.\n(a) Following the Termination Date, the Servicer shall cause the Trustee to the extent funds deposited hereunder (net of withdrawals required hereunder) are sufficient, to withdraw an amount equal to the Program Fee from the Seller Liquidity Reserve Account on each Purchase Date and deposit it in the Equity Account.\n(b) On the first Determination Date on which the aggregate Net Value of all Purchased Receivables (other than Defaulted Receivables) (i) is less than 10% of the aggregate Net Value of Purchased Receivables (other than Defaulted Receivables) on the Termination Date and (ii) is less than the aggregate amounts deposited hereunder (net of withdrawals required hereunder) and remaining in the Seller Credit Reserve Account and the Seller Liquidity Reserve Account, the Servicer shall cause the Trustee to withdraw an amount equal to such aggregate Net Value from such accounts and deposit it in the Purchase Account. Thereupon the Servicer shall cause the Trustee to disburse all remaining amounts held in the Collection Account, the Seller Credit Reserve Account and the Seller Liquidity Reserve Account to the Seller and all interests of the Purchaser in all Purchased Receivables owned by the Purchaser shall be reconveyed by the Purchaser to the Seller. Following such disbursement and reconveyance, this Agreement shall be deemed terminated.\nSECTION 6.05 Accounting. The Servicer shall make all determinations of actual and required amounts in each of the accounts established pursuant to this Agreement, maintain detailed accounting records of all deposits and withdrawals for each such account, including the Seller and the Receivables with respect to which such deposits and withdrawals were made and notify the Trustee as to such determinations.\nARTICLE VII APPOINTMENT OF THE SUBSERVICER, SPECIAL SERVICER, AND SUCCESSOR SERVICER\nSECTION 7.01. Appointment of the Subservicer. The Servicer and the Purchaser hereby appoint the Seller to act as Subservicer hereunder. The Subservicer shall service the Purchased Receivables and enforce the Purchaser's respective rights and interests in and under each Purchased Receivable and each related Contract and shall serve in such capacity until the termination of its responsibilities pursuant to Section 7.09, 7.11 or 8.01. The Subservicer hereby agrees to perform the duties and obligations with respect thereto set forth herein. The Purchaser hereby acknowledges and consents to the appointment of the Subservicer, provided, that (a) the Subservicer shall remain liable for the performance of the duties and obligations of the Subservicer and (b) the appointment of the Subservicer pursuant to this Agreement shall be deemed to be between the Servicer and the Subservicer alone and the Purchaser shall not be deemed to be a party thereto and shall have no duties or obligations with respect to the Subservicer. Notwithstanding any term or provision hereof to the contrary, the Seller, the Subservicer and the Purchaser hereby acknowledge and agree that the Servicer acts as agent hereunder for the Purchaser and has no duties or obligations to, will incur no liabilities or obligations to, and does not act as an agent in any capacity for, the Seller or the Subservicer.\nSECTION 7.02. Additional Subservicers. The Subservicer may, with the prior consent of the Purchaser and the Servicer, which consent shall not be unreasonably withheld, subcontract with a subservicer (each such servicer, an 'Additional Subservicer') for collection, servicing or administration of the Receivables, provided, that (a) the Subservicer shall continue to perform its obligations with respect to collections of Medicaid Receivables, Medicare Receivables and CHAMPUS Receivables, (b) the Subservicer shall remain liable for the performance of the duties and obligations of the Additional Subservicer pursuant to the terms hereof and (c) any subservicing agreement that may be entered into and any other transactions or services relating to the Purchased Receivables involving an Additional Subservicer (each such agreement, an 'Additional Subservicing Agreement') shall be deemed to be between the Additional Subservicer and the Subservicer alone and the Purchaser and Servicer shall not be deemed parties thereto and shall have no obligations, duties or liabilities with respect to the Additional Subservicer.\nSECTION 7.03. Duties and Responsibilities of the Subservicer.\n(a) The Subservicer shall conduct the servicing, administration and collection of the Purchased Receivables and shall take, or cause to be taken, all such actions as may be necessary or advisable to service, administer and collect each Purchased Receivable, from time to time, all in accordance with (i) customary and prudent servicing procedures for health care receivables of a similar type, and (ii) all applicable laws, rules and regulations.\n(b) The duties of the Subservicer shall include, without limitation:\n(i) preparation and submission of claims to, and post-billing liaison with, Eligible Payors;\n(ii) arranging for the direct remittance of all Collections on Purchased Receivables to the Commercial Lockbox Account (other than Collections with respect to Medicaid Receivables, Medicare Receivables and CHAMPUS Receivables, in respect of which it shall arrange for the direct remittance of such Collections to the Lockbox Account);\n(iii) remitting any Collections with respect to Medicaid Receivables, Medicare Receivables and CHAMPUS Receivables it may receive directly for deposit in the Medicare Lockbox Account and remitting any Collections on other Purchased Receivables it may receive directly for deposit in the Commercial Lockbox Account, in each case no later than\nby the end of the day of receipt or the following Business Day if the day of receipt is not a Business Day;\n(iv) maintaining all necessary Servicing Records with respect to the Purchased Receivables and promptly delivering such reports to the Purchaser or the Servicer in respect of the servicing of the Purchased Receivables (including information relating to its performance under this Agreement) as may be required hereunder or as the Purchaser or the Servicer may reasonably request;\n(v) maintaining and implementing administrative and operating procedures (including, without limitation, an ability to recreate Servicing Records evidencing the Purchased Receivables in the event of the destruction of the originals thereof) and keeping and maintaining all documents, books, records and other information reasonably necessary or advisable for the collection of the Purchased Receivables (including, without limitation, records adequate to permit the identification of each new Purchased Receivable and all Collections of and adjustments to each existing Purchased Receivable);\n(vi) identifying each Purchased Receivable clearly and unambiguously in its Servicing Records to reflect that such Purchased Receivable is owned by the Purchaser;\n(vii) complying in all material respects with all applicable laws, rules, regulations and orders with respect to it, its business and properties and all Purchased Receivables and related Contracts and Collections with respect thereto;\n(viii) preserving and maintaining its corporate existence, rights, franchises and privileges in the jurisdiction of its incorporation, and qualifying and remaining qualified in good standing as a foreign corporation and qualifying to and remaining authorized to perform obligations as Subservicer (including enforcement of collection of Purchased Receivables on behalf of the Purchaser) in each jurisdiction where the failure to preserve and maintain such existence, rights, franchises, privileges and qualification would materially adversely affect (A) the rights or interests of the Purchaser in the Purchased Receivables, (B) the collectibility of any Purchased Receivable or (C) the ability of the Subservicer to perform its obligations hereunder or under the Contracts;\n(ix) any time and from time to time at reasonable intervals upon notice to the Subservicer and during regular business hours, permitting the Purchaser, the Servicer or any of their agents or representatives, (A) to examine and make copies of and abstracts from all Servicing Records, and (B) to visit the offices and properties of the Subservicer for the purpose of examining such Servicing Records, and to discuss matters relating to the Receivables or the Subservicer's performance under this Agreement with any officer or employee of the Subservicer having knowledge of such matters;\n(x) at the request of the Servicer, maintaining at its own expense, a blanket fidelity bond with broad coverage, with responsible companies acceptable to the Servicer, on all officers, employees or other persons acting on behalf of the Subservicer in any capacity with regard to the Purchased Receivables, including those handling funds, money, documents and papers relating to the Purchased Receivables. Any such fidelity bond shall protect and insure the Subservicer (and through the Subservicer, the Servicer and the Purchaser) against losses commonly protected against by bonds of a similar type, including forgery, theft, embezzlement, fraud, and negligent acts of such persons and shall be maintained at a level acceptable to the Servicer. No provision of this Section requiring such fidelity bond shall diminish or relieve the Subservicer from its duties and obligations as set forth in this Agreement. Any amounts received under any such bond with respect to Purchased Receivables shall be deposited by the Subservicer in the Collection Account and treated in the same manner as Collections with respect to such Purchased Receivables. Upon request of the Purchaser or the Servicer, the Subservicer shall cause to be delivered to the Purchaser and the Servicer a certification evidencing coverage under such fidelity bond. Promptly upon\nreceipt of any notice from the surety or the insurer that such fidelity bond has been terminated or modified in a materially adverse manner, the Subservicer shall notify the Servicer of any such termination or modification;\n(xi) notifying the Purchaser and the Servicer of any action, suit, proceeding, dispute, offset, deduction, defense or counterclaim that is or may be asserted by a Payor with respect to any Purchased Receivable; and\n(xii) providing the Purchaser and the Servicer with a report on each Determination Date in the form of Exhibit G.\n(c) Notwithstanding anything herein to the contrary, all collection functions in respect of Medicaid Receivables, Medicare Receivables and CHAMPUS Receivables shall be performed in accordance with Medicaid Regulations, Medicare Regulations and CHAMPUS Regulations.\n(d) The Purchaser shall not have any obligation or liability with respect to any Purchased Receivables or related Contracts, nor shall it be obligated to perform any of the obligations of the Subservicer hereunder.\nSECTION 7.04. Authorization of the Servicer. The Seller hereby authorizes the Servicer (including any successors thereto) to take any and all reasonable steps in its name and on its behalf necessary or desirable and not inconsistent with the sale of the Purchased Receivables to the Purchaser, in the determination of the Servicer as the case may be, to collect all amounts due under any and all Purchased Receivables and, to the extent permitted under and in compliance with applicable law and regulations, to commence proceedings with respect to enforcing payment of such Purchased Receivables and the related Contracts, and adjusting, settling or compromising the account or payment thereof, to the same extent as the Seller could have done if it had continued to own such Receivable. The Seller shall furnish the Servicer (and any successors thereto) with any powers of attorney and other documents necessary or appropriate to enable the Servicer to carry out its servicing and administrative duties hereunder, and shall cooperate with the Servicer to the fullest extent in order to ensure the collectibility of the Purchased Receivables. Notwithstanding anything to the contrary contained herein, the Servicer shall have the absolute and unlimited right to direct the Subservicer to commence or settle any legal action to enforce collection of any Purchased Receivable or to foreclose upon, repossess or take any other action which the Servicer deems necessary or advisable with respect thereto. In no event shall the Subservicer be entitled to make the Purchaser, the Servicer or the Special Servicer a party to any litigation without such party's express prior written consent.\nSECTION 7.05. Subservicing Fee; Subservicing Expenses. Upon termination of this Agreement, the Subservicer shall be paid a Subservicing Fee by the Servicer in the amount of 5.25% of the highest Net Value of Purchased Receivables on any Purchase Date (including Receivables purchased on such Purchase Date) other than Defaulted Receivables; provided that, if the Seller ceases to be Subservicer hereunder prior to the Termination Date, the Subservicer shall be paid a pro rata amount of such Subservicing Fee based on the number of complete months elapsed from the Closing Date not to exceed 36 months. The Subservicer shall be required to pay for all expenses incurred by the Subservicer in connection with its activities hereunder (including any payments to accountants, counsel or any other Person) and shall not be entitled to any payment or reimbursement therefor.\nSECTION 7.06. Annual Statement as to Compliance. The Subservicer shall deliver to the Purchaser and the Servicer on or before September 30 of each year, beginning with September 30, 1994 an Officer's Certificate stating, as to each signer thereof, that (a) a review of the activities of the Subservicer during the preceding calendar year and of performance under this Agreement has been made under such officer's supervision; (b) to the best of such officer's knowledge, based on such review, the Subservicer has fulfilled all its obligations as Subservicer under this Agreement throughout such year, or, if there has been a default in the fulfillment of any such obligation, specifying each such default known to such officer and the nature and status thereof.\nSECTION 7.07. Transfer of Servicing Between Subservicer and Special Servicer.\n(a) The Subservicer shall inform the Servicer promptly of any event or condition that may constitute a Servicing Transfer Event. Upon determination that a Servicing Transfer Event has occurred with respect to any Purchased Receivable, the Servicer may and if Servicing Transfer Events with respect to Purchased Receivables with a Net Value greater than 10% of all outstanding Purchased Receivables have occurred, the Servicer shall, immediately give notice to the Subservicer that servicing of all Purchased Receivables as to which a Servicing Transfer Event has occurred will be transferred to the Special Servicer. Thereupon, the Special Servicer shall assume the servicing responsibilities of Subservicer in respect of such Purchased Receivables pursuant to the Special Servicing Agreement. The Subservicer shall thereupon provide the Special Servicer with all information, documents and records (including original copies of documents), to the extent required by the Special Servicer to perform its duties under the Special Servicing Agreement (including such records stored electronically on computer tapes, magnetic discs and the like as may be reasonably requested by the Special Servicer).\n(b) Notwithstanding the provisions of the preceding clause (a), the Subservicer shall maintain ongoing payment records with respect to each Purchased Receivable serviced by the Special Servicer.\n(c) The Subservicer shall pay all fees and costs of the Special Servicer in connection with its duties hereunder. SECTION 7.08. Subservicer Not to Resign. The Subservicer shall not resign from the obligations and duties hereby imposed on it except upon determination that (a) the performance of its duties hereunder has become impermissible under applicable law and (b) there is no reasonable action which the Subservicer could take to make the performance of its duties hereunder permissible under applicable law. Any such determination permitting the resignation of the Subservicer shall be evidenced as to clause (a) above by an opinion of counsel to such effect delivered to the Purchaser and the Servicer. No such resignation shall become effective until the Special Servicer shall have assumed the responsibilities and obligations of the Subservicer in accordance with Section 7.09.\nSECTION 7.09. Appointment of the Successor Subservicer. In connection with the termination of the Subservicer's responsibilities under this Agreement pursuant to Section 8.01, the Servicer may, in its discretion, (a) succeed to and assume all of the Subservicer's responsibilities, rights, duties and obligations as Servicer (but not in any other capacity) under this Agreement except with respect to Medicaid Receivables, Medicare Receivables and CHAMPUS Receivables (and except that the Servicer makes no representations and warranties pursuant to Section 7.05) or (b) require the Seller to continue to act as Subservicer for all of its outstanding Purchased Receivables at the time of the Event of Seller Default.\nSECTION 7.10. Authorization of the Special Servicer. Subject to the provisions of Section 2.01 hereof, in the event that the Servicer has appointed the Special Servicer as Subservicer with respect to specific Purchased Receivables pursuant to Section 7.07, the Seller hereby authorizes the Special Servicer (including any successors thereto) to take any and all reasonable steps in its name and on its behalf necessary or desirable and not inconsistent with the sale of such Purchased Receivables to the Purchaser, in the determination of the Special Servicer as the case may be, to collect all amounts due with respect to such Purchased Receivables, including, without limitation, endorsing any of their names on checks and other instruments representing Collections, executing and delivering any and all instruments of satisfaction or cancellation, or of partial or full release or discharge, and all other comparable instruments, with respect to such Purchased Receivables and, after the delinquency of such Purchased Receivables and to the extent permitted under and in compliance with applicable law and regulations, to commence proceedings with respect to enforcing payment of such Purchased Receivables and the related Contracts, and adjusting, settling or compromising the account or payment thereof, to the same extent as the Seller could have done if it had continued to own such Receivable. The Seller shall furnish the Special Servicer (and any successors thereto) with any powers of attorney and other documents necessary or appropriate to enable the Special Servicer to carry out its servicing and administrative duties hereunder, and shall cooperate with the Special Servicer to the fullest extent in order to ensure the collectibility of such Purchased Receivables.\nSECTION 7.11. Duties of the Subservicer to the Successor Servicer. At any time following the succession of the Servicer to the responsibilities of Subservicer under Section 7.09(a):\n(a) The Subservicer agrees that it will terminate its activities as Subservicer hereunder, except its collection functions in respect of Medicaid, Medicare and CHAMPUS Receivables, in a manner acceptable to the Servicer so as to facilitate the transfer of servicing to the Servicer including, without limitation, timely delivery (i) to the Servicer of any funds that were required to be remitted to the Servicer for deposit in the Collection Account, and (ii) to the Servicer, at a place selected by the Servicer, of all information, documents and records (including original copies of documents), to the extent required by the Servicer to perform its duties under the Agreement (including such records stored electronically on computer tapes, magnetic discs and the like as may be reasonably requested by the Servicer). The Subservicer shall account for all funds and shall execute and deliver such instruments and do such other things as may reasonably be required to more fully and definitely vest and confirm in the Servicer all rights, powers, duties, responsibilities, obligations and liabilities of the Subservicer.\n(b) The Subservicer shall terminate each Additional Subservicing Agreement that may have been entered into and the Servicer shall not be deemed to have assumed any of the Subservicer's interest therein or to have replaced the Subservicer as a party to any such Additional Sub-Servicing Agreement.\n(c) Notwithstanding any termination of the Seller as Subservicer hereunder, the Seller agrees that it will continue to follow the procedures set forth in Section 7.03(b)(iii) with respect to Collections on Purchased Receivables.\nSECTION 7.12. Effect of Termination or Resignation. Any termination or resignation of the Subservicer under this Agreement shall not affect any claims that the Purchaser or the Servicer may have against the Subservicer for events or actions taken or not taken by the Subservicer arising prior to any such termination or resignation.\nARTICLE VIII\nEVENTS OF SELLER DEFAULT\nSECTION 8.01. Events of Seller Default. If any of the following events (each, an 'Event of Seller Default') shall occur and be continuing:\n(a) The Seller (either as Seller or Subservicer) shall materially fail to perform or observe any term, covenant or agreement contained in this Agreement;\n(b) A default shall have occurred and be continuing under any instrument or agreement evidencing, securing or providing for the issuance of Debt of the Seller resulting in a demand or call (automatic or otherwise) for the satisfaction of such Debt;\n(c) The Seller shall generally not pay any of its respective Debts as such Debts become due, or shall admit in writing its inability to pay its Debts generally, or shall make a general assignment for the benefit of creditors; or any proceeding shall be instituted by or against the Seller seeking to adjudicate it a bankrupt or insolvent, or seeking liquidation, winding up, reorganization, arrangement, adjustment, protection, relief, or composition of it or any of its Debts under any law relating to bankruptcy, insolvency or reorganization or relief of debtors, or seeking the entry of an order for relief or the appointment of a receiver, trustee, custodian or other similar official for it or for any substantial part of its property, or any of the actions sought in such proceeding (including, without limitation, the entry of an order for relief against, or the appointment of a receiver, trustee, custodian or other similar official for, it or for any substantial part of its property) shall occur; or the Seller shall take any corporate action to authorize any of the actions set forth in this subsection;\n(d) Judgments or orders for the payment of money (other than such judgments or orders in respect of which adequate insurance is maintained for the payment thereof) in excess of $100,000 in the aggregate against the Seller or any of its Affiliates shall remain unpaid, unstayed on appeal, undischarged, unbonded or undismissed for a period of 30 days or more;\n(e) There is a material breach of any of the representations and warranties of the Seller set forth in Sections 4.01 or 4.02 that has remained uncured for a period of 30 days;\n(f) Any Governmental Authority shall file notice of a lien with regard to any of the assets of the Seller or with regard to the Seller other than a lien that does not materially adversely affect the financial condition of the Seller or the Seller's ability to perform as Subservicer and that (1) is limited by its terms to assets other than Receivables or (2) remains undischarged for a period of 30 days;\n(g) As of the first day of any month, the aggregate Net Values of Purchased Receivables which became Defaulted Receivables (net of recoveries with respect thereto) or Rejected Receivables (other than those with respect to which a withdrawal has previously been made from the Seller Liquidity Reserve Account) during the prior three-month period shall exceed 5% of the average aggregate Net Values of all Purchased Receivables then owned by the Purchaser (other than Defaulted Receivables) at the end of each of such three months;\n(h) The Servicer shall have reasonably determined that any event which materially adversely affects the collectibility of the Receivables has occurred, or that any other event which materially adversely affects the financial condition of the Seller, the ability of the Seller to collect Receivables in its capacity as Subservicer or the ability of the Seller (either as Seller or Subservicer) to perform hereunder has occurred;\n(i) A deterioration has taken place in the quality of servicing of Purchased Receivables or other Receivables serviced by the Seller (in its capacity as Subservicer) which the Servicer, in its sole discretion, determines to be material;\n(j) This Agreement shall for any reason cease to evidence the transfer to the Purchaser (or its assignees or transferees) of the legal and equitable title to, and ownership of, the Purchased Receivables;\n(k) The Lockbox Account Agreement shall have been amended or terminated without the written consent of the Purchaser and the Servicer;\n(l) The amount deposited hereunder (net of withdrawals required hereunder) in the Seller Credit Reserve Account has remained at less than the Specified Credit Reserve Balance for more than 30 days;\n(m) The amount deposited hereunder (net of withdrawals required hereunder) in the Seller Liquidity Reserve Account has remained at less than the Specified Liquidity Reserve Balance for more than 30 days; or\n(n) A Principal Amortization Event shall have been declared by the Trustee; then and in any such event, the Servicer shall, by notice to the Seller and the Purchaser declare that an Event of Seller Default shall have occurred and, the Termination Date shall forthwith occur, without demand, protest or further notice of any kind, all of which are hereby expressly waived by the Seller and the Purchaser shall make no further Purchases from the Seller. Upon any such declaration or automatic occurrence, the Purchaser and the Servicer shall have, in addition to all other rights and remedies under this Agreement, all other rights and remedies provided under the UCC and other applicable law, which rights shall be cumulative.\nARTICLE IX INDEMNIFICATION\nSECTION 9.01. Indemnities by the Seller. (a) Without limiting any other rights that the Purchaser, the Servicer, or any director, officer, employee or agent of either such party (each an 'Indemnified Party') may have hereunder or under applicable law, the Seller hereby agrees to indemnify each Indemnified Party from and against any and all claims, losses, liabilities, obligations, damages, penalties, actions, judgments, suits, and related costs and expenses of any nature whatsoever, including reasonable attorneys' fees and disbursements (all of the foregoing being collectively referred to as 'Indemnified Amounts') which may be imposed on, incurred by or asserted against an Indemnified Party in any way arising out of or relating to any breach of the Seller's obligations (including its obligations as Subservicer) under this Agreement or the ownership of the Purchased Receivables or in respect of any Receivable or any Contract, excluding, however, (i) Indemnified Amounts to the extent resulting from gross negligence or willful misconduct on the part of such Indemnified Party or (ii) recourse for unpaid Purchased Receivables. Without limiting or being limited by the foregoing, the Seller shall pay on demand to each Indemnified Party any and all amounts necessary to indemnify such Indemnified Party from and against any and all Indemnified Amounts relating to or resulting from:\n(A) reliance on any representation or warranty made or deemed made by the Seller (or any of its officers) under or in connection with this Agreement (except with respect to a Purchased Receivable, as to which the Purchaser's remedies are set forth in Section 4.03), any report or any other information delivered by the Seller pursuant hereto, which shall have been incorrect in any material respect when made or deemed made or delivered;\n(B) the failure by the Seller to comply with any term, provision or covenant contained in this Agreement, or any agreement executed by it in connection with this Agreement or with any applicable law, rule or regulation with respect to any Purchased Receivable, the related Contract, or the nonconformity of any Purchased Receivable or the related Contract with any such applicable law, rule or regulation; or\n(C) the failure to vest and maintain vested in the Purchaser, or to transfer to the Purchaser, legal and equitable title to and ownership of the Receivables which are, or are purported to be, Purchased Receivables, together with all Collections in respect thereof, free and clear of any Adverse Claim (except as permitted hereunder) whether existing at the time of the Purchase of such Receivable or at any time thereafter.\n(b) Any Indemnified Amounts subject to the indemnification provisions of this Section shall be paid to the Indemnified Party within five Business Days following demand therefor, together with interest at the lesser of 12% per annum or the highest rate permitted by law from the date of demand for such Indemnified Amount.\nARTICLE X MISCELLANEOUS\nSECTION 10.01. Notices, Etc. All notices and other communications provided for hereunder shall, unless otherwise stated herein, shall be in writing and mailed or telecommunicated, or delivered as to each party hereto, at its address set forth under its name on the signature pages hereof or at such other address as shall be designated by such party in a written notice to the other parties hereto. All such notices and communications shall not be effective until received by the party to whom such notice or communication is addressed.\nSECTION 10.02. Remedies. No failure on the part of the Purchaser or the Servicer to exercise, and no delay in exercising, any right hereunder or under any Purchase Assignment shall operate as a waiver thereof; nor shall any single or partial exercise of any right hereunder preclude any other or\nfurther exercise thereof or the exercise of any other right. The remedies herein provided are cumulative and not exclusive of any remedies provided by law.\nSECTION 10.03. Binding Effect; Assignability. This Agreement shall be binding upon and inure to the benefit of the Seller, the Subservicer, the Purchaser, the Servicer and their respective successors and permitted assigns. Neither the Seller nor the Subservicer may assign any of their rights and obligations hereunder or any interest herein without the prior written consent of the Purchaser and the Servicer. The Purchaser may, at any time, without the consent of the Seller or the Subservicer, assign any of its rights and obligations hereunder or interest herein to any Person. Any such assignee may further assign at any time its rights and obligations hereunder or interests herein without the consent of the Seller or the Subservicer. Without limiting the generality of the foregoing, the Seller acknowledges that the Purchaser has assigned its rights hereunder to the Trustee for the benefit of the holders of the Notes. This Agreement shall create and constitute the continuing obligations of the parties hereto in accordance with its terms, and shall remain in full force and effect until its termination; provided, that the rights and remedies with respect to any breach of any representation and warranty made by the Seller or the Servicer pursuant to Article IV and the indemnification and payment provisions of Article IX shall be continuing and shall survive any termination of this Agreement.\nSECTION 10.04. Costs, Expenses and Taxes. (a) In addition to the rights of indemnification under Article IX, the Seller agrees to pay upon demand, all reasonable costs and expenses in connection with the adminstration (including periodic auditing, modification and amendment) of this Agreement, and the other documents to be delivered hereunder, including, without limitation: (i) the reasonable fees and out-of-pocket expenses of counsel for the Purchaser or the Servicer with respect to (A) advising the Purchaser as to its rights and remedies under this Agreement or (B) the enforcement (whether through negotiations, legal proceedings or otherwise) of this Agreement, the Purchase Assignment or the other documents to be delivered hereunder; and (ii) any and all stamp, sales, excise and other taxes and fees payable or determined to be payable in connection with the execution, delivery, filing or recording of this Agreement, each Purchase Assignment or the other agreements and documents to be delivered hereunder, and agrees to indemnify and save each Indemnified Party from and against any and all liabilities with respect to or resulting from any delay in paying or omission to pay such taxes and fees.\n(b) If the Seller or the Subservicer fails to perform any agreement or obligation contained herein, the Purchaser may, or may direct the Servicer to, (but shall not be required to) itself perform, or cause performance of, such agreement or obligation, and the expenses of the Purchaser or the Servicer incurred in connection therewith shall be payable by the party which has failed to so perform upon the Purchaser's or the Servicer's demand therefor.\nSECTION 10.05. No Proceedings. The Seller and the Subservicer each hereby agree that it will not, directly or indirectly, institute, or cause to be instituted, against the Purchaser any proceeding of the type referred to in Section 8.01(c) so long as there shall not have elapsed one year plus one day since the latest maturing Note has been paid in full in cash. SECTION 10.06. Amendments; Waivers; Consents. No modification, amendment or waiver of, or with respect to, any provision of this Agreement, and all other agreements, instruments and documents delivered pursuant hereto or thereto, nor consent to any departure by the Seller or the Subservicer from any of the terms or conditions thereof, shall be effective unless it shall be in writing and signed by each of the parties hereto. Any waiver or consent shall be effective only in the specific instance and for the purpose for which given. No consent to or demand on the Seller or the Subservicer in any case shall, in itself, entitle it to any other consent or further notice or demand in similar or other circumstances. This Agreement, the Related Documents and the documents referred to therein embody the entire agreement among the Seller, the Subservicer, the Purchaser and the Servicer, and supersede all prior agreements and understandings relating to the subject hereof, whether written or oral.\nSECTION 10.07. GOVERNING LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL. (a) THIS AGREEMENT SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE INTERNAL LAWS (AS OPPOSED TO CONFLICT OF LAWS\nPROVISIONS) OF THE STATE OF OHIO, EXCEPT TO THE EXTENT THAT THE VALIDITY OR PERFECTION OF THE INTERESTS OF THE PURCHASER IN THE PURCHASED RECEIVABLES OR REMEDIES HEREUNDER OR THEREUNDER, IN RESPECT THEREOF, ARE GOVERNED BY THE LAWS OF A JURISDICTION OTHER THAN THE STATE OF OHIO.\n(b) THE SELLER AND THE SUBSERVICER HEREBY SUBMIT TO THE NON-EXCLUSIVE JURISDICTION OF THE COURTS OF THE STATE OF OHIO AND THE UNITED STATES DISTRICT COURT LOCATED IN THE SOUTHERN DISTRICT OF OHIO, AND EACH WAIVES PERSONAL SERVICE OF ANY AND ALL PROCESS UPON IT AND CONSENTS THAT ALL SUCH SERVICE OF PROCESS BE MADE BY REGISTERED MAIL DIRECTED TO THE ADDRESS SET FORTH ON THE SIGNATURE PAGE HEREOF AND SERVICE SO MADE SHALL BE DEEMED TO BE COMPLETED FIVE DAYS AFTER THE SAME SHALL HAVE BEEN DEPOSITED IN THE U.S. MAILS, POSTAGE PREPAID. THE SELLER, AND THE SUBSERVICER EACH HEREBY WAIVES ANY OBJECTION BASED ON FORUM NON CONVENIENS, AND ANY OBJECTION TO VENUE OF ANY ACTION INSTITUTED HEREUNDER AND CONSENTS TO THE GRANTING OF SUCH LEGAL OR EQUITABLE RELIEF AS IS DEEMED APPROPRIATE BY THE COURT. NOTHING IN THIS SECTION SHALL AFFECT THE RIGHT OF THE PURCHASER TO SERVE LEGAL PROCESS IN ANY OTHER MANNER PERMITTED BY LAW OR AFFECT THE RIGHT OF THE PURCHASER TO BRING ANY ACTION OR PROCEEDING AGAINST THE SELLER OR ITS PROPERTY, OR THE SUBSERVICER OR ITS PROPERTY IN THE COURTS OF ANY OTHER JURISDICTION.\n(c) THE SELLER, AND THE SUBSERVICER EACH HEREBY WAIVES ANY RIGHT TO HAVE A JURY PARTICIPATE IN RESOLVING ANY DISPUTE, WHETHER SOUNDING IN CONTRACT, TORT, OR OTHERWISE ARISING OUT OF, CONNECTED WITH, RELATED TO, OR IN CONNECTION WITH THIS PURCHASER AGREEMENT. INSTEAD, ANY DISPUTE RESOLVED IN COURT WILL BE RESOLVED IN A BENCH TRIAL WITHOUT A JURY.\nSECTION 10.08. Execution in Counterparts; Severability. This Agreement may be executed in any number of counterparts, each of which when so executed shall be deemed to be an original and all of which when taken together shall constitute one and the same agreement. In case any provision in or obligation under this Agreement shall be invalid, illegal or unenforceable in any jurisdiction, the validity, legality and enforceability of the remaining provisions or obligations, or of such provision or obligation in any other jurisdiction, shall not in any way be affected or impaired thereby.\nIN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their respective officers thereunto duly authorized, as of the date first above written.\nBURLINGTON WOODS CONVALESCENT CENTER, INC., as Seller and as Subservicer By _____________________________________________ Name: James J. O'Malley Title: Vice President Address at which the chief executive office is located: Address: 5601 Chestnut Street Philadelphia, PA 19139 Attention: Arthur A. Carr, Jr. Phone number: (215) 476-2250 Telecopier number: (215) 748-8118 Additional locations at which Records are maintained: ________________________________________________ ________________________________________________ ________________________________________________\nAdditional names under which, and locations at which, Seller does business: 115 Sunset Road Burlington, NJ 08016 CRESTVIEW CONVALESCENT HOME, INC., as Seller and as Subservicer By______________________________________________ Name: James J. O'Malley Title: Vice President\nAddress at which the chief executive office is located: Address: 5601 Chestnut Street Philadelphia, PA 19139 Attention: Arthur A. Carr, Jr. Phone number: (215) 476-2250 Telecopier number:(215) 748-8118\nAdditional locations at which Records are maintained: ________________________________________________ ________________________________________________ ________________________________________________\nAdditional names under which, and locations at which, Seller does business: Crestview Wyncote Convalescent Center Church Road Wyncote, PA 19095 CRESTVIEW NORTH, INC., as Seller and as Subservicer By _____________________________________________ Name: James J. O'Malley Title:Vice President Address at which the chief executive office is located: Address: 5601 Chestnut Street Philadelphia, PA 19139 Attention: Arthur A. Carr, Jr. Phone number: (215) 476-2250 Telecopier number: (215) 748-8118 Additional locations at which Records are maintained: ________________________________________________ ________________________________________________ ________________________________________________\nAdditional names under which, and locations at which, Seller does business: Crestview North Nursing and Rehabilitation Center 202 Toll Gate Road Langhorne, PA 19047 GERIATRIC AND MEDICAL SERVICES, INC. (NJ), as Seller and as Subservicer By______________________________________________\nName: James J. O'Malley Title: Vice President Address at which the chief executive office is located: Address: 5601 Chestnut Street Philadelphia, PA 19139 Attention: Arthur A. Carr, Jr. Phone number: (215) 476-2250 Telecopier number:(215) 748-8118 Additional locations at which Records are maintained: ________________________________________________ ________________________________________________ ________________________________________________\nAdditional names under which, and locations at which, Seller does business: Cooper River East Convalescent Center 5101 North Park Drive Pennsauken, NJ 08109 Cooper River West Convalescent Center 5101 North Park Drive Pennsauken, NJ 08109 Care Center of Lopatcong Red School Lane & Coventry Drive Phillipsburg, NJ 08865 Care Center of Phillipsburg 843 Wilbur Avenue Phillipsburg, NJ 08865 Lacey Nursing and Rehabilitation Center 916 Lacey Road Forked River, NJ 08731 GERIATRIC AND MEDICAL SERVICES, INC. (PA), as Seller and as Subservicer By _____________________________________________ Name: James J. O'Malley Title:Vice President Address at which the chief executive office is located: Address: 5601 Chestnut Street Philadelphia, PA 19139 Attention: Arthur A. Carr, Jr. Phone number: (215) 476-2250 Telecopier number: (215) 748-8118 Additional locations at which Records are maintained: ________________________________________________ ________________________________________________ ________________________________________________\nAdditional names under which, and locations at which, Seller does business:\nBrandywine Hall Care Center 800 West Miner Street West Chester, PA 19382 Fairview Care Center of Paper Mill Road 850 Paper Mill Road Philadelphia, PA 19118 Mayo Nursing and Convalescent Center 650 Edison Avenue Philadelphia, PA 19116 Silver Stream Nursing and Rehabilitation Center 905 Penllyn Pike Spring House, PA 19477 Fairview Care Center of Bethlehem Pike 184 Bethlehem Pike Philadelphia, PA 19118 Rittenhouse Care Center 1526 Lombard Street Philadelphia, PA 19146 Hamilton Arms Nursing & Rehabilitation Center 336 West End Avenue Lancaster, PA 17603 NPF III, INC. By _____________________________________________ Name: Donald H. Ayers Title: Chairman Address: 6125 Memorial Drive Dublin, OH 43017 Attention: Donald H. Ayers Phone number: (614) 764-9944 Telecopier number: (614) 764-0602 NATIONAL PREMIER FINANCIAL SERVICES, INC. By _____________________________________________ Name: Donald H. Ayers Title: Vice President Address: 6125 Memorial Drive Dublin, OH 43017 Attention: Lance K. Poulsen Phone number: (614) 764-9944 Telecopier number: (614) 764-0602","section_15":""}
{"filename":"26938_1994.txt","cik":"26938","year":"1994","section_1":"Item 1. Business Dart Group Corporation (the \"Corporation\") operates retail discount auto parts stores through Trak Auto Corporation (\"Trak Auto\"), retail discount book stores through Crown Books Corporation (\"Crown Books\"), retail discount grocery stores through Shoppers Food Warehouse Corp. (\"Shoppers Food\"), retail discount beverage stores through Total Beverage Corporation (\"Total Beverage\"), a real estate company through Cabot-Morgan Real Estate Company (\"CMREC\"), and a financial business which purchases bankers' acceptances through Dart Group Financial Corporation (\"Dart Financial\"). The Corporation, Trak Auto, Crown Books, Shoppers Food, Total Beverage, CMREC, Dart Financial and the Corporation's other direct and indirect wholly-owned and majority-owned subsidiaries and majority owned partnerships are referred to collectively as the \"Company\". The Corporation owns 65% of the common stock of Trak Auto, 51% of the common stock of Crown Books, in excess of 50% of the common stock of Shoppers Food, 100% of the common stock of Total Beverage, 100% of the common stock of CMREC and 100% of the common stock of Dart Financial. The common stock of Trak Auto and Crown Books is traded on the National Association of Securities Dealers Automated Quotations Systems (\"NASDAQ\") national market under the symbols TRKA and CRWN, respectively.\nOn January 31, 1994, there were 314 Trak Auto, 240 Crown Books, and 35 Shoppers Food stores; CMREC owned a 75% interest in two real estate partnerships which own and operate two shopping centers and 51% of three real estate partnerships which own and operate two shopping centers and an office building; and there were three Total Beverage stores. On such date, Dart Financial owned approximately $62,307,000 of bankers' acceptances.\nTrak Auto Operations\nTrak Auto operates retail discount specialty stores in the Washington, D.C., Richmond, Virginia, Chicago, Illinois and Los Angeles, California metropolitan areas.\nTrak Auto is engaged in the retail sale of a wide range of automobile parts and accessories for the do-it-yourself market. Trak Auto products include \"hard parts\" (such as alternators, starters, shock absorbers, fan belts, spark plugs, mufflers, thermostats, and wheel bearings), as well as motor oil, oil filters, headlights, batteries, waxes, polishes, car stereos, anti-freeze and windshield wipers. A typical store normally carries 10,000 different item numbers or SKU's. Trak Auto does not sell tires and does not provide automotive service or installation.\nDuring the year ended January 30, 1993, Trak Auto organized Super Trak Corporation. Super Trak was organized as a Delaware corporation to operate retail auto part stores and is a wholly-owned subsidiary of Trak Auto. Super Trak stores are similar to the Trak Auto stores described above, however, the stores provide additional services and merchandise. Super Trak stores carry approximately 5,000 more SKU's, concentrated primarily in application parts categories. Additionally, the stores feature special order services permitting customers access to virtually any automotive part, including engines. The stores also offer extensive technical assistance through computerized parts look-up, instruction for repairs, free use of specialized tools, and factory trained parts people. Trak Auto is planning a conversion to the Super Trak concept through the opening of new stores and the conversion, relocation and expansion of its existing stores.\nTrak Operations (Continued)\nTrak Auto's merchandise is generally purchased directly from a large number of manufacturers and suppliers. Trak Auto's distribution system is computerized utilizing an automated replenishment and perpetual inventory system to generate shipments of product from distribution centers in Landover, Md., Bridgeview, Ill. and Ontario, California. The required items are generally assembled and packaged for delivery in the order in which they will be unpacked and displayed on the shelves at the retail stores, promoting store efficiency. Inventories are monitored both at stores and in the distribution centers to determine purchase requirements. Trak Auto has a computerized point of sale (\"POS\") register system in every store. Trak Auto uses scanners to identify most merchandise at the register and uses a price look-up function to price the sale. Most merchandise is pre-labeled with bar codes by the manufacturers.\nTrak Auto's merchandising philosophy is to develop strong consumer recognition and acceptance of its name by use of mass-media advertising to promote a broad selection of products at low prices. Trak Auto emphasizes quality customer service through knowledgeable personnel and advanced technology such as electronic parts look-up, POS and computerized do-it-yourself aids.\nTrak Auto stores are approximately 5,000 to 6,000 square feet and Super Trak stores range from 6,000 to 11,000 square feet. Trak Auto's stores use modern fixtures and equipment and the interiors have been standardized, so that the interiors of new stores can be assembled quickly. The stores are open seven days a week.\nThe following table indicates Trak Auto's store locations and the number of stores opened, closed and remodeled for the last five years.\nTrak Auto Operations (continued)\nTrak Auto had 15 stores substantially damaged or completely destroyed in the Los Angeles civil disturbances at the end of the first fiscal quarter of 1993. Eleven of these stores have subsequently reopened and four stores remain closed. The Los Angeles earthquake in January of 1994 damaged two Trak Auto stores and one Super Trak resulting in their closing. The Super Trak reopened shortly after year-end while the two Trak Auto stores remain closed.\nTrak Auto has closed certain stores in various markets. At January 29, 1994, Trak Auto had an accrual for closed stores of approximately $1,000,000 which represents estimated unrecoverable lease costs (net of sublease), the remaining book value of leasehold improvements and certain other costs. The net charge (income) was $(943,000), $500,000, and $3,162,000 during fiscal 1994, 1993, and 1992, respectively. Income during the year ended January 29, 1994 was the result of early lease terminations, net of cash buyouts. Trak Auto continually reviews store operations and expects to close additional underperforming stores in the future.\nA restructuring charge of $7,400,000 was recorded in 1993 for the anticipated costs associated with closing, relocating, expanding and converting existing stores to the new Super Trak concept. During the year ended January 29, 1994, approximately $600,000 was charged to this reserve. No store contributed more than 1.0% to Trak Auto's consolidated sales during the year ended January 29, 1994.\nCrown Books Operations Crown Books operates specialty retail book stores offering popular hardback books, paperbacks and magazines below the publishers' suggested retail prices.\nCrown Books responds to the demand for books at prices below the publishers' suggested retail prices and at the same time provides quality service to its customers. Crown Books sells hardbacks on The New York Times best seller list at 40% below the publishers' suggested retail prices, paperbacks on The New York Times best seller list at 25% below the publishers' suggested retail prices, other new books at 10% to 25% below the publishers' suggested retail prices, and magazines at 10% below the publishers' suggested retail prices. Crown Books sells publishers' over-stock, reprints and former best sellers at significant discounts from the publishers' original suggested retail prices. In addition, Crown Books allows customers at all stores to special order books not stocked in inventory at discount pricing. This merchandise is generally purchased directly from a large number of publishers and suppliers and Crown Books is not dependent on any single publisher or supplier.\nCrown Books advertises intensively, primarily through newspapers, seasonal radio and television and direct mail, stressing its pricing policy. Crown Books satisfies regional and local consumer preferences by tailoring the selections and quantities of books that it makes available in individual stores. Crown Books clusters its stores in selected market areas to maximize the efficiency of advertising, publicity, management and distribution. Within those areas, Crown Books generally locates its stores in convenient strip shopping centers and urban street locations. These locations typically may be rented at more favorable rates than locations in large enclosed malls and provide for increased consumer awareness and convenience of the store locations.\nCrown Books Operations (continued)\nAll major merchandising decisions concerning pricing, advertising and promotional campaigns, as well as the initial ordering of inventory for each store, are managed centrally at Crown Books' headquarters in Landover, Maryland. Over 80% of the merchandise is shipped directly from publishers to the stores. Best sellers and other hardback books which are purchased in large quantities are often shipped directly from the publishers to Crown Books' regional warehouses for distribution to the stores. Inventories are monitored both at stores and in the central office in Landover, Maryland, to determine purchase requirements. In general, unsold books and magazines can be returned to the publishers for credit.\nDuring the year ended January 31, 1990, Crown Books organized Super Crown Books Corporation (\"Super Crown Books\"). Super Crown Books was organized as a Delaware corporation to operate retail book superstores and is a wholly-owned subsidiary of Crown Books. The first Super Crown Books store opened in May of 1990 and Crown Books has been expanding the Super Crown concept since. The stores carry as many as 70,000 titles, nearly seven times the number of titles as a classic Crown Books store. Super Crown Books stores provide enhanced service as well as value to its customers, wider aisles, a children's play area, and benches and chairs to sit and relax.\nThe following table indicates the locations of Crown Books' stores and the number of stores opened, closed and remodeled by Crown Books for the last five years:\nClassic Crown Books stores are approximately 2,000 to 3,000 square feet and Super Crown Books stores are approximately 6,500 to 35,000 square feet, and all use specially-designed display fixtures. The Company's new prototype stores, such as the Super Crown White Flint in Rockville, Maryland, generally range from approximately 12,000 to 35,000 square feet. The new prototype stores permit more effective and economic utilization of space. The interior\nCrown Books Operations (continued)\nof the stores is standardized, so that the stores can be assembled quickly. Most of the stores are open seven days a week.\nCurrently, all Super Crown Books stores and all classic Crown Books stores have computerized point of sale and inventory management systems (\"systems\"). Crown Books implemented systems in new stores and in the remaining classic Crown Books stores during fiscal 1994. The systems enable store personnel to scan bar coded merchandise resulting in less time to process the sales transaction and more accurate pricing. The systems also provide detailed inventory information on an item basis to store management and the central office providing for better informed reordering and merchandising decisions.\nCrown Books believes systems will enhance customer service as well as store operating efficiency.\nThe majority of Crown Books' stores are located in strip shopping centers anchored by supermarkets and drug stores.\nCrown Books has closed certain stores in various markets. At January 29, 1994, Crown Books had a reserve for closed stores of approximately $1,000,000, which represents the estimated unrecoverable lease costs, and certain other incidental costs. Crown Books recorded net charges (income) of $(631,000), $513,000 and $1,106,000 during the fiscal years 1994, 1993 and 1992 for closed stores. Income during the year ended January 29, 1994 was the result of early lease terminations, net of cash buyouts. Crown Books continues to review store operations and may close additional stores in the future.\nCrown Books recorded a restructuring charge of $6,600,000 during the year ended January 30, 1993 for anticipated costs associated with closing, relocating, expanding and converting existing classic stores to the Super Crown Books concept. At January 29, 1994, Crown Books had charged approximately $840,000 against this reserve. These charges consisted primarily of unrecoverable lease costs (including buyouts of remaining lease terms) and the remaining book value of leasehold improvements and store fixtures for stores which have closed.\nCrown Books continues to test various concepts (principally related to the size of the store) in the Super Crown Books prototypes. As a result of these test stores, Crown Books has determined that a number of the smaller Super Crown Books stores opened in previous years (typically 6,000 - 10,000 square feet) are not a competitive format in the current market environment. These stores have been negatively impacted by the industry's roll out of the larger stores. Accordingly, Crown Books recorded an additional restructuring charge of $6,200,000 in the year ended January 29, 1994, representing the anticipated costs (unrecoverable lease costs and the remaining book value of leasehold improvements and store fixtures subsequent to management's estimate of the stores' closing dates) associated with closing, relocating and converting these stores to the new, larger prototype.\nNo store contributed more than 2.0% to Crown Books' consolidated sales during the year ended January 29, 1994.\nShoppers Food Operations\nShoppers Food operates retail discount grocery stores that sell groceries, meats, produce, beer and wine, baked goods, cigarettes, health and beauty aids and have a deli department. The stores are located in the Washington, D. C. metropolitan area and the warehouses and office facilities are located in Lanham, Maryland. The Corporation acquired in excess of 50% of the common stock of Shoppers Food (see Note 3 to the Consolidated Financial Statements) during fiscal 1989.\nShoppers Food's stores are operated on a high volume discount pricing marketing strategy. Shoppers Food stores are operated primarily on a self-service basis and customers bag or box their own groceries. The stores sell popular brand names at discount prices as well as manufacturers' or distributors' specials.\nThe following table indicates the number of stores and the number of stores opened, closed and remodeled for the last five years.\nTotal Beverage Corporation\nTotal Beverage operates retail discount beverage superstores in the Washington, D.C. metropolitan area. The stores carry a wide range of foreign and domestic beers and wines as well as non-alcoholic beverages. The Corporation organized Total Beverage Corporation on January 26, 1993 and purchased the assets for the first store on February 27, 1993 from Shoppers Food for approximately $1,494,000. In October 1993 Total Beverage opened two additional stores and is seeking locations for additional stores.\nCabot-Morgan Real Estate Company\nCMREC, a wholly-owned subsidiary, was organized under the laws of Delaware as a real estate development company. CMREC owns the majority interest in five real estate partnerships that own four shopping centers and an office building in the Washington, D.C. metropolitan area. CMREC owns 75% of two of these partnerships (each owning a shopping center) and 51% of the other three partnerships (two owning shopping centers and one owning an office building). The remaining partnership interests are owned by partnerships in which the partners are members of the Haft family. Combined Properties, Inc., a Haft controlled entity, manages the shopping centers and office building for the partnerships. Trak Auto, Crown Books, Shoppers Food and Total Beverage have stores in some of these shopping centers.\nDart Financial Operations\nDart Financial is engaged in the business of buying and holding bankers' acceptances. Dart Financial acquires institutional size transactions of typically $5,000,000. All of the outstanding bankers' acceptances are obligations of Japanese banks with a minimum credit rating of A1\/P1 and are secured further by the underlying commodities.\nA bankers' acceptance is a short-term instrument drawn on and accepted by a bank that, by accepting the draft, assumes the obligation to pay the draft at maturity. By purchasing bankers' acceptances, the purchaser assists in financing purchases of merchandise by commercial businesses. Obligations to the holders of bankers' acceptances typically are secured by the merchandise being purchased. While there is an active market for bankers' acceptances, such market is not regulated by any governmental agency.\nFluctuations in market interest rates and the creditworthiness of the accepting bank are the major factors which affect the value of a bankers' acceptance. Accordingly, management has established certain criteria for buying and holding bankers' acceptances, including limiting purchases to acceptances which have maturities of six months or less, limiting purchases to acceptances of banks selected from a periodically reviewed list which management believes are creditworthy, purchasing acceptances that are \"with recourse\" obligations for which the drawer is contingently liable and diversifying purchases among the selected group of banks.\nIt is management's belief that the foregoing criteria provide an appropriate basis for financing commercial transactions through the purchase and holding of bankers' acceptances and afford an opportunity for reasonable profit relative to the risks incurred.\nDuring the year ended January 31, 1994 Dart Financial purchased bankers' acceptances at face value of approximately $442,125,000, sold bankers' acceptances of approximately $2,000,000 at face value, and held bankers' acceptances of approximately $468,250,000 at face value to maturity. On January 31, 1994, Dart Financial held bankers acceptances of approximately $62,525,000 at face value compared to $90,650,000 one year ago.\nCompetition\nThe market for the products and services provided by the Corporation's retail discount specialty operations is highly competitive. The stores compete with retail outlets, including drug stores, supermarkets, department stores, hardware stores, variety stores, auto parts stores and book stores. Competitors range from small independent stores to large regional and national chains, many of which have greater resources than the Corporation and its subsidiaries. The stores encounter strong competition with respect to the prices at which they sell their products and services. Many companies are engaged in the financial business through dealing in bankers' acceptances and many have greater assets than Dart Financial. Many companies are engaged in real estate development and many have greater resources than CMREC.\nEmployees\nOn January 31, 1994, the Company and its subsidiaries employed approximately 6,580 full time and 4,590 part time persons. The Company considers its relations with employees to be good.\nChanges in Management\nRobert M. Haft's employment as President and Chief Operating Officer of the Corporation terminated in June 1993. In August 1993, Ronald S. Haft was elected President and Chief Operating Officer of the Corporation. Robert M. Haft's employment as Chief Executive Officer and President of Crown Books concluded in November 1992 upon the employment and election of Glenn Hemmerle to those two positions. Robert Haft continued to serve as Chairman of Crown Books until June 25, 1993, when he was removed as a director by action of the Corporation pursuant to its rights under Delaware corporation law. Thereafter, Herbert H. Haft resumed the position of Chairman of the Board of Crown Books.\nThe Board of Directors of each of the Corporation, Crown Books and Trak Auto was reconstituted in 1993 to include five new directors, four of whom are neither officers or employees of the Company. Bonita A. Wilson and Douglas M. Bregman were elected directors of the Corporation, Crown Books and Trak Auto in June 1993. Ronald S. Haft became President and Chief Operating Officer of the Corporation on August 1, 1993 and a director of the Corporation, Crown Books and Trak Auto on July 28, 1993. H. Ridgely Bullock and Larry G. Schafran were elected as directors by the respective boards of the Corporation, Crown Books and Trak Auto pursuant to each company's bylaws on December 20, 1993. Robert M. Haft and Gloria G. Haft ceased to be directors of the Corporation, Crown Books and Trak Auto in June 1993.\nThese changes have affected the Company's operations in two respects. First, current management's review of Crown Books' operations and market position concluded that many of the Super Crown stores opened under the direction of the former Chairman were not in a competitive format in the the current market environment, in which competitors have opened larger stores. Current management has moved in a direction towards the conversion of many of Crown Books' classic Crown and Super Crown Books stores to larger Super Crown Books stores, and the elimination of a number of stores, requiring a restructuring charge of $6.2 million and increased capital expenditures over the next three to five years. Second, litigation, principally that initiated by Robert Haft, has required management to divert significant time and expense to defend against the claims. See Note 6 to the Consolidated Financial Statements.\nSegment Information\nSee Note 16 to the Consolidated Financial Statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Corporation has a lease with a private partnership in which members of the Haft family own all of the beneficial interests for a headquarters building and distribution center of approximately 271,000 square feet in Landover, Maryland. The Corporation has sublet 210,000 square feet of the headquarters building and distribution center to Trak Auto and 28,000 square feet to Crown Books. In addition, the Corporation has a lease agreement with the aforementioned partnership for land, identified for future Trak Auto expansion, adjacent to the headquarters building and distribution center. Trak Auto has agreed to bear the annual carrying cost for the land.\nTrak Auto\nAll of Trak Auto's 314 stores are leased. As of January 31, 1994, the total minimum payments for Trak Auto's retail stores and equipment under leases aggregated approximately $85,555,000 to lease expiration dates. The lease expiration dates (without regard to renewal options) range from 1994 to 2013. Twenty-three of these leases, are with entities in which members of the Haft family have all or substantially all the beneficial interest, two are with CMREC shopping centers and two are subleased from Crown Books.\nTrak Auto leases a 176,000 square foot distribution center located in Bridgeview, Illinois, and a 317,000 square foot distribution center located in Ontario, California, from private partnerships in which members of the Haft family own all of the beneficial interests.\nCrown Books\nAll of Crown Books' 240 stores are leased. As of January 31, 1994, the total minimum payments for Crown Books' retail stores and equipment aggregated approximately $114,297,000 to the lease expiration dates. The lease expiration dates (without regard to renewal options) range from 1994 to 2009. Thirteen of these leases are with entities in which members of the Haft family have all or substantially all the beneficial interest and three are with CMREC shopping centers.\nShoppers Food\nShoppers Food leases 34 stores and owns one store. As of January 31, 1994, the total minimum payments for Shoppers Food's 34 retail stores and equipment under lease aggregated approximately $165,902,000 to the lease expiration dates. The lease expiration dates (without regard to renewal options) range from 1994 to 2013. Seven of these leases are with entities in which members of the Haft family have all or substantially all the beneficial interest and one is with a CMREC shopping center.\nShoppers Food has a lease agreement with a limited partnership in which members of the Haft family and the owners of the minority interest in Shoppers Food own all of the beneficial interests for approximately 86,000 square feet of space in an office building in Lanham, Maryland. Shoppers Food has sublet approximately 25,000 square feet of the office to unaffiliated third parties.\nTotal Beverage\nTotal Beverage's three stores are leased. As of January 31, 1994, the total minimum payments for Total Beverage's retail stores under lease aggregated approximately $10,947,000 to the lease expiration dates. The lease expiration dates (without regard to renewal options) range from 1994 to 2008. One lease agreement is with a partnership in which members of the Haft family have all or substantially all the beneficial interest and two are with CMREC shopping centers.\nCMREC\nAs of January 31, 1994, CMREC owned a 75% interest in two shopping centers located in Greenbelt and Silver Spring, Maryland, a 51% interest in a shopping center and office building located in Fairfax, Virginia and 51% interest in a shopping center located in Prince William County, Virginia. The remaining interests in these properties are owned by partnerships in which members of the Haft family own all the beneficial interests. At January 31, 1994, the total minimum rental revenues for these properties aggregated approximately $113,853,000 to the lease expiration dates, which range from 1994 to 2011.\nWarehouse Facility\nDuring fiscal 1991, the Corporation, because of its guarantee as part of the sale of its drug store division in fiscal 1985, reassumed the lease obligations for certain warehouse and office facility leases. The leases, with private partnerships in which members of the Haft family own all of the beneficial interests, are for 533,800 square feet of warehouse and office facility space in Landover, Maryland. Trak Auto has a sublease agreement for 6,500 square feet of the facility for a term of one year with nine one year option periods and Shoppers Food currently subleases, on a month to month basis, approximately 6,000 square feet of the facility. The Corporation is actively marketing the remaining space for lease to unaffiliated parties.\nSee Note 4 to the Consolidated Financial Statements for further information regarding leases with related parties.\nItem 3.","section_3":"Item 3. Legal Proceedings\nSee Note 6 to the Corporation's Consolidated Financial Statements.\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 the Registrant's Common Equity and Related Stockholder Matters\nThe following table shows the high and low sale prices for the common stock in the over-the-counter market for the fiscal quarters indicated, as reported by NASDAQ.\nClass A Common Stock\nItem 6.","section_6":"Item 6. Selected Financial Data\nIncome Statement Data: (in thousands, except per share and sales % data)\nItem 6. Selected Financial Data (Continued)\n(1) The Corporation owns 65% of the common stock of Trak Auto.\n(2) The Corporation owns 51% of the common stock of Crown Books.\n(3) The Corporation owns in excess of 50% of the common stock of Shoppers Food.\n(4) On December 31, 1989, partnerships in which CMREC holds a 75% interest purchased two shopping centers. The operating results of these partnerships are reported from January 1, 1990. On March 12, 1991 CMREC acquired a 51% interest in two partnerships that own the Greenbriar Town Center. The operating results of these partnerships are reported from March 12, 1991. In January 1993, CMREC acquired a 51% interest in a partnership that owns Bull Run Plaza. The operating results of this partnership are reported from January 1, 1993.\n(5) See Note 14 to the Consolidated Financial Statements.\n(6) The 1993 cumulative effect of a change in accounting principles was the result of Trak Auto's adopting Statement of Financial Accounting Standard No. 109, Accounting for Income Taxes.\nNote: See Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nLIQUIDITY AND CAPITAL RESOURCES\nCash, including short-term instruments, U.S. government and other marketable debt securities and bankers' acceptances, is the Company's primary source of liquidity. Cash, including short-term instruments, U.S. government and other marketable debt securities and bankers' acceptances, increased by $10,300,000 to $287,377,000 at January 31, 1994 from $277,077,000 at January 31, 1993. This increase was primarily due to funds provided by operations, proceeds from a mortgage obtained by CMREC for Bull Run Plaza, stock option exercises, a stock option purchase and funds received from Trak Auto's insurance carrier as a result of the 1993 civil disturbances in Los Angeles. The increase was offset by capital expenditures for superstore expansion by Trak Auto and Crown Books, the acquisition of, and subsequent capital expenditures for Total Beverage, and cash paid by CMREC for construction and renovation of Bull Run Plaza.\nFor the year ended January 31, 1994, the Company realized a pretax yield of approximately 3.2% on the bankers' acceptances, and 3.2% on United States Treasury Bills, and realized an annualized total return of approximately 5.4% on marketable debt securities.\nOperating activities provided $38,402,000 in funds to the Company for the year ended January 31, 1994, compared to $25,223,000 for the same period one year ago. The increase is primarily a result of the timing of payments for merchandise inventory and other accrued liabilities which had the effect of extending payments to after January 31, 1994 and to a decrease in income tax payments as a result of lower taxable income.\nInvesting activities used $71,327,000 of the Company's funds during the year ended January 31, 1994, compared to using $11,212,000 of such funds for the same period one year ago. The primary use of funds was the conversion of Trak Auto and Crown Books United States Treasury Bills to marketable debt securities. Capital expenditures increased $7,644,000 over the prior year as a result of continuing Trak Auto's and Crown Books' expansion to Super Trak and Super Crown formats, respectively, and Total Beverage store openings. In addition, Crown Books completed the purchase and installation of point-of-sale equipment in all stores.\nFinancing activities provided $18,797,000 to the Company during the year ended January 31, 1994, compared to $3,699,000 one year ago. The primary source of these funds in both years was borrowings secured by real estate mortgages (as discussed below), which were partially offset in fiscal 1993 by the repurchase of the Corporation's remaining outstanding debentures.\nThe Corporation, together with Crown Books and Trak Auto, has a $6,000,000 revolving credit facility agreement. As of January 31, 1994 there has been no borrowing under this credit agreement (see Note 7 to the Consolidated Financial Statements).\nDuring fiscal 1994, CMREC (through the Bull Run Plaza partnership) obtained a $9,750,000 mortgage which was used to repay the Corporation the bridge loan it advanced to that partnership for the purchase of its shopping center and the Briggs Chaney partnership refinanced two mortgages at Briggs Chaney Shopping Center into one $16,000,000 mortgage bearing interest at 8.5%\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nfor a term of ten years, secured by the land and building at that shopping center. During fiscal 1993, CMREC (through the Greenbriar Retail partnership) obtained a $38,000,000 mortgage, which may be increased to $40,600,000 upon meeting additional lease criteria.\nAt January 31, 1994, Crown Books had eleven signed leases for Super Crown stores, Trak Auto had eleven signed leases for new stores and 13 signed agreements for additional space in existing stores for Super Trak stores, Shoppers Food had two signed leases for new stores and CMREC's Bull Run Plaza is undergoing renovation and expansion.\nThe Company anticipates that funds necessary to fund these capital expenditures, as well as purchase inventory for new stores, meet the Company's long-term lease obligations, and pay current liabilities, will come from operations, existing current assets and, if necessary, the aforementioned credit agreement.\nThe liquid assets maintained by the Company are intended to fund the expansion of the Company's retail business through opening stores in new markets, converting selected existing stores to superstores, and opening additional stores in existing markets.\nAt January 31, 1994:\nWorking capital increased by $13,441,000 to $281,242,000 at January 31, 1994 from $267,801,000 at January 31, 1993. The increase was primarily due to an increase in cash (see discussion of cash above). Increased inventory levels were offset by increased accounts payable, trade.\nAt January 31, 1993:\nWorking capital increased by $7,427,000 to $267,801,000 at January 31, 1993 from $260,374,000 at January 31, 1992. The increase was primarily due to funds received from the Greenbriar mortgage, current operating results, increased inventory for new Super Trak and Super Crown stores which was more than increased accounts payable as a result of the timing of inventory purchases, and the timing of payments for other current liabilities. The increase was partially offset by the redemption of the outstanding debentures, additional investment in real estate partnerships by CMREC and increased capital expenditures.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nRESULTS OF OPERATIONS Year Ended January 31, 1994 Compared to the Year Ended January 31, 1993\nTrak Auto Sales of $334,798,000 in fiscal 1994 increased by $19,005,000 or 6.0% from the prior fiscal year primarily due to increased sales for stores converted from classic to Super Trak stores. Sales for stores open more than one year increased 1.3% for the year ended January 29, 1994. Super Trak sales increased to $78,054,000 from $6,775,000 one year ago and comparable Super Trak sales decreased 4.0%. Classic Trak Auto store sales decreased to $256,744,000 from $309,018,000 as a result of converting over 50 classic stores to Super Traks. Comparable sales for classic Trak Auto stores increased 1.4%. Sales for Super Trak stores represented 23.3% and 2.1% of total sales for the year ended January 29, 1994 and January 30, 1993, respectively.\nDuring the year ended January 29, 1994, Trak Auto opened ten Super Trak stores, converted 52 classic stores to Super Traks and opened one classic Trak store while closing one Super Trak (temporarily due to the January 1994 Los Angeles earthquake), and 13 classic Trak stores. Super Trak stores have generated increased sales at converted locations as well as increased gross margin as a result of the change in product mix (increased hard parts). Trak Auto believes that by leasing larger stores it can obtain more favorable lease rates and that as the stores mature, operating expenses as a percentage of sales will decrease. The increased sales and margins together with the knowledge acquired during the current year to control operating expenses are expected to have a positive impact on future operating results.\nInterest and other income decreased by $197,000 during the year ended January 29, 1994 compared to the year ended January 30, 1993. The decrease was primarily due to decreased sublease income as a result of the expiration of the primary lease and was partially offset by an increase in interest income as a result of increased average balance on funds available for short-term investment.\nCost of sales, store occupancy and warehousing expenses as a percentage of sales increased to 76.4% for the year ended January 29, 1994, compared to 73.9% for the year ended January 30, 1993. This increase was primarily the result of decreased margins as a result of Trak Auto's marketing strategy of reducing prices to meet increased competition and increased advertising costs resulting from utilizing alternative advertising media.\nSelling and administrative expenses, as a percentage of sales, were 21.2% of sales for the year ended January 29, 1994 compared to 20.9% for the year ended January 30, 1993. The increase was primarily due to increased payroll costs associated with opening and operating Super Trak stores. The increase was partially offset by favorable settlement of future lease obligations of $943,000 for stores closed in prior years and by decreased insurance costs as a result of Trak Auto's safety programs, which have reduced workers compensation claims.\nDepreciation and amortization increased $727,000 when compared to fiscal 1993. The increase was due primarily to the increase in fixed assets resulting from conversions to Super Trak.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1994 Compared to the Year Ended January 31, 1993 (Continued)\nInterest expense increased $40,000 for the year ended January 29, 1994 compared to the year ended January 30, 1993 due to amounts owed under capital lease obligations.\nDuring the year ended January 29, 1994, Trak Auto recorded a tax benefit of $545,000 as a result of its current book net operating loss and the effect of certain permanent book\/tax differences.\nCrown Books\nSales of $275,125,000 for the year ended January 29, 1994 increased by $34,443,000 or 14.3% compared to the year ended January 30, 1993. Sales for stores open more than one year decreased 0.6% for the year ended January 29, 1994. Sales for Super Crown Books stores represented 39.8% and 21.0% of total sales for the twelve months ended January 29, 1994 and January 30, 1993, respectively. Super Crown Books stores sales of $109,637,000 increased 116.7% over the prior year and sales for comparable Super Crown Book stores increased 1.2%. Classic Crown Books stores sales of $164,886,000 decreased 13.3% over the prior year and sales for comparable classic Crown Books stores decreased 1.0%. As a result of the adoption of a 52\/53 week fiscal year in December of 1992, fiscal 1994 has one less day than fiscal 1993. If prior year sales are adjusted to reflect the 52\/53 week fiscal year, total sales increased 14.5% for the year ended January 29, 1994 and comparable sales decreased 0.3%.\nDuring the twelve months ended January 29, 1994, Crown Books opened 37 Super Crown Books stores, five expanded classic Crown Books stores and one store that primarily sells remainders, while closing 45 classic Crown Books stores and four Super Crown Books stores. At January 29, 1994, Crown Books had a total of 240 stores and subsequent to that date, opened five Super Crown Books stores and closed eight classic Crown Books stores.\nInterest and other income increased by $58,000 when compared to the prior fiscal year. The increase was primarily due to increased income from magazine distributors for displays in new stores. Interest income decreased $193,000 as a result of decreased funds available for short term investment.\nCost of sales, store occupancy, and warehousing as a percentage of sales was 80.4% for the year ended January 29, 1994 compared to 78.5% the prior fiscal year. The increase was primarily due to a decrease in store margins, as a result of a less favorable sales mix, increased purchasing from wholesalers at a higher cost and the impact of closed store liquidation sales, and to an increase in store occupancy costs for Super Crown Books stores.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1994 Compared to the Year Ended January 31, 1993 (Continued)\nSelling and administrative expenses as a percentage of sales were 17.1% for the year ended January 29, 1994 compared to 16.0% for the same period one year ago. The increase was due primarily to increased payroll costs at both the store and administrative levels, largely the result of expansion of Super Crown Books stores, and to increased legal fees (see Note 6 to the Consolidated Financial Statements) including the accrual of future estimated legal costs to be incurred in relation to certain litigation. The increases were partially offset by decreased insurance costs as a result of Crown Books' efforts to reduce workers compensation cost.\nDepreciation and amortization expense increased by $1,568,000 for the year ended January 29, 1994 when compared to the prior fiscal year. This increase was primarily due to the acquisition and installation of a point-of-sale system in all stores and to the purchase of fixed assets for new Super Crown Books stores.\nInterest expense decreased by $68,000 in fiscal 1994 compared to fiscal 1993 due to the reduction of amounts owed under capital lease obligations.\nDuring the year ended January 29, 1994, Crown Books recorded a restructuring charge of $6,200,000 before income taxes. The charge includes the anticipated costs associated with closing, relocating, expanding and converting smaller existing Super Crown Books to a new larger prototype store. This charge reflects the cost of implementing a decision of current management to close smaller Super Crown Books stores opened over the past three years which have proved to be too small to compete effectively. These costs are primarily unrecoverable lease obligations and the remaining book value of leasehold improvements.\nCrown Books recorded a $276,000 tax benefit during the year ended January 29, 1994.\nShoppers Food\nShoppers Food sales increased $30,177,000 or 4.4% to $718,144,000 during the twelve months ended January 31, 1994 when compared to the same period in the prior year. The increase is primarily due to the opening of two new stores during 1994. Sales on a comparable basis decreased 3.8% largely due to new stores opening near existing stores.\nInterest and other income increased $1,022,000 during the twelve months ended January 31, 1994 as a result of increased funds available for short-term investment.\nCost of sales, store occupancy and warehousing, as a percentage of sales, decreased to 82.1% during the twelve months ended January 31, 1994 compared to 83.8% for the same period last year. The decrease is primarily due to increased margins as a result of a lessening of competitive pricing pressure in the Washington, D.C. grocery market.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1994 Compared to the Year Ended January 31, 1993 (Continued)\nSelling and administrative expenses, as a percentage of sales, increased to 14.0% from 12.9% during the twelve months ended January 31, 1994. The increase resulted primarily from increased payroll and insurance costs and from a $1,000,000 charge for a closed store reserve.\nDepreciation and amortization decreased $599,000 during the twelve months ended January 31, 1994 when compared to the same period last year. The decrease is primarily the result of an increase in fixed assets last year and Shoppers Food recording a full year depreciation at that time.\nShoppers Foods' effective income tax was 39.2% for the year ended January 31, 1994 compared to 39.0% in the prior year.\nTotal Beverage\nTotal Beverage purchased the assets of a discount beverage superstore in February 1993 and opened two additional stores in October 1993. During the year ended January 31, 1994, Total Beverage sales were $15,273,000 and Total Beverage recorded a net operating loss of $5,512,000 which included legal expenses of approximately $3,800,000 (see Note 6 to the Consolidated Financial Statements).\nCabot-Morgan Real Estate\nRevenues from real estate properties increased by $5,005,000 during the year ended January 31, 1994 when compared to the same period in the prior year. The increase is the result of the acquisition of Bull Run Plaza in January 1993 and Greenbriar Town Center's increased occupancy for the whole year.\nDuring the twelve months ended January 31, 1993, Greenbriar Town Center completed renovation and expansion and the center became fully operational. As a result, and combined with the acquisition of Bull Run Plaza, CMREC's administrative expenses increased to $6,107,000 from $3,957,000 and depreciation expense increased to $4,338,000 from $3,190,000 during the twelve months ended January 31, 1994.\nInterest expense increased by $2,774,000 to $7,683,000 during the twelve months ended January 31, 1994, primarily due to the full year impact of the mortgage for Greenbriar Town Center and to the mortgage at Bull Run Plaza.\nCMREC is included in the Corporation's federal income tax return but files separate state returns. Accordingly, CMREC has recorded a $16,000 tax provision.\nDart Financial and Other Corporate\nIncome from bankers' acceptances decreased $871,000 during the year ended January 31, 1994 when compared to the same period in the prior year. The decrease is due to a decrease in the bankers' acceptances portfolio as a result of funds used for the redemption of the Corporation's debentures in\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1994 Compared to the Year Ended January 31, 1993 (Continued)\nJuly 1992 and to the Corporation converting bankers' acceptances to higher yielding instruments in fiscal 1994.\nInterest and other income increased $270,000 during the year ended January 31, 1994 when compared to the same period in the prior year. In its efforts to maximize total interest income, the Corporation has invested funds where it believes they will generate the highest return consistent with minimizing principal risk. Accordingly, the Corporation transferred bankers' acceptances to marketable debt securities.\nAdministrative expenses for the Corporation increased $2,777,000 during the year ended January 31, 1994, due primarily to increased payroll and legal costs (see Note 6 to the Consolidated Financial Statements).\nInterest expense for the Corporation decreased by $1,787,000 during the year ended January 31, 1994 when compared to the same period in the prior year. The decrease is the result of the Corporation's redemption of the remaining debentures in July 1992.\nTrak Auto, Crown Books and Shoppers Food file separate income tax returns. CMREC, Total Beverage and Dart Financial are included in the Corporation's income tax returns. The Corporation's current net operating loss was not tax benefitted as a result of the complete utilization of all available carrybacks.\nAs a result of the Corporation's operating loss for the year ended January 31, 1994, a net tax operating loss carryforward of $7,090,000 was created. The Corporation's cumulative total net tax operating loss carryforward is $8,643,000. All net operating loss carryforwards will expire by fiscal 2009. In addition, the Corporation has an Alternative Minimum Tax (\"AMT\") credit carryforward of approximately $1,010,000.\nYear Ended January 31, 1993 Compared to the Year Ended January 31, 1992\nTrak Auto\nSales of $315,793,000 in fiscal 1993 decreased by $3,842,000 or 1.2% from the prior fiscal year primarily due to the closure of 11 underperforming stores in San Diego during the second quarter as well as the continuing impact of the stores destroyed or damaged during the civil disturbances in Los Angeles during the first quarter. Trak Auto's decision to close the San Diego stores was largely due to those stores inability to generate the sales volume necessary to meet expenses. In Los Angeles, the six stores that remain closed and the nine stores that subsequently reopened contributed to the decrease in sales. These decreases were partially offset by three new Super Trak stores and increased sales at nine stores converted to Super Trak stores and a 2.6% increase in sales for stores open more than one year.\nInterest and other income increased by $614,000 during the year ended January 31, 1993 compared to the twelve months ended January 31, 1992. The increase was due to increased interest income as a result of increased funds\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1993 Compared to the Year Ended January 31, 1992 (Continued)\navailable for short-term investments, partially offset by lower interest rates, and to increased rental income from subleases.\nCost of sales, store occupancy and warehousing expenses as a percentage of sales decreased to 73.9% for the year ended January 31, 1993, compared to 76.0% for the year ended January 31, 1992. This decrease was primarily the result of strong margins throughout 1993 compared to 1992 when first quarter margins were low due to competitive market pressures, and was partially offset by a small increase in store occupancy costs. Margins for stores open less than one year did not vary significantly from stores open more than one year.\nSelling and administrative expenses were 20.9% of sales for the year ended January 31, 1993 compared to 20.3% for the year ended January 31, 1992. The increase was primarily due to increased payroll costs, largely a result of costs associated with the opening of Super Trak stores, and increased insurance costs associated with Trak Auto's casualty program covering general liability, auto liability and workers compensation and increased health insurance costs.\nDepreciation and amortization decreased $459,000 when compared to fiscal 1992. The decrease was due primarily to the write-off of fixed assets as a result of utilization of net operating loss carryforwards, of negative goodwill amortization and to last year's retroactive adjustment to the useful lives of certain leasehold improvements.\nInterest expense decreased $28,000 for the year ended January 31, 1993 compared to the year ended January 31, 1992 due to the reduction of amounts owed under capital lease obligations.\nDuring the year ended January 30, 1993, Trak Auto recorded a one-time restructuring charge of $7,400,000, before income taxes. The charge includes the anticipated costs associated with store closing, relocating, expanding and converting to the new Super Trak concept. These costs are primarily unrecoverable lease obligations.\nAs a result of the stores destroyed or damaged in the Los Angeles disturbances discussed above, Trak Auto had received payments from insurance carriers of approximately $6,400,000 and recorded a receivable for an additional $3,500,000 which represent settlement of Trak Auto's insurance claims. The payments and receivable, less related expenses and the cost of the related inventory and fixed assets lost, have been recorded as a gain, classified as an unusual item during the year ended January 30, 1993.\nThe effective income tax rate was 32.5% for the year ended January 30, 1993 compared to 31.4% in the prior year. Trak Auto's effective income tax rate was less than the statutory rates as a result of differences in depreciation between the book and tax basis of the assets acquired from Trak Auto West, Inc. (\"Trak West\").\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1993 Compared to the Year Ended January 31, 1992 (Continued)\nTrak Auto adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, Accounting for Income Taxes, effective February 1, 1992. At that time, the Company had existing unrecoverable tax benefits of net operating loss carryforwards of approximately $6,500,000 representing both preacquisition losses of Trak West and its own operating losses in 1991. In conjunction with the adoption of the standard, Trak Auto recorded $1,658,000 as the cumulative effect of recognizing that portion of the previously unrecognized tax benefits that it concluded would more likely than not be recognized and established a valuation reserve of $728,000.\nCrown Books\nSales of $240,682,000 for the year ended January 31, 1993 increased by $8,198,000 or 3.5% compared to the year ended January 31, 1992. Sales for stores open more than one year increased 2.6% for the year ended January 31, 1993. Sales for Super Crown Books stores represented 21.1% and 11.1% of total sales for the twelve months ended January 31, 1993 and 1992, respectively. Super Crown Books stores sales of $50,756,000 increased 96.7% over the prior year and sales for comparable Super Crown Books stores increased 3.4%.\nDuring the twelve months ended January 30, 1993, Crown Books opened 13 Super Crown Books stores and closed 19 classic Crown Books stores. In addition, in September 1992, one classic Crown Books store was completely destroyed in a fire. Crown Books recorded a partial insurance claim receivable of approximately $260,000 which consisted of the net book value of destroyed fixed assets and inventory, at cost and as such, no gain or loss has been recognized. At January 31, 1993, Crown Books had received a partial settlement of $250,000 from its insurance carrier. At January 31, 1993, Crown Books had a total of 247 stores.\nInterest and other income decreased by $1,032,000 when compared to the prior fiscal year. The decrease, due to continuing lower interest rates, was partially offset by increased funds available for short-term investment for most of the year.\nCost of sales, store occupancy, and warehousing as a percentage of sales was 78.5% for the year ended January 31, 1993 compared to 78.1% the prior fiscal year. The increase was primarily due to greater store occupancy costs for Super Crown Books stores, as a percentage of sales, and was partially offset by increased margin as a result of the increasing contribution of Super Crown Books stores margins due to Super Crown Books stores' more favorable sales mix.\nSelling and administrative expenses as a percentage of sales were 16.0% for the year ended January 31, 1993 compared to 15.3% for the same period one year before. The increase was due primarily to payroll increases greater than sales and to increased administrative payroll largely the result of opening Super Crown Books stores. Mature Super Crown Books stores payroll costs are lower than classic Crown Books stores, as a percentage of sales.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1993 Compared to the Year Ended January 31, 1992 (Continued)\nDepreciation and amortization expense increased by $238,000 for the year ended January 31, 1993 when compared to the prior fiscal year. This increase was primarily due to additional fixed assets in new and remodeled stores, primarily Super Crown Books stores.\nInterest expense decreased by $79,000 in fiscal 1993 compared to fiscal 1992 due to the reduction of amounts owed under capital lease obligations.\nDuring the year ended January 31, 1993, Crown Books recorded a restructuring charge of $6,600,000 before income taxes. The charge includes the anticipated costs associated with store closings, relocating, expanding and converting to the Super Crown Books concept. These costs are primarily unrecoverable lease obligations and the remaining book value of leasehold improvements.\nThe effective income tax rate was 37.9% for the year ended January 31, 1993 compared to 38.0% for the year ended January 31, 1992.\nCrown Books adopted SFAS No. 109, Accounting for Income Taxes, effective February 1, 1992. Implementation of the standard had no significant effect on the financial statements.\nShoppers Food\nShoppers Food sales increased $77,910,000 or 12.8% to $687,967,000 during the twelve months ended January 31, 1993 when compared to the same period in the prior year. The increase is primarily due to the opening of four new stores and was partially offset by the closing of one underperforming store. Sales on a comparable basis decreased 6.6%, largely due to the new stores opening near existing stores.\nCost of sales, store occupancy and warehousing, as a percentage of sales, increased to 83.8% during the twelve months ended January 31, 1993 compared to 82.7% for the same period last year. The increase is primarily due to decreased margins resulting from competitive pressures in its market.\nSelling and administrative expenses, as a percentage of sales, decreased to 12.9% from 13.1% during the twelve months ended January 31, 1993. The decrease, as a percentage of sales resulted from cost controls implemented during the year.\nDepreciation and amortization increased $3,107,000 during the twelve months ended January 31, 1993 when compared to the same period last year. The increase is primarily the result of additional fixed assets in new stores.\nShoppers Foods' effective income tax was 39.0% for the year ended January 31, 1993 compared to 38.1% in the prior year.\nShoppers implemented SFAS No. 109, Accounting for Income Taxes, effective February 1, 1992. Adoption of the new statement did not have a material effect on financial statements.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1993 Compared to the Year Ended January 31, 1992 (Continued)\nCabot-Morgan Real Estate\nRevenues from real estate properties increased by $4,471,000 during the year ended January 31, 1993 when compared to the same period in the prior year. The increase is the result of the acquisition of Greenbriar Town Center in March 1991 and that center's increased occupancy, increased rental income at Greenway Center, as well as the acquisition of Bull Run Plaza in January 1993.\nDuring the twelve months ended January 31, 1993, Greenbriar Town Center completed renovation and expansion and the center became fully operational. As a result, CMREC's administrative expenses increased to $3,957,000 from $3,352,000 and depreciation expense increased to $3,190,000 from $2,688,000 during the twelve months ended January 31, 1993.\nInterest expense increased by $1,336,000 to $4,909,000 during the twelve months ended January 31, 1993 primarily due to the $38,000,000 mortgage obtained by Greenbriar (see Note 8 to the Consolidated Financial Statements).\nCMREC is included in the Corporation's federal income tax return but files separate state returns. Accordingly, CMREC has recorded a $71,000 tax provision.\nDart Financial and Other Corporate\nIncome from bankers' acceptances decreased $7,026,000 during the year ended January 31, 1993 when compared to the same period in the prior year. The decrease is due to continued lower interest rates and to a decrease in the size of the bankers' acceptances portfolio, largely the result of funds used for the redemption of the Corporation's outstanding debentures.\nInterest and other income decreased $2,011,000 during the year ended January 31, 1993 when compared to the same period in the prior year. The decrease was primarily due to continuing lower interest rates.\nAdministrative expenses for the Corporation increased $248,000 during the year ended January 31, 1993, due primarily to the result of higher payroll and insurance expenses.\nInterest expense decreased by $12,258,000 during the year ended January 31, 1993 when compared to the same period in the prior year. The decrease is the result of the Corporation's repurchase or redemption of $75,000,000 in face amount of its outstanding debentures in fiscal 1992 and the redemption of the remaining debentures in July of the current fiscal year.\nDuring the year ended January 31, 1993, the Corporation redeemed all of its outstanding debentures, face amount of $29,120,000, resulting in a loss classified as an extraordinary item of $885,000.\nItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued)\nYear Ended January 31, 1993 Compared to the Year Ended January 31, 1992 (Continued)\nTrak Auto, Crown Books and Shoppers Food file separate income tax returns. CMREC and Dart Financial are included in the Corporation's income tax returns. The Corporation's current net operating loss was not tax benefitted.\nAs a result of the Corporation's operating loss for the year ended January 31, 1993, a net tax operating loss carryforward of $4,305,000 was created. This net operating loss carryforward expires in fiscal 2008. In addition, the Corporation had an AMT credit carryforward of approximately $622,000.\nThe Corporation adopted SFAS No. 109, Accounting for Income Taxes, effective February 1, 1992. Implementation of the standard had no significant impact on the financial statements.\nEFFECT OF NEW FINANCIAL ACCOUNTING STANDARDS\nThe Company is required to adopt SFAS No. 112, Employer's Accounting for Postretirement Benefits, no later than fiscal year ending January 31, 1995. The Company does not expect that implementing the standard will have a significant impact on the financial statements.\nThe Company is required to adopt SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, in fiscal 1995. The Company does not expect that implementing the standard will have a material effect on the financial statements.\nSEASONALITY\nCrown Books' sales, net income and increase in working capital for quarter ended January 31 have historically been substantially higher than for any of the previous three quarters. Crown Books inventory and payables have historically been higher at the end of the third quarter than for any other quarter for the year. The fourth quarter results of operations have historically been sufficient to satisfy to a substantial degree the third quarter accounts payable requirements. Management does not believe the Corporation's other partially or wholly-owned businesses are affected by seasonality to any material extent.\nEFFECTS OF INFLATION\nInflation in the past three years has had no significant impact on the Corporation's business. The Corporation believes that Trak Auto, Crown Books, Shoppers Food and Total Beverage will recover most cost increases due to inflation with increasing selling prices.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Date\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO DART GROUP CORPORATION:\nWe have audited the accompanying consolidated balance sheets of Dart Group Corporation (a Delaware corporation) and subsidiaries as of January 31, 1994 and 1993 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended January 31, 1994. 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 financial position of Dart Group Corporation and subsidiaries as of January 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three fiscal years in the period ended January 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the Consolidated Financial Statements, effective February 1, 1992, the Company changed its method of accounting for income taxes.\nARTHUR ANDERSEN & CO.\nWashington, D. C., April 27, 1994.\nDART GROUP CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nASSETS\nThe accompanying notes are an integral part of these balance sheets.\nDART GROUP CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nLIABILITIES AND STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these balance sheets.\nDART GROUP CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\n(continued on following page)\nCONSOLIDATED STATEMENTS OF INCOME (Continued)\nThe accompanying notes are an integral part of these statements.\nDART GROUP CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these statements.\nDART GROUP CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(continued on following page)\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\n(continued on following page)\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\n(continued on following page)\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nSupplemental Disclosures of Noncash Investing and Financing Activities:\nDart Group Corporation, through its wholly-owned subsidiary, Cabot-Morgan Real Estate Company, in fiscal 1993 and 1992 acquired a 51% interest in real estate partnerships for $10,897,000 (including a $8,250,000 promissory note to Bull Run Joint Venture) and $21,355,000, respectively. In conjunction with these acquisitions, liabilities (including the minority interest portion) were assumed as follows:\nSee Note 4 re: capital leases.\nThe accompanying notes are an integral part of these statements.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(1) SIGNIFICANT ACCOUNTING POLICIES:\nBasis of Consolidation: The accompanying consolidated financial statements reflect the accounts of Dart Group Corporation (the \"Corporation\") and its direct and indirect, wholly-owned and majority-owned subsidiaries and majority-owned partnerships, including Trak Auto Corporation (\"Trak Auto\"), Crown Books Corporation (\"Crown Books\"), Shoppers Food Warehouse Corp. (\"Shoppers Food\"), Total Beverage Corporation (\"Total Beverage\"), Cabot-Morgan Real Estate Company (\"CMREC\") and Dart Group Financial Corporation (\"Dart Financial\"). The accounts of CMREC, through partnerships in which it owns the majority interest, are included from the date of their purchase. The accounts of Total Beverage are included from the date of its purchase on February 28, 1993. The Corporation, Trak Auto, Crown Books, Shoppers Food, Total Beverage, CMREC, Dart Financial and the Corporation's other direct and indirect wholly- owned and majority-owned subsidiaries and majority-owned partnerships are referred to collectively as the \"Company\". All significant intercompany accounts and transactions have been eliminated.\nShort-Term Instruments and Marketable Debt Securities:\nAt January 31, 1994, The Company's short-term instruments included United States Treasury Bills and Overnight Repurchase Agreements (collateralized by United States Treasury obligations), and marketable debt securities included United States Treasury Notes, corporate notes, municipal securities and United States Agency Securities Acceptances. These short-term instruments and marketable debt securities are recorded at lower of cost or market. At January 31, 1994 the difference between cost and market was not significant.\nBankers' Acceptances: As of January 31, 1994, the Corporation, through its wholly-owned subsidiary, Dart Financial, held bankers' acceptances of approximately $62,307,000 stated at cost, adjusted for discount amortization, which approximates market. All of the outstanding bankers' acceptances are obligations of Japanese banks with a minimum credit rating of A1\/P1 and are further secured by the underlying commodity.\nFair Value of Financial Instruments: The fair values of current assets and current liabilities are approximately equal to the reported carrying amounts. The carrying amounts of the Company's mortgage payables are based on outstanding principal, and the fair values of these mortgages were estimated based on borrowing rates currently available for bank loans with similar terms (see Note 8). No value has been placed on the Company's line of credit facility as any borrowings would bear interest at market rates.\nStatement of Cash Flows: For purposes of the statements of cash flows, the Corporation considers the short-term instruments, consisting of United States Treasury Bills, purchased with an original maturity of less than one year held by its majority owned subsidiaries to be cash equivalents. The Company's United States Treasury Bills primarily consist of instruments with a maturity of less than four months. These highly liquid instruments are considered to be an integral part of the operating cash management program of the subsidiaries.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(1) SIGNIFICANT ACCOUNTING POLICIES (Continued):\nMerchandise Inventories and Cost of Sales: Trak Auto and Shoppers Food inventories are priced at the lower of last-in, first- out (LIFO) cost or market. At January 31, 1994, 1993 and 1992 inventories would have been greater by $7,187,000, $6,453,000 and $5,890,000 respectively, if they had been valued on the lower of first-in, first-out (FIFO) cost or market basis. Crown Books' inventories are priced at the lower of FIFO cost or market.\nProperty and Equipment and Depreciation: The Company depreciates furniture, fixtures and equipment generally over a ten-year period using the straight-line method. Computer software is charged to expense in the year of acquisition. Computer equipment is depreciated over a five-year period using the straight-line method. All stores are leased except one store owned by Shoppers Food. Improvements to leased premises are amortized generally over a ten-year period, or the term of the lease, whichever is shorter. Assets financed through asset-based financing arrangements are depreciated over the lives of the leases.\nIncome Taxes: Trak Auto, Crown Books and Shoppers Food file separate income tax returns. CMREC, Total Beverage and Dart Financial are consolidated in the Corporation's income tax returns.\nThe Company implemented Statement of Financial Accounting Standards (\"SFAS\") No. 109, Accounting for Income Taxes, effective February 1, 1992. Adoption of the new standard resulted in recognition of a net deferred tax asset associated with the expected realization of Trak Auto's cumulative temporary differences not previously recognized (classified as the cumulative effect of a change in accounting principle). Prior to that date the Company accounted for income taxes under Accounting Principles Board No. 11.\nAdoption of New Accounting Pronouncements: The Company is required to adopt SFAS No. 112, Employers' Accounting for Postemployment Benefits, no later than its fiscal year ending January 31, 1995. The Company does not expect that implementing the standard will have a significant effect on the financial statements or results of operations.\nThe Company is required to adopt SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, no later than its fiscal year ending January 31, 1995. The Company does not expect that implementing the standard will have a significant effect on the financial statements.\nPre-Opening Expenses: All costs of a noncapital nature incurred in opening a new store are charged to expense during the year as incurred.\nFiscal Year: The Corporation's fiscal year ends on January 31 each year. Trak Auto, Crown Books, Shoppers Food and Total Beverage are reported to the Saturday closest to January 31.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(1) SIGNIFICANT ACCOUNTING POLICIES (Continued):\nExcess of Purchase Price Over Net Assets Acquired: The Company amortizes excess of purchase price over net assets acquired over a ten-year period using the straight-line method. However, Trak Auto has elected to amortize negative goodwill (arising from the utilization of a preacquisition net operating loss carryforward) over a five-year period since Trak Auto has utilized such net operating loss over the preceding five years.\nIndustry Segments: The Company operates specialty retail stores, grocery and beverage stores, a real estate company and a financial business that deals primarily in bankers' acceptances.\nEarnings Per Share: Earnings per share is based on the weighted average number of the Corporation's Class A and Class B common stock and common stock equivalents (certain stock options) outstanding during the period. In reporting earnings per share, the Corporation's interest in the earnings of its majority-owned subsidiaries is adjusted for the dilutive effect, if any, of these subsidiaries' outstanding stock options. The difference between primary earnings per share and fully diluted earnings per share is not significant for any period. Weighted average shares and share equivalents for the three years ended January 31, 1994, 1993 and 1992 were 1,867,000, 1,837,000 and 1,825,000, respectively.\nDividends: The holders of Class A Common stock are entitled to receive, when and as declared by the board of directors, noncumulative preferential dividends of up to thirty cents per share. If Class A dividends reach thirty cents per share, in any fiscal year, holders of Class B common stock are entitled to receive dividends not exceeding thirty cents per share. Any dividends cumulatively in excess of thirty cents per share would be shared as if they constituted a single class of stock. During the years ended January 31, 1994, 1993 and 1992, the Corporation paid dividends to the holders of Class A Common Stock at $.13 per share and has not paid dividends to holders of Class B Common Stock.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(2) INCOME TAXES:\nThe provision for income taxes on income before extraordinary items includes current income tax provision and deferred income tax provision as follows:\nAs a result of the Corporation's operating loss for the year ended January 31, 1994, a tax net operating loss carryforward of $7,090,000 was created. At January 31, 1994, the corporation's cumulative net tax operating loss carryforwards were $8,643,000 expiring by fiscal 2009. In addition, the Corporation has an Alternative Minimum Tax credit carryforward of approximately $1,010,000.\nAs a result of the adoption of SFAS No. 109, Accounting for Income Taxes, the Corporation has determined that it required an initial valuation allowance of $3,369,000 during the year ended January 31, 1993. During the year ended January 31, 1994, the Corporation increased the valuation allowance by $3,824,000 to $7,193,000. The valuation allowance was for tax net operating loss carryforwards and alternative minimum tax credit carryforwards, which are not able to be utilized at January 31, 1994 and certain temporary differences that the Corporation believe are not likely to be realizable.\nAt February 2, 1992, Trak Auto had existing unrecognized tax benefits on book net operating loss carryforwards of approximately $6,500,000 representing both preacquisition losses of Trak Auto West, Inc. (\"Trak West\"), and its own operating losses in 1991. In conjunction with the adoption of SFAS No. 109, Accounting for Income Taxes, Trak Auto recorded $1,658,000 as the cumulative effect of recognizing that portion of the previously unrecognized tax benefits that it concluded would more likely than not be realized and established a valuation reserve of $728,000.\nThe Company will evaluate the continuing need for its valuation reserves on a periodic basis.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(2) INCOME TAXES (Continued):\nThe effective income tax rate on income before income taxes, minority interest, extraordinary items and cumulative change in accounting principle is reconciled to the Federal statutory rate as follows:\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(2) INCOME TAXES (Continued):\nTemporary differences and tax carryforwards which give rise to deferred tax assets and liabilities on a consolidated basis are as follows:\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(3) TRANSACTIONS WITH AFFILIATES:\nShoppers Food Warehouse Corp.\nIn fiscal 1989 the Corporation acquired in excess of 50% of the common stock of Shoppers Food, which operates the Shoppers Food Warehouse discount grocery chain in the Washington, D.C. metropolitan area. As a result of the allocation of the net purchase price, the Corporation recorded approximately $11,160,000 as excess of purchase price over net assets acquired. The Corporation and Shoppers Food have a buy\/sell agreement whereby either shareholder has the right, at any time, to initiate procedures under which the initiating party offers both to sell to or buy from the other party the initiating party's or the other party's shares in Shoppers Food at the offer price. The recipient of the offer has the alternative of accepting the offer to sell or the offer to buy. The Corporation is unable to determine the effect that would result if either party initiates this procedure.\nDuring the year ended January 31, 1992, Shoppers Food acquired two Basics Supermarkets from Super Rite Foods, Inc. (\"Super Rite\"). In connection with the purchase of the Basics Supermarkets, Shoppers Food entered into a separate wholesale grocery multiyear supply agreement with Super Rite to supply the Shoppers Food Chain, in exchange for receipt of approximately $4,700,000 in cash and other considerations. This amount is being amortized over the 51 month term of the supply agreement.\nTotal Beverage Corporation:\nOn January 26, 1993, the Corporation organized Total Beverage under the laws of Delaware as a wholly-owned subsidiary. On February 27, 1993, Total Beverage purchased the assets of a discount beverage superstore located in Chantilly, Virginia for approximately $1,494,000 from Shoppers Food. In October 1993, Total Beverage opened two additional stores located in Alexandria and Manassas, Virginia. The stores sell beer, wine and non-alcoholic beverages.\nExercise of Subsidiary Stock Options\nIn each of the three years ended January 31, 1994, Trak Auto and Crown Books stock options have been exercised. As these options are exercised, the number of minority shares outstanding, and accordingly the minority share of the ownership of Trak Auto and Crown Books, increases. The difference attributable to the Corporation's change in ownership percentage for these subsidiaries is reflected in Paid-in Capital.\nCrown Books Corporation\nThe Corporation purchased 50,000 additional shares of Crown Books common stock during the year ended January 31, 1994 that increased its ownership to 51.35%.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(4) LEASE AND LICENSE COMMITMENTS:\nDescription of Leasing Arrangements\nThe Company leases stores, warehouses, leasehold improvements, fixtures and equipment. Renewal options are available on the majority of leases. In some instances, store leases require the payment of contingent rentals and license fees based on sales in excess of specified minimums. Certain properties are subleased with various expiration dates. Certain capital leases have purchase options at fair market value at the end of the lease.\nFollowing is a schedule by fiscal year of future minimum payments under capital leases, license agreements and non-cancelable operating leases having initial or remaining terms in excess of one year at January 31, 1994. The imputed interest rate on the capital leases is 14.74% in the aggregate.\nRent expense for operating leases and license arrangements are as follows:\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(4) LEASE AND LICENSE COMMITMENTS (Continued):\nCapital Lease Arrangements\nThe Corporation has a lease with a private partnership in which Haft family members own all of the partnership interests, for a 271,000 square foot headquarters building and distribution center in Landover, Maryland. The lease is for 30 years and six months, commenced in October 1985, and provides for increasing rental payments over the term of the lease. The current annual rental is $1,819,000. The lease requires the payment for maintenance, utilities, insurance and taxes. The distribution center was constructed by the partnership at a cost of approximately $8,300,000. The Corporation has sublet approximately 238,000 square feet to Trak Auto and Crown Books at a per square foot charge which is equal to the Corporation's per square foot cost under the master lease. The Corporation has a lease agreement with the aforementioned partnership for land, identified for future Trak Auto expansion, adjacent to the headquarters building and distribution center. The lease is for the same period as the headquarters building and distribution center lease. The lease provides for current annual rental of $33,000 with increases of three percent per year. The rent will be renegotiated upon commencement of construction of any improvements. Trak Auto has agreed to bear the annual carrying cost for the land.\nThe Corporation's majority-owned subsidiary, Trak Auto, entered into an agreement to lease a 176,000 square foot distribution center in Bridgeview, Illinois from a private partnership in which Haft family members own all of the partnership interests. The lease is for 30 years and six months, commenced April 1984 and provides for rental payments increasing approximately 15% every five years over the term of the lease. The current annual rental is $588,000. The lease requires payment of maintenance, utilities, insurance and taxes. The Corporation is jointly and severally liable for the lease obligations. The partnership purchased the warehouse on March 12, 1984 for approximately $3,100,000.\nThe Corporation's majority-owned subsidiary, Trak Auto, has an agreement to lease a distribution center in Ontario, California from a private partnership in which Haft family members own all of the partnership interests. The lease is for 20 years and commenced in December 1989. The lease also provides for increasing rental payments, based upon the Consumer Price Index for the Los Angeles area, over the term of the lease. The current annual rental is $1,130,000. The lease requires payment of maintenance, utilities, insurance and taxes. The partnership purchased the distribution center for approximately $10,800,000.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(4) LEASE AND LICENSE COMMITMENTS (Continued):\nThe Corporation's majority-owned subsidiary, Shoppers Food, has a lease agreement for a 86,000 square foot office building in Lanham, Maryland from a private partnership in which Haft family members and the owners of the minority interest in Shoppers Food own all of the partnership interests. The lease is for 20 years and commenced January 9, 1991. The lease provides for yearly increasing rental payments, based upon the Consumer Price Index for the Washington, D.C. Metropolitan Statistical Area, however the increases shall not be more than 6% or less than 3%. The current annual rental is $1,225,000. The lease requires payment of maintenance, utilities, insurance and taxes. The partnership purchased the office building for approximately $8,700,000 in July 1990. There are currently four unaffiliated subtenants in the office building. These subtenants are leasing approximately 36,000 square feet for a current annual rent of $518,000.\nThe capital lease arrangements described above are all included in the lease commitment table.\nLease Guarantee\nThe Corporation, because of its guarantee as part of the sale of its drug store division in 1985, reassumed its lease obligations for its former 533,800 square foot executive office facility and warehouse in Landover, Maryland. The leases are with a private partnership in which Haft family members own all of the partnership interests. The leases expire September 30, 2016 and provide for increasing rental payments over the term of the leases based on Consumed Price Index increases from a base period. The current annual rental is $845,326. The lease requires payment of maintenance, utilities, insurance and taxes. The Corporation has reserved $9.6 million which represents the present value of its estimated future costs under this guarantee.\nTrak Auto has an agreement with the Corporation to sublease 6,500 square feet of the facility. The term of the sublease is one year (with nine one-year option periods). The annual rental is $21,000 and will increase to $24,000 for each of the last five option periods. The sublease requires Trak Auto to pay approximately $6,000 annually for its share of common area maintenance, real estate taxes and insurance premiums. In addition, Shoppers Food has an agreement with the Corporation to rent (on a month to month basis) 6,000 square feet of the above facility for approximately $2,000 a month. The Corporation is actively marketing the remaining space for lease to unaffiliated parties.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(4) LEASE AND LICENSE COMMITMENTS (Continued):\nStore Operating Leases\nDuring the fiscal years ended January 31, 1994, 1993 and 1992, respectively, Trak Auto made rental payments of approximately $2,180,000, $2,008,000 and $1,848,000, Crown Books made rental payments of approximately $1,780,000, $1,410,000 and $1,433,000, and Shoppers Food made rental payments of approximately $2,873,000, $2,873,000 and $2,538,000 and Total Beverage made rental payments of approximately $361,000 during the year ended January 31, 1994 to CMREC shopping centers and to partnerships in which members of the Haft family own all or substantially all of the beneficial interests. Two of the stores involved were acquired by the partnerships within the past two years.\nStore Closing Costs\nThe costs associated with store closings are charged to expense when management makes the decision to close a store. Such costs consist primarily of future lease obligations (including rent, real estate taxes and common area maintenance charges), after the closing date, net of estimated sublease income, and the remaining book value of leasehold improvements.\nTrak Auto, Crown Books and Shoppers Food have closed stores in various markets with leases expiring through 2002. Net charges (income) of approximately $(574,000), $1,013,000 and $4,268,000 were recorded in fiscal 1994, 1993 and 1992, respectively, representing estimated unrecoverable lease costs, net of sublease the remaining book value of leasehold improvements and certain costs for these stores. Income during the year ended January 31, 1994 was the result of Trak Auto and Crown Books early terminations of lease agreements by Trak Auto and Crown Books, net of cash buyouts. Any settlements of lease obligations at amounts originally estimated are recorded at the time of settlement. Trak Auto, Crown Books and Shoppers Food continue to review store operations and may close additional underperforming stores in the future.\n(5) CERTAIN EVENTS:\nEmployment of Ronald S. Haft\nOn August 1, 1993, the Board of Directors of the Corporation approved an employment agreement with Ronald S. Haft (the \"Agreement\"), pursuant to which he was employed by the Corporation as its President and Chief Operating Officer for a term initially ending on January 31, 1997. The term is to be extended for one year on each February 1 that Ronald S. Haft is employed under the Agreement. The Agreement also provides that Ronald S. Haft will be nominated to the Board of Directors of the Corporation at each opportunity during the term of the Agreement; he was elected as a director of the Corporation July 28, 1993. Ronald S. Haft also was elected as a Director of the Corporation's subsidiaries. Under the terms of the Agreement, Ronald S.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(5) CERTAIN EVENTS (Continued):\nHaft may engage, directly or indirectly, in any other business activities so long as they do not interfere with his duties to the Corporation.\nSale of Options to Ronald S. Haft\nUnder the Agreement, Ronald S. Haft acquired for $5.00 per share options (the \"Options\") to purchase 197,048 shares of the Corporation's Class B Common Stock, par value $1.00 (\"Dart Class B Stock\"). All issued and outstanding Dart Class B Stock, which is the only class of common stock of the Corporation with voting rights, is held by members of the Haft family. The total acquisition price for the Options, which has been paid, was $985,240.\nThe exercise price for the Options is $89.65 per share, which as required by the Agreement is 110% of the reported closing price for shares of the Corporation's Class A Common Stock, par value $1.00, on the last trading date prior to the authorization of the Agreement. The Options were immediately exercisable as of the date of the Agreement and expire August 1, 2008. The Options may be exercised by notice to the Corporation, with payment in cash following within 30 days of the notice. Further, if Ronald S. Haft's employment is terminated other than for conviction of an offense involving moral turpitude or for conviction of a felony, he will have the right to exercise all of the Options prior to or at such time; in the event of his death, his personal representative shall have the right to exercise the Options within 60 days thereof.\nUnder the Agreement, the Corporation also agreed to loan to Ronald S. Haft the full amount of the exercise price of any Options which he may exercise. Any such loan is to bear interest at the Prime Rate charged as of the date of the loan by NationsBank or its successor. Principal and interest on any such loan is to be due separately upon the earlier of (i) the sale of shares of Dart Class B Stock purchased with the loan proceeds, (ii) the fifth anniversary of the loan, or (iii) 90 days from the termination of Ronald S. Haft's employment under the Agreement.\nSale of Class B Common Shares to Ronald S. Haft\nOn July 28, 1993, Herbert H. Haft sold his 172,730 shares of Dart Class B Stock to Ronald S. Haft for the purchase price of $80.00 per share, and Ronald S. Haft granted to Herbert H. Haft an irrevocable proxy to vote those shares until his death or incapacity. The total acquisition price for these shares was $13,818,400, of which $2,763,680 was paid at closing; the remaining $11,054,720 was paid for with a promissory note bearing interest at 6.61%, the applicable federal rate, as announced in the Federal Register on July 28, 1993, with the principal amount and any accrued but unpaid interest due and payable on August 1, 2013. Accordingly, as of January 31, 1994, there were 302,952 issued and outstanding shares of Dart Class B Stock, of which Ronald S. Haft owned 25,246 shares (or 8.33%), and another 172,730 shares (or 57.02%) without the power to vote, for a total of 197,976\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(5) CERTAIN EVENTS (Continued):\nshares (or 65.35%). If all of the shares of Dart Class B Stock covered by the Options were issued, there would be 500,000 issued and outstanding shares of Dart Class B Stock, of which Ronald S. Haft would then own 395,024 shares (or 79.00%), with voting power over 222,294 shares (or 44.46%), and Herbert H. Haft would have voting power over 172,730 shares (or 34.54%).\n(6) LITIGATION:\nRobert M. Haft Employment Litigation\nIn August 1993, Robert M. Haft filed a lawsuit in the United States District Court for the District of Delaware naming as defendants the Corporation and two of its subsidiaries, Crown Books and Trak Auto. The complaint, as amended, alleges breach of contract regarding various employment, stock option, stock incentive and loan agreements and seeks declaratory judgment regarding a stock incentive agreement (see Note 10 to the Consolidated Financial Statements) and a possible right by Robert M. Haft to acquire an interest in Total Beverage Corporation, a wholly-owned subsidiary of the Corporation. The complaint, as amended, seeks unspecified damages, costs and attorneys fees.\nUnder the terms of the employment agreements, if upheld by the Court, the Corporation and Crown Books could be required to pay stated compensation plus incentives based on operating or other financial factors. Minimum payments by the Company could be as much as $31.8 million over a nine year period ($16.0 million on an after tax basis, discounted at a 10% rate).\nManagement believes that the Corporation and its subsidiaries have strong defenses to these allegations and intends to contest such claims vigorously. Discovery in the litigation is complete and cross motions for summary judgment have been filed regarding virtually all significant claims. Although the ultimate outcome of this action cannot be ascertained at this time, it is the opinion of management that the resolution will not have a material adverse effect on the Corporation's and its subsidiaries' financial condition or results of operations.\nDerivative Litigation\nIn September 1993, Alan R. Kahn and Tudor Trust, shareholders of the Corporation, filed a lawsuit in the Delaware Court of Chancery for New Castle County naming as defendants Herbert H. Haft, Ronald S. Haft, Douglas M. Bregman, Bonita A. Wilson, Combined Properties, Inc. (\"CPI\"), Combined Properties Limited Partnership (\"Combined\"), and Capital Resources Limited Partnership. The suit is brought derivatively and names as nominal defendants the Corporation and five of its subsidiaries, Trak Auto, Crown Books, Shoppers Food, Total Beverage, and CMREC. The complaint alleges waste, breach of fiduciary duty, and entrenchment in connection with various lease agreements between the Combined Properties defendants and the Corporation and\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(6) LITIGATION (Continued):\nits subsidiaries, the compensation paid Ronald S. Haft and Herbert H. Haft, the Corporation's Agreement with Ronald S. Haft, and the sale of Dart Class B Stock by Herbert H. Haft to Ronald S. Haft. Plaintiffs seek an accounting of unspecified damages incurred by the Corporation, voiding of the options sold to Ronald S. Haft, and costs and attorneys' fees.\nIn November 1993, Robert M. Haft filed another lawsuit in the Delaware Court of Chancery for New Castle County. The lawsuit names as defendants Herbert H. Haft, Ronald S. Haft, Douglas M. Bregman, and Bonita A. Wilson, and also names the Corporation as a nominal defendant. The complaint derivatively alleges interested director transactions, breach of fiduciary duty and waste in connection with the Corporation's Agreement with Ronald S. Haft. Robert M. Haft also brings individual claims for breach of contract and dilution of voting rights in connection with the sale of Dart Class B Stock by Herbert H. Haft and the Corporation's Agreement with Ronald S. Haft. The complaint seeks rescission of the sale of Dart Class B Stock and the options Agreement, unspecified damages from the individual directors, and costs and attorneys' fees.\nIn both of these lawsuits, a Special Litigation Committee consisting of two outside, independent directors has been appointed by the Board of Directors to assess, on behalf of the Corporation, whether to pursue, settle or abandon the claims. Given that the law suits are brought in the name of the Corporation, recovery in them would inure to the benefit of the Corporation if the claims in them are successfully litigated or settled. It is therefore the opinion of management that the resolution of these actions will not have a material adverse effect on the consolidated financial condition or annual results of operations of the Corporation.\nTotal Beverage Litigation\nIn October 1993, the Corporation and two of its wholly-owned subsidiaries, Total Beverage and Total Beverage G.B., Inc., filed a lawsuit in the United States District Court for the Eastern District of Virginia styled The Dart Group Corporation v. The Globe Distributing Company of Virginia, Inc., d\/b\/a The Forman Distributing Company of Virginia, Inc., et al., CA No. 93-1307-A (E.D. Va.). The lawsuit names as defendants The Globe Distributing Company, Inc. d\/b\/a The Forman Distributing Company of Virginia, Inc. (\"Forman\"), four other Virginia wine wholesalers, and several of their principals. The complaint, as amended, alleges violations of the federal and Virginia state antitrust laws and intentional tortious interference with contract by reason of an alleged conspiracy among the wholesalers to divide territories and allocate customers. The complaint, as amended, seeks injunctive relief and unspecified damages, costs and attorneys' fees. In January 1994, the defendants filed counterclaims against the plaintiffs for defamation, conspiracy to injure in reputation, trade and business, conspiracy to coerce and compel, tortious interference with contractual relations and business expectancies, and violation of the Lanham Act.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(6) LITIGATION (Continued):\nSubsequent to January 31, 1994, all claims and counterclaims in these actions were settled. The terms and conditions of the settlement agreements will not have a material adverse effect on the consolidated financial condition or operating results of the Corporation.\nThe Corporation and its subsidiaries have recorded expenses of approximately $8.0 million during the year ended January 31, 1994 for legal expenses incurred during the year. This includes an estimated future amount considered to resolve all legal matters discussed above.\nOther\nIn the normal course of business, the Company is involved in various claims and litigation. It is the opinion of management and counsel that the disposition of these matters will not materially affect the Company's financial position.\n(7) CREDIT AGREEMENT:\nThe Corporation is party to a revolving credit agreement, together with Trak Auto and Crown Books, for a $6,000,000 revolving line of credit. The $6,000,000 is an aggregate amount and not specifically allocated to any of the parties. The line is intended to be used for the issuance of standby and trade letters of credit. At January 31, 1994, there had been no borrowings under the credit agreement. This line of credit expires May 1, 1995.\n(8) CABOT-MORGAN REAL ESTATE COMPANY:\nIn September 1989, the Corporation organized CMREC, a wholly-owned subsidiary. CMREC was organized under the laws of Delaware as a real estate development company.\nIn December 1989, CMREC and Combined Properties\/Briggs Chaney Plaza Limited Partnership (\"Combined\/Briggs Chaney\"), a Delaware limited partnership of which the partners are members of the Haft family, formed CM\/CP Briggs Chaney Plaza Joint Venture (\"CM\/CP Briggs Chaney\"). On December 31, 1989, CM\/CP Briggs Chaney purchased Briggs Chaney Plaza Shopping Center located in Silver Spring, Maryland, for approximately $30,000,000, of which land was approximately $5,986,000, building and improvements was approximately $24,066,000, including the assumption of mortgages. There have been no material additions or improvements to land and building and improvements since acquisition and the carrying amount of these assets was $27,189,000 at January 31, 1994.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(8) CABOT-MORGAN REAL ESTATE COMPANY (Continued):\nIn December 1989, CMREC and Combined Properties\/Greenway Center Limited Partnership (\"Combined\/Greenway\"), a Delaware limited partnership of which the partners are members of the Haft family, formed CM\/CP Greenway Center Joint Venture (\"CM\/CP Greenway\"). On December 31, 1989, CM\/CP Greenway purchased Greenway Center located in Greenbelt, Maryland, for approximately $39,300,000, of which land was approximately $7,813,000, building and improvements was approximately $31,376,000, including the assumption of mortgages. There have been no material additions or improvements to land and building and improvements since acquisition and the carrying amount of these assets was $35,688,000 at January 31, 1994.\nCMREC owns 75% of CM\/CP Briggs Chaney and 75% of CM\/CP Greenway. The remaining 25% interests are owned by the aforementioned limited partnerships. CPI, which is owned by members of the Haft family, provides certain services to the shopping centers at a cost comparable to that available from unaffiliated parties.\nOn March 12, 1991, CMREC acquired from an entity owned by Haft family members, a 51% interest in CM\/CP Greenbriar Retail Joint Venture (\"CM\/CP Greenbriar Retail\") and a 51% interest in CM\/CP Greenbriar Office Joint Venture (\"CM\/CP Greenbriar Office\"), which own Greenbriar Town Center Shopping Center and Greenbriar Town Center Office Building, respectively, located in Fairfax, Virginia. The purchase price for the Corporation's interest in CM\/CP Greenbriar Retail and CM\/CP Greenbriar Office was approximately $20,000,000, which represents 51% of the original cost to the seller of the entire center plus interest and other net holding period costs of approximately $1,350,000 (buyers share). The outside members of CMREC's board of directors approved this transaction. In addition, the Corporation paid fees to CPI for leasing, acquisition and development of the Center at a cost comparable to that available from unaffiliated parties. The Corporation's portion of these fees was approximately $1,300,000. The seller acquired the property on October 24, 1989. The Haft family entity continues to own the remaining 49% interest and CPI manages CM\/CP Greenbriar Retail and CM\/CP Greenbriar Office. The initial cost of land and building and improvements in CM\/CP Greenbriar Retail and CM\/CP Greenbriar Office was approximately $41,392,000. Greenbriar Town Center completed renovation and expansion in fiscal 1993 and the carrying amount of land and building and improvements was $69,653,000 at January 31, 1994.\nOn January 18, 1993, CMREC and CP\/Bull Run Limited Partnership (\"Combined\/Bull Run\"), a Maryland limited partnership of which the partners are members of the Haft family, formed CM\/CP Bull Run Joint Venture (\"CM\/CP Bull Run\"). CMREC owns 51% of CM\/CP Bull Run and Combined\/Bull Run owns 49%. On January 18, 1993, CM\/CP Bull Run purchased a shopping center known as Festival at Bull Run located in Prince William County, Virginia, for approximately $14,097,000 of which land was approximately $5,938,000 and building and improvements was approximately $8,187,000. CMREC's share of the cash portion of the purchase price was approximately $2,647,000. In addition, CMREC has a loan agreement with CM\/CP Bull Run for up to $15,450,000, of which\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(8) CABOT-MORGAN REAL ESTATE COMPANY (Continued):\n$8,250,000 had been utilized toward the purchase price of the center and was considered a bridge loan until CM\/CP Bull Run could secure other financing. Subsequently, CM\/CP Bull Run secured other financing and the $8,250,000 was repaid. The remaining $7,200,000 is intended to fund the construction of certain improvements to the center. At January 31, 1994, CM\/CP Bull Run had borrowed $5,123,000 against the remaining $7,200,000. CM\/CP Bull Run has an agreement with CPI that engages CPI to manage the center.\nCPI charged the four properties for management and related services $3,264,000, $2,365,000, and $3,438,000 in fiscal 1994, 1993 and 1992, respectively.\nTrak Auto, Crown Books, Shoppers Food and Total Beverage have leases in several of the properties in which CMREC has an interest. Rental payments on these leases were $1,765,000, $332,000, and $232,000 in 1994, 1993 and 1992, respectively. The future lease commitments on these leases excluding option periods are $21,591,000 expiring on dates through 2013.\nEach of these CMREC partnerships contains a buy\/sell option under which the partners have the right, at any time, to initiate procedures under which the initiating party offers both to sell to or buy from the other party the initiating party's or the other party's shares in the partnership at the offer price. The recipient of the offer has the alternative of accepting the offer to sell or the offer to buy. The Corporation is unable to determine the effect that would result if either party initiates this procedure.\nDuring the year ended January 31, 1994, CM\/CP Briggs Chaney refinanced two mortgages at Briggs Chaney Shopping Center into one $16,000,000 mortgage and CM\/CP Bull Run obtained a $9,750,000 mortgage. All mortgages payable are secured by the land and buildings and leasehold improvements. Based on borrowing rates currently available for bank loans with similar terms, the fair value of the mortgages are $87,699,000.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(8) CABOT-MORGAN REAL ESTATE COMPANY (Continued):\nMortgage payable at January 31, 1994, consists of the following:\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(8) CABOT-MORGAN REAL ESTATE COMPANY (Continued):\nMaturities of the mortgages payable as of January 31, 1994 are as follows:\nDescription of Leasing Arrangements\nRenewal options are available to the majority of the tenants of CMREC properties and the leases require payment of contingent rentals and license fees based on sales in excess of specified minimums. The net book value of the property held for lease by CMREC included in land, building and leasehold improvements on the accompanying balance sheet at January 31, 1994 was $156,714,000 and the mortgage payable (current and long-term) of $81,697,000 is in connection with these CMREC assets.\nThe following is a schedule by fiscal year of future minimum rental income under these leases having initial or remaining terms in excess of one year at January 31, 1994.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(9) RESTRUCTURING CHARGE\nTrak Auto\nDuring the year ended January 30, 1993, Trak Auto recorded a restructuring charge of $7,400,000, before income taxes. The restructuring charge is divided into two categories consisting of the estimated cost of relocating or expanding an estimated 126 stores to Super Trak stores and discontinuing operations in an estimated 38 stores. The restructuring charge for the two components consists of unrecoverable lease obligations (rent, real estate taxes and common area charges) after the projected closing date of the store or upon remodel or expansion, the write-off of leasehold improvements and costs associated with changing store fixtures for new product lines and cost associated with inventory conversion, as follows:\nThe above lease obligations are for basic lease terms of from one to 74 months. In the case of relocations\/expansions, the reserve has been estimated at 50% of the total lease obligations because Trak Auto believes that certain alternatives to abandonment may be available. These alternatives include leasing different or additional space from the same landlord, subletting the existing space, lease termination and lease buy-out. Therefore, no provision for leasehold improvement write-off has been made, and only one-half of the full lease obligation has been provided.\nThe amount of unrecoverable lease costs relating to properties under related party leases is approximately $823,000.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(9) RESTRUCTURING CHARGE (Continued):\nDuring the year ended January 29, 1994, Trak Auto charged approximately $600,000 against the restructuring reserve, primarily for the write-off of the net book value fixed assets in stores that were converted to Super Traks.\nThe following table indicates the fiscal years in which the restructuring reserve is expected to be utilized.\nCrown Books\nDuring the year ended January 30, 1993, Crown Books recorded a restructuring charge of $6,600,000 before income taxes. The charge includes the anticipated costs associated with closing, relocating, expanding and converting existing stores to the Super Crown Books concept. These costs are primarily unrecoverable lease obligations and the remaining book value of leasehold improvements from the estimated closing date. During the year ended January 29, 1994, Crown Books charged approximately $840,000 against this reserve.\nCrown Books continues to test various concepts (principally related to the size of the store) in its Super Crown Books prototypes. As a result of these test stores, Crown Books has determined that a number of the smaller Super Crown Books stores opened in previous years (typically 6,000 - 10,000 square feet) are not a competitive format in the current environment. These stores have been negatively impacted by the industry's roll out of larger stores.\nAccordingly, Crown Books recorded an additional restructuring charge of $6,200,000 in the year ended January 29, 1994, representing the anticipated costs (unrecoverable lease costs and the remaining book value of leasehold improvements and store fixtures subsequent to management's estimate of the stores' closing dates) associated with closing, relocating and converting these smaller Super Crown Books stores to the new, larger Super Crown Books prototype.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(9) RESTRUCTURING CHARGE (Continued):\nThe restructuring reserve as of January 29, 1994 of approximately $11,960,000 is comprised of the following components:\nThe above lease obligations are for primary terms from 16 to 126 months.\nThe amount of unrecoverable lease costs relating to properties under related party is approximately $708,200.\nThe following table indicates the fiscal years in which the restructuring reserve is expected to be utilized.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(10) INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS (See Notes 4 and 8):\nLeasing Agreements\nThe Corporation's subsidiaries, Trak Auto, Crown Books, Shoppers Food and Total Beverage lease certain real property from CMREC and Haft family owned partnerships. The leased properties consist of 54 stores and four warehouses. These leases provide for various termination dates, which, assuming renewal options are exercised, range from 1994 to 2033 and require the payment of minimum rentals aggregating approximately $318,932,000 to the lease expiration dates. Minimum rentals under these leases are approximately $115,203,000 to the expiration of their original terms. Certain of these leases also require the payment of a percentage of sales in excess of a stated minimum, as well as real estate tax increases.\nPrior to January 29, 1994, the outside members of the board of directors of the Corporation, Trak Auto and Crown Books approved each related party lease. After January 29, 1994, the Real Estate Committee (composed of one independent director) of the Board of Directors approves these transactions. The board of directors are provided with a fairness opinion attesting that the proposed lease is representative of market rent for the subject property. Haft family members do not vote on these leases.\nEmployment Agreement\nThe Corporation has ten-year employment agreements with Mr. Herbert H. Haft and Mrs. Gloria G. Haft, which are automatically extended for an additional year on each January 31 in the absence of an election not to extend the contract. The agreements provide for salaries for Mr. and Mrs. Haft of $1,281,000 and $195,000, $1,154,000 and $177,000, $1,038,000 and $161,000, respectively for the years ended January 31, 1994, 1993 and 1992, respectively, with certain annual cost of living increases based on the CPI (with a minimum increase of 10% annually plus $12,000 for Mr. Haft and 10% annually for Mrs. Haft). Both Mr. Haft and Mrs. Haft elected not to receive the increases in fiscal 1993 and 1992 and therefore their annual salaries remained at $933,000 and $146,000, respectively, for those years. In addition, the agreements provide life insurance coverage and certain other benefits. Mr. Haft's agreement also provides for an annual bonus equal to 1-1\/2% of the Company's consolidated pretax profit not reduced as a result of transactions which are not ordinary, while Mrs. Haft's agreement provides for an annual bonus equal to 3\/8 of 1% of the Company's consolidated pretax profit. Further, the Corporation has agreed to lend to Mr. Haft the funds necessary to purchase a $3,000,000 life insurance policy on his life or on the life of Mrs. Haft or any combination thereof, at his discretion. The Corporation has also agreed to lend Mrs. Haft the funds necessary to purchase a $1,000,000 life insurance policy on her life. At January 31, 1994, Mr. Haft had purchased a $1,000,000 life insurance policy on the life of Mrs. Haft. Mr. Robert M. Haft (the Corporation's former President and Chief Operating Officer) had purchased two $3,000,000 life insurance policies on his life under similar terms with funds\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(10) INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS (See Notes 4 and 8) (Continued):\nloaned by the Corporation and Crown Books. At January 31, 1994, the loan balance for these policies was approximately $288,000 and $477,000 for Herbert H. Haft and Robert M. Haft respectively, and was collateralized by the cash surrender values. The Corporation has elected not to charge interest on these loans.\nHerbert H. Haft's agreement provides for a supplemental bonus related to years beginning February 1, 1984 based on certain performance criteria for the three year period ended January 31, 1985 and each three-year period thereafter. The supplemental bonus payable to him equals the greatest of (i) 3% of the increase in the aggregate market value of the Class A Common Stock on the last day of the three-year period over such market value on the first day of such period; (ii) 3% of any excess in consolidated stockholders' equity (based on generally accepted accounting principles) on the last day of the three-year period over such stockholders' equity on the first day of such period; (iii) 3% of the aggregate consolidated net income during the three-year period; and (iv) his base salary and annual bonus for the last year of the three-year period. The amount accrued under this supplemental bonus plan was approximately $1,531,000 for the three years ended January 31, 1994. The annual bonuses accrued for Herbert and Gloria Haft for the year ended January 31, 1994 was approximately $129,000 and $32,000, respectively. Mr. Herbert H. Haft may elect to receive all or part of the compensation in the future in the form of an option for shares of the Corporation's Class A Common Stock or defer receipt of such income.\nOn August 1, 1993, the Board of Directors of the Corporation approved an employment agreement with Ronald S. Haft (the \"Agreement\"), pursuant to which he was employed by the Corporation as its President and Chief Operating Officer for a term initially ending on January 31, 1997. The term is to be extended for one year on each February 1, that Ronald S. Haft is employed under the Agreement. Ronald S. Haft's annual base salary is $400,000 and shall be increased annually effective February 1, 1995 and each February 1 through the term of the agreement based on review and performance appraisal by the Corporation's Board of Directors. The Agreement provides for a supplemental bonus beginning February 1, 1994 and ending January 31, 1997 with terms similar to Mr. Herbert H. Haft's supplemental bonus and provides for an annual bonus equivalent to Mr. Herbert H. Haft's. The annual bonus accrued for Ronald S. Haft for the year ending January 31, 1994 was approximately $129,000. Mr. Ronald S. Haft may elect to receive all or part of the compensation in the future in the form of an option for shares of the Corporation's Class A Common Stock or defer receipt of such income.\nIn fiscal 1988, the Corporation's Board of Directors concluded that it would be appropriate for Herbert H. Haft and Robert M. Haft each to participate individually in acquisitions of other companies by the Corporation on the same terms and conditions as management of the acquired company might participate or by the purchase of each of ten percent (10%) of the Corporation's interest in the acquired company on an equivalent basis as is paid by the Corporation.\nThe Corporation's interest in Shoppers Food is held through a wholly\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(10) INTEREST OF MANAGEMENT AND OTHERS IN CERTAIN TRANSACTIONS (See Notes 4 and 8) (Continued):\nowned subsidiary, Dart\/SFW Corp. In fiscal 1990, the Corporation granted both Herbert H. Haft and Robert M. Haft an option to purchase up to ten shares of the common stock of Dart\/SFW Corp., or 10 percent of such stock on a fully diluted basis, for approximately $192,688 per share. Each such option is exercisable in whole or in part during the period beginning on August 8, 1994 and ending on August 8, 2004; provided that such options become immediately exercisable in the event of a Major Business Change (as defined in the option agreement) and for a period of ten years thereafter. At any time within three years after receipt of the Dart\/SFW shares pursuant to the exercise of an option, Herbert Haft or Robert Haft, as the case may be, may require the Corporation to purchase all or part of such shares at their then fair market value, as determined by an independent appraiser selected by the Corporation's Board of Directors. Pursuant to agreements dated January 11, 1990, Herbert H. Haft assigned and transferred his option to acquire ten shares of Dart\/SFW Corp. to his two children, Ronald S. Haft and Linda G. Haft, and Robert M. Haft assigned and transferred his option to acquire six shares of Dart\/SFW Corp to Trusts established for the benefit of his two children, Michael A. Haft and Nicholas G. Haft.\nIncentive Stock Agreement\nIn fiscal 1990, Crown Books entered into an incentive stock agreement with Robert M. Haft, the former President of Crown Books. Under the terms of the agreement, Crown Books issued 100,000 shares of stock to Mr. Haft in return for a non-interest bearing promissory note, discounted at an 11% effective interest rate, of $203,750, due January 2, 2004. The agreement provides that the stock certificate representing the 100,000 shares state that the shares are subject to certain transfer restrictions. Crown Books has the right, expiring ratably over the period from January 2, 1999 to January 2, 2001, to repurchase all or a portion of the shares, subject to certain conditions, in the event Mr. Haft voluntarily terminated employment with Crown Books. Crown Books believes that conditions exist which so entitle Crown Books to exercise its right to purchase all or part of the shares issued to Mr. Haft under the agreement at their original issuance price. This matter is in litigation discussed below. As of January 31, 1994, Crown Books had not elected to exercise its right under the agreement to purchase the shares. Purchase of the shares issued to Mr. Haft would result in Crown Books recording a pre-tax gain of approximately $900,000 (on a consolidated basis $462,000 after minority interest) reflecting recovery of compensation previously recognized by Crown Books.\nIn August 1993, Robert M. Haft filed a lawsuit in the United States District Court for the District of Delaware styled Robert M. Haft v. Dart Group et al. (see Note 6 to the Consolidated Financial Statements). Robert M. Haft seeks, among other requests, that Crown Books reissue to Robert M. Haft the stock certificate representing the 100,000 shares without any stated restrictions on the use or transfer of the shares. Reissuance of the shares without restriction would result in Crown Books recording a pre-tax loss of\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\napproximately $1,300,000 (on a consolidated basis $668,000 after minority interest) reflecting the write-off of deferred compensation recorded in Crown Books financial statements on January 31, 1994.\n(11) MINORITY INTERESTS:\nThe $140,637,000 of minority interests reflected in the Consolidated Balance Sheet as of January 31, 1994 represents the portion of real estate partnerships' equity owned by the Haft family partnerships, the portion of Trak Auto and Crown Books equity owned by the public shareholders of Trak Auto and Crown Books, respectively, and the portion of Shoppers Food equity owned by the shareholders of Shoppers Food (other than the Corporation). Income attributed to the minority shareholders of Trak Auto was $27,000, $1,529,000 and $655,000 for the years ended January 31, 1994, 1993 and 1992, respectively. Income (loss) attributed to the minority shareholders of Crown Books was $(101,000), $2,014,000, and $4,825,000 for the years ended January 31, 1994, 1993 and 1992, respectively. Income attributed to the minority ownership of Shoppers Food for the year ended January 31, 1994, 1993 and 1992 was $6,203,000, $4,120,000, and $6,189,000, respectively. Income (loss) attributed to the minority ownership of real estate partnerships was $383,000, $1,003,000, and $133,000 for the years ended January 31, 1994, 1993 and 1992, respectively.\n(12) STOCK OPTION PLANS:\nDart Group Corporation 1992 Stock Option Plan\nThe Corporation has adopted a stock option plan (the \"1992 Plan\") for officers, key employees and directors. The total number of shares that may be issued under the 1992 Plan is 400,000 and the 1992 Plan will terminate June 2, 2002. Options granted pursuant to the 1992 Plan may be incentive stock options, as defined in Section 422 of the Internal Revenue Code or may be non-qualified options. Based on options outstanding at January 31, 1994, the maximum shares issuable under options exercisable over the next five years are: 19,207 in 1995, 41,332 in 1996, 45,750 in 1997 and 1998 and 32,000 in 1999.\nInformation concerning stock options under the 1992 Plan is as follows:\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(12) STOCK OPTION PLANS (Continued):\nOptions for 352,750 shares remain available for grant and 4,583 options were exercisable at January 31, 1994.\nDart Group Corporation 1981 Stock Option Plan\nThe Corporation has a 1981 stock option plan (the \"1981 Plan\") in which directors, officers and key employees participate. Based on outstanding options, on January 31, 1993 the maximum number of shares subject to options exercisable in each of the next three years is 42,500 in 1995, 28,750 in 1996 and 15,000 in 1997. The 1981 Plan terminated December 4, 1991 and no more options may be granted under the 1981 Plan.\nInformation concerning stock options under the 1981 Plan is as follows:\nAt January 31, 1994 there were 36,746 options exercisable under the 1981 Plan.\nThe Board of Directors of the Corporation has authorized certain officers and directors of the Corporation to apply for loans from the Corporation to exercise their vested stock options. Under the plan approved by the board, the loans must bear interest at the prime rate, adjusted annually, must be secured by all of the stock acquired by exercise of the options, must be repaid out of the first proceeds of sale of stock or at the end of three years, whichever is earlier, and the borrower must demonstrate to the Corporation's chief financial officer both that it would be difficult to dispose of the number of shares on the open market and that he or she presents a reasonable credit risk to the Corporation. The Board of Directors for both Trak Auto and Crown Books have authorized such loans to certain officers and directors of Trak Auto and Crown Books.\nIn May 1983, the Corporation adopted an executive non-qualified stock option Plan (the \"Plan\"), amended in September 1983, which provides that a total of 199,500 shares of Class A Common Stock may be issued. Options for 177,500 shares were granted under this Plan when it was adopted. The exercise price at the time of the grant was equal to 100% of the fair market value ($82.50 per share) of the Class A Common Stock. The Plan provides that in the\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(12) STOCK OPTION PLANS (Continued):\nevent of a \"major business change\" the exercise price of options held by persons who are employees of the Corporation on the day immediately preceding such a change is reduced to $20.00 per share. The sale of the Corporation's drug store division in 1985 constituted a major business change as defined by the Plan. Accordingly, outstanding options for 154,500 shares are exercisable at $20.00 per share and options for 3,990 shares are exercisable at $82.50 per share. Options granted under the Plan are exercisable until 1998. The Corporation may lend to each optionee, without interest, as long as he\/she is an employee of the Corporation, the funds necessary to exercise the options until the earlier of three years, the sale of the shares thereby acquired or termination of the optionee's association with the Corporation or the Corporation may permit the optionee to pay for the shares acquired on exercise with shares of the Corporation's Class A Common Stock valued at the market price on the date of exercise. The options are only transferable by will or by the laws of descent and distribution. Options for 100, and 2,000 shares were exercised during the fiscal years ended January 31, 1993 and 1992, respectively. No options were exercised in fiscal 1994.\nIn September 1987, the Corporation adopted the 1987 Executive Non-Qualified Stock Option Plan (\"1987 Plan\"). The 1987 Plan provides for the grant of options to purchase, in the aggregate, 199,500 shares of Class A Common Stock and granting to each of Herbert H. Haft and Robert M. Haft options to purchase 99,750 shares of Class A Common Stock at an exercise price of $148.50 per share, or fair market value at the time of the grant. (On December 9, 1987, when the 1981 Plan exercise prices were reduced, the exercise price for the 1987 Plan was reduced to $68.25 per share.) The 1987 Plan provides that in the event of a \"major business change\" the exercise price of options held by persons who are employees of the Corporation on the day immediately preceding such change is reduced to $36.00 per share. (On December 9, 1987, the exercise price in the event of a \"major business change\", which has not occurred, was reduced to $16.40 per share.) Options granted under the 1987 Plan are exercisable on or after April 1, 1988 and prior to September 30, 2002. The Corporation may lend to each optionee, without interest, as long as he is an employee of the Corporation, the funds necessary to exercise the options until the earlier of three years, the sale of the shares thereby acquired or termination of the optionee's association with the Corporation or the Corporation may permit the optionee to pay for the shares acquired on exercise with shares of the Corporation's Class A Common Stock valued at the market price on the date of exercise. The options are only transferable by will or by the laws of descent and distribution.\nStock options granted for Trak Auto and Crown Books would not, if exercised, have a material dilutive effect on the Corporation's equity interest in those entities.\nStock options granted for Crown Books would, if all were exercised, reduce the Corporation's ownership percentage to 48.9%.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(13) EMPLOYEES' PROFIT-SHARING PLAN\nThe Corporation, Trak Auto and Crown Books maintain separate non-contributory profit-sharing plans for all full-time employees with one year of continuous employment. Annual contributions to the plans are based on a discretionary percentage of net income, as defined in the respective plan, and as determined by the respective board of directors. Contributions are allocated to individual employees based on each employee's salary in relation to the total salaries of all eligible employees. Contributions paid or accrued for the Corporation's, Trak Auto's and Crown Books' plans for the years ended January 31, 1994, 1993 and 1992 were $400,000, $1,175,000, and $870,000, respectively.\nShoppers Food maintains a non-contributory profit sharing plan with discretionary contributions to qualified employees. Generally, employees who complete one year of service are eligible to participate in the plan. The Board of Directors of Shoppers Food authorized contributions of $300,000 to the plan for the 1993 plan year. No contribution was authorized for the 1992 plan year.\n(14) 14% SUBORDINATED DEBENTURES:\nDuring the years ended January 31, 1993 and 1992, the Corporation redeemed its outstanding 14% Subordinated Debentures in face amounts of $29,120,000 and $75,000,000, respectively. The after tax losses associated with these redemptions, including unamortized discount and issue costs, $885,000 and $1,589,000 have been classified as an extraordinary item. As of January 31, 1993, all of the Corporation's debentures had been redeemed.\n(15) UNUSUAL ITEM:\nTrak Auto had 15 stores substantially damaged or completely destroyed in the Los Angeles civil disturbances in May of 1992. Eleven of these stores have subsequently reopened and four remain closed. At January 31, 1993, Trak Auto had received payments from insurance carriers of approximately $6,400,000 and recorded a receivable of an additional $3,600,000 which represent settlement of Trak Auto's insurance claims. Trak Auto received these funds during the first quarter of fiscal 1994. The payment and receivable, less related expenses and the cost of the related inventory and fixed assets lost, have been recorded as a gain, classified as an unusual item during the year ended January 31, 1993.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(16) SEGMENT INFORMATION:\nThe Company's four primary business segments are retail specialty, retail grocery, a real estate company and a financial company. The following is a summary of selected consolidated information for the business segments during January 31, 1994, 1993 and 1992:\n(1) Includes income from bankers' acceptances. (2) Includes consolidating eliminations and adjustments.\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(16) SEGMENT INFORMATION (Continued):\nDART GROUP CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nYEARS ENDED JANUARY 31, 1994, 1993 and 1992\n(17) INTERIM FINANCIAL DATA (Unaudited):\nSelected interim financial data for the fiscal years ended 1994 and 1993 are as follows:\n(1) After deduction for cost of sales, store occupancy and warehousing expenses. (2) The sum of these amounts does not equal the annual amount because of the changes in the average number of shares outstanding during the year. (3) After deduction in 4th Quarter for restructuring charge.\nFinancial data for the year ended January 31, 1994, has been restated to reflect the adoption of SFAS No. 109, Accounting for Income Taxes, effective February 1, 1992.\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 directors and executive officers of the Corporation are as follows.\nDirectors are elected annually by the holders of the Class B Common Stock. All of the foregoing officers have served in the positions stated in the previous table for more than five years, except as stated below. Officers serve at the discretion of the Board of Directors.\nMr. Herbert H. Haft, the founder of the Corporation, has been Chief Executive Officer and Chairman of the Board of the Corporation since 1960. He was Co-Chairman or Chairman of the Board of Directors of Crown Books from its organization until December 1991, when he became Chairman of the Executive Committee. Mr. Haft became Chairman of the Board of Directors of Crown Books, again, in June 1993. Mr. Haft has been Chairman of the Board of Directors and Chief Executive Offficer of Trak Auto since its organization in March 1983. Mr. Haft has been a director of Shoppers Food since April 1989.\nMr. Ronald S. Haft joined the Corporation as President and Chief Operating Officer August 1, 1993. Prior to joining the Corporation, Mr. Haft was President of Combined Properties, Inc., a real estate management company, from 1984, and continues to hold that position. Mr. Haft has been a director of the Corporation, Trak Auto, Crown Books and Shoppers Food since July 28, 1993.\nMr. Marshall joined the Corporation in November 1991 as Senior Vice President and Chief Financial Officer. At the same time he was appointed Treasurer and Principal Financial Officer of Trak Auto and Treasurer and Chief Financial Officer of Crown Books. Prior to joining the Corporation, Mr. Marshall was Chief Financial Officer at Barnes and Noble Bookstores Inc., a national retailer of college bookstores, from 1988 to 1991. Prior to that, he was Vice President of Finance at The Office Place Inc., a subsidiary of NBI, Inc.\nItem 10. Directors and Executive Officers of the Registrant - Continued\nMr. Weiss joined the Corporation in August 1981, as Director of Real Estate. He was appointed Vice President, Real Estate, in June 1983, Senior Vice President, Real Estate, in September 1986, and Executive Vice President, Real Estate in December 1987.\nMs. Bonita A. Wilson has been a retailing executive with Saks Jandel since February 1994. Prior to that she was a retailing executive with the May Company. Ms. Wilson serves on the board of directors of Wedgewood Financial Management, Inc. Ms. Wilson was elected to serve as a director of the Corporation since June 1993 and was elected to be a director of Trak Auto and Crown Books on June 30, 1993.\nMr. Douglas M. Bregman is a partner in the law firm of Bregman, Berbert & Schwarts, specializing in commercial real estate law. Mr. Bregman is also an Adjunct Professor of Law at the Georgetown University Law Center. Mr. Bregman was elected to serve as a director of the Corporation since June 1993 and was elected to be a director of Trak Auto and Crown Books on June 30, 1993.\nMr. H. Ridgely Bullock is president of Montchanin Management Corporation, a management and financial consulting firm, and president and director of Michel Vineyards. Mr. Bullock is an attorney in New York. Mr. Bullock previously served as chairman and chief executive officer of Bank of New England Corporation and UniDynamics Corporation. Mr. Bullock was elected a director of the Corporation, Trak Auto and Crown Books on December 20, 1993.\nMr. Larry G. Schafran is managing general partner of L.G. Schafran and Associates, a New York based investment advisory firm, and is a director of Publicker Industries, Inc., Capsure Holdings, Corp. and OXIGENE, Inc. Mr. Schafran has previously held the positions of vice president and director of Webb & Knapp, Inc. and its successor General Property Corp. Mr. Schafran was elected a director of the Corporation, Trak Auto and Crown Books on December 20, 1993.\nThe other officers of the Corporation are:\nMr. Robert F. Ampula rejoined the Corporation in November 1988 as Vice President, Information Services, a position he held from January 1985 until July 1986. Prior to rejoining the Corporation he was most recently with Coca Cola Enterprises.\nMr. Elliot R. Arditti joined the Corporation in January 1984 as Associate Counsel. He was appointed Assistant Vice President, Corporate Counsel in September 1986 and Vice President, Corporate Counsel in December 1987. Prior to joining the Corporation, he was an associate with the law firm of Pascal, Weiss, Peartree and Habbert.\nMrs. Gloria G. Haft is Vice President of the Corporation and was a director of the Corporation, Trak Auto and Crown Books until June 1993.\nHerbert H. Haft and Gloria G. Haft are husband and wife. They are the parents of Ronald S. Haft and Robert M. Haft. There is no other family relationship between any director and executive officer of the Corporation.\nItem 10. Directors and Executive Officers of the Registrant - Continued\nSection 16(a) of the Securities Exchange Act of 1934 (the \"Exchange Act\") requires the Corporation's officers and directors, and persons who beneficially own more than ten percent of a registered class of the Corporation's equity securities, to file reports of ownership of the Corporation's securities and changes in such ownership with the Securities and Exchange Commission (the \"SEC\"). Officers, directors and ten percent shareholders are required by SEC regulations to furnish the Company with copies of all Section 16(a) forms they file.\nBased solely upon its review of such forms received by it, the Company believes that during the fiscal year ended January 31, 1994, all filing requirements applicable to its officers, directors and ten percent shareholders were complied with, except that each of Herbert H. Haft, Robert M. Haft, Gloria G. Haft, Ron Marshall, Warren Tydings, Charles M. Farkas and Claudine B. Malone, did not file one Form 5 on a timely basis, reporting the granting of stock options on July 31, 1992 pursuant to the Corporation's stock option plan. The granting of such options was reported by each such person, except Robert M. Haft and Warren Tydings (deceased), on Forms 5 filed on March 15, 1994, or for Claudine B. Malone, on or about March 23, 1994.\nItem 11.","section_11":"Item 11. Executive Compensation\nSummary Compensation Table\nThe Summary Compensation Table is intended to provide an overview of both annual and long-term compensation for each of Herbert H. Haft, Ronald S. Haft, Ron Marshall, Dennis N. Weiss, and Robert M. Haft (the \"Executive Group\"). It requires separate, line-by- line entries for compensation paid to each member of the Executive Group for the last three years, including compensation from subsidiaries.\n---------------- (1) Includes Board of Directors fees. Members of the Corporation, Trak Auto and Crown Books Board of Directors are paid $15,000 per year (Trak Auto and Crown Books fees were increased from $10,000 during fiscal 1994). Members of Dart Financial Board of Directors are paid $10,000 per year. In addition, includes: $16,000 for Mr. Herbert H. Haft's auto usage; $206,000 for Mr. Robert M. Haft's compensation associated with the incentive stock agreement; cumulative Shoppers Food Board of Directors fees paid in fiscal 1994 to Mr. Herbert H. Haft, Mr. Ronald S. Haft and Mr. Robert M. Haft of $320,000, $96,000 and $140,000, respectively, for three years ended 1994; and Mr. Ronald S. Haft's and Mr. Marshall's auto allowance. (2) Includes allocations to the accounts of certain members of the Executive Group pursuant to the Profit-Sharing Plans of the Corporation and Subsidiaries and $32,000 and $52,000 to Herbert H. Haft and Robert M. Haft each year for interest on life insurance loans. (3) Mr. Marshall became Senior Vice President and Chief Financial Officer of the Corporation in November 1992. (4) Mr. Ronald S. Haft became President of the Corporation August 1, 1993 and Robert M. Haft's employment was terminated in June 1993.\nItem 11. Executive Compensation - Continued\nOption Grants in Last Fiscal Year\nThis table provides information with respect to grants of options for shares of the Corporation and Subsidiaries Common Stock, to the Executive Group during the prior fiscal year and the exercise or base price, expiration date and estimates of the potential realizable values of such options.\n----------------- (1) Represents options for Class A Shares a. Incentive Stock Options b. Nonqualified Stock Options (2) Represents options for Class B shares that Mr. Ronald S. Haft purchased for $985,000 exercisable on date of purchase. (3) Represents options for Trak Auto Common Stock. (4) Represents options for Crown Books Common Stock. (5) Class A, Trak Auto and Crown Books options become exercisable over time. One-third will become exercisable one year from the date of grant, an additional one-third will become exercisable two years from the date of grant and the last third will become exercisable three years from the date of grant. Options expire five years from the date of grant. Options are granted at market price on the date of grant except for incentive stock options (\"ISO's\") granted to the Hafts which have been granted at 110% of market price. All options granted to\nItem 11. Executive Compensation - Continued\nexecutive officers are ISO's under the Internal Revenue Code except for 8,885 options for the Corporation's Class A Shares and all Trak Auto and Crown Books options to each of Herbert and Ronald Haft which are non-qualified options. ISO's entitle the option holder to special tax treatment provided that the option holder satisfies certain holding periods with respect to shares acquired on the exercise of options. In general, if the holding periods are satisfied, the option holder will incur no taxable income by reason of exercise of the option, and the Corporation will not receive an income tax deduction by reason of the exercise. The option holder will recognize gain or loss upon a subsequent sale of the common stock, based on the difference between the amount for which the stock is sold, and the option price paid. (6) Potential realizable value is based on an assumption that the price of the Common Stock appreciates at the annual rate shown (compounded annually) from the date of grant until the end of the five year option term. These numbers are calculated based on the rules and regulations promulgated by the Securities and Exchange Commission and do not reflect the Company's estimate of future stock price growth.\nItem 11. Executive Compensation - Continued\nAggregated Option Exercises in Last Fiscal Year and Fiscal Year- End Option Values\nThis table provides information regarding the exercise of options during the fiscal year and the number and value of unexercised options held at year end.\n(1) Represents options for Class A Shares (2) Represents options for Trak Auto Common Stock. (3) Represents options for Crown Books Common Stock. (4) Does not include 40,000 options for Class A Shares, 40,000 options for Trak Auto Common Stock or 80,000 options for Crown Books Common Stock, which the Company maintains expired by virtue of Mr. Haft's termination of employment. Mr. Haft has contested this in litigation. See Note 6 to the Consolidated Financial Statements.\nItem 11. Executive Compensation - Continued\nCompensation of Directors\nMembers of the Board of Directors of the Corporation, Trak Auto and Crown Books are each paid $15,000 per year. Members of the Board of Directors of Dart Financial are each paid $10,000 per year. Ms. Wilson and Mr. Bregman are members of the profit sharing and audit committees for the Corporation, Trak Auto and Crown Books and are compensated $5,000 per year for each committee. Mr. Bullock and Mr. Schafran are members of the special litigation committee and are compensated $250 per hour plus expenses.\nThe Dart Group Corporation's, Trak Auto and Crown Books Stock Option Plans specify that each director who is not an employee shall receive 1,500, 1,500 and 2,500 options each year. The options will expire five years from the date of grant.\nIn September 1987, the Corporation adopted the 1988 Dart Group Corporation Deferred Compensation Plan for Directors, effective January 1, 1988 (the \"Compensation Plan\"). The Compensation Plan permits the Corporation's directors to defer the payment of all or a specified part of future compensation payable for services as director, including fees for serving on or attending meetings of committees of the board of directors. Each director may elect, on or before January 31 of any year to defer payment of compensation, payable on or after the February 1st following such election, for services to be performed during the twelve-month period commencing on such February 1 and ending on January 31 of the following calendar year (the \"Plan Year\"). After such an election, all subsequent compensation will be deferred until the director notifies the Corporation, prior to the commencement of any Plan Year, that compensation for future Plan Years is to be paid on a current basis.\nDeferred compensation will not be paid to the director as earned, but will be held in the Corporation's general funds and credited to a bookkeeping account maintained by the Corporation in the name of the director. Each participating director will be treated as a creditor of the Corporation with respect to such funds. Deferred compensation will be paid to directors in a lump sum on the February 15th of the Plan Year after retirement, unless the director elects, at the time he exercises the deferral option, to be paid in up to ten annual installments.\nDuring the year ended January 31, 1994, the former directors of the Corporation, Trak Auto, Crown Books and Dart Financial received board fees on a quarterly basis until June 1993. In addition, the Corporation, Trak Auto and Crown Books purchased the outstanding in-the-money stock options held by Claudine B. Malone ($74,000), Charles Farkas ($40,000) and James G. Leonard ($73,000) (a former director of Trak Auto and Crown Books) at the market price per share. Mr. Leonard also received, at his election, the first two of three payments under the Compensation Plan. The Company also agreed to provide certain retirement benefits to Mr. Leonard of approximately $50,000. The Company agreed to continue the former directors full rights to indemnification as a director.\nEmployment Contracts\nSee Note 5 and 10 to the Consolidated Financial Statements.\nItem 11. Executive Compensation - Continued\nCompensation Committee Interlocks and Insider Participation\nNone of the Boards of Directors of the Corporation, Crown Books or Trak Auto has a compensation committee, and policies regarding executive compensation are formulated by the respective Boards of those companies. This section sets forth certain relationships among the members of the respective Boards.\nCertain members of the Board are directors, officers or employees of the Corporation and its subsidiaries, as follows: Herbert H. Haft is Chairman of the Board and Chief Executive Officer of the Corporation, Chairman of the Board of Crown Books, Chairman of the Board and Chief Executive Officer of Trak Auto, and Chairman of the Board and Chief Executive Officer of Total Beverage. Ronald S. Haft is President and Chief Operating Officer and a Director of the Corporation a Director of Crown Books and Trak Auto.\nCertain former directors of the Board were directors, officers or employees of the Corporation and its subsidiaries during the last fiscal year, as follows: Robert M. Haft was until June 1993 President and Chief Operating Officer and Director of the Corporation, Chairman of the Board of Crown Books, and Vice Chairman of the Board of Directors of Trak Auto. Gloria G. Haft is a Vice President of the Corporation and, until June 1993, was also Secretary and Director of the Corporation, Secretary and Director of Crown Books, and Vice President and Secretary and Director of Trak Auto.\nRonald S. Haft, Robert M. Haft, and Gloria G. Haft are all beneficial owners of more than 5% percent of the Corporation's Class B Common Stock. Herbert H. Haft holds an irrevocable proxy to vote certain Class B Common Stock owned by Ronald S. Haft. See \"Security Ownership of Certain Beneficial Owners and Management.\" Herbert H. Haft and Gloria G. Haft are husband and wife. Ronald S. Haft and Robert M. Haft are their sons. See \"Certain Relations and Related Transactions\" for a description of certain relationships and transactions between the Corporation or its subsidiaries and entities in which members of the Haft family have an interest.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe following table sets forth certain information with respect to the beneficial owners of more than 5% of the Corporation's outstanding voting securities (Class B Common Stock) at January 31, 1994 and the number of shares of Class A Common Stock (non- voting) and Class B Common Stock of the Corporation, common stock of Trak Auto and common stock of Crown Books held beneficially by each director, each member of the Executive Group and all directors and officers as a group. Unless otherwise indicated, all shares are held beneficially and of record.\nDirectors and Executive Officers: - --------------------------------\nItem 12. Security Ownership of Certain Beneficial Owners and Management - (Continued)\nOther Beneficial Owners: - -----------------------\n(1) Includes 139,749 shares subject to exercisable stock options. (2) Includes 49,998 shares subject to exercisable stock options. (3) Includes 29,999 shares subject to exercisable stock options. (4) Includes one-third of 87,043 shares of Class A Common Stock owned by a family partnership. The disposition of the shares is subject to the vote of the partners. (5) Includes 197,048 shares subject to exercisable stock options. (6) Includes one-third of 75,738 shares of Class B Common Stock which were distributed in 1993 by a family partnership to the individual partners. That action has been challenged in litigation by two of the partners. The Corporation has taken no position on this matter. (7) Mr. Herbert H. Haft retains sole voting power over 172,730 Class B shares (owned by Ronald S. Haft) or 57.02% of the outstanding Class B shares. See Note 5 to the Consolidated Financial Statements. (8) Includes 388 shares of Class A Common Stock held as custodian for his children. (9) Includes 219,750 shares subject to exercisable stock options. (10) Includes 41,000 shares of Trak Auto held by his wife. (11) Includes 81,100 shares of Crown Books held by his wife. (12) Includes 1,582 shares subject to exercisable stock options. (13) Includes 333 shares subject to exercisable stock options. (14) Includes 2,250 shares subject to exercisable stock options. (15) Includes 1,000 shares subject to exercisable stock options. (16) Includes 375 shares subject to exercisable stock options. (17) Includes 1,500 shares subject to exercisable stock options. (18) Includes 2,500 shares subject to exercisable stock options. (19) Includes 364,081 shares subject to exercisable stock options. (20) Includes 53,998 shares subject to exercisable stock options. (21) Includes 35,332 shares subject to exercisable stock options. (22) Includes 6,500 shares subject to exercisable stock options. (23) Includes 4,500 shares subject to exercisable stock options. (24) Includes 7,499 shares subject to exercisable stock options. (25) Includes 2,000 shares subject to exercisable stock options. (26) Includes 8,488 shares of Class A Common Stock held as custodian for her children.\nItem 12. Security Ownership of Certain Beneficial Owners and Management (Continued)\nA legal dispute has arisen among members of the Haft family concerning agreements that have previously been reported as restricting the ability of any of them to transfer common stock of the Corporation owned by them among them or to others who are not members of their family. Herbert H. Haft, the Corporation's Chairman, and Ronald S. Haft, its current President, who in July 1993 transferred ownership of certain shares of Class B Common Stock between them (see Note 5 to Consolidated Financial Statements), have taken the position that no enforceable agreement precludes that or similar transfers. The Corporation's former President, Robert M. Haft, has asserted a contrary position. The Corporation, which is not party to any of the purported agreements, has taken no position on the matter.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions (Continued)\nSee Notes 4,8 and 10 to the Consolidated Financial Statements for descriptions of transaction involving the Company and entities owned by members of the Haft family.\nDuring the fiscal year ended January 31, 1994, the Corporation made payments for certain non-business expenses of Herbert H. Haft. The total amounts of such payments during the period was $407,000. As of January 31, 1994, there were no balances due the Corporation. Interest was charged at the prime rate on the average outstanding balances. The Corporation's policy relating to such balances is to require them to be paid in full on at least a monthly basis. See Schedule II for additional information regarding amounts due from related parties.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n(A)\n1. Financial Statements\nSee Item 8.\n2. Schedules (Consolidated) -\nReport of Independent Public Accountants on Schedules\nI - Marketable Securities II - Amounts Receivable from Related Parties V - Consolidated Schedule of Property, Plant and Equipment VI - Consolidated Schedule of Accumulated Depreciation of Property, Plant and Equipment VIII - Valuation and Qualifying Accounts X - Supplementary Income Statement Information\nAll other schedules are omitted because the required information is inapplicable or it is presented in the consolidated financial statements or related notes.\n3. Exhibits...............................................\nE (2a) Purchase agreement dated October 12, 1989 between Greenway Center Associates Limited Partnership and KANAM Grundbesitz Gmbh, tenants in common and Mr. Ronald S. Haft, acting on behalf of CM\/CP Greenway Center Joint Venture. The exhibit includes a list identifying the schedules to the agreement, but does not include the schedules themselves. Copies of the omitted schedules will be furnished supplementally to the Commission upon request.\nE (2b) Purchase agreement dated October 12, 1989 between Briggs Chaney Associates Limited Partnership and Mr. Ronald S. Haft, acting on behalf of CM\/CP Briggs Chaney Plaza Joint Venture. The exhibit includes a list identifying the schedules to the agreement, but does not include the schedules themselves. Copies of the omitted schedules will be furnished supplementally to the Commission upon request.\nF (2c) Purchase agreement dated March 12, 1991 between (i) Robert M. Haft, Ronald S. Haft and Linda G. Haft and (ii) Cabot-Morgan Real Estate Company (\"CMREC\"). Amended and restated agreement of Limited Partnership dated March 12, 1991 by and among (i) CM\/CP Greenbriar Retail Joint Venture (\"CM\/CP Greenbriar Retail\"), (ii) CP Greenbriar Retail, Inc. and (iii) Robert M. Haft, Ronald S. Haft and Linda G. Haft. Joint venture agreement dated March 12, 1991 between CMREC and CP\/Greenbriar Retail Investments Limited Partnership. Exclusive development, leasing management agreement dated March 12, 1991 between Combined Properties\/Greenbriar Limited Partnership (\"CP\/Greenbriar LP\") and Combined Properties Incorporated (\"Combined\"). Contribution agreement dated March 12, 1991 between CP\/Greenbriar LP, CMREC and Linda G. Haft, Ronald S. Haft and Robert M. Haft.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\nF (2d) Purchase agreement dated March 12, 1991 between (i) Robert M. Haft, Ronald S. Haft and Linda G. Haft and (ii) CMREC. Amended and restated agreement of Limited Partnership dated March 12, 1991 by and among (i) CM\/CP Greenbriar Office Joint Venture (\"CM\/CP Greenbriar Office\"), (ii) CP\/Greenbriar Office, Inc. and (iii) Robert M. Haft, Ronald S. Haft and Linda G. Haft. Joint venture agreement dated March 12, 1991 between CMREC and CP\/Greenbriar Office Investments Limited Partnership. Exclusive development, leasing and management agreement dated March 12, 1991 between Combined Properties\/Greenbriar Office Limited Partnership (\"CP\/Greenbriar Office LP\") and Combined. Contribution agreement dated March 12, 1991 between CP\/Greenbriar Office LP, CMREC and Linda G. Haft, Ronald S. Haft and Robert M. Haft.\nH (2e) Purchase agreement dated January 18, 1993 between PS-One Real Estate Limited Partnership and CM\/CP Bull Run Joint Venture. Joint venture agreement dated January 18, 1993 between CMREC and CP\/Bull Run Limited Partnership. Exclusive leasing and management agreement dated January 18, 1993 between CM\/CP Bull Run Joint Venture and Combined. Promissory note agreement between CMREC and CM\/CP Bull Run Joint Venture dated January 18, 1993.\n(2f) Purchase agreement dated February 27, 1993 between Total Beverage G.B., Inc. (a wholly- owned subsidiary of the Corporation) and Total Beverage VA Corp. (a wholly-owned subsidiary of Shoppers Food Warehouse Corp.). Promissory Note between Total Beverage VA Corp. and Total Beverage G.B. Inc.\n* (3) Certificate of Incorporation, incorporated herein by reference to Exhibit #3a to the Company's Form S-1 Registration Statement (File #2-99831) filed with the Securities and Exchange Commission (\"Dart 1985 S1\").\nB (3a) Certificate of Amendment of the Certificate of Incorporation of Dart Group Corporation dated January 13, 1987.\n(3b) Bylaws, amended and restated as of September 14, 1993.\n* (4) Indenture relating to $250,000,000 Subordinated Debentures Due 1995, incorporated herein by reference to Exhibit 4 to Dart 1985 S-1.\nC (10a) Employment agreement with Mr. Herbert H. Haft, as amended.\nC (10b) Employment agreement with Mr. Robert M. Haft, as amended.\nB (10c) Employment agreement with Mrs. Gloria G. Haft.\n* (10f) Indemnity Agreement dated March 10, 1983 between Dart Drug Corporation and Trak Auto Corporation, incorporated by reference to exhibit 10(b) filed with the Trak S-1.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n* (10h) Agreement for the Allocation of United States and State Income Tax Liability and Benefits Among Members of the Dart Drug Corporation Group, incorporated by reference to exhibit 10(d) filed with the Trak S-1.\n* (10i) Agreement, dated March 31, 1983, between Dart Drug Corporation and Trak Auto East Corporation, incorporated by reference to exhibit 10(ffff) filed with the Trak S-1.\n* (10p) Dart Drug Corporation Executive Non-Qualified Stock Option Plan, incorporated herein by reference to exhibit (10o) to the Company's Form 10-K filed with the SEC on May 1, 1984.\n* (10q) Agreement of Sale dated May 25, 1984 among Dart Drug Corporation, Dart Delaware Corporation and Dart Drug Acquisition Corporation, incorporated herein by reference to exhibit (2) to the Company's Form 8-K filed with the SEC on July 16, 1984.\nA (10r) Lease dated December 26, 1984 between Dart Group Corporation and Seventy-Fifth Avenue Associates.\nA (10s) Sublease dated December 26, 1984 between Dart Group Corporation and Trak Auto Corporation.\nA (10t) Sublease dated December 26, 1984 between Dart Group Corporation and Crown Books Corporation.\nA (10u) Lease dated April 27, 1984 between Trak Chicago Limited Partnership I and Trak Auto Corporation.\nB (10w) Dart Group Corporation 1981 Stock Option Plan, as amended.\n* (10ff) Indemnity Agreement by and between Dart Group Corporation and Crown books Corporation dated June 9, 1986 incorporated herein by reference to Exhibit 10(zzzz) to the Crown 10-K.\n* (10gg) Employment Agreement between Crown Books Corporation and Mr. Robert M. Haft dated February 28, 1987 incorporated herein by reference to Exhibit 10(xxxx) to the Crown 10-K.\n* (10hh) Agreement of Amendment, dated June 9, 1986, among Dart Group Corporation, Trak Auto Corporation, Trak Auto West, Inc. and Thrifty Corporation, of the stockholders Agreement dated March 17, 1982 herein incorporated by reference to Exhibit 10(oooo) to the Trak 10-K.\n* (10ii) Indemnity Agreement, dated June 9, 1986, by and between Dart Group Corporation and Trak Auto Corporation herein incorporated by reference to Exhibit 10(pppp) to the Trak 10-K.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n* (10kk) Agreement of Merger dated May 28, 1987 between Trak Auto East Corporation and Trak Auto West, Inc. herein incorporated by reference to Exhibit 10(qqqq) filed with Trak Auto Corporation Fiscal Year 1988 Form 10-K, No. 0- 12202 (\"Fiscal 1988 Trak 10-K\").\nC (10pp) Dart Group Corporation Deferred Compensation Plan for Directors, effective January 1, 1988.\nD (10qq) Lease agreement dated November 22, 1988 between Dart Group Corporation and Seventy-Fifth Avenue Associates.\n* (10rr) Lease agreement dated January 27, 1989 between Trak Auto Corporation and Combined Properties\/Ontario Limited Partnership herein incorporated by reference to Exhibit 10(tttt) filed with Trak Auto Corporation Fiscal Year 1989 Form 10-K, No. 0-12202 (\"Fiscal 1989 Trak 10-K\").\n* (10ss) Lease agreement dated February 27, 1988 between Trak Corporation and Haft\/Equities- General, herein incorporated by reference to Exhibit 10(uuuu) filed with Fiscal 1989 Trak 10-K.\n* (10tt) Lease agreement dated June 17, 1987 between Trak Auto West, Inc. and Haft\/Equities\/Rose Hill Limited Partnership, herein incorporated by reference to Exhibit 10(vvvv) filed with Fiscal 1989 Trak 10-K.\nD (10uu) Agreement dated May 17, 1988 among Dart Group Corporation, Shoppers Food Warehouse Corp., Kenneth M. Herman and Robert N. Herman incorporated herein by reference to Exhibit 1 filed with the Corporation's Report on Form 8-K on July 15, 1988.\nD (10vv) Amendment No. 1 to Stockholders' Agreement (Exhibit D to Stock Purchase Agreement dated May 17, 1988, attached as Exhibit 1 to the Corporation's Report on Form 8-K filed July 15, 1988) dated as of August 24, 1988 herein.\n* (10ww) Assignment and Assumption agreement dated December 30, 1989 between Greenway Center Associates Limited Partnership and CM\/CP Greenway Center Joint Venture, and lease agreement dated March 13, 1980, between Greenway Center Associates Limited Partnership and Trak Auto (612), herein incorporated by reference to Exhibit 10(wwww) filed with Trak Auto Corporation Fiscal Year 1990 Form 10-K, No. 0-12202 (\"Fiscal 1990 Trak 10-K\").\n* (10xx) Assignment and Assumption agreement dated December 30, 1989 between Briggs Chaney Associates Limited Partnership and CM\/CP Briggs Chaney Plaza Joint Venture, and lease agreement dated June 26, 1981, between Western Development Corporation and Trak Auto Corporation (641), herein incorporated by reference to Exhibit 10(xxxx) filed with Fiscal 1990 Trak 10-K.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n* (10yy) Trak Auto Amended Stock Option Plan, herein incorporated by reference to Exhibit 10(yyyy) filed with Fiscal 1990 Trak 10-K.\n* (10zz) Incentive stock agreement between Mr. Robert M. Haft and Crown Books Corporation and promissory note from Mr. Haft to Crown Books Corporation, both dated September 5, 1989, herein incorporated by reference to Exhibit 10(ddddd) filed with Crown Books Corporation Fiscal Year 1990 Form 10-K No. 0-11457 (\"Fiscal 1990 Crown 10-K\").\n* (10ccc) Assignment and Assumption Agreement dated December 30, 1989 between Briggs Chaney Associates Limited Partnership and CM\/CP Briggs Chaney Plaza Joint Venture, and lease agreement dated June 26, 1981 between Crown Books Corporation and Western Development Corporation, herein incorporated by reference to Exhibit 10(ggggg) filed with Fiscal 1990 Crown 10-K.\n* (10eee) Lease agreement dated January 5, 1990 between Combined Properties Limited Partnership and Crown Books Corporation re: Turnpike Shopping Center (815), herein incorporated by reference to Exhibit 10(iiiii) filed with Fiscal 1990 Crown 10-K.\n* (10fff) Lease agreement dated January 5, 1990 between Combined Properties Limited Partnership and Crown Books Corporation re: the Plaza at Landmark (165), herein incorporated by reference to Exhibit 10(jjjjj) filed with Fiscal 1990 Crown 10-K.\n* (10ggg) Lease agreement dated January 5, 1990 between Combined Properties Limited Partnership and Crown Books Corporation re: Manaport Plaza Shopping Center (804), herein incorporated by reference to Exhibit 10(kkkkk) filed with Fiscal 1990 Crown 10-K.\nD (10hhh) Stock option agreement dated August 8, 1989 between Dart\/SFW Corp. and Mr. Herbert H. Haft.\nD (10iii) Stock option agreement dated August 8, 1989 between Dart\/SFW Corp. and Mr. Robert M. Haft.\n* (10jjj) Lease agreement dated October 31, 1990 between CP Acquisitions Limited Partnership and Crown Books Corporation re: McLean Shopping Center (803), herein incorporated by reference to Exhibit 10(lllll) Crown Books Corporation Fiscal Year 1991 Form 10-K No. 0-11457 (\"Fiscal 1991 Crown 10-K\").\n* (10kkk) Lease agreement dated May 11, 1990 between CM\/CP Greenway Center Joint Venture and Crown Books Corporation re: Greenway Center (822), herein incorporated by reference to Exhibit 10(mmmmm) Fiscal 1991 Crown 10-K.\n* (10lll) Lease agreement dated March 20, 1991 between Charles County Associates Limited Partnership and Crown Books Corporation re: Charles County Plaza (833), herein incorporated by reference to Exhibit 10(nnnnn) Fiscal 1991 Crown 10-K.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n* (10mmm) Lease agreement dated May 11, 1990 between Combined Properties\/Greenbriar Limited Partnership and Crown Books Corporation, the First Amendment dated September 13, 1990 and the Second Amendment dated March 14, 1991 re: Greenbriar Town Center (104), herein incorporated by reference to Exhibit 10(ooooo) Fiscal 1991 Crown 10-K.\n* (10nnn) Lease agreement dated May 18, 1990 between Combined Properties Limited Partnership and Trak Corporation and Lease Termination Agreement dated March 31, 1990 between Combined Properties Limited Partnership, Retail Lease Acquisition Limited Partnership and Trak Corporation re: Fair City Mall (605), herein incorporated by reference to Exhibit 10(zzzz) Trak Auto Corporation Fiscal Year 1991 Form 10-K No. 0-12202 (\"Fiscal 1991 Trak 10-K\").\n* (10ooo) Lease agreement dated May 18, 1990 between Retail Lease Acquisition Limited Partnership and Trak Corporation and License Termination Agreement dated March 31, 1990 between Retail Lease Acquisition Limited Partnership and Trak Corporation re: Chantilly Plaza (609), herein incorporated by reference to Exhibit 10(aaaaa) Fiscal 1991 Trak 10-K.\n* (10ppp) Lease agreement dated May 18, 1990 between Retail Lease Acquisition Limited Partnership and Trak Corporation and License Termination Agreement dated March 31, 1990 between Retail Lease Acquisition Limited Partnership and Trak Corporation re: College Plaza (610), herein incorporated by reference to Exhibit 10(bbbbb) Fiscal 1991 Trak 10-K.\n* (10qqq) Lease agreement dated May 18, 1990 between Retail Lease Acquisition Limited Partnership and Trak Corporation and License Termination Agreement dated March 31, 1990 between Retail Lease Acquisition Limited Partnership and Trak Corporation re: Enterprise (614), herein incorporated by reference to Exhibit 10(ccccc) Fiscal 1991 Trak 10-K.\n* (10rrr) Lease agreement dated May 18, 1990 between Retail Lease Acquisition Limited Partnership and Trak Corporation and License Termination Agreement dated March 31, 1990 between Retail Lease Acquisition Limited Partnership and Trak Corporation re: Rolling Valley (630), herein incorporated by reference to Exhibit 10(ddddd) Fiscal 1991 Trak 10-K.\n* (10sss) Lease agreement dated May 18, 1990 between Combined Properties Limited Partnership and Trak Corporation and Lease Termination Agreement dated March 31, 1990 between Combined Properties Limited Partnership, Retail Lease Acquisition Limited Partnership and Trak Corporation re: White Flint (632), herein incorporated by reference to Exhibit 10(eeeee) Fiscal 1991 Trak 10-K.\n* (10ttt) Lease agreement dated November 6, 1990 between CP Acquisition Limited Partnership and Trak Corporation and Settlement Agreement dated November 6, 1990 between CP Acquisitions Limited Partnership and Trak Corporation re: Aspen Manor (615), herein incorporated by reference to Exhibit 10(fffff) Fiscal 1991 Trak 10-K.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n* (10uuu) Lease agreement dated November 6, 1990 between CP Acquisition Limited Partnership and Trak Corporation and Settlement Agreement dated November 6, 1990 between CP Acquisitions Limited Partnership and Trak Corporation re: Lee and Harrison (633), herein incorporated by reference to Exhibit 10(ggggg) Fiscal 1991 Trak 10-K.\n* (10vvv) Lease agreement dated November 6, 1990 between CP Acquisition Limited Partnership and Trak Corporation and Settlement Agreement dated November 6, 1990 between CP Acquisitions Limited Partnership and Trak Corporation re: Penn Daw (642), herein incorporated by reference to Exhibit 10(hhhhh) Fiscal 1991 Trak 10-K.\n* (10www) Lease agreement dated November 6, 1990 between Combined Properties Limited Partnership and Trak Corporation and Settlement Agreement dated November 6, 1990 between Combined Properties Limited Partnership and Trak Corporation re: Fairfax Circle (656), herein incorporated by reference to Exhibit 10(iiiii) Fiscal 1991 Trak 10-K.\n* (10xxx) Lease agreement dated March 23, 1990 between Combined Properties\/Silver Hill Limited Partnership and Trak Corporation and Termination Agreement dated April 13, 1990 between Combined Properties\/Silver Hill Limited Partnership and Trak Corporation re: Silver Hill (619), herein incorporated by reference to Exhibit 10(jjjjj) Fiscal 1991 Trak 10- K.\n* (10yyy) Lease agreement dated November 6, 1990 between Haft\/Equities-Bladen Limited Partnership and Trak Corporation and Lease Termination Agreement dated November 6, 1990 between Haft\/Equities-Bladen Limited Partnership and Trak Corporation re: Bladen Plaza (662), herein incorporated by reference to Exhibit 10(kkkkk) Fiscal 1991 Trak 10-K.\nF (10zzz) Lease agreement dated July 19, 1990 between Combined Properties\/4600 Forbes Limited Partnership and Shoppers Food Warehouse Corp.\nF 10(aaaa) Lease Agreement dated December 27, 1982 between Combined Properties Limited Partnership and Jumbo Food Stores VA, Inc., Amendment dated September 8, 1988 and Amendment dated September 25, 1990 re: Fair City Mall.\nF 10(bbbb) Lease Agreement dated June 28, 1983 between Combined Properties Limited Partnership and Jumbo Food Stores VA, Inc., Amendment dated September 8, 1988, Amendment May 10, 1990 and Amendment dated September 25, 1990 re: Rolling Valley Mall.\nF 10(cccc) Lease Agreement dated September 11, 1987 between Combined Properties Limited Partnership and Jumbo Food Stores Md., Inc., Amendment dated September 25, 1990 re: Maryland City Plaza.\nF 10(dddd) Lease Agreement dated July 7, 1989 between Combined Properties\/Silver Hill Limited Partnership and Jumbo Food Stores Md., Inc., Amendment dated May 10, 1990 and Amendment dated September 25, 1990 re: Silver Hill Plaza.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\nG 10(eeee) Lease agreement dated June 21, 1988 between Combined Properties Limited Partnership and Jumbo Food Stores Md., Inc., First Amendment dated July 7, 1989, Second Amendment dated September 25, 1990, re: Enterprise Plaza.\nG 10(ffff) Letter of Agreement dated February 27, 1992 between Dart Group Corporation and Shoppers Food Warehouse Corp., re: Whse 3, Pennsy Drive.\n* 10(gggg) Lease agreement dated December 23, 1991 between Combined Properties Limited Partnership and Trak Corporation, re: Manaport Plaza (607), herein incorporated by reference to Exhibit 10(lllll) Trak Auto Corporation Fiscal Year 1992 Form 10-K No. 0-12202 (\"Fiscal 1992 Trak 10-K\").\n* 10(hhhh) Amendment of lease dated December 24, 1991 between Haft\/Equities-Bladen Limited Partnership and Trak Corporation, re: Bladen Plaza (662), herein incorporated by reference to Exhibit 10(mmmmm) filed with Fiscal 1992 Trak 10-K.\n* 10(iiii) Sublease agreement dated February 19, 1992 between Crown Books Corporation and Trak Corporation, re: Vienna (616), herein incorporated by reference to Exhibit 10 (nnnn) filed with Fiscal 1992 Trak 10-K\n* 10(jjjj) Sublease agreement dated February 12, 1992 between Crown Books Corporation and Trak Corporation, re: McLean Shopping Center (627), herein incorporated by reference to Exhibit 10(ooooo) filed with Fiscal 1992 Trak 10-K.\n* 10(kkkk) Sublease agreement dated April 20, 1992 between Dart Group Corporation and Trak Corporation, re: Whse 3 Pennsy Drive, herein incorporated by reference to Exhibit 10(ppppp) filed with Fiscal 1992 Trak 10-K.\n* 10(llll) Lease agreement dated May 8, 1991 between Combined Properties Limited Partnership and Crown Books Corporation, re: Montgomery Village (827), herein incorporated by reference to Exhibit 10(qqqqq) filed with Crown Books Corporation Fiscal Year 1992 Form 10-K No. 0-11457.\n* 10(mmmm) Dart Group Corporation 1992 Stock Option Plan incorporated herein by reference to Dart 1993 S-8 file No. 33-57010.\n* 10(nnnn) Amendment of lease dated December 11, 1992 between Combined Properties Limited Partnership and Super Trak Corporation re: Oxon Hill (606), herein incorporated by reference to Exhibit 10(qqqqq) filed with Trak Auto Corporation Fiscal Year 1993 Form 10-K No. 0-12202 (\"Fiscal 1993 Trak 10-K\").\n* 10(oooo) Amendment of lease dated December 1, 1992 between Haft\/Equities-Bladen Limited Partnership and Super Trak Corporation re: Bladen Plaza (662), herein incorporated by reference to Exhibit 10(rrrrr) filed with Fiscal 1993 Trak 10-K.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n* 10(pppp) Amendment of lease dated January 8, 1993 between Retail Lease Acquisition Limited Partnership and Trak Corporation re: Chantilly Plaza (609), herein incorporated by reference to Exhibit 10(sssss) filed with Fiscal 1993 Trak 10-K.\n* 10(qqqq) Note Receivable from Robert M. Haft dated December 31, 1992, herein incorporated by reference to Exhibit 10(ttttt) filed with Fiscal 1993 Trak 10-K.\n* 10(rrrr) Amendment of lease dated December 1, 1992 between Combined Properties\/Montebello Limited Partnership and Super Trak re: Montebello (520), herein incorporated by reference to Exhibit 10(uuuuu) filed with Fiscal 1993 Trak 10-K.\n* 10(ssss) Third Amendment dated June 4, 1992 and Fourth Amendment dated June 15, 1992 to the Lease agreement between Combined Properties Limited Partnership and Crown Books Corporation re: Greenbriar Town Center (104), herein incorporated by reference to Exhibit 10(sssss) filed with Crown Books Corporation Fiscal Year 1992 Form 10-K No. 0-11457 (\"Fiscal 1993 Crown 10-K\").\n* 10(tttt) Notes receivable from Mr. Robert M. Haft dated December 31, 1992, herein incorporated by reference to Exhibit 10(vvvvv) filed with Fiscal 1993 Crown 10-K.\nH 10(uuuu) Third Amendment dated June 17, 1992 to the Lease agreement between Combined Properties Limited Partnership and Jumbo Food Stores MD., Inc., Re: Enterprise Plaza.\nH 10(vvvv) Lease agreement dated January 21, 1993 between CM\/CP Bull Run Joint Venture and Shoppers Food Warehouse VA Corporation Re: Festival at Bull Run.\nH 10(wwww) Lease agreement dated November 1, 1990 between Penn Daw Associates Limited Partnership (A Haft Controlled Entity) and Shoppers Food Warehouse VA Corporation, the First Amendment dated February 13, 1991 Re: Penn Daw Shopping Center.\n* 10(xxxx) Amendment of lease dated February 4, 1993 between Retail Lease Acquisition Limited Partnership and Super trak re: College Plaza (610), herein incorporated by reference to Exhibit 10 (wwwww) filed with Trak Auto Corporation Fiscal Year 1994 Form 10-K No 0-12202 (\"Fiscal 1994 Trak 10-K\").\n* 10(yyyy) Amendment of lease dated Setpember 13, 1993 between Combined Properties Limited Partnership and Super Trak re: Fair City Mall (605), herein incorporated by reference to Exhibit 10(xxxxx) filed with Fiscal 1994 Trak 10-K.\n* 10(zzzz) Amendment of lease dated September 13, 1993 between Combined Properties Limited Partnership and Super Trak re: Maryland City (623), herein incorporated by reference to Exhibit 10(yyyyy) filed with Fiscal 1994 Trak 10-K.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n* 10(aaaaa) Second Amendment of lease dated March 31, 1994 between Combined Properties Limited Partnership and Super Trak Corporation re: Oxon Hill (606), herein incorporated by reference to Exhibit 10 (zzzzz) filed with Fiscal 1994 Trak 10-K.\n* 10(bbbbb) Lease Amendment dated November 22, 1993 between Combined Properties Limited Partnership and Super Trak Corporation re: Landmark (658), herein incorporated by reference to Exhibit 10(A) filed with Fiscal 1994 Trak 10-K.\n* 10(ccccc) Second Amendment of Lease dated August 19, 1993 and Third Amendment of lease dated August 30, 1993 between Combined Properties Limited Partnership and Super Crown Books Corporation re: Landmark (165), herein incorporated by reference to Exhibit 10(wwwww) filed with Crown Books Corporation Fiscal Year 1994 Form 10-K No. 0-11457 (\"Fiscal 1994 Crown 10-K\").\n* 10(ddddd) Lease Agreement dated August 19, 1993 between Retail Lease acquisition Limited Partnership and Super Crown Books Corporation re: White Flint Plaza (132), herein incorporated by reference to Fiscal 1994 Crown 10-K.\n10(eeeee) Employment Agreement dated August 1, 1993, between Ronald S. Haft and Dart Group Corporation.\n10(fffff) Lease agreement dated April 2, 1991 between Combined Properties\/Greenbriar Limited Partnership and Total Beverage Corp. First Amendment dated February 15, 1993 between Combined Properties\/Greenbriar Limited Partnership and Total Beverage VA Corp. Second amendment dated September 29, 1993 between Combined Properties\/Greenbriar Limited Partnership and Total Beverage G.B., Inc. re: Chantilly (201).\n10(ggggg) Lease Agreement dated August 16, 1993 between Combined Properties Limited Partnership and Total Beverage Corp. and First Amendment of Lease dated February 24, 1994 re: Landmark (203).\n10(hhhhh) Lease Agreement dated August 16, 1993 between CM\/CP Bull Run Joint Venture and Total Beverage Corp. and First Amendment dated February 7, 1994 re: Bull Run Plaza (202).\n10(iiiii) Loan Agreement dated May 21, 1993 between Cabot-Morgan Real Estate Company and CM\/CP Bull Run Joint Venture.\n* 10(jjjjj) Trak Auto 1993 Stock Option Plan, herein incorporated by reference to Exhibit 10(vvvvv) filed with Fiscal 1994 10-K.\n* 10(kkkkk) Crown Books 1993 Stock Option Plan, herein incorporated by reference to Exhibit 10(yyyyy) filed with Fiscal 1994 Crown 10-K.\n10(lllll) Lease agreement dated June 8, 1993 between Combined Properties\/Greenbriar Office Limited Partnership and Total Beverage Total Beverage Corp.\nItem 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (Continued)\n(11a) Statement on Computation of Per Share Earnings.\n(21) Subsidiaries of the Corporation.\n(23) Consent to Incorporation by reference to financial statements into Form S-8, 33-12149.\nNote: Dart Drug Corporation changed its name to Dart Group Corporation on July 3, 1984.\nThe exhibits thus indicated were filed with the Forms as noted and are hereby incorporated by reference.\nA Incorporated by reference to Dart Fiscal Year 1986 Form 10-K. B Incorporated by reference to Dart Fiscal Year 1987 Form 10-K. C Incorporated by reference to Dart Fiscal Year 1988 Form 10-K. D Incorporated by reference to Dart Fiscal Year 1989 Form 10-K. E Incorporated by reference to Dart Fiscal Year 1990 Form 10-K. F Incorporated by reference to Dart Fiscal Year 1991 Form 10-K. G Incorporated by reference to Dart Fiscal Year 1992 Form 10-K. H Incorporated by reference to Dart Fiscal Year 1993 Form 10-K.\n(B) Reports on Form 8-K\nDuring the fourth quarter of fiscal year end January 31, 1994, the Corporation filed one report on form 8-K.\n1. Form 8-K dated December 20, 1993 (Item 5 - Other events). The report did not contain financial statements.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTO DART GROUP CORPORATION:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of Dart Group Corporation and subsidiaries included in this Form 10-K and have issued our report thereon dated April 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 are the responsibility of the Corporation'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.\nARTHUR ANDERSEN & CO.\nWashington, D.C., April 27, 1994.\nExhibit 24\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated April 27, 1994 included in this Form 10-K, into Dart Group Corporation's previously filed Form S-8, File Number 33-57010.\nARTHUR ANDERSEN & CO.\nWashington, D.C., April 27, 1994.\nSCHEDULE I\nDart Group Corporation and Subsidiaries\nSCHEDULE OF MARKETABLE SECURITIES\nSchedule II\nDart Group Corporation and Subsidiaries\nAMOUNTS RECEIVABLE FROM RELATED PARTIES\nSee Item 13 for further information regarding amounts receivable from directors and officers.\n(1) Represents non-interest bearing Crown Books note receivable due January 2, 2004.\n(2) Includes $400,000 and $310,000 Crown Books notes receivable and $123,000 Trak Auto note receivable due December 31, 1995 bearing interest at prime and an increase of $11,000 in a non-interest bearing Crown Books note receivable due January 2, 2004.\n(3) Represents bridge loan to Mr. Hemmerle for the purchase of a home. Mr. Hemmerle is President and Chief Executive Officer of Crown Books.\nSchedule V\nDart Group Corporation and Subsidiaries\nConsolidated Schedule of Property, Plant and Equipment\nSchedule VI\nDart Group Corporation and Subsidiaries\nConsolidated Schedule of Accumulated Depreciation and Amortization\nof Property, Plant and Equipment\nSchedule VIII\nDart Group Corporation and Subsidiaries\nValuation and Qualifying Accounts\n(1) The 1993 addition was provided by the utilization of reserves related to the sale of the drug store division in 1985.\nSchedule X\nDart Group Corporation and Subsidiaries\nSCHEDULE OF SUPPLEMENTARY INCOME STATEMENT INFORMATION\nAll other items do not exceed one percent of total sales.\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.\nDART GROUP CORPORATION\nDate: May 2, 1994 By: Herbert H. Haft --------------------------- --------------------------------- Herbert H. Haft 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 below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.\nDate: May 2, 1994 \/S\/ Herbert H. Haft --------------------------- ------------------------------------- Herbert H. Haft Chairman of the Board of Directors and Chief Executive Officer\nDate: May 2, 1994 \/S\/ Ronald S. Haft -------------------------- ------------------------------------- Ronald S. Haft President, Chief Operating Officer and Director\nDate: May 2, 1994 \/S\/ Bonita Wilson --------------------------- ------------------------------------- Bonita Wilson Director\nDate: May 2, 1994 \/S\/ Douglas Bregman --------------------------- ------------------------------------- Douglas Bregman Director\nDate: May 2, 1994 \/S\/ Larry G. Schafran --------------------------- ------------------------------------- Larry G. Schafran Director\nDate: May 2, 1994 \/S\/ H. Ridgely Bullock --------------------------- ------------------------------------- H. Ridgely Bullock Director\nDate: May 2, 1994 \/S\/ Ron Marshall --------------------------- ------------------------------------- Ron Marshall Principal Accounting and Financial Officer\nDART GROUP CORPORATION AND SUBSIDIARIES\nExhibit 11(a)\n(1) Not dilutive.\nExhibit 21\nSUBSIDIARIES OF THE COMPANY\n(1) Wholly-owned by Trak Auto Corporation (2) Wholly-owned by Crown Books Corporation. (3) Wholly-owned by Total Beverage Corp.\nEDGAR APPENDIX\nExhibit 10(fffff) printed version of this document contains a map of the Greenbriar Town Center, Fairfax, Virginia. Printed version of this document contains drawings of store sign criteria.\nExhibit 10(ggggg) printed version of this document contains a map of the Plaza at Landmark, Alexandria, Virginia. Printed version of this document contains floor plans. Printed version of this document contains a drawing of store sign criteria.\nExhibit 10(hhhhh) printed version of this document contains a map of Bull Run Plaza, Manassas, Virginia. Printed version of this document contains a drawing of store sign criteria.\nExhibit 10(lllll) printed version of this document contains a map of the floor plan as of June 8, 1993. Printed version of this document contains a map of Greenbriar Town Center, Fairfax, Virginia.","section_15":""}
{"filename":"92342_1994.txt","cik":"92342","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL DEVELOPMENT OF BUSINESS\nLaurentian Capital Corporation (the 'Company') is a Delaware holding company engaged through its subsidiaries in providing life and health insurance and related services. As the context requires, references herein to the Company refer to the Company individually or to the Company together with its subsidiaries.\nThe Company's principal insurance subsidiaries are Loyal American Life Insurance Company, Mobile, Alabama ('Loyal') and Prairie States Life Insurance Company, Rapid City, South Dakota ('Prairie'). The Company's principal non-insurance subsidiaries are International Funeral Associates, Inc., Hurst, Texas ('IFA'), Laurentian Investment Services, Inc., Houston, Texas ('LIS'), and CSW Management Services, Inc., Houston, Texas ('CSW').\nApproximately 71.6% of the outstanding common stock of the Company is owned by The Imperial Life Assurance Company of Canada ('Imperial') and an additional 9.8% is owned by Imperial's direct parent, Laurentian Financial, Inc. ('Financial'), which in turn is a wholly-owned subsidiary of The Laurentian Group Corporation ('Group'). Prior to January 1, 1994, Group was an indirect subsidiary of The Laurentian Mutual Management Corporation. On that date, La Confederation des caisses popularies et d'economie Desjardins du Quebec, a cooperative association constituted under the laws of the province of Quebec, Canada (the 'Confederation'), through its subsidiaries, Desjardins Laurentian Financial Corporation ('DLFC') and La Societe financiere des caisses Desjardins, Inc. ('SFCD'), acquired substantially all of the outstanding voting shares of Group, thereby becoming beneficial owner of the approximately 81.4% of the outstanding common stock of the Company beneficially owned by Group.\nIn November 1994, the Company engaged Oppenheimer & Co., Inc. ('Oppenheimer') as financial advisor to evaluate various strategies for maximizing shareholder value, including possible business combinations or other transactions. Oppenheimer is in the process of evaluating a variety of alternatives and has contacted third parties in that connection. There can be no assurances that the engagement will result in any transaction.\nINSURANCE OPERATIONS\nThe Company's life and health insurance products are directed primarily towards the middle and lower income markets and are generally sold utilizing third party sponsorship to facilitate solicitation.\nLoyal is a life insurance company incorporated under the laws of Alabama. It writes various forms of life insurance and accident and health insurance, principally with the sponsorship of credit unions and banks, which endorse its products to their members. It also writes life and health insurance through independent brokers.\nPrairie is a life insurance company incorporated under the laws of South Dakota. It markets individual life insurance policies with the sponsorship of state associations of funeral directors as well as individual funeral directors in various locations.\nOf all the prefunded funerals in the United States, approximately 35% are funded through pre-need life insurance and annuity products purchased from life insurance companies, with the balance funded through various state and local master funeral trusts. Prairie's operations are conducted in conjunction with relationships with a variety of non-insurance companies connected with pre-need products and services, including subsidiaries of the Company.\nIFA is an association whose membership consists of funeral directors throughout the United States. IFA members receive a variety of benefits (such as discounts on casket purchases) as a result of their membership.\nLIS provides trust management and investment advisory services for various state and local master funeral trusts. CSW specializes in providing administrative services, including accounting, tax reporting, commission accounting and income and expense allocations, to various funeral trusts.\nMARKETING\nThe Company's marketing emphasizes third party sponsorship and focuses on the middle income and lower income markets, the so-called gray collar and blue collar markets. The Company continues to develop and market products and services designed to serve the needs of the senior life market. Company subsidiaries are licensed in 49 states, the District of Columbia, Puerto Rico and the Virgin Islands. The subsidiaries utilize a variety of distribution channels, including both independent and controlled agency sales forces, brokers and independent Personal Producing General Agents where their specialized product\/market niche requires it. In addition, the companies use direct mail solicitation to specific markets.\nACQUISITIONS\/DIVESTITURES\nThe Company's growth and expansion philosophy has placed an emphasis on internal sales expansion with some reliance upon selective acquisition of insurance and non-insurance operations. The Company believes that under appropriate circumstances, it can acquire established life and health insurance companies, compatible blocks of business or other companies that complement its existing operations. The Company was active in acquisitions prior to 1988, but limited its expansion activities from 1988 through 1993.\nDuring 1994, the Company completed three acquisitions which it anticipates will enhance the operations of its two principal insurance subsidiaries. Prairie acquired Assured Security Life Insurance Company ('Assured') in July 1994, which has resulted in expanded penetration into the pre-need life insurance and annuity marketplace. In September 1994, the Company acquired CSW, which specializes in pre-need trust administration services. In August 1994, Loyal acquired Purity Financial Corporation ('Purity'), a marketing agency based in Jacksonville, Florida which is anticipated to enhance Loyal's business within the credit union market.\nGEOGRAPHIC DISTRIBUTION OF PREMIUM INCOME\nThe Company received premium income from all states in 1994. Based on the premium income of the various subsidiaries in 1994, the Company's premium revenue was distributed approximately as follows:\n------------------\n* No other state produced as much as 2% of premium income.\nThe Company operates primarily in the life and health insurance industry and, therefore, does not present separate segment information with respect to industry segments. Operations of non-life companies are not material to be isolated for segment reporting purposes.\nSTATISTICAL INFORMATION CONCERNING OPERATIONS\nThe following table indicates terminations of individual life insurance in force attributable to death, lapse, expiry, and surrender. Lapse ratios are also indicated, which compare lapses plus surrenders to the average insurance in force.\nINVESTMENTS\nThe laws under which each insurance subsidiary of the Company operates prescribe the nature and quality of and set limits on the various types of investments which may be made by insurance companies. These laws generally permit investments in qualified state, municipal and federal government obligations, corporate bonds, preferred and common stock, real estate, and real estate mortgages where the value of the underlying real estate exceeds the amount of the mortgage loan. The following table shows the Company's investments at December 31, 1994:\nIn accordance with generally accepted accounting principles, all investments other than equity securities and the portion of fixed maturities which the Company has designated as available for sale are valued at either original or amortized cost. The equity securities and fixed maturities available for sale are valued at market with any unrealized investment gains or losses reflected in stockholders' equity, net of applicable deferred taxes. Investments are adjusted for other than temporary declines in carrying value when deemed appropriate. See Note 2 to Consolidated Financial Statements for certain information relating to the market value of the Company's investments. Consistent with the long-term nature of life insurance contracts, the Company expects to hold the fixed maturity investments to maturity, earlier prepayment or redemption.\nThe investment strategy of the Company emphasizes investment quality fixed income securities. Over the past several years the Company has reduced its percentage of investments held in equity securities, mortgage loans, investment real estate, and policy loans from 40% in 1988 to 15% at the end of 1994. As of December 31, 1994, 84.7% of investments were in fixed income securities, and of that total, over 99% of such securities are classified as investment grade.\nThe quality of the Company's fixed maturity investments at December 31, 1994, according to the rating assigned by nationally recognized statistical rating organizations, is as follows:\n------------------ (1) Bonds are classified according to the highest rating by a nationally recognized statistical rating organization. Bonds not rated by any such organization are classified according to the rating assigned to them by the Securities Valuation Office of the National Association of Insurance Commissioners ('NAIC') as follows: for the purposes of the table, NAIC Class 1 is included in the 'A' rating; Class 2, 'BBB-'; Class 3, 'BB-'; and Classes 4-6, 'B and below'.\n(2) The NAIC assigns security quality ratings and uniform book values called 'NAIC Designations' which are used by insurers when preparing their statutory annual statements. The NAIC assigns ratings to publicly traded as well as privately placed securities. The ratings assigned by the NAIC range from Class 1 to Class 6, with a rating in Class 1 being of the highest quality. The NAIC ratings above are as of December 31, 1994, the latest date for which such ratings are available.\n(3) At amortized cost for fixed maturities held to maturity, and at market value for fixed maturities available for sale. See Notes 1 and 2 to the Company's consolidated financial statements for the year ended December 31, 1994.\nThe following table shows the investment results of the Company for the years 1990 through 1994:\nREINSURANCE\nIn keeping with industry practice, the Company's insurance subsidiaries reinsure portions of the life and health insurance and annuities underwritten by them. Under most of the subsidiaries' reinsurance arrangements, new insurance sales are reinsured automatically rather than on a basis that would require the reinsurer's prior approval. Generally, each subsidiary enters into indemnity reinsurance arrangements to assist in diversifying its risks and to limit its maximum loss on large or unusually hazardous risks, including risks that exceed the subsidiary's policy-retention limits, currently ranging from $50,000 to $125,000 per life.\nIn recent years, the Company's amount of ceded reinsurance premium has declined. The reduction was due primarily to the run-off (i.e., non-renewal) of policies subject to certain older reinsurance treaties as well as the continued emphasis on premium growth in the pre-need life insurance market, where face amounts on most policies are within current Company retention limits. Expressed as a percentage of direct premiums written, ceded reinsurance has decreased from approximately 33% in 1987 to 6.3% in 1994.\nIndemnity reinsurance does not fully discharge the ceding insurer's liability to meet policy claims on the reinsured business. The ceding insurer remains responsible for policy claims to the extent the reinsurer fails to pay such claims, as a result, for example, of the insolvency of the reinsurer. No reinsurer of business ceded by a Company subsidiary has failed to pay any material policy claim due to the insolvency of the reinsurer.\nRESERVES\nThe applicable insurance laws under which the Company's insurance subsidiaries operate require that each subsidiary report policy reserves as liabilities to meet future obligations on the outstanding policies. These reserves are amounts which, with the additional premiums to be received and interest thereon compounded annually at certain assumed rates, are calculated to be sufficient to meet the various policy and contract obligations as they mature. These laws specify that the reserves shall not be less than reserves calculated using certain specified mortality tables and interest rates. The policy liabilities carried in the Company's financial statements differ from the policy reserves specified by the laws of the various states which are carried in the insurance subsidiaries' statutory financial statements. These differences arise from the use of mortality and morbidity tables and interest assumptions that are believed to be more appropriate for financial reporting purposes than those required for statutory accounting purposes, from the introduction of lapse assumptions into the reserve calculations and from the use of the net level premium reserve method. For a more complete discussion of policy liabilities, see Note 1 to Consolidated Financial Statements.\nFEDERAL INCOME TAX MATTERS\nThe Company's life insurance subsidiaries are taxed by the federal government in a manner similar to companies in other industries. However, certain restrictions on consolidating life insurance company income with non-insurance income are applicable to the Company; thus, the Company is not able to fully consolidate the operating results of its subsidiaries for federal income tax purposes.\nCOMPETITION\nThe insurance market is highly competitive and occupied by a large number of companies, many of which have substantially greater capital and surplus, larger and more diversified portfolios of life and health insurance products and larger agency sales operations than the Company. The Company's subsidiaries are also encountering increased competition from banks, securities brokerage firms and other financial intermediaries marketing insurance products and other investments such as savings accounts and securities. The Company's subsidiaries compete primarily on the basis of the experience, number, accessibility and claims response of their agent representatives, the suitability and variety of their policy portfolios, and premium rates. The Company believes that its subsidiaries generally have good relationships with their agents, and have an adequate variety of policies approved for issuance which are generally competitive based on premium rates and service in the markets served.\nREGULATION\nThe Company's subsidiaries, like other insurers, are subject to comprehensive regulation in the various states in which they are authorized to conduct business. The laws of such states establish supervisory agencies with broad administrative powers, among other things, to grant and revoke licenses for transacting business, to regulate the form and content of policies, to set reserve requirements, to specify the type and amount of investments and to review premium rates for fairness and adequacy. These supervisory agencies periodically examine the business and accounts of the Company's subsidiaries and require such subsidiaries to file detailed annual convention statements prepared in accordance with statutory requirements.\nInsurance companies also can be required, under the solvency or guaranty laws of most states in which they do business, to pay assessments (up to prescribed limits) to fund policyholder losses or liabilities of insurance companies that become insolvent. These assessments may be deferred or forgiven under most guaranty laws if they would threaten an insurer's financial strength and, in certain instances, may be offset against future premium taxes. The frequency and amount of such assessments have increased in recent years and are generally expected to increase further in future years. Loyal and Prairie were assessed, and paid, $376,000 in 1994 to various state guaranty funds. The amount of any material future assessments under these laws cannot reasonably be estimated.\nAlthough there are no direct restrictions regarding the payment of dividends by the Company, its life insurance subsidiaries may not, under applicable state law, pay a cash dividend to the Company, except out of that part of their available and accumulated surplus funds which is derived from net gains from operations, calculated according to statutory accounting principles. In addition, the payment of principal and interest under surplus debentures, which are debt securities issued by insurance companies and payable solely out of the issuer's unrestricted surplus, require the prior approval of insurance regulatory authorities. The Company derives substantial portions of its operating funds from management fees, dividends and surplus debenture payments by its insurance subsidiaries.\nGenerally, under the insurance statutes of most states, state insurance authorities must approve in advance the direct or indirect acquisition of 10% or more of the voting securities of any insurance company chartered in that state. In addition, because the Company owns voting securities of certain life insurance companies, any acquisition of a substantial block of its outstanding voting securities is subject to certain regulatory requirements of the various subsidiaries' domiciliary states.\nThe National Association of Insurance Commissioners ('NAIC') is an association made up of the officials of each state responsible for the administration of that state's insurance laws. The NAIC and state insurance regulators have become involved in the process of reexamining certain existing insurance laws and regulations and their application to insurance companies. This reexamination has addressed a number of areas, including insurance company investment and solvency issues, risk-based capital ('RBC') guidelines, assumption reinsurance, interpretation of existing laws, the development of new laws, and the circumstances under which dividends may be paid. The NAIC has encouraged states to adopt model NAIC laws on specific topics such as holding company regulations and the definition of extraordinary dividends. It is not possible to predict the future impact of changing state regulation on the operations of the Company.\nThe RBC rules currently in effect attempt to measure statutory capital and surplus needs based upon the risks in an insurance company's mix of products and investment portfolio. An RBC analysis evaluates the adequacy of statutory capital and surplus in relation to investment and insurance risks associated with: (i) asset quality; (ii) mortality and morbidity; (iii) asset and liability matching; and (iv) other business factors. According to the NAIC, the RBC rules are not intended to be used by state insurance regulators as an absolute minimum or ideal level of required surplus. Rather, they are designed to serve as a tool to assist state insurance regulators in identifying potentially impaired insurance companies on a timely basis. The RBC rules will prompt different levels of regulatory action depending upon the result of RBC analysis for each company.\nIn states which have adopted the NAIC regulations, the new RBC requirements provide for four different levels of regulatory attention depending on an insurance company's RBC Ratio (its Adjusted Capital compared to its Authorized Control Level, as defined in the regulations). The 'Company Action Level' is triggered if a company's RBC Ratio is less than 200% but greater than or equal to 150%, or if a negative trend has occurred (as defined in the regulations) and the company's RBC Ratio is less than 250%. At the Company Action Level, the company must submit a comprehensive plan to the regulatory authority which discusses proposed corrective actions to improve its capital position. The 'Regulatory Action Level' is triggered if a company's RBC Ratio is less than 150% but greater than or equal to 100%. At the Regulatory Action Level, the regulatory authority will perform a special examination of the company and issue an order specifying corrective actions that must be followed. The 'Authorized Control Level' is triggered if a company's RBC Ratio is less than 100% but greater than or equal to 70%, and the regulatory authority may take any action it deems necessary, including placing the company under regulatory control. The 'Mandatory Control Level' is triggered if a company's RBC Ratio is less than 70%, and the regulatory authority is mandated to place the company under its control.\nBased upon the enacted RBC rules, both Loyal and Prairie have strong RBC Ratios (in excess of 500%) as of December 31, 1994.\nThe Company is registered under the Securities Exchange Act of 1934 and is subject to rules and regulations of the Securities and Exchange Commission. As a company with securities listed on the American Stock Exchange ('AMEX'), the Company is also subject to the rules and policies of the AMEX.\nEMPLOYEES\nThe Company had approximately 327 full-time employees and 2,617 full and part-time agents at December 31, 1994. The various subsidiaries have separate benefit programs for their employees but in general they are covered by contributory major medical insurance and group life insurance plans. In addition, the Company maintains a 401(k) profit sharing savings plan for its employees and the employees of the Company's subsidiaries. See Note 10 to Consolidated Financial Statements. The costs for all these benefits, except profit sharing plans, amounted to approximately $1.7 million in 1994.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's principal executive offices are located in Wayne, Pennsylvania. It leases approximately 4,100 square feet of office space at 640 Lee Road, Suite 303, Wayne, Pennsylvania. The aggregate monthly rental is approximately $8,800.\nLoyal's Home Office building is located at 2800 Dauphin Street, Mobile, Alabama. This building contains approximately 89,000 square feet, of which approximately 62,000 square feet are utilized for Company purposes. The remainder of the building is leased to outside tenants. The book value of the property at December 31, 1994 is approximately $3.5 million.\nPrairie's Home Office building is located at 440 Mount Rushmore Road, Rapid City, South Dakota. The building contains approximately 44,000 square feet, of which approximately 34,000 square feet are utilized for Company purposes, while the remainder of the building is leased to outside tenants. This six-story building and the underlying real property are subject to mortgage indebtedness (capitalized lease) of approximately $476,000 as of December 31, 1994. The book value of the property at December 31, 1994 is approximately $3.4 million.\nPrairie leases marketing and administrative space in several other locations. The aggregate monthly rental for these locations is approximately $4,000.\nCSW and IFA lease marketing and administrative space in their respective offices. The aggregate monthly rental for these locations is approximately $6,000.\nIn addition, Prairie is obligated on leases for space previously used for administrative purposes. This space is currently being sub-leased. The net monthly rental is approximately $5,500.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is routinely engaged in litigation incidental to its business. In the judgment of management, no individual case or group of similar cases, net of loss reserves established therefore and giving effect to reinsurance, is likely to result in judgments for amounts material to the financial condition of the Company.\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 fourth quarter of the year ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's common stock trades on the American Stock Exchange ('AMEX') under the symbol 'LQ'.\nThe transfer agent for the Company's common stock is Chemical Bank, Security Holder Relations, P.O. Box 24935, Church Street Station, New York, New York 10249.\nThe table below presents the high and low sales prices of the Company's common stock on the AMEX during the time periods indicated.\nThe closing market price of the Company's common stock on March 21, 1995, was $12.00 per share.\nAt March 21, 1995, there were approximately 10,000 holders of record of the Company's common stock.\nThe Company has paid no common stock dividends during the two years ended December 31, 1994. It is the policy of the Company to retain its earnings to finance expansion and growth. While the payment of future dividends will rest with the discretion of the Board of Directors and will depend, among other things, upon the Company's earnings, capital requirements and financial condition, the Company presently expects to retain its earnings to facilitate growth, both internally and by acquisition. The Company has no present plans to pay common stock dividends.\nThe Company's ability to pay common stock dividends may be limited by regulations affecting its insurance subsidiaries. Under applicable insurance laws, the Company's insurance subsidiaries may generally only pay cash dividends out of that part of available surplus which is derived from statutory net gains from operations, unless regulatory approval is obtained. In addition, payments of interest and principal relating to a surplus debenture at one of the Company's insurance subsidiaries also requires prior regulatory approval. See Note 7 to Consolidated Financial Statements and 'LIQUIDITY AND CAPITAL RESOURCES' under Item 7.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected consolidated financial data of the Company has been derived from the Consolidated Financial Statements of the Company. Certain reclassifications have been made to prior year amounts for comparative purposes.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following is an analysis of the results of operations and financial condition of Laurentian Capital and its consolidated subsidiaries. The consolidated financial statements and related notes and schedules included elsewhere in the Form 10-K should be read in conjunction with this analysis. Certain reclassifications have been made to prior year amounts for comparative purposes.\nOVERVIEW\nLaurentian Capital's net income for 1994 was $9.5 million, or $1.22 per share, as compared to net income of $8.2 million, or $1.05 per share, in 1993 and a net income of $6.7 million, or $0.80 per share, in 1992. Excluding the cumulative effect of the adoption of Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes' ('SFAS 109'), which contributed $0.4 million to net income in 1993, the Company's net income for 1993 was $7.8 million, or $1.00 per share.\nThe 1994 net income of $9.5 million, or $1.22 per share, compares favorably to 1993 net income of $8.2 million, or $1.05 per share. The improvement in net income was due primarily to increased life sales, a lower effective tax rate, and reduced interest expense on the Company's debt. During 1994, the Company refinanced its debt at a lower interest rate and used internal funds to repay $10 million of the debt.\nThe 1993 net income of $8.2 million, or $1.05 per share, compared favorably to 1992 net income of $6.7 million, or $0.80 per share. The improvement in net income was due primarily to increased realized capital gains on investments, as well as the Company's successful implementation of expense reduction programs.\nThe 1992 net income of $6.7 million, or $0.80 per share, compared favorably to 1991 net income of $5.4 million, or $0.63 per share. The improvement in net income was due primarily to increased investment income and lower death and health claim benefits. In addition, substantially lower levels of realized investment gains were included in 1992 net income than in the prior year.\nRESULTS OF OPERATIONS\nPREMIUM INCOME\nThe following table sets forth for the periods shown the amount of premium income and the percentage change in each from the prior period:\nPremium income improved in 1994 as compared to 1993 due principally to increased life insurance sales at Prairie. This increase is primarily applicable to the pre-need life insurance line of business, where Prairie has benefitted from expanded relationships with funeral directors. In addition, Loyal's cancer indemnity product sales improved over the prior year.\nPremium income improved in 1993 as compared to 1992 due to improvements in new sales and inforce persistency at Prairie and Loyal. Loyal's accident and health premium, primarily related to a cancer indemnity product, accounted for most of the increase.\nPremium income improved marginally in 1992 as compared to 1991. Improvements in both new sales and inforce persistency at Prairie and Loyal more than offset a decline in renewal premium due to a substantial block of inforce business at Prairie attaining paid-up premium status during the year.\nNET INVESTMENT INCOME, REALIZED INVESTMENT GAINS AND OTHER INCOME\nThe following table sets forth for the periods shown the amount of net investment income, realized investment gains and other income and the percentage increase (decrease) from the corresponding prior periods.\nDuring 1994, there was a decrease of 1.7% in net investment income, realized investment gains and other income as compared to 1993. During 1993 and early 1994, the Company experienced substantial prepayments on its fixed maturity investments as individuals and corporations took advantage of low interest rates and refinanced their debt obligations. These significant prepayments were reinvested at lower interest rates and, as expected, lowered the overall portfolio yield during the year. This decrease during 1994 was partially offset by the Company's sale of its investment in North American National Corporation ('NANC') in the first quarter for a gross realized gain of $1.7 million. Also, partially offsetting the decline in portfolio yield has been an increase in invested assets. The increase in invested assets was partially offset by the Company's payment of $10 million in conjunction with its debt refinancing during 1994.\nDuring 1993, there was an increase of 5.2% in net investment income, realized investment gains and other income as compared to 1992. This increase resulted primarily from a $2.7 million increase in realized investment gains. During 1993, the Company experienced substantial prepayments on its fixed maturity investments as individuals and corporations refinanced their debt obligations. The significant prepayments received in 1993 were reinvested at lower interest rates. The Company's increased level of realized investment gains resulted primarily from the exercise of call provisions on these debt obligations, usually at a premium. Net investment income remained stable as a lower portfolio yield was offset by increased invested assets.\nDuring 1992, there was a decrease of 2.4% in net investment income, realized investment gains and other income as compared to 1991. This decrease resulted primarily from a $3.6 million decline in realized investment gains. During 1992, $4.7 million in other than temporary impairments were recorded, principally to reduce real estate to appraised values, as compared to $0.9 million in 1991. Net investment income in 1992 increased $1.6 million when compared to 1991, due to growth in the Company's invested asset base combined with the accelerated recognition of income on mortgage-backed securities due to increases in prepayment activity.\nBENEFITS AND EXPENSES\nThe following table sets forth for the periods shown the benefits and expenses incurred by the Company as a percentage of premium income:\nBENEFITS\nBenefits for 1994 decreased as a percentage of premium to 92.1% from 94.7% in 1993. The decrease in benefits was due to a decrease in accident and health insurance benefits incurred by Loyal of approximately $0.9 million. In addition, life insurance benefits at Loyal decreased by approximately $0.7 million due to improved claims experience.\nBenefits for 1993 increased as a percentage of premium to 94.7% from 90.4% in 1992. The increase in benefits was due primarily to higher levels of death and health claims in 1993 as compared to 1992. During 1993, the Company achieved sales improvement in single premium funeral related life insurance and cancer indemnity products. Both products have a higher initial benefit to premium ratio than the existing inforce insurance business and substantially account for the increase in benefit ratio.\nBenefits for 1992 decreased as a percentage of premium from 95.9% in 1991 to 90.4% in 1992. The decrease in benefits was due primarily to lower levels of death and health claims in 1992 as compared to 1991.\nEXPENSES\nExpenses as a percentage of premium income in 1994 decreased to 53.8% as compared to 56.2% in 1993. Interest expense during 1994 was $1.3 million lower than during 1993 due to the refinancing of the Company's debt. The refinanced principal was $10 million less than the debt at December 31, 1993, and the effective interest rate was also lower on the refinanced amount due to the maturity of an Interest Rate Swap Agreement.\nExpenses as a percentage of premium income in 1993 decreased to 56.2% as compared to 59.5% in 1992. The decrease was due primarily to continued emphasis on cost containment and reduction as indicated by a $1.7 million decline in selling and administrative expenses.\nExpenses as a percentage of premium income in 1992 remained fairly stable when compared to 1991. Following a period of administrative consolidation, operational efficiencies continued during the year.\nINCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes' ('SFAS 109'). Under SFAS 109, deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities applying enacted tax rates. Deferred income tax expenses or benefits are based on the changes in the deferred tax assets or liabilities from period to period.\nThe Company's effective tax rate for the year ended December 31, 1994 was 24.3%, as compared to 31.5% for the year ended December 31, 1993. The effective tax rate for the year ended December 31, 1994 was lower than the enacted statutory tax rate of 34% due primarily to the reduction in valuation allowances associated with the deferred tax asset related to certain real estate assets sold in 1994, net operating losses utilized in 1994, and temporary differences of the non-life companies. Excluding the effect of these real estate transactions, the effective rate for 1994 would have been marginally higher than the effective rate for 1993.\nThe Company's effective tax rate has varied considerably in past years. Prior to 1992, one of the primary reasons for these variances was the difference in financial statement and tax reporting groups. For financial statement purposes, the profits and losses of all subsidiaries were reported on a consolidated basis; for tax purposes, Laurentian Capital Corporation filed a separate return, while Loyal and a former subsidiary, Defender, filed a consolidated return, as did Prairie and its subsidiary, Rushmore National Life Insurance Company ('Rushmore'). Filing separate tax group returns caused various effective tax rates to apply to the profits and losses of the financial statement filing group. Beginning in 1992, the Company qualified to file a consolidated life\/non-life federal tax return, except that Rushmore and Assured do not qualify to join in the filing of the consolidated Company return until\n1995 and 2000, respectively. The Company elected to file one consolidated return and, therefore, the financial reporting and federal tax reporting groups were primarily the same. However, variations in effective tax rates may persist as a result of limitations imposed by the Internal Revenue Code on the utilization of non-life insurance tax losses against life insurance taxable income. For 1992 and prior tax years, under then existing GAAP, effective tax rates also varied as a result of the differences between the tax bases of assets and liabilities and those assigned under purchase accounting ('Purchase Accounting Adjustments'). Pursuant to then existing GAAP, these Purchase Accounting Adjustments were treated as permanent differences. Accordingly, as these differences reversed, they increased or decreased the Company's effective tax rate. For 1993 and subsequent years under SFAS 109, Purchase Accounting Adjustments are treated as temporary differences and changes in these differences will not affect the Company's effective tax rate.\nNET INCOME\nThe following table sets forth for the periods shown the net income and the earnings per share:\nThe increase in net income for 1994 as compared to 1993 of $1.3 million is due to increased life sales (offset by a decrease in the yield of the investment portfolio), lower benefits and expenses, and a lower effective tax rate. Continued emphasis on cost containment and cost reduction has improved efficiency in the operations during a period of increased selling activity. Expenses were further reduced by $1.3 million as a result of the refinancing of the Company's debt at a lower interest rate which occurred during 1994. The Company also repaid $10 million of debt at the date of refinancing using internal funds.\nThe increase in net income for 1993 as compared to 1992 of $1.5 million was due to higher realized investment gains, lower operating expenses, recognition of a benefit from the adoption of SFAS 109 and a lower effective tax rate.\nThe increase in net income for 1992 as compared to 1991 of $1.3 million was due to higher investment income and lower death and health claims experience which offset the lower levels of realized investment gains.\nLIQUIDITY AND CAPITAL RESOURCES\nThe life insurance industry normally produces a positive cash flow from operations and scheduled principal repayments from portfolios of fixed maturity investments (bonds and redeemable preferred stocks) and mortgage loans. This cash flow is used to fund an investment portfolio to finance future benefit payments, which represent long-term obligations reserved for using certain assumed interest rates. Since future benefit payments are primarily long-term obligations, the Company's investments are predominately long-term fixed rate instruments such as bonds which are expected to provide a sufficient return to cover these obligations. The nature and quality of the various types of investments made by a life insurance company must comply with the statutes and regulations imposed by the states in which that company is licensed. These statutes and regulations generally require that securities acquired be investment grade and provide protection for policyholders.\nOn January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standard No. 115, 'Accounting for Certain Investments in Debt and Equity Securities' ('SFAS 115'). SFAS 115 specifically applies to the accounting for fixed income securities, which have historically been reported at amortized cost. SFAS 115 allows for the continued use of amortized cost reporting only for those securities that the Company has designated as fixed maturities held to\nmaturity. The balance of the Company's fixed maturity portfolio has been designated as available for sale, and must be reported at fair value. The initial effect of the adoption of SFAS 115 on the Company was an increase in stockholders' equity of $4.3 million (or $0.57 per share) as of the adoption date of January 1, 1994. Due to the general decline in the bond market experienced during 1994, the effect of SFAS 115 was to decrease stockholders' equity by $10.5 million (or $1.38 per share), at December 31, 1994.\nIn accordance with generally accepted accounting principles, all of the Company's investments are reported in the financial statements at either their original or amortized cost or their market value. At December 31, 1994, the fixed maturity investments had an amortized cost of $508.0 million with a market value of $461.8 million, $46.2 million below amortized cost. The Company's investment strategy is to hold its investments to maturity, and accordingly, the Company does not intend to realize the losses on its portfolio which have been generated as a result of increases in interest rates. The Company had $21.4 million in mortgage loans at December 31, 1994, which could reflect a small premium or discount if those mortgage loans had quoted market prices. The basis used for carrying these long-term fixed rate investments is consistent with the basis used in determining the liability for future policy benefits. Since these assets are invested for terms corresponding to anticipated future benefit payments and carry interest rates in excess of the assumed reserve interest rates, and because they produce predictable cash flows independent of premium income, they should be sufficient to fund the Company's future benefit payments in the ordinary course of business without any need for liquidation prior to maturity.\nThe Company holds a substantial component of its investment portfolio in mortgage-backed securities and collateralized mortgage obligations (collectively 'MBS'). At the end of 1994, the book value of the total investment in MBS amounted to $437 million, or 75% of total investments. These are instruments collateralized by pools of residential and commercial mortgages, which return interest and principal payments to the investor. Approximately 27% of the Company's MBS holdings are U.S. government agency securities (GNMA, FNMA and FHLMC), which carry either a direct government or a quasi-government guarantee and are rated AAA in terms of quality. The Company also owns non-agency MBS, issued by major U.S. financial institutions, which are rated AAA, AA or A. Non-agency MBS are credit-enhanced in order to achieve a high rating. The form of the credit enhancement is generally a senior\/subordinated structure, a limited corporate guarantee from a large financial institution or a letter of credit from a major commercial bank. Historically, residential mortgages in the U.S. have had a very low default rate and the Company's non-agency MBS are well-diversified geographically. Thus, the Company is protected against adverse regional economic conditions. Mortgage-backed securities typically yield more than corporate bonds of similar maturity. MBS also are not subject to so-called event risk, which can cause investment grade bonds of a corporation to become 'junk', as a result, for example, of a leveraged acquisition. In addition, MBS are generally liquid issues with major brokerage houses providing ready markets. However, MBS are subject to prepayment and extension risk which can adversely affect their yield and expected maturity.\nWith the significant decline in interest rates during the second half of 1992 and the first three quarters of 1993, the Company experienced a substantial increase in the level of prepayments associated with its investments in MBS during 1993 and early 1994. The total prepayments received on the MBS portfolio amounted to $52.7 million during 1994, compared to $137.3 million during 1993. Amounts received associated with these prepayments were accounted for as adjustments to investment yield. The Company experienced a decline in portfolio yield as a result of reinvesting these proceeds into similar investments at lower interest rates. The Company's investment strategy for MBS is to emphasize certain types of MBS that have a more predictable pattern of repayment and therefore reduce risk of a loss of a portion of the original principal due to changes in interest rates. A substantial portion of the MBS portfolio consists of Planned Amortization Class ('PAC'), Target Amortization Class ('TAC') and subordinate instruments. These investments are designed to amortize in a more predictable manner by shifting the primary risk for prepayment of the underlying collateral to investors in other tranches of the MBS. No loss of principal has occurred on the Company's MBS portfolio in recent years. The Company's investment policy has been to avoid investments in highly leveraged\nderivative instruments. For instance, the Company has not owned such mortgage-backed instruments as interest only, principal only, or inverse floaters.\nPolicy loans at December 31, 1994 were $50.6 million. Policy loan rates for the Company's policies are generally in the 3 1\/2% to 8% range, at least equal to the assumed interest rates used for future policy benefits; accordingly, policy loans should not result in negative cash flow.\nIn addition to the cash flow necessary to fund benefit payments, the Company requires cash flows for operating and administrative expenses, which are normally funded from premium income. The level of expenses generally fluctuates in proportion to the amount of premium produced, and the Company's subsidiaries generate sufficient cash flow to meet such expenses. However, the Company's cash disbursements have from time to time exceeded its cash receipts, principally due to its former acquisitions program and commitments made in connection with the acquisitions. Funding of interest on debt incurred in connection with this program of acquisitions as well as the subsequent consolidation of operations, required an expenditure of approximately $3.6 million in 1994, $4.9 million in 1993, and $5.0 million in 1992.\nAs of December 31, 1993, the Company's indebtedness under its then outstanding Revolving Underwriting Facility ('RUF') amounted to $54.8 million, which was due on April 25, 1994. On April 25, 1994, the Company entered into a five year revolving credit facility in the amount of $45 million to refinance part of the RUF. The new credit facility, together with the payment of $10 million by the Company, satisfied the repayment of the RUF. Pursuant to the terms of the new credit facility, the Company will pay interest at a variable rate equal to 1.125% above the London Interbank Offered Rate. There are covenants relating to the Company's activities and financial condition, including a requirement that the Company maintain a minimum net worth, as defined under the new credit facility, of $75 million. In connection with the new credit facility, DLFC has agreed, for the benefit of the lenders, to maintain the minimum net worth at the greater of $75 million and the amount of debt outstanding.\nThe Company issued approximately 58,000 shares of its Series A Preferred Stock on July 7, 1987. The preferred stock is subject to mandatory redemption provisions which provide that no more than 80% of the original issue will be outstanding at the end of the sixth year after issuance, with additional reductions of 20% of the original issue being required in each of the following four years. During 1994, the Company redeemed 8,524 shares of the preferred stock at $100 per share, in accordance with the mandatory redemption provision, and subsequently retired the stock. In order to satisfy the 1995 mandatory redemption provision, the Company must redeem 9,832 additional shares.\nAs a holding company, Laurentian Capital's ability to meet debt service obligations and pay operating expenses depends upon receipt of sufficient funds, primarily through dividends, interest and principal payments on a surplus debenture, and management fees from its subsidiaries. The Company's subsidiaries are currently producing earnings and net cash flow sufficient to cover debt service and preferred stock payment requirements at the parent. However, under the insurance laws of the states in which the Company's insurance subsidiaries are domiciled, certain restrictions are imposed on dividends from the subsidiaries to the parent. The insurance laws and regulations generally limit the amount of dividends to the greater of net statutory gain from operations or 10% of statutory surplus, and dividends in excess of these amounts can be paid only with the prior approval of the insurance regulators. The maximum dividend distribution which can be made to the Company by Loyal during 1995 without prior notice or approval is $3.4 million. Upon prior notice to the Division of Insurance of the State of South Dakota ('Division of Insurance'), the maximum dividend distribution which can be made by Prairie States to Prairie National Life Insurance Company ('Prairie National'), a wholly-owned life insurance subsidiary of the Company, during 1995 under current insurance law is $5.6 million. This would then be available to Prairie National to remit interest and principal payments due under its surplus debenture to the Company, subject to prior approval of the state regulatory authorities.\nDuring 1992, the Company restructured its holding in Prairie States. Following approval by the Division of Insurance, Prairie States was sold to Prairie National. As part of the consideration for\nPrairie National purchasing Prairie States, Prairie National issued capital stock and a $35 million surplus debenture to the Company. Interest and repayment of principal on the debenture is subject to prior approval by the Division of Insurance. The surplus debenture is payable in scheduled installments through 2001. Payments of principal and interest require prior approval by the South Dakota insurance commissioner and cannot reduce Prairie National's surplus below a certain required level. As of December 31, 1994, Prairie National exceeded its required level of surplus by $8.1 million. Since April 4, 1992, the date of the restructuring, and through the end of 1994 the Division of Insurance has approved $5.9 million in interest payments associated with the surplus debenture, of which $1.9 million was approved during 1994. Principal payments of $6.5 million were approved by the Division of Insurance during 1994. The effects of these transactions are eliminated in consolidation.\nIMPACT OF INFLATION\nInflation increases the need for insurance. Many policyholders who once had adequate insurance programs increase their life insurance coverage to provide the same relative financial benefit and protection. The effect of inflation on medical costs leads to accident and health policies with higher benefits. Thus, inflation has increased the need for life and health products.\nInflation has significantly increased the cost of health care. The adequacy of premium rates in relation to the level of health claims is constantly monitored and, where appropriate, premium rates on such policies are increased as policy benefits increase. Failure to make such increases commensurate with health care cost increases may result in a loss from health insurance operations.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe financial statements and supplementary data filed with this Report are as set forth in the 'Laurentian Capital Corporation and Subsidiaries Index to Financial Statements' following Part IV hereof.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThe Company has not had a disagreement with its accountants on any matters of accounting principles or practices or financial statement disclosure which is required to be reported in response to this Item.\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 and executive officers of the Company is incorporated by reference from the sections captioned 'ELECTION OF DIRECTORS', 'ABOUT THE BOARD OF DIRECTORS' and 'EXECUTIVE OFFICERS' in the Company's definitive proxy statement relating to the Company's 1995 Annual Meeting of Stockholders. The proxy statement will be filed with the Securities and Exchange Commission by the Company within the time contemplated by General Instruction G(3) of this Form 10-K or the information required by this Item 10 will be filed within such time by amendment of this Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation with respect to the executive officers of the Company is incorporated by reference from the sections captioned 'EXECUTIVE COMPENSATION' and 'OTHER COMPENSATION' in the Company's definitive proxy statement relating to the Company's 1995 Annual Meeting of Stockholders. The proxy statement will be filed with the Securities and Exchange Commission by the Company within the time contemplated by General Instruction G(3) of this Form 10-K or the information required by this Item 11 will be filed within such time by amendment of this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation with respect to ownership of the Company's stock by certain beneficial owners and by the Company's management is incorporated by reference from the section captioned 'Security Ownership of Certain Beneficial Owners and Management' in the Company's definitive proxy statement relating to the Company's 1995 Annual Meeting of Stockholders. The proxy statement will be filed with the Securities and Exchange Commission by the Company within the time contemplated by the General Instruction G(3) of this Form 10-K, or the information required by this Item 12 will be filed within such time by amendment of this Form 10-K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation with respect to certain relationships and related transactions is incorporated by reference from the sections captioned 'CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS' and 'Compensation Committee Interlocks and Insider Participation' in the Company's definitive proxy statement relating to the Company's 1995 Annual Meeting of Stockholders. The proxy statement will be filed with the Securities and Exchange Commission by the Company within the time contemplated by General Instruction G(3) of this Form 10-K, or the information required by this Item 13 will be filed within such time by amendment of this Form 10-K.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a), (d) Financial Statements and Financial Statement Schedules:\nA listing of financial statements and financial statement schedules filed as a part of this report is set forth in the 'Laurentian Capital Corporation and Subsidiaries Index to Financial Statements and Schedules' following Part IV hereof.\n(b) Reports on Form 8-K:\nThe Company filed a Form 8-K Current Report dated November 9, 1994, reporting its issuance of a press release announcing that it had engaged Oppenheimer & Co., Inc. as a financial advisor to evaluate various strategies for maximizing shareholder value, including possible business combinations or other transactions.\n(c) Listing of Exhibits:\n------------------ * Compensatory plan, contract or arrangement.\n------------------ * Compensatory plan, contract or arrangement.\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.\nLAURENTIAN CAPITAL CORPORATION\nBy: _______\/S\/__BERNHARD M. KOCH______ Bernhard M. Koch Senior Vice President, Chief Financial Officer, Treasurer and Secretary\nDate: March 27, 1995\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 date indicated.\nLAURENTIAN CAPITAL CORPORATION AND SUBSIDIARIES\nFORM 10-K, PART II, ITEM 8 YEAR ENDED DECEMBER 31, 1994\nLAURENTIAN CAPITAL CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nAll other schedules are omitted as the required information is not applicable or the information is presented in the financial statements or related notes.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders Laurentian Capital Corporation\nWe have audited the consolidated financial statements and the financial statement schedules of Laurentian Capital Corporation and Subsidiaries listed in the index on page 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 Laurentian Capital Corporation and Subsidiaries as of December 31, 1994 and 1993 and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 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 1 and 5 to the consolidated financial statements, the Company changed its method of accounting for certain investments in debt and equity securities in 1994 and changed its method of accounting for income taxes in 1993.\nCOOPERS & LYBRAND L.L.P.\nPhiladelphia, Pennsylvania February 17, 1995\nLAURENTIAN CAPITAL CORPORATION CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS)\nSee notes to consolidated financial statements.\nLAURENTIAN CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nLAURENTIAN CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS)\nSee notes to consolidated financial statements.\nLAURENTIAN CAPITAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\nSee notes to consolidated financial statements.\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization And Principles Of Consolidation -- The consolidated financial statements include, after intercompany eliminations, Laurentian Capital Corporation (individually or collectively with its subsidiaries, the Company), and its wholly-owned subsidiaries, principally Loyal American Life Insurance Company (Loyal), and Prairie National Life Insurance Company (Prairie National), a life insurance holding company, which owns Prairie States Life Insurance Company (Prairie States). Prairie States owns Rushmore National Life Insurance Company (Rushmore) and Assured Security Life Insurance Company (Assured). Prairie States acquired Assured during 1994 for $6.7 million in a transaction accounted for as a purchase.\nThe Imperial Life Assurance Company of Canada (Imperial) directly owned approximately 72% of the Company and Imperial's parent, Laurentian Financial, Inc., directly owned approximately 10% of the Company at December 31, 1994. Laurentian Financial, Inc. is a wholly-owned subsidiary of The Laurentian Group Corporation (Group). Effective January 1, 1994, Group became a subsidiary of Desjardins Laurentian Financial Corporation (Desjardins Laurentian). The ultimate owner of Desjardins Laurentian is La Confederation des caisses popularies et d'economie Desjardins du Quebec.\nBasis of Presentation -- The accompanying financial statements have been prepared on the basis of generally accepted accounting principles (GAAP), which vary from accounting principles used by its subsidiaries to prepare financial statements filed with state insurance departments.\nInvestments -- Effective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards Number 115, 'Accounting for Certain Investments in Debt and Equity Securities' (SFAS 115). SFAS 115 requires that debt securities are to be classified as either held to maturity (carried at amortized cost), available for sale (carried at market value with net unrealized gains or losses reported in stockholders' equity), or trading (carried at market value with unrealized gains or losses reported in net income).\nThe Company believes that it has the ability and intent to hold to maturity its debt security investments that are classified as held to maturity. The Company also recognizes that there may be circumstances where it may be appropriate to sell a security prior to maturity in response to changes in a variety of circumstances. In recognizing the need for the flexibility to respond to such changes, the Company has designated a portion of its fixed maturity portfolio as available for sale. The Company has not classified any of its fixed maturity securities as trading.\nSFAS 115 does not permit a retroactive application to prior years' financial statements. The effect of adopting SFAS 115 was to increase the carrying amount of fixed maturity securities classified as available for sale by $6.5 million, increase deferred income taxes payable by $2.2 million, and increase stockholders' equity by $4.3 million (or $0.57 per share), as of January 1, 1994. Due to the general decline in the bond market experienced during 1994, the carrying amount of fixed maturities available for sale, deferred income taxes payable and stockholders' equity decreased by $15.9 million, $5.4 million and $10.5 million (or $1.38 per share), respectively, at December 31, 1994.\nInvestments are reported as follows:\n- Fixed maturities held to maturity (bonds, notes and redeemable preferred stocks) -- at cost, adjusted for amortization of premium or discount and other than temporary impairments in market value. The Company has the ability and intent to hold such investments to maturity and accordingly, reports these investments at amortized cost.\n- Fixed maturities available for sale (bonds, notes and redeemable preferred stocks) -- at current market value, adjusted for other than temporary impairments in market value.\n- Equity securities (common and nonredeemable preferred stocks) -- at current market value, adjusted for other than temporary impairments in market value.\n- Mortgage loans on real estate -- at unpaid balances, net of valuation allowances and adjusted for amortization of premium or discount.\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) - Investment real estate -- at cost, net of valuation allowances and less allowances for depreciation computed on the straight-line method.\n- Policy loans -- at unpaid balances.\n- Short-term investments -- at cost, which approximates market.\nRealized gains and losses on sales of investments are recognized in net income. The cost of investments sold is determined on a specific identification basis. Temporary market value changes in equity securities and fixed maturities available for sale are reflected as unrealized gains or losses directly in stockholders' equity net of related income taxes and, accordingly, have no effect on net income. The rate of amortization of discount or premium on mortgage-backed securities is adjusted to reflect the current rate of prepayments on the related securities. The amortization adjustments are recorded as net investment income in the period that the rate of prepayment changed.\nDeferred Policy Acquisition Costs -- The costs of acquiring new business, which vary with and are directly related to the production of new business, have been deferred to the extent that such costs are deemed recoverable. Such costs include commissions, certain costs of policy issuance and underwriting, and certain variable marketing expenses.\nCosts deferred related to traditional life and health insurance are amortized over the premium paying period of the related policies, in proportion to the ratio of annual premium revenues to total anticipated premium revenues. Such anticipated premium revenues were estimated using the same assumptions used for computing liabilities for future policy benefits.\nCosts deferred related to universal life insurance and deferred annuity products are being amortized over the lives of the policies, in relation to the present value of estimated gross profits.\nIncluded in deferred policy acquisition costs are amounts representing the present value of future profits on business in force of acquired insurance subsidiaries, which represents the portion of the cost to acquire such subsidiaries that is allocated to the value of the right to receive future cash flows from insurance contracts existing at the dates of acquisition. These amounts are amortized with interest over the estimated remaining life of the acquired policies.\nCosts In Excess Of Net Assets Of Business Acquired -- The costs in excess of net assets of business acquired are being amortized to expense on a straight-line basis over periods ranging from twenty-five to forty years.\nProperty And Equipment -- Property and equipment is reported at cost. Depreciation is charged to operations over the estimated useful lives of the assets using the straight-line method.\nCash -- For purposes of reporting cash flows, cash includes all cash and short-term deposits available on demand, including certificates of deposit with an initial term to maturity of three months or less.\nPolicy Liabilities -- Liabilities for future policy benefits of traditional ordinary life policies are computed using a net level premium method including assumptions as to investment yields, mortality, withdrawals, and other assumptions commensurate with the Company's past experience, modified as necessary to reflect anticipated trends, including possible unfavorable deviations. The liability for future policy benefits for universal life policies and deferred annuities is equal to the accumulated fund balance including interest credits at rates declared by the Company. Interest rate assumptions range from 4.25% to 10%. Assumed mortality and withdrawals are based on various industry published tables modified as appropriate for the Company's actual experience. Morbidity and withdrawals are based on actual and projected experience.\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Life insurance in force, net of reinsurance, was approximately $2.6 billion as of December 31, 1994 and 1993.\nLiabilities for other policy claims and benefits payable include provisions for reported claims and an estimate based on ratios developed through prior experience for claims incurred but not reported.\nAssets Held In And Liabilities Related To Separate Accounts -- Investment annuity deposits and related liabilities represent deposits maintained by several banks under a previously offered tax deferred annuity program. The Company receives an annual fee from each bank for sponsoring the program and depositors may elect to purchase an annuity from the Company at which time funds are transferred to the Company.\nPremium Revenue And Related Expenses -- For traditional life and accident and health products, premiums are recognized as revenue when legally collectible from policyholders. Policy reserves have been established in a manner which allocates policy benefits and expenses on a basis consistent with the recognition of related premiums and generally results in the recognition of profits over the premium-paying period of the policies.\nFor interest-sensitive life and universal life products, premiums are recorded in a policyholder account which is classified as a liability. Revenue is recognized as amounts are assessed against the policyholder account for mortality coverage and contract expenses. Surrender benefits reduce the account value. Death benefits are expensed when incurred, net of the account value.\nFor investment type contracts, principally deferred annuity contracts, premiums are treated as policyholder deposits and are recorded as liabilities. Benefits paid reduce the policyholder liability. Revenues for investment products consist of investment income, with profits recognized as investment income earned in excess of the amount credited to the contracts. Reserves for these contracts represent the premiums received, plus accumulated interest. Contract benefits that are charged to expense include benefit claims incurred in excess of related contract values, and interest credited to contract values.\nIncome Taxes -- Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, 'Accounting for Income Taxes' (SFAS 109). This statement requires the use of the asset and liability method of accounting for deferred income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts and their respective tax bases. Deferred tax assets and liabilities are measured by applying enacted statutory tax rates expected to apply to taxable income in the years in which those deferred tax assets and liabilities 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 such change is enacted.\nPrior years' financial statements have not been restated to reflect the provisions of SFAS 109. The adoption of SFAS 109 resulted in a cumulative benefit of $400,000 for the year ended December 31, 1993, or $0.05 per common share.\nReinsurance -- Insurance liabilities are reported gross of the effects of reinsurance. Reinsurance receivables, including amounts related to insurance liabilities, are reported as assets. Estimated reinsurance receivables are recognized in a manner consistent with the liabilities related to the underlying reinsured contracts.\nRecently Issued Accounting Standards -- In May 1993, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 114, 'Accounting by Creditors for Impairment of a Loan' (SFAS 114), as amended by SFAS 118, 'Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures' (SFAS 118), which\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) establishes accounting standards for creditors when a loan is deemed impaired. These statements are primarily applicable to the Company's commercial loan portfolio, as residential loans are excluded. The Company has determined that the adoption of these statements will not have a material effect on the Company's financial position or results of operations, as the Company's impaired loan portfolio is not material. The Company will adopt these statements effective January 1, 1995.\nReclassifications -- Certain reclassifications have been made in the previously reported financial statements to make the prior year amounts comparable to those of the current year.\n2. INVESTMENTS\nMajor categories of net investment income for the years ended December 31 are summarized as follows:\nRealized investment gains (losses) for the years ended December 31 are summarized as follows:\nIncluded in realized investment gains (losses) for the years ended December 31 are adjustments for other than temporary impairments to the carrying value of investments, as follows:\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n2. INVESTMENTS (CONTINUED) The increase (decrease) in unrealized gains (losses) on fixed maturities and equity securities for the years ended December 31 is summarized as follows:\nGross unrealized gains pertaining to equity securities were $0.1 million and $2.4 million and gross unrealized losses were $0.8 million and $0.5 million, before tax effect, at December 31, 1994 and 1993, respectively.\nCertain investments, principally fixed maturities and mortgage loans on which the accrual of interest has been discontinued, amounted to $0.2 million and $1.3 million at December 31, 1994 and 1993, respectively.\nCertain investments totalling $358.7 million and $324.9 million, principally fixed maturities and mortgage loans, were on deposit with insurance departments of various states for the protection of policyholders at December 31, 1994 and 1993, respectively.\nOf the fixed maturity investments, $3.4 million at amortized cost, less other than temporary impairments, were rated as below investment grade as of December 31, 1994. These investments have an associated market value of $3.1 million. As of December 31, 1993, $8.8 million at amortized cost, with an associated market value of $9.1 million, were rated as below investment grade. Most of these securities have been evaluated by the National Association of Insurance Commissioners and found to be suitable for reporting at amortized cost. The Company does not expect these investment holdings to result in a material adverse effect on either the financial condition or results of operations. The Company's investment strategy is to hold fixed income instruments to maturity and to recognize other than temporary impairments on those investments where reduction in amounts to be received at maturity is likely.\nThe amortized cost and fair values of investments in fixed maturities as of December 31, 1994 are as follows:\nFixed Maturities Held to Maturity\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n2. INVESTMENTS (CONTINUED) Included in U.S. government obligations are $94.0 million of mortgage-backed securities at amortized cost, with an associated fair value of $81.4 million, of which $67.0 million carry a U.S. government or quasi-government guarantee.\nFixed Maturities Available for Sale\nIncluded in U.S. government obligations are $64.2 million of mortgage-backed securities at amortized cost, with an associated fair value of $62.5 million, of which $50.2 million carry a U.S. government or quasi-government guarantee. Included in obligations of states and political subdivisions are $3.2 million of mortgage-backed securities at amortized cost, with an associated fair value of $2.8 million, which carry guarantees of various states.\nThe amortized cost and fair value of fixed maturities as of December 31, 1994, by contractual maturity, are as follows. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nFixed Maturities Held to Maturity\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n2. INVESTMENTS (CONTINUED) Fixed Maturities Available for Sale\nThe amortized cost and fair values of investments in fixed maturities as of December 31, 1993 are as follows:\nIncluded in U.S. government obligations are $128.5 million of mortgage-backed securities, with an associated fair value of $130.3 million, of which $91.0 million carry a U.S. government or quasi-government guarantee. Included in obligations of states and political subdivisions are $3.3 million of mortgage-backed securities, with an associated fair value of $3.3 million, which carry guarantees of various states.\nProceeds from sales, maturities and repayments of investments in fixed maturities for 1994, 1993 and 1992 totalled $79.6 million, $192.2 million, and $168.3 million, respectively. Related gross investment gains and losses for the period were as follows:\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n3. OTHER FINANCIAL INSTRUMENTS\nThe following estimated fair value disclosures are limited to the reasonable estimates of the fair value of the Company's 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 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 necessarily be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The disclosures exclude certain financial instruments. Therefore, presentation of the estimated fair value of assets based on the above methodology without a corresponding revaluation of liabilities associated with insurance contracts can be misinterpreted.\nPolicy Loans\nPolicy loans are issued with interest rates that range from 3 1\/2% to 8%, depending on the terms of the insurance policy. Future cash flows of policy loans are uncertain and difficult to predict. As a result, management deems it impractical to calculate the fair value of policy loans.\nMortgage Loans and Real Estate\nMortgage loans are valued at unpaid balances, net of valuation allowances and adjusted for amortization of discount or premium. The Company has not been active in mortgage lending for some time, and the carrying value of the loan portfolio has decreased from $73.0 million at December 31, 1986 to the current balance of $21.4 million. Approximately 75% of the portfolio consists of commercial loans. After comparing the yield and maturity make-up of the portfolio with current offerings of mortgage-backed securities (both residential and commercial), the Company believes that the fair value of its mortgage loans approximates its current carrying value. Real estate is valued at cost less accumulated depreciation. Appraisals are obtained on a periodic basis and adjustments are made when necessary to ensure carrying values are not in excess of the underlying market values of the property.\n4. DEBT\nDebt as of December 31 is summarized as follows:\nOn April 25, 1994, the Company entered into a revolving credit facility in the amount of $45 million which matures on April 25, 1999 to refinance part of its previously outstanding Revolving Underwriting Facility ('RUF') which matured at that date. The new credit facility, together with the payment of $10 million by the Company, satisfied the repayment of the RUF. Pursuant to the terms of the new credit facility, the Company will pay interest at a variable rate equal to 1.125% above the London Interbank Offered Rate (LIBOR). The debt is collateralized by the Company's stock in one of its insurance subsidiaries. There are covenants relating to the Company's activities and financial condition, including a requirement that the Company maintain a minimum net worth, as defined under the new credit facility, of $75 million.\nAs of December 31, 1993, the Company's indebtedness under the RUF amounted to $54.8 million. Pursuant to the terms of the RUF, the Company paid interest at a variable rate, with a maximum rate equal to 0.30% above LIBOR. On March 6, 1991, the Company had entered into an Interest Rate Swap Agreement which fixed the LIBOR component of the RUF at 7.94% beginning April 29, 1991 through April 25, 1994.\n4. DEBT (CONTINUED)\nInterest expense included in the consolidated statements of operations was $3.6 million, $4.9 million, and $5.0 million for 1994, 1993 and 1992, respectively.\nCash paid for interest was $4.0 million, $4.9 million, and $5.3 million for 1994, 1993 and 1992, respectively.\nRepayment of the revolving credit facility is scheduled as follows:\n5. FEDERAL INCOME TAXES\nDeferred tax assets and liabilities computed at the statutory rate related to temporary differences as of December 31 are as follows:\nA valuation allowance of $7.2 million and $8.7 million has been established as of December 31, 1994 and 1993, respectively, for certain capital and operating loss carryforwards and temporary differences due to the uncertainty of their eventual realization. The valuation allowance was reduced by $1.5 million during 1994 for the realization of benefits associated with the deferred tax assets related to certain real estate sold during 1994, net operating losses utilized in 1994, and temporary differences of the non-life companies. The valuation allowance was reduced by $0.6 million during 1993 for the realization of benefits associated with the sale of certain real estate assets. The valuation\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n5. FEDERAL INCOME TAXES (CONTINUED)\nallowance against deferred tax assets will be continually evaluated and adjustments will be reflected in the Statement of Operations as an increase or decrease in income tax expense.\nFor 1992, under previously enacted GAAP, the total provision for federal income tax differed from amounts currently payable due to providing deferred taxes on certain items reported for financial statement purposes in periods which differed from those in which they were reported for tax purposes.\nDetails of the deferred tax provision for the year ended December 31, 1992 are as follows:\nThe Company's effective income tax rate varied from the statutory federal income tax rate for the years ended December 31 as follows:\nUnder previous life insurance company tax laws, a portion of the Company's gain from operations which was not subject to current income taxation was accumulated for tax purposes in memoranda accounts designated as the Policyholders' Surplus Accounts. The aggregate accumulation in these accounts at December 31, 1994 was approximately $8.6 million. The unrecognized deferred tax liability related to this temporary difference is $3.0 million. During 1994, the Company recognized a tax liability of $0.3 million on Prairie States' Policyholders' Surplus Account due to distributions in excess of its Shareholders' Surplus Account balance. With respect to the other Policyholders' Surplus Accounts, should the accumulation in the Policyholders' Surplus Accounts exceed certain stated maximums, or if certain other events occur, all or a portion of the Policyholders' Surplus Accounts may be subject to federal income taxes at rates then in effect. Deferred taxes have not been established for such amounts since the Company does not anticipate paying taxes on the Policyholders' Surplus Accounts.\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n5. FEDERAL INCOME TAXES (CONTINUED) For federal income tax return purposes, the Company has total estimated unused tax loss carryforwards at December 31, 1994 as follows:\nFor federal income tax purposes, the Company has total estimated investment tax credit carryforwards of $0.2 million which expire in years 1997 through 1999. The Company has a total estimated alternative minimum tax (AMT) carryforwards of $1.8 million which can be utilized in future tax years to reduce current taxes payable. Utilization of this AMT credit is limited to the excess, if any, of the Company's regular tax liability over its AMT liability. However, this credit can be carried forward indefinitely into future tax years. Included in the tax loss and credit carryforwards are certain amounts that may only be utilized by the company that generated the loss.\nThe Company recognized tax benefits of $2.7 million in 1992 associated with certain tax loss carryforwards related to previous acquisitions. For 1992, under the then enacted GAAP pronouncements, these benefits were recorded as an adjustment to the purchase price allocation and were reflected as decreases in Deferred Income Taxes, Costs In Excess of Net Assets Acquired, and Deferred Policy Acquisition Costs in the consolidated balance sheets. For 1994 and 1993, under SFAS 109, deferred tax assets have been established for the benefits arising from net loss and credit carryforwards of the Company and its subsidiaries. Future utilization of the net loss and credit carryforwards of the life insurance companies will not affect the Company's effective tax rate in those years because the full tax benefit for these items has been reflected in the financial statements. A portion of the benefit realized from the future utilization of the net losses of the non-life companies will affect the Company's effective tax rates in those years because a valuation allowance has been established against some of these deferred tax assets.\nCash paid for federal income taxes was $1.0 million, $0.3 million, and $0.4 million for 1994, 1993 and 1992, respectively.\n6. REDEEMABLE PREFERRED STOCK\nThe Company has authorized 5 million shares of preferred stock of which approximately 58,000 shares were issued on July 7, 1987. Each share of Series A Redeemable Preferred Stock is entitled to receive cumulative annual dividends of $6 per share. Each share of the Series A Redeemable Preferred Stock was convertible into 3.75 shares of the Company's common stock until July 7, 1994, and is convertible into 2.75 shares until July 7, 1997, subject to adjustment in certain events. The stock has a liquidation preference of $100 per share plus accrued dividends and is subject to mandatory redemption provisions which provide that no more than 80% of the original issue will be outstanding at the end of the sixth year after the issuance, with further reductions of 20% of the original issue being required in each of the following four years. During 1993, the Company completed a tender offer\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n6. REDEEMABLE PREFERRED STOCK (CONTINUED)\nwherein 4,534 shares of the redeemable preferred stock were purchased for $87 per share and subsequently retired. During 1994, the Company redeemed 8,524 shares of the preferred stock at $100 per share, in accordance with the mandatory redemption provision, and subsequently retired the stock. In order to satisfy the 1995 mandatory redemption provision, the Company must redeem 9,832 additional shares by July 7, 1995.\nThe remaining 4.97 million unissued shares of preferred stock may be divided into series with rights and preferences established at the discretion of the Board of Directors.\n7. STOCKHOLDERS' EQUITY AND RESTRICTIONS\nDividend payments to the Company from its insurance subsidiaries are restricted by state insurance law as to the amount that may be paid without prior notice or approval by insurance regulatory authorities. The maximum dividend distribution which can be made to the Company by Loyal during 1995 without prior notice or approval is $3.4 million. Upon prior notice to state regulatory authorities, the maximum dividend distribution which can be made by Prairie States to Prairie National during 1995 under current insurance law is $5.6 million. This distribution would then be available to Prairie National to remit interest and principal payments due under its surplus debenture to the Company, subject to prior approval of the state regulatory authorities. The unpaid balance of the surplus debenture is $24 million at December 31, 1994.\nDividend payments of $4.3 million and $2.1 million were made to the Company by its insurance subsidiaries during the years ended December 31, 1993 and 1992, respectively. Surplus debenture interest and principal payments were $8.4 million, $6.8 million and $1.2 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nIn connection with the 1989 acquisition of Rushmore, the policyholders of Rushmore are entitled to 90% of the statutory accounting earnings arising from the existing participating business during the ten years after the acquisition. In addition, the statutory surplus which was in existence at the date of acquisition has been distributed to the policyholders.\nApproximately 14% of the Company's insurance in force is related to participating insurance policies. A portion of the Company's earnings is allocated to these policies based on excess interest earnings, mortality savings and premium loading experience. Premium income and dividends allocated to participating policies during the past three years were as follows:\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n8. STOCK OPTION AND OTHER INCENTIVE PLANS\nSTOCK OPTION PLAN\nUnder the terms of the Company's Amended and Restated Executive Stock Option Plan (Plan), options to purchase up to the greater of 800,000 shares or 10.3% of the Company's outstanding common stock may be granted to officers and key employees. Options are granted at not less than market value on the date of grant and are exercisable during the term fixed by the Company, but not earlier than six months, nor later than ten years after the date of the grant.\nTransactions for 1994, 1993, and 1992 are as follows:\nThe Plan allows the Company to grant up to 800,000 Rights to officers and key employees. Rights entitle the grantee to receive the appreciation in value of the shares (the difference between market price of a common share at the time of exercise of the Rights and the base price) in cash. The Rights are exercisable during the term fixed by the Company, but in no case sooner than six months or later than ten years after the date of grant.\nNo Rights were exercised or cancelled during 1994. There are currently 349,044 rights granted at exercise prices ranging from $2.125 to $5.50 per share. Compensation expense recorded in 1994, 1993 and 1992 with respect to these Rights was approximately $1.3 million, $0.7 million and $1.0 million, respectively.\nDEFERRED AND INCENTIVE COMPENSATION PLANS\nThe Company has various incentive and deferred compensation plans administered by the Human Resources Committee of the Board of Directors. In 1994, 1993 and 1992, the Company recognized associated expenses of approximately $680,000, $698,000, and $532,000, respectively.\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n9. RELATED PARTY MATTERS\nThe Company paid or accrued approximately $152,000, $209,000, and $214,000, to Desjardins Laurentian and its affiliates for various services in 1994, 1993, and 1992, respectively.\n10. EMPLOYEE BENEFIT PLANS\nThe Company maintains a 401(k) profit sharing savings plan for employees who meet certain eligibility requirements. This plan provides for a Company matching contribution of 25-50% of eligible employee contributions up to 6% of salary. Supplemental Company contributions are provided based on consolidated earnings. The Company contributed approximately $152,000, $148,000 and $98,000 to the 401(k) profit sharing savings plan during 1994, 1993 and 1992, respectively, for employee matching. Effective January 1, 1993, the Company instituted a profit sharing element which provides for contributions by the Company ranging from 2-6% of the annual salary of eligible employees. Additionally, $437,000 and $425,000 were accrued in 1994 and 1993 for the plan's profit sharing element.\nIn January 1993, the Company filed a standard termination notice with the Pension Benefit Guaranty Corporation (PBGC) for the purpose of terminating the Company's former defined benefit pension plan. The Company ceased to accrue benefits for service cost as of December 31, 1992, and all participants in the plan became fully vested at that date. On March 22, 1993 a favorable determination was issued by the Internal Revenue Service on the plan termination. The Company then distributed plan assets to vested participants in accordance with PBGC established formulas. The Company made funding contributions of $1.1 million during 1993 to satisfy all plan obligations. Distributions were in the form of either a rollover to the Company 401(k) profit sharing savings plan, a purchase of a non-participating annuity contract, or a lump sum cash payment.\n11. REINSURANCE\nThe Company is contingently liable with respect to reinsurance ceded in that the liability for such reinsurance would become that of the Company upon the failure of any reinsurer to meet its obligations under a particular reinsurance agreement. The maximum liability which the Company retains on any one life is $125,000 under ordinary and group policies.\nThe Company had reinsured approximately $0.8 billion of life insurance in force at December 31, 1994 and 1993. Total premium income ceded during the years ended December 31, 1994, 1993, and 1992 was $5.8 million, $6.8 million, and $6.4 million, respectively. Reinsurance recoveries for the years ended December 31, 1994, 1993 and 1992 were $7.6 million, $6.8 million and $5.7 million, respectively.\nIncluded in reinsurance receivables are $1.1 million and $1.7 million representing amounts recoverable for claims ceded to reinsurers as of December 31, 1994 and 1993, respectively. Included in other liabilities are $0.9 million and $0.4 million representing amounts payable for premiums ceded to reinsurers as of December 31, 1994 and 1993, respectively.\nAt December 31, 1994 and 1993, reinsurance receivables amounted to $92.2 million and $39.0 million, respectively. Of the 1994 amount, $50.0 million is applicable to reinsurance activities at Assured (which was acquired by Prairie States during 1994) and is associated with two reinsurers. Excluding the amount applicable to Assured, reinsurance receivables with carrying values of $23.8 million and $25.1 million were associated with two additional reinsurers at December 31, 1994 and 1993, respectively.\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n12. COMMITMENTS AND CONTINGENCIES\nLEASES\nOther liabilities include a capitalized lease obligation associated with the financing and leasing of Prairie States' home office. In addition, the Company leases office space, data processing equipment and certain other equipment under operating leases.\nAggregate maturities of the capitalized lease obligation and future minimum aggregate rental payments required under non-cancelable operating leases as of December 31, 1994, are as follows:\nRental expense for operating leases was approximately $0.6 million in 1994, $0.7 million in 1993, and $1.7 million in 1992.\nFINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK\nThe Company had been a party to financial instruments with off-balance-sheet risk in the normal course of business to reduce its own exposure to fluctuations in interest rates. At December 31, 1993, the Company was a party to a five year Revolving Underwriting Facility (RUF) for maximum unsecured borrowings of $54.8 million maturing in April of 1994. Pursuant to the RUF, the Company paid interest at a variable rate, with a maximum rate equal to 0.30% above the London Interbank Offered Rate (LIBOR). On March 6, 1991, the Company entered into an Interest Rate Swap Agreement (Swap Agreement) to reduce the impact of changes in interest rates on its floating long-term debt. The Swap Agreement was with a commercial bank for a notional amount of $55 million. This agreement effectively changed the Company's interest rate exposure on the RUF from a floating LIBOR rate to a fixed LIBOR rate of 7.94%. The Company had been exposed to interest rate risk in the event of nonperformance by the commercial bank. The Swap Agreement matured at the time of the RUF maturity. The Company has not entered into a Swap Agreement or any other agreement which would effectively fix the interest rate on the Company's refinanced debt.\nINVESTMENT PORTFOLIO CREDIT RISK\nBonds:\nThe Company's bond investment portfolio is predominately comprised of investment grade securities. At December 31, 1994, approximately $3.4 million in debt securities, at amortized cost (0.7% of debt securities) are considered 'below investment grade'. Securities are classified as 'below investment grade' by utilizing rating criteria employed by independent bond rating agencies.\nThe Company has approximately 88% of its $508 million fixed maturity portfolio (amortized cost basis) invested in assets of either U.S. government agency pass-through mortgages (GNMA, FNMA, or FHLMC) or 'private-label' mortgage-backed securities as of December 31, 1994.\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n12. COMMITMENTS AND CONTINGENCIES (CONTINUED) Mortgage Loans:\nMortgage loans are primarily related to underlying real property investments in office and apartment buildings and retail\/commercial and industrial facilities.\nAt December 31, 1994, delinquent mortgage loans (i.e., loans where payments on principal and\/or interest are over 60 days past due) amounted to $0.4 million, or 1.9% of the loan portfolio. The Company had loans outstanding in the states of Colorado and Florida, with combined principal balances in the aggregate approximating $9.8 million.\nLITIGATION\nThe Company is involved in certain litigation arising in the ordinary course of business. Management does not anticipate any judgments against the Company in excess of liabilities already established which would have a material impact, individually or in the aggregate, on the financial position or results of operations of the Company.\n13. STATUTORY FINANCIAL STATEMENTS\nInsurance subsidiaries of the Company are required to file statutory financial statements with state insurance regulatory authorities. Accounting principles used to prepare these financial statements differ from GAAP. Consolidated net income and shareholders' equity on a statutory basis for the insurance companies for the years ended December 31 are as follows:\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n14. SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED)\nLAURENTIAN CAPITAL CORPORATION\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(ALL DOLLAR AMOUNTS IN TABLES ARE IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\n14. SELECTED CONSOLIDATED QUARTERLY FINANCIAL DATA (UNAUDITED) (CONTINUED)\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT BALANCE SHEETS\nLAURENTIAN CAPITAL CORPORATION (PARENT COMPANY) (DOLLARS IN THOUSANDS)\n------------------ *Eliminated in consolidation.\nS-1\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF OPERATIONS\nLAURENTIAN CAPITAL CORPORATION (PARENT COMPANY) (DOLLARS IN THOUSANDS)\n------------------ *Eliminated in consolidation.\nS-2\nSCHEDULE III -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT STATEMENTS OF CASH FLOWS\nLAURENTIAN CAPITAL CORPORATION (PARENT COMPANY) (DOLLARS IN THOUSANDS)\n------------------ *Eliminated in consolidation.\nS-3\nLAURENTIAN CAPITAL CORPORATION (PARENT COMPANY) NOTES TO CONDENSED FINANCIAL STATEMENTS\nThe condensed financial statements of Laurentian Capital Corporation (the 'parent company') should be read in conjunction with the Laurentian Capital Corporation and Subsidiaries consolidated financial statements and notes thereto.\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nThe accompanying parent company financial statements reflect only the accounts of Laurentian Capital Corporation. The parent company's investment in its subsidiaries is reflected on the equity basis. Intercompany accounts and transactions have not been eliminated since consolidated financial statements are not presented.\n2. RELATED PARTY TRANSACTIONS\nDuring 1992, the Company restructured its holding in Prairie States Life Insurance Company (Prairie). Following approval by the Division of Insurance for the State of South Dakota, Prairie was sold to a wholly-owned life insurance subsidiary of the Company, Prairie National Life Insurance Company, of Rapid City, South Dakota (Prairie National). As part of the consideration for Prairie National purchasing Prairie, Prairie National issued capital stock and a $35 million surplus debenture to the parent company. Interest and repayment of principal on the debenture is subject to prior approval by the South Dakota Division of Insurance. The Division of Insurance has approved $1.9 million and $2.2 million in interest payments associated with the surplus debenture for the years ended December 31, 1994 and 1993, respectively. Principal payments of $6.5 million and $4.5 million were approved by the Division of Insurance during 1994 and 1993, respectively.\nDuring 1994 and 1992, the parent company sold equity securities to its insurance subsidiaries at fair market value at the dates of sale. Total proceeds, which consisted of cash and fixed maturities, amounted to $2.4 million and $7.9 million, respectively and resulted in a gain on transfer of $0.1 million in 1994 and a loss on transfer of $1.5 million in 1992. The effects of these transactions were eliminated in consolidation.\nS-4\nSCHEDULE VI -- REINSURANCE\nLAURENTIAN CAPITAL CORPORATION AND SUBSIDIARIES (DOLLARS IN THOUSANDS)\nS-5\nINDEX OF\nEXHIBITS TO\nFORM 10-K\nANNUAL REPORT\nFOR THE YEAR ENDED DECEMBER 31, 1994\nLAURENTIAN CAPITAL CORPORATION\nEXHIBIT\nE-1","section_15":""}
{"filename":"25890_1994.txt","cik":"25890","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nCrown Cork & Seal Company, Inc. (the \"Company\" and the \"Registrant\") is a multinational manufacturer of metal and plastic packaging, including cans, bottles, crowns and closures (metal and plastic) and machinery for filling, packaging and handling. The Company is an international packaging producer and, as such, benefits from, but is also exposed to, the fluctuations of world trade. The Company recognizes that it must constantly review operations worldwide to ensure that it maintains its competitive position. To achieve better productivity, the Company closed or reorganized 31 facilities across nine countries between 1991 and 1994 and is scheduled to close three plants and reorganize three others during 1995. The Company continues to review all operations so that it can determine the appropriate number, size and location of plants, emphasizing service to customers and rate of return to investors.\nFinancial information about the Company's operations in its two industry segments and within geographic areas is set forth in Part II of this Report on page 38 under Note S of the Notes to the Consolidated Financial Statements entitled \"Segment Information by Industry and Geographic Areas\".\nThe Company has grown substantially since December 1989 when it commenced a series of acquisitions that have more than doubled its sales. The Company believes that these acquisitions have enabled it to become a leader in North American markets, to better penetrate important international markets, to enhance product quality, to realize economies of scale and to improve its technical and developmental capabilities while preserving the Company's traditional focus on customer service. To further accommodate its expanded base of operations, in 1992, the Company organized into four divisions by adding Plastics to its previously established North American, International and Machinery Divisions.\nThe Company, with its 1992 acquisition of CONSTAR International, Inc., now conducts business in two separate industry segments within the Packaging Industry, Metal and Plastic. Information about the Company's acquisitions over the past three years appears in Part II hereof on pages 25 and 26 under Note C of the Notes to the Consolidated Financial Statements.\nDISTRIBUTION\nThe Company's products are manufactured in 82 plants within the United States and 70 plants outside the U.S., spanning over 40 countries, and are sold through the Company's sales organization to the food, citrus, brewing, soft drink, oil, paint, toiletry, drug, antifreeze, chemical and pet food industries.\nIn 1994 and 1993, no one customer accounted for more than 10 percent of the Company's net sales. In 1992, one customer accounted for approximately 10.6 percent of the Company's net sales.\nRESEARCH AND DEVELOPMENT\nWith the acquisition of Continental Can International in 1991, the Company acquired an international engineering group currently based at the Company's Alsip Technical Center near Chicago. The technical center enables the Company to enhance its technical and engineering services worldwide both within the Company and to third parties. The Company's research and development expenditures of $21.1 million, $23.3 million and $16.7 million in 1994, 1993, and 1992, respectively, are expected to make a greater contribution to improving and expanding the Company's product lines in the future.\nMATERIALS\nThe Company continues to pursue strategies which enable it to source its raw materials with increasing effectiveness, and may consider vertical integration into the production of certain raw materials, such as PET resin, used in plastic bottle production, if it is advantageous to do so.\nSEASONALITY\nThe Company's metal and plastic beverage container businesses are predominately located in the Northern Hemisphere. Generally, beverage products are consumed in greater amounts during warmer months of the year. As such, quarterly sales and earnings of the Company have generally been higher and are expected to be higher in the second and third quarters of the calendar year. The Company's other businesses tend not to be affected by significant seasonal variations.\nENVIRONMENTAL MATTERS\nThe Company's operations, like those of others in the industry, generally are subject to numerous laws and regulations governing the protection of the environment, disposal of waste, discharges into water and emissions into the atmosphere. The Company has a Corporate Environmental Protection Policy, and environmental considerations are among the criteria by which the Company evaluates projects, products, processes and purchases. Further discussion of the Company's environmental matters is contained in Part II, Item 7 Management's Discussion and Analysis , of this Report on page 16 under the caption Environmental Matters .\nWORKING CAPITAL\nInformation relating to the Company's liquidity and capital resources is set forth in Part II, Item 7, \"Management's Discussion and Analysis of Operations and Financial Condition\", of this Report on pages 13 through 17.\nEMPLOYEES\nAt December 31, 1994, the Company employed 22,373 people throughout the world. A significant number of the Company's employees are covered by collective bargaining agreements of varying terms and expiration dates.\nMETAL PACKAGING\nThe Metal Packaging segment includes the North American, International and Machinery Divisions of the Company. This segment in 1994 accounted for approximately 78 percent of net sales and 73 percent of operating profits. This segment manufactures and markets steel and aluminum cans as well as composite cans, crowns (also known as bottle caps) and metal closures. Within the Machinery Division, the Company manufactures filling, packaging and handling machinery. All products are sold through the Company's sales organization to the food, brewing, citrus, soft drink, oil, paint, toiletry, drug, chemical and pet food industries.\nThe Company believes that price, quality and customer service are the principal competitive factors affecting its business. Based upon sales, the Company believes that it is a leader in the markets for metal packaging in which it competes; however, the Company encounters competition from a number of companies offering similar products.\nThe Company's basic raw materials for its Metal Packaging segment's products are tinplate and aluminum. These metals are supplied by the major mills in the countries within which the Company operates plants. Some plants in less-developed countries, which do not have local mills, obtain their metal from nearby\nmore-developed countries. In 1994, the Company obtained more than 90% of its tinplate requirements from ten suppliers with one supplier accounting for more than 20% and obtained its aluminum requirements from ten suppliers of which two suppliers account for 80%. Although sufficient quantities of tinplate and aluminum have been available in the past there can be no assurance that sufficient quantities will be available in the future.\nPrior to 1994, the Company entered into annual agreements with its tinplate and aluminum suppliers, pursuant to which the Company obtained price commitments for its tinplate and aluminum requirements for the next calendar year. The Company continues to contract for its tinplate requirements on this basis.\nDuring 1994, the Company's suppliers of aluminum can and end sheet announced and have implemented a new pricing formula for 1995. Pursuant to the new formula, aluminum can and end sheet prices are now directly tied to the price of aluminum ingot on the London Metal Exchange (LME). The formula price is generally the LME spot price of aluminum ingot plus a charge for the cost of converting and transporting aluminum. The Company believes that this new pricing formula is primarily responsible for the significant increase in the cost of aluminum in 1995 as compared to 1994, and that the effect of this new pricing structure will be to transfer the volatility in the commodity markets to the Company.\nHistorically, the Company has adjusted the prices for its products in response to changes in the cost of tinplate and aluminum. In response to the new aluminum pricing structure, the Company has announced price increases to its customers based upon the price of aluminum ingot on the LME. There can be no assurance, however, that the Company will be able to recover fully any increases or fluctuations in metal prices from its customers. In 1994, consolidated aluminum consumption, primarily for beverage cans and ends, accounted for 36% of the Company's consolidated cost of sales.\nThe Company, based on net sales, is one of two leading producers of aluminum beverage cans within the United States. This sector of its business, while important to the Company, continues to contribute a decreasing proportion of consolidated net sales (26% in 1994 from 30% in 1993 and 42% in 1991) as other sectors develop and as lower aluminum costs have been passed on to customers. Through 1994, beverage can prices in the United States had declined by more than had been realized in lower aluminum costs. The Company is addressing this situation through ongoing non-metal cost reductions and restructuring of production processes. Beverage can capacity in North America is being redeployed in emerging markets and, to a lesser extent, also is being retrofitted to produce two-piece food cans.\nIn North America, based on net sales, the Company believes that, as well as being a market leader in beverage cans, it is a market leader in the manufacture and sale of metal packaging to the processed foods, aerosol and other industries. The Company's customers include leading producers of soft drinks, beer, juice, food and aerosol products.\nIn April 1993, the Company acquired the Van Dorn Company. Van Dorn provides the Company with two piece (drawn) aluminum cans for processed foods and adds additional manufacturing capacity for metal, plastic and composite cans for the paint, chemical, automotive, food, pharmaceutical and household product industries.\nOn June 27, 1994, the Company acquired the container division of Tri-Valley Growers and signed a long-term supply agreement. This acquisition expands the Company's food can business.\nThe Company's Canadian operations continued to improve. The Canadian economy has shown some improvement and the Company is encouraged that a continued recovery will result in a better market for its products in the future.\nOver the next several years, the Company will review the possibility of reducing the number of manufacturing lines used in North America to produce beverage cans in favor of fewer, but faster and more\nefficient lines. Additional restructuring has also been directed towards U. S. non-beverage metal operations. Information relating to the Company's 1994 restructuring program is set forth in Part II, Item 7, Management's Discussion and Analysis , of this Report on pages 14 and 15 under the caption Provision for Restructuring and in Part II, Item 8, on page 28 under Note H to the Notes to the Consolidated Financial Statements.\nOutside North America, the Company's metal packaging products consist of metal crowns and closures as well as metal cans for food, beverage and aerosol customers. Europe is the most significant crown market for the Company with returnable bottles being a dominant form of beverage packaging in the region. In 1994, a joint venture project in Shanghai, China and a wholly-owned facility in Buenos Aires, Argentina became operational. New projects in Beijing, China and Hanoi, Vietnam, as well as expansion of the two-piece can facility in Argentina were announced during 1994. In March 1995, the Company announced plans for a joint venture in Brazil. The Company's non-U.S. beverage can capacity is concentrated in Hong Kong, China, Argentina, the United Arab Emirates(UAE), Korea, Saudi Arabia and Venezuela and consists of an additional 7 billion units of capacity. The operations in the UAE, Hong Kong, China, Korea, Saudi Arabia and Venezuela represent joint-venture operations. This action continues to support the Company's current philosophy that the use of business partners in many overseas locations presents another cost-effective means of entering these new markets.\nInternational margins have been sustained as a result of restructuring actions commenced in 1992. Ongoing review and restructuring, as necessary, continued through 1994.\nThe Machinery division, representing approximately 2 percent of consolidated net sales, reported decreased sales in 1994 as a direct result of the downsizing of its operations in Belgium due to competitive factors.\nPLASTIC PACKAGING\nThe Plastic Packaging segment manufactures plastic containers and plastic closures. With the Company's 1992 acquisition of CONSTAR International and the 1993 acquisition of the remaining 56 percent of CONSTAR'S affiliate in Europe, Wellstar, the Company offers a wider product range to its worldwide customers. The Plastic Packaging segment also includes plastic closure operations in Virginia and Switzerland and the manufacture of plastic closures in Metal Packaging plants in Belgium, Germany, Italy, Spain, Argentina, Thailand and the United Arab Emirates. The Plastic Packaging segment now represents approximately 22 percent of the Company's net sales as compared to approximately 2 percent in 1991. The Company is actively integrating these operations into its organization by installing its cost systems and controls.\nThe Company believes that price, quality and customer service are the principal competitive factors affecting its business. Based upon sales, the Company believes that it is a leader in the markets for plastic packaging in which it competes; however, the Company encounters competition from a number of companies offering similar products.\nCONSTAR and Wellstar manufacture plastic containers for the beverage, food, household, chemical and other industries. Wellstar, based on net sales, is one of four leading European producers of polyethylene terephthalate (PET) preforms and bottles, including PET returnable bottles. The Wellstar acquisition strengthens the Company's plastics marketing base within Europe. CONSTAR, based on net sales, is one of two leading producers of plastic containers produced from PET and HDPE (High-Density Polyethylene) within the United States. Plastic containers continued to increase their share of the packaging market during 1994.\nThe principal raw materials used in the manufacture of plastic containers and closures are various types of resins which are purchased from several commercial sources. Resins, which are petrochemical derivatives, are presently available in quantities adequate for the Company's needs. The Company has\nexperienced fluctuations in the cost of resins in the past and has periodically adjusted its selling prices for plastic containers and closures to reflect these movements in resin costs. There can be no assurance, however, that the Company will be able to recover fully any increases or fluctuations in resin prices from its customers.\nTypically, the Company identifies market opportunities by working cooperatively with customers and implementing commercially successful programs. The Company will capitalize on both the conversions to plastic from other forms of packaging and the new markets through its technical expertise, quality reputation and customer service. The Company believes that its plastic container plant sites are strategically located and sized to meet market requirements.\nCapital expenditures for the Plastic Packaging segment were approximately 47 percent of total capital expenditures for the Company in 1994 as compared to approximately 5 percent in 1991. The Company is committed to servicing its global customers with plastic containers. Information relating to the Company's capital expenditures is set forth in Part II, Item 7, Management's Discussion and Analysis , of this report on page 15 under the caption Capital Expenditures .\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's manufacturing and support facilities are designed according to the requirements of the products to be manufactured, and the type of construction varies from plant to plant. In the design of each facility, particular emphasis is placed on quality assurance in the finished products, safety in the operations, and avoidance or abatement of pollution. The Company maintains its own engineering staff, which aids in achieving close integration of research, design, construction and manufacturing functions and facilitates the construction of plants which will be best suited to their special purposes. Warehouse and delivery facilities are provided at each of the manufacturing locations; however, the Company does lease outside warehouses at some locations.\nThe plants of the Company and its subsidiaries are owned, with the exception of those that have the word \"leased\", in brackets, after the location name. Joint Ventures are indicated by the initials JV, in brackets, after the location name.\nMETAL PACKAGING LOCATIONS IN THE UNITED STATES\nMETAL PACKAGING LOCATIONS OUTSIDE THE UNITED STATES\nSome metal manufacturing locations are supported by locations that provide art work for cans and crowns, coil shearing, coil coating, research, product development and engineering. The support locations within the United States are located in Alsip, IL, Fairless Hills, PA (Leased), Massilon, OH, Philadelphia, PA, Plymouth, FL, Toledo, OH, Youngstown, OH (Leased); and outside the United States in Rotterdam, Holland and Bilbao, Spain.\nPLASTIC PACKAGING LOCATIONS IN THE UNITED STATES\nPLASTIC PACKAGING LOCATIONS OUTSIDE THE UNITED STATES\nThe Company manufactures bottle and can filling machinery and parts at locations within the United States in Baltimore, MD and Titusville, FL; outside the United States in Londerzeel, Belgium and San Luis Potosi, Mexico. The Company also operates two machinery overhaul locations within the United States in Bartow, FL and Philadelphia, PA.\nThe Company has four machine shop locations which manufacture tool and die parts used within its own manufacturing locations and also sells to customers in the packaging industry. The locations are within the United States, with two in Philadelphia, PA, one in Wissota, WI and one in Wilkes Barre, PA.\nThe Company is directly involved in post-consumer plastic packaging recycling and aluminum and steel can recycling through its subsidiary, Nationwide Recyclers, Inc., located in Polkton, NC.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn management's opinion, there are no pending claims or litigation, the adverse determination of which would have a material adverse effect on the consolidated financial position of the Company. The Company has been identified by the Environmental Protection Agency as a potentially responsible party (along with others, in most cases) at a number of sites. Information on this is presented in Part I, Item 1, entitled \"Business\" under the caption \"Environmental Matters\" appearing on page 2 of this Report and in Part II Item 7, entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" under the caption \"Environmental Matters\" appearing on page 16 of this Report.\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 STOCKHOLDER MATTERS\nThe Registrant's Common Stock is listed on the New York Stock Exchange. On March 17, 1995, there were 6,101 registered shareholders of the Registrant's Common Stock. The market price with respect to the Registrant's Common Stock is set forth on page 37 in Note R of the Notes to the Consolidated Financial Statements entitled \"Quarterly Data (unaudited)\".\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE YEAR SUMMARY OF SELECTED FINANCIAL DATA\nCertain reclassifications of prior years' data have been made to improve comparability.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n(in millions, except per share, employee, shareholder and statistical data)\nManagement's discussion and analysis should be read in conjunction with the financial statements and the notes thereto.\nShare data for prior years have been restated for the 3 for 1 common stock split declared in 1992.\nRESULTS OF OPERATIONS\nNET INCOME AND EARNINGS PER SHARE BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES\nNet income for 1994 was $131.0, compared with $180.9 in 1993 and $155.4 in 1992. Earnings per share for 1994 was $1.47, compared with $2.08 and $1.79 in 1993 and 1992, respectively. Excluding the provision for restructuring, net income increased 12.9% to $204.2 and earnings per share increased 10.1% to $2.29. Net income for 1993 and 1992 represents increases of 16.4% and 21.3%, respectively over the preceding year. Earnings per share represents increases of 16.2% and 20.9%, respectively over the preceding year. The sum of per share earnings by quarter does not equal earnings per share for the years ended December 31, 1994 and 1993 due to the effect of shares issued during 1994 and 1993.\nNET SALES\nNet sales during 1994 were $4,452.2, an increase of $289.6 or 7.0% versus 1993 net sales of $4,162.6. Net sales during 1992 were $3,780.7. Sales from domestic operations increased 4.5% in 1994 compared with a 17.9% increase in 1993. Foreign sales increased 12.3% in 1994 following a 3.6% decrease in 1993. Domestic sales accounted for 66.7% of consolidated sales in 1994 and 68.3% in 1993. An analysis of net sales by operating division follows:\nIncluded in the International Division are net sales of $77.0, $58.9 and $57.4 for the years ended December 31, 1994, 1993 and 1992, respectively, related to plastic packaging products manufactured and sold by the International Division.\nThe increase in 1994 North American Division net sales is primarily the result of a full year's sales from Van Dorn acquired in April 1993, and sales unit volume increases in beverage and food cans; offset by (i) lower raw material costs which were passed on to customers in the form of reduced selling prices, (ii) continued competitive pricing in the North American beverage can market, and (iii) the strengthening of the U.S. dollar against the Canadian dollar and Mexican peso. The decrease in 1993 division net sales from 1992 was primarily a result of (i) lower raw material costs which reduced selling prices, (ii) competitive beverage can pricing, and (iii) the weakening of the Canadian dollar; offset by the acquisition of Van Dorn and increased sales unit volume in aerosol and composite cans. U.S. sales accounted for approximately 83% of division net sales in both 1994 and 1993.\nThe increase in 1994 International Division net sales is primarily a result of (i) the first full year of operations at the Company's operations in Buenos Aires, Argentina and the United Arab Emirates, (ii)\ncontinued expansion into China through the Company's Hong Kong affiliate and (iii) increased unit volumes in Europe across most product lines with plastic closures up 21% and aerosol cans up 13%. The decrease in 1993 net sales was primarily a result of (i) the recession in Europe and (ii) the strengthening of the U.S. dollar against international currencies which reduced division sales by $71.\nAs customers continue to convert to plastic for packaging their products, the Company continues to invest to expand unit capacity and meet demand. The increase in 1994 Plastic Division net sales is a result of sales unit volume increases across most product lines in both the U.S. and Europe and increased raw material prices passed on to customers. The increase in 1993 Division net sales was primarily due to a full years sales of CONSTAR in 1993 versus 1992 and the acquisition of Wellstar in 1993.\nCOST OF PRODUCTS SOLD\nCost of products sold, excluding depreciation and amortization for 1994 was $3,699.5, a 6.5% increase from the $3,474.0 in 1993. This increase follows an 8.7% increase and a 2.8% decrease in 1993 and 1992, respectively. The increase in 1994 and 1993 cost of products sold primarily reflects increased sales levels as noted above offset by lower raw material costs and company-wide cost containment programs. The 1992 decrease was primarily due to lower raw material costs.\nAs a percent of net sales, cost of products sold was 83.1% in 1994 as compared to 83.5% in 1993 and 84.6% in 1992.\nSELLING AND ADMINISTRATIVE\nSelling and administrative expenses for 1994 were $135.4, an increase of 7.0% over 1993. This increase compares to increases of 12.9% for 1993 and 6.4% for 1992. Selling and administrative expenses have increased in recent years as a result of businesses acquired and to a lesser extent, general inflation. As a percent of net sales, selling and administrative expenses were 3.0% in 1994, 1993 and 1992.\nOPERATING INCOME\nThe Company views operating income as the principal measure of performance before interest costs and other non-operating expenses. Operating income in 1994 was $289.0 after restructuring charges. Operating income of $403.6 in 1994, before the restructuring charge of $114.6, was $24.9, or 6.6% greater than in 1993. Operating income was $378.7 in 1993, an increase of 18.3% over 1992, and $320.0 in 1992, an increase of 17.6% versus 1991. Operating income, before restructuring, as a percent of net sales was 9.1% in 1994 as compared to 9.1% in 1993 and 8.5% in 1992. An analysis of operating income, before restructuring, by operating division follows:\nIncluded in the International Division is operating income of $9.9, $8.0 and $7.9 for the years ended December 31, 1994, 1993 and 1992, respectively, related to plastic packaging products manufactured and sold by the International Division.\nOperating income in the North American Division was 9.6% of net sales in 1994 versus 10.0% and 9.2% in 1993 and 1992, respectively. The decrease in 1994 operating margins reflects the continued price pressures in the North American beverage can market. This was offset, to some extent, by (i) sales volume increases in most product lines, including beverage cans and ends and (ii) the benefits associated with the\nCompany's efforts in prior years to consolidate acquired plants into existing plants. Operating income in 1993 increased over 1992 as a result of productivity improvements and cost reduction programs. While 1994 operating income in the division decreased from 1993 levels, the Company considered the result satisfactory given the difficult beverage can pricing structure. Additionally, the Company's suppliers of aluminum can and end sheet implemented a new pricing structure for 1995 which, by formula, is directly tied to the price of ingot on the London Metal Exchange (LME). The formula takes the LME spot price of aluminum ingot and adds other costs to convert and transport aluminum, thereby effectively transferring the volatility in the commodity markets to the Company. While the Company has announced price increases to its customers based on LME quotes, the Company may not always be able to fully recover movements in commodity pricing.\nInternational operating income was 8.9% as a percentage of net sales in 1994 compared to 7.0% in 1993, and 5.8% in 1992. The increased operating income in 1994 and 1993 primarily reflects the Company's efforts to restructure certain European affiliates in 1993 and 1992 and the start-up of new operations in Argentina and the United Arab Emirates. The Company expects operating margins to improve as new operations increase capacity and mature through the learning curve.\nIncreased sales volume is the primary reason for operating income increases in the Plastic Division. As a percentage of net sales, operating profit was 7.6% in 1994 compared to 8.4% and 10.5% in 1993 and 1992, respectively. The substantial capital investment program in the division over the past two years has resulted in some temporary production inefficiencies. The Company expects margins to improve as installations are completed. Product mix and increased raw material costs have also contributed to lower operating margins.\nNET INTEREST EXPENSE\/INCOME\nNet interest expense was $91.6 in 1994 an increase of $11.9 when compared to 1993 net interest of $79.7. Net interest expense was $63.9 in 1992. The increase in 1994 and 1993 net interest expense is due primarily to (i) higher interest rates, (ii) acquisition financing for recent companies acquired and (iii) the substantial capital investment program the Company has entered into over the last two years. Specific information regarding acquisitions is found in Note C to the Consolidated Financial Statements, while information specific to Company financing is presented in the Liquidity and Capital Resources section of this discussion and Notes I and J to the Consolidated Financial Statements.\nTAXES ON INCOME\nThe effective tax rates on income were 30.4%, 34.8% and 39.7% in 1994, 1993 and 1992, respectively. The lower effective rates for 1994 and 1993 were primarily a result of lower effective tax rates in non-U.S. operations and higher non-U.S. income as a percentage of consolidated income compared to 1993 and 1992. The higher effective tax rate versus the U.S. statutory rate in 1992 is primarily due to the effect of different tax rates in non-U.S. operations and the increase in non-deductible amortization of goodwill and other intangibles, as a result of recent acquisitions.\nEQUITY IN EARNINGS OF AFFILIATES, NET OF MINORITY INTERESTS\nEquity in earnings of affiliates was $16.3, $5.0 and $6.3 for 1994, 1993 and 1992, respectively. The increase in equity earnings in 1994 is due to improved performance by the Company's non-consolidated affiliates in Saudi Arabia, Korea and Venezuela. The decrease in 1993 equity earnings was a result of the Company selling 30% of its interest in its joint venture in Saudi Arabia.\nMinority interests were $12.4, $6.5 and $4.6 in 1994, 1993 and 1992, respectively. The increase in minority interests relate to increased sales volumes and earnings in Hong Kong, China, the United Arab Emirates and South Africa.\nAs the Company continues to invest in projects in emerging overseas markets, the Company stands to reap the rewards while being exposed to the risks of sometimes volatile growth economies. These new markets\nprovide excellent future growth potential for the Company's products and services while at the same time introducing the Company to viable business partners. The Company believes that the use of business partners in many overseas locations presents another cost-effective means of entering new markets.\nThe Company has presented earnings from equity affiliates, net of minority interests (the components of which can be found in Notes F and P to the Consolidated Financial Statements), as a separate component of net income. Management believes that presenting such earnings as a component of pre-tax income would distort the Company's effective tax rate, and as such, has presented equity earnings after the provision for income taxes.\nINDUSTRY SEGMENT PERFORMANCE\nThis section presents individual segment results for the last three years. The after-tax charge of $73.2 or $.82 per share related to the restructuring charge is included as an after-tax charge in Metal Packaging segment (Metals) and is excluded in making comparisons of 1994 results. The after-tax charge of $81.8 or $.94 per share related to adoption of SFAS 106, SFAS 109 and SFAS 112 in 1993 is included as an after tax charge in Metals of $83.7 or $.96 per share and an after-tax credit in the Plastics Packaging segment (Plastics) of $1.9 or $.02 per share, and is excluded in making comparisons of 1993 results.\nNet sales for Metals in 1994 were $3,494.3, an increase of 3.8% compared to 1993 net sales $3,367.0. Net sales in 1992 were $3,573.1. Metals sales in 1994 increased over 1993 as a result of increased sales in operations in Argentina, the United Arab Emirates, Hong Kong and most European operations. While unit volume increased approximately 8% for beverage and food cans, North American Division sales were up only 2.2% as lower raw material costs were passed on to customers in the form of reduced selling prices. Sales in 1993 were lower than 1992 as a result of lower raw material costs which were passed on to customers.\nMetals operating income in 1994 was $326.6, before restructuring charges of $114.6, or 9.3% of net sales compared to $308.5 in 1993 which was 9.2% of net sales. Operating income in 1992 was $296.4 or 8.3% of net sales. Despite competitive price pressures, the Company continues its efforts to rationalize and improve manufacturing efficiencies thereby achieving cost reductions and increasing operating profits.\nNet sales for Plastics increased $162.3 or 20.4% to $957.9 in 1994 from $795.6 in 1993. Net sales for 1993 increased $588.0 or 283.2% against 1992 net sales of $207.6. The increase in 1994 is primarily a result of the increased unit capacity in the Company's CONSTAR plants. The increased capacity has been generated through significant capital investments in 1994 and 1993. The increase in 1993 is primarily a result of the Company's October 1992 acquisition of CONSTAR and the acquisition during 1993 of the remaining 56% interest in Wellstar Holding B.V. (\"Wellstar\") by CONSTAR. The full year sales of CONSTAR contributed approximately $600 in 1993 compared to two months sales in 1992 of approximately $100. Wellstar from the date of acquisition contributed net sales of $85 in 1993.\nPlastics operating income in 1994 was 8.0% of net sales at $77.0 compared to 8.8% or $70.2 in 1993. Operating income in 1992 was $23.6 or 11.4% of net sales. Increased competition and product sales mix have contributed to decreased margins. The Company expects margins to improve as temporary production inefficiencies from equipment installations in virtually every plant subside.\nACCOUNTING CHANGES\nThe Company adopted SFAS 106 and SFAS 109 on January 1, 1993. Additionally, during the fourth quarter of 1993, the Company adopted SFAS 112 retroactive to January 1, 1993. The after-tax effect of these accounting changes was a one-time charge to 1993 earnings of $81.8 or $.94 per share, with an incremental charge to 1993 earnings of $2.5 or $.03 per share. These accounting changes are more fully described in Note B to the Consolidated Financial Statements.\nAdoption of the above three statements did not and will not have any cash flow impact on the Company.\nFINANCIAL POSITION\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company's financial position remains strong. Cash and cash equivalents totaled $43.5 at December 31, 1994, compared to $54.2 and $26.9 at December 31, 1993 and 1992, respectively. The Company had working capital of $122.6 at December 31, 1994. The Company's primary sources of cash in 1994 consisted of (i) funds provided from operations $6.8; (ii) proceeds from short-term debt borrowings $495.6; and, (iii) proceeds from long-term debt borrowings $154.8. The Company's primary uses of cash in 1994 consisted of (i) payments on long-term debt $186.5; (ii) acquisition of and investments in businesses, $65.7; (iii) capital expenditures $439.8 and (iv) repurchases of common stock $12.7. Funds provided from operations of $6.8 in 1994 decreased $344.4 as compared to 1993. This reduction is primarily due to strong customer demand in the fourth quarter of 1994. Fourth quarter 1994 sales at $1,091.4 increased $156.2 compared to fourth quarter 1993 sales of $935.2. The Company's accounts receivable reflected this increased sales volume as receivables used cash of $185.5 during 1994 as compared to providing cash of $69.2 in 1993. The Company's inventory levels also increased, using cash of $37.8 in 1994 as compared to providing cash of $5.2 in 1993. Additionally, accounts payable was down in 1994 as compared to 1993 causing a use of cash of $153.5 as compared to a use of cash of $140.2 in 1993. The Company expects cash from operations in the first quarter of 1995 to benefit from the collection of December 31, 1994 accounts receivable in comparison to the first quarter of 1994.\nThe Company funds its working capital requirements on a short-term basis primarily through issuances of commercial paper. The commercial paper program is supported by a revolving bank credit agreement with several banks which was to mature on December 20, 1995. Maximum borrowing capacity under the agreement was $275 with borrowings of $40 outstanding as of December 31, 1994. In February 1995, the Company formalized a $1,000 multi-currency credit facility which bears interest at variable market rates and matures in February, 2000. This facility replaces the above lines of credit and the Company's use of this facility is not restricted. Based on the Company's intention and ability to maintain its revolving credit agreement beyond 1995, $235.0 of commercial paper borrowings were classified as long-term at December 31, 1994. There was $660.6 and $324.0 in commercial paper outstanding at December 31, 1994 and 1993, respectively.\nOn December 20, 1994, the Company filed with the Securities and Exchange Commission a shelf registration statement for the possible offering and sale of up to $500 aggregate principal amount of debt securities of the Company. On January 15, 1995, the Company sold $300 of public debt securities. This first tranche of the shelf registration includes $300 of 8.38% notes due 2005, priced at 99.79% to yield 8.4%. Net proceeds from the issue were used to pay down short-term indebtedness.\nIn January 1993, the Company filed with the Securities and Exchange Commission a shelf registration statement for the possible offering and sale of up to $600 aggregate principal amount of debt securities of the Company. On June 9, 1994, the Company sold $100 of public debt securities. This transaction represents the final tranche of the shelf registration. The tranche includes $100 of 7% notes due 1999, priced at 99.71% to yield 7.02%. Net proceeds from the issue were used to refinance outstanding short-term indebtedness.\nOn April 7, 1993 the Company sold $500 of public debt securities in three tranches. The notes and debentures were issued pursuant to the above noted shelf registration. These tranches include $100 of 5.875% notes due 1998, priced at par; $200 of 6.75% notes due 2003, priced at 99.625% to yield 6.80%; and $200 of 8% debentures due 2023, priced at 99.625% to yield 8.03%. Net proceeds from the issues were used to repay the bank facility which financed the acquisition of CONSTAR International in October 1992. The Company's long-term debt securities are rated Baa1 by Moody's Investors Service and BBB+ by Standard & Poor's Corporation.\nThe Company has, when considered appropriate, hedged its currency exposures on its foreign denominated debt through various agreements with lending institutions. The Company also utilizes a\ncorporate \"netting\" system which enables resources and liabilities to be pooled and then netted, thereby mitigating the exposure. The Company enters into limited interest rate and currency swaps and forward exchange contracts in its management of interest rate and foreign currency exposure. At December 31, 1994, the Company had entered into an interest rate swap agreement to convert 1,000.0 Belgian Francs ($31.4 at December 31, 1994) to a 6.53% fixed rate obligation. The contract amount represents 66.7% of the total underlying debt, bears interest at variable market rates and has a maturity which coincides with that of the debt. These financial instruments are more fully described in Notes I and J to the Consolidated Financial Statements.\nThe Company's ratio of total debt (net of cash and cash equivalents) to total capitalization was 55.3%, 50.1% and 52.1% at December 31, 1994, 1993 and 1992, respectively. Total capitalization is defined by the Company as total debt, minority interests and shareholders' equity. The increase in the Company's total debt in recent years is due to the significant capital expenditure program which the Company has committed to in the last three years and businesses acquired since December 29, 1989. As of December 31, 1994, $131.3 of long-term debt matures within one year.\nDuring the year, the Company repaid $50 private placement debt which carried an interest rate of 8.49%. Additionally, the Company's Canadian subsidiary repaid CDN $50 private placement debt which carried an interest rate of 11.75%.\nManagement believes that, in addition to current financial resources (cash and cash equivalents and the Company's commercial paper program), adequate capital resources are available to satisfy the Company's investment programs. Such sources of capital would include, but not be limited to, bank borrowings. Management believes that the Company's cash flow is sufficient to maintain its current operations.\nPROVISION FOR RESTRUCTURING\nThe Company recorded a pre-tax restructuring charge of $114.6 in the third quarter of 1994 ($73.2 after-tax) related to a program announced on September 14, 1994. Affected by the restructuring are plants which produce three-piece steel food and aerosol containers. The restructuring program is expected to enable the Company to remain competitive in its core metal packaging business and improve profitability. The program was implemented in the fourth quarter of 1994 with seven plants being closed as of December 31, 1994. Three plants will be closed and an additional three plants will be reorganized during 1995. The Company estimates that of the total restructuring charge of $114.6, $71.7 will be non-cash charges primarily to reflect the write down of assets. Cash charges related to the restructuring total $42.9 and are net of cash to be generated from the sale of properties and equipment of $32.4. Approximately $10.0 had been expended as of December 31, 1994. No properties or equipment were sold as of December 31, 1994. Cash charges not paid by December 31, 1994 primarily relate to future pension plan contributions and retiree medical benefits to be paid for terminated employees.\nThe cost of providing severance pay and benefits for the reduction of approximately 850 employees (approximately 360 positions eliminated by the end of 1994) was approximately $58.4 and is primarily a cash expense. Actual expenditures for severance pay and benefits through December 31, 1994 amounted to approximately $4.4, with costs attributable to pension and other post-retirement benefits not paid by December 31, 1994 being reclassified to their respective liability accounts. See Note N to the Consolidated Financial Statements. Employees terminated include most, if not all, employees at each plant to be closed or reorganized including salaried employees and employees of the respective unions represented at each plant site. The cost associated with the write down of assets (property, equipment, inventory, etc.) was approximately $50.4 and has been reflected as a reduction in the carrying value of the Company's assets at December 31, 1994. Non-cash charges of $68.2 offset by cash to be generated of $17.8 from the sale of equipment are the components of the asset write down. No assets have been sold as of December 31, 1994. Costs incurred in maintaining properties from the date of closure of the facilities to the estimated sale date or lease termination date of the facilities approximated $6.1 of the charge and is primarily a cash expense of which $.2 had been expended as of December 31, 1994. Included in the charge are cash items\nfor gains expected to be realized upon the sale of two facilities and estimated operating losses to be incurred between the announcement date and closure date of affected facilities. Details of the charge are also presented in Note H to the Consolidated Financial Statements. As of December 31, 1994, the original estimates related to the charge have remained unchanged.\nThe Company estimates that the restructuring, when complete, will generate cost savings of approximately $36 after tax on a full year basis. While the restructuring is being completed during 1995, the Company expects to realize an after tax cost savings of approximately $24 in 1995. The Company expects that the restructuring program will have positive effects on its liquidity and sources and uses of capital resources.\nDuring 1994, the Company acquired businesses for approximately $64, following acquisitions in 1993 and 1992 of $222 and $539, respectively. The details of such acquisitions are discussed in Note C to the Consolidated Financial Statements. The Company has established reserves to restructure acquired companies. At December 31, 1994 and 1993, these reserves totaled $22.2 and $94.1, respectively. These reserves relate primarily to costs associated with Company plans to combine acquired operations with pre-existing operations and include severance costs, plant consolidations and lease terminations. The Company expects these balances to be substantially liquidated during 1995. Cash expenditures for acquired company restructuring efforts were $35, $81 and $30 for the years ended December 31, 1994, 1993 and 1992, respectively.\nCAPITAL EXPENDITURES\nConsolidated capital expenditures totaled $439.8 in 1994 as compared with $271.3 in 1993. Minority partner contributions to consolidated capital expenditures were approximately $27 and $17 in 1994 and 1993, respectively. During the past five years, capital expenditures totaled $1,081.9.\nExpenditures in the North American Division totaled $170 with major spending for ongoing projects to convert domestic beverage can and end lines to the 202 diameter from the 206 diameter, a new technical center and aerosol plant in Alsip, Illinois and 2-Piece food cans in Owatonna, Minnesota.\nInvestments of $58 were made in the International Division. The Company began construction of a beverage can plant in Beijing, China, continued construction of a beverage can plant in Shanghai, China and began installation of beverage end line equipment in Foshan, China. The Company continued its expansion of existing plastic cap production in Europe and also began installation of a second aerosol line in its dedicated Mijrecht, The Netherlands plant.\nSpending in the Plastics Division for 1994 totaled $204 million as the Company continued in its commitment to service global customers with plastic containers. Major spending included the completion of both plant construction and equipment installations in Salt Lake City, Utah and Izmir, Turkey and continued expansion of existing products, specifically single-serve PET preform and bottle lines in the United States, Holland, England, and Hungary.\nThe Company expects its capital expenditures in 1995 to approximate $400 with minority partner contributions estimated at approximately $130 and capital financed by non-recourse debt of joint ventures approximating $60. The Company plans to continue capital expenditure programs designed to take advantage of technological developments which enhance productivity and contain costs as well as those that provide growth opportunities. Capital expenditures, exclusive of potential acquisitions, during the five-year period 1995 through 1999 are expected to approximate $2,000. Cash flow from operating activities will provide support for these expenditures; however, depending upon the Company's evaluation of growth opportunities and other existing market conditions, external financing may be required from time to time.\nENVIRONMENTAL MATTERS\nThe Company has adopted a Corporate Environmental Protection Policy. The implementation of this Policy is a primary management objective and the responsibility of each employee of the Company. The Company is committed to the protection of human health and the environment, and is operating within the increasingly complex laws and regulations of federal, state, and local environmental agencies or is taking action aimed at assuring compliance with such laws and regulations. Environmental considerations are among the criteria by which the Company evaluates projects, products, processes and purchases and, accordingly, does not expect compliance with these laws and regulations to have a material effect on the Company's competitive position, financial condition, results of operations or capital expenditures.\nThe Company is dedicated to a long-term environmental protection program and has initiated and implemented many pollution prevention programs with the emphasis on source reduction. The Company continues to reduce the amount of metal and plastic used in the manufacture of steel, aluminum and plastic containers through a \"lightweighting\" program. The Company not only recycles nearly 100 percent of scrap aluminum, steel, plastic and copper used in its manufacturing processes, but through its Nationwide Recyclers subsidiary, is directly involved in post-consumer aluminum, steel and plastics recycling. Additionally, the Company has already exceeded the Environmental Protection Agency's (EPA) 1995 goals for its 33\/50 program which calls for companies, voluntarily, to reduce toxic air emissions by 33% by the end of 1992 and by 50% by the end of 1995, compared to the base year of 1988. The Company, at the end of 1994, had achieved a more than 65% reduction in the releases of such emissions from all U.S. facilities. The cost to accomplish this reduction did not materially affect operating results. Many of the Company's programs for pollution prevention lower operating costs and improve operating efficiencies.\nThe Company has been identified by the EPA as a potentially responsible party (along with others, in most cases) at a number of sites. Estimated remedial expenses for active projects are recognized in accordance with generally accepted accounting principles governing probability and the ability to reasonably estimate future costs. Actual expenditures for remediation were $2.7 during 1994 and $2.2 in 1993. The Company's balance sheet reflects estimated gross remediation liabilities of $25.6 and $30.7 at December 31, 1994 and 1993, respectively and estimated recoveries related to indemnification from the sellers of acquired companies and the Company's insurance carriers of $16.4 and $19.4 at December 31, 1994 and 1993, respectively.\nEnvironmental exposures are difficult to assess for numerous reasons, including the identification of new sites, advances in technology, changes in environmental laws and regulations and their application, the scarcity of reliable data pertaining to identified sites, the difficulty in assessing the involvement of and the financial capability of other potentially responsible parties and the time periods (sometimes lengthy) over which site remediation occurs. It is possible that some of these matters (the outcome of which are subject to various uncertainties) may be decided unfavorably against the Company. It is however, the opinion of Company management, after consulting with counsel, that any unfavorable decision will not have a material adverse effect on the Company's financial position.\nCOMMON STOCK AND OTHER SHAREHOLDERS' EQUITY\nShareholders' equity was $1,365.2 at December 31, 1994, as compared with $1,251.8 at December 31, 1993. The increase in 1994 equity represents the retention of $131.0 of earnings in the business and the issuance of 892,867 common shares for various stock purchase and savings plans offset by the effect of 347,360 common shares repurchased, $1.8 minimum pension liability adjustment as more fully described in Note N to the Consolidated Financial Statements and equity adjustments for currency translation in non-U.S. subsidiaries of $19.4. The book value of each share of common stock at December 31, 1994 was $15.28, as compared to $14.09 at December 31, 1993.\nIn 1994, the return on average shareholders' equity, before restructuring, was 14.7% as compared to 1993, before the cumulative effect of accounting changes, of 14.6%.\nThe Company purchased 2,536,330 shares of its common stock from CCL Industries Inc. (\"CCL\") on January 7, 1993 for approximately $84.8. The Company and CCL had agreed to the share repurchase in August of 1992 at a then agreed purchase price of $33.00 per share, plus an adjustment computed at a rate of 3.5% per annum. The January 7, 1993 settlement was funded by cash flow from operations, borrowings and cash received from CCL of approximately $21. The cash received from CCL related to the settlement of guarantees made by CCL to the Company regarding the value of certain properties in connection with the Company's 1989 acquisition of Continental Can Canada Inc. The Company issued to CCL a total of 7,608,993 shares in the 1989 acquisition of Continental Can Canada Inc. The purchase of common stock from CCL was made pursuant to the Company's right of first refusal to purchase common stock offered for sale by CCL. After giving effect to the repurchase transaction, CCL held 2,536,331 shares or approximately 2.9% of the Company's shares then outstanding following the January 7, 1993 settlement date.\nThe Board of Directors has approved resolutions authorizing the Company to repurchase shares of its common stock to meet the requirements for the Company's various stock purchase and savings plans. The Company acquired 347,360, 2,580,982 and 1,747,774 shares of common stock in 1994, 1993, and 1992 for $12.7, $86.5 and $61.4, respectively. These purchases included the purchase of stock held by CCL in 1993.\nThe Company has traditionally not paid dividends and does not anticipate paying dividends in the foreseeable future. At December 31, 1994, common shareholders of record numbered 6,011 compared with 6,168 at the end of 1993.\nINFLATION\nGeneral inflation has not had a significant impact on the Company over the past three years due to strong cash flow from operations. The Company continues to maximize cash flow through programs designed for cost containment, productivity improvements, and capital spending. Management does not expect inflation to have a significant impact on the results of operations or financial condition in the foreseeable future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial Statements\nReport of Independent Accountants...............................19\nConsolidated Statements of Income...............................20\nConsolidated Balance Sheets.....................................21\nConsolidated Statements of Cash Flows...........................22\nConsolidated Statements of Shareholders' Equity.................23\nNotes to Consolidated Financial Statements......................24\nFinancial Statement Schedule\nSchedule II - Valuation and Qualifying Accounts and Reserves................................................40\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Shareholders and Board of Directors of Crown Cork & Seal Company, Inc.\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Crown Cork & Seal Company, Inc. and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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 our audits provide a reasonable basis for the opinion expressed above.\nAs discussed in Note B, the Company changed its methods of accounting for income taxes, postretirement benefits and postemployment benefits in 1993.\nPrice Waterhouse LLP Thirty South Seventeenth Street Philadelphia, Pennsylvania 19103 February 10, 1995\nCONSOLIDATED STATEMENTS OF INCOME (in millions, except per share amounts)\nThe accompanying notes are an integral part of these financial statements.\nCONSOLIDATED BALANCE SHEETS (in millions, except share data)\nThe accompanying notes are an integral part of these financial statements.\nCertain reclassifications of prior years' data have been made to improve comparability.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (in millions)\nThe accompanying notes are an integral part of these financial statements.\nCertain reclassifications of prior years' data have been made to improve comparability.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (in millions, except share data)\nThe accompanying notes are an integral part of these financial statements.\nShare data for prior years has not been restated for the 3 for 1 common stock split declared in 1992.\nCertain reclassifications of prior years' data have been made to improve comparability.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(in millions, except per share, employee, shareholder and statistical data)\n(share data for years prior to 1992 have been restated for the 3 for 1 common stock split declared in 1992.)\nA. Summary of Significant Accounting Policies\nPrinciples of Consolidation The consolidated financial statements include the accounts of Crown Cork & Seal Company, Inc. and its wholly-owned and majority-owned subsidiary companies. All significant intercompany accounts and transactions are eliminated in consolidation. Investments in joint ventures and other companies in which Crown does not have control, but has the ability to exercise significant influence over operating and financial policies (generally greater than 20% ownership) are accounted for by the equity method. Other investments are carried at cost.\nForeign Currency Translation For non-U.S. subsidiaries which operate in a local currency environment, assets and liabilities are translated into U.S. dollars at year-end exchange rates. Income and expense items are translated at average rates prevailing during the year. Translation adjustments for these subsidiaries are accumulated in a separate component of Shareholders' Equity. For non-U.S. subsidiaries which operate in U.S. dollars (functional currency) or whose economic environment is highly inflationary, local currency inventories and plant and other property are translated into U.S. dollars at approximate rates prevailing when acquired; all other assets and liabilities are translated at year-end exchange rates. Inventories charged to cost of sales and depreciation are remeasured at historical rates; all other income and expense items are translated at average exchange rates prevailing during the year. Gains and losses which result from remeasurement are included in earnings.\nCash and Cash Equivalents Cash equivalents represent investments with maturities of three months or less from the time of purchase, and are carried at cost which approximates fair value because of the short maturity of those instruments.\nInventory Valuation Inventories are carried at the lower of cost or market, with cost for all domestic metal, plastic container, crown and closure inventories determined under the last-in, first-out (LIFO) method. Machinery Division and non-U.S. inventories are principally determined under the average cost method.\nGoodwill Goodwill, representing the excess of the cost over the net tangible and identifiable intangible assets of acquired businesses, is stated on the basis of cost and is amortized, principally on a straight-line basis, over the estimated future periods to be benefited (primarily 40 years). On a periodic basis the Company reviews the recoverability of goodwill based primarily upon an analysis of cash flows from the acquired businesses. Accumulated amortization amounted to $86.9 and $62.7 at December 31, 1994 and 1993, respectively.\nProperty, Plant and Equipment Property, plant and equipment (PP&E) is carried at cost and includes expenditures for new facilities and those costs which substantially increase the useful lives of existing PP&E. Maintenance, repairs and minor renewals are expensed as incurred. When properties are retired or otherwise disposed, the related costs and accumulated depreciation are eliminated from the respective accounts and any profit or loss on disposition is reflected in income. Costs assigned to PP&E of acquired businesses are based on estimated fair value at the date of acquisition. Depreciation and amortization are provided on a straight-line basis for financial reporting purposes and an accelerated basis for tax purposes. The useful lives range between 40 years for buildings and 5 years for vehicles.\nTreasury Stock Treasury stock is reported at par value and constructively retired. The excess of fair value over par value is first charged to paid-in capital, if any, and then to retained earnings.\nResearch and Development Research, development and engineering expenditures which amounted to $21.1, $23.3 and $16.7 in 1994, 1993 and 1992, respectively, are expensed as incurred.\nEarnings Per Share Earnings per share are computed based on the weighted average number of shares actually outstanding during the period plus the shares that would be outstanding assuming the exercise of dilutive stock options, which are considered to be common stock equivalents. The number of equivalent shares that would be issued from the exercise of stock options is computed using the treasury stock method.\nReclassifications Certain reclassifications of prior years' data have been made to improve comparability.\nB. Accounting Changes\nEffective January 1, 1993, the Company adopted SFAS No.106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and SFAS No. 109, \"Accounting for Income Taxes.\" In the fourth quarter of 1993, effective January 1, 1993, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" The incremental after-tax effect of these accounting changes was a non-cash charge to 1993 earnings of $2.5 or $.03 per share.\nSFAS No. 106 requires employers to recognize the costs and obligations for postretirement benefits other than pensions over the employees' service lives. Previously, such costs were generally recognized as an expense when paid. The cumulative effect of implementing SFAS No. 106 as of January 1,1993 resulted in a non-cash charge to net income, net of $46.0 tax benefit, of $89.2 or $1.03 per share.\nSFAS No. 109 establishes new accounting and reporting standards for income taxes and requires adopting the liability method, which replaces the deferred method required by Accounting Principles Board Opinion (APB) No. 11. The cumulative effect of implementing SFAS No. 109 as of January 1, 1993 resulted in a non-cash increase to net income of $23.5 or $.27 per share.\nSFAS No. 112 requires employers to accrue the costs and obligations of postemployment benefits (severance, disability, and related life insurance and health care benefits) to be paid to inactive or former employees. Prior to adoption, the Company had recognized expense for the cost of these benefits either on an accrual or on an \"as paid\" basis, depending on the plan. The cumulative effect of implementing SFAS No. 112 resulted in a non-cash charge to net income, net of $8.5 tax benefit, of $16.1 or $.18 per share as of January 1, 1993.\nC. Acquisitions\nOn June 27, 1994, the Company acquired the can manufacturing facilities of Tri-Valley Growers for approximately $61 in cash, which was financed principally through cash from operations. The Company also acquired the stock of a tooling company in Pennsylvania for approximately $3 in cash.\nOn April 16, 1993, the Company's acquisition of the Van Dorn Company was completed through the issuance of 3,631,624 shares of the Company's common stock valued at approximately $140, and the payment in cash of approximately $37. The cash portion was financed through cash from operations. Van Dorn's Plastic Machinery Division was then sold on April 20, 1993 for approximately $81 in cash to an\naffiliate of Mannesmann Demag, AG. During 1993, the Company through its affiliate, CONSTAR International, also acquired, in separate transactions, Wellman, Inc.'s 50% interest in Wellstar Acquisition, B.V., for consideration of approximately $33 in cash, and the minority interest in Wellstar Acquisition's affiliate, Wellstar Holding, B.V. The Company now owns 100% of Wellstar Holding.\nDuring 1992, the Company acquired the outstanding stock of Constar International, Inc. (CONSTAR) for approximately $519 in cash, which was financed through bank borrowings. Additionally, during 1992, the Company acquired in separate transactions with an aggregate cost of approximately $20, the stock of a tooling and machine overhaul company in Wisconsin, the assets of a coil coating facility in Ohio and the assets of a crown manufacturer in Texas. The cost of these acquisitions was financed through cash from operations.\nFor financial reporting purposes, all of the acquisitions above were treated as purchases. An excess purchase price of approximately $581 has been determined, based upon the fair values of assets acquired and liabilities assumed in connection with the above acquisitions. A final allocation of the purchase price for 1994 acquisitions will be determined during 1995 when appraisals and other studies are completed. The operating results of each acquisition are included in consolidated net income from the date of acquisition.\nThe following represents the non-cash impact of the acquisitions noted above:\nThe following represents the unaudited pro forma results of operations as if the above noted business combinations had occurred at the beginning of the respective year in which the companies were acquired as well as at the beginning of the immediately preceding year:\nThe pro forma operating results include each company's results of operations for the indicated years with increased depreciation and amortization on property, plant and equipment along with other relevant adjustments to reflect fair market value. Interest expense on the acquisition borrowings has also been included.\nThe pro forma information given above does not purport to be indicative of the results that actually would have been obtained if the operations were combined during the periods presented, and is not intended to be a projection of future results or trends.\nD. Receivables\nE. Inventories\nApproximately 55% and 57% of worldwide inventories at December 31, 1994 and 1993, respectively, were stated on the last-in, first-out (LIFO) method of inventory valuation. Had average cost (which approximates replacement cost) been applied to such inventories at December 31, 1994 and 1993, total inventories would have been $22.4 and $26.8 higher, respectively.\nF. Investments\nG. Property, Plant and Equipment\nH. Restructuring\nOn September 14, 1994 the Company announced its plans to restructure thirteen metal packaging facilities. The balance of these reserves, (excluding the writedown of assets which are reflected as a reduction of the related asset account), are included within accounts payable and accrued liabilities and other non-current liabilities. The components of restructuring are as follows:\nEmployee costs primarily include severance costs to be paid to terminated employees and amounts necessary to reflect pension and retiree medical benefits, as determined by the Company's actuary. Benefits provided to employees to be terminated include only those predetermined benefits fully described in existing union contracts or as described in the \"Company's Salaried Employee's Benefits handbook\". The plan of restructuring only provides for the costs of employees terminated involuntarily. Costs attributable to pension and other post-retirement benefits not paid by December 31, 1994 have been reclassified to their respective liability accounts at year-end. See Note N to the Consolidated Financial Statements.\nThe consolidation of the Company's three-piece steel container business into a reduced number of facilities resulted in certain equipment becoming excess. The Company has written down these excess assets to their estimated realizable values. The restructuring charge also includes the estimated losses on the disposal of the related properties.\nCosts provided for lease termination include remaining lease payments and other costs to be incurred in maintaining the property between the closure date of the facility and the lease termination date. Costs provided for property held for sale include costs incurred in maintaining the property from the date of closure of the facility to estimated sale date of the facility.\nThe Company has offset the cost of restructuring by gains expected to be realized upon the sale of two facilities. Additionally, the Company has provided for estimated operating losses to be incurred between the announcement date and closure date for affected facilities.\nWhere applicable, the Company has also established reserves to restructure acquired companies. These purchase accounting adjustments related primarily to employee separation costs to be incurred upon plant closures, such as severance and additional pension and retiree medical liabilities. As of December 31, 1994, remaining balances from 1994 and 1993 acquisitions were $22.2. The Company expects these balances to be substantially liquidated during 1995.\nThe Company, as appropriate, periodically charges operations in the current period when non-recurring severance plans are announced. The Company charged $4.9 and $11.1 to operations in 1994 and 1993, respectively. Those amounts are also classified as restructuring and are included in accounts payable and accrued liabilities.\nI. Short-Term Borrowings and Long-Term Debt\nOn December 20, 1994, the Company filed an S-3 Registration Statement to issue up to $500.0 of debt securities. On January 15, 1995, $300.0, 8.38% notes due 2005 were issued with the proceeds used to pay down short-term indebtedness.\nAggregate maturities of total long-term debt for the five years subsequent to December 31, 1994 are $131.3; $147.7; $53.5; $120.7 and $109.8, respectively. Cash payments for interest were $107.1 (including capitalized interest of $5.5) in 1994, $82.2 in 1993 and $78.4 in 1992.\nThe carrying value of total debt as of December 31, 1994 and 1993 does not differ materially from its estimated market value.\nJ. Financial Instruments\nIt is the Company's policy to reduce its exposure to adverse fluctuations in interest and foreign exchange rates.\nThe Company has a program to offset equivalent foreign currency assets and liabilities, thereby minimizing net exposures. The Company uses only liquid instruments from credit worthy financial institutions and does not enter into leveraged, tiered or illiquid contracts. Further, the Company does not enter into derivative financial instruments for trading purposes.\nComplementary to this approach, the Company enters into forward exchange contracts, primarily in European currencies, to hedge certain foreign currency transactions for periods consistent with the terms of the underlying transactions. As of December 31, 1994 and 1993, the Company had outstanding foreign exchange contracts to buy or sell foreign currencies for an aggregate notional amount of $126.1 and $59.8, respectively. Based on year-end exchange rates and the maturity date of the various contracts, the aggregate contract value of these items approximated fair value at December 31, 1994 and 1993, respectively. Gains and losses resulting from contracts that are designated and effective as hedges are recognized in the same period as the underlying hedged transaction.\nThe Company also enters into interest rate swap and cap agreements to manage interest rates on its underlying debt obligations. Costs associated with these financial instruments are generally amortized over the lives of the instruments and are not material to the Company's financial results. Differences in interest, which are paid or received, are recognized as adjustments to interest expense of the underlying debt obligation.\nAt December 31, 1994, the Company was party to one material interest rate contract. See Note I to the Consolidated Financial Statements.\nK. Accounts Payable and Accrued Liabilities\nL. Other Non-Current Liabilities\nOther non-current assets includes $16.4 and $19.4 at December 31, 1994 and 1993, respectively, for estimated recoveries related to environmental liabilities.\nM. Stock Options\nAll amounts below have been adjusted to reflect the 3 for 1 stock split to shareholders of record as of May 12, 1992.\nIn accordance with the Stock Option Plans adopted in 1983 and 1984, options to purchase 9,180,000 Common Shares have been granted to officers and key employees. Options were granted at market value on the date of grant and are exercisable beginning one to two years from date of grant and terminate from five to ten years from date of grant.\nIn accordance with the 1990 Stock-Based Incentive Compensation Plan, options to purchase 6,000,000 common shares can be granted to officers and key employees. Options were granted at market value on\nthe date of grant and are exercisable beginning one to two years from date of grant and terminate up to ten years from date of grant. Certain options granted to employees of acquired companies, which are included in the table below, do not reduce the shares available for grant under the 1990 plan.\nN. Pensions and Other Retirement Benefits\nPensions The Company sponsors various pension plans, covering substantially all U.S., Canadian and some non-U.S. and non-Canadian employees and participates in certain multi-employer pension plans. The company-sponsored plans are currently funded. The benefits for these plans are based primarily on years of service and the employees' remuneration near retirement. Contributions to multi-employer plans in which the Company and its non-U.S. and non-Canadian subsidiaries participate are determined in accordance with the provisions of negotiated labor contracts or applicable local regulations.\nPlan assets of company-sponsored plans of $1,119.7 consist principally of common stocks and fixed income securities, including $216.6 of the Company's common stock.\nPension expense amounted to $1.3 (including expense of $7.2 for non-company sponsored plans) in 1994, income of $18.6 (including expense of $5.7 for non-company sponsored plans) in 1993 and income of $4.8 (including expense of $6.0 for non-company sponsored plans) in 1992. Pension cost for non-U.S. and non-Canadian plans in 1994, 1993 and 1992 was determined under statutory accounting principles which are not considered materially different from U.S. generally accepted accounting principles.\nThe 1994, 1993 and 1992 components of pension cost for company-sponsored plans were as follows:\nCost attributable to plant closings is included within the restructuring charge as more fully described in Note H to the Consolidated Financial Statements.\nThe funded status of company-sponsored plans, including the assets and liabilities assumed in connection with acquisitions, at December 31, 1994 and 1993 was as follows:\nThe Company recognizes a minimum pension liability for underfunded plans. The minimum liability is equal to the excess of the accumulated benefit obligation over plan assets. A corresponding amount is recognized as either an intangible asset, to the extent of previously unrecognized prior service cost and previously unrecognized transition obligation, or a reduction of shareholders' equity. The Company had recorded additional liabilities of $96.4 and $84.8 as of December 31, 1994 and 1993, respectively. An intangible asset of $10.6 and $1.5 and a shareholders' equity reduction, net of income taxes, of $48.1 and $46.3 was recorded as of December 31, 1994 and 1993, respectively.\nThe weighted average actuarial assumptions for the Company's pension plans are as follows:\nOther Postretirement Benefit Plans The Company and certain subsidiaries sponsor unfunded plans to provide health care and life insurance benefits to pensioners and survivors. Generally, the medical plans pay a stated percentage of medical expenses reduced by deductibles and other coverages. Life insurance benefits are generally provided by insurance contracts. The Company reserves the right, subject to existing agreements, to change, modify or discontinue the plans.\nThe net postretirement benefit cost was comprised of the following components:\nCost attributable to plant closings is included within the restructuring charge as more fully described in Note H to the Consolidated Financial Statements.\nHealth care claims and life insurance benefits paid totaled $36.3 in 1994, $41.6 in 1993 and $35.2 in 1992.\nThe following provides a reconciliation of the accumulated postretirement benefit obligation to the liabilities recognized in the Company's balance sheet as of December 31:\nThe health care accumulated postretirement benefit obligation was determined at December 31, 1994 and 1993 using health care trend rates of 10.1% and 12.5%, respectively, decreasing to 5.1% over ten years and 7% over fifteen years, respectively. The assumed long-term rate of compensation increase used for life insurance was 5%. The discount rate was 8.5% and 7.1% at December 31, 1994 and 1993, respectively. Changing the assumed health care cost trend rate by one percentage point in each year would change the accumulated postretirement benefit obligation by $42.0 and the net postretirement benefit cost by $4.6.\nEmployee Savings Plan and Employee Stock Purchase Plan The Company sponsors a Savings Investment Plan which covers all domestic salaried employees who are 21 years of age with one or more years of service. The Company matches with equivalent value of Company stock, up to 1.5% of a participant's compensation. The Company's contributions were approximately $.9 in each of the respective years ending December 31, 1994, 1993 and 1992.\nThe Company, commencing in 1994, sponsors an Employee Stock Purchase Plan which covers all domestic employees with one or more years of service who are non-officers and non-highly compensated as defined by the Internal Revenue Code. Eligible participants contribute 85% of the quarter ending market price towards the purchase of each common share. The Company's contribution is equivalent to 15% of the quarter-ending market price. Total shares purchased under the plan in 1994 were 65,437 and the Company's contribution was $.4 .\nO. Income Taxes\nPretax income before cumulative effect of accounting changes for the years ended December 31 was taxed under the following jurisdictions:\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:\nThe Company paid federal, state, local and foreign (net) income taxes of $88.9 for 1994, $11.7 for 1993 and $38.7 for 1992.\nThe components of deferred tax assets and liabilities at December 31, follow:\nPrepaid expenses and other current assets includes $9.2 of deferred tax assets at December 31, 1994. Other non-current assets includes $49.1 and $20.6 of deferred tax assets at December 31, 1994 and 1993, respectively.\nApproximately $38.6 of deferred tax assets relating to net operating losses and tax basis differences were available in various foreign tax jurisdictions at December 31, 1994. Deferred tax assets of $12.1 must be utilized within the next five years and $26.5 can be utilized over an indefinite period. The Company believes that it is more likely than not that $9.4 of these benefits are expected to be realized by achieving future profitable operations based on actions taken by the Company.\nNo net benefit has been recorded for the remaining items. Future recognition of these carryforwards will be made either when the benefit is realized or when it has been determined that it is more likely than not that the benefit will be realized against future earnings. No other tax operating loss or credit carryforwards exist for which the Company has recognized a net financial benefit.\nThe cumulative amount of the Company's share of undistributed earnings of non-U.S. subsidiaries for which no deferred taxes have been provided was $432.2, $401.2 and $385.2 as of December 31, 1994, 1993 and 1992, respectively. Management has no plans to distribute such earnings in the foreseeable future.\nP. Minority Interests\nQ. Leases\nMinimum rental commitments under all noncancelable operating leases, primarily real estate, in effect at December 31, 1994 are:\nOperating lease rental expense (net of sublease rental income of $1.1 in 1994 and $1.0 in 1993 and 1992) was $19.6 in 1994, $21.9 in 1993 and $10.2 in 1992.\nR. Quarterly Data (unaudited)\nThe closing price of the Company's common stock at December 31, 1994 and 1993 was $37.75 and $41.88, respectively.\nThird quarter 1994 includes pre-tax restructuring charges of $114.6, $73.2 after taxes or $.82 per share. Excluding the effects of the restructuring charge, net income for the third quarter was $65.7 and earnings per share was $.74.\nRestatement of previously reported 1993 quarterly data to reflect accounting changes resulted in an increase in the net loss of $16. 1 and an increase in the net loss per share of $.18 for the first quarter of 1993. The restatement does not have a material effect on net income for the second and third quarters of 1993.\nThe sum of the quarters' earnings per share does not equal the year-to-date earnings per share due to changes in average share calculations.\nS. Segment Information by Industry and Geographic Area\nA. Industry Segment\n(1) Transfers between Geographic Areas are not material. (2) Within \"Metal Packaging and Other\" is the Company's machinery operation which along with other non-metal packaging domestic affiliates is not significant. (3) Operating profit for 1994 included restructuring charges of $102.3 for U.S. Metal Packaging and $12.3 for Canadian Metal Packaging. (4) Operating profit for 1992 in Europe and North and Central America includes charges made during the year relating to the Company's continuing efforts to restructure its businesses in these regions.\n(5) The following reconciles operating profit to pre-tax income:\n* Includes interest income and expense along with other corporate income and expense items, such as exchange gains and losses and goodwill amortization.\n(6) The following reconciles identifiable assets to total assets:\n* Included in identifiable assets for 1994 is $85.5 relating to the acquisition of Tri-Valley Growers. ** Included in identifiable assets for 1993 is:\n(a) \"United States,\" $96, relating to the acquisition of the Van Dorn Company. (b) \"Europe,\" $42, relating to the acquisition of the remaining interest in CONSTAR International's affiliate, Wellstar Acquisition, B.V. and its affiliate Wellstar Holdings, B.V.\n(7) For the years ended December 31, 1994 and 1993 no one customer accounted for more than 10% of the Company's net sales. For 1992, one customer accounted for approximately 10.6% of the Company's net sales.\nIncluded in \"Other Non-U.S.\" are affiliates in South America, Africa, Asia and the Middle East. Figures for the United States are not comparable due to the April 1993 acquisition of the Van Dorn Company. Figures for Europe are not comparable due to the 1993 acquisitions of Wellman's interest in Wellstar Acquisition, B.V. and the minority interest in Wellstar Acquisition's affiliate, Wellstar Holding, B.V.\nTotal non-U.S. liabilities were $777.7, $637.0 and $640.7 at December 31, 1994, 1993 and 1992, respectively.\nCertain reclassifications of prior years' data have been made to improve comparability.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES 1 OF 2\n(In millions) For the year Ended December 31, 1994\n(In millions) For the year Ended December 31, 1993\n(In millions) For the year Ended December 31, 1992\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES 2 OF 2\n(In millions) For the year Ended December 31, 1994\n(In millions) For the year Ended December 31, 1993\n(In millions) For the year Ended December 31, 1992\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 called for by this Item, Directors and Executive Officers of the Registrant is set forth on pages 3, 4 and 5 of the Company's 1995 definitive Proxy Statement in the section entitled \"Election of Directors\" and on page 13 in the section entitled \"Section 16 Requirements\" and is incorporated herein by reference.\nThe following table sets forth certain information concerning the principal executive officers of the Company, including their ages and positions as of December 31, 1994.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth on pages 6 through 12 of the Company's 1995 definitive Proxy Statement in the section entitled \"Executive Compensation\" 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 pages 2 through 5 of the Company's 1995 definitive Proxy Statement in the sections entitled \"Proxy Statement - Meeting, April 27, 1995\" and \"Election of Directors\" 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 pages 3, 4 and 5 of the Company's 1995 definitive Proxy Statement in the section entitled \"Election of Directors\" and is incorporated herein by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K\na) The following documents are filed as part of this report:\n(1) All Financial Statements:\nCrown Cork & Seal Company, Inc. and Subsidiaries (see Part II pages 20 through 39 of this Report).\n(2) Financial Statement Schedule:\nSchedule Number\nII.- Valuation and Qualifying Accounts and Reserves (see pages 40 and 41 of this Report).\nAll other schedules have been omitted because they are not applicable or the required information is included in the Consolidated Financial Statements or Notes thereto.\n(3) Exhibits\n3.a Articles of Incorporation of the Registrant (incorporated by reference to Exhibit 4.1 of the Company's Registration Statement on Form S-4 filed with the Securities and Exchange Commission on March 9, 1993 (Registration No. 33-59286)).\n3.b By-laws of the Registrant (incorporated by reference to Exhibit 3(b) of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (File No. 1-2227)).\n4.a Form of the Company's 5-7\/8% Notes Due 1998 (incorporated by reference to Exhibit 22 of Registrant's Current Report on Form 8-K dated April 12, 1993 (File No. 1-2227)).\n4.b Form of the Company's 6-3\/4% Notes Due 2003 (incorporated by reference to Exhibit 23 of Registrant's Current Report on Form 8-K dated April 12, 1993 (File No. 1-2227)).\n4.c Form of the Company's 8% Debentures Due 2023 (incorporated by reference to Exhibit 24 of Registrant's Current Report on Form 8-K dated April 12, 1993 (File No. 1-2227)).\n4.d Officers' Certificate of the Company (incorporated by reference to Exhibit 4.3 of the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993 (File No. 1-2227)).\n4.e Indenture dated as of April 1, 1993 between the Company and Chemical Bank, as Trustee (incorporated by reference to Exhibit 26 of the Registrant's Current Report on Form 8-K dated April 12, 1993 (File No 1-2227)).\n4.f Terms Agreement dated March 31, 1993 (incorporated by reference to Exhibit 27 of the Registrant's Current Report on Form 8-K dated April 12, 1993 (File No. 1-2227)).\n4.g Form of the Company's 7% Notes Due 1999 (incorporated by reference to Exhibit 99.1 of Registrant's Current Report on Form 8-K dated June 16, 1994 (File No. 1-2227)).\n4.h Officers' Certificate of the Company (incorporated by reference to Exhibit 99.2 of the Registrant's Current Report on Form 8-K dated June 16, 1994 (File No. 1-2227)).\n4.i Terms Agreement dated June 9, 1994 (incorporated by reference to Exhibit 99.3 of Registrant's Current Report on Form 8-K dated June 16, 1994 (File No. 1-2227)).\n4.j Indenture dated as of January 15, 1995 between the Company and Chemical Bank, as Trustee (incorporated by reference to Exhibit 4 of the Registrant's Current Report on Form 8-K dated January 25, 1995 (File No. 1-2227)).\n4.k Form of the Company's 8 % Notes Due 2005 (incorporated by reference to exhibit 99a of the Registrant's Current Report on Form 8-K dated January 25, 1995 (File No. 1-2227)).\n4.l Officers' Certificate of the Company dated January 25, 1995 (incorporated by reference to Exhibit 99b of the Registrant's Current Report on Form 8-K dated January 25, 1995 (File No. 1-2227)).\n4.m Terms Agreement dated January 18, 1995 (incorporated by reference to Exhibit 99c of the Registrant's Current Report on Form 8-K dated January 25, 1995 (File No. 1-2227)).\n4.n Revolving Credit and Competitive Advance Facility Agreement dated as of February 10, 1995 among the Registrant, the Subsidiary Borrowers referenced to therein, the Lenders referenced to therein and Chemical Bank, as Administrative Agent.\nOther long-term agreements of the Registrant are not filed pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K and the Registrant agrees to furnish copies of such agreements to the Securities and Exchange Commission upon its request.\n10.a Crown Cork & Seal Company, Inc. Executive Deferred Compensation Plan (incorporated by reference to Exhibit 10 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991 (No. 1-2227)).\n10.b 1990 Stock-Based Incentive Compensation Plan (incorporated by reference to Exhibit 10.2 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 1-2227)).\n10.c Crown Cork & Seal Company, Inc. Restricted Stock Plan for Non-Employee Directors. (incorporated by the reference to Exhibit 10.3 of the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 (File No. 1-2227)).\n10.d Crown Cork & Seal Company, Inc. 1984 Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 28 of Registrant's Registration Statement on Form S-8 (No. 33-06261)).\n10.e Crown Cork & Seal Company, Inc. Retirement Thrift Plan (incorporated by reference to Exhibit 4.3 of the Registrant's Registration Statement on Form S-8 (No. 33-50369)).\n10.f Crown Cork & Seal Company, Inc. Stock Purchase Plan (incorporated by reference to Exhibit 4.3 of the Registrant's Registration Statement on Form S-8, filed March 16, 1994 (No. 33-52699)).\n10.g 1994 Stock-Based Incentive Compensation Plan.\nExhibits 10.a through 10.g, inclusive, are management contracts or compensatory plans or arrangements required to be filed as exhibits pursuant to Item 14(c) of this Report.\n12. Computation of ratio of earning to fixed charges\n21. Subsidiaries of Registrant.\n23. Consent of Independent Accountants.\n27. Financial Data Schedule.\nb) Reports on Form 8-K\nThere were no reports on Form 8-K by the Registrant during the fourth quarter of calendar year 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.\nCrown Cork & Seal Company, Inc. Registrant\nDate March 31, 1995 By: \/s\/ Timothy J. Donahue -------------------------- Timothy J. Donahue Financial 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:\nSIGNATURE TITLE\n\/s\/ William J. Avery 3\/31\/95 ----------------------------------- William J. Avery Chairman of the Board, President and Chief Executive Officer \/s\/ Alan W. Rutherford 3\/31\/95 ----------------------------------- Alan W. Rutherford Director, Executive Vice President and Chief Financial Officer\nDIRECTORS\n\/s\/ Henry E. Butwel 3\/31\/95 \/s\/ Owen A. Mandeville, Jr. 3\/31\/95 ----------------------------------- ----------------------------------- Henry E. Butwel Owen A. Mandeville, Jr.\n\/s\/ Charles F. Casey 3\/31\/95 \/s\/ Michael J. McKenna 3\/31\/95 ----------------------------------- ----------------------------------- Charles F. Casey Michael J. McKenna\n\/s\/ Francis X. Dalton 3\/31\/95 \/s\/ J. Douglass Scott 3\/31\/95 ----------------------------------- ----------------------------------- Francis X. Dalton J. Douglass Scott\n\/s\/ Francis J. Dunleavy 3\/31\/95 \/s\/ Robert J. Siebert 3\/31\/95 ----------------------------------- ----------------------------------- Francis J. Dunleavy Robert J. Siebert\n\/s\/ Chester C. Hilinski 3\/31\/95 \/s\/ Harold A. Sorgenti 3\/31\/95 ----------------------------------- ----------------------------------- Chester C. Hilinski Harold A. Sorgenti\n\/s\/ Richard L. Krzyzanowski 3\/31\/95 \/s\/ Edward P. Stuart 3\/31\/95 ----------------------------------- ----------------------------------- Richard L. Krzyzanowski Edward P. Stuart\n\/s\/ Josephine C. Mandeville 3\/31\/95 ------------------------------------ Josephine C. Mandeville","section_15":""}
{"filename":"16732_1994.txt","cik":"16732","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE COMPANY -----------\nCampbell Soup Company, together with its consolidated subsidiaries, is a leading manufacturer and marketer of high quality, branded convenience food products. Campbell was incorporated as a business corporation under the laws of New Jersey on November 23, 1922; however, through predecessor organizations, its beginnings in the food business can be traced back to 1869.\nAcquisitions in fiscal year 1994 consisted of the Australian mushroom business, Dandy Mushrooms, and the Australian canned meat business, \"Fray Bentos\". The company sold Campbell Chilled Foods Limited, Campbell Foods P.L.C., Casera Foods, Inc., La Forest Perigord S.A., Quadelco Limited and Torres y Ribelles S.A. during the fiscal year.\nPRODUCTS --------\nThe company produces and sells a wide array of food products including canned foods such as soups, juices, gravies, pasta, meat and vegetables; frozen foods such as dinners, breakfasts, entrees, garlic breads and rolls, sandwiches, meat pies, seafood, vegetables, pastries and cakes; pickles, olives, peppers and relishes; fresh bread and rolls; croutons and stuffing; cookies, crackers and snacks; dry soups; refrigerated foods such as salads, antipasto, salad dressings, cheese spreads and dips, sauces, desserts and entrees; vinegar, vegetable oils, mayonnaise and mustard; beverage and dessert mixes; sauces, including spaghetti and barbecue sauces; nuts; pates; chocolates and other confectionery items; bubble gum; fish; poultry; and fresh mushrooms. The company's food products are for the most part prepared from confidential recipes developed in its experimental kitchens and research laboratories. To assure wholesome, attractive, uniform products, high standards of quality are maintained by a rigorous system of quality assurance.\nTRADEMARKS ----------\nThe company markets its food products under a number of significant trademarks. The company considers such trademarks, taken as a whole, to be of material importance to its business and, consequently, aggressively seeks to protect its rights in them. In the United States, these include: Campbell's(R), Pepperidge Farm(R), Godiva(R), Vlasic(R), Swanson(R), Mrs. Paul's(R), V8(R), Franco-American(R), Prego(R), SpaghettiOs(R), Marie's(R), Open Pit(R), Healthy Request(R), Home Cookin'(R), Goldfish(R), Hungry- Man(R), LeMenu(R), Healthy Treasures(R), Early California(R), Great Starts(R), Chunky(TM), Campbell's Simmer Chef(TM), and others.\nSignificant trademarks used extensively outside the United States include: Delacre, Arnott's, Swift, Habitant, Lacroix, Freshbake, Fray Bentos, Pleyben, Exeter, Plate, Ace, La Patrona, Groko, MacFarms, La Main Bleue, Royal Mail, Candy Man, Tubble Gum, Roll Up, Beeck, Kattus, Probare, Granny's, Devos-Lemmens, Imperial, Kwatta, Lutti, Leo and others.\nThe company's trademarks also include federally registered depictions of certain characters and designs such as the \"Campbell Kids\", the \"Campbell's\" condensed soup can label, the \"Vlasic\" stork, the \"Godiva\" Gold Ballotin box, the \"Goldfish\" cracker shape and others.\nAdvertising slogans which have become important trademarks for the company include: \"M'm! M'm! Good!\"(R), \"Home Made Taste. It's in There.\"(R), \"Chunky. Soup So Big, It Eats Like a Meal\"(R), \"Never Underestimate the Power of Campbell's\"(TM) and others.\nThe company considers that, taken as a whole, the rights under its various patents are a valuable asset; however, it does not regard its businesses as being materially dependent upon any single patent or any group of related patents.\nDISTRIBUTION ------------\nThe company distributes its products through direct customers, including chain stores, wholesalers and distributors that maintain central warehouses, institutional and industrial customers, convenience stores, club stores, and certain governmental agencies. In the United States, sales solicitation activities are conducted by employees of subsidiaries and through independent brokers and contract distributors. No material part of the business is dependent upon a single customer. Shipments are made promptly by the company after receipt and acceptance of orders; therefore, there is no significant backlog of unfilled orders.\nCOMPETITION -----------\nThe company experiences vigorous competition for sales of all its principal products in its major markets from numerous competitors of varying sizes. The principal areas of competition are quality, price, advertising, promotion, and service. The company believes that it is the largest manufacturer in the United States of condensed and ready-to-serve soups, vegetable juice, tomato juice, pickles, olives, and canned poultry; a major manufacturer of canned beans, canned gravies, canned pasta products, spaghetti sauces, frozen meat pies, frozen breakfasts, frozen pastries and cakes, frozen prepared seafood, frozen prepared dinners and various specialty food items; and a major producer of fresh mushrooms.\nINGREDIENTS\/SUPPLIES --------------------\nThe ingredients required for the manufacture of the company's food products include vegetables, tomatoes and other fruits, mushrooms, poultry, dairy products, eggs, grain products, meats, seafoods, nuts, spices, and sweeteners. The company does not grow or raise ingredients, except for mushrooms, poultry and beef. Swift-Armour Sociedad Anonima Argentina, an Argentine corporation and a wholly-owned subsidiary, has been the principal supplier of cooked beef to the company.\nIn general, satisfactory sources of supply of ingredients are available. Raw product inventories are at a peak during the late fall and decline during the winter and spring. Since many ingredients of suitable quality are available in sufficient quantities only at certain seasons, the company makes heavy purchases of such ingredients during their respective seasons. The company contracts in advance of growing seasons with growers or processors for a large part of its ingredient requirements. As a result of factors not within the company's control, the prices of ingredients fluctuate significantly from time to time.\nIn the United States, the company manufactures most of the metal containers for its canned products and substantial quantities of plastic containers for its frozen products. The balance of metal, plastic, all glass and fiberboard containers are purchased from independent suppliers. Outside of the United States, packaging is purchased mainly from independent suppliers.\nWORKING CAPITAL ---------------\nInformation relating to the company's cash and other working capital items is set forth in Part II of this Report on pages through in the section entitled \"Management's Discussion and Analysis of Results of Operations and Financial Condition\".\nRESEARCH AND DEVELOPMENT ------------------------\nDuring the last three fiscal years, the company's expenditures on research activities relating to new products and the improvement of existing products were approximately $78 million in 1994, $69 million in 1993, and $60 million in 1992. The company conducts this research at the Campbell Institute for Research and Technology at the company's headquarters in Camden, New Jersey, and in other locations in the United States and foreign countries.\nENVIRONMENTAL MATTERS ---------------------\nThe company has programs for the operation and design of its facilities which meet or exceed applicable environmental rules and regulations. The company's expenditures for capital improvements during fiscal 1994 were approximately $420.5 million, of which, according to company estimates, approximately $14.4 million was for compliance with environmental laws and regulations in the United States. The company further estimates that approximately $18.0 million of the capital expenditures anticipated during fiscal 1995 will be for compliance with such environmental laws and regulations. The company believes that continued compliance with existing environmental laws and regulations will not have a material effect on capital expenditures, earnings or the competitive position of the company.\nEMPLOYEES ---------\nAt July 31, 1994, there were 44,378 persons employed by the company. The decrease of 5.4% from 1993 was primarily due to restructuring.\nFOREIGN OPERATIONS ------------------\nInformation with respect to the revenue, operating profitability and identifiable assets attributable to the company's foreign operations is set forth in Part II of this Report on page in the section of the Notes to Consolidated Financial Statements entitled \"Geographic Area Information\".\nThe businesses of foreign subsidiaries are subject to the laws of foreign countries which may place restrictions and controls on such matters as ownership, imports and exports, prices, products and transfer of funds. The financial results of such subsidiaries are also affected by the changing dollar values of the foreign currencies in which the businesses are conducted.\nFINANCIAL INFORMATION ---------------------\nInformation with respect to the revenue, operating profit and identifiable assets for the company's only industry segment is set forth in Part II hereof on page in the section of the Notes to Consolidated Financial Statements entitled \"Geographic Area Information\".\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES AT JULY 31, 1994\nThe company operates numerous manufacturing and processing plants and sales and distribution centers around the world. Its principal manufacturing and processing operations in the United States are located in Arkansas (frozen foods; ingredients), California (heat processed; dried and frozen foods; condiments; mushrooms, ingredients), Connecticut (bakery), Delaware (condiments), Florida (bakery), Georgia (dry and heat processed foods; ingredients; mushrooms), Hawaii (nuts), Illinois (bakery; mushrooms), Michigan (condiments; heat processed foods; mushrooms), Nebraska (frozen foods, ingredients), New Jersey (ingredients), North Carolina (heat processed foods), Ohio (heat processed, dry foods and biscuit), Pennsylvania (confectionery, biscuit, bakery and mushrooms), South Carolina (bakery), Texas (heat processed foods), Utah (biscuit and frozen) and Wisconsin (ingredients; condiments).\nOutside the U.S. the company has manufacturing and distribution facilities in Argentina (meat products, heat processed and frozen foods), Australia (biscuit; heat processed foods; juices; mushrooms), Belgium (confectionery; biscuit; heat processed foods), Canada (heat processed and frozen foods), England (heat processed and frozen foods), France (confectionery; biscuit; heat processed foods), Germany (refrigerated and heat processed foods; distribution), Hong Kong (distribution), Italy (mushrooms; heat processed foods), Japan (distribution), Mexico (ingredients; heat processed and frozen foods; distribution), the Netherlands (confectionery; frozen foods; biscuit; distribution), New Zealand (biscuit; distribution), Papua New Guinea (biscuit) and Scotland (frozen foods).\nThe company also operates 120 retail candy shops in the United States, Canada and Europe; 87 retail bakery thrift stores in the United States; 1 mail order facility; and other plants and facilities at various locations in the United States and abroad.\nThe company's manufacturing and processing plants are designed according to the requirements of the products to be manufactured, and the type of construction varies from plant to plant. In the design of plant facilities, particular emphasis is placed on quality assurance in the finished products, safety in the operations, and avoidance or abatement of pollution. The company maintains its own engineering staff, which aids in achieving close integration of research, design, construction and manufacturing functions and facilitates the construction of plants which will be best suited to their special purposes.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn management's opinion, there are no pending claims or litigation, the outcome of which would have a material effect on the consolidated financial position of the company. The company has been named as a potentially responsible party in a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act, commonly known as Superfund. The ultimate impact of these environmental proceedings cannot be predicted at this time due to the large number of other potentially responsible parties and the speculative nature of clean- up cost estimates, but it is not expected to be material either individually or in the aggregate.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone.\nEXECUTIVE OFFICERS OF CAMPBELL AT OCTOBER 1, 1994 - -------------------------------------------------\nThe following list of executive officers as of October 1, 1994, is included herein as an item in Part I of this Form 10-K:\nEXECUTIVE OFFICERS OF CAMPBELL AT OCTOBER 1, 1994 (CONT'D.) -------------------------------------------------\nEach of the above-named officers has been employed by the company in an executive or managerial capacity for at least five years, except David W. Johnson, Frank E. Weise, III, Ronald E. Elmquist, John L. Forbis, Ralph A. Harris, Gerald S. Lord, Alfred Poe, J. Neil Stalter and Edward F. Walsh. David W. Johnson served as Chairman, President and Chief Executive Officer of Gerber Products Company prior to joining Campbell in 1990. Frank E. Weise, III served as Comptroller (chief financial officer), Food and Beverage Sector, of The Procter & Gamble Company prior to joining Campbell in 1992. Ronald E. Elmquist served as Chairman and Chief Executive Officer of White Swan, Inc. prior to joining Campbell in 1994. John L. Forbis was a partner at Arthur D. Little prior to joining Campbell in 1994. Ralph A. Harris served as Vice President - Business Development of Quaker Oats Company prior to joining Campbell in 1990. Gerald S. Lord served as Vice President Integration and Productivity of Kraft General Foods Canada prior to joining Campbell in 1990. Alfred Poe served as Vice President - Sales (1991) and Vice President - Brands (1988-1991) of M&M\/Mars prior to joining Campbell in 1991. J. Neil Stalter served as Vice President - Corporate Communications of Eastman Kodak Company prior to joining Campbell in 1991. Prior to joining Campbell in 1993, Edward F. Walsh served as Senior Vice President - Administration of Nutri-System, Inc. (1990-1993) and President - Manor Healthcare Division of Manor Health Care, Inc. (1989-1990).\nThere is no family relationship between any of the above named officers or between any such officer and any director of Campbell. Each officer of Campbell is elected at the meeting of the Board of Directors next following the Annual Meeting of Shareowners to serve one year or until his or her successor is elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREOWNER MATTERS\nCampbell's Capital Stock is listed on the New York and Philadelphia Stock Exchanges, The Stock Exchange-London and the Swiss Stock Exchanges. On September 19, 1994, there were 30,680 holders of record of Campbell's Capital Stock. The market price and dividend information with respect to Campbell's Capital Stock are set forth on page of this Report in the section of the Notes to Consolidated Financial Statements entitled \"Quarterly Data (unaudited)\". Future dividends will be dependent upon future earnings, financial requirements and other factors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information called for by this Item is set forth on page of this Report. Such information should be read in conjunction with the Consolidated Financial Statements and Notes thereto of the company included in Item 8 of this Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nManagement's Discussion and Analysis of Results of Operations and Financial Condition is presented on pages through of this Report.\nCAMPBELL SOUP COMPANY AND CONSOLIDATED SUBSIDIARIES\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information called for by this Item is contained in a separate section of this Report. See Index to Financial Statements and Financial Statement Schedules on page 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\nThe sections entitled \"Election of Directors\" and \"Compliance with Section 16 of the Exchange Act\" set forth on pages 1 through 5 and page 20 of Campbell's Notice of Annual Meeting and Proxy Statement dated October 7, 1994 (the \"1994 Proxy Statement\") are incorporated herein by reference.\nThe information required by this Item relating to the executive officers of Campbell is set forth in Part I of this Report on pages 5 and 6 under the heading \"Executive Officers of Campbell at October 1, 1994\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth on pages 7 through 15 of the 1994 Proxy Statement in the section entitled \"Compensation of Executive Officers\" 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 at pages 4 and 5 and pages 18 through 20 of the 1994 Proxy Statement in the sections entitled \"Election of Directors\" and \"Security Ownership of Certain Beneficial Owners\" and 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) 1. All Financial Statements ------------------------\nThe Index of Financial Statements is included on page of this Report.\n2. Financial Statement Schedules -----------------------------\nThe Index of Financial Statement Schedules is included on page of this Report.\n3. Exhibits --------\nNO. DESCRIPTION --- ----------- 3(a) Campbell's Restated Certificate of Incorporation as amended through November 21, 1991, was filed with the SEC with Campbell's Form 10-K for the fiscal year ended August 2, 1992, and is incorporated herein by reference.\n3(b) Campbell's By-Laws, effective as of November 18, 1993.\n4 There is no instrument with respect to long-term debt of the company that involves indebtedness or securities authorized thereunder exceeding 10 percent of the total assets of the company and its subsidiaries on a consolidated basis. The company agrees to file a copy of any instrument or agreement defining the rights of holders of long-term debt of the company upon request of the Securities and Exchange Commission.\n9 Major Stockholders' Voting Trust Agreement dated June 2, 1990, as amended, was filed with the SEC by the Trustees of the Major Stockholders' Voting Trust as Exhibit A to Schedule 13D dated June 5, 1990, and is incorporated herein by reference.\n10(a) Campbell Soup Company 1984 Long-Term Incentive Plan, as amended on May 27, 1993, was filed with the SEC with Campbell's 10-K for the fiscal year ended August 1, 1993, and is incorporated herein by reference.*\n10(b) Campbell Soup Company Management Worldwide Incentive Plan, as amended on September 26, 1991, was filed with the SEC with Campbell's 10-K for the fiscal year ended August 2, 1992, and is incorporated herein by reference.*\n10(c) Deferred Compensation Plan for Directors, as amended on December 1, 1991, was filed with the SEC with Campbell's 10- K for the fiscal year ended August 2, 1992, and is incorporated herein by reference.*\n10(d) Retirement Benefit Plan for Directors, effective December 1, 1991, was filed with the SEC with Campbell's 10-K for the fiscal year ended August 2, 1992, and is incorporated herein by reference.*\n10(e) Supplemental Retirement Benefit Program for Executives, as amended on March 28, 1991, was filed with the SEC with Campbell's Form 10-K for the fiscal year ended July 28, 1991, and is incorporated herein by reference.*\n10(f) Financial Planning Services for Executives was filed with the SEC with Campbell's Form 10-K for the fiscal year ended July 31, 1988, and is incorporated herein by reference.*\n10(g) Supplemental Post Retirement Benefit Plan for Selected Major Executives, as amended on January 25, 1990, was filed with the SEC with Campbell's Form 10-K for the fiscal year ended July 29, 1990, and is incorporated herein by reference.*\n10(h) Employment Agreement dated January 2, 1990, with David W. Johnson, President and Chief Executive Officer, was filed with the SEC with Campbell's Form 10-K for the fiscal year ended July 29, 1990, and is incorporated herein by reference.*\n3. Exhibits (cont'd.) --------\nNO. DESCRIPTION --- -----------\n10(i) Severance Protection Agreement dated May 18, 1990, with John M. Coleman, Senior Vice President - Law and Public Affairs, was filed with the SEC with Campbell's Form 10-K for the fiscal year ended August 2, 1992, and is incorporated herein by reference. Agreements with nine (9) other Executive Officers are in all material respects the same as that with Mr. John M. Coleman.*\n22 Subsidiaries (Direct and Indirect) of Campbell.\n24 Consent of Independent Accountants.\n25(a) Power of Attorney.\n25(b) Certified copy of the resolution of Campbell's Board of Directors authorizing signatures pursuant to a power of attorney.\n27 Financial Data Schedule\n- --------------------------------------------- * A management contract or compensatory plan required to be filed by Item 14(c) of this Report.\n(b) Reports on Form 8-K -------------------\nThere were no reports on Form 8-K filed by Campbell during the fourth quarter of fiscal 1994.\nSIGNATURES ----------\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Campbell 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 Campbell and in the capacity and on the date indicated.\nITEM 6. SELECTED FINANCIAL DATA - ------- -----------------------\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nCAMPBELL SOUP COMPANY AND CONSOLIDATED SUBSIDIARIES ---------------------------------------------------\nRESULTS OF OPERATIONS - ---------------------\nOVERVIEW\nEarnings per share rose 14% to $2.51, compared to $2.21, before special charges, the prior year. Net earnings climbed 13% to a record $630 million versus $557 million before special charges last year. Special charges in fiscal 1993 consisted of $1.19 per share for restructuring and $.99 per share for adoption of new accounting standards, reducing reported earnings per share to $.03. Net sales rose 2% to a record $6.7 billion, from $6.6 billion in fiscal 1993. Excluding divested businesses and currency fluctuations, sales were up 4%.\nSoup shipments in the U.S. were down 7% from the prior year as the U.S. Soup unit refocused marketing spending on the retail consumer and initiated a program to eliminate costly peaks in the manufacturing and shipping cycles. Outside the U.S., soup volume increased 12%.\nRecord earnings are a tribute to a better-balanced worldwide business portfolio, as both Biscuit and Bakery and International delivered strong earnings gains while U.S. earnings were relatively flat.\n1994 COMPARED TO 1993\nRESULTS BY DIVISION\nCAMPBELL U.S.A. - Operating earnings for Campbell U.S.A. were $783 million in 1994 compared to $780 million in 1993, before 1993 special charges of $175 million. Net sales were $4.0 billion in 1994, 3% below 1993.\nThese results reflect decisions by the U.S. Soup unit to level production and ship to customer demand. \"Swanson\" dinners, \"Great Starts\" breakfasts and \"Prego\" spaghetti sauces achieved solid volume growth. Food service products continued rapid growth led by frozen entrees and custom packed products for quick-service restaurants.\nCAMPBELL BISCUIT AND BAKERY - Operating earnings rose 45% to $153 million in 1994 from $106 million in 1993 before special charges of $5 million. The division achieved net sales of $1.2 billion, a 24% increase. This performance reflects a full year of results for Arnotts in Australia, which was acquired in the third quarter of 1993, and a turnaround at Delacre in Europe. Excluding the effect of the additional investment in Arnotts, earnings increased 17% and sales were flat.\nPepperidge Farm's frozen pastry products and garlic breads achieved solid volume gains. At Arnotts, volume gains were strong in the chocolate category and flavored snacks. Sales at Delacre were down due to the lingering effects of recession in Europe, but earnings were up significantly on lower manufacturing costs.\nCAMPBELL INTERNATIONAL - Operating earnings increased 23% to $136 million in 1994, from $111 million in 1993 before special charges of $173 million. Operating earnings improvements were achieved in all International locations with the United Kingdom, Argentina, Mexico and Campbell's confectionery business turning in strong performances.\nNet sales were $1.55 billion in 1994, a 2% decline from $1.58 billion in 1993. Net sales before divestitures and currency fluctuations increased 6.5%. Soup in the United Kingdom, Mexico, Australia and Hong Kong, and Godiva worldwide achieved very strong volume growth. Sales in the United Kingdom also benefited from the 1993 acquisition of \"Fray Bentos\".\nSTATEMENT OF EARNINGS\nGross margins improved 1.7 points to 40.5% as a result of higher selling prices.\nMarketing and selling expenses increased to 19.0% of sales from 18.3% in 1993. Growth in marketing spending was substantially less than in prior years as a result of company efforts to refocus trade promotional activities on the consumer and better match shipments to consumption. Advertising was even with 1993.\nAdministrative expenses declined to 4.4% of sales from 4.7% a year ago, due principally to lower management incentive plan expenses and cost controls.\nResearch and development increased 13% due to new product development and the opening of a new research and test facility in Camden, New Jersey.\nInterest expense decreased 11% principally as a result of a decline in the company's average effective interest rate to 7.6%.\nOther expense increased $13 million because of minority owners' share of Arnotts' earnings for the full year in 1994 versus five months in 1993.\nThe effective tax rate declined to 34.6% from 50.5% in 1993. The higher rate in 1993 reflected non-deductible divestiture and restructuring charges.\nNet margins increased to 9.4%, the highest level since the company went public in 1954.\n1993 COMPARED TO 1992\nRESULTS BY DIVISION\nCAMPBELL U.S.A. - Operating earnings for Campbell U.S.A. were $605 million in 1993 after special charges of $175 million, compared to $741 million in 1992. Before these charges, operating earnings grew 5% to $780 million.\nNet sales were $4.1 billion in 1993, an increase of 2% over 1992. Soup volume was up 2.5% despite one less week in fiscal 1993, with strong performances by \"Home Cookin'\" and \"Healthy Request\" ready-to-serve soups. In the frozen food business, \"Swanson\" kids' meals and \"Great Start\" breakfast sandwiches turned in impressive volume gains. The newly introduced \"Pepperidge Farm\" gravies delivered strong volume growth as did Food Service frozen products and \"Vlasic\" pickles.\nCAMPBELL BISCUIT AND BAKERY - The Biscuit and Bakery Division reported operating earnings of $101 million after special charges of $5 million. Before the charges, earnings rose 16% to $106 million. Net sales increased 23% to $999 million. These increases stem mainly from attaining 58% ownership of Arnotts in fiscal 1993, which contributed $170 million in sales in the year. Previously, the company owned 33% and accounted for its investment on the equity method. Arnotts had strong earnings growth in the year. Pepperidge Farm volume increased slightly for the year with sales trends improving significantly in the fourth quarter led by the introduction of \"Goldfish\" cookies and frozen garlic bread and rolls.\nEarnings of Delacre in Europe were down because of a sluggish European economy, the costs of starting up new production lines, and the introduction of the new \"Biscuits Maison de Delacre\", patterned after Pepperidge Farm's \"American Collection\" and Old Fashioned cookies.\nCAMPBELL INTERNATIONAL - Campbell International reported an operating loss of $62 million after special charges of $173 million. Before these charges, operating earnings increased 21% over 1992 to $111 million, due primarily to significant improvements in the United Kingdom and Germany.\nSales increased 3% to $1.58 billion from $1.54 billion. Both sales and earnings benefited from the third quarter acquisition of \"Fray Bentos\", the leading premium canned-meat brand in the United Kingdom, and from the company's acquisition of the remaining 50 percent ownership of the Spring Valley juice business in Australia.\nSTATEMENTS OF EARNINGS\nGross margins improved 2.1 percentage points to 38.8%, with improvement due to higher selling prices, which contributed 1.7 points, and lower manufacturing costs.\nMarketing and selling expenses were 18.3% of net sales compared to 16.8% in 1992. The company continued to spend aggressively in support of its brands and new product introductions.\nAdministrative expenses increased to 4.7% of sales from 4.5% a year ago, principally due to accruals for management incentive programs because earnings exceeded target levels.\nInterest expense decreased in 1993 due principally to lower interest rates. The increase in other expense resulted primarily from minority interest and amortization of intangible assets related to Arnotts. The effective tax rate was 50.5% compared to 38.6% in 1992. The principal reason for the high rate for 1993 was that certain of the divestiture and restructuring charges were not tax deductible. Excluding the effects of that program, the effective tax rate for 1993 was 36.2%.\nSPECIAL CHARGES\nOn January 28, 1993, the company's Board of Directors approved a divestiture and restructuring program which specifically identified six manufacturing plants to be closed and fourteen businesses to be sold. This action was taken to consolidate high cost, underutilized plants into more cost effective locations; and to prune out low return, non-strategic businesses which were detracting from the company's earnings and returns and were requiring an inordinate amount of management's time and attention.\nAt the time of the Board's approval, charges of $353 million, $300 million after tax or $1.19 per share, were recorded for the estimated loss on disposition of plant assets, cost of closing each plant and loss on each business divestiture.\nA summary of the original reserve and charges through July 31, 1994 is as follows:\nOf the total charge of $353 million, non-cash charges of $275 million represent the excess of net book value of plants to be closed and businesses to be sold over the estimated sales proceeds. The balance of the charges represents cash outflows of $78 million which occurred or are expected to occur as follows: 1993 - $15 million, 1994 - $23 million, and 1995 - $40 million.\nFour of the six plant closings have been completed. In lieu of closing, one plant was restructured, principally through headcount reductions. Six businesses were divested in 1993 and 1994 and the company plans to complete the restructuring program in fiscal 1995.\nThe businesses to be divested represent approximately $382 million in annual sales. The entire program anticipates an annual improvement in net earnings of $28 million when fully implemented. This total includes savings after tax of $19 million from direct labor and plant overhead reductions and $6 million in non-cash savings principally from reductions in depreciation and amortization. Cash outflows do not adversely affect the company's liquidity.\nEffective August 3, 1992, the company adopted Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" No. 109, \"Accounting for Income Taxes,\" and No. 112, \"Employers' Accounting for Postemployment Benefits\". The after-tax effect of these accounting changes was a \"one- time\" charge to 1993 earnings of $249 million or $.99 per share. These accounting changes are more fully described in Note 2 to the Consolidated Financial Statements.\nLIQUIDITY AND CAPITAL RESOURCES\nConsistently strong cash flows, a strong balance sheet and an \"AA\" credit rating demonstrate the company's continued superior financial strength.\nCASH FLOWS FROM OPERATING ACTIVITIES provided $968 million in 1994, an increase of $316 million or 48% over 1993. Over the last three years, operating cash flow totaled $2.4 billion. This strong cash generating capability provides the company substantial financial flexibility in meeting operating and investing objectives.\nCAPITAL EXPENDITURES were $421 million in 1994, up $50 million from the prior year due to a high level of cost savings projects, including restructuring programs announced in the second quarter of 1993. Capital expenditures are projected to reach $450 million in 1995.\nACQUISITIONS in 1994 totaled $14 million and included the Australian mushroom business, Dandy Mushrooms, and the Australian canned-meat business, \"Fray Bentos\".\nLONG-TERM DEBT increased due to issuance of $100 million of notes bearing an interest rate of 5.625% with a maturity in fiscal 2004.\nSHORT-TERM BORROWINGS decreased by $235 million in 1994 due to strong operating cash flow. The company retired $100 million of 9.125% notes classified as current at the end of 1993.\nThe company has ample financial resources, including unused lines of credit totaling $615 million and has ready access to financial markets around the world. The pre-tax interest coverage ratio was 12.2 for 1994 compared to 10.0 in 1993, before special charges.\nDIVIDEND payments increased $50 million or 23% to $266 million in 1994, compared to $216 million in 1993. Dividends declared in 1994 totaled $1.09 per share, up from $.915 per share in 1993. The 1994 fourth quarter rate was 28 cents.\nCOMMON STOCK REPURCHASES for the treasury totaled 4 million shares at a cost of $145 million during 1994, compared to repurchases of 1.1 million shares at a cost of $42 million in the same period for 1993. In July 1994, the Board of Directors authorized the repurchase of an additional 7.5 million shares.\nTOTAL ASSETS increased 2% to a record $5 billion during 1994. Accounts receivable decreased $68 million as a result of a reduction in year-end sales promotions and inventories were also down. However, fixed assets increased because of heavy capital expenditures.\nTOTAL LIABILITIES decreased $191 million or 6% with total borrowings down $137 million and completion of $89 million of restructuring activities.\nINFLATION\nInflation during recent years has not had a significant effect on the company. The company attempts to mitigate the effects of inflation on sales and earnings by increasing selling prices where appropriate and aggressively pursuing an ongoing cost- improvement effort which includes capital investments in more efficient plants and equipment and integrated business systems. The divestiture and restructuring programs instituted since 1988 have made the company a more cost-effective producer.\nREPORT OF INDEPENDENT ACCOUNTANTS ---------------------------------\nTo the Shareowners and Directors of Campbell Soup Company\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Campbell Soup Company and its subsidiaries at July 31, 1994 and August 1, 1993, and results of their operations and their cash flows for each of the three years in the period ended July 31, 1994 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.\nAs discussed in Note 2, the company changed its methods of accounting for income taxes, postretirement benefits and postemployment benefits in 1993.\nPRICE WATERHOUSE LLP\nThirty South Seventeenth Street Philadelphia, Pennsylvania 19103 September 7, 1994\nCampbell Soup Company CONSOLIDATED STATEMENTS OF EARNINGS (millions, except per share amounts)\nThe accompanying Summary of Significant Accounting Policies and Notes on pages to are an integral part of the financial statements.\nCampbell Soup Company CONSOLIDATED BALANCE SHEETS (millions)\nThe accompanying Summary of Significant Accounting Policies and Notes on pages to are an integral part of the financial statements.\nCampbell Soup Company CONSOLIDATED STATEMENTS OF CASH FLOWS (millions)\nThe accompanying Summary of Significant Accounting Policies and Notes on pages to are an integral part of the financial statements.\nCampbell Soup Company CONSOLIDATED STATEMENTS OF SHAREOWNERS' EQUITY (millions)\nThe accompanying Summary of Significant Accounting Policies and Notes on pages to are an integral part of the financial statements.\nCHANGES IN NUMBER OF SHARES (thousands)\nThe accompanying Summary of Significant Accounting Policies and Notes on pages to are an integral part of the financial statements.\nCAMPBELL SOUP COMPANY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (MILLION DOLLARS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION - The consolidated financial statements include the accounts of the company and its majority-owned subsidiaries. Significant intercompany transactions are eliminated in consolidation. Investments of 20% or more in affiliates are accounted for by the equity method.\nFISCAL YEAR - The company's fiscal year ends on the Sunday nearest July 3l. There were 52 weeks in fiscal 1994 and fiscal 1993 and 53 weeks in fiscal 1992.\nINVENTORIES - Substantially all domestic inventories are priced at the lower of cost or market, with cost determined by the last-in, first-out (LIFO) method. Other inventories are priced at the lower of average cost or market.\nINTANGIBLES - The excess of cost of investments over net assets of purchased companies is amortized on a straight-line basis over periods not exceeding forty years.\nPLANT ASSETS - Plant assets are stated at historical cost. Alterations and major overhauls which extend the lives or increase the capacity of plant assets are capitalized. The amounts for property disposals are removed from plant asset and accumulated depreciation accounts and any resultant gain or loss is included in earnings. Ordinary repairs and maintenance are charged to operating costs.\nDEPRECIATION - Depreciation provided in costs and expenses is on the straight-line method. Accelerated methods of depreciation are used for income tax purposes in certain jurisdictions.\nPENSION AND RETIREE BENEFIT PLANS - Costs are accrued over employees' careers based on plan benefit formulas.\nCASH AND CASH EQUIVALENTS - All highly liquid debt instruments purchased with a maturity of three months or less are classified as Cash equivalents.\nFINANCIAL INSTRUMENTS - In managing interest rate exposure, the company at times enters into interest rate swap agreements. When interest rates change, the difference to be paid or received is accrued and recognized as interest expense over the life of the agreement. In order to hedge foreign currency exposures on firm commitments, the company at times enters into forward foreign exchange contracts. Gains and losses resulting from these instruments are recognized in the same period as the underlying hedged transaction. The company also at times enters into foreign currency swap agreements which are effective as hedges of net investments in foreign subsidiaries. Realized and unrealized gains and losses on these currency swaps are recognized in the Cumulative translation adjustments account in Shareowners' equity. The fair values of the company's financial instruments are estimated based on quoted market prices for the same or similar issues.\nINCOME TAXES - Deferred taxes are provided in accordance with Statement of Financial Accounting Standards (FAS) No. 109 effective in fiscal 1993. In fiscal 1992, deferred taxes were provided in accordance with FAS No. 96.\n2. ACCOUNTING CHANGES\nIn 1993, the company adopted Statements of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" No. 109, \"Accounting for Income Taxes,\" and No. 112, \"Employers' Accounting for Postemployment Benefits.\"\nFAS No. 106 requires accrual of the cost of retiree health and life insurance benefits during the years that employees render service. These costs were previously expensed as claims were paid. The company elected to recognize the effect of the transition liability for past service costs by recording a one-time, non-cash charge against 1993 earnings of $230 or $.91 per share. Adoption of FAS No. 106 also decreased 1993 earnings per share by $.07 for the pre-tax incremental annual charge and 1994 earnings per share by $.08.\nFAS No. 112 requires the company to account for postemployment benefits on the accrual basis. The cumulative effect of this change in accounting decreased 1993 net earnings by $22 or $.09 per share.\nFAS No. 109 requires the company to recognize the benefit of certain deferred tax assets, increasing 1993 net earnings by $3 or $.01 per share.\n3. GEOGRAPHIC AREA INFORMATION\nThe company is predominantly engaged in the manufacture and sale of prepared convenience foods. The following presents information about operations in different geographic areas:\nTransfers between geographic areas are recorded at cost plus markup or at market. 1993 divestiture and restructuring charges of $353 were allocated to geographic areas as follows: United States - $126, Europe - $210 and Other - $17.\n4. INTEREST EXPENSE\n5. OTHER EXPENSE Included in other expense are the following:\n6. DIVESTITURE AND RESTRUCTURING CHARGES\nOn January 28, 1993, the company's Board of Directors approved a divestiture and restructuring program which specifically identified six manufacturing plants to be closed and fourteen businesses to be sold. At the time of the Board's approval, charges of $353, $300 after tax or $1.19 per share, were recorded for the estimated loss on disposition of plant assets, cost of closing each plant and loss on each business divestiture.\nComponents of the original reserve and charges through July 31, 1994 are as follows:\nFour of the six plant closings have been completed. In lieu of closing, one plant was restructured, principally through headcount reductions. Six businesses were divested in 1993 and 1994. The company plans to complete the program in fiscal 1995.\n7. ACQUISITIONS\nDuring 1994, 1993 and 1992 the company made several acquisitions. These acquisitions were accounted for as purchase transactions, and operations of the acquired companies are included in the financial statements from the dates the acquisitions were recorded. The costs of these acquisitions were allocated as follows:\nAcquisitions in 1994 consisted of the Australian mushroom business, Dandy Mushrooms, and the Australian canned-meat business, \"Fray Bentos\".\nDuring 1993, the company increased its ownership of Arnotts Limited, Australia's leading biscuit manufacturer, to 58% from 33% prior to fiscal 1993. Therefore, beginning in the third quarter of fiscal 1993, Arnotts' results were consolidated. Prior to this time, Campbell's investment in Arnotts was accounted for by the equity method. Net sales and net earnings for 1993 would have increased by $295 and $3, respectively, had the increase in ownership of Arnotts occurred at August 3, 1992.\n8. PENSION PLANS AND RETIREMENT BENEFITS\nPension Plans - Substantially all of the company's U.S. and certain non-U.S. employees are covered by noncontributory defined benefit pension plans. Plan benefits are generally based on years of service and employees' compensation during the last years of employment. Benefits are paid from funds previously provided to trustees and insurance companies or are paid directly by the company. Actuarial assumptions and plan provisions are reviewed regularly by the company and its independent actuaries to ensure that plan assets will be adequate to provide pension and survivor benefits. Plan assets consist primarily of investments in common stock, fixed income securities, real estate and money market funds. Pension expense included the following:\nPension coverage for employees of certain non-U.S. subsidiaries and other supplemental pension benefits of the company are provided to the extent determined appropriate through their respective plans. Obligations under such plans are systematically provided for by depositing funds with trusts or under insurance contracts. The assets and obligations of these plans are not material.\nSavings Plans - The company sponsors employee savings plans which cover substantially all U.S. employees. After one year of continuous service the company generally matches 50% of employee contributions up to five percent of compensation. In fiscal 1994, 1993 and 1992 the company increased its contribution to 60% because earnings goals were achieved. Amounts charged to costs and expenses were $14 in 1994, $13 in 1993, and $12 in 1992.\nRetiree Benefits - The company provides certain health care and life insurance benefits (postretirement benefits) to substantially all retired U.S. employees and their dependents. Employees who have 10 years of service after the age of 45 and retire from the company are eligible to participate in the postretirement benefit plans.\nPostretirement benefit expense was comprised of the following:\nHealthcare claims and death benefits paid totaled $18 in 1994, $18 in 1993 and $16 in 1992.\nThe discount rate used to determine the accumulated postretirement benefit obligation was 8.25% in 1994 and 7.5% in 1993. The assumed initial healthcare cost trend rate used to measure the accumulated postretirement benefit obligation was 11.5%, declining to 6.0% over a period of 11 years and continuing at 6.0% thereafter. A one-percentage-point increase in the assumed healthcare cost trend rate would have increased the 1994 accumulated postretirement benefit obligation by $50 and postretirement benefit expense by $7.\nObligations related to non-U.S. postretirement benefit plans are not significant since these benefits are generally provided through government-sponsored plans. Postretirement benefits payable in fiscal 1995 of $19 are included in \"Accrued liabilities.\"\n9. TAXES ON EARNINGS\nThe provision for income taxes consists of the following:\nThe increases in the Non-U.S. current tax provision is primarily attributable to the consolidation of Arnotts beginning in March 1993. The deferred tax credit in 1993 resulted principally from charges for restructuring and other postretirement benefits.\nThe following is a reconciliation of effective income tax rates with the U.S. Federal statutory income tax rate:\nDeferred tax liabilities and assets are comprised of the following at July 31, 1994:\nFor income tax purposes, subsidiaries of the company have tax loss carryforwards of approximately $286 of which $7 relate to periods prior to acquisition of the subsidiaries by the company. Of these carryforwards, $215 expire in 1999, $28 expire through 2005 and $43 may be carried forward indefinitely. The current statutory tax rates in these countries range from 30% to 52%.\nIncome taxes have not been accrued on undistributed earnings of non-U.S. subsidiaries of $344 which are invested in operating assets and are not expected to be remitted. If remitted, tax credits are available to substantially reduce any resultant additional taxes.\n10. SUPPLEMENTARY STATEMENTS OF EARNINGS INFORMATION\nFuture minimum lease payments under operating leases are $76.\n11. CASH AND CASH EQUIVALENTS\nCash and cash equivalents includes cash equivalents of $30 at July 31, 1994 and $17 at August 1, 1993.\n12. ACCOUNTS RECEIVABLE\n13. INVENTORIES\nInventories for which the LIFO method of determining cost is used represented approximately 70% of consolidated inventories in 1994 and 68% in 1993.\n14. PREPAID EXPENSES\n15. PLANT ASSETS\nDepreciation provided in costs and expenses was $237 in 1994, $223 in 1993, and $200 in 1992. Approximately $215 of capital expenditures are required to complete projects in progress at July 31, 1994.\n16. INTANGIBLE ASSETS\n17. OTHER ASSETS\n18. NOTES PAYABLE AND LONG-TERM DEBT\nNotes payable consists of the following:\nThe amount of unused lines of credit at July 31, 1994 approximates $615. The lines of credit are unconditional and generally cover loans for a period of one year at prime commercial interest rates.\nLong-term debt consists of the following:\nThe cost to retire the company's long-term debt would have been $585 and $537 at July 31, 1994 and August 1, 1993, respectively.\nPrincipal amounts of long-term debt mature as follows: 1995 - $12 (in current liabilities); 1996 - $24; 1997 - $4; 1998 - $105; 1999 - $3; and beyond - $425.\nFuture minimum capital lease payments are $63, including implicit interest of $27.\nInformation on financial instruments follows:\nThe company has two primary objectives in using derivative financial instruments. The first is to minimize interest expense within an acceptable range of fixed to variable rate debt ratios. To meet this objective, the company may enter into interest rate swaps which effectively readjust the fixed to variable rate ratio in response to changes in interest rates or the overall level of debt. The second objective is to hedge economic exposures on specific foreign currency transactions.\nThe company uses a mix of equity, intercompany debt and local currency borrowings to finance its international subsidiaries. The risk associated with currency exposure is balanced against the objective of minimizing the overall cost of financing.\nThe company has entered into interest rate swap agreements with financial institutions having a total notional principal of $300 at July 31, 1994 and $200 at August 1, 1993. These were entered into in order to reduce interest expense.\nIn addition, the company has several swap agreements with financial institutions which cover both interest rates and foreign currencies. These agreements had a total notional principal of $10 and $35 at July 31, 1994 and August 1, 1993, respectively, and were entered into to hedge Australian and European currency exposures arising from strategies which replaced local currency debt with lower cost financing from the U.S.\nThe cost to settle all interest and foreign currency swaps was $20 at July 31, 1994, of which $8 was accrued at year end. The company is exposed to credit loss in the event of nonperformance by the counter parties; however, the company does not anticipate any nonperformance. The company's credit risk on swap transactions is minimized by its policy of dealing only with leading, credit-worthy financial institutions having long-term credit ratings of \"A\" or better.\nAt July 31, 1994, the company had contracts to purchase or sell approximately $31 in foreign currency versus $49 at August 1, 1993. The contracts are mostly for Canadian and European currencies and have maturities through 1995.\n19. OTHER LIABILITIES\nAs of July 31, 1994, restructuring reserves are classified as current liabilities.\n20. SHAREOWNERS' EQUITY\nThe company has authorized 280 million shares of Capital Stock of $.075 par value and 40 million shares of Preferred Stock, issuable in one or more classes, with or without par as may be authorized by the Board of Directors. No Preferred Stock has been issued.\nThe Board of Directors authorized a 2-for-1 split of the company's Capital Stock effective December 2, 1991. All shares and per share amounts have been adjusted to reflect the stock split.\nThe following summarizes the activity in the company's 1984 long-term incentive plan:\nAs of July 31, 1994, 5.3 million shares remain available for grant under the long-term incentive plan.\nAll net earnings per share data is based on the weighted average shares outstanding during the applicable periods. The potential dilution from the exercise of stock options is not material.\n21. STATEMENTS OF CASH FLOWS\n22. QUARTERLY DATA (UNAUDITED)\nFINANCIAL STATEMENT SCHEDULES - -----------------------------\nSCHEDULE V\nCAMPBELL SOUP COMPANY AND CONSOLIDATED SUBSIDIARIES\nProperty, Plant and Equipment at Cost -------------------------------------\n(millions)\n*See \"Acquisitions\" in Notes to Consolidated Financial Statements.\nS-1\nSCHEDULE VI\nCAMPBELL SOUP COMPANY AND CONSOLIDATED SUBSIDIARIES\nAccumulated Depreciation and Amortization of Property, Plant and Equipment --------------------------------------------------------------------------\n(millions)\nS-2\nSCHEDULE IX\nCAMPBELL SOUP COMPANY AND CONSOLIDATED SUBSIDIARIES\nShort-term Borrowings ---------------------\n(millions)\nSee footnote 18 for a description of the general terms of short-term borrowings.\nS-3\nINDEX OF EXHIBITS -----------------\nI-1\nINDEX OF EXHIBITS (cont'd.) -----------------\nI-2","section_15":""}
{"filename":"88204_1994.txt","cik":"88204","year":"1994","section_1":"ITEM 1. BUSINESS\n\t Sealed Air Corporation (together with its subsidiaries, the \"Company\") is engaged primarily in the manufacture and sale of a wide variety of protective and specialty packaging materials and systems.\n\t The Company's operations are conducted primarily in North America, Europe and the Asia\/Pacific region, and its products are distributed in these areas as well as in other parts of the world. Information by geographic area, including net sales, operating profit and identifiable assets, for each of the three years in the period ended December 31, 1994 appears in Note 3 of the Notes to Consolidated Financial Statements, which are contained in the Company's 1994 Annual Report to Stockholders. Such Note is incorporated herein by reference.\nRECENT DEVELOPMENTS\n\t On January 10, 1995, the Company acquired Trigon Industries Limited, a privately owned New Zealand corporation (\"Trigon\"), for a purchase price of approximately $57 million consisting of 882,930 newly-issued shares of the Company's Common Stock and $25,496,000 in cash. The cash portion of the purchase price was paid by borrowings by the Company and certain of its subsidiaries under available lines of credit, including primarily borrowings under the Credit Agreement dated as of June 8, 1994 among the Company, certain of its subsidiaries, Bankers Trust Company, as agent, and a syndicate of banks.\n\t Trigon is engaged primarily in the manufacture and sale of flexible packaging materials sold primarily for food packaging, durable mailer and bag products for the banking, security and courier industries, and specialty adhesive products. Trigon employs approximately 730 people, operates six manufacturing facilities in New Zealand, England and the United States and has subsidiaries in Australia and Germany that market certain of its products. The Company intends to integrate Trigon's operations into the Company's other protective and specialty packaging operations.\n\t Further information concerning the Trigon acquisition is set forth in Note 9 of the Notes to Consolidated Financial Statements, which Note appears in the Company's 1994 Annual Report to Stockholders and is incorporated herein by reference.\nPRODUCTS\n\t The Company's principal protective and specialty packaging products are engineered products, surface protection and other cushioning products, and food packaging products. Certain of these products are also produced for non-packaging applications. The Company also manufactures and sells certain other products discussed below.\n\t The net sales contributed by each class of product for each of the five years in the period ended December 31, 1994 appears in the table under the caption \"Selected Financial\nData\" in the Company's 1994 Annual Report to Stockholders, which data is incorporated herein by reference.\nENGINEERED PRODUCTS\n\t The Company's engineered products include its Instapak(R) polyurethane foam packaging systems, specialty polyethylene foams for packaging and non-packaging uses, and certain other engineered packaging products.\n\t Instapak(R) Systems\n\t Instapak(R) polyurethane foam packaging systems consist of proprietary blends of polyurethane chemicals and specially designed dispensing equipment, certain features of which are patented. The Company also manufactures a line of Instamate(R) polyolefin films, which are high-performance plastic films designed for use with Instapak(R) packaging systems. Most of the Company's net sales from Instapak(R) systems are attributable to the sale of the polyurethane chemicals and polyolefin films used in the systems installed at customer locations.\n\t Instapak(R) chemicals, films and equipment are marketed as integrated packaging systems to provide protective packaging for a wide variety of products, including computer, electronic, office, medical and communications equipment, compressors and motors, furniture and spare parts, and void-fill packaging of office supplies, books, cosmetics and other small products for distribution. Instapak(R) systems are also used to produce polyurethane foams used in certain non-packaging applications, including Instapak(R)-Floral, a foam used as a design base for artificial flower arrangements. The Company's Instapak(R) products are sold primarily in North America, Europe and the Asia\/Pacific region.\n\t An Instapak(R) packaging system allows a customer to create protective cushions for products of any shape and thus to tailor its protective packaging to its individual products and needs. When Instapak(R) chemicals are mixed together and dispensed, they expand up to 200 times their liquid volume within seconds after they are dispensed to form a foam cushion. Because Instapak(R) chemicals expand significantly in volume only when mixed together, the storage space required for the chemicals before use is very low.\n\t The Company purchases chemicals from various suppliers, including major chemical companies, and blends these chemicals according to its own proprietary formulations. The Company offers its Instapak(R) customers a family of protective packaging foams, ranging from low-density foams used for light cushioning and void-fill applications to heavy-duty foams used for blocking and bracing heavy items.\n\t The Company produces a number of dispensing equipment models for low, medium and high volume use and maintains an ongoing program to develop new equipment models to meet evolving customer needs. The Company's high-speed Instapacker(TM) automated system and its VersaPacker(TM) system, a bench-top version of the Instapacker(TM) system, produce\nready-to-use foam cushions consisting of Instamate(R) film bags filled with Instapak(R) foam. Hand-held equipment models range from low-volume single station systems to microprocessor-controlled multiple station systems. Generally, customers may either buy or lease equipment from the Company for use with Instapak(R) systems.\n\t Customers are also able to produce pre-formed Instapak(R) foam cushions for use in packaging a wide range of products. The Company offers assistance to its customers in producing, or in preparing the molds used to produce, such pre- formed cushions. The Company offers Instamolder(TM) semi- automated cushion molding equipment that produces Instapak(R) cushions using the Instapacker(TM) system.\n\t Specialty Polyethylene Foams\n\t The Company manufactures and sells extruded plank and laminated foams for packaging and non-packaging applications. Extruded plank foam is offered in varying densities and thicknesses up to three inches. Laminated foams, which are sold under various trademarks including Polylam(R) in the United States and Stratocell(R) in Europe, are produced in various densities and laminated into thicknesses ranging up to six inches. Certain of the Company's specialty polyethylene foam product lines contain post-consumer recycled polyethylene resins. These foams can be produced in various colors and are available in anti-static form.\n\t The Company's specialty polyethylene foams are generally sold to fabricators and converters for packaging and non-packaging applications in which a clean, non-abrasive material is required with such properties as shock absorption, vibration dampening, thermal insulation or buoyancy. In packaging applications, these foams are fabricated into a wide range of protective packaging shapes, forms and die-cuts for designed packages in which a clean, attractive appearance and cushioning or blocking and bracing performance is needed. Non- packaging applications for specialty foams include construction, automotive, sporting and athletic equipment products. The Company's specialty polyethylene foams are sold primarily in North America and Europe.\n\t In May 1994, the Company acquired a French fabricator of polyethylene foams and other packaging materials. This acquisition was not material to the Company's consolidated financial statements.\n\t Other Engineered Products\n\t The Company is engaged in the development, manufacture and sale of Korrvu(R) suspension packaging, which is covered by certain patents. A Korrvu(R) package suspends the product to be packaged in the air space of its shipping container between two strong, flexible low-slip films. Korrvu(R) packaging is sold primarily in North America and Europe.\n\t In September 1994, the Company acquired certain patented technology for the manufacture of Sup-Air-Pack(TM) inflatable cushions, which are cushions made in engineered\nshapes from proprietary films for packaging applications, and the Company is currently engaged in the development of this product line. This acquisition was not material to the Company's consolidated financial statements.\nSURFACE PROTECTION AND OTHER CUSHIONING PRODUCTS\n\t The Company's surface protection and other cushioning products include air cellular cushioning materials, protective and durable mailers and bags, thin polyethylene foams, paper packaging products, automated packaging systems and certain other packaging products.\n\t Air Cellular Cushioning Materials\n\t The Company manufactures and markets air cellular cushioning materials primarily under the trademarks AirCap(R) and PolyCap(R). These materials consist of air bubbles encapsulated between two layers of plastic film, each containing a barrier layer to retard air loss, that form a pneumatic cushion to protect products from damage through shock or vibration during shipment. The Company's PolyCap(R)R line of air cellular cushioning material is similar to AirCap(R)R cushioning in construction except that its plastic film contains a lighter barrier layer.\n\t The Company's air cellular cushioning materials are used by a wide variety of end users, including both manufacturers and retailers. AirCap(R)R cushioning is used primarily to protect a wide variety of lightweight and medium-weight delicate items, such as instruments, electronic components and glassware, that have no limitation on their shipping and shelf-life cycles. PolyCap(R)R cushioning is used primarily for a wide variety of lightweight products that have a relatively short shipping and shelf-life cycle. The Company also markets anti-static forms of its air cellular cushioning materials. The Company's air cellular materials are manufactured and sold primarily in North America and Europe. During 1994, the Company acquired manufacturers of air cellular and other packaging materials in Italy and Norway. Such acquisitions were not material to the Company's consolidated financial statements.\n\t The Company's air cellular cushioning materials are produced in various forms, including continuous rolls, perforated rolls and sheets, depending on customer preference. These materials can be used alone or laminated to other materials such as paper or cardboard. They are also available in bag form (marketed under the trademark Bubblebags(R)), primarily used to provide product protection to small parts. The Company's air cellular cushioning materials can be varied in the size, shape and spacing of their encapsulated air bubbles and the thickness of the plastic to provide specific types of performance in protective packaging and cushioning. The Company's AirCap(R)R and PolyCap(R)R product lines contain post-industrial and post- consumer recycled polyethylene resins.\n\t The Company also manufactures and sells adhesive-coated air cellular cushioning material under the trademark BubbleMask(R) and cohesive air cellular cushioning material under\nthe trademark Cold Seal(R)AirCap(R). Polypride(TM) air cellular materials are multi-web materials with high tensile strength used primarily as furniture wrapping.\n\t Protective and Durable Mailers and Bags\n\t The Company manufactures and markets a variety of protective and durable mailers and bags that are made in several standard sizes and are used for mailing or shipping a wide variety of items for which clean, lightweight preconstructed protective packages are desirable. They can provide the user with significant postage savings, ease of use and enhanced product protection relative to other types of mailers and shipping containers.\n\t The Company's protective mailers include lightweight, tear-resistant, heat-sealable mailers marketed primarily in North America and Europe under the trademark Jiffylite(R) that are lined with air cellular cushioning material. The Company's Jiffylite(R)R line of mailers are made from recycled kraft paper and the Company's PolyCap(R)R air cellular cushioning materials.\n\t These products also include the widely used Jiffy(TM) padded mailers made from recycled kraft paper padded with macerated recycled newspaper, Jiffy(TM) reinforced mailers, which are highly tear resistant and moisture retardant, Jiffy(TM) utility mailers, which are low-cost, lightweight mailers without padding, and Jiffy(TM) Rigi Bag(R) mailers, which are rigid mailers without padding that are well suited for products such as books and photographs. The Company also manufactures and markets Jiffy(TM) foam-lined mailers and Jiffy(TM) floppy disk mailers, which are lined with thin polyethylene foam. The kraft paper used in many of these mailer lines and the foam lining of certain foam mailer products contain recycled content. These mailers are marketed primarily in North America.\n\t The Company's and Trigon's durable plastic mailers and bags, which are produced from coextruded polyolefin film, are lightweight, water-resistant and puncture-resistant and are available in tamper-evident varieties. Such mailers and bags are used by a wide range of customers, including air courier, mail order, banking, security and office supply services, primarily in North America, Europe and the Asia\/Pacific region. Such mailers and bags are marketed under a number of brand names, including Shurtuff(R), Cache-Pak(R), Lok-Sure(R), Protec(R), Keepsafe(TM) and Crush-Gard(TM).\n\t Thin Polyethylene Foams\n\t In addition to the specialty polyethylene foams described above, the Company manufactures thin polyethylene foams in roll or sheet form in low, medium and special densities, in flat, ribbed or bag form and in a number of colors and thicknesses up to one-half inch. The Company also sells thin polyethylene foam that has anti-static properties and foam laminate products in which the foam is laminated to paper, polyethylene film or other substrates for specialized applications. The Company's Quicksilver(TM) polyethylene film and foam laminates\nhave cohesive properties for masking and other applications. Certain of the Company's thin polyethylene foam product lines are made using post-consumer recycled resins.\n\t Low-density thin polyethylene foam manufactured by the Company is marketed primarily in North America and Europe under the trademark Cell-Aire(R) and is used primarily for surface protection and light-duty cushioning.\n\t Medium-density thin polyethylene foam is marketed in North America and Europe under the trademark Cellu-Cushion(R) as a cushioning material to protect products from damage through shock or vibration during shipment. The Company also manufactures special density polyethylene foams for a variety of packaging and non-packaging applications.\n\t Paper Packaging Products\n\t The Company manufactures recycled kraft, tissue and creped paper for use as a raw material in the manufacture of the Company's protective mailer and food packaging products or sale to unaffiliated customers. The Company also manufactures and sells paper packaging products under the trademarks Kushion Kraft(R), Custom Wrap(TM), Jiffy(TM) Padwrap(R) and Void Kraft(TM) for industrial surface protection, furniture surface protection, moving and storage blankets, and for use as cushioning or void fill in various packaging applications. The Company's paper packaging products are sold primarily in North America and Europe.\n\t Packaging Systems\n\t The Company produces and markets the Instasheeter(TM) high-speed converting system, designed for on-line packaging applications, which automatically converts the Company's flexible packaging materials, including air cellular cushioning materials, thin polyethylene foam and paper packaging materials, described above, into sheets of a pre-selected size and quantity. The Company also produces and markets the Accu-Cut(TM) converting system, an economical system for converting the Company's flexible packaging materials in off-line packaging applications. Such systems are sold primarily in North America and Europe.\n\t The Company's Jiffy Packer(TM) high-speed dunnage system, which is marketed in Europe under the name Paper Boy(TM) and in Japan under the name EcoPacker(TM), produces paper dunnage material on site from the Company's 3-ply Void Kraft(TM) recycled kraft paper. The Jiffy Packer(TM) system is also offered in a bench-top version. The Company's VoidPak(TM) inflatable packaging system, marketed in North America and Europe, consists of a compact, portable inflator and self-sealing inflatable plastic bags, available in several sizes. When inflated, the bags can be used in a wide range of void fill applications, and they can be deflated and re-inflated for reuse.\n\t In September 1994, the Company acquired a French business that sells on-site air cellular packaging systems for void fill and light-duty cushioning applications. The systems, marketed primarily in Europe under the trademark Fill-Air(TM), convert rolls of polyethylene film\ninto air cellular packaging materials using patented technology. This acquisition was not material to the Company's consolidated financial statements.\n\t Other Surface Protection and Cushioning Products\n\t The Company participates in a joint venture called PolyMask Corporation with Minnesota Mining and Manufacturing Company (\"3M\") that manufactures and sells protective tapes consisting of adhesive-coated polyethylene films marketed by 3M. These products are used primarily for protecting the surfaces of polished metal, glass, plastic and other materials from abrasion during fabrication, handling and shipping. This joint venture is accounted for using the equity method.\nFOOD PACKAGING PRODUCTS\n\t The Company's food packaging products include absorbent pads and flexible films, bags, pouches and related equipment.\n\t Absorbent Pads\n\t The Company manufactures and sells absorbent pads used for food packaging, including its Dri-Loc(R) absorbent pads, certain features of which are covered by patents. The Company also produces other absorbent pads that utilize the features of its Dri-Loc(R) pads, including the Company's Pad-Loc(TM) pad for the poultry processor industry. These products are used in meat, fish and poultry trays to absorb excess fluids and are sold primarily in North America, Europe and the Asia\/Pacific region.\n\t The Company's Dri-Loc(R) pads consist of two layers of polyethylene film sealed on all four sides which enclose a layer of fluffed virgin wood-pulp fibers. On one side, the layer of film has tiny holes that permit fluids to be absorbed and retained by the enclosed fibers. The Company believes that Dri- Loc(R) pads are more effective and aesthetically attractive than conventional absorbent pads.\n\t The Company also manufactures conventional padding, sold as individual pads and in roll stock form for use by converters and processors to prepad trays. This padding consists of layers of bleached crepe tissue with one or two outer layers of polyethylene film. The Company also sells supermarket display case liners, which are similar in construction to conventional padding, under the trademark Cellu Liner(TM). In July 1994, the Company acquired an English manufacturer of conventional pads used for food and non-food applications. Such acquisition was not material to the Company's consolidated financial statements.\n\t Flexible Films and Related Equipment\n\t Trigon produces a variety of flexible films, bags and pouches and associated packaging systems marketed and sold primarily in Australasia and Europe and used to package a\nbroad range of perishable foods such as meat, poultry, fish, prepared foods, cheese and other dairy products.\n\t Trigon produces proprietary flexible films, bags and pouches in permeable and barrier varieties. Trigon's permeable films, bags and pouches are designed primarily for frozen or dried foods. The oxygen permeability and water vapor barrier properties of the film allow for the retention of fresh product color and appearance to enhance product presentation. Trigon's barrier films, bags and pouches provide a high barrier to oxygen and water, allowing extended storage for fresh chilled or processed products by preserving the texture, taste and moisture balance of the chilled or processed product. Both permeable and barrier films and bags are produced in various grades to meet customer requirements.\n\t Trigon markets permeable and barrier shrinkbags under the Shrinkvac(TM) trademark and barrier shrinkbags under the Perflex(TM) trademark. Permeable and barrier vacuum skin packaging is marketed under the Intact(TM) and Trifresh(TM) trademarks. Trigon also offers Tufflex(TM) barrier pouches with high puncture resistance.\n\t Trigon's packaging equipment offerings include automatic film and bag making, dispensing and loading units to package foods in vacuum or vacuum skin packages using Trigon's films. Systems are marketed to the food processing industry under the Intact(TM), Flexibag(TM) and other trademarks.\n\t Trigon also manufactures printed co-extruded films for frozen food and similar loose product packaging as well as a wide range of mono- and multi-layer films for other food and general applications.\nOTHER PRODUCTS\n\t The Company's other products consist primarily of specialty adhesive products, loose-fill polystyrene packaging, products that control static electricity, and recreation and energy conservation products.\n\t Through a subsidiary in New Zealand, Trigon manufactures and sells a wide range of specialty adhesive tapes on a variety of substrates. These specialty adhesive tapes provide custom formulations for a wide range of applications that include the tape strip or closure tape for disposable diapers, foil tapes used in heating, air conditioning and refrigeration, and cloth based tapes used in construction and underground applications on pipe work for corrosion protection.\n\t Subsidiaries of the Company in the Asia\/Pacific region and Mexico produce loose-fill polystyrene packaging for sale under the trademark Mic-Pac(TM) to customers in those countries.\n\t In addition to air cellular cushioning materials and polyethylene foam with anti-static properties, the Company sells other products related to the elimination and neutralization of static electricity, including conductive shielding bags, floor mats, worktable coverings, and wrist and foot straps. Static control products, which are sold primarily in North America and the Asia\/Pacific region, are used principally by manufacturers of static-sensitive microelectronic devices.\n\t In certain countries, subsidiaries of the Company sell translucent air cellular material similar to AirCap(R) cushioning that is fabricated into solar pool covers. In the United States, the Company manufactures and sells solar heating systems for swimming pools that use thermostatically controlled pumps to circulate pool water through plastic solar collector panels.\nFOREIGN OPERATIONS\n\t The Company sells most of its product lines in a number of foreign countries as well as in the United States, as described more fully above. In addition, the Company has foreign licensees that manufacture certain of its protective packaging products in Australia, Canada, Chile, England, Germany, Japan, South Africa and Sweden. Licensing revenues are not material to the Company's consolidated financial statements.\n\t During 1994, 1993 and 1992, foreign net sales represented approximately 29%, 27% and 30%, respectively, of the Company's total net sales, while operating profit from foreign operations represented approximately 21%, 20% and 25%, respectively, of the Company's total operating profit. For a discussion of the factors affecting these changes in foreign net sales and operating profit, see Management's Discussion and Analysis of Results of Operations and Financial Condition, which appears in the Company's 1994 Annual Report to Stockholders and is incorporated by reference into Item 7 of this Annual Report on Form 10-K. As a consequence of the Trigon acquisition, the Company believes that the percentage of its net sales from foreign operations should increase in 1995. In maintaining its foreign operations, the Company runs the risks inherent in such operations, including those of currency fluctuations.\nMARKETING, DISTRIBUTION AND CUSTOMERS\n\t The Company employs several hundred sales and account representatives in the countries in which it has operations who market the Company's products through a large number of distributors, fabricators and converters as well as directly to end users. In the United States and certain other countries, the Company has separate sales and marketing groups for its engineered products, its surface protection and other cushioning products, its food packaging products and certain of its other products. These groups often work together to develop market opportunities for the Company's products.\n\t To assist its marketing efforts and to provide specialized customer services, the Company maintains packaging laboratories in many of its United States and foreign facilities. These laboratories are staffed by professional packaging engineers and equipped with drop-\ntesting and other equipment used to develop and test cost-effective package designs to meet the particular protective packaging requirements of each customer. Certain of these laboratories also design and construct molds for Instapak(R) packaging customers who prefer to use preformed foam cushions.\n\t The Company has no material long-term contracts for the distribution of its protective packaging products. In 1994, no customer or affiliated group of customers accounted for as much as 10% of the Company's consolidated net sales.\nRAW MATERIALS\n\t The raw materials utilized in the Company's operations generally have been readily available on the open market and are purchased from several suppliers, reprocessed from scrap generated in the Company's manufacturing operations or obtained through participation in recycling programs. The principal raw materials used in the Company's operations include polyethylene resins and films, polyurethane chemicals, and paper and wood pulp products (including recycled or reprocessed paper products, resins, films and chemicals), and blowing agents used in foam products.\nPRODUCT DEVELOPMENT\n\t The Company incurred expenses of $10,912,000 related to Company-sponsored research and development in 1994 compared with $9,168,000 during 1993 and $9,414,000 during 1992. The Company maintains a continuing effort to develop new products based on its existing product lines as well as new packaging and non- packaging applications for its products. The Company also maintains ongoing efforts to add or increase recycled or reprocessed content in its product lines.\nPATENTS AND LICENSES\n\t The Company is the owner or licensee of a number of United States and foreign patents and patent applications that relate to certain of its products, manufacturing processes and equipment. While some of these patents and licenses, as well as certain trademarks which the Company owns, offer some protection and competitive advantage for the Company's products and their manufacture, the Company believes that its success depends primarily on its marketing, engineering and manufacturing skills and on its research and product technology.\nCOMPETITION\n\t The Company's products compete with similar products made by others and with a number of other packaging materials, including various forms of paper packaging products, expanded plastics, corrugated die cuts, loosefill packaging materials, and with envelopes, reinforced bags, boxes and other containers and various corrugated materials. Heavy-duty applications of the Company's engineered products also compete with various types of molded foam plastics, fabricated foam plastics and mechanical shock mounts and with wood blocking\nand bracing systems. Certain firms producing competing products are well established and may have greater financial resources than the Company. Competition for most of the Company's protective and specialty packaging products is based primarily on packaging performance characteristics, service and price. As discussed below under \"Environmental Matters,\" the Company is also subject to competitive factors affecting packaging materials that are based upon customers' environmental preferences.\n\t The Company believes that it is the leading manufacturer of air cellular cushioning materials containing a barrier layer and polyurethane foam packaging systems in the geographic areas in which it sells these products.\n\t There are a number of competing manufacturers of food packaging products. The Company believes that its Dri-Loc(R) products have a competitive advantage over conventional pads because of their efficiency and aesthetic appearance. Conventional pads and display case liners compete primarily on the basis of price, absorbency and service. The Company believes it is one of the leading suppliers of meat, fish and poultry absorbent pads to supermarkets and poultry processors in the United States and Europe. Trigon's food packaging films and systems compete with similar flexible films and systems produced by other companies around the world as well as with other food packaging materials.\nENVIRONMENTAL MATTERS\n\t The Company, like other manufacturers, is subject to various laws, rules and regulations in the countries, jurisdictions and localities in which it operates regulating the discharge of materials into the environment or otherwise relating to the protection of the environment. The Company believes that compliance with current environmental laws and regulations has not had a material effect on the Company's capital expenditures or financial position.\n\t In some jurisdictions in which the Company's packaging products are sold or used, laws and regulations have been adopted or proposed that seek to regulate, among other things, recycled or reprocessed content, sale and disposal of packaging materials. In addition, customer demand for packaging materials that are viewed as being \"environmentally responsible\" and that minimize the generation of solid waste continues to evolve. While these issues have become a competitive factor in the marketplace for packaging materials, the Company maintains active programs designed to comply with these laws and regulations, to monitor their evolution, and to meet such customer demand. The Company believes that its protective packaging materials offer superior packaging protection, enabling customers to achieve lower package cube and weight using the Company's protective packaging materials than with many alternative packaging methods, thereby reducing the disposal of damaged products as well as the generation of packaging waste. Because the Company offers both plastic-based and paper-based protective packaging materials, customers can select the protective packaging materials that they consider to best meet their performance and cost needs and environmental preferences. A number of the Company's product lines incorporate recycled\nor reprocessed content, and the Company maintains ongoing efforts to add or increase recycled or reprocessed content in many of its product lines.\n\t The Company also supports its customers' interests in eliminating waste by offering or participating in collection programs for certain of the Company's products or product packaging and for materials used in certain of the Company's products, including a program with Dow Chemical Company aimed at recovering and recycling polyethylene materials from customers, an Instapak(R) foam return program with return sites throughout the United States, collection programs for packaging materials in Germany and elsewhere in Europe, and local newspaper collection programs to obtain materials used to produce Jiffy(TM) padded mailers and certain other products. Whenever possible, materials collected through these collection programs are reprocessed and either reused in the Company's operations or offered to other manufacturers for use in other products. Certain of the Company's protective packaging products can be reused and, as an alternative to recycling or disposal in solid waste landfills, are suitable fuel sources for waste-to-energy conversion facilities.\nEMPLOYEES\n\t At December 31, 1994, the Company had approximately 3,000 employees, with approximately 320 employees covered by collective bargaining agreements. The Company believes that its employee relations are satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\n\t The Company has manufacturing facilities at twenty-four locations in the United States, three other locations in North America, including facilities in Puerto Rico, Canada and Mexico, sixteen locations in Europe, including facilities in England, France, Germany, Italy, the Netherlands, Norway, Spain and Sweden, and six locations in the Asia\/Pacific region, including two facilities in New Zealand and facilities in Hong Kong, Malaysia, Singapore and Taiwan. The Company occupies other facilities containing sales, technical, warehouse or administrative offices at several locations in the United States and in the other countries in which the Company conducts business.\n\t In the United States, the Company's Instapak(R) products are manufactured at facilities in Connecticut and North Carolina, its surface protection and other cushioning products and certain of its other products are manufactured at facilities in California, Georgia, Illinois, Massachusetts, New Jersey, New York, North Carolina, Pennsylvania, Texas and Washington, and its food packaging products are manufactured at facilities in California, Mississippi, North Carolina and Pennsylvania. Because of the light but bulky nature of the Company's air cellular, polyethylene foam and protective mailer products, significant freight savings may be realized by locating manufacturing facilities for these products near markets. To realize the benefit of such savings, the Company has facilities for manufacturing these products in various locations in proximity to major markets.\n\t \t The Company owns twenty-four of its manufacturing facilities, certain of which are owned subject to mortgages or similar financing arrangements. The balance of the Company's manufacturing facilities are located in leased premises. The Company's manufacturing facilities are located in general purpose buildings in which the Company's specialized machinery for the manufacture of one or more products is contained.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\n\t The Company is a party to various lawsuits and administrative and other proceedings incidental to its business, including certain federal or state governmental environmental proceedings or private environmental claims relating to Superfund sites or other alleged clean-up obligations. The Company believes that its liability with respect to such proceedings is not material.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\n\t No matters were submitted to a vote of the Company's stockholders during the fourth quarter of 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\n\t The information appearing in the table below sets forth the current position or positions held by each executive officer of the Company, his or her age as of March 15, 1995, the year in which he or she first was elected to the position currently held, and the year in which he or she first was elected an officer of the Company.\n\t All of the Company's officers serve at the pleasure of the Board of Directors. All officers have been employed by the Company or its subsidiaries for more than five years. There are no family relationships among any of the Company's officers or directors.\nName and Age as of First Elected to First Elected Current Position March 15, 1995 Current Position an Officer\nT. J. Dermot Dunphy 62 1971 1971 President, Chief Executive Officer and Director\nWilliam V. Hickey 50 1995 1980 Executive Vice President\nElmer N. Funkhouser III 53 1984 1982 Senior Vice President\nWarren H. McCandless 54 1994 1990 Senior Vice President- Finance\nDale Wormwood 60 1991 1989 Senior Vice President\nJonathan B. Baker 42 1994 1994 Vice President\nJames A. Bixby 51 1990 1990 Vice President\nMary A. Coventry 41 1994 1994 Vice President\nBruce A. Cruikshank 52 1990 1990 Vice President\nJean-Luc Debry 49 1992 1992 Vice President\nJames P. Mix 43 1994 1994 Vice President\nRobert A. Pesci 49 1990 1990 Vice President\nAbraham N. Reichental 38 1994 1994 Vice President\nHorst Tebbe 54 1986 1986 Vice President\nRobert M. Grace, Jr. 48 1981 1981 General Counsel and Secretary\n\t\t\t\t PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON \t EQUITY AND RELATED STOCKHOLDER MATTERS\n\t The information appearing under the caption \"Common Stock Information\" in the Company's 1994 Annual Report to Stockholders is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\t The information appearing under the caption \"Selected Financial Data\" in the Company's 1994 Annual Report to Stockholders is incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL \t CONDITION AND RESULTS OF OPERATIONS\n\t The information appearing under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition\" in the Company's 1994 Annual Report to Stockholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINTERIM FINANCIAL INFORMATION (UNAUDITED)\n\t The information appearing under the caption \"Interim Financial Information (Unaudited)\" in the Company's 1994 Annual Report to Stockholders is incorporated herein by reference.\nFINANCIAL STATEMENTS AND SCHEDULE\n\t See Index to Consolidated Financial Statements and Schedule on page of this Annual Report on Form 10-K.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS \t ON ACCOUNTING AND FINANCIAL DISCLOSURE\n\t There has been no change in the independent auditors of the Company's financial statements during 1993 or 1994 or subsequent thereto.\n\t\t\t\t PART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\n\t Part of the information required in response to this Item is set forth in Part I of this Annual Report on Form 10-K under the caption \"Executive Officers of the Registrant,\" and the balance will be set forth in the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders under the caption \"Information Concerning Nominees.\" All such information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\n\t The information required in response to this Item will be set forth in the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders under the caption \"Directors' Compensation\" and under the subheadings \"Summary Compensation Table\" and \"Compensation Committee Interlocks and Insider Participation\" under the caption \"Executive Compensation,\" and such information is incorporated herein by reference. Such incorporated information does not include the information under the subheadings \"Report of Organization and Compensation Committee on Executive Compensation\" and \"Common Stock Performance Comparison\" under the caption \"Executive Compensation\" in such Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS \t AND MANAGEMENT \t\t\n\t The information required in response to this Item will be set forth in the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders under the caption \"Voting Securities,\" and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\n\t The information required in response to this Item will be set forth in the Company's Proxy Statement for its 1995 Annual Meeting of Stockholders under the caption \"Information Concerning Nominees,\" and such information is incorporated herein by reference.\n\t\t\t\t PART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT \t SCHEDULES, AND REPORTS ON FORM 8-K\n(a) DOCUMENTS FILED AS A PART OF THIS ANNUAL REPORT ON FORM 10-K:\n\t (i) Financial Statements and Financial Statement Schedule\n\t See Index to Consolidated Financial Statements and Schedule on page herein.\n\t (ii) Exhibits\nExhibit Number Description\n3.1 Unofficial Composite Certificate of Incorporation \t of the Company as currently in effect. (Exhibit \t (2)(B) to the Company's Quarterly Report on Form \t 10-Q for the quarterly period ended June 30, 1992, \t File No. 1-7834, is incorporated herein by \t reference.)\n3.2 By-Laws of the Company as currently in effect. \t (Exhibit 3.3 to the Company's Annual Report on \t Form 10-K for the fiscal year ended December 31, \t 1993, File No. 1-7834, is incorporated herein by \t reference.)\n4.1 Credit Agreement dated as of June 8, 1994 among \t the Company, certain of its subsidiaries, various \t banks and Bankers Trust Company, as agent (Exhibit \t 4 to the Company's Quarterly Report on Form 10-Q \t for the quarterly period ended June 30, 1994, File \t No. 1-7834, is incorporated herein by reference.)\n4.2 Consent to Credit Agreement among the Company, \t certain of its subsidiaries, various financial \t institutions and Bankers Trust Company, as agent, \t dated as of December 7, 1994 (Exhibit 4.1 to the \t Company's Current Report on Form 8-K, Date of \t Report January 10, 1995, File No. 1-7834, is \t incorporated herein by reference.)\n4.3 Amendment No. 1 to Credit Agreement among the \t Company, certain of its subsidiaries, various \t financial institutions and Bankers Trust Company, \t as agent, dated as of January 3, 1995 (Exhibit 4.2 \t to the Company's Current Report on Form 8-K, Date \t of Report January 10, 1995, File No. 1-7834, is \t incorporated herein by reference.)\n10.1 Contingent Stock Plan of the Company, as amended. \t (Exhibit 4(c) to the Company's Registration \t Statement on Form S-8, Registration No. 33-41734, \t is incorporated herein by reference.)*\n10.2 Restricted Stock Plan for Non-Employee Directors \t of the Company. (Exhibit A to the Company's Proxy \t Statement for the annual meeting held on May 17, \t 1991, File No. 1-7834, is incorporated herein by \t reference.)*\n10.3 Share Purchase Agreement dated as of January 10, \t 1995 among Sealed Air Corporation, Trigon \t Industries Limited, Sealed Air Holdings (NZ) \t Limited, a wholly owned New Zealand subsidiary of \t Sealed Air, James William Ferguson Foreman and \t Diane Shirley Foreman (Exhibit 2 to the Company's \t Current Report on Form 8-K, Date of Report January \t 10, 1995, File No. 1-7834, is incorporated herein \t by reference.)\n13 Portions of the Company's 1994 Annual Report to \t Stockholders that are incorporated by reference \t into this Annual Report on Form 10-K.\n21 Subsidiaries of the Company.\n23 Consent of KPMG Peat Marwick LLP.\n27 Financial Data Schedule \t *Compensatory plan or arrangement of management required to be filed as an exhibit to this report on Form 10-K.\n(b) REPORTS ON FORM 8-K:\nThe Company did not file any reports on Form 8-K during the fiscal quarter ended December 31, 1994.\n\t\t\t SIGNATURES\n\t 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.\n\t\t\t\t SEALED AIR CORPORATION \t\t\t\t (Registrant) \t\nDate: March 28, 1995 By s\/T. J. DERMOT DUNPHY \t\t\t\t\tPresident \t\n\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 and in the capacities and on the dates indicated.\n\t\t\t\t\t Date\nBy s\/ T. J. DERMOT DUNPHY March 28, 1995 President and Director (Principal Executive Officer)\nBy s\/ WILLIAM V. HICKEY March 28, 1995 Executive Vice President (Principal Financial Officer and Principal Accounting Officer)\nBy s\/ JOHN K. CASTLE March 28, 1995 Director\nBy s\/ LAWRENCE R. CODEY March 28, 1995 Director\nBy s\/ CHARLES F. FARRELL, JR. March 28, 1995 Director\nBy s\/ DAVID FREEMAN March 28, 1995 Director\nBy s\/ SHIRLEY A. JACKSON March 28, 1995 Director\nBy s\/ ALAN H. MILLER March 28, 1995 Director\nBy s\/ R. L. SAN SOUCIE March 28, 1995 Director\nSEALED AIR CORPORATION\nCONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES Years ended December 31, 1994, 1993 and 1992\n\t SEALED AIR CORPORATION AND SUBSIDIARIES Index to Consolidated Financial Statements and Schedules\n\t\t\t\t\t\t\t Page\nIndependent Auditors' Report *\nFinancial Statements: Consolidated Statements of Earnings for the years ended December 31, 1994, 1993 and 1992 * Consolidated Balance Sheets - December 31, 1994 and 1993 * Consolidated Statements of Shareholders' Equity (Deficit) for the years ended December 31, 1994, 1993 and 1992 * Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992 * Notes to Consolidated Financial Statements *\nIndependent Auditors' Report on Schedule\nConsolidated Schedule: VIII - Valuation and Qualifying Accounts\n______________________________ *The information required appears on pages 17 through 35 of the Company's 1994 Annual Report to Stockholders and is incorporated by reference into this Annual Report on Form 10-K.\nAll other schedules are omitted, as the required information is inapplicable or the information is presented in the consolidated financial statements or related notes.\nIndependent Auditors' Report on Schedule\nThe Board of Directors and Shareholders Sealed Air Corporation:\nUnder date of January 18, 1995, we reported on the consolidated balance sheets of Sealed Air Corporation and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, shareholders' equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 1994, as contained in the 1994 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 1994. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\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.\n\t\t\t\t\t\t\tKPMG Peat Marwick LLP \t\t\t\t\t\t \t\t\t\t\t Short Hills, New Jersey January 18, 1995","section_15":""}
{"filename":"837579_1994.txt","cik":"837579","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nMCN, through its principal subsidiaries, leases approximately 62,000 sq. feet of office space in Detroit and Grand Rapids under long-term leases.\nGAS DISTRIBUTION\nMichCon operates natural gas distribution, transmission and storage facilities in the state of Michigan. At December 31, 1994, MichCon's distribution system included 15,252 miles of distribution mains, 1,035,542\nservice lines and 1,157,567 active meters. MichCon owns 2,506 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 to affiliates and others.\nMost of MichCon's properties are held in fee, by easement, or under lease agreements expiring at various dates to 2006, with renewal options extending beyond that date. 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. MichCon's capital expenditures for 1994 totaled $145.4 million and could reach $250 million in 1995.\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.\nDIVERSIFIED SERVICES\nThe Saginaw Bay partnership owns substantially all of the properties used in the conduct of its business, primarily a 126-mile transmission line and related lateral lines.\nThe Supply Development Group Inc. has interests in properties used for gas production, including compressor facilities and gathering lines. (See information below on Exploration and Production Activities for further details).\nGenix owns certain properties, including land and building at their headquarters located in Dearborn, Michigan. Genix leases facilities and computer equipment located in Pennsylvania; North Carolina; Southgate, Michigan and London, England. Certain computer equipment is owned at all locations.\nMCN is involved in joint ventures that own property associated with gas storage, cogeneration, gas gathering and processing, and real estate.\nMCN's facilities are suitable and adequate for their intended use.\nEXPLORATION AND PRODUCTION ACTIVITIES\nSupply Development Group, Inc. (SDGI), a subsidiary of MCN, is involved in various gas and oil producing activities. The following data, together with the financial information detailed in Note 12 to the Consolidated Financial Statements, incorporated by reference in Item 8 of this report and the general data provided under the \"Diversified Services: Gas Services -- Exploration & Production\" section of Item 1 located on page 11, provide additional information regarding this activity. Reserves were estimated using contract sales prices. Future revenues (included in the standardized measure of discounted future net cash flows presented in Note 12 to the Consolidated Financial Statements) were increased for the higher fixed prices from swap contracts covering a portion of the volumes. Information on estimated gas and oil reserves was obtained by SDGI from the independent petroleum engineering consultants Ryder Scott Company and Miller and Lents, Ltd.\nPRODUCTION\nPRODUCTIVE WELLS AND ACREAGE\nGross wells include nine with multiple completions.\nDRILLING ACTIVITY\nPRESENT ACTIVITIES\nDELIVERY COMMITMENTS\nOnce operations begin in late 1995, Cogen will provide to the Michigan Power Project up to 9 Bcf of gas, on an annual basis.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nIn addition to the Gas Distribution's regulatory proceedings and other matters described in Item 1, \"Business\", MCN is also involved in a number of lawsuits and administrative proceedings in the ordinary course of business with respect to taxes, environmental matters, personal injury, property damage claims and other matters.\nOn December 27, 1994, a class action complaint was filed against MichCon in Wayne County Circuit Court, Detroit, Michigan, by six residential customers of MichCon on behalf of themselves and others who purchased and installed high efficiency furnaces financed through one of MichCon's energy conservation programs approved by the MPSC. These furnaces were installed by independent licensed contractors. Plaintiffs allege, among other things, that MichCon failed to warn them that unsafe conditions could result from improper installation and venting of gas appliances, failed to take corrective action to remedy such conditions, and made false representations and\/or omissions in connection therewith. Plaintiffs seek injunctive relief requiring MichCon to (a) warn its customers of unsafe conditions created by the installation of high efficiency furnaces, and (b) to reline all chimneys or install hot water heaters that vent to the outside. Plaintiffs also seek unspecified money damages among other things for diminution in the value of their homes, damage to homes, cost of repairs, exemplary damages, attorneys fees and costs. On February 3, 1995, immediately following a hearing on plaintiffs' motion to certify the class of customers, the Wayne County Circuit Court issued an order that denied plaintiffs' motion without prejudice. While plaintiffs could refile the motion, the judge stated on the record that before he would reconsider plaintiffs' motion, plaintiffs must be able to establish a more clearly defined plaintiff class and damages. Management believes plaintiffs' allegations are without merit and intends to vigorously defend this action.\nThe management of MCN believes that the resolution of these matters will not have a material adverse effect on the financial statements 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 21, 1995, 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 27, 1995.\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 February 21, 1995 there were 24,705 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 1994 Annual Report to Shareholders, pages 58 and 59.\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 1994 Annual Report to Shareholders, pages 58 and 59.\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 1994 Annual Report to Shareholders, pages 32 through 39.\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 1994 Annual Report to Shareholders. The consolidated statement of income, cash flows and capitalization are for each of the years ended December 31, 1994, 1993 and 1992 and the consolidated statement of financial position is as of December 31, 1994 and 1993.\nConsolidated Statement of Income, page 40\nConsolidated Statement of Financial Position, page 41\nConsolidated Statement of Capitalization, page 42\nConsolidated Statement of Cash Flows, page 43\nSummary of Accounting Policies, page 44\nNotes to Consolidated Financial Statements, pages 45 through 55\nIndependent Auditors' Report, page 56; and\nSupplementary Financial Information, pages 58 and 59\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 \"Proposal 1-Election of Directors\" in MCN's March 1995 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 18 in Part I of this Report.\nCOMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED\nAll reports concerning ownership of MCN equity securities required to be filed by MCN's directors and executive officers pursuant to Section 16 of the Securities Exchange Act of 1934, as amended, were filed on a timely basis with the Securities and Exchange Commission.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth in the section entitled \"Compensation of Directors and Executive Officers\" in MCN's March 1995 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 \"Beneficial Security Ownership of Directors, Nominees and Executive Officers\" in MCN's March 1995 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 \"Other Compensation Matters\" in MCN's March 1995 definitive Proxy Statement is incorporated by reference herein.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, 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 19 in Part II, Item 8 of this Report.\n2. The Financial Statement Schedule for each of the three years in the period ended December 31, 1994, unless otherwise noted, is included herein in response to Part II, Item 8:\nIndependent Auditor's Report\nSCHEDULE II -- Valuation and Qualifying Accounts\nSchedules other than that 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, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 6, 1995; such consolidated financial statements and report are included in your 1994 Annual Report to Shareholders and are incorporated therein by reference. Our audits also included the consolidated financial statement schedule of MCN Corporation and subsidiaries, listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In 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.\nDeloitte & Touche LLP Detroit, Michigan February 6, 1995\nSCHEDULE II\nMCN CORPORATION AND SUBSIDIARIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (THOUSANDS OF DOLLARS)\n- ---------------\nNOTES:\n(1) During 1994, MCN established a reserve for the expected loss relating to the sale of a partnership interest in a gas marketing joint venture. The sale is anticipated to take place during the first half of 1995.\n(2) Reference is made to Note 5b to the Consolidated Financial Statements in the 1994 Annual Report to Shareholders of MCN Corporation, page 47. 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.\n3. Exhibits, Including Those Incorporated By Reference.\n- --------------- * Indicates document filed herewith.\nReferences are to MCN (File No. 1-10070) for documents incorporate by reference.\n(B) REPORTS ON FORM 8-K:\nMCN filed a report on Form 8-K dated October 21, 1994, under Item 5, with respect to the reporting of its third quarter results of operations.\nMCN filed a report on Form 8-K dated October 26, 1994, under Item 5, with respect to the offering by MCN Michigan Limited Partnership (MCN Michigan) of its 9 3\/8% Cumulative Preferred Securities, Series A, liquidation preference $25 per Preferred Security (Preferred Securities). MCN is the general partner of MCN Michigan. A Form of Purchase Agreement was filed as an Exhibit thereto.\nMCN filed an additional report on Form 8-K dated October 26, 1994, under Item 5, with respect to the offering of the Preferred Securities by MCN Michigan. The following documents were filed as Exhibits thereto:\n- Amended and Restated Limited Partnership Agreement of MCN Michigan Limited Partnership.\n- Action by the General Partner of MCN Michigan Limited Partnership creating the 9 3\/8% Cumulative Preferred Securities, Series A, dated October 26, 1994.\n- Form of Certificate Evidencing Preferred Partner Interest of MCN Michigan Limited Partnership.\n- MCN Corporation Board of Directors' Pricing Committee Resolution establishing the price, terms and conditions of the Debt Securities.\n- Terms and Conditions of Series A Subordinated Deferrable Interest Debt Securities.\n- Form of MCN Corporation Series A Subordinated Deferrable Interest Debt Security for $100,000,000.\n- Form of MCN Corporation Series A Subordinated Deferrable Interest Debt Security for $1,100,000.\n- Form of the Series A Subordinated Deferrable Interest Debt Security to be issued in the event that MCN Michigan ceases to be the sole holder.\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\n-------------------------------------- (Registrant)\nBy: \/s\/ Patrick Zurlinden\n------------------------------------ Patrick Zurlinden Vice President, 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.\nEXHIBIT INDEX\n- --------------- * Indicates document filed herewith.\nReferences are to MCN (File No. 1-10070) for documents incorporate by reference.","section_15":""}
{"filename":"897708_1994.txt","cik":"897708","year":"1994","section_1":"ITEM 1. BUSINESS\nRESTRUCTURING AND INITIAL PUBLIC OFFERING\nAT&T Capital Corporation (\"AT&T Capital\" or the \"Company\"), was incorporated on December 21, 1992 as AT&T Leasing, Inc., and was renamed AT&T Capital Corporation on March 31, 1993. The Company is the successor entity to certain businesses of AT&T Capital Holdings, Inc. (formerly known as AT&T Capital Corporation, renamed AT&T Capital Holdings, Inc. (\"Old Capital\") on March 31, 1993) a wholly owned subsidiary of AT&T Corp. (\"AT&T\") and AT&T Credit Holdings, Inc. which commenced operations in 1985, and renamed AT&T Credit Holdings, Inc. (\"Old Credit\") on March 31, 1993, an indirect wholly owned subsidiary of AT&T. In a restructuring that occurred on March 31, 1993, (the \"Restructuring\") Old Capital and Old Credit transferred substantially all their assets to the Company except for certain assets, consisting principally of equity interests in project finance transactions and leveraged leases of commercial aircraft (\"Lease Finance Assets\"), in exchange for shares of the Company's common stock and the assumption by the Company of certain related liabilities.\nIn connection with the Restructuring, AT&T issued a direct, full and unconditional guarantee of all existing indebtedness outstanding as of March 31, 1993 for borrowed money incurred, assumed or guaranteed by Old Capital entitled to the benefit of a Support Agreement between AT&T and Old Capital (the \"Support Agreement\"), including the debt of Old Capital assumed by the Company in the Restructuring. Debt issued by the Company subsequent to March 31, 1993, however, is not guaranteed or supported by AT&T.\nAn initial public stock offering combined with a management stock offering totalling approximately 14 percent of the Company's stock occurred on August 4, 1993. (See Note 8 to the Consolidated Financial Statements). As a result of the stock offerings, approximately 86 percent of the outstanding common stock of the Company is owned indirectly by AT&T (through Old Capital and Old Credit.)\nIn connection with its initial public offering, the Company entered into certain intercompany, operating, license and tax agreements with AT&T. The Intercompany Agreement includes a provision requiring minimum ownership by AT&T of 20% of the Company's common stock outstanding immediately after the initial public offering for a period of five years. Provisions for management by the Company of certain portfolios owned by AT&T, allowing the Company to utilize certain AT&T corporate and administrative services (for a fee) and generally requiring the Company to continue certain equipment financing programs for AT&T are also included. The Operating Agreement, provides, among other things, that AT&T is required to promote the Company's financing and ancillary services and to provide the Company with certain preferred provider rights in connection with the financing of AT&T products and services. In addition, the Operating Agreement restricts AT&T from competing with the Company with respect to certain products of the Company. The License Agreement defines the Company's rights to use certain AT&T service marks and trade names, and to use \"AT&T\" as part of the corporate names of the Company and certain of its subsidiaries. The initial term of the License Agreement will expire on the seventh\nanniversary of the date of the initial public offering. The License Agreement may be terminated prior to the end of its term by either party if the other party breaches or defaults on terms of the Intercompany agreement, the Operating Agreement or the License Agreement. Additionally, AT&T can elect to terminate the license agreement if the long-term unsecured debt of the Company is rated below investment grade by at least two nationally recognized rating agencies or if the Company receives a qualified audit opinion from its independent accountants. Because such license is an important strategic asset of the Company, termination of the License Agreement could have an adverse effect on the Company.\nDESCRIPTION OF THE BUSINESS\nAT&T Capital is one of the largest equipment leasing and finance companies in the United States based on the aggregate value of equipment leased or financed. The Company is a full-service, diversified equipment leasing and finance company that operates in the United States, Canada, Europe, the Asia\/Pacific Region and Mexico.\nThe Company leases and finances equipment manufactured and distributed by AT&T and its affiliates and numerous other companies. The Company's customers include many of the nation's largest industrial and service companies, as well as many small and mid-size business customers and federal, state and local governments and their agencies.\nAT&T Capital, through its various subsidiaries, leases and finances telecommunications equipment (such as private branch exchanges (\"PBXs\"), telephone systems and voice processing units), general purpose equipment (such as office equipment and manufacturing equipment), data center equipment (including mainframe computers and related equipment), other data processing equipment (such as personal computers, retail point-of-sale computers, automatic teller machines and bank transaction processing equipment) and transportation equipment (primarily vehicles). The Company is the largest lessor in the United States of telecommunications equipment. The Company also provides inventory financing for equipment dealers and distributors, Small Business Administration (\"SBA\")lending, and asset management and remarketing services. In addition, the Company offers its customers certain equipment rental and repair services and certain other asset administration services.\nAT&T Capital offers a variety of lease and other finance instruments, including leases where the Company is the owner of the equipment for tax or accounting purposes and leases and installment sales arrangements where the end-user is such owner. At December 31, 1994, 12.1% of the Company's net investment in leases and finance receivables (\"portfolio assets\") consisted of leases where the Company was the owner of the equipment for both tax and accounting purposes. The Company's portfolio assets, which aggregated approximately $7.5 billion at December 31, 1994, are diversified across various types of financed equipment, with telecommunications equipment comprising approximately 26% of such portfolio assets at such date. At December 31, 1994, approximately 5% of the Company's portfolio assets were comprised of real estate assets (including commercial loans collateralized\nby real estate generated through the Company's small business lending activity, e.g., SBA and franchise lending) and commercial aircraft leases.\nAT&T Capital's portfolio assets are diversified among a large customer base as well as geographic regions. At December 31, 1994, the Company's 99 largest customers (after AT&T and its affiliates) accounted for approximately 20% of the Company's portfolio assets, and no single customer (with the exception of AT&T and its affiliates) accounted for more than 1.0% of such portfolio assets.\nA substantial part of the Company's total United States assets, revenue and net income are attributable to leasing and financing of AT&T equipment provided to customers of AT&T and its affiliates (collectively, \"Customers of AT&T Equipment\"). AT&T and its affiliates and employees (collectively, \"AT&T as End-User\") are also significant customers of the Company, primarily with respect to data processing equipment and vehicles leased to as them as end-users.\nThe following table shows (in millions of dollars) the assets, revenue, net income(loss) and income before cumulative effect of accounting change and impact of tax rate change related to United States operations (together with the respective percentages of the assets, revenue, net income(loss) and income before cumulative effect of accounting change and impact of tax rate change related to United States operations represented by such dollar amounts) attributable to (I) leasing and financing services provided by the Company to customers of AT&T equipment, (ii) transactions involving AT&T as End-User and (iii) the Company's non-AT&T businesses, in each case at and for the years ended December 31, 1992, 1993 and 1994. The net income(loss) and income before cumulative effect of accounting change and impact of tax rate change amounts shown below were calculated based upon what the Company believes to be a reasonable allocation of interest, income taxes and certain corporate overhead expenses.\nCustomers of AT&T Equipment Income before\ncumulative effect of 1993 accounting\nchange and impact Assets Revenue Net Income of tax rate change __________________________________________________________________________ $ % $ % $ % $ % ___________________________________________________________________________\n1992 $2,305.0 40.1% $410.5 32.8% $52.4 60.0% $52.4 60.0% 1993 $2,441.7 40.7% $423.3 33.2% $68.5 87.8% $75.9 80.1% 1994 $2,749.8 38.4% $458.5 36.7% $84.2 80.5% $84.2 80.5%\nAT&T as End-User Income before\ncumulative effect of 1993 accounting\nchange and impact Assets Revenue Net Income of tax rate change ___________________________________________________________________________ $ % $ % $ % $ % ___________________________________________________________________________ 1992 $658.4 11.4% $185.2 14.8% $13.0 14.9% $13.0 14.9% 1993 $608.8 10.1% $201.9 15.9% $14.2 18.3% $16.9 17.9% 1994 $548.0 7.7% $131.2 10.5% $ 8.5 8.2% $ 8.5 8.2%\nNon-AT&T Businesses Income before\ncumulative effect of 1993 accounting\nNet Income change and impact Assets Revenue (Loss) of tax rate change ___________________________________________________________________________ $ % $ % $ % $ % ___________________________________________________________________________ 1992 $2,786.9 48.5% $655.8 52.4% $21.9 25.1% $21.9 25.1% 1993 $2,952.4 49.2% $649.4 50.9% ($ 4.7) (6.1%) $ 1.9 2.0% 1994 $3,850.9 53.9% $660.9 52.8% $11.9 11.3% $11.9 11.3%\nThe net income(loss) and income before cumulative effect of accounting change and impact of tax rate change from the Company's United States non-AT&T businesses reflects the fact that costs and expenses associated with developing additional and changing existing non-AT&T business units were substantial. Conversely, the securitization of certain non-AT&T portfolio assets positively impacted the non-AT&T businesses in 1992, 1993 and 1994 (see Note 6 to the Consolidated Financial Statements). The Company intends to pursue its strategy of expanding its non-AT&T businesses, while at the same time enhancing its AT&T relationship. Because the desired growth in revenue generated by the Company's non-AT&T businesses can be expected to lag behind the incurrence of costs and expenses necessary to expand and operate such businesses, the Company anticipates that the percentage of its total United States net income and revenue growth attributable to non-AT&T businesses may vary from year to year depending upon the developmental stages associated with the non-AT&T businesses.\nAlthough the Company operates principally in the United States, the Company began operations in the United Kingdom in 1991 and, through the hiring of certain employees and the acquisition of certain operating assets (but not Portfolio Assets), began significant operations in Canada in 1992. In January 1994, the Company purchased the stock of Australian Guarantee Corporation Finance (H.K.) Limited (\"A.G.C. Finance\"), a Hong Kong-based vehicle and equipment leasing finance company with assets at that time of approximately $150 million. Also in January 1994, the Company, through its wholly-owned Canadian subsidiary, acquired the vehicle portfolio and infrastructure assets constituting the Avis Canada Leasing Division of AvisCar, Inc. (\"Avis Leasing\"). Avis Leasing provides automobile leasing to small and mid-size commercial and corporate clients in Canada and had\napproximately $90 million in assets at the time of acquisition.\nAlso in 1994, the Company opened offices in Mexico and Australia. The Company, from time to time, investigates potential opportunities to make acquisitions abroad, and the Company may open additional foreign offices on a limited basis either directly or through acquisition.\nOn January 4, 1995, the Company acquired the vendor leasing and finance companies of Banco Central Hispano and certain of its affiliates (collectively, \"CFH Leasing International\") located in the United Kingdom, Germany, France, Italy, Belgium, the Netherlands and Luxembourg. CFH Leasing International provides financial services to equipment manufacturers and vendors. With offices throughout much of western Europe, it serves approximately 4,600 customers and had approximately $540 million in assets at the time of acquisition.\nThe Company's assets, revenue and net income related to foreign operations are not reflected in the above tables which show assets, revenue, net income(loss) and income before cumulative effect of accounting change and impact of tax rate change attributable to the Company's United States operations. At December 31, 1994, 1993 and 1992, the total assets of the Company's foreign operations were $873.2 million (or 10.9% of total assets), $406.9 million (or 6.3% of total assets) and $145.1 million (or 2.5% of total assets), respectively. The total revenue of such operations for the years ended December 31, 1994, 1993 and 1992, were $133.5 million (or 9.6% of total revenue), $85.0 million (or 6.2% of total revenue) and $14.0 million (or 1.1% of total revenue), respectively, and such operations generated net losses of $4.2 million, $9.4 million and $13.8 million, respectively. Such losses reflected the fact that most of the Company's foreign operations are in the start-up phase, with revenue from such operations not yet covering operating costs and expenses.\nAlthough a substantial majority of the Company's foreign assets and revenues at and for the years ended December 31, 1994, 1993 and 1992, were attributable to the Company's non-AT&T businesses, a principal focus of such foreign operations is to serve foreign customers of AT&T and its affiliates as well as other vendors. Total assets, revenue and net income related to non-AT&T businesses including both domestic and international businesses for the year ended December 31, 1994 were $4,698.7 million (or 58.6% of total assets), $789.9 million (or 57.1% of total revenue), and $9.0 million (or 9.0% of total net income), respectively. Total assets, revenue and net loss (before cumulative effect of accounting change and the impact of the tax rate change) related to non-AT&T businesses including both domestic and international businesses for the year ended December 31, 1993 were $3,337.1 million, $731.6 million and $7.5 million, respectively. Total assets, revenue and net loss related to non-AT&T businesses including both domestic and international businesses for the year ended December 31, 1992 were $2,906.3 million, $668.1 million and $11.7 million, respectively.\nIncome Tax Considerations\nThe Company is currently a member of AT&T's consolidated group for federal income tax purposes. The Company would cease to be a member of such consolidated group for federal income tax purposes (a \"Tax\nDeconsolidation\") if, among other events, AT&T's ownership interest in the outstanding common stock decreases to below 80%. Tax Deconsolidation would have certain adverse effects on the Company.\nAs long as the Company is a part of the AT&T consolidated federal income tax group, the payment of federal and state income taxes in all states in which combined returns are filed associated with sales of products manufactured by AT&T is deferred (the amount of such taxes so deferred being herein called \"Gross Profit Tax Deferral\"), generally as the products are depreciated or until sold outside the group. Pursuant to the Gross Profit Tax Deferral Interest Free Loan Agreement between the Company and AT&T, AT&T has extended and has agreed to extend interest-free loans to the Company from time to time in an amount equal to the then outstanding amount of Gross Profit Tax Deferral. Such loans are repayable by the Company when and to the extent that any such deferred taxes are required to be paid by AT&T. Upon any Tax Deconsolidation, the Company would be required to repay such loans and would no longer receive such loans, which have constituted a competitive advantage to the Company in financing AT&T products.\nPursuant to the Federal Tax Sharing and the State Tax Sharing Agreements between the Company and AT&T, the AT&T consolidated federal income tax liability is generally allocated among the members of the AT&T consolidated group that report taxable income. Members of the AT&T consolidated group that report tax losses are compensated currently by AT&T (through cash payments made on a quarterly basis) for their losses to the extent those losses are used to reduce the AT&T consolidated federal income tax liability. Similar principles and cash payments also apply to certain state and local income tax liabilities.\nUpon any Tax Deconsolidation, the Company would no longer be entitled to receive quarterly cash payments from AT&T in compensation for the use of any tax losses. The tax losses would, instead, be available to the Company to reduce future taxable income. Thus, the Company may derive a benefit in the future from tax losses, but only to the extent the Company has taxable income in later years. In 1994, on a stand-alone basis, the Company had taxable income.\nIn addition, upon Tax Deconsolidation, it is possible that the Company could be subject to the federal alternative minimum tax. A taxpayer's alternative minimum tax liability is computed by applying the alternative minimum tax rate, which is lower than the regular tax rate, to a measure of taxable income that is broader than that used in computing the regular tax. Payments of any alternative minimum tax incurred by the Company after a Tax Deconsolidation would be available in the future as credits against the Company's regular tax liability.\nAlthough AT&T has the right to reduce its ownership interest in the\nCompany (subject to certain contractual restrictions in the Intercompany Agreement between the Company and AT&T) and effect a Tax Deconsolidation at any time, AT&T has advised the Company that no decision has been made to reduce its ownership interest in the Company. AT&T has indicated to the Company that any decision by AT&T to reduce such ownership interest would be made, in the future on the basis of all the circumstances existing at such time including the effect of any such reduction on AT&T (including any benefit to AT&T from the removal from AT&T's consolidated balance sheet of the Company's indebtedness (and assets) in the event AT&T's interest in the common stock of the Company is reduced below 50%), the needs of AT&T, the success of the Company, stock market conditions and other factors.\nCredit Quality\nThe control of credit losses is an important element of the Company's business. The Company seeks to minimize its credit risk through diversification of its portfolio assets by customer, customer type, geographic location and maturity. The Company's financing activities have been spread across a wide range of equipment segments (e.g., telecommunications, general, data center, other data processing and transportation) and a large number of end-users located throughout the United States and, to a lesser extent, abroad.\nThe table below provides allowance for credit losses components by loan classification (as prescribed by the Securities and Exchange Commission, \"SEC\") where Lease Financing includes capital leases and rentals receivable on operating leases and Commercial and Financial includes finance receivables (collectively \"finance assets\"), as well as other key credit quality indicators. The breakdown of the allowance for credit losses at each year end reflects management's estimate of credit losses and may not be indicative of actual future charge-offs by loan classification.\n(Dollars in Thousands) 1994 1993 1992 1991 ___________________________________________________________________________ Balance at beginning of year: - - Lease Financing $102,760 $ 87,774 $ 74,106 $ 57,578 $ 31,886 - - Commercial and\nFinancial 57,059 36,187 19,861 17,791 5,982 ___________________________________________________________________________ Total 159,819 123,961 93,967 75,369 37,868 ___________________________________________________________________________ Additions Charged to Operations: - - Lease Financing 66,306 95,034 88,577 100,445 58,767 - - Commercial and Financial 14,582 28,644 23,138 8,190 16,741 ___________________________________________________________________________ Total $ 80,888 $123,678 $111,715 $108,635 $ 75,508 ___________________________________________________________________________\n1994 1993 1992 1991 ___________________________________________________________________________ Charge-offs: - Lease Financing $ 50,294 $ 61,517 $ 76,587 $ 76,422 $ 49,468 - Commercial and Financial 23,223 14,135 18,183 15,466 4,970 ___________________________________________________________________________ Subtotal 73,517 75,652 94,770 91,888 54,438 ___________________________________________________________________________ Recoveries: - Lease Financing 16,316 15,505 15,038 8,261 7,953 - Commercial and Financial 1,656 1,118 1,365 1,672 ___________________________________________________________________________ Subtotal 17,972 16,623 16,403 9,933 7,991 ___________________________________________________________________________ Net Charge-offs: - - Lease Financing 33,978 46,012 61,549 68,161 41,515 - - Commercial and Financial 21,567 13,017 16,818 13,794 4,932 ___________________________________________________________________________ Total 55,545 59,029 78,367 81,955 46,447 ___________________________________________________________________________\nTransfers and Other (a): - - Lease Financing (6,558) (34,036) (13,360) (15,756) 8,440 - - Commercial and Financial (2,176) 5,245 10,006 7,674 - ___________________________________________________________________________ Total (8,734) (28,791) (3,354) (8,082) 8,440 ___________________________________________________________________________\nBalance at end of year: - - Lease Financing 128,530 102,760 87,774 74,106 57,578 - - Commercial and Financial 47,898 57,059 36,187 19,861 17,791 ___________________________________________________________________________\nTotal $ 176,428 $159,819 $123,961 $ 93,967 $ 75,369 =========================================================================== Percentage of lease financing assets to total finance assets 80.6% 80.3% 79.9% 78.9% 78.3% =========================================================================== Percentage of commercial and financial assets to total finance assets 19.4% 19.7% 20.1% 21.1% 21.7% ===========================================================================\n1994 1993 1992 1991 ___________________________________________________________________________ Ratio of Net Charge-offs during the year to average finance assets (excluding operating leases) outstanding during the year: - Lease Financing 0.71% 1.21% 1.89% 2.35% 1.72% - Commercial and Financial 1.67% 1.13% 1.51% 1.34% 0.56% =========================================================================== Nonaccrual assets $120,494 $160,574 $151,562 $ 85,381 $ 80,156 =========================================================================== (a) Primarily includes transfers out of allowance for credit losses related to receivables securitized, transfers in of reserves related to businesses acquired and reclassifications.\nAT&T has agreed in the Operating Agreement to repurchase certain finance assets that go into default. Finance assets subject to such provisions were $243.0 million, $321.0 million and $282.4 million at December 31, 1994, 1993 and 1992, respectively. The Company believes that the remaining net investment in finance assets is adequately reserved for given the level of the Company's total allowance for credit losses.\nPortfolio credit performance indicators in 1994 have continued to show positive trends. Delinquency and charge-off levels have declined during 1994, and the provision for credit losses decreased $42.8 million, or 34.6%, compared with 1993. The allowance for credit losses as a percentage of portfolio assets at December 31, 1994 was 2.30% compared with 2.56% at December 31, 1993. At December 31, 1994 the allowance for credit losses was $176.4 million compared with $159.8 million at December 31, 1993. Nonaccrual assets at December 31, 1994 totalled $120.5 million compared with $160.6 million at December 31, 1993.\nThe ratio of net charge-offs to average commercial and financial assets increased in 1994 compared with 1993, while the allowance for credit losses decreased in 1994 compared with 1993 due to reserves established for specific assets (particularly in the media portfolio) that were subsequently charged off in 1994. As a result, in 1994 there were fewer assets that required specific reserves.\nAccounts are placed in nonaccrual status at 90 days past due or sooner if identified as a problem account. Revenue which would have been recorded in 1994 on nonaccrual assets had these assets been earning at the original contractual rate amounted to approximately $12.9 million. Revenue actually recognized in 1994 for assets in nonaccrual status at December 31, 1994 amounted to approximately $7.3 million.\nLease terms that are modified in the normal course of business, for which additional consideration is received or insignificant concessions are made, are accounted for as changes in a provision for a lease in accordance\nwith Statement of Financial Accounting Standards (\"SFAS\") No. 13, \"Accounting for Leases.\" During the past five years, the Company has had no significant earning finance assets that are required to be reported as a troubled debt restructuring pursuant to SFAS No. 15, \"Accounting by Debtors and Creditors for Troubled Debt Restructurings\".\nResidual Value Realization\nThe establishment and realization of residual values on leases are also important elements of the Company's business. Residual values are established upon acquisition and leasing of the equipment based upon the estimated value of the equipment at the end of the lease term. These estimates are derived by the Company from, among other things, market information on sales of used equipment, end-of-lease customer behavior and estimated obsolescence trends. The Company's risk management department, in conjunction with the management of the Company's business units, regularly reviews residual values, and if they have declined, adjustments are made that result in an immediate charge to income for capital leases and adjustments to depreciation expense for operating leases over the shorter of the useful life of the asset or the remaining term of the lease. In January 1994, the Company entered into a significant lease extension associated with mainframe computers leased to AT&T. This extension significantly reduced related mainframe residual exposure. At December 31, 1994 and 1993, total portfolio assets related to mainframe computers were $527.1 million, or 7.0%, and $687.0 million, or 11.3%, respectively. The related residual values of mainframe computers were $79.1 million and $232.2 million at December 31, 1994 and 1993, respectively.\nThe Company actively manages its residuals by working with lessees during the lease term to encourage lessees to extend their leases or upgrade and enhance their leased equipment, as appropriate, and by monitoring the various equipment industry segments, particularly the data center and other data processing industry segments, for obsolescence trends. The Company utilizes its asset management (including asset remarketing), engineering and other technical expertise to help manage its residual positions.\nIn 1994, 1993 and 1992, the Company recognized, in total revenue, amounts in excess of recorded residuals upon the re-lease, sale or other disposition by the Company of leased equipment.\nCompetition and Related Matters\nThe equipment leasing and finance industry is highly competitive. Participants in the industry compete through price (including the ability to control costs), risk management, innovation and customer service. Principal cost factors include the cost of funds, the cost of selling to or obtaining new end-user customers and vendors, and the cost of managing portfolios (including, for example, billing, collection, credit risk management, residual management, etc.). Adequate risk management is required to achieve satisfactory returns on investment and to provide appropriate pricing of finance products. The Company believes that innovation is necessary to compete in the industry, involving specialization in certain types of equipment, financial structuring for\nlarger transactions, utilization of alternative channels of distribution and optimization of tax treatment between owner and user. End-users of equipment generally desire transactions to be simple, flexible and customer-responsive.\nIn its leasing and financing operations and programs, the Company competes with captive or related leasing companies (such as General Electric Capital Corporation and IBM Credit Corporation), independent leasing companies (such as Comdisco, Inc.), certain banks engaged in leasing, lease brokers and investment banking firms that arrange for the financing of leased equipment, and manufacturers and vendors who lease their own products to customers. In addition, the Company competes with all banking and other financial institutions, manufacturers, vendors and others who extend or arrange credit for the acquisition of equipment and, in a sense, with the available cash resources of end-users (i.e., end-users may use their available cash resources to purchase for cash equipment that the Company may otherwise finance). Many of the competitors of the Company are large companies that have substantial capital, technological and marketing resources; some of these competitors are significantly larger than the Company and have access to capital at a lower cost than the Company.\nRecently there have been substantial changes in the equipment leasing and finance industry, including the sale or cessation of operations of certain large competitors of the Company and an apparent trend toward consolidation. While these developments may on balance be favorable for the Company's prospects, they are indicative of the strong competitive pressures on all participants in the industry, including the Company.\nThe Company's penetration rate for AT&T's sales of telecommunications equipment in the United States (i.e., the percentage of the dollar volume of such sales that the Company finances) was approximately 37% for the year ended December 31, 1994. The Company does not expect material increases in this penetration rate, and there can be no assurance that the existing rate will be maintained. Although, the Company has a lower penetration rate (approximately 22% for the year ended December 31, 1994) with respect to sales of AT&T Global Information Solutions products (data processing and related products, including personal computers, retail point-of-sale computers, automatic teller machines and bank transaction processing equipment), the penetration rate has increased in 1994 compared with 1993. Additionally, the Company has an insignificant penetration rate with respect to international sales of AT&T's network systems products (large telecommunications switches, cable products, cellular telephone equipment and microwave dishes and equipment), which sales the Company has been financing for a shorter period of time. Because the markets for financing these products are highly competitive and substantially different from the markets for financing telecommunications equipment in the United States, there can be no assurance that the penetration rates in these product areas will increase.\nIn addition to competition within the leasing and financing industry, competition experienced by AT&T and its affiliates' industries may adversely affect the Company because of the significance to the Company of its business with customers of AT&T and its affiliates. Those industries\nare highly competitive and subject to rapid changes in technology and customer needs. Many of AT&T and its affiliates' competitors are large companies that have substantial capital, technology and marketing resources.\nEmployees\nAT&T Capital has approximately 2,700 employees as of February 28, 1995, each of whom is referred to within the Company as a \"member\". Titles are generally not used internally. In general, the members function using a team approach, with business conducted on a collaborative rather than hierarchical basis. Management believes that its members are skilled and highly motivated and that the Company's ability to achieve its objectives depends upon their efforts and competencies. None of the Company's members are represented by a union. The Company believes that its relations with its members are good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's properties consist primarily of administrative offices and warehouses for the storage and refurbishment of equipment. The Company has its headquarters in Morristown, New Jersey, with its principal domestic offices and warehouses located in Parsippany, New Jersey; Framingham, Massachusetts; Bloomfield Hills, Michigan; Miamisburg, Ohio; Towson, Maryland; and Dallas, Texas. The Company's principal international offices are in London, England; Toronto, Canada; Hong Kong; Sydney, Australia; and Mexico City, Mexico. All these offices and warehouses are leased (some being subleased from AT&T or one of its affiliates), except for two buildings (of approximately 23,000 and 9,000 square feet) in Framingham, Massachusetts, owned by a subsidiary of the Company. Each of these two buildings is used for office space and storage and one is partially sublet to a nonaffiliated company. The Company considers its present locations suitable and adequate to carry on its current business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is not currently a party to any pending litigation nor is the Company aware of any threatened litigation which in the opinion of the Company's management will have a material adverse impact on the Company's financial condition or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS\nThere have been no matters submitted to a vote of security holders during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n(a) Market Information The principal market on which the common stock of the Company is traded is the New York Stock Exchange.\nQuarter Ended: Quarterly Stock Prices Dividends\ndeclared per share High Low\nDecember 31, 1993 $29.250 $22.375 $0.09 March 31, 1994 $27.000 $22.875 $0.09 June 30, 1994 $24.750 $21.625 $0.09 September 30, 1994 $24.375 $21.375 $0.09 December 31, 1994 $24.500 $19.750 $0.10\n(b) Holders As of February 28, 1995, there were 815 holders of record of the Company's common stock, including AT&T through Old Capital and Old Credit (which held 40,250,000 shares or approximately 86% of total shares outstanding).\n(c) Dividends It is anticipated that the Company will continue to pay regular quarterly dividends. The declaration of dividends and their amounts will be at the discretion of the Company's board of directors, and there can be no assurance that additional dividends will be declared.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Results of Operations Data for the years ended December 31, 1994, 1993, 1992, 1991 and 1990, as well as the Balance Sheet Data and Other Data at December 31, 1994, 1993, 1992 and 1991, are derived from the Consolidated Financial Statements of the Company at such dates and for such periods, which have been audited by Coopers & Lybrand L.L.P., independent accountants. The Results of Operations Data for the years ended December 31, 1989, 1988, 1987, 1986 and 1985, as well as the Balance Sheet Data and Other Data at December 31, 1990, 1989, 1988, 1987, 1986 and 1985, are derived from unaudited consolidated financial information. In management's opinion, the Company's unaudited consolidated financial statements at or for the years ended December 31, 1990, 1989, 1988, 1987, 1986 and 1985, include all adjustments (consisting of normal recurring adjustments) necessary for a fair presentation.\nThe selected financial data as presented under the \"Financial Highlights\" caption in the Company's Annual Report should be read in conjunction with \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the Consolidated Financial Statements and related notes thereto.\nFor the years ended December 31, (Dollars in thousands, 1994 1993 1992 1991 except per share amounts)______ ______ ______ ______ ______\nResults of Operations Data: Total revenue $1,384,079 $1,359,589 $1,265,526 $1,160,150 $ 881,183 Interest expense 271,812 236,335 252,545 275,650 262,646 Operating and administrative expenses 427,187 381,515 359,689 298,833 193,882 Provision for credit losses 80,888 123,678 111,715 108,635 75,508 Income before income taxes, extraordinary loss and cumulative effect on prior years of accounting change 173,614 138,040 114,875 82,559 70,891 Income before extra- ordinary loss, cumu- lative effect on prior years of accounting change and impact of tax rate change 100,336 83,911 73,572 54,199 47,755 Extraordinary loss - - - - - Cumulative effect on prior years of accounting change (1) - (2,914) - - - Impact of 1993 tax rate change (1) - (12,401) - - - Net income (1) 100,336 68,596 73,572 54,199 47,755 Earnings per share (1) 2.14 1.60 1.83 1.35 1.19 Earnings per share before tax charges (1), (2) 2.14 1.95 1.83 1.35 1.19 Dividends paid 17,338 4,216 49,632 55,512 34,423 Dividends per share (7) 0.37 0.09 - - - Return on average equity 10.5% 8.5% 11.4% 10.7% 11.0% Return on average assets 1.4% 1.1% 1.3% 1.1% 1.1% Return on average equity before tax charges (2) 10.5% 10.3% 11.4% 10.7% 11.0% Return on average assets before tax charges (2) 1.4% 1.4% 1.3% 1.1% 1.1% ___________________________________________________________________________ Balance Sheet Data, at December 31: Total assets 8,021,923 6,409,726 5,895,429 5,197,245 4,722,694 Total debt(3) 5,556,458 4,262,405 4,089,483 3,594,247 3,312,421 Total liabilities 7,013,705 5,485,283 5,158,808 4,647,979 4,257,186 Total shareowners' equity $1,008,218 $ 924,443 $ 736,621 $ 549,266 $ 465,508\nFor the years ended December 31, (Dollars in thousands, 1989 1988 1987 1986 except per share amounts)______ ______ ______ ______ ______\nResults of Operations Data: Total revenue $ 466,508 $ 319,029 $ 259,716 $ 191,284 $ 130,473 Interest expense 177,474 130,913 93,275 67,145 55,947 Operating and administrative expenses 118,430 90,528 76,752 55,211 28,198 Provision for credit losses 32,222 19,135 39,227 28,049 5,970 Income before income taxes, extraordinary loss and cumulative effect on prior years of accounting change 59,346 47,306 40,269 38,816 39,283 Income before extra- ordinary loss, cumu- lative effect on prior years of accounting change and impact of tax rate change 44,416 30,756 26,147 22,659 21,256 Extraordinary loss - - - (1,157) - Cumulative effect on prior years of accounting change (1) - - - - - Impact of 1993 tax rate change (1) - - - - - Net income (1) 44,416 30,756 26,147 21,502 21,256 Earnings per share (1) 1.10 0.76 0.65 0.53 0.53 Earnings per share before tax charges (1), (2) 1.10 0.76 0.65 0.53 0.53 Dividends paid 17,746 28,192 24,674 15,195 7,348 Dividends per share (7) - - - - - Return on average equity 12.7% 11.5% 11.8% 13.0% 16.8% Return on average assets 1.4% 1.2% 1.3% 1.7% 3.1% Return on average equity before tax charges (2) 12.7% 11.5% 11.8% 13.0% 16.8% Return on average assets before tax charges (2) 1.4% 1.2% 1.3% 1.7% 3.1% ___________________________________________________________________________ Balance Sheet Data, at December 31: Total assets 3,836,799 2,715,592 2,324,695 1,552,847 1,048,583 Total debt(3) 2,742,843 1,692,556 1,640,879 1,019,970 739,888 Total liabilities 3,435,792 2,417,280 2,074,198 1,360,870 911,006 Total shareowners' equity $ 401,007 $ 298,312 $ 250,497 $ 191,977 $ 137,577\nAt or for the years ended December 31, (Dollars in thousands, 1994 1993 1992 1991 except per share amounts)______ ______ ______ ______ ______\nOther Data: Net portfolio assets of the Company $7,484,798 $6,076,805 $5,600,741 $4,956,830 $4,513,280 Allowance for credit losses 176,428 159,819 123,961 93,967 75,369 Assets of others managed by the Company 2,659,526 2,795,663 1,374,354 649,014 313,981 Volume of equipment financed (4) 4,251,000 3,467,000 3,253,000 2,453,000 2,300,000 Ratio of earnings to fixed charges (5) 1.62 1.57 1.44 1.29 1.26 Ratio of total debt to shareowners' equity 5.51 4.61 5.55 6.54 7.12 Ratio of allowance for credit losses to net charge-offs 3.18 2.71 1.58 1.15 1.62 Ratio of charge-offs to net investment (6) 0.73% 0.95% 1.37% 1.62% 1.01% Ratio of allowance for credit losses to net investment (6) 2.30% 2.56% 2.17% 1.86% 1.64%\nAt or for the years ended December 31, 1989 1988 1987 1986 ______ ______ ______ ______ ______ Other Data: Net portfolio assets of the Company 3,228,609 2,529,834 2,094,593 1,440,626 948,307\nAllowance for credit losses 37,868 42,733 52,695 29,015 8,794 Assets of others managed by the Company 102,003 18,529 - - - Volume of equipment financed (4) $1,729,000 $1,489,000 $1,409,000 $1,101,000 $ 679,000 Ratio of earnings to fixed charges (5) 1.33 1.36 1.43 1.58 1.70 Ratio of total debt to shareowners' equity 6.84 5.67 6.55 5.31 5.38 Ratio of allowance for credit losses to net charge-offs 1.02 1.47 3.04 3.71 4.40 Ratio of charge-offs to net investment (6) 1.13% 1.13% 0.81% 0.53% 0.21% Ratio of allowance for credit losses to net investment (6) 1.16% 1.66% 2.45% 1.97% 0.92%\n(1) Net income and earnings per share for 1993 were adversely impacted by the federal tax rate increase to 35% ($12.4 million) and a cumulative effect on prior years of accounting change ($2.9 million). (See Note 10 to the Consolidated Financial Statements.) Net income and earnings per share without these charges for 1993 would have been $83.9 million and $1.95 per share, respectively. (2) The Company defines return on average equity before tax charges, return on average assets before tax charges and earnings per share before tax charges, as income before cumulative effect on prior years of accounting change and impact of tax rate change as a percentage of average equity, average assets and divided by average weighted shares outstanding, respectively. (3) Does not include certain interest free loans from AT&T to the Company under certain tax agreements, in aggregate outstanding principle amounts of $214.1 million, $188.6 million, $193.1 million, $206.6 million, $239.6 million, $232.6 million, $244.5 million, $209.0 million, $134.1 million and $56.9 million at December 31, 1994, 1993, 1992, 1991, 1990, 1989, 1988, 1987, 1986 and 1985, respectively. (4) Total principal amount of loans and total cost of equipment associated with finance and lease transactions recorded by the Company and the increase, if any, in outstanding inventory financing loans. (5) Earnings before income taxes, extraordinary loss and cumulative effect on prior years of accounting change plus the sum of interest on indebtedness and the portion of rentals representative of the interest factor divided by the sum of interest on indebtedness and the portion of rentals representative of the interest factor. A portion of the Company's indebtedness to AT&T does not bear interest. (6) Net investment includes net investment in finance receivables, capital leases and operating leases, prior to deduction of allowance for credit losses. (7) Prior to July 28, 1993, AT&T owned 100% of the Company's stock and therefore, dividends per share is not meaningful.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\n1994 versus 1993\nNet income for the year ended December 31, 1994, was $100.3 million, an increase of $31.7 million, or 46.3%, compared with 1993. Earnings per share for the year ended December 31, 1994, were $2.14, a 33.8% increase over the $1.60 reported in 1993. The increase in net income and earnings per share for 1994 compared with 1993 was impacted by the 1993 adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS No. 109\"), which resulted in a cumulative effect of accounting change of $2.9 million, and an $11.4 million charge to reflect the impact on deferred tax balances of the third quarter 1993 increase in the income tax rate to 35% from 34%. Absent the 1993 effect of adopting SFAS No. 109 and the impact of the increase in the income tax rate, net income increased $17.4 million, or 21.0%, and earnings per share increased $.21 per share. The increase principally reflected a higher average level of finance assets resulting from both origination volume and acquisitions of portfolios and businesses, and improved portfolio performance attributable to a stronger economy, which contributed to a lower provision for credit losses.\nFinance revenue of $120.8 million increased $13.4 million, or 12.4%, for 1994, compared with 1993, while the average earning finance receivable portfolio increased $165.3 million, or 15.8%, to $1,213.3 million for 1994. The increase in finance revenue due to the higher average earning finance receivables was offset by slightly lower average rates earned on the average 1994 portfolio compared with rates earned on the average portfolio. This is consistent with the Company's slightly lower average cost of borrowing for 1994, compared with 1993. (See interest expense discussion below.) A higher interest rate environment generally does not impact the margin on assets that are already recorded by the Company, since the Company employs a well-defined strategy to match fund assets with borrowings in order to limit interest rate risk. The effects of higher borrowing costs would be reflected in the pricing of new assets leased or financed. As the lower yielding earning assets (as well as the corresponding lower cost borrowings) are replaced with higher yielding assets, reflective of the current interest rate environment, the Company's average rates associated with recorded assets and associated borrowings will increase.\nCapital lease revenue of $477.9 million increased $85.9 million, or 21.9%, for 1994, compared with 1993, while the average earning capital lease portfolio increased $1,007.4 million, or 27.6%, to $4,653.3 million for 1994. $40.7 million of the increase in capital lease revenue for 1994, compared with 1993, is due to international acquisitions and expansion. The growth in capital lease revenue resulted from a higher level of assets (including an AT&T mainframe lease extension which resulted in the reclassification of the lease from an operating lease to a capital lease) but was partially offset by a decline in yields due to lower average rates associated with recorded assets of the Company. As noted above, this is\nconsistent with the Company's slightly lower cost of borrowing for 1994, compared with 1993. However, the Company has experienced some margin compression in certain equipment leasing portfolios as pricing in connection with some portfolios is less reactive to interest rate movements.\nRental revenue on operating leases of $475.4 million decreased $26.8 million, or 5.3%, for 1994, compared with 1993. Depreciation on operating leases of $313.6 million decreased $20.6 million, or 6.2%, for the year ended December 31, 1994, compared with the year ended December 31, 1993. These decreases were primarily due to the AT&T mainframe computer lease extension during the first quarter of 1994. The terms of the extension, which reduced the Company's mainframe residual exposure, resulted in the reclassification of the lease from an operating lease to a capital lease. The impact of this lease extension reduced rental revenue and depreciation by $75.3 million and $51.2 million, respectively, for the year ended December 31, 1994, compared with the year ended December 31, 1993. While domestic rental revenue and depreciation have decreased, rental revenue and depreciation related to the Company's international operations increased $13.0 million and $10.8 million, respectively, for the year ended December 31, 1994, compared with the year ended December 31, 1993. Rental revenue less associated depreciation (\"operating lease margin\") was $161.8 million or 34.0% of rental revenue for 1994, compared with $167.9 million, or 33.4%, for 1993.\nMarket forces, economic uncertainty and the transition to a new generation of mainframes and technological alternatives, have adversely impacted the market for mainframe computers. At December 31, 1994, $527.1 million, or 7.0%, of portfolio assets (with related residual values of $79.1 million) related to mainframe computers. This compares with $687.0 million, or 11.3%, (with related residual values of $232.2 million) at December 31, 1993. The Company regularly monitors its estimates of residual values for all leased equipment including mainframe computers and believes that its residual values are conservatively stated.\nFor the year ended December 31, 1994, revenue from sales of equipment purchased for resale of $126.6 million decreased $35.0 million, or 21.6%, compared with 1993. Cost of equipment sales of $117.0 million decreased $28.8 million, or 19.8%, for 1994, compared with 1993. Equipment sales revenue less associated cost of equipment sold (\"equipment sales margin\") was $9.6 million, or 7.6%, of equipment sales revenue for the year ended December 31, 1994. Equipment sales margin for the year ended December 31, 1993, was $15.7 million, or 9.7%, of equipment sales revenue. The decrease in the equipment sales margin as a percentage of related revenue for 1994, compared with 1993, reflects continued softness in the mainframe computer market, as well as increased competition. In 1993, the Company, was able to seize an opportunity to expand this activity to Europe. However, the European market has experienced increased competition in 1994. Therefore, the Company was not able to maintain its 1993 level of European sales and expects that future European activity in this area will be limited.\nOther revenue of $183.5 million decreased $13.0 million, or 6.6%, in 1994, compared with 1993. Other revenue consists mainly of sales of leased and off-lease equipment, gains on securitization of lease receivables and\nservice fee revenue. (See Note 6 to the Consolidated Financial Statements.) The decrease in other revenue for 1994, compared with 1993, is primarily due to lower securitization gains of $36.7 million and lower service fee revenue of $10.2 million recognized for the year ended December 31, 1994, compared with the year ended December 31, 1993. The decreases were partially offset by increased gains on sales of leased and off-lease equipment of $26.8 million.\nIn the fourth quarter of 1994, the Company securitized $259.1 million of lease receivables resulting in a gain of $14.8 million. Similar securitizations in the first and fourth quarters of 1993 of $561.9 million in lease receivables resulted in $51.5 million in gains. While the assets securitized in 1994 were down by 53.9%, the related gain decreased by 71.3%. The difference is primarily attributable to a higher discount rate used in the 1994 securitization due to the higher interest rate environment.\nUnder the terms of these securitizations, the Company is liable to the purchasers of such receivables for a limited amount of recourse granted by the Company to such purchasers. In the unlikely event that all such receivables became uncollectible at December 31, 1994, the Company's maximum exposure under limited recourse provisions granted to the purchasers of all securitized lease receivables was $353.1 million. In addition, the Company provides such purchasers with billing and collection and other services with respect to such securitized receivables.\nAt December 31, 1994, total assets managed by the Company on behalf of others were $2.7 billion compared with $2.8 billion at December 31, 1993. Of the total assets managed by the Company on behalf of others, 55.9% in 1994 and 59.2% in 1993, were assets managed on behalf of AT&T and its affiliates.\nA substantial part of the Company's total United States assets, revenue and net income are attributable to leasing and financing of AT&T equipment and to leasing and financing equipment to AT&T and its affiliates and employees of AT&T (together, the \"relationship with AT&T\"). Total United States assets associated with the relationship with AT&T were $3,297.8 million (or 46.1% of total United States assets) and $3,050.5 million (or 50.8% of total United States assets) at December 31, 1994 and 1993, respectively. Total United States revenue and net income associated with the relationship with AT&T was $589.7 million (or 47.2% of total United States revenue) and $92.7 million (or 88.7% of total United States net income) for 1994, and $625.2 million (or 49.1% of total United States revenue) and $92.8 million (or 98.0% of total United States net income, excluding the cumulative effect of accounting change and impact of the tax rate change) for 1993. The Company's United States non-AT&T businesses had assets of $3,850.9 million (or 53.9% of total United States assets) and $2,952.4 million (or 49.2% of total United States assets) at December 31, 1994 and 1993, respectively. The Company's United States non-AT&T businesses contributed revenue of $660.9 million (or 52.8% of total United States revenue) and net income of $11.9 million (or 11.3% of total United States net income) for 1994, and revenue of $649.4 million (or 50.9% of total United States revenue) and net income of $1.9 million (or 2.0% of\ntotal United States net income, excluding the cumulative effect of accounting change and the impact of the tax rate change) for 1993.\nAt December 31, 1994 and 1993, the total assets of the Company's international operations were $873.2 million (or 10.9% of total assets) and $406.9 million (or 6.3% of total assets), respectively. The total revenue of such operations for the years ended December 31, 1994, 1993 and 1992, were $133.5 million (or 9.6% of total revenue), $85.0 million (or 6.2% of total revenue) and $14.0 million (or 1.1% of total revenue), respectively. The profitability of the Company's international operations continued to improve in 1994. While such operations generated net losses of $4.2 million for the year ended December 31, 1994, the results compare favorably to the $9.4 million loss reported in 1993 and the $13.8 million loss reported in 1992. These losses reflected the fact that most of the Company's international operations are in the start-up phase, with revenue from such operations not covering operating costs and expenses. The Company's operations in the United Kingdom, which were established in 1991, were profitable for the first time in 1994.\nAlthough a substantial majority of the Company's international assets and revenues at and for the years ended December 31, 1994, 1993 and 1992, were attributable to the Company's non-AT&T businesses, a principal focus of such foreign operations is to serve foreign customers of AT&T and its affiliates as well as other vendors.\nTotal non-AT&T net income, revenue and total assets including both United States and international businesses for the year ended December 31, 1994, was $9.0 million (or 9.0% of total net income), $789.9 million (or 57.1% of total revenue) and $4,698.7 million (or 58.6% of total assets), respectively. For the year ended December 31, 1993, total non-AT&T net loss (before the impact of SFAS No. 109 and the impact of the 1993 increase in the federal tax rate), revenue and total assets including both United States and international businesses were $7.5 million, $731.6 million (or 53.8% of total revenue) and $3,337.1 million (or 52.1% of total assets), respectively.\nGrowth in the Company's portfolio assets caused the average borrowings outstanding to increase by 15.6%, or $650.2 million, to $4.8 billion, while the Company's interest expense increased 15.0%, or $35.5 million, to $271.8 million during the year ended December 31, 1994, compared with the year ended December 31, 1993. The increase in average borrowings caused interest expense to increase by approximately $37.0 million. This increase was partially offset by $1.5 million in lower interest expense due to lower average interest rates for the year ended December 31, 1994, compared with the year ended December 31, 1993. The Company's average interest rate on borrowings was 5.65% for the year ended December 31, 1994, compared with 5.68% for the year ended December 31, 1993. The recent increase in borrowing costs is reflected in new borrowings made by the Company. Generally, the Company's product pricing is impacted by interest rate movements. As interest rates change, product pricing is generally adjusted to compensate for the Company's higher or lower cost of funds. Although, in certain portfolios, the Company may not be able to increase its product pricing commensurate with, or simultaneous to, any future increases in its borrowing costs.\nOperating and administrative costs of $427.2 million increased $45.7 million, or 12.0%, in 1994, compared with 1993. The increase is primarily attributable to costs of approximately $30 million associated with the start-up of certain non-AT&T businesses, acquisitions and international expansion as well as costs of $10.9 million associated with the Company's new benefit and incentive plans for the year ended December 31, 1994, compared with the year ended December 31, 1993. Also contributing to the increase were higher costs associated with managing a higher level of finance assets. For 1994, operating and administrative costs to total year-end assets decreased to 5.3% compared with 6.0% for 1993. This decrease can be attributed to some of the Company's start-up businesses more fully utilizing their infrastructure, increased operating efficiencies and timing of assets financed. The Company's goal is to reach 4.5% or lower within the next few years.\nEffective January 1, 1993, the Company adopted SFAS No. 109. The change in accounting for income taxes resulted in a charge to earnings of $2.9 million in the first quarter of 1993 as the cumulative effect on prior years of this change, but had no effect on cash flows. The majority of this charge related to establishing a valuation allowance against certain deferred tax assets relating to state and local income taxes.\nThe effective income tax rate was 42.2% and 48.2% for 1994 and 1993, respectively. The decrease was primarily due to the effect of the retroactive tax rate increase recorded in the third quarter of 1993. Due to the increase in the federal statutory corporate income tax rate from 34% to 35% signed into law in August 1993, the Company recorded an additional charge to the provision for income taxes of $12.4 million in 1993. The $12.4 million charge includes the impact of increasing previously recorded deferred tax liabilities by $11.4 million. (See Note 10 to the Consolidated Financial Statements.) Excluding the $11.4 million impact of increasing previously recorded deferred tax liabilities to reflect the increase in the federal statutory corporate income tax rate for 1993, the effective tax rate would have been 39.9%. The increase in the effective tax rate for 1994, compared with the adjusted effective tax rate for 1993, was due to increased non-deductible goodwill amortization expense related to goodwill associated with assets that were sold during the second quarter of 1994 as well as various other increases.\nSee \"Credit Quality\" below for a discussion of the provision for credit losses.\n1993 versus 1992\nIncome before income taxes and cumulative effect of an accounting change for the year ended December 31, 1993, of $138.0 million increased $23.2 million, or 20.2%, compared with the year ended December 31, 1992. Total revenue of $1,359.6 million for the year ended December 31, 1993, grew $94.1 million, or 7.4%, compared with the year-earlier period, while total expenses of $1,221.5 million (excluding the provision for income taxes and cumulative effect of accounting change) increased $70.9 million, or 6.2%. The impact of the federal statutory tax rate increase from 34% to 35% in 1993 of $12.4 million (of which $11.4 million related to the impact of adjusting deferred tax balances) adversely affected net income for 1993,\ncompared with 1992. Also in the first quarter of 1993, the Company adopted SFAS No. 109, resulting in a charge to earnings of $2.9 million. Without these charges, net income for the year ended December 31, 1993, would have been $83.9 million or $1.95 per share, a 14.1% increase over net income in the prior year. Reported net income for 1993 was $68.6 million, or $1.60 per share.\nThe Company's increase in earnings before income taxes for the year ended December 31, 1993, compared with 1992, principally resulted from a higher average level of finance assets, increased gains on end of lease activity, lower rates on borrowings and higher servicing fees for managed portfolios.\nFinance revenue of $107.4 million decreased $11.8 million, or 9.9%, for 1993, compared with 1992, while the average finance receivable portfolio increased $73.0 million, or 7.2%, over the same period. The positive revenue variance generated by the increased asset level was more than offset by a decline in rates charged to customers that reflected the lower interest rate environment of 1993, compared with 1992.\nCapital lease revenue of $392.0 million increased $10.8 million, or 2.8%, for 1993, compared with 1992, while the average capital lease portfolio increased 14.8%. The growth in capital lease revenue resulted from a higher level of assets but was partially offset by a decline in product pricing reflective of the lower interest rate environment.\nRental revenue on operating leases of $502.1 million increased $31.1 million, or 6.6%, for 1993, compared with 1992. This increase was due to increased rates charged to customers and to a slight increase in the average net investment in operating leases for 1993, compared with 1992. Depreciation on operating leases of $334.2 million increased $28.7 million, or 9.4%, for 1993, compared with 1992. Rental revenue less associated depreciation (\"operating lease margin\") was $167.9 million, or 33.4%, of rental revenue for 1993, compared with $165.5 million, or 35.1%, for 1992. The operating lease margin for 1993, was somewhat lower than the operating lease margin for 1992, due to lower estimated residual value assumptions of equipment in both the primary and secondary markets, particularly for computers, resulting in higher depreciation expense.\nMarket forces, economic uncertainty and the transition to a new generation of mainframes and technological alternatives, have impacted the market for mainframe computers. At December 31, 1993, $687.0 million, or 11.3%, of portfolio assets, the majority of which were operating leases, related to mainframe computers. This compares with $791.9 million, or 14.1%, at December 31, 1992. The Company regularly monitors its estimates of residual values for all leased equipment including mainframe computers and believes that its residual values are conservatively stated. As a result of the Company's analysis of developments affecting the major mainframe computer manufacturers and their pricing policies, and technological advances in the computer industry (e.g., advances made in client server architectures), declines in the future residual value of certain mainframe computers were identified during 1993. The effect of this change increased depreciation expense by $2.5 million in 1993.\nFor the year ended December 31, 1993, revenue from sales of equipment purchased for resale increased $28.8 million, or 21.7%, to $161.5 million compared with 1992. Cost of equipment sales of $145.8 million increased $24.7 million, or 20.3%, for 1993, compared with 1992. During 1993, the Company expanded this activity to Europe which caused the increase from the prior year.\nIn 1993 and 1992, the Company's total United States revenue associated with financing provided for customers of AT&T and its affiliates was $423.3 million, or 33.2%, of total United States revenue, and $410.5 million, or 32.8%, of total United States revenue, respectively. United States revenue generated from AT&T and its affiliates and employees of AT&T and its affiliates as end-users of equipment was $201.9 million, or 15.9%, and $185.2 million, or 14.8%, in 1993 and 1992, respectively, of total United States revenue. Therefore, $625.2 million, or 49.1%, in 1993 and $595.7 million, or 47.6%, in 1992, of the Company's total United States revenue was associated with the Company's relationship with AT&T.\nOther revenue of $196.5 million grew $35.1 million, or 21.8%, in 1993, compared with 1992. Other revenue consists mainly of gains on securitization of lease receivables, sales of leased and off-lease equipment and service fee revenue. (See Note 6 to the Consolidated Financial Statements.) The increase in other revenue for 1993, compared with 1992, is primarily due to increased gains on sales of leased and off-lease equipment of $9.8 million and increased service fee revenue of $18.8 million, of which $18.4 million relates to service fees from AT&T for managing certain assets on behalf of AT&T.\nIn the first and fourth quarters of 1993, the Company securitized $151.9 million and $410.0 million of lease receivables, respectively, resulting in a gain of $51.5 million. A similar securitization in the fourth quarter of 1992, resulted in a $52.4 million gain.\nUnder the terms of these securitizations, the Company is liable to the purchasers of such receivables for a limited amount of recourse granted by the Company to such purchasers. In the unlikely event that all such receivables became uncollectible at December 31, 1993, the Company's maximum exposure under limited recourse provisions granted to the purchasers of all securitized lease receivables was $347.3 million. In addition, the Company provides such purchasers with billing and collection and other services with respect to such securitized receivables.\nAt December 31, 1993, total assets managed by the Company on behalf of others were $2.8 billion compared with $1.4 billion at December 31, 1992. Included in assets managed at December 31, 1993, was $1.4 billion of lease finance assets retained by AT&T as a result of the Restructuring. These assets consist principally of equity interests in project finance transactions and leveraged leases of commercial aircraft. Of the total assets managed by the Company, 59.2% in 1993, and 21.6% in 1992, were assets managed on behalf of AT&T and its affiliates.\nThe Company continued to benefit from lower interest rates on its borrowings. Interest expense of $236.3 million decreased $16.2 million, or 6.4%, in 1993, compared with 1992. The decrease was the result of a lower\ncost of funds in 1993, compared with 1992. The lower cost of funds was partially offset by an increase in average borrowings for 1993, compared with 1992.\nOperating and administrative costs of $381.5 million increased $21.8 million, or 6.1%, in 1993, compared with 1992. The increase in operating and administrative costs for 1993, compared with 1992, reflected an increase of $11.4 million in the Company's cost of operations in Europe and Canada over 1992. The Company's European and Canadian operations generated an aggregate net loss of $9.4 million for 1993, compared with an aggregate net loss of $13.8 million for 1992.\nThe Company also incurred an additional $6.7 million in operating and administrative costs related to start-up businesses such as Small Business Administration (\"SBA\") lending (which commenced operations late in 1992) for 1993, compared with 1992. The balance of the increase in operating and administrative expenses for the year ended December 31, 1993, compared with the year ended December 31, 1992, is due primarily to costs associated with managing a higher level of finance assets.\nEffective January 1, 1993, the Company adopted SFAS No. 109. The change in accounting for income taxes resulted in a charge to earnings of $2.9 million, in the first quarter of 1993, as the cumulative effect on prior years of this change, but had no effect on cash flows. The majority of this charge related to establishing additional net deferred tax credits relating to state and local income taxes.\nThe effective income tax rate was 48.2% and 36.0% for 1993 and 1992, respectively. The increase was primarily due to the effect of the retroactive 1993 tax rate increase recorded in the third quarter of 1993. Due to the increase in the federal statutory corporate income tax rate from 34% to 35% signed into law in August 1993, the Company recorded an additional charge to the provision for income taxes of $12.4 million in 1993. The $12.4 million charge includes the impact of increasing previously recorded deferred tax liabilities by $11.4 million. (See Note 10 to the Consolidated Financial Statements.)\nSee \"Credit Quality\" below for a discussion of the provision for credit losses.\nFINANCIAL CONDITION\nPortfolio assets (investment in finance receivables, capital leases and operating leases), net of reserves, increased by $1,408.0 million, or 23.2%, at December 31, 1994, to $7,484.8 million compared with December 31, 1993, principally due to growth in the Company's international lease portfolio and the domestic automobile lease portfolio, as well as a lower level of assets securitized in 1994.\nDuring January 1994, the Company purchased Australian Guarantee Corporation Finance (H.K.) Limited (\"A.G.C. Finance\"), a subsidiary of Australian Guarantee Corporation Limited and A.G.C. Overseas Holdings Limited. A.G.C. Finance, renamed The Capita Corporation Hong Kong Limited,\nis a Hong Kong based automobile and equipment financing and leasing company which also provides commercial and personal loans. Also in January 1994, the Company purchased Avis Leasing, a division of AvisCar, which provides automobile fleet leasing and supporting service programs to small and mid-size commercial and corporate customers in Canada. The total assets acquired through these two international acquisitions were approximately $240 million.\nAdditionally, during 1994, the Company opened offices in Mexico and Australia. The Company has from time to time investigated potential opportunities to make acquisitions abroad, and the Company may open additional foreign offices on a limited basis either directly or through acquisition.\nAs a result of the above mentioned acquisitions, the Company's international assets (excluding cross border transactions) at December 31, 1994, grew to 10.9% of total assets, up from 6.3% at December 31, 1993.\nIn January 1995, the Company acquired the vendor leasing and finance companies of Banco Central Hispano and certain of its affiliates (\"CFH Leasing International\") located in the United Kingdom, Germany, France, Italy, Belgium, the Netherlands and Luxembourg. CFH Leasing International provides financial services to equipment manufacturers and vendors. With offices throughout western Europe, it serves approximately 4,600 customers and had approximately $540 million in assets at the time of acquisition.\nThe net investment in finance receivables increased by $255.6 million, or 21.4%, at December 31, 1994, to $1,452.9 million compared with December 31, 1993, due primarily to increases in the Company's telecommunications systems portfolio, small business lending portfolio and the acquisition of A.G.C. Finance.\nThe net investment in capital leases increased by $1,229.1 million, or 31.5%, at December 31, 1994, to $5,129.3 million compared with December 31, 1993. This increase was primarily due to an increase in the international lease portfolio and the domestic automobile lease portfolio, as well as to a lower level of assets securitized in the Company's small ticket business equipment lease portfolio in 1994. Also contributing to the increase was the AT&T lease extension in the first quarter of 1994. The terms of the extension, which reduced the Company's mainframe residual exposure, resulted in a reclassification of the mainframe lease from an operating lease to a capital lease. The net investment recorded in capital leases at December 31, 1994, with respect to this lease, was approximately $150 million.\nThe net investment in operating leases decreased by $76.8 million, or 7.8%, at December 31, 1994, to $902.5 million compared with December 31, 1993. The decline was primarily due to the AT&T lease extension during the first quarter of 1994, discussed above, but was somewhat offset by increases in the international lease portfolio and the domestic automobile lease portfolio.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company generates a substantial portion of its funds from lease and rental receipts, but is also highly dependent upon external financing, including the issuance of commercial paper and medium-term notes in public markets and, to a lesser extent, privately placed asset-backed financings (or securitizations). Standard & Poor's Corporation, Moody's Investors Service, Inc., and Duff & Phelps Credit Rating Co. have rated the Company's senior long-term debt A, A3 and A, respectively, and have rated the Company's commercial paper A-1, P-1 and D-1, respectively.\nFunds required to support the Company's operations during 1994, were derived internally primarily from principal and interest collections from customers (which include realization of cash from residual values through remarketing activities), and externally from issuances of commercial paper, and issuances of medium-term debt. The Company estimates that, under existing lease and loan terms, gross cash receipts of approximately $8.1 billion may be generated in the future.\nIn 1994, the Company issued commercial paper of $29.0 billion, issued medium-term notes of $2.1 billion and made commercial paper repayments of $28.4 billion and medium-term note repayments of $1.4 billion. In 1993, the Company issued commercial paper of $17.0 billion and made commercial paper repayments of $17.4 billion, and issued medium-term notes of $1.2 billion and repaid medium-term notes of $632.6 million. Additionally, the Company borrowed and repaid approximately $5.0 billion from AT&T on a short-term basis during 1993.\nDuring 1994 and 1993, principal collections from customers and proceeds from securitized receivables of approximately $3.8 billion and $4.1 billion, respectively, were received. These receipts were primarily used for financing portfolio assets (including purchases of finance asset portfolios and businesses) of approximately $5.5 billion in 1994, and $5.1 billion in 1993.\nIn conjunction with the Hong Kong acquisition, the Company assumed $106.1 million of A.G.C. Finance's debt, of which $93.0 million was outstanding at December 31, 1994.\nThe Company has paid quarterly dividends every quarter since the fourth quarter of 1993, its first full quarter of operations after its initial public offering. On January 20, 1995, the Company's board of directors declared a quarterly dividend of ten cents per share. The dividend was paid on February 28, 1995, to shareowners of record as of February 10, 1995.\nDuring 1993, the Company's borrowings consisted primarily of loans from AT&T, until July 14, 1993, when the Company established its own commercial paper facility. The Company filed a shelf registration with the Securities and Exchange Commission (\"SEC\") on July 26, 1993, registering $2.5 billion of debt securities. Borrowing under this shelf registration commenced on August 5, 1993. In July 1994, the Company registered with the SEC an additional $2.5 billion of debt securities (including medium-term notes) and warrants to purchase debt securities, currency warrants, index\nwarrants and interest rate warrants. At December 31, 1994, $2,474.7 million of medium-term debt was outstanding under these debt registrations.\nAlso in July 1994, the Company re-established credit facilities of $2.0 billion. These facilities, negotiated with a consortium of 32 lending institutions, support the commercial paper issued. At December 31, 1994, these facilities were unused. The Company also has available local lines of credit to meet local funding requirements in Hong Kong, Canada, the United Kingdom and Australia of approximately $134 million, of which approximately $29 million was unused at December 31, 1994.\nOn August 4, 1993, the Company received $117.2 million of proceeds (excluding costs of the transaction of approximately $1.7 million) from stock offerings. (See Notes 1 and 8 to the Consolidated Financial Statements.) These proceeds were used to reduce the amount of the Company's outstanding commercial paper and loans from AT&T otherwise required to be \"rolled over\" (i.e., refinanced at maturity with the proceeds of newly-incurred indebtedness for borrowed money).\nThe Company has, from time to time, borrowed funds directly from AT&T, including on an interest free basis pursuant to tax agreements. These interest free loans amounted to $214.1 million at December 31, 1994. These sources of funds would not be available if the Company were to cease being a member of AT&T's consolidated group for federal income tax purposes.\nThe Company anticipates obtaining all necessary external financing through issuances of commercial paper, privately placed asset-backed financings (or securitizations), available lines of credit for certain foreign operations and debt registrations.\nFuture financing is contemplated to be arranged through a large number of financial institutions as necessary to meet the Company's capital and other requirements with the timing of issue, principal amount and form depending on the Company's needs, prevailing market and general economic conditions.\nThe Company considers its current financial resources, together with the debt facilities referred to above, and estimated future cash flows, to be adequate to fund the Company's future growth and operating requirements.\nASSET AND LIABILITY MANAGEMENT\nAT&T Capital's asset and liability management (\"ALM\") process takes a coordinated approach to the management of interest rate and foreign currency risks. The Company's overall strategy is to match the average maturities of its borrowings with the average cash flows of its portfolio assets, as well as the currency denominations of its borrowings with those of its portfolio assets, in a manner intended to reduce the Company's interest rate and foreign currency exposure. The following discussion\ndescribes certain key elements of this process, including AT&T Capital's use of derivatives to manage risk.\nMatch Funding\nAT&T Capital generally matches the duration and maturity structure of its liabilities to that of its portfolio assets. The Company routinely projects the expected future cash flows related to its current portfolio assets. Based on these projections, the Company is able to match the maturity and duration of its debt with that of its assets. The cash flow projections incorporate assumptions about customer behavior such as prepayments, refinancings and charge-offs. The assumptions are based on historical experience with the Company's individual markets and customers and are continually monitored and updated as markets and customer behaviors change, to reflect current customer preferences, competitive market conditions, portfolio growth rates and portfolio mix.\nInterest Rate Risk and Currency Exchange Risk\nAT&T Capital actively manages interest rate risk to protect the Company's margins on existing transactions. Interest rate risk is the risk of earnings volatility attributable to changes in interest rates. The Company routinely analyzes its portfolio assets and strives to match floating rate assets with floating rate debt and fixed rate assets with fixed rate debt. The Company generally achieves a matched position through issuances of commercial paper and medium-term notes, as well as through the use of interest rate swaps. The Company does not speculate on interest rates, but rather seeks to mitigate the possible impact of interest rate fluctuations. This is a continual process due to prepayments, refinancings, non-performing loans, as well as other portfolio dynamics, and therefore, interest rate risk can be significantly limited but never fully eliminated. Additionally, the Company enters into foreign exchange contracts and participates in the currency swap market to mitigate its exposure to assets and liabilities denominated in foreign currencies and to meet local funding requirements. The Company expects to enter into more foreign exchange contracts and currency swaps in 1995, as a result of the January 1995 acquisition of CFH Leasing International, described above.\nUsing Derivatives to Manage Interest Rate and Currency Risk\nAT&T Capital uses derivatives to match fund its portfolio and thereby manage interest rate and currency risk. Derivatives can be customized in terms of duration and interest rate basis (i.e., fixed or floating). Derivatives used by the Company are operationally efficient to arrange and maintain. Whether AT&T Capital issues medium-term notes, on which it pays a fixed rate, or issues floating rate debt and utilizes interest rate swaps, on which it generally pays a fixed rate and receives a floating rate, the Company's interest rate risk position can be equally well managed. However, it is the interplay between liquidity, capital, portfolio characteristics, and economic and market conditions which will determine the final mix of medium-term notes, commercial paper and swaps\n(or other derivatives) used to manage interest rate risk. Notes 7 and 13 to the Consolidated Financial Statements provide more details regarding the Company's debt portfolio and interest rate and currency swap and foreign exchange contract positions.\nDerivative Credit Risk\nThe notional amount of derivative contracts does not represent direct credit exposure. Rather, credit exposure may be defined as the market value of the derivative contract and the ability of the counterparty to perform its payment obligation under the agreement. The majority of the Company's interest rate swaps require AT&T Capital to pay a fixed rate and receive a floating rate. Therefore, this risk is reduced in a declining interest rate environment as the Company is generally in a payable position, and is increased in a rising interest rate environment as the Company is generally in a receivable position. The Company seeks to control the credit risk of its interest rate swap agreements through credit approvals, exposure limits and monitoring procedures. All swap agreements are with major money center banks and intermediaries rated \"A\" or better by national rating agencies, with the majority of the Company's counterparties being rated \"AA\" or better.\nThere were no past due amounts or reserves for credit losses at December 31, 1994, related to derivative transactions, nor were there any charge-offs during the three years ended December 31, 1994.\nDebt to Equity\nTotal debt to equity at December 31, 1994, of 5.51 increased from 4.61 at December 31, 1993. This increase was due to the deployment of the proceeds of the initial public offering of the Company's common stock in the third quarter of 1993. As a result of the January 1995 acquisition of CFH Leasing International, leverage increased to approximately 6.00.\nCREDIT QUALITY\nThe control of credit losses is an important element of the Company's business. The Company seeks to minimize its credit risk through diversification of its portfolio assets by customer, customer type, geographic location and maturity. The Company's financing activities have been spread across a wide range of equipment segments (e.g., telecommunications, general, data center, other data processing, and transportation) and a large number of customers located throughout the United States and, to a lesser extent, abroad.\nPortfolio credit performance indicators continued to improve in 1994. Delinquency and charge-off levels declined during 1994, while nonaccrual assets at December 31, 1994, totalled $120.5 million compared with $160.6\nmillion at December 31, 1993. This lower level of nonaccrual assets, charge-off levels and delinquency, resulted in a decrease in the Company's provision for credit losses of $42.8 million, or 34.6%, to $80.9 million, compared with 1993. For 1994, charge-offs to investment in portfolio assets improved to .73%, compared with .95% for 1993. As a result of the improved credit performance indicators and the strong economy, the allowance for credit losses was 2.30% of the Company's investment in portfolio assets at December 31, 1994, compared with 2.56% at December 31, 1993. At December 31, 1994, the allowance for credit losses was $176.4 million, compared with $159.8 million at December 31, 1993.\nThe Company maintains an allowance for credit losses at an amount based on a detailed analysis of delinquencies and problem portfolio assets, an assessment of overall risk and management's evaluation of probable losses in the portfolio as a whole given its diversification, and a review of historical loss experience. Management also takes into consideration the potential impact of existing and anticipated economic conditions.\nThe Company's management believes that the diversity and strength of its portfolio assets, along with vigilant attention to risk management, position it to deal effectively with a changing global economic environment.\nRECENT PRONOUNCEMENTS\nFor a discussion of the effect on the Company of SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\" and SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\", each of which was recently issued by the Financial Accounting Standards Board (\"FASB\"), see Note 4 to the Consolidated Financial Statements included herein.\nThe FASB also recently issued SFAS No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\", which was effective for the Company's December 31, 1994, financial statements. SFAS No. 119 required or suggested certain disclosures with respect to derivative financial instruments. (See Note 13 to the Consolidated Financial Statements included herein.)\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nAT&T CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS ___________________________________________________________________________\nAt December 31, 1994 (Dollars in Thousands) ___________________________________________________________________________\nASSETS: Cash and cash equivalents (Note 2) $ 54,464 $ - Net investment in finance receivables (Note 4) 1,452,947 1,197,303 Net investment in capital leases (Notes 4 and 12) 5,129,326 3,900,224 Net investment in operating leases, net of accumulated depreciation of $567,398 in 1994 and $573,639 in 1993 (Notes 5 and 12) 902,525 979,278 Deferred charges and other assets (Notes 2, 6 and 12) 482,661 332,921 ___________________________________________________________________________\nTotal Assets 8,021,923 6,409,726 ___________________________________________________________________________\nLIABILITIES AND SHAREOWNERS' EQUITY: LIABILITIES: Short-term notes, less unamortized discounts of $4,619 in 1994 and $3,018 in 1993 (Note 7) 2,176,877 1,546,562 Deferred income taxes (Notes 2 and 10) 555,287 445,613 Income taxes and other payables (Notes 2 and 10) 545,270 479,265 Payables to AT&T and affiliates (Notes 10 and 12) 356,690 298,000 Due to AT&T and affiliates for borrowings (Notes 7 and 12) - 35,290 Medium- and long-term debt (Note 7) 3,379,581 2,680,553 Commitments and contingencies (Notes 12 and 13) ___________________________________________________________________________\nTotal Liabilities $7,013,705 $5,485,283 ___________________________________________________________________________\n(Continued on next page)\nAT&T CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued) ___________________________________________________________________________\nAt December 31, 1994 (Dollars in Thousands) ___________________________________________________________________________\nSHAREOWNERS' EQUITY (Notes 1, 8 and 11): Common stock, one cent par value: Authorized 100,000,000 shares, issued and outstanding, 46,962,439 shares in 1994 and\n46,867,022 in 1993 $ 470 $ Additional paid-in capital 782,785 780,591 Recourse loans to senior executives (19,651) (17,788) Foreign currency translation adjustments (2,158) (2,603) Retained earnings 246,772 163,774 ___________________________________________________________________________\nTotal Shareowners' Equity 1,008,218 924,443 ___________________________________________________________________________\nTotal Liabilities and Shareowners' Equity $8,021,923 $6,409,726 ___________________________________________________________________________\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAT&T CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME ___________________________________________________________________________\nFor the Years Ended December 31, 1994 1993 (Dollars in Thousands, except per share amounts) ___________________________________________________________________________\nREVENUE: Finance revenue (Notes 2 and 4) $ 120,800 $ 107,436 $ 119,231 Capital lease revenue (Notes 2, 4 and 12) 477,875 391,985 381,141 Rental revenue on operating leases (includes $79,573 in 1994, $158,592 in 1993, and $143,012 in 1992 from AT&T and affiliates) (Notes 2, 5 and 12) 475,375 502,132 471,039 Equipment sales (includes $18,689 in 1992 from AT&T and affiliates) (Note 12) 126,567 161,529 132,709 Other revenue, net (Notes 6 and 12) 183,462 196,507 161,406 ___________________________________________________________________________\nTotal Revenue 1,384,079 1,359,589 1,265,526 ___________________________________________________________________________\nEXPENSES: Interest (includes $21,602 in 1993 and $27,879 in 1992 to AT&T and affiliates) (Notes 2, 7, 12 and 13) 271,812 236,335 252,545 Operating and administrative (includes $24,729 in 1994, $44,775 in 1993, and $37,457 in 1992 to AT&T and affiliates) (Notes 2, 11 and 12) 427,187 381,515 359,689 Depreciation on operating leases (Notes 2 and 5) 313,583 334,191 305,523 Cost of equipment sales (Note 12) 116,995 145,830 121,179 Provision for credit losses (Note 2) 80,888 123,678 111,715 ___________________________________________________________________________\nTotal Expenses 1,210,465 1,221,549 1,150,651 ___________________________________________________________________________\nIncome before income taxes and cumulative effect on prior years of accounting change 173,614 138,040 114,875 Provision for income taxes (Notes 2 and 10) 73,278 66,530 41,303 ___________________________________________________________________________ Income before cumulative effect on prior years of accounting change 100,336 71,510 73,572 Cumulative effect on prior years of accounting change (Notes 2 and 10) - (2,914) - ___________________________________________________________________________\nNET INCOME $ 100,336 $ 68,596 $ 73,572 ___________________________________________________________________________ (Continued on next page)\nAT&T CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Continued) ___________________________________________________________________________\nFor the Years Ended December 31, 1994 1993 (Dollars in Thousands, except per share amounts) ___________________________________________________________________________\nEarnings per common share and common\nshare equivalent (Note 8): Income before cumulative effect on prior years of accounting change $ 2.14 $ 1.67 $ 1.83 Cumulative effect on prior years of accounting change - (.07) - ___________________________________________________________________________\nNet Income Per Share $ 2.14 $ 1.60 $ 1.83 ___________________________________________________________________________\nWeighted average shares outstanding (thousands): 46,906 43,002 40,250 ___________________________________________________________________________\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAT&T CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS' EQUITY ___________________________________________________________________________\nFor the Years Ended December 31, 1994 1993 1992* (Dollars in Thousands) ___________________________________________________________________________ Common stock Balance at beginning of year $ 469 $ 403 $ 403 Stock issuances: Public offering (Note 1) - 58 - Pension and benefit plans (Note 11) 1 8 - ___________________________________________________________________________ Balance at end of year 470 469 ___________________________________________________________________________ Additional paid-in capital Balance at beginning of year 780,591 638,371 473,409 Capital contributions - 9,106 164,962 Stock issuances: Public offering (Note 1) - 114,482 - Pension and benefit plans (Note 11) 2,194 18,632 - ___________________________________________________________________________ Balance at end of year 782,785 780,591 638,371 ___________________________________________________________________________ Recourse loans to senior executives (Note 11) Balance at beginning of year (17,788) - - Loans made (2,760) (17,788) - Loans repaid 897 - - ___________________________________________________________________________ Balance at end of year (19,651) (17,788) - ___________________________________________________________________________ Foreign currency translation adjustments Balance at beginning of year (2,603) (1,547) - Unrealized translation gain (loss) 445 (1,056) (1,547) ___________________________________________________________________________ Balance at end of year (2,158) (2,603) (1,547) ___________________________________________________________________________ Retained earnings Balance at beginning of year 163,774 99,394 75,454 Net income 100,336 68,596 73,572 Cash dividends paid (Note 8) (17,338) (4,216) (49,632) ___________________________________________________________________________ Balance at end of year 246,772 163,774 99,394 ___________________________________________________________________________ Total Shareowners' Equity $1,008,218 $924,443 $736,621 ___________________________________________________________________________\n* Certain amounts have been reclassified to conform to the 1994 and 1993 presentation.\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nAT&T CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS ___________________________________________________________________________\nFor the Years Ended December 31, 1994 1993 1992* (Dollars in Thousands) ___________________________________________________________________________ CASH FLOW FROM OPERATING ACTIVITIES: Net income $ 100,336 $ 68,596 $ 73,572 Noncash items included in income: Depreciation and amortization 353,954 384,933 308,419 Deferred taxes 106,384 43,419 111,973 Provision for credit losses 80,888 123,678 111,715 Gain on receivables securitizations (14,799) (51,496) (52,887) Cumulative effect on prior years of accounting change - 2,914 - Increase in receivables from AT&T and affiliates - - (66) (Increase) decrease in deferred charges and other assets (41,837) 78,174 (97,156) Increase (decrease) in income taxes and other payables 3,068 72,451 (24,607) Increase (decrease) in payables to AT&T and affiliates (10,257) (1,340) 7,523 ___________________________________________________________________________ Net Cash Provided by Operating Activities 577,737 721,329 438,486 ___________________________________________________________________________ CASH FLOW FROM INVESTING ACTIVITIES: Acquisitions of fixed assets, net (6,622) (6,555) (15,849) Purchase of businesses, net of cash acquired (234,375) - (28,504) Purchase of finance asset portfolios (217,939) (100,589) (228,512) Financings and lease equipment purchases (5,031,041) (5,027,031) (4,782,911) Principal collections from customers, net of amounts included in income 3,572,112 3,621,189 3,457,271 Cash proceeds from receivables securitizations 203,934 507,160 612,709 Increase in investments, net - - ___________________________________________________________________________ Net Cash Used for Investing Activities $(1,713,931) $(1,005,826) $ (985,777) ___________________________________________________________________________\n(Continued on next page)\nAT&T CAPITAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) ___________________________________________________________________________ For the Years Ended December 31, 1994 1993 1992* (Dollars in Thousands)\n___________________________________________________________________________ CASH FLOW FROM FINANCING ACTIVITIES: Increase (decrease) in short-term notes, net $ 523,370 $ (355,463) $ 62,648 Additions to medium- and long-term debt 2,142,993 1,161,638 1,317,618 Repayments of medium- and long-term debt (1,448,470) (632,563) (388,903) Increase (decrease) in payables to AT&T and affiliates (9,897) 9 (559,402) Capital contributions from AT&T - - 164,962 Dividends paid (17,338) (4,216) (49,632) Proceeds from sale of common stock, net - 115,092 - ___________________________________________________________________________ Net Cash Provided by Financing Activities 1,190,658 284,497 547,291 ___________________________________________________________________________ Net Increase in Cash and Cash Equivalents 54,464 - - Cash and Cash Equivalents at Beginning of Period - - - ___________________________________________________________________________ Cash and Cash Equivalents at End of Period $ 54,464 $ - $ - ___________________________________________________________________________\nInterest paid was $253,960, $247,565 and $206,861 during 1994, 1993 and 1992, respectively.\nNet income taxes received were $55,712, $22,972 and $68,753, during 1994, 1993 and 1992, respectively.\nNoncash Investing and Financing Activities:\nIn 1994, 1993 and 1992, the Company entered into capital lease obligations of $41,442, $25,259 and $64,917, respectively, for equipment that was subleased. In 1994, the Company assumed $106,945 of debt in conjunction with acquisitions. In 1993, Old Capital (as defined in Note 1) made capital contributions to the Company of $9,106 primarily relating to deferred tax assets arising as a result of the Restructuring.\n* Certain amounts have been reclassified to conform to the presentation.\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (Dollars in Thousands)\n1. BACKGROUND, INITIAL PUBLIC OFFERING AND BASIS OF PRESENTATION\nBackground\nAT&T Capital Corporation (\"AT&T Capital\" or the \"Company\"), was incorporated on December 21, 1992, as AT&T Leasing, Inc., and was renamed AT&T Capital on March 31, 1993. The Company is the successor entity to certain businesses of AT&T Capital Corporation, a wholly owned subsidiary of AT&T Corp. (\"AT&T\") that was renamed AT&T Capital Holdings, Inc., on March 31, 1993 (\"Old Capital\"), and AT&T Credit Corporation, a wholly owned subsidiary of Old Capital that commenced operations in 1985, and was renamed AT&T Credit Holdings, Inc., on March 31, 1993 (\"Old Credit\"). In a restructuring which occurred on March 31, 1993 (the \"Restructuring\"), Old Capital and Old Credit transferred substantially all their assets, except for certain assets consisting principally of equity interests in project finance transactions and leveraged leases of commercial aircraft (\"Lease Finance Assets\"), in exchange for shares of the Company's common stock and the assumption by the Company of certain related liabilities.\nIn connection with the Restructuring, AT&T issued a direct, full and unconditional guarantee of all existing indebtedness outstanding as of March 31, 1993, for borrowed money incurred, assumed or guaranteed by Old Capital entitled to the benefit of a support agreement between AT&T and Old Capital, including the debt of Old Capital assumed by the Company in the Restructuring. Debt issued by the Company subsequent to March 31, 1993, however, is not guaranteed or supported by AT&T.\nInitial Public Offering\nAn initial public stock offering combined with a management stock offering totalling approximately 14 percent of the Company's stock occurred on August 4, 1993. (See Note 8.) As a result of the stock offerings, approximately 86 percent of the outstanding common stock of the Company is owned by AT&T through Old Credit and Old Capital.\nBasis of Presentation\nThe consolidated financial statements reflect the financial position, results of operations and cash flows of the businesses transferred to the Company on March 31, 1993, by Old Capital and Old Credit as a result of the Restructuring. The Restructuring was accounted for in a manner similar to a pooling of interests. The common stock issued in connection with the incorporation of the Company has been reflected as outstanding for all periods presented.\nThe consolidated financial statements include allocations of certain liabilities and expenses relating to the businesses transferred to the Company by Old Capital and Old Credit.\nIn the Restructuring described above, the Company assumed all the outstanding indebtedness (including indebtedness to third parties) of Old Capital, but none of the outstanding indebtedness to third parties of Old Credit. For the periods and at the dates reflected in the consolidated financial statements, the statements reflect outstanding indebtedness in an aggregate principal amount equal to the aggregate principal amount of indebtedness associated with the assets and business (the \"AT&T Capital Business\") transferred to the Company and its subsidiaries in the Restructuring. However, as actually occurred in the Restructuring, no third-party indebtedness of Old Credit was directly allocated to the AT&T Capital Business. To the extent the third-party indebtedness of Old Capital was not associated with the AT&T Capital Business, such amount was reflected as a reduction of the debt shown as \"Due to AT&T and affiliates for borrowings.\" Conversely, to the extent the third-party indebtedness of Old Credit was associated with the AT&T Capital Business, such amount was reflected as an increase in the debt shown as \"Due to AT&T and affiliates for borrowings.\" Interest expense shown in the consolidated financial statements reflects the actual interest expense associated with the AT&T Capital Business for the periods indicated. See Note 10 for a discussion of certain interest free loans made by AT&T to the Company.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation\nThe accompanying consolidated financial statements include all majority-owned subsidiaries. The accounts of operations located outside of the United States are included on the basis of their fiscal years, ended either November 30, or December 31.\nRevenue Recognition for Finance Receivables and Capital Leases\nFor loans and other financing contracts (Finance Receivables), revenue is recognized over the life of the contract using the interest method.\nFor leases classified as Capital Leases, the difference between (I) the sum of the minimum lease payments due and the estimated unguaranteed residual values and (ii) the asset purchase price paid by the Company is initially recorded as unearned income. The difference is subsequently amortized over the life of the lease contract and recognized as revenue, using the interest method. Unguaranteed residual values are determined on the basis of studies prepared by the Company, professional appraisals, historical experience and industry data.\nAccrual of income on portfolio assets is generally suspended when a loan or a lease becomes contractually delinquent for 90 days or more (or earlier if specifically identified). Accrual is resumed when the receivable becomes contractually current and management believes there is no longer any significant probability of loss.\nInvestment in Operating Leases\nEquipment under Operating Leases is generally depreciated over the estimated useful life of the asset. During the term of the related lease, annual depreciation is generally calculated on a straight-line basis based on the estimated residual values at the end of the respective lease terms. Rental revenue is recognized on a straight-line basis over the related lease term.\nResidual Values\nResidual values are reviewed by the Company at least annually. Declines in residual values for capital leases are recognized as an immediate charge to income. Declines in residual values for operating leases are recognized as adjustments to depreciation expense on operating leases over the shorter of the useful life of the asset or the remaining term of the lease.\nAllowance for Credit Losses\nIn connection with the financing of leases and other receivables, the Company records an allowance for credit losses to provide for estimated losses in the portfolio. The allowance for credit losses is at a level deemed adequate by management considering delinquencies and problem assets, an assessment of overall risks and management's evaluation of probable losses in the portfolio as a whole given its diversification, and a review of historical loss experience. The Company's charge-off policy is based on an analysis of the aging of the Company's portfolio, a review of all non-performing receivables and leases, and prior collection experience. An account is reserved for or charged off when analysis indicates that the account is uncollectible. Additionally, Company policy generally requires accounts 180 days past due to be reserved for or charged off.\nCash Equivalents\nThe Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.\nIncome Taxes\nThrough 1992, the Company used the deferred method under Accounting Principles Board Opinion No. 11, \"Accounting for Income Taxes\" to compute deferred taxes. Effective January 1, 1993, the Company adopted SFAS No. 109, which changed the method of accounting for income taxes from the deferred method to the liability method and requires deferred tax balances to be determined using the enacted income tax rates for the years in which these taxes will actually be paid or refunds received.\nIn the first quarter of 1993, the Company recognized a charge to net income of $2.9 million as the cumulative prior years' effect of this accounting change. This change in accounting for income taxes had no effect on cash flows. Also during 1993, the Company recorded an additional $12.4 million to the provision for income taxes due to the increase in the highest federal corporate income tax rate from 34% to 35% of which $11.4 million relates to adjusting prior years deferred tax balances.\nOther Assets\nThe cost of property and equipment is depreciated on a straight-line basis over their estimated useful lives, which generally range from three to twenty-five years. Leasehold improvements are amortized over the lesser of the term of the related lease or the estimated useful lives of the related assets on a straight-line basis.\nGoodwill represents the excess of the cost of companies acquired over the fair value of their net assets at dates of acquisition, and is amortized as a charge against income on a straight-line basis generally over three to twenty year periods.\nDerivative Financial Instruments\nThe Company enters into derivative financial instruments, mainly interest rate swaps and currency swaps, to hedge interest rate and foreign currency exchange risk and to match fund assets and liabilities. Interest rate swaps generally involve the exchange of interest payments without the exchange of underlying notional principal amounts. Currency swaps generally involve both the exchange of principal and interest payments in distinct currencies. The criteria which must be satisfied for hedges are as follows: (1) the asset or liability to be hedged exposes AT&T Capital, as a whole, to interest rate or currency exchange risk, (2) the derivative acts to reduce the interest rate or currency exchange risk by reducing the sensitivity to interest rate or currency exchange movements, and (3) the derivative is designated and effective as a hedge.\nFor interest rate swaps, the Company records a net receivable or payable related to interest to be received or paid as an adjustment to interest expense. In the event of an early termination of a swap contract, the gain or loss on a swap accounted for as a hedge is amortized over the remaining life of the related asset. The Company does not enter into speculative swaps; however, if the underlying transaction associated with a swap accounted for as a hedge is terminated early, the swap would be considered speculative. The gain or loss on a speculative swap would be recognized immediately.\nThe Company enters into foreign exchange contracts as a hedge against assets and liabilities denominated in foreign currencies. Gains and losses are recognized on the contracts and offset foreign exchange gains or losses on the related assets and liabilities.\nForeign Currency Translation\nThe financial statements of the Company's foreign operations are translated into U.S. dollars in accordance with SFAS No. 52, \"Foreign Currency Translation\", the resulting translation adjustments are recorded\nas a separate component of shareowners' equity. A transaction gain or loss realized upon settlement of a foreign currency transaction generally is included in determining net income for the period in which the transaction is settled.\nEarnings Per Common Share and Common Share Equivalent\nEarnings per common share and common share equivalent are calculated using the weighted average number of common shares outstanding during the period giving effect to dilutive common stock equivalents in the form of stock options using the treasury stock method. Fully diluted earnings per share is not materially different from primary earnings per share.\n3. ACQUISITIONS\nIn January 1994, the Company purchased the stock of A.G.C. Finance, a Hong Kong-based vehicle and equipment leasing finance company with assets at the time of acquisition of approximately $150 million. Also in January 1994, the Company, through its wholly owned Canadian subsidiary acquired the vehicle portfolio and infrastructure assets constituting the Avis Canada Leasing Division of AvisCar, Inc. (\"Avis Leasing\"). Avis Leasing provides automobile leasing to small and mid-size commercial and corporate clients in Canada and had approximately $90 million in assets at the time of acquisition.\nIn April 1994, the Company acquired Goldome Industrial Credit Corporation (\"GICC\"), with assets at the time of acquisition of approximately $75 million. GICC provides financing programs for machine tool vendors, distributors and manufacturers.\nOn January 4, 1995, the Company acquired the vendor leasing and finance companies of Banco Central Hispano and certain of its affiliates (\"CFH Leasing International\") located in the United Kingdom, Germany, France, Italy, Belgium, the Netherlands and Luxembourg. CFH Leasing International provides financial services to equipment manufacturers and vendors and had approximately $540 million in assets at the time of acquisition. This acquisition will be reflected in the Company's financial statements in the first quarter of 1995.\nThe above acquisitions were accounted for by the purchase method and the total cash paid for all of the above was approximately $311.9 million. In addition, the Company assumed certain existing debt associated with these acquisitions. The results of operations are included, or in the case of CFH Leasing International, will be included, in the income statement of the Company from the respective acquisition dates. Unaudited pro forma revenue, net income and earnings per share would have been approximately $1,442.0 million, $108.0 million and $2.31, respectively, for the year ended 1994 had the acquisitions occurred on January 1, 1994, and approximately $1,461.0 million, $78.0 million and $1.82, respectively, for the year ended 1993 had the above acquisitions occurred on January 1, 1993. The pro forma information is based on various assumptions and is not necessarily indicative of results of operations that would have been\nreported had the acquisitions been completed at the dates mentioned above. The associated goodwill is amortized over periods not to exceed 15 years.\n4. INVESTMENT IN FINANCE ASSETS\nThe finance receivable and capital lease portfolios consisted of the following: Finance\nReceivables Capital Leases\nAt December 31, 1994 1993 1994 ___________________________________________________________________________ Receivables $1,634,454 $1,348,691 $5,712,848 $4,267,481 Estimated unguaranteed residual values - - 606,207 566,668 Unearned income (133,620) (94,328) (1,066,457) (835,845) Allowance for credit losses (47,887) (57,060) (123,272) (98,080) ___________________________________________________________________________ Net investment $1,452,947 $1,197,303 $5,129,326 $3,900,224 ___________________________________________________________________________\nThe schedule of maturities at December 31, 1994 for the finance receivable and capital lease portfolios is as follows:\nFinance Capital Receivables Leases ___________________________________________________________________________ 1995 $ 488,403 $1,765,863 1996 268,133 1,485,331 1997 209,750 1,231,372 1998 157,735 689,336 1999 98,396 314,064 2000 and thereafter 412,037 226,882 ___________________________________________________________________________ Total $1,634,454 $5,712,848 ___________________________________________________________________________\nRights to certain lease receivables are purchased at a discount from AT&T. AT&T is appointed as agent to bill and collect purchased receivables, and is reimbursed for the reasonable cost thereof. All rights, title, and interest in these receivables are assigned to the Company by AT&T. AT&T has agreed to repurchase certain finance receivables and capital leases that go into default, and the Company will be reimbursed for any adjustments in the face value of the purchased finance assets. At December 31, 1994 and 1993, $155,312 and $222,803, respectively, of the Company's net investment in finance receivables contained such recourse provisions. At December 31, 1994 and 1993, $87,716 and $98,223, respectively, of the Company's net investment in capital leases contained such provisions.\nThe FASB recently issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\", and SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\", each of which must be adopted by the Company by the first quarter of 1995. The new standards require that impaired loans be measured based on the present value of expected cash flows, discounted at the loan's effective interest rate or the fair value of the collateral if the loan is secured, as well as certain related disclosures. When adopted, the new standards will not have a material effect on the consolidated financial statements of the Company.\n5. EQUIPMENT UNDER OPERATING LEASES\nThe following is a summary of equipment under operating leases at December 31, 1994 and 1993, including equipment on lease to AT&T affiliates (see Note 12):\nAt December 31, 1994 ___________________________________________________________________________ Data processing $ 571,504 $ 838,952 Telecommunications equipment 366,259 348,017 Automobiles 304,936 188,321 Test equipment and other 204,153 134,545 ___________________________________________________________________________ 1,446,852 1,509,835 Less: Accumulated depreciation (567,398) (573,639) Rentals receivable, net 23,071 43,082 ___________________________________________________________________________ Net investment in operating leases $ 902,525 $ 979,278 ___________________________________________________________________________\nMinimum future rentals to be received on noncancelable operating leases as of December 31, 1994, are as follows:\n$362,694 199,671 104,534 30,340 16,203 2000 and thereafter 4,306 ___________________________________________________________________________ Total minimum future rentals $717,748 ___________________________________________________________________________\n6. OTHER REVENUE\nOther revenue consisted of the following:\nFor the Years Ended December 31, 1994 1993 ___________________________________________________________________________ Net gain on sale of leased and off-lease equipment $ 76,453 $ 49,653 $ 39,868 Gain on receivables securitizations 14,799* 51,496* 52,887* Service fee revenue 27,203 37,363 18,559 Other portfolio related revenue 65,007 57,995 50,092 ___________________________________________________________________________ Total other revenue $183,462 $196,507 $161,406 ___________________________________________________________________________ * $14,799, $39,106 and $52,887 relates to securitizations in the fourth quarter of 1994, 1993 and 1992, respectively; and $12,390 relates to a securitization in the first quarter of 1993.\nFor the years ended December 31, 1994, 1993 and 1992, the Company securitized portions of its capital lease portfolio amounting to $259,061, $561,943 and $511,188, with proceeds received of $287,550, $648,887 and $587,292, respectively. In conjunction with the 1994 and 1993 securitizations, at December 31, 1994, $96,177 of the sale proceeds were retained by the purchaser until certain receivable collections are attained and are included in other assets. In addition, in 1992, the Company securitized portions of its finance receivable portfolio of $24,664, with proceeds received of $25,417. The transactions provide for limited recourse to the Company for any uncollectible amounts. Under the agreements, the Company will service these accounts for the purchasers. A portion of the gains have been deferred representing service fees to be earned over the terms of the agreements plus an estimate of the losses under recourse provisions for the lease receivables securitized. In 1992, the Company increased the allowance for losses related to prior securitizations by $8.9 million to reflect the Company's increased exposure to recourse provisions due to economic conditions. At December 31, 1994 and 1993, $853,003 and $985,104, respectively, of receivables previously securitized remained outstanding. The Company's maximum exposure under these recourse provisions, in the unlikely event that all such receivables became uncollectible, amounted to $353,143 at December 31, 1994, and $347,317 at December 31, 1993. The Company has recorded a liability for the amount that it expects to reimburse.\n7. DEBT\nCommercial Paper\nCommercial paper is generally issued at a discount. The maturities of commercial paper ranged up to eight months (with the majority maturing within 90 days) at December 31, 1994 and 1993, respectively. Interest rates ranged from 5.0% to 6.0% and 3.1% to 3.4% at December 31, 1994 and 1993, respectively. The discount amortized on commercial paper amounted to $3,176 and $12,009 in 1994 and 1993, respectively. Interest is payable at maturity.\nThe Company has revolving credit facilities totalling $2.0 billion, all of which were available at December 31, 1994 and 1993, to support the commercial paper issued. These facilities contain certain restrictive covenants with which the Company is in compliance. In addition, certain of the Company's foreign operations had short-term bank lines of credit of approximately $134.0 million, of which approximately $28.6 million was unused at December 31, 1994.\nData with respect to short-term notes (principally commercial paper) are as follows: 1994 1993 ___________________________________________________________________________ End of year balance, net $2,176,877 $1,546,562 $1,899,655 Weighted average interest rate at December 31, 5.8% 3.3% 3.2% Highest month-end balance 2,176,877 2,067,592 2,128,463 Average month-end balance (a) 1,741,872 1,313,312 1,829,298 Weighted average interest rate (b) 4.3% 3.3% 4.0% ___________________________________________________________________________\n(a) The average month-end balance was computed by dividing the total of the outstanding month-end balances by the number of months in the year.\n(b) The weighted average interest rate during the year is calculated by dividing the interest charged for the year by the weighted average short-term notes outstanding during the year.\nMedium- and Long-term Debt\nMedium- and long-term debt outstanding at December 31, 1994 and 1993, consisted of the following:\nMaturities 1994 ___________________________________________________________________________ 3.24% - 5.99% Medium-term notes 1994 - 1998 $1,340,625 $1,731,215 6.00% - 6.99% Medium-term notes 1994 - 1999 1,548,900 377,300 7.00% - 10.05% Medium-term notes 1994 - 2002 326,795 439,520 11.88% - 11.95% Subordinated serial notes 1994 - 1996 6,250 11,250 Other long-term debt 1994 - 2001 157,011 121,268 ___________________________________________________________________________\nTotal medium- and long-term debt $3,379,581 $2,680,553 ___________________________________________________________________________\nThe Company's medium- and long-term debt matures as follows:\n$1,750,172 835,814 507,399 139,018 74,903 2000 and thereafter 72,275 ___________________________________________________________________________ Total $3,379,581 ___________________________________________________________________________\nLong-term debt outstanding at December 31, 1994 and 1993, included $980,000 and $475,000, respectively, of variable rate debt with interest rates ranging from 5.79% to 6.20%, and 3.24% to 3.98%, respectively. Such variable rate debt periodically reprices based on various indices and generally matures in one to two years.\nTo reduce exposure to interest rate movements, the Company enters into interest rate swap agreements. (See Note 13 for a discussion of the Company's derivative activities.) The weighted average interest rate on average total debt outstanding was 5.65% and 5.68% for the years ended December 31, 1994 and 1993, respectively.\nIn addition, the Company had interest bearing debt payable to AT&T and affiliates of $35,290 at December 31, 1993, bearing interest at 3.34%.\nDuring 1994, the Securities and Exchange Commission (\"SEC\") declared effective a debt registration statement (which allows the Company to issue debt to the public) of $2.5 billion. As of December 31, 1994, $1,808,325 of this debt registration was available for issuance.\nAs a result of the Restructuring (see Note 1), medium-term notes outstanding at March 31, 1993, entitled to the benefit of a support agreement between AT&T and Old Capital (which agreement was terminated in the Restructuring) became directly guaranteed by AT&T. At December 31, 1994 and 1993, the amount of such guaranteed debt was $747,895 and $1,441,035, respectively.\n8. SHAREOWNERS' EQUITY AND EARNINGS PER SHARE\nDuring 1994, the Company's board of directors declared dividends totalling thirty-seven cents per share. In addition, on January 20, 1995, the Company's board of directors declared a quarterly dividend of ten cents per share to shareowners of record on February 10, 1995. The dividend was paid on February 28, 1995.\nOn June 28, 1993, the Company effected a 402,500 for one stock reclassification. The par value of the stock remained at $.01 per share. Accordingly, common stock and additional paid-in capital have been restated to reflect the reclassification.\nOn August 4, 1993, the Company sold common shares in an initial public stock offering and in a management stock offering. The shares issued represent approximately 14 percent of the total shares outstanding after the offerings. AT&T, through Old Credit and Old Capital, remains the owner of 40,250,000 shares. The net proceeds received by the Company from the sale of the common stock in the stock offerings were $115,092. Certain costs of the offerings not offset by the proceeds were borne by AT&T. Such proceeds did not include $17,788 of future proceeds attributable to the purchases of common stock in the management stock offering that were funded by recourse loans from the Company to certain senior executives of the Company.\n9. FAIR VALUE DISCLOSURES\nFair value is a subjective and imprecise measurement that is based on assumptions and market data which require significant judgment and may only be valid at a particular point in time. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts. Accordingly, management cannot provide assurance that the fair values presented are indicative of the amounts that the Company could realize in a current market exchange.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments at December 31, 1994 and 1993:\nCash and Cash Equivalents\nFor cash and cash equivalents the carrying amount is a reasonable estimate of fair value.\nNet Investment in Finance Receivables\nThe fair value of the finance receivable portfolio is estimated by discounting the expected future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.\nShort-term Notes and Due to AT&T for Borrowings\nThe carrying amount is a reasonable estimate of fair value.\nGross Profit Tax Deferral Payable to AT&T\nThe fair value of the gross profit tax deferral is estimated by discounting the expected future cash flows using the Company's current cost of debt.\nMedium- and Long-term Debt\nRates currently available to the Company for debt with similar terms and remaining maturities are used to estimate the fair value of existing debt.\nInterest Rate and Currency Swap Agreements\nThe fair value of interest rate and currency swaps is estimated by discounting the expected future cash flows using the rate at which the Company could terminate the swaps in the market today.\nForeign Exchange Contracts\nThe fair value of foreign exchange contracts is estimated based on current market quotes for foreign exchange contracts with the same remaining terms.\nCredit Facilities\nThe fair value of the credit facilities are based on fees currently paid for similar arrangements.\nThe following is the carrying value and fair value (as determined using the methods described above):\nDecember 31, 1994 December 31, 1993 ___________________________________________________________________________ Carrying Fair Carrying Fair Amount Value Amount Value ___________________________________________________________________________ Assets: Cash and cash equivalents $ 54,464 $ 54,464 $ - $ - Net investment in finance receivables (Note 4) 1,452,947 1,432,070 1,197,303 1,213,982\nLiabilities: Short-term notes (Note 7) 2,176,877 2,176,877 1,546,562 1,546,562 Gross profit tax deferral payable to AT&T (Note 10) 214,066 184,238 188,562 162,753 Medium- and long-term debt (Note 7) 3,379,581 3,319,101 2,680,553 2,727,578 Due to AT&T and affiliates for borrowings (Notes 7 $ - $ - $ 35,290 $ 35,290 and 12) ___________________________________________________________________________\nMatching maturities of its portfolio assets and debt is a key component of the financial strategy used by the Company to manage interest rate risk. Based on unaudited calculations performed by the Company, the decreased fair value of the Company's debt has been offset by the decreased fair value of the Company's lease portfolio at December 31, 1994. The fair value of the Company's lease portfolio is not a required disclosure under SFAS No. 107, \"Disclosure About Fair Value of Financial Instruments\" and, therefore, only the fair value of the loan portfolio has been disclosed.\nOff-balance Sheet Financial Instruments\nAt December 31, 1994 and 1993, the Company had interest rate swaps with a notional amount of $2,711,773 and $2,713,569, respectively. Had the Company terminated these swaps at December 31, 1994 and 1993, it would have received $57,033 and $195, respectively, and would have paid $4,726 and $27,764, respectively. (See Note 13.)\nAt December 31, 1994 and 1993, the Company had $221,817 and $149,210, respectively, of currency swaps outstanding. If terminated at December 31, 1994 and 1993, the Company would have received $11,200 and $1,977, respectively, and would have paid $2,338 and $1,734, respectively, for these currency swaps.\nAt December 31, 1994 and 1993, the Company had $318,054 and $165,969, respectively, of foreign exchange forward contracts outstanding. The contracts had a fair value of $321,290 and $165,688 at December 31, 1994 and December 31, 1993, respectively.\nThe fees for the Company's $2.0 billion revolving credit facilities are .0775% of the unused portion per year plus a .0125% set-up fee. In addition, the Company had approximately $28.6 million of unused foreign credit facilities for which the fees are negligible. (See Note 7.)\nAt December 31, 1994 and 1993, the Company had a maximum exposure under limited recourse provisions related to asset securitizations, in the unlikely event that all such receivables became uncollectible, of $353,143 and $347,317, respectively. The Company has recorded a liability for the amount that it expects to reimburse. (See Note 6.)\n10. INCOME TAXES\nThe Company is included in the consolidated federal income tax return, and for certain states, combined state returns, of AT&T. AT&T does not expect to be subject to the alternative minimum tax (\"AMT\") provisions of the 1986 Tax Reform Act in 1994. Also, in 1993, the Company utilized all AMT credits arising from 1990 and 1992 AMT payments made. The Company's income tax expense would not have differed materially from that reported had the Company filed tax returns on a stand-alone basis.\nAs part of an intercompany agreement, the Company has received interest free loans to the extent of the tax deferrals generated by transactions between AT&T and the Company. These interest free loans amounted to $214,066 and $188,562 at December 31, 1994 and 1993, respectively. The average balance outstanding for such loans was $213,172, $200,835 and $198,255 for the years ended December 31, 1994, 1993 and 1992, respectively. These amounts are repaid to AT&T as the temporary differences that generated the deferrals reverse. In the event the Company was not eligible for inclusion in the consolidated tax return of AT&T, these loans would not be available.\nAt December 31, 1994 and 1993, taxes currently receivable from AT&T and third parties were $23,286 and taxes currently payable to AT&T and third parties were $70,010, respectively.\nEffective January 1, 1993, the Company adopted SFAS No. 109. Among other provisions, this standard requires deferred tax balances to be determined using the enacted income tax rates for the years in which taxes will be paid or refunds received. Prior to 1993, the Company's deferred tax accounts reflected the statutory rates that were in effect when the deferrals were initiated. The adoption of SFAS No. 109 resulted in a charge to net income in 1993 of $2,914 which was recorded as the cumulative effect of an accounting change.\nAlso in 1993, the Company recorded an additional $12.4 million ($11.4 million of which relates to prior years deferred tax balances) to the provision for income taxes under SFAS No. 109 to reflect the increase in the highest federal corporate income tax rate from 34% to 35%.\nThe provision (benefit) for income taxes consisted of the following:\nFor the Years Ended December 31, 1994 1993 ___________________________________________________________________________ Current: Federal $(13,494) $ (8,948) $(82,057) State and local (23,150) 31,448 10,691 Foreign taxes 3,538 611 ___________________________________________________________________________\nTotal current portion (33,106) 23,111 (70,670) ___________________________________________________________________________ Deferred: Federal 72,729 67,101 115,242 State and local 33,655 (23,682) (3,269) Foreign - - - ___________________________________________________________________________\nTotal deferred portion 106,384 43,419 111,973 ___________________________________________________________________________\nTotal provision for income taxes $ 73,278 $ 66,530 $ 41,303 ___________________________________________________________________________\nThe Company recorded tax credits of $3,446 in 1994 and $1,019 in 1992. No tax credits were recorded in 1993.\nDeferred income tax (liabilities) assets are composed of the following:\nAt December 31, __________________________________________________________________________ Gross deferred income tax liabilities: Lease related differences $(607,085) $(521,371) Other (89,463) (36,843) __________________________________________________________________________ Gross deferred income tax liabilities (696,548) (558,214) __________________________________________________________________________ Gross deferred income tax assets: Allowance for credit losses 101,591 92,766 Pensions 8,052 7,751 State and foreign net operating losses 18,802 12,617 Other 17,293 4,411 __________________________________________________________________________ Gross deferred income tax assets 145,738 117,545 __________________________________________________________________________\nValuation allowance (4,477) (4,944) __________________________________________________________________________\nNet deferred income tax liabilities $(555,287) $(445,613) __________________________________________________________________________\nA valuation allowance has been recorded to offset related deferred tax assets due to the uncertainty of realizing the benefit of separate state net operating loss carryforwards and net operating loss carryforwards of foreign subsidiaries. State tax loss carryforwards of $285,194 related to various state jurisdictions expire in the following years:\n$ 4,663 10,974 26,090 19,896 9,463 2000 and thereafter 214,108 ___________________________________________________________________________ Total $285,194 ___________________________________________________________________________\nFinancial statements for the years prior to the January 1993 adoption of SFAS No. 109 were not restated to reflect the new accounting standard.\nThis table shows the principal sources of the provision for deferred taxes for 1992:\nFor the Year Ended December 31, ___________________________________________________________________________ Additional tax depreciation on leased equipment $ 403,796 Financing income on leased equipment (318,754) Provision for credit losses (23,699) Gain on sale of assets 39,046 Deferred AMT credits (7,046) Other, net 18,630 ___________________________________________________________________________\nTotal deferred tax provision $ 111,973 ___________________________________________________________________________\nA reconciliation between the federal statutory tax rate and the Company's effective tax rate is shown below:\nFor the Years Ended December 31, 1994 1993 1992 ___________________________________________________________________________ Federal statutory income tax rate 35.0% 35.0% 34.0% State and local income taxes, net of federal income tax effect 3.9 3.7 4.3 Impact of federal tax rate increase on prior years deferred taxes - 8.4 - Excess deferred credits on terminated leases - - - (4.4) Tax exempt lease income (1.7) (0.8) (0.2) Goodwill 1.2 0.8 1.1 Other 3.8 1.1 1.2 ___________________________________________________________________________\nEffective tax rate 42.2% 48.2% 36.0% ___________________________________________________________________________\nThe Company has no available AMT credit carryforwards at December 31, 1994, to reduce future federal income taxes payable.\nFor the years ended December 31, 1994, 1993 and 1992, the consolidated income (loss) before income taxes and cumulative effect of accounting change by domestic and foreign source was $177,662 and $(4,048), $153,010 and $(14,970), and $132,297 and $(17,422), respectively.\n11. PENSION AND BENEFIT PLANS\nPension\nEffective January 1, 1994, all employees of the Company and its domestic subsidiaries were covered by the AT&T Capital Corporation Retirement and Savings Plan (\"RSP\"), a qualified defined contribution plan.\nUnder a defined contribution plan, the amount of future pension benefits is based solely on the amount contributed and the returns earned on those amounts. The RSP is composed of a profit sharing plan (including a cash or deferred arrangement) under Section 401(k) of the Internal Revenue Code and a money purchase plan. The Company's annual contribution, which is discretionary above 5%, is expected to equal approximately 9% of employee pay (i.e., aggregate base salaries and annual incentives of participants in the RSP). In addition, the Company matches an amount equal to 66-2\/3% of the first 6% that each employee contributes to the RSP under Section 401(k). RSP participants can select from a variety of funds within the RSP to invest their allotments. The Company recorded $13,525 of expense in 1994 related to the RSP. In addition, the Company recorded pension expense of $1,366 in connection with RSP-related nonqualified defined contribution plans. The Company also sponsors various international plans which are available to certain employees of its international subsidiaries. The plans are similar to the RSP, in that they provide for employees of the Company to contribute a percentage of their salary to provide for postretirement income. The Company recorded $1,034 of pension expense in 1994 related to the various international plans.\nPrior to 1994, most of the Company's employees were covered by AT&T's noncontributory defined benefit pension plans. Also, through December 31, 1993, other eligible employees of several wholly owned subsidiaries of the Company were covered by an AT&T qualified defined contribution retirement plan, with provisions similar to the RSP. The Company recorded pension expense related to the AT&T noncontributory defined benefit plans of $4,457 and $3,320 in 1993 and 1992, respectively. In addition, the Company recorded costs of $6,312 and $1,795, in 1993 and 1992, respectively, related to the AT&T qualified defined contribution retirement plan.\nOn December 8, 1993, the Company sponsored three unfunded supplemental nonqualified defined benefit retirement plans, which became effective on January 1, 1994, that provide certain employees with additional benefits after retirement. The costs of these plans in 1994 included the following components:\n________________________________________________________________________ Service cost - benefits earned $ 575 Interest cost on projected benefit obligation Amortization ________________________________________________________________________ Net periodic pension cost $1,376 ________________________________________________________________________\nThe funded status of the plans at December 31, 1994 is as follows: ________________________________________________________________________ Accumulated benefit obligations: Vested benefit obligation $1,119 Non-vested benefit obligation 2,578 Total 3,697 Additional benefits on estimated future salary 1,176 Total projected benefit obligation 4,873\nPlan assets at fair value -\nUnfunded projected benefit obligation 4,873\nUnrecognized prior service cost 4,391 Unrecognized net gain (894) Unrecognized transition obligation - Additional liability 2,387 Accrued pension liability recorded $3,763 ________________________________________________________________________\nFor 1994, the projected benefit obligation was determined using an assumed discount rate of 8.75% and assumed long-term rates of increase in future compensation levels of 4.5% or 5.5%, depending on the plan.\nShare Performance Incentive Plan\nThe Company's Share Performance Incentive Plan (\"SPIP\") is designed to grant cash incentive awards to key employees at the end of a three-year performance period, based on the appreciation of the Company's stock relative to (1) the share performance of a select benchmark group of companies in the leasing, finance or lending business, and (2) the return of three-year risk-free treasury notes plus 150 basis points. The cash awards will be calculated at the end of performance periods ending June 30, 1996, 1997, 1998, 1999 and 2000, respectively. The estimated compensation expense relating to the SPIP is charged against income over the respective performance periods.\nLeveraged Stock Purchase Plan\nIn 1993, the Company adopted the Leveraged Stock Purchase Plan (\"LSPP\") under which 2,000,000 shares of common stock and options to purchase common stock were reserved for purchase or grant. The terms and provisions of the LSPP required certain senior management employees to purchase an aggregate of 851,716 shares of common stock in conjunction with the Company's initial public offering at the offering price of $21.50 per share (\"offering price\"). The eligible employees had the option of borrowing from the Company, on a recourse basis, 88.5% to 97.7% of the purchase price of the shares. The recourse loans mature on August 4, 2000, and have a stated interest rate of 6.0% compounded on an annual basis. The purchased shares are pledged as collateral for the recourse loans. Sale of these shares is prohibited prior to August 4, 1996, and is contingent upon repayment of the loan and certain other requirements. The recourse loans are shown on the balance sheet as a reduction of equity.\nIn addition, under the LSPP, the same senior management employees were granted premium priced stock options which will provide participants with an opportunity to purchase up to 1,095,040 shares of Company stock at an exercise price equal to 125% of the initial public offering price ($26.875 per share). The options are exercisable during the period from August 4, 1996, through August 4, 2003. During 1994, 54,895 options were forfeited. No options were forfeited during 1993. Pursuant to the terms of the LSPP, no further purchases of stock, Company loans or option grants will be made under the LSPP.\nLong Term Incentive Plan\nIn 1993, the Company adopted a Long Term Incentive Plan (\"LTIP\") under which the Company may grant various stock-based and other awards to employees of the Company. The number of shares available for grant under the LTIP is 2,000,000. Similar to the LSPP, eligible employees have the option of borrowing from the Company, on a recourse basis, 88.5% to 97.7% of the purchase price of the shares. The recourse loans, which are due seven years from the loan date, have stated interest rates ranging from 6.0% to 7.74% compounded on an annual basis. The purchased shares are pledged as collateral for the recourse loans. Sale of these shares is prohibited for a three-year period and is contingent upon repayment of the loan and certain other requirements. The recourse loans are shown on the balance sheet as a reduction of equity. Awards under the LTIP will be made to executives and employees of the Company at the Company's discretion.\nThe following table summarizes the option activity relating to the LTIP:\nShares Under Option Number Price Per Share ___________________________________________________________________________ Options granted in connection with initial public offering 697,908 $21.50 Changes in 1993: Options canceled (11,605) $21.50 ___________________________________________________________________________ Options outstanding at December 31, 1993 686,303 $21.50 Changes in 1994: Options exercised (274) $21.50 Options canceled (85,367) $21.50-$26.15 Options granted 502,707 $21.81-$30.63 ___________________________________________________________________________ Options outstanding at December 31, 1994 1,103,369 $21.50-$30.63 ___________________________________________________________________________ Options exercisable at December 31, 1994 7,264 $21.50-$26.13 ___________________________________________________________________________\nIn addition, the Company has awarded restricted stock under the LTIP to certain employees in consideration of services rendered. During 1994 and 1993, respectively, restricted stock awards of 17,801 and 15,306 were made to employees under the LTIP.\nAs of December 31, 1994 and 1993, respectively, 735,936 and 1,298,391 shares were available for issuance under the LTIP. The shares are not subject to stock appreciation right features.\nEmployee Stock Purchase Plan\nIn April 1994, the Company's shareowners approved an employee stock purchase plan effective August 1, 1994. The AT&T Capital Corporation 1994 Employee Stock Purchase Plan (\"ESPP\") enables employees to purchase shares of AT&T Capital common stock at a discount. The price per share is 90% of the fair market value of the common stock at the time of its purchase. No compensation expense is recorded in connection with the ESPP. The maximum aggregate number of shares of common stock that may be purchased under the ESPP is 500,000. During 1994, 13,484 shares were purchased by employees at prices ranging from $19.02 to $21.83 per share. At December 31, 1994, there were 486,516 shares available for offering under the ESPP.\nPostretirement and Postemployment Benefits\nEffective January 1, 1993, the Company in conjunction with AT&T, adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The standard requires companies to accrue postretirement benefits during the years employees are working and earning benefits for retirement. Previously, the Company expensed these benefits as the claims were incurred. During 1992, it was decided that AT&T would keep the responsibility for the initial liability at the AT&T consolidated level and charge the Company only for the earned benefit service cost in each period. Accordingly, the Company has no identifiable initial liability and all costs associated with such obligation have been assumed by AT&T. However, had the Company recorded its initial transition obligation in the first quarter of 1993, the amount would have been immaterial to the Company's financial position and results of operations. Additionally, management believes that SFAS No. 106 will not have a material impact on the Company's financial position or its results of operations in the future as postretirement benefits are generally not extended.\nIn November 1992, the FASB issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS No. 112\"). Analogous to SFAS No. 106 for postretirement benefits, this standard requires companies to accrue for estimated future postemployment benefit expenses during the periods when employees are working. Postemployment benefits are any benefits other than retirement benefits that are provided after employment is discontinued. The Company, in conjunction with AT&T, elected to adopt SFAS No. 112 in 1993. Initial adoption of SFAS No. 112 did not have an effect on the Company. Additionally, management believes that SFAS No. 112 will not have a material impact on the Company's financial position or its results of operations in the future.\n12. RELATED-PARTY TRANSACTIONS\nThe Company leases certain office facilities from AT&T and affiliates.\nFuture minimum rental payments under noncancelable, long-term leases with AT&T and affiliates are as follows:\n$ 4,291 4,243 2,640 -\n2000 and thereafter -\n___________________________________________________________________________\nTotal $11,226\n___________________________________________________________________________\nRental expense under existing leases with AT&T and affiliates amounted to $4,101, $7,998 and $8,164, in 1994, 1993 and 1992, respectively.\nThe Company purchases services from AT&T and affiliates, including data processing, billing and collection, administration and other services. The Company's expenses for such services were $20,628 in 1994, $32,320 in 1993 and $19,529 in 1992. Additionally, the Company was charged a fee by AT&T for corporate overhead allocations of $6,444 in 1992. The Company was not charged such a fee from AT&T in 1994 or 1993.\nAt December 31, 1994, 1993 and 1992, the Company was the lessor to AT&T of equipment comprising $268,616, $145,812 and $142,499 of capital leases and $204,647, $376,970 and $468,497 of equipment under operating leases, respectively. Revenue related to these leases was $108,808, $170,788 and $153,087 in 1994, 1993 and 1992, respectively.\nIn 1992, revenue from equipment sales to AT&T and affiliates was $18,689, and the cost of these sales was $17,753. The Company had no significant sales of equipment to AT&T and affiliates in 1994 and 1993.\nThe Company also had an interest bearing intercompany note receivable from AT&T and affiliates of $40,105 at December 31, 1994 and an interest bearing intercompany debt payable to AT&T and affiliates of $35,290 at December 31, 1993, respectively. (See Note 7.) Additionally, the Company had interest free loans related to tax agreements from AT&T at December 31, 1994 and 1993, respectively, of $214,066 and $188,562. (See Note 10.)\nIn 1993, AT&T and the Company entered into an operating agreement, pursuant to which AT&T provides the Company with the right to be the preferred provider of leasing and financing services for AT&T's products on\na basis consistent with past practice. The Company and AT&T have also entered into an intercompany agreement whereby the Company manages and administers, for a fee, certain lease portfolios, including the Lease Finance Assets of Old Capital and Old Credit which were not transferred to the Company. (See Note 1.) During 1994, 1993 and 1992, the Company recognized service fee revenue of $8,551, $18,361 and $4,200, respectively, for such services.\nIn connection with the Restructuring, AT&T has issued a direct, full and unconditional guarantee of all existing indebtedness outstanding as of March 31, 1993 for borrowed money incurred, assumed or guaranteed by Old Capital entitled to the benefit of a support agreement between AT&T and Old Capital, including the debt of Old Capital that was transferred to the Company. Debt issued by the Company subsequent to March 31, 1993, is not guaranteed or supported by AT&T. At December 31, 1994 and 1993, the amount of such guaranteed debt was $747,895 and $1,441,035, respectively.\n13. COMMITMENTS AND CONTINGENCIES\nDerivative Financial Instruments\nIn the normal course of business, the Company is routinely party to various derivative financial instruments. These financial instruments are used by the Company to reduce interest rate and foreign currency exposure, as well as to meet the financing needs of its customers.\nAt both December 31, 1994 and 1993, in management's opinion, there was no significant risk of loss in the event of nonperformance of the counterparties to derivative contracts. Generally, the Company does not require collateral or other security to support financial instruments with credit risk. There were no past due amounts, nor were there any reserves for credit losses on derivatives as of December 31, 1994, 1993 and 1992.\nInformation is provided below for each significant derivative product type. The derivatives, with which the Company is involved, are primarily interest rate swaps, currency swaps, and foreign currency forward exchange contracts.\nInterest Rate and Currency Swaps\nThe Company enters into interest rate and foreign currency swap agreements with major money center banks and intermediaries located in major financial centers to reduce interest rate exposure, to more closely match the maturity of its debt portfolio to that of its asset portfolio and to reduce its exposure to currency fluctuations. Interest rate swaps also allow the Company to raise funds at floating rates and effectively swap them into fixed rates that are lower than those available to the Company if fixed-rate borrowings were made directly. Foreign currency swaps are used primarily to hedge Canadian dollars and pounds sterling.\nUnder interest rate swaps, the Company agrees with other parties to\nexchange, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated by reference to an agreed notional principal amount. A generic swap's notional amount generally does not change for the life of the contract. Amortizing and accreting swaps' notional amounts generally change based upon a predetermined amortization or accretion schedule.\nThe notional amounts shown below represent an agreed upon amount on which calculations of amounts to be exchanged are based. They do not represent amounts exchanged by the parties and, therefore, are not a measure of the exposure of the Company. The Company's exposure is limited to the current fair value of the contracts with a positive fair value at the reporting date. (See Note 9.) A key assumption in the information below is that rates remain constant at the reporting date levels. To the extent that rates change, the variable interest rate information will change.\nActivity in interest rate and currency swaps which are all held for purposes other than trading for 1994 and 1993, is summarized as follows:\nGeneric Amortizing Generic Pay Pay Pay Currency Notional Amounts Fixed Fixed Floating Swaps Total ___________________________________________________________________________ December 31, 1992 $ 650,000 $ 936,684 $ 50,000 $ 32,186 $1,668,870 Additions 789,000 582,744 450,000 117,024 1,938,768 Maturities\/ amortization (300,000) (394,859) (50,000) - (744,859) Terminations - - - - - __________________________________________________________________________ December 31, 1993 1,139,000 1,124,569 450,000 149,210 2,862,779 Additions 607,800 285,972 175,000 129,860 1,198,632 Maturities\/ amortization (175,000) (445,568) (450,000) (57,253) (1,127,821) Terminations - - - - - __________________________________________________________________________ December 31, 1994 $1,571,800 $ 964,973 $175,000 $221,817 $2,933,590 __________________________________________________________________________\nThe schedule of maturities at December 31, 1994 for interest rate and currency swaps which are all held for purposes other than trading is as follows:\nGeneric Amortizing Generic Pay Pay Pay Currency Fixed Fixed Floating Swaps Total ___________________________________________________________________________ Total notional amounts $1,571,800 $964,973 $175,000 $221,817 $2,933,590 Weighted average pay rate 5.75% 5.57% 6.04% 6.21% 5.74% Weighted average receive rate 6.08% 6.09% 5.94% 6.09% 6.08% ___________________________________________________________________________\nGeneric Amortizing Generic Pay Pay Pay Currency Fixed Fixed Floating Swaps Total ___________________________________________________________________________ 1995 Maturities $350,000 $414,180 $175,000 $108,455 $1,047,635 Weighted average pay rate 4.29% 5.19% 6.04% 6.27% 5.14% Weighted average receive rate 6.09% 6.09% 5.94% 6.09% 6.07%\n1996 Maturities $527,000 $291,935 - $ 74,970 $ 893,905 Weighted average pay rate 5.42% 5.35% - 5.83% 5.43% Weighted average receive rate 6.04% 6.09% - 6.09% 6.06%\n1997 Maturities $163,300 $141,019 - $ 36,603 $ 340,922 Weighted average pay rate 5.72% 5.89% - 6.80% 5.91% Weighted average receive rate 6.14% 6.09% - 6.09% 6.11%\n1998 Maturities $300,000 $ 46,749 - $ 1,789 $ 348,538 Weighted average pay rate 6.41% 7.03% - 6.05% 6.49% Weighted average receive rate 6.09% 6.09% - 6.09% 6.09%\n1999 Maturities $200,000 $ 30,736 - - $ 230,736 Weighted average pay rate 8.01% 6.83% - - 7.86% Weighted average receive rate 6.09% 6.09% - - 6.09%\n2000-2017 Maturities $ 31,500 $ 40,354 - - $ 71,854 Weighted average pay rate 7.01% 7.24% - - 7.14% Weighted average receive rate 6.09% 6.09% - - 6.09% ___________________________________________________________________________\nForeign Currency Forward Exchange Contracts\nThe Company enters into foreign currency forward exchange contracts to manage foreign exchange risk (primarily Canadian dollars and pounds sterling). The notional amount of such contracts was $318,054 and $165,969 at December 31, 1994 and 1993, respectively. The Company enters into these contracts to hedge the cash flows associated with foreign currency denominated assets. The term of these contracts is rarely more than three years. The purpose of the Company's foreign currency hedging activities is to protect the Company from the risk that the eventual dollar net cash inflows resulting from these assets will not be adversely affected by changes in exchange rates.\nOther Commitments and Contingencies\nCertain regional office facilities and equipment of the Company are leased from unrelated parties with renewal options of one to five years. Rental expense to unrelated parties for the years ended December 31, 1994, 1993 and 1992 was $14,202, $9,626 and $16,992, respectively. Rental expense associated with sublease rentals on operating leases for 1994, 1993 and 1992, was $115, $419 and $5,026, respectively. Minimum annual rental commitments at December 31, 1994, under these agreements are as follows:\n$21,828 18,171 13,247\n7,769\n7,540\n2000 and thereafter 3,729\n___________________________________________________________________________\nTotal $72,284\n___________________________________________________________________________\nThe total of minimum rentals to be received in the future under noncancelable subleases related to operating leases as of December 31, 1994, was $11,998. The total of minimum rentals to be received in the future under noncancelable subleases related to capital leases as of December 31, 1994, was $65,010.\nThe Company is not currently a party to any material legal proceeding, nor is the Company aware of any pending or threatened litigation which in the opinion of management would have a material impact on its financial condition or results of operations.\n14. FOREIGN OPERATIONS\nThe Company operates primarily in one business segment - equipment leasing and financing. This segment represents more than 90% of consolidated revenue, net income and total assets.\nThe following data on other geographic areas pertain to operations that are located outside the U.S. (primarily Canada, Europe and Hong Kong). Net income includes certain allocated operating expenses and interest expense. Revenues between geographic areas are not material.\nA summary of the Company's operations by geographic area is presented below:\nFor the years ended December 31, 1994 1993 __________________________________________________________________________ Total Revenue: United States $1,250,591 $1,274,615 $1,251,493 Foreign 133,488 84,974 14,033 __________________________________________________________________________ Total $1,384,079 $1,359,589 $1,265,526 __________________________________________________________________________\nNet Income (Loss): United States $104,558 $78,024 $87,329 Foreign (4,222) (9,428) (13,757) __________________________________________________________________________ Total $100,336 $68,596 $73,572 __________________________________________________________________________\nAt December 31, 1994 1993 __________________________________________________________________________ Total Assets: United States $7,148,737 $6,002,857 $5,750,294 Foreign 873,186 406,869 145,135 __________________________________________________________________________ Total $8,021,923 $6,409,726 $5,895,429 __________________________________________________________________________\n15. QUARTERLY DATA (Unaudited)\nQuarters First Second Third Fourth Total ___________________________________________________________________________ Total revenue $326,012 $332,216 $348,368 $377,483 $1,384,079 Interest expense 60,107 65,654 68,942 77,109 271,812 Net income 15,805 18,901 25,040 40,590 100,336 Earnings per share 0.34 0.40 0.53 0.86 $ 2.14 Stock price per share\nhigh 27.000 24.750 24.375 24.500\nlow $ 22.875 $ 21.625 $ 21.375 $ 19.750\n___________________________________________________________________________\nQuarters First Second Third Fourth Total ___________________________________________________________________________ Total revenue $327,542 $317,019 $330,718 $384,310 $1,359,589 Interest expense 59,572 57,747 57,911 61,105 236,335 Income before cumulative effect on prior years of accounting change 14,722 13,769 3,166 39,853 71,510 Net income 11,808 13,769 3,166 39,853 68,596 Earnings per share $ 0.29 $ 0.34 $ 0.07 0.85 $ 1.60 Stock price per share\nhigh - - - 29.250\nlow - - - $ 22.375\n___________________________________________________________________________\nNet income and earnings per share in the first and fourth quarters of 1993, and the fourth quarter of 1994, reflected certain securitization transactions. (See Note 6.)\nNet income and earnings per share for the first quarter of 1993, were impacted by a $2,914 charge, or $.07 per share, for the adoption of SFAS No. 109. (See Notes 2 and 10.)\nNet income and earnings per share for the third quarter of 1993, were impacted by a $11.4 million charge related to the increase in the federal tax rate to 35%. (See Notes 2 and 10.)\nEarnings per share are computed independently for each quarter presented. Because of changes in the weighted average number of shares outstanding, the sum of the quarterly earnings per share may not equal the earnings per share for the year.\nREPORT OF MANAGEMENT ____________________\nManagement is responsible for the preparation, integrity and objectivity of the financial statements and all other financial information included in this report. Management is also responsible for maintaining a system of internal controls as a fundamental requirement for the operational and financial integrity of results.\nThe financial statements, which reflect the consolidated accounts of AT&T Capital Corporation and its subsidiaries, and other financial information shown were prepared in conformity with generally accepted accounting principles. Estimates included in the financial statements were based on judgments of qualified personnel.\nTo maintain its system of internal controls, management carefully selects key personnel and establishes the organizational structure to provide an appropriate division of responsibility. We believe it is essential to conduct business affairs in accordance with the highest ethical standards as set forth in the AT&T Code of Conduct. These guidelines and other informational programs are designed and used to ensure that policies, standards, and managerial authorities are understood throughout the organization. AT&T Capital's Business Controls Group, in conjunction with AT&T's internal auditors, monitor compliance with the system of internal controls by means of an annual plan of internal audits. On an ongoing basis, the system of internal controls is reviewed, evaluated and revised as necessary in light of the results of constant management oversight, internal and independent audits, changes in the Company's business and other conditions.\nManagement believes that the system of internal controls, taken as a whole, provides reasonable assurance that (1) financial records are adequate and can be relied upon to permit the preparation of financial statements in conformity with generally accepted accounting principles, and (2) access to assets occurs only in accordance with management's authorizations.\nThe Audit Committee of the board of directors, which is composed of directors who are not employees of the Company or AT&T, meets periodically with management, AT&T Capital's Business Controls Group and the independent auditors to review the manner in which these groups of individuals are performing their responsibilities and to carry out the Audit Committee's oversight role with respect to auditing, internal controls and financial reporting matters. Periodically, the independent auditors meet privately with the Audit Committee. Both the internal auditors and the independent auditors have access to the Audit Committee and its individual members at any time.\nThe financial statements have been audited by Coopers & Lybrand L.L.P., Independent Auditors. Their audits were conducted in accordance with generally accepted auditing standards and include a consideration of the internal control structure and substantive tests of transactions. Their report follows.\nThomas C. Wajnert Chairman and Chief Executive Officer\nEdward M. Dwyer Senior Vice President, Chief Financial Officer and Treasurer\nREPORT OF INDEPENDENT AUDITORS ______________________________\nTo the Shareowners of AT&T Capital Corporation:\nWe have audited the consolidated balance sheets of AT&T Capital Corporation and Subsidiaries at December 31, 1994 and 1993, and the related consolidated statements of income, changes in shareowners' equity and cash flows for each of the three years in the period ended December 31, 1994. 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 AT&T Capital Corporation and Subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 10 to the Consolidated Financial Statements, in 1993, the Company changed its method of accounting for income taxes.\nCOOPERS & LYBRAND L.L.P.\n1301 Avenue of the Americas New York, New York January 26, 1995\nItem 9.","section_9":"Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere have been no changes in independent auditors and no disagreements with independent auditors on any accounting or financial disclosure during the past two years.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nDIRECTORS\nThe information set forth under the caption \"Nominees for Election\" in the Company's Proxy Statement for its Annual Meeting of Stockholders to be held on April 21, 1995 (the \"Proxy Statement\") to be filed within 120 days after the end of the Company's fiscal year ended December 31, 1994, is incorporated herein by reference.\nEXECUTIVE OFFICERS\nExecutive officers of the Company serve at the discretion of the Board of Directors. No officer of the Company has a written employment or noncompetition agreement with the Company, although each such officer has agreed not to disclose confidential information of the Company. The Company does not have \"key man\" insurance coverage on any of its officers. The executive officers of the Company comprise the Corporate Leadership Team consisting of the following six officers: Messrs. Wajnert, Rothman, Van Sickle, Dwyer, and McCarthy and Ms. Morey.\nThomas C. Wajnert, 51, has served as Chairman of the Board of Directors and Chief Executive Officer of the Company since July 1993 and as a director of the Company since April 1993. From April 1993 to July 1993 Mr. Wajnert was President, Chief Executive Officer and Vice Chairman of the Board of Directors of the Company. From February 1990 to March 1993, Mr. Wajnert was President and Chief Executive Officer and a director of Old Capital. From October 1984 to May 1993, Mr. Wajnert was the Chief Executive Officer of Old Credit.\nIrving H. Rothman, 47, has served as Group President of the Company since April 1993. Together with Mr. Van Sickle, Mr. Rothman shares responsibility for the operations of the Company, with the heads of the Company's several business units reporting to Messrs. Rothman and Van Sickle jointly. From March 1992 to March 1993 Mr. Rothman served as Vice Chairman of Old Credit. From November 1991 to March 1993, Mr. Rothman was Group President of Old Capital. From March 1990 to January 1992, Mr. Rothman was president and Chief Operating Officer of Old Credit and from February 1990 to March 1993, Mr. Rothman was a director of Old Credit. From February 1988 to February 1990, Mr. Rothman was Executive Vice President and Chief Financial Officer of Old Credit.\nCharles D. Van Sickle, 52, has served as Group President of the Company since April 1993. Together with Mr. Rothman, Mr. Van Sickle shares responsibility for the operations of the Company, with the heads of the Company's business units reporting to Messrs. Van Sickle and Rothman jointly. From November 1991 to March 1993, Mr. Van Sickle was Group President of Old Capital and from March 1992 to March 1993, he was Vice Chairman of Old Capital's Capital Markets division. From January 1991 to March 1992 Mr. Van Sickle was President and Chief Operating Officer of Old Capital's Capital Markets division. From March 1990 to January 1991 and from November 1991 to March 1993, Mr. Van Sickle was a director of Old Credit. From February 1988 to January 1991, Mr. Van Sickle was a Senior Vice President of Old Credit's Capital Markets division.\nEdward M. Dwyer, 38, has served as Senior Vice President, Chief Financial Officer and Treasurer of the Company since July 1994. From April 1993 to June 1994, Mr. Dwyer was Vice President and Treasurer of the Company. From July 1991 to March 1993, he was Vice President and Treasurer of Old Capital. From February 1990 to July 1991, Mr. Dwyer was Chief Financial Officer of Old Capital's Capital Markets division. From October 1989 to February 1990, he was Old Capital's Head of Business Planning.\nG. Daniel McCarthy, 45, has served as Senior Vice President, General Counsel, Secretary and Chief Risk Management Officer of the Company since April 1993. From February 1990 to March 1993, Mr. McCarthy was Senior Vice President, General Counsel, Secretary and Chief Risk Management Officer of Old Capital. From February 1988 to February 1990 he was Vice President, General Counsel and Secretary of Old Credit.\nRuth A. Morey, 51, has served as Senior Vice President and Corporate Resource Officer of the Company since April 1993. From February 1990 to March 1993, Ms. Morey served as Senior Vice President and Chief Administrative Officer of Old Capital. From March 1989 to February 1991, Ms. Morey was Vice President of Old Credit's Human Resources division and from March 1990 to March 1993 she was a director of Old Credit. From 1987 to March 1989, Ms. Morey was the head of Old Credit's Human Resources division.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION.\nThe information set forth under the caption \"Executive Compensation\" in the Proxy Statement is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information set forth under the caption \"Security Ownership\" in the Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information set forth under the caption \"Executive Compensation\" in the Proxy Statement is incorporated herein by reference.\nPART IV\nItem 14.","section_14":"Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 10-K.\n(a) Documents filed as a part of the report:\n(1) Financial Statements: Page\nConsolidated Balance Sheets 32 Consolidated Statements of Income 34 Consolidated Statements of Changes in Shareowners' Equity 36 Consolidated Statements of Cash Flows 37 Notes to the Consolidated Financial Statements 39 Report of Management 66 Report of Independent Auditors 68\n(2) Financial Statement Schedules:\nSchedule VIII - Valuation and Qualifying Accounts\nFinancial statement schedules other than the one listed above are omitted because the required information is included in the financial statements or notes thereto or because of the absence of conditions under which they are required.\nReport of Independent Auditors\n(3) Exhibits:\nExhibit Number\n3(a). Restated Certificate of Incorporation of the registrant (incorporated by reference to Exhibit 3.1 to the registrant's Registration Statement on Form S-1 [No. 33-49605], filed with the Securities and Exchange Commission).\n3(b). Amended and Restated By-laws of the registrant dated as of October 21, 1994.\n4(a). Indenture dated as of July 1, 1993 between the registrant and Chemical Bank, Trustee (the \"Indenture\")(incorporated by reference to Exhibit 4A to the registrant's Registration Statement on Form S-3 [No. 33-49671] filed with the Securities and Exchange Commission).\n4(b). First Indenture Supplement dated as of June 24, 1994, to the Indenture (incorporated by reference to Exhibit 4A-2 to the registrant's Registration Statement on Form S-3 [No.33-54359] filed with the Securities and Exchange Commission).\n4(c). Instruments other than described above in 4(a) and 4(b) that define the rights of holders of long-term debt of the registrant and all of its consolidated subsidiaries, are omitted pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K. The registrant hereby agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.\n10(a). Operating Agreement between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to exhibit 10.1 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(b). Intercompany Agreement between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to Exhibit 10.2 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(c). License Agreement between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to Exhibit 10.3 to the registrant's Registration Statement on Form S-1 [No. 33- 49605] filed with the Securities and Exchange Commission).\n10(d). Registration Rights Agreement between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to Exhibit 10.4 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(e). Tax Agreements between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to Exhibit 10.5 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(f). AT&T Capital Corporation 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.9 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(g). Form of Stock Option Agreement under the 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.10 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(h). Form of Restricted Stock Agreement under the 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.11 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(i). Form of Director's Stock Option Agreement under the 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.12 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(j). Form of Director's Restricted Stock Award under the 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.13 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(k). AT&T Capital Corporation 1993 Leveraged Stock Purchase Plan (incorporated by reference to Exhibit 10.14 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(l). Form of Stock Purchase Agreement and related exhibits under the 1993 Leveraged Stock Purchase Plan (incorporated by reference to Exhibit 10.15 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(m). AT&T Capital Corporation 1993 Annual Incentive Plan (incorporated by reference to Exhibit 10.16 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(n). AT&T Capital Corporation 1993 Share Performance Incentive Plan (incorporated by reference to Exhibit 10.17 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(o). Restructuring Agreement dated as of March 29, 1993, among the Registrant, Old Capital, Old Credit and AT&T (incorporated by reference to Exhibit 10.18 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(p). Credit Agreement dated as of July 11, 1994, among the registrant, the Banks listed therein and Morgan Guaranty Trust Company of New York, as Agent (three-year term).\n10(q). Credit Agreement dated as of July 11, 1994, among the registrant, the Banks listed therein and Morgan Guaranty Trust Company of New York, as Agent (364-day term).\n10(r). Form of AT&T Capital Corporation 1993 Employee Compensation Adjustment Plan (incorporated by reference to Exhibit 10.21 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(s). Form of AT&T Capital Corporation 1993 Deferred Compensation Plan (incorporated by reference to Exhibit 10.22 to the registrant's Registration Statement on Form S-1 [No.33- 49605]filed with the Securities and Exchange Commission).\n10(t). Form of AT&T Capital Corporation 1993 Financial Counseling Plan (incorporated by reference to Exhibit 10.22 to the registrant's Registration Statement on Form S-1 [No.33-49605] filed with the Securities and Exchange Commission).\n10(u). AT&T Capital Corporation 1994 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4(c) to the registrant's Registration Statement on Form S-8 [No. 33- 54315] filed with the Securities and Exchange Commission).\n10(v). Form of Summary Plan Description AT&T Capital Corporation Retirement and Savings Plan (including the Form of Description AT&T Capital Corporation Excess Benefit Plan).\n10(w). AT&T Capital Corporation 1995 Annual Incentive Plan.\n10(x). AT&T Capital Corporation 1995 Senior Executive Annual Incentive Plan (incorporated by reference to Exhibit A to the registrant's definitive Proxy Statement dated March 20, 1995 issued in connection with the 1995 Annual Meeting of Stockholders).\n10(y). Form of Summary Plan Description of AT&T Capital Corporation Executive Benefit Plan.\n10(z). Form of Summary Plan Description of AT&T Capital Corporation Supplemental Executive Retirement Plan.\n10(aa).Form of Summary Plan Description of AT&T Capital Corporation Compensation Limit Excess Plan.\n11. Computation of Earnings Per Share\n12. Computation of Ratio of Earnings to Fixed Charges.\n21. Subsidiaries of the registrant.\n23. Consent of Coopers & Lybrand L.L.P.\n24(a). Powers of Attorney executed by officers and directors who signed this report.\n24(b). Certificate of Corporate Resolution.\n27. Financial Data Schedule\n(b) Reports on Form 8-K:\nNone\nSCHEDULE VIII\nAT&T CAPITAL CORPORATION VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Dollars In Thousands)\nColumn A Column B Column C Column D Column E Column F ___________________________________________________________________________ Other Balance at Charge-offs, Additions\/ Balance Beginning Net of (Deductions) at End of Period Additions Recoveries (a) of Period ___________________________________________________________________________\nAllowance for Credit Losses: Lease Financing(1)$102,760 $ 66,306 $ 33,978 $ (6,558) $128,530 Commercial & Financial (2) 57,059 14,582 21,567 (2,176) 47,898 ___________________________________________________________________________ Total $159,819 $ 80,888 $ 55,545 $ (8,734) $176,428\n===========================================================================\nAllowance for Credit Losses: Lease Financing(1)$ 87,774 $ 95,034 $ 46,012 $(34,036) $102,760 Commercial & Financial (2) 36,187 28,644 13,017 5,245 57,059 __________________________________________________________________________ Total $123,961 $123,678 $ 59,029 $(28,791) $159,819 ==========================================================================\nAllowance for Credit Losses: Lease Financing(1)$ 74,106 $ 88,577 $ 61,549 $(13,360) $ 87,774 Commercial &\nFinancial (2) 19,861 23,138 16,818 10,006 36,187 __________________________________________________________________________ Total $ 93,967 $111,715 $ 78,367 $ (3,354) $123,961 ========================================================================== (1) Shown on the balance sheet as a deduction from applicable finance assets, primarily capital leases.\n(2) Shown on the balance sheet as a deduction from finance receivables.\n(a) Primarily includes transfers out of credit losses related to receivables securitized, transfers in of reserves related to businesses acquired and reclassifications.\nREPORT OF INDEPENDENT AUDITORS ______________________________\nOur report on the consolidated financial statements of AT&T Capital Corporation and Subsidiaries is included on page 68 of this Form 10-K. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed as an exhibit on page 71 of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nAs discussed in our report referred to above, the Company changed its method of accounting for income taxes in 1993.\nCOOPERS & LYBRAND L.L.P.\n1301 Avenue of the Americas New York, New York January 26, 1995\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.\nAT&T CAPITAL CORPORATION\nThomas C. Wajnert\nBy_____________________________\nThomas C. Wajnert, March 15, 1995 (Chairman 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.\nPrincipal Executive Officer:\nT. C. Wajnert Chairman and Chief Executive Officer\nPrincipal Financial Officer:\nE. M. Dwyer Senior Vice President, Chief Financial Officer and Treasurer Thomas C. Wajnert By _________________________\nPrincipal Accounting Officer: (Thomas C. Wajnert,\nAttorney-in-fact* and on his own behalf as R. Oliu, Jr. Vice President, Controller Director and a Principal and Chief Accounting Officer Executive Officer).\nDirectors:\nT. C. Wajnert J. P. Clancey J. P. Kelly March 15, 1995 G. M. Lowrie A. J. Mandl R. A. McGinn J. J. Melone R. W. Miller * by power of attorney S. L. Prendergast B. Walker, Jr.\nEXHIBIT INDEX\nExhibit Number\n3(a). Restated Certificate of Incorporation of the registrant (incorporated by reference to Exhibit 3.1 to the registrant's Registration Statement on Form S-1 [No. 33-49605], filed with the Securities and Exchange Commission).\n3(b). Amended and Restated By-laws of the registrant dated as of October 21, 1994.\n4(a). Indenture dated as of July 1, 1993 between the registrant and Chemical Bank, Trustee (the \"Indenture\")(incorporated by reference to Exhibit 4A to the registrant's Registration Statement on Form S-3 [No. 33-49671] filed with the Securities and Exchange Commission).\n4(b). First Indenture Supplement dated as of June 24, 1994, to the Indenture (incorporated by reference to Exhibit 4A-2 to the registrant's Registration Statement on Form S-3 [No.33-54359] filed with the Securities and Exchange Commission).\n4(c). Instruments other than described above in 4(a) and 4(b) that define the rights of holders of long-term debt of the registrant and all of its consolidated subsidiaries, are omitted pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K. The registrant hereby agrees to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.\n10(a). Operating Agreement between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to exhibit 10.1 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(b). Intercompany Agreement between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to Exhibit 10.2 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(c). License Agreement between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to Exhibit 10.3 to the registrant's Registration Statement on Form S-1 [No. 33- 49605] filed with the Securities and Exchange Commission).\n10(d). Registration Rights Agreement between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to Exhibit 10.4 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(e). Tax Agreements between the registrant and AT&T dated as of June 25, 1993 (incorporated by reference to Exhibit 10.5 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(f). AT&T Capital Corporation 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.9 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(g). Form of Stock Option Agreement under the 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.10 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(h). Form of Restricted Stock Agreement under the 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.11 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(i). Form of Director's Stock Option Agreement under the 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.12 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(j). Form of Director's Restricted Stock Award under the 1993 Long Term Incentive Plan (incorporated by reference to Exhibit 10.13 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(k). AT&T Capital Corporation 1993 Leveraged Stock Purchase Plan (incorporated by reference to Exhibit 10.14 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(l). Form of Stock Purchase Agreement and related exhibits under the 1993 Leveraged Stock Purchase Plan (incorporated by reference to Exhibit 10.15 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(m). AT&T Capital Corporation 1993 Annual Incentive Plan (incorporated by reference to Exhibit 10.16 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(n). AT&T Capital Corporation 1993 Share Performance Incentive Plan (incorporated by reference to Exhibit 10.17 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(o). Restructuring Agreement dated as of March 29, 1993, among the Registrant, Old Capital, Old Credit and AT&T (incorporated by reference to Exhibit 10.18 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(p). Credit Agreement dated as of July 11, 1994, among the registrant, the Banks listed therein and Morgan Guaranty Trust Company of New York, as Agent (three-year term).\n10(q). Credit Agreement dated as of July 11, 1994, among the registrant, the Banks listed therein and Morgan Guaranty Trust Company of New York, as Agent (364-day term).\n10(r). Form of AT&T Capital Corporation 1993 Employee Compensation Adjustment Plan (incorporated by reference to Exhibit 10.21 to the registrant's Registration Statement on Form S-1 [No. 33-49605] filed with the Securities and Exchange Commission).\n10(s). Form of AT&T Capital Corporation 1993 Deferred Compensation Plan (incorporated by reference to Exhibit 10.22 to the registrant's Registration Statement on Form S-1 [No.33- 49605]filed with the Securities and Exchange Commission).\n10(t). Form of AT&T Capital Corporation 1993 Financial Counseling Plan (incorporated by reference to Exhibit 10.22 to the registrant's Registration Statement on Form S-1 [No.33-49605] filed with the Securities and Exchange Commission).\n10(u). AT&T Capital Corporation 1994 Employee Stock Purchase Plan (incorporated by reference to Exhibit 4(c) to the registrant's Registration Statement on Form S-8 [No. 33- 54315] filed with the Securities and Exchange Commission).\n10(v). Form of Summary Plan Description of AT&T Capital Corporation Retirement and Savings Plan (including the Form of Description of AT&T Capital Corporation Excess Benefit Plan).\n10(w). AT&T Capital Corporation 1995 Annual Incentive Plan.\n10(x). AT&T Capital Corporation 1995 Senior Executive Annual Incentive Plan (incorporated by reference to Exhibit A to the registrant's definitive Proxy Statement dated March 20, 1995 issued in connection with the 1995 Annual Meeting of Stockholders).\n10(y). Form of Summary Plan Description of AT&T Capital Corporation Executive Benefit Plan.\n10(z). Form of Summary Plan Description of AT&T Capital Corporation Supplemental Executive Retirement Plan.\n10(aa).Form of Summary Plan Description of AT&T Capital Corporation Compensation Limit Excess Plan.\n11. Computation of Earnings Per Share\n12. Computation of Ratio of Earnings to Fixed Charges.\n21. Subsidiaries of the registrant.\n23. Consent of Coopers & Lybrand L.L.P.\n24(a). Powers of Attorney executed by officers and directors who signed this report.\n24(b). Certificate of Corporate Resolution.\n27. Financial Data Schedule","section_15":""}
{"filename":"9534_1994.txt","cik":"9534","year":"1994","section_1":"ITEM 1. BUSINESS\nAll references herein to the \"Corporation\" or \"Bandag\" refer to Bandag, Incorporated and its subsidiaries unless the context indicates otherwise.\nBandag is engaged in the production and sale of precured tread rubber and equipment used by its franchisees for the retreading of tires for trucks, buses, light commercial trucks, industrial equipment, off-the-road equipment and passenger cars. Bandag specializes in a patented cold-bonding retreading process which it introduced to the United States in 1957. The Bandag Method, as it is called, separates the process of vulcanizing the tread rubber from the process of bonding the tread rubber to the tire casing, allowing for optimization of temperature and pressure levels at each stage of the retreading process. Although a Bandag retread is typically sold at a higher unit price than the alternative \"hot-capped\" process, as well as retreads sold using competitive precured systems, the Bandag product is considered to be superior, resulting in a longer lasting retread and lower user cost per mile.\nThe Corporation and its licensees have 1,363 franchisees worldwide, with 37% located in the United States and 63% internationally. The majority of Bandag's franchisees are independent operators of full service tire distributorships. Bandag's revenues primarily come from the sale of retread material and equipment to its franchisees. Bandag's products compete with new tire sales, as well as retreads produced using other retread processes. The Corporation concentrates its marketing effort on existing franchisees and on expanding their respective market penetration. Due to its strong distribution system, marketing efforts, and leading technology, Bandag, through its independent franchisee network, has been able to maintain the largest market presence in the retreading industry.\nThe Company as a tread rubber supplier to its independent network of franchisees competes in the light and heavy truck tire replacement market. Both new tire manufacturers and tread rubber suppliers compete in this market. While the Company has independent franchisees in over 116 countries, and competes in all of these geographic markets, its largest market is the United States. Truck tires retreaded by the Company's franchisees make up approximately 15% of the U.S. light and heavy truck tire replacement market. The Company's primary competitors are new tire manufacturers such as Goodyear Tire and Rubber Company, Bridgestone Corporation and Groupe Michelin. Goodyear Tire and Rubber Company also competes in the U.S. market as a tread rubber supplier to a combination of company owned and independent retreaders.\nAs a result of a recapitalization of the Corporation approved by the Corporation's shareholders on December 30, 1986, and substantially completed in February 1987, the Carver Family (as hereinafter defined) obtained absolute voting control of the Corporation. As of March 24, 1995 the Carver Family beneficially owned shares of Common Stock and Class B Common Stock constituting 74% of the votes entitled to be cast in the election of directors and other corporate matters. The \"Carver Family\" is composed of (i) Lucille A. Carver, a director and widow of Roy J. Carver, (ii) the lineal descendants of Roy J. Carver and their spouses, and (iii) certain trusts and other entities for the benefit of the Carver Family members.\nDescription of Business\nThe Corporation's business consists of the franchising of patented processes for the retreading of tires for trucks, buses, light commercial trucks, industrial equipment, off-the-road equipment, and passenger cars, and the production and sale of precured tread rubber and related products used in connection with these processes.\nThe Bandag process can be divided into two steps: (i) manufacturing the tread rubber and (ii) bonding the tread to a tire casing. Bandag manufactures over 500 separate tread designs and sizes, treads specifically designed for various applications, allowing fleet managers to fine-tune their tire programs. Bandag tread rubber is vulcanized prior to shipment to its independent franchisees. The Bandag franchisee performs the retreading process of bonding the cured tread to a prepared tire casing. This two-step process allows utilization of the optimum temperature and pressure levels at each step. Lower temperature levels during the bonding process result in a more consistent, higher quality finished retread with less damage to the casing. Bandag has developed a totally integrated retreading system with the materials, bonding process and manufacturing equipment specifically designed to work together as a whole.\nThe Corporation also franchises the use of another cold process precured retreading system, the Vakuum Vulk Method, for which the Corporation owns worldwide rights. In connection with the Vakuum Vulk Method, the Corporation currently sells tread rubber, equipment, and supplies to franchisees located in certain European countries.\nMarkets and Distribution\nThe principal market categories for tire retreading are truck and bus, with more than 90% of the tread rubber sold by the Corporation used in the retreading of these tires. Additionally, the Corporation markets tread rubber for the retreading of off-the-road equipment, industrial and light commercial vehicle and passenger car tires; however, historically, sales of tread rubber for these applications have not contributed materially to the Corporation's results of operations.\nTrucks and Buses Tread rubber, equipment, and supplies for retreading and repairing truck and bus tires are sold primarily to independent franchisees by the Corporation to use the Bandag Method for that purpose. Bandag has 1,302 franchisees throughout North America, Central America, South America, Europe, Africa, Far East, Australia and New Zealand. These franchisees are owned and operated by independent franchisees, some with multiple franchises and\/or locations. Of these franchisees 504 are located in the United States. Additionally, the Corporation has approximately 61 franchisees in Europe who retread tires using the Vakuum Vulk Method. One hundred twenty-six of Bandag's foreign franchisees are franchised by licensees of the Corporation in Australia, and joint ventures in India, Sri Lanka and Indonesia. A limited number of franchisees are trucking companies which operate retread shops essentially for their own needs. A few franchisees also offer \"hot-cap\" retreading and most sell one or more lines of new tires.\nThe current franchise agreement offered by the Corporation grants the franchisee the non-exclusive retread manufacturing rights to use the Bandag Method for one or more applications and the Bandag trademarks in connection therewith within a specified territory, but the franchisee is free to market Bandag retreads outside the territory. No initial franchise fee is paid by a franchisee for its franchise.\nOther Applications The Corporation continues to manufacture and supply to its franchisees a limited amount of tread for Off-the-Road (OTR) tires, industrial tires, including solid and pneumatic, passenger car tires and light commercial tires for light trucks and recreational vehicles.\nRegulations\nVarious federal and state authorities have adopted safety and other regulations with respect to motor vehicles and components, including tires, and various states and the Federal Trade Commission enforce statutes or regulations imposing obligations on franchisors, primarily a duty to disclose material facts concerning a franchise to prospective franchisees. Management is unaware of any present or proposed regulations or statutes which would have a material adverse effect upon the Corporation's business, but cannot predict what other regulations or statutes might be adopted or what their effect on the Corporation's business might be.\nCompetition\nThe Corporation faces strong competition in the market for replacement truck and bus tires, the principal retreading market which it serves. The competition comes not only from the major manufacturers of new tires, but also from manufacturers of retread-ing materials. Competitors include producers of \"camelback,\" \"strip stock,\" and \"slab stock\" for \"hot-cap\" retreading, as well as a number of producers of precured tread rubber. Various methods for bonding precured tread rubber to tire casings are used by competitors.\nBandag retreads are often sold at a higher price than tires retreaded by the \"hot-cap\" process as well as retreads sold using competitive precured systems. The Corporation believes that the superior quality and greater mileage of Bandag retreads and expanded service programs to franchisees and end-users outweigh any price differential.\nBandag franchisees compete with many new-tire dealers and retreading operators of varying sizes, which include shops operated by the major new-tire manufacturers, large independent retread companies, retreading operations of large trucking companies, and smaller commercial tire dealers.\nSources of Supply\nThe Corporation manufactures the precured tread rubber, cushion gum, and related supplies in Corporation-owned manufacturing plants in the United States, Canada, Brazil, Belgium, South Africa, Mexico, Malaysia and New Zealand. The Corporation has entered into joint venture agreements in India, Sri Lanka and Indonesia. The Corporation also manufactures pressure chambers, tire casing analyzers, buffers, tire builders, tire handling systems, and other items of equipment used in the Bandag and Vakuum Vulk retreading methods. Curing rims, chucks, spreaders, rollers, certain miscellaneous equipment, and various retreading supplies, such as repair patches sold by the Corporation, are purchased from others.\nThe Corporation purchases rubber and other materials for the production of tread rubber and other rubber products from a number of suppliers. The rubber for tread is primarily synthetic and obtained principally from sources which most conveniently serve the respective areas in which the Corporation's plants are located. Although synthetic rubber and other petrochemical products have periodically been in short supply and significant cost fluctuations have been experienced in previous years, the Corporation to date has not experienced any significant difficulty in obtaining an adequate supply of such materials. However, the effect on operations of future shortages will depend upon their duration and severity and cannot presently be forecast.\nThe principal source of natural rubber, used for the Corporation's cushion gum, is the Far East. The supply of natural rubber has historically been adequate for the Corporation's purposes. Natural rubber is a commodity subject to wide price fluctuations as a result of the forces of supply and demand. Synthetic prices historically have been related to the cost of petrochemical feedstocks which were relatively stable prior to 1994. A relationship between natural rubber and synthetic rubber prices exists, but it is by no means exact.\nPatents\nThe Corporation owns or has licenses for the use of a number of United States and foreign patents covering various elements of the Bandag and Vakuum Vulk Methods. The Corporation has patents covering improved features, some of which start expiring in 1995 and others that will continue to expire through the year 2011, and the Corporation has applications pending for additional patents.\nThe Corporation's patent counsel has advised the Corporation that the United States patents are by law presumed valid and that the Corporation does not infringe upon the patent rights of others. While the outcome of litigation can never be predicted with certainty, such counsel has advised the Corporation that, in his opinion, in the event of litigation placing the validity of such patents at issue, the Corporation's United States patent position should remain adequate.\nThe protection afforded the Bandag Method by foreign patents owned by the Corporation, as well as those under which it is licensed, varies among different countries depending mainly upon the extent to which the elements of the Bandag Method are covered, the strength of the patent laws and the degree to which patent rights are upheld by the courts. Patent counsel for the Corporation is of the opinion that its patent position in the foreign countries in which its principal sales are made is adequate and does not infringe upon the rights of others. The Corporation has, however, extended its foreign market penetration to some countries where little or no patent protection exists.\nThe Corporation does not consider that patent protection is the primary factor in its successful retreading operation, but rather, that its proprietary technical \"know-how,\" product quality, franchisee support programs and effective marketing programs are more important to its success.\nThe Corporation has secured registrations for its trademark and service mark BANDAG, as well as other trademarks and service marks, in the United States and most of the other important commercial countries.\nOther Information\nThe Corporation conducts research and development of new products, primarily in the tire retreading field, and the improvement of materials, equipment, and retreading processes. The cost of this research and development program was approximately $12,612,000 in 1992, $12,321,000 in 1993, and $12,056,000 in 1994.\nThe Company's business has seasonal characteristics which are tied not only to the overall performance of the economy, but more specifically to the level of activity in the trucking industry. Tire demand does, however, lag the seasonality of the trucking industry. The Company's third and fourth quarters have histor-ically been the strongest in terms of sales volume and earnings.\nAs stated in the Company's 13D filed pursuant to the acquisition of the HON Industries common stock, \"The shares of Common Stock purchased by Bandag have been acquired for investment purposes. Bandag believes that the Common Stock represents an attractive investment opportunity at this time.\" The Company continues to believe that HON Industries' common stock is a good, long-term investment consistent with the Company's overall corporate strategy to maximize long term shareholder value. The Company purchased the stock in 1987 and 1988 at a cost of $25.3 million and the market value of the shares currently held at the end of 1994 was $64.1 million.\nThe Corporation has sought to comply with all statutory and administrative requirements concerning environmental quality. The Corporation has made and will continue to make necessary capital expenditures for environmental protection. It is not anticipated that such expenditures will materially affect the Corporation's earnings or competitive position.\nAs of December 31, 1994, the Corporation had 2,502 employees.\nFinancial Information about Industry Segments\nAs stated above, the Corporation's continuing operations are conducted in one principal business and, accordingly, the Corporation's financial statements contain information concerning a single industry segment.\nRevenues of Principal Product Groups\nThe following table sets forth (in millions of dollars), for each of the last three fiscal years, revenues attributable to the Corporation's principal product groups:\n1994 1993 1992 Revenues:\nTread rubber, cushion gum, and retreading supplies $613.1 $555.9 $544.9\nOther products (1) 45.9 39.8 51.6\nCorporate (2) 6.7 5.4 5.9 ------ ------ ------ Total $665.7 $601.1 $602.4\n(1) Includes retreading equipment, rubber compounds, and the sale of new and retreaded tires and related services.\n(2) Consists of interest and dividend income.\nFinancial Information about Foreign and Domestic Operations\nFinancial Statement \"Operations in Different Geographic Areas and Sales by Principal Products\" follows on page 10.\nBANDAG, INCORPORATED AND SUBSIDIARIES\nOperations in Different Geographic Areas and Sales by Principal Products\nThe Company's operations are conducted in one principal business, which includes the manufacture of precured tread rubber, equipment and supplies for retreading tires.\nInformation concerning the Company's operations by geographic area and sales by principal product for the years ended December 31, 1994, 1993 and 1992 is shown below (in millions):\nInformation concerning operations in different geographic areas:\nExecutive Officers of the Corporation\nThe following table sets forth the names and ages of all executive officers of the Corporation, the period of service of each with the Corporation, positions and offices with the Corporation presently held by each, and the period during which each officer has served in his present office:\nPeriod of Service Present Period in with Position or Present Name Age Corporation Office Office\nMartin G. Carver* 46 16 Yrs. Chairman of the 14 Yrs. Board, Chief Executive Officer and President\nLucille A. Carver* 77 37 Yrs. Treasurer 36 Yrs.\nGary L. Carlson 44 21 Yrs. Sr. Vice President 1 Yr. and General Manager Eastern Hemisphere Retreading Division (EHRD)\nDonald F. Chester 59 12 Yrs. Sr. Vice President, 12 Yrs. International\nNathaniel L. 52 23 Yrs. Vice President, 9 Yrs. Derby II Engineering\nThomas E. Dvorchak 62 24 Yrs. Sr. Vice President 17 Yrs. and Chief Financial Officer\nStuart C. Green 53 4 Yrs. Sr. Vice President, 4 Yrs. Manufacturing\nWilliam D. Herd 51 17 Yrs. Sr. Vice President, 5 Yrs. Sales & Marketing\nDr. Floyd S. Myers 54 13 Yrs. Vice President, 9 Yrs. Research and Development\n* Denotes that officer is also a director of the Corporation.\nMr. Martin G. Carver was elected Chairman of the Board effective June 23, 1981, Chief Executive Officer effective May 18, 1982, and President effective May 25, 1983. Prior to his present position, Mr. Carver was also Vice Chairman of the Board from January 5, 1981 to June 23, 1981.\nMrs. Carver has served as a Director and Treasurer of the Corporation for more than five years.\nMr. Carlson joined Bandag in 1974. In 1985 he was appointed to Vice President, Personnel Administration and in 1989 was appointed Vice President, Planning and Development. In November 1993, he was elected to his current position of Sr. Vice President and General Manager EHRD.\nMr. Chester joined Bandag in 1983 and was elected Senior Vice President, International.\nMr. Derby joined Bandag in 1971 and was appointed to his present position in 1985 as Vice President, Engineering.\nMr. Dvorchak joined Bandag in 1971 and was elected to his present office as Senior Vice President and Chief Financial Officer in 1978.\nMr. Green joined Bandag in 1991 and was elected Senior Vice President, Manufacturing. From 1981 to that date, he was employed by Nissan Motor Manufacturing Corporation in various management positions in manufacturing, the latest of which was Director, Manufacturing Vehicle Assembly, Component Assembly and Paint Plants, Manufacturing Division.\nMr. Herd joined Bandag in 1977 as Canadian Division Manager and was appointed to Vice President, North American Sales in August 1982. He was elected to the position of Senior Vice President, North American Sales in 1983, and in 1990 he was elected to his current office of Senior Vice President, Sales and Marketing.\nDr. Myers joined Bandag in 1982 as Vice President, Advanced Research and was appointed to his present position as Vice President, Research and Development in 1985.\nAll of the above-named executive officers are elected annually by the Board of Directors, or are appointed by the Chairman of the Board and serve at the pleasure of the Board of Directors or the Chairman of the Board, as the case may be.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe general offices of the Corporation are located in a 56,000 square foot leased office building in Muscatine, Iowa.\nThe tread rubber manufacturing plants of the Corporation are located to service principal markets. The Corporation operates fourteen of such plants, six of which are located in the United States, and the remainder in Canada, Belgium, South Africa, Brazil, New Zealand, Mexico, Malaysia and Venezuela. The plants vary in size from 9,600 square feet to 194,000 square feet with the first plant being placed into production during 1959. All of the plants are owned in fee or under lease purchase contracts, except for the plants located in New Zealand, Malaysia and Venezuela, which are under standard lease contracts.\nRetreading equipment is manufactured at company-owned plants located in Muscatine, Iowa and Campinas, S.P., Brazil, of approximately 60,000 square feet and 10,000 square feet, respectively. In addition, the Corporation owns a research and development center in Muscatine of approximately 58,400 square feet and a 26,000 square foot facility used primarily for training franchisees and franchisee personnel. Similar training facilities are located in Brazil, South Africa and Western Europe. The Corporation also owns a 26,000 square foot office and warehouse facility in Muscatine.\nIn addition, the Corporation mixes rubber and produces cushion gum at a company-owned 168,000 square foot plant in California. The Company owns its European headquarters office in Belgium and a 129,000 square foot warehouse in the Netherlands.\nIn the opinion of the Corporation, its properties are maintained in good operating condition and the production capacity of its plants is adequate for the near future. Because of the nature of the activities conducted, necessary additions can be made within a reasonable period of time.\nAt December 31, 1994, the net carrying amount of property, plant, and equipment pledged as collateral on other liabilities was approximately $14,023,000.\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.\nInformation concerning cash dividends declared and market prices of the Company's Common Stock and Class A Common Stock for the last three fiscal years is as follows:\nThe approximate number of record holders of the Corporation's Common Stock as of March 24, 1995, was 2,274, the number of holders of Class A Common Stock was 1,846 and the number of holders of Class B Common Stock was 334. The Common Stock and Class A Common Stock are traded on the New York Stock Exchange and the Chicago Stock Exchange. There is no established trading market for the Class B Common Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following table sets forth certain Consolidated Selected Financial Data for the periods and as of the dates indicated:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\n1994-1993\nConsolidated 1994 net sales increased 10% from 1993, of which six percentage points were due to unit volume increases and four percentage points were due to increases in selling prices in response to higher costs for the Company's major raw materials. The Company's seasonal sales pattern, which is tied to trucking industry activity, was similar to previous years. As is normally the case, the third and fourth quarters were the strongest in terms of both sales volume and earnings.\nThe Company's consolidated 1994 net earnings increased 19% from 1993 due to the combined impact of higher unit volume and improved manufacturing efficiencies. The Company's consolidated gross profit margin improved by 1.7 percentage points due to relatively flat manufacturing expenses but higher unit volume. This, while an improvement, still leaves the Company's consolidated gross margin below its 1992 level, which was itself below historic levels. The higher gross profit was partially offset by increased operating expenses related principally to increased spending for marketing programs. The Company's effective income tax rate of 37% was equal to the previous year's rate.\nThe Company's earnings per share for 1994 of $3.51, were $.63 higher, a 22% increase from 1993. During the year, the Company acquired 1,043,000 shares of its outstanding Common Stock and Class A Common Stock for $53,580,000, at prevailing market prices. This, in combination with prior year purchases, resulted in fewer shares outstanding in 1994 which had a favorable impact of $.06 on earnings per share.\nDomestic sales in 1994 were 11% higher than a year ago due to increased unit volume (up 5%), increased selling prices and higher equipment sales. Average raw material costs for the year were approximately 4% higher than the previous year and selling prices were increased a proportional amount to maintain gross margin. Domestic 1994 earnings before income taxes increased 15% over the prior year due to higher sales volume and relatively flat manufacturing costs, the benefit of which was partially offset by an increase in spending for marketing programs.\nThe Company's foreign operations comprised 36% and 17% of 1994's sales revenue and earnings before income taxes, respectively. This represents a one percentage-point decline as a percent of total revenues and a three percentage-point increase as a percent of total earnings before income taxes in comparison to the previous year.\nUnit volume in Western Europe increased 6% over 1993, while sales improved by 8%. Gross profit margin increased 2.7 percentage points in 1994 compared to 1993 due to higher production volume but relatively flat manufacturing costs. Selling price increases during 1994 were not as significant as in the Company's domestic markets because the strong Belgian franc offset most of Western Europe's raw material cost increases, which are based on world prices. Overall, earnings before income taxes improved by 250% over the previous year.\nUnit volume for the Company's other combined foreign operations improved by 11% in 1994 over 1993, with sales increasing by a lesser 9%. The sales increase was lower than the volume increase due to the unfavorable impact of the lower translated value of foreign-currency-denominated sales. The lower translated values more than offset selling price increases initiated during the year in response to higher raw material costs. Gross profit margins remained flat, but operating expenses, as a percent of sales, decreased by approximately one percentage point from the prior year. Earnings before income taxes increased by 23% from the previous year due to the unit volume and sales increases combined with flat operating expenses.\n1993-1992\nConsolidated net sales were approximately equal with 1992, whereas unit volume increased by 4%. Selling prices were generally stable, except in some European markets, but the U.S. dollar strengthened during 1993 and this had an unfavorable impact on the translated value of the Company's foreign-currency-denominated sales. The Company's seasonal sales pattern was comparable to previous years.\nConsolidated net earnings decreased by 5% compared to 1992. The Company's consolidated gross profit margin declined by 2.4 percentage points, but this was partially offset by a 1.5 percentage-point decline in total operating expenses as a percent of sales because of generally lower spending in many categories. The Company's decrease in gross margin was primarily due to higher depreciation expense, attributable to higher capital spending in recent years, and higher overall manufacturing costs in line with generally higher cost levels.\nThe Company's effective income tax rate increased from 36.5% in 1992 to 37% in 1993, reflecting the higher federal income tax rates enacted for 1993. This increase in tax rate reduced net earnings by $625,000 and earnings per share by $.02 compared to the prior year.\nEarnings per share were $.10 lower in 1993, which represents a 3% decrease from the previous year. During the third quarter of 1993, the Company acquired 144,200 shares of its outstanding Common Stock and Class A Common Stock for $6,797,000 at prevailing market prices. There were fewer shares outstanding in 1993 as a result of these purchases. The cumulative current year impact of these purchases and those made in the previous year had a $.02 favorable impact on earnings per share.\nBecause of stable selling prices, domestic unit volume and sales showed 5% and 4% improvements, respectively, over the previous year. Although total domestic revenues increased by 4%, domestic earnings before income taxes were relatively unchanged from the previous year, with higher product costs only partially offset by decreased operating expenses.\nThe Company's foreign operations for 1993 comprised 37% and 14% of the consolidated revenues and earnings before income taxes, respectively. This represented a two percentage-point decline as a percent of total revenues and a three percentage-point decline as a percent of total earnings before income taxes compared to the previous year.\nThe Company's Western European operations, while experiencing a relatively small 1% decrease in unit volume, showed a 13% decrease in sales revenue. The relative lower increase in revenues was due to the unfavorable impact of currency rates and lower selling prices in some European markets, with the currency rates having the greater impact. Earnings before income taxes were adversely impacted in 1993, decreasing by 60% from the previous year. The earnings decrease was due to the lower translation rate, combined with a five percentage point drop in gross profit margin. The lower gross profit margin was due to higher raw material and manufacturing costs, which the Company absorbed because of strong competitive pressures, and non-recurring inventory valuation adjustments.\nUnit volume for the Company's other combined foreign operations improved 7% over the previous year, but sales did not increase proportionately. This again was due to the stronger U.S. dollar and the resulting unfavorable impact when translating foreign-currency-denominated sales at lower rates and, to a lesser extent, due to the discontinuance of sales in certain of the Company's markets. Earnings before income taxes for the combined other foreign operations decreased 12% from last year primarily due to lower gross margins in Brazil and Canada. Brazil's lower margin was primarily due to a refinement in the methodology used to determine certain manufacturing costs. Canada's lower gross margin was the result of a higher than usual amount of finished goods imported from the U.S. in 1993 and the plant being shut down for an extended period in December 1993 in order to relocate its finished goods inventory to a distribution center closer to major markets in Southeastern Canada.\n1992-1991\nConsolidated net sales increased 1% from 1991, which was four percentage points less than the unit volume increase due mainly to the impact of discontinuing the sale of custom compounding services to outside customers. Partially offsetting this decrease was the favorable impact of the higher translated value of foreign- currency-denominated sales.\nConsolidated net earnings increased 4% from 1991. The Company's selling price increases were not sufficient to offset the increases in raw material and plant costs during the year, which resulted in a slight drop in gross profit margin. This was offset by a decrease in operating expenses and higher interest income. The decrease in operating expenses resulted primarily from reduced spending for R&D and marketing programs, especially in the United States. R&D spending was lower in 1992 than the previous year because the previous year included heavy spending on the development of the Eclipse System, which was completed in 1992.\nThe Company's effective income tax rate decreased from 38% in 1991 to 36.5% in 1992, having a positive impact on net income. Earnings per share before the cumulative effect of changes in accounting methods increased $.13, a 5% increase from 1991. During the year, the Company acquired 451,300 shares of its outstanding Common Stock and Class A Common Stock. These purchases took place during the latter half of the year and therefore did not significantly affect the average shares outstanding.\nThe Company adopted, effective January 1, 1992, Financial Accounting Standards No. 106 \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (FAS 106) and No. 109 \"Accounting for Income Taxes\" (FAS 109). The cumulative effect of adopting FAS 106 reduced net earnings by $.09 per share. The cumulative effect of adopting FAS 109 increased net earnings by $.08 per share. Adoption of FAS 106 and 109 did not significantly impact operating results for 1992.\nDomestic unit volume showed nominal improvement despite the soft North American economy, with foreign markets, in total, showing a slightly better performance than the domestic markets.\nEarnings from foreign operations represented 17% and 24% of total earnings before taxes in 1992 and 1991, respectively.\nNet earnings from operations in Western Europe declined by 70% from 1991, even though net sales were 7% higher on a 4% increase in unit volume. The percentage differential between the net sales and volume increases was due primarily to favorable foreign translation rates in U.S. dollars. Net earnings for the year were adversely impacted by a substantial increase in operating expenses and unusually high foreign exchange losses due to devaluations of several European countries' currencies in which sales are denominated. The Company has undertaken a concerted effort to increase market share in Western Europe, and spending related to this effort is primarily responsible for the substantial increase in operating expenses.\nNet sales for the other combined foreign operations increased 10% over last year, with the operations in Mexico and Brazil accounting for the majority of the increase. Net earnings were 14% higher than last year primarily due to improved gross margins in Brazil and slightly lower operating expenses, as a percentage of net sales.\nImpact of Inflation and Changing Prices\nDuring 1994, the Company was again able to adjust its effective selling prices in response to higher raw material costs, after having elected not to increase selling prices for more than a year due to competitive conditions in the new tire industry. Before this, it had been the Company's long-standing practice to adjust its effective selling prices on a routine basis to recover increased production costs and maintain its gross profit margin.\nReplacement of fixed assets requires a greater investment than the original asset cost due to the impact of the general price level increases over the useful lives of plant and equipment. This increased capital investment would result in higher depreciation charges affecting both inventories and cost of products sold.\nHowever, the replacement cost depreciation for new assets, calculated on a straight-line basis, is not significantly greater than historical depreciation using accelerated methods which result in higher depreciation charges in the early years of an asset's life.\nCapital Resources and Liquidity\nCurrent assets exceeded current liabilities by $231,579,000 at the end of 1994. Cash and cash equivalents, which are included therein, totaled $46,519,000 at year-end after decreasing $11,485,000 during the year. The Company invests excess funds over various terms, but only instruments with an original maturity date of over 90 days are classified as investments. These investments increased $11,821,000 from the prior year, which was proportional to the decrease in cash and cash equivalents.\nNo major changes in working capital requirements are foreseen, except those normally faced in the growth of the business. The Company funds its capital expenditures from the cash flow it generates from operations. During 1994 the Company spent $40,799,000 for this purpose.\nAs of December 31, 1994, the Company had available uncommitted lines of credit totaling $83,000,000 in the United States for working capital purposes. Also, the Company's foreign subsidiaries have approximately $49,000,000 in credit and overdraft facilities available to them. From time to time during 1994 the Company's Western European operation borrowed funds to supplement its operational cash flow needs or to settle intercompany transactions. The Company's long-term liabilities totaled $12,252,000 at year end, which are approximately 3% of long-term liabilities and stockholders' equity combined. The Company has no plans at this time to undertake additional liabilities of any material amount.\nDuring the year, the Company acquired a total of 1,043,000 shares of its outstanding Common Stock and Class A Common Stock for $53,580,000 at prevailing market prices and paid cash dividends amounting to $19,310,000. The Company generally funds its dividends and stock repurchases from the cash flow generated from its operations. The Company has historically utilized excess funds to purchase its own shares, believing the acquisition of the Company's stock to be a good investment.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Index to Consolidated Financial Statements\nPage\nReport of Independent Auditors 23\nConsolidated Balance Sheets as of December 31, 1994, 1993 and 1992 24 - 25\nConsolidated Statements of Earnings for the Years Ended December 31, 1994, 1993 and 1992 26\nConsolidated Statements of Changes in Stockholders' Equity for the Years Ended December 31, 1994, 1993 and 1992 27\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 28\nNotes to Consolidated Financial Statements 29 - 41\nReport of Independent Auditors\nStockholders and Board of Directors Bandag, Incorporated\nWe have audited the accompanying consolidated balance sheets of Bandag, Incorporated and subsidiaries as of December 31, 1994, 1993 and 1992, and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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. These 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 Bandag, Incorporated and subsidiaries at December 31, 1994, 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.\nAs discussed in Note B to the consolidated financial statements, as of December 31, 1993, the Company changed its method of accounting for certain investments in debt and equity securities.\n\/s\/ Ernst & Young LLP\nChicago, Illinois February 2, 1995\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements.\nSee notes to consolidated financial statements\nSee notes to consolidated financial statements.\nNotes to Consolidated Financial Statements\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPrinciples of Consolidation: The consolidated financial statements include the accounts and transactions of all subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation.\nCash 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 reported in the consolidated balance sheet for cash and cash equivalents approximates its fair value.\nAccounts Receivable and Concentrations of Credit Risk: Concentrations of credit risk with respect to accounts receivable are limited due to the number of customers the Company has and their geographic dispersion. The Company maintains close working relationships with these customers and performs ongoing credit evaluations of their financial condition. No one customer is large enough to pose a significant financial risk to the Company. The Company maintains an allowance for losses based upon the expected collectibility of accounts receivable. Credit losses have been within management's expectations.\nInventories: Inventories are valued at the lower of cost, determined by the last in, first out (LIFO) method, or market. The excess of current cost over the amount stated for inventories valued by the LIFO method amounted to approximately $19,143,000, $20,189,000 and $18,145,000 at December 31, 1994, 1993, and 1992, respectively.\nProperty, Plant and Equipment: Provisions for depreciation and amortization of plant and equipment are principally computed using declining-balance methods, based upon the estimated useful lives of the various classes of depreciable assets.\nForeign Currency Translation: Assets and liabilities of foreign subsidiaries are translated at the current exchange rate and items of income and expense are translated at the average exchange rate for the year. Exchange gains and losses arising from transactions denominated in a currency other than the functional currency of the foreign subsidiary and translation adjustments in countries with highly inflationary economies or in which operations are directly and integrally linked to the Company's U.S. operations are included in income.\nResearch and Development: Expenditures for research and development are expensed as incurred.\nRevenue Recognition: Sales and associated costs are recognized when products are shipped to dealers.\nB. INVESTMENTS\nThe Company elected to adopt the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" as of December 31, 1993. In accordance with the Statement, prior period financial statements have not been restated to reflect the change in accounting principle. The effect of adopting the Statement increased stockholders' equity at December 31, 1993, by $27,693,000 (net of related deferred income taxes of $16,500,000) to reflect the net unrealized holding gain on marketable equity securities classified as available-for-sale.\nUnder Statement 115, management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date. Debt securities are classified as held-to-maturity based upon the positive intent and ability of the Company to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion is included in investment income. Interest on securities classified as held- to-maturity is included in investment income.\nMarketable equity securities are classified as available-for-sale. Available-for-sale securities are carried at fair value with the unrealized gains, net of tax, reported as a separate component of stockholders' equity. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in investment income. The cost of securities sold is based on the specific identification method. Dividends on securities classified as available-for-sale are included in investment income.\nThe following is a summary of securities held-to-maturity and available- for-sale:\nGross Gross Esti- Unreal- Unreal- mated ized ized Fair Cost Gains Losses Value\nDecember 31, 1994 (In thousands)\nSecurities Held-to-Maturity\nObligations of states and political subdivisions $44,779 $ 23 $ (66) $44,736\nShort-term corporate debt 8,450 - - 8,450\nInvestment in Eurodollar time deposits 22,450 - - 22,450 ------- ------ ----- ------- $75,679 $ 23 $ (66) $75,636 ====== ====== ==== =======\nSecurities Available-for- Sale\nMarketable equity securities $24,416 $39,650 - $64,066 ====== ======= ===== =======\nGross Gross Esti- Unreal- Unreal- mated ized ized Fair Cost Gains Losses Value\nDecember 31, 1993 (In thousands)\nSecurities Held-to-Maturity\nObligations of states and political subdivisions $27,343 $ 28 $ (14) $27,357\nShort-term corporate debt 16,500 - - 16,500\nInvestment in Eurodollar time deposits 33,050 - - 33,050 ------ ------ ------ ------ $76,893 $ 28 $ (14) $76,907 ====== ===== ===== ======\nSecurities Available-for- Sale\nMarketable equity securities $25,303 $44,193 - $69,496 ======= ====== ====== =======\nAt December 31, 1994 and 1993, securities held-to-maturity are due in one year or less and include $38,815,000 and $51,850,000, respectively, reported as cash equivalents.\nPrior to the adoption of Statement 115, investments other than marketable equity securities were carried at cost and included short-term investments with maturities greater than three months when purchased. The carrying amount of such investments approximated its fair value. Marketable equity securities, prior to the adoption of Statement 115, were carried at the lower of cost or market value. At December 31, 1992, the market value of the investment in marketable equity securities based on quoted market prices was $58,327,000, which exceeded cost by $33,024,000.\nC. SHORT-TERM NOTES PAYABLE AND LINES OF CREDIT\nThe carrying amount reported in the consolidated balance sheet of the Company's short-term notes payable approximates its fair value.\nTotal available funds under unused lines of credit at December 31, 1994 amounted to $132 million.\nThe weighted average interest rate on short-term borrowings outstanding as of December 31, 1994, 1993, and 1992, was 7.3%, 8.3%, and 8.1%, respectively.\nInterest paid on short-term notes payable and other obligations amounted to $1,747,000, $1,529,000, and $1,598,000 in 1994, 1993, and 1992, respectively.\nD. INCOME TAXES\nEffective January 1, 1992, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" and changed its method of accounting for income taxes. The cumulative effect of adopting Statement 109 as of January 1, 1992, was to increase net earnings by $2,215,000 or $.08 per share. Other than the cumulative effect of adoption, Statement 109 did not have a material effect on operating results for 1992.\nUnder 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.\nSignificant components of the Company's deferred tax assets (liabilities) reflecting the net tax effects or temporary differences are summarized as follows:\n(In thousands) December 31 1994 1993 1992\nObligation to provide postretirement benefits $ 2,093 $ 1,728 $ 2,242 Marketing programs 10,152 8,515 9,994 Accounts receivable valuation allowances 3,005 2,690 2,445 Unremitted earnings of foreign subsidiaries (3,119) (3,886) (4,760) Excess pension funding (2,890) (2,761) (2,512) Purchased tax benefits (1,975) (2,358) (2,622) Unrealized holding gain on marketable equity securities (15,159) (16,500) - Other, net 6,578 8,724 4,644 ------- -------- ------- Net deferred tax assets (liabilities) ($1,315) ($3,848) $ 9,431 ======= ======= =======\nThe components of earnings before income taxes are summarized as follows:\n(In thousands) Year Ended December 31 1994 1993 1992\nDomestic $123,715 $107,450 $107,094\nForeign 26,120 17,525 23,652 ------- ------- ------- $149,835 $124,975 $130,746 ======= ======= =======\nSignificant components of the provision for income tax expense (credit) are summarized as follows:\n(In thousands) Year Ended December 31 1994 1993 1992 Current:\nFederal $42,965 $35,200 $32,048 State 4,712 3,665 3,939 Foreign 10,118 6,996 12,601\nDeferred:\nFederal (3,842) 1,280 1,040 State (163) 161 21 Foreign 2,434 (736) 843\nEquivalent credit relating to purchased income tax benefits (383) (325) (2,769) ------ ------ ------ $55,841 $46,241 $47,723 ====== ====== =======\nNo item, other than state income taxes in 1994, 1993, and 1992, affects the Company's effective income tax rate by an amount which exceeds 5% of the income tax expense computed at the statutory rate.\nUndistributed earnings of subsidiaries on which deferred income taxes have not been provided are not significant.\nIncome taxes paid amounted to $61,706,000, $42,840,000, and $56,319,000 in 1994, 1993, and 1992, respectively.\nE. STOCKHOLDERS' EQUITY\nOn May 6, 1992, the Company's stockholders adopted an amendment to the Company's articles of incorporation establishing a new class of common stock, Class A Common Stock, and the Board of Directors authorized a stock dividend whereby one share of Class A Common Stock was distributed for each share of Common Stock and Class B Common Stock outstanding at the close of business on May 27, 1992.\nClass A Common Stock and Class B Common Stock have the same rights regarding dividends and distributions upon liquidation as Common Stock. However, Class A Common Stockholders are not entitled to vote, Class B Common Stockholders are entitled to ten votes for each share held and Common Stockholders are entitled to one vote for each share held. Transfer of shares of Class B Common Stock is substantially restricted and must be converted to Common Stock prior to sale. In certain instances, outstanding shares of Class B Common Stock will be converted automatically to shares of Common Stock. Unless extended for an additional period of five years by the Board of Directors, all then-outstanding shares of Class B Common Stock will be converted to shares of Common Stock on January 16, 2002.\nUnder the terms of the Bandag, Incorporated Restricted Stock Grant Plan, the Company is authorized to grant up to an aggregate of 100,000 shares of Common Stock and 100,000 shares of Class A Common Stock to certain key employees. The shares granted under the plan will entitle the grantee to all dividends and voting rights; however, such shares will not vest until seven years after the date of grant. If a grantee's employment is terminated prior to the end of the seven-year period for any reason other than death, disability or termination of employment after age 60, the shares will be forfeited and made available for future grants. A grantee who has attained age 60 and whose employment is then terminated prior to the end of the seven-year vesting period does not forfeit the nonvested shares. During the years ended December 31, 1994, 1993, and 1992, 4,030 shares, 5,150 shares and 5,500 shares of Common Stock, respectively, were granted under the Plan. During the year ended December 31, 1994, 4,030 shares of Class A Common Stock were also granted under the Plan. The resulting charge to earnings amounted to $779,000, $495,000, and $532,000 in 1994, 1993, and 1992, respectively. At December 31, 1994, 50,295 shares of Common Stock and 64,945 shares of Class A Common Stock are available for grant under the Plan.\nUnder the terms of the Bandag, Incorporated Nonqualified Stock Option Plan, the Company is authorized to grant options to purchase up to 500,000 shares of Common Stock and 500,000 shares of Class A Common Stock to certain key employees. The option price is equal to the market value of the shares on the date of grant. At December 31, 1994, options to purchase 100,000 shares of Common Stock and 100,000 shares of Class A Common Stock are outstanding and exercisable at $23.458 per share for Common Stock options and $22.792 per share for Class A Common Stock options. Options to purchase 20,000 shares of Common Stock and 20,000 shares of Class A Common Stock expire on November 13, 1997, and each of the four anniversaries thereafter. At December 31, 1994, no options granted under this Plan have been exercised and options to purchase 400,000 shares of Common Stock and 400,000 shares of Class A Common Stock are available for grant. No options may be granted after November 13, 1997.\nIn November 1994, the Board of Directors authorized a stock award to substantially all U.S. and Canadian employees, to promote employee commitment and ownership in the Company. As of December 31, 1994, 2,810 shares each of Common Stock and Class A Common Stock have been awarded and are being held in trust for the employees. The resulting charge to earnings amounted to $319,000.\nEarnings per share amounts are based upon the weighted average number of shares of Common Stock, Class A Common Stock, Class B Common Stock, and common stock equivalents (dilutive stock options) outstanding during each year. These amounts and the related earnings and cash dividend per share information have been adjusted to reflect the 1992 stock dividend on a retroactive basis.\nF. EMPLOYEE PENSION PLANS\nThe Company sponsors defined-benefit pension plans covering substantially all of its full-time employees in North America and certain employees in the Company's European operations. Benefits are based on years of service and, for salaried employees, the employee's average annual compensation for the last five years of employment. The Company's funding policy is to contribute annually the maximum amount that can be deducted for income tax purposes. Contributions are intended to provide for benefits attributed to service to date and those expected to be earned in the future.\nAggregate accumulated benefit obligations and projected benefit obligations, as estimated by consulting actuaries, and plan net assets and funded status are as follows:\n(In thousands) December 31 1994 1993 1992\nActuarial present value of accumulated benefit obligations: Vested $30,535 $29,463 $25,211 Nonvested 2,310 2,932 3,017 ------ ------- ------- $32,845 $32,395 $28,228 ====== ====== ======\nPlan net assets at fair value $63,594 $60,723 $57,180 Projected benefit obligations 46,367 50,947 42,711 ------ ------ ------- Plan net assets in excess of projected benefit obligations 17,227 9,776 14,469 Unrecognized prior service cost 1,214 1,653 1,764 Unamortized actuarial net loss (gain) (5,728) 481 (4,011) Unamortized net transition gain (7,080) (7,939) (8,614) ------- ------- ------- Prepaid pension cost included in the consolidated balance sheet $ 5,633 $ 3,971 $ 3,608 ====== ====== ======\nAssumptions used in the determination of the actuarial present value of the projected benefit obligation and net pension cost are as follows:\nDecember 31\n1994 1993 1992\nWeighted average discount rate 7.50% 6.50% 6.50%\nRate of increase in future compensation 5.00% 5.25% 5.25%\nExpected long-term rate of return on assets 8.00% 8.00% 8.00%\nAssets of the plans are principally invested in guaranteed interest contracts and common stock.\nThe pension expense is composed of the following:\n(In thousands) Year Ended December 31 1994 1993 1992\nService cost for benefits earned during the year $3,183 $2,957 $2,302\nInterest cost on projected benefit obligations 3,343 3,079 2,556\nInvestment return on plan assets (1,454) (3,958) (4,500)\nNet amortization and deferral (4,161) (1,269) 1,060 ----- ----- ----- $ 911 $ 809 $1,418 ===== ====== =====\nThe Company also sponsors defined-contribution plans, covering substantially all salaried employees in the United States. Annual contributions are made in such amounts as determined by the Company's Board of Directors. Although employees may contribute up to 12% of their annual compensation from the Company, they are generally not required to make contributions in order to participate in the plans. The Company recorded expenses for contributions in the amount of $2,892,000, $2,921,000, and $2,685,000 in 1994, 1993, and 1992, respectively.\nEmployees in most foreign countries are covered by various retirement benefit arrangements generally sponsored by the foreign governments. The Company's contributions to the foreign plans were not significant in 1994, 1993, and 1992.\nG. OTHER POSTRETIREMENT EMPLOYEE BENEFITS\nThe Company provides certain medical benefits under its self-insured health benefit plan to certain individuals who retired from employment before January 1, 1993. The program is contributory, with retiree contributions adjusted periodically. The program also contains co- insurance provisions, which result in shared costs between the Company and the retiree. The Company's postretirement medical obligations are unfunded.\nSubstantially all United States employees with the Company on and after January 1, 1993 are covered by the Bandag Security Program, which provides fully vested benefits after 5 years of service. Benefits under this program are available upon retirement or separation for any other reason and may be used in connection with medical expense, insurance premiums or for any other purpose. The periodic cost and benefit obligation information for the Bandag Security Program is reflected in Note F.\nEffective January 1, 1992, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" and, as permitted by the Statement, elected to immediately recognize the transition obligation. The cumulative effect of adopting Statement 106 was to decrease 1992 net earnings by approximately $2,435,000 or $.09 per share (net of the related tax effect of approximately $1,400,000 or $.05 per share).\nOther than the cumulative effect of adoption, Statement 106 did not have a material effect on the operating results for 1992.\nThe following table sets forth amounts recognized in the Company's consolidated balance sheet:\n(In thousands) December 31 1994 1993 1992\nAccumulated postretirement benefit obligation: Retirees $1,847 $1,998 $2,080 Fully eligible active plan participants 92 114 120\nOther active plan participants 1,801 1,958 2,470 ------ ------- ------- Accumulated postretirement benefit obligation 3,740 4,070 4,670\nUnrecognized net gain (loss) 1,105 443 (559) ------ ------ ------\nAccrued postretirement benefit cost $4,845 $4,513 $4,111 ====== ====== ======\nNet periodic postretirement benefit cost includes the following components:\n(In thousands) December 31 1994 1993 1992\nService cost $167 $195 $185\nInterest cost on accumulated postretirement benefit obligation 261 293 267\nNet amortization and deferral (2) 4 - ----- ----- ----- Net periodic postretirement benefit cost $426 $492 $452 ===== ===== =====\nThe weighted-average annual assumed rate of increase in the per capita cost of covered benefits is 12% for 1995 and is assumed to decrease gradually to 6% for 2001 and remain at that level thereafter. 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, 1994, by $523,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1994 by $74,000. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.5% for 1994, and 6.5% for 1993 and 1992.\nH. DERIVATIVE FINANCIAL INSTRUMENTS\nThe Company enters into agreements (derivative financial instruments) to manage the risks associated with certain aspects of its business. The Company does not actively trade such instruments nor enter into such agreements for speculative purposes. The Company principally utilizes foreign currency forward exchange contracts and foreign currency option contracts.\nAt December 31, 1994, the Company had approximately $10,513,000 in foreign currency forward exchange contracts and foreign currency option contracts designated and effective as hedges which become due in various amounts and at various dates through April 30, 1995. Such contracts at December 31, 1994 were principally for the purpose of hedging commitments arising from intercompany export sales and forecasted material purchases. Unrealized gains and losses on the forward exchange contracts and currency option contracts are deferred and will be recognized in income in the same period as the hedged transaction. The difference between the contract amount and the fair value, in the aggregate, was insignificant at December 31, 1994.\nI. BUSINESS INFORMATION BY GEOGRAPHIC AREA\nThe information regarding operations in different geographic areas is presented on page 10 of this report, and is included herein by reference.\nJ. SUMMARY OF UNAUDITED QUARTERLY RESULTS OF OPERATIONS\nUnaudited quarterly results of operations for the years ended December 31, 1994 and 1993 are summarized as follows:\n(In thousands, except per share data) Quarter Ended Mar. 31 Jun. 30 Sep. 30 Dec. 31 1994: Net sales $131,649 $158,045 $177,231 $183,642\nGross profit 51,618 65,727 78,069 77,768\nNet earnings 15,431 21,645 29,352 27,566\nNet earnings per share $0.57 $0.79 $1.11 $1.04\n1993: Net sales $126,592 $148,950 $154,300 $160,357\nGross profit 49,727 60,212 64,307 63,858\nNet earnings 13,898 19,266 22,547 23,023\nNet earnings per share $0.51 $0.70 $0.83 $0.84\nPART III\nITEM 10.","section_9":"","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information called for by Item 10 (with respect to the directors of the registrant) is incorporated herein by reference from the registrant's definitive Proxy Statement involving the election of directors filed or to be filed pursuant to Regulation 14A not later than 120 days after December 31, 1994. In accordance with General Instruction G (3) to Form 10-K, the information with respect to executive officers of the Corporation required by Item 10 has been included in Part I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information called for by Item 11 is incorporated herein by reference from the registrant's definitive Proxy Statement involving the election of directors filed or to be filed pursuant to Regulation 14A not later than 120 days after December 31, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for by Item 12 is incorporated herein by reference from the registrant's definitive Proxy Statement involving the election of directors filed or to be filed pursuant to Regulation 14A not later than 120 days after December 31, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by Item 13 is incorporated herein by reference from the registrant's definitive Proxy Statement involving the election of directors filed or to be filed pursuant to Regulation 14A not later than 120 days after December 31, 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 are included in Part II, Item 8:\nPage Consolidated Balance Sheets as of December 31, 1994, 1993 and 1992 24-25\nConsolidated Statements of Earnings for the Years Ended December 31, 1994, 1993 and 1992 26\nConsolidated Statements of Stockholders' Equity for the Years Ended December 31, 1994, 1993 and 1992 27\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992 28\nNotes to Consolidated Financial Statements 29-41 (2) Financial Statement Schedule\nPage\nSchedule II - Valuation and qualifying accounts and reserves. 44\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.\nItem 14 (Cont.)\n(3) Exhibits\nExhibit No. Description\n3.1 Bylaws: As amended November 13, 1987. (Incorporated by reference to Exhibit No. 3.1 to the Corporation's Form 10-K for the year ended December 31, 1987.)\n3.2 Restated Articles of Incorporation, effective December 30, 1986. (Incorporated by reference to Exhibit No. 3.2 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n3.3 Articles of Amendment to Bandag, Incorporated's Articles of Incorporation, effective May 6, 1992. (Incorporated by reference to Exhibit No. 3.3 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n4 Instruments defining the rights of security holders. (Incorporated by reference to Exhibit Nos. 3.2 and 3.3 to the Corporation's Form 10-K for the year ended December 31, 1992.)\nThe Corporation agrees to furnish copies of its long-term debt agreements to the Commission on request.\n10.1 *1984 Bandag, Incorporated Restricted Stock Grant Plan, as amended May 6, 1992. (Incorporated by reference to Exhibit No. 10.1 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n10.2 U. S. Bandag System Franchise Agreement Truck and Bus Tires (Incorporated by reference to Exhibit No. 10.2 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n10.3 Agreement of Lease dated June 27, 1975 and Amendment dated November 14, 1982 by and between Bandag, Incorporated and Macomb Motel, Inc. (Incorporated by reference as Exhibit No. 10.5 to the Corporation's Form 10-K for the year ended December 31, 1985.)\n10.4 *Miscellaneous Fringe Benefits for Executives.\n10.5 *Nonqualified Stock Option Plan, as amended May 6, 1992. (Incorporated by reference as Exhibit No. 10.6 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n10.6 *Nonqualified Stock Option Agreement of Martin G. Carver dated November 13, 1987, as amended by an Addendum dated June 12, 1992. (Incorporated by reference as Exhibit No. 10.7 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n10.7 *Form of Participation Agreement under the 1984 Bandag, Incorporated Restricted Stock Grant Plan.\n10.8 *Employment Agreement with Michel Petiot effective January 1, 1994, dated December 20, 1993 (Incorporated by reference to Exhibit No. 10.8 to the Corporation's Form 10-K for the year ended December 31, 1993.) 11 Computation of earnings per share.\n21 Subsidiaries of Registrant.\n27 Financial Data Schedule\n*Represents a management compensatory plan or arrangement.\n(b) Reports on Form 8-K: No report on Form 8-K was 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 Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBANDAG, INCORPORATED\nBy \/s\/ Martin G. Carver Martin G. Carver Chairman of the Board, Chief Executive Officer, President and Director (Principal Executive Officer) Date: March 29, 1995\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\/ Stephen A. Keller \/s\/ Stanley E. G. Hillman Stephen A. Keller Stanley E. G. Hillman Director Director\n\/s\/ Edgar D. Jannotta \/s\/ R. Stephen Newman Edgar D. Jannotta R. Stephen Newman Director Director\n\/s\/ James R. Everline \/s\/ Martin G. Carver James R. Everline Martin G. Carver Director Chairman of the Board, Chief Executive Officer, President and Director (Principal Executive Officer) \/s\/ Thomas E. Dvorchak Thomas E. Dvorchak Senior Vice President and Chief Financial Officer (Chief Accounting Officer)\nDate: March 29, 1995\nEXHIBIT INDEX\nExhibit No. Page No. Description\n3.1 Bylaws: As amended November 13, 1987. (Incorporated by reference to Exhibit No. 3.1 to the Corporation's Form 10-K for the year ended December 31, 1987.)\n3.2 Restated Articles of Incorporation, effective December 30, 1986. (Incorporated by reference to Exhibit No. 3.2 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n3.3 Articles of Amendment to Bandag, Incorporated's Articles of Incorporation, effective May 6, 1992. (Incorporated by reference to Exhibit No. 3.3 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n4 Instruments defining the rights of Security Holders. (Incorporated by reference to Exhibit Nos. 3.2 and 3.3 to the Corporation's Form 10-K for the year ended December 31, 1992.)\nThe Corporation agrees to furnish copies of its long-term debt agreements to the Commission on request.\n10.1 *1984 Bandag, Incorporated Restricted Stock Grant Plan, as amended May 6, 1992. (Incorporated by reference to Exhibit No. 10.1 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n10.2 U. S. Bandag System Franchise Agreement Truck and Bus Tires (Incorporated by reference to Exhibit No. 10.2 to the Corporation's Form 10-K for the year ended December 31, 1993.)\n10.3 Agreement of Lease dated June 27, 1975 and Amendment dated November 14, 1982 by and between Bandag, Incorporated and Macomb Motel, Inc. (Incorporated by reference as Exhibit No. 10.5 to the Corporation's Form 10-K for the year ended December 31, 1985.)\n10.4 *Miscellaneous Fringe Benefits for Executives.\n10.5 *Nonqualified Stock Option Plan, as amended May 6, 1992. (Incorporated by reference as Exhibit No. 10.6 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n10.6 *Nonqualified Stock Option Agreement of Martin G. Carver dated November 13, 1987, as amended by an Addendum dated June 12, 1992. (Incorporated by reference as Exhibit No. 10.7 to the Corporation's Form 10-K for the year ended December 31, 1992.)\n10.7 *Form of Participation Agreement under the 1984 Bandag, Incorporated Restricted Stock Grant Plan.\n10.8 *Employment Agreement with Michel Petiot effective January 1, 1994, dated December 20, 1993 (Incorporated by reference to Exhibit No. 10.8 to the Corporation's Form 10-K for the year ended December 31, 1993.)\n11 Computation of earnings per share.\n21 Subsidiaries of Registrant. 27 Financial Data Schedule\n* Represents a management compensatory plan or arrangement.","section_15":""}
{"filename":"727742_1994.txt","cik":"727742","year":"1994","section_1":"ITEM 1. BUSINESS\nSUMMARY OF SIGNIFICANT TRANSACTIONS Jefferson Smurfit Corporation (formerly SIBV\/MS Holdings, Inc.), hereinafter referred to as \"JSC\", owns 100% of the equity interest in JSCE, Inc. (\"JSCE\"). JSC has no operations other than its investment in JSCE. On December 31, 1994, Jefferson Smurfit Corporation (U.S.), a wholly-owned subsidiary of JSC, merged into its wholly-owned subsidiary, Container Corporation of America (\"CCA\"), with CCA surviving and changing its name to Jefferson Smurfit Corporation (U.S.) (\"JSC (U.S.)\"). JSCE owns a 100% equity interest in JSC (U.S.) and is the guarantor of JSC (U.S.)'s senior indebtedness. Prior to May 4, 1994, 50% of the voting stock of JSC was owned by Smurfit Packaging Corporation and Smurfit Holdings B.V., indirect wholly-owned subsidiaries of Jefferson Smurfit Group plc (\"JS Group\"), a public corporation organized under the laws of the Republic of Ireland. The remaining 50% was owned by The Morgan Stanley Leveraged Equity Fund II, L.P. (\"MSLEF II\") and certain other investors.\nIn May 1994, JSC completed a recapitalization plan (the \"Recapitalization\") to repay or refinance a substantial portion of its indebtedness in order to improve operating and financial flexibility. In connection with the Recapitalization, (i) JSC issued and sold 19,250,000 shares of common stock pursuant to a registered public offering at an initial public offering price of $13.00 per share, (ii) JS Group, through its wholly-owned subsidiary Smurfit International B.V. (\"SIBV\"), purchased an additional 11,538,462 shares of common stock for $150 million, (iii) JSC (U.S.) issued and sold $300 million aggregate principal amount of 11.25% Series A Senior Notes due 2004 and $100 million aggregate principal amount of 10.75% Series B Senior Notes due 2002 pursuant to a registered public offering (the \"1994 Senior Notes\") and (iv) JSC (U.S.) entered into a new bank credit facility (the \"1994 Credit Agreement\") which consists of a $450 million revolving credit facility (the \"New Revolving Credit Facility\") of which up to $150 million may consist of letters of credit, a $900 million Tranche A term loan and a $300 million Tranche B term loan. The proceeds from the equity and debt offerings, the sale to SIBV and borrowings under a new bank facility were used, among other things, to repay outstanding bank debt. The new bank facility enabled JSC (U.S.) to consummate the Subordinated Debt Refinancing which consisted of the redemption of the 13.5% Senior Subordinated Notes due 1999, 14.0% Subordinated Debentures due 2001 and 15.5% Junior Subordinated Accrual Debentures due 2004 (collectively, the \"Subordinated Debt\") and the payment of related premiums on December 1, 1994.\nAll references hereinafter to the \"Company\" shall, as the contract may require, refer collectively to CCA and Jefferson Smurfit Corporation (U.S.) prior to the Merger or JSC, JSCE and JSC (U.S.).\nGENERAL\nThe Company operates in two business segments, Paperboard\/Packaging Products and Newsprint. The Company believes it is one of the nation's largest producers of paperboard and packaging products and is the largest producer of recycled paperboard and recycled packaging products. In addition, the Company believes it is one of the nation's largest producers of recycled newsprint.\nThe Company's Paperboard\/Packaging Products segment includes a system of 16 paperboard mills that, in 1994, produced 1,932,000 tons of virgin and recycled containerboard, 767,000 tons of coated and uncoated recycled boxboard and solid bleached sulfate (\"SBS\") and 209,000 tons of recycled cylinderboard, which were sold to the Company's own converting operations and to third parties. The Company's converting operations consist of 52 corrugated container plants, 18 folding carton plants, and 20 industrial packaging plants located across the country, with three plants located outside the U.S. In 1994, the Company's container plants converted 2,018,000 tons of containerboard, an amount equal to approximately 104.5% of the amount it produced, its folding carton plants converted 543,000 tons of SBS, recycled boxboard and coated natural kraft, an amount equal to approximately 70.8% of the amount of boxboard it produced, and its industrial packaging plants converted 128,000 tons of recycled cylinderboard, an amount equal to approximately 61.1% of the amount it produced. The Company's Paperboard\/Packaging Products segment contributed 92.0% of the Company's net sales in 1994.\nThe Company's paperboard operations are supported by its reclamation division, which processed or brokered 4.1 million tons of wastepaper in 1994, and by its timber division which manages approximately one million acres of owned or leased timberland located in close proximity to its virgin fibre mills. The paperboard\/packaging products operations also include 15 consumer packaging plants.\nThe Company's Newsprint segment includes two newsprint mills in Oregon, which produced 615,000 tons of recycled newsprint in 1994, and two facilities that produce Cladwood, a construction material produced from newsprint and wood by-products. The Company's newsprint mills are also supported by the Company's reclamation division.\nPRODUCTS\nPAPERBOARD\/PACKAGING PRODUCTS SEGMENT\nCONTAINERBOARD AND CORRUGATED SHIPPING CONTAINERS The Company's containerboard operations are highly integrated. Tons of containerboard produced and converted for the last three years were:\nThe Company's mills produce a full line of containerboard, including unbleached kraft linerboard, mottled white linerboard and recycled medium. Unbleached kraft linerboard is produced at the Company's mills located in Fernandina Beach and Jacksonville, Florida and mottled white linerboard is produced at its Brewton, Alabama mill. Recycled medium is produced at the Company's mills located in Alton, Illinois, Carthage, Indiana, Circleville, Ohio and Los Angeles, California. In 1994, the Company produced\n1,085,000, 317,000 and 530,000 tons of unbleached kraft linerboard, mottled white linerboard and recycled medium, respectively.\nLarge capital investment is required to sustain the Company's containerboard mills, which employ state-of-the-art computer controlled machinery in their manufacturing processes. During the last five years, the Company has invested approximately $181 million to enhance product quality, reduce costs, expand capacity and increase production efficiency, as well as make required improvements to stay in compliance with environmental regulations. Major capital projects completed in the last five years include (i) a rebuild of Jacksonville's linerboard machine to produce high performance, lighter weight grades now experiencing higher demand, (ii) modifications to Brewton's mottled white machine to increase run speed by 100 tons per day and (iii) a chip thickness screening project for the Fernandina Beach linerboard mill.\nThe Company's sales of containerboard in 1994 were $786.4 million (including $424.9 million of intracompany sales). During the first part of 1994, sales of containerboard to its container plants were reflected at prices based upon those published by Official Board Markets which were generally higher than those paid by third parties except in exchange contracts. Beginning in September 1994, the sales price of containerboard to the container plants was the same as market price.\nCorrugated shipping containers, manufactured from containerboard in converting plants, are used to ship such diverse products as home appliances, electric motors, small machinery, grocery products, produce, books, tobacco and furniture, and for many other applications, including point of purchase displays. The Company stresses the value added aspects of its corrugated containers, such as labeling and multi-color graphics, to differentiate its products and respond to customer requirements. The Company's 52 container plants serve local customers and large national accounts and are located nationwide, generally in or near large metropolitan areas. The Company's total sales of corrugated shipping containers in 1994 were $1,282.7 million (including $91.4 million of intracompany sales). Total corrugated shipping container sales volumes for 1992, 1993 and 1994 were 28,095, 29,394 and 30,822 million square feet, respectively.\nRECYCLED BOXBOARD, SBS AND FOLDING CARTONS The Company's recycled boxboard, SBS and folding carton operations are also integrated. Tons of recycled boxboard and SBS produced and converted for the last three years were:\nThe Company's mills produce recycled coated and uncoated boxboard and SBS. Coated recycled boxboard is produced at the Company's mills located in Middletown, Ohio, Philadelphia, Pennsylvania, Santa Clara, California and Wabash, Indiana. The Company produces uncoated recycled boxboard at its Los Angeles, California mill and SBS at its Brewton, Alabama mill. The table above excludes production of approximately 87,000 and 85,000 tons in 1992 and 1993, respectively, from the Lockland, Ohio boxboard mill that was closed in January 1994 as part of the Company's Restructuring\nProgram (as discussed in Item 7. - Management's Discussion and Analysis of Financial Condition and Results of Operations). In 1994, the Company produced 586,000 and 181,000 tons of recycled boxboard and SBS, respectively. The Company's total sales of recycled boxboard and SBS in 1994 were $390.9 million (including $197.5 million of intracompany sales).\nThe Company's folding carton plants offer a broad range of converting capabilities, including web and sheet litho, rotogravure and flexo printing and a full line of structural and design graphics services. The Company's 18 folding carton plants convert recycled boxboard and SBS, including approximately 52% of the boxboard and SBS produced by the Company, into folding cartons. Folding cartons are used primarily to protect customers' products while providing point of purchase advertising. The Company makes folding cartons for a wide variety of applications, including food and fast foods, detergents, paper products, beverages, health and beauty aids and other consumer products. Customers range from small local accounts to large national and multinational accounts. The Company's folding carton plants are located nationwide, generally in or near large metropolitan areas. The Company's sales of folding cartons in 1994 were $644.7 million (including $1.8 million of intracompany sales). Folding carton sales volumes for 1992, 1993 and 1994 were 487,000, 475,000 and 486,000 tons, respectively.\nThe Company has focused its capital expenditures in these operations and its marketing activities to support a strategy of enhancing product quality as it relates to packaging graphics, increasing flexibility while reducing customer response time and assisting customers in innovating package designs.\nThe Company provides marketing consultation and research activities through its Design and Market Research (DMR) Laboratory. It provides customers with graphic and product design tailored to the specific technical requirements of lithographic, rotogravure and flexographic printing, as well as photography for packaging, sales promotion concepts, and point of purchase displays.\nRECYCLED CYLINDERBOARD AND INDUSTRIAL PACKAGING The Company's recycled cylinderboard and industrial packaging\noperations are also integrated. Tons of recycled cylinderboard produced and converted for the last three years were:\nThe Company's recycled cylinderboard mills are located in Tacoma, Washington, Monroe, Michigan (2 mills), Lafayette, Indiana, and Cedartown, Georgia. In 1994, total sales of recycled cylinderboard were $67.8 million (including $28.9 million of intracompany sales).\nThe Company's 20 industrial packaging plants convert recycled cylinderboard, including a portion of the recycled cylinderboard produced by the Company, into papertubes and cores. Papertubes and cores are used primarily for paper, film and foil, yarn carriers and other textile products and furniture components. The Company also produces solid fibre partitions for the pharmaceutical, electronics, glass, cosmetics and plastics industries. In addition, the Company produces a patented self-locking partition especially suited for automated packaging and product protection. Also, the Company manufactures corrugated pallets that are made entirely from corrugated components and are lightweight yet extremely strong and are fully recyclable. The Company's industrial packaging sales in 1994 were $94.0 million (including $1.6 million in intracompany sales).\nCONSUMER PACKAGING The Company manufactures a wide variety of consumer packaging products. These products include flexible packaging, paper and metallized paper labels, and labels that are heat transferred to plastic containers for a wide range of industrial and consumer product applications. The contract packaging plants provide cartoning, bagging, liquid- or powder-filling, high-speed overwrapping and fragranced advertising products. The Company produces high-quality rotogravure cylinders and has a full-service organization experienced in the production of color separations and lithographic film for the commercial printing, advertising and packaging industries. The Company also designs, manufactures and sells custom machinery including specialized machines that apply labels to customers' packaging. The Company currently has 15 facilities including the engineering service center referred to below and has improved their competitiveness by installing state- of-the-art production equipment.\nIn addition, the Company has an engineering services center, specializing in automated production systems and highly specialized machinery, providing expert consultation, design and equipment fabrication for consumer and industrial products manufacturers, primarily from the pharmaceutical, agricultural and specialty products industries.\nTotal sales of consumer packaging products and services in 1994 were $179.7 million (including $14.2 million of intracompany sales).\nRECLAMATION OPERATIONS; FIBRE RESOURCES AND TIMBER PRODUCTS The raw materials essential to the Company's business are reclaimed fibre from wastepaper and wood, in the form of logs or chips. The Brewton, Circleville, Jacksonville and Fernandina mills use primarily wood fibres, while the other paperboard mills use reclaimed fibre exclusively. The newsprint mills use approximately 45% wood fibre and 55% reclaimed fibre.\nThe use of recycled products in the Company's operations begins with its reclamation division which operates 26 facilities that collect, sort, grade and bale wastepaper, as well as collect aluminum and glass. The reclamation division provides valuable fibre resources to both the paperboard and newsprint segments of the Company as well as to other producers. Many of the reclamation facilities are located in close proximity to the Company's recycled paperboard and newsprint mills, assuring availability of supply, when needed, with minimal shipping costs. In 1994, the Company processed 4.1 million tons of wastepaper. The amount of wastepaper collected and the proportions sold internally and externally by the Company's reclamation division for the last three years were:\nThe reclamation division also operates a nationwide brokerage system whereby it purchases and resells wastepaper (including wastepaper for use in its recycled fibre mills) on a regional and national contract basis. Such contracts provide bulk purchasing, resulting in lower prices and cleaner wastepaper. Total sales of recycled materials for 1994 were $428.2 million (including $190.2 million of intracompany sales).\nDuring 1994, the wastepaper which was reclaimed by the Company's reclamation plants and brokerage operations satisfied all of the Company's mill requirements for reclaimed fibre.\nThe Company's timber division manages approximately one million acres of owned and leased timberland. In 1994, approximately 61% of the timber harvested by the Company was used in its Jacksonville, Fernandina and Brewton Mills. The Company harvested 953,000 cords of timber which would satisfy approximately 37% of the Company's requirements for wood fibres. The Company's wood fibre requirements not satisfied internally are purchased on the open market or under long-term contracts. In the past, the Company has not experienced difficulty obtaining an adequate supply of wood through its own operations or open market purchases. The Company is not aware of any circumstances that would adversely affect its ability to satisfy its wood requirements in the foreseeable future. In recent years, a shortage of wood fibre in the spotted owl regions in the Northwest has resulted in increases in the cost of virgin wood fibre. In 1994, the Company's total sales of timber products were $235.2 million (including $185.4 million of intracompany sales).\nNEWSPRINT SEGMENT\nNEWSPRINT MILLS The Company's newsprint mills are located in Newberg and Oregon City, Oregon. During 1992, 1993 and 1994, the Company produced 615,000, 615,000 and 615,000 tons of newsprint, respectively. In 1994, total sales of newsprint were $231.4 million (none of which were intracompany sales).\nFor the past three years, an average of approximately 54% of the Company's newsprint production has been sold to The Times Mirror Company (\"Times Mirror\") pursuant to a long-term newsprint agreement (the \"Newsprint Agreement\") entered into in connection with the Company's acquisition of Smurfit Newsprint Corporation (\"SNC\") stock in February 1986. Under the terms of the Newsprint Agreement, the Company supplies newsprint to Times Mirror generally at prevailing West Coast market prices. Sales of newsprint to Times Mirror in 1994 amounted to $113.0 million.\nCLADWOOD Cladwood is a wood composite panel used by the housing industry, manufactured from sawmill shavings and other wood residuals and overlaid with recycled newsprint. The Company has two Cladwood plants located in Oregon. Total sales for Cladwood in 1994 were $28.7 million ($.5 million of which were intracompany sales).\nMARKETING\nThe marketing strategy for the Company's mills is to maximize sales of products to manufacturers located within an economical shipping\narea. The strategy in the converting plants focuses on both specialty products tailored to fit customers' needs and high volume sales of commodity products. The Company also seeks to broaden the customer base for each of its segments rather than to concentrate on only a few accounts for each plant. These objectives have led to decentralization of marketing efforts, such that each plant has its own sales force, and many have product design engineers, who are in close contact with customers to respond to their specific needs. National sales offices are also maintained for customers who purchase through a centralized purchasing office. National account business may be allocated to more than one plant because of production capacity and equipment requirements.\nCOMPETITION\nThe paperboard and packaging products markets are highly competitive and are comprised of many participants. Although no single company is dominant, the Company does face significant competitors in each of its businesses. The Company's competitors include large vertically integrated companies as well as numerous smaller companies. The industries in which the Company competes are particularly sensitive to price fluctuations as well as other competitive factors including design, quality and service, with varying emphasis on these factors depending on product line. The market for the Newsprint segment is also highly competitive.\nBACKLOG\nDemand for the Company's major product lines is relatively constant throughout the year and seasonal fluctuations in marketing, production, shipments and inventories are not significant. The Company does not have a significant backlog of orders, as most orders are placed for delivery within 30 days.\nRESEARCH AND DEVELOPMENT\nThe Company's research and development center works with its manufacturing and sales operations, providing state-of-the-art technology, from raw materials supply through finished packaging performance. Research programs have provided improvements in coatings and barriers, stiffeners, inks and printing. The technical staff conducts basic, applied and diagnostic research, develops processes and products and provides a wide range of other technical services.\nThe Company actively pursues applications for patents on new inventions and designs and attempts to protect its patents against infringement. Nevertheless, the Company believes that its success and growth are dependent on the quality of its products and its relationships with its customers, rather than on the extent of its patent protection. The Company holds or is licensed to use certain patents, but does not consider that the successful continuation of any important phase of its business is dependent upon such patents.\nEMPLOYEES\nThe Company had approximately 16,600 employees at December 31, 1994, of which approximately 11,200 employees (68%), are represented by collective bargaining units. The expiration date of union contracts for the Company's major facilities are as follows: the Newberg mill, expiring March 1995; the Oregon City mill, expiring March 1997; the Brewton mill, expiring October 1997; the Fernandina mill, expiring June 1998; a group of 12 properties,\nincluding 4 paper mills and 8 corrugated container plants, expiring June 1998; and the Jacksonville mill, expiring June 1999. Although the contract for the Alton mill expired in June 1994, production at the mill has not been interrupted and the Company is currently in the process of bargaining with the union representing the mill employees. The Company believes that its employee relations are generally good and is currently in the process of bargaining with unions representing production employees at a number of its other operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's properties at December 31, 1994 are summarized in the table below. Approximately 59% of the Company's investment in property, plant and equipment is represented by its paperboard and newsprint mills.\nIn addition to its manufacturing facilities, the Company owns and leases approximately 758,000 acres and 226,000 acres of timberland, respectively, and also operates wood harvesting facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLitigation In May 1993, the Company received a notice of default on behalf of Otis B. Ingram, as executor of the estate of Naomi M. Ingram, and Ingram-LeGrand Lumber Company with respect to certain timber purchase agreements and timber management agreements between the Company and such parties dated November 22, 1967 pertaining to approximately 30,000 acres of property in Georgia (the \"Agreements\"). In June 1993, the Company filed suit against such parties in the United States District Court, Middle District of Georgia, seeking declaratory and injunctive relief and damages in excess of $3 million arising out of the defendants' alleged breach and anticipatory repudiation of the Agreements. The defendants have filed an answer and counterclaim seeking damages in excess of $14 million based on allegations that the Company breached the Agreements and failed to pay for timber allegedly stolen or otherwise removed from the property by the Company or third parties. The case is set for trial in June 1995. The alleged thefts of timber are being investigated by the Georgia Bureau of Investigation, which has advised the Company that it is not\npresently a target of this investigation. Management does not believe that the outcome of this litigation will have a material adverse effect on the Company's financial condition or operations.\nThe Company is a defendant in a number of other lawsuits which have arisen in the normal course of business. While any litigation has an element of uncertainty, the management of the Company believes that the outcome of such suits will not have a material adverse effect on its financial condition or operations.\nEnvironmental Matters Federal, state and local environmental requirements, particularly relating to air and water quality, are a significant factor in the Company's business. The Company employs processes in the manufacture of pulp, paperboard and other products, resulting in various discharges and emissions that are subject to numerous federal, state and local environmental control statutes, regulations and ordinances. The Company operates and expects to operate under permits and similar authorizations from various governmental authorities that regulate such discharges and emissions.\nOccasional violations of permit terms have occurred from time to time at the Company's facilities, resulting in administrative actions, legal proceedings or consent decrees and similar arrangements. Pending proceedings include the following:\nIn March 1992, the Company entered into an administrative consent order with the Florida Department of Environmental Regulation to carry out any necessary assessment and remediation of Company- owned property in Duval County, Florida that was formerly the site of a sawmill that dipped lumber into a chemical solution. Assessment is on-going, but initial data indicates soil and groundwater contamination that may require nonroutine remediation. Management believes that the probable costs of this site, taken alone or with potential costs at other Company-owned properties where some contamination has been found, will not have a material adverse effect on its financial condition or operations.\nIn February 1994, the Company entered into a consent decree with the State of Ohio in full satisfaction of all liability for alleged violations of applicable standards for particulate and opacity emissions with respect to two coal-fired boilers at its Lockland, Ohio recycled boxboard mill (which was permanently closed as part of the Company's Restructuring Program). The Company paid $122,000 in penalties and enforcement costs pursuant to such consent decree. The United States Environmental Protection Agency also issued a notice of violation with respect to such emissions, but has informally advised the Company's counsel that no Federal enforcement is likely to be commenced in light of the settlement with the State of Ohio.\nIn the fourth quarter of 1994, the Company learned of possible noncompliance with certain provisions of its construction\/operation permit at its D-Graphics labels plant located in Jacksonville, Florida. In October, 1994, the Company voluntarily reported such possible noncompliance to state and local environmental authorities and suspended operations at this facility for several days until temporary operating authority was obtained. Subsequently, a settlement agreement was signed between the Company, the Florida Department of Environmental Protection and the City of Jacksonville Regulatory and Environmental Services Division to resolve all civil and administrative issues regarding this matter, pursuant to which\nthe Company has paid an aggregate of $1.5 million in fines and penalties. An operating permit allowing the plant to be operated on a continuing basis has also been obtained. The United States Department of Justice is currently conducting a criminal investigation of the matters reported by the Company and it is uncertain whether any criminal action will be forthcoming.\nThe Company also faces potential liability as a result of releases, or threatened releases, of hazardous substances into the environment from various sites owned and operated by third parties at which Company-generated wastes have allegedly been deposited. Generators of hazardous substances sent to off-site disposal locations at which environmental problems exist, as well as the owners of those sites and certain other classes of persons (generally referred to as \"potentially responsible parties\" or \"PRPs\"), are, in most instances, subject to joint and several liability for response costs for the investigation and remediation of such sites under the Comprehensive Environmental Response, Compensation and Liability Act (\"CERCLA\") and analogous state laws, regardless of fault or the legality of the original disposal. The Company has received notice that it is or may be a PRP at a number of federal and\/or state sites where remedial action may be required, and as a result may have joint and several liability for cleanup costs at such sites. However, liability of CERCLA sites is typically shared with the other PRPs and costs are commonly allocated according to relative amounts of waste deposited. Because the Company's relative percentage of waste deposited at the majority of these sites is quite small, management of the Company believes that its probable liability under CERCLA, taken on a case by case basis or in the aggregate, will not have a material adverse effect on its financial condition or operations. Pending CERCLA proceedings include the following:\nMiami County, Ohio Site In January 1990, the Company filed a motion for leave to intervene and for modification of the consent decree in United States v. General Refuse Services, a case pending in the United States District Court for the Southern District of Ohio. The Company contended that it should have been allowed to participate in the proposed consent decree, which provided for remediation of alleged releases or threatened releases of hazardous substances at a site in Miami County, near Troy, Ohio, according to a plan approved by the United States Environmental Protection Agency, Region V (the \"Agency\"). The Court granted the Company's motion to intervene in this litigation, but denied the Company's motion for an order denying entry of the consent decree. Consequently, the consent decree was entered without the Company's being included as a party to the decree, meaning that the Company had some exposure to potential claims for contribution to remediation costs incurred by other participants and for non-reimbursed response costs incurred by the Agency.\nIn December 1991, the United States filed a civil action against the Company in United States District Court, Southern District of Ohio, to recover its unreimbursed costs at the Miami County site, and the Company subsequently filed a third-party complaint against certain entities that had joined the original consent decree. The Company and the United States have executed a consent decree which was lodged with the Court in January 1995, pursuant to which the Company will pay $3.1 million in satisfaction of its alleged and\/or potential liability for past and future response costs in connection with this site.\nIn October 1993, the United States filed an additional suit against the Company in the same court seeking injunctive relief\nand damages up to $25,000 per day from March 27, 1989 to the present, based on the Company's alleged failure to properly respond to the Agency's document and information requests in connection with this site. The Company and the United States have reached an agreement in principle pursuant to which the Company will pay $1.2 million in settlement of the pending litigation concerning the Company's allegedly improper responses to the document requests of the Environmental Protection Agency in connection with this site.\nIn July 1993, counsel for the Company was advised by the Office of the United Stated Attorney, Northern District of Illinois that a criminal inquiry is also underway relating to the Company's responses to the Agency's document and information requests. The Company is investigating the circumstances regarding its responses. It is uncertain whether any criminal action will be forthcoming.\nMonterey Park, California Site The Company has paid approximately $768,000 pursuant to two partial consent decrees entered into in 1990 and 1991 with respect to clean-up obligations at the Operating Industries site in Monterey Park, California. It is anticipated that there will be further remedial measures beyond those covered by these partial settlements.\nGriffin, Indiana Site The Company entered into a settlement with the United States, the State of Indiana and certain other parties pursuant to which their obligations in connection with a superfund site in Griffin, Indiana were satisfied in exchange for aggregate payments of approximately $588,000.\nKankakee County, Illinois Site The Company has paid $258,000 and agreed to pay an additional amount of approximately $50,000 in full settlement of its obligations in connection with a superfund site in Kankakee County, Illinois.\nIn addition to other Federal and State laws regarding hazardous substance contamination at sites owned or operated by the Company, the New Jersey Industrial Site Recovery Act (\"ISRA\") requires that a \"Negative Declaration\" or a \"Cleanup Plan\" be filed and approved by the New Jersey Department of Environmental Protection and Energy (\"DEPE\") as a precondition to the \"transfer\" of an \"industrial establishment\". The ISRA regulations provide that a transferor may close a transaction prior to the DEPE's approval of a negative declaration if the transferor enters into an administrative consent order with the DEPE. The Company is currently a signatory to administrative consent orders with respect to two formerly leased or owned industrial establishments and has recently closed a facility and received a negative declaration with respect thereto. Management believes that any requirements that may be imposed by the DEPE with respect to these sites will not have a materially adverse effect on the financial condition or operations of the Company.\nThe Company's paperboard and newsprint mills are large consumers of energy, using either natural gas or coal. Approximately 68% of the Company's total paperboard tonnage is produced by mills which have coal-fired boilers. The cost of energy is dependent, in part, on environmental regulations concerning sulfur dioxide and particulate emissions.\nBecause various pollution control standards are subject to change,\nit is not possible at this time to predict the amount of capital expenditures that will ultimately be required to comply with future standards. In particular, the United States Environmental Protection Agency has proposed a comprehensive rule governing the pulp, paper and paperboard industry, which could require substantial expenditures to achieve compliance on the part of the Company. For the past three years, the Company has spent an average of approximately $10.0 million annually on capital expenditures for environmental purposes. Further sums may be required in the future, although, in the opinion of management, such expenditures will not have a material effect on its financial condition or results of operations. The amount budgeted for such capital expenditures for fiscal 1995 is approximately $20.0 million. Since the Company's competitors are, or will be, subject to comparable pollution control standards, including the proposed rule discussed above, if implemented, management is of the opinion that compliance with future pollution standards will not adversely affect the Company's competitive 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 of the registrant during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nMARKET INFORMATION The Company is a wholly-owned subsidiary of JSC, and therefore, all of the outstanding common stock of the Company (\"JSCE Common Stock\") is owned by JSC. As a result, there is no established public market for the JSCE Common Stock.\nDIVIDENDS The Company has not paid cash dividends on its common stock. The ability of the Company to pay dividends in the future is restricted by certain provisions contained in the 1994 Credit Agreement and the indentures relating to the outstanding indebtedness of JSC (U.S.) which the Company guarantees. Delaware law generally requires that dividends are payable only out of a company's surplus or current net profits in accordance with the General Corporation Law of Delaware. Such Delaware law limitations apply to the payment of dividends by the Company. Any determination to pay cash dividends in the future will be at the discretion of the Board of Directors and will be dependent upon the Company's results of operations, financial condition, contractual restrictions and other factors deemed relevant at the time by the Board of Directors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (In millions, except statistical data)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGeneral\nMarkets for containerboard, corrugated shipping containers and newsprint, three of the Company's most important products, are generally subject to cyclical changes in the economy and changes in industry capacity, both of which can significantly impact selling prices and the Company's profitability. The sluggish U.S. economy in 1991, 1992 and 1993, coupled with a decline in export markets, caused an imbalance of supply and demand, which resulted in excess inventories and lower prices for these products. From the first quarter of 1991 through the third quarter of 1993, reported linerboard prices fell from approximately $350 per ton to approximately $280 per ton. Similarly, newsprint prices were depressed over the same period. As a result, profits of companies in these industries, including profits of the Company, fell sharply in 1993.\nContainerboard markets began to recover in late 1993 and, based on increasing demand, a price increase was successfully implemented in the fourth quarter of 1993. As the economy gained strength and export shipments increased during 1994, demand for containerboard products improved. Excess inventories were sold and additional price increases were rapidly implemented. By the end of 1994, the reported price of linerboard had risen to $430 per ton and increased an additional $50 per ton on January 1, 1995. An additional price increase for containerboard has been announced by the Company for April 1, 1995. Demand for newsprint improved in the second half of 1994 and price increases were implemented by the Company in August and December of 1994, for a total price increase of $87 per ton. Additional newsprint increases have been announced by the Company effective March 1 and May 1, 1995.\nPrices for the Company's other products showed mixed performance for 1994. Recycled boxboard prices were comparable to 1993, but SBS prices, although rising in the second half of 1994, were 5% lower on average compared to last year. Recycled cylinderboard prices were higher by approximately 8% compared to last year.\nAs the economic recovery progressed, unprecedented demand for recycled fibre caused shortages of this material and prices escalated at a dramatic rate beginning in the second quarter of the year. While the effect of the reclaimed fibre price increases is favorable to the Company's reclamation products division, it is unfavorable to the Company overall because of the increase in fibre cost to the paper mills that use reclaimed fibre. The Company believes that its cost of fibre, a key raw material, will remain substantially higher than in prior years, although it does not anticipate a problem satisfying its need for this material in the foreseeable future.\nWith the exception of recycled fibre, the moderate level of inflation during the past few years, has not had a material impact on the Company's financial position or operating results. The Company uses the LIFO method of accounting for approximately 80% of its inventories. Under this method, the cost of products sold reported in the financial statements approximates current cost and thus reduces the distortion in reported income due to increasing costs.\nCost Reduction Initiatives\nThe cyclical downturn of the early 1990's led management to undertake several major cost reduction initiatives. In 1991, the Company implemented an austerity program to freeze staff levels, defer certain discretionary spending programs and more aggressively manage capital expenditures and working capital in order to conserve cash and reduce interest expense. While these measures successfully reduced expenses and increased cash flow, the length and extent of the industry downturn led the Company, in 1993, to initiate a new six year plan to reduce costs, increase volume and improve product mix (the \"Cost Reduction Initiatives\").\nThe Cost Reduction Initiatives include systematic Company-wide efforts designed to improve the cost competitiveness of all the Company's operating facilities and staff functions. In addition to increases in volume and improvements in product mix resulting from less commodity oriented business at its converting operations, the program focuses on opportunities to reduce costs and other measures, including (i) productivity improvements, (ii) capital projects which provide high returns and quick paybacks, (iii) reductions in the purchase cost of materials, (iv) reductions in personnel costs and (v) reductions in waste cost.\nRestructuring Program\nTo further counteract the downturn in the industries in which the Company operates, management examined its cost and operating structure and developed a restructuring program (the \"Restructuring Program\") to improve its long-term competitive position. As a result of management's review, in September 1993, the Company recorded a pre-tax charge of $96 million including a provision for direct expenses associated with (i) plant closures (consisting primarily of employee severance and termination benefits, lease termination costs and environmental costs), (ii) asset write-downs (consisting primarily of write-offs of machinery no longer used in production and nonperforming machine upgrades), (iii) employee severance and termination benefits for the elimination of salaried and hourly personnel in operating and management realignment and (iv) relocation of employees and consolidation of plant operations.\nThe restructuring charge consisted of approximately $43 million for the write-down of assets at closed facilities and other nonproductive assets and $53 million of anticipated cash expenditures. Approximately $23.9 million (45%) of the cash expenditures were incurred through 1994, the majority of which related to plant closure costs. The remaining cash expenditures will continue to be funded through operations, a majority of which will be paid in 1995 and 1996, as originally planned. Based on expenditures to date and those anticipated by the original plan, no significant adjustment to the reserve balance is expected at this time.\nEnvironmental Matters\nIn 1993, the Company recorded a provision of $54 million of which $39 million relates to environmental matters, representing asbestos and PCB removal, solid waste cleanup at existing and former operating sites, and expenses for response costs at various sites where the Company has received notice that it is a potentially responsible party (\"PRP\"). During 1994, the Company incurred $6.1 million in cash expenditures related to these environmental matters. The Company, as well as other companies in the industry,\nfaces potential environmental liability related to various sites at which wastes have allegedly been deposited. The Company has received notice that it is or may be a PRP at a number of federal and state sites (the \"Sites\") where remedial action may be required. Because the laws that govern the clean up of waste disposal sites have been construed to authorize joint and several liability, government agencies or other parties could seek to recover all response costs for any Site from any one of the PRPs for such Site, including the Company, despite the involvement of other PRPs. Although the Company is unable to estimate the aggregate response costs in connection with the remediation of all Sites, if the Company were held jointly and severally liable for all response costs at some or all of the Sites, it would have a material adverse effect on the financial condition and results of operations of the Company. However, joint and several liability generally has not in the past been imposed on PRPs, and, based on such past practice, the Company's past experience and the financial conditions of other PRPs with respect to the Sites, the Company does not expect to be held jointly and severally liable for all response costs at any Site. Liability at waste disposal sites is typically shared with other PRPs and costs generally are allocated according to relative volumes of waste deposited. At most Sites, the waste attributed to the Company is a very small portion of the total waste deposited at the Site (generally significantly less than 1%). There are approximately ten Sites where final settlement has not been reached and where the Company's potential liability is expected to exceed de minimis levels. Accordingly, the Company believes that its estimated total probable liability for response costs at the Sites was adequately reserved at December 31, 1994. Further, the estimate takes into consideration the number of other PRPs at each site, the identity, and financial position of such parties, in light of the joint and several nature of the liability, but does not take into account possible insurance coverage or other similar reimbursement.\nResults of Operations\n1994 Compared to 1993 Results for 1994 reflect the accelerating demand for the Company's products. Net sales of $3.23 billion for 1994 set a record, up 9.7% compared to 1993. Increases\/(decreases) in sales for each of the Company's segments are shown in the chart below.\nNet sales in the Paperboard\/Packaging Products segment for 1994 increased $274.2 million, up 10.2% compared to 1993, due to higher sales prices and increased sales volume. Record sales volume was achieved for several major products, including: containerboard up 3.8%; corrugated shipping containers up 4.7%; and reclamation products up 5.8%. Sales growth for this segment was mitigated by the shutdown of several operating facilities in late 1993 and early 1994, including a coated recycled boxboard mill, five converting plants and two reclamation products facilities, in connection with the Company's Restructuring Program.\nNet sales in the Newsprint segment for 1994 increased $11.5 million, up 4.6% compared to 1993, due primarily to higher sales prices in the second half of the year.\nCosts and expenses in both segments in 1994 were favorably impacted by the Cost Reduction Initiatives begun in 1993 and by the Restructuring Program (together, the \"Plans\"). Cost of goods sold as a percent of net sales in the Paperboard\/Packaging Products segment declined from 85.6% in 1993 to 82.5% in 1994, primarily as a result of higher sales prices, improved capacity utilization and other benefits associated with the Plans. Cost of goods sold as a percent of net sales in the Newsprint segment improved modestly from 102.8% in 1993 to 102.2% in 1994, primarily as a result of higher sales prices. Selling and administrative expenses in both segments in 1994 were also favorably impacted by the Plans.\nThe Company increased its weighted average discount rate in measuring its pension obligations from 7.6% to 8.5% and its rate of increase in compensation levels from 4.0% to 5.0% at December 31, 1994. The net effect of changing these assumptions was the primary reason for the decrease in projected benefit obligations and the changes are expected to decrease pension cost in 1995 by approximately $3.9 million.\nAverage debt levels outstanding decreased in 1994 as a result of the Recapitalization discussed below; however, interest expense of $268.5 million for 1994 increased 5.6% compared to 1993 due to the impact of higher effective interest rates in 1994.\nThe tax provision for 1994 was $16.4 million compared to a tax benefit for 1993 of $83.0 million. The Company's effective tax rate for 1994 was higher than the Federal statutory tax rate due to several factors, the most significant of which was the effect of permanent differences between book and tax accounting.\nThe Company recorded an extraordinary loss from the early extinguishment of debt (net of income tax benefits) amounting to\n$55.4 million in 1994 and $37.8 million in 1993. The Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 112 \"Employers' Accounting for Postemployment Benefits\" in 1994, the effect of which was not material.\n1993 Compared to 1992\nThe Company's net sales for 1993 decreased 1.7% to $2.95 billion compared to $3.0 billion in 1992. Increases\/(decreases) in each of the Company's segment sales are shown in the chart below.\nNet sales decreased 1.9% in the Paperboard\/Packaging Products segment in 1993. The decrease was due primarily to lower prices and changes in product mix for containerboard, corrugated shipping containers and folding cartons. This decrease was partially offset by an increase in sales volume primarily of corrugated shipping containers, which set a record in 1993. A newly constructed corrugated container facility and several minor acquisitions in 1992 caused net sales to increase $34.9 million for 1993.\nNet sales increased 0.3% in the Newsprint segment as a result of an increase in sales volume in 1993 compared to 1992, partially offset by a decline in sales prices.\nCost of goods sold as a percent of net sales for the Paperboard\/Packaging Products segment rose from 81.8% in 1992 to 85.6% in 1993 due primarily to the aforementioned changes in pricing and product mix. Cost of good sold as a percent of net sales in the Newsprint segment rose from 99.0% in 1992 to 102.8% in 1993 due primarily to the higher cost of energy and fibre and decreases in sales price. In 1993, the Company changed the estimated depreciable lives of its paper machines and major converting equipment. These changes were made to better reflect the estimated periods during which the assets will remain in service and were based upon the Company's historical experience and comparable industry practice. These changes were made effective January 1, 1993 and had the effect of reducing depreciation expense by $17.8 million and decreasing the 1993 net loss by $11.0 million.\nSelling and administrative expenses increased to $239.2 million (3.4%) for 1993 compared to $231.4 million for 1992. The increase was due primarily to higher provisions for retirement costs, acquisitions, new facilities and other costs.\nIn order to minimize significant year-to-year fluctuations in pension cost caused by financial market volatility, the Company changed, effective January 1, 1993, the method of accounting for the recognition of fluctuations in the market value of pension\nassets. The effect of this change on 1993 results of operations, including the cumulative effect of prior years, was not material. See Note 6 to the Company's consolidated financial statements.\nThe Company reduced its weighted average discount rate in measuring its pension obligations from 8.75% to 7.6% and its rate of increase in compensation levels from 5.5% to 4.0% at December 31, 1993. The net effect of changing these assumptions was the primary reason for the increase in the projected benefit obligations and the changes are expected to increase pension cost by approximately $3.4 million in 1994.\nInterest expense for 1993 declined $45.9 million due to lower effective interest rates and the lower level of subordinated debt outstanding resulting primarily from a $231.8 million capital contribution received in August 1992.\nThe benefit from income taxes for 1993 was $83.0 million compared to a tax provision of $10.0 million in 1992. The significant difference in the income tax provision from 1993 to 1992 results from the use of the liability method of accounting which restored deferred income taxes and increased the related asset values for tax effects previously recorded as a reduction to the carrying amount of the related assets under prior business combinations. The Company's effective tax rate for 1993 was lower than the Federal statutory tax rate due to the effect of permanent differences between book and tax accounting and a $5.7 million provision to adjust deferred tax assets and liabilities in 1993 due to the enacted Federal income tax rate change from 34% to 35%.\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\" and SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". The cumulative effect of adopting SFAS No. 109 was to increase net income for 1993 by approximately $20.5 million. The cumulative effect of adopting SFAS No. 106 was to decrease net income for 1993 by approximately $37.0 million.\nLiquidity and Capital Resources\nThe Company completed a recapitalization plan in May 1994 (the \"Recapitalization\") in order to improve its operating and financial flexibility by reducing the level and overall cost of its debt, extending maturities of indebtedness, increasing stockholder's equity and increasing its access to capital markets. In connection with the Recapitalization, (i) JSC issued and sold 19,250,000 shares of common stock pursuant to a registered public offering at an initial public offering price of $13.00 per share, (ii) JS Group, through its wholly-owned subsidiary Smurfit International B.V. (\"SIBV\"), purchased an additional 11,538,462 shares of common stock for $150 million, (iii) JSC (U.S.) issued and sold $300 million aggregate principal amount of 11.25% Series A Senior Notes due 2004 and $100 million aggregate principal amount of 10.75% Series B Senior Notes due 2002 pursuant to a registered public offering (the \"1994 Senior Notes\") and (iv) the Company entered into a new bank credit facility (the \"1994 Credit Agreement\") consisting of a $450 million revolving credit facility (the \"New Revolving Credit Facility\") of which up to $150 million may consist of letters of credit, a $300 million Tranche A Term Loan and a $900 million Tranche B Term Loan. Proceeds of the Recapitalization, including $370.6 million from the shares issued to the public and SIBV, $400.0 million from the sale of the 1994 Senior Notes and borrowings under the 1994 Credit Agreement were used to extinguish the Company's 1989 and 1992 term loans, the 1989 revolving credit\nfacility, the Company's senior secured notes and redeem the Company's subordinated debentures, including related premiums and accrued interest, and pay related fees and expenses. Had the Recapitalization occurred on January 1, 1994, the Company's income before extraordinary item would have been $42.0 million and the net loss would have been $15.1 million for 1994.\nOutstanding loans under the Tranche A Term Loan and the New Revolving Credit Facility bear interest at rates selected at the option of the Company equal to the alternate base rate (\"ABR\") plus 1.5% per annum or the adjusted LIBOR Rate plus 2.5% per annum (8.77% at December 31, 1994). Interest on outstanding loans under the Tranche B Term Loan is payable at a rate per annum selected at the option of the Company, equal to the prime rate plus 2% per annum or the adjusted LIBOR rate plus 3% per annum (8.56% at December 31, 1994). The ABR rate is defined as the highest of Chemical Bank's prime lending rate, 1\/2 of 1% in excess of the Federal Funds Rate or 1% in excess of the base certificate of deposit rate. The New Revolving Credit Facility matures in 2001. The Tranche A Term Loan matures in various installments from 1995 to 2001. The Tranche B Term Loan matures in various installments from 1995 to 2002.\nThe 1994 Credit Agreement contains various business and financial covenants including, among other things, (i) limitations on dividends, redemptions and repurchases of capital stock, (ii) limitations on the incurrence of indebtedness, liens, leases, sale- leaseback transactions, (iii) limitations on capital expenditures, (iv) maintenance of minimum levels of consolidated earnings before depreciation, interest, taxes and amortization and (v) maintenance of minimum interest coverage ratios. Such restrictions, together with the highly leveraged position of the Company, could restrict corporate activities, including the Company's ability to respond to market conditions, to provide for unanticipated capital expenditures or to take advantage of business opportunities.\nThe 1994 Credit Agreement imposes an annual limit on future capital expenditures of $150.0 million. The capital spending limit is subject to increase by an amount up to $75.0 million in any year if the prior year's spending was less than the maximum amount allowed. The Company has a carryover of $62.4 million for 1995. Capital expenditures in 1994, including property and timberland additions and acquisitions, were $166.9 million. Because the Company has invested heavily in its core businesses in prior years, management believes the annual limitation for capital expenditures does not impair its plans for maintenance, expansion and continued modernization of its facilities.\nThe Company's earnings are significantly affected by the amount of interest on its indebtedness. The Company enters into interest rate swap, cap and option agreements to manage its interest rate exposure on its indebtedness. Management's objective is to protect the Company from interest rate volatility and reduce or cap interest expense within acceptable levels of risk. Periodic amounts to be paid or received under these agreements are accrued and recognized as adjustments to interest expense. The Company amends existing agreements or enters into agreements with offsetting effects when necessary to change its net position. During 1994, as interest rates increased, the Company amended several of its agreements and entered new agreements, including options, to respond to those rate changes. Significant option positions entered into to offset increasing rates in 1994\nexpired unexercised, and there are no significant options outstanding at December 31, 1994.\nThe table below shows certain interest rate swap agreements outstanding at December 31, 1994, the related maturities for the years thereafter and the contracted pay and receive rates for such agreements. Included are swaps with a notional amount of $345.0 million not associated with existing debt at December 31, 1994, due to previous debt extinguishments, which are carried at fair market value with changes to the fair value reflected in interest expense.\nIn addition, the Company has swap agreements not associated with existing debt at December 31, 1994 with a notional amount of $180 million (of which $100 million matures in 1995 and $80 million matures in 1996) whereby the Company is receiving a weighted average variable rate of 5.2% and pays a weighted average variable rate of 6.1%.\nThe Company has a cap agreement with a notional amount of $100.0 million, which matures in 1996, on variable rate debt which caps the Company's variable interest rates at 7.5% on the notional amount. In addition, the Company has a cap agreement with a notional amount of $100.0 million, which matures in 1996, on variable rate debt which limits the Company's interest payments to a range of 5.5-7.0% on the notional amount.\nOperating activities have historically been the major source of cash for the Company's working capital needs, capital expenditures and debt payments. Net cash provided by operating activities for 1994 improved $71.1 million (90.9%) over 1993. Scheduled payments due in 1995 and 1996 under the 1994 Credit Agreement are $46.0 million and $117.0 million, respectively, with increasing amounts thereafter. The Company believes that cash provided by operating activities and available financing sources will be sufficient for the next several years to pay interest on the Company's obligations, amortize its term loans and fund capital expenditures.\nAt December 31, 1994, the Company had $303.2 million of unused borrowing capacity under its 1994 Credit Agreement and borrowing capacity of $12.0 million under its $230.0 million accounts receivable securitization program (the \"1991 Securitization Program\") subject to the Company's level of eligible accounts receivable. In the first quarter of 1995, the Company entered into a new $315.0 million accounts receivable securitization program (the \"1995 Securitization\"), consisting of a $300.0 million trade\nreceivables-backed commercial paper program and a $15.0 million term loan. Proceeds of the 1995 Securitization were used to extinguish the Company's 1991 Securitization Program.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page No.\nThe following consolidated financial statements of JSCE, Inc. are included in this report:\nConsolidated balance sheets - December 31, 1994 and 1993 . . . . . .27 For the years ended December 31, 1994, 1993 and 1992: Consolidated statements of operations . . . . .. . . . . . . . .28 Consolidated statements of stockholder's deficit. . . . . . . .29 Consolidated statements of cash flows . . . . . . . . . . . . .30 Notes to consolidated financial statements. . . . . . . . . . . . . .31\nThe following consolidated financial statement schedules of JSCE, Inc. are included in Item 14(a):\nVIII: Valuation and Qualifying Accounts . . . . . . . . . . . .71\nAll other schedules specified under Regulation S-X for JSCE, Inc. have been omitted because they are either not applicable, not required or because the information required is included in the financial statements or notes thereto.\nMANAGEMENT'S STATEMENT OF RESPONSIBILITY\nThe management of the Company is responsible for the information contained in the consolidated financial statements and in other parts of this report. The consolidated financial statements have been prepared by the Company in accordance with generally accepted accounting principles appropriate in the circumstances, and necessarily include certain amounts based on management's best estimate and judgment.\nThe Company maintains a system of internal accounting control, which it believes is sufficient to provide reasonable assurance that in all material respects transactions are properly authorized and recorded, financial reporting responsibilities are met and accountability for assets is maintained. In establishing and maintaining any system of internal control, judgment is required to assess and balance the relative costs and expected benefits. Management believes that through the careful selection of employees, the division of responsibilities and the application of formal policies and procedures, the Company has an effective and responsive system of internal accounting controls. The system is monitored by the Company's staff of internal auditors, who evaluate and report to management on the effectiveness of the system.\nThe Audit Committee of the Board of Directors is composed of three directors who meet with the independent auditors, internal auditors and management to discuss specific accounting, reporting and internal control matters. Both the independent auditors and internal auditors have full and free access to the Audit Committee.\nJames E. Terrill President, Chief Executive Officer\nJohn R. Funke Vice President and Chief Financial Officer (Principal Accounting Officer)\nREPORT OF INDEPENDENT AUDITORS\nBoard of Directors JSCE, Inc.\nWe have audited the accompanying consolidated balance sheets of JSCE, Inc. as of December 31, 1994 and 1993, and the related consolidated statements of operations, stockholder's deficit and cash flows for each of the three years in the period ended December 31, 1994. 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 JSCE, Inc. at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 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 5 and Note 6 to the financial statements, in 1993, the Company changed its method of accounting for income taxes and postretirement benefits.\nErnst & Young LLP\nSt. Louis, Missouri January 30, 1995 except as to Note 14, as to which the date is February 23, 1995\nSee notes to consolidated financial statements.\n4. -- Long-Term Debt\nLong-term debt at December 31 consists of:\n5. -- Income Taxes (cont)\nProvisions for (benefit from) income taxes before extraordinary item and cumulative effect of accounting changes were as follows:\nThe Company increased its deferred tax assets and liabilities in 1993 as a result of legislation enacted during 1993 increasing the corporate federal statutory tax rate from 34% to 35% effective January 1, 1993.\nThe federal income tax returns for 1989 through 1991 are currently under examination. While the ultimate results of such examination cannot be predicted with certainty, the Company's management believes that the examination will not have a material adverse effect on its consolidated financial condition or results of operations.\nThe components of the provision for deferred taxes for the year ended December 31, 1992 were as follows:\nThe Company made income tax payments of $2.6 million, $33.0 million, and $6.6 million in 1994, 1993, and 1992, respectively.\n6. -- Employee Benefit Plans\nPension Plans The Company sponsors noncontributory defined benefit pension plans covering substantially all employees not covered by multi-employer plans. Plans that cover salaried and management employees provide pension benefits that are based on the employee's five highest consecutive calendar years' compensation during the last ten years of service. Plans covering non-salaried employees generally provide benefits of stated amounts for each year of service. These plans provide reduced benefits for early retirement. The Company's funding policy is to make minimum annual contributions required by applicable regulations. The Company also participates in several multi-employer pension plans, which provide defined benefits to certain union employees.\nIn order to minimize significant year-to-year fluctuations in pension cost caused by financial market volatility, the Company changed, effective as of January 1, 1993 the method of accounting used for determining the market-related value of plan assets. The method changed from a fair market value to a calculated value that recognizes all changes in a systematic manner over a period of four years and eliminates the use of a corridor approach for amortizing gains and losses. The effect of this change on 1993 results of operations, including the cumulative effect of prior years, was not material.\n6. -- Employee Benefit Plans (cont)\nAssumptions used in the accounting for the defined benefit plans were:\nThe components of net pension income for the defined benefit plans and the total contributions charged to pension expense for the multi- employer plans follow:\nThe following table sets forth the funded status and amounts recognized in the consolidated balance sheets at December 31 for the Company's and its subsidiaries' defined benefit pension plans:\nApproximately 40% of plan assets at December 31, 1994 are invested in cash equivalents or debt securities and 60% are invested in equity securities, including common stock of JS Group having a market value of $117.2 million.\n6. -- Employee Benefit Plans (cont)\nSavings Plans The Company sponsors voluntary savings plans covering substantially all salaried and certain hourly employees. The Company match, which is paid in JSC stock, is fifty percent of each participant's contributions up to an annual maximum. The Company's expense for the savings plans totalled $5.3 million, $5.3 million and $5.0 million in 1994, 1993 and 1992 respectively.\nPostretirement Health Care and Life Insurance Benefits The Company provides certain health care and life insurance benefits for all salaried and certain hourly employees. The Company has various plans under which the cost may be borne either by the Company, the employee or partially by each party. The Company does not currently fund these plans. These benefits are discretionary and are not a commitment to long-term benefit payments. The plans were amended effective January 1, 1993 to allow employees who retire on or after January 1, 1994 to become eligible for these benefits only if they retire after age 60 while working for the Company.\nEffective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\", which requires companies to accrue the expected cost of retiree benefit payments, other than pensions, during employees' active service period. The Company elected to immediately recognize the accumulated liability, measured as of January 1, 1993. The cumulative effect of this change in accounting principle resulted in a charge of $37.0 million (net of income tax benefits of $21.9 million). The Company had previously recorded an obligation of $36.0 million in connection with prior business combinations. In 1992 the cost of the postretirement benefits of $6.4 million was recognized as claims were paid.\nThe following table sets forth the accumulated postretirement benefit obligation (\"APBO\") with respect to these benefits as of December 31:\n6. -- Employee Benefit Plans (cont)\nA weighted-average discount rate of 8.5% and 7.6% was used in determining the APBO at December 31, 1994 and 1993, respectively. The weighted-average annual assumed rate of increase in the per capita cost of covered benefits (\"healthcare cost trend rate\") was 10.5%, with an annual decline of 1% until the rate reaches 5.5%. The effect of a 1% increase in the assumed healthcare cost trend rate would increase both the APBO as of December 31, 1994 by $2.9 million and the annual net periodic postretirement benefit cost for 1994 by $.3 million.\n7. -- Related Party Transactions\nTransactions with JS Group Transactions with JS Group, its subsidiaries and affiliates were as follows:\nProduct sales to and purchases from JS Group, its subsidiaries, and affiliates are consummated on terms generally similar to those prevailing with unrelated parties.\nThe Company provides certain subsidiaries and affiliates of JS Group with general management and elective management services under separate Management Services Agreements. In consideration for general management services, the Company is paid a fee up to 2% of the subsidiaries' or affiliate's gross sales. In consideration for elective services, the Company is reimbursed for its direct cost of providing such services.\nIn 1991 an affiliate of JS Group completed a rebuild of the No. 2 paperboard machine owned by the affiliate that is located in the Company's Fernandina Beach, Florida paperboard mill (the \"Fernandina Mill\"). Pursuant to an operating agreement between the Company and the affiliate, the Company operates and manages the No. 2 paperboard machine and is compensated for its direct production and manufacturing costs and indirect manufacturing, selling and administrative costs incurred by the Company for the entire Fernandina Mill. The compensation is determined by applying various formulas and agreed upon amounts to the subject costs. The amounts reimbursed to the Company are reflected as reductions of cost of goods sold and selling and administrative expenses in the accompanying consolidated statements of operations.\n7. -- Related Party Transactions (cont)\nTransactions with Times Mirror Under the terms of a long-term agreement, Smurfit Newsprint Corporation (\"SNC\"), a majority-owned subsidiary of the Company, supplies newsprint to Times Mirror, a minority shareholder of SNC, at amounts which approximate prevailing market prices. The obligations of the Company and Times Mirror to supply and purchase newsprint are wholly or partially terminable upon the occurrence of certain defined events. Sales to Times Mirror for 1994, 1993 and 1992 were $113.0 million, $115.2 million and $114.0 million, respectively.\nTransactions with Morgan Stanley & Co. In connection with the Recapitalization, Morgan Stanley & Co., in its capacity as underwriter of public equity and debt securities, received fees from the Company of $15.5 million.\n8. -- Leases\nThe Company leases certain facilities and equipment for production, selling and administrative purposes under operating leases. Future minimum lease payments at December 31, 1994, required under operating leases that have initial or remaining noncancelable lease terms in excess of one year are $31.1 million in 1995, $21.5 million in 1996, $15.6 million in 1997, $10.9 million in 1998, $8.6 million in 1999 and $19.5 million thereafter.\nNet rental expense was $45.5 million, $45.0 million, and $42.2 million for 1994, 1993 and 1992, respectively.\n9. -- Fair Value of Financial Instruments\nThe estimated fair values of the Company's financial instruments are as follows:\n9. -- Fair Value of Financial Instruments (cont)\nThe carrying amount of cash equivalents approximates fair value because of the short maturity of those instruments. 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. The fair value of the interest rate swap agreements is the estimated amount the Company would pay or receive, net of accrued interest expense, to terminate the agreements at December 31, 1994 and 1993, taking into account current interest rates and the current credit worthiness of the swap counterparties.\n10. -- Restructuring Charge\nDuring 1993, the Company recorded a pretax charge of $96.0 million to recognize the effects of a restructuring program designed to improve the Company's long-term competitive position of which $43 million related to the write-down of assets at closed facilities and other nonproductive assets and $53 million represented cash expenditures. The charge included a provision for direct expenses associated with plant closures, reductions in workforce, realignment and consolidation of various manufacturing operations and write-downs of nonproductive assets. The restructuring program is proceeding as originally planned and no significant adjustment to the reserve is anticipated at this time.\n11. -- Contingencies\nThe Company's past and present operations include activities which are subject to federal, state and local environmental requirements, particularly relating to air and water quality. The Company faces potential environmental liability as a result of violations of permit terms and similar authorizations that have occurred from time to time at its facilities.\nThe Company faces potential liability for response costs at various sites with respect to which the Company has received notice that it may be a \"potentially responsible party\" (PRP) as well as contamination of certain Company-owned properties, under the Comprehensive Environmental Response, Compensation and Liability Act concerning hazardous substance contamination. In estimating its reserves for environmental remediation and future costs, the Company's estimated liability reflects only the Company's expected share. In determining the liability, the estimate takes into consideration the number of other PRP's at each site, the identity and financial condition of such parties and experience regarding similar matters. No amounts have been recorded for potential recoveries from insurance carriers.\nDuring 1993, the Company recorded a pretax charge of $54.0 million of which $39.0 million represents asbestos and PCB removal, solid waste cleanup at existing and former operating sites and expenses for response costs at various sites where the Company has received notice that it is a potentially responsible party.\nThe Company is a defendant in a number of lawsuits and claims arising out of the conduct of its business, including those related to environmental matters. While the ultimate results of such suits or other proceedings against the Company cannot be predicted with certainty, the management of the Company believes that the resolution of these matters will not have a material adverse effect on its consolidated financial condition or results of operation.\n12. -- Business Segment Information\nThe Company's business segments are paperboard\/packaging products and newsprint. Substantially all the Company's operations are in the United States. The Company's customers represent a diverse range of industries including paperboard and paperboard packaging, consumer products, wholesale trade, retailing, agri-business, and newspaper publishing located throughout the United States. Credit is extended based on an evaluation of the customer's financial condition. The paperboard\/packaging products segment includes the manufacture and distribution of containerboard, boxboard and cylinderboard, corrugated containers, folding cartons, fibre partitions, spiral cores and tubes, labels and flexible packaging. A summary by business segment of net sales, operating profit, identifiable assets, capital expenditures and depreciation, depletion and amortization follows:\nSales and transfers between segments are not material. Export sales are less than 10% of total sales. Corporate assets consist principally of cash and cash equivalents, deferred income taxes, deferred debt issuance costs and other assets which are not specific to a segment.\n13. -- Quarterly Results (Unaudited)\nThe following is a summary of the unaudited quarterly results of operations:\n14. -- Subsequent Events\nOn February 23, 1995, JSC (U.S.) entered into a $315.0 million accounts receivable securitization program (the \"1995 Securitization\") consisting of a $300.0 million trade-receivables-backed commercial paper program and a $15.0 million term loan. The proceeds of the 1995 Securitization were used to extinguish JSC (U.S.)'s borrowings under the 1991 Securitization Program of $230.0 million.\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\nDirectors\nThe following table sets forth the names and ages of the directors of the Company.\nName Age Michael W.J. Smurfit 58 Howard E. Kilroy 59 James E. Terrill 61 James R. Thompson 58 Donald P. Brennan 54 Alan E. Goldberg 40 David R. Ramsay 31 G. Thompson Hutton 39\nThe Board of Directors currently consists of eight directors.\nExecutive Officers\nThe following table sets forth the names, ages and positions of the executive officers of the Company.\nName Age Position Michael W.J. Smurfit 58 Chairman of the Board and Director James E. Terrill 61 President, Chief Executive Officer and Director Howard E. Kilroy 59 Senior Vice President and Director Richard W. Graham 60 Senior Vice President Raymond G. Duffy 53 Vice President - Planning Michael C. Farrar 54 Vice President - Environmental and Governmental Affairs John R. Funke 53 Vice President and Chief Financial Officer Richard J. Golden 52 Vice President - Purchasing Michael F. Harrington 54 Vice President - Personnel and Human Resources Alan W. Larson 56 Vice President and General Manager - Consumer Packaging Division Edward F. McCallum 60 Vice President and General Manager - Container Division Lyle L. Meyer 58 Vice President Patrick J. Moore 40 Vice President and General Manager - Industrial Packaging Division David C. Stevens 60 Vice President and General Manager - Reclamation Division Truman L. Sturdevant 60 Vice President and General Manager of SNC Michael E. Tierney 46 Vice President and General Counsel and Secretary Richard K. Volland 56 Vice President - Physical Distribution William N. Wandmacher 52 Vice President and General Manager - Containerboard Mill Division Gary L. West 52 Vice President - Sales and Marketing\nBiographies\nDonald P. Brennan has been a Director of the Company since 1989. Mr. Brennan joined Morgan Stanley & Co. Incorporated (\"MS&Co.\") in 1982 and has been a Managing Director of MS&Co. since 1984. He is responsible for MS&Co.'s Merchant Banking Division and is 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, Inc.\"). Mr. Brennan serves as Director of Fort Howard Corporation, Hamilton Services Limited, PSF Finance Holdings, Inc., Shuttleway, Stanklav Holdings, Inc. and Waterford Wedgwood U.K. plc and is Deputy Chairman of Waterford Wedgwood plc.\nRaymond G. Duffy has been Vice President - Planning since July 1983 and served as Director of Corporate Planning from 1980 to 1983.\nMichael C. Farrar was appointed Vice President - Environmental and Governmental Affairs in March 1992. Prior to joining the Company, he was Vice President of the American Paper Institute and the National Forest Products Association for more than 5 years.\nJohn R. Funke has been Vice President and Chief Financial Officer since April 1989 and was Corporate Controller and Secretary from 1982 to April 1989.\nRichard J. Golden has been Vice President - Purchasing since January 1985 and was Director of Corporate Purchasing from October 1981 to January 1985. In January 1994, he was assigned responsibility for world-wide purchasing for JS Group.\nAlan E. Goldberg has been a Director of the Company since 1989. Mr. Goldberg joined MS&Co. in 1979 and has been a member of MS&Co.'s Merchant Banking Division since its formation in 1985 and a Managing Director of MS&Co. since 1988. Mr. Goldberg is a Director of MSLEF II, Inc. and a Vice Chairman of MSCP III, Inc. Mr. Goldberg also serves as Director of Amerin Guaranty Corporation, CIMIC Holdings Limited, Centre Cat Limited, Hamilton Services Limited and Risk Management Solutions, Inc.\nRichard W. Graham was appointed Senior Vice President in February 1994. He served as Vice President and General Manager - Folding Carton and Boxboard Mill Division from February 1991 to January 1994. Mr. Graham was Vice President and General Manager - Folding Carton Division from October 1986 to February 1991.\nMichael F. Harrington was appointed Vice President - Personnel and Human Resources in January 1992. Prior to joining the Company, he was Corporate Director of Labor Relations\/Safety and Health with Boise Cascade Corporation for more than 5 years.\nG. Thompson Hutton was elected to the Board of Directors in December 1994. Mr. Hutton has been President and Chief Executive Officer of Risk Management Solutions, Inc., an information services company based in Menlo Park, California, since 1991. Prior to that he was Engagement Manager with McKinsey & Company, Inc. from 1986 to 1991. He also serves as a Director of K2 Technologies, Express Yachts and is a Trustee of Colorado Outward Bound School.\nHoward E. Kilroy has been Chief Operations Director of JS Group since 1978 and President of JS Group since October 1986. He was a member of the Supervisory Board of SIBV from January 1978 to January 1992. He has been a Director of the Company since 1989 and Senior Vice President for more than 5 years. He will retire from his executive positions with JS Group and the Company at the end of March 1995, but will remain a Director of JS Group and the Company. In addition, he is Governor (Chairman) of Bank of Ireland and a Director of Aran Energy plc.\nAlan W. Larson has been Vice President and General Manager - Consumer Packaging Division since October 1988. Prior to joining the Company in 1988, he was Executive Vice President of The Black and Decker Corporation.\nEdward F. McCallum has been Vice President and General Manager - Container Division since October 1992. He served as Vice President and General Manager of the Industrial Packaging Division from January 1991 to October 1992. Prior to that time, he served in various positions in the Container Division since joining the Company in 1971.\nLyle L. Meyer has been Vice President since April 1989. He served as President of Smurfit Pension and Insurance Services Company (\"SPISCO\") from 1982 until 1992, when SPISCO was merged into the Company.\nPatrick J. Moore has been Vice President and General Manager - Industrial Packaging Division since December 1994. He served as Vice President and Treasurer from February 1993 to December 1994 and was Treasurer from October 1990 to February 1993. Prior to joining the Company in 1987 as Assistant Treasurer, Mr. Moore was with Continental Bank in Chicago where he served in various corporate lending, international banking and administrative capacities.\nDavid R. Ramsay has been a Director of the Company since 1989. Mr. Ramsay joined MS&Co. in 1989 and is a Vice President of MS&Co.'s Merchant Banking Division. Mr. Ramsay also serves as a Director of ARM Financial Group Inc., Integrity Life Insurance Company, National Integrity Life Insurance Company, Consolidated Hydro, Inc., Hamilton Services Limited, A\/S Bulkhandling, Stanklav Holdings, Inc. and Risk Management Solutions, Inc. and is President and a Director of PSF Finance Holdings, Inc.\nMichael W.J. Smurfit has been Chairman and Chief Executive Officer of JS Group since 1977. Dr. Smurfit has been Chairman of the Board of the Company since 1989. He was Chief Executive Officer of the Company prior to July 1990.\nDavid C. Stevens has been Vice President and General Manager - Reclamation Division since January 1993. He joined the Company in 1987 as General Sales Manager and was named Vice President later that year. He held various management positions with International Paper and was President of Mead Container Division prior to joining the Company.\nTruman L. Sturdevant has been Vice President and General Manager of SNC since August 1990. Mr. Sturdevant joined the Company in 1984 as Vice President and General Manager of the Oregon City newsprint mill.\nJames E. Terrill was named a Director and President and Chief Executive Officer in February 1994. He served as Executive Vice President - Operations from August 1990 to February 1994. He also served as Executive Vice President of SNC from February 1993 to February 1994 and was President of SNC from February 1986 to February 1993.\nJames R. Thompson was elected to the Board of Directors in July 1994. He is Chairman of Winston & Strawn, a law firm that regularly represents the Company on numerous matters. He served as Governor of the State of Illinois from 1977 to 1991. Mr. Thompson also serves as a Director of FMC Corporation, the Chicago Board of Trade, Chicago and North Western Transportation Company, United Fidelity, Inc., International Advisory Council of the Bank of Montreal, Prime Retail, Inc., Pechiney International, Wackenhut Corrections Corporation and American Publishing Corporation.\nMichael E. Tierney has been Vice President, General Counsel and Secretary since January 1993. He served as Senior Counsel and Assistant Secretary since joining the Company in 1987.\nRichard K. Volland has been Vice President - Physical Distribution since 1978.\nWilliam N. Wandmacher has been Vice President and General Manager - Containerboard Mill Division since January 1993. He served as Division Vice President - Medium Mills from October 1986 to January 1993. Since joining the Company in 1966, he has held increasingly responsible positions in production, plant management and planning, both domestic and foreign.\nGary L. West has been Vice President - Sales and Marketing since December 1994. He was Vice President and General Manager - Industrial Packaging Division from October 1992 to December 1994. He served as Vice President - Converting and Marketing for the Industrial Packaging Division from January 1991 to October 1992. Prior to that time, he held various management positions in the Container and Consumer Packaging divisions since joining the Company in 1980.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nEXECUTIVE COMPENSATION\nThe following table sets forth the cash and noncash compensation for each of the last three fiscal years awarded to or earned by the Chief Executive Officer of JSC and the four other most highly compensated executive officers of JSC (the \"Named Executive Officers\") during 1994. The table also includes Mr. James B. Malloy, who retired from the position of President and Chief Executive Officer on February 1, 1994.\n1992 STOCK OPTION PLAN\nJSC's 1992 Stock Option Plan, as amended (the \"Plan\") became effective on August 26, 1992 and will continue in effect until the later of August 26, 2004 and the expiration of all outstanding options granted thereunder unless terminated sooner by JSC's Board of Directors (the \"Board\"); no options may be granted under the Plan after August 25, 2004 or such earlier date determined by the Board.\nThe purpose of the Plan is to advance the interests of JSC, its subsidiaries and affiliates and their prospective stockholders by providing certain eligible employees of JSC, its subsidiaries and affiliates with an opportunity to acquire a proprietary interest in JSC. Each salaried employee is eligible to be an optionee, provided he\/she is approved by the Board of Directors. In 1994, JSC awarded 640,250 stock options, including 448,000 to all executive officers as a group (12 persons), none to directors (with the exception of Mr. Terrill) and 192,250 to employees other than executive officers, at an exercise or base price of $12.50 with an expiration date of February 14, 2006. As of December 31, 1994, there were 351 participants in the Plan.\nThe Plan provides for the granting of nonstatutory stock options, which are options that do not qualify as incentive stock options within the meaning of the Code.\nThe Plan is administered by a committee of the Board (the \"Option Plan Committee\") consisting solely of two or more directors of JSC who are \"disinterested\" within the meaning of Rule 16b-3 (\"Rule 16b-3\") promulgated under Section 16 of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"). Members of the Option Plan Committee do not receive any remuneration from the Plan. Option Plan Committee members serve at the discretion of the Board.\nThe number of shares reserved for issuance under the Plan is 8,050,000, subject to adjustment upon changes in capitalization. Shares may be treasury shares or authorized but unissued shares.\nUnder the Plan, the Named Executive Officers and certain other eligible employees have been granted options to purchase shares of Common Stock. Options may not be exercised unless they are both \"exercisable\" and \"vested\". The vesting schedule varies according to the schedule set forth in each Option Agreement and provides for vesting over a period of time. The options which have been granted to date generally become fully vested four years from the date of grant. Options vest in their entirety upon the death, disability or retirement, as defined in the Plan, of the optionee. Non-vested options are forfeited upon any other termination of employment. The Option Plan Committee, with the consent of the Board, may accelerate the vesting of options at such times and under such circumstances as it deems appropriate.\nExercisability is determined in accordance with the following rules. Upon the earliest to occur of (i) MSLEF II's transfer of all its Common Stock or, if MSLEF II distributes its Common Stock to its partners pursuant to its dissolution, the transfer by such partners of at least 50% of the aggregate Common Stock received from MSLEF II pursuant to its dissolution, (ii) the 11th anniversary of the grant date of the options, and (iii) a public offering of Common Stock by MSLEF II (a \"MSLEF II Public Offering\") (each, a \"Trigger Date\"), all vested options shall become exercisable and all options which vest subsequently shall become\nexercisable upon vesting; provided, however, that if a public offering occurs prior to the Threshold Date (defined below) all vested options and all options which vest subsequent to the public offering but prior to the Threshold Date shall be exercisable in an amount (as of periodic determination dates) equal to the product of (a) the number of shares of Common Stock vested pursuant to the option (whether previously exercised or not) and (b) the Morgan Percentage (as defined below) as of such date; provided further that, in any event, (i) ten percent of stock options granted prior to 1993 became exercisable on January 1, 1995, and (ii) a holder's options shall become exercisable from time to time in an amount equal to the percentage that the number of shares sold or distributed to its partners by MSLEF II represents of its aggregate ownership of shares on May 11, 1994 (with vested options becoming exercisable up to such number before any non-vested options become so exercisable) less the number of options, if any, which became exercisable on January 1, 1995. The Threshold Date is the earlier of (x) the date the members of the MSLEF II Group (as defined in the Option Plan) shall have received collectively $200,000,000 in cash and\/or other property as a return of their investment in JSC (as a result of sales of shares of JSC's common equity) and (y) the date that the members of the MSLEF II Group shall have transferred an aggregate of at least 30% of JSC's common equity owned by the MSLEF II Group as of August 26, 1992. The Morgan Percentage as of any date is the percentage determined from the quotient of (a) the number of shares of JSC's common equity held as of August 26, 1992, that were transferred by the MSLEF II Group as of the determination date and (b) the number of shares of JSC's common equity outstanding as of such date.\nThe purchase price of the stock purchased pursuant to the exercise of an option is $10 per share for options granted as of August 26, 1992 and $12.50 per share for options granted as of February 15, 1994; and for all other options, such price must be the fair market value of the stock on the day the option is granted. The option price may be adjusted in accordance with the antidilution provisions of the Plan. Upon the exercise of any option, the purchase price must be fully paid in cash or its equivalent or with already owned shares or shares otherwise issuable upon exercise.\nCertain Federal Income Tax Effects -- The following discussion of certain federal income tax effects applicable to options granted under the Plan is a summary only, and reference is made to the Code, the regulations and rulings issued thereunder and judicial decisions relating thereto for a complete statement of all relevant federal tax provisions.\nAn employee generally will not be taxed upon the grant of an option. Rather, at the time of exercise of such option the employee will recognize ordinary income for federal income tax purposes in an amount equal to the excess of the fair market value of the shares purchased over the option price. JSC, or its affiliates and subsidiaries, as the case may be, will generally be entitled to a tax deduction at such time and in the same amount that the employee recognizes ordinary income. Different rules may apply in the case of an employee who is subject to the reporting requirements of Section 16(a) of the Exchange Act.\nIf shares acquired upon exercise of an option are later sold or exchanged, then the difference between the sales price and the fair market value of such shares on the date that ordinary income was recognized with respect thereto will generally be taxable as long- term or short-term capital gain or loss (if the shares are a capital asset of the employee) depending upon whether the shares have been held for more than one year after such date.\nAccording to a published ruling of the Internal Revenue Service, an employee who pays the option price upon exercise of a nonqualified stock option, in whole or in part, by delivering shares already owned by him will recognize no gain or loss for federal income tax purposes on the shares surrendered, but otherwise will be taxed according to the rules described above. With respect to shares acquired upon exercise that are equal in number to the shares surrendered, the basis of such shares will be equal to the basis of the shares surrendered, and the holding period of shares acquired will include the holding period of the shares surrendered. The basis of additional shares received upon exercise will be equal to the fair market value of such shares on the date that governs the determination of the employee's ordinary income, and the holding period for such additional shares will commence on such date.\nOption Grants in Last Fiscal Year -- The following table provides information concerning stock options granted to the Named Executive Officers effective as of February 15, 1994.\nOption Exercises and Year-End Value Table -- The following table summarizes the exercise of options and the value of options held by the Named Executive Officers as of the end of 1994.\nPENSION PLANS\nSalaried Employees' Pension Plan and Supplemental Income Pension Plans\nJSC and its subsidiaries maintain a non-contributory pension plan for salaried employees (the \"Pension Plan\") and two non- contributory supplemental income pension plans (the \"SIP I\" and \"SIP II\", together, the \"SIP Plans\") for certain key executive officers, under which benefits are determined by final average earnings and years of credited service and are offset by a certain portion of social security benefits. For purposes of the Pension Plan, final average earnings equals the average of the highest five consecutive years of the participants' last 10 years of service, including overtime and certain bonuses, but excluding bonus payments under the Management Incentive Plan, deferred or acquisition bonuses, fringe benefits and certain other compensation. For purposes of each SIP, final average earnings equals the participant's average earnings, including bonus payments made under the Management Incentive Plan, for the five consecutive highest-paid calendar years out of the last 10 years of service. SIP I recognizes up to 20 years of credited service and SIP II recognizes 22.5 years of credited service.\nThe pension benefits for the Named Executive Officers can be calculated pursuant to the following table, which shows the total estimated single life annuity payments that would be payable to the Named Executive Officers participating in the Pension Plan and one of the SIP Plans after various years of service at selected compensation levels. Payments under the SIP Plans are an unsecured liability of JSC.\nDr. Smurfit and Mr. Malloy participate in SIP Plan I and have 39 and 15 years of credited service, respectively. SIP Plan II became effective January 1, 1993, and Messrs. Terrill, Graham, Funke and Stevens participate in such plan and have 23, 36, 18 and 7 years of credited service, respectively. Estimated final average earnings for each of the Named Executive Officers are as follows: Dr. Smurfit ($1,069,000); Mr. Terrill ($516,000); Mr. Graham ($340,000); Mr. Funke ($322,000); and Mr. Stevens ($199,000). Mr. Malloy received approximately $208,000 of SIP Plan I payments in 1994.\nEMPLOYMENT CONTRACTS AND TERMINATION, SEVERANCE AND CHANGE OF CONTROL ARRANGEMENTS\nMr. Malloy has a deferred compensation agreement with a subsidiary of JSC, pursuant to which he became entitled upon his retirement to lifetime payments of $70,000 annually in addition to his accrued benefits under SIP Plan I.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nPrior to the Equity Offerings, JSC did not maintain a formal compensation committee. Dr. Smurfit, Mr. Malloy and Mr. Kilroy, executive officers of JSC at the beginning of 1994, participated in deliberations of the Board of Directors on executive compensation matters for 1994.\nDr. Smurfit and Mr. Kilroy are both directors and executive officers of JS Group and JSC, and Mr. Malloy is a director of JS Group and a former director and executive officer of JSC.\nREPORT OF THE COMPENSATION COMMITTEE ON EXECUTIVE COMPENSATION\nThe Compensation Committee (the \"Committee\") was established in connection with the Equity Offerings in 1994. The Committee consists of three members of JSC's Board of Directors who are not employees of JSC and who have no interlocking relationships requiring disclosure. The Committee oversees the administration of executive compensation programs and determines the compensation of the executive officers, including the Named Executive Officers.\nThe goals of JSC's executive compensation program are as follows: to attract, retain and motivate qualified executives with outstanding abilities; to tie a significant portion of the overall compensation of executive officers to JSC's profitability; and to seek to enhance JSC's profitability by aligning the interests of executive officers with those of JSC's stockholders.\nIn determining base salaries for each of the Named Executive Officers, as well as other executive officers, consideration is given to national and local salary surveys and the results of an informal, internal review of salaries paid to officers with comparable qualifications, experience and responsibilities at other companies of similar size. As part of the cost reduction initiatives implemented by JSC in 1993, salaries were frozen at 1993 levels for 1994.\nJSC's executive officers, as well as other key employees of JSC, participate in an annual management incentive plan (the \"MIP\"), with awards based upon the attainment of pre-established individual goals and profit targets for JSC.\nEach fiscal year the Committee considers the desirability of granting awards under JSC's 1992 Stock Option Plan to executive officers, including the Named Executive Officers. In determining the amount and nature of awards under the Plan to executive officers other than the Chief Executive Officer, an initial recommendation is made by the Option Plan Committee, taking into account the respective scope of accountability, strategic and operational goals, and anticipated performance requirements and contributions of each executive officer. The stock options awarded to the Chief Executive Officer are established separately and are described below under CEO Compensation. The Committee believes that past grants of stock options have successfully focused JSC's senior management on building profitability and shareholder value.\nBeginning with 1994, Section 162(m) of the Code (\"Section 162(m)\") generally limits to $1,000,000 per person a publicly held corporation's federal income tax deduction for compensation paid in any year to its Chief Executive Officer and each of its four other highest paid executive officers to the extent such compensation is not \"performance based\" within the meaning of Section 162(m). Section 162(m) does not apply to JSC for either of its 1994 or 1995 tax years because JSC is not \"publicly held\" as defined for this purpose in the Code. JSC has historically set compensation and bonuses based upon performance, and JSC intends to continue this practice. At such time as Section 162(m) becomes applicable to JSC, the Committee will, in general, seek to qualify compensation paid to its executive officers for deductibility under Section 162(m) although the Committee believes it is appropriate to retain the flexibility to authorize payments of compensation that may not qualify for deductibility if, in the Committee's judgment, it is in JSC's best interest to do so.\nCEO Compensation\nMr. Terrill's salary as the new Chief Executive Officer was set by Dr. Smurfit, in consultation with representatives of the major stockholders. Mr. Terrill's salary was based on an informal review of salaries paid to officers with comparable qualifications, experience and responsibilities at other companies of similar size. Based on this assessment, the Chief Executive Officer was awarded a base salary for 1994 of $700,000, effective February 1, 1994. Pursuant to the terms of the MIP, he received a performance based incentive award of $251,029 for 1994. The Chief Executive Officer was also awarded stock options covering an aggregate of 319,000 shares of JSC's common stock in February 1994 in recognition of his new position. The award was based on the Board's evaluation of the Chief Executive Officer's past and expected contributions toward the achievement of JSC's long-term strategic initiatives, including the positive results realized by JSC from the significant restructuring completed and cost savings measures instituted in 1993.\nCommencing on the date of the Equity Offerings, the Committee undertook the responsibility for reviewing the salary level and the overall compensation of the Chief Executive Officer based upon a periodic review of peer group companies, the performance of JSC in relation to its peers and the performance of the individual. The evaluation recognizes the major role of the Chief Executive Officer in strategic initiatives to be accomplished by JSC, including cost savings measures instituted under the tenure of the Chief Executive Officer; growth in the market price for JSC's securities; and favorable corporate developments for increased sales volume.\nSubmitted by the Compensation Committee of JSC's Board of Directors.\nD.P. Brennan A.E. Goldberg D.R. Ramsay\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nAll of the outstanding JSC (U.S.) Common Stock is owned by JSCE, and all of the outstanding JSCE Common Stock is owned by JSC.\nSecurity Ownership of Certain Beneficial Owners\nThe table below sets forth certain information regarding the beneficial ownership of the common stock of JSC (the \"Common Stock\") by each person who is known to JSC to be the beneficial owner of more than 5% of JSC's voting stock as of March 1, 1995. Except as set forth below, the stockholders named below have sole voting and investment power with respect to all shares of Common Stock shown as being beneficially owned by them.\nSecurity Ownership of Management\nThe table below sets forth certain information regarding the beneficial ownership of the Common Stock as of February 10, 1995 for (i) each of the directors of JSC, (ii) each of the Named Executive Officers (as defined below), and (iii) all directors and executive officers of JSC as a group.\nThe Company's obligations under the 1994 Credit Agreement are secured by, among other things, the JSCE Common Stock and the JSC (U.S.) Common Stock. If an Event of Default occurs and is continuing under the 1994 Credit Agreement, the banks will have the right to foreclose upon such stock.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCERTAIN TRANSACTIONS\nIn connection with JSC's recapitalization plan implemented in May 1994, JSC issued 19.25 million shares of Common Stock at an initial public offering price of $13.00 per share and the Company issued\nand sold $400 million of senior notes (the \"Debt Offerings\"). In its capacity as underwriter of the Equity Offerings and Debt Offerings, MS&Co. received net discounts and commissions of $5.5 million and $10.0 million, respectively, in 1994. The Company paid $.5 million to SIBV for legal fees incurred by SIBV in connection with the recapitalization of the Company in 1994.\nIn connection with its issuance in 1993 of $500 million unsecured 9.75% Senior Notes, the Company entered into an agreement with SIBV whereby SIBV committed to purchase up to $200 million aggregate principal amount of 11 1\/2% Junior Subordinated Notes maturing 2005 (the \"Notes\") to be issued by the Company. Proceeds of the Notes were to be used to repurchase or otherwise retire subordinated debt of the Company. The agreement was terminated upon the consummation of the Equity Offerings. In accordance with the agreement, the Company paid $.4 million to SIBV for letter of credit fees incurred by SIBV in connection with this commitment, $1.0 million for annual commitment fees of 1.375% on the undrawn principal amount and $.9 million for certain costs of SIBV associated with such commitments and the termination thereof.\nNet sales by the Company to JS Group, its subsidiaries and affiliates were $36.5 million for the year ended December 31, 1994. Net sales by JS Group, its subsidiaries and affiliates to the Company were $71.0 million for the year ended December 31, 1994. Product sales to and purchases from JS Group, its subsidiaries and affiliates were consummated on terms generally similar to those prevailing with unrelated parties.\nThe Company provides certain subsidiaries and affiliates of JS Group with general management and elective management services under separate management services agreements. The services provided include, but are not limited to, management information services, accounting, tax and internal auditing services, financial management and treasury services, manufacturing and engineering services, research and development services, employee benefit plan and management services, purchasing services, transportation services and marketing services. In consideration of general management services, the Company is paid a fee up to 2% of the subsidiaries' or affiliates' gross sales, which fee amounted to $1.5 million for 1994. In consideration for elective services provided in 1994, the Company received reimbursements of approximately $2.8 million in 1994. In addition, the Company paid JS Group and its affiliates $.6 million in 1994 for management services and certain other services.\nIn October 1991, an affiliate of JS Group completed a rebuild of the No. 2 paperboard machine owned by it, located in the Company's Fernandina Beach, Florida paperboard mill (the \"Fernandina Mill\"). Pursuant to the Fernandina Operating Agreement, the Company operates and manages the machine, which is owned by a subsidiary of SIBV. As compensation to the Company for its services, the affiliate of JS Group agreed to reimburse the Company for production and manufacturing costs directly attributable to the No. 2 paperboard machine and to pay the Company a portion of the indirect manufacturing, selling and administrative costs incurred by the Company for the entire Fernandina Mill. The compensation is determined by applying various formulas and agreed upon amounts to the subject costs. The amounts reimbursed to the Company totaled $54.0 million in 1994.\nThe Registration Rights Agreement\nPursuant to the Registration Rights Agreement, dated as of May 3, 1994, among MSLEF II, SIBV, JSC and certain other parties (the\n\"Registration Rights Agreement\"), each of MSLEF II and SIBV have certain rights, upon giving a notice as provided in the Registration Rights Agreement, to cause JSC to use its best efforts to register under the Securities Act of 1933 the shares of Common Stock owned by MSLEF II (including its partners) and certain other entities (including their affiliates) and certain shares of Common Stock owned by SIBV and its affiliates. Under the terms of the Registration Rights Agreement, JSC may not effect a common stock registration for its own account until the earlier of (i) such time as MSLEF II shall have effected two demand registrations and (ii) July 31, 1996. The Registration Rights Agreement contains customary terms and provisions with respect to, among other things, registration procedures and certain rights to indemnification and contribution granted by parties thereunder in connection with the registration of Common Stock subject to such agreement.\nThe Stockholders Agreement\nPursuant to the Stockholders Agreement, dated as of May 3, 1994, among MSLEF II, SIBV, JSC and certain other parties, SIBV and the MS Holders (as defined in the Stockholders Agreement) shall vote their shares of Common Stock subject to the Stockholders Agreement to elect as directors of JSC a certain number of individuals selected by SIBV and a certain number of individuals selected by MSLEF II, with such numbers varying depending on the amount of Common Stock collectively owned by the MS Holders, the amount of Common Stock owned by SIBV and the magnitude of the Initial Return (as defined in the Stockholders Agreement) received by the MS Holders on their investment of Common Stock. Currently, JSC's Board of Directors consists of four directors selected by MSLEF II (one of whom is not affiliated with MSLEF II or JSC) and four directors selected by SIBV (one of whom is not affiliated with SIBV or JSC). Pursuant to the Stockholders Agreement, SIBV and MSLEF II have agreed to ensure the Board of Directors will consist of only eight directors (unless they otherwise agree). Depending on the amount of Common Stock collectively owned by the MS Holders and the magnitude of the Initial Return received by the MS Holders on their investment of Common Stock, approval of certain specified actions of the Board shall require certain approval as specified in the Stockholders Agreement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) (1) and (2) The list of Financial Statements and Financial Statement Schedules required by this item are included in Item 8 on page 24. (3) Exhibits. 3.1 Certificate of Incorporation of the Company. 3.2 By-laws of the Company. 4.1 Indenture for the Series A 1994 Senior Notes (incorporated by reference to Exhibit 4.1 to JSC's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 4.2 Indenture for the Series B 1994 Senior Notes (incorporated by reference to Exhibit 4.2 to JSC's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 4.3 Indenture for the 1993 Senior Notes (incorporated by reference to Exhibit 4.4 to JSC's Registration Statement on Form S-1 (File No. 33-75520)). 4.4 First Supplemental Indenture to the 1993 Senior Note Indenture (incorporated by reference to Exhibit 4.5 to JSC's Registration Statement on Form S-1 (File No. 33- 75520)). 10.1 Second Amended and Restated Organization Agreement, as of August 26, 1992, among JSC (U.S.), CCA, MSLEF II, Inc., SIBV, JSC and MSLEF II (incorporated by reference to Exhibit 10.1(d) to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended September 30, 1992). 10.2 Stockholders Agreement among JSC, SIBV, MSLEF II and certain related entities (incorporated by reference to Exhibit 10.2 to JSC's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 10.3 Registration Rights Agreement among JSC, MSLEF II and SIBV (incorporated by reference to Exhibit 10.3 to JSC's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 10.4 Subscription Agreement among JSC, JSC (U.S.), CCA and SIBV (incorporated by reference to Exhibit 10.4 to JSC's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 10.5(a) Shareholders Agreement, dated as of February 21, 1986, between JSC (U.S.) and Times Mirror (incorporated by reference to Exhibit 4.2 to JSC (U.S.)'s Current Report on Form 8-K, dated February 21, 1986). 10.5(b) Amendment No. 1 to the Shareholders Agreement (incorporated by reference to Exhibit 10.5(b) to JSC's Registration Statement on Form S-1 (File No. 33-75520)). 10.6(a) Restated Newsprint Agreement, dated January 1, 1990, by and between SNC and The Times Mirror Company (incorporated by reference to Exhibit 10.39 to JSC (U.S.)'s Annual Report on Form 10-K for the fiscal year ended December 31, 1990). Portions of this exhibit have been excluded pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.\n10.6(b) Amendment No. 1 to the Restated Newsprint Agreement (incorporated by reference to Exhibit 10.6(b) to JSC's Registration Statement on Form S-1 (File No. 33-75520)). 10.7 Operating Agreement, dated as of April 30, 1992, by and between CCA and Smurfit Paperboard, Inc. (incorporated by reference to Exhibit 10.42 to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended March 31, 1992). 10.8 Deferred Compensation Agreement, dated January 1, 1979, between JSC (U.S.) and James B. Malloy, as amended and effective November 10, 1983 (incorporated by reference to Exhibit 10(m) to JSC (U.S.)'s Registration Statement on Form S-1 (File No. 2-86554)). 10.9(a) JSC (U.S.) Deferred Compensation Capital Enhancement Plan (incorporated by reference to Exhibit 10(r) to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended September 30, 1985). 10.9(b) Amendment No. 1 to the Deferred Compensation Capital Enhancement Plan (incorporated by reference to Exhibit 10.37 to JSC (U.S.)\/CCA's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.10 Letter Agreement, dated November 24, 1982, between C. Larry Bradford and Alton Packaging Corporation, as amended and effective November 10, 1983 (incorporated by reference to Exhibit 10(g) to JSC (U.S.)'s Registration Statement on Form S-1 (File No. 2-86554)). 10.11(a) JSC (U.S.) Deferred Director's Fee Plan (incorporated by reference to Exhibit 10.33 to JSC (U.S.)\/CCA's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.11(b) Amendment No. 1 to JSC (U.S.) Deferred Director's Fee Plan (incorporated by reference to Exhibit 10.34 to JSC (U.S.)\/CCA's Annual Report on Form 10-K for the fiscal year ended December 31, 1989). 10.12 Jefferson Smurfit Corporation Management Incentive Plan 1994 (incorporated by reference to Exhibit 10.14 to JSC's Registration Statement on Form S-1 (File No. 33-75520)). 10.13 Jefferson Smurfit Corporation (U.S.) 1994 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.13 to JSC's Registration Statement on Form S-1 (File No. 33-75520)). 10.14 Rights Agreement, dated as of April 30, 1992, among CCA, Smurfit Paperboard, Inc. and Bankers Trust Company, as collateral trustee (incorporated by reference to Exhibit 10.43 to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended March 31, 1992). 10.15(a) 1992 SIBV\/MS Holdings, Inc. Stock Option Plan (incorporated by reference to Exhibit 10.48 to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended September 30, 1992). 10.15(b) Amendment No. 1 to 1992 SIBV\/MS Holdings, Inc. Stock Option Plan (incorporated by reference to Exhibit 10.16(b) to JSC's Registration Statement on Form S-1 (File No. 33-75520)). 10.16 Amended and Restated Commitment Letter, dated February 10, 1994, among JSC (U.S.), CCA, Chemical, Bankers Trust, CSI and BTSC (incorporated by reference to Exhibit 10.17 to JSC's Registration Statement on Form S-1 (File No. 33- 75520)). 10.17 Credit Agreement, among JSC (U.S.), CCA and the banks parties thereto (incorporated by reference to Exhibit 10.1 to JSC's quarterly report on Form 10-Q for the quarter ended March 31, 1994). 18.1 Letter regarding change in accounting for pension plans (incorporated by reference to Exhibit 18.1 to JSC (U.S.)'s quarterly report on Form 10-Q for the quarter ended September 30, 1993). 21.1 Subsidiaries of the Company. 24.1 Powers of Attorney (incorporated by reference to Exhibit 24.1 to JSC's Annual Report on Form 10-K for the fiscal year ended December 31, 1994).\n25.1 Statement on Form T-1 of the eligibility of NationsBank of Georgia, National Association, as Trustee under the 1993 Senior Note Indenture (incorporated by reference to Exhibit 25.1 to JSC (U.S.)\/CCA's Registration Statement on Form S-2 (File No. 33-58348)).\n(b) Report on Form 8-K. The Company did not file any reports on Form 8-K during the three months ended December 31, 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.\nDATE March 7, 1995 JSCE, Inc.\n(Registrant)\nBY: \/s\/ John R. Funke John R. Funke 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 in the capacities and on the date indicated.\nSIGNATURE TITLE DATE\n* Chairman of the Board Michael W. J. Smurfit and Director\n* President, Chief Executive James E. Terrill Officer and Director (Principal Executive Officer)\n\/s\/ John R. Funke Vice-President and Chief March 7, 1995 John R. Funke Financial Officer (Principal Accounting Officer)\n* Director Howard E. Kilroy\n* Director Donald P. Brennan\n* Director Alan E. Goldberg\n* Director David R. Ramsay\n* Director James R. Thompson\n* Director G. Thompson Hutton\n* By \/s\/ John R. Funke , pursuant to Powers of Attorney John R. Funke filed as a part of the Form 10-K. As Attorney in Fact\nJSCE, Inc. SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS (In Millions)","section_15":""}
{"filename":"724533_1994.txt","cik":"724533","year":"1994","section_1":"ITEM 1. BUSINESS\nDevelopment and Description of Business - --------------------------------------- Information concerning the business of American Insured Mortgage Investors (the Partnership) is contained in Part II, Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations and in Notes 1, 4, and 5 of the notes to the financial statements of the Partnership (filed in response to Item 8 hereof), which is incorporated herein by reference. Also see Schedule IV-Mortgage Loans on Real Estate for the table of the Insured Mortgages (as defined below) invested in by the Partnership as of December 31, 1994.\nEmployees - --------- The Partnership has no employees. The business of the Partnership is managed by CRIIMI, Inc. (the General Partner), while its portfolio of mortgages is managed by AIM Acquisition Partners, L.P. (the Advisor) pursuant to an advisory agreement (the Advisory Agreement) and CRI\/AIM Management, Inc. (the Sub-advisor) pursuant to a sub-advisory agreement (the Sub-advisory Agreement). CRIIMI, Inc. is a wholly-owned subsidiary of CRIIMI MAE Inc. (CRIIMI MAE), formerly CRI Insured Mortgage Association, Inc., which is managed by an adviser whose general partner is C.R.I., Inc. (CRI). CRI and CRIIMI MAE are also affiliates of the Sub-advisor.\nCRIIMI MAE's Board of Directors has determined that it is in CRIIMI MAE's best interest to consider a proposed transaction in which CRIIMI MAE would become a self-managed and self-administered real estate investment trust (REIT). Under the terms of the proposed transaction, CRIIMI MAE and its affiliates would acquire certain mortgage investment, servicing, origination and advisory business from affiliates of CRI, including the Sub-advisory Agreement in place with respect to the Partnership. This transaction will have no effect on the Partnership's financial statements.\nCompetition - ----------- In disposing of Insured Mortgages, the Partnership competes with private investors, mortgage banking companies, mortgage brokers, state and local government agencies, lending institutions, trust funds, pension funds, and other entities, some with similar objectives to those of the Partnership and some of which are or may be affiliates of the Partnership, its General Partner, the Advisor or their respective affiliates. Some of these entities may have substantially greater capital resources and experience in disposing of Federal Housing Administration (FHA) insured mortgages than the Partnership.\nPursuant to the Sub-advisory Agreement, the Advisor retained the Sub- advisor to perform the services required of the Advisor under the Advisory Agreement. CRI also serves as a general partner of the advisers to CRIIMI MAE and CRI Liquidating REIT, Inc., which have investment objectives similar to those of American Insured Mortgage Investors-Series 85, L.P. (AIM 85), American Insured Mortgage Investors L.P. - Series 86 (AIM 86) and American Insured Mortgage Investors L.P. - Series 88 (AIM 88) as well as the Partnership (collectively, the AIM Partnerships). CRI and its affiliates are also general partners of a number of other real estate limited partnerships. CRI and its affiliates also may serve as general partners, sponsors or managers of real estate limited partnerships, REITs or other entities in the future. The Partnership may attempt to dispose of mortgages at or about the same time that one or more of the other AIM Partnerships and\/or other entities sponsored or managed by CRI, including CRIIMI MAE and CRI Liquidating REIT, Inc., are attempting to dispose of mortgages. As a result of market conditions that could limit dispositions, the Sub-advisor and its affiliates could be faced with conflicts of interest in determining which mortgages would be disposed of. Both CRI and CRIIMI, Inc., however, are subject to their fiduciary duties in\nevaluating the appropriate action to be taken when faced with such conflicts.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAlthough the Partnership does not own the underlying real estate, the mortgages underlying the Partnership's mortgage investments are first non- recourse liens on the respective multifamily residential developments.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material legal proceedings to which the Partnership is a party.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to the security holders to be voted on during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S SECURITIES AND RELATED SECURITY HOLDER MATTERS\nPrincipal Market and Market Price for Units and Distributions - ------------------------------------------------------------- From November 5, 1985 through July 6, 1989, the Units were included in the NASDAQ National Market System. From July 7, 1989 through April 7, 1992, the Units were traded in the over-the-counter market and quoted on the NASDAQ quotation system under the symbol \"AIMAZ.\"\nSince April 8, 1992, the Units have traded on the American Stock Exchange (AMEX) with a trading symbol of AIA.\nThe high and low bid prices for the Units as reported on AMEX and the distributions, as applicable, for each quarterly period in 1994 and 1993 were as follows:\nAmount of 1994 Distribution Quarter Ended High Low Per Unit - ------------------- ------- ------- ------------ March 31, $4 7\/8 $3 3\/4 $ 0.89(1) June 30, 3 13\/16 3 3\/8 0.08 September 30, 3 11\/16 3 7\/16 0.08 December 31, 3 11\/16 3 1\/4 0.08 --------- $ 1.13 =========\nAmount of 1993 Distribution Quarter Ended High Low Per Unit - ------------------- ------- ------- ------------ March 31, $4 7\/8 $4 5\/16 $ 0.095 June 30, 4 3\/4 4 5\/16 0.090 September 30, 4 13\/16 4 7\/16 0.090 December 31, 5 1\/8 4 1\/4 0.370(2) --------- $ 0.645 ========= (1) This includes a special distribution of $0.81 per Unit comprised of: (i) $0.80 per Unit return of capital and capital gain from the disposition of the mortgage on Hidden Oaks Apartments and (ii) $.01 per Unit of previously accrued but undistributed interest received from the mortgage on Creekside Village.\n(2) This includes a special distribution of $0.28 per Unit comprised of: (i) $0.21 per Unit return of capital from the disposition of the mortgages on Chapelgate Apartments and Cumberland Village and (ii) $0.07 per Unit capital gain from these two dispositions plus additional sales proceeds from the sale of the mortgage on Clark and Elm Apartments.\nThere are no material legal restrictions upon the Partnership's present or future ability to make distributions in accordance with the provisions of the Partnership Agreement.\nThe Partnership's Dividend Reinvestment Plan was amended effective April 10, 1992 to exclude the amount of any special distributions from reinvestment under the Plan. The regular distributions will continue to be automatically reinvested in additional Units as in the past.\nApproximate Number\nPART II\nITEM 5. MARKET FOR REGISTRANT'S SECURITIES AND RELATED SECURITY HOLDER MATTERS - Continued\nof Unitholders as of Title of Class December 31, 1994 - --------------------------- ----------------------\nDepositary Units of Limited Partnership Interest 10,000\nPART II\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA (Dollars in thousands, except per Unit amounts)\nThe selected statements of operations data presented above for the years ended December 31, 1994, 1993 and 1992 and the balance sheet data as of December 31, 1994 and 1993, are derived from and are qualified by reference to the Partnership's financial statements which have been included elsewhere in this Form 10-K. The statements of operations data for the years ended December 31, 1991 and 1990 and the balance sheet data as of December 31, 1992, 1991 and 1990 are derived from audited financial statements not included in this Form 10-K. This data should be read in conjunction with the financial statements and the notes thereto.\nPART II\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGeneral - ------- American Insured Mortgage Investors (the Partnership) was formed under the Uniform Limited Partnership Act in the state of California on July 12, 1983. During the period from March 1, 1984 (the initial closing date of the Partnership's public offering) through December 31, 1984, the Partnership, pursuant to its public offering of 10,000,000 depositary units of limited partnership interest (Units), raised a total of $200,000,000 in gross proceeds. In addition, the initial limited partner contributed $2,500 to the capital of the Partnership and received 125 limited partnership interests in exchange therefor.\nAt a special meeting of the limited partners and Unitholders of the Partnership held on August 16, 1991, a majority of these interests approved, among other items, the assignment of the general partner interests and the shares of the company which acts as the assignor limited partner in the Partnership, as described below, and the adoption of provisions which prohibit a \"Reorganization Transaction\" (including transactions commonly known as \"roll- ups\") for a period of five years unless approved by a super-majority.\nEffective September 6, 1991, CRIIMI, Inc. (the General Partner) succeeded AIM Capital Management Corp. (the former managing general partner with a partnership interest of 2.8%) and IRI Properties Capital Corp. (the former corporate general partner with a partnership interest of 0.1%) as the sole general partner of the Partnership. CRIIMI, Inc. is a wholly-owned subsidiary of CRIIMI MAE Inc. (CRIIMI MAE), formerly CRI Insured Mortgage Association, Inc., which is managed by an adviser whose general partner is CRI. In addition, the General Partner acquired the shares of the company which acts as the assignor limited partner in the Partnership. The interest of the former associate general partner (0.1%) was purchased by the Partnership on September 6, 1991, pursuant to the terms of the Partnership Agreement. The former managing general partner, former corporate general partner and former associate general partner are sometimes collectively referred to as former general partners.\nAlso, on September 6, 1991, AIM Acquisition Partners, L.P. (the Advisor) succeeded Integrated Funding, Inc. (Integrated Funding) as the advisor to the Partnership. AIM Acquisition Corporation (AIM Acquisition) is the general partner of the Advisor and the limited partners include, but are not limited to, AIM Acquisition, The Goldman Sachs Group, L.P., Broad Inc. and a limited partnership formed by CRI and CRIIMI MAE. Pursuant to the terms of certain amendments to the Partnership Agreement, as discussed below, the General Partner is required to receive the consent of the Advisor prior to taking certain significant actions which affect the management and policies of the Partnership. The limited partners and Unitholders of the Partnership approved the execution of a Sub-advisory agreement (the Sub-advisory Agreement) with CRI\/AIM Management, Inc., an affiliate of CRI, pursuant to which CRI\/AIM Management, Inc. manages the Partnership's portfolio and disposes of the Partnership's mortgage investments.\nCRIIMI MAE's Board of Directors has determined that it is in CRIIMI MAE's best interest to consider a proposed transaction in which CRIIMI MAE would become a self-managed and self-administered real estate investment trust (REIT). Under the terms of the proposed transaction, CRIIMI MAE and its affiliates would acquire certain mortgage investment, servicing, origination and advisory business from affiliates of CRI, including the Sub-advisory Agreement in place with respect to the Partnership. This transaction will have no effect on the Partnership's financial statements.\nPrior to the expiration of the Partnership's reinvestment period in\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nNovember 1988, the Partnership was engaged in the business of originating mortgage loans (Originated Insured Mortgages) and acquiring mortgage loans (Acquired Insured Mortgages and together with Originated Insured Mortgages, referred to herein as Insured Mortgages). The Partnership purchased the Acquired Insured Mortgages from unaffiliated third parties at a discount from the outstanding principal balance. Through November 1988, the former managing general partner had the right to reinvest the proceeds from any sale or prepayment of an Insured Mortgage or any insurance proceeds received from the assignment of an Insured Mortgage (subject to the conditions set forth in the Partnership Agreement). After the expiration of the reinvestment period, the Partnership is required (subject to the conditions set forth in the Partnership Agreement) to distribute such proceeds to its Unitholders. The Partnership Agreement states that the Partnership will terminate on December 31, 2008, unless previously terminated under the provisions of the Partnership Agreement.\nInvestment in Insured Mortgages - ------------------------------- The Partnership's investment in insured mortgages is comprised of participation certificates evidencing a 100% undivided beneficial interest in government insured multifamily mortgages issued or sold pursuant to programs of the Federal Housing Administration (FHA) (FHA-Insured Certificates) and FHA- insured mortgage loans (FHA-Insured Loans). The mortgages underlying the FHA- Insured Certificates and FHA-Insured Loans are non-recourse first liens on multifamily residential developments.\nIn connection with the Partnership's implementation of Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115) as of January 1, 1994 (see Note 2 to the financial statements), the Partnership's investments in FHA-Insured Certificates are recorded at fair value, as estimated below, as of December 31, 1994. The difference between the amortized cost and the fair value of FHA-Insured Certificates represents the net unrealized gains on these investments and is reported as a separate component of partners' equity as of December 31, 1994. The fair value of FHA-Insured Certificates is based on quoted market prices. The Partnership's Investment in FHA-Insured Loans is recorded at amortized cost as of December 31, 1994 and 1993.\nAs of December 31, 1994, the Partnership had remaining investments in nine FHA-Insured Certificates and six FHA-Insured Loans with an aggregate amortized cost of $35,214,547, face value of $40,966,282, and fair value of $39,420,211, all of which were originated or acquired by the former managing general partner. All of the Partnership's mortgage investments are insured by the United States Department of Housing and Development (HUD) for 100% of their current face value, less a 1% assignment fee, and are non-recourse first liens on multifamily residential developments owned by entities unaffiliated with the Partnership, its General Partner, or their affiliates and are insured under Section 221(d)(4) or Section 231 of the National Housing Act. As of December 31, 1994, all of the Partnership's mortgage investments are current with respect to the payment of principal and interest.\nThe following table summarizes the Partnership's investment in Insured Mortgages as of December 31, 1994:\nIn addition to base interest payments under Originated Insured Mortgages, the Partnership is entitled to additional interest based on a percentage of the net cash flow from the underlying development and of the net proceeds from the refinancing, sale or other disposition of the underlying development (referred to as Participations). During the year ended December 31, 1994, the Partnership received $13,010 from the Participations. During the years ended December 31, 1993 and 1992, the Partnership did not receive any monies from the Participations. These amounts, if any, are included in mortgage investment income in the accompanying statements of operations.\nPART II\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Continued\nMortgage Dispositions - --------------------- A summary of dispositions that are included in the statements of operations for the years ended December 31, 1994, 1993 and 1992 are as follows:\nThe accompanying notes are an integral part of these financial statements.\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION\nAmerican Insured Mortgage Investors (the Partnership) was formed under the Uniform Limited Partnership Act in the state of California on July 12, 1983. From inception through September 6, 1991, AIM Capital Management Corp. served as managing general partner (with a partnership interest of 2.8%), IRI Properties Capital Corp. served as corporate general partner (with a partnership interest of 0.1%) and Z Square G Partners II served as the associate general partner (with a partnership interest of 0.1%). All of the foregoing general partners are sometimes collectively referred to as former general partners.\nAt a special meeting of the limited partners and unitholders of the Partnership held on August 16, 1991, a majority of these interests approved, among other items, the assignment of the general partner interests and the shares of the company which acts as the assignor limited partner in the Partnership.\nEffective September 6, 1991, CRIIMI, Inc. (the General Partner) succeeded the former general partners to become the sole general partner of the Partnership. CRIIMI, Inc. purchased the interests of the former managing general partner and the former corporate general partner pursuant to the terms of the Partnership Agreement. The interest of the former associate general partner was purchased by the Partnership on September 6, 1991, pursuant to the terms of the Partnership Agreement. CRIIMI, Inc. is a wholly-owned subsidiary of CRIIMI MAE Inc. (CRIIMI MAE), formerly CRI Insured Mortgage Association, Inc. CRIIMI MAE is managed by an adviser whose general partner is C.R.I., Inc. (CRI).\nAlso, on September 6, 1991, AIM Acquisition Partners, L.P. (the Advisor) succeeded Integrated Funding, Inc. (Integrated Funding) as the advisor to the Partnership. AIM Acquisition Corporation (AIM Acquisition) is the general partner of the Advisor and the limited partners include, but are not limited to, AIM Acquisition, The Goldman Sachs Group, L.P., Broad Inc. and a limited partnership formed by CRI and CRIIMI MAE. Pursuant to the terms of certain amendments to the Partnership Agreement, as discussed below, the General Partner is required to receive the consent of the Advisor prior to taking certain significant actions which affect the management and policies of the Partnership. The limited partners and Unitholders of the Partnership approved the execution of a Sub-advisory agreement (the Sub-advisory Agreement) with CRI\/AIM Management, Inc., an affiliate of CRI, pursuant to which CRI\/AIM Management, Inc. manages the Partnership's portfolio and disposes of the Partnership's mortgage investments.\nCRIIMI MAE's Board of Directors has determined that it is in CRIIMI MAE's best interest to consider a proposed transaction in which CRIIMI MAE would become a self-managed and self-administered real estate investment trust (REIT). Under the terms of the proposed transaction, CRIIMI MAE and its affiliates would acquire certain mortgage investment, servicing origination and advisory business from affiliates of CRI, including the Sub-advisory Agreement in place with respect to the Partnership. This transaction will have no effect on the Partnership's financial statements.\nPrior to the expiration of the Partnership's reinvestment period in November 1988, the Partnership was engaged in the business of originating mortgage loans (Originated Insured Mortgages) and acquiring mortgage loans (Acquired Insured Mortgages and, together with Originated Insured Mortgages referred to herein as Insured Mortgages). In accordance with the terms of the\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n1. ORGANIZATION - Continued\nPartnership Agreement, the Partnership is no longer authorized to originate or acquire Insured Mortgages and, consequently, its primary objective is to manage its portfolio of mortgage investments, all of which are insured under Section 221(d)(4) or Section 231 of the National Housing Act. The Partnership Agreement states that the Partnership will terminate on December 31, 2008, unless previously terminated under the provisions of the Partnership Agreement.\nDuring the first quarter of 1992, the General Partner applied to list the Units on the American Stock Exchange (AMEX) and the application was approved by AMEX. Trading commenced on April 8, 1992 with a trading symbol of AIA.\n2. SIGNIFICANT ACCOUNTING POLICIES\nMethod of Accounting -------------------- The financial statements of the Partnership are prepared on the accrual basis of accounting in accordance with generally accepted accounting principles.\nInvestment in Insured Mortgages -------------------------------\nThe Partnership's investment in Insured Mortgages is comprised of participation certificates evidencing a 100% undivided beneficial interest in government insured multifamily mortgages issued or sold pursuant to programs of the Federal Housing Administration (FHA) (FHA-Insured Certificates) and FHA-insured mortgage loans (FHA-Insured Loans). The mortgages underlying the FHA-Insured Certificates and FHA-Insured Loans are non-recourse first liens on multifamily residential developments.\nPayment of principal and interest on FHA-Insured Certificates and FHA- Insured Loans is insured by the United States Department of Housing and Urban Development (HUD) pursuant to Title 2 of the National Housing Act.\nPrior to January 1, 1994, the Partnership accounted for its investment in Insured Mortgages at amortized cost in accordance with Statement of Financial Accounting Standard No. 65 \"Accounting for Certain Mortgage Banking Activities\" (SFAS 65) since it had the ability and intent to hold these assets for the foreseeable future. The difference between the cost and the unpaid principal balance at the time of purchase is carried as a discount or premium and amortized over the remaining contractual life of the mortgage using the effective interest method. The effective interest method provides a constant yield of income over the term of the mortgage. Mortgage investment income is comprised of amortization of the discount plus the stated mortgage interest payments received or accrued less amortization of the premium.\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\" (SFAS 115). This statement requires that investments in debt and equity securities be classified into one of the following investment categories based upon the circumstances under which such securities might be sold: Held to Maturity, Available for Sale, and Trading. Generally, certain debt securities for which an\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES - Continued\nenterprise has both the ability and intent to hold to maturity, should be accounted for using the amortized cost method and all other securities must be recorded at their fair values.\nAs of December 31, 1994, the weighted average remaining term of the Partnership's investments in FHA-Insured Certificates is approximately 27 years. However, the Partnership Agreement states that the Partnership will terminate in approximately 14 years, on December 31, 2008, unless previously terminated under the provisions of the Partnership Agreement. As the Partnership is anticipated to terminate prior to the weighted average remaining term of its FHA-Insured Certificates, the Partnership does not have the ability, at this time, to hold these investments to maturity. Consequently, the General Partner believes that the Partnership's FHA-Insured Certificates should be included in the Available for Sale category. Although the Partnership's FHA-Insured Certificates are classified as Available for Sale for financial statement purposes, the General Partner does not intend to voluntarily sell these assets other than those which may be sold as a result of a default or those which are eligible to be put to FHA at the expiration of 20 years from the date of the final endorsement.\nIn connection with this classification, as of December 31, 1994, all of the Partnership's investments in FHA-Insured Certificates are recorded at fair value, with the net unrealized gains on these investments reported as a separate component of partners' equity. Subsequent increases or decreases in the fair value of FHA-Insured Certificates classified as Available for Sale will be included as a separate component of partners' equity. Realized gains and losses on FHA-Insured Certificates classified as Available for Sale will continue to be reported in earnings. The amortized cost of the investments in this category is adjusted for amortization of discounts to maturity. Such amortization is included in mortgage investment income.\nAs of January 1, 1994, and for the first three quarters of 1994, the Partnership adopted SFAS 115 for all of its mortgage investments. Upon further consideration and interpretation of SFAS 115, as of December 31, 1994, the Partnership has only applied this accounting pronouncement to the FHA-Insured Certificates held in its portfolio. The Partnership continues to account for its FHA-Insured Loans in accordance with SFAS 65, or at amortized cost, because such loans are not securities and therefore are not subject to SFAS 115. The impact of this change is immaterial to the financial statements of the Partnership.\nGains from dispositions of mortgage investments are recognized upon the receipt of cash or debentures.\nLosses on dispositions of mortgage investments are recognized when it becomes probable that a mortgage will be disposed of and that the disposition will result in a loss. In the case of Originated Insured Mortgages fully insured by HUD, the Partnership's maximum exposure for purposes of determining the loan losses would generally be an assignment fee charged by HUD representing approximately 1% of the unpaid principal balance of the Originated Insured Mortgage at the date of default, plus the unamortized balance of acquisition fees and closing costs paid in\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES - Continued\nconnection with the acquisition of the Originated Insured Mortgage and the loss of 30-days accrued interest.\nSince Acquired Insured Mortgages were purchased at a discount from the unpaid principal balance of the mortgage, the Partnership's investment in the Acquired Insured Mortgages is less than the amount that would be recovered from HUD in the event of a default. Therefore, the Partnership would experience no loan losses on discounted Acquired Insured Mortgages in the case of a default.\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n2. SIGNIFICANT ACCOUNTING POLICIES - Continued\nCash and Cash Equivalents ------------------------- Cash and cash equivalents consist of time and demand deposits with original maturities of three months or less.\nIncome Taxes ------------ No provision has been made for Federal, state or local income taxes, in the accompanying financial statements since they are the personal responsibility of the unitholders.\nReclassification ---------------- Certain amounts in the financial statements for the year ended December 31, 1993 have been reclassified to conform with the 1994 presentation.\n3. TRANSACTIONS WITH RELATED PARTIES\nThe principal officers of the General Partner for the years ended December 31, 1994, 1993 and 1992 did not receive fees for serving as officers of the General Partner, nor are any fees expected to be paid to the officers in the future.\nThe General Partner and certain affiliated entities have, during the Partnership's years ended December 31, 1994, 1993 and 1992, earned or received compensation or payments for services from the Partnership as follows:\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n3. TRANSACTIONS WITH RELATED PARTIES - Continued\n(1) The General Partner, pursuant to amendments to the Partnership Agreement effective September 6, 1991, is entitled to receive 2.9% of the Partnership's income, loss, capital and distributions including, without limitation, the Partnership's Adjusted Cash from Operations and Proceeds of Mortgage Prepayments, Sales or Insurance (both as defined in the Partnership Agreement).\n(2) The Advisor, pursuant to the Purchase Agreement and amendments to the Partnership Agreement, effective October 1, 1991, is entitled to an Asset Management Fee equal to 0.95% of Total Invested Assets (as defined in the Partnership Agreement).\nOf the amounts paid to the Advisor, the Sub-advisor, CRI\/AIM Management, Inc., earned a fee equal to $104,880, $129,429 and $133,160 or 0.28% of Total Invested Assets, for the years ended December 31, 1994, 1993 and 1992, respectively.\n(3) These amounts are paid to CRI as reimbursement for expenses incurred on behalf of the General Partner and the Partnership. As discussed in Note 1, the proposed transaction in which CRIIMI MAE would become a self-managed and self-administered REIT has no impact on the payments required to be made by the Partnership, other than that the expense reimbursement currently paid by the Partnership to CRI in connection with the provision of services by the Sub- advisor will be paid to an affiliate of CRIIMI MAE subsequent to the consummation of the proposed transaction.\n(4) These amounts include special distributions resulting from mortgage dispositions, as discussed in Note 5.\n4. INVESTMENT IN INSURED MORTGAGES\nIn connection with the Partnership's implementation of SFAS 115 as of January 1, 1994 (see Note 2), the Partnership's investments in FHA-Insured Certificates are recorded at fair value, as estimated below, as of December 31,\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES - Continued\n1994. The difference between the amortized cost and the fair value of FHA- Insured Certificates represents the net unrealized gains on these investments and is reported as a separate component of partners' equity as of December 31, 1994. The fair value of FHA-Insured Certificates is based on quoted market prices. The Partnership's Investment in FHA-Insured Loans is recorded at amortized cost as of December 31, 1994 and 1993.\nAs of December 31, 1994, the Partnership had remaining investments in nine FHA-Insured Certificates and six FHA-Insured Loans with an aggregate amortized cost of $35,214,547, face value of $40,966,282, and fair value of $39,420,211. All of the Partnership's Insured Mortgages are insured by HUD for 100% of their current face value, less a 1% assignment fee. The mortgages underlying the FHA- Insured Certificates and FHA-Insured Loans are non-recourse first liens on multifamily residential developments owned by entities unaffiliated with the Partnership, its General Partner, or their affiliates and are insured under Section 221(d)(4) or Section 231 of the National Housing Act. As of December 31, 1994, all of the Partnership's Insured Mortgages are current with respect to the payment of principal and interest.\nThe following table summarizes the Partnership's Investment in Insured Mortgages as of December 31, 1994:\nIn addition to base interest payments under Originated Insured Mortgages, the Partnership is entitled to additional interest based on a percentage of the net cash flow from the underlying development and of the net proceeds from the refinancing, sale or other disposition of the underlying development (referred to as Participations). During the year ended December 31, 1994, the Partnership received $13,010 from the Participations. During the years ended December 31, 1993 and 1992, the Partnership did not receive any monies from the Participations. These amounts, if any, are included in mortgage investment income in the accompanying statements of operations.\nMortgage Dispositions\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES - Continued\n- --------------------- A summary of dispositions that are included in the statements of operations for the years ended December 31, 1994, 1993 and 1992 are as follows:\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO FINANCIAL STATEMENTS\n4. INVESTMENT IN INSURED MORTGAGES - Continued\nQuarter ended March 31 June 30 September 30 December 31 ---------- ---------- ------------ -----------\nIncome $ 1,304 $ 1,182 $ 1,131 $ 1,129 Loss on mortgage disposition (21) -- -- -- Net earnings 1,027 927 919 994 Net earnings per Limited Partnership Unit .10 .09 .09 .10\n\/TABLE\nAMERICAN INSURED MORTGAGE INVESTORS SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1994\nInterest Face Net Annual Payment Maturity Put Rate on Amount of Carrying Value (Principal and Development Name\/Location Date Date(1) Mortgage(5) Mortgage (3)(7)(9)(10) Interest)(5)(8) - ------------------------- -------- ------------------- ------------ ---------------- ---------------\nAcquired Insured Mortgages - -------------------------- Investment in FHA-Insured Loans (carried at amortized cost)(2)\nEastdale Apts. Montgomery, AL 3\/23 10\/01 7.5% $ 6,862,561 $ 5,179,068 592,406 North River Place Chillecothe, OH 10\/21 12\/01 7.5% 3,222,426 2,435,541 279,509 Portervillage I Apts. Porterville, CA 8\/21 5\/01 7.5% 1,192,395(4) 967,618 103,733(4) Town Park Apts. Rockingham, NC 10\/22 10\/02 7.5% 661,419(4) 535,775 56,755(4) ------------ ------------ Total Investment in FHA-Insured Loans - Acquired Insured Mortgages 11,938,801 9,118,002 ------------ ------------ Originated Insured Mortgages - ---------------------------- Investment in FHA-Insured Loans (carried at amortized cost)(2)\nCreekside Village Beaverton, OR 11\/25 1\/01 11.50%(6) 5,156,167 5,342,046 612,632(6) Waters Edge Apts. Columbus, OH 1\/31 5\/03 8.75%(6) 9,681,033 9,248,226 885,419(6) ------------ ------------ Total Investment in FHA-Insured Loans - Originated Insured Mortgages 14,837,200 14,590,272 ------------ ------------\nTotal Investment in FHA-Insured Loans $ 26,776,001 $ 23,708,274 ------------ ------------ See notes to Schedule IV - Mortgage Loans on Real Estate.\n\/TABLE\nAMERICAN INSURED MORTGAGE INVESTORS SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE DECEMBER 31, 1994\nInterest Face Net Annual Payment Maturity Put Rate on Amount of Carrying Value (Principal and Development Name\/Location Date Date(1) Mortgage(5) Mortgage (3)(7)(9)(10) Interest)(5)(8) - ------------------------- -------- ------------------- ------------ ---------------- ---------------\nAcquired Insured Mortgages - -------------------------- Investment in FHA-Insured Certificates (carried at fair value)\nBay Pointe Apts. Lafayette, IN 2\/23 10\/02 7.5% $ 2,150,243(4) $ 2,023,644 $ 185,272(4) Baypoint Shoreline Apts. Duluth, MN 1\/22 10\/01 7.5% 1,017,099(4) 957,242 87,967(4) Berryhill Apts. Grass Valley, CA 1\/21 11\/02 7.5% 1,324,128(4) 1,246,309 115,899(4) Brougham Estates II Kansas City, KS 11\/22 3\/02 7.5% 2,693,974(4) 2,535,264 230,860(4) College Green Apts. Wilmington, NC 3\/23 2\/02 7.5% 1,445,692(4) 1,360,488 123,455(4) Fox Run Apts. Dothan, AL 10\/19 11\/99 7.5% 1,305,052(4) 1,228,511 116,242(4) Kaynorth Apts. Lansing, MI 4\/23 9\/02 7.5% 1,961,024(4) 1,845,437 167,318(4) Lakeside Apts. Bennettsville, SC 1\/22 2\/02 7.5% 408,182(4) 384,160 35,303(4) Westbrook Apts. Kokomo, IN 11\/22 9\/02 7.5% 1,884,887(4) 1,773,971 163,177(4) ------------ ------------ Total Investment in FHA-Insured Certificates 14,190,281 13,355,026 ------------ ------------ TOTAL INVESTMENT IN INSURED MORTGAGES $ 40,966,282 $ 37,063,300 ============ ============\nSee notes to Schedule IV - Mortgage Loans on Real Estate \/TABLE\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE\n(1) Under the Section 221 program of the National Housing Act of 1937, as amended, a mortgagee has the right to assign a mortgage (\"put\") to FHA at the expiration of 20 years from the date of final endorsement if the mortgage is not in default at such time. Any mortgagee electing to assign an FHA-insured mortgage to FHA will receive in exchange therefore HUD debentures having a total face value equal to the then outstanding principal balance of the FHA-insured mortgage plus accrued interest to the date of assignment. These HUD debentures will mature 10 years from the date of assignment and will bear interest at the \"going Federal rate\" at such date. This assignment procedure is applicable to an insured mortgage which had a firm or conditional FHA commitment for insurance on or before November 30, 1983. The Partnership anticipates that each eligible insured mortgage, for which a prepayment has not occurred and which has not been sold, will be assigned to FHA at the expiration of 20 years from the date of final endorsement. The Partnership, therefore, does not anticipate holding any eligible insured mortgage beyond the expiration of 20 years from final endorsement of that insured mortgage.\n(2) Inclusive of closing costs and acquisition fees.\n(3) Prepayment of these insured mortgages would be based upon the unpaid principal balance at the time of prepayment.\n(4) These amounts represent the Partnership's 50% interest in these insured mortgages. The remaining 50% interest was acquired by AIM 85.\n(5) In addition, the servicer of the insured mortgages, an unaffiliated third party, is entitled to receive compensation for certain services rendered in an amount up to ten basis points (.10%) of the unpaid principal balance of the insured mortgages.\n(6) This represents the base interest rate during the permanent phase of these insured mortgage loans. Additional interest, (referred to as Participations) measured as a percentage of surplus cash and a percentage of the proceeds from sale or refinancing of the development (as defined in the Participation Agreements), will also be due. The Partnership received $13,010 from the Participations for the year ended December 31, 1994. No payments were received for the years ended December 31, 1993 or 1992 as a result of the Participations.\n(7) The mortgages underlying the Partnership's investment in FHA-Insured Certificates and FHA-Insured Loans are non-recourse first liens on multifamily residential developments.\n(8) Principal and interest are payable at level amounts over the life of the insured mortgages.\n(9) A reconciliation of the carrying value of Insured Mortgages, for the years ended December 31, 1994 and 1993, is as follows:\n1994 1993 ------------ ------------ Beginning balance $ 43,342,199 $ 45,760,878\nNet gain on mortgage dispositions 195,820 762,250\nAMERICAN INSURED MORTGAGE INVESTORS\nNOTES TO SCHEDULE IV - MORTGAGE LOANS ON REAL ESTATE - Continued\nDisposition of Insured Mortgages (8,137,327) (2,965,249) Principal receipts on Insured Mortgages (186,145) (215,680) Net unrealized gains on investment in Insured Mortgages 1,848,753 -- ------------ ------------ Ending balance $ 37,063,300 $ 43,342,199 ============ ============\n(10) The tax basis of the Insured Mortgages was approximately $34.9 million and $43.1 million as of December 31, 1994 and 1993, respectively.","section_7A":"","section_8":"","section_9":"","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"","section_15":""}
{"filename":"797463_1994.txt","cik":"797463","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL ELECTRIC CAPITAL SERVICES, INC.\nGeneral Electric Capital Services, Inc. (herein together with its consolidated subsidiaries called \"GE Capital Services\" or the \"Corporation\" unless the context otherwise requires) was incorporated in 1984 in the State of Delaware. Until February 1993, the name of the Corporation was General Electric Financial Services, Inc. All outstanding common stock of GE Capital Services is owned by General Electric Company, a New York corporation (\"GE Company\"). The business of GE Capital Services consists of ownership of two principal subsidiaries which, together with their subsidiaries and affiliates, constitute GE Company's principal financial services businesses. GE Capital Services is the sole owner of the common stock of General Electric Capital Corporation (\"GE Capital\") and Employers Reinsurance Corporation (\"ERC\").\nIn November 1994, the Corporation elected to terminate the operations of Kidder, Peabody Group Inc. (\"Kidder, Peabody\") by initiating an orderly liquidation of its assets and liabilities. As part of the liquidation plan, the Corporation received securities of Paine Webber Group Inc. in exchange for certain broker-dealer assets and operations. Principal activities that were discontinued include securities underwriting, sales and trading of equity and fixed income securities, financial futures activities, advisory services for mergers, acquisitions, and other corporate finance matters, research services and asset management. Kidder, Peabody has been classified as a discontinued operation in the financial statements and supplementary data in Item 8 of this Form 10-K. GE Capital Services' principal executive offices are located at 260 Long Ridge Road, Stamford, Connecticut 06927 (Telephone number (203) 357-4000).\nGENERAL ELECTRIC CAPITAL CORPORATION\nGE Capital was incorporated in 1943 in the State of New York, under the provisions of the New York Banking Law relating to investment companies, as successor to General Electric Contracts Corporation, formed in 1932. The capital stock of GE Capital was contributed to GE Capital Services by GE Company in June 1984. Until November 1987, the name of the corporation was General Electric Credit Corporation. The business of GE Capital originally related principally to financing the distribution and sale of consumer and other products of GE Company. Currently, however, the type and brand of products financed and the financial services offered are significantly more diversified. Very little of the financing provided by GE Capital involves products that are manufactured by GE Company.\nGE Capital operates in four finance industry segments and in a specialty insurance industry segment. GE Capital's financing activities include a full range of leasing, lending, equipment management services and annuities. GE Capital's specialty insurance activities include providing financial guaranty insurance, principally on municipal bonds and structured finance issues, private mortgage insurance, and creditor insurance covering international customer loan repayments. GE Capital is an equity investor in a retail organization and certain other service and financial services organizations. GE Capital's operations are subject to a variety of regulations in their respective jurisdictions.\nServices of GE Capital are offered primarily throughout the United States, Canada, Europe and the Pacific basin. GE Capital's principal executive offices are located at 260 Long Ridge Road, Stamford, Connecticut 06927. At December 31, 1994, GE Capital employed approximately 32,000 persons.\nEMPLOYERS REINSURANCE CORPORATION\nERC, together with its subsidiaries, writes all lines of reinsurance other than title and annuities. ERC reinsures property and casualty risks written by more than 1,000 U.S. and non-U.S. insurers, and also writes certain specialty lines of insurance on a direct basis, principally excess workers' compensation for self-insurers, errors and omissions coverage for insurance and real estate agents and brokers, excess indemnity for self-insurers of medical benefits, and libel and allied torts. ERC and certain U.S. subsidiaries are licensed in all of the United States, the District of Columbia, certain provinces of Canada and write property and casualty reinsurance on a direct basis and through brokers. Other U.S. subsidiaries write excess and surplus lines insurance, and provide reinsurance brokerage services. Subsidiaries in Denmark and the United Kingdom write property and casualty and life reinsurance, principally in Europe, the Pacific basin and the Middle East.\nITEM 1. BUSINESS (CONTINUED). In December 1994, certain life and property and casualty affiliates of GE Capital were transferred to ERC. These affiliates had been managed by ERC since 1986. Insurance and reinsurance operations are subject to regulation by various insurance regulatory agencies. ERC and its subsidiaries conduct business through 16 domestic offices and 12 foreign offices. The principal offices of ERC are located at 5200 Metcalf Avenue, Overland Park, Kansas 66201. At December 31, 1994, ERC employed approximately 1,250 persons.\nINDUSTRY SEGMENTS\nThe Corporation provides a wide variety of financing, asset management, and insurance products and services which are organized into the following industry segments:\n- Specialty Insurance -- U.S. and international multiple-line property and casualty reinsurance, certain directly written specialty insurance and life reinsurance (ERC); financial guaranty insurance, principally on municipal bonds and structured finance issues; private mortgage insurance and creditor insurance covering international customer loan repayments.\n- Consumer Services -- private-label and bank credit card loans, time sales and revolving credit and inventory financing for retail merchants, auto leasing and inventory financing, mortgage servicing and annuity and mutual fund sales.\n- Equipment Management -- leases, loans and asset management services for portfolios of commercial and transportation equipment including aircraft, trailers, auto fleets, modular space units, railroad rolling stock, data processing equipment, ocean-going containers and satellites.\n- Mid-Market Financing -- loans and leases for middle-market customers including manufacturers, distributors and end users, for a variety of equipment, including data processing equipment, medical and diagnostic equipment, and equipment used in construction, manufacturing, office applications and telecommunications activities.\n- Specialized Financing -- loans and leases for major capital assets, including industrial facilities and equipment, and energy-related facilities; commercial and residential real estate loans and investments; and loans to and investments in corporate enterprises.\nRefer to Item 7, \"Management's Discussion and Analysis of Results of Operations,\" in this Form 10-K for discussion of the Corporation's Portfolio Quality.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nGE Capital Services and its subsidiaries conduct their businesses from various facilities, most of which are leased.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe following is not material to the Corporation but is provided for informational purposes. Following GE Company's announcement on April 17, 1994, of a $210 million charge to net earnings based upon its discovery of false trading profits at its indirect subsidiary, Kidder, Peabody & Co., Incorporated (\"Kidder\"), the United States Securities and Exchange Commission, the United States Attorney for the Southern District of New York, and the New York Stock Exchange initiated investigations, which are ongoing, relating to the false trading profits. Also, two civil suits purportedly brought on behalf of GE Company as shareholder derivative actions were filed in New York State Supreme Court in New York County. Both suits claim that GE Company's directors breached their fiduciary duties to GE Company by failing to adequately supervise and control the Kidder employee responsible for the irregular trading. One suit, claiming damages of over $350 million, was filed on May 10, 1994, by the Teachers' Retirement System of Louisiana against GE Company, certain of its directors, Kidder, its parent, Kidder, Peabody Group Inc., and certain of Kidder's former officers and directors. The other suit was filed on June 3, 1994, by William Schrank and others against GE Company's directors claiming unspecified damages and other relief. The defendants' time for responding to these complaints has been extended until 45 days after the plaintiffs file an amended consolidated complaint. In addition, various shareholders of GE Company have filed purported class action suits claiming that GE Company, and certain of its directors and officers, among others, allegedly violated federal securities laws by issuing statements concerning GE Company's\nITEM 3. LEGAL PROCEEDINGS (CONTINUED). financial condition that included the false trading profits at Kidder, and seeking compensatory damages for shareholders who purchased GE Company's stock beginning as early as January 1993. The defendants have filed motions to dismiss these purported class action suits.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nOmitted\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nSee Note 12 to the Consolidated Financial Statements. The common stock of the Corporation is owned entirely by GE Company and, therefore, there is no trading market in such stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected financial data should be read in conjunction with the financial statements of GE Capital Services and consolidated affiliates and the related notes.\n--------------- Prior-period data have been reclassified, when necessary, to reflect classification of Kidder, Peabody as a discontinued operation.\n(a) Statement of Financial Accounting Standards (SFAS) No. 106, Employers' Accounting for Post-retirement Benefits Other Than Pensions, was implemented in 1991 using the immediate recognition transition option. The cumulative effect to January 1, 1991, of adopting SFAS No. 106 was $6 million, net of a $4 million tax benefit, all of which related to ERC.\n(b) The Corporation adopted SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, on December 31, 1993, resulting in the inclusion in equity, net of tax, of net unrealized losses on investment securities of $821 million and net unrealized gains of $812 million at December 31, 1994 and 1993, respectively.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS.\nOVERVIEW\nThe Corporation's net earnings were $896 million in 1994, 50% less than 1993's earnings of $1,807 million, which were 21% more than the comparable 1992 earnings of $1,499 million. The 1994 decrease was due to the discontinued operations of Kidder, Peabody Group Inc. (Kidder, Peabody), discussed below. Net earnings from continuing operations (exclusive of Kidder, Peabody) were $2,085 million in 1994, up 33% from 1993, which increased 18% from 1992.\nDISCONTINUED OPERATIONS\nIn November 1994, the Corporation elected to terminate the operations of Kidder, Peabody by initiating an orderly liquidation of its assets and liabilities, including the sale of certain assets and operations to Paine Webber Group Inc. Discontinued operations resulted in a net loss of $1,189 million in 1994 compared with earnings of $240 million in 1993 and $168 million in 1992. The 1994 net loss included a net loss from operations of $321 million through the date operations were discontinued and a provision of $868 million for exit costs expected to be incurred in connection with the liquidation. The Corporation expects this liquidation will be largely complete by the end of 1995 and that no further associated costs will be incurred. The 1994 net loss from operations included a $210 million ($350 million before tax) first quarter charge resulting from the discovery of false trading profits created by the then head U.S. government securities trader at Kidder, Peabody & Co. Incorporated, a subsidiary of Kidder, Peabody. Approximately $143 million ($238 million before tax) of the charge related to periods prior to 1994. In addition, weakened mortgage-backed securities market conditions and reduced underwritings throughout 1994 contributed to the net loss from operations. See Note 2 to the Consolidated Financial Statements for further details of discontinued operations.\nOPERATING RESULTS FROM CONTINUING OPERATIONS\nEARNINGS FROM CONTINUING OPERATIONS were $2,085 million in 1994, up 33% from 1993 which increased 18% from 1992. The 1994 increase reflected strong performances in the financing businesses resulting primarily from asset growth, improved financing spreads and asset quality. Earnings in the Specialty Insurance segment declined in 1994 due to higher insurance losses. The 1993 earnings increase reflected substantially higher earnings in the financing businesses, mainly as a result of the favorable 1993 interest rate environment, asset growth and improved asset quality. Earnings in the Specialty Insurance segment also increased in 1993 over 1992.\nThe correlation between interest rate changes and financing spreads (the excess of yield over interest rates on borrowings) is subject to many factors and cannot be forecasted with reliability. Although not necessarily relevant to future effects, management estimates that, all else constant, an increase of 100 basis points in interest rates for all of 1994 would have reduced net earnings by approximately $90 million.\nEARNED INCOME increased 15% to $19.9 billion in 1994, following a 20% increase to $17.3 billion in 1993. Asset growth in each of the Corporation's financing segments, through acquisitions of businesses and portfolios as well as origination volume, was the primary reason for increased income from time sales, loans, financing leases and operating lease rentals in both 1994 and 1993. Yields on related assets increased during 1994 after holding essentially flat in 1993 compared with 1992. Earned income from the Corporation's annuity business, formed through two mid-year 1993 acquisitions, was $1,102 million and $571 million in 1994 and 1993, respectively.\nSpecialty Insurance revenues were $4.9 billion in 1994, essentially flat compared with 1993, reflecting steady growth in premium revenue, offset by a reduction in assumed life reinsurance. The increase in 1993 compared with 1992 of 26% reflected higher premium and investment income as well as the impact of the creditor insurance business, which was consolidated at the end of the second quarter of 1992 when an existing equity position was converted to a controlling interest.\nINTEREST EXPENSE on borrowings is the Corporation's principal cost. Interest expense in 1994 totaled $4.5 billion, 28% higher than in 1993, which was 5% lower than in 1992. The 1994 increase reflected the effects of higher average borrowings used to finance asset growth as well as the effects of higher interest rates. The 1993 decrease was a result of substantially lower rates on higher average borrowings supporting financing operations. Composite interest rates on the Corporation's borrowings were 5.47% in 1994 compared with 4.96% in 1993 and 5.78% in 1992.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). OPERATING AND ADMINISTRATIVE EXPENSES were $6.2 billion in 1994, a 10% increase over 1993, which was 23% higher than 1992, primarily reflecting higher investment levels and costs associated with acquired businesses and portfolios over the past two years. These increases in both 1994 and 1993 were partially offset by reductions in provisions for losses on investments charged to operating and administrative expenses, principally those relating to commercial real estate assets, highly leveraged transactions (HLT) and commercial aircraft.\nINSURANCE LOSSES AND POLICYHOLDER AND ANNUITY BENEFITS increased 11% to $3.5 billion in 1994, compared with a 62% increase to $3.2 billion in 1993. The 1994 increase was the result of annuity benefits credited to customers of the annuity business which was acquired in 1993 and adverse loss development in private mortgage pool insurance, particularly related to the effects of poor economic conditions and housing value declines in southern California. These increases were partially offset by lower policyholder benefits in the life reinsurance business resulting from reduced assumed volume. The 1993 increase principally reflected annuity benefits relating to the 1993 annuity business acquisition, as well as higher losses on increased volume in the property and casualty reinsurance and life reinsurance businesses.\nPROVISION FOR LOSSES ON FINANCING RECEIVABLES decreased $114 million to $873 million in 1994 compared with a $69 million decrease to $987 million in 1993. These provisions principally related to the private-label and bank credit cards, auto leasing, commercial real estate loans and, in 1993, the HLT portfolio discussed below under Portfolio Quality in connection with other financing receivables.\nDEPRECIATION AND AMORTIZATION OF BUILDINGS AND EQUIPMENT AND EQUIPMENT ON OPERATING LEASES increased slightly to $1,662 million in 1994, a 4% increase over 1993, which was 22% higher than 1992, as a result of additions to equipment on operating leases through business and portfolio acquisitions as well as origination volume, and in 1993, the acceleration of depreciation of certain assets.\nPROVISION FOR INCOME TAXES was $864 million in 1994 (an effective tax rate of 29%), compared with $642 million in 1993 (29%) and $404 million (23%) in 1992. The increased provision for income taxes in both 1994 and 1993 reflected the effects of additional income before taxes and, in 1993, the 1% increase in the U.S. federal income tax rate. Increases impacting the effective tax rate in 1994, compared with 1993, included proportionately lower tax-exempt income and an increase in state income taxes. In addition, there was no current year counterpart to the effects of certain 1993 financing transactions that reduced the Corporation's obligation for deferred taxes. These increases were offset by the absence of a current year counterpart to the unfavorable effects of the 1993 increase in the U.S. federal income tax rate. The higher rate in 1993, compared with 1992, primarily reflected the increase in the U.S. federal income tax rate and proportionately lower tax-exempt income, partially offset by the aforementioned 1993 financing transactions.\nOPERATING PROFIT BY INDUSTRY SEGMENT\nOperating profit (pre-tax income) of the Corporation, by industry segment, is summarized in Note 17 to the Consolidated Financial Statements and discussed below:\nSPECIALTY INSURANCE operating profit declined from $770 million in 1993 to $589 million in 1994 as a result of an operating loss in the private mortgage insurance business. The 1994 operating loss resulted from adverse loss development in private mortgage pool insurance, the result of poor economic conditions and housing value declines in southern California. These losses more than offset operating profit increases in other parts of the segment, including primary mortgage insurance. Based on conditions at December 31, 1994, management believes that loss development should diminish in 1995 and in subsequent years. However, future economic conditions and housing values in southern California are uncertainties that could affect that outlook. The 1993 operating profit was 20% higher than the $641 million recorded in 1992, reflecting higher premium volume from bond refunding in the financial guaranty insurance business as well as reduced claims expense in the creditor insurance business.\nCONSUMER SERVICES operating profit increased 50% to $1,067 million from $709 million in 1993 which was 16% higher than 1992. The strong 1994 growth in operating profit resulted from origination and acquisition growth in the auto leasing business and the private-label and bank credit card businesses. In addition, the operations of the annuity business, purchased in 1993, were included for a full year in 1994. The 1993 increase reflected lower provisions for receivable losses in the private-label and bank credit card businesses resulting from declines in consumer delinquency as well as strong asset growth and a\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). favorable interest rate environment for both the auto leasing business and the private-label and bank credit card businesses.\nEQUIPMENT MANAGEMENT operating profit increased to $624 million in 1994 from $246 million in 1993. This increase reflected higher volume in most businesses, largely the result of portfolio and business acquisitions, and of improved trailer, container and railcar utilization. In addition, expenses associated with redeployment and refurbishment of owned aircraft declined in 1994 compared with 1993. Operating profit declined 50% in 1993 resulting from the aforementioned expenses associated with owned aircraft and the effects of lower utilization and pricing pressures with respect to ocean-going containers. These declines were partially offset by higher volume in most businesses, largely the result of asset growth and improved trailer and railcar utilization.\nMID-MARKET FINANCING operating profit of $435 million in 1994 was 7% higher than that of 1993 which was 74% higher than 1992. The 1994 and 1993 increases reflected higher levels of invested assets, primarily as a result of business and portfolio acquisitions and increased financing spreads.\nSPECIALIZED FINANCING operating profit was $536 million in 1994, compared with $366 million in 1993, and $35 million in 1992. The increase in 1994 principally reflected much lower provisions for losses on HLT investments and commercial real estate assets. The 1993 increase also principally reflected much lower provisions for losses on HLT investments and higher gains from sales of commercial real estate assets offset in part by higher loss provisions for commercial real estate assets. Further details concerning loss provisions relating to both the commercial real estate portfolio and HLT investments are discussed below.\nCAPITAL RESOURCES AND LIQUIDITY\nThe Corporation's principal source of cash is financing activities that involve the continuing rollover of short-term borrowings and appropriate addition of long-term borrowings, with an appropriate balance of maturities. Over the past three years, the Corporation's borrowings with maturities of 90 days or less have increased by $4.4 billion. New borrowings of $49.5 billion having maturities longer than 90 days were added during those years, while $28.7 billion of such longer-term borrowings were retired. The Corporation also generated significant cash from continuing operating activities, $19.5 billion during the last three years.\nThe Corporation's principal use of cash has been investing in assets to grow the business. Of $41.8 billion that the Corporation invested in continuing operations over the past three years, $18.4 billion was used for additions to financing receivables, $12.2 billion for new equipment, primarily for lease to others, and $6.1 billion to acquire new businesses.\nGE Company has agreed to make payments to GE Capital, constituting additions to pre-tax income, to the extent necessary to cause GE Capital's consolidated ratio of earnings to fixed charges to be not less than 1.10 for each fiscal year commencing with fiscal year 1991. Three years advance written notice is required to terminate this agreement. No payments have been required under this agreement. GE Capital's ratios of earnings to fixed charges for the years 1994, 1993 and 1992, were 1.63, 1.62 and 1.44, respectively.\nThe Corporation's total borrowings were $91.4 billion at December 31, 1994, of which $57.1 billion was due in 1995 and $34.3 billion was due in subsequent years. Comparable amounts at the end of 1993 were $81.1 billion total, $55.3 billion due within one year and $25.8 billion due thereafter. A large portion of the Corporation's borrowings was commercial paper ($43.7 billion and $46.3 billion at the end of 1994 and 1993, respectively). Most of this commercial paper is issued by GE Capital. The average remaining terms and interest rates of GE Capital's commercial paper were 45 days and 5.90%, respectively, at the end of 1994 compared with 35 days and 3.39% at the end of 1993. GE Capital's ratio of debt to equity (leverage) was 8.43 to 1 at the end of 1994 compared with 7.59 to 1 at the end of 1993. Excluding net unrealized gains and losses on investment securities, GE Capital's leverage was 7.94 to 1 at the end of 1994, compared with 7.96 to 1 at the end of 1993.\nManagement believes the Corporation is well positioned to meet the global needs of its customers for capital and to continue growing its diverse asset base.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). INTEREST RATE AND CURRENCY RISK MANAGEMENT\nThe Corporation is exclusively an end user of derivative financial instruments that are used to manage interest rate and currency risk. The Corporation does not engage in any derivatives trading, market-making or other speculative activities.\nThe Corporation manages its exposure to changes in interest rates, in part, by funding its assets with an appropriate mix of fixed and variable rate debt and its exposure to currency fluctuations principally by funding local currency denominated assets with debt denominated in those same currencies. It uses interest rate swaps and currency swaps (including non-U.S. currency and cross currency interest rate swaps) to achieve lower borrowing costs. Substantially all of these swaps have been designated as modifying interest rates and\/or currencies associated with specific debt instruments. All other swaps, forward contracts and other derivatives have been designated as hedges of non-U.S. net investments or other assets, and are not significant. These financial instruments allow the Corporation to lower its cost of funds by substituting credit risk for interest rate and currency risks. Since the Corporation's principal use of swaps is to optimize funding costs, changes in interest rates and exchange rates underlying swaps would not be expected to have a material impact on the Corporation's financial position or results of operations. The Corporation conducts almost all activities with these instruments in the over-the-counter markets.\nEstablished practices require that all derivative financial instruments relate to specific asset, liability or equity transactions or currency exposures. Substantially all treasury actions are centrally executed by the Corporation's Treasury Department, which maintains controls on all exposures, adheres to stringent counterparty credit standards and actively monitors marketplace exposures.\nGiven the ways in which the Corporation uses swaps, market risk associated with swap activities is meaningful only as it relates to how changes in the market value of swaps affect credit exposure to individual swap counterparties. The Corporation has established the following credit policies governing swap transactions: (a) at inception, counterparties must be rated, at a minimum, Aa3 (Moody's) or AA- (S&P) for swaps of five years or less, and Aaa\/AAA for swaps in excess of five years; and (b) mark to market counterparty exposure is limited to $50 million for Aa2\/AA rated institutions and $75 million for Aaa\/AAA rated institutions. When monthly review of the market values indicate that a counterparty is approaching the above limits, appropriate actions are initiated to reduce exposure.\nBecause of the changing nature of financial markets, the Corporation incorporates credit downgrade language in its master swap agreements. If either the Corporation or the counterparty is downgraded below A3 (Moody's) or A- (S&P), the non-downgraded counterparty has the right to require assignment of the affected swap to an approved counterparty or termination of the affected swaps. If termination occurs, the Corporation replaces the swap with an appropriate counterparty.\nThe conversion of interest rate and currency risk into credit risk results in a need to monitor counterparty credit risk actively. At December 31, 1994, the notional amount of derivatives for which the counterparty was rated below Aa3\/AA- was $1,504 million. These amounts are the result of (1) counterparty downgrades, (2) transactions executed prior to the adoption of the Corporation's current counterparty credit standards, and (3) transactions relating to acquired assets or businesses. The total exposure to market value changes related to credit risk on swaps at December 31, 1994 was $412 million. The Corporation does not anticipate any loss on this exposure.\nThe following chart displays the credit risk exposures at the following year ends.\nPERCENTAGE OF NOTIONAL DERIVATIVE EXPOSURE BY COUNTERPARTY CREDIT RATING\nThe optimal funding strategy is sometimes achieved by using multiple swaps. For example, to obtain fixed rate U.S. dollar funding, several alternatives are generally available. One alternative is a swap of non-U.S. dollar denominated fixed rate debt into U.S. dollars. The synthetic U.S. dollar denominated debt would be effectively created by taking the following steps: (1) issuing fixed rate, non-U.S. currency\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). denominated debt, (2) entering into a swap under which fixed rate non-U.S. currency principal and interest will be received and floating rate non-U.S. currency principal and interest will be paid, and (3) entering into a swap under which floating rate non-U.S. currency principal and interest will be received and fixed rate U.S. dollar denominated principal and interest will be paid. The end result is, in every important respect, fixed rate U.S. dollar denominated financing with an element of controlled credit risk. This type of structure usually results from using several swap counterparties for steps (2) and (3). The Corporation uses multiple swaps only as part of such transactions.\nThe interplay of the Corporation's credit risk policy with its funding activities is seen in the following example, in which the Corporation is assumed to have been offered three alternatives for funding five-year fixed rate U.S. dollar assets with five-year fixed rate U.S. dollar debt.\nCounterparty A is a major brokerage house with a Aaa\/AAA rated swap subsidiary and a current exposure to the Corporation of $39 million. Counterparty B is a Aa2\/AA rated insurance company with a current exposure of $50 million.\nIn this hypothetical case, the Corporation would have chosen alternative 2. Alternative 1 is unacceptably costly. Although alternative 3 would have yielded a lower immediate cost of funds, the additional credit risk would have exceeded the Corporation's risk management limits.\nPORTFOLIO QUALITY\nThe portfolio of financing receivables, which was $76.4 billion at the end of 1994 and $63.9 billion at the end of 1993, is the Corporation's largest asset and its primary source of revenues. Related allowances for losses at the end of 1994 aggregated $2.1 billion (2.63% of receivables -- the same level as 1993 and 1992) and are, in management's judgment, appropriate given the risk profile of the portfolio. A discussion about the quality of certain elements of the portfolio of financing receivables follows. Further details are included in Notes 4, 5 and 6 to the Consolidated Financial Statements.\nCONSUMER LOANS RECEIVABLE, primarily retailer and auto receivables, were $23.1 billion and $17.3 billion at the end of 1994 and 1993, respectively. In addition, the Corporation's investment in consumer auto finance lease receivables was $7.5 billion and $5.6 billion at the end of 1994 and 1993, respectively. Nonearning receivables, which were 1.4% of total loans and leases (1.7% at the end of 1993), aggregated $422 million at the end of 1994. The provision for losses on retailer and auto financing receivables was $502 million in 1994, a 7% increase from $469 million in 1993, reflecting growth in the portfolio of receivables. Most nonearning receivables were private-label credit card receivables, the majority of which were subject to various loss-sharing arrangements that provide full or partial recourse to the originating retailer.\nCOMMERCIAL REAL ESTATE LOANS classified as finance receivables by the Commercial Real Estate business were $11.9 billion at December 31, 1994, up $1.0 billion from the end of 1993. In addition, the investment portfolio of the annuity business included $1.4 billion of commercial property loans at December 31, 1994, up $0.3 billion from the end of 1993. Commercial real estate loans are generally secured by first mortgages. In addition to loans, the commercial real estate portfolio included, in other assets, $2.1 billion ($2.2 billion in 1993) of assets acquired for resale from various financial institutions, including the Resolution Trust Corporation. Values realized on sales of these assets and the pace of such sales continue to meet or exceed expectations at the time of purchase. Also included in other assets were investments in real estate ventures at year-end 1994 totaling $1.4 billion, the same as at year-end 1993. Those investments are made as a part of original financings and in conjunction with loan restructurings where management believes that such investments will enhance economic returns.\nCommercial Real Estate's foreclosed properties at the end of 1994 declined to $20 million from $110 million at the end of 1993, primarily because of sales.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS (CONTINUED). At December 31, 1994, Commercial Real Estate's portfolio included loans secured by and investments in a variety of property types that continued to be well dispersed geographically. Nonearning and reduced earning receivables declined to $179 million in 1994 from $272 million in 1993, reflecting write- offs and proactive management of delinquent receivables in a stabilized commercial real estate market. Sustaining the 1994 improvements depends on many factors, including interest rates and various local market conditions. The loss provision for Commercial Real Estate's investments was $287 million in 1994 ($244 million related to receivables and $43 million related to other assets), compared with $387 million and $299 million in 1993 and 1992, respectively. The 1994 decrease resulted from lower provisions related to real estate ventures and foreclosed properties. Loss provisions in 1993 increased as the portfolio was adversely affected by a weakened commercial real estate market.\nOTHER FINANCING RECEIVABLES, $32.5 billion at December 31, 1994, consisted primarily of a diverse commercial, industrial and equipment loan and lease portfolio. This portfolio grew $3.5 billion during 1994, while nonearning and reduced earning receivables decreased to $165 million at year-end 1994 from $237 million at year-end 1993. Included in other financing receivables are financings provided for highly leveraged management buyouts and corporate recapitalizations. The portion of those investments classified as financing receivables was $2.4 billion at the end of 1994, compared with $3.3 billion at the end of 1993, as repayments continued to reduce this liquidating portfolio. The year-end balance of the HLT portfolio included amounts that had been written down to estimated fair value and carried in other assets as a result of restructuring or in-substance repossession. These balances aggregated $336 million at the end of 1994 and $544 million at the end of 1993 (net of allowances of $224 million and $244 million, respectively).\nThe Corporation has loans and leases to commercial airlines, as discussed in Note 6 to the Consolidated Financial Statements, that aggregated about $7.6 billion at the end of 1994, up from $6.8 billion at the end of 1993. At year-end 1994, the Corporation's commercial aircraft positions included financial guaranties and funding commitments amounting to $506 million (compared with $450 million in 1993) and conditional commitments to purchase aircraft at a cost of $81 million ($865 million at December 31, 1993). The decline in purchase commitments resulted from 1994 purchases of aircraft.\nENTERING 1995, management believes that vigilant attention to risk management, along with the diversity and strength of the Corporation's resources, position it to deal effectively with the increasing competition in an ever-changing global economy.\nNEW ACCOUNTING STANDARDS\nPrincipal new accounting standards are SFAS No. 114, Accounting by Creditors for Impairment of a Loan, and the related SFAS No. 118, which together modify the accounting and disclosure that applies when it is probable that all amounts due under contractual terms of a commercial loan will not be collected. Had these standards been adopted for 1994, there would have been no effect on earnings or financial position, and management does not foresee any significant future effect following adoption on January 1, 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors General Electric Capital Services, Inc.\nWe have audited the financial statements of General Electric Capital Services, Inc. and consolidated affiliates as listed in Item 14. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in Item 14. These consolidated financial statements and financial statement schedules are the responsibility of the Corporation'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 General Electric Capital Services, Inc. and consolidated affiliates at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994 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.\nAs discussed in Note 12 to the consolidated financial statements, the Corporation in 1993 adopted required changes in its method of accounting for investments in certain securities.\n\/s\/ KPMG PEAT MARWICK LLP\nStamford, Connecticut February 10, 1995\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nSTATEMENT OF CURRENT AND RETAINED EARNINGS\nSee Notes to Consolidated Financial Statements.\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nSTATEMENT OF FINANCIAL POSITION\nSee Notes to Consolidated Financial Statements.\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nSTATEMENT OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION -- GE Capital Services (the \"Corporation\") owns all of the common stock of General Electric Capital Corporation (\"GE Capital\"), Employers Reinsurance Corporation (\"Employers Reinsurance\") and Kidder, Peabody Group Inc. (\"Kidder, Peabody\"). The consolidated financial statements represent the adding together of GE Capital Services and all majority-owned and controlled affiliates (\"consolidated affiliates\"), including GE Capital and Employers Reinsurance. In 1994, Kidder, Peabody was classified as a discontinued operation (see Note 2). Prior period data shown in the consolidated financial statements and the related notes have been reclassified, as appropriate, to reflect this change. Other prior period data have been reclassified to conform with current year presentation.\nAll significant transactions among the parent and consolidated affiliates have been eliminated. Other affiliates, generally companies in which the Corporation owns 20 percent to 50 percent of the voting rights (\"non-consolidated affiliates\"), are included in other assets and valued at the appropriate share of equity plus loans and advances.\nCASH FLOWS -- Certificates and other time deposits are treated as cash equivalents.\nMETHODS OF RECORDING EARNED INCOME -- Income on all loans is recognized on the interest method. Accrual of interest income is suspended at the earlier of the time at which collection of an account becomes doubtful or the account becomes 90 days delinquent.\nFinancing lease income, which includes residual values and investment tax credits, is recorded on the interest method so as to produce a level yield on funds not yet recovered. Unguaranteed residual values are based primarily on periodic independent appraisals of the values of leased assets remaining at expiration of the lease terms. Operating lease income is recognized on a straight-line basis over the terms of the underlying leases.\nOrigination, commitment and other nonrefundable fees related to fundings are deferred and recorded in earned income on the interest method. Commitment fees related to loans not expected to be funded and line-of-credit fees are deferred and recorded in earned income on a straight-line basis over the period to which the fees relate. Syndication fees are recorded in earned income at the time the related services are performed unless significant contingencies exist.\nPremiums on short duration insurance contracts are reported as earned income over the terms of the related reinsurance treaties or insurance policies. In general, earned premiums are calculated on a pro-rata basis or are determined based on reports received from reinsureds. Premium adjustments under retrospectively rated assumed reinsurance contracts are recorded based on estimated losses and loss expenses, including both case and incurred-but-not-reported reserves. Premiums on long-duration insurance products are recognized as earned when due. Premiums received under annuity contracts are not reported as revenues but as annuity benefits -- a liability -- and are adjusted according to the terms of the respective policies.\nALLOWANCE FOR LOSSES ON FINANCING RECEIVABLES AND INVESTMENTS -- GE Capital maintains an allowance for losses on financing receivables at an amount which it believes is sufficient to provide adequate protection against future losses in the portfolio. For small-balance receivables, the allowance for losses is determined principally on the basis of actual experience during the preceding three years. Further allowances are also provided to reflect management's judgment of additional loss potential. For other financing receivables, principally the larger loans and leases, the allowance for losses is determined primarily on the basis of management's judgment of net loss potential, including specific allowances for known troubled accounts.\nAll accounts or portions thereof deemed to be uncollectible or to require an excessive collection cost are written off to the allowance for losses. Small-balance accounts are progressively written down (from 10% when more than three months delinquent to 100% when nine to twelve months delinquent) to record the balances at estimated realizable value. However, if at any time during that period an account is judged to be uncollectible, such as in the case of a bankruptcy, the uncollectible balance is written off. Larger-balance accounts are reviewed at least quarterly, and those accounts which are more than three months delinquent are written down, if necessary, to record the balances at estimated realizable value.\nWhen collateral is repossessed in satisfaction of a loan, the receivable is written down against the allowance for losses to estimated fair value, transferred to other assets and subsequently carried at the lower of cost or estimated current fair value. This accounting has been employed principally for specialized financing transactions.\nINVESTMENT SECURITIES -- The Corporation has designated its investments in debt securities and marketable equity securities as available-for-sale. Those securities are reported at fair value, with net unrealized gains and losses included in equity, net of applicable taxes. Unrealized losses that are other than temporary are recognized in earnings.\nEQUIPMENT ON OPERATING LEASES -- Equipment is amortized, principally on a straight-line basis, to estimated net salvage value over the lease term or the estimated economic life of the equipment.\nBUILDINGS AND EQUIPMENT -- Depreciation is recorded on a sum-of-the-years' digits basis or a straight-line basis over the lives of the assets.\nGOODWILL -- Goodwill is amortized on a straight-line basis over periods not exceeding 30 years. Goodwill in excess of associated expected operating cash flows is considered to be impaired and is written down to fair value.\nDEFERRED INSURANCE ACQUISITION COSTS -- For the property and casualty businesses, deferred insurance acquisition costs are amortized pro-rata over the contract periods in which the related premiums are earned. For the life insurance businesses, these costs are amortized over the premium-paying periods of the contracts in proportion either to anticipated premium income or to gross profit, as appropriate. For certain annuity contracts, such costs are amortized on the basis of anticipated gross profits. For other lines of business, acquisition costs are amortized over the life of the related insurance contracts. Deferred insurance acquisition costs are reviewed for recoverability; for short-duration contracts, anticipated investment income is considered in making recoverability evaluations.\nINSURANCE LIABILITIES AND RESERVES -- The estimated liability for insurance losses and loss expenses consists of both case and incurred-but-not-reported reserves. Where experience is not sufficient, industry averages are used. Estimated amounts of salvage and subrogation recoverable on paid and unpaid losses are deducted from outstanding losses.\nThe liability for future policyholder benefits of the life insurance affiliates has been computed mainly by a net-level-premium method based on assumptions for investment yields, mortality and terminations that were appropriate at date of purchase or at the time the policies were developed, including provisions for adverse deviations.\nINTEREST RATE AND CURRENCY RISK MANAGEMENT -- As a matter of policy, the Corporation does not engage in derivatives trading or market-making activities. Rather, the principal derivative financial instruments used by the Corporation are interest and currency swaps used in connection with borrowing activities. Such swaps are accounted for on an accrual basis and included in interest expense. Other derivatives, including forwards, futures and options, are hedges of identified assets, liabilities or functional currency equity positions. The cost or revenue from such instruments is recognized in income or equity in a manner consistent with the accounting for the instrument being hedged. If, however, an instrument is designated but is ineffective as a hedge, the instrument is marked to market and recognized in operations immediately.\nNOTE 2. DISCONTINUED OPERATIONS\nIn November 1994, the Corporation elected to terminate the operations of Kidder, Peabody by initiating an orderly liquidation of its assets and liabilities. As part of the liquidation plan, the Corporation received\nsecurities of Paine Webber Group Inc. valued at $657 million in exchange for certain broker-dealer assets and operations. Summary operating results of the discontinued operations are as follows:\nA summary of Kidder, Peabody's assets and liabilities at December 31, 1994, which are expected to be substantially liquidated in 1995, follows:\n--------------- (a) Trading securities included $1.5 billion of collateralized mortgage obligations (CMO's).\nNOTE 3. INVESTMENT SECURITIES\nA summary of investment securities follows:\nContractual maturities of debt securities at December 31, 1994, other than mortgage-backed securities, are shown below.\nIt is expected that actual maturities will differ from contractual maturities because some borrowers have the right to call or prepay certain obligations, sometimes without call or prepayment penalties. Proceeds from sales of investment securities in 1994, 1993 and 1992 were $5,821 million, $6,112 million and $3,514 million, respectively; gross realized gains were $281 million, $173 million and $171 million, respectively; and gross realized losses were $112 million, $34 million and $4 million, respectively.\nNOTE 4. FINANCING RECEIVABLES\nFinancing receivables at December 31, 1994 and 1993 by industry segment are shown below.\nTime sales and loans represent transactions with customers in a variety of forms, including time sales, revolving charge and credit arrangements, mortgages, installment loans, intermediate-term loans and revolving loans secured by business assets. The portfolio includes time sales and loans carried at the principal amount on which finance charges are billed periodically, and time sales and loans acquired on a discount basis carried at gross book value, which includes finance charges. At year-end 1994 and 1993, specialized financing and consumer services loans included $13,282 million and $11,887 million, respectively, for commercial real estate loans. Note 6 contains information on commercial airline loans and leases.\nAt December 31, 1994, contractual maturities for time sales and loans were $20,147 million in 1995, $7,466 million in 1996, $5,708 million in 1997, $4,047 million in 1998, $4,115 million in 1999 and $9,843 million thereafter. Experience of the Corporation has shown that a substantial portion of receivables will be paid prior to contractual maturity. Accordingly, the contractual maturities of time sales and loans are not to be regarded as forecasts of future cash collections.\nFinancing leases consist of direct financing and leveraged leases of aircraft, railroad rolling stock, automobiles and other transportation equipment, data processing equipment, medical equipment, and other manufacturing, power generation, mining and commercial equipment and facilities.\nAs the sole owner of assets under direct financing leases and as the equity participant in leveraged leases, the Corporation is taxed on total lease payments received and is entitled to tax deductions based on the cost of leased assets and tax deductions for interest paid to third-party participants. The Corporation is also generally entitled to any residual value of leased assets and to any investment tax credit on leased equipment.\nInvestments in direct financing and leveraged leases represent unpaid rentals and estimated unguaranteed residual values of leased equipment, less related deferred income. Because the Corporation has no general obligation for principal and interest on notes and other instruments representing third-party participation related to leveraged leases, such notes and other instruments have not been included in liabilities but have been offset against the related rentals receivable. The Corporation's share of rentals receivable on leveraged leases is subordinate to the share of the other participants who also have security interests in the leased equipment.\nThe Corporation's investment in financing leases at December 31, 1994 and 1993 is shown below.\n--------------- (a) Total financing lease deferred income is net of deferred initial direct costs of $93 million and $83 million for 1994 and 1993, respectively.\nAt December 31, 1994, contractual maturities for finance lease rentals receivable were $7,409 million in 1995, $6,235 million in 1996, $5,148 million in 1997, $3,050 million in 1998, $2,096 million in 1999 and $8,927 million thereafter. As with time sales and loans, experience has shown that a portion of receivables will be paid prior to contractual maturity and these amounts should not be regarded as forecasts of future cash flows.\nIn connection with the sales of financing receivables with recourse, GE Capital received proceeds of $1,239 million in 1994, $1,105 million in 1993, and $1,097 million in 1992. GE Capital's exposure under such recourse provisions is included in \"other financial guaranties\" in Note 21.\nNonearning consumer time sales and loans, primarily private-label credit card receivables, amounted to $422 million and $391 million at December 31, 1994 and 1993, respectively. A majority of these receivables was subject to various loss-sharing arrangements that provide full or partial recourse to the originating private-label entity. Nonearning and reduced earning receivables other than consumer time sales and loans were $346 million and $509 million at year-end 1994 and 1993, respectively. Earnings of $4 million and $11 million realized in 1994 and 1993, respectively, were $27 million and $41 million lower than would have been reported had these receivables earned income in accordance with their original terms.\nNOTE 5. ALLOWANCE FOR LOSSES ON FINANCING RECEIVABLES\nThe allowance for losses on financing receivables represented 2.63% of total financing receivables at both year-ends 1994 and 1993. The table below shows the activity in the allowance for losses on financing receivables during each of the past three years.\nAmounts written off in 1994 were approximately 0.91% of average gross financing receivables outstanding during the year, compared with 1.46% and 1.58% of average gross financing receivables outstanding during 1993 and 1992, respectively.\nNOTE 6. EQUIPMENT ON OPERATING LEASES\nEquipment on operating leases by type of equipment and accumulated amortization at December 31, 1994 and 1993 are shown in the following table:\nAmortization of equipment on operating leases was $1,435 million in 1994, $1,395 million in 1993 and $1,133 million in 1992. Noncancelable future rentals due from customers for equipment on operating leases at year-end 1994 totaled $7,329 million and were due $2,306 million in 1995, $1,628 million in 1996, $1,015 million in 1997, $663 million in 1998, $477 million in 1999, and $1,240 million thereafter.\nThe Corporation acts as a lender and lessor to the commercial airline industry. At December 31, 1994 and 1993, the aggregate amount of such loans, leases and equipment leased to others was $7,571 million and $6,776 million, respectively. In addition, the Corporation had issued financial guaranties and funding commitments of $506 million at December 31, 1994 ($450 million at year-end 1993) and had conditional commitments to purchase aircraft at a cost of $81 million ($865 million at year-end 1993). Included in the Corporation's equipment leased to others at year-end 1994 is $226 million of commercial aircraft off-lease ($244 million in 1993).\nNOTE 7. BUILDINGS AND EQUIPMENT\nBuildings and equipment include office buildings, satellite communications equipment, data processing equipment, vehicles, furniture and office equipment. Depreciation expense was $227 million for 1994, $197 million for 1993 and $168 million for 1992.\nNOTE 8. OTHER ASSETS\nOther assets at December 31, 1994 and 1993 are shown in the table below.\nGoodwill, mortgage servicing rights, and other intangibles are shown net of accumulated amortization of $988 million at December 31, 1994 and $781 million at December 31, 1993.\nInvestments in and advances to nonconsolidated affiliates included advances of $949 million and $688 million at December 31, 1994 and 1993, respectively. Assets acquired for resale declined $4.3 billion during 1994 primarily due to sales of mortgages associated with the mortgage servicing business.\nNOTE 9. NOTES PAYABLE\nNotes payable at December 31, 1994 totaled $91,399 million, consisting of $90,702 million of senior debt and $697 million of subordinated debt. The composite interest rate for the Corporation's finance activities during 1994 was 5.47% compared with 4.96% for 1993 and 5.78% for 1992. Total short-term notes payable at December 31, 1994 and 1993 consisted of the following:\nThe average daily balance of short-term debt, excluding the current portion of long-term debt, was $45,729 million in 1994 compared with $43,809 million in 1993 and $40,765 million in 1992. The maximum balances of such debt during each of the past three years were $57,087 million on December 31, 1994, $55,243 million on December 31, 1993 and $50,481 million on December 31, 1992. The average short-term interest rate, including the effects of associated interest and currency swaps discussed below and excluding the current portion of long-term debt, for the year 1994 was 4.53%, representing short-term interest expense divided by the average daily balance, compared with 3.27% for 1993 and 3.93% for 1992. On December 31, 1994 and 1993, average interest rates were 2.46% and 3.25%, respectively, for bank borrowings, 5.90% and 3.39%, respectively, for commercial paper, and 5.66% and 3.10%, respectively, for notes with trust departments of banks.\nOutstanding balances in notes payable after one year at December 31, 1994 and 1993 were as follows.\n--------------- (a) Includes the effects of associated interest rate and currency swaps.\n(b) At December 31, 1994 and 1993, the Corporation had agreed with others to exchange currencies and related interest payments on principal amounts equivalent to U.S. $12,183 million and $8,101 million, respectively. At December 31, 1994 and 1993, the Corporation also had entered into interest rate swaps with others relating to interest on $24,129 million and $13,224 million, respectively.\n(c) At December 31, 1993, counterparties held options under which the Corporation could be caused to execute interest rate swaps associated with interest payments on $500 million.\n(d) Interest rates are reset at the end of the initial and each subsequent interest period. At each rate-reset date, the Corporation may redeem notes in whole or in part at its option. Current interest periods range from May 1996 to March 1997.\n(e) The rate of interest payable on each note is a variable rate based on the commercial paper rate each month. Interest is payable either monthly or semiannually at the option of the Corporation.\n(f) Guaranteed by GE Company.\nAt December 31, 1994, long-term borrowing maturities, including the current portion of long-term debt, were $9,695 million in 1995, $10,394 million in 1996, $6,556 million in 1997, $4,507 million in 1998, and $3,417 million in 1999.\nAt December 31, 1994 GE Capital had committed lines of credit aggregating $20.8 billion with 131 banks, including $7.0 billion of revolving credit agreements with 69 banks pursuant to which GE Capital has the right to borrow funds for periods exceeding one year. A total of $2.6 billion of these lines were also available for use by GE Capital Services. In addition, at December 31, 1994, approximately $109 million of committed lines of credit were directly available to a foreign affiliate of GE Capital. Also, at December 31, 1994, substantially all of the approximately $3.1 billion of GE Company's credit lines were available for use by GE Capital or GE Capital Services. During 1994, GE Capital, GE Capital Services and GE Company did not borrow under any of these credit lines. The Corporation compensates banks for credit facilities in the form of fees which were immaterial for the past three years.\nInterest rate and currency swaps are employed to achieve the lowest cost of funding for a particular funding strategy. Optimizing funding costs is central to maintaining satisfactory financing spreads (the difference between the yield on financial assets and borrowing costs). The Corporation enters into interest rate swaps and currency swaps (including non-U.S. currency and cross-currency swaps) to modify interest rates and\/or currencies of specific debt instruments. For example, to fund U.S. operations, GE Capital may issue fixed-rate debt denominated in a currency other than the U.S. dollar and simultaneously enter into a currency swap to create synthetic fixed-rate U.S. dollar debt with a lower yield than could be achieved directly. Virtually all interest rate and currency swaps have been designated as modifying interest rates and\/or currencies associated with specific debt instruments. All other swaps, forward contracts and other derivatives have been designated as hedges of non-U.S. dollar monetary assets or net investments (see Note 21). The debt-associated swaps allow the Corporation to lower its cost of funds by substituting credit risk for interest rate and currency risks. Since the Corporation's principal use of swaps is to optimize funding costs, changes in interest rates and exchange rates underlying swaps would not be expected to have a material impact on the Corporation's financial position or results of operations. The Corporation conducts almost all activities with these instruments in the over-the-counter markets. The Corporation does not engage in derivatives trading or market-making activities.\nEach party in a swap transaction relies on its counterparties to make contractual payments. Given the ways in which the Corporation uses swaps, associated market risk is meaningful only as it relates to how changes in the market value affect credit exposure to individual swap counterparties. To manage counterparty credit exposure, substantially all transactions are executed centrally by the Corporation's Treasury Department, which maintains controls on all exposures, adheres to stringent counterparty credit standards and actively monitors marketplace exposures. All swap activities are carried out within the following credit policy constraints:\n- At inception, counterparties must be rated, at a minimum, Aa3 (Moody's) or AA- (S&P) for swaps of five years or less and Aaa\/AAA for swaps in excess of five years.\n- Credit exposure is limited to a market value of $50 million for counterparties rated Aa2\/AA and $75 million for those rated Aaa\/AAA.\n- All swaps are executed under master swap agreements containing mutual credit downgrade provisions that provide the ability to require assignment or termination in the event either party is downgraded below A3 or A-. The total exposure to market value changes related to credit risk on swaps at December 31, 1994 was $412 million. The Corporation does not anticipate any loss on this exposure.\nNOTE 10. INSURANCE LIABILITIES, RESERVES AND ANNUITY BENEFITS\nInsurance liabilities, reserves and annuity benefits represent policyholders' benefits, unearned premiums and provisions for policy losses and benefits relating to insurance and annuity businesses. The related balances at December 31, 1994 and 1993 follow.\nThe liability for future policy benefits of the life insurance affiliates, included in other policyholder benefits above, has been computed using average yields of 4.0% to 9.1% in 1994 and 6.2% to 10.1% in 1993.\nActivity in the liability for unpaid claims and claims adjustment expenses is summarized as follows for the past three years.\nFinancial guaranties of insurance affiliates as of December 31, 1994 and 1993 are summarized below.\nThe Corporation's Specialty Insurance businesses are involved significantly in the reinsurance business, ceding reinsurance on both a pro-rata and an excess basis. When the Corporation cedes business to third parties, it is not relieved of its primary obligation to policyholders and reinsureds. Consequently, the Corporation establishes allowances for amounts deemed uncollectible due to the failure of reinsurers to honor their obligations. The Corporation monitors both the financial condition of individual reinsurers and risk concentrations arising from similar geographic regions, activities and economic characteristics of reinsurers. The maximum amount of individual life insurance retained on any one life is $1,300,000.\nThe effects of reinsurance on premiums written and earned were as follows for the past three years.\nReinsurance recoveries recognized as a reduction of insurance losses and policyholder and annuity benefits amounted to $434 million, $304 million and $525 million for the periods ended December 31, 1994, 1993 and 1992, respectively.\nNOTE 11. MINORITY INTEREST\nMinority interest in equity of consolidated affiliates includes 8,750 shares of $100 par value variable cumulative preferred stock issued by GE Capital, with a liquidation preference value of $875 million, and 2,400 shares of $0.01 par value variable cumulative preferred stock issued in 1994 by a subsidiary of GE Capital, with a liquidation preference value of $240 million. Dividend rates on the preferred stock ranged from 2.3% to 4.9% during 1994 and from 2.3% to 2.8% during 1993.\nNOTE 12. EQUITY\nGE Capital Services preferred stock was $510 million at December 31, 1994. At December 31, 1993, all such preferred shares were held by consolidated affiliates; at December 31, 1994, $10 million of such shares, which were dividended to GE Company in 1994, were held by GE Company and the remainder were held by consolidated affiliates of the Corporation. All other equity is owned entirely by GE Company. Cash dividends paid were $904 million in 1994, $610 million in 1993 and $500 million in 1992. In 1994, GE Company contributed to the Corporation the net assets of the recently acquired Consolidated Insurance Group, which increased the Corporation's additional paid-in capital by $187 million. In 1992, GE Company contributed to the Corporation the assets of GE Computer Services and the minority interest in Financial Insurance Group, which increased the Corporation's additional paid-in capital by $155 million.\nOn December 31, 1993, the Corporation adopted Statement of Financial Accounting Standards (SFAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities. As a result of adopting this statement, changes in the fair value of investment securities are reflected, net of tax, in equity. At December 31, 1994, unrealized losses on investment securities were $821 million, a reduction in equity of $1,633 million from year-end 1993. The decrease was primarily attributable to the effect of increases in market interest rates on the fair value of the securities.\nAt December 31, 1994 and 1993, the statutory capital and surplus of the Corporation's insurance affiliates totaled $5,657 million and $4,829 million, respectively, and amounts available for the payment of dividends without the approval of the insurance regulators totaled $413 million and $382 million, respectively.\nNOTE 13. EARNED INCOME\nTime sales, loan and investment and other income includes the Corporation's share of earnings from equity investees of approximately $169 million, $106 million and $72 million for 1994, 1993 and 1992, respectively.\nIncluded in earned income from financing leases for 1994, 1993 and 1992 were gains on the sale of equipment at lease completion or early termination of $180 million, $145 million and $126 million, respectively.\nNOTE 14. INTEREST EXPENSE\nInterest expense reported in the Statement of Current and Retained Earnings in 1994, 1993 and 1992 is net of interest income on temporary investments of excess funds of $45 million, $42 million and $48 million, respectively, and net of capitalized interest of $9 million, $5 million and $6 million, respectively.\nFor purposes of computing the ratio of earnings to fixed charges (the \"ratio\"), earnings consist of earnings from continuing operations adjusted for the cumulative effect of accounting change, the provision for income taxes, minority interest and fixed charges. Fixed charges consist of interest on all indebtedness and one-third of annual rentals, which the Corporation believes is a reasonable approximation of the interest factor of such rentals. The ratio was 1.65 for 1994, compared with 1.63 for 1993 and 1.46 for 1992.\nNOTE 15. OPERATING AND ADMINISTRATIVE EXPENSES\nEmployees and retirees of the Corporation and its affiliates are covered under a number of pension, health and life insurance plans. The principal pension plan is the GE Company pension plan, a defined benefit plan, while employees of certain affiliates, including ERC, are covered under separate plans. The Corporation provides health and life insurance benefits to certain of its retired employees, principally through GE Company's benefit program, as well as through plans sponsored by ERC and other affiliates. The annual cost to the Corporation of providing these benefits is not material.\nGE Company adopted SFAS No. 112, Employers' Accounting for Postemployment Benefits, in the second quarter of 1993. The Corporation adopted this standard in conjunction with its parent. This Statement requires that employers expense the costs of postemployment benefits (as distinct from postretirement pension, medical and life insurance benefits) over the working lives of their employees. This change principally affects the Corporation's accounting for severance benefits, which previously were expensed when the severance event occurred. The net transition obligation related to the Corporation's employees covered under GE Company postemployment benefit plans is not separately determinable from the GE Company plans as a whole. The net transition obligation for employees covered under separate plans is not material.\nRental expense relating to equipment the Corporation leases from others for the purposes of subleasing was $262 million in 1994, $239 million in 1993 and $151 million in 1992. Other rental expense was $206 million in 1994, $174 million in 1993 and $125 million in 1992, principally for the rental of office space and data processing equipment. Minimum future rental commitments under noncancelable leases at December 31, 1994, were $403 million in 1995, $370 million in 1996, $341 million in 1997, $321 million in 1998, $299 million in 1999 and $1,693 million thereafter. The Corporation, as a lessee, has no material lease agreements classified as capital leases.\nAmortization of deferred insurance acquisition costs charged to operations in 1994, 1993 and 1992 was $945 million, $817 million and $624 million, respectively.\nNOTE 16. INCOME TAXES\nThe provision for income taxes is summarized in the following table.\nGE Company files a consolidated U.S. federal income tax return which includes GE Capital Services. The provision for income taxes includes the effect of the Corporation and its affiliates on the consolidated return.\nA reconciliation of the Corporation's actual income tax rate to the U.S. federal statutory rate follows.\nThe tax effects of principal temporary differences follow:\nNOTE 17. INDUSTRY SEGMENT DATA\nIndustry segment operating data and identifiable assets for continuing operations are shown below. Corporate level expenses principally include interest expense related to acquisition debt.\nNOTE 18. QUARTERLY FINANCIAL DATA (UNAUDITED)\nSummarized quarterly financial data are as follows:\nFirst quarter 1994 discontinued operations included a $210 million ($350 million before tax) charge resulting from the discovery of false trading profits created by the then head U.S. government securities trader at Kidder, Peabody & Co. Incorporated, a subsidiary of Kidder, Peabody. Approximately $143 million ($238 million before tax) of the charge related to periods prior to 1994.\nNOTE 19. RESTRICTED NET ASSETS OF AFFILIATES\nVarious state and foreign regulations require that the Corporation's investment in certain affiliates be maintained at specified minimum levels to provide additional protection for insurance customers, investment certificate holders and passbook savings depositors. At December 31, 1994 and 1993, such minimum investment levels approximated $5,828 million and $6,363 million, respectively.\nNOTE 20. SUPPLEMENTAL CASH FLOW INFORMATION\nCash used in 1994, 1993 and 1992 included interest paid by the Corporation of $4,150 million, $3,281 million and $3,511 million, respectively, and income taxes paid by the Corporation of $321 million, $189 million and $97 million, respectively.\nNOTE 21. ADDITIONAL INFORMATION ABOUT FINANCIAL INSTRUMENTS\nThis note contains estimated fair values of certain financial instruments to which the Corporation is a party. Apart from the Corporation's own borrowings and certain marketable securities, relatively few of these instruments are actively traded. Thus, fair values must often be determined using one or more models that indicate value based on estimates of quantifiable characteristics as of a particular date. Because this undertaking is, by its nature, difficult and highly judgmental, for a limited number of instruments, alternative valuation techniques may have produced disclosed values different from those that could have been realized at December 31, 1994 or 1993. Moreover, the disclosed values are representative of fair values only as of the dates indicated. Assets that, as a matter of accounting policy, are reflected in the accompanying financial statements at fair value are not included in the following disclosures; such assets include cash and equivalents, investment securities, and other receivables.\nValues are estimated as follows:\nTIME SALES AND LOANS. Based on quoted market prices, recent transactions and\/or discounted future cash flows, using rates at which similar loans would have been made to similar borrowers.\nINVESTMENTS IN AND ADVANCES TO ASSOCIATED COMPANIES. Based on market comparables, recent transactions or discounted future cash flows. These equity interests were generally acquired in connection with financing transactions and, for the purpose of this disclosure, fair values were estimated.\nBORROWINGS. Based on quoted market prices or market comparables. Fair values of interest rate and currency swaps on borrowings are based on quoted market prices and include the effects of counterparty creditworthiness.\nANNUITY BENEFITS. Based on expected future cash flows, discounted at currently offered discount rates for immediate annuity contracts or cash surrender value for single premium deferred annuities.\nFINANCIAL GUARANTIES. Based on future cash flows, considering expected renewal premiums, claims, refunds and servicing costs, discounted at a market rate.\nALL OTHER INSTRUMENTS. Based on comparable transactions, market comparables, discounted future cash flows, quoted market prices, and\/or estimates of the cost to terminate or otherwise settle obligations to counterparties.\nInformation about financial instruments that were not carried at fair value at December 31, 1994 and 1993, is shown below.\n--------------- (a) See Note 9.\n(b) Includes interest rate and currency swaps.\n(c) Not applicable.\n(d) See Note 10.\n(e) Included in other cash financial instruments.\nFOREIGN CURRENCY FORWARDS AND FOREIGN CURRENCY OPTIONS are employed by the Corporation to manage certain exposures to changes in currency exchange rates associated with net investments in foreign affiliates. However, net investments in foreign affiliates are managed principally by funding local currency denominated assets with debt denominated in those same currencies.\nNOTE 22. GEOGRAPHIC SEGMENT INFORMATION\nGeographic segment operating data and total assets are as follows.\nU.S. amounts were derived from the Corporation's operations located in the U.S.\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.\nOmitted\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nOmitted\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nOmitted\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nOmitted\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\nAll other schedules are omitted because of the absence of conditions under which they are required or because the required information is shown in the financial statements or notes thereto.\n(a) 3. EXHIBIT INDEX\nThe exhibits listed below, as part of Form 10-K, are numbered in conformity with the numbering used in Item 601 of Regulation S-K of the Securities and Exchange Commission.\n(b) REPORTS ON FORM 8-K\nNone.\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nGENERAL ELECTRIC CAPITAL SERVICES, INC.\nCONDENSED STATEMENT OF FINANCIAL POSITION\nSee Notes to Condensed Financial Statements.\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONTINUED)\nGENERAL ELECTRIC CAPITAL SERVICES, INC.\nCONDENSED STATEMENT OF CURRENT AND RETAINED EARNINGS\nSee Notes to Condensed Financial Statements.\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONTINUED) GENERAL ELECTRIC CAPITAL SERVICES, INC. CONDENSED STATEMENT OF CASH FLOWS\nSee Notes to Condensed Financial Statements.\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT -- (CONCLUDED) GENERAL ELECTRIC CAPITAL SERVICES, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS\nINCOME TAXES\nGE Company files a consolidated U.S. federal income tax return which includes GE Capital Services. Income tax benefit includes the effect of GE Capital Services on the consolidated return.\nDIVIDENDS FROM AFFILIATES\nIn 1994 and 1993, GE Capital Services received dividends of $150 million and $150 million, respectively, from Employers Reinsurance and $575 million and $460 million, respectively, from GE Capital.\nDISCONTINUED OPERATIONS\nIn November 1994, GE Capital Services elected to terminate the operations of Kidder, Peabody Group Inc. by initiating an orderly liquidation of its assets and liabilities. As part of the liquidation plan, GE Capital Services received securities of Paine Webber Group Inc. valued at $657 million in exchange for certain broker-dealer assets and operations.\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nSCHEDULE V -- SUPPLEMENTAL INFORMATION CONCERNING PROPERTY AND CASUALTY INSURANCE OPERATIONS (IN MILLIONS)\nEXHIBIT 4(III)\nMarch 29, 1995\nSecurities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549\nSubject: General Electric Capital Services, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1994 -- File No. 0-14804\nDear Sirs:\nNeither General Electric Capital Services, Inc. (the \"Corporation\") nor any of its subsidiaries has outstanding any instrument with respect to its long-term debt under which the total amount of securities authorized exceeds 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. In accordance with paragraph (b)(4)(iii) of Item 601 of Regulation S-K (17 CFR sec. 229.601), the Corporation hereby agrees to furnish to the Securities and Exchange Commission, upon request, a copy of each instrument which defines the rights of holders of such long-term debt.\nVery truly yours,\nGENERAL ELECTRIC CAPITAL SERVICES, INC.\nBy:\/s\/ J. A. PARKE ------------------------------------ J. A. Parke, Senior Vice President, Finance\nEXHIBIT 12(A)\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nCOMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES\nEXHIBIT 12(B)\nGENERAL ELECTRIC CAPITAL SERVICES, INC. AND CONSOLIDATED AFFILIATES\nCOMPUTATION OF RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS\nEXHIBIT 23(II)\nTo the Board of Directors General Electric Capital Services, Inc.\nWe consent to incorporation by reference in the Registration Statement on Form S-3 (No. 33-7348) of General Electric Capital Services, Inc. of our report dated February 10, 1995, relating to the statement of financial position of General Electric Capital Services, Inc. and consolidated affiliates as of December 31, 1994 and 1993 and the related statements of current and retained earnings and cash flows and related schedules for each of the years in the three-year period ended December 31, 1994, which report appears in the December 31, 1994 annual report on Form 10-K of General Electric Capital Services, Inc. Our report refers to a change in 1993 in the method of accounting for investments in certain securities.\n\/s\/ KPMG PEAT MARWICK LLP\nStamford, Connecticut March 31, 1995\nEXHIBIT 24 POWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each of the undersigned, being directors and\/or officers of General Electric Capital Services, Inc., a Delaware corporation (the \"Corporation\"), hereby constitutes and appoints Gary C. Wendt, James A. Parke, Joan C. Amble and Burton J. Kloster, Jr., and each of them, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead in any and all capacities, to sign one or more Annual Reports for the Corporation's fiscal year ended December 31, 1994, on Form 10-K under the Securities Exchange Act of 1934, as amended, or such other form as such attorney-in-fact may deem necessary or desirable, any amendments thereto, and all additional amendments thereto in such form as they or any one of them may approve, 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 to the end that such Annual Report or Annual Reports shall comply with the Securities Exchange Act of 1934, as amended, and the applicable Rules and Regulations of the Securities and Exchange Commission adopted or issued pursuant thereto, 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 any of them or their or his substitute or resubstitute, may lawfully do or cause to be done by virtue hereof.\nIN WITNESS WHEREOF, each of the undersigned has hereunto set his hand this 29th day of March, 1995.\n\/s\/ JOAN C. AMBLE --------------------------------------------------- Joan C. Amble\nVice President and Controller (Principal Accounting Officer)\nA MAJORITY OF THE BOARD OF DIRECTORS\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 date indicated.\nA majority of the Board of Directors\nFile No. 0-14804 -------------------------------------------------------------------------------- --------------------------------------------------------------------------------\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, 1994\n------------------\nGENERAL ELECTRIC CAPITAL SERVICES, INC. (Exact name of registrant as specified in its charter)\n------------------\nEXHIBITS\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\nINDEX TO EXHIBITS","section_15":""}
{"filename":"823549_1994.txt","cik":"823549","year":"1994","section_1":"ITEM 1. BUSINESS.\nTenneco Inc., a Delaware corporation, is a diversified industrial company conducting all of its operations through its subsidiaries. As used herein, \"Tenneco\" refers to Tenneco Inc. and its consolidated subsidiaries.\nThe major businesses of Tenneco are the transportation and sale of natural gas; manufacture and sale of automotive exhaust system parts and ride control products; construction and repair of ships; and manufacture and sale of packaging materials, cartons, containers and specialty packaging products. On December 13, 1994, Tenneco Inc. announced that it intended to sell its chemicals business through an initial public offering of Albright & Wilson plc primarily in the United Kingdom in the first quarter of 1995. The transaction was completed on March 8, 1995. For more information see \"Chemicals\". Also, at December 31, 1994, Tenneco owned approximately 44% of Case Corporation, a manufacturer of farm and construction equipment. For more information see \"Farm and Construction Equipment\". See also \"Business Strategy\".\nAt December 31, 1994, Tenneco had approximately 55,000 employees (excluding employees of Albright & Wilson plc and Case Corporation and their respective subsidiaries).\nCONTRIBUTIONS OF MAJOR BUSINESSES\nInformation concerning Tenneco's principal industry segments and geographic areas is set forth in Note 15 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries. The following tables summarize (i) net sales and operating revenues from continuing operations, (ii) income (loss) from continuing operations before interest expense, income taxes and minority interest and (iii) capital expenditures for continuing operations of the major business groups of Tenneco for the periods indicated.\nNET SALES AND OPERATING REVENUES FROM CONTINUING OPERATIONS\nINCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INTEREST EXPENSE, INCOME TAXES AND MINORITY INTEREST\nCAPITAL EXPENDITURES FOR CONTINUING OPERATIONS\nThe interest expense, income taxes and minority interest from continuing operations which are not allocated to the major businesses were as follows:\n-------- Notes: (a) In December 1994, Tenneco's accounting for its Farm and construction equipment segment changed due to a reduction in its ownership percentage. For the month of December 1994, the Farm and construction equipment segment was reflected in Tenneco's financial statements using the equity method of accounting. Accordingly, the segment's revenues are included in Tenneco's reported revenues for eleven months only. For additional information, see Notes 1 and 3 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries. (b) Includes restructuring charge of $920 million related to Farm and construction equipment in 1992 reduced by $20 million in 1993 and $16 million in 1994. For additional information concerning these charges, see Note 16 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries and Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nNATURAL GAS PIPELINES\nTenneco is engaged in the interstate and intrastate transportation and marketing of natural gas. Its natural gas operations are conducted by Tenneco Gas Inc. and other subsidiaries of Tenneco Inc. (collectively, \"Tenneco Gas\"). In addition, Tenneco Gas has started building new business units that are not generally subject to regulation by the Federal Energy Regulatory Commission (\"FERC\") and that Tenneco Gas believes have the potential to generate higher returns than its regulated businesses. The principal activities of these business units include development of and participation in international natural gas pipeline and international and domestic gas-fired power generation projects; and establishment of natural gas production financing programs for producers.\nINTERSTATE PIPELINE OPERATIONS\nHistorically, interstate pipeline companies served primarily as merchants of natural gas, purchasing gas under long-term contracts with numerous producers and reselling gas to local distribution companies under long-term sales agreements. Interstate pipelines were not required to transport gas for customers who did not purchase the gas from the pipeline company.\nCommencing in 1984, the FERC issued a series of orders that have resulted in a major restructuring of the natural gas transmission industry and its business practices. This restructuring, coupled with a nationwide excess of deliverable natural gas, resulted in increased competition for markets and decreased prices for natural gas, and dramatically increased the ratio that pipelines' transportation volumes bear to their total throughput. With full implementation of the FERC's Order No. 636 (discussed below under the caption \"Federal Regulation\"), most interstate pipeline companies now serve primarily as gas transporters rather than gas merchants.\nDuring this period, pipeline customers have turned more and more to marketers of natural gas to secure natural gas supplies for them, make transportation arrangements and provide other services. Generally, these gas marketers are not subject to the extensive FERC regulations that apply to interstate pipelines, and may be affiliates of regulated interstate pipeline companies. To respond to the changing natural gas industry, Tenneco Gas has been providing natural gas marketing services since 1984.\nTenneco Gas's interstate pipeline operations include the pipeline systems of Tennessee Gas Pipeline Company (\"Tennessee\"), Midwestern Gas Transmission Company (\"Midwestern\") and East Tennessee Natural Gas Company (\"East Tennessee\"), which are engaged in the transportation, storage and, to a limited extent, sale of natural gas primarily to or for other gas transmission or distribution companies for resale.\nTennessee's multiple-line system begins in gas-producing regions of Texas and Louisiana, including the continental shelf of the Gulf of Mexico, and extends into the northeastern section of the United States, including the New York City and Boston metropolitan areas. Midwestern's pipeline system extends from Portland, Tennessee, to Chicago, and principally serves the Chicago metropolitan area. East Tennessee's pipeline system serves the states of Tennessee, Virginia and Georgia.\nAt December 31, 1994, Tenneco's interstate gas transmission systems included approximately 16,300 miles of pipeline, gathering lines and sales laterals, together with related facilities that include 91 compressor stations with an aggregate of approximately 1.5 million horsepower. These systems also include underground and above-ground gas storage facilities to permit increased deliveries of gas during peak demand periods. The total design delivery capacity of Tenneco's interstate systems at December 31, 1994, was approximately 4,822 million cubic feet (\"MMCF\") of gas per day, and approximately 5,628 MMCF on peak demand days, which includes gas withdrawn from storage.\nJoint Ventures\nTenneco also has interests in several joint ventures formed to own and operate interstate pipeline systems. These interests include a 50% interest in Kern River Gas Transmission Company (\"Kern River\") and a 13.2% interest in Iroquois Gas Transmission Company (\"Iroquois\").\nKern River, which owns a 904-mile pipeline system extending from Wyoming to California with a design capacity of 700 MMCF of gas per day, completed its third year of operations in 1994. In 1993, Kern River implemented Order No. 636 with no adverse effect to the pipeline's normal business flow. In 1994, Kern River successfully settled its rate case which was originally filed in August 1992. The settlement will become effective upon the issuance date of a final FERC order, no longer subject to rehearing, which is expected during the second quarter of 1995. An order approving the settlement was issued by the FERC on January 25, 1995 and is currently pending rehearing. The settlement will not have an impact on Tenneco's net income.\nThe 370-mile Iroquois pipeline began initial operation in late 1991 and became fully operational in January 1992. The pipeline extends from the Canadian border at Waddington, New York, to Long Island, New York, and, with additional compression added in 1994, is designed to deliver (directly or through interconnecting pipelines such as Tennessee) 714 MMCF of gas per day to local distribution companies and electric generation facilities in six states. For more information on Iroquois, see Item 3, \"Legal Proceedings.\"\nGas Sales and Transportation Volumes\nThe following table sets forth the volumes of gas, stated in billions of British thermal units (\"BBtu\"), sold and transported by Tenneco's interstate pipeline systems for the periods shown.\n-------- * These sales and transportation volumes include all natural gas sold or transported by Tenneco's interstate pipeline companies. The table includes Tenneco's proportionate share of sales and transportation volumes of the joint ventures in which it has interests; of the total volumes shown, 167,961 BBtu was attributable to these joint venture interests in 1994, 169,871 BBtu in 1993 and 128,263 BBtu in 1992. Intercompany deliveries of natural gas have not been eliminated from the table.\nFederal Regulation\nTenneco's interstate natural gas pipeline companies are \"natural gas companies\" as defined in the Natural Gas Act of 1938, as amended (the \"Natural Gas Act\"). As such, these companies are subject to the jurisdiction of the Department of Energy, including the FERC. Tenneco's interstate pipeline operations are operated pursuant to certificates of public convenience and necessity issued under the Natural Gas Act and pursuant to the Natural Gas Policy Act of 1978. The FERC regulates the interstate transportation and certain sales of natural gas, including, among other things, rates and charges allowed natural gas companies, extensions and abandonments of facilities and service, rates of depreciation and amortization and the accounting system utilized by the companies.\nPrior to the FERC's industry restructuring initiatives in the 1980's, Tenneco's interstate pipeline companies operated primarily as merchants, purchasing natural gas under long-term contracts and reselling the gas to customers, again under long-term contracts. With the FERC mandated conversion from a primarily merchant to a primarily transportation business, Tennessee's sales, and hence its purchases of gas for resale, declined precipitously, and Tennessee incurred significant liability to its producers under its long-term gas supply contracts, many of which specified prices at above market levels. In 1992, pursuant to Order 636 issued by the FERC, Tennessee implemented revisions to its tariff which put into effect on September 1, 1993, the restructuring of its transportation, storage and sales services. Pursuant to the provisions of Order 636 allowing for the recovery of transition costs related to the restructuring, Tennessee has made filings to recover gas production costs related to its Bastian Bay facilities, the remaining balance of purchased gas (\"PGA\") costs, stranded transportation (\"TBO\") costs, and gas supply realignment (\"GSR\") costs resulting from remaining gas purchase obligations.\nTennessee's filings to recover production costs related to its Bastian Bay facilities have been rejected by the FERC based on the continued use of the gas production from the field; however, the FERC recognized the ability of Tennessee to file for the recovery of losses upon disposition of these assets. Tennessee has filed for appellate review of the FERC actions and believes that the Bastian Bay costs will ultimately be recovered as transition costs directly related to Order 636, and no FERC order has questioned the ultimate recoverability of these costs.\nThe filings implementing Tennessee's recovery mechanisms for the following transition costs were accepted effective September 1, 1993, and made subject to refund pending FERC review: 1) direct-billing of unrecovered PGA costs to its former sales customers over a twelve-month period; 2) recovery of TBO costs, which Tennessee is obligated to pay under existing contracts, through a surcharge from firm transportation customers, adjusted annually; and 3) GSR cost recovery of 90% of such costs over a period of up to 36 months from firm transportation customers and recovery of 10% of such costs from interruptible transportation customers.\nFollowing negotiations with its customers, Tennessee filed in July 1994 with the FERC a Stipulation and Agreement (the \"PGA Stipulation\"), which provides for the recovery of PGA costs of approximately $100 million and the recovery of costs associated with the transfer of storage gas inventory to new storage customers in Tennessee's restructuring proceeding. The PGA Stipulation eliminates all challenges to the PGA costs, but establishes a cap on the charges that may be imposed upon former sales customers. On November 15, 1994, the FERC issued an order approving the PGA Stipulation and resolving all outstanding issues. However, certain customers have requested a rehearing and the FERC has deferred action on their issues to a later date. Tennessee implemented the terms of the PGA Stipulation on December 1, 1994, and expects to make refunds in 1995. Tennessee has recorded a liability which it believes is adequate to cover the PGA refunds.\nTennessee is recovering TBO costs formerly incurred to perform its sales functions, subject to refund, pending review of data submitted by Tennessee through technical conference proceedings. On November 18, 1994, the FERC issued an order on Tennessee's initial TBO surcharge filing to recover TBO costs for the twelve-month period beginning September 1, 1993. The order required Tennessee to remove certain costs from this surcharge, subject to FERC's review at a second technical conference and FERC's consideration of a request for rehearing. On November 30, 1994, Tennessee filed for a surcharge to recover approximately $25 million of TBO costs in compliance with the FERC's order, and in a separate filing, Tennessee filed to recover its projected annual TBO costs of approximately $21 million for the twelve-month period beginning September 1, 1994, through a new TBO surcharge. The FERC accepted Tennessee's filing to recover its projected TBO costs, subject to refund, pending review through technical conference proceedings.\nIn connection with Tennessee's GSR cost recovery discussed below, Tennessee, along with three other pipelines, executed four separate settlement agreements with Dakota Gasification Company and the U.S. Department of Energy and initiated four separate proceedings at the FERC seeking approval to implement the settlement agreements. The settlement resolved litigation concerning purchases made by Tennessee of synthetic gas produced from the Great Plains Coal Gasification plant (\"Great Plains\"). On October 18, 1994, the FERC consolidated the four proceedings and set them for hearing before an administrative law judge who is to issue his initial decision by December 31, 1995. The FERC has committed to a final order by December 31, 1996. The FERC order stated that the costs related to the Great Plains project are eligible for recovery through GSR and other special recovery mechanisms and that the costs are eligible for recovery for the duration of the term of the original gas purchase agreements. The hearing will be limited to the issue of whether the settlement agreements are prudent.\nAlso in connection with Tennessee's GSR cost recovery proceedings discussed below, on October 14, 1993, Tennessee was sued in the State District Court of Ector County, Texas, by ICA Energy, Inc. (\"ICA\") and TransTexas Gas Corporation (\"TransTexas\"). In that suit, ICA and TransTexas contended that Tennessee had an obligation to purchase gas production which TransTexas thereafter attempted to add unilaterally to the reserves originally dedicated to a 1979 gas contract. On two subsequent occasions, TransTexas gave Tennessee notice that it was adding new production and\/or acreage \"to the contract.\" An amendment to the pleadings seeks $1.5 billion from Tennessee for alleged damages caused by Tennessee's refusal to purchase gas produced from the TransTexas leases covering the new production and lands. Neither ICA nor TransTexas were original parties to that contract. However, they contend that any stranger acquiring a fractional interest in the original committed reserves thereby obtains a right to add to the contract unlimited volumes of gas production from locations in South Texas. Tennessee believes it has meritorious defenses to the claims of ICA and TransTexas, which defenses it will vigorously assert.\nAs of December 31, 1994, Tennessee has deferred GSR costs yet to be recovered from its customers of approximately $177 million, net of $187 million previously collected from its customers, subject to refund. Proceedings have commenced to review the recovery of these GSR costs; however, the FERC has also generally encouraged pipelines to settle such issues through negotiations with customers. Although Order 636 contemplates complete recovery by pipelines of qualified transition costs, Tennessee has initiated\nsettlement discussions with its customers concerning the amount of recoverable GSR costs in response to recent FERC and customer statements acknowledging the desirability of such settlements. Tennessee is also engaged in separate settlement and contract reformation discussions with holders of certain gas purchase contracts who have sued Tennessee, although Tennessee believes that its defenses in the underlying gas purchase contract actions are meritorious.\nGiven the uncertainty over the results of ongoing discussions between Tennessee and its customers related to the recovery of GSR costs and the uncertainty related to predicting the outcome of its gas purchase contract reformation efforts and the associated litigation, Tenneco is unable to predict the timing or the ultimate impact the resolution of these issues will have on its consolidated financial position or results of operations. For additional information, see Note 6 in the \"Notes to Financial Statements\".\nThe FERC issued final orders approving Tennessee's Stipulation and Agreement partially resolving its 1991 rate case. Pursuant to these final FERC orders, rates for the period February 1, 1992, through August 31, 1993, were approved, and Tennessee paid refunds for this period on June 3, 1994. The refunds had no material effect on reported net income. Also pursuant to these orders, rates for the period after September 1, 1993, were approved and Tennessee paid refunds for the period September 1, 1993 to October 31, 1994, in February 1995. As of December 31, 1994, Tennessee had recorded a liability which was adequate to cover its estimated refund obligations.\nOn December 30, 1994, Tennessee filed a general rate increase in Docket No. RP95-112 which reflected an increase in Tennessee's revenue requirement of $118 million, including recovery of certain environmental costs as discussed in Note 17 in the \"Notes to Financial Statements\". On January 25, 1995, the FERC accepted the filing, suspended its effectiveness for the maximum period of five months pursuant to normal regulatory process, and set the matter for hearing. This order also required the convening of a technical conference to address various concerns raised by the FERC and Tennessee's customers over, among other issues, Tennessee's ability to provide its shippers with timely and accurate operating and billing information, and the associated systems costs. The ultimate resolution of these issues may result in adjustments to customer billings. Subject to the outcome of these issues and certain modifications identified in the FERC order, the increased rates will become effective on July 1, 1995, subject to refund.\nCompetition\nThe natural gas pipeline industry is experiencing increasing competition in virtually every aspect of operations, which is the result of actions by the FERC to strengthen market forces throughout the industry. In a number of key markets, Tenneco's interstate pipelines face competitive pressure from other major pipeline systems, enabling local distribution companies and end users to choose a supplier or switch suppliers based on the short term price of the gas and the cost of transportation. Competition between pipelines is particularly intense in Midwestern's Chicago and Northern Indiana markets, in East Tennessee's Roanoke, Chattanooga and Atlanta markets, and in Tennessee's supply area, Louisiana and Texas. Even in other markets, such as Tennessee's New England market, displacement of load to other pipelines is possible during summer or other low demand seasons. Tenneco Gas pipelines have frequently been required to discount their transportation rates to maintain market share.\nGas Supply\nWith full implementation of Order No. 636, Tennessee's firm sales obligations requiring maintenance of long-term gas purchase contracts have declined from over a 1.4 billion dekatherm maximum daily delivery obligation to less than a 200 million dekatherm maximum daily delivery obligation. As discussed above under the caption \"Federal Regulation\", Tennessee has substantially reduced its natural gas purchase portfolio in line with these requirements through termination and assignment to third parties. Although Tennessee's requirements for purchased gas are substantially less than prior to its implementation of Order No. 636, Tenneco Gas is pursuing the attachment of gas supplies to, and transportation by others through, Tennessee's\nsystem. Current gas supply activities include development of offshore and onshore pipeline gathering projects and utilization of production financing programs to spur exploration and development drilling in areas adjacent to Tennessee's system. Major gathering systems in the Mobile Bay and Viosca Knoll area of the Gulf of Mexico were completed during the fourth quarter of 1994.\nGAS MARKETING AND INTRASTATE PIPELINES\nTenneco Energy Resources Corporation (\"TERC\") was established in 1993 as the holding company for several subsidiaries of Tenneco Gas engaged in nonregulated businesses, including Tenneco Gas Marketing Company, Tenneco Gas Gathering Company, Tenneco Gas Trading Company, Tenneco Gas Processing Company and the companies that collectively comprise the Tenneco Gas Intrastate Group. Together these companies provide the gas industry with a wide range of products and services, including buying, selling, gathering and shipping of natural gas; price risk management services; and liquids processing.\nThe Tenneco Gas Intrastate Group owns approximately 1,200 miles of intrastate pipelines in Texas and manages the buying, selling and transportation services for a volume of approximately 1.1 Bcf of natural gas per day. Within the Intrastate Group is an ownership in the Oasis Pipe Line which serves the Texas Gulf Coast and West Texas markets. This group also provides swing storage services and access to major intrastate and interstate pipelines in Texas.\nThe following table sets forth the volumes of gas, stated in BBtu, sold by subsidiaries of TERC and transported by Tenneco's nonregulated pipelines for the periods indicated:\nIn 1994, TERC issued stock to Ruhrgas AG, resulting in dilution of Tenneco's ownership interest in TERC from 100% to 80%.\nTENNECO VENTURES\nTenneco Gas Production Corporation (\"TGPC\") and Tenneco Ventures Corporation (\"Ventures\"), subsidiaries of Tennessee, together with institutional investors and partners, invest in oil and gas properties by acquiring interests in properties or providing financing to producers for exploration and development. As of December 31, 1994, Ventures and TGPC hold various ownership interests in offshore oil and natural gas fields in the Gulf of Mexico and in onshore Texas and Louisiana properties and own reserves in those fields estimated at over 100 Bcf equivalent.\nOTHER\nTenneco Gas International and Tenneco Power Generation Company were formed to extend Tennessee's traditional interests in North American pipelines to pipeline, power, and energy-related projects throughout the world, with a current focus on activities in four regions: South America, Southeast Asia, Australia, and Europe. Tenneco Gas International, through an Australian affiliate, has been selected to construct, own and operate a 470 mile natural gas pipeline in Queensland, Australia; subject to the completion of all agreements, construction of the pipeline is expected to commence in mid 1995 and be completed by the end of 1996. Tenneco Gas International also has interests in two consortiums pursuing the development of two natural\ngas projects in South America (Argentina to Chile and Bolivia to Brazil) including both pipelines and gas-fired electric generation plants. Tenneco Power Generation Company has a 17.5% interest in a 240 megawatt power plant in Springfield, Massachusetts and is in the process of completing the acquisition of a 50% interest in two additional cogeneration projects with 224 megawatts capacity.\nAUTOMOTIVE PARTS\nThe principal business operations of Tenneco Automotive and its affiliates are Walker Manufacturing Company and Monroe Auto Equipment Company.\nWalker Manufacturing Company and its affiliates (\"Walker\") manufacture a variety of automotive exhaust systems and emission control products. In the United States, Walker operates eight manufacturing facilities and seven distribution centers, three of which are located at manufacturing facilities, and also has two research and development facilities. In addition to the facilities included in the Gillet acquisition described below, Walker operates ten manufacturing facilities located in Australia, Canada, the United Kingdom, Mexico, Denmark, Germany, France, Portugal and Sweden.\nWalker's products are sold to automotive manufacturers for use as original equipment and to wholesalers and retailers for sale as replacement equipment. Sales to the original equipment market are directly dependent on new car sales, and sales to the replacement market are related to the service life of original equipment and to the level of maintenance by individual owners of their automobiles. The service life of exhaust systems has increased in recent years, resulting in a longer time period for the exhaust replacement rate.\nThe following table sets forth information relating to Walker's sales:\n-------- * Does not include sales of Gillet (described below), which was acquired on November 30, 1994.\nOn November 30, 1994, Walker acquired ownership of Heinrich Gillet GmbH & Company and its affiliates (\"Gillet\"), a manufacturer of exhaust systems headquartered at Edenkoben, Germany. The combination of Gillet, Europe's largest original equipment exhaust supplier, and Walker's European division,\nwhich is Europe's biggest replacement market supplier, is expected to more than double Walker's European business.\nGillet operates 14 plants in Germany, France, the United Kingdom, Spain, Portugal and the Czech Republic and operates an engineering and technology center in Edenkoben. As a part of Tenneco Automotive's European consolidation plan, Tenneco Automotive plans to consolidate its headquarters and engineering center in Europe with the Gillet facilities by the end of the second quarter of 1995. A consolidation of Tenneco Automotive's and Gillet's manufacturing facilities will occur later in 1995 and early 1996.\nIn addition to the \"Walker\" line, Walker manufactures and distributes exhaust systems under a number of other brand names in the United States and foreign countries.\nMonroe Auto Equipment Company and its affiliates (\"Monroe\") are engaged principally in the design, manufacture and distribution of ride control products. Monroe ride control products consist of hydraulic shock absorbers, air adjustable shock absorbers, spring assisted shock absorbers, gas charged shock absorbers, struts, replacement cartridges and electronically adjustable suspension systems. Monroe manufactures and markets replacement shock absorbers for virtually all domestic and most foreign makes of automobiles. In addition, Monroe manufactures and markets shock absorbers and struts for use as original equipment on passenger cars and trucks, as well as for other uses. Monroe has six manufacturing facilities in the United States and eight foreign manufacturing operations in Australia, Belgium, Brazil, Canada, Mexico, the United Kingdom and Spain.\nThe following table sets forth information relating to Monroe's sales:\nTenneco Automotive is actively pursuing opportunities to expand its business by entering additional geographic areas, including countries in Eastern Europe, Asia and South America. It is anticipated that this expansion will occur through a variety of means, including joint ventures and acquisitions.\nOn December 23, 1994, the automotive parts business completed the sale of its brakes business. The brakes business consisted of the manufacture of non- asbestos friction material for brakes for cars and light trucks and the manufacture of non-asbestos friction brakes for heavy-duty vehicles. For additional information, see Note 3 in the \"Notes to Financial Statements\".\nThe operations of Tenneco Automotive face intense competition from other manufacturers of automotive equipment.\nPACKAGING\nPackaging Corporation of America and other Tenneco subsidiaries (\"PCA\") manufacture and sell containerboard, paperboard, corrugated shipping containers, folding cartons, disposable plastic and aluminum containers, molded fiber products and other related products. Its shipping container products are used in the packaging of food, paper products, metal products, rubber and plastics, automotive products and point of purchase displays. Its folding cartons are used in the packaging of soap and detergent, food products and a wide range of other consumer goods. Uses for its molded fiber products include produce and egg packaging, food service items and institutional and consumer disposable dinnerware, as well as a wide range of other consumer and industrial goods. Its disposable plastic and aluminum containers are sold to the food service, food processing and related industries. In addition to products bearing the name \"Packaging Corporation of America\", PCA manufactures and distributes products under the names \"EZ POR\", \"Packaging Company of California\", \"Revere Foil Containers\", \"Dahlonega Packaging\", \"Dixie Container,\" \"Agri-Pak\" and \"Pressware International.\"\nThe following table sets forth information with respect to PCA's sales during the past three years:\nAt December 31, 1994, PCA operated 55 container plants, seven folding carton plants and 14 corrugated containerboard and paperboard machines at eight mills. Two of the mills (located in Georgia and Wisconsin), including substantially all of the equipment associated with both mills, are leased from third parties. PCA also has eight molded fiber products plants, one pressed paperboard plant, one lumber plant, three paper stock plants, and 10 disposable plastic and aluminum container plants. PCA's plants are located primarily in the United States. Its foreign plants are located in Great Britain, Spain, Canada, Switzerland, Germany and Hungary. In 1994, PCA increased its ownership in a Hungarian paperboard mill and folding carton plant from 30% to 100%, expanding the number of foreign plants owned by PCA. In the United States, PCA has a 50% ownership interest in a molded fiber distribution company and in a hardwood chip mill. In addition, PCA has a 50% interest in a folding carton plant in Dongguan, China, and a 50% interest in a folding carton plant in Bucharest, Romania.\nGenerally, PCA faces intense competition from numerous competitors and alternative products in each of its geographic and product markets.\nThe principal raw materials used by PCA in its mill operations are virgin pulp and reclaimed paper stock and, in its specialty products operations, aluminum and plastics. PCA obtains virgin pulp and reclaimed paper stock from independent logging contractors, from timberlands owned or controlled by it, from operation of its reclaimed paper stock collecting and processing plants and from other sources. PCA obtains aluminum rolling stock and plastic feed stock from various suppliers.\nAt December 31, 1994, PCA owned 183,000 acres of timberland in Alabama, Michigan, Mississippi and Tennessee and leased, managed or had cutting rights on an additional 820,000 acres of timberland in those\nstates and in Florida, Wisconsin and Georgia. During the years 1994, 1993 and 1992 approximately 20%, 22% and 18%, respectively, of the virgin fiber and timber used by PCA in its operations was obtained from timberlands controlled by it.\nSHIPBUILDING\nNewport News Shipbuilding and Dry Dock Company (\"Newport News\"), a Tenneco subsidiary located in Newport News, Virginia, is the largest privately owned shipbuilding company in the United States. Its primary business is constructing and overhauling nuclear-powered aircraft carriers for the United States Navy. Newport News also overhauls and repairs U.S. Navy and commercial vessels and refuels nuclear-powered ships. In recent months, Newport News has returned to the commercial shipbuilding market with the October 1994 award of a two-ship product tanker contract from a foreign owner. In addition, Newport News is pursuing international sales of its fast frigate. Newport News' shipbuilding facilities are located on the James River on approximately 475 acres of property which it owns.\nAt December 31, 1994, the aggregate amount of Newport News' backlog of work to be completed was approximately $5.6 billion (substantially all of which is U.S. Navy-related), an increase from the backlog of $3.7 billion as of December 31, 1993. Although the cuts in naval shipbuilding following the end of the cold war have continued to put pressure on the Newport News backlog, Newport News was awarded the U.S. Navy contract in December 1994 to build Ronald Reagan, the next aircraft carrier for the United States. At December 31, 1994, Newport News anticipated that it would complete approximately $1.5 billion of the current backlog by December 31, 1995, and an additional $1.0 billion in 1996. The December 31, 1994, backlog of Newport News included contracts for the construction of three Nimitz class aircraft carriers and four Los Angeles class attack submarines. Also included in that backlog is a contract for the conversion of two Sealift ships. The present backlog extends into 2002. Subject to new orders, this existing backlog will decline as two submarines per year, on average, are delivered through 1996, and the aircraft carriers are delivered in 1995, 1998 and 2002.\nNewport News has various other contracts for U.S. Navy design work and for industrial projects. As is typical for similar Government contracts, all of Newport News' contracts with the U.S. Navy are unilaterally terminable by the U.S. Navy at its convenience with compensation for work completed and costs incurred.\nWith respect to all U.S. Navy work, Newport News faces intense business pressures in the future because of expected declines in the United States' defense budget and excess ship building and repair capacity in the United States. Due to uncertainties as to future defense spending levels and the allocation of amounts appropriated for such spending to the various defense programs involved, Tenneco is unable to predict the number or timing of subsequent contracts for U.S. Navy construction or refueling and overhaul which may be awarded.\nTo increase its competitiveness worldwide and in response to the anticipated decline in U.S. Navy budgets, Newport News has reduced its workforce by approximately 9,000 or 31% between December 31, 1990 and December 31, 1994.\nNewport News is aggressively pursuing new business opportunities and attempting to expand its business base in light of the declining U.S. Navy backlog, although there is no assurance that it will be able to do so to a material extent. Newport News recently executed contracts for two product tankers and has been selected to build and manage a shipyard in Abu Dhabi. These are examples of the early success in this diversification strategy. While the mix of jobs between U.S. Navy and commercial work is expected to change somewhat, the U.S. Navy will continue to be the leading customer of the shipyard. Newport News is pursuing major U.S. Navy overhaul and repair work and foreign military sales. For additional information, see Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nFARM AND CONSTRUCTION EQUIPMENT\nCase Corporation and its subsidiaries (\"Case\") design, manufacture, market and distribute farm equipment and light- and medium-sized construction equipment. Case was incorporated on April 22, 1994, as a wholly-owned subsidiary of Tenneco for the purpose of acquiring Tenneco's farm and construction equipment business (the \"Case Business\").\nCase is a leading worldwide manufacturer and distributor of farm equipment and light- and medium-sized construction equipment. Case's market position is particularly significant in several product categories, including loader\/backhoes and large, high-horsepower farm tractors and self-propelled combines.\nCase also manufactures and distributes replacement parts for various models of its farm and construction equipment. Case supplies over 350,000 parts, many of which are proprietary, to support products it has sold. Case distributes these parts to dealers and distributors through a network of parts depots throughout the world.\nCase products are distributed through a network of approximately 4,100 independent dealers and 113 company-owned retail stores located in all 50 states and in approximately 150 countries throughout the world.\nREORGANIZATION AND PUBLIC OFFERINGS\nIn June 1994, pursuant to a Reorganization Agreement between Tenneco, Case and Tenneco Equipment Corporation (the \"Reorganization Agreement\"), Case and its subsidiaries acquired the business and assets of the farm and construction equipment business (other than approximately $1.2 billion of U.S. retail receivables) of Tenneco and its subsidiaries in exchange for the following: (i) the assumption by Case and\/or certain of its subsidiaries of all liabilities of the Case Business existing prior to the acquisition of the Case Business by Case and its subsidiaries (the \"Reorganization\"), except as described below, (ii) demand notes in the aggregate principal amount of $1.552 billion (the \"Demand Notes\"), (iii) 70 million shares of Common Stock of Case, (iv) 1,500,000 shares of Series A Cumulative Convertible Preferred Stock of Case, and (v) $250 million aggregate principal amount of 10 1\/2% Senior Subordinated Notes due 2002 (the \"Subordinated Notes\") (accrued interest on which is payable in additional Subordinated Notes in lieu of cash until the second anniversary of issuance). In accordance with the Reorganization Agreement, upon completion of an appraisal of the Case Business, Case paid to Tenneco $10.6 million, which was the amount by which the fair market value of the business and assets transferred in exchange for the Demand Notes exceeded the principal amount of the Demand Notes. Case and its subsidiaries became responsible and solely liable for all liabilities of the Case Business except for the following liabilities retained by Tenneco and its subsidiaries: (i) liabilities for pension benefits accrued by Case's then current and former employees in the United States, both salaried and hourly, through the date of the Reorganization, (ii) liabilities for postretirement health and life insurance benefits for employees of the Case Business in the United States who retired on or before July 1, 1994, and their dependents, in each case to the extent that the Case Business was obligated on the date of the Reorganization, (iii) certain liabilities for U.S. federal, state, local and foreign income and franchise taxes as agreed by Tenneco and Case, (iv) approximately $1.9 billion of debt of Tenneco's finance subsidiaries not sold to Case arising from the wholesale and retail financing programs historically offered by the Case Business, and (v) certain remaining cash advances from affiliated companies to subsidiaries that transferred net assets to Case but which remained as subsidiaries of Tenneco. The Demand Notes were issued by Case and certain of its subsidiaries in an aggregate principal amount equal to the estimated fair market value of the business and assets transferred to them in exchange for the Demand Notes and were paid in full contemporaneously with the closing on June 30, 1994, of the initial public offering of Case's Common Stock by certain subsidiaries of Tenneco (the \"Initial Offering\") from the proceeds of a term loan and other available cash.\nThe Reorganization Agreement required that, after giving effect to the Reorganization, Case and its subsidiaries have a consolidated stockholders' equity (including Case's Series A Cumulative Convertible Preferred Stock and the Cumulative Convertible Second Preferred Stock) of $1.152 billion. To the extent\nstockholders' equity exceeded such amount, Case was required to pay a dividend on the shares of Common Stock issued to Tenneco and its subsidiaries in the amount of such excess. A dividend in the aggregate amount of $12.9 million was paid by Case on August 12, 1994 in accordance with the Reorganization Agreement.\nOn June 30, 1994, Tenneco sold approximately 29% of Case Corporation's common stock in an underwritten initial public offering and shares of Case Corporation Series A Cumulative Convertible Preferred Stock to unaffiliated investors in a negotiated transaction, resulting in gross proceeds to Tenneco of approximately $457,000,000.\nOn November 22, 1994, Tenneco sold an additional approximately 24% of the Case Corporation common stock in an underwritten secondary public offering (the \"Secondary Offering\"). On December 8, 1994, Tenneco Inc. and certain of its subsidiaries sold an additional 3% of the Case Corporation common shares when the underwriters involved in the Secondary Offering exercised their option to purchase additional shares to cover over-allotments. At December 31, 1994, Tenneco owned approximately 44% of the outstanding shares of common stock of Case Corporation. The Secondary Offering resulted in gross proceeds to Tenneco of approximately $368,000,000.\nIn addition, as part of the Reorganization, Tenneco Credit Corporation, a wholly-owned subsidiary of Tenneco Inc., retained ownership of approximately $1.2 billion of Case's United States retail receivables and related debt existing at the time of the Reorganization which is not redeemable prior to maturity. Since the Reorganization, United States retail finance activity has been conducted by Case's newly-formed United States finance subsidiary. At December 31, 1994, approximately $879 million of the retail receivables remained outstanding. For additional information, see \"Other.\"\nRESTRUCTURING OF CASE OPERATIONS\nOn March 21, 1993, the Board of Directors of Tenneco Inc. adopted a comprehensive restructuring program for Case (the \"Case Restructuring Program\") which resulted in a pre-tax charge of $920 million ($843 million after taxes, or $5.85 per average common share), all of which was reflected in the 1992 loss from continuing operations before interest expense, income taxes and minority interest. Such pre-tax charge was reduced by $20 million and $16 million in 1993 and 1994, respectively. Implementation of the Case Restructuring Program was commenced in 1993, and various restructuring actions in the program were completed in 1993 and 1994 and others are in process. The Case Restructuring Program is expected to be substantially completed by 1997.\nThe Case Restructuring Program is highly complex, and effectively implementing it continues to be a major undertaking. The specific restructuring measures were based on management's best business judgment under prevailing circumstances and on assumptions which may be revised over time and as circumstances change. Case continues to believe that the successful completion of the Case Restructuring Program will enhance its operating income and pre-tax cash flow over 1992 levels by approximately $200 million annually by 1997. For additional information about Case's restructuring program, see Note 16 to \"Notes to the Financial Statements.\"\nOPERATIONS\nThe following were products manufactured by Case in 1994:\nFARM EQUIPMENT CONSTRUCTION EQUIPMENT two-wheel and four- excavators wheel drive farm crawler dozers and loaders tractors wheel loaders combines loader\/backhoes cotton pickers rough terrain forklifts hay and forage skid steer loaders equipment trenchers soil conditioning equipment crop production equipment implements\nCase also distributes excavators in North America that are manufactured by a third party. Case manufactures and distributes equipment primarily under the names \"Case\", \"Case IH\", \"Case Poclain\" and \"Case International.\"\nCase has a 50% interest in a joint venture with Cummins Engine Company, Inc. (\"Cummins\"), which manufactures a line of diesel engines. The joint venture provides Case with a source of technically advanced, low cost, efficient and reliable diesel engines which have been incorporated into virtually all of its product lines. Cummins sells its share of engines manufactured by the joint venture to third parties. The Tenneco Inc. General Employee Benefit Trust holds approximately 8.6% of the outstanding common stock of Cummins.\nIn addition, Case owns a 50% interest in Hay and Forage Industries, a joint venture with AGCO Corporation, which manufactures hay and forage equipment at a plant in Hesston, Kansas. Each of the co-venturers markets and sells the equipment manufactured by the joint venture under the Case and AGCO\/Hesston brand names, respectively, through their respective distribution systems.\nThe following table sets forth information with respect to sales during the past three years:\nThe farm equipment industry is highly competitive, particularly in North America and Europe. Case competes with several large national and international full-line suppliers, as well as numerous short-line and specialty manufacturers with differing manufacturing and marketing methods. The construction equipment industry has a broad spectrum of competitors which specialize in various product lines and which are globally dispersed.\nCHEMICALS\nOn December 13, 1994, Tenneco announced its intention to sell its Albright & Wilson Chemicals division in an underwritten initial public offering primarily in the United Kingdom. The offering was completed on March 8, 1995. Tenneco has agreed to indemnify Albright & Wilson for certain costs that might arise from a patent dispute, the decommissioning of a plant and taxes for previous years.\nAlbright & Wilson plc, a British-based chemical company, and its subsidiaries (\"Albright & Wilson\"), are engaged in the chemical business. Albright & Wilson has four manufacturing facilities in the United Kingdom, five manufacturing facilities in the United States and, together with joint ventures, 26 additional manufacturing facilities in 14 other countries (Canada, Colombia, Australia, Italy, France, Spain, Mexico\nand seven countries in Asia). In the years 1994, 1993 and 1992, approximately 82%, 81% and 84%, respectively, of Albright & Wilson's sales were made outside the United States.\nThe principal products of Albright & Wilson are phosphorus chemicals and surfactants and a range of specialty chemicals for water management, flame retardants and intermediates for pharmaceuticals and agricultural chemicals. The following table sets forth sales of Albright & Wilson by product lines for the periods indicated:\n-------- * Sales by Albright & Wilson's pulp chemicals business, which was sold in 1992 have not been included.\nAlbright & Wilson has a 50% interest in a joint venture that owns and operates a purified wet-process phosphoric acid plant in Aurora, North Carolina, which has largely displaced the use of phosphorus as a feedstock for phosphoric acid manufactured by Albright & Wilson in North America.\nIn December 1994, Albright & Wilson acquired a 50% interest in Troy Grupo Industrial S.A. de C.V., a Mexican corporation whose principal subsidiary is engaged in the manufacture of purified wet phosphoric acid and other phosphate based chemicals.\nOTHER\nTenneco has several wholly-owned finance subsidiaries which purchase interest-bearing and noninterest-bearing trade receivables from its operating subsidiaries. Through June 1994, Tenneco Credit Corporation and Tenneco Credit Canada Corp. purchased retail receivables generated primarily by retail sales of Case's products. As a part of the Reorganization, Tenneco Credit Corporation retained ownership of approximately $1.2 billion of Case's United States retail receivables and related debt existing at the time of the Reorganization which is not redeemable prior to maturity. Since the Reorganization, United States retail finance activity has been conducted by Case's newly-formed United States finance subsidiary. Case services the retail receivables retained by Tenneco Credit Corporation, for which it receives a monthly servicing fee based on the amount of receivables outstanding at the beginning of each month. At December 31, 1994, approximately $879 million of the retail receivables owned by Tenneco Credit Corporation remained outstanding. It is estimated that the receivables retained by Tenneco Credit Corporation will be substantially liquidated by 1999.\nTenneco Credit Corporation in 1994 also purchased receivables from other Tenneco operating subsidiaries. Funding for Tenneco Credit Corporation is provided through the private and public debt markets. Funding for Tenneco Credit Canada Corp. was provided through private debt markets.\nPrior to the Reorganization, Case Finance Company, Tenneco International Finance Limited and Case Canada Wholesale Finance Corporation purchased wholesale receivables primarily generated by the sale or lease of Case farm and construction equipment to its domestic and foreign dealers. The companies were funded primarily through private debt markets. Case Finance Company, Tenneco International Finance Limited and Case Canada Wholesale Finance Corporation continue to be indirect wholly-owned subsidiaries of Tenneco Inc.\nBUSINESS STRATEGY\nSince September 1991 the Company has focused on various initiatives and taken steps designed to strengthen its financial results and improve its financial flexibility and thereby generate greater returns to its stockholders. Asset evaluation and redeployment have been and will continue to be important parts of this strategy. The Company continues to study opportunities for the strategic repositioning and restructuring of its operations (including through acquisitions, dispositions, divestitures, spin-offs and joint venture participation, wholly and partially, of various businesses).\nENVIRONMENTAL MATTERS\nTenneco Inc. estimates that its subsidiaries will make capital expenditures for environmental matters of approximately $90 million in 1995 and that capital expenditures for environmental matters will range from approximately $290 million to $484 million in the aggregate for the years 1996 through 2006.\nFor information regarding environmental matters see Item 3, \"Legal Proceedings--Environmental Proceedings\" and \"--Potential Superfund Liability\", Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Environmental Matters\" and Note 17, \"Commitments and Contingencies\" in the \"Notes to Financial Statements.\" See also Note 1, \"Summary of Accounting Policies--Environmental Liabilities\" in the \"Notes to Financial Statements.\"\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nReference is made to Item 1 for a description of Tenneco's properties.\nTenneco believes that substantially all of its plants and equipment are, in general, well maintained and in good operating condition. They are considered adequate for present needs and as supplemented by planned construction are expected to remain adequate for the near future.\nTenneco Inc. is of the opinion that its subsidiaries have generally satisfactory title to the properties owned and used in their respective businesses, subject to liens for current taxes and easements, restrictions and other liens which do not materially detract from the value of such property or the interests therein or the use of such properties in their businesses.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\n(1) Environmental Proceedings.\nTennessee is a party in proceedings involving federal and state authorities regarding the past use by Tennessee of a lubricant containing polychlorinated biphenyls (\"PCBs\") in its starting air systems.\nTennessee has executed a consent order with the United States Environmental Protection Agency (\"EPA\") governing the remediation of its compressor stations in Regions IV, V and VI. With respect to the stations in Regions II and III, the EPA has advised Tennessee that it is deferring to the Pennsylvania and New York environmental agencies to specify the remediation requirements applicable to Tennessee. Tennessee anticipates that it will soon reach an agreement with the Pennsylvania Department of Environmental Resources (\"PaDER\") and will enter into a consent order on remediation at the Pennsylvania stations (under which Tennessee also agrees to pay a civil penalty and to make a contribution for environmental projects); meanwhile, Tennessee will continue its negotiations with the New York Department of Environmental Conservation on remediation at the New York stations. Tenneco believes that the ultimate resolution of this matter will not have a material adverse effect on the financial position or results of operations of Tenneco Inc. and its consolidated subsidiaries. See Notes 6 and 17 in the \"Notes to Financial Statements\" for additional information.\nIn Commonwealth of Kentucky, Natural Resources and Environmental Protection Cabinet v. Tennessee Gas Pipeline Co. (Franklin County Circuit Court, Docket No. 88-C1-1531, November 16, 1988), the Kentucky environmental agency alleges that Tennessee discharged pollutants into the waters of the state without a permit and seeks an injunction against future discharges and a civil penalty. Counsel for Tenneco are unable to express an opinion as to its ultimate outcome. Tenneco believes that the resolution of this issue will not have a material adverse effect on its consolidated financial position or results of operations.\nA subsidiary of Tennessee owns a 13.2% general partnership interest in Iroquois Gas Transmission System, L.P. (\"Iroquois\"), which owns an interstate natural gas pipeline from the Canadian border through the states of New York and Connecticut to Long Island. The operator of the pipeline is Iroquois Pipeline Operating Company (\"the Operator\"), a subsidiary of TransCanada Pipelines, Ltd., an affiliate of TransCanada Iroquois, Ltd., which is also a partner in Iroquois.\nIn early 1992, Iroquois was informed by U.S. Attorneys' Offices for the Northern, Southern, and Eastern Districts of New York that a civil investigation had been initiated to determine whether civil environmental violations occurred during construction of the pipeline. In February 1992, 26 alleged violations were identified to Iroquois in writing. In response, Iroquois denied that such violations had occurred and asserted that all concerns raised by governmental authorities during construction had been fully addressed. Iroquois subsequently was informed that the alleged violations included certain matters referred to in field reports prepared by a Federal\/State Inter-Agency Task Force which surveyed the right-of-way in connection with the right-of-way restoration program. Iroquois responded to the appropriate U.S. Attorneys' Offices that none of the matters referenced in field reports issued to date represent violations of any law or governmental authorization. As of March 28, 1995, no proceedings in connection with this civil investigation have been commenced against Iroquois by the federal government.\nOn December 3, 1993, Iroquois received notification from the Enforcement Staff of the Federal Energy Regulatory Commission's Office of the General Counsel (\"Enforcement\") that Enforcement has commenced a preliminary, non- public investigation concerning the construction of certain of Iroquois' pipeline facilities. That office has requested certain information regarding such construction. In addition, on December 27, 1993, Iroquois received a similar request for information from the Army Corps of Engineers requesting certain information regarding permit compliance in connection with certain aspects of the pipeline's construction. By a notice issued on February 6, 1995, the Public Service Commission of the State of New York (the \"NYPSC\") also has requested Iroquois to respond to certain allegations set out in a petition filed by GASP Coalition and Anne Marie Mueser in January 1995 with the NYPSC requesting an investigation by the NYPSC of aspects of the construction of the pipeline. Iroquois has been evaluating and responding to these agencies' requests for information. No proceedings have been commenced against Iroquois in connection with these agency inquiries.\nA criminal investigation relating to the construction of the pipeline facilities has been initiated by the U.S. Attorney's Office for the Northern District of New York in conjunction with the EPA and the Federal Bureau of Investigation (\"FBI\"). According to a press release issued by the FBI in June 1992, areas under investigation include possible environmental violations, wire fraud, mail fraud and providing false information or concealment of information from federal agencies in conjunction with construction of the pipeline. While no criminal charges have been filed to date, counsel for Iroquois and counsel for the Operator have met with the Assistant U.S. Attorney in charge of the investigation and plan to meet with him again in the near future in order to discuss the issues under investigation and to explore the possibility of a negotiated resolution of the issues raised in the criminal, civil and administrative inquiries (a \"global resolution\"). In the absence of a negotiated resolution, Iroquois deems it probable that the U.S. Attorney will seek indictments and, in them, substantial fines and other sanctions.\nAs a general partner, Tennessee's subsidiary may be jointly and severally liable with the other partners for the liabilities of Iroquois. Tennessee has a contract to provide gas dispatching as well as post-construction field operation and maintenance services for the Operator of Iroquois, but Tennessee is not the Operator and is not an affiliate of the Operator. Moreover, the foregoing proceedings and investigations have not affected pipeline operations. Based upon information available to Tennessee at March 28, 1995, Tennessee believes that neither Tennessee nor any of its subsidiaries is a target of the criminal investigation described above.\nFurther, while a global resolution of these inquiries could have a material adverse effect on the financial condition of Iroquois, Tenneco believes that the ultimate resolution of these matters will not have a material adverse effect on the financial condition or results of operations of Tenneco Inc. and its consolidated subsidiaries.\nOn August 2, 1993, the Department of Justice filed suit against Packaging Corporation of America (\"PCA\") in the Federal District Court for the Northern District of Indiana, alleging that wastewater from PCA's molded fiber products plant in Griffith, Indiana interfered with or damaged the Town of Griffith's municipal sewage pumping station on two occasions in 1991 and 1993, resulting in discharges by the Town of Griffith of untreated wastewater into a river. PCA and the Department of Justice have agreed in principle to settle the suit. Specifics of the consent decree are still being negotiated by PCA and the Department of Justice.\n(2) Potential Superfund Liability.\nAt December 31, 1994, Tenneco has been designated as a potentially responsible party in 66 \"Superfund\" sites. With respect to its pro rata share of the remediation costs of certain sites, Tenneco is fully indemnified by third parties. With respect to certain other sites, Tenneco has sought to resolve its liability through payments to the other potentially responsible parties. For the remaining sites, Tenneco has estimated its share of the remediation costs to be between $13 million and $72 million or 0.4% to 2.2% of the total remediation costs for those sites and has provided reserves that it believes are adequate for such costs. Because the clean-up costs are estimates and are subject to revision as more information becomes available about the extent of remediation required, Tenneco's estimate of its share of remediation costs could change. Moreover, liability under the Comprehensive Environmental Response, Compensation and Liability Act is joint and several, meaning that Tenneco could be required to pay in excess of its pro rata share of remediation costs. Tenneco's understanding of the financial strength of other potentially responsible parties has been considered, where appropriate, in Tenneco's determination of its estimated liability. Tenneco does not believe that the costs associated with its current status as a potentially responsible party in the Superfund sites described above will be material to its consolidated financial position or results of operations.\nFor additional information concerning environmental matters, see the caption \"Environmental Matters\" under Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\", and the caption \"Environmental Matters\" under Note 17, in the \"Notes to Financial Statements\".\n(3) Other Proceedings.\nOn October 14, 1993, Tennessee was sued in the State District Court of Ector County, Texas, by ICA Energy, Inc. (\"ICA\") and TransTexas Gas Corporation (\"TransTexas\"). In that suit, ICA and TransTexas contended that Tennessee had an obligation to purchase gas production which TransTexas thereafter attempted to add unilaterally to the reserves originally dedicated to a 1979 gas contract. On two subsequent occasions, TransTexas gave Tennessee notice that it was adding new production and\/or acreage \"to the contract\". An amendment to the pleadings seeks $1.5 billion from Tennessee for alleged damages caused by Tennessee's refusal to purchase gas produced from the TransTexas leases covering the new production and lands. Neither ICA nor TransTexas were original parties to that contract. However, they contend that any stranger acquiring a fractional interest in the original committed reserves thereby obtains a right to add to the contract unlimited volumes of gas production from locations in South Texas. Tennessee believes it has meritorious defenses to the claims of ICA and TransTexas, which defenses it will vigorously assert. For additional information, see Note 6 in the \"Notes to Financial Statements\".\nTenneco Inc. and its subsidiaries are parties to numerous other legal proceedings arising from their operations. Tenneco Inc. believes that the outcome of these other proceedings, individually and in the aggregate, will have no material effect on Tenneco's consolidated financial condition 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 of Tenneco Inc. during the fourth quarter of the fiscal year ended December 31, 1994.\nITEM 4.1 EXECUTIVE OFFICERS OF THE REGISTRANT.\nSet forth below is a list of the executive officers of Tenneco Inc. at March 15, 1995. Each of such officers has served in the capacities indicated below with Tenneco Inc. (or prior to a corporate reorganization in 1987 with the then publicly held affiliate of Tenneco Inc. which bore the same name) since the dates indicated below:\n-------- * Unless otherwise indicated, all offices held are with Tenneco Inc.\nEach of the executive officers of Tenneco Inc. has been continuously engaged in the business of Tenneco Inc., its subsidiaries, affiliates or predecessor companies during the past five years except that: (i) from 1986 to 1992, Dana G. Mead was employed by International Paper Co., last serving in the capacity of Executive Vice President; (ii) Theodore R. Tetzlaff has been a partner in the law firm of Jenner & Block, Chicago, for more than five years; (iii) from 1985 to 1992, Stacy S. Dick was employed by The First Boston Corporation, last serving in the capacity of Managing Director; (iv) from 1980 to 1992, John J. Castellani was employed by TRW Inc., last serving in the capacity of Vice President of Government Relations and from August 1992 to March 1995 he served as Vice President--Government Relations of Tenneco Inc.; (v) from 1988 until his employment by Tenneco in 1992, Barry R. Schuman was employed by Union Pacific Railroad Company, last serving in the capacity of Vice President of Human Resources; (vi) from 1990 until 1992, Arthur H. House served as Vice President, Corporate Communications of Aetna Life & Casualty Company; from 1988 to 1990 as Senior Vice President, Corporate Affairs of Shawmut National Corporation; from June 1992 until March 1995, he served as Vice President-- Corporate Affairs of Tenneco Inc.; (vii) from 1975 to 1994, Karen R. Osar was employed by J. P. Morgan & Co., Inc., last serving in the capacity of Managing Director--Corporate Finance Group; (viii) from 1983 to 1990, Robert G. Simpson was employed by Kraft Inc. and Philip Morris Management Co., last serving in the capacity of Director of Kraft General Foods Federal Taxes; (ix) from 1980 to 1994, Mark A. McCollum was employed by Arthur Andersen LLP, last serving as an Audit Partner; and (x) from 1977 to 1993, Paul T. Stecko was employed by International Paper Co., last serving as Vice President and General Manager of Publications Papers, Bristols and Converting Papers.\nTenneco Inc.'s Board of Directors is divided into three classes of directors serving staggered three-year terms, with a minimum of eight directors and a maximum of sixteen directors. At each annual meeting of stockholders, successors to the directors whose terms expire at such meeting are elected. Officers are elected at the annual meeting of directors held immediately following the annual meeting of stockholders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe outstanding shares of Common Stock, par value $5 per share, of Tenneco Inc. (the \"Common Stock\") are listed on the New York, Chicago, Pacific, Toronto, London, Paris, Frankfurt, Dusseldorf, Basel, Geneva and Zurich Stock Exchanges.\nThe following table sets forth the high and low sale prices of Common Stock during the periods indicated on the New York Stock Exchange Composite Transactions Tape and dividends paid per share of Common Stock during such periods:\nThe number of holders of Common Stock of record as of March 1, 1995, was approximately 112,000.\nThe declaration of dividends on the Company's capital stock is at the discretion of the Company's Board of Directors. The Board has not adopted a dividend policy as such; subject to legal and contractual restrictions, its decisions regarding dividends are based on all considerations which in its business judgement are relevant at the time, including past and projected earnings, cash flows, economic, business and securities market conditions and anticipated developments concerning Tenneco's business and operations. For additional information concerning the payment of dividends by Tenneco Inc., see \"Years 1994 and 1993 --Ability to Pay Dividends\" in Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\"\nTenneco's cash flow and the consequent ability of Tenneco Inc. to pay any dividends on the Common Stock is substantially dependent upon Tenneco's earnings and cash flow available after its debt service and the availability of such earnings to Tenneco Inc. by way of dividends, distributions, loans and other advances. The instruments setting forth the rights of the holders of the Preferred Stock and Junior Preferred Stock contain provisions restricting Tenneco Inc.'s right to pay dividends and make other distributions on the Common Stock. Certain of Tenneco Inc.'s subsidiaries have provisions under financing arrangements and an investment agreement which limit the amount of dividends that may be paid by them to Tenneco Inc. At December 31, 1994, such amount was calculated to be $2.9 billion. Tenneco Inc. is a party to credit agreements containing provisions that limit the amount of dividends paid on its common stock. At December 31, 1994, under the most restrictive provisions contained in these credit agreements, Tenneco Inc. would be permitted to pay dividends of as much as $900 million.\nUnder applicable corporate law, dividends may be paid by Tenneco Inc. out of \"surplus\" (as defined under the law) or, if there is not a surplus, out of net profits for the year in which the dividends are declared or the preceding fiscal year. At December 31, 1994, Tenneco Inc. had surplus of at least $1.9 billion for the payment of dividends, and Tenneco Inc. will also be able to pay dividends out of any net profits for the current and prior fiscal year.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nSELECTED CONSOLIDATED FINANCIAL INFORMATION\n(Table continued on next page)\n(Continued from previous page)\n------- Notes: (a) In December 1994, Tenneco's accounting for its Farm and construction equipment segment changed due to a reduction in its ownership percentage. For the month of December 1994, the Farm and construction equipment segment was reflected in Tenneco's financial statements using the equity method of accounting. Accordingly, the segment's revenues are included in Tenneco's reported revenues for eleven months only. For additional information, see Notes 1 and 3 to the Financial Statements of Tenneco Inc. and Consolidated Subsidiaries. (b) Includes the disposition of approximately 56% of Case common stock; a 20% interest in Tenneco Energy Resources Corporation; facility, machinery and equipment at PCA; and facilities and equipment at Case for a gain of $50 million. (c) Includes the disposition of a number of assets and investments including Newport News' Sperry Marine business; several PCA operations; two wholly-owned pipeline companies, Viking Gas Transmission Company and Dean Pipeline Company; and facilities and land of two foreign Farm and construction equipment operations for a gain of $112 million. (d) For Natural gas pipelines, includes a gain of $265 million related to the sale of its natural gas liquids business including its interest in an MTBE plant then under construction. Also, Packaging recorded a gain of $42 million related to the sale of three short-line railroads. (e) Includes restructuring charge of $920 million related to Farm and construction equipment in 1992 reduced by $20 million in 1993 and $16 million in 1994. Losses in 1992 for the Farm and construction equipment segment before the restructuring charge were $260 million. Of the total $473 million restructuring charge recorded in 1991, $461 million related to Farm and construction equipment and $12 million related to Other. Losses in 1991 for the Farm and construction equipment segment before the restructuring charge were $618 million. (f) Includes after-tax restructuring charge reversal of $10 million, or $.05 per average common share, and $12 million, or $.07 per average common share, for 1994 and 1993, respectively, and an after-tax restructuring charge of $843 million, or $5.85 per average common share, and $413 million, or $3.36 per average common share, for 1992 and 1991, respectively. (g) Effective January 1, 1994, Tenneco adopted Statement of Financial Accounting Standards (\"FAS\") No. 112, Employers' Accounting for Postemployment Benefits. This new accounting rule requires employers to account for postemployment benefits for former or inactive employees after employment but before retirement on the accrual basis rather than the \"pay-as-you-go\" basis. Tenneco recorded an after-tax charge of $39 million ($.22 per average common share) which was reported as a cumulative effect of change in accounting principle. Tenneco elected early adoption of FAS No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions, for its domestic operations and FAS No. 109, Accounting for Income Taxes. Both standards were adopted effective January 1, 1992, using the cumulative catch-up method. Under FAS No. 106, Tenneco is required to accrue the estimated costs of retiree benefits other than pensions (primarily health care benefits and life insurance) during the employees' active service period. Prior to 1992, Tenneco expensed the cost of these benefits as medical and insurance claims were paid. Tenneco will adopt the new standard for its non-U.S. plans in the first quarter of 1995 but does not expect that the adoption will have a material effect on Tenneco's consolidated financial position or results of operations. The adoption of FAS No. 109 changed Tenneco's method of accounting for income taxes from the deferred method to the liability method. The liability method requires the recognition of deferred tax assets and\n(Continued from previous page)\nliabilities for the future tax consequences of temporary differences between the financial statement basis and the tax basis of assets and liabilities. The 1992 Statements of Income (Loss) include an after-tax charge of $699 million or $4.86 per average common share for the cumulative effect of the accounting changes consisting of $414 million or $2.88 per share for FAS No. 106 and $285 million or $1.98 per share for FAS No. 109. (h) Earnings per share of common stock are based on the average number of shares of common stock and Series A preferred stock (each share of Series A preferred stock represents approximately two shares of common stock) outstanding during each period. Because Series A preferred stock outstanding is included in average common shares outstanding for purposes of computing earnings per share, the preferred dividends paid are not deducted from net income (loss) to determine net income (loss) to common stock. The inclusion of Series A preferred stock in the computation of earnings per share was antidilutive for the years and certain quarters in 1994, 1993 and 1992. In December 1994, all Series A preferred stock was converted into common stock. In 1992, 12,000,000 shares of common stock were issued to the Stock Employee Compensation Trust (\"SECT\"). Shares of common stock issued to a related trust are not considered to be outstanding in the computation of average shares of common stock until the shares are utilized to fund the obligations for which the trust was established. At December 31, 1994, the SECT had utilized 4,944,146 of these shares. Other convertible securities and common stock equivalents outstanding during each of the five years ended December 31, 1994, 1993, 1992, 1991 and 1990 were not materially dilutive.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following review of the results of operations and financial condition of Tenneco Inc. and consolidated subsidiaries should be read in conjunction with the Consolidated Financial Statements and related notes.\nYEARS 1994 AND 1993\n1994 STRATEGIC ACTIONS\nDuring 1994, Tenneco completed or initiated several strategic objectives designed to demonstrate its commitment to growing earnings per share and building shareowner value. These actions included the following:\n. In June, Tenneco completed an initial public offering (\"IPO\") of approximately 29 percent of the common stock of Case Corporation (\"Case\"), its farm and construction equipment segment. A secondary public offering in November further reduced Tenneco's interest in Case to approximately 44 percent. Combined proceeds from the two transactions were $694 million, net of commissions and expenses. The combined gain on the transactions was $36 million, including a $7 million income tax benefit. From July through November 1994, Tenneco's income was reduced to reflect the 29 percent minority interest in Case resulting from the IPO in June 1994. Subsequent to November, Case was reflected in Tenneco's financial statements using the equity method of accounting.\n. In December, Tenneco announced its intent to offer 100 percent of Albright & Wilson, its chemical segment, in an IPO offered primarily in the United Kingdom. This resulted in an after-tax loss on the sale of $170 million, or 94 cents per average common share, and net proceeds of $707 million. The offering was completed in early March 1995.\n. Also in December, Tenneco began to repurchase up to $500 million of its outstanding common shares. At December 31, 1994, 1,160,000 shares had been acquired at a cost of $49 million. The repurchase program is expected to continue into the second quarter of 1995.\n. New projects or acquisitions have been announced representing capital commitments of approximately $600 million over the next three years as a part of the strategy to redeploy assets from slower-growth cyclical businesses into higher-growth areas. These commitments include new international projects in Australia, India, China and Germany, as well as domestic opportunities in packaging and natural gas.\nRESULTS OF OPERATIONS\nREVENUES\nRevenues for 1994 were $12.17 billion, down slightly from $12.29 billion in 1993. Natural gas pipelines revenues were down $484 million or 17 percent as customers shifted from sales to transportation service in the regulated business and gas prices fell in the nonregulated gas marketing business. Revenues for farm and construction equipment were $3.88 billion, compared with $3.75 billion in 1993. Tenneco excluded Case's revenues for December because of the change to the equity accounting method for Case. Case revenues were up in 1994 over 1993 due to higher sales volumes both in the European construction equipment business and the North American agricultural equipment market. Automotive parts revenues were $1,989 million, a $204 million, or 11 percent increase, compared with 1993 primarily due to improved sales in both the aftermarket and original equipment market. Revenues for shipbuilding decreased to $1.75 billion, or six percent, due to a drop in carrier and submarine construction work and the fourth quarter 1993 divestiture of Sperry Marine. Packaging revenues increased $142 million, or seven percent, to $2.18 billion in 1994, as prices in the containerboard business recovered from the seven-year low reached in the third quarter of 1993.\nINCOME BEFORE INTEREST EXPENSE, INCOME TAXES AND MINORITY INTEREST (OPERATING INCOME)\nOperating income was $1,379 million for 1994. This was an improvement of $282 million over 1993's operating income of $1,097 million. Excluding gains from asset sales and other special items including plant consolidations, 1994 operating income increased $364 million, or 37 percent, compared with 1993 primarily due to improved pricing in packaging's containerboard business and higher volumes in the farm and construction equipment segment.\nNATURAL GAS PIPELINES\nREVENUES\nRevenues for natural gas pipelines decreased $484 million to $2,378 million in 1994. This primarily is a result of the implementation of Federal Energy Regulatory Commission (\"FERC\") Order 636 during the fall of 1993, which essentially ended natural gas sales by regulated pipelines. Additionally, the decline in natural gas prices in 1994 lowered revenues in the nonregulated segment. Revenues from the regulated businesses decreased $384 million to $918 million in 1994, while revenues from nonregulated businesses decreased $100 million to $1,460 million in 1994.\nOPERATING INCOME\nNatural gas pipelines operating income for 1994 was $415 million, compared with $411 million in 1993. Special items, including gains on asset sales along with regulatory and litigation settlements, amounted to $34 million in 1994 and $28 million in 1993. Special items in 1994 included a $23 million gain on the sale of a 20 percent interest in Tenneco Energy Resources Corporation to Ruhrgas AG. When non-recurring items in both years are excluded, operating income in 1994 declined slightly, compared with 1993. Significant growth in the nonregulated businesses, including an increase in Tenneco Ventures' operating income, was offset by declines in the regulated business caused by implementing Order 636.\nOUTLOOK\nTenneco Gas' strategy for future growth is to utilize its regulated pipelines to provide a substantial base of income as well as monetize non-strategic assets and redeploy those resources into more profitable, nonregulated businesses. During 1994, Tenneco Gas achieved record transportation volumes in both its regulated and nonregulated pipelines, and plans to continue maintaining its market strength in the future. Tenneco Gas' regulated pipelines moved to expand its markets by proposing to build the 350-mile Mid-Atlantic Pipeline. In addition, Tenneco Gas has committed approximately one-half of its capital budget for\n1995 to investments in the nonregulated businesses, compared with three percent in 1992. Also, during 1994, Tenneco Gas was chosen to participate in constructing a pipeline from Bolivia to Brazil and to conduct final feasibility studies for an offshore pipeline in Taiwan. Tenneco Gas also was selected by the government of Queensland, Australia, to develop, own and operate a 470- mile, $170 million pipeline, which is expected to be on-line in 1996. In addition, Tenneco Gas is engaged in a feasibility study for the construction, ownership, and operation of a 750-mile pipeline from Argentina to Chile.\nIn October 1994, Tenneco Gas announced the acquisition of ARK Energy, Inc., a privately-owned power generation company, for approximately $60 million in Tenneco Inc. common stock and other consideration. Tenneco Gas is scheduled to complete the acquisition by midyear 1995.\nOn December 30, 1994, Tennessee Gas Pipeline Company (\"Tennessee\") filed a general rate increase in Docket No. RP95-112 which reflected an increase in Tennessee's revenue requirement of $118 million, including recovery of certain environmental costs. On January 25, 1995, the FERC accepted the filing, suspended its effectiveness for the maximum period of five months pursuant to normal regulatory process, and set the matter for hearing. This order also required the convening of a technical conference to address various concerns raised by the FERC and Tennessee's customers over, among other issues, Tennessee's ability to provide its shippers with timely and accurate operating and billing information and the associated systems costs. The ultimate resolution of these issues may result in adjustments to customer billings. Subject to the outcome of these issues and certain modifications identified in the FERC order, the increased rates will become effective on July 1, 1995, subject to refund. (Reference is made to Note 17, \"Commitments and Contingencies--Environmental Matters,\" in the \"Notes to Financial Statements\" for additional information.)\nAUTOMOTIVE PARTS\nREVENUES\nRevenues for automotive parts increased to $1,989 million in 1994 from $1,785 million in 1993 because of increased sales in both the aftermarket and original equipment market. Major promotion efforts in support of Monroe's new Sensa-Trac product were a big factor in the 11 percent revenue increase in the worldwide replacement market for ride control products.\nIncreased new car and truck production in North America contributed to a 14 percent increase in worldwide original equipment sales. Total European revenues improved 19 percent as the economy rebounded from the recession. Worldwide aftermarket revenues were up 10 percent to $1,253 million in 1994 while original equipment revenues increased 14 percent to $736 million.\nOPERATING INCOME\nAutomotive parts operating income for 1994 was $223 million, compared with $222 million in 1993. The 1994 operating income included a $17 million charge for plant consolidations in Europe associated with acquiring Heinrich Gillet GmbH & Company (\"Gillet\") in Germany and a $5 million charge taken in the second quarter for closing a plant in Ohio. Excluding special items, operating income increased $23 million, or 10 percent, compared with 1993. This increase is a result of higher volumes in North America and Europe and was partially offset by higher costs for new product development and new facility start-up.\nIn November 1994, Tenneco acquired Gillet for $44 million in cash and $69 million in assumed debt. Gillet is the leading manufacturer of original equipment exhaust systems and components for European auto makers.\nAs part of the European consolidation plan, Tenneco consolidated the headquarters and engineering center in Europe with the Gillet facilities in the first quarter of 1995. The manufacturing facilities consolidation will occur later in 1995.\nOUTLOOK\nThe Gillet acquisition added to Tenneco Automotive's global manufacturing and engineering network. It also brought many new original equipment customers and orders to Walker, making it the market share leader in the European original equipment exhaust market.\nTenneco Automotive's future growth will also come from new product introductions. Sensa-Trac shocks and struts were introduced in North America, France, and Australia in 1994 with immediate positive customer response. In 1995 Sensa-Trac products will be introduced in South America and the rest of Europe.\nPACKAGING\nREVENUES\nRevenues for the packaging segment increased to $2,184 million in 1994 from $2,042 million in 1993. Containerboard prices improved significantly, and Packaging achieved record productivity levels despite tightening supply conditions. Revenues from the containerboard business were up 11 percent to $1,529 million in 1994 while revenues from the specialty business were essentially flat.\nOPERATING INCOME\nPackaging's operating income for 1994 was $209 million, compared with $139 million in 1993. The 1993 operating income included $29 million from gains related to asset realignment. Excluding these gains, operating income increased $99 million, or 90 percent, compared with 1993 primarily because of improved containerboard pricing.\nThe containerboard business earned $139 million, up $104 million compared with 1993, excluding the 1993 asset realignment gains. Prices rose from depressed levels in 1993 and contributed $125 million, excluding the recycling business, of increased operating income. This was partially offset by higher raw material costs of $32 million, but improved productivity helped counter rising raw material costs. Containerboard productivity rose 1.6 percent, with mill operating rates exceeding rated capacity for the full year. The specialty business operating income for 1994 declined $5 million to $70 million, excluding the asset realignment gains in 1993. Both the aluminum and plastic packaging businesses reported improved operating income. Plastic packaging volumes grew seven percent in 1994 and demand continues to be strong. Operating income for plastics rose 40 percent in 1994, reflecting increased volumes and higher pricing. The increase in operating income provided by the aluminum and plastic businesses was more than offset by weak performance in the molded fiber business, where higher raw material costs had a negative effect on operating income. Prices for recycled newspaper, a major raw material for molded fiber, rose to over $100 per ton, compared with $26 per ton in 1993.\nOUTLOOK\nContainerboard production increased six percent throughout the industry in 1994 and, with industry inventory levels at less than four weeks' supply in December, Packaging expects demand to remain strong in 1995. Despite strong demand overseas, export shipments during the fourth quarter of 1994 dropped sharply, as producers worked to meet domestic demand. Packaging expects both domestic and export demand to remain strong in 1995, and combined with limited capacity additions, this should keep industry production at or near capacity.\nIn October 1994, Tenneco announced a $73 million upgrade at the Counce, Tennessee, mill. This upgrade should be completed by the end of the second quarter of 1996 and increase production capacity by 120,000 tons annually. The upgrade will allow production of lighter weight linerboard with higher recycled content and a smoother surface suitable for higher quality printing.\nThe specialty business also offers opportunities for growth and higher margins. The aluminum foil container market is growing at four percent per year, and the plastic food service business has expanded at five to eight percent per year over the past five years, a pace Packaging expects to continue. To take advantage of these growth markets, Packaging is aggressively managing its costs, developing new products and adding capacity as required. Packaging also consistently reviews acquisition candidates, both domestic and foreign, for additional sources of growth.\nSHIPBUILDING\nREVENUES\nRevenues for shipbuilding of $1,753 million in 1994 were six percent below revenues of $1,861 million in 1993. This decrease was due to the 1993 divestiture of Sperry Marine and lower volumes on carrier and submarine work.\nOPERATING INCOME\nShipbuilding's operating income for 1994 was $200 million compared with $225 million in 1993. Special items in 1993 included a $15 million gain on the sale of Sperry Marine and a $12 million benefit from recovering a portion of the postretirement benefit costs reserve that was established when Statement of Financial Accounting Standards (\"FAS\") No. 106 was adopted in 1992. If these special items were excluded, operating income increased $2 million in 1994 on revenues that were six percent lower due to aggressive efforts to improve productivity and control costs.\nOUTLOOK\nShipbuilding will continue to seek U.S. Navy work, but at the same time will focus more on the large, global commercial and military markets. The target is for Navy work to provide 60 percent of total revenues by 1999, with 40 percent coming from commercial and international military sectors. U.S. Navy work was more than 90 percent of total revenues for 1994. Newport News is making capital investments in support of its efforts to capture future U.S. Navy work and its expansion into commercial and international military markets, and to improve its productivity. Major investments now underway include substantial modifications to its steel production capability to achieve world class efficiency, expansion of Dry Dock 12 (already the largest in the western hemisphere) and construction of a consolidated nuclear powered ship refueling facility.\nThe backlog at the end of 1994 was $5.6 billion, compared with $3.7 billion at the end of 1993. The next aircraft carrier, RONALD REAGAN (CVN-76), a defueling and deactivation contract for the nuclear cruiser LONG BEACH, and two \"Double Eagle\" product tankers were added to the backlog in 1994. Newport News became the first American shipyard since 1957 to obtain a commercial construction contract from a foreign shipowner with the export order for two \"Double Eagle\" product tankers, with an option for two more. The shipyard is also a finalist for the possible sale of two to six fast frigates to the United Arab Emirates.\nIn addition to the three new projects mentioned above, the 1994 backlog included four LOS ANGELES-class submarines, two NIMITZ-class aircraft carriers (JOHN C. STENNIS and HARRY S. TRUMAN) and the SEALIFT conversion contract involving two ships. In addition, Newport News has ongoing engineering contracts as the lead design yard for the LOS ANGELES-class and SEAWOLF-class submarines. Newport News also has contracts to plan upcoming overhauls for the carriers EISENHOWER and ROOSEVELT. Subject to new orders, this existing backlog will decline as two submarines per year, on average, are delivered through 1996, and the aircraft carriers are delivered in 1995, 1998 and 2002.\nFARM AND CONSTRUCTION EQUIPMENT\nIn 1994, Tenneco reduced its ownership in Case to approximately 44 percent through an initial public offering in June and a secondary public offering of Case's stock in November. As a result, the method of accounting for Case's financial results changed in December 1994 to the equity method of accounting. In the months of January through November, Tenneco recorded 100 percent of Case's revenues, operating income, interest expense and taxes. From July through November 1994, Tenneco's income was reduced to reflect the 29 percent minority interest in Case resulting from the initial public offering in June 1994. (For additional information, see \"1994 Strategic Actions\" above and Notes 1 and 3, \"Summary of Accounting Policies\" and \"Discontinued Operations, Disposition of Assets and Extraordinary Loss,\" in the \"Notes to Financial Statements.\")\nREVENUES\nRevenues for Case increased to $3,881 million in 1994 from $3,748 million in 1993 due to higher sales volumes in both the construction and agricultural equipment businesses. Revenues for Case reflected in Tenneco's consolidated revenues included only the first eleven months of 1994 because of Tenneco's reduced ownership following the secondary public offering that was completed in November.\nOPERATING INCOME\nCase reported operating income of $326 million in 1994, a $244 million improvement, compared with the $82 million reported in 1993. Several factors contributed to this improvement in 1994. Higher sales volumes and a 16 percent increase in worldwide production along with lower discounts and better top-line pricing contributed to the operating income improvement. Cost reductions were partially offset by retooling and reconfiguration expenses at the construction equipment plant in Burlington, Iowa. Case also had higher engineering expenses to support new product growth.\nOUTLOOK\nThe worldwide outlook for sales of both agricultural and construction equipment remains strong. Case should benefit from several significant new products and higher-than-projected foreign purchases of United States grains. In Europe the economic recovery that began in mid-1994 is expected to continue to drive increased demand for construction equipment.\nTenneco intends to review its ownership position of Case periodically and may consider future dispositions through sales of shares through public or private offerings, through dividends or distributions to its stockholders, or otherwise. Any such future dispositions will depend upon a number of factors, including existing market conditions and the tax consequences of the transactions in question. Under the terms of Case's credit facilities, Tenneco has agreed that it, directly or indirectly, will own at least 30 percent of Case's outstanding common stock until Case's senior debt has been rated investment grade by two nationally recognized rating agencies, at least one of which shall be Moody's Investors Service or Standard and Poor's Rating Group, and at least $500 million of Case's term loan has been repaid.\nOTHER\nTenneco's other operations reported operating income of $6 million in 1994, compared with $18 million for 1993. The 1993 operating income included a gain of $39 million from contributing Tenneco's investment in Cummins Engine Company to the Case Corporation Pension Plan for Hourly Paid Employees, while the operating income for 1994 included gains of $29 million from the Case initial and secondary public offerings.\nINTEREST EXPENSE (NET OF INTEREST CAPITALIZED)\nNet interest incurred declined $20 million from $427 million in 1993 to $407 million in 1994. The decrease was a result of lower debt levels, continued emphasis on managing for cash flow and working capital and changing Case reporting to the equity method of accounting in December 1994. Due to the change in the method of financing dealer receivables as a result of the Case IPO in June 1994, financing costs for Case's wholesale receivables were reported as interest expense. Before the change in financing method, the Case wholesale financing costs were reported as \"Finance Charges--Tenneco Finance.\" If the Case wholesale receivable interest was excluded for the full year, interest expense would have decreased by an additional $24 million from last year's level. Interest capitalized increased to $6 million in 1994 from $4 million in 1993 due to higher levels of major capital projects.\nFinance charges (interest expense related to finance subsidiaries classified as an operating expense) were $155 million in 1994 versus $254 million in 1993. Approximately $2.0 billion in debt of Tenneco's finance subsidiaries was retired during the year resulting in lower finance charges. Interest expense related to debt on wholesale receivables was included as interest expense rather than finance charges from July through November 1994 as indicated above. In December, the method of reporting Case changed to the equity method, and Case's debt is no longer consolidated with Tenneco's debt on the balance sheet. In addition, Tenneco's finance subsidiaries reduced debt with proceeds from issuing lower-cost asset backed securities.\nMINORITY INTEREST\nMinority interest expense was $30 million for the 1994 year. This primarily reflected the minority shareholders' interest in Case's net income for July through November 1994.\nINCOME TAXES\nIncome tax expense for 1994 was $301 million versus $257 million reported for 1993. The increased tax expense in 1994 was from higher pre-tax income. This was partially offset by tax benefits from the realization of deferred tax assets resulting from consolidation of Tenneco's German operations and the tax benefit associated with sale of businesses. (Reference is made to Note 7, \"Income Taxes,\" in the \"Notes to Financial Statements\" for additional information.)\nDISCONTINUED OPERATIONS AND EXTRAORDINARY LOSS\nLoss from discontinued operations in 1994 of $189 million, net of income tax expense of $104 million, or $1.04 per average common share, resulted from the sale of Tenneco's chemicals and brakes businesses. The loss of $196 million, net of $100 million of income tax expense, on the sale of these businesses included a $170 million loss, net of income tax expense of $115 million, from the sale of the chemicals business, and a $26 million loss from the sale of the brakes business, net of income tax benefit of $15 million. Net income from the chemicals operations in 1994 was $12 million, net of income tax expense of $9 million. Net loss in 1994 from the brakes operations was $5 million, net of income tax benefit of $5 million.\nIncome from discontinued operations in 1993 of $38 million, net of income tax expense of $1 million, or 23 cents per average common share, was attributable to the sale of Tenneco's brakes business and chemical operations in 1994. Net loss for 1993 for the brakes business was $7 million, net of income tax benefit of $4 million. Net income for the chemicals business was $45 million, net of income tax expense of $5 million.\nExtraordinary loss for 1994 was $5 million, net of income tax benefit of $2 million, or 3 cents per average common share. The 1993 amount was $25 million, net of income tax benefit of $13 million, or 15 cents per average common share. Both were the result of redemption premiums from prepaying high interest- bearing long-term debt. (Reference is made to Note 3, \"Discontinued Operations, Disposition of Assets and Extraordinary Loss\" in the \"Notes to Financial Statements\" for additional information.)\nCUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE\nEffective January 1, 1994, Tenneco adopted FAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" This new standard was adopted using the cumulative catch-up method and requires employers to account for postemployment benefits for former or inactive employees after employment but before retirement on the accrual basis rather than the \"pay-as-you-go\" basis. As a result of adopting this statement, the 1994 Statement of Income (Loss) reflected an after-tax charge of $39 million, or 22 cents per average common share, for the cumulative effect of the accounting change. (Reference is made to Note 1, \"Summary of Accounting Policies--Changes in Accounting Principles,\" in the \"Notes to Financial Statements\" for additional information.)\nEARNINGS (LOSS) PER AVERAGE COMMON SHARE\nIncome from continuing operations for 1994 was $641 million, or $3.49 per average common share after preferred dividends. This compares with income from continuing operations of $413 million, or $2.36 per average common share after preferred dividends, in 1993. Net income to common stock was $396 million, or $2.20 per average common share, in 1994 compared with net income to common stock of $412 million, or $2.44 per average common share in the prior year. The 1994 net income to common stock included the loss from discontinued operations of $189 million, or $1.04 per average common share, the extraordinary loss of the $5 million, or 3 cents per average common share, and the loss of $39 million, or 22 cents per average common share, from the cumulative effect of a change in accounting principle. The 1993 net income to common stock included income from discontinued operations of $38 million, or 23 cents per average common share, and the extraordinary loss of $25 million, or 15 cents per average common share. Preferred stock dividends were $12 million for 1994 and $14 million for 1993.\nAverage number of shares of common stock outstanding used for calculating earnings per average common share for 1994 were 180.1 million, compared with 168.8 million in 1993, excluding the SECT shares described below. Most of the increase came from issuing the 23.5 million shares in the April 1993 underwritten public offering and issuing treasury shares and SECT shares to employee benefit plans.\nIn November 1992, Tenneco established a stock employee compensation trust (\"SECT\") to fund a portion of its obligations arising from its various employee compensation and benefit plans. Tenneco issued 12 million shares of treasury stock to the SECT, which has a five-year life during which it will use the common stock to satisfy those obligations. Shares of common stock issued to the SECT are not considered to be outstanding in computing average shares of common stock outstanding until the shares are used to fund the obligations for which the trust was established. In 1994, the SECT issued approximately 2.5 million shares of common stock, with a market value of $120 million, to fund employee compensation and benefit plans. (Reference is made to Note 9 \"Common Stock\" and to Note 10 \"Preferred Stock\" in the \"Notes to Financial Statements\" for additional information.)\nLIQUIDITY & CAPITAL RESOURCES\nOPERATING ACTIVITIES\nNet cash provided by operating activities was $450 million for the year 1994, compared with $1,615 million for 1993, a decrease of $1,165 million. Excluding discontinued operations, there was a decrease of $1,232 million. This decrease was due in part to lower sales of Case retail receivables in the form of asset backed securities. Proceeds from the sale of Case retail receivables in the form of asset backed securities were $850 million in 1994 compared with $1.0 billion in 1993. Also, trade receivables sold to Asset Securitization Cooperative Corporation were $313 million less in 1994 compared with 1993. Higher dealer demand for farm and construction equipment in 1994 resulting in higher receivables compared with 1993 also lowered cash from operating activities. Finally, rate refund payments of approximately $250 million were made to pipeline\ncustomers in 1994. The working capital increase of $587 million for 1994 resulted primarily from the reduction of the pipeline rate refund liability of approximately $250 million and lower tax accruals of $255 million. The lower tax accruals resulted from the utilization of capital losses related to the sale of assets.\nINVESTING ACTIVITIES\nNet cash used by investing activities in 1994 was $117 million, compared with $338 million in 1993. Net proceeds from the sale of businesses and assets were $860 million in 1994, primarily due to the initial and secondary public offerings of Case for $694 million. Net proceeds from the sale of businesses in 1993 of $266 million resulted from the sales of Dean Pipeline, Viking Pipeline, Sperry Marine, and various international aluminum ventures. (Reference is made to Note 3, \"Discontinued Operations, Disposition of Assets and Extraordinary Loss,\" in the \"Notes to Financial Statements\" for additional information.)\nExpenditures for plant, property and equipment from continuing operations for 1994 were $736 million, compared with $525 million for 1993. Increased expenditures for natural gas pipelines ($161 million), automotive parts ($20 million), packaging ($42 million) and other ($13 million) were partially offset by declines for farm and construction equipment ($18 million) and shipbuilding ($7 million). (See Note 15, \"Segment and Geographic Area Information\" in the \"Notes to Financial Statements\" for a complete breakdown of capital expenditures by operating segment.)\nFINANCING ACTIVITIES\nCash used for financing activities for 1994 was $151 million compared with $1,166 million in 1993. In June 1994, as part of the Case reorganization and IPO, Case borrowed $983 million of term loans and $478 million of short-term debt to acquire the net assets of Tenneco's farm and construction equipment segment. Tenneco utilized these funds to repay long-term debt. As a result of the November 1994 secondary public offering which reduced Tenneco's ownership in Case to approximately 44%, Case's debt is no longer consolidated with Tenneco's debt on the balance sheet at December 31, 1994, due to reporting Case on the equity method of accounting.\nIn December 1994, Tenneco sold a 25 percent preferred stock interest in a subsidiary which resulted in net cash proceeds of $296 million. This was included in minority interest in the balance sheet at December 31, 1994. Concurrently, $160 million was used to retire equity securities of another subsidiary which had been included in the balance sheet as minority interest. (Reference is made to Note 11, \"Minority Interest,\" in the \"Notes to Financial Statements\" for additional information.)\nCAPITALIZATION\nCapitalization totaled $7.48 billion at December 31, 1994, a decrease of $1.51 billion from December 31, 1993. The ratio of total debt to capitalization decreased from 67.6 percent at December 31, 1993, to 55.0 percent at December 31, 1994. The ratio of total debt to capitalization was 52.9 percent at December 31, 1994, including the market value of the SECT shares, compared with 64.0 percent at December 31, 1993. Total debt declined by $1.96 billion from December 31, 1993 to December 31, 1994, while stockholders' equity increased $299 million. Minority interest increased $167 million and preferred stock decreased $16 million.\nFERC MATTERS\nTennessee has deferred certain costs associated with renegotiating gas supply contracts as a result of FERC Order 636 (\"GSR costs\"). The amount to be recovered from its customers is approximately $177 million, net of $187 million previously collected subject to refund, at December 31, 1994. Proceedings have commenced to review the recovery of these GSR costs; however, the FERC has also generally encouraged pipelines to settle such issues through negotiations with customers. Although Order 636 contemplates complete recovery by pipelines of qualified transition costs, Tennessee has initiated settlement discussions with its customers concerning the amount of recoverable GSR costs in response to recent FERC and customer statements acknowledging the desirability of such settlements. Tennessee is also engaged in separate settlement and contract reformation discussions with holders of certain gas purchase contracts who have sued Tennessee, although Tennessee believes that its defenses in the underlying gas purchase contract actions are meritorious.\nIn connection with Tennessee's GSR cost recovery, Tennessee, along with three other pipelines executed four separate settlement agreements with Dakota Gasification Company and the U.S. Department of Energy and initiated four separate proceedings at the FERC seeking approval to implement the settlement agreements. The settlement resolved litigation concerning purchases made by Tennessee of synthetic gas produced from the Great Plains Coal Gasification plant (\"Great Plains\"). On October 18, 1994, the FERC consolidated the four proceedings and set them for hearing before an administrative law judge who is to issue his initial decision by December 31, 1995. The FERC has committed to a final order by December 31, 1996. The FERC order stated that the costs related to the Great Plains project are eligible for recovery through GSR and other special recovery mechanisms and that the costs are eligible for recovery for the duration of the term of the original gas purchase agreements. The hearing will be limited to the issue of whether the settlement agreements are prudent.\nAlso in connection with Tennessee's GSR cost recovery proceedings, on October 14, 1993, Tennessee was sued in the State District Court of Ector County, Texas, by ICA Energy, Inc. (\"ICA\") and TransTexas Gas Corporation (\"TransTexas\"). In that suit, ICA and TransTexas contended that Tennessee had an obligation to purchase gas production which TransTexas thereafter attempted to add unilaterally to the reserves originally dedicated to a 1979 gas contract. On two subsequent occasions, TransTexas gave Tennessee notice that it was adding new production and\/or acreage \"to the contract.\" An amendment to the pleadings seeks $1.5 billion from Tennessee for alleged damages caused by Tennessee's refusal to purchase gas produced from the TransTexas leases covering the new production and lands. Neither ICA nor TransTexas were original parties to that contract. However, they contend that any stranger acquiring a fractional interest in the original committed reserves thereby obtains a right to add to the contract unlimited volumes of gas production from locations in South Texas. Tennessee believes it has meritorious defenses to the claims of ICA and TransTexas, which defenses it will vigorously assert.\nGiven the uncertainty over the results of ongoing discussions between Tennessee and its customers related to the recovery of GSR costs and the uncertainty related to predicting the outcome of its gas purchase contract reformation efforts and the associated litigation, Tenneco is unable to predict the timing or the ultimate impact the resolution of these issues will have on its consolidated financial position or results of operations.\nFollowing issuance of the final order by the FERC approving Tennessee's partial settlement of its 1991 rate case, Tennessee has made refunds to its customers of approximately $200 million in February 1995 related to rates collected since September 1, 1993 to October 31, 1994. (See Note 6, \"Federal Energy Regulatory Commission (\"FERC\") Regulatory Matters,\" in the \"Notes to Financial Statements\" for additional information.)\nENVIRONMENTAL MATTERS\nExpenditures for ongoing compliance with environmental regulations that relate to current operations are expensed or capitalized as appropriate. Expenditures that relate to an existing condition caused by past\noperations and that do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments indicate that remedial efforts are probable and the costs can be reasonably estimated. Estimates of the liability are based upon currently available facts, existing technology, and presently enacted laws and regulations taking into consideration the likely effects of inflation and other societal and economic factors. All available evidence is considered, including prior experience in remediation of contaminated sites, other companies' cleanup experience, and data released by the United States Environmental Protection Agency (\"EPA\") or other organizations. These liabilities are included in the balance sheet at their undiscounted amounts. Recoveries are evaluated separately from the liability and, when recovery is assured, are recorded separately from the associated liability in the financial statements.\nTennessee is a party in proceedings involving federal and state authorities regarding the past use by Tennessee of a lubricant containing polychlorinated biphenyls (\"PCBs\") in its starting air systems.\nTennessee has executed a consent order with the EPA governing the remediation of its compressor stations in Regions IV, V and VI. With respect to the stations in Regions II and III, EPA has advised Tennessee that it is deferring to the Pennsylvania and New York environmental agencies to specify the remediation requirements applicable to Tennessee. Tennessee anticipates that it will soon reach an agreement with the Pennsylvania Department of Environmental Resources (\"PaDER\") and will enter into a consent order on remediation at the Pennsylvania stations (under which Tennessee also agrees to pay a civil penalty and to make a contribution for environmental projects); meanwhile, Tennessee will continue its negotiations with the New York Department of Environmental Conservation on remediation at the New York stations. Tenneco believes that the ultimate resolution of this matter will not have a material adverse effect on the financial condition or results of operations of Tenneco Inc. and its consolidated subsidiaries. (See Note 6, \"Federal Energy Regulatory Commission (\"FERC\") Regulatory Matters\" in the \"Notes to Financial Statements\" for additional information.)\nA subsidiary of Tennessee owns a 13.2% general partnership interest in Iroquois Gas Transmission System, L.P. (\"Iroquois\"), which owns an interstate natural gas pipeline from the Canadian border through the states of New York and Connecticut to Long Island. The operator of the pipeline is Iroquois Pipeline Operating Company (\"the Operator\"), a subsidiary of TransCanada Pipelines, Ltd., an affiliate of TransCanada Iroquois, Ltd. which is also a partner in Iroquois.\nIn early 1992, Iroquois was informed by U.S. Attorney's Offices for the Northern, Southern, and Eastern Districts of New York that a civil investigation had been initiated to determine whether civil environmental violations occurred during construction of the pipeline. In February 1992, 26 alleged violations were identified to Iroquois in writing. In response, Iroquois denied that such violations had occurred and asserted that all concerns raised by governmental authorities during construction had been fully addressed. Iroquois subsequently was informed that the alleged violations included certain field reports prepared by a Federal\/State Inter-Agency Task Force which surveyed the right-of-way in connection with the right-of-way restoration program. Iroquois responded to the appropriate U.S. Attorneys' Offices that none of the matters referenced in field reports issued to date represent violations of any law or governmental authorization. As of March 28, 1995, no proceedings in connection with this civil investigation have been commenced against Iroquois by the federal government.\nOn December 3, 1993, Iroquois received notification from the Enforcement Staff of the Federal Energy Regulatory Commission's Office of the General Counsel (\"Enforcement\") that Enforcement has commenced a preliminary, non- public investigation concerning the construction of certain of Iroquois' pipeline facilities. That office has requested certain information regarding such construction. In addition, on December 27, 1993, Iroquois received a similar request for information from the Army Corps of Engineers requesting certain information regarding permit compliance in connection with certain aspects of the pipeline's construction. By a notice issued on February 6, 1995, the Public Service Commission of the State of New York (the \"NYPSC\") also has requested Iroquois to respond to certain allegations set out in a petition filed by GASP\nCoalition and Anne Marie Mueser in January 1995 with the NYPSC requesting an investigation by the NYPSC of aspects of the construction of the pipeline. Iroquois has been evaluating and responding to these agencies' requests for information. No proceedings have been commenced against Iroquois in connection with these agency inquiries.\nA criminal investigation relating to the construction of the pipeline facilities has been initiated by the U.S. Attorney's Office for the Northern District of New York in conjunction with the EPA and the Federal Bureau of Investigation (\"FBI\"). According to a press release issued by the FBI in June 1992, areas under investigation include possible environmental violations, wire fraud, mail fraud and providing false information or concealment of information from federal agencies in conjunction with construction of the pipeline. While no criminal charges have been filed to date, counsel for Iroquois and counsel for the Operator have met with the Assistant U.S. Attorney in charge of the investigation and plan to meet with him again in the near future in order to discuss the issues under investigation and to explore the possibility of a negotiated resolution of the issues raised in the criminal, civil and administrative inquiries (a \"global resolution\"). In the absence of a negotiated resolution, Iroquois deems it probable that the U.S. Attorney will seek indictments and, in them, substantial fines and other sanctions.\nAs a general partner, Tennessee's subsidiary may be jointly and severally liable with the other partners for the liabilities of Iroquois. Tennessee has a contract to provide gas dispatching as well as post-construction field operation and maintenance services for the Operator of Iroquois, but Tennessee is not the Operator and is not an affiliate of the Operator. Moreover, the foregoing proceedings and investigations have not affected pipeline operations. Based upon information available to Tennessee at March 28, 1995, Tennessee believes that neither Tennessee nor any of its subsidiaries is a target of the criminal investigation described above. Further, while a global resolution of these inquiries could have a material adverse effect on the financial condition of Iroquois, Tennessee believes that the ultimate resolution of these matters will not have a material adverse effect on the financial condition or results of operations of Tenneco Inc. and its consolidated subsidiaries.\nAt December 31, 1994, Tenneco has been designated as a potentially responsible party in 66 \"Superfund\" sites. With respect to its pro rata share of the remediation costs of certain sites, Tenneco is fully indemnified by third parties. With respect to certain other sites, Tenneco has sought to resolve its liability through payments to the other potentially responsible parties. For the remaining sites, Tenneco has estimated its share of remediation costs to be between $13 million and $72 million or 0.4% to 2.2% of the total remediation costs for those sites and has provided reserves that it believes are adequate for such costs. Because the cleanup costs are estimates and are subject to revision as more information becomes available about the extent of remediation required, Tenneco's estimate of its share of remediation costs could change. Moreover, liability under the Comprehensive Environmental Response, Compensation and Liability Act is joint and several, meaning that Tenneco could be required to pay in excess of its pro rata share of remediation costs. Tenneco's understanding of the financial strength of other potentially responsible parties has been considered, where appropriate, in Tenneco's determination of its estimated liability. Tenneco believes that the costs associated with its current status as a potentially responsible party in the Superfund sites described above will not be material to its consolidated financial position or results of operations. (For further information, reference is made to Note 17, \"Commitments and Contingencies--Environmental Matters,\" in the \"Notes to Financial Statements.\" )\nCREDIT AGREEMENTS\nIn November 1994, Tenneco entered into a five-year $1.6 billion credit agreement with banks to replace a $1.4 billion credit agreement that would otherwise have terminated in December 1995. With this new credit agreement, Tenneco and its consolidated subsidiaries had, at December 31, 1994, committed credit agreements providing for $2,088 million of borrowing capacity. Of these facilities, $2.0 billion are committed through 1999. As of December 31, 1994, $34 million of borrowings were outstanding under these facilities,\nand the remaining $2,054 million was available for borrowing. The availability of borrowings under Tenneco's credit agreements and facilities is subject to its ability at the time to meet certain specified conditions, which Tenneco believes it currently meets. These conditions include compliance with the financial covenants and ratios required by such agreements, absence of default under such agreements, and continued accuracy of the representations and warranties contained in such agreements (including the absence of any material adverse changes since the specified dates).\nABILITY TO PAY DIVIDENDS\nAs a holding company, Tenneco Inc.'s ability to pay dividends is substantially dependent upon the cash flow from its subsidiaries by way of dividends, distributions, loans and other advances. Under the most restrictive of their covenants, however, Tenneco Inc.'s subsidiaries would have been able to pay $2.9 billion of their retained earnings as dividends to Tenneco Inc. at December 31, 1994.\nDividends may be paid by Tenneco Inc. out of \"surplus\" (as defined by applicable corporate law) or, if there is not a surplus, out of net profits for the year in which the dividends are declared or out of net profits for the preceding fiscal year. At December 31, 1994, Tenneco Inc. had a surplus of at least $1.9 billion available for the payment of dividends.\nTenneco Inc. is a party to credit agreements containing provisions that limit the amount of dividends paid on its common stock. At December 31, 1994, under the most restrictive provisions contained in these credit agreements, Tenneco Inc. had in excess of $900 million available for the payment of dividends.\nLIQUIDITY\nBased upon Tenneco's estimates of anticipated needs and circumstances of business operations, together with anticipated market conditions and including any payments associated with the settlement of the GSR issues discussed below, Tenneco expects adequate sources of funds to be available to finance its future operations through internally generated funds, the sale of assets, the use of credit facilities, and the issuance of other long-term securities.\nTo minimize the cash flow requirements associated with the implementation of the FERC Order 636 and the resolution of the GSR costs issues, Tenneco plans to have available, if required, various financing arrangements to manage the timing between recovery from pipeline customers and payments for transition costs. The actual cash flows will depend upon negotiations between Tennessee, its customers and suppliers, and developments in the restructuring proceedings with the FERC as Order 636 undergoes clarification and judicial review.\nYEARS 1993 AND 1992\nRESULTS OF OPERATIONS\nREVENUES\nRevenues for 1993 were $12.29 billion, up slightly from $12.14 billion in 1992. An increase in natural gas pipeline revenues, up $679 million due to higher gas volumes, was offset by decreased revenues in all other divisions except automotive parts where revenues were slightly ahead of 1992. Shipbuilding reported a $404 million decrease in revenues due to a declining backlog as a result of reductions in defense spending. Revenues for farm and construction equipment were down $81 million primarily due to weak construction and agricultural equipment markets in Europe. Revenues also decreased for packaging, down $36 million due to lower commodity prices.\nINCOME (LOSS) BEFORE INTEREST EXPENSE, INCOME TAXES AND MINORITY INTEREST (OPERATING INCOME OR LOSS)\nOperating income for 1993 was $1,097 million, an improvement of $210 million over 1992, excluding gains of $112 million from 1993 disposition of assets and investments and the 1992 farm and construction\nequipment restructuring charge of $920 million. In 1992, Tenneco recorded a pre-tax restructuring charge of $920 million ($843 million after tax or $5.85 per average common share) for the farm and construction equipment group. (Reference is made to Note 16 \"Restructuring Costs\" and Note 3 \"Discontinued Operations, Disposition of Assets and Extraordinary Loss\" in the \"Notes to Financial Statements\" for additional information.)\nNatural gas pipelines operating income for 1993 was $411 million compared with $360 million in 1992. Revenues increased to $2,862 million in 1993 from $2,183 million in 1992 due primarily to higher gas volumes as a result of the acquisition in December 1992 of EnTrade Corporation, a natural gas marketing firm. Transportation volumes increased due to a return to normal weather and increased market demand. Partially offsetting these revenue increases were higher gas purchase costs, higher depreciation relating to capital additions placed in service in late 1992 and increased pipeline maintenance expenses. The 1993 operating income includes $31 million in gains on asset sales and $34 million from a favorable rate decision that allows collection from customers of the transition obligation that was established at the time Tenneco adopted FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" These gains were partially offset by a reserve of $10 million established for gas costs as well as by litigation settlements related to divested operations and a one-time expense related to a gas inventory charge.\nFarm and construction equipment reported operating income of $82 million in 1993, a $342 million improvement over the $260 million operating loss in 1992, excluding the restructuring charge of $920 million. The $342 million improvement in 1993 results (excluding the restructuring charge) came despite a $81 million drop in revenues compared to the prior year. The decreased revenues were driven by continued weakness in European markets and loss of sales from products discontinued under the Case restructuring programs. Lower worldwide sales volumes in 1993 were more than offset by savings in several critical operating areas. Improved price realization was the major profit driver as Case continued its value-based pricing strategy of lower discounts and higher pricing. The company-wide focus on operating cost reductions and manufacturing performance improvements also contributed to 1993 results.\nAutomotive parts operating income for 1993 declined $15 million to $222 million compared with $237 million in 1992. Revenues were slightly ahead of 1992. Higher revenues were led by an increase in North American original equipment sales relating to Walker exhaust products and Monroe ride control products due to increased new car and light truck production. North American exhaust aftermarket sales were also up. Offsetting the increased revenues were lower revenues in European original equipment and aftermarkets due to the continuing recession in Europe and lower sales in the North American ride control aftermarket due to sluggish demand and stiff price competition. Improvements in 1993 operating income from the higher North American original equipment market and aftermarket exhaust revenues, combined with aggressive cost management and quality program initiatives, were more than offset by the effects of the weaker North American ride control aftermarket conditions, unfavorable foreign exchange rates and the recessionary conditions in Europe.\nShipbuilding's 1993 operating income was $225 million compared with $249 million in 1992. Revenues decreased $404 million in 1993 due to a declining backlog resulting from lower defense spending. The 1993 operating income included a $15 million gain on the sale of the Sperry Marine business and a $12 million benefit from the recognition of the recovery of a portion of the postretirement benefit costs reserve that was established when FAS No. 106 was adopted in 1992. Excluding the gain on the sale of the Sperry Marine business and the recovery of a portion of the postretirement benefit costs, operating income decreased from 1992 due to the declining backlog. Partially offsetting the lower operating income were the effects of several management initiatives undertaken in 1993 and 1992, which included headcount reductions and organization changes that improved operating efficiencies.\nPackaging ended the year with $139 million in operating income, down from $221 million in 1992. Revenues decreased only slightly by $36 million, as higher containerboard volumes were more than offset by\nlower linerboard prices which fell from an average price of approximately $345 per ton in 1992 to an average price of $295 per ton in 1993. Earnings were depressed by weak linerboard and paperboard prices in the commodity business where profitability fell from $134 million in 1992 to $38 million in 1993. The specialty businesses ended the year at $101 million in operating income, which included gains from asset sales, partially offset by asset realignment costs, of $26 million, versus operating income of $87 million for 1992, in spite of extreme pricing pressures in molded fiber markets. Offsetting some of the pricing and market conditions were operating cost reductions and favorable purchasing initiatives.\nTenneco's other operations reported operating income of $18 million for 1993, compared to a loss of $32 million in 1992. The improvement was primarily attributable to the gain of $39 million from the contribution of Tenneco's investment in Cummins Engine Company of 3.2 million shares of common stock to the Case Corporation Pension Plan for Hourly-Paid Employees (\"Case Plan\") in December 1993.\nINTEREST EXPENSE (NET OF INTEREST CAPITALIZED)\nNet interest incurred declined $69 million, from $496 million in 1992 to $427 million in 1993, due primarily to lower debt levels from the retirement of $1.0 billion in debt with the proceeds of the April 1993 equity offering. Interest capitalized decreased to $4 million in 1993 from $5 million in 1992 due to lower levels of major capital projects. Finance charges (interest expense related to finance subsidiaries classified as an operating expense) were $254 million in 1993 versus $364 million in 1992. The lower expense was due to lower average debt levels primarily due to the retirement of $1.0 billion of Tenneco's finance subsidiaries' debt with proceeds from the issuance of lower- cost asset backed securities as well as lower interest rates.\nINCOME TAXES\nIncome tax expense for 1993 was $257 million versus $73 million reported for 1992. The increased tax expense in 1993 was attributable to higher pre-tax income and the increase in the U.S. corporate tax rate from 34 percent to 35 percent. Partially offsetting these increases was a $48 million tax benefit from a tax realignment of Tenneco's operations in Germany and a lower level of unbenefitted foreign losses.\nDISCONTINUED OPERATIONS AND EXTRAORDINARY LOSS\nExtraordinary loss for 1993 of $25 million, net of income tax benefit of $13 million, or 15 cents per average common share, and for 1992 of $12 million, net of income tax benefit of $6 million, or 8 cents per average common share, were attributable to redemption premiums related to the prepayment of higher interest-bearing long-term debt.\nIncome from discontinued operations in 1993 of $38 million, net of income tax expense of $1 million, or 23 cents per average common share, was attributable to the sales of Tenneco's brakes business and chemical operations in 1994. Net loss for 1993 for the brakes business was $7 million, net of income tax benefit of $4 million. Net income for the chemicals business was $45 million, net of income tax expense of $5 million.\nIncome from discontinued operations in 1992 of $102 million, net of income tax expense of $49 million, or 72 cents per average common share, was attributable to the sales of Tenneco's minerals and pulp chemicals businesses in 1992, and brakes and chemicals businesses in 1994. The sales of businesses resulted in a $96 million gain, net of $45 million income tax expense, from the sale of the minerals business, and a $25 million loss from the sale of the pulp chemicals business (no tax effect). Net income for 1992 from minerals operations was $3 million, net of income tax expense of $3 million. Net loss from the brakes business was $7 million, net of income tax benefit of $5 million, and net income from the chemicals operations, including the pulp chemicals business, was $35 million, net of income tax expense of $6 million. (Reference is made to Note 3, \"Discontinued Operations, Disposition of Assets and Extraordinary Loss,\" in the \"Notes to Financial Statements\" for additional information.)\nCUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES\nEffective January 1, 1992, Tenneco elected early adoption of FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" for its domestic operations and FAS No. 109, \"Accounting for Income Taxes.\" Both standards were adopted using the cumulative catch-up method. As a result of the adoption of these two statements, the 1992 Statement of Income (Loss) included an after-tax charge of $699 million, or $4.86 per average common share, for the cumulative effect of the accounting changes consisting of $414 million, or $2.88 per average common share, for FAS No. 106, and $285 million, or $1.98 per average common share, for FAS No. 109.\nEARNINGS (LOSS) PER AVERAGE COMMON SHARE\nIncome from continuing operations for 1993 was $413 million, or $2.36 per average common share after preferred dividends, compared with a loss from continuing operations of $714 million, or $5.07 per average common share after preferred dividends in 1992. Net income to common stock was $412 million, or $2.44 per average common share in 1993, versus a net loss to common stock of $1.34 billion, or $9.29 per average common share in the prior year. Included in the 1993 net income (loss) to common stock was income from discontinued operations of $38 million, or 23 cents per average common share and an extraordinary loss of $25 million, or 15 cents per average common share. Included in 1992 net income (loss) to common stock was income from discontinued operations of $102 million, or 72 cents per average common share, the extraordinary loss of $12 million, or 8 cents per average common share and a charge of $699 million, or $4.86 per average common share relating to the cumulative effect of changes in accounting principles. The 1992 loss from continuing operations of $5.07 per average common share included an after-tax restructuring charge of $5.85 per average common share. Preferred stock dividends were $14 million for 1993 and $16 million for 1992.\nAverage shares outstanding used for the calculation of earnings per average common share for 1993 were 168.8 million compared to 144.1 million in 1992, excluding the SECT shares. The increase was primarily attributable to the 23.5 million shares issued in the April 1993 underwritten public offering and the issuance of treasury shares and SECT shares to employee benefit plans.\nLIQUIDITY AND CAPITAL RESOURCES\nNet cash provided by operating activities was $1,615 million for the year 1993 compared to $929 million for 1992, an increase of $686 million. Excluding discontinued operations, there was an improvement of $673 million. This improvement was due primarily to higher income from continuing operations and the sale of approximately $1.0 billion of Case retail receivables to limited purpose business trusts, which issued asset backed securities to the public in 1993. Partially offsetting these improvements were increased refunds to customers in final settlement of the collection of take-or-pay costs. The variance of the information reflected in the \"Other\" category is due primarily to the reserves established in 1992 for restructuring measures. The working capital decrease of $475 million for 1993 was due primarily to the sale of receivables to limited purpose business trusts, which issued asset backed securities to the public. Partially offsetting the decrease is the reduction in taxes payable due to higher state tax payments associated with shipbuilding contract completions and tax deductions associated with the early funding of the Case Plan through the contribution of Tenneco's investment in Cummins Engine Company to the pension plan.\nNet cash used by investing activities in 1993 was $338 million compared to $105 million of cash provided in 1992. Net proceeds (expenditures) from the sale of discontinued operations were $663 million lower in 1993, primarily due to the sale of Tenneco's minerals and pulp chemicals operations in 1992. This was partially offset by proceeds from the sale of businesses in 1993 of $266 million, primarily the sales of Dean Pipeline Company and Viking Gas Transmission Company, shipbuilding's Sperry Marine business, several packaging operations, and facilities and land of two foreign Case operations. (Reference is made to Note 3, \"Discontinued Operations, Disposition of Assets and Extraordinary Loss,\" in the \"Notes to Financial Statements\" for additional information on cash provided by these investing activities.)\nExpenditures for plant, property and equipment from continuing operations for 1993 were $525 million compared to $507 million for 1992. Increased expenditures for automotive parts ($31 million), farm and construction equipment ($41 million) and packaging ($27 million) were basically offset by declines for natural gas pipelines ($81 million).\nCapitalization totaled $8.99 billion at December 31, 1993, a decrease of $792 million from December 31, 1992. The resulting ratio of total debt to capitalization dropped from 82.8 percent to 67.6 percent. The total debt to capitalization ratio was 64.0 percent including the market value of the SECT shares compared to 78.8 percent at December 31, 1992. The major changes in capitalization were: total debt down $2.02 billion, stockholders' equity up $1.27 billion and preferred stock down $28 million. The increase in stockholders' equity was primarily due to the issuance of 23.5 million shares of common stock in the April 1993 underwritten public offering, the proceeds of which were used to retire debt and redeem variable rate preferred stock. The remaining decrease in debt resulted from the issuance of asset backed securities.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEX TO FINANCIAL STATEMENTS OF TENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Tenneco Inc.:\nWe have audited the accompanying balance sheets of Tenneco Inc. (a Delaware corporation) and consolidated subsidiaries as of December 31, 1994 and 1993, and the related statements of income (loss), cash flows and changes in stockholders' equity for each of the three years in the period ended December 31, 1994. These financial statements and the schedules referred to below are the responsibility of Tenneco'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 Tenneco Inc. and consolidated subsidiaries as of December 31, 1994 and 1993, and the results of their operations, cash flows and changes in stockholders' equity for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs more fully discussed in Note 6 to the financial statements, Tennessee Gas Pipeline Company is a party to litigation, the outcome of which impacts its ongoing customer settlement discussions over the recoverability of its contract reformation costs. The ultimate outcome of the litigation and the extent of its recoverability cannot be presently determined. Accordingly, no provisions for the resolution of these matters have been made in the accompanying financial statements.\nAs discussed in Note 1 to the financial statements, effective January 1, 1994, Tenneco changed its method of accounting for postemployment benefits. Also as discussed in Note 1 to the financial statements, effective January 1, 1992, Tenneco changed its methods of accounting for income taxes and 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 index to Part IV, Item 14 relating to Tenneco Inc. and consolidated subsidiaries are presented for purposes of complying with the Securities and Exchange Commission's rules and are not 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 of Tenneco Inc. and consolidated subsidiaries taken as a whole.\nArthur Andersen LLP\nHouston, Texas February 16, 1995\nThe accompanying notes to financial statements are an integral part of these statements of cash flows.\nReference is made to Note 1 for definitions of \"Tenneco Industrial\" and \"Tenneco Finance.\"\nNote: Cash and temporary cash investments include highly liquid investments with a maturity of three months or less at date of purchase.\nStatements of Changes in Stockholders' Equity\nThe accompanying notes to financial statements are an integral part of these statements of changes in stockholders' equity.\nNotes to Financial Statements\n1. Summary of Accounting Policies\nConsolidation and Presentation\nThe financial statements of Tenneco Inc. and consolidated subsidiaries (\"Tenneco\") include all majority-owned subsidiaries including wholly-owned finance subsidiaries. Companies in which at least a 20% to a 50% voting interest is owned are carried at cost plus equity in undistributed earnings since date of acquisition (except for Tenneco's Farm and construction equipment segment as noted below) and cumulative translation adjustments. At December 31, 1994, equity in undistributed earnings (losses) and cumulative translation adjustments amounted to $154 million and $(29) million, respectively; at December 31, 1993, the corresponding amounts were $(57) million and $(10) million, respectively.\nReference is made to Note 8, \"Investment in Affiliated Companies,\" for summarized financial information of Tenneco's proportionate share of 50% or less owned companies accounted for by the equity method of accounting.\nIn June 1994, Tenneco completed an initial public offering (\"IPO\") of approximately 29% of the common stock of Case Corporation (\"Case\"), the holder of Tenneco's Farm and construction equipment segment. In November 1994, a secondary offering of Case's common stock reduced Tenneco's ownership to approximately 44%. From January through November, Case's financial statements were fully consolidated with Tenneco's. From July through November, the financial statements reflected the 29% minority stockholders' interest in Case. Subsequent to November, Case was reflected in Tenneco's financial statements using the equity method of accounting. For further information on this subject, reference is made to Note 3, \"Discontinued Operations, Disposition of Assets and Extraordinary Loss.\"\nThe accompanying financial statements also include, on a separate and supplemental basis, the combination of Tenneco's industrial companies and finance companies as follows:\nTenneco Industrial--The financial information captioned \"Tenneco Industrial\" reflects the consolidation of all majority-owned subsidiaries except for the finance subsidiaries. The finance operations have been included using the equity method of accounting whereby the net income and net assets of these companies are reflected, respectively, in the income statement caption, \"Equity in net income of affiliated companies,\" and in the balance sheet caption, \"Investment in affiliated companies.\"\nTenneco Finance--The financial information captioned \"Tenneco Finance\" reflects the combination of Tenneco's wholly-owned finance subsidiaries.\nPrior to the Case IPO, the wholesale (dealer) credit and retail credit operations of Case were financed by wholly-owned finance subsidiaries. Subsequent to the IPO, the wholesale (dealer) credit operations are being financed by industrial subsidiaries. As a result of this change, interest expense related to the wholesale (dealer) credit operations has been reported as \"Interest expense\" rather than \"Finance charges--Tenneco Finance\" as in prior periods. If prior periods were reclassified to reflect this prospective presentation of interest expense related to wholesale (dealer) credit operations, consolidated \"Finance charges--Tenneco Finance\" would have been reduced and \"Interest expense\" would have increased by $22 million, $69 million and $123 million for 1994, 1993 and 1992, respectively, with no effect on consolidated net income. At December 31, 1993, this change would have increased receivables and debt of Tenneco Industrial by $1.5 billion, with no effect on the consolidated balance sheet.\nAll significant intercompany transactions, including activity within and between the \"Tenneco Industrial\" and \"Tenneco Finance\" business units, have been eliminated.\nGains or losses on the sale by a subsidiary of its stock are included in the Statements of Income (Loss).\nEnvironmental Liabilities\nExpenditures for ongoing compliance with environmental regulations 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 environmental assessments indicate that remedial efforts are probable and the costs can be reasonably estimated. Estimates of the liability are based upon currently available facts, existing technology and presently enacted laws and regulations taking into consideration the likely effects of inflation and other societal and economic factors. All available evidence is considered including prior experience in remediation of contaminated sites, other companies' clean-up experience and data released by the Environmental Protection Agency or other organizations. These liabilities are included in the\nbalance sheet at their undiscounted amounts. Recoveries are evaluated separately from the liability and, when recovery is assured, are recorded and reported separately from the associated liability in the financial statements.\nFor further information on this subject, reference is made to Note 17, \"Commitments and Contingencies--Environmental Matters.\"\nDepreciation and Amortization\nDepreciation of Tenneco's properties is provided on a straight-line basis in amounts which, in the opinion of management, are adequate to allocate the cost of properties over their estimated useful lives.\nThe excess of investment in subsidiaries over fair value of net assets at date of acquisition is being amortized over periods ranging from 15 years to 40 years. Such amortization relative to continuing operations amounted to $21 million, $15 million and $13 million for 1994, 1993 and 1992, respectively, and is included in the income statement caption, \"Other income, net.\"\nRevenue Recognition\nNewport News Shipbuilding and Dry Dock Company (\"Newport News\"), a wholly-owned subsidiary, reports profits on its long-term shipbuilding contracts on the percentage-of-completion method of accounting, determined on the basis of total costs incurred to date to estimated final total costs. Losses on contracts are reported when first estimated. The performance of contracts usually extends over several years, requiring periodic reviews and revisions of estimated final contract prices and costs during the term of the contracts. The effect of these revisions is included in income in the period the revisions are made.\nSales by Case to independent dealers are recorded at the time of shipment to those dealers. Sales through company-owned retail stores are recorded at the time of sale to retail customers. Case grants certain sales incentives to stimulate sales of the farm and construction equipment products to retail customers. The expense for such incentive programs is recorded at the time of sale.\nTenneco's other divisions recognize revenue on the accrual method when title passes to the customer or when the service is performed.\nRisk Management Activities\nTenneco has utilized financial instruments for many years to mitigate its exposure to various risks. Tenneco is currently a party to financial instruments to hedge its exposure to changes in interest rates, foreign currency exchange rates and natural gas prices. These activities are summarized in the following paragraphs.\nTenneco is a party to various interest rate swaps under which it has agreed with other parties to pay or receive, at specified intervals, the difference between fixed-rate and floating-rate interest amounts calculated by reference to agreed notional principal amounts. The amount paid or received under these agreements is recognized as an adjustment to interest expense.\nTenneco utilizes a combination of forward exchange contracts and currency\/interest rate swaps to hedge the translation effects of its net investment in certain foreign subsidiaries. The after-tax translation gains (losses) incurred are included in the balance sheet caption \"Cumulative translation adjustments.\" Various foreign currency purchase and sale contracts are also utilized to minimize the transaction effect in the income statement of exchange rate movement on receivables and payables denominated in foreign currencies. Tenneco identifies naturally occurring offsetting positions and then hedges residual exposures.\nTenneco also utilizes various financial instruments to hedge firm commitments and transactions associated with its natural gas business. Gains and losses related to hedges are recognized in income when the hedged transaction occurs. As of December 31, 1994 and 1993, Tenneco's deferred gains and losses associated with these transactions were not significant.\nChanges in Accounting Principles\nEffective January 1, 1994, Tenneco adopted Statement of Financial Accounting Standards (\"FAS\") No. 112, \"Employers' Accounting for Postemployment Benefits.\" This new accounting rule requires employers to account for postemployment benefits for former or inactive employees after employment but before retirement on the accrual basis rather than the \"pay-as-you-go\" basis. Tenneco recorded an after-tax charge of $39 million ($.22 per average common share) which was reported as a cumulative effect of change in accounting principle.\nTenneco elected early adoption of FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" for its domestic operations and FAS No. 109, \"Accounting for Income Taxes.\" Both standards were adopted effective January 1, 1992, using the cumulative catch-up method.\nUnder FAS No. 106, Tenneco is required to accrue the estimated costs of retiree benefits other than pensions (primarily health care benefits and life insurance) during the employees' active service period. Prior to 1992, Tenneco expensed the cost of these benefits as medical and insurance claims were paid. Tenneco will adopt the new standard for its non-U.S. plans in the first quarter of 1995 but does not expect that the adoption will have a material effect on Tenneco's consolidated financial position or results of operations.\nThe adoption of FAS No. 109 changed Tenneco's method of accounting for income taxes from the deferred method to the liability method. The liability method requires the recognition of deferred tax assets and liabilities for the future tax consequences of temporary differences between the financial statement basis and the tax basis of assets and liabilities.\nIn 1992, Tenneco recorded an after-tax charge of $699 million or $4.86 per average common share for the cumulative effect of the accounting changes consisting of $414 million or $2.88 per share for FAS No. 106 and $285 million or $1.98 per share for FAS No. 109.\nReference is made to Note 7, \"Income Taxes,\" and Note 13, \"Postretirement and Postemployment Benefits,\" for further information regarding these changes.\nInventories\nAt December 31, 1994 and 1993, inventory by major classification was as follows:\nA portion of domestic inventories are valued using the \"last-in, first-out\" method, which is not in excess of market. All other inventories are valued at the lower of cost (determined on the \"first-in, first-out\" (\"FIFO\") or \"average\" methods) or market based on estimated realizable value. If the FIFO or average method of inventory accounting had been used by Tenneco for all inventories, inventories would have been $54 million, $47 million and $57 million higher at December 31, 1994, 1993 and 1992, respectively.\nNotes Receivable\nShort-term notes receivable of $337 million and $1,359 million were outstanding at December 31, 1994 and 1993, respectively, of which $289 million and $1,299 million, respectively, related to Tenneco Finance. These notes receivable are presented net of unearned finance charges of $43 million and $96 million at December 31, 1994 and 1993, respectively, which related principally to Tenneco Finance. At December 31, 1994 and 1993, unearned finance charges related to long-term notes and other receivables were $66 million and $139 million, respectively, which related principally to Tenneco Finance.\nAllowance for Doubtful Accounts and Notes Receivable\nAt December 31, 1994 and 1993, the allowance for doubtful accounts and notes receivable was $48 million and $129 million, respectively, of which $42 million related to Tenneco Finance at December 31, 1993.\nRestrictions on the Payment of Dividends\nTenneco Inc. is a party to credit agreements containing provisions that limit the amount of dividends paid on its common stock. At December 31, 1994, under the most restrictive provisions contained in these credit agreements, Tenneco Inc. had in excess of $900 million available for the payment of dividends.\nAt December 31, 1994, Tennessee Gas Pipeline Company (\"Tennessee\"), a wholly-owned consolidated subsidiary, had retained earnings of $3,640 million of which $748 million was restricted as to the payment of dividends under certain of its notes and debentures. Also at December 31, 1994, Case, a 44% owned affiliate, had retained earnings of $83 million of which $72 million was restricted as to the payment of dividends pursuant to Case's revolving credit agreement. The payment of unrestricted amounts by such subsidiaries or affiliates would not affect the amount of retained earnings of Tenneco Inc. available for dividends on common stock.\nReclassifications\nPrior years' financial statements have been reclassified where appropriate to conform to 1994 presentations.\n2. Acquisitions\nOn October 6, 1994, Tenneco Inc. (hereinafter referred to as the \"Company\") announced that Tenneco Power Generation Company, a division of Tenneco Gas, signed a letter of intent to complete the acquisition of ARK Energy, Inc., for approximately $60 million in Tenneco Inc. common stock and other consideration. The acquisition is expected to be completed by midyear 1995. ARK Energy, Inc. is a privately-owned power generation company.\nOn November 30, 1994, the Company announced that its Tenneco Automotive subsidiary completed the acquisition of Heinrich Gillet GmbH & Company for $44 million in cash and $69 million in assumed debt. Heinrich Gillet GmbH & Company is the leading manufacturer of original equipment exhaust systems and components for European automakers.\n3. Discontinued Operations, Disposition of Assets and Extraordinary Loss\nDiscontinued Operations\nIn December 1994, the Company announced its intent to offer 100% of its Albright & Wilson chemicals segment in an IPO. The offering was underwritten in the United Kingdom and was offered primarily in the United Kingdom. Also in 1994, Tenneco sold its brakes operation.\nNet proceeds from the sale of the chemicals operations are expected to be $707 million when the sale is completed in early March 1995. Proceeds from the sale of the brakes operations were $18 million. The sales of these discontinued operations resulted in a loss of $170 million and $26 million, net of income tax expense (benefit) of $115 million and $(15) million, respectively.\nRevenues for the chemicals discontinued operations were $986 million, $914 million and $951 million for 1994, 1993 and 1992, respectively. Net income was $12 million, $45 million and $38 million, net of income tax expense of $9 million, $5 million and $8 million for 1994, 1993 and 1992, respectively. Net assets for the chemicals operations were $639 million and $558 million at December 31, 1994 and 1993, respectively.\nRevenues for the brakes discontinued operations were $62 million, $54 million and $45 million for 1994, 1993 and 1992, respectively. Net loss was $5 million, $7 million and $7 million, net of income tax benefit of $5 million, $4 million and $5 million for 1994, 1993 and 1992, respectively. Net assets of the brakes operations were $61 million at December 31, 1993.\nThe allocation of interest expense to discontinued operations is based on the ratio of net assets of discontinued operations to consolidated net assets plus debt. Interest expense, net of income tax, of $19 million, $19 million and $20 million was allocated to the chemicals operations and $2 million, $3 million and $3 million was allocated to the brakes operations for 1994, 1993 and 1992, respectively.\nDuring 1992, Tenneco sold its minerals and pulp chemicals operations for proceeds of $500 million and $202 million, respectively. The sales of these discontinued operations resulted in a gain (loss) of $96 million and $(25) million, net of income tax expense of $45 million and $0, respectively. Revenues for the minerals discontinued operations were $55 million for 1992. Net income was $3 million, net of income tax expense of $3 million for 1992. Revenues for the pulp chemicals discontinued operations were $54 million for 1992. Net loss was $3 million, net of income tax benefit of $2 million for 1992.\nInterest expense, net of income tax, of $5 million each was allocated to the minerals operations and the pulp chemicals operations for 1992.\nDisposition of Assets\nIn June 1994, Tenneco completed an IPO of approximately 29% of the common stock of Case. In November 1994, a secondary offering of Case common stock reduced Tenneco's ownership interest in Case to approximately 44%. Combined proceeds from the two transactions was $694 million, net of commissions and expenses. The combined gain on the transactions was $36 million, including a $7 million tax benefit.\nTenneco disposed of several other assets and investments during 1994 including a facility, machinery and equipment at its Packaging segment (\"PCA\") and facilities and equipment at Case. Proceeds from these dispositions were $125 million resulting in a pre-tax loss of $2 million.\nIn 1994, Tenneco Energy Resources Corporation, a subsidiary which operates non-regulated gas marketing and intrastate pipeline businesses, issued 50 shares of its common stock diluting Tenneco's ownership in this subsidiary to 80%. Cash proceeds were $41 million resulting in a gain of $23 million. No taxes were provided on the gain because management expects that the recorded investment will be recovered in a tax-free manner.\nDuring 1993, Tenneco disposed of a number of assets and investments including its Newport News' Sperry Marine business; several PCA operations; two wholly-owned pipeline companies, Viking Gas Transmission Company and Dean Pipeline Company; and facilities and land of two foreign Case operations. The proceeds from dispositions were $266 million and the pre-tax gain was $112 million.\nExtraordinary Loss\nIn June 1994, an extraordinary loss of $5 million was recorded, net of $2 million income tax benefit, for the redemption premium resulting from the prepayment of debt.\nIn April 1993, the Company issued 23.5 million shares of common stock for approximately $1.1 billion. The proceeds were used to retire $327 million of short-term debt, $688 million of long-term debt and $14 million of variable-rate preferred stock. In November 1993, Tenneco retired DM250 million bonds. The redemption premium related to the retirement of long-term debt resulting from these two transactions ($25 million, net of income tax benefits of $13 million) was recorded as an extraordinary loss.\nIn December 1992, Tenneco deposited cash with a trustee to defease $310 million of its high interest-bearing long-term debt. Accordingly, this amount was excluded from long-term debt on the balance sheet at December 31, 1992. This debt was prepaid in January and February 1993. In November 1992, Tenneco also prepaid $71 million of high interest-bearing long-term debt related to an investment in a partnership. Tenneco recorded an extraordinary loss of $12 million (net of income tax benefits of $6 million) for the redemption premium resulting from these transactions.\n4. Long-Term Debt, Short-Term Debt and Financing Arrangements\nLong-Term Debt\nA summary of long-term debt outstanding at December 31, 1994 and 1993, is set forth in the following table:\nNote: (a) These notes were prepaid as part of the actions taken pursuant to the Case IPO.\nAt December 31, 1994 and 1993, approximately $154 million and $272 million, respectively, of gross plant, property and equipment was pledged as collateral to secure $31 million and $34 million, respectively, principal amounts of long- term debt.\nThe aggregate maturities and sinking fund requirements applicable to the issues outstanding at December 31, 1994, are $493 million, $437 million, $518 million, $843 million and $256 million for 1995, 1996, 1997, 1998 and 1999, respectively.\nShort-Term Debt\nInformation for the years ended December 31, 1994 and 1993, regarding short-term debt follows:\n* Includes borrowings under both committed and uncommitted lines of credit and similar arrangements. Tenneco had other short-term borrowings outstanding of $8 million at December 31, 1994.\nFinancing Arrangements\nAs of December 31, 1994, Tenneco and its subsidiaries had arranged total lines of credit of $2.2 billion, of which $2.1 billion are committed lines of credit as more fully described below:\nNotes: (a) Tenneco and its subsidiaries generally are required to pay commitment fees on the unused portion of the total commitment and facility fees on the total commitment.\n(b) Of the $2 billion lines of credit, $1.9 billion are committed through 1999 and $100 million expire on December 31, 1995. Since December 31, 1994, the $100 million lines of credit due to expire in 1995 have been replaced with $100 million which are committed through 1999. Of the total lines of credit, $300 million are available to both Tenneco Inc. and Tenneco Finance.\n5. Financial Instruments\nThe estimated fair values of Tenneco's financial instruments at December 31, 1994 and 1993, were as follows:\nThe following methods and assumptions were used to estimate the fair value of financial instruments:\nCash and Temporary Cash Investments--Fair value was considered to be the same as the carrying amount.\nReceivables--Tenneco believes that in the aggregate, the carrying amount of its receivables, both current and non-current, was not materially different from the fair value of those receivables. At December 31, 1994, the remainder of the United States retail receivables retained by Tenneco Credit Corporation when Tenneco transferred its Case assets to Case Equipment Corporation in June 1994 accounted for approximately 30% of total customer and long-term receivables; the Case Corporation 10 1\/2% Senior Subordinated Note due June 30, 2002, with a current carrying amount of $264 million accounts for an additional 10%. The Automotive parts segment (15%), Natural gas pipelines segment (11%) and Packaging segment (11%) accounted for the other significant concentrations. At December 31, 1993, approximately 75% of customer and long-term receivables were concentrated in the Farm and construction equipment segment.\nOther Investments--At December 31, 1994, these investments included preferred stock ($17 million) in Steerage Corporation (the acquiror of Newport News' Sperry Marine Business) and venture capital investments ($5 million). At December 31, 1993, these investments included preferred stock ($17 million) in Steerage Corporation and venture capital investments ($8 million). Because of the nature of these investments, it was not practicable to estimate their fair value.\nShort-Term Debt--Fair value was considered to be the same as the carrying amount.\nLong-Term Debt--The fair value of fixed-rate long-term debt was based on the market value of debt with similar maturities and interest rates; the carrying amount of floating-rate long-term debt was assumed to approximate its fair value.\nInterest Rate Swaps--The fair value of interest rate swaps was based on the cost that would have been incurred to buy out those swaps in a loss position and the consideration that would have been received to terminate those swaps in a gain position. At December 31, 1994 and 1993, Tenneco was a party to swaps with a notional value of $1.6 billion and $944 million, respectively, which were in a net payable position and $775 million for 1993 which were in a net receivable position. The amount paid or received on interest rate swap agreements was recognized as an adjustment to interest expense.\nConsistent with its overall policy, Tenneco uses these instruments from time to time only to hedge known, quantifiable risks arising from fluctuations in interest rates. The counterparties to these interest rate swaps are major international financial institutions. The risk associated with counterparty default on interest rate swaps is measured as the cost of replacing, at the prevailing market rates, those contracts in a gain position. In the event of non-performance by the counterparties, the cost to replace outstanding interest rate swaps at December 31, 1994 and 1993, would not have been material.\nForeign Currency Contracts--At December 31, 1994 and 1993, Tenneco was a party to currency\/interest rate swaps and foreign exchange forward contracts totaling $518 million and $133 million, respectively. These instruments hedge certain translation effects of Tenneco's investment in net assets in certain foreign countries, primarily Great Britain. Pursuant to these arrangements, Tenneco recognized aggregate after-tax translation gains (losses) of $(2) million, $5 million and $30 million for 1994, 1993 and 1992, respectively, which have been included in the balance sheet caption \"Cumulative translation adjustments.\"\nIn the normal course of business, Tenneco and its foreign subsidiaries routinely enter into various foreign currency purchase and sale contracts to hedge the transaction effect of exchange rate movements on receivables and payables denominated in foreign currencies. These contracts generally mature in one year or less. At December 31, 1994, Tenneco had net purchase contracts (primarily Australian Dollars, Belgian Francs, French Francs, Dutch Guilders, Danish Krone, Spanish Pesetas, Italian Lira and Swedish Krona) with a notional value of $278 million and net sale contracts (primarily Canadian Dollars, German Marks and British Pounds) with a notional value of $276 million. At December 31, 1993, Tenneco had net purchase contracts (primarily Belgian Francs, French Francs, Dutch Guilders, Danish Krone, Italian Lira and Swedish Krona) with a notional value of $308 million and net sale contracts (primarily Canadian Dollars, U.S. Dollars and British Pounds) with a notional value of $315 million. Based on exchange rates at December 31, 1994 and 1993, the cost of replacing these contracts in the event of non-performance by the counterparties would not have been material.\nSubsequent to the Case IPO and secondary offering, Tenneco has continued to perform certain administrative functions for Case, including certain foreign currency management activities. At December 31, 1994, Tenneco had net purchase contracts (primarily Canadian Dollars, Australian Dollars, Spanish Pesetas, German Marks and British Pounds) with a notional value of $152 million and net sale contracts (primarily U.S. Dollars) with a notional value of $152 million with Case which is now reflected in Tenneco's financial statements using the equity method of accounting.\nPrice Risk Management--Tenneco enters into short-term price swap agreements to hedge against the price risk associated with natural gas sales and supply contracts. Tenneco also\nhedges anticipated injections and withdrawals from gas storage expected to occur within a year. Consistent with its overall policy, Tenneco uses these instruments from time to time to mitigate quantifiable risks arising from fluctuations in gas prices. Tenneco had swap agreements to exchange monthly payments on notional quantities amounting to 70.2 Bcf and 19.3 Bcf as of December 31, 1994 and 1993, respectively. Based upon natural gas prices at December 31, 1994, Tenneco would be required to pay approximately $0.4 million related to these swap agreements. Tenneco is exposed to credit-related losses in the event of non-performance by counterparties to financial instruments. However, Tenneco believes that these counterparties will be able to fully satisfy their obligations under these contracts.\nGuarantees--At December 31, 1994 and 1993, Tenneco had guaranteed payment and performance of approximately $50 million and $95 million, respectively, primarily with respect to letters of credit and other guarantees supporting various financing and operating activities.\n--------------------------------------------------------------------------------\n6. Federal Energy Regulatory Commission (\"FERC\") Regulatory Matters\nRestructuring Proceedings\nPursuant to Order 636 issued by the FERC on April 8, 1992, Tennessee implemented revisions to its tariff which put into effect on September 1, 1993, the restructuring of its transportation, storage and sales services. Pursuant to the provisions of Order 636 allowing for the recovery of transition costs related to the restructuring, Tennessee has made filings to recover gas production costs related to its Bastian Bay facilities, the remaining balance of purchased gas (\"PGA\") costs, stranded transportation (\"TBO\") costs and gas supply realignment (\"GSR\") costs resulting from remaining gas purchase obligations.\nTennessee's filings to recover production costs related to its Bastian Bay facilities have been rejected by the FERC based on the continued use of the gas production from the field; however, the FERC recognized the ability of Tennessee to file for the recovery of losses upon disposition of these assets. Tennessee has filed for appellate review of the FERC actions and is confident that the Bastian Bay costs will ultimately be recovered as transition costs directly related to Order 636, and no FERC order has questioned the ultimate recoverability of these costs.\nThe filings implementing Tennessee's recovery mechanisms for the following transition costs were accepted effective September 1, 1993, and made subject to refund pending FERC review: 1) direct-billing of unrecovered PGA costs to its former sales customers over a twelve-month period, 2) recovery of TBO costs, which Tennessee is obligated to pay under existing contracts, through a surcharge from firm transportation customers, adjusted annually and 3) GSR cost recovery of 90% of such costs over a period of up to thirty-six months from firm transportation customers and recovery of 10% of such costs from interruptible transportation customers.\nFollowing negotiations with its customers, Tennessee filed in July 1994 with the FERC a Stipulation and Agreement (the \"PGA Stipulation\"), which provides for the recovery of PGA costs of approximately $100 million and the recovery of costs associated with the transfer of storage gas inventory to new storage customers in Tennessee's restructuring proceeding. The PGA Stipulation eliminates all challenges to the PGA costs, but establishes a cap on the charges that may be imposed upon former sales customers. On November 15, 1994, the FERC issued an order approving the PGA Stipulation and resolving all outstanding issues. However, certain customers have requested a rehearing and the FERC has deferred action on their issues to a later date. Tennessee implemented the terms of the PGA Stipulation on December 1, 1994, and expects to make refunds in 1995. Tennessee has recorded a liability which it believes is adequate to cover the PGA refunds.\nTennessee is recovering TBO costs formerly incurred to perform its sales functions, subject to refund, pending review of data submitted by Tennessee through technical conference proceedings. On November 18, 1994, the FERC issued an order on Tennessee's initial TBO surcharge filing to recover TBO costs for the twelve-month period beginning September 1, 1993. The order required Tennessee to remove certain costs from this surcharge, subject to FERC's review at a second technical conference and FERC's consideration of a request for rehearing. On November 30, 1994, Tennessee filed for a surcharge to recover approximately $25 million of TBO costs in compliance with the FERC's order, and in a separate filing, Tennessee filed to recover its projected annual TBO costs of approximately $21 million for the twelve-month period beginning September 1, 1994, through a new TBO surcharge. The FERC accepted Tennessee's filing to recover its projected TBO costs, subject to refund, pending review through technical conference proceedings.\nIn connection with Tennessee's GSR cost recovery discussed below, Tennessee, along with three other pipelines, executed four separate settlement agreements with Dakota Gasification Company and the U.S. Department of Energy and initiated\nfour separate proceedings at the FERC seeking approval to implement the settlement agreements. The settlement resolved litigation concerning purchases made by Tennessee of synthetic gas produced from the Great Plains Coal Gasification plant (\"Great Plains\"). On October 18, 1994, the FERC consolidated the four proceedings and set them for hearing before an administrative law judge who is to issue his initial decision by December 31, 1995. The FERC has committed to a final order by December 31, 1996. The FERC order stated that the costs related to the Great Plains project are eligible for recovery through GSR and other special recovery mechanisms and that the costs are eligible for recovery for the duration of the term of the original gas purchase agreements. The hearing will be limited to the issue of whether the settlement agreements are prudent.\nAlso in connection with Tennessee's GSR cost recovery proceedings discussed below, on October 14, 1993, Tennessee was sued in the State District Court of Ector County, Texas, by ICA Energy, Inc. (\"ICA\") and TransTexas Gas Corporation (\"TransTexas\"). In that suit, ICA and TransTexas contended that Tennessee had an obligation to purchase gas production which TransTexas thereafter attempted to add unilaterally to the reserves originally dedicated to a 1979 gas contract. On two subsequent occasions, TransTexas gave Tennessee notice that it was adding new production and\/or acreage \"to the contract.\" An amendment to the pleadings seeks $1.5 billion from Tennessee for alleged damages caused by Tennessee's refusal to purchase gas produced from the TransTexas leases covering the new production and lands. Neither ICA nor TransTexas were original parties to that contract. However, they contend that any stranger acquiring a fractional interest in the original committed reserves, thereby obtains a right to add to the contract unlimited volumes of gas production from locations in South Texas. Tennessee believes it has meritorious defenses to the claims of ICA and TransTexas, which defenses it will vigorously assert.\nAs of December 31, 1994, Tennessee has deferred GSR costs yet to be recovered from its customers of approximately $177 million, net of $187 million previously collected from its customers, subject to refund. Proceedings have commenced to review the recovery of these GSR costs; however, the FERC has also generally encouraged pipelines to settle such issues through negotiations with customers. Although Order 636 contemplates complete recovery by pipelines of qualified transition costs, Tennessee has initiated settlement discussions with its customers concerning the amount of recoverable GSR costs in response to recent FERC and customer statements acknowledging the desirability of such settlements. Tennessee is also engaged in separate settlement and contract reformation discussions with holders of certain gas purchase contracts who have sued Tennessee, although Tennessee believes that its defenses in the underlying gas purchase contract actions are meritorious.\nGiven the uncertainty over the results of ongoing discussions between Tennessee and its customers related to the recovery of GSR costs and the uncertainty related to predicting the outcome of its gas purchase contract reformation efforts and the associated litigation, Tenneco is unable to predict the timing or the ultimate impact the resolution of these issues will have on its consolidated financial position or results of operations.\nRate Proceedings\nThe FERC issued final orders approving Tennessee's Stipulation and Agreement partially resolving its 1991 rate case. Pursuant to these final FERC orders, rates for the period February 1, 1992, through August 31, 1993, were approved, and Tennessee paid refunds for this period in June 1994. The refunds had no material effect on reported net income. Also pursuant to these orders, rates for the period after September 1, 1993, were approved and Tennessee paid refunds for the period September 1, 1993, to October 31, 1994, in February 1995. As of December 31, 1994, Tennessee had recorded a liability which is adequate to cover estimated refund obligations.\nThe approved Stipulation and Agreement discussed above also established procedures for resolving the recovery of certain environmental expenditures. These environmental costs are currently being collected in Tennessee's rates subject to further review and possible refund. Tennessee intends to pursue full recovery of the costs at issue. Tennessee is also currently pursuing the possibility of a global settlement with its customers that would not only address recovery of the environmental costs currently being recovered in its rates, but would also establish a mechanism for recovering a substantial portion of the environmental costs discussed in Note 17, \"Commitments and Contingencies--Environmental Matters,\" that will be expended in the future. The total amount of and timing for any recovery pursuant to such a global settlement will depend upon the results of Tennessee's negotiations with its customers and will be subject to FERC approval.\nOn December 30, 1994, Tennessee filed a general rate increase in Docket No. RP95-112 which reflected an increase in Tennessee's revenue requirement of $118 million, including recovery of certain environmental costs as discussed in Note 17. On January 25, 1995, the FERC accepted the filing, suspended its effectiveness for the maximum period of five months pursuant to normal regulatory process, and set the matter for hearing. This order also required the convening of a technical conference to address various concerns raised by the FERC and Tennessee's customers over, among other issues, Tennessee's ability to provide its shippers with timely and accurate operating and billing information, and the associated systems costs. The ultimate resolution of these issues may result in adjustments to customer billings. Subject to the outcome of these issues and certain modifications identified in the FERC order, the increased rates will become effective on July 1, 1995, subject to refund.\n7. Income Taxes\nEffective January 1, 1992, Tenneco changed its method of accounting for income taxes from the deferred method to the liability method required by FAS No. 109, \"Accounting for Income Taxes,\" using the cumulative catch-up method. This standard requires that a deferred tax be recorded to reflect the tax expense (benefit) resulting from the recognition of temporary differences. Temporary differences are differences between the tax basis of assets and liabilities and their reported amounts in the financial statements that will result in differences between income for tax purposes and income for financial statement purposes in future years. No provision has been made for U.S. income taxes on unremitted earnings of foreign subsidiaries ($440 million at December 31, 1994) except for earnings attributable to Albright & Wilson. It is the present intention of management to reinvest a major portion of such unremitted earnings in foreign operations.\nThe components of income (loss) from continuing operations before income taxes are as follows:\nFollowing is an analysis of the components of consolidated income tax expense applicable to continuing operations:\nIn August 1993, the U.S. federal income tax rate was increased from 34% to 35%, retroactive to January 1, 1993. For 1992, this rate was 34%. Following is a reconciliation of income taxes computed at the U.S. federal income tax rate to the income tax expense from continuing operations reflected in the Statements of Income (Loss):\nThe components of Tenneco's net deferred tax liability at December 31, 1994 and 1993, were as follows:\nAs reflected in the table to the left, Tenneco had potential tax benefits of $374 million and $236 million which were not recognized in the Statements of Income (Loss) when generated. These benefits resulted primarily from tax loss carryforwards which are available to reduce future tax liabilities. During 1994 and 1993, $12 million and $37 million, respectively, were realized as a result of consolidation of Tenneco's German operations. In the first eleven months of 1994, Case generated income which supported a reduction in the valuation allowance of $30 million. The remainder of the change from 1993 to 1994 resulted primarily from the change to the equity method of accounting for Case.\nAt December 31, 1994, Tenneco had unrecognized tax benefits of $267 million related to U.S. capital loss carryforwards which expire in 1999 and had $89 million of foreign net operating loss carryforwards which will carry forward indefinitely.\n--------------------------------------------------------------------------------\n8. Investment in Affiliated Companies\nSummarized financial information of Tenneco's proportionate share of 50% or less owned companies accounted for by the equity method of accounting at December 31, 1994, 1993 and 1992, and for the years then ended is as follows:\nNote: Principal investments include a 44% interest in Case Corporation and a 50% interest in Kern River Gas Transmission Company. Case was reflected in Tenneco's financial statements using the equity method of accounting subsequent to November 1994. Accordingly, \"Revenues and other income,\" \"Costs and expenses\" and \"Net income\" in the table above include 44% of Case's respective amounts for the month of December 1994 only. All balance sheet related captions reflect 44% of Case's respective amounts at December 31, 1994.\n9. Common Stock\nTenneco Inc. has authorized 350 million shares ($5.00 par value) of common stock, and 191,335,193 and 173,953,012 shares were issued at December 31, 1994 and 1993, respectively. Tenneco transferred 12,000,000 shares of common stock to the Stock Employee Compensation Trust when it was established in November 1992. At December 31, 1994, the Trust held 7,055,854 shares which are included in the issued shares quoted above. Treasury stock held by Tenneco was 3,617,510 and 4,166,835 shares at the respective dates.\nStock Repurchase Plan\nOn December 13, 1994, Tenneco announced that it plans to repurchase up to $500 million of its issued and outstanding common shares. Purchases executed through the program will be made in the open market or in negotiated purchases. Timing of purchases, number of shares purchased and prices paid under the program will be at Tenneco's discretion, based upon prevailing market conditions and legal limitations. At December 31, 1994, 1,160,000 shares had been repurchased and are included in treasury stock on the balance sheet.\nEquity Offering\nIn April 1993, Tenneco Inc. completed an underwritten public offering of 23.5 million shares of common stock for approximately $1.1 billion. The proceeds were used to retire $327 million of short-term debt, $688 million of long-term debt and $14 million of variable-rate preferred stock.\nReserved\nAt December 31, 1994, the shares of Tenneco Inc. common stock reserved for issuance were as follows:\nStock Plans\n1994 Tenneco Inc. Stock Ownership Plan--In May 1994, Tenneco adopted the 1994 Tenneco Inc. Stock Ownership Plan effective as of December 8, 1993. This plan provides Tenneco the latitude to grant a variety of awards, such as common stock, stock equivalent units, dividend equivalents, performance units, stock appreciation rights (\"SAR's\") and stock options, to officers and key employees of the Tenneco companies. The plan requires that options and SAR's be granted at not less than the fair market value of a share of common stock on the grant date. The plan also requires that no award granted shall vest in less than six months after the grant date. The Company can issue 8,400,000 shares of common stock under this plan, which will terminate December 31, 1998. At December 31, 1994, 316,805 restricted shares and 23,515 restricted units were outstanding under this plan at an average price of $53.20 per share.\n1988 Key Employee Restricted Stock Plan--At December 31, 1994, 825,393 restricted shares and 82,740 restricted units were outstanding under this plan at an average price of $44.84 per share. These awards generally require, among other things, that the employee remain an employee of Tenneco during the restriction period. This plan was superseded by the 1994 Tenneco Inc. Stock Ownership Plan.\nUnder another arrangement, 250 shares of restricted stock or restricted units are issued annually to each member of the Board of Directors who is not also an officer of Tenneco. At December 31, 1994, 10,000 restricted shares and no restricted units were outstanding under this program at an average price of $46.30 per share.\nOptions and Stock Appreciation Rights--Tenneco Inc. has granted stock options and stock appreciation rights to key employees. The options and SAR's became exercisable over four years and lapse after ten years from the date of grant. This plan was superseded by the 1994 Tenneco Inc. Stock Ownership Plan.\nThe following table reflects the status and activity for all stock options issued by Tenneco Inc., including those outside the option plans discussed above, for the periods indicated:\nFor the years ended December 31, 1994, 1993 and 1992, compensation expense for these stock plans was not material.\nEmployee Stock Purchase Plan--On June 1, 1992, Tenneco initiated an Employee Stock Purchase Plan. The Plan allows U.S. and Canadian Tenneco employees to purchase Tenneco Inc. common stock at a 15% discount. Each year employees in the plan may purchase shares with a discounted value not to exceed $21,250. Tenneco reserved 5,000,000 shares of treasury stock to be issued through this plan. At December 31, 1994, 1,210,849 shares had been issued to participants and the remaining shares are held by the Stock Employee Compensation Trust (discussed below) for issuance to employees in this plan.\nStock Employee Compensation Trust (\"SECT\")\nIn November 1992, Tenneco established a SECT to fund a portion of its obligations arising from its various employee compensation and benefit plans. Tenneco issued 12,000,000 shares of treasury stock to the SECT in exchange for a promissory note of $432 million that bears interest at the rate of 7.8% per annum. The SECT has a five-year life during which it will utilize the common stock to satisfy those obligations. At December 31, 1994, 4,944,146 shares had been utilized.\nShareholder Rights Plan\nIn 1988, Tenneco Inc. adopted a Shareholder Rights Plan (\"the Plan\") to deter coercive takeover tactics and to prevent a potential acquiror from gaining control of Tenneco without offering a fair price to all Tenneco Inc. shareholders. Under the Plan, each outstanding share of Tenneco Inc. common stock received one Purchase Right, exercisable at $130, subject to adjustment. In the event a person or group acquires 20% or more of the outstanding Tenneco Inc. common stock other than pursuant to an offer for all shares of such common stock which is fair and in the best interests of Tenneco Inc. and its shareholders, or has in the judgment of the Tenneco Inc. Board of Directors acquired a substantial amount of common stock under certain motives deemed adverse to Tenneco's best interests, each Purchase Right entitles the holder to purchase shares of common stock or other securities of Tenneco Inc. or, under certain circumstances, of the acquiring person, having a value of twice the exercise price. The Purchase Rights, under certain circumstances, are redeemable by Tenneco Inc. at a price of $.02 per Purchase Right.\nDividend Reinvestment and Stock Purchase Plan\nUnder the Tenneco Inc. Dividend Reinvestment and Stock Purchase Plan, holders of Tenneco Inc. common stock and $7.40 preferred stock may apply their cash dividends and optional cash investments to the purchase of shares of common stock.\nEarnings Per Share\nEarnings per share of common stock are based on the average number of shares of common stock and Series A preferred stock (each share of Series A preferred stock represents approximately two shares of common stock) outstanding during each period. Because Series A preferred stock outstanding is included in average common shares outstanding for purposes of computing earnings per share, the preferred dividends paid are not deducted from net income (loss) to determine net income (loss) to common stock. The inclusion of Series A preferred stock in the computation of earnings per share was antidilutive for the years and certain quarters in 1994, 1993 and 1992. In December 1994, all Series A preferred stock was converted into common stock.\nIn 1992, 12,000,000 shares of common stock were issued to the SECT. Shares of common stock issued to a related trust are not considered to be outstanding in the computation of average shares of common stock outstanding until the shares are utilized to fund the obligations for which the trust was established. At December 31, 1994, 4,944,146 shares had been utilized. Other convertible securities and common stock equivalents outstanding during each of the three years ended December 31, 1994, 1993 and 1992, were not materially dilutive.\n10. Preferred Stock\nAt December 31, 1994, Tenneco Inc. had authorized 15,000,000 shares of preferred stock. In addition, Tenneco Inc. has an authorized class of stock consisting of 50,000,000 shares of junior preferred stock, without par value, none of which has been issued. Tenneco has reserved 3,500,000 shares of junior preferred stock for the Shareholder Rights Plan.\nThe preferred stock issues outstanding at December 31, 1994, are as follows:\nIn December 1991, Tenneco issued 17,870,350 Depositary Shares, each representing one-half of a share of a new series of cumulative preferred stock designated as Series A preferred stock. On December 16, 1994, Tenneco exercised its option to call all of the outstanding shares, which were converted into shares of Tenneco Inc. common stock. In addition, $11 million was paid for dividends on the Series A preferred stock that were accrued but unpaid at the conversion date.\nThe $7.40 and $4.50 preferred stock issues have a mandatory redemption value of $100 per share (an aggregate of $159 million and $178 million at December 31, 1994 and 1993, respectively). Tenneco recorded these preferred stocks at their fair value at the date of original issue (an aggregate of $250 million) and is making periodic accretions of the excess of the redemption value over the fair value at the date of issue. Such accretions are included in the income statement caption \"Preferred stock dividends\" as a reduction of net income to arrive at net income (loss) to common stock.\nDuring 1993, Tenneco retired the remainder of a variable rate preferred stock issue at the redemption price of $100 per share, or $17 million.\nThe aggregate maturities applicable to preferred stock issues outstanding at December 31, 1994, are $20 million for each of the years 1995, 1996, 1997, $19 million for 1998 and $80 million for 1999.\nIn 1991, a French subsidiary issued equity securities that were convertible into Tenneco Inc. preferred stock in 1996. In December 1994, Tenneco redeemed these equity securities for $160 million in cash.\nChanges in Preferred Stock with Mandatory Redemption Provisions*\n* For additional information on Series A preferred stock see Statements of Changes in Stockholders' Equity.\n11. Minority Interest\nAt December 31, 1994 and 1993, Tenneco reported minority interest in the balance sheet of $320 million and $153 million, respectively. At December 31, 1994, $300 million of minority interest resulted from the December 1994 sale by Tenneco of a 25% preferred stock interest in Tenneco International Holding Corp. (\"TIHC\") to a financial investor. TIHC is a separate legal entity from the Company and holds certain assets including the capital stock of Tenneco Canada Inc., S.A. Tenneco Belgium, Monroe Australia Pty. Limited, Walker France and other subsidiaries included in Tenneco's Automotive parts segment. TIHC also holds financial obligations of Tenneco or guaranteed by Tenneco. At December 31, 1994, the Company had borrowings of $264 million from TIHC. For financial reporting purposes, the assets, liabilities and earnings of TIHC and its subsidiaries have continued to be consolidated in Tenneco's financial statements, and the financial investor's preferred stock interest has been recorded as minority interest.\nDividends on the TIHC preferred stock are based on the issue price ($300 million) times a rate per annum equal to 1.12% over LIBOR and are payable quarterly in arrears on the last business day of each quarter commencing on March 31, 1995. Additionally, beginning in 1996, the holder of the 12,000,000 shares of preferred stock will be entitled to receive, when and if declared by the Board of Directors of TIHC, participating dividends based on the operating income growth rate of TIHC.\nAt December 31, 1993, $148 million of minority interest resulted from the 1991 issuance of equity securities by a French subsidiary. In December 1994, these equity securities were redeemed for $160 million in cash.\n12. Plant, Property and Equipment, at Cost\nAt December 31, 1994 and 1993, plant, property and equipment, at cost, by major segment was as follows:\n13. Postretirement and Postemployment Benefits\nPostretirement Benefits\nTenneco has postretirement health care and life insurance plans which cover substantially all of its domestic employees. For salaried employees, the plans cover employees retiring from Tenneco on or after attaining age 55 who have had at least 10 years service with Tenneco after attaining age 45. The salaried plans were amended during 1993 to reduce the cost of providing future benefits. For hourly employees, the postretirement benefit plans generally cover employees who retire pursuant to one of Tenneco's hourly employee retirement plans. All of these benefits may be subject to deductibles, copayment provisions and other limitations, and Tenneco has reserved the right to change these benefits.\nEffective January 1, 1992, for its domestic operations, Tenneco adopted FAS No. 106 which requires employers to account for the cost of these postretirement benefits on the accrual basis rather than on the \"pay-as-you-go\" basis which was Tenneco's previous practice. Tenneco elected to recognize this change in accounting principle on the cumulative catch-up basis. The effect on 1992 income of immediately recognizing the transition obligation was as follows:\nTenneco will adopt FAS No. 106 for its international operations in the first quarter of 1995 but does not expect the adoption to have a material effect on Tenneco's financial position or results of operations.\nThe majority of Tenneco's postretirement benefit plans are not funded. In June 1994, two trusts were established to fund postretirement benefits for certain plan participants of the Natural gas pipelines segment. The contributions are collected from customers in FERC approved rates. As of December 31, 1994, cumulative contributions were $5 million. Plan assets consist principally of fixed income securities.\nThe funded status of the domestic plans reconciles with amounts recognized on the balance sheet at December 31, 1994 and 1993, as follows:\nIn conjunction with the Case IPO in June 1994, active Case salaried employees were transferred from the Tenneco Inc. plans to new Case salaried plans, and Case hourly retirees were transferred from the Case hourly plans to the Tenneco Inc. plans. Amendments to reduce the cost of providing future benefits for Case hourly retirees were reflected at that time.\nIn November 1994, through a secondary offering of Case stock, Tenneco's ownership in Case dropped below 50%. Therefore, all Case liabilities for the new Case plans are excluded from the Tenneco disclosure information for 1994. Benefit costs for these plans have been included up to the date of the secondary offering (for 11 months of 1994). For additional information concerning Tenneco's changing ownership in Case, reference is made to Note 1, \"Summary of Accounting Policies\" and Note 3, \"Discontinued Operations, Dispositions of Assets and Extraordinary Loss.\"\nThe net periodic postretirement benefit cost from continuing operations for the years 1994, 1993 and 1992 consist of the following components:\nA pre-tax loss resulting from curtailments, settlements and special termination benefits under these plans was $3 million, $0 and $40 million for 1994, 1993 and 1992, respectively, which related primarily to restructuring at Case.\nThe initial weighted average assumed health care cost trend rate used in determining the 1994, 1993 and 1992 accumulated postretirement benefit obligation was 8%, 9% and 12%, respectively, declining to 5% in 1997 and remaining at that level thereafter.\nIncreasing the assumed health care cost trend rate by one percentage-point in each year would increase the 1994, 1993 and 1992 accumulated postretirement benefit obligations by approximately $34 million, $47 million and $94 million, respectively, and would increase the aggregate of the service cost and interest cost components of the net postretirement benefit cost for 1994, 1993 and 1992 by approximately $5 million, $10 million and $11 million, respectively.\nThe discount rates (which are based on long-term market rates) used in determining the 1994, 1993 and 1992 accumulated postretirement benefit obligations were 8.25%, 7.50% and 8.75%, respectively.\nPostemployment Benefits\nTenneco adopted FAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" in the first quarter of 1994. This new accounting rule requires employers to account for postemployment benefits for former or inactive employees after employment but before retirement on the accrual basis rather than the \"pay-as-you-go\" basis. Implementation of this new rule reduced 1994 net income by $39 million, or $.22 per share, net of income tax benefits of $26 million, which was reported as the cumulative effect of a change in accounting principle.\n14. Pension Plans\nTenneco has retirement plans which cover substantially all of its employees. Benefits are based on years of service and, for most salaried employees, on final average compensation. Tenneco's funding policies are to contribute to the plans amounts necessary to satisfy the funding requirements of federal laws and regulations. Plan assets consist principally of listed equity and fixed income securities.\nThe funded status of the plans reconciles with amounts recognized on the balance sheet at December 31, 1994 and 1993, as follows:\nNote: Assets of one plan may not be utilized to pay benefits of other plans.\nIn December 1993, all liabilities and assets were transferred from the Case Corporation Pension Plan for Hourly-Paid Employees (\"Case Plan\") to the Tenneco Inc. Retirement Plan. In June 1994, all future accruals for the salaried and hourly active Case employees were transferred from the Tenneco Inc. Retirement Plan to new Case plans. In November 1994, through a secondary offering of Case stock, Tenneco's ownership in Case dropped below 50%. Therefore, all domestic and foreign Case liabilities and assets in the new Case plans are excluded from the Tenneco disclosure information for 1994. Pension cost (income) for these plans has been included up to the date of the secondary offering (for 11 months of 1994).\nNet periodic pension costs from continuing operations for the years 1994, 1993 and 1992 consist of the following components:\nPre-tax gains (losses) resulting from curtailments, settlements and special termination benefits under these plans were $(19) million, $(37) million and $(46) million for 1994, 1993 and 1992, respectively, all of which related primarily to restructuring at Case.\nThe weighted average discount rates (which are based on long-term market rates) used in determining the 1994, 1993 and 1992 actuarial present value of the benefit obligations were 8.4%, 7.6% and 8.9%, respectively. The rate of increase in future compensation was 5.0%, 5.1% and 6.6% for 1994, 1993 and 1992, respectively. The weighted average expected long-term rate of return on plan assets was 10.0%, 9.9% and 10.0% for 1994, 1993 and 1992, respectively.\n15. Segment and Geographic Area Information\nTenneco is engaged in the sale of products for export from the United States. Such sales are reflected in the table below:\n16. Restructuring Costs\nTo respond to depressed market conditions facing the farm and construction equipment business and to improve Case's performance, aggressive measures were taken at Case since September 1991 resulting in significant improvement in Case's performance. However, the worldwide farm and construction equipment market continued to deteriorate during 1992, and Tenneco Management and the Board of Directors determined that major structural and strategic changes were necessary in order to (1) rationalize certain component production operations to reduce the fixed cost portion of the manufacturing process; (2) reduce excess capacity; (3) focus, discontinue or replace unprofitable and noncompetitive product lines; and (4) restructure and refocus product and component parts distribution to strengthen Case's competitive position in the global marketplace.\nConsequently, on March 21, 1993, the Board of Directors of the Company adopted a comprehensive restructuring program for Case. Adoption of this program resulted in a pre-tax restructuring charge of $920 million ($843 million after tax, or $5.85 per average common share), all of which was reflected in the 1992 loss from continuing operations before interest expense and income taxes. The $920 million pre-tax charge was recorded as a $340 million reduction of net plant, property and equipment, a $55 million reduction of inventory, a $63 million reduction of intangibles and other accounts and a $462 million reserve for the future cost of implementing the various restructuring actions.\nAs of December 31, 1994, approximately $271 million of the actions necessary to complete the program had been implemented. Also, as a result of restructuring actions taken to date and changes in estimates for planned actions, it was determined that there were excess reserves of $36 million. Therefore, $20 million and $16 million of the restructuring reserve was reversed in 1993 and 1994, respectively.\nThe specific restructuring measures were based on management's best business judgment under prevailing circumstances and on assumptions which may be revised over time and as circumstances change. The estimated costs associated with such measures may require further revision in the future.\n17. Commitments and Contingencies\nCapital Commitments\nTenneco estimates that expenditures aggregating approximately $1.0 billion will be required after December 31, 1994, to complete facilities and projects authorized at such date, and substantial commitments have been made in connection therewith.\nPurchase Obligations\nIn connection with the financing commitments of certain joint ventures, Tenneco has entered into unconditional purchase obligations for products and services of $190 million ($139 million on a present value basis) at December 31, 1994. Tenneco's annual obligations under these agreements are $27 million for 1995, $27 million for 1996, $25 million for 1997, $23 million for 1998 and $23 million for 1999. Payments under such obligations, including additional purchases in excess of contractual obligations, were $34 million, $31 million and $33 million for the years 1994, 1993 and 1992, respectively. In addition, in connection with the Great Plains coal gasification project (Dakota Gasification Company), Tennessee has contracted to purchase 30% of the output of the plant's original design capacity for a remaining period of 15 years. Tennessee is in the process of settling this contract as a part of its Gas Supply Realignment negotiations discussed in Note 6.\nLease Commitments\nTenneco holds certain of its facilities and equipment under long-term leases. The minimum rental commitments under non-cancelable operating leases with lease terms in excess of one year are $141 million, $124 million, $120 million, $119 million and $110 million for the years 1995, 1996, 1997, 1998 and 1999, respectively, and $968 million for subsequent years. Of these amounts, $79 million for 1995, $81 million for 1996, $84 million for 1997, $93 million for 1998, $86 million for 1999 and $781 million for subsequent years are lease payment commitments to GECC, John Hancock and Metropolitan Life for assets purchased from Georgia-Pacific in January 1991 and leased to Tenneco. Commitments under capital leases were not significant to the accompanying financial statements. Total rental expense for continuing operations for the years 1994, 1993 and 1992, was $197 million, $200 million and $209 million, respectively, including minimum rentals under non-cancelable operating leases of $189 million, $196 million and $206 million for the corresponding periods.\nLitigation\nReference is made to Note 6, \"FERC Regulatory Matters,\" for information concerning gas supply litigation. Tenneco Inc. and its subsidiaries are parties to numerous other legal proceedings arising from their operations. Tenneco Inc. believes that the outcome of these proceedings, individually and in the aggregate, will have no material effect on the financial position or results of operations of Tenneco Inc. and its consolidated subsidiaries.\nEnvironmental Matters\nTennessee is engaged in an internal project to identify and deal with the presence of 1) polychlorinated biphenyls (\"PCBs\") and 2) other substances of concern, including substances on the U.S. Environmental Protection Agency (\"EPA\") List of Hazardous Substances (\"HS List\") at compressor stations and other facilities operated by both its interstate and intrastate natural gas pipeline systems. While conducting this project, Tennessee is in frequent contact with federal and state regulatory agencies, both through informal negotiation and formal entry of consent orders, in order to assure that its efforts meet regulatory requirements.\nTenneco has established a reserve for Tennessee's environmental expenses, which includes: 1) expected remediation expense and associated onsite, offsite and groundwater technical studies, 2) legal fees and 3) settlement of third party and governmental litigation, including civil penalties. Through December 31, 1994, Tenneco has charged approximately $88 million against the environmental reserve. Of the remaining reserve, $30 million has been recorded on the balance sheet under \"Payables-Trade\" and $145 million under \"Deferred credits and other liabilities.\"\nDue to the current uncertainty regarding the further activity necessary for Tennessee to address the substances on the HS List and other substances of concern, including the requirements for site characterization, the actual presence of such substances at the sites, and the final, site-specific cleanup decisions to be made with respect to cleanup levels and remediation technologies, Tennessee cannot at this time project what additional costs, if any, may result from such activity. While there are still many uncertainties relating to the ultimate costs which may be incurred, based upon Tennessee's continuing evaluation and experience to date, Tenneco continues to believe that the amount of the reserve is adequate.\nTenneco believes that a substantial portion of these costs, which will be expended over the next five to ten years, will be recovered from customers of its natural gas pipelines. Tennessee is currently recovering environmental expenses annually in its rates. Reference is made to Note 6 for more information regarding recovery of environmental costs. A significant portion of these expenses remains subject to review and refund in Tennessee's 1991 rate case. Tennessee is also currently pursuing the possibility of a global settlement with its customers that would not only address recovery of the environmental costs currently being recovered in its rates, but would also establish a mechanism for recovering a substantial portion of the environmental costs that will be expended in the future. The total amount of and timing for any recovery pursuant to such a global settlement will depend upon the results of Tennessee's negotiations with its customers and will be subject to FERC approval. As of December 31, 1994, the asset balance is $135 million.\nTenneco believes that its liability insurance policies in effect during the period in which the environmental issues occurred provide coverage for remediation costs and related claims. Tennessee has pending litigation in a Louisiana state court against its insurance carriers during this period, seeking recovery of costs which Tennessee incurred. The issues in dispute involve determining: 1) whether the presence of PCBs and other substances at each compressor station constituted a separate occurrence for purposes of the per-occurrence limits of the policies; 2) the applicability of the pollution exclusions in certain policies issued after 1971; 3) the applicability of provisions which exclude the environmental impacts located solely on the insured's property; 4) whether the term \"property damage\" in the policies will cover the cost of compliance with governmental cleanup directives; 5) the allocation of costs to the various policies in effect during the period the environmental impact occurred; 6) the applicability of provisions excluding pollution that is \"expected or intended\" and 7) the adequacy of notice of claims to insurance carriers. Tenneco has completed settlements with and received payment from several of the defendant carriers and believes that the likelihood of recovery of a portion of its remediation costs and claims against the remaining defendant carriers is reasonably possible. Any such recovery would likely be considered in resolving environmental cost recoveries with Tennessee's customers.\nIn July 1994, Tennessee commenced litigation in a Kentucky state court against the manufacturer of the PCB-containing lubricant used by Tennessee, seeking reimbursement of sums Tennessee has and will incur in the defense and settlement of PCB-related claims brought by state and federal agencies, private individuals and others. Tennessee anticipates that the defendant will raise a variety of issues in dispute of Tennessee's claims.\nWhile Tenneco believes its legal position to be meritorious, Tenneco has not adjusted its environmental reserve to reflect any anticipated insurance recoveries or recoveries from the manufacturer of the PCB-containing lubricant.\nTenneco has identified other sites in its various operating divisions where environmental remediation expense may be required should there be a change in ownership, operations or applicable regulations. These possibilities cannot be predicted or quantified at this time and accordingly, no provision has been recorded. However, provisions have been made for all instances where it has been determined that the incurrence of any material remedial expense is reasonably possible.\n18. Quarterly Financial Data (Unaudited)\nThe preceding notes are an integral part of the foregoing financial statements.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere has been no change in accountants during 1994 or 1993, nor has there been any disagreement on any matter of accounting principles or practices or financial disclosure which in either case is required to be reported pursuant to this Item 9.\nPART III\nItem 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\", have been omitted from this report inasmuch as Tenneco Inc. will file with the Securities and Exchange Commission pursuant to Regulation 14A within 120 days after the end of the fiscal year covered by this report a definitive Proxy Statement for the Annual Meeting of Stockholders of Tenneco Inc. to be held on May 9, 1995, at which meeting the stockholders will vote upon the election of directors. The information under the caption \"Election of Directors\" in such Proxy Statement is incorporated herein by reference.\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.\nFINANCIAL STATEMENTS INCLUDED IN ITEM 8\nSee \"Index to Financial Statements of Tenneco Inc. and Consolidated Subsidiaries\" set forth in Item 8, \"Financial Statements and Supplementary Data.\"\nINDEX TO FINANCIAL STATEMENTS AND SCHEDULES INCLUDED IN ITEM 14\nSCHEDULES OMITTED AS NOT REQUIRED OR INAPPLICABLE\nSCHEDULE I\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nTENNECO INC.\nSTATEMENTS OF INCOME (LOSS)\n(The accompanying notes to financial statements are an integral part of these statements of income (loss).)\nSCHEDULE I (CONTINUED)\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nTENNECO INC.\nSTATEMENTS OF CASH FLOWS\n-------- Note: Cash and temporary cash investments include highly liquid investments with a maturity of three months or less at date of purchase.\n(The accompanying notes to financial statements are an integral part of these statements of cash flows.)\nSCHEDULE I (CONTINUED)\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nTENNECO INC.\nBALANCE SHEETS\n(The accompanying notes to financial statements are an integral part of these balance sheets.)\nSCHEDULE I (CONTINUED)\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nTENNECO INC.\nNOTES TO FINANCIAL STATEMENTS\nAccounting Policies\nThe financial statements of Tenneco Inc. should be read in conjunction with the financial statements of Tenneco Inc. and Consolidated Subsidiaries presented in this document.\nMajority-owned subsidiaries and companies in which at least a 20% voting interest is owned are carried at cost plus equity in undistributed earnings since date of acquisition and cumulative translation adjustments. At December 31, 1994, equity in undistributed earnings and cumulative translation adjustments amounted to $3,241 million and $(199) million, respectively; at December 31, 1993, the corresponding amounts were $1,979 million and $(280) million, respectively.\nDividends received from companies accounted for on an equity basis amounted to $1 million, none and $121 million for 1994, 1993 and 1992, respectively.\nIncome Taxes\nTenneco Inc., together with certain of its respective subsidiaries which are owned 80% or more, have entered into an agreement to file a consolidated federal income tax return. Such agreement provides, among other things, that (1) each company in a taxable income position will be currently charged with an amount equivalent to its federal income tax computed on a separate return basis and (2) each company in a tax loss position will be currently reimbursed to the extent its deductions, including general business credits, are utilized in the consolidated return.\nTenneco Inc.'s pre-tax earnings (losses) from continuing operations (excluding equity in net income (loss) from continuing operations of affiliated companies) for the years 1994, 1993 and 1992 are principally domestic. The differences between the U.S. income tax benefit, reflected in the Statements of Income (Loss), of $187 million, $80 million and $93 million for the years 1994, 1993 and 1992 and the income tax expense (benefit), computed at the U.S. federal income tax rates, of $159 million, $117 million and $(274) million, respectively, consisted principally of the tax effect of equity in net income (loss) from continuing operations of affiliated companies in each of the three years, and permanent differences on the sale of businesses in 1994.\nLong-Term Debt and Current Maturities\nThe aggregate maturities and sinking fund requirements applicable to the long-term debt issues outstanding at December 31, 1994, are $8 million, $9 million, $16 million, $769 million and $251 million for 1995, 1996, 1997, 1998 and 1999, respectively.\nFinancial Instruments\nTenneco Inc. has guaranteed the performance of certain subsidiaries pursuant to arrangements under which receivables are factored on a nonrecourse basis with Tenneco Credit Corporation. Also, Tenneco Inc. has agreed to pay to Tenneco Credit Corporation a service charge to the extent necessary so that the earnings of Tenneco Credit Corporation and its consolidated subsidiaries (before fixed charges and income taxes) are not less than 125% of the fixed charges.\n(The above notes are an integral part of the foregoing financial statements.)\nSCHEDULE II\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (MILLIONS)\n-------------------------------------------------------------------------------- --------------------------------------------------------------------------------\n-------- Note: For 1994, primarily the result of the change to the equity method of accounting for Case. For 1994, 1993 and 1992, includes uncollectible accounts written off, net of recoveries on accounts previously written off.\nREPORTS ON FORM 8-K\nTenneco Inc. did not file any Current Reports on Form 8-K during the fourth quarter of the fiscal year ended December 31, 1994.\nEXHIBITS\nThe following exhibits are filed with Tenneco Inc.'s Annual Report on Form 10-K for the fiscal year ended December 31, 1994, or incorporated therein by reference (exhibits designated by an asterisk were filed with the Report; all other exhibits were incorporated by reference):\n-------- + Management contract or compensatory plan or arrangement.\nUNDERTAKING.\nThe undersigned, Tenneco Inc., hereby undertakes pursuant to Regulation S-K, Item 601(b), paragraph (4)(iii), to furnish to the Securities and Exchange Commission upon request all constituent instruments defining the rights of holders of long-term debt of Tenneco Inc. and its consolidated subsidiaries not filed herewith for the reason that the total amount of securities authorized under any of such instruments does not exceed 10% of the total consolidated assets of Tenneco Inc. and its consolidated subsidiaries.\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.\nTenneco Inc.\nDana G. Mead By___________________________________ Chairman and Chief Executive Officer\nDate: March 29, 1995\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.\nT. R. Tetzlaff March 29, 1995 By___________________________________ Attorney-in-fact\nEXHIBIT 11 TENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nCOMPUTATION OF EARNINGS (LOSS) PER SHARE OF COMMON STOCK\n------- Notes:(a) In 1992, 12,000,000 shares of common stock were issued to the Stock Employee Compensation Trust (\"SECT\"). Shares of common stock issued to a related trust are not considered to be outstanding in the computation of average shares of common stock until the shares are utilized to fund the obligations for which the trust was established. At December 31, 1994, the SECT had utilized 4,944,146 of these shares. (b) Series A preferred stock is converted into common stock under the Contingent Share method. The above computation includes 8,935,175 shares of Series A preferred stock which were converted into 17,342,763 shares of common stock. In December 1994, all of the outstanding shares of Series A preferred stock were converted into Tenneco Inc. common stock. The inclusion of Series A preferred stock in the computation of earnings per share was antidilutive for the years and certain quarters in 1994, 1993 and 1992. (c) These calculations are submitted in accordance with Securities and Exchange Commission requirements although not required by Accounting Principles Board Opinion No. 15 because they result in dilution of less than 3%.\nEXHIBIT 12\nTENNECO INC. AND CONSOLIDATED SUBSIDIARIES\nCOMBINED WITH 50% OWNED UNCONSOLIDATED SUBSIDIARIES\nCOMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (DOLLARS IN MILLIONS)\n-------- Note:(a) For the years ended December 31, 1992 and 1991, earnings were inadequate to cover fixed charges by $550 million and $572 million, respectively.\nINDEX TO EXHIBITS\n-------- * Exhibit incorporated by reference.\n-------- + Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"352541_1994.txt","cik":"352541","year":"1994","section_1":"ITEM 1. BUSINESS\nWPL Holdings, Inc. (referred to herein as the \"Company\") was incorporated under the laws of the State of Wisconsin on April 22, 1981 and operates as a holding company with both utility and nonregulated businesses. It is the parent company of a public utility, Wisconsin Power and Light Company (\"WPL\") and its related subsidiaries, and of Heartland Development Corporation (\"HDC\"), the parent corporation for the Company's nonregulated businesses. The Company has no employees who are not also employees of WPL and or HDC. See Item 8 - \"Financial Statements and Supplementary Data, Notes to Consolidated Financial Statements\", Note 12, for financial information related to the Company's business segments.\nWPL\nWPL, incorporated in Wisconsin on February 21, 1917 as the Eastern Wisconsin Electric Company, is a public utility predominately engaged in the transmission and distribution of electric energy and the generation and bulk purchase of electric energy for sale. WPL also transports, distributes and sells natural gas purchased from gas suppliers. Nearly all of WPL's customers are located in south and central Wisconsin. WPL operates in municipalities pursuant to permits of indefinite duration which are regulated by Wisconsin law. WPL does not derive a material portion of its revenues from any one customer.\nWPL owns all of the outstanding capital stock of South Beloit Water, Gas and Electric Company (\"South Beloit\"), a public utility supplying electric, gas and water service, principally in Winnebago County, Illinois, which was incorporated on July 23, 1908.\nWPL also owns varying interests in several other subsidiaries and investments which are not material to WPL's operations.\nRegulation\nWPL is subject to regulation by the Public Service Commission of Wisconsin (\"PSCW\") as to retail utility rates and service, accounts, issuance and use of proceeds of securities, certain additions and extensions to facilities, and in other respects. South Beloit is subject to regulation by the Illinois Commerce Commission (\"ICC\") for similar items. The Federal Energy Regulatory Commission (\"FERC\") has jurisdiction under the Federal Power Act over certain of the electric utility facilities and operations, wholesale rates and accounting practices of WPL and in certain other respects. Certain of WPL's natural gas facilities and operations are subject to the jurisdiction of the FERC under the Natural Gas Act. The Company is presently exempt from all provisions of the Public Utility Holding Company Act of 1935, except provisions relating to the acquisition of securities of other public utility companies.\nThe PSCW has recently opened a formal docket initiating an inquiry into the future structure of the electric utility industry in Wisconsin. The goals of Wisconsin utility regulation and the principles to be used in choosing among alternative proposals have been identified. WPL has submitted its preferred structure which, in summary form, calls for open access to transmission and distribution systems and a competitive power generation marketplace. It is not possible at this time to predict the outcome of these proceedings.\nWith respect to environmental matters impacting WPL and its subsidiaries, the United States Environmental Protection Agency administers certain federal statutes with administrative responsibility with respect to others being delegated to the Wisconsin Department of Natural Resources (\"DNR\"). In addition, the DNR has jurisdiction over air and water quality standards associated with fossil fuel fired electric generation and the level and flow of water, safety and other matters pertaining to hydroelectric generation.\nWPL is subject to the jurisdiction of the Nuclear Regulatory Commission (\"NRC\") with respect to the Kewaunee Nuclear Power Plant (\"Kewaunee\") and to the jurisdiction of the United States Department of Energy (\"DOE\") with respect to the disposal of nuclear fuel and other radioactive wastes from Kewaunee.\nEmployees\nAt year-end 1994, WPL employed 2,391 persons, of whom 1,924 were considered electric utility employees, 334 were considered gas utility employees and 133 were considered other utility employees. WPL has a three-year contract with members of the International Brotherhood of Electrical Workers, Local 965, that is in effect until June 1, 1996. The contract covers 1,647 of WPL's employees.\nELECTRIC OPERATIONS:\nGeneral\nWPL provides electricity in a service territory of approximately 16,000 square miles in 35 counties in southern and central Wisconsin and four counties in northern Illinois. As of December 31, 1994, WPL provided retail electric service to approximately 371,000 customers in 663 cities, villages and towns, and wholesale service to 27 municipal utilities, one privately owned utility, three rural electric cooperatives and to the Wisconsin Public Power, Inc. system, which provides retail service to nine communities.\nWPL owns 20,969 miles of electric transmission and distribution lines and 362 substations located adjacent to the communities served.\nWPL's electric sales are seasonal to some extent with the yearly peak normally occurring in the summer months. WPL also experiences a smaller winter peak in December or January.\nFuel\nIn 1994, approximately 80 percent of WPL's net kilowatthour generation of electricity was fueled by coal and 17 percent by nuclear fuel (provided by WPL's 41 percent ownership interest in Kewaunee). The remaining electricity generated was produced by hydroelectric, oil-fired and natural gas generation.\nCoal\nWPL anticipates that its average fuel costs will likely increase in the future, due to cost escalation provisions in existing coal and transportation contracts.\nThe estimated coal requirements of WPL's generating units (including jointly-owned facilities) for the years 1995 through 2014 total about 167 million tons. Present coal supply contracts and transportation contracts (excluding extension options) cover approximately 14 percent and 21 percent, respectively, of this estimated requirement. WPL will seek renewals of existing contracts or additional sources of supply and negotiate new or additional transportation contracts to satisfy these requirements and to comply with environmental regulations.\nNuclear\nKewaunee is jointly-owned by WPL (41%), Wisconsin Public Service Corporation (41.2%) and Madison Gas & Electric Company (17.8%). Wisconsin Public Service Corporation (WPSC) is the operating partner. The plant began commercial operation in 1974.\nWPSC, the plant operator, is a member of the INPO, an organization of nuclear utilities which promotes excellence in all aspects of nuclear plant operations. INPO manages the accreditation process for industry training programs, which includes periodic accreditation of those training programs by an independent organization, the NNAB. All ten accredited training programs at Kewaunee are currently in good standing with the NNAB.\nThe supply of nuclear fuel for the Kewaunee plant involves the mining and milling of uranium ore to uranium concentrates, the conversion of uranium concentrates to uranium hexafluoride, enrichment of the uranium hexafluoride and fabrication of the enriched uranium into usable fuel assemblies. After a region (approximately one-third of the nuclear fuel assemblies in the reactor) of spent fuel is removed from the reactor, it is placed in temporary storage for cooling in a spent fuel pool at the plant site. Permanent storage is addressed below. Presently, there are no operating facilities in the United States reprocessing commercial nuclear fuel. A discussion of the nuclear fuel supply for Kewaunee, which requires approximately 250,000 pounds of uranium concentrates per year follows:\n(a) Requirements for uranium are met through spot market purchases of uranium. In general, a four-year supply of uranium is maintained.\n(b) Uranium hexafluoride, from inventory and from spot market purchases, was used to satisfy converted material requirements in 1994. Conversion services relating to uranium hexafluoride will be purchased on the spot market in the future.\n(c) In 1994, enriched uranium was procured from COGEMA, Inc. pursuant to a contract last amended in 1993. Enrichment services were purchased from the Department of Energy (DOE), under the terms of the utility services contract. This contract is in effect for the life of Kewaunee. The partnership is committed to take 70 percent of its annual requirements in 1995, and in alternate years thereafter, from the DOE.\n(d) Fuel fabrication requirements through June 15, 1995 are covered by contract. This contract contains an option to allow extension of the contract through 1998. WPSC is negotiating a contract for fuel fabrication extending through 2001.\n(e) Beyond the stated periods for Kewaunee, additional contracts for uranium concentrates, conversion to uranium hexafluoride, fabrication and spent fuel storage will have to be procured. The prices for the foregoing are expected to increase.\nThe National Energy Policy Act of 1992 provides that both the Federal government and the nuclear utilities fund the decontamination and decommissioning of the three federal gaseous diffusion plants in the United States. This will require the owners of Kewaunee to pay approximately $15 million in current dollars over a period of 15 years. WPL's share amounts to an annual payment of approximately $410,000.\nThe steam generator tubes at the Kewaunee plant are susceptible to corrosion characteristics, a condition that has been experienced throughout the nuclear industry. Annual inspections are performed to identify degraded tubes. Degraded tubes are either repaired by sleeving or are removed from service by plugging. The steam generators were designed with approximately 15 percent heat transfer margin, meaning that full power should be sustainable with the equivalent of 15 percent of the steam generator tubes plugged. Tube plugging and the build-up of deposits on the tubes affect the heat-transfer capability of the steam generators to the point where eventually full power operation is not possible and there is a gradual decrease in the capacity of the plant. As a result of this process, Kewaunee's capacity could be reduced by as much as 20% by the year 2013 when the current operating license expires. Currently, the equivalent of approximately 12 percent of the tubes in the steam generator are plugged. WPL and the joint-owners recently completed studies evaluating the economics of replacing the two steam generators at Kewaunee. The studies resulted in the conclusion that the most prudent course of action is to continue operation of the existing steam generators. WPL and the other joint-owners continue to evaluate appropriate strategies, including replacement, as well as continued operation of the steam generator without replacement. WPL and the joint- owners also continue to fund the development of welded repair technology for steam generator tubes. The plant is expected to be operated until at least 2013. WPL and the joint-owners are also continuing to evaluate and implement initiatives to improve the performance of Kewaunee which already performs at above average levels for the industry. These initiatives include conversion from a 12-month to an 18-month fuel cycle and numerous other cost reduction measures. These initiatives have resulted in reductions in Kewaunee operating and maintenance costs since 1991.\nPhysical decommissioning is expected to occur during the period 2014 to 2021 with additional expenditures being incurred during the period 2022 to 2050 related to the storage of spent nuclear fuel at the site. Wisconsin utilities operating nuclear generating plants are required by the PSCW to establish external trust funds to provide for the decommissioning of such plants. The market value of the investments in the funds established by WPL at December 31, 1994 totaled $51.8 million. Additionally, in July 1994, the PSCW issued a generic order covering utilities that have nuclear generation. This order standardizes the escalation assumptions to be used in determining nuclear decommissioning liabilities.\nWPL's share of the decommissioning costs is estimated to be $159 million (in 1994 dollars, assuming the plant is operating through 2013) based on a 1992 study, using the immediate dismantlement method of decommissioning. The undiscounted amount of decommissioning costs estimated to be expended between the years 2014 and 2050 is $1,016 million. After-tax earnings on the tax-qualified and nontax-qualified decommissioning funds are assumed to be 6.1% and 5.1%, respectively. The future escalation rate is assumed to be 6.5%.\nPursuant to the Nuclear Waste Policy Act of 1982, the DOE has entered into a contract with WPL to accept, transport and dispose of spent nuclear fuel beginning no later than January 31, 1998. It is likely that the DOE will delay the acceptance of spent nuclear fuel beyond 1998. A fee to offset the costs of the DOE's disposal for all spent fuel used since April 7, 1983 has been assessed by the DOE at one mill per net kilowatthour of electricity generated and sold by the Kewaunee nuclear power plant. An additional one-time fee was paid for the disposal of spent nuclear fuel used to generate electricity prior to April 7, 1983.\nSpent fuel is currently stored at Kewaunee. The existing capacity of the spent fuel storage facility will enable storage of the projected quantities of spent fuel through April 2001. WPL is currently evaluating options for the storage of additional quantities beyond 2001. Several technologies are available. An investment of approximately $2.5 million in the early 2000's could provide additional storage sufficient to meet spent fuel storage needs until the expiration of the current operating license.\nThe Low-Level Radioactive Waste Policy Act of 1980 as amended in 1985 provides that states may enter into compacts to provide for regional low-level waste disposal facilities. Wisconsin is a member of the Midwest Interstate Low-Level Radioactive Waste Compact. The state of Ohio has been selected as the host state for the Midwest Compact and is proceeding with the preliminary phases of site selection. In June of 1994, the Branwell, South Carolina disposal facility, which had been accepting Kewaunee low level radioactive waste materials, discontinued taking waste materials from outside its region. WPL expects to have sufficient storage space of its own to satisfy low level radioactive waste disposal needs until the Ohio facility accepts low level radioactive waste materials.\nRecovery of Electric Fuel Costs\nIn 1994 WPL did not automatically pass changes in electric fuel costs through to its Wisconsin retail electric customers. Instead, rates were based on estimated per unit fuel costs established during rate proceedings and were not subject to change by fuel cost fluctuations unless actual costs were outside specified limits. If actual fuel costs had varied from the estimated costs by more than +10 percent in a month or by more than +3 percent for the test year to date, rates could have been adjusted, based on the results of a special fuel cost hearing. During 1994, fuel costs remained within the aforementioned parameters. See Note 1F in the Notes to Consolidated Financial Statements included as part of Item 8 hereto.\nWPL's wholesale rates and South Beloit's retail rates contain fuel adjustment clauses pursuant to which rates are adjusted monthly to reflect changes in the costs of fuel.\nGAS OPERATIONS:\nGeneral\nAs of December 31, 1994, WPL provided retail natural gas service to approximately 141,000 customers in 239 cities, villages and towns in 22 counties in southern and central Wisconsin and one county in northern Illinois.\nWPL's gas sales follow a seasonal pattern. There is an annual base load of gas used for heating, cooking, water heating and other purposes, with a large peak occurring during the heating season.\nIn 1994, WPL continued to purchase significant volumes of lower cost gas directly from producers and marketers and transported those volumes over its two major pipeline supplier's systems. This replaced higher cost gas historically purchased directly from the major pipeline systems.\nGas Supplies\nDuring 1993, both of the interstate pipelines which serve WPL, ANR Pipeline and Northern Natural Pipeline, completed their transition to providing unbundled services as mandated by the FERC in its Order 636. As a result, WPL now contracts with these two parties for various unbundled services such as firm and interruptible transportation, firm and interruptible storage service and \"no-notice\" service. WPL and its gas customers have benefited from enhanced access to competitively priced gas supplies, and from more flexible transportation services. As part of this restructuring, pipelines have sought and received authorization to recover from their customers certain transition costs associated with restructuring. WPL is passing these costs along to its retail gas customers pursuant to provisions of its retail gas tariffs.\nThe gas industry, in general, was put to a severe test during the first quarter of 1994 in the wake of the coldest weather on record. On January 18, 1994, the temperature averaged -17F in Madison, Wisconsin and did not rise above -7F. WPL set a record peak day load of 251,194 MMBTU. Overall throughput for January was 23% above forecast. Through effective use of transportation, supply, and storage contracts and by invoking tariff language allowing interruption and constraint of gas supplies to WPL's large industrial and commercial customers, WPL was able to maintain gas flows within the parameters imposed by its pipeline contracts. By doing so, WPL avoided substantial penalty exposure from the pipeline companies for unauthorized use of gas. WPL's large industrial and commercial customers served under interruptible rates moved to alternate fuel supplies during the periods of interruption and constraint. These customers pay a discounted rate year round in exchange for WPL's right to interrupt service to their facilities.\nWPL's portfolio of natural gas contracts over the last several years is as follows:\nAs the natural gas market continues to evolve, WPL continuously evaluates products and services provided by pipelines and gas suppliers to meet the changing needs of its firm and interruptible gas customers.\nEnvironmental Matters\nWPL cannot precisely forecast the effect of future environmental regulations by Federal, state and local authorities upon its generating, transmission and other facilities, or its operations, but has taken steps to anticipate the future while meeting the requirements of current environmental regulations. The Clean Air Act Amendments of 1977 and subsequent amendments to the Clean Air Act, as well as the new laws affecting the handling and disposal of solid and hazardous wastes along with clean air legislation passed in 1990 by Congress, could affect the siting, construction and operating costs of both present and future generating units.\nUnder the Federal Clean Water Act, National Pollutant Discharge Elimination System permits for generating station discharge into water ways are required to be obtained from the DNR to which the permit program has been delegated. These permits must be periodically renewed. WPL has obtained such permits for all of its generating stations or has filed timely applications for renewals of such permits.\nAir quality regulations promulgated by the DNR in accordance with Federal standards impose statewide restrictions on the emission of particulates, sulfur dioxide, nitrogen oxides and other air pollutants and require permits from the DNR for the operation of emission sources. WPL currently has the necessary permits to operate its fossil-fueled generating facilities. With the passage of the new Federal Clean Air Act Amendments, the states are required to include these provisions into their permit requirements. WPL has submitted timely Title V permit applications in compliance with schedules set forth by the regulators. The operating permits, when issued, will consolidate all existing air permit conditions and regulatory requirements into one permit for each facility. Permits may be issued in late 1995 or 1996. Until such time, the facilities will continue to operate under their existing permit conditions.\nPursuant to Section 144.386(2)of the Wisconsin Statutes, WPL has submitted data and plans for 1995 sulfur dioxide emissions compliance. Actual 1994 emissions were reported to the DNR. WPL is currently in compliance with this state requirement. WPL will make any necessary operational changes in fuel types and power plant dispatch to comply with the system emissions limit of 1.2 pounds SO2 per million BTU.\nWPL's compliance strategy for Wisconsin's sulfur dioxide law (discussed above) and the Federal Clear Air Act Amendments required plant upgrades at its generating facilities. The majority of these projects were completed in 1993. WPL has installed continuous emission monitoring systems at all of its coal fired boilers in compliance with Federal requirements. Monitoring for sulfur dioxide was also required by Title IV of the Federal Clean Air Act at WPL's South Fond du Lac combustion turbine site. These requirements were also met. Additional monitoring systems for nitrogen oxides will be required by January 1, 1996 at the combustion turbine site. WPL will install these monitors in 1995. No significant investments are anticipated at this time to meet the requirements of the Federal Clean Air Act Amendments.\nPursuant to Section 311(j)(5) of the Clean Water Act, WPL has submitted facility response plans for the Rock River generating station and the South Fond du Lac combustion turbine site. The plans address pollution prevention and spill response activities for those facilities with capacity to store in excess of one million gallons of oil.\nWPL maintains licenses for all its ash disposal facilities and regularly reports to the DNR groundwater data and quantities of ash landfilled or reused. The landfills are operated according to a Plan of Operation approved by the DNR.\nWPL's accumulated pollution abatement expenditures through December 31, 1994, totaled approximately $133 million. The major expenditures consist of about $60 million for the installation of electrostatic precipitators for the purpose of reducing particulate emissions from WPL's coal-fired generating stations and approximately $73 million for other pollution abatement equipment at the Columbia, Edge- water, Kewaunee, Nelson Dewey, Rock River and Blackhawk plants. Expenditures during 1994 totalled approximately $5 million. Estimated future pollution abatement expenditures total $1.5 million through 1996. WPL's estimated pollution abatement expenditures are subject to continuing review and are revised from time to time due to escalation of construction costs, changes in construction plans and changes in environmental regulations.\nSee \"Electric Operations - Fuel\" for information concerning the disposal of spent nuclear fuel and high level nuclear waste.\nManufactured Gas Plant Sites\nHistorically, WPL has owned 11 properties that have been associated with the production of manufactured gas. Currently, WPL owns five of these sites, three are owned by municipalities, and the remaining three are owned by private companies. In 1989, WPL initiated investigation of these manufactured gas plant sites. The DNR has been involved in reviewing investigation plans and has received ongoing reports regarding these investigations.\nIn 1992, and into the beginning of 1993, WPL continued its investigations and studies. WPL confirmed that there was no contamination at two of the sites and received a close out letter from the DNR related to one of those sites and requested a close out letter for the other site. Additionally, the investigation of historical records at a third site indicated a minimal likelihood of any significant environmental impacts. In February 1993, WPL completed cost estimates for the environmental remediation of the eight remaining sites. The results of this analysis indicate that during the next 34 years, WPL will expend approximately $81 million for feasibility studies, data collection, soil remediation activities, groundwater research and groundwater remediation activities, including construction of slurry containment walls and the installation of groundwater pump and treatment facilities. This estimate was based on various assumptions, and is subject to continuous review and revision by management.\nThe cost estimate set forth above assumes 4 percent average inflation over a 34 year period. The cost estimate also contemplates that primarily groundwater pump and treatment activities will take place after 1998 through and including 2027. During this time, WPL estimates that it will incur average annual costs of $2.0 million to complete the planned groundwater remediation activities.\nWith respect to rate recovery of these costs, the PSCW has approved a five year amortization of the unamortized balance of environmental costs expended to date.\nIn addition, WPL is pursuing insurance recovery for the costs of remediating these sites and is investigating to determine whether there are other parties who may be responsible for some of the clean-up costs.\nThrough 1994, management has continued its oversight of the issues related to the above manufactured gas plant sites without significant revision to the above estimates and assumptions.\nBased on the present regulatory record at the PSCW, management believes that future costs of remediating these manufactured gas plant sites will be recovered in rates.\nHDC\nIncorporated in 1988, HDC is the parent company of all of the Company's nonutility businesses. HDC and its principal subsidiaries are engaged in business development in three major areas: (1) environmental engineering and consulting, (2) affordable housing, and (3) energy services.\nAt year-end 1994, HDC employed approximately 1,444 persons: 839 in the area of environmental engineering and consulting, 149 in the area of affordable housing, 439 in the area of energy services, and 17 at the HDC level.\nENVIRONMENTAL ENGINEERING AND CONSULTING:\nWPL acquired RMT, Inc. in 1983. It subsequently became a wholly owned subsidiary of HDC in 1988. In 1992, HDC transferred its ownership of RMT to Environmental Holding Company (\"EHC), a wholly owned subsidiary of HDC and the parent company for its environmental engineering and consulting activities. RMT is a Madison, Wisconsin based environmental and engineering consulting company that serves clients nationwide in a variety of industrial segment markets. The most significant of these are foundries, chemical companies, pulp and paper processors, and other manufacturers. RMT specializes in solid and hazardous waste management, ground water quality protection, industrial design and hygiene engineering, laboratory services, and air and water pollution control. RMT owns and operates chemical and soil-testing laboratories in Madison and leases biological-testing laboratories in Greenville, South Carolina.\nEHC acquired Jones & Neuse, Inc. (\"J&N\") in 1993. J&N is based in Austin, Texas and serves EHC's gulf coast region. J&N has four additional Texas offices, a Louisiana office and a Mexican subsidiary (ABC Estudios y Projectos). It provides full capabilities in air quality, water quality, hazardous and solid waste engineering, and remedial projects.\nIn addition to J&N, EHC acquired Hydroscience, Inc. (\"Hydroscience\") and Four Nines, Inc. (\"Four Nines\") in 1993. In 1994, Hydroscience and Four Nines were merged into RMT.\nIn 1994, RMT acquired Braithwaite Consultants, Inc. (\"Braithwaite\"), located in Ann Arbor, Michigan. Braithwaite, combined with the Lansing, MI office of RMT, will primarily serve the Michigan marketplace.\nAFFORDABLE HOUSING:\nFormed by HDC in 1988, Heartland Properties, Inc. (\"HPI\") is responsible for the development and management of HDC's real estate and housing investments. HPI's primary focus has been the development, construction, and management of affordable housing and historic rehabilitation properties in Wisconsin, Indiana, Michigan, and Illinois. As of December 31, 1994, HPI's level of investment in housing was approximately $98 million, providing nearly 2,250 units to a diverse group of residents.\nToolkit Property Management Systems, Inc. (\"Toolkit\"), organized in 1993, provides property management services for many of HPI's housing projects.\nTo facilitate HPI's development and financing efforts, HDC incorporated Capital Square Financial Corporation (\"Capital Square\") in 1992 and Heartland Capital Company LLC (\"HCC\") in 1994 to provide mortgage banking services and construction financing services, respectively, to the affordable housing market.\nHeartland Retirement Services, Inc. (\"HRS\"), organized in 1993, provides a comprehensive range of housing related products for the fastest growing segment of the American population, older adults.\nENERGY SERVICES:\nA&C Enercom, Inc. (\"A&C\") was acquired by HDC in 1993. A&C, a utility service company, is based in Atlanta, Georgia and provides a variety of services including marketing and demand side management primarily to public electric and gas utilitiy companies.\nEntec Consulting, Inc. (\"Entec\"), acquired by HDC in 1993, is a Madison, Wisconsin based firm that provides full-service consulting to the utility industry for power generation computer software programs.\nIn 1994, A&C sold Ecogroup, Inc. Ecogroup, a Phoenix, Arizona based company initially acquired by A&C in 1993, provides energy and environmental programs primarily for the electric and gas utility industry.\nHDC has begun an assessment of the strategic fit of its utility service business and is considering various alternatives, including the possible sale of part or all of this business.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nWPL\nThe following table gives information with respect to electric generating facilities of WPL (including WPL's portion of those facilities jointly-owned).\nThe maximum net hourly peak load on WPL's electric system was 2,002,000 kw and occurred on June 16, 1994. At the time of such peak load, 2,386,000 kw were produced by generating facilities operated by WPL (including other company shared jointly-owned facilities). WPL delivered 934,000 kw of power and received 540,000 kw of power from external sources. During the year ended December 31, 1994, about 84.4 percent of WPL's total kilowatthour requirements were generated by company-owned and jointly-owned facilities and the remaining 15.6 percent was purchased. Substantially all of WPL's facilities are subject to the lien of its first mortgage bond indenture.\nHDC:\nThe following table gives information with respect to rental properties associated with HPI's affordable housing and historic rehabilitation project developments as of December 31, 1994.\nLocation Housing Development Resident Type Amount (In Thousands) Property:\nAntigo, WI The Depot Families $ 2,219 Appleton, WI Lincoln Mills Families\/Elderly 4,495 Appleton, WI Ravine Mills Families\/Elderly 2,510 Appleton, WI The Mills II Families\/Elderly 7,394 DePere, WI Lawton Foundry Families 4,354 Madison, WI The Avenue Disabled\/Families 2,899 Madison, WI YWCA Women & Homeless 5,593 Marinette, WI Dunlap Square Families\/Elderly 8,974 Marshfield, WI The Woodlands Families\/Elderly 2,615 McFarland, WI The Cottages Families\/Elderly 2,390 Sheboygan Falls, WI Jung Apartments Families 3,628 Sheboygan, WI Sunnyside Townhouses Families 2,543 Sheboygan, WI Brickner Woolen Mills Families\/Elderly 3,283 Sun Prairie, WI Vandenburg Heights Families 2,997 Verona, WI Sugar Creek Elderly 3,027 Various Other Families, Elderly, Singles, Disabled & Homeless 45,834 ------- Total property 104,755\nAccumulated depreciation (8,138) ------- Net property $96,617 =======\nOccupancy rates in the 60 properties\/investments owned by HPI averaged 94 percent during 1994.\nHDC has no other properties which it considers to be material in relation to the Company's consolidated financial statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or to which any of their property is subject.\nENVIRONMENTAL MATTERS\nThe information required by Item 3 is included in this Form 10-K in Note 11c to Notes to Consolidated Financial Statements, which information is incorporated herein by reference.\nRATE MATTERS\nThe information required by Item 3 is included in Items 6 and 7 of this Form 10-K within the Management's Discussion and Analysis of Financial Condition and Results of Operations narrative under the caption \"Rates and Regulatory Matters.\"\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 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nErroll B. Davis, Jr, 50, was elected President on January 17, 1990 and Chief Executive Officer, effective July 1, 1990 of the Company. He has served as President and Chief Executive Officer of WPL since August 1, 1988. He has served as a director of the Company since March 1988.\nLance W. Ahearn, 46, was elected President of HDC effective April 1, 1990 and Chief Executive Officer effective May 4, 1990. Prior to joining HDC, he held several management positions with Bucyrus Erie Company, Milwaukee, Wisconsin.\nEdward M. Gleason, 54, was elected Vice President, Treasurer and Corporate Secretary of the Company effective October 3, 1993. He previously served as Vice President-Finance and Treasurer of WPL since May 1986. Mr. Gleason functions as the principal financial officer of the Company.\nWilliam D. Harvey, 45, was appointed Senior Vice President of WPL effective October 3, 1993. He previously served as Vice President- Natural Gas and General Counsel since August 1992, Vice President-General Counsel since October 1, 1990 and Vice President-Associate General Counsel since July 1986. Prior to joining WPL, he was a member of the law firm of Wheeler, Van Sickle, Anderson, Norman and Harvey.\nEliot G. Protsch, 41, was appointed Senior Vice President of WPL effective October 3, 1993. He previously served as Vice President- Customer Services and Sales since August 1992, Vice President and General Manager-Energy Services since January 1989 and District Manager, Dane County, since October 1986.\nA.J. (Nino) Amato, 43, was appointed Senior Vice President of WPL effective October 3, 1993. He previously served as Vice President - Marketing and Strategic Planning of WPL since December 1992, Vice President - Marketing and Communications of WPL since January 1989 and Director of Electric Marketing and Customer Service since October 1988. He had been President of Forward Wisconsin, Inc. from 1987 to 1988.\nDaniel A. Doyle, 36, was appointed Vice President-Finance, Controller and Treasurer of WPL on December 25, 1994. He previously served as Controller and Treasurer of WPL since October 3, 1993. He has served as Controller of WPL since July 1992. Prior to joining WPL, he was Controller of Central Vermont Public Service Corporation since December 1988.\nSteve F. Price, 42, was appointed Assistant Corporate Secretary and Assistant Treasurer on April 15, 1992. He had been Cash Management Supervisor since December 1987. He was also appointed Assistant Corporate Secretary of WPL on April 15, 1992.\nNOTE: All ages are as of December 31, 1994. None of the executive officers listed above is related to any director of the Board or nominee for director of the Company.\nExecutive officers of the Company have no definite terms of office and serve at the pleasure of the Board of Directors.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock trades on the New York Stock Exchange. Quarterly Price Ranges and Dividends with respect to the Common Stock are as follows:\nYear-end stock price: $27 3\/8\nAt December 31, 1994, there were approximately 37,049 holders of record of the Company's common stock including underlying holders in the Company's Dividend Reinvestment and Stock Purchase Plan.\nWPL's retail rate order effective January 1, 1995, requires WPL to maintain a utility common equity level of 51.93 percent of total utility capitalization during the two year test year ending December 31, 1996. In addition, the PSCW ordered that it must approve the payment of dividends by WPL to the Company that are in excess of the level forecasted for 1995 ($58.1 million), if such dividends would reduce WPL's average common equity ratio below 51.93 percent.\nITEMS 6 AND 7. SELECTED FINANCIAL DATA AND MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nWPL HOLDINGS, INC.\nManagement's Discussion and Analysis of Financial Condition and Results of Operations\n1994 COMPARED WITH 1993\nOVERVIEW\nEarnings per share of WPL Holdings, Inc. (the \"Company\") common stock increased to $2.13 in 1994 compared with $2.11 in 1993. Earnings for 1994 were significantly affected by two non-recurring items from the Company's utility subsidiary Wisconsin Power and Light Company (\"WPL\"). These items were the reversal of a coal contract penalty in the 1st quarter and costs associated with early retirement and severance programs which primarily occurred in the 4th quarter. Both of these items are discussed in the \"Other Events\" section of Management's Discussion and Analysis. The following breakout presents the recurring aspects of 1994's operations.\n1994 1993\nEarnings per share, as reported $2.13 $2.11 Less: Increase in earnings from reversal of coal contract penalty (.16) ( - ) Add: Decrease in earnings from costs associated with early retirement and severance programs .27 .04 ----- ----- Earnings per share before the above non-recurring items $2.24 $2.15 ===== =====\nThe increase in the \"Earnings per share before the above non-recurring items\" primarily reflects an increase in operating earnings from WPL. The increase was somewhat offset by program start-up costs associated with expansion of the affordable housing and energy services businesses of the Company's non-regulated subsidiary, Heartland Development Corp. (\"HDC\").\nWPL's electric margin increased during 1994 compared to 1993. The primary factor was a 3.8 percent retail rate increase effective October 1, 1993. Strong economic conditions in the industrial and commercial customer classes contributed higher sales and customer growth. A colder than normal January and a very warm mid-September offset relatively mild summer conditions in July and August making 1994 a relatively average year in terms of degree day impacts on sales volumes. Electric production fuel costs were stable in 1994. The volume of purchased power increased as a result of WPL's efforts to conserve coal inventories during a rail strike in the 3rd quarter of 1994. See \"Other Events\" for details.\nGas margin increased in 1994 from 1993 primarily based on two factors: 1) a 1.4 percent retail rate increase effective October 1, 1993 and, 2) an increase in customers in the higher rate firm service resulted in a more favorable sales mix. The overall cost of purchased gas declined reflecting WPL's effective use of opportunities on the gas spot market.\nFees, Rents and Other Operating Revenues (\"Other Revenues\")\nEnvironmental services revenues increased due to continued strong demand. Other revenues increased due to an increased number of affordable housing project syndications and the inclusion of the full year of revenues in 1994 for A&C Enercom Consultants, Inc. that was acquired in February, 1993.\nOther Operation Expense\nThe increase in other operation expense is primarily related to the early retirement and severance programs discussed later in the \"Other Events\" section and increased program start-up costs associated with the expansion of the Company's affordable housing and energy services businesses. Offsetting these costs were reductions in WPL's operating costs resulting from the ongoing reengineering of its processes.\nMaintenance\nMaintenance expense decreased between years due to the variation in the timing and extent of WPL's maintenance outages at its generating facilities between years. Secondarily, a severe storm in the summer of 1993 increased 1993's maintenance expense related to service restoration.\nDepreciation and Amortization\nDepreciation expense increased, principally reflecting increased property additions, and increased decommissioning costs for WPL.\nOther Income and (Deductions)\nOther income increased due to the reversal of a coal contract penalty discussed later in the \"Other Events\" section.\nIncome Taxes\nIncome taxes increased between years primarily due to higher taxable income.\nAffordable housing tax credits declined as HPI reduced its ownership interests in qualifying properties late in 1993, placing more emphasis on the generation of syndication and development fees and retaining only small ownership interests in additional properties.\n1993 COMPARED WITH 1992\nOVERVIEW\nEarnings per share of the Company common stock increased to $2.11 in 1993 compared with $2.10 in 1992. The increase in earnings primarily reflected an increase in earnings from WPL. The principle factors leading to increased earnings included warmer summer weather and lower electric fuel costs per kWh which yielded higher electric margins for WPL. These increases were somewhat offset by increased depreciation expense resulting from additional investment in utility plant and property additions, a change in the mix of gas sales from higher margin sales to lower margin sales, the increase in the Federal corporate tax rate from 34 percent to 35 percent and a one-time 4-cent-per-share charge associated with a voluntary separation program for the executive management group at the utility.\nThe Company's nonregulated subsidiary, HDC, contributed to earnings through its principal businesses: 1) environmental engineering and consulting, 2) affordable housing, and 3) energy products and services.\nWPL's electric margin in dollars increased during 1993 compared with 1992 due to increased demand for electricity brought on by warmer summer weather. Residential customers, being the most weather sensitive, experienced the most significant increases. Wisconsin's strong economy kept the commercial and industrial classes growing steadily. These increases were coupled with declining electric production fuel costs per kWh. The decrease in electric production fuels was due to WPL's aggressive pursuit of additional spot coal purchase opportunities as its longer term contracts began to expire. Additionally, a highly competitive rail transportation environment significantly reduced the cost of transporting the coal. Also, lower cost purchased power became available due to excess capacity in the bulk-power market.\nWPL's gas revenues for 1992 were affected by the recognition of a $4.9 million before-tax refund to its natural gas customers resulting from an adjustment in the calculation of the purchased gas adjustment clause. Without the impact of this revenue adjustment, comparative gas margins would have declined for 1993 compared with 1992.\nThe overall increases in gas revenues and purchased gas costs between years resulted primarily from increased volumes procured on behalf of transportation customers. This had the impact of decreasing margins as a percentage of total revenues. A change in the mix of gas sales from higher margin residential sales to lower margin sales also moved margins downward. Offsetting this decline, Wisconsin's strong economy enabled growth in the commercial and industrial classes, and there was also some overall increase in the demand for natural gas due to colder weather.\nFees, Rents and Other Operating Revenues (\"Other Revenues\")\nOther revenues increased between years as a result of RMT's and HPI's growth in their respective businesses and the result of acquisitions in the environmental and energy-services businesses.\nOther Operation Expense\nOther operation expense also increased as a result of the above factors. An additional increase resulted from higher WPL employee benefit expense (see Notes to Consolidated Financial Statements, Note 7). These increases were offset somewhat by decreases in WPL's conservation program expenditures and decreases in fees associated with the sale of WPL's accounts receivable due to a decline in interest rates. Additionally, WPL's cost management efforts have helped control annual inflationary pressures on general and administrative costs.\nDepreciation and Amortization\nDepreciation and amortization expense increased, principally reflecting increased property additions and the commencement of deferred charge amortizations approved in WPL's rate orders received in December 1992 and October 1993. The most significant amortizations include the amortization related to an acquisition adjustment which resulted from the purchase of transmission facilities and the amortization of costs incurred related to the remediation of former manufactured gas plant sites (see Notes to the Consolidated Financial Statements, Note 11).\nAllowance for Funds Used During Construction (\"AFUDC\")\nTotal AFUDC increased in 1993 compared with 1992, reflecting the greater amounts of construction work in progress including the costs associated with WPL's construction of two 86-megawatt combustion-turbine generators.\nInterest Expense\nInterest expense on debt decreased between years, primarily reflecting the benefits of WPL's refinancing efforts.\nLIQUIDITY AND CAPITAL RESOURCES\nRates and Regulatory Matters\nOn December 9, 1994, the Public Service Commission of Wisconsin (\"PSCW\") issued rate order UR-109, effective for a two-year period beginning January 1, 1995. The order included the following decisions on WPL's retail rate application as filed on February 4, 1994: 1) electric revenues will be decreased by approximately $12.3 million (2.8 percent) annually, 2) natural gas revenues will be increased by approximately $.7 million (.5 percent) annually, 3) return on common equity will be 11.5 percent versus WPL's previously allowed return on equity of 11.6 percent.\nFurther, the PSCW approved certain incentive programs described below:\n1. The electric fuel adjustment mechanism was eliminated. In its absence, WPL will benefit from reductions in fuel cost. Conversely, WPL will be exposed to increases in fuel costs.\n2. The automatic purchased gas adjustment clause was also eliminated. In the future, the fluctuations in the commodity cost of gas above or below a prescribed commodity price index will serve to increase or decrease WPL's margin on gas sales. Fixed demand costs are excluded from the incentive program. Both benefits and exposures are subject to ratepayer sharing provisions, which are capped at $1.1 million.\n3. In order to promote air quality and reliability, there are SO2 emissions and service reliability incentive clauses. Positive incentive available under these clauses is a pre-tax $1.5 million for the SO2 emissions and a pre-tax $.5 million for the service reliability. WPL's earnings are also negatively exposed for equal amounts. Since WPL is allowed to collect all revenues under these programs in advance, up to $4.0 million annually of pre-tax revenue may be collected subject to refund upon final determination of performance under this program.\nIndustry Outlook\nThe PSCW has recently opened a formal docket initiating an inquiry into the future structure of the electric utility industry in Wisconsin. The goals of Wisconsin utility regulation and the principles to be used in choosing among alternative proposals have been identified. WPL has submitted its preferred structure which, in summary form, calls for open access to transmission and distribution systems and a competitive power generation market place. It is not possible at this time to predict the outcome of these proceedings.\nFinancing and Capital Structure\nThe level of short-term borrowings fluctuates based on seasonal corporate needs, the timing of long-term financing and capital market conditions. The Company's operating subsidiaries generally issue short-term debt to provide interim financing of construction and capital expenditures in excess of available internally generated funds. The subsidiaries periodically reduce their outstanding short-term debt through the issuance of long-term debt and through the Company's additional investment in their common equity. To maintain flexibility in its capital structure and to take advantage of favorable short-term rates, the Company also uses proceeds from the sales of accounts receivable and unbilled revenues to finance a portion of its long-term cash needs. The Company anticipates that short-term debt funds will continue to be available at reasonable costs due to strong ratings by independent utility analysts and rating services. WPL commercial paper has been rated A-1+ by Standard & Poor's Corp. and P-1 by Moody's Investors Service.\nBank lines of credit of $97.5 million at December 31, 1994 are available to support these borrowings.\nThe Company's capitalization at December 31, 1994, including the current maturities of long-term debt, variable rate demand bonds and short-term debt, consisted of 48.8 percent common equity, 4.9 percent preferred stock and 46.3 percent long-term debt. The common-equity-to-total capitalization ratio at December 31, 1994 increased to 48.8 percent from 47.9 percent at December 31, 1993.\nThe retail rate order effective January 1, 1995, requires WPL to maintain a utility common equity level of 51.93 percent of total utility capitalization during the two-year test year ending December 31, 1996. In addition, the PSCW ordered that it must approve the payment of dividends by WPL to the Company that are in excess of the level forecasted for 1995 ($58.1 million), if such dividends would reduce WPL's average common equity ratio below 51.93 percent.\nCapital Requirements\nThe Company's largest subsidiary, WPL, is capital-intensive and requires large investments in long-lived assets. Therefore, the Company's most significant capital requirements relate to WPL construction expenditures. Estimated capital requirements of WPL for the next five years are as follows:\nIncluded in the construction expenditure estimates, in addition to the recurring additions and improvements to the distribution and transmission systems, are the following: 1) expenditures for managing and controlling electric line losses and for the electric delivery system that will reduce electric line losses and enhance WPL's interconnection capability with other utilities; 2) expenditures related to environmental compliance issues, including the installation of additional emissions-monitoring equipment and coal-handling equipment; 3) expenditures associated with the construction of an 86-megawatt combustion-turbine generator expected to become operational in 1996.\nThe Company's capital requirements may also be impacted by decisions relating to the Kewaunee Nuclear Power Plant (\"Kewaunee\"). The steam generator tubes at Kewaunee are susceptible to corrosion characteristics, a condition that has been experienced throughout the nuclear industry. Annual inspections are performed to identify degraded tubes. Degraded tubes are either repaired by sleeving or are removed from service by plugging. The steam generators were designed with an approximately 15 percent heat transfer margin, meaning that full power should be sustainable with the equivalent of 15 percent of the steam generator tubes plugged. Tube plugging and the build-up of deposits on the tubes affect the heat-transfer capability of the steam generators to the point where eventually full-power operation is not possible and there is a gradual decrease in the capacity of the plant. The plant's capacity could be reduced by as much as 20% by the year 2013 when the current operating license expires. Currently, the equivalent of approximately 12 percent of the tubes in the steam generators are plugged. WPL and the joint-owners recently completed studies evaluating the economics of replacing the two steam generators at Kewaunee. The studies resulted in the conclusion that the most prudent course of action is to continue operation of the existing steam generators. WPL and the other joint- owners continue to evaluate appropriate strategies, including replacement, as well as continued operation of the steam generators without replacement. WPL and the joint owners also continue to fund the development of welded repair technology for steam generator tubes. The plant is expected to be operated until at least 2013. WPL and the joint- owners are also continuing to evaluate and implement initiatives to improve the performance of Kewaunee, which already performs at above- average levels for the industry. These initiatives include conversion from a 12-month to an 18-month fuel cycle and numerous other cost reduction measures. These initiatives have resulted in reductions in Kewaunee operating and maintenance costs since 1991.\nHDC has expanded its energy related products and services business and its environmental services through investment in existing businesses during 1994. In addition to its investment in affordable housing, HPI continues to market its affordable housing expertise by expanding its business to provide assistance to other corporate\/public investors in their development, operation and financing of affordable housing projects.\nHDC has begun an assessment of the strategic fit of its utility service business and is considering various alternatives, including the possible sale of part or all of this business.\nIn 1994, A&C Enercom sold its EcoGroup operations. EcoGroup, a Phoenix, Arizona based company initially acquired by A&C Enercom in 1993, provided energy and environmental programs primarily for the electric and gas utility industry.\nCapital Resources\nOne of the Company's objectives is to finance construction expenditures through internally generated funds supplemented, when required, by outside financing. With this objective in place, the Company has financed an average of 85 percent of its construction expenditures during the last five years from internal sources. However, during the next five years, the Company expects this percentage to be reduced primarily due to the continuation of major construction expenditures and the maturity of $64 million of WPL first mortgage bonds. External financing sources such as the issuance of long-term debt, common stock and short-term borrowings will be used by the Company to finance the remaining construction expenditure requirements for this period. Current forecasts are that $40.5 million of additional equity and $65 million of long-term debt will be issued over the next three years.\nIn 1994, the Company increased its dividends by 1.1 percent and issued 337,980 new shares of common stock through its Dividend Reinvestment and Stock Purchase Plan and 401(k) Savings Plan, generating proceeds of $9.7 million.\nINFLATION\nUnder current rate-making methodologies prescribed by the various commissions that regulate WPL, projected or forecasted operating costs, including the impacts of inflation, are incorporated into WPL revenue requirements. Accordingly, the impacts of inflation on WPL are currently mitigated. Although rates will be held flat until at least 1997, management expects that any impact of inflation will be mitigated by customer growth and productivity improvements. Inflationary impacts on the non-regulated businesses are not anticipated to be material to the Company.\nOTHER EVENTS\nCoal Contract Penalty\nIn November 1989, the PSCW concluded that WPL did not properly administer a coal contract, resulting in an assessment to compensate ratepayers for excess fuel costs having been incurred. As a result, WPL recorded a reserve in 1989 that had an after-tax affect of reducing 1989 net income by $4.9 million. The PSCW decision was found to represent unlawful retroactive rate-making by both the Dane County Circuit Court and the Wisconsin Court of Appeals. The case was then appealed to the Wisconsin Supreme Court.\nIn January, 1994, the Wisconsin Supreme Court affirmed the decisions of the Dane County Circuit Court and Wisconsin Court of Appeals. In management's opinion, all avenues for appeal have been exhausted. As a result, WPL reversed the entire reserve and was also allowed to collect interest on amounts of the penalty previously refunded to ratepayers. The reversal of the reserve plus interest had an after-tax affect of increasing net income in 1994 by $5.3 million.\nEarly Retirement and Severance Programs\nGiven the expectation of increasing competition, WPL has continued to reengineer its processes to implement cost efficiencies in its operations. In connection with these efforts, WPL offered voluntary early retirement programs and voluntary severance programs to affected employees in 1994 and 1993. These programs primarily closed late in the fourth quarter of 1994 and 1993.\nIn terms of pre-tax costs, the early retirement programs totalled $9.8 million and the severance programs totalled $3.9 million for a grand total of $13.7 million in 1994. For 1993, program costs totalled $1.8 million.\nCoal Transporter's Strike\nOne of WPL's major coal transporters experienced a labor strike during the third quarter of 1994. During the term of the strike (55 days), WPL's ability to receive coal from its suppliers was impaired, which required WPL to use some of its existing coal reserves and to purchase additional power. On August 29, 1994, President Clinton, acting under the Railway Labor Act, forced a temporary end (the \"cooling off period\") to the strike by ordering the railroad union employees back to work and establishing a three member Presidential Emergency Board to draft a recommended settlement. Railroad management and the United Transportation Union have subsequently settled on a contract. As of December 31, 1994, the existing and anticipated financial impact on WPL's operating results was not material.\nEnvironmental\nWPL cannot precisely forecast the effect of future environmental regulations by federal, state and local authorities upon its generating, transmission and other facilities, or its operations, but has taken steps to anticipate the future while meeting the requirements of current environmental regulations. The Clean Air Act Amendments of 1977 and subsequent amendments to the Clean Air Act, as well as the new laws affecting the handling and disposal of solid and hazardous wastes, along with the clean air legislation passed in 1990 by Congress, could affect the siting, construction and operating costs of both present and future generating units.\nUnder the Federal Clean Water Act, National Pollutant Discharge Elimination System permits for generating station discharge into water ways are required to be obtained from the Wisconsin Department of Natural Resources (DNR). WPL has obtained such permits for all of its generating stations or has filed timely applications for renewals.\nAir quality regulations promulgated by the DNR in accordance with federal standards impose statewide restrictions on the emission of particulates, sulfur dioxide, nitrogen oxides and other air pollutants and require permits from the DNR for the operation of emission sources. WPL currently has the necessary permits to operate its fossil-fueled generating facilities. However, beginning in 1994, new permits were required for all major facilities in Wisconsin. WPL's Columbia Generating facility submitted a permit application on May 1, 1994. The remaining facilities will be addressed in early 1995.\nWPL's compliance strategy for Wisconsin's 1993 sulfur dioxide law and the Federal Clean Air Act Amendments required plant upgrades at its generating facilities. The majority of these projects were completed in 1993 and 1994. WPL has installed continuous emissions monitoring systems at all of its coal fired boilers. No additional costs for compliance with these acid-rain-prevention requirements are anticipated at this time.\nAlso see Note 11c in the Notes to the Consolidated Financial Statements for a discussion of WPL's manufactured gas plant sites.\nITEM 8.","section_6":"","section_7":"","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo WPL Holdings, Inc.:\nWe have audited the accompanying consolidated balance sheets and statements of capitalization of WPL HOLDINGS, INC. (a Wisconsin corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, common shareowners' investment and cash flows for each of the three years in the period ended December 31, 1994. 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 WPL Holdings, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nMilwaukee, Wisconsin, ARTHUR ANDERSEN LLP February 1, 1995\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nThe accompanying notes are an integral part of the consolidated financial statements.\nWPL HOLDINGS, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (dollars in thousands except as otherwise indicated)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES:\na. Business and Consolidation:\nWPL Holdings, Inc. (the \"Company\" or \"WPLH\") is the parent holding company of Wisconsin Power and Light Company (\"WPL\") and Heartland Development Corporation (\"HDC\"). The consolidated financial statements include the Company and its consolidated subsidiaries, WPL and HDC, along with their respective subsidiaries. Certain amounts from prior years have been reclassified to conform with the current year presentation.\nWPL is a public utility predominantly engaged in the transmission and distribution of electric energy and the generation and bulk purchase of electric energy for sale. WPL also transports, distributes and sells natural gas purchased from gas suppliers. Nearly all of WPL's retail customers are located in south and central Wisconsin. WPL's principal consolidated subsidiary is South Beloit Water, Gas and Electric Company.\nHDC and its principal subsidiaries are engaged in business development in three major areas: 1) environmental services through the Environmental Holding Company (\"EHC\"), the parent company of RMT, Inc. (\"RMT\"), Jones and Neuse, Inc., and QES, Inc., 2) affordable housing and historic rehabilitation through Heartland Properties, Inc. (\"HPI\") and 3) energy services, which includes ENSERV, Inc., A&C Enercom Consultants, Inc. and Entec Consulting, Inc.\nb. Regulation:\nWPL's financial records are maintained in accordance with the uniform system of accounts prescribed by its regulators. The Public Service Commission of Wisconsin (\"PSCW\") and the Illinois Commerce Commission have jurisdiction over retail rates, which represent approximately 83 percent of electric revenues plus all gas revenues. The Federal Energy Regulatory Commission (\"FERC\") has jurisdiction over wholesale electric rates representing the balance of electric revenues. Statement of Financial Accounting Standards (\"SFAS\") No. 71, \"Accounting for the Effects of Certain Types of Regulation\" provides that rate-regulated public utilities such as WPL record certain costs and credits allowed in the ratemaking process in different periods than for unregulated entities. These are deferred as regulatory assets or regulatory liabilities and are recognized in the Consolidated Statements of Income at the time they are reflected in rates.\nc. Utility Plant and Other Property and Equipment:\nUtility plant and other property and equipment are recorded at original cost and cost, respectively. Utility plant costs include financing costs that are capitalized through the PSCW-approved allowance for funds used during construction (\"AFUDC\"). The AFUDC capitalization rates approximate WPL's cost of capital. These capitalized costs are recovered in rates as the cost of the utility plant is depreciated.\nNormal repairs, maintenance and minor items of utility plant and other property and equipment are expensed. Ordinary utility plant retirements, including removal costs less salvage value, are charged to accumulated depreciation upon removal from utility plant accounts, and no gain or loss is recognized. Upon retirement or sale of other property and equipment, the cost and related accumulated depreciation are removed from the accounts and any gain or loss is included in other income and deductions.\nd. Nuclear Fuel:\nNuclear fuel is recorded at its original cost and is amortized to expense based upon the quantity of heat produced for the generation of electricity. This accumulated amortization assumes spent nuclear fuel will have no residual value. Estimated future disposal costs of such fuel are expensed based on kilowatthours generated.\ne. Revenue:\nWPL accrues utility revenues for services provided but not yet billed. HDC records revenues earned but not billed and revenues from professional services rendered as incurred using a time-and-materials basis.\nf. Electric Production Fuels and Purchased Gas:\n(1)Electric Production Fuels:\nThrough 1994, the PSCW retail electric rates provided a range from which actual fuel costs could vary in relation to costs forecasted and used in rates. If actual fuel costs fell outside this range, a hearing could be held to determine if a rate change was necessary, and a rate increase or decrease could result.\nBeginning with WPL's latest rate order UR-109, effective January 1, 1995, the automatic fuel adjustment clause was eliminated. In its absence, WPL will benefit from reductions in fuel cost. Conversely, WPL will be exposed to increases in fuel costs.\nAn automatic fuel adjustment clause for the FERC wholesale portion of WPL's electric business operates to increase or decrease monthly rates based on changes in fuel costs.\n(2)Purchased Gas:\nThrough 1994, WPL's base gas cost recovery rates permitted the recovery of or refund to all customers for any increases or decreases in the cost of gas purchased from WPL's suppliers through a monthly purchased gas adjustment clause.\nBeginning with UR-109, the monthly purchased gas adjustment clause was also eliminated. In the future, the fluctuations in the commodity cost of gas above or below a prescribed commodity price index will serve to increase or decrease WPL's margin on gas sales. Fixed demand costs are excluded from the incentive program. Both benefits and\/or exposures are subject to ratepayer sharing provisions, which are capped at $1.1 million.\ng. Cash and Equivalents:\nThe Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. The carrying amount approximates fair value because of the short maturity of these items.\nh. Income Taxes:\nThe Company files a consolidated federal income tax return. Under the terms of an agreement between WPLH and its subsidiaries, WPL and HDC calculate their respective federal tax provisions and make payments to WPLH as if they were separate taxable entities. Beginning in 1993, the Company fully provides deferred income taxes in accordance with SFAS No.109, \"Accounting for Income Taxes,\" to reflect tax effects of reporting book and tax items in different periods.\nAs part of HPI's investments in affordable housing, HPI is eligible to claim affordable housing and historic rehabilitation credits. These tax credits can be recognized to the extent the Company has consolidated taxes payable.\ni. Goodwill:\nThe excess of the purchase cost over the fair value of net assets acquired is amortized over 20 to 30 years on a straight-line basis based on its estimated useful benefit. Subsequent to its acquisitions, the Company continually evaluates whether later events and circumstances have occurred that indicate the remaining estimated useful life of goodwill may warrant revision or that the remaining balance of goodwill may not be recoverable. To evaluate goodwill for possible impairment, the Company uses a forecast of the related business's discounted earnings over the remaining life of the goodwill. Goodwill (net of accumulated amortization) was $20,135 and $20,920 at December 31, 1994 and 1993, respectively.\nNOTE 2. PROPERTY:\na. Jointly-Owned Utility Plants:\nWPL participates with other Wisconsin utilities in the construction and operation of several jointly-owned utility generating plants. The chart below represents WPL's proportionate share of such plants as reflected in the Consolidated Balance Sheets at December 31, 1994 and 1993:\nEach of the respective joint owners finances its portion of construction costs. WPL's share of operation and maintenance expenses is included in the Consolidated Statements of Income.\nb. Capital Expenditures:\nThe Company's capital expenditures for 1995 are estimated to total $102 million. Substantial commitments have been incurred for such expenditures.\nNOTE 3. DEPRECIATION:\nThe Company uses the straight-line method of depreciation. For utility plant, straight-line depreciation is computed on the average balance of depreciable property at individual straight-line PSCW approved rates that consider the estimated useful life and removal cost or salvage value as follows:\nElectric Gas Water Common 1994 3.2% 3.7% 2.5% 7.2% 1993 3.2% 3.7% 2.5% 7.3% 1992 3.2% 3.7% 2.6% 7.1%\nEstimated useful lives related to other property and equipment are from 3 to 12 years for equipment and 31.5 to 40 years for buildings.\nNOTE 4. NUCLEAR OPERATIONS:\nDepreciation expense related to the Kewaunee Nuclear Power Plant (\"Kewaunee\") includes a provision to accrue for the cost of decommissioning over the life of the plant, which totalled $13.4 million, $6.1 million and $3.9 million in 1994, 1993 and 1992, respectively. Wisconsin utilities with ownership of nuclear generating plants are required by the PSCW to establish and make annual contributions to external trust funds to provide for plant decommissioning. Additionally, in July 1994, the PSCW issued a generic order covering utilities that have nuclear generation. This order standardizes the escalation assumptions to be used in determining nuclear decommissioning liabilities.\nWPL's share of the decommissioning costs is estimated to be $159 million (in 1994 dollars, assuming the plant is operating through 2013) based on a 1992 study, using the immediate dismantlement method of decommissioning. The undiscounted amount of decommissioning costs estimated to be expended between the years 2014 and 2050 is $1.016 billion. After-tax earnings on the tax-qualified and nontax-qualified decommissioning funds are assumed to be 6.1 percent and 5.1 percent, respectively. The future escalation rate is assumed to be 6.5 percent.\nDecommissioning costs and a charge to offset earnings on the external trusts are recorded as portions of depreciation expense and accumulated provision for depreciation on the Statements of Consolidated Income and the Consolidated Balance Sheets, respectively. As of December 31, 1994, the total decommissioning costs included in the accumulated provision for depreciation were approximately $62.8 million.\nWPL has established external trusts to hold decommissioning funds, and the PSCW has approved WPL's funding plan which provides for annual contributions of current accruals over the remaining service lives of the nuclear plants. The earnings on the external trusts accumulate in the fund balance and in the accumulated provision for depreciation. Such earnings on the external trust funds, which have been offset by a charge to depreciation expense on the Statements of Consolidated Income, were $2.7, $1.1 and $1.2 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nUnder the Nuclear Waste Policy Act of 1982, the U.S. Department of Energy (\"DOE\") is responsible for the ultimate storage and disposal of spent nuclear fuel removed from nuclear reactors.\nInterim storage space for spent nuclear fuel is currently provided at Kewaunee. Currently there is on-site storage capacity for spent fuel through the year 1999. Nuclear fuel, net, at December 31, consists of:\n1994 1993 Original cost of nuclear fuel $155,190 $147,325 Less--Accumulated amortization 135,794 129,325 -------- -------- Nuclear fuel, net $ 19,396 $ 18,000 ======== ========\nThe Price Anderson Act provides for the payment of funds for public liability claims arising from a nuclear incident. Accordingly, in the event of a nuclear incident, WPL, as a 41-percent owner of Kewaunee, is subject to an overall assessment of approximately $32.5 million per incident for its ownership share of this reactor, not to exceed $4.1 million payable in any given year.\nThrough its membership in Nuclear Electric Insurance Limited, WPL has obtained property damage and decontamination insurance totalling $1.5 billion for loss from damage at Kewaunee. In addition, WPL maintains outage and replacement power insurance coverage totalling $101.4 million in the event an outage exceeds 21 weeks.\nNOTE 5. NET ACCOUNTS RECEIVABLE:\nWPL has a contract with a financial organization to sell, with limited recourse, certain accounts receivable and unbilled revenues. These receivables include customer receivables resulting from sales to other public utilities as well as from billings to the co-owners of the jointly- owned electric generating plants that WPL operates. The contract allows WPL to sell up to $150 million of receivables at any time. Expenses related to the sale of receivables are paid to the financial organization under this contract and include, along with various other fees, a monthly discount charge on the outstanding balance of receivables sold that approximated a 4.86 percent annual rate during 1994. These costs are recovered in retail utility rates as an operating expense. All billing and collection functions remain the responsibility of WPL. The contract expires August 19, 1995, unless extended by mutual agreement.\nAs of December 31, 1994 and 1993, proceeds from the sale of accounts receivable totalled $76.5 million and $74 million, respectively. During 1994, WPL sold an average of $82.3 million of accounts receivable per month, compared with $75.9 million in 1993.\nAs a result of its diversified customer base and WPL's sale of receivables, the Company does not have any significant concentrations of credit risk in the December 31, 1994, net accounts receivable balance.\nNOTE 6. REGULATORY ASSETS AND REGULATORY LIABILITIES:\nCertain costs and credits are deferred and amortized in accordance with authorized or expected rate-making treatment. As of December 31, 1994 and 1993, regulatory created assets include the following:\n1994 1993 Environmental remediation costs $ 82,179 $ 82,380 Tax related (see Note 8) 43,736 47,787 Jurisdictional plant differences 7,173 6,533 Decontamination and decommissioning costs of federal enrichment facilities 7,100 6,181 Other 4,288 5,924 -------- -------- $144,476 $148,805 ======== ========\nAs of December 31, 1994 and 1993, regulatory created liabilities included $6,738 and $6,618 respectively, for amounts due to customers related to the sale of air emissions credits.\nNOTE 7. EMPLOYEE BENEFIT PLANS:\na. Pension Plans:\nWPL has non-contributory, defined benefit retirement plans covering substantially all employees. The benefits are based upon years of service and levels of compensation. WPL's funding policy is to contribute at least the statutory minimum to a trust.\nThe projected unit credit actuarial cost method was used to compute net pension costs and the accumulated and projected benefit obligations. The discount rate used in determining those benefit obligations was 8.25, 7.25 and 8.00 percent for 1994, 1993 and 1992 respectively. The long-term rate of return on assets used in determining those benefit obligations was 9.00, 9.75 and 10.00 percent for 1994, 1993, and 1992, respectively.\nThe following table sets forth the funded status of the WPL plans and amounts recognized in the Company's Consolidated Balance Sheets at December 31, 1994 and 1993:\n1994 1993 Accumulated benefit obligation-- Vested benefits $(134,829) $(135,303) Non-vested benefits (3,295) (2,962) --------- ---------- $(138,124) $(138,265) --------- ---------- Projected benefit obligation $(154,283) $(164,271) Plan assets at fair value, primarily common stocks and fixed income securities 178,095 183,881 --------- --------- Plan assets in excess of projected benefit obligation 23,812 19,610 Unrecognized net transition asset (19,376) (21,823) Unrecognized prior service cost 5,679 7,691 Unrecognized net loss 14,737 20,650 --------- --------- Pre-paid pension costs, included in deferred charges and other $ 24,852 $ 26,128 ========= =========\nThe net pension (benefit) recognized in the Consolidated Statements of Income for 1994, 1993 and 1992 included the following components:\n1994 1993 1992\nService cost $ 5,123 $ 4,263 $ 3,912 Interest cost on projected benefit\nobligation 12,051 11,614 10,615 Actual return on assets 1,016 (24,759) (12,143) Amortization and deferral (17,795) 8,430 (5,317) -------- -------- -------- Net pension cost (benefit) $ 395 $ (452) $ (2,933) ======== ======== ========\nb. Postretirement Health Care and Life Insurance:\nEffective January 1, 1993, the Company prospectively adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\". SFAS No. 106 establishes standards of financial accounting and reporting for the Company's postretirement health care and life insurance benefits. SFAS No. 106 requires the accrual of the expected cost of such benefits during the employees' years of service based on actuarial methodologies that closely parallel pension accounting requirements. WPL has elected delayed recognition of the transition obligation and is amortizing the discounted present value of the transition obligation to expense over 20 years. For WPL, the cost of providing postretirement benefits, including the transition obligation, is being recovered in retail rates under current regulatory practices.\nThe following table sets forth the plans' funded status:\n1994 1993 Accumulated postretirement benefit obligation-- Retirees $(29,273) $(27,358) Fully eligible active plan participants (5,998) (5,429) Other active plan participants (7,675) (9,980) -------- -------- Accumulated benefit obligation (42,946) (42,767) Plan assets at fair value 9,767 7,073 -------- -------- Accumulated benefit obligation in excess of plan assets $(33,179) $(35,694) Unrecognized transition obligation 26,474 29,638 Unrecognized loss (2,570) 2,025 -------- -------- Accrued postretirement benefits liability $ (9,275) $ (4,031) ======== ========\nFor 1994 and 1993, the annual net postretirement benefits costs recognized in the Consolidated Statements of Income consist of the following components:\n1994 1993\nService cost $ 1,739 $ 1,463 Interest cost on projected benefit obligation 3,135 3,151 Actual return on plan assets (253) (696) Amortization of transition obligation 1,527 1,560 Amortization and deferral (381) (27) ------- ------- Net postretirement benefits cost $ 5,767 $ 5,451 ====== ======\nThe postretirement benefits cost components for 1994 were calculated assuming health care cost trend rates ranging from 11.5 percent for 1994 and decreasing to 5 percent by the year 2002. The health care cost trend rate considers estimates of health care inflation, changes in utilization or delivery, technological advances, and changes in the health status of the plan participants. Increasing the health care cost trend rate by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1994 by $2.5 million and the aggregate of the service and interest cost components of the net periodic postretirement benefit cost for the year by $.4 million.\nThe assumed discount rate used in determining the accumulated postretirement obligation was 8.25 and 7.25 percent in 1994 and 1993, respectively. The long-term rate of return on assets was 9.00 and 9.50 percent in 1994 and 1993, respectively. Plan assets are primarily invested in common stock, bonds and fixed income securities. The Company's funding policy is to contribute the tax-advantaged maximum to a trust.\nThe costs for the postretirement health care and life insurance benefits, based on an actuarial determination were $1.3 million in 1992.\nc. Other Postemployment Benefits:\nIn November 1992, the Financial Accounting Standards Board issued SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\". SFAS No. 112, which was effective January 1, 1994, establishes standards of financial accounting and reporting for the estimated cost of benefits provided by an employer to former or inactive employees after employment but before retirement. The effect of adopting SFAS No. 112 was not material.\nNOTE 8. INCOME TAXES:\nThe following table reconciles the statutory federal income tax rate to the effective income tax rate:\n1994 1993 1992 Statutory federal income tax rate 35.0% 35.0% 34.0% State income taxes, net of federal benefit 5.3 5.1 7.0 Investment tax credits restored (1.9) (2.1) (2.7) Amortization of excess deferred taxes (1.6) (1.7) (1.8) Affordable housing and historical tax credits (4.6) (5.7) (7.5) Other differences, net 1.9 (3.2) (.6) ---- ---- ---- Effective income tax rate 34.1% 27.4% 28.4% ==== ==== ====\nThe breakdown of income tax expense as reflected in the Consolidated Statements of Income is as follows:\n1994 1993 1992 Current Federal $26,161 $20,725 $19,703 Current state 5,673 6,500 5,343 Deferred 10,321 5,015 8,124 Investment tax credit restored (1,926) (1,967) (2,125) Affordable housing and historical tax credits (4,818) (5,217) (7,788) ------- ------- ------- $35,411 $25,056 $23,257 ======= ======= =======\nIn 1992, deferred taxes arising from utility plant timing differences, the qualified nuclear decommissioning trust contribution, employee benefits and other totalled $4,104, $709, $2,081, and $1,230, respectively.\nThe temporary differences that resulted in accumulated deferred income tax (assets) and liabilities as of December 31 are as follows:\n1994 1993 Accelerated depreciation and other plant related $186,565 $171,993 Excess deferred taxes 21,215 22,744 Unamortized investment tax credits (21,784) (22,812) Allowance for equity funds used during construction 14,384 13,518 Regulatory liability 17,553 19,179\nOther 6,116 8,222 -------- -------- $224,049 $212,844 ======== ========\nChanges in WPL's deferred income taxes arising from the adoption of SFAS No. 109 represent amounts recoverable or refundable through future rates and have been recorded as net regulatory assets totalling approximately $26 million and $29 million in 1994 and 1993, respectively, on the Consolidated Balance Sheets. These net regulatory assets are being recovered in rates over the estimated remaining useful lives of the assets to which they pertain.\nNOTE 9. SHORT-TERM DEBT AND LINES OF CREDIT:\nThe Company and its subsidiaries maintain bank lines of credit, most of which are at the bank prime rates, to obtain short-term borrowing flexibility, including pledging lines of credit as security for any commercial paper outstanding. Amounts available under these lines of credit totalled $97.5 million, $100 million and $70 million as of December 31, 1994, 1993 and 1992, respectively. Information regarding short-term debt and lines of credit is as follows:\n1994 1993 1992 As of end of year-- Lines of credit borrowings $ - $ 2,000 $ - Commercial paper outstanding $ 50,500 $49,000 $26,000 Notes payable outstanding $ 14,001 $40,954 $44,095 Discount rates on commercial paper 5.64%-6.12% 3.24%-3.40% 3.15%-3.90% Interest rates on notes payable 6.04%-6.07% 3.34%-3.35% 3.46%-3.62%\nFor the year ended-- Maximum month-end amount of short-term debt $ 81,000 $92,000 $70,155 Average amount of short-term debt (based on daily outstanding balances) $ 61,835 $56,250 $41,882 Average interest rate on short-term debt 4.49% 3.33% 3.78%\nNOTE 10. CAPITALIZATION:\na. Common Shareowners' Investment:\nDuring 1994, 1993 and 1992, respectively, the Company issued 337,980, 451,233 and 528,142 new shares of common stock through its Dividend Reinvestment and Stock Purchase Plan and 401(k) Savings Plan, generating proceeds of $9.6 million, $15.3 million and $17.5 million, respectively.\nOn April 27, 1993, a public offering of 1.65 million newly issued shares of the Company's common stock, priced at $35.50 per share, raised net proceeds of $56.7 million. The proceeds were used by the Company to refinance short-term debt and for general corporate purposes including construction.\nIn February 1989, the Board of Directors of the Company declared a dividend distribution of one common stock purchase right (\"right\") on each outstanding share of the Company's common stock. Each right would initially entitle shareowners to buy one-half of one share of the Company's common stock at an exercise price of $60.00 per share, subject to adjustment. The rights are not currently exercisable, but would become exercisable if certain events occurred related to a person or group acquiring or attempting to acquire 20 percent or more of the outstanding shares of common stock. The rights expire on February 22, 1999, unless the rights are earlier redeemed or exchanged by the Company.\nAuthorized shares of common stock total 100,000,000 as of December 31, 1994, and can be categorized as follows:\nNo. Of Shares Issued and outstanding . . . . . . . . . . . . . . 30,773,588 Reserved for issuance for Dividend Reinvestment and Stock Purchase Plan . . . . . . 645,973 Reserved for issuance for WPLH Long-Term Equity Incentive Plan . . . . . . . . . . . . . . 1,000,000 Common Stock Rights Agreement . . . . . . . . . . . 15,709,781 Unreserved . . . . . . . . . . . . . . . . . . . . 51,870,658 ------------ Total authorized . . . . . . . . . . . . . . . 100,000,000 ------------\nA retail rate order effective January 1, 1995, requires WPL to maintain a utility common equity level of 51.93 percent of total utility capitalization during the test year January 1, 1995 to December 31, 1996. In addition, the PSCW ordered that it must approve the payment of dividends by WPL to the Company that are in excess of the level forecasted in the rate order ($58.1 million), if such dividends would reduce WPL's average common equity ratio below 51.93 percent.\nb. Preferred Stock:\nOn October 27, 1993, WPL issued two new series of preferred stock through two separate public offerings. The 6.2 percent Series is non-redeemable for ten years and the 6.5 percent Series is non-redeemable for five years. The proceeds from the sale were used to retire 150,000 shares of 7.56 percent Series and 149,865 shares of 8.48 percent Series preferred stock.\nc. Long-term Debt:\nSubstantially all of WPL's utility plant is secured by its first mortgage bonds. Current maturities of long-term debt are as follows: $2.8 million in 1995, $3.3 million in 1996, $67.6 million in 1997, $11.6 million in 1998 and $2.1 million in 1999.\nThe Company has $150 million of notional principal under interest rate swap contracts. The fair value of these contracts was not material as of December 31, 1994.\nThe fair value of the Company's long-term debt based on quoted market prices for similar issues at December 31, 1994 and 1993 was $501,530 and $518,251, respectively.\nNOTE 11. COMMITMENTS AND CONTINGENCIES:\na. Coal Contract Commitments:\nTo ensure an adequate supply of coal, WPL has entered into certain long-term coal contracts. These contracts include a demand or take-or-pay clause under which payments are required if contracted quantities are not purchased. Purchase obligations on these coal and related rail contracts total approximately $149 million through December 31, 2003. WPL's management believes it will meet minimum coal and rail purchase obligations under the contracts. Minimum purchase obligations on these contracts over the next five years are estimated to be $25 million in 1995 and $26 million in 1996, 1997, 1998 and 1999, respectively.\nb. Purchased Power and Gas:\nUnder firm purchase power and gas contracts, WPL is obligated as follows (dollars in millions):\nPurchased Power Purchased Gas Purchase Purchase Decatherms Obligation MW's Obligation (in millions)\n1995 $ 8.3 1,920 $ 67 89 1996 8.1 1,830 67 90 1997 10.9 1,944 55 78 1998 15.6 2,505 45 66 1999 18.8 2,910 41 53 Thereafter 106.5 12,720 77 101 ------ ------ ---- --- $168.2 23,829 $352 477 ====== ====== ==== ===\nc. Manufactured Gas Plant Sites:\nHistorically, WPL has owned 11 properties that have been associated with the production of manufactured gas. Currently, WPL owns five of these sites, three are owned by municipalities, and the remaining three are owned by private companies. In 1989, WPL initiated investigation of these manufactured gas plant sites. The Wisconsin Department of Natural Resources (\"DNR\") has been involved in reviewing investigation plans and has received ongoing reports regarding these investigations.\nIn 1992, and into the beginning of 1993, WPL continued its investigations and studies. WPL confirmed that there was no contamination at two of the sites. WPL received a close-out letter from the DNR related to one of those sites and requested a close-out letter for the other site. Additionally, the investigation of historical records at a third site indicated a minimal likelihood of any significant environmental impacts. In February 1993, WPL completed cost estimates for the environmental remediation of the eight remaining sites. The results of this analysis indicate that during the next 35 years, WPL will expend approximately $81 million for feasibility studies, data collection, soil remediation activities, groundwater research and groundwater remediation activities, including construction of slurry containment walls and the installation of groundwater pump and treatment facilities. This estimate was based on various assumptions, and is subject to continuous review and revision by management.\nThe cost estimate set forth above assumes 4 percent average inflation over a 35 year period. The cost estimate also contemplates that primarily groundwater pump and treatment activities will take place after 1998 through and including 2027. During this time, WPL estimates that it will incur average annual costs of $2.0 million to complete the planned groundwater remediation activities.\nWith respect to rate recovery of these costs, the PSCW has approved a five year amortization of the unamortized balance of environmental costs expended to date.\nIn addition, WPL is pursuing insurance recovery for the costs of remediating these sites and is investigating to determine whether there are other parties who may be responsible for some of the clean-up costs.\nThrough 1994, management has continued its oversight of the issues related to the above manufactured gas plant sites without significant revision to the above estimates and assumptions.\nBased on the present regulatory record at the PSCW, management believes that future costs of remediating these manufactured gas plant sites will be recovered in rates.\nNOTE 12. SEGMENT INFORMATION:\nThe following table sets forth certain information relating to the Company's consolidated operations:\nYear Ended December 31,\n1994 1993 1992 Operation information: Customer revenues-- Electric $ 531,747 $ 503,187 $ 477,735 Gas 139,646 137,270 119,362 Environmental services 87,673 81,396 67,533 Other 57,093 50,090 8,643 ---------- ---------- ---------- Total operating revenues $ 816,159 $ 771,943 $ 673,273 ========== ========== ========== Operating income (loss)-- Electric $ 120,218 $ 118,785 $ 109,459 Gas 13,344 10,431 8,724 Environmental services 6,038 4,219 3,542 Other (a) (9,591) (7,252) (3,766) Other income and (deductions), net 10,619 2,344 4,741 Interest expense, net (36,657) (37,020) (37,625) Income taxes (35,411) (25,056) (23,257) Preferred stock dividends of subsidiary (3,310) (3,928) (3,811) ---------- ---------- ---------- Net income $ 65,250 $ 62,523 $ 58,007 ========== ========== ==========\nInvestment information: Identifiable assets, including allocated common plant at December 31-- Electric $1,197,060 $1,170,010 $1,064,418 Gas 235,862 228,257 210,965 Environmental services 41,187 40,124 31,400 Other 331,792 323,508 259,115 ---------- ---------- ---------- Total assets $1,805,901 $1,761,899 $1,565,898 ========== ========== ========== Other information: Construction and nuclear fuel expenditures-- Electric $ 113,836 $ 139,805 $ 113,252 Gas 19,683 18,876 13,974 Other 6,169 18,538 45,606 ---------- ---------- ---------- Total construction and nuclear fuel expenditures $ 139,688 $ 177,219 $ 172,832 ========== ========== ==========\nProvision for depreciation and amortization-- Electric $ 65,195 $ 53,398 $ 49,554 Gas 8,082 7,329 6,578 Other 8,203 8,385 3,817 ---------- ---------- ---------- Total provision for depreciation $ 81,480 $ 69,112 $ 59,949 ========== ========== ==========\n(a) Excludes the effects of affordable housing and historical tax credits of $4.8 million, $5.2 million and $7.8 million in 1994, 1993 and 1992, respectively.\nNOTE 13. ACQUISITIONS:\nOn August 31, 1993, the Company issued 515,993 shares of Company common stock in exchange for the outstanding common and preferred stock of Jones and Neuse, Inc. (\"JN\"), a 250-employee environmental consulting and engineering service firm based in Austin, Texas. This transaction was accounted for as a pooling of interests. The Company positioned JN as a service region of its own 550-employee environmental consulting and engineering company, RMT, a subsidiary of HDC.\nIn February 1993, HDC acquired A&C Enercom Consultants, Inc., a Georgia corporation, for cash and new shares of the Company's common stock. A&C Enercom provides demand-side management and energy-related consulting services, primarily to public electric and gas utility companies.\nNOTE 14. CONSOLIDATED QUARTERLY FINANCIAL DATA (Unaudited):\nSeasonal factors significantly affect WPL and, therefore, the data presented below should not be expected to be comparable between quarters nor necessarily indicative of the results to be expected for an annual period.\nThe amounts below were not audited by independent public accountants, but reflect all adjustments necessary, in the opinion of the Company, for a fair presentation of the data.\nOperating Operating Earnings Quarter Ended Revenues Income Net Income Per Share 1994: (in thousands except for per-share data)\nMarch 31 $234,178 $47,245 $26,369 $.87 June 30 181,285 20,864 10,303 .33 September 30 193,706 33,515 15,309 .50 December 31 209,555 28,385 13,269 .43\n1993: March 31 $209,250 $36,490 $19,766 $.70 June 30 173,631 19,872 7,190 .24 September 30 173,869 29,358 13,258 .44 December 31 216,307 40,463 22,309 .73\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 Item 10 relating to directors and nominees for election as directors at the Company's 1995 Annual Meeting of Shareowners is incorporated herein by reference to the information under the caption \"Election of Directors\" in the Company's Proxy Statement for its 1995 Annual Meeting of Shareowners (the \"1995 Proxy Statement\"). The 1995 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year. The information required by Item 10 relating to executive officers is set forth in Part I of this Annual Report on Form 10-K. The information required by Item 10 relating to delinquent filers is incorporated herein by reference to the information under the caption \"Compliance with Section 16(a) of the Securities Exchange Act of 1934\" in the 1995 Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 is incorporated herein by reference to the information under the captions \"Compensation of Executive Officers\" and \"Compensation of Directors\" (but not including the Report of the Compensation and Personnel Committee on Executive Compensation) in the 1995 Proxy Statement. The 1995 Proxy Statement will be filed with the Securities and Exchange Commission within 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\nThe information required by Item 12 is incorporated herein by reference to the information under the caption \"Ownership of Voting Securities\" in the 1995 Proxy Statement. The 1995 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 is incorporated by reference to the information under the caption \"Compensation of Executive Officers\" (but not including the Report of the Compensation and Personnel Committee on Executive Compensation) in the 1995 Proxy Statement. The 1995 Proxy Statement will be filed with the Securities and Exchange Commission within 120 days after the end of the Company's fiscal year.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) (1) Consolidated Financial Statements\nIncluded in Part II of this report:\nReport of Independent Public Accountants\nConsolidated Statements of Income for the Years Ended December 31, 1994, 1993 and 1992\nConsolidated Balance Sheets, December 31, 1994 and 1993\nConsolidated Statements of Cash Flows for the Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Capitalization, December 31, 1994 and 1993\nConsolidated Statements of Common Shareowners' Investment\nNotes to Consolidated Financial Statements\n(a) (2) Financial Statement Schedules\nFor each of the years ended December 31, 1994, 1993 and 1992\nSchedule I. Parent Company Financial Statements Schedule II. Valuation and Qualifying Accounts and Reserves\nAll other schedules are omitted because they are not applicable or not required, or because that required information is shown either in the consolidated financial statements or in the notes thereto.\n(a) (3) Exhibits\nThe following Exhibits are filed herewith or incorporated herein by reference. Documents indicated by an asterisk (*) are incorporated herein by reference.\n3A* Restated Articles of Incorporation (incorporated by reference to Exhibit 4.1 to the Company's Form S-3 Registration Statement No. 33-59972)\n3B By-Laws of the Company as revised to February 23, 1994\n4A* Indenture of Mortgage or Deed of Trust dated August 1, 1941, between WPL and First Wisconsin Trust Company and George B. Luhman, as Trustees, incorporated by reference to Exhibit 7(a) in File No. 2-6409, and the indentures supplemental thereto dated, respectively, January 1, 1948, September 1, 1948, June 1, 1950, April 1, 1951, April 1, 1952, September 1, 1953, October 1, 1954, March 1, 1959, May 1, 1962, August 1, 1968, June 1, 1969, October 1, 1970, July 1, 1971, April 1, 1974, December 1, 1975, May 1, 1976, May 15, 1978, August 1, 1980, January 15, 1981, August 1, 1984, January 15, 1986, June 1, 1986, August 1, 1988, December 1, 1990, September 1, 1991, October 1, 1991, March 1, 1992, May 1, 1992, June 1, 1992 and July 1, 1992 (incorporated by reference to Second Amended Exhibit 7(b) in File No. 2-7361; Amended Exhibit 7(c) incorporated by reference to File No. 2-7628; Amended Exhibit 7.02 in File No. 2-8462; Amended Exhibit 7.02 in File No. 2-8882; Second Amendment Exhibit 4.03 in File No. 2-9526; Amended Exhibit 4.03 in File No. 2-10406; Amended Exhibit 2.02 in File No. 2-11130; Amended Exhibit 2.02 in File No. 2-14816; Amended Exhibit 2.02 in File No. 2-20372; Amended Exhibit 2.02 in File No. 2-29738; Amended Exhibit 2.02 in File No. 2-32947; Amended Exhibit 2.02 in File No. 2-38304; Amended Exhibit 2.02 in File No. 2-40802; Amended Exhibit 2.02 in File No. 2-50308; Exhibit 2.01(a) in File No. 2-57775; Amended Exhibit 2.02 in File No. 2-56036; Amended Exhibit 2.02 in File No. 2-61439; Exhibit 4.02 in File No. 2-70534; Amended Exhibit 4.03 File No. 2-70534; Exhibit 4.02 in File No. 33-2579; Amended incorporated by reference to Exhibit 4.03 in File No. 33-2579; Amended Exhibit 4.02 in File No. 33-4961; Exhibit 4B to WPL's Form 10-K for the year ended December 31, 1988, Exhibit 4.1 to WPL's Form 8-K dated December 10, 1990, Amended Exhibit 4.26 in File No. 33-45726, Amended Exhibit 4.27 in File No.33-45726, Exhibit 4.1 to WPL's Form 8-K dated March 9, 1992, Exhibit 4.1 to WPL's Form 8-K dated May 12, 1992, Exhibit 4.1 to WPL's Form 8-K dated June 29, 1992 and Exhibit 4.1 to WPL's Form 8-K dated July 20, 1992)\n4B* Rights Agreement, dated as of February 22, 1989, between the Company and Morgan Shareholder Services Trust Company (incorporated by reference to Exhibit 4 to the Company's current report on Form 8-K dated February 27, 1989)\n10A*# Executive Tenure Compensation Plan, as revised November 1992 (incorporated by reference to Exhibit 10A to the Company's Form 10-K for the year ended December 31, 1992)\n10B*# Form of Supplemental Retirement Plan, as revised November 1992 (incorporated by reference to Exhibit 10B to the Company's Form 10-K for the year ended December 31, 1992)\n10C*# Forms of Deferred Compensation Plans, as amended June, 1990 (incorporated by reference to Exhibit 10C to the Company's Form 10-K for the year ended December 31, 1990)\n10C.1*# Officer's Deferred Compensation Plan II, as adopted September 1992 (incorporated by reference to Exhibit 10C.1 to the Company's Form 10-K for the year ended December 31, 1992)\n10C.2*# Officer's Deferred Compensation Plan III, as adopted January 1993 (incorporated by reference to Exhibit 10C.2 to the Company's Form 10-K for the year ended December 31, 1993)\n10D*# Pre-Retirement Survivor's Income Supplemental Plan, as revised November 1992 (incorporated by reference to Exhibit 10F to the Company's Form 10-K for the year ended December 31, 1992)\n10E*# Wisconsin Power and Light Company Management Incentive Plan (incorporated by reference to Exhibit 10H to the Company's Form 10-K for the year ended December 31, 1992)\n10F# Deferred Compensation Plan for Directors, as amended January 17, 1995\n10G*# WPL Holdings, Inc. Long-Term Equity Incentive Plan (incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994)\n10H*# Key Executive Employment and Severance Agreement by and between WPL Holdings, Inc., and E.B. Davis, Jr. (incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994)\n10I*# Form of Key Executive Employment and Severance Agreement by and between WPL Holdings, Inc. and each of L.W. Ahearn, W.D. Harvey, E.G. Protsch and A.J. Amato (incorporated by reference to Exhibit 4.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994)\n10J*# Form of Key Executive Employment and Severance Agreement by and between WPL Holdings, Inc. and each of E.M. Gleason, B.J. Swan, D.A. Doyle, N.E. Boys, D.E. Ellestad, P.J. Wegner and K.K. Zuhlke (incorporated by reference to Exhibit 4.4 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994)\n10K*# Restricted Stock Agreement -- Lance Ahearn (incorporated by reference to Exhibit 10J to the Company's Form 10-K for the year ended December 31, 1992)\n10L# Restricted Stock Agreement -- Erroll B. Davis\n10M# Summary of Heartland Development Corporation Short- Term Incentive Plan\n21 Subsidiaries of the Company\n23 Consent of Independent Public Accountants\n27 Financial Data Schedule\n99* 1995 Proxy Statement for the Annual Meeting of Shareowners to be held May 17, 1995 [The Proxy Statement for the 1995 Annual Meeting of Shareowners will be filed with the Securities and Exchange Commission under Regulation 14A within 120 days after the end of the Company's fiscal year; except to the extent incorporated by reference, the Proxy Statement for the 1995 Annual Meeting of Shareowners shall not be deemed to be filed with the Securities and Exchange Commission as part of this Annual Report on Form 10-K]\nPursuant to Item 601(b)(4)(iii) of Regulation S-K, the Company hereby agrees to furnish to the Securities and Exchange Commission, upon request, any instrument defining the rights of holders of unregistered long-term debt not filed as an exhibit\nto this Form 10-K. No such instrument authorizes securities in excess of 10 percent of the total assets of the Company.\n# - A management contract or compensatory plan or arrangement.\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 on the 22nd day of February, 1995.\nWPL HOLDINGS, INC.\nBy:\/s\/ Erroll B. Davis, Jr. Erroll B. Davis, 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 indicated on the 22nd day of February 1995.\n\/s\/ Erroll B. Davis, Jr. President, Chief Executive Officer Erroll B. Davis, Jr. and Director (principal executive officer)\n\/s\/ Edward M. Gleason Vice President, Treasurer and Corporate Edward M. Gleason Secretary (principal financial officer)\n\/s\/ Daniel A. Doyle Vice President - Finance, Controller Daniel A. Doyle and Treasurer - Wisconsin Power and Light Company (principal accounting officer)\n\/s\/ Les Aspin Director \/s\/ Milton E. Neshek Director Les Aspin Milton E. Neshek\n\/s\/ L. David Carley Director \/s\/ Henry C. Prange Director L. David Carley Henry C. Prange\n\/s\/ Rockne G. Flowers Director \/s\/ Judith D. Pyle Director Rockne G. Flowers Judith D. Pyle\n\/s\/ Donald R. Haldeman Director \/s\/ Henry F. Scheig Director Donald R. Haldeman Henry F. Scheig\n\/s\/ Katharine C. Lyall Director \/s\/ Carol T. Toussaint Director Katharine C. Lyall Carol T. Toussaint\n\/s\/ Arnold M. Nemirow Director Arnold M. Nemirow\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo WPL Holdings, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in the 1994 Form 10-K of WPL Holdings, Inc. and have issued our report thereon dated February 1, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. Supplemental Schedules I and II 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.\nMilwaukee, Wisconsin, ARTHUR ANDERSEN LLP February 1, 1995\nWPL HOLDINGS, INC. INDEX TO FINANCIAL STATEMENT SCHEDULES FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nFINANCIAL STATEMENT SCHEDULES:\nI. Parent Company Financial Statements II. Valuation and Qualifying Accounts and Reserves\nNOTE: All other schedules are omitted because they are not applicable or not required, or because that required information is shown either in the financial statements or in the notes thereto.\nSCHEDULE I - CONDENSED PARENT COMPANY FINANCIAL STATEMENTS\nThe accompanying notes are an integral part of these state\nSCHEDULE I - CONDENSED PARENT COMPANY FINANCIAL STATEMENTS\nWPL HOLDINGS, INC. (Parent Company Only)\nBALANCE SHEET\nAs of December 31, 1994 1993 (In Thousands) ASSETS Current assets: Cash and equivalents........................ $1,061 $8,642 Accounts receivable - affiliates (Note B)... 187 109 Notes receivable - affiliates (Note B)..... 28,471 24,948 -------- -------- 29,719 33,699 -------- -------- Accounts receivable from WPL Holding DRIP....... 250 150 -------- ------- Tax benefit receivable.......................... 1,219 2,156 -------- ------- Property and equipment.......................... 1,009 1,023 -------- ------- Investments and other........................... 267 677 -------- ------- Investments in Subsidiaries, at equity: Heartland Development Corporation........... 66,834 71,439 Wisconsin Power and Light Company........... 544,506 522,667 -------- ------- 611,340 594,106 Deferred income taxes........................... 372 372 -------- -------- Total Assets.................................... $644,176 $632,183 ======== ======== LIABILITIES AND CAPITALIZATION\nCurrent liabilities: Short term debt (Note C)................... $11,500 $32,958 Accounts payable - affiliates (Note B)..... (149) 4,727 Accounts payable............................ 3 3 Accrued taxes............................... (912) (94) Accrued interest and other.................. 220 739 Dividends payable........................... 228 148 ------- ------- 10,890 38,481 Long-term debt.................................. 34,000 10,463 Deferred taxes.................................. 274 Deferred credit................................. 1,214 273 ------- ------- 35,488 10,736 ------- ------- Capitalization: Common shareowners' investment: Common stock, $.01 par value, authorized 100,000,000 shares; issued and outstanding -- 30,773,588 shares and 30,438,654 shares at December 31, 1994 and 1993, respectively............. 308 305 Additional paid-in-capital................ 304,442 297,916 Reinvested earnings....................... 293,048 284,745 -------- -------- Total Capitalization.................. 597,798 582,966 -------- -------- Total Capitalization and Liabilities............ $644,176 $632,183 ======== ========\nThe accompanying notes are an integral part of these statements.\nSCHEDULE I - CONDENSED PARENT COMPANY FINANCIAL STATEMENTS\nWPL HOLDINGS, INC. (Parent Company Only)\nThe accompanying notes are an integral part of these statements.\nSCHEDULE I - CONDENSED PARENT COMPANY FINANCIAL STATEMENTS\nWPL HOLDINGS, INC. Supplemental Notes to Parent Company Only Financial Statements\nThe following are supplemental notes to the WPL Holdings, Inc. (the \"Company\") Parent Company Financial Statements and should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in the WPL Holdings, Inc. 1994 Annual Report, which are hereby incorporated herein by reference.\nNote A. The parent company files a consolidated federal income tax return with its subsidiaries.\nNote B. Net amounts due to (due from) affiliates result from intercompany transactions including loans, federal income tax liabilities and an administrative allowance.\nNote C. Information regarding short-term debt is as follows:\n1994 1993 (In Thousands) As of end of year: Notes payable outstanding................ $11,500 $32,958 Interest rates on notes payable.......... 6.06% 3.58% For the year ended: Maximum month-end amount of short-term debt................................... $52,500 $36,000 Average amount of short-term debt........ $36,462 $25,827 Average interest rate on short-term debt. 4.56% 3.37%\nNote D. During 1994, 1993 and 1992, Wisconsin Power and Light Company allocated and billed certain administrative and general expenses to the Company using an allocation method approved by the Public Service Commission of Wisconsin. These expenses totalled $759,000, $777,000 and $867,000 during 1994, 1993 and 1992, respectively.\nSCHEDULE II\nWPL HOLDINGS, INC. AND SUBSIDIARIES\nEXHIBIT INDEX\nExhibit No. Description\n3B By-Laws of as revised to February 23, 1994\n10F Deferred Compensation Plan for Directors, as amended January 17, 1995\n10L Restricted Stock Agreement -- Erroll B. Davis\n10M Summary of Heartland Development Corporation Short- Term Incentive Plan\n21 Subsidiaries of the Company\n23 Consent of Independent Public Accountants\n27 Financial Data Schedule","section_15":""}
{"filename":"63118_1994.txt","cik":"63118","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE COMPANY\nVarity Corporation and its subsidiaries (the Company), founded in 1847, is a major international industrial company with core manufacturing and distribution businesses in automotive components, diesel engines and farm equipment. The Company conducts and manages its businesses under three separate operating groups: the Kelsey-Hayes Group (automotive components), the Perkins Group (diesel engines), and the Massey Ferguson Group (farm equipment). The Company's products are marketed in more than 160 countries.\nKELSEY-HAYES GROUP\nAUTOMOTIVE PRODUCTS\nThe Company's automotive products segment primarily supplies systems and components to domestic and foreign manufacturers of passenger cars and light trucks, as well as medium and heavy duty trucks and trailers. The Company acquired Dayton Walther, a major manufacturer of engineered products for the medium and heavy duty truck and trailer industries in December 1986. On November 30, 1989, the Company acquired K-H Corporation and its subsidiary, Kelsey-Hayes Company (Kelsey-Hayes). Following the acquisition, the Company took actions to reduce employment levels, reorganize the business unit and management structure of Kelsey-Hayes and strengthen its international business operations. The acquisition of Kelsey-Hayes expanded the Company's automotive segment as part of a plan to reduce its dependence on the farm equipment business. Kelsey-Hayes and Dayton Walther comprise the automotive products segment and are referred to herein as the Kelsey-Hayes Group. The most significant automotive products manufactured and marketed by the Kelsey-Hayes Group are anti-lock braking systems (ABS), disc and drum brakes, disc brake rotors, hubs, drums, electromechanical sensors and power door lock actuators for passenger cars and light trucks.\nKelsey-Hayes is a leading producer of brake components for passenger cars and light trucks. The Company believes that Kelsey-Hayes is one of the leaders in the production of ABS, supplying both two-wheel and four-wheel systems. Kelsey- Hayes is the leading manufacturer of two-wheel ABS in North America for light trucks. Kelsey-Hayes has been successful in developing new ABS products for both light trucks and passenger cars and recently introduced a new generation of four-wheel ABS that is compatible with virtually any size passenger car or light truck and any brake configuration. In order to meet increased North American ABS demand, the Company commenced construction of a new plant in Fowlerville, Michigan during fiscal 1993 which is expected to begin production in mid-1994. In addition, the Company believes that Kelsey-Hayes is also one of the leaders in the production of foundation (conventional) brakes, and benefits from its strategic position as a major supplier of both ABS and foundation brakes for light trucks, vans and sport utility vehicles as North American production of these vehicles grew 15% in fiscal 1993.\nThe Company owns 46.3% of the outstanding common stock of Hayes Wheels International, Inc. (Hayes Wheels), which the Company believes is the largest supplier of cast aluminum wheels in Europe, the second largest supplier of cast aluminum wheels in North America and the largest independent supplier of fabricated steel wheels in North America. Prior to December 1992, Hayes Wheels conducted its automotive wheels systems business jointly with the automotive brakes systems business of Kelsey-Hayes. In December 1992, Hayes Wheels sold, in separate public offerings, debt securities and common stock, decreasing the Company's ownership interest in Hayes Wheels from 100% to 46.3%. As a result, Hayes Wheels is no longer consolidated with the Company for accounting purposes and the Company accounts for its investment in Hayes Wheels using the equity method of accounting. The Company believes that its ownership in Hayes Wheels comprises an important and continuing portion of the Kelsey-Hayes Group.\nAFTERMARKET PARTS\nThe aftermarket parts business consists of the Kelsey Parts business, which supplies maintenance and repair parts for many brands of passenger cars and light truck products. In connection with the Company's divestiture of certain non-core businesses, on December 31, 1992 the Company sold Dayton Parts, Inc., a supplier of maintenance and repair parts for heavy trucks.\nINTERNATIONAL\nThe operations outside the U.S., including those of Hayes Wheels, are conducted through various foreign companies in which the Group's interest ranges from minor to complete control. International manufacturing operations are located in Canada, Italy, Mexico, Spain, Venezuela and the Czech Republic. The Kelsey- Hayes Group licenses its patents, designs, manufacturing technology and know-how in a number of other foreign countries.\nDuring the first quarter of fiscal 1993, the Company sold its majority interest in Brembo Kelsey-Hayes, S.p.A., an Italian specialty producer of high performance disc brakes and rotors, in connection with the Company's program to divest non-core businesses. Expanding its international position during fiscal 1993, Kelsey-Hayes established a European ABS marketing and technical center in Wiesbaden, Germany and commenced construction of a new plant in Heerlen, Netherlands for production of ABS. Production at this plant is scheduled to commence in mid-1994.\nCOMPETITION\nSuppliers to original equipment manufacturers (OEMs) operate under highly competitive conditions. Certain OEMs are capable of producing products supplied by the Kelsey-Hayes Group. The Kelsey-Hayes Group competes directly with the OEMs as well as many other suppliers with respect to price, quality, delivery and technical ability in developing products. The Company believes that, as a result of its manufacturing and engineering expertise, combined with an ongoing emphasis on cost control and quality, it has the ability to compete effectively with the OEMs and with other suppliers. With respect to brake components, the Kelsey-Hayes Group has over 15 substantial competitors, most of which are large and diversified concerns. Kelsey-Hayes estimates that its share of the North American four-wheel ABS market grew from 16% in 1992 to 20% in 1993 and is projected to increase in future years in this growth market, based on awarded contracts. Kelsey-Hayes estimates that its share of the North American foundation brake market (excluding OEM captive manufacturers) on a unit basis grew marginally to approximately 35% in 1993.\nMARKETING AND DISTRIBUTION\nMost of the Kelsey-Hayes Group's sales of automotive products are made directly to OEMs, with the remainder sold largely to replacement part distributors. Sales by the Kelsey-Hayes Group to its three major customers, General Motors Corporation (GM), Ford Motor Company (Ford) and Chrysler Corporation (Chrysler), accounted for 80% of the Kelsey-Hayes Group's consolidated net sales in fiscal 1993, with Ford being the largest customer during this period (34% of the Kelsey-Hayes Group's consolidated net sales). Sales to all OEMs accounted for approximately 99% of the Kelsey-Hayes Group's fiscal 1993 revenues. Although the loss of all or a substantial portion of sales to its major customers, GM, Ford or Chrysler, would have a serious adverse effect on its business, management believes that such a loss is unlikely because: the Kelsey-Hayes Group has been doing business with each of these companies for many years; sales to these companies are comprised of a number of different products and models or types of the same products, the sales of which are not dependent on each other; and sales of many products are made to individual divisions and subsidiaries of each of these companies and are not dependent upon sales to other divisions or subsidiaries of the same company.\nMARKET OVERVIEW\nSales of the Kelsey-Hayes Group's automotive products are primarily dependent on the overall level of North American passenger car and light truck production, which, in turn, is sensitive to the overall level of United States economic activity. Moreover, sales of passenger cars and light trucks have, in the past, been adversely affected by recessionary business conditions and increases in the general level of interest rates. The level of economic activity in the United States was generally strong during 1993 as interest rates declined while North American production of cars and light trucks continued its recovery from the depressed 1991 levels. A prolonged downturn in the overall level of United States economic activity or a significant increase in the general level of interest rates or increased competition from imported products or a prolonged strike at one or more of its major customers would adversely affect the Kelsey- Hayes Group. The Kelsey-Hayes Group continues its efforts to increase its global presence and to lessen dependence on North American car and light truck production.\nPERKINS GROUP\nDIESEL ENGINES\nThrough the Perkins Group, the Company designs, produces and markets a comprehensive array of multi-cylinder water-cooled diesel engines in the 50 to 1,500 horsepower range and markets small diesel engines in the 7 to 45 horsepower range purchased from independent Japanese suppliers. The intended uses and markets for the engines vary widely among the configurations of the particular engines. The Company adapts these basic engines to meet the specific requirements of its diverse customer base. The Perkins Group's engines are used as original equipment in virtually every application for which diesel engines are suitable, including agricultural tractors, industrial and construction machinery, material handling equipment, generators, passenger cars, trucks, vans, buses and other commercial vehicles, pleasure and commercial boats, armored personnel carriers and battle tanks. The Perkins Group, together with its associate companies and licensees, is one of the leading producers of diesel engines other than those used as original equipment in passenger cars.\nFully assembled engines, all of which are manufactured by the Perkins Group in the United Kingdom, are widely marketed by the Perkins Group, primarily to OEMs and are installed in the Company's agricultural tractors. In fiscal 1993, 10% of the Perkins Group's net sales were to the Massey Ferguson Group. These sales are made at approximately the same prices charged to OEMs. In addition, the Company has associate companies and licensees in 13 countries that manufacture or assemble Perkins engines, often from kits sold to them by the Company.\nThe Perkins Group's customer base includes over 300 OEMs. The Company believes that its associate companies and licensees sell to a similar number of additional OEMs. The Perkins Group's 10 largest customers accounted for approximately 47% of its net third party sales in fiscal 1993, including one customer which accounted for approximately 12%.\nIn 1993, Perkins continued to build on a ten year supply agreement, commenced in 1992, with Caterpillar Inc. (Caterpillar), the world's largest construction and earth-moving machinery producer, as current year sales increased from the first year of the agreement covering a range of engines for back-hoe and wheeled loaders, road pavers and excavators. Aggregate sales over the ten year term of the agreement could be up to $1.0 billion.\nPARTS\nThe Company provides replacement parts for all of the engines that it sells. The Company carries over 27,000 different replacement parts for diesel engines, many of which it manufactures or assembles and the balance of which it obtains from independent suppliers. In 1993, Perkins consolidated its parts warehouses and opened a new parts distribution center in Manchester, England, managed by Caterpillar Logistics Systems. The center, believed to be the most efficient of its kind in Europe, operates its computerized order processing, retrieval and shipment services 24 hours a day for customers around the world. Sales of parts accounted for 17% of the Perkins Group's net sales in fiscal 1993.\nCOMPETITION\nMost diesel engines are used by the engine manufacturer in other products produced by it or its affiliates, including cars and trucks, agricultural equipment and industrial machinery. Consequently, competition in the diesel engine market is primarily for those customers that do not manufacture engines for their own use. The Company competes for third-party sales directly with other producers of diesel engines, which are either large companies conducting business on an international scale, with full product ranges, or small or medium-sized companies conducting business locally, often with a limited range of products. The Company also competes indirectly with manufacturers of gasoline engines. The Perkins Group's major competitors for third-party sales of diesel engines worldwide are Klockner-Humboldt-Deutz AG (Deutz), Cummins Engines Co. Inc., Caterpillar (generally for products not covered by the supply agreement described above), Detroit Diesel Corporation and several Japanese producers. Perkins estimates that its share of the Western Europe diesel engine market, its primary market, has averaged approximately 12% of units sold over the three year period from fiscal 1991 to fiscal 1993. The Company believes that the most important competitive factor in the diesel engine market is the ability to design and manufacture engines specially adapted to the needs of an individual customer for a particular application. Quality, fuel efficiency, after-sale servicing and pricing are also important, as is the ability to meet increasingly stringent environmental requirements. The Company believes that the Perkins Group competes effectively on all of these bases and compares favorably with many of its competitors in its ability to design and manufacture specialized engines and in its ability to meet environmental requirements.\nMARKETING AND DISTRIBUTION\nThird-party sales of fully assembled diesel engines (mostly to OEMs) and third- party sales of diesel engines replacement parts are made both directly by the Company (primarily through sales offices in eight countries) and through a worldwide network of approximately 4,000 independent distributors and dealers in 160 countries. To facilitate direct sales by the Perkins Group, and to a lesser extent by its distributors and dealers, four of the Perkins Group's sales offices also provide engine finishing services and other support. The Company has a distributorship agreement covering North America with Detroit Diesel Corporation which has significant distribution capabilities in North America. Diesel engines manufactured or assembled by associate companies or licensees are distributed by them, generally in their home countries. Distribution arrangements in certain countries, which may involve those countries' governments, prohibit the Company from effecting sales other than through designated national distributors.\nMASSEY FERGUSON GROUP\nAGRICULTURAL TRACTORS\nThe Massey Ferguson Group's farm equipment operations principally involve the design, manufacture and sale of agricultural tractors. The Massey Ferguson Group offers a full line of agricultural tractors in the 16 to 190 horsepower range. The Massey Ferguson Group and its competitors offer tractors in four general sizes, based primarily on horsepower: compact, small, mid-sized and large. The intended uses and markets for agricultural tractors vary significantly among these sizes. With some overlap, the Massey Ferguson Group has models targeted for each of these sub-markets.\nThe Massey Ferguson Group manufactures small, mid-sized and large tractors in the United Kingdom and France and purchases compact tractors from an independent Japanese producer. It also purchases certain tractors from an associate company in Italy and from licensees in Brazil and Poland. These fully assembled units are sold by the Massey Ferguson Group worldwide, with Western Europe comprising its largest market. In North America, the Company appointed AGCO Corporation (AGCO) as its exclusive, independent distributor in January 1993. Prior thereto the Company marketed its products in North America through 1,350 independent dealers. In addition, the Massey Ferguson Group has associate companies and licensees in 15 countries that manufacture or assemble Massey Ferguson tractors, which are generally sold locally.\nThe Company's tractors are marketed under the \"Massey Ferguson\" trade name and are painted the Company's traditional red.\nPARTS AND OTHER PRODUCTS\nThe Company provides replacement parts for all of the agricultural equipment that it sells. The Company carries over 200,000 different parts for tractors and other farm equipment, some of which it manufactures or assembles and the balance of which it obtains from independent suppliers. In fiscal 1993, net sales of these replacement parts represented 13% of the Massey Ferguson Group's net sales.\nOther products marketed by the Massey Ferguson Group include combine harvesters, balers and other implements. The Company purchases small and mid- sized combines from two European manufacturers, which it markets primarily in Western Europe and in North America through AGCO under the \"Massey Ferguson\" trade name. Additionally, the Company markets a rotary combine in North America through AGCO which is sourced from an independent supplier in the United States.\nASSOCIATE COMPANIES AND LICENSEES\nRetail unit sales by associate companies and licensees represented approximately 70% of worldwide retail sales of Massey Ferguson branded tractors in fiscal 1993. Associate companies and licensees purchase components from the Company ranging from a few parts to a substantially complete tractor. Substantially all of the Company's revenue earned from its associate companies and licensees arises from sales of these components.\nThe contractual arrangements between the Company and these other companies generally provide that the associate company or licensee has the exclusive right to sell the Massey Ferguson Group's tractors in its home country, but may not sell these products in other countries. The Company generally licenses to these associate companies and licensees certain technology, as well as the right to use the Massey Ferguson Group's trade names.\nFINANCE\nIn its farm equipment operations in Europe, the Company, like its competitors, provides retail financing programs, primarily through its associate companies. In January 1993, the Company formed a joint venture with AGCO which acquired substantially all of the net assets of the Company's former North American finance subsidiary (Agricredit) which provides retail financing to end users. Subsequent to January 31, 1994, the Company sold its remaining 50% interest in the joint venture to AGCO.\nMost of the Company's sales of tractors and farm equipment outside North America are made on payment terms customary in the industry, which generally range from 60 to 90 days, although a limited amount of more extended wholesale financing for distributors and dealers is provided by the Company in certain instances.\nCOMPETITION\nThe Company's major competitors in the European tractor markets are New Holland (the merged tractor operations of Fiat S.p.A. and Ford), Case IH, a subsidiary of Tenneco Inc. (Case) and Deere & Company (Deere). In certain European countries Xaver Fendt & Co., Regie Nationale des Usines Renault, Deutz and Valmet Tractors Inc. have significant competitive positions. The Massey Ferguson Group's major competitors in the North American tractor market are Deere, Case and Ford. The Company, New Holland, Deere and Case generally are the principal suppliers to the tractor markets in other regions of the world in which the Company competes. The Company and its licensees are the leading distributors of tractors in the developing third world. The Massey Ferguson brand of tractors accounts for approximately 19% of the worldwide market for agricultural tractors (excluding sales in the former Soviet Union, Eastern Europe, China and under 40 horsepower units in Japan).\nThe Company believes that the principal competitive factors in farm equipment sales are pricing, product performance, reliability and durability, the availability of strong and conveniently located dealers, a reputation for after- sale service and brand loyalty. The Company believes that the Massey Ferguson Group is able to compete effectively in each of these areas.\nMARKETING AND DISTRIBUTION\nSales of fully assembled tractors and related spare parts outside of North America are made through a network of approximately 3,000 independent dealers, primarily in Western Europe, who effect retail sales to end users, and approximately 100 independent national distributors, primarily located in the rest of the world, who sell to dealers or, in some cases, directly to end users. In North America, sales are made through the network of 1,100 independent dealers of AGCO, the Company's exclusive, independent distributor, who sell to end users. Tractors manufactured or assembled by associate companies or licensees are distributed by them, generally in their home countries, and, in some cases, the Company sells agricultural equipment directly to government agencies. In certain countries where distribution is made through national distributors, including associate companies or licensees, the distribution arrangements, which sometimes involve the national government, prohibit the Company from selling in that country except through the designated distributor or prohibit the distributor from selling outside its country. Some dealers also carry competing or complementary products of other manufacturers. Combines, balers and other implements sold by the Massey Ferguson Group are distributed in a similar manner through an overlapping network of dealers and distributors.\nMARKET OVERVIEW\nSince 1977, the agricultural equipment business experienced ten years of market declines with worldwide industry retail unit sales of agricultural tractors decreasing sharply from an estimated 887,500 units in fiscal 1977 to 611,000 units in fiscal 1986 (excluding sales in the former Soviet Union, Eastern Europe, China and under 40 horsepower units in Japan). Between 1986 and 1990, the worldwide agricultural tractor market remained relatively flat at approximately 600,000 units but has declined each year since to approximately 520,000 units in 1993. As a result, the agricultural equipment market has been characterized by overcapacity and periodic excess dealer and manufacturer inventories. These developments have led to intense competition and periodic price discounting which have further depressed profit margins throughout the industry. The decline in the demand for agricultural equipment over these periods has been due to various factors which have resulted in depressed farm incomes and have discouraged farmers from replacing their farm equipment with the same regularity as in the past. These factors have included a worldwide recession and high interest rates in the early 1980s, changes in and uncertainty as to various government agricultural policies and programs, limitations on the availability of hard currency in certain countries, and generally falling agricultural commodity prices and decreasing farm land prices in the United States, Canada and parts of Western Europe.\nThe Company believes that the markets for agricultural equipment have fundamentally changed over the last decade and does not expect that demand will return to the levels of the late-1970s. Massey Ferguson is implementing a strategic plan designed to improve earnings and asset performance over the next few years. This plan includes an emphasis on Massey Ferguson's strength in developing countries, strategic initiatives, such as the January 1993 distributorship agreement with AGCO, which will strengthen distribution capabilities in North America, and continued aggressive cost reduction programs.\nOTHER OPERATIONS\nHYDRAULIC COMPONENTS\nThe Company also manufactures, through its Pacoma components operations, hydraulic cylinders and hydraulic valves and, to a lesser degree, allied equipment for producers of construction machines, agricultural and industrial equipment and, more recently, for the automotive passenger car industry. Pacoma's products, all of which are manufactured in Germany, are marketed by Pacoma to over 80 OEMs and are installed in the Massey Ferguson Group's agricultural tractors. In fiscal 1993, intercompany sales of Pacoma's products accounted for 7% of Pacoma's total sales.\nIn recent years, Pacoma has substantially decreased its dependence on the agricultural equipment business by diversifying applications of its products and expanding its third-party customer base. All third-party sales of components are made directly by the Company to OEMs.\nThe principal competitive factors in the sale of hydraulic cylinders to third parties vary by geographic area and application. In North America, where hydraulic cylinders have generally been standardized, competition, particularly in the agricultural equipment market, is based primarily on price. In Western Europe, where most components purchased by third parties are manufactured according to specific product requirements, competition is based primarily on product performance, pricing and reputation in the industry. The Company believes that, although there are many manufacturers of hydraulic cylinders for the OEM agricultural equipment markets, it is one of a small number of manufacturers with the ability to meet the more stringent quality and durability standards of the OEM construction machinery market and the passenger car industry.\nPOLYGON REINSURANCE\nThe Company's captive insurance subsidiary, Polygon Reinsurance Company Limited, a Bermuda corporation, provides reinsurance for product liability, property, business interruption and other risks arising from the Company's operations. Because it offers reinsurance, the Company believes that primary insurance coverage is more readily available to it and that, in certain instances, its insurance premiums may be favorably affected.\nBACKLOG\nThere is no significant backlog of unfilled equipment orders. Substantially all of the unfilled equipment orders at any time are expected to be filled within the following year.\nINFORMATION BY SEGMENT AND GEOGRAPHIC AREA\nInformation about the Company's operations and assets by industry segment and geographic area for the years ended January 31, 1994, 1993, and 1992 appears in Note 16 of the Notes to Consolidated Financial Statements and is included in Part II on pages 47 through 49 of this Form 10-K. Sales by product are included in Part II on page 56 of this Form 10-K.\nEMPLOYEES AND LABOR RELATIONS\nAt January 31, 1994, the Company had approximately 13,000 full-time employees.\nThe Company's worldwide labor force is represented by approximately 30 labor organizations. Employee-management relations vary from country to country. Certain of the Company's production facilities are located in areas where organized labor has traditionally been very active. The Company has experienced strikes generally varying in length from two days to a month over the past three years, primarily in Europe in connection with the renewal of collective bargaining agreements and the Company's efforts to downsize or shut down manufacturing facilities and to increase the efficient use of its labor force. Due to the interdependence of the Company's diesel engine, agricultural tractor and component operations, a strike at any single production facility could have adverse effects on other Company operations.\nSOURCES AND AVAILABILITY OF COMPONENTS AND RAW MATERIAL\nThe Company purchases numerous components in its manufacturing operations. A number of other significant components utilized in the Company's farm equipment operations are supplied in large measure by other divisions of the Company, including diesel engines manufactured in the United Kingdom and hydraulic cylinders manufactured in Germany. While most components not produced by the Company are available from a variety of sources, certain critical components are produced by a small number of suppliers and may, in certain cases, be purchased from a single source of supply. The unplanned loss of any of these single sources of supply could have a significant adverse effect on those operations.\nThere are many sources of the raw materials and other component parts essential to the conduct of the Company's operations readily available in reasonable proximity to those plants utilizing such materials. The Company has not experienced any significant supply problems for its operations for many years and the Company does not anticipate any significant supply problems in the foreseeable future.\nRESEARCH AND DEVELOPMENT; PATENTS; TRADEMARKS\nDuring fiscal 1993, 1992 and 1991 the Company expended $48.5 million, $41.4 million and $38.1 million, respectively, on research and development. Such research and development expenditures have enabled the Company to upgrade its existing product lines and introduce new products. The Company has a history of developing new technology jointly with its suppliers or customers, particularly for diesel engines. The cost of such programs with suppliers is reflected mainly in unit costs and not necessarily in research and development expenditures.\nThe Company owns numerous patents and trademarks and has patent licenses from third parties relating to products and manufacturing methods. The Company also grants patent and trademark licenses to others throughout the world. The Company is the sole owner of certain advanced diesel engine fuel injection technology and rights, in part by patent license. The Perkins Group is obtaining additional patent protection with respect to this technology. The Company believes that continued development of this technology will aid the Perkins Group in its engineering design, production and sale of advanced diesel engines. Various patents relating to the anti-lock brakes business have been issued to Kelsey-Hayes and others, including its competitors. The Company examines its own and its competitors' products to guard against infringement, both on its own initiative and, where appropriate, in response to inquiries or comments of others. The Company views its own patents and patent applications as significant. Based on examination of its own and others' patents, available existing technology and the ability to avoid infringement issues by engineering design, the Company does not believe its business is materially impacted by patents of others.\nThe Company regards its many trademarks as having significant value and as being an important factor in the marketing of its products. The Company believes that its most significant trademarks are \"Kelsey-Hayes,\" \"Perkins,\" \"Massey Ferguson,\" \"Dayton\" and \"Pacoma,\" as well as Massey Ferguson's triple triangle and Kelsey-Hayes' design trademarks. The foregoing trademarks are generally registered in the United States, Canada, the United Kingdom and a number of other countries where the Company operates. In addition, the Company owns numerous minor trademarks that are registered or for which a registration application is pending. The Company's policy is to pursue trademark registration wherever possible and to oppose infringement of its trademarks.\nENVIRONMENTAL PROTECTION AND SAFETY LAWS\nEnvironmental protection and safety laws in the countries in which the Company manufactures and sells its products have a significant effect on product design, but apply equally to competitors and have not had, nor are they expected to have, a material adverse effect on the Company's competitive position. The Company does not anticipate that the costs it expects to incur in order to meet environmental and safety standards for its products or to satisfy environmental standards relating to operation of its manufacturing and other facilities imposed by various legislative bodies around the world will be materially adverse to the Company.\nIMPACT OF GOVERNMENT AGRICULTURAL POLICIES\nGovernment agricultural policies and programs, particularly those of the United States, Canada and the European Community (the EC), have had a substantial impact on commodity prices and the levels of farm production and income in North America and Western Europe which, in turn, have significantly affected demand for farm equipment. Demand has also been affected by uncertainty as to whether existing government programs will be continued. Generally, the United States, Canada and the EC have attempted to respond to the depressed conditions in their respective farm economies by instituting programs designed to reduce production, through direct and indirect subsidies, selective sales of government-held surpluses, \"payment-in-kind\" programs and the elimination from production of acreage and livestock. The terms and duration of specific programs are dependent on continued support by sponsoring governments and their constituencies. The effect of these and other government policies on future sales of agricultural equipment is uncertain.\nThe Company believes that the recent resolution of the General Agreement on Trade and Tariffs (GATT) negotiations between the United States, the EC and other countries may have a stabilizing influence on agricultural commodity prices, and lead to a firming of some prices and a possible improvement in agricultural incomes and demand for tractors. However, the Company views such an improvement, if it occurs, as a longer term beneficial effect, with relatively little short-term impact.\nIMPACT OF OTHER GOVERNMENT POLICIES\nThe operations of the Company and its competitors are affected by other government policies, such as those relating to interest rates, trade, the price and availability of oil, and exchange and price controls.\nThe Company's production facilities are located principally in the United States, the United Kingdom, France, Canada and Germany. There is a substantial interdependence among some of the Company's facilities for finished products, components and services, and therefore adverse local conditions in one country could have an adverse effect on a substantial portion of the Company's operations.\nThe Company's production costs are affected by conditions prevailing in the countries in which its production facilities are located. The Company is exposed to currency exchange risks in the transfer of goods and services between countries. Exchange rate fluctuations also affect the Company's consolidated financial reporting as a result of the translation of its financial statements into U.S. dollars. The Company's production costs, profit margins, and competitive position are materially affected by the strength of the currencies in the countries where it manufactures goods relative to the strength of the currencies in the countries where its goods are sold. To protect against fluctuations in foreign currencies, the Company from time to time enters into foreign exchange contracts, primarily to purchase or sell European currencies, for periods generally consistent with the underlying transaction exposures.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and its subsidiaries operate 17 manufacturing facilities in the United States and Canada with aggregate space of approximately 3.0 million square feet. There are also 5 facilities located in Europe with a total manufacturing area of approximately 4.9 million square feet. All of these facilities are owned by the Company. All of the Company's Canadian and European manufacturing facilities are pledged to its lenders as well as facilities in the United States related to the production of systems and components for the medium and heavy duty truck and trailer industries.\nThe automotive products segment manufactures its range of products (e.g. brake components, electromechanical auto components, etc.) at 17 locations in North America aggregating approximately 3.0 million square feet and ranging in size from approximately 500,000 square feet in Detroit, Michigan to 56,000 square feet in Carrollton, Kentucky. The locations of this segment's plants are as follows:\nBrighton, Michigan Kingsway, Ohio Camden, Tennessee Milford, Michigan Carrollton, Kentucky-2 Moraine, Ohio Detroit, Michigan Mt. Vernon, Ohio Fayette, Ohio Portsmouth, Ohio Fenton, Michigan St. Catherines, Ontario Fremont, Ohio Woodstock, Ontario-2 Jackson, Michigan\nThe engines segment manufactures diesel engines at two locations in England (Peterborough and Shrewsbury) with a total space of approximately 2.1 million square feet, the largest of which is approximately 1.8 million square feet.\nThe farm equipment segment has two plants, one in Coventry, England and one in Beauvais, France. These facilities are used for manufacturing agricultural tractors and occupy a total space of approximately 2.5 million square feet.\nThe other products segment, which presently includes the hydraulic cylinder and valve manufacturing business, operates from a 313,000 square foot facility in Eschwege, Germany.\nThe Company also operates 13 major parts warehouses in 9 countries, 9 of which are leased. In addition, the Company owns or leases a number of other properties in the United States, Canada, the United Kingdom and certain other countries.\nIn general, the Company believes that its facilities are in good operating condition and are suitable for their intended use. The Company's productive capacity in the farm equipment segment currently exceeds demand and consequently the facilities in this segment are not fully utilized. In order to meet increased ABS demand in the United States and Europe within the automotive products segment, the Company commenced construction of two new plants in fiscal 1993. These facilities, located in Heerlen, Netherlands and Fowlerville, Michigan, are scheduled to begin production in mid-1994. In the remaining segments, productive facilities are adequate for current production needs and provide a reasonable margin for further growth and expansion in the underlying businesses. The Company believes that its plants and equipment are adequately insured.\nOver the last five years, the Company has disposed of a number of its manufacturing facilities as part of the rationalization of its businesses. It continues to own several facilities no longer used in its operations which are being held for development or sale.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nMASSEY COMBINES CORPORATION\nIn the case Howe et al. v. Varity Corporation and Massey-Ferguson Inc. (United States District Court, Southern District of Iowa), plaintiffs, purporting to represent a class of former salaried employees and retirees of Massey-Ferguson Inc. (MF Inc.), commenced an action in October 1988 alleging that the defendant corporations sought to avoid their contractual obligations to provide health and insurance benefits and employment termination allowances by transferring the plaintiffs to Massey Combines Corporation (MCC), a Canadian corporation, in 1986, which subsequently entered receivership in 1988.\nThe action asserts violations of the Employee Retirement Income Security Act of 1974, breach of fiduciary duty, breach of contract, promissory estoppel, wrongful interference with protected rights, and fraudulent misrepresentation. Plaintiffs' motion for a preliminary injunction requiring extension of benefits to retirees and disabled persons pending trial was granted by the lower court but reversed by the appellate court as to retirees. The plaintiffs seek to compel reinstatement of benefits, compensatory damages, punitive damages and costs of the action. The jury on September 23, 1991 awarded two subclasses of former employees of MCC and ten individuals formerly employed by MF Inc., $9.8 million in compensatory damages and $36 million in punitive damages against Varity and MF Inc. On March 26, 1993, the court struck completely the punitive damage award and reduced the compensatory damage award to $8.3 million. The Company and plaintiffs have each appealed.\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 for the quarter ended January 31, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets out the names and ages of each of the executive officers of the Company, their positions as of January 31, 1994, the date on which they were appointed to such positions and their business experience during the past five years:\n- ---------- (1) All positions shown are with the Company unless otherwise indicated.\n(2) All executive officers are appointed by the Board of Directors of the Company and serve at its pleasure.\n(3) There are no family relationships between any of the executive officers, directors or persons nominated for such positions and there is no arrangement or understanding between any of the executive officers and any other person pursuant to which he or she was selected as an officer.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nWORLD HEADQUARTERS 672 Delaware Avenue Buffalo, New York 14209-2202 Telephone: 716 888-8000\nANNUAL MEETING The annual meeting of the Company's shareholders will be held on Thursday, June 2, 1994 in the Albright-Knox Art Gallery, 1285 Elmwood Avenue, Buffalo, New York.\nSTOCK TRADING SYMBOL Common: VAT\nSTOCK EXCHANGE LISTINGS Common: New York, Toronto\nCommon stock has unlisted trading privileges on Boston, Midwest and Pacific stock exchanges.\nTRANSFER AGENT AND REGISTRAR Mellon Securities Trust Company 120 Broadway New York, New York 10271 Telephone 1 800 526-0801 1 412 236-8000 Telecommunications Devices for the Deaf 1 800 231-5469\nDIVIDENDS\nAs long as any shares of Class II Series A Preferred Stock are outstanding, unless all cumulative and \"additional\" dividends then payable on these shares have been declared and paid or amounts set aside for payment, the Company may not, without the prior approval of the holders of these shares:\n1) declare or pay any dividends (other than stock dividends in shares of the Company ranking junior to these shares) on any common or junior shares;\n2) redeem, purchase or make any capital distribution in respect of any equal or junior shares; or\n3) issue any additional shares ranking as to capital or dividends prior to or on a parity with these shares.\nAt this time all dividends now payable have been paid or set aside for payment.\nSTATISTICAL DATA\nMARKET PRICE OF COMMON STOCK\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA \/(1)(2)\/\nThe following selected financial data has been derived from the Consolidated Financial Statements of the Company for the fiscal years 1993, 1992, 1991, 1990 and 1989.\nThe selected financial data should be read in connection with the Consolidated Financial Statements and Notes thereto and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere herein.\n(1) See Note 13 to the Consolidated Financial Statements included herein for discussion of contingent liabilities and commitments. (2) No cash dividends on common stock have been paid in any of the years in the five-year period ended January 31, 1994. (3) Amounts reported for January 31, 1993 reflect the sale of a majority ownership in Hayes Wheels, the sale of substantially all of the net assets of Massey Ferguson's North American distribution operations and the formation of a joint venture that acquired substantially all of the net assets of Agricredit. (4) Amounts reported for January 31, 1990 reflect the acquisition of K-H Corporation effective November 30, 1989.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nOVERVIEW\nVarity Corporation's consolidated financial results for the year ended January 31, 1994 (fiscal 1993) reflected a net loss of $71.5 million ($2.23 per share) compared to net income of $27.0 million ($.32 per share) for fiscal 1992 and a net loss of $178.0 million ($7.87 per share) for fiscal 1991. During the first quarter of fiscal 1993, the Company recognized a one-time, non-cash $146.1 million charge ($3.98 per share) in connection with the adoption of two new accounting standards as described in Note 1 of the Notes to Consolidated Financial Statements. In addition, during fiscal 1993 the Company incurred an extraordinary loss of $1.7 million ($.05 per share) with respect to the early redemption of debt.\nFiscal 1992 results also were affected by several unusual items, including a $23.6 million loss associated with the sale of a Massey Ferguson unit, a $17.3 million gain from the sale of a majority ownership in a Kelsey-Hayes subsidiary and a $6.4 million extraordinary loss resulting from the early redemption of debt. Excluding the effects of the aforementioned one-time accounting changes and other non-recurring gains or charges, fiscal 1993 earnings rose to $76.3 million compared with $39.7 million in fiscal 1992.\nForeign exchange rate fluctuations between various European currencies and the United States dollar can significantly affect the Company's reported results, as a substantial volume of farm equipment products are sold into the United States from Europe. A significant portion of costs associated with the farm equipment segment and the engines segment are incurred at European manufacturing locations in the United Kingdom and France. This cross-trading gives rise to exchange gains and losses on individual transactions in different currencies.\nAs a result of exchange rate volatility, principally during fiscal 1992, the average value of the U.S. dollar (utilized to translate foreign currency revenues and expenses) for fiscal 1993 was 13% higher against the British pound and approximately 7% higher against the other major European currencies compared to such average values in fiscal 1992. As a result, the Company's sales and related costs transacted in the foreign countries where the Company primarily operates were at lower relative values than in the prior year, based on the lower translation value of such foreign currencies. At January 31, 1994, the value of the U.S. dollar was relatively stable against the British pound and approximately 7% higher against the other major European currencies as compared to values at the previous year-end. Accordingly, the Company's consolidated assets and liabilities located in foreign countries (which are translated using the respective year-end rates of exchange) are affected by the lower translation value of such foreign currencies in comparison to the prior year, the impact of which is reflected in the foreign currency translation adjustment account in stockholders' equity in the Company's consolidated balance sheet.\nThe accompanying fiscal 1993 consolidated statement of operations is not readily comparable to fiscal 1992 or fiscal 1991 as a result of the Company's dispositions in the fourth quarter of fiscal 1992 of all or a portion of certain businesses which are no longer included in the Company's consolidated results, as is described more fully in Notes 14 and 15 of the Notes to Consolidated Financial Statements. Significant declines in sales and revenues, cost of goods sold, marketing, general and administration and interest, net are a direct result of such dispositions. The ensuing segment operating review for fiscal 1993 as compared with fiscal 1992 addresses each group's remaining core businesses in the context of its segment results.\nSEGMENT OPERATING REVIEW\n(1) Historical amounts reflect the fiscal 1993 presentation of no longer reporting the finance companies as a separate segment, but incorporating the limited remaining third party business directly into the related manufacturing segment. This change in presentation had no effect on total consolidated sales and revenues or on consolidated net income, as reported, for fiscal 1992 or fiscal 1991.\n(2) Automotive products segment information for fiscal 1992 is presented on a pro forma basis to exclude $547 million of sales and revenues and $56 million of operating earnings of Hayes Wheels International, Inc. (Hayes Wheels), Brembo Kelsey Hayes, S.p.A. (Brembo) and Dayton Parts, Inc. (Dayton Parts). Subsequent to the Company's sale of its majority ownership in Hayes Wheels, during the fourth quarter of fiscal 1992, such operations are not consolidated and accordingly are not included in the above segment information. The Company's 46% share of the earnings of Hayes Wheels for the last month of fiscal 1992 and all of fiscal 1993, excluding charges associated with first quarter fiscal 1993 accounting changes, is included in equity in earnings of associated companies in the consolidated statements of operations. Brembo and Dayton Parts were sold and as a result, did not contribute to the Company's fiscal 1993 results. Automotive products results have also been adjusted to reflect the impact of the incremental costs associated with Statement of Financial Accounting Standard (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which was adopted in the first quarter of fiscal 1993, as if it had been adopted at the beginning of fiscal 1992.\nFarm equipment segment information for fiscal 1992 is presented on a pro forma basis to exclude $145 million of sales and revenues and $3 million of operating losses of Massey Ferguson's North American distribution operations which were sold during the fourth quarter of fiscal 1992 and Agricredit, a diversified wholly-owned North American equipment finance subsidiary, which was sold to a 50% owned joint venture, during the fourth quarter of fiscal 1992. Pro forma amounts have also been adjusted to reflect the impact of the incremental costs associated with SFAS No. 106 as if it had been adopted at the beginning of fiscal 1992.\nAUTOMOTIVE PRODUCTS\nUnited States automobile and light truck demand during fiscal 1993 continued to improve, as measured by a 9% increase in vehicle sales over the comparable fiscal 1992 period, reflecting increased consumer confidence and a generally stronger overall business environment. Correspondingly, North American production of these vehicles, which incorporate Kelsey-Hayes' products and influences the Company's automotive products segment, increased 12% during the same period. Varity's automotive products segment benefitted from its strategic position as a major supplier of anti-lock braking systems (ABS) and foundation (conventional) brakes for light trucks, vans and sport utility vehicles, as North American industry production of these vehicles increased 15% during fiscal 1993. As a result, the Company's automotive products segment recorded sales of $1.1 billion in the current year, reflecting an increase of 19% over pro forma fiscal 1992 levels, as adjusted for business divestitures.\nIn addition to increased North American light vehicle production, higher sales also resulted from expanded ABS installation rates in new vehicles, replacement of two-wheel ABS with higher value four-wheel systems and strong demand for foundation brake products, including the full year impact of certain vehicle platforms launched in the fall of fiscal 1992.\nThe automotive products segment also includes sales of products for the heavy duty truck and trailer market, which are produced by the heavy duty brake group of Dayton Walther, a wholly-owned subsidiary of Kelsey-Hayes. Sales of this unit benefitted from higher industry sales of 33% and 11% for heavy duty and medium duty trucks, respectively, during calendar year 1993 as compared to 1992.\nSegment operating income in 1993 for the automotive products segment was $90 million, up 36% from 1992 pro forma results of $66 million. Earnings improved over the prior year as a direct result of the aforementioned increased sales and the continued focus on implementing cost reductions and productivity improvements. The current year's results were tempered, however, by expenses associated with expanding capacity and pursuing new ABS business. These expenditures included costs for establishment of the European ABS marketing and technical center in Wiesbaden, Germany and the initial start-up activities at the Heerlen, Netherlands and Fowlerville, Michigan ABS manufacturing facilities, which are scheduled to commence production in mid- 1994. The majority of these expenditures were associated with product engineering and vehicle testing activities to support customer programs.\nIn addition, operating margins in Kelsey-Hayes' foundation and heavy duty brakes business were negatively influenced by higher costs from overtime and outsourcing penalties as a result of increased demand for certain high-volume vehicle platforms.\nNorth American Kelsey-Hayes automotive segment engineering and product development costs increased 9% during fiscal 1993, in support of various new programs scheduled for launch in 1994 and beyond. These programs include the four-wheel EBC-10 (tm) ABS system scheduled for production in mid-1994 and another significant vehicle platform program which commences production in early 1994 and encompasses both ABS and conventional brake products.\nDuring fiscal 1992, United States automobile and light truck retail sales increased 5% over the prior period, as consumer and business uncertainty concerning the economy lessened. Correspondingly, industry vehicle production increased 10% during the same period, with light truck production increasing 18%.\nAs a result of the automotive products segment's concentration in light truck products, sales increased 12% to $1.5 billion (before pro forma adjustments) in fiscal 1992 from the prior year. Such sales increased 14% when adjusted to include the sales of the segment's wheels business for the full year in fiscal 1992. During the fourth quarter of fiscal 1992, the Company sold a majority ownership in its Hayes Wheels business to the public. The Company no longer consolidates the results of Hayes Wheels as it now accounts for its 46.3% share of earnings on the equity basis. (Hayes Wheels' sales amounted to $377.6 million during the approximately eleven month period they were consolidated in fiscal 1992).\nUnderlying the increase in segment sales were higher ABS sales due to increased vehicle production, improved market installation rates (approximately 30% in 1992 as compared to approximately 16% in 1991) and a mid-year conversion from two-wheel to higher value four-wheel ABS on several vehicle platforms.\nFoundation brake group sales also experienced significant growth during fiscal 1992, due to higher industry automobile and light truck production and the commencement of sales for several new brake component programs. Additionally, a strong trailer market and gradually improving heavy and medium duty industry truck sales favorably affected the heavy duty brakes group's sales during fiscal 1992.\nThe automotive products segment recorded operating income of $133 million during fiscal 1992 as compared to fiscal 1991 operating income of $56 million. After eliminating the special fiscal 1991 restructuring charge for employment reductions and other related actions, operating income was $106 million. Earnings improvement to $133 million is primarily due to higher volumes and benefits from the fiscal 1991 restructuring program.\nENGINES\nDemand for diesel engines in the major market sectors in which the Company's Perkins engines segment participates (agricultural, construction, industrial, marine and automotive) remained soft during fiscal 1993 as manufacturers that incorporate such equipment in their products experienced little increase in demand, particularly in Europe. For Perkins this was largely offset by increased United Kingdom sales, specifically in the agricultural and power generation sectors, reflecting both sales to new customers, including several international equipment producers, and increased sales to certain existing accounts in connection with new applications for its engines. As a result, total engines segment sales, adjusted to neutralize the effects of differing foreign exchange rates between the periods, increased 8% to $702 million in fiscal 1993 as compared with the prior year. (Reported engines segment sales declined $42 million due to the lower translation value of the British pound during fiscal 1993 versus fiscal 1992). Higher sales in the United Kingdom, United States, Middle East and Far East offset lower volumes attributable to the continuing difficult economic conditions in continental Europe, including a prolonged downturn in its economy and an industrial slowdown affecting demand in several key markets. In addition, sales of engines parts increased approximately $11 million from the prior year primarily as a result of an increase in military equipment repair activity.\nOperating income in fiscal 1993 for the engines segment increased 10% to $46 million as a result of higher exchange adjusted sales, productivity improvements and continuing efforts to control costs, despite certain non- recurring military sales in the prior year.\nEngines segment sales increased 4% to $744 million in fiscal 1992 as compared to fiscal 1991. Despite relatively high exchange rate volatility during fiscal 1992, the average value of the U.S. dollar (utilized to translate foreign currency revenues) for fiscal 1992 was only 1% higher against the British pound compared to the average rate in fiscal 1991. As a result, fiscal 1992 sales, adjusted to neutralize the effects of differing foreign exchange rates between the periods, increased only marginally more than the 4% absolute dollar increase as compared to fiscal 1991. Sales to new customers, wider applications for certain existing customers and sales of engines for military equipment in connection with the United Nations Bosnian relief efforts offset sluggish demand for engines due to recessionary economic conditions.\nOperating income in fiscal 1992 improved to $42 million from $20 million in fiscal 1991 ($32 million after eliminating the fiscal 1991 restructuring provision for employment reductions and other related actions). Operating income benefitted from marginally higher sales, results from the fiscal 1991 restructuring program and ongoing cost reduction efforts. In addition, fiscal 1991 operating earnings were depressed due to a four week strike at Perkins' main diesel engine factory in Peterborough, England.\nFARM EQUIPMENT\nSales of farm equipment declined $243 million to $898 million in fiscal 1993, as a result of certain transactions affecting comparability with the prior year. During the fourth quarter of fiscal 1992, the Company sold substantially all of the net assets of Massey Ferguson's North American farm equipment distribution operations to AGCO Corporation (AGCO), primarily dealer accounts receivable and inventories. Additionally, the Company and AGCO formed a 50% joint venture that acquired substantially all of the net assets of Agricredit, a diversified North American equipment finance company which was previously wholly-owned by Varity. During fiscal 1992, the former North American distribution operations contributed $103.0 million to consolidated sales and revenues (primarily wholesale sales to dealers) for which the Company had no corresponding sales in fiscal 1993. Similarly, Agricredit contributed $42.0 million of revenue in fiscal 1992 for which no corresponding current year revenue exists.\nAfter adjusting fiscal 1992 sales and revenues for such business divestitures, sales in the current year decreased $98 million. Further adjusted to neutralize the effects of differing foreign exchange rates between the periods, sales declined marginally by approximately $6 million, reflecting the continuing decline in demand for agricultural tractors in many markets, partially offset by an increase in aggregate market share.\nDemand for tractors in Europe, the most significant market for the Company's agricultural products, declined by 8% in fiscal 1993. The resultant impact on Massey Ferguson was mitigated by relatively stable demand in France and significant improvement in United Kingdom farm incomes and related purchasing power. As a result of the Company's strong position in the United Kingdom, Massey Ferguson's European market share rose from 9.6% in 1992 to 10.6% in 1993. Sales of unassembled tractor kits to licensees declined 13% in 1993 primarily as a result of economic downturns in Iran, Mexico and Pakistan, partially offset by gains in Turkey. Third world markets continue to be affected by a combination of political instability, funding availability constraints and climate conditions. In North America, Massey Ferguson's market share increased to 8% during the year, reflecting benefits of the 1992 distribution agreement with AGCO.\nOperating income declined to $8 million in fiscal 1993 from $10 million in 1992 principally as a result of marginally lower exchange adjusted sales and certain one-time charges relating to disposed operations and product lines.\nTotal sales of farm equipment increased marginally in fiscal 1992 from the prior year despite contracting worldwide demand, global economic recessionary conditions and uncertainty over reforms in agricultural support programs. Underlying market share increases in North America and increased sales of unassembled tractor kits to licensees, most notably in Pakistan and Turkey, contributed to the modest sales improvement. Foreign exchange translation values were relatively constant between the two periods.\nFarm equipment recorded operating income of $4 million in fiscal 1992 as compared with an operating loss of $55 million in the prior year (income of $28 million and a loss of $11 million after eliminating unusual charges for business dispositions, employment reductions and other related actions, respectively). Improved earnings were a function of marginally higher sales and improved margins reflecting initial benefits of the fiscal 1991 restructuring program in addition to ongoing cost reduction efforts.\nNON-SEGMENT OPERATING REVIEW\nAs a result of the adoption of several new accounting standards in fiscal 1993, the Company incurred a non-cash, one-time charge of $146.1 million, primarily pertaining to postretirement benefits other than pensions.\nIn connection with the use of proceeds generated from a common equity offering during fiscal 1993, the Company incurred an extraordinary loss of $1.7 million on the early redemption of indebtedness consisting of redemption premiums and the write-off of related unamortized debt issuance costs. Similarly, the Company incurred a $6.4 million loss on the early redemption of debt in fiscal 1992.\nAs a result of such debt redemptions, other repayments and business divestitures during fiscal 1993 and the latter portion of fiscal 1992, the Company significantly reduced its interest expense during the current year. Interest expense in fiscal 1993 amounted to $35.8 million compared with $139.0 million in the prior year.\nDuring the fourth quarter of 1992, the Company recognized a gain from the sale of a majority ownership in a Kelsey-Hayes subsidiary amounting to $17.3 million. In accordance with SFAS No. 96, no provision for taxes was made at the time of the transaction with respect to the gain due to the Company's existing tax loss carryforwards. Subsequent to the transaction the Company accounts for its investment in Hayes Wheels on the equity method of accounting. Additionally, in fiscal 1992 the Company sold Agricredit to a 50% owned joint venture and now accounts for this investment on the equity method. As a result, equity in earnings of associated companies rose to $16.4 million in fiscal 1993. Hayes Wheels and Agricredit contributed $11.5 million and $4.3 million, respectively. Subsequent to January 31, 1994, the Company sold its remaining 50% ownership in Agricredit to AGCO for an amount which approximated the Company's carrying value of the investment.\nFINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES\nDuring fiscal 1993, the Company continued a series of actions, commenced in the prior year, to strengthen its balance sheet, improve shareholder value and enhance its competitive position in markets around the world. These actions included a second quarter equity offering of previously unissued common stock and the conversion, in the third quarter, of all the outstanding shares of Class I Preferred Stock into common stock, eliminating an annual dividend requirement of approximately $16 million.\nA substantial portion of the proceeds of the 4.6 million share equity offering at $32.75 a share was used to reduce long-term debt, primarily the remaining public debt of Kelsey-Hayes. The remainder of the proceeds was used to reduce short-term indebtedness in order to improve the Company's financial flexibility to fund increased investment in its Kelsey-Hayes businesses.\nAs a result of debt repayments in connection with funds from the equity offering and the sale of Kelsey-Hayes' majority interest in Brembo, which was completed during fiscal 1993, long-term debt outstanding at January 31, 1994 (including current maturities) decreased to $191.1 million from $334.6 million at January 31, 1993. Short-term notes payable decreased by $59.4 million to $68.0 million at January 31, 1994 from $127.4 million at January 31, 1993 as a result of the use of proceeds from the aforementioned equity offering, further increasing the Company's liquidity.\nUnused long-term and short-term lines of credit at January 31, 1994 were $97.6 million and $185.6 million, respectively. Management believes that Varity, as a result of its continued strategic initiatives, will have improved access to credit markets and that its credit facilities and cash flow from operations will continue to be sufficient to meet its operating needs.\nCertain of the Company's loan agreements provide for financial covenants relating to such matters as the maintenance of specified financial ratios and minimum net worth. Certain loan agreements also contain cross-default provisions. At January 31, 1994 the Company and each of its subsidiaries were in compliance with their financial covenants. Management expects that the Company and each of its subsidiaries will remain in compliance during the year ending January 31, 1995.\nReceivables declined $12.3 million to $540.7 million at January 31, 1994 from $553.0 million at January 31, 1993. After adjusting for the sale of Brembo and to a lesser extent, foreign exchange fluctuations, receivables actually increased by approximately $20 million primarily due to strong sales in the fourth quarter of fiscal 1993.\nInventories of raw materials, work-in-process and finished products decreased to $257.6 million at January 31, 1994 from $271.1 million at January 31, 1993. After adjusting for the sale of Brembo and, to a lesser extent, foreign exchange fluctuations, inventories actually increased by approximately $13 million primarily due to routine adjustments in manufacturing schedules in response to customer demand.\nNet fixed assets increased $5.2 million to $602.3 million at January 31, 1994 from $597.1 million at January 31, 1993 due to capital additions exceeding depreciation and disposals (primarily Brembo), partially offset by marginal declines due to foreign exchange. Capital expenditures during fiscal 1993 and 1992 were $154.8 million and $105.9 million, respectively, and depreciation and amortization were $84.8 million and $123.4 million, respectively, for the same periods. Capital expenditures for fiscal 1994 should approximate $220 million, of which $74.0 million has been committed. These expenditures will be mainly for the completion of construction of new plants in the United States and the Netherlands for the production of ABS, in addition to normal equipment replacements and operating improvements related to reducing costs and increasing output.\nOther long-term liabilities increased by $77.2 million to $382.4 million at January 31, 1994 from $305.2 million at January 31, 1993, primarily due to the recognition of the liability for postretirement benefits other than pensions in the current year as is further described in Note 1 of the Notes to Consolidated Financial Statements, offset in part by a decrease in certain pension liabilities as a result of funding contributions made in fiscal 1993. Pension and other postretirement benefit costs will increase in fiscal 1994 due to lower discount rates necessitated by declining interest rates in the U.S. and elsewhere.\nStockholders' equity increased by $82.2 million to $630.7 million at January 31, 1994, as the increase in common stock of $143.7 million, resulting from the current year equity offering was partially offset by the $71.5 million net loss due principally to the adoption of two new accounting standards as described in Note 1 of the Notes to Consolidated Financial Statements, in addition to preferred dividends paid of $10.4 million. The decrease in preferred stock resulting from the current year conversion of Class I Preferred Stock into common stock was offset by the issuance of 8,085,000 shares of common stock, net of transaction expenses.\nVarity is primarily dependent on its subsidiaries to meet its cash requirements. Varity's ability to obtain cash from its subsidiaries or to transfer cash between subsidiaries is governed by the financial condition and operating requirements of these subsidiaries, and in certain instances the terms of loan agreements or similar agreements to which its subsidiaries are parties. The Company has ongoing short-term cash requirements for working capital, capital expenditures, dividends, interest and debt payments. The Company believes that its cash requirements will be met through internally and externally generated sources, existing cash balances and utilization of available borrowing facilities.\nAs a result of the Company's actions over the past two years to reduce debt and increase operating efficiencies, the Company's financial position and liquidity have improved markedly. The Company believes these actions have improved its access to capital markets and will better posture the Company to finance investment in and expansion of the growth areas of its businesses. The Company is exploring further opportunities to divest operations that do not meet its strategic objectives, including farm equipment. The Company anticipates any such transactions would further improve its liquidity and financial flexibility, if and to the extent that such opportunities might be realized in the future.\nDuring the next five years the Company believes that its cash requirements for working capital, capital expenditures, dividends, interest and debt repayments will continue to be met through internally and externally generated sources and utilization of available borrowing sources.\nThe Company, primarily through its automotive products segment, is involved in a limited number of remedial actions under various federal and state laws and regulations relating to the environment which impose liability on parties to clean up, or contribute to the cost of cleaning up, sites on which their hazardous wastes or materials were disposed or released. The Company believes that it has made adequate provision for costs associated with known remediation efforts in accordance with generally accepted accounting principles and does not anticipate the future cash requirements of such efforts to be significant. The Company has made no provision for any unasserted claims as it is not possible to estimate the potential size of such future claims, if any.\nOUTLOOK\nThe Company believes that its automotive products segment is positioned to benefit in fiscal 1994 from the improving conditions in the North American automotive industry. The Company is also addressing the incremental cost burdens it is experiencing as a result of increased production schedules. Continued management actions and cost reduction efforts have positioned both the engines and farm equipment segments to benefit when the European economy improves, although the Company does not expect a major upturn in Europe during fiscal 1994.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data\nConsolidated Statements of Operations\n* Anti-dilutive\nSee accompanying notes to consolidated financial statements.\nConsolidated Balance Sheets\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Changes in Stockholders' Equity\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Cash Flows\nSee accompanying notes to consolidated financial statements.\nNotes to Consolidated Financial Statements\nYears ended January 31, 1994, 1993 and 1992 (Fiscal 1993, 1992 and 1991, respectively) (Dollars in millions unless otherwise stated)\n1. CHANGES IN ACCOUNTING PRINCIPLES\nDuring fiscal 1993 the Company changed its method of accounting for income taxes, postretirement benefits other than pensions, postemployment benefits and marketable securities in accordance with several new Statements of Financial Accounting Standards. Prior years' financial statements were not restated for these changes.\nEffective February 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" SFAS No. 109 replaced SFAS No. 96 which the Company previously followed in accounting for income taxes. The principal difference between SFAS No. 109 and SFAS No. 96 is the ability, under SFAS No. 109, to record a deferred tax asset for net operating loss and credit carryforwards, when its ultimate realization is more likely than not. The adoption of SFAS No. 109 had no effect on the Company's results of operations or financial condition.\nThe Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective February 1, 1993. This standard requires that the cost of postretirement benefits, primarily health care benefits, be recognized over employees' active working lives. In prior years, these costs were expensed as paid. The Company recorded the transition obligation, which represents costs related to service already rendered by both active and retired employees prior to fiscal 1993, as a cumulative effect of a change in accounting principle. This one-time, non-cash charge was $126.7 million. (The Company did not record an associated income tax benefit from the charge as tax operating losses in prior years diminish the Company's immediate ability to demonstrate that it is more likely than not that such benefits will be realized.) The Company will continue to follow its policy of funding postretirement benefits when due. The adoption of this new standard had the effect of increasing ongoing postretirement benefit expense for the year ended January 31, 1994 by $4.8 million. In addition to the Company's adoption of SFAS No. 106, the cumulative effect of changes in accounting principles in the consolidated statement of operations includes a similar one-time charge ($11.4 million, net of tax benefit) for Hayes Wheels International, Inc. (Hayes Wheels), a 46.3% owned affiliate.\nEffective February 1, 1993, the Company changed its method of accounting for postemployment benefits, in accordance with SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" to recognize a charge for such benefits when it is probable that a liability has been incurred and the amount can be reasonably estimated. The adoption of SFAS No. 112 resulted in a one-time, non-cash $8.0 million charge which has been included within the cumulative effect of changes in accounting principles in the Company's consolidated statement of operations.\nEffective January 31, 1994, the Company adopted the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 supersedes SFAS No. 12 which the Company previously followed in accounting for marketable securities. SFAS No. 115 requires that debt and equity securities not classified as either held-to-maturity securities or trading securities be classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of stockholders' equity. The Company has determined that its marketable securities portfolio at January 31, 1994 is available-for-sale, as defined within the pronouncement, and has presented the unrealized net gain on such portfolio as a separate component of stockholders' equity.\n2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Basis of Presentation and Consolidation\nThe consolidated financial statements include the accounts of all wholly and majority-owned subsidiaries. Investments in associated companies in which the Company's ownership interest ranges from 20 to 50% and over which the Company exercises influence on operating and financial policies are accounted for using the equity method (see Note 17). Other investments are accounted for using the cost method. Significant intercompany balances and transactions have been eliminated in consolidation.\nHistorically, the Company has presented detailed supplemental information with respect to its finance subsidiaries. Such information is no longer presented due to changes in the composition of finance subsidiaries owned by the Company, which are now immaterial.\nCertain reclassifications have been made to the fiscal 1992 and 1991 consolidated financial statements and notes to conform with the fiscal 1993 presentation.\n(b) Cash Equivalents\nCash equivalents consist of liquid instruments with an original maturity of three months or less.\n(c) Marketable Securities\nEffective January 31, 1994, the Company adopted the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" as described in Note 1. The Company has determined that its marketable securities portfolio at January 31, 1994 is available-for-sale, as defined within the pronouncement, and has presented the unrealized net gain on such portfolio as a separate component of stockholders' equity. Prior to the adoption of SFAS No. 115, marketable securities were carried at cost, which approximated market value.\nThe cost, gross unrealized gains and losses and fair value of the Company's marketable securities at January 31, 1994 follows:\nThe Company's marketable securities generally have contractual maturities that are long-term in nature, the majority of which are due after January 31, 1997.\n(d) Inventories\nInventories are valued at the lower of cost or net realizable value with cost determined primarily on the first-in, first-out basis. Cost includes the cost of material, direct labor and an applicable share of manufacturing overhead.\nThe major classes of inventory are as follows:\nThe Company's inventory systems do not permit the disaggregation of raw materials from work in process.\n(e) Fixed Assets\nAdditions to fixed assets are recorded at cost. Depreciation of fixed assets is generally provided on a straight-line basis at rates which are intended to depreciate the assets over their estimated useful lives as follows:\nBuildings ...................................................... 10 to 50 years Machinery, equipment and tooling ............................... 3 to 12 years\nExpenditures for maintenance, repairs and minor replacements of $36.6, $62.3, and $59.3 million for fiscal 1993, 1992 and 1991, respectively, were charged to expense as incurred.\n(f) Goodwill\nThe excess of the acquisition cost over the aggregate fair value of the underlying net assets of businesses acquired is amortized on a straight-line basis over 40 years.\n(g) Revenue Recognition\nSales are recorded by the Company when products are shipped.\n(h) Research and Development Costs\nResearch and development costs, the majority of which are included in engineering and product development expenses, are charged to expense as incurred ($48.5, $41.4, and $38.1 million for fiscal 1993, 1992 and 1991, respectively).\n(i) Foreign Currency Translation\nFor most foreign subsidiaries, the local currency is considered the functional currency. Assets and liabilities of these subsidiaries are translated at year- end rates of exchange. Revenue and expense items are translated at average rates of exchange for the year. Translation adjustments, including the translation effect of intercompany transactions deemed permanent in nature, that arise due to fluctuations in exchange rates are recorded directly in stockholders' equity. Gains and losses resulting from foreign currency transactions are included in the statements of operations.\n(j) Income Taxes\nEffective February 1, 1993, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes,\" as described in Note 1.\nDeferred income taxes are provided on all significant temporary differences and represent the tax effect of transactions recorded for financial reporting purposes in periods different than for tax purposes.\n(k) Financial Instruments\nThe carrying values of the Company's financial instruments at January 31, 1994 approximate their estimated fair values. The carrying amounts of cash and cash equivalents and notes payable approximate fair value due to the short-term maturity of such instruments. The carrying amount of marketable securities is based on quoted market prices. The carrying amount of foreign exchange contracts approximates fair value as all such contracts are revalued monthly based on current exchange or forward rates, as applicable, and substantially all have remaining contractual terms of six months or less. The carrying amount of long-term debt approximates fair value based on the quoted market prices for the same or similar issues, or the current rates offered to the Company for debt with similar maturities and characteristics.\n3. INCOME TAXES\nEffective February 1, 1993, the Company adopted the provisions of SFAS No. 109, \"Accounting for Income Taxes,\" as described in Note 1.\nIncome tax provisions have been recorded in respect of the Company's results of operations as follows:\nUnited States taxes represent federal income taxes. State income taxes are not material.\nThe following table reconciles the 35%, 34% and 34% statutory United States federal income tax rates for the years ended January 31, 1994, 1993 and 1992, respectively, to the Company's effective tax rates:\nThe tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities recorded on the balance sheet as of January 31, 1994 and February 1, 1993, the date of adoption of SFAS No. 109, are as follows:\nThe valuation allowance results principally from tax operating losses in prior years which diminish the Company's immediate ability to demonstrate that it is more likely than not that future benefits will be realized.\nThe Company's fiscal 1993 sale of its majority interest in Brembo Kelsey- Hayes, S.p.A. substantially offsets the expected increase in net deferred tax liability resulting from the current year's deferred income tax expense.\nNo provision has been made for United States federal or foreign taxes on that portion of foreign subsidiaries' undistributed earnings ($57.7 million at January 31, 1994) considered to be permanently reinvested. There would have been no United States federal income tax liability had such earnings actually been repatriated due to the Company's existing tax loss carryforwards, however, upon repatriation, certain foreign countries would impose income and withholding taxes, which in the aggregate would be immaterial.\nDeferred income taxes for fiscal 1992 and 1991 resulted primarily from differences in the depreciation methods used for financial reporting and tax purposes, and certain business acquisition adjustments. Deferred income taxes included in the consolidated balance sheets for those years are not material.\nAt January 31, 1994, the Company had net operating loss carryforwards for tax purposes aggregating approximately $740 million. These loss carryforwards are principally in the United States, the United Kingdom and France, and expire as follows: January 31, 1995 - $16 million; 1996 - $86 million; 1997 - $114 million; 1998 - $21 million and 1999 and beyond - approximately $503 million. Applicable tax laws of the United States and other countries may limit utilization of these losses, including United States federal operating loss carryforwards in the amount of $96 million generated by certain subsidiaries prior to their acquisition.\nCash payments for income taxes were $5.6, $6.1, and $15.2 million for fiscal years 1993, 1992 and 1991, respectively.\n4. PER SHARE DATA\nPrimary earnings per share of common stock have been calculated after deducting dividend entitlements on preferred stock and using the weighted average number of shares of common stock and dilutive common stock equivalents (stock options and awards) outstanding. Fully diluted earnings per share of common stock have been calculated using the fully diluted weighted average number of shares of common stock outstanding, and include the dilutive effect, if any, of convertible preferred stock outstanding.\nIn October 1993, the Company called for redemption all of the outstanding Class I Preferred Stock at a redemption price of $20.00 a share. As each share of Class I Preferred Stock was convertible into .6849 shares of the Company's common stock and as the market price of such common stock was greater than $29.20 per share, substantially all of the holders of such Class I Preferred Stock converted their shares into the Company's common stock in lieu of redemption. As a result of the foregoing the Company issued 8,085,000 additional shares of common stock. The fully diluted weighted average number of shares of common stock outstanding assumes the conversion had taken place on the first day of fiscal 1993.\nAdditionally, in June 1993 and December 1992, the Company sold, through separate public offerings, 4,600,000 and 5,750,000 shares, respectively, of previously unissued common stock. A substantial portion of the proceeds served to reduce short-term and long-term debt. The primary and fully diluted weighted average number of shares outstanding include shares from such offerings from the actual transaction dates. The weighted average shares outstanding are summarized as follows:\n5. RECEIVABLES\nReceivables are presented net of allowances for doubtful accounts of $18.1 million and $20.4 million at January 31, 1994 and 1993, respectively.\nCredit risk is generally concentrated within the Company's primary business segments. Geographically, such concentrations are principally within the United States and Western Europe. The Company performs ongoing credit evaluations of its customers' financial condition and, in certain circumstances, retains as collateral a security interest in products financed or sold.\n6. OTHER ASSETS AND INTANGIBLES\nOther assets and intangibles consist of the following:\nOther assets and intangibles are presented net of accumulated amortization of $68.4 million and $56.3 million at January 31, 1994 and 1993, respectively.\n7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nAccounts payable and accrued liabilities consist of the following:\n8. LONG-TERM DEBT\nDebt is repayable in United States dollars unless otherwise indicated.\n(a) Varity's 11.375% Senior Notes due November 15, 1998 are redeemable at the option of the Company, in whole or in part, at any time on or after November 15, 1996, at 100% of the principal amount thereof plus accrued interest to the date of redemption. The related indenture, among other things, restricts the Company and its subsidiaries' ability to make certain cash distributions, requires minimum levels of net worth, as defined, places restrictions on the use of proceeds from asset sales and limits the incurrence of additional indebtedness. See Note 12(b) (ii).\n(b) In connection with the Company's equity offering in June 1993, as described in Note 4, the 9.75% Senior Notes, 13.5% Senior Subordinated Notes, various term loans and other indebtedness including the 13.75% Senior Subordinated Debentures were retired. The indentures for the 13.5% Senior Subordinated Notes and the 13.75% Senior Subordinated Debentures subjected early debt redemptions to a premium of 3% and 5%, respectively, over the face amount. The redemption premiums and the write-off of related unamortized debt issuance costs resulted in an extraordinary loss of $1.7 million.\n(c) Certain of the Company's loan agreements provide for financial covenants affecting the Company and its principal subsidiaries. These covenants relate to such matters as the maintenance of specified financial ratios and minimum net worth. Certain loan agreements also contain cross-default provisions. At January 31, 1994 the Company and each of its subsidiaries were in compliance with their financial covenants. Management expects that the Company and each of its subsidiaries will remain in compliance during the year ending January 31, 1995.\n(d) As of January 31, 1994, debt maturities for long-term debt during the next five fiscal years are as follows: 1994 - $5.6 million; 1995 - $4.9 million; 1996 - - $3.2 million; 1997 - $3.1 million and 1998 - $174.3 million.\n(e) The Company maintains numerous short-term credit facilities with lenders in various countries for which related amounts outstanding are classified as notes payable in the consolidated financial statements. These credit facilities are generally restricted only in terms of a predefined maximum utilization and are subject to renewal annually or ongoing lender review. The facilities are generally secured by assets of the respective subsidiaries and bear interest at rates ranging from 6.5% to 12.5% at January 31, 1994.\nUnused long-term and short-term lines of credit at January 31, 1994 were $97.6 million and $185.6 million, respectively (January 31, 1993 - $46.0 million and $232.7 million, respectively). Approximately $880 million of consolidated assets secure such lines at January 31, 1994.\n(f) Interest, net includes interest income of $12.0, $11.2 and $17.1 million for fiscal 1993, 1992 and 1991, respectively. Cash payments of interest were $47.0, $146.4 and $166.2 million for fiscal 1993, 1992 and 1991, respectively.\n(g) Certain subsidiaries' debt agreements and various regulatory requirements restrict approximately $510 million of subsidiary net assets from being loaned, advanced or dividended to the Company.\n(h) During fiscal 1992 the Company's wholly-owned subsidiary, Dayton Walther, called its 14% Senior Subordinated Notes. The redemption premium and write-off of related unamortized debt issuance costs resulted in an extraordinary loss of $6.4 million.\n9. OTHER LONG-TERM LIABILITIES Other long-term liabilities consist of the following:\n10. PENSION BENEFITS\nThe Company and its subsidiaries have established pension plans in the principal countries where they operate. The majority of its employees are covered by either government or Company sponsored pension plans. Most of the Company's defined benefit plans provide pension benefits that are based on the employee's highest average eligible compensation. Plan assets consist primarily of exchange-listed stocks and bonds. The Company's funding policy is to contribute at least the amount required by law in the various jurisdictions in which the pension plans are domiciled.\nPension expense consists of the following:\nIn connection with the fiscal 1992 divestitures of certain non-core businesses, the Company recognized $4.6 million of curtailment and settlement losses which are included in the net amortization and deferral component of net pension expense for that year.\nAs a result of company induced early retirement and other programs, the Company recognized expenses totalling $3.2 million and $11.1 million in fiscal 1993 and 1991, respectively. Such amounts are not included in the above table.\nThe funded status of pension plans is as follows:\nThe fiscal 1993 additional minimum pension liability is a non-cash item which is offset by an intangible asset of $7.2 million and a direct reduction in stockholders' equity of $26.7 million (corresponding offsets in fiscal 1992 were $5.9 million and $46.0 million, respectively). The Company's consolidated fiscal 1993 direct reduction in stockholders' equity also includes a component for equity investee Hayes Wheels' additional minimum liability.\nThe actuarial assumptions used to develop pension expense reflect prevailing economic conditions and interest rate environments of the different countries wherein the respective pension plans are domiciled. For the three years ended January 31, 1994, the annual discount rates range from 7.5% to 10.0% (7.5% in fiscal 1993 for plans domiciled in the United States), the remuneration increases range from 4.0% to 8.5% and the expected annual long-term rates of return on assets range from 8.25% to 11.5%.\n11. OTHER POSTRETIREMENT BENEFITS\nEffective February 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" as described in Note 1. This standard requires that the cost of postretirement benefits, primarily health care benefits, be recognized over employees' active working lives. In prior years, these costs were expensed as paid. The Company will continue to follow its policy of funding postretirement benefits when due. The adoption of this new standard had the effect of increasing ongoing postretirement benefit expense for the year ended January 31, 1994 by $4.8 million.\nThe Company provides medical and group life benefits to substantially all North American retirees who elect to participate in the Company's medical and group life plans. Medical plan contributions of the participating employees are adjusted periodically; the life insurance plan is non-contributory.\nThe components of postretirement benefits expense are as follows:\nThe recorded actuarial liabilities for postretirement benefits, including those previously recorded in connection with the fiscal 1989 acquisition of K-H Corporation (the parent of Kelsey-Hayes), are as follows:\nThe weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.67% (7.5% in the United States). The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 10% and was assumed to decrease by 1% per annum to an ultimate rate of 6%. An increase in the assumed health care cost trend rate of 1 percentage point per year would increase the accumulated postretirement benefit obligation as of January 31, 1994 by approximately $18.0 million and the aggregate of the service and interest cost components of postretirement benefit expense for the year then ended by approximately $2.0 million.\nDuring the years ended January 31, 1993 and 1992, $13.6 million and $12.2 million, respectively, were charged to expense with respect to health care claims and life insurance premiums for retired employees based on the Company's previous cash-based method of accounting for these costs.\n12. STOCKHOLDERS' EQUITY\n(a) Authorized, Issued and Outstanding Stock The Company is authorized to issue the following shares of stock:\n(i) Class I Stock:\n50,000,000 shares authorized, par value $.01 per share, issuable in series. Two series had been designated: 11,816,309 shares were designated as U.S. $1.30 Senior Cumulative Redeemable Convertible Exchangeable Preferred Class I Stock, Series A, par value $.01 per share; and 11,816,309 shares were designated as U.S. $1.30 Senior Cumulative Redeemable Convertible Exchangeable Preferred Class I Stock, Canadian Series A, stated value $5.00 per share (collectively, the Class I Preferred Stock). In October 1993 the Company called for redemption all of the previously outstanding shares of Class I Preferred Stock (see Note 4). No shares of Class I Preferred Stock are designated or outstanding at January 31, 1994.\n(ii) Class II Stock:\n50,000,000 shares authorized, par value $.01 per share, issuable in series. Currently, one series of 2,001,000 shares has been designated the Cdn. $1.625 Cumulative Redeemable Convertible Exchangeable Preferred Class II Stock, Series A (Class II Preferred Stock). As of January 31, 1994, 2,001,000 shares of Class II Preferred Stock were outstanding.\nThe holders of the Class II Preferred Stock are entitled to receive, as and when declared by the Board of Directors, fixed, cumulative, preferential dividends at an annual rate of Canadian $1.625 per share, payable quarterly.\nThe Class II Preferred Stock is junior to the Class I Preferred Stock in dividend and liquidation rights. Each share is convertible at any time into common stock at a conversion price of Canadian $75.00 per share of common stock (equivalent to .3333 shares of common stock per share of Class II Preferred Stock), subject to adjustment under certain conditions. Shares are redeemable at the Company's option. Each share is redeemable at, and has a liquidation value of, Canadian $25 plus accrued and unpaid cumulative dividends.\nHolders of Class II Preferred Stock have voting rights limited to a fractional vote per share. The fraction is determined by dividing 5% of the total number of shares of common stock entitled to vote by the total number of shares of Class I and Class II Preferred Stock entitled to vote.\n(iii) Class III Stock:\n50,000,000 shares authorized, par value $.01 per share, issuable in series. No series has been designated or issued.\n(iv) Special Purpose Preferred Stock:\n9,000,000 shares of U.S. $1.30 Redeemable Reset Special Purpose Preferred Stock authorized, par value $.01 per share, were issued for Canadian tax purposes in connection with the reincorporation of the Company from Canada to the United States in 1991. The shares do not have any financial impact on the Company. At January 31, 1994, 8,160,000 shares of this stock were outstanding and held by a wholly-owned subsidiary of the Company. These shares pay dividends at an annual rate of $1.30 per share, have no voting rights, and have a redemption and liquidation value of $20 per share. The shares are junior to the Class I Stock, Class II Preferred Stock and Class III Stock and are entitled to preference over the common stock as to dividends and the distribution of assets in the event of a liquidation of the Company.\n(v) Common Stock and Options:\n150,000,000 shares authorized, par value $.01 per share.\nIn June 1993, the Company sold 4,600,000 shares of previously unissued common stock through a public offering. As a result of this offering and the conversion of the Class I Preferred Stock described herein, 43,957,126 common shares were outstanding at January 31, 1994.\nDuring fiscal 1992, $6.2 million of common stock was issued pursuant to the termination of the Performance Equity Plan in a non-cash transaction.\nUnder the Executive Stock Option Plan, the Company may from time to time grant options to purchase common stock of up to an aggregate of 5 percent of the common stock outstanding. Historically, option exercise prices have been generally equal to market value or in one instance a slight discount to market value at the date of grant. However, the majority of fiscal 1993 grants were at a 35% premium to market value. The following table summarizes common stock option activity during each of the years in the three year period ended January 31, 1994:\n(1) Options have been exercised at average prices of $15.50, $11.59 and $22.77 for fiscal 1993, 1992 and 1991, respectively.\n(2) Options to purchase 586,000, 837,000, and 510,000 common shares were exercisable at January 31, 1994, 1993 and 1992, respectively. Options outstanding at January 31, 1994 were exercisable at prices ranging from $11.59 to $81.40 ($11.59 to $81.40 at January 31, 1993 and $17.50 to $81.40 at January 31, 1992).\n(b) Restrictions on Dividends, Issue and Reduction of Capital\n(i) As long as any Class II Preferred Stock is outstanding, and unless all dividends then payable on such shares have been declared and paid or amounts set aside for payment, the Company may not, without the prior approval of the holders of these shares:\n(1) declare or pay any dividends (other than stock dividends in shares of the Company ranking junior to such shares) on any common stock or junior ranking shares;\n(2) redeem, purchase, or make any capital distribution in respect of any equal or junior ranking shares; or\n(3) issue any additional shares ranking as to capital or dividends prior to or in parity with these shares.\nAs of January 31, 1994, all dividends payable on the Class II Preferred Stock have been paid or set aside for payment.\n(ii) The indenture governing the Company's 11.375% Senior Notes due in 1998 limits the Company's ability to make certain cash distributions to its stockholders. As of January 31, 1994, the Company could pay up to approximately $298 million of cash dividends on its common stock under the most restrictive dividend covenant in such indenture.\n13. CONTINGENT LIABILITIES AND COMMITMENTS\n(a) Investment in Hayes Wheels\nThe Company currently owns 46.3% of Hayes Wheels. If such ownership becomes less than 40%, the Company is required to offer to replace existing creditors under the current Hayes Wheels revolving credit agreement.\n(b) Capital Expenditure Programs\nApproved capital expenditure programs outstanding at January 31, 1994 approximated $95.0 million, including capital commitments of approximately $74.0 million.\n(c) Discounted Obligations\nThe Company has contingent liabilities relating to accounts receivable discounted, bills guaranteed and similar obligations amounting to $8.5 million and $34.0 million at January 31, 1994 and 1993, respectively.\n(d) Foreign Exchange Contracts\nTo protect against fluctuations in foreign currencies, the Company from time to time enters into foreign exchange contracts for periods generally consistent with the underlying transaction exposures. At January 31, 1994, the Company had approximately $206.0 million of contracts outstanding, primarily to purchase or sell European currencies (approximately $73.0 million at January 31, 1993). Substantially all of such contracts mature within a period of six months.\nThe Company is exposed to credit loss in the event of nonperformance by the counterparties to the outstanding contracts. The Company does not anticipate nonperformance by any counterparty, and as the contracts are principally hedges of underlying transactions, the market risk associated with fluctuations in exchange rates is not significant.\n(e) Leases\nThe Company leases certain property and equipment under noncancellable operating leases. Payments due under these leases during the next five fiscal years and thereafter are as follows: 1994 - $16.4 million; 1995 - $13.9 million; 1996 - $10.4 million; 1997 - $7.3 million; 1998 - $2.4 million and $10.7 million thereafter.\n(f) Environmental\nThe Company, primarily through its automotive products segment, is involved in a limited number of remedial actions under various federal and state laws and regulations relating to the environment which impose liability on parties to clean up, or contribute to the cost of cleaning up, sites on which their hazardous wastes or materials were disposed or released. The Company believes that it has made adequate provision for costs associated with known remediation efforts in accordance with generally accepted accounting principles and does not anticipate the future cash requirements of such efforts to be significant in terms of its financial condition or liquidity. The Company has made no provision for unasserted claims as it is not possible to estimate the potential size of such future claims, if any.\n(g) Litigation\nThe Company is party to various litigation, certain of which involve significant claims. Management believes that the outcome of these lawsuits will not have a material adverse effect on the consolidated financial statements.\n14. LOSSES ON SALES OF BUSINESSES AND OTHER RESTRUCTURING CHARGES\nDuring the fourth quarter of fiscal 1992, the Company entered into an agreement with AGCO Corporation (AGCO) whereby AGCO was appointed exclusive distributor of farm equipment in North America for Massey Ferguson. AGCO acquired substantially all the net assets, primarily dealer accounts receivable and inventories, of Massey Ferguson's North American operations.\nIn a related transaction, AGCO and the Company formed a joint venture that acquired substantially all the net assets of Agricredit, a diversified North American equipment finance company, which prior to the formation of the joint venture was wholly-owned by the Company. As a result of this transaction, the Company's ownership percentage was reduced to 50%, and accordingly the Company's investment is accounted for on the equity method of accounting (see Note 17 for summarized financial information). (Subsequent to January 31, 1994, the Company sold its remaining 50% ownership in the joint venture to AGCO for an amount which approximated the Company's carrying value of the investment).\nThe Company recognized losses of $23.6 million on the sales of these businesses during the fourth quarter of fiscal 1992, which included employee termination costs and anticipated losses on real property not acquired by AGCO.\nDuring the fourth quarter of fiscal 1991 the Company commenced a series of restructuring actions, and recorded provisions for employment reductions and anticipated losses on the divestment of certain non-core businesses. As a result of such actions the Company recorded restructuring charges of $108.3 million, consisting of approximately $40 million and $68 million relating to employment reductions and asset dispositions, respectively.\n15. NON-RECURRING GAIN\nDuring the fourth quarter of fiscal 1992, the wheels business of Kelsey-Hayes was reorganized as Hayes Wheels and the non-wheel businesses and assets of Kelsey-Hayes, principally its automotive brake systems business, were transferred to, and the liabilities related thereto were assumed by, a newly- formed, wholly-owned subsidiary of the Company.\nThe Company reduced its ownership percentage in Hayes Wheels to 46.3% through a public offering of approximately 9.4 million common shares by Hayes Wheels in December, 1992. Subsequent to the closing date of the offering, the Company has accounted for its investment in Hayes Wheels on the equity method of accounting (see Note 17 for summarized financial information).\nThe proceeds to Hayes Wheels from the offering at $19.00 per share, after deducting commissions and related expenses, were approximately $162.0 million. The Company recognized a non-cash gain from this transaction amounting to $17.3 million which reflects the net increase in value of the Company's investment in Hayes Wheels at that date. In accordance with SFAS No. 96, no provision for taxes was made at the time of the transaction with respect to the gain due to the Company's existing tax loss carryforwards. An appropriate liability for such deferred taxes was included at the time of adoption of SFAS No. 109.\n16. BUSINESS SEGMENT INFORMATION\nThe principal industry segments and geographic regions in which the Company operates are set forth below. The automotive products segment manufactures and sells brakes and other components primarily to the original equipment manufacturers (OEMs) of the motor vehicle industry. Prior to the sale of a majority ownership in Hayes Wheels, this segment also included the manufacture and sale of aluminum and steel wheels to OEMs and the aftermarket. In fiscal 1993, this segment had sales to two domestic OEM customers that individually comprised more than 10% of consolidated total sales and revenues. The fiscal 1993 sales to these customers were $358 million and $396 million, respectively (the amounts related to these customers in fiscal 1992 were $393 million and $421 million, respectively and in fiscal 1991 were $340 million and $317 million, respectively). The engines segment manufactures and sells multi- cylinder, multi-purpose diesel engines. The farm equipment segment manufactures and sells agricultural tractors and, prior to the divestiture of a non-core business during fiscal 1992, industrial machinery. This segment also sells certain other farm equipment purchased from associated companies and third parties. \"Other\" consists of the hydraulic components business. Intersegment sales are made at transfer prices which the Company believes approximate market.\nDue to the fiscal 1992 sale of Agricredit (see Note 14), the financing activities segment is no longer reported separately. The limited remaining third party business is incorporated directly into the related manufacturing segment. Fiscal 1992 and 1991 amounts have been restated to conform with the current period's presentation.\nThe Company's consolidated financial statements include charges for losses on sales of businesses and other restructuring costs in fiscal 1992 and 1991 as discussed in Note 14. The segment operating income presented below reflects each segment's share of such charges as follows:\nINDUSTRY SEGMENT\nGEOGRAPHIC SEGMENT\nReconciliation to consolidated financial statements:\n(a) Excludes interest expense pertaining to financing activities which is included in the operating income of the related manufacturing segments.\n(b) Includes exchange adjustments, non-recurring gain and general corporate expense net of miscellaneous income.\n17. INVESTMENTS IN ASSOCIATED AND OTHER COMPANIES\nVarity's investments in associated and other companies as of January 31, 1994 and 1993 primarily include a 46.3% interest in Hayes Wheels, a 50% interest in Agricredit and a 49% interest in Massey Ferguson Finance Limited, a European agricultural and industrial equipment finance company. During fiscal 1993 the Company received $.5 million of dividends from Hayes Wheels. No dividends were received from these companies during fiscal 1992. As of January 31, 1994 and 1993, the Company's investment in Hayes Wheels, a publicly traded company, had a market value of approximately $264 million and $171 million, respectively.\nVarity's consolidated statements of operations for fiscal 1992 and 1991 include 100% of the revenues and expenses of Hayes Wheels prior to the completion of the public offering as described in Note 15 and 100% of the revenues and expenses of Agricredit prior to the transactions described in Note 14.\nSummarized financial information of these investee companies, as of and for the years ended January 31, 1994 and 1993, including Hayes Wheels and Agricredit operations prior to their deconsolidation, is presented below:\nSTATEMENTS OF OPERATIONS\n(1) Primarily relates to an investee company's adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\nBALANCE SHEETS\nCertain investees' indebtedness restrict approximately $211 million of investee net assets from being loaned, advanced or dividended to the Company by such investees.\nVarity's consolidated retained earnings (deficit) at January 31, 1994 and 1993 includes $5.8 million and $1.3 million, respectively, of undistributed earnings of the above investees.\nIndependent Auditors' Report\nTHE BOARD OF DIRECTORS AND STOCKHOLDERS VARITY CORPORATION\nWe have audited the consolidated financial statements of Varity Corporation and subsidiaries listed in Item 14(a)(1) of the Annual Report on Form 10-K for the fiscal year 1993. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules listed in Item 14(a)(2) of the Annual Report on Form 10-K for the fiscal year 1993. 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 Varity Corporation and subsidiaries as of January 31, 1994 and 1993 and the results of their operations and their cash flows for each of the years in the three-year period ended January 31, 1994 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.\nAs discussed in Note 1 of the Notes to Consolidated Financial Statements in the year ended January 31, 1994, the Company changed its methods of accounting for income taxes to adopt the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" postretirement benefits to adopt the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" postemployment benefits to adopt the provisions of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" and marketable securities to adopt the provisions of Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\"\n\/s\/ KPMG PEAT MARWICK\nBuffalo, New York March 7, 1994\nManagement's Report on Financial Statements\nThe accompanying consolidated financial statements of the Company have been prepared by management in accordance with generally accepted accounting principles. Management is responsible for all information in the Annual Report. All financial and operating data in the Annual Report are consistent with that contained in the consolidated financial statements.\nManagement is also responsible for the integrity and objectivity of the consolidated financial statements. In the preparation of these statements, estimates are sometimes necessary when transactions affecting the current accounting period are dependent on the outcome of future events. Such estimates are based on careful judgements and have been appropriately reflected in the accompanying consolidated financial statements. Management has established systems of internal control which are designed to provide reasonable assurance that assets are safeguarded from loss or unauthorized use and to produce reliable accounting records.\nThe Board of Directors is responsible for ensuring that management fulfills its responsibilities for financial reporting and internal control. The Board exercises these responsibilities principally through the Audit Committee. The Audit Committee meets periodically with management and the internal and the external auditors to satisfy itself that their responsibilities are properly discharged and to review the consolidated financial statements.\nThe Company's independent external auditors have audited the consolidated financial statements. Their audit was conducted in accordance with generally accepted auditing standards, which includes consideration of the Company's internal controls to the extent necessary to form an independent opinion on the financial statements prepared by management. The internal and external auditors have had, and continue to have, full and free access to the Audit Committee of the Board.\nManagement recognizes its responsibility for conducting the Company's affairs in compliance with established financial standards and applicable laws, and for the maintenance of proper standards of business conduct in its activities.\nMarch 7, 1994\n\/s\/ Victor Rice\nVictor Rice Chief Executive Officer\n\/s\/ Vince D. Laurenzo\nVince D. Laurenzo President\n\/s\/ N. D. Arnold\nN. D. Arnold Senior Vice President Chief Financial Officer\nSupplementary Information (Unaudited)\n(1) Includes fiscal 1992 fourth quarter losses on sales of businesses of $23.6 million and a $17.3 million non-recurring gain from the Company's sale of a majority ownership of a subsidiary. (2) Each extraordinary loss arose on the early extinguishment of debt as described in Note 8 to the Consolidated Financial Statements. (3) Primarily relates to the Company's adoption of SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" effective February 1, 1993, as described in Note 1 to the Consolidated Financial Statements. (4) Per share calculations for each of the quarters is based on the weighted average number of shares outstanding for each period; the sum of the quarters may not necessarily be equal to the full year per share amount.\nFinancial Statistics (Unaudited)\n(1) Amounts reported for fiscal 1992 reflect the sale of a majority ownership of Hayes Wheels, the sale of substantially all of the net assets of Massey Ferguson's North American distribution operations and the formation of a joint venture that acquired substantially all of the net assets of Agricredit. (2) Amounts reported for fiscal 1989 reflect the acquisition of K-H Corporation effective November 30, 1989. (3) Extraordinary loss for fiscal 1993 and 1992 consist of $1.7 million and $6.4 million, respectively, associated with the early extinguishment of debt. (4) Amounts have been restated to reflect the one for 10 reverse stock split as of the earliest period presented.\nSales and Revenues Statistics (Unaudited)\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nFor the fiscal year ended January 31, 1994, there have been no disagreements with accountants on accounting or financial disclosure.\nPART III\nThe following information contained in Varity Corporation's Proxy Statement relating to the Annual Meeting of Stockholders, is incorporated herein by reference: Caption or Location in Proxy Statement ---------------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE Election of REGISTRANT...................................... Directors (Information covering the Executive Officers is included in Part I, on pages 14 through 15 of this Form 10-K)\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.......................... Executive Compensation\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT........................... Election of Directors- Directors' and Officers' Share Ownership and Other Stockholder Ownership\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee Schedule II (pages 62 and 63).\nMr. William A. Corbett, a Director, is a partner of Fraser & Beatty (Barristers & Solicitors), who have provided and continue to provide legal advice to 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\n2. Financial Statement Schedules for the years ended January 31, 1994, 1993 and 1992.\nOther schedules are omitted because they are not applicable, not required or because the information required is included in the Consolidated Financial Statements and Notes thereto (see Part II).\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed with the Securities and Exchange Commission (SEC) subsequent to those listed in the Quarterly Report on Form 10-Q for the three months ended October 31, 1993, filed on December 10, 1993.\n(c) Exhibits\n(G) 3.1 -- Restated Certificate of Incorporation of Varity Corporation. (H) 3.2 -- By-laws. (F) 4.1 -- Indenture, dated as of October 8, 1991 between Varity Corporation and Manufacturers & Traders Trust Company, as trustee, relating to 11 3\/8% Senior Notes due 1998.\n10.0 -- MATERIAL CONTRACTS\n10.1 -- LOAN AGREEMENTS\n(L) (a) -- Amended and restated Credit Agreement dated as of June 9, 1993 between Dayton Walther Corporation, The Bank of Nova Scotia and NBD Bank, N.A. (i) Varity Corporation Guarantee dated June 9, 1993 to The Bank of Nova Scotia and NBD Bank, N.A. (L) (b) -- Amended and restated Credit Agreement dated as of August 31, 1993 between Kelsey-Hayes Company, The Chase Manhattan Bank N.A., as agent, and The Bank of Nova Scotia, as co-agent. (L) (c) -- Facility Agreement dated as of September 30, 1993 among Perkins Limited and others, various banks and Lloyds Bank Plc, as agent. (i) Guarantee Agreement dated September 30, 1993. (ii) Trust Agreement dated September 30, 1993. (iii) Composite Security Assignment and Deposit Charge dated September 30, 1993. (L) (d) -- Facility Agreement dated as of September 30, 1993 among Perkins Group Limited and others, and Lloyds Bank Plc. (i) Composite Debenture dated September 30, 1993. (ii) Guarantee dated September 30, 1993. (iii) Omnibus Guarantee dated September 30, 1993. (L) (e) -- Facility Agreement dated as of September 30, 1993 among Massey Ferguson (United Kingdom) Limited, and Midland Bank Plc. (L) (f) -- Facility Agreement dated as of September 30, 1993 among Massey Ferguson (United Kingdom) Limited, Massey Ferguson Manufacturing Limited, and Midland Bank Plc. (L) (g) -- Facility Agreement dated as of September 30, 1993 among Massey Ferguson Group Limited, Massey Ferguson (United Kingdom) Limited, Massey Ferguson Manufacturing Limited, and Midland Bank Plc. (L) (h) -- Joint and several Guarantee dated as of September 30, 1993 between Massey Ferguson Group Limited, Massey Ferguson Manufacturing Limited, Massey Ferguson (United Kingdom) Limited and Midland Bank Plc, reference (e), (f) and (g). (i) Legal Charge dated September 30, 1993 with Massey Ferguson Manufacturing Limited and Midland Bank Plc. (ii) Legal Charge dated September 30, 1993 with Massey Ferguson (United Kingdom) Limited and Midland Bank Plc. (iii) Fixed and Floating Charge dated September 30, 1993 with Massey Ferguson Manufacturing Limited and Midland Bank Plc. (iv) Fixed and Floating Charge dated September 30, 1993 with Massey Ferguson (United Kingdom) Limited and Midland Bank Plc. (v) Fixed and Floating Charge dated September 30, 1993 with Massey Ferguson Group Limited and Midland Bank Plc. (L) (i) -- Varity Holdings Limited Guarantee dated as of September 30, 1993 to Midland Bank Plc, reference (e), (f) and (g).\n(L) (j) -- Varity Corporation Guarantee dated as of September 30, 1993 to Midland Bank Plc, reference (e), (f) and (g).\n10.2 - OTHER MATERIAL CONTRACTS\n(C) (a) -- Class II Share Exchange Agreement dated April 30, 1986 among MF Limited, CDIC, ODC, Canadian Imperial Bank of Commerce (\"CIBC\") and The Secretary of State for Trade and Industry acting by the Export Credits Guarantee Department (\"ECGD\"). (J) *(b) -- Form of Executive Termination Arrangements. (I) *(c) -- Executive Stock Option Plan. (J) *(d) -- Varity Corporation Retirement Equity and Deferred Compensation Plan. (K) *(e) -- Form of Employment Agreement and Supplement to Retirement Equity and Deferred Compensation Plan of Varity Corporation. (B) *(f) -- Canadian Retirement Income Plan for Designated Employees. (B) *(g) -- United Kingdom Executive Pension Scheme. (E) (h) -- Agreement dated December 17, 1990 between Varity Corporation and the Government of Canada, Canada Development Investment Corporation, the Government of Ontario and Ontario Development Corporation replacing the Governments Foundation Agreement dated as of January 27, 1986. (D) (i) -- Agreement between Varity Corporation and National Automobile, Aerospace and Agricultural Implement Workers Union of Canada and its Locals 439 and 458 dated as of October 18, 1990. (A) *(j) -- Shareholder Value Incentive Plan\n(A) 11. -- Earnings Per Share Computations. (A) 21. -- Subsidiaries of the Registrant. (A) 23. -- Consent of KPMG Peat Marwick, Independent Auditors.\n- ----------\nLEGEND FOR EXHIBITS (PAGES 60 THROUGH 61)\n(A) Filed herewith. (B) Incorporated by reference from the Registrant's Registration Statement No. 33-7716 on Form S-1, filed with the SEC on July 15, 1986, as amended. (C) Incorporated by reference from the Registrant's Annual Report on Form 10-K, for the year ended January 31, 1986 filed with the SEC on May 15, 1986. (D) Incorporated by reference from the Registrant's Quarterly Report on Form 10- Q, for the quarter ended October 31, 1990 filed with the SEC on December 13, 1990. (E) Incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended January 31, 1991 filed with the SEC on April 30, 1991. (F) Incorporated by reference from the Registrant's Registration Statement No. 33-42401 on Form S-3 filed with the SEC on August 23, 1991. (G) Incorporated by reference from the Registrant's Registration Statement on Form 8-B filed with the SEC on September 24, 1991. (H) Incorporated by reference from the Registrant's Registration Statement No. 41125 on Form S-4 filed with the SEC on June 13, 1991. (I) Incorporated by reference from the Registrant's Registration Statement No. 33-44266 on Form S-8 filed with the SEC on November 29, 1991. (J) Incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended January 31, 1992 filed with the SEC on April 30, 1992. (K) Incorporated by reference from the Registrant's Annual Report on Form 10-K for the year ended January 31, 1993 filed with the SEC on April 29, 1993. (L) Incorporated by reference from the Registrant's Quarterly Report on Form 10- Q, for the quarter ended October 31, 1993 filed with the SEC on December 10, 1993.\n* Represents compensatory plans or arrangements for directors or executive officers of the Registrant.\n- ----------\n(d) Financial Statements of Significant Subsidiary\nFinancial statements and notes thereto and the financial statement schedules required by Articles 3 and 5 of Regulation S-X, of a 50 percent or less owned company, as defined, Hayes Wheels International, Inc. (Hayes Wheels), are incorporated herein by reference from Hayes Wheels' Annual Report on Form 10-K for the year ended January 31, 1994.\nSCHEDULE II\nVARITY CORPORATION AMOUNTS RECEIVABLE FROM RELATED PARTIES, UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES Years ended January 31, 1994 and 1993 (Dollars in thousands)\nSCHEDULE II (continued)\nVARITY CORPORATION AMOUNTS RECEIVABLE FROM RELATED PARTIES, UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES Year ended January 31, 1992 (Dollars in thousands)\nSCHEDULE III\nVARITY CORPORATION CONDENSED STATEMENTS OF OPERATIONS AND DEFICIT (Unconsolidated) (Dollars in millions)\nSee accompanying Notes to Condensed Financial Statements.\nSCHEDULE III\nVARITY CORPORATION CONDENSED BALANCE SHEETS (Unconsolidated) (Dollars in millions)\nSee accompanying Notes to Condensed Financial Statements.\nSCHEDULE III\nVARITY CORPORATION CONDENSED STATEMENTS OF CASH FLOWS (Unconsolidated) (Dollars in millions)\nSee accompanying Notes to Condensed Financial Statements.\nSCHEDULE III\nVARITY CORPORATION NOTES TO CONDENSED FINANCIAL STATEMENTS (Unconsolidated) (Dollars in millions)\n1. These notes should be read in conjunction with the accounting policies and other significant accounting matters contained in the Notes to Consolidated Financial Statements (see Part II).\n2. During fiscal 1993 Varity changed its method of accounting for income taxes, postretirement benefits other than pensions, postemployment benefits and marketable securities in accordance with several new Statements of Financial Accounting Standards. A one-time, non-cash charge of $146.1 million was recorded as a cumulative effect of changes in accounting principles and includes the cumulative effect relating to Varity's subsidiaries and associated companies. The details of these changes in accounting principles are discussed in Note 1 to the Consolidated Financial Statements (see Part II).\n3. In fiscal 1992, Varity entered into an agreement with AGCO Corporation (AGCO) whereby AGCO was appointed exclusive distributor of farm equipment in North America for Massey Ferguson. As a result, AGCO acquired substantially all the net assets, primarily dealer accounts receivable and inventories of Massey Ferguson's North American distribution operations, which operated as a division of Varity. Significant declines in sales, cost of goods sold and marketing, general and administration in fiscal 1993 are a direct result of this business divestiture.\n4. In fiscal 1993 and fiscal 1992, Varity increased its investment in subsidiaries through non-cash transactions by approximately $60 million and $149 million, respectively, by capitalizing intercompany loans and receivables.\nDuring fiscal 1992, $6.2 million of common stock was issued pursuant to the termination of the Performance Equity Plan in a non-cash transaction.\n5. Varity received cash dividends from its consolidated subsidiaries amounting to $20.7 million, $45.0 million and nil for the years ended January 31, 1994, 1993 and 1992, respectively.\nVarity charges its subsidiaries for costs which it incurs on their behalf. The amounts of such charges for the years ended January 31, 1994, 1993 and 1992, were $37.0 million, $35.3 million and $38.5 million, respectively.\n6. Varity has guaranteed approximately $120 million of its subsidiaries' indebtedness outstanding at January 31, 1994.\n7. Varity and its subsidiaries have agreed to certain covenants and undertakings with their lenders. There are also certain contingent obligations of the Company and it subsidiaries. The details of these covenants and undertakings, and compliance therewith, and contingent obligations are discussed in Notes 8 and 13 to the Consolidated Financial Statements (see Part II).\nSCHEDULE V\nVARITY CORPORATION PROPERTY, PLANT AND EQUIPMENT Years ended January 31, 1994, 1993 and 1992 (Dollars in millions)\n(1) Includes $70.7 million in connection with the divestiture of a non-core business.\n(2) Includes $55.5 million in connection with the divestiture of certain non- core businesses.\n(3) Reflects the sale of a majority of the Company's investment in Hayes Wheels as described in Note 15 to Consolidated Financial Statements (see Part II).\nSCHEDULE VI\nVARITY CORPORATION ACCUMULATED DEPRECIATION OF PROPERTY, PLANT AND EQUIPMENT Years ended January 31, 1994, 1993 and 1992 (Dollars in millions)\n(1) Includes $17.0 million in connection with the divestiture of a non-core business.\n(2) Includes $30.8 million in connection with the divestiture of certain non- core businesses.\n(3) Reflects the sale of a majority of the Company's investment in Hayes Wheels as described in Note 15 to Consolidated Financial Statements (see Part II).\nSCHEDULE VIII\nVARITY CORPORATION VALUATION AND QUALIFYING ACCOUNTS Years ended January 31, 1994, 1993 and 1992 (Dollars in millions)\n(1) Charges to other accounts arise on translation of reserves of companies outside the United States and are reflected in the currency translation adjustment account.\n(2) Includes reduction due to the sale of Massey Ferguson's North American distribution operations and a North American finance company of $9.3 million for allowance for doubtful notes and accounts and $9.0 million for discounts, volume and performance bonuses, returns and other allowances.\nSCHEDULE IX\nVARITY CORPORATION SHORT-TERM BORROWINGS Years ended January 31, 1994, 1993 and 1992\n- ----------\n(1) Short-term bank and other borrowings relate mainly to loans secured by inventories and receivables. Borrowings against overdraft and similar facilities which have been committed for more than one year are classified as long-term.\n(2) The weighted average interest rate at year end relates to rates on borrowings outstanding at the year end. The weighted average interest rate on borrowings outstanding during the year is the interest expense for the year relating to bank borrowings divided by the average bank borrowings outstanding during the year.\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.\nVarity Corporation\nBy: \/s\/ Vince D. Laurenzo\nVince D. Laurenzo Vice Chairman of the Board and 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.\n\/s\/ Victor Rice Chairman of the Board, - ------------------------- Chief Executive Officer April 12, 1994 Victor Rice and Director\n\/s\/ Vince D. Laurenzo Vice Chairman of the Board, - ------------------------- President and Director April 12, 1994 Vince D. Laurenzo\nSenior Vice President \/s\/ N. D. Arnold and Chief Financial - ------------------------- Officer April 12, 1994 N. D. Arnold (Principal Financial Officer)\n\/s\/ Kevin C. Shanahan Vice President, - ------------------------- Controller April 12, 1994 Kevin C. Shanahan (Principal Accounting Officer)\n\/s\/ W. A. Corbett Director April 12, 1994 - ------------------------- W. A. Corbett\n\/s\/ T. N. Davidson Director April 12, 1994 - ------------------------- T. N. Davidson\n\/s\/ Robert M. Gates Director April 12, 1994 - ------------------------- Robert M. Gates\n\/s\/ L. F. Kahl Director April 12, 1994 - ------------------------- L. F. Kahl\n\/s\/ W. Darcy McKeough Director April 12, 1994 - ------------------------- W. Darcy McKeough\n\/s\/ Sir Bryan Nicholson Director April 12, 1994 - ------------------------- Sir Bryan Nicholson\n\/s\/ Warren S. Rustand Director April 12, 1994 - ------------------------- Warren S. Rustand\n\/s\/ W. R. Teschke Director April 12, 1994 - ------------------------- W. R. Teschke\n\/s\/ Robin Warrender Director April 12, 1994 - ------------------------- The Hon. Robin Warrender\nVARITY CORPORATION\nINDEX TO EXHIBITS\nFILED HEREWITH (1)\nExhibit Number - --------\n10.2 (j) Shareholder Value Incentive Plan\n11.1 Primary Earnings Per Share Computations for the years ended January 31, 1994, 1993 and 1992\n11.2 Fully Diluted Earnings Per Share Computations for the years ended January 31, 1994, 1993 and 1992\n21 Subsidiaries of the Registrant\n23 Consent of KPMG Peat Marwick, Independent Auditors\n- ----------\n(1) Complete listing of all exhibits can be found on pages 60-61.","section_15":""}
{"filename":"777574_1994.txt","cik":"777574","year":"1994","section_1":"Item 1. Business - ----------------\nBalcor Realty Investors 86-Series I A Real Estate Limited Partnership (the \"Registrant\") is a limited partnership formed in 1984 under the laws of the State of Illinois. The Registrant raised $59,791,000 from sales of Limited Partnership Interests. The Registrant's operations consist exclusively of investment in and operation of income-producing real property, and all financial information included in this report relates to this industry segment.\nThe Registrant utilized the net offering proceeds to acquire eight real property investments and a minority joint venture interest in one additional property. Three properties have since been disposed of, including the property in which the Registrant held a minority joint venture interest. The six properties remaining at December 31, 1994 are described under \"Properties\" (Item 2). The Partnership Agreement generally provides that the proceeds of any sale or refinancing of the Registrant's properties will not be reinvested in new acquisitions.\nDuring 1994, institutionally owned and managed multi-family residential properties in many markets continued to experience favorable operating conditions combined with relatively low levels of new construction. These favorable operating conditions were supported by the strong pattern of national economic growth which contributed to job growth and rising income levels in most local economies. However, some rental markets continue to remain extremely competitive; therefore, the General Partner's goals are to maintain high occupancy levels, while increasing rents where possible, and to monitor and control operating expenses and capital improvement requirements at the properties. Of the Registrant's six properties, during 1994, four generated positive cash flow while two generated marginal cash flow deficits. See Item 7. Liquidity and Capital Resources for additional information.\nHistorically, real estate investments have experienced the same cyclical characteristics affecting most other types of long-term investments. While real estate values have generally risen over time, the cyclical character of real estate investments, together with local, regional and national market conditions, has resulted in periodic devaluations of real estate in particular markets, as has been experienced in the last few years. As a result of these factors, it has become necessary for the Registrant to retain ownership of many of its properties for longer than the holding period for the assets originally described in the prospectus. The General Partner examines the operations of each property and each local market in conjunction with the Registrant's long- term dissolution strategy when determining the optimal time to sell each of the Registrant's properties.\nThe Registrant, by virtue of its ownership of real estate, is subject to federal and state laws and regulations covering various environmental issues. Management of the Registrant utilizes the services of environmental consultants to assess a wide range of environmental issues and to conduct tests for environmental contamination as appropriate. The General Partner is not aware of any potential liability due to environmental issues or conditions that would be material to the Registrant.\nThe officers and employees of Balcor Partners-XIX, the General Partner of the Registrant, and its affiliates perform services for the Registrant. The Registrant currently has no employees engaged in its operations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1994, the Registrant owns the six real property investments described below:\nLocation Description of Property - -------- -----------------------\nWashington County, Oregon Brighton Townhomes: a 232-unit apartment complex located on approximately 15 acres.\nOverland Park, Kansas * Cedar Crest Apartments: a 466-unit apartment complex located on approximately 40 acres.\nJacksonville, Florida Lakeside Apartments: a 416-unit apartment complex located on approximately 28 acres.\nPetaluma, California * Lakeville Resort Apartments: a 492-unit apartment complex located on approximately 33 acres.\nFresno, California Lake Ridge Apartments: a 200-unit apartment complex located on approximately 11 acres.\nPittsfield Township, The Pines of Cloverlane Phases I and II: a Michigan 592-unit apartment complex located on approximately 62 acres.\n*Owned by Registrant through a joint venture with an affiliated partnership.\nEach of the above properties is held subject to various mortgages and other forms of financing.\nIn the opinion of the General Partner, the Registrant has provided for adequate insurance coverage for its real estate investment properties.\nSee Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - -------------------------\nProposed class action suit - --------------------------\nOn July 31, 1991, a proposed class-action complaint was filed, Gerald C. & Nancy W. Weir vs. IDS Financial Services, Inc. (\"IDS\"), Shearson Lehman Brothers Inc. (\"Shearson\"), American Express Company (\"AMEX\"), Balcor Securities Company, Balcor Partners XIX, The Balcor Company and Balcor Partners-86, Case No. 91 CH 07035 (Circuit Court of Cook County, Illinois, Chancery Division). The complaint alleges that the defendants violated the Illinois Consumer Fraud and Deceptive Trade Practices Act and the Illinois Securities Law with regard to the adequacy and accuracy of disclosure of information in respect of the offering of limited partnership interests in the Registrant. The complaint also alleges breach of fiduciary duty and seeks unspecified compensatory damages and rescission.\nIn January 1993, the Circuit Court dismissed IDS, Shearson and AMEX as defendants for two of the three counts in the complaint. In July 1993, the defendants filed motions for summary judgment on all remaining counts on the grounds that the claims against them were barred by the statute of limitations. In April 1994, the Circuit Court granted the motions for summary judgment, thereby disposing of all claims in the complaint. In May 1994, the plaintiffs filed a notice of appeal with the Illinois Appellate Court, Appeal No. 94-1610, appealing the January 1993 and April 1994 Circuit Court orders. On February 8, 1995, the Appellate Court dismissed the case for want of prosecution.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - -----------------------------------------------------------\nNo matters were submitted to a vote of the Limited Partners of the Registrant during 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder - ------------------------------------------------------------------------- Matters - -------\nThere has not been an established public market for Limited Partnership Interests and it is not anticipated that one will develop; therefore, the market value of the Limited Partnership Interests cannot reasonably be determined. To date, the Registrant has not made any distributions to investors. For additional information, see Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources, below.\nAs of December 31, 1994, the number of record holders of Limited Partnership Interests of the Registrant was approximately 5,404.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ----------\nTotal income $16,104,170 $15,556,850 $14,850,044 $14,568,343 $15,395,616 Loss before gains on disposition of assets and extraordinary items (1,284,604) (1,466,532) (2,805,340) (2,681,046) (4,138,280) Net loss (1,284,604) (185,093) (2,805,340) (2,681,046) (2,869,008) Net loss per Limited Partner- ship Interest (21.27) (3.06) (46.45) (44.39) (47.50) Total assets 64,717,186 67,387,602 70,842,488 74,143,639 77,400,673 Mortgage notes payable 73,208,295 74,429,557 77,183,221 77,840,780 78,560,938\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nSummary of Operations - ---------------------\nAn extraordinary gain on forgiveness of debt was recognized during 1993 in connection with the refinancing of the Lake Ridge Apartments mortgage note. In addition, improved property operations and lower interest expense as a result of several mortgage note refinancings and modifications contributed to a reduction in the loss before extraordinary items in 1994 and 1993 as compared to 1992. Further discussion of Balcor Realty Investors 86 - Series I's (the \"Partnership\") operations is summarized below.\nOperations - ----------\n1994 Compared to 1993 - ---------------------\nHigher rental rates at the Lakeside, Brighton Townhomes, Pines of Cloverlane and Cedar Crest apartment complexes resulted in an increase in rental and service income during 1994 as compared to 1993.\nHigher average cash balances and an increase in interest rates resulted in an increase in interest income on short-term investments during 1994 as compared to 1993.\nThe refinancings of the Lake Ridge and Lakeville Resort apartment complexes in April 1993 reduced the interest expense incurred on mortgage notes payable. Additionally, the interest rate on the Cedar Crest Apartments mortgage note was adjusted from 9.75 percent to 7.875 percent effective July 1993 in accordance with the loan agreement. The combination of these transactions caused interest expense on mortgage notes payable to decrease during 1994 as compared to 1993. The Lake Ridge Apartments refinancing also resulted in a gain on forgiveness of debt during 1993 due to a discounted prepayment of the original mortgage note.\nIncreases in insurance expense at all properties and increases in landscaping and utility costs at the Cedar Crest Apartments and increases in leasing costs at the Pines of Cloverlane Apartments resulted in an increase in property operating expense during 1994 as compared to 1993.\nHigher expenditures for exterior painting and carpeting at the Lakeville Resort Apartments resulted in an increase in maintenance and repairs expense during 1994 as compared to 1993.\nHigher insurance and maintenance and repairs expense in 1994 at the Lakeville Resort Apartments resulted in affiliates' participation in losses from joint ventures during 1994 as compared to income during 1993.\n1993 Compared to 1992 - ---------------------\nDue to increased occupancy levels at the Lakeside, Lakeville Resort and Pines of Cloverlane apartment complexes and increased rental rates at the Cedar Crest and Brighton Townhomes apartment complexes, rental and service income and property management fees increased during 1993 as compared to 1992.\nCash available for investment in short-term interest-bearing instruments decreased primarily due to the cash required for the Lake Ridge and Lakeville Resort apartment complexes' mortgage note refinancings. In addition, interest rates earned on investments were lower in 1993 than in 1992. As a result, interest income on short-term investments decreased during 1993 as compared to 1992.\nThe April 1993 refinancings of the Lake Ridge and Lakeville Resort mortgage notes and the Brighton Townhomes mortgage note modification in September 1992 have lowered interest expense on mortgage notes payable. Additionally, the interest rate on the Cedar Crest Apartments mortgage was adjusted from 9.75 percent to 7.875 percent effective July 1993 in accordance with the mortgage agreement. The combination of these transactions caused interest expense on mortgage notes payable to decrease for 1993 as compared to 1992. The remaining deferred expense related to the original mortgage note on the\nLake Ridge Apartments was fully amortized during the second quarter of 1993 when the note was refinanced. The refinancing of the Lake Ridge and Lakeville Resort apartment complexes also resulted in the payment of new deferred expenses which are now being amortized over the terms of the mortgage notes payable. As a result of these transactions, amortization expense increased for 1993 as compared to 1992.\nHigher expenditures for parking lot repairs, landscaping and painting at the Brighton Townhomes and Cedar Crest apartment complexes, along with higher expenditures for carpet replacement and roof repairs at the Pines of Cloverlane and Cedar Crest apartment complexes resulted in an increase in maintenance and repairs expense during 1993 as compared to 1992.\nDuring 1992, the Partnership incurred legal fees in connection with the Lake Ridge bankruptcy proceedings which resulted in a decrease in administrative expenses during 1993 as compared to 1992.\nIn 1992, the Partnership reached settlements with the seller of the Cedar Crest, Quail Cove and Sunset Place apartment complexes for proration amounts the seller owed the Partnership pursuant to the terms of the original management and guarantee agreements. The Partnership recognized a loss of $252,949 in 1992 as a result of the write-off of the remaining portion of the receivable from the seller which was forgiven as part of the settlements.\nIncreased rental revenues and lower interest expense at the Lakeville Resort Apartments resulted in affiliates' participation in income from joint ventures during 1993 as compared to losses during 1992.\nLiquidity and Capital Resources - -------------------------------\nThe Partnership's cash flow provided by operating activities during 1994 was generated primarily from the operation of the Partnership's properties which was partially offset by the payment of administrative expenses. The Partnership's financing activities consisted of the payment of principal on the properties' mortgage notes and a net distribution to a joint venture partner- affiliate.\nThe Partnership classifies the cash flow performance of its properties as either positive, a marginal deficit or a significant deficit, each after consideration of debt service payments unless otherwise indicated. A deficit is considered significant if it exceeds $250,000 annually or 20% of the property's rental and service income. The Partnership defines cash flow generated from its properties as an amount equal to the property's revenue receipts less property related expenditures, which include debt service payments. During 1994 and 1993, the Brighton Townhomes, Cedar Crest and Pines of Cloverlane apartment complexes generated positive cash flow. The Lake Ridge Apartments generated positive cash flow during 1994 as compared to a marginal deficit during 1993 due to the refinancing of the mortgage note payable. The Lakeside Apartments generated a marginal deficit during 1994 as compared to positive cash flow during 1993 due to an increase in the monthly debt service payment in early 1994 in accordance with the loan agreement. The Lakeville Resort Apartments generated a marginal deficit during 1994 as compared to positive cash flow during 1993 due to a decrease in rental revenue as a result of lower average occupancy and an increase in insurance and maintenance and repair costs.\nWhile the cash flow of certain of the Partnership's properties has improved, the General Partner continues to pursue a number of actions aimed at improving the cash flow of the Partnership's properties including refinancing of mortgage loans, improving property operating performance, and seeking rent increases where market conditions allow. As of December 31, 1994, the occupancy rates of the Partnership's properties ranged from 94 to 98%. Despite improvements in the local economies and rental markets where certain of the Partnership's properties are located, the General Partner believes that continued ownership of many of the properties is in the best interests of the Partnership in order to maximize returns to Limited Partners and, therefore, the Partnership will continue to own these properties for longer than the holding period for the assets originally described in the prospectus.\nEach of the Partnership's properties is owned through the use of third-party mortgage loan financing and, therefore, the Partnership is subject to the financial obligations required by such loans. See Note 3 of Notes to Financial Statements for information concerning outstanding balances, maturity dates, interest rates, etc., related to each of these mortgage loans. As a result of the General Partner's successful efforts to obtain loan modifications as well as refinancings of many existing loans with new lenders, the Partnership has no third-party financing which matures prior to 1996. The General Partner is currently evaluating options for refinancing the Lakeville Resort Apartments mortgage note which carries an interest rate based on a market index.\nAlthough investors have received certain tax benefits, the Partnership has not commenced distributions. Future distributions will depend on the level of cash flow from the Partnership's remaining properties, the retention of adequate cash reserves for financing and operating needs, and proceeds from future property sales and mortgage loan refinancings, as to all of which there can be no assurances. In light of the results to date and current market conditions, the General Partner does not anticipate that the investors will recover all of their original investment.\nThe General Partner has recently completed the outsourcing of the financial reporting and accounting services, transfer agent and investor records services, and computer operations and systems development functions that provided services to the Partnership. All of these functions are now being provided by independent third parties. Additionally, Allegiance Realty Group, Inc., which has provided property management services to all of the Partnership's properties, was sold to a third party. Each of these transactions occurred after extensive due diligence and competitive bidding processes. The General Partner does not believe that the cost of providing these services to the Partnership, in the aggregate, will be materially different to the Partnership during 1995 when compared to 1994.\nInflation has several types of potentially conflicting impacts on real estate investments. Short-term inflation can increase real estate operating costs which may or may not be recovered through increased rents and\/or sales prices, depending on general or local economic conditions. In the long-term, inflation can be expected to increase operating costs and replacement costs and may lead to increased rental revenues and real estate values.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------\nSee Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\nThe supplemental financial information specified by Item 302 of Regulation S-K is not applicable.\nThe net effect of the differences between the financial statements and the tax returns is summarized as follows:\nDecember 31, 1994 December 31, 1993 ----------------------- ------------------------- Financial Tax Financial Tax Statements Returns Statements Returns ---------- --------- ---------- ---------\nTotal assets $64,717,186 $52,445,528 $67,387,602 $55,841,115 Partners' deficit accounts: General Partner (603,600) (949,298) (590,754) (927,684) Limited Partners (7,469,882) (15,636,631) (6,198,124) (13,706,060) Net (loss) income: General Partner (12,846) (21,614) (1,851) 10,109 Limited Partners (1,271,758) (1,930,571) (183,242) (1,024,284) Per Limited Part- nership Interest (21.27) (32.29) (3.06) (17.13)\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 any matter of accounting principles, practices or financial statement disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - -----------------------------------------------------------\n(a) Neither the Registrant nor Balcor Partners-XIX, its General Partner, has a Board of Directors.\n(b, c & e) The names, ages and business experience of the executive officers and significant employees of the General Partner of the Registrant are as follows:\nTITLE OFFICERS ----- --------\nChairman, President and Chief Thomas E. Meador Executive Officer Executive Vice President, Allan Wood Chief Financial Officer and Chief Accounting Officer Senior Vice President Alexander J. Darragh First Vice President Daniel A. Duhig First Vice President Josette V. Goldberg First Vice President Alan G. Lieberman First Vice President Brian D. Parker and Assistant Secretary First Vice President John K. Powell, Jr. First Vice President Reid A. Reynolds First Vice President Thomas G. Selby\nThomas E. Meador (July 1947) joined Balcor in July 1979. He is Chairman, President and Chief Executive Officer and has responsibility for all ongoing day-to-day activities at Balcor. He is a Director of The Balcor Company. Prior to joining Balcor, Mr. Meador was employed at the Harris Trust and Savings Bank in the commercial real estate division where he was involved in various lending activities. Mr. Meador received his M.B.A. degree from the Indiana University Graduate School of Business.\nAllan Wood (January 1949) joined Balcor in August 1983 and, as Balcor's Chief Financial Officer and Chief Accounting Officer, is responsible for the financial and administrative functions. He is also a Director of The Balcor Company. Mr. Wood is a Certified Public Accountant. Prior to joining Balcor, he was employed by Price Waterhouse where he was involved in auditing public and private companies.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and has primary responsibility for the Portfolio Advisory Group. He is responsible for due diligence analysis and real estate advisory services in support of asset management, institutional advisory and capital markets functions. Mr. Darragh has supervisory responsibility of Balcor's Investor Services, Investment Administration, Fund Management and Land Management departments. Mr. Darragh received masters' degrees in Urban Geography from Queens's University and in Urban Planning from Northwestern University.\nDaniel A. Duhig (October 1956) joined Balcor in November 1986 and is responsible for the Asset Management Department relating to real estate investments made by Balcor and its affiliated partnerships, including negotiations for modifications or refinancings of real estate mortgage investments and the disposition of real estate investments.\nJosette V. Goldberg (April 1957) joined Balcor in January 1985 and has primary responsibility for all human resources matters. In addition, she has supervisory responsibility for Balcor's administrative and MIS departments. Ms. Goldberg has been designated as a Senior Human Resources Professional (SHRP).\nAlan G. Lieberman (June 1959) joined Balcor in May 1983 and is responsible for the Property Sales and Capital Markets Groups. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and is responsible for Balcor's corporate and property accounting, treasury and budget activities. Mr. Parker is a Certified Public Accountant and holds an M.S. degree in Accountancy from DePaul University.\nJohn K. Powell, Jr. (June 1950) joined Balcor in September 1985 and is responsible for the administration of the investment portfolios of Balcor's partnerships and for Balcor's risk management functions. Mr. Powell received a Master of Planning degree from the University of Virginia. He has been designated a Certified Real Estate Financier by the National Society for Real Estate Finance and is a full member of the Urban Land Institute.\nReid A. Reynolds (April 1950) joined Balcor in March 1981 and is involved with the asset management of residential properties for Balcor. Mr. Reynolds is a licensed Real Estate Broker in the State of Illinois.\nThomas G. Selby (July 1955) joined Balcor in February 1984 and has responsibility for various Asset Management functions, including oversight of the residential portfolio. From January 1986 through September 1994, Mr. Selby was Regional Vice President and then Senior Vice President of Allegiance Realty Group, Inc., an affiliate of Balcor providing property management services. Mr. Selby was responsible for supervising the management of residential properties in the western United States.\n(d) There is no family relationship between any of the foregoing officers.\n(f) None of the foregoing officers or employees are currently involved in any material legal proceedings nor were any such proceedings terminated during the fourth quarter of 1994.\nItem 11.","section_11":"Item 11. Executive Compensation - -------------------------------\nThe Registrant has not paid and does not propose to pay any remuneration to the executive officers of Balcor Partners - XIX, the General Partner. Certain of these officers receive compensation from The Balcor Company (but not from the Registrant) for services performed for various affiliated entities, which may include services performed for the Registrant. However, the General Partner believes that any such compensation attributable to services performed for the Registrant is immaterial to the Registrant. See Note 7 of Notes to Financial Statements for the information relating to transactions with affiliates.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - -----------------------------------------------------------------------\n(a) No person owns of record or is known by the Registrant to own beneficially more than 5% of the outstanding Limited Partnership Interests of the Registrant.\n(b) Balcor Partners-XIX and its officers and partners own as a group the following Limited Partnership Interests of the Registrant:\nAmount Beneficially Title of Class Owned Percent of Class -------------- ------------- ----------------\nLimited Partnership Interests 248 Interests Less than 1%\nRelatives and affiliates of the officers and partners of the General Partner own an additional 10 Interests.\n(c) The Registrant is not aware of any arrangements, the operation of which may result in a change of control of the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------\n(a & b) See Note 7 of Notes to Financial Statements for additional information relating to transactions with affiliates.\nSee Note 2 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\n(c) No management person is indebted to the Registrant.\n(d) The Registrant has no outstanding agreements with any promoters.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K - ------------------------------------------------------------------------\n(a) (1 & 2) See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\n(3) Exhibits:\n(3) The Amended and Restated Agreement and Certificate of Limited Partnership is set forth as Exhibit 3 to Amendment No. 1 to Registrant's Registration Statement on Form S-11 dated December 16, 1985 (Registration No. 33-361), and said Agreement and Certificate is incorporated herein by reference.\n(4) Form of Subscription Agreement set forth as Exhibit 4.1 to Amendment No. 1 of the Registrant's Registration Statement on Form S-11 dated December 16, 1985 (Registration No. 33-361), and Form of Confirmation regarding Interests in the Partnership set forth as Exhibit 4.2 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1992 (Commission File No. 0-15649) are incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1994 is attached hereto.\n(b) Reports on Form 8-K: No reports were filed on Form 8-K during the quarter ended December 31, 1994.\n(c) Exhibits: See Item 14(a)(3) above.\n(d) Financial Statement Schedule: See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of l934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALCOR REALTY INVESTORS 86-SERIES I A REAL ESTATE LIMITED PARTNERSHIP\nBy: \/s\/Allan Wood ------------------------------- Allan Wood Executive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XIX, the General Partner\nDate: March 23, 1995 ---------------\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 - ---------------------- ------------------------------- ------------\nPresident and Chief Executive Officer (Principal Executive Officer) of Balcor Partners-XIX, \/s\/Thomas E. Meador the General Partner March 23, 1995 - -------------------- -------------- Thomas E. Meador Executive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor Partners-XIX, \/s\/Allan Wood the General Partner March 23, 1995 - -------------------- -------------- Allan Wood\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Accountants\nFinancial Statements:\nBalance Sheets, December 31, 1994 and 1993\nStatements of Partners' Deficit, for the years ended December 31, 1994, 1993 and 1992\nStatements of Income and Expenses, for the years ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows, for the years ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements\nFinancial Statement Schedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1994\nFinancial Statement Schedules, other than that listed, are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Partners of Balcor Realty Investors 86-Series I A Real Estate Limited Partnership:\nWe have audited the financial statements and the financial statement schedule of Balcor Realty Investors 86-Series I A Real Estate Limited Partnership (An Illinois Limited Partnership) as listed in the index of this Form 10-K. These financial statements and the financial statement schedule are the responsibility of the Partnership's management. Our responsibility is to express an opinion on these financial statements and the 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 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 Balcor Realty Investors 86-Series I A Real Estate Limited Partnership at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nChicago, Illinois March 2, 1995\nBALCOR REALTY INVESTORS 86-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALANCE SHEETS December 31, 1994 and 1993\nASSETS\n1994 1993 -------------- -------------- Cash and cash equivalents $ 1,058,935 $ 556,725 Escrow deposits 379,730 506,759 Accounts and accrued interest receivable 67,036 170,773 Deferred expenses, net of accumulated amortization of $671,472 in 1994 and $521,266 in 1993 382,247 532,453 -------------- -------------- 1,887,948 1,766,710 -------------- -------------- Investment in real estate: Land 11,137,023 11,137,023 Buildings and improvements 83,187,367 83,187,367 -------------- -------------- 94,324,390 94,324,390 Less accumulated depreciation 31,495,152 28,703,498 -------------- -------------- Investment in real estate, net of accumulated depreciation 62,829,238 65,620,892 -------------- -------------- $ 64,717,186 $ 67,387,602 ============== ==============\nLIABILITIES AND PARTNERS' DEFICIT\nAccounts payable $ 169,360 $ 202,883 Due to affiliates 74,467 80,141 Accrued liabilities, principally real estate taxes 169,874 126,652 Security deposits 440,214 419,489 Mortgage notes payable 73,208,295 74,429,557 -------------- -------------- Total liabilities 74,062,210 75,258,722\nAffiliates' participation in joint ventures (1,271,542) (1,082,242) Partners' deficit (59,791 Limited Partnership Interests issued and outstanding) (8,073,482) (6,788,878) -------------- -------------- $ 64,717,186 $ 67,387,602 ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 86-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF PARTNERS' DEFICIT for the years ended December 31, 1994, 1993 and 1992\nPartners' Deficit Accounts ---------------------------------------------- General Limited Total Partner Partners -------------- -------------- --------------\nBalance at December 31, 1991 $ (3,798,445) $ (560,850) $ (3,237,595)\nNet loss for the year ended December 31, 1992 (2,805,340) (28,053) (2,777,287) -------------- -------------- ------------- Balance at December 31, 1992 (6,603,785) (588,903) (6,014,882)\nNet loss for the year ended December 31, 1993 (185,093) (1,851) (183,242) -------------- -------------- ------------- Balance at December 31, 1993 (6,788,878) (590,754) (6,198,124)\nNet loss for the year ended December 31, 1994 (1,284,604) (12,846) (1,271,758) -------------- -------------- -------------- Balance at December 31, 1994 $ (8,073,482) $ (603,600) $ (7,469,882) ============== ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 86-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES for the years ended December 31, 1994, 1993 and 1992\n1994 1993 1992 -------------- -------------- -------------- Income: Rental and service $ 16,036,758 $ 15,518,993 $ 14,775,970 Interest on short-term investments 67,412 37,857 74,074 -------------- -------------- -------------- Total income 16,104,170 15,556,850 14,850,044 -------------- -------------- --------------\nExpenses: Interest on mortgage notes payable 6,287,058 6,739,733 7,623,495 Depreciation 2,791,654 2,791,654 2,789,737 Amortization of deferred expenses 150,206 156,921 71,761 Property operating 4,129,446 3,524,295 3,583,892 Maintenance and repairs 1,569,408 1,306,984 980,223 Real estate taxes 1,391,861 1,350,610 1,407,420 Property management fees 800,216 777,519 737,350 Administrative 373,708 366,880 415,191 Write-off of receivables from seller 252,949 -------------- -------------- -------------- Total expenses 17,493,557 17,014,596 17,862,018 -------------- -------------- -------------- Loss before participation in joint ventures and extraordinary item (1,389,387) (1,457,746) (3,011,974) Affiliates' participation in losses (income) from joint ventures 104,783 (8,786) 206,634 -------------- -------------- -------------- Loss before extraordinary item (1,284,604) (1,466,532) (2,805,340) -------------- -------------- -------------- Extraordinary item: Gain on forgiveness of debt 1,281,439 -------------- -------------- -------------- Net loss $ (1,284,604) $ (185,093) $ (2,805,340) ============== ============== ============== Loss before extraordinary item allocated to General Partner $ (12,846) $ (14,665) $ (28,053) ============== ============== ============== Loss before extraordinary item allocated to Limited Partners $ (1,271,758) $ (1,451,867) $ (2,777,287) ============== ============== ============== Loss before extraordinary item per Limited Partnership Interest (59,791 issued and outstanding) $ (21.27) $ (24.28) $ (46.45) ============== ============== ============== Extraordinary item allocated to General Partner NONE $ 12,814 NONE ============== ============== ============== Extraordinary item allocated to Limited Partners NONE $ 1,268,625 NONE ============== ============== ============== Extraordinary item per Limited Partnership Interest (59,791 issued and outstanding) NONE $ 21.22 NONE ============== ============== ============== Net loss allocated to General Partner $ (12,846) $ (1,851) $ (28,053) ============== ============== ============== Net loss allocated to Limited Partners $ (1,271,758) $ (183,242) $ (2,777,287) ============== ============== ============== Net loss per Limited Partnership Interest (59,791 issued and outstanding) $ (21.27) $ (3.06) $ (46.45) ============== ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 86-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nSTATEMENTS OF CASH FLOWS for the years ended December 31, 1994, 1993 and 1992\n1994 1993 1992 -------------- -------------- -------------- Operating activities:\nNet loss $ (1,284,604) $ (185,093) $ (2,805,340) Adjustments to reconcile net loss to net cash provided by or used in operating activities: Extraordinary gain on forgiveness of debt (1,281,439) Affiliates' participation in (losses) income from joint ventures (104,783) 8,786 (206,634) Depreciation of properties 2,791,654 2,791,654 2,789,737 Amortization of deferred expenses 150,206 156,921 71,761 Payment of insurance claim expenditures (94,425) (529,874) Collection of insurance proceeds 94,425 529,874 Write-off of receivables from seller 252,949 Collection of proceeds from settlement 265,763 Net change in: Escrow deposits 127,029 (230,901) (264,433) Accounts and accrued interest receivable 9,312 85,867 (47,512) Accounts payable (33,523) 3,068 (29,809) Due to affiliates (5,674) (9,167) (30,408) Accrued liabilities 43,222 (239,468) 445,024 Security deposits 20,725 26,569 (43,598) -------------- -------------- -------------- Net cash provided by or used in operating activities 1,807,989 1,562,246 (132,374) -------------- -------------- -------------- Financing activities:\nCapital contributions by joint venture partner - affiliate 47,039 123,638 45,902 Distributions to joint venture partner - affiliate (131,556) (18,729) Issuance of mortgage notes payable 24,010,000 Repayment of mortgage notes payable (24,950,147) Principal payments on mortgage notes payable (1,221,262) (888,913) (657,559) Payment of deferred expenses (392,399) -------------- -------------- -------------- Net cash used in financing activities (1,305,779) (2,097,821) (630,386) -------------- -------------- -------------- Net change in cash and cash equivalents 502,210 (535,575) (762,760) Cash and cash equivalents at beginning of year 556,725 1,092,300 1,855,060 -------------- -------------- -------------- Cash and cash equivalents at end of year $ 1,058,935 $ 556,725 $ 1,092,300 ============== ============== ==============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR REALTY INVESTORS 86-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Accounting Policies:\n(a) Depreciation expense is computed using the straight-line and accelerated methods. Rates used in the determination of depreciation are based upon the following estimated useful lives:\nYears -----\nBuildings and improvements 20 to 30 Furniture and fixtures 5\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nThe Partnership records its investments in real estate at cost, and periodically assesses possible impairment to the value of its properties. In the event that the General Partner determines that a permanent impairment in value has occurred, the carrying basis of the property is reduced to its estimated fair value.\n(b) Deferred expenses consist of financing fees which are amortized over the terms of the respective loan agreements.\n(c) Cash equivalents include all highly liquid investments with a maturity of three months or less when purchased.\n(d) The Partnership is not liable for Federal income taxes and each partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(e) Reclassifications were made to the 1993 and 1992 Financial Statements in order to provide comparability to the 1994 Financial Statements. These reclassifications have not changed the 1993 and 1992 results.\n2. Partnership Agreement:\nThe Partnership was organized on October 1, 1984. The Partnership Agreement provides for Balcor Partners-XIX to be the General Partner and for the admission of Limited Partners through the sale of up to 250,000 Limited Partnership Interests at $1,000 per Interest, 59,791 of which were sold on or prior to July 31, 1986, the termination date of the offering.\nThe Partnership Agreement provides that the General Partner will be allocated 1% of all profits and losses. One hundred percent of Net Cash Receipts available for distribution will be distributed to the holders of Interests in proportion to their Participating Percentages as of the record date for such distributions. There will, however, be accrued for the benefit of the General Partner as its distributive share from operations, an amount equivalent to approximately 1% of the total Net Cash Receipts being distributed. The accrued amount will be paid as a part of the General Partner's share of distributed Net Cash Proceeds. Under certain circumstances, the General Partner may participate in the Net Cash Proceeds of the sale or refinancing of Partnership properties. The General Partner's participation is limited to 15% of remaining Net Cash Proceeds after the return of Original Capital plus any deficiency in the Cumulative Distribution of 6% on Adjusted Original Capital to the holders of Interests.\n3. Mortgage Notes Payable:\nMortgage notes payable at December 31, 1994 and 1993 consisted of the following:\nCarrying Carrying Current Final Property Amount of Amount of In- Matur- Current Estimated Pledged as Notes at Notes at terest ity Monthly Balloon Collateral 12\/31\/94 12\/31\/93 Rate Date Payment Payment - -------------- ---------- ---------- -------- ------ ------- ---------- Apartment Complexes:\nBrighton Townhomes $ 7,217,998 $7,296,849 7.50 1996 $45,112 $7,218,000 (A) Cedar Crest 15,579,305 15,842,539 7.875 1998 123,717 14,293,000\nLakeside 12,550,009 12,654,011 8.50 1996 97,298 12,341,000 (B) Lakeville Resort 18,991,478 19,439,597 10.41 1997 208,759 17,840,000 (C) (C) Lake Ridge 4,269,113 4,294,459 10.05 2000 37,983 3,999,000 (D) Pines of Cloverlane 14,600,392 14,902,102 10.00 1996 148,195 14,178,000 ----------- -----------\nTotal $73,208,295 $74,429,557 =========== ===========\n(A) The lender also receives 70% of all net cash flow annually (as defined in the loan agreement) to reduce the principal balance of the loan with the Partnership retaining the remaining 30%. Additional interest, calculated as 35% of the sales price, or the appraised value upon prepayment or refinancing, in excess of the outstanding principal balance of the loan plus unpaid accrued interest, commissions and closing costs, will also be payable to the lender upon the maturity of the loan, sale or refinancing of the property.\n(B) The lender also receives as additional interest an amount equal to 75% of all net cash flow annually (as defined in the loan agreement) with the Partnership retaining the remaining 25%. Additional interest calculated as 50% to 60% of the sales price of the property, or the fair market value upon prepayment or refinancing, in excess of amounts specified in the modification agreement, will also be payable to the lender upon maturity of the loan, sale or refinancing of the property.\n(C) This mortgage note was refinanced in 1993. The monthly payment varies due to an adjustable interest rate through maturity in April 1997. The former mortgage notes provided for interest rates of 10.16% and 12.75% and monthly payments of $151,214 and $43,263. Proceeds from the new $19,700,000 first mortgage note were used to repay the existing first and second mortgage notes with balances of $16,115,716 and $3,849,222, respectively. Also, the property is required to maintain a minimum \"Debt Service Coverage Ratio\", as defined by a covenant in the mortgage note documents. Since the minimum has not been maintained, the Partnership is required to deposit funds into an escrow account which may later be applied towards the principal balance of the mortgage note or returned to the Partnership upon improvement in property operations.\n(D) These mortgage loans were refinanced in 1993. The original loan, which had an outstanding balance of $6,339,368, including accrued interest of $429,555, was repaid at a cost of $4,985,209 which, after netting the real estate tax escrow balance of $72,720, represents a discount to the Partnership of $1,281,439, which has been recognized as an extraordinary gain. The Partnership used proceeds from the new loans of $4,310,000, and made a principal payment of $675,209 to repay the original loan. The new loans consisted of a first mortgage loan of $4,223,800 and a second mortgage loan of $86,200, bear interest at 10.05% and require monthly payments of $37,983 through maturity in May 2000. The former mortgage note provided for an interest rate of 11.74% and monthly payments of $43,263.\nThe Partnership's loans described above require current monthly payments of principal and interest, except for the Brighton Townhomes mortgage loan which requires interest only payments.\nApproximate principal maturities of the above mortgage notes payable during each of the next five years are as follows:\n1995 $ 1,358,000 1996 34,674,000 1997 18,348,000 1998 14,477,000 1999 42,000\nDuring 1994, 1993 and 1992, the Partnership incurred interest expense on mortgage notes payable of $6,287,058, $6,739,733 and $7,623,495 and paid interest expense of $6,287,058, $6,899,920 and $7,033,754, respectively.\n4. Management Agreements:\nAs of December 31, 1994, all of the properties owned by the Partnership are under management agreements with a third-party management company. These management agreements provide for annual fees of 5% of gross operating receipts.\n5. Affiliates' Participations in Joint Ventures:\nThe Partnership holds 96.36% and 59.75% joint venture interests, respectively, in the Cedar Crest and Lakeville Resort apartment complexes with the remaining interests held by affiliated partnerships. All assets, liabilities, income and expenses of the joint ventures are included in the financial statements of the Partnership with the appropriate adjustment of profit or loss for the affiliates' participation in the joint ventures.\n6. Tax Accounting:\nThe Partnership keeps its books in accordance with the Internal Revenue Code, rules and regulations promulgated thereunder and existing interpretations thereof. The accompanying financial statements, which are prepared in accordance with generally accepted accounting principles, will differ from the tax returns due to the different treatment of various items as specified in the Internal Revenue Code. The net effect of these accounting differences is that the net loss for 1994 in the financial statements is $667,581 less than the tax loss of the Partnership for the same period.\n7. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/94 12\/31\/93 12\/31\/92 -------------- -------------- -------------- Paid Payable Paid Payable Paid Payable ------ ------- ------ ------- ------ -------\nProperty management fees $734,296 None $789,204 $65,796 $757,345 $77,481 Reimbursement of expenses to General Partner, at cost: Accounting 60,490 $29,580 46,332 3,833 43,670 3,266 Data processing 44,397 10,161 28,828 4,601 39,963 3,112 Investor communica- tions 12,506 6,116 10,558 873 9,158 685 Legal 12,847 6,283 15,602 1,291 11,197 838 Portfolio mgmt. 28,114 13,749 35,244 2,915 34,139 2,553 Other 17,542 8,578 12,453 832 18,351 1,373\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed all of the Partnership's properties until the affiliate was sold to a third party in November 1994.\nThe Partnership participates in an insurance deductible program with other affiliated partnerships in which the program pays claims up to the amount of the deductible under the master insurance policies for its properties. The program is administered by an affiliate of the General Partner who receives no fee for administering the program. The Partnership's premiums to the deductible insurance program were $149,324, $97,447 and $89,640 for 1994, 1993 and 1992, respectively.\n8. Write-off of Receivables From Seller:\nIn May 1992, the partnership reached a settlement with the seller of the Cedar Crest, Quail Cove and Sunset Place apartment complexes for proration amounts the seller owed the Partnership pursuant to the terms of the original management and guarantee agreements. The Partnership received $88,579 in June 1992 and a final payment of $177,184 in December 1992 pursuant to the terms of the settlement. The Partnership wrote-off receivables from the seller of $252,949 in connection with this transaction.\nBALCOR REALTY INVESTORS 86-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS 86-SERIES I A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR REALTY INVESTORS 86-SERIES I A Real Estate Limited Partnership (An Illinois Limited Partnership)\nNOTES TO SCHEDULE III\n(a) Consists of legal fees, appraisal fees, title costs, other related professional fees and capitalized construction period interest.\n(b) The aggregate cost of land for Federal income tax purposes is $11,361,137 and the aggregate cost of buildings and improvements for Federal income tax purposes is $83,918,777. The total of the above-mentioned is $95,279,914.\n(c) Reconciliation of Accumulated Depreciation ------------------------------------------\n1994 1993 1992 ----------- ----------- -----------\nBalance at beginning of year $28,703,498 $25,911,844 $23,122,107\nDepreciation expense for the year 2,791,654 2,791,654 2,789,737 ----------- ----------- -----------\nBalance at end of year $31,495,152 $28,703,498 $25,911,844 ============ ============ ============\n(d) See description of Mortgage Notes Payable in Note 3 of Notes to Financial Statements.\n(e) Guaranteed income earned on properties under the terms of certain management and guarantee agreements was recorded by the Partnership as a reduction of the basis of the property to which the guaranteed income relates.\n(f) Depreciation expense is computed based upon the following estimated useful lives: Years -----\nBuildings and improvements 20 to 30 Furniture and fixtures 5\n(g) Lake Ridge Apartments had a reduction of basis due to an impairment of the asset value in 1988.\n(h) This property was constructed in two phases. Phase I was completed in 1975 and Phase II was completed in 1979.","section_15":""}
{"filename":"8919_1994.txt","cik":"8919","year":"1994","section_1":"ITEM 1. BUSINESS\n(a) General Development of Business Aydin Corporation (the \"Company\" or \"Aydin\") was incorporated under the laws of the State of Delaware in September, 1967.\nThe Company consists domestically of three major operating and two smaller support divisions, and three foreign operating subsidiaries. The divisions and subsidiaries are profit centers each with engineering, manufacturing, marketing and accounting functions. In addition, a new division (Aydin Telecom) is presently being formed.\n(b) Financial Information About Industry Segments The Company operates predominantly in the electronics manufacturing industry. Therefore, no segment information is reported.\n(c) Narrative Description of Business The following table sets forth the percentage of the Company's total revenue contributed by each of its classes of products (among which overlapping does occur) for each of the last three years:\nAs stated above, the Company operates predominantly in the electronics manufacturing industry, and all information set forth below is with respect to the Company's business as a whole. The Company designs, manufactures, and sells five classes of products as set forth above and as described below:\n(1) Telecommunications Aydin engineers, manufactures and sells microwave digital and analog transmission equipment and systems for commercial and military applications which include wireless and hybrid fiber coax telephony communications equipment, cellular range extender, line-of-site (LOS) microwave radios, satellite earth stations, TDMA terminals and high power transmitters, portable communications terminals, troposcatter networks and wired network access products. Aydin also installs turnkey telecom systems.\n(2) Airborne and Ground Data Acquisition and Avionics Aydin provides airborne equipment and systems to gather critical information and to process, format and transmit to the ground through communication data links from a communications satellite, spacecraft, aircraft and\/or missile. Aydin's terminals receive this data on the ground and analyze it further for display to track and control.\n(Page 2)\n(3) Computer Equipment and Software Aydin sells a line of commercial, high-resolution CRT monitors ranging in size from 10 inches to 29 inches. Workstations are also offered, mostly for the process control industry. Aydin also offers ruggedized and TEMPEST-qualified versions of the same for military applications. Software is written by Aydin for commercial and military purposes for specific applications such as radar simulation, modernization and integration; command, control and communications; and air traffic control systems.\n(4) Radars, Radar Simulation, Integration and Modernization Aydin has developed a modern 3-dimensional tactical air defense radar and has completed and\/or is working on several projects in radar simulation, radar integration and automation of manual radars. Modernization of previously designed radars is also done by Aydin.\n(5) Command, Control and Communications Systems Aydin provides turnkey command, control and communications (C3) systems with or without radars for defense systems, both fixed and mobile.\nThe Company's products and systems are sold directly by Company sales personnel and manufacturers' representatives. Sales personnel for the Company are located in many cities across the United States as well as at key major military bases, with corporate marketing located in the Washington, D.C. area. With respect to exports, sales efforts are conducted by its international subsidiaries, its international sales network and manufacturers' representatives in many countries.\nThe Company maintains standard product lines and systems sold by catalogue, although it generally does not maintain an inventory of finished goods. A significant portion of current sales is attributable to such standard products, modifications thereof, and turnkey communications systems using these products. Another portion of sales is attributable to special, made-to-order equipment based on customer's specific requirements.\nThe Company's customers include U.S. and foreign communications and electronic and aerospace firms, electric utilities, regulated and unregulated telephone organizations, major transportation organizations, other industrial and financial concerns and process control companies, research laboratories, universities, large defense contractors, foreign governments, the U.S. Government through various agencies of the Department of Defense, and the National Aeronautics and Space Administration.\nA breakdown of sales for the last three years including sales to major customers who accounted for 10% or more of sales is as follows:\nThe Company along with others is responsible for the cost of cleanup at a site leased by the Company prior to 1984 under an order of the State of California. The cost to date for the cleanup of the California site over the past ten years has been approximately $5.8 million. Settlement has been reached with three of four insurance carriers for approximately $6.7 million which was received during 1993 and applied to the cleanup costs previously incurred and cost to go. A court has granted a declaratory judgement requiring the fourth carrier to pay all cleanup costs in excess of the $6.7 million already received. This judgement is being appealed by the fourth carrier. Management believes the ultimate resolution of this entire matter will not have a materially adverse effect on the financial position or results of operations.\nThe Company employs approximately 1,500 persons, with operations concentrated principally in the Philadelphia and San Jose areas. Employer-employee relations are considered to be satisfactory.\n(d) Financial Information About Foreign and Domestic Operations and Export Sales\nThe Company had no significant foreign operations prior to 1991 although a $210 million contract from the Government of Turkey became effective in October, 1990 with approximately 35% of this contract being performed by the Company's Turkish subsidiary. Foreign assets included in the consolidated balance sheet amounted to $33.7 million, $22.9 million, and $23.4 million at December 31, 1994, 1993, and 1992, respectively. Of these amounts, $6.7 million, $10.0 million, and $19.1 million at December 31, 1994, 1993, and 1992, respectively, is cash and short term investments of the Company's Turkish subsidiary consisting mainly of U.S. dollar denominated interest-bearing time deposits. In addition, at December 31, 1994 cash and short-term investments at the Argentina subsidiary was $1.9 million. Foreign sales and pretax income for 1994 amounted to $37.2 million and $6.7 million, respectively, of which $21.1 million and $2.1 million, respectively, was for the Argentina subsidiary. Foreign sales and pretax income for 1993 amounted to $23.0 million and $3.9 million, respectively. Foreign sales and pretax income for 1992 amounted to $19.3 million and $3.3 million, respectively. The Company's domestic operations include sales derived from customers or projects located in areas of the world outside the United States. Export and foreign sales for 1994, 1993, and 1992 by geographic area are set forth below:\nOn a percentage basis, export and foreign sales (direct and indirect) accounted for approximately 53% of total sales in 1994, 56% in 1993, and 54% in 1992. A majority of such export and foreign sales were in the telecommunications field. Licenses are required from U.S. Government agencies for most of the Company's export products. The Company and its foreign subsidiaries may be adversely affected by certain risks\n(page 5)\ngenerally associated with foreign contracts and operations, including ownership and control limitations, currency fluctuations, restrictions on repatriation of profits, difficulty in the enforcement of judgments, late delivery penalties, potential political or labor instability and general worldwide economic conditions. However, such factors have not had a material effect on the Company's operations to date, and management believes that the risks involved in such foreign business are no greater than the normal risks of any other portion of the Company's sales. The Company has generally been able to protect itself against foreign credit risks through contract provisions, advance payments and irrevocable letters of credit in its favor. However, it should be noted that foreign contracts are sometimes subject to foreign laws.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's total plant capacity is approximately 700,000 square feet of administrative and production facilities, 540,000 of which it owns and the balance of which it leases. Three owned properties totalling 192,000 square feet are subject to mortgages and six owned properties totalling 348,000 square feet are unencumbered. All major leased properties are held under leases expiring between 1998 and 1999, most with renewal options. The principal owned properties are two administrative\/production facilities in Fort Washington, Pennsylvania, and five more in the Greater Philadelphia area, and one in the San Jose area. In addition, the Company maintains its corporate headquarters in Horsham, Pennsylvania, and numerous sales offices within and outside the U.S. The administrative and production facilities occupied by the Company are well maintained and suitable for its operations, and include plant area, warehouse space, and management, engineering and clerical offices. The plants of each of the manufacturing operations generally contain machine shops, assembly areas, testing facilities and packing and shipping departments in addition to the engineering and laboratory areas.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn January 5, 1994, the Company reached settlement agreements with the U.S. Army and the Department of Justice (\"DOJ\") with reference to the AN\/GRC-222 microwave radio contract. Under the terms of the agreement, the U.S. Army will reinstate the radio contract by withdrawing its previous termination for default issued November 30, 1993. Further, the investigation and all possible charges against the Company by the DOJ are settled.\nOn January 6, 1994, pursuant to the terms of settlement with DOJ, the Company entered a plea of guilty to the falsification of testing data, charges to which two of its low level employees previously pled guilty to in March 1993, and the plea was accepted by the court (U.S. District Court for the Northern District of California). The Company is reinstated on its AN\/GRC-222 microwave radio contract with all of its previous terms and conditions. Further, the Company withdrew its contract claims, is doing additional work for the Army at no additional cost, and paid $2 million as an added consideration. The total impact on pretax income of this settlement was approximately $14,819,000, which has been charged to the 1993 fourth quarter earnings. The additional work and the related expenditures will be spread over a period of three years or longer.\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 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe names, ages, year first elected as officer or appointed as general manager, positions and recent prior experience of all current executive officers of the Company as of March 21, 1995, are as follows:\nAYHAN HAKIMOGLU, CHAIRMAN AND C.E.O. (1) 67. First elected 1967. Chairman of the Board of Directors; President of the Company through February 1992 and from March 1994 through December 1994.\n(page 6)\nDONALD S. TAYLOR, PRESIDENT 51. 1995. President of the Company and President Aydin Corp. (East) since January 1995. From 1970 through 1994 held various positions with Computer Sciences Corporation, the last 13 years as Vice President of its Integrated Systems Division.\nJOHN F. VANDERSLICE, SENIOR VICE PRESIDENT 53. 1983. Senior Vice President of the Company. President of the Vector Division (manufactures airborne data communications products) since November 1982. Previously, he was Manager of Engineering (1969-1972), Operations Manager (1972-1973), and Vice President of Operations (1973-1982) of the Vector Division.\nDEMIRHAN HAKIMOGLU, VICE PRESIDENT (2) 55. 1992. Vice President of the Company. Chairman of the Board and CEO of the Company's foreign subsidiary, Aydin Yazilim A.S., since July 1990. Prior to that, served in various engineering and management positions with various divisions of the Company since 1968 (except for a two year period, 1978-1980).\nMATS J. OFVERBERG, VICE PRESIDENT (3) 54. 1990. Vice President of the Company and President of Aydin Corporation (West) Division from December 1990 to November 1993 and from March 14, 1994. Prior to his election as an officer, he served as Vice President of Engineering of the Company's Radar & EW Division and Executive Vice President of the Company's Aydin (West) group of divisions from February 1987.\nHERBERT WELBER, CONTROLLER AND ASSISTANT TREASURER 59. 1986. Controller and Assistant Treasurer of the Company since August 1986. Previously, he was Controller and Vice President of Controls Division (manufactures display terminals) since August 1981.\nExcept for Dr. Taylor, each of the above officers was elected at the Annual Meeting of the Board of Directors on April 29, 1994. Dr. Taylor commenced his employment on January 3, 1995 and was elected President of the Company as of that date. Officers are elected each year after the Annual Meeting of Stockholders. Each serves subject to the discretion of the Board of Directors until his successor shall be elected and qualified or until his death, disqualification, resignation or removal in the manner provided in the Company's By-Laws. There are no family relationships among any executive officers of Aydin, except for Ayhan Hakimoglu and Demirhan Hakimoglu who are brothers.\n__________________\n(1) From July 1971 to May 1972 did not serve as an officer of the Company, although he remained as a director.\n(2) First elected Vice President in February 1991, and resigned that position in July 1991. Re-elected Vice President in February 1992.\n(3) Retired November 3, 1993, and accepted re-employment effective March 14, 1994.\n(page 7)\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nIncorporated by reference is the information under the heading, \"Common Stock Prices\" and \"Stockholder and Dividend Information\" on page 24 of the Annual Report. The Company has no present plans to pay any cash dividends. Future cash dividends, if any, will depend on business conditions. There are no restrictions that prevent the Company from paying future cash dividends, except that the Company's Board of Directors had determined in December 1992 that no cash dividend will be declared or paid for the foreseeable future, and except for maintaining compliance with certain covenants of a Credit Agreement for the funding of a standby Letter of Credit, as described more fully in Note D to the Financial Statements.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated by reference is the information under the heading, \"Selected Financial Data\" on page 23 of the Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference is the information under the heading, \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on page 22 of the Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIncorporated by reference are the Consolidated Financial Statements of Aydin Corporation and the related Notes to Consolidated Financial Statements, and Report of Independent Auditors on pages 14 to 21, inclusive, and the data under the heading, \"Quarterly Financial Data\" on page 23, of the Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nIncorporated by reference is the information under the heading, \"Independent Auditors\" on page 17 of the Proxy Statement.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nIncorporated by reference is the information under the heading, \"Election of Directors\" on pages 3-5 of the Proxy Statement, the information under the heading, \"Compliance With Section 16(a) of the Exchange Act\" on pages 11 and 12 of the Proxy Statement, and the information under the heading, \"Executive Officers of the Registrant\" on pages 6 and 7, Part I of this 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated by reference is the information under the heading, \"Compensation of Executive Officers\", \"Option Grants in Last Fiscal, \"Aggregated Option Exercises and Fiscal Year-End Option Values\", \"Ten-Year Option Repricing\", \"Employment Contracts and Termination of Employment Arrangements\", and \"Compensation Committee Interlocks and Insider Participation\" on pages 5-9 and 10 of the Proxy Statement.\n(page 8)\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nIncorporated by reference is the information under the headings, \"Beneficial Ownership of Common Stock\" and \"Beneficial Ownership by Management\" on pages 2 and 3 of the 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\nThe Company files as part of this report the following documents:\n(a) 1. Financial Statements The following is a list of the Consolidated Financial Statements of Aydin Corporation and Subsidiaries which have been incorporated by reference from the Annual Report as set forth in Item 8 - \"Financial Statements and Supplementary Data\":\nConsolidated Balance Sheets, as of December 31, 1994 and 1993. Consolidated Statements of Operations for the years ended December 31, 1994, 1993 and 1992. Consolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992. Notes to Consolidated Financial Statements. Report of Independent Auditors.\n2. Schedules The following is a list of the Schedules of Aydin Corporation and Subsidiaries filed as part of this report:\nSchedule II - Valuation and Qualifying Accounts\nReport of Independent Auditors\nAll other schedules not listed above are omitted because they are inapplicable or are not required.\n3. Exhibits The following is a list of Exhibits filed as part of this report:\n3(i) Restated Certificate of Incorporation\n3(ii) By-Laws\n10.1 Restricted Stock Agreement\n10.2 Form of Individual Non-Qualified Stock Option\n10.3 The 1981 Incentive Stock Option Plan\n10.4 The 1983 Incentive Stock Option Plan\n10.5 The 1984 Non-Qualified Stock Option Plan\n(page 9)\n10.6 The 1994 Incentive Stock Option Plan\n13 Annual Report to Security Holders\n21 Subsidiaries of Registrant\n23.1 Consent of Independent Auditors, Grant Thornton LLP\n23.2 Consent of Independent Auditors, KPMG Peat Marwick LLP\n27 Financial Data Schedule (electronic filing only)\n99.1 Report of Independent Auditors, Grant Thornton LLP\n99.2 Report of Independent Auditors, KPMG Peat Marwick LLP\nAll other exhibits not listed above are omitted because they are inapplicable.\n(b) Reports on Form 8-K No reports on Form 8-K were filed during the Fourth Quarter of 1994.\nAYDIN CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEAR S 1994, 1993, AND 1992\n(page 10)\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.\nAydin Corporation\nDated: March 29, 1995 By: \/s\/ Robert A. Clancy Robert A. Clancy 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.\nBy: \/s\/ Ayhan Hakimoglu Dated: March 29, 1995 Ayhan Hakimoglu Chief Executive Officer and Chairman of the Board of Directors\nBy: \/s\/ Donald S. Taylor Dated: March 29, 1995 Donald S. Taylor President and Director\nBy: \/s\/ John F. Vanderslice Dated: March 29, 1995 John F. Vanderslice Vice President and Director\nBy: \/s\/ Herbert Welber Dated: March 29, 1995 Herbert Welber Controller and Assistant Treasurer Principal Accounting Officer\nBy: \/s\/ Jay L. Landis Dated: March 29, 1995 Jay L. Landis Treasurer Principal Financial Officer\nBy: \/s\/ I. Gary Bard Dated: March 29, 1995 I. Gary Bard Director\nBy: \/s\/ Nev A. Gokcen Dated: March 29, 1995 Nev A. Gokcen Director\nBy: \/s\/ Harry D. Train, II Dated: March 29, 1995 Harry D. Train, II Director\nEXHIBIT INDEX\nExhibit Description No. of Exhibit\n3(i) Restated Certificate of Incorporation\n3(ii) By-Laws\n10.1 Restricted Stock Agreement\n10.2 Form of Individual Non-Qualified Stock Option\n10.3 The 1981 Incentive Stock Option Plan\n10.4 The 1983 Incentive Stock Option Plan\n10.5 The 1984 Non-Qualified Stock Option Plan\n10.6 The 1994 Incentive Stock Option Plan\n13 Annual Report to Security Holders\n21 Subsidiaries of Registrant\n23.1 Consent of Independent Auditors, Grant Thornton LLP\n23.2 Consent of Independent Auditors, KPMG Peat Marwick LLP\n27 Financial Data Schedule (electronic filing only)\n99.1 Report of Independent Auditors, Grant Thornton LLP\n99.2 Report of Independent Auditors, KPMG Peat Marwick LLP\nExhibit 3(i) RESTATED CERTIFICATE OF INCORPORATION of AYDIN CORPORATION\nFIRST. The name of the corporation is AYDIN CORPORATION SECOND. The address of its registered office in the State of Delaware is 32 Loocherman Square, Suite L-100, Dover, County of Kent. The name of its registered agent at such address is United States Corporation Company. THIRD. The nature of the business or purposes to be conducted or promoted is any lawful act or activity for which corporations may be organized under the General Corporation Law of Delaware. FOURTH. The total number of shares of Common Stock which the corporation shall have authority to issue is Seven Million Five Hundred Thousand (7,500,000) and the par value of each of such shares is One Dollar ($1.00) amounting in the aggregate to Seven Million Five Hundred Thousand Dollars ($7,500,000). These shares shall have no preemptive or preferential rights of subscription concerning further issuance or authorization of the corporation's shares. FIFTH. In furtherance and not in limitation of the powers conferred by statute, the board of directors is expressly authorized: To make, alter or repeal by-laws of the corporation. To authorize and cause to be executed mortgages and liens upon the real and personal property of the corporation. To set apart out of any of the funds of the corporation available for dividends a reserve or reserves for any proper purpose and to abolish any such reserve in the manner in which it was created. By a majority of the whole board, to designate one or more committees, each committee to consist of two or more of the directors of the corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, to the extent provided in the resolution or in the by-laws of the corporation, shall have and may exercise the powers of the board of directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it; provided, however, the by- laws may provide that in the absence or disqualification of any member of such committee or committees, the member or members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of any such absent or disqualified member. When and as authorized by the affirmative vote of the holders of a majority of the stock issued and outstanding having voting power given at a stockholders' meeting duly called upon such notice as is required by statute, or when authorized by the written consent of the holders of a majority of the voting stock issued and outstanding, to sell, lease or exchange all or substantially all of the property and assets of the corporation, including its good will and its corporate franchises, upon such terms and conditions and for such consideration, which may consist in whole or in part of money or property including shares of stock in, and\/or other securities of, any other corporation or corporations, as its board of directors shall deem expedient and for the best interests of the corporation. SIXTH. A director of this corporation shall not be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any beach of the director's duty of loyalty to the corporation or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the Delaware General Corporation Law, or (iv) for any transaction from which the director derived an improper personal benefit. SEVENTH. Meetings of stockholders may be held within or without the State of Delaware, as the by-laws may provide. The books of the corporation may be kept (subject to any provision contained in the statutes) outside the State of Delaware at such place or places as may be designated from time to time by the board of directors or in the by-laws of the corporation. Elections of directors need not be by written ballot unless the by-laws of the corporation shall so provide. EIGHTH. The corporation reserves the right to amend, alter, change or repeal any provision contained in this certificate of incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation.\nExhibit 3(ii) AYDIN CORPORATION BY-LAWS (Last Amended July 29, 1994) ******* ARTICLE I OFFICERS Section 1. The registered office shall be in the City of Dover, County of Kent, State of Delaware. Section 2. The corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors may from time to time determine or the business of the corporation may require.\nARTICLE II MEETINGS OF STOCKHOLDERS Section 1. All meetings of the stockholders for the election of Directors shall be held in the City of Fort Washington, State of Pennsylvania, at such place as may be fixed from time to time by the Board of Directors, or at such other place either within or without the State of Delaware as shall be designed from time to time by the Board of Directors and stated in the notice of the meeting. Meetings of stockholders for any other purpose may be held at such time and place, within or without the State of Delaware, as shall be stated in the notice of the meeting or in a duly executed waiver of notice thereof. Section 2. Annual meetings of stockholders shall be held on the third Thursday of April if not a legal holiday, and if a legal holiday, then on the next secular day following at 3:00 P.M. or at such other date and time as shall be designated from time to time by the Board of Directors and stated in the notice of the meeting, at which they shall elect by a plurality vote a board of Directors, and transact such other business as may properly be brought before this meeting. Section 3. Written notice of the annual meeting stating the place, date and hour of the meeting shall be given to each stockholder entitled to vote at such meeting not less than ten nor more than fifty days before the date of the meeting. Section 4. The officer who has charge of the stock ledger of the corporation shall prepare and make, at least ten days before every meeting of stockholders, a complete list of the stockholders entitled to vote at the meeting, arranged in alphabetical order, and showing the address of each stockholder and the number of shares registered in the name of each stockholder. Such list shall be open to the examination of any stockholder, for any purpose germane to the meeting, during ordinary business hours, for a period of at least ten days prior to the meeting, either at a place within the city where the meeting is to be held, which place shall be specified in the notice of the meeting, or, if not so specified, at the place where the meeting is to be held. The list shall also be produced and kept at the time and place of the meeting during the whole time thereof, and may be inspected by any stockholder who is present. Section 5. Special meetings of the stockholders, for any purpose or purposes, unless otherwise prescribed by statute or by the certificate of incorporation, may be called by the Chairman of the Board and shall be called by the Chairman of the Board or Secretary at the request in writing of a majority of the Board of Directors, or at the request in writing of stockholders owning a majority in amount of the entire capital stock of the corporation issued and outstanding and entitled to vote. Such request shall state the purpose or purposes of the proposed meeting. Section 6. Written notice of a special meeting stating the place, date and hour of the meeting and the purpose or purposes for which the meeting is called, shall be given not less than ten nor more than fifty days before the date of the meeting, to each stockholder entitled to vote at such meeting. Section 7. Business transacted at any special meeting of stockholders shall be limited to the purposes stated in the notice. Section 8. The holders of a majority of the stock issued and outstanding and entitled to vote thereat, present in person or represented by proxy, shall constitute a quorum at all meeting of the stockholders for the transaction of business except as otherwise provided by statute or by the certificate of incorporation. If, however, such quorum shall not be present or represented at any meeting of the stockholder, the stockholders entitled to vote thereat, present in person or represented by proxy, shall have power to adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present or represented. At such adjourned meeting at which a quorum shall be present or represented any business may be transaction which might have been transacted at the meeting as originally notified. If the adjournment is for more than thirty days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the meeting. Section 9. When a quorum is present at any meeting, the vote of the holder of a majority of the stock having voting power present in person or represented by proxy shall decide any question brought before such meeting, unless the question is one upon which by express provision of the statutes or of the certificate of incorporation, a different vote is required in which case such express provision shall govern and control the decision of such question. Section 10. Each stockholder shall at every meeting of the stockholders be entitled to one vote in person or by proxy for each share of the capital stock having voting power held by such stockholder, but no proxy shall be voted on after three years from its date, unless the proxy provides for a longer period. Section 11. Whenever the vote of stockholders at a meeting thereof is required or permitted to be taken for or in connection with any corporate action, by any provision of the statutes, the meeting and vote of stockholders may be dispensed with if all of the stockholder who would have been entitled to vote upon the action if such meeting were held shall consent in writing to such corporate action being taken; or if the certificate of incorporation authorizes the action to be taken with the written consent of the holders of less than all of the stock who would have been entitled to vote upon the action if a meeting were held, then on the written consent of the stockholders having not less than such percentage of the total number of votes as may be authorized in the certificate of incorporation; provided that in no case shall the written consent be by the holders of stock having less than the minimum percentage of the total vote required by statute for the proposed corporate action, and provided that prompt notice must be given to all stockholders of the taking of corporate action without a meeting and by less than unanimous written consent.\nARTICLE III DIRECTORS Section 1. The number of Directors which shall constitute the whole Board shall be six (6). The Directors shall be elected at the annual meeting of the stockholders, except as provided in Section 2 of this Article, and each Director elected shall hold office until his successor is elected and qualified. Directors need not be stockholders. Section 2. Vacancies and newly created directorships resulting from any increase in the authorized number of Directors may be filled by a majority of the Directors then in office, though less than a quorum, or by a sole remaining director, and the Directors so chosen shall held office until the next annual election and until their successors are duly elected and shall qualify, unless sooner displaced. If their are no Directors in office, then an election of Directors may be held in the manner provided by statute. If, at the time of filling any vacancy or any newly created directorship, the Directors then in office shall constitute less than a majority of the whole board (as constituted immediately prior to any such increase), the Court of Chancery may, upon application of any stockholder or stockholders holding at least ten percent of the total number of the shares at the time outstanding having the right to vote for such Directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the Directors chosen by the Directors then in office. Section 3. The business of the corporation shall be managed by its Board of Directors which may exercise all such powers of the corporation and do all such lawful acts and things as are not by statute or by the Certificate of Incorporation or by these by-laws directed or required to be exercised or done by the stockholders. MEETING OF THE BOARD OF DIRECTORS Section 4. The Board of Directors of the corporation may hold meetings, both regular and special, either within or without the State of Delaware. Section 5. The first meeting of each newly elected Board of Directors shall be held at such time and place as shall be fixed by the vote of the stockholders at the annual meeting and no notice of such meeting shall be necessary to the newly elected Directors in order legally to constitute the meeting, provided a quorum shall be present. In the event of the failure of the stockholders to fix the time or place of such first meeting of the newly elected Board of Directors, or in the event such meeting is not held at the time and place so fixed by the stockholders, the meeting may be held at such time and place as shall be specified in a notice given as hereinafter provided for special meetings of the Board of Directors, or as shall be specified in a written waiver signed by all of the Directors. Section 6. Regular meetings of the Board of Directors may be held without notice at such time and at such place as shall from time to time be determined by the Board. Section 7. Special meetings of the Board may be called by the Chairman of the Board on one day's notice to each director, either personally, by telephone, by mail or by telegram; special meetings shall be called by the Chairman of the Board or Secretary in like manner and on like notice on the written request of two directors. Section 8. At all meetings of the Board, a majority of the directors shall constitute a quorum for the transaction of business and the act of a majority of the directors present at any meeting at which there is a quorum shall be the act of the Board of Directors, except as may be otherwise specifically provided by statute or by the certificate of incorporation. If a quorum shall not be present at any meeting of the Board of Directors the directors present thereat may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. Section 9. Unless otherwise restricted by the certificate of incorporation or these by-laws, any action required or permitted to be taken at any meeting of the Board of Directors or of any committee thereof may be taken without a meeting, if all members of the Board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board or committee. COMMITTEES OF DIRECTORS Section 10. The Board of Directors may, by resolution passed by a majority of the whole board, designate one or more committees, each committee to consist of two or more of the directors of the corporation. The board may designate one or more directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. Any such committee, to the extent provided in the resolution, shall have and may exercise the powers of the Board of Directors in the management of the business and affairs of the corporation, and may authorize the seal of the corporation to be affixed to all papers which may require it; provided, however, that in the absence or disqualification of any member of such committee or committees, the member of members thereof present at any meeting and not disqualified from voting, whether or not he or they constitute a quorum, may unanimously appoint another member of the Board of Directors to act at the meeting in the place of any such absent or disqualified member. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board of Directors. Section 11. Each committee shall keep regular minutes of its meetings and report the same to the Board of Directors when required.\nCOMPENSATION OF DIRECTORS Section 12. The Directors may be paid their expenses, if any, of attendance at each meeting of the Board of Directors and may be paid a fixed sum for attendance at each meeting of the Board of Directors or a stated salary as Director. No such payment shall preclude any Director from serving the corporation in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings.\nARTICLE IV NOTICES Section 1. Whenever, under the provisions of the statutes or of the Certificate of Incorporation or of these by-laws, notice is required to be given to any Director or stockholder, it shall not be construed to mean personal notice, but such notice may be given in writing, by mail, addressed to such Director or stockholder, at his address as it appears on the records of the corporation, with postage thereon prepaid, and such notice shall be deemed to be given at the time when the same shall be deposited in the United States mail. Notice to Directors may also be given by telegram, or by telephone. Section 2. Whenever any notice is required to be given under the provisions of the statutes or of the Certificate of Incorporation or of these by-laws, a waiver thereof in writing, signed by the person or persons entitled to said notice, whether before or after the time stated therein, shall be deemed equivalent thereto.\nARTICLE V OFFICERS Section 1. The officers of the corporation shall be chosen by the Board of Directors and shall be a Chairman of the Board, a President, an Executive Vice President, a Secretary and a Treasurer. The Board of Directors may also choose additional Vice Presidents, and one or more Assistant Secretaries and Assistant Treasurers. Any number of offices may be held by the same person, unless the certificate of incorporation of these by-laws otherwise provide. Section 2. The Board of Directors at its first meeting after each annual meeting of stockholders shall choose a Chairman of the Board, a President, an Executive Vice President, a Secretary and a Treasurer, and may choose additional Vice Presidents, and one or more Assistant Secretaries and Assistant Treasurers. Section 3. The Board of Directors may appoint such other officers and agents as it shall deem necessary who shall hold their offices for such terms and shall exercise such powers and perform such duties as shall be determined from time to time by the Board. Section 4. The salaries of all officers and agents of the corporation shall be fixed by the Board of Directors. Section 5. The officers of the corporation shall hold office until their successors are chosen and qualified. Any officer elected or appointed by the Board of Directors may be removed at any time by the affirmative vote of a majority of the Board of Directors. Any vacancy occurring in any office of the corporation shall be filled by the Board of Directors. CHAIRMAN OF THE BOARD Section 6. 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 the general direction and supervision over the business and affairs of the corporation. He shall preside at all meetings of the stockholders and of the Board of Directors and shall be an ex officio member of all committees and shall see that all orders and resolutions of the Board of Directors are carried into effect. He shall participate in determining the policies to be followed by the corporation and shall perform such other duties as the Board of Directors shall from time to time request.\nTHE PRESIDENT Section 7. The President shall undertake such duties as may be delegated to him by the Chairman of the Board and shall also have such other powers and duties as the Board of Directors may from time to time determine. In the absence of the Chairman of the Board or in the event of his inability or refusal to act, the President shall perform the duties of the Chairman of the Board, and when so acting, shall have all the powers of and be subject to all the restrictions upon the Chairman of the Board. THE VICE PRESIDENTS Section 8. In the absence of the President or in the event of his inability or refusal to act, the Executive Vice President, (or in the event of the absence or inability of or refusal to act by the Executive Vice President and in the further event there be more than one Vice President, the Vice Presidents in the order designated, or in the absence of any designation, then in the order of their election) shall perform the duties of the President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the President. Such powers of and restrictions upon the President shall include the performance of the duties of the Chairman of the Board in the further event that the Chairman is absent or is unable or refuses to act. Vice Presidents shall perform such other duties and have such other powers as the Board or Directors may from time to time prescribe. THE SECRETARY AND ASSISTANT SECRETARY Section 9. The Secretary shall attend all meetings of the Board of Directors and all meetings of the stockholders and record all the proceedings of the meetings of the corporation and of the Board of Directors in a book to be kept for that purpose and shall perform like duties for the standing committees when required. He shall give, or cause to be given, notice of all meetings of the stockholders and special meetings of the Board of Directors, and shall perform such other duties as may be prescribed by the Board of Directors or Chairman of the Board, under whose supervision he shall be. He shall have custody of the corporate seal of the corporation and he, or an Assistant Secretary, shall have authority to affix the same to any instrument requiring it and when so affixed, it may be attested by his signature or by the signature of such Assistant Secretary. The Board of Directors may give general authority to any other officer to affix the seal of the corporation and to attest the affixing by his signature. Section 10. The Assistant Secretary, or if there be more than one, the Assistant Secretaries in the order determined by the Board of Directors (or if there is no such determination, then in the order of their election), shall, in the absence of the Secretary or in the event of his inability or refusal to act, perform the duties and exercise the powers of the Secretary and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe. THE TREASURER AND ASSISTANT TREASURERS Section 11. The Treasurer shall have the custody of the corporate funds and securities and shall keep full and accurate accounts if receipts and disbursements in books belonging to the corporation and shall deposit all moneys and other valuable effects in the name and to the credit of the corporation in such depositories as may be designated by the Board of Directors. Section 12. He shall disburse the funds of the corporation as may be ordered by the Board of Directors, taking proper vouchers for such disbursements, and shall render to the Chairman of the Board and the Board of Directors, at its regular meetings, or when the Board of Directors so requires, an account of all his transactions as Treasurer and of the financial conditions of the corporation. Section 13. If required by the Board of Directors, he shall give the corporation a bond (which shall be renewed every six years) in such sum and with such surety or sureties as shall be satisfactory to the Board of Directors for the faithful performance of the duties of his office and for the restoration to the corporation, in case of his death, resignation, retirement or removal form office, of all books, papers, vouchers, money and other property of whatever kind in his possession or under his control belonging to the corporation. Section 14. The Assistant Treasurer, or if there shall be more than one, the Assistant Treasurers in the order determined by the Board of Directors (or if there be no such determination, then in the order of their election), shall, in the absence of the Treasurer or in the event of his inability or refusal to act, perform the duties and exercise the powers of the Treasurer and shall perform such other duties and have such other powers as the Board of Directors may from time to time prescribe.\nARTICLE VI CERTIFICATES OF STOCK Section 1. Every holder of stock in the corporation shall be entitled to have a certificate, signed by, or in the name of the corporation by, the Chairman or Vice Chairman of the Board of Directors, the President or a Vice President and the Treasurer or an Assistant Treasurer, or the Secretary or an Assistant Secretary of the corporation, certifying the number of shares owned by him in the corporation. Section 2. Where a certificate is countersigned (1) by a transfer agent other than the corporation or its employee, or, (2) by a registrar other than the corporation or its employee, the signatures of the officers of the corporation may be facsimiles. In case any officer who has signed or whose facsimile signature has been placed upon a 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 issue. LOST CERTIFICATES Section 3. The Board of Directors may direct a new certificate or certificates to be issued in place of any certificate or certificates theretofore issued by the corporation alleged to have been lost, stolen or destroyed, upon the making of an affidavit of that fact by the person claiming the certificate of stock to be lost, stolen or destroyed. When authorizing such issue of a new certificate or certificates, the Board of Directors may, in its discretion and as a condition precedent to the issuance thereof, require the owner of such lost, stolen or destroyed certificate or certificates, or his legal representative, to advertise the same in such manner as it shall require and\/or to give the corporation a bond in such sum as it may direct as indemnity against any claim that may be made against the corporation with respect to the certificate alleged to have been lost, stolen or destroyed. TRANSFERS OF STOCK Section 4. Upon surrender to the corporation or the transfer agent of the corporation of a certificate for shares duly endorsed or accompanied by proper evidence of succession, assignment or authority to transfer, it shall be the duty of the corporation to issue a new certificate to the person entitled thereto, cancel the old certificate and record the transaction upon its books. FIXING RECORD DATE Section 5. In order that the corporation may determine the stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or to express consent to corporate action in writing without a meeting, or entitled to receive payment of any dividend or other distribution or allotment of any rights, or entitled to exercise any rights in respect of any change, conversion or exchange of stock or for the purpose of any other lawful action, the Board of Directors may fix, in advance, a record date, which shall not be more than sixty nor less than ten days before the date of such meeting, nor more than sixty days prior to any other action. A determination of stockholders of record entitled to notice of or to vote at a meeting of stockholders shall apply to any adjournment of the meeting; provided, however, that the Board of Directors may fix a new record date for the adjourned meeting. REGISTERED STOCKHOLDERS Section 6. The corporation shall be entitled to recognize the exclusive right of a person registered on its books as the owner of shares to receive dividends, and to vote as such owner, and to hold liable for calls and assessments a person registered on its books as the owner of shares, and shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of Delaware.\nARTICLE VII GENERAL PROVISIONS DIVIDENDS Section 1. Dividends upon the capital stock of the corporation, subject to the provisions of the Certificate of Incorporation, if any, may be declared by the Board of Directors at any regular or special meeting, pursuant to law. Dividends may be paid in cash, in property, or in shares of the capital stock, subject to the provisions of the Certificate of Incorporation. Section 2. Before payment of any dividend, there may be set aside out of any funds of the corporation available for dividends such sum or sums as the Directors from time to time, in their absolute discretion, think proper as a reserve or reserves to meet contingencies, or for equalizing dividends, or for repairing or maintaining any property of the corporation, or for such other purpose as the Directors shall think conducive to the interest of the corporation, and the Directors may notify or abolish any such reserve in the manner in which it was created. ANNUAL REPORT Section 3. (a) The Board of Directors shall present at each annual meeting, and at any special meeting of the stockholders when called for by vote of the stockholders, a full and clear statement of the business and condition of the corporation. (b) On or before 120 days from the close of each fiscal year, the Board of Directors shall cause to be delivered to each stockholder of record an audited statement of financial condition of the corporation as at the close of such fiscal year, together with a statement of operations, including profit and loss for such fiscal year. For the purposes of subsection (b), it will be sufficient if such report is mailed in the ordinary course of business to those shareholder of record as at the date on which the record of shareholders has been taken for the purpose of the annual meeting, pursuant to Section 5 of ARTICLE VI of these by-laws.\nCHECKS Section 4. All checks or demands for money and notes of the corporation shall be signed by such officer or officers or such other person or persons as the Board of Directors may from time to time designate. FISCAL YEAR Section 5. The fiscal year of the corporation shall be fixed by resolution of the Board of Directors.\nSEAL Section 6. The corporate seal shall have inscribed thereon the name of the corporation, the year of its organization and the words \"Corporate Seal, Delaware.\" The seal may be used by causing it or a facsimile thereof to be impressed or affixed or reproduced or otherwise. INDEMNIFICATION Section 7. (a) Directors, Officers and Employees of the Corporation. Every person now or hereafter serving as a Director, Officer or Employee of the Corporation shall be indemnified and held harmless by the corporation from and against any and all loss, cost, liability and expense that may be imposed upon or incurred by him in connection with or resulting from any claim, action, suit, or proceeding, civil or criminal, in which he may become involved, as a party or otherwise, by reason of his being or having been a director, officer or employee of the corporation, whether or not he continues to be such at the time such loss, cost, liability or expense shall have been imposed or incurred. As used herein, the term \"loss, cost, liability and expense\" shall include, but shall not be limited to, counsel fees and disbursements and amounts of judgments, fines or penalties against, and amounts paid in settlement by, any such director, officer or employee; provided, however that no such director, officer or employee shall be entitled to claim such indemnity: (1) with respect to any matter as to which there shall have been a final adjudication that he has committed or allowed some act or omission, (a) otherwise than in good faith in what he considers to be the best interests of the corporation, and (b) without reasonable cause to believe that such act or omission was proper and legal; or (2) in the event of a settlement of such claim, action, suit, or proceeding unless (a) the court having jurisdiction thereof shall have approved of such settlement with knowledge of the indemnity provided herein, or (b) a written opinion of independent legal counsel, selected by or in manner determined by the Board of Directors, shall have been rendered substantially concurrently with such settlement, to the effect that it was not probable that the matter as to which indemnification is being made would have resulted in a final adjudication as specified in clause (1) above and that the said loss, cost, liability or expense may properly be borne by the corporation. A conviction or judgment (whether based on a plea of guilty or nolo contendere or its equivalent, or after trial) in a criminal action, suit or proceeding shall not be deemed an adjudication that such director, officer or employee has committed or allowed some act or omission as hereinabove provided if independent legal counsel, selected as hereinabove set forth, shall substantially concurrently with such conviction or judgement give to the corporation a written opinion that such director, officer or employee was acting in good faith in what he considered to be the best interests of the corporation or was not without reasonable cause to believe that such act or omission was proper and legal. (b) Directors, Officers and Employees of Subsidiaries. Every person (including a director, officer or employee of the corporation) who at the request of the corporation acts as a director, officer or employee of any other corporation in which the corporation owns shares of stock or of which it is a creditor shall be indemnified to the same extent and subject to the same conditions that the directors, officers, and employees of the corporation are indemnified under the preceding paragraph, except that the amount of such loss, cost, liability or expense paid to any such director, officer or employee shall be reduced by and to the extent of any amounts which may be collected by him from such other corporation. (c) Miscellaneous. The provisions of this section shall cover claims, actions, suits and proceedings, civil or criminal, whether now pending or hereafter commenced and shall be retroactive to cover acts or omissions or alleged acts or omissions which heretofore have taken place. In the event of death of any person having a right of indemnification under the provisions of this section, such right shall inure to the benefit of his heirs, executors, administrators and personal representatives. If any part of this section should be found to be invalid or ineffective in any proceeding, the validity and effect of the remaining provisions shall not be affected. (d) Indemnification Not Exclusive. The foregoing right of indemnification shall not be deemed exclusive of any other right to which those indemnified may be entitled, and the corporation may provide additional indemnity and rights to its directors, officers or employees.\nARTICLE VIII AMENDMENTS Section 1. These by-laws may be altered or repealed at any regular meeting of the stockholders or of the Board of Directors or at any special meeting of the stockholders or of the Board of Directors if notice of such alteration or repeal be contained in the notice of such special meeting.\nExhibit 10.1\nAYDIN CORPORATION RESTRICTED STOCK AGREEMENT\nTHIS AGREEMENT, made on this 3rd day of January, 1995, by and between AYDIN CORPORATION, a Delaware corporation (hereinafter called the \"Company\"), and DONALD S. TAYLOR (hereinafter called the \"Employee\").\nWITNESSETH:\nWHEREAS, the Employee has been elected by the Board of Directors of the Company (the \"Board\") as President of the Company effective January 3, 1995; and\nWHEREAS, the Company and the Employee have agreed to certain terms and conditions of employment of the Employee as set forth in the Company's offer of employment letter (the \"Employment Letter\") dated September 29, 1994; and\nWHEREAS, the Employment Letter provides for a one-time bonus for joining the Company of a restricted stock award (the \"Award\") of 10,000 shares of common stock of the Company (the \"Common Stock\") that will vest over a four-year period; and\nWHEREAS, the Board has authorized the granting of the Award conditioned upon the execution by the Company and the Employee of this Agreement, thereby allowing the Employee to acquire a proprietary interest in the Company in order that the Employee will have a further incentive for remaining with and increasing his efforts on behalf of the Company or one of its Affiliates;\nNOW Therefore, in consideration of the foregoing and of the mutual covenants hereafter set forth and other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, the parties hereto hereby agree as follows:\n1. The Company hereby awards to the Employee as a separate incentive in connection with his employment and not in lieu of any salary or other compensation for his services, an Award covering 10,000 shares (the \"Shares\") of Common Stock on the terms and conditions set forth in this Agreement.\n2. The Shares covered by the Award shall vest in four equal installments of 2,500 Shares each on the first, second, third and fourth anniversary, respectively, of the date of this Agreement as long as the Employee remains employed by the Company or one of its Affiliates until such dates.\n3. Upon notification that the New York Stock Exchange has authorized listing of the Shares, a stock certificate evidencing the Shares shall be registered on the Company's books in the name of the Employee as of the date of this Agreement. Such certificate shall contain a legend restricting the transferability of such certificate and the Shares represented thereby, and referring to the terms and conditions approved by the Board and applicable to the Shares represented by the certificate (the \"Restrictive Legend\"). While the Shares are restricted and subject to the Delaware General Corporation Law, the Employee shall be entitled to all rights of a shareholder of the Company, including the right to vote the Shares and receive dividends and Other distributions declared on the Shares. The Employee shall have the right to return the certificate to the Company at any time for cancellation and to receive a certificate without the Restrictive Legend representing the Shares that have vested as provided in Section 2 hereof and a balance certificate bearing the Restrictive Legend for those Shares, if any, that shall not have been vested at such time; provided, however, that certificates representing vested or unvested Shares shall also bear a restrictive legend restricting transferability if legal counsel for the Company deems such legend to be required under applicable securities laws.\n4. If the employment of the Employee with the Company terminates for any reason during a vesting period, the Shares that have not vested shall be forfeited on the date of such termination of employment, except that for any portion of a vesting period that has elapsed through the date of such termination, the Employee shall receive a pro-rata portion of the Shares that would have been vested at the end of such period (the \"Pro-Rata Shares\") equal to the product of the Shares that are subject to vesting during such period (i.e., 2,500 Shares) multiplied by a fraction the numerator of which is the number of days that have elapsed during such vesting period through the date of termination and the denominator of which is 365. Upon termination of employment, the certificate(s) bearing the Restrictive Legend shall be returned to the Company for cancellation and a new certificate representing Shares that have vested as of the termination date for which the Restrictive Legend had not previously been removed and for the Pro-Rata Shares shall be issued to the Employee. The Employee may designate a beneficiary to receive the stock certificate representing the Shares that the Employee would have been entitled to receive under this Section 4 in the event that termination of employment of the Employee is due to his death. Each such beneficiary designation shall be in writing, making specific reference to this Agreement, and shall be addressed to the Company's Secretary and Corporate Counsel. The Employee has the right to change such beneficiary designation at will by delivering another written designation similar in form to the preceding designation to the Company's Secretary and Corporate Counsel.\n5. The Company shall have the right to obtain and withhold from any payment or transfer of property under this Agreement the amount of taxes required by any government to be withheld or otherwise deducted and paid with respect to such payment or transfer. At its discretion, the Company may require the Employee as a condition to receiving any Shares of pursuant to the Award to reimburse the Company for any such taxes required to be withheld by the Company and withhold any distribution or transfer of Shares in whole or in part until the Company is so reimbursed. In lieu thereof~ the Company shall have the right to withhold from any other cash amount due or to become due from the Company to the Employee an amount equal to such taxes as required to be withheld by the Company to reimburse the Company for any such taxes or to retain and withhold a number of Shares having a market value no less than the amount of such taxes and to cancel (in whole or m part) any such Shares so withheld in order to reimburse the Company for any such taxes. Moreover, if the Employee elects, in accordance with Section 83(b) of the Internal Revenue Code of 1986, as amended, to recognize ordinary income upon the grant of the Award, the Company will require at the time of that election the Employee to reimburse the Company for the amount of taxes required by any government to be withheld or otherwise paid as a consequence of that election.\n6. Any notice to be given to the Company under the terms of this Agreement shall be addressed to the Company, in care of its Secretary and Corporate Counsels at 700 Dresher Road, P.O. Box 349, Horsham, Pennsylvania 19044, or at such other address as the Company may hereafter designate in writing. Any notice to be given to the Employee shall be addressed to the Employee at the Employee's home address of record as reflected in the Company's personnel files. Any such notice shall be deemed to have been duly given, if and when enclosed in a properly sealed envelope, addressed as aforesaid, registered or certified and deposited, postage and registry fee prepaid, in a United States post office.\n7. Nothing herein contained shall affect the Employee's right to participate in and receive benefits under and in accordance with the then current provisions of any pension, insurance or other employee welfare plan or program of the Company or any Affiliate.\n8. Except as otherwise herein provided, the Award herein granted and the rights and privileges conferred hereby shall not be transferred, assigned, pledged or hypothecated in any way (whether by operation of law or otherwise) and shall not be subject to sale under execution, attachment or similar process.\n9. Subject to the limitation on the transferability contained herein, this Agreement shall be binding upon and inure to the benefit of the heirs, legatees, legal representatives, successors and assigns of the parties hereto.\n10. The Board shall have the power to interpret this Agreement and to adopt such rules for the administration, interpretation and application of this Agreement as are consistent therewith and to interpret or revoke any such rules. All actions taken and all interpretations and determinations made by the Board in good faith shall be final and binding upon Employee, the Company and all other interested persons. No member of the Board shall be personally liable for any action, determination or interpretation made in good faith with respect to this Agreement.\n11. In the event of changes in the capital stock of the Company by reason of stock dividends, split-ups or combinations of shares, reclassifications, mergers, consolidations, reorganizations or liquidations during the restriction period, any and all new, substituted or additional securities to which the Employee is entitled by reason of the ownership of the Award shall be subject immediately to the terms, conditions and restrictions of this Agreement.\n12. In the event that any provision in this Agreement shall be held invalid or unenforceable, such provision shall be severable from, and such invalidity or unenforceability shall not be construed to have any effect on, the remaining provisions of this Agreement.\n13. This Agreement shall be construed and enforced in accordance with the internal laws of the Commonwealth of Pennsylvania.\n14. The Agreement may be executed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute but one and the same instrument.\n15. This Agreement may be amended or modified only by a written instrument executed by both the Company and the Employee.\nIN WITNESS WHEREOF, the parties have executed this Agreements in duplicate, the day and year first above written.\nAttest: AYDIN CORPORATION\n\/s\/ Robert A. Clancy By: \/s\/ Ayhan Hakimoglu Secretary Title: Chairman\n\/s\/ Donald S. Taylor Employee's Signature\nPH1\\104045. 1\nExhibit 10.2\nAYDIN CORPORATION\nINDIVIDUAL NON-QUALIFIED STOCK OPTION AGREEMENT\nTHIS AGREEMENT, made on between AYDIN CORPORATION and its subsidiaries (hereinafter called the \"Company\") and (hereinafter called \"Optionee\").\nThe Board of Directors of the Company has determined that it is to the advantage and interest of the Company and its stockholders to grant the option provided for herein to the Optionee for their services to the Company and as an incentive for increased effort in the future, and in consideration of the mutual convenants herein contained, the parties hereto agree as follows:\n1. Shares Optioned; Time of Exercise; Option Price.\nThe Company grants to Optionee the right and option to purchase, on the terms and conditions hereinafter set forth, all or any part of an aggregate of shares of the Company's presently authorized but unissued common stock (par value $1.00) at the purchase price of $ per share, excerisable at the time and for the number of shares indicated hereafter.\nA. On or after , to and including , shares. B. On or after , to and including , shares. C. On or after , to and including . shares.\nD. On or after , to and including . shares.\n2. Payment for Delivery of Stock.\nThe option granted hereunder shall be exercisable by Optionee from time to time (as hereinabove provided), by delivery of written notice specifying therein the number of shares which he has elected to purchase and the payment to the Company of the purchase price of the shares which Optionee shall then elect to purchase. Payment is acceptable if it is made either: (i) in cash (including check, bank draft, or money order); or (ii) by delivering Company Common Stock (\"Stock\") already owned by Optionee; or (iii) by a combination of cash and Stock. The fair market value of Stock so delivered shall be the mean of the high and the low prices on the principal Exchange upon which the Stock is traded on the trading day immediately preceding the date of exercise.\n3. Necessity of Affiliation When Option is Exercised.\nThe option granted hereby and all rights hereunder to the extent such rights shall not have been exercised, shall terminate and become null and void if the Optionee ceases to be affiliated with the Company (whether by resignation, retirement, dismissal, disability or otherwise), except that (a) in the event of the termination of such affiliation for any reason other than the death of the Optionee, the Optionee may at any time within a period of thirty (30) days thereafter exercise the option granted hereby to the extent such option was exercisable by Optionee on the date of the termination of such affiliation, and (b) in the event of the death of the Optionee while affiliated with the Company, the options granted hereby which would have become exercisable by the Optionee at time of death may be exercised immediately or any time within three (3) months after such death by the person or persons to whom the Optionee's rights under the option granted hereby shall pass by will or by the applicable laws of descent and distribution; provided, however, that in no event may the option granted hereby be exercised to any extent by anyone after the terminal date specified in Section 1 of this Agreement. As used herein, the term \"affiliation\" includes, but is not limited to employee or director.\n4. Nonassignability of Options.\nExcept as otherwise provided in Section 3 of this Agreement, the option granted hereunder and the rights and privileges conferred hereby shall be exercisable only by the Optionee and shall not be transferable or be assignable, either voluntarily or by operation of law, by Optionee, in whole or in part, and if the Optionee shall attempt to make any such transfer or assignment of the option granted hereunder, or any of the rights and privileges conferred, such attempt to transfer or assign shall be void and of no affect, and the Company shall have the right to terminate this Agreement as of the date of such purported transfer or assignment.\n5. Termination of Optionee\nIf Optionee is an employee or non-employee Director of the Company, subject to the terms of any employment contract or other arrangement to the contrary, the Company shall have the right to terminate or change the terms of employment of the Optionee at any time for any reason whatsoever. A leave of absence or an interruption in service (including an interruption during military service) authorized or approved by the Company shall not be deemed a termination of employment for the purpose of this Section 5.\n6. Compliance with Governmental and Other Regulations.\nThis option shall not be exercisable in whole or in part, and the Company shall not be obligated to sell any shares of stock pursuant to the exercise of this option, (a) until this option has\nbeen approved by the shareholders of the Company, and (b) if such exercise and sale would, in the opinion of counsel for the Company, require registration of such shares under the Securities Act of 1933 (or other Federal or State statues having similar requirements), as it may be in effect at that time, and the Company shall at such time not desire to so register such shares. If at any time the Board of Directors of the Company shall determine in its discretion that the listing or qualifications of the shares of stock subject to this option on any securities exchange or under any applicable law, or the consent or approval of any governmental regulatory body, is necessary or desirable as a condition of, or in connection with the issue of shares pursuant to the exercise hereof, this option may not be exercised in whole or in part unless such listing, qualification, consent or approval shall have been effected or obtained free of any conditions not acceptable to the Company's Board of Directors. 7. Acquisition for Investment; Notification of Disposition.\nBy accepting this option, Optionee agrees for himself, his heirs, and legates that any and all shares purchased hereunder shall be acquired for investment and not for distribution, and upon the issuance of any or all of the shares subject to the option granted hereunder, Optionee, his heirs or legates receiving such shares, shall deliver to the Company a representation in writing that such shares are being acquired in good faith for investment and not for distribution. The Company, at its sole discretion, may take all reasonable steps (including the affixing of an appropriate legend on certificates embodying the shares) to assure itself against any sale or distribution by Optionee not in compliance with the Federal or State securities laws. In the event that the Optionee at any time contemplates the disposition (whether by sale, exchange, gift or other form of transfer) of any shares of stock acquired pursuant to the exercise of the option granted hereby, Optionee will first notify the Company of such proposed disposition and will thereafter cooperate with the Company in complying with all the applicable requirements of law which, in the opinion of the Company, must be satisfied prior to the making of such disposition. In the event that the Optionee disposes (whether by sale, exchange, gift or any other transfer) of any shares of stock acquired pursuant to the exercise of the option granted hereby, within one (1) year after the transfer of such shares to him upon his exercise of such option, he will notify the Company in writing within thirty (30) days after such disposition.\n8. Adjustments\nIn the event that the shares of stock subject to the option granted hereby shall be changed into or exchanged for a different number of kinds of shares of stock or other securities of the Company, or of another corporation (whether by reason of merger, consolidation, recapitalization, reclassification, split-up, combination of shares or otherwise) or if the number of such shares of stock shall be increased through the payment of a stock\ndividend, then there shall be substituted for or added to each share of stock of the Company theretofore or thereafter subject to this option the number and kind of shares of stock or other securities into which each outstanding share of stock of the Company shall be so changed, or for which each such share shall be exchanged, or to which each such shall be entitled, as the case may be. This option shall also be appropriately amended as to price and any other terms as may be necessary to reflect the foregoing events. In the event there shall be any other change in the number or kinds of the outstanding shares of stock of the Company subject to this option, or of any stock for which it shall have been exchanged, then if the Company's Board of Directors shall, in its sole discretion, determine that such change equitably requires an adjustment in this option, such adjustments shall be made in accordance with such determination. No fractional shares will be issued as a result of any adjustment in this option pursuant to this Section 8, nor shall any cash payment be made in lieu thereof. To the extent possible, any fractional shares resulting from such adjustment will be aggregated and the resulting whole shares added to any shares remaining to be purchased under this option. Notice of any adjustment shall be given by the Company to the Optionee and such adjustment (whether or not such notice is given) shall be final, effective, binding and conclusive for all purposes hereof. The Board of Directors shall have the power, in the event of any merger or consolidation of the Company with or into any other corporation or company, to amend this option to permit the exercise of this option prior to the effectiveness of any such merger or consolidation and to terminate this option as of such effectiveness. If the Board of Directors of the Company shall exercise such power, this option shall be deemed to have been amended to permit the exercise hereof in whole or in part by the Optionee at any time or from time to time as determined by the Board of Directors prior to the effectiveness of such merger or consolidation, and this option shall be deemed to terminate upon such effectiveness. 9. Rights of Optionee in Stock.\nNeither the Optionee nor his executor, administrator, heirs or legatees shall be or have any rights or privileges of a shareholder of the Company in respect to the shares issuable upon exercise of the option granted hereunder, unless and until certificates representing such shares shall have been issued and del ivered. 10. Notices\nAny notice to be given under the terms of this Agreement shall be addressed to the Company at 700 Dresher Road, P.O. Box 349, Horsham, PA 19044, and any notice to be given to the Optionee shall be addressed to him at the address given beneath his signature hereto, or at such other address as either party may\nhereafter designate in writing to the other. Any such notice shall have been deemed duly given when enclosed in a properly sealed envelope or wrapper addressed as aforesaid and deposited (first class postage prepaid) in post office or branch post office regularly maintained by the United States Government.\n11. Effect of Agreement; Execution.\nThis Agreement shall be binding upon and inure to the benefit of any successor or successors of the Company.\nIN WITNESS WHEREOF, the Company has caused these presents to be executed on its behalf by its Chairman, to be sealed by its Corporate seal, attested by its Secretary, and Optionee has hereunto set his hand the day and year first above written which is the time of granting of the option hereunder.\nATTESTED: AYDIN CORPORATION\n_______________________ By___________________________ Robert A. Clancy Ayhan Hakimoglu Secretary Chairman\n{SEAL)\n_____________________________ Optionee's signature\n_____________________________\n_____________________________ Optionee's Address (zip code)\nExhibit 10.3\nTHE 1981 INCENTIVE STOCK OPTION PLAN OF AYDIN CORPORATION\n100,000 Shares\n(Last amended, April 27, 1990)\nI. Purpose\nThe purpose of this Plan is to advance the interests of the Corporation and its shareholders by strengthening the ability of the Corporation to attract and retain in its employ key men of training, experience and ability and to furnish additional incentive to officers and valued key employees upon whose judgement, initiative and efforts the successful conduct and development of its business largely depends, by encouraging them to purchase stock in the Corporation.\nII. Definitions\nAs used in this Plan, \"Corporation\" means Aydin Corporation; \"Board of Directors\" means the Board of Directors of Aydin Corporation; \"employee\" includes officers and other key employees of the Corporation and its subsidiaries but excludes members of the Board of Directors who are not also officers or employees of the Corporation; \"Stock Option Committee\" (the \"Committee\") means the Board of Directors; \"Common Stock\" means the Corporation's Common Stock of the par value of $1.00 per share; \"Code\" means the Internal Revenue Code of 1954, as amended from time to time.\nIII. Eligible Personnel\nA. All full-time salaried officers and key employees.\nB. An employee who has been granted an option may, if he is otherwise eligible, be granted an additional option or options.\nIV. Stock Option Committee\nA. Subject to the provisions of the Plan, the Board of Directors shall be the Stock Option Committee and shall administer the Plan. It shall have authority to construe and interpret the Plan, to define the terms used therein, to prescribe, amend and rescind rules and regulations for the administration of the Plan and to take such other action in the administration of the Plan as it shall deem proper. The interpretation by the Committee of any provision of the Plan or of any option agreement entered into hereunder shall be in accordance with Section 422A of the Code and Regulations issued thereunder as they may be amended from time to time, in order that rights granted hereunder and under said option agreements shall constitute \"Incentive Stock Options\" within the meaning of such Section.\nB. A majority of the members of the Committee shall constitute a quorum and make all Committee determinations, take all Committee actions and conduct all Committee business. The Committee shall keep minutes of its meetings.\nC. Any Committee action may be taken or determination made without a meeting if all members of the Committee shall individually or collectively consent in writing to such action or determination. Such written consent or consents shall be filed with the minutes of the Committee.\nD. All interpretations, determinations and actions by the Committee shall be final, conclusive and binding upon all parties.\nE. No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any option agreement.\nV. Granting of Options\nA. The Board of Directors or the Stock Option Committee may at any time and from time to time grant options to eligible employees, to purchase shares of Common Stock of the Corporation under this Plan, determining the specific employees to whom options may be granted, the number of shares to be subject to each option, the terms and provisions of the option agreements, and the time or times at which such options shall be granted, provided, however, no officer of the Corporation who is also a director of the Corporation on the date of any specific grant may be granted an option if such grant, when aggregated with all previous grants to such person under this plan (as adjusted as provided for in Section IX) would exceed ten percent (10%) of the total number of shares authorized under this plan.\nB. The date of grant shall be the date the Board of Directors or the Stock Option Committee takes the necessary action to make the grant; provided, however, that if the minutes or appropriate resolutions of the Board or the Committee provide than an option is to be granted as of a date in the future, the date of grant shall be such future date. In any event, the optionee must be an employee on the date of the grant.\nC. No option shall be granted under this Plan after the close of business on October 22, 1991, but options theretofore granted may extend beyond that date.\nD. The options granted hereunder shall be \"Incentive Stock Options\" as that term is used in the code.\nVI. Shares Subject to the Plan\nThe total number of shares of Common Stock that may be purchased pursuant to options granted under this Plan shall not exceed 100,000 subject to adjustment as provided in Section IX and subject to amendment as provided in Section X. If any option outstanding hereunder shall expire or terminate for any reasons without having been exercised in full, the unpurchased shares subject to the option shall again be available for the grant of options under this Plan. Upon the exercise of an option outstanding hereunder, the Corporation may reissue Common Stock held in its treasury or issue authorized but unissued Common Stock.\nVII. Terms of Options\nA. Each option granted under the Plan shall include the following provisions, or terms consistent with the following provisions:\n1. The purchase price (option price) of the shares subject to option shall be not less than the fair market value of the stock on the day the option is granted. Such fair market value shall be established as the following, in order of descending preference:\na. Mean between the highest and the lowest quoted selling prices of the stock on an exchange.\nb. Lacking a. above, the mean between the \"bid\" and \"asked\" prices as provided to the Company by a legitimate broker.\nc. Lacking a. or b. for the date of grant, the mean between the \"bid\" and \"asked\" prices for the most recent date quoted, as obtained for the Company by a legitimate broker.\nd. Lacking a., b. or c., the last established determinable price.\n2. Except as provided in Section VIII herein, no option may be exercised unless the optionee is at the time of such exercise in the employ of the Corporation or of a subsidiary and shall have been continuously so employed since the granting of his option. For the purpose of the Plan, an employee who is on leave of absence or who is in the Armed Services or the civilian employment of the United States will be considered in the employ of the Corporation or its subsidiaries to the extent his employment would be treated as continuing intact under Section 421 and 422A of the Code, and the Regulations thereunder, as amended, from time to time.\n3. No option may be exercised prior to one year nor after five years from the date of its grant. Unless the option Agreement provides otherwise, any time after one year from the date of grant the employee may exercise his option in accordance with the following schedule:\nAfter: The optionee may purchase:\nOne year from date of grant.........................25% of the total. Two years from date of grant..........An additional 25% of the total. Three years from date of grant........An additional 25% of the total. Four years from date of grant.........An additional 25% of the total.\n4. An option granted under this Plan prior to January 1, 1987, shall not be exercisable while there is \"outstanding\" (within the meaning of Section 422A(c)(7) of the Code) any incentive stock option which was granted, before the granting of said option, to the optionee to purchase stock (i) of the Corporation, (ii) of a corporation which (at the time of the granting of such option) was a subsidiary of the Corporation, or (iii) of a predecessor corporation of any such corporation.\n5. Upon each exercise of an option the purchase price shall be payable in full in cash, (or its equivalent acceptable to the Corporation), or Common Stock already owned by the employee, or a combination of cash and Common Stock.\n6. No fractional shares shall be issued under this Plan or under any option granted hereunder, nor shall any cash payment be made in lieu thereof.\n7. An option shall not be assignable nor transferable by the employee to whom granted otherwise than by will or by the laws of descent and distribution, and may be exercised, during his lifetime, only by such employee.\n8. No person shall have the rights and privileges of a shareholder with respect to shares subject to or purchased under an option until the date appearing on the certificates issued upon the exercise of the option.\nB. The aggregate fair market value (determined as of the date the option is granted) of the stock for which any employee may be granted options in any calendar year prior to 1987 under this Plan and any other \"Incentive Stock Option Plan\" (within the meaning of Section 422A of the Code) of the Corporation or its subsidiaries, shall not exceed $100,000 plus any \"unused limit carryover\" to such year, as determined in accordance with Subsection (c)(4) of such Section. Subsequent to December 31, 1986, options granted under this Plan shall not be subject to these limitations, provided, however, the value of the shares subject to one or more Incentive Stock Option Plans first exercisable in any calendar year does not exceed $100,000 (determined as of the date the option is granted).\nC. No option under this Plan may be granted to an employee who, at the time the option is granted, owns stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Corporation or of its subsidiaries, provided, however, this limitation shall not apply if such option is granted at an option price of at least 110 percent of the fair market value of the stock on the date of the grant.\nD. Each option granted under this Plan may, but need not, include other terms and conditions not inconsistent with the provisions hereof, including a requirements that the optionee represent at the time of each exercise of option that the shares purchased are being acquired for investment and not for resale.\nE. Nothing in this Plan or in any option granted hereunder shall confer any rights to continue in the employ of the Corporation or its subsidiaries or interfere in any way with the rights of the Corporation or any subsidiary to terminate the employee at any time.\nVIII. Termination of Employment or Death of Employee\nA. If the employment of an optionee is terminated for cause, or if he voluntarily quits, his option shall expire forthwith, but he may exercise any installments accrued as of the date of termination or voluntary quit provided payment for same is received within 30 days of the termination. Retirement, including Early Retirement, under any retirement plan of the Corporation or subsidiary is not deemed a voluntary quit.\nB. If the employment of an optionee terminates for any reason other than termination for cause, a voluntary quit, disability or death, the option shall expire three months thereafter unless by its terms it expires sooner. During said period, the option may be exercised in accordance with its terms but only for the number of shares with respect to which installments had accrued as of the date of termination of employment.\nC. If an optionee dies while he is employed by the Corporation or a subsidiary or within the three month period referred to in Section VIII(B) above or within the twelve month period referred to in Section VIII(D) below, during said period, the option may be exercised by his personal representatives or the persons to whom his rights under the option shall pass by will or the laws of descent and distribution in accordance with terms of the option but only for that number of shares with respect to which installments had accrued as of the date of death or disability. Such exercisable installments must be exercised within three months of death, unless, by its terms, it expires sooner.\nD. If the employment of an optionee terminates by reason of the optionee's \"disability\" (within the meaning of Section 105(d)(4) of the Code), the option shall expire 12 months thereafter unless by its terms it expires sooner. During said period, the option may be exercised in accordance with its terms but only for the number of shares with respect to which installments had accrued as of the date of termination of employment.\nE. Notwithstanding the above, an option may not be exercised after the expiration of five years from the date the option is granted.\nIX. Adjustments Upon Changes in Capitalization\nIn the event of any recapitalization, stock dividend, stock split, or combination affecting the stock subject to this Plan, or in the event of any merger, consolidation, or reorganization as a result of which the Corporation is the surviving corporation, the Committee will make appropriate adjustments in the aggregate number of kind of shares subject to the Plan, the number of shares that may be granted to any one employee, and the number of shares and the price per share subject to outstanding options provided that such options remain or constitute incentive stock options within the meaning of Section 422A of the Code. Any such determination of adjustment shall be final and conclusive upon the parties.\nIn the event of the dissolution or liquidation of the Corporation, or in the event of a reorganization, merger, or consolidation of the Corporation with one or more corporations as a result of which the Corporation is not the surviving corporation, or in the event of a sale of substantially all of the property or stock of the Corporation to another corporation, the Plan shall terminate; and any option then outstanding hereunder shall terminate on the effective date of such transaction; provided, however, that in the event of any such transaction the Board of Directors may, but need not, modify all outstanding options so as to make all such options exercisable in full on a date sufficiently in advance of the effective date of such transaction to permit the shares acquired pursuant to any exercise of such options to be issued before the effective date of such transaction.\nX. Amendment and Termination\nA. The Board of Directors shall have the power, in its discretion, to amend, suspend or terminate this Plan at any time. The Board of Directors shall not have the power except as may be permitted in Section IX herein:\n1. To change the class of employees eligible to receive options under the Plan; or\n2. To increase the number of shares subject to the Plan in the aggregate subsequent to the date the Plan is submitted to the shareholders of the Corporation for their approval; or\n3. To increase the number of shares subject to an option for anyone individual; or\n4. To reduce the option price below the fair market value of the stock at the time the option was granted; or\n5. To increase the maximum terms of options provided herein.\nB. The Board of Directors may, with the consent of an optionee, make such modifications of the terms and conditions of his option as it shall deem advisable.\nXI. Effective Date of Plan\nThis Plan shall become effective as of October 23, 1981 upon approval of the shareholders of the Corporation and shall terminate at the close of business on October 22, 1991.\nExhibit 10.4\nTHE 1983 INCENTIVE STOCK OPTION PLAN OF AYDIN CORPORATION\n120,000 Shares\n(Last amended, April 27, 1990)\nI. Purpose\nThe purpose of this Plan is to advance the interests of the Corporation and its shareholders by strengthening the ability of the Corporation to attract and retain in its employ key men of training, experience and ability and to furnish additional incentive to officers and valued key employees upon whose judgement, initiative and efforts the successful conduct and development of its business largely depends, by encouraging them to purchase stock in the Corporation.\nII. Definitions\nAs used in this Plan, \"Corporation\" means Aydin Corporation; \"Board of Directors\" means the Board of Directors of Aydin Corporation; \"employee\" includes officers and other key employees of the Corporation and its subsidiaries but excludes members of the Board of Directors who are not also officers or employees of the Corporation; \"Stock Option Committee\" (the \"Committee\") means the Board of Directors; \"Common Stock\" means the Corporation's Common Stock of the par value of $1.00 per share; \"Code\" means the Internal Revenue Code of 1954, as amended from time to time.\nIII. Eligible Personnel\nA. All full-time salaried officers and key employees.\nB. An employee who has been granted an option may, if he is otherwise eligible, be granted an additional option or options.\nIV. Stock Option Committee\nA. Subject to the provisions of the Plan, the Board of Directors shall be the Stock Option Committee and shall administer the Plan. It shall have authority to construe and interpret the Plan, to define the terms used therein, to prescribe, amend and rescind rules and regulations for the administration of the Plan and to take such other action in the administration of the Plan as it shall deem proper. The interpretation by the Committee of any provision of the Plan or of any option agreement entered into hereunder shall be in accordance with Section 422A of the Code and Regulations issued thereunder as they may be amended from time to time, in order that rights granted hereunder and under said option agreements shall constitute \"Incentive Stock Options\" within the meaning of such Section.\nB. A majority of the members of the Committee shall constitute a quorum and make all Committee determinations, take all Committee actions and conduct all Committee business. The Committee shall keep minutes of its meetings.\nC. Any Committee action may be taken or determination made without a meeting if all members of the Committee shall individually or collectively consent in writing to such action or determination. Such written consent or consents shall be filed with the minutes of the Committee.\nD. All interpretations, determinations and actions by the Committee shall be final, conclusive and binding upon all parties.\nE. No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any option agreement.\nV. Granting of Options\nA. The Board of Directors or the Stock Option Committee may at any time and from time to time grant options to eligible employees, to purchase shares of Common Stock of the Corporation under this Plan, determining the specific employees to whom options may be granted, the number of shares to be subject to each option, the terms and provisions of the option agreements, and the time or times at which such options shall be granted, provided, however, no officer of the Corporation who is also a director of the Corporation on the date of any specific grant may be granted an option if such grant, when aggregated with all previous grants to such person under this plan (as adjusted as provided for in Section IX) would exceed ten percent (10%) of the total number of shares authorized under this plan.\nB. The date of grant shall be the date the Board of Directors or the Stock Option Committee takes the necessary action to make the grant; provided, however, that if the minutes or appropriate resolutions of the Board or the Committee provide than an option is to be granted as of a date in the future, the date of grant shall be such future date. In any event, the optionee must be an employee on the date of the grant.\nC. No option shall be granted under this Plan after the close of business on October 31, 1993, but options theretofore granted may extend beyond that date.\nD. The options granted hereunder shall be \"Incentive Stock Options\" as that term is used in the code.\nVI. Shares Subject to the Plan\nThe total number of shares of Common Stock that may be purchased pursuant to options granted under this Plan shall not exceed 120,000 subject to adjustment as provided in Section IX and subject to amendment as provided in Section X. If any option outstanding hereunder shall expire or terminate for any reasons without having been exercised in full, the unpurchased shares subject to the option shall again be available for the grant of options under this Plan. Upon the exercise of an option outstanding hereunder, the Corporation may reissue Common Stock held in its treasury or issue authorized but unissued Common Stock.\nVII. Terms of Options\nA. Each option granted under the Plan shall include the following provisions, or terms consistent with the following provisions:\n1. The purchase price (option price) of the shares subject to option shall be not less than the fair market value of the stock on the day the option is granted. Such fair market value shall be established as the following, in order of descending preference:\na. Mean between the highest and the lowest quoted selling prices of the stock on an exchange.\nb. Lacking a. above, the mean between the \"bid\" and \"asked\" prices as provided to the Company by a legitimate broker.\nc. Lacking a. or b. for the date of grant, the mean between the \"bid\" and \"asked\" prices for the most recent date quoted, as obtained for the Company by a legitimate broker.\nd. Lacking a., b. or c., the last established determinable price.\n2. Except as provided in Section VIII herein, no option may be exercised unless the optionee is at the time of such exercise in the employ of the Corporation or of a subsidiary and shall have been continuously so employed since the granting of his option. For the purpose of the Plan, an employee who is on leave of absence or who is in the Armed Services or the civilian employment of the United States will be considered in the employ of the Corporation or its subsidiaries to the extent his employment would be treated as continuing intact under Section 421 and 422A of the Code, and the Regulations thereunder, as amended, from time to time.\n3. No option may be exercised prior to one year nor after five years from the date of its grant. Unless the option Agreement provides otherwise, any time after one year from the date of grant the employee may exercise his option in accordance with the following schedule:\nAfter: The optionee may purchase:\nOne year from date of grant.........................25% of the total. Two years from date of grant..........An additional 25% of the total. Three years from date of grant........An additional 25% of the total. Four years from date of grant.........An additional 25% of the total.\n4. An option granted under this Plan prior to January 1, 1987, shall not be exercisable while there is \"outstanding\" (within the meaning of Section 422A(c)(7) of the Code) any incentive stock option which was granted, before the granting of said option, to the optionee to purchase stock (i) of the Corporation, (ii) of a corporation which (at the time of the granting of such option) was a subsidiary of the Corporation, or (iii) of a predecessor corporation of any such corporation.\n5. Upon each exercise of an option the purchase price shall be payable in full in cash, (or its equivalent acceptable to the Corporation), or Common Stock already owned by the employee, or a combination of cash and Common Stock.\n6. No fractional shares shall be issued under this Plan or under any option granted hereunder, nor shall any cash payment be made in lieu thereof.\n7. An option shall not be assignable nor transferable by the employee to whom granted otherwise than by will or by the laws of descent and distribution, and may be exercised, during his lifetime, only by such employee.\n8. No person shall have the rights and privileges of a shareholder with respect to shares subject to or purchased under an option until the date appearing on the certificates issued upon the exercise of the option.\nB. The aggregate fair market value (determined as of the date the option is granted) of the stock for which any employee may be granted options in any calendar year prior to 1987 under this Plan and any other \"Incentive Stock Option Plan\" (within the meaning of Section 422A of the Code) of the Corporation or its subsidiaries, shall not exceed $100,000 plus any \"unused limit carryover\" to such year, as determined in accordance with Subsection (c)(4) of such Section. Subsequent to December 31, 1986, options granted under this Plan shall not be subject to these limitations, provided, however, the value of the shares subject to one or more Incentive Stock Option Plans first exercisable in any calendar year does not exceed $100,000 (determined as of the date the option is granted).\nC. No option under this Plan may be granted to an employee who, at the time the option is granted, owns stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Corporation or of its subsidiaries, provided, however, this limitation shall not apply if such option is granted at an option price of at least 110 percent of the fair market value of the stock on the date of the grant.\nD. Each option granted under this Plan may, but need not, include other terms and conditions not inconsistent with the provisions hereof, including a requirements that the optionee represent at the time of each exercise of option that the shares purchased are being acquired for investment and not for resale.\nE. Nothing in this Plan or in any option granted hereunder shall confer any rights to continue in the employ of the Corporation or its subsidiaries or interfere in any way with the rights of the Corporation or any subsidiary to terminate the employee at any time.\nVIII. Termination of Employment or Death of Employee\nA. If the employment of an optionee is terminated for cause, or if he voluntarily quits, his option shall expire forthwith, but he may exercise any installments accrued as of the date of termination or voluntary quit provided payment for same is received within 30 days of the termination. Retirement, including Early Retirement, under any retirement plan of the Corporation or subsidiary is not deemed a voluntary quit.\nB. If the employment of an optionee terminates for any reason other than termination for cause, a voluntary quit, disability or death, the option shall expire three months thereafter unless by its terms it expires sooner. During said period, the option may be exercised in accordance with its terms but only for the number of shares with respect to which installments had accrued as of the date of termination of employment.\nC. If an optionee dies while he is employed by the Corporation or a subsidiary or within the three month period referred to in Section VIII(B) above or within the twelve month period referred to in Section VIII(D) below, during said period, the option may be exercised by his personal representatives or the persons to whom his rights under the option shall pass by will or the laws of descent and distribution in accordance with terms of the option but only for that number of shares with respect to which installments had accrued as of the date of death or disability. Such exercisable installments must be exercised within three months of death, unless, by its terms, it expires sooner.\nD. If the employment of an optionee terminates by reason of the optionee's \"disability\" (within the meaning of Section 105(d)(4) of the Code), the option shall expire 12 months thereafter unless by its terms it expires sooner. During said period, the option may be exercised in accordance with its terms but only for the number of shares with respect to which installments had accrued as of the date of termination of employment.\nE. Notwithstanding the above, an option may not be exercised after the expiration of five years from the date the option is granted.\nIX. Adjustments Upon Changes in Capitalization\nIn the event of any recapitalization, stock dividend, stock split, or combination affecting the stock subject to this Plan, or in the event of any merger, consolidation, or reorganization as a result of which the Corporation is the surviving corporation, the Committee will make appropriate adjustments in the aggregate number of kind of shares subject to the Plan, the number of shares that may be granted to any one employee, and the number of shares and the price per share subject to outstanding options provided that such options remain or constitute incentive stock options within the meaning of Section 422A of the Code. Any such determination of adjustment shall be final and conclusive upon the parties.\nIn the event of the dissolution or liquidation of the Corporation, or in the event of a reorganization, merger, or consolidation of the Corporation with one or more corporations as a result of which the Corporation is not the surviving corporation, or in the event of a sale of substantially all of the property or stock of the Corporation to another corporation, the Plan shall terminate; and any option then outstanding hereunder shall terminate on the effective date of such transaction; provided, however, that in the event of any such transaction the Board of Directors may, but need not, modify all outstanding options so as to make all such options exercisable in full on a date sufficiently in advance of the effective date of such transaction to permit the shares acquired pursuant to any exercise of such options to be issued before the effective date of such transaction.\nX. Amendment and Termination\nA. The Board of Directors shall have the power, in its discretion, to amend, suspend or terminate this Plan at any time. The Board of Directors shall not have the power except as may be permitted in Section IX herein:\n1. To change the class of employees eligible to receive options under the Plan; or\n2. To increase the number of shares subject to the Plan in the aggregate subsequent to the date the Plan is submitted to the shareholders of the Corporation for their approval; or\n3. To increase the number of shares subject to an option for anyone individual; or\n4. To reduce the option price below the fair market value of the stock at the time the option was granted; or\n5. To increase the maximum terms of options provided herein.\nB. The Board of Directors may, with the consent of an optionee, make such modifications of the terms and conditions of his option as it shall deem advisable.\nXI. Effective Date of Plan\nThis Plan shall become effective as of November 1, 1983 upon approval of the shareholders of the Corporation and shall terminate at the close of business on October 31, 1993.\nExhibit 10.5\nTHE 1984 NON-QUALIFIED STOCK OPTION PLAN OF AYDIN CORPORATION\n125,000 Shares\n(Last amended, April 27, 1990)\nI. Purpose\nThe purpose of this Plan is to advance the interests of the Corporation and its shareholders by strengthening the ability of the Corporation to attract and retain in its employ key men of training, experience and ability and to furnish additional incentive to officers and valued key employees upon whose judgement, initiative and efforts the successful conduct and development of its business largely depends, by encouraging them to purchase stock in the Corporation.\nII. Definitions\nAs used in this Plan, \"Corporation\" means Aydin Corporation; \"Board of Directors\" means the Board of Directors of Aydin Corporation; \"employee\" includes officers and other key employees of the Corporation and its subsidiaries but excludes members of the Board of Directors who are not also officers or employees of the Corporation; \"Stock Option Committee\" (the \"Committee\") means the Board of Directors; \"Common Stock\" means the Corporation's Common Stock of the par value of $1.00 per share; \"Code\" means the Internal Revenue Code of 1954, as amended from time to time.\nIII. Eligible Personnel\nA. All full-time salaried officers and key employees.\nB. An employee who has been granted an option may, if he is otherwise eligible, be granted an additional option or options.\nIV. Stock Option Committee\nA. Subject to the provisions of the Plan, the Board of Directors shall be the Stock Option Committee and shall administer the Plan. It shall have authority to construe and interpret the Plan, to define the terms used therein, to prescribe, amend and rescind rules and regulations for the administration of the Plan and to take such other action in the administration of the Plan as it shall deem proper.\nB. A majority of the members of the Committee shall constitute a quorum and make all Committee determinations, take all Committee actions and conduct all Committee business. The Committee shall keep minutes of its meetings.\nC. Any Committee action may be taken or determination made without a meeting if all members of the Committee shall individually or collectively consent in writing to such action or determination. Such written consent or consents shall be filed with the minutes of the Committee.\nD. All interpretations, determinations and actions by the Committee shall be final, conclusive and binding upon all parties.\nE. No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any option agreement.\nV. Granting of Options\nA. The Board of Directors or the Stock Option Committee may at any time and from time to time grant options to eligible employees, to purchase shares of Common Stock of the Corporation under this Plan, determining the specific employees to whom options may be granted, the number of shares to be subject to each option, the purchase price (option price) of the shares subject to the option, the terms and provisions of the option agreements, and the time or times at which such options shall be granted, provided, however, no officer of the Corporation who is also a director of the Corporation on the date of any specific grant may be granted an option if such grant, when aggregated with all previous grants to such person under this plan (as adjusted as provided for in Section IX) would exceed ten percent (10%) of the total number of shares authorized under this plan.\nB. The date of grant shall be the date the Board of Directors or the Stock Option Committee takes the necessary action to make the grant; provided, however, that if the minutes or appropriate resolutions of the Board or the Committee provide than an option is to be granted as of a date in the future, the date of grant shall be such future date. In any event, the optionee must be an employee on the date of the grant.\nC. No option shall be granted under this Plan after the close of business on July 1, 1995, but options theretofore granted may extend beyond that date.\nD. The options granted hereunder shall be \"Non-Qualified Stock Options\" as that term is used in the code.\nVI. Shares Subject to the Plan\nThe total number of shares of Common Stock that may be purchased pursuant to options granted under this Plan shall not exceed 125,000 subject to adjustment as provided in Section IX and subject to amendment as provided in Section X. If any option outstanding hereunder shall expire or terminate for any reasons without having been exercised in full, the unpurchased shares subject to the option shall again be available for the grant of options under this Plan. Upon the exercise of an option outstanding hereunder, the Corporation may reissue Common Stock held in its treasury or issue authorized but unissued Common Stock.\nVII. Terms of Options\nA. Each option granted under the Plan shall include the following provisions, or terms consistent with the following provisions:\n1. The purchase price (option price) of the shares subject to option shall be determined by the Board of Directors or the Stock Option Committee, but the option price will not be less than fifty percent (50%) of the fair market value of the shares subject to the option on the date the option is granted. Such fair market value shall be established as the following, in order of descending preference:\na. Mean between the highest and the lowest quoted selling prices of the stock on an exchange.\nb. Lacking a. above, the mean between the \"bid\" and \"asked\" prices as provided to the Company by a legitimate broker.\nc. Lacking a. or b. for the date of grant, the mean between the \"bid\" and \"asked\" prices for the most recent date quoted, as obtained for the Company by a legitimate broker.\nd. Lacking a., b. or c., the last established determinable price.\n2. Except as provided in Section VIII herein, no option may be exercised unless the optionee is at the time of such exercise in the employ of the Corporation or of a subsidiary and shall have been continuously so employed since the granting of his option. For the purpose of the Plan, an employee who is on leave of absence which is authorized or approved by the Corporation or who is in the Armed Services or the civilian employment of the United States will be considered in the employ of the Corporation or its subsidiaries and his employment would be treated as continuing intact under this Plan.\n3. No option may be exercised prior to one year nor after five years from the date of its grant. Unless the option Agreement provides otherwise, any time after one year from the date of grant the employee may exercise his option in accordance with the following schedule:\nAfter: The optionee may purchase:\nOne year from date of grant.........................25% of the total. Two years from date of grant..........An additional 25% of the total. Three years from date of grant........An additional 25% of the total. Four years from date of grant.........An additional 25% of the total.\n4. Upon each exercise of an option the purchase price shall be payable in full in cash, (or its equivalent acceptable to the Corporation), or Common Stock already owned by the employee, or a combination of cash and Common Stock.\n5. No fractional shares shall be issued under this Plan or under any option granted hereunder, nor shall any cash payment be made in lieu thereof.\n6. An option shall not be assignable nor transferable by the employee to whom granted otherwise than by will or by the laws of descent and distribution, and may be exercised, during his lifetime, only by such employee.\n7. No person shall have the rights and privileges of a shareholder with respect to shares subject to or purchased under an option until the date appearing on the certificates issued upon the exercise of the option.\nB. Each option granted under this Plan may, but need not, include other terms and conditions not inconsistent with the provisions hereof, including a requirement that the optionee represent at the time of each exercise of option that the shares purchased are being acquired for investment and not for resale.\nC. Nothing in this Plan or in any option granted hereunder shall confer any rights to continue in the employ of the Corporation or its subsidiaries or interfere in any way with the rights of the Corporation or any subsidiary to terminate the employee at any time.\nVIII. Termination of Employment or Death of Employee\nA. If the employment of an optionee is terminated for cause, or if he voluntarily quits, his option shall expire forthwith, but he may exercise any installments accrued as of the date of termination of employment provided payment for same is received within 30 days of the termination.\nB. If an optionee dies while he is employed by the Corporation or a subsidiary, the option may be exercised by his personal representatives or the persons to whom his rights under the option shall pass by will or the laws of descent and distribution in accordance with terms of the option but only for that number of shares with respect to which installments had accrued as of the date of death. Such exercisable installments must be exercised within three months of death, unless, by its terms, it expires sooner.\nC. Notwithstanding the above, an option may not be exercised after the expiration of five years from the date the option is granted.\nIX. Adjustments Upon Changes in Capitalization\nIn the event of any recapitalization, stock dividend, stock split, or combination affecting the stock subject to this Plan, or in the event of any merger, consolidation, or reorganization as a result of which the Corporation is the surviving corporation, the Committee will make appropriate adjustments in the aggregate number of kind of shares subject to the Plan, the number of shares that may be granted to any one employee, and the number of shares and the price per share subject to outstanding options provided that such options remain or constitute incentive stock options within the meaning of Section 422A of the Code. Any such determination of adjustment shall be final and conclusive upon the parties.\nIn the event of the dissolution or liquidation of the Corporation, or in the event of a reorganization, merger, or consolidation of the Corporation with one or more corporations as a result of which the Corporation is not the surviving corporation, or in the event of a sale of substantially all of the property or stock of the Corporation to another corporation, the Plan shall terminate; and any option then outstanding hereunder shall terminate on the effective date of such transaction; provided, however, that in the event of any such transaction the Board of Directors may, but need not, modify all outstanding options so as to make all such options exercisable in full on a date sufficiently in advance of the effective date of such transaction to permit the shares acquired pursuant to any exercise of such options to be issued before the effective date of such transaction.\nX. Amendment and Termination\nA. The Board of Directors shall have the power, in its discretion, to amend, suspend or terminate this Plan at any time. The Board of Directors shall not have the power except as may be permitted in Section IX herein:\n1. To change the class of employees eligible to receive options under the Plan; or\n2. To increase the number of shares subject to the Plan in the aggregate subsequent to the date the Plan is submitted to the shareholders of the Corporation for their approval; or\n3. To increase the number of shares subject to an option for any one individual; or\n4. To reduce the option price below the fair market value of the stock at the time the option was granted; or\n5. To increase the maximum terms of options provided herein.\nB. The Board of Directors may, with the consent of an optionee, make such modifications of the terms and conditions of his option as it shall deem advisable.\nXI. Effective Date of Plan\nThis Plan shall become effective as of July 1, 1984, upon approval of the shareholders of the Corporation and shall terminate at the close of business on July 1, 1995.\nExhibit 10.6\nTHE 1994 INCENTIVE STOCK OPTION PLAN OF AYDIN CORPORATION\n150,000 Shares (Last amended October 28, 1994) I. Purpose\nThe purpose of this Plan is to advance the interests of the Corporation and its shareholders by strengthening the ability of the Corporation to attract and retain in its employ key individuals of training, experience and ability and to furnish additional incentive to officers and valued key employees upon whose judgement, initiative and efforts the successful conduct and development of its business largely depends, by encouraging them to purchase stock in the Corporation.\nII. Definitions\nAs used in this Plan, \"Corporation\" means Aydin Corporation; \"Board of Directors\" means the Board of Directors of Aydin Corporation; \"employee\" includes officers and other key employees of the Corporation and its subsidiaries but excludes members of the Board of Directors who are not also officers or employees of the Corporation; \"Stock Option Committee\" (the \"Committee\") means the Board of Directors; \"Special Committee\" means a committee composed of at least three non-employee Directors that qualify as \"disinterested persons\" under Rule 16b-3(d)(3); \"Common Stock\" means the Corporation's Common Stock of the par value of $1.00 per share; \"Code\" means the Internal Revenue Code of 1986, as amended from time to time.\nIII. Eligible Personnel\nA. All full-time salaried officers and key employees.\nB. An employee who has been granted an option may, if he is otherwise eligible, be granted an additional option or options.\nIV. Stock Option Committee\nA. Subject to the provisions of the Plan, the Committee shall administer the Plan. It shall have authority to construe and interpret the Plan, to define the terms used therein, to prescribe, amend and rescind rules and regulations for the administration of the Plan and to take such other action in the administration of the Plan as it shall deem proper. The interpretation by the Committee of any provision of the Plan or of any option agreement entered into hereunder shall be in accordance with Section 422 of the Code and Regulations issued thereunder as they may be amended from time to time, in order that rights granted hereunder and under said option agreements shall constitute \"Incentive Stock Options\" within the meaning of that Section.\nB. A majority of the members of the Committee, or the Special Committee as the case may be, shall constitute a quorum and make all determinations, take all actions and conduct all business. They shall keep minutes of their respective meetings.\nC. Any Committee or Special Committee action may be taken or determination made without a meeting if all members of the respective committee shall individually or collectively consent in writing to such action or determination. Such written consent or consents shall be filed with the minutes of the Corporation.\nD. All interpretations, determinations and actions by the respective committee shall be final, conclusive and binding upon all parties.\nE. No member of the Committee, or Special Committee as the case may be,shall be liable for any action or determination made in good faith with respect to the Plan or any option agreement.\nV. Granting of Options\nA. The Committee may at any time and from time to time grant options to eligible employees, to purchase shares of Common Stock of the Corporation under this Plan, determining the specific employees to whom options may be granted, the number of shares to be subject to each option, the terms and provisions of the option agreements, and the time or times at which such options shall be granted, provided, however, only the Special Committee may grant options to officers of the Corporation who are also directors of the Corporation on the date of such grant.\nB. The date of grant shall be the date either committee takes the necessary action to make the grant; provided, however, that if the minutes or appropriate resolutions of the respective committee provide than an option is to be granted as of a date in the future, the date of grant shall be such future date. In any event, the optionee must be an employee on the date of the grant.\nC. No option shall be granted under this Plan after the close of business on December 31, 2003, but options theretofore granted may extend beyond that date.\nD. The options granted hereunder shall be \"Incentive Stock Options\" as that term is used in Section 422 of the Code.\nVI. Shares Subject to the Plan\nThe total number of shares of Common Stock that may be purchased pursuant to options granted under this Plan shall not exceed 150,000 subject to adjustment as provided in Section IX and subject to amendment as provided in Section X. If any option outstanding hereunder shall expire or terminate for any reason without having been exercised in full, the unpurchased shares subject to the option shall again be available for the grant of options under this Plan. Upon the exercise of an option outstanding hereunder, the Corporation may reissue Common Stock held in its treasury or issue authorized but unissued Common Stock.\nVII. Terms of Options\nA. Each option granted under the Plan shall include the following provisions, or terms consistent with the following provisions:\n1. The purchase price (option price) of the shares subject to option shall be not less than the fair market value of the stock on the day the option is granted. Such fair market value shall be established as the following, in order of descending preference:\na. Mean between the highest and the lowest quoted selling prices of the stock on an exchange.\nb. Lacking a. above, the mean between the \"bid\" and \"asked\" prices as provided to the Company by a legitimate broker.\nc. Lacking a. or b. for the date of grant, the mean between the \"bid\" and \"asked\" prices for the most recent date quoted, as obtained for the Company by a legitimate broker.\nd. Lacking a., b. or c., the last established determinable price.\n2. Except as provided in Section VIII herein, no option may be exercised unless the optionee is at the time of such exercise in the employ of the Corporation or of a subsidiary and shall have been continuously so employed since the granting of his option. For the purpose of the Plan, an employee who is on leave of absence or who is in the Armed Services or the civilian employment of the United States will be considered in the employ of the Corporation or its subsidiaries to the extent his employment would be treated as continuing intact under Sections 421 and 422 of the Code, and the Regulations thereunder, as amended, from time to time.\n3. No option may be exercised prior to one year nor after five years from the date of its grant. Unless the option Agreement provides otherwise, any time after one year from the date of grant the employee may exercise his option in accordance with the following schedule:\nAfter: The optionee may purchase:\nOne year from date of grant.....25% of the total. Two years from date of grant....additional 25% of the total. Three years from date of grant..additional 25% of the total. Four years from date of grant...additional 25% of the total.\n4. Upon each exercise of an option the purchase price shall be payable in full in cash, (or its equivalent acceptable to the Corporation), or Common Stock already owned by the employee, or a combination of cash and Common Stock.\n5. No fractional shares shall be issued under this Plan or under any option granted hereunder, nor shall any cash payment be made in lieu thereof.\n6. An option shall not be assignable or transferable by the employee to whom granted otherwise than by will or by the laws of descent and distribution, and may be exercised, during his lifetime, only by such employee.\n7. No person shall have the rights and privileges of a shareholder with respect to shares subject to or purchased under an option until the date appearing on the certificates issued upon the exercise of the option.\nB. The aggregate fair market value (determined as of the date the option is granted) of the stock for which any employee may be granted options first exercisable in any calendar year under this Plan and all other \"Incentive Stock Option Plans\" of the Corporation or its subsidiaries, shall not exceed $100,000.\nC. No option under this Plan may be granted to an employee who, at the time the option is granted, owns stock possessing more than 10 percent of the total combined voting power of all classes of stock of the Corporation or of its subsidiaries, provided, however, this limitation shall not apply if such option is granted at an option price of at least 110 percent of the fair market value of the stock on the date of the grant.\nD. Each option granted under this Plan may, but need not, include other terms and conditions not inconsistent with the provisions hereof, including a requirement that the optionee represent at the time of each exercise of option that the shares purchased are being acquired for investment and not for resale.\nE. Nothing in this Plan nor in any option granted hereunder shall confer any rights to continue in the employ of the Corporation or its subsidiaries or interfere in any way with the rights of the Corporation or any subsidiary to terminate the employee at any time.\nVIII. Termination of Employment or Death of Employee\nA. If the employment of an optionee is terminated for cause, or if he voluntarily quits, his option shall expire forthwith, but he may exercise any options that are exercisable as of the date of termination or voluntary quit provided payment for same is received within 30 days of the termination. Retirement, including Early Retirement, under any retirement plan of the Corporation or subsidiary is not deemed a voluntary quit.\nB. If the employment of an optionee terminates for any reason other than termination for cause, a voluntary quit, disability or death, the option shall expire three months thereafter unless by its terms it expires sooner. During said period, the option may be exercised in accordance with its terms but only for the number of shares with respect to which options could be exercised as of the date of termination of employment.\nC. If an optionee dies while he is employed by the Corporation or a subsidiary or within the three month period referred to in Section VIII(B) above or within the twelve month period referred to in Section VIII(D) below, during said period, the option may be exercised by his personal representatives or the persons to whom his rights under the option shall pass by will or the laws of descent and distribution in accordance with terms of the option but only for that number of shares with respect to which options could be exercised as of the date of death. Such exercisable option must be exercised within three months of death, unless, by its terms, it expires sooner.\nD. If the employment of an optionee terminates by reason of the optionee's \"disability\" (within the meaning of Section 22(e)(3) of the Code), the option shall expire 12 months thereafter unless by its terms it expires sooner. During said period, the option may be exercised in accordance with its terms but only for the number of shares with respect to which options could be exercised as of the date of termination of employment.\nE. Notwithstanding the above, an option may not be exercised after the expiration of five years from the date the option is granted.\nIX. Adjustments Upon Changes in Capitalization\nIn the event of any recapitalization, stock dividend, stock split, or combination affecting the stock subject to this Plan, or in the event of any merger, consolidation, or reorganization as a result of which the Corporation is the surviving corporation, the Committee will make appropriate adjustments in the aggregate number of kind of shares subject to the Plan, the number of shares that may be granted to any one employee, and the number of shares and the price per share subject to outstanding options provided that such options remain or constitute incentive stock options within the meaning of Section 422 of the Code. Any such determination of adjustment shall be final and conclusive upon the parties.\nIn the event of the dissolution or liquidation of the Corporation, or in the event of a reorganization, merger, or consolidation of the Corporation with one or more corporations as a result of which the Corporation is not the surviving corporation, or in the event of a sale of substantially all of the property or stock of the Corporation to another corporation, the Plan shall terminate; and any option then outstanding hereunder shall terminate on the effective date of such transaction; provided, however, that in the event of any such transaction the Board of Directors may, but need not, modify all outstanding options so as to make all such options exercisable in full on a date sufficiently in advance of the effective date of such transaction to permit the shares acquired pursuant to any exercise of such options to be issued before the effective date of such transaction.\nX. Amendment and Termination\nA. The Board of Directors shall have the power, in its discretion, to amend, suspend or terminate this Plan at any time. The Board of Directors shall not have the power except as may be permitted in Section IX herein:\n1. To change the class of employees eligible to receive options under the Plan; or\n2. To increase the number of shares subject to the Plan in the aggregate unless such increase is submitted to the shareholders of the Corporation for their approval; or\n3. To increase the number of shares subject to an option for any one individual; or\n4. To reduce the option price below the fair market value of the stock (or below the 110% fair market value when required by Section VII (C) hereof) at the time the option was granted; or\n5. To increase the maximum terms of options provided herein.\nB. The Board of Directors may, with the consent of an optionee, make such modifications of the terms and conditions of his option as it shall deem advisable.\nXI. Compliance with Rule 16b-3\nThe provisions of this Plan are intended to comply in all respects with the provisions of Rule 16b-3 under the Securities Exchange Act of 1934 and any amendments thereto, and, if this Plan shall not so comply, whether on the date of adoption or by reason of any later amendment to or interpretation of Rule 16b-3, the provisions of this Plan shall be deemed to be automatically amended so as to bring them into full compliance with such rule.\nXII. Effective Date of Plan\nThis Plan shall become effective as of January 3, 1994 upon approval of the shareholders of the Corporation and shall terminate at the close of business on December 31, 2003.\nExhibit 13\nDear Stockholder: Total sales for 1994 were $142,441,000, versus sales of $141,475,000 in 1993. In 1994, the Company had a net income of $5,047,000 or $1.01 per share, as compared to a net loss of $4,967,000 or $1.00 per share in 1993. Aydin's backlog at the end of 1994 was approximately $134 million, as compared to $155 million at this time last year. Lower present backlog, coupled with delays in bookings, may have negative impact on earnings early in 1995. The Company has sizeable production options not included in the above figures. The Company is continuing to bid on large and small military and industrial programs. During the last half of 1994, the Company submitted approximately $800 million in proposals. This is a record for the past several years, and there are several other significant proposals in the preparation stage. The Company's growth strategy is to continue bidding on its basic industrial and military business. In addition, the Company will stress its telecommunication business, including digital wireless telephony and digital telephony for video cable systems. The Company has formed a new division, \"Aydin Telecom\". Mr. Thomas LoCasale has been appointed President of this Division, reporting to me. This Division will develop, market and sell digital wireless telephony equipment & systems, digital telephony networks for video cable systems, network access equipment, satellite modems, satellite TDMA next generation equipment, transcoders and certain types of multiplexers. In the telecommunications field, Aydin (West) will continue as a separate Division to market and sell microwave radios, cell extender for cellular systems, high power amplifiers and other satellite earth station equipment, troposcatter equipment and turnkey telecom systems. Aydin plans to be a major factor in digital wireless telephony and cable video systems telephony products and network access equipment. The Company expects long-distance carriers as well as cable TV companies to enter into competition with the Baby Bells in local telephony business. Similarly, local telephone companies will enter into long-distance telephony. All of these will be the result of deregulation which is at the proposal stage at this time. Digital wireless systems are competitive in providing telephony networks for developing countries such as Russia, China, and others who wish to expand their telephone networks. At this stage, it is not practical to hang or bury wires to bring a connection to every house, especially in low population density areas. Aydin expects that there will be a large market in telecom equipment business of the type Aydin Telecom and Aydin (West) will sell in the USA and world-wide. Another significant part of our growth plan is to stress System Integration (SI). Aydin believes that the Company is well-positioned to expand its Systems Integration business base. This belief is based on the fact that Aydin has already demonstrated its ability to successfully bid and win major SI contracts against U.S. and international competition. Further, Dr. Donald Taylor was hired effective January 3, 1995, as President of Aydin Corporation and President of the Aydin (East) Division being formed by combining three Aydin Divisions. Before joining Aydin, Dr. Taylor was a vice president of Computer Sciences Corporation and was the key executive responsible for over $2 billion in major SI wins. As a recognized industry expert in bidding, winning and performing on SI contracts, Dr. Taylor will provide valuable guidance to the Company's plans to expand its SI contract base. Finally, the Company recognizes that it must expand its SI business base beyond the government military sector. Thus, the Company will leverage its engineering and software expertise in key technology areas to acquire SI contracts in the non-military and commercial\/industrial marketplace. New product development efforts will continue in 1995, especially in the Telecom field. Work is continuing on the Command, Control, and Communication program (Turkish Mobile Radar Complexes), with most of the remaining work being done at Aydin's Turkish subsidiary. This program, valued at approximately $210 million, was awarded to Aydin by the Turkish Government in late 1990. As a result of expected completion of certain phases of this project, Aydin expects a significant reduction of its unbilled revenue and significant positive cash flow starting in the middle of 1995. Capital equipment expenditures in 1994 were approximately $4.4 million, and will probably not change significantly in 1995.\n\/s\/ Ayhan Hakimoglu\nAyhan Hakimoglu Chairman of the Board\nFebruary 24, 1995\n[PHOTO]\n(page 1)\nTHE COMPANY\nCAPABILITIES Aydin's major business areas are described below: Telecommunications - Aydin offers microwave digital and analog transmission equipment and systems for commercial and military applications which include wireless and hybrid fiber coax telephony communications equipment, cellular range extender, line-of-sight (LOS) microwave radios, satellite earth stations, TDMA terminals and high power transmitters, portable communications terminals, troposcatter networks and wired network access products. Aydin also installs turnkey telecom systems. Airborne and Ground Data Acquisition and Avionics - Aydin provides airborne equipment and systems to gather critical information and to process, format and transmit to the ground through communication data links from a communications satellite, spacecraft, aircraft and\/or missile. Aydin's terminals receive this data on the ground and analyze it further for display to track and control. Computer Equipment and Software - Aydin sells a line of commercial, high-resolution CRT monitors ranging in size from 10 inches to 29 inches. Workstations are also offered, mostly for the process control industry. Aydin also offers ruggedized and TEMPEST-qualified versions of the same for military applications. Software is written by Aydin for commercial and military purposes for specific applications such as radar simulation, modernization and integration; command, control and communications; and air traffic control systems. Air and Other Traffic Control - Aydin offers radar approach control systems including appropriate radars. Aydin also manufactures VHF and UHF radios for ground-to-air communication. Radars, Radar Simulation, Integration and Modernization - Aydin has developed a modern 3-dimensional tactical air defense radar and has completed and\/or is working on several projects in radar simulation, radar integration and automation of manual radars. Modernization of previously designed radars is also done by Aydin. Command, Control and Communications - Aydin provides turnkey command, control and communications (C3) systems with or without radars for defense systems, both fixed and mobile. Systems Integration - Some of the capabilities described above consist of system integration. Aydin plans to expand its present system integration business and additionally pursue industrial\/commercial systems.\nORGANIZATION AND MANUFACTURING PLANTS Three major divisions, two smaller support divisions and three operational subsidiaries, form Aydin's organization. The divisions and subsidiaries are profit centers, maintaining individual engineering, manufacturing, marketing and accounting functions. The manufacturing plants, concentrated outside of Philadelphia, Pennsylvania, and in San Jose, California, have approximately 575,000 square feet of space. The Company's foreign subsidiaries, with total plant space of an additional 110,000 square feet, are situated in Ankara, Turkey; Buenos Aires, Argentina; and Hertfordshire, England. An office has been opened in Belgium in support of the NATO RIS Programs.\n-------------------\nOFFICERS Ayhan Hakimoglu * Chairman of the Board, Chief Executive Officer Dr. Donald S. Taylor * President & President, Aydin Corp. (East) John Vanderslice * Exec. Vice President & President, Aydin Vector Demirhan Hakimoglu * Vice President & Chief Executive Officer, Aydin Yazilim ve Elektronik A.S. Mats J. Ofverberg, Ph.D. * Vice President & President, Aydin Corp. (West) Thomas LoCasale * Vice President & President, Aydin Telecom Gary Boswell General Manager, Computer & Monitor Unit of Aydin Corp. (East) John Wong General Manager, Controls Unit of Aydin Corp. (East) Alexis Mozarovski Vice President & President, Aydin S.A. Jay L. Landis Treasurer & Assistant Secretary Herbert Welber * Controller & Assistant Treasurer Robert A. Clancy Secretary Zeynep B. Hakimoglu Assistant Secretary Serdar Akkor General Manager, Aydin Yazilim ve Elektronik A.S. Robert Bancroft President, Aydin Electro Fab Robert Kamin President, Raytor Unit of Aydin Corp. (East) George Isaacs Chief Executive Officer, Aydin Controls (U.K.) Ltd. Gerald Slehofer President, Aydin Molded Devices\nBOARD OF DIRECTORS Ayhan Hakimoglu Chairman of the Board Dr. Donald S. Taylor President Dr. Nev A. Gokcen ** Thermodynamicist Department of the Interior Bureau of Mines, Albany, Oregon Admiral Harry D. Train, II, USN (Ret.) ** General Manager, Strategic Research and Management Services Division of Science Applications International Corporation, Norfolk, Virginia I. Gary Bard ** Consultant and Private Investor John F. Vanderslice Exec. Vice President & President, Aydin Vector\n* Executive Officer ** Member of the Audit Committee\n(page 2)\nThe complementary nature of Aydin's divisions and product lines enables the divisions to work together to develop and market complete systems. Aydin engineers and computer software specialists have the capability to design any communications, information processing, air defense or air traffic control network utilizing Aydin's various product lines. The Company offers a broad range of products due to its ability to combine analog microwave engineering methods with digital techniques and software.\nSALES AND MARKETING Corporate marketing, located in suburban Washington, DC, supports the direct sales forces of the divisions. Major cities and key military bases are covered by Aydin sales personnel or manufacturers' representatives. For exports, Aydin's sales efforts are conducted by its international subsidiaries, its international sales network and representatives in many countries. Proprietary products and systems are available from Aydin, although an inventory of finished goods is not generally maintained. About one-half of the sales is attributable to standard products and systems, including modifications thereof, and the other half is for custom-designed and engineered equipment based on customers' specific requirements. Customers include domestic and foreign electronic and aerospace firms, regulated and unregulated telephone organizations, computer and aircraft manufacturers, large defense contractors, industrial and financial concerns, process control companies, research laboratories, foreign governments, and the military branches and other agencies of the U.S. Government. Industrial business was approximately 18% of the total revenues in 1994, while 29 % was comprised of sales in which Aydin was a prime or subcontractor to the military branches and other agencies of the U.S. Government. The remaining 53% of revenues was from overseas sales including equipment sold to other U.S. companies for export.\nSUBSIDIARIES Aydin has three operating international subsidiaries, all 100%-owned. Aydin Controls (U.K.) Ltd., located in Hertfordshire, England, provides sales and service for color terminals, display processors, high resolution color monitors and telecommunications products. In Argentina, Aydin S.A. sells and installs wireless and other telecommunications products and systems. The Company's subsidiary in Turkey, Aydin Yazilim ve Elektronik A.S., is located in Ankara. Aydin Yazilim ve Elektronik is manufacturing the last portion of the Turkish Mobile Command, Control and Communications (C3) system in Turkey. Aydin Yazilim also writes software for NATO and Turkish Programs in conjunction with Aydin. Aydin Yazilim enhances Aydin's export business. All of the above mentioned subsidiaries have extensive technological capabilities. See Note I to the financial statements for more information concerning export sales.\nRESEARCH AND NEW PRODUCT DEVELOPMENT Product development expenditures in 1994 were 7.0% of Aydin's revenues. About 48% of new product development is done through customer contracts.\n[PHOTO] Line-of-Sight Radios and Troposcatter Terminals, Transportable\n(page 3)\nTELECOMMUNICATIONS\nAydin offers microwave digital and analog transmission equipment and systems for commercial and military applications, which include wireless and hybrid fiber coax telephony communications equipment, cellular range extender, line-of-sight (LOS) microwave radios, satellite earth stations, TDMA terminals and high power transmitters, portable communications terminals, troposcatter communications and wired Network Access products. Aydin also installs turnkey telecom systems.\nWireless and Hybrid Fiber Coax Telephony Aydin is developing its DigiCall(TM) product line which combines our microwave and digital capabilities to provide voice, data and video conferencing services over wireless or hybrid fiber coax networks. The Aydin DigiCall(TM) Model 6032 is a radio frequency-based digital loop carrier system that uses enhanced TDMA\/FDMA to provide a cost effective wireless link between the telecom service provider and service subscribers. Voice quality is far superior to standard cellular telephone. The Aydin DigiCall(TM) Model 7024 provides telephony and PCS services via wired or wireless access to a hybrid fiber coax cable system owned by the Cable TV companies. Aydin's DigiCall(TM) systems interface with all standard telephone infrastructure equipment and are transparent to the cable TV, central office telephone plant and subscriber telephone equipment. The Aydin AyCell, currently under development, provides an inexpensive method of expanding cellular telephone coverage to areas where calls cannot currently be completed. Functioning as a user-transparent remote antenna link, the AyCell will enable an existing cell to communicate with areas that were previously \"blacked out\" due to geographical or man-made obstructions. Applications include coverage inside convention centers, shopping malls and sports arenas. Aydin is continuing work on installation of a cellular telephony network for a local cellular telephone company in Argentina by its subsidiary.\nLine-of-Sight Radios Many types of medium and light route digital and analog microwave radios for commercial and military use are manufactured by Aydin. These radios include a light route AMLD analog and AMLDD digital low density commercial radios, and the new AMCD series of medium route fixed frequency high density digital radios. The AN\/GRC-222 tactical digital radio, used by the U.S. Army in Desert Storm is manufactured by Aydin. For commercial and military users requiring field tunable digital radios, the AMD series is available for tactical, strategic and emergency uses. These radios are available for use with North American or CEPT European data rates from 1.5 to 45 Mbps, and cover tunable bands from 3.2 to 15 GHz. For medium route U.S. domestic and international commercial markets, the AMCD series of fixed frequency, high density digital radios are offered. Both 64 quadrature amplitude modulation (QAM) and 128 Trellis Coded Modulation (TCM) techniques are used to satisfy the bandwidth requirements of modern digital systems. E3 (34 Mbps), DS3 (45 Mbps), and SONET (51 Mbps) data rates and frequency options with 6, 7, and 11 GHz versions are available in a 19-inch EIA rack configuration. The low cost AMLD series of low density analog and digital radios are intended for the light route commercial market. Sales of analog microwave systems continue to be strong, particularly in the Third World, as analog systems are still the most cost effective solution for light route systems. The digital variations are available with optional multiplexers in North American or CEPT rates up to 8 Mbps. Aydin's radio products can be combined with the Aydin multiplex products providing significant Aydin content in turnkey systems.\nSatellite Communications Aydin manufactures the major products used in satellite earth stations, such as high power amplifiers (transmitters), medium power and low noise GaAs amplifiers, up\/down converters, digital data buffers, and modems featuring forward error correction.\n[PHOTO]\nMulti-User Subscriber for DigiCall(TM) for Wireless or Cable TV Telephony Networks\n[PHOTO]\nField Tunable Military AN\/GRC-222 Tactical Digital Radio for U.S. Army\n(page 4)\nAydin and COMSAT Laboratories are cooperating to market and manufacture the Second Generation Satellite TDMA Terminals. These terminals, which significantly reduce the size and cost over first generation terminals, are easily reconfigurable to meet a user's changing traffic needs. Current Aydin satellite communication high speed modems operate up to 120 Mbps; a 420 Mbps modem is in development. Aydin modems are installed in major government and commercial networks in North America and Europe. These products are used for both primary links and as a back-up to cable service. Customers include AT&T, KDD (Japan), British Telecom, France Telecom, Telesat Canada, and Embratel (Brazil).\nHigh Power Transmitters and Magnetics Aydin continues to provide commercial high power transmitters (HPAs) for satellite earth stations. Aydin's line of compact, intelligent, microprocessor controlled TWT and Klystron microwave amplifiers offers a distinct advantage over the competition. Aydin's latest HPA product is an outdoor-mounted 400 Watt Tri-Band (C, X, Ku-Band) TWTA suitable for mobile military SATCOM applications. In addition to the HPA business, Aydin has maintained a steady presence in magnetics products, supplying high power transformers to the electronics industry. Aydin's high efficiency television transmitter upgrade transformers are expected to show continuing demand.\nPortable Communication Terminals Aydin is producing the AYCOM portable line-of-sight communication terminal with two voice and data PABX, capable of providing service for up to 96 subscribers. The AYCOM terminal contains an Aydin Hot-Standby protected microwave radio configured for terminal operation, and an AT&T Definity G3Vs digital automatic PABX with software selectable line and station capabilities. The AYCOM terminal is the perfect solution for short-haul (40-50 Km), low density remote subscriber link requirements.\nTroposcatter Communications As one of the few manufacturers of troposcatter equipment, Aydin has analog and digital versions of this equipment for both transportable and fixed station use. Aydin's digital troposcatter modem is the most modern dual or quad diversity adaptively equalized modem. Troposcatter terminals are used in air defense systems, command and control systems, on offshore platforms and for military tactical communications. Aydin's digital troposcatter terminals have been in production for years and are being delivered to international customers. Some customers are classified, but others include the U.S. Armed Forces, Argentina, Australia, Chile, Egypt, Finland, Malaysia, the Philippines, Saudi Arabia and South Korea. Aydin provides ongoing support to these customers for maintenance and upgrades.\n[PHOTO]\nSatellite TDMA Terminal (Second Generation) Jointly Developed with COMSAT\n[PHOTO]\nFor Satellite Communications, Outdoor-Mounted, 400 Watt Tri-Band (C, X, Ku-Band) TWTA High Power Transmitters\n[PHOTO]\nFor Satellite Communications, 600 Watt Ku-Band TWTA High Power Transmitter\n(page 5)\nNetwork Access Equipment Aydin's network access unit (AYNACS 8000) provides cost effective access to public telephone networks for today's voice, data and video applications. It integrates all communications needs of the user of various bandwidths and transmits them through public networks at T1 standard for domestic market, and E1 standard for the rest of the world, to form an integrated and coherent product family. A major development effort is underway to expand this network access product line to include standalone Digital Access and Cross Connect Systems (DACS), E1\/T1 conversion and HDSL products.\nTranscoders & Multiplexers Aydin has a variety of T1 and E1 transcoders for voice and voiceband applications. Aydin's product line includes T1 and E1 ADPCM 2:1 (Models 9100 and 9102) and 4:1 (Model 6441) T1 transcoders and echo cancellers for the domestic and international marketplace. Customers include Regional Bell Operating Companies and other service providers. Model 9100 transcoder is equipped with unique features including bundle cross connect and drop\/insert capability, automatic routing and protection switching and restoration. Aydin transcoders are capable of handling Group III fax or 9600 bps modem traffic. The 9100 series transcoders are also offered in a single 19-inch rack mount multislot chassis for plugging in up to 11 modules. The Aydin VDM-1000 multiplexer accepts up to 30 standard telephone channels and combines them into E1 digital format. Both voice and data requirements can be combined using the same multiplexer dependent on the channel card mix. A ruggedized version is available for military applications.\nTurnkey Telecommunications Systems Aydin continues to respond to the demands for highly reliable, turnkey systems which may include line-of-sight radios, troposcatter links, satellite earth stations, multiplexers, switches, fiber optic cables, etc. Aydin has established a reputation in this sector of the industry with turnkey systems supplied to countries such as Argentina, Australia, Chile, Egypt, Ghana, Malaysia, Saudi Arabia, Thailand, Turkey, Zambia and Finland.\nThick and Thin Film Microcircuits Aydin's vertical integration strategy enables the design and manufacture of small and highly reliable RF and microwave microcircuits that operate over 100 MHz and through 40 GHz. These hybrid devices are used in extreme environments and meet special performance requirements and applicable Federal-MIL Standards. Applications include high performance telecommunications systems, satellite terminals and microwave simulation, as well as test equipment.\n[PHOTO]\nAydin Portable Communication Terminal (Includes Radio and Switch)\n[PHOTO]\nLight Route, Low Cost LOS Digital Microwave Radio\n[PHOTO]\nMedium Route 34 and 45 Mb\/s QAM or 51 Mb\/s 128 TCM LOS Digital Radios for E3, DS#, or SONET Capacities, respectively\n(page 6)\nDATA ACQUISITION & AVIONICS\nGround-Based Data Receive and Acquisition Systems Aydin provides extensive capabilities in the reception, processing, and analysis of data streams associated with spacecraft, aircraft and missile systems or ground vehicles. Aydin's satellite Telemetry, Tracking, and Control (TT&C) product line continues to expand in response to the proliferation of international commercial communication satellites. Key components of INTELSAT's global system, and many regional systems include Aydin Subsystems which collect and distribute satellite data. Major remote sensing systems like NASA's Earth Observing System (EOS) program have principal components supplied by Aydin, such as the Space Data Receiver. Aydin is a leader in CCSDS communication technology, which serves as a common baseline for many remote sensing systems. Aydin also offers systems that support aircraft testing, using data-driven architectures with advanced database management techniques. The growing small or micro satellite industry uses Aydin's equipment and systems to provide a cost-effective link with these systems. The personal communication satellite systems and remote imaging and sensing fields are all expanding and are attractive markets for Aydin's products.\nAirborne Data Acquisition and Transmission Aydin systems and equipment gather critical information from spacecraft, aircraft, missiles and guided weapons. The data is then processed, formatted and transmitted to a fixed or mobile station on the ground by VHF, UHF or microwave links. Aydin designs and manufactures both the airborne and ground-based links for many types of applications. Aydin airborne data acquisition systems and subsystems are compact, rugged and ideally suited for use in hostile environments or where space is limited. The systems are microprocessor based, computer programmable, and utilize the latest microcircuit technology. Aydin airborne hardware is located on most military aircraft and missiles, and most space programs including the Space Shuttle. Applications include flight certification for commercial and military aircraft. The transmission equipment manufactured by Aydin includes solid state transmitters, receivers, and high power amplifiers. Transmission power of up to 2 kilowatts is available in either continuous or pulsed power operation. Aydin high power UHF transmission communication links are currently being used by NASA to relay satellite and Space Shuttle information from various sites around the world. Advanced airborne RF processors, modulators, power amplifiers and receivers are used in the latest technology missile guidance systems. For remotely piloted vehicles and precision guided weapons, Aydin manufactures command\/control data links, video communications links and telemetry systems.\nAvionics Aydin offers a series of MIL-STD-1553 and ARINC 429 avionic bus systems, tape recorders, and transponders. This equipment provides on board processing of data and communicates with other avionic systems. These avionic products include a small, ruggedized digital tape recorder designed to meet the demands of commercial, industrial and military users. The tape recorder is used in applications which require high capacity data storage. An Aydin companion playback unit with analytical software is used for data reduction and analysis.\n[PHOTO]\nWideband Satellite Telementry Transmitter\n[PHOTO]\nAirborne Data Acquisition Systems for Testing Commercial Aircraft for Indonesia\n(page 7)\nCOMPUTER EQUIPMENT & SOFTWARE\nColor CRT Monitors Aydin provides a complete line of commercial color monitor products ranging in size from 10\" to 28\". The products support applications from TV to 1600 x 1280 resolutions and may integrate with a wide variety of touch screen technologies. With this wide range of sizes and options, Aydin offers customers a single monitor supplier solution. To reinforce our commitment to customer satisfaction, Aydin has a \"Specials\" department to supply customized solutions. Aydin continues its research in CRT and flat panel display technologies. The company expects to introduce new products in 1995 utilizing 29\" CRT's, and 13\" color flat panel displays at resolutions up to 1280 x 1024. The products will include stand alone displays and terminals.\nColor Displays & Workstations Aydin also specializes in providing display processing solutions for the critical man-machine interface between operators and their processes. Applications include petro-chemical, oil, gas, pulp and paper, transportation, power generation, and power distribution utilities, as well as most other industries. Presently, Aydin is manufacturing and developing new products to upgrade these existing customers and to branch out into new application areas. Open system-based solutions are being offered which allow the user to maintain the investment in installed system software, upgrade hardware to current state-of-the-art, and expand capabilities beyond the boundaries of the initial installation. Aydin has developed and offers software packages, which emulate the installed base of Aydin 5215 display processors in process control industries especially by electric utilities. These emulators, which facilitate upgrades for existing customers, are available for a number of platforms including UNIX\/X-Windows, MS-DOS, MS Windows, and Windows NT. The Aydin Model 7402 Industrial Workstation not only provides a replacement for an Aydin display processor, but also functions as the equivalent of eight individual workstations, each with state-of-the-art computing power. UNIX, X-Windows and Ethernet ensure open architecture compliance, along with industry standard VME and SCSI busses. The workstation can connect to existing installed host computers using its own integrated gateway or by means of an external gateway. Both methods provide the user with an economical, yet powerful plug-and-play upgrade solution. Recently, Aydin has included a complete line of high performance X-Terminals to address network solutions in a client-server environment. These are available in a number of configurations, including color (24 bit), greyscale, and monochrome. A 13\" color LCD version is available, as well as other LCD and CRT versions.\nRuggedized Workstations Aydin's ruggedized Sun SPARCstation 10 color workstations have been supplied to the Australian Army for use in a shelter, mobile resource and communications management system. Also, Aydin is under contract to the Australian Army to supply ruggedized Sun SPARCstation 10 servers as line control units for this same project. All of these units have been tested to ground mobile shock and vibration requirements, EMI and TEMPEST, and for operation at temperatures down to -15 degrees C. Aydin also has a ruggedized portable \"briefcase\" style workstation utilizing color LCD displays and a variety of CPUs.\n[PHOTO]\nSpectrum Autosync(R) 28\" Large Screen MicroProcessor-Controlled High Performance Monitor\n[PHOTO]\nSpectrum Autosync(R) 20\" Microprocessor-Controlled VGA Monitor\n(page 8)\nRuggedized Monitors Aydin's ruggedized product line of color video monitors now includes a 19\" auto-scanning RGB monitor (Model 9010R\/20). This high resolution, ruggedized auto-scanning monitor is also offered with a newly developed Active Magnetic Cancellation System (AMCS). The AMCS enables the color monitor to maintain full performance under a high magnetic field used by a warship, including submarines, to eliminate its magnetic signature. Aydin completed the qualification testing and delivery of ruggedized 19\" color monitors (Model 8943R\/19) for use in severe ground mobile environments including operation at low temperature down to -35 degrees C encountered in the Swiss Alps. Air defense consoles and radar displays for airspace management, aircraft simulation training, shipboard combat information centers and air defense centers are manufactured for a variety of programs. Aydin's air defense console, the field-proven ADC-22, is operating effectively in many current Air Defense and Radar Sites in numerous countries. Rugged EMI\/TEMPEST flat panel tactical terminals, TEMPEST monitors, radar displays, and air defense consoles are also manufactured by Aydin.\nSoftware Software is written by Aydin for commercial and military purposes for specific applications such as radar simulation, modernization, integration, and for command, control and communication and traffic control. Aydin has combined several new software technologies into an integrated tool set. The Aydin software engineering includes development platform independent popular software operating environments like Ada, C, C++, FORTRAN and 4th Generation compilers and SQL's, various functional and application dependent library utilities, language linkers, popular relational data bases, symbolic debuggers and automatic software configuration\/documentation tools. Aydin is experienced in developing its software in accordance with MIL-STD-2167A to produce highly reliable, easily maintainable and very transportable applications code. Also, Aydin uses automated \"look and feel\" applications generators like Visual BasicTM to quickly generate Man Machine Interfaces that are essential in its systems products.\n[PHOTO]\nAydin Model 7402 Industrial Workstation\n[PHOTO]\nRuggedized SPARC 10 Workstation with Ruggedized 20\" Color Monitor and Keyboard\/Trackball Unit\n(page 9)\nAIR & OTHER TRAFFIC CONTROL\nRadar Approach Control (RAPCON) Aydin has developed an advanced Mobile Radar Approach Control Operations System which uses extensive multi-processor air traffic and air space management software, large flat panel (plasma) displays, local area networking, and highly automated voice and data communications. The system can be configured for both military fixed site and commercial air traffic control applications. Aydin also offers complete RAPCON systems with surveillance and precision approach radar.\nUHF and VHF Radios Aydin's UHF and VHF transmitters, receivers and power amplifiers are used in ground-to-air communications for air traffic operations, control and reporting centers, airport towers and ground control approach applications. These radios are configured for either collocated transceiver applications or split site, and can be controlled either locally or from a remote position. For UHF operation, Have Quick II anti-jam capability is provided.\nVessel & Other Traffic Control Aydin offers vessel and other traffic control systems similar to Rapcon described above with appropriate communication equipment.\n[PHOTO]\nGCA-1000 Series Radio for Commercial and Military Air Traffic Control Applications\n[PHOTO]\nInterior View of the Operations Center for Air Traffic Control\n(page 10)\nRADARS, RADAR SIMULATION, INTEGRATION & MODERNIZATION\nRadars Aydin has developed a modern three-dimensional (3-D) tactical air defense radar system, ASTAR-3. A C-band radar, it offers the latest technology, microprocessor-based processing, sophisticated ECCM, high system availability, low cost and advanced clutter rejection. A key feature of ASTAR-3 is its mobility, as it can be transported on a single truck. The ASTAR-3 development effort included the design of a sophisticated phased array antenna.\n[PHOTO]\nAydin has delivered eleven Multiple-Threat Emitter Simulator Systems (MUTES), a Radar Simulator System for the U.S. Air Force\nRadar Simulation and EW A contract for the production of eleven Multiple Threat Emitter Simulators (MUTES) was won by Aydin several years ago. The last system was delivered in 1994. MUTES, nomenclatured AN\/MST\/T1A, is a ground-based radar simulator, used for evaluation of airborne radar warning and electronic countermeasures systems and pilot training. Operating under computer control, MUTES controls the radiation characteristics of a bank of transmitters in order to simulate the electronic environment created by a wide range of surveillance, tracking and guidance systems.\nRadar Integration An air defense program for NATO is RIS (Radar Integration System), used for NATO's southern flank. Aydin's system is a LAN for radars. The system is implemented using Ada software which links multiple local and remote radars to a central processor for concurrent display.\nRadar Modernization The Automation of Manual Radars and integration into the NATO Air Defense Ground Environment (NADGE) system, ordered by the Turkish Ministry of Defense in late 1992, is in its final acceptance phases. Aydin is under contract to the Belgian Air Force to add a Radar Environmental Simulator and modern computer workstation to the Belgian Air Defense System. This system contains radar video data extractors, automated data processing including multiple radar target tracking, Link-1 interfacing to other sites and multiple operator display consoles. Aydin will offer this product worldwide.\n[PHOTO]\nRadar Integration System (RIS)\n(page 11)\nCOMMAND, CONTROL & COMMUNICATION (C3)\nTurnkey command, control and communications (C3) and complete air defense systems, both fixed and mobile, are provided by Aydin. In-house capability in sensor technology includes 2-D and 3-D ASTAR radars, long haul communications using microwave radios and\/or troposcatter, local communications using LANs and ground\/air\/ground radios, data links for external systems interfaces, computer systems, display systems and other security devices. Applications software is also provided for air surveillance, sea surveillance, anti-submarine warfare and air defense systems. These C3 and air defense systems are built by coupling hardware elements with standard software elements such as link processing, tracking, correlation, database, sensor and multisensor processing, flight plan processing, data recording-reduction-playback, simulation and training. System elements include Aydin's ADC-22 standard console, large screen plasma display consoles with soft-touch screen controls, color CRT Operator Workstations with Windows environment, Aydin's GRC-222 radio, LINK-11, JTIDS, Aydin UHF\/VHF radios with or without frequency hopping, and a variety of radar specific devices. Using technical expertise in a range of disciplines, such as weapons, communications, radio theory, antenna design and placement, threat analysis, sensor and display technology, coupled with Aydin's wide range of standard hardware and software system elements, Aydin can be very cost effective for C3 and air defense systems. Work continues on the Turkish Mobile Radar Complexes program, the C3 portion of a mobile air defense system, valued at approximately $210 million, awarded to Aydin by the Turkish Government in late 1990. Most of the remaining work is being done at Aydin's Turkish subsidiary.\n[PHOTO]\nInterior View of Aydin's Command Shelter for C3 Applications\n[PHOTO]\nMobile Command, Control, and Communication Shelter Assembly at Aydin Yazilim ve Electronik A.S. in Turkey\n(page 12)\nSYSTEM INTEGRATION\nAydin believes that the Company is well positioned to expand its Systems Integration (SI) business base. This belief is based on the fact that Aydin has already demonstrated its ability to successfully bid and win major SI contracts against U.S. and international competition. The most recent examples are the Turkish TMRC Command, Control, Communication, Belgium Radar, and the NATO RIS projects. The Company successfully executed three major initiatives that were specifically targeted to grow its SI contract base. First, the Sales and Marketing organization was tasked to identify target SI opportunities that fall within Aydin's existing business areas, e.g. telecommunications; command, control, and communications; and radar systems. This initiative resulted in the identification of over $750M of new SI opportunities that the Company is actively pursuing. These opportunities include the Air Traffic, Navigation, Integration, and Coordination System (ATNAVICS), Next Generation Target Control System (NGTCS), Digital Video Teleconferencing System (DVTS), and the Integrated Management Communication Program (IMCP), and the new Egyptian National Railroad Communications Project. Second, recently in 1995, the Company combined its Controls and Computer and Monitor Divisions, forming Aydin Corporation (East), to improve the efficiency and competitiveness of its computer equipment, software, air traffic control, radar integration and command, control and communications operations. Third, the Company sought to acquire a new Corporate President with a proven record of success in the SI arena. This initiative was accomplished when Dr. Donald S. Taylor was hired, effective January 3, 1995, as Corporate President and President of the recently formed Aydin Corporation (East) Division. Before joining Aydin, Dr. Taylor was a Vice President of Computer Sciences Corporation (CSC) and was the key executive responsible for over $2 billion in major SI wins. As a recognized industry expert in bidding, winning, and performing on SI contracts, Dr. Taylor will provide invaluable strategic guidance to the Company's plans to expand its SI contract base. In 1995, Aydin will continue to aggressively pursue SI opportunities world-wide, particularly in Turkey, NATO, Argentina, Egypt, and other countries where the Company has had success in the past. Additionally, Aydin will target selected SI opportunities with the U.S. Government, either as a prime or as a major subcontractor. Corporate focus and priority will be on $50M+ SI opportunities whose technical and cost drivers are directly related to the technology and products provided by the Company's three major product areas. Finally, the Company recognizes that it must expand its SI business base beyond the government military sector. Thus, the Company will leverage its engineering and software expertise in key technology areas to acquire SI contracts in the non-military and commercial\/industrial marketplace. Representative examples of opportunities that the Company is considering include computer-controlled manufacturing, turnkey process control systems, wireless and other communications systems, multimedia systems, and industrial simulation and training systems.\n[PHOTO]\nField Testing of Turkish Mobile Radar Complex (TMRC), actually a Command, Control, and Communications System\n(page 13)\nCONSOLIDATED STATEMENTS OF OPERATIONS\nAydin Corporation and Subsidiaries\nSee notes to consolidated financial statements.\n(page 14)\nCONSOLIDATED BALANCE SHEETS\nAydin Corporation and Subsidiaries\nSee notes to consolidated financial statements.\n(page 15)\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nAydin Corporation and Subsidiaries\nSee notes to consolidated financial statements.\n(page 16)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nAydin Corporation and Subsidiaries\nNote A Summary of Significant Accounting Policies Principles of Consolidation: The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany transactions and balances are eliminated in consolidation. During 1994, $75,000 was paid to minority shareholders in the Turkish subsidiary raising the ownership to 100% from 99% at December 31, 1993. Contract Accounting: Revenue on long-term type contracts in excess of $100,000 is recorded on the percentage-of-completion method. For such contracts, a portion of the total contract price is included in sales in the proportion that costs incurred to date bear to total estimated costs at completion. The impact of periodic revisions in costs and estimated profit is reflected in the accounting period in which the facts become known. For all other contracts, revenue is recognized upon completion of the contract or upon shipment of identifiable units. The entire amount of ultimate losses estimated to be incurred upon completion of contracts is charged to income when such losses become known. Contract progress billings are based upon contract provisions for customer advance payments, contract costs incurred, and completion of specified contract objectives. Contract billings for partial shipments where product title passes to the customer are not considered progress billings. Contracts may provide for customer retainage of a portion of amounts billed until contract completion. All contract retainage at December 31, 1994 matures in 1995. Claims from customers of approximately $1.0 million for work performed outside the scope of certain contracts for which the Company anticipates recovery are included in unbilled revenue at December 31, 1993 and 1994. Unbilled revenue at December 31, 1994 also includes approximately $2.7 million relating to contract options exercised by a customer conditional upon completion of certain acceptance tests. Under the contract with the Government of Turkey, the Company received total advance payments of $56 million in October 1990 which are being applied against future billings over a period of approximately six years. The contract provides for price escalation based on U.S. and Turkish inflation rates. Inventories: Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out (FIFO) and average cost method which approximates FIFO. Depreciation and Amortization: Depreciation is provided by the straight-line method ove the estimated useful lives of the depreciable assets. Amortization of leasehold improvements under operating leases is provided over the terms of the related leases or the asset lives, if shorter. Income Taxes: The Company accounts for income taxes on the liability method in accordance with Statement of Financial Accounting Standards (FAS) No. 109. Foreign Currency Translation: In accordance with FAS No. 52, balance sheet accounts of the Company s United Kingdom and Argentina subsidiaries are translated from the local currency into U.S. dollars at year-end rates while income and expenses are translated at the weighted average exchange rate for the year. The resulting translation gains or losses are shown as a separate component of stockholders equity. The translation effects of the Turkish subsidiary are reflected in the income statement as required by FAS No. 52 because of the high inflation in the Turkish economy. Pretax income for 1994 includes foreign currency translation gains relating to the Turkish subsidiary of $755,000. Earnings (Loss) Per Share: Earnings (loss) per share are based on the weighted average number of common shares outstanding plus shares issuable upon the assumed exercise of dilutive common stock options. The number of shares used in earnings (loss) per share calculations was 4,998,701 for 1994, 4,959,740 for 1993, and 5,043,063 for 1992. Statement of Cash Flows: The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Short-Term Investments: Short-term investments are carried at cost which approximates market. Short-term investments at December 31, 1994 consist of interest-bearing certificates of deposit and time deposits with initial terms of 3 to 6 months. Cash and short term investments include $18.2 million held as collateral against outstanding letters of credit.\nNote B - Inventories Inventories at December 31, 1994 and 1993 consist of:\nNote C - Property, Plant, and Equipment The Company s investment in property, plant, and equipment at December 31, 1994 and 1993 follows:\nNote D - Short- and Long-Term Financing Arrangements The Company has arrangements with certain banks whereby $46,300,000 has been used for letters of credit and short-term cash borrowings. These arrangements provide for interest on borrowings at the prime lending rate (8.5% at December 31, 1994) plus 2%. These arrangements also require informal compensating cash balances of $150,000 and provide for commission rates on letters of credit at 1% to 1 1\/8%. As of December 31, 1994 and 1993, there were $6,486,000 and $21,525,000 of bank borrowings under these arrangements, respectively. The banks are requesting payment of these short-term borrowings which the Company anticipates making during 1995 from internal cash flow. The Company is seeking new banking arrangements to cover future potential needs. At December 31, 1994, $39,843,000 of letters of credit were outstanding under these arrangements. Cash or short-term investment collateral of $13,081,000 is required to be maintained for letters of credit that have been issued. These have been issued to foreign entities, principally to guarantee either contract performance or the return of unearned advance payments in the unlikely event that performance is not in accordance with the contracts, or to foreign suppliers to guarantee payment to them of the amount due. Of the total amount outstanding, $30.3 million pertains to the Company s contract with the Government of Turkey. This letter of credit was issued pursuant to a Credit Agreement with certain banks. The term extends to October 4, 1996 or until the letter of credit is reduced to zero, whichever occurs first. Cash or short-term investment collateral is required to be maintained equal to 1\/3 of the balance outstanding in the letter of credit which amounts to $10.1 million. In addition to certain financial covenant requirements, the Credit Agreement contains restrictions concerning the payment of dividends and purchase of treasury stock which in the aggregate are limited to 50% of net income for the prior four fiscal quarters. Additional letters of credit of $5.1 million pertaining to the Turkish contract and other requirements have been issued by a Turkish bank for the Company s Turkish subsidiary. These letters of credit are not part of the Company s line of credit. Cash or short-term investment collateral is required to be maintained by the Turkish subsidiary equal to 100% of the balance outstanding on these letters of credit.\n(page 17)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAydin Corporation and Subsidiaries\nNote E - Long-Term Debt Long-term debt at December 31, 1994 and 1993 consists of the following:\nInterest expense on long- and short-term debt for the years 1994, 1993, and 1992 amounted to $1,142,000, $1,310,000, and $639,000, respectively. Interest paid for the years 1994, 1993, and 1992 amounted to $1,226,000, $1,402,000, and $409,000, respectively.\nLand and buildings having a net carrying value of $5,276,000 at December 31, 1994 have been pledged as collateral for the mortgages.\nAggregate maturities of long-term debt for each of the years 1995 through 1999 are as follows: 1995-$402,000; 1996-$407,000; 1997-$413,000; 1998-$201,000; and 1999-$207,000.\nNote F - Stockholders' Equity The changes in common stock, additional paid-in capital, treasury stock, retained earnings, and foreign currency translation effects durinq the years 1992, 1993, and 1994 were as follows:\n(page 18)\nNOTES TO CONSOLIDATED FINANCIAL STATMENTS (CONTINUED)\nAydin Corporation and Subsidiaries\nNote G - Stock Options Pursuant to stock option plans, the Company has granted certain officers, directors, and key employees options to purchase shares of its common stock. Options granted under the plans must have an option price determined by the Board of Directors, but in any event, not less than the fair market value of the date of grant except for the 1984 plan of 187,500 shares which permits the Board of Directors to set an option price up to 50% less than the fair market value of the stock on the date of grant. Generally, options become exercisable one-fourth annually beginning one year after grant, on a cumulative basis, and expire five years after grant.\nThere is no charge to income with respect to stock options under the plans. A summary of the changes in options during 1992, 1993, and 1994 follows:\nThese options expire on various dates beginning January 1995 and ending December 1999. The average exercise price of options outstanding at December 31, 1994 is $11.66.\nNote H - Taxes on Income The provision (recovery) for income taxes consists of the following:\nA reconciliation between the federal statutory rate and the effective income tax rate (computed by dividing income taxes by income before income taxes and minority interest) is as follows:\nIncome tax payments, net of refunds, amounted to $5,066,000 in 1992 and $2,138,000 in 1993. Income tax refunds, net of payments, amounted to $940,000 in 1994.\nThe Company has not provided deferred income taxes of approximately $600,000 on cumulative unremitted earnings of foreign subsidiaries, based on management's intention to permanently invest such earnings in the foreign jurisdictions.\nNote I - Export Sales, Major Customers, and Foreign Operations The Company operates predominantly in the electronics manufacturing industry. Export sales by geographic area are as follows:\nThe U.S. Government, the Government of Turkey and CTI (Argentina) were the only customers to whom sales exceeded 10% of consolidated sales during any of the past three years. Sales to U.S. Government agencies, principally the Department of Defense, amounted to $42,015,000, $38,600,000 and $39,347,000 in 1994, 1993 and 1992, respectively. Sales to the Government of Turkey amounted to $24,888,000, $45,134,000 and $48,738,000 in 1994, 1993 and 1992, respectively. Accounts receivable at December 31, 1994 includes $12.5 million from the Government of Turkey. Sales to CTI amounted to $15,739,000 in 1994. Foreign assets included in the consolidated balance sheet amounted to $33.7 million, $22.9 million and $23.4 million at December 31, 1994, 1993 and 1992, respectively. Of these amounts, $6.7 million, $10.0 million and $19.1 million, at December 31, 1994, 1993 and 1992, respectively, is cash and short-term investments of the Company's Turkish subsidiary consisting of U.S. dollar denominated interest-bearing time deposits. In addition, at December 31, 1994 cash and short-term investments at the Argentina subsidiary was $1.9 million. Foreign sales and pretax income for 1994 amounted to $37.2 million and $6.7 million, respectively, of which $21.1 million and $2.1 million, respectively, was for the Argentina subsidiary. Foreign sales and pretax income for 1993 amounted to $23.0 million and $3.9 million, respectively. Foreign sales and pretax income for 1992 amounted to $19.3 mililion and $3.3 million, respectively.\nNote J - Contingencies The Company along with others is responsible for the cost of cleanup at a site leased by the Company prior to 1984 under an order of the State of California. The cost to date for the cleanup of the California site over the past ten years has been approximately $5.8 million. Settlement has been reached with three of four insurance carriers for approximately $6.7 million which was received during 1993 and applied to the cleanup costs previously incurred and cost to go. A court has granted a declaratory judgment requiring the fourth carrier to pay all cleanup costs in excess of the $6.7 million already received. This judgment is being appealed by the fourth carrier. Management believes the ultimate resolution of this entire matter will not have a materially adverse effect on the financial position or results of operations.\n(page 20)\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nAydin Corporation and Subsidiaries\nThe IRS, as part of a field examination, has disallowed certain prior years research and development tax credits taken by the Company amounting to approximately $3.5 million plus related interest. The Company is challenging this finding with the appeals office of the IRS. Management is of the opinion that the ultimate resolution will not have a materially adverse effect on the financial position or results of operations.\nNote K - Settlement with the Department of Justice On January 5, 1994, the Company reached settlement agreements with the U.S. Army and the Department of Justice (\"DOJ\") with reference to the AN\/GRC-222 microwave radio contract. Under the terms of the agreement, the U.S. Army will reinstate the radio contract by withdrawing its previous termination for default issued November 30, 1993. Further, the investigation and all possible charges against the Company by the DOJ are settled.\nOn January 6, 1994, pursuant to the terms of settlement with DOJ, the Company entered a plea of guilty to the falsification of testing data, charges to which two of its low level employees previously pled guilty to in March 1993, and the plea was accepted by the court (U.S. District Court for the Northern District of California). The Company is reinstated on its AN\/GRC-222 microwave radio contract with all of its previous terms and conditions. Further, the Company withdrew its contract claims, is doing additional work for the Army at no additional cost, and paid $2 million as an added consideration. The total impact on pretax income of this settlement was approximately $14,819,000, which has been charged to the 1993 fourth quarter earnings. The additional work and the related expenditures will be spread over a period of three years or longer.\nREPORT OF INDEPENDENT AUDITORS\nReport of Grant Thornton LLP Independent Auditors\nStockholders and Board of Directors Aydin Corporation\nWe have audited the consolidated balance sheet of Aydin Corporation and subsidiaries as of December 31, 1994, and the related consolidated statements of operations and cash flows for the year then ended. These consolidated 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. The consolidated financial statements of Aydin Corporation and subsidiaries as of and for the years ended December 31, 1993 and 1992, were audited by other auditors whose report dated February 25, 1994, expressed an unqualified opinion on those statements.\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 1994 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Aydin Corporation and subsidiaries as of December 31, 1994, and the results of its operations and its cash flows for the year then ended, in conformity with generally accepted accounting principles.\n\/s\/ Grant Thornthon LLP\nPhiladelphia, Pennsylvania February 20, 1995\n(page 21)\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nAydin Corporation and Subsidiaries\nLiquidity and Sources of Capital Cash provided from operations during 1994 was $22.8 million. In addition to the net income, the primary reason for the positive cash flow was a $11.6 million decrease in unbilled revenue mainly because of an excess of billings rendered on the TMRC-C3 contract with the Government of Turkey versus costs incurred and resulting revenue recorded for this contract.\nThe positive cash from operations was used to repay $15.0 million of short-term bank debt and purchase capital equipment of $4.4 million.\nOf the $27.9 million of cash and short-term investments at December 31, 1994, approximately $18.2 million is required to be maintained as collateral against letters of credit on the Turkish and other contracts.\nCash used by operations during 1993 was $7.0 million. The primary reasons for the cash outflow included: (1) a $7.5 million increase in unbilled revenue mainly because of costs incurred and resulting revenue recognized on the TMRC-C3 contract with the Government of Turkey in excess of billings rendered; and (2) a $7.9 million increase in accounts receivable primarily because of the commencement in 1993 of billings on the TMRC-C3 contract especially in the fourth quarter, offset partially by $4.0 million of cash received in settlement of insurance litigation related to environmental matters. Partially offsetting these cash outflows was a $3.3 million decline in inventories and $4.5 million of depreciation.\nAlso during 1993, $2.4 million was spent for capital additions and $2.8 million was spent to increase the ownership in the Turkish subsidiary from 71% at December 31, 1992 to 99% at December 31, 1993.\nThe Company at December 31, 1994 has short-term bank borrowings outstanding of $6.5 million. The banks are requesting payment of these short-term borrowings. The Company anticipates making full payment of these bank loans during 1995 from internal cash flow. The Company is seeking new banking arrangements to cover its future potential needs.\nBased on the present backlog and projected cash flows, the Company anticipates financing its capital needs from internal sources and from some short-term borrowings in the foreseeable future.\nResults of Operations 1994 versus 1993: Net sales for 1994 were basically flat compared to 1993. U.S. Government sales, although still depressed, increased to 29% of total sales from 27% last year. Export and foreign sales declined to 53% of total sales from 56% last year because of a slow down in sales on the TMRC-C3 contract, partially offset by higher sales at the Company s South American subsidiary. There is no assurance that the higher level of sales and earnings at the Argentina subsidiary will continue. Domestic industrial sales increased slightly to 18% of total sales from 17% last year.\nCost of sales, other than the settlement with the Department of Justice, as a percentage of sales was essentially the same as last year. Costs incurred during 1994 against the settlement amounted to $3,994,000 and have been charged against the settlement liability established at December 31, 1993. During 1994 the settlement liability was further reduced by $403,000, reflecting a decrease in the December 31, 1993 estimate of ultimate costs to be incurred.\nSelling, general and administrative expenses increased by $902,000 (4%) in 1994 primarily as a result of a higher level of proposal activity and resulting proposal costs.\nThe effective income tax rate was 27% for 1994 compared to a 34% benefit for 1993. The lower rate for 1994 is primarily the result of the impact on the rates of the 1993 pretax loss compared to pretax income in 1994.\n1993 versus 1992: Net sales of $141,475,000 for 1993 decreased by $3,746,000 from 1992, a decline of 3%. Industrial sales declined to 17% of total sales from 19% last year due to continued market weakness in the Company s market niches. U.S. Government sales declined slightly and were offset by a small increase in export and foreign sales which now represent 56% of total sales versus 54% last year.\nThe $14,819,000 1993 special settlement charge included in the cost of sales caption is the result of the Company s decision to assume responsibility and plead guilty to criminal charges of falsification of test data on a U.S. Government contract (GRC-222), actions to which two low level employees had previously pled guilty. Of this charge, $2.0 million were cash payments made after December 31, 1993. The balance represents additional work and to upgrade the GRC-222 microwave radios for the U.S. Army and Aydin s dropping of claims it had filed against the Army.\nOther cost of sales as a percentage of sales increased to 73.3% from 69.9% last year as a result of a more competitive U.S. Government business environment in 1993, a more favorable sales mix in 1992 and cost overruns on certain contracts in 1993.\nSelling, general and administrative expenses declined by $2,212,000 from 1992 because of cost reductions necessitated by the declines in sales and backlog.\nNet interest expense was $273,000 in 1993 compared to last year s net interest income of $1,177,000. The unfavorable swing reflects the higher level of this year s short-term borrowings and a decreased level of cash available for investment this year.\nThe effective income tax rate decreased to 34% for 1993 from 36% last year. The primary reason for the lower 1993 income tax rate is a function of a pretax loss in the U.S. in 1993 which means that the following elements of tax reduced the effective rate: foreign income tax provisions, non-deductible costs in connection with the Department of Justice settlement, and theimpact on deferred taxes of the increased U.S. statutory rate effective January 1, 1994. Partially offsetting these effects was the tax benefit from non-taxable Foreign Sales Corporation income and a higher state income tax recovery on the 1993 U.S. pretax loss than the 1992 state income tax provision. See Note H for the impact of each of these items.\n(page 22)\nSELECTED FINANCIAL DATA\nAydin Corporation and Subsidiaries\n($000 omitted except for per share amounts)\nQUARTERLY FINANCIAL DATA ($000 omitted except for per share amounts)\n(page 23)\nCOMMON STOCK PRICES\nAydin Corporation and Subsidiaries\nAydin Corporation is listed on the New York Stock Exchange, symbol AYD.\nSTOCKHOLDER AND DIVIDEND INFORMATION Aydin has approximately 6,000 stockholders of record and individual participants in security position listings. Aydin has no present plans to pay any special cash dividends.\nANNUAL MEETING The Company's Annual Meeting of Stockholders will be held on Friday, April 28, 1995, at 3:00 p.m., in the Corporate Office at 700 Dresher Road, Horsham, Pennsylvania. Stockholders are cordially invited to attend the Annual Meeting.\nFORM 10K A copy of Aydin Corporation's Annual Report on Form 10K may be obtained without charge by writing to Aydin Corporation, 700 Dresher Road, P.O. Box 349, Horsham, PA 19044, Attn: Investor Relations.\nHISTORY OF OPERATIONS*\n(page 24)\nExhibit 21\nSUBSIDIARIES OF REGISTRANT","section_15":""}
{"filename":"319687_1994.txt","cik":"319687","year":"1994","section_1":"ITEM 1. BUSINESS.\nContinental Airlines, Inc. (the \"Company\", the \"Reorganized Company\" or \"Continental\") is a United States air carrier engaged in the business of transporting passengers, cargo and mail. Continental is the fifth largest United States airline as measured by 1994 revenue passenger miles and, together with its wholly owned subsidiary, Continental Express, Inc. (\"Express\"), and its 91.0%-owned subsidiary, Continental Micronesia, Inc. (\"CMI\"), serves more than 160 airports worldwide. Internationally, Continental flies to 54 destinations and offers additional connecting service through alliances with foreign carriers. Continental is one of the leading airlines providing service to Mexico and Central America, serving more destinations there than any other United States airline. Through CMI, the Company provides extensive service in the western Pacific. The Company's wholly owned subsidiary, System One Information Management, Inc. (\"System One\"), operates a travel agency computerized reservation system, principally in the United States. See Item 1. \"Business. System One\".\nAs used in this Form 10-K, the terms \"Continental\" and \"Company\" refer to Continental Airlines, Inc. (or, as required by the context, its predecessor) and, unless the context indicates otherwise, its subsidiaries.\nChapter 11 Reorganization\nThe Company reorganized under Chapter 11 of the federal bankruptcy code effective April 27, 1993 (the \"Reorganization\"), after having filed for protection on December 3, 1990. Continental's filing for reorganization was necessitated primarily by declines in revenue resulting from a recessionary environment, extreme price competition and significantly increased fuel prices resulting from the Persian Gulf War.\nPursuant to the Reorganization, Continental Airlines Holdings, Inc. (together with its subsidiaries, \"Holdings\" or the \"Predecessor Company\"), which had been the Company's parent, merged into the Company. The previously outstanding publicly held equity interests in Holdings were cancelled and new stock in the Company was issued. Also pursuant to the Reorganization, a majority of the Company's equity was issued to Air Partners, L.P. (\"AP\") and Air Canada (\"AC\"), in exchange for their investments in the Company. Additional shares of common stock were issued to the Company's retirement plan, and a fixed number of shares of common stock was issued to or for the benefit of prepetition creditors. See Item 3. \"Legal Proceedings. Plan of Reorganization\".\nDuring the Chapter 11 case, Continental (i) restructured substantial amounts of secured aircraft debt and aircraft lease obligations, significantly reducing its annual payments of principal, interest and rent, (ii) retired 42 older jet aircraft and (iii) accelerated the scheduled retirement during 1993, 1994 and 1995 of 52 additional older, Stage II (noise level) aircraft. Also, the Company resolved (largely on a non-cash basis) significant claims and contingencies affecting the Company. Such claims and contingencies included the Company's liability to the Pension Benefit Guaranty Corporation (the \"PBGC\") related to pension plans previously maintained by Eastern Air Lines, Inc. (\"Eastern\") (the \"PBGC Settlement\") and the Company's potential liability to Eastern (or its creditors) as a result of certain transactions entered into with Eastern prior to 1989. Certain parties have appealed the disposition of their claims in the Reorganization. See Item 3. \"Legal Proceedings\". Pursuant to the Reorganization, a substantial amount of unsecured prepetition liabilities was converted to equity, and additional secured and priority debt was restructured to extend payment dates and\/or reduce the interest charge.\nPursuant to the Reorganization, System One, which had been a subsidiary of Holdings, was restructured as a wholly owned subsidiary of Continental, two separate commuter airline subsidiaries were restructured as Express and Continental's western Pacific operations were restructured by establishing CMI.\nDomestic Operations\nContinental operates its domestic route system primarily through three hubs in Newark, Houston and Cleveland. Continental's hub system allows the Company to transport passengers between a large number of destinations with substantially more frequent service than if each route were served directly. The hub system also allows Continental to add service to a new destination from a large number of cities using only one or a limited number of aircraft.\nNewark. As of March 31, 1995, Continental operated 55.8% (181 departures) of the total daily jet departures and, together with Express, accounted for 57.0% (277 departures) of all daily (jet and turboprop) departures from Newark. Considering the three major airports serving New York City (Newark, LaGuardia and John F. Kennedy), Continental and Express accounted for approximately 22.6% of all daily departures, while the next largest carrier, USAir, Inc. (\"USAir\"), and its commuter affiliate accounted for approximately 17.4% of all daily departures as of March 31, 1995.\nHouston. As of March 31, 1995, Continental operated 77.9% (255 departures) of the daily jet departures and, together with Express, accounted for 79.2% (352 departures) of all daily departures from Houston's Intercontinental Airport. Southwest Airlines Co. (\"Southwest\") also has a significant share of the Houston market, primarily through Hobby Airport. Considering both Intercontinental and Hobby Airports, as of March 31, 1995, Continental operated 58.2% and Southwest operated 21.6% of the daily jet departures from Houston.\nCleveland. As of March 31, 1995, Continental operated 54.8% (105 departures) of all daily jet departures and, together with Express, accounted for 60.3% (169 departures) of all daily departures from Cleveland's Hopkins Airport (\"Hopkins\"). The next largest carrier, USAir, and its commuter affiliate accounted for 9.3% of all daily departures from Hopkins as of March 31, 1995.\nDenver. During 1994, the Company significantly reduced operations in Denver, resulting in the conversion of Denver from a hub to a spoke city. In August 1993, prior to management's decision to reduce operations in Denver, Continental operated 165 daily jet departures and 110 daily turboprop departures from Denver. As of March 31, 1995, Continental operated only 19 daily jet departures and had terminated all turboprop operations at Denver. Turboprop service is provided to a number of smaller regional cities by an unaffiliated third party, G.P. Express Airlines, Inc. (\"GP Express\"), under a code-share agreement. As a result of this reduction of operations in Denver, aircraft were redeployed to other hubs and to non-hub flying. See Item 3. \"Legal Proceedings. Denver International Airport\" and Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nGreensboro. As of March 31, 1995, Continental operated 56.3% (57 departures) of all daily jet departures and, together with Express and GP Express, accounted for 60.8% (90 departures) of all daily departures from Greensboro's Piedmont Triad International Airport (\"Piedmont\"). Turboprop service is provided to a number of smaller regional cities by GP Express under a code-share agreement. The next largest carrier, USAir, and its commuter affiliate accounted for 21.8% (34 departures) of all daily departures from Piedmont as of March 31, 1995.\nContinental Lite. In 1994, Continental rapidly expanded \"Continental Lite\" (a network of short-haul, no-frills, low-fare flights initially referred to as Peanuts Flights) from 173 daily flights and 19 aircraft serving 14 cities in November 1993 to 1,000 daily flights and 114 aircraft serving 43 cities in September 1994. The rapid growth of Continental Lite was supplied by redeploying a substantial portion of Continental's capacity, including aircraft made available by elimination of the Denver hub and by deliveries of new aircraft under the Company's agreement with The Boeing Company (\"Boeing\"). Continental Lite experienced operational problems in connection with this rapid growth and was not profitable in 1994. At its peak, approximately 35% of Continental Lite flying consisted of point-to- point, linear service not integrated with the Company's hubs (\"linear flying\"). Linear flying proved to be significantly unprofitable and was responsible for an estimated 70% of all Continental Lite system losses in 1994. In 1995, the Company is substantially reducing its Continental Lite operation. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nAmerica West Airlines, Inc. (\"America West\"). As a limited partner in AmWest Partners, L.P. (\"AmWest\"), Continental participated in the acquisition by AmWest of a portion of the equity of reorganized America West in connection with America West's emergence from bankruptcy, effective August 25, 1994. In the transaction, Continental paid $18.8 million for approximately 4.1% of the equity interest and 17.1% of the voting power of the reorganized America West. Continental also entered into a series of agreements with America West, including agreements related to code-sharing and ground handling, which have created substantial benefits for both airlines.\nEach investor participating in the acquisition did so on individual terms; Continental and certain other parties invested at the same per share price, but at a higher price (approximately $9.36 per share as compared to approximately $7.01 per share) than the price paid by Air Partners, II, L.P., TPG Partners, L.P. and TPG Parallel I, L.P. (collectively, the \"TPG entities\"), partnerships controlled by Mr. David Bonderman, Chairman of the Board of Continental. However, as between Continental and the TPG entities, Continental is entitled to receive a 10.0% per year return on its investment before the TPG entities receive any return and to recoup its invested capital before the TPG entities recoup their capital.\nInternational Operations and Foreign Carrier Alliances\nInternational Operations. Continental has extensive operations in the western Pacific conducted by CMI, and has expanded its presence in Mexico and Central and South America. As measured by available seat miles, as of March 31, 1995, approximately 25.5% of Continental's operations (including CMI) were dedicated to international traffic. As of March 31, 1995, Continental operated seven departures a day to five cities in Europe, with connecting service to additional cities through alliances with foreign carriers.\nForeign Carrier Alliances. Over the last decade, major United States airlines have developed and expanded alliances with foreign air carriers, generally involving adjacent terminal operations, coordinated flights and joint marketing. Continental currently has alliances with AC, Scandinavian Airlines System (\"SAS\"), Transavia Airlines (\"Transavia\") and Alitalia Airlines (\"Alitalia\") which management believes are important to Continental's ability to compete as an international airline. In April 1994, Continental entered into a strategic alliance with Alitalia pursuant to a memorandum of understanding, which provided for a code-share agreement and a framework for jointly developing new and competitive services between the United States and Italy. In addition, Continental and Alitalia entered into a wet lease agreement in May 1994 providing for the sharing of revenues and expenses associated with such new services. Implementation of the new alliance began on July 1, 1994, with the commencement of new service between Newark and Rome. The code-share agreement was given final approval by both the United States and Italian governments in October 1994. New service between Newark\/Milan and Mexico City\/Houston\/Rome is planned to begin in mid 1995.\nContinental Micronesia, Inc.\nContinental has historically had a strong presence in the western Pacific, based in part on operations conducted since 1976 under the name \"Continental\/Air Micronesia\". CMI's operations include a hub operation based on the neighboring islands of Guam and Saipan. The Guam\/Saipan hub provides scheduled service to seven Japanese cities (more Japanese destinations than any other United States carrier), Hong Kong, South Korea, Taiwan, Indonesia, the Philippines and ten islands in the western Pacific. Effective April 15, 1995, CMI is adding service to Sydney, Australia. In 1995, CMI also plans to add service to Cebu, Philippines, subject to certain regulatory matters.\nPursuant to the Reorganization, Continental restructured its western Pacific operations by establishing CMI. Continental provides CMI with pilots, aircraft and other essential services at a price intended to approximate Continental's cost of providing the service. CMI is separately certificated as an airline by the United States Department of Transportation (the \"DOT\"), and holds an operating license issued by the United States Federal Aviation Administration (the \"FAA\") and foreign route authority issued by the DOT.\nThe 9.0% minority interest in CMI is owned by United Micronesia Development Association, Inc. (\"UMDA\"), a private company. Under agreements entered into in connection with the Reorganization, UMDA would have the right to increase its ownership in CMI to just over 20% in the event any participating employer in the Company's pension plans failed to make, or Continental failed to adequately provide for, certain pension plan payments. CMI also pays UMDA a fee of approximately one percent of CMI's gross revenues, as defined, which will continue until January 1, 2012. Prior to the establishment of CMI, Continental had conducted the western Pacific operations itself under the name Continental\/Air Micronesia and had paid UMDA the one percent fee.\nCMI's operations in the western Pacific have consistently provided greater operating profit margins than Continental's overall operations. Any significant and sustained decrease in traffic to and from Guam and Saipan could materially adversely affect the Company. Because the majority of CMI's traffic originates in Japan, its results of operations are substantially affected by the Japanese economy and are impacted by changes in the value of the yen as compared to the dollar. During 1993 and 1994, the yen generally appreciated against the dollar, resulting in an increase in CMI's profitability, revenues and, to a lesser extent, expenses.\nContinental Express\nContinental's jet service at each of its domestic hub cities and at Greensboro is coordinated with Express, which operates under the name \"Continental Express\". Express operates advanced new-generation turboprop aircraft that average approximately five years of age and seat from 30 to 60 passengers. As of March 31, 1995, Express served 23 destinations from Houston, 17 from Newark, 16 from Cleveland and 2 from Greensboro. In general, Express flights are less than 200 miles in length and less than 90 minutes in duration. Management believes the turboprop operations complement Continental's jet operations by allowing more frequent service to small cities than could be provided economically with jets and by carrying traffic that connects onto Continental's jets. In many cases, Express (and Continental) compete for such connecting traffic with commuter airlines owned by or affiliated with other major airlines operating out of the same or other cities.\nIn May 1994, Express terminated substantially all of its unprofitable Denver operations, which were taken over by GP Express, an unaffiliated commuter airline operator. Express has implemented cost-reduction programs, including substantial workforce reductions. In 1994, Continental announced it was considering a possible private placement by Express of less than 20% of the common stock of Express as well as a possible future distribution by Continental to its stockholders of all or part of the stock of Express held by Continental. Continental has currently postponed pursuing these transactions.\nBusiness Strategy\nContinental has developed a new strategic program, the Go Forward Plan, designed to strengthen the Company's domestic hub operations, increase revenues and cash flows, improve profitability by shrinking excess capacity, and enhance customer service. Since the Reorganization, Continental has not been profitable. In late 1993 and throughout 1994, the Company significantly reduced its presence in Denver, which had historically been unprofitable for the Company, and redeployed aircraft and other resources to the eastern United States in connection with the expansion of Continental Lite. Demand for Continental Lite, particularly in linear markets, proved insufficient to absorb the Company's excess capacity, and Continental Lite was not profitable in 1994. Overcapacity worsened in the latter half of 1994 as Continental's fleet expanded due to deliveries of new jet aircraft.\nDuring the fourth quarter of 1994, the Company determined that a new strategic plan was needed to return the Company to profitability and strengthen its balance sheet. The Go Forward Plan has four key strategic components: Fly to Win, Fund the Future, Make Reliability a Reality and Working Together.\nFly to Win. Continental intends to maximize efficiencies and revenues by:\n- - - - Strengthening its domestic hub operations by adjusting frequencies and improving schedules.\n- - - - Pricing fares commensurate with market demand and elasticity.\n- - - - Reducing Continental Lite flying by approximately one-third, primarily in linear markets which, at Continental Lite's peak capacity in 1994, represented approximately 35% of the Continental Lite system but accounted for an estimated 70% of Continental Lite's 1994 losses.\n- - - - Downgauging aircraft and reducing overall capacity by removing from service 24 less-efficient widebody aircraft and accelerating the retirement of 23 older Stage II narrowbody aircraft during 1995.\n- - - - Modernizing its domestic fleet by placing in service 27 new, more efficient aircraft in 1995.\n- - - - Improving customer service by returning Continental's frequent flyer program (\"OnePass\") to its 1993 terms.\n- - - - Reducing staff (at all levels) by approximately 4,000 positions to match the reduction in capacity and to eliminate non-value added activities.\nFund the Future. The Company is taking steps to improve liquidity and, in the long term, de-leverage the balance sheet by:\n- - - - Adjusting Continental's fleet plan by deferring certain aircraft deliveries, canceling options on aircraft deliveries and removing 24 widebody aircraft and 30 narrowbody aircraft (23 of which are being retired on an accelerated schedule) from service in 1995.\n- - - - Negotiating amendments to certain debt and lease agreements to reduce cash requirements in 1995 and 1996.\n- - - - Evaluating the potential disposition of certain non-strategic assets.\nSee Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations. Liquidity and Capital Commitments\".\nMake Reliability a Reality. Continental has placed renewed emphasis on reliability and has named two executives to improve its on-time performance, baggage handling and customer satisfaction. Employees will have the opportunity to earn extra pay each month that the Company meets certain on-time performance targets as measured by the DOT. In order to enhance consumer perception of Continental's reliability, consistency and quality, the Company is completing the refurbishment of its terminal spaces and fleet interiors and exteriors during the first half of 1995. In addition, the Company is installing new passenger in-flight telecommunications and computer facilities on all jet aircraft and expects that installation will be substantially completed by the end of 1995.\nWorking Together. Senior management has instituted a new open-door policy with its employees designed to improve the working environment and encourage all employees to work together as a team to improve operational performance and customer service. In support of the new policy, senior management has hosted hundreds of employees for informal get-togethers and discussion sessions in the executive offices, and more of these sessions are scheduled. In addition, the Company has hired new senior executives with successful records at profitable companies in the areas of pricing, scheduling, distribution, human resources, airport services, law and finance.\nContinental's alliance with America West is producing further efficiencies for the two carriers. Task forces have been established to coordinate and optimize benefits in the areas of code-sharing, frequent flyer programs, maintenance procurement, station operations and information systems.\nEmployees\nLabor costs are a significant variable that can substantially impact airline results. For the year 1994, labor costs constituted approximately 27.0% of total operating expenses. While there can be no assurance that Continental's generally good labor relations and high labor productivity experienced in the past five years will continue, Continental's management has established as a significant component of the Go Forward Plan the preservation of good employee relations.\nAs of December 31, 1994, Continental had approximately 37,800 full-time equivalent employees (including approximately 4,800 pilots, 6,400 flight attendants, 4,900 mechanics, 100 dispatchers, 17,300 customer service agents, reservations agents, ramp and other airport personnel and 4,300 management and clerical employees), approximately 29.8% of whom were represented by unions.\nThe Company and the Independent Association of Continental Pilots (\"IACP\") are negotiating an initial collective bargaining agreement for the pilots. Negotiations have progressed to mediated collective bargaining with the National Mediation Board (\"NMB\") - a normal and usual part of the airline labor negotiation process. The Company is hopeful that a mutually acceptable agreement can be reached without adverse employee work actions; however, the ultimate outcome of the Company's negotiations with the IACP is unknown at this time.\nIn 1992, Continental and its flight attendants entered into a collective bargaining agreement with the International Association of Machinists and Aerospace Workers (\"IAM\") that has been ratified by the Continental flight attendants and becomes amendable in 1996. In 1993, the NMB ruled that the Express flight attendants are also represented by the IAM. Negotiations between Continental and the IAM have commenced, but the parties have not yet reached an agreement. The Company is hopeful that the parties can reach an agreement without adverse employee work actions; however, the ultimate outcome is unknown at this time. CMI's flight attendants are also represented by the IAM, but are covered under a separate four-year contract that was signed in September 1992 and becomes amendable in September 1996.\nContinental's dispatchers are represented by the Transport Workers Union which also represents the dispatchers of Express. CMI's dispatchers are not represented by a union.\nCMI's mechanics and mechanic-related employees are represented by the International Brotherhood of Teamsters (\"IBT\") under a collective bargaining agreement signed in April 1994 which becomes amendable in March 1997. The IBT also represents CMI's agent classification employees located on Guam whose collective bargaining agreement was also signed in April 1994 and becomes amendable in March 1997.\nThe other employees of Continental, Express and CMI are not represented by unions and are not covered by collective bargaining agreements.\nThe Company has taken several cost containment actions affecting employees. In 1992, Continental and its subsidiaries implemented across-the-board salary and wage reductions for all employees, ranging from 5.0% of pay at the lowest level of compensation to approximately 22.5% of base pay for Continental's senior management. The reductions, which lowered payroll expense by approximately 10.0%, were restored in equal increments in December 1992, April 1993, April 1994 and July 1994. In January 1995, Continental determined not to make any longevity pay increases and to eliminate approximately 4,000 positions, including executive and management positions, during 1995.\nFuel\nFuel costs constituted approximately 13.1% of total operating costs in 1994. Consequently, changes in fuel costs can significantly affect Continental's operating results. Fuel prices continue to be susceptible to political events. In the event of any fuel supply shortage, higher fuel prices or curtailment of scheduled service could result. Continental cannot predict near or long-term fuel prices. Continental enters into petroleum purchase option contracts to hedge a portion of its future purchases against significant increases in the market price of jet fuel. In December 1994, approximately three months of jet fuel purchases were hedged by these contracts. In August 1993, the United States increased taxes on domestic fuel, including aviation fuel, by 4.3 cents per gallon. Airlines are exempt from this tax increase until October 1, 1995. When implemented (based on approximately one billion gallons of fuel consumed domestically in 1994), the fuel tax will increase Continental's annual costs by approximately $43.9 million. However, it is possible that the fuel tax exemption will be extended beyond the October 1, 1995 deadline.\nCompetition and Marketing\nThe airline industry is highly competitive and susceptible to price discounting. Continental must compete with carriers having substantially greater resources, as well as smaller carriers with lower cost structures. Overall industry profit margins have historically been low and in recent years, have been substantially negative. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations\".\nAs is the case with other carriers, most tickets for travel on Continental are sold by travel agents. Travel agents generally receive commissions measured by the price of tickets sold. Accordingly, airlines compete not only with respect to the price of tickets sold but also with respect to the amount of commissions paid. Airlines often pay additional commissions in connection with special revenue programs. On February 10, 1995, Delta Airlines, Inc. (\"Delta\") became the first major airline to place a $50 cap on travel agency commissions for round-trip tickets priced over $500. Other airlines, including Continental, imposed similar commission caps. However, due to Continental's low fare structure, this change in its commissions policy is not expected to significantly impact operating results. See Item 3. \"Legal Proceedings. Antitrust Proceedings\".\nFrequent Flyer Program\nEach major airline has established a frequent flyer program designed to encourage travel on that carrier. Continental sponsors OnePass, which allows passengers to earn mileage credits by flying Continental and certain other carriers, including AC, Transavia, Alitalia, America West and SAS (collectively, the \"OnePass Partners\"), and by using the services of hotels, car rental firms and credit card companies participating in the OnePass program.\nContinental accrues the incremental cost associated with the earned flight awards based on expected redemptions. The incremental cost to transport a passenger on a free trip includes the cost of incremental fuel, meals, insurance and miscellaneous supplies and does not include any charge for potential displacement of revenue passengers or costs for aircraft ownership, maintenance, labor or overhead allocation.\nContinental estimates that as of December 31, 1994 and 1993, the total available awards under the OnePass program(based on accumulated mileage) were 1.6 million and 2.5 million roundtrips, respectively, after eliminating those accounts below the minimum level. Continental estimates that as of December 31, 1994 and 1993, 1.1 million and 1.5 million, respectively, of such awards could be expected to be redeemed, and, accordingly, Continental has recorded a liability with respect to such awards. The liability for expected redeemed flight awards decreased from $63.6 million in 1993 to $42 million in 1994 primarily due to a change in the Company's estimate of awards expected to be redeemed. The difference between the awards expected to be redeemed and the total awards available is an estimate, based on historical data, of breakage for those customers who do not redeem all or part of their mileage for travel awards or use their awards with another OnePass Partner.\nThe number of awards used on Continental was approximately 590,000 and 580,000 roundtrips for the years 1994 and 1993, respectively. Such awards represented approximately 4.6% and 4.7% of Continental's total revenue passenger miles for each year, respectively. Due to the structure of the program and the low level of redemptions as a percentage of total travel, Continental believes that displacement of revenue passengers by passengers using flight awards has historically been minimal.\nIndustry Regulation and Airport Access\nContinental, CMI and Express operate under certificates of public convenience and necessity issued by the DOT. Such certificates may be altered, amended, modified or suspended by the DOT after notice and hearing if public convenience and necessity so require, or may be revoked for intentional failure to comply with the terms and conditions of a certificate. The airlines are also regulated by the FAA, primarily in the areas of flight operations, maintenance, ground facilities and other technical matters. Pursuant to these regulations, Continental has established, and the FAA has approved, a maintenance program for each type of aircraft operated by the Company that provides for the ongoing maintenance of such aircraft, ranging from frequent routine inspections to major overhauls. Recently adopted regulations require phase-out of certain aircraft and aging aircraft modifications. Such types of regulations can significantly increase costs and affect a carrier's ability to compete.\nThe DOT allows local airport authorities to implement procedures designed to abate special noise problems, provided such procedures do not unreasonably interfere with interstate or foreign commerce or the national transportation system. Certain airports, including the major airports at Boston, Washington, D.C., Chicago, Los Angeles, San Diego and San Francisco, have established airport restrictions to limit noise, including restrictions on aircraft types to be used and limits on the number of hourly or daily operations or the time of such operations. In some instances these restrictions have caused curtailments in services or increases in operating costs and such restrictions could limit the ability of Continental to expand its operations at the affected airports. Local authorities at other airports are considering adopting similar noise regulations.\nIn the last several years, the FAA has issued a number of maintenance directives and other regulations relating to, among other things, retirement of older aircraft, collision avoidance systems, airborne windshear avoidance systems, noise abatement and increased inspections and maintenance procedures to be conducted on older aircraft.\nOn March 24, 1995, the FAA issued new regulations relating to commuter safety. The new regulations are not expected to have a significant impact on the operations of Express.\nSeveral airports have recently sought to increase substantially the rates charged to airlines, and the ability of airlines to contest such increases has been restricted by a recent decision of the United States Supreme Court. In addition, legislation which became effective June 1, 1992 allows public airports to impose passenger facility charges of up to $3 per departing or connecting passenger at such airports. With certain exceptions, these charges are passed on to the customers.\nThe FAA has designated John F. Kennedy, LaGuardia, O'Hare and Washington National airports as \"high density traffic airports\" and has limited the number of departure and arrival slots at those airports. Currently, slots at the high density traffic airports may be voluntarily sold or transferred between the carriers. The DOT has in the past reallocated slots to other carriers and reserves the right to withdraw slots. Various amendments to the slot system, proposed from time to time by the FAA, members of Congress and others, could, if adopted, significantly affect operations at the high density traffic airports or expand slot controls to other airports. Certain of such proposals could restrict the number of flights, limit the ownership transferability of slots, increase the risk of slot withdrawal, or otherwise decrease the value of Continental's slots. Continental cannot predict whether any of these proposals will be adopted.\nThe award of international routes to United States carriers is regulated by agreements between the United States and foreign governments. The United States has in the past generally followed the practice of encouraging foreign governments to accept multiple carrier designation on foreign routes, although certain countries have sought to limit the number of carriers. Foreign route authorities may become less valuable to the extent that the United States and other countries adopt \"open skies\" policies liberalizing entry on international routes. Continental cannot predict what laws and regulations will be adopted or their impact, but the impact may be significant. Certain regulatory changes, if proposed and adopted, could materially adversely affect Continental, could cause defaults under the Company's secured note agreements with General Electric Capital Corporation and affiliates (collectively \"GE Capital\") and could require charges to the Company's financial statements.\nMany aspects of Continental's operations are subject to increasingly stringent federal, state and local laws protecting the environment. Future regulatory developments could affect operations and increase operating costs in the airline industry, including for Continental.\nAdditional laws and regulations have been proposed or are contemplated that could significantly increase the cost of airline operations by, for example, increasing fuel taxes, imposing additional requirements or restrictions on operations or impairing access to capital markets. Continental cannot predict what laws and regulations will be adopted or their impact, but the impact could be significant.\nSystem One\nSystem One develops, markets and distributes travel-related information management products and services (\"IMS\") to the worldwide travel-related services industry and owns, markets and distributes a computerized reservation system (\"CRS\") to travel agencies, travel suppliers, corporations and other customers. System One has approximately a 15% share of the travel agency business in the United States and has a substantial market share in Latin America and in the Mid-Pacific\/ Micronesia markets. The travel information supplied by the System One CRS to its subscribers includes flight availability, fares, hotel accommodations, car rentals, currency exchange rates and tourist information. System One's IMS business includes management and accounting systems for large travel agencies as well as data consolidation and management products. Approximately 12.3% of System One's 1994 revenues were realized in connection with Continental bookings.\nIn 1991, System One signed a 10-year systems management agreement with Electronic Data Systems (\"EDS\"). The agreement provides for EDS to manage the data processing and telecommunications facilities and services used by System One.\nIn February and March 1995, System One borrowed additional funds from EDS on the same terms as the existing loan agreement with EDS. The proceeds from these borrowings were used to repay a portion of the outstanding amount due Continental from System One under an intercompany revolving credit agreement.\nContinental and System One are currently negotiating a series of transactions whereby the existing systems management agreement between System One and EDS would be terminated and a substantial portion of the assets (including the travel agent subscriber base and IMS software) and certain liabilities of System One would be transferred to a newly formed limited liability company (\"New S1\") that would be owned equally by System One (which will remain a wholly owned subsidiary of Continental), EDS and AMADEUS, a European CRS. Substantially all of System One's remaining assets (including the CRS software) and liabilities would be transferred to AMADEUS. In addition to retaining a one-third interest in New S1, the outstanding indebtedness of System One owed to each of EDS and Continental would be repaid, and System One would receive cash and an equity interest in AMADEUS. New S1 would market the AMADEUS CRS and would continue to develop, market and distribute travel-related IMS. These transactions are anticipated to close in the second quarter of 1995.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nFlight Equipment\nAt December 31, 1994, Continental (including CMI) operated a fleet of 330 jet aircraft, as follows:\n*Stage II (noise level) aircraft.\nAll of the aircraft and engines owned by Continental are subject to mortgages.\nPursuant to the Company's Go Forward Plan, Continental will remove from service 21 A300 aircraft, three 747 aircraft and 30 727 aircraft (23 of which are being retired on an accelerated schedule) during 1995. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations. Results of Operations. Nonrecurring Charges\".\nThe FAA has adopted rules pursuant to the Airport Noise and Capacity Act of 1990 that require a scheduled phase out of Stage II aircraft during the 1990's. As a result of Continental's acquisition of a number of new aircraft and the retirement of older Stage II aircraft in recent years, approximately 60.0% of Continental's current jet fleet was composed of Stage III aircraft at December 31, 1994. The Company plans to either retire or install hush kits on the remainder of its Stage II jet fleet prior to the year 2000 in order to comply with such rules.\nContinental has firm commitments to take delivery of 22 new 737 and five new 757 aircraft in 1995, one new 757 aircraft in 1996 and 43 new jet aircraft during the years 1998 through 2002. The estimated aggregate cost of these aircraft is approximately $3.4 billion.\nAs of December 31, 1994, Express operated a fleet of 76 aircraft, as follows:\nIn late 1994, the Company returned to the lessor five Beech aircraft, sold 10 Beech aircraft and grounded its fleet of five Dash 7 aircraft.\nIn December 1994, Express contracted with Beech Acceptance Corporation (\"Beech\") for the purchase of 25 Beech 1900-D aircraft at an estimated aggregate cost of $104 million, excluding price escalations. Deliveries of these aircraft are scheduled in 1995 and 1996.\nSee Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations. Liquidity and Capital Commitments\" for information regarding capital commitments and financing relating to aircraft.\nFacilities\nContinental's principal facilities are located in Newark, Houston, Cleveland, Guam, Los Angeles, Denver and Honolulu. All such facilities, as well as substantially all of Continental's other facilities, are leased on a long-term, net rental basis, with the lessee responsible for maintenance, taxes, insurance and other facility-related expenses and services. In certain locations, Continental owns hangars and other facilities on land leased on a long-term basis, which facilities will become the property of the lessor on termination of the lease. At each of its hub cities and most other locations, Continental's passenger and baggage handling space is leased directly from the airport authority on varying terms dependent on prevailing practice at each airport.\nDenver's Stapleton Airport closed on February 28, 1995 in connection with the opening of the new Denver International Airport (\"DIA\"). In 1992, the Company agreed to lease (i) 20 gates at DIA for a period of five years from the date DIA opened, (ii) four of such gates for an additional five years and (iii) a substantial amount of operational space in connection with the gates. On April 10, 1995, the Company reached an agreement with the City and County of Denver (the \"City\") and certain other parties to amend its lease of facilities at DIA which, among other things, reduces to 10 the number of gates (and reduces associated operational space) to be leased by Continental. See Item 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nPlan of Reorganization\nThe Company's Plan of Reorganization, which became effective on April 27, 1993, provides for the full payment of all allowed administrative and priority claims. Pursuant to the Plan of Reorganization, holders of allowed general unsecured claims are entitled to participate in a distribution of 1,900,000 shares of Class A common stock, 5,042,368 shares of Class B common stock and $6,523,952 of cash and have no further claim against the Company. The Plan of Reorganization provided for this distribution to be issued initially in trust to a distribution agent and thereafter for distributions to be made from the trust from time to time as disputed claims are resolved. The distribution agent must reserve from each partial distribution of stock or cash to allow a complete pro rata distribution to be made to each holder of a disputed claim in the event such claim is eventually allowed, unless the United States Bankruptcy Court for the District of Delaware (the \"Bankruptcy Court\") establishes a lower reserve or estimates the claim at a lesser amount for purposes of distribution. As of March 31, 1995, there remained 307,939 shares of Class A common stock, 1,115,915 shares of Class B common stock, and approximately $1 million of cash available for distribution. The stock and cash set aside for distribution to prepetition unsecured creditors was fixed in the Plan of Reorganization and will not change as claims are allowed. However, as set forth below, a limited number of proceedings are still pending in which prepetition creditors seek to impose additional obligations on the Company.\nBankruptcy Appeals\nSeveral parties appealed the Bankruptcy Court's April 16, 1993 order confirming the Plan of Reorganization.\nA group of bondholders appealed to have the United States District Court for the District of Delaware (the \"District Court\") declare invalid the Plan of Reorganization provisions relating to the allocation for payment of unsecured creditors and the provisions releasing certain current and former officers and directors of the Company and its former parent from the claims of creditors. If the bondholders successfully imposed liability upon such officers and directors, the Company could be required to indemnify such individuals. The Company opposed the appeal on the merits and sought dismissal of certain of the claims as moot due to the substantial consummation of the Plan of Reorganization. On March 16, 1995, the District Court dismissed the appeal in part on grounds of mootness and denied it in part on the merits. The Company does not believe that the foregoing matter will have a material adverse effect on the Company.\nOn December 3, 1990, Continental owned 77 aircraft and 81 spare engines (in four collateral pools) securing debt evidenced by equipment trust certificates. The trustees for the four collateral pools moved in the Bankruptcy Court for \"adequate protection\" payments under Sections 361 and 363 of the federal bankruptcy code for the Company's retention and use of the aircraft and engines after December 3, 1990, including postpetition claims for the alleged decline in market value of the aircraft and engines after December 3, 1990 and claims for deterioration in the condition of the aircraft and engines in the same period. The Bankruptcy Court rejected the adequate protection claims that alleged market value decline, and prior to April 16, 1993, the Company settled all of the adequate protection claims of the trustees from three of the four collateral pools. The Company also settled all adequate protection claims of the trustees for the fourth collateral pool, except for their claim of approximately $117 million for alleged market value decline of their pool of 29 aircraft and 81 additional engines. On April 16, 1993, the Bankruptcy Court rejected the market value decline claims of the trustees for the fourth collateral pool in their entirety and incorporated those findings into its order confirming the Plan of Reorganization. The trustees for the fourth collateral pool appealed from these orders, but failed to obtain a stay pending appeal. The Company opposed these appeals on the merits and sought dismissal of the appeals on the grounds they were made moot by the substantial consummation of the Plan of Reorganization. The District Court dismissed the appeals as moot, and the trustees appealed to the Third Circuit Court of Appeals seeking review of the District Court's mootness determination and the Bankruptcy Court's finding on the merits. Such appeal is still pending. The Company does not believe that the foregoing matter will have a material adverse effect on the Company.\nOn July 19, 1994, the Bankruptcy Court approved a comprehensive settlement resolving certain claims filed by the Air Line Pilots Association (\"ALPA\") and former pilots of Eastern. A group of separately represented Eastern pilots (the \"LPP Claimants\") filed an appeal from an order disallowing the integration of the Eastern pilots seniority list with Continental pilots seniority list. Continental filed a motion to dismiss as moot the appeals brought by the LPP Claimants, on the grounds that only ALPA had standing with regard to this proceeding and ALPA had previously withdrawn a similar appeal. The motion remains pending. Other Eastern-related claimants, including a group of 130 Eastern pilots who seek jobs and damages from Continental based on alleged prepetition promises of employment with Continental, have filed notices of appeal from the confirmation order. The Company is opposing these appeals on the merits and, in any event, if such parties are successful on their claims, their recovery would be limited to the fixed pools of Company common stock and cash provided for in the Plan of Reorganization.\nAntitrust Proceedings\nIn March 1994, the United States District Court for the Northern District of Georgia approved the July 1992 settlement agreement between Continental and class plaintiffs in the consolidated Domestic Air Transportation Antitrust Litigation, in which Continental and other airlines were alleged to have violated the federal antitrust laws by actions related to pricing. Under the settlement approved by the court, Continental provided approximately $11 million in transportation certificates to class members, in full settlement and release of all claims. Pursuant to this agreement and similar settlements involving other defendant airlines, transportation certificates totaling $438 million were provided by Continental and other airlines, which will be valid on any of the settling defendants and will not be subject to interline reimbursement.\nOn December 21, 1992, the United States Department of Justice (the \"DOJ\") commenced a civil action in the United States District Court for the District of Columbia against Continental, seven other domestic airlines and the Airline Tariff Publishing Company, alleging violations of Section 1 of the Sherman Act by price fixing and maintenance of a \"coordination facilitation device\". The suit sought injunctive relief only. All of the airlines, including Continental, named in the suit have entered into a consent decree with the DOJ that is intended to restrict, to some extent, the airlines' pricing practices. This consent decree was approved by the court on August 10, 1994.\nContinental and other airlines were the subjects of a civil investigation conducted during 1990-1992 by the Attorney General of the State of Florida and, separately, of a multistate civil investigation that was begun in December 1992 by the Attorneys General of several other states, including Colorado, Connecticut, New York, Ohio, Pennsylvania, Utah and Washington. The investigations sought to determine if the airlines had violated federal or analogous state laws with respect to pricing or bidding concerning government air travel. On October 11, 1994, Continental, together with other airlines, entered into a Settlement Agreement with several states to settle the claims by the 50 states of price fixing. The Settlement Agreement requires the airlines to provide a 10% discount off published domestic fares for eligible government travel during a period no greater than 18 months. To implement the Settlement Agreement, on November 10, 1994, the State Attorneys General filed a class action complaint against Continental and the other airlines in the United States District Court for the District of Columbia, along with a motion for preliminary approval of the Settlement Agreement. On December 8, 1994, the District Court issued a preliminary order approving the Settlement Agreement. Final approval of the Settlement Agreement is still pending. The Company does not believe that the foregoing matter will have a material adverse effect on the Company.\nOn February 9, 1995, Delta imposed dollar limits on the base commissions it would pay to travel agents on domestic airline tickets. Shortly thereafter, other airlines, including Continental, imposed similar dollar limits on their respective commissions. In February and March of 1995, Continental and six other major United States airlines were sued in a number of putative class actions, including In re Airline Travel Agents Antitrust Litigation in the United States District Court for the District of Minnesota, in which various travel agents allege that Continental and the other defendants combined and conspired in unreasonable restraint of trade and commerce in violation of applicable antitrust laws. The plaintiffs also allege that the defendant airlines unlawfully fixed, lowered, maintained and stabilized the commissions paid to United States travel agents. Plaintiffs seek injunctive relief, treble damages, attorneys fees and related costs. Continental is in the process of reviewing the specific allegations in light of the pertinent facts and commencing the preparation of its defense. The Company does not believe that the foregoing matter will have a material adverse effect on the Company.\nDenver International Airport\nIn 1992, the Company agreed to lease (i) 20 gates at DIA for a period of five years from the date DIA opened, (ii) four of such gates for an additional five years and (iii) a substantial amount of operational space in connection with the gates and for the terms set forth in the agreement. During 1994, the Company significantly reduced its Denver operations. The City filed a complaint on February 22, 1995 against the Company in the United States District Court for the District of Colorado seeking a determination that the Company materially breached and repudiated the lease and a March 1994 agreement to pay certain costs associated with the delays in opening DIA. In addition, the City sought a judgment declaring the City's rights and the Company's obligations and the award of an injunction that the Company perform such obligations. The City also sought attorneys fees and costs relating to its suit. The Company believes it has defenses against the City, as well as claims against the City that justify rescission of the lease or, if rescission is not awarded by the court, a substantial reduction in the Company's obligations thereunder.\nThe Company, the City and certain other parties have entered into an agreement (\"Settlement\") that was approved by the Denver City Council on April 10, 1995. The Settlement provides for the release of certain claims and the settlement of certain litigation filed by the City against the Company and reduces (i) the full term of the lease to five years, subject to certain rights of renewal granted to Continental, (ii) the number of gates leased from 20 to 10, (iii) the amount of leased operational and other space by approximately 70%. The reduced gates and operational space exceed Continental's current needs at the airport, and the Company is negotiating with America West and Frontier to sublease up to five of its remaining gates and certain operational space. The Company will attempt to sublease additional facilities and operational space as well. To the extent Continental is able to sublease any of its gates and operational space, its costs under the lease would be reduced.\nThe Settlement may still be challenged by certain parties, including by other air carriers, and the Company cannot predict what the outcome of any such challenge would be. Certain air carriers have taken the position that an insufficient number of carriers have executed the Settlement. Failure to implement the Settlement could reduce or eliminate the Company's estimated savings at DIA.\nEnvironmental Proceedings\nThe Company (including its predecessors) has been identified by the United States Environmental Protection Agency (\"EPA\") as a potentially responsible party at three Superfund sites. At each site, the Company's potential responsibility is premised on allegations that the Company generated waste disposed of at such site. The Company believes that, although applicable case law is evolving and some cases may be interpreted to the contrary, any claim of liability associated with these sites was discharged by confirmation of the Company's Plan of Reorganization, principally because the Company's exposure at each site is based on alleged prepetition offsite disposal known as of the date of confirmation. Even if the claims were not discharged, on the basis of currently available information, the Company believes that its potential liability for a share of the cost to remedy each site (to the extent the Company is found to have liability) is not material; however, the Company has not been designated a \"de minimis\" contributor at any of such sites by the EPA. The Company does not believe that the foregoing matters will have a material adverse effect on the Company. The Company may become involved in other environmental proceedings, including the investigation and remediation of environmental contamination at properties or waste disposal sites used or previously used by the Company.\nGeneral\nVarious other claims and lawsuits against the Company are pending, which are of the type reasonably foreseeable in view of the nature of the Company's business. The Company cannot at this time reasonably estimate the possible loss or range of loss that could be experienced if any of the claims were successful. Typically, such claims and lawsuits are covered by insurance. The Company does not believes that the foregoing matters will 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.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nContinental's Class A and Class B common stock began trading on the New York Stock Exchange on a when-issued basis on July 14, 1993 and commenced trading on a regular-way basis on September 2, 1993, following the initial distribution of stock to the Company's prepetition creditors. On December 14, 1993, the Company sold 8,086,579 shares of Class B common stock in an underwritten public offering. Prior to that time, there had been limited trading volume in the Company's common stock.\nThe following table gives the high and low sales prices for the stocks as reported on the New York Stock Exchange for each quarterly period subsequent to July 1993.\nThe stock of Holdings that was cancelled in the Reorganization was publicly traded prior to April 28, 1993. Information regarding the price range of such pre-reorganization trading is not comparable with data provided for the Class A common stock or the Class B common stock and is not included in this Form 10-K.\nAs of March 31, 1995, there were approximately 5,100 and 5,900 holders of record of Continental's Class A and Class B common stock, respectively.\nThe Company has not paid dividends on its common stock. The Company anticipates that no dividends on its common stock will be declared in the foreseeable future, and that earnings, if any, will be retained for the development of the Company's business. The Company's loan agreements with GE Capital prohibit the Company from paying dividends to common stockholders until February 28, 1997, restrict the subsequent payment of dividends to common stockholders to a percentage of eligible net income (as defined) and require CMI to maintain certain minimum cash balances and net worth levels, which effectively restrict the amount of cash available to Continental from CMI.\nThe Company's certificate of incorporation provides that no shares of capital stock may be voted by or at the direction of persons who are not United States citizens unless such shares are registered on a separate stock record. The Company's bylaws further provide that no shares will be registered on such separate stock record if the amount so registered would exceed United States foreign ownership restrictions. United States law currently requires that no more than 25% of the voting stock of the Company (or any other domestic airline) may be owned directly or indirectly by persons who are not citizens of the United States. Because AC owns approximately 23.9% of the voting power of the Company's common stock and shares of common stock owned by AC have priority over shares held by other foreign holders, the number of shares that may be voted by other foreign holders is very limited.\nITEM 7.","section_6":"","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nContinental is the successor to Continental Airlines Holdings, Inc. and Continental Airlines, Inc. On December 3, 1990, Continental and Holdings and all their wholly owned domestic subsidiaries filed voluntary petitions to reorganize under Chapter 11 of the federal bankruptcy code. The companies' consolidated Plan of Reorganization was confirmed on April 16, 1993 and became effective on April 27, 1993. On such date, Holdings merged with and into Continental. System One, which had been a subsidiary of Holdings, was reorganized as a subsidiary of Continental. Because consolidated Continental (as reorganized) includes System One and other businesses that had been consolidated with Holdings for periods through April 27, 1993 (but not with pre-reorganization Continental), the discussion herein generally refers to Holdings' consolidated financial statements for periods through April 27, 1993.\nOn April 27, 1993, the Company adopted fresh start reporting in accordance with SOP 90-7, which resulted in adjustment of the Company's common stockholders' equity and the carrying values of assets and liabilities. The fresh start reporting adjustments, primarily related to the adjustment of the Company's assets and liabilities to fair market values, have also affected the Company's statements of operations. The more significant adjustments related to increased amortization expense relating to routes, gates and slots and reorganization value in excess of amounts allocable to identifiable assets; reduced aircraft rent expense; and increased interest expense.\nAdverse Industry Conditions and Competition\nThe Company has experienced significant losses in the last five fiscal years. The Company's viability is dependent upon its ability to achieve and sustain profitable results of operations and thereby obtain access to external capital sources. During the fourth quarter of 1994, the Company recorded a nonrecurring charge of approximately $446.8 million. See \"Results of Operations. Nonrecurring Charges\".\nThe airline industry is highly competitive and susceptible to price discounting, and Continental must compete with carriers having substantially greater resources, as well as smaller carriers with lower cost structures. Overall industry profit margins have historically been low and in recent years, have been substantially negative. Profit levels are highly sensitive to changes in fuel costs, changes in average yield (fare levels) and changes in passenger demand. Passenger demand and yield have been affected by, among other things, the general state of the economy and fare actions taken by Continental or its competitors.\nIn addition, a number of new carriers have entered the industry, typically with low cost structures. In some cases, the new entrants have initiated or triggered further price discounting. Aircraft, skilled labor and gates at most airports continue to be available to start-up carriers, and additional entrepreneurs have indicated that they intend to enter the airline business. Although management believes Continental may be better able than several of its major competitors to compete with the fares offered by start-up carriers because of Continental's lower cost structure, the entry of new carriers on many of Continental's routes (as well as increased competition from established carriers) could negatively impact Continental's results of operations.\nAirline Costs\nManagement believes that the Company's costs will be affected in 1995 by (i) the full-year impact of the 1994 wage restorations, (ii) higher aircraft rental expense as new aircraft are delivered, (iii) changes in the costs of materials and services (in particular, the cost of fuel, which can fluctuate significantly in response to global market conditions), (iv) changes in governmental regulations and taxes affecting air transportation and the costs charged for airport access, (v) changes in the Company's fleet and related capacity and (vi) the Company's continuing efforts to reduce costs throughout its operations.\nManagement believes that maintaining a cost advantage is crucial to the Company's business strategy, and Continental is pursuing aggressive cost reduction objectives in virtually all aspects of its operations.\nFuel costs constituted approximately 13.1% of Continental's operating costs in 1994 and, although Continental has consistently sought to hedge its short to intermediate term exposure against severe spikes in crude oil prices, future price changes could materially affect Continental's results of operations. See Item 1. \"Business. Fuel\".\nIn the last several years, the FAA has issued a number of maintenance directives and other regulations relating to, among other things, retirement of older aircraft, collision avoidance systems, airborne windshear avoidance systems, noise abatement and increased inspections and maintenance procedures to be conducted on older aircraft. These regulatory actions have imposed, and may in the future impose further, material unanticipated costs upon the Company and other airlines.\nOther\nThe Company had, as of December 31, 1994, deferred tax assets aggregating approximately $1.6 billion, including approximately $1.1 billion of net operating loss carryforwards. The Company recorded a valuation allowance of $844.2 million against such assets as of December 31, 1994. Realization of a substantial portion of the Company's remaining net operating loss carryforwards will require the completion during the next three years of transactions resulting in recognition of built-in gains for federal income tax purposes. Although the Company currently intends to consummate one or more such transactions, in the event the Company were to determine in the future that no such transactions will be completed, an adjustment to the deferred tax liability of up to approximately $194 million would be charged to income in the period such determination was made.\nMany aspects of Continental's operations are also subject to increasingly stringent federal, state and local laws protecting the environment. Continental has been named as a potentially responsible party at three cleanup sites which have been designated as Superfund Sites. At sites where EPA has commenced remedial litigation, potential liability is joint and several. Continental's alleged volumetric contributions at the sites are minimal. The Company does not believe that the foregoing matters will have a material adverse effect on the Company.\nCertain Statistical Information\nAn analysis of statistical information for Continental's jet operations for each of the three years in the period ended December 31, 1994 is as follows:\n_______________\n(a) The number of scheduled miles flown by revenue passengers. (b) The number of seats available for passengers multiplied by the number of scheduled miles those seats are flown. (c) Revenue passenger miles divided by available seat miles. (d) The percentage of seats that must be occupied by revenue passengers in order for the airline to breakeven on an income before income taxes basis, excluding nonrecurring charges, nonoperating items and other special items. This statistic excludes Express operations. (e) Passenger revenues divided by available seat miles. (f) Operating expenses divided by available seat miles. Operating cost for the year ended December 31, 1993 included approximately $37 million of nonrecurring items related to the Reorganization. (g) The average revenue received for each mile a revenue passenger is carried. (h) The average block hours flown per day in revenue service per aircraft.\nResults of Operations\nThe following discussion provides an analysis of the Company's results of operations and reasons for material changes therein for the three years ended December 31, 1994. The Company's results of operations for the periods subsequent to April 27, 1993 have not been prepared on a basis of accounting consistent with its predecessor's results of operations for periods prior to April 28, 1993 due to the implementation of fresh start reporting upon the Company's emergence from bankruptcy. Financial information for 1993 is derived by combining the results of operations of the Company for the period April 28, 1993 through December 31, 1993 with those of Holdings for the period January 1, 1993 through April 27, 1993.\nOverview of 1994. Continental's 1994 loss before nonrecurring charges was $166.5 million, or $6.61 per common share (primary and fully diluted). The 1994 net loss of $613.3 million, or $23.76 per common share (primary and fully diluted), included nonrecurring charges of approximately $446.8 million, or $17.15 per common share (primary and fully diluted). See \"Nonrecurring Charges\" below. The nonrecurring charges and losses in 1994 were caused primarily by major operating changes implemented by Continental during the year and by a late 1994 build-up of excess fleet and related operating capacity that the Company was unable to deploy profitably. Continental's Go Forward Plan, a new, multi-faceted strategy, is designed to redirect and improve the Company's operations, shrink excess capacity, improve liquidity and achieve profitability. See Item 1. \"Business. Business Strategy\".\nReduction in Western United States Operations. During 1994, Continental greatly reduced its operations in the western United States. The Company eliminated its unprofitable Denver hub operation, cutting daily jet departures from 165 in August 1993, to 86 in July 1994, 59 in September 1994 and 19 at March 31, 1995. Beginning in May 1994, Express also terminated all Denver turboprop operations. In November 1994, Continental announced its decision to close its western United States heavy maintenance facilities in Los Angeles and Denver, eliminating approximately 1,640 maintenance positions.\nContinental Lite. In 1994, Continental rapidly expanded Continental Lite (a network of short-haul, no-frills, low-fare flights initially referred to as Peanuts Flights), from 173 daily flights and 19 aircraft serving 14 cities in November 1993 to 1,000 daily flights and 114 aircraft serving 43 cities in September 1994. The rapid growth of Continental Lite was supplied by redeploying a substantial portion of Continental's capacity, including aircraft made available by elimination of the Denver hub and by deliveries of new aircraft under the Company's agreement with Boeing. Continental Lite experienced operational problems in connection with this rapid growth and was not profitable in 1994. At its peak, approximately 35% of Continental Lite flying consisted of point-to-point, linear service not integrated with the Company's hubs. Linear flying proved to be significantly unprofitable and was responsible for an estimated 70% of all Continental Lite system losses in 1994. As part of its Go Forward Plan, the Company is substantially reducing Continental Lite operations by redeploying aircraft out of Continental Lite to replace less efficient, larger aircraft being retired from long-haul service, and implementing other changes intended to improve profitability.\nExpress. Management has implemented strategies designed to improve the performance of Express, which experienced losses in 1994. In addition to terminating its significantly unprofitable Denver operations, Express implemented cost-reduction programs, including substantial workforce reductions, and has entered into an agreement to acquire 25 new, operationally efficient, 19-seat turboprop aircraft from Beech Acceptance Corporation. Fourth quarter results for Express were adversely affected by an FAA Airworthiness Directive, which prohibited all airlines, including Express, from flying ATR-42 and ATR-72 aircraft during atmospheric icing conditions. The Airworthiness Directive was effective December 9, 1994 through January 13, 1995. The FAA may issue further Airworthiness Directives with respect to the ATR aircraft and it is not possible to predict the effect, if any, that future directives or other regulatory actions may have on the use of such aircraft in certain weather conditions.\nInternational. CMI achieved significant profit growth in 1994 and continued to generate operating profit margins greater than those of the rest of the Company. The increase in CMI's profits during 1994 reflected improvement in the Japanese economy, continued appreciation of the Japanese yen against the dollar (which increased CMI's dollar revenues and, to a lesser extent, expenses), the severe typhoons and an earthquake at Guam that adversely affected 1993 results, and continued growth in air traffic demand in CMI's markets. Continental also expanded its presence in Europe and South America in 1994 and is one of the leading airlines providing service to Mexico and Central America, serving more destinations there than any other United States airline.\nNonrecurring Charges. During the fourth quarter of 1994, the Company recorded a nonrecurring charge of approximately $446.8 million associated primarily with (i) the planned early retirement of certain aircraft and (ii) closed or underutilized airport and maintenance facilities and other assets.\nApproximately $278 million of the nonrecurring charge was associated with the planned early retirement during 1995 of 24 widebody jet aircraft (21 Airbus A300s and three Boeing 747s), 23 narrowbody Boeing 727 jet aircraft and five Dash 7 turboprop aircraft, including a provision for the disposal of the related inventory. All of these aircraft (except for two owned Airbus A300 aircraft) have remaining lease obligations beyond the planned retirement dates for such aircraft. The $278 million charge represents the Company's best estimate of the expected loss based upon, among other things, the anticipated resolution of negotiations with certain lessors as well as anticipated sublease rental income of certain aircraft and engines. To the extent the actual resolution of the negotiations, actual sublease rental income or other events or amounts vary from the Company's estimates, the actual charge could be different from the amount estimated.\nApproximately $168.8 million of the nonrecurring charge was associated with the closure of the LAX maintenance facility, underutilized airport facilities and other assets (primarily associated with DIA). This portion of the charge relates to the Company's contractual obligations under the related lease agreements and the write-off of related leasehold improvements, less an estimated amount for sublease rental income. However, should actual sublease rental income be different from the Company's estimates, the actual charge could be different from the amount estimated.\nApproximately $324.2 million of the nonrecurring charge represents an actual cash outlay to be incurred over the remaining lease terms (of from one to 15 years) and approximately $122.6 million represents a noncash charge associated with a write-down of certain assets (principally inventory and flight equipment) to expected net realizable value. Continental expects to finance the cash outlays primarily with internally generated funds.\nComparison of 1994 to 1993. The Company recorded a consolidated loss before nonrecurring charges of $166.5 million for the year ended December 31, 1994 as compared to a consolidated loss before extraordinary gain of $1 billion for the year ended December 31, 1993. The Company's net loss in 1994 included nonrecurring charges of approximately $446.8 million. The Company's net income in 1993 included an extraordinary gain of $3.6 billion primarily related to the discharge of prepetition debt obligations in the Reorganization.\nPassenger revenues of $5 billion in 1994 decreased 1.6%, $79.4 million, from 1993 due primarily to a 1.7% decrease in Continental's jet revenue passenger miles resulting from a 1.7% decrease in available seat miles. Such decrease was partially offset by a 0.8% increase in jet yields.\nCargo, mail and other revenues decreased by 2.8%, $18.3 million, from 1993 to 1994 primarily as a result of Continental's termination of service to Australia and New Zealand in October 1993 and poor weather in the eastern United States in the first quarter of 1994.\nWages, salaries and related costs increased 2.0%, $30.2 million, from 1993 to 1994 due to higher wage rates, partially offset by a decrease in the number of full-time equivalent employees. In July 1992, the Company implemented an average 10.0% wage reduction, which reduction was restored in equal increments in December 1992, April 1993 and April 1994, with the final restoration occurring in July 1994. The number of full-time equivalent employees decreased from approximately 39,700 as of December 31, 1993 to approximately 37,800 at December 31, 1994.\nRentals and landing fees increased 4.0%, $32 million, from 1993 to 1994. Rent expense increased primarily as a result of the delivery of new Boeing 737 and 757 aircraft during 1994. Such increase was partially offset by retirements of leased aircraft and the full year impact in 1994 of the amortization of deferred credits recorded in connection with the Company's adjustment of operating leases to fair market value as of April 27, 1993.\nAircraft fuel expense decreased 8.7%, $70.6 million, from 1993 to 1994 primarily due to a reduction in the average price per gallon. The average price per gallon of fuel decreased 9.7%, from 59.26 cents in 1993 to 53.52 cents in 1994. The quantity of jet fuel used increased from 1.333 billion gallons in 1993 to 1.349 billion gallons used in 1994 principally due to an increase in the frequency of take-offs and landings associated with Continental Lite operations.\nMaintenance, materials and repairs costs decreased 9.5%, $51.8 million, from 1993 to 1994 primarily due to increased operational efficiencies and the retirement of older aircraft.\nCommissions expense decreased 20.6%, $113.9 million, from 1993 to 1994 primarily due to a decrease in commissionable sales and a reduction in the aggregate average commission rate.\nDepreciation and amortization expense increased 7.9%, $18.9 million, from 1993 to 1994 due primarily to (i) an increase in aircraft operated under capital leases during the fourth quarter of 1993, (ii) the amortization of incremental capitalized costs associated with aircraft, and (iii) the annualized impact of fresh start adjustments relating to aircraft, routes, gates and slots and Reorganization Value in Excess of Amounts Allocable to Identifiable Assets.\nOther operating expenses increased 3.8%, $50.7 million, from 1993 to 1994 primarily as a result of increases in reservations and sales expense, advertising expense and other miscellaneous expenses, partially offset by a decrease in passenger service expenses that consist primarily of catering costs.\nThe Company's interest expense increased 10.6%, $23.1 million, from 1993 to 1994 due primarily to a net increase in debt on which the Company was required to accrue interest. As a result of its Chapter 11 filing, through April 1993, the Company was not obligated to pay, and accordingly ceased accruing, contractual interest on its unsecured and undersecured obligations.\nInterest capitalized increased 71.3%, $7.1 million, from 1993 to 1994 due primarily to an increase in 1994 in the average balance during the year of purchase deposits for flight equipment.\nInterest income increased 20.2%, $3.8 million, from 1993 to 1994 primarily due to an increase in the average balance of cash and cash equivalents coupled with an increase in the average interest rate. Interest income earned on the Company's investments during the period prior to April 28, 1993 was netted against reorganization items in accordance with SOP 90-7.\nThe Company recorded gains of $10.5 million and $35.4 million in 1994 and 1993, respectively, relating primarily to Continental's disposition of property, equipment and other assets. In 1994, a gain totaling $8.5 million related to the sale of 10 Beech aircraft and five spare engines was recorded. In 1993, the Company recorded a gain of $34.9 million related to System One's sale to EDS of substantially all of the assets of its Airline Services Division.\nReorganization items, net, in 1993 included professional fees of $58.6 million, accruals for rejected aircraft agreements of $153.3 million and other miscellaneous adjustments of $33.9 million. In addition, in the second quarter of 1993, fresh start adjustments totaling $719.1 million were recorded relating to the adjustment of assets and liabilities to fair market value as well as other miscellaneous fresh start adjustments of approximately $76.8 million. These fresh start adjustments were partially offset by the write off of deferred gains on sale\/leaseback transactions of $218.6 million and interest income of $4.5 million.\nThe Company's other nonoperating income (expense) in 1994 included foreign exchange losses of $5.2 million (primarily related to Japanese yen- denominated transactions). Other nonoperating expense in 1993 included foreign exchange losses (primarily related to Japanese yen, German mark and British pound denominated transactions), charges totaling approximately $13.1 million related to the Company's termination of services to Australia and New Zealand and other expenses primarily related to the abandonment of airport facilities.\nIn 1993, the Company recorded an extraordinary gain of $3.6 billion resulting from the extinguishment of prepetition obligations, including the write off of a deferred credit related to Eastern of $1.1 billion.\nComparison of 1993 to 1992. The Company recorded a consolidated loss before extraordinary gains of $1 billion for the year ended December 31, 1993 as compared to a consolidated net loss of $125.3 million in 1992. The Company's net income in 1993 included an extraordinary gain of approximately $3.6 billion primarily related to the discharge of prepetition debt obligations. The net loss in 1992 included gains aggregating $185 million relating to sales of assets and Eastern-related adjustments, principally the PBGC Settlement.\nPassenger revenues of $5.1 billion in 1993 increased 5.9%, $286.2 million, from 1992 due primarily to an 8.2% increase in Continental's jet yields, partially offset by a 1.7% decrease in Continental's jet revenue passenger miles resulting from a 1.3% decrease in available seat miles. Such increase reflected $75 million of passenger revenues recorded in the third quarter of 1993 as a result of the completion of the Company's periodic evaluation of its air traffic liability account.\nCargo, mail and other revenues increased 3.6%, $22.8 million, from 1992 to 1993 primarily due to an increase in ground handling and similar services.\nWages, salaries and related costs increased 2.5%, $36.6 million, from 1992 to 1993. In July 1992, the Company implemented an average 10.0% wage reduction which was partially offset by increases in worker's compensation and medical benefits expenses. In December 1992, 25% of such wage reduction was restored and in April 1993 another 25% was restored. The number of full-time equivalent employees increased from approximately 35,600 as of December 31, 1992 to approximately 39,700 as of December 31, 1993.\nRentals and landing fees remained relatively constant in 1993 as compared to 1992. Rent expense increased due to Continental's leaseback of previously owned aircraft which were transferred to certain debt holders in December 1992 and April 1993 in settlement of litigation. These increases were offset by the amortization of deferred credits recorded in connection with the Company's adjustment of operating leases to fair market value as of April 27, 1993.\nAircraft fuel expense decreased 3.0%, $25.4 million, from 1992 to 1993. The quantity of jet fuel used increased from 1.307 billion gallons in 1992 to 1.333 billion gallons in 1993 due to an increase in Continental's operating levels, while the average price per gallon of fuel decreased 5.4%, from 62.48 cents per gallon in 1992 to 59.26 cents per gallon in 1993.\nMaintenance, materials and repairs increased 7.8%, $39.6 million, from 1992 to 1993 primarily due to outsourcing certain maintenance to third parties. For outsourcing contracts, 100% of the cost is included in maintenance, materials and repairs, whereas, when Continental performs its own maintenance work, a portion of such cost is classified as wages, salaries and related costs, in accordance with industry practice.\nCommissions expense increased 19.8%, $91.5 million, from 1992 to 1993 primarily due to an increase in passenger revenues.\nDepreciation and amortization expense remained relatively constant in 1993 as compared to 1992. Depreciation decreased due to a reduction in the number of owned aircraft as a result of settlements reached in December 1992 and April 1993 with certain aircraft debt holders (which resulted in the transfer to the debt holders and subsequent leaseback of certain aircraft). This decrease was substantially offset by the amortization of intangibles (including Reorganization Value in Excess of Amounts Allocable to Identifiable Assets) beginning April 28, 1993.\nOther operating expenses increased 6.5%, $82.2 million, from 1992 to 1993 due primarily to increases in reservations and sales expense, advertising expense and other miscellaneous expenses.\nThe Company's interest expense increased 42.0%, $64.3 million, from 1992 to 1993 due primarily to (i) interest accretion associated with the fair market value adjustment for operating leases and debt and (ii) a net increase in debt on which the Company was required to accrue interest.\nInterest capitalized increased 69.5%, $4.1 million, from 1992 to 1993 due primarily to an increase in 1993 in the average balance during the year of purchase deposits for flight equipment.\nInterest income increased 22.9%, $3.5 million, from 1992 to 1993 primarily due to an increase in funds available for investment. Interest income earned on the Company's investments during the period prior to April 27, 1993 was netted against reorganization items in accordance with SOP 90-7.\nThe Company recorded gains on disposition of property, equipment and other assets of approximately $35.4 million in 1993 relating primarily to System One's sale to EDS of substantially all of the assets of its Airline Services Division. The Company recorded gains on disposition of property, equipment and other assets of approximately $53.2 million in 1992 relating primarily to Continental's sale to USAir of certain assets at LaGuardia.\nIn 1992, the Company recorded a $17.3 million gain when it was released from its guaranty of interest payments on certain Eastern Equipment Trust Certificates and a $114.5 million net gain in connection with the PBGC Settlement.\nReorganization items, net, in 1993 included professional fees of $58.6 million, accruals for rejected aircraft agreements of $153.3 million and other miscellaneous adjustments of $33.9 million. In addition, in the second quarter of 1993, fresh start adjustments totaling $719.1 million were recorded relating to the adjustment of assets and liabilities to fair market value as well as other miscellaneous fresh start adjustments of approximately $76.8 million. These fresh start adjustments were partially offset by the write off of deferred gains on sale\/leaseback transactions of $218.6 million and interest income of $4.5 million.\nIn 1992, the Company recorded reorganization items, net, totaling $31.5 million, including $30 million in reorganization-related professional fees, $6.7 million in net adjustments related to rejected leases and $10.1 million of miscellaneous items, offset by $15.3 million of interest income.\nContinental's loss on settlement of litigation in 1992 included a $41.6 million charge recorded in connection with a lawsuit brought by American General Corporation and American General Life Insurance Company and $8 million related to the settlement of certain antitrust litigation.\nThe Company's other nonoperating expense in 1993 included foreign exchange losses (primarily related to Japanese yen, German mark and British pound denominated transactions), charges totaling approximately $13.1 million related to the Company's termination of services to Australia and New Zealand and other expenses primarily related to the abandonment of airport facilities. The Company's other nonoperating income in 1992 included foreign exchange gains of $6.4 million, proceeds of approximately $4.5 million from Trump Shuttle, Inc. (the \"Shuttle\") under a settlement agreement related to the termination of the Shuttle's participation in the OnePass program, insurance proceeds of $6.4 million and other miscellaneous items.\nIn 1993, the Company recorded an extraordinary gain of approximately $3.6 billion resulting from the extinguishment of prepetition obligations, including the write off of a deferred credit related to Eastern of approximately $1.1 billion.\nLiquidity and Capital Commitments\nAs part of the Company's Go Forward Plan, in January 1995 the Company commenced a series of initiatives designed to improve liquidity in 1995 and 1996. The major liquidity elements of this plan include (i) rescheduling principal amortization under the Company's loan agreements with its primary secured lenders (representing approximately $599.4 million of the Company's outstanding long-term debt at December 31, 1994), (ii) restructuring the Company's commitments to purchase new Boeing aircraft and related engines, (iii) deferring or reducing cash requirements associated with certain existing aircraft, (iv) reducing the Company's lease commitments at DIA and (v) evaluating the potential disposition of non-core assets. As discussed below, under agreements in principle and binding agreements reached through April 12, 1995, the Company has improved its liquidity by an estimated $231 million in 1995 and $221 million in 1996. This achieves roughly 75% of the Go Forward Plan liquidity goal.\nOn March 31, 1995 the Company signed agreements with Boeing and certain engine manufacturers to defer substantially all aircraft deliveries that had been scheduled for 1996 and 1997. Five Boeing 767 aircraft that had been scheduled for delivery to Continental in 1995 have been sold to a third party. They have been replaced by five Boeing 767's which Continental will take delivery of starting in 1998. Options to purchase additional aircraft have been canceled. On March 30, 1995 Continental amended its principal secured loan agreements with GE Capital and General Electric Company (collectively, the \"Lenders\") to defer 1995 and 1996 principal payments and amended certain of its operating lease agreements with one of the Lenders to defer 1995 rental obligations. Continental agreed, among other things, to obtain concessions from certain aircraft lessors. Continuing deferrals of these principal and operating lease payments will be suspended if specified portions of such concessions are not obtained by May 31 and June 30, 1995 or if other covenants are not complied with. If the required concessions are obtained at a later date, the deferrals will resume. As discussed immediately below, the Company has reached agreements with some of these lessors and is in negotiations with the remaining lessors. The Company anticipates that it will be successful in timely obtaining the required concessions. These agreements with Boeing, the engine manufacturers and the Lenders will improve the Company's 1995 and 1996 liquidity by approximately $167 million and $161 million, respectively.\nIn connection with the Go Forward Plan, the Company is retiring from service 24 less efficient widebody aircraft during 1995. In February 1995, the Company began paying market rentals, which are significantly less than contractual rentals on these aircraft, and began ceasing all rental payments as the aircraft are removed from service. In addition, in February 1995 Continental reduced its rental payments on an additional 11 widebody aircraft leased at significantly above-market rates. The Company began negotiations in February 1995 with the relevant lessors of the 35 widebody aircraft to amend the lease repayment schedules or provide, effective February 1, 1995, alternative compensation, which could include debt securities convertible into equity, in lieu of current cash payments. As of April 12, 1995, the Company had entered into agreements or agreements in principle with lessors of 16 of these aircraft that will improve the Company's liquidity by an estimated $44 million and $40 million in 1995 and 1996, respectively.\nOn April 10, 1995, the Denver City Council approved an agreement among the City and County of Denver, the Company and certain signatory airlines amending the Company's lease of facilities at DIA by reducing the Company's lease term to five years, reducing to 10 the number of gates (and reducing associated space) leased by the Company and making certain changes in the rates and charges under the lease. The agreement also provides for the release of certain claims and the settlement of certain litigation filed by the City and County of Denver against the Company. See Item 3. \"Legal Proceedings. Denver International Airport\". The agreement is expected to result in annual reduction in costs to the Company of approximately $20 million over the life of the lease.\nContinental and System One are currently negotiating a series of transactions whereby the existing systems management agreement between System One and EDS would be terminated and a substantial portion of the assets (including the travel agent subscriber base and IMS software) and certain liabilities of System One would be transferred to a newly formed limited liability company (New S1) that would be owned equally by System One (which will remain a wholly owned subsidiary of Continental), EDS and AMADEUS, a European CRS. Substantially all of System One's remaining assets (including the CRS software) and liabilities would be transferred to AMADEUS. In addition to retaining a one-third interest in New S1, System One would receive cash proceeds and an equity interest in AMADEUS and the outstanding indebtedness of System One owed to each of EDS and Continental would be repaid. New S1 would market the AMADEUS CRS and would continue to develop, market and distribute travel-related IMS. These transactions are anticipated to close in the second quarter of 1995.\nContinental's failure to make required payments to the Lenders, the City and County of Denver and certain aircraft lessors as described above constituted events of default under the respective agreements with such parties. The agreements reached through April 12, 1995 with the Lenders, the City and County of Denver and two aircraft lessors have cured defaults under their respective agreements. As of April 12, 1995, defaults under the remaining widebody aircraft leases were continuing due to the nonpayment of rents, which could entitle the lessors to pursue contractual remedies, including seeking to take possession of the leased aircraft. As of April 12, 1995, the Company is in negotiations with these remaining lessors and has received proposals from lessors representing a majority of the Company's agreements currently in default. The Company believes it will be able to successfully conclude the remaining negotiations and thus avoid any material adverse effect on the Company. In addition, under \"cross default\" provisions, the payment defaults create defaults under a significant number of Continental's other lease and debt agreements, and the Company's obligations under the agreements subject to such cross defaults are also eligible to be accelerated. However, in the opinion of the Company, it is unlikely that lessors or creditors will exercise remedies under cross default provisions because (i) the Company is making all required contractual payments under the applicable agreements, (ii) the contractual payments on a substantial majority of aircraft leases are at current market rates, (iii) taking possession of the aircraft would cause the lessors or lenders to incur remarketing costs, and (iv) exercise of remedies could expose lessors and lenders to \"lender liability\" litigation. Additionally, the Company has made substantial progress in negotiations with lenders and lessors to cure the payment defaults and expects to complete all such negotiations by June 30, 1995, and as a result all events of default, including cross defaults, should be eliminated. Consequently, the Company does not expect the cross defaults to have a material adverse effect on the Company.\nAs a result of the FAA Airworthiness Directive which forced the partial grounding of the Company's ATR commuter fleet in late 1994 and early 1995, the Company withheld January and February lease payments totaling $7 million on those ATR aircraft leased by the manufacturer. The Company's non-payment of rentals may have resulted in an event of default under the related lease agreements with ATR. As of April 12, 1995, the Company was engaged in discussions with ATR concerning compensation, if any, to be received by the Company as a result of the grounding, and the Company had received a proposal from ATR that, if accepted, would cure the payment default. In addition because of a decrease in the value of certain collateral, the Company may have been in default under the debt agreement relating to the financing of the Company's LAX maintenance facility. At March 31, 1995 the principal balance of the applicable obligation was approximately $64 million and at April 12, 1995, the Company was in negotiations with the creditor. As a result of the progress in the ATR and LAX maintenance facility negotiations, the Company does not anticipate that the foregoing matters will have a material adverse effect on the Company.\nThe Company has no current plans to take other actions in the future that would constitute additional events of default.\nAs a result of the defaults and cross-defaults described above that were continuing at April 12, 1995, approximately $489.9 million of the Company's long-term debt and capital lease obligations were classified as debt and capital leases in default within current liabilities as of December 31, 1994. While the Company does not believe it is probable that it will be required to fund such defaulted obligations in the next twelve months, generally accepted accounting principles require that such defaulted obligations be classified as current liabilities at December 31, 1994. In addition, certain operating leases with remaining aggregate rentals of $1.4 billion as of December 31, 1994 were in default or cross default at April 12, 1995. See Notes 5 and 6 of the Notes to the Consolidated Financial Statements included in Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nIndex to Consolidated Financial Statements\nPage No.\nReport of Independent Auditors\nReport of Independent Public Accountants\nConsolidated Statements of Operations for each of the Three Years in the Period Ended December 31, 1994\nConsolidated Balance Sheets as of December 31, 1994 and 1993\nConsolidated Statements of Cash Flows for each of the Three Years in the Period Ended December 31, 1994\nConsolidated Statements of Redeemable and Nonredeemable Preferred Stock and Common Stockholders' Equity (Deficit) for each of the Three Years in the Period Ended December 31, 1994\nNotes to Consolidated Financial Statements\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders Continental Airlines, Inc.\nWe have audited the accompanying consolidated balance sheets of Continental Airlines, Inc. (the \"Company\") as of December 31, 1994 and 1993, and the related consolidated statements of operations, redeemable and non- redeemable preferred stock and common stockholders' equity and cash flows for the year ended December 31, 1994 and for the period April 28, 1993 through December 31, 1993. We have also audited the accompanying consolidated statements of operations, redeemable and nonredeemable preferred stock and common stockholders' equity and cash flows for the period from January 1, 1993 through April 27, 1993 of Continental Airlines Holdings, Inc. 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.\nAs discussed in Note 2 to the consolidated financial statements, the Company's consolidated Plan of Reorganization was confirmed by the bankruptcy court on April 16, 1993 and became effective April 27, 1993. As a result, Continental Airlines Holdings, Inc. (the \"Predecessor Company\") merged with and into the Company (the \"Reorganized Company\") effective April 27, 1993. The Company also adopted fresh start reporting effective April 27, 1993 and, as a result, the consolidated financial information for the period after April 27, 1993 is presented on a different basis of accounting than for the period before April 28, 1993 and, therefore, is not comparable.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 1994 and 1993, the consolidated results of its operations and its cash flows for the year ended December 31, 1994 and the period from April 28, 1993 to December 31, 1993 and the consolidated results of operations and cash flows of Continental Airlines Holdings, Inc., for the period from January 1, 1993 through April 27, 1993, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nHouston, Texas April 12, 1995\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Continental Airlines Holdings, Inc.:\nWe have audited the accompanying consolidated statements of operations, nonredeemable preferred stock and common stockholders' deficit and cash flows of Continental Airlines Holdings, Inc. (a Delaware corporation) and its subsidiaries, entities in Chapter 11 reorganization proceedings (Holdings), for the year ended December 31, 1992. These financial statements and the schedules referred to below are the responsibility of Holdings' management. Our responsibility is to express an opinion on these financial statements and 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 Holdings for the year ended December 31, 1992, in conformity with generally accepted accounting principles.\nThe accompanying consolidated financial statements have been prepared on a going concern basis. Holdings has experienced significant operating losses in 1990, 1991 and 1992. Furthermore, Holdings is subject to additional uncertainties, including litigation and significant liquidity concerns, which management expects will be substantially resolved upon emergence from bankruptcy and the consummation of the investment by Air Partners, L.P. and Air Canada. In January 1993, Holdings filed a revised second amended joint plan of reorganization and related disclosure statement with the bankruptcy court. If a plan of reorganization is not approved by the bankruptcy court, there is substantial doubt about Holdings' ability to continue as a going concern. In the event a plan of reorganization is approved by the bankruptcy court, the reorganized company will adopt fresh start reporting; however, in the long-term, the reorganized company's viability will be dependent upon its ability to achieve successful future operations. The accompanying consolidated 1992 financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should Holdings be unable to continue in existence nor do the consolidated financial statements reflect the adjustments required by fresh start reporting.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules for Holdings for 1992 listed in the index to financial statement 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 LLP\nHouston, Texas March 12, 1993\n*N.M. - Not meaningful - Historical per share data for the Predecessor Company is not meaningful since the Company has been recapitalized and has adopted fresh start reporting as of April 27, 1993.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\n(continued on next page)\n(continued on next page)\n(continued on next page)\nThe accompanying Notes to Consolidated Financial Statements are an integral part of these statements.\nCONTINENTAL AIRLINES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nContinental Airlines, Inc. (the \"Company\", the \"Reorganized Company\" or \"Continental\") is the successor to Continental Airlines Holdings, Inc. (together with its subsidiaries \"Holdings\" or the \"Predecessor Company\") and Continental Airlines, Inc. On December 3, 1990, Continental and Holdings and all their wholly owned domestic subsidiaries filed voluntary petitions to reorganize under Chapter 11 of the federal bankruptcy code. The Companies' consolidated Plan of Reorganization was confirmed on April 16, 1993 and became effective on April 27, 1993 (the \"Reorganization\"). On such date, Holdings merged with and into Continental. System One Information Management, Inc. (\"System One\"), which had been a subsidiary of Holdings, was reorganized as a subsidiary of Continental. Because consolidated Continental (as reorganized) includes System One and other businesses that had been consolidated with Holdings prior to April 27, 1993 (but not with pre-reorganization Continental), the discussion herein includes references to Holdings' consolidated financial statements for periods prior to April 27, 1993. On April 27, 1993, Continental adopted fresh start reporting in accordance with the American Institute of Certified Public Accountants' Statement of Position 90-7 - \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\" (\"SOP 90-7\"), which resulted in adjustments to the Company's common stockholders' equity and the carrying values of assets and liabilities. Accordingly, the Company's post-reorganization balance sheet and statements of operations have not been prepared on a consistent basis of accounting with the pre-reorganization balance sheet and statements of operations. For accounting purposes, the inception date for the Reorganized Company is deemed to be April 28, 1993. A vertical black line is shown in the consolidated financial statements to separate Continental from the Predecessor Company since they have not been prepared on a consistent basis of accounting.\nNOTE 1 - LIQUIDITY\nDuring the fourth quarter of 1994, the Company determined that a new strategic plan, the Go Forward Plan, was needed to return the Company to profitability and strengthen its balance sheet. As part of the Company's Go Forward Plan, in January 1995, the Company commenced a series of initiatives designed to improve liquidity in 1995 and 1996. The major liquidity elements of this plan include (i) rescheduling principal amortization under the Company's loan agreements with its primary secured lenders (representing approximately $599.4 million of the Company's outstanding long-term debt at December 31, 1994), (ii) restructuring the Company's commitments to purchase new Boeing aircraft and related engines, (iii) deferring or reducing cash requirements associated with certain existing aircraft, (iv) reducing the Company's lease commitments at Denver International Airport (\"DIA\") and (v) evaluating the potential disposition of non-core assets. As discussed below, under agreements in principle and binding agreements reached through April 12, 1995, the Company has improved its liquidity by an estimated $231 million in 1995 and $221 million in 1996. This achieves roughly 75% of the Go Forward Plan liquidity goal.\nOn March 31, 1995 the Company signed agreements with The Boeing Company (\"Boeing\") and certain engine manufacturers to defer substantially all aircraft deliveries that had been scheduled for 1996 and 1997. Five Boeing 767 aircraft that had been scheduled for delivery to Continental in 1995 have been sold to a third party. They have been replaced by five Boeing 767's which Continental will take delivery of starting in 1998. Options to purchase additional aircraft have been canceled. On March 30, 1995 Continental amended its principal secured loan agreements with General Electric Capital Corporation and affiliates (collectively, \"GE Capital\") and General Electric Company (collectively, the \"Lenders\") to defer 1995 and 1996 principal payments and amended certain of its operating lease agreements with one of the Lenders to defer 1995 rental obligations. Continental agreed, among other things, to obtain concessions from certain aircraft lessors. Continuing deferrals of these principal and operating lease payments will be suspended if specified portions of such concessions are not obtained by May 31 and June 30, 1995 or if other covenants are not complied with. If the required concessions are obtained at a later date, the deferrals will resume. As discussed immediately below, the Company has reached agreements with some of these lessors and is in negotiations with the remaining lessors. The Company anticipates that it will be successful in timely obtaining the required concessions. These agreements with Boeing, the engine manufacturers and the Lenders will improve the Company's 1995 and 1996 liquidity by approximately $167 million and $161 million, respectively.\nIn connection with the Go Forward Plan, the Company is retiring from service 24 less efficient widebody aircraft during 1995. In February 1995, the Company began paying market rentals, which are significantly less than contractual rentals on these aircraft, and began ceasing all rental payments as the aircraft are removed from service. In addition, in February 1995 Continental reduced its rental payments on an additional 11 widebody aircraft leased at significantly above-market rates. The Company began negotiations in February 1995 with the relevant lessors of the 35 widebody aircraft to amend the lease repayment schedules or provide, effective February 1, 1995, alternative compensation, which could include debt securities convertible into equity, in lieu of current cash payments. As of April 12, 1995, the Company had entered into agreements or agreements in principle with lessors of 16 of these aircraft that will improve the Company's liquidity by an estimated $44 million and $40 million in 1995 and 1996, respectively.\nOn April 10, 1995, the Denver City Council approved an agreement among the City and County of Denver (the \"City\"), the Company and certain signatory airlines amending the Company's lease of facilities at DIA by reducing the Company's lease term to five years, reducing to 10 the number of gates (and reducing associated space) leased by the Company and making certain changes in the rates and charges under the lease. The agreement also provides for the release of certain claims and the settlement of certain litigation filed by the City against the Company. See Note 13. The agreement is expected to result in annual reduction in costs to the Company of approximately $20 million over the life of the lease.\nContinental and System One are currently negotiating a series of transactions whereby the existing systems management agreement between System One and Electronic Data System (\"EDS\") would be terminated and a substantial portion of the assets (including the travel agent subscriber base and travel-related information management products and services (\"IMS\") software) and certain liabilities of System One would be transferred to a newly formed limited liability company (\"New S1\") that would be owned equally by System One (which will remain a wholly owned subsidiary of Continental), EDS and AMADEUS, a European computerized reservation system (\"CRS\"). Substantially all of System One's remaining assets (including the CRS software) and liabilities would be transferred to AMADEUS. In addition to retaining a one-third interest in New S1, System One would receive cash proceeds and an equity interest in AMADEUS and the outstanding indebtedness of System One owed to each of EDS and Continental would be repaid. New S1 would market the AMADEUS CRS and would continue to develop, market and distribute travel-related IMS. These transactions, which are expected to result in a gain, are anticipated to close in the second quarter of 1995.\nContinental's failure to make required payments to the Lenders, the City and County of Denver and certain aircraft lessors as described above constituted events of default under the respective agreements with such parties. The agreements reached through April 12, 1995 with the Lenders, the City and County of Denver and two aircraft lessors have cured the defaults under their respective agreements. As of April 12, 1995, defaults under the remaining widebody aircraft leases were continuing due to the nonpayment of rents, which could entitle the lessors to pursue contractual remedies, including seeking to take possession of the leased aircraft. As of April 12, 1995, the Company is in negotiations with these remaining lessors and has received proposals from lessors representing a majority of the Company's agreements currently in default. The Company believes it will be able to successfully conclude the remaining negotiations and thus avoid any material adverse effect on the Company. In addition, under \"cross default\" provisions, the payment defaults create defaults under a significant number of Continental's other lease and debt agreements, and the Company's obligations under the agreements subject to such cross defaults are also eligible to be accelerated. However, in the opinion of the Company, it is unlikely that lessors or creditors will exercise remedies under cross default provisions because (i) the Company is making all required contractual payments under the applicable agreements, (ii) the contractual payments on a substantial majority of aircraft leases are at current market rates, (iii) taking possession of the aircraft would cause the lessors or lenders to incur remarketing costs, and (iv) exercise of remedies could expose lessors and lenders to \"lender liability\" litigation. Additionally, the Company has made substantial progress in negotiations with lenders and lessors to cure the payment defaults and expects to complete all such negotiations by June 30, 1995, and as a result all events of default, including cross defaults, should be eliminated. Consequently, the Company does not expect the cross defaults to have a material adverse effect on the Company.\nAs a result of the Federal Aviation Administration (\"FAA\") Airworthiness Directive which forced the partial grounding of the Company's ATR commuter fleet in late 1994 and early 1995, the Company withheld January and February lease payments totaling $7 million on those ATR aircraft leased by the manufacturer. The Company's non-payment of rentals may have resulted in an event of default under the related lease agreements with ATR. As of April 12, 1995, the Company was engaged in discussions with ATR concerning compensation, if any, to be received by the Company as a result of the grounding, and the Company had received a proposal from ATR that, if accepted, would cure the payment default. In addition because of a decrease in the value of certain collateral, the Company may have been in default under the debt agreement relating to the financing of the Company's Los Angeles International Airport (\"LAX\") maintenance facility. At March 31, 1995 the principal balance of the applicable obligation was approximately $64 million and at April 12, 1995, the Company was in negotiations with the creditor. As a result of the progress in the ATR and LAX maintenance facility negotiations, the Company does not anticipate that the foregoing matters will have a material adverse effect on the Company.\nThe Company has no current plans to take other actions in the future that would constitute additional events of default.\nAs a result of the defaults and cross-defaults described above that were continuing at April 12, 1995, approximately $489.9 million of the Company's long-term debt and capital lease obligations were classified as debt and capital leases in default within current liabilities as of December 31, 1994. While the Company does not believe it is probable that it will be required to fund such defaulted obligations in the next twelve months, generally accepted accounting principles require that such defaulted obligations be classified as current liabilities at December 31, 1994. In addition, certain operating leases with remaining aggregate rentals of $1.4 billion as of December 31, 1994 were in default or cross default at April 12, 1995. See Notes 5 and 6.\nNOTE 2 - PREDECESSOR COMPANY CHAPTER 11 REORGANIZATION\nOn April 16, 1993, the United States Bankruptcy Court for the District of Delaware (the \"Bankruptcy Court\") confirmed the Plan of Reorganization of Holdings and all its subsidiaries that had filed for Chapter 11 reorganization, including, among others, Continental, System One and Chelsea Catering Corporation (\"Chelsea\") (collectively, the \"Debtors\"). The Reorganization became effective on April 27, 1993 (the \"Effective Date\"). The Reorganization resolved several large contingent claims that had burdened the Company. Such claims and contingencies included the Company's liability to the Pension Benefit Guaranty Corporation (the \"PBGC\") related to pension plans previously maintained by Eastern Air Lines, Inc. (\"Eastern\") (the \"PBGC Settlement\") and the Company's potential liability to Eastern (or its creditors) as a result of certain transactions entered into with Eastern prior to 1989. Certain of Eastern's former employees continue to assert claims against the Company, including demands that former Eastern pilots be integrated into Continental's work force.\nPursuant to the Reorganization, pre-existing equity interests of the Company were cancelled, the Company's obligations to other prepetition creditors were restructured and general unsecured nonpriority prepetition creditors became entitled, in full satisfaction of their claims, to share in $6,523,952 of cash and fixed pools of Class A Common Stock (\"Class A\") and Class B Common Stock (\"Class B\") of the Reorganized Company.\nPursuant to the Reorganization, on the Effective Date, all of the Debtors other than Continental were merged with and into Continental. Continental capitalized two wholly owned subsidiaries, Continental Express, Inc. (\"Express\") and System One, which continue the commuter airline and computer reservations and related businesses, respectively, of certain of the Debtors, by transferring certain assets and liabilities to such subsidiaries. Also, on the Effective Date, Continental transferred the assets of its Continental\/Air Micronesia division to Continental Micronesia, Inc. (\"CMI\"), an indirect subsidiary 91.0%-owned by Continental which continues Continental's western Pacific operations.\nAs part of the Reorganization and an Investment Agreement dated November 12, 1992, as amended, between Continental, Holdings, Air Partners, L.P. (\"AP\") and Air Canada (\"AC\"), on the Effective Date (i) AP purchased for an aggregate of $55 million (less certain fees) 2,740,000 shares of Class A and 2,260,000 shares of Class B and warrants to purchase an aggregate of 1,519,734 additional shares of Class A and 3,382,632 additional shares of Class B; (ii) AC purchased for an aggregate of $55 million (less certain fees) 1,373,216 shares of Class A and 3,626,784 shares of Class B and warrants to purchase an aggregate of 1,367,880 additional shares of Class A and 4,849,755 additional shares of Class B; (iii) enRoute Enterprises USA Inc., an indirect wholly owned subsidiary of AC, purchased 300,000 shares of Continental's 12% Cumulative Preferred Stock (\"12% Preferred Stock\") for $30 million; (iv) Continental issued to itself, as Distribution Agent, 1,900,000 shares of its Class A and 5,042,368 shares of its Class B for the benefit of general unsecured creditors under the Plan of Reorganization; (v) Continental issued 493,621 shares of Class B to the Master Trust for the Continental Airlines, Inc. Retirement Plan; and (vi) Continental issued to GE Capital, as commitment consideration for its loan to CMI, 171,000 shares of its newly- authorized 8% Cumulative Preferred Stock (\"8% Preferred Stock\"). As a result of such issuances, as of April 27, 1993, AC had 28.7% of the equity interest and 24.3% of the voting power and AP had 28.7% of the equity interest and 41.5% of the voting power of Continental without giving effect to the warrants.\nNonoperating reorganization items recorded by the Predecessor Company consisted of the following (in millions):\nNOTE 3 - FRESH START REPORTING\nIn connection with its emergence from bankruptcy on April 27, 1993, Continental adopted fresh start reporting in accordance with SOP 90-7. The fresh start reporting common equity value of $615 million was determined by the Company with the assistance of its financial advisors. The significant factors used in the determination of this value were analyses of publicly available information of other companies believed to be comparable to the Company, industry, economic and overall market conditions and historical and estimated performance of the airline industry; discussions with various potential investors; and certain financial analyses, including discounted future cash flows.\nUnder fresh start reporting, the reorganization value of the entity has been allocated to the Reorganized Company's assets and liabilities on a basis substantially consistent with the purchase method of accounting. The portion of reorganization value not attributable to specific tangible or identifiable intangible assets of the Reorganized Company has been reflected as \"Reorganization Value in Excess of Amounts Allocable to Identifiable Assets\" in the accompanying consolidated balance sheet as of December 31, 1993. The fresh start reporting adjustments, primarily related to the adjustment of the Company's assets and liabilities to fair market values, will have a significant effect on the Company's future statements of operations. The more significant adjustments relate to increased depreciation and amortization expense relating to aircraft, routes, gates and slots and reorganization value in excess of amounts allocable to identifiable assets; reduced aircraft rent expense; and increased interest expense.\nNOTE 4 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Principles of Consolidation -\nThe consolidated financial statements of the Reorganized Company include the accounts of Continental and its wholly owned operating subsidiaries, System One and Express, as well as CMI. The minority interest holder of CMI has rights to acquire the minimum number of additional shares of CMI necessary to cause Continental's equity interest to decline below 80.0% if certain events relating to the defined benefit plans of Continental occur. The consolidated financial statements of the Predecessor Company include the accounts of Holdings and its wholly owned operating subsidiaries, Continental, System One and Chelsea.\nThe companies operate within the air transportation industry. All significant intercompany transactions have been eliminated in consolidation.\n(b) Cash and Cash Equivalents -\nCash and cash equivalents consist of cash and short-term, highly liquid investments which are readily convertible into cash and have original maturities of three months or less. Approximately $118.7 million and $102.4 million of cash and cash equivalents at December 31, 1994 and December 31, 1993, respectively, were held in restricted arrangements relating primarily to payments for workers' compensation claims and in accordance with the terms of certain other agreements.\n(c) Spare Parts and Supplies -\nFlight equipment expendable parts and supplies were recorded at fair market values (which approximated average cost) as of April 27, 1993; subsequent purchases are valued at average cost. An allowance for obsolescence for flight equipment expendable parts and supplies is accrued to allocate the costs of these assets, less an estimated residual value, over the estimated useful lives of the related aircraft and engines.\n(d) Property and Equipment -\nProperty and equipment were recorded at fair market values as of April 27, 1993; subsequent purchases are valued at cost and are depreciated to estimated residual values over their estimated useful lives using the straight-line method. Estimated useful lives for such assets are 15 to 28 years from date of manufacture for all owned jet and certain commuter aircraft; 9 to 21 years, depending on the lease period, for aircraft acquired under long-term capital leases; and 2 to 25 years for other property and equipment, including airport facility improvements. Effective April 27, 1993, Continental revised the estimated useful lives of its Stage III aircraft from 28 years from date of manufacture to 25 years.\n(e) Intangible Assets -\nRoutes are amortized on a straight-line basis over 40 years, gates over the stated term of the related lease and slots over 20 years. Routes, gates and slots are comprised of the following (in millions):\nReorganization value in excess of amounts allocable to identifiable assets is amortized on a straight-line basis over 20 years. The carrying value of intangible assets is reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that the Company's intangible assets will not be recoverable, as determined based on the undiscounted cash flows over the remaining amortization period, the Company's carrying value of the intangible assets is reduced by the estimated shortfall of cash flows.\n(f) Air Traffic Liability -\nPassenger revenues are recognized when transportation is provided rather than when a ticket is sold. The amount of passenger ticket sales not yet recognized as revenue is reflected in the accompanying consolidated balance sheets as air traffic liability. The Company performs periodic evaluations of this estimated liability, and any adjustments resulting therefrom, which can be significant, are included in results of operations for the periods in which the evaluations are completed. In the third quarter of 1993, the Company recorded an adjustment to increase passenger revenues by $75 million as a result of completion of a periodic evaluation.\nContinental sponsors a frequent flyer program (\"OnePass\") and records an estimated liability for the incremental cost associated with providing the related free transportation at the time a free travel award is earned. The liability is adjusted periodically based on awards earned and awards redeemed.\n(g) Passenger Traffic Commissions -\nPassenger traffic commissions are recognized as expense when the transportation is provided and the related revenue is recognized. The amount of passenger traffic commissions not yet recognized as expense is included in prepayments and other in the accompanying consolidated balance sheets.\n(h) Deferred Income Taxes -\nDeferred income taxes reflect the net tax effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and the income tax amounts.\n(i) Deferred Credit - Aircraft Operating Leases -\nAircraft operating leases were adjusted to fair market value at April 27, 1993. The net present value of the difference between the stated lease rates and the fair market rates has been recorded as a deferred credit in the accompanying consolidated balance sheets. The deferred credit is increased through charges to interest expense and decreased on a straight-line basis as a reduction in rent expense over the applicable lease periods, generally one to 15 years.\n(j) Maintenance and Repair Costs -\nMaintenance and repair costs for owned and leased flight equipment, including the overhaul of aircraft components, are charged to operating expense as incurred.\n(k) Petroleum Option Contracts -\nGains on petroleum option contracts are recognized as a component of fuel expense when the underlying fuel being hedged is used.\n(l) Earnings (Loss) per Share -\nEarnings (loss) per common share computations are based upon earnings (loss) applicable to common shares and the average number of shares of common stock and dilutive common stock equivalents (stock options, warrants and restricted stock) outstanding. The number of shares used in the computation for the year ended December 31, 1994 and the period April 28, 1993 through December 31, 1993 was 26,056,897 and 18,022,918, respectively. Preferred stock dividend requirements (including additional dividends on unpaid dividends) and accretion to redemption value on preferred stock increased the net loss for this computation by approximately $5.7 million and $3.5 million for the year ended December 31, 1994 and for the period April 28, 1993 through December 31, 1993, respectively. On the Effective Date, all of the outstanding common and preferred stock of Holdings was cancelled. Information regarding the earnings (loss) per share computation relating to the pre-reorganization stock is not comparable with data provided for Class A and Class B and is therefore not included.\n(m) Reclassifications -\nCertain reclassifications have been made in the prior year's financial statements to conform to the current year presentation.\nNOTE 5 - LONG-TERM DEBT\nContinental's long-term debt was recorded at fair market value at April 27, 1993. The fair market value adjustment is amortized to interest expense over the life of the debt. Long-term debt as of December 31 is summarized as follows (in millions of dollars):\nSubstantially all of Continental's property, equipment and spare parts and supplies are subject to agreements securing indebtedness of Continental.\nContinental has various loan and lease obligations with GE Capital which were renegotiated in March 1995. In addition, the Company is in default under various loan agreements. See Note 1.\nContinental and CMI have various loan agreements containing significant financial covenants including, among other things, minimum cash balance requirements, consolidated net worth requirements, restrictions on the payment of dividends, restrictions on new borrowings and mandatory prepayments upon sale of certain assets. As of December 31, 1994, CMI had a minimum cash balance requirement of $23.7 million, net assets of $286.7 million and was restricted from paying dividends in excess of approximately $48.7 million.\nIn December 1993, the Company obtained a $50 million secured revolving credit facility, the proceeds from which must be used to finance certain aircraft purchase deposits. During 1994, Continental drew down approximately $21.5 million and repaid a total of $31.6 million of such facility. The revolving credit agreement contains a financial covenant relating to minimum cash balance requirements and is collateralized by certain accounts receivable and the related aircraft agreements.\nMaturities of long-term debt due over the next five years (including the scheduled repayments of debt in default) are as follows (in millions):\nAs of December 31, 1994 and 1993, the prime, LIBOR and Eurodollar rates associated with Continental's indebtedness approximated 8.5% and 6.0%, 6.5% and 3.4%, and 6.3% and 4.0%, respectively.\nNOTE 6 - LEASES\nContinental leases certain aircraft and other assets under long-term lease arrangements. Other leased assets include real property, airport and terminal facilities, sales offices, maintenance facilities, training centers and general offices. Most leases also include renewal options and some aircraft leases include purchase options.\nAt December 31, 1994, the scheduled future minimum lease payments under capital leases and the scheduled future minimum lease rental payments required under aircraft and engine operating leases that have initial or remaining noncancellable lease terms in excess of one year are as follows (in millions):\n______________ * These amounts have not been reduced to reflect the Company's fresh start- related revaluation of leases to fair market value as of April 27, 1993 (see Note 4(i)).\nIn March and April 1995, the Company successfully completed negotiations with lessors of 11 narrowbody aircraft and 16 widebody aircraft which resulted in the deferral of payments due in 1995 and 1996 to later years. Such deferrals are not reflected in the tables above. Operating leases with remaining lease payments of $1.4 billion as of December 31, 1994 are in default as of April 12, 1995. Scheduled repayments have not been adjusted in the above table. See Note 1.\nNot included in the above operating lease table is approximately $240 million in annual minimum lease payments relating to non-aircraft leases, principally airport and terminal facilities and related equipment. See Note 1 for a discussion of the Denver lease.\nThe Company's total rental expense for all operating leases, net of sublease rentals, was $674.6 million, $666.2 million and $645.9 million in 1994, 1993 and 1992, respectively.\nAs of December 31, 1994, Continental remains contingently liable on $202.1 million of long-term lease obligations of USAir, Inc. (\"USAir\") related to the East End Terminal at LaGuardia. In the event USAir defaults on such obligations, Continental may be required to cure the default, at which time it would have the right to reoccupy the terminal.\nNOTE 7 - FINANCIAL INSTRUMENTS\n(a) Cash equivalents -\nCash equivalents consist primarily of commercial paper with maturities of three months or less and approximate fair value due to the short maturity of three months or less.\n(b) Investment in Marketable Equity Securities -\nContinental's investment in America West is classified as available- for-sale and carried at aggregate market value of $16.6 million at December 31, 1994. An unrealized loss of $2.2 million representing the excess of cost over market value is reflected in stockholders' equity.\n(c) Petroleum Option Contracts -\nThe Company enters into petroleum option contracts to protect against a sharp increase in jet fuel prices. These option contracts generally cover the Company's forecasted jet fuel needs for the next three to six months. At December 31, 1994, the Company had options outstanding with an aggregate contract value of approximately $140 million. At December 31, 1994, the fair value of the option contracts was immaterial as the strike price under these contracts exceeded the current spot rate. During the year ended December 31, 1994, option hedging activities reduced fuel expense by approximately $2.2 million, net of the premiums associated with these options.\nThe Company is exposed to credit loss in the event of nonperformance by the counterparty on the petroleum option contracts, however, the Company does not anticipate nonperformance by this counterparty. The amount of such exposure is generally the unrealized gains, if any, on such option contracts.\n(d) Debt -\nThe fair value of the Company's debt with a carrying value of $1.34 billion and $1.53 billion as of December 31, 1994 and December 31, 1993, respectively, estimated based on the discounted amount of future cash flows using the current incremental rate of borrowing for a similar liability or quoted market prices, approximates $1.29 billion and $1.56 billion, respectively. The fair value of the remaining debt (with a carrying value of approximately $84.4 million and $53.1 million, respectively, and primarily relating to modification notes) was not practicable to estimate due to the large number and small dollar amounts of these notes.\nNOTE 8 - PREFERRED AND COMMON STOCK\nOn the Effective Date, all of the then outstanding equity securities of the Predecessor Company were cancelled, including all outstanding common and preferred stock of Continental and Holdings. Continental's Restated Certificate of Incorporation authorizes the issuance of 10 million shares of preferred stock, 50 million shares each of Class A, Class C Common Stock (\"Class C\") and Class D Common Stock (\"Class D\") and 100 million shares of Class B.\nRedeemable Preferred Stock\nPursuant to the Plan of Reorganization and the Investment Agreement, newly authorized shares of redeemable preferred stock were issued. Redeemable preferred stock consists of the following:\nHolders of 12% Preferred Stock and 8% Preferred Stock are entitled to receive, when and if declared by the Board of Directors (the \"Board\") out of legally available funds of the Company, cumulative dividends payable quarterly in cash at an annual rate of $12 and $8 per share for 12% Preferred Stock and 8% Preferred Stock, respectively. To the extent net income, as defined, for any calendar quarter is less than the amount of dividends due on all outstanding shares of 12% Preferred Stock for such quarter, the Board may declare dividends payable in additional shares of 12% Preferred Stock in lieu of cash. At any time, the Company may redeem, in whole or in part, on a pro rata basis among the stockholders, any outstanding shares of 12% Preferred Stock or 8% Preferred Stock. All outstanding shares of both series of preferred stock are mandatorily redeemable on April 27, 2003 out of legally available funds. In each case, the redemption price is $100 per share plus accrued unpaid dividends. Neither series of preferred stock is convertible into shares of common stock and neither series has voting rights, except under limited circumstances. The 8% Preferred Stock ranks pari passu with the 12% Preferred Stock as to payment of dividends and liquidation. As of December 31, 1994, the Company had approximately $8.9 million of dividends on its preferred stock in arrears.\nThe Company recorded a $222,000 and $134,000 charge against additional paid-in capital related to the accretion of the difference between redemption value and fair market value at date of issuance for the 8% Preferred Stock for the year ended December 31, 1994 and for the period from April 28, 1993 through December 31, 1993, respectively.\nCommon Stock\nContinental has two classes of common stock outstanding, Class A and Class B. Holders of shares of Class A and Class B are entitled to receive dividends when and if declared by the Board. Each share of Class A is entitled to 10 votes per share and each share of Class B is entitled to one vote per share. Pursuant to a stockholders' agreement, AC and AP have agreed to vote their shares for the election of six directors nominated by AC, six directors nominated by AP and six directors not affiliated with AP or AC. AC has the right, subject to foreign ownership restrictions, to convert shares of Class B into shares of Class A. Also, AC has the limited right, in certain circumstances, to convert its Class A into Class C and AP has the limited right, in certain circumstances, to convert its Class A into Class D. No person may hold or own Class C or Class D stock, respectively, other than AC and certain of its affiliates or AP and certain of its affiliates. The Class C and Class D common stock, if issued, would preserve the rights of each of AC and AP, respectively, to elect six directors to the Company's Board in certain circumstances, including a sale by the other party of its stock.\nOn December 14, 1993, the Company sold 8,086,579 shares of Class B common stock in an underwritten public offering realizing net proceeds of approximately $153.1 million. In January 1994, AC converted 287,840 shares of Class B into an equal number shares of Class A to preserve its percentage of total voting power. In July 1994, 1,000,000 shares of restricted Class B were granted and issued to substantially all employees at or below the manager or equivalent level and 182,000 shares of restricted Class B were granted and issued to key officers. See Note 9. As of December 31, 1994, AC had 18.7% of the equity interest and 23.9% of the voting power and AP had 18.7% of the equity interest and 35.6% of the voting power.\nWarrants\nThe Company has outstanding 11,120,001 Class A Warrants and Class B Warrants (collectively, the \"Warrants\") of which 4,902,366 Warrants are held by AP and 6,217,635 Warrants are held by AC. Each Warrant entitles the holder to purchase one share of Class A or Class B. The Warrants are exercisable as follows: (i) 7,413,334 Warrants (1,964,534 Class A Warrants and 5,448,800 Class B Warrants) have an initial exercise price of $15 per share, and (ii) 3,706,667 Warrants (923,080 Class A Warrants and 2,783,587 Class B Warrants) have an initial exercise price of $30 per share. The warrants expire on April 27, 1998.\nNOTE 9 - STOCK PLANS AND AWARDS\nOn March 4, 1994, the Board of Directors adopted the Continental Airlines, Inc. 1994 Employee Stock Purchase Plan (the \"Stock Purchase Plan\") effective July 1, 1994 and the Continental Airlines, Inc. 1994 Incentive Equity Plan (the \"Incentive Plan\"), which plans were approved by the stockholders of the Company at the annual stockholders' meeting on June 30, 1994.\nUnder the Company's Stock Purchase Plan, all full and part-time employees of the Company who are on the United States payroll may purchase shares of Class B at 85% of the lower of fair market value on the first or last business day of a calendar quarter. Subject to adjustment, a maximum of 4,000,000 shares of Class B are authorized for purchase under the Stock Purchase Plan. In January 1995, 118,069 shares of Class B were issued in connection with the Stock Purchase Plan.\nUnder the Incentive Plan, key officers and employees of the Company and its subsidiaries may be selected by the Human Resources Committee of the Board of Directors (the \"Committee\") to receive any or all of the following: stock options, restricted stock, long-term incentive awards and annual incentive awards subject to adjustment. The Incentive Plan also provides for each outside director to receive on the day following the annual stockholders meeting options to purchase 1,500 shares of Class B. Subject to adjustment, the number of shares of Class B that may be issued under the Incentive Plan will not in the aggregate exceed 2,300,000. The following table summarizes stock option transactions pursuant to the Company's Incentive Plan for the year ended December 31, 1994:\nGranted*. . . . . . . . . . . . . . . . . . . . . . . . . 2,111,000\nExercised . . . . . . . . . . . . . . . . . . . . . . . . -\nCancelled . . . . . . . . . . . . . . . . . . . . . . . . (265,000)\nOutstanding at December 31, 1994. . . . . . . . . . . . . 1,846,000\nAverage option price per share: Options exercised. . . . . . . . . . . . . . . . . . . . -\nOptions outstanding at end of year . . . . . . . . . . . $20.13\nOptions exercisable at end of year. . . . . . . . . . . . 123,875\n* The option price for all stock options is equal to 100% of the fair market value of Continental's common stock at the date of grant.\nThe stock options generally vest over a four-year period.\nIn addition, the Incentive Plan permits awards of restricted stock to participants, subject to one or more restrictions, including a restriction period and a purchase price, if any, to be paid by the participant, as determined by the Committee. The number of shares of common stock that may be granted or sold as restricted stock under the Incentive Plan may not in the aggregate exceed 300,000 shares of Class B. As of December 31, 1994, 152,000 shares of restricted stock were outstanding with no cost to the participants. These shares vest over a two-year period. During 1994, 30,000 shares were forfeited and returned to treasury stock. At December 31, 1994, 302,000 shares of common stock were available for future grants of stock options or restricted stock under the Incentive Plan. Additionally, on March 4, 1994, the Board approved a one-time grant of 1,000,000 shares of restricted stock to substantially all employees at or below the Manager level. These shares were issued at no cost to the employee and vest over a four-year period. Unvested shares of restricted stock are subject to certain transfer restrictions and forfeiture under certain circumstances. The unearned portion of restricted stock issued for future service, representing the fair market value of the stock on the date of award, is being amortized to wages, salaries and related costs over the vesting period.\nThe Board of Directors, on March 4, 1994, also approved a profit sharing program under which 15% of the Company's pre-tax earnings (before unusual or nonrecurring items) will be distributed each year to all employees on a pro rata basis according to base salary.\nNOTE 10 - EMPLOYEE BENEFIT PLANS\nThe Company has noncontributory defined benefit pension and defined contribution (including 401(k) savings) plans. Substantially all domestic employees of the Company are covered by one or more of these plans. The benefits under the active defined benefit pension plan are based on years of service and an employee's final average compensation. Total pension expense for the defined benefit plans was $50.7 million, $52.1 million and $36 million and total expense for the defined contribution plans was $0.9 million, $0.3 million and $2.1 million for 1994, 1993 and 1992, respectively.\nNet periodic pension cost of the Company's defined benefit plans for 1994, 1993 and 1992 included the following components (in millions):\nIn connection with the Reorganization, the Company recorded an additional liability of approximately $146.1 million (not included in pension expense above) related to the grant of past service credit under the Company's retirement plan for domestic employees and the recognition of unamortized losses and costs. The following table sets forth the defined benefit plans' funded status amounts as of December 31, 1994 and 1993 (in millions):\nIn accordance with Statement of Financial Accounting Standards No. 87 \"Employers' Accounting for Pensions\", an additional minimum pension liability for certain plans, representing the excess of accumulated benefits over plan assets and accrued pension costs, was recognized at December 31, 1994 and 1993. A corresponding amount was recognized as a separate reduction to stockholders' equity.\nPlan assets consist primarily of equity securities, long-term debt securities and short-term investments. Pursuant to the Reorganization, the PBGC Settlement and the Investment Agreement, on April 27, 1993, Continental issued 493,621 shares of Class B to the Master Trust for the Continental Airlines, Inc. Retirement Plan.\nThe weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 8.75%, 7.50% and 8.25% for 1994, 1993 and 1992, respectively. The expected long-term rate of return on assets (which is used to calculate the Company's return on pension assets for the current year) was 9.25%, 9.25% and 9.97% for 1994, 1993 and 1992, respectively. The weighted average rate of salary increases was 4.3%, 5.3% and 6.3% for 1994, 1993 and 1992, respectively. The unrecognized net gain (loss) are amortized on a straight-line basis over the average remaining service period of employees expected to receive a plan benefit.\nContinental's policy is to fund the noncontributory defined benefit pension plans in accordance with Internal Revenue Service (\"IRS\") requirements as modified, to the extent applicable, by agreements with the IRS.\nNOTE 11 - INCOME TAXES\nEffective April 27, 1993, the Reorganized Company adopted the liability method of accounting for income taxes required by SFAS No. 109 (which was adopted January 1, 1993 by the Predecessor Company). Under the provisions of SFAS 109, the Company elected not to restate prior years' consolidated financial statements. The cumulative effect of initial adoption on prior years' retained earnings was not material. Additionally, as of January 1, 1993, the effect of the adoption of SFAS 109 upon income before income taxes was not material.\nThe reconciliation of income tax computed at the United States federal statutory tax rates to income tax benefit for the year ended December 31, 1994 and the period April 28, 1993 through December 31, 1993 are as follows (in millions):\nThe significant component of the provision for income taxes for the year ended December 31, 1994 and the period April 28, 1993 through December 31, 1993 was a deferred tax benefit of $42.2 million and $12.8 million, respectively.\nThe provision for income taxes of the Predecessor Company for the period from January 1 through April 27, 1993 and for the year ended December 31, 1992 was $2.1 million and $0.5 million, respectively. The provision for income taxes of the Predecessor Company represents only state income taxes. Due to losses generated, there is no provision for federal income taxes for the period from January 1, 1993 through April 27, 1993 and for the year ended December 31, 1992.\nThe provision for income taxes for the period from April 28, 1993 through December 31, 1993 reflects an increase of $1.5 million which is related to the increase in the corporate tax rate from 34.0% to 35.0% enacted by the Revenue Reconciliation Act of 1993.\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 related amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets as of December 31, 1994 and 1993 are as follows (in millions):\nAt December 31, 1994, the Company has net operating loss carryforwards of approximately $2.7 billion for income tax purposes that will expire from 1995 through 2009 and investment tax credit carryforwards of approximately $44.7 million that will expire through 2001. As a result of the change in ownership of the Company on April 27, 1993, the ultimate utilization of the Company's net operating losses and investment tax credits could be limited.\nFor financial reporting purposes, a valuation allowance of $844.2 million has been recognized to offset the deferred tax assets related to a portion of those carryforwards. The Company has considered prudent and feasible tax planning strategies in assessing the need for the valuation allowance. The Company has assumed $194 million of benefit attributable to such tax planning strategies. In the event the Company were to determine in the future that any such tax planning strategies would not be implemented, an adjustment to the deferred tax liability would be charged to income in the period such determination was made. In the event the Company recognizes additional tax benefits related to net operating loss carryforwards and investment tax credit carryforwards attributable to the Predecessor Company, those benefits would be applied to reduce Reorganization Value in Excess of Amounts Allocable to Identifiable Assets and other intangibles to zero, and thereafter as an addition to paid-in capital.\nThe deferred tax valuation allowance increased from $667.3 million at December 31, 1993 to $844.2 million at December 31, 1994. This increase is related to deferred tax assets associated with certain nonrecurring charges and net operating losses that may not be realizable.\nApproximately $545 million of the Company's net operating losses can only be used to offset the separate parent company taxable income of Continental Airlines, Inc. Approximately $17.8 million of the Company's investment tax credits can only be used to offset the separate parent company tax liability of Continental Airlines, Inc.\nNOTE 12 - NONRECURRING CHARGES\nDuring the fourth quarter of 1994, the Company recorded a nonrecurring charge of approximately $446.8 million associated primarily with (i) the planned early retirement of certain aircraft and (ii) closed or underutilized airport and maintenance facilities and other assets.\nApproximately $278 million of the nonrecurring charge was associated with the planned early retirement during 1995 of 24 widebody jet aircraft (21 Airbus A300s and three Boeing 747s), 23 narrowbody Boeing 727 jet aircraft and five Dash 7 turboprop aircraft, including a provision for the disposal of the related inventory. All of these aircraft (except for two owned Airbus A300 aircraft) have remaining lease obligations beyond the planned retirement dates for such aircraft. The $278 million charge represents the Company's best estimate of the expected loss based upon, among other things, the anticipated resolution of negotiations with certain lessors as well as anticipated sublease rental income of certain aircraft and engines. To the extent the actual resolution of the negotiations, actual sublease rental income or other events or amounts vary from the Company's estimates, the actual charge could be different from the amount estimated.\nApproximately $168.8 million of the nonrecurring charge was associated with the closure of the LAX maintenance facility, underutilized airport facilities and other assets (primarily associated with DIA). This portion of the charge relates to the Company's contractual obligations under the related lease agreements and the write-off of related leasehold improvements, less an estimated amount for sublease rental income. However, should actual sublease rental income be different from the Company's estimates, the actual charge could be different from the amount estimated.\nApproximately $324.2 million of the nonrecurring charge represents an actual cash outlay to be incurred over the remaining lease terms (of from one to 15 years) and approximately $122.6 million represents a noncash charge associated with a write-down of certain assets (principally inventory and flight equipment) to expected net realizable value. Continental expects to finance the cash outlays primarily with internally generated funds.\nNOTE 13 - COMMITMENTS AND CONTINGENCIES\nCapital Commitments\nOn March 31, 1995, the Company signed agreements with Boeing and certain engine manufacturers that would defer certain aircraft and engine deliveries that previously were scheduled to occur in 1996 and 1997, to cancel orders for certain option aircraft and to obtain refunds of deposits corresponding to the revised delivery schedule.\nContinental has firm commitments to take delivery of 22 new 737 and five new 757 aircraft in 1995, one new 757 aircraft in 1996 and 43 new jet aircraft during the years 1998 through 2002. The estimated aggregate cost of these aircraft is approximately $3.4 billion. In December 1994, Express contracted with Beech Acceptance Corporation (\"Beech\") for the purchase and financing of 25 Beech 1900-D aircraft at an estimated aggregate cost of $104 million, excluding price escalations. Deliveries of the Beech aircraft are scheduled in 1995 and 1996. As of December 31, 1994, Continental had made deposits on jet and turboprop aircraft orders of approximately $166.1 million.\nContinental expects its 1995 capital expenditures, exclusive of aircraft, to aggregate approximately $83 million primarily relating to aircraft modifications, passenger terminal facility improvements and office, maintenance, telecommunications and ground equipment.\nSee Note 1 for a discussion of debt and operating lease obligations in default. See Note 6 for a discussion of Continental's contingent liability on long-term lease obligations.\nLegal Proceedings\nIn 1992, the Company agreed to lease (i) 20 gates at DIA for a period of five years from the date DIA opened, (ii) four of such gates for an additional five years and (iii) a substantial amount of operational space in connection with the gates and for the terms set forth in the agreement. During 1994, the Company significantly reduced its Denver operations. The City filed a complaint on February 22, 1995 against the Company in the United States District Court for the District of Colorado seeking a determination that the Company materially breached and repudiated the lease and a March 1994 agreement to pay certain costs associated with the delays in opening DIA. In addition, the City sought a judgment declaring the City's rights and the Company's obligations and the award of an injunction that the Company perform such obligations. The City also sought attorneys fees and costs relating to its suit. The Company believes it has defenses against the City, as well as claims against the City that justify rescission of the lease or, if rescission is not awarded by the court, a substantial reduction in the Company's obligations thereunder.\nThe Company, the City and certain other parties have entered into an agreement (\"Settlement\") that was approved by the Denver City Council on April 10, 1995. The Settlement provides for the release of certain claims and the settlement of certain litigation filed by the City against the Company and reduces (i) the full term of the lease to five years, subject to certain rights of renewal granted to Continental, (ii) the number of gates leased from 20 to 10, (iii) the amount of leased operational and other space by approximately 70%. The reduced gates and operational space exceed Continental's current needs at the airport, and the Company is negotiating with America West Airlines, Inc. (\"America West\") and Frontier Airlines to sublease up to five of its remaining gates and certain operational space. The Company will attempt to sublease additional facilities and operational space as well. To the extent Continental is able to sublease any of its gates and operational space, its costs under the lease would be reduced.\nThe Settlement may still be challenged by certain parties, including by other air carriers, and the Company cannot predict what the outcome of any such challenge would be. Certain air carriers have taken the position that an insufficient number of carriers have executed the Settlement. Failure to implement the Settlement could reduce or eliminate the Company's estimated savings at DIA.\nCertain parties continue to seek recovery for claims that were subject to the Company's Plan of Reorganization. For the most part, if such parties were successful on their claims, their recovery would be limited to the fixed pools of Company common stock and cash provided for in the Plan of Reorganization. Nevertheless, certain claims, if successful, could result in additional obligations being imposed upon the Company, including the possible indemnification of certain current and former officers and directors of the Company or its former parent. In addition, the Company is a party to certain lawsuits, and the subject of certain claims, which arose after the Company's bankruptcy proceedings were commenced and in the ordinary course of the Company's business. Although the amount sought in certain of these claims and proceedings is substantial, the Company cannot at this time reasonably estimate the possible loss or range of loss that could be experienced if any of the claims were successful. However, the Company believes that the resolution of these matters is unlikely to have a material adverse effect on the Company.\nNOTE 14 - RELATED PARTY TRANSACTIONS\nThe following is a summary of significant related party transactions which have occurred during 1994 and the period April 28, 1993 through December 31, 1993 other than those discussed elsewhere in the Notes to Consolidated Financial Statements.\nCMI and United Micronesia Development Association, Inc. (\"UMDA\"), the minority stockholder of CMI, have a services agreement whereby UMDA is paid a fee for certain services, which fee approximates 1.0% of CMI's revenues. For the year ended December 31, 1994 and the period April 28, 1993 through December 31, 1993, these fees totaled approximately $4.8 million and $3.5 million, respectively. As of December 31, 1994 and 1993, the Company had a payable to UMDA totaling approximately $7.2 million and $7.3 million, respectively. The payable bears interest at 12.0% per annum and matures in 2011. Annual principal and interest payments on the payable aggregating $1,000,000 per year are applied to reduce the 1.0% fee.\nIn connection with AC's investment in the Company, AC, AP and the Company agreed to identify and pursue opportunities to achieve cost savings, revenue enhancement or other synergies from areas of joint operation between the Company and AC. The Company and AC have entered into a series of synergies agreements, primarily in the areas of aircraft maintenance and commercial and marketing alliances (including agreements regarding coordination of connecting flights). The Company believes that the synergies agreements allocate potential benefits to the Company and AC in a manner that is equitable and commercially reasonable, and contain terms at least as favorable to the Company as could be obtained from unrelated parties. As a result of these agreements, Continental paid AC $29.1 million and $9 million for the year ended December 31, 1994 and from the period April 28, 1993 through December 31, 1993, respectively, primarily relating to aircraft maintenance. Continental also reimbursed AC and AP in 1993 for fees incurred in connection with their investment in Continental of $6.9 million and $11.1 million, respectively.\nGE Capital and General Electric Company, owner of 171,000 shares of the Company's 8% Preferred Stock, provide certain services to Continental such as repairing engines and the leasing of certain aircraft. Continental also has loans payable to GE Capital. See Note 5.\nUnder the amended agreements with GE Capital, if Air Partners disposes of any of its Class A shares, Continental must prepay deferred amounts totaling approximately $146 million and, at Continental's election, either (i) prepay loans totaling $150 million or (ii) pledge its Air Micronesia, Inc. stock as collateral for all GE Capital obligations.\nThe Company and America West have entered into a series of agreements during 1994 related to code-sharing and ground handling. The services provided are considered normal to the daily operations of both airlines. As a result of these agreements, Continental paid America West $0.5 million in 1994.\nNOTE 15 - FOREIGN OPERATIONS\nContinental conducts operations to various foreign countries. Operating revenues from foreign operations are as follows (in millions):\nDuring the third quarter of 1994, the Company recorded a favorable adjustment of $23.4 million as a result of the Company's estimate of awards expected to be redeemed for travel on Continental under its frequent flyer program.\nDuring the fourth quarter of 1994, nonrecurring charges of approximately $446.8 million were recorded for costs associated with grounding aircraft, reducing operations at certain airport facilities and modifying certain aircraft and facilities lease agreements.\nDuring the first quarter of 1993, reorganization-related charges of $11.6 million were partially offset by interest income of $3.1 million.\nDuring the second quarter of 1993, the Company recorded a gain of $34.9 million related to System One's sale to EDS of substantially all of the assets of its Airline Services Division. In addition, reorganization- related charges of $234.2 million were recorded. Fresh start adjustments totaling $719.1 million were recorded relating to the adjustment of assets and liabilities to fair market value as well as other miscellaneous fresh start adjustments of approximately $76.8 million. These fresh start adjustments were partially offset by the write-off of deferred gains on sale\/leaseback transactions of $218.6 million. The Company recorded an extraordinary gain of approximately $3.6 billion resulting from the extinguishment of prepetition obligations, including the write-off of a deferred credit related to Eastern of approximately $1.1 billion.\nDuring the third quarter of 1993, the Company recorded nonoperating charges totaling approximately $13.1 million related to the Company's termination of services to Australia and New Zealand and other expenses primarily related to the abandonment of airport facilities. Also included in passenger revenues is $75 million recorded as a result of completion of the Company's periodic evaluation of its air traffic liability account.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. There were no changes in or disagreements on any matters of accounting principles or financial statement disclosure between the Company and its independent public accountants during the registrant'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 REGISTRANT\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders to be held on June 5, 1995.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders to be held on June 5, 1995.\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 for the annual meeting of stockholders to be held on June 5, 1995.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nIncorporated herein by reference from the Company's definitive proxy statement for the annual meeting of stockholders to be held on June 5, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) The following financial statements are included in Item 8. \"Financial Statements and Supplementary Data.\":\nReport of Independent Auditors Report of Independent Public Accountants Consolidated Statements of Operations for each of the Three Years in the Period Ended December 31, 1994 Consolidated Balance Sheets as of December 31, 1994 and 1993 Consolidated Statements of Cash Flows for each of the Three Years in the Period Ended December 31, 1994 Consolidated Statements of Redeemable and Nonredeemable Preferred Stock and Common Stockholders' Equity (Deficit) for each of the Three Years in the Period Ended December 31, 1994 Notes to Consolidated Financial Statements\n(b) Financial Statement Schedules:\nReport of Independent Auditors Schedule I - Condensed Financial Information of Registrant (Parent Company Only) Schedule II - Valuation and Qualifying Accounts\nAll other schedules have been omitted because they are inapplicable, not required, or the information is included elsewhere in the consolidated financial statements or notes thereto.\n(c) Reports on Form 8-K.\nNone.\n(d) See accompanying Index to Exhibits.\nREPORT OF INDEPENDENT AUDITORS\nWe have audited the consolidated financial statements of Continental Airlines, Inc. (the \"Company\") as of December 31, 1994 and 1993, and for the year ended December 31, 1994 and the period from April 28, 1993 through December 31, 1993, and the consolidated statements of operations, redeemable and nonredeemable preferred stock and common stockholders' equity and cash flows for the period from January 1, 1993 through April 27, 1993 for Continental Airlines Holdings, Inc., and have issued our report thereon dated April 12, 1995 (included elsewhere in this Form 10-K). Our audits also included the financial statement schedules for these related periods listed in Item 14(b) of this Form 10-K. 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 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 set forth therein.\nERNST & YOUNG LLP\nHouston, Texas April 12, 1995\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nNOTES TO SCHEDULE I\n(a) See Notes 1 and 2 to Notes to Consolidated Financial Statements for a discussion of Continental Airlines, Inc. (the \"Company\" or \"Continental\") liquidity and predecessor company's emergence from bankruptcy.\n(b) The Condensed Financial Information of Registrant includes the accounts of Continental and its wholly owned subsidiary, Rubicon Indemnity, Ltd., a subsidiary formed for workers' compensation reinsurance purposes. This subsidiary has been included in Schedule I to properly reflect the parent company's workers' compensation liability.\n(c) Continental's long-term debt (parent company only) was recorded at fair market value at April 27, 1993. The fair market value adjustment is amortized to interest expense over the life of the debt. See Note 5 to Notes to Consolidated Financial Statements. Long-term debt as of December 31, 1994 and 1993 is summarized as follows (in millions):\nLong-term debt maturities, excluding $9.2 million of non-cash fair market value adjustments, due over the next five years are as follows (in millions):\nYear ending December 31, 1995. . . . . . . . . . . . . . . . . . . . . . . $157.8 1996. . . . . . . . . . . . . . . . . . . . . . . 144.2 1997. . . . . . . . . . . . . . . . . . . . . . . 167.2 1998. . . . . . . . . . . . . . . . . . . . . . . 142.4 1999. . . . . . . . . . . . . . . . . . . . . . . 154.3\nThe above maturities have not been adjusted to reflect the potential acceleration of certain obligations due to defaults under the loan agreements.\n(d) See Note 13 of Notes to Consolidated Financial Statements.\n(e) See Note 8 of Notes to Consolidated Financial Statements.\n(f) See Note 6 of Notes to Consolidated Financial Statements for a discussion of operating lease obligations in default.\n(g) The Company has not paid dividends on its common stock.\nOn April 27, 1993, Continental adopted fresh start reporting in accordance with Statement of Position 90-7 - \"Financial Reporting by Entities in Reorganization Under the Bankruptcy Code\", which resulted in adjustments to the Company's common stockholders' equity and the carrying values of assets and liabilities. Accordingly, the Parent Company only post-reorganization balance sheets and statements of operations have not been prepared on a consistent basis of accounting with the Parent Company only pre- reorganization balance sheet and statements of operations. See Note 3 of Notes to Consolidated Financial Statements.\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\nThese Statements should be read in conjunction with the Consolidated Financial Statements and Notes thereto and Notes to Schedule I.\n(a) The Condensed Financial Information of Registrant includes the accounts of Continental Airlines Holdings, Inc. (\"Holdings\") and certain special purpose subsidiaries (together, \"CTA\"), primarily formed to provide fuel purchasing services to Holdings' airline subsidiaries and to finance aircraft leased to Continental.\n(b) Prepetition long-term debt for CTA totaling approximately $312.9 million at December 31, 1992 was included in Estimated Liabilities Subject to Chapter 11 Reorganization Proceedings. Pursuant to the Reorganization and the PBGC Settlement, the PBGC receives the equity interest in all of CTA's debt-owned aircraft with the debt totaling approximately $135.2 million. Therefore, scheduled maturities for long-term debt of CTA are immaterial.\n(c) CTA did not pay dividends on its common stock in 1992.\n(a) Primarily represents fresh start adjustments in accordance with SOP 90-7.\nINDEX TO EXHIBITS OF CONTINENTAL AIRLINES, INC.\n2.1 Revised Third Amended Disclosure Statement Pursuant to Section 1125 of the Bankruptcy Code with Respect to Debtors' Revised Second Amended Joint Plan of Reorganization Under Chapter 11 of the United States Bankruptcy Code, as filed with the Bankruptcy Court on January 13, 1993 -- incorporated by reference from Exhibit 2.1 to Continental's Annual Report on Form 10-K for the year ended December 31, 1992 (File no. 0-09781) (the \"1992 10-K\").\n2.2 Modification of Debtors' Revised Second Amended Joint Plan of Reorganization dated March 12, 1993 -- incorporated by reference to Exhibit 2.2 to Continental's Current Report on Form 8-K, dated April 16, 1993 (the \"April 8-K\").\n2.3 Second Modification of Debtors' Revised Second Amended Joint Plan of Reorganization, dated April 8, 1993 -- incorporated by reference to Exhibit 2.3 to the April 8-K.\n2.4 Third Modification of Debtors' Revised Second Amended Joint Plan of Reorganization, dated April 15, 1993 -- incorporated by reference to Exhibit 2.4 to the April 8-K.\n2.5 Confirmation Order, dated April 16, 1993 -- incorporated by reference to Exhibit 2.5 to the April 8-K.\n3.1 Restated Certificate of Incorporation of Continental -- incorporated by reference to Exhibit 4.1 to the April 8-K.\n3.2 By-laws of Continental -- incorporated by reference to Exhibit 4.4 to the April 8-K.\n4.1 Specimen Class B Common Stock Certificates of the Company -- incorporated by reference to Exhibit 4.1 to Continental's Form S- 1 Registration Statement (No. 33-68870) (the \"1993 S-1\").\n4.2 Certificate of Designation of 12% Cumulative Preferred Stock -- incorporated by reference to Exhibit 4.2 to the April 8-K.\n4.3 Certificate of Designation of 8% Cumulative Preferred Stock -- incorporated by reference to Exhibit 4.3 to Continental's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993.\n4.4 Certificate of Correction to Certificate of Designation of 8% Cumulative Preferred Stock -- incorporated by reference to Exhibit 4.4 to the 1993 S-1.\n4.5 Subscription and Stockholders' Agreement - incorporated by reference to Exhibit 4.5 to the April 8-K.\n4.6 Registration Rights Agreement dated as of April 27, 1993, among Continental, Air Partners and Air Canada -- incorporated by reference to Exhibit 4.6 to the April 8-K.\n4.7 Warrant Agreement dated as of April 27, 1993, between Continental and Continental as warrant agent -- incorporated by reference to Exhibit 4.7 to the April 8-K.\n4.8 Loan Agreement dated as of April 27, 1993, among Continental Micronesia, Air Micronesia, Inc. and GE Capital -- incorporated by reference to Exhibit 4.8 to the April 8-K.\n4.8(a) Waiver, Consent and Amendment to CMI Loan Agreement, dated as of March 30, 1995, among CMI, Air Micronesia, Inc. and GE Capital -- filed herewith. (2)\n4.9 Loan Agreements dated as of April 27, 1993, between ASATT Corp. and Continental -- incorporated by reference to Exhibit 4.9 to the April 8-K.\n4.9(a) Waiver, Consent and Amendment to Series B-1 Loan Agreement, dated as of March 30, 1995, between Continental and Global Project & Structured Finance Corporation (successor by merger to ASATT Corp.) -- filed herewith. (2)\n4.9(b) Waiver, Consent and Amendment to Series B-2 Loan Agreement, dated as of March 30, 1995, between Continental and Global Project & Structured Finance Corporation (successor by merger to ASATT Corp.) -- filed herewith. (2)\n4.10 Loan Agreement dated as of April 27, 1993, between Continental and General Electric Company, individually and as agent -- incorporated by reference to Exhibit 4.10 to the 1993 S-1.\n4.10(a) Waiver, Consent and Amendment to Consolidation Loan Agreement, dated as of March 30, 1995, between Continental and General Electric Company, individually and as agent -- filed herewith. (2)\n4.11 Master Restructuring Agreement, dated as of March 30, 1995, between Continental and GE Capital -- filed herewith. (2)\n4.12 Agreement by Continental to furnish to the Commission, upon request, copies of certain instruments defining the rights of holders of long-term debt of the kind described in Item 601(b)(4) of Regulation S-K -- incorporated by reference to Exhibit 4.11 to the 1993 S-1.\n10.1 Master Agreement among Continental, System One and EDS, Continental Services Agreement between Continental and EDS, CRS Services Agreement between System One and EDS, and ASD Services and Acquisition Agreement between System One and EDS, each dated as of May 1, 1991 -- incorporated by reference to Exhibit 10.1 to Holdings' Quarterly Report on Form 10-Q for the quarter ended June 30, 1991. (1)\n10.2 Litigation Settlement Agreement, dated as of August 31, 1992, among the Pension Benefit Guaranty Corporation and, jointly and severally, each of the debtors (as defined) -- incorporated by reference to Exhibit 10.10 to the 1992 10-K.\n10.3 Agreement of Lease dated as of January 11, 1985, between the Port Authority of New York and New Jersey and People Express Airlines, Inc., regarding Terminal C (the \"Terminal C Lease\") -- incorporated by reference to Exhibit 10.61 to the Annual Report on Form 10-K of People Express Airlines, Inc. for the year ended December 31, 1984.\n10.4 Assignment of Lease with Assumption and Consent dated as of August 15, 1987, among the Port Authority of New York and New Jersey, People Express Airlines, Inc. and Continental -- incorporated by reference to Exhibit 10.2 to Continental's Annual Report on Form 10-K for the year ended December 31, 1987 (the \"1987 10-K\").\n10.5 Supplemental Agreements Nos. 1 through 6 to the Terminal C Lease -- incorporated by reference to Exhibit 10.3 to the Continental 1987 10-K.\n10.6 Supplemental Agreement No. 7 to the Terminal C Lease -- incorporated by reference to Exhibit 10.4 to Continental's Annual Report on Form 10-K for the year ended December 31, 1988.\n10.7 Supplemental Agreements No. 8 through 11 to the Terminal C Lease -- incorporated by reference to Exhibit 10.10 to the 1993 S-1.\n10.8(a)* Employment Agreement between the Company and Robert Ferguson -- incorporated by reference to Exhibit 10.11(a) to the 1993 S-1.\n10.8(b)* Termination Agreement between the Company and Robert Ferguson -- filed herewith.\n10.8(c)* Employment Agreement between the Company and Charles Goolsbee -- incorporated by reference to Exhibit 10.11(b) to the 1993 S-1.\n10.8(d)* Memorandum of Agreement between the Company and Charles Goolsbee -- filed herewith.\n10.8(e)* Employment Agreement between the Company and Gordon Bethune -- filed herewith.\n10.8(f)* Employment Agreement between the Company and Daniel Garton -- incorporated by reference to Exhibit 10.2 to Continental's Quarterly Report on Form 10-Q for the quarter ended September 30, 1994 (the \"1994 Third Quarter 10-Q\").\n10.8(g)* Employment Agreement between the Company and John Luth -- incorporated by reference to Exhibit 10.3 to the 1994 Third Quarter 10-Q.\n10.8(h)* Letter Agreement between the Company and John Luth -- filed herewith.\n10.8(i)* Employment Agreement between the Company and Donald Valentine -- filed herewith.\n10.9* Continental Airlines, Inc. 1994 Incentive Equity Plan -- incorporated by reference to Exhibit 4.3 to the Company's Form S- 8 Registration Statement (No. 33-81324).\n10.10 Not used.\n10.11 Purchase Agreement No. 1782, including exhibits and side letters thereto, between the Company and Boeing, effective April 27, 1993, relating to the purchase of Boeing 737-524 aircraft -- incorporated by reference to Exhibit 10.1 to Continental's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993 (the \"June 10-Q\"). (1)\n10.11(a) Supplemental Agreement No. 6 to Purchase Agreement No. 1782 between the Company and Boeing, dated March 31, 1995, relating to the purchase of Boeing 737-524 aircraft -- filed herewith. (2)\n10.12 Purchase Agreement No. 1783, including exhibits and side letters thereto, between the Company and Boeing, effective April 27, 1993, relating to the purchase of Boeing 757-224 aircraft -- incorporated by reference to Exhibit 10.2 to the June 10-Q. (1)\n10.12(a) Supplemental Agreement No. 4 to Purchase Agreement No. 1783 between the Company and Boeing, dated March 31, 1995, relating to the purchase of Boeing 757-224 aircraft -- filed herewith. (2)\n10.13 Purchase Agreement No. 1784, including exhibits and side letters thereto, between the Company and Boeing, effective April 27, 1993, relating to the purchase of Boeing 767-324ER aircraft -- incorporated by reference to Exhibit 10.3 to the June 10-Q. (1)\n10.13(a) Supplemental Agreement No. 3 to Purchase Agreement No. 1784 between the Company and Boeing, dated March 31, 1995, relating to the purchase of Boeing 767-324ER aircraft -- filed herewith. (2)\n10.14 Purchase Agreement No. 1785, including exhibits and side letters thereto, between the Company and Boeing, effective April 27, 1993, relating to the purchase of Boeing 777-224 aircraft -- incorporated by reference to Exhibit 10.4 to the June 10-Q. (1)\n10.14(a) Supplemental Agreement No. 3 to Purchase Agreement No. 1785 between the Company and Boeing, dated March 31, 1995, relating to the purchase of Boeing 777-224 aircraft -- filed herewith. (2)\n10.15 Lease Agreement dated as of May 1992 between the City and County of Denver, Colorado and Continental regarding Denver International Airport -- incorporated by reference to Exhibit 10.17 to the 1993 S-1.\n10.15(a) Supplemental Lease Agreement, including an exhibit thereto, dated as of April 3, 1995 between the City and County of Denver, Colorado and Continental and United Air Lines, Inc. regarding Denver International Airport -- filed herewith.\n10.16 Stock Subscription Warrant of Continental Micronesia granted to United Micronesia Development Association, Inc. -- incorporated by reference to Exhibit 10.18 to the 1993 S-1.\n10.17 Lease Agreement, as amended and supplemented, between the Company and the City of Houston, Texas regarding Terminal C of Houston Intercontinental Airport -- incorporated by reference to Exhibit 10.5 to Continental's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993 (the \"September 10-Q\").\n10.18 Agreement and Lease dated as of May 1987, as supplemented, between the City of Cleveland, Ohio and Continental regarding Cleveland Hopkins International Airport -- incorporated by reference to Exhibit 10.6 to the September 10-Q.\n10.19 Third Revised Investment Agreement dated April 21, 1994 between America West Airlines, Inc. and AmWest Partners, L.P. -- incorporated by reference to Exhibit 1 to the August 25, 1994 Schedule 13D.\n22.1 List of Subsidiaries of Continental -- incorporated by reference to Exhibit 22.1 to the 1993 S-1.\n23.1 Consent of Ernst & Young LLP -- filed herewith.\n23.2 Consent of Arthur Andersen LLP -- filed herewith.\n25.1 Powers of attorney executed by certain directors and officers of Continental -- filed herewith.\n27.1 Financial Data Schedule -- filed herewith.\n__________\n*These exhibits relate to management contracts or compensatory plans or arrangements.\n(1) The Commission has granted confidential treatment for a portion of this agreement. (2) The Company has applied to the Commission for confidential treatment of a portion of this exhibit.\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 AIRLINES, INC.\nBy \/s\/ DANIEL P. GARTON Daniel P. Garton Senior Vice President and Chief Financial Officer\nDate: April 12, 1995\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 Capacity Date\n(i) Principal Executive Officer:\nGORDON M. BETHUNE* President, April 12, 1995 Gordon M. Bethune Chief Executive Officer and Director\n(ii) Principal Financial Officer:\n\/s\/ DANIEL P. GARTON Senior Vice President April 12, 1995 Daniel P. Garton and Chief Financial Officer\n(iii) Principal Accounting Officer:\n\/s\/ MICHAEL P. BONDS Staff Vice President April 12, 1995 Michael P. Bonds and Controller\n(iv) A Majority of the Directors:\nTHOMAS J. BARRACK, JR.* Director April 12, 1995 Thomas J. Barrack, Jr.\nDAVID BONDERMAN* Director and April 12, 1995 David Bonderman Chairman of the Board\nJOEL H. COWAN* Director April 12, 1995 Joel H. Cowan\nPATRICK FOLEY* Director April 12, 1995 Patrick Foley\nROWLAND C. FRAZEE* Director April 12, 1995 Rowland C. Frazee\nHOLLIS L. HARRIS* Director April 12, 1995 Hollis L. Harris\nROBERT L. LUMPKINS* Director April 12, 1995 Robert L. Lumpkins\nDOUGLAS McCORKINDALE* Director April 12, 1995 Douglas McCorkindale\nDAVID E. MITCHELL, O.C.* Director April 12, 1995 David E. Mitchell, O.C.\nRICHARD W. POGUE* Director April 12, 1995 Richard W. Pogue\nWILLIAM S. PRICE* Director April 12, 1995 William Price\nDONALD L. STURM* Director April 12, 1995 Donald L. Sturm\nCLAUDE I. TAYLOR, O.C.* Director April 12, 1995 Claude I. Taylor, O.C.\nKAREN HASTIE WILLIAMS* Director April 12, 1995 Karen Hastie Williams\nCHARLES A. YAMARONE* Director April 12, 1995 Charles A. Yamarone\n*By \/s\/ Daniel P. Garton Daniel P. Garton Attorney-in-Fact April 12, 1995","section_15":""}
{"filename":"6845_1994.txt","cik":"6845","year":"1994","section_1":"ITEM 1. BUSINESS --------\nThe Company - - -----------\nApogee Enterprises, Inc. is a holding company incorporated under the laws of the State of Minnesota in 1949. The Company, through its operating subsidiaries, is primarily engaged in the fabrication, distribution and installation of curtainwall, aluminum windows and glass products. Four divisions comprise Apogee's operations: Commercial Construction (CCD), Window Fabrication (WFD), Glass Fabrication (GFD), and Installation and Distribution (IDD). These divisions serve the commercial and institutional building markets, detention\/security, as well as the automotive glass replacement, consumer and industrial markets. Financial information about the Company's divisions can be found at Note 17 - Business Segments of the Notes to consolidated financial statements of Apogee Enterprises, Inc. contained in a separate section of this report. See \"Index of Financial Statements and Schedules\"\nUnless the context otherwise requires, the terms \"Company\" and \"Apogee\" as used herein refer to Apogee Enterprises, Inc. and its subsidiaries.\nCommercial Construction - - -----------------------\nThe Company's Commercial Construction Division, operating principally under the name \"Harmon Contract\", is engaged in the design, engineering, procurement and installation of custom and standard curtainwall and window systems for commercial, institutional and detention\/security buildings. The Company is the nation's largest curtainwall and glazing contractor with bidding offices throughout the United States as well as in Europe and Asia. CCD performs a subcontractor role at the building site for the purpose of erecting the building's exterior enclosure. This enclosure typically consists of a metal framing system which is glazed (filled) with glass in the vision areas and with opaque glass or panels in the non-vision (spandrel) areas. Panels are usually made from aluminum, precast concrete or natural stone. The division procures its materials from a number of independent fabricators, including the Company's Window Fabrication and Glass Fabrication Divisions. CCD also serves as a stone subcontractor, setting stone on both the exterior and interior of buildings, including floors, benches and lavatories.\nCCD also has seven replacement glazing operations located around the country. These centers offer complete replacement or remodeling glass services for residential and commercial buildings. CCD's engineering capabilities have been used to duplicate the original design or create a completely new appearance while updating costly old window systems with inexpensive energy efficient systems.\nCCD competes in the detention\/security market through its Norment operating unit. Norment, based in Montgomery, Alabama, is a leader in the design, manufacture and installation of institutional and governmental security and detention systems. CCD also operates two other detention related companies including Airteq, located in Portland, Oregon, and EMSS, located in San Francisco, California. Airteq holds patents on the manufacture of pneumatic locks used in Norment's and other detention\/security systems. EMSS is a detention equipment contractor in the prison\/security industry, which operates primarily on the West Coast.\nIn July 1993, CCD acquired an 80% interest in CFEM Facades (CFEM) a French company engaged in both the manufacture and installation of curtainwall. This office, in addition to the other European and Asian offices, has given the division a stronger presence in overseas markets.\nCCD is subject to normal subcontractor's risks, including material and wage increases, construction and transportation work stoppages and contractor credit worthiness. In addition, office vacancy rates, tax laws concerning real estate and interest rates are important factors which affect nonresidential construction markets. Reduced competition on larger projects, custom designing capability and a trend toward the use of more sophisticated materials for energy conservation and design flexibility, have helped CCD increase its market share over the past several years.\nWindow Fabrication - - ------------------\nThe Window Fabrication Division's principal business is the design and manufacture of high-quality, thermally-efficient aluminum window and curtainwall systems. WFD also provides aluminum anodizing and painting services and\nmanufactures and markets miscellaneous architectural metal products and interior window covering products. The division currently operates six businesses, based in Wausau, Wisconsin.\nWFD markets aluminum windows and curtainwall systems (an exterior multi-story wall consisting of an aluminum framing system anchored to steel or concrete, glazed with glass in the vision area and with panels in the non-vision areas) under the \"Wausau Metals\" name. These products meet high standards of wind load capacity and resistance to air and moisture seepage. WFD aluminum window frame designs are engineered to be thermally efficient, utilizing high-strength polyurethane to limit the transfer of heat or cold through the window frame.\nWausau Metals' products are marketed through a nationwide network of distributors and a direct sales staff. Sales are made to building contractors, including Harmon Contract, for new construction and to building owners for retrofitting older buildings. Wausau Metals maintains design and product engineering staffs to prepare aluminum window and curtainwall system designs to fit customers' needs and to originate new product designs. Wausau Metals occasionally joins Harmon Contract in pursuing certain projects, as many architects and general contractors prefer to work with an experienced curtainwall subcontractor and manufacturer team.\nWausau Metals' curtainwall and aluminum window systems are often glazed at the building site. Wausau Metals fabricates much of its own insulating glass for factory glazing requirements. When a customer specifies safety glazing materials, such as tempered or laminated glass, these materials are occasionally purchased from the Company's Glass Fabrication Division. Extruded aluminum is purchased from several principal suppliers and window system hardware is obtained from several sources.\nOperating under the \"Linetec\" name, WFD also operates a metal coating facility which provides anodized and fluoropolymer coatings to metal. Anodizing is the electrolytic process of putting a protective, often colored, oxide film on light metal, typically aluminum. Fluoropolymer coatings are high quality paints which are sometimes preferred over anodizing because of the wide color selection. Coatings are applied to window and curtainwall components for the Company, as well as other companies' architectural and industrial aluminum products.\nThe division also offers several types of window coverings for residential, commercial and institutional markets, under the \"Nanik\" and \"Shuttery\" names. Nanik manufactures various types of custom aluminum, wood and polycarbonate venetian blinds, and markets them primarily to interior designers through independent distributors. The Shuttery is a manufacturer of custom wooden and vinyl interior shutters. Nanik Wood Products was formed in 1991 to provide a reliable source of wood mouldings for both Nanik and The Shuttery, while allowing both units to improve inventory control and production efficiency. All three companies operate manufacturing facilities in Wausau, Wisconsin.\nGlass Fabrication - - -----------------\nThe Glass Fabrication Division fabricates finished glass products and provides glass coating services, primarily under the \"Viracon\", \"Marcon\" and \"Tru Vue\" names, for the architectural, automotive, consumer and industrial markets. The Company's glass fabrication and coating activities are conducted at four facilities, three in Owatonna, Minnesota and one in Chicago, Illinois.\nGFD purchases flat, unprocessed glass in bulk quantities from which it fabricates a variety of glass products, including insulating, tempered and laminated architectural glass; security glass; laminated and tempered automotive and industrial glass; anti-reflection and UV-light blocking picture framing glass; and provides reflective and low-emissivity coatings on glass.\nTempered glass is a heat-processed safety glass which is four to five times stronger than ordinary glass, breaks into \"pebbles\" rather than sharp pieces and has architectural, automotive and industrial applications. Laminated glass consists of two or more pieces of glass fused with a plastic interlayer and is used primarily for strength and safety in automobile windshields and skylights and in security applications. Sales of laminated and tempered safety glass products have increased with the adoption of federal and state safety glazing standards. Insulating glass, comprised of two or more pieces of glass separated by a sealed air space, is used in architectural and residential applications for thermal control.\nGFD's Viracon unit is able to fabricate all types of architectural glass (insulating, laminated, tempered and combinations of all three) at its Owatonna complex. Combined with the adjacent Marcon's glass coating capabilities, GFD is able to\nprovide a full range of products from a central location. GFD markets its products nationally and overseas to glass distributors, glazing contractors (including CCD) and industrial glass fabricators. A substantial portion of its glass products is delivered to customers by GFD's fleet of company-owned trucks, providing \"backhaul\" capability for its raw materials, thereby reducing shipping time, transportation costs and breakage expense. The Company believes Viracon is the largest architectural glass fabricator in the United States.\nThe primary products of the division's automotive unit, known as Viracon\/Curvlite, are replacement windshields for foreign and domestic automobiles and tempered and laminated parts for the transportation industry. It fabricates approximately 800 types of replacement windshields which are marketed nationally to distributors and glass shops, including the Company's Installation and Distribution Division.\nTru Vue, located in Chicago, Illinois, is one of the largest domestic manufacturers of picture framing glass. Tru Vue provides its customers with a full array of picture framing glass products, including clear, reflection control, which diminishes reflection, and conservation glass, which blocks ultraviolet rays. The products are distributed primarily through independent distributors who, in turn, supply the local picture framing market. During 1993, Tru Vue acquired Miller Cardboard Corp. (Miller). Miller, located in New York City, is a manufacturer of conservation picture framing matboard, which complements Tru Vue's glass product offerings.\nViracon is a 50% owner of Marcon Coatings, Inc., (Marcon) a joint venture glass coating facility with Marvin Windows (\"Marvin\"). Marcon provides glass coating services from its Owatonna, Minnesota facility to Marvin and Viracon, as well as outside customers. Marcon's reflective and low-emissivity coatings reduce energy costs and provide innovative design features for window and curtainwall systems. Low-emissivity coatings are an invisible, metallic film deposited on glass which selectively limits the transfer of heat through the glass. Low- emissivity coated glass represents a fast-growing segment of both residential and non-residential glass markets.\nInstallation and Distribution - - -----------------------------\nThe Installation and Distribution Division (IDD) is engaged in the automotive and flat glass replacement business through its auto glass service centers (retail) and distribution centers (wholesale) located throughout the country.\nIDD operates 231 auto glass service centers and 45 distribution centers in 35 states, primarily in the Midwest, Great Lakes, and Southeast regions. The glass service centers replace auto glass on the premises and also provide mobile installation service. Primary customers include insurance companies (on behalf of their insured clients), fleet owners and car owners. The glass service centers also carry limited inventories of flat glass, which are sold at retail for such purposes as home window repair and table tops. Some automotive accessories are also sold and installed at the service centers. Quality service is stressed in the service centers, most of which operate under the name \"Harmon Glass\/TM\/.\" The Company believes Harmon Glass is the second-largest auto glass retailer in the United States.\nThe auto glass distribution centers, known as \"Glass Depot\/TM\/\", supply the Company-owned glass service centers with auto and flat glass, as well as selling wholesale to other glass installers. Purchases of fabricated automotive glass are made from several primary glass manufacturers and fabricators, including the Company's Glass Fabrication Division.\nIn fiscal 1994, the division acquired or opened 5 new wholesale distribution centers, while closing 12 retail auto glass units. The division continues to evaluate opportunities to expand both its retail and wholesale auto glass segments, while closely monitoring existing units' profitability.\nIDD also operates a centralized service for handling auto glass claims under the name Harmon Glass Network\/TM\/ (Network). This service subcontracts auto claims with nearly 3,000 auto glass stores nationwide. The Network seeks to maximize the electronic exchange of information, which reduces claim costs and eliminates errors. This type of service is a fast -growing segment for the division.\nUnder a franchise agreement with Midas International Corporation in 1980, the division operates seven Midas Muffler locations in Minnesota, South Dakota, North Dakota and Wisconsin.\nViratec Thin Films - - ------------------\nIn addition to its four divisions, Apogee owns 50% of Viratec Thin Films, Inc. (Viratec), a optical-quality coating joint venture with Marvin Windows, which was organized in fiscal 1989 in Faribault, Minnesota and began production in early 1990. Viratec develops advanced, optical-display and imaging coatings for glass and other surfaces. These products are used in computer screens, liquid crystal displays, high-quality optical components and high performance mirror products for the imaging industry. Viratec markets optical display and imaging products to both domestic and overseas customers. These customers provide further assembly, marketing and distribution to end users. The Company accounts for its investment in Viratec using the equity method.\nCompetition - - -----------\nAll segments of the Company's business, other than Viratec, are generally fairly mature and are highly competitive. The curtainwall installation business is primarily price competitive, although the Commercial Construction Division's reputation for quality engineering and service is an important factor in receiving invitations to bid on large projects. In addition to the above factors, CCD has the advantage of having the financial strength and long-term viability of Apogee, which allows CCD to be bonded on even the largest, most complex jobs. This is an important competitive advantage in the bidding of larger contracts. The Window Fabrication Division competes against several major aluminum window manufacturers. WFD primarily serves the custom portion of this market in which the primary competitive factors are product quality, reliable service and the ability to provide technical engineering and design services. The Company's Glass Fabrication Division competes with several large integrated glass manufacturers and numerous smaller specialty fabricators. Product pricing and service are the primary competitive factors in this market. The Installation and Distribution Division competes with other auto glass shops and repair\/replacement chains, car dealers and body shops on the basis of pricing and customer service. Its competition consists of national and regional chains as well as significant local competition. Viratec Thin Films has both domestic and foreign competitors, several of whom are older and more established.\nCCD, WFD and GFD serve the nonresidential construction market, which tends to be cyclical and which in recent years has been in decline, both in terms of dollars and square feet of new contract awards. Nonresidential construction, particularly the office building segment, has been hard hit due to the overbuilding in past years, tax law changes, recession, tightening credit standards, business restructurings and other factors. The resulting contraction in demand for building materials and construction services has intensified competition, squeezed profit margins and contributed to some business failures in the market sectors served by the Company. In response to weak markets, the Company's operating divisions have consolidated manufacturing facilities, closed bidding offices and reduced personnel and discretionary expenses. They have also redirected their marketing focus to sectors with relative strength, including remodeling, institutional (including detention\/security) and certain international markets such as Asia and Europe. GFD and IDD service the automotive aftermarket which is influenced by a variety of factors, including new car sales, gasoline prices, speed limits, road conditions, the economy, weather and average number of miles driven. A transformation of the industry's pricing structure has intensified competition. In recent years, major purchasers of auto glass, such as insurance companies, have increasingly requested volume pricing and awarded regions to glass providers at significant discounts from historical levels. As a result, margins have narrowed at the retail level and, to a lesser extent, at wholesale and manufacturing levels.\nSources and Availability of Raw Materials - - -----------------------------------------\nNone of the Company's operating units are significantly dependent upon any one supplier. The Company believes a majority of its raw materials (bulk flat glass, aluminum extrusions, automotive glass and related materials) are available from a variety of domestic sources.\nTrademarks and Patents - - ----------------------\nThe Company has several nationally recognized trademarks and trade names which it believes have significant value in the marketing of its products. Viratec Thin Films has obtained several patents pertaining to its glass coating methods. However, no single patent is considered to be materially important to the Company.\nForeign Operations and Export Sales - - -----------------------------------\nCCD has sales offices in Europe and Asia. Sales for those offices were approximately $65,021,000, $6,490,000 and\n$22,085,000 for the years ended February 26, 1994, February 27, 1993 and February 29, 1992, respectively. During fiscal 1994, such operations had a $887,000 operating loss. At February 26, 1994, the indentifiable assets of foreign operations totaled $31,786,000. At February 26, 1994, the backlog of work for European and Asian projects was $121 million, $65,000,000 of which is not expected to be reflected as revenue in fiscal 1995. In addition, during the years ended February 26, 1994, February 27, 1993 and February 29, 1992, the Company's export sales, principally from GFD operations, amounted to approximately $27,643,000, $22,808,000 and $18,671,000, respectively.\nEmployees - - ---------\nThe Company employed 5,863 persons at February 26, 1994, of whom 1,156 were represented by labor unions. The Company is a party to 94 collective bargaining agreements with several different unions. Seventy-six (76) of the collective bargaining agreements will expire during fiscal 1995. The number of collective bargaining agreements to which the Company is a party will vary with the number of cities with active window and curtainwall installation contracts. The Company considers its employee relations to be very good and has not recently experienced any significant loss of work days due to strike.\nBacklog - - -------\nThe backlog of orders is significant in the Company's three construction- related activities: window fabrication, glass fabrication and contract installation. At February 26, 1994, the Company's total backlog of orders considered to be firm was $405,000,000, compared with $322,000,000 at February 27, 1993. Approximately $115,000,000 is not expected to be reflected as revenue in fiscal 1995.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe following table lists, by division, the Company's major facilities, the general use of the facility and whether it is owned or leased by the Company.\nThe Commercial Construction Division has fifteen sales offices, five glazing service centers and five fabriacation facilities generally located in major metropolitan areas in the United States, Europe and Asia, virtually all of which are leased.\nThe Installation and Distribution Division has 276 retail service centers and warehouses located nationally and seven Midas Muffler franchises located in the Midwest, the majority of which are leased.\nThe GFD Curvlite plant; a Wausau Metals facility; the Linetec paint facility; an addition to one of the Wausau Metals plants; a glass warehouse in Minneapolis; and the Orlando administrative center were constructed with the use of proceeds from industrial revenue bonds issued by those cities. These properties are considered owned, since at the end of the bond term, title reverts to the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -----------------\nThere are no material pending legal proceedings.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ---------------------------------------------------\nNone. EXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------\nExecutive officers are elected annually by the Board of Directors and serve for a one-year period. With the exception of Gerald K. Anderson, who has a post- employment consulting agreement, no officers have employment contracts with the Company. None of the executive officers or directors of the Company are related.\nAll of the above named executive officers have been employees of the Company for more than the last five years.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER ----------------------------------------------------------------- MATTERS -------\nApogee common stock is traded in the National Market System of the NASDAQ over- the-counter market, under the ticker symbol APOG. Stock price quotations are printed daily in major newspapers. During the fiscal year ended February 26, 1994, the average trading volume of Apogee common stock was 259,450 shares per month, according to NASDAQ.\nAs of March 31, 1994, there were 13,313,132 shares of common stock outstanding, of which about 6.8 percent were owned by officers and directors of Apogee. At that date, there were approximately 2,322 shareholders of record and 2,953 shareholders for whom securities firms acted as nominees.\nThe following chart shows the quarterly range and year-end close of the company's common stock over the past five fiscal years.\nIt is Apogee's policy to pay quarterly cash dividends in May, August, November and February. Cash dividends have been paid each quarter since 1974 and have been increased each year since then. The chart below shows quarterly cash dividends per share for the past five years.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -----------------------\nThe following information should be read in conjunction with Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ----------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nFINANCIAL GOALS - - --------------- Last year, we reported that weak demand and highly competitive pricing had caused flat sales levels and lower net earnings. In an effort to resume our historical growth rate, we cited short-term measures to more properly size our profit centers to better fit available business. Longer term, we indicated our focus would be to improve quality, reduce costs and become more responsive to customer needs. During fiscal 1994, this focus allowed Apogee to achieve significant sales and earnings growth in our replacement auto glass and fabricated architectural glass businesses. Meanwhile, in our nonresidential construction businesses, we saw further margin erosion and took some false steps as we struggled to achieve the goals noted above.\nAs we pointed out last year, it is our intention to delay setting specific financial goals until we resumed steady earnings growth. Although we believe important strides were made during the past year, holding off on setting new targets is warranted in light of the difficulties still faced by our construction-related units.\nPERFORMANCE - - ----------- FISCAL 1994 COMPARED TO FISCAL 1993 The following table illustrates the relationship between various components of operations, stated as a percent of net sales, for the three years ended February 26, 1994.\nConsolidated net sales rose 20% to $688 million in fiscal 1994 due to strong replacement auto glass markets, higher overseas nonresidential construction activity and improved demand for architectural glass products. Our window coverings and nonglare picture framing glass units also reported improved sales.\nLow margins in construction markets, ineffective project management and poor factory utilization by our window fabrication division's architectural units caused Apogee's gross profit, as a percent of sales, to fall for the second straight year. Replacement auto glass and architectural glass markets continued to be very competitive, but strong demand for such products allowed for firmer pricing, partially offsetting the negative impact of the factors noted above.\nSelling, general and administrative expenses decreased slightly from a year earlier, as we benefited from cost containment\nefforts throughout the company. This represented a sharp decline as a percent of sales. Higher information systems costsand expanded marketing expenditures were offset by improvements made in other areas.\nOur equity in net earnings of affiliated companies rose 22% in fiscal 1994. Significant earnings improvement at Viratec Thin Films (Viratec) was somewhat offset by lower earnings at Marcon Coatings (Marcon) and the taxability of a portion of Marcon's and Viratec's earnings as their net operating loss carryforwards became fully utilized.\nDuring the fourth quarter of fiscal 1994, Apogee recorded a provision of $5.6 million ($4.5 million after tax, or 34 cents per share), for business restructuring and asset valuation to reflect the costs of consolidating or closing 10 commercial construction division offices and facilities, of writing down certain assets and of reorganizing the window fabrication division's architectural products group. The provision consisted of asset write-downs of $2.5 million plus projected cash outlays of $3.1 million. Most of the $3.1 million will be expended in fiscal 1995 for equipment relocation, employee severance and facility closing costs.\nThe asset valuation component of the provision included a $1,600,000 write-off of certain intangible assets, principally patents and non-compete agreements. Based on our review of expected results for the related operations, we determined that the intangibles assets held no future value and, therefore, were written off. We also wrote down to estimated net realizable value a facility scheduled for closure in the amount of $850,000. We believe that our restructuring plan has resulted in cost reductions which will benefit future periods. However, we expect the greatest benefits will derive from improved project selection, bidding and project management resulting from selective centralization of certain functions.\nThe charge described immediately above was the primary factor leading to Apogee's first-ever reported quarterly loss: $3.0 million, or 22 cents per share, for the thirteen weeks ended February 26, 1994.\nDespite relatively low interest rates, net interest expense jumped 52% to $2.7 million in fiscal 1994, as borrowing levels increased to meet significant working capital needs.\nWe recorded a first quarter gain of $525,000, or 4 cents a share, due to the adoption of Statement of Financial Accounting Standards No. 109-Accounting for Income Taxes (SFAS 109). Under SFAS 109, our deferred tax liabilities declined, primarily reflecting the fact that deferred taxes on depreciation were originally booked at higher tax rates than current tax rates. Other deferred tax assets and liabilities were essentially unchanged due to implementation of SFAS 109.\nThe effective tax rate for fiscal 1994 was 39.8%, up from 30.0% a year ago. The rise was primarily due to the increase in our deferred tax asset valuation allowance related to a capital loss carryforward.\nThe provision for business restructuring and asset valuation and the poor performance of our nonresidential construction units combined to offset the strong results of Apogee's architectural glass and replacement auto glass operations, leading consolidated net earnings, including the SFAS 109 accounting change, to fall 15 % to $3.8 million, or 29 cents per share, from $4.5 million, or 34 cents per share, in 1993. Return on beginning shareholders' equity was 3.4% compared with 4.0% a year ago.\nSEGMENT ANALYSIS - - ---------------- Apogee is organized into four operating divisions, plus the Viratec Thin Films joint venture. Each segment is discussed below.\nCommercial Construction\nThe Commercial Construction Division (CCD), the nation's largest designer and installer of curtainwall and window systems, continued to encounter extremely tough nonresidential construction market conditions. While growth in overseas markets pushed up revenues by 24%, highly competitive pricing took its toll, eroding already very thin margins. In addition, the complexity of many projects stretched the division's ability to effectively manage its book of work. Along with the high costs of international marketing and setting up overseas offices, the aforementioned factors caused CCD to record a $19.0 million operating loss, compared to a $5.1 million operating loss in fiscal 1993. CCD took several steps to lower overhead during fiscal 1994, including closing or consolidating several domestic sales offices. The division's loss included $4.7 million of the provision for business restructuring and asset valuation described above.\nDuring the year, CCD acquired majority ownership of one of Europe's leading curtainwall contracting firms, CFEM Facades (CFEM). The acquisition provided CCD with substantial backlog, a medium-sized manufacturing facility and expertise in European construction techniques. CFEM generated significant sales and operating income during fiscal 1994.\nCCD achieved sharp backlog growth in 1994, finishing the year with $365 million in backlog, up 26% from a year ago. The growth came from European and Asian markets, primarily the addition of the $80 million Petronas Towers project in Kuala Lumpur, Malaysia. While the growth in overseas contracts has bolstered the division's backlog, approximately $115 million will not be reflected as revenue in fiscal 1995.\nWindow Fabrication\nThe difficult market conditions of the nonresidential construction industry contributed to erratic order flow, poor pricing and inconsistent factory utilization at the window fabrication division (WFD). The division suffered an operating loss of $3.5 million, after losing $506,000 the previous year. WFD's architectural units, which serve the commercial and institutional construction markets with custom aluminum windows and curtainwalls, had a 10% rise in revenues, to $83 million, but narrow margins and costs of re-work and rush shipping orders more than offset the sales gain. The division's results included $850,000 of the restructuring and asset valuation provision.\nThe window coverings group of WFD produced strong revenues and earnings, partially offsetting the architectural units' loss. Sales volume was good, but a change in sales mix toward lower margin products kept the group from reporting improved margins. Substantial operating improvements at The Shuttery also helped the group strengthen earnings. The group continues to improve operations and shorten lead times, which should help to produce continued good results in fiscal 1995.\nGlass Fabrication\nThe glass fabrication division (GFD) leveraged sales growth across all product lines into a 73% improvement in operating income, to $13.6 million. Sales rose 21% to $135 million. Strong demand for replacement auto glass required Curvlite, the division's auto glass fabricating unit, to operate at near-capacity levels throughout the year. The resulting efficiency led to sharp unit cost reduction, offsetting price weakness.\nGFD's architectural glass unit, Viracon, also experienced strong product demand, as key competitors left the business due to market weakness. Pricing also improved slightly as industry demand temporarily exceeded capacity. High demand, a healthy year-end backlog and selected increases in production capacity should allow for further earnings improvements in fiscal 1995.\nThe division's picture framing glass unit, Tru Vue, reported stellar results for the year. Tru Vue's sales rose 7%, which combined with productivity gains to improve operating income by 34%. Tru Vue also acquired the assets of Miller Artboard, a manufacturer of picture framing matboard, which complements Tru Vue's product offerings.\nViracon's 50%-owned joint venture, Marcon Coatings, placed its second coater in service during fiscal 1994. The unit was able to boost shipments to both joint venture partners and produced a solid profit for the year. However, earnings were lower than last year due to higher depreciation, debugging costs and training expenses.\nInstallation and Distribution\nThe installation and distribution division (IDD), the nation's second largest retail chain of automotive glass stores, grew sales 19% and earnings 138%. In fiscal 1993, IDD realigned its structure from a regional to a national focus, and split its lines of business into retail and wholesale. This realignment helped the division capitalize on increased unit movement and firmer pricing in the replacement auto glass market. Same-store revenues rose 15%, reflecting industry growth and increased market penetration. The Harmon Glass Network, which subcontracts with more than 3,000 auto glass stores nationwide, reported a 53% jump in sales, about two-thirds of which were handled by company-owned stores.\nThe division also increased its market penetration by adding 5 wholesale distribution centers during the year, for a year-end total of 45 locations. At February 26, 1994, IDD also had 231 retail glass stores and 7 Midas Muffler franchises in 38 states.\nThe division plans to speed up its development of information systems and communications technology during the upcoming year. Additional retail store and warehouse expansion also is anticipated.\nViratec Thin Films\nViratec Thin Films (Viratec), a joint venture with Marvin Windows, develops and applies optical-grade coatings to glass and other substrates. For the third consecutive year, Viratec achieved both sales and earnings growth, reporting a 71% sales jump and a seven-fold increase in pretax earnings. Strong demand, particularly in overseas markets, combined with healthy margins to produce the outstanding results. To meet demand and proceed with new product development, the unit is currently expanding its facility, nearly doubling square footage. Viratec's backlog increased 22% from a year ago, to $13 million at year end.\nFISCAL 1993 COMPARED TO FISCAL 1992\nFor the year ended February 27, 1993, Apogee reported a 4% decrease in sales and a 47% decrease in earnings. Limited demand and severe competitive pricing pressures were experienced by most of our business segments. Sales gains achieved by architectural fabricated glass and installed auto glass were more than offset by declines in curtainwall contracting and aluminum window fabrication. Gross margin fell to its lowest level in over a decade, as decreased volume and falling sales prices took their toll. Selling, general and administrative expenses were reduced through cost containment programs at GFD, restructuring efforts at IDD and lower bad debt expense. CCD experienced higher selling costs as the division furthered its efforts to penetrate foreign and security markets. A sharp turnaround in equity in net earnings of affiliates was due to substantial improvements at Viratec and the absence of the Marcon West coating unit. Net interest expense increased 85%, as bank borrowings rose and less interest income was earned on invested funds. Lower consolidated profits led to a decrease in the tax rate.\nCCD encountered very rugged industry conditions during fiscal 1993, leading to a 10% reduction in division revenues, to $249 million. Narrowing margins and higher marketing costs related to the pursuit of international and detention\/security sales resulted in a $5.1 million operating loss for the year, compared with $15.0 million operating income in fiscal 1992. The division's backlog grew 45% and finished the year at $289 million. This was achieved largely by obtaining a $42 million order for the Getty Museum curtainwall in Los Angeles. Detention\/security and international segments of CCD also reported backlog growth.\nWFD reported a 15% decline in revenues, to $75 million, and a $506,000 operating loss in fiscal 1993. Architectural sales fell 23% from fiscal 1992. Tight margins and erratic productivity were the main factors behind the division's results. The window coverings group, however, reported a 22% increase in sales and strong profits, nearly offsetting the architectural group's loss. The absence of Window Works, sold a year earlier, and operational improvements made by The Shuttery played a major role in the group's results.\nGFD produced a dramatic earnings turnaround in fiscal 1993. Total revenues gained only 3%, but operating income grew to $7.8 million, compared with a $2.3 million loss in fiscal 1992. The consolidation of architectural glass production to its Minnesota facilities and the cumulative effect of several years of continuous cost reduction efforts throughout the division were significant factors leading to the reported gains. Marcon, a 50%-owned glass coating joint venture, reported modest growth in both revenues and operating income due to rising popularity of coated glass for both homes and businesses.\nIDD was able to achieve sales growth and a return to profitability in fiscal 1993 despite continued unfavorable pricing. The division began the process of transformation from a regional to a national company with a line-of-business concept. Strong demand also helped the recovery. The Harmon Glass Network reported 26% revenue growth. The division closed 31 stores while adding only 10.\nViratec Thin Films made substantial improvements in fiscal 1993, closing the year with a modest profit. Viratec's backlog grew to $10.7 million at year end.\nLIQUIDITY AND CAPITAL RESOURCES - - ------------------------------- FINANCIAL CONDITION Major balance sheet items as a percentage of total assets at February 26, 1994 and February 27, 1993 are presented below:\nWorking capital increased 16% to $80.4 million at February 26, 1994. Total receivables grew 36% due to increased sales and extended collection periods. The competitiveness of the construction industry and a greater proportion of institutional, versus commercial, sales have slowed the payment cycle, resulting in extended collection periods. Inventories rose 31% due to higher costs in excess of billings on uncompleted construction contracts, the addition of Miller Artboard's inventory and higher IDD inventories, resulting from the addition of 5 wholesale distribution centers and growth in the number of auto glass parts.\nBank debt increased to fund working capital growth and to pay down other higher- priced debt. Total bank borrowing, including $25 million classified as long- term, rose from $10.9 million to $48.9 million. Long-term debt stood at $35.7 million, but was only 12% of assets and 22% of total invested capital at year end. In fiscal 1995, we expect operating cash flow, after working capital adjustments, to exceed our requirements for debt service and dividends. However, we may continue to rely on bank credit or other sources of financing to support expansion and acquisition activity. We believe that existing and reasonably available sources of financing will enable us to maintain liquidity and achieve improved results.\nCAPITAL INVESTMENT\nNew capital investment for the year totaled $19.4 million, versus $13.6 million and $18.5 million in fiscal 1993 and 1992, respectively. New property, plant and equipment totaled $14.0 million, and we invested $3.2 million to fund CCD's acquisition of CFEM Facades and GFD's acquisition of Miller.\nCapital investment for fiscal 1995 is estimated at $26 million. Upgrading of information and communication systems at IDD and facility expansions at our joint ventures and GFD are the major components of next year's spending plans.\nSHAREHOLDERS' EQUITY\nApogee's quarterly dividend rose 7% to 7 1\/2 cents per share during fiscal 1994, our 19th consecutive year of increase. Total cash dividends slightly exceeded net earnings for the year. The issuance of common stock in connection with the 1987 Stock Option Plan and the 1987 Partnership Plan accounted for the marginal increase in book value, to $8.57 per share.\nIMPACT OF INFLATION\nApogee's financial statements are prepared on an historical cost basis, which does not completely account for the effects of inflation. However, since the cost of most of our inventories is determined using the last-in, first-out (LIFO) method of accounting, cost of sales, except for depreciation expense included therein, generally reflects current costs.\nThe cost of glass, one of Apogee's primary raw materials, modestly increased as both residential building and auto sales were strong in 1993. While our supply and construction contracts are at a fixed price, material cost is usually based on firm quotes obtained from suppliers. Through new production efficiencies and cost containment programs set up at most operating units, selling, general and administrative expenses were held relatively constant. Our divisions continue to improve efficiencies and cost containment programs to offset inflation wherever possible.\nOUTLOOK - - ------- Apogee's backlog grew 26% and stood at $405.0 million at February 26, 1994, our second straight year of double-digit growth. However, a substantial portion of CCD's backlog will not be realized in fiscal 1995. Also, while U.S. nonresidential\nconstruction activity is expected to gradually strengthen, a firmer pricing stance may result in fewer orders. Improved project management, the expected benefit of closing and consolidating CCD offices and facilities, will also be essential in fiscal 1995. The demand in auto replacement glass has slowed somewhat, but remains positive. Overall, improved industry conditions and better management of our businesses should result in improved profitability and, possibly, higher revenues.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA -------------------------------------------\nThe information called for by this Item is contained in a separate section of this report. See \"Index of Financial Statements and Schedules\".\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. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT; --------------------------------------------------- EXECUTIVE COMPENSATION; SECURITY OWNERSHIP OF CERTAIN ----------------------------------------------------- BENEFICIAL OWNERS AND MANAGEMENT; AND CERTAIN --------------------------------------------- RELATIONSHIPS AND RELATED TRANSACTIONS. ---------------------------------------\nThe information required by these Items, other than the information set forth above in \"Executive Officers of the Registrant,\" is included on pages 1 to 10 of the Proxy Statement for the Annual Meeting of Shareholders to be held June 21, 1994, which is incorporated herein by reference.\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) and (d) Financial Statements and Financial Statement Schedules -\nThe consolidated financial statements and schedules of the Registrant listed on the accompanying \"Index to Financial Statements and Schedules\" together with the report of KPMG Peat Marwick, independent auditors, are filed as part of this report.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended February 26, 1994.\n(c) Exhibits -\nExhibit (3A) Restated Articles of Incorporation Filed in Registrant's Annual Report on Form 10-K for year ended February 27, 1988.\nExhibit (3B) Restated By Laws of Apogee Enterprises, Inc., as amended to date. Filed in Registrant's Annual Report on Form 10-K for year ended February 29, 1992.\nExhibit (4A) Specimen certificate for shares of common stock of Apogee Enterprises, Inc. Filed in Registrant's Annual Report on Form 10-K for year ended February 29, 1992.\nExhibit (10A) Deferred Incentive Compensation Plan dated February 27, 1986 between Registrant and certain executive officers. Filed in Registrant's Annual Report on Form 10-K for year ended March 1, 1986.\nExhibit (10B) Amended and Restated 1987 Apogee Enterprises, Inc. Partnership Plan is incorporated by reference to Registrant's S-8 registration statement (File No. 33-60400)\nExhibit (10C) 1987 Apogee Enterprises, Inc. Stock Option Plan is incorporated by reference to Registrant's S-8 registration statement (File No. 33-35944)\nExhibit (10D) Note Agreement dated June 1, 1988 between the registrant and Teachers Insurance and Annuity Association of America ($25,000,000). Filed in Registrant's Quarterly Report on Form 10-Q for quarter ended August 27, 1988.\nExhibit (10E) Incentive Compensation Agreement between Registrant and Gerald K. Anderson dated February 23, 1987. Filed with Registrant's Annual Report on Form 10-K for year ended March 2, 1991.\nExhibit (10F) Consulting Agreement between Registrant and Gerald K. Anderson dated March 1, 1989. Filed with Registrant's Annual Report on Form 10-K for year ended March 2, 1991.\nExhibit (10G) Rights Agreement between Registrant and American Stock Transfer Co. dated October 19, 1990. Filed with Registrant's Form 8-K on October 19, 1990.\nExhibit (10H) $25 million Credit Facilities agreements between Apogee Enterprises, Inc., First Bank National Association and NBD Bank, N.A. Filed with Registrant's Annual Report on Form 10-K for year ended February 27, 1993.\nExhibit (10I) Consulting Agreement between Registrant and Laurence J. Niederhofer dated November 1, 1993.\nExhibit (11) Statement of Determination of Common Shares and Common Share Equivalents\nExhibit (21) Subsidiaries of the Registrant\n- 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.\nDate: May 20, 1994 APOGEE ENTERPRISES, INC.\nBy: \/s\/ Donald W. Goldfus ---------------------------------------- Donald W. Goldfus 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 below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.\nSIGNATURE TITLE DATE - - --------- ----- ----\nChairman of the Board of Directors and \/s\/ Donald W. Goldfus Chief Executive Officer May 20, 1994 - - ---------------------- ----------------------- ------------ Donald W. Goldfus\n\/s\/ Gerald K. Anderson President and Director May 20, 1994 - - ----------------------- ---------------------- ------------ Gerald K. Anderson\n\/s\/ Laurence J. Niederhofer Director May 20, 1994 - - ---------------------------- -------- ------------ Laurence J. Niederhofer\n\/s\/ James L. Martineau Vice President and Director May 20, 1994 - - ----------------------- --------------------------- ------------ James L. Martineau\n\/s\/ D. Eugene Nugent Director May 20, 1994 - - --------------------- -------- ------------ D. Eugene Nugent\nTreasurer, Chief Financial \/s\/ William G. Gardner Officer and Secretary May 20, 1994 - - ----------------------- -------------------------- ------------ William G. Gardner\nAPOGEE ENTERPRISES, INC. FORM 10-K ITEMS 8, 14(A) AND 14(D)\nAll 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.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Apogee Enterprises, Inc.:\nWe have audited the consolidated financial statements of Apogee Enterprises, Inc. and subsidiaries 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 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 Apogee Enterprises, Inc. and subsidiaries as of February 26, 1994 and February 27, 1993 and the results of their operations and their cash flows for each of the years in the three-year period ended February 26, 1994 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.\nAs discussed in notes 1 and 9, the company changed its method of accounting for income taxes in fiscal 1994 to adopt the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nKPMG Peat Marwick\nMinneapolis, Minnesota April 22, 1994\nCONSOLIDATED BALANCE SHEETS Apogee Enterprises, Inc. and Subsidiaries\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED RESULTS OF OPERATIONS Apogee Enterprises, Inc. and Subsidiaries\nSee accompanying notes to consolidated financial statements.\nQUARTERLY DATA (UNAUDITED) (Dollar amounts in thousands, except per share data)\n[FN] *During the first quarter of 1994, we adopted Statement of Accounting Standards No. 109, Accounting for Income Taxes. The cumulative effect of the change in accounting for income taxes increased net earnings by $525,000, or 4 cents per share, and is included in fiscal 1994 figures.\nCONSOLIDATED STATEMENTS OF CASH FLOWS Apogee Enterprises, Inc. and Subsidiaries\nSee accompanying notes to consolidated financial statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Apogee Enterprises, Inc. and Subsidiaries\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RELATED DATA\nPRINCIPLES OF CONSOLIDATION Our consolidated financial statements include the accounts of Apogee and all majority-owned subsidiaries. We use the equity method to account for our 50%-owned joint ventures. All significant intercompany transactions are eliminated. Certain amounts from prior-year financial statements have been reclassified to be consistent with this year's presentation.\nCASH AND CASH EQUIVALENTS Investments with an original maturity of three months or less are included in cash and cash equivalents.\nINVENTORIES Inventories, which consist primarily of purchased glass and aluminum, are valued at cost, principally by using the last-in, first-out (LIFO) method, which does not exceed market. If the first-in, first-out (FIFO) method had been used, our inventories would have been $1,825,000 and $1,900,000 higher than reported at February 26, 1994 and February 27, 1993, respectively.\nPROPERTY, PLANT AND EQUIPMENT Property, plant and equipment, including improvements to existing facilities, are carried at cost. Repairs and maintenance are charged to expense as incurred. Apogee computes depreciation on a straight-line basis, based on estimated useful lives of 20 to 40 years for buildings and 2 to 15 years for equipment. When property is retired or otherwise disposed of, the cost and related depreciation are removed from the amounts and any related gains or losses are included in income.\nINTANGIBLE ASSETS AND AMORTIZATION Intangible assets consist principally of goodwill and non-compete agreements. We review the ongoing future value of intangibles on an annual basis. The continuing benefit of such assets is evaluated based upon an assessment of relevant economic and other criteria, including projections of future results.\nGoodwill is the excess of cost over the fair value of acquired assets of purchased businesses. Goodwill is amortized over periods ranging from 10 to 40 years, except for $923,000, which is not being amortized. In our opinion, there has been no diminution of its value.\nNon-compete agreements are contracts with the previous management of purchased businesses not to enter into competition with us for a certain period of time. Non-compete agreements are amortized ratably over the term of the agreements. Amortization expense amounted to $2,328,000, $2,123,000 and $2,106,000 in 1994, 1993 and 1992, respectively.\nOTHER LONG-TERM LIABILITIES Our long-term liabilities include the long-term portion of accrued insurance costs and deferred compensation.\nREVENUE RECOGNITION We recognize revenue from construction contracts on a percentage-of-completion basis, measured by the percentage of costs incurred to date to estimated total costs for each contract. Contract costs include materials, labor and other direct costs related to contract performance. We establish provisions for estimated losses, if any, on uncompleted contracts in the period in which such losses are determined. Revenue from the sale of products and the related cost of sales are recorded upon shipment. All selling, general and administrative costs are expensed in the period incurred.\nINCOME TAXES Apogee files a consolidated income tax return. Effective February 28, 1993, Apogee adopted the provisions of Statement of Financial Accounting Standards No. 109 (SFAS 109). SFAS 109 requires the asset and liability method be used to account for income taxes. This method recognizes deferred tax assets and liabilities based upon the future tax consequences of temporary differences between financial and tax reporting. Previously Apogee followed the provisions of Accounting Principles Board Opinion No. 11. The cumulative effect of the change in accounting for income taxes is included in the fiscal 1994 Consolidated Results of Operations.\nEARNINGS PER SHARE Apogee computes earnings per share by dividing net earnings by the weighted average number of common shares and common share equivalents outstanding during the year. Our average common shares and common share equivalents outstanding during 1994, 1993 and 1992 were 13,289,000, 13,293,000 and 13,512,000, respectively.\nTRANSLATION OF FOREIGN CURRENCIES The financial statements of our foreign operations have been translated to U.S. dollars, using the rules of Statement of Financial Accounting No. 52. Balance sheet accounts are stated in U.S. dollars at either the year-end or historical exchange rate. Results of operations statement items are translated at average exchange rates for the period.\nACCOUNTING PERIOD Apogee's fiscal year ends on the Saturday closest to February 28. Interim quarters end on the Saturday closest to the end of the months of May, August and November.\n2. RECEIVABLES\nApogee provides products and services to the commercial and institutional new construction and remodeling markets, the automotive replacement glass market (wholesale and retail) and selected consumer markets at the distribution level. We do not believe a concentration of credit risk exists, due to the diversity of our markets and channels of distribution, and the geographic location of our customers. We perform ongoing credit evaluations of our customers' financial condition and limit the amount of credit extended when deemed necessary. We also routinely file liens to protect our interest whenever possible. We generally require no collateral. Allowances are maintained for potential credit losses and such losses have been within management's expectations. The provision for bad debt expense was $2,388,000, $2,061,000 and $6,261,000 in 1994, 1993 and 1992, respectively.\n3. INVENTORIES\n4. PROPERTY, PLANT AND EQUIPMENT\nDepreciation expense was $13,397,000, $12,987,000 and $14,199,000 in 1994, 1993 and 1992, respectively.\n5. ACCRUED EXPENSES\n6. LONG-TERM DEBT\nLong-term debt maturities are as follows:\nIn fiscal 1992, we entered into three interest rate swap agreements with a notional amount of $25 million that effectively converted a portion of our fixed rate, long-term borrowings into variable rate obligations. The swap agreements are accounted for as hedges, with the net interest paid or received included in interest expense. During fiscal 1993, we sold two of the swap agreements at net gains. The gains are being recognized as reductions in interest expense over the original term of the swap agreements.\nThe terms of the promissory note include certain dividend and debt level restrictions and requirements to maintain minimum levels of tangible net worth and certain financial ratios. Retained earnings available for dividends under the terms of the promissory note were approximately $27 million at February 26, 1994.\nThe net book value of property, plant and equipment pledged as collateral, principally under industrial development bonds, was approximately $2 million at February 26, 1994.\nIn February 1993, we entered into new revolving credit agreements with two banks. The agreements allow us to borrow up to $25 million at various alternative rates. The revolving credit term is three years, with an additional three-year term-loan option. At any time through the revolving period, we can convert any outstanding loans into a long-term note. The agreements require us to maintain minimum levels of tangible net worth and certain financial ratios.\nWe also had access to $60 million via committed and uncommitted credit facilities with several major lending institutions. We may elect to have borrowings under the agreements bear interest at fixed or floating rates. At February 26, 1994, $23.9 million in borrowings were outstanding under these agreements. Interest rates on the year-end borrowings ranged from 3.50% to 3.81%.\nSelected information related to bank borrowings under credit agreements is as follows:\n7. SHAREHOLDERS' EQUITY\nA class of 200,000 shares of junior preferred stock with a par value of $1.00 is authorized, but unissued.\nApogee has a Shareholders' Rights Plan, under which each share of our outstanding common stock has an associated preferred share purchase right. The rights are exercisable only under certain circumstances and allow holders of such rights to purchase common stock of Apogee or an acquiring company at a discounted price, which generally would be 50% of the respective stock's current fair market value.\n8. INTEREST EXPENSE, NET\nInterest payments were $3,714,000, $2,556,000 and $2,959,000 in 1994, 1993 and 1992 respectively.\n9. INCOME TAXES\nAs discussed in Note 1, we adopted Statement of Financial Accounting Standards No. 109 (SFAS 109) in 1994. The cumulative effect of this change in accounting for income taxes is reported separately in the accompanying Results of Operations for the year ended February 26, 1994. Prior years' financial statements have not been restated to apply the provisions of SFAS 109.\nThe components of income tax expense for each of the last three fiscal years are as follows:\nIncome tax payments, net of refunds, were $5,934,000, $7,371,000 and $11,337,000 in 1994, 1993 and 1992, respectively.\nThe differences between statutory federal tax rates and our consolidated effective tax rates are as follows:\nThe components of deferred income tax expense (benefit) for 1993 and 1992 are as follows:\nDeferred tax assets and deferred tax liabilities at February 26, 1994 and February 28, 1993 are as follows:\nApogee's valuation allowance increased by $600,000, which relates primarily to a capital loss carryforward. The valuation allowance at February 26, 1994 also included amounts for foreign tax credits.\n10. INVESTMENT IN AFFILIATED COMPANIES\nApogee, through its glass fabrication division, is party to a joint venture agreement with Marvin Windows of Warroad, Minnesota, forming Marcon Coatings, Inc. and its subsidiary, Viratec Thin Films, Inc. (Marcon\/Viratec). Marcon\/Viratec operates two glass coating facilities. Our 50% ownership investment in Marcon\/Viratec is accounted for using the equity method.\nApogee and Marvin have leased certain glass coating equipment, to Marcon and made cash advances to Marcon\/Viratec. Our net investment in Marcon\/Viratec as of February 26, 1994 and February 27, 1993 was $10,652,000 and $8,858,000, respectively. Our equity in Marcon\/Viratec's net (earnings) loss is included in the accompanying Consolidated Results of Operations. Marcon\/Viratec's net earnings for 1994 and 1993 included tax benefits from net operating loss carryforwards in the amounts of $437,000 and $1,200,000, respectively.\nA summary of assets, liabilities and results of operations for Marcon\/Viratec is presented below:\n11. EMPLOYEE BENEFIT AND STOCK OPTION PLANS\nWe maintain a qualified defined contribution pension plan that covers substantially all full-time, non-union employees. Contributions to the plan are based on a percentage of employees' base earnings. Benefits for each employee vary based on total contributions and earnings on invested funds. We deposit pension costs with the trustee annually. All pension costs were fully funded or accrued as of year end. Contributions to the plan were $3,014,000, $2,848,000 and $2,651,000 in 1994, 1993 and 1992, respectively.\nWe also maintain a 401(k) Savings Plan, designed to encourage eligible employees to develop a long-term savings program. The plan allows employees to contribute 1% to 10% of their pretax compensation. Apogee matches 30% of the first 6% of the employee contributions. Amounts contributed by us to the plan were $1,206,000, $1,069,000 and $1,035,000 in 1994, 1993 and 1992, respectively.\nThe 1987 Stock Option Plan provides for the issuance of up to 1,250,000 options to purchase company stock. Options awarded under this plan, either in the form of incentive stock options or nonstatutory options, are exercisable at an option price equal to the fair market value at date of award. Changes in stock options outstanding for each of the last three fiscal years are as follows:\nThe 1987 Partnership Plan, a plan which is designed to increase the ownership of Apogee stock by key employees, allows participants selected by the Compensation Committee of the Board of Directors to use earned incentive compensation to purchase Apogee stock. The purchased stock is then matched by an equal award of restricted stock, which vests over a predetermined period. There are 1,100,000 shares of common stock authorized for issuance or repurchase under the plan. As of February 26, 1994, 500,000 shares have been issued under the plan. We expensed $478,000, $287,000, and $450,000 in conjunction with the Partnership Plan in 1994, 1993, and 1992, respectively.\n12. ACQUISITIONS AND DIVESTITURES\nIn April 1993, our commercial construction division purchased certain assets of CFEM Facades, a French curtainwall company. Also in 1994, our glass fabrication division's Tru-Vue unit purchased the assets of a company serving another segment of the picture framing market.\nDuring 1993 and 1992, our installation and distribution division purchased the assets of several auto glass service and distribution centers. In 1992, our commercial construction division purchased the assets of three companies in the detention\/security sector of the nonresidential construction market.\nAll of the above transactions were accounted for by the purchase method. Accordingly, Apogee's consolidated financial statements include the net assets and results of operations from the dates of acquisition. In connection with the above acquisitions, the fair market value of assets purchased and liabilities assumed were as follows:\n13. PROVISION FOR BUSINESS RESTRUCTURING AND ASSET VALUATION\nDuring 1994, we recorded business restructuring and asset provision of $5.6 million. ($4.5 million pre-tax). The charge was principally related to the consolidation or closing of 10 commercial construction division offices and facilities, the write-down of certain assets and the reorganization of the window fabrication division's architectural products operation. The provision consisted of asset writedowns of $2.5 million and projected cash outlays of $3.1 million, most of which will take place in fiscal 1995.\nDuring 1992, we recorded a business restructuring provision of $5.8 million ($4.1 million after tax). The charge was principally related to the consolidation of our glass fabrication division's fabricating and coating capabilities, which involved the closing of its West Coast facilities and merging them with the division's Minnesota operations. We settled all outstanding matters related to the consolidation during fiscal 1994 and recorded a $405,000 recovery of the fiscal 1992 provision.\n14. LEASES\nAs of February 26, 1994, we were obligated under noncancelable operating leases for buildings and equipment. Certain leases provide for increased rentals based upon increases in real estate taxes or operating costs. Future minimum rental payments under noncancelable operating leases are:\nTotal rental expense was $17,129,000, $15,653,000 and $16,889,000 in 1994, 1993 and 1992, respectively.\n15. COMMITMENTS AND CONTINGENT LIABILITIES\nApogee has entered into a number of non-compete agreements. Non-compete agreements represent contractual agreements with the previous management of purchased businesses not to enter into competition with us for a certain period of time. As of February 26, 1994, we were committed to make future payments of $1,716,000 under such agreements.\nApogee has ongoing letters of credit related to risk management programs, construction contracts and certain industrial development bonds. The total value of letters of credit under which the company is obligated as of February 26, 1994 was approximately $38,923,000.\nApogee, like other participants in the construction business, is routinely involved in disputes and claims arising out of construction projects, sometimes involving significant monetary damages. Although it is impossible to predict the outcome of such disputes, we believe, based on facts currently available to us, that none of such claims will result in losses that would have a material adverse effect on our financial condition.\n16. FAIR VALUE DISCLOSURES\nThe following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107.\nEstimated fair value amounts have been determined using available market information and appropriate valuation methodologies. However, considerable judgment is required in developing the estimates of fair value. Accordingly, these estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The use of different market assumptions and\/or estimating methodologies may have a material effect on the estimated fair value amounts.\nEstimated fair values of our financial instruments at February 26, 1994 are as follows:\nFor cash and cash equivalents, receivables, and accounts payable, carrying value is a reasonable estimate of fair value.\nThe carrying values (face amounts) of our long-term debt that have variable interest rates are reasonable estimates of fair value. For borrowings that have fixed interest rates, fair value is estimated by discounting the projected cash flows using the rate at which similar borrowings could currently be made.\nThe fair value of interest rate swaps is the difference between the present value of our future interest obligation at a fixed rate and the counterparty's obligation at a floating rate.\n17. BUSINESS SEGMENTS\nSales, operating income, identifiable assets and other related data for our operations in different business segments, appearing in this report, are an integral part of these financial statements. Fiscal 1990 and 1991 segment data are not covered by the Independent Auditors' Report.\nNotes: Apogee's commercial construction division has subsidiaries in Europe and Asia. During 1994, such operations had net sales and an operating loss of $65,021,000 and $887,000 respectively. At February 26, 1994, identifiable assets of the subsidiaries totaled $31,786,000. In 1993 and 1992, net sales and identifiable assets of these units were less than 10% of Apogee's consolidated figures. Foreign currency transaction gains or losses included in net earnings for 1994, 1993 and 1992 were immaterial. Apogee's export sales are less than 10% of consolidated net sales. No single customer, including government agencies, accounts for 10% or more of consolidated net sales. Intersegment sales are arms-length transactions. Segment operating profit (loss) is net sales less cost of sales and operating expenses. Operating income does not include provision for interest expense or income taxes. Other income (expense) includes miscellaneous corporate activity not allocable to business segments.\nSCHEDULE V ----------\nAPOGEE ENTERPRISES, INC. AND SUBSIDIARIES\nProperty, Plant and Equipment (In thousands)\n[FN] (1) The amounts listed include property purchased through acquisitions of $986, $164 and $2,975 for the years 1994, 1993 and 1992, respectively, consisting entirely of machinery and equipment and office furniture and equipment, with the exception of $1,435 for a building in 1992.\nSCHEDULE VI -----------\nAPOGEE ENTERPRISES, INC. AND SUBSIDIARIES\nAccumulated Depreciation and Amortization of Property, Plant and Equipment (In thousands)\nSCHEDULE VIII -------------\nAPOGEE ENTERPRISES, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts (In thousands)\n[FN] (1) Net of recoveries","section_15":""}
{"filename":"9389_1994.txt","cik":"9389","year":"1994","section_1":"ITEM 1. BUSINESS\nBall Corporation is an Indiana corporation organized in 1880 and incorporated in 1922. Its principal executive offices are located at 345 South High Street, Muncie, Indiana 47305-2326. The terms \"Ball\" and the \"company\" as used herein refer to Ball Corporation and its consolidated subsidiaries.\nBall Corporation is a manufacturer of packaging products for use primarily in the packaging of food and beverage products. The company also provides aerospace and communications products and professional services to the federal sector and commercial customers.\nThe following sections of the 1994 Annual Report to Shareholders contain financial and other information concerning company business developments and operations, and are incorporated herein by reference: the notes to the financial statements \"Business Segment Information,\" \"Restructuring and Other Charges,\" \"Disposition,\" \"Spin-Off,\" \"Acquisitions\" and \"Management's Discussion and Analysis of Operations\".\nRecent Business Developments\nRestructuring and Other Charges -------------------------------\nIn the company's major packaging markets, excess manufacturing capacity and severe pricing pressures have presented significant competitive challenges in recent years. Moreover, reductions in federal defense expenditures and other attempts to curb the federal budget deficit have resulted in excess capacity in the aerospace and defense industry, a declining number of new contract bidding opportunities and curtailments and delays in existing programs.\nIn late 1993 the company developed plans to restructure its businesses in order to adapt the company's manufacturing capabilities and administrative organizations to meet foreseeable requirements of the packaging and aerospace markets. These plans involved plant closures to consolidate manufacturing activities into fewer, more efficient facilities, principally in the glass and metal food container businesses, and administrative consolidations in the glass, metal packaging and aerospace and communications businesses. In addition to the restructuring plans, decisions were made during 1993 to discontinue two aerospace and communications segment product lines.\nThe financial impact of these plans was recognized through restructuring and other charges recorded in the third and fourth quarters of 1993 in the aggregate amount of $108.7 million ($66.3 million after tax or $2.31 per share). Further information regarding the company's restructuring plans is included in the financial statement note \"Restructuring and Other Charges\" and \"Management's Discussion and Analysis of Operations,\" which are incorporated herein by reference.\nDisposition -----------\nIn March 1995 the company sold the Efratom division to Datum Inc. (Datum) for approximately $29 million which was paid in a combination of cash and Datum common stock. Efratom produces time and frequency devices used in navigation and communication. Total assets of the Efratom division at December 31, 1994 and 1993, were approximately $18.2 million and $16.0 million, respectively. Operating income for the Efratom division was $3.1 million, $2.7 million and $2.5 million in 1994, 1993 and 1992, respectively.\nSpin-Off --------\nOn April 2, 1993, the company completed the spin-off of seven diversified businesses by means of a distribution of 100 percent of the common stock of Alltrista Corporation (Alltrista), a then wholly owned subsidiary, to holders of company common stock. The distributed net assets of Alltrista included the following businesses: the consumer products division; the zinc products division; the metal decorating and service division; the industrial systems division; and the plastic products businesses, consisting of Unimark plastics, industrial plastics and plastic packaging. Following the distribution, Alltrista operated as an independent, publicly owned corporation. Additional information regarding this transaction can be found in the financial statement note \"Spin-Off,\" which is incorporated herein by reference.\nHeekin Can, Inc. ----------------\nOn March 19, 1993, the company acquired Heekin Can, Inc. (Heekin), a manufacturer of metal containers primarily for the food, pet food and aerosol markets, with 1992 sales of $355 million. The acquisition, which has been accounted for as a purchase business combination, was effected by issuance of approximately 2.5 million shares of Ball Corporation common stock valued at approximately $88.3 million, in exchange for 100 percent of Heekin's issued and outstanding common stock. Further information regarding this transaction is included in the financial statement note \"Acquisitions\" and \"Management's Discussion and Analysis of Operations,\" which are incorporated herein by reference.\nOther Information Pertaining to the Business of the Company\nThe company's continuing businesses are comprised of two segments: packaging, and aerospace and communications.\nPackaging Segment -----------------\nThe company's principal business segment develops, manufactures and sells rigid packaging products, containers and materials primarily for use in packaging food and beverage products. Most of the company's packaging segment products are sold in highly competitive markets, primarily based on price, service, quality and performance. The majority of the company's packaging sales are made directly to major companies having leading market positions in packaged food and beverage businesses. While a substantial portion of the company's sales of packaging products is made to relatively few customers, the company believes that its competitors exhibit similar customer concentrations.\nThe packaging business is capital intensive, requiring significant investments in machinery and equipment, and profitability is sensitive to production volumes and the cost of labor and significant raw materials. Generally, profitability is enhanced where greater unit volumes can be produced from a given investment in productive equipment and where material and labor costs per unit of product can be reduced.\nRaw materials used by the company's packaging businesses consist principally of metals (aluminum and steel), sand and soda ash and are generally available from several sources. Currently, the company is not experiencing any shortage of raw materials. The company's manufacturing facilities are dependent, in varying degrees, upon the availability of process energy, such as propane, natural gas, fuel oil and electricity. While certain of these energy sources may become increasingly in short supply, or subject to government allocation or excise taxes, the company cannot predict the effects, if any, of such occurrences on its future operations.\nResearch and development efforts in these businesses generally seek to improve manufacturing efficiencies and lower unit costs, principally raw material costs, by reducing the material content of containers while improving or maintaining other physical properties such as material strength. In addition, the company intends to produce and market new sizes and types of cans and market new products like the SlimCan and the patented Touch Top(TM) end.\nThe operations and products within this segment are discussed below:\nMetal Packaging\nMetal packaging is manufactured by the company's domestic metal beverage container operation as well as its wholly owned subsidiaries, Ball Packaging Products Canada, Inc. and Heekin Can, Inc., and is comprised primarily of two product lines: two-piece beverage containers and two and three-piece food containers. The market share of metal cans has remained relatively unchanged over the past 10 years. Dominance in both the food and beverage markets and high recycling rates contribute to the metal container's significant market share. The company's international metal container division has established business relationships with can manufacturers in Europe, the Middle East, Latin America and the Pacific Rim. In addition, the company began licensing programs in 1994 to provide manufacturing technology and assistance to the largest can maker in Australia and New Zealand and to a joint venture project, in which we have a minority equity position, to build the first two-piece beverage can manufacturing plant in the Philippines. The company and its joint venture partners are the largest producers of beverage cans in the People's Republic of China.\nMetal beverage containers\nMetal beverage containers and ends represent the company's largest product line accounting for approximately 41 percent of 1994 consolidated net sales. Decorated two-piece aluminum beverage cans are produced by seven domestic manufacturing facilities; ends are produced by two of these facilities. Three manufacturing facilities operated by Ball Canada produce aluminum beverage cans; ends are produced at one of these facilities as well as at one other facility. The company believes it is the fourth largest commercial supplier of aluminum beverage cans and ends to the combined U.S. and Canadian market in 1994 with an approximate 17 percent market share, based upon estimated 1994 total industry shipments. The company estimates that its three larger competitors together represent approximately 67 percent of estimated 1994 total industry shipments for the U.S. and Canada. One competitor increased its market share in 1994 by purchasing the beverage can manufacturing operations of a self-manufacturer.\nThe U.S. and Canadian metal beverage container industry has experienced steady demand growth at a compounded annual rate of approximately 3.5 percent over the last decade, with much of that growth in the soft drink market segment. In Canada, metal beverage containers have captured significantly lower percentages of the packaged beverage market than in the U.S., particularly in the packaged beer market, in which the market share of metal containers has been hindered by trade barriers within Canada. As a result of General Agreement on Tariffs and Trade (GATT) rulings, there has been pressure to remove these trade barriers. However, in May 1992, the Ontario government enacted an \"environmental\" tax levy of 10 cents (Canadian) per can of beer sold in Ontario. This tax discriminates against cans in favor of refillable glass bottles. Shipments of cans to the Ontario beer industry declined sharply after this tax was enacted.\nBeverage container industry production capacity in the U.S. and Canada has exceeded demand in the last several years, which has created a competitive pricing environment. In 1994, aluminum suppliers announced a change in the pricing formula for aluminum can sheet to a price based on ingot plus conversion costs in contrast to the current practice of annually negotiated prices. As a result, the cost of aluminum can sheet increased. In 1995 this increase will be reflected in higher beverage can selling prices.\nMetal beverage containers are sold primarily to brewers and fillers of carbonated soft drinks, beer and other beverages, under long-term supply or annual contracts. Sales to the company's largest customer, Anheuser-Busch Companies, Inc., accounted for approximately 11 percent of consolidated 1994 sales. Sales to all bottlers of Pepsi-Cola and Coca-Cola branded beverages comprised approximately 21 percent of consolidated 1994 sales. Sales volume of metal beverage cans and ends tends to be highest during the period between April and September.\nMetal food containers\nTwo-piece and three-piece steel food containers are manufactured by Ball Canada and Heekin, and sold primarily to food processors in Canada and the Midwestern United States. In 1994 metal food container sales comprised approximately 19 percent of consolidated sales. Sales to one customer represented more than 10 percent of this operation's 1994 sales. Sales volume of metal food containers tends to be highest from June through October.\nThe company has one principal competitor located in Canada and numerous competitors located in the U.S. food container market. With the acquisition of Heekin, the company estimates that it was the fourth largest metal food container manufacturer with an approximate 14 percent share of the North American market for metal food containers, based on estimated 1994 industry shipments. A competitor's recent acquisition of a major food processor's self-manufacturing operations resulted in that competitor becoming the third largest food can manufacturer in the North American market with an approximate 20 percent market share. This market has shown an accelerated trend toward the consolidation of manufacturing capacity during 1993 and 1994, including the company's acquisition of Heekin in 1993.\nIn the food container industry, capacity significantly exceeds market demand resulting in a highly price competitive market. During 1993 the company completed consolidation of certain facilities in Canada. In conjunction with the restructuring plans described above, the company closed its Augusta, Wisconsin, plant and sold its Alsip, Illinois, plant during 1994.\nOther metal packaging\nThe company also manufactures containers for aerosol products and other specialty goods, and sells flat sheet products, primarily to customers which manufacture cans for their own use.\nGlass Packaging\nBall Glass Container Corporation (Ball Glass), a wholly owned subsidiary, manufactures a diversified line of glass containers for sale primarily to processors, packers and distributors of food, juice, wine and liquor products. Ball Glass currently operates twelve glass container manufacturing facilities and a glass mold manufacturing facility. One glass plant is owned by Madera Glass Company, a 51 percent owned subsidiary of Ball Glass. Sales of glass containers accounted for approximately 29 percent of consolidated sales in 1994.\nThe company estimates that Ball Glass is the third largest domestic producer of commercial glass containers with an estimated 15 percent market share, based upon 1994 sales dollars. Its two larger competitors together are estimated to comprise in excess of 60 percent of the domestic market. Ball Glass has focused upon the food and juice, still wines and champagnes, and distilled spirits market segments, in which service, quality and performance are discriminating competitive factors. Ball Glass' share positions in these markets are estimated to be 24.2 percent, 23.9 percent and 11.5 percent, respectively.\nOne of the primary market segments served by Ball Glass, food and juice, represents the largest segment of U.S. glass container shipments accounting for 39.2 percent of the market. The total market for all types of glass containers decreased approximately 3.5 percent in 1994, and has declined by an average of 0.4 percent per annum since 1983 as other packaging materials, such as metal, plastic and flexible packaging, have captured a share of products previously packaged in glass, e.g., beer, carbonated soft drinks and specialty items, and due to a decline in alcoholic beverage consumption. Declining long-term demand for glass packaging has resulted in manufacturers reducing their production capacity in order to maintain a balance between market demand and supply. The glass container industry continues to face a challenging environment as plastic container demand rises.\nThe number of glass container manufacturers has consolidated from 21 companies operating 109 plants in 1983 to 11 companies with 67 plants in 1995. In 1992, three plants were closed in the industry: two by the company and one by a competitor. Although several furnaces were idled in 1993, no plants were closed in the industry. In 1994, the company closed its Asheville, North Carolina, and Okmulgee, Oklahoma, glass container manufacturing plants. One competitor closed a plant in 1994 and announced the pending closing of two plants.\nThe majority of Ball Glass sales are made directly to major companies having leading market positions in packaged food and juice, and still wines and champagnes. Sales to no one customer represented more than 10 percent of Ball Glass' 1994 sales.\nPlastic Packaging\nDemand for containers made of polyethylene terephthalate (PET) has increased in the beverage packaging market and is expected to increase in the food packaging market with improved technology and adequate supplies of PET resin. The company announced plans in 1994 to enter the plastic container market which reached $5.5 billion in 1994, surpassing the size of the glass container market for the first time.\nAerospace and Communications Segment ------------------------------------\nThe aerospace and communications segment provides systems, products and services to the aerospace and defense, and commercial telecommunications markets. Sales in the aerospace and communications segment accounted for approximately 10 percent of consolidated sales in 1994. Approximately 11 percent of the segment's sales in 1994 were made to the commercial telecommunications industry and 7 percent of sales were made to international customers.\nThe majority of the company's aerospace business involves work under relatively short-term contracts (generally one to five years) for the National Aeronautics and Space Administration (NASA), the U.S. Department of Defense (DoD) and foreign governments. Contracts funded by the various agencies of the federal government represented approximately 78 percent of this segment's sales in 1994. Overall, competition within the aerospace businesses is expected to intensify. Declining defense spending generally has resulted in greater competition for DoD contracts as the military market decreases, as well as greater competition for NASA and other civilian aerospace contracts historically serviced by Ball, as major defense contractors seek to enter those markets.\nThe segment also supplies commercial telecommunications equipment to customers in satellite and ground communications markets. Products are supplied on a fixed price basis to original equipment manufacturers both domestically and internationally. These markets are generally characterized as having relatively high growth rates (10 percent annually) and the products supplied typically have life cycles of 3 to 5 years.\nThe operations which comprise the aerospace and communications segment presently are organized as two divisions: the aerospace systems division and the telecommunications products division. Included in the aerospace systems division are space systems, systems engineering services, and electro-optics and cryogenics products. The telecommunications products division is comprised of commercial and video products and advanced antenna systems. In late 1994 a new subsidiary, Earthwatch, Inc., was formed to serve the market for satellite-based remote sensing of the earth. A description of the principal products and services of the aerospace and communications segment follows:\nSpace systems and systems engineering services\nThese businesses provide complete space systems including satellites, ground systems and launch vehicle integration to NASA, the DoD and to commercial and international customers. The products and services include mission definition and design; satellite design, manufacture and testing; payload and launch vehicle definition and integration; and satellite ground station control hardware and software.\nBall also provides a range of professional technical services to government customers including systems engineering support; simulation studies, analysis and prototype hardware; and hardware and software research and development tasks for test and evaluation of government programs. Revenues derived from services represented less than two percent of consolidated 1994 sales.\nElectro-optics and cryogenics products\nPrimary products of the electro-optics business include: spacecraft guidance, control instruments and sensors; defense subsystems for surveillance, warning, target identification and attitude control in military and civilian space applications; and scientific instruments used in various space and earth science applications.\nPrimary products in the cryogenics business include: open cycle cryogenic storage and cooling devices; mechanical refrigerators that provide cryogenic cooling; and thermal electric coolers and radiative coolers, all of which are used for the cooling of detectors and associated equipment for space science and earth remote sensing applications. Open cycle cryogenic systems are also provided to NASA for life support on space shuttles.\nTelecommunication products\nBall provides advanced radio frequency transmission and reception antennae for a variety of aerospace and defense platforms, including aircraft, missile, spacecraft, ground mobile equipment and ships. Antenna products are also provided for commercial aircraft for satellite communication and collision avoidance applications.\nBacklog\nBacklog of the aerospace and communications segment was approximately $322 million at December 31, 1994, and $305 million at December 31, 1993, and consists of the aggregate contract value of firm orders excluding amounts previously recognized as revenue. The 1994 backlog includes approximately $223 million which is expected to be billed during 1995 with the remainder expected to be billed thereafter. Unfunded amounts included in backlog for certain firm government orders which are subject to annual funding were approximately $181 million at December 31, 1994. Year-to-year comparisons of backlog are not necessarily indicative of future operations.\nThe company's aerospace and communications segment has contracts with the U.S. Government which have standard termination provisions. The Government retains the right to terminate contracts at its convenience. However, if contracts are terminated, the company is entitled to be reimbursed for allowable costs and profits to the date of termination relating to authorized work performed to such date. U.S. Government contracts are also subject to reduction or modification in the event of changes in Government requirements or budgetary constraints.\nPatents\nIn the opinion of the company, none of its active patents is essential to the successful operation of its business as a whole.\nResearch and Development\nThe note, \"Research and Development,\" of the 1994 Annual Report to Shareholders contains information on company research and development activity and is incorporated herein by reference.\nEnvironment\nCompliance with federal, state and local laws relating to protection of the environment has not had a material, adverse effect upon capital expenditures, earnings or competitive position of the company. As more fully described under Item 3. Legal Proceedings, the U. S. Environmental Protection Agency (EPA) and various state environmental agencies have designated the company as a potentially responsible party, along with numerous other companies, for the cleanup of several hazardous waste sites. However, the company's information at this time does not indicate that these matters will have a material, adverse effect upon financial condition, results of operations, capital expenditures or competitive position of the company.\nLegislation which would prohibit, tax or restrict the sale or use of certain types of containers, and would require diversion of solid wastes such as packaging materials from disposal in landfills, has been or may be introduced in U.S. Congress and the Canadian Parliament, in state and Canadian provincial legislatures and other legislative bodies. For instance, trade barriers were placed on metal containers in Canada. In addition, the Ontario government enacted an \"environmental\" tax levy of 10 cents (Canadian) per can of beer sold in Ontario which caused a decline in shipments of cans to the Ontario beer industry. While container legislation has been adopted in a few jurisdictions, similar legislation has been defeated in public referenda in several other states, in local elections and in many state and local legislative sessions. The company anticipates that continuing efforts will be made to consider and adopt such legislation in many jurisdictions in the future. If such legislation was widely adopted, it could have a material adverse effect on the business of the company, as well as on the container manufacturing industry generally, in view of the company's substantial North American sales and investment in metal beverage container manufacture as well as its investments in glass container packaging.\nGlass and aluminum containers are recyclable, and significant amounts of used containers are being recycled and diverted from the solid waste stream. In 1994 approximately 65 percent of aluminum beverage containers sold in the U.S. were recycled.\nEmployees\nAs of March 1995 Ball employed 12,873 people.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe company's properties are well maintained, considered adequate and being utilized for their intended purposes.\nThe Corporate headquarters, glass packaging group offices and certain research and engineering facilities are located in Muncie, Indiana. The group offices for metal packaging operations are based in Westminster, Colorado. Also located at Westminster is the Edmund F. Ball Technical Center, which serves as a research and development facility primarily for the metal packaging operations. Group offices for the aerospace and communications group are located in Broomfield, Colorado. The group offices and research and development center for the new plastic container division are located in Atlanta, Georgia.\nInformation regarding the approximate size of the manufacturing facilities for significant packaging operations, which are owned by the company, except where indicated otherwise, is provided below.\nThe Colorado-based operations of the aerospace and communications segment operate from a variety of company owned and leased facilities in Boulder, Broomfield and Westminster, Colorado, which together aggregate approximately 1,074,000 square feet of office, laboratory, research and development, engineering and test, and manufacturing space. Other aerospace and communications operations are based in San Diego, California.\nApproximate Floor Space in Plant Location Square Feet -------------- Metal packaging manufacturing facilities: ----------------------------------------\nRed Deer, Alberta (leased) 52,000 Blytheville, Arkansas (leased) 8,000 Springdale, Arkansas 290,000 Richmond, British Columbia 204,000 Fairfield, California 148,000 Golden, Colorado 330,000 Tampa, Florida 139,000 Columbus, Indiana 222,000 Saratoga Springs, New York 283,000 Cincinnati, Ohio 478,000 Columbus, Ohio 50,000 Findlay, Ohio 450,000 Burlington, Ontario 309,000 Hamilton, Ontario 347,000 Whitby, Ontario 195,000 Pittsburgh, Pennsylvania (leased) 81,000 Baie d'Urfe, Quebec 117,000 Chestnut Hill, Tennessee 70,000 Conroe, Texas 284,000 Williamsburg, Virginia 260,000 Weirton, West Virginia (leased) 117,000 DeForest, Wisconsin 45,000\nApproximate Floor Space in Plant Location Square Feet -------------- Glass packaging manufacturing facilities: ----------------------------------------\nEl Monte, California 456,000 Madera, California (Madera Glass Company) 771,000 Dolton, Illinois 490,000 Lincoln, Illinois 327,000 Plainfield, Illinois 419,000 Dunkirk, Indiana (leased) 715,000 Ruston, Louisiana 430,000 Carteret, New Jersey 338,000 Henderson, North Carolina 757,000 Port Allegany, Pennsylvania 451,000 Laurens, South Carolina 623,000 Seattle, Washington 640,000\nAdditional warehousing facilities are leased. The leased mould making facility operated by Ball Glass is located in Washington, Pennsylvania, and has approximately 56,000 square feet of manufacturing and office space.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nAs previously reported, the United States Environmental Protection Agency (EPA) considers the company to be a Potentially Responsible Party (PRP) with respect to the Lowry Landfill (\"site\") located east of Denver, Colorado. On June 12, 1992, the company was served with a lawsuit filed by the City and County of Denver and Waste Management of Colorado, Inc., seeking contribution from the company and approximately 38 other companies. The company filed its answer denying the allegations of the Complaint. On July 8, 1992, the company was served with a third party complaint filed by S. W. Shattuck Chemical Company, Inc., seeking contribution from the company and other companies for the costs associated with cleaning up the Lowry Landfill. The company denied the allegations of the complaint.\nOn July 31, 1992, the company entered into a settlement and indemnification agreement with the City and County of Denver (\"Denver\"), Chemical Waste Management, Inc., and Waste Management of Colorado, Inc., pursuant to which Chemical Waste Management, Inc., and Waste Management of Colorado, Inc. (collectively \"Waste\"), have dismissed their lawsuit against the company and will defend, indemnify, and hold harmless the company from claims and lawsuits brought by governmental agencies and other parties relating to actions seeking contributions or remedial costs from the company for the cleanup of the site. Several other companies which are defendants in the above-referenced lawsuits have already entered into the settlement and indemnification agreement with Denver and Waste. Waste Management, Inc., has guaranteed the obligations of Chemical Waste Management, Inc., and Waste Management of Colorado, Inc. Waste and Denver may seek additional payments from the company if the response costs related to the site exceed $319 million. The company might also be responsible for payments (calculated in 1992 dollars) for any additional wastes disposed of by the company at the site, which are identified after the execution of the settlement agreement. The company's information at this time does not indicate that this matter will have a material, adverse effect upon its financial condition.\nAs previously reported, the EPA issued in August 1988, an administrative order to 12 companies, including the company, pursuant to Section 106A of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (CERCLA), ordering them to remove certain abandoned drums and surface waste at the AERR CO site located in Jefferson County, Colorado. AERR CO, which used the site to recycle wastes, filed a petition with the United States Bankruptcy Court in Denver, Colorado, seeking protection from its creditors. Several of the companies, including the company, are subject to the EPA's order, and have cleaned up the site. The companies negotiated with the EPA with regard to its demand for the payment of oversight costs. The companies and the EPA entered into a settlement agreement on or about January 24, 1994, pursuant to which this matter was settled by payment of $488,867.41 by the companies. The company's portion of this payment was $28,594.82. The company's information at this time does not indicate that this matter will have a material, adverse effect upon its financial condition.\nAs previously reported, in September 1989 the company received a federal grand jury subpoena to produce documents relating to financial transactions and results of operations of the Ball Aerospace Systems Group Colorado operations since 1985. A supplemental subpoena was served in January 1990 requesting additional documents. The company has complied fully with the subpoenas. The Assistant United States Attorney has refused to disclose the specific nature of the investigation, but has indicated informally that the company is not a target of the investigation. The company does not believe that this matter will have a material, adverse effect upon its financial condition.\nAs previously reported, in April 1990 the company received from the EPA, Region V, Chicago, Illinois, a general notice letter and information request regarding the NL Industries\/Taracorp Superfund site located at Granite City, Illinois. The EPA alleges that the company, through its Zinc Products Division (formerly known as Ball Metal and Chemical Division) located in Greeneville, Tennessee, may be a PRP with respect to the NL Industries\/Taracorp site. The EPA requested that the company provide the EPA with any and all information with respect to any business conducted with Taracorp or NL Industries between 1977 and 1983. The company has responded to the EPA's request for information. The company is currently part of a group of companies which are organized to negotiate a de minimis settlement with the EPA. The company's information at this time does not indicate that this matter will have a material, adverse effect upon its financial condition.\nAs previously reported, in April 1987 the EPA notified the company and its wholly owned subsidiary, Heekin Can, Inc., that they may be PRPs in connection with the alleged disposal of waste at the American Chemical Services, Inc. (ACS) site located in Griffith, Indiana. In the fall of 1987, the company, as part of a group of companies, filed a lawsuit in the United States District Court for the Northern District of Indiana against the operators of the facility, ACS, and the Town of Griffith, Indiana, seeking a declaration of landowner's liability under CERCLA and seeking contribution from the landowners for the costs incurred by the companies of performing a remedial investigation and feasibility study. In September of 1990, ACS filed a counterclaim against the companies, including the company. ACS sought a declaratory judgment that the companies are responsible for a proportionate share of the liability for costs associated with the cleanup. The company has denied the allegations of the counterclaim. This lawsuit has now been settled. The company and its wholly owned subsidiary, Heekin Can, Inc., have entered into an Administrative Order On Consent and on January 20, 1995, paid the EPA $68,912.63 to resolve this matter. Based upon the information available to the company at this time, the company does not believe that this matter will have a material, adverse effect upon its financial condition.\nAs previously reported, on or about August 28, 1990, the company received a notice from the Department of Environmental Resources, State of Pennsylvania (DER), that the company may have been responsible for disposing of waste at the Industrial Solvents and Chemical Company site located in York County, Pennsylvania. The company is cooperating with several hundred other companies and the DER to resolve this matter. In December 1993 the company entered into a De Minimis Settlement Agreement with certain other companies who have agreed to indemnify the company with respect to claims arising out of the alleged disposal of hazardous waste at the site in consideration of the company paying an amount not to exceed $11,031.70 to the indemnifying companies. The company has paid the indemnifying companies in accordance with their agreement.\nAs previously reported, the company has been notified by Chrysler Corporation (Chrysler) that Chrysler, Ford Motor Company, and General Motors Corporation have been named in a lawsuit filed in the U.S. District Court in Reno, Nevada, by Jerome Lemelson, alleging infringement of three of his vision inspection system patents used by defendants. One or more of the vision inspection systems used by the defendants may have been supplied by the company's former Industrial Systems Division or its predecessors. The suit seeks injunctive relief and unspecified damages. Chrysler has notified the Industrial Systems Division that the Division may have indemnification responsibilities to Chrysler. The company has responded to Chrysler that it appears at this time that the systems sold to Chrysler by the company either were not covered by the identified patents or were sold to Chrysler before the patents were issued. Based on that information, it is not expected that any obligation to Chrysler because of the patents referred to will have a material, adverse effect on the financial condition of the company.\nAs previously reported, in July 1992 DeSoto, Inc., and other plaintiffs sued the company and other defendants claiming contribution from the defendants, including the company, through its former Plastics Division, for response costs incurred in connection with the Industrial Waste Control Landfill Site located in Fort Smith, Arkansas. The plaintiffs allege that the defendants are jointly and severally liable for response costs in excess of $9 million. The company had denied the allegations contained in the complaint, on the basis, primarily, that the Division did not dispose of hazardous waste at the site. In March 1993 the plaintiffs agreed to dismiss their complaint against the company. This matter now appears to be concluded with no material, adverse effect on the company's financial condition.\nAs previously reported, in September 1992 the company, as a fourth-party defendant, was served with a lawsuit filed by Allied Signal and certain other fourth-party plaintiffs seeking the recovery of certain response costs and contribution under CERCLA with respect to the alleged disposal by its Metal Decorating & Service Division of hazardous waste at the Cross Brothers Site in Kankakee, Illinois, during the years 1961 to 1980. Also in September 1992, the company was sued by another defendant, Krueger Ringier, Inc. In October 1992 the Illinois Environmental Protection Agency filed an action to join the company as a Defendant seeking to recover the State's costs in removing waste from the Cross Brothers Site. The company has denied the allegations of the complaints and will defend these matters, but is unable at this time to predict the outcome of the litigation. The company and certain other companies have entered into a Consent Decree with the EPA pursuant to which the EPA received approximately $2.9 million and provided the companies with contribution protection and a covenant not to sue. Ball's share of the settlement amount was $858,493.60. The company has been indemnified for the settlement payment by Alltrista Corporation which owns the Metal Decorating & Service Division. The Court approved the Consent Decree on April 28, 1994. The company and certain other companies are negotiating with the State of Illinois to settle the State's alleged claim to recover costs expended in the cleanup of the Cross Brothers Site. Based upon the information available to the company at this time, this matter is not likely to have a material, adverse effect upon its financial condition.\nAs previously reported, on October 12, 1992, the company received notice that it may be a PRP for the cleanup of the Aqua-Tech Environmental site located in Greer, South Carolina. The company is investigating this matter. Based upon the limited information that the company has at this time, the company does not believe this matter will have a material, adverse effect upon its financial condition.\nAs previously reported, on April 24, 1992, the company was notified by the Muncie Race Track Steering Committee that the company, through its former Consumer Products Division and former Zinc Products Division, may be a PRP with respect to waste disposed at the Muncie Race Track Site located in Delaware County, Indiana. The company is currently attempting to identify additional information regarding this matter. The Steering Committee has requested that the company pay two percent of the cleanup costs which are estimated at this time to be $10 million. The company has declined to participate in the PRP group because the company's records do not indicate the company contributed hazardous waste to the site. The company also declined to participate in funding an allocation study to be conducted by a consulting company. Based upon the information available to the company at this time, the company does not believe that this matter will have a material, adverse effect upon the company.\nAs previously reported, the company was notified on June 19, 1989, that the EPA has designated the company and numerous other companies as PRPs responsible for the cleanup of certain hazardous wastes that have been released at the Spectron, Inc., site located in Elkton, Maryland. In December 1989 the company, along with other companies whose alleged hazardous waste contributions to the Spectron, Inc., site were considered to be de minimis, entered into a settlement agreement with the EPA. Certain other PRPs have agreed with the EPA to perform a groundwater study of the site. The company's information at this time does not indicate that this matter will have a material, adverse effect upon its financial condition.\nAs previously reported, the company has received information that it has been named a PRP with respect to the Solvents Recovery Site located in Southington, Connecticut. According to the information received by the company, it is alleged that the company contributed approximately .08816% of the waste contributed to the site on a volumetric basis. The company is attempting to identify additional information regarding this matter. The company's information at this time does not indicate that this matter will have a material, adverse effect upon its financial condition.\nOn or about June 14, 1990, the El Monte plant of Ball-InCon Glass Packaging Corp. (now Ball Glass Container Corporation (Ball Glass), through a name change), a wholly owned subsidiary of the company, received a general notification letter and information request from EPA, Region IX, notifying Ball Glass that it may have potential liability as defined in Section 107(a) of the CERCLA incurred with respect to the San Gabriel Valley areas 1-4 Superfund sites located in Los Angeles County, California. The EPA requested certain information from Ball Glass, and Ball Glass has responded. After a period of inactivity, the federal and state governments are proceeding to complete the remedial investigation study which will lead to a proposed cleanup. On October 7, 1994, the U.S. EPA issued \"special notice\" letters requiring (i) the 17 recipients, including Ball Glass, to form an official PRP group to deal with the EPA, (ii) the group to undertake and pay for a remedial investigation\/feasibility study, and (iii) the recipients to pay EPA's administrative costs. The group submitted to the EPA its \"good faith\" response letter outlining how the group proposes to perform the remedial investigation study requested by the EPA. The company and certain other companies continue to negotiate with the EPA. Based on the information, or lack thereof, available at the present time, the company is unable to express an opinion as to the actual exposure of the company for this matter.\nPrior to the acquisition on April 19, 1991, of the lenders' position in the term debt and 100 percent ownership of Ball Canada, the company had owned indirectly 50 percent of Ball Canada through a joint venture holding company owned equally with Onex Corporation (Onex). The 1988 Joint Venture Agreement had included a provision under which Onex, beginning in late 1993, could \"put\" to the company all of its equity in the holding company at a price based upon the holding company's fair value. Onex has since claimed that its \"put\" option entitled it to a minimum value founded on Onex's original investment of approximately $22.0 million. On December 9, 1993, Onex served notice on the company that Onex was exercising its alleged right under the Joint Venture Agreement to require the company to purchase all of the holding company shares owned or controlled by Onex, directly or indirectly, for an amount including \"approximately $40 million\" in respect of the Class A-2 Preference Shares owned by Onex in the holding company. Such \"$40 million\" is expressed in Canadian dollars and would represent approximately $30 million at the year-end exchange rate. The company's position is that it has no obligation to purchase any shares from Onex or to pay Onex any amount for such shares, since, among other things, the Joint Venture Agreement, which included the \"put\" option, is terminated. Onex is now pursuing its claim on arbitration before the International Chamber of Commerce. A hearing has been set to begin on May 30, 1995. The company believes that it has meritorious defenses against Onex's claims, although, because of the uncertainties inherent in the arbitration process, it is unable to predict the outcome of this arbitration.\nOn March 8, 1994, the company and its wholly owned subsidiary, Heekin Can, Inc., were served with a lawsuit by Harlan Yoder, an employee of Heekin Can, Inc., and his spouse seeking $6,500,000 jointly and severally as the result of an alleged injury to Mr. Yoder on or about April 26, 1993. Mr. Yoder sustained a crushing injury to his left hand while operating machinery at the Heekin Can, Inc., metal container manufacturing plant located at Columbus, Ohio. The company and Heekin Can, Inc., deny the material allegations of the complaint filed by the Yoders. Based upon the information available to the company at this time, the company does not believe that this matter will have a material adverse effect upon its financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS\nThere were no matters submitted to the security holders during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS\nBall Corporation common stock (BLL) is traded on the New York, Midwest and Pacific Stock Exchanges. There were 9,105 common shareholders of record on March 1, 1995.\nOther information required by Item 5 appears under the caption, \"Quarterly Stock Prices and Dividends,\" in the section titled, \"Items of Interest to Shareholders,\" of the 1994 Annual Report to Shareholders and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by Item 6 for the five years ended December 31, 1994, appearing in the section titled, \"Eight Year Review of Selected Financial Data,\" of the 1994 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 Operations\" of the 1994 Annual Report to Shareholders is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe consolidated financial statements and notes thereto of the 1994 Annual Report to Shareholders, together with the report thereon of Price Waterhouse, dated January 23, 1995, are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThere were no matters required to be reported under this item.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the company are as follows:\n1. George A. Sissel, 58, Acting President and Chief Executive Officer, since May 1994; Senior Vice President, Corporate Affairs; Corporate Secretary and General Counsel, since January 1993; Senior Vice President, Corporate Secretary and General Counsel, 1987-1992; Vice President, Corporate Secretary and General Counsel, 1981-1987.\n2. William A. Lincoln, 53, Executive Vice President, Metal Container Operations, since March 1993; Executive Vice President, Metal Packaging Operations, 1992-1993; Group Vice President, 1991-1992; President and Chief Executive Officer, Ball Packaging Products Canada, Inc., since 1988; Vice President and Group Executive, Research, Development and Engineering, Packaging Products, 1988; Vice President, Engineering and Development, Metal Container Division, 1978-1988.\n3. Duane E. Emerson, 57, Senior Vice President, Administration, since April 1985; Vice President, Administration, 1980-1985.\n4. R. David Hoover, 49, Senior Vice President and Chief Financial Officer, since August 1992; Vice President and Treasurer, 1988-1992; Assistant Treasurer, 1987-1988; Vice President, Finance and Administration, Technical Products, 1985-1987; Vice President, Finance and Administration, Management Services Division, 1983-1985.\n5. John A. Haas, 58, Group Vice President; President and Chief Executive Officer, Ball Glass Container Corporation, since June 1994; President, Metal Food Container and Specialty Products Group, 1993-1994; President and Chief Executive Officer, Heekin Can, Inc. 1988-1994.\n6. Donovan B. Hicks, 57, Group Vice President; President, Aerospace and Communications Group, since January 1988; Group Vice President, Technical Products, 1980-1988; President, Ball Brothers Research Corporation\/Division, 1978-1980.\n7. David B. Sheldon, 53, Group Vice President; President, Metal Beverage Container Group; Group Vice President, Packaging Products, 1992-1993; Vice President and Group Executive, Sales and Marketing, Packaging Products Group, 1988-1992; Vice President and Group Executive, Sales and Marketing, Metal Container Group, 1985-1988.\n8. Richard E. Durbin, 53, Vice President, Information Services, since April 1985; Corporate Director, Information Services, 1983-1985; Corporate Director, Data Processing, 1981-1983.\n9. Albert R. Schlesinger, 53, Vice President and Controller, since January 1987; Assistant Controller, 1976-1986.\n10. Raymond J. Seabrook, 44, Vice President and Treasurer, since August 1992; Senior Vice President and Chief Financial Officer, Ball Packaging Products Canada, Inc., 1988-1992.\n11. Harold L. Sohn, 49, Vice President, Corporate Relations, since March 1993; Director, Industry Affairs, Packaging Products, 1988-1993.\n12. David A. Westerlund, 44, Vice President, Human Resources, since December 1994; Senior Director, Corporate Human Resources, July 1994-December 1994; Vice President, Human Resources and Administration, Ball Glass, 1988-1994; Vice President, Human Resources, Ball Glass, 1987-1988.\n13. Elizabeth A. Overmyer, 55, Assistant Corporate Secretary, since April 1981; Administrator, Office of the Corporate Secretary, 1979-1981.\n14. Donald C. Lewis, 52, Assistant Corporate Secretary and Associate General Counsel, since May 1990; Associate General Counsel 1983-1990; Assistant General Counsel, 1980-1983.\nOther information required by Item 10 appearing under the caption, \"Director Nominees and Continuing Directors,\" on pages 3 through 5 of the company's proxy statement filed pursuant to Regulation 14A dated March 20, 1995, is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by Item 11 appearing under the caption, \"Executive Compensation,\" on pages 7 through 15 of the company's proxy statement filed pursuant to Regulation 14A dated March 20, 1995, is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by Item 12 appearing under the caption, \"Voting Securities and Principal Shareholders,\" on pages 1 and 2 of the company's proxy statement filed pursuant to Regulation 14A dated March 20, 1995, is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by Item 13 appearing under the caption, \"Relationship with Independent Public Accountants and Certain Other Relationships and Related Transactions,\" on page 17 of the company's proxy statement filed pursuant to Regulation 14A dated March 20, 1995, 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 documents included in the 1994 Annual Report to Shareholders are incorporated by reference in Part II, Item 8:\nConsolidated statement of income (loss) - Years ended December 31, 1994, 1993 and 1992\nConsolidated balance sheet - December 31, 1994 and 1993\nConsolidated statement of cash flows - Years ended December 31, 1994, 1993 and 1992\nConsolidated statement of changes in shareholders' equity - Years ended December 31, 1994, 1993 and 1992\nNotes to consolidated financial statements\nReport of independent accountants\n(2) Financial Statement Schedules:\nThere were no financial statement schedules required under this item.\n(3) Exhibits:\nSee the Index to Exhibits which appears at the end of this document and which is incorporated by reference herein.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the fourth quarter of 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.\nBALL CORPORATION (Registrant) By: \/s\/ George A. Sissel -------------------------------------- George A. Sissel, Acting President and Chief Executive Officer March 29, 1995\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 below.\n(1) Principal Executive Officer: Acting President and \/s\/ George A. Sissel Chief Executive Officer --------------------------------------- March 29, 1995 George A. Sissel\n(2) Principal Financial Accounting Officer: Senior Vice President and \/s\/ R. David Hoover Chief Financial Officer --------------------------------------- March 29, 1995 R. David Hoover\n(3) Controller:\n\/s\/ Albert R. Schlesinger Vice President and --------------------------------------- Controller Albert R. Schlesinger March 29, 1995\n(4) A Majority of the Board of Directors:\n\/s\/ Howard M. Dean * Director --------------------------------------- March 29, 1995 Howard M. Dean\n\/s\/ John T. Hackett * Director --------------------------------------- March 29, 1995 John T. Hackett\n\/s\/ John F. Lehman * Director --------------------------------------- March 29, 1995 John F. Lehman\n\/s\/ Jan Nicholson * Director --------------------------------------- March 29, 1995 Jan Nicholson\n\/s\/ Alvin Owsley * Chairman of the Board and --------------------------------------- Director Alvin Owsley March 29, 1995\n\/s\/ George A. Sissel * Acting President and Chief --------------------------------------- Executive Officer and George A. Sissel Director March 29, 1995\n\/s\/ Delbert C. Staley * Director --------------------------------------- March 29, 1995 Delbert C. Staley\n\/s\/ W. Thomas Stephens * Director --------------------------------------- March 29, 1995 W. Thomas Stephens\n\/s\/ William P. Stiritz * Director --------------------------------------- March 29, 1995 William P. Stiritz\n*By George A. Sissel as Attorney-in-Fact pursuant to a Limited Power of Attorney executed by the directors listed above, which Power of Attorney has been filed with the Securities and Exchange Commission.\nBy: \/s\/ George A. Sissel ------------------------------ George A. Sissel As Attorney-In-Fact March 29, 1995\nBALL CORPORATION AND SUBSIDIARIES ANNUAL REPORT ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1994\nIndex to Exhibits\nExhibit Number Description of Exhibit ------- --------------------------------------------------------------- 3.(i) Amended Articles of Incorporation as of November 26, 1990 (filed by incorporation by reference to the Current Report on Form 8-K dated November 30, 1990) filed December 13, 1990.\n3.(ii) Bylaws of Ball Corporation as amended January 25, 1994 (filed by incorporation by reference to the Annual Report on Form 10-K for the year ended December 31, 1993) filed March 29, 1994.\n4.1 Ball Corporation and its subsidiaries have no long-term debt instruments in which the total amount of securities authorized under any instrument exceeds 10% of the total assets of the registrant and its subsidiaries on a consolidated basis. Ball Corporation hereby agrees to furnish a copy of any long-term debt instruments upon the request of the Commission.\n4.2 Dividend distribution payable to shareholders of record on August 4, 1986, of one preferred stock purchase right for each outstanding share of common stock under the Rights Agreement dated as of July 22, 1986, and as amended by the Amended and Restated Rights Agreement dated as of January 24, 1990 and the First Amendment, dated as of July 27, 1990, between the corporation and The First National Bank of Chicago (filed by incorporation by reference to the Form 8-A Registration Statement, No. 1-7349, dated July 25, 1986, as amended by Form 8, Amendment No. 1, dated January 24, 1990 and by Form 8, Amendment No. 2, dated July 27, 1990) filed August 2, 1990.\n10.1 1975 Stock Option Plan as amended, 1980 Stock Option and Stock Appreciation Rights Plan, as amended, 1983 Stock Option and Stock Appreciation Rights Plan (filed by incorporation by reference to the Form S-8 Registration Statement, No. 2-82925) filed April 27, 1983.\n10.2 Restricted Stock Plan (filed by incorporation by reference to the Form S-8 Registration Statement, No. 2-61252) filed May 2, 1978.\n10.3 1988 Restricted Stock Plan and 1988 Stock Option and Stock Appreciation Rights Plan (filed by incorporation by reference to the Form S-8 Registration Statement, No. 33-21506) filed April 27, 1988.\n10.4 Ball Corporation Deferred Incentive Compensation Plan (filed by incorporation by reference to the Annual Report on Form 10-K for the year ended December 31, 1987) filed March 25, 1988.\n10.5 Ball Corporation 1986 Deferred Compensation Plan, as amended July 1, 1994 (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended July 3, 1994) filed August 17, 1994.\n10.6 Ball Corporation 1988 Deferred Compensation Plan, as amended July 1, 1994 (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended July 3, 1994) filed August 17, 1994.\n10.7 Ball Corporation 1989 Deferred Compensation Plan, as amended July 1, 1994 (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended July 3, 1994) filed August 17, 1994.\n10.8 Form of Severance Agreement which exists between the company and its executive officers (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended October 2, 1994) filed November 15, 1994.\n10.9 An agreement dated September 15, 1988 between Ball Corporation and Onex Corporation to form a joint venture company known as Ball-Onex Packaging Corp., since renamed Ball Packaging Products Canada, Inc. (filed by incorporation by reference to the Current Report on Form 8-K dated December 8, 1988) filed December 23, 1988.\nExhibit Number Description of Exhibit ------- --------------------------------------------------------------- 10.10 Stock Purchase Agreement dated as of June 29, 1989 between Ball Corporation and Mellon Bank, N.A. (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended July 2, 1989) filed August 15, 1989.\n10.11 Stock Purchase Agreement dated July 30, 1990 between Ball Corporation and NV Hollandsch-Amerikaansche Beleggingsmaatschappij (Holland-American Investment Corporation) (filed by incorporation by reference to the Current Report on Form 8-K dated November 30, 1990) filed December 13, 1990, as amended under cover of Form 8 filed on February 12, 1991.\n10.12 Ball Corporation 1986 Deferred Compensation Plan for Directors, as amended October 27, 1987 (filed by incorporation by reference to the Annual Report on Form 10-K for the year ended December 31, 1990) filed April 1, 1991.\n10.13 1991 Restricted Stock Plan for Nonemployee Directors of Ball Corporation (filed by incorporation by reference to the Form S-8 Registration Statement, No. 33-40199) filed April 26, 1991.\n10.14 Agreement of Purchase and Sale, dated April 11, 1991, between Ball Corporation and the term lenders of Ball Packaging Products Canada, Inc., Citibank Canada, as Agent (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended March 31, 1991) filed May 15, 1991.\n10.15 Ball Corporation Economic Value Added Incentive Compensation Plan dated January 1, 1994. (Filed herewith.)\n10.16 Agreement and Plan of Merger among Ball Corporation, Ball Sub Corp. and Heekin Can, Inc. dated as of December 1, 1992, and as amended as of December 28, 1992 (filed by incorporation by reference to the Registration Statement on Form S-4, No. 33-58516) filed February 19, 1993.\n10.17 Distribution Agreement between Ball Corporation and Alltrista (filed by incorporation by reference to the Alltrista Corporation Form 8, Amendment No. 3 to Form 10, No. 0-21052, dated December 31, 1992) filed March 17, 1993.\n10.18 1993 Stock Option Plan (filed by incorporation by reference to the Form S-8 Registration Statement, No. 33-61986) filed April 30, 1993.\n10.19 Letter agreement, dated March 22, 1993, confirming offer and terms of employment to Mr. John A. Haas as Group Vice President; President, Metal Food Container and Specialty Products Group (filed by incorporation by reference to the Annual Report on Form 10-K for the year ended December 31, 1993) filed March 29, 1994.\n10.20 Employment agreement, dated December 1, 1992, among Heekin Can, Inc. and John A. Haas (filed by incorportion by reference to the Annual Report on Form 10-K for the year ended December 31, 1993) filed March 29, 1994.\n10.21 Retirement Agreement dated June 17, 1994, between Delmont A. Davis and Ball Corporation (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended July 3, 1994) filed August 17, 1994.\n10.22 Ball-InCon Glass Packaging Corp. Deferred Compensation Plan, as amended July 1, 1994 (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended July 3, 1994) filed August 17, 1994.\n10.23 Retirement Agreement dated July 29, 1994, between H. Ray Looney and Ball Corporation (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended July 3, 1994) filed August 17, 1994.\n10.24 Retention Agreement dated June 22, 1994, between Donovan B. Hicks and Ball Corporation (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended July 3, 1994) filed August 17, 1994.\nExhibit Number Description of Exhibit ------- ---------------------------------------------------------------\n10.25 Ball Corporation Supplemental Executive Retirement Plan (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended October 2, 1994) filed November 15, 1994.\n10.26 Ball Corporation Split Dollar Life Insurance Plan (filed by incorporation by reference to the Quarterly Report on Form 10-Q for the quarter ended October 2, 1994) filed November 15, 1994.\n10.27 Ball Corporation Long-Term Cash Incentive Plan, dated October 25, 1994. (Filed herewith.)\n11.1 Statement re: Computation of Earnings Per Share. (Filed here- with.)\n13.1 Ball Corporation 1994 Annual Report to Shareholders (The Annual Report to Shareholders, except for those portions thereof incorporated by reference, is furnished for the information of the Commission and is not to be deemed filed as part of this Form 10-K.) (Filed herewith.)\n21.1 List of Subsidiaries of Ball Corporation. (Filed herewith.)\n23.1 Consent of Independent Accountants. (Filed herewith.)\n24.1 Limited Power of Attorney. (Filed herewith.)\n27.1 Financial Data Schedule. (Filed herewith.)\n99.1 Specimen Certificate of Common Stock (filed by incorporation by reference to the Annual Report on Form 10-K for the year ended December 31, 1979) filed March 24, 1980.","section_15":""}
{"filename":"65695_1994.txt","cik":"65695","year":"1994","section_1":"ITEM 1. BUSINESS.\nINTRODUCTION\nANR Pipeline is a Delaware corporation organized in 1945. All of ANR Pipeline's outstanding common stock is owned by ANR. ANR is a direct, wholly- owned subsidiary of Coastal Natural Gas, and an indirect subsidiary of Coastal. ANR Pipeline owns and operates an interstate natural gas pipeline system. At December 31, 1994, the Company had 2,102 employees engaged in the operation of ANR Pipeline and 144 employees engaged in the operation of HIOS, UTOS and Empire.\nNATURAL GAS SYSTEM\nOPERATIONS\nGENERAL\nThe Company is involved in the transportation, storage, gathering and balancing of natural gas. ANR Pipeline provides these services for various customers through its facilities located in Arkansas, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Nebraska, New Jersey, Ohio, Oklahoma, Tennessee, Texas, Wisconsin, Wyoming and offshore in federal waters. Prior to November 1, 1993, the Company was also engaged in the sale for resale of natural gas. With the Company's implementation of Order 636 effective November 1, 1993, ANR Pipeline no longer provides a merchant service. However, former gas sales customers of ANR Pipeline have largely retained their firm storage and transportation service levels previously included in their \"bundled\" gas sales services. The Company auctions gas on the open market in producing areas to handle a residual quantity of gas purchased under certain continuing gas purchase contracts pending renegotiation or expiration of such contracts. The Company operates two offshore gas pipeline systems in the Gulf of Mexico which are owned by HIOS and UTOS, general partnerships composed of ANR Pipeline subsidiaries and subsidiaries of other pipeline companies. The Company also operates Empire, an intrastate pipeline extending from Niagara Falls to Syracuse, New York, in which an affiliate of the Company has a 45% interest.\nThe Company's two interconnected, large-diameter multiple pipeline systems transport gas to the Midwest from (a) the Hugoton Field and other fields in the Anadarko Basin in Texas and Oklahoma and (b) the Louisiana onshore and Louisiana and Texas offshore areas. The Company's principal pipeline facilities at December 31, 1994 consisted of 12,661 miles of pipeline and 96 compressor stations with 1,069,398 installed horsepower. At December 31, 1994, the design peak day delivery capacity of the transmission system, considering supply sources, storage, markets and transportation for others, was approximately 5.6 Bcf per day.\nTRANSPORTATION SERVICES AND GAS SALES\nOn November 1, 1992, as part of its Interim Settlement, ANR Pipeline implemented a restructuring of its traditional sales services by replacing existing services with a combination of competitive service alternatives. This restructuring provided a number of options for pipeline customers and was designed to enhance competition in ANR Pipeline's service areas. Under this restructuring, the sales service was \"unbundled\" on an interim basis into firm sales, transportation, flexible storage and flexible delivery services. Prior to the restructuring, the cost of providing transportation services for sales customers was recovered as part of ANR Pipeline's total resale rate and therefore, was classified as part of gas sales revenue. Under the restructuring, these costs were recovered through a separate rate and were included in transportation revenue. Additional information concerning the restructuring is set forth in \"Regulations Affecting Gas System - Rate Matters\" included herein.\nEffective November 1, 1993, the Company implemented Order 636. This Order required significant changes in the services provided by ANR Pipeline and resulted in the elimination of the Company's merchant service. The Company now offers an array of \"unbundled\" transportation, storage and balancing service options. Additional information concerning Order 636, including transportation and storage, is set forth in \"Regulations Affecting Gas System - General\" included herein.\nANR Pipeline transports gas to markets on its system and also transports gas to other markets off its system under transportation and exchange arrangements with other companies, including distributors, intrastate and interstate pipelines, producers, brokers, marketers and end-users. Transportation service revenues amounted to $555 million for 1994 compared to $533 million for 1993 and $463 million for 1992. The significant increase in transportation revenues for 1993 was largely attributable to the restructuring of the Company's sales service under the Interim Settlement, as discussed above.\nGas sales revenues of ANR Pipeline amounted to $106 million during 1994, compared to $604 million in 1993 and $635 million in 1992. The significant decrease in 1994 is due to the elimination of the Company's merchant function effective November 1, 1993, as discussed above. Gas sales revenues in 1994 were derived primarily from the auctioning of gas on the open market in producing areas, as previously discussed.\nDuring 1994, ANR Pipeline's throughput was 1,371 Bcf, of which approximately 24% was transported for its three largest customers: Michigan Consolidated Gas Company, Wisconsin Gas Company and Wisconsin Natural Gas Company. Michigan Consolidated Gas Company serves the city of Detroit and certain surrounding areas, the cities of Grand Rapids and Muskegon, the communities of Ann Arbor and Ypsilanti and numerous other communities in Michigan. Wisconsin Gas Company serves the Milwaukee metropolitan area and numerous other communities in Wisconsin. Wisconsin Natural Gas Company serves the cities of Racine, Kenosha, Appleton and their surrounding areas in Wisconsin. In 1994, ANR Pipeline provided approximately 70% and 35% of the total gas requirements for Wisconsin and Michigan, respectively.\nANR Pipeline's system deliveries for the years 1994, 1993 and 1992 are as follows:\nGAS PURCHASES\nEffective November 1, 1993, as a result of the elimination of ANR Pipeline's merchant service, as mentioned above, the Company's gas purchases decreased substantially. However, the Company still purchases a residual quantity of gas under certain remaining gas purchase contracts. The Company's Order 636 restructured tariff provides a transitional mechanism for the purpose of recovering from, or refunding to, its customers any pricing differential between costs incurred to purchase this gas and the amount the Company recovers through the auctioning of such gas on the open market in producing areas.\nSome of ANR Pipeline's remaining gas purchase contracts with independent producers contain provisions which require taking minimum volumes and\/or making prepayments for volumes not taken if purchases fall below specified levels during the contract year (\"take-or-pay\"). Additional information on take-or-pay matters is set forth in Note 6 of Notes to Consolidated Financial Statements included herein.\nGAS STORAGE\nANR Pipeline owns seven and leases eight underground storage facilities in Michigan. The total working storage capacity of the system is approximately 193 Bcf, with a maximum day delivery capacity of 2 Bcf as late as the end of February. However, of the 193 Bcf, the Company has reclassified 62.1 Bcf of working gas to recoverable base gas, which is pending approval before the FERC. The Company also has the contract rights for 42 Bcf of storage capacity provided by Blue Lake Gas Storage Company and 30 Bcf of storage capacity provided by ANR Storage. Underground storage services of up to 180 Bcf of gas are provided by the Company to customers on a firm basis. The Company also provides interruptible storage services for customers on a short-term basis.\nCoastal's independent engineers, Huddleston & Co., Inc., have estimated that the Company's gas storage reserves as of December 31, 1994, 1993 and 1992 were 113.8 Bcf, 106.5 Bcf and 128.0 Bcf, respectively. The 1994 gas storage reserves are comprised of 23.4 Bcf of natural gas, maintained under the Company's own account as working gas for system balancing and no-notice services and 90.4 Bcf of recoverable base gas reserves. Of the total recoverable base gas reserves, 28.3 Bcf represents reserves in the seven-owned and eight-leased storage fields and 62.1 Bcf represents working gas which the Company has reclassified as recoverable base gas.\nCOMPETITION\nANR Pipeline has historically competed with interstate pipeline companies in the sale, transportation and storage of gas and with independent producers, brokers, marketers and other pipelines in the gathering and sale of gas within its service areas. On November 1, 1993, the Company implemented Order 636 on its system. As a consequence, the Company is no longer a seller of natural gas to resale customers. 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.\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 ANR Pipeline.\nANR Pipeline's transportation, storage and balancing services are influenced by its customers' access to alternative providers of such services. The Company competes directly with Panhandle Eastern Pipe Line Company, Trunkline Gas Company, Northern Natural Gas Company, Natural Gas Pipeline Company of America, Michigan Consolidated Gas Company and CMS Energy Company in its principal market areas of Michigan and Wisconsin for its transportation, storage and balancing business. The Company's gathering services, which are offered in the southeast and southwest gas producing areas of the United States, compete with other providers of such services, including gathering companies, producers and intrastate and interstate pipeline companies.\nPRODUCING AREA DELIVERABILITY\nShippers on ANR Pipeline have direct access to the two most prolific gas producing areas in the United States, the Gulf Coast and the Midcontinent. Statistics published by the Energy Information Agency, Office of Oil and Gas, U. S. Department of Energy, indicate that approximately 81% of all natural gas in the lower 48 states is produced from these two areas. Interconnecting pipelines provide shippers with access to all other major gas producing areas in the United States and Canada.\nGas deliverability available to shippers on ANR Pipeline's system from the Midcontinent and Gulf Coast producing areas through direct connections and interconnecting pipelines and gatherers is approximately 4,200 MMcf per day. An additional 250 MMcf per day of deliverability is accessible to shippers on Company-owned, or partially-owned, pipeline segments not directly connected to a Company mainline.\nThe Company remains active in locating and connecting new sources of natural gas to facilitate transportation arrangements made by third-party shippers. During 1994, field development, newly connected gas wells, gas production facilities and pipeline interconnections contributed over 1,100 MMcf per day to total deliverability accessible to shippers on the Company's pipeline system.\nREGULATIONS AFFECTING GAS SYSTEM\nGENERAL\nUnder the NGA, the FERC has jurisdiction over ANR Pipeline as to sales, transportation, storage, gathering and balancing of gas, rates and charges, construction of new facilities, extension or abandonment of service and facilities, accounts and records, depreciation and amortization policies and certain other matters. ANR Pipeline, where required, holds certificates of public convenience and necessity issued by the FERC covering its jurisdictional facilities, activities and services.\nANR Pipeline 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.\nOn November 1, 1990, the FERC issued Order No. 528 in which it sets forth guidelines for an acceptable allocation method for a fixed direct charge to collect take-or-pay settlement costs. Pursuant to Order No. 528, the Company has filed for and received approval to recover 75% of expenditures associated with resolving producer claims and renegotiating gas purchase contracts. The approved filings provide for recovery of 25% of such expenditures via a direct bill to the Company's former sales for resale customers and 50% via a surcharge on all transportation volumes. Contract reformation and take-or-pay costs incurred as a result of the mandated Order 636 restructuring will be recovered under the transition cost mechanisms of Order 636, as well as through negotiated agreements with the Company's customers.\nOn April 8, 1992, the FERC issued 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. The case is currently in the briefing phase before the United States Court of Appeals for the D.C. Circuit. ANR Pipeline placed its restructured services under Order 636 into effect on November 1, 1993. As a result, the Company no longer provides a merchant service and now offers a wide range of \"unbundled\" transportation, storage and balancing services. However, the Company still purchases a residual quantity of gas under certain remaining gas purchase contracts. The Company's Order 636 restructured tariff provides a transitional mechanism for the purpose of recovering from, or refunding, to its customers any pricing differential between costs incurred to purchase this gas and the amount the Company recovers through the auctioning of such gas on the open market in producing areas. Several persons, including ANR Pipeline, have sought judicial review of aspects of the FERC's orders approving the Company's restructuring filings. Those appeals have been held in abeyance by the United States Court of Appeals for the D.C. Circuit, pending further order. On March 24, 1994, the FERC issued its \"Fourth Order on Compliance Filing and Third Order on Rehearing,\" which addressed numerous rehearing issues and confirmed that after minor required tariff modifications, the Company is now fully in compliance with Order 636 and the requirements of the orders on ANR Pipeline's restructuring filings. The FERC issued a further order regarding certain compliance issues on July 1, 1994. In accordance with this order, the Company filed revised tariff sheets on July 18, 1994.\nRATE MATTERS\nAll of the Company's service options are subject to rate regulation by the FERC. Under the NGA, ANR Pipeline must file with the FERC to establish or adjust its service rates. The FERC may also initiate proceedings to determine whether the Company's rates are \"just and reasonable.\"\nOn March 10, 1992, the Company submitted to the FERC a comprehensive Interim Settlement designed to resolve all outstanding issues resulting from its 1989 rate case and its 1990 proposed service restructuring proceeding. The Interim Settlement became effective November 1, 1992 and expired with the Company's implementation of Order 636 on November 1, 1993. Under the Interim Settlement, gas inventory demand charges were collected from the Company's resale customers for the period November 1, 1992 through October 31, 1993. This method of gas cost recovery required refunds for any over-collections, and placed the Company at risk for under-collections. As required by the Interim Settlement, the Company filed with the FERC on April 29, 1994, a reconciliation report showing over-collections and, therefore, proposed refunds totaling $45.1 million. Such refund obligations were recorded at December 31, 1994 and December 31, 1993, and are included in the Consolidated Balance Sheet under \"Deferred Credits and Other.\" Certain customers have disputed the level of those refunds. By an order issued in February 1995, the FERC has directed the Company to make immediate refunds of $45.1 million and applicable interest, subject to further investigation of the claims which the customers have made. The matter is still pending.\nOn November 1, 1993, the Company filed a general rate increase with the FERC under Docket No. RP94-43. The increase represents the effects of higher plant investment, Order 636 restructuring costs, rate of return and tax rate changes, and increased costs related to the required adoption of recent accounting rule changes, i.e., FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS No. 106\") and FAS No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"FAS No. 112\"). On March 23, 1994, the FERC issued an order granting and denying various requests for summary disposition and establishing hearing procedures for issues remaining to be investigated in this proceeding. The order required the reduction or elimination of certain costs which resulted in revised rates such that the revised rates reflect an $85.7 million increase in the cost of service from that approved in the Interim Settlement and a $182.8 million increase over the Company's approved rates for its restructured services under Order 636. On April 29, 1994, the Company filed a motion with the FERC that placed the new rates into effect May 1, 1994, subject to refund. On September 21, 1994, the FERC accepted the Company's filing in compliance with the March 23, 1994 order, subject to further modifications including an additional reduction in cost of service of approximately $5 million. The Company submitted its compliance filing to the FERC on October 6, 1994, which compliance filing was accepted by order issued December 8, 1994, subject to a further compliance filing requirement, which ANR Pipeline submitted on January 9, 1995, and which was accepted by an order issued in February 1995. Further, on December 8, 1994, the FERC issued its order denying rehearing of the March 23, 1994 order. On January 26, 1995, ANR Pipeline sought judicial review of these orders before the United States Court of Appeals for the D.C. Circuit.\nANR Pipeline has executed a Settlement Agreement (the \"Settlement Agreement\") with Dakota Gasification Company (\"Dakota\") and the Department of Energy which resolves litigation concerning purchases of synthetic gas by the Company from the Great Plains Coal Gasification Plant (the \"Plant\"). That litigation, originally filed in 1990 in the United States District Court in North Dakota, involved claims regarding the Company's obligations under certain gas purchase and transportation contracts with the Plant. The Settlement Agreement resolves all disputes between the parties, amends the gas purchase agreement between the Company and Dakota and terminates the transportation contract. The Settlement Agreement is subject to final FERC approval, including an approval for the Company to recover the settlement costs from its customers. On August 3, 1994, the Company filed a petition with the FERC requesting: (a) that the Settlement Agreement be approved; (b) an order approving ANR Pipeline's proposed tariff mechanism for the recovery of the costs incurred to implement the Settlement Agreement; and (c) an order dismissing a proceeding currently pending before the FERC, wherein certain of ANR Pipeline's customers have challenged Dakota's pricing under the original gas supply contract. On October 18, 1994, the FERC issued an order consolidating the Company's petition with similar petitions of three other pipeline companies and setting the Settlement Agreement and other Dakota-related proceedings for limited hearing before an Administrative Law Judge who must render an initial decision by December 31, 1995. On December 20, 1994, ANR Pipeline filed its testimony, and has responded to numerous discovery requests. The hearing is scheduled to commence on June 20, 1995. The Company believes the ultimate resolution of the Dakota related issues will not have a material adverse impact on its consolidated financial position or results of operations.\nOrder 636 provides mechanisms for recovery of transition costs associated with compliance with that Order. The Company has estimated that its transition costs will amount to approximately $150 million, which will consist primarily of gas supply realignment costs, the cost of stranded pipeline investment and the Dakota costs described above. As of December 31, 1994, the Company has incurred transition costs in the amount of $43 million. The Company has filed for recovery of approximately $40.5 million of these transition costs, which have been accepted and made effective by the FERC, subject to refund and subject to further proceedings. In addition, the Company has filed for recovery of approximately $90 million of costs associated with the Settlement Agreement, as mentioned above. Additional transition cost filings will be made by the Company in the future. As a result of the recovery mechanisms provided under Order 636, the Company anticipates that these transition costs will not have a material adverse effect on its consolidated financial position or results of operations.\nCertain regulatory issues remain unresolved among 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 and other issues, it cannot estimate when each of these issues will be resolved.\nENVIRONMENTAL\nA subsidiary of the Company owns a 9.4% interest in Iroquois Gas Transmission System, L.P. (\"Iroquois\"), a 370-mile pipeline which transports gas from Canada to the northeastern United States (the \"Iroquois Pipeline\"). Iroquois contracted with Iroquois Pipeline Operating Company (\"IPOC\") for IPOC to construct and operate the Iroquois Pipeline. Federal and state agencies (including the United States Attorney's office for the Northern District of New York) have been investigating alleged civil and criminal violations of environmental laws related to the construction and operation of the Iroquois Pipeline by IPOC. It is possible that this investigation could result in monetary sanctions, of which its subsidiary's share, while not material to the Company, could exceed $100,000.\nInformation concerning other environmental matters is set forth in \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note 7 of Notes to Consolidated Financial Statements included herein.\nOTHER DEVELOPMENTS\nEffective September 9, 1994, Florida Power Corporation (\"FPC\") withdrew as an equity partner in both the SunShine Interstate Transmission Company and SunShine Pipeline Company (\"SunShine\") partnerships. Interests in these partnerships are now held by affiliates of the Company and TransCanada. FPC has also terminated its agreements with the partnerships to transport gas on the proposed SunShine system effective March 2, 1995. Future development of the SunShine project is currently under management review. SunShine has obtained a delay on proceedings pending before the Florida Department of Environmental Protection until October 1995 and on February 24, 1995, requested that FERC allow ninety days for SunShine to report the results of its review.\nSponsors of the Liberty Pipeline Project (\"Liberty\") asked the FERC, on August 1, 1994, to postpone indefinitely its review of the project following the withdrawal in early June of one key shipper who was also a project partner and the withdrawal of another shipper. As a result, the FERC dismissed the application on August 12, 1994. As originally proposed, Liberty consisted of a 38-mile pipeline extending from New Jersey across New York Harbor to Long Island with a potential capacity of 500 MMcf per day and was estimated to cost $170 million. A subsidiary of the Company holds a 25.9% interest in the project. The Liberty partners continue to believe that an additional delivery point onto Long Island, as proposed by Liberty, will be necessary in the future and plan to continue pursuing that goal.\nThe Company has filed an application with the FERC to construct, at a cost of $15.3 million, approximately 12 miles of new pipeline in the State of Michigan (the \"Link Project\") which would interconnect to approximately 8 miles of new pipeline to be constructed by The Consumers' Gas Company, Ltd. (\"Consumers\") at the Canadian-\nUnited States border. The Link Project is an amendment to the Company's earlier application to construct the InterCoastal Pipe Line, which was denied approval by the Canadian National Energy Board. The new facilities will have a capacity of 150 MMcf per day and will serve markets in the United States and Canada, including Consumers and Michigan Consolidated Gas Company. Consumers is expected to file for the necessary Canadian regulatory approvals by the end of March 1995, and, subject to the receipt of the necessary FERC and Canadian regulatory approvals, the project could be in service as early as November 1, 1995.\nA subsidiary of the Company has a 45% equity interest in the proposed Mayflower Pipeline project, which will be owned by a partnership consisting of the Company's subsidiary and affiliates of TransCanada and Brooklyn Union Gas Company. The project is proposed to provide natural gas transportation and storage services to markets in the northeastern United States. The proposed 240- mile pipeline will extend east from the Iroquois Gas Transmission System at Canajoharie, New York to a location near Boston, Massachusetts, and have an initial design capacity of 350 MMcf per day. The total project cost is expected to be $540 million. The project could be in service by late 1999, subject to the receipt of federal regulatory approvals of its construction.\nIn August 1993, the Company and NorAm Energy Corporation, formerly Arkla, Inc. (\"NorAm\") announced execution of a restructured agreement under which the Company, subject to certain conditions precedent, would purchase an ownership interest in 250 MMcf per day of capacity in existing gas transmission facilities. On March 25, 1994, the FERC issued an order approving this acquisition, subject to certain conditions. NorAm and ANR Pipeline have filed for judicial review of this order and FERC's Order on Rehearing issued September 20, 1994.\nFunding for certain pending and proposed natural gas pipeline projects is anticipated to be provided through non-recourse financings in which the projects' assets and contracts will be pledged as collateral. This type of financing typically requires the participants to make equity investments totaling approximately 20% to 30% of the cost of the project, with the remainder financed on a long-term basis.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nInformation on properties of ANR Pipeline is 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 seven-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 gas 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.\nAll of the principal properties of the Company were subject to the lien of its Mortgage and Deed of Trust dated as of September 1, 1948, securing its First Mortgage Pipe Line Bonds, and some of such properties were subject to \"permitted liens\" as defined in such Mortgage and Deed of Trust. The First Mortgage Pipe Line Bonds were retired in 1993 and the associated Mortgage and Deed of Trust was terminated in 1994.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNumerous lawsuits and other proceedings which have arisen in the ordinary course of business are pending or threatened against the Company or its subsidiaries. Although 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 such claims and that any liability which may finally be determined should not have a material adverse effect on the Company's consolidated financial position or results of operations. Additional information regarding legal proceedings is set forth in Notes 6 and 7 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 ANR Pipeline is owned by ANR.\nUnder the terms of the most restrictive of the Company's financing agreements, approximately $166 million was available at December 31, 1994 for payment of dividends on the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following selected financial data (in millions of dollars) for the periods indicated is derived from the Consolidated Financial Statements included herein and Item 6 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993, as adjusted for minor reclassifications. The Notes to Consolidated Financial Statements included herein contain information relating to this data.\nSince all of the outstanding common stock of ANR Pipeline is owned by ANR, 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 ANR Pipeline as of March 15, 1995, were as follows:\nThe above named persons bear no family relationship to each other. Their respective terms of office expire coincident with ANR Pipeline's Annual Meeting of the Sole Stockholder and Annual Meeting of the Board of Directors to be held in May 1995. Each of the directors and officers named above have been officers or employees of ANR Pipeline, Colorado and\/or Coastal for five years or more except for the following:\nMr. Bissell was elected a Director in September 1994. He has been a Director of Coastal since 1985 and of ANR since 1979. He is currently Chairman of the Board of Directors and Chief Executive Officer of Bissell Inc., a position he has held since 1971.\nMr. Burrow was elected Vice Chairman of the Board of Directors in September 1994. He has served as a Director of Coastal since 1973 and as Chairman of the Board of Directors of Colorado since 1974.\nMr. Chapin was elected a Director in September 1994. He has been a Director of Coastal since 1988 and of ANR since 1973. Mr. Chapin was Chairman and Chief Executive Officer of American Motors Corporation from 1967 until his retirement in 1978.\nMr. Doss was elected a Director in September 1994. He has been a Director of ANR since 1980. He is a former partner of Coopers & Lybrand, an international accounting and consulting firm.\nMs. Hesse was elected a Director in September 1994. Ms. Hesse is currently President of Hesse Gas Company, a position she has held since 1991. Prior thereto she served as Senior Vice President of First Chicago Corporation since 1990. She was Chairman of the Federal Energy Regulatory Commission from 1986 to 1989. She has been a Director of ANR since 1990.\nMr. Mack was elected a Director in September 1994. Mr. Mack was an executive with ANR for 24 years, retiring in 1976 as Chairman and Chief Executive Officer and serving on the Board until 1982. He was re-elected to the Board of ANR in 1986.\nMr. MacNeil was elected a Director in September 1994. He has been a Director of ANR since 1993. Mr. MacNeil has been self employed in the securities and brokerage industry since 1980.\nMr. McNeal was elected a Director in September 1994. He has been a Director of ANR since 1982. Mr. McNeal served in various capacities with The Budd Company, retiring in 1989 as Chairman and Chief Executive Officer.\nMr. Matthews was elected Vice President and Treasurer in September 1994. He was elected Vice President and Treasurer of Colorado in October 1994. He has held various positions in financial management with Coastal and its affiliates since 1983, and was elected Treasurer of Coastal in September 1994.\nMs. Nichols was elected Vice President in January 1995. Most recently she served as Director - Application and Maintenance for Whirlpool Corporation, where she worked for more than four years. Prior thereto, she served in various capacities for the Pillsbury Corporation for 21 years.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nANR Pipeline is an indirect, wholly-owned subsidiary of Coastal. Information concerning the cash compensation and certain other compensation of the directors and officers of Coastal is contained in this section.\nThe following table sets forth information for the fiscal years ended December 31, 1994, 1993 and 1992 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 Officer (\"CEO\") and its four other most highly compensated executive officers (the \"Named Executive Officers\").\nSUMMARY COMPENSATION TABLE\n________________________\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)\/ Salary amounts for Messrs. Wyatt, Arledge and Cordes for 1992 and 1993 include directors' fees paid during these periods which were previously reported under \"All Other Compensation.\" Directors' fees for members of management of Coastal were eliminated in September, 1993. There was no salary change for Mr. Wyatt during 1994; the reduced base pay level for 1994 was due to the September 1993 salary reduction (reported in the 1994 Coastal Proxy Statement) being in effect for all of 1994.\n\/(3)\/ 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\/(4)\/ Although 1993 bonus awards were not finalized by Coastal's Compensation and Executive Development Committee until after the 1994 Coastal Proxy Statement had been prepared, all awards were based solely on 1993 performance. Bonuses for 1992 were paid in equal installments over a three-year period, provided the employee was still employed on the anniversary date ofthe award. The 1994 bonuses were based on the following factors: the individual's position; the individual's responsibility and the individual's ability to impact Coastal's financial success.\n\/(5)\/ The options do not carry any stock appreciation rights.\n\/(6)\/ All Other Compensation for 1994 consists of: (i) Coastal contributions to the Coastal Thrift Plan (O. S. Wyatt, Jr. $12,000; David A. Arledge $12,000; James F. Cordes $12,000; James A. King $4,232 and Sam F. Willson, Jr. $12,000) and (ii) certain payments in lieu of Thrift Plan contributions (O. S. Wyatt, Jr. $55,928; David A. Arledge $32,310; James F. Cordes $35,378; James A. King $2,645 and Sam F. Willson, Jr. $14,725). These payments are made to all employees of Coastal and its subsidiaries who participate in the Thrift Plan who must discontinue their Thrift Plan participation due to federal statutory limits.\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\nNo option\/SAR grants were made to the Named Executive Officers during the fiscal year ended December 31, 1994.\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, 1994.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES (1994)\n- ------------------\n\/(1)\/ $-based on the market price of $25.63 at December 31, 1994.\nCOMPENSATION AND EXECUTIVE DEVELOPMENT COMMITTEE REPORT ON EXECUTIVE COMPENSATION\nThe following report has been provided by Coastal's Compensation and Executive Development Committee (the \"Committee\") of the Board of Directors in accordance with current Securities and Exchange Commission (\"S.E.C.\") proxy statement disclosure requirements. The members of the Committee include John M. Bissell (Chairman), Roy D. Chapin, Jr., and Jerome S. Katzin.\nThis material states Coastal's current overall compensation philosophy and program objectives. Detailed descriptions of Coastal's compensation programs are provided as well as the information on Coastal's 1994 pay levels for the CEO.\nOVERALL OBJECTIVES OF THE EXECUTIVE COMPENSATION PROGRAM\nCoastal's compensation philosophy and program objectives are directed by two primary guiding principles. First, the program is intended to provide fully competitive levels of compensation - at expected levels of performance - in order to attract, motivate and retain talented executives. Second, the program is intended to create an alignment of interests between Coastal's executives and shareowners such that a significant portion of each executive's compensation is directly linked to maximizing shareholder value.\nIn support of this philosophy, the executive compensation program is designed to reward performance that is directly relevant to Coastal's short-term and long-term success. As such, Coastal attempts to provide both short-term and long-term incentive pay that varies based on corporate and individual performance.\nTo accomplish these objectives, the Committee has structured the executive compensation program with three primary underlying components: base salary, annual incentives, and long-term incentives (i.e., stock options). The following sections describe Coastal's plans by element of compensation and discuss how each component relates to Coastal's overall compensation philosophy.\nIn reviewing this information, reference is often made to the use of competitive market data as criteria for establishing targeted compensation levels. Coastal targets the market 50th percentile for its total compensation program and actual total compensation rates are generally consistent with that target. (However, Coastal's competitive pay posture varies by pay element, as described below.) Several market data sources are used by Coastal, including energy industry norms for the publicly traded peer companies included in Coastal's shareholder return performance graphs, as reflected in these companies' proxy statements. In addition, we utilize published survey data and data obtained from independent consultants that are for general industry companies similar in size (i.e., revenues) to Coastal. The published surveys include data on over 40 companies of comparable size to Coastal, as measured by revenues. Greater emphasis is placed on the published data and data obtained from consultants than on the data for proxy peers, since the published data and consulting data are reflective of company size.\nBASE SALARY PROGRAM\nCoastal's base salary program is based on a philosophy of providing base pay levels that fall between the market 50th and 75th percentiles. Coastal periodically reviews its executive pay levels to assure consistency with the external market. Generally, Coastal's actual base salary levels for 1994 for executives as a group were consistent with the targeted percentiles. We believe it is crucial to provide strongly competitive salaries over time in order to attract and retain executives who are highly talented.\nAnnual salary adjustments for Coastal are based on several factors: general levels of market salary increases, individual performance, competitive base salary levels, and Coastal's overall financial results. Coastal reviews performance qualitatively considering total shareholder returns, the level of earnings, return on equity, return on total capital and individual business unit performance. These criteria are assessed qualitatively and are not weighted. All base salary increases are based on a philosophy of pay-for-performance and perceptions of an individual's long-term value to Coastal. As a result, employees with higher levels of performance sustained over time will be paid correspondingly higher salaries.\nTHE ANNUAL BONUS PLAN\nCoastal's Annual Bonus Plan is intended to (1) reward key employees based on company\/business unit and individual performance; (2) motivate key employees; and (3) provide competitive cash compensation opportunities to plan participants. Under the plan, target award opportunities vary by individual position and are expressed as a percent of base salary. The individual target award opportunities, which are slightly below market median levels, are then aggregated into a total target pool which is adjusted as described below. The amount a particular executive may earn is directly dependent on the individual's position, responsibility, and ability to impact Coastal's financial success.\nThe actual bonus pool is established each year by modifying the target pool based on Coastal's overall performance against measures established by the Committee. In fiscal year 1994, the key performance measure considered was earnings before interest and taxes (\"EBIT\") against plan. This measure was weighted 50% of the total bonus program. In 1994 Coastal's EBIT performance significantly improved over 1993 performance. This 1994 EBIT achievement was above threshold standards (minimum performance level for bonus payment) but below a very aggressive plan, resulting in the EBIT portion of the bonus paid being below target. The remaining 50% of the annual bonus opportunity in 1994 is a discretionary annual bonus pool. As a result, no formula performance measures were used in establishing the size of awards under this portion of the plan. However, in establishing the size of the discretionary bonus pool, the Committee considered Coastal's Return on Equity relative to industry peers (using the same peers included in the shareholder return graphs), Return on Total Capital compared to industry peers, the EBIT performance of each business unit, progress made toward improving Coastal's operational and financial performance, and the need to reward unique individual contributions. These measures were not formally weighted by the Committee. The size of the discretionary bonus pool element was established above threshold but below target based on the qualitative performance assessment described above. As a result, actual bonus payments for 1994 were below target and median market levels.\nIndividual awards from the established bonus pool are recommended by senior management, with advice and consent from the Committee. Individual awards from the pool are based on business unit and individual employee performance, future potential, and competitive considerations. All individual performance assessments are conducted in a non-formula fashion without specific goal weightings. The total bonus awards made may not exceed the amount of funds in the bonus pool.\nLONG-TERM INCENTIVE PLAN\nCoastal's Long-Term Incentive Plan (\"LTIP\") is designed to focus executive efforts on the long-term goals of Coastal and to maximize total return to Coastal's shareholders. While Coastal's LTIP allows the Committee to use a variety of long-term incentive devices, the Committee has relied solely on stock option awards to provide long-term incentive opportunities in recent years.\nStock options align the interests of employees and shareholders by providing value to the executive through stock price appreciation only. All stock options have a ten year term before expiration and are fully exercisable within 7 years of the grant date.\nNo stock options were granted to the Named Executive Officers in 1994 since Coastal made larger than normal grants to key executives in December 1993. However, it is anticipated that stock option awards will be made periodically at the discretion of the Committee in the future. As in past years, the number of shares actually granted\nto a particular participant is also based on Coastal's financial success, its future business plans, and the individual's position and level of responsibility within Coastal. All of these factors are assessed subjectively and are not weighted.\n1994 CHIEF EXECUTIVE OFFICER PAY\nAs previously described, the Committee considers several factors in developing an executive's compensation package. For the CEO, these include competitive market practices (consistent with the philosophy described for other executives), experience, achievement of strategic goals, and the financial success of Coastal (considering the factors described under the annual bonus plan above).\nMr. Wyatt received no salary increase in 1994. The Committee took no action regarding Mr. Wyatt's base salary, in spite of significantly improved Coastal performance during the year. This lack of any adjustment is not a reflection of performance; rather, it is based on considering strong input from the CEO, who wants to see continued improvement in shareholder returns before receiving any base salary increase.\nMr. Wyatt's bonus for 1994 performance was $200,000. This bonus award was below targeted levels (and below market median levels) since Coastal's aggregate performance on the measures described in the annual bonus section of this report was below the aggressive Coastal targets (but above 1993 levels).\nThe Committee granted no stock options to Mr. Wyatt in 1994 (consistent with past practices), considering the strongly expressed opinion of the CEO. Mr. Wyatt and the Committee considered Mr. Wyatt's current level of stock ownership in reaching this decision.\n$1 MILLION PAY DEDUCTIBILITY CAP\nUnder Section 162(m) of the Internal Revenue Code, public companies are precluded from receiving a tax deduction on compensation paid to executive officers in excess of $1 million. To address the $1 million pay deductibility cap issue, Coastal's 1994 LTIP was structured so that stock option awards (which are intended to be the primary long-term incentive vehicle for the present time) qualify for an exemption from the $1 million pay deductibility limit.\nAlso, at the present time, the CEO is the only executive whose base salary plus target bonus exceeds $1 million. In order to preserve Coastal's tax deduction for the CEO's base salary plus bonus, Coastal has established a nonqualified deferred compensation program for Mr. Wyatt. Under this program, any annual incentive awards that bring Mr. Wyatt's cash compensation to a level over $1 million will be deferred so that payments occur after Mr. Wyatt is no longer a Named Executive Officer, thus preserving the deductibility of the pay for Coastal.\nCOMPENSATION AND EXECUTIVE DEVELOPMENT COMMITTEE\nJohn M. Bissell, Chairman Roy D. Chapin, Jr. Jerome S. Katzin\nPENSION PLAN\nThe following table shows for illustration purposes the estimated annual benefits payable currently 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 $150,000 for 1994.\n(B) Federal legislation has reduced the benefit which may be earned due to future service; however, benefits previously earned may not be reduced. At December 31, 1994 each of the individuals named in the Summary Compensation Table had covered salary for future benefit accrual of $150,000 and the following years of credited service and pension payable at age 65 (or current age, if over 65): Mr. Wyatt, 39 years, $469,834; Mr. Arledge, 14 years, $54,181; Mr. Cordes, 17 years, $74,523; Mr. King, 2 years, $9,474 (not vested) and Mr. Willson, 22 years, $98,357.\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 and footnote (B).\nPERFORMANCE GRAPHS - SHAREHOLDER RETURN ON COMMON STOCK\nFIVE-YEAR CUMULATIVE VALUES $100 INVESTED 12\/31\/89 DIVIDENDS REINVESTED\n[GRAPH APPEARS HERE]\nYEAR ENDED 12\/31\n(1) The Index is based on Value Line Diversified Natural Gas Group - the Performance Graphs reflect total shareholder return weighted to reflect the market capitalizations of the peer companies. The peer group is comprised of: NorAm, Burlington Res., Columbia, Consolidated Nat. Gas, Eastern Enterprises, Enron, Enserch, Equitable Res.,KN Energy, Mitchell Energy, National Fuel Gas, Panhandle Eastern, Seagull Energy, Sonat, Southwestern Energy, Tenneco, Transco, Valero and Williams Cos. (2) Coastal is excluded from the Index.\nTEN-YEAR TWO MONTHS CUMULATIVE VALUES $100 INVESTED 12\/31\/84 DIVIDENDS REINVESTED\n[GRAPH APPEARS HERE]\nYEAR ENDED 12\/31\n(1) The Index is based on Value Line Diversified Natural Gas Group - the Performance Graphs reflect total shareholder return weighted to reflect the market capitalizations of the peer companies. The peer group is comprised of: NorAm, Burlington Res., Columbia, Consolidated Nat. Gas, Eastern Enterprises, Enron, Enserch, Equitable Res.,KN Energy, Mitchell Energy, National Fuel Gas, Panhandle Eastern, Seagull Energy, Sonat, Southwestern Energy, Tenneco, Transco, Valero and Williams Cos. (2) Coastal is excluded from the Index.\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 15, 1995, on each person known or believed by ANR Pipeline to be the beneficial owner of 5% or more of any class of its voting securities:\n(b) Security ownership of management.\nANR Pipeline is an indirect, 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 15, 1995 is 112,960,388 consisting of 63,118 shares of $1.19 Cumulative Convertible Preferred Stock, Series A (the \"Series A Preferred Stock\"), 83,756 shares of $1.83 Cumulative Convertible Preferred Stock, Series B (the \"Series B Preferred Stock\"), 34,191 shares of $5.00 Cumulative Convertible Preferred Stock, Series C (the \"Series C Preferred Stock\") (the Series A Preferred Stock, the Series B Preferred Stock and the Series C Preferred Stock are referred to herein collectively as the \"Preferred Stock\"), 8,000,000 non-voting shares of $2.125 Cumulative Preferred Stock, Series H, 104,363,374 shares of Common Stock and 415,949 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 15, 1995, 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 953 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 15, 1995, regarding each of the then current directors, including Class III 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. Messrs. Bissell, Burrow, Chapin and Katzin are Class I directors whose terms expire in 1996; Messrs. Arledge, Brundrett, Wooddy and Wyatt are Class II directors whose terms expire in 1997 and Messrs. Cordes, Gates, Johnson, Marshall and McDade are 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 186,832 shares of Class A Common Stock, which would constitute 44.9% 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\nas to the shares indicated. Amounts include shares in Coastal ESOP and Thrift Plan, and presently exercisable stock options held by Messrs. Burrow (14,189 shares of Common Stock), Arledge (160,503 shares of Common Stock and 13,868 shares of Class A Common Stock), Cordes (103,785 shares of Common Stock) and Johnson (53,915 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 674,265 shares of Common Stock and 13,868 shares of Class A Common Stock; also includes 280,339 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 Board of Directors of Comerica 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 L.L.P. Prior to forming McDade & Fogler L.L.P. he was a senior partner in the Houston law firm of Fulbright & Jaworski. He is a member of the Board of Directors of Equity Corporation International.\nMessrs. Arledge, Burrow, Cordes and Wyatt are directors of Colorado and ANR Pipeline. Both of these subsidiaries of Coastal are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\n(a) Transactions with management and others.\nANR Pipeline participates in a program which matches short-term cash excesses and requirements of participating affiliates, thus minimizing borrowings from outside sources. At December 31, 1994, the Company had advanced $235.2 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 Note 11 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.\nThe following Consolidated Financial Statements of ANR Pipeline and Subsidiaries are included in response to Item 8 hereof on the attached pages as indicated:\n2. Financial Statement Schedules.\nSchedules 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)+ Composite Certificate of Incorporation of ANR Pipeline effective as of December 31, 1987 (Filed as Module ANRCertIncorp on March 29, 1994).\n(3.2)* Amended By-laws of ANR Pipeline effective as of September 21, 1994.\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(4.1)+ Board Resolution dated September 22, 1975 establishing the $2.675 Series of Cumulative Preferred Stock (Filed as Module BoardRes_092275 on March 29, 1994).\n(4.2)+ Board Resolution dated October 26, 1976 establishing the $2.12 Series of Cumulative Preferred Stock (Filed as Module BoardRes_102676 on March 29, 1994).\n(4.3)+ Board Resolution dated May 12, 1980 establishing the $12.00 Series of Cumulative Preferred Stock (Filed as Module BoardRes_051280 on March 29, 1994).\n(4.4)+ Indenture dated as of February 15, 1994 and First Supplemental Indenture dated as of February 15, 1994 for the $125 million of 7-3\/8% Debentures due February 15, 2024. (Filed as Exhibit 4.4 to ANR Pipeline's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n(10.1)+ Form of Employment Agreement between ANR Pipeline and certain of its executive officers (Filed as a Module ANREmployAgree on March 29, 1994).\n(10.2)+ Form of Employment Agreement between Coastal and certain Company executive officers (Filed as Module TCCEmployAgree on March 29, 1994).\n(21)* Subsidiaries of the Company.\n(23)* Consent of Deloitte & Touche LLP.\n(24)* Power of Attorney (included on signature pages herein).\n(27)* Financial Data Schedule.\nNote:\n+ Indicates documents incorporated by reference from the prior filings indicated. * 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, 1994.\nPOWER OF ATTORNEY\nEach person whose signature appears below hereby appoints Coby C. Hesse, William L. Johnson 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.\nANR PIPELINE COMPANY (Registrant)\nBy: JEFFREY A. CONNELLY -------------------------- Jeffrey A. Connelly President, Chief Executive Officer and Director March 29, 1995\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: JAMES F. CORDES By: DAVID A. ARLEDGE --------------------------- --------------------------- James F. Cordes David A. Arledge Chairman Principal Financial Officer March 29, 1995 and Director March 29, 1995\nBy: WILLIAM L. JOHNSON By: HAROLD BURROW --------------------------- --------------------------- William L. Johnson Harold Burrow Principal Accounting Officer Vice Chairman March 29, 1995 March 29, 1995\nBy: RICHARD A. LIETZ By: JOHN M. BISSELL --------------------------- --------------------------- Richard A. Lietz John M. Bissell Executive Vice President, Director Chief Operating Officer and Director March 29, 1995 March 29, 1995\nBy: ROY D. CHAPIN, JR. By: LAWRENCE P. DOSS --------------------------- --------------------------- Roy D. Chapin, Jr. Lawrence P. Doss Director Director March 29, 1995 March 29, 1995\nBy: MARTHA O. HESSE By: WILBER H. MACK --------------------------- --------------------------- Martha O. Hesse Wilber H. Mack Director Director March 29, 1995 March 29, 1995\nBy: J. CARLETON MACNEIL, JR. By: JAMES H. MCNEAL, JR. --------------------------- --------------------------- J. Carleton MacNeil, Jr. James H. McNeal, Jr. Director Director March 29, 1995 March 29, 1995\nBy: O. S. WYATT, JR. --------------------------- O. S. Wyatt, Jr. Director March 29, 1995\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\nOVERVIEW. Internally generated funds have been the primary source to meet mandatory debt and preferred stock retirements and other cash requirements of the Company over the past three years.\nDuring 1993 the Company retired $78.1 million of its long-term debt obligations, of which $37.7 million of First Mortgage Pipe Line Bonds and $9.7 million of Debentures represented early redemptions. Interest rates associated with the early redemptions ranged from 9-5\/8% to 13-1\/4%, which were significantly higher than market rates.\nOn September 23, 1993, the Company filed a shelf registration statement with the Securities and Exchange Commission for the public offering of up to $200 million in senior unsecured debt securities, which became effective on October 5, 1993. Subsequently, in February 1994, the Company completed an offering of $125 million in principal amount of 7-3\/8% 30-year Debentures due in February 2024. The net proceeds from the sale of the Debentures were added to the general funds of the Company and were used for capital expenditures and for other general corporate purposes, including the payment of a $255 million dividend on its common stock in March 1994. In June 1994, the Company paid an additional $76 million dividend on its common stock which was financed from internally generated funds.\nOn June 16, 1994, the Company redeemed all of the outstanding shares of its Cumulative Preferred Stock. For additional information regarding this matter, see Note 3 of Notes to Consolidated Financial Statements included herein.\nThe Company uses the following consolidated ratios to measure liquidity and ability to meet future funding needs and debt service requirements.\nThe 1994 decrease in cash flows from operating activities to long-term debt and capital lease obligations resulted from an increase in long-term debt due to the issuance of $125 million of Debentures discussed above. The 1993 increase in the cash flows from operating activities to long-term debt and capital lease obligations resulted from a decrease in long-term debt due to the early redemptions in 1993 discussed above. The increase in 1994 in long-term debt and capital lease obligations to total capitalization resulted from issuance of long-term debt and a decrease in retained earnings resulting from dividends paid. The decrease in 1993 in long-term debt and capital lease obligations to total capitalization resulted from the retirement of long-term debt and an increase in retained earnings.\nManagement believes that the Company's stable financial position and earnings ability will enable it to continue to generate and obtain capital for financing needs in the foreseeable future.\nExpenditures for each of the years 1992 through 1994 and the sources of capital used to finance these expenditures are summarized in the \"Statement of Consolidated Cash Flows.\"\nCAPITAL EXPENDITURES. Capital expenditures were $62.0 million in 1994 and $49.4 million in 1993. Capital expenditures for 1995, including the Company's equity investments in partnerships and joint ventures, are currently estimated at $86 million.\nFunding for certain proposed natural gas pipeline projects is anticipated to be provided through nonrecourse financings in which the projects' assets and contracts will be pledged as collateral. This type of financing typically requires the participants to make equity investments totaling approximately 20% to 30% of the cost of the project, with the remainder financed on a long-term basis. Equity participation by other entities will also be considered. To the extent required, cash for equity contributions to projects will be from general corporate funds. Financing for the remaining budgeted expenditures in 1995 will be accomplished by the use of internally generated funds. Information concerning these projects is contained in Part I herein under Item 1, \"Business - Other Developments.\"\nGAS IN UNDERGROUND STORAGE. Gas in underground storage of $207.5 million was reclassified to \"Property, Plant and Equipment\" as of December 31, 1993. For additional information regarding this matter, see Note 1 of Notes to Consolidated Financial Statements included herein.\nASSETS RELATED TO EXCESS GAS SUPPLY. \"Assets related to excess gas supply\" are being recovered through the currently allowed billing mechanism under FERC Order No. 528, through gas takes against prepaid gas and through cash recoveries of gas prepayments under certain take-or-pay contracts. \"Assets related to excess gas supply\" decreased by $29.9 million and $82.6 million in 1994 and 1993, respectively. The decline in each year is attributable to the recovery of producer contract reformation costs pursuant to FERC Order No. 528 and, in 1993, a significant first quarter cash recovery of a prepayment for gas under a purchase contract with a producer.\nCURRENCY SWAPS. The Company has outstanding bonds for 125 million Swiss francs which mature in October 1995, and are expected to be extinguished through an affiliate's repayment of a loan or through alternative financing arrangements. The Company's entire foreign currency risk associated with this debt, including principal and interest, has been hedged by entering into currency swap agreements with maturities matching those of the underlying debt. In the event of nonperformance by the counterparties to the currency swaps, the Company would have possible exposure to credit loss in the amount of $39.5 million as of December 31, 1994. However, the Company has largely mitigated the risk of such a loss occurring by limiting the counterparties of these agreements to a prominent international bank and a prominent international financial institution. For additional information regarding the outstanding Swiss franc bonds, see Note 4 of Notes to Consolidated Financial Statements included herein.\nFINANCING ALTERNATIVES. Alternatives to finance additional capital and other expenditures are limited principally by the terms of certain debt instruments of the Company and certain affiliates. Under the most restrictive of such instruments, as of December 31, 1994, ANR Pipeline and certain affiliates could incur in the aggregate approximately $770 million of additional indebtedness. For the Company and these affiliates to incur indebtedness for borrowed money in excess of this amount, approximately $350 million of indebtedness of Coastal Natural Gas would need to be retired.\nThe Company participates in a program which matches short-term cash excesses and requirements of participating affiliates, thus minimizing borrowing from outside sources. At December 31, 1994, the Company had advanced $235.2 million to an associated company at a market rate of interest. Such amount is repayable upon demand.\nENVIRONMENTAL. The Company's operations are subject to extensive and evolving federal, state and local environmental laws and regulations which may affect such operations and costs as a result of their effect on the construction, operation and maintenance of its pipeline facilities. The Company anticipates annual capital expenditures of $2 million over the next several years aimed at maintaining compliance with such laws and regulations. Additionally, appropriate governmental authorities may enforce the laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties and remediation requirements.\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 has been named as a potentially responsible party in four federal \"Superfund\" waste disposal sites and one state \"Superfund\" site. At the four federal sites for which the EPA has developed sufficient information to estimate total clean-up costs of approximately $31.6 million, the Company estimates its pro-rata exposure is approximately $.8 million. At the state site, the Company has been named a de minimis potentially responsible party. However, since the agency having jurisdiction over the site is currently unable to provide an estimate of the total clean-up costs, the Company is unable to calculate its share of those costs.\nThere are additional areas of environmental remediation responsibilities which may fall on the Company. The states have regulatory programs that mandate waste clean-up. The Clean Air Act Amendments of 1990 include new permitting regulations which will result in increased operating expenditures.\nFuture information and developments will require the Company to continually reassess the expected impact of these environmental matters. However, the Company has evaluated its total environmental exposure based on currently available data, including its potential joint and several liability, and believes that compliance with all applicable laws and regulations will not have a material adverse impact on the Company's liquidity, consolidated financial position or results of operations.\nRESULTS OF OPERATIONS\nOn April 8, 1992 the FERC issued Order 636 which required significant changes in the services provided by interstate natural gas pipelines (see Note 7 of Notes to Consolidated Financial Statements included herein). The intent of Order 636 is to insure that interstate pipeline transportation services are equal in quality for all gas supplies, whether the buyer purchases gas from the pipeline or from any other gas supplier. The FERC amended its regulations to require the use of the straight fixed variable (\"SFV\") rate setting methodology. In general, SFV provides that all fixed costs of providing service to firm customers (including an authorized return on rate base and associated taxes) are to be received through fixed monthly reservation charges, which are not a function of volumes transported, while including within the commodity billing component the pipeline's variable operating costs. In addition, the adoption of Order 636 has resulted in the incurrence of transition costs. However, Order 636 provides mechanisms for the recovery of such costs within a reasonable time period.\nANR Pipeline placed its restructured services under Order 636 into effect on November 1, 1993. The Company now offers a wide range of \"unbundled\" transportation, storage, gathering and balancing services. In anticipation of the competitive environment created by Order 636, the Company entered into a number of firm, long-term storage and transportation contracts with customers. As a result, the majority of the revenue the Company receives from storage and transportation services is now derived from reservation charges associated with these contracts. Over time this will provide a stable stream of revenue and related cash flow for the Company.\nAs a result of Order 636, the Company no longer offers a merchant service. Because of this, a significant portion of the Company's gas purchase contracts have been bought out or assigned. The Company is continuing to negotiate the termination of the remaining gas purchase contract obligations and believes it will recover any costs associated with the resolution of these negotiations with no significant financial impact. In 1994, gas sales revenues reflect amounts related to the auctioning of gas in producing areas acquired under these remaining gas purchase contracts, in addition to purchased gas adjustment recoveries from customers associated with purchase periods prior to Order 636. While operating revenues have been reduced as a result of the implementation of Order 636, purchases and other related costs have also been reduced by a similar amount, thereby having minimal net impact on earnings.\nPrior to Order 636, for the period November 1, 1992 through October 31, 1993, the Company operated under restructured sales services as part of the Interim Settlement. Prior to the restructuring, the cost of providing transportation services for sales customers was recovered as part of the Company's total resale rate and, therefore, was classified as part of gas sales revenue. Under the Interim Settlement, these costs were recovered through a separate \"bundled\" storage and transportation rate and were included in storage and transportation revenue.\nREVENUES. Storage and transportation revenues increased by 11% in 1994 as compared to 1993. The primary factor contributing to the increase was revenues associated with cost recovery mechanisms related to above market gas purchases and certain transportation services provided by others, which were offset by amounts included in cost of gas and operation and maintenance. Revenues have been reduced in 1994 by provisions of $37.6 million for rate related contingencies, associated with Docket No. RP94-43.\nStorage and transportation revenues increased by 19% in 1993 as compared to 1992. The primary factors contributing to the increased revenue were the recognition of $123.8 million of additional transportation revenue due to the sales service restructuring discussed above, and the addition of 24.4 Bcf and 46.2 Bcf of new firm storage and firm transportation services contracted for, effective April 1, and November 1, 1993, respectively. These factors were offset by lower transportation commodity rates associated with the settlement of the Company's 1989 rate case, a decrease in open access transportation volumes of 7% which, in part, is the result of higher sales volumes transported during the period. Also affecting revenues in 1992 was a restoration to income of $53.7 million associated with the settlement of the Company's 1989 rate case.\nGas sales revenues declined significantly in 1994 as compared to 1993 as a result of the elimination of the Company's merchant service, as discussed above. Gas sales revenues decreased by $31 million in 1993 as compared to 1992 primarily as a result of the sales service restructuring discussed above and rate decreases associated with gas pricing. The decreases in 1993 were largely offset by higher sales volumes resulting from sales customers purchasing gas for storage injection during the spring and summer months. This purchase and storage of gas by sales customers was in anticipation of the Company's implementation of Order 636, and the fact that the Company would no longer provide a merchant service effective November 1, 1993.\nOther revenues increased in 1993, as compared to 1992, largely due to additional revenue from investments in pipeline partnerships and an increase in interest income.\nCOST OF GAS. Cost of gas significantly declined during 1994, as compared to 1993, as a result of the elimination of the Company's merchant service, as discussed above. Cost of gas includes purchases required under certain remaining gas purchase contracts and the amortization of purchased gas adjustment recoveries from customers.\nCost of gas increased by $119.6 million in 1993 as compared to 1992 due to higher sales volumes. This increase was partially offset by a decrease in the average rate of the cost of gas purchased. Certain costs previously recorded as a component of cost of gas sold, which are now included in transmission and compression expense within operation and maintenance expenses as a result of the Interim Settlement, also contributed to this decrease.\nOPERATION AND MAINTENANCE. Operation and maintenance expenses decreased by $17.8 million in 1994 as compared to 1993. This decrease was largely due to a reduction in transportation services provided by others and lower costs associated with maintenance of pipeline and compressor station facilities, partially offset by increased benefit costs related to the required adoption of FAS Nos. 106 and 112. Additionally, the variance includes a benefit in 1993 related to revisions of certain estimated costs.\nOperation and maintenance expenses for 1993 approximated those of 1992, although the following fluctuations were noted. Transportation services provided by others increased in 1993 as described above, and storage expense increased due to the addition of 42 Bcf of storage capacity provided by Blue Lake Gas Storage Company commencing in April 1993. These increases were offset by the benefit related to certain estimated costs mentioned above, which were recorded in 1992.\nDEPRECIATION. Depreciation expense increased by $3.9 million in 1994 as compared to 1993, primarily due to an increase in plant balances. The decrease in depreciation expense of $44.1 million in 1993 as compared to 1992 was caused by a decrease in depreciation rates, which became effective November 1, 1992, as a result of the Interim Settlement.\nINTEREST EXPENSE. Interest expense decreased by $7.3 million in 1993 as compared to 1992 due to a lower effective interest rate and lower average outstanding long-term debt, partially offset by a reduction in 1992 interest expense associated with changes in provisions for regulatory matters.\nTAXES ON INCOME. Income taxes increased by $3.3 million in 1993 as compared to 1992 primarily due to an increase in pre-tax income and an increase in the federal income tax rate from 34% to 35%, offset by certain adjustments to state income tax accruals.\nRECENT ADOPTION OF FASB PRONOUNCEMENT\nThe Company adopted FAS No. 112, effective January 1, 1994. The effects of the changes required by FAS No. 112 are not material to the Company. For additional information regarding this matter, see Note 10 of Notes to Consolidated Financial Statements included herein.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholder ANR Pipeline Company Detroit, Michigan\nWe have audited the accompanying consolidated balance sheets of ANR Pipeline Company (an indirect, wholly-owned subsidiary of The Coastal Corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of earnings, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. 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 consolidated financial statements present fairly, in all material respects, the financial position of ANR Pipeline Company and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 10 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 LLP\nDetroit, Michigan February 2, 1995\nANR PIPELINE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Millions of Dollars)\nSee Notes to Consolidated Financial Statements.\nANR PIPELINE COMPANY AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (Millions of Dollars)\nSee Notes to Consolidated Financial Statements.\nANR PIPELINE COMPANY AND SUBSIDIARIES STATEMENT OF CONSOLIDATED EARNINGS (Millions of Dollars)\nSTATEMENT OF CONSOLIDATED RETAINED EARNINGS (Millions of Dollars)\nSee Notes to Consolidated Financial Statements.\nANR PIPELINE COMPANY AND SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS (Millions of Dollars)\nSee Notes to Consolidated Financial Statements.\nANR PIPELINE COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\n- - Basis of Presentation\nANR Pipeline is a subsidiary of ANR, which is a direct subsidiary of Coastal Natural Gas and an indirect subsidiary of Coastal. 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 subject to the regulations and accounting procedures of the FERC. The Company meets the criteria and, accordingly, follows the accounting and reporting requirements of FAS No. 71, \"Accounting for the Effects of Certain Types of Regulation.\"\n- - Reclassifications\nGas in underground storage of $207.5 million was reclassified to \"Property, Plant and Equipment\" as of December 31, 1993. The reclassification of these costs reflect the fact that, effective November 1, 1993, the Company no longer provides a merchant function and that under the Order 636 environment, these costs are now considered an investment needed solely for use in facilitating the overall operations of the Company's pipeline system. Certain other reclassifications of prior period statements have been made to conform with current reporting practices. The effect of these reclassifications was not material to the Company's consolidated financial position or results of operations.\n- - Principles of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, after eliminating all significant intercompany transactions. The equity method of accounting is used for investments in which the Company has a 20% to 50% continuing interest. The cost method of accounting is used for an investment in which the Company has less than a 20% continuing interest.\n- - Depreciation of Gas Plant\nThe Company's annual provisions for depreciation of gas plant are computed on a straight-line basis using rates of depreciation which vary by type of property. The annual composite depreciation rates for 1994, 1993 and 1992 were approximately 1.7%, 1.6% and 3.1%, respectively. The decrease in the annual composite depreciation rate for 1993 resulted from provisions of the Interim Settlement which reduced depreciation rates effective November 1, 1992. The resulting reduction in depreciation expense of $44.1 million was offset by a corresponding decrease in revenues collected from customers. The determination of book depreciation useful lives and the resulting depreciation rates are consistent with the policies and practices normally followed under generally accepted accounting principles. A calculation of the cumulative effect on recorded depreciation resulting from the use of recovery periods for regulatory purposes different from the estimated useful lives absent regulation has not been prepared.\nCosts of minor property units (or components thereof) retired or abandoned are charged or credited, net of salvage, to accumulated depreciation. Gain or loss on sales of major property units is credited or charged to income.\n- - Income Taxes\nThe Company is a member of a consolidated group which files a consolidated federal income tax return. Members of the consolidated group with taxable incomes 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- - Statement of Cash Flows\nFor purposes of these financial statements, 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 interest capitalized, of $50.2 million, $53.0 million and $68.3 million in 1994, 1993 and 1992, respectively. Cash payments for income taxes amounted to $54.9 million, $103.2 million and $104.1 million in 1994, 1993 and 1992, respectively.\n- - Allowance for Funds Used During Construction\nIn accordance with the accounting requirements of the FERC, an allowance for equity and borrowed funds used during construction is included in the cost of the Company's major additions to gas plant. These costs amounted to $1.2 million, $1.5 million and $3.9 million in 1994, 1993 and 1992, respectively.\n- - Currency Swaps\nThe Company has entered into foreign currency swap agreements to manage its foreign exchange exposure on its outstanding bonds for 125 million Swiss francs which mature in October 1995. Costs associated with these swaps were fixed at the date of issuance and are being amortized over the life of the related debt issuance. Gains or losses from foreign currency swaps are deferred and recognized as payments are made on the related foreign currency denominated debt. Such gains or losses are essentially offset by gains or losses on the related debt.\n- - Concentrations of Credit Risk\nThe Company's primary market areas are located in the Midwest region of the United States. The Company has a concentration of receivables due from interstate pipelines, intrastate pipelines and local distribution companies in these market areas. These concentrations of customers may affect the Company's overall credit risk in that the customers may be similarly affected by changes in economic, regulatory and other factors. Trade receivables are generally not collateralized; however, the Company analyzes customers' credit positions prior to extending credit.\n2. Common Stock and Other Stockholder's Equity\nAll of ANR Pipeline's common stock is owned by ANR.\nUnder the terms of the most restrictive of the Company's financing agreements, approximately $166 million was available at December 31, 1994 for payment of dividends on the Company's common stock.\n3. Mandatory Redemption Cumulative Preferred Stock\nOn June 16, 1994, the Company redeemed all outstanding shares of its Cumulative Preferred Stock. Of the 800,000 outstanding shares of the publicly held $2.12 Series, 200,000 shares were redeemed under sinking fund provisions at $25.00 per share, and 600,000 shares were redeemed under optional redemption provisions at $25.318 per share. Of the 200,000 outstanding shares of the publicly held $2.675 Series, all shares were redeemed under sinking fund provisions at $25.00 per share. Of the 86,640 outstanding shares of the privately held $12.00 Series, all shares were redeemed under optional redemption provisions at $103.79 per share. Redemption of these series included the payment of accrued dividends to June 16, 1994. A $328,000 premium paid in excess of par value to redeem the remaining outstanding preferred stock was charged directly to retained earnings in accordance with FERC accounting procedures.\n4. Long-Term Debt\nBalances at December 31 were as follows (millions of dollars):\n* In October 1985, the Company issued 6% bonds for 125 million Swiss francs at a price of 100.25%. The foreign currency exposure resulting from the issue has been contractually hedged through two currency swap agreements, resulting in an effective borrowing cost of approximately 10.7%. Neither the Company nor the counterparties are required to collateralize their respective obligations under these swaps. In the event of nonperformance by the counterparties to the currency swaps, the Company would have possible exposure to credit loss in the amount of $39.5 million as of December 31, 1994. However, the Company has largely mitigated the risk of such a loss occurring by limiting the counterparties of these agreements to a prominent international bank and a prominent international financial institution.\nMaturities of long-term debt during the succeeding five years are as follows (millions of dollars):\n1995.................... $58.1 1996.................... - 1997.................... - 1998.................... - 1999.................... -\nAlternatives to finance additional capital and other expenditures are limited principally by the terms of certain debt instruments of the Company and certain affiliates. Under the most restrictive of such instruments, as of December 31, 1994, ANR Pipeline and certain affiliates could incur in the aggregate approximately $770 million of additional indebtedness. For the Company and these affiliates to incur indebtedness for borrowed money in excess of this amount, approximately $350 million of indebtedness of Coastal Natural Gas would need to be retired.\n5. 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 estimated fair value of the marketable security of a related party is based on market quotes at December 31, 1994 and 1993, respectively, and is included under \"Deferred Charges and Other Assets.\" The note receivable from a related party is at a floating market rate of interest and therefore, the carrying amount is a reasonable estimate of its fair value. The estimated values of the Company's long-term debt and mandatory redemption cumulative preferred stock are based on interest rates at December 31, 1994 and 1993, respectively, for new issues with similar remaining maturities. The fair market values of the Company's foreign currency swaps are based on the estimated termination values at December 31, 1994 and 1993, respectively.\n6. Take-or-Pay Obligations\n\"Assets related to excess gas supply\" consists of $90.8 million and $120.7 million at December 31, 1994 and 1993, 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. Currently, FERC regulations allow for the billing of a portion of the costs of take-or-pay settlements and renegotiating gas purchase contracts. Prepayments are normally recoupable through future deliveries of natural gas.\nContract reformation costs incurred as a result of the mandated Order 636 restructuring will be recovered under the transition cost mechanisms of Order 636, as well as through negotiated agreements with the Company's customers. The Company believes that these mechanisms provide adequate coverage for such costs.\nSeveral 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 13% of the amounts claimed. At December 31, 1994, the Company estimated that unresolved asserted and unasserted producers' claims amounted to approximately $2 million. The remaining disputes will be settled where possible and litigated if settlement is not possible.\nAt December 31, 1994, 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 $21 million, $17 million and $10 million for each of the years 1995 through 1997, respectively, and $1 million thereafter. Such commitments have also 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. Such provisions and accruals were not material to the Company for the years 1994, 1993 and 1992.\n7. Litigation, Environmental and Regulatory Matters\n- - Litigation\nNumerous lawsuits and other proceedings which have arisen in the ordinary course of business are pending or threatened against the Company or its subsidiaries. Although 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 such claims and that any liability which may finally be determined should not have a material adverse effect on the Company's consolidated financial position or results of operations.\n- - Environmental\nThe Company's operations are subject to extensive and evolving federal, state and local environmental laws and regulations which may affect such operations and costs as a result of their effect on the construction, operation and maintenance of its pipeline facilities. The Company anticipates annual capital expenditures of $2 million over the next several years aimed at maintaining compliance with such laws and regulations. Additionally, appropriate governmental authorities may enforce the laws and regulations with a variety of civil and criminal enforcement measures, including monetary penalties and remediation requirements.\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 has been named as a potentially responsible party in four federal \"Superfund\" waste disposal sites and one state \"Superfund\" site. At the four federal sites for which the EPA has developed sufficient information to estimate total clean-up costs of approximately $31.6 million, the Company estimates its pro-rata exposure is approximately $.8 million. At the state site, the Company has been named a de minimis potentially responsible party. However, since the agency having jurisdiction over the site is currently unable to provide an estimate of the total clean-up costs, the Company is unable to calculate its share of those costs.\nThere are additional areas of environmental remediation responsibilities which may fall on the Company. The states have regulatory programs that mandate waste clean-up. The Clean Air Act Amendments of 1990 include new permitting regulations which will result in increased operating expenditures.\nFuture information and developments will require the Company to continually reassess the expected impact of these environmental matters. However, the Company has evaluated its total environmental exposure based on currently available data, including its potential joint and several liability, and believes that compliance with all applicable laws and regulations will not have a material adverse impact on the Company's liquidity, consolidated financial position or results of operations.\n- - Regulatory Matters\nOn March 10, 1992, the Company submitted to the FERC a comprehensive Interim Settlement designed to resolve all outstanding issues resulting from its 1989 rate case and its 1990 proposed service restructuring proceeding. The Interim Settlement became effective November 1, 1992 and expired with the Company's implementation of Order 636 on November 1, 1993. Under the Interim Settlement, gas inventory demand charges were collected from the Company's resale customers for the period November 1, 1992 through October 31, 1993. This method of gas cost recovery required refunds for any over-collections, and placed the Company at risk for under-collections. As required by the Interim Settlement, the Company filed with the FERC on April 29, 1994, a reconciliation report showing over-collections and, therefore, proposed refunds totaling $45.1 million. Such refund obligations were recorded at December 31, 1994 and December 31, 1993, and are included in the Consolidated Balance Sheet under \"Deferred Credits and Other.\" Certain customers have disputed the level of those refunds. By an order issued in\nFebruary 1995, the FERC has directed the Company to make immediate refunds of $45.1 million and applicable interest, subject to further investigation of the claims which the customers have made. The matter is still pending.\nOn April 8, 1992, the FERC issued 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. The case is currently in the briefing phase before the United States Court of Appeals for the D.C. Circuit. ANR Pipeline placed its restructured services under Order 636 into effect on November 1, 1993. As a result, the Company no longer provides a merchant service and now offers a wide range of \"unbundled\" transportation, storage and balancing services. However, the Company still purchases a residual quantity of gas under certain remaining gas purchase contracts. The Company's Order 636 restructured tariff provides a transitional mechanism for the purpose of recovering from, or refunding to, its customers any pricing differential between costs incurred to purchase this gas and the amount the Company recovers through the auctioning of such gas on the open market in producing areas. Several persons, including ANR Pipeline, have sought judicial review of aspects of the FERC's orders approving the Company's restructuring filings. Those appeals have been held in abeyance by the United States Court of Appeals for the D.C. Circuit, pending further order. On March 24, 1994, the FERC issued its \"Fourth Order on Compliance Filing and Third Order on Rehearing,\" which addressed numerous rehearing issues and confirmed that after minor required tariff modifications, the Company is now fully in compliance with Order 636 and the requirements of the orders on ANR Pipeline's restructuring filings. The FERC issued a further order regarding certain compliance issues on July 1, 1994. In accordance with this order, the Company filed revised tariff sheets on July 18, 1994.\nOn November 1, 1993, the Company filed a general rate increase with the FERC under Docket No. RP94-43. The increase represents the effects of higher plant investment, Order 636 restructuring costs, rate of return and tax rate changes, and increased costs related to the required adoption of recent accounting rule changes, i.e., FAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"FAS No. 106\") and FAS No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"FAS No. 112\"). On March 23, 1994, the FERC issued an order granting and denying various requests for summary disposition and establishing hearing procedures for issues remaining to be investigated in this proceeding. The order required the reduction or elimination of certain costs which resulted in revised rates such that the revised rates reflect an $85.7 million increase in the cost of service from that approved in the Interim Settlement and a $182.8 million increase over the Company's approved rates for its restructured services under Order 636. On April 29, 1994, the Company filed a motion with the FERC that placed the new rates into effect May 1, 1994, subject to refund. On September 21, 1994, the FERC accepted the Company's filing in compliance with the March 23, 1994 order, subject to further modifications including an additional reduction in cost of service of approximately $5 million. The Company submitted its compliance filing to the FERC on October 6, 1994, which compliance filing was accepted by order issued December 8, 1994, subject to a further compliance filing requirement, which ANR Pipeline submitted on January 9, 1995, and which was accepted by an order issued in February 1995. Further, on December 8, 1994, the FERC issued its order denying rehearing of the March 23, 1994 order. On January 26, 1995, ANR Pipeline sought judicial review of these orders before the United States Court of Appeals for the D.C. Circuit.\nANR Pipeline has executed a Settlement Agreement (the \"Settlement Agreement\") with Dakota Gasification Company (\"Dakota\") and the Department of Energy which resolves litigation concerning purchases of synthetic gas by the Company from the Great Plains Coal Gasification Plant (the \"Plant\"). That litigation, originally filed in 1990 in the United States District Court in North Dakota, involved claims regarding the Company's obligations under certain gas purchase and transportation contracts with the Plant. The Settlement Agreement resolves all disputes between the parties, amends the gas purchase agreement between the Company and Dakota and terminates the transportation contract. The Settlement Agreement is subject to final FERC approval, including an approval for the Company to recover the settlement costs from its customers. On August 3, 1994, the Company filed a petition with the FERC requesting: (a) that the Settlement Agreement be approved; (b) an order approving ANR Pipeline's proposed tariff mechanism for the recovery of the costs incurred to implement the Settlement Agreement; and (c) an order dismissing a proceeding currently pending before the FERC, wherein certain of ANR Pipeline's customers have challenged Dakota's pricing under the original gas supply contract. On October 18, 1994, the FERC issued an order consolidating the Company's petition with similar petitions of three other pipeline companies and setting the Settlement Agreement and other Dakota-related proceedings for limited hearing before an Administrative Law Judge who must render an initial decision by December 31, 1995. On December 20, 1994, ANR Pipeline filed its testimony, and has responded to numerous discovery requests. The hearing is scheduled to commence on June 20, 1995. The\nCompany believes the ultimate resolution of the Dakota related issues will not have a material adverse impact on its consolidated financial position or results of operations.\nOrder 636 provides mechanisms for recovery of transition costs associated with compliance with that Order. The Company has estimated that its transition costs will amount to approximately $150 million, which will consist primarily of gas supply realignment costs, the cost of stranded pipeline investment and the Dakota costs described above. As of December 31, 1994, the Company has incurred transition costs in the amount of $43 million. The Company has filed for recovery of approximately $40.5 million of these transition costs, which have been accepted and made effective by the FERC, subject to refund and subject to further proceedings. In addition, the Company has filed for recovery of approximately $90 million of costs associated with the Settlement Agreement, as mentioned above. Additional transition cost filings will be made by the Company in the future. As a result of the recovery mechanisms provided under Order 636, the Company anticipates that these transition costs will not have a material adverse effect on its consolidated financial position or results of operations.\nCertain regulatory issues remain unresolved among 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 and other issues, it cannot estimate when each of these issues will be resolved.\n8. Lease Commitments\nThe Company is the lessee of eight storage fields under capital leases. The storage field leases were to expire on May 1, 1998. However, the Company has the option to extend each of the leases for up to three successive five-year periods. On April 27, 1993, the Company exercised the first of these three successive and separate options, extending the current storage field leases to May 1, 2003. The net present value of the future minimum lease payments is included as part of \"Property, Plant and Equipment\" in the Company's Consolidated Balance Sheet as follows (millions of dollars):\nThe annual provision for depreciation included as a part of depreciation expense was $3.0 million for 1994 and 1993, and $4.7 million for 1992.\nFuture minimum lease payments under capital leases together with the present value of the net minimum lease payments as of December 31, 1994 are as follows (millions of dollars):\nOperating lease rentals included in operating expenses totaled $13.7 million for 1994, $16.2 million for 1993 and $16.4 million for 1992. Aggregate minimum lease payments under existing noncapitalized, long-term leases are approximately $14.0 million for each of the years 1995 through 1999, and $117.6 million thereafter.\n9. Taxes On Income\nProvisions for income taxes are composed of the following (millions of dollars):\nProvisions for income taxes were different from the amount computed by applying the statutory U.S. federal income tax rate to earnings before tax. The reasons for these differences are (millions of dollars):\nDeferred tax liabilities (assets) which are recognized for the estimated future tax effects attributable to temporary differences are (millions of dollars):\nThe Coastal consolidated federal income tax returns for the years 1985 through 1987 have been examined by the Internal Revenue Service. The examination did not result in any significant adjustments to the Company's portion of these returns. Examination of such consolidated federal income tax returns for 1988, 1989 and 1990 is currently in progress. It is the opinion of management that adequate provisions for federal income taxes have been reflected in the Company's consolidated financial statements.\n10. Benefit Plans\nThe Company participates with its affiliates 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, 1994, the Plan did not have an unfunded accumulated benefit obligation. ANR Pipeline made no contributions to the Plan for 1994, 1993 or 1992. Assets of the Plan are not segregated or restricted by its participating subsidiaries and pension obligations for Company employees would remain the obligation of the Plan if the Company were to withdraw.\nANR Pipeline 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 are based on matching employee contributions, amounted to $6.3 million, $5.9 million and $5.7 million for 1994, 1993 and 1992, respectively.\nThe Company provides certain health care and life insurance benefits for substantially all of its retired employees. Effective January 1, 1993, the Company adopted FAS No. 106, which requires the Company to accrue the estimated cost of retiree benefit payments during the years the employee provides services. The Company previously expensed the cost of these benefits, which are principally health care, as claims were incurred. FAS No. 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 20 years. The Company has elected to recognize the initial postretirement benefit obligation of approximately $62.7 million over a period of 20 years. In accordance with a FERC policy statement issued on December 17, 1992 (the \"Policy Statement\"), pipeline companies are allowed to defer the difference between the costs of postretirement benefits determined in accordance with FAS No. 106 and those costs currently recovered through their rates. The Company deferred such costs for the period January 1993 through April 1994 and began recovering them over a three-year period effective May 1, 1994, subject to FERC approval, pursuant to provisions of its November 1, 1993 general rate case filing. As of December 31, 1994, the unamortized balance of these deferred costs is $5.7 million. In addition, pursuant to the Policy Statement, the Company has funded approximately $13.7 million of FAS No. 106 costs through December 31, 1994.\nThe following tables set forth the accumulated postretirement benefit obligation recognized in the Company's Consolidated Balance Sheet and the benefit cost for the years ended December 31, 1994 and 1993 (millions of dollars):\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 12% in 1994, declining gradually to 6% by the year 2005. The assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation was 16% in 1993. 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, 1994 and the net postretirement health care cost by approximately 6%. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 8.75%.\nThe Company adopted FAS No. 112, effective January 1, 1994. This standard covers the accounting for estimated costs of benefits provided to former or inactive employees before their retirement. As a result of adopting the provisions of FAS No. 112, the Company recognized an additional liability of $6.4 million, which has been deferred. Of these deferred costs, $3 million is currently being recovered over a three-year period pursuant to the Company's general rate case filing, effective May 1, 1994, subject to FERC approval. The Company will seek to recover the remaining deferred costs in future rate filings, as applicable.\n11. Transactions with Major Customers and Related Parties\n- - Major Customers:\nThe Statement of Consolidated Earnings includes revenues from major customers as follows (millions of dollars):\n- - Related Parties:\n\"Operation and Maintenance\" expenses within the Statement of Consolidated Earnings includes affiliate and other related party transactions as follows (millions of dollars):\nServices provided by the Company at cost for affiliated companies were $9.9 million for 1994, $10.1 million for 1993 and $10.4 million for 1992. The services provided by the Company to affiliates, and by affiliates to the Company, primarily reflect the allocation of costs relating to the sharing of facilities and general and administrative functions, characteristic of group operations. Such costs are allocated using a three-factor formula consisting of revenues, property and payroll, which is reasonable and has been applied on a consistent basis.\nThe Company has lease agreements with Coastal and its affiliates for the rental of office space and certain pipeline facilities. One such lease with Coastal, for pipeline facilities, was terminated during 1994 in conjunction with the terms of the lease.\nANR Pipeline participates in a program which matches short-term cash excesses and requirements of participating affiliates, thus minimizing borrowings from outside sources. At December 31, 1994, the Company had advanced $235.2 million to an associated company at a market rate of interest. Such amount is repayable on demand.\n12. Quarterly Results of Operations (Unaudited)\nThe results of operations by quarter for the years ended December 31, 1994 and 1993 were (millions of dollars):\n* The quarter ended September 30, 1994, has been restated to exclude transportation imbalance activity in the amount of $33.1 million from both \"Revenues\" and \"Cost of gas.\" Such activity is now accounted for on a net basis.\nEXHIBIT INDEX\nExhibit Number Document - ------ -------- (3.1)+ Composite Certificate of Incorporation of ANR Pipeline effective as of December 31, 1987 (Filed as Module ANRCertIncorp on March 29, 1994).\n(3.2)* Amended By-laws of ANR Pipeline effective as of September 21, 1994.\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(4.1)+ Board Resolution dated September 22, 1975 establishing the $2.675 Series of Cumulative Preferred Stock (Filed as Module BoardRes_092275 on March 29, 1994).\n(4.2)+ Board Resolution dated October 26, 1976 establishing the $2.12 Series of Cumulative Preferred Stock (Filed as Module BoardRes_102676 on March 29, 1994).\n(4.3)+ Board Resolution dated May 12, 1980 establishing the $12.00 Series of Cumulative Preferred Stock (Filed as Module BoardRes_051280 on March 29, 1994).\n(4.4)+ Indenture dated as of February 15, 1994 and First Supplemental Indenture dated as of February 15, 1994 for the $125 million of 7-3\/8% Debentures due February 15, 2024. (Filed as Exhibit 4.4 to ANR Pipeline's Annual Report on Form 10-K for the fiscal year ended December 31, 1993.)\n(10.1)+ Form of Employment Agreement between ANR Pipeline and certain of its executive officers (Filed as a Module ANREmployAgree on March 29, 1994).\n(10.2)+ Form of Employment Agreement between Coastal and certain Company executive officers (Filed as Module TCCEmployAgree on March 29, 1994).\n(21)* Subsidiaries of the Company.\n(23)* Consent of Deloitte & Touche LLP.\n(24)* Power of Attorney (included on signature pages herein).\n(27)* Financial Data Schedule.\n- --------------\nNote:\n+ Indicates documents incorporated by reference from the prior filings indicated. * Indicates documents filed herewith.","section_15":""}
{"filename":"744437_1994.txt","cik":"744437","year":"1994","section_1":"ITEM 1. BUSINESS\nAll references to \"Notes\" are to Notes to Financial Statements contained in this report.\nThe registrant, JMB Income Properties, Ltd. - XI (the \"Partnership\"), is a limited partnership formed in 1983 and currently governed under 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 $173,406,000 in limited partnership interests (the \"Interests\") commencing on July 11, 1984, pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 2-90503). A total of 173,406 Interests were sold to the public at $1,000 per Interest and the holders of 173,406 Interests were admitted to the Partnership in fiscal 1985. The offering closed on November 30, 1984. No Investor has made any additional capital contribution after such date. The Investors in the Partnership share in 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 and\/or through joint venture partnership interests. The Partnership's real estate investments are located throughout the nation and it has no real estate investments located outside 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 October 31, 2034. Accordingly, the Partnership intends to hold its remaining properties 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 in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership owns directly or through joint venture partnerships the properties or interests in the properties referred to under Item 1 above to which reference is hereby made for a description of said properties.\nThe following is a listing of principal businesses or occupations carried on in and approximate occupancy levels by quarter during fiscal years 1994 and 1993 for the Partnership's investment properties owned during 1994:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is not subject to any material pending 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 1994 or 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, 1994, there were 14,754 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 Managing 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 July 11, 1984, the Partnership commenced an offering to the public of $60,000,000, subject to increase up to $200,000,000, pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. On November 30, 1984, the initial and final closing of the offering was consummated with the dealer manager of the public offering (an affiliate of which is a limited partner of the Associate General Partner of the Partner- ship), and 173,406 Interests were issued by the Partnership.\nAfter deducting selling expenses and other offering costs, the Partnership had approximately $156,493,000 with which to make investments in commercial real property, to pay legal fees and other costs (including acquisition fees) related to such investments and for working capital. A portion of such proceeds was utilized to acquire the properties described in Item 1 above.\nAt December 31, 1994, the Partnership had cash and cash equivalents of approximately $7,200,000. Such funds and short-term investments of approximately $7,531,000 may be utilized for distributions to partners and for working capital requirements including operating deficits, re-leasing costs of vacant space, and certain capital improvements currently being incurred at Riverside Square Mall. Bank overdrafts of approximately $415,000 as of December 31, 1994 have been subsequently repaid as of January 1995. Additionally, funds may be utilized to fund the Partnership's share of releasing costs and capital improvements at certain portions of the Park Center Financial Plaza. As discussed in Note 2(c), a major tenant at the Bank of Delaware investment property, brought a lawsuit against the Partnership which was decided in the tenant's favor pursuant to an arbitration ruling. The Partnership reimbursed the tenant approximately $802,000, all of which was paid as of December 1992. The Partnership was released from any further obligations pursuant to the assignment of title to the property in November 1994 as described below. The Partnership and its consolidated venture have currently budgeted in 1995 approximately $2,110,000 for tenant improvements and other capital expenditures excluding amounts budgeted for the renovation at Riverside Square Mall as discussed below. The Partnership's share of such items and its share of such similar items for its unconsolidated ventures for 1995 is currently budgeted to be $2,716,000. Actual amounts expended in 1995 may vary depending on a number of factors including actual leasing activity, results of property operations, liquidity considerations and other market conditions over the course of the year. The General Partners have been deferring receipt of distributions in accordance with the subordination requirement of the Partnership Agreement as discussed in Notes 5 and 8. 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 and\/or refinancing of such investments. In such regard, reference is made to the Partnership's property specific discussions below and also to the Partnership's disclosure of certain property lease expirations in Item 6. 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.\nDuring August 1994, San Jose received notification from the Redevelopment Agency of the City of San Jose of its offer to purchase one of the parking garage structures in the office building complex, for an approved Agency project for $4,090,000. The price offered is deemed by the Agency to be just compensation in compliance with applicable State and Federal laws relating to the government's power of eminent domain. San Jose is currently investigating its options with regard to the Agency's offer, including the impact of any purchase on garage spaces leased to tenants of other Partnership properties in the complex. Should the Agency proceed to purchase the property, San Jose would recognize a gain for financial reporting and Federal income tax purposes. However, it is uncertain at this time whether a transfer of the garage to the Agency will occur, or upon what terms.\nSan Jose, during the fourth quarter of 1994, finalized a loan extension and modification with the mortgage lender on the 150 Almaden and 185 Park Avenue buildings and certain parking areas as the mortgage loan secured by this portion of the complex matured on October 1, 1993 and was extended to December 1, 1993. The modified and extended loan has an interest rate of 8.4% per annum, requires monthly interest payments only beginning December 1, 1994 through December 1, 1997 when the loan begins to amortize until it matures November 30, 2001, when the unpaid principal and interest balance is due. The refinancing resulted in a partial paydown of the outstanding principal balance in the amount of $2.5 million of which the Partnership's share was $1.25 million. (Reference is made to Note 3 (b)).\nSan Jose notified the tenants in and invitees to the complex that some of the buildings, particularly the 100-130 Park Center Plaza Buildings and the garage below them, could pose a life safety hazard under certain unusually intense earthquake conditions. While the buildings and the garage were designed to comply with the applicable codes for the period in which they were constructed, and there is no legal requirement to upgrade the buildings for seismic purposes, San Jose is working with consultants to analyze ways in which such a potential life safety hazard could be eliminated. Tenants occupying approximately 55,000 square feet (approximately 13% of the buildings) of the Park Center Plaza investment property have leases that expire in 1995, for which there can be no assurance of renewals. In addition, new leases will likely require expenditures for lease commissions and tenant improvements prior to tenant occupancy. These anticipated costs upon re-leasing will result in a decrease in cash flow from operations over the near term. However, since the costs of both re-leasing space and any seismic program could be substantial, San Jose has commenced discussions with the appropriate lender for additional loan proceeds to pay for all or a portion of these costs. Furthermore, should lender assistance be required to fund significant costs at the 100-130 Park Center Plaza buildings but not be obtained, the Partnership may decide not to commit any additional amounts to this portion of the complex since such amounts are likely to be large in comparison to the Partnership's current equity in this portion of the complex and the likelihood of recovering such funds through increased capital appreciation is remote. The result would be that the Partnership would no longer have an ownership interest in this portion of the complex.\nAs a result, there is uncertainty about the ability to recover the net carrying value of the property through future operations and sale and accordingly, San Jose has made provisions for value impairment on the 100- 130 Park Center Plaza buildings and certain parking areas and the 170 Almaden building of $944,335 in the aggregate. Such provisions at September 30, 1994 were recorded to reduce the net carrying values of these buildings to the then outstanding balances of the related non-recourse financing. Furthermore, at September 30, 1993, San Jose recorded a provision for value impairment on the 150 Almaden and 185 Park Avenue buildings and certain parking areas of $15,549,935 to reduce the net carrying value of these buildings to the then outstanding balance of related non-recourse financing. Additionally, at December 31, 1992, San Jose recorded a provision for value impairment of $8,142,152 on certain other portions of the complex to amounts equal to the then outstanding balances of the related non-recourse financing. In the event the lender on the 100-130 Park Center Plaza portion of the complex exercised its remedies as discussed above, the result would likely be that San Jose would no longer have an ownership interest in such portion. See Note 3(b) for further discussion of this investment property.\nRiverside Square Mall has been experiencing decreasing sales levels as well as increasing competition for new tenants since a competing regional retail center expanded its operations in 1990. Occupancy at the mall, not including Saks Fifth Avenue, has decreased from 81% at December 31, 1993 to 72% at December 31, 1994 primarily due to a certain tenant vacating its space as described below more fully. In an effort to improve the property's competitive position, the Partnership has substantially completed its renovation and is continuing to remerchandise the center. In connection with the renovation, the Partnership, in early 1994, signed 15- year operating covenant extensions with both Saks and Bloomingdales, the latter of which owns their own store. In return for the additional 15-year commitment to the center, the Partnership reimbursed Saks for their recent store renovation in the amount of $6,100,000 and is obligated to pay Bloomingdales $5,000,000 toward their upcoming store renovation (which payment is expected to occur in 1995). In connection with the payment to Saks, the Partnership also acquired title to the Saks building which had previously been owned by Saks. The Partnership is also required to complete the renovation of the mall, with an additional estimated cost of approximately $12,000,000 which has been substantially completed as of December 31, 1994. The Partnership continues to consider expanding the mall at some point in the future as well. Furthermore, the Partnership has commenced a $7,500,000 restoration of the parking deck. This restoration should be completed by the end of 1995. During the third quarter of 1994, the Partnership finalized a refinancing of the existing mortgage loan with a new loan in the amount of $36,000,000. The new loan has an initial interest rate of 8.35% per annum, requires monthly principal and interest 2payments of $286,252 beginning September 1, 1994, and matures December 1, 2006, when the unpaid principal and interest balance is due. The refinancing resulted in net proceeds of approximately $22,300,000 (after retirement of the previous mortgage loan with an outstanding balance of approximately $13,000,000, and payment of a prepayment penalty of approximately $650,000 which has been reflected as an extraordinary item in 1994 in the accompanying financial statements and as discussed in note 2(b)). Of such proceeds, approximately $11,200,000 was escrowed by the lender pursuant to the loan agreement and will be released (none released as of December 31, 1994), including interest earned, to fund certain costs of the renovation and restoration as discussed above. The remaining $11,100,000 represents the replenishment of the Partnership's working capital for amounts paid or to be paid to Saks and Bloomingdales for tenant allowances as discussed above. In connection with the negotiations relating to the refinancing, the Partnership had escrowed approximately $801,000 to serve as collateral to secure a letter of credit. Such letter of credit was released and the funds were refunded to the Partnership in September 1994 in connection with the loan funding.\nThe Partnership is continuing to attempt to lease the vacant space in the mall, but the competitive nature of the surrounding retail area and the fact that the mall was in need of a renovation has extended the time period required to re-lease space as tenant leases expire and are not renewed. On January 7, 1994, Conran's, a tenant occupying approximately 28,000 square feet or 12% of the building, filed for protection pursuant to a Chapter 11 bankruptcy petition. During 1994, the Partnership bought the rights to the Conran's lease for $475,000 through the bankruptcy auction and is in control of the space. The Partnership is reviewing its possible alternatives with respect to replacement tenants for the Conran's lease which was originally scheduled to expire in January 2000.\nIn November 1994, due to the Partnership's default in payment of debt service, the mortgage lender concluded proceedings to realize upon its mortgage security interest represented by the land, building, and related improvements of the Bank of Delaware investment property via a deed in lieu of foreclosure. As a result of the disposition of the property, the Partnership recognized a gain in 1994 for financial reporting purposes of $447,650 and a loss for Federal income tax purposes of $4,756,937 with no corresponding distributable proceeds. In December 1993, a major tenant, E.I. duPont de Nemours (\"duPont\"), which comprised approximately 27% of the building, vacated their space upon expiration of their lease. The property had been operating at a cash deficit due to the significant costs incurred in connection with the re-leasing of vacant space and certain capital improvements. Due to the competitive nature of this marketplace, the Partnership estimated the costs associated with re-leasing any vacant space during the next few years, including those costs to remove the remaining asbestos in tenant space, would have been substantial. As a result of these leasing concerns, the Partnership recorded a provision for value impairment on the Bank of Delaware Building at June 30, 1992 of $11,476,030 to reduce the net carrying value of the Bank of Delaware Building to the then outstanding balance of the related non-recourse debt. Further, the Partnership had commenced discussions with the building's first mortgage lender in order to seek a loan modification. In connection with these discussions, effective January 1994, the Partnership had suspended payment of debt service to the lender. Under the terms of a mortgage and security agreement, the Partnership, in its capacity as mortgagor of the building, agreed to indemnify the mortgage lender, under certain circumstances, against damages, claims, liabilities and expenses incurred by or asserted against the mortgage lender in relation to asbestos in the building. Asbestos had been abated or encapsulated in approximately 62% of the building's space. The Partnership did not believe that any remaining asbestos in the building presented a hazard and did not believe that such asbestos was required to be removed. The Partnership estimated that the cost of asbestos abatement in a portion of the building that could be incurred under certain circumstances in the future would have been approximately $800,000. However, the Partnership did not believe that it would have likely been required to incur (or to indemnify the mortgage lender against) any such cost, although there is no assurance that the Partnership would not have been required to pay such cost or indemnification. In conjunction with the transfer of title, the Partnership paid the mortgage lender a sum of approximately $681,000 which included the net cash flow of the property since the suspension of debt service and an indemnification release fee for which the mortgage lender released the Partnership from all liabilities respecting the property, including those related to asbestos.\nJWP, Inc. leased approximately 78,000 square feet of space (approximately 29% of the property) at Royal Executive Park II in August 1992. As a result of the JWP, Inc. lease, the property has produced sufficient cash flow to fund the Partnership's preferred level of return for 1994 and in addition, recovered a portion of the cumulative shortfall in this return since 1989. The Partnership expects to receive its preferred level of return for 1995 in addition to a partial recovery of its cumulative shortfall in this return since 1989. In early 1994, JWP filed for protection pursuant to a Chapter 11 bankruptcy petition. JWP subsequently subleased approximately 62,000 square feet of its space and these subtenants have assumed the terms of JWP's lease and have become direct tenants. Additionally, JWP formally rejected its lease and vacated the remainder of its space in January 1995. However, this remaining space (of approximately 16,000 square feet) has been leased for a term of one year to a tenant who previously had assumed space sublet by JWP. Thus, through 1995, all of the former JWP space has been re-leased. The previous manager of the property, an affiliate of the venture partner, continued an aggressive marketing program to lease the remaining vacant space but the competitive nature of the market continued to extend the time period required to lease space to initial tenants which will result in a decrease in cash flow from operations over the near term. Effective July 1, 1994, management and leasing activities at the complex were transferred to an affiliate of the General Partners of the Partnership, who managed the property until December 1994. In December 1994, one of the affiliated property managers sold substantially all of its assets and assigned its interest in its management contracts to an unaffiliated third party. In addition, certain of the management personnel of the property manager became management personnel of the purchaser and its affiliates.\nDue to uncertainty about the ability to recover the net carrying value of the property through future operations and sale, Royal Executive has made a provision for value impairment of $25,378,894. Such provision at September 30, 1994 was recorded to reduce the net carrying value of the property to the then estimated valuation. The provision for value impairment has been allocated fully to the venture partner to reflect their subordination to the Partnership in distributions with regard to future operation and sale or financing proceeds as discussed in Note 3(c).\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.\nThough the economy has recently shown signs of improvement and financing is generally becoming more available for certain types of higher- quality properties in healthy markets, real estate lenders are typically requiring a lower loan-to-value ratio for mortgage financing than in the 2past. This has generally made it difficult for owners to refinance real estate assets at their current debt levels unless the value of the underlying property has appreciated significantly. As a consequence, and due to the weakness of some of the local real estate markets in which the Partnership's properties operate, the Partnership is taking steps to preserve its working capital.\nRESULTS OF OPERATIONS\nThe aggregate decrease in cash and cash equivalents and short-term investments as of December 31, 1994 as compared to December 31, 1993 is primarily due to funds utilized in 1994 for the acquisition of the Saks Fifth Avenue building, and renovation work as described above at Riverside Square Mall partially offset by the receipt of $11,100,000 in loan proceeds from the refinancing of long-term debt at the Riverside Square Mall property.\nThe increase in rents and other receivables at December 31, 1994 as compared to December 31, 1993 is primarily due to the timing of rents collected from certain tenants at the Riverside Square Mall property.\nThe increase in escrow deposits as of December 31, 1994 as compared to December 31, 1993 is primarily due to escrow payments made pursuant to the loan refinancing at Riverside Square Mall of approximately $11,500,000 including interest earned on escrowed fund. Reference is made to Note 2(b).\nThe decrease in land, accumulated depreciation, prepaid expenses, and current portion of long-term debt as of December 31, 1994 as compared to December 31, 1993 is primarily due to the lender obtaining title to the Bank of Delaware building via a deed in lieu of foreclosure in November 1994 as discussed above. See Note 2(c).\nThe increase in building and improvements as of December 31, 1994 as compared to December 31, 1993 is primarily due to tenant improvements renovation work, and the purchase of the Saks store of approximately $22,260,000 incurred in 1994 at Riverside Square Mall, as discussed above, partially offset by the lender obtaining title to the Bank of Delaware building via a deed in lieu of foreclosure as discussed above.\nThe increase in deferred expenses at December 31, 1994 as compared to December 31, 1993 is primarily due to $371,000 of certain costs associated with the August 31, 1994 refinancing of the mortgage loan at the Riverside Square Mall property and $558,000 of deferred expenses due to increased leasing activity during the fourth quarter of 1994.\nThe increase in accrued interest payable and long-term debt, less current portion, as of December 31, 1994 as compared to the year ended December 31, 1993 and the increase in mortgage interest expense for the year ended December 31, 1994 as compared to the year ended December 31, 1993 is due to the refinancing of the debt at the Riverside Square Mall property. Reference is made to Note 2(b).\nThe increase in construction costs payable as of December 31, 1994 as compared to December 31, 1993, is due to the renovation at the Riverside Square Mall property. See Note 2(b).\nThe decrease in rental income for the year ended December 31, 1994 as compared to the year ended December 31, 1993 is primarily due to receiving two months less of rent at the Bank of Delaware building due to the lender taking title to the property via a deed in lieu of foreclosure and also due to lower average occupancy at the Bank of Delaware building and the Riverside Square Mall property. The decrease in rental income for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is due to lower occupancy at the Bank of Delaware and tenant billing adjustments in 1993 of approximately $223,000 at Riverside Square Mall.\nThe increase in interest income for the year ended December 31, 1994 as compared to the year ended December 31, 1993 is primarily due to approximately $203,000 of interest earned on escrowed funds and net loan proceeds related to the refinancing at Riverside Square Mall. The decrease in interest income for the year ended December 31, 1993 as compared to December 31, 1992 is primarily due to lower effective yields being earned on U.S. Government obligations held during 1993.\nThe increase in depreciation expense for the year ended December 31, 1994 as compared to the year ended December 31, 1993 is primarily due to the depreciation taken in 1994 on the Saks Fifth Avenue building acquired in 1994 at the Riverside Square Mall property. The decrease in depreciation expense for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is primarily due to a reduction of approximately $223,000 in depreciation expense at the Bank of Delaware building due to the $11,476,000 provision for value impairment recorded at September 30, 1992. See Note 2(c).\nThe increase in property operating expenses for the year ended December 31, 1994 as compared to the year ended December 31, 1993 is primarily due to an increase in real estate taxes (partially recoverable from tenants) of approximately $140,000 and an increase in the provision for doubtful accounts of approximately $276,000 at the Riverside Square Mall property. The increase in property operating expenses for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is partially due to an increase of approximately $272,000 of snow removal costs primarily due to a blizzard in early 1993 at the Riverside Square Mall property.\nThe decrease in professional services for the year ended December 31, 1993 as compared to the year ended December 31, 1992 is primarily due to legal fees incurred in 1992 by the Partnership in its defense of a lawsuit and its subsequent appeal brought against the Riverside Square Mall property concerning public access issues.\nThe provision for value impairment for the year ended December 31, 1992 is due to the Partnership recording a provision for value impairment of $11,476,030 at the Bank of Delaware building at June 30, 1992 to reduce the net carrying value of the investment property to the then outstanding balance of the related non-recourse debt. See Note 1.\nThe Partnership's share of operations of unconsolidated ventures increased for the year ended December 31, 1994 as compared to the year ended December 31, 1993 primarily due to a provision for value impairment of approximately $15,550,000 recorded at the San Jose investment property at September 30, 1993 (of which the Partnership's share was approximately $7,775,000), partially offset by the provision for value impairment recorded at the San Jose investment property at September 30, 1994 of approximately $944,000, of which the Partnership's share is approximately $472,000. See Note 3(b).\nThe gain on disposition of investment property for the year ended December 31, 1994 is due to the lender taking title to the Bank of Delaware building via a deed in lieu of foreclosure in November 1994. See Note 2(c).\nThe $2,206,781 extraordinary item for the year ended December 31, 1994 is due to the refinancing of long-term debt at Riverside Square Mall. See Note 2(b). INFLATION\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 investments 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\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nINDEX\nIndependent Auditors' Report Consolidated Balance Sheets, December 31, 1994 and 1993 Consolidated Statements of Operations, years ended December 31, 1994, 1993 and 1992 Consolidated Statements of Partners' Capital Accounts (Deficit), years ended December 31, 1994, 1993 and 1992 Consolidated Statements of Cash Flows, years ended December 31, 1994, 1993 and 1992 Notes to Consolidated Financial Statements\nSCHEDULE --------\nReal Estate and Accumulated Depreciation III\nSCHEDULES NOT FILED:\nAll schedules other than the one indicated in the index have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nROYAL EXECUTIVE PARK II (A GENERAL PARTNERSHIP)\nINDEX\nIndependent Auditors' Report Balance Sheets, December 31, 1994 and 1993 Statements of Operations, years ended December 31, 1994, 1993 and 1992 Statements of Partners' Capital Accounts, years ended December 31, 1994, 1993 and 1992 Statements of Cash Flows, years ended December 31, 1994, 1993 and 1992 Notes to Financial Statements\nSCHEDULE --------\nReal Estate and Accumulated Depreciation III\nSCHEDULES NOT FILED:\nAll schedules other than the one indicated in the index have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Partners JMB INCOME PROPERTIES, LTD. - XI:\nWe have audited the financial statements of JMB Income Properties, Ltd. - XI (a limited partnership) as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These financial statements and financial statement schedule are the responsibility of the General Partners of the Partnership. Our responsibility is to express an opinion on these 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 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 financial statements referred to above present fairly, in all material respects, the financial position of JMB Income Properties, Ltd. - XI at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1994, 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.\nKPMG PEAT MARWICK LLP\nChicago, Illinois March 27, 1995\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(1) BASIS OF ACCOUNTING\nThe equity method of accounting has been applied in the accompanying financial statements with respect to the Partnership's interest in Royal Executive Park II (\"Royal Executive\") and JMB\/San Jose Associates (\"San Jose\") (note 3). Accordingly, the accompanying financial statements do not include the accounts of Royal Executive and San Jose.\nThe Partnership's records are maintained on the accrual basis of accounting as adjusted for Federal income tax reporting purposes. The accompanying 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\"). Such adjustments are not recorded on the records of the Partnership. The net effect of these items for the years ended December 31, 1994 and 1993 is summarized as follows:\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nThe net earnings (loss) per limited partnership interest is based upon the number of limited partnership interests outstanding at the end of the period (173,411). 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. The Partnership records amounts held in U.S. Government obligations at cost, which approximates market. 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 ($7,200,333 and $0 at December 31, 1994 and 1993, respectively) as cash equivalents with any remaining amounts (generally with original maturities of one year or less) reflected as short-term investments being held to maturity.\nDeferred expenses consist primarily of loan fees and lease commissions which are amortized over the terms stipulated in the related loan agreements or over the terms of the related leases using the straight-line method.\nAlthough certain leases of the Partnership provide for tenant occupancy during periods for which no rent is due and\/or increases in the minimum lease payments over the term of the lease, rental income is accrued for the full period of occupancy on a straight-line basis.\nIn response to the uncertainties relating to the future recovery of the carrying value of the Bank of Delaware investment property through future operations or sale, the Partnership recorded a provision for value impairment on the Bank of Delaware investment property of $11,476,030. Such provision, made as of June 30, 1992, was recorded to reduce the net carrying value of the investment property to the then outstanding balance of the related non-recourse debt. Reference is made to note 2(c) for further discussion of the current status of this investment property.\nIn response to the uncertainties relating to the San Jose joint venture's ability to recover the net carrying value of certain buildings within the Park Center Plaza investment property through future operations or sale, the San Jose joint venture, at December 31, 1992, recorded a provision for value impairment on certain portions of the complex of $8,142,152. Such provision was recorded to reduce the net basis of these portions to the then outstanding balance of the related non-recourse debt. Additionally, a provision for value impairment on the 150 Almaden and 185 Park Avenue buildings and certain parking areas of $15,549,935 was recorded at September 30, 1993 to reduce the net basis to the then outstanding balance of the related non-recourse debt. Furthermore, the San Jose joint venture, recorded a provision for value impairment at September 30, 1994 on the 100-130 Park Center Plaza buildings and certain parking areas, and the 170 Almaden building of $944,335, in aggregate, to reduce the net carrying values to the then outstanding balances of related non-recourse debt. Reference is made to note 3(b) for further discussion of the current status of this investment property.\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nDue to uncertainty about the ability to recover the net carrying value of the property through future operations and sale, Royal Executive has made a provision for value impairment of $25,378,894. Such provision at September 30, 1994 was recorded to reduce the net carrying value of the property to the then estimated valuation. The provision for value impairment has been allocated fully to the venture partner to reflect their subordination to the Partnership in distributions with regard to future operation and sale or financing proceeds as discussed in note 3(c).\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 tax authorities amounts representing withholding from distributions paid to partners.\nCertain amounts in the 1993 and 1992 financial statements have been reclassified to conform to the 1994 presentation.\n(2) INVESTMENT PROPERTIES\n(a) General\nThe Partnership has acquired, either directly or through joint ventures, two shopping centers and three office complexes. In June 1990, the Partnership sold its interest in the Genesee Valley Shopping Center. In November 1994, the lender realized upon its security interest and took title to the Bank of Delaware building via a deed in lieu of foreclosure (note 2(c)). All of the remaining properties were in operation at December 31, 1994. The cost of the investment properties represents the total cost to the Partnership plus miscellaneous acquisition costs.\nDepreciation on the properties has been provided over the estimated useful lives of the various components as follows:\nYEARS -----\nBuilding and Improvements -- straight-line. . . 30 Personal property -- straight-line. . . . . . . 5 ==\nThe investment properties are pledged as security for the long-term debt, for which there is no recourse to the Partnership.\nMaintenance and repair expenses are charged to operations as incurred.\nSignificant betterments and improvements are capitalized and depreciated over their estimated useful lives. Provisions for value impairment are recorded with respect to the investment properties whenever the estimated future cash flows from a property's operations and projected sales are less than the property's carrying value.\n(b) Riverside Square Mall\nDuring October 1983, the Partnership acquired an existing enclosed regional shopping center in Hackensack, New Jersey. The Partnership's purchase price for the mall was $36,236,282. The Partnership made a cash down payment at closing of $20,000,000. The balance of the purchase price was represented by a first mortgage loan which had a balance at closing of $16,236,282 prior to unamortized discount, based upon an imputed interest rate of 12%. During the third quarter of 1994, the Partnership finalized\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\na refinancing of the first mortgage loan with a new loan in the amount of $36,000,000 which matures December 1, 2006 and bear's interest at 8.35%. See Note 4. The refinancing resulted in net proceeds of approximately $22,300,000 (after retirement of the previous mortgage loan with an outstanding balance of approximately $13,000,000 and payment of a prepayment penalty of $649,163). Of such proceeds, approximately $11,200,000 has been escrowed by the lender pursuant to the loan agreement and will be released, including interest, to fund certain costs of the renovation and restoration as discussed below. The remaining $11,100,000 represents the replenishment of the Partnership's working capital for amounts paid or to be paid to Saks and Bloomingdales for tenant allowances as discussed below. In connection with the negotiations relating to the refinancing, the Partnership had escrowed approximately $801,000 to serve as collateral to secure a letter of credit. Such letter of credit was released and the funds were refunded to the Partnership in September 1994 in connection with the loan funding. Additionally, the Partnership has recorded an extraordinary loss on refinancing of $2,206,791 representing the write-off of unamortized discount on the original mortgage loan of $1,557,628 and the $649,163 prepayment penalty as discussed above.\nThe Partnership has substantially completed its renovation of Riverside Square Mall and is continuing to remerchandise the center. In connection with the renovation, the Partnership, in early 1994, signed 15- year operating covenant extensions with both Saks and Bloomingdales, the latter of which owns their own store. In return for the additional 15-year commitment to the center, the Partnership reimbursed Saks for their recent store renovation in the amount of $6,100,000 and is obligated to pay Bloomingdales $5,000,000 toward their upcoming store renovation. In connection with the payment to Saks, the Partnership also acquired title to the Saks building which had previously been owned by Saks. The Partnership is also required to complete the renovation of the mall, with an additional estimated cost of approximately $12,000,000 which has substantially been completed as of December 31, 1994. The Partnership continues to consider expanding the mall at some point in the future as well. Furthermore, the Partnership has commenced a $7,500,000 restoration of the parking deck. This restoration should be completed by the end of 1995.\n(c) Bank of Delaware - office building\nIn December 1984, the Partnership acquired an interest in an existing office building in Wilmington, Delaware. The Partnership's purchase price for the building was $20,900,000, of which approximately $5,945,000, was represented by an existing first mortgage loan. In February 1989, the Partnership refinanced the existing first mortgage loan and received net refinancing proceeds of approximately $4,696,000 which were utilized primarily to pay for the substantially completed renovation program and other capital improvements.\nA major tenant in the building brought a lawsuit against the Partnership which sought reimbursement from the Partnership for certain improvements made by the tenant to its space in the building. Pursuant to an arbitration ruling, the Partnership reimbursed the tenant approximately $802,000, all of which was paid as of December 1992. The Partnership was released from any further obligations pursuant to the assignment of title to the property in November 1994 as described below.\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\nIn December 1993, a major tenant, E.I. duPont de Nemours (\"duPont\"), which comprised approximately 27% of the building, vacated their space upon expiration of their lease. The property had been operating at a cash deficit due to the significant costs incurred in connection with the re- leasing of vacant space and certain capital improvements. Due to the competitive nature of this marketplace, the Partnership estimated the costs associated with re-leasing any vacant space during the next few years, including those costs to remove the remaining asbestos in tenant space, would have been substantial. As a result, the Partnership had commenced discussions with the building's first mortgage lender in order to seek a loan modification. In connection with these discussions, effective January 1994, the Partnership had suspended payment of debt service to the lender. Under the terms of a mortgage and security agreement, the Partnership, in its capacity as mortgagor of the building, agreed to indemnify the mortgage lender, under certain circumstances, against damages, claims, liabilities and expenses incurred by or asserted against the mortgage lender in relation to asbestos in the building. Asbestos had been abated or encapsulated in approximately 62% of the building's space. The Partnership did not believe that any remaining asbestos in the building presented a hazard and did not believe that such asbestos would have been required to be removed. The Partnership estimated that the cost of asbestos abatement in a portion of the building that could be incurred under certain circumstances in the future would have been approximately $800,000. However, the Partnership did not believe that it would have likely been required to incur (or to indemnify the mortgage lender against) any such cost, although there was no assurance that the Partnership would not have been required to pay such cost or indemnification. In November 1994, due to the Partnership's default in payment of debt service, the mortgage lender concluded proceedings to realize upon its mortgage security interest represented by the land, building, and related improvements of the property via a deed in lieu of foreclosure. As a result of the disposition of the property, the Partnership recognized a gain in 1994 for financial reporting purposes of $447,650 and a loss for federal income tax purposes of $4,756,937 with no corresponding distributable proceeds. In conjunction with the transfer of title, the Partnership paid the mortgage lender a sum of approximately $681,000 which included the net cash flow of the property since the suspension of debt service and an indemnification release fee for which the mortgage lender released the Partnership from all liabilities respecting the property, including those related to asbestos.\nAn affiliate of the General Partner of the Partnership managed the office building through the November 1994 date of property title assignment for a fee equal to 3% of the gross revenues of the building plus leasing commissions, subject to an aggregate annual maximum amount of 6% of the gross receipts of the property.\n(3) VENTURE AGREEMENTS\n(a) General\nThe Partnership at December 31, 1994 is a party to two operating venture agreements (San Jose and Royal Executive) and has made capital contributions to the respective ventures as discussed below. 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.\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\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) San Jose\nThe Partnership has acquired, through San Jose, an interest in an existing office building complex in San Jose, California (Park Center Financial Plaza). San Jose acquired nine office buildings and two parking garage structures in June 1985 for a purchase price of approximately $32,472,000 subject to long-term indebtedness of approximately $6,347,000. All of the properties were in operation when acquired.\nIn addition, in May 1986, San Jose purchased an additional office building (150 Almaden) and a parking and retail building (185 Park Avenue) in the Park Center Financial Plaza complex for a total purchase price of approximately $47,476,000. In conjunction with the acquisitions, San Jose reserved approximately $31,590,000 to fund debt service, leasing commissions, and capital and tenant improvements.\nIn 1991, all remaining amounts originally set aside by the Partnership to fund debt service, leasing commissions and capital and tenant improvement costs at Park Center Financial Plaza were utilized.\nIn September 1986, San Jose obtained a mortgage loan in the amount of $25,000,000 secured by the 150 Almaden and 185 Park Avenue buildings and certain parking areas. The outstanding principal balance, which was non- amortizable, bore interest at the rate of 9.5% per annum and had a scheduled maturity in October 1993 and was extended to December 1, 1993. San Jose, during the fourth quarter of 1994, finalized a loan extension and modification with the mortgage lender. The modified and extended loan has an interest rate of 8.4% per annum, requires monthly interest payments only beginning December 1, 1994 through December 1, 1997 when the loan begins to amortize until it matures November 30, 2001, when the unpaid principal and interest balance is due. The refinancing resulted in the 1994 partial paydown of the outstanding principal balance in the amount of $2.5 million.\nThe property was managed by an affiliate of the General Partners of the Partnership for a fee calculated as 3% of gross receipts until December 1994 when the affiliated property manager sold substantially all of its assets and assigned its interests in its management contracts to an unaffiliated third party.\nThe partners of San Jose are the Partnership and JMB Income Properties, Ltd.-XII, another partnership sponsored by the Managing General Partner of the Partnership (\"JMB-XII\"). The terms of San Jose's partnership agreement generally provide that contributions, distributions, cash flow, sale or refinancing proceeds and profits and losses will be distributed or allocated to the Partnership in their respective 50% ownership percentages.\nDuring August 1994, San Jose received notification from the Redevelopment Agency of the City of San Jose of its offer to purchase one of the parking garage structures in the office building complex, for an approved Agency project for $4,090,000. The price offered is deemed by the Agency to be just compensation in compliance with applicable State and Federal laws relating to the government's power of eminent domain. San Jose is currently investigating its options with regard to the Agency's\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\noffer, including the impact of any purchase on garage spaces leased to tenants of other Partnership properties in the complex. Should the Agency proceed to purchase the property, San Jose would recognize a gain for financial reporting and Federal income tax purposes. Therefore, it is uncertain at this time whether a transfer of the garage to the Agency will occur or upon what terms.\nSan Jose notified the tenants in and invitees to the Park Center Plaza complex that some of the buildings, particularly the 100-130 Park Center Plaza Buildings and the garage below them, could pose a life safety hazard under certain unusually intense earthquake conditions. While the buildings and the garage were designed to comply with the applicable codes for the period in which they were constructed, and there is no legal requirement to upgrade the buildings for seismic purposes, San Jose is working with consultants to analyze ways in which such a potential life safety hazard could be eliminated. In addition, tenants occupying approximately 55,000 square feet (approximately 13% of the building) of the Park Center Plaza investment property have leases that expire in 1995, for which there can be no assurance of renewals. However, since the costs of both re-leasing space and any seismic program at the 100-130 Park Center Plaza buildings could be substantial, San Jose has commenced discussions with the appropriate lender for additional loan proceeds to pay for all or a portion of these costs. Should lender assistance be required to fund significant costs at the 100-130 Park Center Plaza buildings but not be obtained, San Jose may decide not to commit any additional amounts to this portion of the complex, since such amounts are likely to be large in comparison to the Partnership's current equity in this portion of the complex and the likelihood of recovering such funds through increased capital appreciation is remote. The result would be that San Jose would no longer have an ownership interest in this portion of the complex.\nAs a result, there is uncertainty about the ability to recover the net carrying value of the property through future operations and sale and accordingly, San Jose has made provisions for value impairment on the 100- 130 Park Center Plaza buildings and certain parking areas and the 170 Almaden building of $944,335 in the aggregate. Such provisions at September 30, 1994 were recorded to reduce the net carrying values of these buildings to the then outstanding balances of the related non-recourse financing. Additionally, at September 30, 1993, San Jose recorded a provision for value impairment on the 150 Almaden and 185 Park Avenue buildings and certain parking areas of $15,549,935 to reduce the net carrying value of these buildings to the then outstanding balance of related non-recourse financing. Additionally, at December 31, 1992, San Jose recorded a provision for value impairment of $8,142,152 on certain other portions of the complex to amounts equal to the then outstanding balances of the related non-recourse financing. In the event the lender on the 100-130 Park Center Plaza portion of the complex exercised its remedies as discussed above, the result would likely be that San Jose would no longer have an ownership interest in such portion.\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\n(c) Royal Executive\nIn December 1985, the Partnership entered into a commitment to fund a $27,000,000 convertible first mortgage note on a three building office park then under construction in Rye Brook, New York (Royal Executive Park II). The first mortgage note called for monthly installments of interest only at a rate of 10% through the period of equity conversion.\nDuring February 1987, the Partnership exercised its option of converting the $27,000,000 mortgage into an ownership position. Upon the conversion of the mortgage note, the Partnership entered into a joint venture (Royal Executive) with the borrower (joint venture partners). Pursuant to the terms of the venture agreement, until certain rental achievement levels are attained, the Partnership is entitled to a cumulative preferred annual return equal to $2,430,000 per year. The next $2,439,732 of annual cash flow is distributable to the joint venture partners, on a non-cumulative basis, with any remaining cash flow distributable 49.9% to the Partnership and 50.1% to the joint venture partners. Therefore, the Partnership's receipt of cash distributions is subject to the actual operations of the property. The Partnership is entitled to any deficiency in its preferred annual return on a cumulative basis as an annual priority distribution from future available operating cash flow. The cumulative deficiency in the preferred annual return is approximately $4,700,000 at December 31, 1994. The Partnership is entitled to priority level of distribution of sale and refinancing proceeds of $27,000,000 plus the cumulative deficiency in its preferred annual return.\nOperating profits of the joint venture, in general, will be allocated in proportion to, and to the extent of, distributions and then based on relative ownership percentages. Operating losses, in general, will be first allocated to the joint venture partners to the extent of any additional contributions made to fund operations or the Partnership's guaranteed return. Remaining losses, if any, will be allocated based upon relative ownership interests. Depreciation and amortization will be allocated based upon the relative ownership interests.\nDue to uncertainty about the ability to recover the net carrying value of the property through future operations and sale, Royal Executive has made a provision for value impairment of $25,378,894. Such provision at September 30, 1994 was recorded to reduce the net carrying value of the property to the then estimated valuation. The provision for value impairment has been allocated fully to the venture partner to reflect their subordination to the Partnership in distributions with regard to future operation and sale or financing proceeds as discussed above.\nEffective July 1, 1994, management and leasing activities at the complex were transferred to an affiliate of the General Partners of the Partnership, who managed the property until December 1994. In December 1994, this affiliated property manager sold substantially all of its assets and assigned its interest in its Management contracts to an unaffiliated third party. In addition, certain of the management personnel of the property manager became management personnel of the purchaser and its affiliates. (4) LONG-TERM DEBT\nLong-term debt consists of the following at December 31, 1994 and 1993:\n1994 1993 ---------- ---------- 8.35% mortgage note, secured by Riverside Square Mall in Hackensack, New Jersey; payable in monthly installments of principal and interest of $286,252 through December 1, 2006, the scheduled maturity date at which time the unpaid principal and interest is due (note 2(b)) $35,891,996 --\n9-1\/2% first mortgage note, secured by Riverside Square Mall in Hackensack, New Jersey which was retired by the loan described above. Balance is net of unamortized discount of $1,658,738 at December 31, 1993 based on an imputed interest rate of 12%. . . . -- 11,634,669\n10-3\/8% mortgage note, secured by Bank of Delaware Office Building in Wilmington, Delaware; retired at disposition in November 1994; was payable in monthly installments of interest only of $82,135 through March 1, 1999 the scheduled maturity date (see note 2(c)) . -- 9,500,000 ----------- ----------\nTotal debt . . . . . . . . . . . 35,891,996 21,134,669\nLess current portion of long-term debt . . 455,199 9,837,354 ----------- ----------\nTotal long-term debt . . . . . . $35,436,797 11,297,315 =========== ==========\nFive year maturities of long-term debt are summarized as follows for the years ending:\n1995 . . . . . . . . . . $455,199 1996 . . . . . . . . . . 494,697 1997 . . . . . . . . . . 537,623 1998 . . . . . . . . . . 584,273 1999 . . . . . . . . . . 634,971 ========\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\n(5) PARTNERSHIP AGREEMENT\nPursuant to the terms of the Partnership Agreement, net profits or losses of the Partnership from operations are allocated 96% to the Limited Partners and 4% to the General Partners. Profits from the sale or refinancing of investment properties will be allocated to the General Partners: (i) to the greater of 1% of such profits or the amount of cash distributable to the General Partner from any such sale or refinancing (as described below); and (ii) in order to reduce deficits, if any, in the General Partners' capital accounts to a level consistent with the gain anticipated to be realized from the sale of properties. Losses from the sale or refinancing of investment properties will be allocated 1% to the General Partners. The remaining sale or refinancing profits and losses will be allocated to the Limited Partners.\nThe General Partners are not required to make any additional capital contributions except under certain limited circumstances upon termination of the Partnership. In general, distributions of cash from operations will be made 90% to the Limited Partners and 10% to the General Partners. However, a portion of such distributions to the General Partners is subordinated to the Limited Partners' receipt of a stipulated return on capital.\nThe Partnership Agreement provides that the General Partners shall receive as a distribution from the sale of a real property by the Partnership amounts equal to the cumulative deferrals of any portion of their 10% cash distribution and 3% of the selling price, and that the remaining proceeds (net after expenses and retained working capital) be distributed 85% to the Limited Partners and 15% to the General Partners. However, the Limited Partners shall receive 100% of such net sale proceeds until the Limited Partners (i) have received cash distributions of sale or refinancing proceeds in an amount equal to the Limited Partners' aggregate initial capital investment in the Partnership, (ii) have received cumulative cash distributions from the Partnership's operations which, when combined with sale or refinancing proceeds previously distributed, equal a 7% annual return on the Limited Partners' average capital investment for each year (their initial capital investment as reduced by sale or refinancing proceeds previously distributed) commencing with the first fiscal quarter of 1985 and (iii) have received cash distributions of sale and refinancing proceeds and of the Partnership operations, in an amount equal to the Limited Partners' initial capital investment in the Partnership plus a 10% annual return on the Limited Partners' average capital investment.\n(6) MANAGEMENT AGREEMENT\nAn affiliate of the General Partners of the Partnership manages Riverside Square Mall for a fee equal to 4% of the fixed and percentage rents of the shopping center plus leasing and operating covenant commissions, subject to deferral if in excess of an aggregate annual maximum amount of 6% of the gross receipts of the property.\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\n(7) LEASES\nAt December 31, 1994, the Partnership's principal asset is one shopping center. The Partnership has determined that all leases relating to this property are properly classified as operating leases; therefore, rental income is reported when earned and the cost of the properties, excluding the cost of the land, is depreciated over the estimated useful lives. Leases with tenants range in term from one to thirty-five years and provide for fixed minimum rent and partial reimbursement of operating costs. In addition, leases with shopping center tenants provide for additional rent based upon percentages of tenants' sales volumes. A substantial portion of the ability of retail tenants to honor their leases is dependant upon the retail economic sector.\nCost and accumulated depreciation of the leased assets are summarized as follows at December 31, 1994:\nShopping Center: Cost. . . . . . . . . . . . . . . $65,406,740 Accumulated depreciation. . . . . (12,951,168) ----------- $52,455,572 ===========\nMinimum lease payments, including amounts representing executory costs (e.g. taxes, maintenance, insurance) and any related profit, to be received in the future under the operating leases are as follows:\n1995. . . . . . . . . . $ 4,924,779 1996. . . . . . . . . . 5,173,086 1997. . . . . . . . . . 5,226,960 1998. . . . . . . . . . 4,911,355 1999. . . . . . . . . . 4,470,724 Thereafter. . . . . . . 17,529,690 -----------\nTotal . . . . . . . $42,236,594 ===========\nContingent rent (based on sales by property tenants) included in rental income was as follows:\n1992 . . . . . . . $296,014 1993 . . . . . . . 302,809 1994 . . . . . . . 274,431 =========\n(8) 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, 1994 and for the years ended December 31, 1994, 1993 and 1992 were as follows:\nJMB INCOME PROPERTIES, LTD. - XI (A LIMITED PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONCLUDED\nThe General Partners have deferred receipt of certain of their distributions (see note 5) of net cash flow of the Partnership. The amount of such deferred distributions aggregated $1,323,705 as of December 31, 1994. The amount is being deferred in accordance with the subordination requirements of the Partnership Agreement. In addition, an affiliate of the General Partner has deferred $300,000 in leasing fees at Riverside Square Mall pursuant to the management agreement (note 6). This amount or amounts currently payable do not bear interest and may be paid in future periods.\n(9) INVESTMENT IN UNCONSOLIDATED VENTURES\nSummary of combined financial information for San Jose and Royal Executive (note 3) as of and for the years ended December 31, 1994 and 1993 are as follows: 1994 1993 ------------ -----------\nCurrent assets . . . . . . . . $ 8,388,581 2,535,033 Current liabilities. . . . . . (1,409,508) (26,399,404) ------------ ----------- Working capital. . . . . . 6,979,073 (23,864,371) ------------ ----------- Investment property, net . . . 54,189,046 80,714,163 Other assets, net. . . . . . . 1,585,304 4,293,567 Long-term debt . . . . . . . . (25,880,881) (3,784,508) Other liabilities. . . . . . . (239,741) (190,834) Venture partners' equity . . . (12,120,193) (35,040,476) ------------ ----------- Partnership's capital. . . $ 24,512,608 22,127,541 ============ =========== Represented by: Invested capital . . . . . . $ 76,505,181 74,947,712 Cumulative distributions . . (36,233,524) (34,443,911) Cumulative losses. . . . . . (15,759,050) (18,376,260) ------------ ----------- $ 24,512,607 22,127,541 ============ =========== Total income . . . . . . . . . $ 15,799,775 16,499,948 ============ =========== Expenses applicable to operating loss . . . . . . . $ 38,119,456 28,375,860 ============ =========== Net loss . . . . . . . . . . . $ 22,319,680 11,875,912 ============ ===========\nReference is made to note 3(b) regarding the provisions for value impairments of $944,335 and $15,549,935 which were recorded in 1994 and 1993, respectively, by San Jose and to 3(c) regarding the provision for value impairment of $25,378,894 which was recorded in 1994 by Royal Executive.\nThe total income, expenses related to operating loss and net loss for the above-mentioned ventures for the year ended December 31, 1992 were $15,934,326, $21,658,285 and $5,723,959, respectively.\n(10) SUBSEQUENT EVENT - DISTRIBUTION TO PARTNERS\nIn February 1995, the Partnership paid a distribution of $520,233 ($3.00 per Interest) to the Limited Partners.\nINDEPENDENT AUDITORS' REPORT\nThe Partners Royal Executive Park II:\nWe have audited the financial statements of Royal Executive Park II (a general partnership) as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the financial statement schedule as listed in the accompanying index. These financial statements are the responsibility of the General Partners of the Partnership. Our responsibility is to express an opinion on these 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 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 financial statements referred to above present fairly, in all material respects, the financial position of Royal Executive Park II at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1994, 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, present fairly, in all material respects, the information set forth therein.\nKPMG PEAT MARWICK LLP\nChicago, Illinois March 27, 1995\nROYAL EXECUTIVE PARK II (A GENERAL PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(1) BASIS OF ACCOUNTING\nThe accompanying financial statements have been prepared for the purpose of complying with Rule 3.09 of Regulation S-X of the Securities and Exchange Commission. They include the accounts of the unconsolidated joint venture, Royal Executive Park II venture (\"Venture\"), in which JMB Income Properties, Ltd.-XI (\"JMB Income-XI\") and an unaffiliated venture are the partners.\nThe Venture's records are maintained on the accrual basis of accounting as adjusted for Federal income tax reporting purposes. The accompanying financial statements have been prepared from such records after making appropriate adjustments to present the Venture's accounts in accordance with generally accepted accounting principles (\"GAAP\"). Such adjustments are not recorded on the records of the Venture. The net effect of these items for the years ended December 31, 1994 and 1993 is summarized as follows:\nROYAL EXECUTIVE PARK II (A GENERAL PARTNERSHIP)\nNotes to Financial Statements - Continued\nStatement of Financial Accounting Standards No. 95 requires the Venture 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. In addition, the Venture records amounts held in U.S. Government obligations at cost, which approximates market. For purposes of these statements, the Venture's policy is to consider all such amounts held with original maturities of three months or less ($692,065 at December 31, 1994) as cash equivalents with any remaining amounts (generally with original maturities of one year or less) reflected as short-term investments being held to maturity.\nDepreciation on buildings and improvements has been provided over the estimated useful lives of the assets (5 to 30 years) using the straight- line method.\nDeferred expenses consist primarily of lease commissions which are amortized over the terms stipulated in the related leases using the straight-line method.\nAlthough certain leases of the Venture provide for tenant occupancy during periods for which no rent is due and\/or increases in the minimum lease payments over the term of the lease, rental income is accrued for the full period of occupancy on a straight-line basis.\nMaintenance and repair expenses are charged to operations as incurred.\nSignificant betterments and improvements are capitalized and depreciated over their estimated useful lives.\nIn 1994, the Venture recorded a provision for value impairment of $25,378,894.\nNo provision for State or Federal income taxes has been made as the liability for such taxes is that of the venture partners rather than the Venture.\n(2) VENTURE AGREEMENT\nA description of the acquisition of the property is contained in Note 3(c) of the consolidated financial statements of JMB Income - XI. Such note is incorporated herein by reference.\n(3) MANAGEMENT AGREEMENT - OTHER THAN VENTURES\nEffective July 1, 1994, management and leasing activities at the complex were transferred to an affiliate of the General Partners of the Partnership, who managed the property until December 1994. In December 1994, this affiliated property manager sold substantially all of its assets and assigned its interest in its Management contracts to an unaffiliated third party. In addition, certain of the management personnel of the property manager became management personnel of the purchaser and its affiliates.\nROYAL EXECUTIVE PARK II (A GENERAL PARTNERSHIP)\nNOTES TO FINANCIAL STATEMENTS - CONTINUED\n(4) LEASES\nAs Property Lessor\nAt December 31, 1994, the Venture's principal asset is an office building complex. The Venture has determined that all leases relating to this property are properly classified as operating leases; therefore, rental income is reported when earned and the cost of the property, excluding the cost of the land, is depreciated over the estimated useful life. Leases with tenants range in term from one to twenty-five years and provide for fixed minimum rent and partial reimbursement of operating costs.\nMinimum lease payments, including amounts representing executory costs (e.g. taxes, maintenance, insurance) and any related profit, to be received in the future under the operating leases are as follows:\n1995. . . . . . . . . . . . . $ 5,654,415 1996. . . . . . . . . . . . . 5,460,232 1997. . . . . . . . . . . . . 5,455,040 1998. . . . . . . . . . . . . 5,330,098 1999. . . . . . . . . . . . . 4,804,742 Thereafter. . . . . . . . . . 6,858,801 ----------- $33,563,328 ===========\n(5) TRANSACTIONS WITH AFFILIATES\nFees, commissions and other expenses required to be paid by the Venture to the General Partners and their affiliates as of December 31, 1994 and for the years ended December 31, 1994, 1993 and 1992 were as follows:\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 1993 and 1994.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE PARTNERSHIP\nThe Managing General Partner of the Partnership is JMB Realty Corporation (\"JMB\"), a Delaware corporation. JMB 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, Income Associates-XI, 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 Managing General Partner and its affiliates are described under the caption \"Conflicts of Interest\" at pages 12-16 of the Prospectus, of which description is hereby incorporated herein by reference to Exhibit 3-A to the Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993.\nThe names, positions held and length of service therein of each director and executive officer and certain officers of the Managing General Partner of the Partnership 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 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 Executive Vice President 1\/02\/87 Chief Executive Officer 8\/01\/93 Glenn E. Emig Executive Vice President 1\/01\/93 Chief Operating Officer 1\/01\/95 Jeffrey R. Rosenthal Managing Director-Corporate 4\/22\/91 Chief Financial Officer 8\/01\/93 Douglas H. Cameron Executive Vice President 1\/01\/95 Gary Nickele Executive Vice President 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\nThere is no family relationship among any of the foregoing directors or officers. The foregoing directors have been elected to serve a one-year term until the annual meeting of the Managing General Partner to be held on June 7, 1995. 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 Managing General Partner to be held on June 7, 1995. 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-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 Income-XIII\"). Most of the foregoing directors and officers are also officer 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-XII, 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-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 Managing General Partner of the Partnership in addition to that described above is as follows:\nJudd D. Malkin (age 57) is an individual general partner of JMB Income-IV and JMB Income-V. Mr. Malkin has been associated with JMB since October, 1969. Mr. Malkin is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers, and a director of Catellus Development Corporation, a major diversified real estate development company. He is a Certified Public Accountant.\nNeil G. Bluhm (age 57) is an individual general partner of JMB Income-IV and JMB Income-V. Mr. Bluhm has been associated with JMB since August, 1970. Mr. Bluhm is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. He is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nBurton E. Glazov (age 56) 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 53) has been associated with JMB since July, 1972. Mr. Nathan is also a director of Sportmart Inc., a retailer of sporting goods. He is a member of the Bar of the State of Illinois.\nA. Lee Sacks (age 61) (President and Director of JMB Insurance Agency, Inc.) has been associated with JMB since December, 1972.\nJohn G. Schreiber (age 48) has been associated with JMB since December, 1970 and served as an Executive Vice President of JMB until December 1990. Mr. Schreiber is President of Schreiber Investments, Inc., a company which is engaged in the real estate investing business. He is also a senior advisor and partner of Blackstone Real Estate Partners, an affiliate of the Blackstone Group, L.P. Since 1994, Mr. Schreiber has also served as a trustee of Amli Residential Property Trust, a publicly-traded real estate investment trust that invests in multi-family properties. Mr. Schreiber is also a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. He is also a director of a number of investment companies advised or managed by T. Rowe Price Associates and its affiliates. He holds a Masters degree in Business Administration from Harvard University Graduate School of Business.\nH. Rigel Barber (age 45) has been associated with JMB since March, 1982. He holds a J.D. degree from Northwestern Law School and is a member of the Bar of the State of Illinois.\nGlenn E. Emig (age 47) has been associated with JMB since December, 1979. Prior to becoming Vice President of JMB in 1993, Mr. Emig was Executive Vice President and Treasurer of JMB Institutional Realty Corporation. He holds a Masters Degree in Business Administration from the Harvard University Graduate School of Business and is a Certified Public Accountant.\nJeffrey R. Rosenthal (age 43) has been associated with JMB since December, 1987. He is a Certified Public Accountant.\nDouglas H. Cameron (age 45) is Executive Vice President of JMB. Mr. Cameron has been associated with JMB since April, 1977. Prior to becoming Executive Vice President of JMB in 1995, Mr. Cameron was Managing Director of Capital Markets -- Property Sales from June 1990. He holds a Masters Degree in Business Administration from the University of Southern California.\nGary Nickele (age 42) 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 43) 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 46) has been associated with JMB since March 1982.\nHe holds a Masters degree in Business Administration from Northern Illinois University and is a Certified Public Accountant.\nHoward Kogen (age 59) has been associated with JMB since March, 1973. He is a Certified Public Accountant.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no officers or directors. The General Partners of the Partnership are entitled to receive a share of cash distributions, when and as cash distributions are made to the Investors, and a share of profits or losses as described under the caption \"Compensation and Fees\" at pages 8-12, \"Cash Distributions\" at pages 56-58, \"Allocation of Profits or Losses for Tax Purposes\" at page 58 and \"Cash Distributions; Allocations of Profits and Losses\" at pages A-8 to A-12 of the Partnership Agreement included as an exhibit to the Prospectus, which descriptions are hereby incorporated herein by reference to Exhibit 3-A to Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993. Reference is also made to Notes 5 and 7 for a description of such transactions, distributions and allocations. In 1994, 1993 and 1992, no cash distributions were paid to the General Partners.\nAffiliates of the Managing General Partner provided property management services to the Partnership for 1994 for the Riverside Square Mall in Hackensack, New Jersey at a fee not to exceed 4% of the fixed and percentage rent of property, plus leasing commissions and the Bank of Delaware Office Building in Wilmington, Delaware at fees calculated at 3% of the gross revenues of the property plus leasing commissions. In 1994, such affiliates earned property management and leasing fees amounting to $608,703, of which $300,000 was unpaid as of December 31, 1994. As set forth in the Prospectus of the Partnership, the Managing 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 6% of the gross receipts from a property), and such agreements must be terminable by either party thereto, without penalty, upon 60 days' notice.\nJMB Insurance Agency, Inc., an affiliate of the Managing General Partner, earned and received insurance brokerage commissions in 1994 aggre- gating $45,765 in connection with the provision of insurance coverage for certain of the real property investments of the Partnership and its venture. Such commissions are at rates set by insurance companies for the classes of coverage provided.\nThe General Partners of the Partnership may be reimbursed for their direct salaries and expenses relating to the administration of the Partnership and the operation of the Partnership's real property investments. In 1994, an affiliate of the General Partners earned reimbursement for such expenses in the amount of $144,232, of which $41,116 was unpaid at December 31, 1994.\nThe Partnership is permitted to engage in various transactions involving affiliates of the Managing General Partner of the Partnership, as described under the captions \"Compensation and Fees\" at pages 8-12, \"Conflicts of Interest\" at pages 12-16 and \"Rights, Powers and Duties of General Partners\" at pages A-12 to A-22 of the Partnership Agreement, included as an exhibit to the Prospectus, which descriptions are hereby incorporated herein by reference to Exhibit 3-A to Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993. The relationship of the Managing General Partner (and its directors and officers) to its affiliates is set forth above in Item 10 above and Exhibit 21 hereto.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the Managing General Partner, affiliates or their management other than those described in Items 10 and 11 above.\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:\n1. Financial Statements (See Index to Financial Statements filed with this annual report).\n2. Exhibits.\n3-A. The Prospectus of the Partnership dated July 11, 1984 as supplemented July 24, 1984 and November 26, 1984, as filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Copies of pages 8-12, 56-58 and A-8 to A-12 are hereby incorporated herein by reference to Exhibit 3-A to the Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993.\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, which agreement is hereby incorporated herein by reference to Exhibit 3-B to the Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993.\n4-A. Mortgage loan agreement, Mortgage and Security Agreement, Secured Promissory Note B, Secured Promissory Note A and Assignment of Leases and Rents between the Partnership and Principal Mutual Life Insurance Company dated August 30, 1994 are hereby incorporated herein by reference to the Partnership's Report on Form 10-K for December 31, 1994 (File No. 0-15966) dated March 27, 1995.\n4-B. Mortgage loan agreement between the Partnership and Equitable Real Estate Investment Management, Inc. dated February 28, 1989 relating to the Bank of Delaware is hereby incorporated herein by reference to Exhibit 4-B to the Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993.\n4-C. Mortgage loan agreement between San Jose and Connecticut General Life Insurance Co. dated June 20, 1985 relating to Park Center Plaza are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated June 20, 1985.\n4-D. Mortgage loan agreement, Amended and Restated Deed of Trust, Security Agreement with assignment of Rents and Fixture Filing and Real Estate tax escrow and Security Agreement between San Jose and Connecticut General Life Insurance Co. dated November 30, 1994 is filed herewith.\n10-A.Acquisition documents relating to the purchase by the Partnership of Riverside Square in Hackensack, New Jersey are hereby incorporated by reference to the Partnership's prospectus on Form S-11 (File No. 2-90503) dated July 11, 1984.\n10-B.Acquisition documents relating to the purchase by the Partnership of the Bank of Delaware Office Building in Wilmington, Delaware are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated December 27, 1984.\n10-C.Acquisition documents including the venture agreement relating to the purchase by the Partnership of Park Center Plaza in San Jose, California are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated June 20, 1985.\n10-D.Sale documents and exhibits thereto relating to the Partnership's sale of the Genesee Valley Shopping Center in Flint, Michigan are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated June 29, 1990.\n10-E.Deed in Lieu of Foreclosure Agreement and Memorandum of Mutual Releases dated November 15, 1994 between Three Hundred Delaware Avenue Associates, L.P. and EML Associates are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated November 15, 1994.\n21. List of Subsidiaries\n24. Powers of Attorney\n27. Financial Data Schedule\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 Securities and Exchange Commissions upon request.\n(b) The following report on Form 8-K has been filed for the quarter covered by this report.\n(i) The Partnership report on Form 8-K (File No.0-15966) describing the deed in lieu of foreclosure agreement for the Bank of Delaware.\nNo annual report or proxy material for the year 1994 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.\nJMB INCOME PROPERTIES, LTD. - XI\nBy: JMB Realty Corporation Managing General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: March 27, 1995\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 Managing General Partner\nJUDD D. MALKIN* By: Judd D. Malkin, Chairman and Director Date: March 27, 1995\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date: March 27, 1995\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date: March 27, 1995\nGLENN E. EMIG* By: Glenn E. Emig, Chief Operating Officer Date: March 27, 1995\nJEFFREY R. ROSENTHAL* By: Jeffrey R. Rosenthal, Chief Financial Officer Principal Financial Officer Date: March 27, 1995\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date: March 27, 1995\nA. LEE SACKS* By: A. Lee Sacks, Director Date: March 27, 1995\nBy: STUART C. NATHAN* Stuart C. Nathan, Executive Vice President and Director Date: March 27, 1995\n*By: GAILEN J. HULL, Pursuant to a Power of Attorney\nGAILEN J. HULL By: Gailen J. Hull, Attorney-in-Fact Date: March 27, 1995\nJMB INCOME PROPERTIES, LTD. - XI\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE Page ------------ ----\n3-A. Pages 8-12, 56-58 and A-8 to A-12 of the Prospectus dated July 11, 1984 Yes\n3-B. Amended and Restated Agreement of Limited Partnership Yes\n4-A. Mortgage loan agreement related to Riverside Square Yes\n4-B. Mortgage loan agreement related to Bank of Delaware Yes\n4-C. Mortgage loan agreement related to Park Center Financial Center Yes\n4-D. Mortgage loan agreement related to Park Center Plaza No\n10-A. Acquisition documents related to Riverside Square Yes\n10-B. Acquisition documents related to Bank of Delaware Yes\n10-C. Acquisition documents related to Park Center Plaza Yes\n10-D. Sale documents related to Genesee Valley Yes\n10-E. Disposition documents related to Bank of Delaware Yes\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No","section_12":"","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThere were no significant transactions or business relationships with the Managing General Partner, affiliates or their management other than those described in Items 10 and 11 above.\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 (See Index to Financial Statements filed with this annual report).\n2. Exhibits.\n3-A. The Prospectus of the Partnership dated July 11, 1984 as supplemented July 24, 1984 and November 26, 1984, as filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Copies of pages 8-12, 56-58 and A-8 to A-12 are hereby incorporated herein by reference to Exhibit 3-A to the Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993.\n3-B. Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, which agreement is hereby incorporated herein by reference to Exhibit 3-B to the Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993.\n4-A. Mortgage loan agreement, Mortgage and Security Agreement, Secured Promissory Note B, Secured Promissory Note A and Assignment of Leases and Rents between the Partnership and Principal Mutual Life Insurance Company dated August 30, 1994 are hereby incorporated herein by reference to the Partnership's Report on Form 10-K for December 31, 1994 (File No. 0-15966) dated March 27, 1995.\n4-B. Mortgage loan agreement between the Partnership and Equitable Real Estate Investment Management, Inc. dated February 28, 1989 relating to the Bank of Delaware is hereby incorporated herein by reference to Exhibit 4-B to the Partnership's Report on Form 10-K for December 31, 1992 (File No. 0-15966) dated March 19, 1993.\n4-C. Mortgage loan agreement between San Jose and Connecticut General Life Insurance Co. dated June 20, 1985 relating to Park Center Plaza are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated June 20, 1985.\n4-D. Mortgage loan agreement, Amended and Restated Deed of Trust, Security Agreement with assignment of Rents and Fixture Filing and Real Estate tax escrow and Security Agreement between San Jose and Connecticut General Life Insurance Co. dated November 30, 1994 is filed herewith.\n10-A.Acquisition documents relating to the purchase by the Partnership of Riverside Square in Hackensack, New Jersey are hereby incorporated by reference to the Partnership's prospectus on Form S-11 (File No. 2-90503) dated July 11, 1984.\n10-B.Acquisition documents relating to the purchase by the Partnership of the Bank of Delaware Office Building in Wilmington, Delaware are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated December 27, 1984.\n10-C.Acquisition documents including the venture agreement relating to the purchase by the Partnership of Park Center Plaza in San Jose, California are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated June 20, 1985.\n10-D.Sale documents and exhibits thereto relating to the Partnership's sale of the Genesee Valley Shopping Center in Flint, Michigan are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated June 29, 1990.\n10-E.Deed in Lieu of Foreclosure Agreement and Memorandum of Mutual Releases dated November 15, 1994 between Three Hundred Delaware Avenue Associates, L.P. and EML Associates are hereby incorporated by reference to the Partnership's Report on Form 8-K (File No. 0-15966) dated November 15, 1994.\n21. List of Subsidiaries\n24. Powers of Attorney\n27. Financial Data Schedule\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 Securities and Exchange Commissions upon request.\n(b) The following report on Form 8-K has been filed for the quarter covered by this report.\n(i) The Partnership report on Form 8-K (File No.0-15966) describing the deed in lieu of foreclosure agreement for the Bank of Delaware.\nNo annual report or proxy material for the year 1994 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.\nJMB INCOME PROPERTIES, LTD. - XI\nBy: JMB Realty Corporation Managing General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: March 27, 1995\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 Managing General Partner\nJUDD D. MALKIN* By: Judd D. Malkin, Chairman and Director Date: March 27, 1995\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date: March 27, 1995\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date: March 27, 1995\nGLENN E. EMIG* By: Glenn E. Emig, Chief Operating Officer Date: March 27, 1995\nJEFFREY R. ROSENTHAL* By: Jeffrey R. Rosenthal, Chief Financial Officer Principal Financial Officer Date: March 27, 1995\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date: March 27, 1995\nA. LEE SACKS* By: A. Lee Sacks, Director Date: March 27, 1995\nBy: STUART C. NATHAN* Stuart C. Nathan, Executive Vice President and Director Date: March 27, 1995\n*By: GAILEN J. HULL, Pursuant to a Power of Attorney\nGAILEN J. HULL By: Gailen J. Hull, Attorney-in-Fact Date: March 27, 1995\nJMB INCOME PROPERTIES, LTD. - XI\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE Page ------------ ----\n3-A. Pages 8-12, 56-58 and A-8 to A-12 of the Prospectus dated July 11, 1984 Yes\n3-B. Amended and Restated Agreement of Limited Partnership Yes\n4-A. Mortgage loan agreement related to Riverside Square Yes\n4-B. Mortgage loan agreement related to Bank of Delaware Yes\n4-C. Mortgage loan agreement related to Park Center Financial Center Yes\n4-D. Mortgage loan agreement related to Park Center Plaza No\n10-A. Acquisition documents related to Riverside Square Yes\n10-B. Acquisition documents related to Bank of Delaware Yes\n10-C. Acquisition documents related to Park Center Plaza Yes\n10-D. Sale documents related to Genesee Valley Yes\n10-E. Disposition documents related to Bank of Delaware Yes\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No","section_15":""}
{"filename":"277948_1994.txt","cik":"277948","year":"1994","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":"75608_1994.txt","cik":"75608","year":"1994","section_1":"ITEM 1. BUSINESS\n(a) GENERAL DESCRIPTION OF BUSINESS\nPacific Scientific Company (\"Registrant\" or the \"Company\") was incorporated in California in 1937 as successor to a company in business since 1919; it has used the name Pacific Scientific Company since 1923. Registrant's business is manufacturing and selling the products of its two segments, Electrical Equipment and Safety Equipment.\nThe various operating divisions and wholly-owned subsidiaries of Registrant are organized (under the two segments) as eight main operating units. The divisions and wholly-owned subsidiaries that make up the operating units are as follows:\nPACIFIC SCIENTIFIC COMPANY\n(1) Acquired in April 1994. Additional information regarding this acquisition is presented in Note 6 on Page 35 of Registrant's Annual Report to Stockholders for the fiscal year ended December 30, 1994, a copy of which has been delivered to the Securities and Exchange Commission (the \"Commission\") pursuant to Rule 14a-3 of the Commission, (the \"Annual Report\") and such Note 6 is incorporated herein by reference in accordance with the provisions of Rule 12b-23 of the Commission (\"Rule 12b-23\").\n(2) Operating division created during 1994. Additional information regarding this division is included in the letter to stockholders beginning on Page 2 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\n(3) Acquired December 31, 1994 (the first day of fiscal 1995). Additional information regarding this acquisition is presented in Note 10 on Page 36 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\n(4) Wholly-owned subsidiary created during 1994. Additional information regarding this operation is included in the letter to stockholders beginning on Page 2 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nFurther discussion regarding the Company's general business development for the fiscal year ended December 30, 1994 is included in the letter to stockholders beginning on Page 2 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\n(b) and (c)(1)(i) DESCRIPTION OF BUSINESS SEGMENTS\nThe Electrical Equipment segment produces: 1) electric motors and generators and related motion control devices such as controllers and drivers, 2) electro-mechanical and electronic controls for use mainly by electric utilities including the controls for street and highway lighting, 3) electronic instruments and 4) electronic ballasts for fluorescent lights. The products are predominately proprietary and once designed, tend to be produced in quantity and sold based on unique specifications. After receipt of an order, deliveries are usually made within a relatively short period of time, ranging from one day to several weeks. The production process typically involves fabrication of special components and the assembly of components produced by other suppliers. Fabrication processes include cutting, stamping, machining, winding, molding, soldering, welding, annealing and painting. Products are sold both to end-users and to original equipment manufacturers.\nThe Safety Equipment segment produces: 1) fire detection and suppression equipment, 2) personnel safety restraints, 3) mechanical and electro-mechanical flight control components, 4) pyrotechnics, and 5) provides service for products already delivered to customers. These products are used mainly in commercial and military aircraft and vehicles, but are also used in a variety of other commercial and industrial applications. In most cases, the Company's products are reconfigured to meet specific customer needs. The Company generally receives long-term purchase orders but also responds to spot buyers, particularly for spare parts. Manufacturing typically involves processes such as cutting, machining, welding, mixing, blending and sewing, with some assembly of components produced by other suppliers. Products in this segment are sold to end-users and original equipment manufacturers.\nFinancial information about industry segments is presented on Page 29 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nEach of Registrant's divisions is responsible for marketing its own products, generally selling through a combination of its own sales personnel, sales representatives and distributors both in the United States and foreign countries. Additional information regarding the Company's products and markets is presented on Pages 5 through 17 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nThe percentages of the Company's consolidated net sales represented by its major markets for the fiscal years 1994, 1993 and 1992 were as follows:\n(c)(1)(ii) MATERIAL NEW PRODUCTS OR SEGMENTS\nIn October 1994, Registrant announced the development of its SoliumTM technology. This technology provides an improved means of dimming compact fluorescent lights (CFLs). Registrant has applied for various patents relating to the new technology. On December 21, 1994, Solium Inc. was formed as a totally-owned subsidiary of Registrant. It is expected that this new subsidiary will require an investment of more than $20 million over the next three years in the areas of manufacturing facilities, machinery, equipment and various other costs incidental to the start-up of a new business. Further information regarding Solium is presented in the letter to stockholders on Pages 2 and 3, and on Page 15 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nDuring 1994, the Company introduced TriodideTM, a drop-in replacement for existing Halon-based suppression agents. The Company has obtained a license (with regard to the pending patent) to the exclusive right to use and sell Triodide as a fire suppression agent. Triodide does not contain chlorofluorocarbons and has virtually no impact on the earth's ozone layer.\n(c)(1)(iii) SOURCES OF RAW MATERIAL\nRegistrant's manufacturing operations consist primarily of fabricating and assembling parts, components and units into finished products and then testing the products. Raw materials, parts, components and assemblies are obtained from independent suppliers. Except as described in the following paragraph, the Registrant generally has not experienced any serious difficulty in obtaining adequate supplies of required materials and services, and continues to seek secondary sources of supply in the few cases where it relies upon a single supplier.\nWithin the Safety Equipment segment, Halon 1301, the fire suppression agent used in all aircraft fire suppression systems, contains chlorofluorocarbon, an ozone depleting chemical. By international agreement, the production of Halon 1301 was discontinued in 1993. In anticipation of the discontinuance of Halon 1301 production, the Company introduced Triodide, discussed at item 1(c)(1)(ii) above, and developed a system capable of recovering and recycling Halon 1301 while also increasing its storage capacity for this material. The Company has been able to maintain a level of supply for this agent that management believes is adequate to meet near-term demands. It is expected that long-term demands will be satisfied by Triodide.\n(c)(1)(iv) EFFECT OF PATENTS, TRADEMARKS, LICENSES, ETC.\nRegistrant owns numerous United States and foreign patents expiring at various dates to 2011. Registrant also owns a number of trademarks. Although, in the opinion of the Registrant, these patents and trademarks have been and are expected to be of value, the loss of any single such item or group of related items would not have a material effect on the conduct of the existing business. However, the granting of patents applied for concerning Solium technology could have a significant positive impact on the future growth rate of the Company.\n(c)(1)(v)&(vi) SEASONAL AND WORKING CAPITAL REQUIREMENTS\nNot applicable.\n(c)(1)(vii) MAJOR CUSTOMERS\nFor the fiscal year ended December 30, 1994, approximately 16% of Registrant's sales were attributable to United States defense contracts, of which 3% were awarded directly by the United States government and 13% through subcontracting procedures. Virtually all defense programs are subject to curtailment or cancellation due to the annual nature of the government appropriations and allocations process. A material reduction in United States government appropriations for defense programs may have an adverse effect on the Registrant's business, depending on the specific defense programs affected by any such reduction. Currently, the Registrant is not aware of the curtailment or cancellation of any United States defense program, under which Registrant is performing as either a prime contractor or subcontractor, that would have a material adverse effect on the Registrant's business. Government contracts are subject to termination by the government without cause, but in the event of such termination, Registrant would ordinarily be entitled to reasonable compensation for work completed prior to termination.\nAdditional information regarding sales to military customers is included in Note 9 on Page 36 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\n(c)(1)(viii) BACKLOG\nRegistrant's backlog of unfilled purchase orders, believed by Registrant to be firm, amounted to $83,555,000 on December 30, 1994, compared with a backlog of $91,774,000 and $77,740,000 at fiscal year-end 1993 and 1992, respectively. Registrant considers an unfilled purchase order to be firm when a specific delivery date has been established by the parties. Of the backlog, approximately 80% is expected to be shipped in the current fiscal year. Additional information concerning backlog is included in Management's Discussion and Analysis on Page 20 of the Annual Report and is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\n(c)(1)(ix) GOVERNMENT CONTRACTS\nThe Company's net sales under prime contracts to defense agencies of the U.S. Government were $8,096,000 in fiscal 1994, $9,471,000 in fiscal 1993 and $12,367,000 in fiscal 1992. Further information with regard to government contracts is contained in section (c)(1)(vii) above.\n(c)(1)(x) COMPETITION\nA number of companies, some of which are significantly larger than Registrant, manufacture products which compete directly with those Registrant produces. No single company competes with Registrant across its entire product line. The Registrant's competitive strategy is to achieve cost and quality advantages, offer excellent customer service, and broaden the markets in which its core competence can be applied. Competition by major product line is as follows:\nELECTRICAL EQUIPMENT\nElectric Motors and Generators\nThe Registrant's five industrial and commercial motor lines are primarily sold for industrial applications with some motors being used in consumer products. The market for permanent magnet brush-type DC motors is extremely fragmented and none of the three main domestic competitors, Baldor Electric Co., Magnetek, Inc. and Leeson Electric Corporation, has a dominant market share. The emerging market for brushless DC servo motors, drives and controls has many competitors vying for market share in industrial markets, although Registrant believes it has the highest share of the U.S. market (excluding the machine tool area, in which it does not compete). Major competitors in the brushless DC motor market area include Reliance Electric Co., Kollmorgen Corporation and Yasakawa Electric America, Inc. The Registrant knows of no competitor that offers a product similar to its Powertec line of high-horsepower variable-speed brushless DC motors and drives. In stepper drives and motors, there are many competitors, with the three largest being Superior Electric Co., a division of Dana Corporation, Oriental Motors USA Corporation and Compumotor, a division of Parker-Hannifin Corporation. The Registrant has a major share of the market for low inertia motors used in applications requiring very fast starting and stopping. The generator product line, for use mainly in aircraft and missiles, has several significant domestic competitors making air cooled generators with output of up to 50kw.\nMotion Controls\nMotion technology products (control products and drives) are mainly sold in conjunction with Registrant's brushless servo and stepper motor products and they, therefore, have similar competitors. The major competitor in multi-axis system control is Allen-Bradley Company, Inc., a subsidiary of Rockwell International Corporation.\nProducts for Electrical Utilities\nThe Registrant and at least four major competitors account for virtually all of the United States market for outdoor lighting controls. However, Registrant has a major share of the United States market for controls used in street and highway lighting. A major share of the market for capacitor controls is also held by the Registrant. Lesser shares are held in the markets for fault indicators and the Registrant's line of metering devices. No single competitor has a product line offering similar to Registrant's.\nParticle Monitoring Instruments\nIn particle monitoring, Registrant has a leading market position for sensing particulate contamination in liquid, air and vacuum environments. There are at least six direct global competitors for particle monitoring. Among the major competitors are PMS, Inc. and Met One, Inc. Registrant is the only supplier of the Optical Production Profiler, a non-destructive quality assurance system that images defects within silicon wafers.\nSolium Ballast\nThe Registrant has applied for a patent on its Solium dimming technology (a two-wire system) and, therefore, there are no competitors with this specific technology. Using other technology, (generally, a four-wire system) there are manufacturers of dimming ballast for conventional fluorescent lighting, including Motorola, Inc. and Advanced Transformer Co., a subsidiary of Philips Electronics N.V. and Lutron Electronics Co., Inc. In addition to the dimming capability, the Solium technology offers other important advantages, on which the Registrant has applied for patents. The Registrant has also applied for a patent on the integral dimming of screw-in compact fluorescent lamps.\nSAFETY EQUIPMENT\nFire Detection, Suppression and Restraints\nRegistrant has a leading position in the aircraft market for its aircraft fire suppression product line. There is one significant domestic competitor in the fire suppression product line, Walter Kidde, Inc., with three other competitors sharing a smaller portion of the market. There are at least five other competitors for fire detection equipment sold to the aerospace and military vehicle markets with the leader being Santa Barbara Research, a division of Hughes Aircraft Co. Registrant's ballistic and inertia reels, which are used mainly in aircraft for the safety restraint of the crews, has, at minimum, two major competitors in the United States and two in Europe. However, Registrant has maintained a significant share of this market. For passenger lap belts, the Registrant's major competitor is Am-Safe Inc. There are two principal competitors for the cable tension regulator, the Registrant's principal flight control component.\nPyrotechnics\nThe pyrotechnic product line addresses multiple niches within the domestic aerospace and commercial oil well marketplace, and the Registrant has at least two competitors in each segment. Among its largest competitors are OEA, Inc. and Special Devices, Inc.\n(c)(1)(xi) RESEARCH AND DEVELOPMENT\nResearch and development is conducted by the Registrant at its various United States divisions for its own account and at some locations for customers on a contract basis. For its own account, Registrant spent $10,521,000, $8,584,000 and $8,235,000 in 1994, 1993 and 1992, respectively. Additional information regarding Research and Development is included in Management's Discussion and Analysis - Research and development expense beginning on Page 21 of the Annual Report and incorporated herein by reference in accordance with Rule 12b-23.\n(c)(1)(xii) ENVIRONMENTAL COMPLIANCE\nIn the opinion of Registrant, compliance with existing federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will not have a material effect on the capital expenditures, earnings or competitive position of Registrant and its subsidiaries. The Company is continuing environmental remediation at one of its former plant sites and has been designated as a potentially responsible party, along with other companies, for certain waste disposal sites. The Company establishes reserves for such costs which are probable and reasonably estimable and believes that any possible liability incurred will not have a material adverse effect on the financial position of the Company.\n(c)(1)(xiii) EMPLOYEES\nRegistrant and its subsidiaries employ 1,848 persons as of December 30, 1994.\n(d)(1) EXPORT SALES\nExport sales by United States operations to customers in foreign countries represented approximately 21% ($49,321,000) in 1994, 18% ($34,483,000) in 1993 and 17% ($29,317,000) in 1992 of Registrant's sales. Starting in 1994, the Registrant manufactured outdoor lighting controls in England for the local market and did some manufacturing in Mexico for shipment to the U.S.\n(d)(1)(i)&(ii) RESTATEMENTS\nNot applicable.\n(d)(2) RISK TO FOREIGN OPERATIONS\nIn the opinion of Registrant, there is no significant risk attendant to its foreign operations or any dependence of its industry segments on its foreign operations.\n(d)(3) INTERIM FINANCIAL STATEMENTS\nNot applicable.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nRegistrant's properties are summarized in the following table:\nManagement believes all manufacturing facilities and manufacturing equipment are adequate, with minor changes and additions, for conducting operations as presently contemplated, except for the manufacturing equipment necessary for the new Solium product discussed at 1(c)(1)(ii) above. To the extent the above referenced leases expire and are not renewed, Registrant believes it has the ability to acquire adequate space for conducting its operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material legal, administrative or judicial proceedings to which the Registrant 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 matter was submitted to a vote of security holders during the fourth quarter of 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe text and tabular presentations appearing under the captions \"Dividend and Quarterly Information\" beginning on Page 36 of the Annual Report are incorporated herein by reference in accordance with the provisions of Rule 12b-23. At the end of fiscal 1994, there were 1,630 stockholders of record. The total number of beneficial holders of Registrant's common stock is estimated at approximately 4,500. Registrant's common stock is traded on the New York, Midwest and Pacific Stock Exchanges.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe material appearing under the caption \"Five Year Financial Summary\" on Page 19 of the Annual Report is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe text under the caption \"Management's Discussion and Analysis\" appearing on Pages 20 through 24 of the Annual Report is incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated Financial Statements for the fiscal years ended December 30, 1994, December 31, 1993 and December 25, 1992 appearing on Pages 25 through 28; the Independent Auditors' Report appearing on Page 24; and Management's Report appearing on Page 18 of the Annual Report are incorporated herein by reference in accordance with the provisions of Rule 12b-23.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nThe Registrant has not had disagreements with, nor has the Registrant changed, independent accountants during the past two years.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation regarding the Company's directors and all persons nominated or chosen to become directors, as well as information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934 (the \"Exchange Act\") by the directors, officers and beneficial owners of more than 10% of any class of equity securities of the Registrant, is incorporated by reference from Registrant's definitive proxy statement to be filed by Registrant with the Commission pursuant to Regulation 14A of the Exchange Act no later than 120 days after the end of Registrant's fiscal year ended December 30, 1994.\nInformation regarding the Company's executive officers appears below:\nNo executive officer of the Registrant is related to any other executive officer of the Registrant. All executive officers of the Registrant serve at the discretion of the Board of Directors. No understanding or arrangement exists between any executive officer and any other person pursuant to which he was chosen as an officer.\nMr. Brower was elected Chairman of the Board of Directors of the Registrant in 1990. He was hired as President and Chief Operating Officer in 1985 and was named Chief Executive Officer later that year.\nMr. Plat was hired as Vice President of Finance and Administration and Secretary in 1977 and was promoted to Senior Vice President in 1983 and Executive Vice President in 1994.\nMr. Breitzka joined Pacific Scientific Company in 1982. He was promoted in 1992 to Corporate Vice President and President of the HTL\/Kin-Tech Division and, in 1994, he was appointed President of the Fisher Pierce Division.\nMr. Day was promoted in 1993 to Corporate Vice President and President of the newly formed Energy Dynamics Division. Previously, Mr. Day was General Manager of the Company's Energy Systems Division. With the acquisition of Unidynamics\/Phoenix, Inc. and its subsequent merger into the Energy Systems product lines, the Energy Dynamics Division was formed. Mr. Day has held various management positions within Pacific Scientific Company since 1981.\nMr. Fejes was promoted in 1994 to Corporate Vice President and President of the newly formed Motion Technology Division. He has held various management positions with the Company since 1981, except for a brief period in 1985 when he was Product Development Manager for EG&G Torque Systems.\nMr. Knoblock joined the Company in 1988 as President of the Electro-Kinetics Division and promoted in 1989 to Corporate Vice President. In 1994, Mr. Knoblock was appointed President of the HTL\/Kin-Tech Division and will also continue as President of the Electro-Kinetics Division.\nDr. Monkowski was hired in 1994 as Corporate Vice President and President of the Instruments Division. From 1985 to 1994, he was associated with Photon Dynamics, Inc., Lam Research Corporation, Monkowski-Rhine Inc. and Schumacher Company. In these companies, he held various management positions including Division President, Executive Vice President, Chief Technical Officer and Vice President of Research and Development.\nMr. Nelson was hired in 1990 as Corporate Vice President and President of the Motor & Control Division. He was General Manager of the Motor Division of Barber Colman Co. from 1982 to 1990.\nMr. Ossenmacher joined the Company in 1992 as Product Line Director for the HTL\/Kin-Tech Division. In 1993, he was promoted to Corporate Vice President and President of the Fisher Pierce Division. In 1994, Mr. Ossenmacher was named President of the newly established subsidiary, Solium Inc. Previously, he was with Parker-Hannifin Corporation where he held various management positions since 1981.\nMr. Nothwang was hired as Corporate Controller in 1978 and later appointed Assistant Secretary.\nMr. Swan was hired in 1977 as Assistant Treasurer and promoted to Treasurer in 1982.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information with respect to executive compensation is incorporated by reference from Registrant's definitive proxy statement to be filed by Registrant with the Commission pursuant to Regulation 14A no later than 120 days after the end of Registrant's fiscal year ended December 30, 1994.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information with respect to security ownership of certain beneficial owners and management is incorporated by reference from Registrant's definitive proxy statement to be filed by Registrant with the Commission pursuant to Regulation 14A no later than 120 days after the end of Registrant's fiscal year ended December 30, 1994.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Registrant and its subsidiaries have not had any transaction or series of similar transactions nor is there any currently proposed transaction or series of transactions that would exceed $60,000 and in which any director, executive officer, security holder of more than 5% of the Company's voting securities or the immediate family of any of the foregoing persons, would have a direct or indirect material interest as defined by Item 404(a) of Regulation S-K.\nThere have been no business relationships, as defined by Item 404(b) of Regulation S-K, with regard to any of the Registrant's directors or nominees for director.\nNo director, executive officer or nominee for election as director nor any member of their immediate family has been indebted to the Registrant or its subsidiaries at any time during the fiscal year ended December 30, 1994 in an amount in excess of $60,000, as defined by Item 404(c) of Regulation S-K.\nItem 404(d) of Regulation S-K does not apply to the Registrant.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(a) 1 List of Documents filed as a part of the Report:\nFinancial Statements:\nConsolidated Financial Statements for the fiscal years ended December 30, 1994, December 31, 1993 and December 25, 1992 appearing on Pages 25 through 28; the Independent Auditors' Report appearing on Page 24 and Management's Report appearing on Page 18 of the Annual Report are incorporated herein by reference in accordance with the provisions of Rule 12b-23. With the exception of the pages referred to in the preceding sentence and other information specifically incorporated by reference in this Form 10-K, the Annual Report is not to be deemed filed as part of this report.\n(a) 2 Included in 14(a)1 above.\n(a) 3 Exhibits\n3.1 Restated Articles of Incorporation, as amended (6)\n3.2 Bylaws, as amended (5)\n4.0 Indenture, dated as of April 25, 1983, for Registrant's 7-3\/4% Convertible Subordinated Debentures, due 2003, incorporated by reference to Form S-3 (Registration Statement No. 2-82947) filed April 8, 1983.\n4.1 Indenture, dated as of October 1, 1989, for Registrant's California Statewide Communities Development Authority Industrial Development Revenue Bonds, due 2019. (6)\n10.1 Lease on facilities at 2642 Eje Juan Gabriel St., Ciudad Juarez, Chihuahua, Mexico.\n10.2 Lease on facilities at 41 Pacella Park Dr., Randolph, Massachusetts.\n10.3 Judgement of Foreclosure and Order of Sale of property at 1350 South State College Blvd., Anaheim, California.\n10.4 Registrant's 1992 Key Employee Stock Option Plan. (8)\n10.5 Directors' Retirement Plan. (4)\n10.6 First Amendment to Directors' Retirement Plan, dated December 8, 1994.\n10.7 Severance Agreement by and between Registrant and Edgar S. Brower, effective December 27, 1985. (2)\n10.8 Severance Agreement by and between Registrant and Richard V. Plat, effective May 24, 1983. (1)\n10.9 Restricted Stock Agreement by and between Registrant and Edgar S. Brower, effective April 23, 1986. (3)\n10.10 Registrant's Shareholders Protection Agreement. (9)\n10.11 Amendment to Registrant's Shareholders Protection Agreement dated August 22, 1990. (7)\n10.12 Agreement for the acquisition of certain assets of Royce Thompson Electric Limited, pursuant to an asset purchase agreement dated April 29, 1994.\n10.13 Agreement for the acquisition of certain assets of Eduard Bautz GmbH, pursuant to an asset purchase agreement dated December 31, 1994.\n12.1 Statement regarding computation of ratios. The current and long-term debt-to-capitalization ratios appearing in \"Management's Discussion and Analysis\" incorporated by reference in Items 1(b) and (c)(1)(i) and the \"Five Year Financial Summary\", incorporated by reference in Item 6 of this Form 10-K are calculated as follows:\nTotal Current Assets Current Ratio -------------------- Total Current Liabilities\nLong-Term Debt Long-Term Debt to -------------- Capitalization Long-Term Debt + Total Stockholders' Equity\n13.0 Annual Report to Stockholders for the fiscal year ended December 30, 1994 (parts not incorporated by reference are furnished for information purposes only and are not filed herewith).\n21.0 Subsidiaries of the Registrant, incorporated by reference to \"Divisions and Subsidiaries\" appearing on Page 38 of the Annual Report.\n23.0 Independent Auditors' Consent\n27.0 Financial Data Schedule\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by Registrant during the fourth quarter of the fiscal year ended December 30, 1994.\n(c) Included in 14(a) 3 above.\n(d) Included in 14(a) 2 above.\n_________________________________________ (1) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 28, 1984.\n(2) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 26, 1986.\n(3) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 24, 1987.\n(4) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 24, 1988.\n(5) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 30, 1989.\n(6) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 28, 1990.\n(7) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 28, 1991.\n(8) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 19, 1993.\n(9) Incorporated by reference to Registrant's Form 8-K filed November 22, 1988.\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 SCIENTIFIC COMPANY\nMarch 17, 1995 By \/s\/ Richard V. Plat ----------------------------------- Richard V. Plat Executive Vice President 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.\nINDEX TO EXHIBITS\n3.1 Restated Articles of Incorporation, as amended (6)\n3.2 Bylaws, as amended (5)\n4.0 Indenture, dated as of April 25, 1983, for Registrant's 7-3\/4% Convertible Subordinated Debentures, due 2003, incorporated by reference to Form S-3 (Registration Statement No. 2-82947) filed April 8, 1983.\n4.1 Indenture, dated as of October 1, 1989, for Registrant's California Statewide Communities Development Authority Industrial Development Revenue Bonds, due 2019. (6)\n10.1 Lease on facilities at 2642 Eje Juan Gabriel St., Ciudad Juarez, Chihuahua, Mexico.\n10.2 Lease on facilities at 41 Pacella Park Dr., Randolph, Massachusetts.\n10.3 Judgement of Foreclosure and Order of Sale of property at 1350 South State College Blvd., Anaheim, California.\n10.4 Registrant's 1992 Key Employee Stock Option Plan. (8)\n10.5 Directors' Retirement Plan. (4)\n10.6 First Amendment to Directors' Retirement Plan, dated December 8, 1994.\n10.7 Severance Agreement by and between Registrant and Edgar S. Brower, effective December 27, 1985. (2)\n10.8 Severance Agreement by and between Registrant and Richard V. Plat, effective May 24, 1983. (1)\n10.9 Restricted Stock Agreement by and between Registrant and Edgar S. Brower, effective April 23, 1986. (3)\n10.10 Registrant's Shareholders Protection Agreement. (9)\n10.11 Amendment to Registrant's Shareholders Protection Agreement dated August 22, 1990. (7)\n10.12 Agreement for the acquisition of certain assets of Royce Thompson Electric Limited, pursuant to an asset purchase agreement dated April 29, 1994.\n10.13 Agreement for the acquisition of certain assets of Eduard Bautz GmbH, pursuant to an asset purchase agreement dated December 31, 1994.\n13.0 Annual Report to Stockholders for the fiscal year ended December 31, 1993 (parts not incorporated by reference are furnished for information purposes only and are not filed herewith).\n21.0 Subsidiaries of the Registrant, incorporated by reference to \"Divisions and Subsidiaries\" appearing on Page 38 of Registrant's 1994 Annual Report to Stockholders.\n23.0 Independent Auditors' Consent\n27.0 Financial Data Schedule\n_________________________________________________________________\n(1) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 28, 1984.\n(2) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 26, 1986.\n(3) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 24, 1987.\n(4) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 24, 1988.\n(5) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 30, 1989.\n(6) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 28, 1990.\n(7) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 28, 1991.\n(8) Incorporated by reference to Registrant's Annual Report on Form 10-K filed March 19, 1993.\n(9) Incorporated by reference to Registrant's Form 8-K filed November 22, 1988.","section_15":""}
{"filename":"79849_1994.txt","cik":"79849","year":"1994","section_1":"Item 1. Business\nGENERAL\nGetty Petroleum Corp. (hereinafter, together with its subsidiaries, called the \"Registrant\", \"Getty\" or the \"Company\") is one of the nation's largest independent marketers of petroleum products. The Company serves retail and wholesale customers through a distribution and marketing network of 1,865 Getty and other branded retail outlets (also referred to as service stations) of which 652 have convenience food stores located in 13 Northeastern and Middle Atlantic states. The Company stores and distributes petroleum products from 26 distribution terminals and bulk plants. The Company purchases gasoline, fuel oil and related petroleum products from Phibro Energy USA, Inc. pursuant to a three-year supply contract expiring on June 30, 1995, and from other suppliers. These products are delivered by cargo ship, barge, pipeline and truck to the Company's distribution terminals and bulk plants located in the Company's marketing region. Through its truck transportation fleet of 145 vehicles and its distribution network, the Company markets and distributes such products throughout its 13 state marketing region. Of the 1,865 retail outlets supplied by the Company at January 31, 1994, over half are owned by the Company in fee or held under long-term leases. The remaining retail outlets purchase petroleum products from the Company under contract as licensed Getty dealers or from licensed Getty distributors who purchase Getty products from the Company. The Company also sells on a wholesale basis gasoline, fuel oil, diesel fuel and kerosene from distribution terminals and bulk plants in truckload, barge and pipeline quantities and sells fuel oil, kerosene and propane to residential, commercial and governmental customers in Maryland, Pennsylvania and upstate New York.\nThe Company and its predecessors have been in the petroleum marketing business for over 39 years. Mr. Leo Liebowitz, a director, President and Chief Executive Officer of the Company, and Mr. Milton Safenowitz, a director and former Executive Vice President of the Company, founded the business in 1955 with one service station and have pursued a strategy of expanding the business principally through acquisitions. Prior to 1985, the Company had expanded into five states under various brand names, principally Power Test. On February 1, 1985, the Company acquired the marketing and distribution assets of Getty Oil Company in the Northeastern and Middle Atlantic states from a subsidiary of Texaco Inc. The Getty acquisition added service stations, distribution terminals and a heating oil and middle distillate marketing network in six additional states. Since 1985, the Company's operations have continued to expand, to its current marketing region in 13 Northeastern and Middle Atlantic states.\nDuring the period from 1985 to 1991, the Company continued to expand by acquiring numerous small regional distributors, stations and convenience food stores. In addition to adding locations through fee ownership and leasing, the Company continued to implement its program of adding non- petroleum products and revenue enhancing services at retail outlets in its\nmarketing network, particularly convenience food stores, automotive repairs and car washes. In 1992, the Company implemented a comprehensive program of evaluating retail outlets to determine the long-term viability of certain locations as gasoline stations. This process has resulted in the sale or lease of 64 properties in fiscal 1994 and is expected to result in the disposal of additional locations in the future.\nOPERATING STRATEGY\nThe Company's operating strategy is to market motor fuels through service stations which are operated by independent Getty licensed dealers who lease or sublease the Company's service stations. Such dealers either buy their petroleum products from the Company or from licensed Getty distributors who purchase Getty products from the Company, or sell the Company's petroleum products and receive a commission. The Company views each of its retail outlets as a \"profit center\" and believes that independent operators, with greater financial incentive than salaried employees, generally operate retail outlets more successfully. Moreover, the leasing and subleasing of retail outlets to independent operators has provided the Company with a stable and increasing source of rental income and has enabled the Company to reduce its direct operating costs.\nThe Company directly operated 21 retail outlets at January 31, 1994 utilizing salaried employees. While the Company seeks to lease or sublease retail outlets to independent operators, it intends to retain a certain number of such company operated outlets. These outlets permit management to keep abreast of changes in retail marketing, to assist in providing practical guidance to independent dealers and to test new products and concepts.\nCertain of the owned and leased outlets have convenience food stores, automotive repair centers and car washes. Getty receives higher rentals from such properties as a result of such additional uses of the properties.\nDISTRIBUTION\nThe retail outlets in the Company's marketing network sell gasoline, diesel fuel and other related petroleum products (such as motor oil and lubricants) under the Company's proprietary brand name Getty or, to a limited extent, under other brand names, in the states of Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island, Vermont, Virginia and West Virginia.\nAs of January 31, 1994, the Company has 1,865 Getty and other branded retail outlets as follows:\n(i) 21 company operated retail outlets which are operated by salaried employees;\n(ii) 449 lessee dealer operated retail outlets (dealers who lease or sublease retail outlets and purchase their petroleum products from the Company);\n(iii) 469 commission lessee dealer operated retail outlets (dealers who lease or sublease retail outlets and receive a commission for sale of Company owned petroleum products);\n(iv) 141 retail outlets operated by management contractors (dealers who operate the Company's retail outlets pursuant to a management contract);\n(v) 206 contract dealer retail outlets (dealers who purchase their petroleum products from the Company but do not lease or sublease retail outlets from the Company); and\n(vi) 48 distributors who purchase their petroleum products from the Company, which distributors in turn supply the petroleum product requirements of 579 retail outlets.\nAs of January 31, 1994, the Company also has 36 non-operating properties being held for disposition and 105 locations in various stages of change.\nGetty distributes its petroleum products from 26 distribution terminals and bulk plants which are Company controlled either through fee ownership or long-term leases and utilizes additional terminals pursuant to thruput and storage agreements with unrelated parties. A substantial portion of the petroleum products are transported to retail outlets by the Company's truck transportation fleet, whose drivers are compensated in part on an incentive-based system.\nThe Company is a supplier of #2 heating oil (also known as home heating oil) in the Northeast, supplying fuel oil to dealers who deliver to residences and commercial accounts. Diesel fuel and kerosene are marketed both to distributors of such products and directly by the Company to retail outlets. In addition, the Company sells home heating oil, propane (LPG) and related services directly to approximately 47,500 retail and commercial customers.\nPRODUCT SUPPLY\nEffective July 1, 1992, the Company entered into a three-year supply contract to purchase gasoline and middle distillates from Phibro Energy USA, Inc. (\"Phibro\") at competitive spot related prices. During the year ended January 31, 1994, the Company purchased approximately 60% of its petroleum product requirements from Phibro and approximately 40% from other sources, principally domestic. Substantially all of the Company's supply contracts are for a term of one year or less except for the contract with Phibro which expires June 30, 1995. The Company has no crude oil reserves or refining capacity. Historically, petroleum prices have been subject to extreme volatility and there have been periodic shortages followed by periods of oversupply. No assurance can be given that petroleum prices will not fluctuate greatly or that petroleum products will continue to be available from multiple sources or available at all in times of shortage. Further, a large, rapid increase in petroleum prices could adversely affect the Company's revenues and profitability if the Company's sales prices could not be increased or automobile consumption of gasoline were to decline as a result of such price increases. The Company's management believes, however, that the structure of the supply contract with Phibro reduces to a certain extent the impact of product price volatility due to lower inventory requirements, and, due to the large volume of its purchases, it will continue to have the ability to acquire petroleum products on competitive terms for the foreseeable future.\nMARKETING\nIn order to provide efficient service to retail dealers and other customers, the Company is divided into various marketing regions. The Company's regional marketing personnel provide significant guidance, counseling and assistance to the Company's dealers, including advice on retail operations. The marketing personnel also supervise the company operated retail outlets.\nThe Company provides advertising and promotional support to its retail outlets. Both radio and newspaper media are utilized, and promotional programs are implemented on an ongoing basis.\nThe Company accepts Visa, MasterCard, Discover and American Express credit cards at Getty outlets and plans in the near future to accept debit cards. In addition, the Company has a proprietary fleet fueling card and a related tracking program which provides cost control data to its fleet customers.\nCOMPETITION\nThe Company believes that, based on the number of locations served, it is currently one of the largest independent marketers of petroleum products in the United States. The petroleum products industry is highly competitive, and the Company competes with a substantial number of integrated oil companies and other companies who may have greater assets, financial resources and sales. Accordingly, the Company's earnings may be adversely affected by the marketing policies of such integrated oil companies, which may have greater flexibility to withstand price changes than the Company because of such integration. The Company competes for new dealers and distributors primarily on the basis of Getty brand acceptance, supply, price and marketing support. The retail outlets in the Company's marketing network compete primarily on the basis of Getty brand acceptance, location, customer service, appearance of the retail outlet and price.\nREGULATION\nThe petroleum products industry is subject to numerous federal, state and local laws and regulations. Compliance with those laws and regulations has not had and is not expected to have a material effect on the competitive position of the Company.\nThe Company is not a refiner and, therefore, is not subject to the Petroleum Marketing Practices Act (\"PMPA\"), a federal law. However, pursuant to the Company's agreements with its Getty dealers and distributors, the Company has voluntarily extended to them the protection of PMPA. Under PMPA, the Company complies with certain notice requirements and extends nondiscriminatory contracts to its Getty licensed dealers and distributors, whose franchises can be terminated or not renewed if certain PMPA-imposed requirements are met. Although a licensed dealer or distributor is not required to renew his or her franchise, because the Company has agreed to comply with PMPA the Company is required (unless there are grounds for non-renewal or termination) to renew the franchises of most of its licensed dealers and distributors who elect to renew. In addition, if the Company elects to sell any of its service stations, the Company shall, in accordance with PMPA, offer the franchisee the right to purchase any of such service stations operated by such franchisee at the price and upon terms at which the Company elects to sell.\nIn addition, the Company's operations are governed by numerous federal, state and local environmental laws and regulations affecting all aspects of its operations. Among these laws are (i) requirements to dispense reformulated gasoline in accordance with the Clean Air Act, (ii) restrictions imposed on the amount of hydrocarbon vapors which may enter the air at the Company's terminals and service stations, (iii) OSHA and other laws regulating terminal employee exposure to benzene and other hazardous materials, (iv) requirements to report to governmental authorities discharges of petroleum products into the environment and, under certain circumstances, to remediate the soil and\/or groundwater contamination pursuant to governmental order and directive, (v) requirements to remove and replace underground storage tanks which have exceeded governmental-mandated age limitations and (vi) the requirement to provide a certificate of financial responsibility with respect to claims relating to underground storage tank failures.\nThe Company believes that it is in substantial compliance with federal, state and local provisions enacted or adopted regulating the discharge of materials harmful to the environment. Although the Company is unable to predict what legislation or regulations may be adopted in the future with respect to environmental protection and waste disposal, existing legislation and regulations have had no material adverse effect on its competitive position. See \"Item 3. Legal Proceedings\".\nPERSONNEL\nAs of January 31, 1994, the Company had 877 employees, of which 105 employees, consisting of truck drivers and service technicians, are represented by Amalgamated Local Union 355. The Company considers its relationships with its employees and the union to be satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nAs of January 31, 1994, the Company owned in fee 457 retail outlets and leased 786 retail outlets, substantially all of which are leased on a long-term net lease basis. The Company, in turn, has leased or subleased 1,128 of such properties to others, substantially all of which are operated as Getty branded service stations.\nThe Company generally extends three-year lease terms to its dealers, except for new dealers, who generally receive a one year trial lease. Such leases provide for fixed and variable rentals at competitive rates. In addition, most leases provide for an additional rental if the dealer fails to sell certain minimum quantities of gasoline during a month. The lessee of a retail outlet is generally responsible for payment of utilities and for all maintenance and repairs, except for structural and marketing equipment repairs and capital improvements, which are performed by the Company.\nThe retail outlets owned in fee or leased by the Company for each of the five fiscal years ended January 31, 1994 are as follows:\nJanuary 31, ------------------------------- 1994 1993 1992 1991 1990 ---- ---- ---- ---- ---- Owned 457 465 463 436 453\nLeased 772 791 825 796 729 ----- ----- ----- ----- ----- Total 1,229 1,256 1,288 1,232 1,182 ====== ===== ===== ===== =====\nThe Company has an upgrading program to enhance the physical appearance of the Company's retail outlets which it expects to complete in fiscal 1995.\nAs of January 31, 1994, the Company also owned in fee 13 distribution terminals and bulk plants and leased 13 distribution terminals and bulk plants (on a long-term net lease basis) located in New York, New Jersey, Maine, Rhode Island, Pennsylvania, Connecticut and Maryland. The terminals and bulk plants owned or leased by the Company have an aggregate storage capacity of approximately 80 million gallons. The terminals located in East Providence (Rhode Island), Rensselaer (New York) and South Portland (Maine) are deep-water terminals, capable of handling large vessels. Some of the Company's terminals have excess capacity and land that could be developed or adapted to handle products, such as residual fuel, jet fuel and lube blending, which the Company does not presently market.\nThe Company leases 309 service stations and 6 distribution terminals on a long-term basis from Power Test Realty Company Limited Partnership (the \"Partnership\"). The sole limited partner of the Partnership is Power Test Investors Limited Partnership (\"PTILP\"), which was created in 1985 pursuant to a rights offering to all of the Company's then existing stockholders. The general partner of the Partnership and PTILP is CLS General Partnership Corp. (\"CLS\"), which manages the Partnership and PTILP. CLS is wholly owned by Messrs. Leo Liebowitz, Milton Safenowitz and Milton Cooper, the principal stockholders of the Company, who as of January 31, 1994, collectively owned 46% of PTILP. The Company does not have any ownership interest in the Partnership or CLS, and does not have any ownership interest or option to purchase the Partnership's property and equipment, except for properties that the Company has determined have become uneconomical or unsuitable for the Company's use. In the event the Company makes such a determination, it must either (i) purchase the property from the Partnership for a sum equal to the greater of (x) the product of the annual rent then in effect multiplied by eleven or (y) 110% of the appraised fair market value of the property considered as encumbered by the lease or (ii) direct the Partnership to sell such property to a third party at a price negotiated by the Company, in which case the Company receives from the Partnership the amount, if any, by which the negotiated price exceeds the price determined by the above formula or pays any deficiency to the Partnership. Each of the leases of the service stations and the distribution terminals with the Partnership has an initial term of 15 years, expiring on January 31, 2000. The Company has the option to extend these leases for up to five consecutive terms of ten years each. During the fiscal years ended January 31, 1994, 1993 and 1992, the Company received from the Partnership $600,000, $576,000 and $552,000, respectively, for administrative and other services rendered to the Partnership and paid rent to the Partnership during such fiscal years of $10,981,000, $11,002,000 and $11,051,000, respectively.\nThe Company leases approximately 41,000 square feet of office space at 125 Jericho Turnpike, Jericho, New York where it currently maintains its corporate headquarters. The Company owns a 23,000 square foot building located at 175 Sunnyside Boulevard, Plainview, New York, where until June 1987 it maintained its corporate headquarters and which it is attempting to sell. Slattery Group Inc., a majority-owned subsidiary of the Company, owns certain properties, which it is attempting to sell, consisting principally of a nine story office building in Easton, Pennsylvania, and vacant land in Alabama and Ohio.\nThe Company believes that substantially all of its owned and leased properties are in good condition.\nItem 3.","section_3":"Item 3. Legal Proceedings\n(a) Information in response to this item is incorporated herein by reference from Note 5 of the Notes to Consolidated Financial Statements set forth on pages 26 and 27 of the Annual Report.\nThe State of New York has brought separate actions against the Company for alleged underground discharges of petroleum products at certain of its service stations. The actions, which were filed in 1983 and 1986, are pending in New York State Supreme Court in Albany County. In each case, the State is seeking reimbursement for clean up costs, interest and penalties for the alleged discharges. Most of any possible compensatory damages relating to clean up activities and any reimbursement to the State arising out of these two cases are covered by liability insurance.\nIn 1990, the State of New York brought an action in the New York State Supreme Court in Albany County seeking reimbursement for clean up costs against the Company and two other petroleum companies arising from an alleged 1984 spill of gasoline. In addition to clean up costs of $167,000, the State is seeking penalties of $500,000 and interest. The State has agreed to dismiss the Company from the lawsuit but a co-defendant has withheld consent.\nIn 1991, the State of New York brought an action in the New York State Supreme Court in Albany County against a subsidiary of the Company seeking reimbursement in the amount of $189,000 for clean up costs incurred at a service station. The State is also seeking penalties of $200,000 and interest.\nIn 1992, the State of New York asserted a claim for reimbursement of clean up costs against the Company and another oil company, in the amount of $121,000, together with statutory penalties of $100,000, pertaining to an alleged spill at a service station in 1984; no further communications have been received.\nOn October 22, 1993, the State of New York asserted a claim against the Company for $453,868 for cleanup costs incurred at a service station and for $68,000 for statutory penalties; no further communications have been received.\nA majority-owned subsidiary of the Company has been named as a Potentially Responsible Party at a Superfund site in Connecticut; the subsidiary is considered to be a \"de minimus\" discharger and the maximum payment required will be approximately $5,000.\nIn 1992, the U. S. Environmental Protection Agency (\"EPA\") advised the Company that it would seek administrative penalties for the Company's failure to cease discharging into, and to close, service station bay drains at approximately 270 retail outlets. The EPA is seeking penalties of approximately $625,000. The Company has had no communications with the EPA during the past fiscal year concerning this matter.\nIn 1990, Getty Terminals Corp. (\"Getty Terminals\"), a subsidiary of the Company, was convicted of conspiracy and evasion of 1985 federal gasoline taxes. The Company provided for the costs associated with this matter in its financial statements for the year ended January 31, 1991 and all taxes, penalties and interest have been paid. As a result of the conviction, the Company and one of its subsidiaries, which have not heretofore bid on U.S. Government contracts, have been precluded from doing so until November 20, 1994. In February 1994, Getty Terminals received notices of proposed license revocations from the New York State Department of Taxation and Finance (\"Department\") for Getty Terminals' operating permits for its three New York State terminals and its motor fuels and diesel distributor licenses. The notices of proposed revocation are based on Getty Terminals' 1990 federal conviction for conspiracy to evade 1985 federal gasoline excise taxes and for non-payment of such taxes. The Department contends that Getty Terminals' federal tax conviction affects its \"duties and obligations\" under Sections 283 and 283-b of the New York Tax Law (\"Tax Law\"). Getty paid all New York State taxes which were due and owing and has fully performed all of its duties and obligations under the Tax Law. Management of the Company believes that the Department does not have cause to revoke Getty Terminals' New York State licenses; therefore, management believes that this matter will have no material adverse effect on the Company's financial position or future business.\nDuring the past fiscal year, the following three proceedings were settled:\nIn 1990, the Commissioner of Environmental Protection of Connecticut filed an action against the Company in the Hartford Superior Court alleging violations at several service station facilities. The matter has been settled and a penalty of $219,500 has been paid.\nIn 1991, the State of New York brought an action in the New York State Supreme Court in Albany County seeking reimbursement for $15,000 for cleanup costs. During the past fiscal year the amount sought was increased to $72,000 for cleanup costs, together with statutory penalties of $500,000 and interest; the case has been settled and $80,000 has been paid to the State.\nOn April 2, 1993, the U. S. Environmental Protection Agency filed an administrative complaint seeking $122,000 in penalties for improper storage and disposition of PCB's which were deposited at two service stations by unknown persons. The matter has been settled and a penalty of $95,200 has been paid.\nThe Company is subject to various laws relating to protection of the environment, and to other contingencies, including legal proceedings and claims which arise in the ordinary course of its business. With respect to environmental contingencies, the total cost to the Company cannot be determined with certainty as a result of such factors as the unknown amount of claims and the timing of clean up efforts at identified sites, which cost may be partially offset by subsequent recoveries against certain state underground tank funds. These factors have been assessed based on management's review of currently known facts and circumstances, and will continue to be assessed by the Company in estimating the reserves for environmental matters to be provided in its financial statements. In the opinion of the Company, the aggregate amount of such environmental and legal liabilities, if any, for which provision has not been made will not have a material adverse effect on its financial position.\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 the Company's fiscal year ended January 31, 1994.\nEXECUTIVE OFFICERS OF REGISTRANT\nThe following table lists the executive officers of the Company, their respective ages, the offices and positions held with the Company as of April 15, 1994 and the year in which each was elected an officer.\nName Age Position Officer Since ---- --- -------- ------------- Leo Liebowitz 66 President and Chief Executive Officer 1971 John J. Fitteron 52 Senior Vice President and Chief Financial Officer 1986 Stephen P. Salzman 57 Senior Vice President and Corporate Secretary 1971 Alvin A. Smith 56 Senior Vice President 1985 L. Douglas Bauguss 35 Vice President 1991 James R. Craig 42 Vice President 1987 Michael K. Hantman 42 Vice President and Corporate Controller 1988 Samuel M. Jones 57 Vice President and General Counsel 1986 Lorenzo Cinque 51 Treasurer 1984\nMr. Liebowitz has been President and Chief Executive Officer and a director of the Company since 1971. He has also served as the President and a director of CLS General Partnership Corp. since 1985. He is also a director of the Regional Banking Advisory Board of Chemical Bank.\nMr. Fitteron joined the Company in 1986 as Senior Vice President and Chief Financial Officer. He has also served as Vice President - Finance and Assistant Secretary of CLS General Partnership Corp. since 1986. Prior to joining Getty, he was a Senior Vice President at Beker Industries Corp., a chemical and natural resource company.\nMr. Salzman became a Senior Vice President of the Company in 1986 and was elected Corporate Secretary in 1985. Prior thereto, he served as Vice President-Finance from 1984 to 1986 and Treasurer of the Company from 1971 to 1984. He has also served as Vice President and Secretary of CLS General Partnership Corp. since 1985.\nMr. Smith has been a Senior Vice President of the Company since 1985. Prior thereto, he was employed at Getty Oil Company as Wholesale Manager and Petroleum Manager.\nMr. Bauguss became a Vice President of the Company in 1991. He joined the Company in 1989 as Director of Real Estate. Prior to joining Getty, he was the Mid-Atlantic Real Estate Manager for Mobil Oil Corp.\nMr. Craig became a Vice President of the Company in 1987. He joined the Company in 1982 as a District Manager and became Manager - Retail Sales in 1984. Prior to joining Getty, he was a Regional Manager of Amerada Hess Corp.\nMr. Hantman became a Vice President of the Company in 1991. He joined the Company in 1985 as Corporate Controller. Prior to joining Getty, he was a Principal at Arthur Young & Company, an international accounting firm.\nMr. Jones joined the Company in 1986 as Vice President and General Counsel. He has also served as Vice President and Assistant Secretary of CLS General Partnership Corp. since 1986. Prior to joining Getty, he was a Senior Attorney with Texaco Inc.\nMr. Cinque has been Treasurer of the Company since 1984. Prior thereto, he served as Controller of the Company from 1976 to 1984.\nManagement is not aware of any family relationships among any of the foregoing executive officers.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\nInformation in response to this item is incorporated herein by reference from material under the heading \"Common Stock\" on page 32 of the Annual Report.\nItem 6.","section_6":"Item 6. Selected Financial Data\nInformation in response to this item is incorporated herein by reference from material under the heading \"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\nInformation in response to this item is incorporated herein by reference from material under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on pages 17 through 20 of the Annual Report.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nInformation in response to this item is incorporated herein by reference from the financial information set forth on pages 21 through 32 of the 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\nInformation with respect to directors in response to this item is incorporated herein by reference from material under the heading \"Election of Directors\" on pages 2 and 3 of the Proxy Statement.\nInformation regarding executive officers is included in Part I hereof.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation in response to this item is incorporated herein by reference from material under the headings \"Directors' Meetings, Committees and Compensation\" and \"Report of the Compensation and Stock Option Committee\" on pages 4 through 9 of the Proxy Statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation in response to this item is incorporated herein by reference from material under the heading \"Beneficial Ownership of Common Stock\" on pages 3 and 4 of the Proxy Statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation in response to this item is incorporated herein by reference from material under the headings \"Compensation Committee Interlocks and Insider Participation\" and \"Certain Transactions\" on pages 8 and 10 of the Proxy Statement.\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 in the Index to Financial Statements and Financial Statement Schedules on page 16 are filed as part of this annual report.\n2. Financial statement schedules\nThe financial statement schedules listed in the Index to Financial Statements and Financial Statement Schedules on page 16 are filed as part of this annual report.\n3. Exhibits\nThe exhibits listed in the Exhibit Index on pages 24 through 29 are filed as part of this annual report.\n4. Reports on Form 8-K\nNone.\nGETTY PETROLEUM CORP. INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES COVERED BY REPORT OF INDEPENDENT ACCOUNTANTS Items 14(a) 1 & 2\nReference -------------------------- Form 10-K 1994 Annual (pages) Report (pages) -------------------------- Data incorporated by reference from attached 1994 Annual Report to Stockholders of Getty Petroleum Corp.: Report of Independent Accountants 32\nConsolidated Statements of Operations for the years ended January 31, 1994, 1993 and 1992 21\nConsolidated Balance Sheets as of January 31, 1994 and 1993 22\nConsolidated Statements of Cash Flows for the years ended January 31, 1994, 1993 and 1992 23\nNotes to Consolidated Financial Statements 24-31\nReport of Independent Accountants - Supplemental Schedules 18\nSchedule V - Property, Plant and Equipment for the years ended January 31, 1994, 1993 and 1992 19\nSchedule VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment for the years ended January 31, 1994, 1993 and 1992 20\nSchedule VIII - Valuation and Qualifying Accounts and Reserves for the years ended January 31, 1994, 1993 and 1992 21\nSchedule IX - Short-Term Borrowings for the years ended January 31, 1994, 1993 and 1992 22\nSchedule X - Supplementary Income Statement Information for the years ended January 31, 1994, 1993 and 1992 23\nAll other schedules are omitted for the reason that they are either not required, not applicable, not material or the information is included in the consolidated financial statements or notes thereto.\nThe financial statements listed in the above index which are included in the 1994 Annual Report to Stockholders are hereby incorporated by reference. With the exception of the pages listed in the above index and the information incorporated by reference included in Part II, Items 5, 6, 7 and 8, the 1994 Annual Report to Stockholders is not deemed filed as part of this report.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Getty Petroleum Corp.:\nOur report on the consolidated financial statements of Getty Petroleum Corp. and Subsidiaries has been incorporated by reference in this Form 10-K from page 32 of the 1994 Annual Report to Stockholders of Getty Petroleum Corp. and Subsidiaries. In connection with our audits of such financial statements, we have also audited the related financial statement schedules listed in the index on page 16 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.\nNew York, New York March 16, 1994, except as to Note 6, the date of which is April 12, 1994.\nEXHIBIT INDEX\nGETTY PETROLEUM CORP.\nAnnual Report on Form 10-K for the fiscal year ended January 31, 1994\nExhibit No. Description Begins on Sequential Page No.\n3.1 Certificate of Filed as Exhibit 3.1 to registrant's Incorporation. Registration Statement on Form S-1 filed on June 23, 1971 (Registration No. 2-40881) and incorporated herein by reference.\n3.2 Certificate of Amendment of Filed as Exhibit B to Certificate of registrant's Annual Report on Incorporation, filed July Form 10-K for the fiscal year 22, 1977. ended January 31, 1978 (File No. 1-8059) and incorporated herein by reference.\n3.3 Certificate of Amendment of Filed as Exhibit 6.3 to Certificate ofIncorporation, Registration Statement on filed September 23, 1980. Form 8-A filed by the Company on July 19, 1985 (File No. 1- 8059) and incorporated herein by reference.\n3.4 Certificate of Amendment of Filed as Exhibit 6.4 to Certificate of Incorporation, Registration Statement on filed June 24, 1985. Form 8-A filed by the Company on July 19, 1985 (File No. 1- 8059) and incorporated herein by reference.\n3.5 Certificate of Amendment of Filed as Exhibit 6.5 to Certificate of Incorporation, Registration Statement on filed, July 11, 1985. Form 8-A filed by the Company on July 19, 1985 (File No. 1- 8059) and incorporated herein by reference.\nExhibit No. Description Begins on Sequential Page No.\n3.6 By-Laws. Filed as Exhibit 3.2 to registrant's Registration Statement on Form S-1 filed on June 23, 1971 (Registration No. 2- 40881) and incorporated herein by reference.\n3.7 Certificate of Amendment Filed as Exhibit A to of Certificate of registrant's definitive proxy Incorporation. statement, dated May 8, 1987, with respect to its Annual Meeting of Stockholders held June 18, 1987 and incorporated herein by reference.\n3.8 Amendment to By-Laws. Filed as Exhibit B to registrant's definitive proxy statement, dated May 8, 1987, with respect to its Annual Meeting of Stockholders held June 18, 1987 and incorporated herein by reference.\n3.9 Amendment to By-Laws. Filed as Exhibit 3.9 to registrant's Quarterly Report on Form 10-Q for the quarter ended April 30, 1988 (File No. 1-8059) and incorporated herein by reference.\n4.1 Indenture dated as of Filed as Exhibit 4.1 to August 1, 1985 between registrant's Annual Report on registrant and BankAmerica Form 10-K for the fiscal year Trust Company of New York, ended January 31, 1986 (File as Trustee, relating to the No. 1-8059) and incorporated 14% Subordinated Debentures herein by reference. due August 1, 2000, including form of Debenture.\n*4.5 Bond Purchase Agreement dated as of October 1, 1981 among Nassau County Industrial Development Agency, Chemical Bank and Leemilt's Petroleum, Inc., relating to a $1,500,000 industrial development bond due November 1, 1996.\nExhibit No. Description Begins on Sequential Page No.\n4.7 $35,000,000 reducing Filed as Exhibit 4.7 to revolving Loan Agreement registrant's Quarterly between Leemilt's Report on Form 10-Q for the Petroleum, Inc. and Bank quarter ended October 31, 1987 of New England, N.A. dated (File No. 1-8059) and as of December 7, 1987 and incorporated herein by reference. related Guaranty Agreement, dated as of December 7, 1987, by and between Getty Petroleum Corp. and Bank of New England, N.A.\n10.2(a) Retirement and Profit Filed as Exhibit 10.2(a) to Sharing Plan (amended registrant's Annual Report and restated as of on Form 10-K for the fiscal September 11, 1986.) year ended January 31, 1987 (File No. 1-8059) and incorporated herein by reference.\n10.3 Asset Purchase Agreement Filed as Exhibit 2(a) to between Power Test Corp. registrant's Current Report (now known as Getty on Form 8-K, filed Petroleum Corp.) and February 19, 1985 (File No. Texaco Inc., Getty Oil 1-8059) and incorporated Company, and Getty herein by reference. Refining and Marketing Company, dated December 21, 1984.\n10.4 Trademark License Agreement Filed as Exhibit 2(b) to between Texaco Inc., Getty registrant's Current Report Oil Company,Texaco on Form 8-K, filed February Refining and Marketing 19, 1985 (File No. 1-8059) Inc., and Power Test Corp. and incorporated herein by (now known as Getty reference. Petroleum Corp.), dated February 1, 1985.\nExhibit No. Description Begins on Sequential Page No.\n10.7 Form of Real Property Filed as Exhibit 2(e) to Leases between Power Test registrant's Current Report Realty Company Limited on Form 8-K, filed February 19, Partnership, as Lessor, 1985 (File No. 1-8059) and and Power Test Corp. incorporated herein by reference. (now known as Getty Petroleum Corp.) (either directly or indirectly through a wholly-owned subsidiary), as Lessee, each dated February 1, 1985.\n10.8 Rolling Stock Lease Filed as Exhibit 2(f) to between Power Test Realty registrant's Current Report Company Limited Partnership, on Form 8-K, filed February as Lessor, and Power Test 19, 1985 (File No. 1-8059) Petro Corp. (a wholly-owned and incorporated herein by subsidiary of registrant), reference. as Lessee, dated February 1, 1985.\n10.9 Equipment Lease between Filed as Exhibit 2(g) to Power Test Realty Company registrant's Current Report Limited Partnership, as on Form 8-K, filed Lessor, and Power Test February 19, 1985 (File Corp. (now known as Getty No. 1-8059) and incorporated Petroleum Corp.) as Lessee, herein by reference. dated February 1, 1985.\n10.16 Registrant's 1985 Stock Filed as Exhibit A to Option Plan. registrant's definitive proxy statement, dated May 31, 1985, with respect to its Annual Meeting of Stockholders held June 20, 1985 and incorporated herein by reference.\n10.17 Hazardous Waste and Filed as Exhibit 10.17 to PMPA Indemnification registrant's Annual Report on Agreement dated as of Form 10-K for the fiscal year December 10, 1986 among ended January 31, 1987 (File Getty Petroleum Corp., No. 1-8059) and incorporated Power Test Realty Company herein by reference. Limited Partnership and Bank of New England, N.A.\nExhibit No. Description Begins on Sequential Page No.\n10.18 Guaranty Agreement dated Filed as Exhibit 10.18 to as of December 1, 1986 of registrant's Annual Report on Getty Petroleum Corp. Form 10-K for the fiscal year regarding distribution ended January 31, 1987 (File terminal leases between No. 1-8059) and incorporated Power Test Realty Company herein by reference. Limited Partnership and Getty Terminals Corp.\n10.19 Form of Indemnification Filed as Exhibit C to Agreement between Getty registrant's definitive proxy Petroleum Corp. and statement, dated May 8, 1987, directors. with respect to its Annual Meeting of Stockholders held June 18, 1987 and incorporated herein by reference.\n10.20 Registrant's 1988 Stock Filed as Exhibit A to Option Plan. registrant's definitive proxy statement, dated April 29, 1988, with respect to its Annual Meeting of Stockholders held June 16, 1988 and incorporated herein by reference.\n10.21 Milton Safenowitz Filed as Exhibit 10.21 to Employment Agreement dated registrant's Annual Report on February 1, 1990. Form 10-K for the fiscal year ended January 31, 1990 (File No. 1-8059) and incorporated herein by reference.\n10.22 Supplemental Retirement Filed as Exhibit 10.22 to Plan for Executives of registrant's Annual Report on Getty Petroleum Corp. and Form 10-K for the fiscal year Participating Subsidiaries. ended January 31, 1990 (File No. 1-8059) and incorporated herein by reference.\n10.23 Form of Agreement dated as 39 of September 9, 1993 between the Company and its non-director officers and one key employee regarding compensation upon change in Company control.\nExhibit No. Description Begins on Sequential Page No.\n10.24 Amendment to Employment Filed as Exhibit 10.24 to Agreement dated February 1, registrant's Annual Report on 1990 (see Exhibit 10.21). Form 10-K for the fiscal year ended January 31, 1991 (File No. 1-8059) and incorporated herein by reference.\n10.25 Registrant's Amended and Filed as Exhibit 4.10 to Restated 1991 Stock Option registrant's Registration Plan. Statement on Form S-8 filed on June 18, 1993 (Registration No. 33- 64746) and incorporated herein by reference.\n10.26 Petroleum Products Supply Filed as Exhibit 10.26 to Agreement dated as of July registrant's Quarterly Report 1, 1992 by and between on Form 10-Q for the quarter Phibro Energy USA, Inc. and ended July 31, 1992 (File No. Getty Petroleum Corp., 1-8059) and incorporated Getty Terminals Corp., and herein by reference. Aero Oil Company.\n13 Annual Report to 42 Stockholders for the fiscal year ended January 31, 1994.\n22 Subsidiaries of the 37 registrant.\n24 Consent of Independent 38 Accountants.\n*Registrant will furnish 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.\nGetty Petroleum Corp. (Registrant)\nBy____________________________ By__________________________ John J. Fitteron, Michael K. Hantman, Senior Vice President and Vice President and Chief Financial Officer Corporate Controller (Principal Financial (Chief Accounting Officer) Officer) April 28, 1994 April 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.\nBy____________________________ By________________________ Leo Liebowitz, President, Milton Cooper, Chief Executive Officer Director and Director April 28, 1994 April 28, 1994\nBy____________________________ By_________________________ Herbert Lotman, Milton Safenowitz, Director Director April 28, 1994 April 28, 1994\nBy____________________________ Warren G. Wintrub, Director April 28, 1994\nFINANCIAL REVIEW\nGETTY PETROLEUM CORP. AND SUBSIDIARIES\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nNet sales for the year ended January 31, 1994 were $772.6 million as compared with $903.7 million in the preceding year. The decrease in net sales was principally due to the Company's decision to effectively eliminate its bulk wholesale activities (which had a minimal effect on earnings) primarily as a result of the July 1992 product supply contract, resulting in $128.0 million lower sales. Also contributing to the decrease in sales was a 1.3% decrease in average selling prices, offset by a 5.3% increase in retail gallonage sold through 6.9% fewer outlets. Gross profit was $45.7 million in fiscal 1994, an increase of $14.2 million over the prior year. The increase in gross profit was principally due to improved gross margins, increased retail gallonage and the inclusion in the prior year period of approximately $1.2 million of non-recurring or unusual pre- tax charges related to settlement of demurrage charges and completion of a product supply contract with a foreign supplier. Fiscal 1993 sales were $903.7 million as compared with $1.12 billion in the preceding year. The decrease in net sales was due principally to the Company's decision during the latter half of fiscal 1993 to substantially reduce bulk wholesale activities primarily as a result of the 1992 product supply contract, and the elimination of direct Company operated convenience store sales as a result of leasing 141 of such stores in December 1991. Gross profit was $31.5 million in fiscal 1993 compared to $26.4 million in the prior fiscal year. Gross profit, although improved over the prior year, remained lower than historical levels principally due to the continuation of unsatisfactory profit margins during the first nine months of fiscal 1993 resulting from highly competitive market conditions.\nAlthough the Company believes that it has only been modestly affected by inflation due to its ability to generally pass on wholesale cost increases at the retail level, there have been wide and rapid fluctuations in product costs and selling prices. Accordingly, the Company's revenues and resultant profit margins from the sale of petroleum products may continue to undergo significant variations.\nRental income of $30.0 million in fiscal 1994 increased 4.4% over fiscal 1993 rental income of $28.8 million. The increase was due to increased lease rental rates resulting from capital improvements in Company owned and leased locations and lease renewals. Rental income in fiscal 1993 amounted to $28.8 million, an increase of 14.9% over the $25.0 million realized in fiscal 1992. The increase in the 1993 period was principally due to additional rental income earned as a result of the convenience store leases.\nOther income, net was $3.9 million in fiscal 1994 which represented a decrease of $.7 million from the prior year. The current year includes $.8 million of gains on dispositions of non-performing assets compared to $2.7 million of gains on dispositions in the prior year. The prior year also included $1.7 million of non-recurring or unusual pre-tax charges relating to cancellation of a cargo freight contract and the planned disposition of two terminals, which charges were incurred principally because of the 1992 product supply contract and severance payments resulting from a work force reduction in October 1992. Other income, net was $4.6 million in fiscal 1993 as compared to $11.8 million in the prior year, a decrease of $7.2 million principally due to a combination of gains or losses from non- recurring or unusual items in both years. Fiscal 1993 included $2.7 million of gains on dispositions of non-performing assets partially offset by the aforementioned $1.7 million of non-recurring or unusual pre-tax charges relating to cancellation of a cargo freight contract, the planned disposition of two terminals and severance payments. Fiscal 1992 included $3.2 million of income recognized by the Company for its portion of a claim settlement, $3.7 million of gains on dispositions of non-performing assets and $1.2 million of miscellaneous income related to the convenience food store operations.\nSelling, general and administrative expenses in fiscal 1994 amounted to $28.8 million, a decrease of $2.8 million from the prior year. The decrease was principally due to lower expenses as a result of cost reduction measures previously instituted by the Company, which included a work force reduction in October 1992, and reduced advertising expenditures. Selling, general and administrative expenses in fiscal 1993 amounted to $31.6 million, a decrease of $8.7 million from the prior year. The decrease was principally due to the elimination of expenses as a result of leasing the convenience food stores, cost reduction measures instituted by the Company, which included the work force reduction in October 1992, and reduced advertising expenditures.\nInterest expense in fiscal 1994 amounted to $14.6 million, a decrease of $2.2 million from the prior year. The decrease was principally due to reduced debt outstanding during the current fiscal year. Interest expense in fiscal 1993 amounted to $16.8 million, a decrease of $2.2 million from fiscal 1992 primarily due to reduced debt outstanding and lower interest rates.\nDepreciation and amortization decreased by $.4 million in fiscal 1994 as compared to the prior year. There was a decrease in amortization of deferred charges of $1.1 million, partially offset by an increase in depreciation of $.7 million as a result of additions to property, plant and equipment. Depreciation and amortization decreased by $.9 million in fiscal 1993 as compared to the prior year principally as a result of the sale in December 1991 of certain equipment used in the convenience food stores, partially offset by a write-off of certain deferred charges in connection with a $30 million term loan, which was prepaid in July 1992.\nThe Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\", during the first quarter of fiscal 1994 and has reported the cumulative effect of the change in accounting principle as a credit to earnings of $.9 million in the consolidated statement of operations.\nLIQUIDITY AND CAPITAL RESOURCES\nAs of January 31, 1994, working capital amounted to $6.2 million as compared to $3.0 million as of January 31, 1993. The increase in working capital was primarily due to funds generated during the year from operations, partially offset by capital expenditures and the reduction in long-term indebtedness.\nThe Company's principal sources of liquidity are cash flows from operations, which amounted to $38.1 million during the year ended January 31, 1994, and its short-term unsecured lines of credit. As of January 31, 1994, lines of credit amounted to $60 million, of which $37.6 million was utilized in connection with outstanding letters of credit. Management believes that cash requirements for operations and debt service can be met by its available cash balances and short-term investments of $50.6 million, cash flows from operations and its credit lines.\nOn April 12, 1994, the Company announced that it will call all of the outstanding 14% subordinated debentures due August 1, 2000. The call price will be 102.8% and the redemption date will be May 16, 1994. Interest will be paid to the redemption date. The redemption will be made with existing funds, a portion of which may be funded by long-term debt.\nCapital expenditures during the fiscal year ended January 31, 1994 amounted to $20.4 million, including $.9 million related to property acquisitions and $9.2 million for replacement of underground storage tanks and vapor recovery facilities at gasoline stations and terminals.\nENVIRONMENTAL MATTERS\nThe Company is subject to various laws relating to protection of the environment, and to contingencies, including legal proceedings and claims which arise in the ordinary course of its business. With respect to environmental contingencies, the total cost to the Company cannot be determined with certainty as a result of such factors as the unknown amount of claims and the timing of clean up efforts at identified sites, which cost may be partially offset by subsequent recoveries against certain state underground tank funds. These factors have been assessed based on management's review of currently known facts and circumstances, and will continue to be assessed by the Company in estimating the reserves for environmental matters to be provided in its financial statements. In the opinion of the Company, the aggregate amount of such environmental and legal liabilities, if any, for which provision has not been made will not have a material adverse effect on its financial position.\nThe Company is impacted by numerous environmental laws and regulations, the most important of which are discussed below.\nThe Clean Air Act Amendments of 1990 requires that the nine worst ozone non-attainment areas in the U.S. must use reformulated fuels gasoline (\"RFG\") year round. These geographic areas plus other areas that elect to participate in the program include substantially all of the Company's marketing area. At the same time it issued the final RFG rule, the U.S. Environmental Protection Agency issued a proposed rule to ensure that at least 30% of the oxygen required to make RFG come from renewable sources. A final rule is expected in June 1994. The Company's supply contract with Phibro Energy USA, Inc. provides for RFG gasoline and, therefore, the Company should not experience any impact to meet these new regulations. The Company has blended gasoline with ethanol successfully in many markets for the past four years and has supply arrangements for ethanol. Many of the Company's terminals are equipped with blending equipment. Accordingly, the Company believes it is well positioned to meet the RFG regulations.\nThe federal underground storage tank (\"UST\") regulations, enacted in 1988, provide that all non-complying UST's must be upgraded or replaced by the end of 1998. The Company estimates that an additional $47 million may be required to meet the 1998 UST deadline.\nVarious environmental regulations require the remediation of discharges or releases of petroleum products from UST's. The Company estimates that for existing remediation projects and anticipated remediation required in conjunction with UST replacements it may be required to expend $65 million in the next five years, reduced by $8 million for expected recoveries against certain state underground tank funds.\nNumerous regulations affect the Company's terminals and, in particular, the imperviousness of the terminals' ground or surface and federal volatile organic compound (\"VOC\") air emission regulations. The Company's terminals are substantially in compliance with all environmental regulations and the Company estimates that only $2 million may be required in the next five years for its terminals, except the Company is unable to estimate the cost of complying with the VOC emission regulations which have not been finalized.\nFederal and local regulations require the permanent closure of service station bay drains and the removal of waste oil and fuel oil tanks. The Company estimates that it may expend $5 million over the next five years to complete this program.\nThe foregoing environmental expenditures are comparable in the aggregate to the amounts spent for environmental matters during the past five fiscal years. It is anticipated that the aforesaid environmental expenditures will be provided from operating cash flow.\nThe Company is a Potentially Responsible Party at one Superfund site in Connecticut for which its maximum exposure is approximately $5,000.\nAs of January 31, 1994, the Company had $6.8 million accrued for environmental matters, principally for service station site remediations and legal matters. During the years ended January 31, 1994, 1993 and 1992, the Company expensed $9.7 million, $12.4 million and $13.0 million, respectively, for environmental matters, which amount in fiscal 1994 was net of $1.1 million for recoveries against certain state underground tank funds.\nThe Company 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 the Company and could require substantial additional expenditures for the installation and operation of pollution control systems and equipment. Moreover, the Company cannot predict the number or the magnitude of new discharges or releases from its UST's.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nConsolidation: The consolidated financial statements include the accounts of Getty Petroleum Corp. and all majority-owned subsidiaries (the \"Company\"). The Company is principally engaged in the marketing and distribution of petroleum products. All significant intercompany accounts and transactions have been eliminated.\nCash and Cash Equivalents: The Company considers highly liquid investments purchased with an original maturity of three months or less to be cash equivalents.\nInventories: Inventories, primarily finished petroleum products, are principally accounted for under the lower of last-in, first-out (\"LIFO\") cost or market. Net product exchange positions with other companies are reflected in inventory.\nThe Company may take positions in the futures market as part of its overall purchasing strategy in order to reduce the risk associated with price fluctuations. The gains and losses on futures contracts are included as a part of product costs.\nProperty, Plant and Equipment: Expenditures for renewals and betterments are capitalized; maintenance and repairs are charged to operations when incurred. When fixed assets are sold or retired, the cost and related accumulated depreciation and amortization are eliminated from the respective accounts and any gain or loss is credited or charged to income.\nDepreciation and Amortization: Depreciation of fixed assets is computed on the straight-line method based upon the estimated useful lives of the assets. Assets recorded under capital leases (including land) and leasehold improvements are amortized on the straight-line method over the shorter of the term of the lease or the useful life of the related asset.\nEnvironmental Costs: The estimated future costs for known environmental remediation requirements are accrued when it is probable that a liability has been incurred and the amount of remediation costs can be reasonably estimated.\nIncome Taxes: Deferred income taxes are provided for the effect of items which are reported for income tax purposes in years different from that in which they are recorded for financial statement purposes.\nRevenue Recognition: Revenue is recognized from sales when product ownership is transferred to the customer and from rentals as earned. Earnings (Loss) Per Share: Earnings (loss) per share of common stock is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the year. Common stock equivalents are not included in earnings (loss) per share computations since their effect is immaterial.\nAccounting Change: The Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\", during the first quarter of fiscal 1994 and has reported the cumulative effect of the change in accounting principle as a credit to earnings of $.9 million in the consolidated statement of operations. In addition to the impact of the cumulative effect on prior years, the effect on the current year of adopting SFAS No. 109 was insignificant. Prior years' financial statements have not been restated to apply the provisions of SFAS No. 109.\n2 INVENTORIES\nAs of January 31, 1994, 1993 and 1992, the carrying value of the Company's LIFO inventories approximated the first-in, first-out (\"FIFO\") method or replacement cost.\n3 LEASES\nIn 1985, Power Test Investors Limited Partnership (the \"Partnership\"), a publicly traded real estate limited partnership, purchased from Texaco certain Getty Oil Company properties and equipment which, in turn, have been leased on a long-term basis to the Company. For financial statement purposes, such leases have been recorded as capital leases.\nThe Partnership is managed by the General Partner, which is CLS General Partnership Corp. The Directors and shareholders of CLS General Partnership Corp. are also Directors and the principal shareholders of the Company. During the years ended January 31, 1994, 1993 and 1992, the Company billed the Partnership and reflected in other income $600,000, $576,000 and $552,000, respectively, for administrative and other services rendered to the Partnership.\nFuture minimum annual rentals under capital leases as of January 31, 1994, payable to the Partnership, are as follows:\nIn addition, the Company has obligations to other lessors under noncancelable operating leases which have terms in excess of one year, principally for gasoline stations. Substantially all of these leases contain renewal options and escalation clauses. Future minimum annual rentals under such leases are as follows:\nRent expense, substantially all of which is included in cost of sales, amounted to $16,955,000, $17,226,000 and $17,276,000 for the years ended January 31, 1994, 1993 and 1992, respectively. Such amounts consist of minimum rentals on noncancelable operating leases referred to above and short-term rentals of terminal facilities and other equipment.\nRental income from fee owned and leased properties aggregated $30,033,000, $28,758,000 and $25,029,000 for the years ended January 31, 1994, 1993 and 1992, respectively, which included $20,308,000, $20,421,000 and $17,960,000 of rent received under subleases. The net book value of fee owned properties leased to lessees was $80,041,000 at January 31, 1994.\nLeased gasoline stations, which have been subleased to lessees, have sublease rentals generally not less than the rentals paid by the Company. No significant difficulty has been experienced in subleasing station properties.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n4 PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment consists of the following:\nProperty, plant and equipment includes the following assets recorded under capital leases, principally with the Partnership:\n5 COMMITMENTS AND CONTINGENCIES\nThe Company is subject to various laws relating to protection of the environment, and to other contingencies, including legal proceedings and claims which arise in the ordinary course of its business. With respect to environmental contingencies, the total cost to the Company cannot be determined with certainty as a result of such factors as the unknown amount of claims and the timing of clean up efforts at identified sites, which cost may be partially offset by subsequent recoveries against certain state underground tank funds. These factors have been assessed based on management's review of currently known facts and circumstances, and will continue to be assessed by the Company in estimating the reserves for environmental matters to be provided in its financial statements. In the opinion of the Company, the aggregate amount of such environmental and legal liabilities, if any, for which provision has not been made will not have a material adverse effect on its financial position.\nGetty Terminals Corp. (\"Getty Terminals\"), a wholly-owned subsidiary of the Company, has received notices of proposed license revocations from the New York State Department of Taxation and Finance (\"Department\") for Getty Terminals' operating permits for its three New York State terminals and its motor fuels and diesel distributor licenses. The notices of proposed revocation are based on Getty Terminals' 1990 federal conviction for conspiracy to evade 1985 federal gasoline excise taxes and for non-payment of such taxes. The Department contends that Getty Terminals' federal tax conviction affects its \"duties and obligations\" under Sections 283 and 283- b of the New York Tax Law (\"Tax Law\"). Getty paid all New York State taxes which were due and owing and has fully performed all of its duties and obligations under the Tax Law. Management of the Company believes that the Department does not have cause to revoke Getty Terminals' New York State licenses; therefore, management believes that this matter will have no material adverse effect on the Company's financial position or future business.\nIn order to minimize the Company's exposure to credit risk associated with financial instruments, the Company places its temporary cash investments with high credit quality financial institutions and, by policy, limits the amount invested with any one financial institution other than the U.S. Government. Concentration of credit risk with respect to trade receivables generally is limited due to the large number of customers comprising the Company's customer base.\n6 DEBT\nAggregate principal payments in subsequent fiscal years relating to long- term debt are as follows (in thousands): 1995--$5,896; 1996--$7,749; 1997-- $6,286; 1998--$21,630; 1999--$3,920 and $10,818 thereafter.\nBorrowings under the mortgage loan are payable monthly over the term of the agreement with a final payment of $15,346,000 on January 1, 1998. The loan, which bears interest at prime, is collateralized by first mortgages on certain service station properties.\nThe subordinated debentures, which bear interest at 14%, are redeemable in whole at any time or in part from time to time, at the option of the Company, at a premium initially equal to the coupon rate declining uniformly over the ten year period ending August 1, 1995. Annual sinking fund payments of $2,625,000, which commenced on August 1, 1990, are calculated to retire 75% of the debentures prior to maturity. As of January 31, 1994, $934,000 of debentures are held in treasury and may be used to meet future sinking fund payments. The debentures are subordinate in right of payment to all existing and future Senior Indebtedness (as defined) of the Company. As of January 31, 1994, Senior Indebtedness amounted to $34,633,000. On April 12, 1994, the Company announced that it will call all of the outstanding subordinated debentures at a price of 102.8% with a redemption date of May 16, 1994.\nCertain long-term debt is collateralized by property, plant and equipment having an aggregate net book value of approximately $54,200,000 at January 31, 1994.\nAs of January 31, 1994, the Company had unsecured lines of credit aggregating $60,000,000, of which $37,624,000 was utilized in the form of outstanding letters of credit. Notes to Consolidated Financial Statements (continued)\n7 INCOME TAXES\nThe provision (credit) for income taxes is summarized as follows:\nThe tax effects of temporary differences which comprise the deferred tax assets and liabilities at January 31, 1994 are as follows:\nAs of January 31, 1994, the Company has state tax operating loss carryforwards of approximately $2,110,000 expiring through 2008 which are available to offset future state income taxes. The following is a reconciliation of the expected statutory federal income tax provision (credit) and the actual provision (credit) for income taxes:\nAs of January 31, 1993, recoverable income taxes amounting to $6,708,000 are included in prepaid expenses and other current assets.\n8 STOCKHOLDERS' EQUITY\nA summary of the changes in stockholders' equity for the three years ended January 31, 1994 is as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9 EMPLOYEE BENEFIT PLANS\nThe Company has a retirement and profit sharing plan with deferred 401(k) savings plan provisions (the \"Retirement Plan\") for non-union employees meeting certain service requirements and a Supplemental Plan for executives. Under the terms of these plans, the annual discretionary contributions to the plans are determined by the Board of Directors. Under the Retirement Plan, employees may make voluntary contributions and the Company has elected to match an amount equal to 50% of such contributions but in no event more than 3% of the employee's eligible compensation. Under the Supplemental Plan, a participating executive may receive an amount equal to 10% of his compensation, reduced by the amount of any contributions allocated to such executive under the Retirement Plan. Net Company contributions under the plans approximated $719,000, $765,000 and $874,000 for the years ended January 31, 1994, 1993 and 1992, respectively.\nThe Company has Stock Option Plans which authorize the Company to grant options to purchase shares of the Company's common stock and to also grant stock appreciation rights (SARs) under the 1985 Plan. The aggregate number of shares of the Company's common stock which may be made the subject of options under the 1985, 1988 and 1991 Plans shall not exceed 281,420 shares (including SARs), 303,876 shares and 500,000 shares, respectively, subject to further adjustment for stock dividends and stock splits. Each plan provides that options are exercisable starting one year from the date of grant, on a cumulative basis at the annual rate of 25 percent of the total number of shares covered by the option.\nChanges in stock options for the three years ended January 31, 1994 are as follows:\n10 QUARTERLY FINANCIAL DATA\nThe following summarizes the quarterly results of operations for the years ended January 31, 1994 and 1993 (unaudited as to quarterly information):\n11 ACQUISITION\nOn May 30, 1991, the Company concluded an agreement to lease on a long-term basis 53 service stations, supply an additional 73 service stations and purchase certain inventories and other assets for approximately $5,803,000. The service stations are located in Massachusetts, Rhode Island and New Hampshire. The leases have been accounted for as operating leases and the assets have been accounted for as a purchase with the purchase price being assigned to the net assets acquired based on the fair value of such assets and liabilities at the date of acquisition as follows:\n- -------------------------------------------------------------------------- (in thousands) Net current assets $ 2,170 Property, plant and equipment 1,062 Other assets 2,693 Other, principally deposits (122) ------------- Net assets acquired $ 5,803\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Stockholders of Getty Petroleum Corp.:\nWe have audited the accompanying consolidated balance sheets of GETTY PETROLEUM CORP. and SUBSIDIARIES as of January 31, 1994 and 1993, and the related consolidated statements of operations and cash flows for each of the three years in the period ended January 31, 1994. 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 Getty Petroleum Corp. and Subsidiaries as of January 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended January 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for income taxes in fiscal 1994.\nNew York, New York March 16, 1994, except as to Note 6, the date of which is April 12, 1994\nCOMMON STOCK\nGetty Petroleum's common stock, its only outstanding voting security, is traded on the New York Stock Exchange (symbol: \"GTY\"). At April 20, 1994, there were approximately 3,300 holders of record of Getty Petroleum's common stock. The price range of common stock and cash dividends paid with respect to each share of common stock during the past two fiscal years were as follows:\nCORPORATE DATA\nBOARD OF DIRECTORS\nMilton Cooper Chairman of the Board of Kimco Realty Corporation and former Vice President of the Company.\nLeo Liebowitz President and Chief Executive Officer of the Company.\nHerbert Lotman Chairman of the Board and Chief Executive Officer of Keystone Foods Corporation.\nMilton Safenowitz Former Executive Vice President of the Company.\nWarren G. Wintrub Retired Partner, Member of the Executive Committee and Chairman of the Retirement Committee of Coopers & Lybrand.\nEXECUTIVE OFFICERS\nLeo Liebowitz President and Chief Executive Officer\nJohn J. Fitteron Senior Vice President and Chief Financial Officer\nStephen P. Salzman Senior Vice President and Corporate Secretary\nAlvin A. Smith Senior Vice President, Operations\nL. Douglas Bauguss Vice President\nLorenzo Cinque Treasurer\nJames R. Craig Vice President\nMichael K. Hantman Vice President and Corporate Controller\nSamuel M. Jones Vice President and General Counsel\nSHAREHOLDER INFORMATION\nANNUAL MEETING All shareholders are cordially invited to attend the Company's annual meeting on June 16, 1994 at 10:30 a.m. at 1301 Avenue of the Americas, 2nd Floor, New York, New York. Holders of common stock of record at the close of business on April 20, 1994, are entitled to vote at the meeting. A notice of meeting, proxy statement and proxy were mailed to shareholders with this report.\nFORM 10-K AND INVESTOR RELATIONS INFORMATION The Company's fiscal 1994 Annual Report on Form 10-K filed with the Securities and Exchange Commission may be obtained by shareholders without charge by writing to:\nCorporate Secretary Getty Petroleum Corp. 125 Jericho Turnpike Jericho, New York 11753\nIn addition, Getty shareholders are informed about Company news through the issuance of press releases and quarterly reports. Investors, brokers, security analysts and others desiring financial information should contact the Corporate Secretary at (516) 338-1212.\nTRANSFER AGENT American Stock Transfer and Trust Company 99 Wall Street New York, New York 10005\nABOUT OUR SHAREHOLDERS As of April 20, 1994, the Company had 12,637,436 outstanding shares of Common Stock owned by approximately 3,300 shareholders of record.\nCORPORATE HEADQUARTERS Getty Petroleum Corp. 125 Jericho Turnpike Jericho, New York 11753\nGetty Petroleum Corp.'s Common Stock is listed on the New York Stock Exchange under the ticker symbol GTY.\nSHAREHOLDER INQUIRIES Inquiries, comments or suggestions concerning Getty Petroleum Corp. are welcome and should be directed to:\nInvestor Relations 125 Jericho Turnpike Jericho, New York 11753 (516) 338-6000\nTelex 175061 GETTY\nTelecopier (516) 338-6062","section_15":""}
{"filename":"64079_1994.txt","cik":"64079","year":"1994","section_1":"Item 1. Business\nGENERAL -------\nMCI* is the second largest nationwide carrier of long-distance telecommunications services and the third largest carrier of international long-distance telecommunications services in the world. MCI provides a wide spectrum of domestic and international voice and data services, which include long-distance telephone services, data communications services and electronic messaging services. During each of the last three years, more than 90% of MCI's operating revenues, operating income and assets related to MCI's activities in the long-distance telecommunications industry.\nAt December 31, 1994, MCI had approximately 41,000 full-time employees.\nSERVICES ---------\nMCI provides a wide range of long-distance telecommunications services, including the following: dial 1 access and dial access long-distance telephone service; voice and data services over software-defined virtual private networks; private line and switched access services; collect calling, operator assistance and calling card services; toll free or 800 services; and 900 services. The company offers these services individually and in combinations to meet the changing needs of its customers. Through combined offerings, MCI is able to provide customers with benefits such as single billing, unified services for multi-location companies and customized calling plans.\n----------------------- *MCI conducts its business primarily through its subsidiaries. Unless the context otherwise requires, \"MCI\" or \"company\" means MCI Communications Corporation, a Delaware corporation organized in August 1968, and its subsidiaries on a consolidated basis. MCI is a registered service mark of MCI Communications Corporation. MCI has its principal executive offices at 1801 Pennsylvania Avenue, N.W., Washington, D.C. 20006 (telephone number (202) 872-1600).\nPage 2 of 28\nMCI markets its domestic and international voice and data communications services through several business units. MCI's Communication Services Group markets domestic and international long-distance telecommunications services to business, government and residential customers through its Business Markets and Consumer Markets Units. Domestic data communications and electronic messaging services are marketed through MCI's Data Services Division which is a part of the Business Markets Unit. International data communications and electronic messaging services are marketed through MCI International, Inc., a wholly-owned subsidiary of MCI. To a lesser extent, MCI also markets its voice and data communications services domestically and internationally through arrangements with third parties.\nSYSTEM ------\nDomestic long-distance services are provided primarily over MCI's own coast-to-coast optical fiber and terrestrial digital microwave communications system and, to a lesser extent, over transmission facilities leased from other common carriers utilizing MCI's digital switches. International communications services are provided by way of submarine cable systems in which MCI holds investment positions, satellites and facilities of other domestic and foreign carriers.\nMCI continues to expand its digital transmission and switching facilities and capabilities to meet the requirements of its customers for additional and enhanced domestic and international services, to add redundancy to its network and to enhance network intelligence. This expansion includes the continued deployment in its network of Synchronous Optical Network (\"SONET\") and Asynchronous Transfer Mode (\"ATM\") technologies.\nSONET technology, which uses laser light instead of electrical signals, will substantially increase the speed at which data is carried on MCI's network allowing MCI to provide high-speed multimedia applications and information services throughout its domestic network and on new international routes across the Atlantic and Pacific. In addition, it allows MCI to install customer circuits faster and identify network problems before customers become aware of them. SONET technology is currently operational on the domestic network and is anticipated to be operational on international routes by year end 1995.\nATM technology, a state-of-the-art switching technology that facilitates the provision of a wide range of data communications services, will increase MCI's network switching capabilities and permit MCI's customers to transmit simultaneously voice, data and video communications over the same line. ATM will be offered\nPage 3 of 28\ncommercially in 1995 on a substantial portion of MCI's network and will be fully deployed in 1996.\nThese network initiatives and continued expansion of the network require a high level of capital expenditures. In 1995, MCI anticipates that capital expenditures of approximately $3 billion will be required in connection with the introduction of new services and the continued development of its communications system. Included in this amount is approximately $500 million for its subsidiary, MCI Metro, Inc. (\"MCImetro\"), which will serve the local services market. See \"LOCAL ACCESS\" below. Capital expenditures were approximately $2.9 billion in 1994, $1.7 billion in 1993 and $1.3 billion in 1992.\nLOCAL ACCESS ------------\nMCI provides customers that typically have very large volumes of communications with direct access to its long-distance network. All other customers are provided access to MCI's services through local interconnection facilities provided by local exchange carriers (\"LECs\") and, to a much lesser extent, by competitive access providers (\"CAPs\").\nThe cost to obtain these interconnection facilities from the LECs and CAPs is a significant component of MCI's operating expenditures. These facilities are typically available only from the LEC which serves the geographic market for local services, including interconnection services. However, as a result of regulatory developments at both the federal and state levels, the local services markets are beginning to open up to competition. These developments include the partial unbundling of special and switched access services and requiring the LECs to provide interconnection outside their switching facilities to allow the CAPs to provide interstate access. See \"COMPETITION and REGULATION\" below. MCI expects to benefit from this competition through lower access costs, although the extent of such benefit cannot be quantified.\nMCImetro --------\nMCI established MCImetro to enter the local services market and compete with the LECs and CAPs, initially in special access services and then, when permitted by local regulation, all local services. MCImetro has (i) filed applications in eleven states for the authority to offer a full range of local services, five of which (New York, Maryland, Massachusetts, Washington and Wisconsin) have granted such authority to date; and (ii) begun construction of fiber-optic rings in twenty major metropolitan areas to be completed by year end 1995. In addition, MCImetro is currently installing and testing switches in several metropolitan areas in\nPage 4 of 28\nanticipation of receiving authority to provide local services. MCImetro expects vigorous competition from both the LECs and CAPs in the local services market. See \"COMPETITION\" below.\nGLOBAL ALLIANCES -----------------\nMCI continues to expand the use and reach of its services through the development of global alliances, in order to meet the global needs of its customers.\nIn 1994, MCI completed all the transactions contemplated under the August 1993 agreements with British Telecommunications plc (\"BT\"). This included (i) the acquisition by BT of approximately a 20% equity interest in MCI for approximately $4.3 billion ($830 million of which was received in June 1993 for approximately a 4.9% equity interest and $3.5 billion of which was received in September 1994 for the remainder); (ii) the formation in July 1994 of Concert Communications Company (\"Concert\"), a business venture between BT and MCI, to provide global enhanced and value-added telecommunications services; and (iii) the purchase in January 1994 by MCI of substantially all the assets of the United States operations of BT's data communications services subsidiary, BT North America, Inc.\nConcert, in which MCI owns a 24.9% equity interest, provides global enhanced and value-added telecommunications services such as packet data, frame relay and managed bandwidth services. MCI is the exclusive distributor of Concert services in North, Central and South America, and BT is the exclusive distributor in the rest of the world. In September 1994, MCI invested $79 million in this business venture and intends to continue making contributions to Concert over the next several years in order to maintain its proportionate interest.\nAlso in 1994, the company entered into a joint venture agreement with Grupo Financiero Banamex-Accival (\"Banacci\"), Mexico's largest financial group, which resulted in the formation of AVANTEL S.A. de C.V. (\"AVANTEL\") to provide competitive domestic and international long-distance telecommunications services in Mexico using MCI's technology. Subject to the grant of a concession from the government of Mexico, AVANTEL is expected to provide competitive switched telecommunication services in Mexico commencing in 1996. MCI owns a 45% equity interest in AVANTEL. The consummation of the transaction with Banacci is subject to the satisfaction of various conditions, including the receipt of a concession which has not yet been obtained.\nIn 1992, MCI entered into a strategic alliance with Stentor, an alliance of major Canadian telephone companies, to develop a fully integrated intelligent network linking the United States and\nPage 5 of 28\nCanada. The Stentor alliance and the AVANTEL joint venture will facilitate the development of a fully integrated, seamless North American network capable of providing services with identical features to customers throughout the United States, Canada and Mexico.\nCOMPETITION -----------\nLong-Distance Telecommunications Services -----------------------------------------\nCompetition in the long-distance telecommunications services market is intense, and MCI expects it to remain so for the foreseeable future. AT&T Corp. (\"AT&T\") continues to be MCI's primary competitor in the domestic and international long-distance telecommunications services market. AT&T is substantially larger than MCI and continues to compete vigorously with MCI. In general, MCI's long-distance telecommunications services are priced lower than the comparable services offered by AT&T. Although price is a significant factor in customer choice, innovation and quality of services, marketing strategy, customer service and other non-price factors are also important elements affecting competition.\nMCI also competes with Sprint Corporation and other facilities-based domestic telecommunications common carriers and numerous resellers of long-distance telecommunications services. Under current Federal Communications Commission (\"FCC\") policy, almost any entity can freely enter the domestic long-distance telecommunications services market. Further, MCI also competes with LECs that service a local access transport area (\"LATA\") where MCI is authorized to provide intra-LATA long-distance telecommunications services. MCI expects competition in this market to remain intense for the foreseeable future.\nThe seven Regional Bell Operating Companies (\"RBOCs\") are currently prohibited by the 1982 AT&T divestiture decree from entering the interstate long-distance telecommunications services market. Nevertheless, they have attempted to obtain relief from this and other restrictions through petitions to the federal courts and support of proposed legislation in Congress.\nA telecommunications bill is pending before the United States Senate which would allow long-distance carriers to provide local services and the RBOCs to provide long-distance services with certain restrictions and requirements applicable to the RBOCs. It is expected that the House of Representatives will introduce a bill covering these subjects in May 1995.\nPage 6 of 28\nIt is not possible at this time to determine if a bill will be adopted or enacted by the United States Congress and, if enacted, what it will provide. However, if such a bill is passed, it is likely it will permit the RBOCs to compete in the long-distance services business subject to certain restrictions and conditions.\nIf the RBOCs are permitted to offer long-distance services, MCI anticipates that the RBOCs, which have very substantial capital and other resources and long standing customer relationships, will compete vigorously in this market. Furthermore, to the extent the RBOCs maintain a monopoly in their local services markets, they have the potential to subsidize long-distance rates with profits from their monopoly business.\nConcert -------\nAT&T and Sprint have formed, or are in the process of forming, global alliances that will compete with Concert. AT&T's WorldPartners is an association of member companies formed in 1993 to provide a family of telecommunications services (private line, frame relay and virtual network services) to multinational customers. Members of the association include AT&T, KDD of Japan, Singapore Telecom, Telstra of Australia, Unisource, Hong Kong Telecom, Unitel of Canada, Korea Telecom and Telefonica of Spain.\nSprint, France Telecom (\"FT\") and Deutsche Telekom (\"DT\") have announced plans to form a global partnership to offer an array of international telecommunication services to multinational business customers. As part of the proposed transaction, FT and DT will each acquire up to 10% of Sprint's common stock. This partnership is subject to various United States regulatory approvals and may be subject to foreign regulatory approvals.\nIt is expected that AT&T's World Partners and the Sprint, FT and DT partnership, if it obtains the necessary regulatory approvals, will be significant competitors of Concert.\nLocal Services --------------\nThe partial unbundling of local special and switched access services through the FCC's actions has created an opportunity for MCI, through MCImetro, and the CAPs to compete with the LECs in providing these services. See \"LOCAL ACCESS\" above. In addition, as the state regulatory authorities open up additional local services to competition, MCImetro will also compete with the LECs in the offering of these services. MCI expects that the LECs, which have substantial capital and other resources, long standing customer relationships, extensive existing facilities and network rights-of- way, will compete vigorously with MCImetro in the local services market. A number of other regulatory issues, such as local number\nPage 7 of 28\nportability, mutual compensation arrangements and universal service reform, will have profound impacts on the development of competition in the local services market. While the FCC has announced its intention to address some of these issues, the timing and possible outcome of its decisions are unknown.\nFurther, the state regulatory agencies regulating the LECs may provide them with a greater degree of flexibility in pricing their services than is currently permitted. This greater flexibility may allow the LECs to determine their rates within a certain range and to enter into individual contracts with customers. The company believes this flexibility and the LECs control of those portions of the local exchange network that cannot be reproduced efficiently by competitors present opportunities for the LECs to subsidize the cost of services which compete with MCImetro's proposed services in an effort to stifle competition.\nMCImetro will also compete in the local services market with a number of CAPs, a few of which have existing local networks and significant financial resources.\nREGULATION ----------\nThe FCC has extensive authority to regulate interstate services and local access facilities and services provided by the common carriers, including the power to review the interstate rates charged by carriers and to establish policies that promote competition for interstate telecommunications services. For example, the FCC requires that all common carriers subject to its jurisdiction file tariffs for service offerings. MCI's long- distance offerings are considered \"non-dominant\" by the FCC and, in general, are subject to less regulatory requirements than AT&T's. The FCC has also announced that CAPs, such as MCImetro, shall file tariffs as non-dominant carriers, which filing requirements are less restrictive than those imposed on the LECs.\nSeveral actions by the FCC will affect MCI's cost of purchasing interstate access from the LECs, although the impact is not quantifiable. For example, in 1992, the FCC required the LECs to offer dedicated, flat-rated (non-usage sensitive) transport. This rate structure is similar to that offered by CAPs and may encourage the development of competitive pricing. The FCC has given the LECs limited pricing flexibility in offering transport, including the ability to offer volume term pricing discounts once a threshold level of CAPs' circuits are interconnected to a LEC network. In addition, LECs are also required to offer transport priced on a per minute of use basis, an alternative that is likely to be used by smaller and mid-sized long-distance companies with lower traffic volumes. This per minute alternative was intended by the FCC to mitigate potential adverse effects on long-distance competition of\nPage 8 of 28\nvolume based transport charges. During 1995, the FCC is expected to consider further revisions to its transport rules, which may require the LECs to revise their transport tariffs.\nThe FCC also has permitted to take effect, subject to further investigation, LEC expanded interconnection tariffs that establish the rates, terms and conditions by which CAPs interconnect to LEC networks for the delivery of interstate access services. The FCC has mandated that the LECs provide interconnection at a point just outside their switching facilities (\"virtual\" collocation), although LECs may at their option allow interconnection inside their switching facilities (\"physical\" collocation). The FCC's decisions are expected to permit MCImetro and CAPs to begin to offer interstate switched and special access services.\nTo the extent MCI and MCImetro provide intrastate local and long-distance services, they are subject to state regulatory commissions which have extensive authority to regulate the provision of such services. MCImetro will not be able to offer a full range of services in competition with the LECs unless state regulatory rules change significantly. MCI will vigorously pursue legislative and regulatory changes that open remaining local services markets to competition. The development of effective competition for local services also depends on state regulators' responses to issues of local number portability, mutual compensation arrangements, universal service reform and other issues.\nRates of international communications carriers for traffic from the United States to foreign countries are subject to regulation by the FCC. Revenues derived from international services (with the exception of leased channel services) are generally collected by the originating carrier and divided with the terminating carriers by means of agreements that are subject to the approval of the FCC and the appropriate overseas agency. International communications facilities in the United States are also subject to the jurisdiction of the FCC, and the provision of services to a foreign country is subject to the approval of the FCC and the appropriate foreign governmental agencies.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties. -------------------\nMCI leases, under long-term leases, portions of railroad, utility and other rights-of-way for its fiber-optic transmission system. MCI also has numerous tower sites, generally in rural areas, to serve as repeater stations in its domestic microwave transmission system. Most of these sites are leased, although MCI does own many of those which are at an intersection of two or more routes of MCI's transmission system. Generally, MCI owns the buildings that serve as switch facilities for the transmission\nPage 9 of 28\nsystem. In metropolitan areas, MCI leases facilities to serve as operations facilities for its intercity and overseas transmissions systems.\nMCI also leases, under long-term leases, office space to serve as sales office and\/or administrative facilities. Some of these facilities are located jointly with operations facilities. In addition, MCI owns its headquarters building in Washington, D.C. and two buildings in a suburb of Washington, D.C., as well as administrative facilities in Cary, North Carolina; Cedar Rapids, Iowa; Colorado Springs, Colorado; Piscataway, New Jersey; and Richardson, Texas.\nItem 3.","section_3":"Item 3. Legal Proceedings. ---------------------------\nInformation regarding contingencies and legal proceedings is included in Note 11 of the Notes to Consolidated Financial Statements on page 23 of the company's Annual Report to Stockholders for the year ended December 31, 1994, which has been filed as Exhibit 13 to this Annual Report on Form 10-K. Such information is incorporated herein by reference pursuant to General Instruction G(2).\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders. -------------------------------------------------------------\nNone.\nITEM 10. EXECUTIVE OFFICERS BEGINS ON NEXT PAGE.\nPage 10 of 28\nItem 10. Executive Officers of the Registrant.* -----------------------------------------------\nThe executive officers of MCI, including its subsidiaries, are elected annually and serve at the pleasure of the respective board of directors. They are:\nName Age* Position**\nBert C. Roberts, Jr. 52 Chairman of the Board, Chief Executive Officer, Director\nGerald H. Taylor 53 President and Chief Operating Officer, Director\nTimothy F. Price 41 Executive Vice President and Group President, MCI Telecommunications Corporation\nSeth D. Blumenfeld 54 President, MCI International, Inc.\nAngela O. Dunlap 38 Executive Vice President, MCI Telecommunications Corporation\nJohn W. Gerdelman 42 Executive Vice President, MCI Telecommunications Corporation\nDouglas L. Maine 46 Executive Vice President and Chief Financial Officer\nScott B. Ross 43 Executive Vice President, MCI Telecommunications Corporation\nMichael J. Rowny 44 Executive Vice President, MCI Telecommunications Corporation\nFred M. Briggs 46 Senior Vice President, MCI Telecommunications Corporation\nLaurence E. Harris 58 Senior Vice President, MCI Telecommunications Corporation\nJohn R. Worthington 64 Senior Vice President, General Counsel, Director\nBradley E. Sparks 48 Vice President and Controller\n-------------------- *As of March 1, 1995. **Unless otherwise indicated, the position is with MCI Communications Corporation.\nPage 11 of 28\nMr. Roberts has been Chairman of the Board of MCI since June 1992 and Chief Executive Officer of MCI since December 1991. He was President and Chief Operating Officer of MCI from October 1985 to June 1992 and President of MCI Telecommunications Corporation, the subsidiary of MCI providing long-distance telecommunications services, from May 1983 to June 1992. Mr. Roberts has been a director of MCI since 1985.\nMr. Taylor has been President and Chief Operating Officer since July 1994. He has been President and Chief Operating Officer of MCI Telecommunications Corporation since April 1994. He was an Executive Vice President and Group Executive of MCI Telecommunications Corporation from September 1993 to April 1994. He was an Executive Vice President of MCI Telecommunications Corporation, serving as President, Consumer Markets, from November 1990 to September 1993. For more than five years prior thereto, Mr. Taylor was a Senior Vice President of MCI Telecommunications Corporation, serving at separate times, as President of the Mid- Atlantic Division and the West Division. Mr. Taylor has been a director since September 1994.\nMr. Price has been an Executive Vice President and Group President of MCI Telecommunications Corporation, serving as Group President, Communication Services, since December 1994. He was an Executive Vice President of MCI Telecommunications Corporation, serving as President, Business Markets, from June 1993 to December 1994. He was a Senior Vice President of MCI Telecommunications Corporation from November 1990 to June 1993, serving as President, Business Services, from July 1992 to June 1993 and as Senior Vice President, Consumer Markets, from November 1990 to July 1992. For more than five years prior thereto, Mr. Price was a Vice President of MCI Telecommunications Corporation.\nMr. Blumenfeld has been President of MCI International, Inc., a subsidiary of MCI that provides and markets telecommunications services internationally, since September 1984.\nMs. Dunlap has been an Executive Vice President of MCI Telecommunications Corporation, serving as President, Consumer Markets, since October 1993. She was a Senior Vice President of MCI Telecommunications Corporation serving as Senior Vice President, Consumer Markets, from April 1993 to October 1993 and Vice President of MCI Telecommunications Corporation from November 1990 to April 1993. For more than five years prior thereto, Ms. Dunlap was employed by MCI Telecommunications Corporation in various managerial positions.\nMr. Gerdelman has been an Executive Vice President of MCI Telecommunications Corporation, serving as President, networkMCI Services, since October 1994. He was a Senior Vice President of MCI Telecommunications Corporation from August 1992 to October 1994. From July 1991 to August 1992 he was President and Chief\nPage 12 of 28\nExecutive Officer of MCI Services Marketing, Inc., a company that provided telemarketing services to, and in which a 51% equity interest was held by, MCI Telecommunications Corporation. For more than two years prior thereto, he was Executive Vice President and Chief Operating Officer of Pioneer Teletechnologies, Inc., a company that provided telemarketing services to, and in which a 25% equity interest was owned by, MCI Telecommunications Corporation. Mr. Gerdelman is also a director of General Communication, Inc., a telecommunications provider in Alaska, of which MCI Telecommunications Corporation owns approximately 33% of its outstanding shares of Class A Common Stock and approximately 31% of its outstanding shares of Class B Common Stock.\nMr. Maine has been an Executive Vice President since April 1994. He was a Senior Vice President from September 1988 to April 1994. Mr. Maine has been Chief Financial Officer of MCI since February 1992, was Senior Vice President of Finance from April 1989 to November 1990 and was Controller of MCI from June 1987 to April 1989. From November 1990 to February 1992, he was a Senior Vice President of MCI Telecommunications Corporation, serving as President of the Southern Division.\nMr. Ross has been an Executive Vice President of MCI Telecommunications Corporation, serving as President, Business Markets, since December 1994. He was a Senior Vice President of MCI Telecommunications Corporation from September 1993 to December 1994 and a Vice President of MCI Telecommunications Corporation for more than five years prior thereto.\nMr. Rowny has been an Executive Vice President of MCI Telecommunications Corporation, serving as Executive Vice President, Alliances and Ventures, since June 1994. Prior thereto, he was President of MJR Enterprises, a consulting company, from April 1994 to June 1994; Executive Vice President and Chief Financial Officer and a director of ICF Kaiser International, Inc., an environmental and engineering services company, from April 1992 to April 1994; and Chairman and Chief Executive Officer of Ransohoff Company, a manufacturer of environmental and industrial equipment, from November 1989 to April 1992.\nMr. Briggs has been a Senior Vice President of MCI Telecommunications Corporation since July 1989. Mr. Briggs has served as Chief Engineering Officer since October 1994 and, for more than five years prior thereto, he served as Senior Vice President, Network Services.\nMr. Harris has been a Senior Vice President of MCI Telecommunications Corporation since January 1995. He was General Manager of MCI's Wireless Communications Services group from December 1993 through December 1994. For more than five years prior thereto, he served, simultaneously, as Chairman, President\nPage 13 of 28\nand Chief Executive Officer of Crico Communications Corporation and President and Chief Executive Officer of International Telecom Systems, each of which provide paging services.\nMr. Worthington has been General Counsel of MCI since 1971, a Senior Vice President of MCI since September 1979, and a director of MCI since 1968.\nMr. Sparks has been a Vice President and Controller of MCI since September 1993 and was a Vice President and Treasurer of MCI from September 1988 to September 1993.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related ----------------------------------------------------------------- Stockholder Matters. -------------------\nMCI Common Stock is traded on the NASDAQ National Market. The tables below set forth the high and low sales prices of the Common Stock as reported for the periods indicated. (Prices in the 1993 table below have been adjusted for the two-for-one stock split effected in the form of a 100% stock dividend issued on July 9, 1993.)\nHIGH LOW -------- ---------\n1st Quarter $29 $22 5\/8 2nd Quarter 24 15\/16 21 3\/8 3rd Quarter 25 7\/8 21 1\/2 4th Quarter 25 1\/2 17 1\/4\nHIGH LOW -------- ---------\n1st Quarter $23 $18 13\/16 2nd Quarter 28 15\/16 21 7\/16 3rd Quarter 29 7\/8 26 1\/4 4th Quarter 29 5\/8 24 1\/8\nPage 14 of 28\nMCI paid cash dividends of $.025 per share of Common Stock in July and December 1993 and 1994 (July 1993 is adjusted for the effect of the two-for-one stock split) and an equivalent cash dividend on the shares of Series D Preferred Stock and Class A Common Stock outstanding at the applicable record date.\nAt February 17, 1995, there were 52,297 holders of record of MCI's Common Stock and 1 holder of record of MCI's Class A Common Stock.\nItems 6 through 8. -----------------\nThe information required by these items is included in pages 4 through 25 of the company's Annual Report to Stockholders for the year ended December 31, 1994. The referenced pages of the company's Annual Report to Stockholders have been filed as Exhibit 13 to this document. Such information is incorporated herein by reference pursuant to General Instruction G(2).\nItem 9. Change in and Disagreements with Accountants on -------------------------------------------------------- Accounting and Financial Disclosure. ------------------------------------\nNone.\nPART III\nItem 10. Directors and Executive Officers. ------------------------------------------\nInformation with respect to executive officers of MCI is set forth in Part I of this Annual Report on Form 10-K.\nInformation with respect to directors of MCI is incorporated herein by reference to the information under the captions \"Election of Directors\" and \"Compliance with Section 16(a) of the Exchange Act\" in MCI's Proxy Statement for its 1995 Annual Meeting of Stockholders (the \"1995 Proxy Statement\").\nItem 11. Executive Compensation. --------------------------------\nInformation with respect to executive compensation is incorporated herein by reference to information under the captions \"Board of Directors' Committees, Meetings and Fees\", \"Remuneration of Executive Officers\", \"Pension Plans\" and \"Compensation Committee Interlocks and Insider Participation\" in the 1995 Proxy Statement.\nPage 15 of 28\nItem 12. Security Ownership of Certain Beneficial Owners and ------------------------------------------------------------- Management. ----------\nInformation with respect to security ownership is incorporated herein by reference to the information under the captions \"Election of Directors\" and \"Security Ownership of Management and Certain Beneficial Owners\" in the 1995 Proxy Statement.\nItem 13. Certain Relationships and Related Transactions. --------------------------------------------------------\nInformation with respect to certain relationships and related transactions is incorporated herein by reference to the information under the caption \"Certain Relationships and Related Transactions\" in the 1995 Proxy Statement.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules and Reports on ----------------------------------------------------------------- Form 8-K. --------\n(a) Documents filed as a part of this report.\n(1) Financial Statements:\nReport of Management\nReport of Independent Accountants\nIncome Statements for the years ended December 31, 1994, 1993 and 1992\nBalance Sheets at December 31, 1994 and 1993\nStatements of Cash Flows for the years ended December 31, 1994, 1993 and 1992\nStatements of Stockholders' Equity for the years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nPage 16 of 28\nThe Financial Statements and Notes thereto are incorporated herein by reference to the appropriate portions of the company's Annual Report to Stockholders for the year ended December 31, 1994. (See Part II.)\n(2) Financial Statement Schedules:\nThe following additional financial data should be read in conjunction with the Financial Statements and Notes thereto which are included in Exhibit 13 to this Annual Report on Form 10-K. Schedules not included with this additional financial data have been omitted because they are not required or applicable or the required information is shown in the Financial Statements or Notes thereto.\nReport of Independent Accountants on Financial Statement Schedules\nCommunications System (Schedule V)\nAccumulated Depreciation of Communications System (Schedule VI)\nValuation and Qualifying Accounts (Schedule VIII)\nThe Financial Statement Schedules are submitted as Exhibits 99(a)-(c) to this Annual Report on Form 10-K.\n(3) Exhibits.\nExecutive compensation plans and arrangements required to be filed, and which have been filed, with the Commission pursuant to Item 14(c) of this Annual Report on Form 10-K are listed in this Annual Report on Form 10-K as Exhibits 10(a)-(i).\nExhibit No. Description ----------- -----------\n3 (a) Restated Certificate of Incorporation of MCI Communications Corporation filed on March 28, 1995.\n(b) By-laws of registrant, as amended. (Incorporated by reference to Exhibit 3(ii) to registrant's Form S-3, Reg. No. 33-57155.)\n4 (a) Indenture, dated as of October 15, 1989, between registrant and Bankers Trust Company. (Incorporated by reference to Exhibit 4(c) to registrant's Registration Statement on Form S-3, Reg. No. 33-31600.)\nPage 17 of 28\n(b) Indenture dated as of October 15, 1989 between registrant and Bankers Trust Company. (Incorporated by reference to Exhibit 4(d) to registrant's Registration Statement on Form S-3, Reg. No. 33-31600.)\n(c) Indenture dated as of October 15, 1989 between registrant and Citibank, N.A. (Incorporated by reference to Exhibit 4(e) to registrant's Registration Statement on Form S-3, Reg. No. 33- 31600.)\n(d) Indenture dated as of February 17, 1995 between registrant and Citibank, N.A.\n(e) Form of Senior Fixed Rate Medium-Term Note. (Incorporated by reference to Exhibit 4(f) to registrant's Registration Statement on Form S-3, Reg. No. 33-57155.)\n(f) Form of Senior Floating Rate Medium-Term Note. (Incorporated by reference to Exhibit 4(g) to registrant's Registration Statement on Form S-3, Reg. No. 33-57155.)\n(g) Form of Subordinated Fixed Rate Medium-Term Note. (Incorporated by reference to Exhibit 4(g) to registrant's Registration Statement on Form S-3, Reg. No. 33-31600.)\n(h) Form of Subordinated Floating Rate Medium-Term Note. (Incorporated by reference to Exhibit 4(i) to registrant's Registration Statement on Form S-3, Reg. No. 33-31600.)\n(i) Form of 7-5\/8% Senior Note due November 7, 1996. (Incorporated by reference to Exhibit 1(c) to registrant's Current Report on Form 8-K dated November 6, 1991.)\n(j) Form of 7-1\/2% Senior Note due August 20, 2004. (Incorporated by reference to Exhibit 4 of registrant's Quarterly Report on Form 10-Q for the Quarter Ended June 30, 1992.)\n(k) Form of 7-1\/8% Senior Note due January 20, 2000. (Incorporated by reference to Exhibit 1(b) of registrant's Current Report on Form 8-K dated January 19, 1993.)\nPage 18 of 28\n(l) Form of 8-1\/4% Senior Debenture due January 20, 2023. (Incorporated by reference to Exhibit 1(c) of registrant's Current Report on Form 8-K dated January 19, 1993.)\n(m) Form of 7-3\/4% Senior Debenture due March 15, 2024. (Incorporated by reference to Exhibit 4(a) of registrant's Current Report on Form 8-K dated March 12, 1993.)\n(n) Form of 6-1\/4% Senior Note due March 23, 1999. (Incorporated by reference to Exhibit 4(a) of registrant's Current Report on Form 8-K dated March 15, 1994.)\n(o) Form of 7-3\/4% Senior Debenture due March 23, 2025. (Incorporated by reference to Exhibit 4(b) of registrant's Current Report on Form 8-K dated March 15, 1994.)\n(p) Form of Senior Floating Rate Note due March 16, 1999. (Incorporated by reference to Exhibit 4(c) of registrant's Current Report on Form 8-K dated March 15, 1994.)\n(q) Rights Agreement dated as of September 30, 1994 between the registrant and Mellon Bank, N.A. (Incorporated by reference to Exhibit 4(a) to registrant's Current Report on Form 8-K dated October 4, 1994.)\n10 (a) 1979 Stock Option Plan of registrant, as amended and restated. (Incorporated by reference to Exhibit 10(a) to registrant's Annual Report on Form 10-K for the year ended December 31, 1988.)\n(b) Supplemental Retirement Plan for Employees of MCI Communications Corporation and Subsidiaries, as amended. (Incorporated by reference to Exhibit 10(b) to registrant's Annual Report on Form 10-K for the year ended December 31, 1993.)\n(c) Description of Executive Life Insurance Plan for MCI Communications Corporation and Subsidiaries. (Incorporated by reference to \"Remuneration of Officers\" in registrant's Proxy Statement for its 1992 Annual Meeting of Stockholders.)\n(d) MCI Communications Corporation Executive Incentive Compensation Plan. (Incorporated by reference to Exhibit 10(d) to registrant's Annual Report on Form 10-K for the year ended December 31, 1988.)\nPage 19 of 28\n(e) MCI Communications Corporation Executive Incentive Compensation Plan.\n(f) Form of Director Indemnification Agreement.(Incorporated by reference to Appendix B to registrant's Proxy Statement for its 1987 Annual Meeting of Stockholders.)\n(g) 1988 Directors' Stock Option Plan of registrant. (Incorporated by reference to Exhibit D to registrant's Proxy Statement for its 1989 Annual Meeting of Stockholders.)\n(h) Stock Option Plan of registrant. (Incorporated by reference to Exhibit C to registrant's Proxy Statement for its 1989 Annual Meeting of Stockholders.)\n(i) Board of Directors Deferred Compensation Plan of Registrant.\n(j) $2,000,000,000 Revolving Credit Agreement dated as of July 8, 1994 among MCI Communications Corporation, Bank of America National Trust and Savings Association and the several financial institutions parties thereto. (Incorporated by reference to Exhibit 10 (a) to registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994.)\n(k) Amended and Restated Investment Agreement dated as of January 31, 1994 between MCI Communications Corporation and British Telecommunications plc. (Incorporated by reference to Appendix I of registrant's Notice of Special Meeting of Stockholders and Proxy Statement dated February 4, 1994.)\n(l) Modified Joint Venture Agreement dated as of July 1, 1994 between MCI Communications Corporation and British Telecommunications plc and MCI Ventures Corporation and Moorgate (Twelve) Limited and Concert Communications Company.\n11 Computation of Earnings per Common Share.\n12 Computation of Ratio of Earnings to Fixed Charges.\n13 Specified portions (pages 4 through 25) of the registrant's Annual Report to Stockholders for the year ended December 31, 1994.\nPage 20 of 28\n21 Significant Subsidiaries of MCI Communications Corporation.\n23 Consent of Independent Accountants.\n27 Financial Data Schedule.\n99 (a) Communications System (Schedule V).\n(b) Accumulated Depreciation of Communications System (Schedule VI).\n(c) Valuation and Qualifying Accounts (Schedule VIII).\n(d) Capitalization Schedule.\n(b) Reports on Form 8-K.\nThe registrant filed a Current Report on Form 8-K dated October 4, 1994 to report in Item 5 the adoption of a stockholder rights plan by the registrant and to file as an Exhibit under Item 7","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":"876858_1994.txt","cik":"876858","year":"1994","section_1":"Item 1. Business\nThe Sears Credit Account Trust 1991 C (the \"Trust\") was formed pursuant to the Pooling and Servicing Agreement dated as of July 1, 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 Bank of America Illinois 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 June, 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 1994 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, 1995, 100% of the Investor Certificates were held in the nominee name of CEDE and Co. for beneficial owners.\nSRFG, as of March 15, 1995, 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. 1994 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT ACCOUTNANTS' REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Agreed Upon Procedures Letter.\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 17, 1994, November 15, 1994, and December 15, 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.\nSears Credit Account Trust 1991 C (Registrant)\nBy: Sears Receivables Financing Group, Inc. (Originator of the Trust)\nBy: \/S\/Perry N. Weine Perry N. Weine Vice President, Administration\nDated: March 30, 1995\nEXHIBIT INDEX\nPage number in sequential Exhibit No. number system\n21. 1994 ANNUAL STATEMENT prepared by the Servicer.\n28. ANNUAL INDEPENDENT ACCOUNTANTS' REPORTS pursuant to Section 3.06 of the Pooling and Servicing Agreement.\n(a) Agreed Upon Procedures Letter.\n(b) Annual Servicing Letter.","section_15":""}
{"filename":"9466_1994.txt","cik":"9466","year":"1994","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 two wholly owned subsidiaries of BGE, Constellation Holdings, Inc. and its subsidiaries (collectively, the Constellation Companies) and BGE Home Products & Services, Inc. (HPS) and its subsidiary Maryland Environmental Systems, Inc. (MES).\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\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 8.\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 offices, 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 and 1994, 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 482 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. 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, 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 Executive 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 STOCK 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, 1995, there were 81,056 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 1994 and 1993 in the amounts set forth below.\nCOMMON STOCK DIVIDENDS AND PRICE RANGES\n*Based on New York Stock Exchange Composite Transactions as reported in the eastern edition of THE WALL STREET JOURNAL.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nCERTAIN PRIOR-YEAR AMOUNTS HAVE BEEN RECLASSIFIED TO CONFORM TO THE CURRENT YEAR'S PRESENTATION.\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.\nEffective July 1, 1994, BGE formed a wholly owned subsidiary, BGE Home Products & Services, Inc. (HPS), consisting of BGE's existing merchandise and gas and appliance service operations. HPS' revenues and expenses are included in diversified businesses revenues and diversified businesses selling, general, and administrative expenses, respectively. Prior-year amounts have been reclassified to conform with the current year's presentation.\nRESULTS OF OPERATIONS\nEARNINGS PER SHARE OF COMMON STOCK\nConsolidated earnings per share were $1.93 for 1994 and $1.85 for 1993, an increase of $.08 and $.22 from prior-year amounts, respectively. The changes in earnings per share reflect a higher level of earnings applicable to common stock, offset partially by the larger number of outstanding common shares. The summary below presents the earnings-per-share amounts.\n1994 1993 1992 Utility business $1.81 $1.77 $1.52 Diversified businesses .12 .08 .11 Total $1.93 $1.85 $1.63\nEARNINGS APPLICABLE TO COMMON STOCK\nEarnings applicable to common stock increased $15.7 million in 1994 and $45.9 million in 1993. The 1994 increase reflects higher utility and diversified businesses earnings. The 1993 increase reflects higher utility earnings, slightly offset by lower earnings from diversified businesses.\nUtility earnings increased in 1994 compared to the prior year due to three principal factors: lower operations and maintenance expenses; an increase in the allowance for funds used during construction; and greater sales of electricity. The higher sales of electricity are primarily due to an increased number of customers compared to 1993. The 1994 earnings increase was offset partially by higher depreciation and amortization expense, which includes the write-off of certain Perryman costs (see discussion on page 29). Utility earnings increased in 1993 over 1992 because BGE sold more electricity than in the previous year and because of increased base rates. Three 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 offset partially by higher operations and maintenance expenses, depreciation and amortization expense, 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%.\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 favorably affected utility earnings through April 1994. Several electric fuel rate cases now pending before the PSC discussed in Notes 1 and 13 could also affect future years' earnings.\nFuture competition may also affect earnings in ways that are not possible to predict (see discussion on page 33).\nEarnings from diversified businesses, which primarily represent the operations of Constellation Holdings, Inc. (CHI) and its subsidiaries (collectively, the Constellation Companies) and BGE Home Products & Services, Inc. (HPS), increased during 1994 and decreased during 1993. The reasons for these changes are discussed in the \"Diversified Businesses Earnings\" section on pages 30 and 31.\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 actual 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. Conversely, 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 for 1994 and 1993.\n30-Year 1994 1993 Average Cooling degree days 949 865 804 Percentage change compared to prior year 9.7% 22.3% Heating degree days 4,670 4,959 4,901 Percentage change compared to prior year (5.8)% (0.3)%\nBGE UTILITY REVENUES AND SALES\nElectric revenues changed during 1994 and 1993 because of the following factors:\n1994 1993 (IN MILLIONS) System sales volumes $ 9.9 $112.4 Base rates 1.4 58.5 Fuel rates (21.5) (55.0) Revenues from system sales (10.2) 115.9 Interchange sales 26.5 27.2 Other revenues (1.9) 3.5 Total electric revenues $ 14.4 $146.6\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. Below is a comparison of the changes in electric system sales volumes.\n1994 1993 Residential 0.5% 9.0% Commercial (0.4) 4.1 Industrial 17.8 2.7 Total 2.5 5.8\nSales to residential and commercial customers were essentially unchanged from the prior year due to three factors: the number of customers increased; higher sales from extreme weather conditions early in the year slightly exceeded lower sales from milder weather in the second half of the year; and usage-per-customer decreased. Sales to industrial customers reflect primarily an increase in the sale of electricity to Bethlehem Steel, which purchased more electricity from BGE due to increased steel production and the fact that Bethlehem Steel is now purchasing its full electricity requirements from BGE. Bethlehem Steel is still producing power with its own generating facility, but is now selling the output from this facility to BGE rather than using the power to reduce its requirements. Hotter summer weather was the main reason for the increase in total sales in 1993. The sales increases to the residential and commercial customers reflect significantly hotter summer weather, and to a lesser extent, increased usage and customer growth. Sales to the industrial class reflect increased sales of electricity to Bethlehem Steel to support its increased steel production during 1993.\nBase rates increased slightly during 1994 due to the remaining effect of the PSC's April 1993 rate order, offset partially by the deferral of the portion of energy conservation surcharge billings subject to refund. Base rates increased in 1993 due to the PSC's April 1993 rate order and an increased recovery of eligible electric conservation program costs through the energy conservation surcharge.\nThe 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%.\nUnder the energy conservation surcharge, if the PSC determines that BGE is earning in excess of its authorized rate of return, BGE will have to refund (by means of lowering future surcharges) a portion of energy conservation surcharge revenues to its customers. The portion subject to the refund is compensation for foregone sales from conservation programs and incentives for achieving conservation goals and will be refunded to customers with interest beginning in the ensuing July when the annual resetting of the conservation surcharge rates occurs. BGE earned in excess of its authorized rate of return on electric operations for the period July 1, 1993 through June 30, 1994. As a result, BGE deferred the portion of electric energy conservation revenues subject to refund for the period December 1993 through November 1994. The deferral of these billings totaled $20.1 million.\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 1994 and 1993 due to a lower fuel rate, offset partially by increased electric system sales volumes. 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 previous year. BGE expects electric fuel rate revenues to remain relatively constant through 1995.\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 its own system sales of electricity, if BGE' s available generation is the least costly available to PJM utilities. Interchange sales increased during 1994 and 1993 because BGE had a less-costly generation mix than other PJM utilities. The less-costly mix reflects greater generation from the Brandon Shores Power Plant and the operation of the Calvert Cliffs Nuclear Power Plant.\nGas revenues decreased during 1994 and increased during 1993 because of the following factors:\n1994 1993 (IN MILLIONS) Sales volumes $ 3.6 $ 0.6 Base rates 2.4 2.6 Gas cost adjustment revenues (16.1) 28.8 Other revenues (1.8) 0.8 Total gas revenues $ (11.9) $32.8\nThe changes in gas sales volumes compared to the year before were:\n1994 1993 Residential 0.6% 2.5% Commercial (3.4) 2.2 Industrial 4.2 (5.8) Total 0.7 (0.6)\nTotal gas sales increased during 1994 because of higher sales to residential and industrial customers, offset partially by lower sales to commercial customers. Sales to industrial customers reflect primarily greater usage of natural gas by Bethlehem Steel. Sales to commercial and industrial customers were negatively impacted because delivery service customers either voluntarily switched their fuel source from natural gas to alternate fuels, or were involuntarily interrupted by BGE as a result of extreme winter weather conditions in the first quarter of 1994. Interruptible customers maintain alternate fuel sources and pay reduced rates in exchange for BGE's right to interrupt service during periods of peak demand. Total gas sales decreased during 1993 because of lower sales to industrial customers, offset partially 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 their L-Blast furnace. The increases in sales to the residential and commercial classes of customers reflect the colder winter weather during the first quarter of 1993 and an increase in the number of customers.\nBase rates increased slightly in 1994 due to an increased recovery of eligible gas conservation program costs through the energy conservation surcharge. Base rates increased in 1993 for two 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 a return on BGE's higher level of gas rate base.\nChanges in gas cost adjustment revenues result primarily from the operation of the purchased gas adjustment clauses which are designed to recover actual gas costs (see Note 1). Changes in gas cost adjustment revenues normally do not affect earnings. Gas cost adjustment revenues decreased during 1994 primarily because of decreased prices of purchased gas and slightly lower sales volumes subject to the clauses. Gas cost adjustment revenues increased during 1993 primarily because of increased prices to recover higher costs of purchased gas and higher sales volumes subject to gas cost adjustment clauses. Delivery service sales volumes are not subject to gas cost adjustment clauses because delivery service customers purchase their gas directly from third parties.\nBGE UTILITY FUEL AND ENERGY EXPENSES\nElectric fuel and purchased energy expenses were as follows:\n1994 1993 1992 (IN MILLIONS) Actual costs $541.2 $483.9 $445.2 Net recovery of costs under electric fuel rate clause (see Note 1) 1.1 50.7 111.0 Total expense $542.3 $534.6 $556.2\nActual electric fuel and purchased energy costs increased during 1994 as a result of a more costly actual generation mix and an increase in the net output of electricity generated to meet the demand of BGE's system and the PJM system. The cost of the actual generation mix increased due to higher purchased energy costs and scheduled outages at the Calvert Cliffs Nuclear Power Plant in 1994. Actual electric fuel and purchased energy costs during 1993 increased for two 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.\nPurchased gas expenses were as follows:\n1994 1993 1992 (IN MILLIONS) Actual costs $222.7 $246.4 $213.6 Net (deferral) recovery of costs under purchased gas adjustment clause (see Note 1) 1.9 (3.7) 0.5 Total expense $224.6 $242.7 $214.1\nActual purchased gas costs decreased during 1994 for two reasons: lower gas prices and lower output associated with the decreased demand for BGE gas. The lower gas prices reflect market conditions and take-or-pay and other supplier refunds, offset by higher costs related to the implementation of Federal Energy Regulatory Commission (FERC) Order 636 and higher demand charges. Actual purchased gas costs increased in 1993 for three reasons: higher gas prices caused by market conditions; higher reservation charges; and higher output to meet greater demand for BGE gas.\nPurchased 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 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\nIn 1994, in order to more accurately reflect utility operations expense, BGE reclassified the amortization of deferred energy conservation expenditures and deferred nuclear expenditures from operations expense to depreciation and amortization expense. In addition, BGE reclassified diversified businesses' expenses from operations expense to diversified businesses-selling, general, and administrative expense. Prior-year amounts have been reclassified to conform with the current year's presentation.\nOperations expense decreased during 1994 primarily due to labor savings achieved as a result of the Company's employee reduction programs discussed in Note 7 and continuing cost control efforts. These savings offset higher expense from the amortization of the cost of the 1993 and 1992 Voluntary Special Early Retirement Programs (VSERP) and a $10.0 million charge for a bonus paid to employees in lieu of a general wage increase. In addition, operations expense for 1994 decreased because operations expense for 1993 included a $17.2 million charge for certain employee reduction programs, offset partially by a credit to expense equivalent to the $9.8 million cost of termination benefits associated with the Company' s 1992 VSERP.\nOperations expense increased during 1993 due to higher labor costs, employee reduction expenses (see Note 7), postretirement benefit expenses resulting from the implementation of Statement of Financial Accounting Standards No. 106 (see Note 6), and higher nuclear operating costs. These increases were offset partially by the 1993 reversal of the $9.8 million charge originally recorded in 1992 for termination benefits associated with the Company's 1992 VSERP to reflect the ratemaking treatment adopted by the PSC in its April 1993 rate order.\nOperations expense is expected to be reduced in 1995 due to the realization of a full year of cost savings from the employee reduction programs and continuing cost control efforts. These lower costs are expected to exceed other increases in operations expenses.\nMaintenance expense decreased during 1994 due primarily to lower costs at the Calvert Cliffs Nuclear Power Plant. Maintenance expense increased in 1993 because of higher labor costs and higher costs at the Calvert Cliffs Nuclear Power Plant.\nDepreciation and amortization expense increased during 1994 because of the write-off of certain Perryman costs discussed below. Additionally, depreciation and amortization expense increased in 1994 and 1993 because of higher depreciable plant in service and higher levels of energy conservation program costs. The increase in depreciable plant in service resulted from the addition of electric transmission and distribution plant and certain capital additions at the Calvert Cliffs Nuclear Power Plant during 1994 and 1993.\nInitially, BGE had planned to build two combined cycle generating units at its Perryman site. However, due to significant changes in the environment in which utilities operate, BGE now has no plans to construct the second combined cycle generating unit. Accordingly, during the third quarter of 1994, BGE wrote off $15.7 million of the costs associated with that second combined cycle unit. This write-off reduced after-tax earnings during 1994 by $11.0 million or 7 cents per share. Work on the first 140mw combustion turbine at Perryman continues to be on schedule for commercial operation in 1995.\nDepreciation and amortization expense in 1995 will be affected by the completion of a facility-specific study of the cost to decommission the Calvert Cliffs Nuclear Power Plant. This study generated a higher decommissioning cost than the prior estimate which will increase depreciation expense $9 million annually. In addition, the PSC issued an order adjusting BGE' s utility plant depreciation rates to reflect the results of a detailed depreciation study. The new depreciation rates are expected to result in an increase in depreciation accruals of approximately $21 million annually. BGE plans to defer the increased depreciation accruals for recovery in a future base rate proceeding, consistent with previous rate actions of the PSC.\nTaxes other than income taxes increased slightly during 1994 due primarily to higher property taxes resulting from higher levels of utility plant in service. Taxes other than income taxes increased during 1993 because of higher property taxes from the addition of Brandon Shores Unit 2 to the taxable base effective July 1, 1992, 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\nThe allowance for funds used during construction (AFC) increased during 1994 because of a higher level of construction work in progress which was offset partially by the lower AFC rate established by the PSC in the April 1993 rate order. AFC was essentially unchanged in 1993 because a higher level of construction work in progress was offset by the lower AFC rate discussed above.\nNet other income and deductions increased in 1994 primarily due to a lower level of charitable contributions and gains realized on the sale of receivables.\nCapitalized interest decreased during 1994 due to lower capitalized interest on the Constellation Companies' power generation systems, offset partially by the accrual by BGE of carrying charges on electric deferred fuel costs excluded from rate base (see Note 5). Capitalized interest increased during 1993 due to the accrual of carrying charges on electric deferred fuel costs excluded from rate base.\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 31.\nDIVERSIFIED BUSINESSES EARNINGS\nEarnings per share from diversified businesses were:\n1994 1993 1992 Constellation Holdings, Inc. Power generation systems $ .10 $ .07 $ .08 Financial investments .03 .10 .09\nReal estate development and senior living facilities (.03) (.04) (.05) Effect of 1993 Tax Act - (.04) - Other (.01) (.01) (.01) Total Constellation Holdings, Inc. .09 .08 .11 BGE Home Products & Services, Inc. .03 - - Total diversified businesses $ .12 $ .08 $ .11\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 increased in 1994 primarily due to payments for the curtailment of output at two wholesale power generating projects as discussed below. Power generation systems earnings during 1993 were essentially unchanged. Earnings for 1993 include $8.0 million of energy tax credits on the commercial operation of the Puna geothermal plant, offset by costs incurred at the Panther Creek waste-coal project in order to resolve fuel quality and other start-up problems.\nThe Constellation Companies' investment in wholesale power generating projects includes $177 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 rate for the first ten years of the agreements and at variable 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 subsequent to the inception of these agreements, 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 and pursuing\nalternatives 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 its ownership interests in the projects. Two of these wholesale power generating projects, in which the Constellation Companies' investment totals $27.4 million, have executed agreements with Pacific Gas & Electric (PG&E) providing for the curtailment of output through the end of the fixed price period in return for payments from PG&E. The payments from PG&E during the curtailment period will be sufficient to fully amortize the existing project finance debt. However, following the curtailment period, the projects remain contractually obligated to commence production of electricity at the avoided cost rates, which could result in reduced earnings or losses for the reasons described above. The Company cannot predict the impact that these matters regarding any of the 16 projects 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. Financial investment earnings decreased during 1994 due to reduced earnings from the investment portfolio. Additionally, 1993 results reflected a $6.1 million gain from the sale of a portion of an investment in a financial guaranty insurance company. Earnings increased slightly in 1993 as compared to 1992 because this gain was substantially offset by lower investment income 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.\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 increased slightly during 1994 due to gains recognized from the sale of two retail centers, an office building, and interests in two senior living facilities. The increases in diversified businesses' revenues and in selling, general, and administrative expenses reflect the proceeds of these sales and the cost of the facilities sold, respectively. Earnings from real estate development and senior living facilities were essentially unchanged in 1993 because a $2.1 million gain on the sale of a substantial portion of the 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.\nThe Constellation Companies' real estate portfolio has experienced continuing carrying costs and depreciation. Additionally, the Constellation Companies have been expensing rather than capitalizing interest on certain undeveloped land where development activities were at minimal levels. These factors have affected earnings negatively and are expected to continue to do so until the levels of undeveloped land are reduced. 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. To the extent the real estate market continues to improve, earnings from real estate activities are expected to improve also.\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 has improved, 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.\nBGE Home Products & Services earnings increased during 1994 primarily due to a gain on the sale of receivables.\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 this Report under 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 1992 through 1994, along with estimated amounts for the years 1995 through 1997, 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 above. Electric construction expenditures include the installation of two 5,000 kilowatt diesel generators at Calvert Cliffs Nuclear Power Plant, one of which is scheduled to be placed in service in 1995 and the second in 1996; 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 expenditures do not include additional generating units.\nDuring 1994, 1993, and 1992, the internal generation of cash from utility operations provided 72%, 71%, and 81% respectively, of the funds required for BGE's capital requirements exclusive of retirements and redemptions of debt and preference stock. In addition, in 1994, $70 million of cash was provided by the sale of certain BGE and HPS receivables (see Note 13). During the three-year period 1995 through 1997, the Company expects to provide through utility operations 100% 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, 1994, BGE's issuances of long-term debt, preference stock, and common stock were $1,557 million, $130 million, and $448 million, respectively. During the same period, retirements and redemptions of BGE's long-term debt and preference stock\ntotaled $1,425 million and $149 million, respectively, exclusive of any redemption premiums or discounts. 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 enhance the capital structure of Constellation Holdings, Inc.\nDIVERSIFIED BUSINESSES CAPITAL REQUIREMENTS\nDEBT AND LIQUIDITY\nThe Constellation Companies intend to meet capital requirements by refinancing debt as it comes due and through internally generated cash. These internal sources include cash that may be generated from operations, 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 31). 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 has entered into a $50 million revolving credit agreement.\nINVESTMENT REQUIREMENTS\nThe 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 1995 through 1997 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 amounts on page 32 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 institutional lenders.\nRESPONSE TO REGULATORY CHANGE\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. 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. In response to the competitive forces and regulatory changes, as discussed in Part 1 of this Report under the heading Regulatory Matters and Competition, BGE from time to time will consider various strategies designed to enhance its competitive position and to increase its ability to adapt to and anticipate regulatory changes in its utility business. These strategies may include internal restructurings involving the complete or partial separation of its generation, transmission and distribution businesses, acquisitions of related or unrelated businesses, business combinations, and additions to or dispositions of portions of its franchised service territories. BGE may from time to time be engaged in preliminary discussions, either internally or with third parties, regarding one or more of these potential strategies. No assurances can be given as to whether any potential transaction of the type described above may actually occur, or as to the ultimate effect thereof on the financial condition or competitive position of BGE.\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, 1994 and 1993, 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, 1994. 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 Baltimore Gas and Electric Company and Subsidiaries at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\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 1989-1991 outages at the Company's nuclear power plant, and the Company established in 1990 a reserve of $35 million 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.\nWe have also previously audited, in accordance with generally accepted standards, the consolidated balance sheets and statements of capitalization at December 31, 1992, 1991, and 1990, and the related consolidated statements of income, cash flows, common shareholders' equity, and income taxes for each of the two years in the period ended December 31, 1991 (none of which are presented herein); and we expressed unqualified opinions on those consolidated 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, 1994, appearing on page 21 is fairly stated in all material respects in relation to the financial statements from which it has been derived.\n\/s\/ Coopers and Lybrand L.L.P. COOPERS & LYBRAND L.L.P.\nBaltimore, Maryland January 20, 1995\nConsolidated Statements of Income\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nCERTAIN PRIOR-YEAR AMOUNTS HAVE BEEN RECLASSIFIED TO CONFORM TO THE CURRENT YEAR'S PRESENTATION.\nConsolidated Balance Sheets\nAT DECEMBER 31, 1994 1993 (IN THOUSANDS) ASSETS Current Assets Cash and cash equivalents $ 38,590 $ 84,236 Accounts receivable (net of allowance for uncollectibles) 314,842 401,853 Fuel stocks 70,627 70,233 Materials and supplies 149,614 145,130 Prepaid taxes other than income taxes 57,740 54,237 Other 47,022 38,971 Total current assets 678,435 794,660\nInvestments and Other Assets Real estate projects 471,435 487,397 Power generation systems 311,960 298,514 Financial investments 224,340 213,315 Nuclear decommissioning trust fund 66,891 56,207 Safe Harbor Water Power Corporation 34,168 34,138 Senior living facilities 11,540 2,005 Other 58,824 65,355 Total investments and other assets 1,179,158 1,156,931\nUtility Plant Plant in service Electric 5,929,996 5,713,259 Gas 616,823 557,942 Common 511,016 487,740 Total plant in service 7,057,835 6,758,941 Accumulated depreciation (2,305,372) (2,161,984) Net plant in service 4,752,463 4,596,957 Construction work in progress 506,030 436,440 Nuclear fuel (net of amortization) 134,012 139,424 Plant held for future use 24,320 24,066 Net utility plant 5,416,825 5,196,887\nDeferred Charges Regulatory assets 773,034 768,125 Other 96,086 70,436 Total deferred charges 869,120 838,561\nTotal Assets $ 8,143,538 $7,987,039\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nConsolidated Balance Sheets\nAT DECEMBER 31, 1994 1993 (IN THOUSANDS) LIABILITIES AND CAPITALIZATION Current Liabilities Short-term borrowings $ 63,700 $ - Current portions of long-term debt and preference stock 323,675 44,516 Accounts payable 181,931 195,534 Customer deposits 24,891 22,345 Accrued taxes 19,585 20,623 Accrued interest 60,348 58,541 Dividends declared 66,012 63,966 Accrued vacation costs 30,917 35,546 Other 30,857 38,716 Total current liabilities 801,916 479,787\nDeferred Credits and Other Liabilities Deferred income taxes 1,156,429 1,067,611 Deferred investment tax credits 149,394 157,426 Pension and postemployment benefits 138,835 183,043 Decommissioning of federal uranium enrichment facilities 45,836 46,858 Other 59,645 56,974 Total deferred credits and other liabilities 1,550,139 1,511,912\nCapitalization Long-term debt 2,584,932 2,823,144 Preferred stock 59,185 59,185 Redeemable preference stock 279,500 342,500 Preference stock not subject to mandatory redemption 150,000 150,000 Common shareholders' equity 2,717,866 2,620,511 Total capitalization 5,791,483 5,995,340\nCommitments, Guarantees, and Contingencies - See Note 13\nTotal Liabilities and Capitalization $8,143,538 $7,987,039\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nConsolidated Statements of Cash Flows\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nCERTAIN PRIOR-YEAR AMOUNTS HAVE BEEN RECLASSIFIED TO CONFORM TO THE CURRENT YEAR'S PRESENTATION.\nConsolidated Statements of Common Shareholders' Equity\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nConsolidated Statements of Capitalization\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nConsolidated Statements of Capitalization\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nConsolidated Statements of Income Taxes\nAT DECEMBER 31, 1994 1993 (DOLLAR AMOUNTS IN THOUSANDS) DEFERRED INCOME TAXES Deferred tax liabilities Accelerated depreciation $ 840,376 $ 789,165 Allowance for funds used during construction 208,726 202,490 Income taxes recoverable through future rates 93,952 90,950 Deferred termination and postemployment costs 53,749 55,890 Deferred fuel costs 41,507 45,518 Leveraged leases 31,948 32,613 Percentage repair allowance 36,630 35,431 Other 148,064 125,850 Total deferred tax liabilities 1,454,952 1,377,907 Deferred tax assets Alternative minimum tax 71,074 73,203 Accrued pension and postemployment benefit costs 51,163 64,065 Deferred investment tax credits 52,288 55,099 Other 123,998 117,929 Total deferred tax assets 298,523 310,296 Deferred income taxes per Consolidated Balance Sheets $1,156,429 $1,067,611\nSEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\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), BGE Home Products & Services, Inc. (HPS) and BNG, Inc. are consolidated in the financial statements, and 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, respectively. 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 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 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.\nCurrent tax expense consists solely of regular tax. In certain prior years, tax expense included an alternative minimum tax (AMT) that 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, 1994, this carryforward totaled $71.1 million.\nThe 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 businesses other than leveraged leases are flowed through to income.\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 AND OTHER ASSETS\nThe Company adopted Statement of Financial Accounting Standards No. 115 (Statement No. 115), \"Accounting for Certain Investments in Debt and Equity Securities,\" effective January 1, 1994. Securities subject to the requirements of Statement No. 115 are reported at fair value as of December 31, 1994. Certain of Constellation Companies' marketable equity securities totaling $24.3 million are classified as trading securities. These securities are reported as other current assets, and unrealized gains and losses are included in diversified businesses revenues. The investments comprising the nuclear decommissioning trust fund and certain marketable equity securities of CHI are classified as available for sale. Unrealized gains and losses on these securities, as well as CHI's portion of unrealized gains and losses on securities of equity-method investees, are recorded in shareholders' equity. At December 31, 1993 marketable equity securities are stated at the lower of cost or market value.\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. Utility plant retired or otherwise disposed of is charged to accumulated depreciation. 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 straight-line rates applied to the average investment in classes of depreciable property. Vehicles are depreciated based on their estimated useful lives. Effective in 1995, BGE revised its utility plant depreciation rates to reflect the results of a detailed depreciation study. The new rates are expected to result in an increase in depreciation accruals of approximately $21 million annually.\nDepreciation expense for 1994 includes the write-off of certain costs at BGE's Perryman site. Initially, BGE had planned to build two combined cycle generating units at this site. However, due to significant changes in the environment in which utilities operate, BGE now has no plans to construct the second combined cycle generating unit. Accordingly, during the third quarter of 1994, BGE wrote off $15.7 million of the costs associated with that second combined cycle unit. This write-off reduced after-tax earnings during 1994 by $11.0 million or 7 cents per share. Also in 1994, BGE reclassified the amortization of deferred energy conservation expenditures and deferred nuclear expenditures from operations expense to depreciation and amortization expense. Prior-year amounts have been reclassified to conform with the current year's presentation.\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 $143 million as of December 31, 1994. 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 sold. 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 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 $109.8 million and $93.4 million at December 31, 1994 and 1993, 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 have 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. The Company completed a facility-specific study in 1995 which generated an estimate of $521 million in 1993 dollars to decommission the radioactive portion of the plant. The Company plans to use the facility-specific cost estimate as a basis for recording decommissioning expense in 1995, for 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.\nPrior to 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.\nThe Constellation Companies capitalize interest on qualifying real estate and power generation development projects. BGE capitalizes interest on carrying charges accrued 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.\nACCOUNTING STANDARDS ISSUED\nThe Financial Accounting Standards Board has issued Statement of Financial Accounting Standards Nos. 114 and 118, regarding accounting for impairment of a loan, effective January 1, 1995. Adoption of these statements is not expected to have a material impact on the Company's financial statements.\nNOTE 2. SEGMENT INFORMATION\nCERTAIN PRIOR-YEAR AMOUNTS HAVE BEEN RECLASSIFIED TO CONFORM TO THE CURRENT YEAR'S PRESENTATION.\nNOTE 3. SUBSIDIARY INFORMATION\nDiversified businesses consist of the operations of Constellation Holdings, Inc. and its subsidiaries, BGE Home Products & Services, Inc. (HPS), and BNG, Inc. Diversified businesses' operating expenses have been reclassified as diversified businesses-selling, general, and administrative expense in the consolidated statements of income. Prior-year amounts have been reclassified to conform with the current year s presentation.\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.\nEffective July 1, 1994, BGE formed a wholly owned subsidiary, BGE Home Products & Services, Inc., which engages in the businesses of appliance and consumer electronics sales and service; heating, ventilation, and air conditioning system sales, installation and service; and home improvements and services.\nBNG, Inc. is a wholly owned subsidiary which engages in natural gas brokering.\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. The condensed financial information does not reflect the elimination of inter-company balances or transactions which are eliminated in the Company's consolidated financial statements.\n1994 1993 1992 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Income Statements Revenues Real estate projects $ 106,915 $ 77,598 $ 76,582 Power generation systems 41,301 24,971 28,084 Financial investments 12,126 21,195 21,485 Total revenues 160,342 123,764 126,151 Expenses other than interest and income taxes 107,267 80,707 77,154 Income from operations 53,075 43,057 48,997 Interest expense (45,782) (47,845) (43,903) Capitalized interest 10,776 14,702 13,800` Income tax benefit (expense) (4,305) 1,984 (3,637) Net income $ 13,764 $ 11,898 $ 15,257 Contribution to the Company's earnings per share of common stock $ .09 $ .08 $ .11 Balance Sheets Current assets $ 53,034 $ 54,039 $ 29,899 Noncurrent assets 1,055,056 1,036,507 990,273 Total assets $1,108,090 $1,090,546 $1,020,172 Current liabilities $ 70,670 $ 24,201 $ 113,404 Noncurrent liabilities 718,846 759,048 611,370 Shareholders' equity 318,574 307,297 295,398 Total liabilities and shareholders' equity $1,108,090 $1,090,546 $1,020,172\nNOTE 4. REAL ESTATE PROJECTS AND FINANCIAL INVESTMENTS\nReal estate projects consist of the following investments held by the Constellation Companies:\nAT DECEMBER 31, 1994 1993 (IN THOUSANDS) Properties under development $267,483 $249,473 Rental and operating properties (net of accumulated depreciation) 203,000 237,194 Other real estate ventures 952 730 Total $471,435 $487,397\nFinancial investments consist of the following investments held by the Constellation Companies:\nAT DECEMBER 31, 1994 1993 (IN THOUSANDS) Insurance companies $ 87,700 $ 83,275 Marketable equity securities 51,175 42,681 Financial limited partnerships 48,014 44,903 Leveraged leases 37,451 38,669 Other securities - 3,787 Total $224,340 $213,315\nThe Constellation Companies' marketable equity securities and the investments comprising the nuclear decommissioning trust fund are classified as available for sale. The fair value and gross unrealized gains and losses for available for sale securities, exclusive of $3.2 million of unrealized net losses on securities of equity-method investees, are as follows:\nFair Unrealized Unrealized AT DECEMBER 31, 1994 Value Gains Loss (IN THOUSANDS) Marketable equity securities $ 51,175 $1,276 $1,859 U.S. government agency 5,102 - 113 State municipal bonds 58,034 929 2,599 Total $114,311 $2,205 $4,571\nContractual maturities of debt securities: (IN THOUSANDS) Less than 1 year $ - 1-5 years 13,855 5-10 years 46,010 More than 10 years 4,765 Total $64,630\nGross realized gains and losses on available for sale securities totaled $1.1 million and $3.1 million, respectively, in 1994. Net realized gains from financial investments totaled $6.5 million in 1993 and $9.8 million in 1992.\nNOTE 5. REGULATORY ASSETS\nCertain utility expenses 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.\nAT DECEMBER 31, 1994 1993 (IN THOUSANDS) Income taxes recoverable through future rates $268,436 $259,856 Deferred fuel costs 118,591 130,052 Deferred nuclear expenditures 90,937 86,726 Deferred termination benefit costs 79,979 96,793 Deferred postemployment benefit costs 73,591 62,892 Deferred cost of decommissioning federal uranium enrichment facilities 52,748 49,562 Deferred energy conservation expenditures 45,534 38,655 Deferred environmental costs 35,015 32,966 Other 8,203 10,623 Total $773,034 $768,125\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.\nDeferred 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 reduced as they are collected from customers.\nThe underrecovered costs deferred under the fuel clauses were as follows:\nAT DECEMBER 31, 1994 1993 (IN THOUSANDS) Electric Costs deferred $152,815 $155,901 Reserve for possible disallowance of replacement energy costs (see Note 13) (35,000) (35,000) Net electric 117,815 120,901 Gas 776 9,151 Total $118,591 $130,052\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 1994 associated with nonrecurring phases of certain nuclear operations projects, and expenditures incurred during 1990 for investigating leaks in the pressurizer heater sleeves.\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 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 in 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 15-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. Deferred 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 deferred fuel costs in excess of $72.8 million, net of related deferred income taxes. 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 and HPS. 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.\nPrior service cost associated with retroactive plan amendments is amortized on a straight-line basis over the average remaining service period of active employees.\nThe Company's funding policy is to contribute at least the minimum amount required under Internal Revenue Service regulations using the projected unit credit cost method. Plan assets at December 31, 1994 consisted primarily of marketable fixed income and equity securities, group annuity contracts, and short-term investments.\nThe tables on page 49 set forth the combined funded status of the plans and the composition of total net pension cost. At December 31, 1994 and 1993, the accumulated pension obligation was greater than the fair value of the Pension Plan's assets. As a result, the Company recorded an additional pension liability, a portion of which was charged to shareholders' equity.\nNet pension cost shown below does not include the cost of termination benefits described in Note 7.\nAT DECEMBER 31, 1994 1993 (IN THOUSANDS) Vested benefit obligation $ 622,445 $ 677,069 Nonvested benefit obligation 8,838 11,359 Accumulated benefit obligation 631,283 688,428 Projected benefits related to increase in future compensation levels 82,815 109,161 Projected benefit obligation 714,098 797,589 Plan assets at fair value (614,284) (605,629) Projected benefit obligation less plan asset 99,814 191,960 Unrecognized prior service cost (23,863) (21,252) Unrecognized net loss (112,546) (148,450) Pension liability adjustment 52,177 58,553 Unamortized net asset from adoption of FASB Statement No. 87 1,586 1,812 Accrued pension liability $ 17,168 $ 82,623\nYEAR ENDED DECEMBER 31, 1994 1993 1992 (IN THOUSANDS) Components of net pension cost Service cost-benefits earned during the period $ 15,015 $ 11,645 $ 11,771 Interest cost on projected benefit obligation 58,723 51,183 47,355 Actual return on plan assets 7,932 (56,225) (33,685) Net amortization and deferral (60,071) 6,591 (12,257) Total net pension cost 21,599 13,194 13,184 Amount capitalized as construction cost (2,578) (1,800) (1,839) Amount charged to expense $ 19,021 $ 11,394 $ 11,345\nThe Company also sponsors a defined contribution savings plan covering all eligible BGE employees and certain employees of the Constellation Companies and HPS. Under this plan, the Company makes contributions on behalf of participants. Company contributions to this plan totaled $8.7 million, $9.0 million, and $14.8 million in 1994, 1993, and 1992, 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 and HPS. 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.\nEffective 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 20-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 in 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 postretirement 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 post-retirement benefit cost. Net postretirement benefit cost shown below does not include the cost of termination benefits described in Note 7.\nYEAR ENDED DECEMBER 31, 1994 1993\n(IN THOUSANDS) Net postretirement benefit cost: Service cost-benefits earned during the period $ 5,035 $ 4,373 Interest cost on accumulated postretirement benefit obligation 23,037 20,451 Amortization of transition obligation 11,700 12,021 Net amortization and deferral 646 - Total net postretirement benefit cost 40,418 36,845 Amount capitalized as construction cost (5,773) (5,898) Amount deferred (10,213) (11,965) Amount charged to expense $ 24,432 $ 18,982\nPostretirement benefit costs recognized under the pay-as-you-go method in 1992 totaled $11.7 million, of which $1.9 million was capitalized and the remainder was charged to expense.\nOTHER POSTEMPLOYMENT BENEFITS\nThe Company provides certain pay continuation payments and health and life insurance benefits to employees of BGE and certain employees of the Constellation Companies and HPS 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 $48 million and $52 million as of\nDecember 31, 1994 and 1993, respectively. The portion of the December 31, 1993 liability attributable to regulated activities was deferred. The amounts deferred will be amortized over a 15-year period beginning in 1998. The adoption of Statement No. 112 did not have a material impact on net income.\nASSUMPTIONS\nThe pension and postemployment benefit liabilities were determined using the following assumptions.\nAT DECEMBER 31, 1994 1993 Assumptions: Discount rate 8.5% 7.5% Average increase in future compensation levels 4.0% 4.5% Expected long-term rate of return on assets 9.0% 9.5%\nThe health care inflation rates for 1994 are assumed to be 9.0% for Medicare-eligible retirees and 11.5% 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 $35 million as of December 31, 1994 and would increase the aggregate of the service cost and interest cost components of postretirement benefit cost by approximately $4 million annually.\nNOTE 7. TERMINATION BENEFITS\nBGE 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 one-time 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.\nBGE 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 one-time 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 is being 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 cost of termination benefits was charged to expense in 1993.\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. 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, HPS 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 5 1\/2% Installment Series of 2002, 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 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 1996 and 1997. 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, 1994, BGE had no borrowings under these revolving credit agreements and had available $125 million of unused capacity under these agreements.\nThe Medium-term Notes Series A mature in February 1996. The weighted average interest rate for notes outstanding at December 31, 1994 is 8.22%.\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, 1994 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, 1994 is 7.16%.\nThe principal amounts of the 5 1\/2% Installment Series Mortgage Bonds payable each year are as follows:\nYEAR (IN THOUSANDS) 1995 through 1997 $ 605 1998 and 1999 690 2000 and 2001 865 2002 6,725\nLONG-TERM DEBT OF CONSTELLATION COMPANIES\nThe mortgage and construction loans and other collateralized notes have varying terms. The $116.6 million of variable rate notes require periodic payment of principal and interest with various maturities from September 1995 through July 2009. The $13 million, 7.67% mortgage note requires monthly interest payments and is due October 1, 1995. The $6.2 million, 7.73% mortgage note requires quarterly principal and interest payments through March 15, 2009.\nThe unsecured notes outstanding as of December 31, 1994 mature in accordance with the following schedule:\nAMOUNT (IN THOUSANDS) 8.35%, due August 28, 1995 $ 20,000 8.71%, due August 28, 1996 23,000 6.19%, due September 9, 1996 10,000 8.93%, due August 28, 1997 52,000 6.65%, due September 9, 1997 15,000 8.23%, due October 15, 1997 30,000 7.05%, due April 22, 1998 25,000 7.06%, due September 9, 1998 20,000 8.48%, due October 15, 1998 75,000 7.30%, due April 22, 1999 90,000 8.73%, due October 15, 1999 15,000 7.55%, due April 22, 2000 35,000 7.43%, due September 9, 2000 30,000 Total $440,000\nThe Constellation Companies entered into an unsecured revolving credit agreement on December 9, 1994 in the amount of $50 million. This agreement matures December 9, 1997 and will be used to provide liquidity for general corporate purposes. As of December 31, 1994, the Constellation Companies had no borrowings under this agreement.\nWEIGHTED AVERAGE INTEREST RATES FOR VARIABLE RATE DEBT\nThe weighted average interest rates for variable rate debt during 1994 and 1993 were as follows:\n1994 1993 BGE Floating rate series mortgage bonds 4.91% -% Pollution control loan 2.80 2.39 Port facilities loan 3.02 2.53 Adjustable rate pollution control loan 3.13 3.00 Economic development loan 3.00 2.49\nConstellation Companies Mortgage and construction loans and other collateralized notes 7.27 6.26 Loans under credit agreements - 5.94\nAGGREGATE 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:\nConstellation YEAR BGE Companies (IN THOUSANDS) 1995 $206,063 $ 56,112 1996 71,997 65,201 1997 80,653 125,389 1998 55,396 134,973 1999 251,467 116,425\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.\nBeginning Series Shares Year 7.50%, 1986 Series 15,000 1992 6.75%, 1987 Series 15,000 1993 8.25%, 1989 Series 100,000 1995 8.625%, 1990 Series 130,000 1996 7.85%, 1991 Series 70,000 1997\nThe combined aggregate redemption requirements for all series of redeemable preference stock for each of the next five years are as follows:\nYEAR (IN THOUSANDS) 1995 $61,500 1996 26,000 1997 83,000 1998 33,000 1999 33,000\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, lease payments for utility operations are charged to expense. Lease expense, which is comprised primarily of operating leases, totaled $12.7 million, $13.8 million, and $14.0 million for the years ended 1994, 1993, and 1992, respectively.\nThe future minimum lease payments at December 31, 1994 for long-term noncancelable operating leases are as follows:\nYEAR (IN THOUSANDS) 1995 $ 4,185 1996 3,881 1997 3,447 1998 2,971 1999 1,409 Thereafter 5,347 Total minimum lease payments $21,240\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 22 years, with options to renew. The net book value of property under operating leases was $148.8 million at December 31, 1994. The future minimum rentals to be received under operating leases in effect at December 31, 1994 are as follows:\nYEAR (IN THOUSANDS) 1995 $ 13,143 1996 12,233 1997 11,062 1998 9,718 1999 9,082 Thereafter 73,693 Total minimum rentals $128,931\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 1995 and subsequent years. In addition, BGE has entered into two long-term contracts for the purchase of electric generating capacity and energy. The contracts expire in 2001 and 2013. Total payments under these contracts were $69.4, $68.7, and $60.6 million during 1994, 1993, and 1992, respectively. At December 31, 1994, the estimated future payments for capacity and energy that BGE is obligated to buy under these contracts are as follows:\nYEAR (IN THOUSANDS) 1995 $ 65,249 1996 62,880 1997 60,068 1998 60,699 1999 60,558 Thereafter 272,826 Total payments $582,280\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, 1994, the total amount of investment requirements committed to by the Constellation Companies is $43.6 million.\nIn December, 1994, BGE and HPS entered into agreements with a financial institution whereby BGE and HPS can sell on an ongoing basis up to an aggregate of $40 million and $50 million, respectively, of an undivided interest in a designated pool of customer receivables. Under the terms of the agreements, BGE and HPS have limited recourse on the receivables and have recorded a reserve for credit losses. At December 31, 1994, BGE and HPS had sold $30 million and $40 million of receivables, respectively, under these agreements.\nGUARANTEES\nBGE has agreed to guarantee two-thirds of certain indebtedness incurred by Safe Harbor Water Power Corporation. The amount of such indebtedness totals $35 million, of which $23.3 million represents BGE' s share of the guarantee. BGE assesses that the risk of material loss on the loans guaranteed is minimal.\nAs of December 31, 1994, the total outstanding loans and letters of credit of certain power generation and real estate projects guaranteed by the Constellation Companies were $31.2 million. Also, the Constellation Companies have agreed to guarantee certain other borrowings of various power generation and real estate projects. The Company has assessed 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 two titles designed to reduce emissions of sulfur dioxide and nitrogen oxide (NOx) from electric generating stations. Title IV contains provisions for compliance in two separate phases. Phase I of Title IV became effective January 1, 1995, and Phase II of Title IV must be implemented by 2000. BGE met the requirements of Phase I by installing flue gas desulfurization systems and fuel switching and through unit retirements. BGE is currently examining what actions will be required in order to comply with Phase II of the Act. 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 NOx control requirements under Title I of the Act are less certain because all implementation regulations have not yet been finalized by the government. It is expected that by the year 1999 these regulations will require additional\nNOx 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 and several state agencies that it is being considered a potentially responsible party (PRP) with respect to the cleanup of certain environmentally contaminated sites owned and operated by third parties. In addition, a subsidiary of Constellation Holdings, Inc. has been named as a defendant in a case concerning an alleged environmentally contaminated site owned and operated by a third party. Cleanup costs for these sites cannot be estimated, except that BGE's 15.79% share of the possible cleanup costs at one of these sites, Metal Bank of America, a metal reclaimer in Philadelphia, could exceed amounts recognized by up to approximately $14 million based on the highest estimate of costs in the range of reasonably possible alternatives. Although the cleanup costs for certain of the remaining 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 against BGE. BGE has recognized estimated environmental costs at these sites totaling $37.9 million as of December 31, 1994. These costs, net of accumulated amortization, have been deferred 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. BGE maintains various insurance policies for these contingencies. The costs that could result from a major accident or an extended outage at either of the Calvert Cliffs units could exceed the coverage limits.\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 $8.92 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 $6.08 million in any one year.\nFor physical damage to Calvert Cliffs, BGE has $2.75 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 $14.3 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 $473.2 million per unit of insurance, provided by the same industry mutual insurance company for replacement power costs. This amount can be reduced by up to $94.6 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 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. 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 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 its Calvert Cliffs Nuclear Power Plant. 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, is 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 value and fair value of financial instruments included in the Consolidated Balance Sheets.\nFinancial instruments included in current assets are cash and cash equivalents, net accounts receivable, trading securities, and miscellaneous loans receivable of the Constellation Companies. Financial instruments included in current liabilities represent total current liabilities from the balance sheet excluding accrued vacation costs. The carrying amount of current assets and current liabilities approximates fair value because of the short maturity of these instruments.\nInvestments and other assets include investments in common and preferred securities, which are classified as financial investments in the balance sheet, and the nuclear decommissioning trust fund. The 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, 1994 and 1993 are excluded from the amounts shown in investments and other assets because it was not practicable to 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 $23.3 million and $17.0 million, respectively, at December 31, 1994 and $26.7 and $36.0 million, respectively, at December 31, 1993 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 FIRST QUARTER OF 1994 REFLECT A $10.0 MILLION ONE-TIME BONUS PAID TO EMPLOYEES IN LIEU OF A GENERAL INCREASE.\nRESULTS FOR THE THIRD QUARTER OF 1994 REFLECT THE $15.7 MILLION ($11.0 MILLION AFTER-TAX) WRITE-OFF OF CERTAIN PERRYMAN COSTS (SEE NOTE 1).\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).\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.\nCERTAIN PRIOR-YEAR AMOUNTS HAVE BEEN RECLASSIFIED TO CONFORM TO THE CURRENT YEAR'S PRESENTATION.\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 13 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: Auditors' Report dated January 20, 1995 of Coopers & Lybrand L.L.P., Independent Auditors\nConsolidated Statements of Income for three years ended December 31,\nConsolidated Balance Sheets at December 31, 1994 and December 31,\nConsolidated Statements of Cash Flows for three years ended December 31, 1994\nConsolidated Statements of Common Shareholders' Equity for three years ended December 31, 1994\nConsolidated Statements of Capitalization at December 31, 1994 and December 31, 1993\nConsolidated Statements of Income Taxes for three years ended December 31, 1994\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules:\nSchedule II -- Valuation and Qualifying Accounts\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*Incorporated by Reference. (b) Reports on Form 8-K: None\nBALTIMORE GAS AND ELECTRIC COMPANY AND SUBSIDIARIES SCHEDULE II -- 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) By \/s\/ C. H. POINDEXTER Date: March 17, 1995 C. H. POINDEXTER 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 Baltimore Gas and Electric Company, the Registrant, and in the capacities and on the dates indicated.\nEXHIBIT INDEX\n*Incorporated by Reference. (b) Reports on Form 10-K: None","section_15":""}
{"filename":"71428_1994.txt","cik":"71428","year":"1994","section_1":"Item 1. Business\nGENERAL\nBell Atlantic - New Jersey, Inc. (the \"Company\") is incorporated under the laws of the State of New Jersey and has its principal offices at 540 Broad Street, Newark, New Jersey 07101 (telephone number 201-649-9900). The Company is a wholly owned subsidiary of Bell Atlantic Corporation (\"Bell Atlantic\"), which is one of the seven regional holding companies (\"RHCs\") formed in connection with the court-approved divestiture (the \"Divestiture\"), effective January 1, 1984, of those assets of American Telephone and Telegraph Company (\"AT&T\") related to exchange telecommunications, exchange access functions, printed directories and cellular mobile communications.\nThe Company presently serves a territory consisting of three Local Access and Transport Areas (\"LATAs\"). These LATAs are generally centered on a city or based on some other identifiable common geography and, with certain limited exceptions, each LATA marks the boundary within which the Company may provide telephone service.\nThe Company provides two basic types of telecommunications services. First, the Company transports telecommunications traffic between subscribers located within the same LATA (\"intraLATA service\"), including both local and toll services. Local service includes the provision of local exchange (\"dial tone\"), local private line and public telephone services (including dial tone service for pay telephones owned by the Company and other pay telephone providers). Among other local services provided are Centrex (telephone company central office-based switched telephone service enabling the subscriber to make both intercom and outside calls) and a variety of special and custom calling services. Toll service includes message toll service (calling service beyond the local calling area) within LATA boundaries, and intraLATA Wide Area Toll Service (WATS)\/800 services (volume discount offerings for customers with highly concentrated demand). The Company also earns toll revenue from the provision of telecommunications service between LATAs (\"interLATA service\") in the corridors between the cities (and certain surrounding counties) of (i) New York, New York and Newark, New Jersey, and (ii) Philadelphia, Pennsylvania and Camden, New Jersey. Second, the Company provides exchange access service, which links a subscriber's telephone or other equipment to the transmission facilities of interexchange carriers which, in turn, provide interLATA telecommunications service to their customers. The Company also provides exchange access service to interexchange carriers which provide intrastate intraLATA long distance telecommunications service.\nOPERATIONS\nDuring 1993, Bell Atlantic reorganized certain functions formerly performed by each of the seven Bell System operating companies (\"BOCs\") transferred to it pursuant to the Divestiture, including the Company (collectively, the \"Network Services Companies\"), into lines of business (\"LOBs\") organized across the Network Services Companies around specific market segments. The Network Services Companies, however, remain responsible within their respective service areas for the provision of telephone services, financial performance and regulatory matters. The LOBs are:\nThe Consumer Services LOB markets communications services to residential customers within the service territories of the Network Services Companies, including the service territory of the Company, and plans to market information services and entertainment programming.\nThe Carrier Services LOB markets (i) switched and special access to the Company's local exchange network, and (ii) billing and collection services, including recording, rating, bill processing and bill rendering. The principal customers of this LOB are interexchange carriers; AT&T is the largest single customer. Other customers include business customers and government agencies with their own special access network connections, wireless companies and other local exchange carriers (\"LECs\") which resell network connections to their own customers.\nBell Atlantic - New Jersey, Inc.\nThe Small Business Services LOB markets communications and information services to small businesses (customers having up to 20 access lines or 100 Centrex lines).\nThe Large Business Services LOB markets communications and information services to large businesses (customers having more than 20 access lines or more than 100 Centrex lines). These services include voice switching\/processing services (e.g., dedicated private lines, custom Centrex, call management and voice messaging), end-user networking (e.g., credit and debit card transactions, and personal computer-based conferencing, including data and video), internetworking (establishing links between the geographically disparate networks of two or more companies or within the same company), network integration (integrating multiple geographically disparate networks into one system), network optimization (disaster avoidance, 911, intelligent vehicle highway systems), video services (distance learning, telemedicine, surveillance, videoconferencing) and integrated multi-media applications services.\nThe Directory Services LOB manages the provision of (i) advertising and marketing services to advertisers, and (ii) listing information (e.g., White Pages and Yellow Pages). These services are currently provided primarily through print media, but the Company expects that use of electronic formats will increase in the future. In addition, the Directory Services LOB manages the provision of photocomposition, database management and other related products and services to publishers.\nThe Public and Operator Services LOB markets pay telephone and operator services in the service territories of the Network Services Companies to meet consumer needs for accessing public networks, locating and identifying network subscribers, providing calling assistance and arranging billing alternatives (e.g., calling card, collect and third party calls).\nThe Federal Systems LOB markets communications and information technology and services to departments, agencies and offices of the executive, judicial and legislative branches of the federal government.\nThe Network LOB manages the technologies, services and systems platforms required by the other LOBs and the Network Services Companies, including the Company, to meet the needs of their respective customers, including switching, feature development and on-premises installation and maintenance services.\nThe Company has been making and expects to continue to make significant capital expenditures to meet the demand for communications services and to further improve such services. Capital expenditures were approximately $596 million in 1992, $590 million in 1993 and $629 million in 1994. The total investment in plant, property and equipment was approximately $8.08 billion at December 31, 1992, $8.38 billion at December 31, 1993, and $8.70 billion at December 31, 1994, in each case after giving effect to retirements, but before deducting accumulated depreciation at such date.\nThe Company is projecting construction expenditures for 1995 of approximately $642 million. The Company will allocate capital resources to the deployment of broadband network platforms (technologies ultimately capable of providing a switched facility for access to and transport of high-speed data services, video-on-demand, and image and interactive multimedia applications). Most of the funds for these expenditures are expected to be generated internally. Some additional external financing may be necessary or desirable.\nLINE OF BUSINESS RESTRICTIONS\nThe consent decree entitled \"Modification of Final Judgment\" (\"MFJ\") approved by the United States District Court for the District of Columbia (the \"D.C. District Court\") which, together with the Plan of Reorganization (\"Plan\") approved by the D.C. District Court, set forth the terms of Divestiture also established certain restrictions on the post-Divestiture activities of the RHCs, including Bell Atlantic\nBell Atlantic - New Jersey, Inc.\nand its subsidiaries. Currently, the MFJ's principal restrictions on post- Divestiture RHC activities are prohibitions on (i) providing interexchange telecommunications, and (ii) engaging in the manufacture of telecommunications equipment and customer premises equipment (\"CPE\"). Since Divestiture, the D.C. District Court has retained jurisdiction over the construction, modification, implementation and enforcement of the MFJ.\nLegislation has been introduced in the current session of Congress pursuant to which the line of business restrictions established by the MFJ could be eliminated or modified. No definitive prediction can be made as to whether or when any such legislation will be enacted, the provisions thereof or the impact on the business or financial condition of the Company.\nFCC REGULATION AND INTERSTATE RATES\nThe Company is subject to the jurisdiction of the Federal Communications Commission (\"FCC\") with respect to interstate services and certain related matters. The FCC prescribes a uniform system of accounts for telephone companies, interstate depreciation rates and 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 those applicable to intrastate services under the jurisdiction of the respective state regulatory authorities (\"separations procedures\"). The FCC also prescribes procedures for allocating costs and revenues between regulated and unregulated activities.\nInterstate Access Charges\nThe Company provides intraLATA service and, with certain limited exceptions, does not participate in the provision of interLATA service except through offerings of exchange access service. The FCC has prescribed structures for exchange access tariffs to specify the charges (\"Access Charges\") for use and availability of the Company's facilities for the origination and termination of interstate interLATA service.\nIn general, the tariff structures prescribed by the FCC provide that interstate costs of the Company which do not vary based on usage (\"non-traffic sensitive costs\") are recovered from subscribers through flat monthly charges (\"Subscriber Line Charges\"), and from interexchange carriers through usage- sensitive Carrier Common Line (\"CCL\") charges. Traffic-sensitive interstate costs are recovered from carriers through variable access charges based on several factors, primarily usage.\nIn May 1984, the FCC authorized the implementation of Access Charge tariffs for \"switched access service\" (access to the local exchange network) and of Subscriber Line Charges for multiple line business customers (up to $6.00 per month per line). In 1985, the FCC authorized Subscriber Line Charges for residential and single-line business customers at the rate of $1.00 per month per line, which increased in installments to $3.50, effective April 1, 1989.\nFCC Access Charge Pooling Arrangements\nThe FCC previously required that all LECs, including the Company, pool revenues from CCL and Subscriber Line Charges that cover the non-traffic sensitive costs of the local exchange network, that is, the interstate costs associated with the lines from subscribers' premises to telephone company central offices. To administer such pooling arrangements, the FCC mandated the formation of the National Exchange Carrier Association, Inc. (\"NECA\"). All but one of the Network Services Companies, including the Company, received substantially less from the pool than the amount billed to their interexchange carrier customers.\nThe FCC changed its mandatory pooling requirements, effective April 1, 1989. As a result, the Network Services Companies as a group withdrew from the pool and were permitted to charge CCL rates which more closely reflect their non- traffic sensitive costs. The Network Services Companies, including the Company, are still obligated to make contributions of CCL revenues to companies who choose to continue to pool non-traffic sensitive costs so that the pooling companies can charge a CCL rate no greater than the nationwide average CCL rate of price cap companies. In addition to this\nBell Atlantic - New Jersey, Inc.\ncontinuing obligation, the Network Services Companies, including the Company, had a transitional support obligation to high cost companies who left the pool in 1989 and 1990. This transitional support obligation ended in July 1994.\nIn February 1995, the FCC issued an Order to Show Cause with respect to certain findings contained in an independent audit concluded in December 1991 with respect to certain filings by the Network Services Companies with NECA. Resolution of these issues is expected in the second half of 1995.\nPrice Caps\nThe price cap system, which has been in effect since 1991, places a cap on overall LEC prices for interstate access services which is modified annually, in inflation-adjusted terms, by a fixed percentage which is intended to reflect increases in productivity. The price cap level can also be adjusted to reflect \"exogenous\" changes, such as changes in FCC separations procedures or accounting rules. LECs subject to price caps have somewhat increased flexibility to change the prices of existing services within certain groupings of interstate services, known as \"baskets\".\nFCC regulations applicable to the Company provide for an authorized rate of return of 11.25% for the years 1991 and beyond. To the extent that a company is able to earn a higher rate of return through improved efficiency, the FCC's price cap rules permit them to retain the full amount of this higher return up to 100 basis points above the authorized rate of return (currently, up to a 12.25% rate of return). If a company's rate of return is between 100 and 500 basis points above the authorized rate of return (that is, currently, between 12.25% and 16.25%), the company must share 50% of the earnings above the 100- basis-point level with customers by reducing rates prospectively. All earnings above the 500-basis-point level must be returned to customers in the form of prospective rate decreases. If, on the other hand, a company's rate of return is more than 100 basis points below the authorized rate of return (that is, currently, below 10.25%), the company is permitted to increase rates prospectively to make up the deficiency.\nUnder FCC-approved tariffs, the Network Services Companies are charging uniform rates for interstate access services (with the exception of Subscriber Line Charges) throughout the service territories and are regarded as a single unit by the FCC for rate of return measurement.\nIn February 1994, the FCC initiated a rulemaking proceeding to determine the effectiveness of LEC price cap rules and to decide what changes, if any, should be made to those rules. This rulemaking is expected to be concluded in the first half of 1995.\nEnhanced Services\nIn 1985, the FCC initiated an examination of its regulations requiring that \"enhanced services\" (e.g. voice messaging services, electronic mail, videotext gateway, protocol conversion) be offered only through a structurally separated subsidiary. In 1986, the FCC eliminated this requirement, permitting the Company to offer enhanced services, subject to compliance with a series of non- structural safeguards. These safeguards include detailed cost accounting, protection of customer information, public disclosure of technical interfaces and certain reporting requirements. In 1990, the U.S. Court of Appeals for the Ninth Circuit (Court of Appeals) vacated and remanded the matter to the FCC. In 1991, the FCC adopted an order which reinstated relief from the separate subsidiary requirement upon a company's compliance with the FCC's Open Network Architecture requirements and strengthened some of the nonstructural safeguards. In 1992, the Company certified to the FCC that it had complied with applicable requirements, and the FCC granted structural relief.\nIn October 1994, the Court of Appeals vacated the 1991 order and remanded the matter to the FCC for further proceedings. As a result, the FCC has initiated a broad examination of the state of competition in the enhanced services business and the adequacy of existing non-structural safeguards. The Company is permitted to continue to offer existing enhanced services pending further action.\nBell Atlantic - New Jersey, Inc.\nFCC Cost Allocation and Affiliate Transaction Rules\nFCC rules govern: (i) the allocation of costs between the regulated and unregulated activities of a communications common carrier and (ii) transactions between the regulated and unregulated affiliates of a communications common carrier.\nThe cost allocation rules apply to certain unregulated activities: activities that have never been regulated as communications common carrier offerings and activities that have been preemptively deregulated by the FCC. The costs of these activities are removed prior to the separations procedures process and are assigned to unregulated activities in the aggregate, not to specific services, for pricing purposes. Other activities must be accounted for as regulated activities, and their costs are subject to separations procedures.\nThe affiliate transaction rules govern the pricing of assets transferred to and services provided by affiliates. These rules generally require that assets be transferred between affiliates at \"market price\", if such price can be established through a tariff or a prevailing price actually charged to third parties. In the absence of a tariff or prevailing price, \"market price\" cannot be established, in which case (i) asset transfers from a regulated to an unregulated affiliate must be valued at the higher of cost or fair market value, and (ii) asset transfers from an unregulated to a regulated affiliate must be valued at the lower of cost or fair market value.\nThe FCC has not attempted to make its cost allocation or affiliate transaction rules preemptive. State regulatory authorities are free to use different cost allocation methods and affiliate transaction rules for intrastate ratemaking and to require carriers to keep separate allocation records.\nTelephone Company Provision of Video Dial Tone and Video Programming\nIn August 1992, the FCC issued an order permitting telephone companies such as the Company to provide \"video dial tone\" service. Video dial tone permits telephone companies to provide video transport to multiple programmers on a non- discriminatory common carrier basis. In November 1994, the FCC issued an order which stated that jurisdiction for video dial tone service will be divided between the FCC and the states. Over the air services and services transported across state lines will be deemed interstate services subject to regulation by the FCC. Services delivered entirely within a single state will be deemed intrastate services subject to state regulation. The order also generally prohibits the Company from acquiring in-region cable television facilities or entering into a joint venture with an in-region cable television company or other video programmer to jointly construct or operate a video dial tone platform.\nIn December 1992, two Bell Atlantic Companies, Bell Atlantic - Virginia, Inc. and Bell Atlantic Video Services Company, filed a lawsuit against the federal government in the United States District Court for the Eastern District of Virginia seeking to overturn the prohibition in the Cable Communications Policy Act of 1984 against LECs providing video programming in their respective telephone service areas. In 1993, the court struck down this prohibition as a violation of the First Amendment's freedom of speech protections and enjoined its enforcement against Bell Atlantic, the Network Services Companies, including the Company, and Bell Atlantic Video Services Company. This decision was affirmed by the United States Court of Appeals for the Fourth Circuit in 1994. The federal government is expected to petition the United States Supreme Court to review the decision.\nIn 1992, the Company entered into an agreement with Future Vision of America Corporation (\"Future Vision\") pursuant to which the Company will deploy fiber optic technology in the Dover Township, New Jersey telephone network to establish a video dial tone platform that will allow Future Vision and other video information providers to deliver video programming services. The FCC approved the deployment of this system in late 1994. Service is expected to commence later in 1995.\nBell Atlantic - New Jersey, Inc.\nInterconnection and Collocation\nIn order to encourage greater competition in the provision of interstate special access services, the FCC issued an order in 1992 allowing third parties to collocate their equipment in telephone company offices to provide special access (private line) services to the public. The order permits collocating parties to pay LECs an interconnection charge that is lower than the existing tariffed rates for similar non-collocated services and it allows LECs limited additional pricing flexibility for their own special access services when collocated interconnection is operational. In 1993, the FCC extended collocation to switched access services under terms and conditions similar to those for special access collocation. In June 1994, the U.S. Court of Appeals for the District of Columbia vacated the FCC's special access collocation order insofar as it required physical collocation. In July 1994, the FCC voted to require LECs to offer virtual collocation, with the LECs having the option to offer physical collocation.\nSTATE REGULATION AND COMPETITIVE ENVIRONMENT\nThe communications services of the Company are subject to regulation by the New Jersey Board of Public Utilities (the \"BPU\") with respect to intrastate rates and services and other matters.\nThe New Jersey Telecommunications Act of 1992 authorized the BPU to adopt alternative regulatory frameworks to address changes in technology and the structure of the telecommunications industry and to promote economic development. It also deregulated services which the BPU found to be competitive. Pursuant to that legislation, the Company filed a Plan for Alternative Form of Regulation (the \"PAR\"), which became effective in May 1993.\nThe PAR replaced the Rate Stability Plan, which was approved by the BPU in 1987. In general, the Rate Stability Plan separated intrastate services into two categories: Group I (more competitive) and Group II (less competitive). Only Group II services were subject to financial performance monitoring by the BPU.\nThe PAR divides the Company's services into Rate-Regulated Services (formerly Group II services) and Competitive Services (formerly Group I services and services which have never been regulated by the BPU). Rate-Regulated Services are grouped in two categories:\n--\"Protected Services\": Basic residence and business service, Touch-Tone, access services, message toll services and the ordering, installation and restoration of these services. Rates for Protected Services, other than basic residence service, may be increased beginning January 1996 in an amount limited to the prior year's increase in the Gross National Product-Price Index (\"GNP-PI\") less a 2% productivity offset, as long as the return on equity for Rate-Regulated Services does not exceed 11.7%. Basic residence service rates are frozen through December 1999.\n--\"Other Services\": Custom Calling, Custom Local Area Signaling Services (\"CLASS\" services which utilize Signaling System 7), operator services and 911 enhanced service. Rates for Other Services may be increased beginning January 1996 in an amount limited to the prior year's increase in the GNP-PI less a 2% productivity offset, as long as the return on equity for Rate- Regulated Services does not exceed 12.7%.\nAll earnings above a return on equity of 13.7% for Rate-Regulated Services will be shared equally with customers. There is no point at which the earnings are capped.\nCompetitive Services are deregulated under the New Jersey Telecommunications Act. Other services such as premises wire maintenance, Answer Call and electronic messaging, which have never been regulated by the BPU, continue to be deregulated under the New Jersey Telecommunications Act. An appeal of the PAR is pending.\nIn January 1995, MFS-Intelenet filed a petition with the BPU requesting authority to provide local exchange services in areas served by the Company.\nBell Atlantic - New Jersey, Inc.\nCOMPETITION\nGeneral\nRegulatory proceedings, as well as new technology, are continuing to expand the types of available communications services and equipment and the number of competitors offering such services. An increasing amount of this competition is from large companies which have substantial capital, technological and marketing resources, many of which do not face the same regulatory constraints as the Company.\nAlternative Access\nA substantial portion of the Company's revenues from business and government customers is derived from a relatively small number of large, multiple-line subscribers.\nThe Company faces competition from alternative communications systems, constructed by large end users, interexchange carriers, and alternative access vendors which are capable of originating and\/or terminating calls without the use of the company's plant. Teleport Communications Group Inc. (\"Teleport\") and MFS provide competitive access service in the Princeton-Trenton corridor and northern New Jersey.\nThe ability of such alternative access providers to compete with the Company has been enhanced by the FCC's orders requiring the Company to offer virtual collocated interconnection for special and switched access services.\nOther potential sources of competition are cable television systems, shared tenant services and other non-carrier systems which are capable of bypassing the Company's local plant, either partially or completely, through substitution of special access for switched access or through concentration of telecommunications traffic on fewer of the Company's lines.\nIntraLATA Toll Competition\nThe ability of interexchange carriers to engage in the provision of intrastate intraLATA toll service in competition with the Company is subject to state regulation. Such competition is permitted in New Jersey.\nIn May 1994, the BPU approved a settlement of a proceeding addressing intraLATA toll competition. The settlement permitted IXCs to compete for the provision of intraLATA toll services on an access code basis (e.g., customers must dial 10XXX to use an IXC), beginning July 1, 1994, and granted the Company substantial flexibility in the pricing and marketing of the services it offers to enable it to compete with the IXCs. In January 1995, the BPU commenced a further proceeding to examine issues of intraLATA toll service competition including whether presubscription should be authorized, and if so, under what terms and conditions, and to address the issue of subsidies embodied in the Company's rates. Currently, intraLATA toll calls default to the Company unless the customer dials a five digit access code to use an alternate carrier. Presubscription would enable customers to make intraLATA toll calls using the carrier of their choice without having to dial the five digit access code. A decision on this proceeding is expected by the end of 1995.\nPersonal Communications Services\nRadio-based personal communications services (\"PCS\") also constitute potential sources of competition to the Company. PCS consists of wireless portable telephone services which would allow customers to make and receive telephone calls from any location using small handsets, and which could also be used for data transmission. The FCC has authorized trials of such services, using a variety of technologies, by numerous companies, including Bell Atlantic's cellular telecommunications subsidiaries.\nIn September 1993, the FCC issued an order allocating radio spectrum to be licensed for use in providing PCS. Under the order, seven separate bandwidths of spectrum, ranging in size from 10 MHz to 30 MHz, would be auctioned to potential PCS providers in each geographic area of the United States; five of the spectrum blocks would be auctioned by \"basic trading area\" and the remaining two would be auctioned\nBell Atlantic - New Jersey, Inc.\nby larger \"major trading area\" (as such trading areas are defined by Rand McNally). LECs and companies with LEC subsidiaries, such as Bell Atlantic, are eligible to bid for PCS licenses, except that cellular carriers, such as Bell Atlantic, are limited to obtaining only 10 MHz of PCS bandwidth in areas where they provide cellular service. Bidders other than cellular providers may obtain multiple licenses aggregating up to 40 MHz of bandwidth in any area.\nIn October 1994, Bell Atlantic, NYNEX, AirTouch Communications and U S WEST, Inc., formed a partnership to bid jointly in the FCC's auctions for PCS licenses. In March 1995, this partnership was a successful bidder for licenses for spectrum to provide PCS services in the following markets: Chicago; Dallas; Tampa; Houston; Miami; New Orleans; Milwaukee; Richmond; San Antonio; Jacksonville; and Honolulu.\nCentrex\nThe Company offers Centrex service, which is a telephone company central office-based communications system for business, government and other institutional customers consisting of a variety of integrated software-based features located in a centralized switch or switches and extended to the customer's premises primarily via local distribution facilities. In the provision of Centrex, the Company is subject to significant competition from the providers of CPE systems, such as private branch exchanges (\"PBXs\"), which perform similar functions with less use of the Company's switching facilities.\nUsers of Centrex systems generally require more subscriber lines than users of PBX systems of similar capacity. The FCC increased the maximum Subscriber Line Charge on embedded Centrex lines to $6.00 per month per line, effective April 1, 1989. Increases in Subscriber Line Charges result in Centrex users incurring higher charges than users of comparable PBX systems. The BPU has permitted flexible pricing of certain Centrex services, which helps offset the effects of higher Subscriber Line Charges.\nDirectories\nThe Company continues to face significant competition from other providers of directories, as well as competition from other advertising media. In particular, the former sales representative of several of the Network Services Companies publishes directories in competition with those published by the Company in its service territory.\nPublic Telephone Services\nThe Company faces increasing competition in the provision of pay telephone services from other pay telephone service providers. In addition, the growth of wireless communications negatively impacts usage of public telephones.\nOperator Services\nAlternative operator services providers have entered into competition with the Company's operator services product line.\nNEW PRODUCTS AND SERVICES\nThe following were among the new products and services introduced by the Company in 1994:\nSmall Business Economic Development Incentive Program provides a discounted rate plan designed to provide an incentive to small business customers to expand business and employment in New Jersey's Urban Enterprise Zones. The program provides the waiving of up to $500 of the nonrecurring charges for the connection of new or additional exchange access lines and will provide one month of free service for up to three new or additional CLASS or Custom Calling features for one business line.\nBell Atlantic - New Jersey, Inc.\nIndividual Line Business IntelliLinQ Basic Rate Interface provides customers with simultaneous access, transmission and switching of voice, data and image capabilities over a single line by utilizing Integrated Services Digital Network architecture.\nConsumer Opportunity Savings Plan is an optional calling plan that provides a 20% discount on direct distance dialed (\"DDD\") calls for residence customers who enroll in the plan and whose monthly intraLATA DDD charges equal or exceed $20.\nToll Savings Plan is an optional toll calling plan for business customers who generate $150,000 or more in annual billing for the Company's services (exclusive of Directory Advertising) or who have 21 or more access lines or 101 or more station lines. This plan provides a fixed rate per minute for 50 hours or more of calling based on the total hours of intraLATA DDD usage.\nOutward WATS Savings Plan is an optional calling plan for business customers who generate $150,000 or more in annual billing for the Company (exclusive of Directory Advertising) or who have 21 or more access lines or 101 or more station lines. This plan provides a fixed rate per minute for 50 hours or more of calling based on the total hours of intrastate intraLATA Outward WATS usage.\nCustoPAK is a Centrex service targeted to small business customers which provides intercommunication between Centrex lines within the customer's system, Local Exchange Service, direct in dialing to Centrex lines, identification and billing of outgoing long distance messages by line number where such billing is done by the Company, Touch Tone Calling service, and intercept to the main listed number.\nThe Company also introduced ISDN Anywhere which allows customers in non- equipped Integrated Services Digital Network (\"ISDN\") offices to be offered service from a designated host switch. Customers served by non-equipped offices will be offered service from the designated host switch until such time as their home office becomes equipped with ISDN. ISDN services provide for simultaneous transport of voice, data and images. Other new services introduced were Three Way Call Transfer and Operator Revert. The Company also introduced the capability for Per Call Blocking and Anonymous Call Rejection.\nCERTAIN CONTRACTS AND RELATIONSHIPS\nCertain planning, marketing, procurement, financial, legal, accounting, technical support and other management services are provided on behalf of the Company on a centralized basis by Bell Atlantic's wholly owned subsidiary, Bell Atlantic Network Services, Inc. (\"NSI\"). Bell Atlantic Network Funding Corporation provides short-term financing and cash management services to the Company.\nThe seven RHCs each own (directly or through subsidiaries) a one-seventh interest in Bell Communications Research, Inc. (\"Bellcore\"). Pursuant to the Plan, Bellcore furnishes the RHCs and their BOC subsidiaries with technical assistance such as network planning, engineering and software development, as well as various other consulting services that can be provided more effectively on a centralized basis. Bellcore is the central point of contact for coordinating the efforts of the RHCs in meeting the national security and emergency preparedness requirements of the federal government. It also helps to mobilize the combined resources of the RHCs in times of natural disasters.\nBell Atlantic - New Jersey, Inc.\nEMPLOYEE RELATIONS\nAs of December 31, 1994, the Company employed approximately 14,500 persons, including personnel managed by the centralized staff of NSI. This represents a decrease of approximately 5% from December 31, 1993. This workforce is augmented by employees of the centralized staff of NSI, who perform services for the Company on a contract basis.\nApproximately 86% of the Company's employees are represented by unions. Of those so represented, approximately 39% are represented by the Communications Workers of America, and approximately 61% are represented by the International Brotherhood of Electrical Workers. Both are affiliated with the American Federation of Labor - Congress of Industrial Organizations.\nThe represented associates received a base wage increase of 4.00% in August 1994 under the terms of three-year contracts, which were ratified in October 1992 by unions representing associate employees of the Bell Atlantic Network Services Companies, including the Company and NSI. Under the same contracts, associates received a Corporate Profit Sharing payment of $480 per person in 1995 based upon Bell Atlantic's 1994 financial performance.\nThe terms of the contracts ratified in October 1992 by unions representing associate employees of the Bell Atlantic Network Services Companies, including the Company and NSI, expire in August 1995.\nBell Atlantic - New Jersey, Inc.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal properties of the Company do not lend themselves to simple description by character and location. The Company's investment in plant, property and equipment consisted of the following at December 31:\n\"Central office equipment\" consists of switching equipment, transmission equipment and related facilities. \"Cable, wiring, and conduit\" consists primarily of aerial cable, underground cable, conduit and wiring. \"Land and buildings\" consists of land owned in fee and improvements thereto, principally central office buildings. \"Other equipment\" consists of public telephone terminal equipment and other terminal equipment, poles, furniture, office equipment, and vehicles and other work equipment. \"Other\" property consists primarily of plant under construction, capital leases and leasehold improvements.\nThe Company's customers are served by electronic switching systems that provide a wide variety of services. The Company's network is in a transition from an analog to a digital network, which provides the capabilities to furnish advanced data transmission and information management services. At December 31, 1994, approximately 71% of the access lines were served by digital capability.\nBell Atlantic - New Jersey, Inc.\nItem 3.","section_3":"Item 3. Legal Proceedings\nPRE-DIVESTITURE CONTINGENT LIABILITIES AND LITIGATION\nThe Plan provides for the recognition and payment by AT&T and the former BOCs (including the Company) of liabilities that are attributable to pre-Divestiture events but do not become certain until after Divestiture. These contingent liabilities relate principally to litigation and other claims with respect to the former Bell System's rates, taxes, contracts and torts (including business torts, such as alleged violations of the antitrust laws). Except to the extent that affected parties otherwise agree, contingent liabilities that are attributable to pre-Divestiture events are shared by AT&T and the BOCs in accordance with formulas prescribed by the Plan, whether or not an entity was a party to the proceeding and regardless of whether an entity was dismissed from the proceeding by virtue of settlement or otherwise. Each company's allocable share of liability under these formulas depends on several factors, including the type of contingent liability involved and each company's relative net investment as of the effective date of Divestiture. Under the formula generally applicable to most of the categories of these contingent liabilities, the Company's aggregate allocable share of liability is approximately 2.8%.\nAT&T and various of its subsidiaries and the BOCs (including, in some cases, the Company) have been and are parties to various types of litigation relating to pre-Divestiture events, including actions and proceedings involving environmental claims and allegations of violations of equal employment laws. Damages, if any, ultimately awarded in the remaining actions relating to pre- Divestiture events could have a financial impact on the Company whether or not the Company is a defendant since such damages will be treated as contingent liabilities and allocated in accordance with the allocation rules established by the Plan.\nWhile complete assurance cannot be given as to the outcome of any contingent liabilities or litigation, in the opinion of the Company's management, any monetary liability or financial impact to which the Company would be subject after final adjudication of all of the remaining potential or actual pre- Divestiture claims would not be material in amount to the financial position of the Company.\nBell Atlantic - New Jersey, Inc.\nPART I\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\n(Omitted pursuant to General Instruction J(2).)\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters\n(Inapplicable.)\nItem 6.","section_6":"Item 6. Selected Financial Data\n(Omitted pursuant to General Instruction J(2).)\nBell Atlantic - New Jersey, Inc.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Results of Operations (Abbreviated pursuant to General Instruction J(2).)\nThis discussion should be read in conjunction with the Financial Statements and Notes to the Financial Statements included in the index set forth on page.\nThe Company reported a loss of $140.7 million in 1994, compared to net income of $450.4 million in 1993.\nResults for 1994 included a noncash, after-tax extraordinary charge of $589.7 million in connection with the Company's decision to discontinue application of regulatory accounting principles required by Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (Statement No. 71). Results also included an extraordinary charge of $6.7 million for the early extinguishment of debt, net of tax.\nThe discontinued application of Statement No. 71 required the Company, for financial reporting purposes, to eliminate its regulatory assets and liabilities, resulting in an after-tax charge of $15.8 million. In addition, the Company recorded an after-tax charge of $573.9 million, net of related investment tax credits of $41.1 million, to adjust the carrying amount of its telephone plant and equipment. On August 1, 1994, the Company began using shorter asset lives to depreciate certain categories of plant and equipment. The use of the shorter asset lives increased depreciation expense in 1994 by approximately $27 million, for financial reporting purposes, over the amount that would have been recorded using asset lives in effect at the time of the discontinued application of Statement No. 71. See Notes 1, 2 and 3 to the Financial Statements for additional information on the discontinuation of regulatory accounting principles.\nResults for 1993 included an extraordinary charge of $6.9 million for the early extinguishment of debt, net of tax, and $30.0 million for the cumulative effect of adopting Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (Statement No. 112).\nIn the third quarter of 1994, the Company recorded a pretax charge of $44.9 million, in accordance with Statement No. 112, to recognize the Company's proportionate share of benefit costs for the separation of employees who are entitled to benefits under preexisting Bell Atlantic separation pay plans. The charge, which was actuarially determined, represents benefits earned through July 1, 1994 for employees who are expected to receive separation payments in the future, including those who will be separated through 1997, pursuant to initiatives announced in August 1994. These workforce reductions will be made possible by changes in provisioning systems and customer service processes, increased spans of control, and consolidation and centralization of administrative and staff groups. Costs to enhance systems and consolidate work activities will be charged to expense as incurred. The Company will continue to evaluate ways to streamline and restructure its operations and reduce its workforce to improve its future cost structure.\nBell Atlantic - New Jersey, Inc.\nTRANSPORT SERVICES OPERATING STATISTICS ---------------------------------------\nLOCAL SERVICE REVENUES\nLocal service revenues are earned by the Company from the provision of local exchange, local private line and public telephone services.\nLocal service revenues increased in 1994 due primarily to the 2.9% growth in the number of access lines in service, as well as higher usage of basic calling services.\nNETWORK ACCESS REVENUES\nNetwork access revenues are received from interexchange carriers (IXCs) for their use of the Company's local exchange facilities in providing long-distance services to IXCs' customers and from end-user subscribers. Switched access service revenues are derived from usage-based charges paid by IXCs for access to the Company's network. Special access revenues arise from access charges paid by customers who have private lines, and end-user access revenues are earned from local exchange carrier customers who pay for access to the network.\nBell Atlantic - New Jersey, Inc.\nNetwork access revenues increased principally due to higher customer demand for access services as reflected by growth in access minutes of use of 8.6%, as well as growth in revenue from end-user charges attributable to increasing access lines in service. Volume-related increases were partially offset by the effect of price reductions.\nTOLL SERVICE REVENUES\nToll service revenues are earned from calls made outside a customer's local calling area, but within the same service area boundaries of the Company, commonly referred to as \"LATAs.\" Other toll services include 800 services, Wide Area Telephone Service (WATS) and corridor services (between southern New Jersey and Philadelphia and northern New Jersey and New York City).\nToll service revenues grew in the first half of 1994 by $22.5 million, but declined by $15.1 million during the second half of 1994 over comparable periods in 1993. Growth in the first half of the year was primarily the result of the recovering economy and harsh weather conditions. The decline in revenues in the second half of the year reflects increased competition. Beginning July 1, 1994, IXCs were permitted to compete for intraLATA toll services on an access code basis. Competition for WATS, private line and interstate toll services resulted in a revenue decline for the year of $5.8 million. The Company expects that competition for toll services will continue to intensify in 1995. (see State Regulation section).\nDIRECTORY ADVERTISING REVENUES\nDirectory advertising revenues are earned primarily from local advertising and marketing services provided to businesses in White and Yellow Page directories. Other directory advertising services include database and foreign directory marketing.\nGrowth in directory advertising revenues was principally due to a change in customer billing resulting in accelerated revenue recognition in 1994, and higher rates charged for these services. Volume growth continues to be impacted by competition from other directory companies, as well as other advertising media.\nOTHER ANCILLARY REVENUES\nOther ancillary services include billing and collection services provided to IXCs, and facilities rental services provided to affiliates and non-affiliates.\nOther ancillary services revenues decreased principally due to a reduction in intraLATA toll compensation, which ceased July 1, 1994 with the commencement of intraLATA toll competition, and a reduction in rental revenues from non- affiliates.\nBell Atlantic - New Jersey, Inc.\nVALUE-ADDED SERVICES REVENUES\nValue-added services represent a family of enhanced services including Call Waiting, Return Call, Caller ID, Answer Call, and Voice Mail. These services also include customer premises services such as inside wire installation and maintenance and other central office services and features.\nContinued growth in the network customer base (access lines) and higher demand by residence customers for value-added central office and voice messaging services offered by the Company increased value-added services revenues in 1994. Value-added services revenues were positively impacted by increased demand and higher rates for inside wire installation and maintenance services. These revenue increases were offset, in part, by lower revenues generated from certain maturing central office services and features.\nOPERATING EXPENSES ------------------\nEMPLOYEE COSTS\nEmployee costs consist of salaries, wages and other employee compensation, employee benefits and payroll taxes paid directly by the Company. Similar costs incurred by employees of Bell Atlantic Network Services, Inc. (NSI), who provide centralized services on a contract basis, are allocated to the Company and are included in other operating expenses.\nThe increase in employee costs was largely attributable to a charge of $35.4 million to recognize, in accordance with Statement No. 112, the Company's proportionate share of benefit costs for the aforementioned separation of employees. The third and fourth quarters of 1994 also included approximately $2 million for the ongoing recognition of costs under separation pay plans. Benefit costs associated with the separation of employees of NSI were allocated to the Company and are included in other operating expenses. Employee costs were also higher due to salary and wage increases, and increased overtime pay and higher repair and maintenance activity caused by unusually severe weather conditions experienced during the year. These expense increases were offset, in part, by the effect of lower workforce levels during 1994.\nDEPRECIATION AND AMORTIZATION\nDepreciation and amortization expense increased due principally to growth in telephone plant and increased rates of depreciation, including depreciation increases resulting from the Company's aforementioned discontinued application of Statement\nBell Atlantic - New Jersey, Inc.\nNo. 71. On August 1, 1994, the Company began using shorter asset lives for certain categories of plant and equipment which reflect the Company's expectations as to the revenue-producing lives of the assets (see Note 3 to the Financial Statements). The use of the shorter asset lives increased depreciation expense in 1994, for financial reporting purposes, by approximately $27 million over the amount that would have been recorded using asset lives in effect at the time of the discontinued application of Statement No. 71. Future depreciation rate changes for regulatory purposes will not affect depreciation expense recognized for financial reporting purposes.\nOTHER OPERATING EXPENSE\nOther operating expenses consist primarily of contracted services including centralized service expenses allocated from NSI, rent, network software costs, operating taxes other than income, provision for uncollectible accounts receivable and other costs.\nThe increase in other operating expenses was due principally to higher costs allocated from NSI primarily as a result of higher employee costs, contracted services, and employee-related expenses incurred in that organization, including $9.5 million for the Company's allocated share of separation benefit costs associated with employees of NSI. Also contributing to the increase were higher costs for non-affiliate contract labor and engineering services.\nThese increases were partially offset by $14.2 million, representing the Company's allocated share of reimbursements of previously recognized costs as a result of the decision by other Bell Communications Research, Inc. owners to participate in the Advanced Intelligent Network (AIN) project. Previously, this project had been supported entirely by Bell Atlantic's network services subsidiaries, including the Company.\nOTHER INCOME AND (EXPENSE), NET\nThe change in other income and (expense), net was largely attributable to the effect of the reversal of an accrual recorded in 1993 in connection with the favorable settlement of a tax issue, and a reduction in income related to the allowance for funds used during construction.\nUpon the discontinued application of Statement No. 71, effective August 1, 1994, interest costs on telephone plant under construction were capitalized in accordance with the provisions of Statement of Financial Accounting Standards No. 34, \"Capitalization of Interest Cost,\" and reported as a cost of telephone plant and a reduction of interest expense. Previously, the Company recorded an allowance for funds used during construction as a cost of plant and an item of other income. The allowance for funds used during construction recorded prior to August 1, 1994 totaled $8.4 million, compared to $11.3 million for the twelve-month period ended December 31, 1993. The lower amount recorded in 1994 resulted primarily from the discontinued application of Statement No. 71 offset, in part, by increased levels of telephone plant under construction during the year.\nBell Atlantic - New Jersey, Inc.\nINTEREST EXPENSE\nInterest expense decreased principally due to the effects of long-term debt refinancings in 1994 and 1993, and a reduction in capital lease interest expense. Interest expense was further reduced by the recognition of $5.1 million in capitalized interest costs, subsequent to the discontinued application of Statement No. 71. These decreases were partially offset by additional expense resulting from higher levels of average short-term debt and rising interest rates.\nPROVISION FOR INCOME TAXES\nEFFECTIVE INCOME TAX RATES\nThe Company's effective income tax rate was higher in 1994 due to the reduction in the amortization of investment tax credits and the elimination of the benefit of the rate differential applied to reversing timing differences as a result of the discontinued application of Statement No. 71. The higher effective income tax rate also resulted from the effect of a one-time net benefit recorded in 1993 to adjust deferred taxes for the increase in the federal corporate income tax rate from 34% to 35%.\nCOMPETITIVE AND REGULATORY ENVIRONMENT --------------------------------------\nThe communications industry continues to undergo fundamental changes which may have a significant impact on future financial performance of telecommunications companies. These changes are being driven by a number of factors, including the accelerated pace of technological innovation, the convergence of the telecommunications, cable television, information services and entertainment businesses and a regulatory environment in which traditional barriers are being lowered or eliminated and competition permitted or encouraged.\nThe Company's telecommunications business is subject to competition from numerous sources. An increasing amount of this competition is from companies that have substantial capital, technological and marketing resources, many of which do not face the same regulatory constraints as the Company.\nWell-financed competitors are seeking authority, or are likely soon to seek authority, to offer competing local exchange services, such as dial tone and local usage, in some of the most lucrative of the Company's local telephone service areas. In January 1995, MFS-Intelenet filed a petition with the Board of Public Utilities (BPU) to provide local exchange service in areas served by the Company.\nThe entry of well-financed competitors has the potential to adversely affect multiple revenue streams of the Company, including toll, local exchange and network access services in the market segments and geographical areas in which the competitors operate. The amount of revenue reductions will depend, in part, on the competitors' success in marketing these services, and the conditions established by regulatory authorities. The potential impact is expected to be offset, to some extent, by revenues from interconnection charges to be paid to the Company by these competitors.\nBell Atlantic - New Jersey, Inc.\nThe Company continues to respond to competitive challenges by intensely focusing on meeting customer requirements and by reducing its cost structure through efficiency and productivity initiatives. In addition, the Company continues to seek growth opportunities in businesses where it possesses core competencies.\nFEDERAL REGULATION\nLegislation has been introduced in the current session of the United States Congress that would remove barriers to entry in the local exchange markets and would permit local exchange carriers, such as the Company, to provide interLATA services. The impact of the enactment of such legislation on the Company's future financial performance will depend on a number of factors, including the degree of parity under which competition is permitted in the local and long- distance markets.\nIn February 1994, the Federal Communications Commission (FCC) initiated a rulemaking proceeding to determine the effectiveness of the price cap rules affecting local exchange carriers, including the Company, and to decide what changes, if any, should be made to those rules. This rulemaking is expected to be concluded in the first half of 1995.\nRecent FCC rulings have sought to expand competition for special and switched access services. The FCC ordered local exchange carriers, including the Company, to provide virtual collocation in the Company's central offices to competitors, with the option of offering physical collocation, for the purpose of providing special and switched access transport services. The Company does not expect the net revenue impact of collocation to be material.\nSTATE REGULATION\nThe communications services of the Company are subject to regulation by the BPU with respect to intrastate rates and services and other matters.\nThe New Jersey Telecommunications Act of 1992 authorized the BPU to adopt alternative regulatory frameworks to address changes in technology and the structure of the telecommunications industry and to promote economic development. It also deregulated services which the BPU found to be competitive. Pursuant to that legislation, the Company filed a Plan for Alternative Form of Regulation, which became effective in May 1993.\nIn May 1994, the BPU approved a settlement of a proceeding addressing intraLATA toll competition. The settlement permits IXCs to compete for the provision of intraLATA toll services on an access code basis (e.g., customers must dial 10XXX to use an IXC), beginning July 1, 1994, and granted the Company substantial flexibility in the pricing and marketing of the services it offers to enable it to compete with the IXCs. In January 1995, the BPU commenced a further proceeding to examine issues of intraLATA toll service competition including whether presubscription should be authorized, and if so, under what terms and conditions, and to address the issue of subsidies embodied in the Company's rates. A decision on this proceeding is expected by the end of 1995. The Company's ability to offset such competition will depend, in part, upon the terms and conditions under which presubscription of intraLATA toll services may be authorized.\nSee Item 1 - Description of Business, State Regulation and Competitive Environment for a complete description of the Company's current regulatory plan and competitive environment.\nOTHER MATTERS -------------\nENVIRONMENTAL ISSUES\nThe Company is subject to a number of environmental proceedings as a result of its operations and shared liability provisions in the Plan of Reorganization related to the Modification of Final Judgment. Certain of these environmental matters relate to Superfund sites for which the Company has been joined as a third-party defendant in pending Superfund litigation. Such joinder subjects the Company to potential liability for costs relating to cleanup of the affected sites. The Company is also\nBell Atlantic - New Jersey, Inc.\nresponsible for the remediation of sites with underground fuel storage tanks and other expenses associated with environmental compliance.\nThe Company continually monitors its operations with respect to potential environmental issues, including changes in legally mandated standards and remediation technologies. The Company's recorded liability reflects those specific issues where remediation activities are currently deemed to be probable and where the cost of remediation is estimable. Management believes that the aggregate amount of any additional potential liability would not have a material effect on the Company's results of operations or financial condition.\nFINANCIAL CONDITION -------------------\nManagement believes that the Company has adequate internal and external resources available to meet ongoing operating requirements, including network expansion and modernization, and payment of dividends. Management expects that presently foreseeable capital requirements will be financed primarily through internally generated funds. Additional long-term debt may be needed to fund development activities and to maintain the Company's capital structure within management's guidelines.\nAs of December 31, 1994, the Company had $354.7 million of an unused line of credit with an affiliate, Bell Atlantic Network Funding Corporation. In addition, the Company had $50.0 million remaining under a shelf registration statement filed with the Securities and Exchange Commission for the issuance of unsecured debt securities.\nThe Company's debt ratio was 48.2% at December 31, 1994, compared to 39.6% at December 31, 1993. The 1994 debt ratio was impacted significantly by the equity reduction associated with the discontinued application of Statement No. 71.\nAs a result of the discontinued application of Statement No. 71, the Balance Sheet at December 31, 1994 reflects significant changes due to the elimination of regulatory assets and liabilities, the revaluation of plant and equipment and the accelerated amortization of investment tax credits (see Note 2 to the Financial Statements).\nBell Atlantic - New Jersey, Inc.\nPART II\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe information required by this Item is set forth on pages through .\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\n(Omitted pursuant to General Instruction J(2).)\nItem 11.","section_11":"Item 11. Executive Compensation\n(Omitted pursuant to General Instruction J(2).)\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(Omitted pursuant to General Instruction J(2).)\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n(Omitted pursuant to General Instruction J(2).)\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:\n(1) Financial Statements\nSee Index to Financial Statements and Financial Statement Schedule appearing on Page.\n(2) Financial Statement Schedules\nSee Index to Financial Statements and Financial Statement Schedule appearing on Page.\nBell Atlantic - New Jersey, Inc.\nPART IV\nItem 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (Continued)\n(3) Exhibits\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated herein by reference as exhibits hereto.\nExhibit Number (Referenced to Item 601 of Regulation S-K) --------------------------------------------------------\n3a Restated Certificate of Incorporation of the registrant, dated September 28, 1989 and filed November 28, 1989. (Exhibit 3a to the registrant's Annual Report on Form 10-K for 1989, File No. 1- 3488.)\n3a(i) Certificate of Amendment to the Certificate of Incorporation of the registrant's, dated January 7, 1994 and filed January 13, 1994. (Exhibit 3a(i) to the registrant's Annual Report on Form 10-K for 1993, File No. 1-3488.)\n3b By-Laws of the registrant, as amended January 26, 1995.\n4 No instrument which defines the rights of holders of long and intermediate 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.\n10a Agreement Concerning Contingent Liabilities, Tax Matters and Termination of Certain Agreements among AT&T, Bell Atlantic Corporation, and the Bell Atlantic Corporation telephone subsidiaries, and certain other parties, dated as of November 1, 1983. (Exhibit 10a to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n10b Agreement among Bell Atlantic Network Services, Inc. and the Bell Atlantic Corporation telephone subsidiaries, dated November 7, 1983. (Exhibit 10b to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n23 Consent of Independent Accountants.\n24 Powers of Attorney.\n27 Financial Data Schedule.\n(b) Reports on Form 8-K:\nThere were no Current Reports on Form 8-K filed during the quarter ended December 31, 1994.\nBell Atlantic - New Jersey, 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.\nBell Atlantic - New Jersey, Inc.\nBy \/s\/ Michael J. Losch ------------------------------------ Michael J. Losch Controller and Treasurer and Chief Financial Officer\nMarch 29, 1995\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.\nBell Atlantic - New Jersey, Inc.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nFinancial statement schedules other than that listed above have been omitted because such schedules are not required or applicable.\nBell Atlantic - New Jersey, Inc.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareowner of Bell Atlantic - New Jersey, Inc.\nWe have audited the financial statements and financial statement schedule of Bell Atlantic - New Jersey, Inc. as listed in the index on page of this Form 10-K. The financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the 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 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 Bell Atlantic - New Jersey, Inc. as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nAs discussed in Notes 1 and 2 to the financial statements, the Company discontinued accounting for its operations in accordance with Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation,\" effective August 1, 1994. Also, as discussed in Notes 1, 7 and 8 to the financial statements, the Company changed its method of accounting for income taxes and postemployment benefits in 1993.\n\/s\/ COOPERS & LYBRAND L.L.P.\n2400 Eleven Penn Center Philadelphia, Pennsylvania February 6, 1995\nBell Atlantic - New Jersey, Inc.\nSTATEMENTS OF OPERATIONS AND REINVESTED EARNINGS FOR THE YEARS ENDED DECEMBER 31 (DOLLARS IN MILLIONS)\nSee Notes to Financial Statements.\nBell Atlantic - New Jersey, Inc.\nBALANCE SHEETS (DOLLARS IN MILLIONS)\nASSETS ------\nSee Notes to Financial Statements.\nBell Atlantic - New Jersey, Inc.\nBALANCE SHEETS (DOLLARS IN MILLIONS)\nLIABILITIES AND SHAREOWNER'S INVESTMENT ---------------------------------------\nSee Notes to Financial Statements.\nBell Atlantic - New Jersey, Inc.\nSTATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31 (DOLLARS IN MILLIONS)\nSee Notes to Financial Statements.\nBell Atlantic - New Jersey, Inc.\nNOTES TO FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nBell Atlantic - New Jersey, Inc. (the Company), is a wholly owned subsidiary of Bell Atlantic Corporation (Bell Atlantic).\nEffective August 1, 1994, the Company discontinued accounting for its operations under the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (Statement No. 71) (see Note 2).\nREVENUE RECOGNITION\nRevenues are recognized as earned on the accrual basis, which is generally when services are rendered based on the usage of the Company's local exchange network and facilities.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid investments with a maturity of 90 days or less when purchased to be cash equivalents. Cash equivalents are stated at cost, which approximates market value.\nMATERIAL AND SUPPLIES\nNew and reusable materials are carried in inventory, principally at average original cost, except that specific costs are used in the case of large individual items.\nPREPAID DIRECTORY\nCosts of directory production and advertising sales are principally deferred until the directory is published. Such costs are amortized to expense and the related advertising revenues are recognized over the average life of the directory, which is generally 12 months.\nPLANT AND DEPRECIATION\nThe Company's provision for depreciation is based principally on the composite group remaining life method of depreciation and straight-line composite rates. This method provides for the recovery of the remaining net investment in telephone plant, less anticipated net salvage value, over the remaining asset lives. In connection with the discontinued application of Statement No. 71, the Company began recording depreciation expense based on expected revenue-producing asset lives. The following asset lives were used, effective August 1, 1994: buildings, 21 to 40 years; central office equipment, 8 to 12 years; cable, wiring, and conduit, 16 to 50 years; and other equipment, 6 to 35 years. Previously depreciation expense was based on regulatory asset lives (see Note 3) and included regulatory determined amortization of certain classes of telephone plant.\nWhen depreciable plant is replaced or retired, the amounts at which such plant has been carried in plant, property and equipment are removed from the respective accounts and charged to accumulated depreciation, and any gains or losses on disposition are amortized over the remaining asset lives of the remaining net investment in telephone plant.\nMAINTENANCE AND REPAIRS\nThe cost of maintenance and repairs, including the cost of replacing minor items not constituting substantial betterments, is charged to operating expense.\nBell Atlantic - New Jersey, Inc.\nCAPITALIZED INTEREST COST\nUpon the discontinued application of Statement No. 71, effective August 1, 1994, the Company began reporting capitalized interest as a cost of telephone plant and equipment and a reduction in interest expense, in accordance with the provisions of Statement of Financial Accounting Standards No. 34, \"Capitalization of Interest Cost.\"\nPrior to the discontinued application of Statement No. 71, the Company recorded an allowance for funds used during construction, which included both interest and equity return components, as a cost of plant and as an item of other income.\nEMPLOYEE BENEFITS\nPension Plans\nSubstantially all employees of the Company are covered under noncontributory multi-employer defined benefit pension plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company.\nAmounts contributed to the Company's pension plans are actuarially determined, principally under the aggregate cost actuarial method, and are subject to applicable federal income tax regulations.\nPostretirement Benefits Other Than Pensions\nSubstantially all employees of the Company are covered under postretirement health and life insurance benefit plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company.\nAmounts contributed to 501(c)(9) trusts and 401(h) accounts under applicable federal income tax regulations to pay certain postretirement benefits are actuarially determined, principally under the aggregate cost actuarial method.\nPostemployment Benefits\nThe Company provides employees with postemployment benefits such as disability benefits, workers' compensation, and severance pay.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits,\" which requires accrual accounting for the estimated cost of benefits provided to former or inactive employees after employment but before retirement. Prior to 1993, the cost of these benefits was primarily charged to expense as the benefits were paid.\nINCOME TAXES\nBell Atlantic and its domestic subsidiaries, including the Company, file a consolidated federal income tax return.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement No. 109), which requires the determination of deferred taxes using the asset and liability method. Under the asset and liability method, deferred taxes are provided on book and tax basis differences and deferred tax balances are adjusted to reflect enacted changes in income tax rates.\nThe consolidated amount of current and deferred tax expense is allocated by applying the provisions of Statement No. 109 to each subsidiary as if it were a separate taxpayer.\nPrior to 1993, the Company accounted for income taxes based on the provisions of Accounting Principles Board Opinion No. 11, \"Accounting for Income Taxes\" (APB No. 11). Under APB No. 11, deferred taxes were generally provided to reflect the effect of timing differences on the recognition of revenue and expense determined for financial and income tax reporting purposes.\nBell Atlantic - New Jersey, Inc.\nThe Tax Reform Act of 1986 repealed the investment tax credit (ITC) as of January 1, 1986, subject to certain transitional rules. ITCs were deferred and are being amortized as a reduction to income tax expense over the estimated service lives of the related assets.\nRECLASSIFICATIONS\nCertain reclassifications of prior years' data have been made to conform to 1994 classifications.\n2. DISCONTINUATION OF REGULATORY ACCOUNTING PRINCIPLES\nIn the third quarter of 1994, the Company determined that it was no longer eligible for continued application of the accounting required by Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation\" (Statement No. 71). In connection with the decision to discontinue regulatory accounting principles under Statement No. 71, the Company recorded a noncash, after-tax extraordinary charge of $589.7 million, which is net of an income tax benefit of $423.2 million.\nThe Company's determination that it was no longer eligible for continued application of the accounting required by Statement No. 71 was based on the belief that the convergence of competition, technological change (including the Company's technology deployment plans), actual and potential regulatory, legislative and judicial actions, and other factors are creating fully open and competitive markets. In such markets, the Company does not believe it can be assured that prices can be maintained at levels that will recover the net carrying amount of existing telephone plant and equipment, which has been depreciated over relatively long regulatory lives.\nThe components of the charge recognized as a result of the discontinued application of Statement No. 71 follow:\nThe increase in the accumulated depreciation reserve of $946.1 million was supported by both an impairment analysis, which identified estimated amounts not recoverable from future discounted cash flows, and a depreciation study, which identified inadequate depreciation reserve levels which the Company believes resulted principally from the cumulative underdepreciation of plant as a result of the regulatory process. Investment tax credit amortization was accelerated as a result of the reduction in remaining asset lives of the associated telephone plant and equipment.\nUpon adoption of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" the effects of required adjustments to deferred tax balances were deferred on the balance sheet as regulatory assets and liabilities and amortized at the time the related deferred taxes were recognized in the ratemaking process. As of August 1, 1994, tax-related regulatory assets of $117.5 million and tax-related regulatory liabilities of $145.1 million were eliminated. The elimination of other regulatory assets and liabilities relate principally to deferred debt refinancing and vacation pay costs, which were being amortized as they were recognized in the ratemaking process.\nBell Atlantic - New Jersey, Inc.\n3. PLANT, PROPERTY AND EQUIPMENT\nPlant, property and equipment, which is stated at cost, is summarized as follows at December 31:\nThe increase in accumulated depreciation in 1994 included $946.1 million attributable to the adjustment to the carrying value of plant and equipment resulting from the discontinued application of Statement No. 71 (see Note 2). The components of the adjustment to the accumulated depreciation reserve are summarized as follows:\nIn connection with the discontinued application of Statement No. 71, effective August 1, 1994, for financial reporting purposes, the Company began using estimated asset lives for certain categories of plant and equipment that are shorter than those in effect prior to the discontinuance of Statement No. 71. The shorter lives result from the Company's expectation as to the revenue- producing lives of the assets. A comparison of the regulatory asset lives to the shorter new asset lives for the most significantly impacted categories of plant and equipment follows:\n4. LEASES\nThe Company has entered into both capital and operating leases for facilities and equipment used in operations. Plant, property and equipment included capital leases of $68.9 million and $85.4 million and related accumulated amortization of $39.1 million and $47.1 million at December 31, 1994 and 1993, respectively. The Company incurred initial capital lease obligations of $.5 million in 1994, as compared to no initial capital lease obligations in 1993 and $.3 million in 1992.\nTotal rent expense amounted to $53.3 million in 1994, $53.6 million in 1993, and $55.1 million in 1992. Of these amounts, the Company incurred rent expense of $12.3 million, $6.8 million, and $3.6 million in 1994, 1993, and 1992, respectively, to affiliated companies.\nBell Atlantic - New Jersey, Inc.\nAt December 31, 1994, the aggregate minimum rental commitments under noncancelable leases for the periods shown are as follows:\n5. DEBT\nLONG-TERM\nLong-term debt consists principally of debentures issued by the Company. Interest rates and maturities of the amounts outstanding are as follows at December 31:\nLong-term debt outstanding at December 31, 1994 includes $390.0 million that is callable by the Company. The call prices range from 102.7% to 100.0% of face value, depending upon the remaining term to maturity of the issue. In addition, long-term debt includes $150.0 million that will become redeemable only on November 15, 1999 at the option of the holders. The redemption price will be 100.0% of face value, plus accrued interest.\nBell Atlantic - New Jersey, Inc.\nOn February 14, 1994, the Company sold $250.0 million of Ten Year 5 7\/8% Debentures, due February 1, 2004, through a public offering. The debentures are not redeemable by the Company prior to maturity. The net proceeds from this issuance were used on March 2, 1994, to redeem $150.0 million of Forty Year 7 3\/4% Debentures due in 2013, and $100.0 million of Forty Year 8% Debentures due in 2016. The Company redeemed the $150.0 million 7 3\/4% debentures at a call price equal to 102.8% of the principal amount, plus accrued interest from March 1, 1994, and the $100 million 8% debentures at a call price equal to 104.1% of the principal amount, plus accrued interest from September 15, 1993. As a result of the early extinguishment of these debentures, which were called on January 31, 1994, the Company recorded a charge of $10.3 million, before an income tax benefit of $3.6 million, in the first quarter of 1994.\nThe Company recorded extraordinary charges associated with the early extinguishment of debentures called by the Company of $10.5 million, before an income tax benefit of $3.6 million in 1993, and $25.3 million, before an income tax benefit of $8.6 million in 1992.\nAt December 31, 1994, the Company had $50.0 million remaining under a shelf registration statement filed with the Securities and Exchange Commission.\nDEBT MATURING WITHIN ONE YEAR\nDebt maturing within one year consists of the following at December 31:\nThe Company has a contractual agreement with an affiliated company, Bell Atlantic Network Funding Corporation (BANFC), for the provision of short-term financing and cash management services. BANFC issues commercial paper and secures bank loans to fund the working capital requirements of Bell Atlantic's network services subsidiaries, including the Company, and invests funds in temporary investments on their behalf. At December 31, 1994, the Company had $354.7 million of an unused line of credit with BANFC.\n6. FINANCIAL INSTRUMENTS\nCONCENTRATIONS OF CREDIT RISK\nFinancial instruments that potentially subject the Company to concentrations of credit risk consist primarily of trade receivables and a note receivable from affiliate.\nConcentrations of credit risk with respect to trade receivables, other than those from AT&T, are limited due to the large number of customers in the Company's customer base. For the years ended December 31, 1994, 1993 and 1992, revenues generated from services provided to AT&T, primarily network access, billing and collection, and sharing of network facilities, were $419.2 million, $423.8 million, and $470.1 million, respectively. At December 31, 1994 and 1993, Accounts receivable, net, included $53.5 million and $66.1 million, respectively, from AT&T.\nBell Atlantic - New Jersey, Inc.\nFAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following methods and assumptions were used to estimate the fair value of each class of financial instruments.\nAccounts Receivable, Note Receivable from Affiliate (BANFC), Accounts Payable, Note Payable to Affiliate (BANFC), and Accrued Liabilities\nThe carrying amount approximates fair value.\nDebt Maturing Within One Year and Long-Term Debt\nFair value is estimated based on the quoted market prices for the same or similar issues or is based on the net present value of the expected future cash flows using current interest rates.\nThe estimated fair values of the Company's financial instruments are as follows at December 31:\n7. EMPLOYEE BENEFITS\nPENSION PLANS\nSubstantially all of the Company's management and associate employees are covered under multi-employer noncontributory defined benefit pension plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company. The pension benefit formula is based on a flat dollar amount per year of service according to job classification under the associate plan and a stated percentage of adjusted career average earnings under the plans for management employees. The Company's objective in funding the plans is to accumulate funds at a relatively stable level over participants' working lives so that benefits are fully funded at retirement. Plan assets consist principally of investments in domestic and foreign corporate equity securities, U.S. and foreign government and corporate debt securities, and real estate.\nAggregate pension cost is as follows:\nBell Atlantic - New Jersey, Inc.\nPension cost in 1994 increased slightly over 1993 cost. Pension cost decreases resulting from plan amendments were more than offset by cost increases resulting from assumption changes, primarily a decrease in the discount rate from 7.75% to 7.25%.\nThe decrease in pension cost in 1993 compared to 1992 is due to the net effect of the elimination of one-time charges associated with special termination benefits that were recognized in the preceding year, favorable investment experience, and changes in plan demographics due to retirement and severance programs.\nStatement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions\" (Statement No. 87) requires a comparison of the actuarial present value of projected benefit obligations with the fair value of plan assets, the disclosure of the components of net periodic pension costs and a reconciliation of the funded status of the plans with amounts recorded on the balance sheets. The Company participates in multi-employer plans and therefore, such disclosures are not presented for the Company because the structure of the plans does not allow for the determination of this information on an individual participating company basis.\nSignificant actuarial assumptions for pension benefits are as follows at December 31:\nThe expected long-term rate of return on plan assets was 8.25% for 1994, 1993, and 1992.\nThe Company has in the past entered into collective bargaining agreements with unions representing certain employees and expects to do so in the future. Pension benefits have been included in these agreements and improvements in benefits have been made from time to time. Additionally, the Company has amended the benefit formula under pension plans maintained for its management employees. Expectations with respect to future amendments to the Company's pension plans have been reflected in determining the Company's pension cost under Statement No. 87.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nSubstantially all of the Company's management and associate employees are covered under postretirement health and life insurance benefit plans sponsored by Bell Atlantic and certain of its subsidiaries, including the Company. The determination of benefit cost for postretirement health benefit plans is based on comprehensive hospital, medical, surgical and dental benefit plan provisions. The postretirement life insurance benefit formula used in the determination of postretirement benefit cost is primarily based on annual basic pay at retirement. The Company funds the postretirement health and life insurance benefits of current and future retirees. Plan assets consist principally of investments in domestic and foreign corporate equity securities, and U.S. Government and corporate debt securities.\nAggregate postretirement benefit cost is as follows:\nYEARS ENDED DECEMBER 31 ------------------------ 1994 1993 1992 ----- ------ ----- (DOLLARS IN MILLIONS)\nPostretirement benefit cost .......... $61.5 $64.1 $59.7 ===== ===== =====\nPostretirement benefit cost decreased in 1994 as a result of favorable claims and demographic experience offset, in part, by cost increases resulting from assumption changes, primarily a decrease in the discount rate from 7.75% to 7.25%. As a result of the 1992 collective bargaining agreements, Bell Atlantic amended the postretirement medical benefit plan for associate employees and certain associate retirees of the Company. The increase in 1993 postretirement benefit cost over 1992 cost was primarily due to the change in benefit levels and claims experience. Also contributing to the increase were changes in actuarial assumptions and demographic experience.\nBell Atlantic - New Jersey, Inc.\nStatement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions,\" (Statement No. 106) requires a comparison of the actuarial present value of projected postretirement benefit obligations with the fair value of plan assets, the disclosure of the components of net periodic postretirement benefit costs, and a reconciliation of the funded status of the plan with amounts recorded on the balance sheets. The Company participates in multi-employer plans and therefore, such disclosures are not presented for the Company because the structure of the plans does not provide for the determination of this information on an individual participating company basis.\nSignificant actuarial assumptions for postretirement benefits are as follows at December 31:\nThe expected long-term rate of return on plan assets was 8.25% for 1994, 1993, and 1992.\nPostretirement benefits other than pensions have been included in collective bargaining agreements and have been modified from time to time. The Company has periodically modified benefits under plans maintained for its management employees. Expectations with respect to future amendments to the Company's postretirement benefit plans have been reflected in determining the Company's postretirement benefit cost under Statement No. 106.\nPOSTEMPLOYMENT BENEFITS\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (Statement No. 112). Statement No. 112 requires accrual accounting for the estimated cost of benefits provided to former or inactive employees after employment but before retirement. The cumulative effect at January 1, 1993 of adopting Statement No. 112 reduced net income by $30.0 million, net of a deferred income tax benefit of $15.4 million. The adoption of Statement No. 112 did not have a significant effect on the Company's ongoing level of operating expense.\nIn the third quarter of 1994, the Company recorded a pretax charge of $44.9 million, in accordance with Statement No. 112, to recognize the Company's proportionate share of benefit costs for the separation of employees who are entitled to benefits under preexisting Bell Atlantic separation pay plans. The charge, which was actuarially determined, represents benefits earned through July 1, 1994 for employees who are expected to receive separation payments in the future, including those employees who will be separated through 1997, pursuant to initiatives announced in August 1994.\nSAVINGS PLANS AND EMPLOYEE STOCK OWNERSHIP PLANS\nSubstantially all of the Company's employees are eligible to participate in savings plans established by Bell Atlantic to provide opportunities for eligible employees to save for retirement on a tax-deferred basis and encourage employees to acquire and maintain an equity interest in Bell Atlantic. Under these plans, a certain percentage of eligible employee contributions are matched with shares of Bell Atlantic common stock. Bell Atlantic funds the matching contribution through two leveraged employee stock ownership plans (ESOPs). Bell Atlantic accounts for its ESOPs in accordance with the accounting rules applicable to companies with ESOP trusts that held securities prior to December 15, 1989. The Company recognizes its proportionate share of total ESOP cost based on the Company's matching obligation attributable to participating Company employees. The Company recorded total ESOP cost\nBell Atlantic - New Jersey, Inc.\nof $14.4 million, $12.8 million, and $19.0 million, in 1994, 1993, and 1992, respectively.\n8. INCOME TAXES\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (Statement No. 109). Statement No. 109 requires the determination of deferred taxes using the asset and liability method. Under the asset and liability method, deferred taxes are provided on book and tax basis differences and deferred tax balances are adjusted to reflect enacted changes in income tax rates. Prior to 1993, the Company accounted for income taxes based on the provisions of Accounting Principles Board Opinion No. 11.\nStatement No. 109 has been adopted on a prospective basis and amounts presented for prior years have not been restated. As of January 1, 1993, the Company recorded a charge to income of $.8 million, representing the cumulative effect of adopting Statement No. 109, which has been reflected in the Provision for Income Taxes in the Statement of Operations and Reinvested Earnings.\nUpon adoption of Statement No. 109, the effects of required adjustments to deferred tax balances of the Company, which would be recognized in the future for regulatory purposes, were deferred on the balance sheet as regulatory assets and liabilities in accordance with Statement No. 71. At January 1, 1993, the Company recorded income tax-related regulatory assets totaling $130.6 million in Other Assets and income tax-related regulatory liabilities totaling $228.6 million in Deferred Credits and Other Liabilities - Other. During 1993, these regulatory assets were increased by $5.9 million and regulatory liabilities were reduced by $21.7 million for the effect of the federal corporate income tax rate increase from 34% to 35%, effective January 1, 1993.\nThe income tax-related regulatory assets and liabilities were eliminated as a result of the discontinued application of Statement No. 71, effective August 1, 1994 (see Note 2).\nThe components of income tax expense are as follows:\nAs a result of the increase in the federal corporate income tax rate from 34% to 35%, effective January 1, 1993, the Company recorded a net charge to the tax provision of $.1 million in 1993.\nThe provision for income taxes varies from the amount computed by applying the statutory federal income tax rate to income before provision for income taxes. The difference is attributable to the following factors:\nBell Atlantic - New Jersey, Inc.\nSignificant components of deferred tax liabilities (assets) were as follows at December 31: 1994 1993 ------- ------- (DOLLARS IN MILLIONS) Deferred tax liabilities: Depreciation................ $ 470.5 $ 832.7 Other....................... 43.6 24.1 ------- ------- 514.1 856.8 ------- ------- Deferred tax assets: Employee benefits........... (346.2) (337.4) Investment tax credits...... (16.3) (67.4) Advance payments............ (30.4) (34.4) Other....................... (97.6) (47.4) ------- ------- (490.5) (486.6) ------- ------- Net deferred tax liability... $ 23.6 $ 370.2 ======= =======\nTotal deferred tax assets include approximately $256 million and $257 million at December 31, 1994 and 1993, respectively, related to postretirement benefit costs recognized in accordance with Statement No. 106. This deferred tax asset will gradually be realized over the estimated lives of current retirees and employees.\nFor the year ended December 31, 1992, a deferred income tax benefit resulted from timing differences in the recognition of revenue and expense for financial and income tax accounting purposes. The sources of these timing differences and the tax effects of each were as follows:\n--------------------- (DOLLARS IN MILLIONS)\nAccelerated depreciation ................ $ 3.9 Employee benefits ....................... (32.7) Other, net .............................. (10.7) ------- Total ................................... $ (39.5) =======\n9. SUPPLEMENTAL CASH FLOW AND ADDITIONAL FINANCIAL INFORMATION\nInterest paid during the year includes $5.1 million in 1994, $3.0 million in 1993, and $3.2 million in 1992 related to short-term financing services provided by Bell Atlantic Network Funding Corporation (see Note 5).\nAt December 31, 1994 and 1993, $37.5 million and $22.0 million, respectively, of negative cash balances were classified as accounts payable.\nBell Atlantic - New Jersey, Inc.\n10. TRANSACTIONS WITH AFFILIATES\nThe financial statements include transactions with Bell Atlantic Network Services, Inc. (NSI), Bell Atlantic Network Funding Corporation (BANFC), Bell Atlantic, and various other affiliates.\nThe Company has contractual arrangements with NSI for the provision of various centralized corporate, administrative, planning, financial and other services. These arrangements serve to fulfill the common needs of Bell Atlantic's telephone subsidiaries on a centralized basis. The Company's allocated share of NSI costs include costs billed by Bell Communications Research, Inc. (Bellcore), another affiliated company owned jointly by the seven regional holding companies (as shown separately below).\nThe Company recognizes interest expense and income in connection with contractual arrangements with BANFC to provide short-term financing, investing and cash management services to the Company (see Note 5).\nOperating revenues include amounts paid to other affiliates in connection with an interstate revenue sharing arrangement with Bell Atlantic network services subsidiaries. Operating revenues and expenses also include miscellaneous items of income and expense resulting from transactions with other affiliates, primarily rental of facilities and equipment. The Company also paid cash dividends to its parent, Bell Atlantic.\nTransactions with affiliates are summarized as follows:\nOutstanding balances with affiliates are reported on the balance sheets at December 31, 1994 and 1993 as Note receivable from affiliate, Accounts receivable - affiliates, Note payable to affiliate, and Accounts payable - parent and affiliates.\nIn 1994, NSI expenses included $9.5 million, representing the Company's proportionate share of separation benefit costs associated with employees of NSI. Bellcore expenses in 1994 included reimbursements of $14.2 million from other Bellcore owners in connection with their decision to participate in the Advanced Intelligent Network (AIN) project. This project previously had been supported entirely by Bell Atlantic's network services subsidiaries, including the Company.\nIn 1993, the Company's reported charge for the cumulative effect of the change in accounting for postemployment benefits included $2.5 million, net of a deferred income tax benefit of $1.3 million, representing the Company's proportionate share of NSI's accrued cost of postemployment benefits at January 1, 1993.\nOn February 1, 1995, the Company declared and paid a dividend in the amount of $108.0 million to Bell Atlantic.\nBell Atlantic - New Jersey, Inc.\n11. QUARTERLY FINANCIAL INFORMATION (unaudited)\n* The loss for the third quarter of 1994 includes an extraordinary charge of $589.7 million, net of an income tax benefit of $423.2 million, related to the discontinuation of regulatory accounting principles (see Note 2).\n** Net income for the first quarter of 1993 includes a charge of $30.0 million, net of a deferred income tax benefit of $15.4 million, related to the adoption of Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (see Note 7).\nBell Atlantic - New Jersey, Inc.\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS For the Years Ended December 31, 1994, 1993, and 1992 (Dollars in Millions)\n------------------------------------------\n(a) (i) Amounts previously written off which were credited directly to this account when recovered; and (ii) accruals charged to accounts payable for anticipated uncollectible charges on purchases of accounts receivable from others which were billed by the Company.\n(b) Amounts written off as uncollectible.\nEXHIBITS\nFILED WITH ANNUAL REPORT FORM 10-K\nUNDER THE SECURITIES EXCHANGE ACT OF 1934\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1994\nBell Atlantic - New Jersey, Inc.\nCOMMISSION FILE NUMBER 1-3488\nForm 10-K for 1994 File No. 1-3488 Page 1 of 1\nEXHIBIT INDEX\nExhibits identified in parentheses below, on file with the Securities and Exchange Commission (SEC), are incorporated herein by reference as exhibits hereto.\nExhibit Number (Referenced to Item 601 of Regulation S-K) ---------------------------------------------------------\n3a Restated Certificate of Incorporation of the registrant, dated September 28, 1989 and filed November 28, 1989. (Exhibit 3a to the registrant's Annual Report on Form 10-K for 1989, File No. 1-3488.)\n3a(i) Certificate of Amendment to the Certificate of Incorporation of the registrant's, dated January 7, 1994 and filed January 13, 1994. (Exhibit 3a(i) to the registrant's Annual Report on Form 10-K for 1993, File No. 1-3488.)\n3b By-Laws of the registrant, as amended January 26, 1995.\n4 No instrument which defines the rights of holders of long and intermediate 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.\n10a Agreement Concerning Contingent Liabilities, Tax Matters and Termination of Certain Agreements among AT&T, Bell Atlantic Corporation, and the Bell Atlantic Corporation telephone subsidiaries, and certain other parties, dated as of November 1, 1983. (Exhibit 10a to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n10b Agreement among Bell Atlantic Network Services, Inc. and the Bell Atlantic Corporations telephone subsidiaries, dated November 7, 1983. (Exhibit 10b to Bell Atlantic Corporation Annual Report on Form 10-K for the year ended December 31, 1993, File No. 1-8606.)\n23 Consent of Independent Accountants.\n24 Powers of Attorney.\n27 Financial Data Schedule.","section_15":""}
{"filename":"108721_1994.txt","cik":"108721","year":"1994","section_1":"ITEM 1. BUSINESS\nWynn's International, Inc., through its subsidiaries, is engaged primarily in the automotive components business and the specialty chemicals business. The Company designs, produces and sells O-rings and other seals and molded elastomeric and thermoplastic polymer products and automotive air conditioning systems and components. The Company also formulates, produces and sells specialty chemical products and automotive service equipment and distributes, primarily in southern California, locks and hardware products manufactured by others.\nO-rings and other molded polymer products are marketed under the trade name \"Wynn's-Precision.\" Air conditioning systems for the automotive aftermarket are marketed by the Company under the trademark FROSTEMP [REGISTERED TRADEMARK] and installation centers are operated under the trademarks MAXAIR [REGISTERED TRADEMARK] and FROSTEMP. Specialty chemical products are marketed under various trademarks, including WYNN'S [REGISTERED TRADEMARK], FRICTION PROOFING [REGISTERED TRADEMARK], X-TEND [REGISTERED TRADEMARK], SPIT FIRE [REGISTERED TRADEMARK] AND DU-ALL [REGISTERED TRADEMARK].\nThe Company's executive offices are located at 500 North State College Boulevard, Suite 700, Orange, California 92668. Its telephone number is (714) 938-3700. The terms \"Wynn's International, Inc.,\" \"Wynn's,\" \"Company\" and \"Registrant\" herein refer to Wynn's International, Inc. and its subsidiaries unless the context indicates otherwise.\nFINANCIAL INFORMATION BY BUSINESS SEGMENT AND GEOGRAPHIC DATA\nThe Company's operations are conducted in three industry segments: Automotive Components; Specialty Chemicals; and Builders Hardware. Financial information relating to the Company's business segments for the five years ended December 31, 1994 is incorporated by reference from Note 14 of \"Notes to Consolidated Financial Statements\" on pages 29 through 31 of the Company's Annual Report to Stockholders for the year ended December 31, 1994 (the \"1994 Annual Report\").\nAUTOMOTIVE COMPONENTS\nThe Automotive Components Division consists of Wynn's-Precision, Inc. (\"Precision\") and Wynn's Climate Systems, Inc. (\"Wynn's Climate Systems\"). During 1994, sales of the Automotive Components Division were $176,346,000, or 60% of the Company's total net sales, as compared with $181,478,000 and 64% in 1993. The operating profit of the division in 1994 was $18,566,000, or 65% of the Company's total operating profit, as compared with $16,643,000 and 70% in 1993. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Business Segment and Geographical Information\" on pages 16 through 19 and 29 through 31, respectively, of the 1994 Annual Report, which are hereby incorporated by reference. See also \"Other Factors Affecting the Business.\"\nWYNN'S-PRECISION, INC. (O-RINGS, SEALS AND OTHER MOLDED ELASTOMERIC AND THERMOPLASTIC POLYMER PRODUCTS)\nPRODUCTS\nPrecision and its affiliated companies design, manufacture and market a variety of static and dynamic sealing products. The principal products of Precision are O-rings, composite gaskets, engineered seals and convoluted boots and seals that are reinforced with plastic, metal and fabric. These products are made from elastomeric and thermoplastic polymers. The products are used for a variety of applications that include engines, transmissions, steering pumps and assemblies, fuel handling, suspension\/brake systems, refrigeration and electronics. Precision's primary customers are manufacturers of automobiles, trucks and off-highway vehicles, fluid handling equipment, and aircraft and aerospace components, and the military.\nDISTRIBUTION\nPrecision sells its products primarily through a direct sales force to original equipment manufacturer (\"OEM\") customers. Precision also markets its products throughout the United States through independent distributors and through Company-operated regional service centers located in California, Illinois, Indiana, Kansas, Michigan, Minnesota, New York, North Carolina, Ohio, Pennsylvania and Texas. Precision's Canadian operation distributes products principally through a direct sales force to OEM customers, through independent distributors and through Precision-operated service centers in Canada and England.\nPRODUCTION\nPrecision's manufacturing facilities are located in Arizona, Tennessee, Texas, Virginia and Ontario, Canada. Precision's administrative headquarters are located at the site of its main manufacturing facility in Lebanon, Tennessee. Also located in Lebanon, Tennessee are Precision's own tool production facility and a facility dedicated exclusively to injection molding. Over the past several years, Precision has made significant investments in modern computerized production equipment and facilities. In 1994, Precision invested approximately $10 million in new production equipment, which expanded production capacity primarily at Precision's Lebanon, Tennessee and Virginia facilities.\nThe principal raw materials used by Precision are elastomeric and thermoplastic polymers. These raw materials generally have been available from numerous sources in sufficient quantities to meet Precision's requirements. Adequate supplies of raw materials were available in 1994 and are expected to continue to be available in 1995.\nWYNN'S CLIMATE SYSTEMS, INC. (AUTOMOTIVE AIR CONDITIONING SYSTEMS AND COMPONENTS)\nPRODUCTS AND SERVICES\nWynn's Climate Systems designs, manufactures and markets automotive air conditioning systems and components for both automotive OEMs and the automotive aftermarket. The components include condensers, evaporator coils, injection- molded and vacuum-formed plastic parts, steel brackets, adapter kits and hose and tube assemblies. In 1994, Wynn's Climate Systems also manufactured and sold refrigerant recovery and recycling equipment (\"A\/C-R Equipment\"). In January 1995, Wynn's Climate Systems sold substantially all of its inventory of A\/C-R Equipment and will discontinue the manufacture of such equipment after December 1995. Wynn's Climate Systems also operates seven installation centers that install air conditioners and accessories for automobile dealers and retail customers.\nDISTRIBUTION\nWynn's Climate Systems sells its air conditioning components to OEM customers and distributors. It sells its air conditioning systems to OEM customers and their distributors and dealers, and to distributors in the automotive aftermarket. During 1994, Wynn's Climate Systems sold its A\/C-R Equipment to end users and distributors.\nPRODUCTION\nWynn's Climate Systems manufactures its products in its 185,000 square foot facility located in Fort Worth, Texas. Wynn's Climate Systems manufactures many of the components that it uses in the production of its air conditioning systems. Outside vendors supply certain finished components such as compressors, accumulators and receiver\/dryers. Adequate supplies of raw materials and components provided by outside vendors are available at present and are expected to continue to be available for the foreseeable future. Wynn's Climate Systems generally experienced only modest price increases for raw materials in 1994.\nSPECIALTY CHEMICALS\nThe Specialty Chemicals Division consists of Wynn Oil Company and its subsidiaries (\"Wynn Oil\"). During 1994, net sales at Wynn Oil were $110,867,000, or 38% of the Company's total net sales, as compared to $98,318,000 and 34% for 1993. The operating profit of the division during 1994 was $9,564,000, or 34% of the Company's total operating profit, compared with $7,046,000 and 29% for 1993. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Business Segment and Geographical Information\" on pages 16 through 19 and 29 through 31, respectively, of the 1994 Annual Report, which are hereby incorporated by reference. See also \"Other Factors Affecting the Business.\"\nPRODUCTS\nThe principal business of Wynn Oil is the development, manufacture and marketing of a wide variety of specialty chemical car care products under the WYNN'S and X-TEND trademarks. Wynn Oil's car care products are formulated to provide preventive or corrective maintenance for automotive engines, transmissions, steering systems, fuel delivery systems, differentials, engine cooling systems and other automotive mechanical parts. Wynn Oil also manufactures industrial specialty chemical products, including forging compounds, lubricants, cutting fluids and multipurpose coolants for precision metal forming and machining operations. Wynn Oil also manufactures the patented DU-ALL antifreeze power drain and fill and recycling machine, which is used in conjunction with proprietary chemicals to service a vehicle's cooling system and recycle the used antifreeze. The DU-ALL system has been approved by General Motors. Wynn Oil also sells its WYNN'S EMISSION CONTROL [REGISTERED TRADEMARK] product, a patented organic fuel combustion catalyst for spark ignition and diesel engines which helps reduce exhaust emissions and improve fuel economy.\nWynn Oil also markets the WYNN'S PRODUCT WARRANTY [REGISTERED TRADEMARK] program, which, in general, are kits containing a specially formulated line of automotive additive products, accompanied by a special product warranty. The warranty kits are sold through distributors and automobile dealers primarily to purchasers of used automobiles. The Wynn's Product Warranty program provides reimbursement of the costs of certain parts and labor and, in some instances, the costs of towing and a rental car, incurred by vehicle owners who use the special products to treat their vehicles in accordance with the terms and conditions of the warranty and who experience certain types of damage which the special products were designed to help prevent. See \"Other Factors Affecting the Business.\"\nDISTRIBUTION\nWynn Oil's car care products are sold in the United States and in approximately 90 foreign countries. See \"Foreign Operations.\"\nWynn Oil distributes its products through a wide range of distribution channels. Domestically, Wynn Oil distributes its products through independent distributors, warehouse distributors, mass merchandisers and chain stores. The Company also uses an internal sales force and manufacturers' representative organizations in the sale and distribution of its products. Foreign sales are made principally through wholly-owned subsidiaries, which sell either through an internal sales force or to independent distributors or through manufacturers' representative organizations. The Company also engages in direct export sales to independent distributors, primarily in Asia and Latin America. See \"Other Factors Affecting the Business.\"\nPRODUCTION\nWynn Oil has manufacturing facilities in California and Belgium. Other foreign subsidiaries either purchase products directly from the manufacturing facilities in the United States or Belgium or have the products manufactured locally by outside suppliers according to Wynn Oil's specifications and\nformulae. Wynn Oil periodically reviews its production and sourcing locations in light of fluctuating foreign currency rates.\nWynn Oil utilizes a large number of chemicals in the production of its various specialty chemical products. Primary raw materials necessary for the production of these products, as well as the finished products, generally have been available from several sources. An adequate supply of materials was available in 1994 and is expected to continue to be available for the foreseeable future.\nBUILDERS HARDWARE\nThe Builders Hardware Division consists of Robert Skeels & Company (\"Skeels\"), a wholesale distributor of builders hardware products, including locksets and locksmith supplies. During 1994, Skeels' net sales were $5,438,000, or 2% of the Company's total net sales, as compared with $5,161,000 and 2% for 1993. The operating profit of the division during 1994 was $392,000, or 1% of the Company's total operating profit, compared with $193,000 and 1% for 1993. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and \"Business Segment and Geographical Information\" on pages 16 through 19 and 29 through 31, respectively, of the 1994 Annual Report, which are hereby incorporated by reference.\nSkeels' main facility is located in Compton, California. In addition, Skeels also has leased satellite facilities located in Fullerton and Los Angeles, California.\nSkeels supplies approximately 35,000 items to retail hardware, locksmith and lumberyard outlets in southern California, Arizona, and Nevada. Skeels also sells directly to large institutional customers. Most of Skeels' sales are derived from replacement items used by industry, institutions and in-home remodeling and repair.\nSkeels has been a distributor of Schlage lock products since 1931. Skeels also distributes other well-known brands such as Lawrence, Kwikset and Master. All of Skeels' distributorship arrangements generally are cancelable by the manufacturers without cause.\nOTHER FACTORS AFFECTING THE BUSINESS\nCOMPETITION\nAll phases of the Company's business have been and remain highly competitive. The Company's products and services compete with those of numerous companies, some of which have financial resources greater than those of the Company. Sales by the Automotive Components Division are in part related to the sales of vehicles by its OEM customers.\nPrecision has a large number of competitors in the market for static and dynamic sealing products, some of which competitors are substantially larger than Precision. The markets in which Precision competes are also sensitive to changes in price. Requests for price reductions are not\nuncommon. Precision attempts to work with its customers to identify ways to lower costs and prices. Precision focuses on high technology, high quality sealing devices and has made significant investments in advanced equipment and other means to raise productivity. In 1994, Precision invested approximately $10 million in new production equipment, which expanded its production capacity primarily at its Lebanon, Tennessee and Virginia facilities. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations.\" Precision's major focus is to be the low cost producer of superior quality products within its industry. Precision believes it must expand into additional areas of sealing technology in order to continue to be an effective competitor.\nWynn's Climate Systems has a number of competitors that manufacture air conditioning systems and components, some which are substantially larger than Wynn's Climate Systems. Automotive air conditioning manufacturers compete in the areas of price, service, warranty and product performance. Wynn's Climate System's focus is to manufacture high quality products. Over time there has been a gradual increase in the number of air conditioning systems installed on the automotive factory line. The increase in the number of factory-installed systems has reduced the size of the market for aftermarket sales.\nCompetition with respect to Wynn Oil's specialty chemical products consists principally of other automotive aftermarket chemical and industrial fluid companies. Some major oil companies also market their own additive products through retail service stations, independent dealers and garages. Certain national retailers market private label brands of specialty chemical products. Wynn Oil's DU-ALL antifreeze recycling equipment and chemicals compete against other antifreeze recycling processes, some of which also have been approved by General Motors. The principal methods of competition vary by geographic locale and by the relative market share held by the Company compared to other competitors.\nSkeels continues to face intense price competition from numerous cash-and- carry discount retailers. Skeels also has observed some manufacturers selling directly to retailers to increase volume.\nKEY CUSTOMERS\nSales to General Motors constituted approximately 10.3% of the total net sales of the Company in 1994.\nGOVERNMENT REGULATIONS\nThe number of governmental rules and regulations affecting the Company's business and products continues to increase.\nWynn Oil markets the Wynn's Product Warranty program in approximately forty-four states and Canada. Questions have been raised by certain state insurance regulators as to whether the product warranty that accompanies the kit is in the nature of insurance. Wynn Oil attempts to resolve these questions to the satisfaction of each state insurance regulator. At times, it has elected to withdraw the Wynn's Product Warranty from certain states. No assurance can be given that governmental regulations will not significantly affect the marketing of the Wynn's Product Warranty in the United States or other countries in the future.\nENVIRONMENTAL MATTERS\nThe Company has used various substances in its past and present manufacturing operations which have been or may be deemed to be hazardous, and the extent of its potential liability, if any, under applicable environmental statutes, rules, regulations and case law is unclear. Under the Comprehensive Environmental Response, Compensation and Liability Act, as amended (\"CERCLA\"), a responsible party may be jointly liable for the entire cost of remediating contaminated property even if it contributed only a small portion of the total contamination. The actual costs to be incurred by the Company for an environmental matter will depend upon such factors as the nature and extent of the contamination, the remedial action selected, the cleanup level required, changes in regulatory requirements, the ability of other responsible parties, if any, to pay their respective shares, and any insurance recoveries. At December 31, 1994, the Company had consolidated accrued reserves of approximately $3.4 million relating to environmental matters. Although the effect of resolution of environmental matters on results of operations cannot be predicted, the Company believes, based on information presently known to the Company, that any liability that may result from environmental matters in excess of accrued reserves should not materially affect the Company's financial position. See Note 11 of \"Notes to Consolidated Financial Statements\" on page 28 of the 1994 Annual Report, which is hereby incorporated by reference. All potentially significant environmental matters presently known to the Company are described below.\n(a) In 1988, the Los Angeles County Department of Health Services (the \"LADHS\") directed Wynn Oil to conduct a site assessment of the Wynn Oil manufacturing facility in Azusa, California (the \"Azusa Facility\"). In April 1989, regulatory jurisdiction over this matter was transferred from the LADHS to the California Regional Water Quality Control Board-Los Angeles Region (the \"RWQCB\"). In July 1990, Wynn Oil received a general notice letter from the United States Environmental Protection Agency (the \"EPA\") stating that it may be a potentially responsible party (\"PRP\") with respect to the San Gabriel Valley, California Superfund Sites regional groundwater problem. The EPA letter included an information request pursuant to Section 104(e) of CERCLA to which Wynn Oil responded within the specified time period.\nSince October 1989, Wynn Oil and its consultants have been working with representatives of the RWQCB to conduct a comprehensive site assessment of the Azusa Facility. In January 1992, at the request of the EPA and the RWQCB, Wynn Oil agreed to expand the scope of its investigation of the Azusa Facility to include three soil gas monitoring wells and one groundwater monitoring well. The monitoring wells were installed in 1992, and the results of ongoing sampling have been reported to the RWQCB. In the fall of 1993, the RWQCB requested Wynn Oil to install a groundwater monitoring well located upgradient of the existing Azusa Facility well. Wynn Oil reached agreement with another PRP located on an approximately upgradient property. The agreement provided for this PRP to install the groundwater monitoring well on its property and for Wynn Oil to share the costs of installation. The well was installed, and the RWQCB has accepted this well as meeting its request for Wynn Oil to install a well upgradient of the Azusa Facility. Wynn Oil continues to monitor the well located at the Azusa Facility in accordance with RWQCB requirements.\nIn March 1994, the EPA issued its Record of Decision (\"ROD\") with respect to the Baldwin Park Operable Unit (\"BPOU\") of the San Gabriel Valley Superfund Sites. The Azusa Facility is located within the BPOU. In the ROD, the EPA selected an interim groundwater remedial action (the \"Interim Remedial Action\") for the BPOU that is estimated to cost in the range of $100 to $120 million. In April 1994, Wynn Oil joined with approximately fifteen other companies, each of which has been identified as a PRP in EPA General Notice letters, to form the BPOU Steering Committee (\"Steering Committee\"). During the past year, the Steering Committee has been negotiating with several local, state and federal entities regarding implementation of the ROD with partial funding from the Metropolitan Water District Groundwater Recovery Program and funds from the federal Bureau of Reclamation available for conjunctive use projects in the San Gabriel Basin. If agreement is reached among these entities, the PRP costs of implementing the ROD reportedly could be reduced to about $35 million. There is, however, no assurance that such agreements will be reached.\nIn January 1995, the EPA issued \"pre-Special Notice\" letters to sixteen companies, including Wynn Oil, requesting them to install up to ten regional monitoring wells and complete other pre-design work needed before the remedy can be implemented (the \"Pre-Design Work\"). In recognition of the Steering Committee's commitment to perform the Pre-Design Work, the EPA has deferred issuance of Special Notice letters for implementation of the ROD until later in 1995. As of this date, eleven members of the Steering Committee, including Wynn Oil, have agreed to fund the costs of the Pre- Design Work on an interim basis subject to reallocation among all of the PRPs who ultimately share the costs of implementing the ROD. The estimated cost of the Pre-Design Work to be paid by the PRPs is approximately $2 million. Wynn Oil's ultimate share of the Interim Remedial Action costs cannot be estimated at this time. The EPA has indicated that it considers Wynn Oil to be one of the four largest contributors to the regional groundwater problem in the BPOU. Wynn Oil disagrees with the views expressed by the EPA. Wynn Oil may at some later date elect or be required to take specific remedial actions with respect to soils conditions at the Azusa Facility.\n(b) In May 1989, Wynn's Climate Systems received notice that it had been identified as a generator of hazardous waste that had been shipped to the Chemical Recycling, Inc. (\"CRI\") site in Wylie, Texas (the \"CRI Site\") for treatment. CRI was engaged in the business of recycling and reclaiming spent solvents and other hazardous wastes at the CRI Site until it ceased operations in February 1989. Wynn's Climate Systems is one of approximately 100 hazardous waste generators that have been identified as potentially responsible parties for the CRI Site. A PRP Steering Committee (the \"Committee\") was formed to negotiate with the EPA on behalf of its members an agreement to take remedial measures voluntarily at the CRI Site. As of March 1995, approximately 88 PRPs, including Wynn's Climate Systems, had agreed to participate in the Committee for the CRI Site. PRPs that have agreed to participate in the Committee have signed Consent Agreements with the EPA with respect to the CRI Site. Remediation efforts have begun at the CRI Site under the guidance of the Committee. As of March 1995, Wynn's Climate Systems' proportionate share of the total volume of waste contributed to the CRI Site by Committee members was approximately two tenths of one percent (0.2%).\n(c) In January 1990, Precision received a letter from the EPA regarding the Saad Site in Nashville, Tennessee. The owner of the Saad Site engaged in reclamation and recycling activities at the Site, which resulted in soil and groundwater contamination. The letter stated that Precision may be a PRP for the Saad Site. The EPA subsequently requested Precision to furnish information about its involvement with the Saad Site. Precision has provided the information requested. Precision's records indicate that a predecessor entity sent wastes to the Saad Site in the mid- 1970s. Based on that information, Precision joined the Saad Site Steering Committee as a Limited Member. In February 1992, the Company received a letter stating that the Allocation Committee had concluded that Precision should become a Full Member of the Steering Committee and thus share proportionately in the liability for the cleanup. Precision responded by letter that there was no legal basis to hold it responsible for the activities of the predecessor entity. As of March 15, 1995, the Allocation Committee has not responded to Precision's letter.\n(d) In January 1991, Wynn's Climate Systems received a letter from the Texas Natural Resources Conservation Commission (the \"TNRCC\") alleging that soil adjacent to one of its leased manufacturing facilities was contaminated with hazardous substances. The TNRCC directed Wynn's Climate Systems to determine the extent of such contamination and then take appropriate remedial measures. Wynn's Climate Systems retained environmental consultants to conduct soil sampling and otherwise comply with the directive of the TNRCC. Performance of this work was completed in late 1991. Wynn's Climate Systems submitted a copy of the report of its consultants to the TNRCC in February 1992. In 1994, Wynn's Climate Systems received a request from the TNRCC for additional information. Wynn's Climate Systems furnished the requested information to the TNRCC. Wynn's Climate Systems also is voluntarily conducting additional investigation at this facility. Wynn's Climate Systems ceased leasing this facility at the end of 1994.\n(e) In 1992, Precision identified an area at its Lebanon, Tennessee facility which contained oil stained soils. Precision retained outside environmental consultants to investigate the nature and extent of the contamination. The soils investigation has been completed and the remedial alternatives have been evaluated. Precision has selected and is in the process of implementing the recommended remedial alternative. Some contamination was detected in the shallow groundwater and this phase of the remedial investigation is continuing.\n(f) In February 1992, an inactive subsidiary of the Company received a letter from the then lessee (the \"Lessee\") of a parcel of real property in Compton, California formerly leased by the subsidiary. The letter stated that the Lessee had discovered soil contamination at the site and asserted that the subsidiary may be liable for the cost of cleanup. The letter stated that the Lessee was investigating the nature and extent of the soil contamination. In July 1993, the Company received a letter from the owner of the real property (the \"Property Owner\") stating that the Property Owner had asserted a claim against the Lessee to pay the cost of remediation and that the Property Owner may assert a claim against the Company. In February 1995, the Property Owner filed a lawsuit in federal court against the Lessee and its principal, the inactive subsidiary, Wynn's International, Inc. and Wynn Oil. The complaint alleges that the defendants stored solid and hazardous wastes at the site and that the storage devices for the wastes leaked, causing contamination of the soils and groundwater. The complaint seeks relief under CERCLA,\nthe Resource Conservation Recovery Act of 1976 and common law, including an unspecified amount of damages and an injunction to compel the defendants to clean up the property. The Company does not know the extent of the contamination or the estimated cost of cleanup at this site.\nFOREIGN CURRENCY FLUCTUATIONS\nIn 1994, the United States dollar generally decreased in value compared to 1993 in the currencies of most countries in which the Company does business. This decrease in the value of the U.S. dollar caused aggregate foreign sales and operating profit to be translated into higher dollar values than what would have been reported if exchange rates had remained constant during 1994. In 1994, the Equity Adjustment from Foreign Currency Translation account on the Consolidated Balance Sheet increased by $576,000, which caused a corresponding increase in Total Stockholders' Equity. See \"Foreign Operations.\"\nPATENTS AND TRADEMARKS\nThe Company holds a number of patents and trademarks which are used in the operation of its businesses. There is no known challenge to the Company's rights under any material patents or material trademarks. In 1989, Wynn Oil filed a lawsuit in the federal district court in Detroit, Michigan against another company and its principal stockholder for infringement of Wynn Oil's X- TEND [REGISTERED TRADEMARK] trademark. In February 1994, the court awarded Wynn Oil $2.0 million in damages. Additionally, in May 1994, the court awarded Wynn Oil approximately $1.2 million in prejudgment interest and attorneys' fees. Defendants filed a timely appeal of the District Court ruling to the United States Court of Appeals for the Sixth Circuit, but did not file the required bond to stay execution of the judgment. Prior to Wynn Oil executing upon the defendants' assets, the defendants filed Chapter 11 bankruptcy proceedings in late 1994 in Florida. The bankruptcy filing resulted in an automatic stay of all pending collection efforts. Wynn Oil and its counsel are working through the bankruptcy process to maximize Wynn Oil's ultimate recovery against the defendants. See \"Legal Proceedings.\"\nSEASONALITY OF THE BUSINESS\nAlthough sales at the Company's divisions are somewhat seasonal, the consolidated results of operations generally do not reflect seasonality.\nRESEARCH AND DEVELOPMENT\nPrecision maintains research and engineering facilities in Tennessee, Virginia and Canada. Research and development is an important aspect of Precision's business as Precision has developed and continues to develop numerous specialized compounds to meet the specific needs of its various customers. Precision also has technical centers in Tennessee, Virginia and Canada to construct prototype products and to perform comprehensive testing of materials and products. Precision maintains extensive research, development and engineering facilities to provide outstanding service to its customers.\nWynn Oil maintains research and product performance centers in California, Belgium, France and South Africa. The main activities of the research staff are the development of new specialty chemicals and other products, improvement of existing products, including finding new applications for their use, evaluation of competitive products and performance of quality control procedures.\nFOREIGN OPERATIONS\nThe following table shows sales to foreign customers for 1994, 1993 and 1992:\nConsolidated operating results are reported in United States dollars. Because the Company's foreign subsidiaries conduct operations in the currencies of the countries in which they are based, all financial statements of the foreign subsidiaries must be translated into United States dollars. As the value of the United States dollar increases or decreases relative to these foreign currencies, the United States dollar value of items on the financial statements of the foreign subsidiaries is reduced or increased, respectively. Consequently, changes in dollar sales of the foreign subsidiaries from year to year are not necessarily indicative of changes in actual sales recorded in local currency. See Note 3 and Note 14 of \"Notes to Consolidated Financial Statements\" on pages 24 and 25, and 29 through 31, respectively, of the 1994 Annual Report, which are hereby incorporated by reference.\nThe value of any foreign currency relative to the United States dollar is affected by a variety of factors. It is exceedingly difficult to predict what such value may be at any time in the future. Consequently, the ability of the Company to control the impact of foreign currency fluctuations is limited.\nA material portion of the Company's business is conducted outside the United States. Consequently, the Company's ability to continue such operations or maintain their profitability is to some extent subject to control and regulation by the United States government and foreign governments.\nEMPLOYEES\nAt December 31, 1994, the Company had 2,052 employees.\nA majority of the production and maintenance employees at the Lebanon, Tennessee plant of Precision are represented by a local lodge of the International Association of Machinists and Aerospace Workers. The collective bargaining agreement for this facility will expire in April 1995, at which time\nthe Company expects to enter into negotiations for a new collective bargaining agreement for this facility. The production and maintenance employees at the Orillia, Ontario, Canada plant of Precision are represented by a local unit of the United Rubber, Cork, Linoleum and Plastic Workers of America. The collective bargaining agreement for the unit will expire in February 1997.\nA majority of the production and maintenance employees at the Lynchburg, Virginia plant of Dynamic Seals, Inc., an affiliate of Precision, are represented by a local of the International Chemical Workers Union. The collective bargaining agreement for this facility expires in February 1996.\nThe Company considers its relations with its employees to be good.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe executive officers of the Company, who are appointed annually, are as follows:\nThe principal occupations of Messrs. Carroll, Schlosser and Gibbons for the past five years have been their current respective positions with the Company. There is no arrangement or understanding between any executive officer and any other person pursuant to which he was selected as an officer. There is no family relationship between any executive officers of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following is a summary description of the Company's facilities, all of which the Company believes to be of adequate construction:\nThe Company believes that all of its operating properties are adequately maintained, fully utilized and suitable for the purposes for which they are used. With respect to those leases expiring in 1995 and 1996, the Company believes it will be able to renew such leases on acceptable terms or find suitable, alternative facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nVarious claims and actions, considered normal to Registrant's business, have been asserted and are pending against Registrant and its subsidiaries. Registrant believes that such claims and actions should not have any material adverse effect upon the results of operations or the financial position of Registrant based on information presently known to Registrant.\nIn February 1994, the United States District Court for the Eastern District of Michigan, Southern Division, in the case of WYNN OIL COMPANY V. AMERICAN WAY SERVICE CORPORATION AND THOMAS A. WARMUS, Case No. 89-CV-71777-DT, awarded Wynn Oil the sum of $2,023,645 in damages in an action brought by Wynn Oil in 1989 asserting trademark infringement by the defendants. In May 1994, the court awarded Wynn Oil approximately $1.2 million in prejudgment interest and attorneys' fees. Subsequently, the defendants filed a timely appeal to the United States Court of Appeals for the Sixth Circuit, but did not file a bond to stay execution of the judgment. Between May and December 1994, Wynn Oil sought out assets of the defendants to satisfy the judgment. Prior to Wynn Oil executing upon the defendants' assets, the defendants filed Chapter 11 bankruptcy proceedings in late 1994 in Florida. The bankruptcy filing resulted in an automatic stay of all pending collection efforts. Wynn Oil and its counsel are working through the bankruptcy process to maximize Wynn Oil's ultimate recovery against the defendants. No portion of this judgment has been included in the results of operations of the Company and all of Registrant's costs relating to this case have been expensed as incurred.\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 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information appearing under \"Cash Dividends and Common Stock Price Per Share: 1993-1994\" on page 32 of the 1994 Annual Report and \"Number of Stockholders\" and \"Stock Exchange Listing\" on page 33 of the 1994 Annual Report is hereby incorporated by reference.\nOn February 15, 1995, the Board of Directors of Registrant declared a cash dividend of $0.13 per share payable March 31, 1995 to stockholders of record on February 27, 1995.\nUnder a long-term loan agreement with an insurance company, Registrant's ability to pay dividends may be restricted under certain circumstances. At the present time, Registrant believes that these restrictions will not have an impact on the declaration of future dividends.\nRegistrant currently expects that it will continue to pay dividends in the future, in amounts per share at least comparable to dividends paid during the past two years.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nIncorporated by reference from page 15 of the 1994 Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIncorporated by reference from the 1994 Annual Report, pages 16 through 19.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nConsolidated financial statements of Registrant at December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994 (including unaudited supplementary data) and the report of independent auditors thereon are incorporated by reference from the 1994 Annual Report, pages 20 through 32.\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 appearing under \"Election of Directors\" on pages 4 and 5 of Registrant's definitive proxy statement for the Annual Meeting of Stockholders to be held on May 10, 1995 (\"Registrant's 1995 Proxy Statement\") is hereby incorporated by reference. A list of executive officers of Registrant is provided in Item 1 of Part I of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information appearing under \"Board of Directors and Committees of the Board--Compensation of Directors\" and \"--Compensation Committee Interlocks and Insider Participation,\" and \"Executive Compensation\" on pages 6 through 10 of Registrant's 1995 Proxy Statement is hereby incorporated by reference. The Report of the Compensation Committee on pages 11 and 12 of Registrant's 1995 Proxy Statement shall not be deemed to be incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information appearing under \"Security Ownership of Certain Beneficial Owners and Management\" on pages 2 and 3 of Registrant's 1995 Proxy Statement is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information appearing under \"Certain Relationships and Related Transactions\" on page 5 of Registrant's 1995 Proxy Statement 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) 1. See Index to Financial Statements and Financial Statement Schedules Covered By Report of Independent Auditors.\n2. See Index to Financial Statements and Financial Statement Schedules Covered By Report of Independent Auditors.\n3. See Index to Exhibits.\n(b) No Reports on Form 8-K were filed by Registrant during the last quarter of 1994.\nWYNN'S INTERNATIONAL, INC.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES COVERED BY REPORT OF INDEPENDENT AUDITORS\n(ITEM 14(a))\nAll other schedules are 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 consolidated financial statements, including the notes thereto.\nThe consolidated financial statements listed in the above index, which are included in the 1994 Annual Report, are hereby incorporated by reference. With the exceptions of the pages listed in the above index and the items referred to in Items 1, 5, 6, 7 and 8, the 1994 Annual Report is not deemed to be filed as part of this report.\nWYNN'S INTERNATIONAL, INC.\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS\nTHREE YEARS ENDED DECEMBER 31, 1994\nPOWER OF ATTORNEY\nEach person whose signature appears below hereby authorizes each of James Carroll, Seymour A. Schlosser and Gregg M. Gibbons as attorney-in-fact to sign on his behalf, individually and in each capacity stated below, and to file all amendments and\/or supplements to this Annual Report on 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, on March 28, 1995.\nWYNN'S INTERNATIONAL, INC.\nBy JAMES CARROLL --------------------------------------------------- James Carroll President 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.\nDate ----\nMarch 28, 1995 By WESLEY E. BELLWOOD --------------------------------------------------- Wesley E. Bellwood Chairman of the Board\nMarch 28, 1995 By JAMES CARROLL --------------------------------------------------- James Carroll President Chief Executive Officer Director\nDate ----\nMarch 28, 1995 By SEYMOUR A. SCHLOSSER --------------------------------------------------- Seymour A. Schlosser Vice President-Finance (Principal Financial and Accounting Officer)\nMarch 28, 1995 By BARTON BEEK --------------------------------------------------- Barton Beek Director\nMarch 28, 1995 By JOHN D. BORIE --------------------------------------------------- John D. Borie Director\nMarch 28, 1995 By BRYAN L. HERRMANN --------------------------------------------------- Bryan L. Herrmann Director\nMarch 28, 1995 By ROBERT H. HOOD, JR. --------------------------------------------------- Robert H. Hood, Jr. Director\nMarch 28, 1995 By RICHARD L. NELSON --------------------------------------------------- Richard L. Nelson Director\nMarch 28, 1995 By JAMES D. WOODS --------------------------------------------------- James D. Woods Director\nWYNN'S INTERNATIONAL, INC.\nINDEX TO EXHIBITS (Item 14(a))\nExhibit Number Description - ------- -----------\n3.1 Certificate of Incorporation, as amended, of Registrant (incorporated herein by reference to Exhibit 3.1 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1987)\n3.2 Certificate of Designations of Junior Participating Preferred Stock (incorporated herein by reference to Exhibit 4.2 to Registrant's Report on Form 8-K dated March 3, 1989)\n3.3 By-Laws, as amended, of Registrant (incorporated herein by reference to Exhibit 3.3 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993)\n4.1 Note Agreement, dated March 5, 1986, between Registrant and Metropolitan Life Insurance Company (incorporated herein by reference to Exhibit 4.1 to Registrant's Report on Form 8-K dated March 5, 1986)\n4.2 Shareholder Rights Agreement, dated as of March 3, 1989, between Registrant and First Interstate Bank of California, as Rights Agent (incorporated by reference to Exhibit 4.1 to Registrant's Report on Form 8-K dated March 3, 1989)\n4.3 Amendment No. 1 to Shareholder Rights Agreement, dated June 11, 1990 (incorporated by reference to Exhibit 28.2 to Registrant's Report on Form 8-K dated June 11, 1990)\n10.1 Employment Agreement, dated February 15, 1995, between Registrant and James Carroll\n10.2 Employment Agreement, dated January 1, 1995, between Registrant and Gregg M. Gibbons\n10.3 Employment Agreement, dated January 1, 1995, between Registrant and Seymour A. Schlosser\nExhibit Number Description - ------- -----------\n10.4 Wynn's International, Inc. Amended and Restated 1980 Stock Option and Appreciation Rights Plan (incorporated herein by reference to Exhibit 4.1 to Registrant's Registration Statement on Form S-8, Registration No. 2-68157)\n10.5 Wynn's International, Inc. Amended and Restated 1982 Incentive Stock Option Plan (incorporated herein by reference to Exhibit 4.2 to Registrant's Registration Statement on Form S-8, Registration No. 2- 68157)\n10.6 Wynn's International, Inc. Stock-Based Incentive Award Plan (incorporated herein by reference to Exhibit 28.1 to Registrant's Registration Statement on Form S-8, Registration No. 33-30296 and Exhibit 28.2 to Registrant's Registration Statement on Form S-8, Registration No. 33-64090)\n10.7 Wynn's International, Inc. 1995 Corporate Management Incentive Plan\n10.8 Deferred Compensation Agreement, dated November 30, 1990, between Registrant and James Carroll (incorporated herein by reference to Exhibit 10.9 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1990)\n10.9 Deferred Compensation Agreement, dated February 15, 1993, between Registrant and James Carroll (incorporated herein by reference to Exhibit 10.11 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1992)\n10.10 Deferred Compensation Agreement, dated April 23, 1993, between Registrant and James Carroll (incorporated herein by reference to Exhibit 10.10 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993)\n10.11 Deferred Compensation Agreement, dated August 5, 1994, between Registrant and James Carroll\n10.12 Form of Indemnification Agreement between Registrant and a director of Registrant (incorporated herein by reference to Exhibit 10.11 to Registrant's Report on Form 10-K for the fiscal year ended December 31, 1993)\n10.13 Wynn's International, Inc. Non-Employee Directors' Stock Option Plan (incorporated herein by reference to Exhibit C of Registrant's Definitive Proxy Statement relating to its Annual Meeting of Stockholders held on May 11, 1994, filed with the Commission on March 25, 1994)\nExhibit Number Description - ------- -----------\n11 Computation of Net Income Per Common Share - Primary and Assuming Full Dilution\n13 Portions of Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1994 that have been expressly incorporated by reference as a part of this Annual Report on Form 10-K\n21 Subsidiaries of Registrant\n23 Consent of Independent Auditors\n27 Financial Data Schedule","section_15":""}
{"filename":"27673_1994.txt","cik":"27673","year":"1994","section_1":"ITEM 1. BUSINESS.\nTHE COMPANY\nThe John Deere Capital Corporation (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.\nThe principal business of the Company is providing and administering financing for retail purchases of new and used John Deere agricultural, industrial and lawn and grounds care equipment. The Company purchases retail installment sales and loan contracts (retail notes) from Deere & Company and its wholly-owned subsidiaries (collectively called John Deere). These retail notes are acquired by John Deere through John Deere retail dealers in the United States. The Company also purchases and finances retail notes unrelated to John Deere, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of those products and from marine product mortgage service companies (recreational product retail notes). The Company also leases John Deere equipment to retail customers, finances and services unsecured revolving charge accounts acquired from and offered through merchants in the agricultural, lawn and grounds care and marine retail markets (revolving charge accounts), and provides wholesale financing for wholesale inventories of recreational vehicles, manufactured housing units, yachts and John Deere engines owned by dealers of those products (wholesale notes). Retail 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, 1995, the Company had 789 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 loaders; scrapers; motor graders; excavators; and log skidders. This segment also\nincludes 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; hand held products such as chain saws, string trimmers and leaf blowers; 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), 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 and employees of John Deere; and life and annuity products to the general public. 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 1994 and 1993, 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, $9.0 billion and $7.8 billion; total sales of equipment, $7.6 billion and $6.5 billion; agricultural equipment sales, $4.7 billion and $4.1 billion; industrial equipment sales, $1.6 billion and $1.3 billion; and lawn and grounds care equipment sales, $1.3 billion and $1.1 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 worldwide net income for 1994 was a record, totaling $604 million compared with last year's income of $248 million before the effects of special items (accounting changes, restructuring charges and the new United States tax law.) 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, 1994. John Deere's strongly improved 1994 results reflect substantially higher North American production and sales volumes, improved operating efficiencies and significantly better overseas results. Additionally, John Deere's exports from the United States set a new record, totaling $1.1 billion. John Deere's results also continued to benefit from the strong performance of its\nFinancial Services subsidiaries. Income in 1993 was $184 million after the effects of the restructuring charges and the tax rate change. However, John Deere incurred a worldwide loss of $921 million in 1993 after the cumulative effect of accounting changes.\nNorth American agricultural economic conditions improved in 1994 compared with 1993. John Deere believes that the resulting improvement in farmers' confidence was a primary contributor to higher agricultural equipment demand in nearly all market areas in North America during 1994. Although direct government payments to farmers declined in 1994, net farm cash income is forecasted to be near record levels. Additionally, farm real estate values increased by nearly four percent during the year, further improving overall farm balance sheets.\nOverseas retail sales also showed improvement during 1994. Although European industry retail sales of agricultural equipment are expected to continue their long-term downward trend, reduced uncertainty over the General Agreement on Tariffs and Trade (GATT) and a better understanding of the new GATT regulations have increased European farmers' confidence. Consequently, many farmers who had delayed making purchases are now buying new equipment. Therefore, European industry sales for fiscal 1994 are expected to be higher than 1993 levels.\nThe North American general economy continued to improve during 1994. Strong employment growth, coupled with related gains in income, stimulated consumer spending on durable goods in 1994. Housing starts and real nonresidential construction in the United States also increased by 11 percent and three percent, respectively, compared with a year ago. These improvements provided a solid base for increases in both John Deere's industrial and lawn and grounds care equipment sales during 1994.\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 31,1994 totaled $800 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\nReceivables 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 John Deere, terminable by either John Deere 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 John Deere. Under these agreements, John Deere is not obligated to sell retail notes to the Company, and the Company is obligated to purchase retail notes from John Deere only if the notes comply with the terms and conditions set by the Company.\nThe terms of retail notes and the basis on which John Deere acquires retail notes from the dealers are governed by agreements with the independent John Deere dealers, terminable at will by either the dealers or John Deere. 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 John Deere. The dealers are not obligated to send retail notes to John Deere, and John Deere is not obligated to accept retail notes from the dealers. In practice, retail notes are acquired from dealers only if the terms of the retail notes and the creditworthiness of the customers are acceptable to the Company for purchase of the retail notes from John Deere. The Company acts on behalf of both itself and John Deere in determining the acceptability of the notes and 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 to fixed charges will not be less than 1.05 to 1 for any fiscal quarter. For 1994, the Company's ratio was 1.96 to 1 and for 1993, it was 1.99 to 1 (excluding the effects of accounting changes). 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 sales 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\nfinancing to recreational product customers through the secured 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 1,500 recreational vehicle dealers and from approximately 1,100 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 on 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. John Deere Credit Revolving Plan is also used by some of the Company's marine customers to finance the purchase of marine-related products. Additionally, through its Farm Plan product, the Company finances revolving charge accounts offered by approximately 2,700 participating agri-businesses 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 agri-businesses, including farm supply, feed and seed, parts supply, bulk fuel, building supply merchants and veterinarians. See notes 1 and 2 to the consolidated financial statements under \"Revolving Charge Accounts Receivable.\"\nThe Company finances wholesale inventories of recreational vehicles, manufactured housing units, yachts and John Deere engines owned by approximately 300 dealers. A portion of the wholesale financing provided by the Company is with dealers from whom it also purchases recreational product and yacht retail notes. See notes 1 and 2 to the consolidated financial statements under \"Wholesale Receivables.\"\nThe Company requires theft and physical damage insurance be carried on all goods leased or securing retail notes. In most cases, the customer may, at his expense, have the Company or the seller of the goods 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\npurchases 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, 1994, approximately 56 percent of the retail notes held by the Company bore a variable finance rate. Recreational product retail notes are primarily fixed finance 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 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 equal to a competitive interest rate for periods during which finance charges have been waived or reduced on retail notes and leases. The portion of the Company's finance income earned on retail notes that was received from John Deere containing waiver of finance charges or reduced rates was 14 percent in 1994 and 19 percent in 1993.\nRECEIVABLES AND LEASES ACQUIRED AND HELD\nReceivable and Lease acquisitions during the fiscal years ended and amounts held at October 31, 1994 and 1993 were as follows in millions of dollars:\nJohn Deere equipment note acquisitions increased by approximately $291 million in 1994 compared with the same period last year. Acceptance increases were consistent with increases in retail sales activities. Acquisitions of recreational product retail notes were 30 percent higher in the current year due to more competitive financing programs offered by the Company in both the recreational vehicle and recreational marine product markets.\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 proceeds from sales of John Deere retail notes of $560 million in 1994 and $1.143 billion in 1993. The unpaid balance of all retail notes previously sold was $1.175 billion at October 31, 1994 and $1.394 billion at October 31, 1993. 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 1994 and 1993:\nThe average original term for recreational products is longer than John Deere equipment notes because of competitive pressures. Because 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 1994 and 1993:\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 $111.4 million and $104.9 million at October 31, 1994 and 1993, respectively. Of this amount, deposits withheld from Farm Plan merchants totaled $.5 million at October 31, 1994 and $.4 million at October 31, 1993. Credit losses are charged against deposits withheld from the originating dealer or merchant. 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. See note 1 to the consolidated financial statements.\nThe Company does not withhold deposits on recreational product retail notes, revolving plan receivables, or wholesale notes acquired. However, an allowance for credit losses has been established by the Company in an amount considered to be appropriate in relation to the total Receivables and Leases outstanding. In addition, for wholesale notes relating to recreational vehicles, manufactured housing units and yachts, there are agreements with the 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 balance (principal plus earned interest) of retail notes outstanding with any such delinquencies, on the basis of retail note terms in effect at the indicated dates, in millions of dollars and as a percentage of the unpaid balance of retail notes 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 the average retail note portfolio financed:\nThe decrease in losses in 1994 and 1993 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, improved collection activities, and lower write-offs of John Deere lawn and grounds care equipment retail notes. Write-offs of recreational product retail notes totaled $12.9 million in 1994 compared with $16.9 million in 1993 and $24.2 million in 1992. The decrease in losses from 1992 to 1993 resulted primarily from lower write-offs of recreational product retail notes and of John Deere industrial equipment retail notes.\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 the average revolving charge amounts financed:\nLosses increased in 1994 for both Farm Plan and the John Deere Credit Revolving Plan. The increase was due primarily to growth in the overall revolving charge account portfolio of 32 percent since 1993.\nLEASES. The following table shows the total balance of financing and operating lease payments 60 days or more past due in millions of dollars and as a percent of the investment in financing and operating leases at those respective dates.\nThe following table shows losses absorbed by the Company, in millions of dollars and as a percent of the average investment in financing and operating leases, on terminated financing and operating leases (after charges to withheld dealer deposits).\nThe decline in 1994 losses resulted from improvements in the Company's overall collection procedures and improved economic conditions.\nWHOLESALE NOTES. The total balance of wholesale notes receivable 60 days or more past due was negligible at October 31, 1994 and October 31, 1992, and $.1 million at October 31, 1993, which represented 0.11 percent of the wholesale notes receivable held at that date.\nThe following table shows wholesale note losses in millions of dollars and as a percentage of the average wholesale notes receivable:\nThe losses in 1993 resulted primarily from a relatively large loss incurred with one recreational vehicle dealer.\nCOMPETITION\nThe businesses in which the Company is engaged are highly competitive. The Company competes for customers based upon its 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 1994 was 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 emphasizes convenient service to retail customers and offers terms desired in its specialized markets such as seasonal schedules of repayment and rentals. The Company's sales and loan finance rates or 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 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 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 Farm Plan and John Deere Credit Revolving Plan 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. The Company obtained certification of a mandatory class in the 281st District Court for Harris County, Texas, in a case named DEERE CREDIT, INC. V. SHIRLEY Y. MORGAN, ET AL., filed February 20, 1992. The Company believes that it has substantial defenses and intends to defend the Morgan and other pending actions vigorously. Although it is not possible to predict with certainty the outcome of these unresolved legal actions, or reasonably estimate the range of possible loss and the amounts of claimed damages and penalties are unspecified, the Company believes that these unresolved legal actions will not be material.\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.\nThe Capital Corporation paid cash dividends to John Deere Credit Company of $210 million in 1994 and $82 million in 1993. In each case, John Deere Credit Company paid a comparable dividend to Deere & Company. During the first quarter of 1995, the Capital Corporation declared and paid a dividend of $15 million to John Deere Credit Company which, in turn, declared and paid a dividend of $15 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\n1994 COMPARED WITH 1993\nTotal acquisitions of Receivables and Leases by the Company increased 18 percent during 1994 compared with acquisitions in 1993. The higher acquisitions this year resulted mainly from an increased volume of John Deere agricultural and industrial equipment retail notes, revolving charge accounts and wholesale receivables. Receivables and Leases held by the Company at October 31, 1994 totaled $4.112 billion compared with $3.437 billion one year ago. Receivables and Leases administered, which include retail notes previously sold but still administered, amounted to $5.326 billion at the end of 1994 compared with $4.873 billion at October 31, 1993.\nDuring 1994, retail notes (principal value financed) acquired by the Company increased 16 percent compared with 1993. Retail note acquisitions totaled $2.488 billion during 1994 compared with 1993 acquisitions of $2.136 billion. The increase was primarily due to increased retail sales of John Deere equipment. Acquisitions of recreational product retail notes accounted for 11 percent of total retail note acquisitions in 1994 and nine percent in 1993.\nRetail note acquisitions from John Deere increased by $291 million in 1994, a 15 percent increase over last year. Acquisitions of agricultural equipment retail notes increased 14 percent over last year. Industrial equipment retail note activity was significantly higher, increasing 24 percent over the prior year. Acquisitions of lawn and grounds care equipment notes were flat compared to last year; however, corresponding financings under the John Deere Credit Revolving Plan, under which lawn and grounds care equipment is also financed, increased significantly. Retail note acquisitions in 1994 from John Deere continued to represent a significant proportion of the total United States retail sales of John Deere equipment.\nAcquisitions of recreational product retail notes, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of several unrelated manufacturers, were $262 million in 1994 compared with $202 million in 1993. This increase resulted primarily from more competitive financing programs in both the recreational vehicle and recreational marine product markets.\nAt October 31, 1994, the amount of retail notes held by the Company was $3.289 billion compared to $2.792 billion last year. Included in these amounts were recreational product retail notes of $800 million in 1994 and $804 million in 1993. The balance of John Deere retail notes held increased from $1.988 billion at October 31, 1993 to $2.489 billion at the end of 1994. This increase resulted from John Deere retail note acquisitions exceeding collections during 1994. However, the Company also securitized and sold retail notes, receiving proceeds of $560 million during 1994 compared to $1.143 billion during 1993. Additional information is presented in note 1 on page 34. The balance of retail notes administered by the Company, which includes retail notes previously sold, amounted\nto $4.464 billion at October 31, 1994, compared with $4.185 billion at October 31, 1993. The balance of retail notes previously sold was $1.175 billion at October 31, 1994 compared with $1.394 billion at October 31, 1993. Additional sales of retail notes are expected to be made in the future. The Company's maximum exposure under all retail note recourse provisions at October 31, 1994 and 1993 was $140 and $175 million, respectively.\nRetail notes bearing variable finance rates totaled 56 percent of the total retail note portfolio at October 31, 1994 compared with 57 percent one year earlier. The Company actively manages interest rate risk through the issuance of fixed-rate and variable-rate borrowings and the use of financial instruments such as interest rate swaps and interest rate caps. See \"Capital Resources and Liquidity\" on pages 20 through 22.\nAt the end of fiscal 1994, revolving charge accounts receivable totaled $437 million, an increase of 32 percent compared with $331 million at October 31, 1993. The balance at October 31, 1994 included $210 million of John Deere Credit Revolving Plan receivables (including a small balance of marine finance receivables) and $227 million of Farm Plan receivables compared with $147 million and $184 million, respectively, at October 31, 1993. Revolving charge account acquisitions increased 24 percent in 1994 compared with 1993, reflecting the increased retail sales of John Deere lawn and grounds care equipment, as well as an increased volume of Farm Plan receivable acquisitions.\nThe portfolio of financing leases totaled $118 million at October 31, 1994 and $85 million at October 31, 1993. The investment in operating leases was $125 million and $119 million at the end of 1994 and 1993, respectively. Overall, 1994 lease acquisitions were flat compared to 1993. The Company also administers municipal leases owned by Deere & Company, which totaled $39 million at October 31, 1994 compared with $43 million at October 31, 1993. During 1994, $20 million of municipal leases were sold to Deere & Company compared with $19 million sold in 1993.\nWholesale notes receivable totaled $142 million at October 31, 1994 compared with $110 million at October 31, 1993. Wholesale note acquisitions increased 23 percent during the year primarily due to acquisitions related to recreational vehicle inventories. Wholesale activity was also favorably impacted by the financing of $24 million in inventory held by dealers of manufactured housing units, a new business for the Company in 1994.\nTotal Receivable and Lease amounts 60 days or more past due were $11.7 million at October 31, 1994 compared with $12.7 million at October 31, 1993. These past-due amounts represent 0.28 percent and 0.37 percent of the total Receivables and Leases held at those respective dates. The balance (principal plus earned interest) of retail notes outstanding with any installments 60 days or more past due was $23.9 million at October 31, 1994 compared with $33.0 million one year earlier. The amount of retail note installments 60 days or more past due was $5.5 million at October 31, 1994 and $6.8 million at October 31, 1993. These past-due installments represented 0.17 percent of the unpaid balance of retail notes at October 31, 1994 and 0.24 percent at October 31, 1993.\nThe total balance of revolving charge accounts receivable 60 days or more past due was $5.6 million at October 31, 1994 compared with $5.3 million at October 31, 1993. These past-due amounts represented 1.28 percent and 1.61 percent of the revolving charge accounts receivable held at each of those respective dates.\nThe total balance of financing and operating lease payments 60 days or more past due was $.6 million at October 31, 1994 compared with $.5 million at October 31, 1993. These past-due installments represented 0.24 percent and 0.25 percent of the investment in financing and operating leases at those respective dates.\nAt October 31, 1994, the Company's allowance for credit losses on all Receivables and Leases financed, totaled $80 million and represented 1.9 percent of the total Receivables and Leases financed compared with $77 million and 2.3 percent, respectively, one year earlier. Deposits withheld from dealers and merchants, representing mainly the aggregate retail note and lease withholding accounts from individual John Deere dealers to which losses from retail notes and lease originating from the respective dealers can be charged, amounted to $111 million at October 31, 1994 compared to $105 million at October 31, 1993.\nThe Capital Corporation's consolidated net income for the fiscal year ended October 31, 1994 was $104.9 million compared with income before the cumulative effect of accounting changes of $111.0 million in 1993 ($107.2 million after the accounting changes). The decrease reflects the impact of increased borrowings resulting from higher dividend payouts during the year, lower gains from the sale of retail notes and higher operating expenses, partially offset by securitization and servicing fee income from retail notes previously sold but still administered. The ratio of earnings to fixed charges was 1.96 to 1 for 1994 compared with 1.99 to 1 (excluding the effects of accounting changes) in 1993.\nTotal revenues of $463 million in 1994 were down slightly from $466 million in 1993. Revenues were affected by lower gains from the sale of retail notes and lower average interest rates resulting in lower finance charges earned in 1994. These decreases in revenues were partially offset by the previously mentioned increase in securitization and servicing income. Lower average borrowing rates this year resulted in a slight decrease in interest expense, which totaled $167 million in 1994 compared with $168 million in 1993. Average borrowings were $3.235 billion in 1994 compared with $3.127 billion in 1993. The weighted average annual interest rate incurred on all interest-bearing borrowings this year declined to 4.9 percent from 5.1 percent in 1993.\nFinance income earned on retail notes was $293 million this year compared with $314 million in 1993, a decrease of seven percent. The average balance of the retail note portfolio financed during 1994 was three percent lower than the comparable 1993 average balance.\nRevenues earned on revolving charge accounts amounted to $67 million in 1994, a 24 percent increase over revenues of $54 million earned during 1993. This increase was primarily due to a 24 percent increase in the average balance of Farm Plan receivables financed and a 32 percent increase in the average balance of John Deere Credit Revolving Plan receivables financed in 1994 compared with 1993.\nThe average net investment in financing and operating leases increased by 19 percent in 1994 compared with 1993. Correspondingly, total lease revenues increased to $43.6 million in 1994 compared with $39.6 million in 1993.\nThe net gain on retail notes sold totaled $10.3 million during 1994 compared with $15.6 million for 1993. The Company received proceeds from the sale of retail notes in the amount of $560 million during 1994 and $1.143 billion in 1993. Securitization and servicing fee income totaled $28.6 million in 1994 compared with $22.3 million during 1993. Securitization and servicing fee income relates to retail notes sold to limited-purpose business trusts and primarily includes the amortization of present value receivable amounts from the trusts established at the time of sale, adjustments related to those sales and reimbursed administrative expenses received from the trusts. Additional sales of retail notes are expected to be made in the future.\nAdministrative and operating expenses increased seven percent to $80 million in 1994 compared with $75 million in 1993. These expenses increased primarily due to the costs of employee reductions.\nThe provision for credit losses was $28 million in both 1994 and 1993. Total write-offs of Receivables and Leases financed were $20.8 million during 1994 compared with $26.1 million in 1993. The decline in write-offs from 1993 related to a decrease in the amount of recreational product write-offs. The provision amount in 1994 exceeded the cost of write-offs due primarily to the overall growth of Receivables and Leases financed.\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 in 1993 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 at October 31, 1992. 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, retail notes (principal value financed) acquired by the Company decreased three percent compared with 1992. 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.\nRetail 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.\nAcquisitions 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 amount of retail notes held by the Company was $2.792 billion compared to $3.509 billion at October 31, 1992. Included in these amounts were recreational product notes of $804 million in 1993 and $870 million in 1992. The 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 retail notes 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 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 balance of retail notes administered by the Company, which include retail notes previously sold, amounted to $4.185 billion at October 31, 1993, compared with $4.197 billion at October 31, 1992. The balance of retail notes previously sold was $1,394 billion at October 31, 1993 compared with $688 million at October 31, 1992. On October 31, 1993, the Company's maximum exposure under all retail note recourse provisions was $175 million.\nRetail notes bearing variable finance rates totaled 57 percent of the total retail note portfolio at October 31, 1993 compared with 54 percent at October 31, 1992. The Company actively manages interest rate risk through the issuance of fixed-rate and variable-rate borrowings and the use of financial instruments such as interest rate swaps and interest rate caps.\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 1992.\nThe portfolio of 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 in 1992. At October 31, 1993, the 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. These past-due amounts represented .37 percent of the total Receivables and Leases held at October 31, 1993 and .36 percent at October 31, 1992. The balance (principal plus earned interest) of retail notes outstanding with any installment 60 days or more past due was $33.0 million at October 31, 1993 compared with $42.6 million one year earlier. The amount of retail note installments 60 days or more past due was $6.8 million at October 31, 1993 and $7.0 million at October 31, 1992. These past-due installments represented 0.24 percent of the unpaid balance of retail notes at October 31, 1993 and 0.20 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 1.61 percent and 2.38 percent of the revolving charge accounts receivable held at each of those respective dates.\nThe total balance of financing and operating lease payments 60 days or more past due was $.5 million at October 31, 1993 compared with $1.2 million at October 31, 1992. These past-due installments represented 0.25 percent and 0.69 percent of the investment in financing and operating leases at those respective dates.\nAt October 31, 1993, the Company's allowance for credit losses, totaled $77 million and represented 2.3 percent of the total 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 in 1992. 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 Financial Accounting Standards Board (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 Receivables and Leases financed was seven percent lower in 1993 compared with 1992 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 1992. These\ndecreases in revenues were partially offset by higher securitization and servicing fee income from retail notes previously sold. However, borrowing rates were also lower in 1993 resulting in the slightly improved financing margins. The lower borrowing rates and decrease in average borrowings in 1993 resulted in an 11 percent decrease in interest expense, which totaled $168 million in 1993 compared with $189 million in 1992. Average borrowings were $3.127 billion in 1993, a seven percent decline from 1992 average borrowings of $3.379 billion. The weighted average annual interest rate incurred on all interest-bearing borrowings in 1993 declined to 5.1 percent from 5.4 percent in 1992.\nFinance income earned on retail notes was $314 million in 1993 compared with $356 million in 1992, a decrease of 12 percent. The average balance of the 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 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 13 percent to $75 million in 1993 compared with $66 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 in 1992 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. 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 1993. 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.\nIn the fourth quarter of 1993, the Company also adopted FASB Statement No. 112, Employers' Accounting for Postemployment Benefits, effective November 1, 1992. 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.\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.\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 equity 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 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.\nCash provided from the Company's operating activities was $160 million in 1994. Financing activities provided $363 million in 1994, resulting from a $910 million increase in outside borrowings which was partially offset by a $337 million decrease in payables to Deere & Company and dividend payments totaling $210 million. The aggregate cash provided by operating activities, financing activities and a $122 million decrease in cash\nand cash equivalents was used to increase credit receivables. Cash used for investing activities totaled $646 million in 1994, primarily due to the cost of Receivables and Leases acquired exceeding collections by $1.285 billion, which was partially offset by the proceeds of $560 million from the securitization and sale of receivables to the public. Other cash flows from investing activities increased in 1994 mainly due to the collection activity on receivables previously sold that were being held for payment to the trusts. See \"Statement of Consolidated Cash Flows\" on page 30.\nOver the past three years, operating activities have provided $473 million in cash. Proceeds from the sale of receivables provided $2.446 billion. Cash and cash equivalents decreased $76.5 million. These amounts were used mainly to fund Receivable and Lease acquisitions which exceeded collections by $2.456 billion, a payment of $362 million in dividends and a decrease of $262 million in net outside borrowings.\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 interest-bearing indebtedness amounted to $3.350 billion at October 31, 1994 compared with $2.777 billion at October 31, 1993. Total borrowing levels increased during 1994, generally corresponding with the level of Receivables and Leases financed and dividends paid. Total short-term indebtedness amounted to $2.316 billion at October 31, 1994 compared with $1.299 billion at October 31, 1993. See note 4 to the consolidated financial statements. Total long-term indebtedness amounted to $1.034 billion at October 31, 1994 and $1.478 billion at October 31, 1993. See note 5 to the consolidated financial statements. The ratio of total interest-bearing debt to stockholder's equity was 5.3 to 1 and 3.8 to 1 at October 31, 1994 and October 31, 1993, respectively.\nIn January 1994, the Company redeemed the $40 million balance of its outstanding 9.35% subordinated debentures due 2003.\nDuring 1994, the Capital Corporation issued $189 million and retired $355 million of medium-term notes. At October 31, 1994, $571 million of medium-term notes were outstanding having original maturity dates of between one and six years and interest rates that ranged from 4.5 percent to 8.9 percent.\nAt October 31, 1994, the Capital Corporation and Deere & Company, jointly, had unsecured lines of credit with various banks in North America and overseas totaling $2.508 billion which included a long-term credit agreement totaling $1.675 billion. In addition, the Capital Corporation, Deere & Company, John Deere Limited (Canada) and John Deere Finance Limited (Canada), jointly, had a long-term credit agreement with various banks in North America and overseas totaling $759 million. In total, the Capital Corporation had\n$3.267 billion in aggregate lines of credit available at October 31, 1994 of which $1.301 billion 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.\nThe Capital Corporation paid cash dividends to John Deere Credit Company of $210 million in 1994 and $82 million in 1993. In each case, John Deere Credit Company paid a comparable dividend to Deere & Company. During the first quarter of 1995, the Capital Corporation declared and paid a dividend of $15 million to John Deere Credit Company which, in turn, declared and paid a dividend of $15 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 23, 1994 (Items 5 and 7).\nCurrent Report on Form 8-K dated October 12, 1994 (Item 5).\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\nDate: 24 January 1995\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 ) 24 January 1995 - - -------------------- Executive Officer ) Hans W. Becherer ) ) \/s\/ J. W. England Director ) - - -------------------- ) J. W. England ) ) \/s\/ B. L. Hardiek Director ) - - -------------------- ) B. L. Hardiek ) ) \/s\/ J. R. Heseman Director ) - - -------------------- ) J. R. Heseman ) ) \/s\/ D. E. Hoffmann Director ) - - -------------------- ) D. E. Hoffmann ) ) \/s\/ F. F. Korndorf Director ) - - -------------------- ) F. F. Korndorf ) ) \/s\/ J. K. Lawson Director ) - - -------------------- ) J. K. Lawson ) ) \/s\/ Pierre E. Leroy Director, Vice President and ) - - -------------------- Principal Financial Officer ) Pierre E. Leroy ) ) \/s\/ M. P. Orr Director and President ) - - -------------------- ) M. P. Orr )\n\/s\/ J. S. Robertson Vice President and Principal ) 24 January 1995 - - -------------------- Accounting Officer ) J. S. Robertson ) ) \/s\/ E. L. Schotanus Director ) - - -------------------- ) E. L. Schotanus ) ) \/s\/ D. H. Stowe, Jr. Director ) - - -------------------- ) D. H. Stowe, Jr. ) ) \/s\/ J. D Volkert Director ) - - -------------------- ) J. D. Volkert ) ) \/s\/ S. E. Warren Director ) - - -------------------- ) S. E. Warren )\n[DELOITTE & TOUCHE LLP LETTERHEAD]\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, 1994 and 1993 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, 1994. Our audits also included the financial statement schedule listed in the Table of Contents on page 27. These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the 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 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, 1994 and 1993 and the results of their operations and their cash flows for each of the three years in the period ended October 31, 1994 in conformity with generally accepted accounting principles. Also, in 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.\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.\n\/s\/ Deloitte & Touche LLP\nDELOITTE & TOUCHE LLP Chicago, Illinois\nDecember 9, 1994\nPAGE\nFINANCIAL STATEMENTS:\nJohn Deere Capital Corporation and Subsidiaries (consolidated):\nStatement of Consolidated Income and Retained Earnings for the Years Ended October 31, 1994, 1993 and 1992 . . . . . . . 28\nConsolidated Balance Sheet, October 31, 1994 and 1993 . . . . . . . 29\nStatement of Consolidated Cash Flows for the Years Ended October 31, 1994, 1993 and 1992 . . . . . . . . . . . . . . . . . 30\nNotes to Consolidated Financial Statements . . . . . . . . . . . . . 31\nFINANCIAL STATEMENT SCHEDULE:\nSchedule II - Valuation and Qualifying Accounts for the Years Ended October 31, 1994, 1993 and 1992 . . . . . . . . . . . 47\nSCHEDULES OMITTED\nThe following schedules are omitted because of the absence of conditions under which they are required:\nI, III, IV, and V.\nSTATEMENT OF CONSOLIDATED INCOME AND RETAINED EARNINGS\nThe accompanying Notes to Consolidated Financial Statements on pages 31 to 46 are an integral part of this statement\nCONSOLIDATED BALANCE SHEET\nThe accompanying Notes to Consolidated Financial Statements on pages 31 to 46 are an integral part of this statement. - - --------------------------------------------------------------------------------\nSTATEMENT OF CONSOLIDATED CASH FLOWS\nThe accompanying Notes to Consolidated Financial Statements on pages 31 to 46 are an integral part of this statement.\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. During 1994, John Deere was compensated by the Company 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. 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 1993. 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.\nIn the fourth quarter of 1993, the Company adopted FASB Statement No. 112, Employers' Accounting for Postemployment Benefits, effective November 1, 1992. 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 $.3 million\n($.2 million net of deferred income taxes). The adoption of FASB Statement No. 112 had an immaterial effect on 1993 expenses.\nRETAIL NOTES RECEIVABLE\nThe principal business of the Company is providing and administering financing for retail purchases of new and used John Deere agricultural, industrial and lawn and grounds care equipment. The Company purchases retail installment sales and loan contracts (retail notes) from John Deere. These retail notes are acquired by John Deere through John Deere retail dealers in the United States. The Company also purchases and finances retail notes unrelated to John Deere, representing primarily recreational vehicle and recreational marine product notes acquired from independent dealers of those products and from marine product 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 equal to a competitive interest rate for periods during which finance charges have been waived or reduced on retail notes and leases. 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 14 percent in 1994, 19 percent in 1993 and 17 percent in 1992.\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\ndepleted. 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 goods leased or securing retail notes. In most cases, the customer may, at his own expense, have the Company or the seller of the goods 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.\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\nequipment. 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 wholesale inventories of recreational vehicles, manufactured housing units, yachts and John Deere engines owned 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 equipment 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 1994 and 1993, 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\nCompany is also compensated by the trusts for certain expenses incurred in the administration of these receivables. Securitization and servicing fee income includes the amortization of the above receivables, adjustments related to those sales and reimbursed administrative expenses.\nRECLASSIFICATIONS\nCertain amounts for prior years have been reclassified to conform with the 1994 financial statement presentations.\nNOTE 2. RECEIVABLES AND LEASES.\nRETAIL NOTES RECEIVABLE\nRetail notes receivable by product category at October 31 in millions of dollars follow:\nRetail note installments at October 31 are scheduled as follows in millions of dollars:\nCompany guidelines relating to down payment requirements and maximum contract terms on retail notes are generally as follows:\nDuring 1994, the average effective yield on retail notes held by the Company was approximately 9.4 percent compared with 9.8 percent in 1993.\nRetail notes acquired by the Company during the year ended October 31, 1994 had an estimated average original term (based on dollar amounts) of 70 months. During 1993 and 1992, the estimated average original term was 67 and 68 months, respectively. Historically, because of prepayments, the average actual life of retail notes has been considerably shorter than the average original term.\nDuring 1994, the Company received proceeds of $560 million 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 1993, the Company received proceeds of $1.143 billion from the sale of retail notes.\nAt October 31, 1994 and 1993, the balance of all retail notes previously sold by the Company was $1.175 billion and $1.394 billion, respectively. Additional sales of retail notes are expected to be made in the future.\nThe Company recognizes any gain or loss at the time of the sale of retail notes. The Company acts as agent for the buyers in collection and administration of all the notes it has sold. The Company's maximum exposure under all retail note recourse provisions at October 31, 1994 and 1993 was $140 million and $175 million, respectively. All retail notes sold are collateralized by security agreements on the related machinery sold to the customers.\nREVOLVING CHARGE ACCOUNTS RECEIVABLE\nRevolving charge accounts receivable at October 31, 1994 totaled $437 million compared with $331 million at October 31, 1993. Account holders may pay the account balance in full at any time, or make payments over a number of months according to a\npayment schedule. A minimum amount is due each month from customers selecting the revolving payment option.\nFINANCING LEASES RECEIVABLE\nFinancing leases receivable by product category at October 31 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.\nInitial 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 $20 million of municipal leases to Deere & Company in 1994 compared with $19 million in 1993. At October 31, 1994, the net balance of leases sold was $39 million compared with $43 million at October 31, 1993.\nWHOLESALE RECEIVABLES\nWholesale receivables at October 31, 1994 totaled $142 million compared with $110 million at October 31, 1993. Generally, the maximum maturity for wholesale notes is 12 months.\nEQUIPMENT ON OPERATING LEASES\nThe 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:\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 the previous tables. 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.\nFAIR VALUE\nThe estimated fair value of total Receivables and Leases was $4.107 billion and $3.516 billion at October 31, 1994 and October 31, 1993, respectively, compared with the carrying value of $4.112 billion and $3.436 billion on those respective dates. 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. A favorable $4.5 million adjustment was made in 1994 related to current and expected losses on agricultural loans.\nAn analysis of the allowance for credit losses on total Receivables and Leases follows in millions of dollars:\nThe allowance for credit losses represented 1.9 percent, 2.3 percent and 2.0 percent of Receivables and Leases outstanding at October 31, 1994, 1993 and 1992, respectively. In addition, the Company had $111 million, $105 million and $101 million at October 31, 1994, 1993 and 1992, 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 provision for credit losses in 1994 reflects the growth in the total Receivables and Leases portfolio, yet, it also reflects a favorable adjustment related to current and expected losses on agricultural loans. The lower provision in 1993, compared to 1992, resulted from a decrease in write-offs of uncollectible Receivables and Leases, particularly recreational product retail notes.\nNOTE 4. SHORT-TERM BORROWINGS.\nOn October 31, 1994, short-term borrowings were $2.316 billion, $1.581 billion of which was commercial paper. Short-term borrowings were $1.299 billion one year ago, $454 million of which was commercial paper. Original maturities of commercial paper outstanding on October 31, 1994 ranged up to 270 days. The weighted average remaining term of commercial paper outstanding on October 31, 1994 was approximately 44 days. The Capital Corporation's short- term debt also includes amounts borrowed from Deere & Company, which totaled $103 million at October 31, 1994. 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, at October 31, 1994 and 1993 were 4.9 percent and 3.3 percent, respectively.\nAt October 31, 1994, the Capital Corporation and Deere & Company, jointly, had unsecured lines of credit with various banks in North America and overseas totaling $2.508 billion which included a long-term credit agreement totaling $1.675 billion. In addition, the Capital Corporation, Deere & Company, John Deere Limited (Canada) and John Deere Finance Limited (Canada), jointly, had a long-term credit agreement with various banks in North America and overseas totaling $759 million. In total, the Capital Corporation had\n$3.267 billion in aggregate lines of credit available at October 31, 1994 of which $1.301 billion 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.\nAt October 31, 1994, the Capital Corporation had no borrowings outstanding under the credit agreements. These agreements require the Capital Corporation to maintain its consolidated ratio of earnings 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 1.96 to 1, 1.99 to 1 (excluding the effect of the accounting changes), and 1.74 to 1 in 1994, 1993 and 1992, respectively. The Company's ratio of senior debt to total stockholder's equity plus subordinated debt was 3.3 to 1 at October 31, 1994 compared with 2.2 to 1 at October 31, 1993.\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 hedge risks 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, 1994 and 1993, the total notional principal amounts of interest rate swap agreements were $563 million and $510 million having rates of 3.6 to 9.6 percent terminating in up to 16 months and 28 months, respectively. The total notional principal amounts of interest rate cap agreements at October 31, 1994 and 1993 were $33 million and $44 million having capped rates of 6.3 percent to 9.0 percent terminating in up to 9 months and 15 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, 1994 and October 31, 1993.\nNOTE 5. LONG-TERM BORROWINGS.\nLong-term borrowings of the Capital Corporation at October 31 consisted of the following in millions of dollars:\nIn 1994, the Capital Corporation issued $189 million and retired $355 million of medium-term notes. In January 1994, the Company redeemed the $40 million balance of its 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. The total notional principal amount of these interest rate swap agreements was $302 and $347 million at October 31,1994 and October 31, 1993, respectively, having variable rates of 3.4 percent to 5.7 percent, terminating in up to 28 months and 40 months, respectively. The Capital\nCorporation 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, 1994 and 1993, the total notional principal amounts of these swap agreements were $40 million and $138 million, terminating in up to 45 months and 42 months, respectively. At October 31, 1993, the total notional principal amount of these cap agreements was $25 million, terminating in up to 22 months. 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.\nThe total estimated fair values of the Company's total long-term borrowings were $1.028 billion and $1.496 billion at October 31, 1994 and October 31, 1993, respectively. The corresponding carrying amounts of total long-term borrowings were $1.035 billion and $1.478 billion on those respective dates. 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, 1994 and 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: 1995 - $633, 1996 - $262, 1997 - $309, 1998 - $193, 1999 - $248.\nNOTE 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 to fixed charges will not be less than 1.05 to 1 for each fiscal quarter. Financial support was not provided in 1994, 1993, or 1992, as the ratios were 1.96 to 1, 1.99 to 1 (excluding the effect of the accounting changes), and 1.74 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, 1994 or 1993. At October 31, 1994, the Company had authorized, but not issued, 10,000 shares of $1 par value preferred stock.\nNOTE 8. DIVIDENDS.\nThe Capital Corporation paid cash dividends to John Deere Credit Company of $210 million in 1994 and $82 million in 1993. In each case, John Deere Credit Company paid a comparable dividend to Deere & Company. During the first quarter of 1995, the\nCapital Corporation declared and paid a dividend of $15 million to John Deere Credit Company which, in turn, declared and paid a dividend of $15 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 both 1994 and 1993. Further disclosure for the plan is included in the Deere & Company 1994 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 31, and the \"Quarterly Data (unaudited)\" on page 46.\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 $.7 million in 1994 and $.6 million in 1993. The 1992 expenses were negligible as determined under the previous accounting principle.\nNOTE 10. INCOME TAXES.\nTAXES ON INCOME AND INCOME TAX CREDITS\nThe 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\nDeferred 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\nA comparison of the statutory and effective income tax provisions of the Company and reasons for related differences follow in millions of dollars:\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 1994, 1993 and 1992 were $173.7 million, $134.8 million and $172.6 million, respectively. Cash payments for income taxes during these same periods were $59.7 million, $54.9 million and $53.0 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. The Company obtained certification of a mandatory class in the 281st District Court for Harris County, Texas, in a case named DEERE CREDIT, INC. V. SHIRLEY Y. MORGAN, ET AL., filed February 20, 1992. The Company believes that it has substantial defenses and intends to defend the Morgan and other pending actions vigorously. Although it is not possible to predict with certainty the outcome of these unresolved legal actions, or reasonably estimate the range of possible loss and the amounts of claimed damages and penalties are unspecified, the Company believes that these unresolved legal actions will not be material.\nNOTE 13. QUARTERLY DATA (UNAUDITED).\nSupplemental consolidated quarterly information for the Company follows in millions of dollars:\nSCHEDULE II\nJOHN DEERE CAPITAL CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED OCTOBER 31, 1994, 1993 AND 1992 (IN THOUSANDS OF DOLLARS)\nINDEX TO EXHIBITS\n3.1 Certificate of Incorporation, as amended.\n3.2 Bylaws, as amended.\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 (Exhibit 4.1 to Form 10-K of the registrant for the year ended October 31, 1993*).\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*).\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, 1994.\n13. Not applicable.\n16. Not applicable.\n18. Not applicable.\n21. Omitted pursuant to instruction J(2).\n22. Not applicable.\n23. Consent of Deloitte & Touche.\n24. Not applicable.\n27. Financial Data Schedule.\n28. Not applicable.\n99. Parts I and II of the Deere & Company Form 10-K for the fiscal year ended October 31, 1994.*\n__________________________ * Incorporated by reference. Copies of these exhibits are available from the Company upon request.","section_15":""}
{"filename":"96638_1994.txt","cik":"96638","year":"1994","section_1":"ITEM 1. BUSINESS.\nOVERVIEW\nAdvanta Corp. (the \"Company\") is a highly focused direct marketer of select consumer financial services. The Company primarily originates and services credit cards and mortgage loans. Other businesses include small ticket equipment leasing, credit insurance and deposit products. At year end 1994, assets under management totaled $9.3 billion.\nApproximately 78% of total revenues are derived from credit cards marketed through carefully targeted direct mail campaigns. By focusing primarily on the no fee gold card, the Company has successfully grown to one of the ten largest issuers of gold cards. Mortgage services contribute 9% of total revenues with a managed loan portfolio of $1.3 billion. Mortgage loans are originated through a network of branch offices, a direct originations center and correspondent relationships.\nThe Company was incorporated in Delaware in 1974 as Teachers Service Organization, Inc., the successor to a business originally founded in 1951. In January 1988, the Company's name was changed from TSO Financial Corp. to Advanta Corp. The Company's principal executive office is located at Brandywine Corporate Center, 650 Naamans Road, Claymont, Delaware 19703. Its principal operating office is located at Five Horsham Business Center, 300 Welsh Road, Horsham, Pennsylvania 19044-0749. The Company's telephone numbers at its principal executive and operating offices are, respectively, (302) 791-4400 and (215) 657-4000. References to the Company in this Report include its consolidated subsidiaries unless the context otherwise requires.\nCREDIT CARDS\nThe Company, which has been in the credit card business since 1983, issues gold and standard MasterCard(R)** MasterCard(R) is a federally registered servicemark of MasterCard International, Inc.; VISA(R) is a federally registered servicemark of VISA, U.S.A., Inc. and VISA(R) credit cards nationwide. The Company has built a substantial cardholder base which, as of December 31, 1994, totaled 3.8 million accounts and $6.5 billion in managed receivables. According to industry statistics, the Company is one of the ten largest issuers of gold cards. Both gold and standard accounts undergo the same credit analysis, but gold accounts have higher initial credit limits because of the cardholders' better credit quality. In addition, gold accounts generally offer a wider variety of services to cardholders.\nThe primary method of account acquisition is direct mail solicitation. The Company generally uses credit scoring by independent third parties and a proprietary market segmentation and targeting model to target its mailings to profitable segments of the market.\nIn 1982, the Company acquired Colonial National Bank USA (\"Colonial National\"). As a national bank, Colonial National has the ability to make loans to consumers without many of the restrictions found in various state usury and licensing laws, to negotiate variable rate loans, to generate funds economically in the form of deposits insured by the Federal Deposit Insurance Corporation (\"FDIC\"), and to include in its product mix a MasterCard and VISA credit card program. Substantially all of the Company's credit card receivables and bank deposits are originated by Colonial National.\n- --------------------- * MasterCard(R) is a federally registered servicemark of MasterCard International, Inc.; VISA(R) is a federally registered servicemark of VISA, U.S.A., Inc.\nAdvanta Corp. and Subsidiaries\nMasterCard and VISA license banks, such as Colonial National and other financial institutions, to issue credit cards using their trademarks and to utilize their interchange networks. Cardholders may use their cards to make purchases at participating merchants or to obtain cash advances at participating financial institutions. Cardholders may also use special credit line drafts issued by Colonial National to draw against their Visa or MasterCard credit lines for cash, purchases or balance transfers. Each purchase is submitted to a merchant bank which remits to the merchant the purchase amount less a merchant discount fee, and submits the purchase to the card issuing bank for payment through the interchange system. The card issuing bank receives an interchange fee as compensation for the funding and credit risk that it takes when its customers use its credit card. MasterCard or VISA sets the interchange fee as a percentage of each card transaction (currently approximately 1.4%).\nThe Company generates interest and other income from its credit card business through finance charges assessed on outstanding loans, interchange income, cash advance and other credit card fees, and securitization income as described below. Credit card income also includes fees paid by credit card customers for product enhancements they may select, and revenues paid to Colonial National by third parties for the right to market their products to the Company's credit card customers.\nMost of the Company's MasterCard and VISA credit cards carry no annual fee, and those credit cards which do include an annual fee generally have lower fees than those charged by many of the Company's competitors. The Company believes that this characteristic of no or low annual fee credit cards has appealed to consumers, and that the Company's credit cards have also appealed to consumers because of their competitive interest rates, quality service, payment terms and credit lines.\nWhile the Company believes that its credit card offers will continue to appeal to consumers for the reasons stated, the Company also notes that competition is increasing in the credit card industry. At the same time, the American people are becoming generally more sophisticated and demanding users of credit. These forces are likely to produce significant changes in the industry; in recent years they have resulted in slower growth and lower yields for the industry, and these trends may continue. The Company is devoting substantial resources to meeting the challenges, and taking advantage of the opportunities, which management sees emerging in the industry. In 1994, this included significant focus on balance transfer initiatives, in which the Company encouraged consumers to transfer account balances they were maintaining with other credit card issuers to a Colonial National account with a lower interest rate. Approximately one-half of the growth in the Company's managed credit card receivables in 1994 resulted from balance transfers. The Company intends to continue exploring new approaches to the credit card market.\nThe interest rates on the majority of the Company's credit card receivables are variable, tied to the prime rate. This helps the Company maintain net interest margins in both rising and declining interest rate environments. As Delaware, Colonial National's state of domicile, does not have a usury ceiling applicable to banks, there is no statutory maximum interest rate that the Company may charge its credit cardholders, nor does Delaware law limit the amount of any annual fees, late charges and other ancillary charges which may be assessed. While the state in which an individual cardholder resides may seek to regulate the annual fees and ancillary charges which Colonial National may charge to that state's residents, the enforceability of such regulation is unclear and is currently the subject of litigation in certain states. At the present time, the only Federal appellate decision addressing this issue held such regulation to be unenforceable. See \"Government Regulation--Colonial National.\"\nAdvanta Corp. and Subsidiaries\nThe following table shows the geographic distribution by state of total managed credit card receivables among the top five states, together with the impaired credit card receivables in those states, as of December 31, 1994.\nSince 1988, Colonial National has been active in the credit card securitization market, securitizing $2.2 billion of credit card receivables in 1994 and $5.4 billion since 1988. The Company continues to recognize income on a monthly basis from the securitized receivables. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Notes 1 and 3 of the Notes to Consolidated Financial Statements.\nColonial National's securitization program provides a number of benefits: diversifying its funding base, providing liquidity, reducing the bank's regulatory capital requirements, lowering its cost of funds, providing a source of variable rate funding to complement the variable rate credit card portfolio and helping to limit the on-balance sheet growth of Colonial National to not more than 7% per annum. See \"Government Regulation--The Company.\" Furthermore, Colonial National continues to own the credit card accounts and customer relationships, which the Company believes continue to build significant long-term value. While the Company believes that securitization will continue to be a reliable source of funding, there is no assurance that the Company will be able to continue securitizations in amounts or under terms comparable to its securitizations to date.\nA securitization involves the transfer by the Company of the receivables generated by a pool of credit card accounts to a securitization trust. Certificates issued by the trust and sold to investors represent undivided ownership interests in receivables transferred to the trust. The securitization results in removal of receivables from the Company's balance sheet for financial and regulatory accounting purposes. For tax purposes, the investor certificates are characterized as a collateralized debt financing of the Company.\nThe trust receives finance and other charges paid by the credit card customers and pays a rate of return on a monthly basis to the certificate holders. While in most cases the rate of return paid to investors is variable in order to match the pricing dynamics of the underlying receivables, the Company also uses fixed rate securitizations in certain circumstances. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Asset\/Liability Management.\" Credit losses on the securitized receivables are paid from the funds in the trust. The Company continues to service the accounts for a fee, generally two percent per annum of the securitized receivables. Excess funds (defined as finance charges plus miscellaneous fees less interest paid to certificate holders, credit losses and servicing fees) are first retained to build up a reserve fund to a certain level, after which amounts are remitted to the Company. The Company's relationship with its credit card customers is not affected by the securitization.\nInvestors in the trust receive payments only of interest during the first two to four years of the trust. Thereafter, an amortization period (generally between six and ten months) commences, during which the certificate holders are entitled to payment of principal and interest. Acceleration of the commencement of the amortization period (which may occur in limited circumstances) on a securitization would accelerate the Company's funding\nAdvanta Corp. and Subsidiaries\nrequirement. Upon full repayment of principal to the certificate holders, whether as a result of normal or accelerated amortization, the trust's lien on the accounts terminates and all related receivables and funds held in the trust, including the reserve fund, are transferred to the Company.\nIn February 1995, Advanta National Bank (\"ANB\"), a new federally chartered institution organized by the Company, opened for business. Currently, ANB assets do not represent a significant portion of the Company's assets. However, the Company does anticipate that ANB will, in the future, become the originator of a substantial portion of the Company's credit card assets.\nMORTGAGE LOANS\nThe Company's subsidiary, Advanta Mortgage Corp. USA (\"Advanta Mortgage\"), originates, purchases, securitizes and services non-conforming credit first and second mortgage loans for itself and for Colonial National's \"Advanta Mortgage USA\" Division. Loan production is generated through a centralized direct origination center, a broker network serviced by selected sales locations, and correspondent relationships.\nAdvanta Mortgage and Colonial National originate or purchase loans and then sell or securitize them, generally retaining servicing rights and the related excess cash flows. Consequently, the mortgage loan receivables on the Company's balance sheet are generally its most recently originated loans being held for sale. Thus, while mortgage loan receivables owned at December 31, 1994 were $143 million, during 1994 the Company originated or purchased $493 million and securitized $456 million of such receivables. At the time the receivables are sold or securitized, the Company recognizes a gain which is included in its mortgage banking income. See Note 1 to the Consolidated Financial Statements.\nWhile the Company has not historically offered mortgage lines of credit, which involve the extension of a revolving amount of credit to a borrower, the Company is planning to offer a home equity line of credit product beginning in 1995. The Company is also in the process of establishing a new consumer finance company, Advanta Finance Corp., which will provide another loan origination source, with loans marketed directly to the consumer through a branch office system. The first Advanta Finance Corp. branch offices will open in the first half of 1995.\nAdvanta Mortgage services Colonial National's mortgage loan portfolio, packages Colonial National's mortgage loans for sale, and performs the servicing on loans sold by Colonial National where Colonial National retains the servicing rights and obligations. In addition, Advanta Mortgage performs fee-based servicing on loans originated and owned by unrelated third party mortgage lenders. Therefore, Advanta Mortgage and Colonial National's Advanta Mortgage USA Division have the following basic sources of income: net interest income on loans outstanding pending their sale, gains on sales and securitizations of loans, and loan servicing fees. The Company generally charges loan origination fees and incurs certain direct costs associated with loan originations. These fees and costs are netted against the gain income when the mortgage loans are sold. Interest income earned on loans prior to their sale or securitization is included in the Company's interest revenues, as detailed in \"Management's Discussion and Analysis of Financial Condition and Results of Operations - Net Interest Income.\"\nAdvanta Mortgage and Colonial National began securitizing mortgage loans in 1988, when they privately placed with institutional investors $72 million of certificates representing fractional ownership interests in securitization trusts. Since 1991, Advanta Mortgage and Colonial National have securitized loans through publicly offered mortgage securitization transactions. They publicly securitized $385 million in 1992, $608 million in 1993 and $456 million in 1994.\nA securitization involves the transfer of specified pools of mortgage loans to a trust which issues certificates representing undivided ownership interests in the loans. The Company acts as servicing agent for the trust, providing customer service and collection efforts, and receives loan servicing fees equal to .5% per annum of the securitized receivables. Finance and other charges paid to the trust are used to pay the investors interest on their certificates and other costs of the trust. Excess amounts, net of credit losses, are ultimately paid to the Company. Credit losses on the securitized loans reduce the amount of these payments to the Company.\nAdvanta Corp. and Subsidiaries\nSignificant differences from the Company's credit card securitizations, however, include: (1) while in most cases the credit card securitization certificates pay a variable interest rate (which complements the variable rate pricing on the Company's credit cards), the mortgage securitization certificates generally carry a fixed rate of interest (as do most of the mortgage loans held by the trust), and (2) payments to investors in the mortgage loan securitizations include both principal and interest from the outset, since the loans held by the trust are not revolving credit lines.\nAt December 31, 1994, Advanta Mortgage and Colonial National had approximately $143 million of mortgage loan receivables outstanding secured by mortgages. Additionally, as of that date, Advanta Mortgage was servicing approximately $1.2 billion in mortgage loans sold by the Company's subsidiaries, as well as $190 million of \"contract servicing\" receivables. Contract servicing receivables are not included in the Company's \"managed portfolio,\" as the performance of such loans does not have a material impact on either the Company's net income or its credit risk profile. In contrast, the performance of the managed portfolio, including loans sold by the Company, can materially impact ongoing mortgage banking income. See Note 1 to the Consolidated Financial Statements.\nApproximately 71% of the managed portfolio is secured by first mortgages and the balance is secured by second mortgages. At December 31, 1994, total mortgage loans managed, and the nonperforming loans included in these totals, are concentrated in the following five states:\nGeographic concentration carries a risk of increased delinquency and\/or loss if an area suffers an economic downturn. Advanta Mortgage monitors economic conditions in those regions through market and trend analyses. A Credit Policy Committee meets through the year to update lending policies based on the results of analyses, which may include abandoning lending activities in economically unstable areas of the country. The Company believes that the concentrations of nonperforming loans reflected in the preceding table are not necessarily reflective of general economic conditions in each region, but rather reflect the credit risk inherent in the different grades of loans originated in each area. The interest rate charged and the maximum loan-to-value ratio permitted with respect to each grade of loans are adjusted to compensate for the credit risk inherent in that loan grade. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Provision for Credit Losses\" and \"-- Credit Risk Management -- Asset Quality.\"\nAdvanta Corp. and Subsidiaries\nEQUIPMENT LEASING AND OTHER SMALL BUSINESS SERVICES\nThe Company's subsidiary, Advanta Business Services (\"ABS\"), formerly Advanta Leasing Corp., engages primarily in non-cancelable financing leases of equipment, including computers, fax machines, copiers and commercial cleaning equipment, primarily to professionals and small businesses. The average initial cost of leased equipment is approximately $7,000. Costs relating to equipment maintenance, insurance and personal property taxes are the responsibility of the lessee. In October 1991, ABS closed its first securitization of lease receivables with a private placement of $74.5 million of certificates and closed a similar transaction in the amount of $53 million in September 1992. ABS securitized $68 million and $102 million of lease receivables in 1993 and 1994, respectively. Securitization of lease receivables is substantially similar to mortgage loan securitization as described above, except that the servicing fee payable to ABS is 1.25% per annum of the securitized lease receivables.\nIn the third quarter of 1994, ABS began marketing business credit cards which are issued through Advanta Financial Corp. (\"AFC\"), formerly known as Colonial National Finance Corp., to its small business customers. As of December 31, 1994, the receivables on these cards issued were immaterial to the Company.\nThe Company anticipates ABS's origination volume increasing in 1995. ABS's 1994 originations, including $29 million of portfolio acquisitions, totaled $190 million. At December 31, 1994, ABS serviced a portfolio of $265 million of net lease receivables, including $179 million of securitized receivables\nCREDIT INSURANCE AND CREDIT PROTECTION\nThrough unaffiliated insurance carriers, the Company offers credit life, disability and unemployment insurance to its credit cardholders and credit life insurance and a limited life\/disability\/unemployment insurance product to its mortgage loan customers. The unaffiliated insurers reinsure 100% of the risk on the credit card credit and limited mortgage life, disability and unemployment insurance (but not the mortgage loan credit life insurance) with one or more of the Company's insurance subsidiaries. Such subsidiaries receive reinsurance premiums approximating 94% of the net premiums written. The subsidiaries are obligated to pay all losses and refunds, and have amounts withheld by the insurance carriers or maintain amounts in separate trust accounts for the benefit of these insurance carriers in an amount equal to statutory reserves as defined by the reinsurance agreements. In addition, in 1992, one of the insurance subsidiaries began direct underwriting of an indemnity policy protecting certain interests in the business equipment leased to customers of ABS against sudden and accidental loss.\nThe credit card credit life insurance insures the life of the borrower (and any joint borrower) and provides for the payment to the primary beneficiary (the lender) in the event of the borrower's death, an amount equal to the unpaid loan balance and accrued interest (subject to a maximum amount equal to the lesser of the borrower's balance at the date of death or $5,000). The credit disability and unemployment insurance pays the minimum monthly payment required by the credit card loan with respect to the debt outstanding at the commencement of a period of the primary borrower's disability or unemployment until the time the customer is able to return to work up to a maximum amount equal to the lesser of the borrower's balance at the date of unemployment or disability or $5,000.\nCommencing in 1992, Colonial National began offering its credit card customers in certain states the option to purchase a debt cancellation agreement entitled Credit Protection Plus(R). Under the terms of the contract, Colonial National will forgive the borrower's balance in the event of the death or permanent disability of either the primary or joint credit card borrower up to the lesser of $10,000, the customer's balance or the customer's credit limit at the time of death or disability. In addition, Colonial National will freeze the contractual principal payment obligation and waive all interest and service fees in the event that either the primary or joint\nAdvanta Corp. and Subsidiaries\ncredit card borrower is unable to work due to involuntary unemployment or short-term disability, commencing from the period of unemployment or disability and extending to the lesser of twelve months or the time the customer is able to return to work. Colonial National has purchased insurance protection against excess losses incurred for providing these services, which insurance protection is directly underwritten by one of the Company's insurance subsidiaries.\nDEPOSIT, SAVINGS AND INVESTMENT PRODUCTS\nThe Company offers a range of insured savings and transaction accounts through Colonial National, and offers uninsured investment products through the direct and brokered public sale of its debt securities. Bank deposit services include demand deposits, money market savings accounts, statement savings accounts, retail certificates of deposit, and large denomination certificates of deposit (certificates of $100,000 or more). During 1993, both the senior debt securities of Advanta Corp. and the senior debt securities and deposits of Colonial National achieved investment-grade ratings from the nationally recognized rating agencies. These ratings have allowed the Company to further diversify its funding sources. In November 1993, the Company filed a shelf registration statement with the Securities and Exchange Commission for $1 billion of senior debt securities, and subsequently sold $150 million of three-year notes in an underwritten transaction. The Company established a $500 million medium-term note program, Series A, under this registration statement. As of March 1, 1995, all of the Series A notes have been issued. In addition, the Company established a $350 million medium-term note program, Series B, of which $15 million has been issued as of March 1, 1995.\nConsumer deposit business at Colonial National is generated from repeat sales to existing customers and new deposits from individuals attracted by newspaper advertising and direct mail solicitations. Also, Colonial National offers retail certificates of deposit to customers through several nationally recognized broker\/dealer firms which offer \"Master Certificate of Deposit\" programs to banks throughout the nation. Under these programs, the customers of the broker\/dealer firms may purchase Colonial National certificates of deposit in $1,000 increments, from $1,000 to $100,000. The award of investment grade ratings to Colonial National's senior debt securities has allowed the bank to acquire additional sources of institutional funds through both deposit and non-deposit products. Colonial National has established a $500 million short-term note program, whereby debt of Colonial National is sold to institutional investors. Under this program, $85 million was issued and outstanding as of December 31, 1994. Together, these various programs provide Colonial National and Advanta with diverse cost effective sources of funding. Additionally, in 1994 further diversification was achieved when the Company obtained revolving credit facilities totaling $255 million from a consortium of banks and $255 million in money market bid lines.\nInvestments in the Company's senior debt securities are marketed primarily to institutional investors through underwritten offerings as well as direct placements pursuant to the Company's medium-term note and Colonial National's short-term note programs. Investments in the Company's subordinated debt securities are generated from newspaper advertisements and direct mail marketing efforts to existing and prospective investors. These subordinated debt securities historically have been and continue to be offered to investors with a variety of maturities (currently ranging from demand to five years) and yield options. Further, a wholly-owned subsidiary of the Company, Advanta Financial Corp. (\"AFC\"), began taking deposits in the form of certificates of deposit in January 1992. AFC is an FDIC-insured industrial loan corporation organized under the laws of the State of Utah. The activities of AFC are not currently material to the Company's business.\nAdvanta Corp. and Subsidiaries\nGOVERNMENT REGULATION\nTHE COMPANY\nThe Company is not required to register as a bank holding company under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"). The Company owns Colonial National, which is a \"bank\" as defined under the BHCA as amended by the Competitive Equality Banking Act of 1987 (\"CEBA\"). However, under certain grandfathering provisions of CEBA, the Company is not required to register as a bank holding company under the BHCA, because Colonial National, which takes demand deposits but does not make commercial loans, did not come within the BHCA's definition of the term \"bank\" prior to the enactment of CEBA and it complies with certain restrictions set forth in CEBA, such as limiting its activities to those in which it was engaged prior to March 5, 1987 and limiting its growth rate to not more than 7% per annum. Such restrictions also prohibit Colonial National from cross-marketing products or services of an affiliate that are not permissible for bank holding companies under the BHCA. In addition, the Company complies with certain other restrictions set forth in CEBA, such as not acquiring control of more than 5% of the stock or assets of an additional \"bank\" or \"savings association\" as defined for these purposes under the BHCA. Consequently, the Company is not subject to examination by the Federal Reserve Board (other than for purposes of assuring continued compliance with the CEBA restrictions referenced in this paragraph). Should the Company or Colonial National cease complying with the restrictions set forth in CEBA, registration as a bank holding company under the BHCA would be required.\nRegistration as a bank holding company is not automatic. The Federal Reserve Board may deny an application if it determines that control of a bank by a particular company will cause undue interference with competition or that such company lacks the financial or managerial resources to serve as a source of strength to its subsidiary bank. While the Company believes that it meets the Federal Reserve Board's managerial standards and that its ownership of Colonial National has improved the bank's competitiveness, should the Company be required to apply to become a bank holding company the outcome of any such application cannot be certain.\nRegistration as a bank holding company would subject the Company and its subsidiaries to inspection and regulation by the Federal Reserve Board. Although the Company has no plans to register as a bank holding company at this time, the Company believes that registration would not restrict, curtail, or eliminate any of its activities at current levels, except that some portions of the current business operations of the Company's insurance subsidiaries would have to be discontinued, the effects of which would not be material.\nCOLONIAL NATIONAL BANK USA\nThe Company conducts substantially all its deposit-taking activities and credit card lending business, as well as a large portion of its mortgage lending business, through Colonial National. Under Federal law, Colonial National may \"export\" (i.e., charge its customers resident in other states) the finance charges permissible under the law of its state of domicile, Delaware, which state has no usury statute applicable to banks. Consistent with prevailing industry practice, the Company also exports credit card fees (including, for example, annual fees, late charges and fees for exceeding credit limits) permitted under Delaware law. There is no precedent clearly applicable to Colonial National as to the permissibility of exporting such fees. In a case involving this issue (to which the Company was not a party), the United States Court of Appeals for the First Circuit ruled that the Commonwealth of Massachusetts did not have the power to prevent a Delaware state-chartered financial institution from charging Massachusetts residents credit card fees in excess of those allowed under Massachusetts law. The United States Supreme Court declined to consider an appeal of the First Circuit's decision, and so that decision became final in 1992. However, litigation involving this issue has been initiated against other credit card issuers in several states, and it is possible that a contrary appellate decision could be reached in a jurisdiction where the judgment of the First Circuit Court of Appeals is not binding. The Company cannot quantify the impact on its business, as a result of possible loss of fees,\nAdvanta Corp. and Subsidiaries\npenalties or other sanctions, that could result from an adverse determination on this issue in one or more states.\nColonial National is subject primarily to regulation and periodic examination by the Office of the Comptroller of the Currency (the \"Comptroller\"). Such regulation relates to the maintenance of reserves for certain types of deposits, the maintenance of certain financial ratios, transactions with affiliates and a broad range of other banking practices. As a national bank, Colonial National is subject to provisions of federal law which restrict its ability to extend credit to its affiliates or pay dividends to its parent company. See \"Dividends and Transfers of Funds.\"\nColonial National is subject to capital adequacy guidelines approved by the Comptroller. These guidelines make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and consider off-balance sheet exposures in determining capital adequacy. As of December 31, 1994, the minimum required ratio of total capital to risk-weighted assets (including certain off-balance sheet items) was 8%. At least half of the total capital is to be comprised of common equity, retained earnings and a limited amount of non-cumulative perpetual preferred stock (\"Tier 1 capital\"). The remainder may consist of other preferred stock, certain hybrid debt\/equity instruments, a limited amount of term subordinated debt or a limited amount of the reserve for possible credit losses (\"Tier 2 capital\"). In addition, the Comptroller has also adopted a minimum leverage ratio (Tier 1 capital divided by total average assets) of 3% for national banks that meet certain specified criteria, including that they have the highest regulatory rating. Under this guideline, the minimum leverage ratio would be at least 1 or 2 percentage points higher for national banks that do not have the highest regulatory rating, for national banks undertaking major expansion programs, and for other national banks in certain circumstances. As of December 31, 1994, Colonial National's Tier 1 capital ratio was 7.95%. The combined Tier 1 and Tier 2 capital ratio was 12.04%, and the leverage ratio was 8.15%.\nRecognizing that the risk-based capital standards address only credit risk (and not interest rate, liquidity, operational or other risks), the Comptroller has indicated that many national banks will be expected to maintain capital in excess of the minimum standards. As indicated above, Colonial National's capital levels currently exceed the minimum standards. To date, the Comptroller has not required Colonial National to maintain capital in excess of the minimum standards. However, there can be no assurance that such a requirement will not be imposed in the future, or if it is, what higher standard will be applicable.\nIn addition, pursuant to certain provisions of the FDIC Improvement Act of 1991 (\"FDICIA\") and regulations promulgated thereunder, FDIC insured institutions such as Colonial National may only accept brokered deposits without FDIC permission if they meet certain capital standards, and are subject to restrictions with respect to the interest they may pay on deposits unless they are \"well-capitalized.\" To be \"well-capitalized,\" a bank must have a ratio of total capital to risk-weighted assets of not less than 10%, Tier 1 capital to risk-weighted assets of not less than 6%, and a Tier 1 leverage ratio of not less than 5%. Based on the applicable standards under these regulations, Colonial National is currently \"well-capitalized,\" and the Company intends to maintain Colonial National as a \"well-capitalized\" institution.\nOTHER FDIC-INSURED DEPOSITORY INSTITUTIONS\nIn January 1992, Advanta Financial Corp. (\"AFC\") opened for business and began taking deposits. AFC is an FDIC-insured industrial loan corporation organized under the laws of the State of Utah and is subject to examination and regulation by both the FDIC and the Utah Department of Financial Institutions. At December 31, 1994, AFC had deposits of $33 million and total assets of $49 million. Currently, AFC's principal activity consists of small ticket equipment lease financing. AFC is also the issuer of the small business credit cards marketed by ABS.\nIn February 1995, Advanta National Bank (\"ANB\") opened for business. As a national bank, ANB, like Colonial National, is subject primarily to regulation and periodic examination by the Comptroller, and the\nAdvanta Corp. and Subsidiaries\nregulations described above with respect to Colonial National apply equally to ANB. As with Colonial National, the Company intends to maintain ANB as a \"well-capitalized\" institution.\nUnder CEBA, neither AFC nor ANB is considered a \"bank\" for purposes of the BHCA, and so the Company's ownership of these institutions does not impact the Company's exempt status under the BHCA. ANB is a \"credit card bank\" under CEBA, and as such is subject to certain restrictions, including that it may only engage in credit card operations, it may not offer checking or transaction accounts, and it may only accept time deposits in amounts of $100,000 or more. However, unlike Colonial National, ANB's growth will not be limited to 7% per annum. Consequently, the Company anticipates that in the future, a substantial portion of the Company's credit card receivables may be originated by ANB.\nLENDING AND LEASING ACTIVITIES\nThe Company's activities as a lender are also subject to regulation under various federal and state laws including the Truth-in-Lending Act, the Equal Credit Opportunity Act, the Home Mortgage Disclosure Act, the Community Reinvestment Act, the Electronic Funds Transfer Act, and the Fair Credit Reporting Act. Provisions of those statutes, and related regulations, among other matters, require disclosure to borrowers of finance charges in terms of an annual percentage rate, prohibit certain discriminatory practices in extending credit, require the Company's FDIC-insured depository institutions to serve the banking needs of their local communities, and regulate the dissemination and use of information relating to a borrower's creditworthiness. Certain of these statutes and regulations also apply to the Company's leasing activities. In addition, Advanta Mortgage and its subsidiaries are subject to licensure and regulation in various states as mortgage bankers, mortgage brokers, and originators, sellers and servicers of mortgage loans.\nDIVIDENDS AND TRANSFERS OF FUNDS\nThere are various legal limitations on the extent to which Colonial National, AFC or ANB can finance or otherwise supply funds through dividends, loans or otherwise to the Company and its affiliates. The prior approval of the Comptroller is required if the total of all dividends declared by Colonial National in any calendar year exceeds its net profits (as defined) for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus accounts. In addition, Colonial National may not pay a dividend in an amount greater than its undivided profits then on hand after deducting its losses and bad debts. The Comptroller also has authority under the Financial Institutions Supervisory Act to prohibit a national bank from engaging in any unsafe or unsound practice in conducting its business. It is possible, depending upon the financial condition of the bank in question and other factors, that the Comptroller could claim that a dividend payment might under some circumstances be an unsafe or unsound practice. All of these restrictions also apply to ANB.\nColonial National, AFC and ANB are also subject to restrictions under Sections 23A and 23B of the Federal Reserve Act. These restrictions limit the transfer of funds by the depository institution to the Company and certain other affiliates, as defined in that Act, in the form of loans, extensions of credit, investments or purchases of assets, and they require generally that the depository institution's transactions with its affiliates be on terms no less favorable to the bank than comparable transactions with unrelated third parties. These transfers by any one institution to the Company or any single affiliate are limited in amount to 10% of the depository institution's capital and surplus and transfers to all affiliates are limited in the aggregate to 20% of the depository institution's capital and surplus. Furthermore, such loans and extensions of credit are also subject to various collateral requirements. In addition, in order for the Company to maintain its grandfathered exemption under CEBA, neither Colonial National nor ANB may make any loans to the Company or any of its subsidiaries.\nAdvanta Corp. and Subsidiaries\nThe Company's insurance subsidiaries are insurance companies organized under and regulated by Arizona law. Arizona insurance regulations restrict the amount of dividends which an insurance company may distribute without the prior consent of the Director of Insurance.\nGENERAL\nBecause the banking and finance businesses in general are the subject of such extensive regulation at both the state and federal levels, and because numerous legislative and regulatory proposals are advanced each year which, if adopted, could affect the Company's profitability or the manner in which the Company conducts its activities, the Company cannot now predict the extent of the impact of any such new laws or regulations.\nVarious legislative proposals have been introduced in Congress in recent years, including, among others, proposals relating to imposing a statutory cap on credit card interest rates, permitting affiliations between banks and commercial or securities firms, and proposals which would place new restrictions on a lender's ability to utilize pre-screening of consumers' credit reports through credit reporting agencies (credit bureaus) in connection with the lender's direct marketing efforts. It is impossible to determine whether any of these proposals will become law and, if so, what impact they will have on the Company.\nIn September 1992, the Federal Communications Commission established rules implementing the Telephone Consumer Protective Act of 1991 which limits telephone solicitations to residences. Because the statute exempts telemarketing to existing or former customers, it does not materially impact the Company's current business operations. In 1994, Congress adopted the Interstate Banking and Branching Efficiency Act, which statute permits nationwide interstate bank acquisitions beginning in 1995, and interstate bank branching in 1997 (or earlier at a state's option). The Company does not currently believe that the changes in the country's banking system wrought by this statute will materially impact the Company's business.\nCOMPETITION\nAs a marketer of credit products, the Company faces intense competition from numerous providers of financial services. Many of these companies are substantially larger and have more capital and other resources than the Company. Competition among lenders can take many forms including convenience in obtaining a loan, customer service, size of loans, interest rates and other types of finance or service charges, duration of loans, the nature of the risk which the lender is willing to assume and the type of security, if any, required by the lender. Although the Company believes it is generally competitive in most of the geographic areas in which it offers its services, there can be no assurance that its ability to market its services successfully or to obtain an adequate yield on its loans will not be impacted by the nature of the competition that now exists or may develop.\nIn the VISA and MasterCard market, the Company competes with national, regional, and local issuers. Additionally, American Express, Discover Card and Diners Club represent additional competition in the general purpose credit card markets in the Unites States. The Company does not believe that single purpose credit cards such as oil company, department store or telephone credit cards represent a significant competitive threat.\nIn seeking investment funds from the public, the Company faces competition from banks, savings institutions, money market funds, credit unions and a wide variety of private and public entities which sell debt securities, some of which are publicly traded. Many of the competitors are larger and have more capital and other resources than the Company. Competition relates to such matters as rate of return, collateral, insurance or guarantees applicable to the investment (if any), the amount required to be invested, convenience and the cost to and conditions imposed upon the investor in investing and liquidating his investment (including any commissions which must be paid or interest forfeited on funds withdrawn), customer service, service charges, if any, and the taxability of interest.\nAdvanta Corp. and Subsidiaries\nEMPLOYEES\nAs of December 31, 1994, the Company had 1,753 employees, up from 1,614 employees at the end of 1993. The Company believes that it has good relationships with its employees. None of its employees are represented by a collective bargaining unit.\nAdvanta Corp. and Subsidiaries\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company leases an aggregate of approximately 155,000 square feet of office space in five office buildings located in Horsham, Pennsylvania, a Philadelphia suburb, and owns two buildings in Horsham aggregating approximately 128,000 square feet. The Company also leases an aggregate of approximately 60,000 square feet of office space for its Advanta Mortgage and Advanta Finance Corp. offices in California, New Jersey, New York and Maryland. In New Jersey, Advanta Business Services owns a 56,000 square foot building.\nThe Company's principal executive offices and Colonial National's principal operating offices are currently located in approximately 83,000 square feet of leased space in two office buildings in Delaware.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material pending legal proceedings to which the Registrant 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.\nNot applicable.\nAdvanta Corp. and Subsidiaries\nEXECUTIVE OFFICERS OF THE REGISTRANT\nEach of the executive officers of the Company listed below was elected by the Board of Directors, to serve at the pleasure of the Board in the capacities indicated.\nAdvanta Corp. and Subsidiaries\nMr. Alter became Executive Vice President and a director of the Company in 1967. He was elected President and Chief Executive Officer in 1972, and Chairman of the Board of Directors in August 1985. In February 1986, he relinquished the title of President, retaining the positions of Chairman and Chief Executive Officer.\nMr. Hart joined the Company in March 1994 as Executive Vice Chairman. For the five years prior to that he had been President and Chief Executive Officer of MasterCard International, Inc., a worldwide association of over 29,000 member financial institutions. Prior to joining MasterCard in November 1988, Mr. Hart was Executive Vice President of First Interstate Bancorp, Los Angeles, California.\nMr. Greenawalt was elected President and Chief Operating Officer of the Company in November 1987. Prior to joining the Company, Mr. Greenawalt served as President of Transamerica Financial Corp., Los Angeles, California, from May 1986. For the 15 years prior to that, Mr. Greenawalt served in various capacities with Citicorp, including most recently as Chairman and Chief Executive Officer of Citicorp Person-to-Person, Inc., St. Louis, Missouri, and, prior to that, as President and Chief Executive Officer of Citicorp Retail Services, Inc., New York, New York.\nMr. Averett came to the Company as Vice President in January 1988. Prior to joining the Company, Mr. Averett worked with Citicorp from 1980 to 1987. Most of this tenure was in a retail credit card division (CRS) holding a wide array of positions from financial analyst to credit cycle manager and eventually Regional Collections Manager.\nMr. Beck joined the Company in 1986 as Senior Vice President of Colonial National and was elected Vice President and Treasurer in 1992. Prior to joining the Company, he was Vice President, Fidelity Bank, N.A., responsible for asset\/liability planning, as well as for managing a portfolio of investment securities held at the bank. From 1970 through 1980, he served in various treasury and planning capacities for Wilmington Trust Company.\nMr. Brenner was elected as Senior Managing Director, Advanta Partners LP in 1994. Prior to his joining Advanta Partners LP, Mr. Brenner has served on the Company's Board of Directors since May 1992. Prior to joining Advanta Partners LP, he had been president of Cedar Capital Investors, LTD, the managing partner of a private venture capital partnership, since 1989. Concurrently, Mr. Brenner served as Chairman and Chief Executive Officer of Liebhardt Mills, Inc. and Chairman of Servomation International, LP.\nAdvanta Corp. and Subsidiaries\nMr. Calamari joined the Company in May 1988. From May 1985 through April 1988, Mr. Calamari served in various capacities in the accounting departments of Chase Manhattan Bank, N.A. and its subsidiaries, culminating in the position of Chief Financial Officer of Chase Manhattan of Maryland. From 1976 until May 1985, Mr. Calamari was an accountant with the public accounting firm of Peat, Marwick, Mitchell in New York.\nMr. Dougherty was elected Senior Vice President, Strategic Business Development in September 1994. Mr. Dougherty came to the Company from MCI Telecommunications, where he held the position of Vice President, International Brand Marketing. Prior to joining MCI in April 1983, Mr. Dougherty served as Vice President, Business Development at Fidelity Capital.\nMs. Dyer joined the Company as Vice President, Marketing in 1992. Prior to joining the Company, she was Vice President and Director of Marketing for the Retail Finance Division of MNC Financial. From 1985 to 1989, she was Director, Product Development and Management at the Student Loan Marketing Association and had previously held marketing management positions with Citicorp in their credit card, mortgage and consumer finance businesses.\nMr. Girman joined the Company as Vice President, Accounting Operations, Policies and Procedures in July 1988, and was elected Vice President, Audit and Control, in April 1991. Prior thereto, Mr. Girman served as Vice President, Management Accounting and Accounting Policies and Procedures for The Chase Manhattan Bank (USA), N.A. from April 1985 until joining the Company.\nMr. Hofmann came to the Company as Director of Human Resources in November 1986 and was elected Vice President, Human Resources in March 1987. Prior to joining the Company, he was Manager, Human Resources Planning and Development for Subaru of America, Inc. from October 1984, and Manager, Management and Organization Development for Shared Medical Systems, Inc. from March 1981 until October 1984.\nMr. John was elected as Senior Vice President of Corporate Administration in June 1994. Prior to joining the Company, Mr. John served as Executive Vice President for MasterCard International from April 1989. Before going to MasterCard International, Mr. John served eleven years at First Interstate Bancorp, holding a variety of senior level financial positions.\nMr. Lindenberg had been the Chairman of the Board and President of an equipment leasing business, LeaseComm Financial Corporation, from that Company's inception in June 1985 until its purchase by the Company in 1987. Following the acquisition, Mr. Lindenberg was elected President and Chief Executive Officer of Advanta Business Services, formerly Advanta Leasing Corp., the successor to LeaseComm. Prior to starting LeaseComm, Mr. Lindenberg had been with First Pennsylvania Bank, Philadelphia, Pennsylvania since 1982, where he had served in various capacities, most recently as Vice President of the national division responsible for that bank's commercial lending activities in leasing and electronics.\nMr. Marshall joined the Company in January 1988 and was elected Senior Vice President in February 1988 and Executive Vice President in 1993. Prior to joining the Company, from July 1987 he was Chief Operations Officer of a Scudder, Stevens & Clark joint venture. Prior to that, Mr. Marshall served in various capacities at Citibank from 1976. At the time he left Citibank, he was a Senior Vice President of Citicorp Retail Services, managing a major portion of its client relationships.\nMr. Millman joined the Company in September 1989 and was elected Assistant Treasurer in July 1990 and Vice President, Corporate Funds Management in August 1991. In November 1993, he became Chief Financial Officer of the Consumer Financial Services unit. Prior to joining the Company, Mr. Millman served as Director of Financial Planning for Knight Ridder, Inc. from March 1987 to January 1988, and as Chief Financial Officer of Osteotech, Inc. from January 1988 to September 1989.\nAdvanta Corp. and Subsidiaries\nMr. Riseman came to the Company in June 1992 as Senior Vice President, Administration. He was appointed to his present position in February 1994. Prior to joining the Company, Mr. Riseman had 27 years experience with Citicorp, most recently as Director of Training and Development. Prior to that he held Citicorp positions as Business Manager for the Long Island Region, Head of Policy and Administration for New York's Retail Bank, and Chairman of Citicorp Acceptance Co. which was involved in the financing and leasing of autos and financing of mobile homes.\nMr. Roblin joined the Company in November 1994 as Senior Vice President and Chief Information Officer for the Consumer Financial Services unit. Prior to joining the Company, Mr. Roblin served The Traveler's Personal Lines Insurance Company, briefly, as Chief Information Officer from May 1994. Prior to that, Mr. Roblin was Senior Vice President and Chief Information Officer for U.S. Fidelity and Guaranty Company from April 1991. Before Joining U.S. Fidelity and Guaranty Company, Mr. Roblin spent 19 years with Chubb and Sons Inc., serving as the Chief Information Officer from June 1986 until December 1992.\nMr. Schneyer joined the Company as Associate General Counsel in September 1986 and was elected to the offices of Vice President, Secretary and General Counsel in March 1989. Prior to joining the Company, from October 1983, Mr. Schneyer was an attorney in the Legal Department of Allied-Signal, Inc., Morristown, New Jersey.\nMr. Wesselink joined the Company in November 1993 as Senior Vice President and Chief Financial Officer. Prior to joining the Company, Mr. Wesselink was Vice President and Treasurer of Household International. Previous positions held by Mr. Wesselink in his 23 years at Household included Vice President-Director of Research, Group Vice President-Chief Financial Officer of Household Finance Corporation (HFC) and Senior Vice President-Chief Financial Officer of HFC.\nAdvanta Corp. and Subsidiaries\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nCOMMON STOCK PRICE RANGES AND DIVIDEND POLICY.\nIn April 1992, the Company approved a dual class stock plan which resulted in an effective two-for-one stock split and established two classes of common stock effective May 5, 1992. On September 23, 1993, the Board of the Directors approved a three-for-two stock split effected in the form of a 50% stock dividend on both the Class A and Class B common stock to shareholders of record as of October 4, 1993, which dividend was paid on October 15, 1993. All share and per share amounts have been adjusted to reflect this stock split as a result of the stock dividend. Both classes of the Company's common stock are traded on the NASDAQ National Market System under the trading symbols of ADVNB (non-voting common stock) and ADVNA (voting common stock). Following are the high and low sale prices and cash dividends declared for the last two years as they apply to each class of stock:\nAt December 31, 1994, the Company had approximately 930 and 750 holders of record of Class B and Class A common stock, respectively.\nAdvanta Corp. and Subsidiaries\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nFINANCIAL HIGHLIGHTS\n(1) 1989-1993 have been restated reflecting the reclassification of the amortization of credit card net deferred origination costs from net interest income to operating expenses.\n(2) Excludes gains on sales of credit card accounts in 1989, 1990 and 1994.\n(3) Compound annual growth rate from December 31, 1989.\n(4) 1992 cash dividends include dividends for three quarters on the Class B common stock and the full year on the Class A common stock, adjusted to reflect the effective stock split.\n(5) Includes common stock equivalents.\n(6) Combination of owned interest-earning assets\/interest-bearing liabilities and securitized credit card assets\/liabilities.\n* Not meaningful.\nAdvanta Corp. and Subsidiaries\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nNet income for 1994 of $106.1 million increased $29.5 million or 38% from the $76.6 million reported for 1993. Earnings per share of $2.58 increased 34% from the $1.92 reported for 1993. Net income before extraordinary item was $77.9 million or $1.95 per share in 1993. The increased earnings resulted primarily from substantial growth in average managed receivables, partially offset by the contraction in the managed net interest margin. Additionally, continued improvement in credit quality and disciplined cost management contributed to the improved financial results.\nAverage managed receivables of $6.1 billion in 1994 increased 45% from $4.2 billion in 1993. As a majority of the receivables continue to be securitized, the Company records the net cash flows on these securitized receivables as noninterest revenues. Noninterest revenues of $395.8 million in 1994 increased $140.2 million or 55% from $255.6 million in 1993. This increase was due to the 45% increase in average managed receivables, as well as an $18.4 million gain on the sale of $150 million of credit card customer relationships. This transaction allowed the Company to make additional investments in marketing and developmental initiatives. Including these increases in marketing and developmental expenses, total other operating expenses (excluding the amortization of credit card deferred origination costs, net) increased only 30% in 1994 despite the 45% growth in average managed receivables. The operating expense ratio decreased to 3.7% in 1994 from 4.1% in 1993. Asset quality indicators also continued to trend favorably. The total managed charge-off rate for 1994 fell to 2.3% from 2.9% in 1993, and the 30-day and over delinquency rate on managed receivables decreased to 2.7% at December 31, 1994 from 3.6% at year end 1993.\nOver the last three years, average managed receivables have grown at a compound annual rate of 38%. This receivable growth has generated higher return on assets, net income and earnings per share. The Company intends to continue pursuing a strategy of receivable growth with a goal of increasing average managed receivables by 40% or more in 1995. A significant component of this growth strategy is the Company's marketing of \"risk-adjusted\" credit card products, whereby credit cards are issued with lower rates to customers whose credit quality is expected to result in a lower rate of credit losses (the \"risk-adjusted pricing strategy\"). The Company's pricing structure on its credit card products also reflects low \"introductory\" credit card rates, which reprice upwards after an introductory period of up to one year. In 1994, the impact of these introductory rates was to reduce the managed net interest margin significantly, as the success of the Company's marketing campaigns resulted in substantial new receivable growth earning interest at the introductory rates. While the Company expects to increase earnings in 1995, it is anticipated that the managed net interest margin will continue to decline in 1995 as the result of the impact of the introductory rates on credit cards.\nNet income for 1993 rose to $76.6 million or $1.92 per share. This reflects increases of 60% and 39%, respectively, from the $48.0 million or $1.38 per share reported in 1992. Earnings for 1993 increased primarily as a result of a $1.1 billion or 33% increase in average managed receivables, improvements in credit quality with the total managed charge-off rate decreasing from 3.4% in 1992 to 2.9% in 1993, and controlled growth in operating expenses. The 33% increase in average managed receivables was the main driver in the $62.5 million or 32% increase in noninterest revenues to $255.6 million in 1993, from $193.1 million in 1992. As a result of improved credit quality, the provision for credit losses in 1993 fell to $29.8 million from $47.1 million in 1992. Despite a lower provision, reserve coverage of impaired owned assets was higher at December 31, 1993 compared to a year earlier. Disciplined cost management resulted in other operating expenses increasing only 27%, while average managed receivables grew 33% and the operating expense ratio fell to 4.1% for 1993 from 4.4% in 1992.\nAdvanta Corp. and Subsidiaries\nNET INTEREST INCOME\nNet interest income represents the excess of income generated from interest-earning assets, including receivables, investments and money market instruments over the interest paid on interest-bearing liabilities, primarily deposits and debt.\nNet interest income of $70.4 million for 1994 decreased $8.2 million or 11% from 1993 as a result of a lower owned net interest margin, which fell to 3.67% in 1994 from 4.85% in 1993. The lower owned net interest margin resulted from a 121 basis point decrease in the yield on interest earning assets due to a significant increase in credit card receivables issued at low introductory rates, partially offset by a $336 million increase in average interest earning assets. Also affecting the owned net interest margin was a timing lag between the adjustments in the Company's funding rates and the repricing of the interest rates on the Company's credit cards as a result of multiple changes in the prime rate during 1994. The Company's credit cards (other than those with fixed rate introductory pricing) are contractually indexed monthly to the prime rate.\nNet interest income of $78.6 million for 1993 increased $5.5 million or 7% from 1992 as a result of a $170 million increase in average earning asset balances, offset by a 22 basis point drop in the owned net interest margin. The Company began to execute its risk-adjusted pricing strategy during 1993. This strategy resulted in a drop in credit card yields thereby lowering the owned net interest margin.\nCredit card, mortgage and lease receivable securitization activity shifts revenues from interest income to noninterest revenues. This ongoing securitization activity reduces the level of higher-yielding receivables on the balance sheet while increasing the balance sheet levels of new lower-yielding receivables and money market assets. Net interest income on securitized credit card balances is reflected in credit card securitization income. Net interest income on securitized mortgage loans is reflected in income from mortgage banking activities, and net interest income on securitized lease receivables is reflected in leasing revenues, net. All securitization income is included in noninterest revenues. See Note 1 to Consolidated Financial Statements.\nAverage managed credit card receivables of $4.7 billion for 1994 increased $1.7 billion or 55% from 1993. This increase resulted from the very successful marketing of low introductory rate credit cards which generated approximately 1.5 million new accounts and a large volume of balance transfers by cardholders. In 1994 average owned credit card receivables were $1.2 billion compared to $900 million in 1993. Owned receivable balances would have been higher in both years had it not been for the securitization of $2.2 billion of credit card receivables in 1994 and $1.0 billion in 1993. A 201 basis point decline in the yield on owned credit card receivables was the result of the Company continuing to employ the risk-adjusted pricing strategy and the influence of a predominance of newer, lower-yielding accounts in the owned portfolio. A majority of these new accounts will be repricing upwards during 1995.\nAverage managed mortgage loans increased to $1.2 billion in 1994, a 17% increase from $1.0 billion in 1993. The average balance of owned mortgage loans decreased to $120.0 million in 1994 from $154.2 million in 1993 primarily due to the securitization of $456 million of receivables in 1994. Mortgage loan originations of $493 million in 1994 were down $17 million or 3% from 1993. Yields on owned mortgage loans decreased to 8.18% from 9.91% in 1993 reflecting a greater proportion of nonperforming loans on the balance sheet. During 1994 the Company initiated a program to repurchase nonperforming loans from the securitization trusts (see discussion under \"Provision for Credit Losses\").\nAdvanta Corp. and Subsidiaries\nAverage managed lease receivables of $201.9 million increased $56.1 million or 39% from 1993. Average owned balances of leases increased only $2.6 million during 1994 due to the securitization of $101.6 million of receivables in 1994. Yields on owned leases decreased to 14.36% in 1994 from 18.70% in 1993 primarily due to the exclusion of late fees on securitized leases from the 1994 yield.\nA slight increase in the owned average cost of funds was experienced in 1994 as the cost of funds rose to 5.22% from 5.18% in 1993. The rollover of deposits and money market instruments at higher rates resulted from a rising rate environment in 1994. The Company has utilized derivatives to manage the impact on the Company from rising rates (see discussion under \"Derivatives Activities\"). The achievement of investment-grade ratings in 1993 also enabled the Company in 1994 to benefit from alternative funding vehicles not previously available.\nThe following table provides an analysis of both owned and managed interest income and expense data, average balance sheet data, net interest spread (the difference between the yield on interest earning assets and the average rate paid on interest-bearing liabilities), and net interest margin (the difference between the yield on interest earning assets and the average rate paid to fund interest earning assets) for 1992 through 1994. Average owned loan and lease receivables and the related interest revenues include certain loan fees.\nAdvanta Corp. and Subsidiaries\nINTEREST RATE ANALYSIS\n(1) Interest and average rate computed on a tax equivalent basis using a statutory rate of 35% in 1994 and 1993 and 34% in 1992.\n(2) Includes assets held and available for sale, and nonaccrual loans and leases.\n(3) Combination of owned interest-earning assets\/owned interest-bearing liabilities and securitized credit card assets\/liabilities.\nAdvanta Corp. and Subsidiaries\nINTEREST VARIANCE ANALYSIS: ON-BALANCE SHEET\nThe following table presents the effects of changes in average volume and interest rates on individual financial statement line items on a tax equivalent basis and including certain loan fees. Changes not solely due to volume or rate have been allocated on a pro rata basis between volume and rate. The effects on individual financial statement line items are not necessarily indicative of the overall effect on net interest income.\n(1) Includes income from assets held and available for sale.\nMANAGED PORTFOLIO DATA\nThe following table provides selected information on a managed basis, as well as a summary of the effects of credit card securitizations on selected line items of the Company's consolidated statements of income for the past three years.\nWith respect to the above information on the effects of credit card securitizations, net interest income represents the amount by which net interest income would have been higher had the securitized receivables remained on the balance sheet. In addition, provision for credit losses represents the amount by which provision for credit losses would have been higher had the securitized receivables remained as owned and provision for credit losses been equal to charge-offs. Both net interest income and provision for credit losses described above are netted and included in other noninterest revenues in the Consolidated Income Statements.\nAdvanta Corp. and Subsidiaries\nPROVISION FOR CREDIT LOSSES\nThe provision for credit losses of $34.2 million in 1994 increased $4.4 million or 15% from $29.8 million in 1993. Net charge-offs on owned receivables for 1994 were $35.3 million, exceeding the provision for credit losses by $1.1 million. In 1993, the Company transferred $11 million of on-balance sheet reserves to off-balance sheet mortgage loan recourse reserves. In 1994, the Company initiated a program to repurchase nonperforming mortgages from the securitization trusts in order to lower funding costs on those mortgages. As a result, in 1994, the Company repurchased approximately $50 million of nonperforming mortgages and transferred approximately $13 million of off-balance sheet recourse reserves related to these loans to on-balance sheet reserves. When these mortgages were charged off in 1994, the Company did not need to provide additional amounts for them since reserves had been specifically provided for these mortgages at their repurchase date. These repurchases increased the owned impaired asset level while having no impact on either the level of managed impaired assets or the provision for credit losses. The owned impaired asset level was $43.3 million at December 31, 1994, compared to $22.5 million a year ago.\nThe provision for credit losses of $29.8 million in 1993 decreased $17.3 million or 37% from $47.1 million in 1992. This decrease was primarily due to lower charge-offs on owned receivables and lower impaired asset levels.\nA description of the credit performance of the loan portfolio is set forth under the section entitled \"Credit Risk Management.\"\nNONINTEREST REVENUES\nNoninterest revenues of $395.8 million in 1994 increased $140.2 million or 55% from $255.6 million in 1993. This improvement resulted from a 66% growth in average securitized credit card receivables, from an $18.4 million gain on the sale of credit card customer relationships (see Note 13 to Consolidated Financial Statements), and from a 61% growth in average securitized lease receivables.\nDue to the securitization of credit card receivables, activity from securitized account balances normally reported as net interest income and charge-offs is reported in securitization income and servicing income, both of which are included in noninterest revenues. Credit card securitization income increased 55% to $210.3 million from $135.8 million in 1993 while average securitized credit card receivables increased 66% to $3.5 billion in 1994 from $2.1 billion in the prior year. See Note 1 to Consolidated Financial Statements for further description of securitization income.\nCredit card securitization income is the excess of revenue collected on the securitized receivables, including interest, interchange income and certain fees, over the related securitization trust expenses, including interest payments to investors in the trusts, charge-offs, servicing costs and transaction expenses. Credit card servicing income which represents fees paid to the Company for continuing to service accounts which have\nAdvanta Corp. and Subsidiaries\nbeen securitized, increased to $69.0 million in 1994 from $41.6 million in 1993. Such fees normally approximate 2% of securitized receivables.\nInterchange income represents fees that are payable by merchants to the credit card issuer for sale transactions. Total interchange income earned approximates 1.4% of credit card purchases. The amount of interchange paid to the securitization trusts ranges from 1% to 2% of securitized balances and is included in credit card securitization income. Interchange income decreased 45% to $10.4 million in 1994 from $18.8 million in 1993 due to a larger proportion of interchange revenues being included in securitization income. Other credit card revenues, which include credit insurance, cash advance fees and other credit card related revenues, increased $2.7 million to $14.2 million in 1994 from $11.5 million in 1993.\nDuring 1994, the Company securitized $456 million of mortgage loans compared to $608 million in 1993. Mortgage banking income of $37.6 million for 1994 increased from $24.1 million in 1993. In 1993, increased credit losses on the securitized portfolio reduced income from mortgage banking activities by approximately $14 million. Increased prepayments also reduced income from mortgage banking activities by $14 million in 1993. In 1994, although credit losses on the managed portfolio increased, the Company did not need to add additional amounts to off-balance sheet reserves as in previous years. Also, the Company did not experience the degree of increased prepayments that it did in 1993. See Note 1 to Consolidated Financial Statements for a description of mortgage banking income.\nNoninterest revenues of $255.6 million in 1993 increased $62.5 million or 32% from $193.1 million in 1992, primarily due to increases in credit card securitization and servicing income, and leasing and insurance revenues. These increases were partially offset by a decrease in credit card interchange income.\nAdvanta Corp. and Subsidiaries\nOPERATING EXPENSES\nThe amortization of credit card deferred origination costs, net, increased from $6.6 million in 1993 to $39.4 million in 1994. In May 1993, the Emerging Issues Task Force (the \"EITF\") of the Financial Accounting Standards Board (the \"FASB\") reached a consensus regarding the deferral of amounts paid to a third party to acquire individual credit card accounts and the amortization period for such costs. As a result of this consensus, deferred origination costs and the amortization thereof are now linked to the privilege period of the card (which is normally 12 months), rather than to the related receivable. In 1994, the Company began including the amortization of these costs as an operating expense rather than a component of net interest income, as the costs no longer relate to the receivables. All prior periods have been reclassified for this change. Costs incurred for credit card originations initiated after the May 1993 EITF consensus date are being amortized over 12 months, rather than pursuant to the previous policy of 60 months. Due to the fact that 1993 was a transition year, the full impact of this change did not occur until 1994. Also affecting the increase in amortization was a $25.7 million increase in amounts deferred under these third party arrangements in 1994.\nTotal other operating expenses of $227.4 million for 1994 were up $52.8 million or 30% from $174.6 million in 1993. The increase in total other operating expenses primarily resulted from: (a) a $23.2 million or 35% increase in salaries and employee benefits, (b) a $13.6 million increase in marketing expenses as the Company promoted its financial products as well as enhanced its general public visibility, (c) a $6.0 million increase in external processing resulting primarily from a 40% increase in the number of accounts managed year-to-year, and (d) an overall increase in credit card related costs due to a 42% increase in the number of managed credit card accounts.\nThe amortization of credit card deferred origination costs, net, rose to $6.6 million in 1993 from $4.5 million in 1992, due to the change in the amortization period discussed above. Total other operating expenses of $174.6 million for 1993 rose $37.0 million or 27% from $137.6 million in 1992, driven by a 33% growth in average managed receivables. The overall growth in operating expenses was reflected in a $13.9 million or 27% increase in salaries and employee benefits, as well as increases in marketing expenses, external processing and other credit card related costs due to the 27% increase in the number of managed credit card accounts during 1993.\nAdvanta Corp. and Subsidiaries\nINCOME TAXES\nThe Company's consolidated income tax expense was $59.1 million for 1994, or an effective tax rate of 36%, compared to tax expense of $45.3 million, or a 37% effective rate, in 1993 and tax expense of $29.1 million, or a 38% effective rate, in 1992. The decrease in the effective tax rate from 1993 to 1994 resulted from a higher level of tax-free income and lower levels of state taxes. The decrease in the effective tax rate from 1992 to 1993 resulted from a higher level of tax-free income.\nASSET\/LIABILITY MANAGEMENT\nThe financial condition of Advanta Corp. is managed with a focus on maintaining high credit quality standards, disciplined interest rate risk management and prudent levels of leverage and liquidity.\nINTEREST RATE SENSITIVITY\nInterest rate sensitivity refers to net interest income variability resulting from mismatches between asset and liability indices (basis risk) and the effects which these changes in market interest rates have on asset and liability maturity mismatches (gap risk).\nThe Company attempts to minimize the impact of market interest rate fluctuations on net interest income and net income by regularly evaluating the risk inherent in its asset and liability structure, including securitized assets. This risk arises from continuous changes in the Company's asset\/liability mix, market interest rates, the yield curve, prepayment trends and the timing of cash flows. Computer simulations are used to evaluate net interest income volatility under varying rate, spread and volume projections over monthly time periods of up to two years.\nIn managing its interest rate sensitivity position, the Company periodically securitizes, sells and purchases assets, alters the mix and term structure of its funding base, changes its investment portfolio and short-term investment position, and uses derivative financial instruments. Derivative financial instruments are used for the express purpose of managing exposure to changes in interest rates and, by policy, are not used for any speculative purposes (see discussion under \"Derivatives Activities\"). The Company has primarily utilized variable rate funding in pricing its credit card securitization transactions in an attempt to match the variable rate pricing dynamics of the underlying receivables sold to the trusts. Variable rate funding is used on the balance sheet as well, in support of unsecuritized receivables which carry variable rates. Although credit card receivable rates are generally set at a spread over the prime rate, they often contain interest rate floors. These floors have the impact of converting the credit card receivables to fixed rate receivables in a low interest rate environment. In instances when a significant portion of credit card receivables are at their floors, the Company may convert part of the underlying funding to a fixed rate by using interest rate hedges, swaps and fixed rate securitizations. In pricing mortgage and lease securitizations, both fixed rate and variable rate funding are used depending upon the characteristics of the underlying receivables. Additionally, basis risk exists in on-balance sheet funding as well as securitizing credit card receivables at a spread over LIBOR when the rate on the underlying assets is indexed to the prime rate. The underlying liability or coupon on a securitization is often indexed to LIBOR, and LIBOR does not perfectly correlate to prime. The Company measures the basis risk resulting from potential variability in the spread between prime and LIBOR and incorporates such risk into the asset and liability management process. During 1994, $425 million in prime-LIBOR corridors were executed in order to provide protection against narrowing of these spreads. The Company continues to seek cost-effective alternatives towards minimizing this risk.\nInterest rate fluctuations affect net interest income at virtually all financial institutions. While interest rate volatility does have an effect on net interest income, other factors also contribute significantly to changes in net interest income. Specifically, within the credit card portfolio, pricing decisions and customer behavior regarding convenience usage affect the yield on the portfolio. These factors may counteract or exacerbate income\nAdvanta Corp. and Subsidiaries\nchanges due to fluctuating interest rates. The Company closely monitors interest rate movements, competitor pricing and consumer behavioral changes in its ongoing analysis of net interest income sensitivity.\nLIQUIDITY, FUNDING AND CAPITAL RESOURCES\nThe Company's goal is to maintain an adequate level of liquidity, both long and short-term, through active management of both assets and liabilities. During 1994, the Company, through its subsidiaries, securitized $2.2 billion of credit card receivables, $456 million of mortgage loans and $102 million of lease receivables. Cash generated from these transactions was temporarily invested in short-term, high quality investments at money market rates awaiting redeployment to pay down borrowings and to fund future credit card, mortgage loan and lease receivable growth. See the Consolidated Statements of Cash Flows for more information regarding liquidity, funding and capital resources. In addition, see Note 5 to Consolidated Financial Statements and Supplemental Schedules thereto for additional information regarding the Company's investment portfolio.\nOver the last seven years, the Company has successfully accessed the securitization market to efficiently support its growth strategy. While securitization should continue to be a reliable source of funding for the Company, other funding sources are available and include deposits, medium-term notes, subordinated debt, repurchase agreements, committed and uncommitted bank lines, bank notes, federal funds purchased and the ability to sell assets and raise additional equity. Funding diversification is an essential component of the Company's liquidity management. During 1993, the debt securities of Advanta Corp. and Colonial National Bank USA (\"Colonial National\" or the \"Bank\"), the principal operating subsidiary, achieved investment-grade ratings from the nationally recognized rating agencies. These ratings have allowed the Company to further diversify its funding sources. Efforts continue to develop new sources of funding, either through previously untapped customer segments or through developing new financing structures.\nIn November 1993, the Company filed a shelf registration statement with the Securities and Exchange Commission for $1 billion of debt securities. In the fourth quarter of 1993, the Company sold $150 million of three-year notes under this registration statement and it sold $360 million of medium-term notes under this registration statement through 1994. The Company may sell up to an additional $490 million of medium-term notes as needed. Further diversification was achieved in 1994 when the Company obtained revolving credit facilities totaling $255 million from a consortium of banks and $255 million in money market bid lines. In addition, steady building of liquidity and capital in 1994 and 1993 was achieved as a result of $39.6 million of dividends from subsidiaries in 1994 and $76.5 million in 1993, and retained earnings of $96.2 million in 1994 and $69.3 million in 1993. The Board of Directors currently intends to have the Company pay regular quarterly dividends to its shareholders, maintaining an approximate 20% premium on the dividend paid on the Class B shares; however, the Company plans to reinvest the majority of its earnings to support future growth.\nAt December 31, 1994, the Company was carrying $573 million of loans available for sale. The fair value of such loans was in excess of their carrying value at year end. In connection with liquidity and asset\/liability management, the Company had $319 million of investments available for sale at December 31, 1994. See Note 19 to Consolidated Financial Statements for fair value disclosures.\nAdvanta Corp. and Subsidiaries\nIn August 1993, Colonial National sold $50 million of subordinated notes which had received an investment-grade rating and qualified as Tier 2 capital for bank regulatory purposes. In December 1994, Colonial National sold $85 million of short-term bank notes which have maturities ranging from seven days to one year from date of issuance. These notes are not subordinated and do not qualify as Tier 2 capital.\nAs a grandfathered institution under the Competitive Equality Banking Act of 1987 (\"CEBA\"), the Company must limit the Bank's average on-balance sheet asset growth to 7% per annum. For the fiscal CEBA year ended September 30, 1994, the Bank's average assets did not exceed the allowable amount and, accordingly, the Bank was in full compliance with CEBA growth limits. The timing and size of securitizations, on-balance sheet liability structure and rapid changes in balance sheet structure are frequently due to the management of the Bank's balance sheet within this growth constraint.\nDeposits at December 31, 1994 include $33 million of deposits at Advanta Financial Corp. (\"AFC\"), a Utah state-chartered, FDIC-insured industrial loan corporation (a wholly-owned subsidiary of the Company, formerly named Colonial National Financial Corp.). AFC's assets and operations are not currently material to the Company, and the Company does not expect them to become material in the near term.\nDuring 1993, the Company raised $90 million in new equity through a 3.0 million share (pre-split) Class B common stock offering. Proceeds were used to support future growth.\nWhile there are no specific capital requirements for Advanta Corp., the Office of the Comptroller of the Currency requires that Colonial National maintain a risk-based capital ratio of at least 8%. Colonial National's risk-based capital ratio of 12.04% at December 31, 1994 was in excess of the required level and exceeded the minimum capital level of 10% required for the designation as a \"well-capitalized\" depository institution. The Company intends to take the necessary actions to maintain Colonial National as a \"well-capitalized\" bank. In addition, the Company's insurance subsidiaries are subject to certain capital, deposit and dividend rules and regulations as prescribed by state jurisdictions in which they are authorized to operate. At December 31, 1994 and 1993 the insurance subsidiaries were in compliance with all requisite rules and regulations.\nThe following tables detail the composition of the deposit base and the composition of debt and other borrowings at year end for each of the past five years.\nCOMPOSITION OF DEPOSIT BASE\nAdvanta Corp. and Subsidiaries\nCOMPOSITION OF DEBT AND OTHER BORROWINGS\nCAPITAL EXPENDITURES\nThe Company spent $24.1 million for capital expenditures in 1994, primarily for the purchase of two buildings, improvements to those buildings, additional space in other buildings, office and voice communication equipment and furniture and fixtures. This compared to $13.3 million for capital expenditures in 1993 and $5.3 million in 1992.\nIn 1995, the Company anticipates capital expenditures to exceed those of 1994 as its facilities are expanding and the Company is continuing to upgrade its voice and communication systems. The Company also anticipates that its 1995 marketing expenditures will exceed those of 1994 as the Company continues to originate new accounts, manage account retention and develop new consumer products for its customers.\nDERIVATIVES ACTIVITIES\nThe Company utilizes derivative financial instruments for the purpose of managing its exposure to interest rate risk. The Company has a number of mechanisms in place that enable it to monitor and control both market and credit risk from these derivatives activities. At the broader level, all derivatives strategies are managed under the hedging policy approved by the Board of Directors that details the use of such derivatives and the individuals authorized to execute derivatives transactions. All derivatives strategies must be approved by a senior management team (President, Chief Financial Officer and Treasurer).\nAs part of this approval process, a market risk analysis is completed to determine the potential impact on the Company from severe negative (stressed) movements in the market. By policy, derivatives transactions may only be used to manage the Company's exposure to interest rate risk and may not be used for speculative purposes. As such, the impact of any derivatives transaction is calculated using the Company's asset\/liability model to determine its suitability.\nThe Company's Board has approved a counterparty credit policy. This policy details the maximum transaction limit and transaction term for counterparties with a given credit rating (from nationally recognized rating agencies) and the maximum allowable exposure amounts. The exposure amount is calculated in a stress environment and represents the maximum aggregate credit exposure from derivatives transactions the Company is willing to accept from a rated counterparty. Under negotiated agreements with the counterparties, once the aggregate exposure exceeds this level, the Company has the right to call for and receive collateral for the amount of such excess, thereby limiting its exposure to the threshold amount. The threshold levels can be fixed or may change as the credit rating of the counterparty changes.\nAdvanta Corp. and Subsidiaries\nUnder the credit policy, the Company's Investment Committee (a management committee) approves each specific derivatives counterparty, including its respective term and transaction limits, and the actual threshold amounts to be set within the Company's bilateral collateral agreements. Each counterparty's credit quality is reviewed as new market information becomes available, and, in any case, at least semi- annually. Counterparties will be dropped if there is reason to believe that their credit quality is below the Company's set standards.\nCounterparty master agreements and any collateral agreements, by policy, must be signed prior to the execution of any derivatives transactions with a counterparty. To date, all master agreements with counterparties have included bilateral collateral agreements. As such, the potential exposure to a particular counterparty is limited to the maximum threshold level for that counterparty.\nThe Company has established an independent treasury accounting group which measures, monitors, and reports on credit, market, and liquidity risk exposures from hedging and derivative product activities. It is the responsibility of this department to ensure compliance with respect to the hedging policy, including the counterparty transaction limits, transaction terms and trader authorizations. In addition, this department marks each derivatives position to market on a weekly basis using both internal and external models that have been benchmarked against the derivatives dealers' monthly valuations. Position and counterparty exposure reports are generated and used to manage collateral requirements of the counterparty and the Company.\nAll of these procedures and processes are designed to provide reasonable assurance that prior to and after the execution of any derivatives strategy, market, credit and liquidity risks are fully analyzed and incorporated into the Company's asset\/liability and risk measurement models and the proper accounting treatment for the transaction is identified.\nCREDIT RISK MANAGEMENT\nManagement regularly reviews the loan portfolio in order to evaluate the adequacy of the reserve for credit losses. The evaluation includes such factors as the inherent credit quality of the loan portfolio, past experience, current economic conditions, projected credit losses and changes in the composition of the loan portfolio. The reserve for credit losses is maintained for on-balance sheet receivables. The on-balance sheet reserve is intended to cover all credit losses inherent in the owned loan portfolio. With regard to securitized assets, anticipated losses and related recourse reserves are reflected in the calculations of Securitization Income, Amounts Due from Credit Card Securitizations and Other Assets. Recourse reserves are intended to cover all probable credit losses over the life of the securitized receivables. Management evaluates both its on-balance sheet and recourse reserve requirements and, as appropriate, effects transfers between these accounts.\nThe reserve for credit losses on a consolidated basis was $41.6 million, or 2.1% of receivables, at December 31, 1994, compared to $31.2 million, or 2.4% of receivables, in 1993. Due to the increase in the proportion of owned impaired mortgages, which have a lower level of reserve coverage, the reserve coverage of impaired assets (nonperforming assets and accruing loans past due 90 days or more on credit cards) dropped to 96.1% at December 31, 1994, from 138.6% at December 31, 1993. Reserve coverage of impaired credit card assets was 186.5% at December 31, 1994, up slightly from 183.7% at year end 1993.\nThe reserve for credit losses on a consolidated basis was $31.2 million, or 2.4% of receivables, in 1993 down from $40.2 million, or 4.0% of receivables, in 1992. Due to improved credit quality, this reserve level resulted in higher reserve coverage of impaired assets.\nAdvanta Corp. and Subsidiaries\nASSET QUALITY\nImpaired assets include both nonperforming assets (mortgage loans and leases past due 90 days or more, real estate owned, credit card receivables due from cardholders in bankruptcy, and off-lease equipment) and accruing loans past due 90 days or more on credit cards. The carrying values for both real estate owned and equipment held for lease or sale are based on net realizable value after taking into account holding costs and costs of disposition and are reflected in other assets.\nOn the total managed portfolio, impaired assets were $102.4 million, or 1.3% of receivables, at year end 1994 compared to $95.1 million, or 1.8% of receivables, in 1993. Nonperforming assets on the total managed portfolio were $61.6 million, or .8% of receivables, compared to $63.6 million, or 1.2%, in 1993. A key credit quality statistic, the 30-day and over delinquency rate on managed credit cards, dropped to 2.0% from 2.4% a year ago. The total managed charge-off rate for 1994 was 2.3%, compared to 2.9% for 1993. The charge-off rate on managed credit cards was 2.5% for 1994, down from 3.5% for 1993.\nOn the total owned portfolio, impaired assets were $43.3 million, or 2.2% of receivables in 1994, compared to $22.5 million, or 1.8%, in 1993. This increase was due to the repurchase of the nonperforming mortgages from the securitization trusts (see \"Provision for Credit Losses\"). Gross interest income that would have been recorded in 1994 and 1993 for owned nonperforming assets, had interest been accrued throughout the year in accordance with the assets' original terms, was approximately $5.1 million and $1.5 million, respectively. The amount of interest on nonperforming assets included in income for 1994 and 1993 was $1.7 million and $.3 million, respectively.\nPast due loans represent accruing loans that are past due 90 days or more as to collection of principal and interest. Credit card receivables, except those on bankrupt, decedent and fraudulent accounts, continue to accrue interest until the time they are charged off at 186 days contractual delinquency. In contrast, all mortgage loans and leases are put on nonaccrual when they become 90 days past due. Owned credit card receivables past due 90 days or more and still accruing interest were $11.2 million or .6% of receivables at December 31, 1994, compared to $11.0 million, or 1.0% of receivables, a year ago.\nThrough 1990, when the Company received notice that a credit cardholder had filed a bankruptcy petition or was deceased, the Company established a reserve equal to the full balance of the receivable. The receivable, if not paid, would be charged off in accordance with the Company's normal credit card charge-off policy at 186 days contractual delinquency. Likewise, receivables in accounts identified as fraudulent would be reserved against and written off (as an operating expense) when they became 186 days contractually delinquent. These policies are consistent with many leading competitors in the credit card industry.\nDuring 1991, the Company adopted a new policy for the charge-off of bankrupt, decedent and fraudulent credit card accounts. Under the new policy, the Company charges off bankrupt or decedent accounts within 30 days of notification and accounts suspected of being fraudulent after a 90 day investigation period, unless the investigation shows no evidence of fraud. Consequently, in 1991, both newly identified bankrupt, decedent and fraudulent accounts, as well as those previously identified, were written off. The 1991 charge-off rates included in the following tables exclude the effect of this acceleration.\nDuring 1994, the Company implemented a new policy for the charge-off of mortgage loans. Under this policy, when a nonperforming mortgage loan becomes twelve months delinquent, the Company writes down the loan to its net realizable value, regardless of anticipated collectibility. Consequently, in 1994 all mortgage loans that had been twelve or more months delinquent, as well as any mortgages that became twelve months delinquent during the year were written down to their net realizable value. Thus, the managed mortgage loan charge-off rate increased from 1.3% in 1993 to 1.7% in 1994. The managed mortgage charge-off rate in 1995 is anticipated to be closer to the 1.0% level.\nAdvanta Corp. and Subsidiaries\nThe following tables provide a summary of reserves, impaired assets, delinquencies and charge-offs for the past five years.\n(1) The 1991 charge-off rates are normalized to exclude the acceleration of the charge-off of bankrupt and decedent accounts related to the adoption of a new credit card charge-off policy in 1991. Including these amounts, the charge-off rates for 1991 were 3.8% and 5.3% on a consolidated-managed and credit card-managed basis, respectively.\n(2) In 1994, the Company implemented a new mortgage loan charge-off policy (see Asset Quality).\nAdvanta Corp. and Subsidiaries\n(1) The 1991 charge-off rates are normalized to exclude the acceleration of the charge-off of bankrupt and decedent accounts related to the adoption of a new credit card charge-off policy in 1991. Including these amounts, the charge-off rates for 1991 were 4.7% and 5.8% on a consolidated-owned and credit card-owned basis, respectively.\n(2) In 1994, the Company initiated a program for repurchasing nonperforming assets from the securitized portfolios and implemented a new mortgage loan charge-off policy (see Asset Quality).\nAdvanta Corp. and Subsidiaries\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nCONSOLIDATED BALANCE SHEETS\nSee Notes to Consolidated Financial Statements.\nAdvanta Corp. and Subsidiaries\nCONSOLIDATED INCOME STATEMENTS\nSee Notes to Consolidated Financial Statements.\nAdvanta Corp. and Subsidiaries\nCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY\nSee Notes to Consolidated Financial Statements.\nAdvanta Corp. and Subsidiaries\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nAdvanta Corp. and Subsidiaries\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands, except per share data)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of Advanta Corp. (the \"Company\") and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\nRECLASSIFICATION\nCertain prior-period amounts have been reclassified to conform with current-year classifications. As indicated in Management's Discussion and Analysis under the caption \"Operating Expenses,\" the Company is including the amortization of credit card deferred origination costs, net of deferred fees, in operating expenses rather than as a component of interest income as these net costs are linked to the privilege period of the cards and not to the credit card receivables.\nCREDIT CARD ORIGINATION COSTS, SECURITIZATION INCOME AND FEES\nCREDIT CARD ORIGINATION COSTS\nThe Company accounts for credit card origination costs under Statement of Financial Accounting Standards No. 91, \"Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases\" (\"SFAS 91\"). This accounting standard requires certain loan and lease origination fees and costs to be deferred and amortized over the life of a loan or lease as an adjustment to interest income. Origination costs are defined under this standard to include costs of loan origination associated with transactions with independent third parties and certain costs relating to underwriting activities and preparing and processing loan documents. The Company engages third parties to solicit and originate credit card account relationships. Amounts deferred under these arrangements approximated $55.2 million in 1994, $29.5 million in 1993 and $20.3 million in 1992.\nThe company amortizes deferred credit card origination costs under the consensus reached at the May 20, 1993 meeting of the Emerging Issues Task Force (\"EITF\") of the Financial Accounting Standards Board regarding the acquisition of individual credit card accounts from independent third parties (EITF Issue 93-1). The consensus stated that credit card accounts acquired individually should be accounted for as originations under SFAS 91 and EITF Issue 92-5. Amounts paid to a third party to acquire individual credit card accounts should be deferred and netted against the related credit card fee, if any, and the net amount should be amortized on a straight line basis over the privilege period. If a significant fee is charged, the privilege period is the period that the fee entitles the cardholder to use the card. If there is no significant fee, the privilege period should be one year. In accordance with this consensus, direct origination costs incurred related to credit card account originations initiated after the May 20, 1993 consensus date are deferred and amortized over 12 months. Costs incurred for originations which were initiated prior to May 20, 1993 will continue to be amortized over a 60 month period as was the practice prior to the EITF 93-1 consensus.\nPrior to the EITF Issue 93-1 consensus, it was the Company's practice to write off deferred origination costs related to credit card receivables that have been securitized. This practice had effectively written off credit card origination costs much more quickly than the 60 month period previously utilized. In connection with the prospective adoption of a 12 month amortization period for deferred credit card account origination costs, the Company no longer writes off deferred origination costs related to credit card receivables being securitized as under the EITF 93-1 consensus, such costs are not directly associated with the receivables.\nAdvanta Corp. and Subsidiaries\nCREDIT CARD SECURITIZATION INCOME\nSince 1988, the Company, through its subsidiary Colonial National Bank USA (\"Colonial National\" or the \"Bank\"), has completed 22 credit card securitizations totaling $5.4 billion in receivables. See Note 3 and Note 17. In each transaction, credit card receivables were transferred to a trust and interests in the trust were sold to investors for cash. The Company records excess servicing income on credit card securitizations representing additional cash flow from the receivables initially sold based on the repayment term, including prepayments. Prior to the EITF Issue 93-1 consensus, net gains were not recorded at the time each transaction was completed as excess servicing income was offset by the write-off of deferred origination costs and the establishment of recourse reserves. Subsequent to the prospective adoption discussed above, excess servicing income has been recorded at a lower level at the time of each transaction, and is predominantly offset by the establishment of recourse reserves. The lower level of excess servicing income corresponds with the discontinuance of deferred origination cost write-offs upon securitization of receivables, as discussed above. During the \"revolving period\" of each trust, income is recorded based on additional cash flows from the new receivables which are sold to the trusts on a continual basis to replenish the investors' interest in trust receivables which have been repaid by the credit cardholders.\nCREDIT CARD FEES\nAnnual fees on credit cards are deferred and amortized on a straight-line basis over the fiscal year of the account.\nThe changes relating to origination costs and securitization income, as discussed above, in the aggregate did not have a material effect on the Company's 1993 financial statements.\nMORTGAGE LOAN ORIGINATION FEES\nThe Company generally charges origination fees (\"points\") for mortgage loans where permitted under state law. Origination fees, net of direct origination costs, are deferred and amortized over the contractual life of the loan. However, upon the sale or securitization of the loans, the unamortized portion of such fees is recognized and included in the computation of the gain on sale.\nLOAN AND LEASE RECEIVABLES AVAILABLE FOR SALE\nLoan and lease receivables available for sale represent receivables currently on the balance sheet that the Company generally intends to sell or securitize within the next six months. These assets are reported at the lower of cost or fair market value.\nINVESTMENTS HELD TO MATURITY\nInvestments held to maturity include those investments that the Company has the positive intent and ability to hold to maturity. These investments are reported at cost, adjusted for the amortization of premiums or the accretion of discounts. At December 31, 1994 and 1993 the Company had no investments classified as held to maturity.\nINVESTMENTS AVAILABLE FOR SALE\nInvestments available for sale include securities that the Company sells from time to time to provide liquidity and in response to changes in the market. In 1993, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (\"SFAS 115\"). This statement requires that debt and equity securities classified as Available for Sale be reported at market value. This Statement is effective for fiscal years beginning after December 15, 1993. The Company elected to adopt this statement as of December 31, 1993, and as such, these securities are recorded at market value at that date. Unrealized holding gains and losses on these securities are reported as a separate component of stockholders' equity and included in retained earnings.\nAdvanta Corp. and Subsidiaries\nDERIVATIVE FINANCIAL INSTRUMENTS\nThe Company uses various derivative financial instruments (\"derivatives\") such as interest rate swaps and caps, forward contracts, options on securities, and financial futures as part of its interest rate risk management strategy. Derivatives are classified as hedges or synthetic alterations of specific on-balance sheet items, off-balance sheet items or anticipated transactions. In order for derivatives to qualify for hedge accounting treatment the following conditions must be met: 1) the underlying item being hedged by derivatives exposes the Company to interest rate risk, 2) the derivative used serves to reduce the Company's sensitivity to interest rate risk, and 3) the derivative used is designated and deemed effective in hedging the Company's exposure to interest rate risk. In addition to meeting these conditions, anticipatory hedges must demonstrate that the anticipated transaction being hedged is probable to occur and the expected terms of the transaction are identifiable.\nFor derivatives designated as hedges, gains or losses are deferred and included in the carrying amounts of the related item exposing the Company to interest rate risk and ultimately recognized in income as part of those carrying amounts. Accrual accounting is applied for derivatives designated as synthetic alterations with income and expense recorded in the same category as the related underlying on-balance sheet or off-balance sheet item synthetically altered. Gains or losses resulting from early terminations of derivatives are deferred and amortized over the remaining term of the underlying balance sheet item or the remaining term of the derivative, as appropriate.\nDerivatives not qualifying for hedge or synthetic accounting treatment would be carried at market value with realized and unrealized gains and losses included in noninterest revenues. At December 31, 1994, 1993 and 1992, all derivatives qualified as hedges or synthetic alterations.\nINCOME FROM MORTGAGE BANKING ACTIVITIES\nThe Company, through its subsidiaries, sells mortgage loans through both secondary market securitizations and whole loan sales, typically with servicing retained. Income is recognized at the time of sale approximately equal to the present value of the anticipated future cash flows resulting from the retained yield adjusted for an assumed prepayment rate, net of any anticipated charge-offs, and allowing for a normal servicing fee. Changes in the anticipated future cash flows, as well as the receipt of cash flows which differ from those projected, affect the recognition of current and future mortgage banking income. Also included in income is any difference between the net sales proceeds and the carrying value of the mortgage loans sold at the time of the transaction. See Note 3 and Note 17. The carrying value includes deferred loan origination fees and costs which include certain fees and costs related to acquiring and processing a loan held for resale. These deferred origination fees and costs are netted against income from mortgage banking activities when the loans are sold. Mortgage banking income also includes loan servicing fees equal to .5% of the outstanding balance of securitized loans and, beginning in 1992, loan servicing fees on mortgage loan portfolios which were never owned by the Company (\"contract servicing\").\nINCOME FROM LEASE SECURITIZATIONS\nThe Company, through its subsidiaries, sells equipment lease receivables through secondary market securitizations. Income is recorded at the time of sale approximately equal to the present value of the anticipated future cash flows net of anticipated charge-offs, partially offset by deferred initial direct costs, transaction expenses and estimated credit losses under certain recourse requirements of the trust. Also included in income is the difference between the net sales proceeds and the carrying amount of the receivables sold. Subsequent to the initial sale, securitization income is recorded in proportion to the actual cash flows received from the trusts. See Note 3 and Note 17.\nAdvanta Corp. and Subsidiaries\nINSURANCE\nReinsurance premiums, net of commissions on credit life, disability and unemployment policies on credit cards, are earned monthly based upon the outstanding balance of the underlying receivables. The cost of acquiring new reinsurance is deferred and amortized over the reinsurance period in order to match the expense with the anticipated premium revenue. Insurance claim reserves are based on estimated settlement amounts for both reported and incurred but not reported losses.\nCREDIT LOSSES\nDuring 1991, the Company adopted a new charge-off policy related to bankrupt, decedent and fraudulent credit card accounts. Under the previous policy, whenever the Company received notification that a credit cardholder had filed a bankruptcy petition or was deceased, a reserve was established equal to the full balance of the receivable. The receivable, if not paid, would be charged off at 186 days contractual delinquency. Likewise, receivables in accounts identified as fraudulent would be reserved against and written off (as an operating expense) when they became 186 days contractually delinquent. Under the policy adopted in 1991, bankrupt and decedent accounts are written off within 30 days of notification, and accounts suspected of being fraudulent are written off after a 90 day investigation period, unless the investigation shows no evidence of fraud. During the 1991 transition period, both newly identified bankrupt, decedent and fraudulent accounts, as well as those previously identified, were written off.\nDuring 1994, the Company implemented a new policy for the charge-off of mortgage loans. Under this policy, the Company charges off potential losses on all nonperforming mortgages that have become twelve months delinquent, regardless of anticipated collectibility. During the 1994 transition period, both mortgages that became twelve months delinquent in 1994, as well as those mortgages that had been twelve months or more delinquent, were charged off.\nPREMISES AND EQUIPMENT\nPremises, equipment, computers and software are stated at cost less accumulated depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Repairs and maintenance are charged to expense as incurred.\nGOODWILL\nGoodwill, representing the cost of investments in subsidiaries and affiliated companies in excess of net assets acquired at acquisition, is amortized on a straight-line basis over 25 years.\nINCOME TAXES\nEffective January 1, 1993, the Company implemented the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") with no material effect on the financial statements. SFAS 109 utilizes the liability method and deferred taxes are determined based on the estimated future tax effects of differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws. Prior to the implementation of SFAS 109, the Company accounted for income taxes using Accounting Principles Board Opinion No. 11.\nEARNINGS PER SHARE\nEarnings per common share are computed by dividing net earnings after preferred stock dividends by the average number of shares of common stock and common stock equivalents outstanding during each year. The outstanding preferred stock is not a common stock equivalent.\nAdvanta Corp. and Subsidiaries\nCASH FLOW REPORTING\nFor purposes of reporting cash flows, cash includes cash on hand and amounts due from banks. Cash paid during 1994, 1993 and 1992 for interest was $91.5 million, $78.8 million and $94.4 million, respectively. Cash paid for taxes during these periods was $60.9 million, $30.0 million and $17.7 million, respectively.\nRECENT ACCOUNTING PRONOUNCEMENTS\nThe FASB has issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan\" (\"SFAS 114\") and SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures\" (\"SFAS 118\"), an amendment of SFAS 114. Both statements are effective for fiscal years beginning after December 15, 1994. By their terms, SFAS 114 and SFAS 118 do not apply either to a large group of smaller-balance homogeneous loans that are collectively evaluated for impairment (such as the Company's credit card loans), or to leases. While SFAS 114 and SFAS 118 may apply to a portion of the Company's mortgage loan portfolio, its adoption will not have a material effect on the Company's financial statements.\nNOTE 2. LOAN AND LEASE RECEIVABLES\nLoan and Lease Receivables consisted of the following:\n(A) Includes credit card receivables available for sale of $420.0 million and $564.0 million in 1994 and 1993, respectively.\n(B) Includes mortgage loan receivables available for sale of $116.1 million and $74.6 million in 1994 and 1993, respectively.\n(C) Includes lease receivables available for sale of $36.0 million and $28.6 million in 1994 and 1993, respectively, and is net of unearned income of $17.9 million and $11.9 million in 1994 and 1993, respectively, and also includes residual interest for both years.\n(D) Includes approximately $1.0 million and $.6 million in 1994 and 1993, respectively, related to loan and lease receivables available for sale.\nReceivables serviced for others consisted of the following items:\nAdvanta Corp. and Subsidiaries\nThe geographic concentration of managed receivables was as follows:\nIn the normal course of business, the Company makes commitments to extend credit to its credit card customers. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any conditions established in the contract. The Company does not require collateral to support this financial commitment. At December 31, 1994 and 1993, the Company had $24.7 billion and $16.0 billion, respectively, of commitments to extend credit outstanding for which there is potential credit risk. The Company believes that its customers' utilization of these lines of credit will continue to be substantially less than the amount of the commitments, as has been the Company's experience to date. At December 31, 1994 and 1993, outstanding managed credit card receivables represented 26% and 24%, respectively, of outstanding commitments.\nNOTE 3. CREDIT CARD, MORTGAGE LOAN AND EQUIPMENT LEASE SECURITIZATIONS\nColonial National has completed 22 sales of credit card receivables through asset-backed securitizations aggregating $5.4 billion. In each transaction, credit card receivables were transferred to a trust which issued certificates representing ownership interests in the trust to institutional investors. Colonial National retained a participation interest in each trust, reflecting the excess of the total amount of receivables transferred to the trust over the portion represented by certificates sold to investors. The retained participation interests in the credit card trusts were $1.3 billion and $371.8 million at December 31, 1994 and 1993, respectively. Although Colonial National continues to service the underlying credit card accounts and maintain the customer relationships, these transactions are treated as sales for financial reporting purposes to the extent of the investors' interests in the trusts. Accordingly, the associated receivables are not reflected on the balance sheet.\nColonial National is subject to certain recourse provisions in connection with these securitizations. At December 31, 1994 and 1993, Colonial National had reserves of $74.5 million and $96.4 million, respectively, related to these recourse provisions. These reserves are netted against the amounts due from credit card securitizations. At December 31, 1994, the Company had amounts receivable from credit card securitizations, which include the related interest-bearing deposits, and amounts due from credit card securitizations of $318.6 million, $174.1 million of which was subject to liens by the providers of the credit enhancement facilities for the individual securitizations. At December 31, 1993, the amounts receivable and amounts subject to lien were $222.5 million and $104.7 million, respectively.\nThrough December 31, 1994, the Company had sold, through securitizations and whole loan sales, approximately $2.2 billion of mortgage loan receivables which sales are subject to certain recourse provisions. The Company had reserves of $17.3 million and $32.1 million at year end 1994 and 1993, respectively, related to these recourse provisions which are netted against the excess mortgage servicing rights. See Note 17. At December 31, 1994, the Company had amounts receivable from mortgage loan sales and securitizations of $128.6 million, $49.1 million of which was subject to liens. At December 31, 1993, the amounts receivable and amounts subject to lien were $102.8 million and $39.7 million, respectively.\nAdvanta Corp. and Subsidiaries\nThrough December 31, 1994, the Company had securitized approximately $298 million of equipment lease receivables which are subject to certain recourse provisions. The asset-backed certificates carry both fixed and variable rates to investors. There were reserves of $9.7 million and $5.3 million at year end 1994 and 1993, respectively, related to these recourse provisions which are netted against the excess servicing on lease securitizations. See Note 17. The Company had accounts receivable from lease securitizations of $14.4 million at year end 1994 and $8.5 million at year end 1993, of which $6.4 million and $5.9 million, respectively, were subject to liens by providers of the credit enhancement facilities. Total interest in residuals for lease assets sold was $12.0 million and $9.6 million at December 31, 1994 and 1993, respectively, and is also subject to recourse provisions.\nNOTE 4. RESERVE FOR CREDIT LOSSES\nThe reserve for credit losses for lending and leasing transactions is established to reflect losses anticipated from delinquencies that have already occurred. Any adjustments to the reserves are reported in the Income Statements in the periods they become known.\nDuring 1994, the Company initiated a mortgage loan repurchase program in which nonperforming mortgage loans were repurchased from the securitization trusts in order to lower the net funding costs\nThe following table displays five years of reserve history:\non these managed assets. In accordance with this program, the Company transferred approximately $13 million of the off-balance sheet mortgage loan recourse reserves associated with these repurchased mortgages to on-balance sheet mortgage loan reserves (see discussion in Management's Discussion and Analysis under the caption \"Provision for Credit Losses\"). During 1993, the Company used $11 million of on-balance sheet unallocated reserves to increase off-balance sheet mortgage loan recourse reserves, which are a component of excess mortgage servicing rights.\nAdvanta Corp. and Subsidiaries\nNOTE 5. INVESTMENTS AVAILABLE FOR SALE\nInvestments available for sale consisted of the following:\nAt December 31, 1994, investment securities with a book value of $106,582 were pledged as collateral for repurchase and derivatives transactions. At December 31, 1993, investment securities with a book value of $17,473 were pledged as collateral for derivatives transactions. At December 31, 1994, 1993 and 1992, investment securities with a book value of $7,133, $7,927 and $9,147, respectively, were deposited with insurance regulatory authorities to meet statutory requirements or held by a trustee for the benefit of primary insurance carriers. At December 31, 1994, $10,059 of net unrealized losses on securities were included in investments available for sale. During 1994, the net change in unrealized losses on available for sale securities included as a separate component of stockholders' equity was $7,062.\nMaturity of investments available for sale at December 31, 1994 was as follows:\nDuring 1994, proceeds from sales of available for sale securities were $624,000. Gross gains of $118 and losses of $596 were realized on these sales. Proceeds during 1993 were $841,000. Gross gains of $3,430 and losses of $888 were realized on these sales. Proceeds during 1992 were $353,000. Gross gains of $2,414 and losses of $427 were realized on these sales. The specific identification method was the basis used to determine the amortized cost in computing realized gains and losses. Equity securities primarily include FRB, FHLB and FNMA stock that the Company is required to hold.\nAdvanta Corp. and Subsidiaries\nNOTE 6. DEBT\nDebt consisted of the following:\nThe annual maturities of long-term debt at December 31, 1994 for the years ending December 31 are as follows: $425.6 million in 1996; $142.7 million in 1997; $27.7 million in 1998; $15.1 million in 1999; and $54.9 million thereafter. The average interest cost of the Company's debt during 1994, 1993 and 1992 was 6.23%, 7.59% and 9.01%, respectively.\nNOTE 7. STOCK DIVIDENDS\nOn September 23, 1993, the Board of Directors approved a three-for-two stock split in the form of a 50% stock dividend on both the Class A and Class B Common Stock to shareholders of record as of October 4, 1993, which dividend was paid on October 15, 1993. All share and per share amounts have been adjusted to reflect the three-for-two stock split as a result of the stock dividend.\nNOTE 8. CAPITAL STOCK\nThe number of shares of capital stock was as follows:\nAdvanta Corp. and Subsidiaries\nThe Class A Preferred Stock is entitled to 1\/2 vote per share and a non-cumulative dividend of $140 per share per year, which must be paid prior to any dividend on the common stock. Dividends were declared on the Class A Preferred Stock for the first time in 1989 and have continued through 1994 as the Company paid dividends on its common stock. The redemption price of the Class A Preferred Stock is equivalent to the par value.\nNOTE 9. ISSUANCE OF COMMON STOCK\nOn March 24, 1993, in a public offering, the Company sold 2,575,000 shares (pre-split) of Class B Common Stock. Proceeds from the offering, net of the underwriting discount, were $77.5 million. On April 21, 1993, the underwriters of the offering purchased an additional 450,000 shares (pre-split) of Class B Common Stock, pursuant to the overallotment option granted to them by the Company. This brought the Company's total proceeds of the offering, net of related expenses, to approximately $90 million. The Company used the proceeds of the offering for general corporate purposes, including financing the growth of its subsidiaries.\nNOTE 10. EXTRAORDINARY ITEM\nIn April of 1993, the Company repurchased the remaining $33.2 million of its 12 3\/4% Senior Subordinated Debentures at a price equal to 104% of par. This transaction resulted in an extraordinary loss of $1.3 million (net of a tax benefit of $.7 million) or $.03 per share for the year ended December 31, 1993.\nNOTE 11. INCOME TAXES\nIncome tax expense consisted of the following components:\nCurrent taxes payable include the earnings of certain subsidiaries which are not included in the consolidated federal income tax return.\nThe reconciliation of the statutory federal income tax to the consolidated tax expense is as follows:\nAdvanta Corp. and Subsidiaries\nDeferred taxes are determined based on the estimated future tax effects of the differences between the financial statement and tax basis of assets and liabilities given the provisions of the enacted tax laws. The net deferred tax asset\/(liability) is comprised of the following:\nThe Company did not record any valuation allowances against deferred tax assets at December 31, 1994 and 1993.\nThe tax effect of significant temporary differences representing deferred tax assets and liabilities is as follows:\nNOTE 12. BENEFIT PLANS\nThe Company has adopted several management incentive plans designed to provide incentives to participating employees to remain in the employ of the Company and devote themselves to its success. Under these plans, eligible employees were given the opportunity to elect to take portions of their anticipated or \"target\" bonus payments for future years in the form of restricted shares of common stock. To the extent that such elections were made (or, for executive officers, were required by the terms of such plans), restricted shares were issued to employees, with the number of shares granted to employees determined by dividing the amount of future bonus payments the employee had elected to receive in stock by the market price as determined under the incentive plans. The restricted shares are subject to forfeiture should the employee terminate employment with the Company prior to vesting. Restricted shares vest 10 years from the date of grant, but with respect to the restricted shares issued under each plan, vesting was and will be accelerated annually with respect to one-third of the shares, to the extent that the employee and the Company met or meet their respective performance goals for a given plan performance year. When newly eligible employees elect to participate in a plan, the number of shares issued to them with respect to their \"target\" bonus payments for the relevant plan performance years is determined based on the average market price of the stock for the 90 days prior to eligibility.\nAdvanta Corp. and Subsidiaries\nThe following table summarizes the Company's incentive plans:\nAt December 31, 1994, a total of 1,240,619 shares issued under these and the predecessor plan to AMIPWISE II (for \"target\" bonuses for 1990-1992) were subject to restrictions and were included in the number of shares outstanding.\nThe Company has an Employee Stock Purchase Plan which allows employees and directors to purchase Class B common stock at a 15% discount from the market price without paying brokerage fees. The Company reports this 15% discount as compensation expense. During 1994, shares were issued under the plan from unissued stock or from treasury stock at the average market price on the day of purchase.\nThe Company has two Stock Option Plans which together authorize the grant to employees and directors of options to purchase an aggregate of 7,425,000 shares of common stock. In connection with the October 15, 1993 stock dividend, the number of outstanding options and the exercise price of each option were modified to reflect the three-for-two stock split. The Company presently intends only to issue options to purchase Class B common stock. Beginning in 1992, options generally vest over a four-year period, and expire 10 years after the date of grant.\nShares available for future grant aggregated 1,362,508 at December 31, 1994, and 2,051,508 at December 31, 1993. Transactions under the plans for the two years ended December 31, 1994, were as follows:\nThe Company also has outstanding options to purchase 691,500 shares of common stock at a price range of $1.52 to $4.75 per share, which were not issued pursuant to either of the Stock Option Plans.\nAt December 31, 1994, 2,144,591 of the 3,415,000 outstanding options issued under the Stock Options Plans had vested and all 691,500 options issued outside the Plans had vested.\nThe Company has a tax-deferred employee savings plan which provides employees savings and investment opportunities, including the ability to invest in the Company's Class B common stock. The employee savings plan provides for discretionary Company contributions equal to a portion of the first 5% of an employee's compensation contributed to the plan. For the three years ended December 31, 1994, 1993 and 1992, the Company contributions equaled 100% of the first 5% of participating employees' compensation contributed to the plan. The expense for this plan totaled $1,565, $1,189 and $882 in 1994, 1993 and 1992,\nAdvanta Corp. and Subsidiaries\nrespectively. At December 31, 1994, 168,592 of the 337,500 shares of common served for issuance under the employee savings plan had been purchased by the plan from the Company at the market price on each purchase date. All other shares purchased by the plan for the three years ended December 31, 1994, 1993 and 1992 were purchased on the open market or issued from treasury stock.\nNOTE 13. CREDIT CARD SALE\nIn April 1994, the Company, through its subsidiary, Colonial National Bank USA, reached an agreement with NationsBank of Delaware, N.A., to sell certain credit card customer relationships which at that time represented approximately $150 million of securitized credit card receivables (less than 4% of the Company's managed credit card receivables as of June 30, 1994). The receivables associated with these relationships will continue to be serviced by Colonial National until the securitization trust terminates. The Company anticipates this will occur in the second quarter of 1995. In the second quarter of 1994, the Company recorded an $18.4 million pretax gain on the sale. In addition, the Company deferred a portion of the proceeds related to the excess spread of the receivables to be generated over the remaining life of the trust. These proceeds are being recognized as securitization income over the related period.\nNOTE 14. COMMITMENTS AND CONTINGENCIES\nThe Company leases office space in several states under leases accounted for as operating leases. Total rent expense for all of the Company's locations for the years ended December 31, 1994, 1993 and 1992 was $5.4 million, $4.8 million and $3.5 million, respectively. The future minimum lease payments of all non-cancelable operating leases are as follows:\nNOTE 15. OTHER BORROWINGS\nThe Company had revolving credit facilities of $255 million and money market bid lines of $255 million at December 31, 1994. There is a quarterly facility fee of up to 1\/3 of 1% of the unused portion of the revolving credit facilities. There is no facility fee on the money market bid lines as they are uncommitted facilities. At December 31, 1994 the Company had borrowed $50 million on the money market bid lines. Under the revolving credit facilities, the Company is subject to various loan covenants, including the maintenance of certain fixed financial ratios and conditions, limitations on mergers and acquisitions, and limitations on liens on property and other assets. One of the two revolving credit facilities (constituting one half of the available principal amount) extends through March 1997; the other is renewable annually. At December 31, 1993 the Company had lines of credit and term funding arrangements of $63.5 million which were collateralized by lease receivables, as well as equipment under operating leases.\nThe composition of other borrowings was as follows:\nAdvanta Corp. and Subsidiaries\nThe following table displays information related to selected types of short-term borrowings:\nThe weighted average interest rates were calculated by dividing the interest expense for the period for such borrowings by the average amount of short-term borrowings outstanding during the period.\nNOTE 16. SELECTED INCOME STATEMENT INFORMATION\nAdvanta Corp. and Subsidiaries\nNOTE 17. SELECTED BALANCE SHEET INFORMATION\n(A) Represents initial deposits and subsequent excess collections up to the required amount on each of the credit card, mortgage and leasing securitizations.\n(A) Carried at the lower of cost or fair market value.\nAdvanta Corp. and Subsidiaries\nAt December 31, 1994 and 1993, the Company had $144.5 million and $117.8 million, respectively, of amounts due from credit card securitizations. These amounts include excess servicing, accrued interest receivable and other amounts related to these securitizations and are net of recourse reserves established.\nNOTE 18. CASH, DIVIDEND AND LOAN RESTRICTIONS\nIn the normal course of business, the Company and its subsidiaries enter into agreements, or are subject to regulatory requirements, that result in cash, debt and dividend restrictions.\nThe Federal Reserve Act imposes various legal limitations on the extent to which banks that are members of the Federal Reserve System can finance or otherwise supply funds to certain of their affiliates. In particular, Colonial National is subject to certain restrictions on any extensions of credit to, or other covered transactions, such as certain purchases of assets, with the Company or its affiliates. Such restrictions prevent Colonial National from lending to the Company and its affiliates unless such extensions of credit are secured by U.S. Government obligations or other specified collateral. Further, such secured extensions of credit by Colonial National are limited in amount: (a) as to the Company or any such affiliate, to 10 percent of Colonial National's capital and surplus, and (b) as to the Company and all such affiliates in the aggregate, to 20 percent of Colonial National's capital and surplus.\nUnder certain grandfathering provisions of the Competitive Equality Banking Act of 1987, the Company is not required to register as a bank holding company under the Bank Holding Company Act of 1956, as amended (the \"BHCA\"), so long as the Company and Colonial National continue to comply with certain restrictions on their activities. With respect to Colonial National, these restrictions include limiting the scope of its activities to those in which it was engaged prior to March 5, 1987. Since Colonial National was not making commercial loans at that time, it must continue to refrain from making commercial loans which would include any loans to the Company or any of its subsidiaries in order for the Company to maintain its grandfathered exemption under the BHCA. The Company has no present plans to register as a bank holding company under the BHCA. Colonial National is subject to various legal limitations on the amount of dividends that can be paid to its parent, Advanta Corp. Colonial National is eligible to declare a dividend provided that it is not greater than the current year's net profits plus net profits of the preceding two years, as defined. During 1994, Colonial National paid $24 million of dividends to Advanta Corp., while $75 million of dividends were paid during 1993.\nThe Office of the Comptroller of the Currency requires that Colonial National maintain a risk-based capital ratio of at least 8%. Colonial National's risk-based capital ratio of 12.04% at December 31, 1994 was in excess of the required level and exceeded the minimum required capital level of 10% for designation as a \"well capitalized\" depository institution.\nAdvanta Corp. and Subsidiaries\nNOTE 19. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair values of the Company's financial instruments are as follows:\nThe above values do not necessarily reflect the premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular instrument. In addition, these values, derived from the methods and assumptions described below, do not consider the potential income taxes or other expenses that would be incurred on an actual sale of an asset or settlement of a liability. With respect to the fair value of liabilities, the above table is prepared on the basis that the amounts necessary to discharge such liabilities represent fair value.\nThe fair value of the Company's off-balance sheet financial instruments relates to managing the interest rate sensitivity position as described in Note 21.\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, FEDERAL FUNDS SOLD AND INTEREST-BEARING DEPOSITS\nFor these short-term instruments, the carrying amount is a reasonable estimate of the fair value.\nAdvanta Corp. and Subsidiaries\nINVESTMENTS\nFor investment securities held to maturity and those available for sale, the fair values are based on quoted market prices, dealer quotes or estimated using quoted market prices for similar securities.\nLOANS, NET OF RESERVE FOR CREDIT LOSSES\nFor credit card receivables and mortgage loans, the fair value is estimated using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value for credit card receivables and mortgage loans also includes the estimated value of the portion of the interest payments and fees which are not sold with the securities backed by these types of loans. The value of the retained interest payments (i.e., excess servicing) is estimated by discounting the future cash flows, adjusted for prepayments, net of anticipated charge-offs and allowing for the value of the servicing. The value of direct finance lease receivables and other loans is estimated based on the market prices of similar receivables with similar characteristics.\nAMOUNTS DUE FROM CREDIT CARD SECURITIZATIONS AND EXCESS MORTGAGE SERVICING RIGHTS\nThe fair values of the excess servicing rights component of amounts due from credit card securitizations and excess mortgage servicing rights are estimated by discounting the future cash flows at rates which management believes to be reasonable. However, because there is no active market for these financial instruments, management has no basis to determine whether the fair values presented above would be indicative of the value negotiated in an actual sale. The future cash flows used to estimate the fair values of these financial instruments are adjusted for prepayments, net of anticipated charge-offs under recourse provisions, and allow for the value of servicing. For the other components of amounts due from credit card securitizations, the carrying amount is a reasonable estimate of the fair value.\nDEMAND AND SAVINGS DEPOSITS\nThe fair value of demand deposits, savings accounts, and money market deposits is the amount payable on demand at the reporting date. This fair value does not include the benefit that results from the low cost of funding provided by these deposits compared to the cost of borrowing funds in the market.\nTIME DEPOSITS AND DEBT\nThe fair value of fixed-maturity certificates of deposit and notes is estimated using the rates currently offered for deposits and notes of similar remaining maturities.\nOTHER BORROWINGS\nThe other borrowings are all at variable interest rates and therefore the carrying value approximates a reasonable estimate of the fair value.\nINTEREST RATE SWAPS, OPTIONS AND FORWARD CONTRACTS\nThe fair value of interest rate swaps, options and forward contracts (used for managing interest rate risk) is the estimated amount that the Company would pay to terminate the agreement at the reporting date, taking into account current interest rates and the current creditworthiness of the counterparty.\nAdvanta Corp. and Subsidiaries\nCREDIT CARD CUSTOMER RELATIONSHIPS (BOTH ON- AND OFF-BALANCE SHEET)\nThe fair value of the credit card relationships, which are not financial instruments, is estimated using a credit card valuation model which considers the value of the existing receivables together with the value of new receivables and the associated fees generated from existing cardholders over the remaining life of the portfolio.\nCOMMITMENTS TO EXTEND CREDIT\nAlthough the Company had $18.2 billion of unused commitments to extend credit, there is no market value associated with these commitments, as any fees charged are consistent with the fees charged by other companies at the reporting date to enter into similar agreements.\nNOTE 20. CALCULATION OF EARNINGS PER COMMON SHARE\nThe following table shows the calculation of earnings per common share for the years ended December 31, 1994, 1993 and 1992:\nNOTE 21. DERIVATIVE FINANCIAL INSTRUMENTS\nIn managing its interest rate sensitivity position, the Company may use derivative financial instruments. These instruments are used for the express purpose of managing exposure to changes in interest rates and are not used for any trading or speculative activities. As of December 31, 1994 and 1993, all of the Company's derivatives were designated as hedges or synthetic alterations and were accounted for as such. For the years ended December 31, 1994, 1993 and 1992, there were no derivatives contracts terminated prior to scheduled maturity.\nThe following table summarizes by notional amounts the Company's derivatives instruments as of December 31, 1994 and 1993:\nThe notional amounts of derivatives do not represent amounts exchanged by the counterparties and, thus, are not a measure of the Company's exposure through its use of derivatives. The amounts exchanged are determined by reference to the notional amounts and the other terms of the derivatives contracts.\nAdvanta Corp. and Subsidiaries\nCredit risk associated with derivatives arises from the potential for a counterparty to default on its obligations. The Company attempts to limit credit risk by only transacting with highly creditworthy counterparties and requiring master netting and collateral agreements for all interest rate swap and interest rate option contracts. All counterparties are associated with organizations having securities rated as investment grade by independent rating agencies. The list of eligible counterparties, setting of counterparty limits, and monitoring of credit exposure is controlled by the Investment Committee, a management committee. The Company's credit exposure to derivatives, with the exception of caps written, is represented by contracts with a positive fair value without giving consideration to the value of any collateral exchanged - see Note 19. For caps written, no credit expense exposure exists since the counterparty has performed its obligation to pay the Company a premium payment.\nInterest rate swap agreements generally involve the exchange of fixed and floating rate interest payments without the exchange of the underlying notional amount on which the interest payments are calculated. Based on its interest rate sensitivity analyses, the Company enters into interest rate swaps to more effectively manage the impact of fluctuating interest rates on its net interest income and noninterest revenues. The Company has used interest rate swaps to synthetically alter its cash flow obligations on certain debt and off- balance sheet credit card securitizations.\nAs of December 31, 1994, the Company used $460 million in notional amounts of interest rate swaps to effectively convert certain fixed rate debt to a LIBOR based variable rate. As of December 31, 1993, $150 million in notional amounts of interest rate swaps were used to convert certain fixed rate debt to a LIBOR based variable rate and $500 million in notional amounts of interest rate swaps were used to convert certain off-balance sheet variable pass-through rate credit card securitizations to a fixed pass-through rate of 4.95%.\nThe following table summarizes by notional amounts the Company's interest rate swap activity by major category for the periods presented:\nThe following table discloses the Company's interest rate swaps by major category, notional value, weighted average interest rates, and annual maturities for the periods presented:\nInterest rate options are contracts that grant the purchaser, for a premium payment, the right to either purchase or sell a financial instrument at a future date for a specified price from the writer of the option. Interest rate caps are option-like contracts that require the seller (writer) to pay the purchaser at specified future dates the amount by which a specified market interest rate exceeds the cap rate applied to a notional amount. A corridor is also an option-like contract which is the simultaneous purchase and sale of separate interest rate caps where each cap is referenced to a different interest rate index.\nAs part of managing its balance sheet and liquidity position, the Company periodically securitizes and sells credit card and lease receivables. For credit enhancement purposes, certain variable pass-through rate credit card and lease securitizations were issued with embedded or purchased interest rate caps. These rate caps, however, were not needed to satisfy asset\/liability management strategies. In order to achieve its\nAdvanta Corp. and Subsidiaries\ndesired interest rate sensitivity structure and further reduce the effective pass-through rate of the securitization, the Company has synthetically altered the interest rate structure on certain off-balance sheet credit card and lease securitizations by writing interest rate caps to offset the embedded and purchased rate caps attached to them.\nThe premiums received or paid for writing or purchasing such cap contracts are included in other assets and are amortized to noninterest revenues over the life of the contract. Any obligations which may arise under these contracts are recorded in noninterest revenues on an accrual basis. As of December 31, 1994, unamortized premiums for caps written and purchased amounted to $5.8 million and $3.3 million, respectively. The weighted average maturity for caps written and purchased was 3.8 years and 3.6 years, respectively.\nWhen the Company periodically securitizes and sells credit card receivables, the receivables sold to the securitization trust may carry rates which are indexed to the prime rate, whereas the securitization certificates issued from the trust may be priced at a spread over LIBOR. The Company is exposed to interest rate risk to the extent that these two rate indices react differently to changes in market interest rates. The Company may choose to hedge its excess servicing revenues from the risk of spread compression between the prime rate and LIBOR by entering into corridor transactions which effectively fix a prime\/LIBOR spread.\nAll of the Company's corridor transactions were executed without exchanges of premiums between counterparties. Any obligations which may arise under these contracts are recorded to noninterest revenues on an accrual basis. As of December 31, 1994, the weighted average maturity of corridor contracts was 1.7 years.\nForward contracts are commitments to either purchase or sell a financial instrument at a future date for a specified price and may be settled in cash or through delivery of the underlying financial instrument. The Company regularly securitizes and sells fixed rate mortgage loan receivables. The Company may choose to hedge the changes in the market value of its fixed rate loans and commitments designated for anticipated securitizations by selling U.S. Treasury securities for forward settlement. The maximum and average terms of hedges of anticipated mortgage loan sales is four and two months, respectively. Gains and losses from forward sales are deferred and included in the measurement of the dollar basis of the loans sold. Realized losses of $32 were deferred as of December 31, 1994 and realized gains of $6 were deferred as of December 31, 1993.\nAdvanta Corp. and Subsidiaries\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTO THE STOCKHOLDERS OF ADVANTA CORP.:\nWe have audited the accompanying consolidated balance sheets of Advanta Corp. (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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 financial position of Advanta Corp. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\n\/s\/ ARTHUR ANDERSEN LLP -----------------------\nPhiladelphia, PA January 23, 1995\nREPORT OF MANAGEMENT ON RESPONSIBILITY FOR FINANCIAL REPORTING\nTO THE STOCKHOLDERS OF ADVANTA CORP.:\nThe management of Advanta Corp. and its subsidiaries is responsible for the preparation, content, integrity and objectivity of the financial statements contained in this Annual Report. These financial statements have been prepared in accordance with generally accepted accounting principles and as such, must, by necessity, include amounts based upon estimates and judgments made by management. The other financial information in the Annual Report was also prepared by management and is consistent with the financial statements.\nManagement maintains a system of internal controls that provides reasonable assurance as to the integrity and reliability of the financial statements. This control system includes: (1) organizational and budgetary arrangements which provide reasonable assurance that errors or irregularities would be detected promptly, (2) careful selection of personnel and communications programs aimed at assuring that policies and standards are understood by employees, (3) a program of internal audits, and (4) continuing review and evaluation of the control program itself.\nThe financial statements in this Annual Report have been audited by Arthur Andersen LLP, independent public accountants. Their audits were conducted in accordance with generally accepted auditing standards and considered the Company's system of internal controls to the extent they deemed necessary to determine the nature, timing and extent of their audit tests. Their report is printed herewith.\nAdvanta Corp. and Subsidiaries\nSUPPLEMENTAL SCHEDULES\nMATURITY OF TIME DEPOSITS OF $100,000 OR MORE\nCOMMON STOCK PRICE RANGES AND DIVIDEND POLICY\nOn September 23, 1993, the Board of Directors approved a three-for-two stock split effected in the form of a 50% stock dividend on both the Class A and Class B common stock to shareholders of record as of October 4, 1993, which dividend was paid on October 15, 1993. All share and per share amounts have been adjusted to reflect this stock split as a result of the stock dividend. The Company's common stock is traded on the NASDAQ National Market System under the trading symbols ADVNB (non-voting common stock) and ADVNA (voting common stock).\nFollowing are the high and low sale prices and cash dividends declared for the last two years as they apply to each class of stock:\nAt December 31, 1994, the Company had approximately 930 and 750 holders of record of Class B and Class A common stock, respectively.\nAdvanta Corp. and Subsidiaries\nQUARTERLY DATA (Unaudited) (In thousands, except per share data)\nAdvanta Corp. and Subsidiaries\nSUPPLEMENTAL SCHEDULE\nALLOCATION OF RESERVE FOR CREDIT LOSSES\nCOMPOSITION OF GROSS RECEIVABLES\nYIELD AND MATURITY OF INVESTMENTS AVAILABLE FOR SALE AT DECEMBER 31, 1994\n(A) Yield computed on a taxable equivalent basis using a statutory rate of 35% in 1994.\nAdvanta Corp. and Subsidiaries\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone\nAdvanta Corp. and Subsidiaries\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe text of the Proxy Statement under the caption \"Election of Directors\" and the last paragraph under the caption \"Security Ownership of Management\" are hereby incorporated herein by reference, as is the text in Part I of this Report under the caption, \"Executive Officers of the Registrant.\"\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe text of the Proxy Statement under the captions \"Executive Compensation,\" \"Compensation Committee Report on Executive Compensation,\" and \"Election of Directors -- Committees, Meetings, Compensation and Other Matters Regarding the Board of Directors\" are hereby incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe text of the Proxy Statement under the captions, \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" are hereby incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe last three paragraphs under the caption \"Election of Directors -- Committees, Meetings, Compensation and Other Matters Regarding the Board of Directors\" in the Proxy Statement are hereby incorporated herein by reference.\nAdvanta Corp. and Subsidiaries\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\nThe following Financial Statements, Schedules, and Other Information of the Registrant and its subsidiaries are included in this Form 10-K:\n(a) (1) Financial Statements\n1. Consolidated Balance Sheets at December 31, 1994 and 1993.\n2. Consolidated Income Statements for each of the three years in the period ended December 31, 1994.\n3. Consolidated Statements of Changes in Stockholders' Equity for each of the three years in the period ended December 31, 1994.\n4. Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1994.\n5. Notes to Consolidated Financial Statements.\n(a) (2) Schedules\n1. Schedule I -- Condensed Financial Information of Registrant.\n2. Schedule II -- Valuation and Qualifying Accounts.\n3. Report of Independent Public Accountants on Supplemental Schedules.\nOther statements and schedules are not being presented either because they are not required or the information required by such statements and schedules is presented elsewhere in the financial statements.\n(a) (3) Exhibits.\n3-a Restated Certificate of Incorporation of Registrant (incorporated by reference to Exhibit 4.1 to Pre-Effective Amendment No. 1 to the Registrant's Registration Statement on Form S-3 (File No. 33-53475), filed June 10, 1994).\n3-b By-laws of the Registrant, as amended (incorporated by reference to Exhibit 3.ii to the Registrant's Current Report on Form 8-K dated December 22, 1994, filed on the same date).\nAdvanta Corp. and Subsidiaries\n4-a* Trust Indenture dated April 22, 1981 between Registrant and CoreStates Bank, N.A. (formerly, The Philadelphia National Bank), as Trustee, including Form of Debenture.\n4-b Specimen of Class A Common Stock Certificate and specimen of Class B Common Stock Certificate (incorporated by reference to Exhibit 1 of the Registrant's Amendment No. 1 to Form 8 and Exhibit 1 to Registrant's Form 8-A, respectively, both dated April 22, 1992).\n4-c Trust Indenture dated as of November 15, 1993 between the Registrant and The Chase Manhattan Bank (National Association), as Trustee (incorporated by reference to Exhibit 4 to the Registrant's Registration Statement on Form S-3 (No. 33-50883), filed November 2, 1993).\n9 Inapplicable.\n10-a Registrant's Stock Option Plan, as amended (incorporated by reference to Exhibit 10-b to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989). +\n10-b Amended and Restated Advanta Corp. 1992 Stock Option Plan (filed herewith). +\n10-c Pooling and Servicing Agreement between Colonial National Bank USA and Bankers Trust Company, as Trustee, dated as of May 1, 1991 (incorporated by reference to Exhibit 4.1 to Colonial National's Registration Statement on Form S-1 (No. 33-40368), filed with Amendment No.1 thereto on May 21, 1991).\n10-d Advanta Management Incentive Plan (incorporated by reference to Exhibit 10-n to the Registrant's Registration Statement on Form S-2 (File No. 33-39343), filed March 8, 1991). +\n10-e* Application for membership in VISA(R) U.S.A. Inc. and Membership Agreement executed by Colonial National Bank USA on March 25, 1983.\n10-f* Application for membership in MasterCard(R) International, Inc. and Card Member License Agreement executed by Colonial National Bank USA on March 25, 1983.\n10-g* Indenture of Trust dated May 11, 1984 between Linda M. Ominsky, as settlor, and Dennis Alter, as trustee.\n10-g(i) Agreement dated October 20, 1992 among Dennis Alter, as Trustee of the trust established by the Indenture of Trust filed as Exhibit 10-g (the \"Indenture\"), Dennis Alter in his individual capacity, Linda A. Ominsky, and Michael Stolper, which Agreement modifies the Indenture (incorporated by reference to Exhibit 10-g(i) to the Registrant's Registration Statement on Form S-3 (File 33-58660), filed February 23, 1993).\nAdvanta Corp. and Subsidiaries\n10-h Agreement dated as of January 21, 1994 between the Registrant and Alex W. Hart (incorporated by reference to Exhibit 10-h to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, filed March 29, 1994). +\n10-i Advanta Management Incentive Plan with Stock Election (incorporated by reference to Exhibit 4-c to Amendment No. 1 to the Registrant's Registration Statement on Form S-8 (No. 33-33350), filed February 21, 1990). +\n10-j Pooling and Servicing Agreement between Colonial National Bank USA and Bankers Trust Company, as Trustee, dated as of August 1, 1990 (incorporated by reference to Exhibit 4 to the Registrant's Report on Form 8-K filed September 11, 1990).\n10-k Pooling and Servicing Agreement between Colonial National Bank USA and Bankers Trust Company, as Trustee, dated as of November 15, 1990 (incorporated by reference to Exhibit 4 to the Registrant's Report on Form 8-K filed November 30, 1990).\n10-l Advanta Management Incentive Plan With Stock Election II (incorporated by reference to Exhibit 10-o to the Registrant's Registration Statement on Form S-2 (File No. 33-39343), filed March 8, 1991). +\n10-m Pooling and Servicing Agreement between Colonial National Bank USA and Banker's Trust Company, as Trustee, dated as of September 1, 1991 (incorporated by reference to Exhibit 4.1 to Colonial National's Registration Statement on Form S-1 (No. 33-42682), filed with Amendment No. 1 thereto on September 23, 1991).\n10-n Pooling and Servicing Agreement between Colonial National Bank USA and Bankers Trust Company, as Trustee, dated as of February 1, 1992 (incorporated by reference to Exhibit 4.1 to Colonial National's Registration Statement on Form S-1 (No. 33-45306), filed with Amendment No.1 thereto on February 3, 1992).\n10-o Amended and Restated Master Pooling and Servicing Agreement between Colonial National Bank USA and Chemical Bank, as Trustee, dated as of April 1, 1992 (incorporated by reference to Exhibit 4.1 to Colonial National's Registration Statement on Form S-1 (No. 33-49602), filed with Amendment No. 1 thereto on August 19, 1992).\n10-p Advanta Management Incentive Plan With Stock Election III (incorporated by reference to Exhibit 10-s to the Registrant's Registration Statement on Form S-3 (File No. 33-58660), filed February 23, 1993). +\n10-q Life Insurance Benefit for Certain Key Executives and Directors (incorporated by reference to Exhibit 10-u to the Registrant's Registration Statement on Form S-3, (File No. 33-58660), filed February 23, 1993). +\n10-r $122.5 Million 364-day Unsecured Revolving Credit Agreement dated as of March 24, 1994 among the Registrant, Mellon Bank, N.A. as Agent and the several bank parties thereto (incorporated by reference to Exhibit 10-r to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, filed March 29, 1994).\nAdvanta Corp. and Subsidiaries\n10-s $122.5 Million 3-year Unsecured Revolving Credit Agreement dated as of March 24, 1994 among the Registrant, Mellon Bank, N.A. as Agent and the several bank parties thereto (incorporated by reference to Exhibit 10-s to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993, filed March 29, 1994).\n10-t Advanta Management Incentive Plan With Stock Election IV (filed herewith). +\n10-u Agreement of Limited Partnership of Advanta Partners LP, dated as of May 6, 1994 (incorporated by reference to Exhibit 10(a) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, filed August 11, 1994).\n10-v Employment Agreement by and between Advanta Partners LP and Anthony P. Brenner, made as of May 6, 1994 (incorporated by reference to Exhibit 10(b) to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, filed August 11, 1994).\n10-w Pooling and Servicing Agreement between Colonial National Bank USA and Bankers Trust Company, as Trustee, dated December 1, 1993, as amended May 23, 1994 (incorporated by reference to Exhibit 4.1 to Colonial National's Registration Statement on Form S-3 (No. 33-79986), filed June 8, 1994).\n11 Inapplicable.\n12 Inapplicable.\n13 Inapplicable.\n16 Inapplicable.\n18 Inapplicable.\n21 Subsidiaries of the Registrant (filed herewith).\n22 Inapplicable.\n23 Consent of Independent Public Accountants (filed herewith).\n24 Powers of Attorney (included on the signature page hereof).\n27 Financial Data Schedule (filed herewith).\n28 Inapplicable.\n99 Inapplicable.\n* Incorporated by reference to the Exhibit with corresponding number constituting part of the Registrant's Registration Statement on Form S-2 (No. 33-00071), filed on September 4, 1985.\n+ Management contract or compensatory plan or arrangement.\nAdvanta Corp. and Subsidiaries\n(b) Reports on Form 8-K\n1. A Report on Form 8-K was filed by the Registrant on October 19, 1994 regarding consolidated earnings of the Registrant and its subsidiaries for the fiscal quarter ended September 30, 1994. Summary earnings and balance sheet information as of that date were filed with such report.\n2. A Report on Form 8-K was filed by the Registrant on December 22, 1994 regarding the commencement of the Registrant's $350,000,000 Medium-Term Note program, Series B. The Registrant's By-laws, as amended, and the Forms of Fixed and Floating Rate Notes with respect to the Registrant's medium-term note program were filed with such report. No financial statements were filed with such report.\n3. A Report on Form 8-K was filed by the Registrant on January 24, 1995 regarding consolidated earnings for the Registrant and its subsidiaries for the fiscal quarter and fiscal year ended December 31, 1994. Summary earnings and balance sheet information as of that date were filed with such report.\nAdvanta Corp. and Subsidiaries\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.\nADVANTA Corp.\nDated: March 15, 1995 By: \/S\/ Richard A. Greenawalt ------------------ -------------------------- Richard A. Greenawalt, President, Chief Operating Officer and Director\nKNOW ALL MEN BY THESE PRESENTS, that each of the undersigned does hereby constitute and appoint Dennis Alter, Richard Greenawalt, Alex W. Hart, John J. Calamari, David D. Wesselink and Gene S. Schneyer, or any of them (with full power to each of them to act alone), his or her true and lawful attorney-in-fact and agent, with full power of substitution, for him or her and on his or her behalf to sign, execute and file an Annual Report on Form 10-K under the Securities Exchange Act of 1934, as amended, for the fiscal year ended December 31, 1994 relating to the Advanta Corp. and any or all amendments thereto, with all exhibits and any and all documents required to be filed with respect thereto, with the Securities and Exchange Commission or any regulatory authority, granting unto such 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 in order to effectuate the same as fully to all intents and purposes as he or she might or could do if personally present, hereby ratifying and confirming all that such attorneys-in-fact and agents, or any of them, or their substitute or substitutes, may lawfully do or cause to be done.\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 indicated on the 15th day of March, 1995.\nAdvanta Corp. and Subsidiaries\nAdvanta Corp. and Subsidiaries\nFINANCIAL SCHEDULES AND INDEPENDENT PUBLIC ACCOUNTANTS' REPORT THEREON\nAdvanta Corp. and Subsidiaries\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SUPPLEMENTAL SCHEDULES\nTo Advanta Corp.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in this Form 10-K, and have issued our report thereon dated January 23, 1995. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The supplemental 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 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 LLP\nPhiladelphia, PA January 23, 1995\nADVANTA Corp. & Subsidiaries December 31, 1994\nSchedule I - Condensed Financial Information of Registrant\nParent Company Only Condensed Balance Sheets\n(Dollars in thousands)\nSchedule I (cont'd)\nParent Company Only Condensed Statements Income\n(Dollars in thousands)\nSchedule I (Cont'd)\nParent Company Only Statements of Cash Flows\nSchedule II\nADVANTA Corp. & Subsidiaries Valuation & Qualifying Accounts ($000's)\n(1) Amounts netted against securitization income. (2) Includes $12.8MM transferred from off-balance sheet to on-balance sheet reserves. (3) Includes $11.0MM transferred from on-balance sheet unallocated reserves. (4) Includes $3.3MM transferred from on-balance sheet unallocated reserves. (5) Relates to net charge-offs.\nAdvanta Corp. and Subsidiaries\nEXHIBIT INDEX\nAdvanta Corp. and Subsidiaries\nAdvanta Corp. and Subsidiaries\nAdvanta Corp. and Subsidiaries\n* Incorporated by reference to the Exhibit with corresponding number constituting part of the Registrant's Registration Statement on Form S-2 (No. 33-00071), filed on September 4, 1985.\n+ Management contract or compensatory plan or arrangement.","section_15":""}
{"filename":"83588_1994.txt","cik":"83588","year":"1994","section_1":"ITEM 1. BUSINESS GENERAL The Reynolds and Reynolds Company (the \"Company\"), an Ohio corporation, incorporated in 1889, operates principally in two business segments -- business forms and computer systems.\nBUSINESS FORMS\nThe business forms segment offers its products and services to the automotive, healthcare and general business markets.\nIn the automotive market, the segment markets its products and services to sales, parts, accounting and administrative departments of automobile, truck and recreational vehicle dealerships, as well as related-automotive businesses such as repair garages, auto parts stores and body shops. Products include standard and custom single (uniset) forms, continuous forms, stationery, envelopes, paper floor mats, promotional items and forms management services.\nIn the healthcare market, the segment markets standard and custom forms and forms management services to hospitals and large healthcare organizations.\nIn the general business market, the segment offers a wide variety of paper and electronic custom business forms both continuous and snap-out, as well as stock continuous computer forms, stationery, envelopes, desktop compatibles, checks, labels and tickets. Electronic forms, on- demand printing and broad security feature capability are also offered as an integrated part of this segment's overall document solutions offering. Forms management services such as forms survey and analysis, inventory management and reporting systems, cost center reporting, low stock reporting and pick-pack distribution help the Company's general business customers manage their business forms needs. One-write pegboard accounting systems are sold primarily to smaller businesses through a network of office supply dealers and independent forms distributors.\nThe business forms segment operates 11 manufacturing facilities in the United States and Canada.\nCOMPUTER SYSTEMS\nThe computer systems segment offers its products and services to the automotive and healthcare markets.\nThe automotive group markets turnkey information management systems and professional services primarily to automobile dealers. The hardware sold is purchased from computer hardware manufacturers which specialize in platforms for the UNIX operating system. With a few minor exceptions, the application software products are owned by the Company and licensed to users. Some of the software products offered include standard programs for accounting, payroll, vehicle and parts inventory control and billing, service merchandising, scheduling and billing, leasing, finance and insurance and manufacturer communications.\nHardware maintenance, software support and training and other professional services are integral parts of the Company's turnkey approach to marketing computer systems. These services are provided by over 1,200 service and support personnel located in nearly 175 offices in principal cities in North America.\nThe Company also markets computer products and services directly to automobile manufacturers.\nWith the November, 1994 acquisition of PD Medical Systems, the Company expanded its array of turnkey computer systems offered to medical practices. That acquisition has been combined with the former subsidiary, NMC Services, and together they now operate as Reynolds and Reynolds Healthcare Systems. (See Management Discussion and Analysis, Page 8).\nFINANCING SUBSIDIARIES -- Various subsidiaries provide financing primarily for the Company's computer systems through non-cancellable finance leases.\nFinancial information about industry segments is included in Notes 5 and 11 on pages 31-32 and 39-40, respectively. Financial services operating results are included in the computer systems information.\nFurther information concerning the Company's business follows.\nNEW PRODUCTS\nThe Company continued to enhance its computer systems product line for automobile dealers. New software releases included numerous information service applications to further develop this major new area of recurring revenue. Among the releases are applications which link: dealerships to service bureaus to determine consumer credit worthiness; process and approve actual credit documentation; and process vehicle registrations by electronic data interface with state authorities (Maryland, Virginia).\nThe Company acquired the One Touch parts locator business, the most frequently used repair parts, marketing and locator service in North America. The Company also acquired the exclusive rights to Document Management software, to enable the integrated storage and retrieval of source documents and ProDesk profit manager software which enables the marketing of leased vehicles and integrates with other dealer management system applications.\nIn addition, the Company also introduced new image-based electronic parts and service applications for parts and service departments in automobile dealerships.\nThe Company also enhanced its document solutions capability by extending its security features offering, and integrating electronic forms and on-demand capability into its broad forms management offering.\nRAW MATERIALS\nAn adequate supply of paper products is essential to the Company's business forms segment. The Company obtains those products from a variety of sources and, historically has not experienced any difficulty in obtaining them. However, during October and November 1994 (fiscal year 1995), the Company experienced higher prices and lower supplies of form bond paper. Some manufacturers are placing their customers on allocations for this product. The Company expects to be able to continue to acquire a sufficient supply of such paper at higher prices, which, the Company believes, can be passed through to the end-user customers.\nComputer hardware is essential to the Company's computer systems segment. This hardware comes from a variety of sources, principally Silicon Graphics, Inc., and historically the Company has experienced an ample supply.\nIn the opinion of the Company, loss of one or more if its present suppliers of either paper products or computer hardware would not have a significant impact on the Company's operations because of the general availability of alternate sources.\nPATENTS, TRADEMARKS AND RELATED RIGHTS\nExcept as described below, the Company does not have any patents, trademarks, licenses, franchises or concessions which are material to an understanding of the Company's business.\nThe Company's trademark REYNOLDS + REYNOLDS(R) is associated with many goods and services provided by the Company.\nIn the computer systems segment, the Company has a number of distribution and licensing arrangements with equipment and software vendors relating to certain components of Reynolds' products, including a distribution license for UNIX operating systems (a product and trademark of Bell Laboratories). Such arrangements are in the aggregate, but not individually (except for UNIX), material to Reynolds' business.\nCOMPETITION\nBoth in the provision of computer systems products and services and in the manufacture and sale of business forms, the Company is subject to competition from a number of other business organizations, some of which have substantially greater assets and financial resources than the Company. The Company believes that it competes by producing high-quality products and by continually upgrading its computer systems and services to utilize the most recent technology and developments in the industry. The Company has specialized in selected markets and has emphasized service and long-term relationships to meet customer needs more effectively. While no single customer represents 5% or more of the revenues of either principal business segment, the Company does have several significant customers whose loss, in the aggregate, could be material to the business forms segment. The Company believes that the likelihood of losing all of such customers is remote.\nBACKLOG\nBUSINESS FORMS: The Company manufactures several thousand different types of standard and custom business forms. The dollar value of the printing backlog as of December 1, 1994, is estimated to be $17,263 compared with $19,382 at December 1, 1993.\nCOMPUTER SYSTEMS: Units in the backlog consist of the number of unbilled computer systems or terminals which have been approved but not yet shipped or for which signed contracts are pending credit investigation. The dollar value of the backlog as of December 1, 1994, is estimated to be $36,626 including software license fees, compared with $35,830 at December 1, 1993.\nRESEARCH AND DEVELOPMENT\nDuring fiscal 1994, the Company continued its research and development of in-house computer systems, terminal products, electronic image-based systems and printing plant automation. In addition to those programs, the Company also had several other development projects of lesser magnitude. Expenditures for all such activities were approximately $18,100 in 1994, $12,400 in 1993 and $9,600 in 1992.\nENVIRONMENTAL PROTECTION\nThe Company believes that it is in substantial compliance with all applicable federal, state and local statutes concerning environmental protection. The Company has not experienced any material costs in this regard. The U.S. Environmental Protection Agency has designated the Company as one of a number of potentially responsible parties under the Comprehensive Environmental Response, Compensation and Liability Act at three environmental remediation sites. (See Note 12, pages 40-41.)\nEMPLOYEES\nOn December 1, 1994, the Company and its subsidiaries had 5,478 employees. It is party to a number of collective bargaining agreements with union locals which represent an aggregate of approximately 336 employees at its Dayton, Ohio, Hagerstown, Maryland, North Hollywood, California and Lebanon, Indiana plants.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nAs of September 30, 1994, the Company operated ten forms manufacturing plants in the United States and one in Canada encompassing approximately 1.2 million square feet. Of those, more than 1 million square feet are owned outright by the Company. The remaining .2 million square feet are leased. Corporate headquarters and the respective headquarters of the business forms segment and the computer systems segment are located in Dayton, Ohio in several buildings owned by the Company which contain more than .5 million square feet. In addition, the Company leases approximately 150 sales offices and more than fourteen warehouses throughout the country. The Company believes its facilities are suitable and adequate for its current business needs.\nThe Company has no encumbrances securing long-term debt as of September 30, 1994 on its owned facilities.\nSubstantially all printing and other equipment used in the manufacture of business forms and systems is owned by the Company and its subsidiaries.\nThe Company believes its properties are in good condition and adequate for current activities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nRelevant information appears in Note 12 to the Financial Statements on pages 40 and 41.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nNot Applicable.\nPART II (DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Class A Common Shares are listed on the New York Stock Exchange. There is no principal market for the Class B Common Shares. The Company also has an authorized class of 60 million preferred shares with no par value. The Company currently has no agreements or commitments with respect to the sale or issuance of the preferred shares.\nInformation on market prices and dividends is set forth below:\nAs of December 1, 1994, there were approximately 2,160 holders of record of Class A Common Shares and one holder of record of Class B Common Shares. See Note 6 on page 32 and 33 regarding the amount of retained earnings available for dividends.\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 REYNOLDS AND REYNOLDS COMPANY AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (Dollars in thousands except per share data)\nBUSINESS ENVIRONMENT The business environment for the company's automobile dealership customers improved greatly in 1994 as the automotive market experienced an excellent year. Analysts project new vehicle sales to be over 15 million in calendar year 1994. Those analysts also project continued strength of new vehicle sales in 1995. This represents a significant increase over the last three years (13.9 million in 1993, 12.9 million in 1992 and 12.3 million in 1991). Aided by this improved business environment, automobile dealerships purchased the company's ERA computer systems in record numbers in 1994. The company also has significant recurring service revenues and business forms sales to automobile dealerships. These revenues do not fluctuate significantly with new vehicle sales.\nIn 1994, overall economic conditions improved and the economy, as measured by gross domestic product, grew at its fastest rate since 1988. The company's overall paper cost remained relatively stable in fiscal 1994 because of lower costs earlier in the year. In the second half of the year, increased demand for paper allowed paper manufacturers to raise prices. In 1995, the company expects higher average paper costs than in 1994. Accordingly, the company intends to raise prices to offset these increased costs.\nThe overall healthcare market remained difficult in fiscal 1994 as the uncertainty surrounding healthcare reform caused many medical practices to postpone investments in computer systems. Recently, the company's healthcare computer systems sales orders have improved and the order backlog at year-end was at its highest level since 1992. In November 1994, the company acquired PD (Poorman-Douglas) Medical Systems, a provider of information management systems to medical practices. PD Medical Systems has annual revenues of about $8,000. Managed care is undergoing rapid growth throughout the country and PD Medical Systems has the industry's most complete managed care system for medical practices. This acquisition strengthens the company's healthcare business and should contribute to improved operating results in 1995.\nSIGNIFICANT EVENTS BUSINESS FORMS RESTRUCTURING During the third quarter of 1994, the company recorded a $12,400 restructuring charge for costs to be incurred in the disposal of part of its stock tab product line and the consolidation of certain custom business forms printing operations. The general printing business was restructured to focus on value-added solutions for customers and to improve profitability. The company discontinued the manufacture of certain low-margin stock tab products and closed its Chambersburg, Pennsylvania plant. To facilitate this process, the company sold a minority interest in a subsidiary to Willamette Industries Inc., a leading supplier of stock tab products. Willamette and the company will jointly own and operate this subsidiary during the transition of manufacturing operations to ensure continuous quality customer service. After this transition period (anticipated to be less than one year), the company will liquidate this subsidiary with no effect on net income. This transaction generated $11,500 of income tax benefits which more than offset the negative after-tax effect of the restructuring charge. This transaction will also generate $24,000 of cash from tax benefits and reductions in accounts receivable and inventories. In addition to closing several distribution facilities and sales offices, the company also closed its custom business forms plant in Chestertown, Maryland and consolidated operations primarily into its Hagerstown, Maryland plant. When fully implemented, it is anticipated that this restructuring will increase operating income by $4,300. See Note 2 to the Consolidated Financial Statements for additional disclosures related to the restructuring.\nBUSINESS CHANGES In 1994, the company continued its practice of supplementing existing businesses with strategic acquisitions. During the year Law Printing Company, Formcraft Inc. and Management Computer Services (MCS) Inc. were acquired. Law Printing was a west-coast manufacturer of business forms and related products primarily for automobile dealerships. This purchase, combined with the 1992 pooling of interests with Norick Brothers Inc., significantly\ngrew the company's position in this important market. Formcraft is a Houston-based manufacturer of general business forms with strong forms management services. In 1993, the company purchased Woodbury Business Systems, another regional provider of forms management services. The acquisition of MCS, a leading provider of parts locator services, under the name of One Touch, expanded the company's computer-based products offered to automobile dealerships. In 1993, the company acquired COIN Inc., which had one of the larger installed bases of customers in the automobile dealership industry and had historically been a leader in automating the finance and insurance function of automobile dealerships.\nDuring the third quarter of 1994, the company sold its French automotive computer systems subsidiary because the European market is very fragmented and does not currently present an attractive growth opportunity. This subsidiary reported sales of $10,000 in 1994 and $18,000 in 1993. See Note 3 of the Consolidated Financial Statements for additional disclosures about the company's business changes.\nSTOCK SPLIT On February 17, 1994, the board of directors approved a two-for-one common stock split. As a result of the split, on March 15, 1994, common shareholders received one additional share for each share held as of March 1, 1994. This split was the second such split since November 1992 and the sixth split since the company's initial public offering in 1961. All share and per share information presented in this annual report was restated to reflect the stock splits.\nRESULTS OF OPERATIONS CONSOLIDATED Consolidated net sales and revenues increased $111,828 or 16% to an all-time record of $808,794 in 1994. Computer systems revenues grew $82,243 and business forms sales rose $29,315. The net effect of acquisitions and divestitures increased 1994 sales $36,323. In 1993, consolidated net sales and revenues of $696,966 increased $52,142 or 8% as computer systems revenues increased 11% and business forms sales increased 7%. In 1993, acquisitions contributed $29,466 of the sales increase.\nConsolidated operating income of $98,067 represented an increase of $6,970 or 8% in 1994. Consolidated operating income increased $22,163 or 24%, excluding business forms $12,400 restructuring charge, $1,043 of restructuring related expenses already incurred and $1,750 of environmental expenses. See Note 12 to the Consolidated Financial Statements for a discussion of the company's environmental contingencies. Operating income increased 34% for computer systems, 24% for financial services and 12% for business forms, excluding the previously mentioned charges. In 1993, operating income grew $23,767 or 35% as computer systems, financial services and business forms all reported substantial increases. As a percentage of sales, operating income was 12% in 1994, 13% in 1993 and 10% in 1992. Excluding the previously mentioned charges, operating income represented 14% of revenues in 1994.\nNet interest expense and other income was $745 in 1994, $1,813 in 1993 and $2,894 in 1992. In 1994, other income included an $817 pre-tax gain on the sale of the French subsidiary. In 1992, interest expense was higher because of higher average debt balances.\nThe effective income tax rate was 32.0% in 1994 compared to 41.2% in 1993 and 40.9% in 1992. In 1994, the company recorded an $11,500 tax benefit associated with the stock tab divestiture. The company also recorded $581 of tax expense related to the sale of the French subsidiary. The 1994 effective tax rate was 41.8%, excluding the effect of the stock tab and French divestitures. The increase over 1993 resulted from an increase in non-deductible goodwill amortization and the 1993 tax law changes. In 1993, the effective tax rate increased because of the tax law changes effective for part of the year. The 1993 favorable settlement of 1984 through 1989 federal tax audits largely offset the effects of the tax law changes.\nIncome before the effect of accounting changes of $66,204 or $1.51 per share, increased $13,682 or 26% in 1994. The effect of the restructuring charge, restructuring related and environmental expenses, net of associated tax benefits, was to increase income by $840 or $.02 per share in 1994. In 1993, income before accounting changes of $52,522 represented an increase of $14,430 or 38% over 1992. In 1994, return on average shareholders' equity (ROE) was\n23.8%. In 1993 and 1992, ROE, calculated using income before accounting changes, was 20.2% and 14.8%, respectively.\nIn 1993, the company adopted Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This statement required the company to record an expense recognizing postretirement benefits, such as medical and life insurance benefits, already earned by employees. Historically, the company recognized these expenses when paid to retirees. The cumulative effect of adopting SFAS No. 106 was to reduce net income by $19,106 or $.44 per share. See Note 9 to the Consolidated Financial Statements for additional disclosures related to SFAS No. 106. In 1992, the company adopted SFAS No. 109, \"Accounting for Income Taxes\" and recorded a tax benefit of $1,100 or $.03 per share.\nCOMPUTER SYSTEMS (excluding financial services) Computer systems revenues increased $82,243 in 1994 and $27,513 in 1993 representing growth of 29% in 1994 and 11% in 1993. Excluding the effect of acquisitions and divestitures, revenues rose $58,244 in 1994 and $13,361 in 1993. In 1994, this increase resulted from a 69% increase in the number of ERA computer systems sold and a substantial increase in related recurring service revenues. The company was able to increase ERA sales dramatically because strong sales orders provided the opportunity to expand installation capacity. The automotive computer systems order backlog was substantial at September 30, 1994 and should support continued strong sales into 1995. Recurring service revenues continued to grow because strong computer systems sales increased the number of software applications supported. These recurring service revenues result from monthly billings for technical support, software updates and hardware maintenance that allow customers to maximize the value of their computer systems. In 1993, sales increased because of the same trends that affected 1994. Healthcare computer systems sales declined for the second straight year in 1994 as medical practices were hesitant to purchase computer systems because of the uncertainty surrounding healthcare reform. Recently, healthcare computer systems sales orders have increased and the year-end order backlog was at its highest level since 1992.\nComputer systems operating income grew $15,173 or 34% to $59,254 in 1994. In 1993, operating income of $44,081 represented an increase of $9,821 or 29%. As a percentage of revenues, operating income was 16% in both 1994 and 1993 and 13% in 1992. Gross profit was 46.5% of revenues in 1994, compared to 48.1% in 1993 and 46.3% in 1992. The gross margin declined in 1994 as the company incurred additional training expenses to expand installation capacity to meet increased demand for its products and because of the full year effect of COIN's product mix. Gross profit rose to 47.3% in the second half of 1994 when many new employees completed training and began installing computers. In 1993, gross margins increased because of the sales growth and lower computer equipment costs. The sales growth increased both ERA and recurring service gross margins in 1993 because of the relatively fixed nature of many software development and support expenses. The company's costs for computer equipment remained relatively stable in 1994 after declining in 1993. Selling, general and administrative (SG&A) expenses were 30.2% of revenues in 1994, compared to 32.4% in 1993 and 32.8% in 1992. The decline in 1994 resulted primarily from the full year effect of successfully integrating COIN into the company's operations. Bad debt expenses decreased $600 in 1994 and $3,200 in 1993.\nBUSINESS FORMS Business forms net sales increased $29,315 in 1994 and $24,601 in 1993 representing a 7% increase each year. Excluding the effect of acquisitions and divestitures, net sales increased $16,991 in 1994 and $9,287 in 1993. In 1994, this increase occurred primarily in automotive forms, which grew 8% because of both higher volume and modest price increases. General business forms sales also grew in 1994 because of the addition of many new forms management services accounts. In 1993, exclusive of acquisitions, sales rose principally because of an increase in general business forms sales.\nRestructuring charges of $12,400, restructuring related expenses of $1,043 and environmental expenses of $1,750 caused business forms operating income to decline in 1994. Excluding these expenses, operating income of $40,934 represented an increase of $4,483 or 12% compared to 1993. In 1993, operating income was $36,451 and represented an increase of $5,925 or 19% over 1992. Gross profit, excluding the restructuring charge, improved to 44.7% of sales in 1994 compared to 43.6% in 1993 and 42.9% in 1992. In both 1994 and 1993, gross profit improved because of the strong growth in higher margin automotive forms and forms management services sales.\nIn 1993, gross profit also improved because of the successful integration of Norick Brothers. The company was able to improve Norick's gross profit through the effective integration of Norick into the company's cost structure resulting in lower paper and freight costs and the closing of two smaller manufacturing plants. From 1990 through 1992 the company saw its overall paper costs decline because of intense competition among paper manufacturers. The company passed much of this cost reduction to customers to meet competitive pressures. In 1993 and 1994 the overall paper costs remained about the same and did not impact the company greatly. However, in 1994, paper costs declined during the first half of the year and increased during the second half of the year. In 1995, the company expects higher average paper costs than in 1994. The company intends to raise prices to offset these increased costs. SG&A expenses were 35.8% of sales in 1994, compared to 34.4% in 1993 and 34.7% in 1992. The 1994 increase consisted primarily of environmental expenses, restructuring related expenses and additional goodwill amortization from acquisitions.\nFINANCIAL SERVICES Financial services revenues increased only slightly in both 1994 and 1993. Finance receivables increased because of strong computer systems sales in both years. However, interest income remained relatively flat because of the decline in interest rates. Financial services operating income increased $2,507 in 1994 and $8,021 in 1993 primarily because of lower bad debt expenses. Bad debt expenses declined $1,800 in 1994 and $6,222 in 1993. Lower interest expense also contributed to improved operating income. Interest expense declined $506 in 1994 and $1,402 in 1993 because of lower interest rates.\nThe company has entered into various interest rate management agreements to limit interest rate exposure on financial services variable rate debt. It is important to manage this interest rate exposure because the proceeds from these borrowings were invested in fixed rate finance receivables. The company believes it has reduced interest expense by using interest rate management agreements and variable rate debt instead of directly obtaining fixed rate debt. See Note 6 to the Consolidated Financial Statements for additional disclosures regarding the company's interest rate management agreements.\nLIQUIDITY AND CAPITAL RESOURCES CASH FLOWS Information systems strong cash flow from operating activities of $94,956 resulted from record net income. The company invested this cash in working capital, acquisitions and capital expenditures. Working capital increased because of higher sales, however, this increase was offset by a reduction in working capital related to the stock tab divestiture. During 1994, the company acquired Formcraft for $5,106 and MCS for $4,708. The Law acquisition was a non-cash transaction whereby the company exchanged 612,692 Class A common shares valued at $13,075 for Law's assets. Accordingly, the Statement of Consolidated Cash Flows does not reflect the Law purchase. Capital expenditures of $27,888 occurred in the normal course of business. Proceeds from asset sales related primarily to the French divestiture. The company also returned cash to shareholders by repurchasing $39,083 of capital stock and paying $14,226 of cash dividends. See the shareholders' equity section for a discussion of dividends and share repurchases.\nFinancial services operating cash flow and collections on finance receivables were invested in new finance receivables for the company's computer systems and used to make scheduled debt repayments.\nCAPITALIZATION The company's ratio of total debt (total information systems debt) to capitalization (total information systems debt plus shareholders' equity) was 12.4% at September 30, 1994 and 13.2% at September 30, 1993. Available credit under existing revolving credit agreements was $31,050 at September 30, 1994. In addition to committed credit agreements, the company also has a variety of other short-term credit lines available. It is expected that cash balances and internally generated cash will be sufficient to fund 1995 normal operations, which include anticipated capital expenditures of about $30,000.\nSHAREHOLDERS' EQUITY The company lists its Class A common shares on the New York Stock Exchange. There is no principal market for the Class B common shares. The company also has an authorized class of 60 million preferred shares with no par\nvalue. As of November 14, 1994, none of these preferred shares were outstanding and there were no agreements or commitments with respect to the sale or issuance of these shares.\nThe company paid cash dividends of $14,226 in 1994, $11,139 in 1993 and $9,831 in 1992. Dividends per Class A common share were $.33 in 1994, $.26 in 1993 and $.225 in 1992. Dividends are typically declared each November, February, May and August and paid in January, April, June and September, respectively. Dividends per Class A common share must be twenty times the dividends per Class B common share and all dividend payments must be simultaneous. In November 1994, the board of directors increased the quarterly dividend to $.10 per Class A common share, an increase of 18%. This increase followed increases of 13% in February 1994 and 15% in November 1993. The company has increased cash dividends eight times since 1989 and paid dividends each year since the company's initial public offering in 1961.\nThe company has conducted an active share repurchase program during recent years to provide increased returns to shareholders. The company repurchased $39,083 of Class A common shares in 1994, $16,500 in 1993 and $34,700 in 1992. Average prices paid per share were $23.61 in 1994, $13.50 in 1993 and $10.85 in 1992. The company could repurchase an additional 1,925,800 Class A common shares under existing board resolutions as of September 30, 1994.\nENVIRONMENTAL MATTERS See Note 12 to the Consolidated Financial Statements for a discussion of the company's environmental contingencies.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial information required by Item 8 is contained in Item 14 of Part IV (pages 13-14) 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 name, age and background information for each of the Company's directors and nominees are incorporated herein by reference to the section of the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders captioned \"ELECTION OF DIRECTORS.\"\nEXECUTIVE OFFICERS OF THE COMPANY\nThe executive officers of the Company are elected by the Board of Directors at its meeting immediately following the Annual Meeting of Shareholders to serve generally for a term of one year. The executive officers of the Company, as of December 1, 1994, are:\nA description of prior positions held by executive officers of the Company within the past 5 years, to the extent applicable, is set forth in the section of the Proxy Statement incorporated by reference above.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation on compensation of the Company's executive officers and directors is incorporated herein by reference to the section of the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders captioned \"EXECUTIVE COMPENSATION.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe number of Common Shares of the Company beneficially owned by each five percent shareholder, director or current nominee for director, and by all directors and officers as a group as of December 1, 1994 is incorporated herein by reference to the section of the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders captioned \"VOTING SECURITIES OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\"\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation concerning transactions with management, certain business relationships and indebtedness of management is incorporated herein by reference to the section of the Company's Proxy Statement for its 1995 Annual Meeting of Shareholders captioned \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nPART IV (Dollars in thousands)\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 Company are set forth on pages 21 through 42.\nStatements of Consolidated Income - for the years ended September 30, 1994, 1993 and 1992\nConsolidated Balance Sheets - September 30, 1994 and 1993\nStatements of Consolidated Shareholders' Equity - for the years ended September 30, 1994, 1993 and 1992\nStatements of Consolidated Cash Flows - for the years ended September 30, 1994, 1993 and 1992\nNotes to Financial Statements (Including Supplementary Data)\n(A) (2) FINANCIAL STATEMENT SCHEDULES FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED SEPTEMBER 30, 1994 ARE ATTACHED HERETO:\nSchedule VIII - Valuation Accounts Page 43 Schedule IX - Short-Term Borrowings Page 44 Schedule X - Supplementary Income Statement Information Page 45\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 or are inapplicable and, therefore, have been omitted.\n(B) REPORTS ON FORM 8-K No reports on Form 8-K have been filed during the last quarter of the period covered by this Report.\n(C) EXHIBITS The exhibits as shown in \"Index of Exhibits\" (pages 46-54) are filed as a part of this Report.\n(D) CONSOLIDATED FINANCIAL STATEMENTS Individual financial statements and schedules of the Company's consolidated subsidiaries are omitted from this Annual Report on Form 10-K because consolidated financial statements and schedules are submitted and because the registrant is primarily an operating company and all subsidiaries included in the consolidated financial statements are wholly owned.\n-------------------------------------------------------------\nThe Company will provide a copy of its 1994 Annual Report to Shareholders to those persons receiving a copy of the Form 10-K without the exhibits upon written request to:\nADAM M. LUTYNSKI, GENERAL COUNSEL & SECRETARY THE REYNOLDS AND REYNOLDS COMPANY P. O. BOX 2608 DAYTON, OHIO 45401\n-------------------------------------------------------------\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 REYNOLDS AND REYNOLDS COMPANY\nBy \/S\/ ADAM M. LUTYNSKI ---------------------------------------\nADAM M. LUTYNSKI General Counsel and Secretary\nDate: December 20, 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.\nDate: December 20, 1994 By \/S\/ DAVID R. HOLMES ---------------------------------------\nDAVID R. HOLMES Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)\nDate: December 20, 1994 By \/S\/ DALE L. MEDFORD ---------------------------------------\nDALE L. MEDFORD Vice President, Corporate Finance and Chief Financial Officer (Principal Financial and Accounting Officer) and Director\nDate: December 20, 1994 By \/S\/ JOSEPH N. BAUSMAN ---------------------------------------\nJOSEPH N. BAUSMAN President, Computer Systems Division and Director\nDate: December 20, 1994 By \/S\/ DR. DAVID E. FRY ---------------------------------------\nDR. DAVID E. FRY, Director\nDate: December 20, 1994 By \/S\/ RICHARD H. GRANT, JR. ---------------------------------------\nRICHARD H. GRANT, JR. Chairman of the Steering Committee and Director\nDate: December 20, 1994 By \/S\/ RICHARD H. GRANT, III ---------------------------------------\nRICHARD H. GRANT, III, Director\nDate: December 20, 1994 By \/S\/ ROBERT C. NEVIN ---------------------------------------\nROBERT C. NEVIN President, Business Forms Division and Director\nDate: December 20, 1994 By \/S\/ GAYLE B. PRICE, JR. ---------------------------------------\nGAYLE B. PRICE, JR., Director\nDate: December 20, 1994 By \/S\/ WILLIAM H. SEALL ---------------------------------------\nWILLIAM H. SEALL, Director\nDate: December 20, 1994 By \/S\/ KENNETH W. THIELE ---------------------------------------\nKENNETH W. THIELE, Director\nDate: December 20, 1994 By \/S\/ MARTIN D. WALKER ---------------------------------------\nMARTIN D. WALKER, Director\nANNUAL REPORT ON FORM 10-K ITEM 14(a)(1) and (2); 14(c) and (d) Financial Statements, Schedules and Exhibits Year Ended September 30, 1994 The Reynolds and Reynolds Company Dayton, Ohio\nMANAGEMENT'S STATEMENT OF RESPONSIBILITY\nNovember 14, 1994\nTo Our Shareholders:\nThe management of The Reynolds and Reynolds Company is responsible for accurately and objectively preparing the company's consolidated financial statements. These statements are prepared in accordance with generally accepted accounting principles and include amounts based on management's best estimates and judgements. Management believes that the financial information in this annual report is free from material misstatement.\nThe company's management maintains an environment of multilevel controls. The COMPANY BUSINESS PRINCIPLES, for example, is distributed to all employees and communicates high standards of integrity that are expected in the company's day-to-day business activities. The COMPANY BUSINESS PRINCIPLES addresses a broad range of issues including potential conflicts of interest, business relationships, accurate and timely reporting of financial information, confidentiality of proprietary information, insider trading and social responsibility.\nThe company also maintains and monitors a system of internal controls designed to provide reasonable assurances regarding the safeguarding of company assets and the integrity and reliability of financial records. These internal controls include the appropriate segregation of duties and the application of formal policies and procedures. Furthermore, an internal audit department, which has access to all financial and other corporate records, regularly performs tests to evaluate the system of internal controls to ensure the system is adequate and operating effectively. At the date of these financial statements, management believes the company has an effective internal control system.\nThe company's independent public accountants, Deloitte & Touche LLP, perform an independent audit of the company's consolidated financial statements. They have access to minutes of board meetings, all financial information and other corporate records. Their audit is conducted in accordance with generally accepted auditing standards and includes consideration of the system of internal controls. Their report is included in this annual report on page 19.\nAnother level of control resides with the audit committee of the company's board of directors. The committee, comprised of four directors who are not members of management, oversees the company's financial reporting process. They recommend to the board, subject to shareholder approval, the selection of the company's independent public accountants. They discuss the overall audit scope and the specific audit plans with the independent public accountants and the internal auditors. This committee also meets regularly (separately and jointly) with the independent public accountants, the internal auditors and management to discuss the results of those audits, the evaluation of internal controls, the quality of financial reporting, and specific accounting and reporting issues.\nDavid R. Holmes Dale L. Medford Chairman, President and Vice President, Corporate Finance Chief Executive Officer and Chief Financial Officer\nINDEPENDENT AUDITORS' REPORT\nThe Reynolds and Reynolds Company Dayton, Ohio\nWe have audited the accompanying consolidated balance sheets of The Reynolds and Reynolds Company and its subsidiaries as of September 30, 1994 and 1993, and the related statements of consolidated income, shareholders' equity and cash flows for each of the three years in the period ended September 30, 1994. 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 The Reynolds and Reynolds Company and its subsidiaries at September 30, 1994 and 1993 and the results of their operations and their cash flows for each of the three years in the period ended September 30, 1994, 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 9 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 (SFAS) No. 106. As discussed in Note 1 to the consolidated financial statements, in 1992 the company changed its method of accounting for income taxes to conform with SFAS No. 109.\n\/s\/ DELOITTE & TOUCHE LLP ____________________________\nDayton, Ohio November 14, 1994\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement No. 33-56045 of The Reynolds and Reynolds Company on Form S-8 and the Post-Effective Amendments No. 1 and No. 2 to Registration Statement No. 33-48546 of The Reynolds and Reynolds Company on Form S-3 and the Post-Effective Amendment No. 1 to Registration Statement No. 33-51895 of The Reynolds and Reynolds Company on Form S-3 of our report dated November 14, 1994, which includes an explanatory paragraph concerning a change in the method of accounting for post-retirement benefits other than pensions in 1993 and a change in the method of accounting for income taxes in 1992, appearing in this Annual Report on Form 10-K of The Reynolds and Reynolds Company for the year ended September 30, 1994 and to the reference to us under the heading \"Experts\" in the Prospectus, which is part of such Registration Statements.\n\/s\/ DELOITTE & TOUCHE LLP ______________________________\nDayton, Ohio December 16, 1994\nTHE REYNOLDS AND REYNOLDS COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Dollars in thousands except per share data)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the parent company and its domestic and foreign subsidiaries and present details of revenues, expenses, assets, liabilities and cash flows for both information systems and financial services. Information systems is comprised of the company's business forms and computer systems businesses. Financial services is comprised of Reyna Financial Corporation, the company's wholly-owned financial services subsidiary and a similar operation in Canada. In accordance with industry practice, the assets and liabilities of information systems are classified as current or non-current and those of financial services are unclassified. Intercompany balances and transactions between the consolidated companies are eliminated.\nCASH AND EQUIVALENTS\nFor purposes of reporting cash flows, cash and equivalents includes cash on hand, cash deposits and investments with maturities of three months or less at the time of purchase.\nCONCENTRATIONS OF CREDIT RISK\nThe company is a leading provider of information management systems to automobile dealerships. Finance receivables and a significant portion of accounts receivable are from automobile dealerships.\nALLOWANCE FOR LOSSES\nAn allowance for losses on finance receivables is established based on historical loss experience, portfolio profile, industry averages and current economic conditions. Finance receivables are charged to the allowance for losses when an account is deemed to be uncollectible, taking into consideration the financial condition of the customer and the value of the collateral. Recoveries of finance receivables, previously charged off as uncollectible, are credited to the allowance for losses.\nINVENTORIES\nInventories are stated at the lower of cost or market. Costs of domestic business forms inventories are determined by the last-in, first-out (LIFO) method. At September 30, 1994 and 1993, LIFO inventories were $29,341 and $32,234, respectively. These inventories determined by the first-in, first-out (FIFO) method would increase by $4,256 in 1994, $4,203 in 1993 and $4,605 in 1992. For other inventories, cost is determined by specific identification or the FIFO method. Market is based on net realizable value.\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued)\nPROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment are stated at cost. Depreciation and amortization are provided over the estimated useful service lives of the assets or asset groups, principally on the straight-line method for financial reporting purposes. Estimated asset lives are:\nYears - - ---------------------------------------------------------------------\nLand improvements 10 Buildings and improvements 3--33 Machinery and equipment 3--18 Furniture and other 3--15\nGenerally, upon asset disposal any gain or loss is included in current income. Improvements and expenditures for maintenance that add materially to productive capacity or extend asset lives are capitalized.\nINTANGIBLE ASSETS\nThe excess of cost over net assets of companies acquired is recorded as goodwill and amortized on a straight-line basis typically over seven to forty years. At September 30, 1994 and 1993, the accumulated amortization was $17,114 and $13,012, respectively.\nThe company capitalizes certain costs of developing its software products. Upon completion of a software product, amortization is determined based on the larger of the amounts computed using (a) the ratio that current gross revenues for each product bears to the total of current and anticipated future gross revenues for that product or (b) the straight-line method over the remaining estimated economic life of the product, ranging from five to seven years. Amortization expense for software licensed to customers was $4,059, $3,936 and $3,065 during the years ended September 30, 1994, 1993 and 1992, respectively. At September 30, 1994 and 1993, the accumulated amortization was $35,626 and $31,982, respectively.\nOther intangible assets are amortized over periods ranging from three to fifteen years. At September 30, 1994 and 1993, the accumulated amortization was $8,252 and $9,490, respectively.\nREVENUE RECOGNITION - INFORMATION SYSTEMS\nInformation systems revenues consist of both product sales and service revenues. Product sales, including business forms, computer hardware and software licenses, are generally recorded upon shipment to customers. In certain instances, computer systems sales are not recognized until installation is completed. In most cases, computer systems product sales are financed for customers through the company's wholly-owned financial services subsidiary. Upon shipment of computer systems, the company records sales and finance receivables pending customer acceptance. These receivables pending customer acceptance are transferred to interest bearing receivables when installation is completed. Service revenues, which include computer hardware maintenance, software support, training and forms\nmanagement services, are recorded ratably over the contract period or as services are performed. Forms management services represent fees for inventory management and warehousing services. Forms management services may be included in the product sales price or separately billed to customers.\nCertain costs, such as software amortization and product development, were allocated because they relate to both products and services.\nREVENUE RECOGNITION - FINANCIAL SERVICES\nFinancial services revenues consist primarily of interest earned on financing the company's computer systems product sales. Revenues are recognized over lives of financing contracts, generally five to seven years, using the interest method.\nLEASE OBLIGATIONS\nThe company leases premises and equipment under various operating lease agreements. As of September 30, 1994, future minimum lease payments relating to these agreements were $13,275 in 1995, $9,270 in 1996, $4,705 in 1997, $2,117 in 1998 and $535 in 1999. Rental expenses were $19,600 in 1994, $18,100 in 1993 and $16,600 in 1992.\nRESEARCH AND DEVELOPMENT COSTS\nThe company expenses research and development costs as incurred. These costs were about $18,100 in 1994, $12,400 in 1993 and $9,600 in 1992.\nINCOME TAXES\nThe parent company and its domestic subsidiaries file a consolidated U.S. federal income tax return. Deferred income taxes are provided for temporary differences between the tax basis of an asset or liability and its reported amount in the financial statements as prescribed by Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" The company adopted SFAS No. 109 in 1992, which increased deferred tax assets and net income by $1,100 or $.03 per share. Temporary differences result principally from financial services product financing activities, postretirement benefits and different depreciation methods. No deferred income tax liabilities are recorded on undistributed earnings of the foreign subsidiary because, for the most part, those earnings are permanently reinvested. Undistributed earnings of the foreign subsidiary at September 30, 1994 were $17,133. The calculation of the unrecognized deferred income tax liability on these earnings is not practicable.\nEARNINGS PER COMMON SHARE\nEarnings per common share are computed by dividing net income by the weighted average number of Class A common shares and Class A common share equivalents outstanding during each year. Class A common share equivalents consist of those shares which would be outstanding, assuming all Class B common shares were converted into Class A common shares and assuming all dilutive stock options were exercised and the proceeds used to repurchase Class A common shares at the average market price. The dilutive effect of stock options is not material.\n2. BUSINESS FORMS RESTRUCTURING\nDuring the third quarter of 1994, the company recorded a restructuring charge of $12,400 for costs to be incurred in the disposal of part of its stock tab product line and the consolidation of certain custom business forms printing operations. The company discontinued the manufacture of certain low-margin stock tab products and closed its Chambersburg, Pennsylvania plant. To facilitate this process, the company sold a minority interest in a subsidiary to Willamette Industries Inc. for $4,000 in cash. Willamette, based in Oregon, is a forest products company and a leading supplier of stock tab products. Willamette and the company will jointly own and operate this subsidiary during the transition of manufacturing operations to ensure continuous quality customer service. After this transition period (anticipated to be less than one year), the subsidiary will be liquidated with no effect on net income. This transaction generated $11,500 of income tax benefits which more than offset the negative after-tax effect of the restructuring charge.\nThe company also consolidated its east coast custom business forms manufacturing operations to maximize plant efficiencies. The company closed its Chestertown, Maryland plant and consolidated operations primarily into its Hagerstown, Maryland plant. In addition, a number of distribution facilities and sales offices were closed and related sales and administrative positions were eliminated.\nSignificant components of the restructuring charge are included in the following table.\n- - -----------------------------------------------------------------------\nWrite-off of goodwill $ 4,000 Plant closure 3,850 Severance and outplacement 2,990 Other 1,560 ------- Total $12,400 =======\nThe severance and outplacement component represents benefits for 288 employees, comprised principally of manufacturing employees and some sales and administrative employees. Through September 30, 1994, 249 employees were terminated and $1,919 of severance, fringe and outplacement benefits were paid.\n3. BUSINESS CHANGES\nBUSINESS COMBINATIONS\nDuring 1994 and 1993 the company completed several business combinations. On May 9, 1994, the company acquired all outstanding shares of Management Computer Services Inc. (MCS) for $4,708 of cash. MCS, a leading provider of parts locator services to automobile dealers under the name of One Touch, had annual sales of about $4,000. On January 5, 1994, the company acquired all outstanding shares of Formcraft Inc. for $5,106 of cash. Formcraft, a manufacturer of general business forms with strong forms management services, had annual sales of about $17,000 in 1993. On January 3, 1994, the company acquired substantially all of the assets and assumed certain liabilities of Law Printing Company Inc. for $13,075. The purchase price was paid by issuing 612,692 Class A\ncommon shares. Law, a manufacturer of business forms primarily for automobile dealerships, had annual sales of about $11,000 in 1993. The acquisition of Law was a non-cash transaction for accounting purposes and was not included in the statement of cash flows.\nOn June 29, 1993, the company acquired COIN Inc. for $29,633 cash, which included the retirement of $19,604 of COIN's debt. COIN had one of the larger installed bases of customers in the automobile dealership systems industry and had historically been a leader in automating the finance and insurance function of the dealership. On May 4, 1993, the company purchased certain net assets of BVI Information Systems Ltd., a Montreal-based provider of computer systems for automobile dealerships. On March 3, 1993 the company purchased certain net assets of Woodbury Business Systems, a sales organization for a regional business forms supplier.\nAll 1994 and 1993 business combinations were accounted for as purchases. The accounts of the acquired businesses were included in the company's financial statements since their respective acquisition dates. Goodwill is being amortized on a straight-line basis over seven to ten years.\nOn May 29, 1992, the company issued 3,545,336 Class A common shares in exchange for all of the outstanding common stock of Norick Brothers Inc. and operating net assets of a related entity. Norick was a manufacturer of business forms, primarily for automobile dealerships. This business combination was accounted for as a pooling of interests.\nALLOCATION OF PURCHASE PRICES\nDIVESTITURE\nOn June 10, 1994, the company completed the sale of its French subsidiary, Reynolds and Reynolds S.A., to Turbodata N.V. of Belgium, and recorded an after-tax gain of $236. In 1993, this subsidiary reported sales of $18,000 and a net loss of $500.\n4. INCOME TAXES\nPROVISION FOR INCOME TAXES\nRECONCILIATION OF INCOME TAX RATES\nIn August 1993, the federal income tax rate was increased from 34% to 35%, retroactive to January 1, 1993.\nThe carryforward of capital losses expires primarily in 2000.\n5. FINANCIAL SERVICES\nAs of September 30, 1994, product financing receivables due for each of the next five years were $66,741 in 1995, $55,789 in 1996, $43,988 in 1997, $27,200 in 1998 and $10,507 in 1999.\n5. FINANCIAL SERVICES (continued)\n6. FINANCING ARRANGEMENTS\nLoan agreements limit consolidated indebtedness and require a minimum current ratio of 1.50. Loan agreements also limit dividend payments to $23,571 as of September 30, 1994. The fair value of information systems debt was $37,590 and $40,000 at September 30, 1994 and 1993, respectively. At September 30, 1994, debt maturities were $287 in 1995, $231 in 1996, $6,313 in 1997, $5,898 in 1998, and $5,714 in 1999. Interest paid was $3,153 in 1994, $3,428 in 1993 and $5,372 in 1992.\nFINANCIAL SERVICES\nThe company maintains various interest rate management agreements to limit interest rate exposure on its variable rate financing arrangements. Interest rate swaps provide for interest to be received on notional amounts at variable rates and provide for interest to be paid on the same notional amounts at fixed rates. Ceiling agreements allow the company to borrow at variable interest rates, but limit the maximum interest rates the company pays. Fixed interest rates do not change over the life of the swap agreements. Variable interest rates are reset at least every ninety days and are based on LIBOR or commercial paper indices. Net interest received or paid on these contracts is reflected in interest expense.\nLoan agreements require financial services to maintain a minimum ratio of income before income taxes and interest expense to interest expense of 1.25. The fair value of financial services debt was $103,266 and $88,442 at September 30, 1994 and 1993, respectively. At September 30, 1994, debt maturities were $29,725 in 1995, $23,825 in 1996, $24,313 in 1997, $15,250 in 1998 and $7,500 in 1999. Interest paid was $5,141, $5,515 and $6,830 in 1994, 1993 and 1992, respectively.\nAt September 30, 1994, notional amount maturities of interest rate management agreements were $15,217 in 1995, $14,063 in 1996, $6,875 in 1997 and $3,750 in 1998. The fair value of interest rate management agreements was $559 and $(632) at September 30, 1994 and 1993, respectively.\nREVOLVING CREDIT AGREEMENTS\nInformation systems and financial services share variable rate revolving credit agreements which total $60,000 and require commitment fees on unused credit. At September 30, 1994, available balances under these agreements were $31,050.\nFAIR VALUES\nFair values were determined using interest rates available to the company for debt and interest rate management agreements with the same remaining maturities.\n7. CAPITAL STOCK\nDividends on Class A common shares must be twenty times the dividends on Class B common shares and must be paid simultaneously. Each share of Class A common and Class B common is entitled to one vote. A Class B common shareholder may convert twenty Class B common shares to one share of Class A common. In 1994 and 1992, 2,000,000 and 22,997,120 Class B common shares were converted into 100,000 and 1,149,856 Class A common shares, respectively. The company has reserved sufficient authorized Class A common shares for Class B conversions and stock option plans.\nEach outstanding Class A common share has one preferred share purchase right. Each outstanding Class B common share has one-twentieth of a right. Rights become exercisable if a person or group acquires or seeks to acquire, through a tender or exchange offer, 20% or more of the company's Class A common shares. In that event, all holders of Class A common shares and Class B common shares, other than the acquiror, could exercise their rights and purchase preferred shares at a substantial discount. At the date of these financial statements, the company had no agreements or commitments with respect to the sale or issuance of the preferred shares.\nOn February 17, 1994, the company's board of directors approved a two-for-one common stock split. As a result of the split, on March 15, 1994, common shareholders received one additional share for each share held as of March 1, 1994. Par value remained $.625 per Class A common share and $.03125 per Class B common share. The company reclassified $13,199 to Class A common and $188 to Class B common from additional paid-in capital because par value did not change. Share and per share information presented in the accompanying financial statements was restated to reflect the stock split.\nThe company repurchased Class A common shares for treasury at average prices of $23.61 in 1994, $13.50 in 1993 and $10.85 in 1992. The remaining balance of shares authorized for repurchase by the board of directors was 1,925,800 at September 30, 1994. Treasury shares at September 30 were 4,519,512 in 1994, 4,036,246 in 1993 and 3,452,224 in 1992.\n8. EMPLOYEE STOCK OPTION PLANS\nThe company's stock option plans consist of incentive stock options and non-qualified stock options to purchase Class A common shares which are awarded to certain key employees. Stock options are typically granted at a price equal to fair market value on the date of grant. Options may be granted at any price not less than par value ($.625 at September 30, 1994). No options were granted at a price less than fair market value in 1994. At September 30, 1994, options to purchase 880,944 Class A common shares were exercisable and options to purchase 1,366,856 additional Class A common shares were available for future awards.\n9. POSTRETIREMENT BENEFITS\nPENSION EXPENSE\n9. POSTRETIREMENT BENEFITS (continued)\nThe company sponsors non-contributory, defined benefit pension plans for most full-time employees. Pension benefits are based on years of service and compensation during an employee's final ten years of employment. The company's funding policy is to make annual contributions to the plans sufficient to meet or exceed the minimum statutory requirements. The company and its actuaries review the pension plans each year. The actuarial assumptions are intended to reflect expected experience over the life of the pension liability.\nThe company sponsors defined contribution savings plans covering most domestic employees. Generally, contributions are funded monthly and represent 40% of the first 3% of compensation contributed to the plan by participating employees. The company also participates in several multi-employer plans which provide defined benefits to union employees.\nFUNDED STATUS OF DEFINED BENEFIT PENSION PLANS\nAt September 30, 1994, the minimum pension liability was offset by a $5,607 intangible asset and a $387 charge to shareholders' equity net of income taxes. At September 30, 1993 the intangible asset was $3,644 and the charge to shareholders' equity net of income taxes was $1,465. There was no effect on income or cash flow.\nAt September 30, 1994 and 1993, about 56% and 62% of the plans' assets were invested in cash, cash equivalents, U.S. treasury bonds and mortgage backed government agency securities. The balance of the plans' assets were invested in equities.\nACCOUNTING CHANGE\nEffective October 1, 1992, the company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS No. 106 requires accrual of postretirement medical and life insurance benefits over the period in which employees provide services. The company elected to immediately recognize the transition obligation and recorded the cumulative effect of the accounting change of $31,500 ($19,106 or $.44 per share net of income tax benefits) in the first quarter of 1993.\nPOSTRETIREMENT MEDICAL AND LIFE INSURANCE EXPENSE\nIn 1994, the company introduced Retiree Medical Savings Accounts, a company funded defined contribution plan. This plan, which covers substantially all employees, will enable future retirees to purchase postretirement medical insurance from the company. Contributions are funded annually based on the company's return on equity and are the same for each eligible employee.\nThe company sponsors a defined benefit life insurance plan for substantially all employees. Upon retirement, this plan provides for a fixed death benefit to be paid to the designated beneficiary. The company also sponsors a defined benefit medical plan for employees who retired prior to October 1, 1993. The cost sharing provisions of the plan depend on the medical plan provisions in effect at the date of retirement. Effective October 1, 1993, the company no longer provides a defined benefit medical plan for new retirees. Future retirees may purchase postretirement medical insurance from the company using Retiree Medical Savings Accounts. Discounts from the market price of postretirement medical insurance will be provided to certain retirees based on age and length of remaining service as of October 1, 1993. These discounts are included in the determination of the accumulated benefit obligation. The company funds medical and life insurance benefits on a pay-as-you-go basis.\n9. POSTRETIREMENT BENEFITS (continued)\nPOSTRETIREMENT MEDICAL AND LIFE INSURANCE OBLIGATION\nThe effect of a 1% increase in the assumed healthcare cost trend rate would have increased the service and interest cost components of postretirement medical insurance in 1994 by $153 and the accumulated benefit obligation at September 30, 1994 by $2,003.\n10. CASH FLOW STATEMENTS\n11. SEGMENT REPORTING\nThe company operates principally in two industry segments, business forms and computer systems.\nThe business forms segment manufactures and distributes printed business forms and systems, custom continuous and snap out forms, specialty printed products and provides forms management services to automotive, healthcare and general business markets.\nThe computer systems segment provides integrated computer systems products and services to automotive and healthcare markets. The segment's products include integrated software packages and computer hardware, hardware and software installation, customer training and consulting, hardware maintenance, software support and financial services.\n[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]\n11. SEGMENT REPORTING (CONTINUED)\n12. CONTINGENCIES\nThe U.S. Environmental Protection Agency (EPA) has designated the company as one of a number of potentially responsible parties (PRP) under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA) at three environmental remediation sites. The EPA has contended that any company linked to a CERCLA site is potentially liable for all response costs under the legal doctrine of joint and several liability.\nThe first site relates to a privately owned and operated solid waste disposal facility. The EPA has issued a Record of Decision mandating certain remediation activities. The company has shared costs with other PRPs for the remedial investigation and feasibility study of the site. The company believes it is a minor participant, and has accrued its estimated share of response costs as of September 30, 1994. The company believes that the reasonably foreseeable resolution will not have a material adverse effect on the financial statements.\nThe second site involves a municipal waste disposal facility owned and operated by four municipalities. The company joined a PRP coalition and is sharing remedial investigation and feasibility study costs with other PRPs. During the quarter ended June 30, 1994, the PRP coalition received an engineering evaluation\/cost analysis of the presumed remedy for the site from its private contractor. However, because the EPA has not yet selected a remedy, potential remediation costs remain uncertain. Remediation costs for a typical CERCLA site on the National Priorities List average about $30,000. The engineering evaluation\/cost analysis was consistent with this average. During the quarter ended June 30, 1994, the company recorded $1,750 of expense and increased its accrual balance to $2,500 where the balance remained at September 30, 1994. The company believes that the reasonably foreseeable resolution will not have a material adverse effect on the financial statements.\nIn January 1994, by means of a special notice letter, the EPA notified the company that it was considered to be one of more than three hundred PRPs at a former drum reconditioning facility. A remedial investigation and feasibility study is complete. A record of decision has been issued, and a statement of work for the remedial design and remedial action is in circulation. The company was unable to substantiate any previous involvement with this facility and believes that the reasonably foreseeable resolution will not have a material adverse effect on the financial statements.\n[REMAINDER OF PAGE INTENTIONALLY LEFT BLANK]\n13. QUARTERLY FINANCIAL DATA (UNAUDITED)","section_15":""}
{"filename":"63814_1994.txt","cik":"63814","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nMAXXAM Inc. and its majority and wholly owned subsidiaries are collectively referred to herein as the \"Company\" or \"MAXXAM\" unless otherwise indicated or the context indicates otherwise. The Company, through Kaiser Aluminum Corporation (\"Kaiser\") and Kaiser's principal operating subsidiary, Kaiser Aluminum & Chemical Corporation (\"KACC\"), is a fully integrated aluminum company. The Company's voting interest in Kaiser is approximately 58.9% on a fully diluted basis. See \"--Aluminum Operations.\" In addition, the Company is engaged in forest products operations through its wholly owned subsidiary, MAXXAM Group Inc. (\"MGI\") and MGI's wholly owned subsidiaries, The Pacific Lumber Company and its wholly owned subsidiaries (collectively referred to herein as \"Pacific Lumber,\" unless the context indicates otherwise), and Britt Lumber Co., Inc. (\"Britt\"). See \"--Forest Products Operations.\" The Company is also engaged in real estate investment and development, principally through MAXXAM Property Company (and its subsidiaries), MCO Properties Inc. (\"MCOP\"), Palmas del Mar Properties, Inc. and various other wholly owned subsidiaries. See \"--Real Estate Operations.\" The Company, through its subsidiaries, also has various interests in a Class 1 thoroughbred and quarter horse racing facility located in the greater Houston metropolitan area. See \"--Sam Houston Race Park.\" See Note 11 to the Consolidated Financial Statements (contained in the Company's Annual Report to Stockholders--see Item 8) for certain financial information by industry segment and geographic area.\nALUMINUM OPERATIONS\nINDUSTRY OVERVIEW\nPrimary aluminum is produced by the refining of bauxite (the major aluminum-bearing ore) into alumina (the intermediate material) and the reduction of alumina into primary aluminum. Approximately two pounds of bauxite are required to produce one pound of alumina, and approximately two pounds of alumina are required to produce one pound of primary aluminum. Aluminum's valuable physical properties include its light weight, corrosion resistance, thermal and electrical conductivity, and high tensile strength.\nDEMAND The packaging and transportation industries are the principal consumers of aluminum in the United States, Japan, and Western Europe. In the packaging industry, which accounted for approximately 22% of consumption in 1993, aluminum's recyclability and weight advantages have enabled it to gain market share from steel and glass, primarily in the beverage container area. Nearly all beer cans and approximately 95% of the soft drink cans manufactured for the United States market are made of aluminum. Growth in the packaging area is generally expected to continue in the 1990s due to general population increase and to further penetration of the beverage can market in Asia and Latin America, where aluminum cans are a substantially lower percentage of the total beverage container market than in the United States.\nIn the transportation industry, which accounted for approximately 29% of aluminum consumption in the United States, Japan, and Western Europe in 1993, automotive manufacturers use aluminum instead of steel or copper for an increasing number of components, including radiators, wheels, and engines, in order to meet more stringent environmental and fuel efficiency requirements through vehicle weight reduction. Kaiser believes that sales of aluminum to the transportation industry have considerable growth potential due to projected increases in the use of aluminum in automobiles.\nSUPPLY As of year-end 1994, Western world aluminum capacity from 108 smelting facilities was approximately 16.3 million tons per year (all references to tons in this Report are to metric tons of 2,204.6 pounds). Net exports of aluminum from the former Sino Soviet bloc increased approximately threefold from 1990 levels during the period from 1991 through 1994 to approximately two million tons per year. These exports contributed to a significant increase in London Metal Exchange stocks of primary aluminum which peaked in mid-1994. See \"--Recent Industry Trends.\"\nGovernment officials from the European Union, the United States, Canada, Norway, Australia, and the Russian Federation have ratified as a trade agreement a Memorandum of Understanding (the \"Memorandum\") which provided, in part, for (i) a reduction in Russian Federation primary aluminum production by 300,000 tons per year within three months of the date of ratification of the Memorandum and an additional 200,000 tons within the following three months, (ii) improved availability of comprehensive data on Russian aluminum production, and (iii) certain assistance to the Russian aluminum industry. The Memorandum did not require specific levels of production cutbacks by other producing nations. The Memorandum was finalized in February 1994 and is scheduled to remain in effect through the end of 1995.\nBased upon information currently available, Kaiser believes that only moderate additions will be made during 1995-1996 to Western world alumina and primary aluminum production capacity. The increases in alumina capacity during 1995-1996 are expected to come from one new refinery and incremental expansions of existing refineries.\nRECENT INDUSTRY TRENDS The aluminum industry environment improved significantly in 1994 compared to 1993. Prices of primary aluminum were at historic lows in real terms near the beginning of 1994, and prices had nearly doubled by the end of 1994. In response to low prices of primary aluminum in 1993 and the first part of 1994, a number of smelting facilities were partially or fully curtailed. Western world production of primary aluminum declined in 1994 to approximately 14.5 million tons from approximately 15.1 million tons in 1993. Demand for aluminum products was relatively weak in 1993, but became very strong in the United States and became firm in Europe in 1994. Primary aluminum prices improved not only because of improved demand, but also because the inventories of primary aluminum on the London Metal Exchange were substantially reduced in the second half of 1994. However, significant amounts of inventory remained at the end of 1994, and some reduction of prices from year-end 1994 occurred in the first quarter of 1995 to reflect that circumstance.\nWhen previously curtailed smelting capacity is restarted, it will result in an increase in the demand for alumina to supply those operations. In addition, in the last several years large amounts of alumina have been imported into the Commonwealth of Independent States. Consequently, Kaiser believes that alumina demand and prices will strengthen as smelters are restarted.\nSupply and demand fundamentals for the flat-rolled aluminum products business, particularly in the can sheet business, improved in 1994 because of higher demand and a reduction of supply. Kaiser believes that supply and demand for these products will move toward being in balance. The demand for aluminum extrusions and forgings in 1994 also improved compared to 1993, and supply and demand for these products is expected to move toward being in balance.\nOverall, Kaiser believes that there will be relatively strong demand for aluminum for the near future, barring an economic recession. This demand is expected to come both from continued growth in the developed markets through increased penetration of the automotive sector, and from general uses in emerging markets.\nKAISER ALUMINUM\nGENERAL Kaiser operates in all principal aspects of the aluminum industry-- the mining of bauxite, the refining of bauxite into alumina, the production of primary aluminum from alumina, and the manufacture of fabricated (including semi-fabricated) aluminum products. In addition to the production utilized in its operations, Kaiser sells significant amounts of alumina and primary aluminum in domestic and international markets. In 1994, Kaiser produced approximately 2,928,500 tons of alumina, of which approximately 71% was sold to third parties, and produced 415,000 tons of primary aluminum, of which approximately 54% was sold to third parties. Kaiser is also a major domestic supplier of fabricated aluminum products. In 1994, Kaiser shipped approximately 399,000 tons of fabricated aluminum products to third parties, which accounted for approximately 6% of the total tonnage of United States domestic shipments in 1994. A majority of Kaiser's fabricated products are used by customers as components in the manufacture and assembly of finished end-use products.\nThe following table sets forth total shipments and intracompany transfers of Kaiser's alumina, primary aluminum, and fabricated aluminum operations:\nSENSITIVITY TO PRICES AND HEDGING PROGRAMS Kaiser's operating results are sensitive to changes in the prices of alumina, primary aluminum, and fabricated aluminum products, and also depend to a significant degree upon the volume and mix of all products sold and on Kaiser's hedging strategies. Through its variable cost structures, forward sales, and hedging programs, Kaiser has attempted to mitigate its exposure to possible declines in the market prices of alumina, primary aluminum, and fabricated aluminum products while retaining the ability to participate in favorable pricing environments that may materialize. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends--Aluminum Operations--Sensitivity to Prices and Hedging Programs.\"\nPRODUCTION OPERATIONS Kaiser's operations are conducted through decentralized business units which compete throughout the aluminum industry.\n- The alumina business unit, which mines bauxite and obtains additional bauxite tonnage under long-term contracts, produced approximately 8% of Western world alumina in 1994. During 1994, Kaiser utilized approximately 80% of its bauxite production at its alumina refineries and the remainder was either sold to third parties or tolled into alumina by a third party. In addition, during 1994 Kaiser utilized approximately 29% of its alumina for internal purposes and sold the remainder to third parties. Kaiser's share of total Western world alumina capacity was approximately 8% in 1994.\n- The primary aluminum products business unit operates two domestic smelters wholly owned by Kaiser and two foreign smelters in which Kaiser holds significant ownership interests. In 1994, Kaiser utilized approximately 46% of its primary aluminum for internal purposes and sold the remainder to third parties. Kaiser's share of total Western world primary aluminum capacity was approximately 3% in 1994.\n- Fabricated aluminum products are manufactured by three business units--flat-rolled products, extruded products, and forgings-- which manufacture a variety of fabricated products (including body, lid, and tab stock for beverage containers, sheet and plate products, screw machine stock, redraw rod, forging stock, truck wheels and hubs, air bag canisters, and other forgings and extruded products) and operate plants located in principal marketing areas of the United States and Canada. Substantially all of the primary aluminum utilized in Kaiser's fabricated products operations is obtained internally, with the balance of the metal utilized in its fabricated products operations obtained from scrap metal purchases.\nALUMINA The following table lists Kaiser's bauxite mining and alumina refining facilities as of December 31, 1994:\nBauxite mined in Jamaica by Kaiser Jamaica Bauxite Company (\"KJBC\") is refined into alumina at Kaiser's plant at Gramercy, Louisiana, or is sold to third parties. In 1979, the Government of Jamaica granted Kaiser a mining lease for the mining of bauxite sufficient to supply Kaiser's then- existing Louisiana alumina refineries at their annual capacities of 1,656,000 tons per year until January 31, 2020. Alumina from the Gramercy plant is sold to third parties. Kaiser has entered into a series of medium-term contracts for the supply of natural gas to the Gramercy plant. The price of such gas varies based upon certain spot natural gas prices. However, for 1995 Kaiser has established a fixed price for a portion of the delivered gas through a hedging program.\nAlumina Partners of Jamaica (\"Alpart\") holds bauxite reserves and owns a 1,450,000 tons per year alumina plant located in Jamaica. Kaiser has a 65% interest in Alpart and Hydro Aluminium Jamaica a.s (\"Hydro\") owns the remaining 35% interest. Kaiser has management responsibility for the facility on a fee basis. Kaiser and Hydro have agreed to be responsible for their proportionate shares of Alpart's costs and expenses. The Government of Jamaica has granted Alpart a mining lease and has entered into other agreements with Alpart designed to assure that sufficient reserves of bauxite will be available to Alpart to operate its refinery as it may be expanded to a capacity of 2,000,000 tons per year through the year 2024.\nIn mid-1990, Alpart entered into a five-year agreement for the supply of substantially all of its fuel oil, the refinery's primary energy source. In February 1992, this agreement was extended to 1996 and the quantity of fuel oil to be supplied was increased. The price for 80% of the initial quantity remains fixed at a price which prevailed in the fourth quarter of 1989; the price for 80% of the increased quantity is fixed at a negotiated price; and the price for the balance of the initial and increased quantities was based upon certain spot fuel oil prices plus transportation costs. Alpart has purchased all of the quantities of fuel oil which could be purchased based upon certain spot fuel oil prices under both the initial and extended agreements.\nAlpart has entered into an agreement for the supply of substantially all of its fuel oil through 1996. The balance of Alpart's fuel oil requirements through 1996 will be purchased in the spot market.\nKaiser holds a 28.3% interest in Queensland Alumina Limited (\"QAL\"), which owns the largest and one of the most efficient alumina refineries in the world, located in Queensland, Australia. QAL refines bauxite into alumina, essentially on a cost basis, for the account of its stockholders pursuant to long-term tolling contracts. The stockholders, including Kaiser, purchase bauxite from another QAL stockholder pursuant to long-term supply contracts. Kaiser has contracted to take approximately 751,000 tons per year of capacity or pay standby charges. Kaiser is unconditionally obligated to pay amounts calculated to service its share ($78.7 million at December 31, 1994) of certain debt of QAL, as well as other QAL costs and expenses, including bauxite shipping costs. QAL's annual production capacity is approximately 3,300,000 tons, of which approximately 934,000 tons are available to Kaiser.\nKaiser's principal customers for bauxite and alumina consist of large and small domestic and international aluminum producers that purchase bauxite and reduction-grade alumina for use in their internal refining and smelting operations and trading intermediaries who resell raw materials to end-users. In 1994, Kaiser sold all of its bauxite to one customer, and sold alumina to 12 customers, the largest and top five of which accounted for approximately 19% and 82% of such sales, respectively. Among alumina producers, Kaiser believes it is now the world's second largest seller of alumina to third parties. Kaiser's strategy is to sell a substantial portion of the bauxite and alumina available to it in excess of its internal refining and smelting requirements pursuant to multi-year sales contracts. Marketing and sales efforts are conducted by executives of the alumina business unit and Kaiser. See Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends--Aluminum Operations-- Sensitivity to Prices and Hedging Programs.\"\nPRIMARY ALUMINUM PRODUCTS The following table lists Kaiser's primary aluminum smelting facilities as of December 31, 1994:\nKaiser owns two smelters located at Mead and Tacoma, Washington, where alumina is processed into primary aluminum. The Mead facility uses pre-bake technology and produces primary aluminum, almost all of which is used at Kaiser's Trentwood fabricating facility and the balance of which is sold to third parties. The Tacoma plant uses Soderberg technology and produces primary aluminum and high-grade, continuous-cast, redraw rod, which currently commands a premium price in excess of the price of primary aluminum. Both smelters have achieved significant production efficiencies in recent years through retrofit technology, cost controls, and semi- variable wage and power contracts, leading to increases in production volume and enhancing their ability to compete with newer smelters. At the Mead plant, Kaiser has converted to welded anode assemblies to increase energy efficiency, extended the anode life-cycle in the smelting process, changed from pencil to liquid pitch to produce carbon anodes which achieved environmental and operating savings, and engaged in efforts to increase production through the use of improved, higher-efficiency reduction cells.\nElectrical power represents an important production cost for Kaiser at its Mead and Tacoma smelters. The basic electricity supply contract between the Bonneville Power Administration (the \"BPA\") and Kaiser expires in 2001. The electricity contracts between the BPA and its direct service industry customers (which consist of 15 energy intensive companies, principally aluminum producers, including Kaiser) permit the BPA to interrupt up to 25% of the amount of power which it normally supplies to such customers. Kaiser has operated its Mead and Tacoma smelters in Washington at approximately 75% of their full capacity since January 1993, when three reduction potlines were removed from production (two at its Mead smelter and one at its Tacoma smelter) in response to a power reduction imposed by the BPA. Although full BPA power was restored as of April 1, 1994, a 25% power reduction was imposed again by the BPA as of August 1, 1994, which reduction continued through November 30, 1994. Full BPA power was restored on December 1, 1994, and the BPA has stated that it expects to be able to provide full service through November 30, 1995. Kaiser has operated its Trentwood fabrication facility without curtailment of its production.\nThrough June 1996, Kaiser pays for power on a basis which varies, within certain limits, with the market price of primary aluminum, and thereafter Kaiser will pay for power at rates to be negotiated. Effective October 1, 1993, an increase in the base rate the BPA charged to its direct service industry customers for electricity was adopted, and that rate is expected to remain in effect through September 1995. In February 1995, the BPA issued an initial rate increase announcement which proposed a 5.4% increase to the direct service industry customers. If the proposed increase becomes effective, it would increase production costs at the Mead and Tacoma smelters by approximately $5.0 million per year based on the current operating rate of those smelters. A rate increase could take effect as early as October 1995; however, there is no certainty that the proposed rate increase, or any rate increase, will become effective in October 1995 or at any later time.\nKaiser manages, and holds a 90% interest in, the Volta Aluminium Company Limited (\"Valco\") aluminum smelter in Ghana. The Valco smelter uses pre-bake technology and processes alumina supplied by Kaiser and the other participant into primary aluminum under long-term tolling contracts which provide for proportionate payments by the participants in amounts intended to pay not less than all of Valco's operating and financing costs. Kaiser's share of the primary aluminum is sold to third parties. Power for the Valco smelter is supplied under an agreement which expires in 2017. The agreement indexes two-thirds of the price of the contract quantity to the market price of primary aluminum. The agreement also provides for a review and adjustment of the base power rate and the price index every five years. The most recent review was completed in April 1994 for the 1994- 1998 period. Valco has entered into an agreement with the government of Ghana under which Valco has been assured (except in cases of force majeure) that it will receive sufficient electric power to operate at its current level of three and one-half potlines through December 31, 1996, and under which Valco may be assured (except in cases of force majeure) of sufficient electric power to operate up to four and one-half potlines in 1996 if a specified minimum amount of water from which hydroelectric power may be generated is stored behind Okosombo Dam. Kaiser believes that with normal rainfall during 1995 and 1996, Valco should have available sufficient electric power to operate at its current level during 1995 and 1996.\nKaiser has a 49% interest in the Anglesey Aluminium Limited (\"Anglesey\") aluminum smelter and port facility at Holyhead, Wales. The Anglesey smelter uses pre-bake technology. Kaiser supplies 49% of Anglesey's alumina requirements and purchases 49% of Anglesey's aluminum output. Kaiser sells its share of Anglesey's output to third parties. Power for the Anglesey aluminum smelter is supplied under an agreement which expires in 2001.\nKaiser has developed and installed proprietary retrofit technology in all of its smelters. This technology--which includes the redesign of the cathodes and anodes that conduct electricity through reduction cells, improved \"feed\" systems that add alumina to the cells, and a computerized system that controls energy flow in the cells--enhances Kaiser's ability to compete more effectively with the industry's newer smelters. Kaiser is actively engaged in efforts to license this technology and sell technical and managerial assistance to other producers worldwide, and may participate in joint ventures or similar business partnerships which employ Kaiser's technical and managerial knowledge. See \"--Research and Development.\"\nKaiser's principal primary aluminum customers consist of large trading intermediaries and metal brokers, who resell primary aluminum to fabricated product manufacturers, and large and small international aluminum fabricators. In 1994, Kaiser sold the approximately 54% of its primary aluminum production not utilized for internal purposes to approximately 35 customers, the largest and top five of which accounted for approximately 25% and 68% of such sales, respectively. Marketing and sales efforts are conducted by a small staff located at the business unit's headquarters in Pleasanton, California, and by senior executives of Kaiser who participate in the structuring of major sales transactions. A majority of the business unit's sales are based upon long-term relationships with metal merchants and end-users. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends--Aluminum Operations-- Sensitivity to Prices and Hedging Programs.\"\nFABRICATED ALUMINUM PRODUCTS Kaiser manufactures and markets fabricated aluminum products for the packaging, transportation, construction, and consumer durables markets in the United States and abroad. Sales in these markets are made directly and through distributors to a large number of customers, both domestic and foreign. In 1994, seven domestic beverage container manufacturers constituted the leading customers for Kaiser's fabricated products and accounted for approximately 17% of Kaiser's sales revenue.\nKaiser's fabricated products compete with those of numerous domestic and foreign producers and with products made with steel, copper, glass, plastic, and other materials. Product quality, price, and availability are the principal competitive factors in the market for fabricated aluminum products. Kaiser has refocused its fabricated products operations to concentrate on selected products in which Kaiser has production expertise, high quality capability, and geographic and other competitive advantages. See also \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends--Aluminum Operations--Sensitivity to Prices and Hedging Programs.\"\nFlat-Rolled Products. The flat-rolled products business unit, the largest of Kaiser's fabricated products businesses, operates the Trentwood sheet and plate mill at Spokane, Washington. The Trentwood facility is Kaiser's largest fabricating plant and accounted for substantially more than one-half of Kaiser's 1994 fabricated aluminum products shipments. The business unit supplies the beverage container market (producing body, lid, and tab stock), the aerospace market, and the tooling plate, heat-treated alloy and common alloy coil markets, both directly and through distributors. Kaiser announced in October 1993 that it was restructuring its flat-rolled products operation at its Trentwood plant to reduce that facility's annual operating costs. The Trentwood restructuring is expected to result in annual cost savings of at least $50.0 million after it has been fully implemented (which is expected to occur by the end of 1995). In connection with the restructuring, the number of salaried employees at Trentwood has been reduced, and it is anticipated that a 25% reduction in the hourly workforce at Trentwood will be achieved by the end of 1995.\nKaiser's flat-rolled products are sold primarily to beverage container manufacturers located in the western United States and in the Asian Pacific Rim countries where the Trentwood plant's location provides Kaiser with a transportation advantage. Quality of products for the beverage container industry and timeliness of delivery are the primary bases on which Kaiser competes. Kaiser believes that its capital improvements at Trentwood have enhanced the quality of its products for the beverage container industry and the capacity and efficiency of its manufacturing operations and that it is one of the highest quality producers of aluminum beverage can stock in the world.\nIn 1994, the flat-rolled products business unit had 26 foreign and domestic can stock customers, the majority of which were beverage can manufacturers (including five of the six major domestic beverage can manufacturers) and the balance of which were brewers. The largest and top five of such customers accounted for approximately 26% and 51%, respectively, of the business unit's sales revenue. In 1994, the business unit shipped products to over 200 customers in the aerospace, transportation, and industrial (\"ATI\") markets, most of which were distributors who sell to a variety of industrial end-users. The top five customers in the ATI markets for flat-rolled products accounted for approximately 12% of the business unit's sales revenue. The marketing staff for the flat-rolled products business unit is located at the Trentwood facility and in Pleasanton, California. Sales are made directly to customers (including distributors) from eight sales offices located throughout the United States. International customers are served by sales offices in the Netherlands and Japan and by independent sales agents in Asia and Latin America.\nExtruded Products. The extruded products business unit is headquartered in Dallas, Texas, and operates soft-alloy extrusion facilities in Los Angeles, California; Santa Fe Springs, California; Sherman, Texas; and London, Ontario, Canada; a cathodic protection business located in Tulsa, Oklahoma that also extrudes both aluminum and magnesium; rod and bar facilities in Newark, Ohio, a facility in Jackson, Tennessee, which produce screw machine stock, redraw rod, forging stock, and billet; and a facility in Richland, Washington, which is expected to be in full operation in the second quarter of 1995 and which will produce seamless tubing in both hard and soft alloys for the automotive, other transportation, export, recreation, agriculture, and other industrial markets. Each of the soft-alloy extrusion facilities has fabricating capabilities and provides finishing services. The extruded products business unit's major markets are in the transportation industry, to which it provides extruded shapes for automobiles, trucks, trailers, cabs, and shipping containers, and distribution, durable goods, defense, building and construction, ordnance, and electrical markets. In 1994, the extruded products business unit had over 950 customers for its products, the largest and top five of which accounted for approximately 6% and 20%, respectively, of its sales revenue. Sales are made directly from plants as well as marketing locations across the United States.\nForgings. The forgings business unit operates forging facilities at Erie, Pennsylvania; Oxnard, California; and Greenwood, South Carolina; and a machine shop at Greenwood, South Carolina. The forgings business unit is one of the largest producers of aluminum forgings in the United States and is a major supplier of high-quality forged parts to customers in the automotive, commercial vehicle, and ordnance markets. The high strength- to-weight properties of forged aluminum make it particularly well suited for automotive applications. In 1994, the forgings business unit had over 300 customers for its products, the largest and top five of which accounted for approximately 30% and 69%, respectively, of the forgings business unit's sales revenue. The forgings business unit's headquarters is located in Erie, Pennsylvania, and additional sales, marketing, and engineering groups are located in the midwestern and western United States.\nCOMPETITION Aluminum products compete in many markets with steel, copper, glass, plastic, and numerous other materials. Within the aluminum business, Kaiser competes with both domestic and foreign producers of bauxite, alumina, and primary aluminum, and with domestic and foreign fabricators. Many of Kaiser's competitors have greater financial resources than Kaiser. Kaiser's principal competitors in the sale of alumina include Alcoa of Australia Ltd., Glencore Ltd., and Pechiney S.A. Kaiser competes with most aluminum producers in the sale of primary aluminum.\nPrimary aluminum and, to some degree, alumina are commodities with generally standard qualities, and competition in the sale of these commodities is based primarily upon price, quality, and availability. Kaiser also competes with a wide range of domestic and international fabricators in the sale of fabricated aluminum products. Competition in the sale of fabricated products is based upon quality, availability, price, and service, including delivery performance. Kaiser concentrates its fabricating operations on selected products in which Kaiser has production expertise, high quality capability, and geographic and other competitive advantages. Kaiser believes that, assuming the current relationship between worldwide supply and demand for alumina and primary aluminum does not change materially, the loss of any one of Kaiser's customers, including intermediaries, would not have a material adverse effect on Kaiser' business or operations.\nRESEARCH AND DEVELOPMENT Kaiser conducts research and development activities principally at four facilities - the Center for Technology (\"CFT\") in Pleasanton, California; the Primary Aluminum Products Division Technology Center (\"DTC\") adjacent to the Mead smelter in Washington; the Alumina Development Laboratory (\"ADL\") at the Gramercy, Louisiana refinery and the Automotive Product Development Office located near Detroit, Michigan. Net expenditures for Company-sponsored research and development activities were $16.7 million in 1994, $18.5 million in 1993, and $13.5 million in 1992. Kaiser's research staff totaled 166 at December 31, 1994. Kaiser estimates that research and development net expenditures will be in the range of approximately $20.0 - $22.0 million in 1995.\nCFT performs research and development across a range of aluminum process and product technologies to support the business units of Kaiser and new business opportunities and selectively offers technical services to third parties. The largest and most notable single project being developed at CFT is a \"micromill\" process for producing can body sheet. The micromill concept allows elimination of a large share of the traditional ingot process and a dramatic reduction in equipment and processing costs. A pilot facility has been constructed and operated at CFT. Based on the results achieved so far, Kaiser hopes to finalize in 1995 plans for construction of a full-scale commercial micromill.\nDTC maintains specialized laboratories and a miniature carbon plant where experiments with new anode and cathode technology are performed. ADL provides improved alumina process technology to Kaiser facilities and technical support to new business ventures in cooperation with Kaiser's international business development group. The Automotive Product Development Office is a sales and application engineering facility located near Detroit-area carmakers and works with customers, CFT and plant personnel, to create new automotive component designs and improve existing products.\nKaiser is actively engaged in efforts to license its technology and sell technical and managerial assistance to other producers worldwide. Pursuant to various arrangements, Kaiser's technology has been installed in alumina refineries, aluminum smelters and rolling mills located in the United States, Sweden, Germany, Russia, India, Australia, Korea, New Zealand, Ghana, the United Kingdom, Jamaica and Europe. Kaiser's technology sales and revenue from technical assistance to third parties were $10.0 million in 1994, $12.8 million in 1993, and $14.1 million in 1992.\nEMPLOYEES During 1994, Kaiser employed an average of 9,740 persons, compared with an average of 10,220 employees in 1993, and 10,130 employees in 1992. At December 31, 1994, Kaiser's work force was approximately 9,500, including a domestic work force of approximately 5,800, of whom approximately 4,000 were paid at an hourly rate. Most hourly paid domestic employees are covered by collective bargaining agreements with various labor unions. Approximately 71% of such employees are covered by a master agreement (the \"Labor Contract\") with the United Steelworkers of America (\"USWA\") which expires on September 30, 1998. The Labor Contract covers Kaiser's plants in Spokane (Trentwood and Mead) and Tacoma, Washington; Gramercy, Louisiana; and Newark, Ohio.\nThe Labor Contract provides for base wages at all covered plants. In addition, workers covered by the Labor Contract may receive quarterly bonus payments based on various indices of profitability, productivity, efficiency, and other aspects of specific plant performance, as well as, in certain cases, the price of alumina or primary aluminum. Pursuant to the Labor Contract, base wage rates were raised effective January 2, 1995 and will be raised an additional amount effective November 6, 1995 and November 3, 1997, and an amount in respect of the cost of living adjustment under the previous master agreement will be phased into base wages during the term of the Labor Contract. In the second quarter of 1995, Kaiser will acquire up to $2,000 of preference stock held in a stock plan for the benefit of each of approximately 82% of the employees covered by the Labor Contract and in the first half of 1998 up to an additional $4,000 of such preference stock held in such plan for the benefit of substantially the same employees. In addition, if a profitability test is satisfied, Kaiser will acquire during 1996 or 1997 up to an additional $1,000 of such preference stock held in such plan for the benefit of substantially the same employees. Kaiser will make comparable acquisitions of preference stock held for the benefit of each of certain salaried employees. Kaiser considers its employee relations to be satisfactory.\nSee also Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends--Aluminum Operations--Labor Matters.\"\nENVIRONMENTAL MATTERS Kaiser is subject to a wide variety of international, state, and local environmental laws and regulations (\"Environmental Laws\") which continue to be adopted and amended. The Environmental Laws regulate, among other things, air and water emissions and discharges; the generation, storage, treatment, transportation, and disposal of solid and hazardous waste; the release of hazardous or toxic substances, pollutants and contaminants into the environment; and, in certain instances, the environmental condition of industrial property prior to transfer or sale. In addition, Kaiser is subject to various federal, state, and local workplace health and safety laws and regulations (\"Health Laws\").\nFrom time to time, Kaiser is subject, with respect to its current and former operations, to fines or penalties assessed for alleged breaches of the Environmental and Health Laws and to claims and litigation brought by federal, state or local agencies and by private parties seeking remedial or other enforcement action under the Environmental and Health Laws or damages related to alleged injuries to health or to the environment, including claims with respect to certain waste disposal sites and the remediation of sites presently or formerly operated by Kaiser. See \"Item 3. Legal Proceedings--Kaiser Environmental Litigation.\" Kaiser currently is subject to a number of lawsuits under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended by the Superfund Amendments and Reauthorization Act of 1986 (\"CERCLA\"). Kaiser, along with certain other entities, has been named as a Potentially Responsible Party (\"PRP\") for remedial costs at certain third-party sites listed on the National Priorities List under CERCLA and, in certain instances, may be exposed to joint and several liability for those costs or damages to natural resources. Kaiser's Mead, Washington, facility has been listed on the National Priorities List under CERCLA. In addition, in connection with certain of its asset sales, Kaiser has indemnified the purchasers of assets with respect to certain liabilities (and associated expenses) resulting from acts or omissions arising prior to such dispositions, including environmental liabilities. While uncertainties are inherent in the final outcome of these matters, and it is presently impossible to determine the actual costs that ultimately may be incurred, Management believes that the resolution of such uncertainties should not have a material adverse effect on the Company's consolidated financial position or results of operations.\nEnvironmental capital spending was $11.9 million in 1994, $12.6 million in 1993, and $13.1 million in 1992. Annual operating costs for pollution control, not including corporate overhead or depreciation, were approximately $23.1 million in 1994, $22.4 million in 1993, and $21.6 million in 1992. Legislative, regulatory, and economic uncertainties make it difficult to project future spending for these purposes. However, Kaiser currently anticipates that in the 1995-1996 period, environmental capital spending will be within the range of approximately $15.0 - $18.0 million per year, and operating costs for pollution control will be within the range of $25.0 - $27.0 million per year. In addition, $3.6 million in cash expenditures in 1994, $7.2 million in 1993, and $9.6 million in 1992 were charged to previously established reserves relating to environmental cost. Approximately $11.4 million is expected to be charged to such reserves in 1995.\nSee also Note 9 to the Consolidated Financial Statements.\nOTHER Kaiser's obligations under its 1994 Credit Agreement are secured by, among other things, mortgages on Kaiser's plants located in Spokane (the Trentwood and Mead plants) and Tacoma, Washington; Erie, Pennsylvania; Newark, Ohio; and Sherman, Texas.\nFOREST PRODUCTS OPERATIONS\nGENERAL\nThe Company also engages in forest products operations through MGI and MGI's wholly owned subsidiaries, Pacific Lumber and Britt. Pacific Lumber, which has been in continuous operation for 125 years, engages in all principal aspects of the lumber industry--the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber products and the manufacturing of lumber into a variety of value-added finished products. Britt manufactures redwood and cedar fencing and decking products from small diameter logs, a substantial portion of which Britt acquires from Pacific Lumber.\nPACIFIC LUMBER OPERATIONS\nTIMBERLANDS Pacific Lumber owns and manages approximately 189,000 acres of commercial timberlands in Humboldt County in northern California. These timberlands contain approximately three-quarters redwood and one-quarter Douglas-fir timber. Pacific Lumber's acreage is virtually contiguous, is located in close proximity to its sawmills and contains an extensive (1,100 mile) network of roads. These factors significantly reduce harvesting costs and facilitate Pacific Lumber's forest management techniques. The extensive roads throughout Pacific Lumber's timberlands facilitate log hauling, serve as fire breaks and allow Pacific Lumber's foresters access to employ forest stewardship techniques which protect the trees from forest fires, erosion, insects and other damage.\nApproximately 179,000 acres of Pacific Lumber's timberlands are owned by Scotia Pacific Holding Company (the \"SPHC Timberlands\"), a special purpose Delaware corporation and wholly owned subsidiary of Pacific Lumber. Pacific Lumber has the exclusive right to harvest (the \"Pacific Lumber Harvest Rights\") approximately 8,000 non-contiguous acres of the SPHC Timberlands consisting substantially of virgin old growth redwood and virgin old growth Douglas-fir timber located on numerous small parcels throughout the SPHC Timberlands. Substantially all of SPHC's assets, including the SPHC Timberlands, are pledged as security for SPHC's 7.95% Timber Collateralized Notes due 2015 (the \"Timber Notes\"). Pacific Lumber harvests and purchases from SPHC all or substantially all of the logs harvested from the Subject Timberlands. See \"--Pacific Lumber Operations-- Relationships among Pacific Lumber, SPHC and Britt Lumber\" for a description of this and other relationships among Pacific Lumber, SPHC and Britt.\nThe forest products industry grades lumber in various classifications according to quality. The two broad categories within which all grades fall, based on the absence or presence of knots, are called \"upper\" and \"common\" grades, respectively. \"Old growth\" trees, often defined as trees which have been growing for approximately 200 years or longer, have a higher percentage of upper grade lumber than \"young growth\" trees (those which have been growing for less than 200 years). \"Virgin\" old growth trees are located in timber stands that have not previously been harvested. \"Residual\" old growth trees are located in timber stands which have been selectively harvested in the past.\nPacific Lumber has engaged in extensive efforts, at relatively low cost, to supplement the natural regeneration of timber and increase the amount of timber on its timberlands. Regeneration of redwood timber generally is accomplished through the natural growth of redwood sprouts from the stump remaining after a redwood tree is harvested. Such new redwood sprouts grow quickly, thriving on existing mature root systems. In addition, Pacific Lumber supplements natural redwood generation by planting redwood seedlings. Douglas-fir timber grown on Pacific Lumber's timberlands is regenerated almost entirely by planting seedlings. During the 1993-94 planting season (December through March), Pacific Lumber planted approximately 554,000 redwood and Douglas-fir seedlings.\nHARVESTING PRACTICES The ability of Pacific Lumber to sell logs or lumber products will depend, in part, upon its ability to obtain regulatory approval of timber harvesting plans (\"THPs\"). THPs are required to be filed with the California Department of Forestry (\"CDF\") prior to the harvesting of timber and are designed to comply with existing environmental laws and regulations. The CDF's evaluation of proposed THPs incorporates review and analysis of such THPs provided by several California and federal agencies and public comments received with respect to such THPs. An approved THP is applicable to specific acreage and specifies the harvesting method and other conditions relating to the harvesting of the timber covered by such THP. The method of harvesting as set forth in a THP is chosen from among a number of accepted methods based upon suitability to the particular site conditions. Pacific Lumber maintains a detailed geographical information system covering its timberlands (the \"GIS\"). The GIS covers numerous aspects of Pacific Lumber's properties, including timber type, tree class, wildlife data, roads, rivers and streams. By carefully monitoring and updating this data base, Pacific Lumber's foresters are able to develop detailed THPs which are required to be filed with and approved by the CDF prior to the harvesting of timber. Pacific Lumber also utilizes a Global Positioning System (\"GPS\") which allows precise location of geographic features through satellite positioning. Use of the GPS greatly enhances the quality and efficiency of GIS data.\nPacific Lumber principally harvests trees through selective harvesting, which harvests only a portion of the trees in a given area, as opposed to clearcutting, which harvests an entire area of trees in one logging operation. Selective harvesting generally accounts for over 90% (by volume on a net board foot basis) of Pacific Lumber's timber harvest in any given year. Harvesting by clearcutting is used only when selective harvesting methods are impractical due to unique conditions. Selective harvesting allows the remaining trees to obtain more light, nutrients and water thereby promoting faster growth rates. Due to the size of its timberlands and conservative harvesting practices, Pacific Lumber has historically conducted harvesting operations on approximately 5% of its timberlands in any given year.\nSee also Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends--Forest Products Operations.\"\nPRODUCTION FACILITIES Pacific Lumber owns four highly mechanized sawmills and related facilities located in Scotia, Fortuna and Carlotta, California. The sawmills historically have been supplied almost entirely from timber harvested from Pacific Lumber's timberlands. Since 1986, Pacific Lumber has implemented numerous technological advances which have increased the operating efficiency of its production facilities and the recovery of finished products from its timber. Over the past three years, Pacific Lumber's annual lumber production has averaged approximately 259 million board feet, with approximately 286, 228 and 264 million board feet produced in 1994, 1993 and 1992, respectively. Pacific Lumber operates a finishing plant which processes rough lumber into a variety of finished products such as trim, fascia, siding and paneling. These finished products include the industry's largest variety of customized trim and fascia patterns. Pacific Lumber also enhances the value of some grades of common grade lumber by cutting out knot-free pieces and reassembling them into longer or wider pieces in Pacific Lumber's state-of-the-art end and edge glue plant. The result is a standard sized upper grade product which can be sold at a significant premium over common grade products. Pacific Lumber owns and operates 34 kilns, having an annual capacity of approximately 95 million board feet, to dry its upper grades of lumber efficiently in order to produce a quality, premium product. Pacific Lumber also maintains several large enclosed storage sheds which hold approximately 25 million board feet of lumber.\nIn addition, Pacific Lumber owns and operates a modern 25-megawatt cogeneration power plant which is fueled almost entirely by the wood residue from Pacific Lumber's milling and finishing operations. This power plant generates substantially all of the energy requirements of Scotia, California, the town adjacent to Pacific Lumber's timberlands owned by Pacific Lumber where several of its manufacturing facilities are located. Pacific Lumber sells surplus power to Pacific Gas and Electric Company. In 1994, the sale of surplus power to Pacific Gas and Electric Company accounted for approximately 2% of Pacific Lumber's total revenues.\nPRODUCTS Lumber. Pacific Lumber primarily produces and markets lumber. In 1994, Pacific Lumber sold approximately 272 million board feet of lumber, which accounted for approximately 82% of Pacific Lumber's total revenues. Lumber products vary greatly by the species and quality of the timber from which it is produced. Lumber is sold not only by grade (such as \"upper\" grade versus \"common\" grade), but also by board size and the drying process associated with the lumber.\nRedwood lumber is Pacific Lumber's largest product category, constituting approximately 77% of Pacific Lumber's total lumber revenues and 63% of Pacific Lumber's total revenues in 1994. Redwood is commercially grown only along the northern coast of California and possesses certain unique characteristics which permit it to be sold at a premium to many other wood products. Such characteristics include its natural beauty, superior ability to retain paint and other finishes, dimensional stability and innate resistance to decay, insects and chemicals. Upper grade redwood lumber, which is derived primarily from old growth trees and is characterized by an absence of knots and other defects and a very fine grain, is used primarily in more costly and distinctive interior and exterior applications. During 1994, upper grade redwood lumber products accounted for approximately 17% of Pacific Lumber's total lumber production volume (on a net board foot basis), 41% of its total lumber revenues and 33% of its total revenues. Common grade redwood lumber, Pacific Lumber's largest volume product, has many of the same aesthetic and structural qualities of redwood uppers, but has some knots, sapwood and a coarser grain. In 1994, common grade redwood lumber accounted for approximately 58% of Pacific Lumber's total lumber production volume (on a net board foot basis), 36% of its total lumber revenues and 29% of its total revenues.\nDouglas-fir lumber is used primarily for new construction and some decorative purposes and is widely recognized for its strength, hard surface and attractive appearance. Douglas-fir is grown commercially along the west coast of North America and in Chile and New Zealand. Upper grade Douglas-fir lumber is derived primarily from old growth Douglas-fir timber and is used principally in finished carpentry applications. In 1994, upper grade Douglas-fir lumber accounted for approximately 3% of Pacific Lumber's total lumber production volume (on a net board foot basis), 7% of its total lumber revenues and 5% of its total revenues. Common grade Douglas-fir lumber is used for a variety of general construction purposes and is largely interchangeable with common grades of other whitewood lumber. In 1994, common grade Douglas-fir lumber accounted for approximately 20% of Pacific Lumber's total lumber production volume, 13% of its total lumber revenues and 10% of its total revenues.\nLogs. Pacific Lumber currently sells certain logs that, due to their size or quality, cannot be efficiently processed by its mills into lumber. The purchasers of these logs are largely Britt, and surrounding mills which do not own sufficient timberlands to support their mill operations. In 1994, log sales accounted for approximately 9% of Pacific Lumber's total revenues. See \"--Relationships among Pacific Lumber, SPHC and Britt Lumber\" below. Except for the agreement with Britt described below, Pacific Lumber does not have any significant contractual relationships with any third parties relating to the purchase of logs. Pacific Lumber has historically not purchased significant quantities of logs from third parties; however, Pacific Lumber may from time to time purchase logs from third parties for processing in its mills or for resale to third parties if, in the opinion of management, economic factors are advantageous to the Company. See also Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations-- Forest Products Operations--Operating Income\" for a description of 1993 log purchases by Pacific Lumber due to inclement weather conditions.\nWood Chips. In 1990, Pacific Lumber installed a whole-log chipper to produce wood chips from hardwood trees which were previously left as waste. These chips primarily are sold to third parties for the production of facsimile and other specialty papers. In 1994, hardwood chips accounted for approximately 4% of Pacific Lumber's total revenues. Pacific Lumber also produces softwood chips from the wood residue and waste from its milling and finishing operations. In 1994, softwood chips accounted for approximately 4% of Pacific Lumber's total revenues.\nBACKLOG AND SEASONALITY Pacific Lumber's backlog of sales orders at December 31, 1994 and 1993 was approximately $11.9 million and $16.0 million, respectively, the substantial portion of which was delivered in the first quarter of the succeeding fiscal year. Pacific Lumber has historically experienced lower first and fourth quarter sales due largely to the general decline in construction-related activity during the winter months. As a result, Pacific Lumber's results in any one quarter are not necessarily indicative of results to be expected for the full year.\nMARKETING The housing, construction and remodeling markets are the primary markets for Pacific Lumber's lumber products. Pacific Lumber's policy is to maintain a wide distribution of its products both geographically and in terms of the number of customers. Pacific Lumber sells its lumber products throughout the country to a variety of accounts, the large majority of which are wholesalers, followed by retailers, industrial users, exporters and manufacturers. Upper grades of redwood and Douglas-fir lumber are sold throughout the entire United States, as well as to export markets. Common grades of redwood lumber are sold principally west of the Mississippi river, with California accounting for approximately 55% of these sales in 1994. Common grades of Douglas-fir lumber are sold primarily in California. In 1994, no single customer accounted for more than 4% of Pacific Lumber's total revenues. Exports of lumber accounted for approximately 4% of Pacific Lumber's total lumber revenues in 1994. Pacific Lumber markets its products through its own sales staff which focuses primarily on domestic sales.\nCOMPETITION Pacific Lumber's lumber is sold in highly competitive markets. Competition is generally based upon a combination of price, service and product quality. Pacific Lumber's products compete not only with other wood products but with metals, masonry, plastic and other construction materials made from non-renewable resources. The level of demand for Pacific Lumber's products is dependent on such broad factors as overall economic conditions, interest rates and demographic trends. In addition, competitive considerations, such as total industry production and competitors' pricing, as well as the price of other construction products, affect the sales prices for Pacific Lumber's lumber products. Pacific Lumber currently enjoys a competitive advantage in the upper grade redwood lumber market due to the quality of its timber holdings and relatively low cost production operations. Competition in the common grade redwood and Douglas-fir lumber market is more intense, and Pacific Lumber competes with numerous large and small lumber producers.\nEMPLOYEES As of March 1, 1995, Pacific Lumber had approximately 1,520 employees.\nRELATIONSHIPS AMONG PACIFIC LUMBER, SPHC AND BRITT LUMBER In March 1993, Pacific Lumber consummated its offering of $235 million of 10-1\/2% Senior Notes due 2003 (the \"Pacific Lumber Senior Notes\") and SPHC consummated its offering of $385 million of Timber Notes. Upon the closing of such offerings, Pacific Lumber, SPHC and Britt entered into a variety of agreements. Pacific Lumber and SPHC entered into a Services Agreement (the \"Services Agreement\") and an Additional Services Agreement (the \"Additional Services Agreement\"). Pursuant to the Services Agreement, Pacific Lumber provides a variety of operational, management and related services with respect to timberlands containing timber of SPHC (\"SPHC Timber\") not performed by SPHC's own employees. Pursuant to the Additional Services Agreement, SPHC provides Pacific Lumber with a variety of services, including assisting Pacific Lumber to operate, maintain and harvest its own timber properties.\nPacific Lumber and SPHC also entered into the Master Purchase Agreement. The Master Purchase Agreement governs all purchases of logs by the Company from SPHC. Each purchase of logs by Pacific Lumber from SPHC is made pursuant to a separate log purchase agreement (which incorporates the terms of the Master Purchase Agreement) for the SPHC Timber covered by an approved THP. Each log purchase agreement generally constitutes an exclusive agreement with respect to the timber covered thereby, subject to certain limited exceptions. The purchase price must be at least equal to a price published periodically by the California State Board of Equalization. As Pacific Lumber purchases logs from SPHC pursuant to the Master Purchase Agreement, Pacific Lumber is responsible, at its own expense, for harvesting and removing the standing SPHC Timber covered by approved THPs. Title to the harvested logs does not pass to Pacific Lumber until the logs are transported to Pacific Lumber's log decks and measured. Substantially all of SPHC's revenues are derived from the sale of logs to Pacific Lumber under the Master Purchase Agreement.\nPacific Lumber, SPHC and Salmon Creek also entered into a Reciprocal Rights Agreement granting to each other certain reciprocal rights of egress and ingress through their respective properties in connection with the operation and maintenance of such properties and their respective businesses. In addition, Pacific Lumber entered into an Environmental Indemnification Agreement with SPHC pursuant to which Pacific Lumber agreed to indemnify SPHC from and against certain present and future liabilities arising with respect to hazardous materials, hazardous materials contamination or disposal sites, or under environmental laws with respect to the SPHC Timberlands.\nPacific Lumber also entered into an agreement with Britt which governs the sale of logs by Pacific Lumber and Britt to each other, the sale of hog fuel (wood residue) by Britt to Pacific Lumber for use in Pacific Lumber's cogeneration plant, the sale of lumber by Pacific Lumber and Britt to each other, and the provision by Pacific Lumber of certain administrative services to Britt (including accounting, purchasing, data processing, safety and human resources services). The logs which Pacific Lumber sells to Britt and which are used in Britt's manufacturing operations are sold at approximately 75% of applicable SBE prices (to reflect the lower quality of these logs). Logs which either Pacific Lumber or Britt purchases from third parties and which are then sold to each other are transferred at the actual cost of such logs. Hog fuel is sold at applicable market prices, and administrative services are provided by Pacific Lumber based on Pacific Lumber's actual costs and an allocable share of Pacific Lumber's overhead expenses consistent with past practice.\nBRITT LUMBER OPERATIONS\nBUSINESS Britt is located in Arcata, California, approximately 45 miles north of Pacific Lumber's headquarters. Britt's primary business is the processing of small diameter redwood logs into wood fencing products for sale to retail and wholesale customers. Britt was incorporated in 1965 and operated as an independent manufacturer of fence products until July 1990, when it was purchased by a subsidiary of the Company. Britt purchases small diameter (6 to 14 inch) and short length (6 to 12 feet) redwood logs from Pacific Lumber and a variety of different diameter and different length logs from various timberland owners. Britt processes logs at its mill into a variety of different fencing products, including \"dog-eared\" 1\" x 6\" fence stock in six and eight foot lengths, 4\" x 4\" fence posts in 6 through 12 foot lengths, and other fencing products in 6 through 12 foot lengths. Britt's purchases of logs from third parties are generally consummated pursuant to short-term contracts of twelve months or less. See \"--Pacific Lumber Operations--Relationships Among Pacific Lumber, SPHC and Britt Lumber\" for a description of Britt's log purchases from Pacific Lumber.\nMARKETING In 1994, Britt sold approximately 79 million board feet of lumber products to approximately 83 different customers. Over one-half of its sales were in northern California. The remainder of its 1994 sales were in southern California, Arizona, Colorado, Hawaii, Nevada, Oregon and Washington. The largest and top five of such customers accounted for approximately 35% and 81%, respectively, of such 1994 sales. Britt markets its products through its own sales person to a variety of customers, including distribution centers, industrial remanufacturers, wholesalers and retailers.\nFACILITIES AND EMPLOYEES Britt's manufacturing operations are conducted on 12 acres of land, 10 acres of which are leased on a long-term fixed-price basis from an unrelated third party. Fence production is conducted in a 46,000 square foot mill. An 18 acre log sorting and storage yard is located one-quarter of a mile away. The mill was constructed in 1980, and capital expenditures to enhance its output and efficiency are made on a yearly basis. Britt's (single shift) mill capacity, assuming 40 production hours per week, is estimated at 40.3 million board feet of fencing products per year. As of March 1, 1995, Britt employed approximately 100 people.\nCOMPETITION Management estimates that Britt accounted for approximately one- quarter of the redwood fence market in 1994 in competition with the northern California mills of Louisiana Pacific, Georgia Pacific and Eel River.\nREGULATORY AND ENVIRONMENTAL FACTORS\nRegulatory and environmental issues play a significant role in Pacific Lumber's forest products operations. Pacific Lumber's forest products operations are subject to a variety of California, and in some cases, federal laws and regulations dealing with timber harvesting, endangered species, and air and water quality. These laws include the California Forest Practice Act (the \"Forest Practice Act\"), which requires that timber harvesting operations be conducted in accordance with detailed requirements set forth in the Forest Practice Act and in the regulations promulgated thereunder by the California Board of Forestry (the \"BOF\"). The federal Endangered Species Act (the \"ESA\") and the California Endangered Species Act (the \"CESA\") provide in general for the protection and conservation of specifically listed fish, wildlife and plants which have been declared to be endangered or threatened. The California Environmental Quality Act (\"CEQA\") provides, in general, for protection of the environment of the state, including protection of air and water quality and of fish and wildlife. In addition, the California Water Quality Act requires, in part, that Pacific Lumber's operations be conducted so as to reasonably protect the water quality of nearby rivers and streams. The regulations under certain of these laws are periodically modified. For instance, in March and May 1994, the BOF approved additional rules providing for, among other things, inclusion of additional information in THPs (concerning, among other things, timber generation systems, the presence or absence of fish, wildlife and plant systems, potentially impacted watersheds and compliance with long term sustained yield objectives) and modification of certain timber harvesting practices (including the creation of buffer zones between harvest areas and increases in the amount of timber required to be retained in a harvest area). See also Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends--Forest Products Operations\" for a description of the sustained yield regulations. Pacific Lumber does not expect that compliance with such existing laws and regulations will have a material adverse effect on its timber harvesting practices or future operating results. There can be no assurance, however, that future legislation, governmental regulations or judicial or administrative decisions would not adversely affect Pacific Lumber.\nVarious groups and individuals have filed objections with the CDF regarding the CDF's actions and rulings with respect to certain of Pacific Lumber's THPs, and the Company expects that such groups and individuals will continue to file objections to certain of Pacific Lumber's THPs. In addition, lawsuits are pending which seek to prevent Pacific Lumber from implementing certain of its approved THPs. These challenges have severely restricted Pacific Lumber's ability to harvest virgin old growth timber on its property during the past few years. To date, litigation with respect to Pacific Lumber's THPs relating to young growth and residual old growth timber has been limited; however, no assurance can be given as to the extent of such litigation in the future.\nIn June 1990, the U.S. Fish and Wildlife Service (the \"USFWS\") designated the northern spotted owl as threatened under the ESA. The owl's range includes all of Pacific Lumber's timberlands. The ESA and its implementing regulations (and related California regulations) generally prohibit harvesting operations in which individual owls might be killed, displaced or injured or which result in significant habitat modification that could impair the survival of individual owls or the species as a whole. Since 1988, biologists have conducted inventory and habitat utilization studies of northern spotted owls on Pacific Lumber's timberlands. Pacific Lumber has developed and the USFWS has given its full concurrence to a comprehensive wildlife management plan for the northern spotted owl (the \"Owl Plan\"). By incorporating the Owl Plan into each THP filed with the CDF, Pacific Lumber is able to expedite the approval process with respect to its THPs. Both federal and state agencies continue to review and consider possible additional regulations regarding the northern spotted owl. It is uncertain if such additional regulations will become effective or their ultimate content.\nIn March 1992, the marbled murrelet was approved for listing as endangered under the CESA. Pacific Lumber has incorporated, and will continue to incorporate as required, additional mitigation measures into its THPs to protect and maintain habitat for marbled murrelets on its timberlands. The California Department of Fish and Game (the \"CDFG\") requires Pacific Lumber to conduct pre-harvest marbled murrelet surveys and to provide certain other site specific mitigations in connection with its THPs covering virgin old growth timber and unusually dense stands of residual old growth timber. Such surveys can only be conducted during April to July, the murrelets' nesting and breeding season. Accordingly, such surveys are expected to delay the review and approval process with respect to certain of the THPs filed by Pacific Lumber. The results of such surveys could prevent Pacific Lumber from conducting certain of its harvesting operations. In October 1992, the USFWS issued its final rule listing the marbled murrelet as a threatened species under the ESA in the tri-state area of Washington, Oregon and California. In January 1994, the USFWS proposed designation of critical habitat for the marbled murrelet under the ESA. This proposal is subject to public comment, hearings and possible future modification. Both federal and state agencies continue to review and consider possible additional regulations regarding the marbled murrelet. It is uncertain if such additional regulations will become effective or their ultimate content.\nPacific Lumber's wildlife biologist is conducting research concerning the marbled murrelet on Pacific Lumber's timberlands and is currently developing a comprehensive management plan for the marbled murrelet (the \"Murrelet Plan\") similar to the Owl Plan. Pacific Lumber is continuing to work with the USFWS and the other government agencies on the Murrelet Plan. It is uncertain when the Murrelet Plan will be completed.\nLaws and regulations dealing with Pacific Lumber's operations are subject to change and new laws and regulations are frequently introduced concerning the California timber industry. From time to time, bills are introduced in the California legislature and the U.S. Congress which relate to the business of Pacific Lumber, including the protection and acquisition of old growth and other timberlands, endangered species, environmental protection and the restriction, regulation and administration of timber harvesting practices. Because such bills are subject to amendment, it is premature to assess the ultimate content of these bills, the likelihood of any of the bills passing, or the impact of any of these bills on the consolidated financial position or results of operations of the Company. Furthermore, any bills which are passed are subject to executive veto and court challenge. In addition to existing and possible new or modified statutory enactments, regulatory requirements, administrative and legal actions, the California timber industry remains subject to potential California or local ballot initiatives and evolving federal and California case law which could affect timber harvesting practices. It is, however, impossible to assess the effect of such matters on the future operating results or consolidated financial position of the Company.\nREAL ESTATE OPERATIONS\nThe Company, principally through its wholly owned subsidiaries, is also engaged in the business of real estate development and commercial real estate investment in Arizona, California, Colorado, New Mexico, Texas and Puerto Rico. The Company has outstanding receivables from the financing of real estate sales in its developments and may continue to finance such real estate sales in the future. The Company also holds other receivables as a portion of its commercial real estate investments.\nPROPERTIES Texas. In 1991, a subsidiary of the Company purchased for approximately $122.0 million a portfolio of real property and loans secured by real property at auction from the Resolution Trust Corporation (consisting of twenty-seven properties and twenty-eight loans). Substantially all of the real property was located in Texas, with the largest concentration in the vicinity of San Antonio, Houston, Austin and Dallas. During 1992, $13.8 million of loans were sold or paid off and six properties were sold for an aggregate of $5.3 million. In 1993, $9.8 million of loans were sold or paid off and eighteen properties were sold for an aggregate of $117.7 million. During 1994, $2.9 million of loans were sold or paid off and two properties were sold for an aggregate of $11.3 million. As of December 31, 1994, the Company had six of the original loans and fifteen of the original properties remaining. All of the remaining assets are being marketed by the Company.\nPalmas del Mar. Palmas del Mar (\"Palmas\"), a resort, time-sharing and land development and sales business, located on the southeastern coast of Puerto Rico near Humacao, was acquired in 1984. Originally 2,762 acres, Palmas now includes approximately 2,140 acres of undeveloped land, 100 condominiums utilized in its time-sharing program (comprising 5,300 time- share intervals of which approximately 1,135 remain to be sold), a 100-room hotel and adjacent executive convention center known as the Candelero Hotel, a 23-room luxury hotel known as the Palmas Inn, a casino, a Gary Player-designed 18-hole golf course, 20 tennis courts, golf and tennis pro shops, restaurants, beach and pool facilities, an equestrian center and a sailing center. Certain stores and restaurants and the equestrian center are operated by third parties. Approximately 1,300 private residences and a marina are owned by third parties. A number of these private residences are made available to Palmas by their owners throughout the year for rental to vacationers. Since 1985, the Company has been actively engaged in the development and sale of condominiums, estate lots and villas. In 1994, Palmas sold approximately twenty-two acres of undeveloped land, twenty-two condominium units, three estate lots and fifty time-share intervals.\nFountain Hills. In 1968, a subsidiary of the Company purchased and began developing approximately 12,100 acres of real property at Fountain Hills, Arizona, which is located near Phoenix and adjacent to Scottsdale, Arizona. As of December 31, 1994, Fountain Hills had approximately 5,000 acres of undeveloped land, 107 commercial and industrial lots and 56 developed residential lots available for sale. The population of Fountain Hills is approximately 13,000. The Company is planning the development of certain of its remaining acreage. Future sales are expected to consist mainly of undeveloped acreage, semi-developed parcels and fully-developed lots, although the Company may engage in limited construction and direct sale of residential units. In 1994, approximately 181 lots and 161 acres were sold. Additionally, in 1994 a subsidiary of the Company entered into a venture to develop 950 acres in Fountain Hills in an area known as SunRidge Canyon.\nLake Havasu City. In 1963, a subsidiary of the Company purchased and began developing approximately 16,700 acres of real property at Lake Havasu City, Arizona, which were offered for sale in the form of subdivided single and multiple family residential, commercial and industrial sites. The Company has sold substantially all of its lot inventory in Lake Havasu City and is currently planning the development of its remaining acreage.\nRancho Mirage. In 1991, a subsidiary of the Company acquired Mirada, a 195-acre luxury resort-residential project located in Rancho Mirage, California. The Company is currently marketing the project's fully- developed lots.\nOther. The Company, through its subsidiaries, owns a number of other properties in Arizona, New Mexico, Texas and Colorado. Efforts are underway to sell most of these properties.\nMARKETING The Company is engaged in marketing and sales programs of varying magnitudes at its real estate developments. In recent years, the Company has constructed residential units and sold time-share intervals at certain of its real estate developments. The Company intends to continue selling land to builders and developers and lots to individuals and expects to continue to construct and sell completed residential units at certain of its developments. It also expects to sell certain of its commercial real estate assets. All sales are made directly to purchasers through the Company's marketing personnel, independent contractors or through independent real estate brokers who are compensated through the payment of customary real estate brokerage commissions.\nCOMPETITION AND REGULATION AND OTHER INDUSTRY FACTORS There is intense competition among companies in the real estate development business and the commercial real estate business for sales to residential and commercial lot purchasers and to commercial property investors. Sales and payments on real estate sales obligations depend, in part, on available financing and disposable income and, therefore, are affected by changes in general economic conditions and other factors. The real estate development business and commercial real estate business are subject to other risks such as shifts in population, fluctuations in the real estate market, and unpredictable changes in the desirability of residential, commercial and industrial areas. The resort and time-sharing business of Palmas competes with similar businesses in the Caribbean, Florida and other locations. The resort operations of Palmas are seasonal and are subject to, among other things, the condition of the United States economy and tourism business in Puerto Rico.\nThe Company's real estate operations are subject to comprehensive federal, state and local regulation. Applicable statutes and regulations may require disclosure of certain information concerning real estate developments and credit policies of the Company and its subsidiaries. Periodic approval is required from various agencies in connection with the layout and design of developments, the nature and extent of improvements, construction activity, land use, zoning, and numerous other matters. Failure to obtain such approval, or periodic renewal thereof, could adversely affect real estate development and marketing operations of the Company and its subsidiaries. Various jurisdictions also require inspection of properties by appropriate authorities, approval of sales literature, disclosure to purchasers of specific information, bonding for property improvements, approval of real estate contract forms and delivery to purchasers of a report describing the property.\nSAM HOUSTON RACE PARK\nACQUISITION AND INITIAL OPERATIONS On July 8, 1993, subsidiaries of the Company acquired, for a total investment of $9.1 million, the following interests in Sam Houston Race Park, a Class 1 thoroughbred and quarter horse racing facility (the \"Race Park\") located in the greater Houston metropolitan area: (i) a 28.7% equity interest in Sam Houston Race Park, Ltd. (the \"Partnership\"), which owns the land, facilities and the racing license with respect to the Race Park, (ii) all of the outstanding Class B Common Stock of the sole general partner (the \"General Partner\") of the Partnership, (representing a further 1% equity interest in the Partnership), and (iii) a 75% interest in Race Track Management Enterprises, the manager of the Race Park. The Race Park commenced operations on April 29, 1994, but has sustained substantial operating losses since commencing operations. The General Partner has taken a number of steps intended to improve the Race Park's operations, including strengthening on-site management, reducing general and administrative costs, negotiating amendments to the contracts for purse payments, principally to reduce purse payments, and negotiating reductions with other obligees. In addition to its efforts to strengthen the Race Park's operations, in September 1994 the General Partner conducted a capital call for $6.5 million in additional capital for the Partnership (the \"Capital Call\"). A substantial portion of the proceeds of the Capital Call ($5.6 million) was contributed by a wholly owned subsidiary of the Company pursuant, in large degree, to its oversubscription rights arising from limited participation by other partners. As a result of the Capital Call, the Company's equity interest in the Partnership held by its subsidiaries increased to approximately 45.0%. The Company through its subsidiaries is the largest limited partner in the Partnership.\nThe cash received from the Capital Call was expected to be used, among other things, to make the January 15, 1995 interest payment on the Partnership's 11-3\/4% Senior Secured Notes (the \"SHRP Notes\"). However, in order to continue operations, the Partnership was required to use a portion of the cash that had been expected to be used for such interest payment. Accordingly, the Partnership has defaulted on the $4.4 million semi-annual interest payment that was due on January 15, 1995 with respect to the SHRP Notes. Certain of the holders of the SHRP Notes have formed an unofficial committee (the \"Committee\"), and the Committee has retained counsel and a financial advisor (at the Partnership's expense) to advise them in this matter. The General Partner has retained a financial advisor and entered into ongoing discussions with representatives of the Committee regarding the restructuring of the SHRP Notes. However, there can be no assurance that the General Partner and the Committee will reach an agreement or as to the terms of any such agreement. See also Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations-- Financial Condition and Investing and Financing Activities--Parent Company.\"\nRACING OPERATIONS AND RACE PARK FACILITIES The Race Park offers pari-mutuel wagering on live thoroughbred or quarter horse racing or simulcast racing generally seven days a week throughout the year. Simulcasting is the process by which live races held at one facility are broadcast simultaneously to other locations at which additional wagers are placed on the race being broadcast. In addition to revenues from wagering and simulcasting, the Race Park derives revenues from admission fees, food services, club memberships, luxury suites, advertising sales and other sources. The Race Park is located on approximately 215 acres of land in northwest Harris County approximately 18 miles from the Houston central business district and approximately 15 miles from Houston Intercontinental Airport. The Race Park has a one-mile dirt track and a one and one-eighth mile turf course. The Race Park is bordered by the Sam Houston Parkway on the north and is accessible by freeway.\nRACING OPERATIONS The ownership and operation of horse racetracks in Texas are subject to significant regulation by the Texas Racing Commission (the \"Racing Commission\") under the Texas Racing Act and related regulations (collectively, the \"Racing Act\"). The Racing Act provides, among other things, for how wagering proceeds are to be allocated among betting participants, horsemens purses, racetracks, the State of Texas and for other purposes, and empowers the Racing Commission to license and regulate substantially all aspects of horse racing in the state. The Racing Commission must approve the number of live race days that may be offered at the Race Park each year, as well as all simulcast agreements.\nMARKETING AND COMPETITION The Race Park competes with other forms of entertainment, including casinos located a little over 100 miles from Houston, a greyhound racetrack located 60 miles from the Race Park and a wide range of live and televised professional and collegiate sporting events that are available in the Houston area. The Race Park could in the future also compete with other forms of gambling in Texas, including casino gambling on Indian reservations or otherwise.\nEMPLOYEES\nAt March 1, 1994, the Company and its subsidiaries employed approximately 2,500 persons, exclusive of those involved in Aluminum Operations.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nFor information concerning the principal properties and operations of the Company, see Item 1. \"Business.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nKAISER ENVIRONMENTAL LITIGATION\nABERDEEN PESTICIDE DUMPS SITE MATTER The Aberdeen Pesticide Dumps Site, listed on the Superfund National Priorities List, is composed of five separate sites around the town of Aberdeen, North Carolina (collectively, the \"Sites\"). The Sites are of concern to the United States Environmental Protection Agency (the \"EPA\") because of their past use as either pesticide formulation facilities or pesticide disposal areas from approximately the mid-1930's through the late-1980's. The United States originally filed a cost recovery complaint (as amended, the \"Complaint\") in the United States District Court for the Middle District of North Carolina, Rockingham Division, No. C-89-231-R, which, as amended, includes KACC and a number of other defendants. The Complaint seeks reimbursement for past and future response costs and a determination of liability of the defendants under Section 107 of CERCLA. The EPA has performed a Remedial Investigation\/Feasibility Study and issued a Record of Decision (\"ROD\") for the Sites in September 1991. The major remedy selected for the Sites would have a cost of approximately $32 million. Other possible remedies described in the ROD would have estimated costs of approximately $53 million and $222 million, respectively. The EPA has stated that it has incurred past costs at the Sites in the range of $7.5--$8 million as of February 9, 1993, and alleges that response costs will continue to be incurred in the future.\nOn May 20, 1993, the EPA issued three unilateral Administrative Orders under Section 106(a) of CERCLA ordering the respondents, including KACC, to perform the remedial design and remedial action described in the ROD for three of the Sites. The estimated cost as set forth in the ROD for the remedial action at the three Sites is approximately $27 million. A number of other companies are also named as respondents. KACC has entered into PRP Participation Agreement with certain of the respondents to participate jointly in responding to the Administrative Orders dated May 20, 1993, regarding soil remediation, to share costs incurred on an interim basis, and to seek to reach a final allocation of costs through agreement or to allow such final allocation and determination of liability to be made by the United States District Court. By letter dated July 6, 1993, KACC has notified the EPA of its ongoing participation with such group of respondents which, as a group, are intending to comply with the Administrative Orders to the extent consistent with applicable law. By letters dated December 30, 1993, the EPA notified KACC of its potential liability for, and requested that KACC, along with a number of other companies, undertake or agree to finance, groundwater remediation at certain of the Sites. The ROD-selected remedy for the groundwater remediation selected by EPA includes a variety of techniques. The EPA has estimated the total present worth cost, including 30 years of operation and maintenance, at approximately $11.8 million. A definitive PRP Participation Agreement with respect to groundwater remediation is under negotiation among certain of the respondents, including KACC, and these respondents are proceeding with work required under the Administrative Orders.\nBased upon the information presently available to it, Kaiser is unable to determine whether KACC has any liability with respect to any of the Sites or, if there is any liability, the amount thereof. Two government witnesses have testified that KACC acquired pesticide products from the operator of the formulation site over a two to three year period. KACC has been unable to confirm the accuracy of this testimony.\nUNITED STATES OF AMERICA V. KAISER ALUMINUM & CHEMICAL CORPORATION In February 1989, a civil action was filed by the United States Department of Justice at the request of the EPA against KACC in the United States District Court for the Eastern District of Washington, Case Number C-89-106-CLQ. The complaint alleged that emissions from certain stacks at Kaiser's Trentwood facility in Spokane, Washington intermittently violated the opacity standard contained in the Washington State Implementation Plan (\"SIP\"), approved by the EPA under the federal Clean Air Act. The complaint sought injunctive relief, including an order that KACC take all necessary action to achieve compliance with the Washington SIP opacity limit and the assessment of civil penalties of not more than $25,000 per day.\nIn the course of the litigation, questions arose as to whether the observers who recorded the alleged exceedances were qualified under the Washington SIP to read opacity. In July 1990, KACC and the Department of Justice agreed to a voluntary dismissal of the action. At that time, however, the EPA had arranged for increased surveillance of the Trentwood facility by consultants and the EPA's personnel. From May 1990 through May 1991, these observers recorded approximately 130 alleged exceedances of the SIP opacity rule. Justice Department representatives have stated their intent to file a second lawsuit against KACC based on the opacity observations recorded during that period.\nThe second lawsuit has not yet been filed. Instead, KACC has entered into negotiations with the EPA to resolve the claims against KACC through a consent decree. The EPA and KACC have made substantial progress in negotiating the terms of the consent decree. The terms of the consent decree currently being negotiated include, in principle, a commitment by KACC to improve emission control equipment at the Trentwood facility and a civil penalty assessment against KACC. The Company anticipates that agreement upon the terms of a consent decree will be reached during 1995. In the event the terms of a consent decree are not agreed upon, the matter would likely be resolved in federal court.\nCATELLUS DEVELOPMENT CORPORATION V. KAISER ALUMINUM & CHEMICAL CORPORATION AND JAMES L. FERRY & SON INC. In January 1991, the City of Richmond, et al. (the \"Plaintiffs\") filed a Second Amended Complaint for Damages and Declaratory Relief against Catellus Development Corporation (\"Catellus\") and other defendants (collectively, the \"Defendants\") alleging, among other things, that the Defendants caused or allowed hazardous substances, pollutants, contaminants, debris and other solid wastes to be discharged, deposited, disposed of or released on certain property located in Richmond, California (the \"Property\") formerly owned by Catellus and leased to KACC for the purpose of shipbuilding activities conducted by KACC on behalf of the United States during World War II. Plaintiffs allege, among other things, that the Defendants are jointly and severally liable for response costs, declaratory relief and natural resources damages under CERCLA, and that Defendant Catellus is strictly liable on grounds of continuing nuisance, continuing trespass and negligence for such discharge, deposit, disposal or release, and is liable for fraudulent concealment of the alleged contamination. Certain of the Plaintiffs have alleged that they had incurred or expect to incur costs and damages in the amount of approximately $49 million, in the aggregate. KACC is alleged to have performed certain excavation activities on the Property and, as a result thereof, to have released contaminants on the Property and to have arranged for the transportation, treatment and disposal of such contaminants.\nCatellus has filed a third party complaint (the \"Third Party Complaint\") against KACC in the United States District Court for the Northern District of California, Case No. C-89-2935 DLJ. The Third Party Complaint, as amended, seeks contribution and indemnity from KACC and another party under a variety of theories (including negligence, nuisance, waste and alleged contractual indemnities) for, among other things, Catellus' response costs and natural resources damages under CERCLA, any liability or judgment imposed against Cattelus, and treble damages for the injury to its interest in the Property, and treble damages from KACC pursuant to California Code of Civil Procedure Section 732.\nBy an October 1992 letter, counsel for certain underwriters at Lloyd's London and certain London Market insurance companies (the \"London Insurers\") advised that the London Insurers agreed to reimburse KACC for defense expenses in the third party action filed by Catellus, subject to a full reservation of rights. The Plaintiffs filed a motion for leave to file a Third Amended Complaint which would have added KACC as a first party defendant. This motion was denied. In October 1992, the Plaintiffs served a separate Complaint against KACC for damages and declaratory relief. The claims asserted by the Plaintiffs are for, among other things, (i) response costs, recovery of costs, natural resources damages and declaratory relief under CERCLA; (ii) damages for injury to the Property arising from negligence, and (iii) damages under a theory of strict liability. This matter has been tendered to the London Insurers. On June 24, 1994, the District Court approved a Consent Decree consummating the settlement of the Plaintiffs' CERCLA and tort claims against the United States in exchange for payment of approximately $3.5 million plus 35% of future response costs. Trial of this matter commenced in March 1995.\nPICKETVILLE ROAD LANDFILL MATTER In July, 1991, the EPA served on KACC and thirteen other PRPs a Unilateral Administrative Order For Remedial Design and Remedial Action (the \"Order\") at the Picketville Road Landfill site in Jacksonville, Florida. The EPA seeks remedial design and remedial action pursuant to CERCLA from some, but apparently not all, PRPs based upon a Record of Decision outlining remedial cleanup measures to be undertaken at the site adopted by the EPA in September 1990. The site was operated as a municipal and industrial waste landfill from 1968 to 1977 by the City of Jacksonville. KACC was first notified by the EPA in January 1991, that wastes from one of KACC's plants may have been transported to and deposited in the site. In its Record of Decision, the EPA estimated that the total capital, operations and maintenance costs of its elected remedy for the site would be approximately $9.9 million. In addition, the EPA has reserved the right to seek recovery of its costs incurred relating to the Order, including, but not relating to, reimbursement of the EPA's cost of response. KACC has reached an agreement with certain PRPs who are conducting remedial design and remedial action at the site, under which KACC will fund $146,700 of the cost of the remedial design and remedial action (unless remedial costs exceed $19 million in which event the settlement agreement will be re-opened).\nASBESTOS-RELATED LITIGATION KACC is a defendant in a number of lawsuits in which the plaintiffs allege that certain of their injuries were caused by exposure to asbestos during, and as a result of, their employment with KACC or to products containing asbestos produced or sold by KACC. The lawsuits generally relate to products KACC has not manufactured for at least 15 years. At December 31, 1994, the number of such lawsuits pending was approximately 25,200. See Note 9 to the Consolidated Financial Statements.\nOTHER KAISER LITIGATION\nOn August 24, 1994, the United States Department of Justice (the \"DOJ\") issued Civil Investigative Demand No. 11356 (\"CID\") requesting information from Kaiser regarding (i) its production, capacity to produce, and sales of primary aluminum from January 1, 1991, to the date of the response; (ii) any actual or contemplated reduction in its production of primary aluminum during that period; and (iii) any communications with others regarding any actual, contemplated, possible or desired reductions in primary aluminum production by Kaiser or any of its competitors during that period. Kaiser has submitted documents and interrogatory answers to the DOJ responding to the CID.\nVarious other lawsuits and claims are pending against Kaiser. The Company believes that resolution of the lawsuits and claims made against Kaiser, including the matters discussed above, will not have a material adverse effect on Kaiser's consolidated financial position or results of operations.\nPACIFIC LUMBER MERGER LITIGATION\nAs a result of the below-described settlement of the In Re Ivan F. Boesky Multidistrict Securities Litigation (the \"Boesky Settlement\"), all material stockholder claims against the Company and other defendants have been resolved and have been dismissed or are in the process of being dismissed.\nDuring the mid-to-late 1980's, Pacific Lumber was named as defendant along with several other entities and individuals, including the Company and MGI, in various class, derivative and other actions brought in the Superior Court of Humboldt County by former stockholders of Pacific Lumber relating to the cash tender offer (the \"Tender Offer\") for the shares of Pacific Lumber by a subsidiary of MGI and the subsequent merger (the \"Merger\"), as a result of which Pacific Lumber became a wholly-owned subsidiary of MGI (the \"Humboldt County Lawsuits\"). As of the date the Court approved the Boesky Settlement, the Humboldt County Lawsuits which remained open were captioned: Fries, et al. v. Carpenter, et al. (No. 76328) (\"Fries State\"); Omicini, et al. v. The Pacific Lumber Company, et al. (No. 76974) (\"Omicini\"); Thompson, et al. v. Elam, et al. (No. 78467) (\"Thompson State\"); and Russ, et al. v. Milken, et al. (No. DR-85429) (\"Russ\"). The Humboldt County Lawsuits generally alleged, among other things, that in documents filed with the Securities and Exchange Commission (the \"Commission\"), the defendants made false statements concerning, among other things, the estimated value of Pacific Lumber's assets, financing for the Tender Offer and the Merger and minority stockholders' appraisal rights, and that the individual directors of Pacific Lumber breached certain fiduciary duties owed stockholders and other constituencies of Pacific Lumber. The Company and MGI were alleged to have aided and abetted these violations and committed other wrongs. The Thompson State, Omicini and Fries State suits sought compensatory damages in excess of $1 billion, exemplary damages in excess of $750 million, rescission and other relief. The Russ suit did not specify the amount of damages sought.\nIn 1988, two lawsuits similar to the Humboldt County Lawsuits were filed in the United States District Court, Central District of California-- Fries, et al. v. Hurwitz, et al. (No. 88-3493 RMT) (\"Fries Federal\") and Thompson, et al. v. MAXXAM Group Inc., et al. (No. 88-06274) (\"Thompson Federal\"). These actions sought damages and relief similar to that sought in the Humboldt County Lawsuits. In May 1989, the Thompson Federal and Fries Federal actions were consolidated in the In re Ivan F. Boesky Multidistrict Securities Litigation in the United States District Court, Southern District of New York (MDL No. 732 M 21-45-MP) (\"Boesky\"). An additional action filed in November 1989, entitled American Red Cross, et al. v. Hurwitz, et al. (No. 89 Civ 7722) (\"American Red Cross\"), was also consolidated with the Boesky action. The American Red Cross action contained allegations and sought damages and relief similar to that contained in the Humboldt County Lawsuits.\nAt a fairness hearing held on November 17, 1994, the Court approved a settlement of, and dismissed with prejudice, the pending federal actions against the settling defendants. The actions dismissed with prejudice include specifically: In Re Ivan F. Boesky Multidistrict Securities Litigation; the Fries Federal action; the Thompson Federal action; and the American Red Cross, et al. v. Hurwitz, et al. action. The court's order also provides for the dismissal of all other shareholder claims against the defendants, including dismissal of the Fries State, Omicini, and Russ actions in their entirety, and all shareholder claims in the Thompson State action. Of the approximately $52 million settlement, approximately $33 million was paid by insurance carriers of the Company, MGI and Pacific Lumber, approximately $14.8 million was paid by Pacific Lumber and the balance was paid by the other defendants and through the assignment of certain claims. Dismissals have already been entered or are in process with respect to all of the dismissed actions.\nIn September 1989, seven past and present employees of Pacific Lumber brought an action against Pacific Lumber, the Company, MGI, certain current and former directors and officers of the Company, Pacific Lumber and MGI, and First Executive Life Insurance Company (\"First Executive\") (subsequently dismissed as a defendant) in the United States District Court, Northern District of California, entitled Kayes, et al. v. Pacific Lumber Company, et al. (No. C89-3500) (\"Kayes\"). Plaintiffs purport to be participants in or beneficiaries of Pacific Lumber's former Retirement Plan (the \"Retirement Plan\") for whom a group annuity contract was purchased from Executive Life Insurance Company (\"Executive Life\") in 1986 after termination of the Retirement Plan. The Kayes action alleges that the Company, Pacific Lumber and MGI defendants breached their ERISA fiduciary duties to participants and beneficiaries of the Retirement Plan by purchasing the group annuity contract from First Executive and selecting First Executive to administer the annuity payments. Plaintiffs seek, among other things, a new group annuity contract on behalf of the Retirement Plan participants and beneficiaries. This case was dismissed on April 14, 1993 and was refiled as Jack Miller, et al. v. Pacific Lumber Company, et al. (No. C-89-3500-SBA) (\"Miller\") on April 26, 1993; the Miller case was dismissed on May 14, 1993. These dismissals have been appealed. On October 3, 1994, the U.S. House of Representatives approved a bill amending ERISA, which had previously been passed by the U.S. Senate, and is intended, in part, to overturn the U.S. District Court's dismissal of the Miller action and to make available certain remedies not previously provided under ERISA. On October 22, 1994, the President signed this legislation (the Pension Annuitants' Protection Act of 1994). As a result of the passage of this legislation, the Miller plaintiffs have asked the U.S. Ninth Circuit Court of Appeals to vacate the U. S. District Court judgment dismissing their case and to remand the case to the U.S. District Court; defendants have opposed this request. It is uncertain what effect, if any, this legislation will have on the pending appeal or the final disposition of this case. The defendants and plaintiff in the DOL civil action have invited the Miller plaintiffs to participate in the court- supervised settlement discussions concerning the Miller and DOL civil actions.\nIn June 1991, the U.S. Department of Labor filed a civil action entitled Lynn Martin, Secretary of the U.S. Department of Labor v. The Pacific Lumber Company, et al. (No. 91-1812-RHS) (\"DOL civil action\") in the United States District Court, Northern District of California, against the Company, Pacific Lumber, MGI and certain of their current and former officers and directors. The allegations in the DOL civil action are substantially similar to that in the Kayes action. The DOL civil action has been stayed pending resolution of the Kayes and Miller appeals. Formal settlement negotiations continue to be overseen by the court in this matter.\nManagement is of the opinion that the outcome of the foregoing litigation should not have a material adverse effect on the Company's consolidated financial position or results of operations.\nZERO COUPON NOTE LITIGATION\nIn April 1989, an action was filed against the Company, MGI, MAXXAM Properties Inc. (\"MPI\") and certain of the Company's directors in the Court of Chancery of the State of Delaware, entitled Progressive United Corporation v. MAXXAM Inc., et al., Civil Action No. 10785. Plaintiff purports to bring this action as a stockholder of the Company derivatively on behalf of the Company and MPI. In May 1989, a second action containing substantially similar allegations was filed in the Court of Chancery of the State of Delaware, entitled Wolf v. Hurwitz, et al. (No. 10846) and the two cases were consolidated (collectively, the \"Zero Coupon Note\" actions). The Zero Coupon Note actions relate a Put and Call Agreement entered into between MPI and Mr. Charles Hurwitz (Chairman of the Board of the Company, MGI and MPI), as well as a predecessor agreement (the \"Prior Agreement\"). Among other things, the Put and Call Agreement provided that Mr. Hurwitz had the option (the \"Call\") to purchase from MPI certain notes (or the common stock of the Company into which they were converted) for $10.3 million. In July 1989, Mr. Hurwitz exercised the Call and acquired 990,400 shares of the Company's common stock. The Zero Coupon Note actions generally allege that in entering into the Prior Agreement Mr. Hurwitz usurped a corporate opportunity belonging to the Company, that the Put and Call Agreement constituted a waste of corporate assets of the Company and MPI, and that the defendant directors breached their fiduciary duties in connection with these matters. Plaintiffs seek to have the Put and Call Agreement declared null and void, among other remedies.\nRANCHO MIRAGE LITIGATION\nIn May 1991, a derivative action entitled Progressive United Corporation v. MAXXAM Inc., et al. (No. 12111) (\"Progressive United\") was filed in the Court of Chancery, State of Delaware against the Company, Federated Development Company (\"Federated\"), MCO Properties Inc. (\"MCOP\"), a wholly-owned subsidiary of the Company, and the Company's Board of Directors. The action alleges abuse of control and breaches of fiduciary obligations based on, and unfair consideration for, the Company's Agreement in Principle with Federated to (a) forgive payments of principal and interest of approximately $32.2 million due from Federated under two loan agreements between MAXXAM and Federated and (b) grant an additional $11.0 million of consideration to Federated, in exchange for certain real estate assets valued at approximately $42.9 million in Rancho Mirage, California, held by Federated (the \"Mirada transactions\"). Plaintiff seeks to have the Agreement in Principle rescinded, an accounting under the loan agreements, repayment of any losses suffered by the Company or MCOP, costs and attorneys fees.\nThe following six additional lawsuits similar to the Progressive United case have been filed in Delaware Chancery Court challenging the Mirada transactions: NL Industries, et al. v. MAXXAM Inc., et al. (No. 12353); Kahn, et al. v. Federated Development Company, et al. (No. 12373); Thistlethwaite, et al. v. MAXXAM Inc., et al. (No. 12377); Glinert, et al. v. Hurwitz, et al. (No. 12383); Friscia, et al. v. MAXXAM Inc., et al. (No. 12390); and Kassoway, et al. v MAXXAM Inc., et al. (No. 12404). The Kahn, Glinert, Friscia and Kassoway actions have been consolidated with the Progressive United action into In re MAXXAM Inc.\/Federated Development Shareholders Litigation (No. 12111); the NL Industries action has been \"coordinated\" with the consolidated actions; the Thistlethwaite action has been stayed pending the outcome of the consolidated actions. In January 1994, a derivative action entitled NL Industries, Inc., et al. v. Federated Development Company, et al. (No. 94-00630) was filed in the District Court of Dallas County, Texas, against the Company (as nominal defendant) and Federated. This action contains allegations and seeks relief similar to that contained in the In re MAXXAM Inc.\/Federated Development Shareholders Litigation. With respect to the In Re: MAXXAM Inc.\/Federated Development Shareholders Litigation, on February 10, 1995, the Court issued its decision disapproving a proposed settlement. With respect to the similar NL Industries Inc., et. al., v. Federated Development Co., et. al. action, the Court is reviewing a previously agreed to stay and related issues in light of the In Re: MAXXAM Inc., Federated Development Shareholders litigation action.\nOTHER LITIGATION MATTERS\nThe Company is involved in various other claims, lawsuits and other proceedings relating to a wide variety of matters. While uncertainties are inherent in the final outcome of such matters and it is presently impossible to determine the actual costs that ultimately may be incurred, management believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position or results of operations.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNot applicable.\nMAXXAM INC.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nReference is made to this section in the portions of the Company's 1994 Annual Report to Stockholders (the \"Annual Report\") which are included as part of Exhibit 13.1 hereto and incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nReference is made to this section in the portions of the Annual Report which are included as part of Exhibit 13.1 hereto and incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nReference is made to this section in the portions of the Annual Report which are included as part of Exhibit 13.1 hereto and incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReference is made to the consolidated financial statements and notes thereto and the quarterly financial information in the portions of the Annual Report which are included as part of Exhibit 13.1 hereto and incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nMAXXAM INC.\nPART III\nInformation required under Part III (Items 10, 11, 12 and 13) has been omitted from this report since the Company 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 pursuant to Regulation 14A which involves the election of directors.\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\n1. FINANCIAL STATEMENTS (INCLUDED UNDER ITEM 8):\nThe consolidated financial statements and the Report of Independent Public Accountants are included on pages 38 to 67 of the Annual Report which are included as part of Exhibit 13.1 hereto and incorporated herein by reference.\n2. FINANCIAL STATEMENT SCHEDULES: PAGE\nReport of Independent Public Accountants on Financial Statement Schedule 33 Schedule III - Condensed financial information of Registrant at December 31, 1994 and 1993 and for the years ended December 31, 1994, 1993 and 1992 34\nAll other schedules are inapplicable or the required information is included in the consolidated financial statements or the notes thereto.\n(B) REPORTS ON FORM 8-K\nNone.\n(C) EXHIBITS\nReference is made to the Index of Exhibits immediately preceding the exhibits hereto (beginning on page 40), which index is incorporated herein by reference.\nMAXXAM INC.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Stockholders and Board of Directors of MAXXAM Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in MAXXAM Inc.'s 1994 Annual Report to Stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 17, 1995. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The schedule listed in the index on page 32 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic consolidated financial statements and, in our opinion, fairly states 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 LLP\nHouston, Texas February 17, 1995\nMAXXAM INC.\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nBALANCE SHEET (UNCONSOLIDATED)\nSee notes to consolidated financial statements and accompanying notes.\nMAXXAM INC.\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nSTATEMENT OF OPERATIONS (UNCONSOLIDATED)\nSee notes to consolidated financial statements and accompanying notes.\nMAXXAM INC.\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nSTATEMENT OF CASH FLOWS (UNCONSOLIDATED)\nSee notes to consolidated financial statements and accompanying notes.\nMAXXAM INC.\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT (CONTINUED)\nNOTES TO FINANCIAL STATEMENTS (IN MILLIONS OF DOLLARS, EXCEPT SHARE AMOUNTS)\nA. SIGNIFICANT TRANSACTIONS\nOn August 4, 1993, MAXXAM Group Inc. (\"MGI,\" a wholly owned subsidiary of the Company) issued $100.0 aggregate principal amount of 11-1\/4% Senior Secured Notes due 2003 (the \"MGI Senior Notes\") and $126.7 aggregate principal amount (approximately $70.0 net of original issue discount) of 12-1\/4% Senior Secured Discount Notes due 2003 (the \"MGI Discount Notes,\" which, together with the MGI Senior Notes, are referred to collectively as the \"MGI Notes\"). The MGI Notes are secured by MGI's pledge of 100% of the common stock of The Pacific Lumber Company, Britt Lumber Co., Inc. and MAXXAM Properties Inc. (wholly owned subsidiaries of MGI) and by the Company's pledge of 28 million shares of the common stock of Kaiser Aluminum Corporation (\"Kaiser,\" a majority owned subsidiary of the Company). Contemporaneously with the issuance of the MGI Notes, MGI (i) transferred to the Company 50 million common shares of Kaiser held by a subsidiary of MGI, representing MGI's (and the Company's) entire interest in Kaiser's common stock, (ii) transferred to the Company 60,075 shares of the Company's common stock held by a subsidiary of MGI, (iii) transferred to the Company certain notes receivable, long-term investments, and other assets, each net of related liabilities, collectively having a carrying value to MGI of approximately $1.1 and (iv) exchanged with the Company 2,132,950 of Kaiser's $.65 Depositary Shares (the \"Depositary Shares\") (acquired by MGI from Kaiser in exchange for a $15.0 cash loan made by MGI to Kaiser Aluminum & Chemical Corporation, Kaiser's operating subsidiary, in January 1993), such exchange being in satisfaction of a related $15.0 promissory note evidencing a cash loan made by the Company to MGI in January 1993. On the same day, the Company assumed approximately $17.5 of certain liabilities of MGI that were unrelated to MGI's forest products operations or were related to operations which have been disposed of by MGI. Additionally, on September 28, 1993, MGI transferred its interest in Palmas del Mar to the Company.\nDuring 1994, the Company sold 1,239,400 of the Depositary Shares for an aggregate net proceeds of $10.3, resulting in pre-tax gains of $1.6. The carrying value of the remaining 893,550 Depositary Shares at December 31, 1994 was $6.3. The Company may consummate the sale of all or any portion of the remaining Depositary Shares at any time.\nB. DEFERRED INCOME TAXES\nThe deferred income tax assets and liabilities reported in the accompanying unconsolidated balance sheet are determined by computing such amounts on a consolidated basis, for the Company and members of its consolidated federal income tax return group, and then reducing such consolidated amounts by the amounts recorded by the Company's subsidiaries pursuant to their respective tax allocation agreements with the Company. The Company's net deferred income tax assets relate primarily to the excess of the tax basis over financial statement basis with respect to timber and timberlands and real estate of subsidiaries. The Company has concluded that it is more likely than not that these net deferred income tax assets will be realized based in part upon the estimated values of the underlying assets which are in excess of their tax basis.\nC. LONG-TERM DEBT\nLong-term debt consists of the following:\nScheduled maturities of long-term debt outstanding at December 31, 1994 are as follows: years ending December 31, 1995 - $2.4; 1996 - $3.6; 1997 - $3.3; 1998 - $3.3; 1999 - $11.0; thereafter - $25.1.\nD. NOTES PAYABLE TO SUBSIDIARIES, NET OF NOTES RECEIVABLE AND ADVANCES\nAt December 31, 1994, the Company has unsecured notes payable to its real estate subsidiaries totalling $73.8 (including interest) which consist of a $60.9 note, bearing interest at 6% per annum, and four notes totalling $12.9, bearing interest at 7% per annum. The Company also has secured nonrecourse notes receivable from a real estate subsidiary totalling $43.6 (including interest) which bear interest at 12% per annum on the first $15.0 of principal and at prime plus 1% to 2% per annum on the remaining principal.\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, who has signed this report on behalf of the Registrant and as the chief financial officer of the Registrant.\nINDEX OF EXHIBITS","section_15":""}
{"filename":"205239_1994.txt","cik":"205239","year":"1994","section_1":"ITEM 1. Business.\nGeneral\nDatapoint Corporation, including its subsidiaries (hereinafter \"Datapoint\" or \"the Company\"), is principally engaged in the development, manufacture, acquisition, marketing and servicing of computer and communication products -- both hardware and software -- for integrated computer, telecommunication and video conferencing network systems worldwide.\nDatapoint was reincorporated in Delaware in 1976 as the successor corporation to a Texas corporation originally incorporated in 1968 as Computer Terminal Corporation and which changed its name to Datapoint Corporation in 1972. Its principal executive offices are located at 5-7 rue Montalivet 75008, Paris, France (telephone number - (33-1) 40 07 37 37) and at 8400 Datapoint Drive, San Antonio, Texas 78229-8500 (telephone number - (210)- 593-7000).\nThroughout the 1970's, the Company developed, distributed and serviced minicomputers, and later computer networks and telecommunications products. During that period sales and service revenue was predominately derived from the U.S. market, supplemented by international sales through a network of independent distributors.\nIn 1981, the Company purchased most of its major international distributors, which have been subsequently operated as subsidiaries. In 1985, the Company separately incorporated its U.S. hardware service business as an independent company and distributed its shares to shareholders.\nThroughout the 1980's, the Company's business has been characterized by a significant decline in total revenue, recurring significant losses, and a reduction of the domestic workforce. During the 1990's this trend has continued as the Company has experienced a decline in both foreign and domestic total revenue (predominately in 1993 and 1994), and has experienced significant lossesand a substantial reduction in the workforce. The continuation of this trend was primarily due to (1) a mass entry of competitors in the networking marketplace compounded by (2) a marketplace demand for \"Open Systems\" products and standard interfaces, both of which had a negative impact on the traditional networking and data processing components of the Datapoint business.The marketplace was forced into a sameness of design that lead to highly competitive pricing being the only significant product differentiator. Theseadverse effects were, in turn, worsened by the increasing availability of low-cost, off-the-shelf hardware applications packages written in a number of industry-standard programming languages. This resulted in a substantial decline in both foreign and domestic revenues (see note 1 to Consolidated Financial Statements).\nProducts\nThe Company provides a complete line of products that meet data processing, video communications, and telecommunications requirements. The network-based products include video communications, data sharing applications, platform-independency, local area networking, wide area networking, relational database systems, and telecommunications integration.\nThe Company announced it's third generation of Multimedia Information Network Exchange (MINX) video communications products which provide the capacity for large video networks, data conferencing features, and aggressive pricing. A complete range of products is available from a fully interactive, broadcast-quality, full-motion video network which can accommodate over 700 local workstations to a single video station for a remote office. All of the video products are interoperable and provide functionality and picture quality that is unparalleled in the industry. Concurrently, the Company strengthened its direct Sales, Support, and Engineering efforts to respond to the growing desktop video communications market.\nThe Company was successful in asserting its United States video conferencing patents resulting in payment for a license. The Company believes that these patents provide broad coverage in switched video conferencing technology and present the opportunity for further royalty bearing licenses. \t Open Systems Networking products are industry-standard. The file servers are based upon a scaleable architecture using the Intel microprocessor because of its cost and performance. The multi-processor functionality is provided for both the Company's highly sophisticated RMS network operating system and the industry-standard UNIX operating system. The Company offers high-performance, Pentium-based file servers for less demanding configurations in both the RMS and UNIX environments. Redundant disk systems are also available for customers who require uninterruptable services from their computer systems.\nThe Company's networking products focus on linking file servers, workstations, terminals, printers, and other peripherals (such as modems) to the network. High performance networking software and hardware components comprise the product offering and provide the ability to implement high-capacity, highly efficient networks composed of client\/server and data communications devices. The networking solutions provide the capability of running MS-DOS, UNIX, and RMS simultaneously along with both ARCNET, ARCNETPLUS, and Ethernet adapters. These capabilities provide customers the flexibility to design network architecture's to meet their specific requirements.\nRealizing that personal computers are the desktop workstation of choice, the Company offers PC-based hardware and software. The software component is a full featured, Microsoft Windows compliant terminal emulation package for the RMS environment which can be run on existing PCs. An industry-standard UNIX terminal is offered for customers who desire a low-cost data station rather than a networked PC.\nThe Company offers a complete set of telecommunications products and services to meet the requirements of large call centers, customer service organizations, and telemarketing firms. Power dialers to increase call efficiency for outbound communications applications, interactive voice response systems which allow customers to interrogate an organization's database with a simple telephone, and automatic call distribution systems that manage large volumes of incoming calls comprise the portfolio of telecommunications products. The Company has an agreement with AT&T to market their Definity line of automatic call distributors through several of the Company's European subsidiaries. Telecommunications solutions are provided with the combined expertise in networking, data processing, and telecommunications products.\nThe supplier and value-added reseller relationships that the Company continues to develop, allow its customers worldwide to enhance their productivity with sensible, cost-effective computer-based networking, telephony and video communication solutions.\nMarkets\nCustomers\nDatapoint sells generally to business and government customers, including the U.S. government, financial institutions, insurance companies, educational institutions, and manufacturers. During fiscal 1994, no one customer accounted for 10 percent or more of consolidated revenues.\nDomestic\nDatapoint markets its products in the United States through independent sales representatives who, on a commission basis, solicit orders for Datapoint's products; through value-added resellers, who purchase Datapoint's products for resale; original equipment manufacturers, who integrate Datapoint's products into their overall offerings; and through Datapoint's own end user sales force. Independent sales representatives, value-added resellers, and original equipment manufacturers generally market Datapoint's products in conjunction with application software and other products developed and marketed by such firms.\nInternational\nDatapoint's products are marketed to end users in over forty countries through a network of wholly-owned subsidiaries and independent distributors. Datapoint distributes its products internationally through wholly-owned sales and service operations in Belgium, France, Germany, Holland, Hong Kong, Italy, New Zealand, Portugal, Spain, Sweden, Switzerland and the United Kingdom and through authorized distributors worldwide. During fiscal year 1994, 92 percent of Datapoint's international revenue was derived from customers in Western Europe.\nCustomer Service\nPursuant to a Master Maintenance Agreement between Intelogic Trace, Inc. (\"Intelogic\") and Datapoint dated June 28, 1985, Datapoint retained Intelogic to serve as the exclusive authorized service agent for Datapoint's proprietary data processing products in the United States for an evergreen term of six years, subject to Datapoint's right to earlier termination under certain conditions. Maintenance of equipment outside the United States is provided by Datapoint's international subsidiaries and distributors. The maintenance operations of the Company's international subsidiaries produced 50 percent of total company revenues and 44 percent of total company gross profit for the fiscal year ended July 30, 1994.\nManufacturing, Raw Materials, and Supplies\nA significant portion of Datapoint's products are purchased from third parties, who manufacture products meeting Datapoint's specifications. The products are then resold badged\/unbadged within Datapoint configurations. Datapoint manufactures the remainder of its products, primarily by assembling various purchased components into subassemblies which are then assembled into finished products, primarily performed at Datapoint's facilities in San Antonio, Texas.\nDatapoint seeks, and maintains where practical, multiple sources of supply for the products, components, and raw materials which it uses. However, certain products and components are purchased only from single sources, and Datapoint could experience manufacturing delays if such suppliers should fail to meet Datapoint's requirements. The interruption of any components, whether for supply or quality reasons, can become critical to production flows. The Company's general experience has been good in terms of minimizing exposure; however, guarantees regarding possible future situations and rectifying actions that could arise cannot be made.\nResearch and Product Development\nThe technology involved in the design and operation of Datapoint's products is complex and subject to constant change. Accordingly, Datapoint is committed to a program of research and development which is oriented toward the development of new hardware and software products and the improvement and expansion of its existing products and services.\nDatapoint incurred expense of $5.3 million, $7.8 million, and $9.3 million in the fiscal years ended July 30, 1994, July 31, 1993, and August 1, 1992, respectively, on research and development activity. Datapoint maintains research and development facilities in San Antonio, Texas.\nCompetition\nDatapoint operates in the intensely competitive computer data processing, video conferencing and telephony industries that are characterized by the frequent introduction of new products based upon technological advances. Datapoint competes, domestically and abroad, with a substantial number of companies, many of which are larger and have greater resources than Datapoint. Such companies, considered in the aggregate, compete in the entire line of products manufactured and marketed by Datapoint. These competitors differ somewhat depending on the market segment, customer and geographic area involved.\nCompetition in this market is based primarily on the relationship between price and performance; the ability to offer a variety of products and unique functional capabilities; the strength of sales, service and support organizations; and upgradability, flexibility, and ease of use of products. The Company could be adversely affected if its competitors introduced technologically superior products or substantial price reductions.\nBacklog\nThe backlog of firm orders for the sale or lease of the Company's products (using then existing end-user purchase prices for products to be leased and giving effect to appropriate discounts for products to be sold) as of July 30, 1994 and July 31, 1993 was $5.9 million and $11.1 million, respectively. The backlog amounts are not necessarily indicative of the Company's future results, since an increasing amount of the Company's revenues are derived from orders obtained in the period of shipment. Furthermore, a portion of the Company's backlog may be cancelable at the customer's option, under certain conditions, without financial penalty. All orders included in the backlog at July 30, 1994 are currently scheduled for delivery during the subsequent 12 months. All orders are subject to the Company's ability to meet delivery commitments. The Company records only firm orders as backlog, and generally such orders are cancelable only by the Company. In the event that a new product is released, a customer is allowed to upgrade (i.e., cancel) an existing order and place a new order for the new product. This is done at the Company's discretion with no financial penalty to the customer.\nBacklog is also not a reliable indicator of future results, as changes in product mix (depending on whether the product content contained in backlog has a low or high sales margin) and costs may significantly impact reported results. Therefore, the Company believes that the backlog data is not meaningful to an understanding of the Company's business or future reported results.\nPatents and Trademarks\nDatapoint owns certain patents, copyrights, trademarks and trade secrets in both network and video conferencing technologies, which it considers valuable proprietary assets. The Company does not primarily rely on these rights to establish or protect its market position, but does view them as providing the Company a technological advantage in certain cases and does intend to fully exploit their value, particularly with regard to the licensing of video conferencing technology. While in the aggregate its patents are of material importance to its business, the Company believes that no one single patent or group of patents are of material importance to its business as a whole, with the possible future exception of its video conferencing patents. During 1994 the Company began patent infringement suits against several defendants related to the Company's video conferencing patents. Subsequent to 1994, the Company received $0.5 million from one such defendant and patent infringement suits against other defendants are pending. Because of the many patents issued in the electronics industry, the Company's operations may involve claims of infringement of existing patents.\nThe Company utilizes a number of trademarks, most importantly \"DATAPOINT\", \"ARCNET\" and \"MINX\". The Company registers or otherwise protects those trademarks it deems valuable to its business and anticipates no significant impairment of its ability to continue to use and protect its important trademarks. Datapoint, the \"D\" logo, ARC, ARCNET, RMS, MINX, and Resource Management System are trademarks of Datapoint Corporation registered in the U.S. Patent and Trademark office. Attached Resource Computer, ARCNETPLUS, and DATALAN are trademarks of the Company. (AT&T is a registered trademark of American Telephone and Telegraph. Ethernet is a registered trademark of Xerox Corporation. Intel is a registered trademark of Intel Corporation. Microsoft and MS-DOS are registered trademarks of Microsoft Corporation. UNIX is a registered trademark of UNIX System Laboratories, Inc.)\nEmployees\nAt July 30, 1994, the Company had 1,444 employees. The Company considers its relations with employees to be satisfactory.\nEnvironmental Matters\nCompliance with current federal, state, and local regulations relating to the protection of the environment has not had, and is not expected to have, a material effect upon the capital expenditures, earnings, or competitive position of Datapoint.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties.\nDatapoint's principal executive offices are located in Paris, France and the Company maintains executive offices in San Antonio, Texas. Datapoint believes that its plants and offices are generally well maintained, in good operating condition and are adequately equipped for their present use. Information regarding the principal plants and properties, excluding leases assigned or subleased, as of July 30, 1994 is as follows:\n\t\t Approximate \t\t Facility Location Use \t Sq. Footage Owned or Leased Land Area\nSan Antonio, Texas\t Raw Land \t -- Owned; 148 acres(a) San Antonio, Texas\t Office\t 144,000 Owned; 12 acres San Antonio, Texas\t Manufacturing, \t warehouse and office \t 126,000 Leased (b) Gouda, Netherlands\t Office\t 52,000 Owned; 1 acre Paris, France\t Office\t 16,000 Leased (b)\n(a) The raw land owned by the Company in San Antonio, Texas is being held for sale. (b) Leases on facilities expire on various dates extending through July, 2002.\nAdditionally, at July 30, 1994, excluding leases assigned or subleased, the Company leased sales and service offices having an aggregate of 429,000 square feet in metropolitan areas throughout the world, pursuant to lease agreements which expire between 1995 and 2009. The aggregate annual rental of all of these sales and service offices is approximately $6.6 million and most of these leases are subject to rental increases under certain escalation provisions and renewals on similar terms.\nITEM 3.","section_3":"ITEM 3. Legal Proceedings. \t The Company is a defendant in various lawsuits generally incidental to its business. The amounts sought by the plaintiffs in such cases are substantial and, if all such cases were decided adversely to the Company, the Company's aggregate liability might be material. However, the Company does not expect such an aggregate result based upon the limited number of such actions and an assessment that most such actions will be successfully defended. No provision has been made in the accompanying financial statements for any possible liability with respect to such lawsuits.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nExecutive Officers of the Registrant\nThe following information is submitted with respect to the executive officers of the Company as of October 28, 1994: \t\t\t\t Officer Name Age Position\t Since A. B. Edelman\t 54\t Chairman of the Board and Chief Executive Officer\t 1985 D. D. Bencsik\t 63\t President and Chief Operating Officer 1993 D. Berger\t 45 Vice President, Sales and Distribution 1993 J. Berger\t 51\t Vice President, Marketing 1991 P. P. Krumb\t 52 Vice President and Chief Financial Officer 1994 G. N. Agranoff\t 47 Vice President, General Counsel and Corporate Secretary 1994 J. L. Richey, Jr.\t 46 Vice President, Technical Operations \t 1994 K. L. Thrower \t 50 Vice President, Technical Service\t 1991 P. D. Sheetz 37 Assistant Corporate Controller 1994\nThe officers named above serve at least until the next Board of Directors meeting immediately following the Annual Meeting of Stockholders.\nMr. Edelman joined the Company's Board of Directors as it's Chairman in March 1985. For more than the past five years, Mr. Edelman has served as General Partner of Plaza Securities Company. From January 1977 through June 1984 he served as the General Partner of Arbitrage Securities Company, a broker-dealer; from June 1984 he has served as General Partner of Asco Partners, the sole general partner of Arbitrage thereafter. Mr. Edelman is a director, Chairman of the Board and Chairman of the Executive Committee of Intelogic Trace, Inc.; and a director, Chairman of the Board and Chairman of the Executive Committee of Canal Capital Corporation (formerly United Stockyards Corporation). The principal business address of Mr. Edelman is 85 Av. General Guisan, CH-1009 Pully, Switzerland.\nMs. Bencsik joined the Company as Executive Vice President and Chief Operating Officer in February 1993. In November 1993, she was promoted to President and Chief Operating Officer. Ms. Bencsik has been a member of the Company's Board of Directors since 1985. From 1991 to 1993 Ms. Bencsik had been employed by Modular Computer Systems Inc., as President and Chief Executive Officer. In addition, Ms. Bencsik has maintained a business consulting practice for more than the past five years. Ms. Bencsik also worked at the Company from 1982 to 1987. Ms. Bencsik joined the Company in November 1982 as Vice President, Engineering. In May 1984, she was promoted to Vice President, Operations, and was promoted to Senior Vice President, Operations in January 1985. In November 1985, she was promoted to Executive Vice President, Chief Operating Officer and elected as a member of the Board of Directors. In January 1987, Ms. Bencsik was named acting Chief Executive Officer and in June 1987 was named to the Office of the President. The principal business address of Ms. Bencsik is 8400 Datapoint Drive, San Antonio, Texas 78229-8500.\nMr. D. Berger was promoted to Vice President, Sales and Distribution in July 1993. Mr. Berger joined the Company in 1991 as Managing Director of the Company's United Kingdom subsidiary. Prior to joining the Company, Mr. Berger was employed from 1988 to 1991 by RS2, a U.K. marketing communications company, as Group Managing Director. The principal business address of Mr. Berger is 5-7 rue Montalivet 75008, Paris, France.\nMr. J. Berger joined the Company as Vice President, Marketing in June 1991. Prior to joining the Company, Mr. Berger was employed by SCANVEST of Norway, Datapoint's largest independent foreign distributor, for 21 years, most recently as Managing Director, and previously as Director of Marketing. The principal business address of Mr. Berger is 5-7 rue Montalivet 75008, Paris, France.\nMr. Krumb joined the Company as Vice President and Chief Financial Officer in September 1994. Prior to joining the Company he was employed by IOMEGA Corporation for the past 7 years as Senior Vice President Finance and Chief Financial Officer. The principal business address of Mr. Krumb is 8400 Datapoint Drive, San Antonio, Texas 78229-8500.\nMr. Agranoff joined the Company as Vice President, General Counsel and Corporate Secretary September 1994. Mr. Agranoff has been a member of the Company's Board of Directors since March 1991, and is a member of the Audit and Compensation Committees. He has been the General Partner of Asco Partners, the sole general partner of Arbitrage securities Company for more than five years. He has also been the general counsel to Arbitrage Securities Company and Plaza Securities Company for more than the past five years. He is also a member of the Board of Directors for Intelogic Trace, Inc. The principal business address of Mr. Agranoff is 5-7 rue Montalivet 75008, Paris, France.\nMr. Richey joined the Company as Vice President, Technical Operations in March 1994. He was previously employed by Data General and Honeywell. During the last five years Mr. Richey was Director of Operations and most recently Vice President, Engineering with Idea Associates and Modular Computer Systems, Inc., respectively. The principal business address of Mr. Richey is 8400 Datapoint Drive, San Antonio, Texas 78229-8500.\nMr. Thrower joined the Company as Vice President, Technical Services in April 1991. He was previously employed by Memorex Telex for 12 years. He held numerous positions with Memorex Telex, the most recent being Vice President, Worldwide Customer Engineering. The principal business address of Mr. Thrower is 5-7 rue Montalivet 75008, Paris, France.\nMr. Sheetz joined the Company in 1982 and has assumed an increasing level of management responsibilities since joining the Company. He was promoted to Assistant Controller in November 1994.\nThere are no family relationships between any of the executive officers of the Company.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nDatapoint Corporation common stock is traded on the New York Stock Exchange under the symbol \"DPT\". The prices below represent the high and low prices for composite transactions for stock traded during the applicable period. The Company has not paid cash dividends to date on its common stock and has no present intention to pay cash dividends on its common stock in the near future.\nFiscal\t year \t\t High Low 1994 Q4 \t 6.13 3.38 \t Q3 \t 7.38 4.50 \t Q2 \t 8.25 5.88 \t Q1 \t 7.63 5.50\n\tHigh \tLow 1993 Q4 \t 7.38 3.88 \t Q3 \t 6.75 4.25 \t Q2 \t 5.25 1.63 \t Q1 \t 2.88 1.38\nITEM 7.","section_6":"","section_7":"ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nOverview\nDuring 1994, the Company experienced substantial operating losses due to competitive pressures which caused a significant decline in revenues and to a lesser extent gross profit margins. The adverse effects of competition and the resulting decline in revenue produced an operating loss of $81.0 million, negative working capital of $18.3 million and negative cash flows from operations of $6.3 million for the year ended July 30, 1994. During the past year the Company emphasized the traditional line of business and the relatively new video conferencing and telephony markets which includes a strategic partnership with AT&T. However, the investment in these markets have resulted in revenues far below the Company's expectations.\nThe Company recorded special charges of $75.7 million during 1994. These charges consisted of $57.7 million in write-offs of investments in the Company's international operations, $14.8 million of reorganization charges and $3.2 million in the write-off of a partially owned company.\nThe write-offs of investments in the Company's international operations (\"Goodwill\") was recorded in the fourth quarter of 1994 and was the result of a reassessment of the carrying value of the Company's intangible assets. The Company periodically reviews the carrying value of its intangible assets. The performance of the Company's European subsidiaries began to worsen in 1993 as the operating performance of certain of these subsidiaries turned negative. Revenue during 1993 of these subsidiaries declined 15% from the 1992 level. The Company's projections for 1994 were for all the European subsidiaries to return to the profitability level of 1992, and the future projections for these operations was adequate to support the related goodwill balance. However, in 1994, revenue for the European subsidiaries experienced a further 16% decline from the 1993 level and cash flow from certain of these operations was negative for the second year in a row. Accordingly, at the end of 1994 the Company performed a review of the carrying value of it's goodwill. The resulting long-term projections of earnings before interest, depreciation and amortization on an undiscounted basis were insufficient to support the goodwill balance. As a result of these long-term projections and the historical declines in revenue and increased operating losses, the Company recorded a write-off of the entire remaining goodwill balance of $57.7 million (see note 1 to Consolidated Financial Statements).\nAdditionally, the Company recorded $13.4 million of charges in the fourth quarter of 1994 as a result of the implementation of a statutory plan of reorganization for one of its European subsidiaries (see note 2 to Consolidated Financial Statements). Management developed the plan, which is subject to administrative approval, as a result of a continued decline in revenues resulting from the loss of several significant accounts. These charges relate principally to severance costs associated with the termination of approximately 140 employees spread throughout sales, service, and general and administrative positions involved in this European subsidiary. The plan is expected to be completed during 1995. Management expects to fund these charges through cash inflows of the Company. These charges have been classified as current liabilities (see note 10 to Consolidated Financial Statements) but up to approximately $6.0 million may be deferred and paid out on a long-term basis depending on the outcome of the administrative proceeding. Upon completion of the plan the Company expects annual savings to exceed $10.0 million. Although the plan may have a negative impact upon revenue, the Company does not believe that such impact will be material. In addition to the charges pertaining to the European subsidiary, the Company recorded $1.4 million in Company-wide reorganization charges related to reductions of personnel whose skills do not fit with the Company's future plans.\nThe $3.2 million write-off of an investment in a partially owned company was recorded in the fourth quarter of 1994 and resulted from a reassessment of the carrying value of the asset in light of a sharp decline in the performance of the partially owned company (see note 3 to Consolidated Financial Statements). The write-off was recorded upon a succession of weakening quarterly operating performances.\nThese reorganization actions taken at the end of 1994, continued cost cutting in 1995 and a stabilized level of revenue consistent with 1994 are anticipated to preserve and improve the Company's cash liquidity position. Revenue has declined for six consecutive years and the stabilization of the revenue stream is a requirement if the Company is to continue to meet its various obligations. The Company has aggressively pursued further cost-cutting actions such as reductions of personnel and reorganization of one of the Company's European subsidiaries, while simultaneously undertaking other actions to supplement the cash flow from operations. These cash supplementation efforts include the sale of common stock, potential sale of the Company's unimproved real property situated in San Antonio, Texas, pursuit of patent infringement claims and other cash infusions. These additional infusions are necessary to meet certain of the Company's obligations, including interest of $2.9 million on its 8-7\/8% convertible subordinated debentures payable on December 1, 1994. While management anticipates meeting this obligation, no assurances can be given that sufficient funds will be available. In the event the payment is not made within the 30-day period following December 1, 1994, the resulting default would entitle the holders of the debentures to elect to declare the entire indebtedness of $64.4 million as immediately due and payable. Such a default would likewise result in defaults in certain of the Company's other debt instruments.\nFinancial Condition and Liquidity\nThe Company's cash and cash equivalents decreased $16.2 million in 1994, compared with an increase of $2.4 million in 1993 and a decrease of $13.3 million in 1992. The decrease in 1994 was due to the decline in revenue and gross profit margins partially offset by reduced operating costs and expenses. The increase in 1993 was due primarily to improved collections of accounts receivables, partially offset by the decline in revenue and margins and continued spending on new products. During 1994, 1993 and 1992, the Company paid dividends of $1.8 million $1.8 million and $0.3 million on the $1.00 preferred stock.\nAs of July 30, 1994, the Company had restricted cash of $4.3 million as compared to $4.5 million the prior year. The 1994 and 1993 balances were restricted primarily to cover various lines of credits, reflected as payables to banks. In 1993, $2.0 million of guaranteed dividends on the $1.00 preferred stock was included in the restricted cash balance.\nDuring 1994 the Company withdrew $3.7 million of cash from an investment portfolio, which had $3.9 million of cash at the beginning of 1994, for the operations of the Company. The withdrawal and disposition of these funds has reduced the Company's liquid reserves for the internal financing of cash flow requirements.\nCash used for investment in fixed assets was $10.8 million in 1994, compared to $10.9 million in 1993 and $11.1 million in 1992. There are no material commitments for capital expenditures at the present time.\nAccounts payable increased to $25.6 million in 1994 from $15.9 million in 1993. As cash and cash equivalents have declined the Company has utilized bank debt and trade account payables to finance its operations. The Company continued to work with its accounts payable creditors to extend additional credit and credit terms, thus maintaining functional relationships with such creditors during 1994. The Company has no significant purchase commitments outstanding as of July 30, 1994.\nAs of July 30, 1994, the Company has included in payables to banks an amount of $7.5 million payable to International Factors \"De Factorij\" B.V., a subsidiary of ABN-AMRO Bank of the Netherlands. The loan is secured by the receivables of the Company's U.K., Dutch and German subsidiaries. The Company paid down the loan by $1.0 million in September 1994 and is in discussion with other various potential sources of financing to reduce the borrowings by a further $1.5 million. Upon conclusion of such financing the borrowings with International Factors B.V. will be secured by the U.K. and Dutch receivables.\nThe Company has a secured credit facility with The CIT Group\/Credit Finance (\"CIT\"), which consists of a term loan and a revolving loan. As of July 30, 1994, the Company had borrowings against this facility of $3.3 million, the maximum based on the available collateral as of that date and the credit facility is callable at the option of the lender. The collateral for the revolving credit facility consists of the Company's U.S. trade receivables, certain trade receivables from independent foreign distributors, U.S. inventories, real property, contract rights and general intangibles, equipment and fixtures, and certain certificates of deposit issued to or for the account of the Company. Available borrowings are calculated by multiplying various percentages times the collateral, based upon type of inventory, type of account receivable and value of such certificates of deposit issued to or for the account of the Company. The credit facility also includes a restriction upon the payment of dividends, allowing dividends to be paid on the Company's $1.00 preferred stock, but prohibiting dividend payments on the Company's common stock.\nThe Company has available lines of credit from foreign banks to its foreign subsidiaries. The unused lines of credit at July 30, 1994 totaled $2.7 million after borrowings of $7.2 million.\nDuring 1993 the Company settled two long standing patent-related legal actions brought against it by Northern Telecom Inc. (\"NTI\") and Compagnie Internationale de Services en Informatique, S.A. (\"CISI\"). Pursuant to these settlements, during 1994 and 1993, the Company paid NTI $1.0 million and $7.5 million and paid CISI $1.0 million and $0.8 million. The Company also agreed to a ten-year note payable to NTI which requires annual $1.0 million payments each December. As of July 30, 1994 the Company owed CISI $0.2 million and NTI $6.1 million which were included in current and long-term debt (see note 11 to Consolidated Financial Statements). The Company is also contingently obligated to make payments to NTI dependent upon the Company's future profitability. The contingent payments, up to a cumulative maximum of $12.5 million, are to be paid in annual installments calculated at 33-1\/3% of the Company's pre-tax annual profits in excess of $10.0 million in each of the 10 fiscal years beginning with fiscal 1993. During 1994 and 1993, the Company incurred no liability to make such contingent payments as a result of the net losses incurred.\nThe Company received subsequent to 1994 several one-time cash infusions. During August 1994, the Company sold 700,000 shares of the Company's Common Stock for $1.8 million. The Company received subsequent to 1994 a settlement payment of $0.5 million from a defendant in patent infringement litigation brought by the Company. Patent infringement suits against other defendants are pending. Also, subsequent to 1994, the Company received the final $1.5 million insurance payment related to the fire in the Belgian subsidiary. The Company will continue to pursue additional one-time cash infusions as a means of augmenting cash during 1995. No assurances can be given that the efforts to pursue such cash infusions will be successful.\nAs an additional means of preserving cash flow for operations, the Company's Board of Directors elected to defer the October 15, 1994 preferred dividend payment to shareholders. If dividends are six quarters in arrears, the preferred stock shareholders have the right to vote as a separate class and elect two board members at the next annual meeting of shareholders and each preferred share is exchangeable into two shares of common stock at the option of the holder.\nThe Company adopted, effective August 1, 1993, SFAS No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"), which superseded SFAS No. 96 and APB Opinion No. 11. The Company recorded a favorable cumulative accounting change effect of approximately $1.3 million in the first quarter of fiscal 1994 (see note 4 to Consolidated Financial Statements).\nAt July 30, 1994, the Company had available federal tax net operating losses aggregating approximately $133 million, expiring in various amounts beginning in 2001. In the event that the Company's ability to utilize its net operating losses to reduce its federal tax liability with respect to current and future income becomes subject to limitation, the Company may be required to pay, sooner than it otherwise might have to, any amounts owing with respect to such federal tax liability, which would reduce the amount of cash otherwise available to the Company (see note 4 to Consolidated Financial Statements).\nResults of Operations\nThe following is a summary of the Company's sources of revenue for each of fiscal 1994, 1993 and 1992:\n(In thousands)\n\t\t\t 1994 \t 1993 \t 1992 Sales: \tU.S. \t\t \t $6,453 \t $5,757 \t $7,483 \tForeign \t\t\t 78,300 \t 94,463 \t 131,742 \t\t\t 84,753 \t 100,220 \t 139,225\nService and other: \tU.S. \t\t\t 1,164 \t 1,529 \t 1,762 \tForeign \t\t\t 87,019 \t 106,595 \t 114,256 \t\t\t 88,183 \t 108,124 \t 116,018\nTotal revenue \t \t\t$172,936 $208,344 $255,243\n1994 Compared to 1993\nTotal revenue declined 17% to $172.9 million in 1994 from $208.3 million in 1993. The decline was due to a stronger U.S. dollar, on average, in 1994 as compared to the average U.S. dollar strength in 1993 as the Company incurred a $16.0 million decline in total revenue attributable solely to currency changes. In addition the French subsidiary incurred a sharp loss of business due to the loss of several significant accounts to competitors and accordingly suffered a total revenue loss of $11.7 million. The decline was also due to the sale of the Australian subsidiary in 1993 which accounted for total revenue of $4.2 million in 1993. The Company also incurred less significant declines in revenue in the Company's subsidiaries in Germany, Sweden and Holland attributable to performance declines resulting primarily from competitive pressures.\nOperating income during 1994 included a fire insurance settlement gain of $0.9 million related to a fire in the second quarter in a leased warehouse facility in the Company's Belgian subsidiary. Operating income during 1993 also included $2.8 million in gains on a fire insurance settlement related to a fire in the French subsidiary, and an additional $2.5 million for business interruption coverage.\nGross profit margins during 1994 were 37.9% compared with 41.6% for 1993. Excluding the impact upon cost of sales of the fires noted above, gross profit margins during 1994 were 37.4% compared with 39.0% for 1993.\nOperating expenses (research and development plus selling, general & administrative) during 1994 declined 9% from 1993 to $74.1 million. The decline was a result of cost-cutting actions taken over 1994 which significantly reduced costs of internal operations. In addition, operating expenses were favorably impacted by the stronger U.S. dollar.\nInterest expense decreased slightly in 1994 from 1993 as the Company benefited from lower rates on borrowings in Europe and late in 1994 the Company renegotiated its loan with CIT and significantly lowered its borrowing rate in the U.S. The effect of lower interest rates more than offset a higher borrowing level.\nNon-operating results for 1994 includes the $3.2 million write-off of an investment in a partially owned company, $0.7 million in foreign currency exchange rate losses on certain of the Company's intercompany payables and receivables and a $0.5 million fire settlement gain on fixed assets. Non-operating results for 1993 also included a fire settlement gain on fixed assets of $1.2 million. Interest income in 1994 declined significantly from 1993 as the average investment balance in 1994 declined due to the usage of cash in operations.\nPrior to 1994, the Company's foreign subsidiaries reported their results to the parent on a one-month lag which allowed more time to compile results but produced comparability problems in management accounting. Due to improved internal applications, the one-month lag became unnecessary and therefore was eliminated subsequent to 1993 and prior to 1994. As a result, the July 1993 results of operations for the Company's foreign subsidiaries was recorded to the retained deficit. This action resulted in a charge of $5.5 million being recorded against the retained deficit. The loss incurred in July 1993 resulted primarily from a low revenue level, which is usual for the first month following the end of a fiscal year.\nFor a discussion of income tax expense for 1994 and 1993, see note 4 to Consolidated Financial Statements.\n1993 Compared to 1992\nTotal revenue declined significantly during 1993 as compared to 1992. The decline was most evident in sales revenue which declined 28%, primarily in the Company's European subsidiaries. The decline was due to a recessionary economic climate in much of Europe, exacerbated by industry difficulties, and partially to the negative impact of a relatively stronger U.S. dollar compared to 1992. The decline in sales revenue was also the result of the mid-year sale of the Company's Australian subsidiary. In addition, sales were adversely impacted by the diversion of resources to effect the Company's transition away from reliance on traditional product lines and markets, and toward opportunities in the growing video conferencing and telephony markets. Serviceand other revenue declined during 1993, as compared to 1992, due mainly to the negative effect of the stronger U.S. dollar and the sale of the Australian subsidiary.\nDuring the second quarter of 1993, the operations of the Company's French subsidiary were interrupted by a fire in its leased warehouse facility. The fire negatively impacted revenue in the subsidiary, but this was compensated for by business interruption insurance proceeds of $2.5 million. Operating income also included $2.8 million in gains on the fire insurance settlement related primarily to destroyed inventory and spare parts. Non-operating income included $1.2 million in gains on the fire insurance settlement related to destroyed fixed assets.\nGross profit margins during 1993 were 41.6% compared with 39.9% for 1992. Excluding the $2.5 million of business interruption insurance coverage and $2.8 million of gains on the fire insurance settlement which favorably impacted cost of sales, the gross profit margin for 1993 would have been 39.0%.\nOperating expenses during 1993 declined significantly from 1992, as the Company's emphasis on improving operating efficiencies resulted in significant expense reductions in all major expense categories. Expenses were also favorably effected by the stronger U.S. dollar.\nOperating results during 1993 were negatively impacted by $6.2 million of restructuring costs which were incurred to streamline the Company's internal operations and re-position its sales, marketing and support teams to benefit from the planned introduction of a broad range of new products. Over 97% of these restructuring costs were related to staff reductions, of which 51% of these costs are attributable to the French subsidiary, 23% are attributable to the U.S. operations and the remaining percentage are attributable to subsidiaries in Sweden, U.K., New Zealand, Germany and the Company's former subsidiary in Australia.\nInterest expense increased $0.9 million in 1993 as compared to 1992, due primarily to an increase in debt resulting from the settlement of the NTI and CISI patent litigation's. Other non-operating expenses for 1993 were nominal, as foreign exchange losses resulting from the difficulties within the European exchange rate system and the general strengthening of the U.S. dollar against European currencies were essentially offset by interest income and the $1.2 million of insurance settlement gain related to the French fire. During 1992, non-operating expenses were negatively impacted by $15.3 million in patent litigation settlements with NTI and CISI, partially offset by interest income of $3.1 million, a $3.0 million gain on the curtailment of the U.K. pension and $2.3 million of foreign currency gains resulting from a weakening of the U.S. dollar during 1992.\nFor a discussion of income tax expense for 1993 and 1992, see note 4 to Consolidated Financial Statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data.\nINDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nReport of Ernst & Young LLP Independent Auditors\nConsolidated Financial Statements\nConsolidated Statements of Operations for the fiscal years 1994, 1993 and 1992\n\tConsolidated Balance Sheets as of July 30, 1994 and July 31, 1993 \t Consolidated Statements of Cash Flows for the fiscal years 1994, 1993 and 1992\n\t Consolidated Statements of Stockholders' Equity (Deficit) for the fiscal years 1994, 1993 and 1992\t\nNotes to Consolidated Financial Statements\t\nSupplementary Data\nREPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS\nThe Board of Directors Datapoint Corporation\nWe have audited the accompanying consolidated balance sheets of Datapoint Corporation and subsidiaries (the Company) as of July 30, 1994 and July 31, 1993 and the related consolidated statements of operations, stockholders' equity (deficit) and cash flows for each of the three fiscal years in the period ended July 30, 1994. 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 the Company at July 30, 1994 and July 31, 1993 and the consolidated results of its operations and its cash flows for each of the three fiscal years in the period ended July 30, 1994 in conformity with generally accepted accounting principles.\nThe accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1 to the consolidated financial statements, the Company has incurred recurring operating losses, has negative working capital at July 30, 1994, and negative cash flows from operations for the year ended July 30, 1994. These conditions raise 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 consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.\nAs discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1994.\n\/s\/Ernst & Young LLP Ernst & Young LLP\nDallas, Texas November 14, 1994\nCONSOLIDATED STATEMENTS OF OPERATIONS Datapoint Corporation and Subsidiaries Fiscal Years 1994, 1993 and 1992 (In thousands, except share and per share data)\n\t 1994 \t 1993 \t 1992\nRevenue: \tSales\t $84,753 \t $100,220 $139,225 \tService and other\t 88,183 \t 108,124 \t 116,018 \t\tTotal revenue\t 172,936 \t 208,344 \t 255,243\nOperating costs and expenses: \tCost of sales\t 49,912 \t 48,359 \t 76,287 \tCost of service and other\t 57,459 \t 73,387 \t 77,079 \tResearch and development\t 5,268 \t 7,754 \t 9,330 \tSelling, general and administrative\t 68,808 \t 73,859 \t 85,892 \tWrite-off of investment in foreign operations\t 57,657 \t - - \tReorganization\/restructuring costs \t 14,853 \t 6,243 \t - \t\tTotal operating costs and expenses\t 253,957 \t 209,602 \t 248,588\nOperating income (loss)\t (81,021)\t (1,258)\t 6,655\nNon-operating income (expense): \tInterest expense\t (9,097)\t (9,349)\t (8,432) \tOther, net\t (4,293)\t (291) (7,324) \t\tLoss before income taxes, extraordinary credit and effect of change in accounting principle\t (94,411)\t (10,898)\t (9,101) Income taxes \t 354 \t 961 \t 1,308 \t\tLoss before extraordinary credit and effect\tof change in accounting principle\t (94,765)\t (11,859)\t (10,409) \t Extraordinary credit: \tUtilization of tax loss carryforward\t - \t 599 \t 1,653 \t\tLoss before effect of change in \t\t accounting principle\t $(94,765)\t $(11,260)\t $(8,756)\nEffect of change in accounting principle\t 1,340 \t - \t -\n\t\tNet loss\t $(93,425)\t $(11,260)\t $(8,756) Net loss, less preferred stock dividends paid or accumulated \t $(95,209) \t $(13,044) \t $(16,357)\nNet loss per common share: \tBefore extraordinary credit and effect of change in accounting principle\t $(6.69) \t $(.97) \t $(1.62) \tUtilization of tax loss carryforward\t - \t .04 \t .15 \tEffect of change in accounting principle\t .09\t - \t - \t\tNet loss\t $(6.60)\t $(.93) $(1.47) \t \t Average common shares\t 14,430,574 \t 14,081,964 \t 11,093,431\nSee accompanying Notes to Consolidated Financial Statements.\nCONSOLIDATED BALANCE SHEETS Datapoint Corporation and Subsidiaries July 30, 1994 and July 31, 1993 (In thousands, except share data) \t 1994 \t 1993 Assets\nCurrent assets: \tCash and cash equivalents\t $6,241 \t $22,452 \tRestricted cash and cash equivalents\t 4,312 \t 4,459 \tMarketable securities\t 334 \t 789 \tAccounts receivable, net of allowance for doubtful\taccounts of $2,568 and $2,466, respectively\t 44,379 \t 45,090 \tInventories\t 17,674 \t 17,536 \tPrepaid expenses and other current assets\t 6,975 \t 3,843 \t\tTotal current assets\t 79,915 \t 94,169\nFixed assets, net\t 29,088 \t 27,950 Excess of cost of investment over net assets acquired, net\t - \t 58,216 Other assets, net\t 18,431 \t 21,940 \t\t $127,434 $202,275\nLiabilities and Stockholders' Equity (Deficit)\nCurrent liabilities: \tPayables to banks\t $17,963 \t $14,129 \tCurrent maturities of long-term debt \t 2,370 \t 4,246 \tAccounts payable\t 25,649 \t 15,914 \tAccrued expenses\t 37,732 \t 26,683 \tDeferred revenue\t 13,728 \t 12,579 \tIncome taxes payable\t 760 \t 1,208 \t\tTotal current liabilities\t 98,202 \t 74,759\nLong-term debt, exclusive of current maturities\t 70,561 \t 71,551 Other liabilities\t 9,432 \t 8,944\nCommitments and contingencies\t \t\nStockholders' equity (deficit): \tPreferred stock of $1.00 par value. Shares authorized 10,000,000; shares issued and outstanding 1,784,456 (aggregate liquidation preference $35,689).\t 1,784 \t 1,784 \tCommon stock of $0.25 par value. Shares authorized 40,000,000; shares\tissued and outstanding 20,991,217, including treasury shares of 6,546,825 in 1994 and 6,637,065 in 1993.\t 5,248 \t 5,248 \tOther capital\t 212,599 \t 212,599 \tForeign currency translation adjustment \t 10,552 \t 7,707 \tRetained deficit\t (226,977)\t (125,581) \tTreasury stock, at cost \t (53,967)\t (54,736) \t\tTotal stockholders' equity (deficit)\t (50,761)\t 47,021 \t\t $127,434 $202,275\nSee accompanying Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS Datapoint Corporation and Subsidiaries Fiscal Years 1994, 1993 and 1992 (In thousands) \t 1994 \t 1993 \t 1992 Cash flows from operating activities: \tNet loss \t $(93,425) $(11,260) $(8,756) \tAdjustments to reconcile net loss to net cash provided from (used in) operating activities: \tLosses incurred in lag month eliminated\t (5,470)\t - - \tEffect of change in accounting principle\t (1,340)\t - - \tDepreciation and amortization\t 10,729\t 11,083 \t 12,898 \tWrite-offs of investment in foreign operations\t57,657 \t - - Write-off of investment in partially owned company 3,210 - - \tNet realized losses (gains) on marketable securities\t -\t (26) 387 \tProvision for unrealized losses (recoveries) \t on marketable securities\t 454 \t (314) (297) \tRealized gain on fixed assets fire settlement\t (534) (1,165) -- \tPension plan curtailment\t - \t - (3,009) \tProvision for losses (recoveries) on accounts receivable\t 803 \t (405) \t 530 \tChanges in assets and liabilities:\t \t\tDecrease (increase) in receivables \t 801 17,643 (1,089) \t\tDecrease (increase) in inventory\t 1,007 \t 2,124 (729) \t\tIncrease (decrease) in accounts payable and accrued expenses 19,747\t (19,871)\t (1,680) \t\tIncrease in other liabilities and deferred credits\t 388 \t 1,678 3,758 \tOther, net\t (315)\t 314 \t (1,198) \t\tNet cash provided from (used in) operating activities\t (6,288) \t (199) 815\nCash flows from investing activities: \tProceeds from marketable securities\t - \t 88 \t 1,319 \tPayments for fixed assets\t (10,828)\t (10,874)\t (11,118) \tProceeds from disposition of fixed assets\t 2,426 \t 7,739 \t 744 \tOther, net \t (648) \t 510 (506) \t\tNet cash used in investing activities\t (9,050)\t (2,537) (9,561)\nCash flows from financing activities: \tPayments on borrowings\t (32,606)\t (51,746) (50,958) \tProceeds from borrowings\t 33,126 \t 59,235 \t 50,857 \tPayments of dividends on preferred stock\t (1,784)\t (1,784) (303) \tDisbursements related to Preferred Stock Exchange \t - (116) (2,439) \tRestricted cash for letters of credit\t 147 \t (240) (4,219) \tProceeds on sale of stock\t 52 \t 763 \t 125 \tOther, net\t - \t - (8) \t\tNet cash provided from (used in) financing activities\t (1,065) 6,112 (6,945)\nEffect of foreign currency translation on cash\t 192 \t (945) 2,428 Net increase (decrease) in cash and cash equivalents\t (16,211)\t 2,431 (13,263) Cash and cash equivalents at beginning of year\t 22,452 \t 20,021 33,284 Cash and cash equivalents at end of year\t $6,241 \t $22,452 \t $20,021 \t\t\t\t Cash payments for:\t\t\t\t Interest\t $8,781 \t $8,938 \t $8,549 Income taxes, net\t 362 \t 1,156 \t 2,558\nSee accompanying Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Datapoint Corporation and Subsidiaries July 30, 1994, July 31, 1993 and August 1, 1992 (Dollars in thousands, except share data)\n1. Summary of Significant Accounting Policies\nLiquidity\nIn the current year, the Company's operating results continued to be adversely affected by competition in the networking marketplace and highly competitive pricing. Additionally, while the Company has increased its emphasis on the telephony and video conferencing markets and management believes these markets have significant opportunities, revenues have been substantially below the Company's expectations.\nAs a result, the operating loss for 1994 was $81,021 with negative working capital at July 30, 1994 of $18,287 and negative cash flows from operations of $6,288 for the year ended July 30, 1994.\nManagement has undertaken several plans to improve operations, and reduce negative working capital and negative cash flows. These plans include strengthening its direct sales, support and engineering efforts to respond to the growing video conferencing market. The Company has also announced several new products and new peripherals which they hope will reverse the downward trend in sales. It will be necessary for the Company to reverse this downward trend in sales if it is to meet its various obligations. Additionally, the Company's viability as a going concern is ultimately dependent on a return to profitability. However, the effectiveness of these plans can not necessarily be assured.\nThe Company has also aggressively pursued cost-cutting actions including reductions of personnel whose skills do not fit with the Company's future plans (see note 2 for discussion of a statutory plan of reorganization for one of the Company's European subsidiaries and related severance costs). Management has also actively undertaken other actions to supplement the cash flow from operations, including the sale of common stock, potential sale of assets, patent infringement claims and other cash infusions. These additional infusions are necessary to meet certain of the Company's obligations, including interest of $2,857 on its 8-7\/8% convertible subordinated debentures payable on December 1, 1994 (see note 11). While management anticipates meeting this obligation, no assurances can be given that sufficient funds will be available. In the event the payment is not made within the 30-day period following December 1, 1994, the resulting default would entitle the holders of the debentures to elect to declare the entire indebtedness of $64,394 as immediately due and payable. Such a default would likely result in defaults in certain of the Company's other debt instruments.\nThese conditions raise substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty.\nFiscal Year\nThe Company utilizes a 52-53 week fiscal year. References to 1994, 1993 and 1992 are for the 52-week periods ended July 30, 1994, July 31, 1993 and the 53-week period ended August 1, 1992.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Intercompany accounts and transactions have been eliminated upon consolidation.\nPrior to 1994, the Company's foreign subsidiaries reported their results to the parent on a one-month lag which allowed more time to compile results but produced comparability problems in management accounting. Due to improved internal applications, the one-month lag became unnecessary and therefore was eliminated subsequent to 1993 and prior to 1994. As a result, the July 1993 results of operations for the Company's foreign subsidiaries was recorded to the retained deficit. This action resulted in a charge of $5,470 being recorded against the retained deficit. The loss incurred in July 1993 resulted primarily from a low revenue level, which is usual for the first month following the end of a fiscal year.\nCash and Cash Equivalents\nCash equivalents include short-term, highly liquid investments with maturities of three months or less from date of acquisition and as a result the carrying value approximates fair value because of the short maturity of those instruments. At July 30, 1994, the Company has $4,312 of restricted cash. The amount collateralizes various lines of credit payable to banks which are recorded as current liabilities.\nMarketable Securities\nMarketable securities are stated at the lower of cost, determined on a first-in, first-out basis, or market at the balance sheet date and consist of equity securities. At July 30, 1994, the carrying value of marketable securities is based on quoted market prices.\nInventories\nInventories are stated at the lower of standard cost (approximates first-in, first-out) or market (replacement cost as to raw materials and net realizable value as to work in process and finished products).\nFixed Assets\nFixed assets are carried at cost and depreciated for financial purposes using straight-line and accelerated methods at rates based on the economic lives of the assets, which are generally as follows:\n\tBuildings and land improvements\t 5-30 years \tMachinery, equipment, furniture and fixtures \t 3-10 years \tEquipment leased to customers\t 4 years \tField support spares\t 3 years\nMajor improvements that add to the productive capacity or extend the life of an asset are capitalized while repairs and maintenance are charged to expense as incurred.\nDebt\nThe carrying amounts and the fair values of the Company's debt at July 30, 1994 are:\n\t\t\tCarrying\t Fair \t\t\t Amount\t Value \t8-7\/8% convertible subordinated debentures\t $64,394 $33,807 \tAll other debt\t 8,537 \t 8,537\nThe fair value of the Company's 8-7\/8% convertible subordinated debentures is based on a quoted market price at July 29, 1994. The carrying value of all other debt is stated at fair value as the borrowings are at current market borrowing rates or the debt is stated at net present value for zero interest notes (see note 11).\nTranslation of Foreign Currencies\nManagement has determined that all of the Company's foreign subsidiaries operate primarily in local currencies. All assets and liabilities of foreign subsidiaries are translated into U.S. dollars using the exchange rate prevailing at the balance sheet date, while income and expense accounts are translated at average exchange rates during the year.\nReclassifications\nCertain reclassifications to the financial statements for prior years have been made to conform to the 1994 presentation.\nRevenue Recognition\nRevenue is recognized in accordance with the following criteria:\n\t(a)\tSales revenue is generally recognized at the time of shipment. \t(b)\tSoftware revenue is recognized when the program is shipped, or as the monthly license fees accrue, or over the terms of the support agreement. \t(c)\tService revenue is recognized ratably over a contractual period or as services are provided. \t(d)\tLease revenue is recognized on the operating method ratably over the term of the lease.\nExcess of Cost of Investment Over Net Assets Acquired\nThe excess of cost of investment over net assets acquired was amortized on a straight-line basis, over 40 years, following the date of purchase.\nThe write-offs of investments in the Company's international operations (\"Goodwill\") was recorded in the fourth quarter of 1994 and was the result of a reassessment of the carrying value of the Company's intangible assets. The Company periodically reviews the carrying value of its intangible assets. The performance of the Company's European subsidiaries began to worsen in 1993 as the operating performance of certain of these subsidiaries turned negative. Revenue during 1993 of these subsidiaries declined 15% from the 1992 level. The Company's projections for 1994 were for all the European subsidiaries to return to the profitability level of 1992 and the future projections for these operations was adequate to support the related goodwill balance. However, in 1994, revenue for the European subsidiaries experienced a 16% decline from the 1993 level and cash flow from certain of these operations was negative for the second year in a row. Accordingly, at the end of 1994 the Company performed a review of the carrying value of it's goodwill. The resulting long-term projections of earnings before interest, depreciation and amortization on an undiscounted basis were insufficient to support the goodwill balance. As a result of these long-term projections and the historical declines in revenue and increased operating losses, the Company recorded a write-off of the entire remaining goodwill balance of $57,657.\nIncome Taxes\nThe provision for income taxes is reduced by investment tax credits, which are recognized in the year the assets giving rise to the credits are placed in service (flow-through method) or when realized for income tax purposes, if later.\nNo tax provision has been made for the undistributed earnings of foreign subsidiaries as management expects these earnings to be reinvested indefinitely or received substantially free of additional tax.\nIn February 1992, the Financial Accounting Standards Board issued SFAS No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"), which superseded SFAS No. 96 and APB Opinion No. 11. The adoption of this new standard had a favorable cumulative accounting change effect of $1,340 recorded in the first quarter of fiscal 1994 (see note 4).\nLoss per Common Share\nLoss per common share is based on the weighted average number of common shares outstanding during each year presented. The Company's common stock equivalents, which include convertible debt, were antidilutive for the years presented and, therefore, were excluded from the computation. The 1994, 1993 and 1992 computations include the effect of dividends paid or accumulated on preferred stock of $1,784, $1,784, and $7,601, respectively. Dividends of $1,784 were paid during 1994 and 1993, and dividends of $303 were paid during the fourth quarter of 1992 on the $1.00 preferred stock. All other dividends accrued during 1992 were not paid, and were eliminated in the exchange of $4.94 preferred stock for $1.00 preferred stock.\n2. Reorganization\/Restructuring Costs\nThe Company recorded $13,360 of charges in the fourth quarter of 1994 as a result of the implementation of a statutory plan of reorganization for one of its European subsidiaries. Management developed the plan, which is subject to administrative approval, as a result of a continued decline in revenues resulting from the loss of several significant accounts. These charges relate principally to severance costs associated with the termination of approximately 140 employees spread throughout sales, service, and general and administrative positions involved in this European subsidiary. The plan is expected to be completed during 1995. Management expects to fund these charges through cash inflows of the Company. These charges have been classified as current liabilities (see note 10) but up to approximately $6,000 may be deferred and paid out on a long-term basis depending on the outcome of the administrative proceeding. Upon completion of the plan the Company expects annual savings to exceed $10,000. Although the plan may have a negative impact upon revenue, the Company does not believe that such impact will be material. In addition to the charges pertaining to the European subsidiary, the Company recorded $1,493 in Company-wide reorganization charges related to reductions of personnel whose skills do not fit with the Company's future plans.\nDuring 1993, the Company implemented a restructuring plan designed to improve the Company's internal operations and re-position its sales and marketing teams to benefit from the planned introduction in fiscal 1994 of a broad range of new products. As a result, the Company recorded restructuring charges of $6,243 primarily related to staff reductions of which 51% of these costs are attributable to the French subsidiary, 23% are attributable to the U.S. operations and the remaining percentage are attributable to subsidiaries in Sweden, U.K., New Zealand, Australia and Germany.\n3. Non-operating Income (Expense) \t 1994 \t 1993 \t 1992 Interest earned\t $313 \t $2,018 \t $3,141 Realized gain on fixed assets fire settlement\t 534 \t 1,165 \t - Write-off of investment in partially owned company\t (3,210) -\t - Net unrealized recoveries (losses) on marketable securities\t (454)\t 314 297 Foreign currency gains (losses)\t (718)\t (2,361)\t 2,318 Settlement of litigation \t - \t - (15,282) Pension plan curtailment \t - \t - \t 3,009 Other \t (758)\t (1,427)\t (807) \t $(4,293)\t $(291) $(7,324)\nThe $3,210 write-off of an investment in a partially owned company was recorded in the fourth quarter of 1994 and resulted from a reassessment of the carrying value of the asset in light of a sharp decline in the performance of the partially owned company. The write-off was recorded upon a succession of weakening quarterly operating performances.\n4. Income Taxes\nEffective August 1, 1993, the Company adopted SFAS No. 109 \"Accounting for Income Taxes\" prospectively. 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.\nAs a result of adoption of SFAS No. 109, the Company recorded additional deferred income tax assets of $2,075, after a valuation allowance of $66,720, and increased deferred income tax liabilities by $735 which, in total resulted in a $1,340 credit ($.09 per share) for the cumulative effect of the accounting change.\n\t 1994 \t 1993 \t 1992 Income (loss) before income taxes, extraordinary credit and effect of change in accounting principle: \tU.S. $(11,430) \t $2,646 $(16,083) \tOutside the U.S.\t (82,981) \t (13,544) 6,982 \t\t\t $(94,411) $(10,898) $(9,101)\nProvision for income taxes: \tU.S. federal: \t\tCurrent\t $73 \t $32 \t $617 \t\tDeferred\t -\t (221)\t (1,980) \t\t $73 \t $(189) \t $(1,363)\n\tOutside the U.S.: \t\tCurrent\t (61) 793 \t 1,066 \t\tDeferred\t 342 \t (242) (48) \t\tCharge in lieu of income taxes\t - \t 599 \t 1,653 \t\t\t 281 \t 1,150 \t 2,671\nTotal provision\t $354 \t $961 \t $1,308\nThe differences between the tax provision in the financial statements and the tax expense computed at the U.S. federal statutory rates are:\n\t\t 1994 \t 1993 \t 1992 Tax expense (benefit) at statutory rate\t $(33,043)\t $(3,705)\t $(3,094) Increase (decrease) in taxes resulting from: \tBenefit of U.S. tax loss not recognized \t 3,298 \t - \t 4,768 \tForeign losses and other transactions on which a tax benefit could not be recognized\t 9,288 \t 3,684 \t 1,136 \tAdjustment of prior year taxes\t -\t (336)\t (1,390) \tNondeductible amortization and write-off \t of intangible assets\t 20,875 \t 712 \t 724 \tEffect of foreign tax refunds and U.S. tax \t associated with dividends paid \t 73 \t 143 33 \tEffect of federal tax rate less than (greater than) foreign tax rates\t 142 \t 452 (839) \tBenefit of operating loss carryforwards\t (286)\t - - \tOther, net\t 7 \t 11 (30) Provision for income taxes\t $354 \t $961 \t $1,308\nThe undistributed earnings, indefinitely reinvested in international business, of the Company's foreign subsidiaries aggregated approximately $17,000 at July 30, 1994. Determination of the amount of unrecognized deferred tax liability on these unremitted earnings is not practicable.\nThe primary components of deferred income tax assets and liabilities at July 30, 1994 are as follows: Deferred income tax assets: \tProperty, plant and equipment\t $3,955 \tLoss and credit carryforwards\t 68,213 \tAccrued restructuring costs \t 4,453 \tOther\t 9,180 \t 85,801 Less: valuation allowance\t 82,217 \t 3,584 Deferred income tax liabilities: \tAccrued retirement costs\t (2,141) \tOther\t (988) \t (3,129) Net deferred income tax asset\t $455\nAt July 30, 1994, the net deferred income tax asset of $455 was presented in the balance sheet, based on tax jurisdiction, as deferred income tax assets of $2,742 and deferred income tax liabilities of $2,287.\nTiming differences at July 31, 1993, consisted primarily of differences in depreciation rates, accrued retirement costs, accrued restructuring costs, and legal settlements not deducted for tax purposes.\nAt July 30, 1994, the Company has tax operating loss carryforwards approximating $133,000 and $30,000 for federal and foreign tax purposes, respectively, expiring in various amounts beginning in 2001 and 1995, respectively. Federal long-term capital loss carryforwards of $19,000 expire in various amounts beginning in 1995. Utilization of the ordinary and capital tax loss carryforwards is subject to limitation in the event of a more than 50% change in ownership of the Company.\nThe Company has unused investment, research, and alternative minimum tax credits for income tax purposes at July 30, 1994 of approximately $3,700 expiring at various dates through 2001 which may be used to offset future tax liabilities of the Company. Utilization of these credits is subject to limitation in the event of a more than 50% change in ownership of the Company.\nIncome taxes paid were $362, $1,156 and $2,558 for 1994, 1993 and 1992, respectively.\n5. Marketable Securities\nMarketable securities are stated at market value for 1994 and 1993. Cost for marketable securities was $4,573 for both 1994 and 1993. At July 30, 1994, gross unrealized losses were $4,239, which represents the excess of cost over market value. There were no gross unrealized gains as of July 30, 1994.\n6. Inventories\n\t\t\t\t 1994 \t 1993 \t\t\t\t Finished products\t\t\t$10,416 \t $9,876 Work in process\t\t\t 1,601 \t 2,041 Raw materials\t\t \t 5,657 \t 5,619 \t\t\t$17,674 \t $17,536\n7. Fixed Assets\nAccumulated \t Cost\t Depreciation Net\nJuly 30, 1994 Property, plant and equipment: \tBuildings and land improvements \t $19,736 \t $14,102 \t $5,634 \tMachinery, equipment, furniture and fixtures \t 88,213 75,959 \t 12,254 \tLand ($5,500 held for sale) \t 6,856 \t - \t 6,856 \t\t\t 114,805 \t 90,061 \t 24,744 Field support spares\t 15,262 11,337 \t 3,925 Equipment leased to customers \t 5,009 \t 4,590 \t 419 \t\t\t $135,076 $105,988 \t $29,088\nJuly 31, 1993 Property, plant and equipment: \tBuildings and land improvements \t $19,276 \t $13,430 \t $5,846 \tMachinery, equipment, furniture and fixtures \t 84,896 \t 74,600 \t 10,296 \tLand \t 6,807 \t - \t 6,807 \t\t\t 110,979 \t 88,030 \t 22,949 Field support spares\t 18,763 14,294 4,469 Equipment leased to customers \t 14,294 \t 13,762 \t 532 \t\t\t $144,036 $116,086 \t $27,950\n8. Lease Commitments\nThe Company leases certain facilities and equipment under various leases. Substantially all of the leases are classified as operating leases. Rental expense for operating leases for 1994, 1993 and 1992 was $9,137, $10,785, and $13,314, respectively. Most of the leases contain renewal options for various periods and require the Company to maintain the property. Certain leases contain provisions for periodic rate adjustments to reflect Consumer Price Index changes.\nAt July 30, 1994, future minimum lease payments for noncancelable leases totaled $37,790 and are payable as follows: 1995-$7,666; 1996-$7,058; 1997-$5,281; 1998-$4,472; 1999-$4,203 and $9,110 thereafter.\n9. Payables to Bank\nAs of July 30, 1994, the Company has included in payables to banks an amount of $7,500 payable to International Factors \"De Factorij\" B.V., a subsidiary of ABN-AMRO Bank of the Netherlands. The loan is secured by the receivables of the Company's U.K., Dutch and German subsidiaries. The Company paid down the loan by $1,000 in September 1994 and is in discussion with other various potential sources of financing to reduce the borrowings by a further $1,500. Upon conclusion of such financing the borrowings with International Factors B.V.will be secured by the U.K. and Dutch receivables.\nThe Company has a secured credit facility (\"Credit Facility\") with The CIT Group, with a maximum borrowing level of $7,500, given sufficient collateral. The Credit Facility consists of a term loan and a revolving loan. The borrowings outstanding under the Credit Facility, as of July 30, 1994, were $3,312, the maximum based upon the available collateral as of that date, and the Credit Facility is callable at the option of the lender. The borrowing consists of $2,246 related to the revolving loan and included in payables to banks, and $1,066 related to the term loan and included in current maturities of long-term debt. The collateral for the revolving Credit Facility consists of the Company's U.S. trade receivables and certain trade receivables from independent foreign distributors, U.S. inventories, real property, contract rights and general intangibles, equipment and fixtures, and certain certificates of deposit issued to or for the account of the Company. The Credit Facility requires that the Company meet a number of non- financial covenants on an ongoing basis. The Credit Facility also requires the Company to pay down the term loan subsequent to the sale of certain assets. The Credit Facility expires in June 1995. The Credit Facility also includes a restriction upon the payment of dividends, allowing dividends to be paid on the Company's $1.00 preferred stock; but prohibiting dividend payments on the Company's common stock.\nThe Company has other borrowings of $1,000 and available lines of credit from foreign banks to its foreign subsidiaries. The unused lines of credit at July 30, 1994 totaled $2,662 after borrowings of $7,217 which were included in payables to banks.\n10. Accrued Expenses\n\t 1994 \t 1993\nSalaries, commissions, bonuses and other benefits\t $8,839 $10,680 Taxes other than income taxes\t 6,986 \t 5,378 Reorganization\/restructuring costs\t 13,988 \t 2,565 Other \t 7,919 \t 8,060 \t $37,732 \t $26,683\n11. Long-Term Debt \t Maturities\t 1994 \t 1993\n8-7\/8% convertible subordinated debentures \t 2006 $64,394 $64,394 Domestic term loan, average interest 9.4%\t 1995\t 1,066 \t 2,158 6.5% to 9.0% real estate notes\t 1995 - 1999\t 993 \t 1,361 Non interest bearing note-NTI\t 2002\t 6,094 \t 6,503 Non interest bearing note-CISI\t 1995\t 195 \t 1,083 Other obligations \t 1996\t 189 \t 298 72,931 \t 75,797 Less: current maturities\t\t 2,370 \t 4,246 $70,561 \t $71,551\nInterest on the 8-7\/8% convertible subordinated debentures is payable semiannually on June 1 and December 1. The debentures are subordinated in right of payments to all senior indebtedness, as defined, and are convertible into common stock of the Company at any time prior to the close of business on June 1, 2006, unless previously redeemed. Each one thousand dollar principal amount debenture is convertible into 55.231 shares of common stock and, as of July 30, 1994, there were 3,556,545 shares reserved for possible issuance. The debentures are entitled to a mandatory sinking fund, which commenced June 1, 1991, of $5,000 annually. The Company, at its option, may increase the sinking fund payment to $10,000 and may also receive credit against mandatory sinking fund payments for debentures acquired through means other than the sinking fund. The Company has applied $20,000 in previous debenture retirements against the sinking fund requirements for 1991 through 1994. The Company also intends to apply previous debenture retirements of $15,606 through July 30, 1994 against the sinking fund requirements for 1995 through 1997. The debentures are also redeemable at the option of the Company, in whole or in part, at any time at 100% of the principal amount together with accrued interest to the date of redemption.\nDuring fiscal 1985, the Company's Board of Directors authorized management to make repurchases of up to $25,000 aggregate face value amount of its 8-7\/8% convertible subordinated debentures. Prior to 1992, the Company had repurchased debentures having a total face value of $21,054 under this plan. There were no such repurchases made in 1992, 1993, or 1994.\nDuring fiscal 1993, the Company settled two long standing legal patent actions brought against it by Northern Telecom Inc. (\"NTI\") and Compagnie Internationale de Services en Informatique, S.A. (\"CISI\"). The Company agreed to a ten-year note payable to NTI which requires annual $1,000 payments beginning in December 1993. The Company is also obligated to contingent payments to NTI dependent upon the Company's future profitability. The contingent payments, up to a cumulative maximum of $12,500, are to be paid in annual installments calculated at 33-1\/3% of the Company's pre-tax annual profits in excess of $10,000 in each of the 10 fiscal years beginning with fiscal 1993. Pursuant to these settlements, during 1994, the Company paid NTI and CISI $1,000 and $1,000, respectively. At July 30, 1994 the nine remaining $1,000 annual payments to NTI were discounted at a 10.0% effective rate. During 1994 and 1993, the Company incurred no liability to make the contingent payments as a result of the net losses incurred.\nAggregate annual maturities of long-term debt are as follows: 1995--$2,370; 1996--$769; 1997--$749; 1998--$5,159; 1999--$5,714 and $58,170 thereafter.\n12. Stockholders' Equity (Deficit)\nDuring 1994, employees and directors of the Company exercised 113,274 options for shares of common stock. In addition, the Company repurchased and placed into treasury stock 24,023 shares from the Company's U.S. 401(k) retirement and savings plan. Also related to this plan, the Company issued 989 shares from treasury stock to participants.\nIn the fourth quarter of 1992, the Company completed an exchange of 1,931,218 shares of $4.94 preferred stock for 1,869,456 shares of $1.00 preferred stock and 3,862,436 shares of common stock (\"the Preferred Stock Exchange\"). The $1.00 preferred stock has a liquidation preference of $20.00 per share and cumulative dividends of $1.00 annually. If dividends are six quarters in arrears, the preferred stock shareholders have the right to vote as a separate class and elect two board members at the next annual meeting of shareholders and each preferred share is exchangeable into two shares of common stock at the option of the holder. These new directorships will be filled annually by the preferred shareholders voting as a separate class until the dividends in arrears have been paid in full. As an additional means of preserving cash flow for operations, the Company's Board of Directors elected to defer the October 15, 1994 preferred dividend payment to shareholders.\nIn August 1994, subsequent to the balance sheet date, the Company sold 700,000 shares of its common stock held in treasury for $1,750 in a transaction outside the United States pursuant to Regulation S of the Securities and Exchange Commission. The Company utilized the proceeds for working capital needs. In addition, in September 1994, the Company reached an agreement with Intelogic Trace, Inc. (\"Intelogic\"), in conjunction with Intelogic's court approved reorganization, to cancel its option to repurchase at $.75 per share, its common stock held by Intelogic in exchange for all of the Company's holding of Intelogic preferred stock, which had no carrying value. As a result of the exchange, the Company received from Intelogic 2,400,000 shares of Datapoint common stock. Had these transactions occurred at the beginning of 1994 the impact on the earnings per share calculations, would have increased the loss per common share to $(7.42) from $(6.60) per share.\n13. Stock Option Plans\nAt July 30, 1994, 2,557,537 shares were reserved for issuance in connection with the Company's stock option plans. Total options outstanding for all plans total 1,524,873 and are exercisable at an average price of $4.13.\nUnder the Company's employee stock option plans, officers and other key employees may be granted options to purchase common stock and related stock appreciation rights. Under the terms of these plans, options may be granted at no less than 75% of fair market value and expire no later than ten years from the date of grant. The Board may grant options exercisable in full or in installments, and has generally granted options at fair market value exercisable in two to four installments beginning one year from the date of grant. As of July 30, 1994 and July 31, 1993, options for 561,209 and 282,729 shares, respectively, under all employee plans were exercisable and no stock appreciation rights had been granted. Options outstanding as of July 30, 1994 have an average exercise price of $4.43 and expire during the period August 1994 through June 2004.\n\t Employee Stock Option Plans\t\t \t Price Range \t Number of Share\t \t of Shares \t Under Available \t Under Option \t Option \tfor Option Outstanding at July 31, 1993\t $1.38-8.00 1,195,658 \t 951,653 Shares authorized\t - \t - \t - Granted\t 2.50-7.25 \t 276,989 \t (276,989) Exercised\t 1.38-5.62 \t (103,274)\t - Canceled\t 1.38-7.13 \t (84,500)\t 84,500 Expired\t - \t - \t (1,500) Outstanding at July 30, 1994\t $1.38-8.00 1,284,873 \t 757,664\nDuring 1992, the 1985 Director Stock Option Plan was terminated. As of July 30, 1994, there were continuing options for 50,000 shares outstanding from this plan which expire five years from the date of grant. The 1985 Plan was replaced by the 1991 Director Stock Option Plan. This plan greatly resembles the terminated 1985 Plan and provides for a one-time grant of an option to purchase, at fair market value as of the date of the grant, 25,000 shares of common stock to each director, and an additional 50,000 shares to the present and any newly elected Chairman of the Board. The 1991 Plan does not grant any options to individuals holding options under the 1985 Plan. The Plan includes both employee and non-employee directors and options expire five years from the date of grant. Total director options outstanding as of July 30, 1994 have an average exercise price of $2.53 and expire during the period April 1996 through May 1997.\n\t Director Stock Option Plans \t\t \t Price Range \t Number of Shares \t of Shares \t Under \t Available \tUnder Option \t Option for Option Outstanding at July 31, 1993\t $1.88-3.06 \t 250,000 \t 275,000 Shares authorized\t - \t - \t - Granted\t - \t - \t - Exercised\t 2.50 \t (10,000) \t - Canceled\t - \t - \t - Expired \t - \t - \t - Outstanding at July 30, 1994 \t $1.88-3.06 \t 240,000 \t 275,000\n14. Information Relating to Business Segments and International Operations\nBusiness Segment Information\nThe Company operates in one industry and is an international computer and communications systems marketer, manufacturer and developer. Additionally, the Company provides maintenance services on its products in the United States through Intelogic, and services its products outside the United States through its international distributors and subsidiaries.\nInternational Operations\nThe Company conducts the majority of its international marketing and service operations through its subsidiaries and, to a lesser extent, through various distributorship arrangements. The Company's manufacturing is performed domestically, and the Company's policy is to transfer products between affiliates at prices which reflect market conditions. Financial information on a geographic basis follows:\n\t 1994 \t 1993 \t 1992 Revenue - unaffiliated customers: United States \t- domestic \t $7,617 \t $7,286 \t $9,245 \t\t - export sales \t 6,174 \t 8,039 \t 7,828 Europe \t 156,403 \t 185,595 \t 219,553 Other international \t 2,742 \t 7,424 \t 18,617 Total revenue from unaffiliated customer\t 172,936 \t 208,344 \t 255,243\nRevenue - intercompany: United States\t 20,868 \t 24,910 \t 40,495 Europe\t 518 \t 516 \t 759 Other international\t 7 \t 62 \t 793 Eliminations \t (21,393) \t (25,488)\t (42,047) Total consolidated revenue $172,936 $208,344 $255,243\nOperating income (loss): United States\t $(8,728) \t $1,080 \t $5,636 Europe\t (72,517)\t (5,376)\t 2,952 Other international\t (904)\t (1,297)\t 881 Eliminations \t 1,128\t 4,335\t (2,814) Total operating income (loss)\t $(81,021)\t $(1,258)\t $6,655\nIdentifiable assets: United States\t $43,595 \t $57,506 \t $61,873 Europe\t 87,159 \t 156,320 \t 195,649 Other international\t 1,250 \t 1,384 \t 8,435 Eliminations\t (4,570)\t (12,935)\t (17,144) Total identifiable assets $127,434 $202,275 $248,813\nIncluded in identifiable assets for 1993 is the excess of the cost of the foreign investments over the value of the net assets acquired. The balance was written-off in 1994 as part of a reassessment of the carrying value in light of the financial condition of the Company. Accumulated amortization and write-down of this excess was $110,476 at July 30, 1994 and $50,797 at July 31, 1993.\nAs the value of the U.S. dollar weakens, net assets recorded in local currencies translate into more U.S. dollars than they would have at the previous year's rates. Conversely, as the U.S. dollar becomes stronger, net assets recorded in local currencies translate into fewer U.S. dollars than they would have at the previous year's rates. The translation adjustments, resulting from the translation of net assets, amounted to a unfavorable $2,845 and $15,033 in 1994 and 1992 respectively, reflecting a weakening U.S. dollar, at the balance sheets dates, in those years. During 1993 the U.S. dollar strengthened and resulted in a favorable translation adjustment of $15,533 at the balance sheet date.\n15. Retirement Income Plans\nRetirement expenses incurred by the Company were as follows:\n\t 1994 \t 1993 \t 1992 U.S.: Matching contributions \t $143 \t $138 \t $137 Profit sharing contributions\t - \t -\t 323 \t 143 \t 138 460 Outside the U.S.: Defined benefit plans\t 119 \t (8) 778 Other plans \t 600 \t 65 \t 349 \t 719 \t 57 \t 1,127\n\t $862 \t $195 $1,587\nU.S. Plan\nThe Company adopted a 401(k) retirement and savings plan effective January 1988. The plan covers all full-time employees who have been employed for at least 12 months. The Company's retirement and savings plan contribution has been a 25% matching contribution for employee contributions up to 5% of each employee's compensation. At the Board's discretion, the Company may also contribute a profit sharing amount to the plan that is contingent upon the performance level of the Company at the net income line. During 1993 the Company reversed the $323 that was accrued for profit sharing in 1992.\nPlans Outside the U.S.\nMost of the Company's foreign subsidiaries provide retirement income plans which conform to the practice of the country in which they do business. The types of company-sponsored plans in use are defined benefit and defined contribution.\nFive of the Company's subsidiaries, including the United Kingdom, utilize defined benefit plans with employee benefits being based primarily on years of service and wages near retirement. The plans cover all full-time employees who have been employed for at least 12 months. Obligations under these plans are funded primarily through fixed rate of return investments, primarily insurance policies, except for Germany where reserves are established for the obligations. During 1992, the Company curtailed, but has not settled, the defined benefit plan in the United Kingdom. This action resulted in the recognition of a curtailment gain of $3,009.\nThe Company's United Kingdom and New Zealand subsidiaries have defined contribution plans. During 1992, Australia and New Zealand had a defined contribution plan. Retirement expenses related to defined contribution plans declined in 1993, as compared to 1992, due primarily to a relatively expensive Australian plan. The 1994 plans cover all full-time salaried employees who have been employed for at least 12 months and contributions are based upon a percentage of compensation. Obligations under these plans are funded primarily through deposits in pooled investments or insurance policies.\n\t 1994 \t 1993 \t 1992\nDefined benefit plans:\nService cost \t $773 \t $1,329 $1,880 Interest cost \t 1,770 \t 1,917 \t 2,067 Actual return on assets \t (926)\t (860)\t (2,803) Net amortization and deferral \t(1,498) (2,394)\t (366)\nNet pension cost \t $119 \t $(8) $778\nThe funded plan status at July 30, 1994 and July 31, 1993 was:\n\t 1994 1993 \t \t Over- \t\tUnder- Over- Under- funded \t\tfunded \t funded funded Actuarial present value of:\nVested benefits \t $16,389 \t $3,234 $15,059 \t $2,402\nAccumulated benefit obligations \t $16,699 \t $3,815 $15,431 \t $3,337\nProjected benefit obligations \t $17,619 \t $5,624 $16,605 \t $5,672\nPlan assets at fair value\t 21,259 \t 918 \t 21,951 \t 755 Plan assets in excess of (less than) projected benefit obligation\t 3,640 \t (4,706)\t 5,346 \t (4,917) Unrecognized net (gain)loss\t 1,519\t (1,955)\t (511) (989) Unrecognized transition net loss\t 806 \t 31 \t 791 \t 32 Prepaid (accrued) pension cost \t $5,965 $(6,630)\t $5,626 $(5,874)\nActuarial assumptions used to determine funded status for 1994 and 1993 varied between subsidiaries. Discount rates used to determine projected benefit obligations range from 5.0% to 9.0% in 1994 and 1993. Rates of increase in future compensation levels range from 3.0% to 3.5% in 1994 and 3.5% to 5.0% in 1993. The long-term rates of return on plan investments range from 5.0% to 10.0% in 1994 and 1993, and 6.5% to 10.5% in 1992.\n16. Certain Relationships and Related Transactions\nThe Company's directors Messrs. Agranoff, Edelman, and Kail are also directors of Intelogic, comprising three of Intelogic's seven directors. As such, they receive compensation and\/or benefits from Intelogic. Also, these three directors may be deemed to beneficially own approximately 14% of Intelogic's common stock. In addition, they have options to purchase shares of Intelogic common stock equal in the aggregate to approximately 4% of the amount presently outstanding.\nSince the 1985 spin-off of Intelogic, the Company has engaged in and continues to engage in various transactions with Intelogic. All such transactions are billed to Intelogic by the Company at its cost. All other transactions between the Company and Intelogic are pursuant to a Master Maintenance Agreement entered into at the time of the spin-off and relate to the ordinary business operations of both the Company and Intelogic. For 1994, 1993 and 1992, Intelogic paid the Company approximately $196, $366 and $688, respectively, for equipment and field support spares, royalties and expenses, and the Company paid Intelogic approximately $28, $246 and $162, respectively, primarily for services and sales. Included in accounts receivable are amounts due from Intelogic of $298, $315 and $300, respectively.\nDirector Agranoff provided various tax, legal and real estate consulting services for the Company. During 1994, 1993 and 1992, the Company paid Mr. Agranoff $126, $104 and $87, respectively, for those services.\n17. Commitments and Contingencies\nThe Company is a defendant in various lawsuits generally incidental to its business. The amounts sought by the plaintiffs in such cases are substantial and, if all such cases were decided adversely to the Company, the Company's aggregate liability might be material. However, the Company does not expect such an aggregate result based upon the limited number of such actions and an assessment that most such actions will be successfully defended. No provision has been made in the accompanying financial statements for any possible liability with respect to such lawsuits.\nSUPPLEMENTARY DATA (Unaudited) Selected Quarterly Financial Data (In thousands, except per share data)\nSummarized operating results of the Company by quarter for fiscal years 1994 and 1993 are presented as follows:\n\t Q1 \t Q2 \t Q3 \t Q4\t \t\t 1994 (1)\t\t\nRevenue \t $41,648 \t $44,786 \t $42,802 \t $43,700 Gross profit \t 17,114 \t 19,229 \t 14,618 \t 14,604 Operating income (loss)\t (291) \t 1,984 \t (4,593)\t (78,121) Income (loss) before effect of change in accounting principle\t (2,326)\t 532 \t (7,961)\t (85,010) Effect of change in accounting principle\t 1,340\t -\t -\t - Net income (loss) (986) \t 532 \t (7,961)\t (85,010) Income (loss) per common share: \tBefore effect of change in accounting principle\t (.19) .01 \t (.58)\t (5.93) \tEffect of change in accounting principle\t .09 \t - \t -\t - \tNet income (loss) \t (.10)\t .01 \t (.58) (5.93)\n\t\t\t 1993 (2)\t\t\nRevenue \t $60,543 \t $54,296 \t $48,584 \t $44,921 Gross profit \t 25,736 \t 25,969 \t 19,428 \t 15,465 Operating income (loss)\t 2,839 \t 3,690 \t (1,523)\t (6,264) Income (loss) before extraordinary items\t (378) 1,234 \t (4,311)\t (8,404) Extraordinary items 473 \t 722 \t (593) (3) Net income (loss) 95 \t 1,956 \t (4,904) (8,407) Income (loss) per common share: \tBefore extraordinary items\t (.06) .06 \t (.34)\t (.62) \tExtraordinary items \t .03 \t .05 (.04)\t - \tNet income (loss) \t (.03)\t .11 \t (.38) (.62)\nThe sum of the quarterly income (loss) per share indicated above does not necessarily equal the annual per share amount due to rounding and changes in the average number of shares outstanding from quarter to quarter.\n(1) As a result of adoption of SFAS No. 109, the Company recorded additional deferred income tax assets of $2,075, after a valuation allowance of $66,720, and increased deferred income tax liabilities by $735 which, in total resulted in a $1,340 credit ($.09 per share) for the cumulative effect of the accounting change (see note 4 to Consolidated Financial Statements).\nThe fourth quarter results include a reorganization charge of $13,360 for one of the Company's European subsidiaries. In addition, the third and fourth quarter results include Company-wide reorganization charges of $955 and $538, respectively (see note 2 to Consolidated Financial Statements).\nFourth quarter results included a charge of $57,657 for the write-offs of investments in the Company's international operations (see note 1 to Consolidated Financial Statements) and a $3,210 write-off of an investment in a partially owned company (see note 3 to Consolidated Financial Statements).\n(2) The recognition of tax loss carryforward benefits resulted in extraordinary gains (losses) of $473, $722, $(593) and $(3) in the first, second, third and fourth quarters, respectively.\nThe first, second, third and fourth quarter results include restructuring charges of $189, $1,455, $2,206 and $2,393, respectively (see note 2 to Consolidated Financial Statements). The second and third quarter results include restructuring charges of $78 and $371, respectively, that have been reclassified to restructuring costs from cost of service and other.\nDuring the second quarter of 1993, operations of the Company's French subsidiary were interrupted by a fire in its leased warehouse facility. The fire negatively impacted revenue in the subsidiary, but this was compensated for by business interruption insurance coverage of $2,500. Operating income also included $2,800 in gains on the fire insurance settlement related primarily to destroyed inventory and spare parts. Non-operating income included $1,165 in gains on the fire insurance settlement related to destroyed fixed assets.\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 Item 10 with respect to the directors and nominees for election to the Board of Directors of the Company is incorporated by reference to the information set forth under the caption \"ELECTION OF DIRECTORS\" in the Company's definitive proxy statement dated November 1994. Information with respect to executive officers of the Company is set forth in Part I hereof.\nITEM 11.","section_11":"ITEM 11. Executive Compensation.\nThe information required by Item 11 is incorporated by reference to the information set forth under the caption \"COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS\" in the Company's definitive proxy statement dated November 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 to the information set forth under the captions \"SECURITY OWNERSHIP OF MANAGEMENT\" in the Company's definitive proxy statement dated November 1994.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions.\nThe information required by Item 13 is incorporated by reference to the information set forth under the caption \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\" in the Company's definitive proxy statement dated November 1994.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.\n\t(a)1\tFinancial Statements\n\t\tThe consolidated financial statements listed in the accompanying index to the financial statements are filed as part of this report.\n\t(a)2 \tFinancial Statement Schedules\n\t\tSchedule I - Marketable Securities\n\t\tSchedule VIII - Valuation and Qualifying Accounts and Reserves\n\t\tSchedule IX - Short-Term Borrowings\n\t\tSchedule X - Supplementary Consolidated Statements of Operations Information\nAll other schedules are omitted since they are either not applicable or the required information is shown in the Company's financial statements or notes thereto.\nIndividual financial statements of the Company are omitted because the Company is primarily an operating company and all subsidiaries included in the Consolidated Financial Statements being filed, in the aggregate, do not have minority equity interest and\/or indebtedness to any person other than the Company or its consolidated subsidiaries in amounts which together exceed 5% of the total consolidated assets as shown by the most recent year-end Consolidated Balance Sheet.\n\t(a)3 \tExhibits\nThe exhibits listed on the accompanying index to exhibits are filed as part of this report.\n\t(b)\tThere were no reports filed on Form 8-K by the Company during the last quarter of the fiscal year ended July 30, 1994.\nINDEX TO EXHIBITS\n\t\t Sequentially Exhibit\t\t Numbered Number\t Description of Exhibits\t Pages\n(3)(a)\t Certificate of Incorporation of Datapoint Corporation, as amended (filed as Exhibit (3)(a) to the Company's Annual Report on Form 10K for the year ended July 31, 1993, and incorporated herein by reference).\n(3)(b)\t Bylaws of Datapoint Corporation, as amended (filed as Exhibit (3)(b) to the Company's Annual Report on Form 10-K for the year ended August 1, 1992, and incorporated herein by reference).\n(4)(a) \tDebenture holder Notice of Adjustment to Conversion Rate, dated July 11, 1985, under Indenture dated as of June 1, 1981, between Datapoint Corporation and Continental Illinois National Bank and Trust Company of Chicago, as Trustee, providing for 8-7\/8% Convertible Subordinated Debentures Due 2006 (filed as Exhibit (4)(a) to the Company's Annual Report on Form 10-K for the year ended July 27, 1985 and said Indenture filed as Exhibit 4 to the Company's Registration Statement on Form S-16 (No. 2-72395), each incorporated herein by reference).\n(4)(c)\t Certificate of Designation, Preferences, Rights and Limitations of Series of $1.00 Preferred Stock (filed as Exhibit (4)(e) to the Company's Registration Statement on Form S-4 dated April 30, 1992 and incorporated herein by reference).\n(10)(a)\t1983 Employee Stock Option Plan (filed as Exhibit (4)(a)(4) to the Company's Registration Statement on Form S-8 dated November 9, 1983 and incorporated herein by reference).\n(10)(b)\t1985 Director Stock Option Plan (filed as Exhibit (10)(i) to the Company's Annual Report on Form 10-K for the year ended August 1, 1987 and incorporated herein by reference). \t\n(10)(c)\t1986 Employee Stock Option Plan (filed as Exhibit (10)(h) to the Company's Annual Report on Form 10-K for the year ended August 1, 1987 and incorporated herein by reference).\n(10)(d)\t1991 Director Stock Option Plan (filed as Exhibit (10)(b)(2) to Amendment No. 1 dated February 6, 1992 to the Company's Registration Statement on Form S-4 (Registration No. 33- 44097) and incorporated herein by reference).\n(10)(e)\t1992 Employee Stock Option Plan (filed as Exhibit (4)(a)(4) to the Company's Registration Statement on Form S-8 dated January 19, 1993 and incorporated herein by reference).\n(10)(f)\tAgreement for Transfer of Assets and Liabilities in Exchange for Stock, dated as of June 28, 1985, between the Company and Intelogic Trace, Inc. (filed as Exhibit (10)(a) to the Company's Current Report on Form 8-K dated July 28, 1985 and incorporated herein by reference).\n(10)(g)\tMaster Maintenance Agreement, dated as of June 28, 1985, between the Company and Intelogic Trace, Inc. (filed as Exhibit (10)(b) to the Company's Current Report on Form 8-K dated July 28, 1985 and incorporated herein by reference).\n(10)(h)\tMaintenance Agreement regarding open systems products between the Company and Intelogic Trace, Inc., (filed as Exhibit (10)(g) to the Company's Annual Report on Form 10-K for the year ended August 1, 1992, and incorporated herein by reference).\n(10)(i)\tAgreement between the Company and Arbitrage Securities Company, as amended (filed as Exhibit (10)(f) to the Company's Annual Report on Form 10-K for the year ended July 29, 1989 and incorporated herein by reference).\n(10)(j)\tIndemnity Agreements with Officers and Directors (filed as Exhibit (10)(f) to the Company's Annual Report on Form 10-K for the year ended August 1, 1987 and incorporated herein by reference).\n(10)(k)\tFirst Amendment to Indemnification Agreement with certain Officers and Directors. (filed as Exhibit (10)(h) to the Company's Annual Report on Form 10-K for the year ended July 28, 1990 and incorporated herein by reference).\n(10)(l)\tSecond Amendment to Employment Agreement with A. B. Edelman (said amendment filed as Exhibit (10)(h)(3) to the Company's Registration Statement on Form S-4 dated April 30, 1992), amending Employment Agreement dated January 9, 1991 (said agreement filed as Exhibit (10)(j) to the Company's Annual Report on Form 10-K for the year ended July 28, 1990), as amended by Amendment No. 1 dated December 1, 1990 (said amendment filed as Exhibit (10)(i) to the Company's Annual Report on Form 10-K for the year ended July 27, 1991), each of which are incorporated herein by reference.\n(10)(m)\tEmployment Agreement with D. Berger (filed as Exhibit (10)(m) to the Company's Annual report on Form 10 K for the Year ended July 31, 1993 and incorporated herein by reference).\n(10)(n)\tEmployment Agreement with J. Berger (filed as Exhibit (10)(l) to the company's Annual Report on Form 10 K for the year ended August 1,1992 and incorporated herein by reference).\n(10)(o)\tEmployment Agreement with K. L. Thrower (filed as Exhibit (10)(o) to the company's Annual Report on Form 10 K for the year ended August 1,1992 and incorporated herein by reference).\n(10)(p)\tFirst Amendment to the Grantor Trust Agreement dated June 18, 1991. (filed as exhibit (10)(n) to the Company's Annual Report on Form 10-K for the year ended July 27, 1991 and incorporated herein by reference).\n(10)(q)\tManufacturing facilities Agreement of Lease between the Company and Willis and Cox Associates dated June 21, 1991 (filed as Exhibit (10)(q) to the Company's Annual Report on Form 10-K for the year ended August 1,1992 and incorporated herein by reference).\n(10)(r)\tEmployment agreement with D. Bencsik.\n(22)\t Subsidiaries of Datapoint Corporation.\n(24)\t Consent of Independent Auditors.\n(27)\t Article 5, Financial Data Schedule.\nSIGNATURES\n\tPursuant 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.\n\t DATAPOINT CORPORATION \t (Registrant)\n\t BY:\/s\/Asher B. Edelman \t Asher B. Edelman \t Chief Executive Officer and \t Chairman of The Board\nDATED: November 14, 1994\n\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 and in the capacities and on the dates indicated.\n\tSignature\t Title\t Date\n\/s\/Asher B. Edelman Chairman of the Board and November 14, 1994 Asher B. Edelman Chief Executive Officer \t\t (Principle Executive Officer)\n\/s\/Doris D. Bencsik\t\t President and Chief Operating Officer November 14, 1994 Doris D. Bencsik\n\/s\/Phillip P. Krumb Vice President and Chief November 14, 1994 Phillip P. Krumb\t\t Financial Officer\n\/s\/Paul D. Sheetz Assistant Corporate Controller November 14, 1994 Paul D. Sheetz (Principal Accounting Officer)\n\/s\/Gerald N. Agranoff\t\tVice President, General Counsel November 14, 1994 Gerald N. Agranoff and Corporate Secretary\n\/s\/Irving J. Garfinkel Director November 14, 1994 Irving J. Garfinkel\n\/s\/Daniel R. Kail Director November 14, 1994 Daniel R. Kail\n\/s\/Clark R. Mandigo\t\t Director November 14, 1994 Clark R. Mandigo\n\/s\/Didier M.M. Ruffat\t\t Director November 14, 1994 Didier M.M. Ruffat\t\t\n\/s\/Blake D. Thomas Director November 14, 1994 Blake D. Thomas \t\t\nREPORT OF ERNST & YOUNG LLP INDEPENDENT AUDITORS\nThe Board of Directors Datapoint Corporation\nWe have audited the consolidated financial statements of Datapoint Corporation and subsidiaries (the Company) as of July 30, 1994 and July 31, 1993, and for each of the three fiscal years in the period ended July 30, 1994, and have issued our report thereon dated November 14, 1994. Our audits also included the financial statement schedules listed in the Index at 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 financial statements 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 set forth therein.\n\/s\/Ernst & Young LLP Ernst & Young LLP\nDallas, Texas November 14, 1994\nSchedule I\nDATAPOINT CORPORATION AND SUBSIDIARIES Marketable Securities July 30, 1994 (In thousands, except share data)\nName of issuer Number of Cost of Market value Lower of and title of shares each at balance cost or each issue \t owned issue sheet date\t market\nCanal Capital Corp. Common Stock\t 169,100\t $1,157\t $ 13\t\t $ 13 Preferred Stock\t 430,842\t 2,097\t 101 101\nIntelogic Trace, Inc. Common Stock\t 292,920\t 1,319\t 220\t\t 220\nSchedule VIII\nDATAPOINT CORPORATION AND SUBSIDIARIES Valuation and Qualifying Accounts and Reserves (In thousands)\n(a) (b) \t\t Balance \t Charged Charged at to (to) from Other Balance Beginning Costs and Other \tAdditions\t at End Classification \t of Year Expenses Accounts (Deductions) of Year\nAllowance for doubtful accounts:\nYear ended July 30, 1994\t $2,466 \t $ 803 \t $ (8) $ (693) $2,568\nYear ended July 31, 1993\t $5,297 \t $(405)\t $ 312 $(2,738)\t $2,466\nYear ended Aug. 1, 1992\t $2,461 \t $ 530 \t $ -\t $ 2,306\t $5,297\n(a) Transfers to and from other balance sheet reserve accounts. (b) Accounts written-off net of recoveries, other expense accounts and translation adjustments.\nSchedule IX\nDATAPOINT CORPORATION AND SUBSIDIARIES Short-Term Borrowings (In thousands, except interest rates)\nType of Short-Term Borrowing\t 1994 1993 1992\nPayable to Banks: (a)\n\tBalance at end of period\t $17,963 \t$14,129\t $5,898\n\tWeighted average interest rate\t 10.5% \t 10.0% 12.3%\n\tMaximum amount outstanding during the period\t $19,088\t $14,672 $8,597\n\tAverage amount outstanding during the period (b)\t $17,493 $10,917\t $5,806\n\tWeighted average interest rate during the period (c)\t 11.0% \t 12.2%\t 13.5%\n(a) Payables to banks include debt instruments incurred by international subsidiaries that are payable in foreign currencies and a domestic revolving loan.\n(b) Computed by taking the average of the end-of-month balances for the 13-month period ended July of each respective year.\n(c) Computed by taking actual interest expense divided by average short- term debt outstanding.\nSchedule X\nDATAPOINT CORPORATION AND SUBSIDIARIES Supplementary Consolidated Statements of Operations Information (In thousands)\n\tItem\t 1994 \t 1993 \t 1992\nMaintenance and repairs\t $5,293\t $4,995\t $5,635\nAmortization of intangible assets\t $2,021\t $2,127 $2,338\nAdvertising costs\t $2,052\t $2,106 $3,279\n\t\t\t\t\t\tExhibit 10(r) FIRST AMENDMENT TO EMPLOYMENT AGREEMENT\nThis Agreement (\"Amendment\") shall serve to modify the employment agreement between DATAPOINT CORPORATION (\"Datapoint\") and DORIS D. BENCSIK (\"Bencsik\") dated as of October 1, 1986 (\"Agreement\") effective as of February 4, 1993.\n1.\tThe parties note that Bencsik resigned as an officer and employee of Datapoint on September 4, 1987, and subsequently elected and is receiving payments attributable to early retirement within the meaning of Section 1.b.(3) of the Agreement. The parties hereby agree to the re-employment of Bencsik. Nothing contained herein shall suspend or terminate Datapoint's supplemental retirement payment obligations to Bencsik. Furthermore, Bencsik's part-time employment hereunder shall not give rise to further service credit for supplemental retirement; however, any full-time employment of Bencsik hereunder shall be bridged so as to give rise to further service credit for supplemental retirement. Notwithstanding anything to the contrary appearing in the Agreement or Schedule 1 thereto relating to supplemental retirement, such further service credit shall result in additional monthly benefits to commence upon termination of employment, whether by retirement or for any other reason, only as follows: each month of full-time service (including any period of full-time salary continuation after termination pursuant to sections 6.3 or 6.5 hereinafter) will add $250 per year to the monthly supplemental retirement payable, subject to the restriction that the aggregate increase by reason of such renewed service credit shall not exceed $9,000 per year. \t\t 2.\tBencsik's position shall be that of Executive Vice President and Chief Operating Officer, with her duties being those defined from time to time by the Board of Directors.\n3.\tThe parties agree that Bencsik may concurrently hold such other employment and\/or management consulting assignments as she holds as of the effective date hereof, and Datapoint hereby acknowledges that Bencsik's work pursuant hereto, including work for Datapoint performed outside her Datapoint office, shall exceed thirty (30) hours per week for purposes of qualifying for participating in any Datapoint benefit plans wherein participation is limited to full-time employees.\n4.1\tSection 1.b.(1) of the Agreement is modified to provide for a minimum annual base salary of $150,000.\n4.2\tThe parties note Datapoint's action in connection with Bencsik's re-employment granting her an option to purchase up to 75,000 shares of the Common Stock of Datapoint at a price equal to the market price of such stock on February 1, 1993, vesting in equal anniversary installments over 3 years and terminating after 10 years.\n4.3\tBencsik will be granted an additional stock option on September 27, 1993, allowing her to purchase 75,000 shares of Datapoint Common Stock at fair market value that date under a Datapoint employee stock option plan, said option to vest in three (3) equal annual installments, subject to the condition subsequent that she assumes the position set forth in section 9.1 hereinafter on or about November 1, 1993.\n5.\t Bencsik will be provided with any and all benefits and perquisites provided to any U.S.-based Datapoint vice presidents except that life insurance need be provided only to the extent that she is reasonably insurable.\n6.\t The term and termination of the Agreement as amended shall be as set forth in this section 6 hereinbelow.\n6.1 The Agreement and Bencsik's employment with Datapoint shall continue indefinitely, unless earlier terminated pursuant to this section 6 hereinbelow, until September 21, 1996, whereupon Datapoint will acquire the continuing right, notwithstanding any contrary provision appearing elsewhere herein, to require the retirement of Bencsik as an employee of Datapoint; beyond this obligation, Datapoint shall not be liable to Bencsik by reason of Datapoint requiring such retirement beyond those items listed in section 6.2 hereinbelow.\n6.2\tBencsik may terminate the employment relationship at any time upon thirty (30) days notice to Datapoint, whereupon Datapoint's only liability to Bencsik shall be to pay any earned but unpaid salary through the effective date of the notice, any bonus owed for any fiscal year completed on or before such date, and any legitimate but as yet unreimbursed employee business expenses.\n6.3\tDatapoint may terminate Bencsik's employment without her consent during the term of the Agreement as herein amended, but any such termination prior to September 21, 1996 will require Datapoint to provide Bencsik with the items referenced in section 6.2 hereinabove, plus: (i) six (6) months of base salary continuation; and (ii) payment of then-current- fiscal-year bonus to the extent earned by performance until termination; all benefits shall terminate immediately. Notwithstanding the foregoing, Datapoint may terminate Bencsik's employment without her consent for \"cause\" as defined in former section 3.d. of the Agreement without any termination liability of Datapoint whatsoever.\n6.4\tAny termination of Bencsik's employment other than pursuant to section 6.2 or for cause pursuant to section 6.3 hereinabove shall result in the immediate acceleration of vesting of all stock options.\n6.5\tNeither the expiration nor the termination of the Agreement shall in any way impair Datapoint's liability to pay supplemental retirement benefits to Bencsik as specified in section 1.b.(3) of the Agreement as increased pursuant to section 1 hereinabove, and this obligation is hereby expressly specified as surviving any such expiration or termination.\n7. \tBencsik shall be entitled to an annual performance bonus payable as soon as practical after the close of Datapoint's fiscal year. Bencsik shall be eligible for a prorated bonus for fiscal year 1993 provided she remains in the employ of Datapoint through the close of that year. Bencsik shall not be eligible for this bonus for any fiscal year which is not completed prior to the termination of her employment, except as otherwise provided in section 6 hereinabove with respect to involuntary termination. Bencsik's annual performance bonus shall be calculated as follows:\n\t\tDatapoint's net pre-tax earnings, excluding the excess over $US10,000,000 of the net of any extraordinary gains due to debt repurchase or exchange against all extraordinary losses, times one and three quarters percent (1.75%).\n8. \tSections 1.a.(2), 1.b.(2), 2.a. and 3 of the Agreement are hereby deleted in their entirety.\n9. \tEffective November 1, 1993, the following provisions shall become effective and shall thereafter govern over any conflicting provisions of this Amendment or the Agreement.\n9.1\tBencsik shall become President and Chief Operating Officer and a full-time employee of Datapoint, and section 1.b.(1) of the Agreement is modified to provide for a minimum annual base salary of $300,000.\n9.2\tThe base salary continuation period provided for in section 6.3 hereinabove shall be increased from six (6) months to twenty-four (24) months.\n9.3\tThe following new section 6.6 shall be added to this Amendment:\n\t\t 6.6\tIf Bencsik should become substantially totally disabled (as defined in former section 3.c. of the Agreement) from performing her duties hereunder, Datapoint shall have the right to terminate her employment by providing to Bencsik, for a period of six (6) months from the termination of the six-month disability evaluation period set forth in such definition, base salary and medical benefit continuation, with base salary to be offsetable by any benefits received by Bencsik on account of disability under any government program and\/or any benefit plan of Datapoint relating to Bencsik's disabled status.\n9.4\tThe percentage of defined pre-tax profits upon which Bencsik's bonus shall be calculated pursuant to section 7 hereinabove for Datapoint's fiscal year ended 1994 and thereafter shall be increased from one and three quarters percent (1-3\/4%) to three percent (3%), except that should the annual operating plan for a bonus year be achieved, the applicable percentage for that year shall become four percent (4%).\n9.5\tBencsik's monthly car allowance (a perquisite under section 5 hereinabove) shall be increased from $500 to $750.\n9.6\tSections 1.a.(20, 1.b.(2) and 2.a. of the Agreement shall become once again applicable.\n10.\tThe provisions of this Amendment shall govern any conflict between the provisions of this Amendment and the Agreement. The remaining provisions of the Agreement shall remain in full force and effect.\nINTENDING TO BE BOUND, THE PARTIES AFFIX THEIR SIGNATURES.\nDATAPOINT CORPORATION\t\t\tDORIS D. BENCSIK\n\/s\/ Asher B. Edelman\t\t\t\t\/s\/ Doris D. Bencsik Asher B. Edelman\t\t\t Doris D. Bencsik Chairman of the Board Chief Executive Officer\nDate:__________________________\tDate:__________________________\n[DDBKA1993F:RLHQ]\nEXHIBIT 22\nSUBSIDIARIES OF DATAPOINT CORPORATION\nAs of October 28, 1994, the following list sets forth all entities which might be deemed to be subsidiaries of the Company (excluding subsidiaries which, considered in the aggregate as a single subsidiary, would not constitute a significant subsidiary). Except as otherwise noted below, all of the voting securities of the entities described are held directly or indirectly by the Company and all are included in the consolidated financial statements of the Company contained herein. The Company has no \"parents.\"\nDatapoint International, Inc. (Delaware) Inforex International, Inc. (Delaware) Datapoint International Exports, Inc. (Delaware) Datapoint International Investments, Inc. (Delaware) Datapoint International Holdings, Inc. (Delaware) Datapoint Disc, Inc. (Delaware) Datapoint Development Center, Inc. (Delaware) Datapoint Belgium S.A. (Belgium) Datapoint S.A. (France) Datapoint Deutschland GmbH (Germany) Datapoint Italia S.P.A. (Italy) Datapoint Vastgoed, B.V. (Netherlands) Datapoint Beheer, B.V. (Netherlands) Datapoint Nederland, B.V. (Netherlands) Datapoint Corporation (N.Z.) Ltd. (New Zealand) Point Data Sistemas Informaticos S.A. (Portugal) Datapoint Iberica S.A. (Spain) Datapoint Svenska AB (Sweden) Datapoint Switzerland (Schweiz) AG (Switzerland) Datapoint Holdings Ltd. (United Kingdom) Datapoint (U.K.) Ltd. (United Kingdom) Inforex Ltd. (United Kingdom) Datapoint International Headquarters, S.A.R.L. (France) Datapoint Far East Ltd. (Hong Kong)\nEXHIBIT 24\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the following registration statements, and in the related prospectuses, reoffer prospectuses, and amendments previously filed thereto, of our report dated November 14, 1994, with respect to the consolidated financial statements and schedules of the Company included in this Annual Report on Form 10-K for the year ended July 30, 1994: Registration Statement No. 2-60374 on Form S-8, Registration Statement No. 2-87765 on Form S-8, Registration Statement No. 33-19328 on Form S-8, Registration Statement No. 33-19427 on Form S-8, and Registration Statement No. 33-57102 on Form S-8.\n\/s\/ Ernst & Young LLP Ernst & Young LLP\nDallas, Texas November 14, 1994","section_15":""}
{"filename":"317814_1994.txt","cik":"317814","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL. OEC develops, manufactures, markets, and services computer-based X-ray and fluoroscopic imaging systems for use in hospitals, out-patient clinics, and surgi-centers for intraoperative and interventional procedures.\nOEC was originally established in Indiana in 1942. In response to surgeons' need for improved methods to monitor and guide the implantation of the various internal fixation devices, OEC entered the medical X-ray imaging market in 1972. OEC was acquired by Diasonics, Inc. in October 1983 as a separate operating subsidiary. The Company was merged into Diasonics in September of 1993 as part of a Restructuring\/Distribution in which the other operating businesses of Diasonics were spun off to shareholders and the Diasonics, Inc. name was changed to OEC Medical Systems, Inc.\nToday, OEC is recognized as the pioneer and continued domestic market leader of intraoperative\/interventional X-ray imaging systems. These systems combine radiographic and fluoroscopic imaging with digital image processing capabilities. X-rays are passed through the body and either recorded on radio- graphic film or passed through an image intensifier system and displayed as a real-time fluoroscopic image on a video monitor. Digital image processing of the fluoroscopic image improves the image quality, lowers X-ray dosage and results in reduced costs for a number of applications.\nOEC seeks to provide cost-effective imaging systems directed towards medical specialties in which minimally invasive techniques are replacing expensive open surgical procedures. High quality digital fluoroscopy has become mandatory in today's modern operating room. Minimally invasive techniques are expanding into many areas of surgery (vascular, neurological, orthopedic, urologic, cardiac and general surgery). OEC's products are designed to meet the needs of these new procedures.\nTechnical leadership, strong customer relationships, and a cost-effective product line have earned OEC the domestic market share leadership position in the intraoperative and interventional X-ray imaging markets.\nOEC believes its international markets represent a significant growth opportunity and expects to expand its network of international distributors. Building on its leadership position in the U.S., OEC's focus is to become the worldwide leader for intraoperative and interventional fluoroscopy imaging. With this focus in mind, OEC has been investing in the future through research and development. The introduction of the Series 9600 Mobile Digital Imaging System in 1994, just two and half years after the introduction of the Series 9400 C- arm, and the Uroview 2600 urology table introduced in February 1995, are the results of these investments.\nOEC's expanding presence in international markets is another example of the Company's investment in the future, having strengthened its wholly-owned subsidiaries in France, Germany, Italy and Switzerland with new personnel and training, and by designing its new products to be more appealing and acceptable to international customers. OEC also strengthened its international network in new markets in 1994 by establishing new distributors or contracting with existing distributors in South America and the Pacific Rim. OEC intends to continue these activities during 1995.\nOEC'S PRODUCTS. The products produced by OEC consist of mobile X-ray imaging systems as well as fixed-room urological X-ray imaging systems.\nSERIES 9600 MOBILE DIGITAL IMAGING SYSTEMS (C-ARM). In March 1994, OEC introduced the Series 9600 Mobile Digital Imaging System. This mobile imaging device can be wheeled from operating room to operating room to provide high quality, real-time fluoroscopic imaging for a wide variety of surgical and interventional procedures that require X-ray control.\nThe modular architecture of the system allows the Series 9600 to be tailored to meet the needs of the surgeon. For example, the 9600 can be equipped with an expanded surgical package for general surgery and orthopedics. When equipped with a vascular special procedures module, it can perform complex subtraction angiography in the operating room, emergency room, or in radiology. The most advanced version of the Series 9600 can perform many of the tasks of a sophisticated, fixed-room digital X-ray system costing several times more than the Series 9600. Prices of the Series 9600 Mobile Digital Imaging System range from $100,000 to $208,000.\nDuring 1994, 1993 and 1992 the OEC C-arm business represented 84%, 80% and 79% of total sales respectively.\nUROVIEW 2600 DIGITAL IMAGING SYSTEM. Urology is another surgical specialty requiring intraoperative imaging that is rapidly moving away from the use of static X-ray films to monitor and guide procedural progress. Diagnostic and interventional urological procedures are typically performed in a separate area of the operating room environment known as the Cysto Department. Until recently, these specialized rooms were equipped with a fixed (bolted down) urological- specific patient positioning table (motorized in movement) that also had static X-ray filming capability built into it. These films, once exposed, would need to be taken to a dark room to be developed prior to being brought back to the Cysto Department for evaluation by the urologist, resulting in long procedural delays. Additionally, real-time events could not be recorded since radiographic film produces a static image. Eventually, real-time fluoroscopic imaging capabilities began to be added to these systems.\nIn 1987, OEC introduced the UroView product line. The UroView was the industry's first urological table with fully integrated digital fluoroscopy, resulting in significant image improvement, lower X-ray dosages, and reduced costs. Prices for the UroView system presently range from $210,000 to $230,000.\nDuring 1994, 1993 and 1992 the OEC urology business represented 16%, 20% and 21% of total sales, respectively.\nSALES AND SERVICE. Domestic sales are made primarily through direct representatives and exclusive independent distributors with installation and service performed by OEC.\nIn Europe, OEC distributes its products primarily through wholly owned subsidiaries in Italy, France, Germany and Switzerland. For the remainder of Europe, the Far East and Latin America, distribution is done through independent dealers and distributors.\nOEC generally provides warranty for its products for a period of six to twelve months from the date of installation. OEC offers service contracts for products for which the warranty has expired.\nDuring 1994, 1993 and 1992, service revenue represented 13.2%, 10.8% and 8.9% of net sales respectively.\nMANUFACTURING. OEC's manufacturing operations are located in Salt Lake City, Utah and Warsaw, Indiana. OEC owns sufficient property at its Salt Lake City site to expand its facilities if needed. OEC's products incorporate microprocessors for which proprietary software has been designed by OEC. Major items that OEC currently purchases from others include video monitors, X-ray tubes, image intensifiers, CCD cameras and power supplies. Some of these parts and components are available from a limited number of single-source manufacturers or suppliers, and termination or interruption of such sources could have temporary adverse effect on the Company. OEC's Warsaw, Indiana facility manufacturers the sheet metal enclosures, the mechanical C-arm assembly and all major mechanical components for OEC's products. The electronics and imaging components are manufactured at OEC's Salt Lake City facility, which also performs final assembly and test of the finished devices.\nCOMPETITION. The market for mobile X-ray and urology products is highly competitive. Many of OEC's existing and potential competitors have substantially greater financial, marketing and technological resources. In the market for products similar to OEC's Series 9600 Mobile C-arm, OEC competes with General Electric Corporation, Siemens Medical Systems, Inc., Philips Medical Systems, Inc. and Toshiba Medical Systems, Inc. Competitive companies offering products similar to the UroView 2600 include Picker International, Inc., Dornier Medical Systems, Inc., and Liebel-Flarsheim Company. OEC competes on the basis of price, imaging quality, technological innovation, upgradeability, reliability, and quality of service and support.\nBACKLOG. At December 31, 1994, OEC's backlog was approximately $11.2 million, as compared with approximately $17.1 million at December 31, 1993. OEC includes in backlog only firm orders deliverable within 12 months. Backlog also includes service contract revenue which will be earned over the next twelve months.\nRESEARCH AND DEVELOPMENT. The medical imaging business involves rapid technological change and innovation. OEC believes the ability to use technological innovation to advance the clinical utility of diagnostic imaging has and will continue to be a significant factor in its success in competing in its marketplaces. OEC has continued to invest in research and development to identify solutions to the imaging requirements of the area of minimally invasive medical practices. This has led to a continuous release of both improvements in existing products and the introduction of the Series 9600 Mobile Digital Imaging System in 1994 along with the introduction in February 1995 of the Uroview 2600.\nDuring 1994, 1993, and 1992, OEC's research and development expenses totaled $8.4 million, $8.7 million and $7.1 million, respectively, representing 8.6%, 8.7% and 7.3% of net sales.\nEMPLOYEES. On December 31, 1994, OEC had approximately 536 employees. None of OEC's employees are covered by collective bargaining agreements, and OEC considers its employee relations to be satisfactory.\nGOVERNMENT REGULATION. As a manufacturer of medical devices, OEC is subject to extensive and rigorous governmental regulation, principally by the FDA and corresponding state and foreign agencies. The FDA administers the Federal Food, Drug and Cosmetic Act, as amended. OEC is subject to the standards and procedures contained in the Act and the regulations promulgated thereunder and is subject to inspection by the FDA for compliance with such standards and procedures. Failure to comply with FDA regulations could result in sanctions being imposed, including restrictions on the marketing of or recall of the affected products of OEC.\nOEC's facilities and manufacturing processes have been periodically inspected by the FDA and other agencies, but remain subject to audit from time to time. The most recent inspection was in September 1993, and no observations of noncompliance were issued. OEC continues to devote substantial human and financial resources to regulatory compliance, and believes that it remains in substantial compliance with all applicable federal and state regulations. Nevertheless, there can be no assurance that the FDA or a state agency will agree with OEC's position, or that its GMP compliance will not be challenged at some subsequent point in time.\nEnforcement of the GMP regulations has increased significantly in the last several years and the FDA has publicly stated that compliance will be more strictly scrutinized. In the event that OEC or any of its facilities was determined to be in noncompliance, and to the extent that OEC or such facility or operation was unable to convince the FDA or state agency of the adequacy of its compliance, the FDA or state agency has the power to assert penalties or remedies, including a recall or temporary suspension of product shipment until compliance is achieved. Such penalties or remedies could have a materially adverse effect on OEC's financial condition.\nOEC has received approval from the FDA and foreign regulatory authorities in the past, when required, to market its products. In general, the length of time for all reviews and approvals, most particularly from the FDA, has been lengthening and the review or approval process for medical devices has become substantially more difficult and expensive. Moreover, regulatory approvals, when granted, may contain significant limitations on the uses for which a product may be marketed. Approvals may be withdrawn for failure to conform to regulatory standards due to unforeseen problems. To date, product reviews for medical imaging technologies have been obtained within three to twelve months. There can be no assurance that OEC will be able to obtain necessary regulatory approvals in the future, and delays in the receipt of or failure to receive such approvals, the\nloss of existing approvals or failure to comply with regulatory requirements could have a material adverse effect on the business, financial condition and results of operation of OEC.\nIn June 1994 the Company's Quality Assurance System received the Certificate of Compliance with ISO 9001, the international standard for quality assurance in design, development, production, installation and servicing.\nPATENTS AND LICENSES. OEC owns or licenses rights with respect to various patents and has applied for other patents. These licenses generally do not have a fixed term and expire only when the last patent covered by the license expires. Because the licenses generally include patents on future innovations, OEC cannot approximate any expiration date. OEC believes the loss of any patent would not have a material adverse effect on OEC's business, the success of which will depend principally on its engineering, marketing, service, manufacturing skills, and upon the quality and economic value of its products. In addition, OEC has received notices of certain patents held by third parties and it is investigating the validity and applicability of these patents to OEC's products and processes.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nOEC owns its corporate headquarters and manufacturing facility of 105,000 square feet in Salt Lake City, Utah, and leases another 80,000 square feet of manufacturing in Warsaw, Indiana. The lease expires on May 31, 1995, at which time it is our intention to renew the lease.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nIn November 1993, a $3.1 million judgment against the company was reversed on appeal. The earlier judgment from May 1992 was the result of litigation initiated against it in 1986 by a terminated distributor of X-ray products. After the 1992 judgment, OEC placed $3.1 million in reserve for the full amount. The appellate court decision in favor of the Company has been appealed by the plaintiff to the Indiana Supreme Court. While the Company believes that the appellate decision will stand, no determination can be made as to whether some or all of the reserve should be reversed until all further appellate and related proceedings have finally been determined.\nOn May 4, 1992, Medical Diagnostic Imaging Center filed litigation in Superior Court of Los Angeles against Diasonics, Inc., Toshiba America, Inc., and others alleging misrepresentation, breach of contract, and unfair competition. This action has been dismissed with prejudice. On May 6, 1992, Mobil MR Venture, Ltd., filed litigation in Superior Court of San Mateo County against the Company, Toshiba America Medical Systems (\"TAMS\") and others alleging breach of contract and misrepresentation. This action has been consolidated in an arbitration originally filed by Toshiba America Medical Systems, Inc. in San Francisco, California against Mobile MR Venture, Ltd. Arbitration has been stayed while various litigations not involving the Company are being pursued. On May 8, 1992, Federal Deposit Insurance Corporation, as receiver for Citytrust, filed litigation in the United States District Court of the Southern District of New York against the Company, Toshiba America Medical Systems, Inc., and others to collect on a guaranty. On June 16, 1992, Medical Imaging Center of Southern California, Ltd. filed litigation in Superior Court of Los Angeles against Toshiba America Medical Systems, Inc., the Company and others alleging breach of contract and misrepresentation. TAMS has assumed defense of this action, which resulted in a net trial verdict of approximately $20,000. On July 1, 1992, Lenox Hills Leasing Associates and others filed litigation in the Supreme Court of the State of New York, county of New York, against the Company, Toshiba America Medical Systems, Inc., and others alleging breach of contract and misrepresentation. On January 19, 1992, Toshiba America Medical Systems, Inc., filed litigation in Superior Court of New Jersey against TME, Inc., which subsequently brought a third party complaint against the Company and others alleging breach of contract and misrepresentation. All of these actions relate to the magnetic resonance imaging business which Diasonics, Inc. sold to Toshiba America Medical Systems on November 21, 1989. As the successor to Diasonics, Inc., the Company is now the defendant in these actions. The Company believes that all of these actions are covered by the indemnity provisions in the MRI Purchase Agreement with Toshiba, and the Company initiated an arbitration in San Francisco to determine its right to reimbursement. On December 6, 1993, the arbitration panel issued its award ruling that TAMS was required to indemnify OEC for compensatory damages and punitive damages, if any, awarded against OEC as well as attorney's fees and expenses incurred by OEC in\nlitigation involving the MRI division of Diasonics, Inc., whether existing or later filed, and regardless of whether the claims asserted against OEC involved allegations of intentional misconduct or fraud. Toshiba has appealed the arbitrator's award. While the Company believes the artibrator's award will be sustained, the Company may incur interim expense prior to receiving full reimbursement from TAMS. To the extent that any liability would not be covered by its indemnity or its arbitrator's award, OEC does not believe that an adverse outcome would have a material impact on its financial position or results of operations.\nOEC is also a defendant in other ordinary commercial litigation. In light of available insurance and reserves, management believes that such litigation will not have a material effect on its 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 the Company's Security Holders during the fourth quarter of fiscal year 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nNAME AGE POSITION\nBarry K. Hanover 40 Vice President, Engineering\nLarry E. Harrawood 47 Vice President, Marketing\nGary N. Kilman 50 Vice President, Sales\nRuediger Naumann-Etienne 48 President and Chief Executive Officer\nRandy W. Zundel 39 Chief Financial Officer\nBarry K. Hanover has been Vice President, Engineering of the Company since December 1992. Previously, he was Director, Mechanical Engineering from October 1992 to December 1992. Prior to that, he was President of Hanover Engineering Services, an engineering consulting firm, from June 1992 to October 1992, and Vice President, Technical Development and member of the Board of Directors of Sarcos, Inc., a biomedical technology company from 1988 through 1992.\nLarry E. Harrawood has been Vice President, Marketing and Business Development of the Company since July 1987. Previously, he was Vice President, Business Development from October 1986 to July 1987, Vice President, Sales and Marketing from July 1985 to October 1986, and General Manager of X-ray operations from December 1972 to July 1985.\nGary N. Kilman has been Vice President, Sales of the Company since February 1987. Previously, he was National Sales Manager for ADAC Laboratories, a medical imaging company. Prior to that, he held progressively titles of Sales\nRep, Regional Sales Manager, and Area Sales Manager at that company. Prior to that he was Area Sales Manager, IBM, BioMedical Systems.\nRuediger Naumann-Etienne was named CEO and President of OEC in February 1995. He has been a director of the Company since January 1989, and was named Chairman of the Board in September 1993. He has been Managing Director of Intertec since July 1990. He was President and Chief Operating Officer of the Company from December 1987 to July 1990 and Executive Vice President and Chief Financial Officer from April 1984 to September 1988.\nRandy W. Zundel is the Chief Financial Officer. He was the Chief Operating Officer of the Company from February 1990 to September 1993. Prior to that he was Vice President, Operations from May 1987 to February 1990.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe Company's common stock is presently traded on the New York Stock Exchange under the trading symbol OXE. Prior to the Restructuring\/Distribution on October 1, 1993 and the spin-out of its other operating businesses, the Company was traded under the symbol DIA. Prices shown for the periods prior to the quarter beginning October 1, 1993 are for the stock trading as DIA and are not meaningful when compared to OXE stock because it now excludes the separately traded shares of Diasonics Ultrasound (NASDAQ: DIAU through October 1994, then acquired by Elbit, Ltd.) and Focus Surgery (NASDAQ: FCUS). Prices shown are the range of high and low closing prices per share on the New York Stock Exchange -- Composite Transactions, as reported by the Wall Street Journal. On March 1, 1995, the number of holders of record of common stock was 3,536.\nPrices ---------------------- Quarter Ended: High Low ------------- ------ ------\nTrading as DIA: March 31, 1993 . . . . . . . . . . . . 15 7\/8 11 5\/8 June 30, 1993. . . . . . . . . . . . . 13 1\/2 10 1\/4 September 30, 1993 . . . . . . . . . . . 13 1\/4 11\nTrading as OXE: December 31, 1993. . . . . . . . . . . . 8 1\/8 6 1\/8 March 31, 1994 . . . . . . . . . . . . 7 3\/4 6 1\/8 June 30, 1994. . . . . . . . . . . . . 6 3\/8 5 September 30, 1994 . . . . . . . . . . 6 7\/8 5 1\/4 December 31, 1994. . . . . . . . . . . . 6 7\/8 5 3\/4\nThe Company has not paid any dividend on its common stock. The Company presently intends to retain all earnings for use in the business and, therefore, does not anticipate paying any cash dividends in the foreseeable future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe table labeled \"Five Year Summary\" appearing as page 1 of 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.\nThe section labeled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" appearing as pages 2 through 4 of Exhibit 13 is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA.\nThe Consolidated Financial Statements and Notes thereto appearing at pages 5 through 13 of Exhibit 13 is incorporated herein by reference. For Financial Statement Schedule and Independent Auditors' Report thereon filed as part of this report, see Item 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 REGISTRANT.\nInformation concerning the directors of the Company is incorporated by reference to the sections titled \"Information with Respect to Nominees\" and in the definitive Proxy Statement to be filed in connection with the Annual Meeting of Stockholders (the \"1994 Proxy Statement\"). Information regarding executive officers is set forth in Part I of this report.\nPursuant to Section 16(b) of the Securities Act of 1934, the Company's directors, its executive (and certain other) officers, and any persons holding more than 10 percent of the Company's stock are required to report their ownership and any changes in beneficial ownership of the Company's stock to the Securities and Exchange Commission and to the New York Stock Exchange. Specific due dates for these reports have been established and the Company is required to report any failure to file by these dates.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation concerning management compensation is incorporated by reference to the section titled \"Cash Compensation of Executive Officers\" in the 1994 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation concerning the stock ownership of each person known to the Company to be a beneficial owner of five percent or more of the Company's Common Stock and management is incorporated by reference to the sections titled \"Information with Respect to Nominees\" and \"Principal Stockholders\" in the 1994 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation concerning relationships and related transactions is incorporated by reference to the section titled \"Transactions with Management and Others\" in the 1994 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(a) 1. Index to Financial Statements\nThe following consolidated financial statements of the Company are included in Exhibit 13 of this Form 10-K: Page in EXHIBIT 13 ----------\nConsolidated statements of operations for each of the three years in the period ended December 31, 1994 . . . . . . . . . . . . . . . . . 5\nConsolidated balance sheets at December 31, 1994 and 1993. . . . . 6\nConsolidated statements of stockholders' equity for each of the three years in the period ended December 31, 1994. . . . . . . . . 7\nConsolidated statements of cash flows for each of the three years in the period ended December 31, 1994 . . . . . . . . . . . . . . . . . 8\nNotes to consolidated financial statements . . . . . . . . . . . . 9-13\nIndependent Auditors' Report . . . . . . . . . . . . . . . . . . . 14\n2. Index to Financial Statement Schedule\nThe following consolidated financial statement schedule of the Company is filed as part of this report: Page in Form 10-K ---------\nIndependent Auditors' Report . . . . . . . . . . . . . . . . . . . 14\nSchedule VIII -- Valuation and qualifying accounts . . . . . . . . 15\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 consolidated financial statements, including the notes thereto.\n3. Index to Exhibits\nThe following exhibits (numbered in accordance with Item 601 of SEC Regulation S-K) are filed as part of this report or are incorporated by reference as indicated below:\nExhibit Number Description ------- -----------\n2 Agreement and Plan of Merger. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed March 30, 1994.\n3.1 Certificate of Incorporation, as amended. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed March 30, 1994.\n3.2 By-Laws, as amended. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed March 30, 1994.\n4 Rights Agreement, dated as of June 20, 1988, between Diasonics, Inc. and Bank of America NT&SA. Incorporated by reference to Exhibit 4.3 of the Diasonics, Inc. Form 8-K, filed August 1, 1988.\n10.1 Diasonics, Inc. 1979 Stock Option Plan, amended and restated as of June 1, 1982. Incorporated by reference to Exhibit 10.6 of the Diasonics, Inc. Registration Statement on Form S-8, filed May 2, 1983.\n10.2 Termination Agreement between Diasonics, Inc. and Stewart Carrell dated November 16, 1987. Incorporated by reference to Exhibit 10.69 of the Diasonics, Inc. Form 10-K, filed on March 9, 1988.\n10.3 Amendment to Termination Agreement between Diasonics, Inc. and Stewart Carrell. Incorporated by reference to Exhibit 10.77 of the Diasonics, Inc. Form 10-K, filed on March 31, 1990.\n10.4 Diasonics, Inc. 1990 Stock Option\/Stock Purchase Plan. Incorporated by reference to Exhibit 10.79 of the Diasonics, Inc. Form S-8, filed on May 1, 1991.\n10.5 Warrant for the Purchase of Common Shares issued to PaineWebber R&D Partners II, L.P., as amended. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed on March 30, 1994.\n10.6 Amendment, dated September 8, 1993, to Termination Agreement between Diasonics, Inc. and Stewart Carrell dated December 8, 1989. Incorporated by reference to OEC Medical Systems, Inc. Form 10-K, filed on March 30, 1994.\n10.7 Asset Stock Exchange Agreement between Diasonics, Inc. and Diasonics Ultrasound, Inc. dated April 30, 1993. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed on March 30, 1994.\n10.8 Asset Stock Exchange Agreement between Diasonics, Inc. and FOCAL Surgery, Inc. dated April 30, 1993. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed on March 30, 1994.\n10.9 Distribution Agreement by and among Diasonics, Inc. (OEC Medical Systems, Inc.), Diasonics Ultrasound, Inc. and FOCAL Surgery, Inc. dated September 17, 1993. Incorporated by reference to Diasonics Ultrasound, Inc. Form 10-A, filed September 17, 1993.\n10.10 Tax Allocation Agreement by and among Diasonics, Inc. and Diasonics Ultrasound, Inc. and FOCAL Surgery, Inc. dated September 30, 1993. Incorporated by reference to Diasonics Ultrasound, Inc. Form 10-A, filed September 17, 1993.\n10.11 Cross License Agreement by and between Diasonics, Inc., Diasonics Ultrasound, Inc. and FOCAL Surgery, Inc. dated September 17, 1993. Incorporated by reference to Diasonics Ultrasound, Inc. Form 10-A, filed September 17, 1993.\n10.12 Employment Benefits Allocation Agreement by and among Diasonics, Inc., Diasonics Ultrasound, Inc., and FOCAL Surgery, Inc. dated September 17, 1993. Incorporated by reference to Diasonics Ultrasound, Inc. Form 10-A, filed September 17, 1993.\n10.13 Note agreement between OEC Medical Systems, Inc. and Diasonics Ultrasound, Inc. dated September 30, 1993, as amended. Incorporated by reference to Diasonics Ultrasound, Inc. Form 10-A, filed September 17, 1993.\n10.14 Form of Option Agreement to be generally used in connection with options having service vesting provisions. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed March 30, 1994.\n10.15 Form of Option Agreement to be generally used in connection with options having milestone vesting provisions. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed March 30, 1994.\n10.16 Form of Option Agreement to be generally used in connection with automatic option grant program for non-employee directors. Incorporated by reference to the OEC Medical Systems, Inc. Form 10-K, filed March 30, 1994.\n10.17 Second Amendment, dated October 17, 1994, to Termination Agreement between Diasonics, Inc., and Stewart Carrell dated December 8, 1989.\n13 Portions of the 1994 Annual Report to Shareholders, including Five Year Summary, Management's Discussion & Analysis of Financial Condition and Results of Operations, and Consolidated Financial Statements and Notes thereto.\n21 List of Subsidiaries.\n23 Independent Auditors' Consent.\n27 Financial Data Schedule (FDS) for Edgar Filing.\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.\nOEC MEDICAL SYSTEMS, INC.\nBy: \/s\/ Randy W. Zundel --------------------------------- Randy W. Zundel Vice President & Chief Financial Officer\nDate: March 28, 1995\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\/s\/ Ruediger Naumann-Etienne Chairman, President & CEO March 28, 1995 - -------------------------------- Ruediger Naumann-Etienne\n\/s\/ Edwin W. Macrae Director March 28, 1995 - -------------------------------- Edwin W. Macrae\n\/s\/ Allan W. May Director March 28, 1995 - -------------------------------- Allan W. May\n\/s\/ Chase N. Peterson Director March 28, 1995 - -------------------------------- Chase N. Peterson\n\/s\/ Randy W. Zundel Principal Financial & March 28, 1995 - -------------------------------- Accounting Officer Randy W. Zundel\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders of OEC Medical Systems, Inc.:\nWe have audited the consolidated financial statements of OEC Medical Systems, Inc. and subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated January 20, 1995; such consolidated financial statements and report are included in your 1994 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the consolidated financial statement schedule of OEC Medical Systems, Inc. and subsidiaries, listed in Item 14. This consolidated financial statement schedule is 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 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.\nDELOITTE & TOUCHE LLP\nSalt Lake City, Utah January 20, 1995\nSCHEDULE VIII\nOEC MEDICAL SYSTEMS, INC.\nVALUATION AND QUALIFYING ACCOUNTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS)","section_15":""}
{"filename":"317187_1994.txt","cik":"317187","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE COMPANY Pennsylvania Power & Light Company (Company) is an operating electric utility, incorporated under the laws of the Commonwealth of Pennsylvania in 1920.\nThe Company's general offices are located at Two North Ninth Street, Allentown, Pennsylvania 18101. The Company's telephone number is (610) 774-5151.\nThe Company is subject to regulation as a public utility by the Pennsylvania Public Utility Commission (PUC) and is subject in certain of its activities to the jurisdiction of the Federal Energy Regulatory Commission (FERC) under Parts I, II and III of the Federal Power Act. The Company is a holding company under the Public Utility Holding Company Act of 1935 (PUHCA) but has been exempted by the Securities and Exchange Commission from the provisions of that Act applicable to it as a holding company.\nThe Company is subject to the jurisdiction of the Nuclear Regulatory Commission (NRC) in connection with the operation of the two nuclear-fueled generating units at the Company's Susquehanna station. The Company owns a 90% undivided interest in each of the Susquehanna units and Allegheny Electric Cooperative, Inc. owns a 10% undivided interest in each of those units.\nThe Company is also subject to the jurisdiction of certain federal, regional, state and local regulatory agencies with respect to air and water quality, land use and other environmental matters. The operations of the Company are subject to the Occupational Safety and Health Act of 1970 and the coal cleaning and loading operations of a Company subsidiary are subject to the Federal Mine Safety and Health Act of 1977.\nThe Company operates its generation and transmission facilities as part of the Pennsylvania-New Jersey-Maryland Interconnection Association (PJM). The PJM, one of the world's largest power pools, includes 11 companies serving about 21 million people in a 50,000 square mile territory covering all or part of Pennsylvania, New Jersey, Maryland, Delaware, Virginia and Washington, D.C.\nThe Company serves approximately 1.2 million customers in a 10,000 square mile territory in 29 counties of central eastern Pennsylvania (see Map on page 17), with a population of approximately 2.6 million persons. This service area has 128 communities with populations over 5,000, the largest cities of which are Allentown, Bethlehem, Harrisburg, Hazleton, Lancaster, Scranton, Wilkes-Barre and Williamsport.\nDuring 1994, about 98% of total operating revenue was derived from electric energy sales, with 35% coming from residential customers, 28% from commercial customers, 20% from industrial customers, 11% from contractual sales to other major utilities, 3% from energy sales to members of the PJM and 3% from others. The Company's largest industrial customer provided about 1.4% of revenues from energy sales during 1994. Twenty-six industrial customers, whose billings exceeded $3 million each, provided about 7.1% of such revenues. Industrial customers are broadly distributed among industrial classifications.\nWholly owned subsidiary companies of the Company principally are engaged in oil pipeline operations, unregulated business activities, passive financial investments and holding coal reserves. See \"Increasing Competition\" on page 42 for information concerning the Company's ongoing effort to create a new corporate structure to pursue new business opportunities.\nFINANCIAL CONDITION\nEarnings per share of common stock were $1.41 in 1994, $2.07 in 1993 and $2.02 in 1992.\nEarnings for 1994 were adversely affected by several one-time charges, including two major charges during the fourth quarter. One charge amounted to $75.9 million, or 28 cents per share of common stock, resulting from costs associated with a voluntary early retirement program; and the other charge amounted to $73.7 million, or 26 cents per share, from a write down in the carrying value of a subsidiary's investment in undeveloped coal reserves. In addition, two nonrecurring charges recorded earlier in the year reflected the disallowance by the PUC of recovery through the Energy Cost Rate (ECR) of replacement power costs incurred during an extended outage at the Susquehanna station, amounting to $15.7 million, or 6 cents per share of common stock; and a decision by the Commonwealth Court of Pennsylvania which reversed a PUC order that permitted deferral of the cost of postretirement benefits other than pensions. The Company charged the deferred postretirement benefit costs applicable to 1993 against income, which amounted to $10.8 million or 4 cents per share.\nAlthough these nonrecurring charges depressed earnings in 1994, underlying sales performance was strong, with a 4.1% increase in sales to ultimate customers due to improving economic conditions and colder-than-normal weather in the winter months. Other positive effects on earnings included the Company's continued efforts to control operating and maintenance costs, and the refinancing of higher cost securities to take advantage of favorable market conditions.\nDue to the one-time charges to income in 1994, several financial indicators decreased from 1993. The Company earned an 8.73% return on average common equity during 1994, down from the 13.06% earned in 1993. The ratio of the Company's pre-tax income to interest charges decreased from 3.3 in 1993 to 2.7 in 1994. Excluding these one-time charges, the return on average common equity and the ratio of pre-tax income to interest charges in 1994 would have been 12.53% and 3.1, respectively. See \"Earnings\" on page 28. The Company increased common stock dividends from an annual per share rate of $1.65 in 1993 to $1.67 in 1994. The book value per share of common stock decreased 1.0% from $15.95 at the end of 1993 to $15.79 at the end of 1994. The ratio of the market price to book value of common stock was 120% at the end of 1994 compared with 169% at the end of 1993.\nThe allowance for funds used during construction (AFUDC), a non- cash credit to income, accounted for about 6.1% of earnings in 1994. The amount of AFUDC recorded in the future will depend on the timing and level of construction work in progress as well as the rate treatment afforded the capital expenditures required to comply with the clean air legislation. Under current Pennsylvania law, construction work in progress for certain non-revenue producing assets, such as capital expenditures for pollution control equipment, can be claimed in rate base.\nThe Company's strong generating capacity position has enabled it to enter into a number of capacity-related transactions, as discussed under \"Capacity-Related and Transmission Entitlement Transactions\" on page 29 and in Note 4 to Financial Statements.\nRevenues from the sale of capacity credits, the reservation of output from the generating units and the sale of transmission entitlements, net of foregone PJM interchange savings which are included in the Company's ECR, totaled $28.7 million in 1994, $35.0 million in 1993 and $35.0 million in 1992. The 1994 revenues exclude approximately $8.4 million of receipts from installed capacity credit sales which were credited to customers through the ECR. The Company currently expects about $14.6 million of revenues from these transactions during 1995, exclusive of credits to be applied to the ECR.\nThe Company is continuing to look for opportunities to derive additional revenues from these transactions due to its strong generating capacity position. However, increased competition in capacity credit transactions has reduced the Company's share of this market and the unit price received for such sales. The amount of revenues from these transactions depends on many factors, and the Company cannot predict the amount of revenues it will ultimately realize from these transactions.\nIn October 1994, the PUC approved a settlement agreement resolving all complaints against the 1990-91 ECR through 1993-94 ECR, including issues related to capacity-related transactions. The agreement provides, among other things, for crediting the 1994-95 ECR with a portion of the receipts from capacity credit sales. See \"Rate Matters\" on page 30 for additional information.\nEconomic activity in the Company's service territory continued to increase in 1994. Energy sales to service area customers, when adjusted for normal weather, increased by 1.1 billion kilowatt-hours (kwh), or 3.5%, over 1993. By comparison, weather-normalized energy sales in 1993 increased by only 2.8% over 1992 levels.\nIn 1994, residential sales and commercial sales, when adjusted for normal weather, increased by 2.2% and 3.5%, respectively, over 1993. Industrial sales, which are not affected by the weather, were up 4.8%. System sales in 1995 are currently forecasted to be approximately 32.5 billion kwh, an increase of 136 million kwh, or 0.4%, over 1994 actual system sales, and a 419 million kwh, or 1.3%, increase over 1994 weather-normalized sales.\nThe electric utility industry, including the Company, has experienced and will continue to experience a significant increase in the level of competition in the energy supply market. The Energy Policy Act of 1992 (Energy Act) is having a significant impact on the Company and the electric utility industry, primarily through amendments to the PUHCA that create a new class of independent power producers, and amendments to the Federal Power Act that open access to electric transmission systems for wholesale transactions. In response to this increased competition, the Company has undertaken strategic initiatives to strengthen its position in the market.\nIn the wholesale supply market, the Company has entered into new five-year supply agreements at reduced prices with its existing wholesale customers. In addition, the Company is actively participating in negotiations and proceedings involving the sale of electricity to wholesale customers currently served by other utilities.\nWhile there is currently no comparable competition in the retail electric market, the Company anticipates similar competitive pressures in that market in the future. Accordingly, the Company has obtained PUC approval to enter into negotiated, competitive rates with certain industrial and commercial customers and to provide real time pricing rates on a three-year experimental basis to certain industrial and commercial customers.\nTo remain competitive, the Company also has taken steps to increase efficiency and reduce costs. The Company has initiated a program to make its generating stations more efficient and competitive in the power supply market. In addition, the Company has reorganized its operations along functional, instead of geographic, lines to enhance customer service. The Company's ongoing re- engineering efforts also are expected to improve efficiency and reduce costs. As part of its effort to reduce costs, the Company in 1994 offered an early retirement program to 851 employees, which was accepted by 640 employees.\nFinally, the Company's strategic initiatives include investment in power-related businesses outside of the Company's service territory, both domestically and in foreign countries. Any expansion by the Company into these areas would be methodical and deliberate. To take advantage of these new business opportunities, the Company will form a holding company structure, subject to the receipt of appropriate regulatory approvals and shareowner approval at the 1995 annual meeting.\nIn March 1994, the Company incorporated a new subsidiary, Power Markets Development Company (PMD), and made an initial investment of $50 million in this new subsidiary. PMD will help the Company take advantage of new opportunities in the building and operation of power plants in North America and elsewhere. Other subsidiaries will be formed to take advantage of new business opportunities.\nIn connection with the formation of the holding company structure, the Company filed the requisite applications for approval with the PUC, the FERC, the Securities and Exchange Commission (SEC) and the NRC. The FERC, the NRC and the PUC approvals have been obtained, while the SEC application remains pending. The PUC approval is subject to certain conditions, which are not expected to materially restrict the Company's entry into unregulated business activities.\nFor a further discussion of these competitive initiatives, see \"Increasing Competition\" on page 41.\nFor a discussion of the assessment on the Company pursuant to the Energy Act for the Uranium Enrichment Decontamination and Decommissioning Fund, see the discussion under that caption on page 40.\nCAPITAL EXPENDITURE REQUIREMENTS, FINANCING AND RATE MATTERS\nSee \"Capital Expenditure Requirements\" on page 34 for information concerning the Company's estimated capital expenditure requirements for the years 1995-1997. See \"Clean Air Legislation and Other Environmental Matters\" on page 37 and Note 15 to Financial Statements for information concerning the Company's estimate of the cost to comply with the federal clean air legislation enacted in 1990, to address groundwater degradation and waste water control at Company facilities and to comply with solid waste disposal regulations adopted by the Pennsylvania Department of Environmental Resources (DER).\nAfter the payment of dividends, internally generated funds during the years 1995-1997 are currently expected to provide approximately 70-85% of the Company's construction expenditures which are expected to be $1.3 billion. Sales of securities will be undertaken during the 1995-1997 period as needed to meet the Company's capital requirements, to meet a total of $211 million of long-term debt maturities and to provide funds for the early retirement of high cost securities if such retirements are determined to be appropriate in the light of market conditions and other factors. The Company expects to issue $180 million of common stock in 1995 through its Dividend Reinvestment Plan and a public sale of common stock. In addition, the Company expects to arrange for the refinancing of $55 million of higher cost tax-exempt securities issued to provide pollution control and solid waste disposal facilities at the Company's generating stations.\nThe Company's ability to issue securities during the next three years is not expected to be limited by earnings or other issuance tests.\nIn December 1994, the Company filed a request with the PUC for a $261 million increase in electric base rates, an 11.7% increase in PUC - jurisdictional rates. The PUC has decided to hold hearings and conduct an investigation of the request. A final rate decision is expected in late September 1995. See Note 3 to Financial Statements for information concerning the base rate case and other rate matters.\nPOWER SUPPLY\nThe Company's system capacity (winter rating) at December 31, 1994 was as follows: Net Kilowatt Plant Capacity Nuclear-fueled steam station Susquehanna 1,950,000 (a) Coal-fired steam stations Montour 1,525,000 Brunner Island 1,469,000 Sunbury 389,000 Martins Creek 300,000 Keystone 210,000 (b) Conemaugh 194,000 (c) Holtwood 73,000 Total coal-fired 4,160,000 Oil-fired steam station Martins Creek 1,640,000 Combustion turbines and diesels 508,000 Hydroelectric 146,000 Total generating capacity 8,404,000 Firm purchases Hydroelectric 139,000 (d) Qualifying facilities 504,000 (e) Total firm purchases 643,000 Total system capacity 9,047,000 _____________________________ (a) Company's 90% undivided interest. (b) Company's 12.34% undivided interest. (c) Company's 11.39% undivided interest. (d) From Safe Harbor Water Power Corporation. (e) From non-utility generating companies.\nThe system capacity shown in the preceding tabulation does not reflect: (i) sales of capacity and energy to Atlantic City Electric Company (Atlantic) through September 2000; (ii) sales of capacity and energy to Baltimore Gas and Electric Company (BG&E) through 2001; (iii) sales of capacity and energy to Jersey Central Power & Light Company (JCP&L) through 1999; or (iv) sales of capacity credits to GPU Service Corporation for PJM installed capacity accounting purposes only, which capacity credit sales aggregated 390,000 kilowatts at December 31, 1994. Giving effect to the sales to Atlantic (125,000 kilowatts), BG&E (129,000 kilowatts) and JCP&L (945,000 kilowatts), the Company's net system capacity at December 31, 1994 was 7,844,000 kilowatts.\nThe capacity of generating units is based upon a number of factors, including the operating experience and physical condition of the units, and may be revised from time to time to reflect changed circumstances.\nDuring 1994, the Company produced about 37.9 billion kwh in plants owned by it. The Company purchased 5.0 billion kwh under purchase agreements and received 1.0 billion kwh as power pool interchange. During the year, the Company delivered about 3.2 billion kwh as pool interchange and about 0.4 billion kwh under purchase agreements.\nDuring 1994, 56.9% of the energy generated by the Company's plants came from coal-fired stations, 36.4% from nuclear operations at the Susquehanna station, 4.7% from the Martins Creek oil-fired steam station and 2.0% from hydroelectric stations.\nThe maximum one-hour demand recorded on the Company's system is 6,508,000 kilowatts, which occurred on February 6, 1995. The maximum recorded one-hour summer demand is 5,638,000 kilowatts, which occurred on July 20, 1994. The peak demands do not include energy sold to Atlantic, BG&E or JCP&L.\nThe Company purchases energy from other utilities when it is economically desirable to do so. The Company occasionally purchases energy from systems located to the west of the Company's service area on a weekly basis at advantageous prices. The amount of energy purchased depends on a number of factors, including cost and the import capability of the transmission network. When it has been economical to do so, the Company has sold portions of its entitlement to use the bulk power transmission system to import energy from utilities outside the PJM, rather than utilize its entitlement for purchases from such western systems.\nThe Company also has entered into separate agreements with several utilities in New York and New England to provide energy on an as available, as needed basis. Transactions under these agreements are expected to continue to allow the Company to make more efficient use of its generating capacity and provide benefits to customers of both the Company and the purchasing utilities. The Company also has entered into agreements with several utilities both inside and outside the PJM for the reservation of output during certain periods from the Company's Martins Creek units, with the option to purchase energy from those units.\nSee \"Capacity-Related and Transmission Entitlement Transactions\" on page 29 and Note 4 to Financial Statements for additional information concerning the sale of capacity and energy to Atlantic, BG&E and JCP&L, the sale of capacity credits (but not energy) to other electric utilities in the PJM and the sale of transmission entitlements and the reservation of output from the Martins Creek units. See \"Rate Matters\" on page 30 and Note 3 to Financial Statements for information concerning a settlement agreement between the Company and ECR complainants with respect to capacity-related transactions.\nIn addition to the 504,000 kilowatts of non-utility generation shown in the preceding tabulation, the Company is purchasing about 3,000 kilowatts of output from various other non-utility generating companies. The payments made to non-utility generating companies, all of whose facilities are located in the Company's service area, are recovered from customers through the ECR applicable to PUC- jurisdictional customers and base rate charges applicable to FERC- jurisdictional customers.\nThe PJM companies had approximately 56 million kilowatts of installed generating capacity at December 31, 1994, and transmission line connections with neighboring power pools have the capability of transferring an additional 4 to 5 million kilowatts between the PJM and neighboring power pools. Through December 31, 1994, the maximum one-hour demand recorded on the PJM was approximately 46.4 million kilowatts, which occurred on July 8, 1993. The Company is also a party to the Mid-Atlantic Area Coordination Agreement, which provides for the coordinated planning of generation and transmission facilities by the companies included in the PJM.\nThe Company currently plans to convert the two oil-fired generating units at the Martins Creek station to burn both oil and natural gas, subject to appropriate regulatory approvals. A Company subsidiary filed an application with the PUC for authority to also transport natural gas through the pipeline to the existing pipeline customers, which include the Company and another utility. Two parties have protested the subsidiary's application, asserting that they have the sole authority to provide such gas service to the Company and the other utility, respectively. The matter is presently being litigated at the PUC and the Company cannot predict the outcome.\nFUEL SUPPLY\nCoal\nDuring 1994, the Company's generating stations burned about 7.8 million tons of bituminous coal and about 1.2 million tons of anthracite and petroleum coke.\nDuring 1994, 78% of the coal delivered to the Company's generating stations was purchased under contracts and 22% was obtained through open market purchases.\nThe amount of bituminous coal carried in inventory at the Company's generating stations varies from time to time depending on market conditions and plant operations. As of December 31, 1994, the Company's bituminous coal supply was sufficient for about 48 days of operations.\nContracts with non-affiliated coal producers provided the Company with about 5.4 million tons of bituminous coal in 1994 and are expected to provide the Company with about 5.4 million tons in both 1995 and 1996.\nA wholly owned subsidiary of the Company also holds certain undeveloped coal reserves which the Company does not plan to develop. At December 31, 1994, the investment by the subsidiary in those coal reserves was about $10 million. See \"Write Down of Coal Reserves\" on page 41 and Note 14 to Financial Statements for information concerning the impairment of the subsidiary's investment in these coal reserves.\nThe coal burned in the Company's generating stations contains both organic and pyritic sulfur. Mechanical cleaning processes are utilized to reduce the pyritic sulfur content of the coal. The reduction of the pyritic sulfur content by either mechanical cleaning or blending has lowered the total sulfur content of the coal burned to levels which permit compliance with current sulfur dioxide emission regulations established by the DER. For information concerning the Company's plans to achieve compliance with the federal clean air legislation enacted in 1990, see \"Clean Air Legislation and Other Environmental Matters\" on page 37 and Note 15 to Financial Statements.\nThe Company owns a 12.34% undivided interest in the Keystone station and an 11.39% undivided interest in the Conemaugh station, both of which are generating stations located in western Pennsylvania. The owners of the Keystone station have a long-term contract with a coal supplier to provide at least two-thirds of that station's requirements through 1999 and declining amounts thereafter until the contract expires at the end of 2004. The balance of the Keystone station requirements are purchased in the open market. The coal supply requirements for the Conemaugh station are being met from several sources through a blend of long-term and short-term contracts and spot market purchases.\nAt December 31, 1994, the Company's inventory of anthracite was about 4.9 million tons. The Company's requirements for petroleum coke and any additional anthracite that may be required over the remainder of the expected useful lives of the Company's anthracite- fired generating stations are expected to be obtained by contract and market purchases.\nNuclear\nThe nuclear fuel cycle consists of the mining of uranium ore and its milling to produce uranium concentrates; the conversion of uranium concentrates to uranium hexafluoride; the enrichment of uranium hexafluoride; the fabrication of fuel assemblies; the utilization of the fuel assemblies in the reactor; the temporary storage of spent fuel; and the permanent disposal of spent fuel.\nThe Company has entered into uranium supply agreements that, together with options to extend, satisfy 100% of the uranium concentrate requirements for the Susquehanna units through 1997, approximately 70% of the requirements for the period 1998-1999, and approximately 35% of the requirements for the period 2000-2001. Deliveries under these agreements are expected to provide sufficient quantities of uranium concentrates to permit Unit 1 to operate into the third quarter of 1999 and Unit 2 to operate into the third quarter of 1998.\nThe Company has entered into agreements that satisfy 100% of its conversion requirements through 1997 and approximately 25% of the conversion requirements for the period 1998-1999.\nThe Company also has entered into agreements for other segments of the nuclear fuel cycle. Based upon the current operating plans for each of the Susquehanna units, the following tabulation shows the years through which contracts, including options to extend, could provide the indicated segments of the nuclear fuel cycle:\nEnrichment 2014 Fabrication 2004\nThe Company has elected to cancel all or a portion of deliveries under its existing enrichment contract during the period 1999 through 2002, and plans to competitively bid those requirements on the open market. Additional arrangements will be necessary to satisfy the remaining fuel requirements of the Susquehanna units over their anticipated useful lives.\nThe Company estimates that there is sufficient storage capability in the spent fuel pools at Susquehanna to accommodate the fuel that is expected to be discharged through the year 1997. Federal law requires the federal government to provide for the permanent disposal of commercial spent nuclear fuel. Pursuant to the requirements of that law, the United States Department of Energy (DOE) has initiated an analysis of a site in Nevada for a permanent nuclear waste repository. The most recent estimated in-service date for the repository is beyond 2010. However, the location of the site for the repository in Nevada has been opposed by the state of Nevada. The DOE is also pursuing implementation of a Monitored Retrievable Storage (MRS) facility which is intended to permit the receipt of spent nuclear fuel for interim storage by the year 1998, or shortly thereafter. Even if the DOE is successful in implementing its plans for the MRS, it is unlikely that any spent fuel will be shipped from Susquehanna until well after the year 2000 because of the limited capacity of the MRS and the large volume of other utilities' spent fuel that is scheduled to be shipped before the Company's spent fuel. Therefore, expansion of Susquehanna's spent fuel storage capability will be necessary. To support this expansion, a contract was recently signed providing for the design and construction of a new spent fuel storage facility at the Susquehanna plant. The facility will be modular so that additional storage capacity can be added as needed. The Company currently estimates that the initial construction will be completed in the spring of 1997.\nFederal law also provides that the costs of spent nuclear fuel disposal will be the responsibility of the generators of such wastes. The Company includes in customer rates the fees charged by the DOE to fund the permanent disposal of spent nuclear fuel.\nFor a discussion of the assessment on the Company pursuant to the Energy Act for the Uranium Enrichment Decontamination and Decommissioning Fund, see the discussion under that caption on page 40.\nOil\nThe Company has agreements with two suppliers under which it can purchase its expected oil requirements for the Martins Creek units. However, if there are price advantages to be realized from purchasing oil in the spot market, these contracts permit the Company to acquire up to one-half of its expected oil requirements for the Martins Creek units in that manner. One oil purchase agreement expired in mid-1994 and was replaced with a similar two-year agreement which will expire in mid-1996. The other agreement expires in mid-1995.\nDuring 1994, approximately 80% of the oil requirements for the Martins Creek units was purchased under the Company's oil contracts and the balance was purchased on the spot market.\nSee \"POWER SUPPLY\" on page 6 for information concerning the planned conversion of the two oil-fired generating units at the Martins Creek station to burn both oil and natural gas.\nENVIRONMENTAL MATTERS\nThe Company is subject to certain present and developing federal, regional, state and local laws and regulations with respect to air and water quality, land use and other environmental matters. See \"Capital Expenditure Requirements\" on page 34 for information concerning environmental expenditures during the years 1992-1994 and the Company's estimate of those expenditures during the years 1995- 1997. The Company believes that it is presently in substantial compliance with applicable environmental laws and regulations.\nSee \"Clean Air Legislation and Other Environmental Matters\" on page 37 and Note 15 to Financial Statements for information concerning federal clean air legislation enacted in 1990, groundwater degradation and waste water control at Company facilities, DER's solid waste disposal regulations, the Company's negotiations with the DER concerning remediation at certain sites of past operations, and the issue of electric and magnetic fields. Other environmental laws, regulations and developments that may have a substantial impact on the Company are discussed below.\nAir\nThe Federal Clean Air Act includes, among other things, provisions that: (a) require the prevention of significant deterioration of existing air quality in regions where air quality is better than applicable ambient standards; (b) restrict the construction of and revise the performance standards for new coal- fired and oil-fired generating stations; and (c) authorize the United States Environmental Protection Agency (EPA) to impose substantial noncompliance penalties of up to $25,000 per day of violation for each facility found to be in violation of the requirements of an applicable state implementation plan. The DER administers the EPA's air quality regulations through the Pennsylvania State Implementation Plan and has concurrent authority to impose penalties for noncompliance.\nAs a result of computer dispersion modeling of the effects of the Company's Martins Creek station (located in Pennsylvania) on ambient air quality in New Jersey, the EPA redesignated Warren County, New Jersey to non-attainment status for sulfur dioxide, effective February 1, 1988. However, the EPA withheld further regulatory action until the Company, the EPA, the DER and the New Jersey Department of Environmental Protection (NJDEP) could agree upon and apply a computer model that will more accurately predict the actual ambient air quality of the area. The Company negotiated with the EPA, the DER and the NJDEP on a study to allow the use of a more accurate model. This study began in May 1992 and is expected to be concluded in 1996. In addition, the regulatory agencies have required the Company to expand the study area beyond the designated sulfur dioxide non-attainment area to include any predicted \"areas of concern\" in the vicinity of the plant. The Company is developing a study to address this expanded area. If it is determined that the Martins Creek operations are causing ambient air violations, the Company may be required to make changes to reduce sulfur dioxide emissions. However, it is currently expected that the reductions planned to meet the requirements of the Clean Air Act acid rain provisions should be adequate to meet any reduction that may be required as a result of these studies. See \"Clean Air Legislation and Other Environmental Matters\" on page 37 and Note 15 to Financial Statements.\nWater\nTo implement the requirements established by the Federal Water Pollution Control Act of 1972, as amended by the Clean Water Act of 1977 and the Water Quality Act of 1987, the EPA has adopted regulations including effluent standards for steam electric stations. The DER administers the EPA's effluent standards through state laws and regulations relating, among other things, to effluent discharges and water quality. The standards adopted by the EPA pursuant to the Clean Water Act may have a significant impact on the Company's existing facilities depending on the DER's interpretation and future amendments to its regulations.\nThe EPA and DER limitations, standards and guidelines for the discharge of pollutants from point sources into surface waters are enforced through the issuance of National Pollutant Discharge Elimination System (NPDES) permits. The Company has NPDES permits necessary for the operation of its facilities.\nPursuant to the Surface Mining and Reclamation Act of 1977 (Reclamation Act), the United States Office of Surface Mining (OSM) has adopted effluent guidelines which are applicable to Company subsidiaries as a result of their past coal mining and continued coal processing activities. The EPA and the OSM limitations, guidelines and standards also are enforced through the issuance of NPDES permits. In accordance with the provisions of the Clean Water Act and the Reclamation Act, the EPA and the OSM have authorized the DER to implement the NPDES program for Pennsylvania sources. Compliance with applicable water quality standards is assured by DER review of NPDES permit conditions. The Company's subsidiaries have received NPDES permits for their mines and related facilities.\nSolid and Hazardous Waste\nThe 1976 Resource Conservation and Recovery Act (RCRA) regulates the generation, transportation, treatment, storage and disposal of hazardous wastes. RCRA also imposes joint and several liability on generators of solid or hazardous waste for clean-up costs. A revision of RCRA in late 1984 lowered the threshold for the amount of on-site hazardous waste generation requiring regulation and incorporated underground tanks used for the storage of petroleum and petroleum products as regulated units. Based upon the results of a survey of its solid waste practices, the Company in the past has filed notices with the EPA indicating that hazardous waste is occasionally generated at all of its steam electric generating stations and service centers. The Company has established routine operating procedures for handling this hazardous waste. Therefore, at this time RCRA and related DER regulations are not expected to have a significant additional impact on the Company.\nThe provisions of the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (Superfund), authorize the EPA to require past and present owners of contaminated sites and generators of any hazardous substance found at a site to clean up the site or pay the EPA or the state for the costs of clean- up. The generators and past owners can be liable even if the generator contributed only a minute portion of the hazardous substances at the site. Present owners can be liable even if they contributed no hazardous substances to the site.\nIn 1981 the Company was notified by the EPA that the Company could be liable for the cost of removing coal tar deposits discovered at a former gas plant site owned by the Company along Brodhead Creek in Monroe County, Pennsylvania, and on adjacent property owned by a company unrelated to the Company. The EPA used Superfund monies to construct a slurry wall which was paid for by the adjacent property owner. The Company removed approximately 8,000 gallons of coal tar from its property. To determine whether additional work needed to be done, a Remedial Investigation and a Risk Assessment were conducted by the Company and the adjacent property owner and submitted to the EPA and the DER. Although the Risk Assessment showed acceptable risk levels, the EPA and the DER required a Feasibility Study to identify whether additional remedial action was required.\nBased on the results of that Feasibility Study and other investigations, the Company and the adjacent property owner signed a consent decree with the EPA in November 1991. Under the terms of that consent decree, the Company and the adjacent property owner will remove two subsurface coal tar accumulations, monitor the site for up to 30 years and pay all past unreimbursed and all future EPA oversight costs. The Company's share of the costs associated with the consent decree is estimated to be about $2 million.\nIn May 1992, the Company and the adjacent property owner signed a consent order from the EPA directing that an additional Remedial Investigation and Feasibility Study be performed to address groundwater contamination at the site. This investigation is now underway and could result in the EPA requiring additional site remediation, the cost of which cannot now be determined but could be material.\nThe EPA has placed the site of a former Company gas plant in Columbia, Pennsylvania on the national Superfund list. The Company and another potentially responsible party (PRP) had previously conducted a detailed investigation of the site, and the Company removed a substantial amount of coal tar from a pedestrian tunnel at the rear of the property. However, coal tar remains in two brick pits on the site. There also is coal tar contamination of the soil and groundwater at the site and of river sediment adjacent to the site. The Company is negotiating with EPA and DER on additional investigation and remediation required at the site. The costs of investigation and remediation of the areas of the site where the agencies have required action are estimated at $1.2 million, all of which has been spent or is budgeted. Further remediation of other areas of the site may be required, the costs of which are not now determinable but could be material.\nThe Company at one time also owned and operated several other gas plants in its service area. None of these sites is presently on the Superfund list. However, a few of them may be possible candidates for listing at a future date. The Company expects to continue to investigate and, if necessary, remediate these sites. The cost of this work is not now determinable but could be material.\nSee \"LEGAL PROCEEDINGS\" on page 18 for information concerning an EPA order and a complaint filed by the EPA in federal district court against the Company and 35 unrelated parties for remediation of a Superfund site in Berks County, Pennsylvania; a complaint filed by the Company and 16 unrelated parties in federal district court against other parties for contribution under Superfund relating to the Novak landfill site in Lehigh County, Pennsylvania; an EPA complaint in federal district court against the Company and 10 unrelated parties to recover all past and future EPA costs of investigating and remediating the Heleva landfill site in Lehigh County, Pennsylvania; and action by the EPA for reimbursement of the EPA's past response costs and remediation at the site of a former metal salvaging operation in Montour County, Pennsylvania.\nThe Company is involved in several other sites where it may be required, along with other parties, to contribute to investigation and remediation. Some of these sites have been listed by the EPA under Superfund, and others may be candidates for listing at a future date. Future investigation or remediation work at sites currently under review, or at sites currently unknown, may result in material additional operating costs which the Company cannot estimate at this time. In addition, certain federal and state statutes, including Superfund and the Pennsylvania Hazardous Sites Cleanup Act, empower certain governmental agencies, such as the EPA and the DER, to seek compensation from the responsible parties for the lost value of damaged natural resources. The EPA and the DER may file such compensation claims against the parties, including the Company, held responsible for cleanup of such sites. Such natural resource damage claims against the Company could result in material additional liabilities.\nThe Pennsylvania Superfund law gives the DER broad authority to identify hazardous or contaminated sites in Pennsylvania and to order owners or responsible parties to clean up the sites. If responsible parties cannot or will not perform the clean-up, the DER can hire contractors to clean up the sites and then require reimbursement from the responsible parties after the clean-up is completed. To date, the Company's involvement in such state sites has been minimal.\nLow-Level Radioactive Waste\nUnder federal law, each state is responsible for the disposal of low-level radioactive waste generated in that state. States may join in regional compacts to jointly fulfill their responsibilities. The states of Pennsylvania, Maryland, Delaware and West Virginia are members of the Appalachian States Low-Level Radioactive Waste Compact. Efforts to develop a regional disposal facility in Pennsylvania are currently underway. Low-level radioactive wastes resulting from the operation of Susquehanna are currently stored onsite. Any additional required storage capacity will have to be provided by the Company. The Company cannot predict the future availability of low-level waste disposal facilities or the cost of such disposal.\nGeneral\nIn addition to the matters described above, the Company and its subsidiaries have been cited from time to time for temporary violations of the DER and EPA regulations with respect to air and water quality and solid waste disposal in connection with the operation of their facilities and may be cited for such violations in the future. As a result, the Company and its subsidiaries may be subject to certain penalties which are not expected to be material in amount.\nThe Company is unable to predict the ultimate effect of evolving environmental laws and regulations upon its existing and proposed facilities and operations. In complying with statutes, regulations and actions by regulatory bodies involving environmental matters, including the areas of water and air quality, hazardous and solid waste handling and disposal and toxic substances, the Company may be required to modify, replace or cease operating certain of its facilities. The Company may also incur material capital expenditures and operating expenses in amounts which are not now determinable.\nFRANCHISES AND LICENSES\nThe Company has authority to provide electric public utility service throughout its entire service area as a result of grants by the Commonwealth of Pennsylvania in corporate charters to the Company and companies to which it has succeeded and as a result of certification thereof by the PUC. The Company has been granted the right to enter the streets and highways by the Commonwealth subject to certain conditions. In general, such conditions have been met by ordinance, resolution, permit, acquiescence or other action by an appropriate local political subdivision or agency of the Commonwealth.\nThe Company operates Susquehanna Unit 1 and Unit 2 pursuant to NRC operating licenses which expire in 2022 and 2024, respectively. The Company operates two hydroelectric projects pursuant to licenses which were renewed by the FERC in 1980: Wallenpaupack (44,000 kilowatts capacity) and Holtwood (102,000 kilowatts capacity). The Wallenpaupack license expires in 2004 and the Holtwood license expires in 2014.\nThe Company also owns one-third of the capital stock of Safe Harbor Water Power Corporation, which holds a project license which extends until 2030 for the operation of its hydroelectric plant. The total capability of the Safe Harbor plant is 417,500 kilowatts, and the Company is entitled by contract to one-third of the total capacity (139,000 kilowatts).\nEMPLOYEE RELATIONS\nAs of December 31, 1994, approximately 4,428 of the Company's 6,934 full-time employees were represented by the International Brotherhood of Electrical Workers under a three-year agreement which expires in May 1997.\nPage 17 contains a map of the Company's service territory which shows its location, the location of each of the Company's coal-fired, oil-fired, hydro and nuclear-fueled generating stations and the location of major population centers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Map on page 17 shows the location of the Company's service area and generating stations.\nReference is made to Exhibit 99 - Schedule of Property, Plant and Equipment for information concerning the Company's investment in property, plant and equipment. Substantially all electric utility plant is subject to the lien of the Company's first mortgage. Additional information concerning capital leases is set forth in Note 8 to Financial Statements.\nFor additional information concerning the properties of the Company see Item 1, \"BUSINESS - Power Supply\" and \"BUSINESS - Fuel Supply\".\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nReference is made to Note 3 to Financial Statements for information concerning rate matters.\nReference is made to Note 15 to Financial Statements for information concerning two complaints filed against the Company by fuel oil dealers alleging that the Company's promotion of electric heat pumps and off-peak storage systems had violated and continues to violate the federal antitrust laws.\nIn April 1991, the U.S. Department of Labor through its Mine Safety and Health Administration (MSHA) issued citations to one of the Company's coal-mining subsidiaries for alleged coal-dust sample tampering at one of the subsidiary's mines. The MSHA at the same time issued similar citations to more than 500 other coal-mine operators. Based on a review of its dust sampling procedures, the subsidiary is contesting all of the citations. It is believed at this time, based on the information available, that the MSHA allegations are without merit. Citations were also issued against the independent operator of another subsidiary mine, who is also contesting the citations issued with respect to that mine. The Administrative Law Judge (Judge) assigned to the proceedings ordered that one case be tried against a single mine operator unrelated to the Company to determine whether the MSHA could prove its general allegations regarding sample tampering. In April 1994, the Judge ruled in favor of the mine operator and vacated the 75 citations against it. The MSHA is appealing the Judge's decision to the Mine Safety & Health Review Commission. The other cases, including those involving the Company's subsidiaries, have been stayed pending the outcome of the appeal.\nThe Company cannot predict the eventual outcome of this matter. If violations are found, it is currently estimated that potential administrative penalties could range from approximately $90,000 to approximately $4.6 million.\nOn July 25, 1994, Mon Valley Steel Company, Inc. (Mon Valley) filed suit in the Court of Common Pleas of Fayette County, Pennsylvania, against the Company and two of its subsidiaries, claiming that the Company and those subsidiaries made fraudulent misrepresentations during negotiations for the 1992 sale to Mon Valley of Tunnelton Mining Company (Tunnelton). Tunnelton was a coal-mining operation formerly owned by the Company's subsidiary, Pennsylvania Mines Corporation. Specifically, Mon Valley alleges that the Company and those subsidiaries misrepresented Tunnelton's capability to produce coal, as well as the amount of funding Tunnelton would receive for mine closing costs. Mon Valley is claiming about $6 million to cover mine closing costs, as well as punitive damages in an unspecified amount. In July 1994, the Company and those subsidiaries filed a legal action in the Court of Common Pleas of Allegheny County, Pennsylvania, requesting a judicial determination that they had not breached any of their contractual obligations to Mon Valley. The Company cannot predict the outcome of these proceedings.\nIn August 1991, the Company and 35 other unrelated parties received an Environmental Protection Agency (EPA) order under Section 106 of the federal Comprehensive Environmental Response Compensation and Liability Act of 1980, as amended (Superfund), requiring that certain remedial actions be taken at a former oil recovery site in Berks County, Pennsylvania, which has been included on the federal Superfund list. The Company had been identified by the EPA as a potentially responsible party, along with over 100 other parties. The EPA order required remediation by the 36 named parties of four specific areas of the site. Remedial action under this order has essentially been completed at a cost of approximately $2 million, of which the Company's share was approximately $50,000.\nThe EPA at the same time filed a complaint under Section 107 of Superfund in the United States District Court for the Eastern District of Pennsylvania (District Court) against the Company and the same 35 unrelated parties. The complaint asks the District Court to hold the parties jointly and severally liable for all past and future EPA costs of remediating some of the remaining areas of the site. The EPA claims it has spent approximately $21 million to date. The Company and a group of the other named parties have sued in District Court approximately 460 other parties that have contributed waste to the site, demanding that these companies contribute to the clean-up costs.\nIn July 1993, the Company and 33 of the 35 unrelated parties received an EPA order under Section 106 of Superfund requiring remediation of the remaining areas of the site identified by EPA. Current estimates of remediating the remainder of the site range from $50 million to $200 million. These costs would be shared among the responsible parties. The Company is negotiating with the federal government to settle both the Section 107 and Section 106 actions, for an amount which currently is not expected to be material.\nIn October 1993, the Pennsylvania Department of Environmental Resources (DER) moved to intervene in the EPA suit, seeking to hold 16 of the originally named parties, including the Company, liable for all past and future DER costs of remediating the site and for any natural resource damages at the site. According to the complaint, the DER has spent at least $800,000 to date. The Company may incur material costs for this DER action in amounts which are not now determinable.\nIn December 1991, the Company and 16 unrelated parties filed complaints against 64 other parties in District Court seeking reimbursement under Superfund for costs the plaintiffs have incurred and will incur to investigate and remediate the Novak landfill site in Lehigh County, Pennsylvania. The complaints allege that the 64 defendants generated or transported substances disposed of at the Superfund site. A Remedial Investigation and Feasibility Study for the site has been completed at a cost of approximately $3 million, of which the Company's share was approximately $300,000. EPA's selected remedy is currently estimated to cost approximately $20 million. EPA has issued a proposed Consent Decree to the Company and several other parties to implement the remedy. The Company may incur material costs for this matter in amounts which are not now determinable.\nIn March 1993, the EPA filed a complaint under Section 107 of Superfund in District Court against the Company and 10 unrelated parties to recover all past and future EPA costs of investigating and remediating the Heleva landfill site in Lehigh County, Pennsylvania. The EPA alleges it has spent approximately $10 million to date at this site. The Company has filed an answer to the complaint denying liability based on the absence of evidence that the Company sent any hazardous substances to the site. The Company expects to settle this matter for a sum which currently is not expected to be material.\nIn April 1993, the Company received an order under Section 106 of Superfund requiring that actions be taken at the site of a former metal salvaging operation in Montour County, Pennsylvania. The EPA has taken similar action with two other potentially responsible parties at the site. The cost of compliance with the order is currently estimated to be approximately $37 million. The EPA currently estimates that additional remediation work not covered by the order will cost an additional $36 million. In addition, the EPA has already incurred clean-up costs of approximately $5 million to date. The EPA had indicated that it will seek to recover these additional costs at a later date. The Company's records indicate that scrap metal, wire and transformers were sold to the salvage operator between 1969 and 1971. Current information indicates that the Company's contribution to the site, if any, is de minimis.\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, through the solicitation of proxies or otherwise, during the fourth quarter of 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nOfficers are elected annually by the Board of Directors to serve at the pleasure of the Board. There are no family relationships among any of the executive officers, or any arrangement or understanding between any executive officer and any other person pursuant to which the officer was selected.\nThere 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.\nListed below are the executive officers of the Company:\nEffective Date of Election to Name Age Position Present Position\nWilliam F. Hecht 51 Chairman, President and Chief Executive Officer January 1, 1993\nFrancis A. Long 54 Executive Vice President and Chief Operating Officer January 1, 1993\nRobert G. Byram 49 Senior Vice President- Nuclear March 26, 1993\nRonald E. Hill 52 Senior Vice President- Financial January 1, 1994\nLinda Curry 46 Vice President - Bartholomew Public Affairs June 1, 1989\nJohn R. Biggar 50 Vice President- Finance March 1, 1984\nJohn M. Chappelear 56 Vice President- Investments and Pensions June 1, 1986\nRobert M. Geneczko 42 Vice President- Electrical Systems November 1, 1994\nEffective Date of Election to Name Age Position Present Position\nRobert S. Gombos 51 Vice President- Mobile Work Force November 1, 1994\nRobert J. Grey 44 Vice President, General Counsel and Secretary March 6, 1995\nMichael D. Hill 52 Vice President-Infor- mation Services August 1, 1993\nGeorge T. Jones 47 Vice President-Nuclear Engineering June 1, 1993\nJohn P. Kierzkowski 55 Vice President and Treasurer March 1, 1984\nJoseph J. McCabe 44 Controller May 1, 1994\nJohn R. Menichini 47 Vice President- Customer Service November 1, 1994\nRobert J. Shovlin 54 Vice President-Power Production and Engineering January 1, 1992\nHarold G. Stanley 54 Vice President-Nuclear Operations June 1, 1993\nRaymond F. Suhocki 49 Vice President-Marketing and Economic Develop- ment November 1, 1994\nEach of the above officers, with the exception of Mr. Grey, Mr. Jones and Mr. McCabe, has been employed by the Company for more than five years as of December 31, 1994. Mr. Jones joined the Company in September 1991 and was previously employed by Entergy Operations, Inc. The positions he held at Entergy Operations, Inc. between January 1990 and September 1991 were General Manager-Engineering and Director of Engineering-Arkansas Nuclear One. Mr. McCabe joined the Company in May 1994 and was previously employed by Deloitte & Touche LLP (Deloitte). He held the position of partner at Deloitte between Janaury 1990 and May 1994. Mr. Grey will join the Company on March 6, 1995. Mr. Grey has been General Counsel of Long Island Lighting Company since 1992. Prior to that time, he held the position of partner at the law firm of Preston, Thorgrimson Shidler Gates & Ellis between 1982 and 1992.\nPrior to election to the positions shown above, the following executive officers held other positions with the Company since January 1, 1990: Mr. Hecht was Senior Vice President-System Power and Engineering, Executive Vice President- Operations and President and Chief Operating Officer; Mr. Long was Vice President-Power Supply and Senior Vice President - System Power & Engineering; Mr. Byram was Vice President-Nuclear Operations and Senior Vice President - System Power & Engineering; Mr. R. E. Hill was Vice President and Comptroller; Ms. Bartholomew was Senior Director and Economist-Public Affairs; Mr. Geneczko was Manager-System Planning and Vice President- Division; Mr. Gombos was Vice President-Human Resource and Development; Mr. M. D. Hill was Manager-Bulk Power Engineering and Manager-System Operating; Mr. Jones was Manager-Nuclear Plant Engineering and Manager-Nuclear Engineering; Mr. Menichini was Vice President-Division; Mr. Shovlin was Director-Power Production and Engineering; Mr. Stanley was Superintendent of Plant-Susquehanna Steam Electric Station and Mr. Suhocki was Manager-Marketing & Economic Development, Vice President-Division and Vice President-System Power.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nAdditional information for this item is set forth in the section entitled \"Shareowner and Investor Information\" on pages 87 through 89 of this report, and the number of common shareowners is set forth in the section entitled \"Selected Financial and Operating Data\" on page 85.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nInformation for this item is set forth in the section entitled \"Selected Financial and Operating Data\" on pages 85 and 86 of this report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nInformation for this item is set forth in the section entitled \"Review of the Company's Financial Condition and Results of Operations\" on pages 28 through 45 of this report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nFinancial statements and supplementary data are set forth on the pages indicated below.\nPage\nIndependent Auditors' Report 47\nManagement's Report on Responsibility for Financial Statements 48\nFinancial Statements:\nConsolidated Statement of Income for the Three Years Ended December 31, 1994 49 Consolidated Statement of Cash Flows for the Three Years Ended December 31, 1994 50 Consolidated Balance Sheet at December 31, 1994 and 1993 51 Consolidated Statement of Shareowners' Common Equity for the Three Years Ended December 31, 1994 53 Consolidated Statement of Preferred and Preference Stock at December 31, 1994 and 1993 53 Consolidated Statement of Long-Term Debt at December 31, 1994 and 1993 55 Notes to Financial Statements 56\nQuarterly Financial, Common Stock Price and Dividend Data 90\nSupplemental Financial Statement Schedule:\nII - Valuation and Qualifying Accounts and Reserves for the Three Years Ended December 31, 1994 91\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nBased upon a recommendation of its Audit Committee, the Company's Board of Directors decided on January 25, 1995 that Deloitte & Touche LLP (Deloitte) would not be retained as the Company's independent auditors for 1995. On February 22, 1995, the Company's Board of Directors, based upon a recommendation of it's Audit Committee, appointed Price Waterhouse LLP as the Company's new independent auditors.\nThe auditors' reports of Deloitte on the Company's financial statements for each of the two most recent fiscal years reported upon, ending December 31, 1994, did not contain any adverse opinion or disclaimer of opinion, nor were the reports modified or qualified in any manner.\nDuring the period of such two fiscal years and the period from December 31, 1994 through January 25, 1995, there were no disagreements with Deloitte on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure. During such periods, there were no \"reportable events\" as that term is defined in Item 304(a)(1)(v) of Regulation S-K.\nDeloitte provided a letter to the Company regarding this matter, dated February 1, 1995, indicating that they agreed with the statements in the two preceding paragraphs.\n(THIS PAGE LEFT BLANK INTENTIONALLY.)\nREVIEW OF THE COMPANY'S FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\nEarnings\nEarnings per share of common stock were $1.41 in 1994, $2.07 in 1993 and $2.02 in 1992.\nEarnings for 1994 were adversely affected by several one-time charges, including two major charges, during the fourth quarter. One amounted to $75.9 million, or 28 cents per share of common stock, resulting from costs associated with a voluntary early retirement program, and the other amounted to $73.7 million, or 26 cents per share, from a write down in the carrying value of a subsidiary's investment in undeveloped coal reserves. In addition, two nonrecurring charges recorded earlier in the year reflected the disallowance by the Pennsylvania Public Utility Commission (PUC) of recovery of replacement power costs, incurred during an extended outage at the Susquehanna station, through the Energy Cost Rate (ECR) amounting to $15.7 million, or 6 cents per share of common stock, and a decision of the Commonwealth Court of Pennsylvania which reversed a PUC order that permitted deferral of the cost of postretirement benefits other than pensions. The Company charged the deferred postretirement benefit costs applicable to 1993 against income which amounted to $10.8 million or 4 cents per share. These matters are discussed in more detail in this review.\nAlthough the nonrecurring charges depressed earnings in 1994, underlying sales performance was strong, with a 4.1% increase in sales to ultimate customers, due to improving economic conditions and colder-than- normal weather in the winter months. Other positive effects on earnings included the Company's continued efforts to control operating and maintenance costs, and refinancing higher cost securities to take advantage of favorable market conditions.\nIn 1993 increasing economic activity and the effects of hotter-than- normal weather in the summer were the primary causes for the earnings improvement over 1992. Earnings in 1993 also benefited from the Company's efforts to control costs and refinance higher cost securities. In 1993 the Company recorded charges against income that, in the aggregate, adversely affected earnings by about $31.5 million, or 12 cents per share, related to: (i) a settlement agreement with complainants against the Company's 1990-91 through 1993-94 ECRs; (ii) the write off of certain deferred retiree benefit costs; and (iii) the adoption of Statement of Financial Accounting Standards (SFAS) 112, \"Employers' Accounting for Postemployment Benefits.\"\nElectric Energy Sales\nSystem, or service area, sales were 32.3 billion kwh in 1994, an increase of about 1.3 billion kwh, or 4.1%, over 1993. The extreme cold weather in the first quarter of 1994 and the continued increase in economic activity in Central Eastern Pennsylvania were the primary reasons for the increases in system sales. Sales in all major customer categories were higher in 1994 than in 1993. The higher system sales in 1994 followed an increase in 1993 system sales over 1992 of about 1.3 billion kwh that was due to increased economic activity in the service area and the effect of hotter summer weather resulting in higher air conditioner use. The Company estimates that if normal weather had been experienced in both years, system sales for 1994 would have increased by 1.1 billion kwh, or 3.5%, over 1993.\nActual sales to residential and commercial customers in 1994 increased 402 million kwh, or 3.6%, and 342 million kwh, or 3.6%, respectively, over 1993. The Company estimates that under normal weather conditions for both years, sales to residential and commercial customers in 1994 would have increased 243 million kwh, or 2.2%, and 327 million kwh, or 3.5%, respectively, over 1993.\nIndustrial sales, which are not affected by weather conditions, increased 437 million kwh in 1994, or 4.8%, over 1993. Industrial sales are an important indicator of the economic health of the Company's service area.\nSystem sales in 1995 are currently forecasted to be approximately 32.5 billion kwh, an increase of 136 million kwh, or 0.4%, over 1994 system sales, and a 419 million kwh, or 1.3%, increase over 1994 weather- normalized sales.\nTotal electric energy sales, which include contractual sales to other major utilities and energy sales to Pennsylvania-New Jersey-Maryland Interconnection Association (PJM) utilities, were essentially unchanged during the 1992-1994 period.\nContractual sales to other major utilities include: (i) energy sold to Atlantic City Electric Company (Atlantic), Baltimore Gas & Electric Company (BG&E) and Jersey Central Power & Light Company (JCP&L) pursuant to long-term contracts under which these utilities purchase a specified percentage of the capacity and related energy from Company-owned generating units; and (ii) energy sold on a short-term basis to other electric utilities. Contractual sales to other major utilities were 6.3 billion kwh in 1994, or 11.7% lower than 1993, as a result of reduced output from the Company's coal-fired generating units. Contractual sales to other major utilities in 1993 were about 7.1 billion kwh, or 2.5% lower than 1992.\nSales to JCP&L will continue at the current level through 1995 and then begin to phase out in equal annual amounts during the remaining term of the agreement which ends in December 1999. Sales to Atlantic and BG&E continue through September 2000 and May 2001, respectively. In its pending rate case (see \"Rate Matters\"), the Company has proposed that the costs associated with the returning capacity be recovered through the ECR. If the PUC denies this request, the Company expects that any sales of the returning capacity and related energy under bulk power marketing conditions would be at prices less than those reflected in the existing agreements. PJM energy sales were about 3.2 billion kwh in 1994, or 23.7% lower than 1993. In 1993 PJM energy sales were about 4.1 billion kwh, or 19.7% lower than 1992. The decreases in both years were primarily due to increased system sales and a decrease in the output of the Company's generating units. In 1994 the decrease in output was primarily due to lower availability of the coal-fired units. The decrease of output in 1993 resulted from an increase in the availability of nuclear generating capacity of the other PJM utilities.\nCapacity-Related and Transmission Entitlement Transactions\nThe Company's strong generating capacity position has enabled it to enter into a number of transactions with other electric utilities. These transactions include: (i) the sale of capacity credits but no energy to other utilities in the PJM to enable them to satisfy their PJM contractual capacity obligations; (ii) agreements with both PJM and non-PJM utilities for the reservation of output during certain periods from the Company's generating units, with the option to purchase energy from those units; and (iii) arrangements whereby other PJM utilities can purchase the Company's entitlements to use the PJM transmission system to import energy from utilities outside the PJM.\nRevenues from the sale of capacity credits, the reservation of output from generating units and the sale of transmission entitlements, net of foregone PJM interchange savings which are included in the Company's ECR, totaled $28.7 million in 1994, $35.0 million in 1993 and $35.0 million in 1992. The 1994 revenues exclude approximately $8.4 million of receipts from installed capacity credit sales which were credited to customers through the ECR. The Company currently expects about $14.6 million of revenues from these transactions during 1995, exclusive of credits to be applied to the ECR.\nThe Company is continuing to look for opportunities to derive additional revenues from these transactions due to its strong generating capacity position. However, increased competition in capacity credit transactions has reduced the Company's share of this market and the unit price received for such sales. The amount of revenues from these transactions depends on many factors, and the Company cannot predict the amount of revenues it will ultimately realize from these transactions.\nIn October 1994, the PUC approved a settlement agreement resolving all complaints against the 1990-91 ECR through 1993-94 ECR including issues related to capacity-related transactions. The agreement provides, among other things, for crediting the 1994-95 ECR with a portion of the receipts from capacity credit sales. See \"Rate Matters\" below for additional information.\nRate Matters\nBase Rate Filing with the PUC\nIn December 1994, the Company filed a request with the PUC for a $261 million increase in electric base rates, an 11.7% increase in PUC- jurisdictional rates. The PUC has decided to hold hearings and conduct an investigation of the request. A final rate decision is expected in late September 1995. A detailed discussion of the rate filing is presented in Financial Note 3.\nEnergy Cost Rate Issues\nIn April 1994, the PUC reduced the Company's 1994-95 ECR claim by approximately $15.7 million to reflect costs associated with replacement power during a portion of the time that Unit 1 of the Company's Susquehanna station was out of service for refueling and repairs. As a result of the PUC's action, the Company recorded a charge against income in the first quarter of 1994 for the $15.7 million of unrecovered replacement power costs. This charge adversely affected net income by about $9.0 million or 6 cents per share of common stock.\nThe Company filed a complaint with the PUC objecting to the decision to exclude these replacement power costs from the 1994-95 ECR and subsequently entered into a settlement agreement with the complainants and the Office of Trial Staff on this matter.\nThe PUC approved the settlement agreement on February 24, 1995. As a result of the PUC Order, the Company, in the first quarter of 1995, will record a credit to income of $9.7 million which would increase net income by about $5.5 million or 4 cents per share of common stock.\nIn October 1994, the PUC issued an order approving a settlement agreement the Company reached in January 1994 with the Office of Consumer Advocate (OCA) and certain industrial customers concerning the 1990-91 ECR through the 1993-94 ECR. The PUC order resolved all complaints against those ECRs, and required the Company to credit the 1994-95 ECR with a one- time adjustment for a portion of the receipts from installed capacity credit sales made from April 1990 through December 31, 1993 and also provided that about one-third of the receipts from installed capacity credit sales made after December 31, 1993 will be credited through future ECRs. These capacity credit sales are discussed in Financial Notes 3 and 4. The PUC order also provided that a portion of the PUC-jurisdictional amount of deferred retired miners' health care benefits costs, which the Company sought to recover through the ECR, will not be recoverable. As a result of this order, in the fourth quarter of 1993 the Company recorded a charge to expense of $17.1 million, which reduced 1993 net income by approximately $9.7 million or 6 cents per share of common stock.\nPostretirement Benefits Other Than Pensions\nIn March 1993, the PUC approved the Company's petition to defer the increase in retiree benefits costs arising from adoption of SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" Under the PUC order, the increased costs applicable to PUC-jurisdictional customers would have been deferred from January 1, 1993 until such costs were included in customer rates in the Company's next retail base rate proceeding. Accounting rules permit deferral of the costs for about five years.\nIn May 1994, in response to an appeal by the OCA, the Commonwealth Court of Pennsylvania reversed the PUC order and held that the Company could not defer these costs.\nAs a result of the Court's decision, the Company began expensing the increased costs applicable to operations that would have otherwise been deferred and wrote off the costs that had been deferred from January 1, 1993. The charge to expense for 1994 amounted to $22.9 million, which included $10.8 million applicable to 1993. The Company is charging expense on a current basis for retiree benefits costs.\nIn June 1994, the PUC and the Company requested the Pennsylvania Supreme Court to hear an appeal of the Commonwealth Court decision.\nFERC-Jurisdictional Rates\nThe Company has entered into five year sales contracts with certain small utilities the Company currently serves, which reduced rates to these small utilities by about $3.3 million in 1994 and will reduce rates by about an additional $4.1 million in 1996. In connection with these agreements, in the fourth quarter of 1993 the Company wrote off the deferred portions of retired miners' health care benefits costs and postretirement benefits other than pensions applicable to FERC- jurisdictional customers. The charge to expense amounted to $8.9 million, which reduced 1993 net income by $5.1 million or 3 cents per share of common stock.\nOperating Revenues\nTotal operating revenues in 1994 decreased $1.9 million, or 0.1%, from 1993. Revenues from energy sales to ultimate customers in 1994 increased $44.7 million over 1993 due to higher customer usage and recoverable fuel and energy costs. These increases were principally offset by: (i) lower sales to other major utilities, $13.3 million; (ii) lower sales on the PJM, $21.1 million; and (iii) unrecovered replacement power costs, $15.7 million as discussed in \"Rate Matters.\" Operating revenues for 1993 decreased $17.1 million, or 0.6%, from 1992. Changes in 1993 operating revenues from 1992 principally included: (i) revenues from sales to ultimate customers increased $18.4 million; (ii) sales to other major utilities decreased $16.4 million; and (iii) PJM sales decreased $14.8 million.\nTariffs subject to PUC-jurisdiction accounted for approximately 83% of the Company's revenues from energy sales in 1994. The remaining 17% of such revenues resulted from sales regulated by the FERC and include the Company's PJM energy sales.\nBillings to customers under PUC jurisdiction include: (i) base rate charges; (ii) the ECR which is a supplemental charge or credit for fuel and other energy costs over or under the levels included in base rates; (iii) a State Tax Adjustment Surcharge (STAS) which adjusts retail customers' bills for the effects of changes in state tax rates; and (iv) a Special Base Rate Credit Adjustment (SBRCA) that flows through to customers the effects of certain nonrecurring items.\nBillings to utilities are subject to FERC jurisdiction. In the case of certain small utilities, billings include base rate charges and a supplemental charge or credit for fuel costs over or under the levels included in base rates. The FERC also regulates contractual sales to other major utilities, PJM energy sales and capacity-related and transmission entitlement transactions. Sales to Atlantic, BG&E and JCP&L are made at a price covering the Company's cost of service, including a return on investment.\nEnergy sales relating to the reservation of output from the Company's generating units are generally made at a price equal to the cost of fuel plus an amount to reflect foregone interchange savings. PJM energy sales are made at a price equal to the midpoint between the sellers' actual costs and costs that the buyers would have incurred to produce the energy. Capacity-related and transmission entitlement transactions are made at prices negotiated by the Company and the purchaser, subject to a price cap accepted by the FERC.\nFuel Expense\nFuel expense for 1994 and 1993 decreased by $33.3 million and $49.5 million, respectively, from the prior year. These decreases excluded the write off of $11 million of deferred retired miners' health care benefits in 1993 and a related credit to expense of $3.6 million in 1994. The decrease in 1994 was primarily due to lower availability of coal-fired generation which resulted in reduced sales to PJM and other major utilities. Lower fuel costs for off-system sales were partially offset by higher cost oil-fired generation for base load during the first quarter of 1994. The decrease in 1993 was primarily due to lower unit fuel costs for coal-fired generation, partially offset by higher oil-fired generation. For 1993, the cost of coal delivered to the Company's generating stations declined to $36.23 per ton from $41.44 per ton for 1992.\nSpent Nuclear Fuel\nThe U.S. Department of Energy (DOE) is responsible for the permanent storage and disposal of spent nuclear fuel removed from nuclear reactors. The Company currently pays DOE a fee for future disposal services and recovers such costs in customer rates.\nDelays in opening a federal permanent storage facility will require the Company to provide interim storage for spent fuel at the Susquehanna station beginning in 1997 until at least 2010.\nPower Purchases\nIn 1994, power purchases were $287.3 million, an increase of $8.5 million over 1993. Power purchases were $278.8 million in 1993, an increase of $3.3 million over 1992. The increases were due to greater quantities of power purchased from PJM and other utilities, partially offset by lower power purchases from non-utility generators.\nOther Operation, Maintenance and Depreciation\nThe increase in other operation expenses in 1994 compared to 1993 is primarily the result of the Commonwealth Court of Pennsylvania decision reversing the PUC order regarding the deferral of postretirement benefits costs other than pensions. See \"Rate Matters\" for further discussion.\nIn 1993 the Company wrote off $9.1 million of obsolete and excess materials and supplies at its fossil-fueled steam generating stations. Of this amount, $2.2 million was charged to other operation expense and $6.9 million was charged to maintenance expense.\nThe amortization of the deferred income effect of adopting the inventory method of accounting for power plant spare parts is credited to maintenance expense on the Consolidated Statement of Income. This amortization amounted to $24.7 million in 1994, $24.3 million in 1993, and $23.5 million in 1992. Excluding the credits associated with power plant spare parts and the 1993 accrual for the recognition of obsolete and excess materials and supplies, maintenance expense decreased by $5.9 million, or 2.8% in 1994 compared to 1993. A similar comparison of 1993 to 1992 indicated a $14.1 million, or 6.3%, decrease. The reduction in maintenance expense resulted primarily from lower costs associated with maintaining the Company's generating stations.\nHigher depreciation expense reflects the annual increase associated with the method of depreciating the Susquehanna station and the depreciation of new property, plant and equipment placed in service. As approved by the PUC and the FERC, depreciation expense for the Susquehanna station will increase annually through the year 1998. In 1993 and 1994, the amount of depreciation expense applicable to the Susquehanna station exceeded the amount that would have been recorded using the straight-line method, resulting in an amortization of previously deferred depreciation. Beginning in 1999, depreciation is scheduled to change to the straight-line method at a level substantially less than the amount expected to be recorded in 1998. The amount of depreciation applicable to that portion of the Susquehanna station subject to an annual increase in the amount of depreciation was $128 million in 1994 and $116 million in 1993, and will increase annually to $192 million in 1998 and then decline to $102 million in 1999. Proposed changes to the Company's current depreciation methods were included in the December 1994 base rate filing with the PUC. See Financial Note 3.\nFor a discussion of the Company's efforts to continue to reduce costs, see \"Increasing Competition\" on page 42.\nTaxes\nIn June 1994, Pennsylvania enacted legislation that decreased the Company's state corporate net income tax rate from 12.25% to 11.99% retroactive to January 1, 1994 with further reductions to 10.99%, 10.75% and 9.99% in 1995, 1996 and 1997, respectively. This resulted in a decrease of $0.8 million in income tax expense for 1994. Substantially all of this amount was reflected in lower customer rates through the STAS beginning in July 1994.\nIn August 1993, the Omnibus Budget Reconciliation Act of 1993 was enacted, which contained a provision that increased the Company's federal income tax rate from 34% to 35% retroactive to January 1, 1993. This higher tax rate increased the Company's federal income tax expense for 1993 by $5.9 million.\nFinancing Costs\nThe Company continued in 1994 to take advantage of opportunities to reduce its financing costs by retiring long-term debt and preferred stock with the proceeds from the sales of securities at a lower cost. Interest on long-term debt and dividends on preferred and preference stock decreased by $34 million from $277 million in 1991 to $243 million in 1994.\nFinancial Condition\nCapital Expenditure Requirements\nThe schedule below shows the Company's actual capital expenditures for electric utility operations for the years 1992-1994 and current projections for the years 1995-1997. Construction expenditures during the years 1992- 1994 totaled about $1.3 billion and are expected to be at the same level during the years 1995-1997.\nCapital Expenditure Requirements (a)\n------Actual------ ----Projected---- 1992 1993 1994 1995 1996 1997 (Millions of Dollars) Construction expenditures Generating facilities $136 $142 $152 $111 $107 $ 99 Transmission and distribution facilities 186 173 170 166 159 165\nEnvironmental 13 65 94 40 52 156 Other 52 51 58 70 83 58 387 431 474 387 401 478 Nuclear fuel owned and leased 42 64 35 54 79 49 Other leased property 20 20 25 39 31 22 Total $449 $515 $534 $480 $511 $549\n(a) Capital expenditure plans are revised from time to time to reflect changes in conditions. Actual expenditures may vary from those projected because of changes in plans, cost fluctuations, environmental regulations and other factors. Construction expenditures include Allowance for Funds Used During Construction (AFUDC) which is expected to be less than $25 million in each of the years 1995-1997.\nFinancing and Liquidity\nNet cash provided by operating activities in 1994 decreased by $58.7 million primarily due to lower earnings, increases in income tax payments, higher fuel inventories and a reduction in accounts payable. Cash provided by operating activities in 1993 and 1992 were essentially unchanged.\nNet cash used in investing activities was $78.7 million higher in 1994 than 1993 and $25.6 million higher in 1993 than in 1992. The increase in 1994 was due to higher construction expenditures and an increase in financial investments by a subsidiary of the Company. The increase in investing activities in 1993 was due to higher construction expenditures.\nFor the years 1992-1994, the Company issued $2.16 billion of long-term debt, $380 million of preferred stock and about $83 million of common stock. Proceeds from security sales were used to retire about $1.8 billion of long-term debt and about $500 million of preferred and preference stock to lower the Company's financing costs, to reduce short-term debt and to finance construction expenditures. During the years 1992-1994, the Company also incurred $211 million of obligations under capital leases (primarily nuclear fuel). In 1994, the Company sold $919 million principal amount of first mortgage bonds and $80 million of preferred stock and issued $70 million of common stock of which $63 million was issued through its Dividend Reinvestment Plan (DRIP) and the remaining $7 million issued to the Employee Stock Ownership Plan. During the year, the Company retired $637 million of long-term debt, $120 million of preferred stock and decreased its short-term debt by $128 million.\nAfter the payment of dividends, internally generated funds during the years 1995-1997 are expected to provide approximately 70-85% of the Company's construction expenditures which are expected to be $1.3 billion.\nSales of securities will be undertaken during the 1995-1997 period as needed to meet the Company's capital requirements, to meet a total of $211 million of long-term debt maturities and to provide funds for the early retirement of high cost securities if such retirements are determined to be appropriate in the light of market conditions and other factors. The Company expects to issue $180 million of common stock in 1995 through its DRIP and a public sale of common stock. In addition, the Company expects to arrange for the refinancing of $55 million of higher cost tax-exempt securities issued to provide pollution control and solid waste disposal facilities at the Company's generating stations.\nThe Company's ability to issue securities during the 1995-1997 period is not expected to be limited by earnings or other issuance tests. To enhance financing flexibility, a $250 million revolving credit arrangement is maintained with a group of banks and is used principally as a back-up for the Company's commercial paper and $45 million in credit arrangements are maintained with a group of banks to provide back-up for the Company's commercial paper and short-term borrowings of certain subsidiaries. No borrowings were outstanding at December 31, 1994 under these arrangements.\nAllowance for Funds Used During Construction\nThe AFUDC, a non-cash credit to income, accounted for about 6.1% of earnings in 1994. The amount of AFUDC recorded will depend on the timing and level of construction work in progress as well as the rate treatment afforded the capital expenditures required to comply with the clean air legislation. Under current Pennsylvania law, construction work in progress for certain non-revenue producing assets, such as capital expenditures for pollution control equipment, can be claimed in rate base.\nFinancial Indicators\nDue to one-time charges to income in 1994, several financial indicators decreased from 1993. The Company earned an 8.73% return on average common equity during 1994, down from the 13.06% earned in 1993. The ratio of the Company's pre-tax income to interest charges decreased from 3.3 in 1993 to 2.7 in 1994. Excluding these one-time charges, the return on average common equity and the ratio of pre-tax income to interest charges in 1994 would have been 12.53% and 3.1, respectively. See \"Earnings\" on page 28. The Company increased common stock dividends from an annual per share rate of $1.65 in 1993 to $1.67 in 1994. The book value per share of common stock decreased 1.0% from $15.95 at the end of 1993 to $15.79 at the end of 1994. The ratio of the market price to book value of common stock was 120% at the end of 1994 compared with 169% at the end of 1993.\nClean Air Legislation and Other Environmental Matters\nThe Federal Clean Air Act Amendments of 1990 deal, in part, with acid rain under Title IV, attainment of federal ambient ozone standards under Title I, and toxic air emissions under Title III. The acid rain provisions specify Phase I sulfur dioxide emission limits for about 55% of the Company's coal-fired generating capacity by January 1995, and more stringent Phase II sulfur dioxide emission limits for all of the Company's fossil-fueled generating units by January 2000.\nThe Company's capital costs of compliance with the Phase I requirements under Title IV are included in the table of \"Capital Expenditure Requirements\" on page 35. The Company may also incur operating expenses not reflected therein, and may choose to limit the generation of certain units and to bank or trade emission allowances among its generating units or with other utilities, to the extent permitted by the legislation.\nTo meet the Phase II acid rain sulfur dioxide emission standards, the Company may install flue gas desulfurization equipment (FGD) on up to 60% of its coal-fired generating capacity, purchase lower sulfur coal, and bank or trade emission allowances among its generating units or with other utilities to the extent permitted by the legislation. The exact mix of lower sulfur fuel, emission allowance purchases, sales or trades, and the amount and timing of FGD will be based on FGD installation costs, fuel cost and availability and emission allowance prices.\nThe ambient ozone attainment provisions contained in Title I of the legislation require all major stationary sources within the Northeast Ozone Transport Region (which includes all of Pennsylvania) to install reasonably available control technology (RACT) for nitrogen oxides emissions by May 1995. The Company has complied with this requirement. The associated capital costs are included in the table of \"Capital Expenditure Requirements\" on page 35.\nFurther ozone reductions may be required as a result of modeling of nitrogen oxides and volatile organic compounds emissions in the Northeast Ozone Transport Region. A two-phase nitrogen oxides reduction from pre- Clean Air Act levels has been proposed for the area where the Company's plants are located -- a 55% reduction by May 1999 and a 75% reduction by 2003 -- unless scientific studies to be completed by 1997 indicate a different reduction. The reductions would be required during a five-month ozone season from May through September.\nIn addition to acid rain and ambient ozone attainment provisions, the legislation requires the Environmental Protection Agency (EPA) to conduct a study of hazardous air emissions from power plants. EPA is also studying the health effects of fine particulates which are emitted from power plants and other sources. Adverse findings from either study could cause the EPA to mandate additional ultra high efficiency particulate removal baghouses or specialized flue gas scrubbing to remove certain vaporous trace metals and certain gaseous emissions.\nIn addition to the \"Capital Expenditure Requirements\" shown on page 35, the Company currently estimates that additional capital expenditures and operating costs for environmental compliance will be incurred beyond 1997. Capital expenditures that may be required and the additional revenue required to recover these costs, based on 1994 revenues, are as follows: Capital Cost Revenue ($ millions) Requirement Phase II acid rain 1998-2005 $300-500 3.0% Nitrogen oxides and ambient ozone by: 1999 80 0.5% 2003 150 1.3% Hazardous air emissions by 2000 310 1.8%\nCollectively, these costs represent a potential capital exposure of up to $1.0 billion beyond 1997, as well as additional operating costs in amounts which are not now determinable but could be material.\nThe Pennsylvania Air Pollution Control Act implements the Federal Clean Air Act Amendments of 1990. The state legislation essentially requires that new state air emission standards be no more stringent than federal standards. This legislation has no effect on the Company's plans for compliance with the Federal Clean Air Act Amendments of 1990.\nThe PUC's policy regarding the trading and usage of, and the ratemaking treatment for, emission allowances by Pennsylvania electric utilities provides, among other things, that the PUC will not require approval of specific transactions and the cost of allowances will be recognized as energy-related power production expenses and recoverable through the ECR.\nThe Pennsylvania Department of Environmental Resources (DER) regulations governing the handling and disposal of industrial (or residual) solid waste require the Company to submit detailed information on waste generation, minimization and disposal practices. They also require the Company to upgrade and repermit existing ash basins at all of its coal- fired generating stations by applying updated standards for waste disposal. Ash basins that cannot be repermitted are required to close by July 1997. Any groundwater contamination caused by the basins must also be addressed. Any new ash disposal facility must meet the rigid site and design standards set forth in the regulations. In addition, the siting of future facilities at Company facilities could be affected.\nTo address the DER regulations, the Company plans to install dry fly ash handling systems at the Brunner Island, Sunbury and Holtwood stations. The Company, with siting assistance from a public advisory group, has chosen mine sites at which to use the dry fly ash from the Sunbury and Holtwood stations for reclamation. In addition, the Company is exploring opportunities to beneficially use coal ash from Brunner Island in various roadway construction projects in the vicinity of the plant that may delay or preclude the need for a new disposal facility.\nGroundwater degradation related to fuel oil leakage from underground facilities and seepage from coal refuse disposal areas and coal storage piles has been identified at several Company generating stations. Many requirements of the DER regulations address these groundwater degradation issues. The Company has reviewed its remedial action plans with the DER. Remedial work is substantially completed at one generating station, and remedial work may be required at others.\nThe DER regulations to implement the toxic control provisions of the Federal Water Quality Act of 1987 and to advance Pennsylvania's toxic control program authorize the DER to use both biomonitoring and a water quality based chemical-specific approach in the National Pollutant Discharge Elimination System (NPDES) permits to control toxics. In 1993, the Company received new NPDES permits for the Montour and Holtwood stations. The Montour permit contains very stringent limits for certain toxic metals and increased monitoring requirements. More toxic reduction studies will be conducted at Montour before the permit limits become effective. Additional water treatment facilities may be needed at Montour, depending on the results of the studies.\nAt Holtwood, toxics are required to be monitored at the fly ash basin until its closure in 1997. No limits have been set at this time. The Company will therefore comply with an implementation schedule for such closure and for construction of a new dry fly ash handling system at Holtwood. The closure of the Holtwood fly ash basin will require changes to the facility's existing waste water treatment system. Improvements and upgrades are being planned for the Sunbury and Brunner Island waste water treatment systems to meet the anticipated permit requirements.\nCapital expenditures through 1997, to comply with the residual waste regulations, correct groundwater degradation at fossil-fueled generating stations and address waste water control at Company facilities, are included in the \"Capital Expenditure Requirements\" on page 35. The Company currently estimates that about $77 million of additional capital expenditures could be required beyond 1997. Actions taken to correct groundwater degradation, to comply with the DER's regulations and to address waste water control are also expected to result in increased operating costs in amounts which are not now determinable but could be material.\nThe Company has been discussing with the DER the issue of potential polychlorinated biphenyl (PCB) contamination at certain of the Company's substations and pole sites. In addition, the Company at one time owned and operated a number of coal gas manufacturing facilities, all of which were later sold. During their operation, these gas plants produced waste byproducts, some amount of which may still remain at the plant sites. Also, oil and\/or other contamination may exist at some of the Company's former generating facilities. As a current or past owner\/operator of these sites, the Company may be liable under the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (Superfund), or other laws for the costs associated with addressing any hazardous substances at these sites.\nIn early 1995 the Company expects to finalize a negotiated Consent Order with the DER to address a number of these sites where remediation may be necessary or desirable. The sites will be prioritized based upon a number of factors, including any human health or environmental risk posed by the site, the public's interest in the site, and the Company's plans for the site. Under the Consent Order, the Company will not be required by DER to spend more than $5 million per year on investigation and remediation at those sites covered by the Consent Order.\nAt December 31, 1994, the Company had accrued $8.3 million, representing the amount the Company can reasonably estimate it will have to spend to remediate sites involving the removal of hazardous or toxic substances including those covered by the Consent Order mentioned above. The Company is involved in several other sites where it may be required, along with other parties, to contribute to such remediation. Some of these sites have been listed by the EPA under Superfund, and others may be candidates for listing at a future date. Future cleanup or remediation work at sites currently under review, or at sites currently unknown, may result in material additional operating costs which the Company cannot estimate at this time. In addition, certain federal and state statutes, including Superfund and the Pennsylvania Hazardous Sites Cleanup Act, empower certain governmental agencies, such as the EPA and the DER, to seek compensation from the responsible parties for the lost value of damaged natural resources. The EPA and the DER may file such compensation claims against the parties, including the Company, held responsible for cleanup of such sites. Such natural resource damage claims against the Company could result in material additional liabilities.\nConcerns have been expressed by some members of the scientific community and others regarding the potential health effects of electric and magnetic fields (EMF). These fields are emitted by all devices carrying electricity, including electric transmission and distribution lines and substation equipment. Federal, state and local officials are focusing increased attention on this issue. The Company is actively participating in the current research effort to determine whether or not EMF causes any human health problems and is taking steps to reduce EMF, where practical, in the design of new transmission and distribution facilities. The Company is unable to predict what effect the EMF issue might have on Company operations and facilities.\nIn complying with statutes, regulations and actions by regulatory bodies involving environmental matters, including the areas of water and air quality, hazardous and solid waste handling and disposal and toxic substances, the Company may be required to modify, replace or cease operating certain of its facilities. The Company may also incur material capital expenditures and operating expenses in amounts which are not now determinable.\nUranium Enrichment Decontamination and Decommissioning Fund\nThe Energy Policy Act of 1992 (Energy Act) established the Uranium Enrichment Decontamination and Decommissioning Fund (Fund) and provides for an assessment on domestic utilities with nuclear power operations, including the Company. Assessments are based on the amount of uranium a utility had processed for enrichment prior to enactment of the Energy Act and are expected to be paid to the Fund by such utilities over a 15-year period. Amounts paid to the Fund are to be used for the ultimate decontamination and decommissioning of the Department of Energy's uranium enrichment facilities. The Energy Act states that the assessment shall be deemed a necessary and reasonable current cost of fuel and shall be fully recoverable in rates in all jurisdictions in the same manner as the utility's other fuel costs.\nAs of December 31, 1994, the Company's recorded liability for its total assessment amounted to about $31.5 million. The liability is subject to adjustment for inflation. The corresponding charge to expense was deferred because the Company includes its annual payments to the Fund in the ECR which is in the Company's PUC tariffs and in the fuel adjustment clause which is in the Company's FERC tariffs. As a result, the assessment does not affect net income.\nPostretirement Benefits Other Than Pensions and Postemployment Benefits\nIn January 1993, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS 106 establishes new rules for accounting for the costs of postretirement benefits other than pensions. The statement requires accrual, during the years that the employees render the necessary service, of the expected cost of providing those benefits. Caps have been established on the amount the Company will pay for retiree health care costs for all employees who retire after March 1993. See \"Rate Matters\" on page 13 for additional information on postretirement benefit issues.\nThe Company provides health and life insurance benefits to disabled employees and income benefits to eligible spouses of deceased employees. In December 1993, the Company adopted SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" which requires the Company to accrue, during the years that the employees render the necessary service, the expected cost of providing benefits to former or inactive employees after employment but before retirement. The adoption of SFAS 112 did not have a material effect on the Company's net income. Postemployment benefits charged to operating expenses were $2.1 million, $6.5 million and $1.0 million for 1994, 1993 and 1992, respectively.\nWrite Down of Coal Reserves\nIn connection with a review by the Company of its non-core business assets performed in 1994, a subsidiary of the Company initiated an evaluation of the carrying value of its $83.5 million investment in undeveloped coal reserves in western Pennsylvania. The Company had acquired these reserves in 1974 through the subsidiary with the intent to supply future coal-fired generating stations. The Company has concluded that it would not develop such reserves as a source of fuel for its generating stations.\nThis evaluation of the carrying value of the subsidiary's investment in such reserves was completed by outside appraisal firms and indicated that an impairment had occurred. Accordingly, the carrying value of this investment was written down to its estimated net realizable value of $9.8 million. This write down resulted in an after-tax charge to income of $40 million in the fourth quarter of 1994, which reduced 1994 earnings by approximately 26 cents per share of common stock.\nIncreasing Competition\nThe electric utility industry, including the Company, has experienced and will continue to experience a significant increase in the level of competition in the energy supply market. The Energy Act is having a significant impact on the Company and the electric utility industry, primarily through amendments to the Public Utility Holding Company Act of 1935 (PUHCA) that create a new class of independent power producers, and amendments to the Federal Power Act that open access to electric transmission systems for wholesale transactions. In response to this increased competition, the Company has undertaken strategic initiatives to strengthen its position in the market.\nMarket Initiatives\nThe Company entered into new five-year supply agreements at reduced prices with its existing wholesale customers. In addition, the Company is actively participating in negotiations and proceedings involving the sale of electricity to wholesale customers currently served by other electric utilities. These wholesale customers are generally small utilities that do not have their own generating capability and purchase electricity from others.\nWhile there is currently no comparable competition in the retail electric market, the Company anticipates that it will face similar competitive pressures in the industrial and large commercial sectors of that market in the future.\nThe Company has received PUC approval to enter into negotiated rates (\"flexible rates\") with certain industrial and commercial customers and also provide real time pricing rates on a three-year experimental basis to certain industrial and commercial customers. The flexible rate initiative will enable the Company to negotiate rates with new and existing commercial and industrial customers that have competitive alternatives to purchasing electricity from the Company. Rates could be negotiated between a ceiling of full costs and a floor of variable costs of production. The real time pricing initiative will enable the Company to offer to large commercial and industrial customers rates based upon the Company's hourly cost of generation. The Company will select a maximum of 25 large industrial customers to participate in the real time pricing project.\nAs the electric utility industry moves toward increased competition, the Company has developed initiatives that would make its steam electric stations more efficient and better able to compete in an environment of market-based pricing of electricity. Included in the proposed initiatives are measures to decrease annual operation and maintenance costs and reduce capital expenditures. In addition, the Company has developed initiatives to achieve longer refueling cycles, reduce the duration of refueling outages and reduce costs at the Susquehanna station.\nRestructuring\nThe Company also has initiated a restructuring of its utility operations, to better position itself for the competitive future. The organization moved from a geographic to a functional organization and physical workers were consolidated in a new mobile work force. The new organization replaces the Company's five geographic operating divisions with three new departments, based on services provided to customers. Electrical Systems is responsible for designing, maintaining and operating the facilities that transmit and deliver electricity to customers; Customer Services is responsible for customer inquiries and billing; and Marketing and Economic Development is responsible for marketing electric heat and other applications to residential customers, providing energy services to industrial and commercial customers, and community activities.\nOngoing department-level re-engineering efforts are expected to continue to impact the size of the Company's workforce. The redesigned work is expected to require fewer employees. Although no specific targets have been set, the Company currently expects that employment levels may decline to the 6,000 to 6,500 level over the next three years. The Company may incur additional costs as a result of these workforce reductions.\nVoluntary Early Retirement Program\nIn conjunction with the announcement of the corporate restructuring, the Company offered a voluntary early retirement program to 851 employees who were age 55 or older by December 31, 1994. A total of 640 employees elected to retire under the program, at a total cost of $75.9 million. Prior to the early retirement program, the Company had about 7,600 employees. The early retirement program provided for a lump sum payment based on an employee's years of service, no reduction in retirement benefits for age and supplemental monthly payments. The Company recorded the cost of the program as a one-time charge in the fourth quarter of 1994, which, after income taxes, reduced net income by $43.4 million, or 28 cents per share of common stock. A portion of the costs applicable to the voluntary early retirement program will be recovered through power contract billings. Annual savings in operating expenses associated with this reduction in employees are estimated to be approximately $35 million.\nThe Company's PUC base rate filing reflects an estimate of the savings from the early retirement program and seeks recovery of the cost of the program over a five-year period. To the extent that the PUC permits recovery of the cost of the program in rates, the Company will record a credit to income to recognize the income effect related to the recoverable portion of the charge recorded in 1994.\nNew Markets\nThe Company's strategic initiatives also include an assessment of entering power-related businesses outside of the Company's service territory, both domestically and in foreign countries. Any expansion by the Company into these areas would be methodical and deliberate. To take advantage of these new business opportunities, the Company has decided to pursue the formation of a holding company structure, subject to the receipt of appropriate regulatory approvals and, ultimately, shareowner approval at the 1995 annual meeting.\nIn March 1994, the Company incorporated a new subsidiary, Power Markets Development Company (PMD), and made an initial investment of $50 million in this new subsidiary. PMD will help the Company take advantage of new opportunities in the building and operation of power plants in North America and elsewhere. Other subsidiaries will be formed to take advantage of new business opportunities.\nIn connection with the formation of the holding company structure, the Company filed the requisite applications for approval with the PUC, the FERC, the Securities and Exchange Commission (SEC) and the Nuclear Regulatory Commission (NRC). The FERC, the NRC and the PUC approvals have been obtained, while the SEC application remains pending. The PUC approval is subject to certain conditions, which are not expected to materially restrict the Company's entry into unregulated business activities.\nRegulatory Developments\nIn light of the increased competition in the electric utility market, in June 1994 FERC issued a Notice of Proposed Rulemaking (NOPR) regarding recovery of stranded costs. In general, the FERC has proposed that utilities should address stranded cost recovery in all of their contracts with wholesale customers and that the states should address the issue of retail stranded costs. The NOPR also provides different treatment for stranded costs related to wholesale contracts which were existing prior to the date of the proposed rule and those executed after that date. The proposed rule defines wholesale stranded costs as \"....any legitimate, prudent and verifiable costs incurred by a public utility or a transmitting utility to provide service to a wholesale requirements customer that subsequently becomes, in whole or in part, an unbundled transmission services customer of that public utility or transmitting utility.\" For contracts executed after the date of the proposed rule, utilities will not be allowed to seek recovery of stranded costs except through explicit stranded cost provisions, such as exit fee provisions, contained in their contracts and may not seek recovery of stranded costs through any transmission rates. For contracts executed prior to the date of issuance of the proposed rule, the FERC has proposed a three-year transition period in which utilities are required to renegotiate their wholesale requirements contracts which do not already contain stranded cost provisions, to include such provisions. The NOPR also provides guidance on the conditions a utility must demonstrate to the FERC in order to be allowed recovery of stranded costs.\nIn addition, in May 1994 the PUC ordered an investigation to examine the role of competition in Pennsylvania's electric utility industry. The investigation will allow the PUC to solicit input regarding the potential impact of competition on the state's electric utilities and their customers. The investigation, which will gather and analyze data at both the wholesale and retail levels of the electric utility industry, will be a paper proceeding conducted over approximately one year. Interested parties have the opportunity to file written comments addressing the following specific topics: wheeling - issues and impact, consumer issues, safety and reliability, the impact of market structure changes and legal issues.\nThe Company has submitted comments in response to both the FERC NOPR and the PUC order.\nWith respect to stranded costs, the Company has three general categories of costs whose recovery may depend to a large degree on the transition rules established to introduce increased competition in the industry. One category is the investment in utility plant, principally generating facilities, that might not be fully recoverable if electricity is based on market pricing. The second category consists of regulatory assets, or costs that have been deferred, whose recovery is based solely on continued cost-based rate regulation. The third category represents purchase power agreements where the price being paid may exceed the market price for electricity.\nThe Company has exposure to each of these categories of potential stranded costs to varying degrees and may not be able to fully recover them if the price of electricity is no longer subject to cost-based rate regulation. However, the Company cannot predict to what extent, if any, it may not be able to fully recover its costs if the price of electricity is no longer subject to cost-based rate regulation.\nIndependent Auditors' Report\nDeloitte & Touche\nPennsylvania Power & Light Company:\nWe have audited the accompanying consolidated balance sheets and statements of preferred and preference stock and long-term debt of Pennsylvania Power & Light Company and its subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, shareowners' common equity, and cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedules listed in the Index at Item 8 and in the Exhibit Index as Exhibit 99. These financial statements and the 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 the Pennsylvania Power & Light Company and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, the 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 7 to the consolidated financial statements, in 1994 the Company changed its method of accounting for certain investments in debt and equity securities to conform with Statement of Financial Accounting Standards Number 115.\n(Signed) Deloitte & Touche Parsippany, New Jersey February 3, 1994\nManagement's Report on Responsibility for Financial Statements\nThe management of Pennsylvania Power & Light Company is responsible for the preparation, integrity and objectivity of the consolidated financial statements and all other sections of this annual report. The financial statements were prepared in accordance with generally accepted accounting principles and the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission. In preparing the financial statements, management makes informed estimates and judgments of the expected effects of events and transactions based upon currently available facts and circumstances. Management believes that the financial statements are free of material misstatement and present fairly the financial position, results of operations and cash flows of the Company.\nThe Company's consolidated financial statements have been audited by Deloitte & Touche LLP (Deloitte), independent certified public accountants, whose report with respect to the financial statements appears on page 47. Deloitte's appointment as auditors was previously ratified by the shareowners. Management has made available to Deloitte all the Company's financial records and related data, as well as the minutes of shareowners' and directors' meetings. Management believes that all representations made to Deloitte during its audit were valid and appropriate.\nThe Company maintains a system of internal control designed to provide reasonable, but not absolute, 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 concept of reasonable assurance recognizes that the cost of a system of internal control should not exceed the benefits derived and that there are inherent limitations in the effectiveness of any system of internal control.\nFundamental to the control system is the selection and training of qualified personnel, an organizational structure that provides appropriate segregation of duties, the utilization of written policies and procedures and the continual monitoring of the system for compliance. In addition, the Company maintains an internal auditing program to evaluate the Company's system of internal control for adequacy, application and compliance. Management considers the internal auditors' and Deloitte's recommendations concerning its system of internal control and has taken actions which are believed to be cost-effective in the circumstances to respond appropriately to these recommendations. Management believes that the Company's system of internal control is adequate to accomplish the objectives discussed in this report.\nThe Board of Directors, acting through its Audit Committee, oversees management's responsibilities in the preparation of the financial statements. In performing this function, the Audit Committee, which is composed of five independent directors, meets periodically with management, the internal auditors and the independent certified public accountants to review the work of each. The independent certified public accountants and the internal auditors have free access to the Audit Committee and to the Board of Directors, without management present, to discuss internal accounting control, auditing and financial reporting matters.\nManagement also recognizes its responsibility for fostering a strong ethical climate so that the Company's affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in the Company's Standards of Integrity, which is publicized throughout the Company. The Standards of Integrity addresses: the necessity of ensuring open communication within the Company; potential conflicts of interest; proper procurement activities; compliance with all applicable laws, including those relating to financial disclosure; and the confidentiality of proprietary information. The Company maintains a systematic program to assess compliance with these policies.\n(signed) William F. Hecht\nWilliam F. Hecht Chairman, President and Chief Executive Officer\n(signed) R. E. Hill\nR. E. Hill Senior Vice President - Financial\nNOTES TO FINANCIAL STATEMENTS\n1. Summary of Significant Accounting Policies\nAccounting Records\n\tAccounting records for utility operations are maintained in accordance with the Uniform System of Accounts prescribed by the Federal Energy Regulatory Commission (FERC) and adopted by the Pennsylvania Public Utility Commission (PUC).\nRegulation\n\tThe Company prepares its financial statements in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" SFAS 71 requires a rate-regulated entity to reflect the effects of regulatory decisions in its financial statements. In accordance with SFAS 71, the Company has deferred certain costs pursuant to the rate actions of the PUC and the FERC and is recovering or expects to recover such costs in electric rates charged to customers. These deferred costs or \"regulatory assets\" are enumerated and discussed in Note 9.\n\tThe Company's base rate filing with the PUC discussed in Note 3 includes claims for recovery of certain of these costs. To the extent that the Company concludes that recovery of a regulatory asset is no longer probable, due to regulatory treatment, the effects of competition or other factors, the amount would have to be written off against income.\nPrinciples of Consolidation\n\tAll wholly owned subsidiaries (principally involved in oil pipeline operations, conducting unregulated business activities, passive financial investments and holding coal reserves) have been consolidated in the accompanying financial statements and all significant intercompany transactions have been eliminated. Income and expenses of subsidiaries not related to utility operations have been classified under other income and deductions on the Consolidated Statement of Income.\n\tThe investment in Safe Harbor Water Power Corporation (Safe Harbor), of which the Company owns one-third of the outstanding capital stock representing one-half of the voting securities, is recorded using the equity method of accounting. The Company's principal transaction with Safe Harbor is the purchase of electricity amounting to (millions of dollars): 1994, $9.6; 1993, $9.9 and 1992, $9.4. Under equity accounting, the operations of Safe Harbor resulted in additional income to the Company of (millions of dollars): 1994, $2.2; 1993, $2.1 and 1992, $2.1.\nUtility Plant and Depreciation\n\tAdditions to utility plant and replacement of units of property are capitalized at cost. The cost of units of property retired or replaced is removed from utility plant accounts and charged to accumulated depreciation. Expenditures for maintenance and repairs of property and the cost of replacing items determined to be less than units of property are charged to operating expense.\n\tFor financial statement purposes, depreciation is being provided over the estimated useful lives of property and is computed using a straight- line method for all property except for property placed in service prior to January 1, 1989 at the nuclear-fueled Susquehanna steam electric station. Current PUC and FERC rate orders provide for an increasing amount of annual depreciation for property placed in service prior to January 1, 1989 at the Susquehanna station through 1998, at which time depreciation will change to the straight-line method. Provisions for depreciation, as a percent of average depreciable property, approximated 3.5% in 1994, 3.3% in 1993 and 3.2% in 1992.\nUtility Plant Carrying Charges\n\tCarrying charge accruals on certain facilities for the Susquehanna and Martins Creek stations are recorded as deferred debits in accordance with a FERC order. These amounts are being amortized to expense over the remaining lives of the stations.\nNuclear Decommissioning and Fuel Disposal\n\tAn annual provision for the Company's share of the future decommissioning of the Susquehanna station, equal to the amount allowed for ratemaking purposes, is charged to operating expense. Such amounts are invested in trust funds which can be used only for future decommissioning costs. See Note 6.\n\tThe U.S. Department of Energy (DOE) is responsible for the permanent storage and disposal of spent nuclear fuel removed from nuclear reactors. The Company currently pays DOE a fee for future disposal services and recovers such costs in customer rates.\nFinancial Investments and Marketable Securities\n\tIn January 1994, the Company adopted 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 and for all investments in debt securities.\n\tSecurities subject to the requirements of SFAS 115 are carried at fair value, determined at the balance sheet date. Net unrealized gains and losses on available-for-sale securities are included in common equity. Net unrealized gains and losses on trading securities are included in income. Net unrealized gains and losses on securities that are not available for unrestricted use by the Company due to regulatory or legal reasons are reflected in the related asset and liability accounts. Realized gains and losses on the sale of securities are recognized utilizing the specific cost identification method. The adoption of SFAS 115 did not have a material effect on the Company's net income. Investments in financial limited partnerships are accounted for using the equity method of accounting and venture capital investments are recorded at cost.\n\tFor years prior to 1994, marketable equity securities were carried at the lower of their aggregate cost or market value, determined at the balance sheet date. Noncurrent marketable debt securities were carried at amortized cost. Current marketable debt securities were carried at the lower of amortized cost or market value. See Note 7.\nPremium on Reacquired Long-Term Debt\n\tAs provided in the Uniform System of Accounts, the premium paid and expenses incurred to redeem long-term debt are deferred and amortized over the life of the new debt issue or the remaining life of the retired debt when the redemption is not financed by a new issue.\nAllowance for Funds Used During Construction\n\tAs provided in the Uniform System of Accounts, the cost of funds used to finance construction projects is capitalized as part of construction cost. The components of allowance for funds used during construction (AFUDC) shown on the Consolidated Statement of Income under other income and deductions and interest charges are non-cash items equal to the cost of funds capitalized during the period.\n\tAFUDC serves to offset on the Consolidated Statement of Income the interest charges on debt and dividends on preferred and preference stock incurred to finance construction. In addition, a return on common equity used to finance construction is imputed.\nCapital Leases\n\tLeased property capitalized on the Consolidated Balance Sheet is recorded at the present value of future lease payments and is amortized so that the total of interest on the lease obligation and amortization of the leased property equals the rental expense allowed for ratemaking purposes. See Note 8.\nRevenues\n\tElectric revenues are recorded based on the amounts of electricity delivered to customers through the end of each accounting period. This includes amounts customers will be billed for electricity delivered from the time meters were last read to the end of the respective period.\n\tThe Company's PUC tariffs contain an Energy Cost Rate (ECR) under which customers are billed an estimated amount for fuel and other energy costs. Any difference between the actual and estimated amount for such costs is collected from or refunded to customers in a subsequent period. Revenues applicable to ECR billings are recorded at the level of actual energy costs and the difference is recorded as payable to or receivable from customers.\n\tThe Company's PUC tariffs include a Special Base Rate Credit Adjustment (SBRCA) that currently credits retail customers' bills for three nonrecurring items related to: (i) the use of an inventory method of accounting for certain power plant spare parts; (ii) the sale of capacity and related energy from the Company's wholly owned coal-fired stations to Atlantic City Electric Company (Atlantic); and (iii) the proceeds from a settlement of outstanding contract claims arising from construction of the Susquehanna station.\n\tThe Company reflects changes in certain state taxes through a State Tax Adjustment Surcharge (STAS). See Note 3.\nIncome Taxes\n\tThe Company and its wholly owned subsidiaries file a consolidated federal income tax return. Income taxes are allocated to operating expenses and other income and deductions on the Consolidated Statement of Income.\n\tIn January 1993, the Company adopted SFAS 109, \"Accounting for Income Taxes.\" SFAS 109 required a change from the deferred method to the asset and liability method of accounting for income taxes. See Note 5.\n\tThe provision for deferred income taxes included on the Consolidated Statement of Income is based upon the ratemaking principles reflected in rates established by the PUC and FERC. The difference in the provision for deferred income taxes determined under SFAS 109 and the amount recorded based on ratemaking procedures adopted by the PUC and FERC is deferred and included in taxes recoverable through future rates on the Consolidated Balance Sheet. See Note 5.\n\tInvestment tax credits were deferred when utilized and are amortized over the average lives of the related property.\nPension Plan and Other Postretirement and Postemployment Benefits\n\tThe Company has a noncontributory pension plan covering substantially all employees, and subsidiary companies formerly engaged in coal mining have a noncontributory pension plan for substantially all non-bargaining, full-time employees. Funding is based upon actuarially determined computations that take into account the amount deductible for income tax purposes and the minimum contribution required under the Employee Retirement Income Security Act of 1974.\n\tIn January 1993, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" SFAS 106 requires the Company to accrue, during the years that the employees render the necessary service, the expected cost of providing retiree health care and life insurance benefits.\n\tIn December 1993, the Company adopted SFAS 112, \"Employers' Accounting for Postemployment Benefits.\" SFAS 112 requires the accrual of the expected cost of providing benefits to former or inactive employees after employment but before retirement.\n\tFor additional information on these matters, see Note 11.\nCash Equivalents\n\tThe Company considers all highly liquid debt instruments purchased with original maturities of three months or less to be cash equivalents. Reclassification\n\tCertain amounts from prior years' financial statements have been reclassified to conform to the current year presentation.\n2. Sources of Revenues\n\tThe Company is an operating electric utility serving about 1.2 million customers in a 10,000 square-mile territory of central eastern Pennsylvania with a population of approximately 2.6 million persons. Substantially all of the Company's operating revenues are derived from the sale of electric energy subject to PUC and FERC regulation. Customers are generally billed for electric service on a monthly basis after electricity is delivered.\n\tDuring 1994, about 98% of total operating revenues were derived from electric energy sales, with 35% coming from residential customers, 28% from commercial customers, 20% from industrial customers, 11% from contractual sales to other major utilities, 3% from energy sales to members of the Pennsylvania-New Jersey-Maryland Interconnection Association (PJM), and 3% from others. The Company's largest industrial customer provided about 1.4% of revenues from energy sales during 1994. Twenty-six industrial customers, whose billings exceeded $3 million each, provided about 7.1% of such revenues. Industrial customers are broadly distributed among industrial classifications.\n3. Rate Matters\nBase Rate Filing with the PUC\n\tIn December 1994, the Company filed a request with the PUC for a $261 million increase in electric base rates, an 11.7% increase in PUC- jurisdictional rates. Various parties have filed complaints against the rate increase including the Office of Consumer Advocate (OCA), the PUC's Office of Trial Staff (OTS) and a group of industrial customers. In January 1995, the PUC suspended the request for investigation and hearings. A final rate decision is not expected until late September 1995.\n\tSeveral items included in the rate filing relate to the Company's Susquehanna station. The Company currently uses a modified sinking fund method of depreciation for property placed in service at Susquehanna prior to January 1989, which results in substantial increases in annual depreciation expense each year until 1999. At that time, annual depreciation expense is scheduled to decline by about $90 million to the amount that would have been recorded if a straight-line method of depreciation had been in effect since the in-service dates of the units. The Company is seeking to levelize this depreciation expense at an annual amount of about $173 million over the period October 1995 through December 1998, which would eliminate the currently scheduled increases in depreciation during that time period.\n\tThe Company also is seeking recovery, over a 10-year period, of certain deferred operating and capital costs, net of energy savings, incurred from the time the Susquehanna units were placed in service until the effective dates of the rate increases for those units. These costs, which were deferred in accordance with PUC orders, total about $39 million including related deferred income taxes.\n\tWhen the PUC decided the Company's last rate case in 1985, it determined that the Company had excess generating capacity and disallowed a return on the common equity investment in Susquehanna Unit 2. The Company's generating reserves have declined over the past 10 years and are projected to be below the level considered excess by the PUC in 1985. Accordingly, the Company's rate increase request also reflects a return on its common equity investment in Susquehanna Unit 2.\n\tAdditionally, the Company is requesting an $18 million increase in the amount it collects from customers for the estimated cost to decommission the Susquehanna station. This increase reflects a site-specific decommissioning study completed in late 1993 which indicates that the Company's 90 percent share of the cost to decommission Susquehanna will be about $724 million, an amount substantially greater than the amount currently reflected in rates.\n\tThe Company also is requesting to collect about $43 million annually for the estimated cost of dismantling its fossil-fuel plants at the end of their expected useful lives.\n\tThe rate request also seeks recovery of the full amount of retiree health care costs being recorded in accordance with SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" including the amount the Company began to defer as of January 1993 pursuant to a PUC order but subsequently charged to expense due to a decision by the Commonwealth Court of Pennsylvania that reversed the PUC order. The charge to expense in 1994 amounted to $22.9 million, which included $10.8 million applicable to 1993.\n\tThe filing also requests shortening the depreciation lives of certain coal-fired generating stations by up to twelve years and lengthening the depreciation lives of certain transmission, distribution and other property.\n\tThe Company is seeking recovery of the costs related to the voluntary early retirement program over a 5-year period, as discussed in Note 12. The rate filing reflects an estimate of the savings from the early retirement program. To the extent that the PUC permits recovery of the cost of the program in rates, the Company will record a credit to income to reverse the recoverable portion of the charge recorded in the fourth quarter of 1994.\n\tThe Company has also proposed a method of recovering costs currently being billed to other utilities pursuant to contractual arrangements for the sale of capacity and related energy to those utilities. These contracts begin to phase-out in 1996, and the Company has proposed to recover the costs associated with the returning capacity through the ECR. Under the proposal, the ECR would be adjusted automatically each year as capacity is returned pursuant to the contracts. In this way, customer rates, through ECR billings, will reflect both the capital-related and operating costs associated with the returning capacity. The Company's proposal provides for all the revenues associated with sales of any returning capacity or related energy to be flowed through the ECR for the benefit of customers.\nEnergy Cost Rate Issues\n\tIn April 1994, the PUC reduced the Company's 1994-95 ECR claim by approximately $15.7 million to reflect costs associated with replacement power during a portion of the period that Unit 1 of the Company's Susquehanna station was out of service for refueling and repairs. As a result of the PUC's action, the Company recorded a charge against income in the first quarter of 1994 for the $15.7 million of unrecovered replacement power costs. This charge adversely affected net income by about $9.0 million or 6 cents per share of common stock.\n\tThe Company filed a complaint with the PUC objecting to the decision to exclude these replacement power costs from the 1994-95 ECR and subsequently reached a settlement with the complainants and the OTS on this matter.\n\tThe PUC approved the settlement agreement on February 24, 1995. As a result of the PUC Order, the Company, in the first quarter of 1995, will record a credit to income of $9.7 million which would increase net income by about $5.5 million or 4 cents per share of common stock.\n\tIn October 1994, the PUC issued an order approving the settlement agreement the Company reached in January 1994 with the OCA and certain industrial customers concerning the 1990-91 ECR through the 1993-94 ECR. The PUC order resolved all complaints against those ECRs, and required the Company to credit the 1994-95 ECR with a one-time adjustment for a portion of the receipts from installed capacity credit sales made from April 1990 through December 31, 1993 and also provided that about one-third of the receipts from installed capacity credit sales made after December 31, 1993 will be credited through future ECRs. These capacity credit sales are discussed in Notes 3 and 4. The PUC order also provided that a portion of the PUC-jurisdictional amount of deferred retired miners' health care benefits costs, which the Company sought to recover through the ECR, will not be recoverable.\n\tAs a result of the settlement agreement, in the fourth quarter of 1993 the Company recorded a charge to expense of $17.1 million, which reduced 1993 net income by approximately $9.7 million or 6 cents per share of common stock.\nPostretirement Benefits Other Than Pensions\n\tPursuant to a PUC order, the Company had been deferring the increase in retiree benefits costs arising from adoption of SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" beginning January 1, 1993 until such costs were included in customer rates in the Company's next retail base rate proceeding. Accounting rules permit deferral of the costs for about five years.\n\tThe OCA appealed the PUC's decision permitting deferral and future recovery of the increased retiree benefits costs to the Commonwealth Court of Pennsylvania. In May 1994, the Commonwealth Court reversed the PUC order and held that the Company could not defer these costs. As a result, in the second quarter of 1994, the Company began expensing the increased costs applicable to operations that would have otherwise been deferred and wrote off the costs deferred from January 1, 1993. The PUC and the Company requested the Pennsylvania Supreme Court to hear an appeal of the Commonwealth Court decision. See Note 11.\nUranium Enrichment Decontamination and Decommissioning Fund\n\tThe Energy Policy Act of 1992 (Energy Act) provides for an assessment, over a 15-year period, on utilities with nuclear power operations, including the Company, to provide funds for the decontamination and decommissioning of DOE's uranium enrichment facilities.\n\tAs of December 31, 1994, the Company's liability for its total assessment amounted to about $31.5 million. The liability is subject to adjustment for inflation. The corresponding charge to expense was deferred and is being amortized as the Company recovers its annual payments from customers. As a result, the assessment does not affect net income.\nSpecial Base Rate Credit Adjustment\n\tThe SBRCA has been in effect since April 1, 1991 and currently reduces PUC-jurisdictional customers' bills for the effects of three nonrecurring items. The first item is the annual amortization over a five-year period of a credit to income associated with the Company's use of an inventory method of accounting for power plant spare parts beginning January 1, 1991.\n\tThe second relates to costs that are being recovered from Atlantic pursuant to the sale of 125,000 kilowatts of capacity (summer rating) and related energy from the Company's wholly owned coal-fired stations beginning October 1, 1991. The costs recovered from Atlantic are currently reflected in PUC base rate tariffs. Accordingly, the Company included a credit in the SBRCA for the costs, except energy costs, recovered from Atlantic. The change in energy costs associated with the sale is reflected in the ECR.\n\tThe third relates to the proceeds from the settlement of outstanding contract claims arising from construction of the Susquehanna station. In accordance with approval of the settlement by the PUC, the Company began on April 1, 1992 to return the settlement proceeds to PUC customers through the SBRCA at the rate of $11 million per year for five years. In addition, the proceeds from the settlement applicable to FERC-jurisdictional and other major utilities are being credited to those customers.\n\tThe SBRCA reduced revenues from PUC customers by about $45.4 million in 1994, $44.5 million in 1993 and $39.1 million in 1992. The reductions in revenues due to the SBRCA do not affect the Company's net income.\nRefund of State Tax Decrease\n\tIn June 1994, legislation was enacted that decreased the state corporate net income tax rate from 12.25% to 11.99% retroactive to January 1, 1994, with further reductions to 10.99%, 10.75% and 9.99% in 1995, 1996 and 1997, respectively. In accordance with the terms of its tariffs, the Company filed with the PUC a recomputation of its STAS to reflect the decrease in state income taxes for 1994. The application of the STAS reflecting the 1994 tax decrease began in July 1994 and is expected to reduce customer bills through March 1995 by about $1.5 million.\nFERC-Jurisdictional Rates\n\tThe Company has entered into five year sales contracts with certain small utilities the Company currently serves, which reduced rates to these small utilities by about $3.3 million in 1994 and will reduce rates by about an additional $4.1 million in 1996. In connection with these agreements, in the fourth quarter of 1993 the Company wrote off the deferred portions of retired miners' health care benefits costs and postretirement benefits other than pensions applicable to FERC- jurisdictional customers. The charge to expense amounted to $8.9 million, which reduced 1993 net income by $5.1 million or 3 cents per share of common stock.\n4. Sales to Other Major Electric Utilities\n\tThe Company provides Atlantic with 125,000 kilowatts of capacity (summer rating) and related energy from the Company's wholly owned coal- fired stations. Sales to Atlantic will continue through September 2000. The Company also provides Baltimore Gas & Electric (BG&E) with 129,000 kilowatts or 6.6 percent of the Company's share of capacity and related energy from the Susquehanna station. Sales to BG&E will continue through May 2001.\n\tThe Company provides Jersey Central Power and Light Company (JCP&L) with 945,000 kilowatts of capacity and related energy from all the Company's generating units. Sales to JCP&L will continue at the 945,000 kilowatt level through 1995, with the amount then declining uniformly each year until the end of the agreement on December 31, 1999.\n\tThese agreements provide that sales are to be made at a price equal to the Company's cost of providing service, which includes a return on the Company's investment in generating capacity. Revenues from these sales totaled $286.3 million in 1994, $282.2 million in 1993 and $293.8 million in 1992.\n\tThe Company has also sold capacity credits to other electric utilities in the PJM from the Company's system capacity. These capacity credits are used by the other utilities to meet their installed capacity obligations in the PJM. The price received for these sales is based on a percentage of the rate the utilities would have paid to purchase installed capacity under the PJM agreement. These sales are currently being made under short-term arrangements and it is uncertain how this market will continue to develop. The Company includes, as a credit to the ECR, about one-third of the receipts from these sales.\n\tThe Company has entered into arrangements with several utilities both inside and outside the PJM for the reservation of output from any of the Company's steam generating stations during certain periods of time. Specific deliveries of energy are requested by the purchasing utility as needed during the reservation period. One utility has agreed to purchase a maximum of 10 megawatt hours per hour of the output the Company purchases from non-utility generating companies through May 1995. The Company includes as a credit to the ECR, the revenue received for deliveries of energy under reservation of output sales, the revenue received for deliveries of output from non-utility generating companies and the foregone PJM energy savings that were not realized when PJM energy sales are reduced because of reservation agreements.\n\tArrangements also have been entered into whereby PJM utilities can purchase a portion of the Company's entitlement to use the PJM transmission system to import energy from utilities outside the PJM. These transactions are made through negotiated prices for various periods of time. The Company includes, as a credit to the ECR, the foregone PJM energy savings that are not realized when the sale of transmission entitlements reduces the amount of energy the Company imports and sells to other utilities.\n\tRevenues from the sale of capacity credits, the reservation of output from generating units and the sale of transmission entitlements (net of the amount that is credited to customers through the ECR) totaled $28.7 million in 1994 and $35.0 million in both 1993 and 1992. For information relating to a settlement agreement between the Company and complainants to the ECR with respect to capacity-related sales, see Note 3.\n5. Taxes\n\tIn January 1993, the Company adopted SFAS 109, \"Accounting for Income Taxes.\" SFAS 109 required a change from the deferred method to the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred income tax assets and liabilities are recognized for the tax consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amount and the tax bases of existing assets and liabilities.\n\tUnder SFAS 109, the Company in January 1993 recorded an increase of approximately $1.1 billion in its deferred tax liability for tax benefits previously flowed through to customers and for other temporary differences. The increased tax liability was offset by a corresponding asset representing the future revenue expected through the ratemaking process to pay for the taxes, based on the established regulatory practices and legislative history in Pennsylvania permitting recovery of actual taxes payable. The adoption of SFAS 109 did not have a material effect on the Company's net income.\n\tIn August 1993, federal legislation was enacted that increased the corporate federal income tax rate to 35% from 34% retroactive to January 1, 1993. For 1993, the Company recorded additional income tax expense of $5.9 million and an increase in deferred income tax liabilities and taxes recoverable through future rates of $79.5 million to reflect the new tax rate.\n\tIn June 1994, state legislation was enacted that decreased the state corporate net income tax rate from 12.25% to 11.99% retroactive to January 1, 1994, with further reductions to 10.99%, 10.75% and 9.99% in 1995, 1996 and 1997, respectively. For 1994, the Company recorded a decrease in income tax expense of $0.8 million, substantially all of which will be reflected in lower customer rates through the STAS. The Company also recorded a decrease in deferred income tax liabilities and taxes recoverable through future rates of $124.0 million to reflect the new tax rates.\n\tThe tax effects of significant temporary differences comprising the Company's net deferred income tax liability were as follows (thousands of dollars):\nDecember 31 1994 1993 Deferred tax assets Deferred investment tax credits $ 94,650 $ 103,084 Accrued pension costs 67,327 38,821 Other 107,830 108,441 Valuation allowance (8,183) (8,694) 261,624 241,652 Deferred tax liabilities Electric utility plant - net 1,790,378 1,892,366 Other property - net 13,829 26,629 Taxes recoverable through future rates 409,417 500,959 Reacquired debt costs 46,934 43,580 Other 20,355 35,120 2,280,913 2,498,654 Net deferred tax liability $2,019,289 $2,257,002\n\tIn 1993, the valuation allowance related to deferred tax assets decreased $2.9 million from $11.6 million established upon the adoption of SFAS 109 at January 1, 1993.\n\tDetails of the components of income tax expense and a reconciliation of federal income taxes derived from statutory tax rates applied to income from continuing operations for accounting purposes are as follows (thousands of dollars):\nIncome Tax Expense 1994 1993 1992 Included in operating expenses Provision - Federal $198,777 $162,795 $144,546 State 76,903 63,508 64,648 275,680 226,303 209,194 Deferred - Federal (34,177) 22,491 30,654 State (11,021) (124) 2,521 (45,198) 22,367 33,175 Investment tax credit, net - Federal (12,253) (13,506) (14,029) 218,229 235,164 228,340 Included in other income and deductions Provision (credit) - Federal (18,453) (5,134) 676 State (7,309) 486 483 (25,762) (4,648) 1,159 Deferred - Federal (8,688) 4,047 (441) State (4,197) (679) (396) (12,885) 3,368 (837) (38,647) (1,280) 322\nTotal income tax expense - Federal 125,206 170,693 161,406 State 54,376 63,191 67,256 $179,582 $233,884 $228,662\nDetail of deferred taxes in operating expenses Tax depreciation $ (2,133) $ 33,195 $ 38,026 Pension and early retirement costs (28,176) (4,602) (5,341) Other (14,889) (6,226) 490 $(45,198) $ 22,367 $ 33,175\nReconciliation of Income Tax Expense Indicated federal income tax on pre-tax income at statutory tax rate (1994, 35%; 1993, 35%; 1992, 34%) $148,373 $203,704 $195,631 Increase (decrease) due to: State income taxes 35,017 41,829 44,575 Depreciation differences not normalized 14,883 8,470 6,805 Amortization of investment tax credit (12,253) (13,506) (14,029) AFUDC (Note 1) (1,640) (2,794) (2,302) Other (4,798) (3,819) (2,018) 31,209 30,180 33,031 Total income tax expense $179,582 $233,884 $228,662 Effective income tax rate 42.4% 40.2% 39.7%\nTaxes, other than income, consist of the following (thousands of dollars):\nTaxes, Other Than Income State gross receipts $ 99,311 $ 98,280 $ 94,926 State utility realty 46,556 45,292 48,511 State capital stock 34,739 35,943 37,279 Social security and other 20,555 24,452 24,602 $201,161 $203,967 $205,318\n6. Nuclear Decommissioning Costs\n\tThe Company's most recent estimate of the cost to decommission the Susquehanna nuclear-fueled generating station was completed in 1993 and was a site-specific study, based on immediate dismantlement and decommissioning each unit following final shutdown. The study indicates that the Company's ninety percent share of the total estimated cost of decommissioning the Susquehanna station is approximately $724 million in 1993 dollars. The operating licenses for Units 1 and 2 expire in 2022 and 2024, respectively. The estimated cost includes decommissioning the radiological portions of the station and the cost of removal of nonradiological structures and materials.\n\tDecommissioning costs charged to operating expense were $7.2 million in 1994, and $6.9 million in 1993 and 1992 and are based upon amounts included in customer rates. Decommissioning costs included in PUC- jurisdictional customer rates are based upon estimates developed in 1985 and are substantially lower than the level needed to recover the cost estimates in the 1993 site-specific study. In its pending base rate filing, the Company has requested an $18 million annual increase in the amount it collects from PUC-jurisdictional customers for decommissioning costs. Rates charged to other small utilities reflect the estimated cost of decommissioning in the 1993 study.\n\tAmounts collected from customers for decommissioning, less applicable taxes, are deposited in external trust funds for investment and can be used only for future decommissioning costs. The market value of securities held and accrued income in the trust funds at December 31, 1994 and 1993 aggregated approximately $87.5 and $82.9 million, respectively. The trust funds experienced a net loss in 1994 of $2.3 million on a fair value basis, which includes unrealized depreciation in the value of securities of $6.7 million. The net loss reduced the trust fund balance and accrued nuclear plant decommissioning costs recognized on the Company's Consolidated Balance Sheet at December 31, 1994. The net loss of the trust funds excludes the recognition by the Company of unrealized appreciation in the value of securities in the trust funds on January 1, 1994 of $5.9 million in connection with the adoption of SFAS 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" Recognition of the unrealized appreciation at January 1, 1994 increased the balance in the trust funds and accrued nuclear plant decommissioning costs recognized on the Company's Consolidated Balance Sheet.\n\tThe Financial Accounting Standards Board is currently reviewing the accounting for removal costs, including decommissioning of nuclear power plants. As a result, current electric utility industry accounting practices for decommissioning may change, including the possibility that the estimated cost for decommissioning could be recorded as a liability on a basis other than an accrual over the estimated life of the power plant.\n7. Financial Instruments\n\tThe fair value of investments including securities subject to the requirements of SFAS 115 at December 31, 1994 on the Consolidated Balance Sheet was (thousands of dollars):\nNuclear Marketable Financial Decommissioning Aggregate Securities(a) Investments(b) Trust Fund(c)\nTrading securities $ 12,302 $ 12,302 Available-for-sale securities: Equity securities 11,268 9,113 $ 2,155 Debt securities 215,189 79,122 51,502 $84,565 Total available- for-sale 226,457 88,235 53,657 84,565 Total trading and available-for-sale 238,759 100,537 53,657 84,565 Other investments 68,900 65,975 2,925 $307,659 $100,537 $119,632 $87,490\n\tAvailable-for-sale securities at amortized cost consisted of the following (thousands of dollars):\nNuclear Marketable Financial Decommissioning Aggregate Securities(a) Investments(b) Trust Fund(c)\nDebt-U.S. Government $ 27,436 $ 3,414 $24,022 Debt - Municipals 187,873 75,919 $ 52,373 59,581 Debt - Other 1,656 1,656 216,965 79,333 52,373 85,259 Common Stock 9,572 9,113 459 $226,537 $88,446 $ 52,832 $85,259\n\tMaturities of debt securities included in available-for-sale securities consisted of the following (thousands of dollars):\nNuclear Marketable Financial Decommissioning Aggregate Securities(a) Investments(b) Trust Fund(c)\nFair Value Within 1 year $ 80,773 $79,122 $ 1,651 1-5 years 29,824 $10,353 19,471 5-10 years 46,455 11,450 35,005 over 10 years 58,137 29,699 28,438 $215,189 $79,122 $51,502 $84,565\nAmortized Cost Within 1 year $ 80,989 $79,333 $ 1,656 1-5 years 29,935 $10,658 19,277 5-10 years 46,364 11,771 34,593 over 10 years 59,677 29,944 29,733 $216,965 $79,333 $52,373 $85,259\n\tUnrealized gains and losses on available-for-sale securities at December 31, 1994 were (thousands of dollars):\nNuclear Marketable Financial Decommissioning Aggregate Securities(a) Investments(b) Trust Fund(c)\nUnrealized holding gains $3,582 $ 1 $2,363 $1,218\nUnrealized holding losses $3,663 $ 212 $1,539 $1,912\n\tNet unrealized gains on available-for-sale securities included in common equity at December 31, 1994 amounted to $0.3 million after applicable income taxes. The net unrealized loss on trading securities included in income for 1994 was $0.2 million.\n\tRealized gains and losses on the sale of securities are based on the specific cost identification method. The proceeds from sales and maturities and the gross realized gains and losses for 1994 were (thousands of dollars):\nNuclear Marketable Financial Decommissioning Aggregate Securities(a) Investments(b) Trust Fund(c)\nProceeds from sales and maturities $224,453 $149,384 $28,101 $46,968 Gross realized gains $ 398 $ 48 $ 350 Gross realized losses $ 676 $ 4 $ 672\n_____________________ (a)\tIncluded in the amount shown as Current Assets-Marketable Securities on the Consolidated Balance Sheet. (b)\tIncluded in the amount shown as Investments-Financial Investments on the Consolidated Balance Sheet. (c)\tIncluded in the amount shown as Nuclear Plant Decommissioning Trust Funds on the Consolidated Balance Sheet. Realized and unrealized gains and losses are reflected in the related asset and liability accounts.\n\tThe carrying amount and the estimated fair value of the Company's financial instruments are as follows (thousands of dollars):\nDecember 31, 1994 December 31, 1993\nCarrying Fair Carrying Fair Amount Value Amount Value Assets Nuclear plant decommissioning trust funds (a) $ 87,490 $ 87,490 $ 76,913 $ 82,860 Financial investments (b) 119,632 118,501 149,326 155,237 Other investments (c) 8,654 8,654 7,805 7,805 Cash and cash equivalents (c) 10,079 10,079 8,271 8,271 Marketable securities (d) 100,537 100,537 17,792 16,791 Other financial instruments included in other current assets (c) 2,435 2,435 3,102 3,102 Liabilities Preferred stock with sinking fund requirements (e) 295,000 265,275 335,000 336,388 Long-term debt (e) 2,940,789 2,756,131 2,662,570 2,843,635 Commercial paper and bank loans (c) 74,168 74,168 202,260 202,260 Taxes and interest accrued, dividends payable and other liabilities included in other current liabilities (c) 187,367 187,367 219,505 219,505 Accrued nuclear assessment -- noncurrent (c) 31,522 31,522 31,871 31,871 __________________ (a) The fair value generally is based on established market prices. For a minor portion, the fair value approximates the carrying amount. (b) The fair value is based on established market prices. For venture capital investments included in financial investments, fair value is determined in good faith by management of the venture capital entity. (c) The fair value approximates carrying amount. (d) The fair value is based on established market prices. (e) The fair value is based on quoted market prices for the securities where available and estimates based on current rates offered to the Company where quoted market prices are not available.\n\tFinancial investments as shown on the Consolidated Balance Sheet consisted of the following (thousands of dollars):\nDecember 31 1994 1993\nMarketable equity securities $ 23,570 (a) $ 11,196 (b) Marketable debt securities 130,624 (a) 84,337 (c) Financial limited partnerships 60,739 (e) 65,378 (e) Venture capital investments 5,236 (b) 6,207 (b) 220,169 167,118 Less marketable securities included in current assets 100,537 (a) 17,792 (d) Total $119,632 $149,326 _____________\n(a) At fair value (b) At cost (c) At amortized cost (d) At the lower of amortized cost or market value (e) At equity\n\tThe fair value of marketable equity securities and marketable debt securities at December 31, 1993 was (thousands of dollars) $13,337 and $88,594, respectively.\n8. Leases\n\tThe Company has entered into capital leases consisting of the following (thousands of dollars):\nDecember 31 1994 1993 Nuclear fuel, net of accumulated amortization (1994, $196,617; 1993, $191,812) $144,380 $173,395 Vehicles, oil storage tanks and other property, net of accumulated amortization (1994, $84,330; 1993, $83,224) 80,385 75,630 Net property under capital leases $224,765 $249,025\n\tCapital lease obligations incurred for the acquisition of nuclear fuel and other property were (millions of dollars): 1994, $62.0; 1993, $84.0 and 1992, $64.8.\n\tNuclear fuel lease payments, which are charged to expense as the fuel is used for the generation of electricity, were (millions of dollars): 1994, $71.8; 1993, $67.6 and 1992, $70.4. Future nuclear fuel lease payments will be based on the quantity of electricity produced by the Susquehanna station. The maximum amount of unamortized nuclear fuel leasable under current arrangements is $200 million.\n\tFuture minimum lease payments under capital leases in effect at December 31, 1994 (excluding nuclear fuel) would aggregate $96.7 million, including $16.3 million in imputed interest. During the five years ending 1999, such payments would decrease from $26.8 million per year to $7.1 million per year.\n\tInterest on capital lease obligations was recorded as operating expenses on the Consolidated Statement of Income in the following amounts (millions of dollars): 1994, $11.1; 1993, $9.1 and 1992, $10.5.\n\tGenerally, capital leases contain renewal options and obligate the Company to pay maintenance, insurance and other related costs. Various operating leases have also been entered into which are not material with respect to the Company's financial position.\n9. Regulatory Assets\n\tThe Company has deferred certain costs (regulatory assets) in accordance with the rate actions of the PUC and FERC and is recovering or expects to recover such costs in electric rates charged to customers. Regulatory assets consist of the following (thousands of dollars):\nDecember 31 1994 1993\nDeferred depreciation $ 256,021 $ 282,115 Deferred operating and carrying costs - Susquehanna 39,215 39,215 Utility plant carrying charges - net of amortization 23,142 24,097 Deferred refueling outage costs - Susquehanna 14,629 16,027 Reacquired debt costs 113,466 101,836 Taxes recoverable through future rates 986,292 1,166,118 Retired miners' health care benefits 14,536 24,096 Assessment for decommissioning uranium enrichment facilities 33,492 33,710 Postretirement benefits other than pensions 14,855\n$1,480,793 $1,702,069\n\tDeferred depreciation is the accumulated difference between the straight-line depreciation that would have been recorded on property placed in service at the Susquehanna station prior to January 1, 1989 and the amount of depreciation on such property provided for financial reporting purposes and included in rates. The annual difference is shown as amortized depreciation on the Consolidated Statement of Income.\n\tDeferred operating and carrying costs - Susquehanna consist of certain operating and capital costs, net of energy savings, associated with Units 1 and 2 at the Susquehanna station. The costs, deferred in accordance with orders from the PUC, were incurred from the date the units were placed in commercial operation until the effective dates of the rate increases reflecting operation of the units. The deferred costs include related deferred income taxes. See Note 3 for information on recovery of these costs. No return is being accrued on the deferred costs.\n\tUtility plant carrying charges were reclassified from electric utility plant in service to a deferred debit in accordance with a FERC order. Such charges are being amortized over the remaining depreciable lives of the related property and are included in PUC electric service rates.\n\tDeferred refueling outage costs - Susquehanna represent incremental maintenance costs incurred during refueling and inspection outages which are deferred and subsequently amortized from the cessation of the outage until the next scheduled refueling and inspection outage is completed. Such costs are included in electric service rates.\n\tReacquired debt costs represent premiums and expenses incurred in the redemption of long-term debt. In accordance with FERC regulations, reacquired debt costs are amortized over either the life of the refunding issue or the remaining life of the redeemed issue, as appropriate. The Company is seeking recovery of reacquired debt costs in its current base rate filing.\n\tFor a discussion of taxes recoverable through future rates, postretirement benefits other than pensions, retired miners' health care benefits and assessment for decommissioning uranium enrichment facilities, see Notes 3, 5 and 11.\n10. Credit Arrangements\n\tThe Company issues commercial paper and, from time to time, borrows from banks to provide short-term funds required for general corporate purposes. In addition, certain subsidiaries also borrow from banks to obtain short-term funds. Bank borrowings generally bear interest at rates negotiated at the time of the borrowing. The Company's weighted average interest rate on short-term borrowings was 6.1% and 3.4% at December 31, 1994 and 1993, respectively.\n\tIn 1994, the Company entered into a $250 million revolving credit arrangement with a group of banks in return for the payment of commitment fees which replaced a similar credit arrangement totaling $140 million. Any loans made under this credit arrangement would mature in September 1999 and, at the option of the Company, interest rates would be based upon certificate of deposit rates, Eurodollar deposit rates or the prime rate. The Company has additional credit arrangements with another group of banks in return for the payment of commitment fees. The banks have committed to lend the Company up to $45 million under these credit arrangements, which mature on November 2, 1995 at interest rates based upon Eurodollar deposit rates or the prime rate. These credit arrangements produce a total of $295 million of lines of credit to provide back-up for the Company's commercial paper and short-term borrowings of certain subsidiaries. No borrowings were outstanding at December 31, 1994 under these credit arrangements.\n\tThe Company leases its nuclear fuel from a trust funded by sales of commercial paper. The maximum financing capacity of the trust under existing credit arrangements is $200 million.\n\tCommitment fees incurred were (millions of dollars): 1994, $0.4; 1993, $0.3 and 1992, $0.4.\n11. Pension Plan and Other Postretirement and Postemployment Benefits\nPension Plan\n\tThe Company has a funded noncontributory defined benefit pension plan (Plan) covering substantially all employees. Benefits are based upon a participant's earnings and length of participation in the Plan, subject to meeting certain minimum requirements.\n\tThe Company also has two supplemental retirement plans for certain management employees and directors that are not funded. Benefit payments pursuant to these supplemental plans are made directly by the Company. At December 31, 1994, the projected benefit obligation of these supplemental plans was approximately $12.5 million.\n\tThe components of the Company's net periodic pension cost for the three plans were (thousands of dollars):\n1994 1993 1992\nService cost-benefits earned during the period $ 33,527 $ 31,381 $ 29,967 Interest cost 51,330 48,266 44,203 Actual return on plan assets 28,680 (92,085) (95,969) Net amortization and deferral (96,413) 29,696 40,251\nNet periodic pension cost $ 17,124 $ 17,258 $ 18,452\n\tThe net periodic pension cost charged to operating expenses was $9.9 million in 1994, $10.1 million in 1993 and $11.6 million in 1992. The balance was charged to construction and other accounts. The funded status of the Company's Plan was (thousands of dollars):\nDecember 31 1994 1993\nFair value of plan assets $888,214 $943,889 Actuarial present value of benefit obligations: Vested benefits 573,564 490,567 Nonvested benefits 1,396 1,543 Accumulated benefit obligation 574,960 492,110 Effect of projected future compensation 173,311 191,302 Projected benefit obligation 748,271 683,412\nPlan assets in excess of projected benefit obligation 139,943 260,477\nUnrecognized transition assets (being amortized over 23 years) (67,796) (72,316) Unrecognized prior service cost 61,941 34,240 Unrecognized net gain (288,105) (305,577)\nAccrued expense $(154,017) $(83,176)\n\tThe weighted average discount rate used in determining the actuarial present value of projected benefit obligations was 7.5% and 7.0% on December 31, 1994 and 1993, respectively. The rate of increase in future compensation used in determining the actuarial present value of projected benefit obligations was 5.7%, on December 31, 1994 and 1993. The assumed long-term rates of return on assets used in determining pension cost in 1994 and 1993 was 8.0%. Plan assets consist primarily of common stocks, government and corporate bonds and temporary cash investments.\n\tSubsidiary companies formerly engaged in coal mining have a noncontributory defined benefit pension plan covering substantially all non-bargaining, full-time employees which is fully funded, primarily by group annuity contracts with insurance companies. In addition, the companies are liable under federal and state laws to pay black lung benefits to claimants and dependents with respect to approved claims, and are members of a trust which was established to facilitate payment of such liabilities. Such costs were not material in 1994, 1993 and 1992.\nPostretirement Benefits Other Than Pensions\n\tSubstantially all employees of the Company and its subsidiaries will become eligible for certain health care and life insurance benefits upon retirement. The Company sponsors four health and welfare benefit plans that cover substantially all management and bargaining unit employees upon retirement. One plan provides for retiree health care benefits to certain management employees, another plan provides retiree health care benefits to bargaining unit employees, a third plan provides retiree life insurance benefits to certain management employees up to a specified amount and a fourth plan provides retiree life insurance benefits to bargaining unit employees.\n\tDollar limits have been established for the amount the Company will contribute annually toward the cost of retiree health care for employees retiring after March 1993.\n\tIn January 1993, the Company adopted SFAS 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which requires the Company to accrue, during the years that the employees render the necessary service, the expected cost of providing retiree health care and life insurance benefits. The adoption of SFAS 106 did not have a material effect on the Company's net income. In accordance with a PUC order, the Company deferred the PUC-jurisdictional accrued cost of retiree health and life insurance benefits in excess of actual claims paid pending recovery of the increased cost in retail rates. As a result of a decision of the Commonwealth Court, in 1994, the Company began expensing the increased costs applicable to operations that were previously being deferred and wrote off such costs deferred in 1993.\n\tIn December 1993, the Company established a separate Voluntary Employee Benefit Association trust (VEBA) for each of the four health and welfare benefit plans for retirees and adopted a funding policy that takes into account the maximum amount allowed as a deduction for federal income tax purposes. After making initial contributions, additional funding of the trusts was deferred pending resolution of the Company's ability to recover the costs of the plans in rates.\n\tLife insurance benefits for certain management employees beyond a specified amount are not funded through the VEBA for retiree life insurance benefits to management employees but are combined with the disclosures below for the health care and life insurance plans. The cost of retiree health care and life insurance benefits for officers of the Company are not material and are combined with the disclosures below for health care and life insurance plans.\n\tThe following table sets forth the plans' combined funded status reconciled with the amount shown on the Company's Consolidated Balance Sheet (thousands of dollars):\nDecember 31 1994 1993\nAccumulated postretirement benefit obligation: Retirees $ 124,484 $ 95,046 Fully eligible active plan participants 13,604 32,742 Other active plan participants 68,828 75,185 206,916 202,973 Plan assets at fair value, primarily temporary cash investments 23,506 14,848 Accumulated postretirement benefit obligation in excess of plan assets 183,410 188,125 Unrecognized net loss (13,770) (20,573) Unrecognized transition obligation (being amortized over 20 years) (156,448) (165,140)\nAccrued postretirement benefit cost $ 13,192 $ 2,412\n\tAt December 31, 1993, the plan that provides retiree health care benefits to certain management employees was unfunded; the amount included in the accumulated postretirement benefit obligation attributable to that plan was (thousands of dollars) $70,630.\n\tThe net periodic postretirement benefit cost included the following components (thousands of dollars):\n1994 1993\nService cost - benefits attributed to service during the period $ 4,286 $ 3,699 Interest cost on accumulated postretirement benefit obligation 14,189 13,008 Actual return on plan assets (435) Net amortization and deferral 7,645 8,691\nNet periodic postretirement benefit cost $ 25,685 $ 25,398\n\tRetiree health and benefits costs charged to operating expenses were approximately (millions of dollars): 1994, $27.2 (which includes $10.8 million of retiree health and benefits costs previously deferred in 1993) and 1993, $6.9. Costs in excess of the amount charged to expense were charged to construction and other accounts. In 1993, the increase in expenses due to the adoption of SFAS 106 was $2.3 million. The cost of retiree health and life insurance benefits recognized as expense by the Company and its subsidiaries in 1992 was approximately $5.5 million.\n\tFor measurement purposes, a 9% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1995; the rate was assumed to decrease gradually to 6% by 2006 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 December 31, 1994 by about $9.4 million and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year then ended by about $1.0 million.\n\tIn determining the accumulated postretirement benefit obligation, the weighted average discount rate used was 7.5% and 7.0% on December 31, 1994 and 1993, respectively. The trusts holding plan assets, except for retiree health care benefits to certain management employees, are tax-exempt. The expected long-term rate of return on plan assets for the tax-exempt trusts was 6.5% on December 31, 1994 and 1993.\n\tSubsidiary companies formerly engaged in coal mining had accrued $32 million for an estimated payment they expected to make for future retiree health care. However, the Energy Act imposed a new liability, currently estimated at about $58 million on a net present value basis, on the Company or its subsidiary coal-mining companies for the cost of health care of retired miners previously employed by those subsidiaries.\nPostemployment Benefits\n\tThe Company provides health and life insurance benefits to disabled employees and income benefits to eligible spouses of deceased employees. In December 1993, the Company adopted SFAS 112, \"Employers' Accounting for Postemployment Benefits,\" which requires the Company to accrue, during the years that the employees render the necessary service, the expected cost of providing benefits to former or inactive employees after employment but before retirement. The adoption of SFAS 112 did not have a material effect on the Company's net income. Postemployment benefits charged to operating expenses were $2.1 million, $6.5 million and $1.0 million for 1994, 1993 and 1992, respectively.\nEmployee Stock Ownership Plan\n\tThe Company has an Employee Stock Ownership Plan (ESOP) for all full- time employees having more than one year of service. Contributions to the ESOP had been funded with investment and payroll-based tax credits previously available to the Company under federal law to acquire shares of the Company's common stock. Contributions funded with these tax credits were completed in 1991. Since 1990, all dividends on shares credited to participants' accounts have been paid in cash. The Company deducts the amount of those dividends for income tax purposes and contributes to the ESOP shares having a cost equal to the tax savings resulting from that deduction and contribution.\n12. Voluntary Early Retirement Program\n\tAs part of its efforts to continue to reduce costs, the Company offered a voluntary early retirement program to 851 employees who were age 55 or older by December 31, 1994. A total of 640 employees elected to retire under the program, at a total cost of $75.9 million. The early retirement program provided for a lump sum payment based on an employee's years of service, no reduction in retirement benefits for age and supplemental monthly payments. The Company recorded the cost of the program as a charge against income in the fourth quarter of 1994, which reduced net income by $43.4 million, or 28 cents per share of common stock. Annual savings in operating expenses associated with this program are estimated to be approximately $35 million.\n\tThe Company's PUC base rate filing reflects an estimate of the savings from the early retirement program and seeks recovery of the cost of the program over a five-year period. To the extent that the PUC permits recovery of the cost of the program in rates, the Company will record a credit to income to recognize the income effect related to the recoverable portion of the charge recorded in 1994.\n13. Jointly Owned Facilities\n\tAt December 31, 1994, the Company or a subsidiary owned undivided interests in the following facilities (millions of dollars):\nMerrill ------Generating Stations----- Creek Susquehanna Keystone Conemaugh Reservoir\nOwnership interest 90.00% 12.34% 11.39% 8.37% Electric utility plant in service $4,015 $60 $91 Other property $22 Accumulated depreciation 697 29 26 6 Construction work in progress 56 2 7\n\tEach participant in these facilities provides its own financing. The Company receives a portion of the total output of the generating stations equal to its percentage ownership. The Company's share of fuel and other operating costs associated with the stations is reflected on the Consolidated Statement of Income. The Merrill Creek Reservoir provides water during periods of low river flow to replace water from the Delaware River used by the Company and other utilities in the production of electricity.\n14. Write Down of Coal Reserves\n\tIn connection with a review by the Company of its non-core business assets performed in 1994, a subsidiary of the Company initiated an evaluation of the carrying value of its $83.5 million investment in undeveloped coal reserves in western Pennsylvania. The Company had acquired these reserves in 1974 through the subsidiary in order to supply future coal-fired generating stations. The Company has concluded that it would not develop such reserves as a source of fuel for its generating stations.\n\tThis evaluation of the carrying value of the subsidiary's investment in such reserves was completed by outside appraisal firms and indicated that an impairment had occurred. Accordingly, the carrying value of this investment was written down to its estimated net realizable value of $9.8 million, resulting in a $73.7 million pre-tax charge to income. This write down resulted in an after-tax charge to income of $40 million in the fourth quarter of 1994, which reduced 1994 earnings by approximately 26 cents per share of common stock.\n15. Commitments and Contingent Liabilities\nConstruction Expenditures\n\tThe Company's construction expenditures are estimated to aggregate $387 million in 1995, $401 million in 1996 and $478 million in 1997, including AFUDC. For discussion pertaining to construction expenditures, see Review of the Company's Financial Condition and Results of Operations under the caption \"Financial Condition - Capital Expenditure Requirements\" (Capital Expenditure Requirements) on page 34.\nNuclear Operations\n\tThe Company is a member of certain insurance programs which provide coverage for property damage to members' nuclear generating stations. Facilities at the Susquehanna station are insured against property damage losses up to $3.6 billion under these programs. The Company is also a member of an insurance program which provides insurance coverage for the cost of replacement power during prolonged outages of nuclear units caused by certain specified conditions. Under the property and replacement power insurance programs, the Company could be assessed retrospective premiums in the event of the insurers' adverse loss experience. The maximum amount the Company could be assessed under these programs at December 31, 1994 was about $41.9 million.\n\tNuclear Regulatory Commission regulations require that in the event of an accident, where the estimated cost of stabilization and decontamination exceeds $100 million, proceeds of property damage insurance be segregated and used, first, to place and maintain the reactor in a safe and stable condition and, second, to complete required decontamination operations before any insurance proceeds would be made available to the Company or the trustee under the Mortgage. The Company's on-site property damage insurance policies for the Susquehanna station conform to these regulations.\n\tThe Company's public liability for claims resulting from a nuclear incident at the Susquehanna station is limited to about $8.9 billion under provisions of The Price Anderson Amendments Act of 1988 (the Act). The Company is protected against this liability by a combination of commercial insurance and an industry assessment program. A utility's liability under the assessment program will be indexed not less than once during each five- year period for inflation and will be subject to an additional surcharge of 5% in the event the total amount of public claims and costs exceeds the basic assessment. In the event of a nuclear incident at any of the reactors covered by the Act, the Company could be assessed up to $151 million per incident, payable at a rate of $20 million per year, plus the additional 5% surcharge, if applicable.\nFuel Oil Dealers' Litigation\n\tIn August 1991, a group of 21 fuel oil dealers in the Company's service area filed a complaint against the Company in United States District Court for the Eastern District of Pennsylvania (District Court) alleging that the Company's promotion of electric heat pumps and off-peak thermal storage systems, through the use of a special customer rate (Rate RTS) and incentives to builders and developers, had violated and continues to violate the federal antitrust laws. The complaint also alleged that the Company's use of incentives for the installation of high efficiency heat pumps violated and continues to violate the Racketeer Influenced and Corrupt Organizations Act (RICO).\n\tThe complaint requested judgment against the Company for a sum in excess of $10 million for the alleged antitrust violations, treble the damages alleged to have been sustained by the plaintiffs. Separately, the complaint requested judgment for a sum in excess of $10 million for the alleged RICO violations, treble the damages alleged to have been sustained by the plaintiffs. Finally, the complaint requested a permanent injunction against all activities found to be illegal (including the cash grant program described below).\n\tIn April 1992, a fuel oil dealer in the Company's service area filed a class action complaint against the Company in the District Court alleging, as did the August 1991 complaint, that the Company's promotion of electric heat pumps and off-peak thermal storage systems had violated and continues to violate the federal antitrust laws. The complaint did not allege any violation of RICO, but did allege that the Company engaged in a civil conspiracy and unfair competition in violation of Pennsylvania law.\n\tThe plaintiff sought to represent as a class all fuel oil dealers in the Company's service area. The complaint requested a permanent injunction against all activities found to be illegal and treble the damages alleged to have been sustained by the class. No specific damage amount was set forth in the complaint. This second antitrust complaint was consolidated with the August 1991 complaint for pre-trial purposes.\n\tIn September 1992, the Court granted the Company's motion for summary judgment and dismissed both suits filed against the Company. The plaintiffs appealed the decision to the United States Court of Appeals for the Third Circuit (Court of Appeals).\n\tIn April 1994, the Court of Appeals affirmed in part and reversed in part the District Court's decision. The Court of Appeals affirmed the District Court's grant of summary judgment for the Company as to the Company's use of Rate RTS and the Company's builder and developer incentives, but reversed and remanded as to plaintiffs' claims regarding the Company's alleged agreements with developers that their developments consist of only electrically heated units (all-electric agreements). The Court of Appeals also reversed and remanded the grant of summary judgment as to the state law claims related to such agreements.\n\tThe case is now proceeding in the District Court on the issue of the all-electric agreements and the related state law claims. In addition, in June 1994 plaintiffs filed an amended complaint in District Court alleging that the Company's former residential conversion program -- under which cash grants were offered to contractors and homeowners to convert from fossil fuel heating systems to electric systems -- also violated the federal antitrust laws.\n\tThe Company cannot predict the outcome of this litigation.\nClean Air Legislation and Other Environmental Matters\n\tThe Federal Clean Air Act Amendments of 1990 deal, in part, with acid rain under Title IV, attainment of federal ambient ozone standards under Title I, and toxic air emissions under Title III. The acid rain provisions specify Phase I sulfur dioxide emission limits for about 55% of the Company's coal-fired generating capacity by January 1995, and more stringent Phase II sulfur dioxide emission limits for all of the Company's fossil-fueled generating units by January 2000.\n\tThe Company's capital costs of compliance with the Phase I requirements under Title IV are included in the table of \"Capital Expenditure Requirements\" on page 35. The Company may also incur operating expenses not reflected therein, and may choose to limit the generation of certain units and to bank or trade emission allowances among its generating units or with other utilities, to the extent permitted by the legislation.\n\tTo meet the Phase II acid rain sulfur dioxide emission standards, the Company may install flue gas desulfurization equipment (FGD) on up to 60% of its coal-fired generating capacity, purchase lower sulfur coal, and bank or trade emission allowances among its generating units or with other utilities to the extent permitted by the legislation. The exact mix of lower sulfur fuel, emission allowance purchases, sales or trades, and the amount and timing of FGD will be based on FGD installation costs, fuel cost and availability and emission allowance prices.\n\tThe ambient ozone attainment provisions contained in Title I of the legislation require all major stationary sources within the Northeast Ozone Transport Region (which includes all of Pennsylvania) to install reasonably available control technology (RACT) for nitrogen oxides emissions by May 1995. The Company has complied with this requirement. The associated capital costs are included in the table of \"Capital Expenditure Requirements\" on page 34.\n\tFurther ozone reductions may be required as a result of modeling of nitrogen oxides and volatile organic compounds emissions in the Northeast Ozone Transport Region. A two-phase nitrogen oxides reduction from pre- Clean Air Act levels has been proposed for the area where the Company's plants are located -- a 55% reduction by May 1999 and a 75% reduction by 2003 -- unless scientific studies to be completed by 1997 indicate a different reduction. The reductions would be required during a five-month ozone season from May through September.\n\tIn addition to acid rain and ambient ozone attainment provisions, the legislation requires the Environmental Protection Agency (EPA) to conduct a study of hazardous air emissions from power plants. EPA is also studying the health effects of fine particulates which are emitted from power plants and other sources. Adverse findings from either study could cause the EPA to mandate additional ultra high efficiency particulate removal baghouses or specialized flue gas scrubbing to remove certain vaporous trace metals and certain gaseous emissions.\n\tIn addition to the \"Capital Expenditure Requirements\" shown on page 35, the Company currently estimates that additional capital expenditures and operating costs for environmental compliance will be incurred beyond 1997. Capital expenditures that may be required and the additional revenue required to recover these costs, based on 1994 revenues, are as follows: Capital Cost Revenue ($ millions) Requirement Phase II acid rain 1998-2005 $300-500 3.0% Nitrogen oxides and ambient ozone by: 1999 80 0.5% 2003 150 1.3% Hazardous air emissions by 2000 310 1.8%\n\tCollectively, these costs represent a potential capital exposure of up to $1.0 billion beyond 1997, as well as additional operating costs in amounts which are not now determinable but could be material.\n\tThe Pennsylvania Air Pollution Control Act implements the Federal Clean Air Act Amendments of 1990. The state legislation essentially requires that new state air emission standards be no more stringent than federal standards. This legislation has no effect on the Company's plans for compliance with the Federal Clean Air Act Amendments of 1990.\n\tThe PUC's policy regarding the trading and usage of, and the ratemaking treatment for, emission allowances by Pennsylvania electric utilities provides, among other things, that the PUC will not require approval of specific transactions and the cost of allowances will be recognized as energy-related power production expenses and recoverable through the ECR.\n\tThe Pennsylvania Department of Environmental Resources (DER) regulations governing the handling and disposal of industrial (or residual) solid waste require the Company to submit detailed information on waste generation, minimization and disposal practices. They also require the Company to upgrade and repermit existing ash basins at all of its coal- fired generating stations by applying updated standards for waste disposal. Ash basins that cannot be repermitted are required to close by July 1997. Any groundwater contamination caused by the basins must also be addressed. Any new ash disposal facility must meet the rigid site and design standards set forth in the regulations. In addition, the siting of future facilities at Company facilities could be affected.\n\tTo address the DER regulations, the Company plans to install dry fly ash handling systems at the Brunner Island, Sunbury and Holtwood stations. The Company, with siting assistance from a public advisory group, has chosen mine sites at which to use the dry fly ash from the Sunbury and Holtwood stations for reclamation. In addition, the Company is exploring opportunities to beneficially use coal ash from Brunner Island in various roadway construction projects in the vicinity of the plant that may delay or preclude the need for a new disposal facility.\n\tGroundwater degradation related to fuel oil leakage from underground facilities and seepage from coal refuse disposal areas and coal storage piles has been identified at several Company generating stations. Many requirements of the DER regulations address these groundwater degradation issues. The Company has reviewed its remedial action plans with the DER. Remedial work is substantially completed at one generating station, and remedial work may be required at others.\n\tThe DER regulations to implement the toxic control provisions of the Federal Water Quality Act of 1987 and to advance Pennsylvania's toxic control program authorize the DER to use both biomonitoring and a water quality based chemical-specific approach in the National Pollutant Discharge Elimination System (NPDES) permits to control toxics. In 1993, the Company received new NPDES permits for the Montour and Holtwood stations. The Montour permit contains very stringent limits for certain toxic metals and increased monitoring requirements. More toxic reduction studies will be conducted at Montour before the permit limits become effective. Additional water treatment facilities may be needed at Montour, depending on the results of the studies.\n\tAt Holtwood, toxics are required to be monitored at the fly ash basin until its closure in 1997. No limits have been set at this time. The Company will therefore comply with an implementation schedule for such closure and for construction of a new dry fly ash handling system at Holtwood. The closure of the Holtwood fly ash basin will require changes to the facility's existing waste water treatment system. Improvements and upgrades are being planned for the Sunbury and Brunner Island waste water treatment systems to meet the anticipated permit requirements.\n\tCapital expenditures through 1997, to comply with the residual waste regulations, correct groundwater degradation at fossil-fueled generating stations and address waste water control at Company facilities, are included in the \"Capital Expenditure Requirements\" on page 34. The Company currently estimates that about $77 million of additional capital expenditures could be required beyond 1997. Actions taken to correct groundwater degradation, to comply with the DER's regulations and to address waste water control are also expected to result in increased operating costs in amounts which are not now determinable but could be material.\n\tThe Company has been discussing with the DER the issue of potential polychlorinated biphenyl (PCB) contamination at certain of the Company's substations and pole sites. In addition, the Company at one time owned and operated a number of coal gas manufacturing facilities, all of which were later sold. During their operation, these gas plants produced waste byproducts, some amount of which may still remain at the plant sites. Also, oil and\/or other contamination may exist at some of the Company's former generating facilities. As a current or past owner\/operator of these sites, the Company may be liable under the Federal Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended (Superfund), or other laws for the costs associated with addressing any hazardous substances at these sites.\n\tIn early 1995 the Company expects to finalize a negotiated Consent Order with the DER to address a number of these sites where remediation may be necessary or desirable. The sites will be prioritized based upon a number of factors, including any human health or environmental risk posed by the site, the public's interest in the site, and the Company's plans for the site. Under the Consent Order, the Company will not be required by DER to spend more than $5 million per year on investigation and remediation at those sites covered by the Consent Order.\n\tAt December 31, 1994, the Company had accrued $8.3 million, representing the amount the Company can reasonably estimate it will have to spend to remediate sites involving the removal of hazardous or toxic substances including those covered by the Consent Order mentioned above. The Company is involved in several other sites where it may be required, along with other parties, to contribute to such remediation. Some of these sites have been listed by the EPA under Superfund, and others may be candidates for listing at a future date. Future cleanup or remediation work at sites currently under review, or at sites currently unknown, may result in material additional operating costs which the Company cannot estimate at this time. In addition, certain federal and state statutes, including Superfund and the Pennsylvania Hazardous Sites Cleanup Act, empower certain governmental agencies, such as the EPA and the DER, to seek compensation from the responsible parties for the lost value of damaged natural resources. The EPA and the DER may file such compensation claims against the parties, including the Company, held responsible for cleanup of such sites. Such natural resource damage claims against the Company could result in material additional liabilities.\n\tConcerns have been expressed by some members of the scientific community and others regarding the potential health effects of electric and magnetic fields (EMF). These fields are emitted by all devices carrying electricity, including electric transmission and distribution lines and substation equipment. Federal, state and local officials are focusing increased attention on this issue. The Company is actively participating in the current research effort to determine whether or not EMF causes any human health problems and is taking steps to reduce EMF, where practical, in the design of new transmission and distribution facilities. The Company is unable to predict what effect the EMF issue might have on Company operations and facilities.\n\tIn complying with statutes, regulations and actions by regulatory bodies involving environmental matters, including the areas of water and air quality, hazardous and solid waste handling and disposal and toxic substances, the Company may be required to modify, replace or cease operating certain of its facilities. The Company may also incur material capital expenditures and operating expenses in amounts which are not now determinable.\nOther \tAt December 31, 1994, the Company had guaranteed $11.7 million of obligations of Safe Harbor. The Company does not expect to fund the guarantee and has concluded that it is impractical to determine the fair value of the guarantee.\nSHAREOWNER AND INVESTOR INFORMATION\nThe following information is provided as a service to shareowners and other investors. For any questions you may have or additional information you may require about PP&L or your investments in the Company, please feel free to call the toll-free number listed below, or write to:\nGeorge I. Kline, Manager Investor Services Department Pennsylvania Power & Light Co. Two North Ninth Street Allentown, PA 18101-1179\nToll-Free Phone Number: For information regarding your investor account, or other inquiries, call toll-free: 800- 345-3085.\nAnnual Meeting: The annual meeting of shareowners is held each year on the fourth Wednesday of April. The 1995 annual meeting will be held at 1:30 p.m. on Wednesday, April 26, 1995, at Lehigh University's Stabler Arena, Lower Saucon Valley Goodman Campus Complex, Bethlehem, PA. A reservation card for meeting attendance is included with shareowners' proxy material.\nProxy Material: A proxy statement, a proxy and a reservation card for the Company's annual meeting are mailed in a package that includes the Company's Annual Report. This material was mailed to all shareowners of record as of February 28, 1995.\nDividends: For 1995, the dates the declaration of dividends is considered by the board or its executive committee are: February 22, May 24, August 23 and November 22, for payment on April 1, July 1 and October 1, 1995, and January 1, 1996, respectively. Dividend checks are mailed ahead of those dates with the intention that they arrive as close as possible to the payment dates.\nRecord Dates: The 1995 record dates for dividends are March 10, June 9, September 8 and December 8.\nDirect Deposit of Dividends: Shareowners may choose to have their dividend checks deposited directly into their checking or savings account. Quarterly dividend payments are electronically credited on the dividend date, or the first business day thereafter.\nDividend Reinvestment Plan: Shareowners may choose to have dividends on their common or preferred stocks reinvested in PP&L common stock instead of receiving the dividend by check.\nCertificate Safekeeping: Shareowners participating in the Dividend Reinvestment Plan may choose to have their common stock certificates forwarded to the Company for safekeeping. These shares will be registered in the name of the Company as agent for plan participants and will be credited to the participants' accounts.\nLost Dividend or Interest Checks: Dividend or interest checks lost by investors, or those that may be lost in the mail, will be replaced if the check has not been located by the 10th business day following the payment date.\nTransfer of Stock or Bonds: Stock or bonds may be transferred from one name to another or to a new account in the name of another person. Please call or write regarding transfer instructions.\nBondholder Information: Much of the information and many of the procedures detailed here for shareowners also apply to bondholders. Questions related to bondholder accounts should be directed to Investor Services.\nLost Stock or Bond Certificates: Please call or write to Investor Services for an explanation of the procedure to replace lost stock or bond certificates.\nPublications: Several publications are prepared each year and sent to all investors of record and to others who request their names be placed on our mailing lists. These publications are:\nAnnual Report -- published and mailed to all shareowners of record in mid-March.\nShareowners' Newsletter -- an easy-to-read newsletter containing current items of interest to shareowners -- published and mailed at the beginning of each quarter. Additionally, a special year-end edition containing unaudited results of the year's operations is mailed in early February.\nQuarterly Review -- published in May, August and November to provide quarterly financial information to investors.\nPeriodic Mailings: Letters from the Company regarding new investor programs, special items of interest, or other pertinent information are mailed on a non-scheduled basis as necessary.\nDuplicate Mailings: Annual reports and other investor publications are mailed to each investor account. If you have more than one account, or if there is more than one investor in your household, you may call or write to request that only one publication be delivered to your address. Please provide account numbers for all duplicate mailings.\nForm 10-K and PP&L Profile: The Company's annual report, filed with the Securities and Exchange Commission on Form 10-K, is available about mid-March. The PP&L Profile, a 10- year statistical review containing in-depth information about the Company, is available in May. Investors may obtain a copy of these publications, at no cost, by calling or writing to Investor Services.\nListed Securities: Fiscal Agents: New York Stock Exchange Stock Transfer Agents and Common Stock (Code: PPL) Registrars 4-1\/2% Preferred Stock First Chicago Trust Co. of (Code: PPLPRB) New York 4.40% Series Preferred Stock P.O. Box 2506 (Code: PPLPRA) Suite 4659 Jersey City, NJ 07303-2506\nPhiladelphia Stock Exchange Pennsylvania Power & Light Co. Common Stock Investor Services Department 4-1\/2% Preferred Stock Dividend Disbursing Office 3.35% Series Preferred Stock and Dividend Reinvestment 4.40% Series Preferred Stock Plan Agent 4.60% Series Preferred Stock Pennsylvania Power & Light Co. Investor Services Department Mortgage Bond Trustee Bankers Trust Co. Attn: Security Transfer Unit P.O. Box 291569 Nashville, TN 37229 Bond Interest Paying Agent Pennsylvania Power & Light Co. Investor Services Department\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nInformation for this item concerning directors of the Company will be set forth in the sections entitled \"Nominees for Directors\" and \"Directors Continuing in Office\" in the Company's 1995 Notice of Annual Meeting and Proxy Statement, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1994, and such information is incorporated herein by reference.\nInformation required by this item concerning the executive officers of the Company is set forth on pages 22 through 24 of this report.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nInformation for this item will be set forth in the sections entitled \"Compensation of Directors,\" \"Summary Compensation Table\" and \"Retirement Plans for Executive Officers\" in the Company's 1995 Notice of Annual Meeting and Proxy Statement, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1994, and such information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation for this item will be set forth in the section entitled \"Stock Ownership\" in the Company's 1995 Notice of Annual Meeting and Proxy Statement, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1994, and such information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation for this item will be set forth in the section entitled \"Certain Transactions Involving Directors or Executive Officers\" in the Company's 1995 Notice of Annual Meeting and Proxy Statement, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1994, and such 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 following documents are filed as part of this report:\n1. Financial Statements - included in response to Item 8.\nIndependent Auditors' Report Consolidated Statement of Income for the Three Years Ended December 31, 1994 Consolidated Statement of Cash Flows for the Three Years Ended December 31, 1994 Consolidated Balance Sheet at December 31, 1994 and 1993 Consolidated Statement of Shareowners' Common Equity for the Three Years Ended December 31, 1994 Consolidated Statement of Preferred and Preference Stock at December 31, 1994 and 1993 Consolidated Statement of Long-Term Debt at December 31, 1994 and 1993 Notes to Financial Statements\n2. Supplementary Data and Supplemental Financial Statement Schedule - included in response to Item 8.\nSchedule II - Valuation and Qualifying Accounts and Reserves for the Three Years Ended December 31, 1994\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.\n3. Exhibits\nExhibit Index on page 96.\n(b) Reports on Form 8-K:\nThe following Reports on Form 8-K were filed during the three months ended December 31, 1994:\nReport dated October 3, 1994\nItem 5. Other Events\nInformation regarding (l) the Company's early retirement program offer to eligible employees, and (2) an agreement in principle to settle the Company's proposed 1994-95 ECR proceeding.\nItem 7. Financial Statements, Pro Forma Financial Infor- mation and Exhibits.\nConformed copy of Sixty-second Supplemental Indenture related to the Company's issuance of First Mortgage Bonds, Pollution Control Series J, filed as an Exhibit to the Report on Form 8-K.\nConformed copy of Underwriting Agreement and Sixty-third Supplemental Indenture related to the Company's issuance of $200,000,000 principal amount of First Mortgage Bonds, 7.70% Series due 2009, filed as Exhibits to the Report on Form 8-K.\nConformed copy of Consent of Counsel.\nStatement of Eligibility of Trustee, filed due to the designation of Bankers Trust Company as Trustee under the Company's Mortgage and Deed of Trust, as successor to Morgan Guaranty Trust Company of New York.\nNo financial statements were required to be filed with the above referenced report.\nReport dated December 12, 1994\nItem 5. Other Events\nInformation regarding the write down of a Company subsidiary's undeveloped coal reserves to net realizable value.\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.\nPENNSYLVANIA POWER & LIGHT COMPANY (Registrant)\nBy (Signed) William F. Hecht William F. Hecht - 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 date indicated.\nTitle\nBy (Signed) William F. Hecht Principal Executive William F. Hecht - Chairman, President Officer and Director and Chief Executive Officer\nBy (Signed) R. E. Hill Principal Financial and R. E. Hill - Senior Vice President- Accounting Officer Financial\nBy (Signed) J. J. McCabe Chief Accounting J. J. McCabe - Controller Officer\nRichard S. Barton Jeffrey J. Burdge E. Allen Deaver Nance K. Dicciani William J. Flood Daniel G. Gambet Elmer D. Gates Directors Stuart Heydt Clifford L. Jones John T. Kauffman Robert Y. Kaufman Ruth Leventhal Francis A. Long Norman Robertson David L. Tressler\nBy (Signed) William F. Hecht William F. Hecht, Attorney-in-fact\nPENNSYLVANIA POWER AND LIGHT COMPANY\nEXHIBIT 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 Commission and pursuant to Rule 12(b)-32 are incorporated herein by reference. Exhibits indicated by a # are filed or listed pursuant to Item 601(b)(10)(iii) of Regulation S-K.\n3(i) - Copy of Restated Articles of Incorporation (Exhibit 3(i) to the Company's Form 8-K Report (File No. 1-905) dated January 26, 1994)\n3(i)-1 - Copy of Amendments to the Restated Articles of Incorporation (Exhibit 4(b) to the Company's Form 8-K Report (File No. 1-905) dated March 15, 1994)\n3(ii) - Copy of By-laws (Exhibit 3(ii) to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1993)\n4(a)-1 - Copy of Amended and Restated Employee Stock Ownership Plan, dated October 26, 1988 (Exhibit 4(b) to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1988)\n4(a)-2 - Copy of Amendment No. 1 to said Employee Stock Ownership Plan, effective January 1, 1989 (Exhibit 4(b)-2 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n4(a)-3 - Copy of Amendment No. 2 to said Employee Stock Ownership Plan, effective January 1, 1990 (Exhibit 4(b)-3 to the Company's Form 10-K Report (File No. 1 - 905) for the year ended December 31, 1989)\n4(a)-4 - Copy of Amendment No. 3 to said Employee Stock Ownership Plan, effective January 1, 1991 (Exhibit 4(b)-4 to the Company's Form 10-K Report (File No. 1 - 905) for the year ended December 31, 1990)\n4(a)-5 - Copy of Amendment No. 4 to said Employee Stock Ownership Plan, effective January 1, 1991 (Exhibit 4(a)-5 to the Company's Form 10-K Report (File No. 1 - 905) for the year ended December 31, 1991)\n4(a)-6 - Copy of Amendment No. 5 to said Employee Stock Ownership Plan, effective October 23, 1991 (Exhibit 4(a)-6 to the Company's Form 10-K Report (File No. 1 - 905) for the year ended December 31, 1991)\n4(a)-7 - Copy of Amendment No. 6 to said Employee Stock Ownership Plan, effective January 1, 1990 and January 1, 1992 (Exhibit 4(a)-7 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n4(a)-8 - Copy of Amendment No. 7 to said Employee Stock Ownership Plan, effective January 1, 1992 (Exhibit 4(a)-8 to the Company's Form 10-K Report (File No. 1 - 905) for the year ended December 31, 1991)\n4(a)-9 - Copy of Amendment No. 8 to said Employee Stock Ownership Plan, effective July 1, 1992 (Exhibit 4(a)-9 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1992)\n4(a)-10 - Copy of Amendment No. 9 to said Employee Stock Ownership Plan, effective January 1, 1993 (Exhibit 4(a)-10 to the Company's Form 10-K Report (File No. 1 - 905) for the year ended December 31, 1992)\n4(a)-11 - Copy of Amendment No. 10 to said Employee Stock Ownership Plan, effective January 1, 1993 (Exhibit 4(a)-11 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1993)\n*4(a)-12 - Copy of Amendment No. 11 to said Employee Stock Ownership Plan, effective January 1, 1994\n*4(a)-13 - Copy of Amendment No. 12 to said Employee Stock Ownership Plan, effective January 1, 1994\n*4(a)-14 - Copy of Amendment No. 14 to said Employee Stock Ownership Plan, effective January 1, 1989 and January 1, 1995\n4(b)-l - Mortgage and Deed of Trust, dated as of October l, 1945, between the Company and Guaranty Trust Company of New York (now Morgan Guaranty Trust Company of New York), as Trustee (Exhibit 2(a)-4 to Registration Statement No. 2-60291)\n4(b)-2 - Supplement, dated as of July 1, 1954, to said Mortgage and Deed of Trust (Exhibit 2(b)-5 to Registration Statement No. 219255)\n4(b)-3 - Supplement, dated as of June l, 1966, to said Mortgage and Deed of Trust (Exhibit 2(a)-l3 to Registration Statement No. 2-60291)\n4(b)-4 - Supplement, dated as of November 1, 1967, to said Mortgage and Deed of Trust (Exhibit 2(a)-14 to Registration Statement No. 2-60291)\n4(b)-5 - Supplement, dated as of January 1, 1969, to said Mortgage and Deed of Trust (Exhibit 2(a)-16 to Registration Statement No. 2-60291)\n4(b)-6 - Supplement, dated as of June 1, 1969, to said Mortgage and Deed of Trust (Exhibit 2(a)-17 to Registration Statement No. 2-60291)\n4(b)-7 - Supplement, dated as of February 1, 1971, to said Mortgage and Deed of Trust (Exhibit 2(a)-19 to Registration Statement No. 2-60291)\n4(b)-8 - Supplement, dated as of February 1, 1972, to said Mortgage and Deed of Trust (Exhibit 2(a)-20 to Registration Statement No. 2-60291)\n4(b)-9 - Supplement, dated as of January 1, 1973, to said Mortgage and Deed of Trust (Exhibit 2(a)-21 to Registration Statement No. 2-60291)\n4(b)-10 - Supplement, dated as of June 15, 1985, to said Mortgage and Deed of Trust (Exhibit 4(a)-35 to the Company's Form l0-K Report (File No. l-905) for the year ended December 31, 1985)\n4(b)-11 - Supplement, dated as of October 1, 1989, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated November 6, 1989)\n4(b)-12 - Supplement, dated as of July 1, 1991, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8- K Report (File No. 1-905) dated July 29, 1991)\n4(b)-13 - Supplement, dated as of May 1, 1992, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated June 1, 1992)\n4(b)-14 - Supplement, dated as of November 1, 1992, to said Mortgage and Deed of Trust (Exhibit 4(b)-29 to the Company's Form 10-K Report (File 1-905) for the year ended December 31, 1992)\n4(b)-15 - Supplement, dated as of February 1, 1993, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated February 16, 1993)\n4(b)-16 - Supplement, dated as of April 1, 1993, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated April 30,\n4(b)-17 - Supplement, dated as of June 1, 1993, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated July 7, 1993)\n4(b)-18 - Supplement, dated as of October 1, 1993, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated October 29, 1993)\n4(b)-19 - Supplement, dated as of February 15, 1994, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated March 11, 1994)\n4(b)-20 - Supplement, dated as of March 1, 1994, to said Mortgage and Deed of Trust (Exhibit 4(b) to the Company's Form 8-K Report (File No. 1-905) dated March 11, 1994)\n4(b)-21 - Supplement, dated as of March 15, 1994, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated March 30, 1994)\n4(b)-22 - Supplement, dated as of September 1, 1994, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K (File No. 1-905) dated October 3, 1994)\n4(b)-23 - Supplement, dated as of October 1, 1994, to said Mortgage and Deed of Trust (Exhibit 4(a) to the Company's Form 8-K Report (File No. 1-905) dated October 3, 1994)\n*l0(a)-1 - Revolving Credit Agreement, dated as of August 30, 1994, between the Company and the Banks named therein\nl0(b) - Copy of Pollution Control Facilities Agreement, dated as of May 1, 1973, between the Company and the Lehigh County Industrial Development Authority (Exhibit 5(z) to Registration Statement No. 2-60834)\nl0(c)-l - Copy of Interconnection Agreement, dated September 26, 1956, among Public Service Electric & Gas Company, Philadelphia Electric Company, the Company, Baltimore Gas & Electric Company, Pennsylvania Electric Company, Metropolitan Edison Company, New Jersey Power & Light Company and Jersey Central Power & Light Company (Exhibit 5(e) to Registration Statement No. 2-60291)\nl0(c)-2 - Copy of Supplemental Agreement, dated April 1, 1974, to said Interconnection Agreement (Exhibit 5(f)-4 to Registration Statement No. 2-51312)\nl0(c)-3 - Copy of Supplemental Agreement, dated June 15, 1977, to said Interconnection Agreement (Exhibit 5(e)-5 to Registration Statement No. 2-60291)\nl0(c)-4 - Copy of Agreement of Settlement and Compromise, dated July 25, 1980, among the parties to said Interconnection Agreement (Exhibit 20(b)-8 to the Company's Form l0-Q Report (File No. l-905) for the quarter ended September 30, 1980)\nl0(c)-5 - Copy of Supplemental Agreement, dated March 26, 1981, to said Interconnection Agreement (Exhibit l0(b)-l0 to the Company's Form l0-K Report (File No. 1-905) for the year ended December 31, 1981)\nl0(c)-6 - Copy of Revisions to Schedules 4.02, 7.01, and 9.01, all effective August 9, 1982, to said Interconnection Agreement (Exhibit 10(e)-11 to the Company's Form l0- K Report (File No. l-905) for the year ended December 31, 1982)\nl0(c)-7 - Copy of Schedules 4.02, 5.01, 5.02, 5.04, 5.05, 6.01, 6.03, 6.04, 7.01, 7.02 7.03; all effective February 6, 1984, to said Interconnection Agreement (Exhibit 10(e)-8 to the Company's Form l0-K Report (File No. 1-905) for the year ended December 31, 1985)\nl0(c)-8 - Copy of Schedule 5.03, Revision l, Exhibit A, revised May 31, 1985, to said Interconnection Agreement (Exhibit 10(e)-10 to the Company's Form l0-K Report (File No. 1-905) for the year ended December 31, 1985)\n10(c)-9 - Copy of Schedule 4.02, Revision No. 2, effective December 4, 1989, to said Interconnection Agreement (Exhibit 10(d)-13 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n10(c)-10 - Copy of Schedule 5.06, Revision No. 1, effective June 1, 1990, to said Interconnection Agreement (Exhibit 10(d)-14 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n10(c)-11 - Copy of Schedule 2.21, Revision No. 1, effective June 1, 1990, to said Interconnection Agreement (Exhibit 10(d)-15 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n10(c)-12 - Copy of Schedule 2.212, Revision No. 2, effective June 1, 1990, to said Interconnection Agreement (Exhibit 10(d)-16 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n10(c)-13 - Copy of Schedule 9.01, Revision No. 4, effective June 1, 1992, to said Interconnection Agreement (Exhibit 10(d)-18 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n10(c)-14 - Copy of Schedule 3.01, Revision No. 3, effective June 1, 1992, to said Interconnection Agreement (Exhibit 10(c)-15 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n10(c)-15 - Copy of Schedule 4.01, Revision No. 13, effective June 1, 1993, to said Interconnection Agreement (Exhibit 10(c)-15 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1993)\nl0(d) - Copy of Capacity and Energy Sales Agreement, dated June 29, 1983, between the Company and Atlantic City Electric Company (Exhibit 10(f)-2 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1983)\n10(e)-1 - Copy of Capacity and Energy Sales Agreement, dated March 9, 1984, between the Company and Jersey Central Power & Light Company (Exhibit l0(f)-3 to the Company's Form l0-K Report (File No. 1- 905) for the year ended December 31, 1984)\n10(e)-2 - Copy of First Supplement, effective February 28, 1986, to said Capacity and Energy Sales Agreement (Exhibit 10(e)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1986)\n10(e)-3 - Copy of Second Supplement, effective January 1, 1987, to said Capacity and Energy Sales Agreement (Exhibit 10(g)-3 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n10(e)-4 - Copy of amendments to Exhibit A, effective October 1, 1987, to said Capacity and Energy Sales Agreement (Exhibit 10(e)-6 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1987)\n10(e)-5 - Copy of Third Supplement, effective December 1, 1988, to said Capacity and Energy Sales Agreement (Exhibit 10(g)-5 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n10(e)-6 - Copy of Fourth Supplement, effective December 1, 1988, to said Capacity and Energy Sales Agreement (Exhibit 10(g)-6 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n10(f)-1 - Copy of Capacity and Energy Sales Agreement, dated December 21, 1989, between the Company and GPU Service Corporation (Exhibit 10(h) to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n10(f)-2 - Copy of First Supplement, effective June 1, 1991, to said Capacity and Energy Sales Agreement between the Company and GPU Service Corporation (Exhibit 10(f)-2 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n10(g)-1 - Copy of Capacity and Energy Sales Agreement, dated January 28, 1988, between the Company and Baltimore Gas and Electric Company (Exhibit 10(e)-7 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1987)\n10(g)-2 - Copy of First Supplement, effective November 1, 1988, to said Capacity and Energy Sales Agreement (Exhibit 10(i)-2 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n10(g)-3 - Copy of Second Supplement, effective June 1, 1989, to said Capacity and Energy Sales Agreement (Exhibit 10(i)-3 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1989)\n10(g)-4 - Copy of Third Supplement, effective June 1, 1991, to said Capacity and Energy Sales Agreement between the Company and Baltimore Gas & Electric Company (Exhibit 10(g)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(h)-1 - Copy of Amended and Restated Directors Deferred Compensation Plan, effective January 1, 1990 (Exhibit 10(q) to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n#10(h)-2 - Copy of Amendment No. 1 to said Directors Deferred Compensation Plan, effective January 1, 1991 (Exhibit 10(h)-2 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(h)-3 - Copy of Amendment No. 2 to said Directors Deferred Compensation Plan, effective October 23, 1991 (Exhibit 10(h)-3 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(h)-4 - Copy of Amendment No. 3 to said Directors Deferred Compensation Plan, effective January 1, 1992 and April 1, 1992 (Exhibit 10(h)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(i)-1 - Copy of Directors Retirement Plan, effective January 1, 1988 (Exhibit 10(f)-2 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1988)\n#10(i)-2 - Copy of Amendment No. 1 to said Directors Retirement Plan, effective January 1, 1991 (Exhibit 10(i)-2 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(i)-3 - Copy of Amendment No. 2 to said Directors Retirement Plan, effective October 23, 1991 (Exhibit 10(i)-3 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(i)-4 - Copy of Amendment No. 3 to said Directors Retirement Plan, effective January 1, 1992 (Exhibit 10(i)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(j)-1 - Copy of Amended and Restated Deferred Compensation Plan for Executive Officers, effective January 1, 1990 (Exhibit 10(s) to the Company's Form 10-K Report (File No. 1- 905) for the year ended December 31, 1990)\n#10(j)-2 - Copy of Amendment No. 1 to said Officers Deferred Compensation Plan, effective January 1, 1991 (Exhibit 10(j)-2 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(j)-3 - Copy of Amendment No. 2 to said Officers Deferred Compensation Plan, effective October 23, 1991 (Exhibit 10(j)-3 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(j)-4 - Copy of Amendment No. 3 to said Officers Deferred Compensation Plan, effective January 1, 1992 and April 1, 1992 (Exhibit 10(j)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n*#10(j)-5 - Copy of Amendment No. 4 to said Officers Deferred Compensation Plan, effective January 1, 1995\n#l0(k)-1 - Copy of Supplemental Executive Retirement Plan, effective January 1, 1987 (Exhibit 10(f)-3 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1986)\n#10(k)-2 - Copy of Amendment No. 1 to said Supplemental Executive Retirement Plan, effective January 1, 1987 (Exhibit 10(f)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1987)\n#10(k)-3 - Copy of Amendment No. 2 to said Supplemental Executive Retirement Plan, effective January 1, 1990 (Exhibit 10(t)-3 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n#10(k)-4 - Copy of Amendment No. 3 to said Supplemental Executive Retirement Plan, effective November 1, 1990 (Exhibit 10(t)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n#10(k)-5 - Copy of Amendment No. 4 to said Supplemental Executive Retirement Plan, effective January 1, 1991 (Exhibit 10(k)-5 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(k)-6 - Copy of Amendment No. 5 to said Supplemental Executive Retirement Plan, effective October 23, 1991 (Exhibit 10(k)-6 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(k)-7 - Copy of Amendment No. 6 to said Supplemental Executive Retirement Plan, effective January 1, 1992 (Exhibit 10(k)-7 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(k)-8 - Copy of Amendment No. 7 to said Supplemental Executive Retirement Plan, effective July 1, 1992 (Exhibit 10(k)-8 to the Company's Form 10-K Report (File No. 1- 905) for the year ended December 31, 1992)\n#10(k)-9 - Copy of Amendment No. 8 to said Supplemental Executive Retirement Plan, effective January 1, 1993 (Exhibit 10(k)-9 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1993)\n*#10(k)-10- Copy of Amendment No. 9 to said Supplemental Executive Retirement Plan, effective July 1, 1994\n*#10(k)-11- Copy of Amendment No. 10 to said Supplemental Executive Retirement Plan, effective January 1, 1995\n#10(l)-1- Copy of Executive Retirement Security Plan, effective January 1, 1987 (Exhibit 10(f)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1986)\n#10(l)-2 - Copy of Amendment No. 1 to said Executive Retirement Security Plan, effective January 1, 1987 (Exhibit 10(f)-6 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1987)\n#10(l)-3 - Copy of Amendment No. 2 to said Executive Retirement Security Plan, effective January 1, 1990 (Exhibit 10(u)-3 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n#10(l)-4 - Copy of Amendment No. 3 to said Executive Retirement Security Plan, effective November 1, 1990 (Exhibit 10(u)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1990)\n#10(l)-5 - Copy of Amendment No. 4 to said Executive Retirement Security Plan, effective January 1, 1991 (Exhibit 10(l)-5 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(l)-6 - Copy of Amendment No. 5 to said Executive Retirement Security Plan, effective October 23, 1991 (Exhibit 10(l)-6 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(l)-7 - Copy of Amendment No. 6 to said Executive Retirement Security Plan, effective January 1, 1992 (Exhibit 10(l)-7 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1991)\n#10(l)-8 - Copy of Amendment No. 7 to said Executive Retirement Security Plan, effective January 1, 1993 (Exhibit 10(l)-8 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1994)\n*#10(l)-9 - Copy of Amendment No. 8 to said Executive Retirement Security Plan, effective July 1,\n*#10(l)-10 - Copy of Amendment No. 9 to said Executive Retirement Security Plan, effective January 1, 1995 and upon the effectiveness of the Agreement and Plan of Exchange between the Company and PP&L Resources, Inc.\n*#10(l)-11 - Copy of Amendment No. 10 to said Executive Retirement Security Plan, effective January 1, 1995\n#10(m)-1 - Copy of Amended and Restated Incentive Compensation Plan, effective July 1, 1992 (Exhibit 10(m)-4 to the Company's Form 10-K Report (File No. 1-905) for the year ended December 31, 1992)\n*#10(n) - Description of Executive Compensation Incentive Award Program, effective January 1, 1995 (Footnote 1\/)\n10(o) - Conformed copy of Nuclear Fuel Lease, dated as of February 1, 1982, between the Com pany, as lessee, and Newton I. Waldman, not in his individual capacity, but solely as Cotrustee of the Pennsylvania Power & Light Energy Trust, as lessor (Exhibit 10(g) to the Company's Form l0-K Report (File No. 1- 905) for the year ended December 31, 1981)\n*12 - Computation of Ratio of Earnings to Fixed Charges *16 - Letter re: Change in Certifying Accountants (Exhibit 16 to the Company's Form 8-K Report (File No. 1-905) dated February 1, 1995)\n*23 - Consent of Deloitte & Touche\n*24 - Power of Attorney\n*27 - Financial Data Schedule\n*99 - Schedule of Property, Plant and Equipment\n________________________\nCertain long-term debt instruments of the Company's consolidated subsidiaries have been omitted from this filing pursuant to 17 C.F.R. Section 229.601(b)(4)(iii)(A). The Company will furnish a copy of any such instrument to the Commission upon request.\n_______________________________ Footnote 1\/ This description is provided pursuant to 17 C.F.R. Section 229.601(b)(10)(iii)(A).\n(PP&L LOGO Appears Here) Pennsylvania Power & Light Company Two North Ninth Street - Allentown, PA 18101","section_15":""}
{"filename":"802361_1994.txt","cik":"802361","year":"1994","section_1":"ITEM 1. BUSINESS\nTHE PARTNERSHIP. Jones Intercable Investors, L.P. (the \"Partnership\") is a Colorado limited partnership that was formed to acquire, own and operate cable television systems in the United States. Jones Intercable, Inc., a Colorado corporation, is the general partner of the Partnership (the \"General Partner\"). The Partnership was formed for the purpose of acquiring and operating cable television systems. The Partnership owns the cable television systems serving the areas in and around the City of Independence and suburban Kansas City, Missouri communities (the \"Independence System). See Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership owned only one cable television system at December 31, 1994, the Independence System, which was acquired in May 1987.\nThe following sets forth (i) the monthly basic plus service rates charged to subscribers, (ii) the number of basic subscribers and pay units and (iii) the range of franchise expiration dates for the Independence System. The monthly basic service rates set forth herein represent, with respect to systems with multiple headends, the basic service rate charged to the majority of the subscribers within the Independence System. While the charge for basic plus service may have increased in 1993 in some cases as a result of the FCC's rate regulations, overall revenues may have decreased due to the elimination of charges for additional outlets and certain equipment. In cable television systems, basic subscribers can subscribe to more than one pay TV service. Thus, the total number of pay services subscribed to by basic subscribers are called pay units. As of December 31, 1994, the Independence System operated approximately 1,400 miles of cable plant, passing approximately 130,000 homes, representing an approximate 61% penetration rate. Figures for numbers of subscribers, miles of cable plant and homes passed are compiled from the General Partner's records and may be subject to adjustments.\nFranchise expiration dates range from April 1995 to March 2009. Any franchise expiring in 1995 is in the renewal process.\nPROGRAMMING SERVICES\nProgramming services provided by the Independence System include local affiliates of the national broadcast networks, local independent broadcast channels, the traditional satellite services (e.g., American Movie Classics, Arts & Entertainment, Black Entertainment Network, C-SPAN, The Discovery Channel, Lifetime, Entertainment Sports Network, Home Shopping Network, Mind Extension University, Music Television, Nickelodeon, Turner Network Television, The Nashville Network, Video Hits One, and superstations WOR, WGN and TBS. The Independence System also provides a selection of premium channel programming (e.g., Cinemax, Encore, Home Box Office, Showtime and The Movie Channel).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn February 22, 1994, the General Partner and The Jones Group, Ltd. (\"Jones Group\"), an affiliate of the General Partner engaged in the cable brokerage business, were named as defendants in a lawsuit brought by three individuals who are Class A Unitholders in the Partnership. The litigation, entitled Luva Vaughan et al v. Jones Intercable, Inc. et al, Case No. CV 94-3652 was filed in the Circuit Court for Jackson County, Missouri, and purports to be \"for the use and benefit of\" the Partnership. The suit seeks rescission of the sale of the Alexandria, Virginia cable television system (the \"Alexandria System\") by the Partnership to the General Partner, which sale was completed on November 2, 1992. It also seeks a constructive trust on the profits derived from the operation of the Alexandria System since the date of the sale, and seeks an accounting and other equitable relief. The plaintiffs also allege that the $1,800,000 commission paid to Jones Group by the Partnership in connection with such sale was improper, and ask the Court to order that such commission be repaid to the Partnership.\nOn October 21, 1994, plaintiffs filed a motion to dismiss Jones Group in response to Jones Group's argument that Missouri lacked personal jurisdiction over it. Plaintiffs' motion was granted, and plaintiffs then filed an action in Colorado against Jones Group seeking a return of the brokerage commission.\nUnder the terms of the partnership agreement of the Partnership, the General Partner has the right to acquire cable television systems from the Partnership at a purchase price equal to the average of three independent appraisals of the cable television system to be acquired. The plaintiffs claim that the appraisals obtained in connection with the sale of the Alexandria System were improperly obtained, were not made by qualified appraisers and were otherwise improper. The purchase price paid by the General Partner upon such sale was approximately $73,200,000.\nThe amount of damages being sought by the plaintiffs has not yet been specified. The General Partner believes both that the appraisals were properly obtained and that the brokerage commission was properly paid to Jones Group in accordance with the express terms of the partnership agreement. The General Partner further believes that its defenses are meritorious and it intends to vigorously defend the litigation.\nThe General Partner and Jones Group have filed motions for summary judgment in the Missouri and Colorado cases, respectively, which are pending before the Missouri and Colorado courts. In addition, the General Partner has conducted written discovery in the form of interrogatories and requests for production of documents, and has noticed the depositions of plaintiffs and plaintiffs' expert. A trial date of April 3, 1995 has been set in the Missouri case, but it will likely be continued in accordance with the General Partner's request. No trial date has been set in the Colorado case. Because defendants' motions have not been resolved and because discovery has just commenced, it is premature to present a realistic evaluation of the probability of a favorable or unfavorable outcome.\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 SECURITY HOLDER MATTERS\nThe Partnership's Class A Units are traded on the American Stock Exchange (\"AMEX\") under the symbol JTV.\nThe following table shows the high and low prices as regularly quoted on AMEX for each quarterly period of 1994 for the Partnership's Class A Units:\nAt February 15, 1995, there were 1,594 record holders of the Class A Units of the Partnership and 8,322,632 outstanding Class A Units.\nThe Partnership distributed $.15 per Class A Unit for each of the calendar quarters in 1994. See Note 4 of the Notes to Financial Statements for discussion of the Partnership's cash distribution policy.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n*Includes gain on sale of Alexandria System of $47,118,868 during November 1992. ** Results reflect the sale of the Alexandria System during November 1992.\nItem 7.","section_7":"Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nResults of Operations\n1994 Compared to 1993\nPartnership revenues increased $567,333, or approximately 2 percent, from $26,955,292 in 1993 to $27,522,625 in 1994. This increase is primarily the result of increases in basic subscribers. The Independence System added 4,868 basic subscribers in 1994, an increase of approximately 6 percent. Basic subscribers for the Independence System totalled 75,117 at December 31, 1993 compared to 79,985 at December 31, 1994. The increase in revenues would have been greater but for the reduction in basic rates due to regulations issued by the FCC in April 1993 with which the Partnership complied effective September 1, 1993.\nOperating, general and administrative expenses increased $735,071, or approximately 6 percent, from $13,021,954 in 1993 to $13,757,025 in 1994. Operating, general and administrative expense represented 48 percent and 50 percent of revenue in 1993 and 1994, respectively. This increase in operating, general and administrative expenses was primarily due to an increase in programming costs, which accounted for approximately 80 percent of the total increase. No other individual factor was significant to the increase in operating, general and administrative expenses.\nManagement fees and allocated overhead from the General Partner increased $222,042, or approximately 7 percent, from $3,228,652 in 1993 to $3,450,694 in 1994 due primarily to increases in allocated expenses from the General Partner. The General Partner has experienced increases in expenses, including personnel expenses and reregulation expenses, a portion of which is allocated to the Partnership.\nDepreciation and amortization expense decreased $1,452,075, or approximately 15 percent, from $9,793,347 in 1993 to $8,341,272 in 1994. This decrease was due to the maturation of the Independence System's asset base.\nOperating income increased $1,062,295, from $911,339 in 1993 to $1,973,634 in 1994. This increase is due to the factors discussed above. Operating income before depreciation and amortization decreased $389,780, or approximately 4 percent, from $10,704,686 in 1993 to $10,314,906 in 1994. This decrease is due to the increases in operating, general and administrative expense and allocated overhead from the General Partner exceeding the increase in revenue. The decrease in operating income before depreciation and amortization reflects the current operating environment of the cable television industry. The FCC rate regulations under the 1992 Cable Act have caused revenues to increase more slowly than otherwise would have been the case. In turn, this has caused certain expenses which are a function of revenue, such as franchise fees, copyright fees and management fees, to increase more slowly than in prior years. However, other operating costs such as programming fees, salaries and benefits, and marketing costs as well as other costs incurred by the General Partner, which are allocated to the Partnership, continue to increase at historical rates. This situation has led to reductions in operating income before depreciation and amortization as a percent of revenue (\"Operating Margin\"). Such reductions in Operating Margins may continue in the near term as the Partnership and the General Partner incur cost increases due to, among other things, increases in programming fees, compliance costs associated with reregulation and competition, that exceed increases in revenue. The General Partner will attempt to mitigate a portion of these reductions through (a) new service offerings, (b) product re-marketing and re-packaging and (c) marketing efforts targeted at non-subscribers.\nInterest expense increased $321,034, or approximately 33 percent, from $978,624 in 1993 to $1,299,658 in 1994 due to higher interest rates and higher average outstanding balances on interest bearing obligations in 1994. The effective interest rates on amounts outstanding as of December 31, 1994 and 1993 were 7.09 percent and 4.80 percent, respectively.\nThe Partnership reported a net loss of $57,867 in 1993 compared to net income of $578,056 in 1994. The increase was due to the factors discussed above.\n1993 Compared to 1992\nPartnership revenues decreased $11,382,456, or approximately 30 percent, from $38,337,748 in 1992 to $26,955,292 in 1993. This decrease was primarily the result of the sale of the Alexandria System on November 2, 1992. The sale of the Alexandria System resulted in a decrease in 1993 revenues of approximately $12,828,410, while revenues in the Partnership's Independence System increased approximately $1,445,954. An increase in the number of basic subscribers accounted for approximately 46 percent of the increase in revenues for the Independence System. The Independence System added 2,687 basic subscribers in 1993, an increase of approximately 4 percent. Basic subscribers for the Independence System totalled 72,430 at December 31, 1992 compared to 75,117 at December 31, 1993. Basic service rate adjustments primarily accounted for the remainder of the revenue increase. The increase in revenues in the Independence System would have been greater but for the reduction in basic rates due to basic rate regulations issued by the FCC in April 1993 with which the Partnership complied effective September 1, 1993.\nOperating, general and administrative expenses decreased $5,613,741, or approximately 30 percent, from $18,635,695 in 1992 to $13,021,954 in 1993. Operating, general and administrative expense represented 48 percent and 49 percent of revenue in 1993 and 1992, respectively. Comparatively, these expenses decreased by approximately $6,632,968 due to the sale of the Alexandria System and increased by approximately $1,019,227 in the Partnership's Independence System. This increase in operating, general and administrative expenses in the Partnership's Independence System was primarily due to an increase in programming costs, which accounted for approximately 37 percent of the increase. Increases in professional services accounted for approximately 23 percent of the increase. No other individual factor was significant to the increase in operating, general and administrative expenses in the Partnership's Independence System.\nManagement fees and allocated overhead from the General Partner decreased $1,231,062, or approximately 28 percent, from $4,459,714 in 1992 to $3,228,652 in 1993 due primarily to the decrease in revenues due to the sale of the Alexandria System.\nDepreciation and amortization expense decreased $5,258,250, or approximately 35 percent, from $15,051,597 in 1992 to $9,793,347 in 1993. This decrease was due to the sale of the Alexandria System in November 1992 and the maturation of the Independence System's depreciable asset base.\nOperating income increased $720,597 to $911,339 in 1993 from $190,742 in 1992, due to the factors discussed above.\nInterest expense decreased $2,160,715, or approximately 69 percent, from $3,139,339 in 1992 to $978,624 in 1993 due to lower interest rates and lower average outstanding balances on interest bearing obligations in 1993. A portion of the proceeds from the sale of the Alexandria System were used to repay a portion of the amounts outstanding on the Partnership's credit facility.\nThe Partnership recognized a gain on the sale of the Alexandria System in 1992 of $47,118,868. No similar gain was recognized in 1993. The Partnership recorded net income of $44,060,105 in 1992, primarily due to the gain on the Alexandria System, compared to a net loss of $57,867 in 1993.\nFinancial Condition\nThe Partnership's capital expenditures for 1994 totalled approximately $8,500,000. Approximately 54 percent of these expenditures related to the extension and rebuild of cable plant. Service drops to homes accounted for approximately 16 percent of such expenditures. The remainder of the capital expenditures related to various enhancements in the Partnership's Independence System. Funding for these expenditures was provided primarily by cash generated from operations and borrowings from the Partnership's revolving credit facility.\nAnticipated capital expenditures for 1995 are approximately $8,200,000. The continuation of the rebuild of the Independence System is expected to account for approximately 38 percent of the anticipated capital expenditures. Service drops connecting new subscribers are expected to account for approximately 19 percent. The remainder of the expenditures will relate to various enhancements in the Independence System. Funding for these capital improvements is expected to be provided by cash generated from operations and borrowings from the Partnership's credit facility.\nThe maximum amount available under the Partnership's revolving credit facility is subject to the terms of the credit agreement and the Partnership's limited partnership agreement's leverage limitations discussed below. Upon completion of the Alexandria System sale, the maximum amount available under the Partnership's revolving credit facility was reduced to $35,000,000. As of December 31, 1994, $23,000,000 was outstanding, leaving $12,000,000 of available borrowings for future needs. Although the revolving credit period was scheduled to expire on December 31, 1994, the General Partner completed negotiations in December 1994 to extend the revolving credit period to December 31, 1996. Interest on outstanding principal balances is at the Partnership's option of the Prime rate plus .25 percent, the CD rate plus 1.25 percent or the Euro-rate plus 1.25 percent. In addition, a fee of 3\/8 percent per annum is required on the unused portion of the commitment.\nThe level of borrowing allowed by the Partnership's limited partnership agreement is limited to 25 percent of the fair market value of the Partnership's assets at the time of borrowing or 25 percent of the cost of the Partnership's assets at the time of borrowing, whichever is higher. This limitation restricts the Partnership's ability to borrow funds for capital expenditures and to make distributions. In addition, such limitations may reduce the financial flexibility and liquidity of the Partnership. Further, the payment of principal and interest on outstanding debt obligations will diminish the level of funds available to the Partnership and reduce the financial flexibility of the Partnership. The Partnership's most recent appraisal of the Independence System was $157,046,000. Based upon this appraised value, the Partnership has a borrowing capacity of approximately $39,000,000, which would allow the Partnership to borrow the maximum amount ($12,000,000) currently available under its credit facility.\nThe Partnership declared a $.15 per unit distribution for each of the four quarters of 1994. The Partnership intends to distribute all cash flow from operations after payment of expenses, capital additions and creation of cash reserves deemed reasonably necessary to preserve and enhance the value of the Partnership's cable television system. The General Partner will determine the level of distributions on a quarter-by-quarter basis.\nRegulatory Matters\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. In April 1993, the FCC adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The Partnership has filed cost-of-service showings for its Independence System and thus anticipates no further reductions in rates. The cost-of-service showings have not yet received final approval from franchising authorities, however, and there can be no assurance that the Partnership's cost-of-service showings will prevent further rate reductions until such final approvals are received. See Item I for further discussion of the provisions of the 1992 Cable Act and the FCC regulations promulgated thereunder.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\nJONES INTERCABLE INVESTORS, L.P.\nFINANCIAL STATEMENTS\nAS OF DECEMBER 31, 1994 AND 1993\nINDEX\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Partners of Jones Intercable Investors, L.P.:\nWe have audited the accompanying balance sheets of JONES INTERCABLE INVESTORS, L.P. (a Colorado limited partnership) as of December 31, 1994 and 1993, and the related statements of operations, partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the General Partner'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 Jones Intercable Investors, L.P. as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nARTHUR ANDERSEN LLP\nDenver, Colorado, March 8, 1995.\nJONES INTERCABLE INVESTORS, L.P. (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nJONES INTERCABLE INVESTORS, L.P. (A Limited Partnership)\nBALANCE SHEETS\nThe accompanying notes to financial statements are an integral part of these balance sheets.\nJONES INTERCABLE INVESTORS, L.P. (A Limited Partnership)\nSTATEMENTS OF OPERATIONS\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES INTERCABLE INVESTORS, L.P. (A Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL (DEFICIT)\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES INTERCABLE INVESTORS, L.P. (A Limited Partnership)\nSTATEMENTS OF CASH FLOWS\nThe accompanying notes to financial statements are an integral part of these statements.\nJONES INTERCABLE INVESTORS, L.P. (A Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n(1) ORGANIZATION OF PARTNERSHIP\nFormation and Business\nJones Intercable Investors, L.P. (the \"Partnership\"), a Colorado limited partnership, was formed on September 18, 1986, to acquire, own and operate cable television systems in the United States. On November 28, 1986, the Partnership completed the sale of 3,230,000 Class A Units, representing beneficial ownership of Class A Limited Partnership Interests, to the public at a price of $16.00 per Class A Unit. On May 23, 1987, the Partnership completed the sale of an additional 4,300,000 Class A Units, representing beneficial ownership of Class A Limited Partnership Interests to Jones Intercable, Inc. (800,000 Units) and to the public at a price of $15.00 per Class A Unit. In addition to its 800,000 Class A Units, Jones Intercable, Inc. purchased, through a series of transactions, 792,632 Class B Units. These purchases by Jones Intercable, Inc. represent an approximate 19 percent ownership interest in the Partnership. At December 31, 1989, the Initial Period ended and all Class B Units were converted to Class A Units. Jones Intercable, Inc. is the general partner of the Partnership (the \"General Partner\"). The General Partner and its subsidiaries also own and operate cable television systems. In addition, the General Partner manages cable television systems for other limited partnerships for which it is general partner and, also, for affiliated entities.\nIn September 1992, the Partnership entered into an agreement with the General Partner to sell its Alexandria System to the General Partner for $73,234,000. This transaction was completed on November 2, 1992. The Partnership recognized a gain of $47,118,868, on this sale. The Partnership used the net sale proceeds to retire a portion of its debt and to distribute $3 per Class A Unit on November 6, 1992. See Note 8, however, for a discussion of pending litigation that seeks, among other things, to rescind the sale of the Alexandria System.\nAt December 31, 1994, the Partnership owned the cable television system serving certain communities in and around Independence, Missouri.\nContributed Capital of the Partnership\nThe capitalization of the Partnership is set forth in the accompanying statements of partners' capital (deficit).\nAll profits and losses of the Partnership are allocated 99% to the Unitholders and 1 percent to the General Partner.\nPartnership Acquisitions\nThe Partnership's acquisitions were accounted for using the \"purchase method\" of accounting. The allocation of purchase price (determined by independent appraisal) was distributed as follows: first, to the fair value of net tangible assets acquired; second, to the value of subscriber lists; third, to franchise costs; and fourth, to costs in excess of interests in net assets purchased.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nAccounting Records\nThe accompanying financial statements have been prepared on the accrual basis of accounting in accordance with generally accepted accounting principles. The Partnership's tax returns are also prepared on the accrual basis.\nProperty, Plant and Equipment\nDepreciation of property, plant and equipment is provided primarily using the straight-line method over the following estimated service lives:\nReplacements, renewals and improvements are capitalized and maintenance and repairs are charged to expense as incurred.\nIntangible Assets\nCosts assigned to franchises and costs in excess of interests in net assets purchased are being amortized using the straight-line method over the following remaining estimated useful lives:\nRevenue Recognition\nSubscriber prepayments are initially deferred and recognized as revenue when earned.\n(3) TRANSACTIONS WITH THE GENERAL PARTNER AND AFFILIATES\nManagement Fees, Reimbursements of Allocated Expenses and Distribution Ratios\nThe General Partner manages the Partnership and receives a fee for its services equal to 5 percent of the gross revenues of the Partnership, excluding revenues from the sale of cable television systems or franchises. Management fees for the years ended December 31, 1994, 1993 and 1992 were $1,376,131, $1,347,765 and $1,916,887, respectively.\nThe Partnership reimburses the General Partner for certain allocated overhead and administrative expenses. These expenses represent salaries and related benefits for corporate personnel, rent, data processing services and other corporate facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to the Partnership. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner with respect to each partnership managed. Other overhead costs are allocated primarily based on total revenues and\/or the cost of partnership assets managed. Effective December 1, 1993, the allocation method was changed to be based only on revenue, which the General Partner believes provides a more accurate method of allocation. Systems owned by the General Partner and all other systems owned by partnerships for which Jones Intercable, Inc. is the general partner are also allocated a proportionate share of these expenses. The General Partner believes that the methodology used in allocating overhead and administrative expenses is reasonable. Amounts charged the Partnership by the General Partner for allocated\noverhead and administrative expenses for the years ended December 31, 1994, 1993 and 1992 were $2,074,563, $1,880,887 and $2,542,827, respectively.\nThe General Partner will receive 40 percent of distributions made upon sale or refinancing of Partnership cable television systems or upon dissolution after holders of the Class A Units have first received distributions equal to the Preferred Return, plus distributions, other than distributions of Cash Flow from Operations, equal to the capital contributions made to the Partnership with respect to the Class A Units. The \"Preferred Return\" is defined as a return equal to 10 percent per annum, cumulative and non-compounded on an amount equal to the capital contribution made with respect to a Class A Unit, less any portion of such amount which has been returned to the holders of Class A Units from prior sale or refinancing proceeds; provided that such return will be reduced by all prior distributions of Cash Flow from Operations on the Class A Units, and certain prior distributions of proceeds from sales or refinancing of Partnership cable television properties.\nThe Partnership is charged interest on accounts payable to the General Partner at a rate which approximates the General Partner's weighted average cost of borrowing. In addition, the Partnership was charged interest on a note payable to the General Partner at a rate equal to the interest rate payable on the Partnership's credit facility. This note was repaid in November 1992. Total interest charged to the Partnership by the General Partner during 1992 was $182,620. There was no interest charged to the Partnership by the General Partner during 1994 and 1993.\nPayments to\/from Affiliates for Programming Services\nThe Partnership receives programming from Product Information Network, Superaudio and The Mind Extension University, affiliates of the General Partner. Payments to Superaudio totalled approximately $46,113, $45,763 and $63,485 in 1994, 1993 and 1992, respectively. Payments to The Mind Extension University totalled approximately $41,783, $26,607 and $36,366 in 1994, 1993 and 1992, respectively. The Partnership receives a commission from Product Information Network based on a percentage of advertising revenue and number of subscribers. Product Information Network, which initiated service in 1994, paid commissions to the Partnership totalling $4,073 in 1994.\n(4) DISTRIBUTIONS TO UNITHOLDERS\nThe Partnership declared a $.15 per unit distribution for each of the four quarters of 1994. All declared distributions were paid at December 31, 1994, except for the fourth quarter distribution, which was paid in February 1995. The Partnership intends to distribute all cash flow from operations after payment of expenses, capital additions and creation of cash reserves deemed reasonably necessary to preserve and enhance the value of the Partnership's cable television system.\n(5) PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment as of December 31, 1994 and 1993, consists of the following:\n(6) DEBT\nDebt consists of the following:\nAs of December 31, 1994, $23,000,000 was outstanding on the Partnership's $35,000,000 revolving credit facility, leaving $12,000,000 of available borrowings for future needs. Although the revolving credit period was scheduled to expire on December 31, 1994, the General Partner completed negotiations in December 1994 to extend the revolving credit period to December 31, 1996. Interest on outstanding principal balances is at the Partnership's option of the Prime rate plus .25 percent, the CD rate plus 1.25 percent or the Euro-rate plus 1.25 percent. The effective interest rates on outstanding obligations as of December 31, 1994 and 1993 were 7.09 percent and 4.8 percent, respectively. In addition, a fee of 3\/8 percent per annum is required on the unused portion of the commitment.\nInstallments due on debt principal and capital lease obligations for each of the five years in the period ending December 31, 1999 and thereafter, respectively, are $148,152, $148,152, $1,298,152, $2,924,385, $5,750,000 and $13,225,000. At December 31, 1994, substantially all of the Partnership's property, plant and equipment secured the above indebtedness.\n(7) INCOME TAXES\nIncome taxes have not been recorded in the accompanying financial statements because the Partnership will pay no Federal or state income taxes as an entity. Instead, all of the income, gains, losses, deductions and credits of the Partnership will pass through to the General Partner and the Unitholders. The Federal and state income tax returns of the Partnership are prepared and filed by the General Partner.\nThe Partnership's tax returns, the qualification of the Partnership as such for tax purposes, and the amount of distributable Partnership income or loss are subject to examination by Federal and state taxing authorities. If such examinations result in changes with respect to the Partnership's qualification as such, or in changes with respect to the Partnership's recorded income or loss, the tax liability of the General Partner and Unitholders would likely be changed accordingly.\nTaxable income to the General Partner and Unitholders is different from that reported in the statements of operations largely due to the difference in depreciation recognized under generally accepted accounting principles and the expense allowed for tax purposes under the Modified Accelerated Cost Recovery System. Since the Partnership has previously made an IRC Section 754 election, the cost basis of the Partnership assets has been increased or decreased to reflect the difference between the new unitholders' purchase price and their proportionate share of the adjusted tax basis of the Partnership properties. The portion of this adjustment which relates to depreciable or amortizable assets results in difference between book and tax depreciation or amortization. Under IRC Section 197, certain intangibles placed in service after August 10, 1993, including goodwill, are allowed to be amortized over a 15 year period for tax purposes, creating additional book and tax amortization differences. There are no other significant differences between taxable loss and the net loss reported in the statements of operations.\nThe General Partner does not expect any currently proposed tax legislation to have a significant impact on the business of the Partnership. Current tax law impacts the Unitholders due to limitations on the utilization of passive losses generated by the Partnership. Investors in Publicly Traded Partnerships (\"PTP's\"), such as Jones Intercable Investors, L.P., are subject to additional limitations under the passive-activity loss rules as amended by the Revenue Act of 1987. Passive losses reported on Schedule K-1, Form 1065, by a PTP can only be used to offset passive income from the same partnership. Passive losses of a PTP which are limited by this rule may be carried forward.\n(8) COMMITMENTS AND CONTINGENCIES\nOn October 5, 1992, Congress enacted the Cable Television Consumer Protection and Competition Act of 1992 (the \"1992 Cable Act\"), which became effective on December 4, 1992. The 1992 Cable Act generally allows for a greater degree of regulation of the cable television industry. In April 1993, the Federal Communications Commission (the \"FCC\") adopted regulations governing rates for basic and non-basic services. These regulations became effective on September 1, 1993. Such regulations caused reductions in rates for certain regulated services. On February 22, 1994, the FCC adopted several additional rate orders including an order which revised its earlier-announced regulatory scheme with respect to rates. The Partnership has filed cost-of-service showings for its Independence System and thus anticipates no further reductions in rates. The cost-of-service showings have not received final approval from franchising authorities, however, and there can be no assurance that the Partnership's cost-of-service showings will prevent further rate reductions until such final approvals are received.\nOn February 22, 1994, the General Partner and The Jones Group, Ltd. (\"Jones Group\"), a subsidiary of the General Partner engaged in the cable brokerage business, were named as defendants in a lawsuit brought by three individuals who are Class A Unitholders in the Partnership. The litigation, entitled Luva Vaughan et al v. Jones Intercable, Inc. et al, Case No. CV 94-3652 was filed in the Circuit Court for Jackson County, Missouri, and purports to be \"for the use and benefit of\" the Partnership. The suit seeks rescission of the sale of the Alexandria, Virginia cable television system (the \"Alexandria System\") by the Partnership to the General Partner, which sale was completed on November 2, 1992. It also seeks a constructive trust on the profits derived from the operation of the Alexandria System since the date of the sale, and seeks an accounting and other equitable relief. The plaintiffs also allege that the $1,800,000 commission paid to Jones Group by the Partnership in connection with such sale was improper, and ask the Court to order that such commission be repaid to the Partnership.\nOn October 21, 1994, plaintiffs filed a motion to dismiss Jones Group in response to Jones Group's argument that Missouri lacked personal jurisdiction over it. Plaintiffs' motion was granted, and plaintiffs then filed an action in Colorado against Jones Group seeking a return of the brokerage commission.\nUnder the terms of the partnership agreement of the Partnership, the General Partner has the right to acquire cable television systems from the Partnership at a purchase price equal to the average of three independent appraisals of the cable television system to be acquired. The plaintiffs claim that the appraisals obtained in connection with the sale of the Alexandria System were improperly obtained, were not made by qualified appraisers and were otherwise improper. The purchase price paid by the General Partner upon such sale was approximately $73,200,000.\nThe amount of damages being sought by the plaintiffs has not yet been specified. The General Partner believes both that the appraisals were properly obtained and that the brokerage commission was properly paid to Jones Group in accordance with the express terms of the partnership agreement. The General Partner further believes that its defenses are meritorious and it intends to vigorously defend the litigation.\nThe General Partner and Jones Group have filed motions for summary judgment in the Missouri and Colorado cases, respectively, which are pending before the Missouri and Colorado courts. In addition, the General Partner has conducted written discovery in the form of interrogatories and requests for production of documents, and has noticed the depositions of plaintiffs and plaintiffs' expert. A trial date of April 3, 1995 has been set in the Missouri case, but it will likely be continued in accordance with the General Partner's request. No trial date has been set in the Colorado case. Because defendants' motions have not been resolved and because discovery has just commenced, it is premature to present a realistic evaluation of the probability of a favorable or unfavorable outcome.\nThe Partnership rents office and other facilities under various long-term operating lease arrangements. Rent paid under such lease arrangements totalled $147,185, $63,698 and $282,117, respectively, for the years ended December 31, 1994, 1993 and 1992. Minimum commitments for each of the five years in the period ending December 31, 1999, and thereafter are as follows:\n(9) SUPPLEMENTARY PROFIT AND LOSS INFORMATION\nSupplementary profit and loss information for the respective years is presented below:\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 Partnership itself has no officers or directors. Certain information concerning the directors and executive officers of the General Partner is set forth below.\nMr. Glenn R. Jones has served as Chairman of the Board of Directors and Chief Executive Officer of the General Partner since its formation in 1970, and he was President from June 1984 until April 1988. Mr. Jones was elected a member of the Executive Committee of the Board of Directors in April 1985. Mr. Jones is the sole shareholder, President and Chairman of the Board of Directors of Jones International, Ltd. He is also Chairman of the Board of Directors of the subsidiaries of the General Partner and of certain other affiliates of the General Partner. Mr. Jones has been involved in the cable television business in various capacities since 1961, is a past and present member of the Board of Directors of the National Cable Television Association, and is a former member of its Executive Committee. Mr. Jones is a past director and member of the Executive Committee of C-Span. Mr. Jones has been the recipient of several awards including the Grand Tam Award in 1989, the highest award from the Cable Television Administration and Marketing Society; the Chairman's Award from the Investment Partnership Association, which is an association of sponsors of public syndications; the cable television industry's Public Affairs Association President's Award in 1990, the Donald G. McGannon award for the advancement of minorities and women in cable; the STAR Award from American Women in Radio and Television, Inc. for exhibition of a commitment to the issues and concerns of women in television and radio; and the Women in Cable Accolade in 1990 in recognition of support of this organization. Mr. Jones is also a founding member of the James Madison Council of the Library of Congress and is on the Board of Governors of the American Society of Training and Development.\nMr. Derek H. Burney was appointed a Director of the General Partner in December 1994 and Vice Chairman of the Board of Directors in January 1995. He is also a member of the Executive Committee of the Board of Directors. Mr. Burney joined BCE Inc., Canada's largest telecommunications company, in January 1993 as Executive Vice President, International. He has been the Chairman of Bell Canada International Inc., a\nsubsidiary of BCE, since January 1993 and, in addition, has been Chief Executive Officer of BCI since July 1993. Prior to joining BCE, Mr. Burney served as Canada's ambassador to the United States from 1989 to 1992. Mr. Burney also served as chief of staff to the Prime Minister of Canada from March 1987 to January 1989 where he was directly involved with the negotiation of the U.S. - Canada Free Trade Agreement. In July 1993, he was named an Officer of the Order of Canada. Mr. Burney is chairman of Bell Cablemedia plc. He is a director of Mercury Communications Limited, Videotron Holdings plc, Tele-Direct (Publications) Inc., Teleglobe Inc., Bimcor Inc., Maritime Telegraph and Telephone Company, Limited, Moore Corporation Limited and Northbridge Programming Inc.\nMr. James B. O'Brien, the General Partner's President, joined the General Partner in January 1982. Prior to being elected President and a Director of the General Partner in December 1989, Mr. O'Brien served as a Division Manager, Director of Operations Planning\/Assistant to the CEO, Fund Vice President and Group Vice President\/Operations. Mr. O'Brien was appointed to the General Partner's Executive Committee in August 1993. As President, he is responsible for the day-to-day operations of the cable television systems managed and owned by the General Partner. Mr. O'Brien is also President and a Director of Jones Cable Group, Ltd., Jones Global Funds, Inc. and Jones Global Management, Inc., all affiliates of the General Partner. Mr. O'Brien is a board member of Cable Labs, Inc., the research arm of the U.S. cable television industry. He also serves as a director of the Cable Television Administration and Marketing Association and as a director of the Walter Kaitz Foundation, a foundation that places people of any ethnic minority group in positions with cable television systems, networks and vendor companies.\nMs. Ruth E. Warren joined the General Partner in August 1980 and has served in various operational capacities, including system manager and Fund Vice President, since then. Ms. Warren was elected Group Vice President\/Operations of the General Partner in September 1990.\nMr. Kevin P. Coyle joined The Jones Group, Ltd. in July 1981 as Vice President\/Financial Services. In September 1985, he was appointed Senior Vice President\/Financial Services. He was elected Treasurer of the General Partner in August 1987, Vice President\/Treasurer in April 1988 and Group Vice President\/Finance and Chief Financial Officer in October 1990.\nMr. Christopher J. Bowick joined the General Partner in September 1991 as Group Vice President\/Technology and Chief Technical Officer. Previous to joining the General Partner, Mr. Bowick worked for Scientific Atlanta's Transmission Systems Business Division in various technical management capacities since 1981, and as Vice President of Engineering since 1989.\nMr. Timothy J. Burke joined the General Partner in August 1982 as corporate tax manager, was elected Vice President\/Taxation in November 1986 and Group Vice President\/Taxation\/Administration in October 1990.\nMr. Raymond L. Vigil joined the General Partner in June 1993 as Group Vice President\/Human Resources. Previous to joining the General Partner, Mr. Vigil served as Executive Director of Learning with USWest. Prior to USWest, Mr. Vigil worked in various human resources posts over a 14-year term with the IBM Corporation.\nMs. Cynthia A. Winning joined the General Partner as Group Vice President\/Marketing in December 1994. Previous to joining the General Partner, Ms. Winning served since 1994 as the President of PRS Inc., Denver, Colorado, a sports and event marketing company. From 1979 to 1981 and from 1986 to 1994, Ms. Winning served as the Vice President and Director of Marketing for Citicorp Retail Services, Inc., a provider of private-label credit cards for ten national retail department store chains. From 1981 to 1986, Ms. Winning was the Director of Marketing Services for Daniels & Associates cable television operations, as well as the Western Division Marketing Director for Capital Cities Cable. Ms. Winning also serves as a board Member of Cities in Schools, a dropout intervention\/prevention program.\nMs. Elizabeth M. Steele joined the General Partner in August 1987 as Vice President\/General Counsel and Secretary. From August 1980 until joining the General Partner, Ms. Steele was an associate and then a partner at the Denver law firm of Davis, Graham & Stubbs, which serves as counsel to the General Partner.\nMr. Larry Kaschinske joined the General Partner in 1984 as a staff accountant in the General Partner's former Wisconsin Division; was promoted to Assistant Controller in 1990 and named Controller in August 1994.\nMr. James J. Krejci was President of the International Division of International Gaming Technology International headquartered in Reno, Nevada, until March 1995. Prior to joining IGT in May 1994, Mr. Krejci was Group Vice President of Jones International, Ltd. and a Group Vice President of the General Partner. Prior to May 1994, he also served as Group Vice President of Jones Futurex, Inc., an affiliate of the General Partner engaged in manufacturing and marketing data encryption devices, Jones Interactive, Inc., a subsidiary of Jones International, Ltd. providing computer data and billing processing facilities and Jones Lightwave, Ltd., a company owned by Jones International, Ltd. and Mr. Jones, which is engaged in the provision of telecommunications services. Mr. Krejci has been a Director of the General Partner since August 1987.\nMs. Christine Jones Marocco was appointed a Director of the General Partner in December 1994. She is the daughter of Glenn R. Jones. Ms. Marocco is also a director of Jones International, Ltd.\nMr. Daniel E. Somers was appointed a Director of the General Partner in December 1994 and also serves on the General Partner's Audit Committee. From January 1992 to January 1995, Mr. Somers worked as Senior Vice President and Chief Financial Officer of Bell Canada International Inc. and was appointed Executive Vice President and Chief Financial Officer on February 1, 1995. He is also a Director of certain of its affiliates. Prior to joining Bell Canada International Inc. and since January 1989, Mr. Somers was the President and Chief Executive Officer of Radio Atlantic Holdings Limited. Mr. Somers is a member of the North American Society of Corporate Planning, the Financial Executives Institution and the Financial Analysts Federation.\nMr. Robert S. Zinn was appointed a Director of the General Partner in December 1994. Mr. Zinn joined the General Partner in January 1991 and is a member of its Legal Department. He is also Vice President\/Legal Affairs of Jones International, Ltd. Prior to joining the General Partner, Mr. Zinn was in private law practice in Denver, Colorado for over 25 years.\nMr. David K. Zonker was appointed a Director of the General Partner in December 1994. Mr. Zonker has been the President of Jones International Securities, Ltd., a subsidiary of Jones International, Ltd. since January 1984 and he has been its Chief Executive Officer since January 1988. From October 1980 until joining Jones International Securities, Ltd. in January 1984, Mr. Zonker was employed by the General Partner. Mr. Zonker is a member of the Board of Directors of various affiliates of the General Partner, including Jones International Securities, Ltd. Mr. Zonker is licensed by the National Association of Securities Dealers, Inc. and he is a past chairman of the Investment Program Association, a trade organization based in Washington, D.C. that promotes direct investments. He is a member of the Board of Trustees of Graceland College, Lamoni, Iowa; the International Association of Financial Planners and the American and Colorado Institutes of Certified Public Accountants.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Partnership has no employees; however, various personnel are required to operate the Independence System. Such personnel are employed by the General Partner and, pursuant to the terms of the limited partnership agreement of the Partnership, the cost of such employment is charged by the General Partner to the Partnership as a direct reimbursement item. See Item 13.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGERS\nNo person or entity owns more than 5 percent of the limited partnership interests of the Partnership.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe General Partner and its affiliates engage in certain transactions with the Partnership as contemplated by the limited partnership agreement of the Partnership. The General Partner believes that the terms of such transactions are generally as favorable as could be obtained by the Partnership from unaffiliated parties. This determination has been made by the General Partner in good faith, but none of the terms were or will be negotiated at arm's-length and there can be no assurance that the terms of such transactions have been or will be as favorable as those that could have been obtained by the Partnership from unaffiliated parties.\nThe General Partner charges the Partnership a management fee, and the Partnership reimburses the General Partner for certain allocated overhead and administrative expenses in accordance with the terms of the limited partnership agreement of the Partnership. These expenses consist primarily of salaries and benefits paid to corporate personnel, rent, data processing services and other facilities costs. Such personnel provide engineering, marketing, administrative, accounting, legal and investor relations services to the Partnership. Allocations of personnel costs are based primarily on actual time spent by employees of the General Partner with respect to the Partnership managed. Remaining overhead costs are allocated based on revenues and\/or the costs of assets managed for the Partnership. Systems owned by the General Partner and all other systems owned by partnerships for which Jones Intercable, Inc. is the general partner, are also allocated a proportionate share of these expenses.\nFrom time to time, The Jones Group, Ltd., an affiliate of the General Partner, performs brokerage services for the Partnership in connection with Partnership acquisitions and sales.\nThe Independence System receives stereo audio programming from Superaudio, a joint venture owned 50% by an affiliate of the General Partner and 50% by an unaffiliated party and educational video programming from Mind Extension University, Inc., an affiliate of the General Partner for fees based upon the number of subscribers receiving the programming.\nProduct Information Network (\"PIN\"), an affiliate of the General Partner, provides advertising time for third parties on the Independence System. In consideration, the revenues generated from the third parties are shared two-thirds and one-third between PIN and the Partnership. During the year ended December 31, 1994, the Partnership received revenues from PIN of $4,073.\nThe charges to the Partnership for related party transactions are as follows for the periods indicated:\n*The decreases appearing in 1993 in the fees and expense allocations reflect the sale in 1992 of the Alexandria, Virginia cable television system.\nPART IV.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n-------------------\n(1) Incorporated by reference from Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1986.\n(2) Incorporated by reference from Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1987.\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.\nJONES INTERCABLE INVESTORS, L.P., a Colorado limited partnership By: Jones Intercable, Inc.\nBy: \/s\/ Glenn R. Jones ------------------------------- Glenn R. Jones Chairman of the Board Dated: March 27, 1995 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.\nBy: \/s\/ Glenn R. Jones ------------------------------- Glenn R. Jones Chairman of the Board and Chief Executive Officer Dated: March 27, 1995 (Principal Executive Officer)\nBy: \/s\/ Kevin P. Coyle ------------------------------- Kevin P. Coyle Group Vice President\/Finance Dated: March 27, 1995 (Principal Financial Officer)\nBy: \/s\/ Larry Kaschinske ------------------------------- Larry Kaschinske Controller Dated: March 27, 1995 (Principal Accounting Officer)\nBy: \/s\/ James B. O'Brien ------------------------------- James B. O'Brien Dated: March 27, 1995 President and Director\nBy: \/s\/ Raymond L. Vigil ------------------------------- Raymond L. Vigil Dated: March 27, 1995 Group Vice President and Director\nBy: \/s\/ Robert S. Zinn ------------------------------- Robert S. Zinn Dated: March 27, 1995 Director\nBy: \/s\/ David K. Zonker ------------------------------- David K. Zonker Dated: March 27, 1995 Director\nBy: ------------------------------- Derek H. Burney Dated: Director\nBy: ------------------------------- James J. Krejci Dated: Director\nBy: ------------------------------- Christine Jones Marocco Dated: Director\nBy: ------------------------------- Daniel E. Somers Dated: Director\nEXHIBIT INDEX\n----------------\n(1) Incorporated by reference from Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1986.\n(2) Incorporated by reference from Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1987.\n(3) Incorporated by reference from Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1988.\n(4) Incorporated by reference from Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1992.\n(5) Incorporated by reference from Registrant's Annual Report on Form 10-K for fiscal year ended December 31, 1993.","section_15":""}
{"filename":"36678_1994.txt","cik":"36678","year":"1994","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":"809697_1994.txt","cik":"809697","year":"1994","section_1":"Item 1. Business.\nUnited Parcel Service of America, Inc., through subsidiaries, provides specialized transportation services, primarily through the delivery of packages. Service is offered throughout the United States and over 200 other countries and territories around the world. In terms of revenue, UPS is the largest package delivery company in the world. During 1994 UPS delivered approximately 3 billion packages. UPS currently has approximately 1.4 million customer locations to which it provides daily pickup services.\nWith minor exceptions, UPS Common Stock is owned by or held for the benefit of managers and supervisors actively employed by UPS, or their families; or by former employees, their estates or heirs; or by charitable foundations established by UPS founders and their family members; or by other charitable organizations which have acquired their stock by donations from shareowners. UPS stock is not listed on a national securities exchange or traded in the organized over-the-counter markets. When used herein the term \"UPS\" refers to United Parcel Service of America, Inc., a Delaware corporation, and its subsidiaries.\nDelivery Service in the United States\nGround Services\nUPS is engaged primarily in the delivery of packages with dimensional limitations of 108 inches in length and 130 inches in length and girth combined. Effective February 1994, UPS increased the weight limit for individual packages from 70 to 150 pounds for interstate and certain intrastate deliveries. As of January 1, 1995, as a result of deregulation, the 150 pound weight limit was made available in all of the 48 contiguous states. UPS provides interstate and intrastate ground service to every address in the 48 contiguous states and between those states and Hawaii and Alaska. In Hawaii, an intra-island service is provided between addresses on Oahu and an inter-island air service is offered between all islands of the state. In Alaska, an intrastate package delivery service is available throughout the state.\nEffective January 1, 1995, UPS began providing Hundredweight Service(SM) for ground shipments to all 48 contiguous states. Under this service, contract rates are established for multi-package shipments weighing in the aggregate 200 pounds or more and addressed to one consignee at one location on one day. Customers can realize savings on such shipments compared to regular ground service rates. In 1994, UPS Hundredweight volume grew over 36% from 1993. This growth was primarily due to the increase in new customers as a result of the Teamsters strike of less-than-truckload (LTL) carriers last spring. UPS has managed to retain much of the volume after the strike ended. UPS Hundredweight also offers Weight Break Pricing, which provides rate incentives for shipments of over 500 pounds.\nUPS also provides UPS GroundSaver(SM), a contract service, offering special rates and services for business-to-business shipments to specified ZIP Codes. GroundSaver revenue for 1994 increased over 15% from 1993.\nUPS's domestic ground revenue increased in 1994 by 5.3% over 1993 as a result of higher volume, which was up 0.5%, favorable changes in rates and higher average weights per package. For a description of the rate increase, see \"Item 1 -- Rates.\"\nDomestic Air Services\nUPS provides domestic air delivery services known as \"UPS Next Day Air(R)\" and \"UPS 2nd Day Air(R),\" which are available throughout the United States and Puerto Rico. UPS also provides UPS Prepaid Letter, which permits customers to purchase UPS Next Day Air and 2nd Day Air Letters in advance at lower prices. For both UPS Next Day Air and UPS 2nd Day Air, packages and documents are either picked up from shippers by UPS or are dropped off by shippers at Air Service Centers or Letter Centers located throughout UPS's service network.\nUPS offers guaranteed delivery by 10:30 a.m. for UPS Next Day Air Packages and Letters sent to areas covering over 76% of the U.S. population and noon delivery to areas covering an additional 15% of the U.S. population. In 1994, UPS introduced Early A.M.(SM) service in all of the 48 contiguous states, which provides guaranteed next-day delivery of packages and documents by 8:30 a.m. In 1993, UPS began offering Next Day Air Saver(SM), which is Next Day Air delivery in the afternoon -- by either 3 p.m. or 4:30 p.m., depending on location, at a slightly lower rate than 10:30 a.m. delivery. UPS also guarantees on-schedule delivery of UPS 2nd Day Air packages.\nIn early 1995, UPS acquired SonicAir, a provider of same-day delivery and third-party logistics services. Through this wholly-owned subsidiary, customers will be offered same-day delivery anywhere in the continental United States, as well as next-flight-out services internationally.\nUPS offers Saturday Delivery for UPS Next Day Air shipments to an area covering approximately 76% of all UPS customers. UPS also offers Saturday Pickup service of air shipments in all areas served by UPS Saturday delivery. Further, in 1993, UPS began accepting hazardous materials in its air services, for an additional charge.\nUPS offers UPS Next Day Air and UPS 2nd Day Air Hundredweight Service for package shipments totaling at least 100 pounds addressed to one consignee at one location on the same day. UPS Air Cargo Service provides two services designed to fill what would otherwise be unfilled capacity on regular UPS flights: the transportation of containerized and palletized cargo in available space on UPS flights and aircraft charters when UPS planes are not being utilized by UPS.\nThe volume of UPS's higher margin air services, such as UPS Next Day Air service, continued to grow during 1994. In 1994, UPS's air services' volume increased by 22% and revenues increased by 20%.\nTo enable UPS to accommodate future demand for air delivery services, UPS, in 1994, completed an expansion of its Dallas, Texas regional air sorting facility and opened a new regional air sorting facility in Rockford, Illinois. UPS also has plans to open an additional new regional air sorting facility in Columbia, South Carolina in 1995. Other regional air sorting facilities are located in Ontario, California and Philadelphia, Pennsylvania. In 1993, UPS ordered thirty new Boeing 767 freighter aircraft and ten more 757 freighter aircraft, in addition to the twenty-one 757 freighter aircraft previously ordered, to meet anticipated future growth in air delivery volume. In 1994, UPS took delivery of twelve more 757 freighter aircraft. For a further description of UPS's properties, see \"Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nOperating Facilities\nDuring 1991, UPS moved its corporate office to Atlanta, Georgia. In 1994, UPS completed its new headquarters at a cost of $105 million, and moved all of its staff into the headquarters.\nAmong UPS's principal operating facilities are those located in Dallas (Texas), Denver (Colorado), Earth City (Missouri), Grand Rapids (Michigan) and Palatine (Illinois). These operating facilities, having floor spaces which range from 350,000 to 1,000,000 square feet, have central sorting facilities, operating hubs and service centers for local operations. UPS has recently completed construction of a large hub facility near Chicago, Illinois. This facility has floor space of approximately 1,900,000 square feet and has\nrecently commenced operations on a limited basis. The estimated cost of this facility, including plant equipment, was approximately $318 million.\nUPS also owns approximately 700 and leases approximately 1,000 other operating facilities throughout the territories it serves. The smaller of these facilities have vehicles and drivers stationed for the pickup of packages and facilities for sorting and transfer and delivery of packages. The larger of these facilities have additional facilities for servicing UPS vehicles and equipment, and employ specialized mechanical installations for the sorting and handling of packages.\nUPS's aircraft are operated in a hub and spokes pattern in the United States. UPS's principal air hub in the United States is located in Louisville, Kentucky, with regional air hubs in Philadelphia, Pennsylvania and Ontario, California. These hubs house facilities for sorting, transfer and delivery of packages. The Louisville hub handles the largest volume of packages for air delivery in the United States. In 1994, UPS finished construction of a regional air hub in Rockford, Illinois and completed the hub expansion in Dallas, Texas. UPS has plans to construct its last regional air hub in Columbia, South Carolina. UPS's European air hub is located in Cologne, Germany.\nUPS's computer operations have been consolidated in a 400,000 square foot leased facility located on a 39 acre site in Mahwah, New Jersey. The construction of a 27,000 square foot addition to the facility commenced in 1994 and should be completed by the fourth quarter of 1995. The addition will accommodate further expansions of up to 54,000 square feet. UPS has leased this facility for an initial term ending in 2019 for use as a data processing, telecommunications and operations facility. UPS has also begun construction of a 160,000 square foot facility located on a 25 acre site in the Atlanta, Georgia area, which will serve as a backup to the main facility in New Jersey. The new facility, to be completed in July 1995, will provide backup capacity in case a power outage or other disaster incapacitates the main data center, and it will also help meet future communication needs.\nAircraft\nUPS operates a fleet of 462 aircraft. UPS's fleet at December 31, 1994 consisted of the following aircraft:\nAn inventory of spare engines and parts is maintained for each aircraft.\nAll of UPS's DC-8-71's, DC-8-73's, B757PF's and 747-100's meet Stage III federal noise regulations. UPS is replacing the three engines on all but seven B727-100 aircraft with new, quieter engines. These re-engined B727-100's will meet Stage III federal noise regulations and will allow UPS to operate into airports with aircraft noise restrictions that exclude B727-100's that have not been re-engined. UPS will accomplish engine modifications for each of its eight 727-200 aircraft to achieve Stage III noise compliance.\nThe current noise regulations do not impact the valuation of these aircraft as their depreciable lives all end before the final phase-in date for Stage III compliance in 1999. All other aircraft operated by UPS are not subject to Stage III noise regulations.\nIn 1994, UPS completed a cockpit modernization program of all but seven aircraft in the B727-100 fleet. This modernization program consisted of replacing many of the original cockpit instruments with modern cathode ray tube (CRT) instrumentation. In addition, the layout and positioning of instruments in these B727-100 cockpits has been standardized to a common configuration. A similar cockpit modernization program is also underway for all the UPS DC8-71 and DC8-73 aircraft. At this time, UPS has not committed seven B727-100's purchased in 1994 to either the re-engining program or the cockpit modernization program.\nDuring 1994, UPS ordered 30 new Boeing 767 freight aircraft (B767-300F) with options to buy 30 more. The delivery of the first 767 is scheduled for October 1995. UPS also accelerated the delivery of two B757-200 aircraft from 1995 to 1994. A total of 12 B757-200's were delivered to UPS in 1994. Eight B757-200's will be delivered to UPS in 1995, along with 5 B767-300F's. In addition, UPS has options for the purchase of 31 additional B757-200 aircraft and 30 B767-300F aircraft for delivery between 1997 and 2008, if additional aircraft are required.\nVehicles\nUPS owns and operates a fleet of approximately 132,000 vehicles and leases 2,400 vehicles, ranging in size from panel delivery cars to large tractors and trailers, including 1,483 temperature-controlled trailers owned by Martrac and 3,917 vehicles owned by UPS Truck Leasing. During 1994, approximately 4,245 package cars, tractors and trailers were purchased and approximately 3,764 older vehicles were retired.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nWhile UPS is routinely involved in litigation relating to the conduct of its business, there are no pending legal proceedings which, individually or in the aggregate, are material to the business of UPS. UPS was subject to tax audits by the United States Internal Revenue Service for the 1983 through 1987 tax years. Information regarding the tax audit is incorporated herein by reference from Note 4 to the Consolidated Financial Statements filed herewith.\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.\nUPS is authorized to issue 900,000,000 shares of common stock, par value $.10 per share, of which 580,000,000 shares were issued and outstanding (including those shares held by UPS for distribution in connection with its stock plans) as of February 28, 1995. UPS is also authorized to issue 200,000,000 shares of preferred stock, without par value. No shares of preferred stock have been issued or are outstanding.\nEach share of UPS Common Stock is entitled to one vote in the election of directors and other matters, except that, generally, any shareowner, or shareowners acting as a group, who beneficially own more than 10 percent of the voting stock are entitled to only one one-hundredth of a vote with respect to each vote in excess of 10 percent of the voting power of the then outstanding shares of voting stock. Holders have no preemptive or other right to subscribe to additional shares. In the event of liquidation or dissolution, they are entitled to share ratably in the assets available after payment of all obligations. The shares are not redeemable by UPS except through UPS's exercise of the preferential right of purchase mentioned below and, in the case of stock subject to the UPS Managers Stock Trust, UPS's right of purchase in the circumstances described herein.\nShareowners are entitled to such dividends as are declared by the Board of Directors. The policy of the UPS Board is to declare dividends each year out of current earnings. However, the declaration of future dividends is subject to the discretion of the Board of Directors in light of all relevant facts, including UPS's earnings, general business conditions and capital requirements.\nUPS Common Stock is not listed on a national securities exchange or traded in the organized over-the-counter market. The UPS Certificate of Incorporation provides that no outstanding shares of UPS capital stock entitled to vote generally in the election of directors may be transferred to any other person, except by bona fide gift or inheritance, unless the shares shall have first been offered, by written notice, for sale to UPS at the same price and on the same terms upon which they are to be offered to the proposed transferee.\nUPS has the right, within 30 days after receipt of the notice, to purchase all or a part of the shares at the price and on the terms offered. If it fails to exercise or waives the right, the shareowner may, within a period of 20 days thereafter, sell to the proposed transferee all, but not part, of the shares which UPS elected not to purchase, for the price and on the terms described in the offer. All transferees of shares hold their shares subject to the same restriction. Shares previously offered but not transferred within the 20 day period remain subject to the initial restrictions. Shares may be pledged or otherwise used for security purposes, but no transfer may be made upon a foreclosure of the pledge until the shares have been offered to UPS at the price and on the terms and conditions bid by the purchaser at the foreclosure.\nUPS, from time to time, has waived its right of first refusal to purchase its shares in order to permit managers and supervisors to purchase shares at the same price as UPS was willing to pay. The grant of waivers in these cases has been effected after considering the needs of UPS for purposes of the UPS Managers Incentive Plan and UPS's 1986 and 1991 Stock Option Plans (\"Plans\") and other corporate purposes and has been subject to those needs. Persons who purchase shares in this manner are required to deposit them in the UPS Managers Stock Trust.\nUPS notifies its shareowners periodically of its willingness to purchase shares at specified prices determined by the Board of Directors, in the event that shareowners wish to sell their shares. During 1994, UPS purchased 29,290,052 shares at an aggregate purchase price of approximately $632 million.\nIn determining the prices, the Board considers a variety of factors, including past and current earnings, earnings estimates, the ratio of UPS Common Stock to debt of UPS, other factors affecting the business and outlook of UPS and general economic conditions, as well as opinions furnished from time to time by two firms of investment counselors, each acting independently, as to the value of UPS shares. The Board has not followed any predetermined formula. It has considered a number of formulas commonly used in the evaluation of securities of closely held and of publicly held companies, but its decisions have been based primarily on the judgment of the Board of Direc-\ntors as to the long-range prospects of UPS rather than what the Board considers to be the short-term trends relating to UPS or the values of securities generally. Thus, for example, the Board has not given substantial weight to short-term variations in average price-earnings ratios of publicly traded securities which at times have been considerably higher, and at other times, considerably lower, than those for UPS's securities. However, the Board's decision as to prices does take into account factors affecting generally the market prices of publicly traded securities, and prolonged changes in those prices could have an effect on the prices offered by UPS.\nOne factor in determining the prices at which securities trade in the organized markets is that of supply and demand. When demand is high in relation to the shares which investors seek to sell, prices tend to increase, while prices tend to decrease when demand is low in relation to the shares being sold. To date, the UPS Board of Directors has not given significant weight to considerations of supply and demand in determining the price to be paid by UPS for its shares. UPS has had a need for many of its shares for purposes of awards under the Plans, and eligible managers and supervisors have purchased many other available shares. When the number of shares acquired by UPS exceeds the number needed for these purposes within a reasonable period, the excess shares are constructively retired and treated as authorized and unissued shares by UPS.\nUPS intends to continue its policy of purchasing a limited number of shares when offered by shareowners. However, there can be no assurance of continuation of that policy. The feasibility of purchases by UPS and the prices at which shares may be purchased are both subject to the continued maintenance by UPS of satisfactory earnings and financial condition. Hence, both the salability of UPS shares and the prices at which they may be sold would be adversely affected by a continuous decline of UPS's earnings or by unfavorable changes in its financial position and might be adversely affected by decisions of shareowners to sell substantially more shares than the Board considers necessary for the ultimate purpose of making awards under the Plans.\nThe prices at which UPS has published notices of its willingness to purchase shares of Common Stock since January 1993 have been as follows:\nOn February 16, 1995, UPS expressed its willingness to purchase shares at $23.75 per share, which is still the price at the date of this report.\nIn February 1995, UPS distributed an aggregate of 6,487,408 shares of UPS Common Stock, subject to the UPS Managers Stock Trust, under the UPS Managers Incentive Plan to a total of 29,462 employees at a managerial or supervisory level. In February 1994, it distributed an aggregate of 6,325,902 shares of UPS Common Stock under that Plan to a total of 28,096 managerial or supervisory employees. The UPS Managers Stock Trust and the Managers Incentive Plan have been previously described in the UPS Registration Statement on Form 10 and in the UPS Prospectus, dated February 1, 1995, relating to the UPS Managers Incentive Plan awards. Such distributions do not represent \"sales\" as defined under the Securities Act of 1933, as amended (the \"1933 Act\"). However, the shares awarded were registered under the 1933 Act to permit resales of the shares consistent with the interpretations of the Securities and Exchange Commission under Rule 144 adopted under the 1933 Act.\nDuring 1994, 1,215,680 shares of UPS Common Stock were distributed to 1,881 employees upon the exercise of stock options granted to them by UPS under the 1986 Stock Option Plan. In addition, a total of 5,433,772 shares of UPS Common Stock were sold, pursuant to a stock offering by UPS, to 13,373 UPS managers and supervisors. The offering has been previously described in the UPS Registration Statement on Form S-3 (No. 33-54297), which became effective in August 1994. The shares issued upon exercise of the options and the shares purchased pursuant to the offering are subject to the UPS Managers Stock Trust. During 1994, UPS also sold 15 million shares of UPS Common Stock to the UPS Thrift Plan at a price of $330 million.\nShares of UPS Common Stock issued to employees under the Plans and most other shares of UPS Common Stock owned by UPS employees are held subject to the UPS Managers Stock Trust (the \"Trust\"). First Fidelity Bank (\"Fidelity\") serves as trustee under the Trust. The Trust agreement gives UPS the right to purchase the shares of UPS Common Stock of members deposited in the Trust at their fair market value, as defined, when the member retires, dies or ceases to be an employee of UPS, or when the member requests the withdrawal of shares from the Trust. Fair market value is defined as the fair market value of the shares at the time of the sale, or in the event of differences of opinion as to value, the average price per share of all shares of UPS sold during the 12 months preceding the sale involved. UPS becomes entitled to purchase shares of UPS Common Stock held under the Trust within 60 days of a request from the member to release the shares from the Trust and upon occurrence of the other enumerated events. The time during which UPS may purchase shares of UPS Common Stock following the cessation of employment varies from three years to thirteen years, depending upon the number of shares held by the employee and the date of the applicable trust agreement. In the event UPS fails to exercise its option within the prescribed periods, the employee would become entitled, upon request, to the delivery of the shares of\nUPS Common Stock free and clear of the Trust, unless the purchase period has been extended by agreement of UPS and the shareowner. UPS has consistently exercised its purchase rights.\nMembers of the Trust are entitled to the dividends on shares of UPS Common Stock held for their accounts (except that stock dividends are added to the shares held by the Trustee for the benefit of the individual members), to direct the Trustee as to how the shares held for their benefit are to be voted and to request proxies from the Trustee to vote shares held for their accounts.\nIn January 1995, UPS paid a cash dividend of $.30 a share. For the fiscal year ended December 31, 1994, UPS paid cash dividends of $.25 a share in January 1994 and $.25 in June 1994. For the fiscal year ended December 31, 1993, UPS paid a cash dividend of $.25 a share in June 1993.\nUPS intends to continue its policy of paying dividends to its shareowners. However, the declaration of future dividends is subject to the discretion of the Board of Directors in light of all relevant facts, including earnings, general business conditions and working capital requirements. Loan agreements, to which UPS is a party, limit the amount which UPS may declare as dividends and use for the repurchase of its Common Stock. The most restrictive of these agreements limits the declaration of dividends, other than stock dividends, and payments for the purchase of Common Stock to the extent that such declarations and payments, together with all other payments made subsequent to January 1, 1985 would exceed, in the aggregate, (i) $250,000,000, (ii) 66-2\/3% of net income, as defined in the agreement, and (iii) the net proceeds from the issuance, sale or disposition of any shares of stock of UPS or any warrants or other rights to purchase such stock subsequent to January 1, 1985. As of December 31, 1994 UPS had approximately $979 million not subject to these restrictions. These limits do not materially restrict the declaration of dividends.\nSet forth below is the approximate number of record holders of equity securities of UPS as of February 28, 1995.\n________________________________________________________________________________\n1. Refers to beneficial owners. The record holder of the shares of Common Stock subject to the Trust is Saul & Co., as nominee for First Fidelity Bank, N.A., Newark, New Jersey, as Trustee.\nItem 6.","section_6":"Item 6. Selected Financial Data.\n___________________________ (1) All per share amounts have been restated to reflect the 4-for-1 stock split effective September 6, 1991.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nOperations\n1994 Compared to 1993\nRevenue increased $1.793 billion, or 10.1%, during 1994 compared to 1993. For 1994, domestic revenue totaled $17.298 billion, an increase of $1.475 billion, or 9.3%, over 1993 and international revenue totaled $2.278 billion, an increase of $318 million, or 16.2%, over 1993.\nDomestic revenue increased as a result of higher volume which was up 2.3%, favorable changes in rates and a continuing shift toward higher yielding packages. During the first quarter of 1994, published rates for domestic ground services for commercial and residential deliveries were increased by 3.8% and 4.3%, respectively. Additionally, the published rates for Next Day Air and 2nd Day Air packages each increased by 3.9% and the published rates for Next Day Air and 2nd Day Air letters increased by 2.4% and 4.5%, respectively.\nThe increase in international revenue was primarily attributable to higher volume, which was up 8.0%. The majority of the increased volume related to higher yielding, export packages.\nOperating expenses increased by $1.695 billion, or 10.4%, which was commensurate with the increase in revenues. Higher wages and employee benefits accounted for the majority of the increase. Other operating expenses were up in a variety of categories with the largest increases relating to depreciation and purchased transportation. As part of UPS's overall effort to lower operating expenses, it is considering a possible reduction in the number of managers it employs from the current level of approximately 35,000. However, no decisions have been made as to the size of a possible reduction. UPS is considering the extent to which its objectives can be met through attrition, early retirement and possible layoffs. Therefore, the projected savings or expenses associated with a possible reduction in the number of managers cannot be determined.\nOperating profit for 1994 increased by $98 million, or 6.7%. This increase resulted primarily from higher revenue discussed above.\nIncome before income taxes and cumulative effect of a change in accounting principle (\"pre-tax income\") increased by $144 million, or 10.0%. Domestic pre-tax income amounted to $1.902 billion, an increase of $204 million, or 12.0%, over 1993. This increase was a result of higher operating profit and the sale of an investment property in January at a gain of approximately $46 million. The\ninternational pre-tax loss increased by $60 million, or 22.6%, bringing the total international pre-tax loss to $327 million for 1994.\nThe international pre-tax loss attributable to the foreign domestic operations increased by $56 million, or 31.8%, primarily as a result of competitive factors. The pre-tax loss associated with export operations increased by $4 million, or 4.8%. Export volume increased by 48.0% and 16.3% for international and U.S. origin, export shipments, respectively. UPS expects the cost of operating its international business will continue to exceed revenue in the near future.\nNet income increased by $134 million, or 16.5%. This increase resulted primarily from the higher operating profit, a gain on a long-term investment property described above and a deferred tax adjustment recorded in 1993 to reflect the effect of the increase in the maximum U.S. federal income tax rate for corporations from 34% to 35%. See also Note 7 to the consolidated Financial Statements.\n1993 Compared to 1992\nRevenue increased $1.264 billion, or 7.7%, during 1993 compared to 1992. For 1993, domestic revenue totaled $15.823 billion, an increase of $1.101 billion, or 7.5%, over 1992, and international revenue totalled $1.960 billion, an increase of $163 million, or 9.1%, over 1992. Domestic revenue increased as a result of favorable changes in rates and a shift toward higher yielding packages. Increases in published rates during the first quarter of 1993 ranged from 4.9% to 5.9% for domestic air shipments and averaged approximately 4.5% for domestic ground shipments. These increases offset a 0.6% decline in domestic volume during 1993. The increase in international revenue was attributable to higher volume, which was up 11.8%. However, the effect of the international volume increase on revenue was partially offset by a decrease in revenue per piece. This decrease resulted from competitive pressures and poor economic conditions in certain foreign markets along with currency exchange rate fluctuations with respect to the U.S. dollar and discounting in connection with efforts to build volume.\nOperating expenses increased by $1.084 billion, or 7.1%. The increase was primarily the result of increases in average pay rates and employee benefits. In November 1993, UPS entered into a new, four-year labor agreement with the International Brotherhood of Teamsters (\"Teamsters\"). The new agreement resulted in hourly increases in wages and employee benefits for senior drivers of $2.25 and $1.80, respectively, over the four-year term. The agreement will result in similar increases in wages and employee benefits for the Company's other Teamsters employees. Terms of the agreement were effective August 1, 1993.\nOperating profit for 1993 increased by $180 million, or 14.1%. This increase resulted primarily from higher revenue.\nIncome before income taxes and cumulative effect of a change in accounting principle (\"pre-tax income\") increased by $162 million, or 12.8%. Domestic pre-tax income amounted to $1.698 billion, an increase of $153 million, or 9.9%, over 1992 as a result of higher operating profit. The international pre-tax loss decreased by $10 million, or 3.5% bringing the international pre-tax loss to $267 million for 1993. This change resulted from improved export operations and favorable swings in currency exchange rates offset by declines in foreign domestic operations.\nThe international pre-tax loss attributable to the foreign domestic operations increased by $71 million, or 68.2%, primarily as a result of weak economic conditions and tough competition. The pre-tax loss associated with export operations decreased by $81 million, or 47.1%, as a result of increased volume and the achievement of greater cost efficiencies in the international network. Export volume increased by 36.1% and 35.7% for international and U.S. origin, export shipments, respectively.\nThe provision for income taxes increased by approximately $118 million, or 23.4%. This increase is a result of higher pre-tax income as well as an increase in the U.S. federal income tax rate, as described more fully in Note 7 to the Consolidated Financial Statements.\nIncome before cumulative effect of a change in accounting principle increased by $45 million, or 5.8%. This increase resulted from the increase in pre-tax income, partially offset by the increase in the U.S. federal income tax rate.\nLiquidity and Capital Resources\nUPS believes that its internally generated funds, revolving credit facilities and commercial paper program (discussed below) will provide adequate sources of liquidity and capital resources to meet its expected future short-term and long-term needs for the operation of its business, including anticipated capital expenditures of $2.2 billion for land, buildings, equipment and aircraft in 1995, as well as commitments for aircraft purchases through 2000.\nDuring the fourth quarter of 1993, UPS established a commercial paper program under which it may borrow up to $500 million on a short-term, unsecured basis at favorable rates. The amount which UPS can borrow under this program was increased to $1 billion in 1995.\nAgents for the United States Internal Revenue Service (\"IRS\") have asserted in reports that UPS is liable for additional tax for the 1984 through 1987 tax years. The assertions are based in large part on the theory that UPS is liable for tax on income of Overseas Partners Ltd. (\"OPL\"), a Bermuda company, which has reinsured excess value package insurance purchased by UPS's customers from unrelated insurers. The adjustments sought by the agent relating to package insurance are based on a number of inconsistent theories and range from $97 million to $183 million of tax, plus penalties and interest, for the period stated above.\nIn addition, the agents have raised a number of other issues relating to the timing of deductions; the characterization of expenses as capital rather than ordinary; and UPS's entitlement to the Investment Tax Credit in the 1983 through 1987 tax years. The adjustments sought on these issues aggregate $127 million in tax, the majority of which would reverse in future years, plus penalties and interest.\nAfter consultation with legal experts, management believes there is no merit to any material issues raised by the IRS and that the eventual resolution of these matters will not have a material impact on the Company. Although no assessment has yet been made by the IRS with respect to the years 1983 through 1987, it is likely the IRS will issue a Notice of Deficiency for the years 1983 and 1984 which the Company will contest through litigation. The IRS has not proposed adjustments for years subsequent to 1987, although the IRS may take positions similar to those in the reports described above for periods after 1987.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nFinancial Statements\nThe Financial Statements of UPS are filed together with this Report: see Index to Financial Statements, page, which 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.\nInformation regarding the Directors of UPS is presented under the caption \"Election of Directors\" in UPS's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on May 11, 1995, which will be filed with the Securities and Exchange Commission (the \"SEC\") by March 31, 1995, is incorporated herein by reference.\nInformation concerning UPS's executive officers can be found in Part I, Item 1, of this Form 10-K under the caption \"Executive Officers\" in accordance with Instruction 3 of Item 401(b) of Regulation S-K and General Instruction G(3) of Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation in answer to this Item 11 is presented under the caption \"Compensation of Executive Officers and Other Information\" excluding the information under the captions \"Report of the Officer Compensation Committee on Executive Compensation\" and \"Shareowner Return Performance Graph\" in UPS's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on May 11, 1995, which will be filed with the SEC by March 31, 1995, is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation in answer to this Item 12 is presented under the caption \"Stock Ownership\" in UPS's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on May 11, 1995, which will be filed with the SEC by March 31, 1995, is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation in answer to this Item 13 is presented under the captions \"Certain Business Relationships\" and \"Common Relationships with Overseas Partners Ltd.\" in UPS's definitive Proxy Statement for the Annual Meeting of Shareowners to be held on May 11, 1995, which will be filed with the SEC by March 31, 1995, 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. - See Index to Financial Statements and Financial Statement Schedules at page, which is incorporated herein by reference.\n2. Financial Statement Schedules - Not applicable\n3. List of Exhibits. - See Exhibit Index at page E-1, which is incorporated herein by reference.\n(b) Reports on Form 8-K. - No reports on Form 8-K were filed during the quarter ended December 31, 1994\n(c) Exhibits required by Item 601 of Regulation S-K. - See Exhibit Index at page E-1, which is incorporated herein by reference.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, United Parcel Service of America, Inc. has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nUNITED PARCEL SERVICE OF AMERICA, INC. (Registrant)\nDate: March 29, 1995 By: \/s\/ Kent C. Nelson --------------------------------- Kent C.Nelson 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.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES\nCONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nCOMPRISING ITEMS 8 AND 14(a) (2) OF ANNUAL REPORT ON FORM 10-K\nTO SECURITIES AND EXCHANGE COMMISSION\nTHREE YEARS ENDED DECEMBER 31, 1994\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND FINANCIAL 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 notes thereto.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareowners United Parcel Service of America, Inc. Atlanta, Georgia\nWe have audited the accompanying consolidated balance sheets of United Parcel Service of America, Inc., and its subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, shareowners' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 consolidated financial statements present fairly, in all material respects, the financial position of United Parcel Service of America, Inc., and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 5 to the consolidated financial statements, in 1992 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 LLP\nAtlanta, Georgia February 8, 1995\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET December 31, 1994 and 1993 (000's omitted except share amounts)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET December 31, 1994 and 1993 (000's omitted except share amounts)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES STATEMENT OF CONSOLIDATED INCOME Years Ended December 31, 1994, 1993 and 1992 (000's omitted except per share amounts)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES STATEMENT OF CONSOLIDATED SHAREOWNERS' EQUITY Years Ended December 31, 1994, 1993 and 1992 (000's omitted except per share amounts)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC., AND SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS Years Ended December 31, 1994, 1993 and 1992 (000's omitted)\nSee notes to consolidated financial statements.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\n1. SUMMARY OF ACCOUNTING POLICIES\nBasis of Financial Statements and Business Activities\nThe accompanying consolidated financial statements include the accounts of United Parcel Service of America, Inc., and all of its subsidiaries (collectively \"UPS\"). All material intercompany balances and transactions have been eliminated.\nUPS concentrates its operations in the field of transportation services, primarily domestic and international package delivery. Revenue is recognized upon delivery of a package.\nCash Equivalents\nCash equivalents (short-term investments) consist of highly liquid investments which are readily convertible into cash. The carrying amount approximates fair value because of the short-term maturity of these instruments.\nCommon Stock Held for Stock Plans\nUPS accounts for its common stock held for distribution pursuant to awards under the UPS Managers Incentive Plan and the UPS Stock Option Plan as a current asset. The liability for the amount of the annual managers incentive award is included in accrued wages and withholdings. Common stock held in excess of current requirements is accounted for as a reduction in Shareowners' Equity.\nProperty, Plant and Equipment\nProperty, plant and equipment are carried at cost. Depreciation (including amortization) is provided by the straight-line method over the estimated useful lives of the assets, which are as follows: Vehicles - 9 years; Aircraft - 12 to 20 years; Buildings - 10 to 40 years; Leasehold Improvements - lives of leases; Plant Equipment - 8 1\/3 years.\nCosts in Excess of Net Assets Acquired\nCosts in excess of net assets acquired are amortized over a 10-year period using the straight-line method.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nIncome Taxes\nDeferred income taxes result primarily from the use of accelerated depreciation methods allowable for income tax purposes, certain differences in asset lives adopted for income tax purposes, temporary differences between the accrual and payment of employee compensation and investments in leveraged leases. UPS adopted Statement of Financial Accounting Standards (\"FAS\") No. 96, \"Accounting for Income Taxes,\" in 1987, and FAS 109, \"Accounting for Income Taxes,\" in 1993.\nThe benefit of investment tax credits is amortized over seven years except investment tax credits from the investment in leveraged leases, which is amortized over the life of the lease.\nCapitalized Interest\nInterest incurred during the construction period of certain property, plant and equipment is capitalized until the underlying assets are placed in service, at which time amortization of the capitalized interest begins, straight-line, over the estimated useful lives of the related assets. Capitalized interest was $45,400,000, $27,800,000, and $26,500,000 for 1994, 1993 and 1992, respectively.\nDerivative Instruments\nUPS has entered into interest rate swap agreements to lower the effective interest rate on its debentures. These agreements have an average remaining life of two years. The periodic settlement payments are accrued monthly, as either a charge or credit to expense, and are not material to net income. Based on estimates provided by third party investment bankers, the fair value of the Company's interest rate swap agreements is not material to the Company's financial statements.\nThe Company also purchases options to reduce the impact of changes in foreign currency rates on its foreign currency purchases and to moderate the impact of major increases in the cost of crude oil on fuel expense. The options are adjusted to fair value at period end based on market quotes and are not material to the Company's financial statements.\nUPS is exposed to credit loss in the event of nonperformance by the other parties to the interest rate swap agreements. However, UPS does not anticipate nonperformance by the counterparties. UPS is exposed to market risk based upon changes in interest rates, foreign currency exchange rates, and crude oil prices.\nChanges in Presentation\nCertain prior year amounts have been reclassified to conform to the current year presentation.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\n2. LONG-TERM DEBT\nLong-term debt, as of December 31, consists of the following (000's omitted):\nThe debentures are not subject to redemption prior to maturity and are not subject to sinking fund requirements. Interest is payable semi-annually on the first of April and October. The average interest rate on the commercial paper outstanding as of December 31, 1994, was 6.0%. The commercial paper has been classified as long-term debt in accordance with the Company's intention and ability to refinance such obligations on a long-term basis. However, the amount of commercial paper outstanding in 1995 is expected to fluctuate and may be reduced from time to time. The industrial development bonds bear interest at either a daily, variable, or fixed rate. The average interest rates for 1994 and 1993 were 2.7% and 2.2%, respectively. The installment notes, mortgages and bonds bear interest at rates of 6.0% to 11.5%.\nThe aggregate annual principal payments for the next five years, excluding commercial paper, are: 1995- $1,675,000; 1996- $3,720,000; 1997- $3,105,000; 1998- $3,293,000; and 1999- $2,514,000.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nBased on the borrowing rates currently available to the Company for long-term debt with similar terms and maturities, the fair value of long-term debt is approximately $1,127,000,000 as of December 31, 1994.\n3. COMMON STOCK PER SHARE DATA\nPer share amounts related to income are based on 580,000,000 shares in 1994 and 1993 and 595,000,000 shares in 1992 and include Common Stock Held for Stock Plans.\n4. LEGAL PROCEEDINGS AND COMMITMENTS\nUPS is a defendant in various lawsuits which arose in the normal course of business. In the opinion of management, none of these cases are expected to have a material effect on the financial condition of UPS.\nAgents for the United States Internal Revenue Service (\"IRS\") have asserted in reports that UPS is liable for additional tax for the 1984 through 1987 tax years. The assertions are based in large part on the theory that UPS is liable for tax on income of Overseas Partners Ltd. (\"OPL\"), a Bermuda company, which has reinsured excess value package insurance purchased by UPS's customers from unrelated insurers. The adjustments sought by the agents relating to package insurance are based on a number of inconsistent theories and range from $97 million to $183 million of tax, plus penalties and interest, for the period stated above.\nIn addition, the agents have raised a number of other issues relating to the timing of deductions; the characterization of expenses as capital rather than ordinary; and UPS's entitlement to the Investment Tax Credit in the 1983 through 1987 tax years. The adjustments sought on these issues aggregate $127 million in tax, the majority of which would reverse in future years, plus penalties and interest.\nAfter consultation with legal experts, management believes there is no merit to any material issues raised by the IRS and that the eventual resolution of these matters will not have a material impact on the Company. Although no assessment has yet been made by the IRS with respect to the years 1983 through 1987, it is likely the IRS will issue a Notice of Deficiency for the years 1983 and 1984 which the company will contest through litigation. The IRS has not proposed adjustments for years subsequent to 1987, although the IRS may take positions similar to those in the reports described above for periods after 1987.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nUPS leases certain operating facilities and aircraft, the majority of which are from related parties, including various UPS employee benefit plans. These leases expire at various dates through 2030. Total aggregate minimum lease commitments are as follows (000's omitted):\nUPS maintains two credit agreements with a consortium of banks which provide revolving credit facilities of $500,000,000 each, with one expiring June 12, 1995 and the other June 14, 1996. At December 31, 1994, there were no outstanding borrowings under these facilities. As of December 31, 1994, UPS has outstanding letters of credit totaling approximately $783,732,000 issued in connection with routine business requirements.\nAt December 31, 1994, UPS had commitments outstanding for capital expenditures under purchase orders and contracts of approximately $3.4 billion, of which approximately $1.2 billion is expected to be spent in 1995.\n5. EMPLOYEE BENEFIT PLANS\nUPS maintains the UPS Retirement Plan (the \"Plan\"). The Plan is a defined benefit plan which provides employees annual defined retirement benefits. The Plan is noncontributory and all employees who meet certain minimum age and years of service are eligible, except those covered by certain multi-employer plans provided for under collective bargaining agreements.\nThe Plan provides for retirement benefits based on average compensation levels earned by employees during certain years of service preceding retirement. The Plan's assets consist primarily of publicly traded stocks and bonds. In addition, the Plan's assets include 8,052,840 shares of UPS common stock at both December 31, 1994 and 1993. The actual earnings on the Plan's assets were $88,944,000, $224,405,000, and $124,661,000, in 1994, 1993 and 1992, respectively. UPS's funding policy is consistent with relevant federal tax regulations. Accordingly, UPS contributes amounts deductible for federal income tax purposes.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nPension expense, consisting of various component parts, and certain assumptions used during the years ended December 31, are as follows (000's omitted):\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nThe following schedule reconciles the funded status of the Plan with certain amounts included in the balance sheet as of December 31 (000's omitted):\nUPS also contributes to several multi-employer pension plans for which the above information is not determinable. Amounts charged to operations for contributions to pension plans other than the Plan described above were $506,215,000, $455,842,000, and $407,879,000 during 1994, 1993 and 1992, respectively.\nUPS sponsors defined benefit postretirement medical plans that provide health care benefits to its retirees who meet certain eligibility requirements and who are not covered by multi-employer retirement plans. Generally, this includes employees with at least 10 years of service who have reached age 55 and will be receiving benefits from one of the Company's retirement plans. The Company has the right to modify or terminate certain of these plans. Historically, these benefits have been provided to retirees on a noncontributory basis; however, effective January 1, 1992, the Company made modifications which will likely result in cost sharing in the future for certain of its retirees.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nPrior to 1992, UPS had generally expensed the costs of these benefits on a current, \"pay as you go\" basis. During 1992, UPS adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" This Statement requires accrual of postretirement benefits, which include health care benefits, during the years an employee provides service.\nThe effect of adoption resulted in a one-time \"catch-up\" charge during 1992 of approximately $248.9 million, after tax, representing the cumulative effect of the change as of January 1, 1992. In addition to the cumulative effect, adoption of this Statement resulted in additional charges to income in 1994, 1993 and 1992 of approximately $64,300,000, $47,500,000, and $40,300,000, respectively, after tax ($0.11, $0.08, and $0.07 per share, respectively). Overall, net income for 1994, 1993 and 1992 was reduced $64,300,000, $47,500,000, and $289,200,000, respectively, as a result of adoption ($0.11, $0.08, and $0.49 per share, respectively).\nThe accumulated postretirement benefit obligation at December 31, is detailed as follows (000's omitted):\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nNet periodic postretirement benefit cost for the years ended December 31, included the following components (000's omitted):\nThe significant assumptions used in determining postretirement benefit cost and the accumulated postretirement benefit obligation were as follows:\nFuture benefit costs were forecasted assuming an initial annual increase of 10.25% for pre-65 medical costs and an increase of 9.25% for post-65 medical costs, decreasing to 7.25% for pre-65 and 6.25% for post-65 by the year 2000 and with consistent annual increases at those ultimate levels thereafter. A one percentage point increase in the annual trend rate would have increased the total accumulated postretirement benefit obligation at December 31, 1994, by $71.8 million and the aggregate of the service and interest components of the net periodic postretirement benefit costs for 1994 by $11.5 million.\nPlan assets consist primarily of publicly traded stocks and bonds. The Trust holding the Plan assets is not subject to income taxes. UPS's funding policy is consistent with relevant federal tax regulations. Accordingly, UPS contributes amounts deductible for federal income tax purposes.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\n6. MANAGEMENT INCENTIVE PLANS\nUPS maintains the UPS Managers Incentive Plan. Persons earning the right to receive awards are determined annually by either the Officer Compensation Committee or the Salary Committee of the UPS Board of Directors. Awards consist primarily of UPS common stock and cash equivalent to the tax withholdings on such awards. The total of all such awards is limited to 15% of consolidated income before federal income taxes for the 12-month period ending each September 30, exclusive of gains and losses from the sale of real estate and stock of subsidiaries. In addition, the cumulative effect of a change in accounting principle was specifically excluded from the 1992 award calculation in accordance with a vote of shareowners. Amounts charged to operations were $255,482,000, $217,784,000, and $198,943,000, during 1994, 1993 and 1992, respectively.\nUPS maintains stock option plans. Originally, these plans were established to issue Book Value Shares. Book Value Shares were shares of UPS common stock with a stated value equal to the UPS book value per share as of the year end immediately preceding the date of option grant. Voting, dividends and liquidation rights for the Book Value Shares were the same as for other UPS common stock. UPS repurchased all Book Value Shares immediately after their issuance except for certain repurchases from officers and directors which were deferred for up to six months.\nExcept in the case of death, disability, or retirement, options are exercisable only during a limited period after the expiration of five years from the date of grant but are subject to earlier cancellation or exercise under certain conditions. The number of options and option prices for Book Value Shares exercised under the Plans were 4,611,372 and $5.68 in 1992. There were no Book Value Shares exercised during 1994 or 1993. Compensation expense charged to operations related to exercise of these options was not material. No further shares may be issued under the 1986 plan.\nPrior to issuing options for any Book Value Shares, the 1991 Plan was amended during 1992 to change it to a Current Price Plan. Under a Current Price Plan, options are granted to purchase shares of UPS common stock at the current price of UPS shares as determined by the Board of Directors on the date of option grant. Unlike Book Value Shares, the optionee may continue to hold the shares of common stock received on exercise, subject to the terms of the UPS Managers Stock Trust. Persons earning the right to receive stock options under the 1991 plan are determined each year by either the Officer Compensation Committee or Salary Committee of the UPS Board of Directors. Options covering a total of 30,000,000 common shares may be granted during the five-year period ending in 1996.\nAlso during 1992, an amendment was made to the 1986 plan to allow options on Book Value Shares issued during the period 1988 through 1991 to be converted to Current Price options in the\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nratio of three common shares for five Book Value Shares. Substantially all holders of unexpired options for Book Value Shares elected to convert to options for common stock as of December 31, 1992. Following is an analysis of options for shares of common stock issued and outstanding:\nCurrent Price options converted from Book Value options were issued with exercise prices equal to the published price of UPS common stock as of the year end immediately preceding the original date of grant. Compensation expense charged to operations related to these options was not material. Options granted during 1994, 1993 and 1992 have an exercise price equal to the current price of a share of UPS common stock at the date of grant.\n7. INCOME TAXES\nEffective January 1, 1993, UPS adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"FAS 109\"). FAS 109 is an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. In estimating future tax consequences, FAS 109 generally considers all expected future events other than enactments of changes in the tax law or rates. Previously, the Company used the FAS 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.\nThe effects of adopting FAS 109 were not material to the Company's financial position or results of operations.\nDuring the third quarter of 1993, the maximum U.S. federal income tax rate for corporations was increased from 34% to 35%\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\neffective January 1, 1993. In addition to increasing the Company's income tax accruals for its 1993 current and deferred taxable income, the Company made a $31.8 million adjustment to reflect the effect of the rate change on its net deferred tax liabilities on January 1, 1993.\nThe provision for income taxes for the years ended December 31, consists of the following (000's omitted):\nIncome before income taxes and cumulative effect of a change in accounting principle includes losses of foreign subsidiaries of $172,311,000, $169,689,000 and $114,941,000 for 1994, 1993 and 1992, respectively.\nA reconciliation of the statutory federal income tax rate to the effective income tax rate for the years ended December 31, consists of the following:\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nDeferred tax liabilities and assets are comprised of the following at December 31 (000's omitted):\nThe valuation allowance increased approximately $64,000,000 and $90,000,000 during the years ended December 31, 1994 and 1993, respectively.\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nThe tax effects of items included in the deferred tax provision for 1992, consist of the following (000's omitted):\nUPS has international loss carryforwards of approximately $598,000,000 as of December 31, 1994. Of this amount, $337,000,000 expires in varying amounts through 2000. The remaining $261,000,000 may be carried forward indefinitely.\n8. OTHER ASSETS\nOther assets, as of December 31, consist of the following (000's omitted):\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\nLeveraged Leases\nThe net investment in leveraged leases, as of December 31, consists of the following (000's omitted):\nUnearned income on each leveraged lease is amortized to provide an approximate level rate of return when compared to UPS's unrecovered net investment.\n9. DEFERRED TAXES, CREDITS AND OTHER LIABILITIES\nDeferred taxes, credits and other liabilities, as of December 31, consist of the following (000's omitted):\nUNITED PARCEL SERVICE OF AMERICA, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1994, 1993 and 1992\n10. SEGMENT AND GEOGRAPHIC INFORMATION\nUPS operates primarily in one industry segment, transportation services, which is comprised principally of domestic and international package delivery. Information about operations in different geographic segments for the years ended December 31, is shown below (000's omitted):\nForeign operations include shipments which either originate in or are destined to foreign (non-U.S.) locations. Foreign revenues attributable to shipments which originated in the U.S. totaled $495,957,000, $390,984,000, and $323,732,000 in 1994, 1993 and 1992, respectively.\n11. OTHER OPERATING EXPENSES\nThe major components of other operating expenses for the years ended December 31, are as follows (000's omitted):\n________________________________________________________________________________ ________________________________________________________________________________\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\n_______________________\nEXHIBITS\nTO\nFORM 10-K\nANNUAL REPORT\nFOR THE FISCAL YEAR ENDED DECEMBER 31, 1994\n_______________________\nUNITED PARCEL SERVICE OF AMERICA, INC.\n________________________________________________________________________________ _______________________________________________________________________________\nEXHIBIT INDEX\n(3) Articles of Incorporation and By-laws.\n(a) Restated Certif- Incorporated by Reference to icate of Incorpo- Exhibit 4(iv) to Form S-8 ration of UPS. Registration Statement (No. 33-19622).\n(b) By-laws of UPS as Incorporated by Reference amended through to Exhibit 3(b) to 1991 February 21, 1992. Annual Report on Form 10-K.\n(4) Instruments defining the rights of security holders, including indentures.\n(a) Specimen Certif- Incorporated by Reference to icate of Capital Exhibit 3(a) to Form 10, as Stock of UPS. filed April 29, 1970.\n(b) UPS Managers Stock Incorporated by Reference to Trust Agreement. Exhibit 2 to Registration Statement No. 2-46382.\n(c) Specimen Certificate Incorporated by Reference to of 8 3\/8% Debentures Exhibit 4(c) to Registration due April 1, 2020. Statement No. 33-32481.\n(d) Indenture relating to Incorporated by Reference to 8 3\/8% Debentures Exhibit 4(c) to Registration due April 1, 2020. Statement No. 33-32481.\n(10) Material Contracts.\n(a) UPS Thrift Plan, as Amended and Restated January 1, 1976, in- cluding Amendments Nos. 1 and 2.\n(1) Amendment Incorporated by Reference to No. 3 to the Exhibit 20(b) to 1980 Annual UPS Thrift Plan. Report on Form 10-K.\n(2) Amendment Incorporated by Reference to No. 4 to the Exhibit 20(b) to 1981 Annual UPS Thrift Plan. Report on Form 10-K.\nE-1\n(3) Amendment Incorporated by Reference to No. 5 to the Exhibit 19(b) to 1983 Annual UPS Thrift Plan. Report on Form 10-K.\n(4) Amendment Incorporated by Reference to No. 6 to the Exhibit 10(a)(4) to 1985 UPS Thrift Plan. Annual Report on Form 10-K.\n(5) Amendment Incorporated by Reference to No. 7 to the Exhibit 10(a)(5) to 1985 UPS Thrift Plan. Annual Report on Form 10-K.\n(6) Amendment Incorporated by Reference to No. 8 to the Exhibit 10(a)(6) to 1987 UPS Thrift Plan. Annual Report on Form 10-K.\n(7) Amendment Incorporated by Reference to No. 9 to the Exhibit 10(a)(7) to 1987 UPS Thrift Plan. Annual Report on Form 10-K.\n(8) Amendment Incorporated by Reference to No. 10 to the Exhibit 10(a)(8) to 1990 UPS Thrift Plan. Annual Report on Form 10-K.\n(9) Amendment Incorporated by Reference to No. 11 to the Exhibit 10(a)(9) to 1991 UPS Thrift Plan. Annual Report on Form 10-K.\n(10) Amendment Incorporated by Reference to No. 12 to the Exhibit 10(a)(10) to 1991 UPS Thrift Plan. Annual Report on Form 10-K.\n(11) Amendment Incorporated by Reference to No. 13 to the Exhibit 10(a)(11) to 1991 UPS Thrift Plan. Annual Report on Form 10-K.\n(12) Amendment Incorporated by Reference to No. 14 to the Exhibit 10(a)(12) to 1991 UPS Thrift Plan. Annual Report on Form 10-K.\n(13) Amendment Incorporated by Reference to No. 15 to the Exhibit 10(a)(13) to 1992 UPS Thrift Plan. Annual Report on Form 10-K.\n(14) Amendment No. 16 Incorporated by Reference to to the UPS Thrift Exhibit 10(a)(14) to 1993 Plan Annual Report on Form 10-K\n(15) Amendment Incorporated by Reference to No. 17 to the UPS Exhibit 10(a)(15) to 1994 Thrift Plan Annual Report on Form 10-K\n(16) Amendment No. 18 to Filed herewith. the UPS Thrift Plan\n(17) Amendment No. 19 to Filed herewith. the UPS Thrift Plan\n(b) UPS Retirement Plan Incorporated by Reference to (including amend- Exhibit 9 to 1979 Annual ments 1 through 4). Report on Form 10-K.\nE-2\n(1) Amendment No. 5 Incorporated by Reference to to the UPS Re- Exhibit 20(a) to 1980 Annual tirement Plan. Report on Form 10-K.\n(2) Amendment No. 6 Incorporated by Reference to to the UPS Re- Exhibit 19(a) to 1983 Annual tirement Plan. Report on Form 10-K.\n(3) Amendment No. 7 Incorporated by Reference to to the UPS Re- Exhibit 10(b)(3) to 1984 tirement Plan. Annual Report on Form 10-K.\n(4) Amendment No. 8 Incorporated by Reference to to the UPS Re- Exhibit 10(b)(4) to 1985 tirement Plan. Annual Report on Form 10-K.\n(5) Amendment No. 9 Incorporated by Reference to to the UPS Re- Exhibit 10(b)(5) to 1986 tirement Plan. Annual Report on Form 10-K.\n(6) Amendment No. 10 Incorporated by Reference to to the UPS Re- Exhibit 19(a) to 1988 Annual tirement Plan. Report on Form 10-K.\n(7) Amendment No. 11 Incorporated by Reference to to the UPS Re- Exhibit 19(b) to 1988 Annual tirement Plan. Report on Form 10-K.\n(8) Amendment No. 12 Incorporated by Reference to to the UPS Re- Exhibit 10(b)(8) to 1989 tirement Plan. Annual Report on Form 10-K.\n(9) Amendment No. 13 Incorporated by Reference to to the UPS Re- Exhibit 10(b)(9) to 1989 tirement Plan. Annual Report on Form 10-K.\n(10) Amendment No. 14 Incorporated by Reference to to the UPS Re- Exhibit 10(b)(10) to 1990 tirement Plan. Annual Report on Form 10-K.\n(11) Amendment No. 15 Incorporated by Reference to the UPS Re- to Exhibit 10(b)(11) to tirement Plan. 1992 Annual Report on Form 10-K.\n(12) Amendment No. 16 Filed herewith. to the UPS Retirement Plan\n(13) Amendment No. 17 Filed herewith. to the UPS Retirement Plan\n(c) UPS Managers Incorporated by Reference to Incentive Plan definitive Proxy Statement (as amended). for 1992 Special Meeting of Shareowners.\n(d) 1986 UPS Stock Option Incorporated by Reference to Plan, as amended Exhibit 4(iv) to Form S-8 through March 5, 1987. Registration Statement (No. 33-12576).\nE-3\n(1) Amendment to UPS Incorporated by Reference to 1986 Stock Option Exhibit 10(e)(1) to 1987 Plan adopted Annual Report on Form 10-K. November 30, 1987.\n(2) Amendment to UPS Incorporated by Reference 1986 Stock Option Exhibit 10(e)(2) to 1992 Plan adopted Annual Report on Form October 30, 1992. 10-K.\n(e) Intentionally omitted.\n(f) Agreement and Plan of Incorporated by Reference Reorganization, dated to Exhibit l(a) to Amend- December 4, 1979, by ment No. 1 to Form S-14, and between United Registration No. 2-65859. Parcel Service of America, Inc. and Parmac Corporation.\n(g) Agreement and Plan of Incorporated by Reference Reorganization, dated to Exhibit l(b) to Amend- December 4, 1979, by ment No. 1 to Form S-14, and between United Registration No. 2-65859. Parcel Service of America, Inc. and Nuparmac Corporation.\n(h) Agreement and Plan of Incorporated by Reference Reorganization, dated to Exhibit l(c) to Amend- December 4, 1979, by ment No. 1 to Form S-14, and between United Registration No. 2-65859. Parcel Service of America, Inc. and Parco Managers Corporation.\n(i) Indemnification Con- Incorporated by Reference to tracts or Arrangements. Item 8 of Form 10, as filed April 29, 1970.\n(j) Agreement of Sale be- Incorporated by Reference to tween Delaware County Exhibit 10(m) to 1985 Annual Industrial Development Report on Form 10-K. Authority and Penallen Corporation, dated as of December 1, 1985; Remarketing Agreement, dated as of December 1, 1985, among United Parcel Service of America, Inc., Penallen Corporation and Salomon Brothers Inc.; Guarantee Agreement, dated as of December 1, 1985, between United Par- cel Service of America, Inc. and Irving Trust Company; Guarantee by United Parcel Service of America, Inc. to Dela- ware County Industrial Development Authority,\nE-4\ndated as of December 1, 1985.\n(k) Participation Agree- Incorporated by Reference to ment, dated November 17, Exhibit 10(k) to 1989 Annual 1986, among United Report on Form 10-K. Parcel Service Co. (\"UPS Co.\"), Bankers Trust Company, as Trustee under a Master Trust Agreement for the bene- fit of the participants and the beneficiaries of the UPS Thrift Plan and the UPS Retirement Plan, Overseas Partners Ltd., Wilmington Trust Company and The Connecticut National Bank (\"Owner Trustee\").\n(l) Aircraft Purchase Incorporated by Reference to Agreement, dated Exhibit 10(l) to 1989 Annual November 5, 1986, Report on Form 10-K. between UPS Co. and the Owner Trustee.\n(m) Lease Agreement, Incorporated by Reference to dated November 17, Exhibit 10(m) to 1989 Annual 1986, between UPS Report on Form 10-K. Co. and the Owner Trustee\n(n) Guarantee Agree- Incorporated by Reference to ment between United Exhibit 10(n) to 1989 Annual Parcel Service of Report on Form 10-K. America, Inc., as Guarantor and the Owner Trustee.\n(o) Receivables Purchase Incorporated by Reference to and Sale Agreement, Exhibit 10(l) to 1987 Annual dated as of Novem- Report on Form 10-K. ber 24, 1987, among United Parcel Service, Inc., an Ohio corpora- tion, United Parcel Service, Inc., a New York corporation, United Parcel Service of America, Inc., Coop- erative Receivables Corporation and Citicorp North America, Inc.\n(p) Receivables Purchase Incorporated by Reference to and Sale Agreement, Exhibit 10(m) to 1987 Annual dated as of November 24, Report on Form 10-K. 1987, among United Parcel Service, Inc., an Ohio corporation, United Parcel Service,\nE-5\nInc., a New York cor- poration, United Parcel Service of America, Inc., Citibank, N.A., and Citicorp North America, Inc.\n(q) Membership Agreement, Incorporated by Reference to dated as of November 24, Exhibit 10(n) to 1987 Annual 1987, by and between on Form 10-K. Cooperative Receivables Corporation and United Parcel Service of America, Inc.\n(r) Amended and Restated Incorporated by Reference to Facility Lease Agree- Exhibit 10(r) to 1990 Annual ment, dated as of Report on Form 10-K. November 6, 1990, among Overseas Part- ners Leasing, Inc., United Parcel Service General Services Co. and United Parcel Service of America, Inc.\n(s) Amended and Restated Incorporated by Reference to Aircraft Lease Agree- Exhibit 10(s) to 1990 Annual ment, dated as of Report on Form 10-K. November 6, 1990, among Overseas Part- ners Leasing, Inc., United Parcel Service Co. and United Parcel Service of America, Inc.\n(t) Agreement of Sale, Incorporated by Reference to dated as of December 28, Exhibit 10(t) to 1989 Annual 1989, between Edison Report on Form 10-K. Corporation and Over- seas Partners Leasing, Inc.\n(u) Assignment and Assump- Incorporated by Reference to tion Agreement, dated Exhibit 10(u) to 1989 Annual as of December 28, 1989, Report on Form 10-K. between and among Edison Corporation, Overseas Partners Leasing, Inc., McBride Enterprises, Inc. and Ramapo Ridge-McBride Office Park.\n(v) UPS Deferred Compensation Incorporated by Reference to Plan for Non-Employee Exhibit 10(v) to 1990 Annual Directors Report on Form 10-K.\n(w) UPS Retirement Plan for Incorporated by Reference to Outside Directors Exhibit 10(w) to 1990 Annual Report on Form 10-K.\nE-6\n(x) UPS Savings Plan, as Incorporated by Reference to Amended and Restated, Exhibit 10(x) to 1990 Annual including Amendments Report on Form 10-K. No. 1-5.\n(1) Amendment No. 6 to Incorporated by Reference to the UPS Savings Plan Exhibit 10(x)(1) to 1990 Annual Report on Form 10-K.\n(2) Amendment No. 7 to Incorporated by Reference to the UPS Savings Plan Exhibit 10(x)(2) to 1991 Annual Report on Form 10-K.\n(3) Amendment No. 8 to Incorporated by Reference the UPS Savings Plan to Exhibit 10(x)(3) to 1992 Annual Report on Form 10-K.\n(4) Amendment No. 9 to Incorporated by Reference the UPS Savings Plan to Exhibit 10(x)(4) to 1992 Annual Report on Form 10-K.\n(5) Amendment No. 10 to Incorporated by Reference the UPS Savings Plan to Exhibit 10(x)(5) to 1992 Annual Report on Form 10-K.\n(6) Amendment No. 11 to Filed herewith. the UPS Savings Plan\n(7) Amendment No. 12 to Filed herewith. the UPS Savings Plan\n(8) Amendment No. 13 to Filed herewith. the UPS Savings Plan\n(9) Amendment No. 14 to Filed herewith. the UPS Savings Plan\n(10) Amendment No. 15 to Filed herewith. the UPS Savings Plan\n(y) Competitive Advance and Incorporated by Reference to Revolving Credit Facility Exhibit 10(y) to 1990 Annual Agreement, dated as of Report on Form 10-K. May 7, 1990 among UPS, named banks and Chemical Bank, as Agent.\n(1) Letter, dated Nov- Incorporated by Reference to ember 13, 1990 re- Exhibit 10(y)(1) to 1990 ducing commitment Annual Report on Form 10-K. under Competitive Advance and Revolving Credit Facility Agreement.\n(z) UPS 1991 Stock Option Incorporated by Reference to Plan (Amended and Exhibit 10(z) to 1991 Annual. Restated as of Report on Form 10-K. February 20, 1992).\nE-7\n(aa) UPS Coordinating Benefit Incorporated by Reference to Plan. Exhibit 10(aa) to 1991 Annual Report on Form 10-K.\n(1) Amendment No. 1 to Incorporated by Reference UPS Coordinating to Exhibit 10(aa)(1) to Benefit Plan. 1992 Annual Report on Form 10-K.\n(2) Amendment No. 2 to Incorporated by Reference UPS Coordinating to Exhibit 10(aa)(2) to Benefit Plan. 1992 Annual Report on Form 10-K.\n(21) Subsidiaries of the Filed herewith as Exhibit Registrant. 21.\n(23) Consent of Deloitte & Touche LLP. Filed herewith as Exhibit 23.\n(27) Financial Data Schedule Filed herewith as Exhibit 27 (for SEC use only).\nE-8","section_15":""}
{"filename":"850414_1994.txt","cik":"850414","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL -------\nOn August 15, 1994, a newly organized subsidiary of Handex Environmental Recovery, Inc. (\"Company\"), New Horizons Education Corporation, acquired all of the issued and outstanding shares of New Horizons Franchising, Inc. Simultaneously, a newly organized subsidiary of New Horizons Education Corporation, acquired substantially all of the assets of New Horizons Computer Learning Center, Inc. As a result of these acquisitions, the Company now conducts two distinct lines of business and will report its results in two segments, environmental and educational. The acquisitions mark the Company's first step towards diversification outside its core environmental business.\nThe discussion that follows and note 10 to the consolidated financial statements (see Item 8) highlight the business conditions and certain financial information specific to each of the two business segments.\nENVIRONMENTAL BUSINESS SEGMENT ------------------------------\nThe Company, through subsidiaries of a newly organized subsidiary, Handex Environmental, Inc., (collectively \"Handex Environmental\") provides a comprehensive solution to hydrocarbon contamination of groundwater and soil due to leaking underground storage tanks, petroleum distribution systems and related contamination sources. Handex Environmental's full service approach addresses the entire remediation process, from detection and delineation to recovery and treatment. Specific services include detailed site assessments, analysis of groundwater and soil contamination, development and installation of on-site recovery systems, permitting services, maintenance and monitoring of recovery systems and complete documentation of all services and systems. Handex Environmental also provides environmental dewatering services to petroleum producers and suppliers. In late 1988 Handex Environmental introduced environmental site assessment services at industrial sites, primarily in the State of New Jersey. During 1990, Handex Environmental also increased its capability to perform other types of remediation projects through the acquisition of sludge dewatering equipment.\nHandex Environmental's primary clients continue to be the major petroleum companies which store petroleum products in underground storage tanks. While the bulk of Handex Environmental's underground storage tank and related services remained concentrated at retail gasoline stations during the fiscal year ended December 31, 1994 (\"1994\"), Handex Environmental continued to pursue and obtained additional work at bulk petroleum storage terminals, refineries and industrial sites. During 1994, Handex Environmental performed services on over 100 terminals, pipelines and refineries which generated gross revenues of approximately $5,600,000. Handex Environmental intends to continue its marketing efforts in these directions.\nThrough 1991, Handex Environmental's net operating revenues grew substantially while it operated primarily in New Jersey, Florida, New England, Maryland and surrounding states. In 1990, Handex Environmental opened area offices in eastern Pennsylvania, Virginia and Gainesville, Florida. In 1991, Handex Environmental continued its expansion by opening area offices in western Pennsylvania; Long Island, New York; Jacksonville, Florida; Chicago, Illinois and Charlotte, North Carolina. Handex Environmental also acquired, through a merger, a small groundwater remediation business in Palm Springs, Florida. In 1993, Handex Environmental opened area offices in Cincinnati, Ohio and Atlanta, Georgia. In 1994, Handex Environmental opened area offices in Golden, Colorado; Wixom, Michigan; Mobile, Alabama; Kansas, Missouri and Batavia, New York. The area offices differ from Handex Environmental's other locations in that they do not have their own remediation capability. When such services are needed, they are provided by Handex Environmental's larger offices or by subcontractors.\nImproved economic conditions in 1994, and an increased demand for environmental services combined with Handex Environmental's sustained marketing efforts contributed to the growth in its net operating revenues compared to 1993. However, price competition remained intense during the year and is expected to continue in the future.\nHandex Environmental believes that the quality and comprehensive nature of its services, its focus on well defined markets, both geographically and in terms of services offered, and the response of governmental authorities to public concern with groundwater contamination are material to the success of its business. Handex Environmental intends to continue its strategy of focusing on its primary service market -- hydrocarbon contamination of groundwater and soil due to leaking underground storage tanks and related contamination sources -- and to grow by entering new geographic markets where there is active enforcement of environmental protection statutes and significant petroleum industry presence, by expanding its focus to include bulk petroleum storage terminals and refineries; by offering its services to a broader range of customers and by continuing to improve operating efficiencies while maintaining a high level of technical quality. In addition, Handex Environmental is expanding its expertise and operations beyond the hydrocarbon remediation contamination services market.\nHandex Environmental currently conducts its groundwater remediation business through eight wholly-owned subsidiaries, Handex of New Jersey, Inc., Handex of Maryland, Inc., Handex of Florida, Inc., Handex of New England, Inc., Handex of the Carolinas, Inc., Handex of Illinois, Inc., Handex of Ohio, Inc. and Handex of Colorado, Inc. In addition, Handex Environmental performs other remediation services, such as sludge dewatering and facility decontamination, through its wholly owned subsidiary, Handex Environmental Management, Inc.\nSERVICES --------\nSite Remediation Services. Handex Environmental provides its clients with comprehensive groundwater and soil remediation services directed at contamination resulting from leaking underground storage tanks, petroleum distribution systems and related contamination sources. A Handex Environmental project team includes hydrogeologists, geologists and other professionals working in connection with its operations department, which includes licensed well drillers, treatment system installers and operators.\nA Handex Environmental remediation project begins with the investigation of the contaminated site. Handex Environmental's hydrogeologists and geologists develop a hydrogeological profile of the site by obtaining soil and groundwater samples through a diagnostic monitoring well system. This diagnostic system is designed by the hydrogeologist, installed by a licensed well-drilling team and monitored by staff environmental technicians. The collected samples are sent to independent laboratories for analysis. Through analysis of field data and the results of laboratory analysis of soil and groundwater samples, hydrogeologists determine the extent of the contamination, soil characteristics (such as porosity and permeability) and groundwater flow rate and direction. This information forms the basis for the design of a site recovery system.\nBased on the information generated from its diagnostic monitoring well system and using its technical operational expertise, Handex Environmental designs recovery systems to meet the needs of each site. A typical Handex Environmental groundwater recovery system generally includes hydrocarbon recovery wells, equipped with either double or single pump recovery systems, and water treatment systems designed to address site specific water soluble contamination. Equipment used in a recovery system is often modified by Handex Environmental to enhance its performance and to provide an integrated system. Installation of the recovery system is performed by Handex Environmental's licensed drillers and trained installation technicians. Applicable provisions of Federal, state and local laws require various permits and governmental approvals prior to the installation of the recovery system, and Handex Environmental's permitting department generally obtains the necessary permits and approvals for its customers.\nOnce the recovery system is installed, Handex Environmental's environmental technicians monitor the depth and thickness of hydrocarbons above the water table, collect water and soil samples and perform routine inspection, adjustment and maintenance of the recovery system to insure proper operation. Handex Environmental monitors the progress of the recovery system until a remediation project is complete. A project may continue for five to seven years before applicable governmental cleanup standards are achieved. Handex Environmental has over 600 projects currently being monitored. It provides groundwater data and analysis of such data to its customers and in some cases to various regulatory bodies to comply with certain individual state and local regulations.\nGenerally, hydrocarbons are recovered by pumping groundwater out of the aquifer in order to induce hydrocarbon flow into the recovery system. Hydrocarbons recovered by pumping are separated from the groundwater and stored on site until properly disposed. However, because certain petroleum products, particularly gasoline, contain water soluble compounds such as benzene, toluene and xylene, the groundwater must be treated prior to discharge back into the environment.\nWhile several different groundwater treatment techniques may be utilized at a particular site, Handex Environmental's principal water treatment technique is carbon adsorption. In this process, the contaminated water is pumped through one or more vessels containing activated carbon which adsorbs the contaminants. Handex Environmental's carbon vessels are manufactured to its specifications and operate at higher pressures than standard carbon tanks, permitting system operations to remain at desired flow rates. Flow rates below the desired rate may cause a loss of hydraulic control of the contaminant plume and its spread to a larger area of groundwater.\nWhen carbon adsorption is not an economically feasible water treatment technique, Handex Environmental will use air stripping. Air stripping involves pumping the contaminated water through a spray nozzle and over plastic packing material contained in a steel or fiberglass tower approximately 1 to 4 feet in diameter and up to 20 feet tall. A fan blows air through the tower counter current to the flow of the water, stripping off the contaminants. Due to air quality standards in some states, the contaminants released through air stripping must also be treated.\nAn important aspect of the problems caused by hydrocarbon contamination is the vapors that develop in the sediments above the water table. Left unabated, potentially explosive vapors can develop in nearby buildings and utilities. Also, rainwater percolating through soils containing residual hydrocarbons can contribute additional contamination to the aquifer. Accordingly, Handex Environmental performs vapor extraction services as part of the recovery program. Vapor extraction accelerates the recovery program since it removes a potential source of further groundwater contamination from the soil. In order to comply with applicable air pollution regulations, vapors extracted from the soil are often processed through a catalytic converter, which breaks the vapors down into non-hazardous components.\nEmergency Response Capabilities. As a result of Handex Environmental's ability to provide comprehensive groundwater remediation services and the equipment necessary to perform such services, Handex Environmental is often called upon to respond to emergency spills or leaks by its customers or by state or local governmental bodies or agencies. Emergency situations involve the application of the various techniques used by Handex Environmental in providing groundwater remediation services in non-emergency situations. However, due to the need for prompt action as a result of the higher level of contamination which may be present and publicity concerning the problem, Handex Environmental's emergency response services typically involve a substantially greater initial commitment of personnel and equipment than routine projects.\nEnvironmental Dewatering Services. Handex Environmental provides environmental dewatering services to petroleum producers and suppliers who desire to replace underground storage tanks or petroleum distribution systems in areas where groundwater is located near the surface. Dewatering consists of pumping groundwater in order to reduce the water table elevation in a given area to a level sufficient to permit installation of new underground storage tanks or systems. Water generated during the dewatering process is generally contaminated with soluble components of gasoline and is treated through the use of mobile water treatment units employing separation and carbon adsorption prior to its discharge back into the environment.\nGeneral Site Assessment and Remediation Services. Handex Environmental provides environmental site assessment services to its customers. The areas of environmental concern that need to be investigated in connection with a site assessment include underground storage tanks, groundwater and soil quality, areas of known hazardous spills, drum storage areas, lagoons and loading and unloading areas. In addition, the interiors of buildings on the site must also be examined. As areas of contamination are discovered, a cleanup plan is designed, approved by the appropriate regulatory authorities and implemented.\nCustomers for environmental site assessment services have included potential buyers, owners and operators of various industrial and commercial facilities. In addition, banks and other financial institutions that provide financing to such owners and operators, as well as potential acquirers of such facilities, have requested environmental site assessments.\nCUSTOMERS AND MARKETING -----------------------\nHandex Environmental's principal customers are major petroleum companies, which accounted for approximately 86.2%, 84.0% and 80.2% of Handex Environmental's net operating revenues in 1992, 1993 and 1994. Handex Environmental's four largest petroleum company customers, Amoco Oil Company, Exxon Company, U.S.A., Shell Oil Company and Star Enterprises, accounted for 18.3%, 16.2%, 13.2% and 10.3%, respectively, of Handex Environmental's net operating revenues in 1994. Handex Environmental's level of business with those customers increased over its 1993 level, reflecting improved economic conditions and availability of funds for environmental services. The loss of business from any of its major customers could have a material adverse effect on Handex Environmental.\nHandex Environmental currently performs approximately 80% of its work for petroleum companies at retail gasoline stations, although it does perform work at bulk petroleum terminals, pipelines, refineries and industrial sites from time to time. Handex Environmental's non-petroleum customers are primarily industrial clients and\/or state and local governmental bodies or agencies which engage Handex Environmental to provide emergency response services. Most of Handex Environmental's jobs for petroleum companies are performed pursuant to purchase orders or non-exclusive contracts, neither of which provide for any minimum purchase requirements. Most customers now require Handex Environmental to bid on certain phases of recovery projects, and Handex Environmental believes that this trend will continue in the future. In addition, many customers of Handex Environmental now purchase certain services and equipment historically provided by or through Handex Environmental as part of its full service approach from other contractors. Handex Environmental believes the unbundling of services, such as laboratory testing and analysis, is an indication of the increasing focus by its customers on containing costs associated with environmental remediation projects.\nHandex Environmental historically charged its customers for the services of its employees on an hourly basis with few budgetary limitations, as well as for the cost of materials and equipment used in connection with its services. Starting in 1993 and continuing into 1994, a majority of Handex Environmental's work was performed under fixed price contracts and unit prices, and it is expected that this trend will continue.\nHandex Environmental historically marketed through its senior professional staff and executives who have focused primarily on existing customers. Since competition in the groundwater remediation services industry has increased substantially the past few years and is likely to continue to increase further, Handex Environmental has significantly increased its marketing function. In August 1993, Handex Environmental hired a Vice President of Sales and Marketing and has committed significantly more monies for sales and marketing activities.\nCOMPETITION -----------\nWhile many companies are engaged in various aspects of the soil and groundwater remediation services industry, only a few provide the full service approach to groundwater remediation provided by Handex Environmental in its principal geographic markets. There are, however, a large number of firms which provide consulting and assessment services with respect to hydrocarbon recovery and soil\/groundwater remediation. In addition, a large number of firms perform remediation services, but these firms concentrate their operations on major spills, Superfund site cleanups, and the removal of substances such as polychlorinated biphenols (\"PCBs\") and asbestos. There are also numerous small independent pump and tank contractors which remove contaminants and transport them to hazardous waste sites or other storage facilities. These contractors collectively have a significant share of the market for such services.\nThe increasing focus on lower remediation costs by major consumers of environmental services has heightened competition in the soil\/groundwater remediation services industry and this trend will likely continue as the industry matures, as other companies enter the market and expand the range of services which they offer and as Handex Environmental and its competitors move into new geographic markets. For example, major engineering and consulting companies are becoming increasingly involved in the engineering related aspects and subsequent remediation of hazardous waste sites. It is also likely that some of the major consulting firms will expand their groundwater remediation services and compete directly with Handex Environmental. Competition from these larger companies could have a materially adverse effect on Handex Environmental's business. Further, competition from small firms which offer a more limited range of services but which can compete effectively on price has and may continue to adversely affect Handex Environmental's profitability by reducing its margins.\nHandex Environmental historically responded to competition on the basis of its ability to provide a comprehensive response to the problems of soil\/groundwater contamination and the quality of its services, rather than on the price of its services. However, Handex Environmental believes that price has now become of primary importance to its customers, and believes that it must compete on this basis. Handex Environmental also believes that, over the long term, the quality of its services will continue to be an important competitive advantage. Accordingly, in attempting to respond to price competition, Handex Environmental will attempt to maintain a high level of technical quality in its services.\nENVIRONMENTAL LEGISLATION -------------------------\nThe current demand for Handex Environmental's soil\/groundwater remediation services is a result of a number of overlapping Federal, state and local laws concerned with the protection of human health and the environment, as well as regulations promulgated by administrative agencies thereunder. The principal Federal statutes affecting groundwater include the Safe Drinking Water Act of 1974, the Resource Conservation and Recovery Act of 1976 (\"RCRA\") and the Comprehensive Environmental Response, Compensation and Liability Act of 1980. One of the more important Federal regulatory developments relating to Handex Environmental's business occurred in September 1988 when the EPA issued comprehensive regulations under RCRA governing underground storage tanks containing hazardous substances or petroleum. Such regulations require the owners of underground storage tanks to upgrade or close existing tanks within 10 years, and to install release detection equipment on existing tanks over a five- year period. Such regulations also require all new tanks which are installed to have protection against spills, overflows and corrosion. In addition, such regulations also prescribe the procedures by which tank owners and operators should investigate and report confirmed or suspected releases from tanks, and if applicable, proceed with corrective actions.\nMany of the foregoing Federal statutes encourage significant state involvement in their administration and enforcement, and various states have been authorized by the Environmental Protection Agency to implement their own underground storage tank programs. Various states have also enacted their own statutes designed to protect and restore environmental quality and to deal directly with the problem of soil and groundwater contamination. The state statutes and regulations are in some cases, different or more stringent than the other Federal statutes, and Handex Environmental believes that statutes and regulations enacted at the state level have had a greater impact on the demand for its services than those enacted at the Federal level. Some examples of such state statutes include New Jersey's Spill Compensation and Control Act, Environmental Clean Up Responsibility Act and its Underground Storage of Hazardous Substances Act, Maryland's Hazardous Substance Spill Response Law, Florida's Water Quality Assurance Act and the Florida Inland Protection Trust Fund. The Florida Inland Protection Trust Fund has recently been revised by the Florida legislature to require site prioritization and prior approval of costs by the Florida Department of Environmental Protection for reimbursement of cleanup expenditures. These revisions of the fund are intended to assure its economic integrity. It is likely that such revisions will have a material adverse effect on Handex Environmental's operations in Forida, and may have a material adverse effect on the Company given the size of Handex Environmental's operations in that state.\nPERMITS, LICENSES AND REGULATORY APPROVALS ------------------------------------------\nThe installation and operation of remediation systems are subject to various licensing, permitting, approval and reporting requirements imposed by Federal, state and local laws. For example, National Pollutant Discharge Elimination System (\"NPDES\") permits and other regulatory program permits are typically required in connection with the installation of the recovery system, and the terms of these permits often require ongoing reporting to governmental agencies concerning the operation of the recovery system. Approvals of corrective action plans by the appropriate regulatory agency is increasingly being required before a recovery system can be installed to address contaminated soil and\/or groundwater due to a release from an underground storage tank.\nVarious state and local laws require the monitoring wells and wells used in the recovery process to be installed by licensed well drillers, and installation of the recovery system may also require compliance with applicable provisions of construction and zoning laws. Some of the states in which Handex Environmental operates require that groundwater recovery systems installed at a facility be operated by licensed wastewater treatment plant operators. Some states have also adopted testing and licensing programs to regulate professionals who typically conduct subsurface investigations and propose remedial action workplans.\nIn order to provide a full service approach to subsurface remediation, Handex Environmental employs licensed well drillers, and many of its environmental technicians are licensed wastewater treatment plant operators. In addition, Handex Environmental employs individuals who specialize in obtaining the required Federal, state and local environmental and operational permits necessary for Handex Environmental and its customers to install and operate remediation systems. Handex Environmental also provides the documentation of the recovery process necessary to assist its customers in satisfying applicable reporting requirements.\nINSURANCE ---------\nIn 1992, the Company purchased an interest in a trade association captive insurance group through which it obtains comprehensive general liability insurance, with coverage limits of $5,000,000, including losses for sudden and accidental pollution damage. While Handex Environmental believes that it operates its business safely and prudently, there can be no assurance that liabilities incurred from a claim for professional liability or some other risk will be covered by insurance or, if covered, that the dollar amount of such liabilities will not exceed coverage limits.\nEMPLOYEES ---------\nAs of December 31, 1994, Handex Environmental, including the Corporate offices, employed 611 employees. Of these, 329 are skilled professionals (hydrogeologists, geologists, environmental scientists and field technicians), 131 are non-professional technical support personnel, and 151 are administrative and executive personnel.\nHandex Environmental believes that a key factor in its success will be its ability to continue to attract and retain highly skilled professionals. Handex Environmental attempts to meet its need for these professionals both by training hydrogeologists and geologists in the field of hydrocarbon recovery and groundwater cleanup and by recruiting qualified candidates from other companies, governmental agencies and colleges and universities.\nNone of Handex Environmental's employees are represented by a labor organization. Handex Environmental considers relations with its employees to be satisfactory.\nEDUCATIONAL BUSINESS SEGMENT ----------------------------\nThe Company's educational segment is operated through subsidiaries of its newly organized subsidiary, New Horizons Education Corporation (collectively, \"New Horizons\"). The education segment is comprised of two distinct businesses: one operates computer training centers, while the other supplies a system of instructions, sales and management concepts concerning computer training to independent franchisees.\nNew Horizons Training Centers. New Horizons operates computer training facilities in Santa Ana, California; Chicago, Illinois; and New York, New York. In addition, New Horizons holds a minority interest in a joint venture which operates a facility in Cleveland, Ohio. Prior to the Company's acquisition of New Horizons, it operated a single training center in Santa Ana. The other centers were acquired from franchisees subsequent to the acquisition as part of New Horizons' strategic plan to operate training centers in selected major United States markets.\nThrough its computer training centers, New Horizons offers comprehensive instruction in the use of personal computers and computer software, including instructor-led courses in software applications, networking and work stations. Each training center is equipped with computer hardware, software, and peripherals, in order to provide students with hands-on training. Students are provided with internally developed coursewares and other training materials purchased by New Horizons from leading software manufacturers under license agreements. Revenues from the computer training centers are derived from training fees paid by clients and proceeds from the sale of training materials related to the computer courses.\nThe Company believes there is a nationwide trend toward out-sourcing of computer training. Typical students in a New Horizons' classroom consist of individuals from private employers or various government agencies, which contract with New Horizons to provide training in personal computer and software applications to their personnel. Most of the classes are held at New Horizons' facilities. However, in response to the needs of their customers, New Horizons also provides instructions at client's offices. All training is instructor-led, with approximately 70% being conducted at the training centers and 30% at the client locations.\nFranchising Operations. New Horizons began offering franchise territories in 1992, and as of March 1, 1995, there were 42 operating franchises in the United States, 11 additional franchises sold but not yet operational and 21 operating franchise locations outside the United States. New Horizons sells only one franchise within a defined geographic area. Franchisees pay an initial franchise fee, and royalty fee based on both gross training revenues and gross sales of course materials and publications.\nA new franchise owner undergoes an intensive training program, receiving in-depth instruction in sales, marketing, computer training and the management of a computer training facility. New Horizons also provides franchisees with sales, management and advertising support.\nCustomers. Customers for the training provided at New Horizons' operated and franchised training centers are employer-sponsored individuals from a wide range of corporations, professional service organizations, government agencies and municipalities. No single customer accounted for more than 10% of New Horizons revenues during fiscal 1994.\nMarketing. According to the survey conducted by International Data Corporation, the information technology training and education industry generates domestic revenues of approximately $6 billion annually, and will grow approximately 15% annually through 1997. The majority of all company-sponsored computer education and training is currently supplied through the use of in- house training staffs. The Company believes that there is a trend in the United States toward out-sourcing non-core operations such as computer training, as a means of increasing corporate efficiency and competitiveness.\nNew Horizons markets its services through the use of aggressive selling formulas. Account executives utilize telemarketing technologies to target potential customers. New Horizons has recently established a national account program designed to market computer training services to Fortune 500 companies throughout the United States.\nCompetition The information technology training and education industry is highly fragmented. Computer education and training is supplied primarily by in- house training departments, regional personal computer application specialists, such as ExecuTrain, Catapult and Productivity Point International, small local independents, computer dealers and superstores and computer resellers. None of the Company's competitors currently have a national presence.\nThe instructor-led computer training markets are locally oriented. Although national marketing efforts are conducted, a training center's success depends upon execution at the local level. Although competitive pricing is important, New Horizons believes that it is a less important competitive factor than the quality of training, flexibility and convenience of service.\nTraining Authorization. New Horizon is authorized to provide training by more than 30 software publishers, including Microsoft, Novell, Apple and Sun Microsystems. The authorization agreements are typically short-term in nature and are renewable at the option of the publisher. While New Horizons believes that its relationship with software publishers are good, the loss of any one of these agreements could have a material adverse impact on its business.\nEmployees. As of December 31, 1994, the Company's educational business segment employed 245 individuals, consisting of 73 computer instructors, 67 account executives and 105 in the administration and executive areas. None of these employees are represented by a labor organization. The Company considers relations with its employees to be satisfactory.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's corporate headquarters occupy a portion of a 33,000 square foot facility in Morganville, New Jersey, which it shares with two wholly owned subsidiaries, pursuant to a lease which expires in 2003. The lease gives the Company an option to extend its tenancy for the entire facility for an additional five-year period.\nAs of December 31, 1994, Handex Environmental conducted business at twenty-one facilities located in the states of New Jersey, New York, Pennsylvania, Maryland, North Carolina, Ohio, Florida, Georgia, Illinois, Massachusetts, Colorado, Michigan, Alabama, and Missouri. Handex Environmental owns facilities in New Jersey and Maryland, while leasing facilities in all locations. Handex's main facility in Florida is owned by a general partnership whose partners are executive officers and Directors of the Company and is covered by a lease which expires in 1999.\nNew Horizons' headquarters and primary training center are located in Santa Ana, California, pursuant to a lease which expires in 1997.\nAs of December 31, 1994, New Horizons conducted business at leased facilities located in California, Ohio, and Illinois. In February 1995, New Horizons leased a facility in New York where it operates a computer training center.\nThe Company believes that its properties are well maintained and are adequate to meet current requirements and that suitable additional or substitute space will be available as needed to accommodate any expansion of operations and for additional offices if necessary.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is involved in several lawsuits incidental to the ordinary conduct of its business. The Company does not believe that the outcome of any or all these claims will have a material adverse effect upon its business or financial condition or result 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 a list of the executive officers of the Company. The executive officers are elected each year and serve at the pleasure of the Board of Directors.\nNAME AGE POSITION\nCurtis Lee Smith, Jr. 67 Chairman of the Board and Chief Executive Officer\nThomas J. Bresnan 42 President and Chief Operating Officer\nP. Craig Modesitt 38 Vice President, Sales and Marketing\nNelson Mossholder 49 Vice President, Operations\nStuart O. Smith 62 Vice Chairman of the Board, Chief Development Officer and Secretary\nJohn T. St. James 48 Vice President, Treasurer and Chief Financial Officer\n*The description of executive officers called for in this Item is included pursuant to Instruction 3 to Section (b) of Item 401 of Regulation S-K.\nSet forth below is a brief description of the background of those executive officers of the Company who are not Directors of the Company. Information with respect to the background of those executive officers who are also Directors of the Company is incorporated herein by reference as set forth in Part III, Item 10, of the Company's Annual Report on Form 10-K.\nJOHN T. ST. JAMES joined the Company in December 1988 and was elected its Treasurer in January 1989, Chief Financial Officer in February 1989 and Vice President in February 1991. Prior to joining the Company, Mr. St. James served as Vice President and Chief Financial Officer for B.A.T.U.S., Inc., an operator of retail concerns, from 1984 to 1987, as Vice President and Chief Financial Officer for the Henri Bendel division of The Limited, Inc., an operator of retail clothing stores, from 1987 to 1988; and as Vice President - Financial Operations\/Control for Brooks Fashions, Inc., an operator of retail clothing stores, for a brief period during 1988.\nP. CRAIG MODESITT joined the Company in August 1993 and was elected Vice President, Sales and Marketing. From 1979 until that time, he was with Ejector Systems, Inc. as both a founder and Vice President of Sales and Marketing. Ejector Systems, Inc. is a privately-held manufacturer of groundwater remediation equipment.\nNELSON MOSSHOLDER joined the Company in August 1994 and was elected Vice President, Operations. Prior to joining the Company, Mr. Mossholder served as Senior Vice President at Envirite Corporation, where he managed their $40 million hazardous waster management business. His twenty-four years of experience includes business development, technical and sales and marketing positions with Laidlaw Environmental, Stablex Corporation and Celanese Corporation.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\nThe Common stock is traded on the NASDAQ National Market System under the symbol HAND. The following table sets forth the range of high and low bid quotations per share of Common stock from January 1, 1993 through December 31, 1994, as reported by the NASDAQ system.\n1994 HIGH LOW 1st Quarter (January 2 - April 2) 8-1\/2 6-1\/4 2nd Quarter (April 3 - July 2) 7-1\/2 6 3rd Quarter (July 3 - October 1) 9-3\/8 7 4th Quarter (October 2 - December 31) 8-5\/8 6-1\/4\n1st Quarter (January 1 - April 3) 9-3\/4 6-1\/2 2nd Quarter (April 4 - July 3) 9 5-3\/4 3rd Quarter (July 4 - October 2) 7-3\/4 6-1\/4 4th Quarter (October 3 - January 1, 7-1\/2 6-1\/2 1994)\nAs of March 1, 1995, the Company's Common stock was held by 297 holders of record. The Company has never paid cash dividends on its Common stock and has no present intention to pay cash dividends in the foreseeable future. The Company currently intends to retain any future earnings to finance the growth of the Company.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the Consolidated Financial Statements and related notes and \"SELECTED FINANCIAL DATA\" included elsewhere in this report.\nThe following table presents, for the periods indicated (i) the percentage relationship which certain items in the Company's Consolidated Statements of Income bear to net operating revenues and (ii) the percentage change in the dollar amount of such items. All references to 1993 in the financial statements refer to the fiscal year ended January 1, 1994.\nPERCENTAGE RELATIONSHIP TO NET OPERATING REVENUES PERIOD TO PERIOD CHANGE\n1994 1993 1992 VS. VS. VS. 1994 1993 1992 1993 1992 1991\nNet operating revenues 100.0% 100.0% 100.0% 35.8% (8.8)% (14.6)% Cost of net operating revenues 64.3 66.9 67.7 30.4 (9.8) 5.7 Gross profit 35.7 33.1 32.3 46.6 (6.6) (38.8) Selling, general and administrative expenses 28.9 28.4 25.8 38.5 .4 4.0 Operating income 6.8 4.7 6.5 95.6 (34.5) (76.7) Interest income 1.5 2.0 1.4 (0.5) 32.0 11.3 Income before income taxes 7.4 5.8 7.5 73.9 (29.7) (73.5) Provision for income taxes 3.0 2.2 2.9 80.7 (31.0) (73.3) Net income 4.4 3.5 4.6 69.6 (28.9) (73.6)\nGENERAL -------\nOn August 15, 1994, a newly organized subsidiary of Handex Environmental Recovery, Inc. (\"Company\"), New Horizons Education Corporation, acquired all of the issued and outstanding shares of New Horizons Franchising, Inc. Simultaneously, a newly organized subsidiary of New Horizons Education Corporation, acquired substantially all of the assets of New Horizons Computer Learning Center, Inc. As a result of these acquisitions, the Company now conducts two distinct lines of business and will report its results in two segments, environmental and educational. The acquisitions mark the Company's first step towards diversification outside its core environmental business.\nThe discussion that follows and note 10 to the consolidated financial statements highlight the business conditions and certain financial information specific to each of the two business segments.\nENVIRONMENTAL BUSINESS SEGMENT ------------------------------\nNet operating revenues include fees for services provided directly by Handex Environmental, Inc. (\"Handex Environmental\") and fees for arranging for subcontractors' services, as well as proceeds from the rental and sale of equipment. Handex Environmental, in the course of providing its services, routinely subcontracts for outside services such as soil cartage, laboratory testing and other specialized services. These costs are generally passed through to clients and, in accordance with industry practice, are included in total operating revenues. Because subcontractor services can change significantly from project to project, changes in total operating revenues may not be truly indicative of business trends. Accordingly, Handex Environmental views net operating revenues, which is total operating revenues less the cost of subcontractor services, as its primary measure of revenue growth.\nCost of net operating revenues includes professional salaries, other direct labor, material purchases and certain direct and indirect overhead costs. Selling, general and administrative expenses include management salaries, sales and marketing salaries and expenses, and clerical and administrative overhead.\nDuring 1993 and 1994, several trends continued to develop which Handex Environmental believes will have a direct impact on its future results of operations. Handex Environmental believes that expenses for administration, computerization, marketing and engineering will continue to increase. Administrative costs have increased and will continue to increase as a result of the increasing desire of Handex Environmental's customers for more detailed information concerning the status of their environmental projects. Handex Environmental's marketing costs will continue to increase due to the effects of increased competition in the environmental industry and Handex Environmental's strategy to diversify its client base.\nHandex Environmental's customers have become increasingly cost conscious during recent periods in part due to their own financial constraints. To date, this cost consciousness on the part of customers has manifested itself primarily in three areas: (i) the manner in which Handex Environmental obtains its business and charges for its services; (ii) the use of other contractors to provide certain services traditionally provided by Handex Environmental; and (iii) an increasing preference to purchase, rather than lease, remediation equipment.\nOver the last three years, Handex Environmental has experienced a significant increase in customer demand for competitive bidding and\/or fixed price contracts. During 1993 and 1994, a majority of Handex Environmental's work was performed under fixed price contracts and unit prices. However, management believes that, over the long term, the quality and cost effectiveness of its services will continue to be an important competitive advantage. Accordingly, in responding to price competition, Handex Environmental will attempt to maintain a high level of technical quality in its services.\nA majority of Handex Environmental's major customers now purchase from other contractors equipment and certain services, such as laboratory analyses, which were formerly provided by or through Handex Environmental as part of its full service approach. Management believes that this trend will continue.\nHandex Environmental's quarterly results may fluctuate from period to period. Among the principal factors influencing quarterly variations are weather, which may limit the amount of time Handex Environmental's professional and technical personnel have in the field; the addition of new professionals who require training and initially bill a lower percentage of their time; the timing of receipt of discharge and other permits necessary to install dewatering and recovery systems, and the opening of new offices, which initially have higher expenses relative to revenues than established offices.\nIn recent years, Handex Environmental's business has been helped considerably by the cost reimbursement program maintained by the State of Florida through the Florida Inland Protection Trust Fund. The Florida Inland Protection Trust Fund has recently been revised by the Florida legislature to require site prioritization and prior approval of costs by the Florida Department of Environmental Protection for reimbursement of cleanup expenditures. These revisions of the fund are intended to assure its economic integrity. It is likely that such revisions will have a material adverse effect on Handex Environmental's operations in Florida, and may have a material adverse effect on the Company given the size of Handex Environmental's operations in that state.\nEDUCATIONAL BUSINESS SEGMENT ----------------------------\nThe Company, through its newly organized subsidiary, New Horizons Education Corporation (\"New Horizons\"), operates the educational segment of its business.\nThe education segment is comprised of two distinct businesses, one operates wholly-owned training centers, and the second, supplies systems of instruction, sales and management concepts concerning computer training to independent franchisees.\nRevenues for the wholly-owned training centers consist primarily of training fees and fees derived from sales of courseware materials. Cost of sales consists primarily of instructors' salaries and benefits, facilities costs such as rent, utilities and classroom equipment, courseware, and computer hardware, software and peripherals. Selling, general and administrative expenses consist primarily of costs associated with technical support personnel, facilities support personnel, scheduling personnel, training personnel, accounting and finance support and sales executives.\nRevenues for the franchising operation consist primarily of initial franchise fees associated with the sale of a franchise, royalty and advertising fees based on a percentage of franchisee gross training revenues, and percentage royalties received on the gross sales of courseware. Cost of sales consists primarily of costs associated with franchise support personnel who provide system guidelines and advice on daily operating issues including sales, marketing, instructor training and general business problems. Selling, general and administrative expenses consist primarily of technical support, courseware development, accounting and finance support, national account sales support, and advertising expenses.\nRESULTS OF OPERATIONS ----------------------\n1994 VERSUS 1993\nNET OPERATING REVENUES ----------------------\nThe Company's net operating revenues increased $13,858,000 or 35.8% in 1994 compared to 1993. Net operating revenues of $52,571,000 in 1994 included New Horizons net operating revenues of $5,989,000 for the period August 15, 1994 through December 31, 1994. These revenues represented 11.4% of the Company's total net operating revenues for 1994. Handex Environmental's net operating revenues of $46,582,000 reflect the improved market for environmental services during 1994, the impact of Handex Environmental's focused marketing initiatives, disciplined geographical expansion program and comprehensive personnel training programs which enhanced its competitiveness. Handex Environmental's net operating revenues increased $7,869,000 or 20.3% in 1994 compared to 1993. Each of Handex Environmental's subsidiaries which were in operation prior to 1993 reported revenue growth which totaled 13.5% in 1994 compared to 1993.\nNew Horizons combined with Handex Environmental's subsidiaries which began operations in 1994 and 1993, contributed over 17% of the Company's net operating revenues for 1994.\nCOST OF NET OPERATING REVENUES -------------------------------\nThe Company's cost of net operating revenues for 1994 increased $7,886,000 or 30.4% compared to 1993. As a percentage of net operating revenues, the Company's cost of net operating revenues declined to 64.3% in 1994, from 66.9% in 1993. Cost of net operating revenues for New Horizons for 1994 amounted to $3,269,000 (54.6% of New Horizons' revenues) and accounted for 12.6% of the increase over last year. Handex Environmental's cost of net operating revenues, as a percentage of net operating revenues decreased to 65.5% from 66.9% in 1993. The increase in Handex Environmental's cost of net operating revenues in absolute dollars was primarily due to the hiring of additional employees, increases in materials and supplies purchased, other expenses related to the increase in the level of business and new offices opened in 1993 and 1994. As a percentage of net operating revenues, Handex Environmental's cost of net operating revenues declined mainly due to the growth in net operating revenues and improved utilization of staff resulting from its comprehensive training programs.\nGROSS PROFIT -------------\nThe Company's gross profit for 1994 increased $5,972,000 or 46.6% compared to 1993. As a percentage of net operating revenues, the Company's gross profit increased to 35.7% in 1994, from 33.1% in 1993. Gross profit from New Horizons included in 1994 amounted to $2,720,000 (45.4% of New Horizons' revenues) and accounted for 21.2 % of the increase over last year. Handex Environmental's gross profit, as a percentage of net operating revenues, grew to 34.5%, from 33.1% in 1993. The improvement in Handex Environmental's gross profit, both in absolute dollars and as a percentage of its net operating revenues was due mainly to the growth in net operating revenues.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES --------------------------------------------\nThe Company's selling, general and administrative expenses for 1994 increased $4,233,000 or 38.5% compared to the same period last year. As a percentage of net operating revenues, the Company's selling, general and administrative expenses increased to 28.9% in 1994, from 28.4% in 1993. New Horizons' operations incurred $2,233,000 in selling, general and administrative expenses (37.3% of New Horizons' revenues) and accounted for 20.3% of the increase over last year. Handex Environmental's selling, general and administrative expenses, as a percentage of environmental net operating revenues declined to 27.9% in 1994 from 28.4% in 1993. The increase in Handex Environmental's selling, general and administrative expenses in absolute dollars was due mainly to the increase in its marketing expenses, legal and professional fees, fees associated with the hiring of professional staff and expenses related to new offices opened in 1993 and 1994. The decrease in Handex Environmental's selling, general and administrative expenses as a percentage of net operating revenues was due largely to the growth in net operating revenues.\nOTHER INCOME\/EXPENSE --------------------\nInterest expense for 1994 increased to $37,000 from $9,000 in 1993. The increase was primarily due to interest expense on New Horizons loan obligations. As a percentage of net operating revenues, interest expense increased to .1% in 1994 from 0% in 1993 primarily due to New Horizons' loan obligations. The Company did not use its credit facility with a commercial bank.\nInterest income of $789,000 in 1994 decreased slightly from $793,000 in 1993. As a percentage of net operating revenues, interest income decreased to 1.5% in 1994 from 2.0% in 1993. The Company's interest income generated by its investment in tax-free notes and bonds declined significantly in 1994 compared to 1993 primarily due to the use of investment funds in the acquisition of New Horizons. This was offset largely by the increase in interest income generated under a financing agreement between Handex Environmental and one of its customers. The decline in interest income as a percentage of net operating revenues in 1994 was due to a combination of higher net operating revenues and lower interest income from the Company's tax-free investments.\nOther expenses in 1994 increased to $409,000 from $360,000 in 1993. Included in other expenses for 1994 was goodwill amortization expense of $132,000 arising from the acquisition of New Horizons. Other expenses in 1994 also included a charge in the amount of $240,000 representing advances to a bio- remediation contractor whose operations ceased during the year. This was offset by the reversal to income of excess accrual for litigation expenses. As a percentage of Handex Environmental's net operating revenues, Handex Environmental's other expenses declined from .9% in 1993 to .6% in 1994, mainly due to the higher level of net operating revenues and lower provision for litigation expenses.\nINCOME TAXES ------------\nThe provision for income taxes as a percentage of income before income taxes increased to 40.3% in 1994 from 38.7% in the year ago period. The increase in the provision for income taxes was due primarily to the reduction in the Company's tax-free interest income.\nNET INCOME -----------\nNet income for 1994 increased $957,000 or 69.6% from the same period last year. Included in net income for 1994 was New Horizons' contribution which amounted to $174,000 (2.9% of New Horizons' revenues) and which represented 12.7% of the percentage increase over last year. Excluding the revenue and net income contributions of New Horizons, net income for Handex Environmental as a percentage of net operating revenues, increased to 4.6% in 1994 from 3.5% for the same period last year.\nRESULTS OF OPERATIONS ---------------------\n1993 VERSUS 1992\nNET OPERATING REVENUES ----------------------\nThe Company's net operating revenues decreased $3,728,000 or 8.8% in 1993 when compared to the prior year. Net operating revenues for 1993 followed the trends that began in the second quarter of 1992 namely; increased price-based competition resulting from a less active approach on the part of environmental service market customers and direct procurement by customers of equipment and services historically provided by or through the Company. Except for the Company's Florida and Illinois subsidiaries, which reported increases in net operating revenues of 32.9% and 10.3% respectively, all other subsidiaries experienced a decline in net operating revenues compared to the previous year.\nDuring 1993, The Company started operations in Cincinnati, Ohio, and Atlanta, Georgia. These two operations combined, contributed minimally to the total net operating revenues for 1993.\nCOST OF NET OPERATING REVENUES ------------------------------\nCost of net operating revenues for 1993 decreased $2,821,000 or 9.8% compared to 1992. As a percentage of net operating revenues, cost of net operating revenues decreased to 66.9% in 1993 from 67.7% in 1992. The decrease in net operating revenues both in absolute dollars and as a percentage of net operating revenues was due primarily to lower payroll and associated costs and lower level of purchases resulting from a lower level of net operating revenues.\nGROSS PROFIT ------------\nGross profit for 1993 decreased $908,000 or 6.6% compared to 1992. As a percentage of net operating revenues, gross profit for 1993 increased to 33.1% from 32.3% in 1992. The decrease in gross profit dollars was attributable to the lower net operating revenues for 1993. The increase in gross profit as a percentage of net operating revenues was due mainly to lower personnel costs resulting from fewer employees and lower level of purchases.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES --------------------------------------------\nSelling, general and administrative expenses for 1993 increased $49,000 or .4% compared to 1992. As a percentage of net operating revenues, selling, general and administrative expenses increased to 28.4% for 1993 from 25.8% for 1992, reflecting the decrease in net operating revenues. The increase in selling, general and administrative expenses was due mainly to the new offices opened during 1993 and the addition of personnel to the marketing staff. This was offset by lower expenses for legal and professional fees and lower provision for bad debts.\nOTHER INCOME\/EXPENSE ---------------------\nInterest expense for 1993 increased to $9,000 from $6,000 in 1992 and remained at less than 1% of net operating revenues for both periods. The Company has not utilized its credit facility with a commercial bank since June 1991.\nInterest income increased from $601,000 in 1992 to $793,000 for 1993. As a percentage of net operating revenues, interest income increased from 1.4% in 1992 to 2.0% in 1993. The increase in interest income for 1993 was due primarily to the interest income generated under a financing agreement between the Company and one of its major customers. This increase, combined with a lower level of net operating revenues, was the primary contributor to the increase in interest income as a percentage of net operating revenues.\nOther expenses increased from $178,000 in 1992 to $360,000 in 1993. As a percentage of net operating revenues, other expenses increased to .9% in 1993 from .4% in 1992. The increase in other expenses was due primarily to the higher provision for litigation expenses which was partially offset by gains realized from the disposition of excess operating equipment. Combined with a lower level of net operating revenues, other expenses as a percentage of net operating revenues increased compared to last year.\nINCOME TAXES ------------\nThe provision for income taxes for 1993 was 38.7% of income before income taxes compared with 39.5% for 1992. The decrease in the provision for income taxes as a percentage of income before income taxes was due primarily to the Company's tax-free interest income.\nNET INCOME -----------\nNet income for 1993 decreased $559,000 or 28.9% compared to 1992. As a percentage of net operating revenues, net income declined to 3.5% from 4.6% in 1992. The decline in net income both in absolute dollars and as a percentage of net operating revenues was due mainly to the lower level of net operating revenues.\nLIQUIDITY AND CAPITAL RESOURCES --------------------------------\nAs of December 31, 1994, the Company's working capital was $24,666,000 and its cash, cash equivalents and short-term investments totaled $6,835,000. Working capital as of December 31, 1994 reflected a decrease of $13,528,000 from $38,194,000 as of January 1, 1994. The Company's cash flow from operating activities was lower than last year primarily due to the higher receivable balance resulting from improved sales during the year. The Company also has available a $5,500,000 unsecured credit facility with a commercial bank. This facility bears interest at either the bank's prime rate (8.5% as of December 31, 1994), or the bank's short-term money market rate, whichever the Company elects. The Company has not utilized this facility since June 1991.\nThe full service approach to Handex Environmental's hydrocarbon recovery business in certain markets and its continuing geographic expansion require Handex Environmental to make capital expenditures for machinery and equipment and to incur costs associated with the establishment of new office locations. During 1994, the Company spent approximately $2,490,000 on capital equipment and anticipates spending up to $3,750,000 during 1995.\nOn August 15, 1994, the Company, through New Horizons, acquired the assets of New Horizons Computer Learning Center, Inc. and all the stock of New Horizons Franchising, inc. for a combined cash price of $14,000,000. Cash expenses related to the transaction were approximately $600,000 and non-cash expenses were approximately $179,000. Included in the acquisition were certain debt obligations. The rapid changes in information technology require New Horizons to make capital expenditures for computer equipment, software and facilities. During the period since the acquisition, New Horizons has spent approximately $970,000 for capital equipment and leasehold improvements and anticipates spending up to $1,500,000 during 1995.\nManagement believes that current cash and cash equivalents together with cash generated by operations, and its funds available under its revolving credit facility will provide the liquidity necessary to support its current and anticipated capital expenditures through the end of 1995.\nITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following pages contain the Financial Statements and supplementary data specified for Item 8 of Part II of Form 10K.\nHANDEX ENVIRONMENTAL RECOVERY, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994\nPage\nREPORT OF INDEPENDENT AUDITORS\nFINANCIAL STATEMENTS\nConsolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements -\nSCHEDULES\nSchedule VIII - Valuation and Qualifying Accounts and Reserves 19\nAll other schedules have been omitted because the material is not applicable or is not required as permitted by the rules and regulations of the Commission, or the required information is included in Notes to Consolidated Financial Statements.\nKPMG Peat Marwick LLP\n1500 National City Center 1900 East Ninth Street Cleveland, OH 44114-3495\nIndependent Auditors' Report\nThe Board of Directors and Stockholders Handex Environmental Recovery, Inc.:\nWe have audited the consolidated financial statements of Handex Environmental Recovery, Inc. and subsidiaries 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 the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the 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 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 Handex Environmental Recovery, Inc. and subsidiaries as of December 31, 1994 and January 1, 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, 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.\ns\/s -------------------------------------- Cleveland, Ohio February 17, 1995\nCONSOLIDATED BALANCE SHEETS HANDEX ENVIRONMENTAL RECOVERY, INC. AND SUBSIDIARIES DECEMBER 31, 1994 AND JANUARY 1, 1994\nASSETS 1994 1993 ------ Current assets: Cash and cash equivalents $ 2,895,478 $ 882,823 Marketable securities 3,940,000 23,095,000 Accounts receivable, less allowance for doubtful accounts of $934,560 in 1994 and $840,091 in 1993 (note 3) 26,854,906 16,810,586 Inventories 298,326 156,513 Prepaid expenses 214,198 312,050 Refundable income tax 388,682 131,998 Deferred income tax assets (notes 1 and 4) 609,668 595,669 Other current assets 394,948 696,713 -------------- -------------- Total current assets 35,596,206 42,681,352 -------------- --------------\nProperty, Plant and equipment, at cost: (note 2) Land 518,478 516,378 Buildings and improvements 2,347,918 1,785,597 Machinery and equipment 12,479,364 9,649,761 Furniture and fixtures 2,284,281 1,685,458 Motor vehicles 5,087,435 4,679,758 -------------- -------------- 22,717,476 18,316,952 Less accumulated depreciation and 13,980,868 11,764,508 amortization -------------- -------------- Net property, plant and equipment 8,736,608 6,552,444\nExcess of cost over net assets of acquired companies, net of accumulated amortization 15,921,530 1,710,512 of $421,357 in 1994 and $239,298 in 1993 Cash surrender value of life insurance 1,054,426 961,134 Other assets (notes 5 and 12) 611,367 487,329 -------------- -------------- $ 61,920,137 $ 52,392,771 ============== ============== LIABILITIES & STOCKHOLDERS' EQUITY ----------------------------------- Current liabilities: Current installments of long-term obligations (note 2) $ 579,991 $ -- Accounts payable 4,523,848 1,714,874 Accrued expenses (note 6) 5,826,066 2,772,766 -------------- -------------- Total current liabilities 10,929,905 4,487,640\nLong-term obligations, excluding current 464,357 -- installments (note 2)\nDeferred income tax liability (notes 1 888,516 844,811 and 4)\nStockholders' equity: Preferred stock, without par value, 2,000,000 shares authorized, no shares issued, Common stock, $.01 par value, 15,000,000 shares authorized; 7,050,212 shares in 1994 and 7,040,212 shares in 1993 70,502 70,402 Additional paid in capital 24,365,566 24,119,669 Retained Earnings 26,499,416 24,168,374 Treasury stock at cost - 185,000 shares in (1,298,125) (1,298,125) 1994 and 1993 (note 1) -------------- -------------- Total stockholders' equity 49,637,359 47,060,320 Commitments and contingencies (notes 9, 11 -- -- 12) ------------- ------------- $ 61,920,137 $ 52,392,771 ============== ==============\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME\nHandex Environmental Recovery, Inc. and Subsidiaries\nYears ended December 31, 1994, January 1, 1994 and December 31, 1992\n1994 1993 1992 ---- ---- ----\nTotal operating revenues $64,772,555 $48,194,334 $52,097,761 Subcontractor costs 12,201,809 9,481,455 9,656,508 ------------- ------------ ------------- Net operating revenues 52,570,746 38,712,879 42,441,253 (note 3) Cost of net operating revenues 33,795,664 25,910,121 28,730,737 ------------- ------------ ------------- Gross profit 18,775,082 12,802,758 13,710,516 Selling, general and 15,216,108 10,983,284 10,934,636 administrative expenses ------------- ------------ ------------- Operating income 3,558,974 1,819,474 2,775,880 Other income (expense): Interest expense (37,042) (8,601) (5,791) Interest income 789,097 792,743 600,520 Other (409,190) (360,260) (177,606) ------------- ------------ ------------- 342,865 423,882 417,123 ------------- ------------ ------------- Income before income taxes 3,901,839 2,243,356 3,193,003 Provision for income taxes 1,570,797 869,144 1,259,837 (note 4) ------------- ------------ ------------- Net income $ 2,331,042 $1,374,212 $ 1,933,166 ============ ============ ============= Net income per share of Common stock $ .34 $ .20 $ .28 ============ ============ =============\nSee accompanying notes to consolidated financial statements\nSee accompanying notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nHandex Environmental Recovery, Inc. and Subsidiaries\nYears ended December 31, 1994, January 1, 1994, and December 31, 1992\n1994 1993 1992 ------ ----- ----- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $2,331,042 $1,374,212 $1,933,166 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Depreciation and amortization 2,664,871 2,685,448 2,731,583 Gain on disposal of equipment (42,711) (33,325) (54,320) Deferred taxes 29,706 (327,102) (112,642) Cash provided (used) from the change in: Accounts receivable (10,044,320) (1,384,659) 11,071,595 Inventories (141,813) 41,143 328 Prepaid expenses 97,852 (270,838) 84,204 Other current assets 301,765 (246,712) 60,480 Other assets and cash surrender value of life insurance (219,656) (714,131) (332,016) Accounts payable 2,808,974 417,745 (1,465,366) Accrued expenses and income taxes payable\/ refundable 2,798,433 1,047,595 546,050 ------------- ------------ ------------ Net cash provided (used) by operating activities 584,143 2,589,376 14,463,376 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of marketable securities, (17,855,000) (40,570,000) (29,270,000) Redemption of marketable securities 37,010,000 39,865,000 16,231,000 Additions to property, plant and equipment (4,621,759) (541,096) (1,803,699) Investment in captive insurance company -- -- (158,750) Excess of cost over net assets of acquired company (14,214,077) -- -- ------------- ------------- ----------- Net cash provided (used) in investing activities 319,164 (1,246,096) (15,001,449) ------------ ------------- -------------\nCASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 65,000 -- 7,150 Debt obligations assumed from 1,198,308 -- -- acquisition Repurchase of treasury stock -- (566,875) (731,250) Principal payments on debt obligations (153,960) -- (57,919) ---------- ---------- ---------- Net cash provided (used) in financing activities 1,109,348 (566,875) (782,019) ---------- ----------- ---------- Net increase (decrease) in cash and cash equivalents 2,012,655 776,405 (1,320,406) Cash and cash equivalents at beginning of period 882,823 106,418 1,426,824 ---------- ------------- ------------- Cash and cash equivalents at end of period $ 2,895,478 $ 882,823 $ 106,418 ============= ============= =============\nSUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash was paid for: Interest $ 37,042 $ 8,601 $ 5,791 ============= ============= ============= Income taxes $ 2,144,135 $ 872,390 $ 1,172,807 ============= ============= =============\nInvesting and financing activities ---------------------------------- The Company acquired certain assets and liabilities of a computer training school and all the issued and outstanding shares of stock of a computer training franchising company in August, 1994 at an aggregate cash price of $14,000,000 and related cash expenses of approximately $600,000 and non-cash expenses of $179,000. The non-cash expenses represent the excess of the fair market value over the issue price on warrants on 40,000 shares of Handex's Common stock.\nSee accompanying notes to consolidated financial statements\nHANDEX ENVIRONMENTAL RECOVERY, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1994, January 1, 1994, and December 31, 1992\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\n(a) Basis of Accounting and Principles of Consolidation ---------------------------------------------------\nThe consolidated financial statements include the accounts of Handex Environmental Recovery, Inc., and its subsidiaries, all of which are wholly owned. All significant intercompany balances and transactions have been eliminated in consolidation.\nIn August 1992, the Company's Board of Directors authorized the purchase of up to 500,000 shares of Handex's Common stock in the open market or in private transactions. The repurchase program lasted through June 30, 1993, and was limited to an aggregate expenditure of $4,500,000. The Company had repurchased 185,000 shares of the Common stock under this program at an aggregate cost of $1,298,125.\n(b) Revenue Recognition -------------------\nRevenue is recognized at the time work is performed and services are rendered.\n(c) Marketable Securities ---------------------\nFunds retained for future use in the business are temporarily invested in tax-exempt bonds and municipal funds.\nEffective January 2, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in debt and Securities\" (\"SFAS 115\"). SFAS 115 requires the accounting for certain investments in debt and equity securities based on certain specific guidelines.\nThe Company's investments are presented at their aggregate face value. Amounts paid over face value are amortized through maturity. Unamortized premiums amounted to $8,946 and are included in other current assets. As of December 31, 1994 and January 1, 1994, the Company's security portfolio had aggregate fair market values of $3,945,350 and $23,168,951, respectively. Unrealized gains and losses as of December 31, 1994, amounted to $21,854 and $25,450, respectively. For the year ended December 31, 1994, securities with an aggregate face value of $37,010,000, were redeemed at maturity. There were neither gains nor losses realized from the redemption.\n(d) Inventories -----------\nInventories are stated at the lower of cost or market. Inventory costs are determined using the first-in, first-out (FIFO) method.\n(e) Property, Plant and Equipment -----------------------------\nProperty, plant and equipment are stated at cost.\nDepreciation is provided over the estimated useful lives of the respective assets, principally 3 to 25 years using the straight-line method.\n(f) Income Taxes -------------\nThe Company accounts for income taxes under the asset and liability method. Under this method, 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, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years when 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.\n(g) Excess of Cost Over Net Assets Acquired ---------------------------------------\nThe excess of cost over net assets acquired is being amortized on a straight-line basis over a period of 40 years.\n(h) Asset Impairments -----------------\nThe Company periodically reviews the carrying value of certain of its assets in relation to historical results, current business conditions and trends to identify potential situations in which the carrying value of assets may not be recoverable. Such assets would include, cost in excess of fair market value of net assets of acquired businesses and other identifiable intangible assets. If such reviews indicate that the carrying value of such assets may not be recoverable, the Company would estimate the undiscounted sum of the expected future cash flows to determine if they are less than the carrying value of such assets to ascertain if a permanent impairment has occurred. The carrying value of any impaired assets will be reduced to fair market value.\n(i) Cash and Cash Equivalents --------------------------\nFor purposes of the statements of cash flows, the Company considers all highly liquid debt instruments with purchased maturities of three months or less to be cash equivalents.\n(j) Net Income Per Share ---------------------\nThe computation of net income per share of Common stock is based on the average number of shares outstanding during each year. Inclusion of the incremental shares applicable to outstanding stock options in the computation would have no material effect.\nThe average number of shares outstanding used in determining net income per share was 6,863,069 in 1994, 6,881,267 in 1993, and 7,006,599 in 1992.\n(k) Reclassification ----------------\nCertain items on the 1993 and 1992 consolidated statements of income have been reclassified to conform to the 1994 presentation.\n2. LONG-TERM OBLIGATIONS ---------------------\nThe Company's debt and capital lease obligations represent indebtedness of New Horizons, either existing at the time of or entered into, subsequent to the acquisition.\nA summary of these obligations is as follows:\n------\nNotes payable to bank with interest rates adjusted to prime (8.5% at December 31, 1994), plus up to 2.5%, paid in full in February 1995, secured by assets of New Horizons $ 304,776\nNote payable to bank at 9.99% interest rate, payable in monthly installments of $9,306, secured by assets of New Horizons 253,349\nNote payable to a former franchisee, non-interest bearing, unsecured, paid in full in January 1995 35,000\nAmounts due under noncancelable leases accounted for as capital leases. These leases have effective interest rates ranging from 8.5% to 12.3% per annum 520,838\nAmount of capital leases representing interest (69,615) ------------ Present value of minimum lease payments 451,223 ------------\n1,044,348 ------------\nLess: current portion of notes payable and lease obligations 579,991 ------------\n$ 464,357 ============\nThe following is a summary of future payments required under the above obligations:\nDEBT LEASE ----- ------\n1995 $430,206 $194,378 1996 99,889 192,798 1997 63,030 104,712 1998 -- 15,791 1999 -- 13,159 2000 and after -- --\nIncluded in the Company's plant, property and equipment is New Horizons' equipment under capital leases amounting to $373,321, net of accumulated amortization of $45,992.\nThe Company has available an unsecured credit facility which provides a maximum credit of $5,500,000 through June 30, 1995. The revolving credit facility bears interest at the Company's preference of either the prime rate (8.5% at December 31, 1994), or the bank's short-term money market rate. The Company is required to pay a fee of 1\/4 of 1% of the unused balance of the facility. The Company has not used this facility since June 1991.\n3. BUSINESS AND CREDIT CONCENTRATIONS ----------------------------------\nThe Company's primary, environmental customers are major petroleum companies who store petroleum products in underground storage tanks.\nHandex Environmental has four major customers which account for 10% or more of both its total and net operating revenues. The approximate total and net operating revenues for these customers are as follows:\n1994 1993 1992 ----- ----- ----- Total operating revenues: Customer 1 $ 10,567,000 $ 9,049,000 $ 8,230,000 Customer 2 8,592,000 7,391,000 7,861,000 Customer 3 7,306,000 7,241,000 12,021,000 Customer 4 6,138,000 5,359,000 4,877,000 ------------ ----------- ------------ Total $ 32,603,000 $29,040,000 $ 32,989,000 ============ =========== ============\nNet operating revenues: Customer 1 $ 8,544,000 $ 7,294,000 $ 7,163,000 Customer 2 7,542,000 6,489,000 6,395,000 Customer 3 6,131,000 6,415,000 9,547,000 Customer 4 4,812,000 4,244,000 3,924,000 ------------ ------------- ------------- Total $ 27,029,000 $ 24,442,000 $ 27,029,000 ============ ============ ============\nAs of December 31, 1994 Handex Environmental's receivables from such customers amounted to approximately $10,621,000.\nNew Horizons has no customer which accounts for 10% or more of its operating revenues for 1994.\n4. INCOME TAXES -------------\nIncome tax expense for the periods below differs from the amounts computed by applying the U.S. federal income tax rate of 34 percent to the pretax income as a result of the following:\n1994 1993 1992 ------ ------ ------ Computed \"expected\" tax expense $ 1,326,625 $ 762,741 $ 1,085,621 Amortization of excess cost over net assets acquired 22,450 16,950 16,950 State and local tax expense, net of Federal income tax effect 291,400 232,100 270,100 Interest income from tax- free investments (149,800) (205,200) (182,600) Other 80,122 62,553 69,766 ------------- ----------- ------------ Income tax expense $ 1,570,797 $ 869,144 $ 1,259,837 ============= =========== ===========\nEffective rates 40.3% 38.7% 39.5% ============= ============ ===========\nIncome tax expense consists of: 1994 1993 1992 ----- ----- ------ Federal Current $ 1,131,620 $ 760,000 $ 930,000 Deferred (2,281) (242,509) (79,326) State and local 441,458 351,653 409,163 ------------- ---------- ----------- $ 1,570,797 $ 869,144 1,259,837 ============= =========== ============\nIn 1994 and 1993, respectively, deferred tax expense resulted from tax over book depreciation of $74,000 and $142,000, litigation (benefit) expense of ($27,000) and $71,000 and amortization (benefit) expense of cost over net assets of acquired companies of ($83,000) in 1994.\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1994 and January 1, 1994 are presented below:\nDECEMBER 31, JANUARY 1, 1994 1994 ------ ------ Deferred tax assets: Accounts receivable, principally due to allowance for doubtful accounts $ 373,824 336,036 Reserve for uninsured losses and litigations 188,250 219,562 Other 47,594 40,071 ----------- ---------- Total gross deferred tax assets 609,668 595,669 Less valuation allowance -- -- ----------- ----------- Net deferred tax assets 609,668 595,669 ----------- ----------- Deferred tax liability: Property, plant and equipment, principally due to differences in depreciation (805,920) (844,811) Excess of cost over net assets of (82,596) -- acquired company ------------- ----------- Deferred tax liability (888,516) (844,811) ------------- ------------ Net deferred tax liability $ (278,848) $ (249,142) ============= ============\nThere is no valuation allowance required at December 31, 1994 and January 1, 1994.\n5. NOTE RECEIVABLE FROM OFFICER ----------------------------\nIncluded in other assets is a note receivable from an officer of the Company for an interest-free loan in the amount of $250,000. The loan is payable on or before September 30, 1997 and is fully secured by a mortgage on real estate to which the loan proceeds were applied.\n6. ACCRUED EXPENSES ----------------\nAccrued expenses consist of:\n1994 1993 ------ ------ Sales taxes payable $ 713,617 $ 470,560 Salaries, wages and bonuses 1,264,405 891,804 payable Amounts received on behalf of a 1,346,665 472,564 customer Deferred revenues 994,167 -- Allowance for uninsured claims 270,624 268,904 Allowance for litigation expenses 200,000 280,000 Other 1,036,588 388,934 ------------ ------------\n$ 5,826,066 $ 2,772,766 =========== ============\n7. EMPLOYEE SAVINGS PLAN ----------------------\nThe Company has a 401(k) Profit Sharing Trust and Plan in which all employees in its environmental business segment not currently covered by a collective bargaining agreement are eligible to participate. None of the Company's employees are covered by any collective bargaining agreement. The Company, at its option, matches each participant's contribution to the Plan at the rate of 50% of up to 6% of each participant's compensation, up to the maximum allowable under the Internal Revenue Code. Employer contributions for the years ended December 31, 1994, January 1, 1994 and December 31, 1992 totaled $269,068 $235,384 and $296,392 respectively. Employees vest in the Company contributions at a rate of 20% per year based upon years of service. The Company is in the process of developing a 401K plan for New Horizons' employees.\n8. STOCK OPTION PLAN ------------------\nThe Company maintains a key employee stock option plan which provides for the issuance of non qualified options, incentive stock options and stock appreciation rights. The plan currently provides for the granting of options to purchase up to 1,200,000 shares of common stock. Incentive stock options are exerciseable for up to ten years, at an option price of not less than the market price on the date the option is granted or at a price of not less than 110% of the market price in the case of an option granted to an individual who, at the time of grant, owns more than 10% of the Company's Common stock. Nonqualified stock options may be issued at such exercise price and on such other terms and conditions as the Compensation Committee of the Board of Directors may determine. Optionees may also be granted stock appreciation rights under which they may, in lieu of exercising an option, elect to receive cash or Common stock, or a combination thereof, equal to the excess of the market price of the Common stock over the option price. All options were granted at fair market value at dates of grant.\nThe stock option plan for directors who are not employees of the Company provides for the issuance of up to 75,000 shares of Common stock and may be issued at such price per share and on such other terms and conditions as the Compensation Committee may determine. All options were granted at fair market value at dates of grant.\nThe following table summarizes all transactions during 1994 and 1993 under the Stock Option Plans.\n1994 1993 ----- ------ Options granted (number of shares): Key employees 253,000 166,500 Outside directors -- -- Average grant price: Key employees $ 7.96 $ 8.10 Outside directors -- -- Options exercised (number of shares): Key employees 10,000 -- Outside directors -- -- Average exercise price: Key employees $ 6.50 -- Outside directors -- -- Options exerciseable (number of shares): Key employees 279,700 214,250 Outside directors 24,750 24,750 Aggregate price of exerciseable options Key employees $2,011,345 $1,552,500 Outside directors 230,200 230,200 Option canceled (number of shares): Key employees 25,600 36,500 Outside directors -- --\n9. LEASES ------\nThe Company, is obligated under operating leases primarily for office space and training facilities, with rental arrangements for various periods of time ending through 2003. These leases provide for minimum fixed rents for the following fiscal years as follows: 1995, $1,666,016; 1996, $1,445,331; 1997, $1,071,689; 1998, $848,287; 1999, $801,811; and 2000 and after, $1,797,035 excluding the related-party lease described below. Rent expense was $1,370,365, $1,287,231, and $1,081,502 during the years ended December 31, 1994, January 1, 1994, and December 31, 1992, respectively.\nA subsidiary of the Company leases a building from a partnership comprised of related parties. Rent under this lease, which commenced in June 1987 and expires in June 1999, was $36,000 for each of the years ended December 31, 1994, January 1, 1994 and December 31, 1992.\n10. SEGMENT INFORMATION AND REPORTING ---------------------------------\nOn August 15, 1994, the Company, through New Horizons, acquired substantially all of the assets of New Horizons Computer Learning Center, Inc. and all of the issued and outstanding shares of stock of New Horizons Franchising, Inc. for an aggregate cash price of $14,000,000. During 1994, New Horizons also acquired certain assets of franchises covering the Chicago and Cleveland markets. In February 1995, New Horizons contributed the Cleveland assets to a newly formed joint venture in exchange for a minority interest. The joint venture operates the Cleveland franchise. Also in February 1995, New Horizons acquired certain assets of the franchise covering the metropolitan New York market. New Horizons specializes in providing instructor-led training in the use of computers and computer software, offering courses in PC software applications, networking, and work stations. Training is provided at New Horizons' owned training centers located in Santa Ana, California, Chicago, Illinois, and New York, New York. Franchising is engaged in the business of offering systems of instructions, sales and management concepts for training in the use of computers and computer system through the sale of franchises throughout the United States and internationally.\nThese acquisitions have been accounted for as purchases, and accordingly the purchase prices have been allocated to assets and liabilities based upon New Horizon's estimate of their fair market values. The aggregate purchase price and related expenses exceeded the net assets and liabilities by $14,393,077 and are included in Goodwill. The excess will be amortized on a straight line basis over 40 years from the acquisition date.\nPrior to August 15, 1994, the Company's business operations were concentrated in the environmental services industry. With the acquisition of New Horizons, the Company extended its operations into the computer training industry.\nInformation about the Company's segment operating data for 1994 follows:\nHANDEX ENVIRONMENTAL NEW HORIZONS CORPORATE CONSOLIDATED ------------- ------------- --------- ------------ Net operating $46,581,612 $5,989,134 $ -- $52,570,746 revenues -- Operating income (a) 3,761,475 486,676 -- 4,248,151 -- Identifiable assets 35,196,487 17,501,727 9,221,923 61,920,137 (b)\nCapital expenditures 2,057,407 2,382,446(c) 181,906 4,621,759\nDepreciation and 2,160,473 325,271 179,127 2,664,871 amortization\n(a) Operating income is shown before corporate selling, general and administrative expenses, interest income, interest and other income\/expenses.\n(b) Identifiable assets are those used in the operation of each segment. Corporate assets consist primarily of cash and short-term marketable securities.\n(c) Includes plant, property and equipment at acquisition.\nA reconciliation of operating income to income before income taxes follows:\n------ Operating income before corporate selling, general and administrative expenses $ 4,248,151 Corporate selling, general and administrative (5,294,768) expenses Operating income 3,558,974 Interest expense (37,042) Interest income 789,097 Other (409,190) Income before income taxes 3,901,839\nNew Horizons has no assets outside the United States and derives revenues from the sale of franchises and royalties based on certain revenues of licensed franchises. From acquisition date through December 31, 1994, revenues derived from the sale of franchises and royalties derived from franchised operations outside the United States amounted to approximately $99,000.\nThe assets, liabilities and results of New Horizons have been included in the consolidated financial statements from acquisition date. The following pro forma summary presents the consolidated results of operations for the fiscal years ended December 31, 1994 and January 1, 1994, as if the acquisition had occurred at the beginning of the respective periods, as adjusted for certain expenses such as salaries, depreciation, goodwill amortization, interest income and income taxes.\n1994 1993 ----- -----\nNet operating revenues $ 60,440,000 $ 49,176,000\nNet income 2,575,000 1,774,000\nEarnings per share $ .38 $ .26\n11. QUARTERLY FINANCIAL DATA (UNAUDITED) ------------------------------------\nSummarized quarterly financial data for 1994 and 1993 are as follows (in thousands, except per share data):\nNET OPERATING GROSS INCOME NET EARNINGS YEAR QUARTER REVENUES PROFIT BEFORE INCOME PER ---- ------ -------- ------- INCOME ------ SHARE TAXES ------- -------- 1994 First $ 9,806 $ 2,993 $ 83 $ 60 $.01 Second 11,876 4,311 1,112 677 .10 Third 14,338 5,269 1,437 858 .12 Fourth 16,551 6,202 1,270 736 .11\n1993 First $ 9,784 $ 3,033 $ 348 $ 211 $.03 Second 9,553 3,186 526 320 .05 Third 9,838 3,265 553 333 .05 Fourth 9,538 3,319 816 510 .07\nThe fourth quarter of 1994 reflects adjustments aggregating to approximately $200,000 for excess provision for vacation, holiday, major medical and dental expenses. The quarter also reflects the write-off to expense of advances to a bio-remediation contractor amounting to $240,000 which was partially offset by the reversal to income of excess provision for litigation expenses.\nDuring the fourth quarter of 1993, adjustments aggregating to approximately $284,000 for excess provision for vacation, holiday and depreciation expenses and the reduction of its accrual for bonuses under its incentive plan were recognized. In addition, the Company reduced its provision for liability insurance in the amount of $95,000.\n12. CAPTIVE INSURANCE COMPANY -------------------------\nIn February 1992, the Company purchased stock in a holding company which owns a captive insurance company through which the Company obtains its general liability insurance coverage. The stock purchase price of $476,250 was paid by $158,750 in cash, which is reflected in other non-current assets in the accompanying financial statements, and the balance is secured by an irrevocable letter of credit. As of December 31, 1994, there has not been any draw against the letter of credit. The Company has no obligations to the holding company\/captive insurance group other than the amount represented by the letter of credit and as a shareholder and director of the holding company. The Company owns 1 share (4.2%) of the 24 shares of common stock, and 466.25 shares of 1,731.48 shares of Preferred stock, Series A, issued and outstanding as of December 31, 1994.\n13. COMMITMENTS AND CONTINGENCIES ------------------------------\nThe Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position or results of operations.\n14. CHANGE IN FISCAL YEAR ----------------------\nOn December 18, 1992, the Board of Directors approved a change in the Company's fiscal year from one ending on December 31st of each year to a 52- 53 week fiscal year ending on the Saturday nearest the last day of December. Fiscal 1994 ended on December 31, 1994. Fiscal 1993, the first fiscal year under this change, ended on January 1, 1994. Fiscal 1992 ended on December 31, 1992. All references to 1993 in the financial statements refer to the fiscal year ended January 1, 1994. The Company filed a Form 8-K report on December 31, 1992.\nITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable. PART III\nITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information required by this Item 10 as to the Directors of the Company is incorporated herein by reference to the information set forth under the caption \"Election of Directors\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A. Information required by this Item 10 as to the executive officers of the Company is included in Part I of this Annual Report on Form 10-K.\nITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is incorporated by reference to the information set forth under the caption \"Compensation of Directors and Executive Officers\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item 12 is incorporated by reference to the information set forth under the caption \"Share Ownership of Principal Holders and Management\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item 13 is incorporated by reference to the information set forth under the caption \"Certain Transactions\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A.\nPART IV\nITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\n(A) (1) FINANCIAL STATEMENTS\nThe following Consolidated Financial Statements of the Registrant and its subsidiaries are included in Part II, Item 8:\nPage\nReport of Independent Auditors Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements to\n(A) (2) FINANCIAL STATEMENTS SCHEDULES\nThe following Consolidated Financial Statement Schedules of the Registrant and its subsidiaries are included in Item 14 hereof:\nPage\nReport of Independent Auditors as to Schedules Schedule VIII Valuation and Qualifying Accounts and Reserves 19\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.\n(A) (3) EXHIBITS\nReference is made to the Exhibit Index at sequential page hereof. -----\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 (Reg. No. 33-32239):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 is 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 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized at Morganville, New Jersey this 31st day of March, 1995.\nHANDEX ENVIRONMENTAL RECOVERY, INC.\nBy:\/s\/Curtis Lee Smith, Jr. ---------------------------- Curtis Lee Smith, Jr., Chairman 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:\nSIGNATURE TITLE DATE ----------- ----- ----- \/s\/Curtis Lee Smith, Jr. Chairman, and ) Curtis Lee Smith, Jr. Chief Executive Officer ) (Principal Executive ) Officer) ) )\n\/s\/John T. St. James Vice President, ) John T. St. James Treasurer and ) Chief Financail Officer ) (Principal Financial ) and ) Accounting Officer) )\n\/s\/Stuart O. Smith Director ) Stuart O. Smith ) ) March 31, 1995 ) \/s\/Thomas J. Bresnan Director ) Thomas J. Bresnan ) ) ) \/s\/Gregory J. Reuter Director ) Gregory J. Reuter ) ) ) \/s\/David A. Goldfinger Director ) David A. Goldfinger ) ) ) \/s\/Richard L. Osborne Director ) Richard L. Osborne ) ) ) \/s\/Scott R. Wilson Director ) Scott R. Wilson ) ) ) \/s\/William H. Heller Director ) William H. Heller ) ) )\nSCHEDULE VIII --------------- HANDEX ENVIRONMENTAL RECOVERY, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts and Reserves\nYears ended December 31, 1994, January 1, 1994 and December 31, 1992\nAllowance for Doubtful Accounts Balance at January 1, 1992 $ 727,933\nAdditions - Charged to costs and expenses 692,463\nDeductions (A) (528,562) -----------\nBalance at December 31, 1992 891,834\nAdditions - Charged to costs and expenses 192,943\nDeductions (A) (244,686) -----------\nBalance at January 1, 1994 840,091\nAdditions - Charged to costs and expenses 195,552\nDeductions (A) (101,083) -----------\nBalance at December 31, 1994 $ 934,560 ===========\n(A) - Accounts charged off, less recoveries\nEXHIBIT INDEX\nPAGINATION BY SEQUENTIAL EXHIBIT EXHIBIT NUMBERING NUMBER DESCRIPTION SYSTEM -------- ----------- -------\n3.1 Amended Certificate of Incorporation of the Registrant(1)\n3.2 By-Laws of the Registrant(1)\n4.1 Specimen Certificate for Share of Common Stock, $.01 par value, of the Registrant(1)\n4.2 Unsecured Revolving Loan Agreement(4)\n4.3 First Amendment to Unsecured Revolving Loan Agreement (7)\n4.4 Working Capital Line of Credit Note (7)\n10.1 Key Employees Stock Option Plan of the Registrant(1)*\n10.2 Amendment No. 1 to Key Employees Stock Option Plan of the Registrant(7)*\n10.3 Form of Stock Option Agreement executed by recipients of options under Key Employees Stock Option Plan(6)\n10.4 Stock Option Agreement dated August 6, 1992, between the Registrant and Thomas J. Bresnan (7)*\n10.5 Outside Directors Stock Option Plan of the Registrant(1)*\n10.6 Amendment No. 1 to the Outside Directors Stock Option Plan of the Registrant (7)*\n10.7 Form of Stock Option Agreement executed by recipients of options under the Outside Directors Stock Option Plan(7)\n10.8 Amended and Restated 401(k) Profit sharing Trust and Plan of the Registrant(1)*\n10.9 Amendment No. 1 to the Registrant's Amended and Restated 401(k) Profit Sharing Trust and Plan(2)*\n10.10 Amendment No. 2 to the Registrant's Amended and Restated 401(k) Profit Sharing Trust and Plan(3)*\n10.11 Amendment No. 3 to the Registrant's Amended and Restated 401(k) Profit Sharing Trust and Plan(6)*\n10.12 Form of Indemnity Agreement with Directors and Officers of the Registrant(6)\n10.13 Employment Agreement dated August 3, 1992, between the Registrant and Thomas J. Bresnan(7)*\n10.14 Lease Agreement dated April 26, 1988, between Jocama Construction Inc. and the Registrant(1)\nEXHIBIT INDEX PAGINATION BY SEQUENTIAL EXHIBIT EXHIBIT NUMBERING NUMBER DESCRIPTION SYSTEM -------- ------------ -------\n10.15 Addenda to the Lease Agreement dated April 6, 1988 between Jocama Construction and the Registrant (8)\n10.16 Indenture of Lease dated June 17, 1987, between Xednah Investments and Handex of Florida, as amended(1)\n10.17 Lease Agreement dated March 25, 1991, between Handex of New England, Inc. and Metro Park Marlboro Realty Trust, as amended(6)\n10.18 Lease Agreement dated January 20, 1992, between Handex of Maryland, Inc. and Winmeyer Commons II Limited Partnership (6)\n10.19 Lease Agreement dated between New Horizons Learning Center of Metropolitan New York Inc. and Mid City Associates, guaranteed by the Registrant\n10.20 Lease Agreement dated February 24, 1995, between New Horizons Learning Centers of Cleveland Ltd., and Realty One Property Management, guaranteed by the Registrant\n10.21 Consulting Agreement between the Registrant and The Nassau Group, Inc. dated December 17, 1993 (9)\n10.22 Warrants for the purchase of 25,000 shares of Common Stock $.01 par value per share of the Registrant issued to The Nassau Group, Inc. on December 17, 1993 (9)\n10.23 Warrants for the purchase of 40,000 shares of common stock $.01 par value per share of the registrant issued to The Nassau Group, Inc. on August 15, 1994.\n10.24 Asset Purchase Agreement, dated as of August 15, 1994, by and among New Horizons Computer Learning Centers, Inc. a Delaware Corporation, New Horizons Learning Center, Inc., a California Corporation and Michael A. Brinda (10)\n10.25 Stock Purchase Agreement dated as of August 15, 1994 by and among New Horizons Education Corporation, a Delaware Corporation and Michael A. Brinda (10)\n21.1 Subsidiaries of the Registrant\n23.1 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule\n99.1 Directors and Officers and Company Indemnity Policy(5)\n-------------------------------------------------------------- (1) Incorporated herein by reference to the appropriate exhibits to the Registrant's Registration Statement on Form S-1 (File No. 33-28798). (2) Incorporated herein by reference to the appropriate exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. (3) Incorporated herein by reference to the appropriate exhibit to the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 1990. (4) Incorporated herein by reference to the appropriate exhibit to the Registrant's Quarterly Report or Form 10-Q for the period ended June 30, 1990. (5) Incorporated herein by reference to the appropriate exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990. (6) Incorporated herein by reference to the appropriate exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991. (7) Incorporated herein by reference to the appropriate exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31,1992. (8) Incorporated herein by reference to the appropriate exhibit to the Registrant's Quarterly Report on Form 10-Q for the period ended July 3, 1993. (9) Incorporated herein by reference to the appropriate exhibit to the Registrants Annual Report on Form 10-K for the year ended January 1, 1994. (10) Incorporate herein by reference to the appropriate exhibit to the Registrants Form 8-K dated August 15, 1994.\n* Represents a management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14 of Form 10-K.\nSUBSIDIARIES OF HANDEX --------------------------\nHandex Environmental Recovery, Inc. has the following subsidiaries, all of which are incorporated in the State of Delaware.\n1. Handex of New Jersey, Inc. 2. Handex of Maryland, Inc. 3. Handex of Florida, Inc. 4. Handex of New England, Inc. 5. Handex Environmental Management, Inc. 6. Handex of the Carolinas, Inc. 7. Handex of Illinois, Inc. 8. Handex of Ohio, Inc. 9. Handex of Colorado, Inc. 10. Handex Environmental, Inc. 11. New Horizons Computer Learning Centers, Inc. 12. New Horizons Education Corporation 13. New Horizons Franchising, Inc. 14. New Horizons Computer Learning Center of Chicago, Inc. 15. New Horizons Computer Learning Center of Metropolitan New York, Inc.","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 conjunction with the Consolidated Financial Statements and related notes and \"SELECTED FINANCIAL DATA\" included elsewhere in this report.\nThe following table presents, for the periods indicated (i) the percentage relationship which certain items in the Company's Consolidated Statements of Income bear to net operating revenues and (ii) the percentage change in the dollar amount of such items. All references to 1993 in the financial statements refer to the fiscal year ended January 1, 1994.\nPERCENTAGE RELATIONSHIP TO NET OPERATING REVENUES PERIOD TO PERIOD CHANGE\n1994 1993 1992 VS. VS. VS. 1994 1993 1992 1993 1992 1991\nNet operating revenues 100.0% 100.0% 100.0% 35.8% (8.8)% (14.6)% Cost of net operating revenues 64.3 66.9 67.7 30.4 (9.8) 5.7 Gross profit 35.7 33.1 32.3 46.6 (6.6) (38.8) Selling, general and administrative expenses 28.9 28.4 25.8 38.5 .4 4.0 Operating income 6.8 4.7 6.5 95.6 (34.5) (76.7) Interest income 1.5 2.0 1.4 (0.5) 32.0 11.3 Income before income taxes 7.4 5.8 7.5 73.9 (29.7) (73.5) Provision for income taxes 3.0 2.2 2.9 80.7 (31.0) (73.3) Net income 4.4 3.5 4.6 69.6 (28.9) (73.6)\nGENERAL -------\nOn August 15, 1994, a newly organized subsidiary of Handex Environmental Recovery, Inc. (\"Company\"), New Horizons Education Corporation, acquired all of the issued and outstanding shares of New Horizons Franchising, Inc. Simultaneously, a newly organized subsidiary of New Horizons Education Corporation, acquired substantially all of the assets of New Horizons Computer Learning Center, Inc. As a result of these acquisitions, the Company now conducts two distinct lines of business and will report its results in two segments, environmental and educational. The acquisitions mark the Company's first step towards diversification outside its core environmental business.\nThe discussion that follows and note 10 to the consolidated financial statements highlight the business conditions and certain financial information specific to each of the two business segments.\nENVIRONMENTAL BUSINESS SEGMENT ------------------------------\nNet operating revenues include fees for services provided directly by Handex Environmental, Inc. (\"Handex Environmental\") and fees for arranging for subcontractors' services, as well as proceeds from the rental and sale of equipment. Handex Environmental, in the course of providing its services, routinely subcontracts for outside services such as soil cartage, laboratory testing and other specialized services. These costs are generally passed through to clients and, in accordance with industry practice, are included in total operating revenues. Because subcontractor services can change significantly from project to project, changes in total operating revenues may not be truly indicative of business trends. Accordingly, Handex Environmental views net operating revenues, which is total operating revenues less the cost of subcontractor services, as its primary measure of revenue growth.\nCost of net operating revenues includes professional salaries, other direct labor, material purchases and certain direct and indirect overhead costs. Selling, general and administrative expenses include management salaries, sales and marketing salaries and expenses, and clerical and administrative overhead.\nDuring 1993 and 1994, several trends continued to develop which Handex Environmental believes will have a direct impact on its future results of operations. Handex Environmental believes that expenses for administration, computerization, marketing and engineering will continue to increase. Administrative costs have increased and will continue to increase as a result of the increasing desire of Handex Environmental's customers for more detailed information concerning the status of their environmental projects. Handex Environmental's marketing costs will continue to increase due to the effects of increased competition in the environmental industry and Handex Environmental's strategy to diversify its client base.\nHandex Environmental's customers have become increasingly cost conscious during recent periods in part due to their own financial constraints. To date, this cost consciousness on the part of customers has manifested itself primarily in three areas: (i) the manner in which Handex Environmental obtains its business and charges for its services; (ii) the use of other contractors to provide certain services traditionally provided by Handex Environmental; and (iii) an increasing preference to purchase, rather than lease, remediation equipment.\nOver the last three years, Handex Environmental has experienced a significant increase in customer demand for competitive bidding and\/or fixed price contracts. During 1993 and 1994, a majority of Handex Environmental's work was performed under fixed price contracts and unit prices. However, management believes that, over the long term, the quality and cost effectiveness of its services will continue to be an important competitive advantage. Accordingly, in responding to price competition, Handex Environmental will attempt to maintain a high level of technical quality in its services.\nA majority of Handex Environmental's major customers now purchase from other contractors equipment and certain services, such as laboratory analyses, which were formerly provided by or through Handex Environmental as part of its full service approach. Management believes that this trend will continue.\nHandex Environmental's quarterly results may fluctuate from period to period. Among the principal factors influencing quarterly variations are weather, which may limit the amount of time Handex Environmental's professional and technical personnel have in the field; the addition of new professionals who require training and initially bill a lower percentage of their time; the timing of receipt of discharge and other permits necessary to install dewatering and recovery systems, and the opening of new offices, which initially have higher expenses relative to revenues than established offices.\nIn recent years, Handex Environmental's business has been helped considerably by the cost reimbursement program maintained by the State of Florida through the Florida Inland Protection Trust Fund. The Florida Inland Protection Trust Fund has recently been revised by the Florida legislature to require site prioritization and prior approval of costs by the Florida Department of Environmental Protection for reimbursement of cleanup expenditures. These revisions of the fund are intended to assure its economic integrity. It is likely that such revisions will have a material adverse effect on Handex Environmental's operations in Florida, and may have a material adverse effect on the Company given the size of Handex Environmental's operations in that state.\nEDUCATIONAL BUSINESS SEGMENT ----------------------------\nThe Company, through its newly organized subsidiary, New Horizons Education Corporation (\"New Horizons\"), operates the educational segment of its business.\nThe education segment is comprised of two distinct businesses, one operates wholly-owned training centers, and the second, supplies systems of instruction, sales and management concepts concerning computer training to independent franchisees.\nRevenues for the wholly-owned training centers consist primarily of training fees and fees derived from sales of courseware materials. Cost of sales consists primarily of instructors' salaries and benefits, facilities costs such as rent, utilities and classroom equipment, courseware, and computer hardware, software and peripherals. Selling, general and administrative expenses consist primarily of costs associated with technical support personnel, facilities support personnel, scheduling personnel, training personnel, accounting and finance support and sales executives.\nRevenues for the franchising operation consist primarily of initial franchise fees associated with the sale of a franchise, royalty and advertising fees based on a percentage of franchisee gross training revenues, and percentage royalties received on the gross sales of courseware. Cost of sales consists primarily of costs associated with franchise support personnel who provide system guidelines and advice on daily operating issues including sales, marketing, instructor training and general business problems. Selling, general and administrative expenses consist primarily of technical support, courseware development, accounting and finance support, national account sales support, and advertising expenses.\nRESULTS OF OPERATIONS ----------------------\n1994 VERSUS 1993\nNET OPERATING REVENUES ----------------------\nThe Company's net operating revenues increased $13,858,000 or 35.8% in 1994 compared to 1993. Net operating revenues of $52,571,000 in 1994 included New Horizons net operating revenues of $5,989,000 for the period August 15, 1994 through December 31, 1994. These revenues represented 11.4% of the Company's total net operating revenues for 1994. Handex Environmental's net operating revenues of $46,582,000 reflect the improved market for environmental services during 1994, the impact of Handex Environmental's focused marketing initiatives, disciplined geographical expansion program and comprehensive personnel training programs which enhanced its competitiveness. Handex Environmental's net operating revenues increased $7,869,000 or 20.3% in 1994 compared to 1993. Each of Handex Environmental's subsidiaries which were in operation prior to 1993 reported revenue growth which totaled 13.5% in 1994 compared to 1993.\nNew Horizons combined with Handex Environmental's subsidiaries which began operations in 1994 and 1993, contributed over 17% of the Company's net operating revenues for 1994.\nCOST OF NET OPERATING REVENUES -------------------------------\nThe Company's cost of net operating revenues for 1994 increased $7,886,000 or 30.4% compared to 1993. As a percentage of net operating revenues, the Company's cost of net operating revenues declined to 64.3% in 1994, from 66.9% in 1993. Cost of net operating revenues for New Horizons for 1994 amounted to $3,269,000 (54.6% of New Horizons' revenues) and accounted for 12.6% of the increase over last year. Handex Environmental's cost of net operating revenues, as a percentage of net operating revenues decreased to 65.5% from 66.9% in 1993. The increase in Handex Environmental's cost of net operating revenues in absolute dollars was primarily due to the hiring of additional employees, increases in materials and supplies purchased, other expenses related to the increase in the level of business and new offices opened in 1993 and 1994. As a percentage of net operating revenues, Handex Environmental's cost of net operating revenues declined mainly due to the growth in net operating revenues and improved utilization of staff resulting from its comprehensive training programs.\nGROSS PROFIT -------------\nThe Company's gross profit for 1994 increased $5,972,000 or 46.6% compared to 1993. As a percentage of net operating revenues, the Company's gross profit increased to 35.7% in 1994, from 33.1% in 1993. Gross profit from New Horizons included in 1994 amounted to $2,720,000 (45.4% of New Horizons' revenues) and accounted for 21.2 % of the increase over last year. Handex Environmental's gross profit, as a percentage of net operating revenues, grew to 34.5%, from 33.1% in 1993. The improvement in Handex Environmental's gross profit, both in absolute dollars and as a percentage of its net operating revenues was due mainly to the growth in net operating revenues.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES --------------------------------------------\nThe Company's selling, general and administrative expenses for 1994 increased $4,233,000 or 38.5% compared to the same period last year. As a percentage of net operating revenues, the Company's selling, general and administrative expenses increased to 28.9% in 1994, from 28.4% in 1993. New Horizons' operations incurred $2,233,000 in selling, general and administrative expenses (37.3% of New Horizons' revenues) and accounted for 20.3% of the increase over last year. Handex Environmental's selling, general and administrative expenses, as a percentage of environmental net operating revenues declined to 27.9% in 1994 from 28.4% in 1993. The increase in Handex Environmental's selling, general and administrative expenses in absolute dollars was due mainly to the increase in its marketing expenses, legal and professional fees, fees associated with the hiring of professional staff and expenses related to new offices opened in 1993 and 1994. The decrease in Handex Environmental's selling, general and administrative expenses as a percentage of net operating revenues was due largely to the growth in net operating revenues.\nOTHER INCOME\/EXPENSE --------------------\nInterest expense for 1994 increased to $37,000 from $9,000 in 1993. The increase was primarily due to interest expense on New Horizons loan obligations. As a percentage of net operating revenues, interest expense increased to .1% in 1994 from 0% in 1993 primarily due to New Horizons' loan obligations. The Company did not use its credit facility with a commercial bank.\nInterest income of $789,000 in 1994 decreased slightly from $793,000 in 1993. As a percentage of net operating revenues, interest income decreased to 1.5% in 1994 from 2.0% in 1993. The Company's interest income generated by its investment in tax-free notes and bonds declined significantly in 1994 compared to 1993 primarily due to the use of investment funds in the acquisition of New Horizons. This was offset largely by the increase in interest income generated under a financing agreement between Handex Environmental and one of its customers. The decline in interest income as a percentage of net operating revenues in 1994 was due to a combination of higher net operating revenues and lower interest income from the Company's tax-free investments.\nOther expenses in 1994 increased to $409,000 from $360,000 in 1993. Included in other expenses for 1994 was goodwill amortization expense of $132,000 arising from the acquisition of New Horizons. Other expenses in 1994 also included a charge in the amount of $240,000 representing advances to a bio- remediation contractor whose operations ceased during the year. This was offset by the reversal to income of excess accrual for litigation expenses. As a percentage of Handex Environmental's net operating revenues, Handex Environmental's other expenses declined from .9% in 1993 to .6% in 1994, mainly due to the higher level of net operating revenues and lower provision for litigation expenses.\nINCOME TAXES ------------\nThe provision for income taxes as a percentage of income before income taxes increased to 40.3% in 1994 from 38.7% in the year ago period. The increase in the provision for income taxes was due primarily to the reduction in the Company's tax-free interest income.\nNET INCOME -----------\nNet income for 1994 increased $957,000 or 69.6% from the same period last year. Included in net income for 1994 was New Horizons' contribution which amounted to $174,000 (2.9% of New Horizons' revenues) and which represented 12.7% of the percentage increase over last year. Excluding the revenue and net income contributions of New Horizons, net income for Handex Environmental as a percentage of net operating revenues, increased to 4.6% in 1994 from 3.5% for the same period last year.\nRESULTS OF OPERATIONS ---------------------\n1993 VERSUS 1992\nNET OPERATING REVENUES ----------------------\nThe Company's net operating revenues decreased $3,728,000 or 8.8% in 1993 when compared to the prior year. Net operating revenues for 1993 followed the trends that began in the second quarter of 1992 namely; increased price-based competition resulting from a less active approach on the part of environmental service market customers and direct procurement by customers of equipment and services historically provided by or through the Company. Except for the Company's Florida and Illinois subsidiaries, which reported increases in net operating revenues of 32.9% and 10.3% respectively, all other subsidiaries experienced a decline in net operating revenues compared to the previous year.\nDuring 1993, The Company started operations in Cincinnati, Ohio, and Atlanta, Georgia. These two operations combined, contributed minimally to the total net operating revenues for 1993.\nCOST OF NET OPERATING REVENUES ------------------------------\nCost of net operating revenues for 1993 decreased $2,821,000 or 9.8% compared to 1992. As a percentage of net operating revenues, cost of net operating revenues decreased to 66.9% in 1993 from 67.7% in 1992. The decrease in net operating revenues both in absolute dollars and as a percentage of net operating revenues was due primarily to lower payroll and associated costs and lower level of purchases resulting from a lower level of net operating revenues.\nGROSS PROFIT ------------\nGross profit for 1993 decreased $908,000 or 6.6% compared to 1992. As a percentage of net operating revenues, gross profit for 1993 increased to 33.1% from 32.3% in 1992. The decrease in gross profit dollars was attributable to the lower net operating revenues for 1993. The increase in gross profit as a percentage of net operating revenues was due mainly to lower personnel costs resulting from fewer employees and lower level of purchases.\nSELLING, GENERAL AND ADMINISTRATIVE EXPENSES --------------------------------------------\nSelling, general and administrative expenses for 1993 increased $49,000 or .4% compared to 1992. As a percentage of net operating revenues, selling, general and administrative expenses increased to 28.4% for 1993 from 25.8% for 1992, reflecting the decrease in net operating revenues. The increase in selling, general and administrative expenses was due mainly to the new offices opened during 1993 and the addition of personnel to the marketing staff. This was offset by lower expenses for legal and professional fees and lower provision for bad debts.\nOTHER INCOME\/EXPENSE ---------------------\nInterest expense for 1993 increased to $9,000 from $6,000 in 1992 and remained at less than 1% of net operating revenues for both periods. The Company has not utilized its credit facility with a commercial bank since June 1991.\nInterest income increased from $601,000 in 1992 to $793,000 for 1993. As a percentage of net operating revenues, interest income increased from 1.4% in 1992 to 2.0% in 1993. The increase in interest income for 1993 was due primarily to the interest income generated under a financing agreement between the Company and one of its major customers. This increase, combined with a lower level of net operating revenues, was the primary contributor to the increase in interest income as a percentage of net operating revenues.\nOther expenses increased from $178,000 in 1992 to $360,000 in 1993. As a percentage of net operating revenues, other expenses increased to .9% in 1993 from .4% in 1992. The increase in other expenses was due primarily to the higher provision for litigation expenses which was partially offset by gains realized from the disposition of excess operating equipment. Combined with a lower level of net operating revenues, other expenses as a percentage of net operating revenues increased compared to last year.\nINCOME TAXES ------------\nThe provision for income taxes for 1993 was 38.7% of income before income taxes compared with 39.5% for 1992. The decrease in the provision for income taxes as a percentage of income before income taxes was due primarily to the Company's tax-free interest income.\nNET INCOME -----------\nNet income for 1993 decreased $559,000 or 28.9% compared to 1992. As a percentage of net operating revenues, net income declined to 3.5% from 4.6% in 1992. The decline in net income both in absolute dollars and as a percentage of net operating revenues was due mainly to the lower level of net operating revenues.\nLIQUIDITY AND CAPITAL RESOURCES --------------------------------\nAs of December 31, 1994, the Company's working capital was $24,666,000 and its cash, cash equivalents and short-term investments totaled $6,835,000. Working capital as of December 31, 1994 reflected a decrease of $13,528,000 from $38,194,000 as of January 1, 1994. The Company's cash flow from operating activities was lower than last year primarily due to the higher receivable balance resulting from improved sales during the year. The Company also has available a $5,500,000 unsecured credit facility with a commercial bank. This facility bears interest at either the bank's prime rate (8.5% as of December 31, 1994), or the bank's short-term money market rate, whichever the Company elects. The Company has not utilized this facility since June 1991.\nThe full service approach to Handex Environmental's hydrocarbon recovery business in certain markets and its continuing geographic expansion require Handex Environmental to make capital expenditures for machinery and equipment and to incur costs associated with the establishment of new office locations. During 1994, the Company spent approximately $2,490,000 on capital equipment and anticipates spending up to $3,750,000 during 1995.\nOn August 15, 1994, the Company, through New Horizons, acquired the assets of New Horizons Computer Learning Center, Inc. and all the stock of New Horizons Franchising, inc. for a combined cash price of $14,000,000. Cash expenses related to the transaction were approximately $600,000 and non-cash expenses were approximately $179,000. Included in the acquisition were certain debt obligations. The rapid changes in information technology require New Horizons to make capital expenditures for computer equipment, software and facilities. During the period since the acquisition, New Horizons has spent approximately $970,000 for capital equipment and leasehold improvements and anticipates spending up to $1,500,000 during 1995.\nManagement believes that current cash and cash equivalents together with cash generated by operations, and its funds available under its revolving credit facility will provide the liquidity necessary to support its current and anticipated capital expenditures through the end of 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following pages contain the Financial Statements and supplementary data specified for Item 8 of Part II of Form 10K.\nHANDEX ENVIRONMENTAL RECOVERY, INC.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994\nPage\nREPORT OF INDEPENDENT AUDITORS\nFINANCIAL STATEMENTS\nConsolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements -\nSCHEDULES\nSchedule VIII - Valuation and Qualifying Accounts and Reserves 19\nAll other schedules have been omitted because the material is not applicable or is not required as permitted by the rules and regulations of the Commission, or the required information is included in Notes to Consolidated Financial Statements.\nKPMG Peat Marwick LLP\n1500 National City Center 1900 East Ninth Street Cleveland, OH 44114-3495\nIndependent Auditors' Report\nThe Board of Directors and Stockholders Handex Environmental Recovery, Inc.:\nWe have audited the consolidated financial statements of Handex Environmental Recovery, Inc. and subsidiaries 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 the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and the 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 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 Handex Environmental Recovery, Inc. and subsidiaries as of December 31, 1994 and January 1, 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994 in conformity with generally accepted accounting principles. Also in our opinion, the related financial statement schedule, 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.\ns\/s -------------------------------------- Cleveland, Ohio February 17, 1995\nCONSOLIDATED BALANCE SHEETS HANDEX ENVIRONMENTAL RECOVERY, INC. AND SUBSIDIARIES DECEMBER 31, 1994 AND JANUARY 1, 1994\nASSETS 1994 1993 ------ Current assets: Cash and cash equivalents $ 2,895,478 $ 882,823 Marketable securities 3,940,000 23,095,000 Accounts receivable, less allowance for doubtful accounts of $934,560 in 1994 and $840,091 in 1993 (note 3) 26,854,906 16,810,586 Inventories 298,326 156,513 Prepaid expenses 214,198 312,050 Refundable income tax 388,682 131,998 Deferred income tax assets (notes 1 and 4) 609,668 595,669 Other current assets 394,948 696,713 -------------- -------------- Total current assets 35,596,206 42,681,352 -------------- --------------\nProperty, Plant and equipment, at cost: (note 2) Land 518,478 516,378 Buildings and improvements 2,347,918 1,785,597 Machinery and equipment 12,479,364 9,649,761 Furniture and fixtures 2,284,281 1,685,458 Motor vehicles 5,087,435 4,679,758 -------------- -------------- 22,717,476 18,316,952 Less accumulated depreciation and 13,980,868 11,764,508 amortization -------------- -------------- Net property, plant and equipment 8,736,608 6,552,444\nExcess of cost over net assets of acquired companies, net of accumulated amortization 15,921,530 1,710,512 of $421,357 in 1994 and $239,298 in 1993 Cash surrender value of life insurance 1,054,426 961,134 Other assets (notes 5 and 12) 611,367 487,329 -------------- -------------- $ 61,920,137 $ 52,392,771 ============== ============== LIABILITIES & STOCKHOLDERS' EQUITY ----------------------------------- Current liabilities: Current installments of long-term obligations (note 2) $ 579,991 $ -- Accounts payable 4,523,848 1,714,874 Accrued expenses (note 6) 5,826,066 2,772,766 -------------- -------------- Total current liabilities 10,929,905 4,487,640\nLong-term obligations, excluding current 464,357 -- installments (note 2)\nDeferred income tax liability (notes 1 888,516 844,811 and 4)\nStockholders' equity: Preferred stock, without par value, 2,000,000 shares authorized, no shares issued, Common stock, $.01 par value, 15,000,000 shares authorized; 7,050,212 shares in 1994 and 7,040,212 shares in 1993 70,502 70,402 Additional paid in capital 24,365,566 24,119,669 Retained Earnings 26,499,416 24,168,374 Treasury stock at cost - 185,000 shares in (1,298,125) (1,298,125) 1994 and 1993 (note 1) -------------- -------------- Total stockholders' equity 49,637,359 47,060,320 Commitments and contingencies (notes 9, 11 -- -- 12) ------------- ------------- $ 61,920,137 $ 52,392,771 ============== ==============\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF INCOME\nHandex Environmental Recovery, Inc. and Subsidiaries\nYears ended December 31, 1994, January 1, 1994 and December 31, 1992\n1994 1993 1992 ---- ---- ----\nTotal operating revenues $64,772,555 $48,194,334 $52,097,761 Subcontractor costs 12,201,809 9,481,455 9,656,508 ------------- ------------ ------------- Net operating revenues 52,570,746 38,712,879 42,441,253 (note 3) Cost of net operating revenues 33,795,664 25,910,121 28,730,737 ------------- ------------ ------------- Gross profit 18,775,082 12,802,758 13,710,516 Selling, general and 15,216,108 10,983,284 10,934,636 administrative expenses ------------- ------------ ------------- Operating income 3,558,974 1,819,474 2,775,880 Other income (expense): Interest expense (37,042) (8,601) (5,791) Interest income 789,097 792,743 600,520 Other (409,190) (360,260) (177,606) ------------- ------------ ------------- 342,865 423,882 417,123 ------------- ------------ ------------- Income before income taxes 3,901,839 2,243,356 3,193,003 Provision for income taxes 1,570,797 869,144 1,259,837 (note 4) ------------- ------------ ------------- Net income $ 2,331,042 $1,374,212 $ 1,933,166 ============ ============ ============= Net income per share of Common stock $ .34 $ .20 $ .28 ============ ============ =============\nSee accompanying notes to consolidated financial statements\nSee accompanying notes to consolidated financial statements\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nHandex Environmental Recovery, Inc. and Subsidiaries\nYears ended December 31, 1994, January 1, 1994, and December 31, 1992\n1994 1993 1992 ------ ----- ----- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $2,331,042 $1,374,212 $1,933,166 ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES: Depreciation and amortization 2,664,871 2,685,448 2,731,583 Gain on disposal of equipment (42,711) (33,325) (54,320) Deferred taxes 29,706 (327,102) (112,642) Cash provided (used) from the change in: Accounts receivable (10,044,320) (1,384,659) 11,071,595 Inventories (141,813) 41,143 328 Prepaid expenses 97,852 (270,838) 84,204 Other current assets 301,765 (246,712) 60,480 Other assets and cash surrender value of life insurance (219,656) (714,131) (332,016) Accounts payable 2,808,974 417,745 (1,465,366) Accrued expenses and income taxes payable\/ refundable 2,798,433 1,047,595 546,050 ------------- ------------ ------------ Net cash provided (used) by operating activities 584,143 2,589,376 14,463,376 ------------- ------------- ------------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of marketable securities, (17,855,000) (40,570,000) (29,270,000) Redemption of marketable securities 37,010,000 39,865,000 16,231,000 Additions to property, plant and equipment (4,621,759) (541,096) (1,803,699) Investment in captive insurance company -- -- (158,750) Excess of cost over net assets of acquired company (14,214,077) -- -- ------------- ------------- ----------- Net cash provided (used) in investing activities 319,164 (1,246,096) (15,001,449) ------------ ------------- -------------\nCASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock 65,000 -- 7,150 Debt obligations assumed from 1,198,308 -- -- acquisition Repurchase of treasury stock -- (566,875) (731,250) Principal payments on debt obligations (153,960) -- (57,919) ---------- ---------- ---------- Net cash provided (used) in financing activities 1,109,348 (566,875) (782,019) ---------- ----------- ---------- Net increase (decrease) in cash and cash equivalents 2,012,655 776,405 (1,320,406) Cash and cash equivalents at beginning of period 882,823 106,418 1,426,824 ---------- ------------- ------------- Cash and cash equivalents at end of period $ 2,895,478 $ 882,823 $ 106,418 ============= ============= =============\nSUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Cash was paid for: Interest $ 37,042 $ 8,601 $ 5,791 ============= ============= ============= Income taxes $ 2,144,135 $ 872,390 $ 1,172,807 ============= ============= =============\nInvesting and financing activities ---------------------------------- The Company acquired certain assets and liabilities of a computer training school and all the issued and outstanding shares of stock of a computer training franchising company in August, 1994 at an aggregate cash price of $14,000,000 and related cash expenses of approximately $600,000 and non-cash expenses of $179,000. The non-cash expenses represent the excess of the fair market value over the issue price on warrants on 40,000 shares of Handex's Common stock.\nSee accompanying notes to consolidated financial statements\nHANDEX ENVIRONMENTAL RECOVERY, INC. AND SUBSIDIARIES\nNotes to Consolidated Financial Statements\nDecember 31, 1994, January 1, 1994, and December 31, 1992\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------\n(a) Basis of Accounting and Principles of Consolidation ---------------------------------------------------\nThe consolidated financial statements include the accounts of Handex Environmental Recovery, Inc., and its subsidiaries, all of which are wholly owned. All significant intercompany balances and transactions have been eliminated in consolidation.\nIn August 1992, the Company's Board of Directors authorized the purchase of up to 500,000 shares of Handex's Common stock in the open market or in private transactions. The repurchase program lasted through June 30, 1993, and was limited to an aggregate expenditure of $4,500,000. The Company had repurchased 185,000 shares of the Common stock under this program at an aggregate cost of $1,298,125.\n(b) Revenue Recognition -------------------\nRevenue is recognized at the time work is performed and services are rendered.\n(c) Marketable Securities ---------------------\nFunds retained for future use in the business are temporarily invested in tax-exempt bonds and municipal funds.\nEffective January 2, 1994, the Company adopted Statement of Financial Accounting Standards No. 115 \"Accounting for Certain Investments in debt and Securities\" (\"SFAS 115\"). SFAS 115 requires the accounting for certain investments in debt and equity securities based on certain specific guidelines.\nThe Company's investments are presented at their aggregate face value. Amounts paid over face value are amortized through maturity. Unamortized premiums amounted to $8,946 and are included in other current assets. As of December 31, 1994 and January 1, 1994, the Company's security portfolio had aggregate fair market values of $3,945,350 and $23,168,951, respectively. Unrealized gains and losses as of December 31, 1994, amounted to $21,854 and $25,450, respectively. For the year ended December 31, 1994, securities with an aggregate face value of $37,010,000, were redeemed at maturity. There were neither gains nor losses realized from the redemption.\n(d) Inventories -----------\nInventories are stated at the lower of cost or market. Inventory costs are determined using the first-in, first-out (FIFO) method.\n(e) Property, Plant and Equipment -----------------------------\nProperty, plant and equipment are stated at cost.\nDepreciation is provided over the estimated useful lives of the respective assets, principally 3 to 25 years using the straight-line method.\n(f) Income Taxes -------------\nThe Company accounts for income taxes under the asset and liability method. Under this method, 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, and operating loss and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years when 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.\n(g) Excess of Cost Over Net Assets Acquired ---------------------------------------\nThe excess of cost over net assets acquired is being amortized on a straight-line basis over a period of 40 years.\n(h) Asset Impairments -----------------\nThe Company periodically reviews the carrying value of certain of its assets in relation to historical results, current business conditions and trends to identify potential situations in which the carrying value of assets may not be recoverable. Such assets would include, cost in excess of fair market value of net assets of acquired businesses and other identifiable intangible assets. If such reviews indicate that the carrying value of such assets may not be recoverable, the Company would estimate the undiscounted sum of the expected future cash flows to determine if they are less than the carrying value of such assets to ascertain if a permanent impairment has occurred. The carrying value of any impaired assets will be reduced to fair market value.\n(i) Cash and Cash Equivalents --------------------------\nFor purposes of the statements of cash flows, the Company considers all highly liquid debt instruments with purchased maturities of three months or less to be cash equivalents.\n(j) Net Income Per Share ---------------------\nThe computation of net income per share of Common stock is based on the average number of shares outstanding during each year. Inclusion of the incremental shares applicable to outstanding stock options in the computation would have no material effect.\nThe average number of shares outstanding used in determining net income per share was 6,863,069 in 1994, 6,881,267 in 1993, and 7,006,599 in 1992.\n(k) Reclassification ----------------\nCertain items on the 1993 and 1992 consolidated statements of income have been reclassified to conform to the 1994 presentation.\n2. LONG-TERM OBLIGATIONS ---------------------\nThe Company's debt and capital lease obligations represent indebtedness of New Horizons, either existing at the time of or entered into, subsequent to the acquisition.\nA summary of these obligations is as follows:\n------\nNotes payable to bank with interest rates adjusted to prime (8.5% at December 31, 1994), plus up to 2.5%, paid in full in February 1995, secured by assets of New Horizons $ 304,776\nNote payable to bank at 9.99% interest rate, payable in monthly installments of $9,306, secured by assets of New Horizons 253,349\nNote payable to a former franchisee, non-interest bearing, unsecured, paid in full in January 1995 35,000\nAmounts due under noncancelable leases accounted for as capital leases. These leases have effective interest rates ranging from 8.5% to 12.3% per annum 520,838\nAmount of capital leases representing interest (69,615) ------------ Present value of minimum lease payments 451,223 ------------\n1,044,348 ------------\nLess: current portion of notes payable and lease obligations 579,991 ------------\n$ 464,357 ============\nThe following is a summary of future payments required under the above obligations:\nDEBT LEASE ----- ------\n1995 $430,206 $194,378 1996 99,889 192,798 1997 63,030 104,712 1998 -- 15,791 1999 -- 13,159 2000 and after -- --\nIncluded in the Company's plant, property and equipment is New Horizons' equipment under capital leases amounting to $373,321, net of accumulated amortization of $45,992.\nThe Company has available an unsecured credit facility which provides a maximum credit of $5,500,000 through June 30, 1995. The revolving credit facility bears interest at the Company's preference of either the prime rate (8.5% at December 31, 1994), or the bank's short-term money market rate. The Company is required to pay a fee of 1\/4 of 1% of the unused balance of the facility. The Company has not used this facility since June 1991.\n3. BUSINESS AND CREDIT CONCENTRATIONS ----------------------------------\nThe Company's primary, environmental customers are major petroleum companies who store petroleum products in underground storage tanks.\nHandex Environmental has four major customers which account for 10% or more of both its total and net operating revenues. The approximate total and net operating revenues for these customers are as follows:\n1994 1993 1992 ----- ----- ----- Total operating revenues: Customer 1 $ 10,567,000 $ 9,049,000 $ 8,230,000 Customer 2 8,592,000 7,391,000 7,861,000 Customer 3 7,306,000 7,241,000 12,021,000 Customer 4 6,138,000 5,359,000 4,877,000 ------------ ----------- ------------ Total $ 32,603,000 $29,040,000 $ 32,989,000 ============ =========== ============\nNet operating revenues: Customer 1 $ 8,544,000 $ 7,294,000 $ 7,163,000 Customer 2 7,542,000 6,489,000 6,395,000 Customer 3 6,131,000 6,415,000 9,547,000 Customer 4 4,812,000 4,244,000 3,924,000 ------------ ------------- ------------- Total $ 27,029,000 $ 24,442,000 $ 27,029,000 ============ ============ ============\nAs of December 31, 1994 Handex Environmental's receivables from such customers amounted to approximately $10,621,000.\nNew Horizons has no customer which accounts for 10% or more of its operating revenues for 1994.\n4. INCOME TAXES -------------\nIncome tax expense for the periods below differs from the amounts computed by applying the U.S. federal income tax rate of 34 percent to the pretax income as a result of the following:\n1994 1993 1992 ------ ------ ------ Computed \"expected\" tax expense $ 1,326,625 $ 762,741 $ 1,085,621 Amortization of excess cost over net assets acquired 22,450 16,950 16,950 State and local tax expense, net of Federal income tax effect 291,400 232,100 270,100 Interest income from tax- free investments (149,800) (205,200) (182,600) Other 80,122 62,553 69,766 ------------- ----------- ------------ Income tax expense $ 1,570,797 $ 869,144 $ 1,259,837 ============= =========== ===========\nEffective rates 40.3% 38.7% 39.5% ============= ============ ===========\nIncome tax expense consists of: 1994 1993 1992 ----- ----- ------ Federal Current $ 1,131,620 $ 760,000 $ 930,000 Deferred (2,281) (242,509) (79,326) State and local 441,458 351,653 409,163 ------------- ---------- ----------- $ 1,570,797 $ 869,144 1,259,837 ============= =========== ============\nIn 1994 and 1993, respectively, deferred tax expense resulted from tax over book depreciation of $74,000 and $142,000, litigation (benefit) expense of ($27,000) and $71,000 and amortization (benefit) expense of cost over net assets of acquired companies of ($83,000) in 1994.\nThe tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 1994 and January 1, 1994 are presented below:\nDECEMBER 31, JANUARY 1, 1994 1994 ------ ------ Deferred tax assets: Accounts receivable, principally due to allowance for doubtful accounts $ 373,824 336,036 Reserve for uninsured losses and litigations 188,250 219,562 Other 47,594 40,071 ----------- ---------- Total gross deferred tax assets 609,668 595,669 Less valuation allowance -- -- ----------- ----------- Net deferred tax assets 609,668 595,669 ----------- ----------- Deferred tax liability: Property, plant and equipment, principally due to differences in depreciation (805,920) (844,811) Excess of cost over net assets of (82,596) -- acquired company ------------- ----------- Deferred tax liability (888,516) (844,811) ------------- ------------ Net deferred tax liability $ (278,848) $ (249,142) ============= ============\nThere is no valuation allowance required at December 31, 1994 and January 1, 1994.\n5. NOTE RECEIVABLE FROM OFFICER ----------------------------\nIncluded in other assets is a note receivable from an officer of the Company for an interest-free loan in the amount of $250,000. The loan is payable on or before September 30, 1997 and is fully secured by a mortgage on real estate to which the loan proceeds were applied.\n6. ACCRUED EXPENSES ----------------\nAccrued expenses consist of:\n1994 1993 ------ ------ Sales taxes payable $ 713,617 $ 470,560 Salaries, wages and bonuses 1,264,405 891,804 payable Amounts received on behalf of a 1,346,665 472,564 customer Deferred revenues 994,167 -- Allowance for uninsured claims 270,624 268,904 Allowance for litigation expenses 200,000 280,000 Other 1,036,588 388,934 ------------ ------------\n$ 5,826,066 $ 2,772,766 =========== ============\n7. EMPLOYEE SAVINGS PLAN ----------------------\nThe Company has a 401(k) Profit Sharing Trust and Plan in which all employees in its environmental business segment not currently covered by a collective bargaining agreement are eligible to participate. None of the Company's employees are covered by any collective bargaining agreement. The Company, at its option, matches each participant's contribution to the Plan at the rate of 50% of up to 6% of each participant's compensation, up to the maximum allowable under the Internal Revenue Code. Employer contributions for the years ended December 31, 1994, January 1, 1994 and December 31, 1992 totaled $269,068 $235,384 and $296,392 respectively. Employees vest in the Company contributions at a rate of 20% per year based upon years of service. The Company is in the process of developing a 401K plan for New Horizons' employees.\n8. STOCK OPTION PLAN ------------------\nThe Company maintains a key employee stock option plan which provides for the issuance of non qualified options, incentive stock options and stock appreciation rights. The plan currently provides for the granting of options to purchase up to 1,200,000 shares of common stock. Incentive stock options are exerciseable for up to ten years, at an option price of not less than the market price on the date the option is granted or at a price of not less than 110% of the market price in the case of an option granted to an individual who, at the time of grant, owns more than 10% of the Company's Common stock. Nonqualified stock options may be issued at such exercise price and on such other terms and conditions as the Compensation Committee of the Board of Directors may determine. Optionees may also be granted stock appreciation rights under which they may, in lieu of exercising an option, elect to receive cash or Common stock, or a combination thereof, equal to the excess of the market price of the Common stock over the option price. All options were granted at fair market value at dates of grant.\nThe stock option plan for directors who are not employees of the Company provides for the issuance of up to 75,000 shares of Common stock and may be issued at such price per share and on such other terms and conditions as the Compensation Committee may determine. All options were granted at fair market value at dates of grant.\nThe following table summarizes all transactions during 1994 and 1993 under the Stock Option Plans.\n1994 1993 ----- ------ Options granted (number of shares): Key employees 253,000 166,500 Outside directors -- -- Average grant price: Key employees $ 7.96 $ 8.10 Outside directors -- -- Options exercised (number of shares): Key employees 10,000 -- Outside directors -- -- Average exercise price: Key employees $ 6.50 -- Outside directors -- -- Options exerciseable (number of shares): Key employees 279,700 214,250 Outside directors 24,750 24,750 Aggregate price of exerciseable options Key employees $2,011,345 $1,552,500 Outside directors 230,200 230,200 Option canceled (number of shares): Key employees 25,600 36,500 Outside directors -- --\n9. LEASES ------\nThe Company, is obligated under operating leases primarily for office space and training facilities, with rental arrangements for various periods of time ending through 2003. These leases provide for minimum fixed rents for the following fiscal years as follows: 1995, $1,666,016; 1996, $1,445,331; 1997, $1,071,689; 1998, $848,287; 1999, $801,811; and 2000 and after, $1,797,035 excluding the related-party lease described below. Rent expense was $1,370,365, $1,287,231, and $1,081,502 during the years ended December 31, 1994, January 1, 1994, and December 31, 1992, respectively.\nA subsidiary of the Company leases a building from a partnership comprised of related parties. Rent under this lease, which commenced in June 1987 and expires in June 1999, was $36,000 for each of the years ended December 31, 1994, January 1, 1994 and December 31, 1992.\n10. SEGMENT INFORMATION AND REPORTING ---------------------------------\nOn August 15, 1994, the Company, through New Horizons, acquired substantially all of the assets of New Horizons Computer Learning Center, Inc. and all of the issued and outstanding shares of stock of New Horizons Franchising, Inc. for an aggregate cash price of $14,000,000. During 1994, New Horizons also acquired certain assets of franchises covering the Chicago and Cleveland markets. In February 1995, New Horizons contributed the Cleveland assets to a newly formed joint venture in exchange for a minority interest. The joint venture operates the Cleveland franchise. Also in February 1995, New Horizons acquired certain assets of the franchise covering the metropolitan New York market. New Horizons specializes in providing instructor-led training in the use of computers and computer software, offering courses in PC software applications, networking, and work stations. Training is provided at New Horizons' owned training centers located in Santa Ana, California, Chicago, Illinois, and New York, New York. Franchising is engaged in the business of offering systems of instructions, sales and management concepts for training in the use of computers and computer system through the sale of franchises throughout the United States and internationally.\nThese acquisitions have been accounted for as purchases, and accordingly the purchase prices have been allocated to assets and liabilities based upon New Horizon's estimate of their fair market values. The aggregate purchase price and related expenses exceeded the net assets and liabilities by $14,393,077 and are included in Goodwill. The excess will be amortized on a straight line basis over 40 years from the acquisition date.\nPrior to August 15, 1994, the Company's business operations were concentrated in the environmental services industry. With the acquisition of New Horizons, the Company extended its operations into the computer training industry.\nInformation about the Company's segment operating data for 1994 follows:\nHANDEX ENVIRONMENTAL NEW HORIZONS CORPORATE CONSOLIDATED ------------- ------------- --------- ------------ Net operating $46,581,612 $5,989,134 $ -- $52,570,746 revenues -- Operating income (a) 3,761,475 486,676 -- 4,248,151 -- Identifiable assets 35,196,487 17,501,727 9,221,923 61,920,137 (b)\nCapital expenditures 2,057,407 2,382,446(c) 181,906 4,621,759\nDepreciation and 2,160,473 325,271 179,127 2,664,871 amortization\n(a) Operating income is shown before corporate selling, general and administrative expenses, interest income, interest and other income\/expenses.\n(b) Identifiable assets are those used in the operation of each segment. Corporate assets consist primarily of cash and short-term marketable securities.\n(c) Includes plant, property and equipment at acquisition.\nA reconciliation of operating income to income before income taxes follows:\n------ Operating income before corporate selling, general and administrative expenses $ 4,248,151 Corporate selling, general and administrative (5,294,768) expenses Operating income 3,558,974 Interest expense (37,042) Interest income 789,097 Other (409,190) Income before income taxes 3,901,839\nNew Horizons has no assets outside the United States and derives revenues from the sale of franchises and royalties based on certain revenues of licensed franchises. From acquisition date through December 31, 1994, revenues derived from the sale of franchises and royalties derived from franchised operations outside the United States amounted to approximately $99,000.\nThe assets, liabilities and results of New Horizons have been included in the consolidated financial statements from acquisition date. The following pro forma summary presents the consolidated results of operations for the fiscal years ended December 31, 1994 and January 1, 1994, as if the acquisition had occurred at the beginning of the respective periods, as adjusted for certain expenses such as salaries, depreciation, goodwill amortization, interest income and income taxes.\n1994 1993 ----- -----\nNet operating revenues $ 60,440,000 $ 49,176,000\nNet income 2,575,000 1,774,000\nEarnings per share $ .38 $ .26\n11. QUARTERLY FINANCIAL DATA (UNAUDITED) ------------------------------------\nSummarized quarterly financial data for 1994 and 1993 are as follows (in thousands, except per share data):\nNET OPERATING GROSS INCOME NET EARNINGS YEAR QUARTER REVENUES PROFIT BEFORE INCOME PER ---- ------ -------- ------- INCOME ------ SHARE TAXES ------- -------- 1994 First $ 9,806 $ 2,993 $ 83 $ 60 $.01 Second 11,876 4,311 1,112 677 .10 Third 14,338 5,269 1,437 858 .12 Fourth 16,551 6,202 1,270 736 .11\n1993 First $ 9,784 $ 3,033 $ 348 $ 211 $.03 Second 9,553 3,186 526 320 .05 Third 9,838 3,265 553 333 .05 Fourth 9,538 3,319 816 510 .07\nThe fourth quarter of 1994 reflects adjustments aggregating to approximately $200,000 for excess provision for vacation, holiday, major medical and dental expenses. The quarter also reflects the write-off to expense of advances to a bio-remediation contractor amounting to $240,000 which was partially offset by the reversal to income of excess provision for litigation expenses.\nDuring the fourth quarter of 1993, adjustments aggregating to approximately $284,000 for excess provision for vacation, holiday and depreciation expenses and the reduction of its accrual for bonuses under its incentive plan were recognized. In addition, the Company reduced its provision for liability insurance in the amount of $95,000.\n12. CAPTIVE INSURANCE COMPANY -------------------------\nIn February 1992, the Company purchased stock in a holding company which owns a captive insurance company through which the Company obtains its general liability insurance coverage. The stock purchase price of $476,250 was paid by $158,750 in cash, which is reflected in other non-current assets in the accompanying financial statements, and the balance is secured by an irrevocable letter of credit. As of December 31, 1994, there has not been any draw against the letter of credit. The Company has no obligations to the holding company\/captive insurance group other than the amount represented by the letter of credit and as a shareholder and director of the holding company. The Company owns 1 share (4.2%) of the 24 shares of common stock, and 466.25 shares of 1,731.48 shares of Preferred stock, Series A, issued and outstanding as of December 31, 1994.\n13. COMMITMENTS AND CONTINGENCIES ------------------------------\nThe Company is involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's consolidated financial position or results of operations.\n14. CHANGE IN FISCAL YEAR ----------------------\nOn December 18, 1992, the Board of Directors approved a change in the Company's fiscal year from one ending on December 31st of each year to a 52- 53 week fiscal year ending on the Saturday nearest the last day of December. Fiscal 1994 ended on December 31, 1994. Fiscal 1993, the first fiscal year under this change, ended on January 1, 1994. Fiscal 1992 ended on December 31, 1992. All references to 1993 in the financial statements refer to the fiscal year ended January 1, 1994. The Company filed a Form 8-K report on December 31, 1992.\nITEM 9.","section_9":"ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable. PART 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 the Directors of the Company is incorporated herein by reference to the information set forth under the caption \"Election of Directors\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A. Information required by this Item 10 as to the executive officers of the Company is included in Part I of this Annual Report on Form 10-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item 11 is incorporated by reference to the information set forth under the caption \"Compensation of Directors and Executive Officers\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item 12 is incorporated by reference to the information set forth under the caption \"Share Ownership of Principal Holders and Management\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's fiscal year pursuant to Regulation 14A.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item 13 is incorporated by reference to the information set forth under the caption \"Certain Transactions\" in the Company's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 9, 1995, since such Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the end of the Company's 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) (1) FINANCIAL STATEMENTS\nThe following Consolidated Financial Statements of the Registrant and its subsidiaries are included in Part II, Item 8:\nPage\nReport of Independent Auditors Consolidated Balance Sheets Consolidated Statements of Income Consolidated Statements of Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements to\n(A) (2) FINANCIAL STATEMENTS SCHEDULES\nThe following Consolidated Financial Statement Schedules of the Registrant and its subsidiaries are included in Item 14 hereof:\nPage\nReport of Independent Auditors as to Schedules Schedule VIII Valuation and Qualifying Accounts and Reserves 19\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.\n(A) (3) EXHIBITS\nReference is made to the Exhibit Index at sequential page hereof. -----\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 (Reg. No. 33-32239):\nInsofar as indemnification for liabilities arising under the Securities Act of 1933 is 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 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized at Morganville, New Jersey this 31st day of March, 1995.\nHANDEX ENVIRONMENTAL RECOVERY, INC.\nBy:\/s\/Curtis Lee Smith, Jr. ---------------------------- Curtis Lee Smith, Jr., Chairman 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:\nSIGNATURE TITLE DATE ----------- ----- ----- \/s\/Curtis Lee Smith, Jr. Chairman, and ) Curtis Lee Smith, Jr. Chief Executive Officer ) (Principal Executive ) Officer) ) )\n\/s\/John T. St. James Vice President, ) John T. St. James Treasurer and ) Chief Financail Officer ) (Principal Financial ) and ) Accounting Officer) )\n\/s\/Stuart O. Smith Director ) Stuart O. Smith ) ) March 31, 1995 ) \/s\/Thomas J. Bresnan Director ) Thomas J. Bresnan ) ) ) \/s\/Gregory J. Reuter Director ) Gregory J. Reuter ) ) ) \/s\/David A. Goldfinger Director ) David A. Goldfinger ) ) ) \/s\/Richard L. Osborne Director ) Richard L. Osborne ) ) ) \/s\/Scott R. Wilson Director ) Scott R. Wilson ) ) ) \/s\/William H. Heller Director ) William H. Heller ) ) )\nSCHEDULE VIII --------------- HANDEX ENVIRONMENTAL RECOVERY, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts and Reserves\nYears ended December 31, 1994, January 1, 1994 and December 31, 1992\nAllowance for Doubtful Accounts Balance at January 1, 1992 $ 727,933\nAdditions - Charged to costs and expenses 692,463\nDeductions (A) (528,562) -----------\nBalance at December 31, 1992 891,834\nAdditions - Charged to costs and expenses 192,943\nDeductions (A) (244,686) -----------\nBalance at January 1, 1994 840,091\nAdditions - Charged to costs and expenses 195,552\nDeductions (A) (101,083) -----------\nBalance at December 31, 1994 $ 934,560 ===========\n(A) - Accounts charged off, less recoveries\nEXHIBIT INDEX\nPAGINATION BY SEQUENTIAL EXHIBIT EXHIBIT NUMBERING NUMBER DESCRIPTION SYSTEM -------- ----------- -------\n3.1 Amended Certificate of Incorporation of the Registrant(1)\n3.2 By-Laws of the Registrant(1)\n4.1 Specimen Certificate for Share of Common Stock, $.01 par value, of the Registrant(1)\n4.2 Unsecured Revolving Loan Agreement(4)\n4.3 First Amendment to Unsecured Revolving Loan Agreement (7)\n4.4 Working Capital Line of Credit Note (7)\n10.1 Key Employees Stock Option Plan of the Registrant(1)*\n10.2 Amendment No. 1 to Key Employees Stock Option Plan of the Registrant(7)*\n10.3 Form of Stock Option Agreement executed by recipients of options under Key Employees Stock Option Plan(6)\n10.4 Stock Option Agreement dated August 6, 1992, between the Registrant and Thomas J. Bresnan (7)*\n10.5 Outside Directors Stock Option Plan of the Registrant(1)*\n10.6 Amendment No. 1 to the Outside Directors Stock Option Plan of the Registrant (7)*\n10.7 Form of Stock Option Agreement executed by recipients of options under the Outside Directors Stock Option Plan(7)\n10.8 Amended and Restated 401(k) Profit sharing Trust and Plan of the Registrant(1)*\n10.9 Amendment No. 1 to the Registrant's Amended and Restated 401(k) Profit Sharing Trust and Plan(2)*\n10.10 Amendment No. 2 to the Registrant's Amended and Restated 401(k) Profit Sharing Trust and Plan(3)*\n10.11 Amendment No. 3 to the Registrant's Amended and Restated 401(k) Profit Sharing Trust and Plan(6)*\n10.12 Form of Indemnity Agreement with Directors and Officers of the Registrant(6)\n10.13 Employment Agreement dated August 3, 1992, between the Registrant and Thomas J. Bresnan(7)*\n10.14 Lease Agreement dated April 26, 1988, between Jocama Construction Inc. and the Registrant(1)\nEXHIBIT INDEX PAGINATION BY SEQUENTIAL EXHIBIT EXHIBIT NUMBERING NUMBER DESCRIPTION SYSTEM -------- ------------ -------\n10.15 Addenda to the Lease Agreement dated April 6, 1988 between Jocama Construction and the Registrant (8)\n10.16 Indenture of Lease dated June 17, 1987, between Xednah Investments and Handex of Florida, as amended(1)\n10.17 Lease Agreement dated March 25, 1991, between Handex of New England, Inc. and Metro Park Marlboro Realty Trust, as amended(6)\n10.18 Lease Agreement dated January 20, 1992, between Handex of Maryland, Inc. and Winmeyer Commons II Limited Partnership (6)\n10.19 Lease Agreement dated between New Horizons Learning Center of Metropolitan New York Inc. and Mid City Associates, guaranteed by the Registrant\n10.20 Lease Agreement dated February 24, 1995, between New Horizons Learning Centers of Cleveland Ltd., and Realty One Property Management, guaranteed by the Registrant\n10.21 Consulting Agreement between the Registrant and The Nassau Group, Inc. dated December 17, 1993 (9)\n10.22 Warrants for the purchase of 25,000 shares of Common Stock $.01 par value per share of the Registrant issued to The Nassau Group, Inc. on December 17, 1993 (9)\n10.23 Warrants for the purchase of 40,000 shares of common stock $.01 par value per share of the registrant issued to The Nassau Group, Inc. on August 15, 1994.\n10.24 Asset Purchase Agreement, dated as of August 15, 1994, by and among New Horizons Computer Learning Centers, Inc. a Delaware Corporation, New Horizons Learning Center, Inc., a California Corporation and Michael A. Brinda (10)\n10.25 Stock Purchase Agreement dated as of August 15, 1994 by and among New Horizons Education Corporation, a Delaware Corporation and Michael A. Brinda (10)\n21.1 Subsidiaries of the Registrant\n23.1 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule\n99.1 Directors and Officers and Company Indemnity Policy(5)\n-------------------------------------------------------------- (1) Incorporated herein by reference to the appropriate exhibits to the Registrant's Registration Statement on Form S-1 (File No. 33-28798). (2) Incorporated herein by reference to the appropriate exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989. (3) Incorporated herein by reference to the appropriate exhibit to the Registrant's Quarterly Report on Form 10-Q for the period ended March 31, 1990. (4) Incorporated herein by reference to the appropriate exhibit to the Registrant's Quarterly Report or Form 10-Q for the period ended June 30, 1990. (5) Incorporated herein by reference to the appropriate exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1990. (6) Incorporated herein by reference to the appropriate exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991. (7) Incorporated herein by reference to the appropriate exhibit to the Registrant's Annual Report on Form 10-K for the year ended December 31,1992. (8) Incorporated herein by reference to the appropriate exhibit to the Registrant's Quarterly Report on Form 10-Q for the period ended July 3, 1993. (9) Incorporated herein by reference to the appropriate exhibit to the Registrants Annual Report on Form 10-K for the year ended January 1, 1994. (10) Incorporate herein by reference to the appropriate exhibit to the Registrants Form 8-K dated August 15, 1994.\n* Represents a management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14 of Form 10-K.\nSUBSIDIARIES OF HANDEX --------------------------\nHandex Environmental Recovery, Inc. has the following subsidiaries, all of which are incorporated in the State of Delaware.\n1. Handex of New Jersey, Inc. 2. Handex of Maryland, Inc. 3. Handex of Florida, Inc. 4. Handex of New England, Inc. 5. Handex Environmental Management, Inc. 6. Handex of the Carolinas, Inc. 7. Handex of Illinois, Inc. 8. Handex of Ohio, Inc. 9. Handex of Colorado, Inc. 10. Handex Environmental, Inc. 11. New Horizons Computer Learning Centers, Inc. 12. New Horizons Education Corporation 13. New Horizons Franchising, Inc. 14. New Horizons Computer Learning Center of Chicago, Inc. 15. New Horizons Computer Learning Center of Metropolitan New York, Inc.","section_15":""}
{"filename":"805357_1994.txt","cik":"805357","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Company is engaged in newspaper publishing and television and radio broadcasting. Its newspaper operations consist of two major metropolitan dailies: the St. Louis Post-Dispatch (the \"Post-Dispatch\"), the only major daily newspaper serving the St. Louis metropolitan area; and The Arizona Daily Star (the \"Star\"), serving the Tucson metropolitan area. The Company's broadcasting operations consist of nine network-affiliated television stations located in Greenville, South Carolina; New Orleans, Louisiana; Lancaster, Pennsylvania; Winston-Salem, North Carolina; Albuquerque, New Mexico; Louisville, Kentucky; Omaha, Nebraska; Daytona Beach\/Orlando, Florida and Des Moines, Iowa; and two radio stations located in Phoenix, Arizona. The Daytona Beach\/Orlando and Des Moines television stations were acquired during 1993.\nThe Pulitzer Publishing Company was founded by the first Joseph Pulitzer in 1878 to publish the original St. Louis Post-Dispatch and has operated continuously since that time under the direction of the Pulitzer family. Michael E. Pulitzer, a grandson of the founder, currently serves as Chairman of the Board, President and Chief Executive Officer of the Company.\nThe following table sets forth certain historical financial information regarding the Company's two business segments, publishing and broadcasting, for the periods and at the dates indicated. The publishing segment includes amounts from Pulitzer Community Newspapers (\"PCN\") prior to its disposition on December 22, 1994. (See \" -- Publishing -- Chicago Publications.\") The broadcasting segment includes amounts from WESH-TV and KCCI-TV following their respective acquisitions on June 30, 1993 and September 9, 1993.\n- --------------- (1) Operating margins for publishing are stated with St. Louis Agency adjustment (which is recorded as an operating expense for financial reporting purposes) added back to publishing operating income. See \" -- Publishing--Agency Agreements.\"\nOPERATING STRATEGY\nPulitzer's long-term operating strategy for its media assets is to maximize each property's growth and profitability through maintenance of editorial excellence, leadership in locally-responsive news, and tight control of costs. Management believes that editorial excellence and leadership in local provision of news will, over the long-term, allow Pulitzer to maximize its revenue share in each of its respective markets. Experienced local managers implement the Company's strategy in each media market, with centralized Pulitzer management providing oversight and guidance in all areas of planning and operations.\nIn addition to internal growth, Pulitzer selectively acquires media properties which the Company believes are consistent with its operating strategy and present attractive investment opportunities. Management believes that the Company's strong cash flow and conservative capital structure, among other reasons, will enable the Company to pursue additional acquisitions as opportunities arise, although no acquisitions are presently contemplated.\nPulitzer believes that cost controls are an important tool in the management of media properties which are subject to significant fluctuations in advertising volume. The Company believes that tight control of costs permits it to respond quickly when positive operating conditions offer opportunities to expand market share and profitability and, alternatively, when deteriorating operating conditions require cost reductions to protect profitability.\nThe Company aggressively employs production technology in all of its media operations in order to minimize production costs and produce the most attractive and timely news product for its readers, viewers and listeners.\nPulitzer's media operations are geographically diverse, placing the Company in the Midwest, Southwest, Southeast, and Northeast regions of the United States. Due to the close relationship between economic activity and advertising volume, the Company believes that geographic diversity provides the Company with valuable protection from regional economic variances.\nPUBLISHING\nThe Company intends to continue the tradition of reporting and editorial excellence that has resulted in 17 Pulitzer Prizes* over the years. While opportunities to increase revenues in publishing are limited, management believes that with strict financial controls and cost reductions, newspaper publishing can produce good financial returns. In addition, given the mature nature of the newspaper industry, management is continuing to seek ways to leverage its newspaper assets, such as developing electronic publishing. Further, the Company is pursuing a number of other initiatives to augment advertising revenues. These include voice services delivered by phone, electronic dissemination of information and alternative newspaper delivery systems to provide advertisers with either targeted or total market coverage.\n*Pulitzer Prizes are awarded annually at Columbia University by the Pulitzer Prize Board, an independent entity affiliated with the Columbia University School of Journalism, founded by the first Joseph Pulitzer.\nThe Company publishes two major metropolitan daily newspapers, the St. Louis Post-Dispatch and The Arizona Daily Star. Both daily newspapers have weekly total market coverage sections to provide advertisers with market saturation.\nThe Company's publishing revenues are derived primarily from advertising and circulation, averaging approximately 86 percent of total publishing revenue over the last five years. Advertising rates and rate structures and resulting revenues vary among publications based, among other things, on circulation, type of advertising, local market conditions and competition. The following table provides a breakdown of the Company's publishing revenues for the past five years.\n- --------------- Note Publishing revenues include amounts from Pulitzer Community Newspapers (\"PCN\") prior to its dispostion on December 22, 1994.\nST. LOUIS POST-DISPATCH\nFounded in 1878 by the first Joseph Pulitzer, the Post-Dispatch has a long history of reporting and editorial excellence and innovation in newspaper publishing under the direction of the Pulitzer family. The Post-Dispatch is a morning daily and Sunday newspaper serving primarily the greater St. Louis metropolitan area. St. Louis is the sixteenth largest metropolitan statistical area in the United States (Source: Sales and Marketing Management). Based on Audit Bureau of Circulations (\"ABC\") Publisher's Statement and reports for the six-month period ended September 30, 1994, the market penetration (i.e., percentage of households reached) of both the Post-Dispatch's daily and Sunday editions is seventh in the United States among major metropolitan newspapers. The newsstand price is $0.50 for the daily paper and $1.25 for the Sunday edition.\nThe Post-Dispatch operates under an Agency Agreement between the Company and The Herald Company, Inc. (the \"Herald Company\") pursuant to which the Company performs all activities relating to the day-to-day operations of the newspaper, but pursuant to which it must share one-half of the Agency's operating income or one-half of the Agency's operating loss with the Herald Company. The following table sets forth for the past five years certain circulation and advertising information for the Post-Dispatch and operating revenues for the St. Louis Agency, all of which are included in the Company's consolidated financial statements. See \" -- Publishing -- Agency Agreements.\"\n- --------------- (1) Amounts for 1994 based on Company records for the twelve-month period ended September 30, 1994. All other years based on ABC Publisher's Statement for the twelve-month period ended September 30. (2) Primarily revenues from preprinted inserts.\nThe Post-Dispatch's reporting and editorial excellence is evidenced by the 17 times it and its staff members have been awarded the Pulitzer Prize for outstanding accomplishments in journalism and by a number of other journalistic awards received by members of its staff in recent years.\nThe Post-Dispatch has consistently been a leader in technological innovation in the newspaper industry. It was the first major metropolitan newspaper in the United States to be printed by the offset process. Currently, sophisticated computer systems are used for writing, editing, composing and producing the printing plates used in each edition. In the preparation of news and advertising sections, the Post-Dispatch utilizes a Scitex color graphics system which automates the processing of film and color separations. This system is part of an ongoing project intended to give the Post-Dispatch the capability of full-page pagination. At presstime, a microwave link allows the Post-Dispatch to send full-page images and then print newspapers simultaneously in its downtown and suburban plants, thereby allowing it to deliver newspapers to suburban readers earlier in the morning. In the distribution process, certain sections of the newspaper as well as advertising supplements are handled using a sophisticated palletized inserting operation. This allows the Post-Dispatch to efficiently distribute into selected geographic areas as necessary. The Company's commitment to the ongoing enhancement of its operating systems has enabled the Post-Dispatch to offer a continually improving product to both readers and advertisers while also realizing substantial savings in labor cost. The Company believes the Post-Dispatch has adequate facilities to sustain up to a 30 percent increase in daily circulation without incurring significant capital expenditures.\nThe Post-Dispatch is distributed primarily through independent home delivery carriers and single copy dealers. Home delivery accounted for approximately 76 percent of circulation for the daily Post-Dispatch and 60 percent of circulation for the Sunday edition during 1994.\nTHE ARIZONA DAILY STAR\nFounded in 1877, the Star is published in Tucson, Arizona, by the Company's wholly-owned subsidiary, Star Publishing Company. The Star, a morning and Sunday newspaper, and the Tucson Citizen (the \"Citizen\"), an afternoon newspaper owned by Gannett Co., Inc. (\"Gannett\"), are southern Arizona's\nleading dailies. The Star and the Citizen are published through an agency operation (the \"Tucson Agency\") and have a combined weekday circulation of approximately 146,000. Tucson is currently the 74th largest metropolitan statistical area in the country with a population of approximately 722,600 (Source: Sales and Marketing Management).\nThe Tucson Agency operates through TNI Partners, an agency partnership which is owned half by the Company and half by Gannett. TNI Partners is responsible for all aspects of the business of the two newspapers other than editorial opinion and gathering and reporting news. Revenues and expenses are generally shared equally by the Star and the Citizen. Unlike the St. Louis Agency, the Company's consolidated financial statements include only its share of the combined operating revenues and operating expenses of the two newspapers. See \"-- Publishing -- Agency Agreements.\"\nAs a result of the Tucson Agency, the financial performance of the Company's Star Publishing Company subsidiary is directly affected by the operations and performance of both the Star and the Citizen. The following table sets forth certain information concerning circulation and combined advertising linage of the Star and the Citizen and the Company's share of the operating revenues of the Star and the Citizen for the past five years.\n- --------------- (1) Amounts for 1994 based on Company records for the 52 week period ended December 31. All other years based on ABC Publisher's Statement for the 52 week period ended December 31. (2) Primarily revenues from preprinted inserts.\nIn 1994, the Star's daily edition accounted for approximately 67 percent of the combined daily circulation of the Tucson Agency publications. The Star's daily and Sunday editions accounted for approximately 60 percent of the agency's total advertising linage.\nThe Star and the Citizen are printed at TNI Partners' modern, computerized facility equipped with two, eight-unit Metro offset presses. Present inserter equipment enables all home delivery supplements to be inserted on line at press speeds. In addition, the writing, editing and composing functions have been computerized, increasing efficiency and reducing workforce requirements.\nThe newsstand prices of the daily editions of the Star and the Citizen are $0.50 and $0.35, respectively, and the newsstand price of the Sunday edition of the Star is $1.50. The Star and the Citizen are distributed by independent contractors.\nCHICAGO PUBLICATIONS\nOn December 22, 1994, the Company sold Pulitzer Community Newspapers, Inc., a wholly-owned subsidiary with operations in the Chicago area. Since 1986, PCN's primary operations consisted of the publication of a daily suburban newspaper, the Daily Southtown, and commercial printing services for several national and local newspapers. The sale of PCN completes the Company's exit of the Chicago area after having closed down and partially sold its weekly community newspaper business, Lerner Newspapers, in October 1992.\nThe Company's 1994 consolidated and publishing segment operating results include substantially a full year of PCN operations. During 1994, advertising, preprints, circulation and contract printing accounted for approximately 55 percent, 4 percent, 11 percent and 28 percent, respectively, of PCN's total operating revenues of $48,652,000. The sale of PCN is not expected to have a significant impact on the Company's future earnings results.\nAGENCY AGREEMENTS\nNewspapers in approximately 18 cities operate under joint operating or agency agreements. Agency agreements generally provide for newspapers servicing the same market to share certain printing and other facilities and to pool certain revenues and expenses in order to decrease aggregate expenses and thereby allow the continuing operation of multiple newspapers serving the same market. The Newspaper Preservation Act of 1970 permits joint operating agreements between newspapers under certain circumstances without violation of the Federal antitrust laws.\nSt. Louis Agency. An agency operation between the Company and the Herald Company is conducted under the provisions of an Agency Agreement, dated March 1, 1961, as amended. For many years, the Post-Dispatch was the afternoon and Sunday newspaper serving St. Louis, and the Globe-Democrat was the morning paper and also published a weekend edition. Although separately owned, from 1961 through February 1984, the publication of both the Post-Dispatch and the Globe-Democrat was governed by the St. Louis Agency Agreement. From 1961 to 1979, the two newspapers controlled their own news, editorial, advertising, circulation, accounting and promotion departments and Pulitzer managed the production and printing of both newspapers. In 1979, Pulitzer assumed full responsibility for advertising, circulation, accounting and promotion for both newspapers. In February 1984, after a number of years of unfavorable financial results at the St. Louis Agency, the Globe-Democrat was sold by the Herald Company and the St. Louis Agency Agreement was revised to eliminate any continuing relationship between the two newspapers and to permit the repositioning of the daily Post-Dispatch as a morning newspaper.\nFollowing the renegotiation of the St. Louis Agency Agreement at the time of the sale of the Globe-Democrat, the Herald Company retained the contractual right to half the profits or losses (as defined) of the operations of the St. Louis Agency, which from February 1984 forward consisted solely of the publication of the Post-Dispatch. The St. Louis Agency Agreement provides for the Herald Company to share half the cost of, and to share in a portion of the proceeds from the sale of, capital assets used in the production of the Post-Dispatch. Under the St. Louis Agency Agreement, Pulitzer supervises, manages and performs all activities relating to the day-to-day publication of the Post-Dispatch and is solely responsible for the news and editorial policies of the newspaper.\nThe consolidated financial statements of the Company include all the operating revenues and expenses of the St. Louis Agency. An agency adjustment is provided as an operating expense which reflects that portion of the operating income of the St. Louis Agency allocated to the Herald Company. Under the\nSt. Louis Agency Agreement, for fiscal 1994, 1993, 1992, 1991, and 1990, the Company paid the Herald Company $14,706,000, $10,660,000, $11,690,000, $7,290,000, and $5,253,000, respectively, in respect of the Herald Company's share of the operating income of the St. Louis Agency. As a result of such agency adjustment, the Company is, and during the term of the St. Louis Agency will continue to be, entitled to only half the profits (as defined) from the operations of the St. Louis Agency, the amount of which cannot be determined until the end of each fiscal year.\nThe current term of the St. Louis Agency Agreement runs through December 31, 2034, following which either party may elect to renew the agreement for successive periods of 30 years each.\nTucson Agency. The Tucson Agency Agreement has, since 1940, governed the joint operations of the Star and Citizen. For financial reporting purposes the operations of the Tucson Agency are reflected in the Company's consolidated financial statements differently from the operations of the St. Louis Agency. The consolidated financial statements of the Company include only the Company's share of the combined revenues, operating expenses and income of the Star and Citizen. TNI Partners, as agent for the Company and Gannett, is responsible for advertising and circulation, printing and delivery and collection of all revenues of the Star and the Citizen. The Board of Directors of TNI Partners presently consists of three directors chosen by the Company and three chosen by Gannett. Budgetary, personnel and other non-news and editorial policy matters, such as advertising and circulation policies and rates or prices, are determined by the Board of Directors of TNI Partners. Each newspaper is responsible for its own news and editorial content. Revenues and expenses are recorded by TNI Partners, and the resulting profit is split 50-50 between Pulitzer and Gannett. Both partners have certain administrative costs which are borne separately. As a result of the Tucson Agency, the Star and the Citizen benefit from increases and can be adversely affected by decreases in each other's circulation.\nThe Tucson Agency Agreement runs through June 1, 2015, and contains renewal provisions for successive periods of 25 years each.\nCOMPETITION\nThe Company's publications compete for readership and advertising revenues in varying degrees with other metropolitan, suburban, neighborhood and national newspapers and other publications as well as with television, radio, direct mail and other news and advertising media. 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 publication. In St. Louis and its surrounding suburban communities, the Post-Dispatch's competition for circulation and advertising revenues includes paid suburban daily newspapers as well as a chain of community newspapers and shoppers. These community newspapers and shoppers target selected geographic markets throughout the St. Louis metropolitan area.\nDue to the agency relationship existing in Tucson, the Star and the Citizen cannot be viewed as competitors for advertising or circulation revenues. The Star and the Citizen compete primarily against other media and against Phoenix-area and suburban, neighborhood and national newspapers and publications.\nEMPLOYEE RELATIONS\nThe Company has contracts with substantially all of its production unions related to the Post-Dispatch, with expiration dates ranging from February 1999 through September 2002. In addition, the Company signed a new eight-year contract with the St. Louis Newspaper Guild in December 1994. All of the Post-Dispatch labor contracts contain no strike provisions.\nTNI Partners has a one-year contract, expiring December 31, 1995, with Tucson Graphic Communications Union Local No. 212, covering certain pressroom employees.\nRAW MATERIALS\nThe publishing segment's results are significantly impacted by the cost of newsprint which accounted for approximately 19 percent of the segment's total 1994 operating expenses. During 1994, the Company used approximately 109,900 metric tons of newsprint in its production process. The Company's recurring newsprint cost and metric tons of consumption for 1994, after giving effect to the St. Louis Agency adjustment and excluding PCN, were approximately $22,800,000 and 50,600 metric tons, respectively. In the last five years, the Company's average cost per ton of newsprint has varied from a low of $402 per ton in 1992 to a high of $495 per ton in 1990. After declining during the first half of 1994, newsprint prices have since been on an upward trend through early 1995. For the first quarter of 1995, the Company expects its average cost per metric ton to increase to approximately $555. Based upon notification from the Company's newsprint vendors of an increase scheduled for May 1995, the Company's average cost per metric ton for the second quarter and the balance of the year (assuming no further increases) are estimated to be approximately $625 and $680, respectively. These estimated higher newsprint prices for fiscal year 1995 are expected to have a significant effect on the performance of the publishing segment. No assurance, however, can be given that the estimated newsprint average cost increases for fiscal 1995 will be as projected, and actual average cost increases may be higher or lower.\nThe Post-Dispatch obtains the newsprint necessary for its operations from six separate suppliers, three of which are Canadian. The Post-Dispatch has guaranteed the future supply of certain volume levels through long-term agreements with three of these newsprint suppliers. The Company believes that the absence of long-term agreements with the remaining three newsprint suppliers will not limit the Company's ability to obtain newsprint at competitive prices.\nTNI Partners obtains the newsprint necessary for the Tucson Agency's operations pursuant to an arrangement with Gannett, the owner of the Citizen. Gannett purchases newsprint on behalf of TNI Partners under various contractual arrangements and agreements. Newsprint is also purchased on the spot market.\nBROADCASTING\nThe Company's broadcasting operations currently consist of the ownership and operation of eight network-affiliated VHF television stations, one network-affiliated UHF television station, two satellite network television stations and one AM and one FM radio station. Pulitzer Broadcasting has traditionally focused on mid-sized television markets. The Company has diversified its revenues by purchasing properties in different geographic regions of the United States, thus insulating itself, somewhat, from regional economic downturns. The local management of each of the Company's broadcasting properties are partially compensated based on the cash flow performance of their respective stations. Senior management believes that the success of a local television station is driven by strong local news programming, and that the Company has developed a particular strength in local news programming. As is the case with all Company operations, there is major emphasis on cost control in the broadcasting segment.\nTELEVISION The following table sets forth certain information concerning the television stations which the Company owns and the markets in which they operate.\n- ---------------\n(1) Based upon the Designated Market Area (\"DMA\") for the station as reported in the November, 1994 Nielsen Station Index (\"NSI\"). DMA is a geographic area defined as all counties in which the local stations receive a preponderance of total viewing hours. DMA data is a primary factor in determining television advertising rates. NOTE: Previous years' schedules include market data from the Arbitron Company which ceased to provide local television market reports in 1994.\n(2) National DMA rank for each market as reported in the November, 1994 NSI.\n(3) Based on November, 1994 NSI audience estimates, 7:00am-1:00am, Sunday-Saturday. The number of commercial stations operating in market does not include public broadcasting stations, satellite stations or translators which rebroadcast signals from distant stations.\n(4) See \" -- Federal Regulation of Broadcasting -- Broadcast Licenses.\"\n(5) VHF (very high frequency) stations transmit on channels 2 through 13, and UHF (ultra high frequency) stations transmit on channels 14 through 69. Technical factors, such as station power, antenna location and height and topography of the area served, determine geographic market served by a television station. In general, a UHF station requires greater power or antenna height to cover the same area as a VHF station.\n(6) The Company is also the licensee of KOVT, a satellite TV station licensed to Silver City, New Mexico and the holder of a construction permit to build a satellite TV station, KOFT, in Gallup, New Mexico. Pulitzer has filed a Petition for Rule Making with the FCC requesting that the community of license of KOFT be changed from Gallup to Farmington, New Mexico. In 1993, the Company purchased the operating assets of KVIO, a satellite TV station licensed to Carlsbad, New Mexico. The call letters of KVIO were subsequently changed to KOCT.\nAverage audience share, market rank and the number of stations serving the market for each television station which the Company currently owns for the past five years are shown in the following table.\n- ---------------\n(1) Represents the number of television households tuned to a specific station 9:00am-Midnight, Sunday-Saturday, as a percentage of Station Total Households. Source: 1994 data from February, May and November Nielsen Station Index (\"NSI\"). Schedules for 1990-1993 include both NSI and Arbitron Ratings Audience Estimates information. NOTE: The Arbitron Company ceased to provide local television market reports in 1994.\n(2) Stations serving market and local market rank data for 1994 based on November, 1994 NSI. Schedules for 1990-1993 include both NSI and Arbitron Ratings Audience Estimates information.\n(3) Acquired June 30, 1993.\n(4) Acquired September 9, 1993.\n(5) Switched affiliations from ABC to CBS in September, 1990.\nThe Company's television stations are affiliated with national television networks under ten-year contracts which are automatically renewed for successive five-year terms unless the Company or network exercises its right to cancel. Prior to executing new contracts in early 1995, the stations' old network affiliation agreements were for two year periods with automatic renewal provisions.\nThe ratings of the Company's television stations are affected by fluctuations in the national ratings of its affiliated networks. The Company believes that such network rating fluctuations are normal for the broadcasting industry and in the past has not sought to change its network affiliations based on the decline of the national ratings of an affiliated network.\nADVERTISING REVENUES\nThe principal source of broadcasting revenues for the Company is the sale of time to advertisers. The Company derives television broadcasting revenues from local and national spot advertising and network compensation. Local advertising consists of short announcements and sponsored programs on behalf of advertisers in the immediate area served by the station. National spot advertising generally consists of short announcements and sponsored programs on behalf of national and regional advertisers. Network revenue is based upon a contractual agreement with a network and is dependent upon the network programs broadcast by the stations. The following table sets forth the television broadcasting revenues received by the Company from each of these types of advertising during the past five years.\n- --------------- (1) The Company acquired television stations WESH and KCCI on June 30, 1993 and September 9, 1993, respectively.\nThe Company believes that its stations are particularly strong in local news programming, an important revenue source for network-affiliated stations. Local news programs generate approximately a quarter of each station's revenues.\nLocal time spots are sold by the Company's sales personnel at each broadcast station. Company sales departments make extensive use of computers to track and schedule all commercial spots sold, to maintain the broadcast station operating schedule, to determine time spot availability and to record accounts receivable. National spots are sold by the Company's three national sales representative firms.\nAdvertising rates are based primarily on audience size, audience share, demographics and time availability. The Company's ability to maximize advertising revenues is dependent upon, among other things, its management of the inventory of advertising time available for sale.\nPROGRAMMING\nThe national television networks with which the Company's stations are affiliated offer a variety of sponsored and unsponsored programs to affiliated stations. The affiliated stations have the right of first refusal before the programs may be offered to any other television station in the same city.\nWhen not broadcasting network programs, the Company's stations broadcast local news programs, movies, syndicated programs acquired from independent sources and public service programs. Movies and syndicated programs have frequently been shown previously on network or cable television. Syndicated programs are programs that are licensed to individual stations for one or more showings in a particular market as distinguished from programs licensed for national distribution through one of the major networks.\nThe Company's stations make programming decisions on the basis of a number of factors, including program popularity and cost. On occasion, the Company has not renewed a popular program when syndication costs exceeded the level the Company believed appropriate compared to the potential advertising revenues to be derived from the program.\nRADIO\nThe Company owns two radio stations serving the Phoenix, Arizona market: KTAR (AM) and KKLT (FM). Phoenix is the 20th largest Metro Market in the United States, and the Phoenix Radio Metro Area is served by thirteen AM and seventeen FM radio stations. KTAR (AM) ranks fourth in the Phoenix market and KKLT (FM) ranks ninth, with 5.8 percent and 4.3 percent average quarter hour market shares, respectively (source: Arbitron Radio Ratings Summary-Fall 1994). KTAR (AM) operates as a news\/talk\/sports radio station while KKLT (FM) has an adult contemporary music format. The FCC licenses for KTAR (AM) and KKLT (FM) expire on June 1, 1997.\nAdvertising rates charged by a radio station are based primarily upon the number of homes in the station's primary market, the number of persons using radio in the area and the number of persons listening to the station. Advertising is sold by a national sales representative and by the stations' advertising sales personnel, consisting of approximately twenty-one salespersons and three sales managers. The Company's radio stations manage their inventory of available advertising time in much the same manner as the television stations. Radio broadcasting net revenues during each of the past five years were as follows: 1994 - $13,023,000; 1993 - $12,900,000; 1992 - $12,320,000; 1991 - $12,973,000; and 1990 - $14,170,000.\nCOMPETITION\nCompetition for television and radio audiences is based primarily on programming content. Programming content for the Company's television stations is significantly affected by network affiliation and by local programming activities. Competition for advertising is based on audience size, audience share, audience demographics, time availability and price. The Company's television stations compete for audience and advertising with other television stations and with radio stations, cable television and other news, advertising and entertainment media serving the same markets. In addition, the Company's television stations compete for audience and, to a lesser extent, advertising, with other forms of home entertainment such as home video recorders and direct broadcast satellite service. Cable systems, which operate generally on a subscriber payment basis, compete by carrying television signals from outside the broadcast market and by distributing signals from outside the broadcast market and by distributing programming that is originated exclusively for cable systems. The Company's television stations are also affected by local competitive conditions, including the number of stations serving a particular area and the programming content of those stations.\nThe Company believes that the competitive position of its radio and television properties is enhanced by the Company's policy of operating its broadcasting properties with a view to long-term growth. Strong local news programming is an important factor for the competitive position of the Company's television stations. The Company's system for managing advertising inventory of its television and radio stations is also an important factor in its ability to compete effectively for advertising revenues.\nThe Company's radio stations compete for audience and advertising with other radio and television stations in the Phoenix area and with other print, advertising and entertainment media. The Company's radio stations compete for audience primarily on the basis of their broadcasting format.\nFEDERAL REGULATION OF BROADCASTING\nTelevision and radio broadcasting are subject to the jurisdiction of the Federal Communications Commission (\"FCC\") pursuant to the Communications Act of 1934, as amended (the \"Communications Act\"). The Communications Act prohibits the public dissemination of radio and television broadcasts except in accordance with a license issued by the FCC and empowers the FCC to issue, revoke, modify and renew broadcasting licenses and adopt such regulations as may be necessary to carry out the provisions of the Communication Act.\nBROADCAST LICENSES\nBroadcasting licenses are granted for a maximum period of seven years in the case of radio stations and five years in the case of television stations and are renewable upon application. During the period when a renewal application is pending, competing applicants may file for the frequency being used by the renewal applicant. Petitions to deny license renewals and other applications may also be filed against licensees and applicants. Such petitions can be used by interested parties, including members of the public, to raise issues before the FCC.\nAn application to renew the license of WDSU, New Orleans, was filed by the Company with the FCC on January 19, 1992; the National Black Media Coalition has filed with the FCC a petition to deny the grant of the application based on alleged violations of the FCC's equal employment opportunity rules. The Company has filed an opposition to the aforementioned petition and is confident of a favorable outcome.\nMULTIPLE OWNERSHIP\nFCC regulations govern the multiple, common and cross ownership of broadcast stations. Under the FCC's current multiple ownership rules, a license for an AM radio or FM radio or television station will not be granted if (i) the applicant already owns, operates or controls or has an interest in another television station of the same type which provides service to substantially the same area as the television station owned, operated or controlled by the applicant, or (ii) the grant of the license would result in the applicant's owning, operating or controlling or having an interest in more than 20 AM stations, more than 20 FM stations or more than 12 television stations, except in special situations. With respect to television stations, there is an additional ownership limit based on audience reach. Under the audience reach limitation, an entity may acquire cognizable ownership interests in up to 12 markets, if the households reached by the television stations do not exceed 25% of the national television household audience as determined by the Arbitron ADI market rankings.\nThe common ownership rules generally prohibit ownership of a VHF television station and either an AM or FM radio station in the same market, and the AM-FM radio ownership rules prohibit granting a license to operate an AM or FM radio station or television station to an applicant who already owns, operates or controls or has an interest in a daily newspaper in the community in which the broadcast license is requested. Further, the cross ownership rules prohibit a cable television system from carrying the signal of a television broadcast station if such system owns, operates, controls or has an interest in a broadcast television station which serves substantially the same area that the cable television system is serving. The FCC and the Congress are currently considering the elimination or liberalization of various national and local restrictions on the ownership of television stations.\nRECENTLY ADOPTED AND PROPOSED FCC RULE CHANGES\nThere are currently pending before Congress bills which would allow ownership of cable systems by the Bell Operating Companies located outside of their service areas. There is pending before the courts an appeal of a decision of the FCC which authorizes telephone companies to offer a type of cable service, known as \"video dialtone,\" by furnishing transmission facilities on a common carrier basis to customers who desire to distribute video programming.\nIt is the current policy of the FCC to rely increasingly upon the interplay of marketplace forces in lieu of direct government regulation and to encourage increasing competition among different electronic communication media. The FCC has granted several applications proposing to establish direct broadcast satellite systems (\"DBS\"). Several other new technologies are in their developmental stages, such as High Definition Television capable of transmitting television pictures with higher resolution, truer color and wider aspect ratios, and Digital Audio Broadcasting capable of transmitting radio signals on a terrestrial basis and by space satellites. The potential impact of these technologies on the Company's business cannot be predicted.\nA controversy exists among television broadcasters, cable companies and program producers relating to rules requiring cable television systems (\"cable systems\") to carry the signals of local television stations. On March 11, 1993, the FCC adopted rules concerning the mandatory signal carriage (\"must carry\") rights of commercial and noncommercial television stations that are local to the area serviced by a cable system and the requirement prohibiting cable operators and other multichannel video programming providers from carrying television stations without obtaining their consent (\"retransmission consent\") in certain circumstances. Later that year, a three-judge panel of the United States District Court found that the FCC rules governing must carry and retransmission consent are constitutional. On appeal, the United States Supreme Court vacated the District Court decision and remanded the case back to the three-judge panel for further proceedings. While the case is pending, the must-carry provisions of the 1992 Cable Act remain in effect, as do the Commission's must-carry rules and retransmission consent requirements.\nLIMITATIONS ON OWNERSHIP OF THE COMPANY'S STOCK\nThe Communications Act prohibits the assignment or transfer of broadcasting licenses, including the transfer of control of any corporation holding such licenses, without the prior approval of the FCC. The Communications Act would prohibit the Company from continuing to control broadcast licenses if, in the absence of FCC approval, any officer of the Company or more than one-fourth of its directors were aliens, or if more than one-fourth of the Company's capital stock were acquired or voted directly or indirectly by alien individuals, corporations, or governments, or if it otherwise fell under alien influence or control in a manner determined by the FCC to be contrary to the public interest.\nBecause of the multiple, common and cross ownership rules, if a holder of the Company's common stock or Class B common stock acquired an attributable interest in the Company and had an attributable interest in other broadcast stations, a cable television operation or a daily newspaper, there could be a violation of FCC regulations depending upon the number and location of the other broadcasting stations, cable television operations or daily newspapers attributable to such holder.\nThe information contained under this heading does not purport to be a complete summary of all the provisions of the Communications Act and the rules and regulations of the FCC thereunder or of pending proposals for other regulation of broadcasting and related activities. For a complete statement of such provisions, reference is made to the Communications Act, to such rules and regulations and to such pending proposals.\nJOINT VENTURE INVESTMENT\nOn January 1, 1994, the Company acquired a one-third interest in RXL Communications (\"RXL\") for $5,000,000. The joint venture, originally formed by affiliates of Morgan-Murphy Broadcasting and The Rocky Company in 1988, produces and broadcasts interactive educational programming as a curriculum supplement to school systems across the United States. In addition, RXL produces training, seminar and conference broadcasts and videos for a variety of corporate, governmental and trade organizations. The joint venture, with operating facilities in the states of Washington and Missouri, was renamed RXL Pulitzer as of January 1, 1994.\nEMPLOYEES\nAt December 31, 1994, the Company had approximately 2,400 full-time employees, of whom approximately 1,300 were engaged in publishing and 1,100 in broadcasting. In St. Louis, a majority of the approximately 1,100 full-time employees engaged in publishing are represented by unions. In addition, certain employees of the broadcasting segment and TNI Partners are represented by unions. The Company considers its labor relations with its employees to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe corporate headquarters of the Company is located at 900 North Tucker Boulevard, Saint Louis, Missouri. The general character, location and approximate size of the principal physical properties used by the Company at December 31, 1994, are set forth below. Leases on the properties indicated as leased by the Company expire at various dates through July 2012.\nThe Company believes that all of its owned and leased properties are in good condition, well maintained and adequate for its current and immediately foreseeable operating needs. The Company currently has two building projects in process to address the long-term operating requirements of its New Orleans televison station and Phoenix radio stations.\n- --------------- * Property is subject to the provisions of the St. Louis Agency Agreement.\n** The 265,000 square foot facility in Tucson, Arizona, is used in the production of the Star and the Citizen and is jointly owned with Gannett pursuant to the Tucson Agency. Approximately 900 square feet of the leased properties in Tucson, Arizona, are leased by the Company for use as a bureau office for the Star. The remaining leased facilities are leased by TNI Partners pursuant to the Tucson Agency.\nITEM 3.","section_3":"ITEM 3. LITIGATION\nThe Company becomes involved from time to time in various claims and lawsuits incidental to the ordinary course of its business, including such matters as libel, slander and defamation actions and complaints alleging discrimination. In addition, the Company is involved from time to time in various governmental and administrative proceedings relating, among other things, to renewal of broadcast licenses. While the results of litigation cannot be predicted, management believes the ultimate outcome of such litigation will not have a material adverse effect on the consolidated financial statements of the Company and its subsidiaries.\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\nThe Company's common stock is listed and traded on the New York Stock Exchange under the symbol \"PTZ.\"\nAt March 14, 1995, there were approximately 454 record holders of the Company's common stock and one record holder of its Class B common stock.\nThe following table sets forth the range of high and low sales prices and dividends paid for each quarterly period in the past two years:\n- ---------------\n* In 1994 and 1993, the Company paid cash dividends of $0.46 and $0.43, respectively, per share of common stock and Class B common stock (see Note 5 of Notes to Consolidated Financial Statements for restrictions on dividends).\n** The high and low sales prices and dividends per share have been adjusted to reflect the impact of a five-for-four stock split, effected in the form of a 25 percent common and Class B common stock dividend, declared by the Company's Board of Directors on January 4, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 6. SELECTED FINANCIAL DATA - CONTINUED\n- ---------------\n(1) In 1994, shares outstanding, dividends per share and earnings per share were adjusted for 1994 and restated for 1993 - 1990 to reflect the impact of a five-for-four stock split, effected in the form of a 25 percent common and Class B common stock dividend, declared by the Company's Board of Directors on January 4, 1995. In 1992, shares outstanding, dividends per share and earnings per share were adjusted for 1992 and restated for 1991 - 1990 to reflect the impact of 10 percent common and Class B common stock dividend declared by the Company's Board of Directors on January 4, 1993.\n(2) During 1993 the Company acquired television stations WESH and KCCI for approximately $164.7 million.\n(3) As of December 31, 1993, approximately $118.6 million of new long-term debt financing was outstanding related to the acquisition of WESH and KCCI.\n(4) On July 9, 1993, the Company sold 1.35 million shares of common stock in a public offering. The $37 million in net proceeds from the offering was used to partially finance the acquisition of WESH and KCCI in 1993.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe Company's operating revenues are significantly influenced by a number of factors, including overall advertising expenditures, the appeal of newspapers, television and radio in comparison to other forms of advertising, the performance of the Company in comparison to its competitors in specific markets, the strength of the national economy and general economic conditions and population growth in the markets served by the Company.\nThe Company's business tends to be seasonal, with peak revenues and profits generally occurring in the fourth and, to a lesser extent, second quarters of each year as a result of increased advertising activity during the Christmas and spring holiday periods. The first quarter is historically the weakest quarter for revenues and profits.\n1994 COMPARED WITH 1993\nCONSOLIDATED\nOperating revenues for the year ended December 31, 1994 increased 13.7 percent to $485.6 million from $427 million in 1993. The revenue comparison was affected by the acquisitions of television stations WESH and KCCI on June 30, 1993 and September 9, 1993, respectively. The Company's 1994 results included full periods for WESH and KCCI while the prior year included the results of the two television stations only after their respective acquisition dates. Excluding WESH (first six months only) and KCCI (first nine months only) from the comparison, consolidated revenues would have increased 7.9 percent. These increases reflected gains in both broadcasting and publishing revenues.\nOperating expenses, excluding the St. Louis Agency adjustment, were $396.3 million compared to $368.4 million in 1993, an increase of 7.6 percent. Excluding WESH (first six months only) and KCCI (first nine months only) from the comparison, consolidated operating expenses would have increased 1.5 percent. Major increases in comparable expenses included overall personnel costs ($3.2 million), circulation delivery expense ($1.1 million), national advertising representative commissions ($783,000) and newsprint expense ($396,000). Expense increases were partially offset by a decline in programming rights expense ($2.9 million) and the reversal of an accrual due to the settlement of a sales tax issue ($437,000).\nOperating income for fiscal 1994 increased 55.5 percent to $74.6 million from $48 million in 1993. Excluding WESH (first six months only) and KCCI (first nine months) from the comparison, operating income would have increased 50.7 percent. The increase reflected improvements in operating income in both the publishing and broadcasting segments due to a combination of increased revenues and cost control.\nInterest expense increased $2.2 million in 1994 compared to 1993, due to higher debt levels in 1994. The Company's average debt level for 1994 increased to $160.1 million from $119.7 million in the prior year, due to borrowings related to the 1993 acquisitions of WESH and KCCI. Lower rates on the WESH and KCCI borrowings reduced the Company's average interest rate for 1994 to 7.5 percent from 7.8 percent in the prior year. Interest expense also included a declining interest factor related to annual payments (1990-1994) under a non-competition agreement entered into in connection with the 1989 acquisition of television station WDSU\nin New Orleans. Interest income for the year increased $881,000, due to both higher average balances of invested funds and higher interest rates.\nThe effective income tax rate for 1994 decreased to 39.4 percent from 39.9 percent in the prior year. The rates in both 1994 and 1993 were affected by non-recurring items. The 1994 rate included the effect of approximately $1.8 million in tax expense related to the gain on the sale of Pulitzer Community Newspapers, Inc. In addition, 1994 income tax expense was reduced by a $500,000 positive adjustment related to the fourth-quarter settlement of the 1992 federal tax examination. The 1993 effective tax rate was lowered by a $225,000 adjustment to the tax provision, reflecting a change in the Company's deferred income tax rates as a result of the Revenue Reconciliation Act of 1993. Excluding these non-recurring items from both years, the effective income tax rates for 1994 and 1993 would have been 39.2 percent and 40.5 percent, respectively. The lower 1994 rate reflected the Company's reduced exposure to further tax adjustments for open tax years, following the settlement of the 1990-1992 federal tax examinations during 1994, and the impact of 1993 tax law changes in the deductibility of the amortization of intangibles. The effective tax rates in both years also reflected the effect of approximately $500,000 of non-deductible goodwill amortization expense. The Company expects the estimated tax rate for 1995 will be in the 39 percent range, approximately the same as the effective rate for 1994.\nEffective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits (\"SFAS 112\") and recorded its initial liability thereunder, resulting in a one-time after-tax charge of $719,000 (see Note 10 of the Notes to Consolidated Financial Statements). After recording the one-time charge, the Company's 1994 expense under SFAS 112 did not differ significantly from the prior year pay-as-you-go amount.\nOn December 22, 1994, the Company sold its Chicago publishing subsidiary, Pulitzer Community Newspapers, Inc. (\"PCN\"), for approximately $33.7 million. The gain on the sale of PCN added approximately $1 million ($2.8 million less income taxes of $1.8 million), or $0.06 per share, to 1994 net income. The sale of PCN is not expected to have a significant impact on the Company's future earnings results.\nFor the year ended December 31, 1994, the Company reported net income of $39.2 million, or $2.41 per share, compared with net income of $23.3 million, or $1.53 per share, in the prior year. Net income for 1994 included the non-recurring SFAS 112 charge of $719,000, or $0.04 per share. In 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, resulting in a positive adjustment to income of $360,000, or $0.02 per share.\nExcluding the cumulative effects of accounting changes from both years and the 1994 one-time gain from the sale of PCN, 1994 net income increased to $38.9 million, or $2.39 per share, from $23 million, or $1.51 per share, for the prior year. The 1994 gain in net income reflected improvements in operating profits in both the publishing and broadcasting segments due to a combination of increased revenues and cost control. The Company's earnings per share comparison for the year-to-date period was affected by the larger average number of shares outstanding in 1994 as a result of the public offering of 1.35 million shares in July 1993.\nPUBLISHING\nOperating revenues from the Company's publishing segment for 1994 increased 5 percent to $304.8 million from $290.1 million in 1993, primarily reflecting increased revenues from advertising, particularly classified, at all three newspaper locations.\nNewspaper advertising revenues increased $12.3 million, or 7.3 percent, in 1994. The 1994 increase resulted from higher advertising volume which contributed $9.3 million and higher average rates which contributed $3 million. In January 1994, all publishing properties increased rates for certain advertising categories, ranging from 3 percent to 6.5 percent. In the first quarter of 1995, both the St. Louis Post-Dispatch (\"Post-Dispatch\") and The Arizona Daily Star (\"Star\") implemented rate increases for most advertising categories, ranging from 4 percent to 6 percent and 6 percent to 8 percent, respectively.\nCirculation revenues decreased $720,000, or 0.9 percent, in 1994. The slight revenue decline for 1994 resulted from average circulation decreases at the Post-Dispatch while average circulation rates were virtually unchanged from the prior year. Average daily and Sunday circulation of the Post-Dispatch for the fourth quarter of 1994 was 331,676 and 552,647 compared to 342,687 and 561,744, respectively, for the corresponding 1993 period. Effective February 5, 1995, the home-delivered price of the Sunday Post-Dispatch was increased $1.00 per month. In addition, the home-delivered price of the daily Star will be increased $0.80 per month, effective March 27, 1995.\nOperating expenses (including selling, general and administrative expenses and depreciation and amortization) for the publishing segment, excluding the St. Louis Agency adjustment, increased to $259.6 million in 1994 from $255.8 million in 1993, an increase of 1.5 percent. The increase was principally attributable to higher circulation delivery expense ($1.1 million), increases in overall personnel costs ($746,000) and an increase in newsprint expense ($396,000), due to higher newsprint consumption.\nOperating income from the Company's publishing activities increased 28.6 percent to $30.5 million from $23.7 million in 1993, reflecting a combination of increased revenues and cost control.\nThe publishing segment's 1994 results were favorably impacted by a downward trend in newsprint prices during the first half of 1994. However, during the second half of 1994, newsprint prices began to increase and have continued to rise in early 1995. The Company's recurring newsprint cost and metric tons of consumption for 1994, after giving effect to the St. Louis Agency adjustment and excluding PCN, were approximately $22.8 million and 50,600 metric tons, respectively. For the first quarter of 1995, the Company expects its average cost per metric ton to increase to approximately $555. Based upon notification from the Company's newsprint vendors of an increase scheduled for May 1995, the Company's average cost per metric ton for the second quarter and the balance of the year (assuming no further price increases) are estimated to be approximately $625 and $680, respectively. These estimated higher newsprint prices for fiscal year 1995 are expected to have a significant effect on the performance of the publishing segment. No assurance, however, can be given that the estimated newsprint average cost increases for fiscal 1995 will be as projected, and actual average cost increases may be higher or lower.\nBROADCASTING\nBroadcasting operating revenues for 1994 increased 32.1 percent to $180.8 million from $136.8 million in 1993. The revenue comparison was affected by the Company's acquisition of television stations WESH and KCCI on June 30, 1993 and September 9, 1993, respectively. Excluding WESH (first six months only) and KCCI (first nine months only) from the comparison, broadcasting revenues would have increased 14.1 percent in 1994. On a comparable basis, local spot advertising would have increased 9.2 percent; national spot advertising would have increased 23 percent; and network compensation would have declined 4 percent. Political advertising, including WESH and KCCI, increased $8.1 million in 1994.\nBroadcasting operating expenses (including selling, general and administrative expenses and depreciation and amortization) increased 22 percent to $132.8 million in 1994 from $108.9 million in 1993. Excluding WESH (first six months only) and KCCI (first nine months only) from the comparisons, operating\nexpenses would have increased 1.4 percent in 1994. Major increases in comparable expenses were overall personnel costs ($2.4 million), national advertising representative commissions ($783,000) and promotion expense ($395,000). Partially offsetting these increases were a decline in programming rights expense ($2.9 million) and the reversal of an accrual due to the settlement of a sales tax issue ($437,000).\nOperating income from broadcasting operations in 1994 increased 71.6 percent to $48 million from $27.9 million in the prior year. Excluding WESH (first six months only) and KCCI (first nine months only), broadcasting operating income would have increased 63.2 percent in 1994, due to a combination of increased advertising revenues and cost control.\nEarly in 1995, the Company executed a new 10-year network affiliation agreement for each of its nine television stations. None of these new agreements represents a change in affiliation from the prior year. On an annual basis, beginning in 1995, the new agreements with ABC, CBS and NBC will add approximately $10.5 million to the Company's annual network compensation revenue. The Company anticipates, however, that approximately $2 million of this revenue increase will be invested back into its stations to strengthen their local news operations. These costs will be reflected in the ongoing annual expenses of the broadcasting operations.\n1993 COMPARED WITH 1992\nCONSOLIDATED\nOperating revenues for the year ended December 31, 1993 increased 7.2 percent to $427 million from $398.4 million in 1992. Revenue comparisons were affected by the acquisitions of television stations WESH and KCCI on June 30, 1993 and September 9, 1993, respectively, and the closedown and partial sale of certain assets of Pulitzer's Lerner Newspapers operation in Chicago on October 13, 1992. Revenues for the year ended December 31, 1993 included the operations of the two television stations following their acquisitions. Prior year revenues included Lerner's operations for the first nine months while no amounts for Lerner are included in 1993. Excluding WESH and KCCI's 1993 revenues and Lerner's 1992 revenues from the comparisons, consolidated revenues would have increased 3.5 percent. These increases reflected gains in both broadcasting and publishing revenues.\nOperating expenses, excluding the St. Louis Agency adjustment, were $368.4 million compared to $350.1 million in 1992, an increase of $18.3 million, or 5.2 percent. Expense comparisons were also affected by the television acquisitions, Lerner and two non-recurring charges in 1992 (a $3 million lawsuit settlement at the Post-Dispatch and a $1.5 million corporate charge for a feature film write-off). Excluding WESH and KCCI's 1993 expenses and 1992 items affecting comparability, consolidated operating expenses would have increased $12.3 million or 3.7 percent. This 3.7 percent increase was primarily attributable to increased overall personnel costs ($8.7 million) and increased newsprint expense ($4.4 million). Expense increases were partially offset by decreased depreciation and amortization ($1.5 million); decreased purchased supplements in publishing ($1.1 million); and decreased programming rights ($1 million).\nOperating income for fiscal 1993 increased 30.9 percent, to $48 million from $36.6 million in 1992. Excluding the effects of WESH and KCCI from 1993, and Lerner, the lawsuit settlement and the film write-off from 1992, operating income would have increased 9.7 percent for 1993. The 1993 increase reflected improvements in operating income in both the publishing and broadcasting segments, primarily as a result of increased revenues.\nInterest expense increased $2 million in 1993 compared to 1992, due to higher debt levels in the second half of 1993. Interest expense on new long-term borrowings related to the WESH and KCCI acquistions amounted to $3.8 million in 1993. The Company's average debt level for 1993 increased to $119.7 million from $80.6 million in the prior year. Lower rates on the new long term borrowings reduced the Company's average interest rate for 1993 to 7.8 percent from 8.9 percent in the prior year. Interest expense\nalso included a declining interest factor related to annual payments (1990-1994) under a non-competition agreement entered into in connection with the 1989 acquisition of television station WDSU in New Orleans. Interest income for the year declined marginally as the benefit from higher average invested funds was more than offset by lower interest rates.\nThe effective income tax rate for 1993 increased to 39.9 percent from 18.2 percent for 1992. The lower rate in 1992 resulted from two non-recurring items; 1) an approximate $1.7 million tax benefit associated with the closedown and partial sale of Lerner Newspapers, principally due to a tax deduction for intangible assets, and 2) positive adjustments to the tax reserve in the 1992 second and fourth quarters amounting to $3.4 million and $2.5 million, respectively, following the favorable settlement of federal tax examinations for 1985 through 1989. Without giving effect to these non-recurring items, the effective tax rate for 1992 would have been 42 percent. The effective tax rates in 1993 and 1992 also reflected the effects of approximately $500,000 and $1.4 million, respectively, of non-deductible goodwill amortization expense.\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\") (see Note 11 of the Notes to Consolidated Financial Statements). Adoption of SFAS 109 resulted in an increase in net income of $360,000, or $0.02 per share, in 1993 to record deferred tax liabilities at the current (lower) tax rate than when originally recorded. As of December 31, 1993, the Company had a net deferred tax asset of $10.9 million. The deferred tax asset was recorded based upon management's belief that realization of the deferred tax asset was likely considering the Company's sufficient taxable income in prior carryback years (1993, 1992 and 1991) and anticipated sufficient future levels of taxable income.\nFor the year ended December 31, 1993, the Company reported net income of $23.3 million, or $1.53 per share, compared with a net loss of $1.2 million, or $0.09 per share loss, in the prior year. Net income for 1993 included a non-recurring positive adjustment to income of $360,000, or $0.02 per share, in connection with the adoption of SFAS 109 effective January 1, 1993. The 1992 net loss resulted from the Company's adoption of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") and the related one-time after-tax charge of $25.1 million, or $1.74 per share loss.\nExcluding the cumulative effects of accounting changes, other non-recurring items and WESH and KCCI, net income for 1993 would have been $24.3 million, or $1.59 per share, compared with $20.3 million, or $1.41 per share (see summary below). The gain in net income, on a comparable basis, reflected improvements in operating profits in both the publishing and broadcasting segments, primarily as a result of increased revenues. The earnings per share comparison was impacted by the increase in shares outstanding due to the public offering of 1.35 million shares in July 1993.\nDuring the third quarter of 1993, the Company completed the purchase of two television stations, WESH in Daytona Beach\/Orlando, Florida and KCCI in Des Moines, Iowa. For the year ended December 31, 1992, these stations had combined operating revenues of $44.8 million and combined operating expenses, excluding depreciation and amortization, of $27.2 million. The Company closed the WESH acquisition on June 30, 1993, paying a purchase price of $136.2 million plus $6.4 million for net receivables. The Company closed the KCCI acquisition on September 9, 1993, paying a purchase price of $20.8 million plus $1.3 million for net receivables. Substantially all of the purchase price for the acquisitions was allocated to amortizable and depreciable property. The depreciation, amortization and, to a lesser extent, the increased interest expense resulting from the acquisitions, had a negative impact on the Company's 1993 net income of $0.08 per share.\nPUBLISHING\nOperating revenues from the Company's publishing operations for 1993 increased to $290.1 million from $285 million in 1992, an increase of 1.8 percent. Excluding Lerner's 1992 revenues, publishing revenues would have increased 3.6 percent, reflecting increased revenues from advertising, circulation and commercial printing.\nExcluding Lerner's 1992 revenues from the comparison, newspaper advertising revenues increased $3.1 million (1.9 percent) in 1993. A $9 million increase generated by increased advertising volumes was partially offset by the price effect, totalling $5.9 million, of lower average rates. Advertising rate increases of 5 percent to 6 percent were implemented at the Tucson Agency in January 1993. Essentially no 1993 advertising rate increases were put into effect at the Company's St. Louis or Chicago newspaper operations. Average rates for the newspaper segment were lower for 1993 due to the mix of advertising, frequency discounts and competitive pricing pressures. Effective January 1994, advertising rates were increased at all publishing properties in varying percentages among certain categories ranging from 3 percent to 6.5 percent.\nCirculation revenues increased $900,000 (1.2 percent) for 1993. The increase reflected the combination of circulation price increases, principally at the St. Louis Post-Dispatch (\"Post-Dispatch\") and The Arizona Daily Star (\"Star\"), amounting to $1.3 million and of partially offsetting average circulation decreases amounting to $400,000. The effect of the closedown\/partial sale of Lerner on circulation revenues was not material.\nThe home-delivered price of the daily Post-Dispatch was increased $1.04 per month, effective March 2, 1992, and an additional $0.52 per month, effective March 1, 1993. Average daily and Sunday circulation of the Post-Dispatch for the fourth quarter of 1993 was 342,687 and 561,744 compared to 347,971 and 570,983, respectively, for the corresponding 1992 period.\nThe single copy price of the daily Star was increased to $0.50 from $0.35 as of October 4, 1993.\nOperating expenses (including selling, general and administrative expenses and depreciation and amortization) for the publishing segment, excluding the St. Louis Agency adjustment, increased to $255.8 million in 1993 from $255.1 million in 1992, an increase of 0.3 percent. Excluding Lerner's 1992 expenses, the non-recurring Lerner sale\/closedown charge of $1.6 million and the $3 million lawsuit settlement from the comparison, publishing expenses would have increased 4.6 percent. This 4.6 percent increase was principally attributable to increased overall personnel costs ($5.9 million) and increased newsprint expense ($4.4 million), due to both higher newsprint prices and increased volume. Expense increases were partially offset by decreased depreciation and amortization ($1.2 million) and decreased purchased supplements ($1.1 million).\nOperating income from the Company's publishing activities increased 30.4 percent to $23.7 million from $18.2 million in 1992. Excluding Lerner and the lawsuit settlement from the prior year, publishing operating income for 1993 would have increased 6.2 percent due to increased revenues.\nBROADCASTING\nBroadcasting operating revenues for 1993 increased 20.7 percent to $136.8 million from $113.4 million in 1992. Revenue comparisons were affected by the acquisitions of television stations WESH and KCCI during the third quarter of 1993. Excluding the revenues of WESH and KCCI, broadcasting revenues would have increased 3.3 percent for 1993. Exclusive of WESH and KCCI, local spot advertising increased 7.6 percent; national spot advertising decreased 0.9 percent; and network compensation decreased 1 percent for 1993. The revenue comparison was affected by strong revenue gains in the prior year due to the Summer Olympics carried on the NBC television network and political advertising.\nBroadcasting operating expenses (including selling, general and administrative expenses and depreciation and amortization) increased 20.9 percent to $108.9 million in 1993 from $90.1 million in 1992. Excluding WESH and KCCI, operating expenses would have increased 0.8 percent. This increase, on a comparable basis, was due primarily to increased overall personnel costs ($2.6 million) offset in part by decreases in programming rights expense ($1 million), depreciation and amortization ($316,000) and bad debt expense ($254,000).\nOperating income from the broadcasting operations increased 19.9 percent to $27.9 million from $23.3 million due to increased advertising revenues and a $1.6 million contribution to operating income from WESH and KCCI. Excluding WESH and KCCI, broadcasting operating results would have increased $3 million or 13.1 percent in 1993. See Note 3 of Notes to Consolidated Fiancial Statements for pro forma information related to the WESH and KCCI acquisition.\nLIQUIDITY AND CAPITAL RESOURCES\nOutstanding debt, inclusive of the short-term portion of long-term debt, as of December 31, 1994, was $143 million, compared with $176.2 million at December 31, 1993. The decrease since the prior year end reflected a scheduled repayment of $14.3 million under the Company's Senior Note Agreement maturing in 1997 and $18.6 million in prepayments of borrowings under its credit agreement with Canadian Imperial Bank of Commerce as Agent (\"CIBC\"). In 1994 CIBC prepayments reduced the credit agreement borrowings to zero and, in December 1994, the Company terminated the credit agreement.\nAs of December 31, 1994, the Company's long-term borrowings consisted of $143 million of fixed-rate senior notes with The Prudential Insurance Company of America.\nThe Company's Senior Note Agreements require it to maintain certain financial ratios, place restrictions on the payment of dividends and prohibit new borrowings, except as permitted thereunder.\nAs of December 31, 1994, commitments for capital expenditures were approximately $12.6 million, relating to normal capital equipment replacements and a portion of the costs for new facilities for television station WDSU in New Orleans and the radio operations in Phoenix. Commitments for film contracts and license fees as of December 31, 1994 were approximately $28.9 million. At December 31, 1994, the Company had working capital of $96.7 million and a current ratio of 2.55 to 1. This compares to working capital of $60.7 million and a current ratio of 2.00 to 1 at December 31, 1993.\nThe Company generally expects to generate sufficient cash from operations to cover ordinary capital expenditures, film contract and license fees, working capital requirements, debt installments and dividend payments.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following consolidated financial statements of Pulitzer Publishing Company and Subsidiaries are filed as part of this report. Supplementary unaudited data with respect to the quarterly results of operations of the Company are set forth in the Notes to Consolidated Financial Statements.\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES\nIndependent Auditors' Report\nStatements of Consolidated Income for each of the Three Years in the Period Ended December 31, 1994\nStatements of Consolidated Financial Position at December 31, 1994 and 1993\nStatements of Consolidated Stockholders' Equity for each of the Three Years in the Period Ended December 31, 1994\nStatements of Consolidated Cash Flows for each of the Three Years in the Period Ended December 31, 1994\nNotes to Consolidated Financial Statements for the Three Years in the Period Ended December 31, 1994\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Pulitzer Publishing Company:\nWe have audited the accompanying statements of consolidated financial position of Pulitzer Publishing Company and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 consolidated financial statements present fairly, in all material respects, the financial position of the companies at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 10 to the consolidated financial statements, in 1994 the Company changed its method of accounting for postemployment benefits to conform with Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits. As discussed in Note 11 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, Accounting for Income Taxes. As discussed in Note 10 to the consolidated financial statements, in 1992 the Company changed its method of accounting for postretirement benefits other than pensions to conform with Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions.\nDELOITTE & TOUCHE LLP\nSaint Louis, Missouri February 3, 1995\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED INCOME\n(Continued)\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED INCOME\nSee accompanying notes to consolidated financial statements. (Concluded)\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED FINANCIAL POSITION\n(Continued) PULITZER PUBLISHING COMPANY AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED FINANCIAL POSITION\nSee accompanying notes to consolidated financial statements. (Concluded)\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED STOCKHOLDERS' EQUITY\nSee accompanying notes to consolidated financial statements.\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED CASH FLOWS\n(Continued)\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES\nSTATEMENTS OF CONSOLIDATED CASH FLOWS\nSUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITY - See Note 10 for information regarding the noncash activity relating to the Company's adoption of Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits in 1994, and Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions in 1993.\nSee accompanying notes to consolidated financial statements. (Concluded)\n- 38 -\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation - The consolidated financial statements include the accounts of Pulitzer Publishing Company (the \"Company\") and its subsidiary companies. All significant intercompany transactions have been eliminated from the consolidated financial statements.\nFiscal Year - The Company's fiscal year ends on the last Sunday prior to December 31. For ease of presentation, the Company has used December 31 as the year-end.\nCash Equivalents - For purposes of reporting cash flows, the Company considers all highly liquid debt instruments purchased with an original maturity of three months or less to be cash equivalents.\nInventory Valuation - Inventory, which consists primarily of newsprint, is stated at the lower of cost (determined primarily using the last-in, first-out method) or market. The difference between inventory balances recorded under the last-in, first-out method and the first-in, first- out method is not significant. Ink and other miscellaneous supplies are expensed as purchased.\nProgram Rights - Program rights represent license agreements for the right to broadcast programs over license periods which generally run from one to five years. The total cost of each agreement is recorded as an asset and liability when the license period begins and the program is available for broadcast. Program rights covering periods greater than one year are amortized over the license period using an accelerated method as the programs are broadcast. In the event that a determination is made that programs will not be used prior to the expiration of the license agreement, unamortized amounts are then charged to operations. Payments are made in installments as provided for in the license agreements. Program rights expected to be amortized in the succeeding year and payments due within one year are classified as current assets and current liabilities, respectively.\nPayments made on license agreements prior to the availability of the program for broadcast are classified as prepaid assets. When the license period begins and the program is available for broadcast, these amounts are recorded as program rights and the related obligations are recorded.\nProperty and Depreciation - Property is recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the individual assets. Buildings are depreciated over 20 to 50 years and all other property over lives ranging from 3 to 15 years.\nJoint Venture Investments - The Company has a one-third interest in RXL Pulitzer (see Note 3) and also participates in other joint ventures. These investments are accounted for by the equity method.\nIntangible Assets - Intangible assets are stated net of applicable amortization. Intangibles in the amount of $1,520,000, related to acquisitions prior to the effective date of Accounting Principles Board Opinion No. 17 (\"Opinion No. 17\"), are not being amortized because, in the opinion of management, their value is of undeterminable duration. In addition, the intangible asset relating to the Company's additional minimum pension liability under Statement of Financial Accounting Standards No. 87 is adjusted, as necessary, when a new determination of the amount of the additional minimum pension liability is made annually. Intangibles consisting of goodwill, television licenses and network affiliations acquired\n- 39 -\nsubsequent to the effective date of Opinion No. 17 are being amortized over 40 years while all other intangible assets are being amortized over 4 to 21 years with the exception of all the intangible assets acquired in conjunction with the 1993 acquisition of WESH and KCCI (see Note 3) which are all being amortized over 15 years.\nManagement periodically evaluates the recoverability of the Company's intangible assets based upon the undiscounted cash flow method. If a permanent impairment in value is determined to exist, any necessary write-down will be charged to operations.\nIncome Taxes - In 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this asset and liability approach, deferred tax assets and liabilities are determined based on temporary differences between the financial statement and tax bases of assets and liabilities by applying enacted statutory tax rates applicable to future years in which the differences are expected to reverse. Prior to 1993, income taxes were determined under the deferred method in accordance with Accounting Principles Board Opinion No. 11, Accounting for Income Taxes.\nEarnings Per Share of Stock - Earnings per share of stock is computed using the weighted average number of Common and Class B shares outstanding during the applicable period, adjusted for the stock split described in Note 8.\nBenefit Plans - The Company accounts for its pension plans in accordance with Statement of Financial Accounting Standards No. 87, Employers Accounting for Pensions, (see Note 9). Effective January 1, 1992, the Company accounts for its postretirement benefit plans in accordance with Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (see Note 10). Prior to January 1, 1992, the Company's postretirement benefits were expensed as paid. Effective January 1, 1994, the Company accounts for its postemployment benefit plans in accordance with Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits (see Note 10). Prior to January 1, 1994, the Company's postemployment benefits were expensed as paid.\nReclassifications - Certain reclassifications have been made to the 1993 and 1992 consolidated financial statements to conform with the 1994 presentation.\n2. AGENCY AGREEMENTS\nAn agency operation between the Company and The Herald Company is conducted under the provisions of an Agency Agreement, dated March 1, 1961, as amended. For many years, the Post-Dispatch (owned by the Company) was the afternoon and Sunday newspaper serving St. Louis, and the Globe-Democrat (formerly owned by The Herald Company) was the morning paper and also published a weekend edition. Although separately owned, from 1961 through February 1984, the publication of both the Post-Dispatch and the Globe-Democrat was governed by the St. Louis Agency Agreement. From 1961 to 1979, the two newspapers controlled their own news, editorial, advertising, circulation, accounting and promotion departments and Pulitzer managed the production and printing of both newspapers. In 1979, Pulitzer assumed full responsibility for advertising, circulation, accounting and promotion for both newspapers. In February 1984, after a number of years of unfavorable financial results at the St. Louis Agency, the Globe-Democrat was sold by The Herald Company and the St. Louis Agency Agreement was revised to eliminate any continuing relationship between the two newspapers and to permit the repositioning of the daily Post-Dispatch as a morning newspaper. Following the renegotiation of the St. Louis Agency Agreement at the time of the sale of the Globe-Democrat, The Herald Company retained the contractual\nright to receive one-half the profits (as defined), and the obligation to share one-half the losses (as defined), of the operations of the St. Louis Agency, which from February 1984 forward consisted solely of the publication of the Post-Dispatch. The St. Louis Agency Agreement also provides for The Herald Company to share one-half the cost of, and to share in a portion of the proceeds from the sale of, capital assets used in the production of the Post-Dispatch. Under the St. Louis Agency Agreement, Pulitzer supervises, manages and performs all activities relating to the day-to-day publication of the Post-Dispatch and is solely responsible for the news and editorial policies of the newspaper. The consolidated financial statements of the Company include all the operating revenues and expenses of the St. Louis Agency relating to the Post-Dispatch.\nIn Tucson, Arizona, a separate partnership, TNI Partners, (\"TNI\"), acting as agent for the Star (a newspaper owned by the Company) and the Citizen (a newspaper owned by Gannett Co., Inc.), is responsible for printing, delivery, advertising, and circulation of the Star and the Citizen. TNI collects all of the receipts and income relating to the Star and the Citizen and pays all operating expenses incident to the partnership's operations and publication of the newspapers. Each newspaper is solely responsible for its own news and editorial content. Net income or net loss of TNI is generally allocated equally to the Star and the Citizen. The Company's consolidated financial statements include its share of TNI's revenues and expenses.\n3. ACQUISITION AND DISPOSITION OF PROPERTIES\nOn December 22, 1994, the Company sold its wholly-owned subsidiary, Pulitzer Community Newspapers (\"PCN\"), Chicago, Illinois, for approximately $33,746,000. The Company received approximately $31,862,000 when the transaction was completed with an additional payment of approximately $1,884,000 expected in the second quarter of 1995. The final proceeds from the sale of PCN are based on net current assets reflected in its closing balance sheet. Any changes in proceeds as a result of adjustments to the closing balance sheet are not expected to be material. A gain of $2,791,000 ($1,051,000 after taxes or $0.06 per share) was recognized on this transaction. The Company's 1994 statement of consolidated income includes substantially a full year of operating results for PCN.\nDuring 1993, the Company acquired in a purchase transaction substantially all of the assets and operations of two television stations, WESH, Daytona Beach\/Orlando, Florida and KCCI, Des Moines, Iowa, for a purchase price of $164,765,000, including approximately $7,765,000 in net receivables, plus acquisition costs of approximately $1,300,000. The closing dates for WESH and KCCI were June 30, 1993 and September 9, 1993, respectively. The results of operations of WESH and KCCI are included in the Company's Statement of Consolidated Income from their respective closing dates.\nThe cost of the acquisition (excluding acquisition costs) included goodwill of $657,000, television licenses and network affiliations of $69,346,000 and other intangibles of $23,660,000 all of which are being amortized over 15 years.\nThe following supplemental unaudited pro forma information shows the results of operations of the Company for the years ended December 31, 1993 and 1992 adjusted for the acquisition of WESH and KCCI assuming such transaction and the related debt and equity financing had been consummated at the beginning of each year presented. The unaudited pro forma financial information is not necessarily indicative either of results of operations that would have occurred had the transaction occurred at the beginning of each year presented, or of future results of operations.\nOn January 1, 1994, the Company acquired for $5,000,000 a one-third interest in RXL Communications (subsequently renamed RXL Pulitzer), a provider of interactive educational programming. This joint venture investment is recorded on the equity basis in the accompanying statement of consolidated financial position.\nDuring the third quarter of 1992, the Company recorded a pretax charge of $1,535,000 in connection with the close-down and sale of certain assets of its Lerner Newspapers (\"Lerner\") operation in Chicago. The charge, included in publishing operations in the accompanying statements of consolidated income, reflects the estimated loss from the disposition and abandonment of net assets, anticipated operating losses from the respective measurement date through the estimated date of disposal\/close-down, and related contingencies. There were associated tax benefits of $1,682,000, principally due to a tax deduction for intangible assets, reflected in the current provision for income taxes.\n4. INTANGIBLE ASSETS\nIntangible assets consist of:\nThe declines in goodwill, other intangibles and accumulated amortization balances at December 31, 1994 result from the sale of PCN on December 22, 1994 (see Note 3).\n- 42 -\n5. FINANCING ARRANGEMENTS\nLong-term debt consists of:\nOn June 30, 1993, in connection with the acquisition of WESH, Daytona Beach\/Orlando, Florida, the Company issued to The Prudential Insurance Company of America $50,000,000 principal amount of 6.76% Senior Notes due 2001 and $50,000,000 principal amount of 7.22% Senior Notes due 2005 (collectively, the \"Notes\"). The proceeds received by the Company from the issuance of the Notes were used to partially finance the acquisition of WESH. In addition, to partially finance the WESH acquisition, the Company borrowed $40,000,000 on June 30, 1993 from The Canadian Imperial Bank of Commerce (\"CIBC\") pursuant to a $60,000,000 five-year revolving and term credit facility (\"Credit Agreement\"), which the Company entered into on June 30, 1993. On July 12, 1993, the Company repaid $37,422,000 of the CIBC borrowings with the proceeds from the issuance of 1,350,000 shares of the Company's common stock on July 9, 1993. This repayment of the CIBC borrowing permanently reduced the original $40,000,000 term portion of the credit facility by the repayment amount. On December 22, 1994, the Company repaid the remaining balance of the CIBC term borrowing and elected to terminate the Credit Agreement prior to its scheduled maturity in 1998.\nOn September 9, 1993, in connection with the acquisition of KCCI, Des Moines, Iowa, the Company borrowed $20,000,000 under the revolving credit portion of the Credit Agreement. In December 1993, the Company made a $4,000,000 payment on the revolving credit facility. Prior to the termination of the Credit Agreement in December 1994, the Company made additional payments during 1994 sufficient to eliminate the revolving credit borrowings.\nAt December 31, 1993, the interest rates on the term and revolving credit borrowings with CIBC were 3.875% and 4%, respectively.\nThe terms of the various senior note agreements contain certain covenants and conditions including the maintenance of cash flow and various other financial ratios, limitations on the incurrence of other debt and limitations on the amount of restricted payments (which generally includes dividends, stock purchases and redemptions).\nUnder the terms of the most restrictive borrowing covenants, in general, the Company may pay annual dividends not to exceed the sum of $10,000,000, plus 75% of consolidated net earnings commencing January 1, 1993, less the sum of all dividends paid or declared and redemptions in excess of sales of Company stock after December 31, 1992.\n6. PROGRAM CONTRACTS PAYABLE\nProgram contracts payable represent amounts related to programs currently available for broadcast. Maturities of program contracts payable over the license periods are as follows (in thousands):\n7. COMMITMENTS AND CONTINGENCIES\nAt December 31, 1994, the Company and its subsidiaries had construction and equipment commitments of approximately $12,564,000 and commitments for program contracts payable and license fees of approximately $28,867,000.\nDuring December 1994, the Company entered into a limited partnership agreement with a maximum capital contribution commitment of $5,000,000. This commitment extends over a three year funding period ending January 2, 1998. As of December 31, 1994, the Company had funded approximately $593,000 of the total investment commitment.\nThe Company and its subsidiaries are defendants in a number of lawsuits, some of which claim substantial amounts. While the results of litigation cannot be predicted, management believes the ultimate outcome of such litigation will not have a material adverse effect on the consolidated financial statements of the Company and its subsidiaries.\nIn connection with the September 1986 purchase of the Company's Class B common stock, the Company agreed to make an additional payment to the selling stockholders in the event that prior to May 13, 2001, the stockholders receive dividends or distributions in excess of specified amounts in connection with the sale of more than 85% of the voting securities or equity of the Company, a merger, or a complete or partial liquidation or similar corporate transaction. Any payment pursuant to this requirement would be based upon a percentage of the dividend or distribution per share in excess of $23.06 increased by 15% compounded annually beginning May 12, 1986.\n8. STOCKHOLDERS' EQUITY\nEach share of the Company's common stock is entitled to one vote and each share of Class B common stock is entitled to ten votes on all matters. Holders of all outstanding shares of Class B common stock, which represents 96.4% of the combined voting power of the Company, have deposited their shares in a voting trust (the \"Voting Trust\").\n- 44 -\nThe trustees generally hold all voting rights with respect to the shares of Class B common stock subject to the Voting Trust; however, in connection with certain matters, including any proposal for a merger, consolidation, recapitalization or dissolution of the Company or disposition of all or substantially all its assets, the calling of a special meeting of stockholders and the removal of directors, the Trustees may not vote the shares deposited in the Voting Trust except in accordance with written instructions from the holders of the Voting Trust Certificates. The Voting Trust may be terminated with the written consent of holders of two-thirds of all outstanding Voting Trust Certificates. Unless extended or terminated by the parties thereto, the Voting Trust expires on January 16, 2001.\nOn May 11, 1994, the Company's stockholders adopted the Pulitzer Publishing Company 1994 Stock Option Plan (the \"1994 Plan\"), replacing the Pulitzer Publishing Company 1986 Employee Stock Option Plan (the \"1986 Plan\"). The 1994 Plan provides for the issuance to key employees and non-employee directors of incentive stock options to purchase up to a maximum of 1,875,000 shares of common stock. Under the 1994 Plan, options to purchase 1,000 shares of common stock will be automatically granted to non-employee directors on the date following each annual meeting of the Company's stockholders and will vest on the date of the next annual meeting of the Company's stockholders. Total shares available for issue to non-employee directors under this automatic grant feature are limited to a maximum of 125,000. The issuance of all other options will be administered by the Compensation Committee of the Board of Directors, subject to the 1994 Plan's terms and conditions. Specifically, the exercise price per share may not be less than the fair market value of a share of common stock at the date of grant. In addition, exercise periods may not exceed ten years and the minimum vesting period is established at six months from the date of grant. Option awards to an individual employee may not exceed 187,500 shares in a calendar year.\nPrior to 1994, the Company issued incentive stock options to key employees under the 1986 Plan. As provided by the 1986 Plan, certain option awards were granted with tandem stock appreciation rights which allow the employee to elect an alternative payment equal to the appreciation of the stock value instead of exercising the option. Outstanding options issued under the 1986 Plan have an exercise term of ten years from the date of grant and vest in equal installments over a three-year period.\nStock option transactions during 1994, 1993 and 1992 are summarized as follows:\nAt December 31, 1994, 1,701,263 shares remain available for grant under the Stock Plan.\nThe Company recognizes compensation expense on stock appreciation rights as the market value fluctuates above the $19.82 per share option price.\nOn May 11, 1994, the Company's stockholders adopted the Pulitzer Publishing Company 1994 Key Employees' Restricted Stock Purchase Plan (the \"1994 Stock Plan\") which replaced the Pulitzer Publishing Company 1986 Key Employees' Restricted Stock Purchase Plan (\"1986 Stock Plan\"). The 1994 Stock Plan provides that an employee may receive, at the discretion of the Compensation Committee, a grant or right to purchase at a particular price, shares of common stock subject to restrictions on transferability. A maximum of 312,500 shares of common stock may be granted or purchased by employees. In addition, no more than 62,500 shares of common stock may be issued to an employee in any calendar year.\n- 46 -\nPrior to 1994, the Company granted stock awards under the 1986 Stock Plan. For grants awarded under both the 1994 and 1986 Stock Plans, compensation expense is recognized over the vesting period of the grants. Stock Purchase Plan transactions for 1994, 1993 and 1992 are summarized as follows:\nAt December 31, 1994, 308,868 shares remain available for grant or purchase under the 1994 Stock Plan.\nOn January 4, 1995, the Board of Directors declared a five-for-four stock split of the Company's common and Class B common stock payable in the form of a 25% stock dividend. The dividend was distributed on January 24, 1995 to stockholders of record on January 13, 1995. Even though this stock split was declared subsequent to December 31, 1994, the Company's capital balances and share amounts have been adjusted in 1994 to reflect the split.\nOn January 4, 1993, the Board of Directors declared a 10% special stock dividend on its common and Class B common stock payable on January 22, 1993 to stockholders of record on January 14, 1993. Even though this stock dividend was consummated subsequent to December 31, 1992, the fair value of the dividend was charged to retained earnings and credited to common and Class B common stock and additional paid-in capital during 1992.\n9. PENSION PLANS\nThe Company and its subsidiaries have several noncontributory pension plans covering substantially all of their employees. Benefits under the plans are generally based on salary and years of service. Plan funding strategies are influenced by tax regulations. Plan assets consist primarily of government and equity securities.\nThe pension cost components for the pension plans in 1994, 1993 and 1992 were as follows:\nThe funded status of the Company's pension plans at December 31, 1994 and 1993 is presented below (in thousands):\nThe projected benefit obligation was determined using assumed discount rates of 8% and 7% at December 31, 1994 and 1993, respectively. The expected long-term rate of return on plan assets was 8.5% for both 1994 and 1993. For those plans that pay benefits based on final compensation levels, the actuarial assumptions for overall annual rate of increase in future salary levels ranged from 6% to 6.5% and 5.5% to 6% for December 31, 1994 and 1993, respectively.\nCertain of the Company's employees participate in multi-employer retirement plans sponsored by their respective unions. Amounts charged to operations, representing the Company's required contributions to these plans in 1994, 1993 and 1992 were approximately $715,000, $822,000 and $701,000, respectively.\nThe Company also sponsors an employee savings plan under Section 401(k) of the Internal Revenue Code. This plan covers substantially all employees. Contributions by the Company amounted to approximately $1,735,000, $1,582,000 and $1,459,000 for 1994, 1993 and 1992, respectively.\n10. POSTRETIREMENT AND POSTEMPLOYMENT BENEFITS\nEffective January 1, 1992, the Company adopted the provisions of Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (\"SFAS 106\"), which requires the accrual of retiree benefits during the years an employee provides services.\n- 48 -\nThese benefits, primarily medical and life insurance benefits at the Post-Dispatch, were previously expensed as paid.\nIn applying this pronouncement, the Company immediately recognized the Accumulated Postretirement Benefit Obligation of $40,625,000 (there are no assets in the plans), net of the St. Louis Agency adjustment of $36,052,000, as of January 1, 1992. On an after tax basis, this charge was $25,147,000 or $1.74 per share. In addition to the one-time effect of the adjustment, the application of SFAS No. 106 during 1992 decreased income before cumulative effect of changes in accounting principles by $1,388,000 ($0.10 per share).\nNet periodic postretirement benefit cost for 1994, 1993 and 1992 consists of the following components:\nThe Company continues to fund its postretirement benefit obligation on a pay-as-you-go basis, and, for 1994, 1993 and 1992 made payments of $3,484,000, $3,561,000 and $3,587,000, respectively.\nThe accumulated postretirement benefit obligation included in the statements of consolidated financial position as of December 31, 1994 and 1993 consists of the following components:\nThe preceding amounts for the December 31, 1994 and 1993 accumulated postretirement benefit obligation and the 1994, 1993 and 1992 net periodic postretirement benefit expense have not been reduced for The Herald Company's share of the respective amounts. However, pursuant to the St. Louis Agency Agreement (see Note 2), the Company has recorded a receivable for The Herald Company's share of the accumulated postretirement benefit obligation as of December 31, 1994 and 1993.\nFor 1994 measurement purposes, health care cost trend rates of 13%, 11% and 10% were assumed for indemnity plans, PPO plans and HMO plans, respectively; these rates were assumed to decrease gradually to 6%, through the year 2008 and remain at that level thereafter. For 1993 measurement purposes, health care cost trend rates of 16% and 13% were assumed for indemnity plans and HMO plans, respectively; these rates were assumed to decrease gradually to 5% through the year 2008 and remain at that level thereafter. The health care cost trend rate assumptions have a significant effect on the amount of obligation and expense reported. A 1% increase in these annual trend rates would have increased the accumulated benefit obligation at December 31, 1994 by approximately $11,766,000 and the 1994 annual\nbenefit expense by approximately $1,148,000. Administrative costs related to indemnity plans were assumed to increase at a constant annual rate of 5% and 6% for 1994 and 1993, respectively. The assumed discount rate used in estimating the accumulated benefit obligation was 8% and 7% for 1994 and 1993, respectively.\nThe changes in the December 31, 1994 reconciliation of the accumulated postretirement benefit obligation compared to the prior year resulted primarily from the modifications of certain interest rate and trend rate assumptions (discussed above) and from current year changes in certain benefits under the Company's postretirement plans.\nEffective January 1, 1994, the Company adopted the provisions of Statement of Financial Accounting Standards No. 112, Employers' Accounting for Postemployment Benefits (\"SFAS 112\"), to account for certain disability benefits at the St. Louis Post-Dispatch. SFAS 112 requires that the cost of these benefits provided to former employees prior to retirement be recognized on the accrual basis of accounting. Previously, the Company recognized its postemployment benefit costs when paid. The cumulative effect of adopting SFAS 112 was a reduction of 1994 net income of approximately $719,000 or $0.04 per share. After recording the cumulative effect adjustment, the Company's on-going expense under the new standard will not differ significantly from the prior pay-as-you-go basis.\nUnder SFAS 112, the Company accrues the disability benefits when it becomes probable that such benefits will be paid and when sufficient information exists to make reasonable estimates of the amounts to be paid. As required by the standard, prior year financial statements have not been restated to reflect the change in accounting method.\n11. INCOME TAXES\nEffective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\"). This change in accounting method has been applied by recording a positive cumulative effect adjustment of $360,000 or $0.02 per share in the first quarter of 1993. The positive earnings impact of the cumulative effect adjustment results principally from the recalculation of certain deferred income taxes at the lower 34% federal statutory rate as opposed to the higher tax rates which were in effect when certain of the deferred income taxes originated. Prior years' consolidated financial statements have not been restated to apply the provisions of SFAS 109.\nProvisions for income taxes (benefits) consist of the following:\nUnder the Revenue Reconciliation Act of 1993, the marginal corporate tax rate was increased from 34% to 35%. The deferred tax benefit for 1993 was increased by approximately $225,000 to reflect this change.\nFactors causing the effective tax rate to differ from the statutory Federal income tax rate were:\nThe Company's current and noncurrent deferred taxes, included net in other assets in the statements of consolidated financial position as of December 31, 1994 and 1993, consisted of the following deferred tax assets and liabilities:\nDuring 1994, the Company settled federal tax examinations for 1990 through 1992 and paid additional taxes of approximately $2,048,000. This payment represented an extension of the tax amortization period for certain prior year acquisition intangibles. Accordingly, a deferred tax asset for the amount of the payment was recorded during 1994.\nThe Company had no valuation allowance for deferred tax assets as of December 31, 1994, December 31, 1993 and January 1, 1993; therefore, there were no changes in the valuation allowance for deferred tax assets for the years ended December 31, 1994 and 1993.\nFor 1992, the deferred tax provision, computed in accordance with Accounting Principles Board Opinion No. 11, represent the effects of timing differences between financial and income tax reporting. The significant components giving rise to the timing differences for 1992 were:\n12. FAIR VALUE OF FINANCIAL INSTRUMENTS\nAs required by Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments, the Company has estimated the following fair value amounts using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that 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.\nCash and Cash Equivalents, Accounts Receivable, and Accounts Payable - The carrying amounts of these items are a reasonable estimate of their fair value.\nProgram Contracts Payable - The estimated fair value is determined by discounting the related future maturities (see Note 6) using the Company's incremental borrowing rate.\nLong-Term Debt - Interest rates that are currently available to the Company for issuance of debt with similar terms and remaining maturities are used to estimate fair value.\nThe fair value estimates presented herein are based on pertinent information available to management as of December 31, 1994 and 1993. Although management is not aware of any facts that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date, and current estimates of fair value may differ from the amounts presented herein.\n13. BUSINESS SEGMENTS\nThe Company's operations are divided into two business segments, publishing and broadcasting. The following is a summary of operations, assets and other data.\n* Operating margins for publishing stated with St. Louis Agency adjustment (which is recorded as an operating expense in the accompanying consolidated financial statements) added back to publishing operating income.\n- 53 - 14. QUARTERLY FINANCIAL DATA (UNAUDITED)\nOperating results for the years ended December 31, 1994 and 1993 by quarters are as follows:\nIn the fourth quarter of 1994, a federal tax examination for 1992 was settled; that settlement, together with the settlements earlier in the year of federal tax examinations for 1990 and 1991, resulted in reduced income tax expense of approximately $500,000, or $0.03 per share, in the 1994 fourth quarter. Due to the Company's reduced exposure to further tax adjustments for open tax years, and the impact of 1993 tax law changes in the deductibility of the amortization of intangibles, the 1994 estimated tax rate was lowered from approximately 41 percent (estimated earlier in the year) to approximately 39 percent, resulting in a gain of approximately $1,000,000, or $0.06 a share. The Company expects to use the lower, approximately 39 percent, estimated tax rate in 1995.\n* * * * * *\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 caption \"Management\" in the Company's definitive Proxy Statement to be used in connection with the 1995 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth under the caption \"Executive Compensation\" in the Company's definitive Proxy Statement to be used in connection with the 1995 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 set forth under the caption \"Principal Stockholders\" in the Company's definitive Proxy Statement to be used in connection with the 1995 Annual Meeting of Stockholders is incorporated herein by reference.\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 Company's definitive Proxy Statement to be used in connection with the 1995 Annual Meeting of Stockholders 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) DOCUMENT LIST\n1. Financial Statements\nThe following financial statements are set forth in Part II, Item 8 of this report.\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES:\n(i) Independent Auditors' Report. (ii) Statements of Consolidated Income for each of the Three Years in the Period Ended December 31, 1994. (iii) Statements of Consolidated Financial Position at December 31, 1994 and 1993. (iv) Statements of Consolidated Stockholders' Equity for each of the Three Years in the Period Ended December 31, 1994. (v) Statements of Consolidated Cash Flows for each of the Three Years in the Period Ended December 31, 1994. (vi) Notes to Consolidated Financial Statements for the Three Years in the Period Ended December 31, 1994.\n2. Supplementary Data and Financial Statement Schedules\n(i) Supplementary unaudited data with respect to quarterly results of operations is set forth in Part II, Item 8 of this Report. (ii) The following financial statement schedule and opinion thereon are filed as a part of this Report: Sequential Page --------------- Independent Auditors' Report 61 Schedule II - Valuation and Qualifying Accounts and Reserves 62\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 or are inapplicable and, therefore have been omitted.\n3. Exhibits Required by Securities and Exchange Commission Regulation S-K\n(a) The following exhibits are filed as part of this report:\nExhibit No. Sequential Page - ----------- ---------------\n10.8.1 Amendment, dated January 24, 1995, to Pulitzer Retirement Savings Plan. 65\n10.8.2 Amended and restated Pulitzer Retirement Savings Plan. 68\n10.9 Amended and restated Joseph Pulitzer Pension Plan. 120\n10.10 Amended and restated Pulitzer Publishing Company Pension Plan. 169\n10.14 Deferred Compensation Agreement, dated December 16, 1994, between the Pulitzer Publishing Company and Michael E. Pulitzer. 216\n10.25 Stock Purchase Agreement dated as of December 22, 1994 by and among Pulitzer Publishing Company, American Publishing Company and American Publishing Holdings, Inc. 220\n21 Subsidiaries of Registrant 274\n23 Independent Auditors' Consent 275\n24 Power of Attorney 276\n27 Financial Data Schedule 277\n(b) The following exhibits are incorporated herein by reference:\n3.1 - Restated Certificate of Incorporation of the Company.(iii)\n3.2 - By-Laws of the Company restated as of June 23, 1993.(x)\n4.1 - Form of Certificate for Common Stock.(iii)\n9.1 - Voting Trust Agreement, dated January 17, 1991 between the holders of voting trust certificates and Michael E. Pulitzer, Emily Rauh Pulitzer, Ronald H. Ridgway, Nicholas G. Penniman IV, Ken J. Elkins, William F. Woo and David Moore.(vi)\n10.1 - Agreement, dated January 1, 1961, between the Pulitzer Publishing Company, a Missouri corporation, and the Globe- Democrat Publishing Company, as amended on September 4, 1975, April 12, 1979 and December 22, 1983.(i)\n10.2.1 - Amended and Restated Joint Operating Agreement, dated December 30, 1988 between Star Publishing Company and Citizen Publishing Company.(v)\n10.2.2 - Partnership Agreement, dated December 30, 1988 between Star Publishing Company and Citizen Publishing Company.(v)\nExhibit No. - -----------\n10.3 - Agreement, dated as of May 12, 1986, among the Pulitzer Publishing Company, Clement C. Moore, II, Gordon C. Weir, William E. Weir, James R. Weir, Kenward G. Elmslie, Stephen E. Nash and Manufacturers Hanover Trust Company, as Trustees and Christopher Mayer.(i)\n10.4 - Letter Agreement, dated September 29, 1986, among the Pulitzer Publishing Company, Trust Under Agreement Made by David E. Moore, David E. Moore, Frederick D. Pulitzer, Michael E. Pulitzer, Jr., Robert S. Pulitzer, Joseph Pulitzer, IV, Joseph Pulitzer, Jr., Michael E. Pulitzer, Stephen E. Nash and Manufacturers Hanover Trust Company, as Trustees, Kenward G. Elmslie, Gordon C. Weir, William E. Weir, James R. Weir, Peter W. Quesada, T. Ricardo Quesada, Elinor P. Hempelmann, The Moore Foundation, Inc., Mariemont Corporation, Z Press Inc. and Clement C. Moore, II.(ii)\n10.5 - Letter Agreement, dated May 12, 1986, among the Pulitzer Publishing Company, Peter W. Quesada, T. Ricardo Quesada, Kate Davis Pulitzer Quesada and Elinor P. Hempelmann.(i)\n10.6 - Agreement, dated as of September 29, 1986, among the Pulitzer Publishing Company, Peter W. Quesada, T. Ricardo Quesada, Kate Davis Pulitzer Quesada and Elinor Hempelmann.(ii)\n10.7.1 - Amendment, dated March 9, 1992, to the Pulitzer Publishing Annual Incentive Plan.(vii)\n10.7.2 - Annual Incentive Compensation Plan.(iii)\n10.11 - Restated Supplemental Executive Benefit Pension Plan.(viii)\n10.12 - Employment Agreement, dated October 1, 1986, between the Pulitzer Publishing Company and Joseph Pulitzer, Jr.(i)\n10.13 - Employment Agreement, dated January 2, 1986, between the Pulitzer Publishing Company and Michael E. Pulitzer.(i)\n10.15 - Consulting Agreement, dated May 1, 1993, between Pulitzer Publishing Company and Glenn A. Christopher.(x)\n10.16 - Supplemental Executive Retirement Pay Agreement dated June 5, 1984, between the Pulitzer Publishing Company and Glenn A. Christopher.(i)\n10.17 - Letter Agreement, dated October 26, 1984, between the Pulitzer Publishing Company and Glenn A. Christopher.(i)\n10.18 - Letter Agreement, dated October 21, 1986, between the Pulitzer Publishing Company and David E. Moore.(i)\n10.19 - Pulitzer Publishing Company 1994 Key Employees' Restricted Stock Purchase Plan.(xi)\n10.20 - Pulitzer Publishing Company 1994 Stock Option Plan.(xi)\nExhibit No. - ----------- 10.21 - Registration Rights Agreement.(i)\n10.22 - Note Agreement, dated April 22, 1987, between the Pulitzer Publishing Company and The Prudential Insurance Company of America.(iv)\n10.23 - Employment Agreement, dated May 10, 1955, between the Pulitzer Publishing Company and Joseph Pulitzer, Jr.(ii)\n10.24 - Note Agreement, dated June 30, 1993, between Pulitzer Publishing Company and The Prudential Insurance Company of America.(ix)\n- --------------- (i) Incorporated by reference to Registration Statement on Form S-1 (No. 33-9953) filed with the Securities and Exchange Commission on November 4, 1986.\n(ii) Incorporated by reference to Amendment No. 1 to Registration Statement on Form S-1 (No. 33-9953) filed with the Securities and Exchange Commission on December 9, 1986.\n(iii) Incorporated by reference to Amendment No. 2 to Registration Statement on Form S-1 (no. 33-9953) filed with the Securities and Exchange Commission on December 11, 1986.\n(iv) Incorporated by reference to Current Report on Form 8-K dated May 4, 1987.\n(v) Incorporated by reference to Annual Report on Form 10-K for the fiscal year ended December 31, 1988.\n(vi) Incorporated by reference to Annual Report on Form 10-K for the fiscal year ended December 31, 1990.\n(vii) Incorporated by reference to Annual Report on Form 10-K for the fiscal year ended December 31, 1991.\n(viii) Incorporated by reference to Annual Report on Form 10-K for the fiscal year ended December 31, 1992.\n(ix) Incorporated by reference to Quarterly Report on Form 10-Q for the quarterly period ended June 30, 1993.\n(x) Incorporated by reference to Annual Report on Form 10-K for the fiscal year ended December 31, 1993.\n(xi) Incorporated by reference to the Company's definitive Proxy Statement used in connection with the 1994 Annual Meeting of Stockholders\n(c) Reports on Form 8-K.\nThe Company did not file any reports on Form 8-K during the fourth quarter of fiscal year 1994.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Stockholders of Pulitzer Publishing Company:\nWe have audited the consolidated financial statements of Pulitzer Publishing Company and its subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated February 3, 1995; such report is included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedule of Pulitzer Publishing Company and its subsidiaries, listed in the accompanying index at Item 14. This financial statement schedule is 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 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.\nDELOITTE & TOUCHE LLP\nSaint Louis, Missouri February 3, 1995\nSCHEDULE II\nPULITZER PUBLISHING COMPANY AND SUBSIDIARIES SCHEDULE II - VALUATION & QUALIFYING ACCOUNTS & RESERVES FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 & 1992\n(a) - Accounts reinstated, cash recoveries, etc.\n(b) - Accounts written off, except 1994 which also includes $761 related to sale of PCN.\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, on the 14th day of March, 1995.\nPULITZER PUBLISHING COMPANY\nBy: \/s\/ Michael E. Pulitzer ---------------------------------- Michael E. Pulitzer, Chairman, President 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 indicated on the dates indicated.\nBy: \/s\/ Ronald H. Ridgway ----------------------------- Ronald H. Ridgway* attorney-in-fact\nPULITZER PUBLISHING COMPANY\nReport on Form 10-K for the Fiscal Year Ended\nDecember 31, 1994\nEXHIBIT INDEX\nExhibit No. Sequential Page - ----------- ---------------\n10.8.1 Amendment, dated January 24, 1995, to Pulitzer Retirement Savings Plan. 65\n10.8.2 Amended and restated Pulitzer Retirement Savings Plan. 68\n10.9 Amended and restated Joseph Pulitzer Pension Plan. 120\n10.10 Amended and restated Pulitzer Publishing Company Pension Plan. 169\n10.14 Deferred Compensation Agreement, dated December 16, 1994, between the Pulitzer Publishing Company and Michael E. Pulitzer. 216\n10.25 Stock Purchase Agreement dated as of December 22, 1994 by and among Pulitzer Publishing Company, American Publishing Company and American Publishing Holdings, Inc. 220\n21 Subsidiaries of Registrant 274\n23 Independent Auditors' Consent 275\n24 Power of Attorney 276\n27 Financial Data Schedule 277\nAMENDMENT OF PULITZER RETIREMENT SAVINGS PLAN\nPursuant to resolutions adopted on January 24, 1995 by the Board of Directors of Pulitzer Publishing Company, the Pulitzer Retirement Savings Plan (the \"Plan\") is hereby amended as follows:\n1. The monthly Employer Profit Sharing Contributions for participants who are members of the St. Louis Newspaper Guild shall be $50 effective February 1, 1995.\n2. Schedule B annexed to the Plan is revised accordingly.\nPULITZER PUBLISHING COMPANY\nBy: \/s\/ Ronald H. Ridgway -------------------------------- Ronald H. Ridgway Senior Vice President - Finance","section_15":""}
{"filename":"6082_1994.txt","cik":"6082","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL DEVELOPMENT OF BUSINESS\nAMETEK, Inc. (\"AMETEK\" or the \"Company\") was incorporated in Delaware in 1930 under the name of American Machine and Metals, Inc. and maintains its principal executive offices at Station Square, Paoli, Pennsylvania 19301.\nAMETEK is an international manufacturer of high-quality, engineered products for industrial and commercial markets. The Company has a significant market share for many of its products: Electro-mechanical Group is the world's largest producer of electric motors for vacuum cleaners and floor care products; Precision Instruments Group builds high-technology monitoring, sensing, calibration and alarm devices for the aerospace and process and heavy vehicle industries; and Industrial Materials Group uses plastics, metals and fibers for a variety of consumer and industrial products. The Company has grown through a primary focus on manufacturing electronic, electro-mechanical and electrical products for diverse markets where its technology or cost advantage will lead to a significant share of one or more niche markets.\nShareholder Value Enhancement Plan (\"Plan\")\nIn November 1993, the Company completed a broad strategic review and announced a Plan intended to enhance shareholder value over the long term. From an operational point of view, the Company is increasing profitability and growth by (i) capitalizing on the competitive advantages of the floor care, specialty metals and water filtration businesses; and building on unique advantages in other businesses, by extending core technologies into new products and markets, (ii) placing continued emphasis on cost control, (iii) expanding internationally in the Pacific Rim and Europe and, (iv) pursuing strategic acquisitions and divestments on a selective basis. In February 1995, the Company reached an agreement in principle to acquire the heavy vehicle instrumentation business of privately held Dixson, Inc. On March 21, 1995, the Company signed an agreement to sell its Microfoam Division to Astro Valcour, Inc.\nFrom a financial perspective, the Company's Plan takes advantage of its historically strong cash flow to decrease debt and repurchase its common stock up to a total of $150 million. Existing debt was refinanced with the proceeds of the March 1994 public issuance of $150 million principal amount of 9 3\/4% senior notes, borrowings under a bank credit agreement, and available cash. In the first quarter of 1994 the Company recorded an extraordinary after tax charge of $11.8 million or $.32 per share for the early retirement of then- existing debt in accordance with the Plan (above); a $3.8 million after tax gain was recorded due to a required change in accounting for marketable securities. The Plan also reduced the quarterly per share dividend rate on the Company's common stock from $.17 to $.06, beginning with the dividend payable December 24, 1993. The effect of the 9.2 million shares repurchased as of December 31, 1994 for $119 million in combination with the dividend reduction is to generate incremental after tax cash flow of approximately $22 million per year. Since refinancing the Company in March 1994, revolving credit loans have been reduced by $61 million and early debt repayments of $40 million were made, as of December 31, 1994. Early debt repayment is a key part of the Plan to enhance financial strength, return on assets, and profitability. The Company amended its bank credit agreement in October 1994, which reduced the available credit facility from $250 million to $200 million, negotiated lower interest rates and reduced commitment fees on all bank debt.\nIn connection with a business restructuring program, the Company recorded after tax charges against earnings of $28.6 million during the fourth quarter of 1993, resulting in aggregate charges of $33.5 million for all of 1993. A substantial portion of these charges related to the restructuring of U.S. Gauge and Aerospace divisions and the remainder reflects asset write-downs and other special charges against income. The restructuring charges primarily result from actions taken or planned to improve competitive position due to the weak aerospace market and the actions at a U.S. Gauge facility in Sellersville, Pennsylvania, to make this operation competitive.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS, FOREIGN OPERATIONS AND EXPORT SALES\nBusiness segment and geographic information is shown on pages 36 and 37 of this report.\nIn response to increasing globalization of its markets and opportunities for growth, the Company has expanded its international operations. This expansion has resulted from a combination of increasing export sales of products manufactured in the United States, sales from overseas operations and strategic alliances.\nThe Company's strategy for international growth requires global cost- competitiveness. AMETEK Singapore Private, Ltd. was established to expand its product sales throughout the Pacific Rim and to secure lower-cost supply arrangements.\nInternational operations of the Company are subject to certain risks which are inherent in conducting business outside the United States, such as fluctuation in currency exchange rates and controls, restrictions on the movement of funds, import and export controls, and other economic, political and regulatory policies of the countries in which business is conducted.\nNARRATIVE DESCRIPTION OF BUSINESS\nPRODUCTS AND SERVICES\nThe Company classifies its operations into three principal business segments. A description of the business, products and markets of each segment is described below:\nELECTRO-MECHANICAL GROUP\nThe Company's Electro-mechanical Group (\"EMG\") is a major supplier of fractional-horsepower electric motors and blowers for vacuum cleaners and other floor care products. EMG also manufactures electric motors and blowers for furnaces, lawn tools, photocopiers, computer equipment and other applications.\nEMG has ten manufacturing locations, six in the United States, three in Italy and one in Mexico. It employs approximately 2,600 people. EMG produced over 24 million motors in 1994 and approximately 18 million motors in 1993. EMG's facilities are equipped with efficient state-of-the-art production lines designed to maximize manufacturing flexibility. Because of its high production volume and technological resources, EMG offers its customers cost competitive and custom-designed products on a timely basis.\nFloor Care Products\nEMG has a major market share, through the sale of air-moving electric motors to most of the major vacuum cleaner original equipment manufacturers (OEMs) on a global scale including integrated OEMs who produce some of their own motors. It produces a full range of floor care products from the hand-held, canister, upright and central vacuums for household use to the more sophisticated vacuum products for commercial and industrial applications.\nIn recent years, EMG has expanded its sales in the floor care industry by marketing to vertically integrated vacuum cleaner manufacturers who realize the economic and operational advantages of reducing or discontinuing their own motor production and instead purchase EMG's motors. By using EMG's motors, vacuum cleaner manufacturers are able to reduce the substantial capital expenditures they would otherwise have to make to maintain their own motor production, with frequent design changes, at acceptable volumes.\nEMG will continue to participate in the growth of the floor care market by investing in production capacity and new product development to serve its customers' proliferation of new products. Changing customer demands increase the necessary investment of vertically integrated OEMs to design and produce motors for the resulting stream of new products. In addition, EMG's floor care product development is\nfocused on enhancing motor-blower cost-performance through advances in power, efficiency and quieter operation. EMG has recently developed a 1200-watt brushless motor-blower for high-end floor care applications in commercial vacuum cleaners and central vacuum systems, as well as a new low-cost \"world lamination\" motor designed for export markets with high-volume applications.\nEMG is pursuing joint ventures to serve the Pacific Rim market and the market in Eastern Europe. It has a significant position in the European market for floor care products based on exports from the United States and production from its Italian operations. EMG's plants in Italy are producing electric motors for vacuum cleaner manufacturers throughout Western Europe and, to a more limited extent, Eastern Europe. These motors are similar to those produced in the United States. Capacity at these plants has been increased through product standardization, manufacturing integration and efficiency, as well as improvement in labor flexibility.\nConsistent with its strategy for long-term growth, EMG is increasing its unit production capacity for floor care products by approximately 50%, principally to meet anticipated growth in customer demand for smaller size motors over the next several years. This is being accomplished primarily by adding substantial production capacity at the Graham, North Carolina facility.\nTechnical Motor Products\nEMG formed its Technical Motor Division to focus and expand its production of motor-blowers for nonfloor care applications by capitalizing on its market presence and technological expertise in floor care products. It is establishing a significant market position in customer applications by introducing brushless motor technology.\nEMG's technical motor products include motors for furnaces, lawn tools, photocopiers, computer equipment, business machines, medical equipment and evaporative cooling equipment. Its brushless motors, which are free of static charges, are becoming increasingly popular in medical and other applications where flammability is a concern. Recent product developments include the use of brushless motors in systems designed to assist patients with sleep-breathing disorders, systems which help bedridden patients avoid bedsores and systems to recover gasoline fumes at automotive fueling stations.\nConsistent with its strategy for long-term growth, EMG has recently increased its unit production capacity for technical motor products by approximately 25% to meet anticipated growth in customer demand with production at its Rock Creek, North Carolina plant.\nThrough the Company's Singapore sales subsidiary, its Shanghai office, and the pursuit of joint ventures, EMG is building a presence in the Pacific Rim.\nCustomers\nEMG is not dependent on any single customer such that its loss would have a material adverse effect on its operations. Approximately 25% of EMG's sales for 1994 were made to its five largest customers.\nPRECISION INSTRUMENTS GROUP\nThe Precision Instruments Group (\"PI\") serves a diverse group of markets, the largest of which are the aerospace, general gauge, process industries and heavy-duty vehicle markets; 22% of sales are international. Through its six operating divisions and 14 plants, PI employs approximately 2300 people.\nAerospace Products\nApproximately 40% of PI revenues are from the sale of aerospace products including cockpit instruments\/displays, engine sensors and monitoring systems, fuel\/liquid sensors, thermocouple sensors, and\noptical cables for aircraft and aircraft engines. These products are designed and manufactured to record, process and display information for use by flight and ground crews. PI serves all segments of the commercial aerospace industry including business and commuter aircraft and the commercial airlines; defense markets account for about one-third of aerospace sales. There are three customer categories: OEM air frame manufacturers; jet engine producers; repair and maintenance products which are marketed to the airlines. PI's aerospace products are designed to customer specifications and meet stringent operational and reliability requirements.\nPI's strategy in aerospace products is to operate in niche categories where its products have a technological or cost advantage. PI believes that its extensive experience and technological expertise in aerospace, together with long-standing customer relationships with leading international manufacturers of commercial aircraft, provide it with a competitive advantage. PI was selected by Boeing to manufacture an engine vibration monitoring system and sensor system for Boeing's new 777 aircraft. Variations of this product are marketed to other aircraft manufacturers. Strategic investment in new product development has resulted in orders for aircraft engine sensors, an active matrix liquid crystal display and a business jet fuel quantity system.\nAs a result of the overall weakness in the aerospace industry, PI sales to the military and commercial aircraft markets have declined significantly. In response to these conditions, PI aggressively reduced costs through consolidation and downsizing. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" on page 13 of this report.\nProcess Industry and General Gauge Products\nApproximately 45% of PI sales are from the sale of products to general gauge markets and the process industry, including gas and liquid analyzers, emission monitors, process annunciators and control room graphic displays. PI concentrates in the process measurement portion of this business serving segments of the process industry, including refining and petrochemical, power generators, steel plants, water and waste treatment, natural gas distribution, and pulp and paper. PI also produces a wide variety of pressure gauge products for numerous industrial and commercial uses. These products primarily measure physical characteristics such as pressure, temperature, gas, moisture and liquid concentration, force, air, noise levels, and speed.\nIn recent years, domestic market conditions have been soft due primarily to adverse conditions in the refining and petrochemical industry. These conditions have been accentuated by environmental regulations which have reduced new refinery and petrochemical plant construction, and industry operating rates in the United States. PI is expanding into Asia where markets for the process industry are stronger due to new construction.\nPI's business strategy is to concentrate on markets where it has a competitive advantage and to customize products around core technologies to meet customer requirements. For example, PI's oxygen and combustion analyzers have a leading market position and are designed to meet customer-specific applications.\nPressure gauges are produced by the U.S. Gauge Division, a leader in the North American pressure gauge market, for a wide variety of industrial and manufacturing processes. The general pressure gauge market has been adversely affected by competition from low-cost offshore producers; PI is reducing costs and refocusing its domestic manufacturing to concentrate on higher-priced pressure gauge applications. In addition, through a joint venture with a Taiwanese company, PI is producing and marketing low-cost pressure gauges manufactured in Taiwan and the People's Republic of China.\nHeavy Vehicle Products\nPI is a leading domestic producer of electronic instrument panels and instruments for the heavy truck market which has been strong; domestic truck manufacturers have faced a growing demand for more fuel-\nefficient trucks that satisfy applicable air pollution guidelines. PI has participated in this market by working closely with heavy truck manufacturers to develop solid-state instruments to monitor engine efficiency and emissions. PI is expanding this product line into construction and agricultural equipment and into international markets with products similar to those currently produced. In February 1995 the Company reached an agreement in principle to acquire for cash the heavy vehicle instrumentation business of privately held Dixson, Inc. The strategic acquisition of this producer of electronic instrumentation products will strengthen new product development and increase international sales. Terms of the transaction were not disclosed and it is subject to the signing of a definitive agreement and other conditions.\nCustomers\nThe Precision Instruments Group is not dependent on any single customer such that its loss would have a material adverse effect on its operations. Approximately 27% of its 1994 sales were made to its five largest customers.\nINDUSTRIAL MATERIALS GROUP\nThe Industrial Materials Group (\"IMG\") manufactures water filtration products, high-purity engineered metals, compounded plastics, high-temperature fabrics and plastic packaging materials in five divisions (respectively): Plymouth Products, Specialty Metal Products, Westchester Plastics, Haveg and Microfoam. IMG's strategic focus is to target niche markets by differentiating its products on the basis of quality, price and service and to pursue new product development by exploiting its proprietary technologies and specialized manufacturing processes.\nThe Plymouth Products Division (including AMETEK Filters Ltd.) produces water filtration products for residential, commercial and industrial uses in the United States and over 80 other countries. Plymouth Products sells its products in retail and wholesale markets. Plymouth has the broadest cartridge filter line of any company; this includes complete water filtration systems, special- purpose filter housings and many different replacement cartridges. Plymouth's filter cartridges and housings are used in applications such as water filtration, food and beverage dispensing, and cosmetics and chemical production. Plymouth's point-of-use drinking water filters are used for the removal of objectionable taste and odor, hazardous chemicals, bacteria and heavy metals. In addition, it produces filters, housings and cartridges for plumbing professionals to serve their residential and commercial customers. The Company has identified the water filtration market as a significant growth opportunity and recently completed a $4 million plant expansion, the fifth in 13 years.\nThe Specialty Metal Products Division produces high-purity strip and wire from metal powder and manufactures clad products with multiple metallurgical properties. Products are used in the manufacture of appliances, electronic connectors, rechargeable batteries and TV cathode ray tubes. Clad metals are used in gourmet cookware and chemical and pressure vessels. Metal matrix composites, a new product development, are used for thermal management in high- power electronic circuits.\nThe Westchester Plastics Division is the world's largest independent custom compounder of specialty resins and thermoplastics, including developing processing techniques that enhance properties such as fire retardance and adhesion. Markets include automotive parts, electronics, appliances and telecommunications housings.\nThe Haveg Division manufactures products for high-temperature and highly corrosive environments. Haveg's products are made of silicas, phenolic resins and Teflon (R) (a registered trademark of the DuPont Company). Product applications include protective welding curtains, as a textile replacement for asbestos, as a laminate for printed circuit boards, and in foundries to filter molten metal.\nThe Microfoam Division is the world's only producer of a very low-density polypropylene foam used primarily for packaging items, such as furniture and agricultural products, that require cushioning, surface\nprotection and insulation. CouchPouch(TM) is made from the division's MicroTuff(TM) composite material and is stitched into bags large enough to protect furniture. Because they are made of pure polypropylene, the products are suitable for reuse and recycling. On March 21, 1995, the Company signed an agreement to sell the Microfoam Division to Astro Valcour, Inc. The division's sales in 1994 were approximately $34 million.\nCustomers\nAlthough IMG is not dependent on any single customer such that its loss would have a material adverse effect on its operations, approximately 15% of IMG's sales for 1994 were made to its five largest customers.\nMARKETING\nGenerally, the Company's marketing efforts are organized and carried out at the divisional level.\nGiven the similarity of its many products, its significant market share worldwide and the technical nature of its products, EMG conducts most of its domestic and international marketing activities through its direct sales force. EMG makes limited use of sales agents in those foreign countries where its sales activity is relatively low.\nBecause of their relatively diverse product lines, PI and IMG make significant use of distributors and sales agents in their marketing. With its specialized customer base of aircraft manufacturers and airlines, PI's Aerospace Division relies primarily on its sales engineers.\nCOMPETITION\nGenerally, most markets in which the Company operates are highly competitive. The principal elements of competition for the products manufactured in each of the Company's business segments are price, product features, distribution, quality and service.\nFor EMG, the primary competition in the United States floor care market is from a few competitors, one of which has a smaller market share but is part of a company which is larger and has greater resources than AMETEK. Additional competition could come from vertically integrated manufacturers of floor care products which produce their own motors and blowers. In Europe, competition is from a small group of very large competitors and numerous small competitors.\nIn the markets served by PI, the Company believes that it is one of the world's largest pressure gauge manufacturers and ranks among the top 10 producers of certain measuring and control instruments in the United States. It is one of the leading instrument and sensor suppliers, with a broad product offering for military and commercial aviation. As a result of the decline in demand for aircraft instruments and engine sensors due to the consolidation and deregulation of the airline industry and reduced military spending, competition is strong and is expected to intensify for certain aerospace products. In the pressure gauge and heavy vehicle markets served by PI, there are a limited number of companies competing on price and technology. In process measurement markets, there are numerous companies in each market niche competing on the basis of product quality, performance and innovation.\nMany of the products sold by IMG are made by few competitors and competition is mainly from producers of substitute materials. The Westchester Plastics Division is one of the nation's largest independent plastics compounders. Competition is from other independent toll compounders and some customers which have similar in-house compounding capabilities. Plymouth Products is one of the major suppliers of household water filtration systems, a market with numerous competitors. In the industrial and commercial filtration markets which Plymouth Products serves, it does not have a major market share and faces competition from numerous sources. Specialty Metals is comprised of five niche product lines with few competitors. The primary form of competition is from competitive materials and processes.\nBACKLOG AND SEASONAL VARIATIONS OF BUSINESS\nThe Company's approximate backlog of unfilled orders at the dates specified by business segment was as follows:\nOf the total backlog of unfilled orders at December 31, 1994, approximately 92% is expected to be shipped by December 31, 1995.\nThe Company believes that neither its business as a whole nor any of its business segments is subject to significant seasonal variations, although certain individual operations experience some seasonal variability.\nRAW MATERIALS\nThe Company's business segments obtain raw materials and supplies from a variety of sources, generally from more than one supplier. However, in the Industrial Materials segment, certain items are only available from a limited number of suppliers. The Company believes that its sources and supply of raw materials are adequate for its needs.\nRESEARCH AND DEVELOPMENT\nThe Company continues to be committed to appropriate research and development activities designed to identify and develop potential new and improved products. Company-funded research and development costs during the past three years were: 1994-$17.8 million, 1993-$15.1 million, and 1992-$14.7 million. Research activities are conducted by the various businesses of the Company in their respective technologies and markets.\nENVIRONMENTAL COMPLIANCE\nInformation with respect to environmental compliance by the Company is set forth on page 18 of this report in the section of Management's Discussion and Analysis of Financial Condition and Results of Operations entitled \"Environmental Matters.\"\nPATENTS, LICENSES AND TRADEMARKS\nThe Company owns numerous unexpired United States patents, United States design patents and foreign patents, including counterparts of its more important United States patents, in the major industrial countries of the world. The Company is a licensor or licensee under patent agreements of various types and its products are marketed under various registered United States and foreign trademarks and trade names. However, the Company does not consider any single patent or trademark, or any group thereof, essential to its business as a whole, or to any of its business segments. The annual royalties received or paid under license agreements are not significant to any single business segment or to the Company's overall operations.\nEMPLOYEES\nAt December 31, 1994, the Company employed approximately 6,200 individuals.\nWORKING CAPITAL PRACTICES\nThe Company does not have extraordinary working capital requirements in any of its business segments. Customers generally are billed at normal trade terms with no extended payment provisions. Inventories are closely controlled and maintained at levels related to production cycles and responsive to normal delivery requirements of customers.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company has 33 plant facilities in 13 states and five foreign countries. Of these facilities, 26 are owned by the Company and seven are leased. The properties owned by the Company consist of approximately 441 acres, of which approximately 3,537,000 square feet are under roof. Under lease is a total of approximately 463,000 square feet. The leases expire over a range of years from 1995 to 2009 with renewal options for varying terms contained in most of the leases. The Company also has certain parcels of land available for sale. The Company's executive offices in Paoli, Pennsylvania occupy approximately 32,000 square feet under a lease which will expire in 1997. The Company's New York City office occupies approximately 2000 square feet under a lease which will expire in 1996.\nThe Company's machinery, plants and offices are in satisfactory operating condition and are adequate for the uses to which they are put. The operating facilities of the Company by business segment are summarized in the following table:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nNot applicable.\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, through the solicitation of proxies or otherwise, during the last quarter of its fiscal year ended December 31, 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe principal market on which the Company's common stock is traded is the New York Stock Exchange. The Company's common stock is also listed on the Pacific Stock Exchange. On March 3, 1995, there were approximately 5,700 record holders of the Company's common stock.\nThe market price and dividend information with respect to the Company's common stock are set forth on page 38 in the section of the Notes to the Consolidated Financial Statements entitled \"Quarterly Financial Data (Unaudited)\". Future dividend payments by the Company will be dependent upon future earnings, financial requirements, contractual provisions of debt agreements and other relevant factors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA(\/1\/)\n-------- (1) Certain prior-year items have been restated to conform to the current year's presentation. (2) Amounts in 1994 include an after tax loss on early extinguishment of debt totaling $11.8 million ($.32 per share), and an after tax gain from the cumulative effect of an accounting change totaling $3.8 million ($.11 per share). Amounts in 1993 include after tax charges totaling $33.5 million or $.77 per share for restructuring and other unusual items. These charges were for costs related to work force reductions, asset write-downs, relocation and consolidation of certain product lines and operations, and for other unusual items. (3) Net income for 1988 includes costs and losses related to operations spun off in 1988 totaling $8.1 million, or $.18 per share, and a gain of $3.6 million, or $.08 per share, from a change in accounting for income taxes. Net income prior to 1988 includes operating results of spun off operations. SEE ADDITIONAL NOTES ON PAGE 12.\nITEM 6. SELECTED FINANCIAL DATA(\/1\/)--(CONTINUED)\n-------- (4) Based on earnings and net assets of continuing operations. (5) EBITDA represents income before interest, amortization of deferred financing costs, taxes, depreciation and amortization, and 1994 and 1993 nonrecurring items. It should not be considered, however, as an alternative to operating income as an indicator of the Company's operating performance, or as an alternative to cash flows as a measure of the Company's overall liquidity. (6) 1993 earnings were insufficient to cover fixed charges by approximately $12.2 million. N\/A--Data not available for years indicated. SEE ADDITIONAL NOTES ON PAGE 11.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nManagement's discussion and analysis of the Company's financial condition and results of operations set forth below should be read in conjunction with the consolidated financial statements of the Company and the related notes shown in the index on page 19 of this report.\nYEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993\nResults of Operations\nIn 1994, the Company achieved record sales of $808.0 million, an increase of $75.8 million or 10.3% from 1993. All business segments reported improved sales, led by the Electro-mechanical Group, where increased worldwide demand for electric motor products manufactured by the Company's United States and Italian operations resulted in a significant sales increase by these businesses in 1994. The Precision Instruments Group's 1994 sales increased due to improved demand for heavy truck instruments, offset somewhat by lower sales of aerospace instruments. The Industrial Materials Group benefited from improved business conditions in many of its markets, resulting in increased sales by most of the businesses in the group. Sales by all business segments to foreign markets totaled $238.0 million in 1994 compared to $202.9 million in 1993, an increase of 17.3%. Export shipments from the United States in 1994 continued to increase and reached $116.5 million, compared to $105.7 million in 1993, an increase of 10.3%.\nNew orders during 1994 were $831.4 million, an increase of $127.6 million or 18.1% from 1993, reflecting the overall increases in demand mentioned above. The backlog of orders was $236.0 million at year-end, an increase of 11.0% from $212.6 million at the end of 1993.\nBusiness segment operating profit was $102.7 million in 1994, compared to $74.8 million in 1993, an increase of 37.3% before 1993 restructuring and other unusual operating charges. The increase in profits was due to the higher sales volume, and improved operating efficiencies in the Precision Instruments Group, due primarily to the realization of significant cost savings resulting from the restructuring activities initiated in 1993. After reflecting the restructuring and other unusual charges, business segment operating profit for 1993 was $22.7 million.\nCorporate expenses (including unallocated administrative expenses, interest expense and net other income) were $40.9 million in 1994, an increase of $7.0 million or 20.7% from 1993, primarily due to increased interest expense and higher amortization of debt issuance costs, both associated with the new debt agreements entered into by the Company in March of 1994. Interest income was lower in 1994 resulting from a decrease in average invested cash during the year as the Company made substantial early debt repayments and repaid revolving credit loans in the third and fourth quarters of the year.\nThe effective tax rate for 1994 was 36.9%, and reflects favorable state income tax adjustments recorded in the third and fourth quarters, primarily related to prior tax years. The effective rate of income tax benefit for 1993 was 34.5%, and reflected the 1993 increase in the U.S. federal statutory rate from 34% to 35%. The 1993 U.S. income tax benefit was reduced somewhat by a tax provision on foreign pre-tax earnings.\nThe weighted average shares outstanding during 1994 was 37.1 million shares, compared to the average of 43.9 million shares for 1993, a reduction of 15.4%. The net reduction in the average number of shares outstanding in 1994 results from the repurchase and retirement of 9.2 million shares under the Company's share repurchase program which began in March 1994.\nIncome before an extraordinary charge and a gain from the cumulative effect of an accounting change in 1994 was $39.0 million, or $1.05 per share, compared with 1993, when earnings before restructuring and other unusual charges were $26.2 million, or $.60 per share, an improvement of 49.0%.\nAfter an extraordinary loss of $11.8 million, net of taxes, or $.32 per share, from the early extinguishment of debt, and a $3.8 million after tax gain ($.11 per share) due to a required change in accounting for certain marketable securities, both occurring in the first quarter of 1994, net income for 1994 was $31.0 million or $.84 per share. This compares to a net loss of $7.3 million or $.17 per share for 1993, which included a $.77 per share charge for resizing, restructuring and other unusual charges.\nNet income for the fourth quarter of 1994 was $10.3 million, or $.30 per share, on sales of $200.3 million, compared to earnings of $7.0 million or $.16 per share on sales of $183.3 million for the fourth quarter of 1993 before unusual charges. After a $28.6 million ($.66 per share) charge, net of taxes, for restructuring and other unusual items, the fourth quarter of 1993 had a net loss of $21.6 million or $.50 per share. Operating profit by business segment in the fourth quarter of 1994 increased by $7.2 million or 39.4% to $25.4 million, compared to the 1993 fourth quarter profit of $18.2 million before $43.8 million of pre-tax unusual charges; all business segments reflected an increase in fourth quarter operating profit.\nBusiness Segment Results\n-------- \/(1)\/ After elimination of intersegment sales, which are not significant in amount. \/(2)\/ Segment operating profit represents sales less all direct costs and expenses (including certain administrative and other expenses) applicable to each segment, but does not include interest expense. \/(3)\/ Reflects charges of $47.8 million primarily for resizing and restructuring activities, principally work force reductions, asset write-downs, relocation of product lines and the overall consolidation of the Company's aerospace operations. \/(4)\/ Reflects charge of $3.9 million primarily for asset write-downs. \/(5)\/ Includes unallocated administrative expenses, interest expense and net other income and, in 1993, $2.8 million of restructuring and other unusual charges.\nThe Electro-mechanical Group's sales increased $59.6 million or 21.2% to $340.4 million primarily due to increased market share and improved worldwide demand for electric motor products manufactured by this group. Domestic sales increased $28.5 million or 18.3% and international sales improved $31.2 million or 24.9% over 1993. Operating profit of this group increased 31.9% to $46.2 million in 1994, due to the increase in sales volume and improved operating margins, primarily by the Italian motor businesses. The Italian operations reported a 29.1% increase in sales in 1994, and operating profit grew by 82.7% with minimal currency translation effects. Capacity expansions at the two plants in North Carolina were substantially completed in 1994, providing for potentially higher sales and increased efficiency.\nPrecision Instruments Group sales in 1994 were $280.6 million, an increase of $5.3 million or 1.9% from 1993. Higher sales of heavy truck instruments were significantly offset by lower sales of aerospace and process\nmeasurement instruments caused by the continuing overall weakness in process instruments markets. Group operating profit in 1994 increased sharply to $29.2 million, compared to $17.1 million in 1993, before 1993 restructuring and other unusual operating charges of $47.8 million. The increased profitability is due primarily to realized cost savings from the successful implementation of the restructuring program initiated in 1993. The cost savings from the restructuring programs result from the relocation of aerospace manufacturing operations and facilities combination, as well as selected work force reductions (including certain pension-related costs) and production efficiencies. The cost savings being realized from the restructuring program are ahead of plan, and are expected to continue. Under the restructuring program, this group is experiencing a delay in the timing of certain planned work force reductions, due to a one-year extension of the current labor contract at a facility in Sellersville, Pennsylvania to September 1995. Except for this delay, the restructuring program is on schedule and is still expected to be fully implemented as planned. In February 1995, the Company announced that it had reached an agreement in principle to acquire, for cash, the heavy vehicle instrumentation business of privately owned Dixson, Inc. Upon completion of this acquisition, estimated for the second quarter of 1995, this business will be included in the Precision Instruments Group.\nIndustrial Materials Group sales were $187.0 million in 1994, an increase of $10.9 million or 6.2% from 1993 due to general improvements in most of the markets served by this group. All but one business in this group reported 1994 sales increases. Group operating profit in 1994 increased $5.1 million or 22.8% to $27.3 million, before 1993 restructuring charges of $3.9 million. The increase in profitability was mainly attributable to improved operating efficiencies in the group, despite significant increases in raw materials costs experienced by the specialty metal business. The higher sales volume also contributed to the profit improvement, due in part to a cyclical rebound by the plastics compounding and foam packaging businesses. In November 1994, the Company announced that it intends to sell its Microfoam packaging division, which is part of this group. The Company expects positive financial results from the sale of this business, which is expected to be completed in the second quarter of 1995.\nYEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992\nResults of Operations\nSales for 1993 were $732.2 million, a decrease of $37.4 million or 4.9% from 1992. The sales decrease was attributable to reduced domestic and European demand for electric motor products and the negative effect of translating sales of the Company's Italian operations from the weaker Italian lire to U.S. dollars. Sales by the Precision Instruments Group also declined as a result of continued poor market conditions for aerospace products and process and analytical instruments. A sales improvement was reported by the Industrial Materials Group due to the strength of demand for liquid filtration products, specialty metal products and compounded plastics. Sales by all business segments to foreign markets totaled $202.9 million in 1993 compared to $233.7 million in 1992, a decrease of 13.2%. Export shipments from the United States in 1993 were $105.7 million, a decrease of 11.4% from 1992, primarily as a result of weak economic conditions in Europe.\nNew orders during 1993 were $703.9 million, a decrease of $31.6 million or 4.3% from 1992. The backlog of orders was $212.6 million at year-end, an 11.8% decrease from 1992, reflecting the lower level of business in the Electro- mechanical and Precision Instruments Groups.\nBusiness segment operating profit before restructuring and other unusual operating charges was $74.8 million in 1993, compared to $100.1 million in 1992, a decrease of 25.3%. Along with the reduction due to the lower sales volume, this decline reflected operating inefficiencies (primarily within the Electro-mechanical and the Precision Instruments Groups) and higher expenses caused by a plant start-up and plant rearrangements in the Electro-mechanical Group. In 1993, business segment results also reflected charges totaling $52.1 million for resizing and restructuring certain operations and other unusual expenses. After reflecting these charges, business segment operating profit for 1993 was $22.7 million.\nCorporate expenses (including unallocated administrative expenses, interest expense and net other income) were $33.9 million in 1993, substantially unchanged from $33.3 million in 1992.\nThe effective rate of income tax benefit for 1993 of 34.5% reflected the new U.S. federal statutory income tax rate of 35% for all of 1993. The overall effective rate of the tax benefit was reduced somewhat by a tax provision on foreign pre-tax earnings.\nAfter tax earnings for 1993, before restructuring and other unusual charges, were $26.2 million or $.60 per share. This compared to net income of $44.4 million or $1.01 per share earned in 1992. After restructuring and other unusual charges totaling $33.5 million (after tax), the Company reported a net loss of $7.3 million, or $.17 per share for 1993.\nBusiness Segment Results\nThe Electro-mechanical Group's sales decreased $28.8 million or 9.3% to $280.7 million primarily because of Italian lire currency translation and because of reduced customer demand for domestically produced electric motor products during the year. Before currency translation, the Italian operations reported 2.6% higher sales over 1992. Operating profit of this group decreased 29.8% to $35.0 million due to lower sales volume, higher costs related to new product introductions, a plant start-up and plant rearrangements, less favorable product mix and negative foreign currency translation effects.\nPrecision Instruments Group sales in 1993 were $275.4 million, a decrease of $21.7 million or 7.3% from 1992. The sales decline reflected the continuing weakness in demand for aircraft instruments and engine sensors from commercial airlines and poor conditions in the aerospace industry and in process control markets. The sales decline was partially offset by increased sales of truck instruments, flight reference systems and sales by a new business acquired in the first quarter of 1993. Operating profit of this group before restructuring and other unusual charges was $17.1 million in 1993 compared to $28.0 million in 1992, a $10.9 million or 39.0% decline. This decrease was due to the sales decline, production inefficiencies and changes in product mix. This group's profits were further reduced by restructuring and unusual operating charges of $47.8 million in 1993, of which $39.8 million was recorded in the fourth quarter, and resizing charges of $8.0 million which were recorded in the first nine months of the year. These charges were primarily for work force reductions planned or which occurred in 1993 (including certain pension-related costs), asset write-downs, product line relocations of certain gauge manufacturing operations, and consolidation of the Company's aerospace businesses. Most of these actions were necessary due to the unwillingness of the union at the Company's Sellersville facility to agree to wage and work rule concessions requested by the Company necessary to make that operation competitive. After restructuring and other unusual operating charges, this group reported an operating loss of $30.6 million for 1993.\nIndustrial Materials Group sales in 1993 were $176.1 million, an increase of $13.1 million or 8.1% from 1992, largely due to increased sales of liquid filtration products, compounded plastics and specialty metal products. Group operating profit before restructuring and other unusual charges was $22.2 million, a slight improvement over operating profit of $22.1 million reported for 1992. An increase in profits by the Specialty Metal Products Division was substantially offset by lower profits from the other businesses in this group due to operating inefficiencies and changes in product mix at certain divisions. After fourth quarter 1993 restructuring and other unusual charges of $3.9 million, primarily for certain asset write-downs, group operating profit was $18.3 million for 1993. In February 1994, a warehouse attached to a plant in this group collapsed under the weight of heavy snow. Later that month, the plant returned to full operation and the damages and related losses were covered by insurance.\nLIQUIDITY AND CAPITAL RESOURCES\nLiquidity\nWorking capital at December 31, 1994 amounted to $70.7 million, a decrease of $63.4 million from December 31, 1993, due primarily to a decrease in cash and securities caused by scheduled and early debt\nrepayments, repayment of revolving credit loans and offset somewhat by an increase in accounts payable and accruals due to the higher level of business activity. The ratio of current assets to current liabilities at December 31, 1994 was 1.39 to 1, compared to 1.80 to 1 at December 31, 1993.\nThe Company's earnings before interest, taxes, depreciation and amortization (EBITDA) was $119.0 million in 1994, compared to $92.4 million in 1993, before unusual items.\nCash generated by the Company's operating activities totaled $111.7 million in 1994 compared to $65.3 million in 1993, an increase of $46.5 million. The increase was caused primarily by net cash inflows of $31.6 million from the sale of trading securities precipitated by restrictive covenants in the Company's new bank credit agreement (see Note 4 to the financial statements). Higher income after adjusting for nonrecurring and other noncash items, reduced somewhat by slightly less favorable changes in operating working capital items, also contributed to the improved operating cash flow.\nTotal cash and noncash charges against reserves for restructuring and other unusual items, for which $54.9 million was provided in 1993, amounted to $10.9 million in 1994, and did not significantly affect the Company's liquidity. The cash portion of the 1994 charges was $5.5 million. For 1993, cash and noncash charges of $6.7 million were incurred, including $4.1 million of cash charges. Charges in 1994 were primarily for work force reductions, the relocation of aerospace operations and facilities combination, as well as the planned write- off of certain assets. In 1995, the Company expects to incur charges in the range of $14-$17 million (principally cash) related to the restructuring activities, and anticipates the completion of the restructuring program as planned. During 1994, the Company experienced certain delays in implementing specific portions of the restructuring plan, due to a one-year extension to September 1995, of the current labor contract at its facility in Sellersville, Pennsylvania. Also, the Company encountered a delay in securing a facility in Binghamton, New York for the relocation of the Sellersville aerospace manufacturing operations. The Binghamton facility opened in mid-1994, and shipments began in September 1994. Although the timing of certain cash expenditures related to these activities are running behind the original plan, the Company believes the total restructuring reserve is adequate for its intended purpose. When the entire restructuring program is completed, it is anticipated that the benefits, which have already been substantial, will more than offset the required cash expenditures under the plan over time.\nCash used for investing activities totaled $7.1 million in 1994, compared to $31.9 million in 1993, a decline of $24.8 million. The current year includes lower capital expenditures ($23.1 million compared to $38.3 million in 1993), and cash proceeds from the sale of an idle facility and other assets totaling $11.5 million. The sale of the noninvestment assets was part of the 1993 restructuring program. Investing activities in 1993 also included the purchase of a business.\nFinancing activities used cash totaling $137.9 million in 1994, compared to $52.0 million in 1993. Total borrowings were $307.6 million in 1994 and consisted of the public sale of $150 million in 9 3\/4% senior notes in March 1994, plus $157.6 million of borrowings under the Company's senior secured bank credit agreement, also effected in March 1994, and amended in October 1994 (see Note 6 to the financial statements). These borrowings, plus cash available and cash generated were used: (a) to prepay outstanding debt of $185.4 million in March 1994, (b) to fund debt prepayment premiums and debt issuance costs of $29.2 million, (c) to repay $107.1 million which was borrowed primarily under the bank credit agreement since March 1994, including early repayments, (d) to fund $8.9 million in dividend payments, and (e) to repurchase 9.2 million shares of the Company's common stock at a cost of $118.8 million under the Company's share repurchase program, offset somewhat by $3.9 million of cash received from employees upon the exercise of employee stock options.\nThe financing activities noted above caused the Company's debt at December 31, 1994 to increase $15.2 million from December 31, 1993 to $202.1 million, while its equity decreased $92.2 million during the same period to $73.2 million, resulting in a total decrease in capitalization for the year of $77.0 million to $275.3 million.\nThis change resulted in increased leverage. The Company's strong cash flow since its refinancing in March 1994 permitted the Company to make early debt repayments of $40 million and reduce revolving credit loans by $61 million as of year-end. Restrictive covenants in the Company's debt agreements limit the Company's ability to engage in certain types of investing or financing activities, including purchases and sales of assets outside the ordinary course of business, and the incurrence of further indebtedness beyond that allowed by the credit facility. The Company's increasing cash flow from its operations, estimated annual savings of $22 million from the reduction in annual dividends and stock repurchases, and lower required debt principal payments in the near term are expected to more than compensate for these restrictions.\nThe Company amended the bank credit agreement in October 1994 allowing for increased operating and financial flexibility by reducing the total credit facility, resulting in reduced term loan commitments, and increased revolving loan commitments, as well as lowering interest rates and commitment fees. The amended agreement also permits the Company additional flexibility to spend up to $25 million to repurchase portions of its senior notes, or make additional repurchases of its common stock, or a combination thereof, subject to approval by the Board of Directors. The Company now has total domestic bank loan commitments of $200 million, consisting of a $50 million 5-year term loan and a $150 million revolving credit commitment. The total commitment of $200 million was reduced from the initial commitment of $250 million and expires in 1999. At December 31, 1994, $135.3 million is unused and available. The Company's subsidiaries also had unused foreign lines of credit with European banks of approximately $15.9 million at December 31, 1994.\nAs a result of all 1994 cash flow activities, cash and cash equivalents decreased $33.2 million since December 31, 1993, to $7.2 million at December 31, 1994. The Company believes it has sufficient cash-generating capabilities and available credit facilities to enable the Company to meet its needs in the foreseeable future.\nCapital Expenditures\nCapital expenditures were $23.1 million in 1994, compared to $38.3 million in 1993. The 1994 expenditures were for additional manufacturing equipment to provide expanded production capacity, primarily in the Electro-mechanical Group, and the completion of a plant expansion in the Industrial Materials Group. The 1993 expenditures included an additional production facility. The Company expects to increase its capital spending in 1995, to a level approximating the level incurred in 1993, with continuing emphasis on expansion of production capacity, primarily in the Electro-mechanical Group.\nENVIRONMENTAL MATTERS\nThe Company is subject to environmental laws and regulations, as well as stringent clean-up requirements, and has also been named a potentially responsible party at several sites which are the subject of government-mandated clean-ups. Provisions for environmental clean-up at these sites and other sites were approximately $1.6 million in 1994, $4.9 million in 1993 and $1.4 million in 1992.\nWhile it is not possible to accurately quantify the potential financial impact of actions regarding environmental matters, the Company believes that, based upon past experience and current evaluations, the outcome of these actions is not likely to have a material adverse effect on future results of operations, financial position, or cash flows of the Company.\nACCOUNTING STANDARDS RECENTLY ADOPTED\nEffective January 1, 1994, the Company adopted FASB Statement No. 115 relating to certain investments in marketable securities. The after tax effect of this accounting change was a one-time credit to 1994 earnings of $3.8 million, or $.11 per share. Additionally, in 1994 the Company adopted FASB Statement No. 119 relating to disclosure about derivative financial instruments.\nIMPACT OF INFLATION\nThe Company attempts to minimize the impact of inflation through cost reduction programs and by improving productivity. In addition, the Company uses the LIFO method of accounting for inventories (whereby the cost of products sold approximates current costs), and therefore, the impact of inflation is substantially reflected in operating costs. In general, the Company believes that programs are in place designed to monitor the impact of inflation and to take necessary steps to minimize its effect on operations.\nOUTLOOK\nThe Company is subject to economic uncertainties in its worldwide markets. Management believes that operating performance and strong cash flow have strengthened the Company considerably in 1994, and that the business and financial strategies initiated in 1993 will continue to benefit the Company. In management's view, the continued expansion of the Company's global businesses and historically strong cash flow position AMETEK to deal effectively with the anticipated business environment. The Company foresees opportunities for continued growth in 1995.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nFINANCIAL STATEMENT SCHEDULES (ITEM 14(A) 2)\nFinancial statement schedules have been omitted since they are either no longer required to be submitted, they are inapplicable, or the required information is included in the financial statements or the notes thereto.\nREPORT OF INDEPENDENT AUDITORS\nWe have audited the accompanying consolidated balance sheets of AMETEK, Inc. as of December 31, 1994 and 1993, and the related consolidated statements of income, cash flows and stockholders' equity for each of the three years in the period ended December 31, 1994. 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 AMETEK, Inc. at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for marketable securities.\n\/s\/ ERNST & YOUNG LLP\nPhiladelphia, PA January 31, 1995\nAMETEK, INC.\nCONSOLIDATED STATEMENT OF INCOME (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes.\nAMETEK, INC.\nCONSOLIDATED BALANCE SHEET (DOLLARS IN THOUSANDS)\nSee accompanying notes.\nAMETEK, INC.\nCONSOLIDATED STATEMENT OF CASH FLOWS (DOLLARS IN THOUSANDS)\nSee accompanying notes.\nAMETEK, INC.\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DOLLARS IN THOUSANDS)\nSee accompanying notes.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation\nThe consolidated financial statements include the accounts of the Company and subsidiaries, after elimination of all significant intercompany transactions in consolidation.\nCash Equivalents, Securities and Other Investments\nAll highly liquid investments with maturities of three months or less when purchased are considered cash equivalents. Marketable equity securities and fixed income securities which are available for sale are carried at market value. Unrealized holding gains and losses on securities classified as available-for-sale, less deferred income taxes, are reflected as a component of stockholders' equity. Unrealized holding gains and losses on securities classified as trading are reported in earnings. At December 31, 1994, the Company classified all of its equity securities and fixed income securities as available-for-sale. Other investments are accounted for by the equity method.\nInventories\nInventories are stated at the lower of cost or market, cost being determined principally by the last-in, first-out (LIFO) method of inventory valuation, and market on the basis of the lower of replacement cost or estimated net proceeds from sales. The excess of the first-in, first-out (FIFO) method over the LIFO value was $33.5 million and $29.4 million at December 31, 1994 and 1993.\nProperty, Plant and Equipment\nProperty, plant and equipment are stated at cost. Expenditures for additions to plant facilities, or which extend their useful lives, are capitalized. The cost of tools, jigs and dies, and maintenance and repairs are charged to operations as incurred. Depreciation of plant and equipment is calculated principally on a straight-line basis over the estimated useful lives of the related assets.\nRevenue Recognition\nThe Company's revenues are recorded as products are shipped and services are rendered. The policy with respect to sales returns and allowances generally provides that a customer may not return products, or be given allowances, except at the Company's option. The aggregate provisions for estimated warranty costs (not significant in amount) are recorded at the time of sale and periodically adjusted through current operations to reflect actual experience.\nResearch and Development\nCompany-funded research and development costs are charged to operations as incurred and during the past three years were: 1994-$17.8 million, 1993-$15.1 million, and 1992-$14.7 million.\nEarnings Per Share\nEarnings per share are based on the average number of common shares outstanding during the period. No material dilution of earnings per share would result for the periods if it were assumed that all outstanding stock options were exercised.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nForeign Currency Translation\nAssets and liabilities of foreign operations are translated using exchange rates in effect at the balance sheet date, and their results of operations are translated using average exchange rates for the year.\nCertain transactions of the Company and its subsidiaries are made in currencies other than their own. Gains and losses from these transactions (not significant in amount) are included in operating results for the year.\nAdditionally, the Company utilizes hedging arrangements in the context of its operational transactions to hedge firm commitments for certain export sales, thereby minimizing its exposure to foreign currency fluctuation.\nForeign exchange contracts, foreign currency options and foreign currency swaps may be entered into for periods consistent with the Company's exposure, generally one year or less. Gains and losses from these arrangements are deferred and are reflected as adjustments of the related foreign currency transaction.\nInterest Rate Swap and Cap Agreements\nThe Company enters into interest rate swap and cap agreements to modify the interest characteristics of certain long-term debt and to reduce the impact of increases in interest rates on its floating-rate long-term debt. These agreements generally involve the exchange of fixed and floating rate interest payments periodically over the life of the agreement without an exchange of the underlying principal amount. The differential to be paid or received is accrued as interest rates change, and is recognized as an adjustment to interest expense related to the debt over the life of the agreements. Under interest rate cap agreements, the interest rate on a specified percentage of certain long-term debt outstanding, which is subject to a floating interest rate, cannot exceed a fixed percentage.\nIntangible Assets\nPatents are being amortized on a straight-line basis over 9 to 10 years. The excess of cost over net assets acquired is being amortized on a straight-line basis over 20 to 30 years. Other acquired intangibles are being amortized on a straight-line basis over 2 to 30 years.\nReclassifications\nCertain amounts appearing in the prior year's financial statements and supporting footnote disclosures have been reclassified to conform to the current year's presentation.\n2. BUSINESS RESTRUCTURING\nIn 1993 the Company recorded a charge of $45.1 million ($27.5 million after tax, or $.63 per share) for costs associated with resizing and restructuring several of its businesses, and also recorded charges of $9.8 million ($6 million after tax, or $.14 per share) for other unusual expenses. Of the resizing and restructuring charges, $4 million required the use of cash in 1993. Most of the charges were recorded in the fourth quarter of 1993, and were for planned work force reductions, asset write-downs and the relocation of certain product lines and overall consolidation of the Company's aerospace operations. The resizing and restructuring charges primarily related to the Company's plan to make certain operations in its aerospace and general gauge businesses more competitive.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe total reserve balance for restructuring at December 31, 1994 was $33.1 million, of which approximately $16 million was for planned work force reductions (including certain pension-related costs) and the remaining $17.1 million was for asset write-downs, facilities combinations and other items. In 1994, the total reserve balance declined $7.9 million, of which $3.9 million related to work force reductions, the relocation of aerospace operations and facilities combination. The remaining $4.0 million reduction was due primarily to the sale of an idle facility which was included in the restructuring reserve in 1993. The Company is experiencing a delay in the completion of certain planned work force reductions at its Sellersville, Pennsylvania facility due to a one-year extension of the current labor contract to September 1995. However, the restructuring program is still expected to be fully implemented with no material change in the estimated costs anticipated.\n3. ACQUISITIONS AND DIVESTITURES\nIn March 1993, the Company purchased certain assets of Revere Aerospace Inc., a United States subsidiary of Dobson Park Industries PLC, United Kingdom, for approximately $7 million in cash. Revere is a producer of thermocouple and fiber optic cable assemblies.\nIn February 1992, the Company purchased the Tencal operations of Cambridge- Lee Industries. Tencal is a producer of small electric motors and injection- molded plastic components. In August 1992, the Company purchased the industrial filtration operation of Eurofiltec, Ltd. Early in October 1992, the Company purchased Debro Messtechnik GmbH, an instrument manufacturer located in Germany. Also during 1992, the Company acquired two product lines consisting of silica fiber technology, and consumer filtration products. The cost of these acquisitions was $11.7 million and the Company assumed $3.8 million in debt.\nAll of the above acquisitions were accounted for by the purchase method, and accordingly, the results of their operations are included from the respective acquisition dates. The above acquisitions would not have had a material effect on sales or earnings for 1993 or 1992 had they been made at the beginning of the year prior to their acquisition.\n4. ACCOUNTING CHANGE\nEffective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" which requires that certain debt and equity securities be carried at market value. The cumulative effect on net income as of January 1, 1994, of adopting this statement for trading securities was to increase net income by $3.8 million (net of a tax benefit of $2.4 million), or $.11 per share. The impact on stockholders' equity of adopting this statement for all securities was not significant.\nAs required by SFAS No. 115, management is to reevaluate the appropriate classification of securities at each balance sheet date, based on its intent to trade or hold the securities. Accordingly, and as a result of the consummation of new debt agreements by the Company in late March 1994 which contain restrictive covenants as to the amount and composition of the Company's investment portfolio (see Note 6), all securities classified as trading securities on March 31, 1994 (primarily those of a captive insurance subsidiary) having an aggregate fair value of $16.7 million were transferred to available-for-sale securities. The transfer had no effect on income or stockholders' equity.\nDue to the restrictive covenants, most of the Company's trading securities portfolio were sold in late March 1994 and not replaced. Cash proceeds of $31.6 million were received from the sale of the securities, and the gross realized holding gains and losses were not significant. Under management's new investment\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nobjectives, the Company does not intend to actively trade securities currently held, or securities to be acquired in the future. Accordingly, at December 31, 1994, all of the Company's equity securities and fixed income securities are classified as available-for-sale. The aggregate market value of securities available-for-sale and classified as current and noncurrent assets at December 31, 1994 was $18.1 million ($19.3 million amortized cost). The gross unrealized holding gains and losses on these securities were not significant.\n5. OTHER BALANCE SHEET INFORMATION\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n6. LONG-TERM DEBT\nAt December 31, 1994 and 1993, long-term debt consisted of:\nThe annual future payments required by the terms of the long-term debt is approximately $10 million per year for the years 1996 through 1999.\nOn March 21, 1994, the Company completed an offering of $150 million in principal amount of 9 3\/4% senior notes due March 15, 2004. Also in March 1994, the Company entered into a $250 million fixed\/floating rate senior secured credit agreement with a group of banks which provided commitments of $125 million each for term loans and revolving loans. The net proceeds from these debt issuances, together with available cash, were used to: (a) finance the Company's early retirement of debt in March 1994 aggregating $185.4 million, (b) fund prepayment premiums and other expenses related to the sale of the senior notes and the bank credit agreement totaling $29.2 million, and (c) repurchase outstanding shares of the Company's common stock (see Note 7). In connection with the early retirement of debt, the Company recorded an extraordinary loss of $11.8 million (net of tax benefits of $7.6 million) or $.32 per share, for the prepayment premiums paid and the write-off of related deferred debt issuance costs.\nIn October 1994, the Company amended the bank credit agreement, reducing the total credit facility from $250 million to $200 million. The amended agreement reduces the term loan commitment from $125 million to $50 million, all of which is outstanding at December 31, 1994, and which is to be repaid in semiannual installments over five years beginning in 1995. The agreement also increases the revolving loan commitment from $125 million to $150 million, of which $1.6 million was outstanding at December 31, 1994 and which is classified as short- term borrowings. The revolving loan commitment expires in 1999, and any loans outstanding thereunder are due and payable at final maturity.\nAdditionally, the amended agreement provides for lower interest rates and a reduction in commitment fees and, subject to authorization by the Board of Directors, allows the Company to spend up to $25 million to repurchase a portion of its 9 3\/4% senior notes, or to make additional repurchases of the Company's common stock, or a combination thereof (see Note 7).\nOutstanding loans under the credit facility are subject to interest rate swap and cap agreements based on a combination of a fixed rate and the London Interbank Offered Rate (LIBOR), plus a negotiated spread over LIBOR. The weighted average interest rates on loans under the agreement at December 31, 1994 was 7.48% for term loans and 8.50% for revolving loans. The Company's loan agreements contain covenants, which among other things, provide for compliance with certain financial ratios with respect to leverage, net worth and fixed charge coverage. At December 31, 1994, the Company was in compliance with all such covenants.\nThe Company also has outstanding letters of credit totaling $13.1 million at December 31, 1994, and its subsidiaries had foreign lines of credit with European banks of approximately $15.9 million, all of which was unused.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n7. STOCKHOLDERS' EQUITY\nAs part of its plan to enhance shareholder value, the Company announced in the fourth quarter of 1993 its intent to repurchase outstanding shares of its common stock for an aggregate purchase price of up to $150 million. As part of an amendment to its bank credit agreement in October 1994, the Company was permitted to purchase up to an additional $25 million of its outstanding common stock, subject to Board approval, for a maximum total potential purchase of $175 million.\nThe stock repurchase was contingent upon the Company completing the refinancing of its long-term debt, which occurred in March of 1994. In anticipation of the contemplated stock repurchases, the Company, from November 1993 to January 1994, entered into a series of equity option contracts with a counterparty to hedge itself against changes in the market price of its stock between the time the plan was announced and completion of the debt refinancing. These contracts, which were to expire in March and April of 1994, covered an aggregate of 3,924,200 shares of the Company's common stock.\nOn February 14, 1994, to extend this hedge, the options (including those entered into in January 1994) were settled for approximately $330,000 and were replaced with a swap agreement with the same counterparty covering the same number of shares. The swap extended the hedge to May 31, 1994, with the Company maintaining the right to terminate the swap at any time prior to April 5, 1994 and buy the shares at a cost of $12.125 per share plus certain carrying costs. On March 22, 1994, following completion of the debt refinancing arrangements mentioned above, the Company exercised its option, terminated the swap agreement and acquired the 3,924,200 shares covered thereby at a total cost of approximately $47.8 million.\nDuring 1994, the Company repurchased a total of 9,221,100 shares of its common stock upon the exercise of the option described above, and in a combination of privately negotiated and open market transactions for an aggregate cost of $118.8 million, financed in part by a portion of the proceeds from the debt issuances described in Note 6.\nAll of the repurchased shares have been retired as required by the Company's loan agreements, and such shares have been returned to the status of authorized but unissued shares. At December 31, 1994, shares outstanding totalled 34,707,160, compared to 43,639,645 shares outstanding at December 31, 1993.\nAt the Annual Meeting of Stockholders on April 26, 1994, the Company's shareholders approved a reduction in the par value of the Company's common stock from $1.00 per share to $.01 per share. This change resulted in a transfer of $39.1 million from the common stock account to the capital in excess of par value account.\nThe Company has a Shareholder Rights Plan, under which the Board of Directors declared a dividend of one Right for each share of Company common stock owned. The Plan provides, under certain conditions involving acquisition of the Company's common stock, that holders of Rights, except for the acquiring entity, would be entitled (i) to purchase shares of preferred stock at a specified exercise price, or (ii) to purchase shares of common stock of the Company, or the acquiring company, having a value of twice the Rights exercise price. The Rights under the Plan expire in 1999.\nThe Company provides, among other things, for restricted stock awards of common stock to eligible employees and nonemployee directors of the Company at such cost to the recipient as the Stock Incentive Plan Committee of the Board of Directors may determine. These shares are issued subject to certain conditions, and transfer and other restrictions as prescribed by the Plan. In 1994 and 1993, the Company awarded 20,000 shares of restricted common stock to certain directors under the Plan. No restricted stock was awarded during 1992. Upon issuance of restricted stock, unearned compensation, equivalent to the excess of the market value of the shares awarded over the price paid by the recipient at the date of the grant, is charged to stockholders' equity and is amortized to expense over the periods until the restrictions lapse. Amortization charged to expense in 1994, 1993, and 1992 was not significant.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nAt December 31, 1994, 4,240,362 (4,732,053 in 1993) shares of common stock were reserved under the Company's incentive and nonqualified stock option plans. The options are exercisable at prices not less than market value on dates of grant, and in installments over five- to seven-year periods from such dates. Information on options follows:\n-------- * Expiring from 1995 through 2001\nThe Company also has outstanding 148,513 stock appreciation rights exercisable for cash and\/or shares of the Company's common stock when the related option is exercised. Subject to certain limitations, each right relates to the excess of the market value of the Company's common stock over the exercise price of the related option. Charges and credits, immaterial in amount, are made to income for these rights and certain related options.\n8. LEASES\nMinimum aggregate rental commitments under noncancellable leases in effect at December 31, 1994 (principally for production and administrative facilities and equipment) amounted to $7.7 million consisting of annual payments of $2.2 million in 1995, $1.6 million in 1996, and decreasing amounts thereafter. Rental expense of $5 million was charged to income in 1994 and 1993 and $4 million in 1992.\n9. INCOME TAXES\nThe components of income (loss) before income taxes, an extraordinary item, and the cumulative effect of an accounting change, and the details of the provision for (benefit from) income taxes are as follows:\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSignificant components of the Company's deferred tax (asset) liability as of December 31 are as follows:\nThe effective rate of the provision for (benefit from) income taxes reconciles to the statutory rate as follows:\n10. RETIREMENT AND PENSION PLANS\nThe Company maintains noncontributory defined benefit retirement and pension plans, with benefits for eligible United States salaried and hourly employees funded through trusts established in conjunction with these plans. Employees of certain foreign operations participate in various local plans which in the aggregate are not significant.\nThe Company also has nonqualified unfunded retirement plans for its directors and certain retired employees, and contractual arrangements with certain executives that provide for supplemental pension benefits in excess of those provided by the Company's primary pension plan. Fifty percent of the projected benefit obligation of the supplemental pension benefit arrangements with the executives has been funded by grants of restricted shares of the Company's common stock. The remaining 50% is unfunded. The Company is providing for these arrangements by charges to earnings over the periods to age 65 of the participants.\nThe Company's funding policy with respect to its qualified plans is to contribute amounts determined annually on an actuarial basis that provides for current and future benefits in accordance with funding requirements of federal law and regulations. Assets of funded benefit plans are invested in a variety of equity and debt instruments and in pooled temporary funds.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNet pension expense, excluding plan administrative expenses, consists of the following components:\nIn addition to pension expense shown in the table above, in 1993 the Company also recorded a charge for curtailments of $7.6 million related to an hourly pension plan as part of the resizing and restructuring of its general gauge and aerospace operations. This action, in part, accounts for the lower pension expense in 1994.\nThe charge to income for all retirement and pension plans, including the 1993 curtailment provision, was $4.5 million in 1994, $14.4 million in 1993, and $6.7 million in 1992.\nNet pension expense reflects an expected long-term rate of return on plan assets of 9 1\/4% for 1994, and 9 1\/2% for 1993 and 1992. The actual return has been adjusted to defer gains and losses which differ from the expected return. The present value of projected benefit obligations was determined using an assumed discount rate of 7 3\/4% for 1994, 7 1\/4% for 1993, and 8% for 1992. The assumed rate of compensation increase used in determining the present value of projected benefit obligations was 5 1\/4% for 1994, and 5 1\/2% for 1993 and 1992.\nFor pension plans with accumulated benefits in excess of assets at December 31, 1994, the balance sheet reflects an additional long-term pension liability of $10.0 million ($11.0 million--1993), a long-term intangible asset of $3.2 million ($3.7 million--1993), and a charge to stockholders' equity of $4.4 million ($4.7 million--1993 and $4.2 million--1992), net of a deferred tax benefit, representing the excess of the additional long-term liability over unrecognized prior service cost. No balance sheet recognition is given to pension plans with assets in excess of accumulated benefits.\nThe Company provides limited postretirement benefits other than pensions to certain retirees, and a small number of employees. These benefits are accounted for on the accrual basis, thereby meeting the accounting requirements of the current accounting standard for postretirement benefits other than pensions.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe following table sets forth the funded status of the plans:\n11. DERIVATIVE FINANCIAL INSTRUMENTS\nThe Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. Such instruments are generally used to manage well-defined interest rate risks and to hedge firm commitments relating to certain export sales denominated in a foreign currency.\nInterest rate swap and cap agreements are used to reduce the potential impact of increases in interest rates on the Company's floating-rate long-term debt. Accordingly, the Company enters into these agreements to effectively convert floating-rate debt to fixed-rate debt and to cap certain rates, which are indexed to LIBOR rates, to reduce the Company's risk of incurring higher interest costs due to rising interest rates. At December 31, 1994, the Company was party to one interest rate swap agreement with a notional amount of $28.3 million, which decreases by $2.2 million semiannually through May of 1997. The interest rate cap agreement entitles the Company to receive amounts from counterparties on a quarterly basis if specified market interest rates rise above fixed cap rates.\nForward currency contracts are entered into to hedge certain firm export sales commitments denominated in German marks. The purpose of these hedging activities is to protect the Company from the risk that the eventual net cash dollar inflows resulting from the sale of products to foreign customers will be adversely affected by changes in exchange rates. At December 31, 1994 and 1993, the notional value of these contracts was $10.3 million and $3.0 million, respectively. The terms of the currency contracts are dependent on the sale commitment and generally do not exceed one year. Deferred losses on these contracts at December 31, 1994 and 1993 were not significant and are recognized in operations as the related sales occur.\nIn addition, as discussed in Note 7, the Company exercised an option and terminated a swap agreement covering 3,924,200 shares of its common stock for an aggregate purchase price of $47.8 million.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n12. FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair values of the Company's financial instruments are compared below to the recorded amounts at December 31. Cash equivalents, marketable equity securities and fixed income securities, which are available-for-sale, are recorded at fair value at December 31, 1994. Prior to the Company's adoption of SFAS No. 115 for marketable securities on January 1, 1994, fixed income marketable securities, included in the table below, were carried at the lower of cost or market.\nThe fair values of fixed income and equity investments are based on quoted market value. The fair value of short-term borrowings is based on the carrying value at year-end. The fair value of the Company's publicly traded notes, included in long-term debt, are based on the quoted market price for such notes. The fair value of other long-term debt is estimated based on borrowing rates currently available to the Company for loans with similar terms and maturities. The fair value of forward currency contracts (used for hedging firm commitments) is based on quoted market prices for comparable contracts.\n13. ADDITIONAL INCOME STATEMENT AND CASH FLOW INFORMATION\nIncluded in other income, net, is interest and other investment income of $5.0 million, $8.4 million, and $8.6 million for 1994, 1993 and 1992. Income taxes paid in 1994, 1993 and 1992 were $13.6 million, $13.8 million, and $21.8 million. Cash paid for interest for each of the three years approximated interest expense.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n14. SEGMENT AND GEOGRAPHIC INFORMATION\nThe Company classifies its operations into three business segments: Electro- mechanical, Precision Instruments, and Industrial Materials. The Electro- mechanical Group produces motor-blower systems and injection-molded components for manufacturers of floor care appliances, and fractional horsepower motors and motor-blowers for computer, business machine, medical equipment and high- efficiency heating equipment producers. Sales of fractional horsepower electric motors and blowers represented 42% in 1994 (38% in 1993 and 39% in 1992) of the Company's consolidated net sales.\nThe Precision Instruments Group produces aircraft cockpit instruments and displays, and pressure, temperature, flow and liquid level sensors for aircraft and jet engine manufacturers and for airlines, as well as airborne electronics systems to monitor and record flight and engine data. The group also produces instruments and complete instrument panels for heavy truck builders, process monitoring and display systems, combustion, gas analysis, moisture and emissions monitoring systems, force and speed measuring instruments, air and noise monitors, pressure and temperature calibrators and pressure-indicating and digital manometers. The Precision Instruments Group has for many years been a leading producer of the widely used mechanical pressure gauge.\nThe Industrial Materials Group produces high-temperature-resistant materials and textiles, corrosion-resistant heat exchangers, tanks and piping for process systems; ultralightweight foam sheet packaging material; drinking water filter and treatment systems; industrial and commercial filters for other liquids; replacement filter cartridges, liquid bag filters and multiple cartridge filter housings, high-purity metals and alloys in powder, strip and wire form for high-performance aircraft, automotive and electronics requirements; and thermoplastic compounds and concentrates for automotive, appliance and telecommunication applications.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n14. SEGMENT AND GEOGRAPHICAL FINANCIAL INFORMATION\nBusiness Segments\n(1) After elimination of intersegment sales and intercompany sales between geographic areas, which are not significant in amount. Such sales are generally priced based on prevailing market prices. (2) Segment operating profit represents sales less all direct costs and expenses (including certain administrative and other expenses) applicable to each segment, but does not include interest expense. (3) Reflects charges of $47.8 million for resizing and restructuring costs associated with planned work force reductions and those which occurred in 1993, asset write-downs, relocation of product lines and the overall consolidation of the Company's aerospace operations, and other unusual charges. (4) Reflects charge of $3.9 million primarily for asset write-downs. (5) Includes unallocated administrative expenses, interest expense and net other income and, in 1993, $2.8 million of restructuring and other unusual charges. (6) Includes $2.8 million in 1993 and $9.5 million in 1992 from acquired businesses. (7) Included in total United States sales above.\nAMETEK, INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\n15. QUARTERLY FINANCIAL DATA (Unaudited)\n-------- (a) Excludes an extraordinary loss of $11.8 million ($.32 per share) for early extinguishment of debt, and a $3.8 million after tax gain ($.11 per share) from the cumulative effect of an accounting change for certain marketable securities, which are included in net income (see Notes 4 and 6). (b) The sum of 1994 quarterly earnings per share will not equal total year earnings per share due to the effect of the Company purchasing shares of its outstanding common stock. (c) Trading ranges are based on the New York Stock Exchange composite tape. (d) Amounts for each quarter exclude charges for resizing, restructuring and other unusual items, which are included in net income (loss). (e) Includes pre-tax charges of $46.9 million ($28.6 million after tax or $.66 per share) for restructuring and other unusual items.\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 with respect to Directors and Executive Officers of the Company, and information with respect to compliance with Section 16(a) of the Securities Exchange Act of 1934, is incorporated herein by reference to the Company's definitive Proxy Statement to be filed with the Securities and Exchange Commission (the \"Commission\") not later than 120 days after the close of the fiscal year ended December 31, 1994, under the captions \"Information as to Nominees for Election of Directors,\" \"Executive Officers of the Registrant\" and \"Compliance with Section 16(a) of the Securities Exchange Act of 1934.\"\nITEMS 11, 12 AND 13.\nThe information required by Item 11, Executive Compensation, by Item 12, Security Ownership of Certain Beneficial Owners and Management, and by Item 13, Certain Relationships and Related Transactions, is incorporated herein by reference to the Company's definitive Proxy Statement to be filed with the Commission not later than 120 days after the close of the fiscal year ended December 31, 1994, under the headings \"Executive Compensation,\" \"Stock Ownership\" and \"Compensation Committee Interlocks and Insider Participation.\"\nPART IV\nITEM 14.","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) Financial Statements, Financial Statement Schedules and Exhibits filed.\n1. and 2.\nFinancial statements and schedules are shown in the index and other information on page 19 of this report.\n3. Exhibits\nExhibits are shown in the index on page 41 of this report.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the quarter ended December 31, 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.\nAMETEK, Inc.\n\/s\/ Walter E. Blankley Dated: March 28, 1995 By __________________________________ WALTER E. BLANKLEY, 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.\nSIGNATURE TITLE DATE --------- ----- ----\n\/s\/ Walter E. Blankley Chairman of the March 28, 1995 ------------------------------------- Board and Chief WALTER E. BLANKLEY Executive Officer (Principal Executive Officer)\n\/s\/ Roger K. Derr Executive Vice March 28, 1995 ------------------------------------- President--Chief ROGER K. DERR Operating Officer\n\/s\/ John J. Molinelli Senior Vice March 28, 1995 ------------------------------------- President-- Chief JOHN J. MOLINELLI Financial Officer (Principal Financial Officer)\n\/s\/ Otto W. Richards ------------------------------------- Vice President and March 28, 1995 OTTO W. RICHARDS Comptroller (Principal Accounting Officer)\n\/s\/ Lewis G. Cole Director March 28, 1995 ------------------------------------- LEWIS G. COLE\n\/s\/ Helmut N. Friedlaender Director March 28, 1995 ------------------------------------- HELMUT N. FRIEDLAENDER\n\/s\/ Sheldon S. Gordon Director March 28, 1995 ------------------------------------- SHELDON S. GORDON\n\/s\/ Charles D. Klein ------------------------------------- Director March 28, 1995 CHARLES D. KLEIN\n\/s\/ James R. Malone Director March 28, 1995 ------------------------------------- JAMES R. MALONE\n\/s\/ David P. Steinmann Director March 28, 1995 ------------------------------------- DAVID P. STEINMANN\n\/s\/ Elizabeth R. Varet ------------------------------------- Director March 28, 1995 ELIZABETH R. VARET\nINDEX TO EXHIBITS ITEM 14(A)3)\nINDEX TO EXHIBITS ITEM 14(A)3)\nINDEX TO EXHIBITS ITEM 14(A)3)\nINDEX TO EXHIBITS ITEM 14(A)3)\n-------- * Management contract or compensatory plan required to be filed pursuant to Item 601 of Regulation S-K.","section_15":""}
{"filename":"109198_1994.txt","cik":"109198","year":"1994","section_1":"ITEM 1. Business\nThe Company is the largest off-price specialty apparel retailer in North America, comprised of the T.J. Maxx and Winners family apparel chains, the Hit or Miss chain of women's specialty stores and Chadwick's of Boston mail- order catalog. T.J. Maxx, Hit or Miss and Chadwick's of Boston operate in the United States and Winners operates in Canada. The Company is also developing HomeGoods which operates home fashions stores in the United States and T.K. Maxx, a new venture in the United Kingdom, which will be a T.J. Maxx-like business.\nThe Company strives to provide value to its customers by delivering brand names, fashion, quality and price. During the fiscal year ended January 29, 1994 (\"fiscal 1994\"), the Company's stores derived 30.9% of its sales from the Northeast, 24.3% from the Midwest, 28.0% from the South, 1.6% from the Central States, 12.5% from the West and 2.7% from Canada.\nThe greatest share of sales volume is done through the Company's T.J. Maxx chain, which operates 512 stores in 47 states, with an average store size of 27,000 gross square feet. T.J. Maxx sells a broad range of brand name family apparel, accessories, women's shoes, domestics, giftware and jewelry at prices generally 20% to 60% below department and specialty store regular prices. Hit or Miss, with 493 stores averaging 4,000 square feet in 34 states, is a chain of off-price women's specialty apparel stores featuring women's brand name and private label fashions including both wear-to-work and weekend wear. Chadwick's of Boston sells, through a mail-order catalog, women's career and casual fashion apparel priced significantly below department store regular prices. Winners Apparel Ltd., which was acquired by the Company in fiscal 1991, is a Canadian off-price family apparel retailer, which operates 27 stores in Canada. HomeGoods, a new business the Company began testing in fiscal 1993, sells domestics, giftware and other home fashions and operates a total of 10 stores. T.K. Maxx anticipates opening its first two stores in the United Kingdom in the spring of 1994. Unless otherwise indicated, all figures herein relating to numbers of stores are as of January 29, 1994.\nIn common with the business of apparel retailers generally, the Company's business is subject to seasonal influences, with higher levels of sales and income generally realized in the second half of the year.\nSet forth in the following table are the locations of stores operated by the Company's United States operations as of January 29, 1994:\nT.J. Maxx Hit or Miss\nAlabama................................ 9 3 Arizona................................ 7 1 Arkansas............................... 2 - California............................. 44 38 Colorado............................... 8 4 Connecticut............................ 18 21 Delaware............................... 2 1 District of Columbia................... - 3 Florida................................ 38 41 Georgia................................ 15 9 Idaho.................................. 1 - Illinois............................... 36 33 Indiana................................ 8 5 Iowa................................... 3 1 Kansas................................. 3 2 Kentucky............................... 4 3 Louisiana.............................. 5 7 Maine.................................. 4 2 Maryland............................... 9 12 Massachusetts.......................... 35 39 Michigan............................... 22 23 Minnesota.............................. 12 6 Mississippi............................ 1 - Missouri............................... 9 10 Montana................................ 1 - Nebraska............................... 2 - Nevada................................. 2 - New Hampshire.......................... 8 5 New Jersey............................. 14 48 New Mexico............................. 1 - New York............................... 33 30 North Carolina......................... 13 11 North Dakota........................... 2 - Ohio................................... 29 22 Oklahoma............................... 2 2 Oregon................................. 3 - Pennsylvania........................... 26 32 Rhode Island........................... 3 10 South Carolina......................... 8 4 South Dakota........................... 1 - Tennessee.............................. 8 10 Texas.................................. 22 28 Utah................................... 3 - Vermont................................ 1 1 Virginia............................... 19 15 Washington............................. 7 - West Virginia.......................... 1 - Wisconsin.............................. 8 11 Total Stores..................... 512 493\nWinners Apparel Ltd. operates 27 stores in Canada: 2 in Alberta, 1 in Manitoba and 24 in Ontario.\nHomeGoods operates a total of 10 stores: 4 in New England, 3 in the Cincinnati, Ohio area, and 3 in the Milwaukee, Wisconsin area.\nT.J. MAXX\nT.J. Maxx is the largest off-price family apparel chain in the United States, selling brand name family apparel and accessories, women's shoes, domestics, jewelry and giftware. T.J. Maxx's target customers are women between the ages 25 to 50, who typically have families with middle and upper- middle incomes and generally fit the profile of a department store shopper. Over 95% of T.J. Maxx's merchandise is first quality, and the balance consists of irregulars, samples and department or specialty store over- stocks. The chain uses a number of opportunistic buying strategies to purchase large quantities of merchandise at significant discounts from initial wholesale prices. Its strategies include special situation purchases, closeouts of current season fashions and out-of-season purchases of basic seasonal items for warehousing until the appropriate selling season. Pricing and markdown decisions and store replenishment requirements are determined centrally, using information provided by electronic point-of-sale computer terminals. T.J. Maxx employs a disciplined markdown policy to ensure that substantially all merchandise is sold within targeted selling periods.\nT.J. Maxx stores are generally located in suburban strip shopping centers, in close proximity to population centers, and average approximately 27,000 gross square feet. In recent years, T.J. Maxx has enlarged a number of stores to a larger prototype format, typically 30,000-40,000 square feet in size, and plans to enlarge highly successful stores where adjacent real estate is available. This larger format allows T.J. Maxx to expand all of its departments, with particular emphasis on its highly successful giftware and housewares departments.\nIn fiscal 1994, 38 stores were opened, including 20 of the new larger prototype, and 5 were closed. In addition, 17 existing stores were expanded to the larger format bringing the total of T.J. Maxx stores in the larger format to 128. In fiscal 1995, approximately 45 new stores are planned, of which approximately 25 are expected to be larger stores, along with the planned expansion of 25-30 existing locations. During the past five years, T.J. Maxx has opened 211 new stores and closed 7. T.J. Maxx has increased its presence in the metropolitan New York market with the addition of stores on Long Island and in New Jersey. In addition, in fiscal 1994 T.J. Maxx opened a new distribution center in Charlotte, North Carolina, to help support its store growth.\nHIT OR MISS\nHit or Miss sells first quality current season women's apparel, and targets working women 20 to 45 years old who desire up-to-date fashion and brand name quality merchandise at affordable prices. Hit or Miss sells nationally recognized brand name merchandise, purchased directly from manufacturers at prices below initial wholesale prices, and also sells private label merchandise, a large percentage of which is imported, in lines where quality, price and fashion are more important to customers than brand names. An aggressive markdown policy is pursued to achieve the turnover necessary to offer up-to-date fashionable merchandise. All purchasing, stocking, replenishment, initial pricing and markdowns are determined centrally rather than at the store level.\nA majority of Hit or Miss stores are located in suburban strip shopping centers, with the balance located in downtown areas, town centers and\nregional malls. Hit or Miss stores average approximately 4,000 gross square feet with an average of approximately 3,100 square feet of selling space.\nDuring fiscal 1994, Hit or Miss opened 18 stores and closed 30 stores as it continued with its real estate repositioning strategy initiated in fiscal 1993. The short average remaining lease life of the Hit or Miss stores provides the Company the opportunity to close additional stores, if warranted, in a cost effective manner. In the past five years, Hit or Miss has opened 161 new stores, and has closed 174 stores. Hit or Miss expects to open 35 new stores in fiscal 1995, and anticipates closing approximately 15 stores depending upon management's review of lease terms and store performance.\nCHADWICK'S OF BOSTON\nThe Chadwick's of Boston catalog features first quality, current fashion and classic merchandise, including career sportswear, casual wear, dresses, suits and accessories, with a mix of brand name and private label merchandise priced significantly below department store regular prices. Through marketing efforts, Chadwick's continues to refine the look of its catalogs. In the short term, Chadwick's will concentrate on its existing apparel lines, expanding large and petite sizes, and including menswear. Chadwick's target customers are 20 to 45 year old women interested in moderate to upper moderate priced merchandise and include both homemakers and working women.\nChadwick's is continuing to invest in its infrastructure to support its growth. During fiscal 1993, Chadwick's completed a major addition to its fulfillment center and installed a state-of-the-art telephone order system and an upgraded order processing system. Further expansion of its fulfillment center, started in fiscal 1994, is currently near completion.\nWINNERS APPAREL LTD.\nWinners Apparel Ltd., acquired by the Company in fiscal 1991, is a Canadian off-price family apparel retailer offering top brands and designer names at substantial savings. Winners emphasizes off-price designer and brand name misses sportswear, dresses and accessories as well as menswear and clothing for children and infants and toddlers. In addition, during the year Winners rolled-out giftware departments in all of its stores. In fiscal 1994, Winners opened 12 new stores and now operates a total of 27 stores. Winners entered new markets in the western provinces with stores in Calgary, Edmonton and Winnipeg. Winners expects to open 10 new stores in fiscal 1995 and to expand further into new Canadian markets. In support of its store growth, Winners moved into a new distribution facility during the year.\nHOMEGOODS\nThe Company continues to test its new HomeGoods stores, designed to expand the Company's off-price presence in the home fashions market. Based on the continuing success of T.J. Maxx's domestics and giftware categories, the Company believes an opportunity exists for a chain of large off-price stores focusing exclusively on home fashions. HomeGoods offers a broad and deep range of home fashion products, including domestics, cookware, bath accessories, and giftware in a no-frills, multi-department store format. Still in the developmental stage, the Company has refined HomeGoods' merchandise mix and softened the look of its store layout. The stores currently average approximately 50,000 square feet, but the Company intends to move to a smaller 35,000 square foot prototype with future openings and\nhas plans to downsize existing locations. The Company opened 4 HomeGoods stores in fiscal 1994 and expects to open 3-4 new stores in fiscal 1995.\nThe first 6 stores were opened in former Ames locations for which the Company has assumed lease liability, enabling the Company to test this new concept at relatively low cost.\nT.K. MAXX\nDuring fiscal 1995, the Company will open its first T.K. Maxx stores in the United Kingdom, and begin testing the off-price family apparel concept overseas. This concept will be similar to T.J. Maxx and Winners, with 2 store openings planned for the spring and possibly 3-4 more in the fall.\nEMPLOYEES\nAt January 29, 1994, the Company had approximately 36,000 employees, many of whom work less than 40 hours per week. In addition, temporary employees are hired during the peak back-to-school and holiday seasons. The Company has several collective bargaining agreements with the International Ladies Garment Workers Union (\"ILGWU\"), covering approximately 3,400 employees in its distribution facilities in Stoughton, West Bridgewater and Worcester, Massachusetts; Evansville, Indiana; Las Vegas, Nevada and Charlotte, North Carolina. Agreements for the three New England distribution facilities and the Las Vegas facility expire December 31, 1994, and it is expected that negotiations for new agreements will commence in October 1994. The Company considers its labor\/management relations and overall employee relations to be good.\nCOMPETITION\nThe retail apparel business is highly competitive. The Company generally competes for customers with a variety of conventional and other retail stores, including national, regional and local independent department and specialty stores, as well as with catalog operations, factory outlet stores and other off-price stores. Competitive factors important to the Company's customers include fashion, value, merchandise selection, brand name recognition and, to a lesser degree, store location. In addition, because the Company purchases much of its inventory opportunistically, the Company competes for merchandise with other national and regional off-price apparel retailers.\nMany of the Company's competitors handle identical or similar lines of merchandise and have comparable locations, and some have greater financial resources than the Company. The Company has relied and will continue to rely on a strong focus on consistently executing its mission of delivering exceptional fashion value to its target customers as a means of distinguishing itself from its competitors.\nCREDIT\nThe Company's stores operate primarily on a cash-and-carry basis. Each chain accepts credit sales through programs offered by banks and others.\nBUYING AND DISTRIBUTION\nEach of the Company's chains is serviced through its own centralized buying and distribution network. Each T.J. Maxx store is serviced by one of the chain's four distribution centers in Worcester, Massachusetts, Evansville, Indiana, Las Vegas, Nevada and Charlotte, North Carolina. T.J. Maxx's Charlotte distribution center of 600,000 square feet became operational in September 1993. Shipments are made twice a week by contract carrier to each store. All Hit or Miss stores are serviced by its warehouse facility in Stoughton, Massachusetts. Chadwick's of Boston's customers are serviced from its fulfillment center in West Bridgewater, Massachusetts, which was expanded in fiscal 1993, with further expansion currently near completion. Winners Apparel Ltd. stores are serviced from a new distribution center in Mississaugau, Ontario, which was opened in fiscal 1994.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. Properties\nT.J. Maxx, Hit or Miss and Winners lease virtually all of their store locations. Leases are generally for 10 years with options to extend for one or more 5 year periods. The Company has the right to terminate certain leases before the expiration date under certain circumstances and for a specified payment.\nThe approximate average size of a T.J. Maxx store is 27,000 square feet, Hit or Miss stores average approximately 4,000 square feet, Winners stores are approximately 21,000 square feet on average and HomeGoods stores currently average approximately 50,000 square feet. The Company owns four T.J. Maxx distribution facilities - a 500,000 square foot facility in Worcester, Massachusetts, a 980,000 square foot facility in Evansville, Indiana, a 400,000 square foot facility in Las Vegas, Nevada, and a 600,000 square foot facility in Charlotte, North Carolina. Hit or Miss leases its 334,000 square foot warehouse and office facility in Stoughton, Massachusetts under a lease expiring in September 1999, with renewal options extending to 2019. Chadwick's owns a 443,000 square foot fulfillment center and office facility in West Bridgewater, Massachusetts, with 110,000 square feet of additional expansion currently near completion. Chadwick's is also leasing a nearby 126,000 square foot warehouse and office facility. Winners leases 257,000 square feet of warehouse and office space in Mississaugau, Ontario. HomeGoods leases a 30,000 square foot processing center in Milford, Massachusetts as well as 50,000 square feet of the Hit or Miss distribution facility. In anticipation of its T.K. Maxx venture in the United Kingdom, the Company has leased a 62,000 square foot office and distribution facility in Yeading, England. The Company's, T.J. Maxx's and HomeGoods' executive and administrative offices are located in a 517,000 square foot office facility, which the Company leases in Framingham, Massachusetts.\nThe table below indicates the approximate gross square footage of stores and distribution centers, by division, in operation as of January 29, 1994.\n(In Thousands) Stores Distribution Centers Leased Owned\nT.J. Maxx 13,807 - 2,466 Winners 574 230 Hit or Miss 1,964 214 - HomeGoods 494 80 - Chadwick's N\/A 84 330 Total 16,839 608 2,796\nITEM 3.","section_3":"ITEM 3. Legal Proceedings\nThe Company is a defendant in a class action lawsuit, In Re TJX Companies, Inc., Consolidated Civil Action No. 10514, in the Court of Chancery of the State of Delaware. The former The TJX Companies, Inc. (\"old TJX\"), formerly an 83%-owned subsidiary of the Company, and the directors of old TJX are also named as defendants in this lawsuit. The lawsuit alleges that certain actions of the defendants in respect of the merger in 1989 of old TJX into The TJX Operating Companies, Inc., a wholly-owned subsidiary subsequently merged into the Company, constituted self-dealing, deception, unfair dealing, overreaching and a breach of fiduciary duties owed by the defendants to the then public stockholders of old TJX. In particular, the amended complaint alleges that the terms of the merger were unfair and offered inadequate consideration to the then public stockholders of old TJX. The suit seeks to recover unspecified monetary damages. The defendants have filed answers denying any wrongdoing. The Company believes that the substantive allegations of the case are without merit and that the case will not have a material effect on the Company's financial position.\nITEM 4.","section_4":"ITEM 4. Submission of Matters to a Vote of Security Holders\nThere was no matter submitted to a vote of the Company's security holders during the fourth quarter of fiscal 1994.\nITEM 4A. Executive Officers of the Registrant\nThe following persons are the executive officers of the Company as of the date hereof:\nOffice and Employment Name Age During Last Five Years\nBernard Cammarata 54 President, Chief Executive Officer and Director since 1989 and Chairman of the T.J. Maxx Division since 1986. Executive Vice President of the Company from 1986 to 1989. President, Chief Executive Officer and Director of the Company's former TJX subsidiary from 1987 to 1989; President of T.J. Maxx, 1976 to 1986.\nDonald G. Campbell 42 Senior Vice President - Finance since 1989. Senior Financial Executive of the Company, 1988 to 1989; Senior Vice President - Finance and Administration Zayre Stores Division 1987-1988; Vice President and Corporate Controller of the Company prior to 1987.\nSumner L. Feldberg 69 Chairman of the Board of Directors since 1989. Chairman of the Executive Committee of the Board of Directors since 1987; Chairman of the Board of Directors prior to 1987.\nRichard Lesser 59 Executive Vice President of the Company since 1991, Senior Vice President of the Company 1989-1991 and President of the T.J. Maxx Division since 1986. Senior Executive Vice President - Merchandising and Distribution 1986. Executive Vice President - General Merchandise Manager 1984 to 1986; Senior Vice President - General Merchandise Manager 1981 to 1984.\nThe foregoing were elected to their current Company offices by the Board of Directors in June 1993. All officers hold office until the next annual meeting of the Board in June 1994 and until their successors are elected and qualified.\nPART II\nITEM 5.","section_5":"ITEM 5. Market for the Registrant's Common Stock and Related Security Holder Matters\nThe information required by this Item is incorporated herein by reference from page 34 of the Annual Report, under the caption \"Price Range of Common Stock,\" and from inside the back cover of the Annual Report, under the caption \"Shareholder Information.\"\nITEM 6.","section_6":"ITEM 6. Selected Financial Data\nThe information required by this Item is incorporated herein by reference from page 27 of the Annual Report, under the caption \"Selected Financial Data.\"\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 incorporated herein by reference from pages 29 through 31 of the Annual Report, under the caption \"Management's Discussion and Analysis of Results of Operations and Financial Condition.\"\nITEM 8.","section_7A":"","section_8":"ITEM 8. Financial Statements and Supplementary Data\nThe information required by this Item and not filed with this report as Financial Statement Schedules is incorporated herein by reference from pages 14 through 27 of the Annual Report, under the captions; \"Consolidated Statements of Income,\" \"Consolidated Balance Sheets,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Statements of Shareholders' Equity,\" \"Selected Information by Major Business Segment\" and \"Notes to Consolidated Financial Statements.\"\nITEM 9.","section_9":"ITEM 9. Disagreements 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 Company will file with the Securities and Exchange Commission a definitive Proxy Statement no later than 120 days after the close of its fiscal year ended January 29, 1994 (the \"Proxy Statement\"). The information required by this Item and not given in Item 4A, Executive Officers of the Registrant, is incorporated by reference to the Proxy Statement. However, information under the captions \"Executive Compensation Committee Report\" and \"Performance Graph\" in the Proxy Statement is not so incorporated.\nITEM 11.","section_11":"ITEM 11. Executive Compensation\nThe information required by this Item is incorporated by reference to the Proxy Statement.\nITEM 12.","section_12":"ITEM 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this Item is incorporated by reference to the Proxy Statement.\nITEM 13.","section_13":"ITEM 13. Certain Relationships and Related Transactions\nThe information required by this Item is incorporated by reference to the Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\nA. The Financial Statements and Financial Statement Schedules filed as part of this report are listed and indexed at Page.\nListed below are all Exhibits filed as part of this report. Certain Exhibits are incorporated by reference to documents previously filed by the Registrant with the Securities and Exchange Commission pursuant to Rule 12b- 32 under the Securities Exchange Act of 1934, as amended.\n(3i) Articles of Incorporation.\n(a) Second Restated Certificate of Incorporation filed June 5, 1985 is incorporated by reference to Exhibit 3(a) to the Form 10-K filed for the fiscal year ended January 30, 1988.\n(b) Certificate of Amendment of Second Restated Certificate of Incorporation filed June 3, 1986 is incorporated by reference to Exhibit 3(a) to the Form 10-K for the fiscal year ended January 30, 1988.\n(c) Certificate of Amendment of Second Restated Certificate of Incorporation filed June 2, 1987 is incorporated by reference to Exhibit 3(a) to the Form 10-K for the fiscal year ended January 30, 1988.\n(d) Certificate of Amendment of Second Restated Certificate of Incorporation filed June 20, 1989 is incorporated by reference to Exhibit 8 to the Company's Current Report on Form 8-K dated June 21, 1989.\n(e) Certificate of Designation, Preferences and Rights of Series B Junior Participating Preferred Stock of the Company filed May 3, 1988 is incorporated by reference to Exhibit 2 of the Company's Current Report on Form 8-K dated April 29, 1988.\n(f) Certificate of Designations, Preferences and Rights of New Series A Cumulative Convertible Preferred Stock of the Company is incorporated by reference to Exhibit 4.6 to the Pre-Effective Amendment No. 2 to the Company's Registration Statement on Form S-3 (Registration No. 33-50330).\n(g) Certificate of Designations, Preferences and Rights of $3.125 Series C Cumulative Convertible Preferred Stock of the Company is incorporated by reference to Exhibit 19.2 to the Form 10-Q filed for the quarter ended July 25, 1992.\n(3ii) By-laws.\n(a) The by-laws of the Company, as amended, are incorporated by reference to Exhibit 3(f) to the Form 10-K for the fiscal year ended January 27, 1990.\n(4) Instruments defining the rights of security holders, including indentures.\n(a) Common and Preferred Stock: See the Second Restated Certificate of Incorporation, as amended (Exhibit (3i)(a)-(g) hereto).\n(b) A composite copy of the Share Purchase Agreements dated as of April 15, 1992 regarding Series A Cumulative Convertible Preferred Stock is incorporated by reference to Exhibit 4(c) to the Form 10-K filed for the fiscal year ended January 25, 1992.\n(c) Exchange Agreement dated as of August 6, 1992 between the Company and the holders of Series A Cumulative Convertible Preferred Stock is incorporated by reference to Exhibit 19.1 to the Form 10-Q filed for the quarter ended July 25, 1992.\nEach other instrument relates to securities the total amount of which does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis. The Company agrees to furnish to the Securities and Exchange Commission copies of each such instrument not otherwise filed herewith or incorporated herein by reference.\n(10) Material Contracts.\n(a) The Amended and Restated Employment Agreement dated as of April 26, 1988 with Stanley Feldberg is incorporated herein by reference to Exhibit 10(a) to the Form 10-K filed for the fiscal year ended January 30, 1988. The First Amendment to the 1988 Amended and Restated Employment Agreement of Stanley Feldberg dated June 8, 1993 is filed herewith. *\n(b) The Amended and Restated Employment Agreement dated as of June 1, 1989 with Sumner L. Feldberg is incorporated herein by reference to Exhibit 10(b) to the Form 10-K filed for the fiscal year ended January 27, 1990. The First Amendment dated as of December 9, 1992 to Sumner L. Feldberg's Amended and Restated Employment Agreement is incorporated herein by reference to Exhibit 10(b) to the Form 10-K for the fiscal year ended January 30, 1993. *\n(c) The Employment Agreement dated as of June 1, 1989 with Arthur F. Loewy is incorporated herein by reference to Exhibit 10(c) to the\nForm 10-K filed for the fiscal year ended January 27, 1990. The Amendment dated as of January 26, 1991 to Arthur F. Loewy's Employment Agreement is incorporated herein by reference to Exhibit 10(c) to the Form 10-K filed for the fiscal year ended January 26, 1991. Amendment No. 2 dated as of January 25, 1992 to Arthur F. Loewy's Employment Agreement is incorporated herein by reference to Exhibit 10(c) to the Form 10-K filed for the fiscal year ended January 25, 1992. Amendment No. 3 dated as of January 30, 1993 to Arthur F. Loewy's Employment Agreement is incorporated herein by reference to Exhibit 10(c) to the Form 10-K filed for the fiscal year ended January 30, 1993. Amendment No. 4, dated as of January 29, 1994, to Arthur F. Loewy's Employment Agreement is filed herewith. *\n(d) The Employment Agreement dated as of June 1, 1989 with Bernard Cammarata is incorporated herein by reference to Exhibit 10(d) to the Form 10-K filed for the fiscal year ended January 27, 1990. The Amendment to Employment Agreement with Bernard Cammarata dated as of February 1, 1992 is incorporated herein by reference to Exhibit 10(d) to the Form 10-K filed for the fiscal year ended January 30, 1993. *\n(e) The Amended and Restated Employment Agreement dated as of February 1, 1992 with Richard Lesser is incorporated herein by reference to Exhibit 10(e) to the Form 10-K filed for the fiscal year ended January 30, 1993. The Amendment to Richard Lesser's Employment Agreement dated as of January 31, 1994 is filed herewith. *\n(f) The Amended and Restated Employment Agreement dated as of February 1, 1992 with Donald G. Campbell is incorporated herein by reference to Exhibit 10(f) to the Form 10-K filed for the fiscal year ended January 30, 1993. The Amendment to Donald G. Campbell's Employment Agreement dated as of January 31, 1994 is filed herewith. *\n(g) The Management Incentive Plan, as amended, is filed herewith. *\n(h) The 1982 Long Range Management Incentive Plan, as amended, is filed herewith. *\n(i) The 1986 Stock Incentive Plan, as amended, is filed herewith. *\n(j) The TJX Companies, Inc. Long Range Performance Incentive Plan, as amended, is filed herewith. *\n(k) The General Deferred Compensation Plan, as amended, is incorporated herein by reference to Exhibit 10(n) to the Form 10-K filed for the fiscal year ended January 27, 1990. *\n(l) The Supplemental Executive Retirement Plan, as amended, is incorporated herein by reference to Exhibit 10(l) to the Form 10-K filed for the fiscal year ended January 25, 1992. *\n(m) The 1993 Stock Option Plan for Non-Employee Directors is incorporated herein by reference to Exhibit 10.1 to the Form 10-Q filed for the quarter ended May 1, 1993. *\n(n) The Retirement Plan for Directors, as amended, is incorporated herein by reference to Exhibit 10.2 to the Form 10-Q filed for the quarter ended May 1, 1993. *\n(o) The form of Indemnification Agreement between the Company and each of its officers and directors is incorporated herein by reference to Exhibit 10(r) to the Form 10-K filed for the fiscal year ended January 27, 1990. *\n(p) The Trust Agreement dated as of April 8, 1988 between the Company and State Street Bank and Trust Company is incorporated herein by reference to Exhibit 10(y) to the Form 10-K filed for the fiscal year ended January 30, 1988. *\n(q) The Trust Agreement dated as of April 8, 1988 between the Company and Shawmut Bank of Boston, N.A. is incorporated herein by reference to Exhibit 10(z) to the Form 10-K filed for the fiscal year ended January 30, 1988. *\n(r) The Distribution Agreement dated as of May 1, 1989 between the Company and Waban Inc. is incorporated herein by reference to Exhibit 3 to the Company's Current Report on Form 8-K dated June 21, 1989.\n(s) The Services Agreement between the Company and Waban Inc. dated as of May 1, 1989 is incorporated herein by reference to Exhibit 4 to the Company's Current Report on Form 8-K dated June 21, 1989. Correspondence related to the Services Agreement is incorporated herein by reference to Exhibit 10(dd) to the Form 10-K filed for fiscal year ended January 27, 1990. Correspondence related to the Services Agreement is incorporated herein by reference to Exhibit 10(z) to the Form 10-K filed for fiscal year ended January 26, 1991. Correspondence related to the Services Agreement is incorporated herein by reference to Exhibit 10(x) to the Form 10-K filed for the fiscal year ended January 25, 1992. Correspondence related to the Services Agreement is incorporated herein by reference to Exhibit 10(s) to the Form 10-K filed for fiscal year ended January 30, 1993. Correspondence related to the Services Agreement is filed herewith.\n(t) The Executive Services Agreement between the Company and Waban Inc. dated as of June 1, 1989, with respect to the services of Sumner L. Feldberg is incorporated herein by reference to Exhibit 10(ff) to the Form 10-K filed for the fiscal year ended January 27, 1990.\n(u) The Executive Services Agreement between the Company and Waban Inc. dated as of June 1, 1989, with respect to the services of Arthur F. Loewy is incorporated herein by reference to Exhibit 10(gg) to the Form 10-K filed for the fiscal year ended January 27, 1990. Amendment dated as of January 26, 1991 to Executive Services Agreement between the Company and Waban Inc. with respect to the services of Arthur F. Loewy is incorporated herein by reference to Exhibit 10(cc) to Form 10-K filed for the fiscal year ended January 26, 1991. Amendment No. 2 dated as of January 25, 1992 to Executive Services Agreement between the Company and Waban Inc. with respect to the services of Arthur F. Loewy is incorporated\nherein by reference to Exhibit 10(aa) to the Form 10-K filed for the fiscal year ended January 25, 1992. Amendment No. 3 dated as of January 30, 1993 to Executive Services Agreement between the Company and Waban Inc. with respect to the services of Arthur F. Loewy is incorporated herein by reference to Exhibit 10(u) to Form 10-K filed for the fiscal year ended January 30, 1993. Amendment No. 4 dated as of January 29, 1994 to Executive Services Agreement between the Company and Waban Inc. with respect to the services of Arthur F. Loewy is filed herewith.\n(v) The Agreement dated as of July 5, 1989 between the Company and Waban Inc. is incorporated herein by reference to Exhibit 10(hh) to the Form 10-K filed for the fiscal year ended January 27, 1990.\n(11) Statement re computation of per share earnings.\nThis statement is filed herewith.\n(13) Annual Report to security holders.\nPortions of the Annual Report to Stockholders for the fiscal year ended January 29, 1994 are filed herewith.\n(21) Subsidiaries.\nA list of the Registrant's subsidiaries is filed herewith.\n(23) Consents of experts and counsel.\nThe Consent of Coopers & Lybrand is contained on Page of the Financial Statements filed herewith.\n(24) Power of Attorney.\nThe Power of Attorney given by the Directors and certain Executive Officers of the Company is filed herewith.\n* Management contract or compensatory plan or arrangement.\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 TJX COMPANIES, INC.\nDated: April 22, 1994 \/s\/ Donald G. Campbell Donald G. Campbell Senior Vice President - Finance\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\/s\/ BERNARD CAMMARATA \/s\/ DONALD G. CAMPBELL Bernard Cammarata, President Donald G. Campbell, Senior and Principal Executive Officer Vice President - Finance, and Director Principal Financial and Accounting Officer\nJOHN M. NELSON* Michael H. Davis, Director John M. Nelson, Director\nPHYLLIS B. DAVIS* ROBERT F. SHAPIRO* Phyllis B. Davis, Director Robert F. Shapiro, Director\nSTANLEY H. FELDBERG* BURTON S. STERN* Stanley H. Feldberg, Director Burton S. Stern, Director\nSUMNER L. FELDBERG* FLETCHER H. WILEY* Sumner L. Feldberg, Director Fletcher H. Wiley, Director\nARTHUR F. LOEWY* ABRAHAM ZALEZNIK* Arthur F. Loewy, Director Abraham Zaleznik, Director\nDated: April 22, 1994 *By \/s\/ DONALD G. CAMPBELL Donald G. Campbell as attorney-in-fact\nSECURITIES AND EXCHANGE COMMISSION Washington, DC 20549\nTHE TJX COMPANIES, INC.\nFORM 10-K\nANNUAL REPORT\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nFor the Fiscal Years Ended January 29, 1994, January 30, 1993 and January 25, 1992\nTHE TJX COMPANIES, INC. AND SUBSIDIARIES\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES\nFor Fiscal Years Ended January 29, 1994, January 30, 1993 and January 25, 1992\nReport of Independent Accountants 28*\nConsent and Report of Independent Accountants\nSelected Quarterly Financial Data (Unaudited) 34*\nConsolidated Financial Statements:\nConsolidated Statements of Income for the fiscal years ended January 29, 1994, January 30, 1993 and January 25, 1992 14*\nConsolidated Balance Sheets as of January 29, 1994 and January 30, 1993 15*\nConsolidated Statements of Cash Flows for the fiscal years ended January 29, 1994, January 30, 1993 and January 25, 1992 16*\nConsolidated Statements of Shareholders' Equity for the fiscal years ended January 29, 1994, January 30, 1993 and January 25, 1992 17*\nNotes to Consolidated Financial Statements 19-27*\nSchedules:\nV Property, Plant and Equipment\nVI Accumulated Depreciation and Amortization of Property, Plant and Equipment\nIX Short-Term Borrowings\nX Supplementary Income Statement Information\n* Refers to page numbers in the Company's Annual Report to Stockholders for the fiscal year ended January 29, 1994, certain portions of which pages are incorporated by reference in Part II, Item 8 of this report as indicated.\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the Registration Statements of The TJX Companies, Inc. on Form S-3 (File No. 33-50259) and on Forms S-8 (File Nos. 2-79089 and 33-12220) of (1) our report dated March 2, 1994 on our audits of the consolidated financial statements of The TJX Companies, Inc. as of January 29, 1994 and January 30, 1993 and for the years ended January 29, 1994, January 30, 1993 and January 25, 1992, which report is included in the 1993 Annual Report to Shareholders of The TJX Companies, Inc. and (2) our report dated March 2, 1994 on our audits of the financial statement schedules of The TJX Companies, Inc. as of January 29, 1994 and January 30, 1993, and for the years ended January 29, 1994, January 30, 1993 and January 25, 1992, which report is included in this Annual Report on Form 10-K.\nBoston, Massachusetts April 19, 1994 Coopers & Lybrand\nREPORT OF INDEPENDENT ACCOUNTANTS\nOur report on the consolidated financial statements of The TJX Companies, Inc. has been incorporated by reference in this Form 10-K from page 28 of the 1993 Annual Report to Shareholders of The TJX Companies, Inc. 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.\nBoston, Massachusetts March 2, 1994 Coopers & Lybrand","section_15":""}
{"filename":"71304_1994.txt","cik":"71304","year":"1994","section_1":"Item 1. Business\nGeneral\nCommonwealth Energy System, a Massachusetts trust, is an unincorporated business organization with transferable shares. It is organized under a Declaration of Trust dated December 31, 1926, as amended, pursuant to the laws of Massachusetts. It is an exempt public utility holding company under the provisions of the Public Utility Holding Company Act of 1935, holding all of the stock of four operating public utility companies. Commonwealth Energy System, the parent company, is referred to in this report as the \"System\" and, together with its subsidiaries, is collectively referred to as \"the system.\"\nThe operating utility subsidiaries of the System are engaged in the generation, transmission and distribution of electricity and the distribution of natural gas, all within Massachusetts. These subsidiaries are:\nElectric Gas\nCambridge Electric Light Company Commonwealth Gas Company Canal Electric Company Commonwealth Electric Company\nIn addition to the utility companies, the System also owns all of the stock of a steam distribution company (COM\/Energy Steam Company), five real estate trusts and a liquefied natural gas (LNG) and vaporization facility (Hopkinton LNG Corp.). Subsidiaries of the System have common executive and financial management and receive technical assistance as well as financial, data processing, accounting, legal and other services from a wholly-owned services company subsidiary (COM\/Energy Services Company).\nThe five real estate subsidiaries are: Darvel Realty Trust, which is a joint-owner of the Riverfront Office Park complex in Cambridge; COM\/Energy Acushnet Realty, which leases land to Hopkinton LNG Corp. (Hopkinton); COM\/Energy Research Park Realty, which was organized to develop a research building in Cambridge; COM\/Energy Cambridge Realty, which was organized to hold various properties; and COM\/Energy Freetown Realty (Freetown), which was organized in 1986 to purchase and develop 596 acres of land in Freetown, Massachusetts. As a result of unsuccessful efforts to develop an energy park on this site, the System wrote down its investment in the Freetown project and plans to sell the property.\nEach of the operating utility subsidiaries serves retail customers except for Canal Electric Company (Canal) which operates an electric generating station located in Sandwich, Massachusetts. The station consists of two oil-fired steam electric generating units: Canal Unit 1, with a rated capacity of 569 MW, wholly-owned by Canal; and Canal Unit 2, with a rated capacity of 580 MW, jointly-owned by Canal and Montaup Electric Company (Montaup) (an unaffiliated company). Canal Unit 2 is operated under an agreement with Montaup which provides for the equal sharing of output, fixed charges and operating expenses. In October 1993, Canal reached an agreement with Montaup and Algonquin Gas Transmission Company to build a natural gas\nCOMMONWEALTH ENERGY SYSTEM\npipeline that will serve Unit 2, subject to regulatory approvals. The project will improve air quality on Cape Cod, enable the plant to exceed the stringent 1995 air quality standards established by the Massachusetts Department of Environmental Protection and strengthen Canal's bargaining position as it seeks to secure the lowest-cost fuel for its customers. Plant conversion and pipeline construction are expected to be completed in 1996.\nElectric service is furnished by Cambridge Electric Light Company (Cam- bridge Electric) and Commonwealth Electric Company (Commonwealth Electric) at retail to approximately 308,000 year-round and 49,000 seasonal customers in 41 communities in eastern Massachusetts covering 1,112 square miles and having an aggregate population of 645,000. The territory served includes the communities of Cambridge, New Bedford and Plymouth and the geographic area comprising Cape Cod and Martha's Vineyard. Cambridge Electric also sells power at wholesale to the Town of Belmont, Massachusetts.\nNatural gas is distributed by Commonwealth Gas Company (Commonwealth Gas) to approximately 232,000 customers in 49 communities in central and eastern Massachusetts covering 1,067 square miles and having an aggregate population of 1,128,000. Twelve of these communities are also served by system companies with electricity. Some of the larger communities served by Commonwealth Gas include Cambridge, Somerville, New Bedford, Plymouth, Worcester, Framingham, Dedham and the Hyde Park area of Boston.\nSteam, which is produced by Cambridge Electric in connection with the generation of electricity, is purchased by COM\/Energy Steam and, together with its own production, is distributed to 20 customers in Cambridge and one customer (Massachusetts General Hospital) in Boston. Steam is used for space heating and other purposes. On August 17, 1993 COM\/Energy Steam began providing steam service to Genzyme Corporation (Genzyme), a biotechnology company that is expected to become one of its largest customers. Genzyme's steam need for 1995 is estimated to be 83.3 million pounds, which represents approximately 5% of steam unit sales, for heating, air conditioning and testing processes. In 1996, Genzyme's annual requirement is estimated to reach approximately 175 million pounds based upon the expectation of commercial manufacturing of a biotherapeutic product in 1995.\nIndustry in the territories served by system companies is highly diversified. The larger industrial customers include high-technology firms and manufacturers of such products as photographic equipment and supplies, rubber products, textiles, wire and other fastening devices, abrasives and grinding wheels, candy, copper and alloys, and chemicals. Among customers served are several major educational institutions, including Harvard University (Harvard) and the Massachusetts Institute of Technology (MIT).\nMIT has completed construction of a 19 MW natural gas-fired cogeneration facility which is expected to be in operation in 1995. MIT anticipates this cogeneration facility will meet approximately 94% of its power, heating and cooling requirements. Sales to MIT in 1994 accounted for approximately 1.8% of total unit sales. MIT and Cambridge Electric were unsuccessful in attempts to reach agreement on the cost to provide back up and supplemental service. In March 1995, Cambridge Electric filed four rate schedules with the Massachusetts Department of Public Utilities (DPU) which, in part, seek to recover costs incurred to serve large customers such as MIT. These rates\nCOMMONWEALTH ENERGY SYSTEM\ninclude costs associated with providing standby, maintenance and supplemental service on an ongoing basis as well as a customer transition charge to recover other costs incurred to serve its largest customers should they discontinue service with Cambridge Electric while remaining in Cambridge.\nIn March 1994, Cambridge Electric was successful in negotiating a seven- year service agreement with another large customer, Harvard, whose sales in 1994 accounted for approximately 1.6% of the System's total unit sales.\nElectric Power Supply\nTo satisfy demand requirements and provide required reserve capacity, the system supplements its generating capacity by purchasing power on a long and short-term basis through capacity entitlements under power contracts with other New England and Canadian utilities and with Qualifying Facilities and other non-utility generators through a competitive bidding process that is regulated by the DPU.\nSystem companies own generating facilities with a capability totaling 1,046.5 MW at December 31, 1994. Including 560 MW provided by Canal Unit 1, of which three-quarters (420 MW) is sold to neighboring utilities under long- term contracts, and 292.0 MW provided by Canal Unit 2. Another 145.1 MW is provided by various smaller system units. Of the 577.1 MW available to the system, 77.6 MW are used principally for peaking purposes. A 3.52% ownership interest in the Seabrook 1 nuclear power plant provides 40.5 MW of capability to the system and Central Maine Power Company's Wyman Unit 4, an oil-fired facility in which the system has a 1.4% joint-ownership interest, provides 8.9 MW. In 1991, Canal executed a transaction with Central Vermont Public Service Corporation (CVPS) whereby 50 MW of Canal Unit 2 was exchanged for 25 MW each of CVPS's entitlement in the Vermont Yankee nuclear power plant and the Merrimack 2 coal-fired unit through October 1995. Additionally, in 1993, Canal extended an agreement with New England Power Company (NEP) whereby 50 MW of Canal Unit 2 (previously 20 MW) is exchanged for 50 MW of Bear Swamp Unit Nos. 1 and 2 through April 1997. The Bear Swamp Units are pumped storage hydro electric generating facilities. These contracts are designed to reduce the system's reliance on oil.\nIn addition, through Canal's equity ownership in Hydro-Quebec Phase II, the system has an entitlement of 67.9 MW. Purchase power arrangements were also in place with the following natural gas-fired cogenerating units in Massachusetts: 23 MW from Lowell Cogeneration Company Limited Partnership (Lowell), 38 MW from Pepperell Power Associates Limited Partnership (Pepperell), 53.0 MW from Northeast Energy Associates, 59.9 MW from Masspower and 58.9 MW from Altresco Pittsfield. Additionally, the system receives 67.0 MW from the SEMASS waste-to-energy plant (which includes 20.8 MW from the expansion unit which went on-line in May 1993); has entitlements totaling 24.4 MW through contracts with five (5) hydroelectric suppliers, including 20 MW from Boott Hydropower, Inc., in Lowell, Massachusetts; and also receives 68.2 MW from a natural gas-fired independent power producer, Dartmouth Power Associates.\nThe system anticipates providing for future peak load plus reserve requirements through existing system generation, including purchasing\nCOMMONWEALTH ENERGY SYSTEM\navailable capacity from neighboring utilities and\/or non-utility generators. Effective January 1, 1995, the system negotiated a restructured power sale agreement with Lowell and terminated the Pepperell power sale agreement through a buy-out arrangement, effective January 27, 1995.\nIn addition, the system has available 140.7 MW from four nuclear units in which system distribution companies have life-of-the-unit contracts for power. Information with respect to these units is as follows:\nConnecticut Maine Vermont Yankee Yankee Yankee Pilgrim\nYear of Initial Operation 1968 1972 1972 1972 Contract Expiration Date 1998 2008 2012 2012 Equity Ownership (%) 4.50 4.00 2.50 - Plant Entitlement (%) 4.50 3.59 2.25 11 Plant Capability (MW) 560.0 870.0 496.0 664.7 System Entitlement (MW) 25.2 31.2 11.2 73.1\nOn February 26, 1992, the Yankee Atomic Electric Company (Yankee) board of directors agreed to permanently cease power operation of the Yankee nuclear power plant in Rowe, Massachusetts. For additional information, refer to Note 2(e) of the Notes to Consolidated Financial Statements filed under Item 8 of this report.\nOne of the operating nuclear units, located in Wiscasset, Maine and operated by Maine Yankee Atomic Power Company, has been experiencing degradation of its steam generator tubes, principally in the form of circumferential cracking, which until early 1995 was believed to be limited to a relatively small number of tubes. During a refueling and maintenance outage that began in early February 1995, Maine Yankee, through the use of new inspection methods, detected increased degradation of the tubes well above its expectations. Maine Yankee is currently evaluating alternative courses of action to remedy this situation, most of which could result in significant capital expenditures and an extended outage period. At this time, Cambridge Electric cannot predict what action will be needed to rectify the situation, the costs to be incurred or the length of the outage. The Board of Directors of Maine Yankee will be meeting in early April 1995 to consider various options.\nOn October 1, 1992, Commonwealth Electric ceased power generation at its 60 MW Cannon Street generating station located in New Bedford, Massachusetts. During the past few years, the plant had been used primarily to meet peak electric demand and as a backup unit for Commonwealth Electric and the New England Power Pool (NEPOOL). A sharp decline in electric demand brought about by the present economic slowdown was the key factor in management's decision to close the plant. This decision was viewed as the most cost-effective among several alternatives and leaves Commonwealth Electric with the most flexibility for future capacity planning.\nCambridge Electric, Canal and Commonwealth Electric, together with other electric utility companies in the New England area, are members of NEPOOL, which was formed in 1971 to provide for the joint planning and operation of electric systems throughout New England.\nCOMMONWEALTH ENERGY SYSTEM\nNEPOOL operates a centralized dispatching facility to ensure reliability of service and to dispatch the most economically available generating units of the member companies to fulfill the region's energy requirement. This concept is accomplished by use of computers to monitor and forecast load requirements.\nNEPOOL, on behalf of its members entered into an Interconnection Agree- ment with Hydro-Quebec, a Canadian utility operating in the Province of Quebec. The agreement provided for construction of an interconnection (referred to as the Hydro-Quebec Project-Phase I and Phase II) between the electrical systems of New England and Quebec. The parties have also entered into an Energy Contract and an Energy Banking Agreement; the former obligates Hydro-Quebec to offer NEPOOL participants up to 33 million MWH of surplus energy during an eleven-year term that began September 1, 1986 and the latter provides for energy transfers between the two systems. NEPOOL has also entered into Phase II agreements for an additional purchase from Hydro-Quebec of 7 million MWH per year for a twenty-five year period which began in late 1990.\nCanal is obligated to pay its share of operating and capital costs for Phase II over a 25 year period ending in 2015. Future minimum lease payments for Phase II have an estimated present value of $13.8 million at December 31, 1994. In addition, Canal has an equity interest in Phase II which amounted to $3.8 million in 1994 and $3.9 million in 1993.\nThe System's electric subsidiaries are also members of the Northeast Power Coordinating Council (NPCC), an advisory organization that includes the major power systems in New England and New York plus the Provinces of Ontario and New Brunswick in Canada. NPCC establishes criteria and standards for reliability and serves as a vehicle for coordination in the planning and operation of these systems.\nThe reserve requirements used by the NEPOOL participants in planning future additions are determined by NEPOOL to meet the reliability criteria recommended by NPCC. The system estimates that, during the next ten years, reserve requirements so determined will be in the range of 23% to 29% of peak load.\nPower Supply Commitments and Support Agreements\nCambridge Electric and Commonwealth Electric, through Canal, secure cost savings for their respective customers by planning for bulk power supply on a single system basis. Additionally, Cambridge Electric and Commonwealth Electric have long-term contracts for the purchase of electricity from various sources. Generally, these contracts are for fixed periods and require payment of a demand charge for the capacity entitlement and an energy charge to cover the cost of fuel. For additional information concerning system commitments under long-term power contracts, refer to Note 2(d) of Notes to Consolidated Financial Statements filed under Item 8 of this report.\nThe system's 3.52% interest in the Seabrook nuclear power plant is owned by Canal to provide for a portion of the capacity and energy needs of Cambridge Electric and Commonwealth Electric. For additional information\nCOMMONWEALTH ENERGY SYSTEM\nconcerning Seabrook 1, refer to Note 2(b) of Notes to Consolidated Financial Statements filed under Item 8 of this report.\nElectric Fuel Supply\n(a) Oil\nImported residual oil is the fuel used in the generation of power in system generating plants, producing approximately 24% of the system's total energy requirement for 1994.\nEffective July 1, 1993, Canal executed a twenty-two month contract with Coastal Oil of New England, Inc. (Coastal) for the purchase of residual fuel oil. The contract provides for delivery of a set percentage of Canal's fuel requirement, the balance (a maximum of 20%) to be met by spot purchases or by Coastal at the discretion of Canal. Through December 31, 1994, approximately 16% of Canal's total requirements have been met by lower-cost spot purchases.\nEnergy Supply and Credit Corporation (ESCO) operates Canal's oil terminal and manages the purchase, receipt and payment of oil under assignment of Canal's supply contracts to ESCO (Massachusetts), Inc. Oil in the terminal's tanks is held in inventory by ESCO and delivered upon demand to Canal's tanks.\nFuel oil storage facilities at the Canal site have a capacity of 1,199,000 barrels, representing 60 days of normal operation of the two units. During 1994, ESCO maintained an average daily inventory of 575,000 barrels of fuel oil which represents 30 days of normal operation of the two units. This supply is maintained by tanker deliveries approximately every ten to fifteen days.\nReference is made to Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" for a discussion of the cost of fuel oil.\n(b) Nuclear Fuel Supply and Disposal\nApproximately 25% of the system's total energy requirement for 1994 was generated by nuclear plants. The nuclear fuel contract and inventory informa- tion for Seabrook 1 has been furnished to the system by North Atlantic Energy Services Corporation (NAESCO), the plant manager responsible for operation of the unit. Seabrook's requirement for nuclear fuel components are 100% covered through 1999 by existing contracts.\nThere are no spent fuel reprocessing or disposal facilities currently operating in the United States. Instead, commercial nuclear electric generating units operating in the United States are required to retain high level wastes and spent fuel on-site. As required by the Nuclear Waste Policy Act of 1982 (the Act), as amended, the joint-owners entered into a contract with the Department of Energy for the transportation and disposal of spent fuel and high level radioactive waste at a national nuclear waste repository or a monitored retrievable storage facility. Owners or generators of spent nuclear fuel or its associated wastes are required to bear all of the costs for such transportation and disposal through payment of a fee of approximately\nCOMMONWEALTH ENERGY SYSTEM\n1 mill\/KWH based on net electric generation to the Nuclear Waste Fund. Under the Act, a temporary storage facility for nuclear waste was anticipated to be in operation by 1998; however, a reassessment of the project's schedule requires extending the completion date of the permanent facility until at least 2010. Seabrook 1 is currently licensed for enough on-site storage to accommodate all spent fuel expected to be accumulated through at least the year 2010.\nGas Supply\nIn April 1992, the Federal Energy Regulatory Commission (FERC) issued Order No. 636 (Order 636) which became effective on November 1, 1993. The order requires interstate pipelines to unbundle existing gas sales contracts into separate components (gas sales, transportation and storage services) and to provide transportation services that allow customers to receive the same level and quality of service they had with the previous bundled contracts. Prior to the implementation of Order 636 Commonwealth Gas purchased the majority of its gas supplies from either Tennessee Gas Pipeline Company (Tennessee) or Algonquin Gas Transmission Company (Algonquin), supplemented with third-party firm gas purchases, storage services, and firm transportation from various pipelines. Presently, Commonwealth Gas purchases only transportation, storage, and balancing services from these pipelines (and other upstream pipelines that bring gas from the supply wells to the final transporting pipelines) and procures all of its gas supplies from third-party vendors, utilizing firm contracts with terms ranging from less than one year to three or more years. The vendors vary from small independent marketers to major gas and oil companies. For additional information on Order 636, refer to Note 2(g) of Notes to Financial Statements filed under Item 8 of this report.\nIn addition to firm transportation and gas supplies mentioned above, Commonwealth Gas utilizes contracts for underground storage and LNG facilities to meet its winter peaking demands. The underground storage contracts are a combination of existing and new agreements which are the result of Order 636 service unbundling. The LNG facilities, described below, are used to liquefy and store pipeline gas during the warmer months for use during the heating season. During 1994, over 98% of the gas utilized by Commonwealth Gas was delivered by the interstate pipeline system, the remaining small quantity (approximately 662,000 MMBTU) was delivered as liquid LNG from Distrigas of Massachusetts.\nCommonwealth Gas entered into a multi-party agreement in 1992 to assume a portion of Boston Gas Company's contracts to purchase Canadian gas supplies from Alberta Northeast (ANE), and have the volumes delivered by the Iroquois Gas Transmission System and Tennessee pipelines. The ANE gas supply contract was filed with the DPU and hearings were completed in April 1993. Commonwealth Gas is currently awaiting an order from the DPU.\nCommonwealth Gas began transporting gas on its distribution system in 1990 for end-users. There are currently eleven customers using this transpor- tation service, accounting for 2,208 BBTU (4.5%) of system throughput in 1994.\nCOMMONWEALTH ENERGY SYSTEM\nHopkinton LNG Facility\nA portion of Commonwealth Gas' gas supply during the heating season is provided by Hopkinton LNG Corp. (Hopkinton), a wholly-owned subsidiary of the System. The facility consists of a liquefaction and vaporization plant and three above-ground cryogenic storage tanks having an aggregate capacity of 3 million MCF of natural gas.\nIn addition, Hopkinton owns a satellite vaporization plant and two above-ground cryogenic storage tanks located in Acushnet, Massachusetts with an aggregate capacity of 500,000 MCF of natural gas and are filled with LNG trucked from Hopkinton.\nCommonwealth Gas has a contract for LNG service with Hopkinton ex- tending through 1996, thereafter renewable year to year with notice of termination due five years in advance. Contract payments include a demand charge sufficient to cover Hopkinton's fixed charges and an operating charge which covers liquefaction and vaporization expenses. Commonwealth Gas furnishes pipeline gas during the period April 15 to November 15 each year for liquefaction and storage. As the need arises, LNG is vaporized and placed in the distribution system of Commonwealth Gas.\nBased upon information presently available regarding projected growth in demand and estimates of availability of future supplies of pipeline gas, Commonwealth Gas believes that its present sources of gas supply are adequate to meet existing load and allow for future growth in sales.\nRates, Regulation and Legislation\nCertain of the System's utility subsidiaries operate under the jurisdiction of the DPU, which regulates retail rates, accounting, issuance of securities and other matters. In addition, Canal, Cambridge Electric and Commonwealth Electric file their respective wholesale rates with the FERC.\n(a) Most Recent Rate Case Proceedings\nElectric\nOn May 28, 1993, the DPU issued an order increasing Cambridge Electric's retail revenues by approximately $7.2 million, or 6.4%. The rates, based on a June 30, 1992 test-year and effective June 1, 1993, provide an overall return of 9.95%, including an equity return of 11% and represented approximately 70% of the amount requested. The new rates reflect the costs associated with postretirement benefits other than pensions which were determined in accordance with Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" adopted as of January 1, 1993. The DPU authorized full recovery of these costs over a four-year phase-in period with carrying costs on the deferred portion. The new base rates also reflect the roll-in of costs associated with the Seabrook nuclear power plant which are billed to Cambridge Electric by Canal. Previously these costs were recovered through Cambridge Electric's Fuel Charge decimal.\nCOMMONWEALTH ENERGY SYSTEM\nOn July 1, 1991, the DPU issued an order increasing Commonwealth Elec- tric's retail electric revenues by $10.9 million, or 3.1%. The requested increase was $17.3 million. The order, based on a June 30, 1990 test-year, provided an overall return of 10.49%, including a return on equity of 12%.\nGas\nOn April 16, 1991, Commonwealth Gas requested a $27.7 million (11.3%) revenue increase in a filing with the DPU using a test-year ended December 31, 1990. On September 16, 1991, the DPU approved a settlement of the revenue requirements portion of the filing authorizing a $22.8 million increase in annual revenues, approximately 82% of the original request. The agreement included a return on equity, for accounting purposes, of 13%. The DPU later ruled on the rate design portion of the request and new rates went into effect on November 1, 1991.\nIn May 1994, Commonwealth Gas requested the DPU to change the backup service charges under its firm transportation rate. Back up charges result when Commonwealth Gas sells gas from its system supplies to a customer whose off-system gas supply has failed or is temporarily unavailable for causes beyond the customer's control. The change involved an upward indexing based on changes in the gas supply demand costs occasioned by Order 636. On December 22, 1994, the DPU approved Commonwealth Gas' requested change effective January 1, 1995. This change, which has no effect on revenue, results in a more equitable recovery of pipeline capacity costs between Commonwealth Gas' total requirements and transportation customers.\n(b) Wholesale Rate Proceedings\nCambridge Electric requires FERC approval to increase its wholesale rates to the Town of Belmont, Massachusetts (Belmont), a \"partial requirements\" customer since 1986. These rates include a fuel adjustment clause which reflects changes in costs of fuels and purchased power used to supply Belmont.\nDuring March of 1993, Cambridge Electric and Belmont signed a net requirements power supply agreement, the terms and conditions of which required Belmont to pay for all costs except transmission fees which Cambridge Electric and Belmont attempted to negotiate. The negotiations were not successful and Cambridge Electric filed for approval of transmission rates with the FERC on June 29, 1994. The FERC accepted the rates effective January 25, 1995, subject to refund. At the same time, an investigation was opened by the FERC to determine the reasonableness of both the existing and the proposed transmission rates charged to Belmont. Cambridge Electric filed its case with the FERC on October 25, 1994 and hearings are scheduled to begin during the second quarter of 1995.\n(c) Automatic Adjustment Clauses\nElectric\nBoth Commonwealth Electric and Cambridge Electric have Fuel Charge rate schedules which generally allow for current recovery, from retail customers, of fuel used in electric production, purchased power and transmission costs.\nCOMMONWEALTH ENERGY SYSTEM\nThese schedules require a quarterly computation and DPU approval of a Fuel Charge decimal based upon forecasts of fuel, purchased power, transmission costs and billed unit sales for each period. To the extent that collections under the rate schedules do not match actual costs for that period, an appropriate adjustment is reflected in the calculation of the next subsequent calendar quarter decimal.\nCambridge Electric and Commonwealth Electric collect a portion of the capacity-related purchased power costs associated with certain long-term power arrangements through base rates. The recovery mechanism for these costs uses a per kilowatthour (KWH) factor that is calculated using historical (test- period) capacity costs and unit sales. This factor is then applied to current monthly KWH sales. When current period capacity costs and\/or unit sales vary from test-period levels, Cambridge Electric and Commonwealth Electric experience a revenue excess or shortfall which can have a significant impact on net income. All other capacity and energy-related purchased power costs are recovered through the Fuel Charge. Cambridge Electric and Commonwealth Electric made a filing in late 1992 with the DPU seeking an alternative method of recovery. This request was denied in a letter order issued on October 6, 1993. However, the companies were encouraged by the DPU's acknowledgement that the issues presented warrant further consideration. The DPU encouraged each company to continue to work with other interested parties, including the Attorney General of Massachusetts, to reach a consensus solution on the issue for future consideration. The companies have been involved in discussions with interested parties in an effort to resolve this issue in a positive fashion and hope to reach an agreement in the near future.\nBoth Commonwealth Electric and Cambridge Electric have separately stated Conservation Charge rate schedules which allow for current recovery, from retail customers, of Conservation and Load Management program costs. For further information, refer to Management's Discussion and Analysis of Financial Condition and Results of Operations filed under Item 7 of this report.\nGas\nCommonwealth Gas has a Standard Seasonal Cost of Gas Adjustment rate schedule (CGA) which provides for the recovery, from firm customers, of purchased gas costs not collected through base rates. These schedules, which require DPU approval, are estimated semi-annually and include credits for gas pipeline refunds and profit margins applicable to interruptible sales. Actual gas costs are reconciled annually as of October 31 and any difference is included as an adjustment in the calculation of the decimals for the two subsequent six-month periods.\nThe DPU and the Massachusetts Energy Facilities Siting Council (the Council) were merged in 1992. The Council is now a division of the DPU. Periodically, Commonwealth Gas is required to file a long-range forecast of the energy needs and requirements of its market area and annual supplements thereto with the Council. To approve a long-range forecast, the Council must find, among other things, that Commonwealth Gas plans for construction of new gas manufacturing or storage facilities and certain high-pressure gas pipelines are consistent with current health, environmental protection, and resource use and development policies as adopted by the Commonwealth of\nCOMMONWEALTH ENERGY SYSTEM\nMassachusetts. Commonwealth Gas filed a long-range forecast with the Council on July 20, 1990 and updated aspects of the filing in March 1991. This forecast was combined with the DPU review of the ANE contract. Both issues are pending before the DPU.\n(d) Gas Demand, Take-or-Pay Costs and Transition Costs\nCommonwealth Gas is obligated, as part of its pipeline transportation and supplier gas purchase contracts, to pay monthly demand charges which are recovered through the CGA.\nIn June 1991, Tennessee filed a settlement with the FERC dealing with a variety of contract restructuring issues, including the allocation of take-or- pay costs to Tennessee's customers including Commonwealth Gas. This comprehensive settlement was approved and implemented on July 1, 1992. As part of the settlement, the allocation of take-or-pay costs was changed from a deficiency basis to a contract demand basis which increased Commonwealth Gas' allocation. There are still some small on-going amounts of take-or-pay costs being collected by the pipeline, however, Tennessee has nearly reached the cap of allowable collections under the settlement.\nAlgonquin made a series of filings with the FERC to recover from its customers take-or-pay charges imposed on it by its upstream suppliers. Algonquin billed Commonwealth Gas for gas supply inventory charges from Texas Eastern and others through the Algonquin commodity rate. With the implementation of Order 636, Algonquin allocated the remaining costs utilizing a formula based on actual purchases for the twelve months prior to May 1, 1993. Commonwealth Gas' allocation was in excess of $5 million. Commonwealth Gas successfully appealed Algonquin's allocation method to the FERC. The change in allocation, combined with issues being settled in Algonquin's current rate case will reduce Commonwealth Gas' allocated share to $2.5 million. In addition, a settlement was reached with Koch Gateway Pipeline (formerly the United Gas Pipeline) whereby Commonwealth Gas received approximately $2 million in refunds for take-or-pay costs allocated through Texas Eastern and Algonquin since 1985. This amount is currently being refunded to firm customers through the CGA.\nCommonwealth Gas is collecting all contract restructuring costs from its customers through the CGA as permitted by the DPU.\nCompetition\nThis past year, the system continued to develop and implement strategies to deal with the increasingly competitive environment in our gas and electric businesses. The inherently high cost of providing energy services in the Northeast has placed the region at a competitive disadvan- tageas more customers begin to explore alternative supply options. Many state and federal government agencies are considering implementing programs under which utility and non-utility generators can sell electricity to customers of other utilities without regard to previously closed franchise service areas. In 1994, the DPU began an inquiry into incentive rate-making and in February 1995 opened an investigation into electric industry restructuring.\nCOMMONWEALTH ENERGY SYSTEM\nActions by system companies in response to the new competitive challenges have been well received by regulators, business groups and customers. For a more detailed discussion of competition and the programs currently in place within the system, refer to the \"Competition\" section of Management's Discussion and Analysis of Financial Condition and Results of Operation filed under Item 7 of this report.\nSegment Information\nSystem companies provide electric, gas and steam services to retail customers in service territories located in central and eastern Massachusetts and, in addition, sell electricity at wholesale to Massachusetts customers. Other operations of the system include the development and management of new real estate ventures and operation of rental properties and other investment activities which do not presently contribute significantly to either revenues or operating income.\nReference is made to additional industry segment information in Note 10 of Notes to Consolidated Financial Statements filed under Item 8 of this re- port.\nEnvironmental Matters\nThe system is subject to laws and regulations administered by federal, state and local authorities relating to the quality of the environment. System compliance with these laws and regulations will require capital expenditures of $41.8 million from 1995 through 1999 for the electric and gas divisions.\nFor additional information concerning environmental issues including those relating to former gas manufacturing sites, refer to the \"Environmental Matters\" section of \"Management's Discussion and Analysis of Financial Condi- tion and Results of Operations\" filed under Item 7 of this report.\nConstruction and Financing\nFor information concerning the system's financing and construction programs refer to Management's Discussion and Analysis of Financial Condition and Results of Operations filed under Item 7 and Note 2(a) of the Notes to Consolidated Financial Statements filed under Item 8 of this report.\nEmployees\nThe total number of full-time employees for the system declined 2.2% to 2,169 in 1994 from 2,217 employees at year-end 1993. Of the current total, 1,282 (59%) are represented by various collective bargaining units. Existing agreements are for varying periods and expire in 1995 and thereafter. Employee relations have generally been satisfactory.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe system's principal electric properties consist of Canal Unit 1, a 569 MW oil-fired steam electric generating unit, and its one-half ownership in Canal Unit 2, a 580 MW oil-fired steam electric generating unit, both located\nCOMMONWEALTH ENERGY SYSTEM\nat Canal Electric's facility in Sandwich, Massachusetts. Other electric properties include an integrated system of distribution lines and substations together with Commonwealth Electric's 60 MW steam electric generating station located in New Bedford, Massachusetts which ceased operations in October 1992 and was abandoned in 1993.\nCambridge Electric has two steam electric generating stations with a net capability of 76.5 MW located in Cambridge, Massachusetts. In addition, the system has a 3.52% interest (40.5 MW of capacity) in Seabrook 1 and a 1.4% or 8.9 MW joint-ownership interest in Central Maine Power Company's Wyman Unit 4. The system also has an interest in smaller generating units totaling 77.6 MW used primarily for peaking and emergency purposes. In addition, the system's other principal properties consist of an electric division office building in Wareham, Massachusetts and other structures such as garages and service buildings.\nAt December 31, 1994, the electric transmission and distribution system consisted of 5,790 pole miles of overhead lines, 4,192 cable miles of underground line, 355 substations and 374,055 active customer meters.\nThe principal natural gas properties consist of distribution mains, services and meters necessary to maintain reliable service to customers. At the end of 1994, the gas system included 2,761 miles of gas distribution lines, 162,971 services and 239,302 customer meters together with the necessary measuring and regulating equipment. In addition, the system owns a liquefaction and vaporization plant, a satellite vaporization plant and above- ground cryogenic storage tanks having an aggregate storage capacity equivalent to 3.5 million MCF of natural gas. The system's gas division owns a central headquarters and service building in Southborough, Massachusetts, five district office buildings and several natural gas receiving and take stations.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe system is subject to legal claims and matters arising from its course of business, including its participation in power contract arbitrations as discussed in the \"Power Contract Arbitrations\" section of Management's Discussion and Analysis of Financial Condition and Results of Operations filed under Item 7 of this report.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNone\nCOMMONWEALTH ENERGY SYSTEM\nPART II.\nItem 5.","section_5":"Item 5. Market for the Registrant's Securities and Related Stockholder Matters\n(a) Principal Markets\nThe System's common shares are listed on the New York, Boston and Pacific Stock Exchanges. The table below sets forth the high and low closing prices as reported on the New York Stock Exchange composite transactions tape.\n1994 by Quarter First Second Third Fourth High $45 1\/2 $43 3\/4 $40 3\/4 $38 3\/4 Low 42 7\/8 39 1\/2 37 1\/2 35 3\/8\n1993 by Quarter First Second Third Fourth High $48 7\/8 $48 5\/8 $50 1\/8 $49 3\/4 Low 40 1\/2 43 3\/8 46 3\/4 43\n(b) Number of Shareholders at December 31, 1994\n15,081 shareholders\n(c) Frequency and Amount of Dividends Declared in 1994 and 1993\n1994 1993 Per Per Share Share Declaration Date Amount Declaration Date Amount March 24, 1994 $ .75 March 25, 1993 $ .73 June 23, 1994 .75 June 24, 1993 .73 September 22, 1994 .75 September 23, 1993 .73 December 15, 1994 .75 December 16, 1993 .73 $3.00 $2.92\n(d) Future dividends may vary depending upon the System's earnings and capital requirements as well as financial and other conditions existing at that time.\nItem 6.","section_6":"Item 6. Selected Financial Data\nInformation required by this item is incorporated herein by reference to Exhibit A to the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Information dated March 31, 1995, page 58.\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 herein by reference to Exhibit A to the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Information dated March 31, 1995, pages 20 through 35.\nCOMMONWEALTH ENERGY SYSTEM\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements and supplementary data of the System and its subsidiaries are incorporated herein by reference to Exhibit A to the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Information dated March 31, 1995 on pages 35 through 58.\nProxy Page Reference\nManagement's Report 35\nReport of Independent Public Accountants 36\nConsolidated Balance Sheets - At December 31, 1994 and 1993 37\/38\nConsolidated Statements of Income - Years Ended December 31, 1994, 1993 and 1992 39\nConsolidated Statements of Cash Flows - Years Ended December 31, 1994, 1993 and 1992 40\nConsolidated Statements of Capitalization - At December 31, 1994 and 1993 41\nConsolidated Statements of Changes in Common Shareholders' Investment and in Redeemable Preferred Shares - Years Ended December 31, 1994, 1993 and 1992 42\nNotes to Consolidated Financial Statements 43\/57\nQuarterly Information pertaining to the results of operations for the years ended December 31, 1994 and 1993 58\nItem 9.","section_9":"Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure\nNone\nCOMMONWEALTH ENERGY SYSTEM\nPART III.\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Trustees and Executive Officers of the Registrant\na. Trustees of the Registrant:\nInformation required by this item is incorporated herein by reference to the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Information dated March 31, 1995, pages 3-6.\nb. Executive Officers of the Registrant: Age at December Name of Officer Position and Business Experience 31, 1994\nWilliam G. Poist President, Chief Executive Officer and 61 Trustee of the System and Chairman and Chief Executive Officer of its principal subsidiary companies since January 1, 1992; Vice President of the System and COM\/Energy Services Company* effective September 1, 1991; President and Chief Operating Officer of Commonwealth Gas Company* from 1983 to 1991 and Hopkinton LNG Corp.* from 1985 to 1991.\nJames D. Rappoli Financial Vice President and Treasurer of 43 the System and its subsidiary companies effective March 1, 1993; Treasurer of System subsidiary companies 1990; Assistant Treas- urer of System subsidiary companies 1989.\nRussell D. Wright President and Chief Operating Officer of 48 Cambridge Electric Light Company*, Canal Electric Company*, COM\/Energy Steam Company*, and Commonwealth Electric Company* effective March 1, 1993; Financial Vice President and Treasurer of the System and Financial Vice President of its subsidiary companies (July 1987 to March 1993); Treasurer of System subsidiary companies (December 1989 to December 1990), Assistant Vice President- Finance of System subsidiary companies 1986.\nKenneth M. Margossian President and Chief Operating Officer of 46 Commonwealth Gas Company* and Hopkinton LNG Corp.* effective September 1, 1991; Vice President of Operations from 1988 to 1991; Vice President of Facilities Develop- ment from 1987 to 1988; Vice President of Human Resources and Administration of Commonwealth Gas Company from 1985 to 1987.\n*Subsidiary of the System.\nCOMMONWEALTH ENERGY SYSTEM\nb. Executive officers of the Registrant (Continued):\nAge at December Name of Officer Position and Business Experience 31, 1994\nMichael P. Sullivan Vice President, Secretary, and 46 General Counsel of the System and subsidiary companies (effective June 1993); Vice President, Secretary, and General Attorney of the System and subsidiary companies since 1981.\nJohn A. Whalen Comptroller of the System and subsidiary 47 companies since 1978.\nThe term of office for System officers expires May 4, 1995, the date of the next Annual Organizational Meeting.\nThere are no family relationships between any trustee and executive officer and any other trustee or executive of the System. There were no arrangements or understandings between any officer or trustee and any other person pursuant to which he was or is to be selected as an officer, trustee or nominee.\nThere have been no events under any bankruptcy act, no criminal pro- ceedings and no judgments or injunctions material to the evaluation of the ability and integrity of any trustee or executive officer during the past five years.\nItem 11.","section_11":"Item 11. Executive Compensation\nInformation required by this item is incorporated herein by reference to the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Informa- tion dated March 31, 1995, pages 6-11.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nInformation required by this item is incorporated herein by reference to the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Inform- ation dated March 31, 1995, pages 3-6.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nInformation required by this item is incorporated herein by reference to the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Inform- ation dated March 31, 1995, pages 3-6.\nCOMMONWEALTH ENERGY SYSTEM\nPART IV.\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K\n(a) 1. Index to Financial Statements\nConsolidated financial statements and notes thereto of Commonwealth Energy System and Subsidiary Companies together with the Report of Independent Public Accountants, as detailed on page 17 in Item 8 of this Form 10-K, have been incorporated herein by reference to Exhibit A to the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Information dated March 31, 1995.\n(a) 2. Index to Financial Statement Schedules\nCommonwealth Energy System and Subsidiary Companies\nFiled herewith at page(s) indicated -\nReport of Independent Public Accountants on Schedules (page 42).\nSchedule I - Investments in, Equity in Earnings of, and Dividends Received from Related Parties - Years Ended December 31, 1994, 1993 and 1992 (pages 43-45).\nSchedule II - Valuation and Qualifying Accounts - Years Ended December 31, 1994, 1993 and 1992 (page 46).\nAll other schedules have been omitted because they are not applicable, not required or because the required information is included in the financial statements or notes thereto.\nSubsidiaries not Consolidated and Fifty-Percent or Less Owned Persons\nFinancial statements of 50% or less owned persons accounted for by the equity method have been omitted because they do not, considered individ- ually or in the aggregate, constitute a significant subsidiary.\nForm 11-K, Annual Reports of Employee Stock Purchases, Savings and Similar Plans\nPursuant to Rule 15(d)-21 of the Securities and Exchange Act of 1934, the information, financial statements and exhibits required by Form 11-K with respect to the Employees Savings Plan of Commonwealth Energy System and Subsidiary Companies will be filed as an amendment to this report under cover of Form 10-K\/A no later than May 1, 1995.\n(a) 3. Exhibits: Notes to Exhibits -\na. Unless otherwise designated, the exhibits listed below are incorporated by reference to the appropriate exhibit numbers and the Securities and Exchange Commission file numbers indicated in parentheses.\nCOMMONWEALTH ENERGY SYSTEM\nb. During 1981, New Bedford Gas and Edison Light Company sold its gas business and properties to Commonwealth Gas Company and changed its corporate name to Commonwealth Electric Company.\nc. The following is a glossary of Commonwealth Energy System and subsid- iary companies' acronyms that are used throughout the following Exhibit Index:\nCES ......................Commonwealth Energy System CE .......................Commonwealth Electric Company CEL ......................Cambridge Electric Light Company CEC ......................Canal Electric Company CG .......................Commonwealth Gas Company NBGEL ....................New Bedford Gas and Edison Light Company HOPCO ....................Hopkinton LNG Corp.\nExhibit Index\nExhibit 3. Declaration of Trust\nCommonwealth Energy System (Registrant)\n3.1.1 Declaration of Trust of CES dated December 31, 1926, as amended by vote of the shareholders and trustees May 5, 1994 (Exhibit 1 to the CES Form S-3 (September 1994), File No. 1-7316).\nExhibit 4. Instruments defining the rights of security holders, including indentures\nCommonwealth Energy System (Registrant)\nDebt Securities -\n4.1.1 CES Note Agreement ($40 Million Privately Placed Senior Notes) dated June 28, 1989 (Exhibit 1 to the CES Form 10-Q (September 1989), File No. 1-7316).\nCambridge Electric Light Company\nIndenture of Trust or Supplemental Indenture of Trust -\n4.2.1 Original Indenture on Form S-1 (April, 1949) (Exhibit 7(a), File No. 2-7909)\n4.2.2 Third Supplemental on Form 10-K (1984) (Exhibit 1, File No. 2-7909)\n4.2.3 Fourth Supplemental on Form 10-K (1984) (Exhibit 2, File No. 2- 7909)\n4.2.4 Sixth Supplemental on Form 10-Q (June 1989) (Exhibit 1, File No. 2- 7909)\nCOMMONWEALTH ENERGY SYSTEM\nSubsidiary Companies of the Registrant\n4.2.5 Seventh Supplemental on Form 10-Q (June 1992), (Exhibit 1, File No 2-7909).\nCanal Electric Company\nIndenture of Trust and First Mortgage or Supplemental Indenture of Trust and First Mortgage -\n4.3.1 Indenture of Trust and First Mortgage with State Street Bank and Trust Company, Trustee, dated October 1, 1968 (Exhibit 4(b) to Form S-1, File No. 2-30057).\n4.3.2 First and General Mortgage Indenture with Citibank, N.A., Trustee, dated September 1, 1976 (Exhibit 4(b)2 to Form S-1, File No. 2- 56915).\n4.3.3 First Supplemental dated October 1, 1968 with State Street Bank and Trust Company, Trustee, dated September 1, 1976 (Exhibit 4(b)3 to Form S-1, File No. 2-56915).\n4.3.4 Third Supplemental dated September 1, 1976 with Citibank, N.A., New York, NY, Trustee, dated December 1, 1990 (Exhibit 3 to 1990 Form 10-K, File No. 2-30057).\n4.3.5 Fourth Supplemental dated September 1, 1976 with Citibank, N.A., New York, NY, Trustee, dated December 1, 1990 (Exhibit 4 to 1990 Form 10-K, File No. 2-30057).\nCommonwealth Gas Company\nIndenture of Trust or Supplemental Indenture of Trust -\n4.4.1 Original Indenture on Form S-1 (Feb., 1949) (Exhibit 7(a), File No. 2-7820)\n4.4.2 Sixteenth Supplemental on Form 10-K (1986) (Exhibit 1, File No. 2- 1647)\n4.4.3 Seventeenth Supplemental on Form 10-K (1990) (Exhibit 2, File No. 2-1647)\n4.4.4 Eighteenth Supplemental on Form 10-Q (March 1994) (Exhibit 1, File No. 2-1647).\nExhibit 10. Material Contracts\n10.1 Power contracts.\n10.1.1 Power contracts between CEC (Unit 1) and NBGEL and CEL dated December 1, 1965 (Exhibit 13(a)(1-4) to the CEC Form S-1, File No. 2-30057).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.2 Power contract between Yankee Atomic Electric Company (YAEC) and CEL dated June 30, 1959, as amended April 1, 1975 (Refiled as Exhibit 1 to the 1991 CEL Form 10-K, File No. 2-7909).\n10.1.2.1 Second, Third and Fourth Amendments to 10.1.2 as amended October 1, 1980, April 1, 1985 and May 6, 1988, respectively (Exhibit 2 to the CEL Form 10-Q (June 1988), File No. 2-7909).\n10.1.2.2 Fifth and Sixth Amendments to 10.1.2 as amended June 26, 1989 and July 1, 1989, respectively (Exhibit 1 to the CEL Form 10-Q (September 1989), File No. 2-7909).\n10.1.3 Power Contract between YAEC and NBGEL dated June 30, 1959, as amended April 1, 1975 (Refiled as Exhibit 2 to the 1991 CE Form 10-K, File No. 2-7749).\n10.1.3.1 Second, Third and Fourth Amendments to 10.1.3 as amended October 1, 1980, April 1, 1985 and May 6, 1988, respectively (Exhibit 1 to the CE Form 10-Q (June 1988), File No. 2-7749).\n10.1.3.2 Fifth and Sixth Amendments to 10.1.3 as amended June 26, 1989 and July 1, 1989, respectively (Exhibit 3 to the CE Form 10-Q (September 1989), File No. 2-7749).\n10.1.4 Power Contract between Connecticut Yankee Atomic Power Company (CYAPC) and CEL dated July 1, 1964 (Exhibit 13-K1 to the System's Form S-1, (April 1967) File No. 2-25597).\n10.1.4.1 Additional Power Contract providing for extension on contract term between CYAPC and CEL dated April 30, 1984 (Exhibit 5 to the CEL Form 10-Q (June 1984), File No. 2-7909).\n10.1.4.2 Second Supplementary Power Contract providing for decommissioning financing between CYAPC and CEL dated April 30, 1984 (Exhibit 6 to the CEL Form 10-Q (June 1984), File No. 2-7909).\n10.1.5 Power contract between Vermont Yankee Nuclear Power Corporation (VYNPC) and CEL dated February 1, 1968 (Exhibit 3 to the CEL 1984 Form 10-K, File No. 2-7909).\n10.1.5.1 First Amendment dated June 1, 1972 (Section 7) and Second Amendment dated April 15, 1983 (decommissioning financing) to 10.1.5 (Exhibits 1 and 2, respectively, to the CEL Form 10-Q (June 1984), File No. 2- 7909).\n10.1.5.2 Third Amendment dated April 1, 1985 and Fourth Amendment dated June 1, 1985 to 10.1.5 (Exhibits 1 and 2, respectively, to the CEL Form 10-Q (June 1986), File No. 2-7909).\n10.1.5.3 Fifth and Sixth Amendments to 10.1.5 dated February 1, 1968, both as amended May 6, 1988 (Exhibit 1 to the CEL Form 10-Q (June 1988), File No. 2-7909).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.5.4 Seventh Amendment to 10.1.5 dated February 1, 1968, as amended June 15, 1989 (Exhibit 2 to the CEL Form 10-Q (September 1989), File No. 2-7909).\n10.1.5.5 Additional Power Contract dated February 1, 1984 between CEL and VYNPC providing for decommissioning financing and contract extension (Refiled as Exhibit 1 to CEL 1993 Form 10-K, File No. 2-7909).\n10.1.6 Power contract between Maine Yankee Atomic Power Company (MYAPC) and CEL dated May 20, 1968 (Exhibit 5 to the System's Form S-7, File No. 2-38372).\n10.1.6.1 First Amendment dated March 1, 1984 (decommissioning financing) and Second Amendment dated January 1, 1984 (supplementary payments) to 10.1.6 (Exhibits 3 and 4 to the CEL Form 10-Q (June 1984), File No. 2-7909).\n10.1.6.2 Third Amendment to 10.1.6 dated October 1, 1984 (Exhibit 1 to the CEL Form 10-Q (September 1984), File No. 2-7909).\n10.1.7 Agreement between NBGEL and Boston Edison Company (BECO) for the purchase of electricity from BECO's Pilgrim Unit No. 1 dated August 1, 1972 (Exhibit 7 to the CE 1984 Form 10-K, File No. 2- 7749).\n10.1.7.1 Service Agreement between NBGEL and BECO for purchase of stand-by power for BECO's Pilgrim Station dated August 16, 1978 (Exhibit 1 to the CE 1988 Form 10-K, File No. 2-7749).\n10.1.7.2 System Power Sales Agreement by and between CE and BECO dated July 12, 1984 (Exhibit 1 to the CE Form 10-Q (September 1984), File No. 2-7749).\n10.1.7.3 Power Exchange Agreement by and between BECO and CE dated December 1, 1984 (Exhibit 16 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.7.4 Power Exchange Agreement by and between BECO and CEL dated December 1, 1984 (Exhibit 5 to the CEL 1984 Form 10-K, File No. 2- 7909).\n10.1.7.5 Service Agreement for Non-Firm Transmission Service between BECO and CEL dated July 5, 1984 (Exhibit 4 to the CEL 1984 Form 10-K, File No. 2-7909).\n10.1.8 Agreement for Joint-Ownership, Construction and Operation of New Hampshire Nuclear Units (Seabrook) dated May 1, 1973 (Exhibit 13(N) to the NBGEL Form S-1 dated October 1973, File No. 2-49013 and as amended below:\n10.1.8.1 First through Fifth Amendments to 10.1.8 as amended May 24, 1974, June 21, 1974, September 25, 1974, October 25, 1974 and January 31, 1975, respectively (Exhibit 13(m) to the NBGEL Form S-1 (November 7, 1975), File No. 2-54995).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.8.2 Sixth through Eleventh Amendments to 10.1.8 as amended April 18, 1979, April 25, 1979, June 8, 1979, October 11, 1979 and December 15, 1979, respectively (Refiled as Exhibit 1 to the CEC 1989 Form 10-K, File No. 2-30057).\n10.1.8.3 Twelfth through Fourteenth Amendments to 10.1.8 as amended May 16, 1980, December 31, 1980 and June 1, 1982, respectively (Filed as Exhibits 1, 2, and 3 to the CE 1992 Form 10-K, File No. 2-7749).\n10.1.8.4 Fifteenth and Sixteenth Amendments to 10.1.8 as amended April 27, 1984 and June 15, 1984, respectively (Exhibit 1 to the CEC Form 10- Q (June 1984), File No. 2-30057).\n10.1.8.5 Seventeenth Amendment to 10.1.8 as amended March 8, 1985 (Exhibit 1 to the CEC Form 10-Q (March 1985), File No. 2-30057).\n10.1.8.6 Eighteenth Amendment to 10.1.8 as amended March 14, 1986 (Exhibit 1 to the CEC Form 10-Q (March 1986), File No. 2-30057).\n10.1.8.7 Nineteenth Amendment to 10.1.8 as amended May 1, 1986 (Exhibit 1 to the CEC Form 10-Q (June 1986), File No. 2-30057).\n10.1.8.8 Twentieth Amendment to 10.1.8 as amended September 19, 1986 (Exhibit 1 to the CEC 1986 Form 10-K, File No. 2-30057).\n10.1.8.9 Twenty-First Amendment to 10.1.8 as amended November 12, 1987 (Exhibit 1 to the CEC 1987 Form 10-K, File No. 2-30057).\n10.1.8.10 Settlement Agreement and Twenty-Second Amendment to 10.1.8, both dated January 13, 1989 (Exhibit 4 to the CEC 1988 Form 10-K, File No. 2-30057).\n10.1.9 Interim Agreement to Preserve and Protect the Assets of and Investment in the New Hampshire Nuclear Units dated April 27, 1984 (Exhibit 2 to the CEC Form 10-Q (June 1984), File No. 2-30057).\n10.1.10 Resolutions proposed by Merrill Lynch Capital Markets and adopted by the Joint-Owners of the Seabrook Nuclear Project regarding Project financing, dated May 14, 1984 (Exhibit 1 to the CEC Form 10-Q (March 1984), File No. 2-30057).\n10.1.11 Agreement for Seabrook Project Disbursing Agent establishing YAEC as the disbursing agent under the Joint-Ownership Agreement, dated May 23, 1984 (Exhibit 4 to the CEC Form 10-Q (June 1984), File No. 2-30057).\n10.1.11.1 First Amendment to 10.1.11 as amended March 8, 1985 (Exhibit 2 to the CEC Form 10-Q (March 1985), File No. 2-30057).\n10.1.11.2 Second through Fifth Amendments to 10.1.11 as amended May 20, 1985, June 18, 1985, January 2, 1986 and November 12, 1987, respectively (Exhibit 4 to the CEC 1987 Form 10-K, File No. 2-30057).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.12 Agreement to Share Certain Costs Associated with the Tewksbury- Seabrook Transmission Line dated May 8, 1986 (Exhibit 2 to the CEC 1986 Form 10-K, File No. 2-30057).\n10.1.13 Purchase and Sale Agreement together with an implementing Addendum dated December 31, 1981, between CE and CEC, for the purchase and sale of the CE 3.52% joint-ownership interest in the Seabrook units, dated January 2, 1981 (Refiled as Exhibit 4 to the CE 1992 Form 10-K, File No. 2-7749).\n10.1.14 Agreement to transfer ownership, construction and operational interest in the Seabrook Units 1 and 2 from CE to CEC dated January 2, 1981 (Refiled as Exhibit 3 to the 1991 CE Form 10-K, File No. 2- 7749).\n10.1.15 Termination Supplement between CEC, CE and CEL for Seabrook Unit 2, dated December 8, 1986 (Exhibit 3 to the CEC 1986 Form 10-K, File No. 2-30057).\n10.1.16 Power Contract, as amended to February 28, 1990, superseding the Power Contract dated September 1, 1986 and amendment dated June 1, 1988, between CEC (seller) and CE and CEL (purchasers) for seller's entire share of the Net Unit Capability of Seabrook 1 and related energy (Exhibit 1 to the CEC Form 10-Q (March 1990), File No. 2- 30057).\n10.1.17 Agreement between NBGEL and Central Maine Power Company (CMP), for the joint-ownership, construction and operation of William F. Wyman Unit No. 4 dated November 1, 1974 together with Amendment No. 1 dated June 30, 1975 (Exhibit 13(N) to the NBGEL Form S-1, File No. 2-54955).\n10.1.17.1 Amendments No. 2 and 3 to 10.1.17 as amended August 16, 1976 and December 31, 1978 (Exhibit 5(a) 14 to the System's Form S-16 (June 1979), File No. 2-64731).\n10.1.18 Agreement between the registrant and Montaup Electric Company (MEC) for use of common facilities at Canal Units I and II and for allocation of related costs, executed October 14, 1975 (Exhibit 1 to the CEC 1985 Form 10-K, File No. 2-30057).\n10.1.18.1 Agreement between the registrant and MEC for joint-ownership of Canal Unit II, executed October 14, 1975 (Exhibit 2 to the CEC 1985 Form 10-K, File No. 2-30057).\n10.1.18.2 Agreement between the registrant and MEC for lease relating to Canal Unit II, executed October 14, 1975 (Exhibit 3 to the CEC 1985 Form 10-K, File No. 2-30057).\n10.1.19 Contract between CEC and NBGEL and CEL, affiliated companies, for the sale of specified amounts of electricity from Canal Unit 2 dated January 12, 1976 (Exhibit 7 to the System's 1985 Form 10-K, File No. 1-7316).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.20 Capacity Acquisition Agreement between CEC,CEL and CE dated September 25, 1980 (Refiled as Exhibit 1 to the 1991 CEC Form 10-K, File No. 2-30057).\n10.1.20.1 Supplement to 10.1.20 consisting of three Capacity Acquisition Commitments each dated May 7, 1987, concerning Phases I and II of the Hydro-Quebec Project and electricity acquired from Connecticut Light and Power Company (CL&P) (Exhibit 1 to the CEC Form 10-Q (September 1987), File No. 2-30057).\n10.1.20.2 Supplements to 10.1.20 consisting of two Capacity Acquisition Commitments each dated October 31, 1988, concerning electricity acquired from Western Massachusetts Electric Company and\/or CL&P for periods ranging from November 1, 1988 to October 31, 1994 (Exhibit 2 to the CEC Form 10-Q (September 1989), File No. 2- 30057).\n10.1.20.3 Amendment to 10.1.20 as amended and restated June 1, 1993, henceforth referred to as the Capacity Acquisition and Disposition Agreement, whereby Canal Electric Company, as agent, in addition to acquiring power may also sell bulk electric power which Cambridge Electric Light Company and\/or Commonwealth Electric Company owns or otherwise has the right to sell (Exhibit 1 to Canal Electric's Form 10-Q (September 1993), File No. 2-30057).\n10.1.20.4 Capacity Disposition Commitment dated June 25, 1993 by and between Canal Electric Company (Unit 2) and Commonwealth Electric Company for the sale of a portion of Commonwealth Electric's entitlement in Unit 2 to Green Mountain Power Corporation (Exhibit 2 to Canal Electric's Form 10-Q (September 1993), File No. 2-30057).\n10.1.21 Phase 1 Vermont Transmission Line Support Agreement and Amendment No. 1 thereto between Vermont Electric Transmission Company, Inc. and certain other New England utilities, dated December 1, 1981 and June 1, 1982, respectively (Exhibits 5 and 6 to the CE 1992 Form 10-K, File No. 2-7749).\n10.1.21.1 Amendment No. 2 to 10.1.21 as amended November 1, 1982 (Exhibit 5 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.21.2 Amendment No. 3 to 10.1.21 as amended January 1, 1986 (Exhibit 2 to the CE 1986 Form 10-K, File No. 2-7749).\n10.1.22 Participation Agreement between MEPCO and CEL and\/or NBGEL dated June 20, 1969 for construction of a 345 KV transmission line between Wiscasset, Maine and Mactaquac, New Brunswick, Canada and for the purchase of base and peaking capacity from the NBEPC (Exhibit 13 to the CES 1984 Form 10-K, File No. 1-7316).\n10.1.22.1 Supplement Amending 10.1.22 as amended June 24, 1970 (Exhibit 8 to the CES Form S-7, Amendment No. 1, File No. 2-38372).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.23 Power Purchase Agreement between Weweantic Hydro Associates and CE for the purchase of available hydro-electric energy produced by a facility located in Wareham, Massachusetts, dated December 13, 1982 (Exhibit 1 to the CE 1983 Form 10-K, File No. 2-7749).\n10.1.23.1 Power Purchase Agreement (Revised) between Weweantic Hydro Associ- ates and Commonwealth Electric (CE) for the purchase of available hydro-electric energy produced by a facility located in Wareham, MA, originally dated December 13, 1982, revised and dated March 12, 1993 (Exhibit 1 to the CE Form 10-Q (June 1993), File No. 2-7749).\n10.1.24 Power Purchase Agreement between Pioneer Hydropower, Inc. and CE for the purchase of available hydro-electric energy produced by a facility located in Ware, Massachusetts, dated September 1, 1983 (Refiled as Exhibit 1 to the CE 1993 Form 10-K, File No. 2-7749).\n10.1.25 Power Purchase Agreement between Corporation Investments, Inc. (CI), and CE for the purchase of available hydro-electric energy produced by a facility located in Lowell, Massachusetts, dated January 10, 1983 (Refiled as Exhibit 2 to the CE 1993 Form 10-K, File No. 2-7749).\n10.1.25.1 Amendment to 10.1.25 between CI and Boott Hydropower, Inc., an assignee therefrom, and CE, as amended March 6, 1985 (Exhibit 8 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.26 Phase 1 Terminal Facility Support Agreement dated December 1, 1981, Amendment No. 1 dated June 1, 1982 and Amendment No. 2 dated November 1, 1982, between New England Electric Transmission Corporation (NEET), other New England utilities and CE (Exhibit 1 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.26.1 Amendment No. 3 to 10.1.26 (Exhibit 2 to the CE Form 10-Q (June 1986), File No. 2-7749).\n10.1.27 Preliminary Quebec Interconnection Support Agreement dated May 1, 1981, Amendment No. 1 dated September 1, 1981, Amendment No. 2 dated June 1, 1982, Amendment No. 3 dated November 1, 1982, Amendment No. 4 dated March 1, 1983 and Amendment No. 5 dated June 1, 1983 among certain New England Power Pool (NEPOOL) utilities (Exhibit 2 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.28 Agreement with Respect to Use of Quebec Interconnection dated December 1, 1981, Amendment No. 1 dated May 1, 1982 and Amendment No. 2 dated November 1, 1982 among certain NEPOOL utilities (Exhibit 3 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.28.1 Amendatory Agreement No. 3 to 10.1.28 as amended June 1, 1990, among certain NEPOOL utilities (Exhibit 1 to the CEC Form 10-Q (September 1990), File No. 2-30057).\n10.1.29 Phase I New Hampshire Transmission Line Support Agreement between NEET and certain other New England Utilities dated December 1, 1981 (Exhibit 4 to the CE Form 10-Q (June 1984), File No. 2-7749).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.30 Agreement, dated September 1, 1985, with Respect To Amendment of Agreement With Respect To Use Of Quebec Interconnection, dated December 1, 1981, among certain NEPOOL utilities to include Phase II facilities in the definition of \"Project\" (Exhibit 1 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.31 Agreement to Preliminary Quebec Interconnection Support Agreement - Phase II among Public Service Company of New Hampshire (PSNH), New England Power Co. (NEP), BECO and CEC whereby PSNH assigns a portion of its interests under the original Agreement to the other three parties, dated October 1, 1987 (Exhibit 2 to the CEC 1987 Form 10-K, File No. 2-30057).\n10.1.32 Preliminary Quebec Interconnection Support Agreement - Phase II among certain New England electric utilities dated June 1, 1984 (Exhibit 6 to the CE Form 10-Q (June 1984), File No. 2-7749).\n10.1.32.1 First, Second and Third Amendments to 10.1.32 as amended March 1, 1985, January 1, 1986 and March 1, 1987, respectively (Exhibit 1 to the CEC Form 10-Q (March 1987), File No. 2-30057).\n10.1.32.2 Fifth, Sixth and Seventh Amendments to 10.1.32 as amended October 15, 1987, December 15, 1987 and March 1, 1988, respectively (Exhibit 1 to the CEC Form 10-Q (June 1988), File No. 2-30057).\n10.1.32.3 Fourth and Eighth Amendments to 10.1.32 as amended July 1, 1987 and August 1, 1988, respectively (Exhibit 3 to the CEC Form 10-Q (September 1988), File No. 2-30057).\n10.1.32.4 Ninth and Tenth Amendments to 10.1.32 as amended November 1, 1988 and January 15, 1989, respectively (Exhibit 2 to the CEC 1988 Form 10-K, File No. 2-30057).\n10.1.32.5 Eleventh Amendment to 10.1.32 as amended November 1, 1989 (Exhibit 4 to the CEC 1989 Form 10-K, File No. 2-30057).\n10.1.32.6 Twelfth Amendment to 10.1.32 as amended April 1, 1990 (Exhibit 1 to the CEC Form 10-Q (June 1990), File No. 2-30057).\n10.1.33 Phase II Equity Funding Agreement for New England Hydro- Transmission Electric Company, Inc. (New England Hydro) (Massachusetts), dated June 1, 1985, between New England Hydro and certain NEPOOL utilities (Exhibit 2 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.34 Phase II Massachusetts Transmission Facilities Support Agreement dated June 1, 1985, refiled as a single agreement incorporating Amendments 1 through 7 dated May 1, 1986 through January 1, 1989, respectively, between New England Hydro and certain NEPOOL utilities (Exhibit 2 to the CEC Form 10-Q (September 1990), File No. 2-30057).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.35 Phase II New Hampshire Transmission Facilities Support Agreement dated June 1, 1985, refiled as a single agreement incorporating Amendments 1 through 8 dated May 1, 1986 through January 1, 1990, respectively, between New England Hydro-Transmission Corporation (New Hampshire Hydro) and certain NEPOOL utilities (Exhibit 3 to the CEC Form 10-Q (September 1990), File No. 2-30057).\n10.1.36 Phase II Equity Funding Agreement for New Hampshire Hydro, dated June 1, 1985, between New Hampshire Hydro and certain NEPOOL utilities (Exhibit 3 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.36.1 Amendment No. 1 to 10.1.36 dated May 1, 1986 (Exhibit 6 to the CEC Form 10-Q (March 1987), File No. 2-30057).\n10.1.36.2 Amendment No. 2 to 10.1.36 as amended September 1, 1987 (Exhibit 3 to the CEC Form 10-Q (September 1987), File No. 2-30057).\n10.1.37 Phase II New England Power AC Facilities Support Agreement, dated June 1, 1985, between NEP and certain NEPOOL utilities (Exhibit 6 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.37.1 Amendments Nos. 1 and 2 to 10.1.37 as amended May 1, 1986 and February 1, 1987, respectively (Exhibit 5 to the CEC Form 10-Q (March 1987), File No. 2-30057).\n10.1.37.2 Amendments Nos. 3 and 4 to 10.1.37 as amended June 1, 1987 and September 1, 1987, respectively (Exhibit 5 to the CEC Form 10-Q (September 1987), File No. 2-30057).\n10.1.38 Phase II Boston Edison AC Facilities Support Agreement, dated June 1, 1985, between BECO and certain NEPOOL utilities (Exhibit 7 to the CEC Form 10-Q (September 1985), File No. 2-30057).\n10.1.38.1 Amendments Nos. 1 and 2 to 10.1.38 as amended May 1, 1986 and February 1, 1987, respectively (Exhibit 2 to the CEC Form 10-Q (March 1987), File No. 2-30057).\n10.1.38.2 Amendments Nos. 3 and 4 to 10.1.38 as amended June 1, 1987 and September 1, 1987, respectively (Exhibit 4 to the CEC Form 10-Q (September 1987), File No. 2-30057).\n10.1.39 Agreement Authorizing Execution of Phase II Firm Energy Contract, dated September 1, 1985, among certain NEPOOL utilities in regard to participation in the purchase of power from Hydro-Quebec (Exhibit 8 to the CEC Form 10-Q (September 1985), File No. 2- 30057).\n10.1.40 System Power Sales Agreement by and between CE, as seller, and Central Vermont Public Service Corporation (CVPS), as buyer, dated September 15, 1984 (Exhibit 2 to the CE Form 10-Q (September 1984), File No. 2-7749).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.40.1 System Sales Agreement by CVPS, as seller, and CE, as buyer, dated September 15, 1984 (Exhibit 9 to the CE 1984 Form 10-K, File No. 2- 7749).\n10.1.40.2 System Sales and Exchange Agreement by and between CVPS and CE on energy transactions, dated September 15, 1984 (Exhibit 10 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.40.3 System Exchange Agreement by and between CE and CVPS for the exchange of capacity and associated energy, dated September 3, 1985 (Exhibit 1 to the CE 1985 Form 10-K, File No. 2-7749).\n10.1.40.4 Purchase Agreement by and between CEC and CVPS for the purchase of capacity from CEC for the term March 1, 1991 to October 31, 1995, dated March 1, 1991 (Exhibit 1 to CEC Form 10-Q (June 1991), File No. 2-30057).\n10.1.40.5 Power Sale Agreement by and between CEC and CVPS for the purchase of 50 MW of capacity from CVPS's units (25 MW from Vermont Yankee and 25 MW from Merrimack 2) for the term of March 1, 1991 to October 31, 1995, dated March 1, 1991 (Exhibit 2 to CEC Form 10-Q (June 1991), File No. 2-30057).\n10.1.41 Agreements by and between Swift River Company and CE for the purchase of available hydro-electric energy to be produced by units located in Chicopee and North Willbraham, Massachusetts, both dated September 1, 1983 (Exhibits 11 and 12 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.41.1 Transmission Service Agreement between Northeast Utilities' companies (NU) - The Connecticut Light and Power Company (CL&P) and Western Massachusetts Electric Company (WMECO), and CE for NU companies to transmit power purchased from Swift River Company's Chicopee Units to CE, dated October 1, 1984 (Exhibit 14 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.41.2 Transformation Agreement between WMECO and CE whereby WMECO is to transform power to CE from the Chicopee Units, dated December 1, 1984 (Exhibit 15 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.42 System Power Sales Agreement by and between CL&P and WMECO, as buyers, and CE, as seller, dated January 13, 1984 (Exhibit 13 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.43 System Power Sales Agreement by and between CL&P, WMECO, as sellers, and CEL, as buyer, of power in excess of firm power customer requirements from the electric systems of the NU Companies, dated June 1, 1984, as effective October 25, 1985 (Exhibit 1 to CEL 1985 Form 10-K, File No. 2-7909).\n10.1.44 Power Purchase Agreement with Respect to South Meadow Unit Nos. 11, 12, 13, and 14 of the NU system company of CL&P (seller) and CE (buyer), dated November 1, 1985 (Exhibit 1 to the CE Form 10-Q (June 1986), File No. 2-7749).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.45 Power Purchase Agreement by and between SEMASS Partnership, as seller, to construct, operate and own a solid waste disposal facility at its site in Rochester, Massachusetts and CE, as buyer of electric energy and capacity, dated September 8, 1981 (Exhibit 17 to the CE 1984 Form 10-K, File No. 2-7749).\n10.1.45.1 Power Sales Agreement to 10.1.45 for all capacity and related energy produced, dated October 31, 1985 (Exhibit 2 to the CE 1985 Form 10-K, File No. 2-7749).\n10.1.45.2 Amendment to 10.1.45 for all additional electric capacity and related energy to be produced by an addition to the Original Unit, dated March 14, 1990 (Exhibit 1 to the CE Form 10-Q (June 1990), File No. 2-7749).\n10.1.45.3 Amendment to 10.1.45 for all additional electric capacity and related energy to be produced by an addition to the Original Unit, dated May 24, 1991 (Exhibit 1 to CE Form 10-Q (June 1991), File No. 2-7749).\n10.1.46 System Power Sales Agreement by and between CE (seller) and NEP (buyer), dated January 6, 1984 (Exhibit 1 to the CE Form 10-Q (June 1985), File No. 2-7749).\n10.1.47 Service Agreement by and between CE and NEP dated March 24, 1984, whereas CE agrees to purchase short-term power applicable to NEP'S FERC Electric Tariff Number 5 (Exhibit 1 to the CE Form 10-Q (June 1987), File No. 2-7749).\n10.1.48 Power Sale Agreement by and between CE (buyer) and Northeast Energy Associated, Ltd. (NEA) (seller) of electric energy and capacity, dated November 26, 1986 (Exhibit 1 to the CE Form 10-Q (March 1987), File No. 2-7749).\n10.1.48.1 First Amendment to 10.1.48 as amended August 15, 1988 (Exhibit 1 to the CE Form 10-Q (September 1988), File No. 2-7749).\n10.1.48.2 Second Amendment to 10.1.48 as amended January 1, 1989 (Exhibit 2 to the CE 1988 Form 10-K, File No. 2-7749).\n10.1.48.3 Power Sale Agreement dated August 15, 1988 between NEA and CE for the purchase of 21 MW of electricity (Exhibit 2 to the CE Form 10-Q (September 1988), File No. 2-7749).\n10.1.48.4 Amendment to 10.1.48.3 as amended January 1, 1989 (Exhibit 3 to the CE 1988 Form 10-K, File No. 2-7749).\n10.1.49 Exchange of Power Agreement between Montaup Electric Company and CE dated January 17, 1991 (Exhibit 2 to CE Form 10-Q (September 1991) File No. 2-7749).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.49.1 First Amendment, dated November 24, 1992, to Exchange of Power Agreement between Montaup Electric Company and Commonwealth Electric Company (CE) dated January 17, 1991 (Exhibit 1 to CE Form 10-Q (March 1993) File No. 2-7749).\n10.1.50 System Power Exchange Agreement by and between Commonwealth Electric Company (CE) and New England Power Company dated January 16, 1992 (Exhibit 1 to CE Form 10-Q (March 1992), File No. 2-7749).\n10.1.50.1 First Amendment, dated September 8, 1992, to System Power Exchange Agreement by and between Commonwealth Electric Company (CE) and New England Power Company dated January 16, 1992 (Exhibit 1 to CE Form 10-Q (September 1992), File No. 2-7749).\n10.1.50.2 Second Amendment, dated March 2, 1993, to System Power Exchange Agreement by and between CE and New England Power Company (NEP) dated January 16, 1992 (Exhibit 2 to CE Form 10-Q (March 1993) File No. 2-7749).\n10.1.51 Power Purchase Agreement and First Amendment, dated September 5, 1989 and August 3, 1990, respectively, by and between Commonwealth Electric (CE) (buyer) and Dartmouth Power Associates Limited Partnership (seller), whereby buyer will purchase all of the energy (67.6 MW) produced by a single gas turbine unit (Exhibit 1 to the CE Form 10-Q (June 1992), File No. 2-7749).\n10.1.52 Power Exchange Contract, dated March 24, 1993, between NEP and Canal Electric Company (Canal) for an exchange of unit capacity in which NEP will purchase 20 MW of Canal Unit 2 capacity in exchange for Canal's purchase of 20 MW of NEP's Bear Swamp Units 1 and 2 (10 MW per unit) commencing May 31, 1993 through April 28, 1997 and NEP will purchase 50 MW of Canal's Unit 2 capacity in exchange for Canal's purchase of 50 MW of NEP's Bear Swamp Units 1 and 2 (25 MW per unit) commencing November 1, 1993 through April 28, 1997 (Exhibit 1 to Canal's Form 10-Q (March 1993) File No. 2-30057).\n10.1.53 Power Purchase Agreement by and between Masspower (seller) and Com- monwealth Electric Company (buyer) for a 11.11% entitlement to the electric capacity and related energy of a 240 MW gas-fired cogen- eration facility, dated February 14, 1992 (Exhibit 1 to Common- wealth Electric's Form 10-Q (September 1993), File No. 2-7749).\n10.1.54 Power Sale Agreement by and between Altresco Pittsfield, L.P. (seller) and Commonwealth Electric Company (buyer) for a 17.2% entitlement to the electric capacity and related energy of a 160 MW gas-fired cogeneration facility, dated February 20, 1992 (Exhibit 2 to Commonwealth Electric's Form 10-Q (September 1993), File No. 2- 7749).\n10.1.54.1 System Exchange Agreement by and among Altresco Pittsfield, L.P., Cambridge Electric Light Company, Commonwealth Electric Company and New England Power Company, dated July 2, 1993 (Exhibit 3 to Commonwealth Electric's Form 10-Q (September 1993), File No 2- 7749).\nCOMMONWEALTH ENERGY SYSTEM\n10.1.54.2 Power Sale Agreement by and between Altresco Pittsfield, L. P. (seller) and Cambridge Electric Light Company (Cambridge Electric) (buyer) for a 17.2% entitlement to the electric capacity and related energy of a 160 MW gas-fired cogeneration facility, dated February 20, 1992 (Exhibit 1 to Cambridge Electric's Form 10-Q (September 1993), File No. 2-7909).\n10.2 Natural gas purchase contracts.\n10.2.2 Service Agreement Applicable to Rate Schedule between AGT and CG for Firm natural gas services, dated January 28, 1981 (Exhibit 1 to the CG Form 10-Q (March 1987), File No. 2-1647).\n10.2.3 Service Agreement Applicable to Rate Schedule between AGT and CG for the purchase of certain quantities of natural gas acquired by AGT from CGS, dated April 11, 1985 (Exhibit 2 to the CG Form 10- Q (March 1987), File No. 2-1647).\n10.2.4 Service Agreement Applicable to Rate Schedule between AGT and CG for the purchase of certain quantities of natural gas acquired by AGT from National Fuel Gas Supply Corporation, dated April 11, 1985 (Exhibit 3 to the CG Form 10-Q (March 1987), File No. 1-1647).\n10.2.5 Service Agreement Applicable to Rate Schedule between AGT and CG for the purchase of certain quantities of natural gas acquired by AGT from Texas Eastern Transmission Company, dated December 26, 1985 (Exhibit 4 to the CG Form 10-Q (March 1987), File No. 2-1647).\n10.2.6 Gas Service Contract between HOPCO and NBGEL for the performance of liquefaction, storage and vaporization service and the operation and maintenance of an LNG facility located at Acushnet, MA dated September 1, 1971 (Exhibit 8 to the CG 1984 Form 10-K, File No. 2- 1647).\n10.2.6.1 Gas Service Contract between HOPCO and CG for the performance of liquefaction, storage and vaporization services and the operation of LNG facilities located in Hopkinton, MA dated September 1, 1971 (Exhibit 9 to the CG 1984 Form 10-K, File No. 2-1647).\n10.2.6.2 Amendments to 10.2.6 and 10.2.6.1 as amended December 1, 1976 (Exhibits 2 and 3 to the CG 1986 Form 10-K, File No. 2-1647).\n10.2.6.3 Supplement 1 to Gas Service Contract between HOPCO and NBGEL dated September 1, 1973 and September 14, 1977 (Exhibit 5(c)5 to the CES Form S-16 (June 1979), File No. 2-64731).\n10.2.6.4 Supplement 1 to 10.2.6.1 dated September 14, 1977 (Exhibit 5(c)6 to the CG Form S-16 (June 1979), File No. 2-64731).\n10.2.6.5 Supplement 2 to 10.2.6.1 dated September 30, 1982 (Refiled as Exhibit 2 to the CG 1992 Form 10-K, File No. 2-1647).\nCOMMONWEALTH ENERGY SYSTEM\n10.2.6.6 1986 Consolidating Supplement to CG Service Contract and NBGEL Service Contract by and between CG and HOPCO dated December 31, 1986 amending and consolidating the CG Service Contract and the NBGEL Service Contract both as amended December 1, 1976 and supplemented September 14, 1977 (Exhibit 2 to CG Form 10-Q (March 1988), File No. 2-1647).\n10.2.7 Operating Agreement between Air Products and Chemicals, Inc., (APC) and HOPCO, dated as of September 1, 1971, as supplemented by Supplements No. 1, No. 2 and No. 3 dated as of July 1, 1974, August 1, 1975 and January 1, 1985, respectively, with respect to the operation and maintenance by APC of HOPCO's liquefied natural gas facilities located at Hopkinton, MA (Exhibit 11 to the CES 1984 Form 10-K, File No. 1-7316).\n10.2.7.1 Engineering and Prime Contracting Agreement between APC and HOPCO for performance of engineering services and capital project construction at LNG facility in Hopkinton, MA (Exhibit 12 to the CES 1984 Form 10-K, File No. 1-7316).\n10.2.8 Firm Storage Service Transportation Contract by and between TGP and CG providing for firm transportation of natural gas from CGT, dated December 15, 1985 (Exhibit 1 to the CG 1985 Form 10-K, File No. 2- 1647).\n10.2.9 Agency Agreement for Certain Transportation Arrangements by and between CG and Citizens Resources Corporation (CRC) whereby CRC arranges for a third party transportation of natural gas acquired by CG, dated April 14, 1986 (Exhibit 1 to the CG Form 10-Q (June 1986), File No. 2-1647).\n10.2.9.1 Natural Gas Sales Agreement between CG and CRC, dated April 14, 1986 (Exhibit 2 to CG Form 10-Q (June 1986), File No. 2-1647).\n10.2.10 Gas Sales Agreement by and between Enron Gas Marketing, Inc. and CG relating to the sale and purchase of natural gas on an interruptible basis, dated June 17, 1986 (Exhibit 3 to the CG Form 10-Q (June 1986), File No. 2-1647).\n10.2.11 Agency Agreement for Certain Transportation Arrangements, dated June 18, 1985 and Gas Purchase and Sales Agreement dated August 6, 1985 by and between CG and Tenngasco Corporation and other related entities (Exhibit 4 to the CG Form 10-Q (June 1986), File No. 2-1647).\n10.2.12 Service Agreement dated December 14, 1985 and an amendment thereto dated May 15, 1986 by and between Texas Eastern Transmission Corporation (TET) and CG to receive, transport and deliver to points of delivery natural gas for the account of CG, dated December 14, 1985 (Exhibit 5 to the CG Form 10-Q (June 1986), File No. 2-1647).\nCOMMONWEALTH ENERGY SYSTEM\n10.2.13 Gas Transportation Agreement by and between TET and CG to receive, transport and deliver on an interruptible basis, certain quantities of natural gas for the account of CG, dated January 31, 1986 (Exhibit 6 to the CG Form 10-Q (June 1986), File No. 2-1647).\n10.2.14 Service Agreement dated May 19, 1988, by and between TET and CG, whereby TET agrees to receive, transport and deliver natural gas to CG (Exhibit 1 to the CG Form 10-Q (September 1988), File No. 2- 1647).\n10.2.15 Gas Sales Agreement by and between Texas Eastern Gas Trading Company and CG providing for the sale of certain quantities of natural gas to CG, dated May 15, 1986 (Exhibit 7 to the CG Form 10- Q (June 1986), File No. 2-1647).\n10.2.16 Service Agreement applicable to Rate Schedule TS-3 between TET and CG for Firm natural gas service, dated April 16, 1987 (Exhibit 1 to the CG Form 10-Q (June 1987), File No. 2-1647).\n10.2.17 Natural Gas Sales Agreement between Summit Pipeline and Producing Company and CG, dated April 16, 1987 (Exhibit 2 to the CG Form 10-Q (June 1987), File No. 2-1647).\n10.2.18 Natural Gas Sales Agreement between Natural Gas Supply Company and CG, dated May 12, 1987 (Exhibit 3 to the CG Form 10-Q (June 1987), File No. 2-1647).\n10.2.19 Natural Gas Sales Agreement between Stellar Gas Company and CG, dated April 15, 1988 (Exhibit 1 to the CG Form 10-Q (March 1988), File No. 2-1647).\n10.2.20 Natural Gas Sales Agreement between Amalgamated Gas Pipeline Company and CG dated April 5, 1988 (Exhibit 1 to the CG Form 10-Q (June 1988), File No. 2-1647).\n10.2.21 Natural Gas Sales Agreement between Gulf Ohio Pipeline Corporation and CG dated May 18, 1988 (Exhibit 2 to the CG Form 10-Q (June 1988), File No. 2-1647).\n10.2.22 Natural Gas Sales Agreement between Phillips Petroleum Company and CG dated May 18, 1988 (Exhibit 3 to the CG Form 10-Q (June 1988), File No. 2-1647).\n10.2.23 Natural Gas Sales Agreement between TXO Gas Marketing Corp. and CG dated April 25, 1988 (Exhibit 1 to the CG 1988 Form 10-K, File No. 2-1647).\n10.2.24 Gas Transportation Agreement by and between AGT and CG to receive, transport and deliver certain quantities of natural gas on a firm basis for the account of CG dated December 1, 1988 (Exhibit 2 to the CG 1988 Form 10-K, File No. 2-1647).\nCOMMONWEALTH ENERGY SYSTEM\n10.2.25 Natural Gas Sales Agreement between Enermark Gas Gathering Corporation and CG dated January 6, 1989 (Exhibit 3 to the CG 1988 Form 10-K, File No. 2-1647).\n10.2.26 Gas Sales Agreement between BP Gas Inc. (seller) and CG (purchaser) for the purchase of spot market gas, dated March 31, 1989 with a contract term of at least one year (Exhibit 1 to the CG Form 10-Q (March 1989), File No. 2-1647).\n10.2.27 Gas Sales Agreement between Tejas Power Corporation (seller) and CG (purchaser) for the purchase of spot market gas, dated February 21, 1989 with a contract term of at least one year (Exhibit 2 to the CG Form 10-Q (March 1989), File No. 2-1647).\n10.2.28 Gas Sales Agreement between Catamount Natural Gas, Inc. (seller) and CG (purchaser) for the purchase of spot market gas, dated April 5, 1988, with a contract term of at least one year (Exhibit 1 to the CG Form 10-Q (June 1989), File No. 2-1647).\n10.2.29 Gas Sales Agreement between Transco Energy Marketing Company (seller) and CG (purchaser) for the purchase of spot market gas, dated March 1, 1989, with a contract term of at least one year (Exhibit 2 to the CG Form 10-Q (June 1989), File No. 2-1647).\n10.2.30 Gas Sales Agreement between V.H.C. Gas Systems, L.P. (seller) and CG (purchaser) for the purchase of spot market gas, dated June 2, 1989, with a contract term of at least one year (Exhibit 3 to the CG Form 10-Q (June 1989), File No. 2-1647).\n10.2.31 Gas Sales Agreement between End-Users Supply System (seller) and CG (purchaser) for the purchase of spot market gas, dated June 29, 1989, with a contract term of at least one year (Exhibit 1 to the CG Form 10-Q (September 1989), File No. 2-1647).\n10.2.32 Gas Sales Agreement between Entrade Corporation (seller) and CG (purchaser) for the purchase of spot market gas, dated August 14, 1989, with a contract term of at least one year (Exhibit 2 to the CG Form 10-Q (September 1989), File No. 2-1647).\n10.2.33 Gas Sales Agreement between Fina Oil and Chemical Company (seller) and CG (purchaser) for the purchase of spot market gas, dated July 10, 1989, with a contract term of at least one year (Exhibit 3 to the CG Form 10-Q (September 1989), File No. 2-1647).\n10.2.34 Gas Sales Agreement between Mobil Natural Gas Inc. (seller) and CG (purchaser) for the purchase of spot market gas, dated August 14, 1989, with a contract term of at least one year (Exhibit 4 to the CG Form 10-Q (September 1989), File No. 2-1647).\n10.2.35 Gas Storage Agreement between Steuben Gas Storage Company (Steuben) and CG (customer) for the storage and delivery of customer's natural gas to and from underground gas storage facilities, dated May 23, 1989, with a contract term of at least one year (Exhibit 4 to the CG Form 10-Q (June 1989), File No. 2-1647).\nCOMMONWEALTH ENERGY SYSTEM\n10.2.35.1 Amendment, dated August 28, 1989, to 10.2.35 dated May 23, 1989 (Exhibit 5 to the CG Form 10-Q (September 1989), File No. 2-1647).\n10.2.36 Gas Sales Agreement between PSI, Inc. (seller) and CG (purchaser) for the purchase of spot market gas, dated September 25. 1989, with a term of at least one year (Exhibit 1 to the CG 1989 Form 10-K, File No. 2-1647).\n10.2.37 Gas Sales Agreement between Hadson Gas Systems (seller) and CG (purchaser) for the purchase of firm gas, dated August 15, 1990, with a contract term of at least six years (Exhibit 1 to the CG Form 10-Q (September 1990), File No. 2-1647).\n10.2.38 Gas Sales Agreement between Odeco Oil Company (seller) and CG (purchaser) for the purchase of firm gas, dated August 15, 1990, with a contract term of at least five years (Exhibit 2 to the CG Form 10-Q (September 1990), File No. 2-1647).\n10.2.39 Operating Agreement between AGT, CG and Distrigas of Massachusetts Corporation in connection with the deliveries of regasified liquified natural gas into the Algonquin J-system, dated August 1, 1990 (Exhibit 3 to the CG Form 10-Q (September 1990), File No.2- 1647).\n10.2.40 Gas Sales Agreement between TEX\/CON Marketing Gas Company (seller) and CG (purchaser) for the purchase of firm gas, dated September 12, 1990, with a contract term of five years (Exhibit 3 to the CG 1990 Form 10-K, File No. 2-1647).\n10.2.41 Transportation Agreement between AGT and CG to provide for firm transportation of natural gas on a daily basis, dated December 1, 1988 (Exhibit 3 to the CG 1991 Form 10-K, File No. 2-1647).\n10.2.42 Transportation Assignment Agreement between AGT and CG regarding Rate Schedule ATAP Agreement No. 9020016 which provides for the assignment, on an interruptible basis, of firm service rights on TET's system under Rate Schedule FT-1, dated January 3, 1990, for a term ending October 31, 1999 (Exhibit 4 to the CG 1991 Form 10-K, File No. 2-1647).\n10.2.43 Gas Sales Agreement between AFT and CG to reduce the volume of Rate Schedule, dated October 15, 1990 (Exhibit 5 to the CG 1991 Form 10-K, File No. 2-1647).\n10.2.44 Transportation Agreement between AFT and CG for Rate Schedule AFT- 1, dated November 1, Agreement No. 90103, 1990 (Exhibit 6 to the CG 1991 Form 10-K, File No. 2-1647).\n10.2.45 Transportation Assignment Agreement between AFT and CG regarding Rate Schedule ATAP Agreement No. 90202, which provides for the assignment, on a firm basis, of firm service rights on TET's system under Rate Schedule FT-1 dated November 1, 1990 (Exhibit 7 to the CG 1991 Form 10-K, File No. 2-1647).\nCOMMONWEALTH ENERGY SYSTEM\n10.2.46 Gas Sales Agreement between TGP and CG under TGP's CD-6 Rate Schedules dated September 1, 1991 (Exhibit 8 to the CG 1991 Form 10-K, File No. 2-1647).\n10.2.47 Transportation Agreement between TGP and CG dated September 1, 1991 (Exhibit 9 to the CG 1991 Form 10-K, File No. 2-1647).\n10.2.48 Transportation Agreement between CNG and CG to provide for transportation of natural gas on a daily basis from Steuben Gas Storage Company to TGP (Exhibit 10 to the CG 1991 Form 10-K, File No. 2-1647).\n10.2.49 Service Line Agreement by and between Commonwealth Gas Company (CG) and Milford Power Limited Partnership dated March 12, 1992 for a term ending January 1, 2013. (Exhibit 1 to the CG Form 10-Q (March 1992), File No. 2-1647.\n10.3 Other agreements.\n10.3.1 Pension Plan for Employees of Commonwealth Energy System and Subsidiary Companies as amended and restated January 1, 1993 (Exhibit 1 to CES Form 10-Q (September 1993), File No. 1-7316).\n10.3.2 Employees Savings Plan of Commonwealth Energy System and Subsid- iary Companies as amended and restated January 1, 1993.(Exhibit 2 to CES Form 10-Q (September 1993), File No. 1-7316).\n10.3.2.1 First Amendment to the Employees Savings Plan of Commonwealth Energy System and Subsidiary Companies, as amended and restated as of January 1, 1993, effective October 1, 1994. (Exhibit 1 to CES Form S-8 (January 1995), File No. 1-7316).\n10.3.3 New England Power Pool Agreement (NEPOOL) dated September 1, 1971 as amended through August 1, 1977, between NEGEA Service Corporation, as agent for CEL, CEC, NBGEL, and various other electric utilities operating in New England together with amendments dated August 15, 1978, January 31, 1979 and February 1, 1980. (Exhibit 5(c)13 to New England Gas and Electric Association's Form S-16 (April 1980), File No. 2-64731).\n10.3.3.1 Thirteenth Amendment to 10.3.3 as amended September 1, 1981 (Refiled as Exhibit 3 to the System's 1991 Form 10-K, File No. 1-7316).\n10.3.3.2 Fourteenth through Twentieth Amendments to 10.3.3 as amended December 1, 1981, June 1, 1982, June 15, 1983, October 1, 1983, August 1, 1985, August 15, 1985 and September 1, 1985, respectively (Exhibit 4 to the CES Form 10-Q (September 1985), File No. 1-7316).\n10.3.3.3 Twenty-first Amendment to 10.3.3 as amended to January 1, 1986 (Exhibit 1 to the CES Form 10-Q (March 1986), File No. 1-7316).\n10.3.3.4 Twenty-second Amendment to 10.3.3 as amended to September 1, 1986 (Exhibit 1 to the CES Form 10-Q (September 1986), File No. 1-7316).\nCOMMONWEALTH ENERGY SYSTEM\n10.3.3.5 Twenty-third Amendment to 10.3.3 as amended to April 30, 1987 (Exhibit 1 to the CES Form 10-Q (June 1987), File No. 1-7316).\n10.3.3.6 Twenty-fourth Amendment to 10.3.3 as amended March 1, 1988 (Exhibit 1 to the CES Form 10-Q (March 1989), File No. 1-7316).\n10.3.3.7 Twenty-fifth Amendment to 10.3.3. as amended to May 1, 1988 (Exhibit 1 to the CES Form 10-Q (March 1988), File No. 1-7316).\n10.3.3.8 Twenty-sixth Agreement to 10.3.3 as amended March 15, 1989 (Exhibit 1 to the CES Form 10-Q (March 1989), File No. 1-7316).\n10.3.3.9 Twenty-seventh Agreement to 10.3.3 as amended October 1, 1990 (Exhibit 3 to the CES 1990 Form 10-K, File No. 1-7316)\n10.3.3.10 Twenty-eighth Agreement to 10.3.3 as amended September 15, 1992 (Exhibit 1 to the CES Form 10-Q (September 1994), File No. 1-7316)\n10.3.3.11 Twenty-ninth Agreement to 10.3.3 as amended May 1, 1993 (Exhibit 2 to the CES Form 10-Q (September 1994), File No. 1-7316)\n10.3.4 Fuel Supply, Facilities Lease and Operating Contract by and between, on the one side, ESCO (Massachusetts), Inc. and Energy Supply and Credit Corporation, and on the other side, CEC, dated as of February 1, 1985 (Exhibit 1 to the CEC 1984 Form 10-K, File No. 2-30057\n10.3.4.1 Amendments Nos. 1 and 2 to 10.3.5 as amended July 1, 1986 and November 15, 1989, respectively (Exhibit 3 to the CEC 1989 Form 10- K, File No. 2-30057).\n10.3.5 Assignment and Sublease Agreement and Canal's Consent of Assignment thereto whereby ESCO-Mass assigns its rights and obligations under Part II of the Resupply Agreement dated February 1, 1985 to ESCO Terminals Inc., dated June 4, 1985 (Exhibit 4 to CEC Form 10-Q (June 1985), File No. 2-30057).\n10.3.6 Oil Supply Contract by and between CEC (buyer) and Coastal Oil New England, Inc. (seller) for a portion of CEC's requirements of No. 6 residual fuel oil, dated July 1, 1991 (Exhibit 3 to CEC Form 10-Q (June 1991), File No. 2-30057).\n10.3.6.1 Assignment Agreement between CEC and ESCO (Massachusetts), Inc. (ESCO-Mass) and Energy Supply and Credit Corporation whereby CEC assigns to ESCO-Mass rights and obligations under 10.3.7 (above) dated July 1, 1991 (Exhibit 4 to CEC Form 10-Q (June 1991), File No. 2-30057).\n10.3.7 Guarantee Agreement by CEL (as guarantor) and MYA Fuel Company (as initial lender) covering the unconditional guarantee of a portion of the payment obligations of Maine Yankee Atomic Power Company under a loan agreement and note initially between Maine Yankee and MYA Fuel Company (Exhibit 3 to the CEL Form 10-K for 1985, File No. 2-7909).\nCOMMONWEALTH ENERGY SYSTEM\n10.3.8 Stock Purchase Agreement by and among Texas Eastern Corporation (purchaser) and Eastern Gas and Fuel Associates, Commonwealth Energy System and Providence Energy Corporation (sellers) for the purchase and sale of ownership interests in Algonquin Energy, Inc., dated June 10, 1986 (Exhibit 1 to the CEC Form 10-Q (June 1986), File No. 1-7316).\nExhibit 21. Subsidiaries of the Registrant\nIncorporated by reference to Exhibit 2 (page 101) to the System's 1988 Annual Report on Form 10-K, File No. 1-7316.\nExhibit 22. Published Report Regarding Matters Submitted to Vote of Security Holders.\nFiled herewith as Exhibit 1 is the Notice of 1995 Annual Meeting, Proxy Statement and 1994 Financial Information dated March 31, 1995.\nExhibit 27. Financial Data Schedule\nFiled herewith as Exhibit 2 is the Financial Data Schedule for the twelve months ended December 31, 1994.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the three months ended December 31, 1994.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Commonwealth Energy System:\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements of Commonwealth Energy System appearing in Exhibit A to the proxy statement for the 1995 annual meeting of shareholders, incorporated by reference in this Form 10-K, and have issued our report thereon dated February 21, 1995. Our audits were made for the purpose of forming an opinion on those consolidated financial statements taken as a whole. The schedules listed in Part IV, Item 14 of this Form 10-K 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.\nARTHUR ANDERSEN LLP Arthur Andersen LLP\nBoston, Massachusetts February 21, 1995\nSCHEDULE II\nCOMMONWEALTH ENERGY SYSTEM AND SUBSIDIARY COMPANIES\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(Dollars in Thousands)\nAdditions Balance at Provision Deductions Balance Beginning Charged to Accounts at End Description of Year Operations Recoveries Written Off of Year\nYear Ended December 31, 1994\nAllowance for Doubtful Accounts $7 761 $ 9 396 $2 138 $11 339 $7 956\nYear Ended December 31, 1993\nAllowance for Doubtful Accounts $6 861 $ 9 468 $2 142 $10 710 $7 761\nYear Ended December 31, 1992\nAllowance for Doubtful Accounts $5 233 $12 082 $1 918 $12 372 $6 861\nCOMMONWEALTH ENERGY SYSTEM\nFORM 10-K DECEMBER 31, 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.\nCOMMONWEALTH ENERGY SYSTEM (Registrant)\nBy: WILLIAM G. POIST William G. Poist, 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.\nPrincipal Executive Officer:\nWILLIAM G. POIST March 23, 1995 William G. Poist, President and Chief Executive Officer\nPrincipal Financial Officer:\nJAMES D. RAPPOLI March 23, 1995 James D. Rappoli, Financial Vice President and Treasurer\nPrincipal Accounting Officer:\nJOHN A. WHALEN March 23, 1995 John A. Whalen, Comptroller\nA majority of the Board of Trustees:\nSINCLAIR WEEKS, JR. March 23, 1995 Sinclair Weeks, Jr., Chairman of the Board\nSHELDON A. BUCKLER March 23, 1995 Sheldon A. Buckler, Trustee\nPETER H. CRESSY March 23, 1995 Peter H. Cressy, Trustee\nHENRY DORMITZER March 23, 1995 Henry Dormitzer, Trustee\nCOMMONWEALTH ENERGY SYSTEM\nFORM 10-K DECEMBER 31, 1994\nSIGNATURES (Continued)\nB. L. FRANCIS March 23, 1995 Betty L. Francis, Trustee\nFRANKLIN M. HUNDLEY March 23, 1995 Franklin M. Hundley, Trustee\nWILLIAM J. O'BRIEN, March 23, 1995 William J. O'Brien, Trustee\nWILLIAM G. POIST March 23, 1995 William G. Poist, Trustee\nMarch , 1995 Gerald L. Wilson, Trustee\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation by reference in this Form 10-K of our report dated February 21, 1995 included in Exhibit A to the proxy statement for the 1995 annual meeting of shareholders and the incorporation of our reports included and incorporated by reference in this Form 10-K into the System's previously filed Registration Statements on Form S-8 File No. 33-57467 and on Form S-3 File No. 33-55593. It should be noted that we have not audited any financial statements of the System subsequent to December 31, 1994 or performed any audit procedures subsequent to the date of our report.\nARTHUR ANDERSEN LLP Arthur Andersen LLP\nBoston, Massachusetts March 30, 1995","section_15":""}
{"filename":"100726_1994.txt","cik":"100726","year":"1994","section_1":"ITEM 1. BUSINESS:\nUnifi, Inc., a New York corporation formed in 1969, together with its subsidiaries, hereinafter set forth, (the \"Company\" or \"Unifi\"), is engaged predominantly in the business of processing yarns by: texturing of synthetic filament polyester and nylon fiber; and spinning of cotton and cotton blend fibers.\nThe Company's texturing operation mainly involves purchasing partially oriented yarn (POY), which is either raw polyester or nylon filament fiber, from chemical manufacturers and using high speed machines to draw, heat and twist the POY to produce yarns having various physical characteristics, depending upon its ultimate end-use. The Company's spinning operation mainly involves the spinning on either open-end or ring equipment of cotton, cotton and undyed synthetic blends, and cotton and pre-dyed polyester blends into yarns of different strengths and thickness.\nThe Company currently sells textured polyester yarns, nylon yarns, dyed yarns, covered yarns, spun yarns made of cotton, cotton and un-dyed synthetic blends, and cotton and pre-dyed polyester blends domestically and internationally to weavers and knitters who produce fabrics for the apparel, industrial, hosiery, home furnishing, auto upholstery, activewear, and underwear markets.\nOn August 18, 1993, the Company concluded an agreement with the principals of Pioneer Yarn Mills, Inc., Pioneer Spinning, Inc., Edenton Cotton Mills, Inc., and Pioneer Cotton Mill, Inc., (the \"Pioneer Corporations\"), all of which are affiliated privately-held North Carolina corporations, where through a Triangular Merger, the Pioneer Corporations would merge into Unifi Spun Yarns, Inc., a wholly-owned subsidiary of Unifi (\"USY\"). The Pioneer Corporations' primary products included spun yarns made solely of cotton, although two of the Pioneer Corporations' plants have or will have the capability of adding synthetic blends.\nThe Company, internationally, has manufacturing facilities in Letterkenny, County Donegal, Republic of Ireland, which texturizes polyester, as well as producing its own polymer (POY).\nI-1\nSOURCES AND AVAILABILITY OF RAW MATERIALS:\nA. POY. The primary suppliers of POY to the Company are E. I. DuPont de Nemours and Company, Hoechst Celanese Corporation, and Wellman Industries, with the majority of the Company's POY being supplied by DuPont. Although the Company is heavily dependent upon a limited number of suppliers, the Company has not had and does not anticipate any material difficulty in obtaining its raw POY.\nB. Cotton. The Company buys its cotton, which is a commodity and is traded on established markets, from brokers such as Dunavant Enterprises, HoHenBerg Brothers Co., Staple Cotton, and Stahel (America). The Company has not had and does not anticipate any material difficulty in obtaining cotton.\nPATENTS AND LICENSES: The Company currently has several patents and registered trademarks, including the following:\nDATE ISSUED PATENT TITLE\/DESCRIPTION PAT\/APP. NO. OR APPLIED - - - --------------------------- ------------- ------------- Yarn Package Cover 080,654 06\/18\/93\nWallpaper Backing 1,317,705 (Canada) 05\/18\/93\nNylon\/Lycra Composit Yarn 5,237,808 08\/24\/93\nPolyester Substrate (Vinyl) 5,063,108 11\/05\/91\nPolyester Substrate (Vinyl) 5,043,208 08\/27\/91\nContinuous Multi-Filament 4,935,293 06\/19\/90 Polyester Substrate\nWallpaper Backing 4,925,726 05\/15\/90\nWallpaper Backing 4,874,019 10\/17\/89\nWallpaper Backing 325,028 07\/26\/89 (United Kingdom)\nFriction Discs For False- 4,129,980 12\/19\/78 Twist Head\nApparatus for Restarting 4,125,229 11\/14\/78 a Broken Thread or Yarn Strand During a Winding Process\nSafety Guard for the Blade 4,086,698 05\/02\/78 of Carton Openers\nI-2\nREGISTRATION\/ DATE REGISTRATION TRADEMARK NAME SERIAL NO. FILED - - - ----------------------- ------------- ---------------- Unifi 299,227 07\/28\/92 Quality Through Pride (Stylized)\nUnifi 261,913 04\/02\/92\nUnifi (Stylized) 261,912 04\/02\/92\nTrifi 1,703,349 07\/28\/92\nMactex 1,511,013 11\/01\/88\nBi-Dye 1,105,160 06\/19\/84\nThe Company does not have any patents, trademarks, licenses, or franchises which are material to its business as a whole.\nCUSTOMERS: The Company in fiscal year ended June 26, 1994, sold textured and spun yarns to approximately 1,000 customers, one customer's purchases were approximately 12% of the net sales during said period, the ten largest customers accounted for approximately 30% of the total sales and the Company does not believe that it is dependent on any one customer.\nBACKLOG: The Company, other than in connection with certain foreign sales and for textured yarns that are package dyed according to customers' specifications, does not manufacture to order. The Company's products can be used in many ways and can be thought of in terms of a commodity subject to the laws of supply and demand and, therefore, does not have what is considered a backlog of orders. In addition, the Company does not consider its products to be seasonal ones.\nI-3 COMPETITIVE CONDITIONS: The textile industry in which the Company currently operates is keenly competitive. The Company processes and sells high-volume commodity products, pricing is highly competitive with product quality and customer service being essential for differentiating the competitors within the industry. Product quality insures manufacturing efficiencies for the customer. The Company's polyester and nylon yarns, dyed yarns, covered yarns and cotton and cotton blend yarns compete with a number of other domestic producers of such yarns. In the sale of polyester filament yarns major competitors are Atlas Yarn Company, Inc., Burlington Industries, Inc. and Milliken & Company, in the sale of nylon yarns, dyed yarns, and covered yarns major competitors are Glen Raven Mills, Inc., Jefferson Mills, Inc., Spanco Yarns, Inc., Regal Manufacturing Company and Spectrum Dyed Yarns, Inc., and in the sale of cotton and cotton blend yarns major competitors are Parkdale Mills, Inc., Avondale Mills, Inc., Harriett & Henderson, Mayo Yarns, Inc. and TNS Mills, Inc..\nRESEARCH AND DEVELOPMENT: The estimated amount spent during each of the last three fiscal years on Company-sponsored and Customer-sponsored research and development activities is considered immaterial.\nCOMPLIANCE WITH CERTAIN GOVERNMENT REGULATIONS: Management of the Company believes that the operation of the Company's production facilities and the disposal of waste materials are substantially in compliance with applicable laws and regulations.\nEMPLOYEES: The number of employees of the Company is approximately 6,000 full-time employees.\nFINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC INTERNATIONAL OPERATIONS AND EXPORT SALES: The information included under the heading \"Business Segments and Foreign Operations\" on page 19 of the Annual Report of the Company to the Shareholders for the fiscal year ended June 26, 1994, is incorporated herein by reference. In addition, on September 9, 1994, the Company completed the sale of its wholly-owned French subsidiary, Unifi Texturing, S.A. (\"UTSA\") located in St. Juliene, France, to Continental Fibre, Spa.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. DESCRIPTION OF PROPERTY:\nThe following table sets forth the location and general character of the principal plants and other physical properties (properties) of the Company, which contain approximately 6,775,370 sq. ft. of floor space. All properties are well maintained and in good operating condition.\nI-4 APPROXIMATE LOCATION OF AREA FACILITY (SQUARE FEET) HOW HELD TYPE OF OPERATION - - - ------------------ ------------- --------- -------------------- Yadkinville, NC 1,831,000 Owned Texturizing of POY, ware- housing and office space\nGreensboro, NC 65,000 Leased (1) Executive offices\nStaunton, VA 424,000 Owned Texturizing of POY, ware- housing and office space\nLetterkenny, 488,000 Owned Production of filament County Donegal, polyester fiber, texturiz- Ireland ing facility, warehousing and office space\nArchdale, NC 122,000 Owned (2) Production of covered yarns and associated warehousing\n301 N. Hwy St. 160,000 Owned (2) Production of covered Madison, NC yarns and associated warehousing\nPiedmont Street 504,000 Owned (2) Texturizing of nylon Madison, NC and polyester, and associ- ated warehousing\n200 S Ayersville Rd. 79,000 Owned (2) Transportational Madison, NC Terminal\nDecatur Warehouse Madison, NC 31,000 Owned Nylon Warehouse\nAyersville Road 314,000 Owned (2) Plant 1 - Texturizing Mayodan, NC of nylon, associated ware- housing and office space\nAyersville Road 213,000 Owned (2) Plant 5 - Production Mayodan, NC of covered yarns and asso- ciated warehousing\nCardwell Road 130,000 Owned (2) Dyeing facility Mayodan, NC\nMayodan, NC 150,000 Owned Central Distribution CDC Center\nVance Street Ext. 485,000 Owned (2) Plants 2 & 4 - Textur- Reidsville, NC izing of polyester, dyeing and associated warehousing\nI-5 SR 770 East 230,000 Owned (2) Texturizing of nylon, Stoneville, NC production of covered yarn and associated warehousing\nDistribution Center 20,000 Owned (2) Distribution Center Fort Payne, AL and Office Space\nState Road 1366 151,000 Owned (3) Spun Cotton Yarn Pro- Booneville, NC duction and office space\nOakland Avenue 211,000 Owned (3) Spun Cotton Yarn Pro- Eden, NC duction and office space\nOakland Avenue 195,000 Owned (3) Spun Cotton Yarn Pro- Eden, NC duction and office space\nU.S. Route 311 214,000 Owned (3) Spun Cotton Yarn Pro- Walnut Cove, NC duction and office space\n400 West Franklin St. 172,000 Owned (3) Spun Cotton Yarn Pro- Mt. Pleasant, NC duction and office space\n420 Elliot 114,600 Owned (4) Spun Cotton Yarn Pro- Edenton, NC duction and office space\n2000 Boone Trail Road 137,850 Owned (4) Spun Cotton Yarn Pro- Sanford, NC duction and office space\n2000 Boone Trail Road 77,520 Owned (4) Spun Cotton Yarn Pro- Sanford, NC duction and office space\n1901 Boone Trail Road 245,200 Owned (4) Spun Cotton Yarn Pro- Sanford, NC duction and office space\n9480 Neuville Avenue 11,200 Owned Nylon covered yarn and Hickory, NC cotton warehouse\nI-6\nThe Company leases sales offices and apartments in New York City and Coleshill, England, and has a representative office in Tokyo, Japan.\n(1) This property consists of a building containing approximately 65,000 square feet which is being used by the Company as its executive offices and is located on a tract of land containing approximately 8.99 acres and is known as 7201 West Friendly Avenue, Greensboro, North Carolina. This property is leased by Unifi, Inc. from NationsBank, Trustee under the Unifi, Inc. Profit Sharing Plan and Trust, and Wachovia Bank & Trust Company, N.A., Independent Trustee. In September, 1991, the Company exercised its option to extend the term of the lease on this property for five (5) years, through March 13, 1997. Reference is made to a copy of the lease agreement attached to the Registrant's Annual Report on Form 10-K as Exhibit (10d) for the year ended June 28, 1987 and which is by reference incorporated herein.\n(2) Acquired pursuant to the merger of Macfield into Unifi on August 8, 1991.\n(3) Acquired pursuant to the Reverse Triangular Merger with USY (formerly Vintage Yarns, Inc.) on April 23, 1993.\n(4) Acquired pursuant to the Triangular Merger of the Pioneer Corporations into USY on August 18, 1993.\nThe information included under Leases, Contingencies and Commitments on page 19 of the Annual Report to Shareholders for fiscal year ended June 26, 1994, is incorporated herein by reference.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS:\nThe Company is not currently involved in any litigation which is considered as material, as that term is used in Item 103 of the Regulations S-K.\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 for the fiscal year ended June 26, 1994.\nI-7\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\n(a)(c) PRICE RANGE OF COMMON STOCK AND DIVIDENDS PAID.\nThe information included under the heading \"Market and Dividend Information\" on page 23 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 26, 1994, is incorporated herein by reference.\n(b) Approximate Number of Equity Security Holders:\nTitle of Class Number of Record Holders ----------------- ------------------------ (as of August 5, 1994) ------------------------ Common Stock, $.10 par value 1,524 --------- (c) CASH DIVIDEND POLICY. In April 1990, the Board of Directors of the Company adopted a resolution that it intended to pay a cash dividend in quarterly installments equal to approximately thirty percent (30%) of the earnings after taxes of the Company for the previous year, payable as hereafter declared by the Board of Directors. Prior to this action by the Board of Directors, the Company had since 1978 followed a policy of retaining earnings for working capital, acquisitions, capital expansion and modernization of existing facilities. The Company paid a quarterly dividend of $.14 per share on its common stock for each quarter of the 1994 fiscal year. The Board of Directors in July 1994, declared a cash dividend in the amount of $.10 per share on each issued and outstanding share of the common stock of the Company, payable on August 12, 1994, to shareholders of record at the close of business on August 5, 1994.\n(d) 6% CONVERTIBLE SUBORDINATED NOTES DUE MARCH 15, 2002. The information contained under the heading \"Notes Payable\/Long-Term Debt\", regarding the Convertible Subordinated Notes, on page 18 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 26, 1994, is incorporated herein by reference. For additional information regarding the 6% Convertible Subordinated Notes Due 2002 reference is made to Exhibit (4b) of this Form 10-K.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA:\nThe financial data for the five fiscal years included under the heading \"Summary of Selected Data\" on page 22 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 26, 1994, is incorporated herein by reference.\nII-1\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:\nThe information included under the heading \"Management's Review and Analysis of Operations and Financial Position\" on pages 20 and 21 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 26, 1994, is incorporated herein by reference. In addition, on September 9, 1994, the Company completed the sale of its wholly-owned French subsidiary, Unifi Texturing, S.A. (\"UTSA\") located in St. Juliene, France, to Continental Fibre, Spa.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:\nThe consolidated financial statements and notes beginning on page 19 and the information included under the heading \"Quarterly Results\" on page 22 of the Annual Report of Unifi, Inc. to its shareholders for the year ended June 26, 1994, are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE:\nThe Company has not changed accountants nor are there any disagreements with its accountants, Ernst & Young LLP, on accounting and financial disclosure that should be reported pursuant to Item 304 of the Regulation S-K.\nII-2\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT AND COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT:\n(A) DIRECTORS OF REGISTRANT: The information included under the headings \"Election of Directors\", \"Vote Required\", \"Security Holding of Directors, Nominees, And Executive Officers\", \"Directors Compensation\", and \"Committees of The Board of Directors\", beginning on page 2 and ending on page 6 of the definitive Proxy Statement filed with the Commission since the close of the Registrant's fiscal year ended June 26, 1994, and within 120 days after the close of said fiscal year, are incorporated herein by reference.\n(B) IDENTIFICATION OF EXECUTIVE OFFICERS:\nCHAIRMAN OF THE BOARD OF DIRECTORS\nG. ALLEN MEBANE Mr. Mebane is 65 and has been an Executive Officer and member of the Board of Directors of the Company since 1971, and served as President and Chief Executive Officer of the Company, relinquishing these positions in 1980 and 1985, respectively. He was the Chairman of the Board of Directors for many years, Chairman of the Executive Committee since 1974, and was elected as one of the three members of the Office of Chairman on August 8, 1991. On October 22, 1992, Mr. Mebane was again elected as Chairman of the Board of Directors.\nVICE CHAIRMAN OF THE BOARD OF DIRECTORS\nWILLIAM J. ARMFIELD, IV Mr. Armfield is 59 and was President of Macfield, Inc. from 1970 until August 8, 1991, when Macfield merged with and into Unifi. He has been a Director of Unifi and was elected as one of the three members of the Office of Chairman on August 8, 1991. On October 22, 1992, Mr. Armfield was elected as Vice Chairman of the Board of Directors.\nPRESIDENT AND CHIEF EXECUTIVE OFFICER\nWILLIAM T. KRETZER Mr. Kretzer is 48 and served as a Vice President or Executive Vice President from 1971 until 1985. He has been the President and Chief Executive Officer since 1985. He has been a member of the Board of Directors since 1985 and is a member of the Executive Committee.\nEXECUTIVE VICE PRESIDENTS\nJERRY W. ELLER Mr. Eller is 54 and has been a Vice President or Executive Vice President since 1975. He has been a member of the Board of Directors since 1985 and is a member of the Executive Committee.\nIII-1\nROBERT A. WARD Mr. Ward is 54 and has been a Vice President or Executive Vice President since 1974. He has been a member of the Board of Directors since its inception in 1971 and is a member of the Executive Committee. Mr. Ward is also the Company's Chief Financial Officer.\nG. ALFRED WEBSTER Mr. Webster is 46 and has been a Vice President or Executive Vice President since 1979. He has been a member of the Board of Directors since 1985 and is a member of the Executive Committee.\nSENIOR VICE PRESIDENTS\nGEORGE R. PERKINS, JR. Mr. Perkins is 54 and was the President and a director of Pioneer Yarn Mills, Inc., Pioneer Spinning, Inc. and Pioneer Cotton Mill, Inc. since each was founded in 1988, 1991, and 1993, respectively, and of Edenton Cotton Mills, Inc., since its acquisition in 1989 (Pioneer Corporations) until August 18, 1993, when the Pioneer Corporations merged with and into Unifi Spun Yarns, Inc. He has been a director of Unifi since August 18, 1993, President and Chief Executive Officer of Unifi Spun Yarns, Inc. since August 19, 1993 and a Senior Vice President of Unifi since October 21, 1993.\nKENNETH L. HUGGINS Mr. Huggins is 50, had been an employee of Macfield since 1970 and, at the time of the merger, was serving as a Vice President of Macfield, Inc. and President of Macfield's Dyed Yarn Division. He was a Director of Macfield from 1989 until August 8, 1991, when Macfield, Inc. merged into and with Unifi, Inc. He is Senior Vice President of Unifi and is also the Assistant to the President.\nRAYMOND W. MAYNARD Mr. Maynard is 51 and had been a Vice President of the Company since June 27, 1971 and a Senior Vice President of Unifi since October 22, 1992.\nThese officers were elected by the Board of Directors of the Registrant at the Annual Meeting of the Board of Directors held on October 21, 1993. Each officer was elected to serve until the next Annual Meeting of the Board of Directors or until his successor was elected and qualified.\n(c) FAMILY RELATIONSHIP: Mr. Mebane, Chairman of the Board, and Mr. C. Clifford Frazier, Jr., the Secretary of the Registrant, are first cousins. Except for this relationship, there is no family relation between any of the Officers.\n(d) Compliance with Section 16(a) of the Exchange Act: Based solely upon the review of the Form 3's and 4's and amendments thereto, furnished to the Company during the most recent fiscal year, no Form 3's or Form 4's were\nIII-2\nfiled late by a director, officer, or beneficial owner of more than ten percent of any class of equity securities of the Company. The Company received written representation from reporting persons that Form 5's were not required.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION:\nThe information set forth under the headings \"Compensation And Option Committees Interlocks And Insider Participation In Compensation Decisions\", \"Executive Officers and Their Compensation\", \"Employment And Termination Agreements\", \"Options Granted\", \"Option Exercises and Option\/SAR Values\", and \"Performance Graph-Shareholder Return on Common Stock\" and the Report of The Compensation And Stock Option Committees on Executive Compensation beginning on page 6 and ending on page 11 of the Company's definitive Proxy Statement filed with the Commission since the close of the Registrant's fiscal year ended June 26, 1994, and within 120 days after the close of said fiscal year, are incorporated herein by reference.\nFor additional information regarding executive compensation reference is made to Exhibits (10i), (10j), and (10k) of this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT:\nSecurity ownership of certain beneficial owners and management is the same as reported under the heading \"Information Relating to Principal Security Holders\" on page 2 of the definitive Proxy Statement and under the heading \"Security Holding of Directors, Nominees and Executive Officers\" beginning on page 4 and ending on page 5 of the definitive Proxy Statement filed with the Commission pursuant to Regulation 14(a) within 120 days after the close of the fiscal year ended June 26, 1994, which are hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:\nThe information included under the heading \"Compensation And Option Committees Interlocks And Insider Participation In Compensation Decisions\", on page 6 of the definitive Proxy Statement filed with the Commission since the close of the Registrant's fiscal year ended June 26, 1994, and within 120 days after the close of said fiscal year, is incorporated herein by reference.\nIII-3\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.\nUnifi, Inc. September 21, 1994 By: ROBERT A. WARD ---------------------------------- Robert A. Ward, Executive Vice President (Chief Financial Officer)*\nSeptember 21, 1994 By: WILLIAM T. KRETZER ---------------------------------- William T. Kretzer, President (Chief Executive Officer)\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:\nSeptember 21, 1994 Chairman G. ALLEN MEBANE -------------------------- and Director G. Allen Mebane\nSeptember 21, 1994 Vice Chairman WILLIAM J. ARMFIELD, IV -------------------------- and Director William J. Armfield, IV\nSeptember 21, 1994 President, Chief Executive Officer WILLIAM T. KRETZER -------------------------- and Director William T. Kretzer\nSeptember 21, 1994 Executive Vice President, Chief Financial Officer ROBERT A. WARD -------------------------- and Director Robert A. Ward\nSeptember 21, 1994 Executive Vice President and JERRY W. ELLER -------------------------- Director Jerry W. Eller\nSeptember 21, 1994 Executive Vice President and G. ALFRED WEBSTER -------------------------- Director G. Alfred Webster\nSeptember 21, 1994 Director CHARLES R. CARTER -------------------------- Charles R. Carter\nSeptember 21, 1994 Director -------------------------- Kenneth G. Langone\nSeptember 21, 1994 Director GEORGE R. PERKINS -------------------------- George R. Perkins\nSeptember 21, 1994 Director DONALD F. ORR -------------------------- Donald F. Orr\nSeptember 21, 1994 Director TIMOTHEUS R. POHL -------------------------- Timotheus R. Pohl\n* Mr. Ward is the Principal Financial and Accounting Officer and has been duly authorized to sign on behalf of the Registrant.\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 financial statements and report of independent auditors included in the Annual Report of Unifi, Inc. to its shareholders for the year ended June 26, 1994, are incorporated herein by reference. With the exception of the aforementioned information and the information incorporated by reference in Items 1, 2, 5, 6, 7 and 8 herein, the 1994 Annual Report to shareholders is not deemed to be filed as part of this report.\nAnnual Report Pages\nConsolidated Balance Sheets at June 26, 1994 and June 27, 1993 11 Consolidated Statements of Income for the Years Ended June 26, 1994, June 27, 1993, and June 28, 1992 12 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended June 26, 1994, June 27, 1993 and June 28, 1992 13 Consolidated Statements of Cash Flows for the Years Ended June 26, 1994, June 27, 1993 and June 28, 1992 14 Notes to Consolidated Financial Statements 15-19 Report of Independent Auditors 10\n(a) 2. Financial Statement Schedules\nForm 10-K Pages\nSchedules for the three years ended June 26, 1994: I - Investments-Marketable Securities IV - 6 V - Property, Plant and Equipment IV - 7 VI - Accumulated Depreciation and Amortization of Property, Plant and Equipment IV - 8 VIII - Valuation and Qualifying Accounts IV - 9 IX - Short-Term Borrowings IV -10 X - Supplementary Income Statement Information IV -11\nIV-1\nSchedules other than those above are omitted because they are not required, are not applicable, or the required information is given in the consolidated financial statements or notes thereto.\nIndividual financial statements of the Registrant have been omitted because it is primarily an operating company and all subsidiaries included in the consolidated financial statements being filed, in the aggregate, do not have minority equity interest and\/or indebtedness to any person other than the Registrant or its consolidated subsidiaries in amounts which together exceed 5% of the total assets as shown by the most recent year end consolidated balance sheet.\n(a) 3. Exhibits\n(2a-1) Form of Agreement and Plan of Merger, dated as of May 24, 1991, by and between Unifi, Inc. and Macfield, Inc., including exhibits, filed as Exhibit 2.1 to Unifi, Inc.'s Registration Statement on Form S-4 (Registration No. 33-40828) which is incorporated herein by reference.\n(2a-2) Form 8-K, filed by Unifi, Inc. in relation to the confirmation of the merger of Macfield, Inc. with and into Unifi, Inc. and related exhibits, filed with the Securities and Exchange Commission on August 8, 1991, which is incorporated herein by reference.\n(2a-3) Form of Agreement and Reverse Triangular Merger, dated February 10, 1993, by and between Unifi, Inc. and Vintage Yarns, Inc., filed as Exhibit 2.1 to Unifi, Inc.'s Registration Statement on Form S-4 (Registration No. 33-58282), which is incorporated herein by reference.\n(2a-4) Form 8-K, filed by Unifi, Inc. in relation to the confirmation of the Reverse Triangular Merger, where Vintage Yarns, Inc. became a wholly-owned subsidiary of Unifi, and related exhibits, filed with the Securities and Exchange Commission on May 10, 1993, which is incorporated herein by reference.\n(2a-5) Form of Agreement and Plan of Triangular Merger, dated July 15, 1993, by and between Unifi, Inc. and Pioneer Yarn Mills, Inc., Pioneer Spinning, Inc., Edenton Cotton Mills, Inc., and Pioneer Cotton Mill, Inc., (the \"Pioneer Corporations\"), filed as Exhibit 2.1 to Unifi, Inc's Registrations Statement on Form S-4 (Registration No. 33-65454), which is incorporated herein by reference.\nIV-2\n(2a-6) Form 8-K, filed by Unifi, Inc. for the purpose of reporting the Pioneer Corporations' Interim Combined Financial Statements (Unaudited) and Unifi, Inc.'s and the Pioneer Corporations' Proforma Combined Interim Financial Information (Unaudited), and related exhibits, filed with the Securities and Exchange Commission on September 2, 1993, which is incorporated herein by reference.\n(2a-7) Form 8-K, filed by Unifi, Inc. for the purpose of reporting the Pioneer Corporations' merger with and into USY and related exhibits filed with the Securities and Exchange Commission on November 5, 1993, which is incorporated herein by reference.\n(3a) Restated Certificate of Incorporation of Unifi, Inc., dated July 21, 1994, filed electronically herewith.\n(3b) Restated By-Laws of Unifi, Inc., effective July 21, 1994, filed herewith.\n(4a) Specimen Certificate of Unifi, Inc.'s common stock, filed as Exhibit 4(a) to the Registration Statement on Form S-1, (Registration No. 2-45405), which is incorporated herein by reference.\n(4b) Unifi, Inc.'s Registration Statement for the 6% Convertible Subordinated Notes Due 2002, filed on Form S-3, (Registration No. 33-45946), which is incorporated herein by reference.\n(10a) *Unifi, Inc. 1982 Incentive Stock Option Plan, as amended, filed as Exhibit 28.2 to the Registration Statement on Form S-8, (Registration No. 33-23201), which is incorporated herein by reference.\n(10b) *Unifi, Inc. 1987 Non-Qualified Stock Option Plan, as amended, filed as Exhibit 28.3 to the Registration Statement on Form S-8, (Registration No. 33-23201), which is incorporated herein by reference.\nIV-3\n(10c) *Unifi, Inc. 1992 Incentive Stock Option Plan, effective July 16, 1992, (filed as Exhibit (10c) with the Company's Form 10-K for the Fiscal year ended June 27, 1993), and included as Exhibit 99.2 to the Registration Statement on Form S-8 (Registration No. 33-53799), which is incorporated herein by reference.\n(10d) *Unifi, Inc.'s Registration Statement for selling Shareholders, who are Directors and Officers of the Company, who acquired the shares as stock bonuses from the Company, filed on Form S-3 (Registration No. 33-23201), which is incorporated herein by reference.\n(10e) *Unifi Spun Yarns, Inc.'s 1992 Employee Stock Option Plan filed as Exhibit 99.3 to the Registration Statement on Form S-8 (Registration No. 33-53799), which is incorporated herein by reference.\n(10f) Lease Agreement, dated March 2, 1987, between NationsBank, Trustee under the Unifi, Inc. Profit Sharing Plan and Trust, Wachovia Bank and Trust Co., N.A., Independent Fiduciary, and Unifi, Inc. (filed as Exhibit (10d) with the Company's Form 10-K for the fiscal year ended June 28, 1987), which is incorporated herein by reference.\n(10g) Factoring Contract and Security Agreement, (a similar agreement was entered into by Unifi Spun Yarns, Inc. and the CIT Group\/DCC, Inc.) and a Letter Amendment thereto, all dated as of May 25, 1994, by and between Unifi, Inc. and the CIT Group\/DCC, Inc., filed herewith.\n(10h) Factoring Contract and Security Agreement, dated as of May 2, 1988, between Macfield, Inc. and First Factors Corp., and first amendment thereto, dated September 28, 1990, (both filed as Exhibit (10g) with the Company's Form 10-K for the fiscal year ended June 30, 1991), Second Amendment to the Factoring Contract and Security Agreement, dated March 1, 1992, (filed as Exhibit (10g) with the Company's Form 10-K for the Fiscal Year Ended June 28, 1992), which are incorporated herein by reference, and Letter Agreement dated August 31, 1993 and Amendment To Factoring Contract and Security Agreement, dated January 5, 1994, filed herewith.\n(10i) *Employment Agreement between Unifi, Inc. and G. Allen Mebane, dated July 19, 1990, (filed as Exhibit (10h) with the Company's Form 10-K for the fiscal year ended June 30, 1991), which is incorporated herein by reference.\nIV-4\n(10j) *Employment Agreement between Unifi, Inc. and William T. Kretzer, dated July 19, 1990, (filed as Exhibit (10i) with the Company's Form 10-K for the fiscal year ended June 30, 1991) which is incorporated herein by reference and Amendment to Employment Agreement between Unifi, Inc. and William T. Kretzer, dated October 22, 1992, (filed as Exhibit (10j) with the Company's Form 10-K for fiscal year ended June 27, 1993), which is incorporated herein by reference.\n(10k) *Severance Compensation Agreement between Unifi, Inc. and William T. Kretzer, dated July 20, 1993, expiring on July 19, 1996 (similar agreements were signed with G. Allen Mebane, William J. Armfield, IV, Robert A. Ward, Jerry W. Eller and G. Alfred Webster), (filed as Exhibit (10k) for the fiscal year ended July 27, 1993), which is incorporated herein by reference.\n(11) Computation of Earnings per share.\n(13a) Portions of Unifi, Inc.'s 1994 Annual Report to Shareholders which are incorporated by reference as a part of this Form 10-K for fiscal year ended June 26, 1994, filed herewith.\n(13b-1) Report of Independent Auditors\/Ernst & Young LLP - on the Consolidated Financial Statements of Unifi, Inc. as of June 26, 1994 and each of the two years in the period ended June 26, 1994.\n(21) Subsidiaries of Unifi, Inc.\n(23) Consents of Ernst & Young LLP\n(27) Financial Data Schedules\n(b) Reports on Form 8-K\n(i) No Form 8-K's were filed.\n* NOTE: These Exhibits are management contracts or compensatory plans or arrangements required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of this report.\nIV-5\nIV-6\nIV-7\nIV-8\nIV-9\nIV-10\nIV-11\nExhibit (3a)\nRESTATED CERTIFICATE OF INCORPORATION\nOF\nUNIFI, INC.\nUNDER SECTION 807 OF THE BUSINESS CORPORATION LAW\nTHE UNDERSIGNED, Robert A. Ward and Clifford Frazier, Jr., being respectively the Executive Vice President and Secretary of Unifi, Inc., pursuant to Section 807 of the Business Corporation Law of the State of New York, hereby restate, certify, and set forth: (1) The name of the Corporation is Unifi, Inc.. The name under which the Corporation was formed is Automated Environmental Systems, Inc. (2) A Certificate of Incorporation of Unifi, Inc. was filed by the Department of State on the 18th day of January, 1969, under the name Automated Environmental Systems, Inc. A Restated Certificate of Incorporation was filed by the Department of State on the 6th day of November, 1990, a Certificate of Amendment was filed by the Department of State on the 13th day of November, 1991, and a Certificate of Amendment was filed by the Department of State on the 20th day of January, 1994. (3) The text of the Certificate of Incorporation is hereby restated without amendment or change to read as herein set forth in full: \"FIRST: The name of the Corporation shall be Unifi, Inc.\nSECOND: The purposes for which the Corporation is formed are to texture, prepare, buy, sell, deal in, trade, import, export, and generally deal in synthetic and natural yarns of every type and description.\nTo dye and finish, knit, buy, sell, acquire, import, export, manufacture, prepare and generally deal in as dyers and finishers, knitters, manufacturers, converters, jobbers, purchasers, or as agents in all types and forms of knitted fabrics including, without limitation, polyesters, acetates, nylon, cotton, wool, rayon, silk, and otherwise with yarn and fabric of every kind and description; and to generally deal in and with any and all things made wholly or in part of composition, imitation, or substitutes of any raw or finished products thereof.\nTo create, manufacture, contract for, buy, sell, import, export, distribute, job, and generally deal in and with, whether at wholesale or retail, and as principal, agent, broker, factor, commission merchant, licensor, licensee or otherwise, any and all kinds of goods, wares, and merchandise, and, in connection therewith or independent thereof, to construct, establish, and maintain, by any manner or means, factories, mills, buying offices, distribution centers, specialty, and other shops, stores, mail order establishments, concessions, leased departments, and any and all other departments, sites, and locations necessary, convenient or useful in the furtherance of any business of the corporation.\nTo export from and import into the United States of America and its territories and possessions, and any and all foreign countries, as principal or agent, merchandise of every kind and nature, and to purchase, sell, and deal in and with, at wholesale and retail, merchandise of every kind and nature for exportation from, and importation into the United States, and to and from all countries foreign thereto, and for exportation from, and importation into, any foreign country, to and from any other country foreign thereto, and to purchase and sell domestic and foreign merchandise in domestic markets, and domestic and foreign merchandise in foreign markets and to do a general foreign and domestic exporting and importing business.\nTo take, lease, purchase, or otherwise acquire, and to own, use, hold, sell, convey, exchange, lease, mortgage, clear, develop, redevelop, manage, operate, maintain, control, license the use of, publicize, advertise, promote, and generally deal in and with, whether as principal, agent, broker, or otherwise, real and personal property of all kinds, and, without limiting the generality of the foregoing, stores, shops, markets, supermarkets, departments, and merchandising facilities, shopping centers, recreational centers, discount centers, merchandising outlets of all kinds, parking areas, offices and establishments of all kinds, and to engage in the purchase, sale, lease and rental of equipment and fixtures for the same and for other enterprises, for itself or on behalf of others.\nTo carry on a general mercantile, industrial, investing, and trading business in all its branches; to devise, invent, manufacture, fabricate, assemble, install, service, maintain, alter, buy, sell, import, export, license as licensor or licensee, lease as lessor or lessee, distribute, job, enter into, negotiate, execute, acquire, and assign contracts in respect of, acquire, receive, grant, and assign licensing arrangements, options, franchises, and other rights in respect of, and generally deal in and with, at wholesale or retail, as principal, and as sales, business, special or general agent, representative, broker, factor, merchant, distributor, jobber, advisor, or in any other lawful capacity, goods, wares, merchandise, commodities, and unimproved, improved, finished, processed, and other real, personal and mixed property of any kind and all kinds, together with the components, resultants, and by-products thereof; to acquire by purchase or otherwise own, hold, lease, mortgage, sell, or otherwise dispose of, erect, construct, make, alter, enlarge, improve, and to aid or subscribe toward the construction, acquisition, or improvement of any factories, shops, storehouses, buildings, and commercial and retail establishments of every character, including all equipment, fixtures, machinery, implements, and supplies necessary, or incidental to, or connected with, any of the purposes or business of the corporation; and generally to perform any and all acts connected therewith or arising therefrom or incidental thereto, and all acts proper or necessary for the purpose of the business.\nTHIRD: The office of the Corporation is to be located in the City, County and State of New York.\nFOURTH: The aggregate number of shares of capital stock which the Corporation shall have the authority to issue is five hundred million shares, all of which are to consist of one class of common stock only of the par value of $.10 each.\nFIFTH: The Secretary of State is designated as the agent of the Corporation, upon whom process against it may be served, and the post office address to which the Secretary of State shall mail a copy of any process against the Corporation served upon him is:\nc\/o KREINDLER & RELKIN, P.C. Attn: Donald L. Kreindler, Esquire Empire State Building 350 Fifth Avenue, 65th Floor New York, New York 10118.\nSIXTH: No holder of any shares of any class of the Corporation shall as such holder have any pre-emptive right or be entitled as a matter of right to subscribe for or to purchase any other shares or securities of any class which at any time may be sold or offered for sale by the Corporation.\nSEVENTH: The number of Directors shall be fixed in the By-Laws but in no case shall be less than nine (9), but this number may be increased and subsequently increased or decreased from time to time by the affirmative vote of the majority of the Board, except that the number of Directors shall not be less than nine (9). The Directors shall be divided into three classes designated as Class 1, Class 2 and Class 3. Each class shall be as nearly equal in number as possible and no class shall include less than three (3) Directors. The term of office of the Directors initially classified shall be as follows: Class 1 shall expire at the next (1992) Annual Meeting of the Shareholders, Class 2 at the second succeeding (1993) Annual Meeting of the Shareholders and Class 3 shall expire at the third succeeding (1994) Annual Meeting of the Shareholders. At each Annual Meeting after such initial Classification, Directors to replace those whose terms expire at such Annual Meeting shall be elected to hold office until the third succeeding Annual Meeting of the Shareholders. A Director shall hold office until the Annual Meeting of the year in which his term expires and until his successor shall be elected and qualified, subject to prior death, resignation, retirement, or removal from office.\nIf the number of Directors is changed pursuant to the By-Laws of the Corporation after the effective date of this ARTICLE SEVENTH, any newly created Directorships or any decrease in Directorships shall be apportioned among the classes so as to make all classes as nearly equal in number as possible. Newly created Directorships resulting from an increase in the number of Directors and vacancies caused by death, resignation, retirement, or removal from office, may be filled by the majority of the Directors present at the meeting, if a quorum is present. If the number of Directors then in office is less than a quorum, such newly created Directorships and vacancies may be filled by the affirmative vote of a majority of the Directors in office. When the number of Directors is increased by the Board, and the newly created Directorships are filled by the Board, there shall be no classification of the additional Directors until the next Annual Meeting of the Shareholders. Any Director elected by the Board to fill a vacancy shall serve until the next meeting of the Shareholders, at which the election of the Directors is in the regular order of business, and until his successor is elected and qualified. In no case will a decrease in the number of Directors shorten the term of an incumbent Director.\nEIGHTH: A Director of the Corporation shall not be liable to the Corporation or its Shareholders for monetary damages for breach of duty as a Director, except to the extent such exemption from liability or limitation thereof is not permitted under the New York Business Corporation Law as the same exists or may hereafter be amended.\nAny repeal or modification of the foregoing paragraph by the Shareholders of the Corporation shall not adversely affect any right or protection of a Director of the Corporation existing at the time of such repeal or modification.\" (4) The restatement of the Certificate of Incorporation was authorized by resolution duly adopted by the Board of Directors of the Corporation at its Regular Meeting on July 21, l994. IN WITNESS WHEREOF, this Certificate has been subscribed this the 7th day of September, 1994, by the undersigned, who affirmed that the statements made herein are true under penalties of perjury.\nROBERT A. WARD _____________________________________ Robert A. Ward Executive Vice President of Finance and Administration\nCLIFFORD FRAZIER, JR. _____________________________________ Clifford Frazier, Jr. Secretary\nExhibit (3b) RESTATED BY-LAWS OF UNIFI, INC.\n(Effective July 21, 1994) -----------------------------------------------------------------\nARTICLE I SHAREHOLDERS\nSection 1.01 - Annual Meeting.........................1 Section 1.02 - Special meetings.......................1 Section 1.03 - Notice of Meetings of Shareholders........................1 Section 1.04 - Waivers of Notice......................3 Section 1.05 - Quorum.................................3 Section 1.06 - Fixing Record Date.....................3 Section 1.07 - List of Shareholders at Meeting.............................4 Section 1.08 - Proxies................................4 Section 1.09 - Selection of Duties of Inspectors..........................7 Section 1.10 - Qualification of Voters................8 Section 1.11 - Vote of Shareholders..................10 Section 1.12 - Written Consent of Shareholders..........................10\nARTICLE II DIRECTORS\nSection 2.01 - Management of Business; Qualification of Directors............11 Section 2.02 - Number of Directors...................12 Section 2.03 - Classification and Election..............................12 Section 2.04 - Newly Created Directorships and Vacancies.........................12 Section 2.05(a) - Resignations..........................13 Section 2.05(b) - Removal of Directors..................14 Section 2.06 - Quorum of Directors...................14 Section 2.07 - Annual Meetings.......................14 Section 2.08 - Regular Meetings......................15 Section 2.09 - Special Meetings......................15 Section 2.10 - Compensation..........................15 Section 2.11 - Committees............................15\n-i- Section 2.12 - Interested Directors..................16 Section 2.13 - Loans to Directors....................17 Section 2.14 - Consent to Action.....................17\nARTICLE III OFFICERS\nSection 3.01 - Election or Appointment; Number................................18 Section 3.02 - Term..................................18 Section 3.03 - Removal...............................19 Section 3.04 - Authority.............................19 Section 3.05 - Voting Securities Owned by the Corporation....................19\nARTICLE IV CAPITAL STOCK\nSection 4.01 - Stock Certificates....................20 Section 4.02 - Transfers.............................21 Section 4.03 - Registered Holders....................21 Section 4.04 - New Certificates......................21\nARTICLE V FINANCIAL NOTICES TO SHAREHOLDERS\nSection 5.01 - Dividends.............................22 Section 5.02 - Share Distribution and Changes...............................22 Section 5.03 - Cancellation of Reacquired Shares................................23 Section 5.04 - Reduction of Stated Capital...........24 Section 5.05 - Application of Capital Surplus to Elimination of a Deficit...........24 Section 5.06 - Conversion of Shares..................24\n-ii- ARTICLE VI INDEMNIFICATION\nSection 6.01 - Right to Indemnification.............25 Section 6.02 - Right of Claimant to Bring Suit...........................27 Section 6.03 - Nonexclusiveness.....................28 Section 6.04 - Insurance for Indemnification of Directors and Officers............29\nARTICLE VII MISCELLANEOUS\nSection 7.01 - Offices..............................30 Section 7.02 - Seal.................................30 Section 7.03 - Checks...............................30 Section 7.04 - Fiscal Year..........................30 Section 7.05 - Books and Records....................30 Section 7.06 - Duty of Directors and Officers.............................31 Section 7.07 - When Notice or Lapse of Time Unnecessary; Notices Dispensed With When Delivery is Prohibited........................31 Section 7.08 - Entire Board.........................32 Section 7.09 - Amendment of By-Laws.................32 Section 7.10 - Nonapplication of North Carolina Shareholder Protection Act...........33 Section 7.11 - Section Headings.....................33\n-iii-\nRESTATED BY-LAWS OF UNIFI, INC. ARTICLE I SHAREHOLDERS SECTION 1.01. ANNUAL MEETING. The Annual Meeting of Shareholders for the election of Directors and the transaction of such other business as may come before it shall be held on such date in each calendar year, not later than the one hundred fiftieth (150) day after the close of the Corporation's preceding fiscal year, and at such place as shall be fixed by the President and stated in the notice or waiver of notice of the meeting. SECTION 1.02. SPECIAL MEETINGS. Special meetings of the shareholders, for any purpose of purposes, may be called at any time by any Director, the President, any Vice President, the Treasurer or the Secretary or by resolution of the Board of Directors. Special meetings of the shareholders shall be held at such place as shall be fixed by the person or persons calling the meeting and stated in the notice or waiver of notice of the meeting. SECTION 1.03. NOTICE OF MEETINGS OF SHAREHOLDERS. Whenever shareholders are required or permitted to take any action at a meeting, written notice shall state the place, date and hour of the meeting and, unless it is the Annual Meeting, indicate that it is being issued by or at the direction of the person or persons calling the meeting. Notice of a special meeting shall also state the purpose or purposes for which the meeting is called. If, at any meeting, action is proposed to be taken which would, if taken, entitle shareholders fulfilling the requirements of Section 623 of the Business Corporation Law to receive payment for their shares, the notice of such meeting shall include a statement of that purpose to that effect. A copy of the notice of any meeting shall be given, personally or by mail, not less than ten nor more than fifty days before the date of the meeting, to each shareholder entitled to vote at such meeting. If mailed, such notice is given when deposited in the United States mail, with postage thereon prepaid, directed to the shareholder at his address as it appears on the record of shareholders, or, if he shall have filed with the Secretary of the Corporation a written request that notices to him be mailed to some other address, then directed to him at such other address. When a meeting is adjourned to another time or place, it shall not be necessary to give any notice of the adjourned meeting if the time and place to which the meeting is adjourned are announced at the meeting at which the adjournment is taken, and at the adjourned meeting any business may be transacted that might have been transacted on the original date of the meeting. However, if after the adjournment, the Board of Directors fixes a new record date for the adjourned meeting, a notice of the adjourned meeting shall be given to each shareholder of record on the new record date entitled to notice under the next preceding paragraph.\nSECTION 1.04. WAIVERS OF NOTICE. Notice of meeting need not be given to any shareholder who submits a signed Waiver of Notice, in person or by proxy, whether before or after the meeting. The attendance of any shareholder at a meeting, in person or by proxy, without protesting prior to the conclusion of the meeting the lack of notice of such meeting, shall constitute a Waiver of Notice by him. SECTION 1.05. QUORUM. The holders of a majority of the shares entitled to vote thereat shall constitute a quorum at a meeting of shareholders for the transaction of any business, provided that when a specified item of business is required to be voted on by a class or series, voting as a class, the holders of a majority of the shares of such class or series shall constitute a quorum for the transaction of such specified item of business. When a quorum is once present to organize a meeting, it is not broken by the subsequent withdrawal of any shareholders. The shareholders present may adjourn the meeting despite the absence of a quorum and at andy such adjourned meeting at which the requisite amount of voting stock shall be represented, any business may be transacted which might have been transacted at the meeting as originally noticed. SECTION 1.06. FIXING RECORD DATE. For the purpose of determining the shareholders entitled to notice of or to vote at any meeting of shareholders or any adjournment thereof, or to express consent to or dissent from any proposal without a meeting, or for the purpose of determining shareholders entitled to receive payment of any dividend or the allotment of any rights, or for the purpose of any other action, the Board of Directors may fix, in advance, a date as the record date for any such determination of shareholders. Such date shall not be more than fifty nor less than ten days before the date of such meeting, nor more than fifty days prior to any other action. When a determination of shareholders of record entitled to notice of or to vote at any meeting or shareholders has been made as provided in this Section, such determination shall apply to any adjournment thereof, unless the Board of Directors fixes a new record date under this Section for the adjourned meeting. SECTION 1.07. LIST OF SHAREHOLDERS AT MEETING. A list of shareholders as of the record date, certified by the corporate officer responsible for its preparation or by a transfer agent, shall be produced at any meeting of shareholders upon the request thereat or prior thereto of any shareholder. If the right to vote at any meeting is challenged, the inspectors of election, or person presiding thereat, shall require such list of shareholders to be produced as evidence of the right of the persons challenged to vote at such meeting, and all persons who appear from such list to be shareholders entitled to vote thereat may vote at such meeting. SECTION 1.08. PROXIES. Every shareholder entitled to vote at a meeting of shareholders or to express consent or dissent without a meeting may authorize another person or persons to act for him by proxy.\nEvery proxy must be signed by the shareholder or his attorney- in-fact. No proxy shall be valid after the expiration of eleven months from the date thereof unless otherwise provided in the proxy. Every proxy shall be revocable at the pleasure of the shareholder executing it, except as otherwise provided in this Section. The authority of the holder of a proxy to act shall not be revoked by the incompetence or death of the shareholder who executed the proxy unless, before the authority is exercised, written notice of an adjudication of such incompetence or of such death is received by the Corporate Officer responsible for maintaining the list of shareholders. Except when other provision shall have been made by written agreement between the parties, the record holder of shares which are held by a pledgee as security or which belong to another, upon demand therefor and payment of necessary expenses thereof, shall issue to the pledgor or to such owner of such shares a proxy to vote or take other action thereon. A shareholder shall not sell his vote or issue a proxy to vote to any person for any sum of money or anything of value, except as authorized in this Section and Section 620 of the Business Corporation Law. A proxy which is entitled \"irrevocable proxy\" and which states that it is irrevocable, is irrevocable when it is held by any of the following or a nominee of any of the following:\n(1) A Pledgee;\n(2) A person who has purchased or agreed to purchase the shares;\n(3) A creditor or creditors of the Corporation who extend or continue credit to the Corporation in consideration of the proxy if the proxy states that it was given in consideration of such extension or continuation of credit, the amount thereof, and the name of the person extending or continuing credit;\n(4) A person who has contracted to perform services as an Officer of the Corporation, if a proxy is required by the contract of employment, if the proxy states that it was given in consideration of such contract of employment, the name of the employee and the period of employment contracted for;\n(5) A person designated by or under an agreement under paragraph (a) of said Section 620.\nNotwithstanding a provision in a proxy, stating that it is irrevocable, the proxy becomes revocable after the pledge is redeemed, or the debt of the Corporation is paid, or the period of employment provided for in the contract of employment has terminated, or the agreement under paragraph (a) of said Section 620 has terminated, and becomes revocable, in a case provided for in subparagraph (3) or (4) above, at the end of the period, if any, specified therein as the period during which it is irrevocable, or three years after the date of the proxy, whichever period is less, unless the period of irrevocability is renewed from time to time by the execution of a new irrevocable proxy as provided in this Section. This paragraph does not affect the duration of a proxy under the second paragraph of this Section.\nA proxy may be revoked, notwithstanding a provision making it irrevocable, by a purchaser of shares without knowledge of the existence of the provision unless the existence of the proxy and its irrevocability is noted conspicuously on the face or back of the certificate representing such shares. SECTION 1.09. SELECTION AND DUTIES OF INSPECTORS. The Board of Directors, in advance of any shareholders' meeting, may appoint one or more inspectors to act at the meeting or any adjournment thereof. If inspectors are not so appointed, the person presiding at a shareholders' meeting may, and on the request of any shareholder entitled to vote thereat shall, appoint one or more inspectors. In case any person appointed failed to appear or act, the vacancy may be filled by appointment made by the Board in advance of the meeting or at the meeting by the person presiding thereat. Each inspector, before entering upon the discharge of his duties, shall take and sign an oath faithfully to execute the duties of inspector at such meeting with strict impartiality and according to the best of his ability. The inspectors shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, the validity and effect of proxies, and shall receive votes, ballots or consents, hear and determine all challenges and questions arising in connection with the right to vote, count and tabulate all votes, ballots or consents, determine the result, and do such acts as are proper to conduct the election or vote with fairness to all shareholders. On request of the person presiding at the meeting or any shareholder entitled to vote thereat, the inspectors shall make a report in writing of any challenge, question or matter determined by them and execute a certificate of any fact found by them. Any report or certificate made by them shall be prima facie evidence of the facts stated and of the vote as certified by them. Unless appointed by the Board of Directors or requested by a shareholder, as above provided in this Section, inspectors shall be dispensed with at all meetings of shareholders. The vote upon any question before any shareholders' meeting need not be by ballot. SECTION 1.10. QUALIFICATION OF VOTERS. Every shareholder of record shall be entitled at every meeting of shareholders to one vote for every share standing in his name on the record of shareholders, except as expressly provided otherwise in this Section and except as otherwise expressly provided in the Certificate of Incorporation of the Corporation. Treasury shares and shares held by another domestic or foreign corporation of any type or kind, if a majority of the shares entitled to vote in the election of Directors of such other corporation is held by the Corporation, shall not be shares entitled to vote or to be counted in determining the total number of outstanding shares. Shares held by an administrator, executor, guardian, conservator, committee, or other fiduciary, except a Trustee, may be voted by him, either in person or by proxy, without transfer of such shares into his name. Shares held by a Trustee may be voted by him, either in person or by proxy, only after the shares have been transferred into his name as Trustee or into the name of his nominee. Shares held by or under the control of a receiver may be voted by him without the transfer thereof into his name if authority so to do is contained in an order of the court by which such receiver was appointed. A shareholder whose shares are pledged shall be entitled to vote such shares until the shares have been transferred into the name of the pledgee, or a nominee of the pledgee. Redeemable shares which have been called for redemption shall not be deemed to be outstanding shares for the purpose of voting or determining the total number of shares entitled to vote on any matter on and after the date on which written notice of redemption has been sent to holders thereof and a sum sufficient to redeem such shares has been deposited with a bank or trust company with irrevocable instruction and authority to pay the redemption price to the holders of the shares upon surrender of certificates therefor. Shares standing in the name of another domestic or foreign corporation of any type or kind may be voted by such Officer, agent or proxy as the By-Laws of such corporation may provide, or, in the absence of such provision, as the Board of Directors of such corporation may determine.\nWhen shares are registered on the record of shareholders of the Corporation in the name of, or have passed by operation of law or by virtue of any deed of trust or other instrument to two or more fiduciaries, and if the fiduciaries shall be equally divided as to voting such shares, any court having jurisdiction of their accounts, upon petition by any of such fiduciaries or by any party in interest, may direct the voting of such shares for the best interest of the beneficiaries. This paragraph shall not apply in any case where the instrument or order of the court appointing such fiduciaries shall otherwise direct how such shares shall be voted. Notwithstanding the foregoing paragraphs of this Section, the Corporation shall be protected in treating the persons whose names shares stand on the record of shareholders as the owners thereof for all purposes. SECTION 1.11. VOTE OF SHAREHOLDERS. Directors shall be elected by a plurality of the votes cast at a meeting of shareholders by the holders of shares entitled to vote in the election. Whenever any corporate action, other than the election of Directors, is to be taken by vote of the shareholders, it shall, except as otherwise required by the Business Corporation Law or by the Certificate of Incorporation of the Corporation, be authorized by a majority of the votes cast at a meeting of shareholders by the holders of shares entitled to vote thereon. SECTION 1.12. WRITTEN CONSENT OF SHAREHOLDERS. Whenever under the Business Corporation Law shareholders are required or permitted to take any action by vote, such action may be taken without a meeting on written consent, setting forth the action so taken, signed by the holders of all outstanding shares entitled to vote thereon. This paragraph shall not be construed to alter or modify the provisions of any section of the Business Corporation Law or any provision in the Certificate of Incorporation of the Corporation not inconsistent with the Business Corporation Law under which the written consent of the holders of less than all outstanding shares is sufficient for corporate action. Written consent thus given by the holders of all outstanding shares entitled to vote shall have the same effect as a unanimous vote of shareholders. ARTICLE II DIRECTORS SECTION 2.01. MANAGEMENT OF BUSINESS; QUALIFICATIONS OF DIRECTORS. The business of the Corporation shall be managed by its Board of Directors, each of whom shall be at least twenty-one years of age. Directors need not be Stockholders. The Board of Directors, in addition to the powers and authority expressly conferred upon it herein, by statute, by the Certificate of Incorporation of the Corporation and otherwise, is hereby empowered to exercise all such powers as may be exercised by the Corporation, except as expressly provided otherwise by the statutes of the State of New York, by the Certificate of Incorporation of the Corporation and these By-Laws.\nSECTION 2.02. NUMBER OF DIRECTORS. The number of Directors which shall constitute the entire Board shall be eleven (11), but this number may be increased and subsequently again increased or decreased from time to time by the affirmative vote of the majority of Directors, except that the number of Directors shall not be less than nine (9). SECTION 2.03. CLASSIFICATION AND ELECTION. (a) The Directors shall be divided into three classes designated as Class 1, Class 2 and Class 3. All classes shall be as nearly equal in number as possible and no class shall include less than three (3) Directors. The term of office of the Directors initially classified shall be as follows: Class 1 shall expire at the next (1992) Annual Meeting of the Shareholders, Class 2 shall expire at the second succeeding (1993) Annual Meeting of the Shareholders, and Class 3 shall expire at the third succeeding (1994) Annual Meeting of the Shareholders. (b) At each Annual Meeting after such initial classification, Directors to replace those whose terms expired at such Annual Meeting shall be elected to hold office until the third succeeding Annual Meeting of the Shareholders. A Director shall hold office until the Annual Meeting for the year in which his term expires and subject to prior death, resignation, retirement, or removal from office, until his successor shall be elected and qualified. SECTION 2.04. NEWLY CREATED DIRECTORSHIP AND VACANCIES. Newly created Directorships or any decrease in Directorship shall be apportioned among the classes as to make all classes as nearly equal in number as possible. Newly created Directorships resulting from an increase in the number of Directors and vacancies caused by death, resignation, retirement, or removal from office, subject to Section 2.05(b), may be filled by the majority of the Directors voting on the particular matter, if a quorum is present. If the number of Directors then in office is less than a quorum, such newly created Directorships and vacancies may be filled by the affirmative vote of a majority of the Directors in office. When the number of Directors is increased by the Board, and the newly created Directorships are filled by the Board, there shall be no classification of the additional Directors until the next Annual Meeting of the shareholders. Any Director elected by the Board to fill a vacancy shall serve until the next meeting of the shareholders, at which the election of the Directors is in the regular order of business, and until his successor is elected and qualified. In no case will a decrease in the number of Directors shorten the term of an incumbent Director. SECTION 2.05(A). RESIGNATIONS. Any Director of the Corporation may resign at any time by giving written notice to the Board of Directors, the President or the Secretary of the Corporation. Such resignation shall take effect at the time specified therein, if any, or if no time is specified therein, then upon receipt of such notice by the addressee; and, unless otherwise provided therein, the acceptance of such resignation shall not be necessary to make it effective. SECTION 2.05(B). REMOVAL OF DIRECTORS. Any or all of the Directors may be removed at any time (i) for cause by vote of the shareholders or by action on the Board of Directors or (ii) without cause by vote of the shareholders, except as expressly provided otherwise by Section 706 of the Business Corporation Law. The Board of Directors shall fill vacancies occurring in the Board by reason of removal of Directors for cause. Vacancies occurring by reason of removal without cause shall be filled by the Shareholders. SECTION 2.06. QUORUM OF DIRECTORS. At all meetings of the Board of Directors, a majority of the number of Directors then office shall be necessary and sufficient to constitute a quorum for the transaction of business and the act of a majority of the Directors present at any meeting at which there is a quorum shall be the act of the Board of Directors, except as expressly provided otherwise by the statutes of the State of New York and except as provided in the third sentence of Section 2.04, in Section 2.11 and Section 7.09 hereof. A majority of the Directors present, whether or not a quorum is present, may adjourn any meeting of the Directors to another time and place. Notice of any adjournment need not be given if such time and place are announced at the meeting. SECTION 2.07. ANNUAL MEETING. The Board of Directors shall meet immediately following the adjournment of the Annual Meeting of shareholders in each year at the same place and no notice of such meeting shall be necessary. SECTION 2.08. REGULAR MEETINGS. Regular meetings of the Board of Directors may be held at such time and place as shall from time to time be fixed by the Board and no notice thereof shall be necessary. SECTION 2.09. SPECIAL MEETINGS. Special meetings may be called at any time by any Director, the President, any Vice President, the Treasurer, or the Secretary or by resolution of the Board of Directors. Special meetings shall be held at such place as shall be fixed by the person or persons calling the meeting and stated in the notice or waiver of notice of the meeting. SECTION 2.10. COMPENSATION. Directors shall receive such fixed sums and expenses of attendance for attendance at each meeting of the Board or of any committee and\/or such salary as may be determined from time to time by the Board of Directors; provided that nothing herein contained shall be construed to preclude any Director from serving the Corporation in any other capacity and receiving compensation therefor. SECTION 2.11. COMMITTEES. The Board of Directors, by resolution adopted by a majority of the entire Board, may designate from among its members an Executive Committee and other committees, each consisting of three or more Directors, and each of which, to the extent provided in the resolution, shall have the authority of the Board of Directors, except that no such committee shall have authority as to the following matters: (a) The submission to shareholders of any action that needs shareholder's authorization under the Business Corporation Law.\n(b) The filling of vacancies in the Board of Directors or in any committee.\n(c) The fixing of compensation of the Directors for serving on the Board of Directors or on any committee.\n(d) The amendment or repeal of the By-Laws, or the adoption of new By-Laws.\n(e) The amendment or repeal of any resolution of the Board of Directors which by its terms shall not be so amendable or repealable.\nThe Board may designate one or more Directors as alternate members of any such committee, who may replace any absent member or members at any meeting of such committee. Each such committee shall serve at the pleasure of the Board of Directors. Regular meetings of any such committee shall be held at such time and place as shall from time to time be fixed by such committee and no notice thereof shall be necessary. Special meetings may be called at any time by any Officer of the Corporation or any member of such committee. Notice of each special meeting of each such committee shall be given (or waived) in the same manner as notice of a special meeting of the Board of Directors. A majority of the members of any such committee shall constitute a quorum for the transaction of business and the act of a majority of the members present at the time of the vote, if a quorum is present at such time, shall be the act of the committee. SECTION 2.12. INTERESTED DIRECTORS. No contract or other transaction between the Corporation and one or more of its Directors, or between the Corporation and any other corporation, firm, association or other entity in which one or more of the Corporation's Directors are Directors or Officers, or are financially interested, shall be either void or voidable for this reason alone or by reason alone that such Director or Directors are present at the meeting of the Board of Directors, or of a committee thereof, which approves such contract or transaction, or that his or their votes are counted for such purpose: (1) If the fact of such common Directorship, Officership or financial interest is disclosed or known to the Board or committee, and the Board or committee approves such contract or transaction by a vote sufficient for such purpose without counting the vote or votes of such interested Director or Directors;\n(2) If such common Directorship, Officership or financial interest is disclosed or known to the shareholders entitled to vote thereon, and such contract or transaction is approved by vote of the shareholders; or\n(3) If the contract or transaction is fair and reasonable as to the Corporation at the time it is approved by the Board, a committee of the shareholders.\nCommon or interested Directors may be counted in determining the presence of a quorum at a meeting of the Board or of a committee which approves such contract or transaction. SECTION 2.13. LOANS TO DIRECTORS. A loan shall not be made by the Corporation to any Director unless it is authorized by vote of the shareholders. For this purpose, the shares of the Director who would be the borrower shall not be shares entitled to vote. A loan made in violation of this Section shall be a violation of the duty to the Corporation of the Directors approving it, but the obligation of the borrower with respect to the loan shall not be affected thereby. SECTION 2.14. CONSENT TO ACTION. Any action required or permitted to be taken by the Board of Directors or any committee thereof may be taken without a meeting if all members of the Board or committee consent in writing, whether done before or after the action so taken, to the adoption of a resolution authorizing the action. The resolution and the written consent thereto shall be filed with the Minutes of the proceeding of the Board or the committee. ARTICLE III OFFICERS SECTION 3.01. ELECTION OR APPOINTMENT: NUMBER. The Officers shall be a Chairman, a Vice-Chairman, a President, a Secretary, a Treasurer, and such number of Executive Vice-Presidents, Vice- Presidents, Assistant Secretaries and Assistant Treasurers, and such other Officers as the Board may from time to time determine. Any person may hold two or more offices at the same time, except the offices of President and Secretary. Any Officer, except the Chairman, Vice-Chairman and the President of the Corporation, may but does not need to be chosen from among the Board of Directors. SECTION 3.02. TERM. Subject to the provisions of Section 3.03 hereof, all officers shall be elected or appointed to hold office until the meeting of the Board of Directors following the next Annual Meeting of shareholders, and each officer shall hold office for the term for which he is elected or appointed and until his successor has been elected or appointed and qualified.\nThe Board may require any Officer to give security for the faithful performance of his duties. SECTION 3.03. REMOVAL. Any Officer elected or appointed by the Board of Directors may be removed by the Board with or without cause. The removal of an Officer without cause shall be without prejudice to his contract rights, if any. The election or appointment of an Officer shall not of itself create contract rights. SECTION 3.04. AUTHORITY. Any Director or such other person as may be designated by the Board of Directors, and in the absence of such Director or other person, the President shall be the Chief Executive Officer of the Corporation. The Chairman shall oversee the general operations of the Corporation and set company policy which would be implemented, interpreted and carried out by the President and Chief Executive Officer who will report directly to the Chairman. The Chairman shall preside at all meetings of the Board of Directors unless some other person is designated by the Board. SECTION 3.05. VOTING SECURITIES OWNED BY THE CORPORATION. Powers of attorney, proxies, waivers or notice of meeting, consents and other instruments relating to securities owned by the Corporation may be executed in the name of and on behalf of the Corporation by the President or any Vice-President and any such officer may, in the name of and on behalf of the Corporation, take all such action as any such officer may deem advisable to vote in person or by proxy at any meeting of security holders of any Corporation in which the Corporation may own securities and at any such meeting shall possess and may exercise any and all rights and powers incident to the ownership of such securities and which, as the owner thereof, the Corporation might have exercised and possessed if present. The Board of Directors may, by resolution, from time to time confer like powers upon any other person or persons. ARTICLE IV CAPITAL STOCK SECTION 4.01. STOCK CERTIFICATES. The shares of the Corporation shall be represented by certificates signed by the Chairman of the Board or the President or a Vice-President and the Secretary or an Assistant Secretary or the Treasurer or an Assistant Treasurer of the Corporation, and may be sealed with the seal of the Corporation or a facsimile thereof. The signatures of the Officers upon a certificate may be facsimiles if the certificate is countersigned by a transfer agent or registered by a registrar other than the Corporation itself or its employee. In case any Officer who has signed or whose facsimile signature has been placed upon a 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 issue.\nEach certificate representing shares shall also set fort such additional material as is required by subdivisions (b) and (c) of Section 508 of the Business Corporation Law. SECTION 4.02. TRANSFERS. Stock of the Corporation shall be transferable in the manner prescribed by the laws of the State of New York and in these By-Laws Transfers of stock shall be made on the books of the Corporation only by the person named in the certificate or by attorney lawfully constituted in writing and upon the surrender of the certificate therefor, which shall be canceled before the new certificate shall be issued. SECTION 4.03. REGISTERED HOLDERS. The Corporation shall be entitled to treat and shall be protected in treating the persons in whose names shares or any warrants, rights or options stand on the record of shareholders, warrant holders, right holders or option holders, as the case may be, as the owners thereof for all purposes and shall not be bound to recognize any equitable or other claim to, or interest in, any such share, warrant, right or option on the part of any other person, whether or not the Corporation shall have notice thereof, except as expressly provided otherwise by the Statutes of the State of New York. SECTION 4.04. NEW CERTIFICATES. The Corporation may issue a new certificate of stock in the place of any certificate theretofore issued by it, alleged to have been lost, stolen or destroyed, and the Directors may, in their discretion, require the owner of the lost, stolen or destroyed certificate, or his legal representatives, to give the Corporation a bond sufficient (in the judgment of the Directors) to indemnify the Corporation against any claim that may be made against it on account of the alleged loss or theft of any such certificate or the issuance of such new certificate. A new certificate may be issued without requiring any bond when, in the judgment of the Directors, it is proper so to do. ARTICLE V Financial Notices to Shareholders SECTION 5.01. DIVIDENDS. When any dividend is paid or any other distribution is made, in whole or in part, from sources other than earned surplus, it shall be accompanied by a written notice (1) disclosing the amounts by which such dividend or distribution affects stated capital, capital surplus and earned surplus, or (2) if such amounts are not determinable at the time of such notice, disclosing the approximate effect of such dividend or distribution upon stated capital, capital surplus and earned surplus and stating that such amounts are not yet determinable. SECTION 5.02. SHARE DISTRIBUTION AND CHANGES. Every distribution to shareholders of certificates representing a share distribution or a change of shares which affects stated capital, capital surplus or earned surplus shall be accompanied by a written notice (1) disclosing the amounts by which such distribution or change affects stated capital, capital surplus or earned surplus, or (2) if such amounts are not determinable at the time of such notice, disclosing the approximate effect of such distribution or change upon stated capital, capital surplus and earned surplus and stating that such amounts are not yet determinable. When issued shares are changed in any manner which affects stated capital, capital surplus or earned surplus, and no distribution to shareholders of certificates representing any shares resulting from such change is made, disclosure of the effect of such change upon the stated capital, capital surplus and earned surplus shall be made in the next financial statement covering the period in which such change is made that is furnished by the Corporation to holders of shares of the class or series so changed or, if practicable, in the first notice of dividend or share distribution or change that is furnished to such shareholders between the date of the change and shares and the next such financial statement, and in any event within six months of the date of such change. SECTION 5.03. CANCELLATION OF REACQUIRED SHARES. When reacquired shares other than converted shares are canceled, the stated capital of the Corporation shall be reduced by the amount of stated capital then represented by such shares plus any stated capital not theretofore allocated to any designated class or series which is thereupon allocated to the shares canceled. The amount by which stated capital has been reduced by cancellation of required shares during a stated period of time shall be disclosed in the next financial statement covering such period that is furnished by the Corporation to all its shareholders or, if practicable, in the first notice of dividend or share distribution that is furnished to the holders of each class or series of its shares between the end of the period and the next such financial statement, and in any event to all its shareholders within six months of the date of the reduction of capital. SECTION 5.04. REDUCTION OF STATED CAPITAL. When a reduction of stated capital has been effected under Section 516 of the Business Corporation Law, the amount of such reduction shall be disclosed in the next financial statement covering the period in which such reduction is made that is furnished by the Corporation to all its shareholders or, if practicable, in the first notice of dividend or share distribution that is furnished to the holders of each class or series of its shares between the date of such reduction and the next such financial statement, and in any event to all its shareholders within six months of the date of such reduction. SECTION 5.05. APPLICATION OF CAPITAL SURPLUS TO ELIMINATION OF A DEFICIT. Whenever the Corporation shall apply any part or all of its capital surplus to the elimination of any deficit in the earned surplus account, such application shall be disclosed in the next financial statement covering the period in which such elimination is made that is furnished by the Corporation to all its shareholders or, if practicable, in the first notice of dividend or share distribution that is furnished to holders of each class or series of its shares between the date of such elimination and the next such financial statement, and in any event to all its shareholders within six months of the date of such action. SECTION 5.06. CONVERSION OF SHARES. Should the Corporation issue any convertible shares, then, when shares have been converted, disclosure of the conversion of shares during a stated period of time and its effect, if any, upon stated capital shall be made in the next financial statement covering such period that is furnished by the Corporation to all its shareholders or, if practicable, in the first notice of dividend or share distribution that is furnished to the holders of each class or series of its shares between the end of such period and the next financial statement, and in any event to all its shareholders within six months of the date of the conversion of shares. ARTICLE VI INDEMNIFICATION SECTION 6.01. RIGHT TO INDEMNIFICATION. The Corporation shall indemnify, defend and hold harmless any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative, investigative or other, including appeals, by reason of the fact that he is or was a Director, Officer or employee of the Corporation, or is or was serving at the request of the Corporation as a Director, Officer or employee of any Corporation, partnership, joint venture, trust or other enterprise, including service with respect to employee benefit plans, whether the basis of such proceeding is alleged action in an official capacity as a Director, Officer or employee or in any other capacity while serving as a Director, Officer or employee, to the fullest extent authorized by the New York Business Corporation Law, as the same exists or may hereafter be amended, against all expenses, liability and loss (including attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid or to be paid in settlement) reasonably incurred or suffered by such person in connection therewith; provided, however, that except as provided in Section 6.02 hereof with respect to proceedings seeking to enforce rights to indemnification, the Corporation shall indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) initiated by such person only if the proceeding (or part thereof) was authorized by the Board of Directors of the Corporation. The right to indemnification conferred in this Article shall be a contract right and shall include the right to be paid by the Corporation expenses incurred in defending any such proceeding in advance of its final disposition; provided, however, that if required by law at the time of such payment, the payment of such expenses incurred by a Director or Officer in his capacity as a Director or Officer (and not in any other capacity in which service was or is rendered by such person while a Director or Officer, including, without limitation, service to an employee benefit plan) in advance of the final disposition of such proceeding, shall be made only upon delivery to the Corporation of an undertaking, by or on behalf of such Director or Officer, to repay all amounts so advanced if it should be determined ultimately that such Director or Officer is not entitled to be indemnified under this Section or otherwise.\n\"Employee\" as used herein, includes both an active employee in the Corporation's service, as well as a retired employee who is or has been a party to a written agreement under which he might be, or might have been, obligated to render services to the Corporation. SECTION 6.02. RIGHT OF CLAIMANT TO BRING SUIT. If a claim under Section 6.01 is not paid in full by the Corporation within sixty (60) days or, in cases of advances of expenses, twenty (20) days after a written claim has been received by the Corporation, the claimant may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim and, if successful in whole or in part, the claimant shall be entitled to be paid also the expense of prosecuting such claim. It shall be a defense to any such action (other than an action brought to enforce claim for expenses incurred in defending any proceeding in advance of its final disposition where the required undertaking has been tendered to the Corporation) that the claimant has not met the standards of conduct which make it permissible under the New York Business Corporation Law for the Corporation to indemnify the claimant for the amount claimed, but the burden of proving such defence shall be on the Corporation. Neither the failure of the Corporation (including its Board of Directors, independent legal counsel, or its shareholders) to have made a determination prior to the commencement of such action that indemnification of the claimant is proper in the circumstances because he has met the applicable standard of conduct set forth in the New York Business Law, nor an actual determination by the Corporation (including its Board of Directors, independent legal counsel, or its shareholders) that the claimant had not met such applicable standard of conduct shall be a defense to the action or create a presumption that claimant had not met the applicable standard of conduct. The Corporation shall be precluded from asserting in any judicial proceeding commenced pursuant to this Article that the procedures and presumptions of this Article are not valid, binding and enforceable and shall stipulate in any such proceeding that the Corporation is bound by all provisions of this Article. SECTION 6.03. NONEXCLUSIVENESS. The indemnification and advances of expenses granted pursuant to, or provided by, this Article shall not be deemed exclusive of any other rights to which a Director or Officer seeking indemnification or advancement or expenses may be entitled, whether contained in the Certificate of Incorporation or these By-Laws, and the Board of Directors is authorized, from time to time in its discretion, to enter into agreements with one or more Directors, Officers and other persons providing for the maximum indemnification allowed by applicable law. The right to indemnification and the payment of expenses incurred in defending a proceeding in advance of its final disposition conferred in this Article (a) shall apply to acts or omissions antedating the adoption of this By-Law, (b) shall be severable, (c) shall not be exclusive of other rights to which any Director, Officer or employee may now or hereafter become entitled apart from this Article, (d) shall continue as to a person who has ceased to be such Director, Officer or employee and (e) shall inure to the benefit of the heirs, Executors and Administrators of such a person. SECTION 6.04. INSURANCE FOR INDEMNIFICATION OF DIRECTORS AND OFFICERS. The Corporation shall have the power to purchase and maintain insurance (a) to indemnify the Corporation for any obligations which it incurs as the result of the indemnification of Directors and Officers under the provisions of this Article; (b) to indemnify Directors and Officers in instances which they may be indemnified by the Corporation under the provisions of this Article; and (c) to indemnify Directors and Officers in instances in which they may not otherwise be indemnified by the Corporation under the provisions of this Article, provided the contract of insurance covering such Directors and Officers provides, in a manner acceptable to the Superintendent of Insurance of the State of New York, for a retention amount and for co-insurance. No insurance under the preceding paragraph of this Section may provide for any payment, other than the cost of defense, to or on behalf of any Director of Officer: (i) if a judgment or other final adjudication adverse to the insured Director or Officer establishes that his acts of active and deliberate dishonesty were material to the cause of action so adjudicated or that he personally gained in fact a financial profit or other advantage to which he was not legally entitled, or (ii) in relation to any risk the insurance of which is prohibited under the insurance laws of the State of New York. ARTICLE VII\nMISCELLANEOUS\nSECTION 7.01. OFFICES. The principal office of the Corporation shall be in the City of New York, County of New York, State of New York. The Corporation may also have offices at other places, within and\/or without the State of New York. SECTION 7.02. SEAL. The corporate seal shall have inscribed thereon the name of the Corporation, the year of its incorporation and the words \"Corporate Seal of New York\". SECTION 7.03. CHECKS. All checks or demands for money shall be signed by such person or persons as the Board of Directors may from time to time determine. SECTION 7.04. FISCAL YEAR. The fiscal year of the Corporation shall begin on the 1st day of July in each year and shall end on the 30th day of June of the ensuing year and the first fiscal year shall end on June 30, 1969. SECTION 7.05. BOOKS AND RECORDS. The Corporation shall keep correct and complete books and records of accounts and shall keep minutes of the proceedings of its shareholders, Board of Directors and Executive Committee, if any, and shall keep at the office of the Corporation in New York State or at the office of its transfer agent or registrar in New York State, a record containing the names and addresses of all shareholders, the number and class of shares held by each and the dates when they respectively became the owners of record thereof. Any of the foregoing books, minutes or records may be in written form or in any other form capable of being converted into written form within a reasonable time. SECTION 7.6. DUTY OF DIRECTORS AND OFFICERS. Directors and Officers shall discharge the duties of their respective positions in good faith and with that degree of diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in like positions. In discharging their duties, Directors and Officers, when acting in good faith, may rely upon financial statements of the Corporation represented to them to be correct by the President or the Officer of the Corporation having charge of its books of accounts, or stated in a written report by an independent public or certified public accountant or firm of such accountants fairly to reflect the financial condition of the Corporation. SECTION 7.07. WHEN NOTICE OR LAPSE OF TIME UNNECESSARY; NOTICE DISPENSED WITH WHEN DELIVERY IS PROHIBITED. Whenever, under the Business Corporation Law or the Certificate of Incorporation or the By-Law of the Corporation or by the terms of any agreement or instrument, the Corporation or the Board of Directors or any committee thereof is authorized to take any action after notice to any person or persons or after the lapse of a prescribed period of time, such action may be taken without notice and without the lapse of such period of time, if at any time before or after such action is completed the person or persons entitled to such notice or entitled to participate in the action to be taken or, in the case of a shareholder, by his attorney-in-fact, submit a signed waiver of notice of such requirements. Whenever any notice or communication is required to be given to any person by the Business Corporation Law, the Certificate of Incorporation of the Corporation or theses By-Laws, or by the terms of any agreement or instrument, or as a condition precedent to taking any corporate action and communication with such person is then unlawful under any statute of the State of New York or of the United States or any regulation, proclamation or order issued under said statutes, then the giving of such notice or communication to such person shall not be required and there shall be no duty to apply for license or other permission to do so. Any affidavit, certificate or other instrument which is required to be made or filed as proof of the giving of any notice or communication required the Business Corporation Law shall, if such notice or communication to any person is dispensed with under this paragraph, include a statement that such notice or communication was not given to any person with whom communication is unlawful. Such affidavit, certificate or other instrument shall be as effective for all purposes as though such notice or communication had been personally given to such person. SECTION 7.08. ENTIRE BOARD. As used in these By-Laws, the term \"Entire Board\" means the total number of Directors which the Corporation would have if there were no vacancies. SECTION 7.09. AMENDMENT OF BY-LAWS. These By-Laws may be amended or repealed and new By-Laws adopted by the Board of Directors or by vote of the holders of the shares at the time entitled to vote of the holders of the shares at the time entitled to vote in the election of any Directors, except that any amendment by the Board changing the number of Directors shall require the vote of a majority of the Entire Board and except that any By-Laws adopted by the Board may be amended or repealed by the shareholders entitled to vote thereon as provided in the Business Corporation Law. If any By-Law regulating an impending election of Directors is adopted, amended or repealed by the Board, the shall be set forth in the notice of the next meeting of shareholders for the election of Directors the By-Law so adopted, amended or repealed, together with a concise statement of the changes made. SECTION 7.10 NONAPPLICATION OF NORTH CAROLINA SHAREHOLDER PROTECTION ACT. The provisions of North Carolina General Statutes 55-75 through 55-79 shall not be applicable to this Corporation. SECTION 7.11. SECTION HEADINGS. The Headings to the Articles and Sections of these By-Laws have been inserted for convenience of reference only and shall not be deemed to be a part of these By- Laws.\nEXHIBIT (10g)\nFrom: Unifi, Inc. P. O. Box 19109 Greensboro, N.C. 27419\nTHE CIT GROUP\/BCC, INC. P. O. Box 31307 Charlotte, North Carolina 28231\nGentlemen:\nWe are pleased to propose the terms upon which you are to act as our factor, effective as of May 25, 1994.\n1. We hereby sell and assign to you as absolute owners and you hereby purchase from us without recourse to us except as hereinafter set forth, Receivables now or hereafter owned by us which are acceptable to you. The term \"Receivables\" means and includes accounts, contract rights, documents, instruments and other evidence of customer indebtedness, whether secured or unsecured, all proceeds thereof and all of our rights to any merchandise, delivered or undelivered, which is represented thereby, including all of our rights of stoppage in transit, replevin and reclamation as an unpaid vendor or lienor; limited, however, to those Receivables which we assign to you. On all Receivables approved by you, you assume the risk of loss resulting solely from customers' failure to pay at maturity because of financial inability (\"Credit Risk\"), but you shall not be responsible where nonpayment is due to any other cause. Receivables not approved by you, as provided below in whole or in part, are assigned to you with full recourse to the undersigned to the extent and in the respects not so approved.\n2. The amount and terms of each proposed sale or service to our customers shall be submitted to you for your written approval (which shall include facsimile) which approval may be withdrawn at any time before actual shipment or performance is completed. We warrant as to each such Receivable that: it is a bona fide existing obligation created by the absolute sale and delivery of merchandise or the rendition of services to customers in the ordinary course of business; we have good title thereto and good right to sell and assign same to you; all documents delivered to you in connection therewith are genuine; it will at all times be enforceable against all parties thereto without defense, offset or counterclaim, real or claimed; it is and will at all times be free and clear of liens and encumbrances, except in your favor; it will be paid according to its terms and it does not represent a sale to any entity which is our parent, subsidiary or affiliate.\n3. You shall purchase and acquire a security interest in our Receivables in accordance with the terms of this Agreement and, in payment, shall credit the gross amount of all assigned Receivables to a Reserve Account which you shall establish on your books in our name. You shall also establish a Cash Account on your books in our name and, at the time you credit the gross amount of assigned receivables to our Reserve Account, you shall charge the Cash Account with appropriate factoring charges and on the average maturity date of each assignment (calculated on the maturity date of each invoice in the assignment plus five business days for collection) you will transfer the net amount of the assignment (invoices less credits and discounts made available to or extended to our customers, whether taken or not) from the Reserve Account to the Cash Account. The Cash Account shall be charged with interest and any other amounts chargeable to us hereunder. You shall furnish us with advices of all entries to our Reserve and Cash Accounts. As you credit our Reserve Account with the gross amount of Receivables assigned to you, you will debit the same amount to an Accounts Receivable Account which you shall establish on your books in our name and which you shall credit with all credit memoranda and allowances to our customers and with all payments received from our customers. A discount, factored credit or allowance after issuance or granting may be claimed solely by the customer, and after your purchase of Receivables we will not issue or grant any discounts, credits or allowances to the customer without your prior written consent.\nYou may, at your option, maintain such reserve as you deem necessary from time to time as security for payment and performance of our Obligations, as defined in Paragraph \"6\".\n4. Subject to the provisions of this Agreement, you shall remit to us (and at any time in your sole discretion, you may remit) any moneys standing to our credit in our Cash Account on your books in excess of the reserve provided for herein. You may charge to our Cash Account interest on any debit balance in our Cash Account. Such interest shall be charged as of the last day of each month, at the \"Chemical Rate\". (\"Chemical Rate\" is defined as the per annum rate of interest publicly announced by Chemical Bank in New York, New York, from time to time as its prime rate. The Chemical Rate is not intended to be the lowest rate charged by Chemical Bank to its borrowers.) All such interest shall be computed for the actual number of days elapsed on the basis of a year consisting of 360 days. Any adjustment in your interest rate, whether downward or upward, will become effective on the first day of the month next following the month in which the Chemical rate of interest is reduced or increased. You shall also be entitled to charge interest at the cost of funds rate (as defined below) on Receivables with respect to which an alleged claim, defense or offset is asserted or for which you have not assumed the Credit Risk from the maturity date of the Receivable invoice until such Receivable has been cleared from the Accounts Receivable Account. If you hold a collected credit balance, you shall credit our Cash Account as of the last day of the month, interest on such credit balance at 2.75% below the Chemical Rate of interest as defined above. Within fifteen (15) days after the end of each month or as soon thereafter as is reasonably possible, you shall send us a statement of our account. Each such statement will be fully binding upon us and shall constitute an account stated unless we give you written notice of exceptions within thirty (30) days from its date of mailing. We agree to pay to you on demand any debit balance in our account. Your factoring charge referred to above shall be as follows: .35% of the net amount of all Receivables. We together with our subsidiary company, Unifi Spun Yarns, Inc., which has entered into a separate factoring agreement with you of even date hereof (\"Unifi Spun Agreement\") jointly and severally agree to factor a minimum annual volume of $100,000,000.00 during each Contract Year this Agreement and the Unifi Spun Agreement is in effect. (\"Contract Year\" shall mean the twelve month period beginning on the effective date of this agreement and each succeeding twelve month period beginning on the anniversary date of this agreement.) Please reference Letter Amendment of even date hereof.\n5. We agree to notify you promptly of all customer disputes, claims and returns, to indemnify and protect you against liability, loss or expense caused by or arising out of such disputes, claims or returns, and, subject to your prior approval in each instance, to issue credit memoranda immediately (with duplicates to you) upon the acceptance of returns or granting of allowances. Without your prior written consent, we will not change the amount or terms of any Receivable, whether or not approved, or grant any other indulgence with respect thereto. You may at any time charge to our Cash Account, after 60 days notice, the amount of any customer deduction and as of the due date of the invoice, the amount of (a) each Receivable with respect to which any customer dispute is asserted or which is not paid in full at its due date for any reason other than financial ability to pay and (b) each Receivable upon which you have not assumed the Credit Risk. Such charge shall not constitute a reassignment to us of the Receivable involved and title remains in you until you are fully reimbursed. Until reassigned to us you shall remain the absolute owner of each Receivable assigned to you and of any rejected, returned or recovered merchandise in connection therewith, with the right to take possession thereof at any time, and until such possession is taken, such merchandise shall be set aside, marked in your name and held for your account as owned. At your option, we agree to resell such merchandise for your account at prices you deem advisable with the proceeds made payable to you in all events and any deficiencies, costs and expenses thereof payable by us.\n6. With regard to those Receivables which we assign to you hereunder, we hereby grant you a security interest in our now existing and future accounts (whether or not specifically scheduled in accordance with Paragraph \"7\"), instruments, documents, contract rights, chattel paper, general intangibles, unpaid seller's rights, returned and repossessed goods, reserves and credit balances hereunder, and in all guaranties and collateral therefor, and all proceeds of all the foregoing. We will not grant a security interest in Inventory to anyone else without giving you prior written notice.\n7. We shall, from time to time, provide you with a schedule of Receivables purchased by you, together with copies of customers' invoices, conclusive evidence of shipment, and such other documentation and proof of delivery as you shall at any time require and documents, instruments and other evidences of customer indebtedness, duly endorsed in blank by us. All invoices to customers shall state plainly on their face that the accounts receivable represented by such invoices have been assigned and are payable only to you. We are to prepare and mail all customers' invoices, but you may do so at your option. All Receivables shall be subject to the assignment prescribed herein, whether or not we execute any specific instrument of assignment or schedule. You are authorized to regard our printed name or rubber stamp signature on assignment schedules or invoices as the equivalent of a manual signature by one of our authorized officers or agents. If any remittances are made directly to us by our customers, we shall act as trustee of an express trust for your benefit, hold the same as your property and immediately deliver to you the identical checks, moneys or other forms of remittance received, and you shall have the right to endorse our name on any and all checks and other forms of remittances received where such endorsement is required to effect collection. We shall not sell or assign, negotiate, pledge or grant any security interest in any Receivables to anyone other than you without prior written notification to you. All sales of Receivables to you by us shall be deemed to include all of our right, title and interest to all of our books, records and files and all other data and documents relating to each Receivables. If any tax by any governmental authority is imposed on any transaction between us, or in respect to sales or the merchandise affected by such sales, which you are required to withhold or pay, we agree to indemnify and hold you harmless in respect to such taxes, and we will repay you the amount of any such taxes, which shall be charged to our Cash Account.\n8. The initial term of this agreement shall be two years from the effective date of this agreement. Thereafter, this agreement may be terminated by us upon written notice to you prior to the anniversary date of this agreement, and at any time upon 30 days written notice by you to us. Notwithstanding the foregoing, should we become insolvent, be unable to meet our debts as they mature, commit an act of bankruptcy, stop doing business, call a meeting of our creditors, breach any warranty, promise or covenant in this Agreement, fail to pay any Obligation when due, or have commenced by or against us any bankruptcy, insolvency arrangement, reorganization, receivership or similar proceeding, you shall have the right to terminate this agreement at any time without notice. Notwithstanding any termination, all the terms, conditions, security interests and provisions hereof shall continue to be fully operative during the time (\"Termination Period\") until all transactions entered into, rights created or obligations incurred hereunder prior to the termination and all of our Obligations have been fully disposed of, concluded, paid, satisfied any\/or liquidated. If the debit balance of our Accounts Receivable Account exceeds the credit balance of our Reserve Account, the difference will appear on your monthly statement to us as a debit balance of funds advanced and vice versa. You shall be entitled to charge our Reserve Account for funds advanced hereunder, as of the last day of each month, interest on the debit balance of average daily funds advanced for the month at the \"Chemical Rate\". (\"Chemical Rate\" is defined as the per annum rate of interest publicly announced by Chemical Bank in New York, New York, from time as its prime rate. The Chemical Rate is not intended to be the lowest rate of interest charged by Chemical Bank to its borrowers.) All such interest shall be computed for the actual number of days elapsed on the basis of a year consisting of 360 days. Any adjustment in your interest rate, whether downward or upward, will become effective on the first day of the month next following the month in which the Chemical Rate of interest is reduced or increased. Upon termination of this Agreement, the provisions of this paragraph shall supersede any provisions of the Agreement which are or become inconsistent herewith. Please reference Letter Amendment dated of even date hereof.\n9. This Agreement and all transactions hereunder shall be governed as to validity, enforcement, interpretation, construction and in all other respects by the laws of the State of North Carolina and shall be binding upon the parties hereto and their heirs, legal representatives, successors and assigns. The agreement shall become effective only from the date of your written acceptance.\n10. No delay or failure on your part in the exercise of any right, privilege or option hereunder shall operate as a waiver of any thereof, and no waiver whatever shall be valid unless in writing signed by you and then only to the extent therein set forth. This Agreement cannot be changed or terminated orally, is our entire contract and is for the benefit of and binding upon us and our respective successors and assigns, heirs, executors and administrators. All notices are given when mailed registered or certified mail, return receipt requested.\n11. Each of us expressly submits and consents to the jurisdiction of the Courts of the State of North Carolina and United States District Court for the Western District of North Carolina with respect to any controversy arising out of or relating to this Agreement or any supplement hereto or to any transactions in connection herewith and hereby waive personal service of the summons, complaint or other process or papers to be issued therein and hereby agree that service of such summons, complaint, process or papers may be made by registered or certified mail addressed to the other party at the address appearing herein; failure on the part of either party to appear or answer within thirty (30) days after the mailing of such summons, complaint, process or papers shall constitute a default entitling the other party to enter a judgment or order as demanded or prayed for therein. Insofar as permitted by law, WE EACH HEREBY WAIVER ANY RIGHT TO A TRIAL BY JURY IN ANY ACTION OR PROCEEDING ARISING OUT OF THIS AGREEMENT.\n12. We hereby constitute and appoint you or such person as you may name, including substitutions, as our attorney-in-fact to exercise, and at your cost and expense, to execute all necessary documents in our name and do all other things necessary to carry out this Agreement. We hereby ratify and approve all acts of the attorney and agree that neither you nor the attorney will be liable for any acts of commission or omission nor for any error of judgement or mistake of fact or law, provided you have acted as in a manner consistent with reasonable prudent business standards. This power being coupled with an interest is irrevocable so long as any Receivable assigned and sold you remains unpaid or we are indebted to you in any manner.\nVery truly yours,\nATTEST: UNIFI, INC.\nCLIFFORD FRAZIER, JR. By: ROBERT A. WARD - - - --------------------- --------------------------- Secretary Title: Executive Vice President (Corporate Seal) ------------------------ Date: May 25, 1994\nAccepted at Charlotte, North Carolina\nATTEST: THE CIT GROUP\/BCC, INC. BRENDA C. PAINTER - - - ----------------- By: EDWARD L. BOYD Asst. Secretary --------------------------- Title: President-Charlotte Division (Corporate Seal) ---------------------------- Date: May 25, 1994\nUnifi, Inc. and Unifi Spun Yarns, Inc. Post Office Box 19109 Greensboro, North Carolina 27419\nMay 25, 1994\nThe CIT Group\/BCC, Inc. Post Office Box 31307 Charlotte, North Carolina 28231\nGentlemen:\nThis letter amendment shall serve to modify the terms and conditions of the separate Factoring Agreements between you and us dated of even date hereof. Notwithstanding the minimum Annual Volume guaranteed amount as set forth in paragraph 4 of both of the Factoring Agreements, the minimum Annual Volume guaranteed amount will be increased based on the customer credit line provided jointly and severally to Unifi, Inc. and Unifi Spun Yarns, Inc. by you for Texfi Industries, Inc. and subsidiaries (\"Texfi\"), and will be as set forth in the chart below.\nAlso, in the event that the credit line to Texfi is increased or reduced by CIT, Unifi, Inc. or Unifi Spun Yarns, Inc., the minimum Annual Volume guaranteed amount, which is the joint and several obligation of Unifi, Inc. and Unifi Spun Yarns, Inc. will be as set forth below.\nMinimum Annual Volume Texfi Line Rate Guaranteed Amount Term ---------- ---- --------------------- ------- Less Than $3,000,000 .35% $100,000,000 1 Year $3,000,000 .35% $190,000,000 2 Years $4,000,000 .35% $220,000,000 2 Years $5,000,000 .35% $250,000,000 2 Years\nAny excess volume factored over the minimum Annual Volume guaranteed amount during the first Contract Year shall be applied to the second Contract Year's minimum Annual Volume guaranteed amount. (Contract Year is defined in the Factoring Agreements.) Any shortfall in the first Contract Year may be made up during the second Contract Year. At the end of the two-year period, any shortfall in the minimum Annual Volume guaranteed amount will be paid to you based on the .35% rate.\nFurthermore, we agree that the minimum Annual Volume guaranteed amount will also be increased on a pro rata basis at credit lines offered to Texfi between amounts stated above.\nFinally, notwithstanding the termination language as stated in paragraph 8 of the Factoring Agreements, the Factoring Agreements may be terminated after the first Contract Year if the Texfi credit provided jointly and severally to us by you is less than $3,000,000, by giving you written notice prior to the anniversary date.\nThe remaining terms and conditions of the Factoring Agreements shall remain in full force and effect unless specifically amended herein.\nVery truly yours,\nUNIFI, INC.\nBy: ROBERT A. WARD ----------------------------- Its: Executive Vice President ----------------------------- UNIFI SPUN YARNS, INC.\nBy: ROBERT A. WARD ----------------------------- Its: Executive Vice President ----------------------------- READ AND AGREED TO:\nTHE CIT GROUP\/BCC, INC.\nBy: TERRY D. OELSCHLAEGER ---------------------- Its: Senior Vice President --------------------- Date: May 29, 1994 ---------------------\nExhibit (10h)\nUNIFI August 31, 1993 QUALITY THROUGH PRIDE\nMr. T. Lynwood Smith, Jr. Senior Vice President First Factors Corporation P. O. Box 2730 High Point, NC 27261-2730\nDear Woody:\nAs we discussed, this letter sets forth our basic understanding in regard to our factoring contract:\nA) Name: Unifi, Inc. and Wholly-Owned Subsidiaries, including but not limited to Unifi Spun Yarns, Inc.\nB) Assignment: Accounts are assigned on a collection basis and remain Unifi's property until purchased and paid for by First Factors.\nC) Remittance of Funds: Based on a matured account with 5-day collection.\nD) Rate: .55% on net assignments.\nE) Interest: Borrowing at Prime Rate + 2% or earnings on credit balance at Prime Rate less 2%.\nShould you have any questions, please don't hesitate to call me. If you agree with the preceding, then please sign and return a copy of this letter.\nSincerely,\nROBERT A. WARD\nRobert A. Ward bpc - 093 Executive Vice President\nRead & Agreed to this 9th day of September, 1993.\nFIRST FACTORS CORPORATION\nT. LYNWOOD SMITH, JR. - - - ------------------------- T. Lynwood Smith Senior Vice President\nAMENDMENT TO FACTORING CONTRACT AND SECURITY AGREEMENT BETWEEN UNIFI, INC. AND FIRST FACTORS CORPORATION\nTHIS AMENDMENT, entered into this 5th day of January, 1994, by and between UNIFI, INC. (the \"Client\") and FIRST FACTORS CORPORATION, (the \"Factor\");\nWHEREAS, the Client and the Factor wish to amend the Factoring Contract and Security Agreement of May 2, 1988 to provide for the addition of the following:\n8. INTEREST. Client shall pay interest upon the daily debit balance in the Client Maturity Account at the close of business each day at a rate equal to two percent (2%) per annum over the Prime Rate. \"Prime Rate\" is defined as the interest rate announced from time to time by First Union National Bank as its prime interest rate. Interest will be calculated on a daily basis (computed on the actual number of days elapsed over a year of three hundred sixty (360) days) and shall be charged to the Client Maturity Account as of the last day of each month. If the daily balance in the Client Maturity Account reflects a credit balance, Factor shall credit the Client Maturity Account, as of the last day of the month, with interest on such daily credit balance at a rate equal to one percent (1%) below the Prime Rate. The Prime Rate in effect on the date of this agreement and on the last day of each calendar month hereafter shall be the applicable Prime Rate in determining the rate of interest payable hereunder for the following month and shall be effective as of the first day of such following month.\nNOW, THEREFORE, said Factoring Contract is hereby amended. Except as specifically amended herein, all of the terms and provisions of the Factoring Contract and Security Agreement referred to above shall remain in full force and effect.\nThis 5th day of January, 1994.\nUNIFI, INC. (Client)\nBy: ROBERT A. WARD ------------------------- Title: EVP ------------------------- FIRST FACTORS CORPORATION (Factor)\nBy: T. LYNWOOD SMITH, JR. ------------------------- Title: Senior Vice President -------------------------\nEXHIBIT (11)\nExhibit (13a)\n. . . and wherever there's fiber, there's Unifi.\nWherever there's fabric, there's fiber . . .\n. . . and wherever there's fiber, there's Unifi.\nWherever there's fabric, there's fiber . . .\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nACCOUNTING POLICIES AND FINANCIAL STATEMENT INFORMATION\nPRINCIPLES OF CONSOLIDATION: The consolidated financial statements include the accounts of the Company and all subsidiaries. The accounts of all foreign subsidiaries have been included on the basis of fiscal periods ended three months or less prior to the dates of the consolidated balance sheets. All significant intercompany accounts and transactions have been eliminated.\nFISCAL YEAR: The Company's fiscal year is the fifty-two or fifty-three weeks ending the last Sunday in June. All three fiscal years presented were comprised of fifty-two weeks.\nRECLASSIFICATION: The Company has reclassified the presentation of certain prior year information to conform with the current presentation format.\nREVENUE RECOGNITION: Substantially all revenue from sales is recognized at the time shipments are made.\nFOREIGN CURRENCY TRANSLATION: Assets and liabilities of foreign subsidiaries are translated at year-end rates of exchange and revenues and expenses are translated at the average rates of exchange for the year. Gains and losses resulting from translation are accumulated in a separate component of shareholders' equity. Gains and losses resulting from foreign currency transactions (transactions denominated in a currency other than the subsidiary's functional currency) are included in net income.\nCASH AND CASH EQUIVALENTS: Cash equivalents are defined as short-term investments having an original maturity of three months or less.\nSHORT-TERM INVESTMENTS: Short-term investments are compromised primarily of high quality, highly liquid marketable securities with original maturities greater than three months. The Company adopted Statement of Financial Accounting Standard No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" as of the end of its current fiscal year and the adoption had no significant impact on the financial statements. Short-term investments at June 26, 1994 are classified as available-for-sale securities and are carried at fair market value, with the unrealized gains and losses, net of tax, reported in a separate component of shareholders' equity. Short-term investments at June 27, 1993 are carried at the lower of cost or market, with market value exceeding cost by approximately $.6 million.\nACCOUNTS RECEIVABLE: Certain customer accounts receivable are factored. An allowance for losses is provided for accounts not factored based on a periodic review of the accounts. Reserve for such losses was $4.3 million in 1994 and 3.7 million in 1993.\nINVENTORIES: The Company utilizes the last-in, first-out (LIFO) method for valuing certain inventories representing 57% of all inventories at June 26, 1994, and the first-in first-out (FIFO) method for all other inventories. Inventory values computed by the LIFO method are lower than current market values. Inventories valued at current or replacement cost would have been approximately $5.6 million and $7.4 million in excess of the LIFO valuation at June 26, 1994 and June 27, 1993, respectively. Finished goods, work in process, and raw materials and supplies at June 26, 1994 and June 27, 1993, amounted to $57.6 million and $50.3 million; $12.9 million and $13.2 million; and $29.8 million and $41.5 million, respectively.\n. . . and wherever there's fiber, there's Unifi.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nINVESTMENT IN NONCONSOLIDATED AFFILIATED COMPANIES: The investments in common stock of 45% and 32% owned affiliated companies are accounted for by the equity method and are stated at cost plus the Company's share of undistributed earnings since acquisition.\nPROPERTY, PLANT AND EQUIPMENT: Property, plant and equipment are stated at cost. Depreciation is computed for asset groups primarily utilizing the straight-line method for financial reporting and accelerated methods for tax reporting.\nOTHER ASSETS: Other assets consist primarily of long-term investments in marketable equity securities, long-term notes receivable, deferred debt expense and, in the prior year, noncompete covenants and identified intangibles associated with acquisitions. The long-term investments in marketable equity securities are classified as available-for-sale and are carried at fair market value of $9.5 million and $8.5 million at June 26, 1994 and June 27, 1993, respectively. The deferred debt expense, intangible assets and noncompete covenants are being amortized on a straight-line method over periods of two to fifteen years. Accumulated amortization at June 26, 1994 and June 27, 1993 was $16.0 million and $17.9 million, respectively.\nINCOME TAXES: The Company and its domestic subsidiaries file a consolidated federal tax return. Income tax expense is computed on the basis of transactions entering into pretax operating results. Deferred income taxes have been provided for the tax effect of temporary differences between financial statement carrying amounts and the tax basis of existing assets and liabilities. Income taxes have not been provided on the undistributed earnings of certain foreign subsidiaries as such earnings are deemed to be permanently invested.\nEARNINGS PER SHARE: Earnings per common and common equivalent share are computed on the basis of the weighted average number of shares of common stock outstanding plus, to the extent applicable, common stock equivalents. Average common and common equivalent shares for primary earnings per share were 71,020,075, 70,861,463 and 70,226,216 for 1994, 1993 and 1992, respectively. Reported fully diluted earnings per share amounts are based on 71,026,610, 78,640,459 and 72,578,448 shares for 1994, 1993 and 1992, respectively. The effect of the convertible subordinated notes was antidilutive for the fiscal year ended June 26, 1994.\nBUSINESS COMBINATIONS\nOn August 18, 1993, Pioneer Yarn Mills, Inc. Edenton Cotton Mills, Inc., Pioneer Spinning, Inc., Pioneer Cotton Mills, Inc. and certain real estate (collectively the Pioneer Corporations) were merged into Unifi Spun Yarns, Inc. a wholly-owned subsidiary of the Company. In order to effect the merger, 2,745,284 shares of the Company's common stock were issued for all of the outstanding shares of the Pioneer Corporations. On April 23, 1993, Vintage Yarns, Inc. (Vintage) was merged with and became a wholly-owned subsidiary of the Company, and 7,891,800 shares of the Company's common stock were issued in exchange for all of the outstanding common stock of Vintage. Additionally, 496,832 shares of the Company's common stock were reserved for issuance pursuant to outstanding options on Vintage common stock. On August 8, 1991, Macfield, Inc. (Macfield) was merged with and into the Company, and 16,263,644 shares of the Company's common stock were issued in exchange for all of the outstanding common stock of Macfield. All three mergers were accounted for as a pooling of interests, and accordingly, the accompanying financial statements for the years ended June 27, 1993 and June 28, 1992 have been restated to include the accounts and operations of the Pioneer Corporations, Vintage and Macfield for all periods prior to each of the representative mergers.\nWherever there's fabric, there's fiber . . .\nPrior to the mergers, the Pioneer Corporations used a fiscal year ending on the last Saturday in September, Vintage used a fiscal year ending September 30 and Macfield used a fiscal year ending on the Saturday nearest April 30. The 1992 restated financial statements combine the June 28, 1992 financial statements of the Company with the September 26, 1992 financial statements of the Pioneer Corporations and the September 30, 1992 financial statements of Vintage and the 1993 restated financial statements combine the June 27, 1993 financial statements of the Company with the financial statements of the Pioneer Corporations and Vintage for their respective twelve month periods ended June 26, 1993 and June 30, 1993, respectively. Accordingly, to conform the fiscal years of the Pioneer Corporations and Vintage with the Company's, the results of operations of the Pioneer Corporations and Vintage for the three months ended September 26, 1992 and September 30, 1992, respectively, have been included in both fiscal 1993 and 1992. Combined net sales and net income for the three month periods of the Pioneer Corporations and Vintage were $60.8 million and $9.6 million, respectively. An adjustment for the net income of the three month period has been reflected as an adjustment to the June 29, 1992 consolidated retained earnings and an additional adjustment of $1.9 million has been reflected to conform the accounting policies of the previously separate companies. Additionally, to conform the fiscal years of Macfield and the Company, the net income of Macfield for the two months ended June 30, 1991 of $2.8 million has been reflected as an adjustment to retained earnings effective July 1, 1991. Separate results of the combining entities for each of the two years in the period ended June 27, 1993 are as follows (in 000's):\nFor all periods prior to the merger, to the date of the acquisitions, the Pioneer Corporations and Vintage were taxed as S Corporations and, therefore, federal and state taxes were assessed to the shareholders. For purposes of the consolidated financial statements, income taxes have been provided on the Pioneer Corporations' and Vintage's earnings at the rates which would have been applicable had such earnings been taxed to it. Distributions to S Corporation shareholders have been adjusted for the effects of corporate, federal and state taxes payable on an annualized basis.\nIn connection with the merger with Macfield, approximately $24.8 million of merger costs and expenses ($18.4 million net of income taxes, or $.26 per share) were incurred and have been charged to expense in the Company's first quarter of fiscal 1992.\nNON-RECURRING CHARGE\nIn the fiscal 1994 fourth quarter, the Company recorded a non-recurring charge of $13.4 million ($14.1 million after-tax or $.20 per share) related to the planned sale of the Company's investment in its wholly-owned French subsidiary, Unifi Texturing, S.A. (UTSA) and the Company's decision to exit the European nylon market. Of the non-recurring charge, $3.1 million relates to the loss from the sale of UTSA, 8.8 million relates to the write-off of goodwill and other intangibles associated with the Company's European nylon operations and $1.5 million relates to the write-down of nylon production equipment and inventories. The net sales and net income of UTSA included in the Company's consolidated results of operations were not significant during any of the periods presented.\n. . . and wherever there's fiber, there's Unifi.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThere are no scheduled maturities of long-term debt in the five years following June 26, 1994 other than the amounts classified as current above. The 6% convertible subordinated notes due March 15, 2002 are convertible at any time on or before the due date, unless previously redeemed, into common stock of the Company at a conversion price of $29.67 per share, subject to adjustment in certain events. The notes are redeemable, in whole or in part, at the option of the Company on or after March 27, 1995 at redemption prices beginning at 104% of their principal amount, declining to par on or after March 15, 2001. The Company had 7.8 million shares reserved at year end for potential conversion. Interest is payable semi-annually on March 15 and September 15 of each year. The fair value of the Company's long-term debt is estimated using quoted market price at June 26, 1994 of 99.75% or a total value of $229.4 million.\nINCOME TAXES\nDeferred income taxes of $32.4 million and $37.0 million at June 26, 1994 and June 27, 1993, respectively, have been provided as a result of differences between accounting for financial statement versus tax purposes. The net deferred tax liability of $32.4 million at June 26, 1994 and $37.0 million at June 27, 1993 consist of deferred tax liabilities resulting primarily from the temporary differences related to property, plant and equipment of $52.7 million and $44.8 million, other assets of $.7 million and $1.9 million and deferred tax assets attributable to merger, valuation, other assets and reserves of $21.0 million and $9.7 million, respectively. U.S. deferred income taxes have not been recognized on $35.2 million at June 26, 1994 ($34.0 million at June 27, 1993) of undistributed earnings of foreign subsidiaries, because assets representing those earnings are permanently invested. The amount of foreign withholding taxes and U.S. taxes that would be payable upon the repatriation of assets that represent those earnings would be approximately $13.6 million at June 26, 1994 ($13.1 million at June 27, 1993).\nSignificant items affecting a reconciliation of the statutory federal income tax rates and the effective rate are attributable to the following:\nWherever there's fabric, there's fiber . . .\nCommon Stock\nShares authorized were 500 million in 1994 and 100 million in 1993. Common shares outstanding at June 26, 1994 and June 27, 1993 were 70,432,862 and 70,339,965, respectively. The Company has an Incentive Stock Option Plan with 1,964,027 shares reserved at June 26, 1994. There remain 1,061,000 options available for grant at year end. The transactions for 1994, 1993 and 1992 are as follows:\nThe Company also has Non-Qualified Stock Option Plans with 968,635 shares reserved at June 26, 1994. There remain 417,935 options available for grant at year end. Transactions for 1994, 1993 and 1992 are as follows:\nRETIREMENT PLAN\nThe Company has a qualified profit-sharing plan which provides benefits for eligible salaried and hourly employees. The annual contribution to the plan, which is at the discretion of the Board of Directors, amounted to $15.8 million, $13.3 million and $4.8 million in 1994, 1993 and 1992, respectively. The Company leases its corporate office building from its profit-sharing plan through an independent trustee.\nLEASES, CONTINGENCIES AND COMMITMENTS\nThe Company is obligated under operating leases expiring in 1998, consisting primarily of real estate and equipment. Future obligations for minimum rentals under the leases during fiscal years after June 26, 1994 are $.6 million in 1995, $.6 million in 1996, $.4 million in 1997, and $.1 million in 1998. Rental expense was $3.2 million, $2.7 million and $2.7 million for the fiscal years 1994, 1993 and 1992, respectively. The Company had committed approximately $41.7 million for the purchase of equipment and facilities at June 26, 1994.\nBUSINESS SEGMENTS AND FOREIGN OPERATIONS\nThe Company and its subsidiaries are engaged predominantly in the processing of yarns by: texturing of synthetic filament polyester and nylon fiber and spinning of cotton and cotton blend fibers with sales domestically and internationally, mostly to knitters and weavers for the apparel, industrial, hosiery, home furnishing, automotive upholstery and other end-use markets. The Company had sales to one customer of approximately 12% in 1994 and 12% in 1993 and 11% in 1992. The Company's foreign operations are comprised primarily of its manufacturing facilities in Ireland and France, along with its foreign sales corporation. The foreign operations had net sales of $178.5 million, $199.3 million and $209.9 million; pretax income, before non-recurring charges, of $4.4 million, $7.6 million and $12.4 million; and identifiable assets of $132.0 million, $123.4 million and $159.9 million in 1994, 1993 and 1992, respectively.\n. . . and wherever there's fiber, there's Unifi.\nMANAGEMENT'S REVIEW AND ANALYSIS OF OPERATIONS AND FINANCIAL POSITION\nFISCAL 1994\nNet sales decreased 1.5% from 1.406 billion in 1993 to $1.385 billion in 1994. This reduction resulted from an overall decline in sales prices of 6.6% based on product mix offset by volume gains of 5.5% experienced for the year in our combined domestic and foreign markets. Domestic growth was achieved through phased in production from a new texturizing plant in Yadkinville, NC that commenced operations in 1993 and the completion of other modernization projects in 1994 and latter stages of the prior fiscal year. Also, significant volume growth was noted in our spun yarn business for the year although pressure on pricing and raw material increases adversely impacted the margins. In the first quarter of 1994, the Company increased its presence in the cotton and cotton blend spun yarn business through the merger with the Pioneer Corporations. During 1993, the Company entered this market through its merger with Vintage Yarns.\nOur European facilities also experienced overall capacity increases. However, sales prices in local currencies were adversely affected due to weak economic conditions and overcapacity throughout most of the year. Sales from foreign operations are denominated in local currencies and are hedged in part by the purchase of raw materials and services in those same currencies. The net asset exposure is hedged by borrowings in local currencies which minimize the risk of currency fluctuations. Cost of sales as a percentage of sales increased from 81.2% in 1993 to 85.6% in 1994. Impacting cost of sales in the current year was increased fixed charges, such as depreciation, resulting from added capacity being absorbed on a lower net sales base. Also, our spun operations experienced significant raw material price increases during 1994 adversely impacting cost of sales. On a Company wide basis, however, raw material prices per pound were lower in the current fiscal year than in the prior year. Selling, general and administrative expenses as a percentage of net sales increased from 2.7% in 1993 to 2.9% in 1994 primarily as a result of increased fixed charges over a reduced net sales base. Interest expenses declined $7.6 million from $25.8 million in 1993 to $18.2 million in 1994. This decline was attributable to the payoff of long- term debt acquired through merger activity. The only long-term debt remaining at June 26, 1994 is the $230 million in convertible subordinated notes issued in March 1992. Interest income declined $5.2 million from 1993 to 1994 as a result of decreased short-term investment levels. These investments were used to payoff acquired debt, modernize capital equipment and for other financing activities. Other income declined $4.5 million from 1993 to 1994 mainly as a result of the prior year gains recognized from the sale of investment in affiliates and short-term investments while no such activity was present in the current year. In connection with the planned sale of the nylon operations in France, the Company recognized the anticipated loss on the sale of its French subsidiary and wrote off certain intangible costs, primarily goodwill, and other costs associated with the European nylon business. These costs aggregated $14.1 million, or $.20 per share on an after tax basis. The effective income tax rate increased from 37.8% in 1993 to 44.1 % in 1994. This increase was mainly due to the non-deductible, non-recurring charge in the current year while no such charge was incurred in 1993. Also adversely impacting the current year's effective tax rate was the decreased foreign earnings which are taxed at rates lower than the federal tax rate and the increase in the statutory federal rate from 34% to 35% for all of 1994. Net income declined from $136.6 million or $1.93 per share in 1993 to $76.5 million or $1.08 per share in 1994. Net income and net income per share in 1994 before the non-recurring charge previously discussed were $90.6 million or $1.28 per share.\nFISCAL 1993\nNet sales increased 6.3% from 1.323 billion in 1992 to $1.406 billion in 1993. The sales growth resulted from volume increases as average pricing based on overall product mix remained constant. Volume gains were seen in both domestic and foreign markets. Growth in domestic markets came from expenditures for improvements and capacity expansion. Unifi entered the spun yarn business during 1993 through its acquisition of Vintage Yarns. During the year the Company commenced production in a new texturizing plant at its Yadkinville, NC facility, completed the modernization of its covering plants and began upgrading the texturing equipment that provides yarn to its dyeing operations. We also experienced volume increases in our European plants; however, these operations were adversely impacted by weak economic conditions prevalent throughout most of the year. The sales from foreign operations are\nWherever there's fabric, there's fiber . . .\nin local currencies and are hedged in part by the purchase of raw materials and services in those same currencies. The net asset exposure is hedged by borrowings in local currencies which minimizes the risks of currency fluctuations. Cost of sales as a percentage of net sales improved from 82.4% in 1992 to 81.2% in 1993. Based on our overall product mix, increases in manufacturing costs and other components of cost of sales on a per unit basis were offset by decreases in raw material costs. Selling, general and administrative expenses remained constant from 1992 to 1993 at $38.5 million, reflecting an improvement from 2.9% and 2.7% of net sales, respectively. These improvements were mainly due to the centralization of operations and the elimination of duplications in staff and support systems. Interest expense increased from $16.8 million in 1992 to $25.8 million in 1993. This increase was due primarily to the $230 million of convertible subordinated debt outstanding during the current year. The debt was issued in March 1992. Interest income increased from $5.3 million in 1992 to $13.5 million in 1993 due to higher investment levels stemming from the proceeds made available from the issuance of the subordinated debt. Other income of $5.8 million in 1993 was mainly comprised of gains from the sale of investments in affiliates and from the sale of short-term investments in marketable securities. Other income in 1992 of $1.6 million was derived primarily from the equity in earnings of nonconsolidated affiliates. In connection with the 1991 merger, the Company incurred approximately $24.8 million of nonrecurring expenses that were charged to earnings in the first quarter of 1992. These nonrecurring costs and expenses resulted in an after-tax effect on net income of $18.4 million, or $.26 per share. The effective income tax rate decreased form 39.1% in 1992 to 37.8% in 1993. This decrease in the effective rate was mainly due to a combination of nondeductible merger expenses in 1992 whereas there were no such expenses in 1993. Net income for 1993 was $136.6 million or $1.93 per primary share as compared to net income of $96.8 million or $1.38 per primary share, in 1992. Net income and net income per primary share for fiscal 1992 before the effects of the nonrecurring merger expenses, previously described, were $115.2 million and $1.64, respectively.\nLIQUIDITY AND CAPITAL RESOURCES\nCash generated from operations is a major source of liquidity for the Company. During 1994, $130.8 million was generated as a result of net income, adjusted for the effects of depreciation, amortization and noncash expenses and decreases in both receivables and inventories offset by the decreases in trade payables and accruals and income taxes. The decrease in accounts payable results from maintaining lower quantities of raw yarn inventory in 1994 than in 1993 and in connection with other reductions experienced with the merged companies. In addition to cash generated from operations, the Company has access to debt and equity markets. In 1992 the Company generated $104.7 from the sale of Unifi common stock and approximately $230 million from the sale of 6% convertible subordinated notes due March 15, 2002. The Company also maintains reserves of liquid short-term investments which can be used for corporate purposes as needed. Proceeds from these sources and existing reserves were used primarily for repayment of debt of acquired companies and capital expenditures. During 1994 the Company expended $104.7 million for additions to property and equipment, $32.2 million for repayment of long-term debt associated with acquired companies, $39.1 million for cash dividend payments and $2.1 million for stock repurchase. At June 26, 1994 the Company has working capital of $304.3 million which reflects a 3 to 1 current ratio (current assets compared to current liabilities). This represents a decrease in working capital from June 27, 1993 of $320.2 million. The decrease is primarily attributable to the debt repayments and purchases of property and equipment discussed above. On October 21, 1993, the Board of Directors authorized Management to repurchased from time to time up to 15 million shares of Unifi's common stock at such price as Management feels advisable and in the best interest of the Company. It has not been determined how many shares, if any, will be repurchased nor has the time frame been established in which such purchases may take place. To date, approximately 98,000 shares have been repurchased by the Company. Management believes the current financial position is sufficient to complete anticipated capital expenditures, working capital, acquisitions and other financial needs. It is anticipated that the sale of our French nylon facility will produce $16 million to $18 million.\n. . . and wherever there's fiber, there's Unifi.\nWherever there's fabric, there's fiber . . .\nMARKET AND DIVIDEND INFORMATION\nThe Company's common stock is listed for trading on the New York Stock Exchange. The following table sets forth the range of high and low sales prices of the Unifi Common Stock as reported on the NYSE Composite Tape and the regular cash dividends per share declared by Unifi during the periods indicated. This information has been adjusted to reflect the stock splits described below.\n. . . and wherever there's fiber, there's Unifi.\nExhibit (13b-1)\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders of Unifi, Inc.\nWe have audited the accompanying consolidated balance sheets of Unifi, Inc. as of June 26, 1994, and June 27, 1993, and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended June 26, 1994. 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 consolidated financial position of Unifi, Inc. at June 26, 1994 and June 27, 1993, and the consolidated results of its cash flows for each of the three years in the period ended June 26, 1994, in conformity with generally accepted accounting principles.\nERNST & YOUNG LLP\nGreensboro, North Carolina July 19, 1994\nWherever there's fabric, there's fiber . . .\nExhibit (21)\nUNIFI, INC.\nSUBSIDIARIES\nPercentage of Voting Securities Name Address Incorporation Owned - - - ------------------------------------------------------------------------\nUnifi Spun Yarns, Inc. Greensboro, NC North Carolina 100%\nUnifi, FSC Limited Agana, Guam Guam 100%\nUnifi Textured Yarns Letterkenny, Europe, Ltd. Ireland United Kingdom 100%\nUnifi International Service, Inc. Greensboro, NC North Carolina 100%\nExhibit (23)\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report (Form 10- K) of Unifi, Inc. of our report dated July 19, 1994, included in the 1994 Annual Report to Shareholders of Unifi, Inc.\nOur audits also included the financial statement schedules of Unifi, Inc. 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. 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 set forth therein.\nWe also consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-23201) pertaining to the Unifi, Inc. 1982 Incentive Stock Option Plan and the 1987 Non-qualified Stock Option Plan, Registration Statement (Form S-3 No. 33-45946) pertaining to the Unifi, Inc. 6% Convertible Subordinated Notes, and Registration Statement (Form S-8 No. 33-53799) pertaining to the Unifi, inc. 1992 Incentive Stock Option Plan and Unifi Spun Yarns, Inc. 1992 Employee Stock Option Plan of our report dated July 19, 1994, with respect to the consolidated financial statements incorporated herein by reference and of our report included in the preceding paragraph with respect to the financial statement schedules included in this Annual Report (Form 10-K) for the year ended June 26, 1994.\nErnst & Young LLP\nGreensboro, North Carolina September 16, 1994\nExhibit 27\nFINANCIAL DATA SCHEDULES","section_15":""}
{"filename":"88296_1994.txt","cik":"88296","year":"1994","section_1":"Item 1. Business.\nSeaway Food Town, Inc., was founded in 1957 and is a leading regional supermarket chain located predominantly in northwest and central Ohio and southeast Michigan. Beginning in 1986,the Company began adding deep discount drug stores to its chain. The merchandise sold in these stores is similar to that sold in a conventional supermarket but with a greater emphasis on non-food items and package size of such items. At year end, the Company operated 24 Food Town Supermarkets, 20 Food Town Plus Supermarkets, and 22 deep discount drug stores under the name of the Pharm.\nNo material portion of the Company's business is seasonal, as that term is commonly used, although holiday periods may result in greater sales volume. There is substantial competition, principally price-oriented, from national, regional and local companies. The Company is in one line of business selling substantially the same types of retail food and convenience-related non-food merchandise.\nThe Company employs approximately 2,265 employees on a full-time basis and 2,235 on a part-time basis.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company leases 43 of its stores (3 of which are accounted for as capital leases) and certain other facilities and equipment under leases generally for fifteen years, although some are for shorter as well as longer periods. The Company owns 23 stores and a relatively large distribution center (approximately 477,174 square feet) which includes offices, warehousing and shipping facilities, located in Maumee, Ohio. It also owns a 133,000 square foot warehouse in Toledo, Ohio which is used as a satellite facility and a 105,000 square foot warehouse facility which houses health and beauty aids and general merchandise operations. The Company believes that its physical facilities, both leased and owned, are suitable and adequate for the intended uses and purposes.\nIn addition, the Company leases 2 locations that are closed and not subleased.\nAt August 27, 1994, the approximate undepreciated cost of real property subject to mortgages was $9,954,000 and the approximate undepreciated cost of real property subject to capital lease obligations was $6,997,000.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThere are no significant legal proceedings pending.\nItem 4.","section_4":"Item 4. Submission of matters to a vote of Security Holders.\nNo matters have been submitted to a vote of security holders since the Annual Meeting held January 6, 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for registrant's common equity and related security holder matters.\nInformation with respect to the market for the registrant's common stock and related security holder matters on page 32 of Exhibit (13) filed hereunder is incorporated herein by reference.\nItem 6.","section_6":"Item 6. Selected financial data.\nThe five year summary of selected financial data on page 13 of Exhibit (13) filed hereunder 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 included on pages 15 through 18 of Exhibit (13) filed hereunder is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial statements and supplementary data.\nThe consolidated financial statements and report of independent auditors on pages shown below of Exhibit (13) filed hereunder are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and disagreements with accountants on accounting and financial disclosure.\nThere have been no disagreements on accounting and financial disclosure matters reported on Form 8-K during the fiscal years ended August 27, 1994 and August 28, 1993.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and executive officers of the Registrant.\nInformation with respect to non-officer directors is included in the Proxy Statement in the Section entitled \"Information concerning Nominees and Directors\" and is incorporated herein by reference.\nInformation with respect to executive officers, family relationships and business experience is included in the Proxy Statement in the Sections entitled \"Executive Compensation,\" \"Compensation of Directors,\" and \"Executive Officers\". That information (except the Compensation Committee Report, and the graph indicating Comparison of 4 Year Cumulative Total Return), is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation.\nInformation regarding Executive Compensation is included in the Proxy Statement in the sections entitled \"Interest of Management in Certain Transactions,\" \"Executive Compensation,\" and \"Compensation of Directors\". That information (except the Compensation Committee Report, and the graph indicating Comparison of 4 Year Cumulative Total Return), is incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nInformation as to Security Ownership of Certain Beneficial Owners and Management included in the Proxy Statement in the Sections entitled \"Information Concerning Nominees and Directors,\" and \"Principal Holders of Voting Securities\" is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nInformation regarding Certain Relationships and Related Transactions is included in the Proxy Statement in the Sections entitled \"Interest of Management in Certain Transactions,\" \"Executive Compensation,\" and \"Compensation of Directors\". That information (except the Compensation Committee Report, and the graph indicating Comparison of 4 Year Cumulative Total Return), 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 or portions thereof indicated are filed as a part of this report on Form 10-K.\n(1) The following consolidated financial statements of Seaway Food Town, Inc. and its subsidiaries, included on pages 19 - 31 of Exhibit (13) filed hereunder are incorporated by reference in Item 8.\nReport of Independent Auditors\nConsolidated statements of Income - Years ended August 27, 1994, August 28, 1993 and August 29, 1992\nConsolidated balance sheets at August 27, 1994 and August 28, 1993\nConsolidated statements of cash flows - Years ended August 27, 1994, August 28, 1993 and August 29, 1992\nConsolidated statement of shareholders' equity - Years ended August 27, 1994, August 28, 1993 and August 29, 1992\nNotes to consolidated financial statements - August 27, 1994\n(2) The following consolidated financial statement schedules of Seaway Food Town, Inc. and its subsidiairies are filed under Item 14(d):\nSCHEDULE PAGE(S)\nSchedule V - Property, plant and equipment 9 Schedule VI - Accumulated depreciation and amortization of property, plant and equipment 10 Schedule VIII - Valuation and qualifying accounts 11\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 consolidated financial statements or the notes thereto.\nb.) Reports on Form 8-K.\nNo reports on Form 8-K were required to be filed for the three months ended August 27, 1994.\nc.) Exhibits Required by Item 601 of Regulation S-K Index.\nExhibit 3 - Data required by this item has previously been filed and is incorporated by reference from the Company's Annual Report on Form 10-K for the Year Ended September 25, 1982, File 0-80.\nA copy of the Amendment to the Articles of Incorporation filed with the Secretary of State of Ohio, January 17, 1989, is incorporated by reference from the Company's Annual Report on Form 10-K for the Year Ended August 26, 1989, File 0-80.\n4 - Data required by this item has previously been filed and is incorporated herein by reference from the Company's Annual Report on Form 10-K for the Year Ended September 26, 1981, File 0-80.\n10 - Contracts required by this item have previously been filed and are Incorporated herein by reference from the Company's Annual Report on Form 10-K for the Years Ended September 26, 1981, September 24, 1983, the eleven months ended August 27, 1988, File 0-80, on the Company's Issuer Tender Offer Statement on Schedule 13 E-4 filed November 4, 1987, and on form 10-K for the years ended August 25, 1990, August 31, 1991, August 29, 1992, and August 28, 1993.\n11 - Computation of income per share.\n13 - Portions of the 1994 Annual Report to Shareholders (to the extent incorporated by reference hereunder.)\n22 - Subsidiaries of the Registrant.\n23 - Consent of Independent Auditors.\n99 - Financial Data Schedule\nd. Financial Statements Required by Regulation S-X.\nIncluded in Item 14 (a), above.\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.\nSEAWAY FOOD TOWN, INC. (Registrant)\n11\/18\/94 By \/s\/ Richard B. Iott Date Richard B. Iott, President & 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.\n11\/18\/94 By \/s\/ Wallace D. Iott Date Wallace D. Iott, Chairman of the Board (Principal Executive Officer) & Director\n11\/18\/94 By \/s\/ Waldo E. Yeager Date Waldo E. Yeager, Director (Chief Financial Officer and Treasurer)\n11\/18\/94 By \/s\/ Robert J. Kirk Date Robert J. Kirk, Director\n11\/18\/94 By \/s\/ Thomas M. O'Donnell Thomas M. O'Donnell, Director\n11\/18\/94 By \/s\/ David J. Walrod Date David J. Walrod, Director\n11\/18\/94 By \/s\/ Richard K. Ransom Date Richard K. Ransom, Director\n13 EXHIBIT (13)\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following discussion should be read in conjunction with the financial statements and notes thereto contained herein.\nRESULTS OF OPERATIONS\nThe following table sets forth certain income statement components expressed as a percentage of net sales and the year-to-year percentage changes in such components. As of the end of fiscal 1994, Seaway Food Town, Inc. operated 66 retail stores, 44 supermarkets, 20 of which were large combination stores operating as Food Town Plus stores, and 22 deep discount drugstores operating as the Pharm. This compares to 44 supermarkets, 20 of which were Food Town Plus stores, and 20 Pharm deep discount drugstores as of the end of fiscal 1993. During 1994 the Company opened one new, prototype Food Town Plus store while closing one and opening two Pharm drugstores. All stores operate predominately in northwest and central Ohio and southeast Michigan.\nNet Sales\nConsolidated net sales decreased 3.6% in fiscal 1994 and increased 2.2% in fiscal 1993. Nearly all of the 1994 net sales decrease is attributable to the supermarkets which experienced severe competitive pressures, especially in the first three quarters of the year. Nearly all of the 1993 net sales increase was attributable to the Pharms deep discount drugstores. Retail sales in stores that were open throughout all three years decreased approximately 2.4% in 1994 compared to 1993 and increased approximately 5.7% in 1993 over 1992. Sales, though down for fiscal 1994, steadily improved as the 1994 year unfolded.\nManagement believes that the inflation component in sales was less than 1% in 1994, 1993, and 1992.\nGross Profit\nIn 1994, the gross profit percentage increased from 24.4% to 25.1% despite a dollar decrease due to lower sales. Margins improved in both the supermarkets and the deep discount drugstores in 1994 compared to 1993 and warehousing and transportation expenses in 1994 decreased nearly $800,000. In 1993, gross margin decreased slightly from 24.5% to 24.4% with the supermarkets showing virtually no change in gross margins during 1993 and the deep discount drugstores showing a slight decrease.\nSelling, General and Administrative Expenses\nIn 1994, selling, general and administrative expenses decreased by $3.3 million in dollars; however, increased as a percentage of sales due to lower sales. This dollar decrease was attributable principally to lower retail wages as well as lower workers compensation expense. In 1993, selling, general and administrative expenses as a percent to sales increased .4% or $4.8 million. This increase was attributable to increased selling expenses, principally wages, benefits, and advertising expenses as well as expenses associated with the opening of new and remodeled stores and the closing of small, outmoded stores. General and administrative expenses increased as a result of costs associated with enhancing management information systems. Costs associated with closed stores were approximately $285,000 in 1994, $961,000 in 1993, and $661,000 in 1992.\nInterest Expense\nInterest expense decreased both in 1994 and 1993 due to declining interest rates and the early retirement of certain higher cost borrowings. The weighted average interest rate on long-term debt has declined by .59% from 1993 to 1994 and 1.08% from 1992 to 1993.\nIncome Taxes\nThe effective tax rates for 1994, 1993, and 1992 were 34.6%, 34.1%, and 34.0%, respectively, which approximated the statutory rates in effect.\nNet Income\nNet income in 1994 was $2,059,000 which included an extraordinary charge of $123,000, net of applicable income taxes, from early extinguishment of debt as well as a charge of $256,000 resulting from the cumulative effect of a change in accounting for income taxes due to the adoption of FASB 109. Income before the extraordinary item and the cumulative effect of a change in accounting for income taxes was $2,438,000 in 1994 compared to $1,123,000 in 1993. This increase was principally due to lower selling, general, and administrative expenses previously mentioned combined with the effect of increasing margins on lower sales volume. Net income in 1993 was $1,032,000 lower than in 1992 principally due to higher selling, general, and administrative expenses. Excluding the extraordinary items and cumulative effect of the change in accounting in 1994 and 1992, income as a percent of net sales was .45% in 1994, .20% in 1993, and .43% in 1992.\nLIQUIDITY AND CAPITAL RESOURCES\nCapital Expenditures And Financing\nDuring 1994 capital expenditures were $12,681,000 compared to $17,353,000 in 1993 and $9,842,000 in 1992. These were financed by operations and additional long-term debt. As of the end of 1994, over 74% of the Company's retail space is either new or has been remodeled within the last five years. In addition, the Company continues to upgrade its corporate information systems to provide more timely and sophisticated information to improve the Company's competitive advantage. The Company continues to expand the benefits of the Company's Plus Card program, which, launched in 1993, initially provided instant discounts (paperless coupons) to customers. In early 1995 the program will provide customers with the opportunity to pay for their purchases with a bank ATM card, credit card, or their Plus Card which will enable them to make their purchase via the Federal Reserve's Automated Clearing House (ACH). This feature has been made a part of the Plus Card so that the customer can make a fast paperless check transaction when paying for their purchases. The Company is expecting expenditures of approximately $12,000,000 in fiscal 1995.\nAs of the end of 1994, the Company had a total of $22.7 million borrowed against its revolving credit loan agreements with banks which provide maximum borrowings of $35.0 million. This compares to $22.0 million borrowed against revolving credit agreements which provided maximum borrowings of $30.0 million at the end of 1993. The Company believes that cash provided by operations along with the remaining $12.3 million available under the credit agreements will be sufficient to finance fiscal 1995 capital additions and other business needs. The Company's plan for store construction, acquisition, remodeling and expansion is frequently reviewed and revised in light of changing conditions. The Company's ability to proceed with projects, or to complete projects during a particular period, is subject to normal construction and other delays. Therefore, it is likely that not all the projects included in the above mentioned figure will commence or be completed in the 1995 fiscal year.\nThe long-term debt-to-shareholders' equity ratio was 1.46 to 1 at the end of 1994 compared to 1.50 to 1 at the end of 1993 and 1.45 to 1 at the end of 1992.\nLiquidity\nMeasures of liquidity for each of the last three fiscal years were as follows:\nREPORT OF INDEPENDENT AUDITORS\nThe Board of Directors and Shareholders Seaway Food Town, Inc.\nWe have audited the accompanying consolidated balance sheets of Seaway Food Town, Inc. as of August 27, 1994 and August 28, 1993, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended August 27, 1994. 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 Seaway Food Town, Inc. at August 27, 1994 and August 28, 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended August 27, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 3 to the financial statements, in fiscal 1994, the Company changed its method of accounting for income taxes.\n\/s\/ Ernst & Young LLP\nOctober 14, 1994 Toledo, Ohio\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SIGNIFICANT ACCOUNTING POLICIES Business -- The business of Seaway Food Town, Inc. and its consolidated subsidiaries (the Company) consists of the sale and distribution of food, drugs, and related products, principally through supermarkets and drugstores predominately in northwest and central Ohio and southeast Michigan.\nBasis of presentation -- The consolidated financial statements include the accounts of Seaway Food Town, Inc. and all wholly-owned subsidiaries.\nCash 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 reported in the balance sheets for cash equivalents approximates its fair value.\nInventories -- Meat, produce and drug inventories are valued at the lower of cost, using the first-in, first-out (FIFO) method, or market. All other merchandise inventories are valued at the lower of cost, using the last-in, first-out (LIFO) method, or market. Inventories have been reduced by $17,576,000 and $17,594,000 at August 27, 1994 and August 28, 1993, respectively, from amounts which would have been reported under the FIFO method (which approximates current cost).\nDuring 1994 and 1993, merchandise inventory quantities were reduced. These reductions resulted in liquidations of the LIFO inventory quantities carried at lower costs prevailing in prior years as compared with costs of 1994 and 1993 purchases, the effect of which increased consolidated net income by approximately $75,000 ($.03 per share) in 1994 and $156,000 ($.07 per share) in 1993.\nDepreciation and amortization -- Depreciation and amortization are provided principally under the straight-line method at rates based upon the estimated useful lives of the various classes of assets. Capital leases not involving a purchase of the assets are amortized over the lease term.\nPension -- The Company contributes to pension plans covering substantially all employees. Pension costs include defined contributions based upon wages, and specified amounts per hour as required under collective bargaining agreements. The Company's policy is to fund pension costs annually in the amount accrued.\nDeferred income taxes -- Deferred income taxes are provided on the asset and liability method for all significant temporary differences between income reported for financial statement purposes and taxable income.\nNet income per common share -- Net income per common share is based upon the weighted average number of common shares outstanding of 2,306,881 in 1994, 2,332,016 in 1993 and 2,326,972 in 1992. Unallocated shares held by the ESOP were not considered outstanding.\n2. NOTES PAYABLE AND LONG-TERM DEBT Long-term debt at August 27, 1994 and August 28, 1993 consisted of the following (in thousands):\nDuring fiscal 1994, the Company renewed its three revolving credit loan agreements and obtained one additional revolving credit agreement permitting borrowings up to $35,000,000 in the aggregate. The loan agreements are due in fiscal 1997, at which time the borrowings are convertible into term notes payable over four years. Interest is charged at the Company's option, at the current prime rates charged by the banks or 1.25 percentage points in excess of the current LIBOR rate. The Company is required to pay a fee of 1\/4% per annum on any unused portion of the loan commitment. Under these agreements, the Company had borrowed $22,700,000 and $22,000,000 at August 27, 1994 and August 28, 1993, respectively.\nDuring fiscal 1994, the Company entered into interest rate cap agreements in the management of interest rate exposure. These transactions reduce the Company's exposure to significant variations in interest rates. At August 27, 1994, a notional amount of $20,000,000 was covered by these agreements at an average borrowing rate of 9.375% through 1999. If the counterparties to these agreements fail to perform, the Company would no longer be protected from interest rate fluctuations by these agreements and could incur additional interest expense as a result. However, the Company does not anticipate nonperformance by the counterparties, since all of these agreements are with banks with which the Company has revolving credit agreements, having the right of offset.\nThe senior note agreements provide for repurchases of the notes, at either the Company's or holder's option, in amounts not in excess of $4,000,000 in 1997 and $8,000,000 in 2000. In addition, the agreement allows for prepayments, at the Company's option, subject to certain prepayment provisions.\nThe senior notes and revolving credit loan agreements referred to above include certain working capital, net worth and debt service covenants along with restrictions on the payment of cash dividends. The restriction of dividends is based on a percentage of income available for debt service above debt service.\nAt August 27, 1994, the approximate undepreciated cost of property and equipment subject to mortgages was $16,951,000.\nIn 1994 and 1992, respectively, the Company recorded extraordinary losses from early extinguishment of debt which consisted mainly of prepayment penalties and unamortized financing fees amounting to $123,000 (net of $63,000 income tax benefit) and $220,000 (net of $113,000 income tax benefit).\nAnnual maturities of long-term debt for each of the five fiscal years subsequent to August 27, 1994 are as follows: 1995 - $3,341,000; 1996 - $3,055,000; 1997 - $6,543,000; 1998 - $2,325,000; 1999 - $4,361,000.\nAt August 27, 1994, the carrying value of the long-term debt in aggregate, excluding capitalized lease obligations, approximates its fair value. The fair value is estimated using discounted cash flow analyses, based on the Company's current incremental borrowing rates.\n3. INCOME TAXES\nEffective August 29, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" As permitted by Statement 109, prior year financial statements have not been restated to reflect the change in accounting method. The cumulative effect as of August 29, 1993 of adopting Statement 109 decreased net income by $256,000 or $.11 per share.\nUnder Statement 109, the asset and 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 liability method prescribed by Statement 96, which is superseded by Statement 109. The classification criteria changed and resulted in a reclassification between current and long-term deferred income taxes of approximately $2,376,000 at August 29, 1993.\nThe provision (credit) for income taxes consists of the following (in thousands):\nThe consolidated effective tax rate differs from the statutory U.S. Federal tax rate for the following reasons and by the following percentages:\nSignificant components of the Company's deferred income tax assets and liabilities as of August 27, 1994 are as follows (in thousands):\nThe above are reflected in the balance sheet as of August 27, 1994 as follows (in thousands):\nUnder the provisions of Statement 96, the deferred tax provision by major element was attributable to the following (in thousands):\nThe Company has alternative minimum tax credit carryforwards of $1,127,000 and targeted jobs tax credit carryforwards of $298,000 which can be applied against regular tax liabilities in future years. Additionally, the Company has contribution carryforwards of approximately $201,000 which can be applied against taxable income in future years. The targeted jobs tax credits expire in 2008 and 2009 while the contribution carryforwards expire in 1997 through 1999.\n4. EMPLOYEE BENEFIT PLANS For eligible nonunion employees, the Company has a 401(k) salary deferral plan which permits employee salary deferrals of up to 15%, but not to exceed the maximum annual allowable amount for income tax purposes, and an Employee Stock Ownership Plan (ESOP). The Company used $2,000,000 of excess pension plan assets returned to the Company upon termination of the Defined Benefit Pension Plan in fiscal 1988 to advance fund the ESOP. The amount of shares held by the ESOP which had not been allocated to plan participants are considered to be treasury shares and have been shown as a reduction of Shareholders' Equity. All such shares were allocated in fiscal 1994. Allocations to the participants in the ESOP are not less than 2 1\/2% of total annual compensation. Company matching contributions to the 401(k) plan are 50% of employee salary deferral contributions. The Company matching contributions are not made on salary deferrals in excess of 6% of an employee's compensation. The Company's expense for these plans was $832,000 in 1994, $991,000 in 1993, and $812,000 in 1992.\nIn addition, the Company contributes to several area-wide defined benefit union pension plans established under collective bargaining agreements. The aggregate costs for these plans amounted to $2,428,000 in 1994, $2,963,000 in 1993, and $2,392,000 in 1992. Under the Multi-employer Pension Plan Amendments Act of 1980, the Company could become liable for its proportionate share of unfunded vested benefits, if any, in the event of the termination of, or its withdrawal or partial withdrawal from, the union- sponsored plans to which the Company makes contributions. The increase in 1993 expense is principally attributable to the withdrawal liability related to one of the union sponsored pension plans.\n5. LEASE COMMITMENTS Capital leases The cost and accumulated amortization of property leased under long-term noncancellable leases are as follows (in thousands):\nFuture minimum lease payments under capital leases together with the present value of the net minimum lease payments as of August 27, 1994 are as follows (in thousands):\nThe leases expire at various dates from 1995 to 2010 and substantially all are renewable for one or more successive five year periods, in some cases at slightly higher rentals.\nTotal rent expense attributable to operating leases amounted to approximately $6,816,000 in 1994, $7,375,000 in 1993, and $7,494,000 in 1992 and included provision for additional rentals of $222,000 in 1994, $256,000 in 1993, and $234,000 in 1992 based upon gross sales in excess of specified amounts.\nThe Company entered into capital leases amounting to approximately $615,000 in 1994 and $1,844,000 in 1993.\n6. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Quarterly financial data for the years ended August 27, 1994, and August 28, 1993 are presented below (in thousands of dollars except per share amounts):\nThe price is the high and low price on the NASDAQ National Market. The Company's NASDAQ ticker symbol is \"SEWY\". As of August 27, 1994, the approximate number of record holders of common stock was 568.\n34 EXHIBIT 22\nSEAWAY FOOD TOWN, INC.\nSUBSIDIARIES OF REGISTRANT\nAt the fiscal year ended August 27, 1994 the Company had the following subsidiaries, all of which are included in the consolidated financial statements:\nEXHIBIT 23\nCONSENT OF INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in this Annual Report [Form 10-K] of Seaway Food Town, Inc. of our report dated October 14, 1994 included in Exhibit 13 to Form 10-K.\nOur audits also included the financial statement schedules listed in Item 14(a)(2). These schedules are the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedules to above, 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 LLP\nToledo, Ohio October 14, 1994\nEXHIBIT 99 FINANCIAL DATA SCHEDULE ARTICLE 5 OF REGULATION S-X\nDOCUMENT TYPE EX-27 DESCRIPTION ART.5 FDS FOR ANNUAL 10-K TEXT ARTICLE 5 MULTIPLIER 1,000 TABLE PERIOD-TYPE 12 MONTHS FISCAL YEAR-END AUG 27-1994 PERIOD-END AUG-27-1994 CASH 7,137 SECURITIES 0 RECEIVABLES 5,627 ALLOWANCES 450 INVENTORY 44,749 CURRENT-ASSETS 63,421 PP&E 184,825 DEPRECIATION 99,479 TOTAL-ASSETS 155,203 CURRENT-LIABILITIES 54,484 BONDS 55,060 COMMON 4,485 PREFERRED-MANDATORY 0 PREFERRED 0 OTHER-SE 33,100 TOTAL-LIABILITY-AND-EQUITY 155,203 SALES 546,193 TOTAL-REVENUES 546,193 CGS 409,305 TOTAL-COSTS 409,305 OTHER-EXPENSES 129,921 LOSS-PROVISION 0 INTEREST-EXPENSE 4,410 INCOME-PRETAX 3,726 INCOME-TAX 1,288 INCOME-CONTINUING 2,438 DISCONTINUED 0 EXTRAORDINARY 123 CHANGES 256 NET-INCOME 2,059 EPS-PRIMARY .89 EPS-DILUTED .89 TABLE TEXT DOCUMENT","section_15":""}
{"filename":"703360_1994.txt","cik":"703360","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nLSI Logic Corporation (the \"Company\") is a leader in the design, development, manufacture and marketing of application-specific integrated circuit (\"ASIC\") products. The Company provides computer aided engineering design and technology services and software design tools that utilize the Company's proprietary technologies for the design and development of ASICs by the Company and its customers. The Company's ASIC technologies and engineering design services enable its customers to reduce component design costs, improve product performance, retain control over proprietary logic and shorten product development cycles. The Company's ASIC technologies also are used in the design, manufacture and marketing of certain types of integrated circuits as standard products.\nThe Company has focused its marketing efforts primarily on a broad base of manufacturers in the electronic data processing, telecommunications and certain office automation industries and, within these industries, emphasizes desktop and personal computing, networking and digital video applications. The Company increasingly directs its marketing and selling efforts towards customers that are acknowledged industry leaders in these markets. Customers include Alcatel NV, Digital Equipment Corporation, Intel Corporation, Siemens AG, Silicon Graphics, Inc. and Sun Microsystems, Inc.\nThe Company's ASIC design methodology permits very high levels of function integration, thereby allowing implementation of systems-level solutions on a single chip. A key factor in this approach is the Company's CoreWare product library, which is comprised of predefined and characterized cells of industry standard functions, protocols and interfaces such as the R33000 MIPS microprocessor core family and DSPs implementing Ethernet, MPEG, JPEG, and ATM. Using the Company's proprietary software design tools, one or more CoreWare library elements may be combined with a customer's proprietary logic in an ASIC design, thereby allowing the customer to significantly shorten product development cycles when compared to traditional integrated circuit design approaches.\nAn integral part of the Company's ability to deliver advanced integrated circuits is its sophisticated process technologies and manufacturing capabilities. The Company has developed and uses advanced manufacturing process technologies, including a 0.6-micron CMOS process for the Company's advanced products. The Company also has recently introduced a 0.5-micron CMOS process and has begun performing product engineering services for certain customers that are intended to result in products to be manufactured using this 0.5-micron process. The densities achieved by these process technologies allow the Company to implement systems-level designs on a single chip. The Company's proprietary design tools are highly integrated with the Company's manufacturing process requirements, thereby providing very high predictability that the product's\nphysical performance will mirror the computer simulation of the chip and afford very high predictability of performance of products developed through use of the Company's design methodology.\nThe Company obtains substantially all of its wafers from a majority-owned subsidiary in Japan, Nihon Semiconductor Inc. (\"NSI\"). To date, the Company has purchased substantially all of the output of NSI. NSI commenced volume production at a second wafer fabrication facility in the first quarter of 1994.\nThe Company markets its products and services on a worldwide basis through a direct sales, marketing and field technical staff of approximately 775 employees (including its majority-owned subsidiaries in Europe, Canada and Japan), and through independent sales representatives and distributors. The Company has over 30 design centers around the world to assist customers in product design activities.\nThe Company was incorporated in California on November 6, 1980 and reincorporated in Delaware on June 11, 1987. Its principal offices are located at 1551 McCarthy Boulevard, Milpitas, California 95035, and its telephone number at that location is (408) 433-8000. Except where otherwise indicated, references to \"the Company\" shall mean LSI Logic Corporation and its majority- owned subsidiaries.\nPRODUCTS AND SERVICES\nSTRATEGY\nThe Company's strategy is to provide its customers with a comprehensive approach and a continuum of solutions for the design and manufacture of ASICs. This strategy is intended to maximize the advantages of the Company's ASIC design methodology while allowing customers substantial flexibility in how they wish to complete an ASIC design project for products to be purchased from the Company.\nThe Company's design environment reflects a high level of technology integration from design concept through prototype manufacture to volume production. Within this environment, the customer has a number of choices to accomplish its design objective:\n- The customer may choose the degree of engineering involvement it will have in the design activities. The Company may provide advice for the partitioning of systems functions to be implemented in one or more ASICs for the customer's system. Alternatively, the customer may establish product specifications for implementation into a particular chip design by the its engineers, by the Company's engineers on a \"turn-key\" basis or through a collaborative effort.\n- The customer may choose which ASIC software design tools to use for much of its ASIC design activities. The Company's design environment, which includes expanded interface capabilities to certain third party EDA software design tools from companies such as Cadence Designs Systems, Inc., Mentor Graphics Corporation, and Synopsys, Inc., allows for such third party tools to be used to perform substantial portions of an ASIC design for a customer. The Company has expertise in the use of these tools and can assist the customer if so desired.\n- The customer may choose the extent to which the customer's ASIC design is based upon the customer's proprietary logic and upon the Company's library elements of predetermined blocks of standard functions. The Company's CoreWare product library elements are the most complex of these predetermined blocks of functions.\n- The customer can choose the degree of functionality it wishes to integrate on a single chip. For example, the customer may integrate an entire electronic system on a single chip or may partition the system's functionality over two or more chips, depending upon a variety of factors.\nUpon completion of the activities that result in a fully computer-simulated ASIC design, the Company's design environment supports automated completion of the physical portions of the design activities such as chip layout and test tape generation. The Company's proprietary design tools are highly integrated with the Company's manufacturing process requirements, thereby providing very high predictability that the product's physical performance will mirror the computer simulation of the chip.\nThe Company believes that prompt delivery of ASIC prototypes is an important element of full customer support in ASIC product development. Accordingly, the Company schedules its manufacturing operations to permit both timely delivery of engineering prototype ASICs and efficient volume production operations.\nASICS\nDESIGN AND TECHNOLOGY SERVICES. The Company has developed and offers to customers its proprietary software design tools. These design tools comprise a computer aided engineering (CAE) design system consisting of a central design software module integrated with other software programs that, together, improve the circuit designer's productivity. The Company's capabilities in design automation are based upon its proprietary Concurrent Modular Design Environment System, also known as C-MDE design tools. The C-MDE design tools are a graphics-based suite of CAE tools that are interactive and provide the designer with the capability of performing design activities based on a single unified database. The Company's earlier design automation tools, known as Modular Design Environment software, or MDE software, continue to be supported by the Company. The Company's proprietary design tools (which operate on a variety of generally available advanced\ncomputer workstation platforms) are used by the Company and its customers to design ASICs which meet the customer's specific functionality and performance requirements.\nThe Company's proprietary software design tools include a basic set of library elements of semiconductor macrocells (these are the basic silicon structures used in the design of logic circuits and the larger predefined functional building blocks \"megacells\" and \"megafunctions\"), technology data bases and design automation software programs. In addition, the Company's CoreWare product library elements are designed for use with the Company's C-MDE design tools. Engineering resources required for development and productization of CoreWare elements are substantially greater than for megacells and megafunctions.\nThe Company's engineering design service approach allows the customers to determine the level of participation which the customers will have in the design process. The Company may provide complete \"turn-key\" engineering support for design projects where the customer provides high-level functional objectives. This type of engineering support is well suited for a customer's system-level design project in which the Company is engaged to utilize one or more of its CoreWare library elements for delivering a system on a single chip. However, the customer may also perform substantial design activity on its own using either the Company's C-MDE design tools or any of a variety of third party EDA vendor's design tools. Access to the Company's C-MDE design tools is available at each of the Company's design centers and for installation at a customer's site pursuant to a licensing agreement with the Company. See \"Properties.\" In addition, customers' designs that have originated through the use of certain third party EDA vendors' design tools are transferrable into the Company's ASIC design environment for manufacture of ASIC devices.\nThe ultimate output of the Company's integrated circuit design system is a pattern generation tape from which the semiconductor \"masks\" or production tooling is made. The system also produces a test tape which is readable by standard industry semiconductor testing equipment. The Company's software design tools support and automatically perform key elements of the design process from circuit concept through physical layout of the circuit design and preparation of pattern generation tapes.\nAfter completion of the engineering design effort, the Company produces and tests prototype circuits for shipment to the customer. Thereafter, the Company will commence volume production of integrated circuits that have been developed through one or more of the arrangements described above in accordance with the customer's quantity and delivery requirements. The Company generally does not have volume production contracts with its customers for engineering design services. Therefore, whether any specific ASIC design will result in volume production orders and the quantities included in such orders are factors beyond the control of the Company. Insufficient orders will result in underutilization of the Company's factory which would adversely impact the Company's operating results.\nAs part of its strategy, the Company has granted licenses to certain large customers for the right to use certain elements of its process technology know- how to enable the customer to manufacture certain products as an internal alternate source of supply. Generally, these licenses are\ngranted in connection with development projects of a customer that has licensed the Company's design tools and has selected the Company as its primary source of ASIC products. In addition, the Company has entered into alternate source license agreements pursuant to which the Company has granted to certain companies the non-exclusive right to utilize and market certain of the Company's logic array design and production technology in competition with the Company. The Company believes that these agreements are important for the long-term development of the logic array semiconductor market.\nCOMPONENTS AND TECHNOLOGIES. The Company offers its customers ASIC solutions based upon metal programmable array, cell-based and Embedded Array architectures which utilize the Company's CoreWare product libraries, the customer's proprietary logic, or a combination of both approaches. The Company offers a wide variety of die sizes and functionality configurations, including both logic and memory elements, for its ASIC products. These products are available in different feature sizes and are based on different process technologies.\nA metal programmable array, also known as a gate array, is a matrix of uncommitted transistors contained on a single chip of silicon. The gate array is \"programmed\" (I.E., customized) only in the last steps of the fabrication process. This enables the manufacturer to produce large quantities of uncommitted gate arrays, known as \"base arrays,\" and to benefit from the economies of volume chip production. These basic silicon substrates, sometimes referred to as \"masterslices\", are designed and manufactured in a fashion similar to standard integrated circuits. The individual elements are interconnected at the metallization step in the manufacturing process to implement user defined functions. Gate arrays, when compared to many standard logic circuits, provide the system manufacturer with lower cost, higher reliability, lower power consumption, increased performance and smaller end products.\nThe Company emphasizes its proprietary Channel-Free gate array architecture for gate array designs. The Company's gate array products offer high levels of design complexity. Base arrays for the Company's different gate arrays are mass produced in a variety of die sizes and are held in inventory by the Company for customization at a later time. During customization, the array is programmed quickly by the interconnection of its logic elements into the exact circuit specified by the customer.\nThe Company's cell-based technology allows the customer to combine standard cells, memories such as fully static random access memory (RAM), static multi- port RAM, metal programmable read only memory (ROM) and other dedicated very large scale integration (VLSI) building blocks called megacells on a single chip. Through combinations of these various cell-based structures, the Company can provide the customer with customized solutions to a wide variety of digital design problems.\nIn addition, the Company offers its customers the opportunity to create proprietary masterslices by utilizing a combination of the Company's standard cell technology with metal programmable Channel-Free gate array technology. This Embedded Array option can provide the\ncustomer with both high performance and density features normally associated with cell-based technology and with fast turnaround times resembling those available only for gate array-based designs.\nDuring 1992, the Company expanded its ASIC product lines with the addition of its CoreWare product library elements. CoreWare library elements are complex VLSI or large system-level pre-designed building blocks of integrated circuit logic functions. CoreWare elements may be either developed by the Company or acquired under technology transfer or licensing agreements between the Company and other developers. In addition, CoreWare elements are highly integrated for use with the Company's proprietary software design tools and those advanced manufacturing processes to which individual cores are targeted.\nThe Company intends the CoreWare elements it offers to be based upon industry standard functions, protocols and interfaces, thereby positioning them to be useful in a wide variety of systems applications. The additional capability afforded by the Company's CoreWare product libraries allows customers to increase functional integration, including system-level applications on a single chip. The Company's CoreWare product libraries are designed to allow CoreWare elements to be used with the customer's proprietary logic in gate array, cell-based or Embedded Array designs based upon the Company's design methodology. Expansion of the Company's CoreWare library elements continued during 1993 and is expected to continue into the foreseeable future.\nThe Company is increasingly emphasizing engineering development and acquisition of CoreWare products and integration of CoreWare libraries into its ASIC design capabilities in the Company's transition from manufacturing products substantially based on the customer's proprietary logic design to emphasizing ASIC opportunities that utilize the Company's CoreWare product libraries. There can be no assurance, however, that the cores selected for investment of the Company's financial and engineering resources will enjoy market acceptance or that such cores can be successfully integrated into the Company's ASIC design environment on a timely basis. See \"Marketing and Customers.\"\nSTANDARD PRODUCTS\nThe Company's product engineering activities for its standard products operations employ the same proprietary computer aided design tools that are used in the Company's ASIC operations. As a result, many of the Company's standard integrated circuit products are available both as standard devices and as large building blocks, and as \"cores\" through the Company's CoreWare product library elements, that may be implemented into a customer's design with the Company's design tools. See \"Products and Services -- ASICs.\" The Company believes that this use of its ASIC technologies affords its standard products operations many of the engineering benefits associated with ASIC designs and offers its customers added flexibility in their systems engineering.\nThe Company's principal microprocessor product focus is on the two 32-bit RISC (Reduced Instruction Set Computer) microprocessor architectures that have met with broad market acceptance. These are the MIPS and the SPARC architectures, which were originally developed by MIPS Computer Systems, Inc. (\"Mips\") and Sun Microsystems, Inc. (\"Sun\"), respectively. In 1992 as a result of a merger, Mips became part of Silicon Graphics, Inc. Both the Mips and Sun architectures are \"open systems\" designs, which various computer and systems companies have adopted for their new products.\nThe Company offers several microprocessor products that implement the MIPS and the SPARC 32-bit RISC architectures. Currently, these microprocessor products are based on certain rights that the Company has received under license agreements from Mips and Sun, respectively. As part of its microprocessor product strategy, the Company also offers a number of peripheral chips that are designed for use in systems based on the two RISC architectures that the Company supports. These chips, which are offered as \"chipsets\", reduce the time required for complete systems design, thereby allowing a systems customer an enhanced opportunity for earlier market entry of its system-level products.\nTo address the telecommunications market, in 1993 the Company announced a reprogrammable asynchronous transfer mode (ATM) termination device which features an on-chip RISC based ATM processing unit. The Company also announced its Compact and Scalable Dedicated Ethernet (CASCADE) product line for implementing single-chip network hubs and routers for internetworking applications.\nThe Company offers a family of high-speed digital signal and image processing devices that perform a wide variety of common DSP operations. These components are designed to operate in stand-alone or in multi-processing configurations that offer flexibility and precision. In 1991, the Company introduced a set of devices which may be combined to allow customers to design high performance video compression \"engines\", such as in video-telephony and high-definition television. In addition, a chipset supporting the JPEG (Joint Photographic Experts Group) standard for still picture compression was introduced in 1991. In 1993, the Company introduced its second generation JPEG device. This JPEG co-processor is a single-chip device targeted at cost sensitive imaging and desktop video applications. Also in 1993, the Company introduced its MPEG2 (Motion Picture Experts Group) video decoder chip, used to create products for digital TV set-top decoders. Many of the DSP devices are available in both commercial and military versions and may be integrated as \"cores\" in a customer's ASIC designs.\nMANUFACTURING\nThe Company's manufacturing operations convert a customer's design into packaged silicon chips and support customer volume production requirements. Manufacturing begins with fabrication of uncommitted (\"masterslice\") wafers (for gate array ASICs) or custom diffused wafers (for cell-based ASICs). Although base layers for cell-based designs are themselves customized, gate array\nmasterslices are not and therefore may be inventoried by the Company pending customization accomplished in the metallization stage of fabrication. In the next stage of manufacture, metallization, layers of metal interconnects are diffused onto the masterslice using customized masks. Wafers are then tested, cut into die and sorted. The die that have passed initial test are then assembled (embedded in and connected to one of a wide variety of packages) and encapsulated. The finished devices then undergo additional tests before shipment.\nIn 1985, the Company and Kawasaki Steel Corporation (\"Kawasaki\") formed a Japanese subsidiary, Nihon Semiconductor Inc. (\"NSI\"), as part of a comprehensive business relationship, including licensing certain technology to Kawasaki. The Company maintains a majority ownership interest in NSI and is the customer for substantially all of NSI's production. The Company has licensed to NSI, on a non-exclusive basis, certain technology rights and is providing NSI related support services. NSI has been in commercial production since August of 1988. NSI commenced volume production at a second wafer fabrication facility in the first quarter of 1994. The Company manufactures substantially all of its wafers at the two NSI facilities in Tsukuba, Japan pursuant to an agreement with NSI and Kawasaki. The Company's ability to supply semiconductors currently depends on an adequate continued supply of wafers from NSI. If the supply of wafers from NSI were interrupted for any reason, including work stoppages, or natural disasters, or if such supplies of wafers were inadequate to meet the Company's demand, the Company would need to purchase wafers from one or more alternate suppliers. There can be no assurance that alternate supplies of wafers would be available on a timely basis or at all or that if available, they could be purchased on favorable terms. The Company continues to perform certain fabrication activities for metallization and for custom diffused wafers in its wafer fabrication facilities in California.\nThe semiconductor industry is capital intensive. In order to remain competitive, the Company must continue to make significant investments in new facilities and capital equipment. In the last three years, the Company has expended over $300 million in property and equipment, net of retirements. In the first quarter of 1994, the Company commenced volume production at its Japanese affiliate's second wafer fabrication facility and anticipates incurring in excess of $100 million during 1994 for capital equipment and significant amounts thereafter to bring this facility to full capacity. The Company believes that in order to remain competitive, it will need to continue making significant capital expenditures. There can be no assurance that the Company will have the resources available when needed to meet these requirements. In addition, these significant capital expenditures result in a relatively high level of fixed costs. Accordingly, fluctuations in revenues may significantly affect profitability.\nOver the past four years, the Company has restructured its worldwide manufacturing operations. This process has included, among other things, the phase-down of older process technology facilities in Germany, the United Kingdom and Canada, the consolidation of certain manufacturing to facilities in the United States and Japan, the construction of a second wafer fabrication facility in Japan, and the transfer of certain packaging, assembly and final test operations to subcontractors in various locations. The Company continues to evaluate its worldwide manufacturing operations to effect additional cost- savings and technological improvements.\nTo remain competitive, the Company must be able to develop and implement new process technologies to reduce semiconductor die size, increase device performance, and manufacturing yields. The Company utilizes different high performance complementary metal oxide semiconductor (\"CMOS\") process technologies in the volume manufacture of its products, including a 0.6-micron \"drawn\" CMOS process for the Company's most advanced products. The Company also has recently introduced a 0.5-micron \"drawn\" CMOS process and has begun performing product engineering services for certain customers that are intended to result in products to be manufactured using this 0.5-micron process. The Company is currently implementing this new 0.5-micron process technology at NSI's second Japanese wafer manufacturing facility. If the Company is not able to successfully implement new process technologies and to achieve volume production of new products at acceptable yields using new manufacturing processes, the Company's operating results will be adversely affected.\nDevelopment of advanced manufacturing technologies in the semiconductor industry frequently requires that critical selections be made as to those vendors from which essential equipment (including future enhancements) and after sales services and support will be purchased by the Company. Similarly, procurement of certain types of materials required by the Company's manufacturing technologies also are closely linked with certain equipment selections. When the Company implements specific technology choices, it may become dependent upon certain sole- or single- source vendors. Accordingly, the Company's capability to switch to other technologies and vendors may be substantially restricted and may involve significant expense and delay in the Company's technology advancements and manufacturing capabilities. The semiconductor equipment and materials industries also contain a number of vendors that are relatively small and have limited resources. Several of these vendors provide equipment and or services to the Company. The Company does not have long term supply or service agreements with vendors of certain critical items. Additionally, there can be no assurances that disruptions in these vendors' ability to perform will not occur. Should the Company experience such disruptions, the Company's operations could be adversely affected.\nThe Company has in the past and will in the future, consider developing foundry relationships with certain other semiconductor manufacturers whereby the Company may purchase quantities of masterslices (both unmetallized and metallized) that are manufactured to the Company's specifications. The Company believes that the combination of the Company's own wafer fabrication facilities and these relationships will provide the Company with adequate sources for meeting its masterslice wafer and custom diffused wafer requirements for the foreseeable future.\nIn the assembly process, the fabricated circuit is encapsulated into ceramic or plastic packages. Plastic packaging is normally associated with lower cost, commercially oriented products. Ceramic packaging is primarily utilized in applications involving the need to protect the circuit against a potentially harsh operating environment, such as in military applications.\nThe Company performs ceramic package assembly for its products at its Fremont, California facility. This assembly line has been specially equipped to support both the packaging needs of military as well as selected commercial applications. The proportion of ceramic packaging being\ndone by independent assembly plants continues to increase and the Company intends to begin ceramic packaging offshore in the next year. The Company has subcontracted its plastic packaging requirements to several independent offshore assembly plants.\nTesting includes final test and final quality assurance acceptance. Dedicated computer systems are used in this comprehensive testing sequence. The test programs utilize the basic functional test criteria from the design simulation which was generated and approved by the customers' design engineers. Most product testing operations are currently conducted in close proximity to the particular facility where assembly activities are performed. The Company intends to continue increasing its use of independent assembly plants to test its products.\nCertain of the raw materials used in the manufacture of circuits are available from a limited number of suppliers in the United States and elsewhere. For example, for several types of the integrated circuit packages that are purchased by the Company, as well as by the majority of other companies in the semiconductor industry, the Company must rely on one vendor for the majority of its supply. The Company does not have long-term fixed supply contracts with its suppliers. Shortages could occur in various essential materials due to interruption of supply or increased demand in the industry. If the Company were unable to procure certain of such materials from any source, it would be required to reduce its manufacturing operations. To date, the Company has experienced no significant difficulty in obtaining the necessary raw materials. The Company's operations depend upon a continuing adequate supply of electricity, natural gas and water.\nThe Company purchases substantially all of the semiconductor wafers used for its products from NSI, its Japanese affiliate. These transactions are denominated in Japanese yen. In addition, the Company purchases a substantial portion of its raw materials and equipment from foreign suppliers and incurs labor costs in foreign locations. A portion of these transactions are denominated in currencies other than in U.S. dollars, principally in Japanese yen. The Company also has borrowings denominated in yen, which totaled approximately 15 billion yen (approximately $136 million) at December 31, 1993. Such transactions and borrowings expose the Company to exchange rate fluctuations for the period of time from inception of the transaction until it is settled. In recent years, the yen has fluctuated substantially against the U.S. dollar. There can be no assurance that fluctuations in the currency exchange rates in the future will not have an adverse impact on the Company's results of operations. The Company has entered and will from time to time enter into hedging transaction in order to minimize exposure to currency rate fluctuations. In addition, there can be no assurance that inflation rates in countries where the Company conducts operations will not adversely affect the Company's operating results in the future.\nBoth manufacturing and sales of the Company's products may be adversely affected by political and economic conditions abroad. Protectionist trade legislation in either the United States or foreign countries, such as a change in the current tariff structures, export compliance laws or other trade policies, could adversely affect the Company's ability to manufacture or sell in foreign markets. In countries in which the Company is conducting business in local currency, currency exchange fluctuations could adversely affect the Company's revenues or costs.\nMARKETING AND CUSTOMERS\nThe Company has focused its marketing efforts primarily on a broad base of manufacturers in the electronic data processing, telecommunications and certain office automation industries and, within these industries emphasizes desktop and personal computing, networking and digital video applications.\nAn essential element of the Company's marketing strategy is to develop close working relationships with its major customers' engineers by using the Company's proprietary software design tools for design support and training services. The customers' product or system design engineers typically attend a training session at one of the Company's design centers. Alternatively, the customer may elect to have the Company design the circuit, or may design the circuit at its own facility through the licensing of the Company's proprietary design tools. The Company currently has regional design centers in Canada, Japan, other Asia Pacific countries and throughout the United States and Western Europe. See \"Properties\".\nThe Company markets its products and services through its worldwide direct sales and marketing organization which consists of approximately 775 employees (including subsidiaries), and through independent sales representatives and distributors. All of the Company's design centers also include a direct sales office. See \"Properties\". For information concerning foreign operations, see Note 7 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Stockholders and \"Products and Services--Strategy.\" International sales are generally denominated in local currencies. International sales are subject to risks common to export activities, including governmental regulations, trade barriers, tariff increases and currency fluctuations. To date, the Company has not experienced any material difficulties because of these risks.\nIn 1993, 1992 and 1991 Sun Microsystems, Inc. accounted for approximately 12%, 15% and 16%, respectively, of the Company's revenues. The Company has increasingly directed its efforts on developing strategic relationships with key technology leaders with differentiated products. This strategy provides the Company with access to leading technologies, some of which may be included in its CoreWare library. The Company, however, expects that this strategy will result in the Company becoming increasingly dependent on a limited number of customers for a substantial portion of its revenues.\nBACKLOG\nGenerally, the Company's customers are not subject to long-term contracts, but to purchase orders which are accepted by the Company. Quantities of the Company's products to be delivered and delivery schedules under purchase orders outstanding from time to time are frequently revised to reflect changes in customer needs. In addition, the timing of the performance of design services\nincluded in the Company's backlog at any particular time is generally within the control of the customer, not the Company. For these reasons, the Company's backlog as of any particular date is not a meaningful indicator of future sales.\nCOMPETITION\nThe semiconductor industry is intensely competitive and is characterized by rapid technological change, rapid product obsolescence and price erosion. The semiconductor industry has historically been characterized by wide fluctuations in product supply and demand. From time to time, the industry also has experienced significant downturns, often in connection, or in anticipation of maturing product cycles (of both the Company and its customers) and declines in general economic conditions. These downturns have been characterized by diminished product demand, production overcapacity and subsequent accelerated erosion of average selling prices, and in some cases have lasted for more than a year. Currently, the semiconductor industry in general, including the Company, is experiencing a period of increased demand. There is no assurance that these conditions will continue. The Company may experience substantial period-to- period fluctuations in future operating results due to general industry conditions or events occurring in the general economy and the Company's business could be materially and adversely affected by a significant industry-wide downturn in the future.\nThe Company's competitors include many large domestic and foreign companies which have substantially greater financial, technical and management resources than the Company, as well as emerging companies attempting to sell products to specialized markets such as those addressed by the Company. Several major diversified electronics companies, including Fujitsu, Ltd., Toshiba Corporation, NEC Corporation and a number of United States semiconductor manufacturers offer ASIC products and\/or offer products which are competitive to the product lines of the Company. In addition, there is no assurance that certain large customers, some of whom the Company has licensed to use elements of its process and product technologies, will not develop internal design and production operations to produce their own ASICs.\nThe principal factors on which competition in the ASIC market is based include design capabilities (including both the software design tool features, compatibility with industry standard design tools, CoreWare library and the skills of the design team), quality, delivery time and price. The Company believes that it presently competes favorably on these bases, and that its success will depend on its continued ability to provide its customers with a complete range of design services and manufacturing capabilities. There can be no assurance, however, that other custom logic design approaches will not be developed which could have an adverse impact on the Company's business and results of operations.\nRESEARCH AND DEVELOPMENT\nThe market for the Company's products is characterized by rapid changes in both product and process technologies. Because of continual improvements in these technologies, the Company\nbelieves that its future success will depend, in part, upon its ability to continue to improve its product and process technologies and to develop new technologies in order to maintain the performance advantages of its products and processes relative to competitors, to adapt products and processes to technological changes and to adopt emerging industry standards.\nThe Company's research and development emphasizes the design of new products, improvements in process technologies, enhancements of design tools, and cost reduction of existing products. During 1993, 1992 and 1991, the Company expended $78,995,000, $78,825,000, and $80,802,000, respectively, on its research and development activities. The Company expects to continue to make significant investments in research and development activities and believes such investments are critical to its ability to continue to compete with other ASIC manufacturers. See \"Management's Discussion and Analysis\" in the 1993 Annual Report to Stockholders.\nPATENTS, TRADEMARKS AND LICENSES\nThe Company owns various United States and international patents and has additional patent applications pending relating to certain of its products and technologies. The Company also maintains trademarks on certain of its products and services. Although the Company believes that patent and trademark protection have value, the rapidly changing technology in the semiconductor industry makes the Company's future success dependent primarily upon the technical competence and creative skills of its personnel rather than on patent and trademark protection.\nAs is typical in the semiconductor industry, the Company has from time to time received, and may in the future receive, communications from other parties asserting patent rights, mask work rights, copyrights or trademark rights that such other parties allege cover certain of the Company's products, processes, technologies or information. Several such assertions relating to patents are in various stages of evaluation. The Company is considering whether to seek licenses with respect to certain of these claims. Litigation has arisen with respect to one of these assertions. Based on industry practice, the Company believes that licenses or other rights, if necessary, could be obtained on commercially reasonable terms. Nevertheless, no assurance can be given that licenses can be obtained, or if obtained will be on acceptable terms or that litigation or other administrative proceedings will not occur. The inability to obtain licenses or other rights or to obtain licenses or rights on favorable terms, should such become necessary, or litigation arising out of such other parties' assertions, could have a material adverse effect on the Company's future operating results. See \"Legal Proceedings.\"\nThe Company has also entered into certain license agreements which generally provide for the non-exclusive licensing of design and product manufacturing rights and for cross-licensing of future improvements developed by either party. See \"Products and Services--Strategy\" and \"Competition\".\nENVIRONMENTAL REGULATION\nFederal, state and local regulations impose various environmental controls on the use and discharge of certain chemicals and gases used in semiconductor processing. The Company's facilities have been designed to comply with these regulations and the Company believes that its activities conform to present environmental regulations. Increasing public attention has, however, been focused on the environmental impact of electronics and semiconductor manufacturing operations. While the Company to date has not experienced any materially adverse effects on its business from environmental regulations, there can be no assurance that such regulations will not be amended so as to impose expensive obligations on the Company. In addition, violations of environmental regulations or unpermitted discharges of hazardous substances could result in the necessity for additional capital improvements to comply with such regulations or to restrict discharges, liability to Company employees and\/or third parties, and business interruptions as a consequence of permit suspensions or revocations or as a consequence of the granting of injunctions requested by governmental agencies or private parties.\nEMPLOYEES\nAt January 2, 1994, the Company and its subsidiaries had approximately 3,370 employees, including approximately 775 in field marketing and sales, approximately 425 in product marketing and support, approximately 525 in engineering and research and development activities, approximately 1,370 in manufacturing and approximately 275 in executive and administrative activities.\nMany of the Company's employees are highly skilled, and the Company's continued success will depend in part upon its ability to attract and retain such employees, who are in great demand. The Company has never had a work stoppage, slow-down or strike and no United States employees are represented by a labor organization. The Company considers its employee relations to be good.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe following table sets forth certain information concerning the Company's principal facilities.\nThe Company maintains leased regional office space for its field sales offices at the locations described below, some of which also contain design centers as indicated. In addition, the Company maintains design centers at various distributor locations.\nRegional Offices - ---------------- U.S. Locations: - --------------\n*Encino, CA Grass Valley, CA *Irvine, CA Mountain View, CA San Diego, CA *San Jose, CA Boca Raton, FL *Melbourne, FL Atlanta, GA *Schaumburg, IL *Waltham, MA *Bethesda, MD Columbia, MD *Minneapolis, MN *Raleigh, NC *Edison, NJ Hopewell Junction, NY Victor, NY Beaverton, OR Hanover, PA Willow Grove, PA Austin, TX *Dallas, TX *Bellevue, WA\nNon-U.S. Locations: - ------------------\n*Burnaby, British Columbia, Canada *Etobicoke, Ontario, Canada *Kanata, Ontario, Canada *Montreal, Quebec, Canada *Paris, France Berlin, Germany *Munich, Germany *Stuttgart, Germany *Ramat Hasharon, Israel *Milan, Italy Kanagawa, Japan *Osaka, Japan *Seoul, Korea *Livingstone, Scotland Madrid, Spain *Kista, Sweden *Taipei, Taiwan ___________________________ * Indicates location of Design Center as well as Sales Office\nLeased facilities described above are subject to operating leases which expire in 1994 through 2003. See Note 8 of Notes to Consolidated Financial Statements in the 1993 Annual Report to Stockholders.\nThe Company believes that its existing facilities and equipment are well maintained, in good operating condition and are adequate to meet its current requirements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn July 9, 1990, Texas Instruments Incorporated (\"TI\") filed a complaint in the United States District Court in Dallas, Texas and with the International Trade Commission (\"ITC\") against the Company and four other defendants, Analog Devices, Inc., Integrated Device Technology, Inc., VLSI Technology, Inc. and Cypress Semiconductor Corporation. In these complaints, TI alleged that the Company's manufacturing processes relating to device encapsulation in certain types of plastic packages infringe certain of TI's patents.\nIn the ITC action, TI sought to prohibit the importation into the U.S. of such plastic encapsulated devices assembled offshore and to enjoin the sale of any inventory of such devices which were previously imported. On October 15, 1991, the Administrative Law Judge (\"ALJ\") determined that the TI patent was valid and that the plastic encapsulation process used by the Company referred to as \"opposite-side\" gated encapsulation infringed the TI patent. The ALJ also determined that the plastic encapsulation process referred to as \"same-side\" gated encapsulation did not infringe the TI patent. On December 3, 1991, the ITC issued a notice of its intent not to review the ALJ's determination on non- infringement by the \"same-side\" gated process, thereby confirming the ALJ's determination. On February 19, 1992, the ITC issued its final order which confirmed the ALJ's determination regarding validity of the TI patent and infringement by the \"opposite-side\" gated process. Pursuant thereto, the ITC issued a limited exclusion order applicable to future imports of integrated circuits manufactured using the \"opposite-side\" gated process into the United States and a cease and desist order applicable to sales of previously imported integrated circuits manufactured using the \"opposite-side\" gated process. Since the beginning of 1992, the Company's plastic encapsulation operations have only used the non-infringing \"same-sided\" gating process. The Court of Appeals for the Federal Circuit has affirmed the ruling of the ITC in all respects in March 1993.\nIn TI's United States District Court action, TI also seeks to enjoin the Company from assembling and selling plastic encapsulated integrated circuits in the U.S. and seeks damages in an unspecified amount for alleged prior patent infringement. Although at one point in the District Court proceedings a trial date was set for mid-1992, that date was taken off the calendar and no new trial date has been scheduled. The Company anticipates that the judge will consider and rule on a number of pretrial motions, including motions on what significance, if any, various elements of the prior ITC action should or should not have on trial proceedings in the District Court, before a new trial date is scheduled.\nThe Company believes that it has meritorious defenses to the District Court action and intends to defend itself vigorously. The Company also believes that the ultimate outcome of this action will not result in a material adverse effect on the Company's consolidated financial position or results of operations. No assurance can be given, however, that this matter will be resolved without the\npayment of damages and other costs, thereby having an adverse effect on the Company.\nThe Company is a party to other litigation matters and claims which are normal in the course of its operations, and while the results of such litigation and claims cannot be predicted with certainty, the Company believes that the final outcome of such matters will not have a materially adverse effect on the Company's consolidated financial position or results of operations.\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\nThe information required by this Item is incorporated by reference to page 31 of the Company's 1993 Annual Report to Stockholders.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe information required by this Item is incorporated by reference to pages 32-33 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 by this Item is incorporated by reference to pages 13-16 of the Company's 1993 Annual Report to Stockholders.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe information required by this Item is incorporated by reference to pages 17-31 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\nCertain information required by Part III is omitted from this Report in that the registrant will file a definitive proxy statement within 120 days after the end of its fiscal year pursuant to Regulation 14A (the \"Proxy Statement\") for its Annual Meeting of Stockholders to be held May 6, 1994, and certain of the information included therein is incorporated herein by reference.\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information concerning the Company's directors required by this Item is incorporated by reference to \"ELECTION OF DIRECTORS--Nominees\" in the Company's Proxy Statement.\nThe executive officers of the Company, who are elected by and serve at the discretion of the Board of Directors, are as follows:\nEmployed Name Age Position Since - ---- --- -------- --------\nWilfred J. Corrigan 55 Chairman, Chief Executive Officer 1981\nBruce L. Entin 43 Vice President, Investor Relations 1984 and Corporate Communications\nBrian L. Halla 47 Executive Vice President, 1988 LSI Logic Products\nCyril F. Hannon 55 Executive Vice President, 1984 Worldwide Operations\nAlbert A. Pimentel 38 Senior Vice President, Finance 1992 and Chief Financial Officer\nDavid E. Sanders 46 Vice President, General Counsel and 1986 Secretary\nHorst G. Sandfort 51 Executive Vice President, 1984 Geographic Markets\nLewis C. Wallbridge 50 Vice President, Human Resources 1984\nExcept as set forth below, all of the officers have been associated with the Company in their present position or other capacities for more than the past five years.\nBrian C. Halla joined the Company in August of 1988 as Vice President, Microprocessor Products. He was promoted to Executive Vice President, LSI Logic Products in May 1992. From January, 1975 to August, 1988, Mr. Halla was employed by Intel Corporation in positions of increasing responsibility, including posts in product marketing management for Intel's Development Systems Group and more recently as Director of Marketing for Intel's Microcomputer Group.\nAlbert A. Pimentel joined the Company in July 1992 as Senior Vice President, Finance and Chief Financial Officer. From December 1990 until February 1991, Mr. Pimentel served as Vice President of Finance, Chief Financial Officer and Secretary of Momenta Corporation, a start up company in the pen computing business. As the result of a corporate reorganization, Momenta Corporation became a wholly-owned subsidiary of Momenta International Ltd. and Mr. Pimentel assumed the same positions for Momenta International Ltd. until July 1992. In August 1992, Momenta International Ltd. and its subsidiaries filed a petition for relief in Federal bankruptcy court. Mr. Pimentel served as Vice President, Finance of Conner Peripherals, Inc., a manufacturer of disk drives, from May of 1986 until December of 1990.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information required by this Item is incorporated by reference to \"EXECUTIVE COMPENSATION\" in the Company's Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information required by this Item is incorporated by reference to \"SECURITY OWNERSHIP -- Principal Stockholders and Security Ownership of Management\" in the Company's Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information required by this Item is incorporated by reference to \"CERTAIN TRANSACTIONS\" in the Company's Proxy Statement.\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. The following Consolidated Financial Statements of LSI Logic Corporation and Report of Independent Accountants are incorporated by reference to the Company's 1993 Annual Report to Stockholders:\nPage in Annual Report ------------- Consolidated Balance Sheets - As of December 31, 1993 and 1992 17\nConsolidated Statements of Operations - For the Three Years Ended December 31, 1993 18\nConsolidated Statement of Stockholders' Equity - For the Three Years Ended December 31, 1993 19\nConsolidated Statements of Cash Flows - For the Three Years Ended December 31, 1993 20\nNotes to Consolidated Financial Statements 21\nReport of Independent Accountants 30\nReport of Independent Accountants on Financial Statement Schedules - See page 32 of this Report.\nEffective beginning 1990, the Company changed its fiscal year end from December 31 to the 52 or 53 week period which ends on the Sunday closest to December 31. For presentation purposes, the consolidated financial statements, notes and financial statement schedules will continue to refer to December 31 as the year end. Fiscal 1993 was a 53 week year that ended on January 2, 1994.\n2. FINANCIAL STATEMENT SCHEDULES. For years ended December 31, 1993, 1992 and 1991:\nSchedule Page - -------- ---- II Amounts Receivable from Related Parties and Underwriters, Promoters and Employees other than Related Parties S-1\nV Property and Equipment S-2\nVI Accumulated Depreciation of Property and Equipment S-3\nVIII Valuation and Qualifying Accounts and Reserves S-4\nX Supplementary Income Statement Information S-5\nAll other schedules are omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\n3. EXHIBITS:\n3.1 Restated Certificate of Incorporation of Registrant. (1)\n3.2 By-laws of Registrant. (1)\n4.1 Articles 4 and 9 of the Restated Certificate of Incorporation of Registrant (included in Exhibit 3.1). (1)\n4.2 Indenture dated April 14, 1987 between LSI Logic Corporation and United States Trust Company of New York, Trustee, covering $125,000,000 principal amount of 6 1\/4% Convertible Subordinated Debentures due 2002 (including form of Debenture). (2)\n4.3 Stockholder Rights Plan dated November 16, 1988. (3)\n10.1 Lease dated March 26, 1981 for 1601 McCarthy Boulevard between the Registrant and McCarthy Industrial Investors. (4)\n10.1A First Amendment to Lease dated May 1, 1991 to Lease dated March 26, 1981 for 1601 McCarthy Boulevard between the Registrant and McCarthy Industrial Investors. (11)\n10.2 Registrant's 1982 Incentive Stock Option Plan, as amended, and forms of Stock Option Agreement. (9)\n10.3 Registrant's Employee Stock Purchase Plan, as amended, and form of subscription Agreement.\n10.6 Series B Preferred Shares Purchase Agreement for 1,395,864 shares of Series B Preferred Stock dated as of February 8, 1982. (4)\n10.7 Modification Agreement dated as of February 8, 1982 between the Registrant and holders of its Series A Preferred Stock. (4)\n10.8 Lease Agreement dated November 22, 1983 for 48580 Kato Road, Fremont, California between the Registrant and Bankamerica Realty Investors. (6)\n10.19 Registrant's 1985 Nonstatutory Stock Option Plan for Shares of LSI Logic Europe plc and form of Nonstatutory Stock Option Agreement. (5)\n10.20 LSI Logic Europe plc 1984 Nonstatutory Stock Option Plan and form of Nonstatutory Share Option Agreement. (5)\n10.21 Registrant's 1985 Nonstatutory Stock Option Plan for Shares of LSI Logic Corporation of Canada, Inc. and form of Nonstatutory Stock Option Agreement. (5)\n10.24 Registrant's 1986 Directors' Stock Option Plan and forms of stock option agreements. (7)\n10.25 LSI Logic Europe plc 1986 Share Option Scheme. (7)\n10.26 LSI Logic Europe plc Share Acquisition Scheme. (7)\n10.27 LSI Logic Corporation of Canada, Inc. 1985 Stock Option Plan and form of Stock Option Agreement. (7)\n10.29 Form of Indemnification Agreement entered and to be entered into between Registrant and its officers, directors and certain key employees. (8)\n10.35 LSI Logic Corporation 1991 Equity Incentive Plan.\n10.36 Lease Agreement dated February 28, 1991 for 765 Sycamore Drive, Milpitas, California between the Registrant and the Prudential Insurance Company of America. (10)\n11.1 Statement Re Computation of Earnings Per Share\n13.1 Annual Report to Stockholders for the year ended January 2, 1994 (to be deemed filed only to the extent required by the instructions to exhibits for Reports on Form 10-K).\n21.1 List of Subsidiaries.\n23.1 Consent of Independent Accountants (see page 33).\n24.1 Power of Attorney (included on page 30).\n____________ (1) Incorporated by reference to exhibits filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 26, 1988.\n(2) Incorporated by reference to exhibits filed with the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 27, 1988.\n(3) Incorporated by reference to exhibits filed with the Registrant's Form 8-A filed on November 21, 1988.\n(4) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-1 (No. 2-83035) which became effective May 13, 1983.\n(5) Incorporated by reference to exhibits filed with the Registrant's Registration Statement on Form S-1 (No. 33-3612), and Amendment No. 1 thereto, which became effective March 20, 1986.\n(6) Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1983.\n(7) Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1986.\n(8) Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1987.\n(9) Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1988.\n(10) Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1991.\n(11) Incorporated by reference to exhibits filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992. ____________\n(b) Reports on Form 8-K. ------------------- None.\nTRADEMARK ACKNOWLEDGMENTS\n- LSI Logic is a registered trademark of the Company and CoreWare is a trademark of the Company. All other brandnames or trademarks appearing in the Form 10-K are the property of their respective owners.\n- Channel-Free, Embedded Array, LDS, Modular Design Environment, MDE and Headland Technology are registered trademarks of the Company. C-MDE, CASCADE, Compacted Array and CoreWare are trademarks of the 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.\nLSI LOGIC CORPORATION\nBy: \/s\/ WILFRED J. CORRIGAN ------------------------------- Wilfred J. Corrigan, Chairman and Chief Executive Officer\nDated: March 4, 1994\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Wilfred J. Corrigan and David E. Sanders, jointly and severally, his attorneys-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may 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 Registrant and in the capacities and on the dates indicated.\nSignature Title Date --------- ----- ----\n\/s\/ Wilfred J. Corrigan Chairman of the Board and March 4, 1994 - ----------------------- Chief Executive Officer (Wilfred J. Corrigan) (Principal Executive Officer)\n\/s\/ Albert A. Pimentel Senior Vice President, Finance March 4, 1994 - ----------------------- and Chief Financial Officer (Albert A. Pimentel) (Principal Financial Officer and Principal Accounting Officer)\n\/s\/ T.Z. Chu Director March 4, 1994 - ----------------------- (T.Z. Chu)\n\/s\/ Malcolm R. Currie Director March 4, 1994 - ----------------------- (Malcolm R. Currie)\n\/s\/ James H. Keyes Director March 4, 1994 - ----------------------- (James H. Keyes)\n\/s\/ R. Douglas Norby Director March 4, 1994 - ----------------------- (R. Douglas Norby)\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of LSI Logic Corporation\nOur audits of the consolidated financial statements referred to in our report dated January 25, 1994 appearing on Page 30 of the 1993 Annual Report to Stockholders of LSI Logic 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 Item in 14(a) of this 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.\nPrice Waterhouse San Jose, California January 25, 1994\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 2-86474, No. 2-91907, No. 2-98732, No. 33-6188, No. 33-6203, No. 33-13265, No. 33-17720, No. 33-30385, No. 33-30386, No. 33-36249, No. 33-41999, No. 33-42000, No. 33-53054, No. 33-66548, No.33-66546) of LSI Logic Corporation of our report dated January 25, 1994 appearing on page 30 in 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 32 of this Annual Report on Form 10-K.\nPRICE WATERHOUSE San Jose, California March 4, 1994\nSCHEDULE II\nSCHEDULE V\nSchedule VI\nSCHEDULE VIII\nSCHEDULE X\nINDEX TO EXHIBITS\nEXHIBIT NUMBER\n10.3 Employee Stock Purchase Plan and form of Subscription Agreement\n10.35 LSI Logic Corporation 1991 Equity Incentive Plan\n11.1 Statement Re Computation of Earnings Per Share\n13.1 Annual Report to Stockholders for the year ended January 2, 1994 (to be deemed filed only to the extent required by the instructions to exhibits for Reports on Form 10-K)\n21.1 List of Subsidiaries\n23.1 Consent of Independent Accountants (see page 33)\n24.1 Power of Attorney (included on page 30)","section_15":""}
{"filename":"46080_1994.txt","cik":"46080","year":"1994","section_1":"ITEM 1. BUSINESS -------- (a) General Development of Business ------------------------------- The Company designs, manufactures and markets a diverse line of toy products and related items throughout the world. Included in its offerings are games and puzzles, preschool, boys' action and girls' toys, dolls, plush products and infant products, including infant apparel. The Company also licenses various tradenames, characters and other property rights for use in connection with the sale by others of noncompeting toys and non-toy products.\nExcept as expressly indicated or unless the context otherwise requires, as used herein, the \"Company\" means Hasbro, Inc., a Rhode Island corporation organized on January 8, 1926, and its subsidiaries.\n(b) Description of Business Products -------------------------------- The Company's products are categorized for marketing purposes as follows:\n(i) Hasbro Toy Group ---------------- During 1994, the Company established the Hasbro Toy Group, bringing all of its domestic infant, preschool, activity, boys and girls products together within one organization. Previously, the Company operated separate organizations to develop and market its Playskool, Hasbro Toy and Kenner brand products.\nThe infant and preschool items are principally marketed under the Playskool brand and are specifically designed for preschool children, toddlers and infants.\nThe preschool line includes such well known products as Lincoln Logs(R), Tinkertoy(R), Mr. Potato Head(R), In-Line Skates, 1-2-3 Bike(TM) and the \"Busy(R)\" line of toys; electronic items including Talking Alphie(R) and Talking Barney(TM); various role play products including the Magic Tea Party(TM) and the Magic Smoking Grill(TM) and toys utilizing the \"Sesame Street(R)\" character motifs sold under licenses from Children's Television Workshop. New items for 1995 include the Playskool(R) Playstore, the 1-2-3 Swing(TM), 1-2-3 Baseball(TM) and All-in-One Fun Learning Center.\nPlayskool's line of infant and juvenile items consists of products for very young children, including the award winning 1-2-3 High Chair(TM), Musical Dream Screen(TM), the Steady Steps(R) line of walkers, the Pur(R) line of silicone nipples and pacifiers, bibs and other infant accessories such as the Hugger(R) toothbrush, a full line of health care and safety products, Tommee Tippee(TM) training cups and feeding items, water-filled teething rings, soft toys, rattles and infant apparel including the Scootees(R) line of soft shoes for babies. New products in 1995 include the Roll 'n Rattle Ball, Big 'n Bright Quilt and First Wheels.\nThe Hasbro Toy Group also offers activity items for both girls and boys including the Fantastic Sticker Maker(TM) and the Fantastic Flowers(TM) flower making kit as well as such classics as Play-Doh(R), Easy-Bake(R) Oven and the Spirograph(R) design toy. New offerings for 1995 include several innovative toys based on The Magic School Bus(TM) television and book series, an assortment of toys marketed under the Nickelodeon(R) name, the Power Spark(TM) Welding Set and Techno Zoids(TM) action construction toys.\nIts girls items include the Raggedy Ann(R) and Raggedy Andy(R) line of rag dolls and the Littlest Pet Shop(R) figures and playsets along with the Baby Check-Up(R) and Baby All Gone(R) dolls. Included in its new introductions for 1995 are Bride Surprise(TM), Princess Wishing Star(TM) and the Baby Buddies(TM) line of collectible figures and playsets.\nIn boys' toys it offers a wide range of products, many of which are tied to entertainment properties, including Batman(R), Mortal Kombat(TM) and Congo(TM) action figures and accessories. It also offers such classic properties as G.I. Joe(R), The Transformers(R), the Tonka(R) line of trucks and vehicles, including the Electronic Talk'n Play(TM) Fire Truck, and the Nerf(R) line of soft action play equipment. A sucessful entrant into the remote controlled vehicle category in 1994 was the Ricochet(TM) radio-controlled vehicle which will be joined by other vehicles in 1995, namely the Tirestorm(TM) and Stunt Boss(TM). Other new introductions for 1995 include action figures based on the upcoming movie Batman(TM) Forever and the television series Gargoyles and Saban's VR Troopers(TM) and the Tonka(R) Farm Playset. In 1995, the Company acquired the Super Soaker(TM) line of water products and certain other assets from the Larami group of companies. These products will give the Company a core franchise in an area in which it had not previously been represented.\n(ii) Hasbro Games Group ------------------ Beginning in 1995, the Company's two game units, Milton Bradley and Parker Brothers, are being managed as one organization, the Hasbro Games Group.\nMilton Bradley markets quality games and puzzles, including board, strategy and word games, skill and action games and travel games. It maintains a diversified line of more than 200 games and puzzles for children and adults. Its staple items include Battleship(R), The Game of Life(R), Scrabble(R), Chutes and Ladders(R), Candy Land(R), Lite-Brite(R), Trouble(R), Mousetrap(R), Operation(R), Hungry Hungry Hippos(R), Connect Four(R), Twister(R) and Big Ben(R) Puzzles. The Company also manufactures and sells games and puzzles for the entire family, including such games as Yahtzee(R), Parcheesi(R), Aggravation(R), Jenga(R) and Scattergories(R) and Puzz 3-D(TM), a series of three dimensional jigsaw puzzles. Games added to the Milton Bradley line for 1995 include Chicken Limbo(TM), Channel Surfing(TM) and a refreshed version of Pictionary(R).\nParker Brothers markets a full line of games for families, children and adults. Its classic line of family board games includes Monopoly(R), Clue(R), Sorry!(R), Risk(R), Boggle(R), Ouija(R) and Trivial Pursuit(R), some of which have been in the Parker Brothers' line for more than 50 years. The Company also markets traditional card games such as Mille Bornes(R), Rook(R), Rack-O(R), Old Maid and Go Fish. Its line of travel games includes travel editions of Monopoly(R) Junior, Clue(R), Sorry!(R) and Boggle(R) Jr. Several well-known games, including Balderdash(R), Hi! Ho! Cherry-O(R) and Outburst(R), were added to its portfolio during 1994 through the acquisition of certain game and puzzle assets from Western Publishing. New to the Parker Brothers' line in 1995 are Peanut Panic(TM), Marble Dome(TM) and Puzzle Pursuit(TM), a new game from the makers of Trivial Pursuit(R).\n(iii) International ------------- The Company conducts its international operations through subsidiaries in more than 25 countries which sell a representative range of the products marketed in the United States together with some items which are sold only internationally.\nThroughout the world, the Company markets products sourced by a Hong Kong subsidiary working primarily through unrelated manufacturers in various Far East countries, and in the Americas it markets products supplied by the Company's Mexican and U.S. manufacturing operations. Additionally, subsidiaries in Europe market products primarily manufactured by the Company in Ireland and Spain; those in Australia and New Zealand, products manufactured by the Company in New Zealand and in Canada, certain products which it assembles in Canada from components supplied by the Company's U.S. and Mexican operations. The Company has small investments in joint ventures in India and the Peoples Republic of China which manufacture and sell products both to the Company and unaffiliated customers. The Company also has Hong Kong units which market directly to retailers a line of high quality, low priced toys, games and related products, primarily on a direct import basis.\nIn addition, certain toy products are licensed to other toy companies to manufacture and sell product in selected foreign markets where the Company does not otherwise have a presence.\nWorking Capital Requirements ---------------------------- The Company's shipments of products are greater in each of the third and fourth quarters than shipments in each of the first and second quarters. During the past several years, the Company has experienced a gradual shift in its revenue pattern wherein the second half of the year has grown in significance to its overall business and within that half, the fourth quarter has become more prominent and the Company expects this trend to continue. Production has been financed historically by means of short-term borrowings which reach peak levels during September through November of each year when receivables also generally reach peak levels. The toy business is also characterized by customer order patterns which vary from year to year largely because of differences each year in the degree of consumer acceptance of a product line, product availability, marketing strategies and inventory levels of retailers and differences in overall economic conditions. As a result, comparisons of unshipped orders on any date with those at the same date in a prior year are not necessarily indicative of sales for that entire given year. In addition, as more retailers move to\njust-in-time inventory management practices, fewer orders are being placed in advance of shipment and more orders, when placed, are for immediate delivery. The Company's unshipped orders at March 3, 1995 and March 4, 1994 were approximately $170,000,000 and $150,000,000, respectively. Also, it is a general industry practice that orders are subject to amendment or cancellation by customers prior to shipment. The backlog at any date in a given year can be affected by programs the Company may employ to induce its customers to place orders and accept shipments early in the year. This method is a general industry practice. The programs the Company is employing to promote sales in 1995 are not substantially different from those employed in 1994.\nAs part of the traditional marketing strategies of the toy industry, many sales made early in the year are not due for payment until the fourth quarter, thus making it necessary for the Company to borrow significant amounts pending collection of these receivables. The Company relies on internally generated funds and short-term borrowing arrangements, including commercial paper, to finance its working capital needs. Currently, the Company has available to it unsecured lines of credit, which it believes are adequate, of approximately $1,400,000,000 including a $440,000,000 revolving credit agreement with a group of banks which is also used as a back-up to commercial paper issued by the Company.\nResearch and Development ------------------------ The Company's business is based to a substantial extent on the continuing development of new products and the redesigning of existing items for continuing market acceptance. In 1994, 1993 and 1992, approximately $135,406,000, $125,566,000 and $109,655,000, respectively, were incurred on activities relating to the development, design and engineering of new products and their packaging (including items brought to the Company by independent designers) and to the improvement or modification of ongoing products. Much of this work is performed by the Company's staff of designers, artists, model makers and engineers.\nIn addition to its own staff, the Company deals with a number of independent toy designers for whose designs and ideas the Company competes with many other toy manufacturers. Rights to such designs and ideas, when acquired by the Company, are usually exclusive under agreements requiring the Company to pay the designer a royalty on the Company's net sales of the item. These designer royalty agreements in some cases provide for advance royalties and minimum guarantees.\nThe Company also produces a number of toys under trademarks and copyrights utilizing the names or likenesses of Sesame Street, Walt Disney, Barney(TM) and other familiar movie, television and comic strip characters. Licensing fees are paid as a royalty on the Company's net sales of the item. Licenses for the use of characters are generally exclusive for specific products or product lines in specified territories. In many instances, advance royalties and minimum guarantees are required by character license agreements.\nMarketing and Sales ------------------- The Company's products are sold nationally and internationally to a broad spectrum of customers including wholesalers, distributors, chain stores, discount stores, mail order houses, catalog stores, department stores and other retailers, large and small. The Company and its subsidiaries employ their own sales forces which account for nearly all of the sales of their products. Remaining sales are generated by independent distributors who sell the Company's products principally in areas of the world where the Company does not otherwise maintain a presence. The Company maintains showrooms in New York and selected other major cities world-wide as well as at most of its subsidiary locations. Although there has been significant consolidation at the retail level over the last several years, in the United States and Canada, the Company has more than 2,000 customers, most of which are wholesalers, distributors or large chain stores. In other countries, the Company has in excess of 20,000 customers, many of which are individual retail stores. During 1994, sales to the Company's two largest customers represented 21% and 12%, respectively, of consolidated net revenues.\nThe Company advertises its toy and game products extensively on television. The Company generally advertises selected items in its product groups in a manner designed to promote the sale of other specific items in those product groups. Each year, the Company introduces its new products at its New York City showrooms at the time of the American International Toy Fair in February. It also introduces some of its products to major customers during the last half of the prior year.\nIn 1994, the Company spent approximately $397,094,000 in advertising, promotion and marketing programs compared to $383,918,000 in 1993 and $377,219,000 in 1992.\nManufacturing and Importing --------------------------- The Company manufactures its products in facilities within the United States and various foreign countries (see \"Properties\"). Most of its toy products are manufactured from basic raw materials such as plastic and cardboard which are readily available. The Company's manufacturing process includes injection molding, blow molding, metal stamping, printing, box making, assembly and wood processing. In early 1994, the Company announced the planned closure of its manufacturing operation in The Netherlands with the transfer of its production to plants in Ireland and Spain. This closure was subsequently delayed until the first quarter of 1995. During the fourth quarter of 1994, the Company announced a consolidation of its domestic manufacturing facilities through the closure of one facility and the reduction of the workforce at a second location. The Company purchases certain components and accessories used in its toys and some finished items from domestic manufacturers as well as from manufacturers in the Far East, which is the largest manufacturing center of toys in the world, and other foreign countries. The Company believes that the manufacturing capacity of its facilities and the supply of components, accessories and completed products which it purchases from unaffiliated manufacturers is adequate to meet the foreseeable demand for the products which it markets. The Company's reliance on external sources of manufacturing can be shifted, over a period of time, to alternative sources of supply for products it sells, should such changes be necessary. However, if the Company is prevented from obtaining products from a substantial number of its current Far East suppliers due to\npolitical, labor and other factors beyond its control, the Company's operations would be disrupted while alternative sources of product were secured. While the recently rescinded trade sanctions proposed by the United States against the Peoples Republic of China did not affect any of the Company's products, the imposition of same by the United States against a class of products imported by the Company from China or the loss by the People's Republic of China of \"most favored nation\" trading status as granted by the United States, could significantly increase the cost of the Company's products imported into the United States from China. The Company anticipates that the implementation of the new General Agreement on Tariffs and Trade will reduce or eliminate customs duties on certain of the products imported by the Company.\nThe Company makes its own tools and fixtures but purchases dies and molds principally from independent domestic and foreign sources. Several of the Company's domestic production departments operate on a two-shift basis and its molding departments operate on a continuous basis through most of the year.\nCompetition ----------- The Company's business is highly competitive and it competes with several large and many small domestic and foreign manufacturers. The Company is a worldwide leader in the design, manufacture and marketing of toys, games and infant care products.\nEmployees --------- The Company employs approximately 12,500 persons worldwide, approximately 7,000 of whom are located in the United States.\nTrademarks, Copyrights and Patents ---------------------------------- The Company's products are protected, for the most part, by registered trademarks, copyrights and patents to the extent that such protection is available and meaningful. The loss of such rights concerning any particular product would not have a material adverse effect on the Company's business, although the loss of such protection for a number of significant items might have such an effect.\nGovernment Regulation --------------------- The Company's toy products sold in the United States are subject to the provisions of the Consumer Product Safety Act (the \"CPSA\"), The Federal Hazardous Substances Act (the \"FHSA\") and the regulations promulgated thereunder. The CPSA empowers the Consumer Product Safety Commission (the \"CPSC\") to take action against hazards presented by consumer products, including the formulation and implementation of regulations and uniform safety standards. The CPSC has the authority to seek to declare a product \"a banned hazardous substance\" under the CPSA and to ban it from commerce. The CPSC can file an action to seize and condemn an \"imminently hazardous consumer product\" under the CPSA and may also order equitable remedies such as recall, replacement, repair or refund for the product. The FHSA provides for the repurchase by the manufacturer of articles which are banned. Similar\nlaws exist in some states and cities and in Canada, Australia and Europe. The Company maintains a laboratory which has testing and other procedures intended to maintain compliance with the CPSA and FHSA. Notwithstanding the foregoing, there can be no assurance that all of the Company's products are or will be hazard free. While the Company neither has had any material product recalls nor knows of any currently, should any such problem arise, it could have an effect on the Company depending on the product and could affect sales of other products.\nThe Children's Television Act of 1990 and the rules promulgated thereunder by the Federal Communications Commission as well as the laws of certain foreign countries place certain limitations on television commercials during children's programming.\n(c) Financial Information About Foreign and Domestic Operations ----------------------------------------------------------- and Export Sales ---------------- The information required by this item is included in note 16 of Notes to Consolidated Financial Statements in Exhibit 13 to this Report and is incorporated herein by reference.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ---------- Lease Square Type of Expiration Location Use Feet Possession Dates -------- --- ------ ---------- ----------\nRhode Island ------------ Pawtucket Executive, Sales & Marketing Offices & Product Development 343,000 Owned -- Pawtucket Administrative Office 23,000 Owned -- Pawtucket Manufacturing 306,500 Owned -- Central Falls Manufacturing 261,500 Owned -- West Warwick Warehouse 402,000 Leased 1995 East Providence Administrative Office 120,000 Leased 1999\nMassachusetts ------------- East Longmeadow Office, Manufacturing & Warehouse 1,147,500 Owned -- East Longmeadow Office, Manufacturing & Warehouse 254,400 Owned -- East Longmeadow Warehouse 500,000 Leased 1998 Beverly Office 100,000 Owned --\nNew Jersey ---------- Northvale Office & Manufacturing 75,000 Leased 2002 Wayne Manufacturing 65,000 Leased 1995\nLease Square Type of Expiration Location Use Feet Possession Dates -------- --- ------ ---------- ----------\nNew York -------- New York Office & Showroom 70,300 Leased 2000 New York Office & Showroom 32,300 Leased 1999 Arcade Manufacturing 15,000 Leased 1998 Amsterdam Manufacturing 297,400 Owned -- Orangeburg Warehouse 51,000 Leased 2002\nOhio ---- Cincinnati Office 161,000 Leased 2007 Cincinnati Warehouse 33,000 Leased 1999\nPennsylvania ------------ Lancaster Warehouse 464,000 Owned (1) --\nSouth Carolina -------------- Easley Manufacturing 31,500 Leased 1997 Easley Manufacturing 75,000 Owned -- Easley Manufacturing 29,000 Owned --\nTexas ----- El Paso Manufacturing & Warehouse 373,000 Owned -- El Paso Manufacturing & Warehouse 487,000 Leased 1998 El Paso Warehouse 97,200 Leased 1995 El Paso Warehouse 100,000 Leased 1995\nVermont ------- Fairfax Manufacturing 43,000 Owned --\nWashington ---------- Seattle Office & Warehouse 125,100 Leased(2) 1995\nAustralia --------- Lidcombe Office & Warehouse 161,400 Leased 2002 Eastwood Office 16,900 Leased 1997\nAustria ------- Vienna Office 2,505 Leased 1997\nBelgium ------- Brussels Office & Showroom 16,700 Leased 1995\nLease Square Type of Expiration Location Use Feet Possession Dates -------- --- ------ ---------- ----------\nCanada ------ Montreal Office, Manufacturing & Showroom 133,900 Leased 1997 Montreal Warehouse 88,100 Leased 1997 Mississauga Sales Office & Showroom 16,300 Leased 1998\nPeoples Republic of China ------------------------- Guangzhou Manufacturing 22,900 Leased 1995\nDenmark ------- Copenhagen Office 5,900 Leased 1999\nEngland ------- Uxbridge Office & Showroom 94,500 Leased 2013 Castlegate Office & Manufacturing 400,000 Leased 1997 Paddock Wood Office 30,000 Leased 1995\nFrance ------ Le Bourget du Lac Office, Manufacturing & Warehouse 108,300 Owned -- Savoie Technolac Office 33,500 Owned -- Pantin Office 20,900 Leased 2001 Creutzwald Warehouse 108,700 Owned --\nGermany ------- Fuerth Office & Warehouse 28,400 Owned -- Soest Warehouse 78,800 Owned -- Dietzenbach Office 30,400 Leased 1998 Soest Office & Warehouse 156,300 Owned --\nGreece ------ Athens Office & Warehouse 176,500 Leased 1996 Athens Office 26,900 Leased 1995\nHong Kong --------- Kowloon Office 36,700 Leased 1995 Kowloon Office & Warehouse 14,900 Leased 1995 Kowloon Office 18,600 Leased 1996 Kowloon Office 16,100 Leased 1996 Harbour City Office 11,000 Leased 1996 \t\nLease Square Type of Expiration Location Use Feet Possession Dates -------- --- ------ ---------- ----------\nHungary ------- Budapest Office 3,700 Leased 1996\nIreland ------- Waterford Office, Manufacturing & Warehouse 244,400 Owned -- Italy ----- Milan Office & Showroom 12,100 Leased 1998\nJapan ----- Tokyo Office 10,800 Leased 1995\nMalaysia ------- Selangor Darul Ehsan Office 6,800 Leased 1995\nMexico ------ Tijuana Office & Manufacturing 144,000 Leased 1995 Tijuana Warehouse 45,000 Leased 1995 Tijuana Warehouse 117,300 Leased 1995 Reyna Office 61,000 Leased 1996 Espana Warehouse 53,700 Leased 1996 Venados Warehouse 59,100 Leased 1995 Juarez Manufacturing 169,500 Owned --\nThe Netherlands --------------- Ter Apel Office & Warehouse 139,300 Owned -- Utrecht Sales Office & Showroom 17,000 Leased 1996 Emmen Warehouse 40,800 Leased 1995 Emmen Warehouse 21,500 Leased 1995\nNew Zealand ----------- Auckland Office, Manufacturing & Warehouse 110,900 Leased 2005 Portugal -------- Estoril-Lisboa Office 2,900 Leased 1995\nSingapore --------- Singapore Office & Warehouse 12,900 Leased 1995\nLease Square Type of Expiration Location Use Feet Possession Dates -------- --- ------ ---------- ----------\nSpain ----- Valencia Office, Manufacturing & Warehouse 115,100 Leased 1999 Valencia Manufacturing & Warehouse 161,700 Leased 2002 Valencia Office 46,300 Leased 1995 Valencia Warehouse 21,500 Leased 1995 Valencia Warehouse 94,400 Owned -- Valencia Warehouse 43,000 Leased 1996\nSwitzerland ----------- Mutschellen Office & Warehouse 23,400 Leased 1995\nTaiwan ------ TPE County Warehouse 9,800 Leased 1996\nWales ----- Newport Warehouse 76,000 Leased 2003 Newport Warehouse 52,000 Owned --\n(1) See ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS ----------------- The Company has been proceeding with an environmental clean-up (the clean-up) at its former manufacturing facility in Lancaster, Pennsylvania. This facility, a portion of which is being utilized for limited warehousing operations in 1994, was acquired in 1986 from the CBS Toys Division of CBS Inc. (CBS) in conjunction with the purchase of rights to selected products formerly marketed by CBS. Since 1992, the Company has been involved in a legal action against CBS to recover all costs associated with the clean-up and, on August 10, 1994, the U.S. District Court for the Eastern District of Pennsylvania entered a judgment in favor of the Company, awarding the Company all of its past and future costs associated with such clean-up. The Company and CBS subsequently negotiated and concluded a resolution of the matter involving CBS' waiver of its rights to appeal the judgment, a payment by CBS to the Company on account of costs to date associated with environmental remediation together with interest and certain litigation costs, CBS' undertaking responsibility for future remediation of the site, the termination by the Pennsylvania Department of Environmental Resources of the consent order directing the Company to undertake such responsibility and the Company's agreement to sell the site to CBS on or before April 15, 1995.\nPreston Robert Tisch, a director of the Company, is also a director of CBS and Co-Chairman and Co-Chief Executive Officer of Loews Corporation, a major shareholder of CBS. By virtue of the foregoing, Mr. Tisch may be deemed to have an interest adverse to the Company with respect to the above-described action.\nThe Company is party to certain other legal proceedings involving routine litigation incidental to the Company's business, none of which, individually or in the aggregate, is deemed to be material.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------- None.\nEXECUTIVE OFFICERS OF THE REGISTRANT ------------------------------------ The following persons are the executive officers of the Company and its subsidiaries and divisions. Such executive officers are elected annually. The position and office listed below are the principal position(s) and office(s) held by such person with the Company, subsidiary or divisions employing such person. The persons listed below generally also serve as officers and directors of the Company's various subsidiaries at the request and convenience of the Company.\nPeriod Serving in Current Name Age Position and Office Held Position ---- --- ------------------------ ----------\nAlan G. Hassenfeld 46 Chairman of the Board, President and Chief Executive Officer Since 1989\nBarry J. Alperin (1) 54 Vice Chairman Since 1990\nHarold P. Gordon (2) 57 Vice Chairman Since 1995\nGeorge R. Ditomassi, Jr.(3) 60 Chief Operating Officer, Games and International Since 1990\nAlfred J. Verrecchia (4) 52 Chief Operating Officer, Domestic Toy Operations Since 1990\nJohn T. O'Neill 50 Executive Vice President and Chief Financial Officer Since 1989\nNorman C. Walker (5) 56 Executive Vice President and President, International Since 1990\nDan D. Owen (6) 46 President, Hasbro Toy Group Since 1994\nE. David Wilson (7) 57 President, Hasbro Games Group Since 1995\nRichard B. Holt (8) 53 Senior Vice President and Controller Since 1992\nDonald M. Robbins (9) 59 Senior Vice President General Counsel and Corporate Secretary Since 1992\nPhillip H. Waldoks (10) 42 Senior Vice President- Corporate Legal Affairs Since 1992\nRussell L. Denton 50 Vice President and Treasurer Since 1989\n(1) Prior thereto, Co-Chief Operating Officer.\n(2) Prior thereto, Partner, Stikeman, Elliott (law firm).\n(3) Prior thereto, Group Vice President and President, Milton Bradley.\n(4) Prior thereto, Co-Chief Operating Officer.\n(5) Prior thereto, Senior Vice President and President - European Operations.\n(6) Prior thereto, President, Playskool.\n(7) Prior thereto, President, Milton Bradley.\n(8) Prior thereto, Vice President and Controller.\n(9) Prior thereto, Vice President\/General Counsel and Secretary.\n(10) Prior thereto, Vice President - Corporate Legal Affairs.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED ----------------------------------------------------- STOCKHOLDER MATTERS ------------------- The information required by this item is included in Market for the Registrant's Common Equity and Related Stockholder Matters in Exhibit 13 to this Report and is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ----------------------- The information required by this item is included in Selected Financial Data in Exhibit 13 to this 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 ------------------------- The information required by this item is included in Management's Review in Exhibit 13 to this Report and is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------- The information required by this item is included in Financial Statements and Supplementary Data in Exhibit 13 to this Report and 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\nITEMS 10, 11, 12 and 13.\nThe information required by these items is included in registrant's definitive proxy statement for the 1995 Annual Meeting of Shareholders and is incorporated herein by reference, except that the sections under the headings (a) \"Comparison of Five Year Cumulative Total Shareholder Return Among Hasbro, S&P 500 and Russell 1000 Consumer Discretionary Economic Sector\" and accompanying material and (b) \"Report of the Compensation and Stock Option Committee of the Board of Directors\" in the definitive proxy statement shall not be deemed \"filed\" with the Securities and Exchange Commission or subject to Section 18 of the Securities Exchange Act of 1934.\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 --------------------------------------------------------------- (a) Financial Statements, Financial Statement Schedules and Exhibits ---------------------------------------------------------------- (1) Financial Statements -------------------- Included in PART II of this report: Independent Auditors' Report\nConsolidated Balance Sheets at December 25, 1994 and December 26, 1993\nConsolidated Statements of Earnings for the Three Fiscal Years Ended in December 1994, 1993 and 1992\nConsolidated Statements of Shareholders' Equity for the Three Fiscal Years Ended in December 1994, 1993 and 1992\nConsolidated Statements of Cash Flows for the Three Fiscal Years Ended in December 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n(2) Financial Statement Schedules ----------------------------- Included in PART IV of this Report: Report of Independent Certified Public Accountants on Financial Statement Schedule\nFor the Three Fiscal Years Ended in December 1994, 1993 and 1992: Schedule VIII - Valuation and Qualifying Accounts and Reserves\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. Columns omitted from schedules filed have been omitted because the information is not applicable.\n(3) Exhibits -------- The Company will furnish to any shareholder, upon written request, any exhibit listed below upon payment by such shareholder to the Company of the Company's reasonable expenses in furnishing such exhibit.\nExhibit ------- 3. Articles of Incorporation and Bylaws (a) Restated Articles of Incorporation of the Company. (Incorporated by reference to Exhibit (c)(2) to the Company's Current Report on Form 8-K, dated July 15, 1993, File No. 1-6682.)\n(b) Amended and Restated Bylaws of the Company.\n4. Instruments defining the rights of security holders, including indentures. (a) Revolving Credit Agreement, dated as of June 22, 1992, among the Company, certain banks (the \"Banks\"), and The First National Bank of Boston, as agent for the Banks (the \"Agent\"). (Incorporated by reference to Exhibit 4(a) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(b) Subordination Agreement, dated as of June 22, 1992, among the Company, certain subsidiaries of the Company, and the Agent. (Incorporated by reference to Exhibit 4(b) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(c) Amendment No. 1, dated as of April 1, 1994, to Revolving Credit Agreement among the Company, the Banks and the Agent. (Incorporated by reference to Exhibit 4 to the Company's Quarterly Report on Form 10-Q for the Period Ended March 27, 1994, File No. 1-6682.)\n10. Material Contracts (a) Lease between Hasbro Canada Inc. (formerly named Hasbro Industries (Canada) Ltd.) and Central Toy Manufacturing Co. (\"Central Toy\"), dated December 23, 1976. (Incorporated by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-14, File No. 2-92550.)\n(b) Lease between Hasbro Canada Inc. and Central Toy, together with an Addendum thereto, each dated as of May 1, 1987. (Incorporated by reference to Exhibit 10(f) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1987, File No. 1-6682.)\nExecutive Compensation Plans and Arrangements (c) Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-8, File No. 2-78018.)\n(d) Amendment No. 1 to Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(l) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 28, 1986, File No. 1-6682.)\n(e) Amendment No. 2 to Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(n) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1987, File No. 1-6682.)\n(f) Amendment No. 3 to Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(o) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 25, 1988, File No. 1-6682.)\n(g) Amendment No. 4 to Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(s) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1989, File No. 1-6682.)\n(h) Form of Incentive Stock Option Agreement for incentive stock options. (Incorporated by reference to Exhibit 10(o) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1987, File No. 1-6682.)\n(i) Form of Non Qualified Stock Option Agreement under the Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(q) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 25, 1988, File No. 1-6682.)\n(j) Non Qualified Stock Option Plan. (Incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form 14, File No. 2-92550.)\n(k) Amendment No. 1 to Non Qualified Stock Option Plan. (Incorporated by reference to Exhibit 10(j) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 28, 1986, File No. 1-6682.)\n(l) Amendment No. 2 to Non Qualified Stock Option Plan. (Incorporated by reference to Appendix A to the Company's definitive proxy statement for its 1987 Annual Meeting of Shareholders, File No. 1-6682.)\n(m) Amendment No. 3 to Non Qualified Stock Option Plan. (Incorporated by reference to Exhibit 10(l) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1989, File No. 1-6682.)\n(n) Form of Stock Option Agreement (For Employees) under the Non Qualified Stock Option Plan. (Incorporated by reference to Exhibit 10(t) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(o) 1992 Stock Incentive Plan (Incorporated by reference to Appendix A to the Company's definitive proxy statement for its 1992 Annual Meeting of Shareholders, File No. 1-6682.)\n(p) Form of Stock Option Agreement (For Employees) under the 1992 Stock Incentive Plan. (Incorporated by reference to Exhibit 10(v) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(q) Form of Stock Option Agreement (For Participants in the Long Term Incentive Program) under the 1992 Stock Incentive Plan. (Incorporated by reference to Exhibit 10(w) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(r) Form of Employment Agreement, dated July 5, 1989, between the Company and six executive officers of the Company. (Incorporated by reference to Exhibit 10(v) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1989, File No. 1-6682.)\n(s) Hasbro, Inc. Retirement Plan for Directors. (Incorporated by reference to Exhibit 10(x) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 30, 1990, File No. 1-6682.)\n(t) Form of Director's Indemnification Agreement. (Incorporated by reference to Appendix B to the Company's definitive proxy statement for its 1988 Annual Meeting of Shareholders, File No. 1-6682.)\n(u) Hasbro, Inc. Deferred Compensation Plan for Non-Employee Directors.(Incorporated by reference to Exhibit 10(cc) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 26, 1993, File No. 1-6682.)\n(v) Hasbro, Inc. Stock Option Plan for Non-Employee Directors. (Incorporated by reference to Appendix A to the Company's definitive proxy statement for its 1994 Annual Meeting of Shareholders, File No. 1-6682.)\n(w) Form of Stock Option Agreement for Non-Employee Directors under the Hasbro, Inc. Stock Option Plan for Non-Employee Directors.\n(x) Hasbro, Inc. Senior Management Annual Performance Plan. (Incorporated by reference to Appendix B to the Company's definitive proxy statement for its 1994 Annual Meeting of Shareholders, File No. 1-6682.)\n(y) Hasbro, Inc. Stock Incentive Performance Plan. (Incorporated by reference to Appendix A to the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders, File No. 1-6682.)\n11. Statement re computation of per share earnings\n12. Statement re computation of ratios\n13. Selected information contained in Annual Report to Shareholders\n22. Subsidiaries of the registrant\n24. Consents of experts and counsel (a) Consent of KPMG Peat Marwick LLP\n27. Financial data schedule\nThe Company agrees to furnish the Securities and Exchange Commission, upon request, a copy of each agreement with respect to long-term debt of the Company, the authorized principal amount of which does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis.\n(b) Reports on Form 8-K ------------------- A Current Report on Form 8-K dated February 9, 1995 was filed to announce the Company's results for the quarter and year ended December 25, 1994. Consolidated statements of earnings (without notes) for the quarter and year ended December 25, 1994 and December 26, 1993 and consolidated condensed balance sheets (without notes) as of said dates were also filed.\n(c) Exhibits -------- See (a)(3) above\n(d) Financial Statement Schedules ----------------------------- See (a)(2) above\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Hasbro, Inc.:\nUnder date of February 8, 1995, we reported on the consolidated balance sheets of Hasbro, Inc. and subsidiaries as of December 25, 1994 and December 26, 1993 and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the fiscal years in the three-year period ended December 25, 1994, as contained in the 1994 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 1994. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule listed in Item 14 (a)(2). This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.\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.\n\/s\/ KPMG Peat Marwick LLP\nProvidence, Rhode Island\nFebruary 8, 1995\nSCHEDULE VIII HASBRO, INC. AND SUBSIDIARIES\nValuation and Qualifying Accounts and Reserves\nFiscal Years Ended in December\n(Thousands of Dollars)\nProvision Balance at Charged to Write-Offs Balance Beginning of Costs and Other Allowances at End of Year Expenses Additions Taken(a) Year ------------ ---------- ------------ ----------- ---------\nValuation accounts deducted from assets to which they apply - for doubtful accounts receivable:\n1994 $54,200 5,120 - (8,320) $51,000 ====== ====== ====== ====== ======\n1993 $52,200 13,078 - (11,078) $54,200 ====== ====== ====== ====== ======\n1992 $60,500 10,674 - (18,974) $52,200 ====== ====== ====== ====== ======\n(a) Includes write-offs, recoveries of previous write-offs and translation adjustments.\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.\nHASBRO, INC. (Registrant)\nBy: \/s\/ Alan G. Hassenfeld Date: March 24, 1995 ------------------------- --------------- Alan G. Hassenfeld 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.\nSignature Title Date --------- ----- ----\n\/s\/ Alan G. Hassenfeld ---------------------------- Chairman of the Board, March 24, 1995 Alan G. Hassenfeld President, Chief Executive Officer and Director (Principal Executive Officer)\n\/s\/ John T. 0'Neill ---------------------------- Executive Vice President March 24, 1995 John T. 0'Neill and Chief Financial Officer (Principal Financial and Accounting Officer)\n\/s\/ Barry J. Alperin ---------------------------- Director March 24, 1995 Barry J. Alperin\n\/s\/ Alan R. Batkin ---------------------------- Director March 24, 1995 Alan R. Batkin\n\/s\/ George R. Ditomassi, Jr. ---------------------------- Director March 24, 1995 George R. Ditomassi, Jr.\n\/s\/ Harold P. Gordon ---------------------------- Director March 24, 1995 Harold P. Gordon\n\/s\/ Alex Grass ---------------------------- Director March 24, 1995 Alex Grass\n\/s\/ Sylvia K. Hassenfeld ---------------------------- Director March 24, 1995 Sylvia K. Hassenfeld\n\/s\/ Claudine B. Malone ---------------------------- Director March 24, 1995 Claudine B. Malone\n\/s\/ Norma T. Pace ---------------------------- Director March 24, 1995 Norma T. Pace\n\/s\/ E. John Rosenwald, Jr. ---------------------------- Director March 24, 1995 E. John Rosenwald, Jr.\n\/s\/ Carl Spielvogel ---------------------------- Director March 24, 1995 Carl Spielvogel\n\/s\/ Henry Taub ---------------------------- Director March 24, 1995 Henry Taub\n\/s\/ Preston Robert Tisch ---------------------------- Director March 24, 1995 Preston Robert Tisch\n\/s\/ Alfred J. Verrecchia ---------------------------- Director March 24, 1995 Alfred J. Verrecchia\nHASBRO, INC.\nAnnual Report on Form 10-K\nfor the Year Ended December 25, 1994\nExhibit Index\nExhibit ------- 3. Articles of Incorporation and Bylaws (a) Restated Articles of Incorporation of the Company. (Incorporated by reference to Exhibit (c)(2) to the Company's Current Report on Form 8-K, dated July 15, 1993, File No. 1-6682.)\n(b) Amended and Restated Bylaws of the Company.\n4. Instruments defining the rights of security holders, including indentures. (a) Revolving Credit Agreement, dated as of June 22, 1992, among the Company, certain banks (the \"Banks\"), and The First National Bank of Boston, as agent for the Banks (the \"Agent\"). (Incorporated by reference to Exhibit 4(a) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(b) Subordination Agreement, dated as of June 22, 1992, among the Company, certain subsidiaries of the Company, and the Agent. (Incorporated by reference to Exhibit 4(b) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(c) Amendment No. 1, dated as of April 1, 1994, to Revolving Credit Agreement among the Company, the Banks and the Agent. (Incorporated by reference to Exhibit 4 to the Company's Quarterly Report on Form 10-Q for the Period Ended March 27, 1994, File No. 1-6682.)\n10. Material Contracts (a) Lease between Hasbro Canada Inc. (formerly named Hasbro Industries (Canada) Ltd.) and Central Toy Manufacturing Co. (\"Central Toy\"), dated December 23, 1976. (Incorporated by reference to Exhibit 10.15 to the Company's Registration Statement on Form S-14, File No. 2-92550.)\n(b) Lease between Hasbro Canada Inc. and Central Toy, together with an Addendum thereto, each dated as of May 1, 1987. (Incorporated by reference to Exhibit 10(f) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1987, File No. 1-6682.)\nExecutive Compensation Plans and Arrangements (c) Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 4.1 to the Company's Registration Statement on Form S-8, File No. 2-78018.)\n(d) Amendment No. 1 to Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(l) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 28, 1986, File No. 1-6682.)\n(e) Amendment No. 2 to Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(n) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1987, File No. 1-6682.)\n(f) Amendment No. 3 to Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(o) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 25, 1988, File No. 1-6682.)\n(g) Amendment No. 4 to Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(s) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1989, File No. 1-6682.)\n(h) Form of Incentive Stock Option Agreement for incentive stock options. (Incorporated by reference to Exhibit 10(o) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1987, File No. 1-6682.)\n(i) Form of Non Qualified Stock Option Agreement under the Employee Incentive Stock Option Plan. (Incorporated by reference to Exhibit 10(q) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 25, 1988, File No. 1-6682.)\n(j) Non Qualified Stock Option Plan. (Incorporated by reference to Exhibit 10.10 to the Company's Registration Statement on Form 14, File No. 2-92550.)\n(k) Amendment No. 1 to Non Qualified Stock Option Plan. (Incorporated by reference to Exhibit 10(j) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 28, 1986, File No. 1-6682.)\n(l) Amendment No. 2 to Non Qualified Stock Option Plan. (Incorporated by reference to Appendix A to the Company's definitive proxy statement for its 1987 Annual Meeting of Shareholders, File No. 1-6682.)\n(m) Amendment No. 3 to Non Qualified Stock Option Plan. (Incorporated by reference to Exhibit 10(l) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1989, File No. 1-6682.)\n(n) Form of Stock Option Agreement (For Employees) under the Non Qualified Stock Option Plan. (Incorporated by reference to Exhibit 10(t) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(o) 1992 Stock Incentive Plan (Incorporated by reference to Appendix A to the Company's definitive proxy statement for its 1992 Annual Meeting of Shareholders, File No. 1-6682.)\n(p) Form of Stock Option Agreement (For Employees) under the 1992 Stock Incentive Plan. (Incorporated by reference to Exhibit 10(v) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(q) Form of Stock Option Agreement (For Participants in the Long Term Incentive Program) under the 1992 Stock Incentive Plan. (Incorporated by reference to Exhibit 10(w) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 27, 1992, File No. 1-6682.)\n(r) Form of Employment Agreement, dated July 5, 1989, between the Company and six executive officers of the Company. (Incorporated by reference to Exhibit 10(v) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1989, File No. 1-6682.)\n(s) Hasbro, Inc. Retirement Plan for Directors. (Incorporated by reference to Exhibit 10(x) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 30, 1990, File No. 1-6682.)\n(t) Form of Director's Indemnification Agreement. (Incorporated by reference to Appendix B to the Company's definitive proxy statement for its 1988 Annual Meeting of Shareholders, File No. 1-6682.)\n(u) Hasbro, Inc. Deferred Compensation Plan for Non-Employee Directors. (Incorporated by reference to Exhibit 10(cc) to the Company's Annual Report on Form 10-K for the Fiscal Year Ended December 26, 1993, File No. 1-6682.)\n(v) Hasbro, Inc. Stock Option Plan for Non-Employee Directors. (Incorporated by reference to Appendix A to the Company's definitive proxy statement for its 1994 Annual Meeting of Shareholders, File No. 1-6682.)\n(w) Form of Stock Option Agreement for Non-Employee Directors under the Hasbro, Inc. Stock Option Plan for Non-Employee Directors.\n(x) Hasbro, Inc. Senior Management Annual Performance Plan. (Incorporated by reference to Appendix B to the Company's definitive proxy statement for its 1994 Annual Meeting of Shareholders, File No. 1-6682.)\n(y) Hasbro, Inc. Stock Incentive Performance Plan. (Incorporated by reference to Appendix A to the Company's definitive proxy statement for its 1995 Annual Meeting of Shareholders, File No. 1-6682.)\n11. Statement re computation of per share earnings\n12. Statement re computation of ratios\n13. Selected information contained in Annual Report to Shareholders\n22. Subsidiaries of the registrant\n24. Consents of experts and counsel (a) Consent of KPMG Peat Marwick.\n27. Financial data schedule","section_15":""}
{"filename":"749872_1994.txt","cik":"749872","year":"1994","section_1":"Item 1. Business.\nPrincipal Products\nR. G. Barry Corporation (the \"Registrant\") is organized under the laws of the State of Ohio. The Registrant and its subsidiaries (collectively, the \"Company\") design, manufacture and market specialized comfort footwear for men, women and children. The Company is in the business of responding to consumer demand for comfortable footwear combined with attractive appearance. The Company also designs, manufactures and markets thermal comfort products in the food preservation, comfort therapy and cold weather categories. Comfort is the dominant influence in the Company's brand lines.\nHistorically, the Company's primary products have been foam-soled, soft washable slippers for men, women and children. The Company developed and introduced women's Angel Treads*, the world's first foam-soled, washable slipper, in 1947. Since that time, the Company has introduced additional slipper-type brand lines for men, women and children based upon the concept of comfort, softness and washability. These footwear products are sold, for the most part, under various brand names including, but not limited to, Angel Treads*, Dearfoams*, Dearfoams* for Kids, Dearfoams* for Men, Madye's*, Snug Treds* and Soft Notes*. The Company has also marketed certain of its slipper-type footwear under licensed trademarks. See \"Trademarks and Licenses\".\nThe Company's foam-soled footwear lines have fabric uppers made of terry cloths, velours, fleeces, satins, nylons and other washable materials. Different brand lines are marketed for men, women and children with a variety of styles, colors and ornamentation.\nThe marketing strategy for the Company's slipper-type brand lines has been to expand counter space for its products by creating and marketing brand lines to different segments of the consumer market. Retail prices for the Company's footwear range from approximately $4 to $30 per pair, depending on the style of footwear, type of retail outlet and retailer mark-up.\nSince 1988, the Company has manufactured and marketed the Soft Notes* foam cushioned casual slipper line. The Company\n------------------------\n* Hereinafter denotes a trademark of the Company registered in the United States Department of Commerce Patent and Trademark Office.\nbelieves that this brand line is a bridge between slippers and casual footwear. The marketing strategy with respect to this product emphasizes the fashion, comfort and versatility provided by the Soft Notes* foam cushioned casual slippers.\nThe Company believes that many consumers of its slippers are loyal to the Company's brand lines, usually own more than one pair of slippers and have a history of repeat purchases. Substantially all of the slipper brand lines are displayed on a self-selection basis in see-through packaging at the point of purchase and have appeal to the \"impulse\" buyer. The Company believes that many of the slippers are purchased as gifts for others.\nMany styles of slipper-type footwear have become standard in the Company's brand lines and are in demand year after year. For many of these styles, the most significant changes made in response to fashion changes are in ornamentation, fabric and\/or color. The Company also introduces new, updated styles of slippers with a view toward enhancing the fashion appeal and freshness of its products. The Company anticipates that it will continue to introduce new styles in future years responsive to fashion changes.\nIt is possible to fit most consumers of the Company's slipper-type footwear within a range of four or five sizes. This allows the Company to carry lower levels of inventories in these lines in comparison with other footwear styles.\nIn 1994, the Company introduced on a national basis its thermal comfort products featuring MICROCORE(TM) microwave-activated technology developed by the Company. On July 14, 1994, the Registrant also acquired all of the outstanding stock of Vesture Corporation (\"Vesture\"), the originators of microwave-heated comfort care products, in consideration of the issuance of 319,362 common shares of the Registrant which were valued by the Registrant at $5 million.\nThe Company's thermal comfort products generally fall within three categories -- food preservation products such as breadwarmer baskets; comfort therapy products such as heating pads and backwarmers; and cold weather products such as heated seat cushions, booties, scarves and ear muffs. Retail prices for the Company's thermal comfort products range from approximately $12 to $30, depending on the product, type of retail outlet and retailer mark-up. The Company believes that the food preservation and comfort therapy thermal products are not weather sensitive and have a year-round sales appeal while the cold weather portion of the thermal comfort product line is more seasonal and affected by weather changes.\nThe thermal comfort products are sold under the major brand lines of Dearfoams*, Vesture* and Lava*.\nThe Company has six manufacturing facilities. The Company operates sewing plants in Nuevo Laredo, Ciudad Acuna, and Zacatecas, Mexico. The Company also operates a cutting plant in Laredo, Texas and a sole molding operation in San Angelo, Texas. The Company also has the exclusive rights to the manufacturing output of a factory in Shenzhen, People's Republic of China. The Company produces thermal comfort products at its manufacturing facilities in Asheboro, North Carolina and Nuevo Laredo, Mexico. The Company operates distribution centers in Asheboro and Goldsboro, North Carolina and San Angelo and Laredo, Texas.\nMarketing\nThe Company's brand lines are sold to department, chain and specialty stores; through mass merchandising channels of distribution such as discount stores, drug and variety chain stores, and supermarkets; and to independent retail establishments. The Company's brand lines are marketed primarily through Company salespersons and, to a lesser extent, through independent sales representatives. The Company does not finance its customers' purchases.\nEach spring and autumn, new designs and styles are presented to buyers representing the Company's retail customers at regularly scheduled showings. Company designers also produce new styles and experimental designs throughout the year which are evaluated by the Company's sales and marketing personnel. Buyers for department stores and other large retail customers attend the spring and autumn showings and make periodic visits to the Company's showrooms in New York and Los Angeles. Company salespersons regularly visit retail customers. The Company also regularly makes catalogs available to its current and potential customers and periodically follows up with such current and potential customers by telephone. In addition, the Company participates in trade shows, both regionally and nationally.\nSales during the last six months of each year have historically been greater than during the first six months. The Company's inventory is largest in early autumn in order to accommodate the retailers' fall selling seasons. See \"Backlog of Orders\".\nThe Company advertises principally in the print media. The Company also tested television advertising of its thermal comfort products in six markets during the fourth quarter of 1994 and intends to expand this television advertising to incorporate\nmarkets on a more nationwide basis in 1995. The Company's promotional efforts are often conducted in cooperation with customers. The Company's products are displayed at the retail- store level on a self-selection and gift-purchase basis.\nThe Company operates an European sales and marketing organization in London, England and markets its products in Canada, Mexico and several other countries around the world. In 1994, the Company's foreign sales compromised approximately 5% of its total sales.\nDue to the more seasonal nature of the cold weather portion of the thermal comfort product line, in 1995, the Company intends to place more emphasis in the thermal comfort product mix on the comfort therapy and food preservation categories. The Company intends to develop and introduce a variety of new products using thermal technology in 1995. In May 1994, the Company announced a strategic alliance with Battelle Memorial Institute (\"Battelle\"), the world's largest independent scientific research institute which is based in Columbus, Ohio, to continually advance the state of art of thermal technology and broadly expand commercialization of the technology. Under the alliance, the Company has assigned to Battelle a pending patent relating to microwave-activated thermal storage materials technology. Battelle will provide expertise to the Company in advancing thermal technologies and products, the Company will have royalty-free exclusive rights to the technology covering a major category of consumer products and Battelle and the Company will share all income from licensing of thermal comfort products.\nResearch and Development\nMost of the Company's research efforts are undertaken in connection with the design and consumer appeal of new styles of slipper-type footwear and thermal comfort products. During fiscal years 1994, 1993 and 1992, the amounts spent by the Company in connection with the research and design of new products and the improvement or redesign of existing products were approximately $3.3 million, $2.8 million and $2.9 million, respectively. Substantially all of the foregoing activities were Company-sponsored. Approximately 55 employees were engaged full time in research and design during the 1994 fiscal year.\nMaterials\nThe principal raw materials used by the Company in the manufacture of its slipper and thermal comfort brand lines are textile fabrics, threads, foams and other synthetic products. All are available domestically from a wide range of suppliers. The Company has experienced no difficulty in obtaining raw materials from suppliers and anticipates no future difficulty. In addition, in the manufacture of its thermal comfort products, the Company uses proprietary patent pending materials developed with Battelle.\nTrademarks and Licenses\nApproximately 95% of the Company's sales are represented by brand items sold under trademarks owned by the Company. The Company is the holder of many trademarks which identify its products. The trademarks which are most widely used by the Company include Angel Treads*, Dearfoams*, Dearfoams* for Kids, Dearfoams* for Men, Madye's*, Snug Treds*, Soft Notes*, Vesture*, Lava Pak*, Lava Buns* and Lava Booties*. The Company believes that its products are identified by its trademarks and, thus, its trademarks are of significant value. Each trademark has a duration of 20 years and is subject to an indefinite number of renewals for a like period upon appropriate application. The Company intends to continue the use of and to renew each of its trademarks.\nThe Company also has sold comfort footwear under various names as licensee under license agreements with the owners of those names. In the 1994, 1993 and 1992 fiscal years, 5%, 6% and 7%, respectively, of the Company's total footwear sales were represented by footwear sold under these names.\nIn 1989, the Company entered into a licensing agreement with Fieldcrest Cannon, Inc., the largest marketer of bed and bath products in the United States, which allows the Company to manufacture and sell a line of mid-priced slippers under the Cannon** trademark in the mass merchandise channels of the Company's business. The Company continued its distribution and marketing of the Cannon** line of slippers in the 1994 fiscal year. The term of the Company's license to use the Cannon** trademark expires in June, 1996; however, the term may be extended for such period as may be mutually agreed upon by the Company and Fieldcrest Cannon, Inc.\n-------------------- ** Denotes a trademark of the licensor registered in the United States Department of Commerce Patent and Trademark Office.\nIn 1992, the Company entered into a licensing agreement with Jordache Enterprises, Inc. which allows the Company to manufacture and sell a line of mid-priced slippers under the Jordache** trademark in the mass merchandise channels of the Company's business. The Company's license to use the Jordache** trademark expires on February 28, 1998; however, such license may be renewed by the Company annually through February 28, 2003, provided the Company meets certain levels of sales of the Jordache** slippers.\nCustomers\nThe only customers of the Company which accounted for 10% or more of the Company's consolidated revenues in fiscal year 1994 were Wal Mart Stores, Inc. and J.C. Penney Company, Inc., which accounted for approximately 15% and 12%, respectively. The only customers of the Company which accounted for 10% or more of the Company's consolidated revenues in fiscal year 1993 were Hutcheson Shoe Co., a division of Wal Mart Stores, Inc., and J.C. Penney Company, Inc., which accounted for approximately 15% and 10%, respectively. The only customers of the Company which accounted for more than 10% of the Company's consolidated revenues in fiscal year 1992 were Hutcheson Shoe Co., a division of Wal Mart Stores, Inc., J.C. Penney Company, Inc. and Dayton-Hudson Corporation and its subsidiaries and affiliated companies, which accounted for approximately 10%, 10% and 12%, respectively.\nBacklog of Orders\nThe Company's backlog of orders at the close of fiscal year 1994 was $12.2 million and at the end of fiscal year 1993 was $9.5 million. It is anticipated that a large percentage of the orders as of the end of the Company's last fiscal year will be filled during the current fiscal year.\nGenerally, the Company's backlog of unfilled sales orders is largest after the spring and autumn showings of the Company. For example, the Company's backlog of unfilled sales orders following the conclusion of such showings during the last two years were as follows: August, 1994 - $74.1 million; August, 1993 - $56.1 million; February, 1994 - $11.5 million; and February, 1993 - $11.7 million. The Company's backlog of unfilled sales orders reflects the seasonal nature of the Company's sales - approximately 80% of such sales occur during the autumn as compared to approximately 20% during the spring.\nInventory\nWhile the styles of some of the Company's slipper brand lines change little from year to year, the Company has also introduced, and intends to continue to introduce, new, updated styles in an effort to enhance the comfort and fashion appeal of its products. As a result, the Company anticipates that some of its slipper styles will change from year to year, particularly in response to fashion changes. The Company has introduced, and intends to continue to introduce, a variety of new thermal comfort products to compliment its existing products in response to consumer demand. The Company believes that it will be able to control the level of its obsolete inventory. The Company traditionally has had a limited exposure to obsolete inventory.\nCompetition\nThe Company operates in the slipper portion of the footwear industry. The Company believes that it is a small factor in the highly competitive footwear industry. The Company also believes that it is a significant factor in the slipper portion of the footwear industry. The Company also operates in an area where it provides portable warmth through its line of thermal comfort products. The Company competes primarily on the basis of the value, quality and comfort of its products, service to its customers, and its marketing expertise. The Company knows of no reliable published statistics which indicate its current relative position in the footwear or any other industry or in the slipper portion of the footwear industry.\nEffect of Environmental Regulation\nCompliance with federal, state and local provisions regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had a material effect upon the capital expenditures, earnings or competitive position of the Company. The Company believes that the nature of its operations has little, if any, environmental impact. The Company, therefore, anticipates no material capital expenditures for environmental control facilities for its current fiscal year or for the foreseeable future.\nEmployees\nAt the close of the 1994 fiscal year, the Company employed approximately 3,000 persons.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe Company owns a warehouse facility in Goldsboro, North Carolina, containing approximately 120,000 square feet. The Company also owns a 52,800 square foot manufacturing facility in Del Rio, Texas (the \"Del Rio Facility\"). The Company leases the Del Rio Facility to a third party pursuant to a lease with a current term expiring in December, 1995. The lessee has an option to renew the term of the lease through December, 2000.\nThe Company leases two facilities pursuant to lease agreements with local governments which issued industrial revenue bonds to construct and equip these facilities. The Company has the right to purchase each facility at a nominal sum upon retirement of the bonds issued in respect thereof. These transactions have been treated as purchases for accounting and tax purposes. See Note (6) to the Company's Consolidated Financial Statements set forth on pages 20 and 21 of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994. The following table describes the facilities leased by the Company under the terms of industrial revenue bonds issued by the local governments specified:\n_________________\n(1) The Company subleases the manufacturing facility in Conway, Arkansas to a third party under a sublease with a current term expiring on May 31, 1995. Payments under this sublease approximate the Company's rental obligations under its lease with the City of Conway, Arkansas. The sublessee has the right to purchase the facility from the Company after the Company exercises its purchase option.\nIn addition to the leased properties described above, the Company leases space aggregating approximately 970,000 square feet at an approximate aggregate annual rental of $2.3 million. The following table sets forth certain information with respect to the Company's principal leased properties which were not in the preceding table:\n________________\n(1) Net lease.\nThe Company believes that all of the buildings owned or leased by it are well maintained, in good operating condition, and suitable for their present uses.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Registrant has been named as a defendant in three related putative class action lawsuits styled as Gerber, et al. v. R. G. Barry Corporation, et al., Case No. C2-94-1190 (filed December 8, 1994), Culveyhouse v. R. G. Barry Corporation, et al., Case No. C2-94-1250 (filed December 27, 1994), and Knopf, et al. v. R. G. Barry Corporation, et al., Case No. C2-95-50, (filed January 17, 1995) in the United States District Court for the Southern District of Ohio. Plaintiffs allege that public statements made by the Registrant in 1994 were false and misleading and that these disclosures and non-disclosures violated federal securities laws. One complaint also asserts common law fraud. Plaintiffs seek to recover on behalf of a class of purchasers of stock of the Registrant who purchased between approximately April and early December, 1994 and claim they are entitled to the per share difference between their purchase price and the price subsequent to certain press releases issued by the Registrant on December 5 and 6 which reduced estimated earnings for the Registrant. These lawsuits are presently pending.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNot applicable.\nExecutive Officers of the Registrant.\nThe following table lists the names and ages of the executive officers of the Registrant as of the date of this Annual Report on Form 10-K, the positions with the Registrant presently held by each such executive officer and the business experience of each such executive officer during the past five years. Unless otherwise indicated, each person has held his principal occupation for more than five years. All executive officers serve at the pleasure of the Board of Directors of the Registrant.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nIn accordance with General Instruction G(2), the information called for in this Item 5 is incorporated herein by reference to page 10 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nIn accordance with General Instruction G(2), the information called for in this Item 6 is incorporated herein by reference to pages 8 and 9 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation.\nIn accordance with General Instruction G(2), the information called for in this Item 7 is incorporated herein by reference to pages 11 through 14 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nThe Consolidated Balance Sheets of the Registrant and its subsidiaries as of December 31, 1994 and January 1, 1994, the related Consolidated Statements of Earnings, Shareholders' Equity and Cash Flows for each of the fiscal years in the three-year period ended December 31, 1994, the related Notes to Consolidated Financial Statements and the Independent Auditors' Report, appearing on pages 15 through 27 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994, are incorporated herein by reference. Quarterly Financial Data set forth on page 10 of the Registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994, are also 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.\nIn accordance with General Instruction G(3), the information called for in this Item 10 is incorporated herein by reference to the Registrant's definitive Proxy Statement, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934, relating to the Registrant's Annual Meeting of Shareholders to be held on May 10, 1995, under the captions \"SHARE OWNERSHIP,\" \"ELECTION OF DIRECTORS\" and \"COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS--Employment Contracts and Termination of Employment and Change-in- Control Arrangements.\" In addition, certain information concerning the executive officers of the Registrant called for in this Item 10 is set forth in the portion of Part I of this Annual Report on Form 10-K entitled \"Executive Officers of the Registrant\" in accordance with General Instruction G(3). The Registrant is not required to make any disclosure pursuant to Item 405 of Regulation S-K.\nItem 11.","section_11":"Item 11. Executive Compensation.\nIn accordance with General Instruction G(3), the information called for in this Item 11 is incorporated herein by reference to the Registrant's definitive Proxy Statement, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934, relating to the Registrant's Annual Meeting of Shareholders to be held on May 10, 1995, under the captions \"COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS\" and \"COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION.\" Neither the report of the Compensation Committee of the Registrant on executive compensation nor the performance graph included in the Registrant's definitive Proxy Statement relating to the Registrant's Annual Meeting of Shareholders to be held on May 10, 1995, shall be deemed to be incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nIn accordance with General Instruction G(3), the information called for in this Item 12 is incorporated herein by reference to the Registrant's definitive Proxy Statement, to be filed\nwith the Securities and Exchange Commission pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934, relating to the Registrant's Annual Meeting of Shareholder to be held on May 10, 1995, under the captions \"SHARE OWNERSHIP\" and \"COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS -- Employment Contracts and Termination of Employment and Change-in-Control Arrangements.\"\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nIn accordance with General Instruction G(3), the information called for in this Item 13 is incorporated herein by reference to the Registrant's definitive Proxy Statement, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the General Rules and Regulations under the Securities Exchange Act of 1934, relating to the Registrant's Annual Meeting of Shareholders to be held on May 10, 1995, under the captions \"SHARE OWNERSHIP,\" \"ELECTION OF DIRECTORS\" and \"COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS.\"\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.\n(a)(1) Financial Statements.\nFor a list of all financial statements incorporated by reference in this Annual Report on Form 10-K, see \"Index to Financial Statements\" at page 22.\n(a)(2) Financial Statement Schedules.\nFor a list of all financial statement schedules included in this Annual Report on Form 10-K, see \"Index to Financial Statements\" at page 22.\n(a)(3) Exhibits.\nExhibits filed with this Annual Report on Form 10-K are attached hereto. For list of such exhibits, see \"Index to Exhibits\" at page 59. The following table provides certain information concerning executive compensation plans and arrangements required to be filed as exhibits to this Annual Report on Form 10-K.\nExecutive Compensation Plans and Arrangements\n(b) Reports on Form 8-K\nThere were no Current Reports on Form 8-K filed during the fiscal quarter ended December 31, 1994.\n(c) Exhibits\nExhibits filed with this Annual Report on Form 10-K are attached hereto. For a list of such exhibits, see \"Index to Exhibits\" at page 59.\n(d) Financial Statement Schedules\nFinancial Statement Schedules included with this Annual Report on Form 10-K are attached hereto. See \"Index to Financial Statements\" at page 22.\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.\nR. G. BARRY CORPORATION\nDate: March 29 , 1995 By \/s\/ Richard L. Burrell ---- ----------------------- Richard L. Burrell, Senior Vice President-Finance, Secretary 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 and in the capacities and on the dates indicated.\nR. G. BARRY CORPORATION __________________________________\nFinancial Statements\nDecember 31, 1994, January 1, 1994 and January 2, 1993\nFor Inclusion in Form 10-K To Securities and Exchange Commission\nR. G. BARRY CORPORATION\nThe consolidated balance sheets of R. G. Barry Corporation and subsidiaries as of December 31, 1994 and January 1, 1994 and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the fiscal years in the three-year period ended December 31, 1994, together with the opinion thereon of KPMG Peat Marwick LLP dated February 14, 1995, appearing on pages 15 through 27 of the accompanying 1994 annual report to shareholders are incorporated by reference in this Form 10-K annual report. The following additional financial data should be read in conjunction with the consolidated financial statements in such 1994 fiscal year annual report to shareholders. Schedules not included with this additional financial data have been omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto.\nADDITIONAL FINANCIAL DATA:\nIndependent Auditors' Report on Financial Statement Schedules\nSchedules for the fiscal years ended December 31, 1994, January 1, 1994 and January 2, 1993:\nII Reserves Five Year Review of Selected Financial Data\nR.G. Barry Corporation and Subsidiaries --------------------------------------------------------------------------------\nSUMMARY OF OPERATIONS (thousands) Net Sales Cost of sales Gross profit Selling, general and administrative expenses Provision for restructuring Interest expense, net Royalty income Earnings (loss) before income taxes and extraordinary credit Income tax expense (benefit) Earnings (loss) before extraordinary credit Extraordinary credit - utilization of net operating loss carryforward Net earnings (loss)\nADDITIONAL DATA Earnings (loss) per share before extraordinary credit* Net earnings (loss) per share after extraordinary credit* Book value per share* Annual % change in net sales Annual % change in net earnings (loss) Net earnings (loss) as a percentage of beginning shareholders' equity Average number of shares outstanding (in thousands)*\nFINANCIAL SUMMARY (thousands) Current assets Current liabilities Working capital Long-term debt and capital leases Net shareholders' equity Net property, plant and equipment Total assets Capital expenditures, net of disposals Depreciation and amortization of property, plant and equipment See also Management's Discussion & Analysis of Financial Condition & Results of perations. *Retroactively restated to reflect 4 for 3 share split distributed June 22, 1994. **Fiscal year includes fifty-three weeks.\nMarket and Dividend Information\nStock Exchange: American Stock Exchange\nStock Ticker Symbol: RGB\nWall Street Journal Listing: BarryRG\nApproximate Number of Registered Shareholders: 1,300\nA four for three share split was distributed on June 22, 1994 to shareholders of record on June 1, 1994.\nNo cash dividends were paid during the periods noted. While the Company has no current intention to pay cash dividends, it is currently able to pay cash dividends, and is subject to the restrictions contained in the various loan agreements. See also Note 5 to Consolidated Financial Statements, and Management's Discussion & Analysis of Financial Condition & Results of Operations.\nQuarterly Financial Data\nSee also Management's Discussion & Analysis of Financial Condition & Results of Operations.\nManagement's Discussion & Analysis of Financial Condition & Results of Operations -------------------------------------------------------------------------------\nACQUISITION OF VESTURE CORPORATION\nDuring July 1994, the Company purchased all the outstanding stock of Vesture Corporation, which manufactures and markets thermal comfort products. The purchase was paid entirely by the issuance of approximately 319 thousand treasury shares of the Company valued at $5 million. As a result of the purchase the Company recognized approximately $4.6 million in goodwill which is being amortized over a forty year period. The operating results of Vesture are included in the consolidated financial statements for the period following the acquisition by the Company.\nFOUR FOR THREE SHARE SPLIT\nOn May 13, 1994, the Company declared a 4 for 3 share split. The share split was distributed on June 22, 1994, to shareholders of record as of June 1, 1994. All per share calculations have been retroactively restated to give effect to the 4 for 3 share split.\nLIQUIDITY AND CAPITAL RESOURCES\nThe assets used by the Company in the development, production, marketing, warehousing and distribution, and sale of its products consist mainly of current assets such as cash, receivables, inventory, and prepaid expenses; and net property, plant and equipment. Most of the Company's assets are current assets. At year end 1994, 73.3 percent of the Company's assets were current, compared with 71.9 percent at the end of 1993. Substantially all the remaining assets of the Company are net property, plant and equipment.\nAt year end 1994, the Company had $39.1 million in net working capital, comprised of $56.4 million in current assets, less $17.3 million in current liabilities. At year end 1993, the Company had $27.9 million in net working capital. About $7.4 million of the increase in net working capital is derived from additional long-term debt that the Company borrowed in July, 1994 (see also the discussion that follows regarding long-term borrowings). An additional $5.1 million of the increase has been generated by current year's operation. In previous years, most of the increase in net working capital was generated from operations.\nThe Company ended 1994, with $2.4 million in cash on hand, $21.0 million in trade receivables and $26.1 million in inventories. This compares with $1.5 million in cash at year end 1993, $13.5 million in trade receivables and $17.8 million in inventories.\nSubstantially all the increase in trade receivables is attributable to the increase in net sales during the fourth quarter of the year. Net sales increased 9.2 percent, during the fourth quarter, from $51.9 million in 1993 to $56.7 million in 1994.\nInventories at the end of 1994, increased by $8.3 million from the prior year. Throughout much of the third quarter, the Company purchased additional raw materials, and worked overtime hours to increase its level of finished goods inventory in anticipation of shipping that inventory in the fourth quarter. In early December, 1994, the Company received cancellations on about $3.5 million in orders for thermal comfort products. The Company had already purchased the raw materials, and produced the finished goods inventory and was prepared to ship the orders; but unusually warm weather in the fall of 1994, prompted retailers to place cancellations on orders for thermal products. This left the Company with additional inventory. The Company expects to utilize this added inventory to satisfy expected customer orders for fall of 1995.\nA portion of the increase in inventory is attributable to Vesture Corporation which the Company purchased in 1994. In addition, inventory generally maintained throughout the Company has increased from 1993 to 1994. The Company believes that it has some excess inventory on hand at the end of the year. There has traditionally been little risk of markdown or obsolescence to the Company from this inventory. Throughout 1995, the Company plans to systematically reduce the amount of excess inventory on hand.\nOther receivables at year end 1994 amounted to $2.4 million, compared with $3.5 million at year end 1993. In both years, other receivables were comprised mainly of recoverable customs duties, and balances that the Company expects to collect from its supplier in the orient.\nThe Company traditionally leases most of its facilities. During 1994, a warehouse was leased in Laredo, Texas, to handle the storage and distribution of thermal comfort products. Also, late in 1994, the Company leased a facility in Asheboro, North Carolina to combine the operating facilities of Vesture Corporation into one location.\nIn 1993, the Company leased a manufacturing plant in Zacatecas, Mexico.\nThe operations of the Company have historically been funded by internally generated capital. In recent years, the Company has relied on its Revolving Credit Agreement (\"Revolver\") to provide any additional capital requirements, including seasonal working capital needs.\nManagement's Discussion & Analysis of Financial Condition & Results of Operations\ncontinued ----------------------------------------------------------------------------\nDuring 1994, the Company issued a $15 million, 9.7% Note, due in 2004. The Note has certain covenants which the Company believes are normally found in agreements of this type. The Note places restrictions on the amount of future borrowings the Company may incur, and contains other financial covenants. The Note requires semi-annual interest payments beginning in 1995, with principal repayments commencing in 1998. A portion of the proceeds of the Note was used to prepay the $2.8 million outstanding balance of 10 3\/8% Notes due in 1997. The balance of the proceeds were used to repay long-term borrowings under the Revolver of $5.5 million, and to add about $7.4 million to the net working capital of the Company.\nThe Company and its lending banks have modified certain covenants of the Revolver several times in the last few years in order to meet the Company's needs. During 1993, the Revolver was amended to extend its term through June 30, 1995, and in February 1994, it was amended to modify certain other covenants. The Company has discussed, with its banks, the need to renew and extend the Revolver. During 1995, the Company intends to seek a multiyear extension of the term of the Revolver in order to better meet the Company's anticipated financing needs for a longer period. The Company is in compliance with all covenants of the Revolver and all other debt agreements.\nThe Revolver provides the Company with a seasonally adjusted available line of credit ranging from $5.5 million as of December 31st annually, to a peak of $38.0 million during the months of July through November. The Revolver contains certain restrictions relating to net working capital, tangible net worth, additional seasonal borrowings, gross sales and maximum annual capital expenditures, all as explained in the Revolver.\nDuring 1994, the maximum amount that the Company borrowed under the Revolver was $26 million. At the end of 1994, $2 million in notes were outstanding and classified as short-term notes in the accompanying consolidated financial statements. During 1993, the maximum amount that the Company borrowed under the Revolver, was $35.0 million, including $5.5 million, which at the end of 1993 was classified as long-term debt in the accompanying consolidated financial statements.\nIn June, 1994, the Company distributed a four for three share split, as discussed above. The Company last paid cash dividends in 1981. While the Company's various loan agreements, at year end 1994, permit the payment of dividends and the repurchase of common shares for treasury, the Company has no current plans to resume the payment of cash dividends. Subject to certain limitations contained in various loan agreements, the Company may borrow additional long term debt, should that be necessary. See Note 5 to the Consolidated Financial Statements for additional information.\nThe Company believes that it has a strong balance sheet, with good financial ratios. At year end 1994, the Company's total capitalization amounted to $57.5 million. It was comprised of 28.6 percent long-term debt and capital lease obligations and 71.4 percent equity. This compares with total capitalization of $41.2 million at year end 1993, with a ratio of 23.6 percent long-term debt and capital lease obligations and 76.4 percent equity. The Company's current ratio, a relationship of current assets to current liabilities, was 3.25 to 1 at year end 1994, compared with 3.30 to 1 at year end 1993.\nIMPACT OF MEXICAN PESO DEVALUATION\nIn late December 1994, the Mexican Peso suffered increasing devaluation pressure on world currency markets. When compared with its value throughout most of 1994, by early March 1995, the Peso had declined in value versus the US Dollar by approximately 50 percent. The Company believes that the longer term exchange value of the Peso will not be clear for several months, as world currency markets settle upon a new exchange value.\nThe Company believes that, during 1995, the devaluation will have a positive impact on its cost of manufacturing, and a negative impact of its sales to Mexican customers. The magnitude of the impact is not readily determinable, as it is dependent upon a number of factors. Those factors include: i) the ultimate exchange value of the Peso, and ii) the impact of offsetting potential inflationary increases in the cost of the wages, goods and services that the Company purchases in Mexico. While none of these are known currently, the Company believes the net effect in 1995 will be favorable.\nEFFECT OF NEW ACCOUNTING STANDARDS FINANCIAL ACCOUNTING STANDARDS NO. 109 - \"ACCOUNTING FOR INCOME TAXES\"\nIn 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard 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\nManagement's Discussion & Analysis of Financial Condition & Results of Operations\ncontinued -------------------------------------------------------------------------------\nconsequences 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 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.\nThe Company adopted Statement 109 on the first day of fiscal 1993. The cumulative effect of this change in accounting method for income taxes had no material impact on the consolidated statement of operations. Prior periods' financial statements have not been restated to apply the provisions of Statement 109.\nIn order to realize the deferred tax asset established, the Company will need to generate future taxable income or be able to carryback taxable income to 1994, 1993 or 1992, totaling $7.8 million. The Company's income before taxes and taxable income history is as follows (in thousands):\nThe Company believes the existing net deductible temporary differences will reverse during periods in which the Company generates net taxable income, or in periods in which a carryback to 1994, 1993 or 1992 is available. Further, the Company believes it has available certain alternate tax planning strategies, principally related to the LIFO method of accounting for inventory, that could be implemented, if necessary, to supplement taxable income from operations. The Company has considered the above factors in concluding that it is more likely than not that the Company will realize the benefits of existing deferred tax assets. There can be no assurance, however, that the Company will generate any specific level of continuing earnings. See also Note 7 to the Consolidated Financial Statements for additional information concerning Income Taxes.\nRESULTS OF OPERATIONS 1994 SALES AND OPERATIONS COMPARED WITH 1993\nDuring 1994, the Company successfully expanded the net sales of thermal comfort products, providing substantially all of the growth in net sales from 1993. The acquisition of Vesture Corporation, the originators of thermal comfort products, in July 1994, enhanced the Company's growth in the thermal comfort products marketplace.\nDuring 1994, net sales grew 15.4 percent to $116.7 million from $101.2 million during 1993. Substantially all the growth in net sales occurred in thermal comfort products. As a result of unseasonably warm fall and early winter weather throughout much of the United States, the Company received order cancellations of approximately $3.5 million in thermal comfort products from department store cold weather departments. Had it not been for those cancellations, net sales would have been near $120 million.\nGross profit for the year increased to $46.7 million from $41.7 million in 1993. Gross profit as a percent of net sales declined slightly in 1994 to 40.0 percent, having been 40.9 percent in 1993. The reasons for the slight decline include the added costs the Company incurred following the implementation of a fully integrated manufacturing control software system. As a result of the implementation of this system, which occurred during the second quarter, the Company experienced delays in production, resulting in lost slipper production and adverse manufacturing variances, during the final nine months of the year. Manufacturing variances were also incurred as the Company increased head-counts to catch up on production. This increased spending lowered efficiencies and adversely affected gross profit for the year. The lost production also adversely affected slipper deliveries in 1994.\nSelling, general and administrative expenses increased by 14.7 percent during 1994, to $39.4 million from $34.3 million in 1993. Much of the increase is in the area of marketing, selling and promotional support programs put into place to support increases in net sales.\nRoyalty income in 1994, declined from 1993. The royalty agreement in place for many years, was terminated at the request of the licensee. The Company is in the process of negotiating a new agreement, at a reduced royalty, to replace the previous agreement.\nNet interest expense in 1994, increased to $1.7 million from $1.4 million in 1993. The primary cause of the increased interest was the increase in the amount of long-term debt that the Company carried since borrowing $15 million in July 1994. During 1994, the average short-term bank borrowings amounted to $12.5 million, compared with $14.2 million during 1993. Interest rates on short term seasonal borrowings in 1994 averaged 5.7 percent, compared with 4.9 percent in 1993.\nManagement's Discussion & Analysis of Financial Condition & Results of Operations\ncontinued -----------------------------------------------------------------------------\nFor the year, earnings before income taxes amounted to $6.0 million, up slightly from prior year's pretax earnings of $5.98 million. Net earnings after taxes amounted to $3.81 million up slightly from the prior year's net earnings of $3.80 million. Earnings per common share amounted to $0.72 in 1994 compared with $0.76 in 1993. The principle cause of the decline in earnings per share results from the additional shares outstanding following the purchase of Vesture Corporation. All per share calculations have been retroactively restated to give effect to the 4 for 3 share split distributed to shareholders on June 22, 1994.\n1993 SALES AND OPERATIONS COMPARED WITH 1992\nNet sales in 1993 totaled $101.2 million, which was slightly less than net sales of $101.8 million in 1992. During the first half of 1993, net sales were about $600 thousand less than in the first six months of 1992. During the second six months of both 1992 and 1993, net sales were essentially flat at $81.3 million.\nDuring the fall of 1993, the Company test marketed a microwave heated seat cushion in several cities. The test results were very encouraging. The test in 1993 had no material impact on the net sales or results of operations for 1993.\nGross profit improved in 1993 compared with the prior year. Gross profit as a percent of net sales amounted to 40.9 percent in 1993, increasing from 40.2 percent in 1992. Improved manufacturing efficiencies, and the increased use of computer aided cutting of materials were positive influences on holding manufacturing costs in line for the year. Many cost reduction plans, begun in earlier years, contributed to improved gross profit margins.\nSelling, general and administrative expenses of $34.3 million in 1993, were essentially flat with those incurred in 1992 of $34.5 million.\nInterest expense in 1993 was substantially lower than in 1992, principally resulting from lower long-term debt outstanding and from lower short-term interest rates incurred by the Company. In 1993, short-term rates were about 1.3 percent lower than in 1992. During 1993, the Company's average short-term borrowings amounted to $14.2 million compared with average short-term borrowings in 1992 of $14.7 million.\nEarnings before income taxes were $6.0 million for 1993, compared with $4.8 million in 1992. Net earnings after taxes amounted to $3.8 million for 1993, or $0.76 per share. For 1992, earnings before an extraordinary credit from the utilization of a net operating loss carryforward, amounted to $3.0 million, or $0.61 per share. Net earnings after the extraordinary credit amounted to $3.3 million or $0.67 per share. No similar extraordinary credit was available in 1993.\n1992 SALES AND OPERATIONS COMPARED WITH 1991\nThe operations of the Company returned to profitability in 1992. The implementation of previous years' restructuring decisions had been largely completed, and the operations of the Company benefited from restructuring.\nFor 1992, the Company's net sales were $101.8 million, slightly less than net sales for 1991 of $102.8 million. The Company anticipated that the economy would not improve during 1992 and operated accordingly.\nGross profit of the Company improved during 1992 to 40.2 percent, compared with gross profit of 32.8 percent during 1991. Nearly all the gross profit improvement resulted from cost reductions, directly related to the cost reduction strategies implemented following the restructuring that began in early 1991.\nSelling, general and administrative expenses increased in 1992 to $34.4 million from $33.0 million in 1991. During 1991, the Company pared back many of its marketing and sales programs. The restoration of these programs, in 1992, coupled with cost increases resulted in increased selling, general and administrative expenses for the year.\nNet interest expense declined during 1992 to $2.1 million, from $2.4 million in 1991. Most of the decline resulted from lower interest rates in 1992, although the improved profitability of the Company translated into lower average borrowings during the year.\nAs a result of the improved operating performance of the Company for the year, the Company earned a pretax profit of $4.8 million compared with a pretax loss in 1991 of $1.3 million. After taxes and before an extraordinary credit, in 1992, the Company earned $3.0 million, or $0.61 per share, compared with an after tax loss in 1991 of $1.3 million, or a loss of $0.25 per share. As a result of the losses that the Company incurred in 1991, the Company had available a net operating loss carryforward that was used in 1992. The financial impact of utilization of the carryforward, was the realization of an extraordinary credit for the tax impact of the carryforward equal to $300 thousand. After taxes and the extraordinary credit, the Company earned $3.3 million, or $0.67 per share in 1992.\nConsolidated Balance Sheets\nR.G. Barry Corporation and Subsidiaries\nConsolidated Statements of Earnings\nR.G. Barry Corporation and Subsidiaries\nConsolidated Statements of Shareholders' Equity\nR.G. Barry Corporation and Subsidiaries\nSee accompanying notes to consolidated financial statements.\nConsolidated Statements of Cash Flows\nR.G. Barry Corporation and Subsidiaries\nSee accompanying notes to consolidated financial statements.\nNotes to Consolidated Financial Statements\nR.G. Barry Corporation and Subsidiaries --------------------------------------------------------------------------------\n(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) Principles of Consolidation and Industry Information\nThe consolidated financial statements include the accounts of the Company and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The Company operates in the comfort products industry.\nIn 1994, two customers accounted for approximately 26% of the Company's net sales. In 1993, two customers accounted for approximately 25% of the Company's net sales. In 1992, three customers accounted for approximately 33% of net sales. Substantially, all the Company's sales are to customers involved in the retail industry.\n(b) Inventory\nInventory is valued at the lower of cost or market. Substantially all ending inventory costs in 1993 and 1992 are determined on the last in, first out (LIFO) basis and the remainder are determined on the first in, first out (FIFO) basis. Approximately 76% of the 1994 ending inventory costs are determined on the LIFO basis.\n(c) Depreciation and Amortization\nDepreciation and amortization have been provided substantially on the double declining-balance method over the estimated useful lives of the assets prior to September 30, 1991. On or after October 1, 1991, the Company adopted the straight-line method of depreciation on its machinery and equipment for all property acquired after October 1, 1991. Similar equipment placed in service prior to October 1, 1991 continues to be depreciated by the double declining-balance method.\nThe Company has capitalized hardware and software costs related to its new computer system and is amortizing such costs on a straight-line basis over a five-year period. At December 31, 1994, costs related to the hardware and software are included in machinery and equipment. Substantially all construction in progress (see note 4) at January 1, 1994 is related to the new computer system.\n(d) Revenue Recognition\nThe Company recognizes revenue when the goods are shipped to customers.\n(e) Income Taxes\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 3, 1993, the Company adopted Statement 109. The cumulative effect of that change was immaterial to the 1993 consolidated 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.\n(f) Preferred Shares\nEach Class A Preferred share is entitled to one-tenth of one vote, while each Class B Preferred share, including the Series I Junior Participating shares, is entitled to ten votes. The preferred shares are entitled to a preference in liquidation. The Series I Junior Participating Class B Preferred shares are entitled to cumulative dividends at a quarterly rate of five cents per share. None of these shares have been issued.\n(g) Employee Retirement Plans\nRetirement plan expense is determined in accordance with Statement of Financial Accounting Standards No. 87, Employers' Accounting for Pensions (FAS 87).\nNotes to Consolidated Financial Statements\nR.G. Barry Corporation and Subsidiaries\ncontinued --------------------------------------------------------------------------------\n(h) Per-Share Information\nEarnings per common share have been computed using the average number of shares outstanding each year (5,294,000; 5,024,000; and 5,023,000 in 1994, 1993 and 1992, respectively). There is no material dilution in the per-share information as a result of outstanding stock options. The average number of shares in 1993 and 1992 have been adjusted to reflect the four-for-three stock split.\n(i) Reclassification\nCertain amounts in the 1993 financial statements have been reclassified to conform to the 1994 presentation.\n(2) ACQUISITION\nEffective July 14, 1994, the Company acquired all of the outstanding stock of Vesture Corporation of Randleman, North Carolina. Vesture Corporation manufactures and markets microwave heated comfort products. The acquisition has been accounted for by the purchase method of accounting. The purchase price was paid by the issuance of approximately 319,000 common shares of the Company held in treasury, valued at $5,000,000. As a result of the purchase, the Company recognized approximately $4,600,000 in goodwill which is being amortized on a straight-line basis over 40 years. The acquisition did not result in a significant business combination within the definition provided by the Securities and Exchange Commission and therefore, pro forma financial information has not been presented.\n(3) INVENTORY\nIf the FIFO method had been used to value inventory, inventory would have been $2,669,000, $2,915,000, and $2,933,000 higher than that reported at the end of 1994, 1993 and 1992, respectively. Because LIFO inventory is valued using the dollar value method, it is impracticable to separate inventory values between raw materials, work-in-process and finished goods.\n(4) PROPERTY, PLANT AND EQUIPMENT\nOn July 5, 1994, the Company issued a $15 million 9.7% note, due July 2004. The note requires semi-annual interest payments, with annual principal repayments commencing in 1998. A portion of the proceeds of the note was used to prepay $2.83 million of 10 3\/8% notes due July 1997.\nIn December 1993, the Company amended the revolving credit agreement with its banks. The new agreement provides the Company with a seasonally adjusted amount of credit that has a minimum availability of $5.5 million and a peak availability of $38 million, with interest at prevailing rates (8.5% in 1994 and 5% in 1993). Advances under the revolving credit agreement are due June 30, 1995. At December 31, 1994, $2 million was outstanding.\nNotes to Consolidated Financial Statements\nR.G. Barry Corporation and Subsidiaries\ncontinued ----------------------------------------------------------------------------\nThe indentures related to the Subordinated Sinking Fund Debentures require annual payments to the trustee sufficient to redeem approximate annual principal amounts as follows: $497,000 in 1995 and $700,000 in 1996. The 9 3\/4% debentures are redeemable in whole or in part without premium.\nUnder the most restrictive covenants of the various loan agreements, the Company is (1) required to maintain a seasonally adjusted minimum working capital, as defined; (2) required to maintain a minimum seasonally adjusted tangible net worth, as defined; (3) required to restrict the annual acquisition of fixed assets; (4) required to achieve a seasonally adjusted minimum amount of gross sales and open orders, as defined; and (5) restricted with regard to the amount of additional borrowings, purchase of treasury shares and payment of dividends. At December 31, 1994, approximately $7,700,000 of retained earnings was available for the payment of cash dividends and the purchase of treasury shares (see also note 10). There were no covenant violations during fiscal 1994 and 1993.\nThe Company maintains compensating cash balances, which are not legally restricted, to defray the costs of other banking services provided.\n(6) LEASED ASSETS AND LEASE COMMITMENTS\nThe Company has lease agreements with local governments which issued Industrial Development Revenue Bonds to construct and purchase office and plant facilities and equipment. The leases expire in 1998 and 1999, at which time the Company has the right to acquire (at nominal amounts) the property under these lease agreements. The Company also has the option to acquire these leased assets prior to the expiration of the leases for amounts approximating the outstanding bonds, plus accrued interest. The outstanding bonds bear interest from 6.5% to 6.6%.\nAt December 31, 1994, minimum lease payments due under these capital leases are:\nThe present value of minimum capital lease payments are reflected in the balance sheets:\nThese leased assets are capitalized in property, plant and equipment:\nNotes to Consolidated Financial Statements\nR.G. Barry Corporation and Subsidiaries\ncontinued --------------------------------------------------------------------------------\nThe Company occupies certain manufacturing, warehousing, operating and sales facilities and uses certain equipment under other cancelable and noncancelable operating lease arrangements. A summary of the noncancelable operating lease commitments at December 31, 1994 follows:\nSubstantially all of these operating lease agreements are renewable for periods of 3 to 15 years and require the Company to pay insurance, taxes and maintenance expenses. Rent expense under cancelable and noncancelable operating lease arrangements in 1994, 1993 and 1992 amounted to $3,480,000, $2,619,000, and $2,665,000, respectively.\n(7) INCOME TAXES\nEffective January 3, 1993, the first day of fiscal 1993, the Company adopted Financial Accounting Standards Board Statement 109, Accounting for Income Taxes (FASB 109). The cumulative effect of this change determined as of January 3, 1993, had no material impact on the consolidated statement of earnings. The 1992 financial statements have not been restated to apply the provisions of FASB 109.\nIncome tax expense (benefit) consists of:\nThe differences between income taxes computed by applying the statutory federal income tax rate (34%) and income tax expense in the consolidated financial statements are:\nNotes to Consolidated Financial Statements\nR.G. Barry Corporation and Subsidiaries\ncontinued ------------------------------------------------------------------------------- The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 1994 and January 1, 1994 are presented below:\nFor the fiscal year 1992, deferred income tax expense (benefit) results from temporary differences in the recognition of revenues and expenses for financial accounting and income tax purposes. Components of the deferred tax expense (benefit) were:\nNotes to Consolidated Financial Statements\nR.G. Barry Corporation and Subsidiaries\ncontinued --------------------------------------------------------------------------------\n(9) EMPLOYEE RETIREMENT PLANS\nThe Company and its domestic subsidiaries have noncontributory retirement plans for the benefit of salaried and nonsalaried employees (the Plans).\nThe employees covered under the Plans are eligible to participate upon the completion of one year of service. Salaried retirement plan benefits are based upon a formula applied to a participant's final average salary and years of service, which is reduced by a certain percentage of the participant's social security benefits. Nonsalaried retirement plan benefits are based on a fixed amount for each year of service. The Plans provide reduced benefits for early retirement. The Company intends to fund the minimum amounts required under the Employee Retirement Income Security Act of 1974.\nThe funded status of the salaried retirement plan and the prepaid retirement cost recognized at December 31, 1994 and January 1, 1994 are:\nThe funded status of the nonsalaried retirement plan and the accrued retirement cost recognized at December 31, 1994 and January 1, 1994 are:\nThe Company also has a Supplemental Retirement Plan (SRP) for certain officers of the Company as designated by the Board of Directors. The SRP is unfunded, noncontributory, and provides for the payment of monthly retirement benefits. Benefits are based on a formula applied to the recipients' final average monthly compensation, reduced by a certain percentage of their social security benefits.\nNotes to Consolidated Financial Statements\nR.G. Barry Corporation and Subsidiaries\ncontinued --------------------------------------------------------------------------------\nThe funded status of the SRP and the accrued retirement cost recognized at December 31, 1994 and January 1, 1994 are:\nThe weighted-average discount rate and the rate of increase in future compensation levels (salaried and SRP plans only) used in determining the actuarial present value of the PBO for the Plans was 8.0% in 1994 and 7.5% in 1993, and 5% in 1994 and 1993, respectively. The expected long-term rate of return on assets for the Plans was 9% in 1994 and 1993. The Plans' assets consist primarily of stocks and corporate bonds listed on national exchanges, and U.S. government obligations.\nThe components of net pension cost for the salaried, nonsalaried and supplemental retirement plans were:\nThe Company adopted an Employee Stock Ownership Plan (ESOP) in 1986. The rate of contribution to the ESOP is discretionary with the Company's Board of Directors. There was no charge to earnings for the ESOP in 1994, 1993 and 1992.\n(10) SHAREHOLDERS' EQUITY\nEffective June 22, 1994, the Board of Directors of the Company approved a four-for-three share split, distributed in the form of a share dividend, to shareholders of record on June 1, 1994. All references below to the number of shares and per share amounts have been retroactively restated to reflect the split.\nThe Company has various stock option plans, which have granted incentive stock options exercisable for periods of up to 10 years from date of grant at prices not less than 100% of the fair market value at date of grant. Stock appreciation rights may be issued on certain options subject to certain limitations. Information with respect to options under these plans is:\nNotes to Consolidated Financial Statements\nR.G. Barry Corporation and Subsidiaries\ncontinued\nAt December 31, 1994, the options outstanding under these plans were held by 81 employees and had expiration dates ranging from 1995 to 2004.\nDuring 1994, the Company granted approximately 51,000 nonqualified stock options to three officers. The shares will become exercisable over a five-year period starting in 1995 at an option price of $14.06.\nDuring 1992, an outstanding nonqualified stock option for 19,800 shares was exercised by an executive at $4.26 per share. This exercise price represents 110% of the fair market value on the date the option was granted.\nPursuant to the terms of the various stock option plans, optionees may tender shares previously owned in exchange for the exercise of options under the plans. The 6,000 and 21,000 treasury shares acquired by the Company in fiscal 1994 and 1992, respectively, were acquired in conjunction with the exercise of options.\nThe Company has an employee stock purchase plan in which approximately 600 employees are eligible to participate. Under the terms of the plan, employees receive options to acquire common shares at the lower of 85% of the fair market value on their enrollment date or the termination date of the plan term. At December 31, 1994, there were options to purchase approximately 41,000 common shares outstanding held by 264 employees at $18.49 per share, with an expiration date of September 1996; $92,000 had been paid in to the plan, and 165,000 shares are reserved for issuance. During 1994, options were exercised by 107 employees to purchase approximately 86,000 common shares at $3.84 per share.\nThe Company had previously issued 359,000 restricted common shares pursuant to employment agreements with two key executives. These shares may not otherwise be disposed of or transferred by the holder until the restrictions lapse; however, the shares are entitled to full voting and dividend rights. The restrictions, with certain exceptions, lapse at a rate of 10% per year through 1995; provided, however, that the restricted shares may be forfeited if the executives terminate their employment under certain circumstances. During 1992, the employment agreement with one executive relating to 59,000 of these restricted shares was terminated, and the restrictions lapsed on the remaining shares. Provisions as set forth in the agreements, allow for accelerated release of the restrictions on the shares upon achievement of specified earnings levels by the Company. Charges to earnings relating to these plans were $167,000 in 1994, $167,000 in 1993, and $271,000 in 1992. The agreements also provide for separation compensation in the event of certain early termination. Without regard to any debt covenant limitations, the Company is obligated under one of the agreements relating to 300,000 restricted shares, to purchase up to 50% of the unrestricted shares presented by the key executive. The purchase price shall be at the market value on the date the transfer restrictions on such shares lapse. No shares were presented or purchased in 1992 and 1991. In March 1994 and January 1993, the Company purchased 30,000 unrestricted shares presented by the key executive at $17.25 and $7.63 per share, respectively, which represented the market price on the date of purchase.\nIn the event that shares received through the various stock plans are sold within one year of exercise, the Company is entitled to a tax deduction. The deduction is not reflected in the consolidated statement of earnings but is reflected as an increase in additional capital in excess of par value.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nR.G. Barry Corporation and Subsidiaries\ncontinued -------------------------------------------------------------------------------\n(11) PREFERRED SHARE PURCHASE RIGHTS\nThe Company's Board of Directors previously declared a dividend of one Preferred Share Purchase Right (Right) on each outstanding common share of the Company. Under certain conditions, each Right may be exercised to purchase a unit consisting of 1\/10 of a share of Series I Junior Participating Class B Preferred Shares, par value $1 per share, at an initial exercise price of $20 per unit. The Rights may not be exercised until the earlier of 15 days after a public announcement that a person or group has acquired, or obtained the right to acquire, 25% or more of the Company's outstanding common shares (Share Acquisition Date) or 10 business days after the commencement of a tender or exchange offer that would result in a person or group owning 30% or more of the Company's outstanding common shares.\nIn the event that, at any time following the Share Acquisition Date, the Company is acquired in a merger or other business combination transaction in which the Company is not the surviving corporation or 50% or more of the Company's assets or earning power is sold or transferred, each holder of a Right will be entitled to buy the number of shares of common stock of the acquiring company which at the time of such transaction will have a market value of two times the exercise price of the Right. If, after the Share Acquisition Date, the Company is the surviving corporation in a merger with the acquiring person or group, or if a person or group acquires 30% or more of the Company's common shares under certain circumstances, then each holder of a Right will be entitled to buy common shares of the Company having a market value of two times the exercise price of the Right.\nThe Rights, which do not have any voting rights, expire on March 16, 1998, and may be redeemed by the Company at a price of $0.01 per Right at any time until 15 days following the Share Acquisition Date.\n(12) RELATED PARTY OBLIGATION\nThe Company and a key executive have entered into an agreement pursuant to which the Company is obligated for up to one year after the death of the key executive to purchase, if the estate elects to sell, up to $4 million of the Company's common shares, at their fair market value on the date of purchase, held by the key executive. To fund its potential obligation to purchase such shares, the Company has purchased a $5 million life insurance policy on the key executive, the cash surrender value of which is included in other assets in the accompanying balance sheet. In addition, for a period of 24 months following the key executive's death, the Company will have a right of first refusal to purchase any shares of the Company owned by the key executive at the time of his death if his estate elects to sell such shares. The Company would have the right to purchase such shares on the same terms and conditions as the estate proposes to sell such shares.\n(13) CONTINGENT LIABILITIES\nIn 1994, the Company and several of its officers and directors were named as defendants in three purported class actions presently pending in the United States District Court for the Southern District of Ohio, Eastern Division. The complaints generally allege that the Company made several false and misleading statements in violation of certain provisions of the federal securities laws. One complaint also alleges claims arising under state law. The Company believes that these actions are without merit and that it has meritorious defenses. The Company intends to defend itself vigorously against these actions. Management does not expect the resolution of this matter to have a material adverse effect on the Company's financial position or results of operations.\nThe Company has been named as defendant in various lawsuits arising from the ordinary course of business. In the opinion of management, the resolution of such matters is not expected to have a material adverse effect on the Company's financial position or results of operations.\nINDEPENDENT AUDITORS' REPORT\nR.G. Barry Corporation and Subsidiaries\n-------------------------------------------------------------------------------\nThe Board of Directors and Shareholders R.G. Barry Corporation:\nWe have audited the accompanying consolidated balance sheets of R.G. Barry Corporation and subsidiaries (the Company) as of December 31, 1994 and January 1, 1994, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the fiscal years in the three-year period ended December 31, 1994. 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 R.G. Barry Corporation and subsidiaries as of December 31, 1994 and January 1, 1994, and the results of their operations and their cash flows for each of the fiscal years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in notes 1 and 7, the Company changed its method of accounting for income taxes in fiscal 1993 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nKPMG Peat Marwick LLP\nColumbus, Ohio\nFebruary 14, 1995\nINDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES\nThe Board of Directors and Shareholders R. G. Barry Corporation:\nUnder date of February 14, 1995, we reported on the consolidated balance sheets of R. G. Barry Corporation and subsidiaries as of December 31, 1994 and January 1, 1994, and the related consolidated statements of earnings, shareholders' equity and cash flows for each of the fiscal years in the three-year period ended December 31, 1994, as contained in the fiscal 1994 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 fiscal year 1994. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated 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, 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 1 and 7 to the consolidated financial statements, the Company changed its method of accounting for income taxes in fiscal 1993 to adopt the provisions of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\nKPMG Peat Marwick LLP\nColumbus, Ohio February 14, 1995 Schedule II -----------\nSchedule II -----------\nR. G. BARRY CORPORATION AND SUBSIDIARIES\nReserves\nFiscal year ended January 1, 1994\nSchedule II -----------\nR. G. BARRY CORPORATION AND SUBSIDIARIES\nReserves\nFiscal year ended January 2, 1993\nR. G. BARRY CORPORATION ANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1994\nINDEX TO EXHIBITS","section_15":""}
{"filename":"40877_1994.txt","cik":"40877","year":"1994","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, Oregon and Washington. Prior to the sale of properties described below, the Company also provided communications services in the state of Montana.\nOn November 30, 1994, the Company sold all of its local exchange properties (representing 7,000 access lines) in the state of Montana to Citizens Utilities Company.\nOn December 31, 1993, the Company sold a portion of its telephone plant in service, materials and supplies and customers (representing 17,000 access lines) in the state of Idaho to Citizens Utilities Company.\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.\"\nAdditional information related to the above transactions can be found in Note 3 and Note 4 of the Company's consolidated financial statements included in Item 8.\nThe Company provides a wide variety of communications services ranging from local telephone service for the home and office to highly complex voice and data services for industry. The 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. 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 AT&T Corp. The number of access lines served has grown steadily from 996,382 on January 1, 1990 to 1,373,845 on December 31, 1994.\nThe number of access lines in the states in which the Company operates as of December 31, 1994, was as follows:\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:\nAt December 31, 1994, the Company had 4,336 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 1994, there were no contracts expiring or agreements reached. During 1995, the contract with the CWA will expire.\nTelephone Competition and Regulatory Developments\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, 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 13 of the Company's consolidated financial statements included in Item 8.\nDuring 1994, the Company began implementation of a three-year $125 million re-engineering plan. In the initial year of the plan, $26 million was expended\nto implement this program. These expenditures were primarily associated with the consolidation of certain customer service centers, separation benefits associated with employee reductions and incremental expenditures to redesign and streamline systems and processes. During 1995, the level of re-engineering activities and related expenditures are expected to accelerate as pilot programs are rolled out and other major initiatives are completed. The overall re-engineering plan remains on schedule and is expected to be completed by the end of 1996. Continued implementation of this program will position the Company to accelerate delivery of a full array of voice, video and data services and to reach its stated objective of being the easiest company to do business with in the industry.\nIn late 1994, the FCC began to auction new licenses for radio spectrum in 51 major markets and 492 basic trading areas across the United States to encourage the development of a new generation of wireless voice, data and messaging services which are generally referred to as broadband Personal Communication Services (PCS). PCS will compete with the Company's traditional wireline services.\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. On January 13, 1995, the United States District Court for the Eastern District of Virginia issued an injunction declaring that GTE has the right to provide video programming to its in-franchise customers. The court's decision means that GTE is now permitted to offer video programming over its own video dialtone networks, as well as to compete as a franchised cable operator in the Company's telephone territories.\nDuring 1994, GTE unveiled its World Class Network in eight key markets, including Seattle, Washington and Portland, Oregon, to provide advanced communications for business customers. This program includes sophisticated high-speed, digital fiber-optic rings, a high-capacity switching network (known as SONET), and a new centralized operations center that monitors the entire network. These SONET rings are an integral part of the high-speed information network that enables GTE to provide advanced services such as high-speed data transmission and video conferencing.\nFederal and state regulatory activity directed toward changing the traditional cost-based rate of return regulatory framework for intrastate and interstate telephone services has continued. Regulatory authorities have adopted various forms of alternative regulation, which provide economic incentives to telephone service providers to improve productivity and provide the foundation for implementing pricing flexibility necessary to address competitive entry into the markets the Company serves.\nMany states are currently investigating whether to authorize local and toll competition. Several have concluded that competition is in the public interest and five states, none within the Company's operating jurisdictions, have authorized plans that would allow customers to pre-subscribe to a specific carrier to handle intraLATA toll calls. GTE is challenging these orders primarily based on the lack of equality since the Company is prohibited from providing interLATA toll service.\nFor the provision of interstate services, the Company operates under the terms of the FCC's price cap incentive plan. The \"price cap\" mechanism serves to limit the rates a carrier may charge, rather than just regulating the rate of return which may be achieved. Under this approach, the maximum prices that the Company may charge are increased or decreased each year by a price index based upon inflation less a predetermined productivity target. The Company may, within certain ranges, price individual services above or below the overall cap.\nUnder its price cap regulatory plan, the FCC adopted a productivity sharing feature. Because of this feature, under the minimum productivity-gain option, the Company must share equally with its ratepayers any realized interstate return above 12.25% up to 16.25%, and all returns higher than 16.25%, by temporarily lowering prospective prices.\nDuring 1992-1994, the FCC took a number of steps to increase competition for local exchange carrier (LEC) access services. These steps, known as Expanded Interconnection requirements, allow competing communications carriers to interconnect to the local exchange network for the purpose of providing switched access transport services and private line services. Expanded Interconnection requires LECs to permit competitors to connect directly to LEC central offices and the LEC network under negotiated terms and conditions. Competitors are thereby able to compete more effectively than previously to replace LEC services between large users and interexchange carriers (IXCs), or between large users and the LEC switch. The FCC accompanied its Expanded Interconnection mandate with a slight relaxation of the rigid pricing rules that govern how LECs price their access services. In 1994, the FCC also reaffirmed the switched access rate structure changes adopted in 1993 that allow LECs to better reflect the actual cost characteristics of transport services and improve the LEC's ability to compete with alternative access providers.\nThe GTE Consent Decree, which was issued in connection with the 1983 acquisition of GTE Sprint and GTE Spacenet (both since divested), prohibits GTE's domestic telephone operating subsidiaries from providing long distance service beyond the boundaries of the LATA. This prohibition restricts the Company's 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.\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 intends to continue to respond aggressively to regulatory and legal developments that allow for increased competition and opportunities in the marketplace. The Company expects its financial results to benefit from reduced costs and the introduction of new products and services that will result in increased usage of its networks. However, it is likely that such improvements will be offset, in part, by continued strategic pricing reductions and the effects of increased competition.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company's property consists of network facilities (82%), customer premises equipment (1%), company facilities (13%) and other (4%). From January 1, 1990 to December 31, 1994, the Company made gross property additions of $1.3 billion and property retirements of $0.7 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.\nTRANSFER AGENT AND REGISTRAR The Transfer Agent and Registrar for GTE Northwest's common stock and no par preferred stock is the First National Bank of Boston.\nGTE Corporation C\/O Bank of Boston P.O. Box 9191 Boston, MA 02205-9191\n10-K REPORT A copy of the 1994 annual report on Form 10-K filed with the Securities and Exchange Commission may be obtained by writing to:\nGTE Telephone Operations External Reporting P.O. Box 407, MC: INAAACG Westfield, IN 46074 (317)896-6464\nPARENT COMPANY ANNUAL REPORT A copy of the 1994 annual report of our parent company may be obtained by writing to:\nGTE Corporation Corporate Secretary's Office One Stamford Forum Stamford, CT 06904\nItem 6.","section_6":"Item 6. Selected Financial Data\nGTE Northwest Incorporated and Subsidiary\n(a) Per share data is omitted since the Company's common stock is 100% owned by GTE Corporation. (b) Net operating income in 1993 included a $125.0 million pretax charge for restructuring costs which reduced net income by $77.0 million.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nBUSINESS OPERATIONS\nGTE Northwest Incorporated (the Company), a wholly-owned subsidiary of GTE Corporation (GTE), provides local exchange, network access and long distance telecommunications services for over 1.3 million access lines in California, Idaho, Oregon, and Washington.\nIn February 1993, the Company merged with Contel of the Northwest, Inc., a wholly-owned subsidiary of Contel Corporation (which is a wholly-owned subsidiary of GTE). The merger was accounted for similar to a \"pooling of interests\" and accordingly, the previously issued financial results have been restated to reflect the combined historical results of operations, financial position, and cash flows of the Company and Contel of the Northwest, Inc. All comparative data presented in this discussion reflects such restatement.\nRESULTS OF OPERATIONS\nNet income was $119 million for the year ended December 31, 1994 including an $8 million gain, net of tax, associated with the sale of certain non-strategic properties in Montana. Net income was $10 million for the year ended December 31, 1993 including one-time after-tax charges of $87 million to restructure operations and complete enhanced early retirement and voluntary separation programs and for the early retirement of high-coupon debt. The 1993 results also included an after-tax gain of $11 million due to the sale of certain non-strategic properties in Idaho.\nExcluding these special items, net income increased 29% or $25 million in 1994 and decreased 32% or $41 million in 1993. The 1994 increase is primarily due to customer growth reflected in an 8% increase in access lines and lower interest costs. The increase is partially offset by an increase in depreciation and amortization. The 1993 decrease was primarily due to the impact of the adoption of Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective January 1, 1993 and lower operating revenues due to voluntary rate reductions in an ongoing effort to price services more competitively.\nOPERATING REVENUES\nOperating revenues were $907 million and $875 million in 1994 and 1993, respectively. This represents an increase of 4% or $32 million in 1994 compared to a decrease of 1% or $11 million in 1993.\nLocal network service revenues are comprised mainly of fees charged to customers for providing local exchange service. In 1994 local network service revenues were $347 million compared to $331 million in 1993. This represents increases of 5% or $16 million in 1994 and 3% or $10 million in 1993. The 1994 increase is due to the growth of Extended Area Services revenue from residential customers and the continued customer growth reflected by an 8% increase in access lines. The 1993 increase was primarily due to continued customer growth in access lines of 5%, offset by an $8 million annual rate\nreduction in Washington and a $1 million annual rate reduction in Oregon as a result of the legal entity merger filing.\nNetwork access service revenues are fees charged to interexchange carriers and intraLATA (Local Access Transport Area) toll providers that use the local telecommunication network to provide long-distance services to their customers. In addition, end users pay access fees to connect to the local network to obtain long-distance service. Revenues derived from network access services were $359 million in 1994 and $371 million in 1993. This represents a decrease of 3% or $12 million in both 1994 and 1993. The 1994 decrease is primarily due to the transition by Oregon and Washington in May 1994 and July 1994, respectively, to a Primary Toll Carrier (PTC) plan. Before transitioning to the PTC plan, all intraLATA toll was remitted to US WEST, Inc. In turn, US WEST, Inc. paid the Company access charges for intraLATA toll that was originated or terminated by the Company. Under the PTC plan, the Company keeps the revenues from originating toll calls, records them as long distance service revenues and remits access charges to the local exchange carriers (LECs). Therefore, under the PTC plan, the Company only receives access revenues for intraLATA toll calls that are terminated by the Company. The PTC plan is income neutral to the Company since decreases in access revenues are offset by increases in toll revenues and increases in access charge expenses. This decrease is partially offset by a decrease in transitional support payments to the National Exchange Carrier Association. The 1993 decrease was due to voluntary rate reductions and additional reductions associated with the merger filing in Washington.\nThe Company's long distance services are provided under PTC arrangements. In 1994, the long distance revenues were $72 million compared to $14 million in 1993. This represents an increase of $58 million in 1994 compared to a $3 million decrease in 1993. The 1994 increase is primarily due to the transition to the PTC plan discussed above. The 1993 decrease was due to an unfavorable calling card settlement and a revenue reserve charge.\nEquipment sales and services revenues consist primarily of the sale, lease, installation and maintenance of customer premises equipment. In 1994, equipment sales and services revenues were $68 million compared to $78 million for 1993. These revenues decreased 13% or $10 million in 1994 and were relatively unchanged in 1993. The 1994 decrease is primarily due to a decrease in telephone system sales and rental and installation revenues.\nOther revenues were $60 million in 1994 and $81 million in 1993. This represents decreases of 25% or $21 million in 1994 and 7% or $6 million in 1993. The 1994 decrease is due primarily to decreases in both directory service and billing and collection service revenues partially offset by a decrease in end user uncollectible provisions. The 1993 decrease was due to reductions in revenues from leased facilities and higher provisions for uncollectible accounts partially offset by an increase in operator service revenue.\nOPERATING EXPENSES\nCost of sales and services were $214 million compared to $213 million for 1993. The slight increase in 1994 is primarily due to the payment of access charges under the PTC plan to other local exchange carriers for intraLATA toll calls that are originated by the Company and terminated by another local exchange carrier, and the final resolution of certain settlement activities\npartially offset by the continuing cost reduction efforts of the Company and lower expenses relating to product sales and installation and maintenance. Costs of sales and services increased 5% or $9 million in 1993. The 1993 increase primarily reflected costs associated with the adoption of SFAS No. 106 effective January 1, 1993.\nDepreciation and amortization were $182 million in 1994 compared to $167 million in 1993, reflecting increases of 9% or $15 million in 1994 and 7% or $10 million in 1993. The 1994 increase is primarily due to depreciation and amortization rate adjustments effective January 1994. The 1993 increase was due to an increase in plant activity.\nExpenses for marketing, selling, general and administrative costs were $295 million in 1994 and $313 million in 1993. The 1993 expense included a one-time charge of $8 million associated with the enhanced early retirement and voluntary separation programs offered to eligible employees. Excluding this charge, marketing, selling, general and administrative expenses decreased 3% or $10 million in 1994 compared to an increase of 10% or $28 million in 1993. The 1994 decrease primarily reflects lower systems costs, a decrease in labor and benefits costs and lower costs associated with billing and collection services. These decreases are partially offset by an increase in regulated sales expenses and higher property taxes. The 1993 increase reflected costs of $5 million associated with the adoption of SFAS No. 106. The increase was also due to higher data processing costs due to system conversions and higher property and gross receipt taxes.\nOTHER (INCOME) DEDUCTIONS\nInterest expense was $52 million in 1994 compared to $58 million in 1993. This represents a decrease of 10% or $6 million in 1994 compared to an increase of 7% or $4 million in 1993. The 1994 decrease reflects an overall decrease in the coupon rates of the first mortgage bonds due to the early extinguishment of high-coupon first mortgage bonds in November 1993 and refinancing with debentures that were issued in May 1994. The 1993 increase reflected higher than average long-term debt levels, due to the issuance of first mortgage bonds in February 1993, partially offset by a decrease in the average short-term debt level and rate.\nThe $12 million pretax gain on disposition of assets represents the excess of cash proceeds over book value of assets and liabilities sold to Citizens Utilities Company on November 30, 1994. In 1993 a $20 million pretax gain on the disposition of assets was recognized resulting from the excess of cash proceeds over the book value of assets and liabilities sold to Citizens Utilities Company in December 1993. See Note 3 to the consolidated financial statements included in Item 8","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nCONSOLIDATED STATEMENTS OF INCOME (NOTE 4) GTE Northwest Incorporated and Subsidiary\n(a) Includes billings to affiliates of $42,368, $49,454 and $50,400 for the years 1994-1992, respectively. (b) Includes billings from affiliates of $55,040, $46,352 and $45,170 for the years 1994-1992, respectively.\nCONSOLIDATED STATEMENTS OF REINVESTED EARNINGS (NOTE 4)\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED BALANCE SHEETS (NOTE 4) GTE Northwest Incorporated and Subsidiary\nSee Notes to Consolidated Financial Statements.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 4) GTE Northwest Incorporated and Subsidiary\nSee Notes to Consolidated Financial Statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS GTE Northwest Incorporated and Subsidiary\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of GTE Northwest Incorporated (the Company) and its wholly-owned subsidiary, GTE West Coast Incorporated. All significant intercompany transactions have been eliminated. The Company is a wholly-owned subsidiary of GTE Corporation (GTE).\nTRANSACTIONS WITH AFFILIATES\nCertain affiliated companies supply construction and maintenance equipment and supplies to the Company. These purchases amounted to $55.2 million, $61.5 million and $72.0 million for the years 1994-1992, respectively. Such purchases are recorded in the accounts of the Company at cost which includes a normal return realized by the affiliates.\nThe Company is billed for certain printing and other costs associated with telephone directories, data processing services and equipment rentals, and receives management, consulting, research and development and pension management services from other affiliated companies. These charges amounted to $55.0 million, $46.4 million and $45.2 million for the years 1994-1992, respectively. The amounts charged for these affiliated transactions are based on a proportional cost allocation method.\nThe Company has an agreement with GTE Directories Corporation (Directories) (100% owned by GTE), whereby the Company provides its subscriber lists, billing and collection and other services to Directories. Revenues from these activities amounted to $42.4 million, $49.5 million and $50.4 million for the years 1994-1992, respectively.\nTELEPHONE PLANT\nMaintenance and repairs are charged to income as incurred. Additions to, replacements and renewals of property are charged to telephone plant accounts. Property retirements are charged in total to the accumulated depreciation account. No adjustment to depreciation is made at the time properties are retired or otherwise disposed of, except in the case of significant sales of property where profit or loss is recognized.\nThe Company provides for depreciation on telephone plant on a straight-line basis over asset lives approved by regulators. Depreciation is based upon rates prescribed by the Federal Communications Commission (FCC) and the state regulatory commissions. The provisions for depreciation and amortization were equivalent to composite annual rates of 6.3%, 6.0% and 6.0% for the years 1994-1992, respectively.\nREGULATORY ACCOUNTING\nThe Company follows the accounting prescribed by the Uniform System of Accounts of the FCC and the regulatory commissions in each of the Company's operating jurisdictions and Statement of Financial Accounting Standards (SFAS)\nNo. 71, \"Accounting for the Effects of Certain Types of Regulation.\" This accounting recognizes the economic effects of rate regulation by recording costs and a return on investment as such amounts are recovered through rates authorized by regulatory authorities. Accordingly, SFAS No. 71 requires companies to depreciate plant and equipment over lives approved by regulators. It also requires deferral of certain costs and obligations based upon approvals received from regulators to permit recovery of such amounts in future years. The Company annually reviews the continued applicability of SFAS No. 71 based upon the current regulatory and competitive environment.\nREVENUE RECOGNITION\nRevenues are recognized when earned. This is generally based on usage of the Company's local exchange networks or facilities. For other products and services, revenue is recognized when services are rendered or products are delivered to customers.\nMATERIALS AND SUPPLIES\nMaterials and supplies are stated at the lower of cost (average cost) or market value.\nEMPLOYEE BENEFIT PLANS\nEffective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The new standard requires that the expected costs of postretirement benefits be charged to expense during the years that the employees render service. The Company elected to adopt this new accounting standard on the delayed recognition method and commencing January 1, 1993, began amortizing the estimated unrecorded accumulated postretirement benefit obligation over twenty years. Prior to the adoption of SFAS No. 106, the cost of these benefits was charged to expense as paid.\nThe Company also adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" effective January 1, 1993. SFAS No. 112 requires employers to accrue the future cost of benefits provided to former or inactive employees and their dependents after employment but before retirement. Previously, the cost of these benefits was charged to expense as paid. The impact of this change in accounting on the Company's results of operations was immaterial.\nINCOME TAXES\nIncome tax expense is based on reported earnings before income taxes. Deferred income taxes are established for all temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and for tax purposes.\nAs further explained in Note 9, during the fourth quarter of 1992, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" retroactive to January 1, 1992. SFAS No. 109 changed the method by which companies account for income taxes. Among other things, the Statement requires that deferred tax balances be adjusted to reflect new tax rates when they are enacted into law. The impact of this change in accounting on the Company's results of operations was immaterial.\nInvestment tax credits were repealed by the Tax Reform Act of 1986 (the Act). Those credits claimed prior to the Act were deferred and are being amortized over the lives of the properties giving rise to the credits.\nFINANCIAL INSTRUMENTS\nThe fair values of financial instruments, other than long-term debt, closely approximate their carrying value. As of December 31, 1994, the estimated fair value of long-term debt based on either quoted market prices or an option pricing model was lower than the carrying value by approximately $22 million. The estimated fair value of long-term debt as of December 31, 1993, exceeded the carrying value by approximately $28 million.\nCOMPUTER SOFTWARE\nThe cost of computer software for internal use, except initial operating system software, is charged to expense as incurred. Initial operating system software is capitalized and amortized over the life of the related hardware.\n2. RESTRUCTURING COSTS\nResults for 1993 included a one-time pretax restructuring charge of $125.0 million, which reduced net income by $77.0 million, primarily for incremental costs related to implementation of the Company's three-year re-engineering plan. The re-engineering plan will redesign and streamline processes to improve customer-responsiveness and product quality, reduce the time necessary to introduce new products and services and further reduce costs. The re-engineering plan included $49.7 million to upgrade or replace existing customer service and administrative systems and enhance network software, $56.2 million for employee separation benefits associated with workforce reductions and $15.2 million primarily for the consolidation of facilities and operations and other related costs.\nImplementation of the re-engineering plan began during 1994 and is expected to be completed by the end of 1996. During 1994, expenditures of $25.5 million were made in connection with the implementation of the re-engineering plan. These expenditures were primarily associated with the consolidation of customer contact, network operations and operator service centers, separation benefits from employee reductions and incremental expenditures to redesign and streamline processes. The level of re-engineering activities and related expenditures are expected to accelerate in 1995.\nDuring 1993, the Company offered various voluntary separation programs to its employees. These programs resulted in a pretax charge of $7.8 million which reduced 1993 net income by $5.1 million.\n3. PROPERTY REPOSITIONING\nOn November 30, 1994, the Company sold 7,000 access lines in Montana to Citizens Utilities Company for $22 million in cash. This represents less than 1% of the Company's access lines. The transaction was accounted for as a sale. The net sales proceeds exceeded the book value and therefore, a pretax gain of $12 million was recognized on the transaction. The proceeds from this transaction were used to pay down short-term commercial paper borrowings.\nOn February 23, 1993, the Idaho properties of Contel of the West, Inc. were purchased by the Company for their book value of $25 million.\nOn December 31, 1993, the Company sold a portion of its telephone plant in service, materials and supplies and customers (representing 17,000 access lines) in the state of Idaho to Citizens Utilities Company for $54 million in cash. This transaction was accounted for as a sale. The net sales proceeds exceeded the book value and therefore, a pretax gain of $20 million was recognized on the transaction. The proceeds from this transaction were used to pay down $50 million of debt.\n4. LEGAL ENTITY MERGER\nOn February 26, 1993, Contel of the Northwest, Inc. merged into the Company. Contel of the Northwest, Inc. was a wholly-owned subsidiary of Contel Corporation (a wholly-owned subsidiary of GTE Corporation) prior to the merger.\nThe 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.\" Accordingly, the financial statements and the notes include the results of operations and financial position of the Company and Contel of the Northwest, Inc. for all periods. Operating revenues and net income of the separate entities for the year ended December 31, 1992 were as follows (in thousands of dollars):\n5. PREFERRED STOCK\nCumulative preferred stock (without par value), subject to mandatory redemption, is as follows:\n* Thousands of Dollars\nThe stock is redeemable, in whole or in part, at the option of the Company. A sinking fund provision requires the Company to retire 8,000 shares on each February 1. In each of the years 1992-1994, the Company redeemed 16,000 shares at its $100 stated value.\nThe aggregate redemption requirement of preferred stock subject to mandatory redemption is $800,000 in each of the years 1995-1999.\nIn the event of default in the payment of accrued dividends in an amount equal to four full quarterly-yearly dividends, the preferred shareholders, voting as a class, will be entitled to elect two directors in addition to the directors elected by GTE. Otherwise, the preferred shareholders have no voting rights. The Company is not in arrears in its dividend payments at December 31, 1994.\nNo shares of preferred stock were held by or for the account of the Company and no shares were reserved for officers and employees, or for options, warrants, conversions or other rights.\n6. COMMON STOCK\nThe authorized common stock of the Company consists of 20,000,000 shares without par value. The Company received proceeds of $38 million and $20 million from the issuance of common stock to GTE in 1993 and 1992, respectively. All outstanding shares of common stock are held by GTE.\nThere were no shares of common stock held by or for the account of the Company and no shares were reserved for officers and employees, or for options, warrants, conversions or other rights.\nAt December 31, 1994, $127.7 million of reinvested earnings was restricted as to the payment of cash dividends or the repurchase of common stock under the most restrictive terms of the Company's indentures.\n7. LONG-TERM DEBT\nLong-term debt outstanding, exclusive of current maturities, is as follows:\nIn November 1993, the Company called $125 million of high-coupon first mortgage bonds with proceeds from commercial paper borrowings. These bonds had coupons ranging from 9 1\/4% to 9 3\/4%. The cost of calling these bonds is reflected as an extraordinary after-tax charge of $4.5 million in the Consolidated Statements of Income.\nIn May 1994, the Company issued $200 million of 7 3\/8% Series A Debentures, due 2001, for the repayment of short-term borrowings incurred in connection with the 1993 early retirement of high-coupon first mortgage bonds and for the purpose of financing the Company's construction program.\nThe aggregate principal amount of bonds and debentures that may be issued is subject to the restrictions and provisions of the Company's indentures.\nNone of the securities shown above were held in sinking or other special funds of the Company or pledged by the Company.\nDebt discount on the Company's outstanding long-term debt is amortized over the lives of the respective issues.\nMaturities, installments and sinking fund requirements for the five-year period from January 1, 1995 are summarized below (in thousands of dollars):\nSubstantially all of the Company's telephone plant is subject to the liens of the indentures under which the bonds listed above were issued.\n8. SHORT-TERM DEBT\nThe Company finances part of its construction program through the use of interim short-term loans, primarily commercial paper, which are generally refinanced at a later date by issues of long-term debt or equity. Information relating to short-term borrowings is as follows:\nUnused lines of credit of $2.8 billion are available to the Company to support outstanding commercial paper and other short-term financing needs through shared lines of credit with GTE and other affiliates. Most of these arrangements require payment of annual commitment fees of .1% of the unused lines of credit.\n9. INCOME TAXES\nThe provision for income taxes is as follows:\nThe components of deferred income tax provision (benefit) are as follows:\nA reconciliation between taxes computed by applying the statutory federal income tax rate to pretax income and income taxes provided in the Consolidated Statements of Income is as follows:\nAs a result of implementing SFAS No. 109, the Company recorded additional deferred income tax liabilities primarily related to temporary differences which had not previously been recognized in accordance with established rate-making practices. Since the manner in which income taxes are treated for rate-making has not changed, pursuant to SFAS No. 71 a corresponding regulatory asset was also established. In addition, deferred income taxes were adjusted and a regulatory liability established to give effect to the current statutory federal income tax rate and for unamortized investment tax credits. The unamortized regulatory asset and regulatory liability balances at December 31, 1994 amounted to $18.5 million and $1.8 million, respectively, and the unamortized regulatory asset and liability balances at December 31, 1993 amounted to $16.7 million and $2.0 million, respectively, and are reflected as other assets and other deferred credits, respectively, in the accompanying Consolidated Balance Sheets. These amounts are being amortized over the lives of the related depreciable assets concurrent with recovery in rates and in conformance with the provisions of the Internal Revenue Code. The assets and liabilities established in accordance with SFAS No. 71 have been increased for the tax effect of future revenue requirements.\nThe tax effects of all temporary differences that give rise to the deferred tax liability and deferred tax asset at December 31 are as follows:\n10. EMPLOYEE BENEFIT PLANS\nRETIREMENT PLANS\nThe Company has trusteed, noncontributory, defined benefit pension plans covering substantially all employees. The benefits to be paid under these plans are generally based on years of credited service and average final earnings. The Company's funding policy, subject to the minimum funding requirements of U.S. employee benefit and tax laws, is to contribute such amounts as are determined on an actuarial basis to provide the plans with assets sufficient to meet the benefit obligations of the plans. The assets of the plans consist primarily of corporate equities, government securities and corporate debt securities.\nThe components of the net pension credit for 1994-1992 were as follows (in thousands of dollars):\nThe expected long-term rate of return on plan assets was 8.5% for 1994 and 8.25% for 1993 and 1992.\nThe funded status of the plans and the prepaid pension costs at December 31, 1994 and 1993 were as follows (in thousands of dollars):\nThe projected benefit obligations at December 31, 1994 and 1993 include accumulated benefit obligations of $221.9 million and $245.0 million and vested benefit obligations of $189.7 million and $214.2 million, respectively.\nAssumptions used to develop the projected benefit obligations at December 31, 1994 and 1993 were as follows:\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nAs described in Note 1, effective January 1, 1993, the Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\"\nSubstantially all of the Company's employees are covered under postretirement health care and life insurance benefit plans. The health care benefits paid under the plans are generally based on comprehensive hospital, medical and surgical benefit provisions. The Company funds amounts for postretirement benefits as deemed appropriate from time to time.\nThe postretirement benefit cost for 1994 and 1993 included the following components (in thousands of dollars):\nDuring 1992, the cost of postretirement health care and life insurance benefits on a pay-as-you-go basis was $4.6 million.\nThe following table sets forth the plans' funded status and the accrued obligations as of December 31, 1994 and 1993 (in thousands of dollars):\nThe assumed discount rates used to measure the accumulated postretirement benefit obligations were 8.25% at December 31, 1994 and 7.5% at December 31, 1993. The assumed health care cost trend rates in 1994 and 1993 were 12% and 13% for pre-65 participants and 9.0% and 9.5% for post-65 retirees, each rate declining on a graduated basis to an ultimate rate in the year 2004 of 6%. A one percentage point increase in the assumed health care cost trend rate for each future year would have increased 1994 costs by $1.8 million and the accumulated postretirement benefit obligations at December 31, 1994 by $16.6 million.\nDuring 1993, the Company made certain changes to its postretirement health care and life insurance benefits for non-union employees retiring on or after January 1, 1995. These changes include newly established limits to the Company's annual contribution to postretirement medical costs and a revised cost sharing schedule based on a retiree's years of service. The net effect of these changes reduced the accumulated postretirement benefit obligations at December 31, 1993 by $26.0 million.\nSAVINGS PLANS\nThe Company sponsors employee savings plans under section 401(k) of the Internal Revenue Code. The plans cover substantially all full-time employees. Under the plans, the Company provides matching contributions in GTE common stock based on qualified employee contributions. Matching contributions charged to income were $3.1 million for the years 1994-1992.\n11. LEASE COMMITMENTS\nThe Company has noncancelable leases covering certain buildings, office space and equipment. Minimum rental commitments for noncancelable leases through 1999 and thereafter are minimal. Rental expense was $12.0 million, $11.3 million and $11.9 million in 1994-1992, respectively.\n12. PROPERTY, PLANT AND EQUIPMENT\nProperty, plant and equipment, which is stated at cost, is summarized as follows at December 31:\n13. REGULATORY MATTERS\nThe Company is subject to regulation by the FCC for its interstate business operations. The state regulatory commissions governing the states of California, Idaho, Oregon and Washington regulate the Company's intrastate operations. Prior to the sale of properties described in Note 3, the state regulatory commission in Montana also regulated the Company's intrastate operations.\nINTRASTATE SERVICES\nA filing was made on July 9, 1992 with the Washington Utility and Transportation Commission (WUTC) for approval of the legal entity merger in Washington (see Note 4). A settlement agreement was approved by the WUTC on September 24, 1992. Pursuant to the stipulation order, local service rates were reduced by $8.0 million annually and a filing was made to reduce switched access rates by $2.0 million, effective January 1, 1993. On January 25, 1993, the WUTC filed a complaint alleging that the $2.0 million access reduction filing was not in accordance with the settlement agreement. The Company disagreed with the allegations. On February 11, 1994, as a resolution to the WUTC complaint associated with the legal entity merger, the WUTC ordered the Company to reduce its switched access rates $6.7 million, effective immediately.\nA filing was made on July 10, 1992 with the Oregon Public Utility Commission (OPUC) for approval of the legal entity merger in Oregon (see Note 4). A settlement agreement was filed on October 9, 1992 and approved by the OPUC on November 5, 1992. The Company's rates were reduced by $1.3 million effective January 1, 1993.\nThe Company began a major Extended Area Service (EAS) offering in the Portland metropolitan area in November 1991. This non-optional EAS offering provides expanded local calling to customers in Portland's metropolitan EAS region allowing customers to choose between flat rate, measured, or a combination of flat rate and measured EAS calling plans. On August 29, 1994 the OPUC ordered the expansion of the Portland Metro area to add new EAS routes, eleven of which involved the Company's exchanges. The net revenue reduction from this EAS expansion is projected to be $2.4 million.\nIn 1992, the Company filed tariffs in both Washington and Oregon that would allow it to operate under a Primary Toll Carrier (PTC) plan in its service areas. Under this plan, the toll billed to end users for intraLATA toll calls originating in the Company's service area are retained by the Company. The Company, in turn, pays access charges to the company terminating the call based on that company's approved access charge tariff. Likewise the Company will receive access charges for terminating any intraLATA toll call that originates outside of its service area based on its approved access charge tariff. On January 28, 1993, the WUTC authorized the Company to operate as a PTC in its service areas, effective July 1, 1994. As a result of the order, the Company reduced its toll rates by an average of 4.5%, its switched access rates by $8.4 million and special access rates by $2.6 million. Special access meet point billing will be implemented in the second quarter of 1995. In Oregon, when the Company filed for authority to operate under a PTC plan, it agreed that as part of the PTC proceeding, it would file financial data to enable the OPUC staff to review its earnings. On February 22, 1994 the OPUC approved the Company's request to operate under a PTC plan effective\nMay 1, 1994. It also ordered $5.1 million of local and access rate reductions effective April 1, 1994 to reflect the findings from the earnings review part of the proceeding. The Company was authorized a return on equity (ROE) of 10.36% and a rate of return (ROR) of 9.48%. The Company had requested an ROE and ROR of 13.25% and 11.31%, respectively.\nOn December 21, 1994, the WUTC authorized the Company an ROE of 11.25% and an overall ROR of 9.76%. The Company had requested a 13.8% ROE and an 11.58% ROR. No rate changes were required.\nThe Company received approval December 21, 1994, from the WUTC for the represcription of its depreciation rates and amortization of analog switching investments resulting in increased intrastate depreciation expenses of $12.9 million.\nOn January 1, 1995, GTE West Coast Incorporated's Implementation Rate Design (IRD) rates became effective in California. This IRD order authorized intraLATA toll competition. The net impact of this filing was intended to be revenue neutral to the Company as toll rates were reduced by 40% with an offsetting increase in basic local rates. Effective February 1, 1995, GTE West Coast Incorporated is also authorized to recover $345,000 for its High Cost Fund filing.\nINTERSTATE SERVICES\nFor the provision of interstate services, the Company operates under the terms of the FCC's price cap incentive plan. The \"price cap\" mechanism serves to limit the rates a carrier may charge, rather than just regulating the rate of return which may be achieved. Under this approach, the maximum price that the local exchange carrier (LEC) may charge is increased or decreased each year by a price index based upon inflation less a predetermined productivity target. LECs may, within certain ranges, price individual services above or below the overall cap.\nAs a safeguard under its price cap regulatory plan, the FCC adopted a productivity sharing feature. Because of this feature, under the minimum productivity-gain option, the Company must share equally with its ratepayers any realized interstate returns above 12.25% up to 16.25%, and all returns higher than 16.25%, by temporarily lowering the prospective prices. During 1995, the FCC is scheduled to review the LEC price cap plan to determine whether it should be continued or modified.\nIn 1992, the Company's rates were voluntarily reduced by $4.3 million effective July 1, 1992, $1.9 million effective July 17, 1992, $7.2 million effective October 2, 1992 and $4.0 million effective December 15, 1992.\nSIGNIFICANT CUSTOMER\nRevenues received from AT&T Corp. include amounts for access, billing and collection and interexchange leased facilities during the years 1994-1992 under various arrangements and amounted to $128.3 million, $129.3 million and $131.7 million, respectively.\n14. SUPPLEMENTAL CASH FLOW DISCLOSURES\nSet forth below is information with respect to changes in current assets and current liabilities, and cash paid for interest and income taxes:\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Shareholders of GTE Northwest Incorporated:\nWe have audited the accompanying consolidated balance sheets of GTE Northwest Incorporated (a Washington corporation and wholly-owned subsidiary of GTE Corporation) and subsidiary as of December 31, 1994 and 1993, and the related consolidated statements of income, reinvested earnings and cash flows for each of the three years in the period ended December 31, 1994. These financial statements and the schedule referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the 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 financial position of GTE Northwest Incorporated and subsidiary as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for postretirement benefits other than pensions. Also as discussed in Note 1, effective January 1, 1992, the Company changed its method of accounting for income taxes.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The supporting schedule listed under Item 14 is presented for purposes of complying with the Securities and Exchange Commission's rules and is not a required part of the basic financial statements. This supporting schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states 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 LLP\nDallas, Texas January 25, 1995.\nMANAGEMENT REPORT\nTo Our Shareholders:\nThe management of the Company is responsible for the integrity and objectivity of the financial and operating information contained in this Annual Report, including the consolidated financial statements covered by the Report of Independent Public Accountants. These statements were prepared in conformity with generally accepted accounting principles and include amounts that are based on the best estimates and judgments of management.\nThe Company has a system of internal accounting controls which provides management with reasonable assurance that transactions are recorded and executed in accordance with its authorizations, that assets are properly safeguarded and accounted for, and that financial records are maintained so as to permit preparation of financial statements in accordance with generally accepted accounting principles. This system includes written policies and procedures, an organizational structure that segregates duties, and a comprehensive program of periodic audits by the internal auditors. The Company has also instituted policies and guidelines which require employees to maintain the highest level of ethical standards.\nEILEEN O'NEILL ODUM President\nGERALD K. DINSMORE Senior Vice President - Finance and Planning\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\na. Identification of Directors\nThe names, ages and positions of the directors of the Company as of March 27, 1995 are listed below along with their business experience during the past five years.\nDirectors are elected annually. The term of each director expires on the date of the next annual meeting of shareholders, which is to be held on the third Friday in March.\nThere are no family relationships between any of the directors or executive officers of the Company.\nb. Identification of Executive Officers\nThe Company's policies are established not only by the Company's executive officers, but also by the executive officers of GTE Telephone Operations (Telops). Accordingly, the list below contains the names, ages and positions of the executive officers of both the Company and GTE Telephone Operations as of March 27, 1995.\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.\nNOTES:\n(1) Mary Beth Bardin was elected Vice President - Public Affairs of GTE Telephone Operations replacing G. Bruce Redditt who was appointed Vice President - Public Affairs and Communications, GTE Corporation.\n(2) Eileen O'Neill Odum was elected President replacing Larry J. Sparrow who was elected President - Carrier Markets of GTE Telephone Operations and Vice President - Carrier Markets of the Company.\n(3) Charles J. Somes was elected Secretary replacing Kenneth K. Okel who was appointed Assistant Vice President and Associate General Counsel - Regional Operations - Western, GTE Telephone Operations.\nDuring 1994, the organizational structure of GTE Telephone Operations was restructured to included 11 regions, eliminating the previous Area management structure.\nItem 11.","section_11":"Item 11. Executive Compensation\nExecutive Compensation Tables\nThe following tables provide information about executive compensation.\nSUMMARY COMPENSATION TABLE\nThe following table sets forth information about the compensation of the 1994 Chief Executive Officer and each of the other three most highly compensated executive officers (the named executive officers) of the Company in 1994 for services in all capacities to the Company and its subsidiary.\n(1) Annual Compensation represents the Company's pro rata share, if applicable, of salaries, bonuses and other annual compensation. Total annual cash compensation for Mr. Sparrow, Ms. Edwards and Messrs. Armstrong and Foster, for whom allocated amounts are shown above, is $494,462; $200,469; $148,800 and $1,525,508 for 1994, respectively. (2) 1994 Long-Term Incentive Plan (LTIP) Payouts include transition awards for the 1994 period, which were established by the Committee as a special grant to allow for the smooth transitioning from a single long-term performance measure (return on equity) to a combined measure (return on equity and operating cash flow margin). (3) All other compensation includes Company contributions to defined contribution plans. (4) Mr. Sparrow served as President until February 15, 1995, when he was elected Vice President - Carrier Markets for all GTE domestic telephone companies. On February 15, 1995, Ms. O'Neill Odum was elected President of the Company. (5) Ms. Edwards served as Regional Vice President - General Manager until February 1995. In September 1994, she was also appointed Vice President - Commercial Services, GTE Data Services. (6) Mr. Armstrong served as Regional Vice President - External Affairs until February 1995. In September 1994, he was also appointed Regional Director - Governmental Affairs (California, Arizona and Nevada), GTE Telephone Operations.\nOPTION\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table shows all grants of options and tandem stock appreciation rights (SARs) to the named executive officers of the Company in 1994, whether or not specifically allocated to the Company. The options and SARs were granted under the LTIP. Pursuant to Securities and Exchange Commission rules, the table also shows the value of the options granted at the end of the option terms (ten years) if the stock price were to appreciate annually by 5% and 10%, respectively. There is no assurance that the stock price will appreciate at the rates shown in the table. The table also indicates that if the stock price does not appreciate, there will be no increase in the potential realizable value of the options granted.\n(1) Each option was granted in tandem with a SAR, which will expire upon exercise of the option. Under the LTIP, one-third of these grants vest annually commencing one year after the date of grant.\nAGGREGATED OPTION\/SAR EXERCISES IN LAST FISCAL YEAR AND FY-END OPTION\/SAR VALUES\nThe following table provides information as to options and SARs exercised by each of the named executive officers of the Company during 1994. The table sets forth the value of options and SARs held by such officers at year-end measured in terms of the closing price of GTE Corporation (GTE) common stock on December 30, 1994.\nLong-Term Incentive Plan - Awards in Last Fiscal Year\nThe GTE 1991 LTIP provides for awards, currently in the form of stock options with tandem SARs and cash bonuses, to participating employees. The primary purpose of the LTIP is to offer participants an incentive to cause GTE to achieve superior financial performance, thereby helping to assure superior performance for the shareholders. The stock options and tandem SARs awarded under the LTIP to the named executive officers in 1994 are shown in the table on page 40.\nThe named executive officers are eligible to receive annual grants of performance bonuses which are earned during a 36-month performance cycle. The performance bonuses are paid in cash. Awards for the three-year performance cycle ending in 1994 are based on GTE's financial performance during the relevant cycle as measured by GTE's average return on equity (ROE) against pre-established target levels. In 1994, the Executive Compensation and Organizational Structure Committee of the Board of Directors of GTE (the Committee) established an additional measure of corporate performance - operating cash flow margin (OCFM). The Committee views OCFM as an excellent complement to ROE due to its capacity to accurately measure profitable revenue growth, a key determinant of financial strength, especially for high growth businesses. To transition from awards based solely on performance against ROE targets to awards based on a combination of ROE and OCFM performance, the Committee established two performance periods - a one-year period to run concurrently with the final year of the three-year ROE performance cycle ending in 1994 and a two-year period to run concurrently with the final two years of the three-year ROE performance cycle ending in 1995. The awards for the two award periods will be based on GTE's performance against ROE and OCFM performance for the one- and two-year periods. Awards for the three-year performance cycle ending in 1996 will be based on GTE's performance against the ROE and OCFM targets established for the full three-year cycle. Seventy-five percent of the award is determined based on ROE performance and 25% of the award is determined based on OCFM performance.\nAt the time performance targets for the current LTIP cycles are established, a Common Stock Unit account is set up for each participant in the LTIP. An initial dollar amount for each account (target award) is determined based on the competitive performance bonus grant practices of other major companies in the telecommunications industry and with practices of other major corporations not involved in the telecommunications industry that have a reputation for excellence, are comparable to GTE in terms of such quantitative measures as revenues, market value and total shareholder return and are viewed as direct competitors for executive talent in the overall labor market as well as GTE's past and projected financial performance. That amount is then divided by the average market price of GTE common stock for the calendar week preceding the day the account is established to determine the number of Common Stock Units in the account. The value of the account increases or decreases based on the market price of the GTE common stock. An amount equal to the dividends paid on an equivalent number of shares of GTE common stock is added on each dividend payment date. This amount is then converted into the number of Common Stock Units obtained by dividing the amount of the dividend by the average price of the GTE common stock on the composite tape of the New York Stock Exchange on the dividend payment date and added to the Common Stock Unit account. Messrs. Sparrow and Foster are the only individuals of the named executive officers eligible to receive a cash award under the LTIP. The\nnumber of Common Stock Units initially allocated in 1994 to the named executive officers' accounts and estimated future payouts under the LTIP are shown in the following table:\n(1) It is not possible to predict future dividends and, accordingly, estimated Common Stock Unit accruals in this table are calculated for illustrative purposes only and are based upon the dividend rate and price of GTE common stock at the close of business on December 30, 1994. The target award is the dollar amount derived by multiplying the Common Stock Unit balance at the end of the award cycle by the price of GTE common stock.\n(2) The Threshold is the level of the average ROE and the average OCFM during the relevant cycle which represents the minimum acceptable performance level for both the ROE and OCFM performance measures. If the Threshold is attained with respect to both performance measures, the award will be equal to 20% of the combined target award for ROE and OCFM. Because ROE and OCFM are separate performance measures, it is possible to receive an award if the Threshold is achieved with respect to only one of the performance measures. If the actual results for one, but not both, performance measures is at the Threshold level, the portion of the award determined by the measure performing at the Threshold level will be at 20% of the target award for that performance measure, and no award will be made for the portion of the award determined by the measure performing at less than the Threshold level. However, if the actual results for both performance measures are below the minimum acceptable performance level, no award will be earned.\n(3) The Target is the level of the average ROE and the average OCFM during the cycle which represents outstanding performance for both the ROE and OCFM performance measures. If the Target is attained with respect to both performance measures, the award will be equal to 100% of the target award for ROE and OCFM. If the actual results for one, but not both, performance measures is at the Target level, the portion of the award determined by the measure performing at the Target level will be at 100% of the target award for that performance measure, and the portion of the award determined by the measure performing at less than 100% will be determined accordingly.\n(4) This column has intentionally been left blank because it is not possible to determine the maximum award until the award cycle has been completed. The maximum amount of the award is limited by the amount the actual ROE\nand the actual OCFM exceed the targeted ROE and the targeted OCFM. If GTE's average ROE and OCFM during the cycle exceed their performance targets, additional bonuses may be earned according to the following schedule:\nFor example, if average ROE and OCFM performance each exceed the ROE and OCFM targets by 0.5%, respectively, the performance bonus will equal 114% of the combined target award.\nExecutive Agreements\nGTE has entered into agreements (the Agreements) with Messrs. Sparrow and Foster 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.\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 and Foster 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; ten years if credited service is more than five and not more than ten years; and, if the executive's credited service exceeds ten 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 (SERP) 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. The Agreements provide that 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\nGTE Service Corporation, a wholly-owned subsidiary of GTE, maintains the GTE Service Corporation Plan for Employees' Pensions (the Service Corporation Plan), a noncontributory pension plan for the benefit of GTE employees based on years of service. Pension benefits to be paid from the Service Corporation Plan and contributions to this plan are related to basic salary exclusive of\novertime, differentials, incentive compensation (except as otherwise described) and other similar types of payment. Under the Service Corporation 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 February 15, 1995, the credited years of service under the plan for Mr. Sparrow, Ms. Edwards, Messrs. Armstrong and Foster are 27, 18, 21, and 24, respectively.\nUnder Federal law, an employee's benefits under a qualified pension plan such as the Service Corporation Plan are limited to certain maximum amounts. GTE maintains a SERP, which supplements, on an unfunded basis, the benefits of any participant in the Service Corporation Plan in an amount by which any participant's benefits under the Service Corporation 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 Service Corporation Plan on remuneration accrued under management incentive plans as determined by the Committee. SERP benefits are payable in a lump sum or an annuity.\nExecutive Retired Life Insurance Plan\nThe Executive Retired Life Insurance Plan (ERLIP) provides Messrs. Sparrow and Foster a maximum postretirement life insurance benefit of three times final base salary and provides Ms. Edwards a postretirement life insurance benefit of one times final base salary. Upon retirement, ERLIP benefits may be paid as life insurance, or optionally, an equivalent amount equal to the present value of the life insurance amount (based on actuarial factors and the interest rate then in effect), as a lump sum payment, as an annuity or as installment payments.\nDirectors' Compensation\nThe current directors, all of whom are employees of GTE, are not paid any fees or remuneration, as such, for services on the Board.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\n(a) Security Ownership of Certain Beneficial Owners as of February 28, 1995:\n(b) Security Ownership of Management as of December 31, 1994:\n(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 Messrs. Foster, Cahill, Dinsmore, Esstman, White, Sparrow, Ms. Edwards and Mr. Armstrong and all directors and executive officers as a group are 214,539; 32,616; 39,499; 46,466; 109,299; 50,716; 9,033; 300 and 959,759 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 1994.\nThe Federal securities laws require the Company's directors and executive officers, and persons who own more than 10% of a registered class of the Company's equity securities, to file with the Securities and Exchange Commission initial reports of ownership and reports of changes in ownership of any equity securities of the Company.\nTo the Company's knowledge, based solely on review of the copies of such reports furnished to the Company and representations that no other reports were required, all persons subject to these reporting requirements filed the required reports on a timely basis. All of the Company's common stock is owned by GTE and, to the Company's knowledge, none of such directors or executive officers currently owns, or has ever owned, any shares of the Company's registered preferred stock (which is the only registered class of the Company's equity securities).\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 - See GTE Northwest Incorporated's consolidated financial statements and report of independent accountants thereon in the Financial Statements section included elsewhere herein.\n(2) Financial Statement Schedules - Schedules supporting the consolidated financial statements for the years ended December 31, 1994-1992 (as required):\nII - Valuation and Qualifying Accounts\nNote: Schedules other than that listed above are omitted as not applicable, not required, or the information is included in the consolidated financial statements or notes thereto.\n(3) Exhibits - Included in this report or incorporated by reference.\n2.1* Agreement of Merger dated November 18, 1992 between Contel of the Northwest, Inc. and GTE Northwest Incorporated. (Exhibit 2.1 of the 1993 Form 10-K, File No. 0-2908.)\n3*\n4* Indenture dated as of April 1, 1994 between GTE Northwest Incorporated and Bank of America National Trust and Savings Association, as Trustee (Exhibit 4.1 of the Company's Registration Statement on Form S-3, File No. 33-52909).\n27 Financial Data Schedule.\n(b) Reports on Form 8-K - No reports on Form 8-K were filed during the fourth quarter of 1994.\n* Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated.\nGTE NORTHWEST INCORPORATED AND SUBSIDIARY\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Thousands of Dollars)\n_____________________________________________________ NOTES:\n(21 Charges for purpose for which reserve was created.\n(2) Recoveries of previously written-off amounts.\n(3) See Note 2 to the Consolidated Financial Statements included elsewhere 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.\nGTE NORTHWEST INCORPORATED (Registrant)\nDate March 27, 1995 By EILEEN O'NEILL ODUM ----------------------- EILEEN O'NEILL ODUM President\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.\nExhibit Index\nExhibit No. ----------- 2.1* Agreement of Merger dated November 18, 1992 between Contel of the Northwest, Inc. and GTE Northwest Incorporated. (Exhibit 2.1 of the 1993 Form 10-K, File No. 0-2908.)\n3*\n4* Indenture dated as of April 1, 1994 between GTE Northwest Incorporated and Bank of America National Trust and Savings Association, as Trustee (Exhibit 4.1 of the Company's Registration Statement on Form S-3, File No. 33-52909).\n27 Financial Data Schedule.\n* Denotes exhibits incorporated herein by reference to previous filings with the Securities and Exchange Commission as designated.","section_15":""}
{"filename":"798790_1994.txt","cik":"798790","year":"1994","section_1":"Item 1. Business - ----------------\nBalcor Current Income Fund-87 A Real Estate Limited Partnership (the \"Registrant\") is a limited partnership formed in 1986 under the laws of the State of Delaware. The Registrant raised $14,942,190 from sales of Limited Partnership Depositary Units. The Registrant's operations consist exclusively of investment in and operation of one existing real property, and all financial information included in this report relates to this industry segment.\nAs of December 31, 1994, the Registrant owns Autumn Woods Apartments, as described under \"Properties\" (Item 2). The Partnership Agreement provides that the proceeds of any sale, financing or refinancing will not be reinvested in new acquisitions. The General Partner loan, which matured in December 1994, has been extended. See Liquidity and Capital Resources for additional information.\nAutumn Woods Apartments is subject to certain competitive conditions in the markets in which it is located. See Liquidity and Capital Resources for additional information.\nThe Registrant, by virtue of its ownership of real estate, is subject to federal and state laws and regulations covering various environmental issues. Management of the Registrant utilizes the services of environmental consultants to assess a wide range of environmental issues and to conduct tests for environmental contamination as appropriate. The General Partner is not aware of any potential liability due to environmental issues or conditions that would be material to the Registrant.\nThe officers and employees of Balcor CIF Partners, the General Partner of the Registrant, and its affiliates perform services for the Registrant. The Registrant currently has no employees engaged in its operations.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties - ------------------\nAs of December 31, 1994, the Registrant has a 99.7291% interest in the joint venture that owns Autumn Woods Apartments, a 424-unit apartment complex located on approximately 37 acres in Indianapolis, Indiana.\nThe property is held subject to a mortgage loan.\nIn the opinion of the General Partner, the Registrant has provided for adequate insurance coverage for its interest in the real estate investment property.\nSee Notes to Financial Statements for other information regarding real property investments.\nItem 3.","section_3":"Item 3. Legal Proceedings - -------------------------\nThe Registrant is not subject to any material pending legal proceedings, nor were any such proceedings terminated during the fourth quarter of 1994.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders - -----------------------------------------------------------\nNo matters were submitted to a vote of the Unitholders of the Registrant during 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder - ------------------------------------------------------------------------- Matters - -------\nThere has not been an established public market for Units and it is not anticipated that one will develop; therefore, the market value of the Units cannot reasonably be determined. For information regarding previous distributions, see Financial Statements, Statements of Partners' Capital and Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.\nAs of December 31, 1994, the number of record holders of Units of the Registrant was 786.\nItem 6.","section_6":"Item 6. Selected Financial Data - -------------------------------\nYear ended December 31, ---------------------------------------------------------- 1994 1993 1992 1991 1990 ---------- ---------- ---------- ---------- ----------\nTotal income $2,687,874 $2,626,906 $2,474,941 $2,374,468 $2,268,651 Net loss 629,096 513,729 492,547 662,552 738,590 Net loss per Unit .63 .51 .49 .66 .73 Total assets 11,185,388 12,409,021 12,933,218 13,482,036 14,252,271 Promissory note payable - affiliate None None 9,433,787 8,608,584 7,868,097 Mortgage note payable 9,606,251 9,679,905 None None None Distributions per Unit .90 .90 .90 .90 .90\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and - ----------------------------------------------------------------------- Results of Operations - ---------------------\nSummary of Operations - ---------------------\nAn overall decrease in operations at Autumn Woods Apartments due primarily to increased property operating and maintenance and repair expenses resulted in an increase in the net loss during 1994 as compared to 1993.\nOverall interest expense on long term financing was higher in 1993 than in 1992 and resulted in an increase in the net loss during 1993. Further discussion of Balcor Current Income Fund-87 (the \"Partnership\") operations is summarized below.\n1994 Compared to 1993 - ---------------------\nRental rates increased at Autumn Woods Apartments, resulting in an increase in rental and service income during 1994 as compared to 1993.\nBalcor Real Estate Holdings, Inc. (\"BREHI\"), an affiliate of the General Partner, previously funded a zero coupon loan to the Partnership on which interest expense compounded semi-annually. During May 1993, this loan was prepaid with proceeds received from the financing with a third party of the Autumn Woods mortgage loan and funds advanced from the General Partner. This resulted in the cessation of interest expense on the promissory note payable -\naffiliate. This new mortgage loan resulted in an increase in interest expense on the mortgage note payable and amortization of deferred expenses during 1994 as compared to 1993.\nThe General Partner advanced funds to prepay the remainder of the zero coupon loan in May 1993, and advanced funds as required by the Limited Partnership Agreement to pay the monthly debt service payments due on the property's mortgage loan through December 1994. As a result, interest expense on the short-term loan payable - affiliate increased during 1994 as compared to 1993.\nDue to higher insurance premiums, payroll expenses and contract services, property operating expenses increased during 1994 as compared to 1993.\nDue to higher expenditures for roof repairs and floor covering replacement, maintenance and repair expenses increased during 1994 as compared to 1993.\nDuring 1994, the Partnership received a refund of prior years' taxes from taxing authorities due to a decrease in the assessed value of Autumn Woods Apartments. This resulted in a decrease in real estate tax expense during 1994 as compared to 1993.\nDue to a decrease in the distribution level to Unitholders for the fourth quarter of 1994, incentive partnership management fees decreased during 1994 as compared to 1993.\n1993 Compared to 1992 - ---------------------\nRental rates increased at Autumn Woods Apartments in 1993, resulting in an increase in rental and service income in 1993 as compared to 1992.\nDue to lower average cash balances and lower interest rates on short-term interest-bearing instruments, interest income on short-term investments decreased during 1993 as compared to 1992.\nDuring May 1993, the BREHI note was prepaid with proceeds received from the financing of the Autumn Woods mortgage loan and funds advanced from the General Partner. This resulted in a decrease in interest expense on the promissory note payable-affiliate during 1993 as compared to 1992.\nAs a result of the financing of the Autumn Woods mortgage loan, interest expense on the mortgage note payable and amortization of deferred expenses were incurred during 1993.\nDue to higher expenditures for roof and pavement repairs, maintenance and repair expense increased during 1993 when compared to 1992.\nHigher accounting and portfolio management costs resulted in an increase in administrative expenses during 1993 as compared to 1992.\nLiquidity and Capital Resources - -------------------------------\nThe Partnership's cash flow provided by operating activities during 1994 was generated primarily from the operation of Autumn Woods Apartments, which was partially offset by the payment of administrative expenses and incentive partnership management fees. Financing activities included the payment of distributions to Unitholders and the General Partner, the receipt of loan proceeds from the General Partner to fund debt service payments on the Autumn Woods mortgage loan, and the payment of principal on the mortgage note payable. A portion of the loan from the General Partner was also repaid during December 1994 from Partnership cash reserves, causing the cash position of the Partnership at December 31, 1994 to decrease in comparison to December 31, 1993.\nAutumn Woods Apartments is located on the northeast side of Indianapolis in the\ncity submarket of Castleton\/Nora. There are approximately 11,000 rental units in this submarket, most of which are newer and have slightly higher rental rates than Autumn Woods Apartments. Autumn Woods Apartments competes most directly with approximately 3,000 rental units located within a 2 mile radius of the property, many of which have been renovated within the last 3 years. The average property in this market is 12-15 years old, consists of 300 units and has an occupancy rate of 92%. Autumn Woods Apartments, a 424-unit property built in 1977, has a current occupancy rate of 93%. There are currently 300 new rental units under construction in this market. The average rental rate for these units are $100-$200 a month per unit higher than Autumn Woods Apartments.\nAs of December 31, 1994, Autumn Woods Apartments was generating positive cash flow. The Partnership defines cash flow as an amount equal to the property's revenue receipts less property related expenditures, which include debt service payments. Autumn Woods Apartments is encumbered by a first mortgage loan which matures in 1998.\nIn conjunction with the May 1993 financing of the Autumn Woods loan, the monthly debt service payments due on the first mortgage loan were required by the Limited Partnership Agreement to be funded by advances from the General Partner on a zero coupon basis until December 1994 when the General Partner loan matured. The Partnership repaid a portion of the loan in December and the remainder of the loan is expected to be repaid from the available cash flow from operations of the property. Additionally, all debt service payments required under the first mortgage loan will now be paid from the cash flow of the property. As of December 31, 1994, the loan payable to the General Partner is $1,041,594, including accrued interest thereon. See Note 7 of Notes to Financial Statements for additional information.\nIn January 1995, the Partnership paid $74,711 ($.075 per Unit) of Net Cash Receipts to the Unitholders representing the distribution for the fourth quarter of 1994. The level of this distribution decreased from the amount distributed to Unitholders for the third quarter of 1994 due to the maturity and partial repayment of the General Partner loan in December 1994. During 1994, 1993 and 1992, the Partnership made four quarterly distributions of Net Cash Receipts to Unitholders totaling $.90 per Unit for each year. See Financial Statements, Statements of Partners' Capital. The distributions paid to Unitholders in 1994, 1993 and 1992 represent annual returns of 6.00% on Adjusted Original Capital. The General Partner presently expects that cash flow from property operations will allow the Partnership to continue making quarterly distributions to Unitholders. However, the level of future distributions will be dependent on the repayment of the General Partner loan and the cash flow generated by the Autumn Woods Apartments. In light of results to date and current market conditions, there can be no assurance that investors will recover all of their original investment.\nSince the Preferred Distribution levels to Unitholders specified in the Partnership Agreement have not been attained in any year, the General Partner subordinated 25% of its share of Net Cash Receipts, in the cumulative amount of $127,915 of incentive partnership management fees and $16,998 as its distributive share, in accordance with the Partnership Agreement. The General Partner anticipates that future distribution levels will continue to result in further subordinations of its incentive management fee and distributive share from operations. During 1988 and 1989, the General Partner also voluntarily agreed to subordinate $82,953 of incentive partnership management fees and $15,130 as its distributive share, to the prior receipt of the specified returns by Unitholders. These amounts may be paid to the General Partner from Net Cash Proceeds received by the Partnership prior to any other payments out of Net Cash Proceeds.\nThe General Partner has recently completed the outsourcing of the financial reporting and accounting services, transfer agent and investor records services, and computer operations and systems development functions that provided services to the Partnership. All of these functions are now being provided by independent third parties. Additionally, Allegiance Realty Group, Inc., which has provided property management services to the Partnership's\nproperty, was sold to a third party. Each of these transactions occurred after extensive due diligence and competitive bidding processes. The General Partner does not believe that the cost of providing these services to the Partnership, in the aggregate, will be materially different to the Partnership during 1995 when compared to 1994.\nInflation has several types of potentially conflicting impacts on real estate investments. Short-term inflation can increase real estate operating costs which may or may not be recovered through increased rents and\/or sales prices, depending on general or local economic conditions. In the long-term, inflation can be expected to increase operating costs and replacement costs and may lead to increased rental revenues and real estate values.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------\nSee Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\nThe supplemental financial information specified by Item 302 of Regulation S-K is not applicable.\nThe net effect of the differences between the financial statements and the tax returns is summarized as follows:\nDecember 31, 1994 December 31, 1993 ---------------------- ------------------------- Financial Tax Financial Tax Statements Returns Statements Returns ---------- --------- ---------- --------- Total assets $11,185,388 $9,009,012 $12,409,021 $10,165,555 Partners' capital accounts (deficit): General Partner (101,009) (475,883) (87,247) (90,709) Unitholders 151,924 (1,616,990) 1,671,261 (535,974) Net loss: General Partner (6,291) (377,703) (5,137) (8,151) Unitholders (622,805) (184,484) (508,592) (566,157) Per Unit (.63) (.19) (.51) (.57)\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 any matter of accounting principles, practices or financial statement disclosure.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant - -----------------------------------------------------------\n(a) Neither the Registrant nor Balcor CIF Partners, its General Partner, has a Board of Directors.\n(b, c & e) The names, ages and business experience of the executive officers and significant employees of the General Partner of the Registrant are as follows:\nTITLE OFFICERS ----- --------\nChairman, President and Chief Thomas E. Meador Executive Officer Executive Vice President, Allan Wood Chief Financial Officer and Chief Accounting Officer Senior Vice President Alexander J. Darragh First Vice President Daniel A. Duhig First Vice President Josette V. Goldberg First Vice President Alan G. Lieberman First Vice President Brian D. Parker and Assistant Secretary First Vice President John K. Powell, Jr. First Vice President Reid A. Reynolds First Vice President Thomas G. Selby\nThomas E. Meador (July 1947) joined Balcor in July 1979. He is Chairman, President and Chief Executive Officer and has responsibility for all ongoing day-to-day activities at Balcor. He is a Director of The Balcor Company. Prior to joining Balcor, Mr. Meador was employed at the Harris Trust and Savings Bank in the commercial real estate division where he was involved in various lending activities. Mr. Meador received his M.B.A. degree from the Indiana University Graduate School of Business.\nAllan Wood (January 1949) joined Balcor in August 1983 and, as Balcor's Chief Financial Officer and Chief Accounting Officer, is responsible for the financial and administrative functions. He is also a Director of The Balcor Company. Mr. Wood is a Certified Public Accountant. Prior to joining Balcor, he was employed by Price Waterhouse where he was involved in auditing public and private companies.\nAlexander J. Darragh (February 1955) joined Balcor in September 1988 and has primary responsibility for the Portfolio Advisory Group. He is responsible for due diligence analysis and real estate advisory services in support of asset management, institutional advisory and capital markets functions. Mr. Darragh has supervisory responsibility of Balcor's Investor Services, Investment Administration, Fund Management and Land Management departments. Mr. Darragh received masters' degrees in Urban Geography from Queens's University and in Urban Planning from Northwestern University.\nDaniel A. Duhig (October 1956) joined Balcor in November 1986 and is responsible for the Asset Management Department relating to real estate investments made by Balcor and its affiliated partnerships, including negotiations for modifications or refinancings of real estate mortgage investments and the disposition of real estate investments.\nJosette V. Goldberg (April 1957) joined Balcor in January 1985 and has primary responsibility for all human resources matters. In addition, she has supervisory responsibility for Balcor's administrative and MIS departments. Ms. Goldberg has been designated as a Senior Human Resources Professional\n(SHRP).\nAlan G. Lieberman (June 1959) joined Balcor in May 1983 and is responsible for the Property Sales and Capital Markets Groups. Mr. Lieberman is a Certified Public Accountant.\nBrian D. Parker (June 1951) joined Balcor in March 1986 and is responsible for Balcor's corporate and property accounting, treasury and budget activities. Mr. Parker is a Certified Public Accountant and holds an M.S. degree in Accountancy from DePaul University.\nJohn K. Powell, Jr. (June 1950) joined Balcor in September 1985 and is responsible for the administration of the investment portfolios of Balcor's partnerships and for Balcor's risk management functions. Mr. Powell received a Master of Planning degree from the University of Virginia. He has been designated a Certified Real Estate Financier by the National Society for Real Estate Finance and is a full member of the Urban Land Institute.\nReid A. Reynolds (April 1950) joined Balcor in March 1981 and is involved with the asset management of residential properties for Balcor. Mr. Reynolds is a licensed Real Estate Broker in the State of Illinois.\nThomas G. Selby (July 1955) joined Balcor in February 1984 and has responsibility for various Asset Management functions, including oversight of the residential portfolio. From January 1986 through September 1994, Mr. Selby was Regional Vice President and then Senior Vice President of Allegiance Realty Group, Inc., an affiliate of Balcor providing property management services. Mr. Selby was responsible for supervising the management of residential properties in the western United States.\n(d) There is no family relationship between any of the foregoing officers.\n(f) None of the foregoing officers or employees are currently involved in any material legal proceedings nor were any such proceedings terminated during the fourth quarter of 1994.\nItem 11.","section_11":"Item 11. Executive Compensation - -------------------------------\nThe Registrant has not paid and does not propose to pay any remuneration to the executive officers and directors of the general partner. Certain of these officers receive compensation from The Balcor Company (but not from the Registrant) for services performed for various affiliated entities, which may include services performed for the Registrant. However, the general partner believes that any such compensation attributable to services performed for the Registrant is immaterial to the Registrant. See Note 7 of Notes to Financial Statements for the information relating to transactions with affiliates.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management - -----------------------------------------------------------------------\n(a) No person owns of record or is known by the Registrant to own beneficially more than 5% of the Units issued by the Registrant, other than that listed in Item 12(b) below.\n(b) Balcor Employee Investment Partners-1987, a partnership which is an affiliate of the General Partner, and the General Partner's officers and partners own as a group the following number of Units, which are controlled by the General Partner.\nAmount Beneficially Title of Class Owned Percent of Class -------------- ------------- ----------------\nUnits 117,065 Units 12%\nRelatives and affiliates of the officers and partners of the General Partner own an additional 334 Units.\n(c) The Registrant is not aware of any arrangements, the operation of which may result in a change of control of the Registrant.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------\n(a & b) See Note 7 of Notes to Financial Statements for information relating to transactions with affiliates.\nSee Note 2 of Notes to Financial Statements for information relating to the Partnership Agreement and the allocation of distributions and profits and losses.\n(c) No management person is indebted to the Registrant.\n(d) The Registrant has no outstanding agreements with any promoters.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K - ------------------------------------------------------------------------\n(a) (1 & 2) See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\n(3) Exhibits:\n(3) The Amended and Restated Agreement and Certificate of Limited Partnership, previously filed as Exhibit 3 to Amendment No. 2 to the Registrant's Registration Statement on Form S-11 dated December 17, 1986 (Registration No. 33-7858), is hereby incorporated herein by reference.\n(4) Form of Subscription Agreement set forth as Exhibit 4.1 to Amendment No. 2 to the Registrant's Registration Statement on Form S-11 dated December 17, 1986 (Registration No. 33-7858) and Form of Confirmation regarding Depositary Units in the Registrant set forth as Exhibit 4.2 to the Registrant's Report on Form 10-Q for the quarter ended June 30, 1992 (Commission File No. 0-16712) are incorporated herein by reference.\n(27) Financial Data Schedule of the Registrant for 1994 is attached hereto.\n(b) Reports on Form 8-K: No reports were filed on Form 8-K during the quarter ended December 31, 1994.\n(c) Exhibits: See Item 14(a)(3) above.\n(d) Financial Statement Schedule: See Index to Financial Statements and Financial Statement Schedule in this Form 10-K.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of l934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nBALCOR CURRENT INCOME FUND-87 A REAL ESTATE LIMITED PARTNERSHIP\nBy: \/s\/Allan Wood ---------------------------- Allan Wood Executive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor CIF Partners, the General Partner\nDate: March 24, 1995 ----------------\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 - --------------------- ------------------------------- ------------\nPresident and Chief Executive Officer (Principal Executive Officer) of Balcor CIF Partners, \/s\/Thomas E. Meador the General Partner March 24, 1995 - -------------------- -------------- Thomas E. Meador\nExecutive Vice President, and Chief Accounting and Financial Officer (Principal Accounting and Financial Officer) of Balcor CIF \/s\/Allan Wood Partners, the General Partner March 24, 1995 - -------------------- -------------- Allan Wood\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nReport of Independent Auditors\nFinancial Statements:\nBalance Sheets, December 31, 1994 and 1993\nStatements of Partners' Capital, for the years ended December 31, 1994, 1993 and 1992\nStatements of Income and Expenses, for the years ended December 31, 1994, 1993 and 1992\nStatements of Cash Flows, for the years ended December 31, 1994, 1993 and 1992\nNotes to Financial Statements\nSchedule:\nIII - Real Estate and Accumulated Depreciation, as of December 31, 1994\nSchedules, other than that listed, are omitted for the reason that they are inapplicable or equivalent information has been included elsewhere herein.\nREPORT OF INDEPENDENT AUDITORS\nTo the Partners of Balcor Current Income Fund-87 A Real Estate Limited Partnership:\nWe have audited the accompanying balance sheets of Balcor Current Income Fund-87 A Real Estate Limited Partnership (A Delaware Limited Partnership) as of December 31, 1994 and 1993, and the related statements of partners' capital, income and expenses and cash flows for each of the three years in the period ended December 31, 1994. 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 Partnership'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 financial position of Balcor Current Income Fund-87 A Real Estate Limited Partnership at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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.\nERNST & YOUNG LLP\nChicago, Illinois March 1, 1995\nBALCOR CURRENT INCOME FUND-87 A REAL ESTATE LIMITED PARTNERSHIP (A Delaware Limited Partnership)\nBALANCE SHEETS December 31, 1994 and 1993\nASSETS\n1994 1993 ------------- ------------- Cash and cash equivalents $ 639,493 $ 1,050,766 Escrow deposits 105,883 102,628 Deferred expenses, net of accumulated amortization of $50,445 in 1994 and $18,585 in 1993 108,855 140,715 ------------- ------------- 854,231 1,294,109 ------------- ------------- Investment in real estate, at cost: Land 940,021 940,021 Buildings and improvements 16,578,369 16,578,369 ------------- ------------- 17,518,390 17,518,390 Less accumulated depreciation 7,187,233 6,403,478 ------------- ------------- Investment in real estate, net of accumulated depreciation 10,331,157 11,114,912 ------------- ------------- $ 11,185,388 $ 12,409,021 ============= =============\nLIABILITIES AND PARTNERS' CAPITAL\nLoan payable - affiliate $ 1,041,594 $ 635,776 Accounts payable 17,887 16,758 Due to affiliates 118,273 115,869 Accrued liabilities, principally real estate taxes 283,839 287,318 Security deposits 41,760 59,708 Mortgage note payable 9,606,251 9,679,905 ------------- ------------- Total liabilities 11,109,604 10,795,334\nAffiliate's participation in joint venture 24,869 29,673 Partners' capital (996,146 Units issued and outstanding) 50,915 1,584,014 ------------- ------------- $ 11,185,388 $ 12,409,021 ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR CURRENT INCOME FUND-87 A REAL ESTATE LIMITED PARTNERSHIP (A Delaware Limited Partnership)\nSTATEMENTS OF PARTNERS' CAPITAL For the years ended December 31, 1994, 1993 and 1992\nPartners' Capital (Deficit) Accounts ----------------------------------------- General Unit- Total Partner holders ------------- ------------- ------------- Balance at December 31, 1991 $ 4,398,276 $ (62,263) $ 4,460,539\nCash distributions to: Unitholders (A) (896,532) (896,532) General Partner (7,451) (7,451) Net loss for the year ended December 31, 1992 (492,547) (4,925) (487,622) ------------- ------------- ------------- Balance at December 31, 1992 3,001,746 (74,639) 3,076,385\nCash distributions to: Unitholders (A) (896,532) (896,532) General Partner (7,471) (7,471) Net loss for the year ended December 31, 1993 (513,729) (5,137) (508,592) ------------- ------------- ------------- Balance at December 31, 1993 1,584,014 (87,247) 1,671,261\nCash distributions to: Unitholders (A) (896,532) (896,532) General Partner (7,471) (7,471) Net loss for the year ended December 31, 1994 (629,096) (6,291) (622,805) ------------- ------------- ------------- Balance at December 31, 1994 $ 50,915 $ (101,009) $ 151,924 ============= ============= =============\n(A) Summary of cash distributions paid per Unit:\n1994 1993 1992 ------------- ------------- -------------\nFirst Quarter $ .225 $ .225 $ .225 Second Quarter .225 .225 .225 Third Quarter .225 .225 .225 Fourth Quarter .225 .225 .225\nThe accompanying notes are an integral part of the financial statements.\nBALCOR CURRENT INCOME FUND-87 A REAL ESTATE LIMITED PARTNERSHIP (A Delaware Limited Partnership)\nSTATEMENTS OF INCOME AND EXPENSES For the years ended December 31, 1994, 1993 and 1992\n1994 1993 1992 ------------- ------------- ------------- Income: Rental and service $ 2,652,841 $ 2,598,588 $ 2,436,961 Interest on short-term investments 35,033 28,318 37,980 ------------- ------------- ------------- Total income 2,687,874 2,626,906 2,474,941 ------------- ------------- -------------\nExpenses: Interest on promissory note payable - affiliates 356,633 825,203 Interest on mortgage note payable 843,120 520,648 Interest on short-term loan payable - affiliate 55,442 4,613 Depreciation 783,755 773,708 773,708 Amortization 31,860 18,585 Property operating 676,075 561,507 524,691 Maintenance and repairs 329,682 271,292 242,932 Real estate taxes 261,018 300,047 303,083 Property management fees 132,642 128,973 122,040 Incentive partnership management fees 56,033 67,240 67,240 Administrative 148,441 137,322 107,316 ------------- ------------- ------------- Total expenses 3,318,068 3,140,568 2,966,213 ------------- ------------- -------------\nLoss before affiliate's participation in joint venture (630,194) (513,662) (491,272)\nAffiliate's participation in loss (income) from joint venture 1,098 (67) (1,275) ------------- ------------- ------------- Net loss $ (629,096) $ (513,729) $ (492,547) ============= ============= ============= Net loss allocated to General Partner $ (6,291) $ (5,137) $ (4,925) ============= ============= ============= Net loss allocated to Unitholders $ (622,805) $ (508,592) $ (487,622) ============= ============= ============= Net loss per Unit (996,146 issued and outstanding) $ (0.63) $ (0.51) $ (0.49) ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR CURRENT INCOME FUND-87 A REAL ESTATE LIMITED PARTNERSHIP (A Delaware Limited Partnership)\nSTATEMENTS OF CASH FLOWS For the years ended December 31, 1994, 1993 and 1992\n1994 1993 1992 ------------- ------------- ------------- Operating activities: Net loss $ (629,096) $ (513,729) $ (492,547) Adjustments to reconcile net loss to net cash provided by operating activities: Affiliate's participation in (loss) income from joint venture (1,098) 67 1,275 Depreciation of property 783,755 773,708 773,708 Amortization of deferred expenses 31,860 18,585 Accrued interest expense due at maturity - affiliate 55,442 361,246 825,203 Net change in: Escrow deposits (3,255) (93,372) 54,228 Accounts payable 1,129 (7,671) (2,837) Due to affiliates 2,404 1,894 (4,719) Accrued liabilities (3,479) 12,729 28,002 Security deposits (17,948) 7,743 4,183 ------------- ------------- ------------- Net cash provided by operating activities 219,714 561,200 1,186,496 ------------- ------------- ------------- Investing activities: Additions to property (130,642) ------------- Net cash used in investing activities (130,642) ------------- Financing activities: Distributions to Unitholders (896,532) (896,532) (896,532) Distributions to General Partner (7,471) (7,471) (7,451) Capital contribution by joint venture partner - affiliate 157 Distributions to joint venture partner - affiliate (3,706) (3,278) (3,395) Proceeds from loan payable - affiliate 850,376 631,163 Repayment of loan payable - affiliate (500,000) Proceeds from issuance of mortgage note payable 9,720,000 Prepayment of promissory note payable - affiliate (9,790,420) Principal payments on mortgage note payable (73,654) (40,095) Payment of deferred expenses (159,300) Funding of improvement reserve (200,850) Proceeds from release of improvement reserve 200,850 ------------- ------------- ------------- Net cash used in financing activities (630,987) (545,776) (907,378)\n------------- ------------- ------------- Net change in cash and cash equivalents (411,273) (115,218) 279,118 Cash and cash equivalents at beginning of year 1,050,766 1,165,984 886,866 ------------- ------------- ------------- Cash and cash equivalents at end of year $ 639,493 $ 1,050,766 $ 1,165,984 ============= ============= =============\nThe accompanying notes are an integral part of the financial statements.\nBALCOR CURRENT INCOME FUND-87 A REAL ESTATE LIMITED PARTNERSHIP (A Delaware Limited Partnership)\nNOTES TO FINANCIAL STATEMENTS\n1. Accounting Policies:\n(a) Depreciation expense is computed using the straight-line method. Rates used in the determination of depreciation are based upon the following estimated useful lives:\nYears -----\nBuildings and improvements 20 Furniture and fixtures 5\nMaintenance and repairs are charged to expense when incurred. Expenditures for improvements are charged to the related asset account.\nThe Partnership records its investments in real estate at cost, and periodically assesses possible impairment to the value of its properties. In the event that the General Partner determines that a permanent impairment in value has occurred, the carrying basis of the property is reduced to its estimated fair value.\n(b) Deferred expenses consist of loan commitment fees and other loan closing costs which are amortized over the term of the loan.\n(c) Cash equivalents include all highly liquid investments with a maturity of three months or less when purchased.\n(d) The Partnership is not liable for Federal income taxes and each partner recognizes his proportionate share of the Partnership income or loss in his tax return; therefore, no provision for income taxes is made in the financial statements of the Partnership.\n(e) Reclassifications have been made to the previously reported 1993 and 1992 statements in order to provide comparability with the 1994 statements. These reclassifications have not changed the 1993 or 1992 results.\n2. Partnership Agreement:\nThe Partnership was organized in July 1986. The Partnership Agreement provides for Balcor CIF Partners to be the General Partner and for the sale of up to 5,000,000 Limited Partnership Depositary Units at $15 per Unit, 996,146 of which were sold through December 1987, when the offering terminated.\nThe Partnership Agreement provides that, except for profit or loss from the sale or other disposition of Partnership property, each item of profit or loss will be allocated 1% to the General Partner and 99% to Unitholders. Net Cash Receipts available for distribution will be distributed to Unitholders on a quarterly basis as follows: 94% to Unitholders and 6% to the General Partner for the 12-month period commencing on the first day of the first full calendar quarter following the termination of the offering, 93% to Unitholders and 7% to the General Partner for the next 12-month period, 92% to Unitholders and 8% to the General Partner for the next 12-month period, 91% to Unitholders and 9% to the General Partner for the next 12-month period and 90% to Unitholders and 10% to the General Partner for each 12-month period thereafter. For such periods, 1% of such Net Cash Receipts shall be the General Partner's distributive share from operations and 5%, 6%, 7%, 8% and 9%, respectively, shall be its Incentive Partnership Management Fee. To the extent of any deficiency in the Unitholders' receipt of Preferred Distributions for any year, up to 25% of the General Partner's share of Net Cash Receipts (including Incentive Partnership\nManagement Fees) for that year shall be subordinated to the Unitholders' receipt of such Preferred Distributions. Preferred Distributions are those amounts equal to 8% per annum for the three-year period commencing on the first day of the full calendar quarter following the termination of the offering, 8.5% per annum for the next three-year period, 9% per annum for the next two-year period and 10% per annum for each 12-month period thereafter on Adjusted Original Capital, to be satisfied from Net Cash Receipts and Net Cash Proceeds.\nThe distributions paid to Unitholders in 1994, 1993 and 1992 represent average annual returns of 6.00% on Adjusted Original Capital. Since the Preferred Distribution levels to the Unitholders have not been attained in any year, the General Partner subordinated 25% of its share of Net Cash Receipts. The General Partner received $67,240, $67,240 and $65,208 of incentive partnership management fees and $7,471, $7,471 and $7,451 as its unsubordinated distributive share during 1994, 1993 and 1992, respectively. The remaining 75% of Net Cash Receipts distributions which the General Partner was entitled to receive in 1988 and 1989 was voluntarily subordinated to the prior receipt of certain returns to the Unitholders.\nWhen the Partnership sells or refinances its property, the Net Cash Proceeds resulting therefrom which are available for distribution will be distributed first to the General Partner to the extent of its share of Net Cash Receipts voluntarily subordinated in 1988 and 1989 which totals $98,083; then to Unitholders until such time as Unitholders have received an amount equal to their Original Capital plus any deficiency in a 6% per annum Cumulative Distribution on Adjusted Original Capital. Thereafter, remaining Net Cash Proceeds will be paid to the General Partner to pay any subordinated real estate commissions on property sales; next, to pay to Unitholders an amount equal to any deficiency in their receipt of Preferred Distributions; next, to the General Partner in an amount equal to any deficiencies in its required subordinated share of Net Cash Receipts and Incentive Partnership Management Fees; and finally 85% to Unitholders and 15% to the General Partner.\n3. Mortgage Note Payable:\nIn May 1993, the Partnership obtained a $9,720,000 first mortgage loan collateralized by Autumn Woods Apartments. The loan matures in June 1998, bears interest at a rate of 8.74%, and requires monthly payments of principal and interest of $76,398. During 1994 the Partnership incurred and paid interest expense of $843,120.\nApproximate maturities of the Autumn Woods mortgage note payable during each of the next four years are summarized below.\n1995 $ 80,000 1996 88,000 1997 96,000 1998 9,343,000\n4. Management Agreement:\nAs of December 31, 1994, Autumn Woods Apartments is under a management agreement with a third-party management company. This management agreement provides for annual fees of 5% of gross operating receipts.\n5. Affiliate's Participation in Joint Venture:\nAutumn Woods Apartments is owned by a joint venture between the Partnership and an affiliated partnership. All assets, liabilities, income and expenses of the joint venture are included in the financial statements of the Partnership with the appropriate adjustment of profit or loss for the affiliate's participation in the joint venture. Profits and losses are allocated 99.7291% to the Partnership and .2709% to the affiliate.\n6. Tax Accounting:\nThe Partnership keeps its books in accordance with the Internal Revenue Code, rules and regulations promulgated thereunder and existing interpretations thereof. The accompanying financial statements, which are prepared in accordance with generally accepted accounting principles, will differ from the tax returns due to the different treatment of various items as specified in the Internal Revenue Code. The net effect of these accounting differences is that the net loss for 1994 in the financial statements is $66,909 more than the tax loss of the Partnership for the same period.\n7. Transactions with Affiliates:\nFees and expenses paid and payable by the Partnership to affiliates are:\nYear Ended Year Ended Year Ended 12\/31\/94 12\/31\/93 12\/31\/92 -------------- -------------- -------------- Paid Payable Paid Payable Paid Payable ------ ------- ------ ------- ------ -------\nProperty management fees $121,289 None $128,591 $10,289 $122,133 $ 9,907 Incentive partnership management fees 67,240 $88,557 67,240 99,764 65,208 99,764 Reimbursement of expenses to the General Partner, at cost: Accounting 38,067 15,183 31,773 2,624 28,364 2,240 Data processing 12,200 2,131 4,329 640 6,094 475 Investor communica- tions 12,373 4,935 9,877 816 8,150 644 Legal 4,537 1,810 3,083 255 3,515 278 Portfolio management 9,296 3,707 9,288 767 3,704 293 Other 4,890 1,950 8,648 714 4,752 374\nAllegiance Realty Group, Inc., an affiliate of the General Partner, managed the Partnership's property until the affiliate was sold to a third party in November 1994.\nIn May 1993, the Partnership used proceeds from the Autumn Woods first mortgage loan and a General Partner loan to prepay the zero coupon loan and accrued interest thereon. During 1993 and 1992, the Partnership incurred interest expense of $356,633 and $825,203 respectively, in connection with the zero coupon financing, all of which was paid in 1993.\nIn conjunction with the May 1993 financing of the Autumn Woods loan, the monthly debt service payments due on the first mortgage loan were required to be funded by advances from the General Partner through December 16, 1994, at which time the General Partner loan became due. The Partnership repaid $500,000 of the loan in December and the remainder of the General Partner loan has been extended and is expected to be repaid from the available cash flow from operations of the property. As of December 31, 1994, this loan had a balance of $1,041,594. During 1994 and 1993, the Partnership incurred interest expense of $55,442 and $4,613, respectively. Interest expense was computed at the American Express Company cost of funds rate plus a spread to cover administrative costs. As of December 31, 1994, this rate was 6.562%.\nThe Partnership participates in an insurance deductible program with other affiliated partnerships which program pays claims up to the amount of the deductible under the master insurance policies for its properties. The program is administered by an affiliate of the General Partner who receives no compensation for administering the program. The Partnership's premiums to the deductible insurance program were $27,289, $18,640 and $17,526 for 1994, 1993 and 1992, respectively.\n8. Subsequent Event:\nIn January 1995, the Partnership made a distribution of $74,711 ($.075 per Unit) to the Unitholders for the fourth quarter of 1994.\nBALCOR CURRENT INCOME FUND-87 A REAL ESTATE LIMITED PARTNERSHIP (An Illinois Limited Partnership)\nBALCOR CURRENT INCOME FUND-87 A REAL ESTATE LIMITED PARTNERSHIP (A Delaware Limited Partnership)\nNOTES TO SCHEDULE III\n(a) See the description of the mortgage note payable in Note 3 of Notes to Financial Statements.\n(b) Consists of legal fees, appraisal fees, title costs, other related professional fees and acquisition fees.\n(c) The aggregate cost of land for Federal income tax purposes is $942,454 and the aggregate cost of buildings and improvements for Federal income tax purposes is $16,620,663. The total of the above-mentioned is $17,563,117.\n(d) Reconciliation of Real Estate -----------------------------\n1994 1993 1992 ---------- ---------- ----------\nBalance at beginning of year $17,518,390 $17,387,748 $17,387,748\nAdditions during the year: Improvements None 130,642 None ----------- ----------- -----------\nBalance at close of year $17,518,390 $17,518,390 $17,387,748 =========== =========== ===========\nReconciliation of Accumulated Depreciation ------------------------------------------\n1994 1993 1992 ---------- ---------- ----------\nBalance at beginning of year $6,403,478 $5,629,770 $4,856,062\nDepreciation expense for the year 783,755 773,708 773,708 ---------- ---------- ----------\nBalance at end of year $7,187,233 $6,403,478 $5,629,770 ========== ========== ==========\n(e) Depreciation expense is computed based upon the following estimated useful lives: Years -----\nBuildings and improvements 20 Furniture and fixtures 5","section_15":""}
{"filename":"36340_1994.txt","cik":"36340","year":"1994","section_1":"Item 1. Business\nPremier Financial Services, Inc. (the \"Company\") is a registered bank holding company organized in 1976 under Delaware law. The operations of the Company and its subsidiaries consist primarily of those financial activities, including trust and investment services, common to the commercial banking industry. Unless the context otherwise requires, the term \"Company\" as used herein includes the Company and its subsidiaries on a consolidated basis. Substantially all of the operating revenue and net income of the Company is attributable to its subsidiary banks.\nThe primary function of the Company is to coordinate the banking policies and operations of its subsidiaries in order to improve and expand their services and effect economies in their operations by joint efforts in certain areas such as auditing, training, marketing, and business development. The Company also provides operational and data processing services for its subsidiaries. All services and counsel to subsidiaries are provided on a fee basis, with fees based upon fair market value.\nThe Company's banking subsidiaries include First Bank North (\"FBN\"), First Bank South (\"FBS\"), First National Bank of Northbrook (\"FNBN\") and First Security Bank of Cary Grove (\"FSBCG\"). Although chartered as commercial banks, the offices of the banks serve as general sales offices providing a full array of financial services and products to individuals, businesses, local governmental units and institutional customers throughout northern Illinois. Banking services include those generally associated with the commercial banking industry such as demand, savings and time deposits, loans to commercial, agricultural and individual customers, cash management, electronic funds transfers and other services tailored for the client. The Company has banking offices located in Freeport, Stockton, Warren, Mt. Carroll, DeKalb, Dixon, Rockford, Polo, Sterling, Northbrook, Riverwoods and Cary, Illinois.\nPremier Trust Services, Inc., (\"PTS\") a wholly owned subsidiary of FBN, provides a full line of fiduciary and investment services throughout the Company's general market area. Premier Insurance Services, Inc., also a wholly owned subsidiary of FBN, is a full line casualty and life insurance agency.\nPremier Operating Systems, Inc., (\"POS\") a direct subsidiary of the Company, provides data processing and operational services to the Company and its subsidiaries.\nCompetition\nActive competition exists in all principal areas where the Company and its subsidiaries are engaged, not only with commercial banking organizations, but also with savings and loan associations, finance companies, mortgage companies, credit unions, brokerage houses and other providers of financial services. The Company has seen the level of competition and number of competitors in its markets increase in recent years and expects a continuation of these aggressively competitive market conditions.\nTo gain a competitive market advantage, the Company relies on a strategic marketing plan that is employed throughout the Company, reaching every level of its sales force. The marketing plan includes the identification of target markets and customers so that the Company's resources, both financial and manpower, can be utilized where the greatest opportunities for gaining market share exist. The differentiation between the Company's approach to providing products and services to its customers and that of the competition is in the individualized attention that the Company devotes to the needs of its customers. This focus on fulfilling customer's financial needs generally results in long - -term customer relationships.\nBanking deposits are well balanced, with a large customer base and no dominant accounts in any category. The Company's loan portfolio is also characterized by a large customer base, balanced between loans to individuals, commercial and agricultural customers, with no dominant relationships. There is no readily available source of information which delineates the market for financial services, including services offered by non-bank competitors, in the company's market area.\nRegulation and Supervision\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 references to the particular statutes and regulations. Any significant change in applicable law or regulation may have an effect on the business and prospects of the Company and its subsidiaries.\nThe Company is registered under and is subject to the provisions of the Bank Holding Company Act, and is regulated by the Federal Reserve Board. Under the Bank Holding Company Act the Company is required to file annual reports 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 all aspects of the Company's business.\nThe 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. Bank holding companies are also prohibited from acquiring shares of any bank located outside the state in which the operations of the holding company's banking subsidiaries are principally conducted unless such an acquisition is specifically authorized by statute of the state of the bank whose shares are to be acquired. On September 29, 1994, the Reigle-Neal Interstate Banking and Branching Efficiency Act (the \"Reigle- Neal Act\") became law. The Act authorizes interstate acquisitions by bank holding companies, interstate mergers of banks, interstate bank branching and \"agency banking\" with affiliate banks in different states.\nThere are several effective dates under the Reigle-Neal Act. Generally, interstate acquisitions and \"agency banking\" are permitted as of September 29, 1995, and interstate bank mergers and interstate branching are permitted as of June 1, 1997. However, states may \"opt-in\" or \"opt-out\" of the interstate merger and branching provisions before June 1, 1997.\nThe Bank Holding Company Act also 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 services to banks and their subsidiaries. The Company, however, may engage 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 Company is also subject to the Illinois Bank Holding Company Act of 1957, as amended (the \"Illinois Act\"). Effective December 1, 1990, certain provisions of the Illinois Act were amended to permit Illinois banks and bank holding companies to acquire or be acquired by banks and bank holding companies located in any state having a reciprocal law. The approval of the Commissioner of Banks and Trusts Companies of Illinois is required to complete such an interstate acquisition in Illinois. The Illinois Act also permits intrastate acquisition throughout Illinois by Illinois bank holding companies.\nThe passage of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") resulted in significant changes in the enforcement powers of federal banking agencies, and more significantly, the manner in which the thrift industry is regulated. While FIRREA's primary purpose is to address public concern over the financial crisis of the thrift industry through the imposition of strict reforms on that industry, FIRREA grants bank holding companies more expansive rights of entry into \"the savings institution\" market through the acquisition of both healthy and failed savings institutions. Under the provisions of FIRREA, a banking holding company can expand its geographic market or increase its concentration in an existing market by acquiring a savings institution, but the bank holding company cannot expand its product market by acquiring a savings institution.\nFIRREA authorizes the Federal Reserve Board to approve applications under Section 4(c)(8) of the Act for bank holding companies to acquire savings associations, under certain conditions, regardless of the associations' financial condition. Previously, under the provisions of the Garn-St. Germain Depository Institutions Act of 1983 and subsequent Federal Reserve Board interpretations, bank holding companies could generally acquire only failing thrifts. Under FIRREA, they realize a significant expansion of authority. Furthermore, bank holding companies may acquire thrifts without regard to certain restrictions on interstate banking, as long as the thrift is operated as a separate subsidiary. FIRREA also allows a bank holding company to merge an acquired savings association or branch office with a bank holding company's subsidiary bank, if the bank continues to pay insurance assessments to the Savings Association Insurance Fund for the deposits acquired from the savings association and if, among other conditions, the merger complies. with current state law. On September 5, 1989, the Federal Reserve Board promulgated a final rule amending Regulation Y to allow bank holding companies to acquire savings associations.\nOn December 19, 1991, The Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") was enacted into law. In addition to providing for the recapitalization of the Bank Insurance Fund (the\"BIF\"), FDICIA contains, among other things: (i) truth-in savings legislation that requires financial institutions to disclose terms, conditions, fees and yields on deposit accounts in a uniform manner; (ii) provisions that impose strict audit requirements and expand the role of independent auditors of financial institutions; (iii) provisions that require regulatory agencies to examine financial institutions more frequently than was required in the past; (iv) provisions that limit the powers of state-chartered banks to those of national banks unless the state-chartered bank meets minimum capital requirements and the FDIC finds that the activity to be engaged in by the state-chartered banks poses no significant risk to the BIF; (v) provisions that require the expedited resolution of problem financial institutions; (vi) provisions that require regulatory agencies to develop a method for financial institutions to provide information concerning the estimated fair market value of assets and liabilities as supplemental disclosures to the financial statements filed with the regulatory agencies; (vii)provisions that require regulators to consider adopting capital requirements that account for interest rate risk; (viii) provisions that require the regulatory agencies to adopt regulations that facilitate cross-industry transactions, and (ix) provisions for acquisition of banks by thrift institutions.\nWhile regulations implementing many of the provisions of FDICIA have been issued by the federal banking agencies, regulations implementing certain significant FDICIA requirements (including requirements for establishment of operational and managerial standards to promote bank safety and soundness and modification of regulatory capital standards to account for interest rate risk) have not yet been issued in final form. Consequently, it is not possible at this time to determine the full impact FDICIA will have on the Company and its operations. It is expected, however, that FDICIA is likely to result in, among other things, increased regulatory compliance costs and a greater emphasis on capital.\nThe Company's Subsidiaries\nFBN and FBS are State chartered, Federal Reserve member banks. They are, therefore, subject to regulation and an annual examination by the Illinois Commissioner of Banks and Trust Companies and by the Board of Governors of the Federal Reserve Bank. FNBN is a nationally chartered bank and is under the supervision of and subject to examination by the Comptroller of the Currency. All national banks are members of the Federal Reserve System and subject to applicable provisions of the Federal Reserve Act and to regular examination by the Federal Reserve Bank of their district. FSBCG is a State chartered non- member bank and is subject to regulation and an annual examination by the Illinois Commissioner of Banks and Trust Companies and by the Federal Deposit Insurance Corporation.\nAll of the Company's banks are insured by the Federal Deposit Insurance Corporation and each bank is consequently subject to the provisions of the Federal Deposit Insurance Act. The examinations by the various regulatory authorities are designed for the protection of bank depositors and not for bank or holding company stockholders.\nThe federal and state laws and regulations generally applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the nature and amount of and collateral for loans, minimum capital requirements and 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 collateralized by such stock or other securities.\nCapital Requirements\nIn December 1992, the Federal Reserve Board's final rules for risk-based capital guidelines became effective. These guidelines establish risk-based capital ratios based upon the allocation of assets and specified off-balance sheet commitments into four risk-weighted categories. The guidelines require all bank holding companies and banks to maintain a minimum Tier 1 capital to risk weighted asset ratio of 4% and a total capital to risk weighted asset ratio of at least 8.00%. In addition to the risk-based capital guidelines, the Federal Reserve Board has adopted the use of a leverage ratio as an additional tool to evaluate the capital adequacy of banks and bank holding companies. The leverage ratio is defined to be a company's \"Tier 1\" capital divided by its adjusted total assets. The Company and its banking subsidiaries meet or exceed the regulating capital guidelines as currently defined.\nMonetary Policy and Economic Conditions\nThe earnings of commercial banks and bank holding companies are affected not only by general economic conditions, but also by the policies of various governmental regulatory authorities. In particular, the Federal Reserve Board influences conditions in the money and capital markets, which affect interest rates and growth in bank credit and deposits. Federal Reserve Board monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to in the future. Also, assessments from the Bank Insurance Fund, which insures commercial bank deposits, will continue to impact future earnings of the company.\nEmployees\nAs of December 31, 1994, the Company and its subsidiaries had a total of 273 full-time and 65 part-time employees.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe Company owns a two story office building at 27 West Main Street, Freeport, Illinois which has a total of 13,900 square feet and approximately 5.5 acres of land located at the northeast corner of Lake-Cook Road and Corporate Drive in Riverwoods, Illinois. The land in Riverwoods, Illinois was acquired in 1992 for possible future use as a branch site or denovo bank location.\nFBN conducts its operations from its offices located in Freeport, Stockton, Rockford, Warren, Mount Carroll, and DeKalb, Illinois. Its main office is located at 101 West Stephenson Street, Freeport, Illinois and includes approximately 26,400 square feet. In addition, two other office buildings are attached to the bank's main office by a parking deck. One is occupied by the Commercial Division. The other serves as a drive in facility and operations center. All three buildings including the underlying land, are owned by the Bank. FBN also operates a remote banking facility located approximately 1.5 miles southwest of the Bank's main office in a shopping center. The underlying land is leased by FBN from an unaffiliated party through 1995, and the Bank has an option to renew through 2000. The annual rental payment for the remaining year is $6,000.\nFBN's office in Mount Carroll is located at 102 E. Market Street, Mount Carroll, Illinois, with a separate drive-in facility located at 315 N. Clay Street (Highway 78), in Mount Carroll. The main bank building, containing approximately 12,000 square feet, is owned by the bank as is the underlying land. FBN occupies the main floor and most of the basement, with total square footage of approximately 9,000 square feet. The second floor, containing approximately 3,400 square feet, is rented to various professional organizations. The drive-in facility is approximately one block east of the main office. It houses the drive-in and walk-up facilities as well as a small lobby in a building containing approximately 1,200 square feet. The drive-in facility as well as the underlying land is owned by FBN.\nFBN conducts its operations in Stockton from its quarters located at 133 W. Front Street, Stockton, Illinois. The office at Stockton includes drive-in facilities and is approximately 8,000 square feet. The building, underlying land and an adjoining 9,000 square foot parking lot are owned by FBN.\nFBN's office in Warren is located at 135 Main Street, Warren, Illinois. The building, which contains approximately 9,000 square feet is owned and occupied by the bank. The building also houses its wholly owned insurance subsidiary, Premier Insurance Services, Inc.\nFBN's Rockford office is located at 3957 Mulford Road, Rockford, Illinois. Both the building which contains approximately 1358 square feet and underlying land are leased from an unaffiliated party through May 1, 1999, with an option to renew annually.\nFBN's office in DeKalb is located at 301-9 East Lincoln Highway, DeKalb, Illinois. Both the building and underlying land are leased from an unaffiliated party through August 1995, with an option to renew annually.\nFBS conducts its operations from its offices located in Dixon, Polo, and Sterling, Illinois. Its main office is located at 102 Galena Avenue, Dixon, Illinois. The building, which contains approximately 15,000 square feet, is owned and occupied by the bank. The land underlying the building, as well as an adjoining parking lot, are also owned by the bank.\nFBS's office in Polo is located at 101 W. Mason St., Polo, Illinois. Drive - -In and Walk-up facilities are part of the building. The building contains approximately 17,000 square feet, and is owned by the bank as is the underlying land. FBS occupies the first floor and the majority of the basement, with total square footage of about 10,000 square feet. The remainder of the basement and the second floor, which contain the remaining 7,000 square feet, are rented to various professional and\/or retail organizations.\nFBS's Sterling office is located at 3014 E. Lincolnway, Sterling, Illinois. Drive-in and Walk-up facilities are part of the building. The building contains approximately 6,800 square feet. Both the building, which is occupied solely by the bank, and the underlying land are owned by FBS.\nFNBN owns the land and building on which its main office and adjacent drive-through facility are located at 1300 Meadow Road, Northbrook, Illinois. The two story, colonial building and drive-through facility are located on 30,318 square feet of land. The main building consists of 8,035 square feet. This property also includes a satellite parking area with 29 parking spaces.\nFNBN also owns the land and building located at 2755 West Dundee Road, Northbrook, Illinois, which houses a full-service branch facility. The building consists of 4,913 square feet and is located on 22,500 square feet of land. FNBN leases 16,739 square feet for its Riverwoods branch at Milwaukee and Deerfield Road.\nFSBCG conducts its business in Cary from its main office located at Route 45 Highway 14. The main bank building containing approximately 3,500 square feet is owned by the bank as is the 4 lane drive-through and the underlying land. The adjoining parking lot contains 26,000 square feet of land.\nFSBCG owns a second banking center at 3114 Northwest Highway, Cary, Illinois. The building consists of 1,856 square feet, and three drive-through lanes situated on 145,953 square feet of land.\nPremier Operating Systems, Inc. conducts the majority of its operations from a 13,000 square foot, two story office building at 110 West Stephenson Street, Freeport, Illinois. The building and underlying land is owned by Premier Operating Systems, Inc.\nItem 3.","section_3":"Item 3. Legal Proceedings\nNeither the Company nor its subsidiaries are a party to any material legal proceedings, other than routine litigation incidental to the business of the banks as of December 31, 1994.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters, through the solicitation of proxies or otherwise, have been submitted to a vote of security holders for the quarter ended December 31, 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThe approximate number of Holders of Common Stock as of 12\/31\/94 was as follows: Title of Class No. of Record Holders\nCommon Stock 671 ($5 Par Value)\nOther information required by this item is incorporated herein by reference to the Registrant's Annual Report to its shareholders for the year ended December 31, 1994, which is included as an exhibit to this report.\nItem 6.","section_6":"Item 6. Selected Financial Data\nIncorporated herein by reference to the Registrant's Annual Report to its shareholders for the year ended December 31, 1994, which is included as an exhibit to this report.\nOn July 16, 1993, the Company acquired 100% of the common stock of First Northbrook Bancorp, Inc. The acquisition was accounted for as a purchase transaction; accordingly, the assets and liabilities of First Northbrook Bancorp, Inc. were recorded at fair market value on the acquisition date and the results of operations have been included in the consolidated statements of earnings since July 16, 1993. For a discussion regarding the business combination see footnote #12 on pages 16 and 17 of Registrant's Annual Report.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nIncorporated by reference to the Registrant's Annual Report to its shareholders for the year ended December 31, 1994, which is included as an exhibit to this report.\nSubmitted herewith is the following supplementary financial information of the registrant for each of the last five years (Unless otherwise stated):\nDistribution of Assets, Liabilities and Stockholders' Equity Interest Rates and Interest Differential Changes in Interest Margin for each of the last two years Investment Portfolio Maturities of Investments, December 31, 1994 Loan Portfolio Loan Maturities and Sensitivity to Changes in Interest Rates, December 31, 1994 Risk Elements in the Loan Portfolio Summary of Loan Loss Experience Deposits Time Certificates and Other Time Deposits of $100,000 or more as of December31, 1994 Return on Equity and Assets Short Term Borrowings\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe following consolidated financial statements of the Company, which are included in the annual report of the registrant to its stockholders for the year ended December 31, 1994, are submitted herewith as an exhibit, and are incorporated by reference:\n1. Consolidated Balance Sheets, December 31, 1994 and 1993 2. Consolidated Statements of Earnings, for the three years ended December 31, 1994 3. Consolidated Statements of Changes in Stockholders' Equity for the three years ended December 31, 1994 4. Consolidated Statements of Cash Flows for the three years ended December 31, 1994 5. Notes to Consolidated Financial Statements 6. Independent Auditors' Report\nItem 9.","section_9":"Item 9. Change in and Disagreements with Accountants on Accounting and Financial Disclosures\nNone\nDISTRIBUTION OF ASSETS, LIABILITIES AND STOCKHOLDERS' EQUITY\nPREMIER FINANCIAL SERVICES, INC.\nThe following table sets forth the registrant's consolidated average daily condensed balance sheet for each of the last five years (dollar figures in thousands): Year Ended December 31\n1990 1991 1992 1993 1994\nASSETS: Cash & Non-interest bearing deposits $ 16,457 $ 15,129 $ 17,162 $30,003 $ 27,316 Interest Bearing Deposits 1,701 1,114 880 1,677 12,027\nTaxable Investment Securities 119,804 114,281 95,691 102,323 185,110 Non-Taxable Investment Securities 20,102 26,200 24,374 37,038 40,498\nTotal Investment Securities 139,906 140,481 120,065 139,361 225,608\nTrading Account Assets 386 773 2,017 --- --- Federal Funds Sold 9,390 1,704 656 4,706 3,737 Loans (Net) 169,711 182,975 219,684 273,951 287,825 All Other Assets 17,827 16,755 17,450 32,101 46,101\nTOTAL ASSETS $355,378 $358,931 $377,914 $481,799 $602,614\nLIABILITIES & STOCKHOLDERS EQUITY: Non-Interest Bearing Deposits $ 36,437 $ 36,118 $ 38,402 $ 66,895 $ 88,594 Interest Bearing Deposits 275,436 244,253 259,271 335,510 420,530\nTotal Deposits 311,873 280,371 297,673 402,405 509,124\nShort Term Borrowings 12,469 49,544 47,556 24,014 33,033 Long Term Debt 4,532 826 --- --- --- All Other Liabilities & Reserves 3,500 2,861 2,844 10,785 4,619 Stockholders' Equity 23,004 25,329 29,841 44,595 55,838\nTOTAL LIABILITIES & EQUITY $355,378 $358,931 $377,914 $481,799 $602,614\nINTEREST RATES AND INTEREST DIFFERENTIAL PREMIER FINANCIAL SERVICES, INC. The following table sets forth the registrant's interest earned or paid, as well as the average yield or average rate paid on each of the major interest earning assets and interest bearing liabilities for each of the last five years (dollar figures are in thousands): Year Ended December 31\n1990 1991 1992 1993 1994 Interest Earned: Interest Bearing Deposits Interest Earned $ 144 $ 94 $ 68 $ 104 $ 514 Average Yield 8.47% 8.43% 7.73% 6.20% 4.27% Taxable Investment Securities Interest Earned 10,234 9,387 6,691 6,077 9,929 Average Yield 8.54% 8.21% 6.99% 5.94% 5.36% Non-Taxable Investment Securities (taxable equivalent) (1) Interest Earned 1,961 2,593 2,418 3,080 3,965 Average Yield 9.76% 9.89% 9.92% 8.32% 9.79% Trading Account Assets Interest Earned 31 58 151 --- --- Average Yield 8.03% 7.50% 7.49% --- --- Federal Funds Sold Interest Earned 768 88 25 133 150 Average Yield 8.18% 5.16% 3.81% 2.83% 4.01% Loans (Excluding Unearned Discount & Non Accrual Loans) (taxable equivalent) (1) Interest & Fees Earned (2) 19,226 19,357 19,860 22,262 23,641 Average Yield (3) 11.21% 10.56% 9.06% 8.13% 8.21% Interest Paid: Interest Bearing Deposits Interest Paid 18,464 14,358 11,559 11,461 13,511 Average Effective Rate Paid 6.70% 5.87% 4.46% 3.42% 3.21% Borrowed Funds Interest Paid 968 2,921 1,800 1,289 1,619 Average Effective Rate Paid 7.76% 5.89% 3.79% 5.37% 4.90% Long Term Debt Interest Paid 465 88 --- --- --- Average Effective Rate Paid 10.26% 10.65% --- --- --- Margin Between Rates Earned and Rates Paid: All Interest Earnings Assets (taxable equivalent) Interest & Fees Earned 32,364 31,577 29,213 31,656 38,199 Average Yield 10.02% 9.65% 8.52% 7.55% 7.24% All Interest Bearing Liabilities Interest Paid 19,898 17,367 13,359 12,750 15,130 Average Effective Rate Paid 6.80% 5.89% 4.35% 3.55% 3.33%\nNet Interest Earned 12,466 14,210 15,854 18,906 23,069\nNet Yield 3.86% 4.34% 4.62% 4.43% 4.32% (1) Yields on tax exempt securities and loans are full tax equivalent yields at 34%. (2) Includes fees of $255, $548, $568, $718 and $675 for 1990 through 1994 respectively. (3) There were no material out-of-period adjustments or foreign activities for any reportable period.\nCHANGES IN INTEREST MARGIN\nPREMIER FINANCIAL SERVICES, INC.\nThe following table sets forth the registrant's dollar amount of change in interest earned on each major interest earning assets and the dollar amount of change in interest paid on each major interest bearing liabilities, as well as the portion of such changes attributable to changes in rate and changes in volume for each of the last two years (Dollar figures in thousands): Increase (Decrease) 1993 over 1992 1994 over 1993 Rate Volume Rate Volume Changes in Interest Earned:\nInterest Bearing Deposits $ (16) $ 52 (42) 452\nTaxable Investment Securities (1,055) 441 (644) 4,496\nNon-taxable Investment Securities (taxable equivalent) (438) 1,100 579 306\nTrading Account Assets --- (151) --- ---\nFed Funds Sold (8) 116 48 (31)\nLoans (net) (2,185) 4,587 224 1,155\nTotal $(3,702) $6,145 $ 165 6,378\nChanges in Interest Paid:\nInterest Bearing Deposits $(3,051) $2,953 (735) 2,785\nShort Term Borrowings 581 (1,092) (121) 451\nTotal $(2,470) 1,861 (856) 3,236\nChanges in Interest Margin $(1,232) $4,284 $ 1,021 $3,142\nChanges attributable to rate\/volume, i.e., changes in the interest margin which occurred because of a combination rate\/volume change and cannot be attributed solely to a rate change or a volume change, are apportioned between rate and volume as follows:\n1. Percentage rate increases (decreases) in rate and in volume were calculated for each major interest earning asset and interest bearing liability based upon their year-to-year change.\n2. The percentage rate changes in rate and in volume were then allocated proportionately in relationship to 100%.\n3. The proportionate allocations were applied to the total rate\/volume change.\nINVESTMENT PORTFOLIO\nPREMIER FINANCIAL SERVICES, INC.\nThe following table sets forth the registrant's book values of investments in obligations of the U.S. Treasury Government Agencies and Corporations, State and Political Subdivisions (U.S.), and other securities for each of the last five years (dollar figures in thousands):\n1990 1991 1992 1993 1994 U.S. Treasury and U.S. Agency Securities $114,485 $ 89,825 $ 77,897 $140,725 $203,956 Obligations of States and Political Subdivisions 26,145 25,258 24,358 36,693 40,513\nOther Securities 16,425 10,308 3,580 3,068 4,009\nTotal $157,055 $125,391 $105,835 $180,486 $248,478\nThe following table sets forth the registrant's book values of investments in obligations of the U.S. Treasury, U.S. Government Agencies and Corporations, State and Political Subdivisions (U.S.), and other securities as of December 31, 1994 by maturity and also sets forth the weighted average yield for each range of maturities.\nObligations of U.S. Treasury States and Weighted and U.S. Agency Political Other Average Book Value: Securities Subdivision Securities Yield\nOne Year or Less $ 85,341 $ 9,025 $ --- 6.17% After One Year to Five Years 75,434 21,739 18 6.98% After Five Years to Ten Years 8,729 5,949 --- 9.00% Over Ten Years 34,452 3800 3,991 8.74%\nTotal $ 203,956 $ 40,513 $ 4,009 6.77%\n(1) Weighted Average Yields were calculated as follows:\n1. The weighted average yield for each category in the portfolio was calculated based upon the maturity distribution shown in the table above.\n2. The yields determined in step 1 were weighted in relation to the total investments in each maturity range shown in the table above.\n(2) Yields on tax exempt securities are full tax equivalent yields at a 34% rate.\n(3) At December 31, 1994 the Company did not own any Obligation of a State or Political Subdivision or Other Security which was greater than 10% of its total equity capital.\nLOAN PORTFOLIO\nPREMIER FINANCIAL SERVICES, INC.\nThe following table sets forth the registrant's Loan Portfolio by major category for each of the last five years (dollar figures in thousands):\nYear Ended December 31\n1990 1991 1992 1993 1994\nCommercial & Financial Loans $ 56,043 $ 83,777 $ 88,341 $121,514 $ 91,392 Agricultural Loans 38,738 32,428 45,924 40,972 31,564 Real Estate - Residential Mortgage Loans 56,980 66,256 54,728 103,234 86,105 Real Estate - Other 10,130 18,289 16,904 35,832 53,289 Loans to Individuals 16,185 13,364 13,268 29,728 22,056 Other Loans 1,857 859 980 625 394\n179,933 214,973 220,145 331,905 284,800\nLess: Unearned Discount 223 231 182 518 344 Allowance for Possible Loan Losses 3,160 3,202 2,713 4,369 3,688\nNet Loans $176,550 $211,540 $217,250 $327,018 $280,768\nThe following tables set forth the registrant's loan maturity distribution for certain major categories of loans as of December 31, 1994 (dollar figures in thousands). AMOUNT DUE IN\n1 Year or Less 1-5 Years After 5 Years\nCommercial & Financial Loans $ 77,301 $ 13,947 $ 144 Agricultural Loans 26,806 4,471 287 Real Estate - Other Loans 26,528 22,715 4,046\nTotal $ 130,635 $ 41,133 $ 4,477\nAs of December 31, 1994 loans totaling $45,274,000, which are due after one year have predetermined interest rates, while $336,000 of loans due after one year have floating interest rates.\nRISK ELEMENTS IN THE LOAN PORTFOLIO PREMIER FINANCIAL SERVICES, INC.\nThe Company's financial statements are prepared on the accrual basis of accounting, and substantially all of the loans currently accruing interest are accruing at the rate contractually agreed upon when the loan was negotiated. When in the judgement of management the timely receipt of interest payments on a loan is doubtful, it is the Company's policy to cease the accrual of interest thereon and to recognize income on a cash basis when payments are received, unless there is adequate collateral or other substantial basis for continued accrual of interest. An exception is made in the case of consumer installment and charge card loans; such loans are not placed on a cash basis and all interest accrued thereon is charged against income at the time a loan is charged off. At the time a loan is placed in non-accrual status all interest accrued in the current year but not yet collected is reversed against current interest income. Troubled debt restructurings (renegotiated loans) are loans on which interest is being accrued at less than the original contractual rate of interest because of the inability of the borrower to service the obligation under the original terms of the agreement. Income is accrued at the renegotiated rate so long as the borrower is current under the revised terms and conditions of the agreement. Other Real Estate is real estate, sales contracts, and other assets acquired because of the inability of the borrower to serve the obligation of a previous loan collateralized by such assets.\nThe following table sets forth the registrant's non-accrual, past due, and renegotiated loans, and other Real Estate for each of the last five years (dollar figures in thousands): Year Ended December 31\n1990 1991 1992 1993 1994 Non-accrual Loans $ 156 $ 3,683 $ 2,915 $ 5,791 $ 4,879 Loans Past Due 90 days or More 946 501 152 5,151 144 Renegotiated Loans 372 314 288 523 261 Other Real Estate 210 48 153 1,749 1,403\nTotal $ 1,684 $ 4,546 $ 3,508 $13,214 $6,687\nThe following table sets forth interest information for certain non- performing loans for the year ended December 31, 1994 (dollar figures in thousands): Non-Accrual Loans Renegotiated Loans\nBalance December 31, 1994 $ 4,879 $ 261\nGross interest income that would have been recorded if the loans had been current in accordance with their original terms 507 23\nAmount of interest included in net earnings. 87 23\nSUMMARY OF LOAN LOSS EXPERIENCE PREMIER FINANCIAL SERVICES, INC.\nThe Company and its subsidiary banks have historically evaluated the adequacy of their Allowance for Possible Loan Losses on an overall basis, and the resulting provision charged to expense has similarly been determined in relation to management's evaluation of the entire loan portfolio. In determining the adequacy of its Allowance for Possible Loan Losses, management considers such factors as the size, composition and quality of the loan portfolio, historical loss experience, current loan losses, current potential risks, economic conditions, and other risks inherent in the loan portfolio.\nBecause the Company has historically evaluated its Allowance for Loan Losses on an overall basis, the Allowance has not been allocated by category. The allocation shown in the table below, encompassing the major segments of the loan portfolio judged most informative by management, represents only an estimate for each category of loans based upon historical loss experience and management's judgement of amounts deemed reasonable to provide for the possibility of losses being incurred within each category. Approximately 28% remain unallocated as a general valuation reserve for the entire portfolio to cover unexpected variations from historical experience in individual categories. The following table sets forth the registrant's loan loss experience for each of the last five years (dollar figures in thousands):\nCommercial & Real Loans to Agricultural Estate Individuals Other Unallocated Total\nYear Ended 12\/31\/94:\nLoans-year End (Gross) $ 122,956 $139,394 $ 22,056 $ 394 $ --- $284,800 Average Loans (Gross) 131,808 135,561 24,354 581 --- 292,304 Allowance for Loan Losses (Beginning of Year) 1,105 1,607 585 21 1,051 4,369\nLoans Charged Off 1,081 73 370 --- --- 1,524 Recoveries - Loans Previously Charged Off 414 15 214 --- --- 643 Net Loan Losses (Recoveries) 667 58 156 --- --- 881 Operating Expense Provision 200 --- --- --- --- 200 Allowance For Loan Losses (Year End) 638 1,549 429 21 1,051 3,688\nRatios: Loans in Category to Total Loans 43.17% 48.95% 7.74% .14% --- 100% Net Loan Losses (Recoveries) to Average Loans .50% .04% .64% --- --- .30%\nCommercial & Real Loans to Agricultural Estate Individuals Other Unallocated Total Year Ended 12\/31\/93: Loans-year End (Gross) $162,486 $139,066 $29,728 $ 625 --- $331,905 Average Loans (Gross) 148,376 107,254 21,498 800 --- 277,928 Allowance for Loan Losses (Beginning of Year) 1,062 853 77 21 700 2,713 Allowance from Acquired Entities 750 750 500 --- 351 2,351 Loans Charged Off 1,845 546 129 --- --- 2,520 Recoveries - Loans Previously Charged Off 138 --- 67 --- --- 205 Net Loan Losses (Recoveries) 1,707 546 62 --- --- 2,315 Operating Expense Provision 1,000 550 70 --- --- 1,620 Allowance For Loan Losses (Year End) 1,105 1,607 585 21 1,051 4,369 Ratios: Loans in Category to Total Loans 48.96% 41.90% 8.96% .18% --- 100% Net Loan Losses (Recoveries) to Average Loans 1.15% .51% .29% --- --- .83%\nCommercial & Real Loans to Agricultural Estate Individuals Other Unallocated Total Year Ended 12\/31\/92: Loans-year End (Gross) $ 134,265 $ 71,632 $ 13,268 $ 980 $ --- $220,145 Average Loans (Gross) 129,764 77,851 13,976 1,041 --- 222,632 Allowance for Loan Losses (Beginning of Year) 1,553 832 97 21 700 3,203 Loans Charged Off 925 9 124 --- --- 1,058 Recoveries - Loans Previously Charged Off 159 30 54 --- --- 243 Net Loan Losses (Recoveries) 766 (21) 70 --- --- 815 Operating Expense Provision 275 --- 50 --- --- 325 Allowance For Loan Losses (Year End) 1,062 853 77 21 700 2,713 Ratios: Loans in Category to Total Loans 60.99% 32.54% 6.03% .44% --- 100% Net Loan Losses (Recoveries) to Average Loans .59% (.03%) .50% --- --- .37%\nCommercial & Real Loans to Agricultural Estate Individuals Other Unallocated Total\nYear Ended 12\/31\/91: Loans-year End (Gross) $ 116,205 $ 84,545 $ 13,364 $ 859 $ --- $214,973 Average Loans (Gross) 101,545 69,453 13,873 1,500 --- 186,371 Allowance for Loan Losses (Beginning of Year) 1,394 837 208 21 700 3,160 Loans Charged Off 337 36 165 --- --- 538 Recoveries - Loans Previously Charged Off 496 31 54 --- --- 581 Net Loan Losses (Recoveries) (159) 5 111 --- --- (43) Operating Expense Provision --- --- --- --- --- --- Allowance For Loan Losses (Year End) 1,553 832 97 21 700 3,203 Ratios: Loans in Category to Total Loans 54.06% 39.32% 6.22% .40% --- 100% Net Loan Losses (Recoveries) to Average Loans (.16%) .01% .80% --- --- (.02%)\nCommercial & Real Loans to Agricultural Estate Individuals Other Unallocated Total\nYear Ended 12\/31\/90: Loans-year End (Gross) $ 94,781 $ 67,110 $ 16,185 $ 1,857 $ --- $179,933 Average Loans (Gross) 88,431 66,887 15,789 2,204 --- 173,311 Allowance for Loan Losses (Beginning of Year) 1,647 824 285 21 700 3,477 Loans Charged Off 712 58 120 --- --- 890 Recoveries - Loans Previously Charged Off 459 71 43 --- --- 573 Net Loan Losses (Recoveries) 253 (13) 77 --- --- 317 Operating Expense Provision --- --- --- --- --- --- Allowance For Loan Losses (Year End) 1,394 837 208 21 700 3,160\nRatios: Loans in Category to Total Loans 52.68% 37.30% 9.00% 1.02% --- 100% Net Loan Losses (Recoveries) to Average Loans .29% (.02%) .49% --- --- .18%\nDEPOSITS\nPREMIER FINANCIAL SERVICES, INC.\nThe following table sets forth the registrant's average daily deposits for each of the last five years (dollar figures in thousands):\nYear Ended December 31\n1990 1991 1992 1993 1994\nDemand Deposits (Non- Interest Bearing) $ 36,437 $ 36,119 $ 38,402 $66,895 $ 88,594\nDemand Deposits (Interest Bearing) 32,948 38,194 44,772 57,937 93,788\nSavings Deposits 71,821 67,456 73,684 95,351 154,188\nTime Deposits 170,667 138,603 140,815 182,222 172,554\nDeposits in Foreign Bank Offices None None None None None\nTOTAL DEPOSITS $311,873 $280,372 $297,673 $402,405 $509,124\nThe following table sets forth the average rate paid on interest bearing deposits by major category for each of the last five years (dollar figures in thousands):\nYear Ended December 31\n1990 1991 1992 1993 1994\nDemand Deposits (Interest Bearing) 5.26% 4.83% 3.67% 2.41% 2.37%\nSavings Deposits 5.45% 4.89% 3.52% 2.74% 2.99%\nTime Deposits 7.50% 6.65% 5.20% 4.09% 4.30%\nTIME CERTIFICATE OF DEPOSIT\/TIME DEPOSITS OF $100,000 OR MORE\nPREMIER FINANCIAL SERVICES, INC.\nThe following table sets for the registrant's maturity distribution for all time deposits of $100,000 or more as of December 31, 1994 (in thousands):\nMaturity Amount Outstanding\n3 months or less $ 8,006 3 through 6 months 2,953 6 through 12 months 5,809 Over 12 months 4,097\nTOTAL $ 20,865\nRETURN ON EQUITY AND ASSETS\nPREMIER FINANCIAL SERVICES, INC.\nThe following table sets forth the registrant's return on average assets, return on average common equity, return on average equity, dividend payout ratio, and average equity to average asset ratio for each of the last five years:\nYear Ended December 31\n1990 1991 1992 1993 1994\nReturn on Average Assets .81% 1.01% 1.15% .83% .95%\nReturn on Average Common Equity 12.53% 14.29% 14.58% 10.80% 11.11%\nReturn on Average Equity 12.53% 14.29% 14.58% 8.99% 10.23%\nDividend Payout Ratio 16.32% 16.75% 19.73% 29.27% 26.47%\nAverage Equity to Average Asset Ratio 6.47% 7.06% 7.90% 9.26% 9.27%\nSHORT TERM BORROWINGS\nPREMIER FINANCIAL SERVICES, INC.\nThe following table sets forth a summary of the registrant's short- term borrowings for each of the last five years (dollar figures in thousands):\nYear Ended December 31\n1990 1991 1992 1993 1994\nBalance at End of Period: Federal Funds Purchased $ 4,272 $ 14,241 $ 4,272 $ --- $ 13,975 Securities Sold Under Repurchase Agreements 50,534 43,688 14,854 20,571 16,086 Notes Payable to Banks 1,030 260 1,880 12,410 12,210 Other 2,000 --- --- --- ---\nTOTAL $ 57,836 $ 58,189 $21,006 $32,981 $ 42,271\nWeighted Average Interest Rate at the end of Period: Federal Funds Purchased 7.68% 4.75% 3.53% --- 5.75% Securities Sold Under Repurchase Agreements 7.19% 4.53% 3.79% 2.76% 4.47% Notes Payable to Banks 10.00% 6.50% 6.00% 6.00% 8.00% Other 6.50% --- --- --- ---\nHighest Amount Outstanding at Any Month-End: Federal Funds Purchased $ 7,072 $ 14,241 $16,614 $18,535 $13,975 Securities Sold Under Repurchase Agreements 50,534 47,033 45,557 23,952 23,127 Notes Payable to Banks 3,300 1,115 1,880 17,500 14,555 Other 2,380 2,000 --- --- 1,000\nAverage Outstanding During the Year: Federal Funds Purchased $ 2,737 $ 6,305 $10,715 $ 8,534 $ 3,205 Securities Sold Under Repurchase Agreements 8,187 42,320 36,073 15,480 16,872 Notes Payable to Banks 1,370 760 768 7,362 12,755 Other 176 160 --- --- 201\nWeighted Average Interest Rate During the Year: Federal Funds Purchased 8.00% 5.78% 3.93% 3.30% 4.90% Securities Sold Under Repurchase Agreements 7.31% 5.87% 3.74% 3.58% 3.26% Notes Payable to Banks 10.17% 8.63% 6.12% 6.14% 7.07% Other 6.75% 6.40% --- --- 3.98%\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nIncorporated herein by reference to the Registrant's Proxy Statement dated March 20, 1995 in connection with its annual meeting to be held on April 27, 1995.\nItem 405 of Regulation S-K calls for disclosure of any known late filing or failure by an insider to file a report required by Section 16 of the Exchange Act. This disclosure is contained in the Registrant's Proxy Statement dated March 20, 1995 on page 20 under the Section \"Compliance with Section 16 (a) of the Exchange Act\" and is incorporated herein by reference in this Annual Report on Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nIncorporated herein by reference to the Registrant's Proxy Statement dated March 20, 1995, in connection with its annual meeting to be held on April 27, 1995.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nIncorporated herein by reference to the Registrant's Proxy Statement dated March 20, 1995, in connection with its annual meeting to be held on April 27, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIncorporated herein by reference to the Registrant's Proxy Statement dated March 20, 1995 in connection with its annual meeting to be held on April 27, 1995.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K\n1. The following documents are filed as a part of this report:\nA. Consolidated Financial Statements of the Company which are included in the annual report of the registrant to its stock- holders for the year ended December 31, 1994 as follows:\n1. Consolidated Balance Sheets, December 31, 1994 and 1993 2. Consolidated Statements of Earnings, for the three years ended December 31, 1994. 3. Consolidated Statements of Cash Flows, for the three years ended December 31, 1994. 4. Consolidated Statements of Changes in Stockholders' Equity, for the three years ended December 31, 1994. 5. Independent Auditors' Report 6. Notes to Consolidated Financial Statements\nB. Financial Statement Schedules as follows:\nSchedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission have been omitted because they are not required under the related instructions or the required information as set forth in the financial statements and related notes.\nC. Exhibits as follows:\n13. Premier Financial Services, Inc. Annual Report for 1994.\n21. Subsidiaries of the Registrant.\n22. Published report regarding matters submitted to vote of security holders. See previous filing submitted on March 13, 1995.\n23. Consents of Experts and Counsel.\n99a. Premier Financial Services, Inc. Stock and Savings Plan Form 11-K Annual Report for the Fiscal Year ended December 31, 1994.\n99b. Premier Financial Services, Inc. Senior Leadership and Directors Deferred Compensation Plan Form 11-K Annual Report for the Fiscal Year ended December 31, 1994.\n2. Reports on Form 8-K\nThe registrant has not filed a report on Form 8-K, during the quarter ended December 31, 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.\nPremier Financial Services, Inc.\nRichard L. Geach By: Richard L. Geach, President Chief Executive Officer and Director\nDate: March 23, 1995\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.\nD. L. Murray Donald E. Bitz\nBy: D. L. Murray, Executive Vice President Chief Financial Officer and Director\nDate: March 23, 1995 Date: March 23, 1995\nR. Gerald Fox Charles M. Luecke\nDate: March 23, 1995 Date: March 23, 1995\nJoseph C. Piland H. Barry Musgrove\nDate: March 23, 1995 Date: March 23, 1995\nE. G. Maris\nDate: March 23, 1995\nAppendix\nPursuant to paragraph 232.311 (c) of Regulatin S-T, Premier Financial Services, Inc. is submitting on paper under cover of Form SE the financial statements of the Plan which are included in the annual report of the Plan to its participants for the year ended December 31, 1994.","section_15":""}
{"filename":"60860_1994.txt","cik":"60860","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nLukens Inc. is a holding company incorporated in Delaware. Subsidiaries of Lukens Inc. manufacture carbon, alloy and clad steel plates, and stainless steel sheet, strip, plate, hot band and slabs. In 1992, Lukens expanded into stainless steel product lines with the acquisition of Washington Steel Corporation for $273.7 million. Production facilities and markets are located primarily in the United States.\nAs part of a program adopted in 1993 to focus Lukens' resources on its steel businesses, the subsidiaries previously reported in the Corrosion Protection Group, Safety Products Group and most subsidiaries in the Diversified Group were classified as discontinued operations. In 1994, all of these subsidiaries were sold except for our pipe-coating subsidiary, which is actively being marketed.\nBUSINESS GROUPS\nLukens has two business groups, the Lukens Steel Group and the Washington Stainless Group. Financial information for these business groups is incorporated herein by reference to Note 3 to the financial statements included in Part II, Item 8 of this Form 10-K. The chart below outlines the business group composition of consolidated net sales for each of the last three years. The Washington Stainless Group 1992 percent represents sales from the acquisition date on April 24, 1992.\nComposition of Consolidated Net Sales by Business Group\nLUKENS STEEL GROUP\nThe Lukens Steel Group specializes in the production of carbon, alloy and clad steel plate. Lukens Steel Company ranks as one of the three largest domestic plate steel producers and is the largest domestic producer in the alloy plate market. There are several domestic and foreign competitors. Major competitors are United States Steel, a subsidiary of the USX Corporation, and Bethlehem Steel Corporation.\nLukens Steel's competitive position is enhanced by a concentration on plate with a product line that includes a wide range of plate sizes and grades. In addition to price and quality, customer satisfaction, measured by shipped-on- time performance and production lead times, has become increasingly important in the competitive environment. Price competition has been and is expected to remain intense.\nProducts are sold primarily by an in-house sales force. Steel service centers are the largest market for the group, accounting for approximately 40 percent of annual shipments in the last three years. The Lukens Steel Group supplies a wide range of markets in the capital-goods sector of the economy, including markets for:\n. Machinery and Industrial Equipment . Infrastructure . Environmental and Energy . Transportation . Military and Defense.\nSome sales involve government contracts which, under certain circumstances, are subject to termination or renegotiation. Terminations for convenience of the government generally provide for payments to a contractor for its costs and a portion of its profit. Lukens does not expect any material portion of its business to be terminated or renegotiated.\nRaw materials used in the production of carbon and alloy steel plate include carbon scrap, alloy scrap and alloy additives. Generally, these materials are purchased in the open market and are available from several sources. Prices and availability are affected by the operating level of the domestic steel industry, the quantity of scrap exported, and world political and economic conditions. Scrap costs increased significantly in 1993 and remained at relatively high levels in 1994. Increasing selling prices during 1994 began to offset these higher scrap costs. Scrap remains readily available.\nPrincipal energy sources used in production include electricity and natural gas. Propane gas back-up systems are available at the Coatesville, Pennsylvania, manufacturing facility in the event of natural gas supply restrictions. Forward exchange or hedge contracts for the purchase of natural gas are used to manage the group's exposure to price volatility.\nWASHINGTON STAINLESS GROUP\nWashington Steel Corporation is the largest subsidiary in the group, representing 69 percent of the group's sales in 1994. This subsidiary specializes in the manufacture and marketing of stainless steel sheet, strip, plate, hot band and slabs. Primary competitors include Allegheny Ludlum Corporation, J&L Specialty Products Corporation, North American Stainless and Armco Inc. Washington Steel's competitive position is built on the ability to serve niche markets by providing a wide range of quality products.\nSimilar to the competitive environment in the Lukens Steel Group, customer satisfaction, measured by shipped-on-time performance and production lead times, has become increasingly important. Price and quality are also significant factors in the competitive environment. Since 1993, increased competition has put pressure on selling prices; however, strong demand for stainless steel products has resulted in recent improvements in price.\nWashington Specialty Metals Corporation is a service and distribution center that specializes in stainless steel. There are numerous competitors on both a national and a regional scale. Washington Specialty Metals is a leading distributor of flat-rolled stainless steel.\nProducts are sold primarily by the group's own sales organizations. The primary market of the group is service centers, which represented approximately 37 percent of shipments in 1994. The Washington Stainless Group ultimately supplies diverse markets, including:\n. Process Industries . Food Service Equipment . Architecture and Construction . Transportation . Consumer Durables.\nRaw materials used in production include stainless scrap, chrome, nickel and molybdenum. Generally, these materials are purchased in the open market and are available from several sources. Prices and availability are affected by the operating level of the domestic steel industry, the quantity of scrap exported, and world political and economic conditions. Nickel costs remain highly volatile. Forward exchange or hedge contracts for nickel are used to manage the group's exposure to market price volatility. Due to recent significant increases in costs for nickel and molybdenum, Washington Steel Corporation has been able to institute price increases. Principal energy sources used in production include electricity and natural gas.\nSALES ORDER BACKLOG (Dollars in thousands)\nListed below is the backlog from continuing operations at the end of 1994 and 1993. The backlog at year-end 1994 is anticipated to be shipped in 1995.\nENVIRONMENT\nLukens is subject to Federal, state, and local environmental laws and regulations. An environmental committee meets quarterly to review environmental and remediation issues. Also, outside consultants are used on technical issues. The trend for tighter environmental standards is expected to result in higher waste disposal costs and additional capital expenditures in the long term.\nIn 1994, capital expenditures for environmental compliance projects were $3.9 million. In 1995 and 1996, capital expenditures are anticipated to be approximately $16.3 million and $4.6 million, respectively. Projected 1995 capital expenditures are primarily for expanded pollution control equipment at the melting facilities of Washington Steel Corporation.\nLukens is a potentially responsible party under Superfund law at certain waste disposal sites. The company's exposure to remediation costs at these sites depends upon several factors, including changing laws and regulations and the allocation of costs among all potentially responsible parties. Our exposure is expected to be limited based on the volumes of waste which might be attributable to Lukens and the number and financial strength of other potentially responsible parties. Based on information currently available, management believes that any future costs in excess of amounts already accrued will not have a material adverse effect on the company's financial condition, results of operations or competitive position.\nEMPLOYEES\nThe average number of employees during 1994 was 4,060.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nCAPITAL EXPENDITURE PROGRAM\nCapital expenditures in 1994 of $120.3 million were part of a five-year, $400 million program that began in 1993. The program is aimed at promoting synergies between the Lukens Steel Group and the Washington Stainless Group, and expanding our product lines to take advantage of anticipated long-term growth in stainless steel markets. The centerpiece of the program is the installation of a plate and sheet processing system at our facility in Conshohocken, Pennsylvania. The new system utilizes Steckel rolling technology and is designed to lower production costs, improve quality and expand the product range of both the Lukens Steel Group and the Washington Stainless Group. Start-up of this system is expected to begin at the end of the first quarter of 1995. Benefits from this system will not begin to be realized until late in 1995. Other expenditures in the program include an increase in stainless melting capacity and upgrades to stainless finishing facilities.\nLUKENS STEEL GROUP\nRaw steel is produced by an electric arc furnace at the Coatesville, Pennsylvania, plant. Approximately 70 percent of 1994 production was continuously cast into slabs at this facility. Rolling and fabrication facilities are located in Coatesville and Conshohocken, Pennsylvania. Other relatively small properties include a fabrication facility, located in Newton, North Carolina, and a real estate development and management company in New Castle, Delaware. The group operated near capacity in 1994. In 1995, steel slabs are anticipated to be purchased to supplement melting capacity. Capacity of other facilities is considered adequate to support projected sales.\nWASHINGTON STAINLESS GROUP\nWashington Steel Corporation has melting, continuous casting and rolling facilities in Houston, Pennsylvania. Both the Washington, Pennsylvania, and Massillon, Ohio, facilities have rolling and finishing facilities. Utilization of these facilities ranged between 85 and 100 percent in 1994. Our stainless melting facilities operated at full capacity through most of 1994. Capacity of facilities is considered adequate to support projected sales.\nWashington Specialty Metals Corporation has fabrication and distribution facilities in Wheeling, Illinois, and Lawrenceville, Georgia. Additional distribution centers are located in:\n. Carrollton, Texas . Youngsville, North Carolina . Tampa, Florida . Brampton, Ontario, Canada . Vaudreuil, Quebec, Canada.\nPLANT AND EQUIPMENT PLEDGED AS COLLATERAL\nPlant and equipment with a net depreciated cost of $47.3 million are pledged as collateral, primarily for industrial revenue bonds.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nApproximately 350 workers' compensation claims alleging hearing loss have been asserted against Lukens Steel Company, a wholly-owned subsidiary, by current and former employees before the Pennsylvania Workers' Compensation Board. A $5.6 million reserve has been established to cover potential awards and defense costs resulting from these claims. As of year-end 1994, an aggregate of 249 workers' compensation claimants released their claims and received negotiated payments which were, in the aggregate, within the amount of the established reserve.\nIn 1994, approximately 22 workers' compensation claims alleging hearing loss were asserted against Washington Steel Corporation, a wholly-owned subsidiary. Management does not have sufficient information at this time to assess the impact, if any, of these claims on the financial condition or results of operations of Lukens Inc.\nLukens is involved in litigation and administrative proceedings which seek the recovery of response costs with respect to certain waste disposal sites. Lukens' potential exposure in these actions will vary according to the amount of responsibility attributed to Lukens, the allocation of responsibility among and financial viability of other responsible parties, and the method and duration of remedial action. In the opinion of management, any liabilities arising from these sites in excess of amounts already accrued will not have a materially adverse effect on the company's financial position.\nThe company is party to various claims, disputes, legal actions and other proceedings involving product liability, contracts, equal employment opportunity, occupational safety and various other matters. In the opinion of management, the outcome of these matters should 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.\nNo matters were voted upon during the fourth quarter of 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following executive officers were elected by the Board of Directors until their respective successors are elected:\nExecutive Officer Executive Officer\/Title Age Since - ----------------------- --- ----------------- R. W. Van Sant 56 October 1991 Chairman and Chief Executive Officer\nJohn H. Bucher 55 April 1993 Vice President-Technology\nRobert E. Heaton 65 April 1992 Senior Vice President- Vice Chairman-Stainless Group\nC. B. Houghton, Jr. 54 November 1994 Vice President and Controller\nT. Grant John 56 February 1993 Vice President-President and Chief Operating Officer-Washington Steel\nRichard D. Luzzi 43 February 1993 Vice President-Human Resources\nJames J. Norton 38 April 1992 Vice President-President and Chief Operating Officer-Washington Specialty Metals\nDennis M. Oates 42 February 1987 Senior Vice President-President and Chief Operating Officer-Carbon and Alloy Group\nFrederick J. Smith 51 April 1993 Vice President-Manufacturing Services\nWilliam D. Sprague 53 October 1988 Vice President, General Counsel and Secretary\nJohn C. van Roden, Jr. 46 February 1987 Vice President and Treasurer\nListed below are executive officers that have not been employed by Lukens in an executive or managerial capacity during the last five years.\nR. W. VAN SANT was previously the president and chief executive officer and a director of Blount, Inc. Prior to his association with Blount in 1987, he served as president and chief operating officer and a director of the Cessna Aircraft Company. He had earlier served as vice president of manufacturing and engineering at Deere and Company where he was employed for 26 years.\nROBERT E. HEATON, prior to the acquisition of Washington Steel Corporation by Lukens in 1992, was president and chief operating officer of Washington Steel since 1989, and served as president and chief executive officer from 1981.\nT. GRANT JOHN was previously with the Axel Johnson Group, a privately-owned Swedish company with extensive holdings of stainless steel businesses. During his 14 years with Axel Johnson, Mr. John held operating and management positions in the corporation's United States operations. Since 1985, Mr. John was a corporate vice president of Axel Johnson, Inc.\nRICHARD D. LUZZI joined Rockwell International Corporation in 1980 and became vice president-human resources at Rockwell Graphic Systems, Inc. in 1988. In 1991, he assumed the additional responsibility of vice president- international human resources for Rockwell International.\nJAMES J. NORTON, prior to the acquisition of Washington Steel Corporation by Lukens in 1992, was president of the service center group. Previously, he was the chief financial officer of Mercury Stainless Corporation, including Washington Steel, from 1986 to 1991.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThe information contained in the section entitled \"Dividends\" in Part II, Item 7 of this Form 10-K and in the section entitled \"Quarterly Financial Data\" in Part II, Item 8 of this Form 10-K is incorporated herein by reference in response to this item.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nLukens Inc. -- Financial Information\nSELECTED FINANCIAL HIGHLIGHTS FOR ELEVEN YEARS\na. Includes results from the Washington Steel Corporation acquisition on April 24, 1992.\nDollars and shares in thousands except per share amounts\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nLukens Inc. -- Management's Discussion and Analysis Dollars in thousands except per share amounts\nTHE YEAR IN REVIEW\nThe following discussion focuses on the results of operations and on the financial condition of Lukens Inc. In addition to the consolidated results analysis, the results of our two business groups, Lukens Steel Group and Washington Stainless Group, are discussed. The Washington Stainless Group resulted from the acquisition of Washington Steel Corporation in April 1992. This acquisition had a significant impact on Lukens' results of operations and financial condition.\nThis section should be read in conjunction with the consolidated financial statements and notes.\nSUMMARY OF RESULTS\nCONSOLIDATED RESULTS FROM CONTINUING OPERATIONS\nNet Sales. Sales were up 10 percent in 1994 with both business groups contributing to the increase. The Washington Stainless Group benefited from higher shipments and strong service center market conditions. Higher selling prices and shipments resulted in the Lukens Steel Group improvement.\n1993 sales were up 24 percent compared to 1992. The increase primarily reflected the comparison of Washington Stainless Group 1993 sales to 1992, which was for a partial year from the April 1992 acquisition to year-end. The Lukens Steel Group recorded a sales increase, primarily from higher shipments.\n[GRAPH APPEARS HERE]\nLukens Inc. -- Management's Discussion and Analysis\nOperating Earnings. Operating earnings were up 35 percent in 1994. Included in 1993 earnings was a $14,921 fourth quarter provision recorded in the Lukens Steel Group that was primarily for a work force reduction program. Excluding the 1993 provision for comparison purposes, 1994 operating earnings were down 4 percent. The decline reflected Lukens Steel Group results that were impacted by increased scrap costs, costs associated with severe winter weather, and costs and disruptions related to the capital expenditure program. Sales improvements at the Washington Stainless Group translated to higher earnings in 1994.\nOperating earnings in 1993 were down 29 percent compared to 1992. The decrease was attributable to the Lukens Steel Group, which experienced a less profitable shipment mix, higher scrap costs and recorded a fourth quarter provision discussed previously. Selling and administrative expenses increased 43 percent in 1993 compared to 1992. The increase reflected the comparison of Washington Stainless Group 1993 expenses to a partial year in 1992. Higher expenses were also attributable to increased retiree benefit costs associated with the adoption of a new accounting standard, discussed in Note 1, and increased pension expense and consulting fees.\nInterest Income. Since the acquisition of Washington Steel in April 1992, short- term investment levels and related interest income have remained at relatively low levels.\nInterest Expense. Interest expense in 1994 decreased 19 percent with most of the decline attributable to higher amounts of capitalized interest associated with capital expenditures. Lower interest rate swap expense also contributed to the decline.\nAcquisition-related interest for a full year in 1993 compared to a partial year in 1992 resulted in a 21 percent increase. The increase also reflected higher interest rates on the $150,000 of long-term notes, 7.625 percent coupon rate, issued in the third quarter of 1992, compared to lower short-term interest rates incurred prior to the issuance of the notes.\nIncome Tax Expense. The effective tax rate was 39.0 percent in 1994, 35.3 percent in 1993 and 39.1 percent in 1992. Included in the 1994 rate was .7 percent from the revaluation of net deferred tax assets following changes to Pennsylvania corporate income tax rates and net operating loss deduction rules. The 1993 rate included a favorable adjustment of 3.6 percent from the revaluation of net deferred tax assets following a 1 percent increase in the Federal corporate tax rate to 35 percent.\nThe effective tax rate for 1994 and 1993 was based on a new accounting standard for income taxes discussed in Note 1. The deferred tax assets recognized in the adoption of the standard were based on the combination of future reversals of existing taxable temporary differences, carryback availability, tax planning strategies and future taxable income.\nEarnings From Continuing Operations. In 1994, higher operating earnings combined with lower interest expense generated a 69 percent increase in earnings from continuing operations compared to 1993.\nIn 1993, lower operating earnings and higher interest expense translated into a 45 percent drop in earnings from continuing operations compared to 1992.\nEarnings From Discontinued Operations. 1993 earnings from discontinued operations, net of taxes, were down 40 percent compared to 1992 earnings. Lower activity for large pipe-coating orders at our ENCOAT subsidiary and weaker market conditions experienced by the other subsidiaries resulted in the decline. During the fourth quarter of 1993, a $4,500 provision, $2,772 after tax, was recorded to recognize a change in the estimated realizable value of discontinued operations. In 1994, results and divestiture gains and losses were charged against this reserve.\nEarnings Before Cumulative Effect of 1993 Accounting Changes. As a result of the factors discussed above, 1994 earnings were up 39 percent over 1993 earnings before the cumulative effect of accounting changes. 1993 earnings were down 52 percent compared to 1992.\nDollars in thousands except per share amounts\n[GRAPH APPEARS HERE]\nNet Earnings (Loss). During 1993, Lukens adopted new accounting standards for retiree medical and life insurance benefits and for income taxes, discussed in Note 1. The cumulative effect of adopting these accounting standards was a net expense of $65,901. As a result, a net loss of $49,999 was recorded in 1993.\nBUSINESS GROUPS\nLukens Steel. The 7 percent sales increase in 1994 reflected higher selling prices and increased shipments. Shipped tons of 725,900 in 1994 were up slightly from 1993 shipments of 711,800 tons. Operating earnings were up 51 percent compared to 1993. Earnings in 1993 included a $14,921 fourth quarter provision. The provision included $9,660 for a work force reduction program, and other charges for environmental remediation and workers' compensation claims.\nExcluding the 1993 provision for comparison purposes, operating earnings were down 19 percent in 1994. The decline reflected higher scrap costs, costs associated with severe weather conditions during the first quarter, and production disruptions and related costs from the capital expenditure program.\nStrong shipment levels partially offset by a lower-value shipment mix resulted in a 7 percent increase in 1993 sales from 1992. Shipments for the year were up 10 percent from 1992 shipped tons of 646,100.\nOperating earnings in 1993 were down 59 percent compared to 1992, largely the result of the fourth quarter charge discussed previously. Additionally, the impact of a less profitable shipment mix and higher scrap costs squeezed profit margins. Increased employee benefit costs were also incurred from the recognition of accrual expense for retiree medical and life insurance benefits resulting from the adoption of a new accounting standard, discussed in Note 1, and from higher pension expense.\n[GRAPH APPEARS HERE]\n[GRAPH APPEARS HERE]\nLukens Inc. -- Management's Discussion and Analysis\nWashington Stainless. The 16 percent increase in 1994 sales reflected improved service center sales and increased shipments of sheet, strip and plate products. Lower selling prices on certain products, especially during the first half of the year, partially offset sales gains. Shipped tons of 259,500 in 1994 were 24 percent higher than 1993 shipments of 208,800. Sales improvements translated to a 7 percent increase in earnings with the increase limited by the impact of lower selling prices and a less profitable shipment mix.\nSales for 1993 were up 50 percent and operating earnings were up 64 percent compared to 1992 results. The increases partially reflected the comparison of 1993 to 1992 results that were from the acquisition of the group in late April 1992. 1993 results benefited from production efficiencies, lower nickel costs and improved earnings from the service center operations. On the negative side, increased imports put pressure on 1993 selling prices. Shipped tons in 1992 were 147,500.\n[GRAPH APPEARS HERE]\n[GRAPH APPEARS HERE]\nBUSINESS OUTLOOK\n1995 will be a pivotal year for Lukens with major capital expenditure projects scheduled to come on-line. These projects represent key elements of our five- year, $400,000 capital expenditure program that began in 1993.\nBy the end of the first quarter, the plate and sheet processing system that utilizes Steckel rolling technology is scheduled to start up at our Conshohocken, Pennsylvania, facility. Anticipated benefits from this project include lower production costs, improved quality and an expanded product range. The start-up will require several months and the benefits will not begin to be realized until late in 1995. Also in 1995, projects to increase stainless melting capacity will be completed.\nEarnings in 1995 will be limited by start-up expenses and production disruptions from these projects, particularly during the first half of the year. The plate and sheet processing system is a complex project, and our ability to implement the start-up as planned will be a significant factor in 1995.\nDollars in thousands except per share amounts\nBusiness conditions in 1995 are expected to remain strong for both business groups. In the Lukens Steel Group, higher selling prices are anticipated. Although scrap prices remain high, continued selling price improvements should improve margins. The Washington Stainless Group is expected to benefit from higher selling prices to help offset rising nickel and other raw material costs. Overall, the successful start-up of our capital expenditure projects combined with anticipated strong market conditions should result in an earnings improvement over 1994.\nFINANCIAL CONDITION\nCapital Structure. At the end of 1994, cash and cash equivalents totaled $9,806, a decrease of $1,677 from the end of 1993. Working capital of $106,480 was down $39,554. The divestitures of discontinued operations caused a decrease in working capital of $31,925. The current ratio was 1.6 compared to 1.9 at year-end 1993.\nDebt at the end of 1994 was $208,485, a decrease of $18,104, or 8 percent from year-end 1993. The decrease was caused primarily by the net repayment of short- term notes under our revolving credit agreements and by the repayment of a $3,000 industrial revenue bond. Proceeds from discontinued operations divestitures contributed to reduced debt levels.\nThe $150,000 of long-term notes at year-end were rated Baa2 by Moody's and BBB+ by Standard and Poor's. Included in year-end debt was $22,767 of ESOP debt, which is guaranteed by Lukens. The ratio of long-term debt to total capital (long-term debt plus stockholders' investment) was 42.1 percent at the end of 1994, which compared to 45.3 percent at year-end 1993.\nDuring June 1994, a shelf registration for $100,000 of Lukens Inc. notes was completed. Although there are no immediate plans to issue the notes, they are available as a financing option for our capital expenditure program and other long-term liquidity needs. The notes are structured to provide Lukens with flexibility in maturities, from nine months to 30 years, and flexibility in interest rate structures.\nEffective January 15, 1995, our revolving credit agreements were amended. The amendments increased our committed line of credit by $25,000 to $150,000 and reduced our rate structures. The term of the agreements was also extended until January 15, 2000.\nLukens enters forward exchange contracts (derivatives) with the objective to manage or hedge our exposure to market price changes of certain commodities used in manufacturing. We do not speculate or trade in these agreements for profit. These contracts generally provide for the exchange of a market price for a fixed price based on a notional quantity. Contracts are executed under the guidelines of a corporate policy. The policy specifies members of management with the authority to execute agreements and establishes limits on the amount of contracts outstanding. As of year-end 1994, we were party to several agreements for 1995, which are discussed in Note 9.\n[GRAPH APPEARS HERE]\nLukens Inc. -- Management's Discussion and Analysis\nLiquidity -- Short Term. Cash flow from operating activity was $79,180 in 1994 compared to $72,290 in 1993. Financing activity required $31,397 with dividend payments of $17,140 and net debt repayments of $14,726. Investing activity required $49,460 with capital spending of $120,342 partially offset by proceeds from the sale of assets and subsidiaries of $70,433.\nBased on our business outlook, we do not anticipate any significant increases to our cash flow from operating activity in the short term. As discussed previously, the key to 1995 results and cash flow will be our ability to implement the start-up of major capital expenditure projects as planned. Consolidated backlog at year-end 1994 was $168,500, up 66 percent from the beginning of the year.\nCapital expenditure projections for 1995 are relatively high at approximately $110,000. We anticipate funding these expenditures primarily through the combination of cash flow from operations and debt under our existing committed line of credit.\n[GRAPH APPEARS HERE]\nLiquidity -- Long Term. In the long term, Lukens relies on the ability to generate sufficient cash flows from operating activity to fund investing and financing requirements and to maintain a target long-term debt-to-capital ratio of 35 percent. As the chart below indicates, Lukens has consistently generated cash from operations totaling $210,654 over the past three years. Because of our five-year, $400,000 capital expenditure program that began in 1993, we continue to exceed our target long-term debt-to-capital ratio. The projected benefits of the program should improve cash flow from operations and enable us to reach our target in the long term.\n[GRAPH APPEARS HERE]\nEnvironmental Compliance. We are projecting capital expenditures of approximately $16,308 in 1995 and $4,577 in 1996 for environmental compliance. The trend for tighter environmental standards is expected to result in higher waste disposal costs and additional capital expenditures in the long term.\nLukens is a potentially responsible party under Superfund law at certain waste disposal sites. As discussed in Note 11, our exposure to remediation costs at these sites depends on several factors. Based on information currently available, we believe that any future costs in excess of amounts already accrued will not have a material adverse effect on our financial condition, results of operations or competitive position.\nDollars in thousands except per share amounts\nDebt Financing. Lukens' long-term notes outstanding of $150,000 are due in 2004. Supporting both our short- and long-term liquidity needs are agreements for a committed line of credit and a shelf registration for $100,000 of Lukens Inc. notes, discussed in the Capital Structure section.\nOther Commitments. A contract for the supply of oxygen and related products to a Lukens Steel Group manufacturing facility runs until 2007 and includes take- or-pay provisions totaling $30,838 at the end of 1994. Washington Steel Corporation has contracts for the supply of nickel. The contracts include minimum quantities and market-based pricing. Based on year-end 1994 market conditions, the value of these contracts totaled $83,981.\nInflation. On average, inflation rates for the domestic economy have not been severe over the past few years. Although long-term inflation rates are difficult to predict, Lukens believes it has the flexibility in operations and capital structure to maintain a competitive position.\nDividends. Lukens paid $1.00 per share in common stock dividends in 1994. A quarterly common dividend of $.25 per share was paid on February 17, 1995. It is our objective to pay common dividends approximating 35 percent of net earnings over the long term. As of February 13, 1995, there were approximately 5,900 common stockholders of record.\nThe Series B Convertible Preferred Stock held by the ESOP carries a cumulative annual dividend of $4.80 per share.\nLukens' common stock is listed and traded on the New York Stock Exchange, ticker symbol \"LUC.\" Dividends and stock market price ranges for the last two years are included in the section entitled \"Quarterly Financial Data\" in Part II, Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nLukens Inc. -- Consolidated Financial Statements Dollars and shares in thousands except per shares amounts\nConsolidated Financial Statements\nConsolidated Statements of Earnings (Note 2) for the 53 weeks ended December 31, 1994, and the 52 weeks ended December 25, 1993, and December 26, 1992\nThe accompanying notes are an integral part of these statements.\nDollars in thousands\nConsolidated Balance Sheets as of December 31, 1994, and December 25, 1993\nThe accompanying notes are an integral part of these statements.\nLukens Inc. -- Consolidated Financial Statements Dollars in thousands except per share amounts\nConsolidated Statements of Stockholders' Investment for the 53 weeks ended December 31, 1994, and the 52 weeks ended December 25, 1993, and December 26, 1992\nThe accompanying notes are an integral part of these statements.\nDollars in thousands\nConsolidated Statements of Cash Flows for the 53 weeks ended December 31, 1994, and the 52 weeks ended December 25, 1993, and December 26, 1992\nThe accompanying notes are an integral part of these statements.\nLukens Inc. -- Notes to Consolidated Financial Statements\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. ACCOUNTING POLICIES\nConsolidation and Fiscal Year. The consolidated financial statements include the accounts of Lukens Inc. and all majority-owned subsidiaries. Our fiscal year is the 52- or 53-week period that ends on the last Saturday of December. Certain subsidiaries are consolidated on a calendar year basis.\nCash and Cash Equivalents. Highly liquid investments with maturities of three months or less when purchased are recognized as cash equivalents.\nInventories. Inventories are recorded at the lower of cost or market. Cost is determined by the last-in, first-out (LIFO) method for most product and raw material inventories. The service center operations of the Washington Stainless Group determine cost by the first-in, first-out (FIFO) method. Supplies are valued at the lower of average cost or market. Additional inventory disclosures are included in Note 8.\nPlant and Equipment. Plant and equipment are stated at cost and are depreciated using the straight-line method over the estimated useful life. The useful life ranges from 20 to 40 years for buildings and from 10 to 18 years for most production machinery and equipment. The cost of plant and equipment retired in the normal course of business is generally charged against accumulated depreciation. Gains and losses on other retirements are reflected in earnings.\nIntangible Assets. Intangible assets consist primarily of goodwill resulting from the Washington Steel Corporation acquisition, discussed in Note 2. Goodwill from the acquisition is amortized on a straight-line basis over 25 years. Also included in intangible assets are pension-related assets, discussed in Note 5.\nDerivative Financial Instruments. Derivative financial instruments, such as forward exchange contracts, are used to manage exposure to changes in market conditions for certain raw material purchases and debt transactions. Gains or losses on these contracts are recognized as a component of the related transaction over the life of the contract. Additional disclosures are included in Note 9.\nEnvironmental Liabilities. Environmental liabilities recognized represent our best estimate of remediation expenditures that are probable and that can be reasonably estimated. Environmental costs are expensed unless they increase the value of the related asset and\/or prevent or mitigate future contamination. Additional disclosures are included in Note 11.\nEarnings Per Share. Primary earnings per common share are calculated by dividing net earnings applicable to common stock by the average number of common shares outstanding and common stock equivalents. On a fully-diluted basis, both net earnings and shares outstanding are adjusted to assume the conversion of convertible preferred stock.\nDuring 1992, Lukens issued long-term notes and common stock (Notes 9 and 10) to refinance the Washington Steel acquisition (Note 2). If the long-term notes and common stock had been issued on the acquisition date, primary earnings per common share reported for 1992 would not have been significantly different.\n1993 Accounting Changes -- Income Taxes. In the first quarter of 1993, Lukens adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" The statement requires an asset and liability approach to determine the tax provision and related deferred tax assets and liabilities. We elected to record the cumulative effect of this accounting change by the recognition of a $1,321 gain, or $.09 per common share.\nAs a result of adopting SFAS No. 109, the tax benefit on the Lukens preferred stock dividends for the shares allocated to employee stock ownership plan (ESOP) participants is recognized as a reduction to the income tax provision. In prior years, this amount was recognized as a direct increase to retained earnings.\nResults for years prior to 1993 have not been restated. See Note 6 for additional income tax disclosures.\nDollars in thousands except per share amounts\n1993 Accounting Changes -- Retiree Medical & Life Insurance Benefits. In the first quarter of 1993, Lukens adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The statement requires the liability and expense to be actuarially determined in a framework similar to the one used to measure defined benefit pension plans. We elected to record the cumulative effect of this accounting change by the recognition of a $108,000 expense, which represented the accumulated postretirement benefit obligation for current and future retirees at the beginning of 1993. On an after-tax basis, the expense was $67,222, or $4.55 per common share.\nThe recognition of retiree medical and life insurance benefits in years prior to 1993 was on a cash basis. Results for these years have not been restated. See Note 5 for additional disclosures.\n2. ACQUISITIONS & DISCONTINUED OPERATIONS\nAcquisitions. On April 24, 1992, Washington Steel Corporation was acquired for $273,718 in cash. Washington Steel is a stainless steel producer with two production facilities in Pennsylvania and one in Ohio. Also included in the acquisition were seven stainless service centers in the United States and Canada. The acquisition was accounted for as a purchase with the results of Washington Steel included from the acquisition date.\nThe pro forma consolidated results listed below are unaudited and reflect purchase accounting adjustments assuming the acquisition occurred at the beginning of 1992.\nDiscontinued Operations. As part of a program adopted in 1993 to focus Lukens' resources on its steel businesses, the subsidiaries previously reported in the Corrosion Protection Group, Safety Products Group and most subsidiaries in the Diversified Group were reported as discontinued operations. In the fourth quarter of 1993, a $4,500 provision was recognized to revise estimates of the realizable value of discontinued operations. On an after-tax basis, the provision was $2,772, or $.19 per common share.\nDuring 1994, net proceeds from the divestiture of discontinued operations totaled $69,256. One subsidiary remains, our pipe-coating business, that is actively being marketed. In 1994, results and divestiture gains and losses were charged against the reserve established in the fourth quarter of 1993. Operating results for 1994 included net sales of $70,925 and a net loss of $1,067.\nNet sales and income tax expense of the discontinued operations and an earnings per common share reconciliation for 1993 and 1992 are presented below.\nLukens Inc. -- Notes to Consolidated Financial Statements\n3. BUSINESS GROUPS\nListed below is a description of our business groups, which operate primarily in the United States. Sales to foreign countries are not significant.\nLukens Steel Group -- specializes in the production of carbon, alloy and clad plate steels.\nWashington Stainless Group -- specializes in the production of stainless steel sheet, strip, plate, hot band and slabs. The group also operates stainless service centers.\nSummary business group information is included in the following chart.\na. Lukens Steel Group Operating Earnings: 1994 -- In the first quarter, the group recorded a loss of $1,339 caused primarily by production disruptions and maintenance costs associated with severe weather conditions. 1993 -- In the fourth quarter, charges of $14,921 were recognized that included $9,660 of expense for a work force reduction program (Note 4). The remaining charges included provisions for environmental remediation and workers' compensation claims. The adoption of an accounting standard for retiree medical and life insurance benefits (Note 1) resulted in additional expense of $4,610 over the cash claims. 1992 -- In the fourth quarter, a provision for workers' compensation claims alleging hearing loss reduced results by $3,500. Also in the fourth quarter of 1992, a favorable LIFO inventory accounting adjustment increased earnings by $2,719.\nb. Washington Stainless Group Results: 1994 -- In the fourth quarter, charges of $1,069 were recognized, primarily for an early retirement program. 1992 -- Results are for a partial year, from the acquisition date on April 24, 1992, to year-end.\nc. Corporate Expenses: 1993 -- Results included higher consulting fees and expenses from a work force reduction program.\nd. Corporate Assets: Corporate assets consist primarily of cash and cash equivalents, refundable income taxes, office facilities and deferred income taxes.\nDollars in thousands except per share amounts\n4. UNUSUAL ITEM\nDuring the fourth quarter of 1993, $10,626 of expenses for a work force reduction program were recognized. The expenses were primarily for pension and medical benefits associated with an early retirement program. On an after-tax basis, the provision reduced net earnings before the cumulative effect of accounting changes by $6,247, or $.43 per common share.\n5. RETIREE BENEFITS\nPensions. Lukens has several defined benefit plans that provide pension and survivor benefits for most employees. Benefits are primarily based on the combination of years of service and compensation. Plans are funded in accordance with applicable regulations.\nThe components of pension expense are listed below.\na. The increase in 1993 pension expense resulted primarily from plan improvements for Lukens Steel Group salary employees. The increase was also attributable to a full year of Washington Stainless Group expense compared to 1992, which was from the acquisition on April 24.\nThe following table reconciles the net funded status of our plans to amounts recognized in the Consolidated Balance Sheets.\na. The decrease in the 1994 benefit obligations primarily reflected a higher discount rate. b. Plan assets primarily consist of stocks, bonds and short-term investments. Included in plan assets is Lukens' common stock totaling $734 in 1994 and $10,585 in 1993.\nLukens Inc. -- Notes to Consolidated Financial Statements\nThe net pension liability was recognized in the following accounts in the Consolidated Balance Sheets.\nSignificant assumptions used in the calculation of pension expense and obligations are listed below.\nRetiree Health & Life Insurance Benefits. Lukens provides retiree health and life insurance benefits for most employees if they continue to work for the company until they reach retirement age. These benefits are funded as the claims are submitted.\nDuring 1993, Lukens adopted a new accounting standard, SFAS No. 106, for these retiree benefits. As discussed in Note 1, we elected to recognize the cumulative effect of adopting the standard in 1993. Accrual expense under the new standard is significantly higher than the expense recognized under the previous cash- basis method. Cash payments in 1992 were $6,514.\nComponents of retiree health and life insurance expense in 1994 and 1993 are listed below.\nThe table below reconciles the actuarial present value of our obligations to the liability recognized in the Consolidated Balance Sheets.\na. The decrease in the 1994 benefit obligations primarily reflected a higher discount rate. b. Obligations include life insurance benefits of $16,246 in 1994 and $14,430 in 1993.\nSignificant assumptions used in the calculation of expense and obligations are listed below.\na. Health-care cost increase assumptions are reduced to a rate of 5 percent beginning in 2003.\nDollars in thousands except per share amounts\nA one-percentage point increase in the medical cost trend rate for each year would increase the accumulated postretirement benefit obligation by approximately $17,819 and would increase net postretirement benefit expense by approximately $2,544.\n6. Income Taxes\nDuring 1993, Lukens adopted a new income tax accounting standard, discussed in Note 1. Because we elected to recognize the cumulative effect of adopting the standard in 1993, prior years accounted for under the deferral method have not been restated.\nThe reconciliation between the federal statutory rate applicable to Lukens' earnings from continuing operations and our effective rate is listed below. Essentially all earnings are from United States sources.\na. Deferral method.\nThe components of the deferred income tax assets and liabilities are listed below.\nThe current and deferred components of the income tax provision are listed below.\na. Deferral method.\nLukens Inc. - Notes to Consolidated Financial Statements\nDeferred income taxes recognized under the deferral method were the result of the timing differences between financial reporting and taxable earnings listed below.\nOn a cash basis, Lukens paid the following amounts of income taxes, including payments for discontinued operations.\n1994 1993 1992 $4,040 $18,938 $10,960\n7. Compensation Plans\nStock Options. The 1985 Stock Option and Appreciation Plan provides for the issuance of non-qualified stock options and incentive stock options (ISO's) to officers and other executives. A maximum of 1,837,500 options to purchase Lukens' common stock can be granted until February 26, 1998, at an exercise price not less than the fair market value on the grant date. Options granted vest after one year and expire in ten years.\nThe Lukens Inc. Stock Option Plan for Non-Employee Directors provides for the issuance of up to 75,000 non-qualified options to purchase Lukens Inc. common stock at an exercise price based on the fair market value on the grant date.\nDuring 1991, 330,000 non-qualified stock options were granted to Mr. Van Sant as part of his employment agreement. These options become exercisable ratably over 11 years. The options carry an exercise price of $23.38 per share, which was 85 percent of the fair market value on the grant date. Compensation expense from this discount from fair market value is being recognized on a straight-line basis over his expected service period.\nA summary of stock option activity is presented below.\nDollars in thousands except per share amounts\nIncentive Compensation. Most Lukens' employees participate in incentive compensation plans that are based on the consolidated results of Lukens Inc. and on the results of various subsidiaries. Compensation expense under these plans is listed below.\n1994 1993 1992 $17,444 $19,419 $13,016\nEmployee Stock Ownership Plan (ESOP). In 1989, an ESOP within an existing 401(k) employee savings plan for most salaried employees was established. The ESOP was designed to provide 401(k) employer matching benefits in the form of convertible preferred stock that was acquired with the proceeds from a $33,075 term loan (Note 9). The stock is released for allocation to participants' accounts based on the relationship of debt and interest payments to the total of all scheduled debt and interest payments. Dividends on allocated stock are paid, in-kind, with preferred stock. The projected maturities of the ESOP loan over the remaining term are listed below.\n1995 1996 1997 1998 $4,085 $6,232 $7,630 $4,820\nThe loan is guaranteed by Lukens, and the outstanding balance is recognized as debt in the Consolidated Balance Sheets. An offsetting amount, representing deferred compensation measured by the stated value of convertible preferred stock, is recognized in the stockholders' investment section. Debt service requirements of the ESOP are met by the combination of Lukens' cash contributions to the ESOP and dividends on the preferred stock.\nRegarding expense recognition, cash contributions to the ESOP are recorded as compensation expense, and preferred stock dividends reduce retained earnings. This recognition results in interest expense incurred on the ESOP debt not being recognized as interest expense on Lukens' financial statements. Cash contributions are listed below.\n1994 1993 1992 $2,551 $2,222 $1,597\n8. Inventories\na. Approximately 75 percent of inventories were accounted for under the LIFO inventory valuation method.\nThe estimated cost to replace inventories at year-end is listed below.\n1994 1993 1992 $178,000 $197,000 $180,000\nIn 1992, reductions in inventory quantities resulted in a liquidation of LIFO inventory carried at lower costs from prior years. The effect of this liquidation reduced cost of products sold by $3,234. The effects of LIFO liquidations in 1994 and 1993 were not significant.\nLukens Inc. - Notes to Consolidated Financial Statements\n9. Financial Instruments\nLong-term Debt. Listed below is a summary of long-term debt outstanding.\n- ------------ a. The weighted-average interest rate was 6.3% at year-end 1994 and 3.7% at year-end 1993. Short-term notes are classified as long term because they are supported by the revolving credit agreements discussed below. b. The weighted-average interest rate was 5.4% at year-end 1994 and 4.8% at year-end 1993. c. The ESOP debt, guaranteed by Lukens, carries an 8.26% interest rate on $18,582 as of December 31, 1994. The remaining ESOP debt carries a variable rate of 80.5% of prime. For a discussion on ESOP accounting, see Note 7. d. Annual maturities of long-term debt, excluding the ESOP debt guarantee, over the next five years are listed below.\n1995 1996 1997 1998 1999 $3,049 $5,600 $ 316 $ 318 $ 321\ne. Plant and equipment with a net depreciated cost of $47,300 are pledged as collateral, primarily for industrial revenue bonds.\nNotes Payable. Lukens has notes outstanding of $150,000 which are due in 2004. Interest is payable semi-annually. The notes are currently rated Baa2 by Moody's and BBB+ by Standard and Poor's.\nDuring June 1994, a shelf registration for an additional $100,000 of Lukens Inc. notes was completed. Although there are no immediate plans to issue the notes, they are available as a financing option for our capital expenditure program discussed in Note 11 and other long-term liquidity needs. The notes are structured to provide Lukens with flexibility in maturities, from nine months to 30 years, and flexibility in interest rate structures.\nRevolving Credit Agreements. Subsequent to year-end, Lukens amended its revolving credit agreements to provide for a $150,000 committed line of credit, an increase of $25,000. The amended agreements expire on January 15, 2000.\nInterest is based on one of the following rates:\n. The higher of the Prime Rate or the Federal Funds Rate plus .5%\n. London Inter-Bank Offered Rate (LIBOR) adjusted for applicable reserves plus .225% to .5% depending on the Standard and Poor's or Moody's rating of the long-term notes of Lukens\n. Competitively bid rates from lenders.\nA facility fee is required on the total line of credit and ranges from .125% to .3% based on the lower of Standard and Poor's or Moody's rating of Lukens' long- term notes.\nThe agreements include covenants that require a maximum leverage ratio (defined in the agreement) of 55 percent and restrictions on additional debt and asset dispositions. At year-end, we were in compliance with these covenants. Additional borrowings of $128,150 were available under the amended agreements.\nDollars in thousands except per share amounts\nInterest Expense. Interest costs include interest on obligations, amortization of debt set-up costs and interest rate swap expense. For a discussion of ESOP debt accounting, see Note 7. Interest components are listed below.\nDerivative Financial Instruments - Commodity Hedges. As of year-end 1994, Lukens was party to several commodity hedge agreements for 1995. Based on year- end market conditions, the value of Lukens' contractual obligations for these commodity hedges is $45,891, and the obligation of the counterparties to the agreements is $59,536. Gains and losses on these contracts are recognized as a component of cost of products sold. Lukens is exposed to credit risk from nonperformance by the counterparties to these agreements.\nFair Value of Financial Instruments. The following table presents the fair value of certain financial instruments as of year-end 1994 and 1993.\n- ------------ a. Fair value was estimated by discounting cash flows using year-end interest rates. b. Fair value was estimated by using quotes from brokers. c. Interest exchange agreements with a notional principal amount of $81,250 were outstanding at year-end 1993.\n10. Stockholders' Investment\nCommon Stock. At the Annual Meeting of Stockholders on April 28, 1993, a 20,000,000 increase in the number of authorized common shares was approved. The increase, which was designed to provide greater flexibility in future capital structure requirements, brought the total number of shares authorized to 40,000,000. The par value remained at $.01 per share.\nOn July 28, 1992, Lukens issued 1,132,300 shares of common stock. The net proceeds of $58,529 were used to reduce the debt incurred to finance the Washington Steel acquisition. On September 28, 1992, a three-for-two common stock split was completed in the form of a 50 percent stock dividend. As a result of the split, $53, representing the par value of the additional shares, was transferred from capital in excess of par value to common stock. Common shares and equivalents outstanding and per share amounts in this Annual Report have been restated to reflect the stock split.\nUnder the stock option plans discussed in Note 7, 2,242,500 shares of common stock have been reserved.\nLukens Inc. - Notes to Consolidated Financial Statements\nPreferred Stock. There are 1,000,000 shares of series preferred stock, par value $.01 per share, authorized. An ESOP was established in 1989 with the issuance of 551,250 shares of Series B Convertible Preferred Stock. The preferred stock is stated at its liquidation preference of $60 per share and carries an annual cumulative dividend of $4.80 per share. Each share may be converted into three shares of common stock within the guidelines of an employee 401(k) savings plan. The stock is currently redeemable in common stock, cash or a combination at the option of Lukens at a price of $63.60 per share. The redemption price declines gradually each year to $60 per share on or after July 2, 2000.\nHolders of the Series B preferred stock are entitled to vote upon all matters submitted to the holders of common stock for a vote. The number of votes is equal to the number of common shares into which the preferred shares are convertible.\nShareholder Rights Plan. Lukens has a Shareholder Rights Plan designed to deter coercive or unfair takeover tactics and to prevent a buyer from gaining control of Lukens without offering a fair price to stockholders. The plan entitles each outstanding share of common stock to four-ninths (reflects adjustment for 1988 and 1992 common stock splits) of a right. Each right entitles stockholders to buy one one-hundredth of a share of Series A Junior Participating Preferred Stock at an exercise price of $110. The rights become exercisable if a person or group acquires or makes a tender or exchange offer for 20 percent or more of common stock outstanding. The rights can also become exercisable if the Board of Directors determines, with the concurrence of outside directors, that a person has certain interests adverse to Lukens and has acquired at least 10 percent of common stock outstanding.\nIf the company is then acquired in a merger or other business combination transaction, each right will entitle the holder to receive, upon exercise, common stock of either Lukens or the acquiring company having a value equal to two times the exercise price of a right.\nLukens will generally be entitled to redeem the rights at $.05 per right at any time until the tenth day following public announcement that a 20 percent position has been acquired. The purchase rights will expire on August 10, 1997. Of the 1,000,000 shares of series preferred stock authorized, 75,000 have been reserved for the Series A preferred stock discussed above. As of December 31, 1994, there were 6,511,911 rights outstanding.\n11. Commitments & Contingencies\nLeases. Lukens has various operating leases primarily for real estate and production equipment. At year-end 1994, minimum rental payments under noncancelable leases totaled $24,440. Listed below are the scheduled payments over the next five years for these leases.\n1995 1996 1997 1998 1999 $4,874 $4,530 $ 3,814 $ 2,948 $2,443\nRent expense for all operating leases is listed below.\n1994 1993 1992 $7,459 $12,245 $10,100\nEnvironmental Protection. Lukens is a potentially responsible party under Superfund law at certain waste disposal sites. The company's exposure to remediation costs at these sites depends upon several factors, including changing laws and regulations and the allocation of costs among all potentially responsible parties. Our exposure is expected to be limited based on the volumes of waste which might be attributable to Lukens and the number and financial strength of other potentially responsible parties. Based on information currently available, management believes that any future costs in excess of amounts already accrued will not have a material adverse effect on our consolidated financial condition, results of operations or competitive position.\nDollars in thousands except per share amounts\nLitigation. During 1992, approximately 300 workers' compensation claims alleging hearing loss were filed against Lukens Steel Company, a wholly-owned subsidiary. A $3,500 reserve was established in the fourth quarter of 1992 to cover potential awards and defense costs resulting from these claims. In 1993, additional claims were filed bringing the total number of claims to approximately 350. Additional reserves totaling $2,100 were established in 1993. As of year-end 1994, 249 of the workers' compensation claimants had released their claims and received negotiated payments.\nThe company is party to various claims, disputes, legal actions and other proceedings involving product liability, contracts, equal employment opportunity, occupational safety and various other matters. In the opinion of management, the outcome of these matters should not have a material adverse effect on the consolidated financial condition or results of operations of the company.\nCommitments. At year-end 1994, purchase commitments for capital expenditures were $33,773. Capital expenditures projected for 1995 are historically high at approximately $110,000. These expenditures are part of a five-year, $400,000 program that began in 1993.\nLukens Steel Company has a long-term contract for the supply of oxygen and related products to its facility in Coatesville, Pennsylvania. The contract runs until 2007 and has take-or-pay provisions totaling $30,838 for the remaining term. Annual minimum commitments are $2,517, which can be adjusted for inflation. Washington Steel Corporation has contracts for the supply of nickel. The contracts include minimum quantities and market-based pricing. Based on year-end 1994 market conditions, the value of these contracts totaled $83,981.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Stockholders and Board of Directors, Lukens Inc.:\nWe have audited the accompanying consolidated balance sheets of Lukens Inc. (a Delaware Corporation) and subsidiaries as of December 31, 1994 and December 25, 1993 and the related consolidated statements of earnings, cash flows and stockholders' investment for each of the three fiscal years in the period ended December 31, 1994. 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 Lukens Inc. and subsidiaries as of December 31, 1994 and December 25, 1993, and the consolidated results of their operations and their cash flows for each of the three fiscal years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 1 to the consolidated financial statements, effective December 27, 1992, the Company changed its methods of accounting for postretirement benefits other than pensions and income taxes.\n\/s\/ Arthur Andersen LLP\nArthur Andersen LLP, Philadelphia, Pennsylvania January 23, 1995\nLukens Inc. - Financial Information Dollars in thousands except per share amounts and market prices of common stock\nQuarterly Financial Data (Unaudited)\n- ------------- a. Earnings per share calculations were based on the weighted-average shares and equivalents outstanding during the period reported. No adjustments were made that would be antidilutive or reduce the loss per share. Consequently, the sum of the quarterly earnings per share amounts may not equal the annual per share amounts. b. In the first quarter of 1994, production disruptions and maintenance costs associated with severe weather conditions resulted in a net loss. c. During the fourth quarter of 1993, $10,626 of expenses from a work force reduction program were recognized. On an after-tax basis, the provision was $6,247, or $.43 per common share. Also during the fourth quarter, a $4,500 provision was recognized to revise estimates of the realizable value of discontinued operations. On an after-tax basis, the provision was $2,772, or $.19 per common share.\nLukens Inc. - Financial Information\nResponsibilities for Financial Reporting To Our Stockholders:\nLukens has prepared and is responsible for the following financial statements. The financial statements were prepared in conformity with generally accepted accounting principles in the United States. Other financial information in this Annual Report is consistent with the financial statements.\nManagement maintains a system of internal accounting control that is designed to provide reasonable, but not absolute, assurance that we are meeting our responsibility for the integrity and objectivity of the financial statements. This control system includes:\n. subsidiary reporting, including budget analysis, that provides reasonable assurance that errors or irregularities that could be material to the consolidated financial statements would be detected promptly\n. a statement of Corporate Integrity Guidelines monitored regularly\n. an Internal Audit Department\n. continuing review and evaluation of the control environment.\nThe audit report of Arthur Andersen LLP, independent public accountants, is included in Part II, Item 8 of this Form 10-K.\nThe Board of Directors pursues its oversight role for these financial statements through its Audit Committee, composed solely of directors who are neither officers nor employees of Lukens. The Audit Committee meets periodically with the independent public accountants and internal auditors, with and without the presence of management, to review their activities and to discuss internal accounting control, auditing, and financial reporting matters.\n\/s\/ R. W. Van Sant\nR. W. Van Sant Chairman and Chief Executive Officer\n\/s\/ C. B. Houghton, Jr.\nC. B. Houghton, Jr. Vice President and Controller\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.\na. Directors\nThe information contained in the section entitled \"Election of Directors\" in the Lukens Inc. 1995 Proxy Statement is incorporated herein by reference in response to this item.\nb. Executive Officers of the Registrant\nInformation required by this item is contained in Part I of this Form 10-K in the section entitled \"Executive Officers of the Registrant.\"\nc. Compliance With Section 16(a)\nInformation contained in the section entitled \"Section 16 Compliance\" in the Lukens Inc. 1995 Proxy Statement is incorporated herein by reference in response to this item.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information contained in the sections entitled \"Management\" and \"Report of Executive Development and Compensation Committee\" in the Lukens Inc. 1995 Proxy Statement 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 contained in the sections entitled \"Principal Holders of Stock\" and \"Management\" in the Lukens Inc. 1995 Proxy Statement is incorporated herein by reference in response to this item.\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.\na. Documents filed as a part of this report.\n1. Financial Statements\nNo financial statements have been filed with this Form 10-K other than those included in Item 8.\n2. Financial Statement Schedules\nII Valuation and Qualifying Accounts\nSchedules, other than Schedule II, have been omitted because they are not applicable.\n3. Exhibits\nSee Index to Exhibits.\nb. Reports on Form 8-K.\nNo reports on Form 8-K were filed during the fourth quarter of 1994 that ended on December 31, 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.\nLUKENS INC. (Registrant)\nDate: March 2, 1995 By \/s\/ R. W. Van Sant ----------------------- R. W. Van Sant Chairman and Chief Executive Officer\nSIGNATURES (continued)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below, as of March 2, 1995, by the following persons on behalf of the registrant and in the capacities indicated.\nSignature and Title\n\/s\/ Michael O. Alexander \/s\/ Stuart J. Northrop ------------------------ ---------------------- Michael O. Alexander Stuart J. Northrop Director Director\n\/s\/ T. Kevin Dunnigan \/s\/ Robert L. Seaman --------------------- -------------------- T. Kevin Dunnigan Robert L. Seaman Director Director\n\/s\/ Ronald M. Gross \/s\/ Joab L. Thomas ------------------- ------------------ Ronald M. Gross Joab L. Thomas Director Director\n\/s\/ Nancy Huston Hansen \/s\/ W. Paul Tippett ----------------------- ------------------- Nancy Huston Hansen W. Paul Tippett Director Director\n\/s\/ Sandra L. Helton \/s\/ R. W. Van Sant -------------------- ------------------ Sandra L. Helton R. W. Van Sant Director Chairman and Chief Executive Officer\n\/s\/ William H. Nelson, III \/s\/ C. B. Houghton, Jr. -------------------------- ----------------------- William H. Nelson, III C. B. Houghton, Jr. Director Vice President and Controller\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nWe have audited, in accordance with generally accepted auditing standards, the consolidated financial statements included in the Lukens Inc. 1994 Annual Report to stockholders, included or incorporated by reference in this Form 10-K, and have issued our report thereon dated January 23, 1995. Our report on the financial statements includes an explanatory paragraph with respect to the change in the method of accounting for income taxes in 1993 as discussed in Note 1 to the financial statements. Our audits were made for the purpose of forming an opinion on those statements taken as a whole. The financial statement schedule referred to in Item 14 is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. The financial statement schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states 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 LLP\nArthur Andersen LLP Philadelphia, Pennsylvania January 23, 1995\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation of our reports dated January 23, 1995 included or incorporated by reference in this annual report on Form 10-K, into the Company's previously filed: Form S-8 Registration Statements File Numbers 33-6673, 33-23405, 33-29105, 33-54269, 33- 54271, 33-54371 and 33-69780, and Form S-3 Registration Statements File Numbers 33-6792 and 33-53681.\n\/s\/ Arthur Andersen LLP\nArthur Andersen LLP Philadelphia, Pennsylvania March 24, 1995\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS (Dollars in Thousands)\nAllowance for Doubtful Receivables and Customer Claims\n(a) Balance assumed in the Washington Steel Corporation acquisition. (b) Amounts determined not to be collectible, net of recoveries. In 1994, amount also includes a reduction in the reserve of $1,159 from the divestiture of subsidiaries.\nDeferred Income Tax Asset Valuation Allowance\n(a) Included in cumulative effect of accounting changes from the adoption of SFAS No. 109.\nINDEX TO EXHIBITS (Note 1)\n( 3) Certificate of incorporation and by-laws (Note 2)\n( 4) Lukens Inc. Indenture dated as of July 1, 1992 (Note 3)\n(10) Material Contracts\n(10.1) Lukens Inc. Supplemental Retirement Plan for Target Incentive Plan Participants, as amended, effective January 1, 1988 (Note 6)\n(10.2) Lukens Inc. Supplemental Retirement Plan, as amended and restated, effective January 1, 1990 (Note 8)\n(10.3) Lukens Inc. Supplemental Retirement Plan for Designated Executives, effective January 1, 1990 (Note 7)\n(10.4) Lukens Inc. 1985 Stock Option and Appreciation Plan, as amended (Note 4)\n(10.5) Lukens Inc. Stock Option Plan for Non-employee Directors (Note 4)\n(10.6) Employment Agreement dated October 12, 1991, between R. William Van Sant and Lukens Inc. (Note 6)\n(10.7) Severance Agreement dated October 12, 1991, between R. William Van Sant and Lukens Inc. (Note 6)\n(10.8) Lukens Inc. Severance Plan for Participants in the Lukens Inc. 1983 Target Incentive Plan and the Lukens Inc. 1985 Division Incentive Compensation Plan (Note 6)\n(10.9) Form of Severance Agreement between certain Executive Officers and Lukens Inc. (Note 7)\n(10.10) Form of Indemnification Agreement between certain Executive Officers and Lukens Inc. (Note 8)\n(10.11) Lukens Inc. 1983 Target Incentive Compensation Plan, as amended through January 1, 1993 (Note 5)\n(10.12) Washington Steel Corporation 1994 Target Incentive Compensation Plan\n(10.13) Lukens Inc. Directors' Deferred Payment Plan (Note 9)\n(10.14) Guaranty Agreement dated as of June 28, 1989, between Lukens Inc. and The\nToronto-Dominion Bank & Trust Company as Agent for the Guaranteed Parties (Note 8)\n(10.15) Retirement Plan for Non-Employee Directors of Lukens Inc., as amended through November 30, 1994.\n(10.16) Form of Indemnification Agreement between Directors and Lukens Inc. (Note 8)\n(10.17) Amended and Restated Credit Agreement, dated as of April 22, 1992, and Amended and Restated as of September 30, 1992 among Lukens Inc. and Lukens Steel Company, as the Borrowers, Certain Commercial Lending Institutions, the Toronto-Dominion Bank, and NBD Bank, N.A., as the Co-Agents, and Provident National Bank, as the Administrative Agent (Note 5)\n(10.18) First Amendment, dated as of January 15, 1995, to Amended and Restated Credit Agreement\n(10.19) Allied Corporation - Washington Steel Corporation Equipment Lease and Maintenance Agreement, dated September 22, 1986 (Note 5)\n(10.20) Lease among PNC Leasing Corp., Blount, Inc., and Washington Steel Corporation, dated as of October 1, 1986 (Note 5)\n(10.21) Lease Amendment No. 1, dated July 22, 1987, among PNC Leasing Corp., Blount, Inc. and Washington Steel Corporation (Note 5)\n(10.22) Lease Amendment No. 2, Assumption and Consent among PNC Leasing Corp., Blount, Inc. and Washington Steel Corporation, dated as of October 18, 1988 (Note 5)\n(10.23) Lease Amendment No. 3, Assumption and Consent among PNC Leasing Corp., Lukens Inc. and Washington Steel Corporation, dated as of July 21, 1992 (Note 5)\n(10.24) Agreement, dated October 31, 1989, between Robert E. Heaton and Washington Steel Corp. (Note 5)\n(10.25) Washington Steel Division Annual Bonus Plan for Elected Officers (Note 5)\n(10.26) Agreement between James J. Norton and Mercury Stainless Corp., Mercury Stainless, Inc., Mercury Stainless Canada Inc., Washington Steel Corp. and Kramo Corp., dated October 31, 1989 (Note 5)\n(10.27) Amended and Restated Employment Contract between James J. Norton and Mercury Stainless Corp., Mercury Stainless, Inc., Kramo Corp. and Washington Steel Corp., dated as of October 9, 1990 (Note 5)\n(10.28) First Amendment to Amended and Restated Employment Contract between James J. Norton and Mercury Stainless Corp., Mercury Stainless, Inc., Kramo Corp. and Washington Steel Corp., dated as of January 3, 1991 (Note 5)\n(10.29) Second Amendment to Amended and Restated Employment Contract between James J. Norton and Mercury Stainless Corp., Mercury Stainless, Inc., Kramo Corp. and Washington Steel Corp., dated as of July 3, 1991 (Note 5)\n(11) Statement regarding Computation of Per Share Earnings\n(21) Subsidiaries of the Registrant\n(23) Consent of Arthur Andersen LLP (Note 10)\n(27) Financial Data Schedule\nNotes to Exhibits\n1. Copies of exhibits will be supplied upon request. There is no charge for a copy of the Lukens Inc. 1994 Annual Report to stockholders. Other exhibits will be provided at $.25 per page requested.\n2. Certificate of incorporation is incorporated by reference to exhibits included in the Lukens Inc. Post-Effective Amendment No. 1 to the Registration Statement on Form S-8, File No. 33-23405. By-laws as amended and restated June 26, 1991, are incorporated by reference to exhibits included in the Lukens Inc. Form 10-Q for the quarter ended June 29, 1991.\n3. Incorporated by reference to exhibits included in the Lukens Inc. Registration Statement on Form S-3, File No. 33-49112.\n4. Incorporated by reference to exhibits included in the Lukens Inc. Form 10-K for the fiscal year ended December 25, 1993.\n5. Incorporated by reference to exhibits included in the Lukens Inc. Form 10-K for the fiscal year ended December 26, 1992.\n6. Incorporated by reference to exhibits included in the Lukens Inc. Form 10-K for the fiscal year ended December 28, 1991.\n7. Incorporated by reference to exhibits included in the Lukens Inc. Form 10-K for the fiscal year ended December 29, 1990.\n8. Incorporated by reference to exhibits included in the Lukens Inc. Form 10-K for the fiscal year ended December 30, 1989.\n9. Incorporated by reference to exhibits included in the Lukens Inc. Registration Statement on Form S-4, File No. 33-10935.\n10. Incorporated by reference to the section entitled \"Consent of Independent Public Accountants\" in this Form 10-K.","section_15":""}
{"filename":"73124_1994.txt","cik":"73124","year":"1994","section_1":"ITEM 1 - BUSINESS\nNORTHERN TRUST CORPORATION\nNorthern Trust Corporation (Corporation) is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended. The Corporation was organized in Delaware in 1971 and on December 1 of that year became the owner of all of the outstanding capital stock, except directors' qualifying shares, of The Northern Trust Company (Bank), an Illinois banking corporation located in the Chicago financial district. The Corporation also owns three other banks in the Chicago metropolitan area, a bank in each of Florida, Arizona, California and Texas, and various other nonbank subsidiaries, including a securities brokerage firm and a futures commission merchant. The Corporation expects that although the operations of other subsidiaries will be of increasing significance, the Bank will in the foreseeable future continue to be the major source of the Corporation's assets, revenues and net income. Except where the context otherwise requires, the term \"Northern Trust\" refers to Northern Trust Corporation and its consolidated subsidiaries.\nAt December 31, 1994, Northern Trust had consolidated total assets of approximately $18.6 billion and stockholders' equity of $1.3 billion. At June 30, 1994 Northern Trust was the third largest bank holding company headquartered in Illinois and the 37th largest in the United States, based on consolidated total assets of approximately $18.4 billion on that date.\nTHE NORTHERN TRUST COMPANY\nThe Bank was founded by Byron L. Smith in 1889 to provide banking and trust services to the public. Currently in its one hundred and sixth year, the Bank's growth has come from internal sources rather than through merger or acquisition. At December 31, 1994, the Bank had consolidated assets of approximately $14.7 billion. At June 30, 1994, the Bank was the third largest bank in Illinois and the 38th largest in the United States, based on consolidated total assets of approximately $14.9 billion on that date.\nThe Bank currently has six active wholly owned subsidiaries: The Northern Trust International Banking Corporation, NorLease, Inc., MFC Company, Inc., Nortrust Nominees Ltd., The Northern Trust Company U.K. Pension Plan Limited and The Northern Trust Company, Canada. The Northern Trust International Banking Corporation, located in New York, was organized under the Edge Act for the purpose of conducting international business. NorLease, Inc. was established by the Bank to enable it to broaden its leasing and leasing-related lending activities. MFC Company, Inc. holds properties that are received from the Bank in connection with certain problem loans. Nortrust Nominees Ltd., located in London, is a U.K. trust corporation organized to hold U.K. real estate for fiduciary accounts. The Northern Trust Company U.K. Pension Plan Limited was established in connection with the pension plan for the Bank's London branch. The Northern Trust Company, Canada was established to offer institutional trust products and services to Canadian entities.\nIn early 1995, Northern Global Financial Services Ltd. was incorporated in Hong Kong and, upon receipt of regulatory approval will enhance securities lending and relationship servicing capabilities for large asset custody clients in Asia and the Pacific Rim.\nOTHER NORTHERN TRUST CORPORATION SUBSIDIARIES\nThe Corporation has three banking subsidiaries in the Chicago metropolitan area: Northern Trust Bank\/O'Hare N.A., Northern Trust Bank\/DuPage, and Northern Trust Bank\/Lake Forest N.A. At December 31, 1994, these three Illinois banking subsidiaries had nine office locations with combined total assets of approximately $1.5 billion. The Corporation expects to seek regulatory approval to merge these three Illinois banking subsidiaries into the Bank during 1995. The Corporation's Florida banking subsidiary, Northern Trust Bank of Florida N.A., is headquartered in Miami and at December 31, 1994, had sixteen offices located throughout Florida, with total assets of approximately $1.4 billion. The Corporation's Arizona banking subsidiary, Northern Trust Bank of Arizona N.A., is headquartered in Phoenix and at December 31,1994 had total assets of approximately $270 million and serviced clients from five office locations. The Corporation has a Texas banking subsidiary, Northern Trust Bank of Texas N.A., headquartered in Dallas. It had four office locations and total assets of approximately $190 million at December 31, 1994. The Corporation's California banking subsidiary, Northern Trust Bank of California N.A., is headquartered in Santa Barbara. At December 31,1994, it had six office locations and total assets of approximately $250 million.\nThe Corporation has several nonbank subsidiaries. Among them are Northern Trust Securities, Inc. which provides full brokerage services to clients of the Bank and the Corporation's other banking and trust subsidiaries and selectively underwrites general obligation tax-exempt securities. Northern Futures Corporation is a futures commission merchant. Northern Investment Corporation holds certain investments, including a loan made to a developer of a property in which the Bank is the principal tenant. Berry, Hartell, Evers & Osborne, Inc. is an investment management firm in San Francisco. The Northern Trust Company of New York provides security clearance services for all nondepository eligible securities held by\n================================================================================\n================================================================================ trust, agency, and fiduciary accounts administered by the Corporation's subsidiaries. Northern Trust Cayman International, Ltd. provides fiduciary services to clients residing outside of the U.S. Hazlehurst & Associates, Inc. is a retirement benefit plan services company in Atlanta, Georgia. Northern Trust Services, Inc. provides management consulting services to nonaffiliated financial institutions.\nCORPORATION'S INTERNAL ORGANIZATION\nNorthern Trust's business is organized broadly into two principal business units: Corporate and Institutional Services, and Personal Financial Services, both of which report to President and Chief Operating Officer William A. Osborn. In addition, the Worldwide Operations Unit encompasses all trust and banking operations and systems activities, and the Risk Management Unit focuses on financial and risk management. The following is a brief summary of each unit's business activities.\nCORPORATE AND INSTITUTIONAL SERVICES (CIS)\nDuring late 1994, client corporate and institutional markets were brought together by merging Corporate Financial Services, Commercial Banking and Treasury Management Services into a single business unit. The commercial banking and corporate trust relationship teams were brought together under Sheila A. Penrose, Executive Vice President of the Corporation and the Bank. This realignment focuses Northern Trust's knowledge of the client's needs and provides more seamless service across product lines, thereby increasing client satisfaction opportunities, and strengthens relationships.\nTrust activities encompass custody related services for securities in the United States and foreign markets, as well as securities lending, asset management, and related cash management services. Master Trust and Master Custody are the principal products. Custody of securities traded in markets foreign to the client, has been provided primarily through the Bank's London Branch. Related foreign exchange services are also conducted at the London Branch as well as in Chicago.\nAs measured by number of clients, Northern Trust is a leading provider of Master Trust and Master Custody services in various market segments. At December 31,1994, total assets under administration were $447.2 billion. The major market segments served are corporate pension, profit sharing and savings plans; state and municipal retirement funds; taxable asset portfolios (foundations, endowments and insurance companies); international asset portfolios (international assets of domestic and foreign institutions); and a correspondent trust market segment which provides custody, systems and investment services to smaller bank trust departments. The Northern Trust Company of New York, The Northern Trust Company, Canada, NorLease, Inc., The Northern Trust International Banking Corporation and Hazlehurst & Associates, Inc. are also included in CIS.\nA full range of commercial banking services through the Bank which places special emphasis on developing institutional relationships in three target markets: middle market companies in the Chicago and Midwest area, large domestic corporations, and financial institutions (both domestic and international). Credit services are administered in three groups: a Large Corporations Group, a Mid-sized Corporations Group, and a Financial Institutions Group.\nTreasury Management Services serves the treasury needs of major corporations and financial institutions by providing products and services to accelerate cash collections, control disbursement outflows, and generate information to manage their cash positions. Treasury management products and services, including lockbox collection, controlled disbursement products and electronic banking, are developed and marketed in this group.\nPERSONAL FINANCIAL SERVICES (PFS)\nServices to individuals is another major dimension of the trust business. Barry G. Hastings, Vice Chairman of the Corporation and the Bank, is head of Personal Financial Services (PFS) which encompasses personal trust, investment management services, estate administration, personal banking and mortgage lending. A key element of the personal trust strategy combines private banking and trust services to targeted high net worth individuals in rapidly growing areas of wealth concentration. These services are delivered through the Bank and a network of banking subsidiaries located in Florida, Arizona, California, Texas and suburban Chicago. PFS is one of the largest bank managers of personal trust assets in the United States, with total assets under administration of $51.4 billion at December 31, 1994.\nNorthern Trust Securities, Inc. and Berry, Hartell, Evers & Osborne, Inc. are also part of PFS.\nIn December 1993, Northern Trust Corporation entered into a definitive agreement to acquire Beach One Financial Services, Inc., parent company of The Beach Bank of Vero Beach (Florida). Beach One's assets totaled $198.6 million at December 31, 1994 and net income totaled $2.9 million in 1994. The acquisition agreement calls for Beach One shareholders to receive Northern Trust Corporation Common Stock aggregating $56.2 million with the exchange ratio set on the basis of the average last-sale prices for Northern Common Stock on the NASDAQ National Market System over a 20-day trading period ending just prior to closing. The maximum number of shares Northern is required to issue without further approval of\n================================================================================\n================================================================================ directors is 1,701,515, equivalent to a formula price of $33 per share. The minimum number of shares Beach One holders are required to accept is 1,169,791, equivalent to a formula price of $48 per share. The acquisition was approved by Beach One shareholders on February 23, 1995 and by the Federal Reserve Bank on March 1, 1995, and, is expected to close on March 31, 1995. This transaction is expected to be accounted for as a pooling-of-interests.\nIn February, 1995, the Corporation entered into a definitive agreement to acquire Tanglewood Bancshares, Inc., parent company of Tanglewood Bank N.A. Houston for $33.0 million in cash. Tanglewood's assets totaled $229.9 million at December 31, 1994 and net income totaled $2.6 million in 1994. The agreement is subject to the approval of Tanglewood shareholders, to final due diligence and to various regulatory approvals and is expected to close in the second half of 1995.\nWORLDWIDE OPERATIONS UNIT\nSupporting all of Northern Trust's business activities is the Worldwide Operations Unit. During the fourth quarter of 1994 Trust and Banking operations and system activities were merged to insure that both day-to-day and strategic linkage between the new operations unit and all the areas it supports are maintained and strengthened. This combined unit will leverage experience in quality and productivity improvements, develop a shared technology strategy, and draw on a large pool of talent to address product and delivery complexities.\nJames J. Mitchell, Executive Vice President of the Corporation and the Bank, heads the Worldwide Operations Unit. This Unit focuses on supporting sales, relationship management and product management activities for Corporate and Institutional Services and Personal Financial Services.\nRISK MANAGEMENT UNIT\nThe Risk Management Unit, headed by Senior Executive Vice President and Chief Financial Officer Perry R. Pero, includes the Credit Policy function and the Bank's Treasury Department. The Credit Policy function is described fully on page 16 of this report. The Treasury Department is responsible for managing the Bank's wholesale funding and interest rate risk, as well as the portfolio of interest rate risk management instruments under the direction of the Corporate Asset and Liability Policy Committee. It is also responsible for the investment portfolios of the Corporation and the Bank and provides investment advice and management services to the subsidiary banks.\nThe Risk Management Unit also includes the Corporate Controller, Corporate Treasurer, Investor Relations and Economic Research functions.\nGOVERNMENT POLICIES\nThe earnings of Northern Trust are affected by numerous external influences, principally general economic conditions, both domestic and international, and actions that the United States and foreign governments and their central banks take in managing their economies. These general conditions affect all of the Northern Trust's businesses, as well as the quality and volume of the loan and investment portfolios.\nAn important regulator of domestic economic conditions is the Board of Governors of the Federal Reserve System, which has the general objective of promoting orderly economic growth in the United States. Implementation of this objective is accomplished by its open market operations in United States Government securities, the discount rate at which member banks may borrow from Federal Reserve Banks and changes in the reserve requirements for deposits. The policies adopted by the Federal Reserve may strongly influence interest rates and hence what banks earn on their loans and investments and what they pay on their savings and time deposits and other purchased funds. Fiscal policies in the United States and abroad also affect the composition and use of the Northern Trust's resources.\nCOMPETITION\nNorthern Trust's principal business strategy is to provide quality financial services to targeted market segments in which it believes it has a competitive advantage and favorable growth prospects. As part of this strategy, Northern Trust seeks to deliver a level of service to its clients that distinguishes it from its competitors. In addition, Northern Trust emphasizes the development and growth of recurring sources of fee-based income and is one of only six major bank holding companies in the United States that generates more revenues from fee-based services than from net interest income. Northern Trust seeks to develop and expand its recurring fee-based revenue by identifying selected market niches and providing a high level of individualized service to its clients in such markets. Northern Trust also seeks to preserve its asset quality through established credit review procedures and to maintain a conservative balance sheet. Finally, Northern Trust seeks to maintain a strong management team with senior officers having broad experience and long tenure.\nActive competition exists in all principal areas in which the subsidiaries are presently engaged. CIS and PFS compete with domestic and foreign financial institutions, trust companies, financial companies, personal loan companies, mutual funds and investment advisers. Northern Trust is a leading provider of Master Trust and Master Custody services and has the leading market share in the Chicago area personal trust market.\n================================================================================\n================================================================================ Commercial Banking and Treasury Management Services compete with domestic and foreign financial institutions, finance companies and leasing companies. Its products also face increased competition due to the general trend among corporations and other institutions to rely more upon direct access to the credit and capital markets (such as through the direct issuance of commercial paper) and less upon commercial banks and other traditional financial intermediaries.\nThe chief local competitors of the Bank for trust and banking business are Bank of America Illinois N.A., The First National Bank of Chicago and its affiliate American National Bank and Trust Company of Chicago, Harris Trust and Savings Bank, and LaSalle National Bank. The chief national competitors of the Bank for Master Trust\/Master Custody services are Mellon Bank Corporation, State Street Boston Corporation, Bankers Trust New York Corporation, Chase Manhattan Corporation and Bank of New York Company, Inc.\nREGULATION AND SUPERVISION\nThe Corporation is a bank holding company subject to the Bank Holding Company Act of 1956, as amended (Act), and to regulation by the Board of Governors of the Federal Reserve System. The Act limits the activities which may be engaged in by the Corporation and its nonbanking subsidiaries to those so closely related to banking or managing or controlling banks as to be a proper incident thereto. Also, under section 106 of the 1970 amendments to the Act and the Federal Reserve Board's regulations, a bank holding company, as well as certain of its subsidiaries, is prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or provision of any property or services.\nThe Act also prohibits bank holding companies from acquiring substantially all the assets of or owning more than 5% of the voting shares of any bank or nonbanking company which is not already majority owned without prior approval of the Board of Governors. No application to acquire shares or assets of a bank located outside the state in which the operations of a bank holding company's banking subsidiaries are principally conducted may be approved by the Federal Reserve Board unless such acquisition is specifically authorized by a statute of the state in which the bank to be acquired is located.\nIllinois law permits bank holding companies located in any state of the United States to acquire banks or bank holding companies located in Illinois subject to regulatory determinations that the laws of the other state permit Illinois bank holding companies to acquire banks and bank holding companies within that state on qualifications and conditions not unduly restrictive compared to those imposed by Illinois law. Subject to these regulatory determinations, the Corporation may acquire banks and bank holding companies in such states, and bank holding companies in those states may acquire banks and bank holding companies in Illinois.\nApplicable laws also permit the Corporation to acquire banks or bank holding companies in Arizona, California, Texas, Florida and certain other states.\nIllinois law permits an Illinois bank holding company to acquire banks anywhere in the state. Illinois legislation also now allows Illinois banks to open branches anywhere within Illinois.\nBeginning September 29, 1995 the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Interstate Act) permits an adequately capitalized and adequately managed bank holding company to acquire, with Federal Reserve Board approval, a bank located in a state other than the bank company's home state, without regard to whether the transaction is permitted under any state law, except that a host state may establish by statute the minimum age of its banks (up to a maximum of 5 years) subject to acquisition by out-of-state bank holding companies. The Federal Reserve Board may not approve the acquisition if the applicant bank holding company, upon consummation, would control more than 10% of total U.S. insured depository institution deposits or more than 30% of the host state's total insured depository institutions deposits. Effective as of September 29, 1994, the Interstate Act permits a bank, with the approval of the appropriate Federal bank regulatory agency, to establish a de novo branch in a state, other than the bank's home state, in which the bank does not presently maintain a branch if the host state has enacted a law that applies equally to all banks and expressly permits all out-of-state banks to branch de novo into the host state. Commencing June 1, 1997, banks having different home states may, with approval of the appropriate Federal bank regulatory agency, merge across state lines, unless the home state of a participating bank has opted-out. The Interstate Act permits as of September 29, 1995 any bank subsidiary of a bank holding company to receive deposits, renew time deposits, close loans, service loans and receive payments on loans and other obligations as agent for a bank or thrift affiliate, whether such affiliate is located in a different state or in the same state.\nThe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (FIRREA) amended the Act to authorize the Federal Reserve Board to allow bank holding companies to acquire any savings association (whether healthy, failed or failing) and removed \"tandem operations\" restrictions, which previously prohibited savings associations from being operated in tandem with a bank holding company's other subsidiaries. As a result, bank holding companies now have expanded opportunities to acquire savings associations.\nUnder FIRREA, an insured depository institution which is commonly controlled with another insured depository institution shall generally be liable for any loss incurred, or reasonably anticipated to be incurred, by the Federal Deposit Insurance Corporation (FDIC) in connection with the default of such commonly controlled institution, or for any assistance\n================================================================================\n================================================================================ provided by the FDIC to such commonly controlled institution, which is in danger of default. The term \"default\" is defined to mean the appointment of a conservator or receiver for such institution. Thus, any of the Corporation's banking subsidiaries could incur liability to the FDIC pursuant to this statutory provision in the event of a loss suffered by the FDIC in connection with any of the Corporation's other banking subsidiaries (whether due to a default or the provision of FDIC assistance). Although neither the Corporation nor any of its nonbanking subsidiaries may be assessed for such loss under FIRREA, the Corporation has agreed to indemnify each of its banking subsidiaries, other than the Bank, for any payments a banking subsidiary may be liable to pay to the FDIC pursuant to the provisions of FIRREA.\nThe Bank is a member of the Federal Reserve System, its deposits are insured by the FDIC and it is subject to regulation by both these entities, as well as by the Illinois Commissioner of Banks and Trust Companies. The Bank is also a member of and subject to the rules of the Chicago Clearinghouse Association, and is registered as a government securities dealer in accordance with the Government Securities Act of 1986. As a government securities dealer its activities are subject to the rules and regulations of the Department of the Treasury. The Bank is registered as a transfer agent with the Federal Reserve and is therefore subject to the rules and regulations of the Federal Reserve.\nThe national bank subsidiaries are members of the Federal Reserve System and the FDIC and are subject to regulation by the Comptroller of the Currency. Northern Trust Bank\/DuPage, a state chartered institution that is not a member of the Federal Reserve System, is regulated by the FDIC and the Illinois Commissioner of Banks and Trust Companies.\nThe Corporation's nonbanking affiliates are all subject to examination by the Federal Reserve. In addition, The Northern Trust Company of New York is subject to regulation by the Banking Department of the State of New York. Northern Futures Corporation is registered as a futures commission merchant with the Commodity Futures Trading Commission, is a member of the National Futures Association, the Chicago Board of Trade and the Board of Trade Clearing Corporation, and is a clearing member of the Chicago Mercantile Exchange. Northern Trust Securities, Inc. is registered with the Securities and Exchange Commission and is a member of the National Association of Securities Dealers, Inc., and, as such, is subject to the rules and regulations of both these bodies. Berry, Hartell, Evers & Osborne, Inc. is registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940 and is subject to that Act and the rules and regulations of the Commission promulgated thereunder. Two families of mutual funds for which the Bank acts as investment adviser are also subject to regulation by the Securities and Exchange Commission under the Investment Company Act. Various other subsidiaries and branches conduct business in other states and foreign countries and, therefore, may be subject to their regulations and restrictions.\nThe Corporation and its subsidiaries are affiliates within the meaning of the Federal Reserve Act so that the banking subsidiaries are subject to certain restrictions with respect to loans to the Corporation or its nonbanking subsidiaries and certain other transactions with them or involving their securities.\nInformation regarding dividend restrictions on banking subsidiaries is incorporated herein by reference to Note 12 titled Restrictions on Subsidiary Dividends and Loans or Advances on page 59 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994.\nUnder the FDIC's risk-based insurance assessment system, each insured bank is placed in one of nine risk categories based on its level of capital and other relevant information. Each insured bank's insurance assessment rate is then determined by the risk category in which it has been classified by the FDIC. There is an eight basis point spread between the highest and lowest assessment rates, so that banks classified as strongest by the FDIC are subject to a rate of .23%, and banks classified as weakest by the FDIC are subject to a rate of .31%. The FDIC is prohibited from lowering the average assessment rate below .23% until the Bank Insurance Fund (Fund) has reached a reserve ratio of 1.25%. The FDIC currently estimates the Fund will achieve the designated reserve ratio in 1995 and has proposed significant reductions in assessment rates.\nThe Federal Deposit Insurance Corporation Improvement Act of 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. In general, FDICIA subjects banks to significantly increased regulation and supervision. 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, and imposes certain restrictions upon banks which meet minimum capital requirements but are not \"well capitalized\" for purposes of FDICIA. FDICIA and the regulations adopted under it establish five capital categories as follows, with the category for any institution determined by the lowest of any of these ratios:\n================================================================================\n================================================================================ Tier 1 Tier 1 Total Leverage Ratio Risk-Based Ratio Risk-Based Ratio -------------- ---------------- ---------------- Well Capitalized 5% or above 6% or above 10% or above\nAdequately Capitalized 4% or above* 4% or above 8% or above\nUndercapitalized Less than 4% Less than 4% Less than 8%\nSignificantly Undercapitalized Less than 3% Less than 3% Less than 6%\nCritically Undercapitalized - - 2% or below\n*3% for banks with the highest CAMEL (supervisory) rating.\nAn insured depository institution may be deemed to be in a capital category that is lower than is indicated by the capital position reflected on its balance sheet if it receives an unsatisfactory rating by its examiners with respect to its assets, management, earnings or liquidity. Although a bank's capital categorization thus depends upon factors in addition to the balance sheet ratios in the table above, the Corporation has set capital goals for each of its subsidiary banks that would allow each bank to meet the minimum ratios that are one of the conditions for it to be considered to be well capitalized. At December 31, 1994, the Bank and each of the other subsidiary banks met or exceeded these goals. The capital ratios are disclosed and discussed on page 44 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994.\nUnder FDICIA, a bank that is not well capitalized is generally prohibited from accepting or renewing brokered deposits and offering interest rates on deposits significantly higher than the prevailing rate in its normal market area or nationally (depending upon where the deposits are solicited); in addition, \"pass through\" insurance coverage may not be available for certain employee benefit accounts.\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 banks are subject to limitations on growth and are required to submit a capital restoration plan, which must be guaranteed by the institution's parent company. Institutions that fail to submit an acceptable plan, or that are significantly undercapitalized, are subject to a host of more drastic regulatory restrictions and measures.\nFDICIA directs that each federal banking agency prescribe standards for depository institutions or depository institutions' holding companies relating to internal 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 and other standards as they deem appropriate. Many regulations implementing these directives have been proposed and adopted by the agencies.\nFDICIA also contains a variety of other provisions that may affect the operations of a bank, including new reporting requirements, regulatory standards for real estate lending, \"truth in savings\" provisions and a requirement that a depository institution give 90 days' prior notice to customers and regulatory authorities before closing any branch.\nSTAFF\nNorthern Trust employed 6,608 full-time equivalent officers and staff members as of December 31, 1994, approximately 4,800 of whom were employed by the Bank.\n================================================================================\n================================================================================\nSTATISTICAL DISCLOSURES\nThe following statistical disclosures, included in the Corporation's Annual Report to Stockholders for the year ended December 31, 1994, are incorporated herein by reference.\nANNUAL REPORT SCHEDULE PAGE(S) ___________________________________________________ _____________ Foreign Outstandings.............................. ......... 37\nNonperforming Assets and 90 Day Past Due Loans.... ......... 37\nAnalysis of Reserve for Credit Losses............. ......... 38\nAverage Balance Sheet............................. ......... 72\nRatios............................................ ......... 72\nAnalysis of Net Interest Income................... .... 74 & 75 ___________________________________________________ _____________ Additional statistical information on a consolidated basis is set forth below.\nREMAINING MATURITY AND AVERAGE YIELD OF SECURITIES HELD TO MATURITY AND AVAILABLE FOR SALE (Yield on a taxable equivalent basis giving effect of the federal and state tax rates)\n================================================================================\n*Prior to 1994, securities shown as Available for Sale were classified as Held for Sale and carried at the lower of cost or fair value.\n================================================================================\n================================================================================\n===============================================================================\nAVERAGE DEPOSITS BY TYPE\nAVERAGE RATES PAID ON TIME DEPOSITS BY TYPE\nREMAINING MATURITY OF TIME DEPOSITS $100,000 AND MORE\n================================================================================\n================================================================================\n================================================================================\nPERCENT OF INTERNATIONAL RELATED AVERAGE ASSETS AND LIABILITIES TO TOTAL CONSOLIDATED AVERAGE ASSETS\nRESERVE FOR CREDIT LOSSES RELATING TO INTERNATIONAL OPERATIONS\nThe Securities and Exchange Commission requires the disclosure of the reserve for credit losses that is applicable to international operations. The above table has been prepared in compliance with this disclosure requirement and is used in determining international operating performance. In 1990 the remaining $13.1 million of the reserve designated for loans to less developed countries was transferred to the general unallocated portion of the reserve for credit losses. The amounts shown in the table should not be construed as being the only amounts that are available for international loan charge-offs, since the entire reserve for credit losses is available to absorb losses on both domestic and international loans. In addition, these amounts are not intended to be indicative of future charge-off trends. ================================================================================\nDISTRIBUTION OF INTERNATIONAL LOANS AND DEPOSITS BY TYPE\n================================================================================\n================================================================================\nCREDIT RISK MANAGEMENT\nOverview\nThe Credit Policy function reports to the Chief Financial Officer. Credit Policy provides a system of checks and balances for Northern Trust's diverse credit-related activities by establishing and monitoring all credit- related policies and practices and ensuring their uniform application. These activities are designed to ensure that credit exposure is diversified on an industry and client basis, thus lessening the overall credit risk.\nIndividual credit authority for commercial loans and within Personal Financial Services is limited to specified amounts and maturities. Credit decisions involving commitment exposure in excess of the specified individual limits are submitted to the appropriate Group Credit Approval Committee (Committee). Each Committee is chaired by the executive in charge of the area and has a Credit Policy officer as a voting participant. Each Committee's credit approval authority is specified, based on commitment levels, credit ratings and maturities. Credits involving commitment exposure in excess of these group credit limits require, dependent upon the internal credit rating, the approval of the Credit Policy Credit Approval Committee, the head of Credit Policy, or the business unit head.\nCredit Policy established the Counterparty Risk Management Committee in order to manage counterparty risk more effectively. This committee has sole credit authority for exposure to all foreign banks, certain domestic banks which Credit Policy deems to be counterparties and which do not have commercial credit relationships within the Corporation, and other organizations which Credit Policy deems to be counterparties.\nUnder the auspices of Credit Policy, country exposure limits are reviewed and approved on a country-by-country basis.\nAs part of the Corporation's ongoing credit granting process, internal credit ratings are assigned to each client and credit before credit is extended, based on creditworthiness. Credit Policy performs at least annually a review of selected significant credit exposures to identify at the earliest possible stages clients who might be facing financial difficulties. Internal credit ratings are also reviewed during this process. Above average risk loans, which will vary from time to time, receive special attention by both lending officers and Credit Policy. This approach allows management to take remedial action in an effort to deal with potential problems.\nAn integral part of the Credit Policy function is a monthly formal review of all past due and potential problem loans to determine which credits, if any, need to be placed on nonaccrual status or charged off. The provision is reviewed quarterly to determine the amount necessary to maintain an adequate reserve for credit losses.\nManagement of credit risk is reviewed by various bank regulatory agencies. Independent auditors also perform a review of credit-related procedures, the loan portfolio and other extensions of credit, and the reserve for credit losses as part of their audit of the consolidated financial statements.\nAllocation of the Reserve for Credit Losses\nThe reserve for credit losses is established and maintained on an overall basis and in practice is not specifically allocated to specific loans or segments of the portfolio. Thus, the reserve is available to absorb credit losses from all loans, leases and credit related exposures. Bank disclosure guidelines issued by the Securities and Exchange Commission request management to furnish a breakdown of the reserve for credit losses by loan category and provide the percentage of loans in each category to total loans.\nIn prior years, the allocation of the reserve represented an estimate of the amount that was necessary to provide for potential losses related to specific nonperforming loans only. Beginning in 1994, the methodology was revised to allocate the reserve for credit losses associated with all loans, leases and commitments based on historical loss experience, internal credit ratings and specific amounts designated for certain above average risk loans. This allocation method should not be interpreted as an indication of expected losses within the next year or any specified time period.\n================================================================================\n================================================================================\nAs required by the Securities and Exchange Commission, the following tables break down the reserve for credit losses at December 31, 1990 through 1994:\nReserve for Credit Losses\nReserve for Credit Losses\nLoan and lease categories as a percent of total loans and leases as of December 31, 1990 through 1994, are presented below.\nLoan and Lease Category to Total Loans and Leases\n================================================================================\n================================================================================\nThe information presented in the \"Credit Risk Management\" section should be read in conjunction with the following information that is incorporated herein by reference to the Corporation's Annual Report to Stockholders for the year ended December 31, 1994:\nAnnual Report Notes to Consolidated Financial Statements Page(s) ---------------------------------------------------------------- ------------- 1. Accounting Policies D. Interest Risk Management Instruments..................... ...........50 E. Loans and Leases......................................... ......50 & 51 F. Reserve for Credit Losses................................ ...........51 I. Other Real Estate Owned.................................. ...........51 4. Loans and Leases............................................ ...........54 5. Reserve for Credit Losses................................... ...........55 15. Contingent Liabilities...................................... ...........61 17. Off-Balance Sheet Financial Instruments..................... ........63-66 ---------------------------------------------------------------- Management's Discussion and Analysis of Financial Condition and Results of Operations ---------------------------------------------------------------- Asset Quality and Credit Risk................................... ........34-39 ---------------------------------------------------------------- -------------\nIn addition, the following schedules on page 15 of this Form 10-K should be read in conjunction with the \"Credit Risk Management\" section:\nReserve for Credit Losses Relating to International Operations\nDistribution of International Loans and Deposits by Type\n================================================================================\n================================================================================\nINTEREST RATE SENSITIVITY ANALYSIS\nFor the discussion of interest rate sensitivity, see the section entitled \"Asset and Liability Management\" on page 41 of Management's Discussion and Analysis of Financial Condition and Results of Operations of the Corporation's Annual Report to Stockholders, which is incorporated herein by reference.\n================================================================================\n================================================================================\nThe following unaudited Consolidated Balance Sheet and Consolidated Statement of Income for The Northern Trust Company were prepared in accordance with generally accepted accounting principles and are provided here for informational purposes. These consolidated financial statements should be read in conjunction with the footnotes accompanying the consolidated financial statements, included in the Corporation's Annual Report to Stockholders for the year ended December 31, 1994, and incorporated herein by reference on page 24 of this report.\nThe Northern Trust Company Consolidated Balance Sheet (unaudited)\n================================================================================\nTHE NORTHERN TRUST COMPANY CONSOLIDATED STATEMENT OF INCOME (unaudited)\nSUPPLEMENTAL ITEM--EXECUTIVE OFFICERS OF THE REGISTRANT\nDAVID W. FOX\nMr. Fox was elected Chairman of the Board of the Corporation and the Bank in April 1990, and Chief Executive Officer of the Corporation and the Bank on December 1989. He held the title of President of the Corporation and the Bank from 1987 through 1993. Mr. Fox, 63, joined the Bank in 1955.\nWILLIAM A. OSBORN\nMr. Osborn was elected President and Chief Operating Officer of the Corporation and the Bank effective January 1994. He was a Senior Executive Vice President of the Corporation and the Bank from 1992 through 1993 and prior to that time had served as an Executive Vice President of the Bank since 1987, and of the Corporation since 1989. Mr. Osborn, 47, began his career with the Bank in 1970.\nBARRY G. HASTINGS\nMr. Hastings was elected Vice Chairman of the Corporation and the Bank effective January 1994, and is currently head of Personal Financial Services. He was a Senior Executive Vice President of the Corporation and the Bank from 1992 through 1993 and prior to that time had served as an Executive Vice President of the Bank since 1987, and of the Corporation since 1990. Mr. Hastings, 47, began his career with the Corporation in 1974.\nJ. DAVID BROCK\nMr. Brock became an Executive Vice President of the Corporation and the Bank in April 1990. Currently, he is responsible for Institutional Financial Services in the Corporate and Institutional Services Business Unit. From 1990 to 1994, he was head of Corporate Management Services and the Commercial Banking Services Group. Mr. Brock, 50, joined the Bank in 1966.\nDAVID L. EDDY\nMr. Eddy became a Senior Vice President of the Corporation and the Bank and Treasurer of the Corporation in 1986. Mr. Eddy, 58, joined the Bank in 1960.\nJOHN V. N. McCLURE\nMr. McClure was appointed an Executive Vice President of the Corporation and the Bank in February 1994, and is currently responsible for strategic expense management. Previously, he was responsible for Strategic Planning and Marketing. He served as head of the Private Banking Division of Personal Financial Services from 1989 to 1991. He had been a Senior Vice President of the Bank since 1986 and of the Corporation since 1991. Mr. McClure, 43, joined the Bank in 1973.\nJAMES J. MITCHELL\nMr. Mitchell was appointed an Executive Vice President of the Bank in December 1987 and of the Corporation in October 1994, and is currently head of the Worldwide Operations Unit. Mr. Mitchell, 52, joined the Bank in 1964.\nSHEILA A. PENROSE\nMs. Penrose is an Executive Vice President of the Corporation and the Bank, and Head of the Corporate and Institutional Services Business Unit. She became an Executive Vice President of the Corporation in November 1994 and of the Bank in November 1993, and prior to that time had been Senior Vice President of the Bank since 1986. Ms. Penrose, 49, began her career with the Bank in 1977.\nPERRY R. PERO\nMr. Pero is Chief Financial Officer of the Corporation and the Bank and Cashier of the Bank. Mr. Pero is also head of the Risk Management Unit and Chairman of the Corporate Asset and Liability Policy Committee. He became a Senior Executive Vice President of the Corporation and the Bank in 1992 after serving as an Executive Vice President of the Corporation and the Bank since 1987. Mr. Pero, 55, joined the Bank in 1964.\nPETER L. ROSSITER\nMr. Rossiter was appointed General Counsel of the Corporation and the Bank in April 1993. He joined the Corporation and the Bank in 1992 as an Executive Vice President and Associate General Counsel. Mr. Rossiter, 46, had been a partner in the law firm of Schiff Hardin & Waite from 1979 to 1992.\nHARRY W. SHORT\nMr. Short was appointed Senior Vice President and Controller of the Corporation and the Bank in October 1994. He joined the Corporation and the Bank in January 1990 and served as Senior Vice President and General Auditor. Mr. Short, 46, had been a partner in the accounting firm of KPMG Peat Marwick from 1982 to 1990.\nWILLIAM S. TRUKENBROD\nMr. Trukenbrod was appointed an Executive Vice President of the Corporation and the Bank in February 1994, and is currently Chairman of the Credit Policy Committee. Previously, he served as head of the U.S. Corporate Group of Commercial Banking from 1987 to 1992. He had been a Senior Vice President of the Bank since 1980 and of the Corporation since 1992. Mr. Trukenbrod, 55, joined the Bank in 1962.\nThere is no family relationship between any of the above executive officers and directors.\nThe positions of Chairman of the Board and Chief Executive Officer, President and Vice Chairman are elected annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of stockholders. The other officers are appointed annually by the Board. Officers continue to hold office until their successors are duly elected or unless removed by the Board.\nMr. Fox has announced his intention to retire on October 3, 1995. The Board of Directors of the Corporation has approved a succession plan under which Mr. Osborn will become Chief Executive Officer on June 30, 1995, and Mr. Hastings will become Chief Operating Officer on that date. Mr. Fox will remain Chairman until his retirement, whereupon Mr. Osborn will become Chairman as well as Chief Executive Officer and Mr. Hastings will become President as well as Chief Operating Officer.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 - -PROPERTIES\nThe executive offices of the Corporation and the Bank are located at 50 South LaSalle Street in the financial district of Chicago. This Bank-owned building is occupied by various divisions of Northern Trust's business units. Financial services are provided by the Bank at this location. Adjacent to this building are two office buildings in which the Bank leases approximately 316,000 square feet of space for staff divisions of the business units. The Bank also leases approximately 112,000 square feet of a building at 125 South Wacker Drive in Chicago for computer facilities, banking operations and personal banking services. Financial services are also provided by the Bank at five other Chicago area locations, two of which are owned and three of which are leased. The Bank's trust and banking operations are located in a 465,000 square foot facility at 801 South Canal Street in Chicago. The building is owned by a developer and leased by the Corporation. Space for the Bank's London branch, Edge Act subsidiary and The Northern Company, Canada are leased.\nThe Corporation's other subsidiaries operate from 45 locations, 10 of which are owned and 35 of which are leased. Detailed information regarding the addresses of all Northern Trust's locations can be found on pages 80 and 81 in the Corporation's Annual Report to Stockholders for the year ended December 31, 1994, which is incorporated herein by reference.\nThe facilities which are owned or leased are suitable and adequate for business needs. For additional information relating to properties and lease commitments, refer to Note 6 titled Buildings and Equipment and Note 7 titled Lease Commitments on pages 55 and 56 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994, which information is incorporated herein by reference.\nITEM 3","section_3":"ITEM 3 - -LEGAL PROCEEDINGS\nThe information called for by this item is incorporated herein by reference to Note 15 titled Contingent Liabilities on page 61 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994.\nIn late November, 1993, the U.S. Department of Justice informed the Corporation that the Department is investigating the mortgage lending practices of the Bank and the Corporation's three other Illinois banking subsidiaries, as part of its responsibility to investigate possible discrimination on the basis of race or national origin under the Equal Credit Opportunity Act and the Fair Housing Act. The Corporation believes it has cooperated fully with the Department of Justice in the investigation, which is still pending.\nITEM 4","section_4":"ITEM 4 - -SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNone\n===============================================================================\nPART II\nITEM 5","section_5":"ITEM 5 - -MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe information called for by this item is incorporated herein by reference to the section of the Consolidated Financial Statistics titled \"Common Stock Dividend and Market Price\" on pages 76 and 77 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994.\nInformation regarding dividend restrictions of the Corporation's banking subsidiaries is incorporated herein by reference to Note 12 titled \"Restrictions on Subsidiary Dividends and Loans or Advances\" on page 59 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 6","section_6":"ITEM 6 - -SELECTED FINANCIAL DATA\nThe information called for by this item is incorporated herein by reference to the table titled \"Summary of Selected Consolidated Financial Data\" on page 26 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 7","section_7":"ITEM 7 - -MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe information called for by this item is incorporated herein by reference to Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 26 through 45 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994.\nITEM 8","section_7A":"","section_8":"ITEM 8 - -FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements of the Corporation and its subsidiaries included in the Corporation's Annual Report to Stockholders for the year ended December 31, 1994, are incorporated herein by reference.\nThe section titled \"Quarterly Financial Data\" on pages 76 and 77 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1994, is incorporated herein by reference.\nITEM 9","section_9":"ITEM 9 - -CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\n===============================================================================\n===============================================================================\nPART III\nITEM 10","section_9A":"","section_9B":"","section_10":"ITEM 10 - -DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe information called for by Item 10, relating to Directors and Nominees for election to the Board of Directors, is incorporated herein by reference to pages 2 through 5 of the Corporation's definitive 1995 Notice and Proxy Statement filed in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 18, 1995. The information called for by Item 10 relating to Executive Officers is set forth in Part I of this Annual Report on Form 10-K.\nITEM 11","section_11":"ITEM 11 - -EXECUTIVE COMPENSATION\nThe information called for by this item is incorporated herein by reference to pages 8 and 9 and pages 10 through 17 of the Corporation's definitive 1995 Notice and Proxy Statement filed in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 18, 1995.\nITEM 12","section_12":"ITEM 12 - -SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information called for by this item is incorporated herein by reference to pages 6 and 7 of the Corporation's definitive 1995 Notice and Proxy Statement filed in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 18, 1995.\nITEM 13","section_13":"ITEM 13 - -CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe information called for by this item is incorporated herein by reference to page 9 of the Corporation's definitive 1995 Notice and Proxy Statement filed in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 18, 1995.\n===============================================================================\n===============================================================================\nPART IV\nITEM 14","section_14":"ITEM 14 - -EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nITEM 14(A)(1) AND (2)-- NORTHERN TRUST CORPORATION AND SUBSIDIARIES LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following financial information is set forth in Item 1 for informational purposes only:\nFinancial Information of The Northern Trust Company (Bank Only):\nUnaudited Consolidated Balance Sheet--December 31, 1994 and 1993.\nUnaudited Consolidated Statement of Income--Years Ended December 31, 1994, 1993 and 1992.\nThe following consolidated financial statements of the Corporation and its subsidiaries are incorporated by reference into Item 8 from the Corporation's Annual Report to Stockholders for the year ended December 31, 1994:\nConsolidated Financial Statements of Northern Trust Corporation and Subsidiaries:\nConsolidated Balance Sheet--December 31, 1994 and 1993.\nConsolidated Statement of Income--Years Ended December 31, 1994, 1993 and 1992.\nConsolidated Statement of Changes in Stockholders' Equity--Years Ended December 31, 1994, 1993 and 1992.\nConsolidated Statement of Cash Flows--Years Ended December 31, 1994, 1993 and 1992.\nThe following financial information is incorporated by reference into Item 8 from the Corporation's Annual Report to Stockholders for the year ended December 31, 1994:\nFinancial Statements of Northern Trust Corporation (Corporation):\nCondensed Balance Sheet--December 31, 1994 and 1993.\nCondensed Statement of Income--Years Ended December 31, 1994, 1993 and 1992.\nConsolidated Statement of Changes in Stockholders' Equity--Years Ended December 31, 1994, 1993 and 1992.\nCondensed Statement of Cash Flows--Years Ended December 31, 1994, 1993 and 1992.\nThe Notes to Consolidated Financial Statements as of December 31, 1994, incorporated by reference into Item 8 from the Corporation's Annual Report to Stockholders for the year ended December 31, 1994, pertain to the Bank only information, consolidated financial statements and Corporation only information listed above.\nThe Report of Independent Public Accountants incorporated by reference into Item 8 from the Corporation's Annual Report to Stockholders for the year ended December 31, 1994 pertains to the consolidated financial statements and Corporation only information listed above.\nFinancial statement schedules have been omitted for the reason that they are not required or are not applicable.\nITEM 14(A)3--EXHIBITS\nThe exhibits listed on the Exhibit Index beginning on page 28 of this Form 10-K are filed herewith or are incorporated herein by reference to other filings.\nITEM 14(B)--REPORTS ON FORM 8-K\nNo reports on Form 8-K were filed by the Corporation during the quarter ended December 31, 1994.\n===============================================================================\n===============================================================================\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 Form 10-K Report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 14, 1995 Northern Trust Corporation (Registrant)\nBy: David W. Fox ---------------------------------- David W. Fox Chairman of the Board and Chief Executive Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Form 10-K Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated.\n===============================================================================\n============================================================================== EXHIBIT INDEX\nThe following Exhibits are filed herewith or are incorporated herein by reference.\n===============================================================================\n==============================================================================\n===============================================================================\n==============================================================================\n* Prior Filings (File No. 0-5965, except as noted) -----------------------------------------------\n(1) Annual Report on Form 10-K for the year ended December 31, 1992\n(2) Registration Statement on Form S-4 dated February 10, 1994 (Reg. No. 33-52219)\n(3) Quarterly Report on Form 10-Q for the quarter ended March 31, 1993\n(4) Quarterly Report on Form 10-Q for the quarter ended September 30, 1986\n(5) Annual Report on Form 10-K for the year ended December 31, 1986\n(6) Annual Report on Form 10-K for the year ended December 31, 1988\n(7) Form 8-K dated January 26, 1989\n(8) Annual Report on Form 10-K for the year ended December 31, 1989\n(9) Form 8-A dated October 30, 1989\n(10) Annual Report on Form 10-K for the year ended December 31, 1990\n(11) Annual Report on Form 10-K for the year ended December 31, 1991\n(12) Quarterly Report on Form 10-Q for the quarter ended March 31, 1992\n(13) Form 8-K dated February 20, 1991\n(14) Annual Report on Form 10-K for the year ended December 31, 1993\n** Denotes management contract or compensatory plan or arrangement ---------------------------------------------------------------\nUpon written request to Peter L. Rossiter, Secretary, Northern Trust Corporation, 50 South LaSalle Street, Chicago, Illinois 60675, copies of exhibits listed above are available to Northern Trust Corporation stockholders by specifically identifying each exhibit desired in the request.\nPursuant to Item 601(b)(4)(iii) of Regulation S-K, the Corporation hereby agrees to furnish the Commission, upon request, any instrument defining the rights of holders of long-term debt of the Corporation not filed as an exhibit herein. No such instrument authorizes long-term debt securities in excess of 10% of the total assets of the Corporation and its subsidiaries on a consolidated basis. ==============================================================================","section_15":""}
{"filename":"38074_1994.txt","cik":"38074","year":"1994","section_1":"ITEM 1. BUSINESS \t -------- GENERAL\nForest Laboratories, Inc. and its subsidiaries (collectively, \"Forest\" or the \"Company\") develop, manufacture and sell both branded and generic forms of ethical drug products which require a physician's prescription, as well as non-prescription pharmaceutical products sold over-the-counter. Forest's most important United States products consist of branded ethical drug specialties marketed directly, or \"detailed,\" to physicians by the Company's salesforce and its controlled release line of generic products sold to wholesalers, chain drug stores and generic distributors. In recent years the Company has emphasized increased detailing to physicians of those branded ethical drugs it believes have the most potential for growth, and the introduction of new products acquired from other companies or developed by the Company.\nForest's products include those developed by Forest and those acquired from other pharmaceutical companies and integrated into Forest's marketing and distribution systems. See \"Recent Developments.\"\nForest is a Delaware corporation organized in 1956, and its principal executive offices are located at 150 East 58th Street, New York, New York 10155-10015 (telephone number (212-421-7850).\nRECENT DEVELOPMENTS\nPROSTAGLANDIN E(2) INSERT: In October 1993, Forest entered into a license and supply agreement granting Forest exclusive United States rights to develop and market a pessary infused with the hormone Prostaglandin E(2). The product will be used for the initiation or continuation of cervical ripening in patients where there is a medical or obstetrical indication for the induction of labor. A New Drug Application (an \"NDA\") was filed with the United States Food and Drug Administration (the \"FDA\") with respect to this product in December 1993. The Company plans to market this product under the brand name Cervidil-TM- C.R.\nFLUMADINE: In September 1993, Forest received the approval of the FDA to market rimantadine, an antiviral agent used for the treatment and prophylaxis of Influenza A. The Company markets this product under the trademark Flumadine-R-.\nFOSFOMYCIN TROMETAMOL: In November 1991, the Company entered into a licensing agreement with the Zambon Group of Italy for the marketing by the Company in the United States of the antibiotic fosfomycin trometamol. Fosfomycin trometamol is currently approved for marketing in eleven countries, including the United Kingdom, Germany, Italy and Spain, under the brand name Monurol-R-. The product is a single dose antibiotic used for the treatment of uncomplicated urinary tract infections. There are currently no single dose antibiotics approved for this indication in the United States. It is currently anticipated that an NDA will be filed for the product in 1994.\nINFASURF: In June 1991, the Company entered into a licensing agreement with ONY, Inc. for the marketing by the Company in the United States, the United Kingdom and Canada of the product Infasurf-R- for the treatment of respiratory distress syndrome in premature infants. Such licensing arrangements were expanded in May 1992 to include worldwide rights to the product. Infasurf is currently in Phase III clinical trials in the United States. The Company is also conducting early stage clinical trials of Infasurf in order to evaluate its possible use in adult respiratory distress syndrome. It is currently anticipated that an NDA will be filed for the product in 1994.\nSYNAPTON: The Company is conducting multi-center clinical trials to study the safety and efficacy of Synapton-TM- for the treatment of Alzheimer's Disease. Synapton contains physostigmine, a cholinesterase inhibitor. Cholinesterase is an enzyme which metabolizes or breaks down acetylcholine, which is the neurotransmitter in the brain most associated with memory. It is believed that in Alzheimer's patients, the cells that produce acetylcholine progressively die, and it is the reduced availability of this important neurotransmitter that is believed to contribute to the patient's mental deterioration. Synapton is formulated to partially inhibit cholinesterase activity so that the acetylcholine produced by the body is available for a longer period of time. It is recognized that cholinesterase inhibitors generally are not a cure for Alzheimer's Disease but are expected to have an ameliorative effect for certain patients.\nSynapton is a controlled release formulation of physostigmine. Synapton makes use of Forest's patented Synchron-R- technology which provides for the continuous release of medication into the bloodstream and, in the case of Synapton, permits twice-a-day administration. The Company has concluded one Phase III clinical study which demonstrates Synapton's effectiveness. The Company hopes to complete a second successful Phase III study which would enable an NDA to be filed.\nMICTURIN: In August 1989, Forest completed and submitted a full NDA to the FDA covering Micturin-R-, which is\nlicensed to Forest in the United States by the Swedish pharmaceutical manufacturer Pharmacia AB (\"Pharmacia\"). The product had been marketed outside the United States by Pharmacia since 1986 and by 1991 was approved and marketed in 20 countries, with over 400 million doses having been sold. In mid-1991, some cases of a rare but serious cardiac side effect, polymorphic ventricular tachycardia, were reported principally in the United Kingdom among patients taking Micturin. In all but a few of those cases, the patients appeared to have identifiable predisposing risk factors. As a result of those reports, the United Kingdom Committee on the Safety of Medicines (the \"CSM\") sent a letter to physicians and pharmacists advising them of those reported cases and contraindicating the drug for patients with the predisposing risk factors. In September 1991, following the CSM action and after regulatory action in other markets, including withdrawals of the product in Germany and Austria, Pharmacia withdrew Micturin from all markets worldwide. Following the worldwide withdrawal of Micturin, the FDA requested that Forest discontinue its ongoing studies of Micturin in the United States until the FDA could review the possible relationship between the use of Micturin and the reported cardiac side effect. Forest is presently conducting clinical studies to further assess Micturin's safety.\nPRINCIPAL PRODUCTS\nThe Company actively promotes in the United States those of its branded products which the Company's management believes have the most potential for growth and which enable its salesforce to concentrate on specialty groups of physicians who are high prescribers of its products. Such products include the respiratory products Aerobid-R-, Aerochamber-R- and Tessalon-R-, the thyroid product Levothroid-R-, the ESGIC-R- and Lorcet-R- lines of analgesics and Flumadine (See \"Recent Developments\").\nAerobid is a metered dose inhaled steroid used in the treatment of asthma. Sales of Aerobid accounted for 21.3% of Forest's sales for the fiscal year ended March 31, 1994 as compared to 17.7% and 14.2% for the fiscal years ended March 31, 1993 and 1992, respectively. During fiscal 1992, the National Institutes of Health recommended inhaled steroid therapy as a first-line therapy for an expanded group of asthma patients, rather than bronchodilators (such as beta-2-agonists and theophylline). This recommendation has resulted in the increased use of metered dose inhaled corticosteroids such as Aerobid. Aerochamber is a spacer device used to improve the delivery of aerosol administered products, including Aerobid.\nESGIC and its line extension, ESGIC Plus, are combination analgesic\/sedatives for the relief of tension headaches, while Lorcet is a line of potent analgesics. Lorcet\nsales accounted for 11.2% of sales for the fiscal year ended March 31, 1994, as compared to 7.8% and 6.7% of sales for the fiscal years ended March 31, 1993 and 1992, respectively. Tessalon is a solid dose non-narcotic cough suppressant. Sales of Tessalon (including sales of a generic formulation) accounted for 6.0% of sales for the fiscal year ended March 31, 1994, as compared to 10.9% and 7.9% for the fiscal years ended March 31, 1993 and 1992, respectively.\nForest's generic line emphasizes the Company's capability to produce difficult to formulate controlled release products which are sold in the United States by Forest's Inwood Laboratories, Inc. subsidiary. Inwood's most important products include Propranolol E.R., a controlled release beta blocker used in the treatment of hypertension, Indomethacin E.R., a controlled release non-steroidal anti-inflammatory drug used in the treatment of arthritis, and Theochron-TM- , a controlled release theophylline tablet used in treatment of asthma. Sales of Propranolol accounted for 14.3% of Forest's sales for the fiscal year ended March 31, 1994, as compared to 14.1% and 12.5% for the fiscal years ended March 31, 1993 and 1992, respectively.\nThe Company's United Kingdom and Ireland subsidiaries sell both ethical products requiring a doctor's prescription and over-the-counter preparations. Their most important products include Sudocrem, a topical preparation for the treatment of diaper rash, Colomycin, an antibiotic used in the treatment of Cystic Fibrosis and Suscard and Sustac, sustained action nitroglycerin tablets in both buccal and oral form used in the treatment of angina pectoris, an ailment characterized by insufficient oxygenation of the heart muscle.\nMARKETING\nIn the United States, Forest directly markets its products through its domestic salesforce, currently numbering 450 persons, which details products directly to physicians, pharmacies and managed care organizations. The expansion of Forest's direct sales efforts and related promotional activities has significantly increased sales of Forest's branded ethical pharmaceutical products, including certain of those acquired or licensed by Forest. See \"Principal Products\". In the United Kingdom, the Company's Pharmax subsidiary's salesforce, currently 62 persons, markets its products directly. Forest's products are sold elsewhere through independent distributors.\nCOMPETITION\nThe pharmaceutical industry is highly competitive as to the sale of products, research for new or improved products and the development and application of competitive controlled release technologies. There are numerous companies in the United States and abroad engaged in the manufacture and sale of both proprietary and generic drugs of the kind sold by Forest and drugs utilizing controlled release technologies. Many of these companies have substantially greater financial resources than Forest. In addition, the marketing of pharmaceutical products is increasingly affected by the growing role of managed care organizations in the provision of health services. Such organizations negotiate with pharmaceutical manufacturers for highly competitive prices for pharmaceutial products in equivalent therapeutic categories, including certain of the Company's principal promoted products.\nGOVERNMENT REGULATION\nThe pharmaceutical industry is subject to comprehensive government regulation which substantially increases the difficulty and cost incurred in obtaining the approval to market newly proposed drug products and maintaining the approval to market existing drugs. In the United States, products developed, manufactured or sold by Forest are subject to regulation by the FDA, principally under the Federal Food, Drug and Cosmetic Act, as well as by other federal and state agencies. The FDA regulates all aspects of the testing, manufacture, safety, labeling, storage, record keeping, advertising and promotion of new and old drugs, including the monitoring of compliance with good manufacturing practice regulations. Non-compliance with applicable requirements can result in fines and other sanctions, including the initiation of product seizures, injunction actions and criminal prosecutions based on practices that violate statutory requirements. In addition, administrative remedies can involve voluntary recall of products as well as the withdrawal of approval of products in accordance with due process procedures. Similar regulations exist in most foreign countries in which Forest's products are manufactured or sold. In many foreign countries, such as the United Kingdom, reimbursement under national health insurance programs frequently require that manufacturers and sellers of pharmaceutical products obtain governmental approval of initial prices and increases if the ultimate consumer is to be eligible for reimbursement for the cost of such products.\nDuring the past several years the FDA, in accordance with its standard practice, has conducted a number of inspections of the Company's manufacturing facilities. Following these inspections the FDA called the Company's attention to certain\n\"Good Manufacturing Practices\" compliance and record keeping deficiencies, including a warning letter issued April 22, 1994 with respect to Forest's manufacture of Indomethacin. The Company believes it has satisfactorily remedied these deficiencies.\nThe cost of human health care products continues to be a subject of investigation and action by governmental agencies, legislative bodies, and private organizations in the United States and other countries and is the focus of legislative efforts by the Clinton Administration in Washington. In the United States, most states have enacted generic substitution legislation requiring or permitting a dispensing pharmacist to substitute a different manufacturer's version of a drug for the one prescribed. Federal and state governments continue to press efforts to reduce costs of Medicare and Medicaid programs, including restrictions on amounts agencies will reimburse for the use of products. Under the Omnibus Budget Reconciliation Act of 1990 (OBRA), manufacturers must pay certain statutorily-prescribed rebates on Medicaid purchases for reimbursement on prescription drugs under state Medicaid plans. Federal Medicaid reimbursement for drug products of original NDA-holders is denied if less expensive generic versions are available from other manufacturers. In addition, the Federal government follows a diagnosis related group (DRG) payment system for certain institutional services provided under Medicare or Medicaid. The DRG system entitles a health care facility to a fixed reimbursement based on discharge diagnoses rather than actual costs incurred in patient treatment, thereby increasing the incentive for the facility to limit or control expenditures for many health care products.\nUnder the Prescription Drug User Fee Act of 1992, the FDA has imposed fees on various aspects of the approval, manufacture and sale of prescription drugs. The Health Security Act (the \"HSA\") proposed by the Clinton Administration and currently pending before Congress is highly regulatory and contains provisions which would affect the marketing of prescription drug products. Among other things, the HSA provides for the establishment of an Advisory Council to make recommendations to the Secretary of Health and Human Services as to the reasonableness of new drug prices and contemplates the increased use of managed care programs for the provision of health care services. The debate as to reform of the health care system is expected to be protracted and the Company cannot predict the outcome or effect on the marketing of prescription drug products of the legislative process.\nPRINCIPAL CUSTOMERS\nNo customer accounted for more than 10% of Forest's consolidated sales in the fiscal years ended March 31, 1994 and March 31, 1993.\nENVIRONMENTAL STANDARDS\nForest anticipates that the effects of compliance with federal, state and local laws and regulations relating to the discharge of materials into the environment will not have any material effect on capital expenditures, earnings or the competitive position of Forest.\nRAW MATERIALS\nThe principal raw materials used by Forest for its various products are purchased in the open market. Most of these materials are obtainable and available from several sources in the United States and elsewhere in the world, although certain of Forest's products contain patented or other exclusively manufactured materials available from only a single source. Forest has not experienced any significant shortages in supplies of such raw materials.\nPRODUCT LIABILITY INSURANCE\nForest currently maintains $50 million of product liability coverage per \"occurrence\" and in the aggregate. Although in the past there have been claims asserted against Forest, none for which Forest has been found liable, there can be no assurance that all potential claims which may be asserted against Forest in the future would be covered by Forest's present insurance.\nRESEARCH AND DEVELOPMENT\nDuring the year ended March 31, 1994, Forest spent approximately $27,998,000 for research and development, as compared to approximately $22,054,000 and $17,771,000 in the fiscal years ended March 31, 1993 and 1992, respectively. A portion of such funds spent for research and development in the fiscal years ended March 31, 1993 and 1992 was reimbursed to Forest pursuant to research and development contracts with other pharmaceutical companies and pursuant to two research and development agreements with Prutech Research and Development Partnership. Forest's research and development activities during the past year consisted primarily of the conduct of clinical studies required to obtain approval of new products and the development of additional products some of which utilize the Company's controlled release technologies.\nEMPLOYEES\nAt March 31, 1994, Forest had a total of 1,259 employees.\nPATENTS AND TRADEMARKS\nForest owns and licenses certain U.S. patents, and has pending U.S. and foreign patent applications, relating to various aspects of its Synchron technology and to other controlled release technology. The patents expire through 2008. Forest believes that patents are useful in its business; however, there are numerous patents and unpatented technologies owned by others covering other controlled release processes.\nForest owns various trademarks and trade names which it believes are of significant benefit to its business.\nBACKLOG -- SEASONALITY\nBacklog of orders is not considered material to Forest's business prospects. Forest's business is not seasonal in nature.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES \t ---------- Forest owns six buildings and leases three buildings in and around Inwood, Long Island, New York, containing a total of approximately 140,000 square feet. The buildings are used for manufacturing, research and development, warehousing and administration. Forest has recently acquired a 150,000 square foot building on 28 acres in Commack, New York. The building and land will initially be used for packaging, warehousing and administration and, in the future, for the expansion of Forest's Long Island facilities.\nFPI owns two facilities in Cincinnati, Ohio aggregating approximately 140,000 square feet, including a recently acquired facility of 108,000 square feet. In St. Louis, Missouri, FPI owns facilities of 22,000 square feet and 87,000 square feet and leases a 12,000 square foot facility. These facilities are used for manufacturing, warehousing and administration. It is not anticipated that the lease for the 12,000 square foot facility will be renewed. In addition, the Company sold a facility of approximately 35,000 square feet in St. Louis during 1994.\nPharmax owns an approximately 95,000 square foot complex in the London suburb of Bexley, England, which houses its plant and administrative and central marketing offices. Approximately 15,000 square feet of such space is leased by Pharmax to other tenants.\nForest leases two buildings of 39,250 and 34,400 square feet located in Rio Piedras, Puerto Rico, under leases which expire in 1998 subject to one five-year renewal option. The space is used by Sein-Mendez, Forest Laboratories Caribe, Inc. and Forest Pharmaceuticals, Inc., wholly-owned subsidiaries of Forest, for manufacturing, warehousing and administration.\nForest's Tosara subsidiary owns an 18,000 square foot manufacturing and distribution facility located in an industrial park in Dublin, Ireland. A newly-formed subsidiary of Forest has recently commenced the development, together with the Development Authority of the Republic of Ireland of an approximately 86,000 square foot manufacturing and distribution facility to be located in Dublin, Ireland. The facility, expected to be completed in mid-1994, will be used principally for the manufacture and distribution of products in Europe.\nForest's UAD division owns an 18,000 square foot office and distribution facility located in Jackson, Mississippi.\nForest presently leases approximately 37,000 square feet of office space at 150 East 58th Street, New York, New York, subject to a lease which expires in 1995. Forest has recently entered into a lease for a new principal executive office at 909 Third Avenue, New York, New York. The lease covers approximately 70,000 square feet and is for a sixteen (16) year term, subject to 2 five year renewal options.\n\t Management believes that the above-described properties, including those under development, are sufficient for Forest's present and anticipated needs.\nNet rentals for leased space for the fiscal year ended March 31, 1994 aggregated approximately $1,821,000 and for the fiscal year ended March 31, 1993 aggregated approximately $1,691,000.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS \t ----------------- The Company and certain of its officers are currently defendants in WILSON, ET AL. V. FOREST LABORATORIES, INC., ET AL., 91 Civ. 5815 (S.D.N.Y.) (the \"Federal Action\"), a putative class action that seeks to assert claims based on alleged violations of the Securities Exchange Act of 1934 and common law negligent misrepresentation arising out of certain statements allegedly made by the defendants concerning Micturin.\nThe Company is the nominal defendant in WEISBERG ET ANO V. CANDEE, ET AL., (Sup. Ct. New York Cty.), a putative derivative action against the directors of the Company seeking to\nvoid certain options granted to the director defendants and require the director defendants to indemnify the Company for any liability resulting from statements concerning Micturin.\nThe Company believes the claims in both cases are without merit and intends to vigorously defend the actions.\nThe Company is a defendant in several actions filed in various federal district courts alleging certain violations of the Federal anti-trust laws in the marketing of pharmaceutical products. In each case, the actions were filed against many pharmaceutical manufacturers and suppliers and allege price discrimination and conspiracy to fix prices in the sale of pharmaceutical products. The actions were brought by various pharmacies (certain of which purport to represent a class) and seek injunctive relief and monetary damages. The Judicial Panel on Multi-District Litigation has ordered these actions coordinated (and, with respect to those actions purporting to be class actions, consolidated) in the Federal District Court for the Northern District of Illinois (Chicago) under the caption \"In re Brand Name Prescription Drugs Antitrust Litigation.\" Similar actions alleging price discrimination claims under state law are pending against many pharmaceutical manufacturers, including the Company, in state courts in California and Alabama. The Company believes these actions are without merit and intends to defend them vigorously.\n\t The Company is not subject to any other material pending legal proceedings, other than ordinary routine claims incidental to its business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE \t OF SECURITY HOLDERS \t ------------------------------- \t Not Applicable.\nPAGE\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS ------------------------------ The information required by this item is incorporated by reference to page 24 of the Annual Report.\n\t Forest has never paid cash dividends on its Common Stock and does not expect to pay such dividends in the foreseeable future. Management presently intends to retain all available funds for the development of its business and for use as working capital. Future dividend policy will depend upon Forest's earnings, capital requirements, financial condition and other relevant factors.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA \t ----------------------- The information required by this item is incorporated by reference to page 11 of the Annual Report.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION \t AND RESULTS OF OPERATIONS \t ------------------------------- \t The information required by this item is incorporated by reference to pages 9 and 10 of the Annual Report.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND \t SUPPLEMENTARY DATA \t ------------------------ \t The information required by this item is incorporated by reference to pages 12 through 24 of the Annual Report.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING \t AND FINANCIAL DISCLOSURE ------------------------------ Not Applicable.\nPAGE\nPART III\n\t In accordance with General Instruction G(3), the information called for by Part III (Items 10 through 13) is incorporated by reference from Forest's definitive proxy statement to be filed pursuant to Regulation 14A promulgated under the Securities Exchange Act of 1934 in connection with Forest's 1994 Annual Meeting of Stockholders.\nPAGE\nPART IV\nITEM 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES \t AND REPORTS ON FORM 8-K \t ---------------------------------------\n\t (a) 1. Financial statements. The following consolidated \t\t financial statements of Forest Laboratories, Inc. \t\t and subsidiaries included in the Annual Report \t\t are incorporated by reference herein in Item 8:\n\t \t Report of Independent Certified Public \t \t Accountants\n\t \t Consolidated balance sheets - \t March 31, 1994 and 1993\n\t\t Consolidated statements of income - \t \t years ended March 31, 1994, 1993 and 1992\n\t Consolidated statements of shareholders' \t\t equity - \t \t years ended March 31, 1994, 1993 and 1992\n\t\t Consolidated statements of cash flows - \t \t years ended March 31, 1994, 1993 and 1992\n\t \t Notes to consolidated financial statements\n\t 2. Financial statement schedules. The following \t \t consolidated financial statement schedules of \t\t Forest Laboratories, Inc. and Subsidiaries are \t \t included herein:\nReport of Independent Certified Public Accountants S-1\nSchedule II Amounts receivable from related \t parties and underwriters, promoters \t and employees other than related \t parties S-2\nSchedule VIII Valuation and qualifying accounts S-3\nSchedule X Supplementary income statement \t information S-4\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 or are inapplicable, and therefore have been omitted. \t\t\t\n\t 3. Exhibits:\n(3)(a) Articles of Incorporation of Forest, as amended. \t Incorporated by reference from the Current Report \t on Form 8-K dated March 9, 1981 filed by Forest, \t from Registration Statement on Form S-1 \t (Registration No. 2-97792) filed by Forest on May \t 16, 1985, from Forest's definitive proxy statement \t filed pursuant to Regulation 14A with respect to \t Forest's 1987, 1988 and 1993 Annual Meetings of \t Shareholders and from the Current Report on Form \t 8-K dated March 15, 1988.\n(3)(b) By-laws of Forest. Incorporated by reference from \t Form 10-K for the fiscal year ended March 31, 1981 \t filed by Forest on June 26, 1981.\n(10) Material Contracts \t ------------------ \t 10.1 Option Agreement and Registration Rights \t\t\t Agreement dated February 18, 1988 between \t\t\t Forest and Howard Solomon. Incorporated \t by reference to Forest's Annual Report on \t Form 10-K for the fiscal year ended March \t \t 31, 1988 (the \"1988 10-K\").\n\t 10.2 Option Agreement and Registration Rights Agreement dated February 18, 1988 between Forest and Joseph M. Schor. Incorporated by reference to the 1988 10-K.\n10.3 Option Agreement and Registration Rights Agreement dated February 18, 1988 between Forest and Kenneth E. Goodman. Incorporated by reference to the 1988 \t\t 10-K.\n10.4 Option Agreement and Registration Rights \t\t Agreement dated February 18, 1988 between Forest and Phillip M. Satow. Incorporated by reference to the 1988 10-K.\n10.5 Benefit Continuation Agreement dated as \t\t of December 1, 1989 between Forest and Howard Solomon. Incorporated by reference to Forest's Annual Report on Form 10-K for the fiscal year ended March 31, 1990 (the \"1990 l0-K\").\n10.6 Benefit Continuation Agreement dated as \t \t\t of December 1, 1989 between Forest and Joseph M. Schor. Incorporated by reference to the 1990 10-K.\n10.7 Benefit Continuation Agreement dated as \t of May 27, 1990 between Forest and Kenneth E. Goodman. Incorporated by reference to the 1990 10-K.\n10.8 Benefit Continuation Agreement dated as of December 10, 1989 between Forest and \t\t Phillip M. Satow. Incorporated by reference to the 1990 10-K.\n10.9 Option Agreement dated December 10, 1990 \t between Forest and Howard Solomon. Incorporated by reference to Forest's Annual Report on Form 10-K for the fiscal year ended March 31, 1991 (the \"1991 10-K\").\n10.10 Option Agreement dated December 10, 1990 \t\t between Forest and Joseph M. Schor. Incorporated by reference to the 1991 10-K.\n10.11 Option Agreement dated December 10, 1990 \t between Forest and Kenneth E. Goodman. Incorporated by reference to the 1991 10-K.\n10.12 Option Agreement dated December 10, 1990 between Forest and Phillip M. \t\t\t Satow. Incorporated by reference to the 1991 10-K.\n10.13 Split Dollar Life Insurance Agreement dated March 29, 1994 between Forest and Howard Solomon.\n10.14 Split Dollar Life Insurance Agreement dated March 29, 1994 between Forest and \t Joseph M. Schor.\n10.15 Split Dollar Life Insurance Agreement \t dated March 29, 1994 between Forest and Phillip M. Satow.\n10.16 Split Dollar Life Insurance Agreement dated March 29, 1994 between Forest and Kenneth E. Goodman.\n(13) Portions of the Registrant's Annual \t \t Report to Stockholders.\n\t \t22 List of Subsidiaries. Incorporated by \t\t reference to Exhibit 22 to the 1988 \t \t\t 10-K.\n\t\t24 (a) Consent of BDO Seidman\nPAGE\nSIGNATURES\n\tPursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, Forest has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDated: June 24, 1994 \t \t\t\t FOREST LABORATORIES, INC.\n\t \t\t\t By: \/s\/ Howard Solomon \t\t\t\t -------------------------- \t\t\t\t\t Howard Solomon, \t\t\t\t President, Chief Executive \t\t \t\t\t Officer and Director\n\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 Forest and in the capacities and on the dates indicated.\nPRINCIPAL EXECUTIVE OFFICER:\n\/s\/ Howard Solomon President, Chief June 24, 1994 - - --------------------------- Executive Officer Howard Solomon and Director\nPRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:\n\/s\/ Kenneth E. Goodman Vice President, June 24, 1994 - - --------------------------- Finance Kenneth E. Goodman\nDIRECTORS\n\/s\/ George S. Cohan Director June 24, 1994 - - --------------------------- George S. Cohan\n\/s\/William J. Candee, III Director June 24, 1994 - - --------------------------- William J. Candee, III\n\/s\/ Dan L. Goldwasser Director June 24, 1994 - - --------------------------- Dan L. Goldwasser\n\/s\/ Joseph Martin Schor Director June 24, 1994 - - -------------------------- Joseph Martin Schor\nPAGE\n\t REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nForest Laboratories, Inc. New York, New York\nThe audits referred to in our report dated May 2, 1994 relating to the consolidated financial statements of Forest Laboratories, Inc. and Subsidiaries, which is incorporated in Item 8 of this Form 10-K by reference to the annual report to the shareholders for the year ended March 31, 1994, included the audits of the financial statement schedules 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 upon our audits.\nIn our opinion, such financial statement schedules present fairly, in all material respects, the information set forth therein.\n\t\t\t\t\t \/s\/ BDO Seidman \t\t\t\t\t --------------------- \t\t\t\t\t BDO Seidman\nNew York, New York May 2, 1994\n\t\t\t\t S-1\n\t\t\t\t\t\t\t\t SCHEDULE II\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\nAMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND \t\t EMPLOYEES OTHER THAN RELATED PARTIES\n\t\t\t\t\n\t\t\t\t \t\t\t\t\t Column D Column E \t\t\t\t\t ------------------------------------- \t\t\t\t\t\t\t Balance at end of Column A Column B Column C Deductions period - - ------------------------------------------------------------------------------- \t\t Balance at (1) (2) (1) (2) \t\t beginning Amounts Amounts Not Name of Debtor of period Additions collected written off Current Current - - -------------------------------------------------------------------------------\nJames A. McCabe -0- 150,000 25,000 -0- 125,000 -0-\n\t\t\t\t\tS-2\nSCHEDULE VIII \t\t\t\t \t\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t\t\t\t VALUATION AND QUALIFYING ACCOUNTS\n\t\t\t\t\t\t S-3\n\t\t\t\t\t\n\t \t\t\t\t\t SCHEDULE X\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t\t SUPPLEMENTARY INCOME STATEMENT INFORMATION \t\t\t\t\t\t\t\t\t \t Column A Column B - - --------------------------------- -------------------------------------- \t Item Charged to costs and expenses - - --------------------------------- -------------------------------------- \t\t\t \t\t\t Year ended March 31,\n\t\t\t \t\t 1994 1993 1992 \t\t\t\t\t ---- ---- ---- 1. Maintenance and repairs ..... (*) (*) (*)\n2. Depreciation and amortization of intangible assets, pre- operating costs and similar deferrals .................. $ 6,915,000 $ 6,646,000 $6,730,000 \t =========== =========== ==========\n3. Taxes, other than payroll and income taxes ........... (*) (*) (*)\n4. Royalties ................... $14,972,000 $11,433,000 $8,754,000 \t =========== =========== ========== 5. Advertising costs ........... $16,265,000 $12,845,000 $8,377,000 \t\t\t\t =========== =========== ==========\n(*) Amounts not in excess of 1% of net sales are not presented. \t\t\t \t S-4\n\t\t\t\t\nEXHIBIT 10.13\n\t\t EQUITY SPLIT DOLLAR AGREEMENT\nTHIS AGREEMENT, made and entered into this 29th day of\nMarch, 1994, by and among FOREST LABORATORIES, INC. a corporation\norganized and existing under the laws of the State of Delaware\n(hereinafter referred to as the \"Corporation\"), and Howard\nSolomon (hereinafter referred to as the \"Executive\").\n\t WHEREAS, the Executive has served as a senior executive\nofficer of the Corporation for more than the past 10 years; and\n\t WHEREAS, the Corporation is desirous of retaining the\nservices of the Executive; and\n\t WHEREAS, the Corporation is desirous of assisting the\nExecutive in paying for life insurance on his own life; and\n\t WHEREAS, the Corporation has determined that this\nassistance can best be provided under a \"split-dollar\"\narrangement; and\n\t WHEREAS, the Executive or a trust established by the\nExecutive (the \"Trust\") has applied for, and is the owner and\nbeneficiary of Insurance Policy No. 77,684,850 (the \"Policy\")\nissued by the Prudential Life Insurance Company (\"Prudential\") in\nthe face amount of $5,062,187; and\n\t WHEREAS, the Corporation and the Executive agree to\nmake said insurance policy subject to this Split-Dollar\nAgreement; and \t PAGE\n\t WHEREAS, the Executive has agreed to assign (or cause\nthe Trust to assign) the Policy to the Corporation as collateral\nfor amounts to be advanced by the Corporation under this\nAgreement by an instrument of assignment, in form and substance\nreasonably acceptable to the Corporation (the \"Assignment\"); and\n\t WHEREAS, it is understood and agreed that this\nsplit-dollar agreement is to be effective as of the date on which\nthe Policy is assigned to the Corporation;\n\t NOW THEREFORE, for value received and in consideration\nof the mutual covenants contained herein, the parties agree as\nfollows:\n\t\t\t ARTICLE I - DEFINITIONS\n\t For purposes of this Agreement, the following terms\nwill have the meanings set forth below:\n\t 1. \"CASH SURRENDER VALUE OF THE POLICY\" will mean the Cash Value of the Policy; plus the cash value of any paid-up additions; plus any dividend accumulations and unpaid dividends; and less any Policy Loan Balance.\n\t 2. \"CASH VALUE OF THE POLICY\" will mean the cash value as illustrated in the table of values shown in the Policy.\n\t 3. \"CORPORATION'S INTEREST IN THE POLICY\" will be as defined in Article VI.\n\t 4. \"CURRENT LOAN VALUE OF THE POLICY\" will mean the Loan Value of the Policy reduced by any outstanding Policy Loan Balance.\n\t 5. \"LOAN VALUE OF THE POLICY\" will mean the amount which, with loan interest, will equal the Cash Value\nof the Policy and of any paid-up additions on the next loan interest due date or on the next premium due date whichever is the smaller amount.\n\t 6. \"POLICY LOAN BALANCE\" at any time will mean policy loans outstanding plus interest accrued to date.\n\t 7. \"CORPORATION\" shall be defined as Forest Laboratories, Inc. or any successor thereto.\n\t 8. \"CHANGE OF CONTROL\" shall be defined as:\n\t A majority of members of the Corporation's Board of Directors (the \"Board\") are no longer appointees, nominees or designees of a majority of the members of the Board serving on the date hereof (\"Continuing Directors\") or members of the Board nominated, designated or appointed by Continuing Directors.\n\t\t ARTICLE II - ALLOCATION OF PREMIUMS\n\t The Executive will pay that portion of the annual\npremium due on the Policy that is equal to the lesser of (a) the\namount of the entire economic benefit (including any economic\nbenefit attributable to the use of Policy dividends) that would\nbe taxable to the Executive but for such payment, or (b) the\namount of the premium due on the policy. The Corporation will\npay the remainder of the premium. The economic benefit that\nwould be taxable to the Executive will be computed in accordance\nwith applicable I.R.S. Revenue Rulings.\n\t\t ARTICLE III - WAIVER OF PREMIUMS RIDER\n\t If there is a rider on the Policy providing for the\nwaiver of premiums in the event of the Executive's disability,\nany additional premium attributable to such rider will be payable\nby the Corporation.\n\t\t\t ARTICLE IV - OTHER RIDERS \t\t\tAND SUPPLEMENTAL AGREEMENTS\n\t The Executive may add to the Policy one or more of\nother riders or supplemental agreements which may be from time to\ntime available. Any additional premium attributable to such\nrider or supplemental agreement will be payable by the Executive.\nAny additional death benefits provided by such rider or\nsupplemental agreement will be paid to the beneficiary designated\nby the Executive under the terms of the policy.\n\t\t ARTICLE V - PAYMENT OF PREMIUMS\n\t Any premium or portion thereof which is payable by the\nExecutive under any Article of this Agreement may at the election\nof the Executive be deducted from the cash compensation otherwise\npayable to him and the Corporation agrees to transmit that\npremium or portion, along with any premium or portion thereof\npayable by it, to Prudential on or before the premium due date.\n\t\t ARTICLE VI - RIGHTS IN THE POLICY\n\t The Executive may exercise all rights, options and\nprivileges of ownership in the Policy except those granted to the\nCorporation by the Assignment. The Corporation will have those\nrights in the Policy given to it by the Assignment except as\nhereinafter modified. The Corporation will not surrender the\npolicy for cancellation except upon expiration of the thirty (30)\nday period described in Article X. The Corporation will not,\nwithout the written consent of the Executive, assign its rights\nin the Policy, other than for the purpose of obtaining a loan\nagainst the Policy, to anyone other than the Executive. The\nCorporation will not take any action in dealing with Prudential\nthat would impair any right or interest of the Executive in the\nPolicy. The Corporation will have the right to borrow from\nPrudential, and to secure that loan by the Policy, an amount\nwhich, together with the unpaid interest accrued thereon, will at\nno time exceed the lesser of (a) the Corporation's interest in\nthe Policy and (b) the Loan Value of the Policy. The\nCorporation's Interest in the Policy will be the liability of the\nExecutive for which the Policy is held as collateral security\nunder the Assignment. \"Corporation's Interest in the Policy\"\nwill mean, at any time at which the value of such interest is to\nbe determined under this Agreement, the total of premiums\ntheretofore paid on the Policy by the Corporation (including\npremiums paid by loans charged automatically against the Policy,\nbut not including any premiums paid, by loan or otherwise, for\nany supplemental agreement or rider), reduced by the Policy Loan\nBalance, with respect to any loan made or charged automatically\nagainst the Policy by the Corporation. In the event that the\nCorporation has paid additional premiums attributable to a rider\nproviding for the waiver of the premiums in the event of the\nExecutive's disability, \"premiums\" as used in the preceding\nsentence will not include any premiums waived pursuant to the\nterms of such rider while this Agreement is in force.\n\t\t \t ARTICLE VII - RIGHTS \t \t\t TO THE PROCEEDS AT DEATH\n\t Upon the death of the Executive while this Agreement is\nin force, the Corporation will, without delay, take whatever\naction is necessary and required of it to collect the proceeds of\nthe Policy from Prudential. Upon collection of the Policy\nproceeds, the Corporation will promptly pay the excess of the\nPolicy proceeds over the Corporation's Interest in the Policy to\nthe beneficiary designated by the Executive under the terms of\nthe Policy.\n\t\t\t ARTICLE VIII - DISABILITY\n\t If at any time the policy contains a rider providing\nfor the waiver of premiums in the event of the Executive's\ndisability, then, in the event of the Executive's Total\nDisability, as defined in the rider, which begins while the rider\nis in force and which continues for at least six months, the\nExecutive will pay to the Corporation the excess, if any, of the\nCorporation's Interest in the Policy over the Current Loan Value\nof the Policy and the Corporation will release its interest in\nthe Policy to the Executive. Upon release by the Corporation of\nall of its interest in the Policy, the Executive will thereafter\nown the Policy free from the Assignment and from this Agreement\nbut subject to any Policy loans and interest thereon.\n\t \t ARTICLE IX - TERMINATION OF AGREEMENT\n\t This Agreement may be terminated at any time while the\nInsured is living with the agreement of the Corporation and the\nExecutive and, in any event, this Agreement will terminate upon\nthe later of twenty years from the date hereof or the date on\nwhich the Corporation has recovered funds in respect of the\nPolicy equal to the Corporation's Interest in the Policy.\n\t\t ARTICLE X - EXECUTIVE'S RIGHTS \t\t\t UPON TERMINATION\n10.1 The Corporation shall remain obligated to pay premiums due\nunder the Policy until the Policy is fully paid (as\ndefined below) notwithstanding the termination of\nExecutive's employment with the Corporation, however\ncaused. For purposes of this Agreement, the Policy shall\nbe deemed \"fully paid\" when the Policy's Cash Surrender\nValue is sufficient to maintain the Policy in effect based\non current mortality and interest rate projections without\nthe payment of additional premiums at a time when the\nCorporation has recovered an amount in respect of the\nPolicy equal to the Corporation's Interest in the Policy.\n10.2 Except as otherwise provided for in Article IX or\nArticle X, Section 10.1, if the Termination of the\nExecutive's Employment is within two (2) years after a\nChange of Control, the Corporation or any succeeding\ncorporation or organization will immediately deposit in to\nthe policy a lump sum cash payment, this sum calculated by\nThe Prudential, which will cause the policy to become\n\"fully paid\" as defined in Section 10.1 but without regard\nto the receiving by the Corporation of the Corporation's\nInterest in the Policy. The Corporation further agrees\nthat it will make a second lump sum cash payment to the\nExecutive which will effectively allow the Executive to\nmake the then appropriate federal, state and city income\ntax payments on the cash surrender value of the policy\ntransferred to the Executive. Upon a Change of Control\nand the making of the two payments detailed above, the\nterms of this Agreement will be deemed satisfied and this\nAgreement will be deemed terminated.\n\t\t ARTICLE XI - STATUS OF AGREEMENT \t\t\tVS. COLLATERAL ASSIGNMENT\n\t As between the Executive and the Corporation, this\nAgreement will take precedence over any provisions of the\nAssignment. The Corporation agrees not to exercise any right\npossessed by it under the Assignment except in conformity with\nthis Agreement.\n\t \t ARTICLE XII - SATISFACTION OF CLAIM\n\t The Executive's rights and interest, and rights and\ninterest of any persons taking under or through him, will be\ncompletely satisfied upon compliance by the Corporation with the\nprovisions of this Agreement.\n\t\t ARTICLE XIII - AMENDMENT AND ASSIGNMENT\n\t This Agreement may be altered, amended or modified,\nincluding the addition of any extra policy provisions, by a\nwritten instrument signed by the Corporation and the Executive.\nEither party may, subject to the limitations of Article VII,\nassign its interest and obligations under this Agreement,\nprovided, however, that any assignment will be subject to the\nterms of this Agreement.\n\t\t ARTICLE XIV - POSSESSION OF POLICY\n\t The Corporation will keep possession of the Policy.\nThe Corporation agrees from time to time to make the Policy\navailable to the Executive or the Prudential for the purpose of\nendorsing or filing any change of beneficiary on the Policy but\nthe Policy will promptly be returned to the Corporation.\n\t\t ARTICLE XV - MERGER; GOVERNING LAW\n\t This Agreement sets forth the entire Agreement of the\nparties hereto, and any and all prior agreements, to the extent\ninconsistent herewith, are hereby superseded. This Agreement\nwill be governed by the laws of the State of New York.\n\t\t ARTICLE XVI - INTERPRETATION\n\t Where appropriate in this Agreement, words used in the\nsingular will include the plural and words used in the masculine\nwill include the feminine.\n\t IN WITNESS WHEREOF, the parties have hereunto set their\nhands and seals, the Corporation by its duly authorized officer,\nin the day and year first above written.\n\t\t ------------------------------------ (L.S.) \t\t\t Howard Solomon\n\t\t\t FOREST LABORATORIES, INC.\n\t\t\t By: ____________________________\nEXHIBIT 10.14\n\t\t EQUITY SPLIT DOLLAR AGREEMENT\nTHIS AGREEMENT, made and entered into this 29th day of\nMarch, 1994, by and among FOREST LABORATORIES, INC. a corporation\norganized and existing under the laws of the State of Delaware\n(hereinafter referred to as the \"Corporation\"), and Joseph M.\nSchor (hereinafter referred to as the \"Executive\").\n\t WHEREAS, the Executive has served as a senior executive\nofficer of the Corporation for more than the past 10 years; and\n\t WHEREAS, the Corporation is desirous of retaining the\nservices of the Executive; and\n\t WHEREAS, the Corporation is desirous of assisting the\nExecutive in paying for life insurance on his own life; and\n\t WHEREAS, the Corporation has determined that this\nassistance can best be provided under a \"split-dollar\"\narrangement; and\n\t WHEREAS, the Executive or a trust established by the\nExecutive (the \"Trust\") has applied for, and is the owner and\nbeneficiary of Insurance Policy No. 77,684,845 (the \"Policy\")\nissued by the Prudential Life Insurance Company (\"Prudential\") in\nthe face amount of $2,499,593; and\n\t WHEREAS, the Corporation and the Executive agree to\nmake said insurance policy subject to this Split-Dollar\nAgreement; and PAGE\n\t WHEREAS, the Executive has agreed to assign (or cause\nthe Trust to assign) the Policy to the Corporation as collateral\nfor amounts to be advanced by the Corporation under this\nAgreement by an instrument of assignment, in form and substance\nreasonably acceptable to the Corporation (the \"Assignment\"); and\n\t WHEREAS, it is understood and agreed that this\nsplit-dollar agreement is to be effective as of the date on which\nthe Policy is assigned to the Corporation;\n\t NOW THEREFORE, for value received and in consideration\nof the mutual covenants contained herein, the parties agree as\nfollows:\n\t\t\t ARTICLE I - DEFINITIONS\n\t For purposes of this Agreement, the following terms\nwill have the meanings set forth below:\n\t 1. \"CASH SURRENDER VALUE OF THE POLICY\" will mean the Cash Value of the Policy; plus the cash value of any paid-up additions; plus any dividend accumulations and unpaid dividends; and less any Policy Loan Balance.\n\t 2. \"CASH VALUE OF THE POLICY\" will mean the cash value as illustrated in the table of values shown in the Policy.\n\t 3. \"CORPORATION'S INTEREST IN THE POLICY\" will be as defined in Article VI.\n\t 4. \"CURRENT LOAN VALUE OF THE POLICY\" will mean the Loan Value of the Policy reduced by any outstanding Policy Loan Balance.\n\t 5. \"LOAN VALUE OF THE POLICY\" will mean the amount which, with loan interest, will equal the Cash Value \t\t\t\t\nof the Policy and of any paid-up additions on the next loan interest due date or on the next premium due date whichever is the smaller amount.\n\t 6. \"POLICY LOAN BALANCE\" at any time will mean policy loans outstanding plus interest accrued to date.\n\t 7. \"CORPORATION\" shall be defined as Forest Laboratories, Inc. or any successor thereto.\n\t 8. \"CHANGE OF CONTROL\" shall be defined as:\n\t A majority of members of the Corporation's Board of Directors (the \"Board\") are no longer appointees, nominees or designees of a majority of the members of the Board serving on the date hereof (\"Continuing Directors\") or members of the Board nominated, designated or appointed by Continuing Directors.\n\t\t ARTICLE II - ALLOCATION OF PREMIUMS\n\t The Executive will pay that portion of the annual\npremium due on the Policy that is equal to the lesser of (a) the\namount of the entire economic benefit (including any economic\nbenefit attributable to the use of Policy dividends) that would\nbe taxable to the Executive but for such payment, or (b) the\namount of the premium due on the policy. The Corporation will\npay the remainder of the premium. The economic benefit that\nwould be taxable to the Executive will be computed in accordance\nwith applicable I.R.S. Revenue Rulings.\n\t\t ARTICLE III - WAIVER OF PREMIUMS RIDER\n\t If there is a rider on the Policy providing for the\nwaiver of premiums in the event of the Executive's disability,\nany additional premium attributable to such rider will be payable\nby the Corporation.\n\t\t\t ARTICLE IV - OTHER RIDERS \t\t\tAND SUPPLEMENTAL AGREEMENTS\n\t The Executive may add to the Policy one or more of\nother riders or supplemental agreements which may be from time to\ntime available. Any additional premium attributable to such\nrider or supplemental agreement will be payable by the Executive.\nAny additional death benefits provided by such rider or\nsupplemental agreement will be paid to the beneficiary designated\nby the Executive under the terms of the policy.\n\t\t ARTICLE V - PAYMENT OF PREMIUMS\n\t Any premium or portion thereof which is payable by the\nExecutive under any Article of this Agreement may at the election\nof the Executive be deducted from the cash compensation otherwise\npayable to him and the Corporation agrees to transmit that\npremium or portion, along with any premium or portion thereof\npayable by it, to Prudential on or before the premium due date. \t\t \t \t ARTICLE VI - RIGHTS IN THE POLICY\n\t The Executive may exercise all rights, options and\nprivileges of ownership in the Policy except those granted to the\nCorporation by the Assignment. The Corporation will have those\nrights in the Policy given to it by the Assignment except as\nhereinafter modified. The Corporation will not surrender the\npolicy for cancellation except upon expiration of the thirty (30)\nday period described in Article X. The Corporation will not,\nwithout the written consent of the Executive, assign its rights\nin the Policy, other than for the purpose of obtaining a loan\nagainst the Policy, to anyone other than the Executive. The\nCorporation will not take any action in dealing with Prudential\nthat would impair any right or interest of the Executive in the\nPolicy. The Corporation will have the right to borrow from\nPrudential, and to secure that loan by the Policy, an amount\nwhich, together with the unpaid interest accrued thereon, will at\nno time exceed the lesser of (a) the Corporation's interest in\nthe Policy and (b) the Loan Value of the Policy. The\nCorporation's Interest in the Policy will be the liability of the\nExecutive for which the Policy is held as collateral security\nunder the Assignment. \"Corporation's Interest in the Policy\"\nill mean, at any time at which the value of such interest is to\nbe determined under this Agreement, the total of premiums\ntheretofore paid on the Policy by the Corporation (including\npremiums paid by loans charged automatically against the Policy,\nbut not including any premiums paid, by loan or otherwise, for\nany supplemental agreement or rider), reduced by the Policy Loan\nBalance, with respect to any loan made or charged automatically\nagainst the Policy by the Corporation. In the event that the\nCorporation has paid additional premiums attributable to a rider\nproviding for the waiver of the premiums in the event of the\nExecutive's disability, \"premiums\" as used in the preceding\nsentence will not include any premiums waived pursuant to the\nterms of such rider while this Agreement is in force.\n\t\t\t ARTICLE VII - RIGHTS \t\t\t TO THE PROCEEDS AT DEATH\n\t Upon the death of the Executive while this Agreement is\nin force, the Corporation will, without delay, take whatever\naction is necessary and required of it to collect the proceeds of\nthe Policy from Prudential. Upon collection of the Policy\nproceeds, the Corporation will promptly pay the excess of the\nPolicy proceeds over the Corporation's Interest in the Policy to\nthe beneficiary designated by the Executive under the terms of\nthe Policy.\n\t \t\t ARTICLE VIII - DISABILITY\n\t If at any time the policy contains a rider providing\nfor the waiver of premiums in the event of the Executive's\ndisability, then, in the event of the Executive's Total\nDisability, as defined in the rider, which begins while the rider\nis in force and which continues for at least six months, the\nExecutive will pay to the Corporation the excess, if any, of the\nCorporation's Interest in the Policy over the Current Loan Value \t\t\t\t\nof the Policy and the Corporation will release its interest in\nthe Policy to the Executive. Upon release by the Corporation of\nall of its interest in the Policy, the Executive will thereafter\nown the Policy free from the Assignment and from this Agreement\nbut subject to any Policy loans and interest thereon.\n\t\t ARTICLE IX - TERMINATION OF AGREEMENT\n\t This Agreement may be terminated at any time while the\nInsured is living with the agreement of the Corporation and the\nExecutive and, in any event, this Agreement will terminate upon\nthe later of twenty years from the date hereof or the date on\nwhich the Corporation has recovered funds in respect of the\nPolicy equal to the Corporation's Interest in the Policy.\n\t\t ARTICLE X - EXECUTIVE'S RIGHTS \t\t\t UPON TERMINATION\n10.1 The Corporation shall remain obligated to pay premiums due\nunder the Policy until the Policy is fully paid (as\ndefined below) notwithstanding the termination of\nExecutive's employment with the Corporation, however\ncaused. For purposes of this Agreement, the Policy shall\nbe deemed \"fully paid\" when the Policy's Cash Surrender\nValue is sufficient to maintain the Policy in effect based\non current mortality and interest rate projections without\nthe payment of additional premiums at a time when the\nCorporation has recovered an amount in respect of the\nPolicy equal to the Corporation's Interest in the Policy.\n10.2 Except as otherwise provided for in Article IX or\nArticle X, Section 10.1, if the Termination of the\nExecutive's Employment is within two (2) years after a\nChange of Control, the Corporation or any succeeding\ncorporation or organization will immediately deposit in to\nthe policy a lump sum cash payment, this sum calculated by\nThe Prudential, which will cause the policy to become\n\"fully paid\" as defined in Section 10.1 but without regard\nto the receiving by the Corporation of the Corporation's\nInterest in the Policy. The Corporation further agrees\nthat it will make a second lump sum cash payment to the\nExecutive which will effectively allow the Executive to\nmake the then appropriate federal, state and city income\ntax payments on the cash surrender value of the policy\ntransferred to the Executive. Upon a Change of Control\nand the making of the two payments detailed above, the\nterms of this Agreement will be deemed satisfied and this\nAgreement will be deemed terminated.\n\t\t ARTICLE XI - STATUS OF AGREEMENT \t\t\tVS. COLLATERAL ASSIGNMENT\n\t As between the Executive and the Corporation, this\nAgreement will take precedence over any provisions of the\nAssignment. The Corporation agrees not to exercise any right\npossessed by it under the Assignment except in conformity with\nthis Agreement.\n\t\t ARTICLE XII - SATISFACTION OF CLAIM\n\t The Executive's rights and interest, and rights and\ninterest of any persons taking under or through him, will be\ncompletely satisfied upon compliance by the Corporation with the\nprovisions of this Agreement.\n\t\t ARTICLE XIII - AMENDMENT AND ASSIGNMENT\n\t This Agreement may be altered, amended or modified,\nincluding the addition of any extra policy provisions, by a\nwritten instrument signed by the Corporation and the Executive.\nEither party may, subject to the limitations of Article VII,\nassign its interest and obligations under this Agreement,\nprovided, however, that any assignment will be subject to the\nterms of this Agreement.\n\t ARTICLE XIV - POSSESSION OF POLICY\n\t The Corporation will keep possession of the Policy.\nThe Corporation agrees from time to time to make the Policy\navailable to the Executive or the Prudential for the purpose of\nendorsing or filing any change of beneficiary on the Policy but\nthe Policy will promptly be returned to the Corporation.\n\t\t ARTICLE XV - MERGER; GOVERNING LAW\n\t This Agreement sets forth the entire Agreement of the\nparties hereto, and any and all prior agreements, to the extent\ninconsistent herewith, are hereby superseded. This Agreement\nwill be governed by the laws of the State of New York.\nARTICLE XVI - INTERPRETATION\n\t Where appropriate in this Agreement, words used in the\nsingular will include the plural and words used in the masculine\nwill include the feminine.\n\t IN WITNESS WHEREOF, the parties have hereunto set their\nhands and seals, the Corporation by its duly authorized officer,\nin the day and year first above written.\n\t\t\t __________________________________(L.S.) \t\t\t\t Joseph M. Schor\n\t FOREST LABORATORIES, INC.\n\t\t\t By: ______________________________\nEXHIBIT 10.15\n\t\t EQUITY SPLIT DOLLAR AGREEMENT\nTHIS AGREEMENT, made and entered into this 29th day of\nMarch, 1994, by and among FOREST LABORATORIES, INC. a corporation\norganized and existing under the laws of the State of Delaware\n(hereinafter referred to as the \"Corporation\"), and Phillip M.\nSatow (hereinafter referred to as the \"Executive\").\n\t WHEREAS, the Executive has served as a senior executive\nofficer of the Corporation for more than the past 9 years; and\n\t WHEREAS, the Corporation is desirous of retaining the\nservices of the Executive; and\n\t WHEREAS, the Corporation is desirous of assisting the\nExecutive in paying for life insurance on his own life; and\n\t WHEREAS, the Corporation has determined that this\nassistance can best be provided under a \"split-dollar\"\narrangement; and\n\t WHEREAS, the Executive or a trust established by the\nExecutive (the \"Trust\") has applied for, and is the owner and\nbeneficiary of Insurance Policy No. 77,684,830 (the \"Policy\")\nissued by the Prudential Life Insurance Company (\"Prudential\") in\nthe face amount of $2,372,584; and\n\t WHEREAS, the Corporation and the Executive agree to\nmake said insurance policy subject to this Split-Dollar\nAgreement; and PAGE\n\t WHEREAS, the Executive has agreed to assign (or cause\nthe Trust to assign) the Policy to the Corporation as collateral\nfor amounts to be advanced by the Corporation under this\nAgreement by an instrument of assignment, in form and substance\nreasonably acceptable to the Corporation (the \"Assignment\"); and\n\t WHEREAS, it is understood and agreed that this\nsplit-dollar agreement is to be effective as of the date on which\nthe Policy is assigned to the Corporation;\n\t NOW THEREFORE, for value received and in consideration\nof the mutual covenants contained herein, the parties agree as\nfollows:\n\t\t\t ARTICLE I - DEFINITIONS\n\t For purposes of this Agreement, the following terms\nwill have the meanings set forth below:\n\t 1. \"CASH SURRENDER VALUE OF THE POLICY\" will mean the Cash Value of the Policy; plus the cash value of any paid-up additions; plus any dividend accumulations and unpaid dividends; and less any Policy Loan Balance.\n\t 2. \"CASH VALUE OF THE POLICY\" will mean the cash value as illustrated in the table of values shown in the Policy.\n\t 3. \"CORPORATION'S INTEREST IN THE POLICY\" will be as defined in Article VI.\n\t 4. \"CURRENT LOAN VALUE OF THE POLICY\" will mean the Loan Value of the Policy reduced by any outstanding Policy Loan Balance.\n\t 5. \"LOAN VALUE OF THE POLICY\" will mean the amount which, with loan interest, will equal the Cash Value\nof the Policy and of any paid-up additions on the next loan interest due date or on the next premium due date whichever is the smaller amount.\n\t 6. \"POLICY LOAN BALANCE\" at any time will mean policy loans outstanding plus interest accrued to date.\n\t 7. \"CORPORATION\" shall be defined as Forest Laboratories, Inc. or any successor thereto.\n\t 8. \"CHANGE OF CONTROL\" shall be defined as:\n\t A majority of members of the Corporation's Board of Directors (the \"Board\") are no longer appointees, nominees or designees of a majority of the members of the Board serving on the date hereof (\"Continuing Directors\") or members of the Board nominated, designated or appointed by Continuing Directors.\n\t ARTICLE II - ALLOCATION OF PREMIUMS\n\t The Executive will pay that portion of the annual\npremium due on the Policy that is equal to the lesser of (a) the\namount of the entire economic benefit (including any economic\nbenefit attributable to the use of Policy dividends) that would\nbe taxable to the Executive but for such payment, or (b) the\namount of the premium due on the policy. The Corporation will\npay the remainder of the premium. The economic benefit that\nwould be taxable to the Executive will be computed in accordance\nwith applicable I.R.S. Revenue Rulings.\n\t\t ARTICLE III - WAIVER OF PREMIUMS RIDER\n\t If there is a rider on the Policy providing for the\nwaiver of premiums in the event of the Executive's disability,\nany additional premium attributable to such rider will be payable\nby the Corporation.\n\t\t\t ARTICLE IV - OTHER RIDERS \t\t\tAND SUPPLEMENTAL AGREEMENTS\n\t The Executive may add to the Policy one or more of\nother riders or supplemental agreements which may be from time to\ntime available. Any additional premium attributable to such\nrider or supplemental agreement will be payable by the Executive.\nAny additional death benefits provided by such rider or\nsupplemental agreement will be paid to the beneficiary designated\nby the Executive under the terms of the policy.\n\t\t ARTICLE V - PAYMENT OF PREMIUMS\n\t Any premium or portion thereof which is payable by the\nExecutive under any Article of this Agreement may at the election\nof the Executive be deducted from the cash compensation otherwise\npayable to him and the Corporation agrees to transmit that\npremium or portion, along with any premium or portion thereof\npayable by it, to Prudential on or before the premium due date.\n\t\t ARTICLE VI - RIGHTS IN THE POLICY\n\t The Executive may exercise all rights, options and\nprivileges of ownership in the Policy except those granted to the\nCorporation by the Assignment. The Corporation will have those\nrights in the Policy given to it by the Assignment except as\nhereinafter modified. The Corporation will not surrender the\npolicy for cancellation except upon expiration of the thirty (30)\nday period described in Article X. The Corporation will not,\nwithout the written consent of the Executive, assign its rights\nin the Policy, other than for the purpose of obtaining a loan\nagainst the Policy, to anyone other than the Executive. The\nCorporation will not take any action in dealing with Prudential\nthat would impair any right or interest of the Executive in the\nPolicy. The Corporation will have the right to borrow from\nPrudential, and to secure that loan by the Policy, an amount\nwhich, together with the unpaid interest accrued thereon, will at\nno time exceed the lesser of (a) the Corporation's interest in\nthe Policy and (b) the Loan Value of the Policy. The\nCorporation's Interest in the Policy will be the liability of the\nExecutive for which the Policy is held as collateral security\nunder the Assignment. \"Corporation's Interest in the Policy\"\nwill mean, at any time at which the value of such interest is to\nbe determined under this Agreement, the total of premiums\ntheretofore paid on the Policy by the Corporation (including\npremiums paid by loans charged automatically against the Policy,\nbut not including any premiums paid, by loan or otherwise, for\nany supplemental agreement or rider), reduced by the Policy Loan\nBalance, with respect to any loan made or charged automatically\nagainst the Policy by the Corporation. In the event that the\nCorporation has paid additional premiums attributable to a rider\nproviding for the waiver of the premiums in the event of the\nExecutive's disability, \"premiums\" as used in the preceding\nsentence will not include any premiums waived pursuant to the\nterms of such rider while this Agreement is in force.\n\t \t\t ARTICLE VII - RIGHTS \t\t \t TO THE PROCEEDS AT DEATH\n\t Upon the death of the Executive while this Agreement is\nin force, the Corporation will, without delay, take whatever\naction is necessary and required of it to collect the proceeds of\nthe Policy from Prudential. Upon collection of the Policy\nproceeds, the Corporation will promptly pay the excess of the\nPolicy proceeds over the Corporation's Interest in the Policy to\nthe beneficiary designated by the Executive under the terms of\nthe Policy.\n\t\t\t ARTICLE VIII - DISABILITY\n\t If at any time the policy contains a rider providing\nfor the waiver of premiums in the event of the Executive's\ndisability, then, in the event of the Executive's Total\nDisability, as defined in the rider, which begins while the rider\nis in force and which continues for at least six months, the\nExecutive will pay to the Corporation the excess, if any, of the\nCorporation's Interest in the Policy over the Current Loan Value\nof the Policy and the Corporation will release its interest in\nthe Policy to the Executive. Upon release by the Corporation of\nall of its interest in the Policy, the Executive will thereafter\nown the Policy free from the Assignment and from this Agreement\nbut subject to any Policy loans and interest thereon.\n\t\t ARTICLE IX - TERMINATION OF AGREEMENT\n\t This Agreement may be terminated at any time while the\nInsured is living with the agreement of the Corporation and the\nExecutive and, in any event, this Agreement will terminate upon\nthe later of twenty years from the date hereof or the date on\nwhich the Corporation has recovered funds in respect of the\nPolicy equal to the Corporation's Interest in the Policy.\n\t\t ARTICLE X - EXECUTIVE'S RIGHTS \t\t\t UPON TERMINATION\n10.1 The Corporation shall remain obligated to pay premiums due\nunder the Policy until the Policy is fully paid (as\ndefined below) notwithstanding the termination of\nExecutive's employment with the Corporation, however\ncaused. For purposes of this Agreement, the Policy shall\nbe deemed \"fully paid\" when the Policy's Cash Surrender\nValue is sufficient to maintain the Policy in effect based\non current mortality and interest rate projections without\nthe payment of additional premiums at a time when the\nCorporation has recovered an amount in respect of the\nPolicy equal to the Corporation's Interest in the Policy.\n10.2 Except as otherwise provided for in Article IX or\nArticle X, Section 10.1, if the Termination of the\nExecutive's Employment is within two (2) years after a\nChange of Control, the Corporation or any succeeding\ncorporation or organization will immediately deposit in to\nthe policy a lump sum cash payment, this sum calculated by\nThe Prudential, which will cause the policy to become\n\"fully paid\" as defined in Section 10.1 but without regard\nto the receiving by the Corporation of the Corporation's\nInterest in the Policy. The Corporation further agrees\nthat it will make a second lump sum cash payment to the\nExecutive which will effectively allow the Executive to\nmake the then appropriate federal, state and city income\ntax payments on the cash surrender value of the policy\ntransferred to the Executive. Upon a Change of Control\nand the making of the two payments detailed above, the\nterms of this Agreement will be deemed satisfied and this\nAgreement will be deemed terminated.\n\t \t ARTICLE XI - STATUS OF AGREEMENT \t\t\tVS. COLLATERAL ASSIGNMENT\n\t As between the Executive and the Corporation, this\nAgreement will take precedence over any provisions of the\nAssignment. The Corporation agrees not to exercise any right\npossessed by it under the Assignment except in conformity with\nthis Agreement.\n\t\t ARTICLE XII - SATISFACTION OF CLAIM\n\t The Executive's rights and interest, and rights and\ninterest of any persons taking under or through him, will be\ncompletely satisfied upon compliance by the Corporation with the\nprovisions of this Agreement.\n\t\t ARTICLE XIII - AMENDMENT AND ASSIGNMENT\n\t This Agreement may be altered, amended or modified,\nincluding the addition of any extra policy provisions, by a\nwritten instrument signed by the Corporation and the Executive.\nEither party may, subject to the limitations of Article VII,\nassign its interest and obligations under this Agreement,\nprovided, however, that any assignment will be subject to the\nterms of this Agreement.\n\t\t ARTICLE XIV - POSSESSION OF POLICY\n\t The Corporation will keep possession of the Policy.\nThe Corporation agrees from time to time to make the Policy\navailable to the Executive or the Prudential for the purpose of\nendorsing or filing any change of beneficiary on the Policy but\nthe Policy will promptly be returned to the Corporation.\n\t\t ARTICLE XV - MERGER; GOVERNING LAW\n\t This Agreement sets forth the entire Agreement of the\nparties hereto, and any and all prior agreements, to the extent\ninconsistent herewith, are hereby superseded. This Agreement\nwill be governed by the laws of the State of New York.\n\t\t ARTICLE XVI - INTERPRETATION\n\t Where appropriate in this Agreement, words used in the\nsingular will include the plural and words used in the masculine\nwill include the feminine.\n\t IN WITNESS WHEREOF, the parties have hereunto set their\nhands and seals, the Corporation by its duly authorized officer,\nin the day and year first above written.\n\t\t\t______________________________________ (L.S.) \t\t \t\t Phillip M. Satow\n\t\t\t FOREST LABORATORIES, INC.\n\t\t\t By: ________________________________\nEXHIBIT 10.16\n\t\t EQUITY SPLIT DOLLAR AGREEMENT\nTHIS AGREEMENT, made and entered into this 29th day of\nMarch, 1994, by and among FOREST LABORATORIES, INC. a corporation\norganized and existing under the laws of the State of Delaware\n(hereinafter referred to as the \"Corporation\"), and Kenneth E.\nGoodman (hereinafter referred to as the \"Executive\").\n\t WHEREAS, the Executive has served as a senior executive\nofficer of the Corporation for more than the past 10 years; and\n\t WHEREAS, the Corporation is desirous of retaining the\nservices of the Executive; and\n\t WHEREAS, the Corporation is desirous of assisting the\nExecutive in paying for life insurance on his own life; and\n\t WHEREAS, the Corporation has determined that this\nassistance can best be provided under a \"split-dollar\"\narrangement; and\n\t WHEREAS, the Executive or a trust established by the\nExecutive (the \"Trust\") has applied for, and is the owner and\nbeneficiary of Insurance Policy No. 77,684,852 (the \"Policy\")\nissued by the Prudential Life Insurance Company (\"Prudential\") in\nthe face amount of $2,297,917; and\n\t WHEREAS, the Corporation and the Executive agree to\nmake said insurance policy subject to this Split-Dollar\nAgreement; and PAGE\n\t WHEREAS, the Executive has agreed to assign (or cause\nthe Trust to assign) the Policy to the Corporation as collateral\nfor amounts to be advanced by the Corporation under this\nAgreement by an instrument of assignment, in form and substance\nreasonably acceptable to the Corporation (the \"Assignment\"); and\n\t WHEREAS, it is understood and agreed that this\nsplit-dollar agreement is to be effective as of the date on which\nthe Policy is assigned to the Corporation;\n\t NOW THEREFORE, for value received and in consideration\nof the mutual covenants contained herein, the parties agree as\nfollows:\n\t \t\t ARTICLE I - DEFINITIONS\n\t For purposes of this Agreement, the following terms\nwill have the meanings set forth below:\n\t 1. \"Cash Surrender Value of the Policy\" will mean the Cash Value of the Policy; plus the cash value of any paid-up additions; plus any dividend accumulations and unpaid dividends; and less any Policy Loan Balance.\n\t 2. \"Cash Value of the Policy\" will mean the cash value as illustrated in the table of values shown in the Policy.\n\t 3. \"Corporation's Interest in the Policy\" will be as defined in Article VI.\n\t 4. \"Current Loan Value of the Policy\" will mean the Loan Value of the Policy reduced by any outstanding Policy Loan Balance.\n\t 5. \"Loan Value of the Policy\" will mean the amount which, with loan interest, will equal the Cash Value\nof the Policy and of any paid-up additions on the next loan interest due date or on the next premium due date whichever is the smaller amount.\n\t 6. \"Policy Loan Balance\" at any time will mean policy loans outstanding plus interest accrued to date.\n\t 7. \"Corporation\" shall be defined as Forest Laboratories, Inc. or any successor thereto.\n\t 8. \"Change of Control\" shall be defined as:\n\t A majority of members of the Corporation's Board of Directors (the \"Board\") are no longer appointees, nominees or designees of a majority of the members of the Board serving on the date hereof (\"Continuing Directors\") or members of the Board nominated, designated or appointed by Continuing Directors.\n\t\t ARTICLE II - ALLOCATION OF PREMIUMS\n\t The Executive will pay that portion of the annual\npremium due on the Policy that is equal to the lesser of (a) the\namount of the entire economic benefit (including any economic\nbenefit attributable to the use of Policy dividends) that would\nbe taxable to the Executive but for such payment, or (b) the\namount of the premium due on the policy. The Corporation will\npay the remainder of the premium. The economic benefit that\nwould be taxable to the Executive will be computed in accordance\nwith applicable I.R.S. Revenue Rulings.\n\t\t ARTICLE III - WAIVER OF PREMIUMS RIDER\n\t If there is a rider on the Policy providing for the\nwaiver of premiums in the event of the Executive's disability,\nany additional premium attributable to such rider will be payable\nby the Corporation.\n\t\t\t ARTICLE IV - OTHER RIDERS \t\t\tAND SUPPLEMENTAL AGREEMENTS\n\t The Executive may add to the Policy one or more of\nother riders or supplemental agreements which may be from time to\ntime available. Any additional premium attributable to such\nrider or supplemental agreement will be payable by the Executive.\nAny additional death benefits provided by such rider or\nsupplemental agreement will be paid to the beneficiary designated\nby the Executive under the terms of the policy.\n\t ARTICLE V - PAYMENT OF PREMIUMS\n\t Any premium or portion thereof which is payable by the\nExecutive under any Article of this Agreement may at the election\nof the Executive be deducted from the cash compensation otherwise\npayable to him and the Corporation agrees to transmit that\npremium or portion, along with any premium or portion thereof\npayable by it, to Prudential on or before the premium due date.\n\t\t ARTICLE VI - RIGHTS IN THE POLICY\n\t The Executive may exercise all rights, options and\nprivileges of ownership in the Policy except those granted to the\nCorporation by the Assignment. The Corporation will have those\nrights in the Policy given to it by the Assignment except as\nhereinafter modified. The Corporation will not surrender the\npolicy for cancellation except upon expiration of the thirty (30)\nday period described in Article X. The Corporation will not,\nwithout the written consent of the Executive, assign its rights\nin the Policy, other than for the purpose of obtaining a loan\nagainst the Policy, to anyone other than the Executive. The\nCorporation will not take any action in dealing with Prudential\nthat would impair any right or interest of the Executive in the\nPolicy. The Corporation will have the right to borrow from\nPrudential, and to secure that loan by the Policy, an amount\nwhich, together with the unpaid interest accrued thereon, will at\nno time exceed the lesser of (a) the Corporation's interest in\nthe Policy and (b) the Loan Value of the Policy. The\nCorporation's Interest in the Policy will be the liability of the\nExecutive for which the Policy is held as collateral security\nunder the Assignment. \"Corporation's Interest in the Policy\"\nwill mean, at any time at which the value of such interest is to\nbe determined under this Agreement, the total of premiums\ntheretofore paid on the Policy by the Corporation (including\npremiums paid by loans charged automatically against the Policy,\nbut not including any premiums paid, by loan or otherwise, for\nany supplemental agreement or rider), reduced by the Policy Loan\nBalance, with respect to any loan made or charged automatically\nagainst the Policy by the Corporation. In the event that the\nCorporation has paid additional premiums attributable to a rider\nproviding for the waiver of the premiums in the event of the\nExecutive's disability, \"premiums\" as used in the preceding\nsentence will not include any premiums waived pursuant to the\nterms of such rider while this Agreement is in force.\n\t\t\t ARTICLE VII - RIGHTS \t\t\t TO THE PROCEEDS AT DEATH\n\t Upon the death of the Executive while this Agreement is\nin force, the Corporation will, without delay, take whatever\naction is necessary and required of it to collect the proceeds of\nthe Policy from Prudential. Upon collection of the Policy\nproceeds, the Corporation will promptly pay the excess of the\nPolicy proceeds over the Corporation's Interest in the Policy to\nthe beneficiary designated by the Executive under the terms of\nthe Policy.\n\t\t\t ARTICLE VIII - DISABILITY\n\t If at any time the policy contains a rider providing\nfor the waiver of premiums in the event of the Executive's\ndisability, then, in the event of the Executive's Total\nDisability, as defined in the rider, which begins while the rider\nis in force and which continues for at least six months, the\nExecutive will pay to the Corporation the excess, if any, of the\nCorporation's Interest in the Policy over the Current Loan Value\nof the Policy and the Corporation will release its interest in\nthe Policy to the Executive. Upon release by the Corporation of\nall of its interest in the Policy, the Executive will thereafter\nown the Policy free from the Assignment and from this Agreement\nbut subject to any Policy loans and interest thereon.\n\t\t ARTICLE IX - TERMINATION OF AGREEMENT\n\t This Agreement may be terminated at any time while the\nInsured is living with the agreement of the Corporation and the\nExecutive and, in any event, this Agreement will terminate upon\nthe later of twenty years from the date hereof or the date on\nwhich the Corporation has recovered funds in respect of the\nPolicy equal to the Corporation's Interest in the Policy.\n\t\t ARTICLE X - EXECUTIVE'S RIGHTS \t\t\t UPON TERMINATION\n10.1 The Corporation shall remain obligated to pay premiums due\nunder the Policy until the Policy is fully paid (as\ndefined below) notwithstanding the termination of\nExecutive's employment with the Corporation, however\ncaused. For purposes of this Agreement, the Policy shall\nbe deemed \"fully paid\" when the Policy's Cash Surrender\nValue is sufficient to maintain the Policy in effect based\non current mortality and interest rate projections without\nthe payment of additional premiums at a time when the\nCorporation has recovered an amount in respect of the\nPolicy equal to the Corporation's Interest in the Policy.\n10.2 Except as otherwise provided for in Article IX or\nArticle X, Section 10.1, if the Termination of the\nExecutive's Employment is within two (2) years after a\nChange of Control, the Corporation or any succeeding\ncorporation or organization will immediately deposit in to\nthe policy a lump sum cash payment, this sum calculated by\nThe Prudential, which will cause the policy to become\n\"fully paid\" as defined in Section 10.1 but without regard\nto the receiving by the Corporation of the Corporation's\nInterest in the Policy. The Corporation further agrees\nthat it will make a second lump sum cash payment to the\nExecutive which will effectively allow the Executive to\nmake the then appropriate federal, state and city income\ntax payments on the cash surrender value of the policy\ntransferred to the Executive. Upon a Change of Control\nand the making of the two payments detailed above, the\nterms of this Agreement will be deemed satisfied and this\nAgreement will be deemed terminated.\n\t\t ARTICLE XI - STATUS OF AGREEMENT \t\t\tVS. COLLATERAL ASSIGNMENT\n\t As between the Executive and the Corporation, this\nAgreement will take precedence over any provisions of the\nAssignment. The Corporation agrees not to exercise any right\npossessed by it under the Assignment except in conformity with\nthis Agreement.\n\t\t ARTICLE XII - SATISFACTION OF CLAIM\n\t The Executive's rights and interest, and rights and\ninterest of any persons taking under or through him, will be\ncompletely satisfied upon compliance by the Corporation with the\nprovisions of this Agreement.\n\t\t ARTICLE XIII - AMENDMENT AND ASSIGNMENT\n\t This Agreement may be altered, amended or modified,\nincluding the addition of any extra policy provisions, by a\nwritten instrument signed by the Corporation and the Executive.\nEither party may, subject to the limitations of Article VII,\nassign its interest and obligations under this Agreement,\nprovided, however, that any assignment will be subject to the\nterms of this Agreement.\n\t\t ARTICLE XIV - POSSESSION OF POLICY\n\t The Corporation will keep possession of the Policy.\nThe Corporation agrees from time to time to make the Policy\navailable to the Executive or the Prudential for the purpose of\nendorsing or filing any change of beneficiary on the Policy but\nthe Policy will promptly be returned to the Corporation.\n\t \t ARTICLE XV - MERGER; GOVERNING LAW\n\t This Agreement sets forth the entire Agreement of the\nparties hereto, and any and all prior agreements, to the extent\ninconsistent herewith, are hereby superseded. This Agreement\nwill be governed by the laws of the State of New York.\n\t\t ARTICLE XVI - INTERPRETATION\n\t Where appropriate in this Agreement, words used in the\nsingular will include the plural and words used in the masculine\nwill include the feminine.\n\t IN WITNESS WHEREOF, the parties have hereunto set their\nhands and seals, the Corporation by its duly authorized officer,\nin the day and year first above written.\n____________________________________(L.S.) \t\t\t\tKenneth E. Goodman\n\t\t\t FOREST LABORATORIES, INC.\n\t\t\t By: _______________________________\n\t\t\t\t EXHIBIT 13\nQUARTERLY STOCK MARKET PRICES\n\t\t\t\t\t High Low ____________________________________________________________________________ April-June 1992 34 7\/8 30 - - ---------------------------------------------------------------------------- July-September 1992 40 3\/8 30 3\/4 - - ---------------------------------------------------------------------------- October-December 1992 44 7\/8 30 3\/4 - - ---------------------------------------------------------------------------- January-March 1993 43 1\/4 27 1\/2 - - ---------------------------------------------------------------------------- April-June 1993 38 1\/2 31 1\/2 - - ---------------------------------------------------------------------------- July-September 1993 37 7\/8 28 1\/4 - - ---------------------------------------------------------------------------- October-December 1993 47 7\/8 37 3\/8 - - ---------------------------------------------------------------------------- January-March 1994 52 1\/2 41 1\/2 - - ----------------------------------------------------------------------------\nAs of June 3, 1994 there were 3,211 stockholders of record of the Company's common stock.\nSELECTED FINANCIAL DATA\nNo dividends were paid on common shares during the period. PAGE\nSELECTED FINANCIAL DATA\nA. Net income per share was computed by dividing net income by the weighted average number of common and common equivalent shares during each year. All amounts give effect to the February 1991 100% stock dividend. Common equivalent shares consist of unissued shares under options and included to the extent that they have a dilutive effect. Fully dilutednet income per share is presented because of an increase in the dilutive effect of stock options (method) which resulted from the higher price of the Company's stock at the end of the year as compared with the average price during the year. The weighted average number of common and common equivalent shares outstanding for 1994 was computed as follows:\nPAGE\nFOREST LABORATORIES, INC. AND SUBSIDIARIES\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe following comments should be read in conjunction with the Consolidated Financial Statements and Notes contained therein:\nFINANCIAL CONDITION AND LIQUIDITY Net current assets increased by $21,826,000 in fiscal 1994. The increase, due principally to increases in cash and accounts receivable, resulted from the increases in sales and profits due to the continuing growth of the Company's branded promoted products, specialty controlled release generic products and the launch, during the third quarter, of Flumadine-R-. Long-term marketable securities increased as a result of the Company reinvesting a portion of its cash in securities maturing over a period of one to two years. Such securities are expected to increase the Company's yield on investments as compared to the short-term securities which they replaced. License agreements and other intangible assets increased primarily due to the final payment on the acquisition of worldwide rights to the product Flumadine. Other assets increased mostly as a result of a payment made to extinguish future royalty obligations related to the purchase of Flumadine. Deferred income taxes-current increased while non-current deferred income taxes decreased due principally to the utilization of tax benefit carryforwards recorded during fiscal 1993.\nProperty, plant and equipment increased during fiscal 1994 principally from the expansion of the Company's United States and Irish facilities in order to meet increased demand for the Company's products. The expansion will continue in fiscal 1995 in order to adequately meet the Company's needs for the manufacturing, warehousing and distribution of its existing and future products. Management believes that current cash levels, coupled with funds to be generated by on-going operations, will sufficiently support these capital expenditures and should facilitate potential acquisitions of products or companies.\nRESULTS OF OPERATIONS Net sales increased in 1994 by $66,277,000 as a result of the continued strong growth of the Company's branded promoted products, specialty controlled release generic products and the introduction of Flumadine. Net volume growth of the Company's principal promoted and generic product lines accounted for $46,103,000 of the increase. Flumadine sales during fiscal 1994 amounted to $21,660,000. Sales volume of the Company's older unpromoted product lines increased by $2,384,000, while foreign exchange translation rate declines reduced net sales by $5,936,000. The remainder of the net sales increase was attributed to price increases. Net sales for fiscal 1993 increased by $46,171,000 as compared with fiscal 1992. Volume growth of the Company's principal promoted and generic product lines, including the introduction, during 1993, of two new product line extensions, accounted for $45,982,000 of the increase. Sales decreases of the Company's older unpromoted product lines amounted to $9,925,000. The remainder of the net sales increase was attributed to price increases.\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nOther income decreased $1,390,000 during fiscal 1994 as a result of lower commission income and interest income. The lower commission income resulted from the termination, during the third quarter of fiscal 1993, of a joint marketing agreement with Rorer Pharmaceuticals, Inc. for the product DDAVP-R- . Interest income decreased due to the maturing of long-term bonds of the Commonwealth of Puerto Rico and lower interest rates in the United States. The increase in other income in fiscal 1993 as compared to 1992 was principally the result of higher commission income pursuant to the Company's joint marketing agreements with other pharmaceutical companies.\nCost of sales as a percentage of sales decreased to 18% in 1994 from 19% in 1993 and 20% in 1992 due to changes in product mix and volume and price increases.\nSelling, general and administrative expense increased by $25,587,000 during 1994. The increase is principally attributed to the continued growth of the Company's salesforce efforts ($4,645,000), and marketing activities ($19,762,000) related to the Company's principal promoted and generic product lines, including the launch of Flumadine. The increase in selling, general and administrative expense of $16,872,000 in fiscal 1993 as compared to 1992 resulted primarily from the Company's salesforce efforts and marketing activities related to the Company's principal promoted products, including the introduction of two product line extensions.\nInterest expense of $1,957,000 in fiscal 1993 and $3,706,000 in 1992 was the result of the debt incurred in connection with the purchase of a line of thyroid products. The debt was repaid during fiscal 1993 and no further interest expense is being incurred. \t\t\t\t\t Research and development increased by $5,944,000 during fiscal 1994 and $4,283,000 in 1993 as a result of the cost of conducting clinical studies in order to obtain approval of new products and the cost of developing products using the Company's controlled release technology. During fiscal 1994, there was particular emphasis on Synapton-TM- and Monurol-R-. Synapton, is the Company's controlled release formulation of physostigmine being tested for the treatment of Alzheimer's Disease. Monurol is a single dose antibiotic being tested for use in the treatment of uncomplicated urinary tract infections. The Company anticipates a continued increase in research and development expense as these and other potential products are developed and tested.\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)\nThe Company has not elected to adopt SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\" early. However, if adopted, the change would not have had a material effect on the Company's financial statements.\nInflation has not had a material effect on the Company's operations for the periods presented.\n\t\tFOREST LABORATORIES, INC. AND SUBSIDIARIES \t\t------------------------------------------ \t\t CONSOLIDATED FINANCIAL STATEMENTS \t --------------------------------- \t\t YEARS ENDED MARCH 31, 1994, 1993 AND 1992 \t\t -----------------------------------------\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS - - --------------------------------------------------\nBoard of Directors and Shareholders Forest Laboratories, Inc. New York, New York\nWe have audited the accompanying consolidated balance sheets of Forest Laboratories, Inc. and Subsidiaries as of March 31, 1994 and 1993, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended March 31, 1994. 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 presentation of the financial statements. 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 Forest Laboratories, Inc. and Subsidiaries as of March 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended March 31, 1994 in conformity with generally accepted accounting principles.\n\/s\/ BDO SEIDMAN ----------------------- \t\t\t\t\t BDO SEIDMAN\nNew York, New York May 2, 1994\nPAGE\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t\t\t CONSOLIDATED BALANCE SHEETS \t\t\t\t (IN THOUSANDS)\n\t\t\t\t\t\t\t MARCH 31, \t\t\t\t\t ------------------------ \t\t\t\t\t\t\t 1994 1993 \t\t\t\t\t\t --------- --------- ASSETS - - ------ Current assets: Cash (including cash equivalent investments of $181,094 $172,286 $176,336 in 1994 and $160,180 in 1993) Accounts receivable, less allowances of $4,918 in 1994 and $4,630 in 1993 111,670 90,965 Inventories 37,180 38,221 Deferred income taxes 12,172 9,039 Other current assets 5,424 4,125 \t\t\t\t\t\t -------- -------- Total current assets 347,540 314,636 \t\t\t\t\t\t -------- -------- Long-term marketable securities 47,953 20,058 \t\t\t\t\t\t -------- -------- Property, plant and equipment: Land and buildings 43,264 20,324 Machinery and equipment 21,483 19,131 Vehicles and other 8,968 9,676 \t\t\t\t\t\t -------- -------- \t\t\t\t\t\t 73,715 49,131\nLess accumulated depreciation 20,694 19,320 \t\t\t\t\t\t -------- -------- \t\t\t\t\t\t 53,021 29,811 \t\t\t\t\t\t -------- -------- Other assets: Excess of cost of investment in subsidiaries over net assets acquired, less accumulated amortization of $5,614 in 1994 and $4,988 in 1993 19,345 19,971 License agreements and other intangible assets, net 131,824 123,677 Deferred income taxes 3,787 6,520 Other 15,741 5,839 \t\t\t\t\t\t -------- -------- \t\t\t\t\t\t 170,697 156,007 \t\t\t\t\t\t -------- -------- \t\t\t\t\t\t $619,211 $520,512 \t\t\t\t\t\t ======== ======== \t\t\t\t\t\t\t\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t\t\t CONSOLIDATED BALANCE SHEETS \t\t (IN THOUSANDS, EXCEPT FOR PAR VALUES)\n\t\t\t\t\t \t\t MARCH 31, \t\t\t\t\t\t ----------------------- \t\t\t\t\t\t 1994 1993 \t\t\t\t\t\t -------- -------- LIABILITIES AND SHAREHOLDERS' EQUITY - - ------------------------------------ Current liabilities: Accounts payable $ 10,507 $ 7,958 Accrued expenses 25,552 21,191 Income taxes payable 16,164 11,996 \t\t\t\t\t\t -------- -------- Total current liabilities 52,223 41,145 \t\t\t\t\t\t -------- -------- Deferred income taxes 206 191 \t\t\t\t\t -------- -------- Commitments and contingencies\nShareholders' equity: Series A junior participating preferred stock, $1.00 par; shares authorized 1,000 in 1994 and 200 in 1993; no shares issued or outstanding Common stock $.10 par; shares authorized 250,000 in 1994 and 100,000 in 1993; issued 46,276 shares in 1994 and 45,515 shares in 1993 4,628 4,551 Capital in excess of par 266,233 253,257 Retained earnings 337,611 257,413 Cumulative foreign currency translation adjustments ( 3,817) ( 2,658) \t\t\t\t\t\t -------- -------- \t\t\t\t\t\t 604,655 512,563 Less common stock in treasury, at cost (2,587 shares in 1994 and 2,490 shares in 1993) 37,873 33,387 \t\t\t\t\t\t -------- -------- \t\t\t\t\t\t 566,782 479,176 \t\t\t\t\t\t -------- -------- \t\t\t\t\t\t $619,211 $520,512 \t\t\t\t\t\t ======== ========\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. \t\t\t\t\t\t\t\t\nPAGE\n\t\t CONSOLIDATED STATEMENTS OF INCOME \t (IN THOUSANDS, EXCEPT PER SHARE DATA)\n\t\t\t\t\t\t YEAR ENDED MARCH 31, \t\t\t\t\t ----------------------------- \t\t\t\t\t \t 1994 1993 1992 \t\t\t\t\t -------- -------- --------\nNet sales $351,641 $285,364 $239,193 Other income 9,680 11,070 9,244 \t\t\t\t\t -------- -------- -------- \t\t\t\t\t 361,321 296,434 248,437 \t\t\t\t\t -------- -------- -------- Costs and expenses: Cost of sales 64,150 53,629 48,219 Selling, general and administrative 143,695 118,108 101,236 Research and development 27,998 22,054 17,771 Interest 1,957 3,706 \t\t\t\t\t -------- -------- -------- \t\t\t\t\t 235,843 195,748 170,932 \t\t\t\t\t -------- -------- -------- Income before income taxes 125,478 100,686 77,505\nIncome taxes 45,280 36,379 27,936 \t\t\t\t\t -------- -------- -------- Net income $ 80,198 $ 64,307 $ 49,569 \t\t\t \t\t ======== ======== ======== Earnings per common and common equivalent share:\nPrimary $1.75 $1.42 $1.13 \t\t\t\t\t \t===== ===== ===== Fully diluted $1.72 $1.41 $1.13 \t\t\t\t\t\t===== ===== ===== Weighted average number of common and common equivalent shares outstanding:\nPrimary 45,957 45,432 43,992 \t\t\t\t\t ====== ====== ====== Fully diluted 46,614 45,764 44,044 \t\t\t\t\t ====== ====== ======\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nPAGE\n\t \t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t\tCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY \t\t YEARS ENDED MARCH 31, 1994, 1993 AND 1992\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t\t CONSOLIDATED STATEMENTS OF CASH FLOWS \t\t\t\t (IN THOUSANDS) \t\t\t\t\t\t\t\t\t \t\t \t\t\t\t YEAR ENDED MARCH 31, \t\t\t\t\t -------------------------------- \t\t\t\t\t \t1994 1993 1992 \t\t\t\t\t -------- -------- -------- Cash flows from operating activities: Net income $ 80,198 $ 64,307 $ 49,569 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 3,763 3,868 3,581 Amortization 6,915 6,646 6,730 Deferred income tax benefit ( 385) ( 13,797) ( 2,491) Foreign currency transaction \t (gain) loss ( 240) 108 ( 189) Net change in operating assets \t and liabilities: \t Decrease (increase) in: \t Accounts receivable, net ( 20,705) ( 18,224) ( 18,803) \t Inventories 1,041 ( 7,457) ( 10,558) \t Other current assets ( 1,299) ( 872) 119 \t Increase (decrease) in: \t Accounts payable 2,549 ( 864) 2,624 \t Accrued expenses 4,361 3,087 6,321 \t Income taxes payable 4,168 6,048 3,834 \t Decrease (increase) in other \t assets ( 9,902) ( 5,280) 40 \t\t\t\t\t -------- -------- ------ \t Net cash provided by operating \t activities 70,464 37,570 40,777 \t\t\t\t\t -------- -------- ------ Cash flows from investing activities: Purchase of property, plant and equipment, net ( 27,070) ( 6,255) ( 3,642) Purchase of license agreements and other intangibles ( 14,436) ( 12,612) ( 962) Redemption (purchase) of long-term marketable securities ( 27,895) 894 \t\t\t\t\t -------- -------- -------- \t Net cash used in investing \t activities ( 69,401) ( 17,973) ( 4,604) \t\t\t\t\t -------- -------- --------\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t\t CONSOLIDATED STATEMENTS OF CASH FLOWS \t\t\t\t (IN THOUSANDS)\n\t \t\t\t\t\t YEAR ENDED MARCH 31, \t\t\t\t\t\t ---------------------------- \t\t\t\t\t \t1994 1993 1992 \t\t\t\t\t -------- ------- --------\nCash flows from financing activities: Net proceeds from common stock options exercised by employees under stock option plans and warrants 6,682 8,907 3,528 Tax benefit realized from the exercise of stock options by employees 1,885 36,180 2,443 Proceeds from sale of stock 53,386 Repayment of debt ( 23,069) ( 21,931) \t\t\t\t\t -------- -------- -------- \t Net cash provided by \t financing activities 8,567 22,018 37,426 \t\t\t\t\t -------- -------- -------- Effect of exchange rate changes on cash ( 822) ( 2,806) 342 \t\t\t\t\t -------- -------- -------- Increase in cash and cash equivalents 8,808 38,809 73,941 Cash and cash equivalents, beginning of year 172,286 133,477 59,536 \t\t\t\t\t -------- -------- -------- Cash and cash equivalents, end of year $181,094 $172,286 $133,477 \t\t\t\t\t ======== ======== ========\nSupplemental disclosures of cash flow information:\n(In thousands) 1994 1993 1992 \t\t\t\t\t -------- -------- -------- Cash paid during the year for: Interest $ 4,999 $ 2,055 Income taxes $ 39,612 7,967 24,150 \t\t\t\t\t -------- -------- --------\nSEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.\nPAGE\n\t \t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nBASIS OF CONSOLIDATION: The consolidated financial statements include the accounts of Forest Laboratories, Inc. (the \"Company\") and its subsidiaries, all of which are wholly owned. All significant intercompany accounts and transactions have been eliminated.\nINVENTORIES: Inventories are stated at the lower of cost or market, with cost determined on the first-in, first-out basis.\nLONG-TERM MARKETABLE SECURITIES: Long-term marketable securities are stated at amortized cost, which approximates market, and consist of investments in municipal bonds maturing through 1996 and bonds of the Commonwealth of Puerto Rico maturing through 2002. Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", shall be effective for the Company's fiscal year beginning April 1, 1994. The Company has not elected to adopt this statement early, however if adopted, the change would not have had a material effect on the Company's financial position and results of operations as of and for March 31, 1994.\nPROPERTY, PLANT AND EQUIPMENT AND DEPRECIATION: Property, plant and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the assets primarily by the straight-line method.\nINTANGIBLE ASSETS: The excess of cost of investment over the fair value of net assets of subsidiaries at the time of acquisition is being amortized over 35 to 40 years. The costs of obtaining license agreements and other intangible assets are being amortized over the estimated lives of the assets, 10 to 40 years.\nCASH EQUIVALENTS: Cash equivalents consist of short-term, highly liquid investments (primarily municipal bonds with interest rates that are re-set weekly) which are readily convertible into cash at par value (cost).\nREVENUE RECOGNITION: Sales are recorded in the period the merchandise is shipped.\nRESEARCH AND DEVELOPMENT: Expenditures for research and development are charged to expense as incurred.\nSAVINGS AND PROFIT SHARING PLANS: The Company's domestic and Puerto Rican subsidiaries have savings and profit sharing plans. Under these plans, substantially all non-bargaining unit employees may participate in the plans after becoming eligible (as defined). The profit sharing plan contributions are primarily at the discretion of the Company. The savings plan contributions include a matching contribution made by Company. Savings and profit sharing contributions amounted to $2,818,000, $1,959,000 and $1,601,000 for 1994, 1993 and 1992, respectively.\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)\nEARNINGS PER SHARE: Earnings per share are based on the weighted average number of common and common equivalent shares outstanding during each year. Common equivalent shares consist of the dilutive effect of unissued shares under options and warrants, computed using the treasury stock method (using the average stock prices for primary basis and the higher of average or period end stock prices for fully diluted basis). At March 31, 1994, 1993 and 1992, the primary and fully diluted common equivalent shares amounted to 2,672,000 and 3,329,000, 3,346,000 and 3,678,000 and 4,992,000 and 5,044,000, respectively.\nINCOME TAXES: The Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\", for the year ended March 31, 1993 and, accordingly, has accounted for income taxes on the liability method. Under the liability method, deferred income taxes are provided on the differences in bases of assets and liabilities between financial reporting and tax returns using enacted tax rates. Previously, the Company utilized the deferred method when accounting for income taxes. The effect of this accounting change had an immaterial impact on the consolidated results ofoperations for the year ended March 31, 1993 and no cumulative effect adjustment was required as of April 1, 1992.\n2. BUSINESS OPERATIONS:\nThe Company and its subsidiaries, which are located in the United States, Puerto Rico, the United Kingdom and Ireland, manufacture and market ethical and other pharmaceutical products. Information about the Company's sales and profitability by different geographic areas for the years ended March 31, 1994, 1993 and 1992 follows:\nPAGE\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n2.\t BUSINESS OPERATIONS: (CONTINUED)\nThe Company sells primarily in the United States and European markets. Operating profit is net sales less operating expenses, and does not include other income, unallocated expenses or income taxes. PAGE\n\t \t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n3. INVENTORIES:\nInventories consist of the following:\nMARCH 31, (IN THOUSANDS) 1994 1993 \t\t\t\t\t\t ------- ------- Raw materials $13,250 $11,490 Work in process 3,012 2,664 Finished goods 20,918 24,067 \t\t\t\t\t\t\t ------- ------- \t\t\t\t\t\t\t $37,180 $38,221 \t\t\t\t\t\t\t ======= ======= 4. OTHER ASSETS:\nLicense agreements and other intangible assets consist of the following:\nMARCH 31, (IN THOUSANDS, EXCEPT FOR ESTIMATED WHICH ARE STATED IN YEARS) Estimated - - ----------------------------------------- lives 1994 1993 \t\t\t\t\t --------- -------- -------- License agreements 10-40 $ 67,799 $ 53,361 Trade names 20-40 34,190 34,190 Goodwill 25-40 29,412 29,412 Non-compete agreements 10-13 22,987 22,987 Customer lists 10 3,506 3,506 Other 10-40 3,568 3,570 \t\t\t\t\t\t-------- -------- \t\t\t\t\t\t\t 161,462 147,026 Less accumulated amortization ( 29,638) ( 23,349) \t\t\t\t\t\t-------- -------- \t\t\t\t\t\t\t$131,824 $123,677 \t\t\t\t\t\t\t======== ======== 5. ACCRUED EXPENSES:\nAccrued expenses consist of the following:\nMARCH 31, (IN THOUSANDS) 1994 1993 \t\t\t\t\t ------- -------\nEmployee compensation and other benefits $ 6,975 $ 6,620 Clinical research 3,451 3,800 Customer discounts 4,045 2,500 Royalties 3,064 2,800 Other 8,017 5,471 \t\t\t\t\t\t\t ------- ------- \t\t\t\t\t\t\t $25,552 $21,191 \t\t\t\t\t\t\t ======= =======\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. COMMITMENTS:\nLEASES: The Company leases manufacturing, office and warehouse facilities, equipment and automobiles under operating leases expiring through 1999. Rent expense approximated $4,215,000 for 1994, $3,213,000 for 1993 and $3,142,000 for 1992. Aggregate minimum rentals under noncancellable leases are as follows:\nYEAR ENDING MARCH 31, (IN THOUSANDS) 1995 $3,152 1996 1,883 1997 1,002 1998 413 1999 350 \t\t\t\t\t\t\t\t ------ \t\t\t\t\t\t\t\t $6,800 \t\t\t\t\t\t\t ======\n\t\t\t\t\t\t\t\t\t ROYALTY OBLIGATIONS: In connection with the product rights acquisition of Armour-R- Thyroid, Levothroid-R- and Thyrolar-R- on December 31, 1990, the Company was required to pay royalties of 10% of the related product sales in excess of defined amounts. In December 1992, the Company prepaid such royalties for $7,000,000. Royalty expense under this agreement totalled $778,000, $778,000 and $570,250 in 1994, 1993 and 1992, respectively. At March 31, 1994, $5,250,000 remains prepaid and is appropriately included and other assets and is being amortized over seven years.\nIn July 1992, the Company acquired the worldwide rights to the product Flumadine-R- for $20 million. The Company paid $10 million upon the execution of the agreement, and the remaining $10 million was paid at the time of the product launch in October 1993. The Company was also required to pay royalties of 10% of product sales in excess of defined amounts. In January 1994, the Company prepaid such royalties for $10 million. Royalty expense under this agreement for 1994 amounted to $417,000. At March 31, 1994, $9,583,000 remains prepaid and is appropriately included in current and other assets is being amortized over eleven years.\nIn 1984 and 1986, the Company entered into agreements for research and development (the \"1984 Prutech Agreement\" and \"1986 Prutech Agreement\") with Prutech Research and Development Partnership (\"Prutech\"). In accordance with the provisions of these agreements, the Company granted Prutech nonexclusive licenses to certain of the Company's controlled release technologies for the purpose of developing certain products. Prutech contracted with the Company to perform research necessary to develop the products. In addition, Prutech granted the Company options (some of which were exercised) to acquire exclusive manufacturing and marketing rights to the products if they are successfully developed. Under the 1984 Prutech Agreement, the Company is paying to Prutech royalties of 12% on sales of the products. The Company paid to Prutech royalty payments of $7,732,000, $6,273,000 and $5,200,000 in 1994, 1993 and 1992, respectively. Under the 1986 Prutech Agreement, the Company will pay to Prutech an initial royalty on sales of the products of 7%, decreasing to 2%, through December 31, 1999. No royalties have been incurred under this agreement.\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES \t\t\t\t\t \t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. SHAREHOLDERS' EQUITY:\nPREFERRED STOCK PURCHASE RIGHTS: On February 18, 1988, the Company's Board of Directors declared a distribution of one preferred stock purchase right for each outstanding share of common stock. Each right will entitle the holder to buy one one-hundredth of a share of authorized Series A Junior Participating Preferred Stock (\"Series A Preferred Stock\") at an exercise price of $60 per right, subject to adjustment. Prior to becoming exercisable, the rights are evidenced by the certificates representing the common stock may not be traded apart from the common stock. The rights become exercisable on the tenth day after public announcements that a person or group has acquired, the right to acquire, 20% or more of the Company's outstanding common stock, or an announcement of a tender offer that would result in a beneficial ownership by a person or group of 20% or more of the Company's common stock.\nIf, after the rights become exercisable, the Company is a party to certain merger or business combination transactions, or transfers 50% or more of its assets or earning power, or if an acquirer engages in certain self-dealing transactions, each right (except for those held by the acquirer) will entitle its holder to buy a number of shares of the Company's Series A Preferred Stock or, in certain circumstances, a number of shares of the acquiring company's common stock, in either case having a value equal to two-and-one-half times the exercise price of the right. The rights may be redeemed by the Company at any time up to ten days after a person or group acquires 20% or more of the Company's common stock at a redemption price of $.001 per right. The rights will expire on February 17, 1998.\nSTOCK OPTIONS: The Company has various Employee Stock Option Plans whereby options to purchase an aggregate of 9,800,000 shares of common stock have been or remain to be issued to employees of the Company and its subsidiaries at prices not less than the fair market value of the common stock at the date of grant. \t\t\t\t\t\t\nPAGE\nFOREST LABORATORIES, INC. AND SUBSIDIARIES \t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. SHAREHOLDERS EQUITY: (CONTINUED)\nTransactions under the stock option plans and individual non-qualified options not under the plans are summarized as follows: \t\t\t\t\t\t\t\t\t Non- \t\t\t\t\t\t Stock qualified \t\t\t\t\t\t option individual \t\t\t\t\t\t plans options \t\t\t\t\t\t --------- ---------- Shares under option at April 1, 1991 (at $4.02 to $24.25 per share) 5,050,112 3,171,498 Granted (at $35.31 to $39.69 per share) 302,650 8,000 Exercised (at $4.02 to $24.25 per share) ( 315,510) (1,501,000) Cancelled ( 92,090) \t\t\t\t\t\t --------- --------- Shares under option at March 31, 1992 (at $6.59 to $39.69 per share) 4,945,162 1,678,498 Granted (at $32.25 to $42.81 per share) 741,100 8,000 Exercised (at $6.59 to $24.25 per share) (1,719,884) ( 21,800) Cancelled ( 45,890) \t\t\t\t\t\t --------- ---------\nShares under option at March 31, 1993 (at $6.59 to $42.81 per share) 3,920,488 1,664,698\nGranted (at $30.00 to $44.50 per share) 422,650 6,000 Exercised (at $9.91 to $42.81 per share) ( 349,165) ( 11,600) Cancelled ( 67,055) \t\t\t\t\t --------- --------- Shares under option at March 31, 1994 (at $6.59 to $44.50 per share) 3,926,918 1,659,098 \t\t\t\t\t\t ========= ========= Options exercisable at March 31: 1992 3,751,442 1,585,698 1993 2,452,168 1,612,498 1994 2,511,247 1,607,498\nAt March 31, 1994 and 1993, 348,373 and 709,968 shares, respectively, were available for grant.\n\t\t\t FOREST LABORATORIES, INC.\n\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. CONTINGENCIES:\nThe Company is subject to several product liability and other claims which Management does not believe will have a material effect on the Company.\nThe Company and certain of its officers are defendants in a putative class action alleging certain misrepresentations in disclosures related to Micturin. The Company is a nominal defendant in a putative derivative action against the Company's directors arising from such disclosures and challenging the validity of certain options granted to the director defendants. Management believes the claims are without merit and intends to vigorously defend the actions.\nThe Company has been served in several civil actions in various federal district courts and in the Superior Court of California in San Francisco. In each case, the actions were filed against many major pharmaceutical manufacturers and suppliers, including the Company, alleging price discrimination in the sale of pharmaceutical products in violation of federal law (and, in the case of the California actions, California law) and related anti-trust claims. The actions were brought by pharmacies (in certain cases purporting to represent a class) and seek injunctive relief and monetary damages. The manufacturer defendants, including the Company, have filed motions to dismiss and demurrers in each of the actions. On February 4, 1994, the Judicial Panel on District Litigation has ordered the federal actions consolidated for coordinated proceedings in the Federal District Court for the Northern District of Illinois (Chicago). The Company believes the lawsuits are without merit and intends to defend them vigorously.\n9. OTHER INCOME:\nOther income consists of the following:\nYEAR ENDED MARCH 31, (IN THOUSANDS) 1994 1993 1992 - - ------------------------------------ ------ ------- ------ Interest and dividends $7,077 $ 7,521 $5,489 Research revenue 51 1,228 Commissions 1,342 3,245 1,874 Other 1,261 253 653 \t\t\t\t\t ------ ------- ------ \t\t\t\t\t $9,680 $11,070 $9,244 \t\t\t\t\t ====== ======= ====== 10. INCOME TAXES:\nThe Company and its mainland U.S. subsidiaries file a consolidated federal income tax return.\nIncome before income taxes includes income from foreign operations of $7,615,000, $8,163,000 and $6,025,000 for the years ended March 31, 1994, 1993 and 1992, respectively.\nThe Company has tax holidays in Puerto Rico and Ireland which expire primarily in 1997 and 2010, respectively. The net impact of these tax holidays was to increase net income and net income per share (primary) by approximately $1,938,000 and $.04 in 1994, $2,571,000 and $.06 in 1993 and $2,924,000 and $.07 in 1992.\n\t \t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n10. INCOME TAXES: (CONTINUED)\nThe provision for income taxes consists of the following:\nYEAR ENDED MARCH 31, (IN THOUSANDS) 1994 1993 1992 - - ----------------------------------- ------- ------- ------- Current: U.S. federal $36,845 $ 7,810 $23,020 State and local 4,909 3,575 3,364 Foreign 2,026 2,611 1,600 \t\t\t ------- ------- ------- \t\t\t\t\t 43,780 13,996 27,984 \t\t\t\t\t ------- ------- ------- Deferred: Domestic ( 382) ( 13,677) ( 2,697) Foreign ( 3) ( 120) 206 \t\t\t\t ------- ------- ------- \t\t\t\t\t ( 385) ( 13,797) ( 2,491) \t\t\t\t\t ------- ------- ------- Charge in lieu of income taxes, relating to the tax effect of stock option tax deduction 1,885 36,180 2,443 \t\t\t\t\t ------- ------- ------- \t\t\t\t\t $45,280 $36,379 $27,936 \t\t\t\t\t ======= ======= ======= \t\t\t\t\t\t\t\t No provision has been made for income taxes on the undistributed earnings of the Company's foreign subsidiaries of approximately $35,391,000 at March 31, 1994, as the Company intends to indefinitely reinvest such earnings.\nThe reasons for the difference between the provision for income taxes and expected federal income taxes at statutory rates are as follows:\nYEAR ENDED MARCH 31, (IN THOUSANDS) 1994 1993 1992 - - ----------------------------------- ------- ------- ------- Expected federal income taxes $43,917 $34,233 $26,352 State and local income taxes, less federal income tax benefit 3,274 3,745 2,581 Benefit of tax-exempt earnings of subsidiaries ( 2,348) ( 2,838) ( 2,762) Benefit of tax-exempt earnings not available (utilized) in current year ( 234) 126 37 Tax effect of permanent differences 631 838 171 Other 40 275 1,557 \t\t\t\t ------- ------- ------- \t\t\t\t\t $45,280 $36,379 $27,936 \t\t\t\t\t ======= ======= =======\n\t\t FOREST LABORATORIES, INC. AND SUBSIDIARIES\n\t NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n10. INCOME TAXES (CONTINUED)\nNet deferred income taxes as of March 31, 1994 and 1993 consist of the following (IN THOUSANDS): \t\t\t\t\t\t\t 1994 1993 \t\t\t\t\t\t ------- ------- Inventory valuation $ 992 $ 776 Receivable reserves and other allowances 6,848 3,616 State and local net operating loss carryforwards 3,724 6,814 Depreciation ( 1,523) ( 1,583) Amortization 3,353 1,106 Tax credits and other carryforwards 226 1,753 Accrued liabilities 1,162 624 Other 971 2,262 \t\t\t\t\t\t ------- ------- \t\t\t\t\t\t $15,753 $15,368 \t\t\t\t\t ======= =======\nDeferred income tax benefits for the year ended March 31, 1992 resulted from the recognition of revenue and expense items in different periods for financial reporting and tax purposes. Principally, items making up deferred income taxes include tax over book depreciation, provisions for uncollectible accounts receivable and provisions for inventory.\n11. QUARTERLY FINANCIAL DATA (UNAUDITED): (IN THOUSANDS, EXCEPT PER SHARE DATA) \t\t\t\t\t\t\t\t Primary \t\t\t\t\t\t\t\t earnings 1994 Net sales Gross profit Net income per share - - ---- --------- ------------ ---------- --------- First quarter $79,251 $65,174 $17,544 $.39 Second quarter 82,814 67,375 19,547 .43 Third quarter 96,996 79,425 20,809 .45 Fourth quarter 92,580 75,517 22,298 .48\n- - ---- First quarter $65,743 $52,464 $13,969 $.31 Second quarter 69,841 56,347 15,797 .35 Third quarter 75,472 61,701 16,739 .37 Fourth quarter 74,308 61,223 17,802 .39\nFully diluted earnings per share are not presented, as the results obtained are substantially the same as primary earnings per share.\nPAGE\n\t\t\t\t EXHIBIT 24(a)\nCONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nForest Laboratories, Inc. New York, New York\nWe hereby consent to the incorporation by reference in the Registration Statement of Forest Laboratories, Inc. on Form S-8, filed with the Securities and Exchange Commission on November 13, 1990, of our reports dated May 2, 1994, on the consolidated financial statements and schedules of Forest Laboratories, Inc. and Subsidiaries, included or incorporated by reference in the Forest Laboratories, Inc. Annual Report on Form 10-K for the year ended March 31, 1994.\n\t\t\t\t \/s\/ BDO Seidman \t\t\t\t ------------------------- \t\t\t\tBDO Seidman\nNew York, New York June 27, 1994","section_15":""}
{"filename":"731190_1994.txt","cik":"731190","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL\nInternational Technology Corporation, a Delaware corporation (the Company or IT), provides a wide range of environmental management services and technologies including the assessment, decontamination, and remediation of situations involving hazardous materials and pollution prevention and minimization. The Company was incorporated in 1983; the earliest antecedent of the Company commenced operations in California in 1926.\nThe Company's services are provided to a broad array of governmental and commercial entities predominantly in the U.S. market. The Company's business strategy is to provide its environmental services on a turnkey basis, particularly by focusing on its capabilities to manage complex environmental issues from the initial assessment of the level and extent of contamination through the design, engineering and execution of a solution. In recent years, the Company has worked on several hundred Superfund sites for various governmental and commercial clients.\nDemand for the Company's services is heavily influenced by the level of enforcement of existing and new environmental laws and regulations, funding levels for government projects and spending patterns of commercial clients. Within the last three years, spending by commercial clients has slowed primarily due to reduced implementation and enforcement activities by government regulatory agencies and weak economic conditions. During the same period, however, the Company has experienced significant growth in its business with federal, state and local governmen- tal clients, particularly the U.S. Department of Defense (DOD) and the U.S. Department of Energy (DOE), resulting in total federal, state and local governmental revenues constituting 63% of the Company's revenues in fiscal year 1994. (See Business - Operations - Customers.)\nThe operations of the Company are performed subject to a comprehensive federal, state, and local environmental regulatory structure. (See Business - Operations - Regulations.) Although this regulatory structure creates opportunities for the Company, the analysis, assessment, and remediation of hazardous substanc- es necessarily involves significant risks, including the possibility of damages or injuries caused by the escape of hazardous substances into the environment. (See Business - Operations - Environmental Contractor Risks, and Legal Proceed- ings.)\nIn December 1987, IT adopted a strategic restructuring program to focus its resources on developing its engineering, consult- ing, analytical and remediation businesses. The program included a formal plan to divest its transportation, treatment and disposal operations, through sale of some facilities and closure of certain other facilities. Although the Company believes it has gained valuable, marketable experience through the closure of its inactive hazardous waste disposal sites in Northern California, the Company has incurred and will incur significant closure and post-closure costs for the sites. (See Business - Discontinued Operations - Transportation, Treatment and Disposal). Continuing with the ongoing restructuring of its businesses, the Company sold its pollution control manufacturing business in fiscal year 1992. (See Business - Discontinued Operations - Pollution Control Manufacturing.)\nEffective April 1, 1993, the Company realigned its existing business into three areas: Environmental Services (including Pollution Control Engineering), Analytical Services, and Construction and Remediation. As a result of this realignment, there has been a consolidation of domestic environmental services offices. Further, the Company disposed of most of its European businesses and refocused on its major domestic busi- nesses. The success of the Company in developing its capabili- ties is demonstrated by IT's designation by Engineering News- Record as the largest hazardous waste design firm for the last five years.\nOn June 28, 1994, pursuant to a definitive agreement signed on May 2, 1994, the Company and an affiliate of Corning Incorporat- ed (Corning) combined the two companies' environmental analyti- cal services businesses into a newly formed 50\/50 jointly-owned company (the joint company). The joint company will operate independently with a separate board of directors comprised of representation from IT and Corning and will provide services to the Company on a competitive basis. In connection with the transaction, IT and Corning will contribute the net assets of their respective laboratory businesses into the joint company. The financing of the joint company will be provided by a $60,000,000 bank line of credit. (See Business - Operations - Analytical Services.)\nBACKGROUND\nHazardous materials management and remediation are widely acknowledged as a significant national priority. As of December 31, 1992, the United States Environmental Protection Agency (USEPA) had designated approximately 1,200 sites as Superfund locations with significant concentrations of hazardous materi- als, although less than 25% of these sites had undergone substantial remediation. In addition, there are a large number of small commercial and governmental sites that will require cleanup. The assessment, decontamination and remediation of hazardous sites are governed by increasingly complex environmen- tal and occupational safety and health regulations administered by numerous federal, state and local agencies.\nThe Company's clients, whether in the governmental or the commercial sector, are continuing to require a turnkey solution, in which a single supplier or team takes responsibility for the entire process from identification and assessment through remediation. Successful remediation of hazardous sites requires a multidisciplinary approach, since such sites typically involve a variety of waste which affects air, soil and\/or water. Depending on the circumstances, the required skills may include analytical chemistry, risk assessment, computer modeling, ambient air monitoring, process and design engineering, and construction\/remediation. The application of these disciplines to solve client problems requires substantial operational know- how, and the Company believes that it is well-positioned to solve client problems because of the combination of its capabil- ities and experience. Additionally, the Company's technical expertise and operational know-how are sought by other firms for project-specific teaming and joint venture relationships, thereby allowing the Company access to an increased number of large scale governmental and commercial programs.\nOPERATIONS\nThe major part of IT's business is the management of complex projects involving the assessment, planning and execution of the decontamination and restoration of property, plant and equipment that have been contaminated by hazardous substances. These projects include the cleanup of rivers, streams and groundwater contaminated by chemical substances; buildings, production facilities and storage sites contaminated with hazardous chemical and\/or radioactive materials; and land disposal sites where hazardous or toxic substances have been improperly disposed and pose a threat to the surrounding environment. These projects require considerable engineering and analytical work to determine the substances involved, the extent of the contamination, the appropriate alternatives for containing or removing the contamination, and the selection of the technolo- gies for treatment, including transportable treatment equipment, to perform the cleanup of the site. The Company is involved in many areas of the United States in the assessment or cleanup phases of site remedial action projects.\nAdditionally, the Company performs a variety of consulting services for clients to help them comply with environmental and\/or health and safety regulations. The Company also provides assistance to these clients in developing corporate policies and procedures in areas such as pollution prevention and waste minimization that integrate environmental regulations into their business decisions.\nEnvironmental Services (ES)\nES performs consulting services, site assessment\/characteriza- tion, facility decontamination\/ decommissioning, and site remediation. In the remediation area, ES generally handles projects involving less than $5,000,000 in revenues with larger projects being handled by Construction and Remediation. ES represents the largest IT business area, generating approximate- ly 63% of the Company's revenues in fiscal year 1994. The Company operates approximately 34 ES regional offices located across the U.S.\nThe Company's clients may have need for environmental management services with respect to contamination of air, water or soil. Federal legislation such as the Clean Air Act and Safe Drinking Water Act provide environmental regulations which require compliance by the Company's clients. Environmental problems generally require multidisciplinary capabilities. While some offices specialize in one capability (e.g., air quality), the typical ES office is staffed by professionals with expertise in a variety of disciplines and the operating experi- ence required to provide clients with turnkey, cost-effective environmental solutions. The turnkey services strategy supports the Company's marketing efforts toward developing partnering arrangements with clients in which IT is the primary supplier of all client environmental management services.\nES provides a wide range of environmental management services including remedial design, environmental permitting, facility siting and design, environmental compliance\/auditing, risk assessment\/management, environmental assessment\/characteriza- tion, facility decontamination\/decommissioning, chemical packaging services, underground storage tank (UST) or above- ground storage tank (AST) management, emergency response and remediation.\nPollution Control Engineering (PCE)\nThe PCE group of ES provides a broad range of environmental services including consulting engineering, pollution prevention, waste minimization, permitting assistance, and equipment design, installation, and start-up services. Serving domestic and international clients in industries such as refining, petrochem- ical, pharmaceutical, chemical and other manufacturing, this group's particular focus is pollution prevention, waste minimi- zation and thermal incineration. Although the PCE group currently represents only a small portion of the Company's revenues (approximately 3% in fiscal year 1994, which are included in the revenues of ES above), this group is focused on a market segment with growth potential. While providing a broad range of engineering and consulting services, PCE has been responding to this market through evaluation, redesign and re- engineering of client manufacturing processes. The Company's mobile on-site incineration Hybrid Thermal Treatment System (HTTS) units utilize the thermal construction capabilities of this group. The HTTS technology has found principal applica- tions on large scale remediation projects and is suitable for use at integrated hazardous waste treatment facilities. (See Business - Operations - Construction and Remediation.)\nAnalytical Services (AS)\nOn June 28, 1994, pursuant to a definitive agreement signed on May 2, 1994, the Company and Corning combined the two companies' environmental analytical services businesses into a newly formed joint company. The joint company will operate independently with a separate board of directors comprised of representation from IT and Corning, and will provide services to the Company on a competitive basis. In connection with the transaction, IT and Corning will contribute the net assets of their respective laboratory businesses into the joint company. Additionally, IT issued to Corning 333,000 shares of IT common stock and a five- year warrant to purchase 2,000,000 shares of IT common stock at $5.00 per share. The financing of the joint company will be provided by a $60,000,000 bank line of credit. IT's 50 percent investment in the joint company will be accounted for under the equity method. An aggressive integration plan will be imple- mented in the early stages of operations of the joint company. The plan will include consolidation and closure of redundant lab facilities and equipment, a reduction in force to eliminate duplicative overhead and excess capacity and a consolidation of laboratory management and accounting systems, resulting in productivity gains achieved through economies of scale. Consequently, it is estimated that the joint company will incur a charge for integration of approximately $20,000,000, princi- pally non-cash, in the quarter ending June 30, 1994. IT will reflect 50 percent of such charge in its financial statements in the same quarter. Upon completion of the integration process, the joint company will have estimated revenues of $150,000,000 and employ approximately 1,300 people in its laboratory network throughout the United States.\nThe Company's AS area, now part of the joint company, has provided qualitative and quantitative analytical chemistry services to governmental and commercial clients. Prior to the IT\/Corning transaction, the Company operated ten analytical laboratories located across the U.S. The ten laboratory facili- ties include: one lab which is dedicated to radiological analyses; two labs which perform radiological, chemical, and mixed waste analyses; five labs dedicated to a broad range of chemical analyses; and two specialty labs, one dedicated to air analyses and one dedicated to dioxin testing. This group provides routine and specialty chemical analyses of organic, inorganic, and biological constituents in chemical and radio- chemical mixed wastes, air, water and soil; geotechnical analyses to establish design parameters; and non-routine analyses of dioxin, pesticides, and polychlorinated biphenyl compounds (PCBs). The AS area provides specialized analyses of radioactive and radiochemical mixed wastes including bioassay, immunoassay, and environmental radiochemistry. Although IT's analytical services have been frequently utilized as part of projects performed by ES and C&R, services supporting those Company business units have represented only approximately 30 percent of AS revenues. The majority of AS revenues resulted from analytical work performed directly for federal, state and local governmental agencies or commercial clients which include other environmental management firms. AS revenues in fiscal year 1994 represented approximately 14% of the Company's revenues.\nConstruction and Remediation (C&R)\nC&R provides turnkey capabilities for site cleanups, as well as remedial construction, mobile treatment, and decontamina- tion\/decommissioning capabilities. In the area of remedial construction, IT offers diverse services, such as excavation and isolation, installation of subsurface recovery systems, thermal treatment solutions, bioremediation approaches, chemical treatment, soil washing, fixation or stabilization, facility or site closures, solidification\/stabilization, landfill cell construction, and slurry wall and cap installation. In fiscal year 1994, C&R generated approximately 23% of the Company's revenues.\nOn large scale remediation projects (generally greater than $5,000,000 in revenues), C&R utilizes IT's various capabilities to assess, design, and implement environmental solutions, and design treatment systems. The preferred solution to many hazardous waste remediation projects is to locate treatment equipment on site. IT's proprietary HTTS system was designed by the Company to incinerate large quantities of hazardous waste on-site. From the introduction of HTTS technology in 1987 through fiscal year 1994, the Company has processed approximate- ly 639,000 tons of contaminated materials at various projects. (See Business - Operations - Environmental Contractor Risks.)\nCurrently, C&R is utilizing the HTTS technology for the incineration of hazardous materials at the Sikes Disposal Pits Superfund site near Houston, Texas, which is nearing completion, and at the Bayou Bonfouca Superfund site in Slidell, Louisiana. In September 1992, C&R was awarded the thermal remediation contract at the Superfund site in Times Beach, Missouri. In April 1994, C&R, with a partner, was the apparent low bidder on a contract utilizing an HTTS unit at the Texarkana Wood Process- ing Company Superfund site in Texarkana, Texas; however, award of this project has been delayed pending a review of the use of incineration technology at that site requested by a local Congressman. In June 1994, the Company was the apparent low bidder for a contract utilizing an HTTS unit at the American Creosote site in Winnfield, Louisiana. The formal contract award is expected in 30 days.\nTechnology Development\nIT emphasizes technology development and the innovative application of existing methods. The Company's technology development program is directed toward the internal development of technologies as well as the evaluation of technologies developed outside the Company. In addition, the Company operates the USEPA Test & Evaluation Facility in Cincinnati, Ohio, which is available for private-party use.\nThe Company's commitment to technology development is demonstrated by the IT Technical Associates Program which recognizes associates who have a unique value to the Company due to their technical qualifications and accomplishments. This program provides a forum for communication of IT's latest advances in various technical disciplines to associates and clients.\nThe Company's technology development program has continued to focus on the identification and evaluation of innovative technologies which present commercialization opportunities for IT. The Company has obtained an exclusive license for photocat- alytic oxidation technology applied to the destruction of air toxics. IT also licensed a chemically-enhanced soil- or waste- washing process for the treatment of certain refinery wastes and an analytical method to identify a particular class of toxic substances in oil industry wastewaters.\nCustomers\nThe Company's services are provided to a broad range of federal, state and local governmental and commercial clients in the U.S. market. Demand for the Company's services is heavily influenced by the level of implementation and enforcement of existing and new environmental regulation and funding levels for governmental projects and by spending patterns of commercial clients. Over the last several fiscal years, the Company has experienced a significant shift in its revenues from the commercial sector to the governmental sector.\nFederal, State and Local Governmental Clients\nDue to its technical expertise and turnkey capabilities, the Company has successfully bid on and executed contracts with federal and other governmental agencies for the performance of various CERCLA and RCRA (as defined below) activities. (See Business - Operations - Regulations.) The Company's governmen- tal contracts can generally be canceled, delayed or modified at the sole option of the client and are typically subject to annual funding limitations and public sector budgeting con- straints.\nThe following table shows, for the last three years, the Company's revenues attributable to federal, state and local government contracts as a percentage of the Company's total consolidated revenues:\nCommercial Clients\nThe Company serves numerous commercial clients including chemical, petroleum and other manufacturing firms, utilities, and real estate and transportation service companies. A substantial portion of the Company's commercial work represents new contracts awarded by existing clients. No single commercial client accounted for 10% of the Company's revenues in fiscal years 1994, 1993 or 1992.\nCompetition\nThe environmental management industry is very competitive and requires professional personnel with technical and project management skills. The Company believes that the principal competitive factors in all areas of its business are operational experience, technical proficiency, breadth of services offered, local presence and price. In certain aspects of the AS and C&R areas of the Company's business, substantial capital investment is required for facilities and equipment.\nIncreased competition, combined with changes in client procurement procedures, has resulted in recent general market trends toward lower contract margins, unfavorable changes in contract terms and conditions in areas such as indemnification of contractors, and a client preference for fixed-price arrange- ments for environmental management contracts. Additionally, certain of the Company's larger competitors have greater financial resources which allow for better access to bonding and insurance markets. These larger competitors have a competitive advantage over the Company in providing the financial assurance instruments which are frequently required by clients. The entry of aerospace and other defense contractors, and international construction and engineering firms into the environmental management industry has materially increased the level of competition for major federal governmental contracts and programs, which have been the primary source of the Company's revenue over the three-year period ended March 31, 1994.\nThe Company faces competition from a diverse array of small and large organizations in each of its three business areas:\n- - ES: national or regional environmental management firms; national, regional and local architectural, engineering and construction firms; environmental management divisions or subsidiaries of international engineering, construction and aerospace companies; and hazardous waste generators which have developed in-house capabilities similar to those of the Company.\n- - AS: a few national, several regional and many single-location analytical services' firms; analytical services' divisions or subsidiaries of national or regional environmental management companies; and laboratory operations associated with universi- ties or other nonprofit or governmental agencies.\n- - C&R: national environmental management firms; and national or regional construction firms.\nRegulations\nThe Company and its clients are subject to extensive and evolving environmental laws and regulations which affect the demand for many of the services offered by the Company (see Business - Operations - Environmental Contractor Risks) and create certain significant risks for the Company in providing its services and at its inactive disposal sites in Northern California. (See Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and dispos- al.) The principal environmental legislation affecting the Company and its clients is described below.\nNational Environmental Policy Act of 1969 (NEPA). Under NEPA, all federal agencies must consider ecological factors when dealing with activities that may have an impact on the environ- ment. Among other things, NEPA was the first federal legisla- tion to establish guidelines and requirements for environmental baseline studies, impact assessments and mitigation studies for a variety of major industrial and governmental projects, including development and construction of power plants and transmission lines, pipelines, highways, landfills, mines, reservoirs and residential and commercial developments.\nResource Conservation and Recovery Act of 1976 (RCRA). RCRA regulates the treatment, storage and disposal of hazardous and solid wastes. The 1984 Hazardous and Solid Waste Amendments to RCRA (HSWA) expanded RCRA's scope by providing for the listing of additional wastes as hazardous and lowering the quantity threshold of wastes subject to regulation. HSWA also imposes restrictions on land disposal of certain wastes, prescribes more stringent management standards for hazardous waste disposal sites, sets standards for UST management and provides for corrective action procedures. Under RCRA, liability and stringent management standards are imposed on a person who is a generator or transporter of hazardous waste or an owner or operator of a waste treatment, storage or disposal facility.\nComprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA). CERCLA addresses cleanup of sites at which there has been or may be a release of hazardous substances into the environment. CERCLA assigns liability for costs of cleanup and damage to natural resources to any person who, currently or at the time of disposal of a hazardous substance, owned or operated any facility at which hazardous substances were deposited; to any person who by agreement or otherwise arranged for disposal or treatment, or arranged with a transporter for transport of hazardous substances owned or possessed by such person for disposal or treatment by others; and to any person who accepted hazardous substances for trans- port to disposal or treatment facilities or sites from which there is a release or threatened release of hazardous substanc- es. CERCLA authorizes the federal government either to clean up these sites itself or to order persons responsible for the situation to do so. CERCLA created the Superfund to be used by the federal government to pay for the cleanup efforts. Where the federal government expends money for remedial activities, it must seek reimbursement from the potentially responsible parties (PRPs). CERCLA imposes strict, joint and several retroactive liability upon such parties. CERCLA was amended in 1986 by the Superfund Amendments and Reauthorization Act (SARA) which authorizes increased federal expenditures and imposes more stringent cleanup standards and accelerated timetables. SARA also contains provisions which expand the enforcement powers of the USEPA. CERCLA's authorization to expend funds expires in September 1994 and its taxing authority expires in December 1995. Although it is expected that Congress will reauthorize the statute, the scope of the changes to the statute and the level of funding to be provided are not yet certain, as are the potential impacts upon the Company's business.\nClean Air Act and 1990 Amendments. The Clean Air Act requires compliance with national ambient air quality standards (NAAQS) and empowers the USEPA to establish and enforce limits on the emission of various pollutants from specific types of facili- ties. The Clean Air Act Amendments of 1990 modify the Clean Air Act in a number of significant areas. Among other things, they establish new programs and deadlines for achieving compliance with NAAQS, controls for hazardous air pollutants, a national permit program for all major sources of pollutants and create significant new penalties, both civil and criminal, for viola- tions of the Clean Air Act.\nOther Federal and State Environmental Laws. The Company's services are also utilized by its clients in complying with, and the Company's operations are subject to regulation under, among others, the following federal laws: the Toxic Substances Control Act, the Clean Water Act, the Safe Drinking Water Act, the Occupational Safety and Health Act and the Hazardous Materials Transportation Act. In addition, many states have passed Superfund-type legislation and other regulations and policies to cover more detailed aspects of hazardous materials management. The State of California, for example, has consis- tently been a leader in enacting and implementing hazardous materials legislation. This legislation, and similar laws in other states, address such topics as air pollution control, UST and AST management, water quality, solid waste, hazardous waste, surface impoundments, site cleanup and wastewater discharge. Several states have modeled their environmental laws and regulations on those of California.\nEnvironmental Contractor Risks\nAlthough the Company believes that it generally benefits from increased environmental regulations affecting business, and from enforcement of those regulations, increased regulation and enforcement also create significant risks for the Company. These risks include potentially large civil and criminal liabilities from violations of environmental laws and regula- tions and liabilities to customers and to third parties for damages arising from performing services for clients. (For a discussion of the environmental regulatory risks posed by the Company's Northern California sites, see Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and disposal.)\nLiabilities Arising out of Environmental Laws and Regulations\nAll facets of the Company's business are conducted in the context of a rapidly developing and changing statutory and regulatory framework. The Company's operations and services are affected by and subject to regulation by a number of federal agencies including the USEPA, Occupational Safety and Health Administration (OSHA), and Nuclear Regulatory Commission as well as applicable state and local regulatory agencies. (For a description of certain applicable laws and regulations, see Business - Operations - Regulations.)\nIncreasingly, there are efforts to expand the reach of CERCLA to make contractor firms responsible for cleanup costs by claiming that environmental contractors are owners or operators of hazardous waste facilities or that they arranged for treat- ment, transportation or disposal of hazardous substances. Several recent court decisions have accepted these claims. Should the Company be held responsible under CERCLA for damages caused while performing services or otherwise, it may be forced to bear such liability by itself, notwithstanding the potential availability of contribution or indemnity from other parties.\nOther environmental statutes and regulations also pose risks for the Company. For example, the Company's employee health and safety practices, particularly its activities at hazardous waste sites, are extensively regulated by OSHA. RCRA and similar state statutes regulate the Company's practices for the treat- ment, transportation, storage, disposal and other handling of hazardous materials. Substantial fines and penalties may be imposed not only for the mishandling of such substances, but also for failure to keep proper records and other administrative practices. The Company's failure to observe such laws and\/or the terms and conditions of licenses and permits it holds under these and other laws, could adversely impact the Company's ability to carry on one or more of its service areas as present- ly constituted.\nIncreased regulation under RCRA may adversely affect the Company's services in other ways. For example, the USEPA, on May 18, 1993, citing its authority under RCRA, announced the Draft Strategy imposing additional requirements and costs on incineration facilities, the effect of which has been a \"freeze\" on the permitting of any new fixed-base hazardous waste inciner- ators or cement kilns. Although the \"freeze\" is presently scheduled to expire in late 1994, the effects of the USEPA policy may continue for an undetermined period thereafter. The USEPA initiated these actions after highly publicized protests against a new fixed-base hazardous waste incinerator facility in Ohio. In public remarks at the time these plans were announced, USEPA stated that its freeze will not affect on-site incinera- tion of hazardous waste at Superfund sites, such as projects utilizing the Company's HTTS on-site incineration units. Although the potential exists for increased demand for the Company's on-site incineration capabilities, as well as for the Company's services to assist facility owners and operators to comply with the new requirements, expansion of USEPA's program to cover on-site incineration, if it were to occur, could increase the compliance costs or hinder or prevent the Company from fully participating in on-site incineration projects using its HTTS technology. On May 9, 1994, the USEPA issued a new policy which, while seemingly affirming incineration as an allowable remedy under CERCLA, calls for additional procedures and studies to be conducted before incineration may be selected as a remedy, or which may result in the deselection of incinera- tion as a remedy, at a Superfund site. The impact upon the Company's business of this new policy, as well as court chal- lenges to USEPA's May 1993 action, cannot yet be predicted. The heightened scrutiny of incineration as a treatment solution is likely to lead to delays and added costs in permitting the Company's HTTS units, a significant portion of which the Company expects will be borne by clients. One of the Company's pro- jects, as well as one anticipated contract (see Business - Operations - Construction and Remediation), have been affected by such delays. Public opposition to the use of certain remedies, such as incineration, the cost of those remedies, and CERCLA changes under consideration reducing requirements for \"permanent remedies\" such as incineration, may also cause the USEPA and\/or private parties to prefer other remedies in Superfund remediations which may have a material adverse impact on the Company's business. (See Management's Discussion and Analysis of Results of Operations and Financial Condition - Results of Operations - Continuing Operations - Revenues.)\nPotential Liabilities Involving Customers and Third Parties\nIn performing services for its customers, the Company could potentially be liable for breach of contract, personal injury, property damage, and negligence, including claims for lack of timely performance and\/or for failure to deliver the service promised (including improper or negligent performance or design, failure to meet specifications, and breaches of express or implied warranties). The damages available to a customer, should it prevail in its claims, are potentially large and could include consequential damages.\nMany of those contracting for environmental management services, particularly those involving large scale remediations, seek to shift to contractors the risk of completing the project in the event the contamination is either more extensive or difficult to resolve than originally anticipated. The Company has from time to time been involved in claims and litigation involving disputes over such issues. (See Legal Proceedings.)\nEnvironmental management contractors, in connection with work performed for customers, also potentially face liabilities to third parties from various claims including claims for property damage or personal injury stemming from a release of toxic substances or otherwise. Claims for damage to third parties could arise in a number of ways, including through a sudden and accidental release or discharge of contaminants or pollutants during the performance of services, through the inability -- despite reasonable care -- of a remedial plan to contain or correct an ongoing seepage or release of pollutants through the inadvertent exacerbation of an existing contamination problem, or through reliance on reports prepared by the Company. Personal injury claims could arise contemporaneously with performance of the work or long after completion of the project as a result of alleged exposure to toxic substances. In addition, increasing numbers of claimants assert that companies performing environmental remediation should be adjudged strictly liable, i.e., liable for damages even though its services were performed using reasonable care, on the grounds that the Company's services involved \"abnormally dangerous activities\".\nCustomers frequently attempt to shift various of the liabili- ties arising out of remediation of their own environmental problems to contractors through contractual indemnities. Such provisions seek to require the Company to assume liabilities for damage or injury to third parties and property and for environ- mental fines and penalties. The Company has adopted risk management policies designed to address these problems, but cannot assure their adequacy. (See Business - Operations - Insurance and Risk Management.)\nOver the past two years, the USEPA has constricted signifi- cantly the circumstances under which it will indemnify its contractors against liabilities incurred in connection with CERCLA projects. There are other proposals both in Congress and at the regulatory agencies to further restrict indemnification of contractors from third party claims. These changes may have a material adverse effect on the Company's business.\nGovernment Contracting Risk\nAs a major provider of services to government agencies, the Company also faces the risks associated with government con- tracting, which include substantial civil and criminal fines and penalties for, among other matters, failure to follow procure- ment integrity and bidding rules, employing improper billing practices or otherwise failing to follow cost accounting standards, receiving or paying kickbacks or filing false claims. Government contracting requirements are complex, highly techni- cal and subject to varying interpretations. Additionally, the USEPA recently announced that it will hold contractors as well as their federal agency clients, responsible for regulatory and permit violations at federal facilities. As a result of its government contracting business, the Company has been, is, and expects in the future to be, the subject of audits and investi- gations by governmental agencies. (See Legal Proceedings.) In addition to the potential damage to the Company's business reputation, the failure to comply with the terms of one or more of its government contracts could also result in the Company's suspension or debarment from future government contract projects for a significant period of time. The fines and penalties which could result from non-compliance with appropriate standards and regulations, or the Company's suspension or disbarment, could have a material adverse effect on the Company's business, particularly in light of the increasing importance to the Company of work for various government agencies. (See Business - Operations - Customers.)\nInsurance and Risk Management\nThe Company has adopted a range of insurance and risk management programs designed to reduce potential liabilities, including an insurance program, policies to seek indemnity where possible in its contracts, other contract administration procedures, and employee health, safety, training, and environ- mental monitoring programs. In addition, as a result of the substantial increase over the past several years in the percent- age of the Company's revenues derived from work for governmental agencies, the Company has been actively implementing a govern- ment contracts compliance program. The Company cannot assure the adequacy of the program and compliance failure could have a material adverse effect on the Company's business.\nThe Company's insurance program in effect from April 1994 through March 1995 includes $5,000,000 of coverage each for commercial general liability, product liability, automotive liability and employers' liability. Workers' compensation insurance is provided to statutory limits. The commercial general liability and product liability policies are issued on a \"claims-made\" basis. All listed coverages are provided under an arrangement with an insurance company pursuant to which the Company's captive insurance subsidiary (the Captive) is required to indemnify the insurance carrier against all losses and costs of defense up to a maximum of $5,000,000 for each policy per fiscal year (except for employers' liability and workers' compensation which have a $250,000 per occurrence loss limit and automotive liability which has a $5,000,000 per occurrence loss limit) and to support the indemnity commitment with appropriate letters of credit. The Company has caused to be issued $11,435,000 in letters of credit to support the Captive's existing or anticipated obligations to indemnify the insurance carrier, which amount is adjusted at least annually. From a risk management perspective, all policies provided by the Captive are, in effect, a self-insurance layer. Additionally, the Company has $70,000,000 in excess liability policies insuring claims in excess of the $5,000,000 covered by the policies noted above. The Company also has other insurance policies with various self-insured retentions or deductibles for the management of its risk including but not limited to all risk property coverage, contractor's pollution liability, profession- al errors and omissions, and directors' and officers' liability insurance coverage.\nEnvironmental Impairment Liability (EIL) coverage is provided through the Captive which has issued a $32,000,000 policy exclusively for IT's inactive treatment, storage and disposal sites located in Northern California. (See Notes to Consolidat- ed Financial Statements - Discontinued operations - Transporta- tion, treatment and disposal.) This coverage meets the current requirements of both federal and state law.\nAlthough the Company believes its insurance program to be appropriate for the management of its risk, its insurance policies may not fully cover risks arising from the Company's operations. The exclusion of certain pollution and other liabilities from some insurance policies, or losses in excess of the coverage, may cause all or a portion of one or more losses not to be covered by such insurance. Further, the cost and limited availability of insurance has resulted in the Company's use of self-insurance through the Captive, thus exposing the Company to additional liabilities.\nDISCONTINUED OPERATIONS\nPollution Control Manufacturing\nOn February 24, 1992, the Company entered into an agreement for the sale of the manufacturing operations of IT's Pollution Control Systems division which closed on May 15, 1992. This business, located in Tulsa, Oklahoma and Hull, England, designed and manufactured combustion, hydrocarbon vapor recovery, waste treatment and other environmental control systems for domestic and international clients.\nTransportation, Treatment and Disposal\nIn December 1987, the Company's Board of Directors adopted a strategic restructuring program which included a formal plan to divest the transportation, treatment and disposal operations through sale of some facilities and closure of certain other facilities. These operations included the handling and trans- portation of clients' wastes and their treatment and\/or disposal at Company or third party-owned facilities. On June 22, 1989, the Company completed the sale of IT's active treatment and disposal operations in Imperial Valley and at Bakersfield, California, as well as its transportation business. The Company's four inactive treatment, storage and disposal sites located in Northern California were not included in this transaction. Substantial progress has been made to date toward the closure of these facilities, with two of these sites closed and the others in the process of closure.\nThere are substantial financial implications related to the Transportation, Treatment and Disposal discontinued operations. For further information regarding the Company's discontinued operations, see Notes to Consolidated Financial Statements - Discontinued operations, Management's Discussion and Analysis of Results of Operations and Financial Condition - Liquidity and Capital Resources, and Legal Proceedings.\nEMPLOYEES\nAt March 31, 1994, the Company employed 3,264 regular employees. Of these employees, 2,834 were employed in opera- tions, 52 in discontinued operations, and 378 in sales, corpo- rate office and group administration.\nAt March 31, 1994, none of the Company's employees were repre- sented by labor unions under collective bargaining agreements. The Company employs union labor from time to time on a project basis. The Company cannot predict whether any of its employees who currently are not represented by unions will elect to be so represented in the future. The Company considers its relations with its employees to be good and has not experienced a signifi- cant work stoppage in the past nine years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nIT owns or leases property in 25 states, the District of Columbia, and the United Kingdom. Excluding its discontinued operations, the Company owns approximately 58 acres and leases approximately 1,050,000 square feet of property for various uses, including equipment yards, laboratories, engineering and services offices, sales offices, and corporate and regional offices. Management considers the facilities adequate for the present and anticipated activities of the Company.\nAdditionally, the Company owns approximately 3,900 acres related to its discontinued operations, principally in Northern California and Louisiana, of which approximately 500 acres have been used for hazardous waste disposal facilities and approxi- mately 2,200 are adjacent to those facilities.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nClass Action Lawsuits\nIn re International Technology Corporation - Securities Liti- gation (C.D.Cal., Master File No. CV-88-440- RMT) was a class action arising out of the public offering of 3,525,000 shares of the Company's common stock pursuant to a prospectus dated September 29, 1987 and subsequent trading activity. Plaintiffs alleged that the Company and certain of its past and present directors and officers and the Company's underwriters were responsible for the issuance of false and misleading statements actionable under the Securities Act of 1933, the Securities Ex- change Act of 1934, and the common law. After several court- sponsored mandatory settlement conferences, the parties reached a settlement which was approved by the Court. The settlement provided for the creation of a total settlement fund of $12,000,000 plus interest from December 14, 1992. The Company's contribution to the settlement agreement was 1,872,759 shares of newly issued, freely tradeable common stock with a market value at the date of issuance of approximately $6,350,000. In fiscal year 1993, the Company recorded a charge to earnings for the $6,350,000 value of these shares with a corresponding credit to stockholders' equity and accrued $950,000 of litigation costs to be paid in cash. The dismissal of the action is now final, with no rights of appeal.\nMancino et al. v. Hutchison et al. - (Los Angeles Superior Court, Case No. CA001120) was a purported class action lawsuit filed in state court in July 1988, on behalf of stockholders and noteholders of the Company alleging state securities law violations and fraud and negligent misrepresentation in connec- tion with the purchase of shares of the Company's common stock and 9 3\/8% senior notes by members of the purported class between January 1986 and April 1987. The complaint also named as defendants the underwriters who performed services in connection with the senior note offering. In addition, the com- plaint alleged that certain of the Company's officers and directors sold shares of the Company's common stock at artifi- cially inflated prices based on undisclosed information about the Company. The plaintiffs sought unspecified damages, including punitive damages plus costs associated with the litigation. Upon motions filed by all defendants, the Court dismissed this lawsuit with prejudice on January 3, 1990. Plaintiff filed an appeal of this dismissal on February 15, 1990 in the California Court of Appeal for the Second Appellate District, which was denied on May 3, 1991. On June 12, 1991, plaintiff filed a petition for review with the California Supreme Court regarding this appeal, and review of the case was granted by the Court. The California Supreme Court affirmed the Court of Appeals, and the dismissal is now final. Additional- ly, in December 1989, plaintiffs in this lawsuit filed another class action in federal court (Mancino et al. v. International Technology Corporation, et al., U.S.D.C. - Central District No. 89 - 7244 RMT) which contains essentially the same factual allegations and damage claims as those set forth in the dis- missed state action, except that it has been brought only on behalf of the stockholders of the Company and raises a claim under the Securities Exchange Act of 1934. The Company is defending the action vigorously. Discovery on this action was in progress when, by order dated March 11, 1992, the federal court granted the Company's motion for reconsideration of its earlier denied motion for judgment on the pleadings and, on March 31, 1992, judgment was entered against the plaintiffs' claims. In dismissing the plaintiffs' claims, the court accepted defendants' arguments based on a 1991 United States Supreme Court decision which declared a uniform statute of limitations for such actions. Congress has since passed Section 27A of the Securities Exchange Act of 1934, which purports to reinstate the formerly applicable statute of limitations for actions pending on the date of the Supreme Court's decision. The plaintiffs moved the court to reconsider its March 11, 1992 order in part based upon a recent Ninth Circuit Court of Appeal case upholding the constitutionality of Section 27A, which motion was granted on May 11, 1993. The court has set a trial date of January 10, 1995.\nAfter consultation with outside counsel and in consideration of the availability of insurance coverage, management believes the outcome of the Mancino actions will not have a material adverse effect on the consolidated financial condition of the Company.\nMotco\nOn December 4, 1991, the Company announced the suspension of work on the Motco project, the cleanup of a Superfund site in Texas, and the filing of a $56,000,000 breach of contract lawsuit, captioned IT Corporation v. Motco Site Trust Fund and Monsanto Company in the United States District Court for the Southern District of Texas, Houston Division, Civil Action No. H-91-3532, against the Motco Trust, the potentially responsible party (PRP) group that agreed to finance remediation of the site and Monsanto Company, the leader of the PRP group.\nIn January 1988, the Company was retained by the Motco Trust to destroy waste contained in pits at the site using two transportable incinerators designed and operated by IT. Based on information provided to IT in the Motco Trust's request for proposal, the Company bid and was awarded a fixed-price contract for approximately $33,000,000 which was subsequently increased to approximately $38,000,000 through change orders. Of that amount, approximately $21,000,000 has been paid to the Company. In early 1991, IT advised the Motco Trust and Monsanto that it would cost substantially more to complete the project because the scope of work had changed and because the chemical makeup, quantities and mixture of waste at the site were dramatically different from that portrayed by data provided to IT in Motco Trust's request for proposal. Additionally, the project was impacted by other actions of the Motco Trust and Monsanto, including the pumping of contaminated water and waste into the Motco pits from an unrelated project which was managed by the Motco Trust and Monsanto.\nIT continued work at the site in good faith while negotiations were occurring with the Motco Trust and Monsanto. Approximately $31,000,000 of direct costs were incurred in excess of those recovered under the contract and recorded as a contract claim receivable and are included in noncurrent assets in the Com- pany's consolidated balance sheet at March 31, 1994 and 1993. IT has not recognized any overhead cost recovery or profit on this project to date. IT sued to recover costs and profit of approximately $56,000,000.\nOn December 26, 1991, the Motco Trust and Monsanto filed an answer to IT's lawsuit and asserted a counterclaim against IT. In their answers to IT's lawsuit, the Motco Trust and Monsanto denied liability to IT on the grounds that the Motco Trust had executed a change order on or about September 28, 1990 address- ing many of the claims and purported underlying events alleged in the lawsuit and had received a full release from IT regarding those matters, that IT has failed to mitigate the damages alleged to have been incurred by IT, that IT has failed to manage and control its costs with respect to its work on the project, and that IT's lawsuit fails to state a claim upon which relief can be granted as it claims extra-contractual compensa- tion. Monsanto also denies any separate liability from that of the Motco Trust.\nIn its counterclaim, the Motco Trust seeks recovery of $27,000,000 of monetary damages including all payments to third parties to complete performance of the project, all penalties or other liabilities to any governmental entity, and any related damages which occur as a result of the breach of contract by IT which is alleged to have occurred upon the filing of the lawsuit by IT and concurrent suspension of work at the site.\nThe case was tried to a jury during March and April of 1994. As a result of that trial, the jury rendered a special verdict in IT's behalf wherein they found that Monsanto had breached its contract with IT, had defrauded IT and had provided IT with information which constituted a negligent misrepresentation as to the waste characteristics. The jury found that the amount of damages caused IT as a result of these acts was in the amount of $52,800,000. The jury also found that Monsanto should pay punitive damages in the amount of $28,550,000, together with attorneys' fees in the amount of approximately $2,300,000. The jury further found that IT did not commit fraud against the defendants, that any breach of contract IT may have committed was excused, and that Motco Trust should not recover on its $27,000,000 counterclaim.\nMonsanto has filed a motion for judgment notwithstanding the verdict, and, alternatively, for a new trial. If the Court orders a new trial, the verdict will be set aside pending a retrial before a new jury. If Monsanto's motions with the trial court are denied, the judgment is subject to appeal.\nAfter consideration of the merits of the Company's position in the lawsuit and after consultations with its outside counsel, management believes that, subject to the inherent uncertainties of litigation, the Company more likely than not will recover the contract claim receivable recorded to date and prevail on Motco Trust's counterclaim. However, if this matter is resolved in an amount significantly lower than the contract claim receivable recorded by IT or if the Motco Trust prevails in its counter- claim and recovers any significant amount of damages, a material adverse effect to the consolidated financial condition of the Company would result.\nCentral Garden\nOn July 14, 1992, the Company responded to an emergency call to clean up a chemical spill at a finished product warehouse facility leased by Central Garden & Pet Supply Company (Central) in Baton Rouge, Louisiana. While cleanup was under way, a fire began which damaged the warehouse facility. In addition to the owner of the facility, Central and two other lessees of the finished product warehouse facility (an electrical supply company and a pharmaceutical company) incurred significant property damage and substantial loss of inventory.\nOn August 2, 1992, a petition for damages was filed against the Company and Central by residents of a nearby apartment complex alleging personal injuries caused by the release of hazardous and noxious materials into the atmosphere as a result of the fire (Gravois et al. v. IT Corporation, et al., #92-649, U.S. District Court, Central District of Louisiana). Central filed an answer, cross-claim, and third-party complaint. In the complaint and cross-claim, Central alleges, among other things, that the Company was the cause of the fire in failing to exercise proper care in the cleanup of the spill, and was responsible for the property damage, loss of contents, loss of profits and other economic injury, and expenses incurred in the cleanup. Further, Central claims a set-off for monies due the Company for cleanup services rendered by the Company after the fire and seeks indemnity for any damages assessed against Central. The Company has responded to the complaint and cross- claim alleging, among other things, improper storage and handling of hazardous materials by Central. This case was remanded to state court for lack of diversity jurisdiction (19th Judicial District Court, Parish of East Baton Rouge, Louisiana, #383,887). The Company has also filed its own cross-complaint against Central for services rendered after the fire and has denied responsibility for the fire, raised certain defenses, and further claimed that Central was not entitled to a set-off. The monies due the Company for services rendered to Central approxi- mate $1,700,000 and are included in accounts receivable in the Company's consolidated balance sheet at March 31, 1994 and 1993. Neither Central nor the nearby residents have formally specified the damages they seek, although, based on early discovery, it appears Central claims losses in the $3,000,000 range for destruction of inventory, plus unspecified additional damages, including other amounts it may be required to pay as a result of the fire, for which it seeks indemnity from IT.\nA complaint has also been filed in state court in this matter by the insurer for the electrical supply company against the Company, Central, the lessor and certain insurers (American Manufacturers Mutual Insurance Company v. IT Corporation, et al., 19th Judicial District Court, Parish of East Baton Rouge, Louisiana, #390,241). While the complaint does not specify the damages sought, an earlier demand was made for approximately $1,800,000.\nIn addition, the owner of the adjacent pharmaceutical company and its insurers have filed suit against the Company, Central, the lessor, a construction company which built a fire wall that allegedly did not meet the building code, the manufacturer of the chemicals which were spilled and certain insurers (Bergen Brunswig Drug Co., et al. v. IT Corporation et al., 19th Judicial District Court, Parish of East Baton Rouge, Louisiana, #393,056). While damages have not been formally specified, it appears plaintiff is claiming loss of the warehouse inventory valued in excess of $9,000,000, as well as business interrup- tion. The lessor has also filed a cross-claim and third party complaint against the Company and others in this action.\nSeveral other actions arising out of the fire have recently been filed which the Company believes are substantially duplica- tive of the previously filed cases in the types and amounts of relief sought.\nThese matters are at a relatively early stage, and trial dates have not been set. A discovery schedule has been established which contemplates completion in the fall of 1994 as to the issues of factual causation. The Company is unable at this time to predict the outcome and is defending the actions vigorously. The Company's insurance carrier has been notified of the matter and is a defendant in one of the actions. The Company's carrier is defending the actions subject to a reservation of its rights to contest coverage at a later date. The Company has filed a protective action seeking determination of coverage (Interna- tional Technology Corporation, et al., v. National Union Insurance Company, etc., et al., Los Angeles County, California Superior Court, #BC079193).\nHelen Kramer\nOn May 3, 1993, the Company received an administrative subpoena from the Office of the Inspector General (OIG) of the USEPA seeking documents relating to certain of the Company's claims which were submitted to the U.S. Army Corps of Engineers with regard to the Helen Kramer remediation contract, a substan- tially completed project which the Company performed in joint venture. Since August 1992, the Defense Contract Audit Agency (DCAA) has been conducting an audit of certain claims submitted by the joint venture. The Company has been informed that there is a federal civil and criminal investigation into the claims. The Company is also aware that one of its employees who provided procurement support for the Helen Kramer project has been subpoenaed to appear before a federal grand jury in Philadel- phia, Pennsylvania. This matter is at a very preliminary stage. The Company is cooperating fully with the government's investi- gation. In addition, by letter dated October 3, 1993, a shareholder of the Company alleged that the acts giving rise to the OIG's investigation constituted, among other things, a waste of the Company's assets, and demanded that the Company institute an action against those responsible for the alleged wrongdoing. The Company is investigating the shareholder's claims fully. (See Business - Operations - Environmental Contractor Risks and Notes to Consolidated Financial Statements - Summary of signifi- cant accounting policies - Contract accounting and accounts receivable.)\nOther Legal Proceedings\nThe actions discussed below relate to the transportation, treatment and disposal discontinued operations of the Company and have been considered in the provision for loss on disposi- tion. (See Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and dispos- al.)\nOperating Industries, Inc. Superfund Site\nIn June 1986, IT was notified by the USEPA that its subsidi- aries and predecessors, IT Corporation, Routh Transportation and William H. Hutchison & Sons, Inc., (the IT subsidiaries), were PRPs for actual and threatened releases of hazardous wastes at the Operating Industries, Inc. (OII) site in Monterey Park, California, which is on the National Priorities List (NPL) of Superfund sites. The USEPA named the IT subsidiaries as PRPs because they allegedly disposed of hazardous substances at OII between 1948 and 1984.\nBetween February 1988 and December 1991, IT was advised by USEPA of the opportunity to settle its alleged liabilities concerning the OII site by entering into Partial Consent Decrees (PCDs) with respect to the USEPA's prior response costs and the first two interim remedial measures at the site and by perform- ing services or paying for the third interim remedial measure. The claims by the USEPA against IT with respect to the various PCDs entered to date total approximately $8,500,000 (including certain USEPA oversight costs but without any allowance for any mitigating factors or IT's defenses). The PRP steering commit- tee is also seeking cost recovery of approximately $2,700,000 from IT for the first two PCDs. IT believes that there is substantial duplication between the claims of the USEPA and the PRP steering committee.\nThe current PCDs, which address certain USEPA response costs and call for completing certain interim remedial measures, do not address the final remedy for site cleanup or for long-term monitoring of the site. These costs, and the cost of possible additional interim remedial measures, are anticipated to be substantial. USEPA has announced it will continue to look to the PRPs to perform or finance performance of interim remedial measures at the site and will pursue those who fail to agree to do so.\nAccording to USEPA records, IT allegedly arranged for disposal of two percent (2%) of the known volume of waste liquids received at the site during its operating life. IT is currently disputing such volume calculations. Based on the nature of the waste streams handled by the IT subsidiaries and their conduct in handling them, IT believes that its proper share of responsi- bility for the site is less than the share attributed to it by the USEPA and the PRP steering committee.\nMost but not all of the major volume PRPs elected to enter into the various PCDs. IT elected not to enter any of the PCDs. To date, no cost recovery action has been filed against the Company; however, either the USEPA or the PRPs which entered the PCDs could bring such an action at any time. The Company has advised its liability carriers as to the pendency of the USEPA's claim and requested indemnification and legal representation. These carriers dispute the scope of their coverage obligation to IT.\nIT has met with the USEPA to propose and negotiate a release from alleged liability for past costs in return for IT undertak- ing remediation work at the OII site. No response has been received to IT's formal proposal. The PRP steering committee has entered into a series of short-term tolling agreements extending the statute of limitations on its potential claim against the IT subsidiaries and has informed the IT subsidiaries of its desire to explore settlement of its potential claims for contribution.\nOther Site Cleanup Actions\nIn addition to the OII matter identified above, the Company has been identified as a PRP for actual or threatened releases of hazardous substances under California's State Superfund Statute in the following two instances: - - On September 25, 1987, the Company was served with a Remedial Action Order (RAO) issued by the California Department of Health Services, now California EPA Department of Toxic Substances Control (DTSC), concerning the GBF Pittsburg landfill site near Antioch, California, a site which has been proposed by the USEPA to be added to the NPL under CERCLA. IT and seventeen (17) other firms and individuals were character- ized as responsible parties in the RAO and directed to undertake investigation and potential remediation of the site which consists of two (2) contiguous parcels. From 1968 through 1974, a predecessor to IT Corporation operated a portion of one parcel as a liquid hazardous waste site. The activity ceased in 1974, and the disposal site was closed pursuant to a closure plan approved by the appropriate Regional Water Quality Control Board (RWQCB). Both of the parcels have since served as a municipal and industrial waste site and, until March 1992, continued to accept municipal waste. Water quality samples from monitoring wells in the vicinity of the site were analyzed by the property owner in August 1986 and indicated the presence of volatile organics and heavy metals along the periphery of the site.\nAdditional PRPs, consisting primarily of known waste genera- tors, were subsequently served with an amended RAO by the DTSC. IT and other PRPs (the PRP group) are participating on a voluntary basis to further investigate the nature and extent of any subsurface contamination beneath the site and beyond its borders. During fiscal year 1992, the PRP group submitted Remedial Investigation and Feasibility Study reports to the DTSC. In fiscal year 1994, the PRP group completed a supple- mental remedial investigation and a revised baseline risk assessment. The studies indicate that groundwater quality impact is not affecting drinking water supplies and is not attributable solely to the portion of the site previously operated by IT's predecessor. The current owner\/operator at the site was ordered to cease the municipal landfill opera- tions and close the site and, pursuant to a court approved settlement, ceased accepting waste.\nIn June 1993, the Company was notified of the DTSC's intent to issue a revised RAO and Imminent and Substantial Endangerment Order (ISE Order). In July 1993, the DTSC issued a revised RAO and ISE Order to the Company and 72 other respondents. While it primarily restates previous RAOs, it also requires the respondents to undertake additional tasks including a portion of the closure activities of the entire municipal landfill and the design and installation of interim caretaker measures. A conceptual design for an interim groundwater treatment facility was submitted to DTSC in April 1994. The terms of the new order and\/or partial closure of the landfill and remediation of groundwater contamination at the entire site may result in significant costs. Due to the early stage of this matter, it cannot be determined what impact, if any, the new order will have on the Company. The Company intends to resist any attempts to cause it to assume liabilities in excess of those associated with the portion of the site previously operated by IT's predecessor.\n- - In November 1987, the Company was advised that the DTSC had issued an RAO to certain owners of the real property and the operator of an underground injection well operation known as the Rio Bravo site. The site located near Shafter, California is under investigation by the DTSC for storage and disposal activities conducted between May 1984 and January 1985. From available information, it appears that, between December 10, 1984 and January 10, 1985, IT transported loads of liquid wastes to the site, primarily for one client.\nThe DTSC listed Rio Bravo on its Bond Expenditure Plan in January 1987, issued a remedial investigative order, and began cleanup activity. By letter dated February 21, 1989, the DTSC notified IT that it was identified as a PRP under California law for having transported waste to the site, and that the Company and other PRPs could be liable for cleanup costs for the site. In March 1991, the DTSC issued an ISE Order naming IT and 98 other individuals and firms as responsible parties and directing them to assume responsibility for assessment and remediation of the Rio Bravo site. A PRP group consisting of generators and transporters, including IT, is implementing the terms of the ISE Order and is seeking to recover response costs from non-settling PRPs. To date, the group has not sought payment from IT or any other transporter PRP for past costs or implementation of the ISE Order. The DTSC has advised IT and the other PRPs that it is seeking to recover its oversight costs, and the PRP group is attempting to settle the DTSC's claim for past response costs.\nThe Company has been, and from time to time may be, named as a PRP at other sites as a result of its transportation, treatment and disposal discontinued operations.\nThe Company is subject to other claims and lawsuits in the ordinary course of its business. In the opinion of management, all such other pending claims are either adequately covered by insurance or, if not insured, will not individually or in the aggregate result in a material adverse effect on the consolidat- ed financial condition of the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS.\nThere were no matters submitted to a vote of the Company's common shareholders during the fourth quarter of fiscal year 1994.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe following table provides information as of June 29, 1994 regarding the Company's executive officers and the positions they hold with the Company. The officers are appointed annually by the Board of Directors to serve at the discretion of the Board.\nMr. Sheh joined the Company in July 1992 as President and Chief Executive Officer and a Director. Prior to joining the Company, Mr. Sheh was President of The Ralph M. Parsons Company, a subsidiary of The Parsons Corporation, since 1989. Mr. Sheh had a broad range of management responsibilities during his 21 years with Parsons, including international operations, corpo- rate business development and management of major divisional operations. Parsons is a major international engineering and construction company, which serves the energy, natural resource, environmental and defense industries. Mr. Sheh serves on the Board of Directors of Davidson & Associates, Inc.\nMr. Hart joined the Company in November 1993 as Senior Vice President and Chief Operating Officer. Prior to joining the Company, Mr. Hart served from 1967 to 1993 in several capacities for Fluor Daniel, Inc., a major engineering and construction firm. At Fluor Daniel, Inc., Mr. Hart served as Executive Project Leader for several multi-billion dollar construction projects, President of the Power Business Sector, and a Fluor Daniel Group Executive.\nMr. DeLuca joined the Company in April 1990 as Senior Vice President and Chief Financial Officer. Prior to then, he was with the public accounting firm Ernst & Young for 20 years, including the last 8 years as a partner in the firm.\nMr. Mahoney joined the Company in January 1991 as Senior Vice President and Director of Technology and was named Senior Vice President, Corporate Development and Sales in April 1992. Prior to joining the Company, Mr. Mahoney was Director of the National Acid Precipitation Assessment Program, a U.S. government research and assessment program, from 1988 to 1991. From 1984 to 1988, Mr. Mahoney served in various environmental managerial capacities with Bechtel Group, Incorporated, a major construc- tion firm.\nMr. Schwartz joined the Company in October 1992. Prior to joining the Company, Mr. Schwartz served in various capacities for Tosco Corporation, an energy company, from 1978 to 1992, including that of Executive Vice President, Finance, Administra- tion and General Counsel, a member of its Board of Directors and a consultant. From 1972 to 1978, Mr. Schwartz was associated with the law firm of Cleary, Gottlieb, Steen & Hamilton.\nIn April 1994, Mr. Andersen was elected Vice President, Environmental Services of the Company. Mr. Andersen joined the Company in June 1992 as the Director of the Groundwater Services Group and most recently served as Director of Environmental Services, West. Prior to joining the Company, he served as Senior Vice President - Operations of Canonie Environmental Services Corporation, a nationwide environmental engineer- ing\/construction firm, from 1989 to 1992. From 1984 to 1989, Mr. Andersen served in various capacities, including Vice President - Operations, for Warzyn Inc., a privately-owned environmental, civil and geotechnical consulting engineering company. From 1965 to 1984, he was employed by D'Appolonia Consulting Engineers, a privately-owned engineering\/consulting company, in various positions including Vice President, Eastern Region.\nMr. Pompe joined the Company in 1988 as Vice President, Construction and Remediation. Prior to joining the Company, Mr. Pompe was employed by Dravo Corporation, a major construction firm, from 1956 to 1988 in various executive capacities, most recently as Senior Vice President responsible for construction projects.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.\nThe Company's common stock is listed on the New York Stock Exchange (NYSE) under the symbol of ITX. The following table sets forth the high and low sale prices, as reported by the NYSE.\nOn June 17, 1994, the closing sale price of the common stock on the NYSE as reported by The Wall Street Journal was $3.00 per share. On that date there were 2,521 shareholders of record.\nThe Company has not paid a cash dividend on its common stock for the three years ended March 31, 1994. The Company has no present intention to pay cash dividends on its common stock for the foreseeable future in order to retain all earnings for in- vestment in the Company's business. IT's credit agreements pro- hibit cash dividends on common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe following table sets forth income statement information for the Company's continuing operations and other financial information for each of the five years in the period ended March 31, 1994. (See Notes to Consolidated Financial Statements - Discontinued operations.)\nNo cash dividends were paid on common shares for any period.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION.\nRESULTS OF OPERATIONS\nCONTINUING OPERATIONS\nOverview\nThe Company operates in one industry segment and provides a range of services to clients principally in the United States which, effective April 1, 1993, were Environmental Services, Analytical Services, and Construction and Remediation. The Company may compete for contracts which utilize only one of its services; however, the Company's principal strategy is to market its services on a turnkey basis. There are operating and economic synergies between these service areas, as they are complementary and often used in combination.\nOn June 28, 1994, pursuant to a definitive agreement signed on May 2, 1994, the Company and an affiliate of Corning Incorporat- ed (Corning) combined the two companies' environmental analyti- cal services businesses into a newly formed 50\/50 jointly-owned company (the joint company). The joint company will operate independently with a separate board of directors comprised of representation from IT and Corning, and will provide services to the Company on a competitive basis. In connection with the transaction, IT and Corning will contribute the net assets of their respective laboratory businesses into the joint company. Additionally, IT issued to Corning 333,000 shares of IT common stock and a five-year warrant to purchase 2,000,000 shares of IT common stock at $5.00 per share. The financing of the joint company will be provided by a $60,000,000 bank line of credit. IT's 50 percent investment in the joint company will be account- ed for under the equity method. An aggressive integration plan will be implemented in the early stages of operations of the joint company. The plan will include consolidation and closure of redundant lab facilities and equipment, a reduction in force to eliminate duplicative overhead and excess capacity and a consolidation of laboratory management and accounting systems, resulting in productivity gains achieved through economies of scale. Consequently, it is estimated that the joint company will incur a charge for integration of approximately $20,000,000, principally non-cash, in the quarter ending June 30, 1994. IT will reflect 50 percent of such charge in its financial statements in the same quarter. Upon completion of the integration process, the joint company will have estimated revenues of $150,000,000 and employ approximately 1,300 people in its laboratory network throughout the United States.\nThe Company's financial performance in fiscal year 1994 continued to be impacted by weak market demand, particularly in the commercial sector, due to the effect on the environmental management industry of the sluggish U.S. economy. The Company increased its volume of business in the federal governmental sector as spending programs remained strong; however, the growth in federal governmental revenues was more than offset by the decline in the commercial market due to lower demand for environmental engineering consulting services (and related analytical laboratory support), as well as small remediation and groundwater services projects. Pricing pressures resulting from weak client demand and increased competition adversely impacted gross margins in the Environmental Services and Analytical Services areas.\nRevenues\nThe following table provides information on revenues attribut- able to the business areas of the Company.\nOver the three-year period ended March 31, 1994, only the Construction and Remediation service area reported revenue growth. Revenues for the Environmental Services and Analytical Services areas peaked in fiscal year 1992 and have thereafter been adversely impacted by recessionary pressures, primarily in the commercial sector. An increasing percentage of the Com- pany's revenues during this three-year period was earned through executing governmental contracts for various federal, state and local agencies. Although governmental clients continue to spend at high levels, many commercial clients have reduced and deferred environmental expenditures pending further improvement in the U.S. economy and increased regulation and enforcement. Revenues from federal, state and local governmental contracts accounted for 63% of the Company's revenue in fiscal year 1994, compared to 62% and 43% in fiscal years 1993 and 1992, respec- tively. Federal governmental revenues are derived principally from work performed for the U.S. Department of Energy (DOE) and the U.S. Department of Defense (DOD). In the near term, the Company expects that the percentage of total revenues from the execution of federal, state and local governmental contracts will continue to be substantial.\nRevenues for fiscal year 1994 declined $17,736,000 or 4.3%, from fiscal year 1993 levels as revenue decreases were experi- enced in Environmental Services and Analytical Services for the reasons noted above. Construction and Remediation experienced a significant 26.3% year-to-year increase in revenues primarily because of higher levels of work performed on large thermal remediation projects and various federal governmental programs.\nDuring fiscal year 1994, a significant percentage of the Company's revenues continued to be derived from large, complex thermal remediation contracts utilizing the Company's Hybrid Thermal Treatment System (HTTS) technology, many of which are fixed-price. This type of contract accounted for 63% of Construction and Remediation revenues in fiscal year 1994 compared to 58% in fiscal year 1993 and 53% in fiscal year 1992. To date, the Company has entered into five of such contracts, while two others where the Company is the apparent low bidder are pending awards. Certain of the contracts are executed in joint venture with other companies. The first contract utiliz- ing the HTTS technology was substantially completed in fiscal year 1990. Work under a second contract was suspended during fiscal year 1992 and is currently being litigated due to a contractual dispute. (See Notes to Consolidated Financial Statements - Commitments and contingencies.) A third contract is currently in progress utilizing the HTTS technology to incinerate contaminated materials. This contract is scheduled to be completed in fiscal year 1995. Activities on a fourth contract awarded in fiscal year 1992 utilizing the HTTS technol- ogy began that year, with incineration of materials having begun in fiscal year 1994 and continuing into fiscal year 1996. A fifth contract utilizing HTTS equipment was awarded in fiscal year 1993 and permit applications have been submitted for regulatory agency review and public hearings. In April 1994, C&R, with a partner, was the apparent low bidder on a contract utilizing an HTTS unit; however, award of this project has been delayed pending a review of the use of incineration technology at that site requested by a local Congressman. In June 1994, the Company was the apparent low bidder for a contract utilizing an HTTS unit. The formal contract award is expected in 30 days.\nOn May 18, 1993, the U.S. Environmental Protection Agency (USEPA), citing its authority under RCRA, announced the Draft Strategy imposing additional requirements and costs on incinera- tion facilities, the effect of which has been a \"freeze\" on the permitting of any new fixed-base hazardous waste incinerators or cement kilns. Although the \"freeze\" is presently scheduled to expire in late 1994, the effects of the USEPA policy may continue for an undetermined period thereafter. On May 9, 1994, the USEPA issued a new policy which, while seemingly affirming incineration as an allowable remedy under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), calls for additional procedures and studies to be conducted before incineration may be selected as a remedy, or which may result in the deselection of incineration as a remedy, at a Superfund site. The impact upon the Company's business of this new policy, as well as court challenges to USEPA's May 1993 action, cannot yet be predicted. If policies were implemented or regulations were changed such that the Company was unable to permit and use incinerators at future remediation projects due to either regulatory or market factors, the Company would have to find alternative uses for its HTTS equipment, which currently has a net book value of approximately $40,000,000. If alterna- tive uses, such as foreign installations, were not found or were uneconomical, there could be a material adverse effect to the Company's consolidated financial condition due to impairment of HTTS assets as well as lost project opportunities.\nThe Company has a number of contracts for projects which are in progress or have not yet commenced. At March 31, 1994, these contracts represent a backlog of approximately $640,000,000 in contract revenues (including $274,000,000 of which is scheduled to be completed during fiscal year 1994) compared with $391,000,000 at March 31, 1993. This increase is due principal- ly to the receipt by the Company of two major contracts at the DOE Hanford site, one of which is for Analytical Services and the other of which is described below. At March 31, 1994 and 1993, the Company's total backlog included $141,000,000 and $32,000,000, respectively, of Analytical Services' backlog. The $141,000,000 ($15,000,000 of which is current backlog) will be transferred to the new IT\/Corning joint company.\nAlthough the Company has significant contracts with various governmental agencies which provide for a general undefined scope of work, the backlog reported above includes only the value of the defined task orders under such contracts. The Company estimates it will receive $600,000,000 over the next five years of additional future project work under existing governmental indefinite delivery order contracts.\nBacklog revenues are expected to be earned primarily over the next one to five years, with a substantial portion of the backlog consisting of governmental contracts which are of a defined scope, some of which are subject to annual funding. In accordance with industry practices, substantially all of the Company's contracts are subject to cancellation by the customer; however, the Company has not experienced cancellations which would have a material effect on backlog amounts shown.\nIn January 1993, the Company was a participant on a team which was awarded a five-year contract (with a three-year option) to perform environmental work at the DOE site in Hanford, Washing- ton under the Environmental Restoration Management Contract (ERMC) program. Although the scope and value of the work under the cost-plus-award-fee contract will be more accurately defined in the initial phases of the project, it is estimated that the minimum value of the contract is approximately $800,000,000 for the first five years. The Company's estimated portion is approximately 20-30 percent of the contract value. On February 22, 1994, the DOE upheld the award of the ERMC program to the team which included IT. Previously, the contract award had been under protest by two losing competitors.\nThe Company's backlog at any given time is subject to changes in scope of services required by the contracts as well as increases or decreases in costs relating to the contracts in backlog. The increased volume of contracts performed subject to such scope changes has also increased the number of contract claims requiring negotiations with clients in the ordinary course of business, leading to some estimates of claim amounts being included in revenues. When such amounts are finalized, any changes from the estimates are reflected in earnings.\nThe Company expects a long-term growth trend from Construction and Remediation revenues due to increasing federal, state and local legislation and enforcement, including CERCLA which, as reauthorized, provides for approximately $1,800,000,000 per year in funding for the cleanup of high priority hazardous waste sites through September 30, 1994. An increasing number of sites, particularly those involving federal agencies such as the DOD and the DOE, are nearing completion of investigative stages and will require remedial action. The Company expects that larger remedial actions in the commercial sector, however, will continue to be deferred until there is improvement in the U.S. economy or a more vigorous enforcement climate.\nThe impact on the Company's business of the possible expira- tion of CERCLA cannot yet be predicted. Although it is expected that Congress will reauthorize the statute, the scope of the changes to the statute, the level of funding to be provided and the timing of reauthorization and implementation of the changes are not yet certain. Among the changes proposed are standard- ization of cleanup levels, reduction of requirements for permanent remedial treatment and other modifications designed to speed remediation of contaminated sites as well as modification or elimination of CERCLA's liability allocation scheme. Although these changes may create greater demand for certain of the Company's services such as on-site containment and similar types of remediation, they may decrease demand for certain other services, such as engineering, design and incineration. Additionally, a delay in reauthorization of CERCLA or a short- term reauthorization, could result in a delay in expenditures for site cleanups.\nThe Company's ability to successfully bid and negotiate additional large contracts is constrained in some instances by the Company's limited ability to obtain performance and payment bonds, as a result of both the Company's current financial condition and the limited availability of such bonds from traditional corporate sureties to meet the requirements of firms engaged in large scale environmental remediation projects. Where bonding is a requirement and unavailable to the Company, the Company will continue to pursue contracts through joint ventures with partners able to provide necessary bonding, or may provide letters of credit available under the Company's revolv- ing credit facility in place of bonds. (See Liquidity and Capital Resources.)\nWith the completion of the IT\/Corning transaction, the Company will no longer record any revenue in the Analytical Services area; however, since roughly 30 percent of Analytical Services area revenue has been derived from Environmental Services or Construction and Remediation projects, revenue will now be recorded in those two business areas related to analytical services subcontracts performed by the joint company for IT, similar to other third party subcontracts.\nFiscal year 1995 revenues for Environmental Services and Construction and Remediation are expected to continue to increase in the governmental sector. Generally, growth in all areas is partially dependent upon the Company's ability to attract, train and retain qualified professional staff.\nGross Margin\nGross margin percentage for fiscal year 1994 decreased in all of the Company's service areas. Analytical Services experienced a significant decline in gross margin percentage in fiscal year 1994 because of increased pricing pressure in the chemical analysis area due to weak customer demand, and decreased utilization of laboratory capacity resulting from start-up delays on certain governmental projects in the radiochemical analysis area. The substantial increase in Analytical Services' gross margin percentage from fiscal year 1992 to fiscal year 1993 was primarily attributable to increased utilization of radiochemical mixed waste capacity and the benefit of continuing cost containment programs which were initially implemented in the fourth quarter of fiscal year 1992 and included the closure of the San Jose, California laboratory. (See Restructuring Charges.)\nIn fiscal year 1994, Environmental Services' gross margin percentage declined from the prior year level due to overall pricing pressure resulting from generally lower commercial client demand leading to increased competition which has caused lower hourly billing rates on time-and-material contracts as well as lower bidding margins required to win small remediation and groundwater services projects. Environmental Services' gross margins in fiscal year 1993 were essentially equal to those of the prior year.\nConstruction and Remediation gross margin percentage for the current fiscal year decreased primarily because fiscal year 1993 gross margin was favorably affected by a positive margin adjustment related to the closeout of a thermal remediation project which was completed in a prior fiscal year. Construc- tion and Remediation project margins were depressed in fiscal year 1992 due to the nonrecognition of any overhead cost recovery or profit on the Motco Site Trust Fund contract. (See Notes to Consolidated Financial Statements - Commitments and contingencies.)\nThe Company's ability to improve upon fiscal year 1994 gross margins is heavily dependent on increasing utilization of professional staff and successfully bidding new contracts at adequate margin levels. The Company does not expect any significant margin improvement until current industry pricing pressures are relieved as a result of commercial clients requiring increased services due to greater enforcement of environmental regulations. Additionally, since the cost of HTTS equipment is generally recovered over three or more projects, margins in Construction and Remediation are dependent on successful performance of existing contracts and on winning new contracts utilizing existing HTTS equipment upon the completion of previous projects; otherwise, depreciation on HTTS equipment idle for significant periods of time will continue to negatively affect gross margin.\nSelling, General and Administrative Expenses\nSelling, general and administrative expenses averaged 12.1% of revenues during the three fiscal years ended March 31, 1994. Selling, general and administrative expenses were 12.4%, 11.9% and 11.9% of revenues in fiscal years 1994, 1993 and 1992, respectively.\nIn the fourth quarter of fiscal year 1994, selling, general and administrative expenses include $4,500,000 related to the actuarially determined value of contractual retirement benefits to be provided to its former Chairman of the Board (who was also Chief Executive Officer from 1975 through 1992) who retired from that position effective April 1, 1994. Such retirement agree- ment is currently subject to further review by a special committee of the Board of Directors. Ongoing selling, general and administrative expense for discount amortization related to this retirement agreement will initially be approximately $300,000 per year and will decline over time.\nSelling, general and administrative expenses excluding the above item decreased $4,760,000 or 9.7% in fiscal year 1994 from the prior year level due to the elimination of management layers in the Environmental Services area as a result of actions taken in late fiscal year 1993 involving organizational realignment, the elimination of administrative costs in Europe, and ongoing reductions in certain corporate office administrative costs. Excluding the $4,500,000 charge, selling, general and adminis- trative expenses would have been 11.2% of revenues, down from 11.9% of revenues in the prior year.\nSelling, general and administrative expenses declined $1,131,000 or 2.3% in fiscal year 1993 from the prior year level through cost containment efforts, but remained at 11.9% of revenues because of the decrease in revenues reported for fiscal year 1993.\nMaintaining selling, general and administrative expenses at the adjusted fiscal year 1994 level of 11.2% of revenues is dependent upon continuing cost controls; however, management believes some decrease in this percentage is achievable if revenues increase significantly. The Company expects to reduce selling, general and administrative expenses essentially proportionally to the lost revenues from Analytical Services as a result of the IT\/Corning transaction.\nRestructuring Charges\nIn connection with the realignment and streamlining of the Company's organization which was initiated in the fourth quarter of fiscal year 1993, the Company incurred a pre-tax restructur- ing charge of $8,378,000 which represented 2.0% of annual revenues. The restructuring charge includes costs for the consolidation of facilities in the United States through office combinations or shutdowns, related asset writeoffs, severance payments to employees, and the disposition of most of the Company's European operations through either closure or sale.\nAt the end of fiscal year 1992, the Company implemented a restructuring program which was the result of an evaluation of operational capacity, productivity and overhead costs. The program included staff reductions, facility closures of several unproductive engineering offices and the San Jose, California laboratory, and related asset writeoffs and lease termination accruals. In fiscal year 1992, the $6,997,000 restructuring charge represented 1.7% of revenues.\nOther Income (Expense)\nIn April 1994, the Company was notified that planning permission was denied for an integrated treatment facility located in Salt End, North Humberside, England. The Company wrote off its investment in the facility, reporting a $2,500,000 non-cash charge to continuing operations in the fourth quarter of fiscal year 1994. (See European Operations.)\nAt December 31, 1992, the Company accrued a provision of $1,981,000 for the writeoff of nonrecoverable costs invested in a U.K. joint venture.\nAt December 31, 1992, the Company accrued a provision of $6,300,000 for the anticipated settlement of certain class action shareholder litigation. The litigation was tentatively settled in the quarter ending March 31, 1993, and an additional $1,000,000 provision was taken at that time, principally for related litigation costs. (See Notes to Consolidated Financial Statements - Class action lawsuit.)\nOn April 9, 1992, the Company, in connection with a secondary public offering, sold its investment in stock options of EXEL Limited, an offshore casualty insurance company, for $3,733,000 in cash. The Company reported a pre-tax gain of $3,483,000 in the first quarter of fiscal year 1993.\nOn July 26, 1991, in an initial public offering, the Company sold its investment in the common stock of EXEL Limited for $12,035,000 in cash. The Company reported a pre-tax gain on this transaction of $7,285,000 in the second fiscal quarter of fiscal year 1992.\nInterest, Net\nNet interest expense has averaged 2.4% of revenues for the past three fiscal years. Net interest expense was 2.1%, 2.7% and 2.3% of revenues in fiscal years 1994, 1993 and 1992, respectively. The following table shows net interest expense for the three fiscal years ended March 31, 1994.\nIn fiscal year 1994, interest incurred declined $2,390,000 or 20.4% from the level of the prior fiscal year. The net proceeds of $57,130,000 received by the Company from the public offering of 2,400,000 depositary shares (see Notes to Consolidated Financial Statements - Preferred stock) were utilized to repay outstanding cash advances under the Company's credit facility and to repay $25,000,000 of the Company's senior notes (see Notes to Consolidated Financial Statements - Long-term debt). These actions significantly reduced interest incurred for the third and fourth quarters of fiscal year 1994. During the first six months of fiscal year 1994, which were prior to the public offering, net interest expense declined slightly from the level of the prior year primarily because of lower average borrowings under the Company's revolving credit line resulting from improved cash flows from the Company's operating activities. For fiscal year 1994, capitalized interest increased because of the higher level of capitalized costs related to a major Company-wide systems project included in construction-in- progress.\nNet interest expense increased in fiscal year 1993 from fiscal year 1992 primarily because of lower capitalized interest. Capitalized interest in fiscal year 1993 declined $916,000 or 63.9% from the prior year level due to the completion of the Company's fourth and fifth HTTS units in the fourth quarter of fiscal year 1992. Interest incurred declined slightly in fiscal year 1993 principally because of lower interest rates. The closing of the sale of the pollution control manufacturing discontinued operations also resulted in the cessation of the allocation of interest incurred to discontinued operations early in fiscal year 1993.\nIncome Taxes\nIn fiscal year 1994, the Company recorded an income tax benefit of $124,000. This amount differs from the $418,000 benefit which would be implied at a 34% federal statutory rate primarily due to the partial nondeductibility of certain expenses and a provision for state taxes. Excluding the effect of expenses recorded in the fourth quarter of fiscal year 1994 of $2,500,000 related to the writeoff of a permit in the U.K. and $4,500,000 for certain retirement benefits, the Company's effective tax rate for fiscal year 1994 would have been 39%.\nDuring the third quarter of fiscal year 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS No. 109), effective April 1, 1992. The cumulative effect on prior years of this change in accounting principle increased net income in fiscal year 1993 by $13,000,000. Under the new standard, the Company's tax provi- sion from continuing operations at March 31, 1993, exclusive of the one-time cumulative adjustment, was $1,160,000, despite the fact the Company realized a pre-tax loss of $922,000. The income tax provision differs from the $313,000 benefit which would be implied at a 34% federal statutory rate as a result of the partial nondeductibility of certain expenses as well as a provision for state taxes. (See Notes to Consolidated Financial Statements - Income taxes.)\nDuring fiscal year 1992, prior to the adoption of SFAS No. 109, the effective tax rate was 8.5%. This rate is below the 34% federal statutory rate due to the utilization of the Company's financial accounting net operating loss (NOL) carry- forwards as allowed by SFAS No. 96, which was used by the Company to account for income taxes in that year. The genera- tion of NOL carryforwards was primarily related to cash expendi- tures made for closure activities of transportation, treatment and disposal discontinued operations which are deductible for tax purposes when paid.\nEuropean Operations\nThe Company had committed expenditures for developing a market position in Europe from 1988 through 1993. As part of its organizational realignment and restructuring at the end of fiscal year 1993, the Company decided to significantly reduce its European operations, which resulted in the sale or closure of various businesses. In the near future, the Company intends to fund only project-specific opportunities in the European market.\nAs part of its European activities, the Company incurred costs related to the filing of a permit for an integrated facility for chemical and thermal treatment of municipal waste in the United Kingdom. In April 1994, planning permission was denied for the facility. The Company has provided for the writeoff of its investment in the facility, reporting a $2,500,000 non-cash charge to continuing operations in the fourth quarter of fiscal year 1994. See Other Income (Expense).\nDISCONTINUED OPERATIONS\nPollution Control Manufacturing\nOn February 24, 1992, the Company entered into an agreement for the sale of the manufacturing operations of IT's Pollution Control Systems (PCS) division located in Tulsa, Oklahoma and Hull, England. This business designed and manufactured combus- tion, hydrocarbon vapor recovery, waste treatment and other environmental control systems for domestic and international clients. The sale closed on May 15, 1992 when the Company received $20,888,000 in cash for certain assets and liabilities of the business. Additionally, the Company received payments totaling $1,789,000 during fiscal year 1993 in settlement of certain post-closing adjustments.\nIn the third quarter of fiscal year 1993, the Company recorded a charge of $3,809,000 (net of income tax benefit of $2,176,000) to adjust the net gain of $13,088,000 (net of provision for income taxes of $575,000) which had been recorded in fiscal year 1992 from the sale of the PCS manufacturing business. This charge resulted from unexpected cost overruns in connection with the completion and closeout of certain projects retained by the Company as well as some difficulties the Company has experienced in collecting receivables and limiting its warranty obligations on certain projects for which the Company retained financial responsibility. At March 31, 1994, several warranty issues remain open, including certain matters which are in litigation.\nTransportation, Treatment and Disposal\nIn the fourth quarter of fiscal year 1993, the Company recorded an increase in the provision for loss on disposition of its discontinued transportation, treatment and disposal business of $6,800,000, with no offsetting income tax benefit. This increased provision principally relates to estimated additional costs resulting from delays in the regulatory approval process and associated closure plan revisions pertaining to the closure of the Company's inactive disposal sites located in Northern California.\nIn the fourth quarter of fiscal year 1992, the Company recorded an increase in the provision for loss on disposition of its discontinued transportation, treatment and disposal business of $32,720,000, net of income tax benefit of $2,280,000. The provision for loss included the write-off of the Company's $30,400,000 investment in the disposal and transportation operations of Laidlaw Environmental Services of California. The remaining loss represented expected costs related to a waste disposal site where IT has been named as a potentially responsi- ble party and an increase in costs related to the closure of the Company's disposal sites in Northern California, principally due to delays in the regulatory approval process.\nFor further information regarding the Company's discontinued operations, see Notes to Consolidated Financial Statements - Discontinued operations.\nLIQUIDITY AND CAPITAL RESOURCES\nWorking capital increased by $3,241,000 or 5.4%, to $63,522,000 at March 31, 1994 from $60,281,000 at March 31, 1993. The current ratio at March 31, 1994 was 1.70:1 which compares to 1.64:1 at March 31, 1993. On September 27, 1993, the Company completed a public offering at $25 per share of 2,400,000 depositary shares, each representing 1\/100th of a share of 7% Cumulative Convertible Exchangeable Preferred Stock (see Notes to Consolidated Financial Statements - Preferred stock). The Company received net cash proceeds of $57,130,000 from the public offering.\nLong-term debt decreased to $68,625,000 at March 31, 1994 from $115,811,000 at March 31, 1993. On November 15, 1993, the Company prepaid at par value $25,000,000 of its 9 3\/8% Senior Notes (the Notes), utilizing the proceeds from the public offering of depositary shares. On March 31, 1994, the Company prepaid the $4,952,000 balloon payment due June 30, 1995 on an 11.63% secured equipment loan. (See Notes to Consolidated Financial Statements - Long-term debt.) The Company's ratio of debt (including current portion) to equity was 0.46:1, 1.13:1 and 1.43:1 at March 31, 1994, 1993 and 1992, respectively.\nCash provided by operating activities for fiscal year 1994 totaled $17,998,000, a $911,000 increase from the $17,087,000 of cash provided by operating activities in the prior fiscal year. Capital expenditures were $14,745,000, $15,624,000 and $33,243,000 for fiscal years 1994, 1993 and 1992, respectively. During fiscal years 1994 and 1993, capital expenditures were much reduced from the fiscal year 1992 level due principally to the absence of any aquisitions, the modest level of spending on HTTS unit enhancements and increased management attention to capital spending. In September 1992, the Company was awarded a fifth contract utilizing HTTS equipment. Approximately $6,000,000 of equipment enhancements may be required during fiscal years 1995 and 1996 to fulfill this contract. Overall, management believes capital expenditures in fiscal year 1995 will be somewhat lower than 1994 levels due to modest revenue growth focused in areas such as DOE Hanford ERMC, which do not require major capital investments, completion of a major Company-wide systems project, and the elimination of all capital requirements for the Analytical Services business upon closing of the IT\/Corning transaction. Depreciation will decline due to the IT\/Corning transaction as well. Closure costs at the Company's Northern California disposal sites in fiscal year 1995 are expected to be higher than the $12,179,000 spent in fiscal year 1994 as interim construction costs are anticipated to increase at the Vine Hill site while continuing at the same level at the Panoche site. The Company has accrued approximate- ly $49,000,000 as of March 31, 1994 primarily to complete closure and post-closure, most of which is expected to be spent through fiscal year 1998.\nWith regard to the transportation, treatment and disposal discontinued operations, a number of items could potentially affect the liquidity and capital resources of the Company, including changes in closure and post-closure costs, realization of excess and residual land values, demonstration of financial assurance and resolution of other regulatory and legal contin- gencies. (See Notes to Consolidated Financial Statements - Discontinued operations - Transportation, treatment and dispos- al.)\nAt March 31, 1994, a deferred tax asset in the amount of $14,790,000 (net of a valuation allowance of $13,519,000) is included in the Company's consolidated balance sheet. The asset represents the tax benefit of future tax deductions and net operating loss, alternative minimum and investment tax carry- forwards. The asset will be realized principally as closure expenditures related to the Company's Northern California disposal sites over the next several years are deductible in the years the expenditures are made but only to the extent the Company has sufficient levels of taxable income. The Company will evaluate the adequacy of the valuation allowance and the realizability of the deferred tax asset on an ongoing basis.\nThe Company's current banking arrangement provides for a revolving credit facility of up to $95,000,000 through September 30, 1995. The amount of the credit facility was reduced from $120,000,000 to $95,000,000 in March 1994 in connection with the extension of the availability period from July 31, 1994 to September 30, 1995. Additionally, the Company has an 11.63% loan secured by certain HTTS equipment amortizing through May 31, 1995 with a balance of $5,835,000 at March 31, 1994. Due to the Company's fourth quarter loss in fiscal year 1994, amend- ments were required to certain of the Company's loan covenants in both of these agreements in order to maintain compliance. Terms of these amendments were approved subsequent to March 31, 1994 and the Company is in compliance with such amended terms.\nIn aggregate, at March 31, 1994, letters of credit totaling approximately $55,500,000 were outstanding against the Company's credit facility, including $29,000,000 issued to partially fulfill financial assurance requirements of the Company's inactive disposal facilities, with the remainder being used to satisfy insurance and bonding requirements. Additionally, the Company had $17,000,000 of cash advances outstanding under the line, for total line usage of approximately $72,500,000. The maximum amount available under the Company's line is $95,000,000; however, the amount of current availability is limited to the amount of collateral available to secure the loan as calculated in accordance with the loan agreement, principally 70-80 percent of the Company's eligible accounts receivable. At March 31, 1994, approximately $17,000,000 was available under the line. Availability fluctuates from month to month depending on the level of accounts receivable outstanding.\nThe Company's ability to obtain additional secured borrowings is limited as a result of certain negative pledges related to assets (primarily HTTS units) utilized on certain of the Company's projects and the nature of its other assets.\nThe Company's analytical services joint company agreements with Corning contain general provisions which could affect liquidity including restrictions on joint company dividends to the partners, buy-sell provisions obligating the Company to sell its interests in the joint company in certain circumstances and to contribute up to an additional $5,000,000 to the joint company under certain circumstances, and requirements that the Company indemnify the joint company and Corning from certain liabilities arising prior to the closing of the transaction. In connection with the transaction, the Company will transfer to the joint company the accounts receivable of its Analytical Services division in the approximate amount of $10,000,000, which, pursuant to the terms of the Company's credit agreements, will decrease the receivables available as collateral for borrowing by approximately $7,000,000. The credit agreements for the joint company prohibit the Company from pledging its interest in the joint company to other lenders, including the Company's current lenders.\nAlthough the Company paid down $25,000,000 of the Notes, the remaining $50,000,000 of Notes outstanding will come due on July 1, 1996, if not paid off prior to that time. Management is currently evaluating its strategic alternatives for repaying or refinancing the Notes.\nOver the past two years, the Company's liquidity has required careful management. Although consummation of the September 1993 public offering and application of the net proceeds principally to reduce debt has improved the Company's financial leverage and provided it with greater liquidity and flexibility to address its cash needs, the Company will continue to have significant cash requirements, including working capital, capital expendi- tures, expenditures for the closure of its inactive disposal sites, debt service including repayment or refinancing of the remaining $50,000,000 of the Notes, dividend obligations on the depositary shares and contingent liabilities. Since the Company's September 1993 public offering, bank availability has declined approximately $20,000,000 due to operating cash requirements, the normal amortization and prepayment on the 11.63% secured equipment loan totaling over $7,000,000, and reductions in receivables collateral. On June 29, 1994, after giving effect to the formation of the joint company with Corning, the Company had bank availability of approximately $16,000,000. Any proceeds related to the disposition of the Motco litigation could be used to address the above cash needs of the Company. (See Notes to Consolidated Financial Statements - - Commitments and contingencies.)\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES FOR THE THREE YEARS IN THE PERIOD ENDED MARCH 31, 1994\nSchedules not filed herewith are omitted because of the absence of conditions under which they are required or because the information called for is shown in the consolidated finan- cial statements or notes thereto.\nREPORT OF ERNST & YOUNG, INDEPENDENT AUDITORS\nThe Board of Directors International Technology Corporation\nWe have audited the accompanying consolidated balance sheets of International Technology Corporation at March 31, 1994 and 1993 and the related consolidated statements of operations, stock- holders' equity and cash flows for each of the three years in the period ended March 31, 1994. These financial statements are the responsibility of the Company's management. Our responsi- bility 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 consoli- dated financial position of International Technology Corporation at March 31, 1994 and 1993 and the consolidated results of operations and cash flows for each of the three years in the period ended March 31, 1994 in conformity with generally accepted accounting principles.\nIn December 1987, the Company adopted a plan to divest the transportation, treatment and disposal operations through sale and in part closure. In connection with the plan, the Company recorded a provision, which was increased in 1993 and 1992, for the estimated net loss involved in the ultimate divestiture of these operations. Although the basis for the provision appears reasonable, as more fully explained in the note \"Discontinued operations - Transportation, treatment and disposal,\" the ultimate effect of the divestiture is dependent on future events, the outcome of which cannot be determined at this time. Accordingly, the ultimate loss could be greater or less than the amount recorded.\nAs more fully explained in the note \"Commitments and contingen- cies - Motco,\" the Company has recorded a contract claim receivable related to the Motco Site Trust Fund (Motco Trust) contract, the realization of which is dependent on future events involving the resolution of the Company's lawsuit against Motco Trust and Motco Trust's counterclaim against the Company. No provision for any contingent asset or liability that may result from the lawsuits has been recorded in the financial statements. Although an initial jury finding favorable to the Company has been rendered, the ultimate outcome of this litigation cannot be determined at this time.\nERNST & YOUNG Los Angeles, California May 23, 1994, except for the note \"Long-term debt\" as to which the date is June 29, 1994\nINTERNATIONAL TECHNOLOGY CORPORATION CONSOLIDATED BALANCE SHEETS\nSee accompanying notes to consolidated financial statements.\nINTERNATIONAL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)\nSee accompanying notes to consolidated financial statements.\nINTERNATIONAL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY For the three years ended March 31, 1994 (In thousands)\nSee accompanying notes to consolidated financial statements. INTERNATIONAL TECHNOLOGY CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)\nSee accompanying notes to consolidated financial statements.\nINTERNATIONAL TECHNOLOGY CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSummary of significant accounting policies:\nBasis of presentation and principles of consolidation\nThe consolidated financial statements include International Technology Corporation (IT or the Company) and its wholly owned subsidiaries. The Company also includes its proportionate interest in joint ventures which were entered into for the purpose of executing large remediation projects and in which the Company does not have in excess of 50% of voting control. Intercompany transactions are eliminated. Certain other reclassifications have been made to prior year consolidated financial statements in order to conform to the current year presentation.\nCash equivalents\nCash equivalents include highly liquid investments with an original maturity of three months or less, principally commercial paper.\nContract accounting and accounts receivable\nThe Company primarily derives its revenues from providing environmental management services in the United States, principal- ly to federal, state and local governmental entities, large industrial companies, utilities and waste generators. Services are performed under time-and-material, cost-reimbursement, fixed- price and unit-bid contracts.\nRevenues from time-and-material and cost-reimbursement contracts are recognized as costs are incurred. Estimated fees on such contracts and revenues on fixed-price and certain unit-bid contracts are recognized under the percentage-of-completion method determined based on the ratio of costs incurred to estimated total costs. Anticipated losses on contracts are recorded as identi- fied. Certain contracts include provisions for revenue adjust- ments to reflect scope changes and other matters, including claims, which require negotiations with clients in the ordinary course of business, leading to some estimates of claim amounts being included in revenues. When such amounts are finalized, any changes from the estimates are reflected in earnings.\nUnbilled receivables typically represent amounts earned under the Company's contracts but not yet billable according to the contract terms, which usually consider the passage of time, achievement of certain milestones or completion of the project. Unbilled receivables, included in accounts receivable, were $16,316,000 and $14,751,000 at March 31, 1994 and 1993, respec- tively. Generally, unbilled receivables are expected to be billed and collected in the subsequent fiscal year. Included in unbilled receivables at March 31, 1994 is approximately $7,000,000 of claims related to the Helen Kramer project which is subject to a governmental investigation. (See Commitments and contingencies.)\nAt March 31, 1994 and 1993, an approximately $31,000,000 claim receivable related to the Motco Site Trust Fund (Motco) contract, a major fixed-price remediation contract, is included in non- current other assets as a result of the Company's lawsuit involving the Motco Trust. (See Commitments and contingencies.)\nBillings in excess of revenues represent amounts billed in accordance with contract terms, which are in excess of the amounts includable in revenue determined based on the policies discussed above.\nAt March 31, 1994, accounts receivable are primarily concentrat- ed in federal, state and local governmental entities and in commercial clients in which the Company does not believe there is any undue credit risk.\nProperty, plant and equipment\nThe cost of property, plant and equipment is depreciated using the straight-line method over the estimated useful lives of the individual assets, except for the Hybrid Thermal Treatment System (HTTS) transportable incineration units, which are generally depreciated on the basis of operating days.\nCapitalized interest\nInterest incurred on qualified capital expenditures is capitalized and is included in the cost of such constructed assets. Interest incurred was $9,326,000, $11,716,000 and $11,926,000 for fiscal years 1994, 1993 and 1992, respectively. Total interest capitalized was $893,000, $518,000 and $1,434,000 for fiscal years 1994, 1993 and 1992, respectively.\nIncome taxes\nThe Company adopted Statement of Financial Accounting Standards No. 109 (SFAS No. 109) as of April 1, 1992 and reported the cumulative effect of the change in accounting for income taxes in the consolidated statement of operations for fiscal year 1993. Since the Company reported the effect of the adoption of SFAS No. 109 as a cumulative effect of a change in accounting principle, financial statements for years prior to fiscal year 1993 have not been restated and are presented in accordance with the previous standard used by the Company, SFAS No. 96. (See Income taxes.)\nIntangible assets\nCost in excess of net assets of acquired businesses is amortized over 20 years on a straight-line basis. At March 31, 1994 and 1993, accumulated amortization is $6,671,000 and $5,818,000, respectively. Other intangibles, arising principal- ly from acquisitions, are amortized on a straight-line basis over periods not exceeding 20 years. The Company regularly reviews the individual components of its intangible assets and recognizes, on a current basis, any diminution in value.\nPer share information\nPer share information is based on the weighted average number of outstanding common shares and common share equivalents during each period which aggregated 34,762,280 in 1994, 33,530,420 in 1993 and 33,425,360 in 1992.\nCommon share equivalents include dilutive stock options and common shares to be issued in connection with the settlement of a class action stockholders' lawsuit. (See Class action lawsuit.)\nIn fiscal year 1994, the computation of net income per share, assuming the conversion into common shares of the Company's 7% Cumulative Convertible Exchangeable Preferred Stock, is antidi- lutive. (See Preferred stock.)\nFair value of financial instruments\nIn accordance with the requirements of Statement of Financial Accounting Standards No. 107, \"Disclosures about Fair Value of Financial Instruments,\" the following methods and assumptions were used by the Company in estimating its fair value disclo- sures for financial instruments:\nCash and cash equivalents: The carrying amount reported in the balance sheet approximates its fair value.\nLong and short-term debt: The fair value of the 9 3\/8 % senior notes is based upon the quoted market price. A reasonable estimate of fair value for the 11.63% secured loan was based upon a discounted cash flow analysis. The carrying amount of other debt, including borrowings under the Company's revolving credit facility, approximates its fair value.\nThe carrying amounts and estimated fair values of the Company's financial instruments are:\nAccrued contractual retirement benefits\nIn the fourth quarter of fiscal year 1994, the Company recorded a nonrecurring $4,500,000 provision to selling, general and administrative expenses in the consolidated statement of operations related to the actuarially determined present value of contractual retirement benefits to be provided to its former Chairman of the Board (who was also Chief Executive Officer from 1975 through 1992) who retired from that position effective April 1, 1994. Such retirement agreement is currently subject to further review by a special committee of the Board of Directors. The noncurrent portion of this obligation is reported in other long-term accrued liabilities in the consoli- dated balance sheet. Terms of the retirement agreement call for total payments by the Company of approximately $400,000 per year through the year 2003 and approximately $300,000 per year thereafter for the duration of the former executive's lifetime.\nConsolidated statements of cash flows supplemental disclosures:\nSupplemental cash flow information is:\nDiscontinued operations:\nPollution control manufacturing\nOn February 24, 1992, the Company entered into an agreement for the sale of the manufacturing operations of IT's Pollution Control Systems (PCS) division located in Tulsa, Oklahoma and Hull, England. This business designed and manufactured combus- tion, hydrocarbon vapor recovery, waste treatment and other environmental control systems for domestic and international clients. The sale closed on May 15, 1992 when the Company received $20,888,000 in cash for certain assets and liabilities of the business. Additionally, the Company received payments totaling $1,789,000 during fiscal year 1993 in settlement of certain post-closing adjustments.\nIn the third quarter of fiscal year 1993, the Company recorded a charge of $3,809,000 (net of income tax benefit of $2,176,000) to adjust the net gain of $13,088,000 (net of provision for income taxes of $575,000) which had been recorded in fiscal year 1992 from the sale of the PCS manufacturing business. This charge resulted from unexpected cost overruns in connection with the completion and closeout of certain projects retained by the Company as well as from difficulties the Company has experienced in collecting receivables and limiting its warranty obligations on certain projects for which the Company retained financial responsibility. At March 31, 1994, several warranty issues remain open, including certain matters which are in litigation.\nInformation regarding the results of PCS discontinued operations prior to February 24, 1992 is as follows:\n(1) Amounts include activity to February 24, 1992, the effective date of the discontinuance.\nTransportation, treatment and disposal\nIn December 1987, the Company's Board of Directors adopted a strategic restructuring program which included a formal plan to divest the transportation, treatment and disposal operations through sale of some facilities and closure of certain other facilities. As of March 31, 1994, two of the Company's inactive disposal sites have been formally closed and the other two are in the process of closure. In connection with the divestiture at December 31, 1987, the Company recorded a provision for loss on disposition of transportation, treatment and disposal discontinued operations in the amount of $110,069,000, net of income tax benefit of $24,202,000, which included the estimated net loss on sale or closure and the results of operations of the active disposal sites and the transportation business through the then estimated sale date. At March 31, 1992, the Company increased the provision for loss on disposition by the amount of $32,720,000, net of income tax benefit of $2,280,000, principal- ly due to the write-off of the $30,400,000 contingent purchase price from the earlier sale of certain assets. The remaining loss represented expected costs related to a waste disposal site where IT has been named as a potentially responsible party (PRP) and an increase in costs related to the closure of the Company's disposal sites in Northern California, principally due to delays in the regulatory approval process. At March 31, 1993, the Company increased the provision for loss on disposition by $6,800,000, with no offsetting income tax benefit, related to estimated additional costs resulting from further delays in the regulatory approval process and associated closure plan revi- sions. The Company has incurred costs of $12,179,000 in 1994, $10,671,000 in 1993 and $16,686,000 in 1992 relating to the site closure plans and related construction. The Company expects to incur significant closure and post-closure costs over the next several years. At March 31, 1994, the Company's consolidated balance sheet included accrued liabilities of approximately $49,000,000 to complete the closure and post-closure of its disposal sites and related matters.\nOn June 22, 1989, the Company completed the sale of its active treatment and disposal operations in Imperial Valley and at Bakersfield, California and its transportation business for approximately $85,000,000 including $54,600,000 of cash plus $30,400,000 which represented the contingent portion of the purchase price in the form of a 30 percent equity interest in the purchaser's subsidiary formed to purchase the business. This equity interest was subject to a put and call agreement, the ultimate realization of which was dependent on a formula related to the cumulative earnings of the subsidiary from the date of closing through August 31, 1992. On March 31, 1993, the Company received $400,000 pursuant to this agreement. At March 31, 1992, the Company had written off its interest in the subsidiary since the severe shortfall in the subsidiary's earnings at that time indicated that insignificant value would be generated from the investment.\nThe Company has closed two of the inactive disposal sites and is pursuing formal permanent closure of its Panoche and Vine Hill disposal sites, for which there will be significant closure and post-closure costs over the next several years. Closure and post-closure plans for the Panoche facility were revised to incorporate regulatory agency comments in March 1991 and an Environmental Impact Report (EIR), required by California law prior to plan approval, is being prepared by the California EPA Department of Toxic Substances Control (DTSC). The Company expects final determination on closure plans in time for implementation of closure construction in fiscal year 1996 through fiscal year 1998. The California Supreme Court in December 1991 reversed a lower court decision regarding an aspect of the closure plan at Panoche relating to the County of Solano's authority in the closure process and the method of closure of peripheral waste areas at the facility (the Buffer Zone Areas). During fiscal year 1993, the Company was required to submit additional information and closure designs for the Buffer Zone Areas, including a design for excavation and relocation on-site of significant quantities of wastes and soils. Clean closure by excavation and relocation on-site of materials in the Buffer Zone Areas will be evaluated in the EIR. The additional study of this and other alternatives has resulted in delays to the closure plan approval. The delays have resulted in additional costs for monitoring and maintaining the facility, conducting engineering and permitting activities, and charges for the EIR contractor. A determination to excavate and relocate a substantial amount of materials in the Buffer Zone Areas would increase costs substantially which would have a material adverse effect on the consolidated financial condition of the Company.\nProgress on the Vine Hill Complex facility closure plan continues, with a revised closure plan submitted to the DTSC in August 1991. In April 1992, the Company received and subse- quently responded to comments on the plan from DTSC. An EIR is being prepared by DTSC. The Company expects the plan to be approved late in fiscal year 1995 or early in fiscal year 1996; however, significant solidification work which will ultimately be required for closure will occur prior to that time. The Company is targeting completion of the closure by the end of fiscal year 1996. Delay in the closure plan approval process at this site or further delays at the Panoche site would cause an increase in the provision for discontinued operations.\nClosure construction was completed for the Montezuma Hills site and the Benson Ridge facility in December 1991 and December 1992, respectively. Upon completion of closure construction, the Company is required to perform post-closure monitoring and maintenance of its disposal sites for at least 30 years. Operation of the sites in the closure and post-closure periods is subject to numerous federal, state and local regulations. The Company may be required to perform unexpected remediation work at the sites in the future or to pay penalties for alleged noncompliance with regulatory permit conditions.\nRegulations of the DTSC and the USEPA require that owners and operators of hazardous waste treatment, storage and disposal facilities provide financial assurance for closure and post-- closure costs of those facilities. The Company has provided financial assurance equal to its estimate for closure costs at March 31, 1994, which could be subject to increase at a later time as a result of regulatory requirements, in the form of letters of credit totalling approximately $29,000,000 and a trust fund containing approximately $9,000,000, and has pur- chased annuities which will ultimately mature over the next 31 years to pay for its estimates of post-closure costs as part of a consent order with the DTSC entered on June 27, 1989. Among other provisions, the consent order requires IT to revise its financial assurance estimates on March 1 of each year to reflect inflation adjustments and any changes in the cost estimates resulting from completion of interim closure procedures and from revisions in the closure and post-closure plans. Thereafter, the Company has sixty (60) days to adjust its financial assur- ance mechanisms to reflect the changed costs. IT has completed cost revisions required at March 1, 1994 and provided financial assurance on the amounts called for by the cost revisions. The DTSC is reviewing the revised amounts and is discussing certain aspects of the cost estimates with the Company.\nIT's inactive disposal sites are subject to the Resource Conservation and Recovery Act and other federal laws including the Toxic Substances Control Act, the Clean Water Act, the Clean Air Act and the regulations of the Occupational Safety and Health Act. The provisions of the Comprehensive Environmental Response, Compensation and Liability Act and its amendments generally do not presently affect the Company's four inactive disposal sites, but do apply in some cases to former business operations where the Company is an alleged generator or trans- porter of waste or former operator of a disposal site owned by others. California has been one of the leading states in regulating the transportation, treatment and disposal of hazardous waste substances. Under the Hazardous Waste Control Act, the DTSC administers a comprehensive regulatory program. California operations are also subject to regulation by the State Water Resources Control Board, the California Air Resourc- es Board, Regional Water Quality Control Boards (RWQCBs), Air Quality Management Districts and various other state authori- ties. At the local level, treatment and disposal sites are also subject to zoning and land use restrictions, and other ordinanc- es.\nThe California Toxic Pits Cleanup Act of 1984 (TPCA) required operators of certain surface impoundments to cease discharging liquid hazardous wastes into these units by a statutory dead- line, unless the units were retrofitted to meet minimum tech- nology requirements. The Company has taken reasonable measures and has made substantial progress toward compliance at the Vine Hill Complex, but cannot fully meet statutory requirements until final closure plans have been approved. The Company has discussed its TPCA compliance activities with the applicable RWQCB. Although substantial civil penalties are available for noncompliance with TPCA, the Company does not expect that penalties, if imposed, would be material to the Company's financial condition, given the circumstances and the Company's good faith efforts to achieve compliance and conclude closure.\nClosure and post-closure costs are incurred over a significant number of years and are subject to a number of variables including, among others, completion of negotiations regarding specific site closure and post-closure plans with applicable regulatory agencies. Such closure costs are comprised princi- pally of engineering, design and construction costs and of caretaker and monitoring costs during closure. The Company has estimated the impact of closure and post-closure costs in the provision for loss on disposition of transportation, treatment and disposal discontinued operations; however, closure and post-closure costs could be higher than estimated if regulatory agencies were to require closure and\/or post-closure procedures significantly different than those in the plans developed by the Company. Certain revisions to the closure procedures could also result in impairment of the residual land values attributed to certain of the sites.\nThe carrying value of the long-term assets of transportation, treatment and disposal discontinued operations of $41,705,000 at March 31, 1994 is principally comprised of residual land at the inactive disposal sites and assumes that sales will occur at current market prices estimated by the Company based on certain assumptions (entitlements, development agreements, etc.), taking into account market value information provided by independent real estate appraisers. During fiscal year 1992, the Company entered into an agreement with a real estate developer to develop some of this property as part of a larger development in the local area involving a group of developers. The entitlement process has been delayed due to uncertainties over the Company's closure plans for its adjacent disposal site and local community review of growth strategy. If the developers' plans change or the developers are unable to obtain entitlements as planned, the carrying value of this property could be significantly impaired. With regard to this property or any of the other residual land, there is no assurance as to the timing of sales or the Company's ability to ultimately liquidate the land for the sale prices assumed. If the assumptions used to determine such prices are not realized, the value of the land could be materially differ- ent from the current carrying value.\nThe USEPA and the DTSC are investigating certain transporta- tion and disposal activities conducted by numerous companies, including the Company or its predecessors, involving certain disposal sites in California, including the Operating Indus- tries, Inc. (OII) Superfund site. In connection with the OII action, the Company did not elect to join various proposed settlements with the USEPA for the first three interim remedial measures. The claims against the Company by the USEPA for these costs total approximately $8,500,000 and the claims by the PRP steering committee approximate $2,700,000. (The Company believes there is substantial duplication between the USEPA's and the PRP steering committee's claims.) The claims to date do not include certain future costs for site remediation and long- term monitoring and maintenance which are expected to be substantial. Based on the nature of the waste streams handled by the Company's subsidiaries and their conduct in handling the wastes, the Company believes its proper share of responsibility for the site is less than the share attributed to it by the USEPA and the PRP steering committee. Accordingly, the Company has not been able to agree to USEPA's or the PRP steering committee's claims. IT has met with the USEPA to propose and negotiate a release from alleged liability for past costs in return for IT undertaking remediation work at the site but the USEPA has not responded to the proposal. The Company has advised its liability insurance carriers as to the pendency of the USEPA's claim and requested indemnification and legal representation. The carriers dispute the scope of their coverage obligations to IT. The Company has also been named as a PRP in several other investigations, and has either denied responsibility and\/or is participating with others named by the USEPA and\/or the DTSC in conducting investigations as to the nature and extent of contamination at the sites.\nThe provision for loss on disposition of transportation, treatment and disposal discontinued operations is based on various assumptions and estimates, including those discussed above. The adequacy of the provision for loss has been currently reevaluated in light of the developments since the adoption of the divestiture plan, and management believes that the provision as adjusted is reasonable; however, the ultimate effect of the divestiture on the consolidated financial condition of the Company is dependent upon future events, the outcome of which cannot be determined at this time. Outcomes significantly different from those used to estimate the provision for loss could result in a material adverse effect on the consolidated financial condition of the Company.\nLong-term debt:\nLong-term debt consists of the following:\nAggregate amounts of long-term debt maturing in the five years following March 31, 1994 and thereafter are $5,268,000, $18,168,000, $50,151,000, $67,000, $66,000 and $173,000, respectively.\nIn July 1986, the Company issued $75,000,000 principal amount of senior notes, 9 3\/8%, due July 1, 1996, with interest payable semiannually. The notes are redeemable at the Company's option at par after July 1, 1993. On November 15, 1993, the Company prepaid at par value $25,000,000 of the senior notes, utilizing the proceeds from the public offering of depositary shares (see Preferred stock).\nOn June 25, 1990, an asset-based lender funded a $25,000,000 five-year installment loan at a fixed interest rate of 11.63%. The loan is secured by certain of the Company's HTTS equipment. On March 31, 1994, the Company prepaid the $4,952,000 balloon payment due June 30, 1995 on the loan in return for a partial release of collateral, leaving $5,835,000 outstanding which will be amortized over its original schedule through May 31, 1995. The loan agreement contains certain financial ratio covenants, including working capital, interest coverage and leverage requirements. Due to the Company's fourth quarter loss in fiscal year 1994, an amendment was required to the loan agree- ment to maintain compliance. Terms of the amendment were approved subsequent to March 31, 1994 and the Company is in compliance with such amended terms.\nThe Company's current banking arrangement provides for a revolving credit facility of up to $95,000,000 through September 30, 1995 and is secured principally by accounts receivable. In general, interest on borrowings under this line is at the bank's reference rate plus 1.75%, or in the case of Eurodollar borrow- ings, at the interbank offered rate plus 2.75%. The Company is subject to a 0.5% per annum charge on the unused portion of the commitment. The line of credit agreement stipulates that the Company must maintain certain minimum working capital, financial ratios and net worth requirements. In addition, the agreement includes certain other restrictive covenants, including limita- tions on the payment of cash dividends on common stock (and, if the Company is in default under the line, on the preferred stock), the repurchase of stock, the purchase or sale of significant assets, the aggregate amount of capital expendi- tures, and the incurrence of debt. Due to the Company's fourth quarter loss in fiscal year 1994, amendments were required to certain of the Company's loan covenants in order to maintain compliance. Terms of these amendments were approved subsequent to March 31, 1994 and the Company is in compliance with such amended terms.\nAt March 31, 1994, the Company had $17,000,000 of borrowings outstanding against its credit facility. Additionally, standby letters of credit totaling approximately $55,500,000 were outstanding at March 31, 1994 related to financial assurance for the Company's inactive disposal facilities (see Discontinued operations - Transportation, treatment and disposal), and the Company's insurance and bonding requirements, leaving approxi- mately $22,500,000 unused. However, the amount of current availability under the Company's line is limited to the amount of collateral available in accordance with the loan agreement, principally 70-80 percent of the Company's eligible accounts receivable. At March 31, 1994, approximately $17,000,000 was available under the line. Availability fluctuates from month to month depending on the level of accounts receivable outstanding.\nIncome taxes:\nThe benefit for income taxes consists of the following:\nThe (benefit) provision for income taxes is included in the statements of operations as follows:\nA reconciliation of the provision for income taxes on continuing operations computed by applying the federal statutory rate of 34% to income from continuing operations before income taxes and the reported provision (benefit) for income taxes of continuing operations is as follows:\nYear ended March 31, 1994 1993 1992 ----------------------------- (In thousands) Income tax provision (benefit) computed at statutory federal income tax rate $ (418) $ (313) $ 3,305 State income taxes, net of federal tax benefit, if any 422 650 675 Equity in loss of foreign subsidiaries (374) - 475 Amortization of cost in excess of net assets of acquired businesses 212 212 300 Benefit from utilization of financial accounting net operating loss carryforwards - - (4,318) Other (principally nondeductible items) 34 611 390 ------- ------- ------ Total provision (benefit) $ (124) $ 1,160 $ 827 ------- ------- -------\nAt March 31, 1994, the Company had net operating loss (NOL) carryforwards of approximately $52,300,000 for tax reporting purposes expiring primarily in 2007 through 2009. The Company also has tax credit carryforwards of approximately $2,496,000 which expire in various years through 2002 and Alternative Minimum Tax credit carryforwards of approximately $1,809,000.\nDuring the third quarter of fiscal year 1993, the Company adopted SFAS No. 109, retroactive to April 1, 1992. This statement supersedes SFAS No. 96 which the Company adopted effective April 1, 1988. As allowed under SFAS No. 109, the Company reported the effect of the adoption of SFAS No. 109 as a cumulative effect of a change in accounting for income taxes of $13,000,000 of income and prior year consolidated financial statements were not restated. SFAS No. 109 retains the princi- pal objectives of SFAS No. 96; however, the new standard applies less restrictive criteria for recognizing deferred tax assets. Unlike the prior standard, SFAS No. 109 permits consideration of future events to assess the likelihood that tax benefits will be realized in future years. To the extent that current available evidence about the future raises doubt about the realization of the deferred tax asset, a valuation allowance must be estab- lished.\nUpon adoption of SFAS No. 109, the Company recorded a deferred tax asset of $22,667,000 as of April 1, 1992 representing the tax benefit of future federal and state tax deductions, net operating loss, alternative minimum and investment tax carry- forwards and established a valuation allowance of $7,700,000 against that asset. This allowance may be adjusted based upon the Company's ability or inability to demonstrate with reason- able certainty there will be sufficient taxable income as may be required to utilize tax benefits related to the balance of the asset. At March 31, 1993, the Company increased the valuation allowance to $10,119,000 due to the relative uncertainty that the tax benefits from the additional provision for loss from discontinued operations recorded in the fourth quarter of fiscal year 1993 would be realized. At March 31, 1994, the Company increased the valuation allowance to $13,519,000, principally due to the recognition of additional state deferred tax assets, principally state NOL carryforwards, and the relative uncertain- ty that such state benefits will be fully utilized. At March 31, 1994 and 1993, the Company had deferred tax assets and liabilities as follows:\nMarch 31, 1994 1993 -------------------------- (In thousands) Deferred tax assets: Closure accruals - discontinued operations $ 21,630 $ 25,223 Net operating loss carryforwards 17,784 8,062 Alternative minimum tax credit carryforwards 1,809 1,866 Investment and other tax credit carryforwards 2,496 2,496 Other, net 6,684 7,835 ------- ------- Gross deferred tax asset 50,403 45,482 Valuation allowance for deferred tax asset (13,519) (10,119) ------- ------- Total deferred tax asset 36,884 35,363 ------- ------\nDeferred tax liabilities: Tax depreciation in excess of book depreciation (11,793) (10,926) Asset basis difference - discontinued operations (10,301) (10,301) --------- -------- Total deferred tax liabilities (22,094) (21,227) --------- --------\nNet deferred tax asset $ 14,790 $ 14,136 --------- --------\nNet current asset $ 9,329 $ 10,638 Net noncurrent asset 5,461 3,498 --------- -------- Net deferred tax asset $ 14,790 $ 14,136 --------- --------\nCommitments and contingencies:\nLease commitments\nThe Company's operating lease obligations are principally for buildings and equipment. Generally, the Company is responsible for property taxes and insurance on its leased property. At March 31, 1994, future minimum rental commitments under noncan- celable operating leases with terms longer than one year aggregate $49,521,000 and require payments in the five succeed- ing years and thereafter of $12,939,000, $12,177,000, $8,573,000, $4,613,000, $3,694,000, and $7,525,000, respective- ly.\nRental expense related to continuing operations was $14,912,000, $17,467,000 (including $2,014,000 of the restruc- turing charge) and $18,668,000 (including $2,969,000 of the restructuring charge) for fiscal years 1994, 1993 and 1992, respectively.\nContingencies\nClass action lawsuit\nIn July 1988, a purported class action lawsuit was filed in California state court on behalf of stockholders and noteholders of the Company alleging securities law violations and fraud and negligent misrepresentation in connection with the purchase of shares of the Company's common stock and 9 3\/8% senior notes by members of the purported class between January 1986 and April 1987. The complaint also named as defendants the underwriters who performed services in connection with the senior note offering. In addition, the complaint alleged that certain of the Company's officers and directors sold shares of the Com- pany's common stock at artificially inflated prices based on undisclosed information about the Company. The plaintiffs sought unspecified damages, including punitive damages plus costs associated with the litigation. Upon motions filed by all defendants, the Court dismissed this lawsuit with prejudice on January 3, 1990. Plaintiff filed an appeal of this dismissal on February 15, 1990 in the California Court of Appeal for the Second Appellate District, which was denied on May 3, 1991. On June 12, 1991, plaintiff filed a petition for review with the California Supreme Court regarding this appeal and review of the case was granted by the Court. The California Supreme Court affirmed the Court of Appeals, and the dismissal is now final.\nAdditionally, in December 1989, plaintiffs in this lawsuit filed another class action in federal court which contains essentially the same allegations and damage claims as those set forth in the dismissed state action, except that it has been brought only on behalf of the stockholders of the Company and raises a claim under the Securities Exchange Act of 1934. The Company is defending the action vigorously. Discovery on this action was in progress when, by order dated March 11, 1992, the federal court granted the Company's motion for reconsideration of its earlier denied motion for judgment on the pleadings and, on March 31, 1992, judgment was entered against the plaintiffs' claims. In dismissing the plaintiffs' claims, the court accepted defendants' arguments based on a 1991 United States Supreme Court decision which declared a uniform statute of limitations for such actions. Congress has since passed Section 27A of the Securities Exchange Act of 1934, which purports to reinstate the formerly applicable statute of limitations for actions pending on the date of the Supreme Court's decision. The plaintiffs moved the court to reconsider its March 11, 1992 order in part based upon a recent Ninth Circuit Court of Appeal case upholding the constitutionality of Section 27A which motion was granted on May 11, 1993. The court has set a trial date of January 10, 1995. After consultation with outside counsel and in consider- ation of the availability of insurance coverage, management believes the outcome of this matter will not have a material adverse effect on the consolidated financial condition of the Company.\nMotco\nOn December 4, 1991, the Company announced the suspension of work on the Motco project, the cleanup of a Superfund site in Texas, and the filing of a $56,000,000 breach of contract lawsuit against the Motco Trust, the potentially responsible party (PRP) group that agreed to finance remediation of the site and Monsanto Company, the leader of the PRP group.\nIn January 1988, the Company was retained by the Motco Trust to destroy waste contained in pits at the site using two transportable incinerators designed and operated by IT. Based on information provided to IT in the Motco Trust's request for proposal, the Company bid and was awarded a fixed-price contract for approximately $33,000,000 which was subsequently increased to approximately $38,000,000 through change orders. Of that amount, approximately $21,000,000 has been paid to the Company. In early 1991, IT advised the Motco Trust and Monsanto that it would cost substantially more to complete the project because the scope of work had changed and because the chemical makeup, quantities and mixture of waste at the site were dramatically different from that portrayed by data provided to IT in Motco Trust's request for proposal. Additionally, the project was impacted by other actions of the Motco Trust and Monsanto, including the pumping of contaminated water and waste into the Motco pits from an unrelated project which was managed by the Motco Trust and Monsanto.\nIT continued work at the site in good faith while negotiations were occurring with the Motco Trust and Monsanto. Approximately $31,000,000 of direct costs were incurred in excess of those recovered under the contract and recorded as a contract claim receivable and are included in noncurrent assets in the Com- pany's consolidated balance sheet at March 31, 1994 and 1993. IT has not recognized any overhead cost recovery or profit on this project to date. IT sued to recover costs and profit of approximately $56,000,000.\nOn December 26, 1991, the Motco Trust and Monsanto filed an answer to IT's denied liability to IT on the grounds that the Motco Trust had executed a change order on or about September 28, 1990 address- ing many of the claims and purported underlying events alleged in the lawsuit and had received a full release from IT regarding those matters, that IT has failed to mitigate the damages alleged to have been incurred by IT, that IT has failed to manage and control its costs with respect to its work on the project, and that IT's lawsuit fails to state a claim upon which relief can be granted as it claims extra-contractual compensa- tion. Monsanto also denies any separate liability from that of the Motco Trust.\nIn its counterclaim, the Motco Trust seeks recovery of $27,000,000 of monetary damages including all payments to third parties to complete performance of the project, all penalties or other liabilities to any governmental entity, and any related damages which occur as a result of the breach of contract by IT which is alleged to have occurred upon the filing of the lawsuit by IT and concurrent suspension of work at the site.\nThe case was tried to a jury during March and April of 1994. As a result of that trial, the jury rendered a special verdict in IT's behalf wherein they found that Monsanto had breached its contract with IT, had defrauded IT and had provided IT with information which constituted a negligent misrepresentation as to the waste characteristics. The jury found that the amount of damages caused IT as a result of these acts was in the amount of $52,800,000. The jury also found that Monsanto should pay punitive damages in the amount of $28,550,000, together with attorneys' fees in the amount of approximately $2,300,000. The jury further found that IT did not commit fraud against the defendants, that any breach of contract IT may have committed was excused, and that Motco Trust should not recover on its $27,000,000 counterclaim.\nMonsanto has filed a motion for judgment notwithstanding the verdict, and, alternatively, for a new trial. If the Court orders a new trial, the verdict will be set aside pending a complete retrial before a new jury. If Monsanto's motions with the trial court are denied, the judgment is subject to appeal.\nAfter consideration of the merits of the Company's position in the lawsuit and after consultations with its outside counsel, management believes that, subject to the inherent uncertainties of litigation, the Company more likely than not will recover the contract claim receivable recorded to date and prevail on Motco Trust's counterclaim. However, if this matter is resolved in an amount significantly lower than the contract claim receivable recorded by IT or if the Motco Trust prevails in its counter- claim and recovers any significant amount of damages, a material adverse effect to the consolidated financial condition of the Company would result.\nCentral Garden\nOn July 14, 1992, the Company responded to an emergency call to clean up a chemical spill at a finished product warehouse facility leased by Central Garden & Pet Supply Company (Central) in Baton Rouge, Louisiana. While cleanup was under way, a fire began which damaged the warehouse facility. In addition to the owner of the facility, Central and two other lessees of the finished product warehouse facility (an electrical supply company and a pharmaceutical company) incurred significant property damage and substantial loss of inventory.\nOn August 2, 1992, a petition for damages was filed against the Company and Central by residents of a nearby apartment complex alleging personal injuries caused by the release of hazardous and noxious materials into the atmosphere as a result of the fire. Central filed an answer, cross-claim, and third- party complaint. In the complaint and cross-claim, Central alleges, among other things, that the Company was the cause of the fire in failing to exercise proper care in the cleanup of the spill, and was responsible for the property damage, loss of contents, loss of profits and other economic injury, and expenses incurred in the cleanup. Further, Central claims a set-off for monies due the Company for cleanup services rendered by the Company after the fire and seeks indemnity for any damages assessed against Central. The Company has responded to the complaint and cross-claim alleging, among other things, improper storage and handling of hazardous materials by Central. This case was remanded to state court for lack of diversity jurisdiction. The Company has also filed its own cross-com- plaint against Central for services rendered after the fire and has denied responsibility for the fire, raised certain defenses, and further claimed that Central was not entitled to a set-off. The monies due the Company for services rendered to Central approximate $1,700,000 and are included in accounts receivable in the Company's consolidated balance sheet at March 31, 1994 and 1993. Neither Central nor the nearby residents have formally specified the damages they seek, although, based on early discovery, it appears Central claims losses in the $3,000,000 range for destruction of inventory, plus unspecified additional damages, including other amounts it may be required to pay as a result of the fire, for which it seeks indemnity from IT.\nA complaint has also been filed in state court in this matter by the insurer for the electrical supply company against the Company, Central, the lessor and certain insurers. While the complaint does not specify the damages sought, an earlier demand was made for approximately $1,800,000.\nIn addition, the owner of the adjacent pharmaceutical company and its insurers have filed suit against the Company, Central, the lessor, a construction company which built a fire wall that allegedly did not meet the building code, the manufacturer of the chemicals which were spilled and certain insurers. While damages have not been formally specified, it appears plaintiff is claiming loss of the warehouse inventory valued in excess of $9,000,000, as well as business interruption. The lessor has also filed a cross-claim and third party complaint against the Company and others in this action.\nSeveral other actions arising out of the fire have recently been filed which the Company believes are substantially duplica- tive of the previously filed cases in the types and amounts of relief sought.\nThese matters are at a relatively early stage, and trial dates have not been set. A discovery schedule has been established which contemplates completion in the fall of 1994 as to the issues of factual causation. The Company is unable at this time to predict the outcome and is defending the actions vigorously. The Company's insurance carrier has been notified of the matter and is a defendant in one of the actions. The Company's carrier is defending the actions subject to a reservation of its rights to contest coverage at a later date. The Company has filed a protective action seeking determination of coverage.\nHelen Kramer\nOn May 3, 1993, the Company received an administrative subpoena from the Office of the Inspector General (OIG) of the USEPA seeking documents relating to certain of the Company's claims which were submitted to the U.S. Army Corps of Engineers with regard to the Helen Kramer remediation contract, a substan- tially completed project which the Company performed in joint venture. Since August 1992, the Defense Contract Audit Agency (DCAA) has been conducting an audit of certain claims submitted by the joint venture. The Company has been informed that there is a federal civil and criminal investigation into the claims. The Company is also aware that one of its employees who provided procurement support for the Helen Kramer project has been subpoenaed to appear before a federal grand jury in Philadel- phia, Pennsylvania. This matter is at a very preliminary stage. The Company is cooperating fully with the government's investi- gation. In addition, by letter dated October 3, 1993, a shareholder of the Company alleged that the acts giving rise to the OIG's investigation constituted, among other things, a waste of the Company's assets, and demanded that the Company institute an action against those responsible for the alleged wrongdoing. The Company is investigating the shareholder's claims fully.\nOther\nVarious other claims and actions, considered normal to the Company's business, have been asserted and are pending against the Company. Management believes that such claims and actions are either adequately covered by insurance, or if not insured, will not, in the aggregate, have a material adverse effect on the consolidated financial condition of the Company.\nThe Company maintains a liability insurance program which includes commercial general liability, product liability, automotive liability, employers' liability, workers' compensa- tion, all risk property coverage, contractor's pollution liability, professional errors and omissions, and directors' and officers' liability insurance coverage. A portion of the Company's commercial general liability, automotive liability and workers' compensation insurance is provided through arrangements which require the Company to indemnify the insurance carriers for all losses and expenses under the policies and to support the indemnity commitments with letters of credit.\nEnvironmental Impairment Liability coverage is provided through the Company's captive insurance subsidiary, which has issued a $32,000,000 policy exclusively for IT's inactive treatment, storage and disposal sites located in Northern California. See Discontinued operations - Transportation, treatment and disposal for information regarding certain legal and governmental proceedings affecting the Company's treatment, storage and disposal sites.\nRestructuring charges:\nIn connection with the realignment and streamlining of the Company's organization which was initiated in the fourth quarter of fiscal year 1993, the Company incurred a pre-tax restructur- ing charge of $8,378,000. The restructuring charge included costs for the consolidation of facilities in the United States through office combinations or shutdowns, related asset write- offs, severance payments to employees, and the disposition of most of the Company's European operations through either closure or sale.\nAt the end of fiscal year 1992, the Company implemented a restructuring program which was the result of an evaluation of operational capacity, productivity and overhead costs. The program included staff reductions, facility closures of several unproductive engineering offices and the San Jose, California laboratory, and related asset writeoffs and lease termination accruals. In fiscal year 1992, the Company recorded a $6,997,000 restructuring charge.\nGovernmental regulation:\nThe Company is subject to extensive regulation by applicable federal, state and local agencies. All facets of the Company's business are conducted in the context of a rapidly developing and changing statutory and regulatory framework, aggressive governmental enforcement and a highly visible political environ- ment. The Company's operations must satisfy stringent laws and regulations applicable to performance. Future changes in regulations may have an adverse effect on the Company's busi- ness.\nPreferred stock:\nIn a September 1993 public offering, the Company issued 2,400,000 depositary shares, each representing a 1\/100th interest in a share of the Company's 7% Cumulative Convertible Exchangeable Preferred Stock (Preferred Stock). The depositary shares entitle the holder to all proportional rights and preferences of the Preferred Stock, including dividend, liquida- tion, conversion, redemption and voting rights and preferences. The net proceeds from the issuance were $57,130,000.\nThe Preferred Stock ranks as to dividends and liquidation, prior to the Company's common stock and Series A Junior Partici- pating Cumulative Preferred Stock, if issued. (See Stockholder Rights Plan.) The dividend per annum and liquidation preference for each share of Preferred Stock are $175 and $2,500, respec- tively, and for each depositary share are $1.75 and $25, respectively. Dividends on the Preferred Stock and depositary shares are cumulative and payable quarterly.\nThe Preferred Stock is convertible at the option of the holder into shares of the Company's common stock at a conversion price of $5.84 per share. On any dividend payment date on or after September 30, 1996, the Preferred Stock is exchangeable at the option of the Company, in whole but not in part, for 7% Convert- ible Subordinated Debentures Due 2008 in a principal amount equal to $2,500 per share of Preferred Stock (equivalent to $25 per depositary share). The Preferred Stock may be redeemed at any time on or after September 30, 1996, at the option of the Company, in whole or in part, initially at a price of $2,622.50 per share of Preferred Stock (equivalent to $26.225 per deposi- tary share) and thereafter at prices declining to $2,500 per share of Preferred Stock (equivalent to $25 per depositary share) on or after September 30, 2003.\nThe Preferred Stock is non-voting, except that holders are entitled to vote as a separate class to elect two directors if the equivalent of six or more quarterly dividends (whether consecutive or not) on the Preferred Stock is in arrears. Such voting rights will continue until such time as the dividend arrearage on the Preferred Stock has been paid in full.\nStock incentive plans:\nThe Company has a 1991 Stock Incentive Plan (1991 Plan) which provides for the issuance of the Company's common stock or any other security or benefit with a value derived from the value of its common stock. Options are granted at exercise prices equal to or greater than the quoted market price at the date of the grant. At March 31, 1994, the maximum number of shares of the Company's common stock that may be issued pursuant to awards granted under the 1991 Plan is 1,377,758. At April 1 of each fiscal year, the maximum number of shares available for award under the 1991 Plan will be increased by an amount which represents 2% of the number of shares of the Company's common stock which are issued and outstanding at that date. During the fiscal year ended March 31, 1994, the first series of options were granted under the 1991 Plan, which expires in fiscal year 1996.\nThe Company also had a 1983 Stock Incentive Plan (1983 Plan) which provided for the granting of incentive and non-qualified stock options and stock appreciation rights and the issuance of restricted common stock. Options granted under the 1983 Plan and outstanding at March 31, 1994, will expire at various dates through July 3, 2003. No stock appreciation rights were granted under the 1983 Plan. No shares are available for grant under the 1983 Plan, which expired in September 1993.\nChanges in the number of shares represented by outstanding options under the 1991 Plan and the 1983 Plan during the fiscal years ended March 31, 1994, 1993 and 1992 are summarized as follows:\nYear ended March 31, 1994 1993 1992 ------------------------------------- Outstanding at beginning of year 2,787,152 2,640,578 2,891,057\nOptions granted (1994, $3.125 - $5.875 per share; 1993, $4.875 - $7.00 per share; 1992, $7.625 - $9.75 per share) 1,007,200 797,500 366,865\nOptions exercised (1994, $2.75 - $4.625 per share; 1993, $3.00 - $5.50 per share; 1992, $2.75 - $8.00 per share) (170,583) (239,539) (335,663)\nOptions expired and forfeited (436,750) (411,387) (281,681) --------- -------- ---------\nOutstanding at end of year (1994, $3.125 - $11.00 per share) 3,187,019 2,787,152 2,640,578 --------- --------- ---------\nVested options 1,484,947 1,390,574 1,179,960 --------- --------- ---------\nStockholder Rights Plan:\nOn December 14, 1989, the Company adopted a Stockholder Rights Plan (the Rights Plan), pursuant to which the Company distribut- ed one stock purchase right (a Right) with respect to each share of common stock outstanding on the December 26, 1989 record date. The Rights Plan provides that in the event that any person becomes the beneficial owner of 20% or more of the outstanding shares of common stock (a 20% Stockholder) or commences a tender offer or exchange offer, the consummation of which would cause such person to become a 20% Stockholder, each Right will entitle the holder (other than a 20% Stockholder) to purchase, at any time on or after the tenth business day following the date of such event, at the then-current exercise price (initially $35), one two-thousand-five-hundredth of a share of Series A Junior Participating Cumulative Preferred Stock, par value $100, of the Company, which one two-thousand- five-hundredth of a share is designed to have a value approxi- mately equal to the value of one share of common stock. In the event that any person becomes a 20% Stockholder, each previously unexercised Right will entitle the holder (other than the 20% Stockholder) to purchase, at any time on or after the tenth business day following the date of such event, shares of common stock having a market value equal to two times the then-current exercise price. In the event that, at any time on or after the date that a person becomes a 20% Stockholder, the Company is merged into another corporation or 50% or more of the Company's assets are sold, then each previously unexercised Right will entitle the holder (other than the 20% Stockholder) to purchase, at any time on or after such date, shares of common stock of the acquiring corporation having a market value equal to two times the exercise price. In connection with the Rights Plan, the Company has designated 40,000 shares of its authorized preferred stock as Series A Junior Participating Cumulative Preferred Stock.\nThe Rights may be redeemed by the Company at a price of $.01 per Right at any time until they become exercisable to purchase common stock of the Company or another corporation. The Company may redeem the Rights only with the concurrence of a majority (but not less than three) of the independent directors. The Rights, which do not have voting rights and are not entitled to dividends, expire on December 14, 1999.\nClass action lawsuit:\nIn fiscal year 1994, 1,872,759 shares of common stock valued at $6,350,000 were issued in settlement of a class action lawsuit alleging certain securities law violations emanating from a 1987 offering of common stock. A charge of $7,300,000 was taken to other expense in the consolidated statement of operations in fiscal year 1993 to provide for this settlement and related expenses.\nMajor customers:\nA total of 53%, 45% and 37% of the Company's revenues during fiscal years 1994, 1993 and 1992, respectively, were from federal governmental agencies, primarily the U.S. Department of Defense (DOD) and the U.S. Department of Energy (DOE). In fiscal years 1994, 1993 and 1992, the DOD provided 33%, 19% and 12%, respectively, of the Company's revenues. The DOE provided 15%, 16% and 15% of the Company's revenues during fiscal years 1994, 1993 and 1992, respectively.\nEmployee benefit plans: The Company has a defined contribution, contributory pension and profit sharing plan (the Plan), covering all employees with one year of continuous service. The Company funds current costs as accrued, and there are no unfunded vested benefits. The Plan requires a minimum annual Company contribution of 4% and allows a maximum contribution of up to 8% of participants' eligible compensation up to $235,840, $228,860 and $222,220 for fiscal years 1994, 1993 and 1992, respectively. In fiscal years 1992 through 1994, 4% of participants' eligible compensation was annually contributed to the Plan.\nPension and profit sharing expense was $3,987,000, $3,580,000 and $3,170,000 for fiscal years 1994, 1993 and 1992, respective- ly.\nThe Company presently provides certain health care benefits for retirees who are over age 60 and have completed a specified number of years of service. In fiscal year 1994, the Company contributed approximately $50,000 toward these benefits. Statement of Financial Accounting Standards No. 106 (SFAS No. 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" which became effective for the Company in fiscal year 1994, requires accrual, during the years that the employee renders the necessary service, of the expected cost of providing these benefits to an employee and the employee's covered dependents. Under SFAS No. 106, the Company is recognizing its Accumulated Postretirement Benefit Obligation (APBO or Transi- tion Obligation) of $733,000 on a delayed basis as a component of net periodic postretirement benefit cost and will amortize this cost over 20 years. Annual total expense for postretire- ment benefits under SFAS No. 106 including amortization of the APBO in fiscal year 1994 was $250,000.\nEvents subsequent to March 31, 1994 (unaudited):\nOn June 28, 1994, pursuant to a definitive agreement signed on May 2, 1994, the Company and an affiliate of Corning Incorporat- ed (Corning) combined the two companies' environmental analyti- cal services businesses into a newly formed 50\/50 jointly-owned company (the joint company). The joint company will operate independently with a separate board of directors comprised of representation from IT and Corning, and will provide services to the Company on a competitive basis. In connection with the transaction, IT and Corning will contribute the net assets of their respective laboratory businesses into the joint company. Additionally, IT issued to Corning 333,000 shares of IT common stock and a five-year warrant to purchase 2,000,000 shares of IT common stock at $5.00 per share. The financing of the joint company will be provided by a $60,000,000 bank line of credit. IT's 50 percent investment in the joint company will be account- ed for under the equity method. An aggressive integration plan will be implemented in the early stages of operations of the joint company. The plan will include consolidation and closure of redundant lab facilities and equipment, a reduction in force to eliminate duplicative overhead and excess capacity and a consolidation of laboratory management and accounting systems, resulting in productivity gains achieved through economies of scale. Consequently, it is estimated that the joint company will incur a charge for integration of approximately $20,000,000, principally non-cash, in the quarter ending June 30, 1994. IT will reflect 50 percent of such charge in its financial statements in the same quarter.\nQuarterly results of operations (In thousands, except per share data) (unaudited):\nFirst Second Third Fourth quarter quarter quarter quarter ----------------------------------------------------- 1994: Revenues . . . $ 102,549 $ 100,665 $ 92,524 $ 97,065 Gross margin . 17,249 16,319 13,380 11,239 Net income (loss) 1,962 1,692 726 (5,486) Net income (loss) applicable to common stock 1,962 1,657 (324) (6,536) Net income (loss) per share (net of preferred stock dividends) . $ .06 $ .05 $ (.01) $ (.19) ---------- ----------- ---------- ---------\n1993: Revenues . . . $ 102,558 $ 102,811 $ 101,673 $ 103,497 Gross margin . 19,235 18,842 18,019 17,177 Income (loss) from continuing operations . 4,790 2,127 (4,346) (4,653) Loss from discontinued operations. . - - (3,809) (6,800) Income (loss) before cumulative effect of change in accounting for income taxes. 4,790 2,127 (8,155) (11,453) Cumulative effect of change in accounting for income taxes 13,000 - - - Net income (loss). 17,790 2,127 (8,155) (11,453) Net income (loss) per share: Continuing operations . $ .14 $ .06 $ (.13) $ (.13) Discontinued operations. - - (.11) (.20) Cumulative effect of change in accounting for income taxes . . . . . .39 - - - --------- ----------- ---------- --------- Net income (loss) per share . . $ .54 $ .06 $ (.24) $ (.33) --------- ----------- ---------- ----------\nBeginning with the second quarter of fiscal year 1994, net income (loss) applicable to common stock represents net income (loss) after preferred dividends on the Company's 7% Cumulative Convertible Exchangeable Preferred Stock. (See Preferred stock.) In the fourth quarter of fiscal year 1994, the Company recorded a $3,000,000 ($.09 per share ) after tax provision related to the actuarially determined value of contractual retirement benefits to be provided to its former Chairman of the Board (who was also Chief Executive Officer from 1975 to 1992) who retired from that position effective April 1, 1994. (See Summary of significant accounting policies - Accrued contractual retirement benefits.) In addition, the Company wrote off its investment in a planned treatment facility in the U.K. in the amount of $1,600,000 ($.05 per share) after tax in the fourth quarter of fiscal year 1994.\nDuring the fourth quarter of fiscal year 1993, the results of continuing operations were impacted by two items. The Company recorded an approximate $5,900,000 ($.17 per share) after tax restructuring charge for the consolidation of operations in the United States and the disposition of most of the Company's European operations. (See Restructuring charges.) Additional- ly, the Company provided for an approximately $700,000 ($.02 per share) after tax adjustment to the initial provision for the anticipated settlement of the stockholders' lawsuit. (See Class action lawsuit.)\nDuring the third quarter of fiscal year 1993, the Company recorded charges to continuing operations related to the following: approximately $5,400,000 ($.16 per share) after tax for the initial anticipated settlement of a stockholders' lawsuit (see Class action lawsuit); and approximately $1,700,000 ($.05 per share) after tax for the writeoff of nonrecoverable costs invested in a U.K. joint venture.\nDuring the first quarter of fiscal year 1993, the results of continuing operations were affected by the approximately $2,200,000 ($.07 per share) after tax gain on the sale of the Company's investment in common stock options of EXEL Limited, an offshore casualty insurance company.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere were none.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nThe section entitled \"Election of Directors\" in the regi- strant's Definitive Proxy Statement to be filed with the Securities and Exchange Commission for the Annual Meeting of Stockholders scheduled for September 1, 1994 (the Proxy State- ment) is incorporated herein by reference. See also \"Executive Officers of the Company\" in Part I of this report for certain information concerning the Company's executive officers.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe section entitled \"Executive Compensation\" in the Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe section entitled \"Beneficial Ownership of Shares\" in the Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe section entitled \"Certain Transactions\" in the 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.\nFinancial Statement Schedules II. Loans receivable from employees. . . . . . . . . . . S-1 V. Property, plant and equipment. . . . . . . . . . . . S-2 VI. Accumulated depreciation on property, plant and equip ment . . . . . . . . . . . . . . . . . . . . . . . S-3 VIII. Valuation and qualifying accounts. . . . . . . . . . S-4 X. Supplementary income statement information . . . . . S-4\nSchedules not filed herewith are omitted because of the absence of conditions under which they are required or because the information called for is shown in the consolidated finan- cial statements or notes thereto.\nExhibits\nThese Exhibits are numbered in accordance with the Exhibit Table of Item 601 of Regulation S-K.\nExhibit No. Description - ----------------------------------------------------------------------------- 2 Omitted - Inapplicable.\n3(i) Certificate of Incorporation of the registrant as amended by Amendment to Certificate of Incorporation filed September 17, 1987, with Delaware Secretary of State.(2)\n3(ii) Bylaws of the registrant as amended through June 2, 1994.\n4(i) 1. Rights Agreement dated as of December 14, 1989 by and between International Technology Corporation and Bank of America National Trust and Savings Association, as Rights Agent.(3)\n2. Amendment No. 1 to Rights Agreement.(9)\n4(iii) 1. Indenture dated as of June 15, 1986 between Inter- national Technology Corporation and Continental Illinois National Bank and Trust Company of Chicago relating to the Company's 9 3\/8% Senior Notes due 1996.(1)\n2. Certificate of Designations of Series A Junior Participating Cumulative Preferred Stock, $100 par value.(8)\n3. Certificate of Amendment of Certificate of Designa- tions of Series A Junior Participating Cumulative Preferred Stock, $100 par value.(9)\n4. Certificate of Designations with respect to the registrant's 7% Cumulative Convertible Exchangeable Preferred Stock, $100 par value.(9)\n5. Indenture for the registrant's 7% Convertible Subordinated Debentures Due 2008.(9)\n9 Omitted - Inapplicable.\n10(ii) 1. Secured Loan Agreement dated as of April 20, 1990 among the registrant, IT Corporation and Household Commercial of California, Inc.(5)\n2. First Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of June 16, 1992.(9)\n3. Second Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of June 28, 1993.(9)\n4. Third Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of November 11, 1993.\n5. Fourth Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of February 11, 1994.\n6. Fifth Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of March 31, 1994.\n7. Sixth Amendment to Secured Loan Agreement among the registrant, IT Corporation, Household Bank, f.s.b. as assignee of Household Commercial of California, Inc. dated as of June 28, 1994.\n8. Syndicated Credit Agreement dated as of August 27, 1991 among the registrant, IT Corporation and Bank of America National Trust and Savings Association, as agent for the bank group.(7)\n9. First Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America National Trust and Savings Association and certain other signatory banks, dated as of June 19, 1992.(9)\n10. Second Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America National Trust and Savings Association and certain other signatory banks, dated as of June 28, 1993.(9)\n11. Third Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America National Trust and Savings Association and certain other signatory banks, dated as of March 24, 1994.\n12. Fourth Amendment to Credit Agreement and Waiver among the registrant, IT Corporation, Bank of America National Trust and Savings Association and certain other signatory banks, dated as of June 24, 1994.\n13. Asset Transfer Agreement among MetPath Inc., the registrant and IT Corporation dated as of May 2, 1994.\n14. Securities Acquisition Agreement between the regis- trant and MetPath Inc. dated as of May 2, 1994.\n10(iii) 1. Directors' Retirement Program.(4)\n2. Description of Special Turn-a-Round Plan (Fiscal Year 1995 Management Incentive Plan) of the registrant.\n3. 1983 Stock Incentive Plan, as amended.(8)\n4. Retirement Plan of IT, as amended by Amendment No. 1 and Amendment No. 2.(1)\n5. Form of Severance Benefit Agreement between the registrant and certain officers of the regis- trant.(5)\n6. 1991 Stock Incentive Plan.(6)\n7. Agreement dated July 14, 1992 between Robert B. Sheh and the registrant.(8)\n8. Agreement dated November 4, 1993 between Larry M. Hart and the registrant.\n9. Agreements dated November 5, 1993 between E. Brian Smith and the registrant.\n10. Retirement Agreement dated March 3, 1994 between Murray H. Hutchison and the registrant.\n11 1. Computation of Per Share Earnings for the three years ended March 31, 1994.\n12 Omitted - Inapplicable.\n13 Omitted - Inapplicable.\n16 Omitted - Inapplicable.\n18 Omitted - Inapplicable.\n21 1. List of the registrant's subsidiaries.\n22 Omitted - Inapplicable.\n23 Consent of Independent Auditors.\n24 Omitted - Inapplicable.\n27 1. Financial Data Schedule for the year ended March 31, 1994.\n2. Financial Data Schedule for the quarter ended March 31, 1994.\n28 Omitted - Inapplicable.\n99 Omitted - Inapplicable. __________ (1) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Registration Statement on Form S-l (No. 33-6310) and incorporated herein by reference. (2) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Annual Report on Form 10-K for the year ended March 31, 1988 and incorporated herein by reference. (3) Previously filed with the Securities and Exchange Commission as an Exhibit to registrant's Form 8-K dated December 14, 1989 and incorporated herein by reference. (4) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Annual Report on Form 10-K for the year ended March 31, 1989 and incorporated herein by reference. (5) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Amended Annual Report on Form 10-K for the year ended March 31, 1990 and incorporated herein by reference. (6) Previously filed with the Securities and Exchange Commission as an Exhibit to registrant's Registration Statement on Form S-8 (No. 33-52974) and incorporated herein by reference. (7) Previously filed with the Securities and Exchange Commission as an Exhibit to registrant's Form 8-K dated September 4, 1991 and incorporated herein by reference. (8) Previously filed with the Securities and Exchange Commission as an Exhibit to the registrant's Annual Report on Form 10-K for the year ended March 31, 1993 and incorporated herein by reference. (9) Previously filed with the Securities and Exchange Commission as an Exhibit to registrant's Registration Statement on Form S-3 (No. 33-65988) and 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, in Torrance, California on the 29th day of June 1994.\nINTERNATIONAL TECHNOLOGY CORPORATION\nBy ROBERT B. SHEH\nRobert B. Sheh 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.\nINTERNATIONAL TECHNOLOGY CORPORATION Schedule II -- Loans receivable from employees (1) (In thousands)\n(1) Amounts relate to interest-free loans to certain officers and employees principally for real estate purchases in connection with relocations and are classified as long-term assets in the consolidated financial statements.\n(2) Represents annual forgiveness of loans based on continuing service to the Company.\n(3) Represents loan forgiveness resulting from an employment termination agreement with this former President and Chief Operating Officer of the Company.\nINTERNATIONAL TECHNOLOGY CORPORATION Schedule V -- Property, plant and equipment (1) (In thousands)\n(1) Estimated useful lives of the elements of property, plant and equipment are as follows:\nLand improvements. . . . . . . . . . . . . . . . . . . . 10-20 years Buildings and leasehold improvements . . . . . . . . . . 3-20 years Machinery and equipment. . . . . . . . . . . . . . . . . 3-10 years\n(2) Represents net changes in period, excluding write-offs.\n(3) Represents primarily property, plant and equipment classified as discontinued operations or transferred to\/from discontinued operations. (See Notes to Consolidated Financial Statements - Discontinued operations.)\nINTERNATIONAL TECHNOLOGY CORPORATION Schedule VI -- Accumulated depreciation on property, plant and equipment (In thousands)\n(1) Represents primarily accumulated depreciation on property, plant and equipment classified as discontinued operations or transferred to\/from discontinued operations. (See Notes to Consolidated - Discontinued operations.)\nINTERNATIONAL TECHNOLOGY CORPORATION Schedule VIII -- Valuation and qualifying accounts (In thousands)\nINTERNATIONAL TECHNOLOGY CORPORATION Schedule X -- Supplementary income statement information (In thousands)\n(1)Represents cost and expenses of continuing operations. Exhibit 11.1\nINTERNATIONAL TECHNOLOGY CORPORATION COMPUTATION OF PER SHARE EARNINGS (In thousands, except per share data)\nExhibit 27.2\nTHE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM International Technology Corporation's Consolidated Balance Sheet as of March 31, 1994, Consolidated Statement of Operations for the fourth quarter of the Fiscal Year Ended March 31, 1994 and related Notes to onsolidated Financial Statements, all of which were filed with the SEC on June 29, 1994 on Form 10-K for the fiscal year ended March 31, 1994 (commission file number 1-9037) AND QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.\n(Amounts in thousands except per share data)","section_15":""}
{"filename":"99974_1994.txt","cik":"99974","year":"1994","section_1":"ITEM 1. BUSINESS\nITEM 1(a). GENERAL DEVELOPMENT OF BUSINESS\nTJ International, Inc. includes the operations of its subsidiaries and its 51% interest in Trus Joist MacMillan a Limited Partnership (the Partnership). Reference in this document to \"the Company\" includes TJ International, its subsidiaries, and the Partnership unless otherwise specified.\nThe Company posted an all time sales record in a market which had only 5% more U.S. and Canadian housing starts than 1992. On a year-to-year comparative basis, sales increased 38% from $400,480,000 in 1992 to $551,204,000 in 1993. The 1993 net income was $12,528,000 or $.76 per fully diluted share. These results compare with a 1992 net income of $7,311,000 or $.45 per fully diluted share which includes a credit of $900,000 or $.07 per fully diluted share resulting from adoption of Financial Accounting Standards Board (FASB) Statement No. 109, which governs accounting for income taxes.\nFor the fourth quarter, sales increased 44% to $144,725,000 from $100,383,000. Net income for the fourth quarter of 1993 was $3,007,000, or $.16 per fully diluted share. This compares with 1992's fourth quarter net income of $465,000 or $.01 per fully diluted share.\nSignificant Company items or events which occurred in 1993 included:\nMARKET DEVELOPMENTS. The Company's engineered lumber sales, used in residential construction, per North American housing start increased 49% in 1993 to $246 per start as compared to $165 in 1992. The Company believes this increased market acceptance is due to engineered lumber products offering advantages in both performance and cost effectiveness over natural lumber. The Company also believes its products are well positioned to benefit from the increasing scarcity and associated higher prices of the older, large diameter logs historically utilized to make the solid structural lumber products (2x10's, 2x12's, etc.) with which the Company's products compete.\nThe Company's window and door sales per North American housing start decreased somewhat from $88 per start in 1992 to $86 per start in 1993. This market performance was despite these products' dependence on the California and Eastern Canadian markets, two regions still suffering from latent recession. In 1993, housing starts were down 13% in California and 14% in the combined Eastern Canadian provinces of Ontario, Quebec and Maritimes. The Company believes its window and patio door products are well positioned to capitalize on the decline in the all-aluminum window market as consumers and regulators demand the higher insulating qualities of vinyl and wood products. The Company also believes it is well positioned to benefit from any economic recovery in the cyclically depressed markets of California and Eastern Canada.\nTECHNOLOGY DEVELOPMENTS. In July 1993, the Company announced it had successfully manufactured a high-strength TimberStrand-TM- laminated strand lumber in limited quantities at its Deerwood, Minnesota manufacturing facility. The Company believes this significant technological breakthrough, which enables the Company to develop high strength structural products from alternative wood resources such as Aspen or Yellow Popular, will be a significant competitive advantage. Aspen and Yellow Poplar are abundant, less environmentally pressured, and more competitively priced than traditional structural wood species such as Douglas Fir and Southern Yellow Pine.\nWINDOW AND PATIO DOOR OPERATING STRATEGY REFOCUS. During the third quarter of 1993, the Company completed an in-depth analysis of its strategy for the window and patio door products. The operating strategy adopted will refocus the business on becoming the \"no-problem\" supplier to the move-up, new construction market. The strategy will emphasize a high level of product quality and delivery reliability together with a high degree of personal service in regionally focused market areas. It will also take advantage of the Company's multiple, geographically dispersed manufacturing facilities to offer products designed for local market preferences and fast delivery times.\nSTOCK SPLIT; DIVIDEND INCREASE. At the Company's August 26, 1993 Board of Directors meeting, the Company's Board of Directors approved a two-for-one stock split to be effected in the form of a 100% stock dividend. The stock dividend was paid on October 1, 1993 to stockholders of record on September 7, 1993.\nThe Company's Board of Directors also authorized an increase in the Company's quarterly cash dividend from $0.0525 to $0.055 per post-split share, beginning with the dividend paid on October 20, 1993 to holders of record on September 24, 1993.\nARRANGEMENT WITH WEYERHAEUSER. The Company announced in July 1993 an arrangement with Weyerhaeuser's Building Materials Distribution Division to further develop distribution of the Company's engineered lumber products. Under the arrangement, 45 Weyerhaeuser customer service centers in the United States and Canada will distribute the Company's engineered lumber products. In addition, Weyerhaeuser is assuming an expanded role as a supplier of veneer and oriented strand board to the Company's manufacturing facilities. The Company believes the arrangement with Weyerhaeuser will enhance the visibility and sales of the Company's products.\nCAPITAL EXPANSION PROGRAM. At the Company's August 26, 1993 Board of Directors meeting, the Board of Directors approved a two-year capital expansion program. The program is intended to enhance the Company's leading position in engineered lumber products through the capacity expansion of existing facilities and construction of new production facilities. The capital expansion program is predicated on the positive developments in the engineered lumber products business, including higher commodity lumber prices and increased market acceptance of engineered lumber products. The Company believes that the new housing construction industry is undergoing a transition toward increased use of engineered lumber for structural building material, as wide-dimension commodity lumber increases in price and decreases in quality. The Company believes this expansion plan is appropriate because its new LSL technology represents a significant technological advancement which the Company believes will further strengthen its market leading position. The Company believes undertaking this capacity expansion program on an accelerated time schedule is prudent given the demand for these new technologies and competition in these markets that the Company expects will develop over time. However, there can be no assurance that the market for engineered lumber products will increase or that markets for new products will develop.\nThe capital expansion program includes the following:\nHazard, Kentucky, TimberStrand-TM- LSL Plant. The Company is proceeding with construction of a TimberStrand-TM- LSL engineered lumber production facility for approximately $100 million near Hazard, Kentucky. Construction of the facility commenced in the fall of 1993 with initial production expected in 1995.\nBuckhannon, West Virginia, Combination Plant. In November 1993, the Company announced it will proceed with construction of a combination facility near\nBuckhannon, West Virginia which will manufacture both MICRO=LAM-R- LVL and Parallam-R- PSL. It will cost approximately $85 million. Initial production of LVL is expected in the spring of 1995 and PSL production is scheduled for fall 1995.\nExisting Plants. The Company also authorized capital expenditures of approximately $25 millon to expand capacity at its existing MICRO=LAM-R- LVL, Parallam-R- PSL, and I-joist production facilities.\nThe Company is also examining potential sites for a third TimberStrand-TM- LSL plant, or an additional combination LVL and PSL plant. Commitment to this third plant is contingent upon continued market demand and acceptance of engineered lumber.\nITEM 1(b). FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS.\nThe primary business of the Company is the manufacture and marketing of specialty building products for the light construction industry. Principal products are wooden structural components, such as roof and floor joists and beams, headers, columns and posts, and wood windows and patio doors. Over 90% of the Company's sales are derived from this activity. The remainder of the Company's sales consist primarily of direct sales of various MICRO=LAM-R- LVL and TimberStrand-TM- LSL products to industrial users and the resale of certain accessory products sold in conjunction with products manufactured by the Company. The Company believes that these industrial and resale sales do not constitute a separate industry segment and that separate financial information would not be material to an understanding of the Company's business as a whole. Financial information relating to foreign and domestic operations is presented in Note 10 to the consolidated financial statements, page 42 of this Report.\nITEM 1(c). NARRATIVE DESCRIPTION OF BUSINESS.\nThe Company is the leading manufacturer and marketer of engineered lumber products in the world and a significant North American manufacturer of windows and patio doors. Engineered lumber products are high quality substitutes for sawn structural lumber historically obtained from the logging of older, large diameter trees. The Company utilizes advanced technology to manufacture engineered lumber at fourteen facilities located in the United States and Canada and estimates that its market share is in excess of 60% for engineered lumber products sold in North America. The Company's residential engineered lumber sales per North American housing start have increased from $75 per start in 1988 to $246 per start in 1993, an increase of 228%. The Company also manufactures and markets windows and patio doors through its three wholly-owned subsidiaries, Norco Windows, Inc. in the United States and R. Laflamme & Frere, Inc. and Dashwood Industries Limited in Canada.\nSTRATEGY. The Company's strategy in engineered lumber is to be a leading manufacturer and marketer of value-added specialty building products to the residential and light commercial construction industry. The Company believes it is well positioned to benefit from the increasing scarcity and associated higher prices of the older, large diameter logs historically utilized to make the sawn structural lumber products with which the Company's products compete. The Company's strategy is to increase the product acceptance of its engineered lumber products and to strengthen its market leadership in these products. To increase product acceptance, the Company's selling efforts highlight product advantages including consistent quality, superior strength, relatively light weight, and ease of installation targeted at end users such as architects and contractors. The Company seeks to strengthen its leading market position through (i) the addition of production capacity including the construction of new engineered lumber manufacturing\nfacilities, the expansion of existing facilities, and the construction of other facilities as market conditions warrant, (ii) the ongoing development of proprietary technologies including processes utilizing relatively low-cost wood fiber from abundantly available tree species, such as aspen and yellow poplar, (iii) an aggressive sales, marketing and service effort, and (iv) the establishment of an extensive North American distribution network including strategic alliances with MacMillan Bloedel and Weyerhaeuser.\nIn its window operations, the Company's strategy is to market its products directly to builders and dealers, supporting these efforts with high levels of personal service and by building relationships with customers. The Company's product line includes windows with price points and features that allow its products to be cost competitive in the entire range of homes from entry level housing to high-end custom housing. The Company has also recently added all-vinyl window manufacturing capacity to capitalize on the decline in the all-aluminum window market as consumers and regulators demand the higher insulating qualities of vinyl and wood windows. In its window operations, the Company believes it is well positioned to benefit from any economic recovery in its cyclically depressed markets, including eastern Canada and California.\nTIMBER SUPPLY. In general, the supply of public timber in the Pacific Northwest and to a lesser extent in the southern United States has declined over the past several years principally due to environmentally related pressures. In addition, the Clinton Administration in July 1993 announced a forest management plan calling for reduced harvests in the public forests west of the Cascade mountains, which have traditionally been a source of high quality sawn structural lumber. The plan, as proposed, represents an approximate 75% reduction in harvest levels on federal lands which historically prevailed in this region. Non-federal owned timber has traditionally provided approximately two-thirds of the volume harvested annually in Oregon and Washington. Harvest rates in excess of replacement growth rates and more restrictive environmental regulation on these timberlands have also reduced the volume of high grade timber available from this source.\nThe Company believes this plan, if implemented, would materially and permanently reduce the supply of wood available in the region. As a result of this plan and general environmentally-related timber supply pressures, the Douglas fir veneer utilized as the raw material in the Company's Oregon engineered lumber facilities could materially increase in cost due to limited availability.\nUnlike many of its principal competitors in engineered lumber, the Company does not currently manufacture veneer on the West Coast or own any timberlands or standing timber. The Company buys its raw materials on contract both from small independent suppliers and larger integrated forest products companies. In addition, a significant portion of its wood raw materials are purchased on the spot market. The reduced supplies could result in more volatile wood markets. The Company has experienced and believes it may continue to experience volatility in its quarter-to-quarter results due to raw material price volatility.\nThe Company, however, believes it will be able to satisfy its needs for raw materials and it is not currently aware of any potential shortages for its longer-term requirements. The Company believes that it has significant competitive advantages over companies marketing traditional sawn lumber products in an environment of reduced timber supply because its engineered lumber technologies are able to utilize non-traditional sources of wood fiber, which are both more abundant and less expensive.\nACQUISITIONS. The Company regularly reviews potential opportunities to acquire additional facilities or companies. These acquisitions must complement the Company's\ninternal growth by adding to its product line of value-added specialty building materials, adding to its customer base, or enhancing its technological advantages. The Company intends to capitalize on its improved financial flexibility by examining potential acquisitions that meet its strategic objectives.\nENGINEERED LUMBER PRODUCTS\nOVERVIEW. The Company believes that the new housing construction industry is undergoing a transition in its use of structural building materials as sawn structural lumber increases in price and decreases in quality. Engineered lumber is enjoying accelerated market acceptance and is displacing sawn structural lumber.\nThis transition is driven by the changing composition of the North American timberlands, both in terms of regional log supply restrictions and the type and size of logs currently available for use as raw material. The availability of timber from federally owned forests in the Pacific Northwest has been greatly restricted and the size of an average sawlog has decreased to the point where it is often too small to produce significant quantities of high grade, wide-dimension structural lumber.\nTECHNOLOGY. The Company is the industry leader in developing and commercializing proprietary technologies that enable the manufacturing of engineered lumber products from wood that has been regarded as not sufficiently large, strong, straight, or free of defects to be sawn into structural lumber.\nThe following table outlines the principal features of the Company's technologies:\nThe Company's three engineered lumber technologies are: laminated veneer lumber, or LVL, the oldest and most commercialized of the technologies; parallel strand lumber, or PSL, first introduced in the mid-1980's in Canada; and laminated strand lumber, or LSL, a new technology introduced in the fall of 1991. Both PSL and LSL are proprietary to the Company, while equipment to produce LVL is now available from several machinery manufacturers and is utilized by an increasing number of forest products manufacturers. The Company believes its LVL manufacturing process enjoys several advantages which make this process cost-competitive compared to the commercially available alternatives.\nAlthough the Company has been issued or has applied for a number of patents on its current processes, the Company believes that its technological competitiveness depends more upon continued innovation and technical expertise than on legal protection of its patent rights. There can be no assurance that the Company's efforts to protect its proprietary rights will be successful.\nLAMINATED VENEER LUMBER (LVL). LVL uses thin sheets of veneer peeled from a log. Each sheet is carefully dried and individually graded using ultrasonic measurements to determine its strength characteristics. Sheets are then placed in specific sequence and location within the product to maximize its strength and randomize wood defects, such as knots. This engineered configuration of veneers is then laminated with adhesives under heat and pressure to form a piece of wood in widths of 24 inches or 48 inches, thicknesses from 3\/4 inches to 3 1\/2 inches, and up to 80 feet in length.\nPARALLEL STRAND LUMBER. This technology, which is proprietary to the Company, starts with sheets of thin veneer peeled from a log. These sheets are then clipped into strands which are four feet long and 5\/8 inches wide. The ability to use this very narrow strand allows a significantly higher percentage of the log to be manufactured into a value-added product. The strand is then coated with an adhesive. The next step in the process employs a pressing system in which microwaves are used to cure the adhesive and form a large block, or billet, of engineered lumber measuring up to 11 inches by 20 inches and 80 feet long. The Company's PSL process is protected by 21 patents in 16 countries. These patents expire in the years 1994 through 2008.\nThe Company believes that the combination of the PSL and LVL technologies in a single manufacturing facility will allow it to be among the most competitive purchasers of whole logs.\nLAMINATED STRAND LUMBER (LSL). The Company's other proprietary engineered lumber technology, LSL, begins with small-diameter, 8-foot-long logs such as aspen and yellow poplar. These are species traditionally used in lower value applications such as pulp logs and are therefore substantially less expensive than traditional sources of sawn lumber. These logs are flaked into strands about 12 inches long, which are then treated with an adhesive. The strands are put into a steam-injection press that significantly densifies the wood and creates boards 35 feet long, up to 5 1\/2 inches thick, and 8 feet wide. The Company's LSL process is protected by 20 patents in 25 countries. In addition, one patent is pending approval. These patents expire in the years 1994 through 2010.\nThe Company's future success will depend in large part on its ability to achieve market acceptance of its LSL technology and to obtain cost reductions in the implementation of this technology sufficient to provide the Company with an adequate return. The Company's Deerwood, Minnesota plant, where LSL is manufactured, experienced a loss in all quarters of 1993. The Company's strategic decision to operate the plant to achieve manufacturing efficiencies in higher value TimberStrand-TM- LSL products that are still in start-up, to develop a broad and deep product line and to test equipment designs for the larger plant near Hazard, Kentucky, contributed to this loss. There can be no assurance that the Company will be able to achieve such market acceptance or to lower manufacturing costs to a level sufficient to earn an adequate return.\nAll the Company's technologies can use wood fiber from trees that were previously not suitable for the manufacture of structural lumber, and this allows the Company to access the current inventory of wood fiber. The current inventory of wood fiber differs from that in the past, primarily in the species and size of the trees available for harvest. Much of today's potential LSL lumber supply consists of smaller second growth logs or is found in the interior forests of Appalachia, the upper Midwest and the Canadian interior forests. These forests include faster-growing, more abundant and competitively priced species of trees such as aspen and yellow poplar. Previously, these trees had not been regarded as sufficiently large, straight, or strong to be sawn into structural lumber. New technologies now allow the use of these species. The Company will continue to use\nsubstantial volumes of Douglas fir in the West and southern yellow pine wood fiber in the South from the available supply of large mature trees and smaller second growth logs, respectively. It will also pursue, as appropriate, use of non-traditional saw timber species such as aspen and yellow poplar for its future wood supply.\nPRODUCTS. The Company produces the broadest line of structural engineered lumber building products in the industry, possesses certain exclusive product technologies, and believes it enjoys a reputation for superior quality and service.\nThe table below lists the Company's products, the technology utilized, product size, and end use of such products.\nThe Company continues to explore the development of new and improved engineered lumber products which have superior performance and quality characteristics relative to traditional sawn lumber. The Company currently has a\nfocused effort to develop further TimberStrand-TM- LSL products including a product which substitutes for premium length lumber (lengths over 22'), a fascia board which substitutes for 2x8, rough sawn, clear spruce, and a solid floor joist targeted at the multi-family construction market. The Company is also in the process of developing a series of I-joists utilizing TimberStrand-TM- LSL as the flange material.\nThe Company owns a number of registered and non-registered trademarks for its promotional literature and engineered lumber products. The Company believes that its engineered lumber trademarks, and in particular, the Silent Floor-R- brand of residential structural products, have achieved significant name recognition in the engineered lumber industry.\nMARKETS. The Company's engineered lumber is sold primarily into three markets. The largest market is the new-construction residential housing market, which includes single-family detached homes, apartments, condominiums, townhouses, and manufactured housing. Industrial uses are another market and include core components for the millwork and furniture industry, scaffold plank, and concrete forming and shoring products. The third market is the light-commercial construction market, which includes structures such as warehouses, schools, gymnasiums, shopping centers, and low-rise office buildings.\nThe Company estimates that at today's price levels a typical newly constructed 2,000 square foot house could utilize $2,100 of engineered structural lumber products. This estimate is based upon factors such as average house size, geographic preferences for framing methods, differing foundation and subfloor composition, and multi-story construction.\nSALES, MARKETING, AND DISTRIBUTION. The Company's residential engineered lumber products are sold directly to more than 260 stocking retail lumber dealers in the United States and Canada. In addition, the Company's sales through its network of 118 wholesale lumber distributors, which include the MacMillan Bloedel Building Materials Distribution Centers and Weyerhaeuser Building Materials Customer Service Centers, broadens the Company's market to include an extensive range of smaller lumber dealers and outlets. The Company believes this distribution network gives it the broadest and deepest reach into the market of any engineered lumber producer.\nThe Company's products are supported by an advanced computer-assisted software package. The Company's proprietary TJXpert software, which is receiving increasing acceptance by builders, translates a builder's blueprints into a complete framing plan for a structural system using engineered lumber products.\nThe Company employs the engineered lumber industry's largest sales force consisting of 215 technical sales representatives who market the Company's products directly to architects, project engineers, contractors, developers, independent lumber dealers, national wholesale building material suppliers, and industrial users. This enables the Company to better educate and assist customers in the use of engineered lumber and simultaneously helps create demand, further enabling the Company to differentiate its products from those of its competition.\nThe Company also has sales offices and representatives in Japan and the United Kingdom, and conducts business in much of Europe through several distributors and agents. While not currently comprising a significant portion of the Company's business, the Company believes these markets present future growth opportunities for its products.\nCOMPETITION. Sawn lumber products produced in traditional sawmills remain the primary competition for the Company's engineered lumber products.\nThe Company's competition in the growing engineered lumber industry includes five large competitors producing LVL in six plants across North America, and eight that are manufacturing wood I-joists. Competition is expected to continue to increase. In particular, competition may emerge or increase from established wood products companies that now sell primarily traditional wood products. A number of existing or potential competitors such as Louisiana-Pacific Corporation, Boise Cascade Corporation, Willamette Industries, Inc., and Georgia-Pacific Corporation, own a significant portion of their own raw materials and generally have greater financial resources than the Company.\nThe Company believes that the principal competitive factors in the market for engineered lumber are price, performance, market acceptance, distribution capabilities, and customer support. The Company believes its broader product line, based in part on its proprietary technologies PSL and LSL lumber, provide an important advantage in this competition.\nOther materials, including steel, plastic, brick, and cement are alternative basic materials for construction. However, these materials may not readily lend themselves to traditional residential framing methods or tools and have certain inherent manufacturing and performance deficiencies.\nWINDOW AND DOOR PRODUCTS\nOVERVIEW. The Company entered the window industry in 1986 with the acquisition of Norco Windows, Inc., located in Hawkins, Wisconsin. This was followed by the acquisitions of Dashwood Industries Limited of Centralia, Ontario, in 1987, and R. Laflamme & Frere Inc. of St. Apollinaire, Quebec, in 1992.\nThe Company's strategy is to offer highly reliable product quality and personal service through locally tailored distribution channels. The Company manufactures and markets full lines of all-vinyl windows and all-wood windows and patio doors which include maintenance-free exterior options such as cladding with aluminum or vinyl or encapsulating in vinyl.\nThe Company's window operations have achieved high penetration in regional markets in portions of Canada and the U.S. The Company's Canadian window group is the leading manufacturer in eastern Canada. It markets an extensive line of windows and patio doors through its Dashwood and Laflamme brands for sale primarily in the provinces of Ontario and Quebec. The Company's U.S. window operations are best established in the upper Midwest and Ohio River Valley and are marketed primarily under the SiteLine-R-, Teton-TM- and Sierra-TM- brands. In recent years, the Company has sought to expand distribution and build new manufacturing capacity in the western U.S.\nRAW MATERIAL RESOURCES. The Company's windows and patio doors employ vinyl (PVC) or wood as the primary raw materials for construction of the window frames. A portion of the Company's wood windows and patio doors use Ponderosa pine cutstock, which is obtained from independent suppliers. The Company is actively pursuing substitutes in the form of composite or engineered lumber to reduce its dependence on Ponderosa pine. The Company's window subsidiaries have substituted engineered lumber for frame components in several window and patio door products. The Company obtains vinyl and insulating glass from several suppliers and is not aware of any potential shortages for its long-term requirements.\nTECHNOLOGY. The Company believes that both its wood and vinyl windows will benefit from a fundamental and accelerating shift away from the use of energy-inefficient aluminum windows to those with superior insulating characteristics. This reflects an overall construction industry trend toward products that can best substitute new\nenergy- and material-efficient composites and components in place of poorly performing or inefficient materials.\nThe Company's window operations are actively involved in the development and use of new composite technologies in the manufacture of its windows. Among others, these alternative composite technologies could include the use of vinyl, fiberglass, and engineered lumber or combinations thereof. Toward this end, the Company's window operations have recently intensified R&D efforts over historical levels.\nPRODUCTS. The Company's window and patio door product line is among the industry's broadest. In Canada, the Company has broadened its product line during a severe recession in eastern Canada to include windows for housing ranging from government-financed starter homes to high-end custom homes. The Company's product line in Canada includes all-vinyl windows and all-wood windows and patio doors which include maintenance-free exterior options such as cladding with aluminum or vinyl or encapsulating in vinyl. The Company manufactures wood patio doors and steel-entry doors at three locations in eastern Canada and markets them under the Dashwood and Laflamme brands.\nThe Company manufactures the SiteLine-R- wood window at Hawkins, Wisconsin, and markets this product to builders for use in custom and single family homes. The Company positions this product as a value-priced, high volume window with wide local distribution. The Company manufactures the Teton wood window at a new plant in Twin Falls, Idaho, primarily for use in high-end custom homes. The product is positioned as a premium quality window with multiple features and superior insulating performance. The Company manufactures the all-vinyl Sierra- TM- window at a facility opened in the summer of 1993 in Indianapolis, Indiana, and markets it to the entire spectrum of residential housing, from starter homes to custom homes. The Company is positioning this product as a cost competitive, better insulating alternative to aluminum windows which are declining in sales because of poor performance characteristics.\nSALES, MARKETING AND DISTRIBUTION. The Company's windows, patio doors and steel-entry doors are shipped directly to end users, to Company distribution centers and stores, or to independent distributors and dealers. Serving customers through Company-owned distribution facilities in the United States provides the Company with service advantages over those of its competitors selling to independent distributors. A network of sales and service centers under the Dashwood name in Ontario, Canada has strengthened the Company's leading market share position in eastern Canada. The Company's window sales force consists of 73 Company-employed salespersons. The Company distributes its window and patio door products through nine facilities located in the United States and Canada.\nCOMPETITION. Competition for the Company's windows comes from all other windows produced in the United States and Canada. A number of large integrated forest products, window, and other companies manufacture competing products. Three companies are especially significant in the wood window segment of the industry: Andersen Corporation, Rolscreen Company, and Marvin Windows, each of which is larger and has greater brand awareness than the Company's window businesses. Competition exists from many small, local concerns as well.\nBACKLOG\nThe Company's order backlog at January 1, 1994 was approximately $44.4 million compared to approximately $25.5 million at January 2, 1993. Some portion of the current order backlog will probably not be filled due to extended deliveries or cancellations. In addition, lead times of orders can vary significantly from quarter\nto quarter and year to year. Accordingly, the Company's backlog on a particular date may not be representative of the level of future sales.\nEMPLOYEES\nAs of January 1, 1994, the Company employed a total of approximately 3,600 employees, of which 2,300 were in the Company's engineered lumber operations and 1,300 were in the Company's window operations. Hourly employees at Norco's Hawkins, Wisconsin, plant and manufacturing facilities in Eastern Canada are represented under collective bargaining agreements. The Company's labor agreements covering employees at these sites expire at various dates, the earliest of which is July 1, 1994. The Company believes that it has good relations with its employees and their unions.\nENVIRONMENTAL MATTERS\nThe Company is subject to various federal, state, provincial, and local environmental laws and regulations, particularly relating to air and water quality and the storage, handling, and disposal of various materials and substances used in the Company's plants and processes. Permits are required for certain of the Company's operations, and these permits are subject to revocation, modification, and renewal by issuing authorities. Governmental authorities have the power to enforce compliance with their regulations, and violations may result in the payment of fines or the entry of injunctions, or both.\nThe Company believes that it is in material compliance with existing environmental laws and regulations, and that its expenditures in future years for environmental compliance will not have a material adverse effect on its operations.\nITEM 1(d) FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC ------------------------------------------------ OPERATIONS AND EXPORT SALES. ---------------------------\nThe Company operates manufacturing facilities in two countries, the United States and Canada; and the majority of all sales are made domestically in those countries. Financial information relating to foreign and domestic operations is presented in Note 10 to the consolidated financial statements, page 42 of this Report.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ----------\nThe Partnership owns office and manufacturing facilities used for open web joist fabrication, TJI-R- joist series manufacturing and\/or TJI-R- joist cut-up remanufacturing in Chino, California; Claresholm, Alberta; Delaware, Ohio; and Hillsboro, Oregon. In addition, the Partnership leases plants in Oxford, North Carolina and Quebec City, Quebec for the production of I joists. The Partnership also owns in Boise, Idaho, a machine shop and research and development facilities.\nThe Partnership owns plants in Eugene, Oregon; Junction City, Oregon; Natchitoches, Louisiana; Stayton, Oregon; and Valdosta, Georgia, for the production of MICRO=LAM-R- lumber and various MICRO=LAM-R- lumber industrial products. The Eugene, Natchitoches and Valdosta plants also produce TJI-R- joists principally for the Company's residential structural distribution system program and the Stayton plant produces TJI-R- joists principally for the Company's light commercial markets.\nThe Partnership also owns plants in Colbert, Georgia, and Vancouver, British Columbia, for the production of Parallam-R- lumber, and a plant in Deerwood, Minnesota, for the production of TimberStrand-TM- lumber.\nNorco owns manufacturing facilities for window and patio door fabrication and raw material production in Hawkins, Wisconsin; Marenisco, Michigan; Indianapolis, Indiana; and Twin Falls, Idaho. Additionally, Norco owns a window distribution facility in Grand Rapids, Michigan; and it leases distribution centers in Indianapolis, Indiana; Bow, New Hampshire; Sacramento, California; Kansas City, Kansas; Reynoldsburg, Ohio; and Salt Lake City, Utah.\nDashwood owns a window and door manufacturing facility in Centralia, Ontario, and leases a store in London, Ontario. Dashwood also leases a small warehouse in Ottawa, Ontario for sales to the direct sell market. Laflamme owns window manufacturing plants in Saint-Apollinaire and Thetford Mines, Quebec.\nThe Company owns Boise, Idaho, property of approximately 32 acres of unimproved land. Both the Company's, Norco's, and the Partnership's headquarters staff are located in leased locations in Boise, Idaho.\nThe properties at Eugene, Oregon; Stayton, Oregon; Natchitoches, Louisiana and Twin Falls, Idaho; are subject to mortgages aggregating $25,600,000. Because the costs of these latter properties are financed partially or wholly by Industrial Development Revenue Bonds, record title to a significant portion of the land, buildings, and equipment is being held by the bond issuing authorities until the bonds are retired.\nA former TJI joist cut-up remanufacturing plant located in Fort Lupton, Colorado was closed in late 1990 and is presently for sale. The MICRO=LAM-R- lumber portion of the Stayton, Oregon plant was mothballed during 1992 and was reopened in April, 1993.\nAll properties in use or held for future use are considered suitable for the Company's present and future needs and should have adequate capacity for those needs.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. -----------------\nNo material legal proceedings or claims are pending or known to the Company other than several claims and suits for damages arising in the ordinary conduct of business, resulting primarily from construction accidents and often involving contractors and others as joint defendants.\nBased on current facts and knowledge, all material liabilities under any of the pending claims and suits would be covered under the limits of coverage of the Company's liability insurance policies, or are otherwise provided for on the Company's books.\nFor several years, the Company has self-insured its risks up to certain loss amounts and has obtained insurance to cover losses in excess of the retained amounts. Such risk retention enables the Company to participate more actively in the management of any claims or lawsuits and to control or better contain the attendant costs and expenses. Over time, based principally on loss experience, the amount of such risk retention has been increased. Additionally, because the cost of available insurance has become exorbitant, beginning in 1986, the Company has determined it appropriate to accept greater levels of self-insurance and lower limits for excess coverages. Nevertheless, based on its claims history, the Company believes its insurance coverages are adequate relative to its potential exposures.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.\nITEM A. EXECUTIVE OFFICERS OF THE REGISTRANT.\nFollowing is a schedule of names and certain information regarding all of the executive officers of the Company, as of January 1, 1994, each of whose term of office is one year.\nNAME AND AGE OFFICE\nHarold E. Thomas, age 67 Chairman of the Board, TJ International, Inc.\nWalter C. Minnick, age 51 President and Chief Executive Officer, TJ International, Inc.\nJohn L. Cook, age 52 Senior Vice President, Canadian Window Operations, TJ International, Inc.\nThomas H. Denig, age 47 Senior Vice President, Structural Operations, TJ International, Inc.\nValerie A. Heusinkveld, age 35 Vice President, Finance Chief Financial Officer, TJ International, Inc.\nRichard B. Drury, age 44 Secretary and Treasurer, TJ International, Inc.\nJody B. Olson, age 46 Vice President, Corporate Development, TJ International, Inc.\nKevin R. Case, age 39 Senior Vice President, Eastern Operations, Trus Joist MacMillan\nRobert J. Dingman, age 52 Senior Vice President, Western Operations, Trus Joist MacMillan\nRandy W. Goruk, age 41 Senior Vice President, Industrial Operations, Trus Joist MacMillan\nHarold E. Thomas holds a Bachelor of Science Degree in Forestry from the University of Idaho, and worked in sales for lumber mills prior to 1960, when Mr. Thomas and Arthur L. Troutner founded the Company. Mr. Thomas was first elected to the Board of Directors in 1960 and was President of the Company from 1960 to 1971. Mr. Thomas has been Chairman since 1960 and served as Chief Executive Officer from 1971 to 1975 and from 1979 to 1986.\nWalter C. Minnick was elected President and Chief Executive Officer on May 8, 1986. On December 6, 1991, Mr. Minnick was also elected Chairman of the Board of\nthe Partnership. Mr. Minnick has served as a director since 1979. Mr. Minnick was also the acting chief financial officer from January 31, 1991 until December 1, 1992. Between January 1979 and May 1986, Mr. Minnick served as President and Chief Operating Officer. Mr. Minnick was Manager of the Company's Boise, Idaho, open web plant from December 1974 to September 1975, and National Manufacturing Manager from September 1975 to June 1976, as well as serving as Secretary from May 1974 to June 1976, at which time he was elected Vice President. Mr. Minnick, who joined the Company in April 1974, is a graduate of Whitman College, Harvard Law School, and Harvard Graduate School of Business.\nJohn L. Cook was elected Senior Vice President, Canadian Window Operations on January 7, 1992. Mr. Cook was appointed President, Design Master Corporation, on September 15, 1988, and continues as President of Dashwood Industries Limited, having served in this capacity since 1985. Previously, Mr. Cook was President of Champion Road Machinery Limited and, prior to Champion, held numerous senior management positions within various heavy equipment divisions of Eaton Corporation, a Cleveland-based multinational corporation. Mr. Cook is a graduate of the School of Business, Wilfrid Laurier University.\nThomas H. Denig was elected Senior Vice President, Structural Operations on January 2, 1990. Mr. Denig was also elected President and Chief Executive Officer of the Partnership on December 6, 1991, after having served as President of Trus Joist Corporation since January 2, 1990. Mr. Denig joined the Company in 1974 as a salesperson and has subsequently served as California South Sales Manager, MICRO=LAM-R- Lumber Industrial Sales Manager, National Sales Manager, Western Division Manager, Eastern Division Manager and had been elected Vice President, Eastern Operations on December 17, 1985. Mr. Denig is a graduate of Valparaiso University and served as a lieutenant in the U.S. Marine Corp. before joining the Company.\nValerie A. Heusinkveld was elected Vice President of Finance and Chief Financial Officer of TJ International, Inc., on December 1, 1992. Ms. Heusinkveld is an honors graduate of the University of Idaho and a Certified Public Accountant. Before being named CFO, Ms. Heusinkveld served as Vice President of Finance and Treasurer for Trus Joist MacMillan. Ms. Heusinkveld has also served as controller of Norco Windows Western Operations group and as a corporate accountant and assistant to the Vice President of Finance. Ms. Heusinkveld joined TJ International in 1989 after working for Arthur Andersen & Co.\nRichard B. Drury was elected Secretary on May 21, 1985 and was elected to the additional position of Treasurer on January 4, 1991. Mr. Drury is a graduate of Boise State University and a Certified Public Accountant. Prior to joining the Company in 1979, Mr. Drury gained audit and tax experience with Arthur Andersen & Co.\nJody B. Olson was elected Vice President, Corporate Development on December 17, 1987. On December 6, 1991, Mr. Olson was also elected Secretary of the Board of the Partnership. Previous positions held by Mr. Olson were MICRO=LAM- R- Lumber Division Controller; MICRO=LAM-R- Lumber Industrial Salesperson and Sales Manager; General Manager of the Company's former trucking subsidiary; Manager, Energy Systems; Assistant to the President, Mergers and Acquisitions; and Manager, Corporate Development. Mr. Olson, who joined the Company in 1979, is a graduate of the University of Idaho and the Lewis and Clark Law School.\nKevin R. Case was appointed Sr. Vice President, Eastern Operations for Trus Joist MacMillan, on May 7, 1992. Mr. Case joined the Company in 1984 as a Residential Products Salesman and has subsequently served as a Regional Sales Manager, and General Manager of Northeast Operations. Mr. Case holds a B.A. degree from Dartmouth College and an MBA from Stanford University.\nRobert J. Dingman was appointed Sr. Vice President, Western Operations for Trus Joist MacMillan, on May 7, 1992. Mr. Dingman joined the Company in 1984 as the Southwest Division Manager and has subsequently served as Division Manager, MICRO=LAM-R- Lumber Operations and Vice President, Western Operations. Before joining the Company, Mr. Dingman, a graduate of St. Lawrence College, had been for a period of more than three years Vice President and General Manager of the Architectural Building Products Division of Koppers Company, Inc.\nRandy W. Goruk was appointed Sr. Vice President, Industrial Operations for Trus Joist MacMillan, on May 7, 1992. Mr. Goruk joined the Company in 1974 as a draftsperson and has subsequently served as a salesperson, British Columbia Regional Sales Manager, Canadian Division Sales Manager and Canadian Division Manager, Vice President, Canadian Operations, and Vice President, Eastern Operations. Mr. Goruk is a graduate of the Northern Alberta Institute of Technology and the University of British Columbia.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY ----------------------------------------- AND RELATED STOCKHOLDER MATTERS. -------------------------------\nThe approximate number of record holders of the Company's $1.00 par value common stock at March 15, 1994, is set forth below:\n(1) (2) TITLE OF CLASS NUMBER OF RECORD HOLDERS -------------- ------------------------ Common Stock, $1 par value 1,845\nThe remainder of this Item 5 is contained in the following sections of the Report at the pages indicated below:\n\"Market and Dividend Information,\" on page 29 of this Report, to the extent that said section discusses the principal market or markets on which the Company's common stock is being traded; the range of high and low quoted sales prices (closing) for each quarterly period during the past two years; the source of such quotations; and the frequency and amount of any dividends paid during the past two years with respect to such common stock.\n\"Note 3 to the consolidated financial statements,\" page 35 of this Report, to the extent that said Note describes any restriction on the Company's present or future ability to pay such dividends.\nITEMS 6, 7, AND 8. - ------------------\nThe information called by Items 6, 7 and 8, inclusive of Part II of this form, is contained in the following sections of this Report at the pages indicated below:\nCAPTIONS AND PAGES OF THIS REPORT ---------------------------------\nITEM 6","section_6":"ITEM 6 Selected Financial Data \"Selected Financial Data\" ......25\nITEM 7","section_7":"ITEM 7 Management's Discussion \"Management's Discussion and Analysis of Financial and Analysis\" ..................26 Conditions and Results of Operations\nITEM 8","section_7A":"","section_8":"ITEM 8 Financial Statements and \"Consolidated Financial Supplementary Data Statements\".....................31\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND --------------------------------------------------------------- FINANCIAL DISCLOSURE. --------------------\nNot applicable.\nPART III -------- ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. --------------------------------------------------\nIdentification of the Company's executive officers is included in Item A (following Item 4) in Part I of this Form 10-K.\nThe Company has adopted procedures to assist its directors and executive officers in complying with Section 16(a) of the Exchange Act, which includes assisting the director or executive officer in preparing forms for filing. Through an oversight, in 1993 Mr. Dingman was late filing one Form 4 in connection with two transactions in the Company's Common Stock.\nThe balance of this Item 10 is included in the Company's definitive proxy statement, under the caption \"Election of Directors;\" and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. ----------------------\nItem 11 is included in the Company's definitive proxy statement, under the caption \"Compensation of Executive Officers,\" including the sub-caption \"Executive Compensation Tables,\" and is incorporated herein by reference. The subcaption \"Report of the Executive Compensation Committee on Executive Compensation,\" and \"Performance Graph,\" under the caption \"Compensation of Executive Officers\" in the Company's definitive proxy statement are not incorporated herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND --------------------------------------------------- MANAGEMENT. ----------\nItem 12 is included in the Company's definitive proxy statement under the caption \"Security Ownership of Certain Beneficial Owners and Management;\" and is incorporated herein by reference.\nFor purposes of calculating the aggregate market value of the voting stock held by non-affiliates as set forth on the cover page of this Form 10-K, the Company has assumed that affiliates are those persons identified in the portion of the definitive proxy statement identified above.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. ----------------------------------------------\nThis item 13 is included in Note 9 to the consolidated financial statements, page 41 of this Report.\n-R- - MICRO=LAM, Parallam, TJI, and The Silent Floor are registered trademarks of the Company. -TM- - Siteline, Sierra, Teton, Ecowood, TimberStrand, and TJL are trademarks of the Company.\nPART IV ------- ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ---------------------------------------------------- ON FORM 8-K. -----------\nA-1 Financial Statements A list of the financial statements included herein is set forth in the Index to Financial Statements, Schedules and Exhibits submitted as a separate section of this Report.\nA-2 Financial Statement Schedules A list of financial schedules included herein is contained in the accompanying Index to Financial Statements, Schedules and Exhibits submitted as a separate section of this Report.\nA-3 Exhibits. The following documents are filed as Exhibits to this Form 10-K:\n(3) Limited Partnership Agreement between TJ International, Inc. and MacMillan Bloedel of America, Inc. whereby the Partnership was formed. This document was filed as an exhibit to the Company's Form 8-K dated September 30, 1991 and is incorporated herein by reference.\nBylaws of Trus Joist Corporation (a Delaware corporation). This document was filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 28, 1991 and is incorporated herein by reference.\nAmendment to Limited Partnership Agreement effective the beginning of the Company's fiscal year 1993. This document was filed as an exhibit to the Company's Form 10-Q for the quarter ended September 26, 1992 and is incorporated herein by reference.\nCertificate of Ownership and Merger of TJ Merger Corporation with and into Trus Joist Corporation, whereby the Company changed its name from Trus Joist Corporation to TJ International, Inc. effective September 16, 1988. This document was filed as an exhibit to the Company's Form 10-K for the fiscal year ended January 2, 1993 and is incorporated herein by reference.\nAmended Certificate of Incorporation of Trus Joist Corporation. This document was filed as an exhibit to the Company's Form 10-Q for the quarter ended July 3, 1993 and is incorporated herein by reference.\n(4) Rights Agreement, dated as of August 24, 1989, between TJ International and West One Bank. This document was filed as an exhibit to the Company's Form 8-K dated October 6, 1989 and is incorporated herein by reference.\nNonstatutory Stock Option Plan, as amended. This document was filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 30, 1989 and is incorporated herein by reference.\n1982 Incentive Stock Option Plan, as amended. This document was filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 30, 1989 and is incorporated herein by reference.\n1985 Incentive Stock Option Plan, as amended. This document was filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 30, 1989 and is incorporated herein by reference.\n1988 Stock Option Plan, as amended. This document was filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 30, 1989 and is incorporated herein by reference.\n1992 Stock Option Plan. This document was filed as an exhibit to the Company's Form 10-K for the fiscal year ended January 2, 1993 and is incorporated herein by reference.\n1993 Stock Option Plan. This document was filed as an exhibit to the Company's Form 10-Q for the quarter ended July 3, 1993 and is incorporated herein by reference.\nAmended and Restated Restricted Stock Plan for Non-Employee Directors. This document was filed as an exhibit to the Company's Form 10-Q for the quarter ended July 3, 1993 and is incorporated herein by reference.\n(10) Amendment to Reimbursement Agreement pertaining to the Natchitoches, Louisiana, plant. This document was filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 30, 1989 and is incorporated herein by reference.\nLoan Agreement, Trust Indenture and Deed of Trust pertaining to Twin Falls, Idaho, plant. These documents were filed as an exhibit to the Company's Form 10-K for the fiscal year ended December 30, 1989 and are incorporated herein by reference.\nCertificate of Designation, Preferences and Rights of ESOP Convertible Preferred Stock; Stock Purchase Agreement; and ESOP Term Note. These documents were filed as an exhibit to the Company's Form 10-Q for the quarter ended September 29, 1990 and are incorporated herein by reference.\nIndenture, Lease and Guaranty pertaining to Eugene, Oregon, plant. These documents were filed as Exhibits to the Company's Form 10-K for the fiscal year ended December 28, 1991 and are incorporated herein by reference.\nMortgage, Security Interest and Indenture of Trust; Lease Agreement; Guaranty Agreement; Reimbursement Agreement; Remarketing and Interest Services Agreement; pertaining to Stayton, Oregon, plant. These documents were filed as Exhibits to the Company's Form 10-K for the fiscal year\nended December 28, 1991 and are incorporated herein by reference.\nTrust Indenture; Refunding Agreement; Remarketing Agreement; Reimbursement Agreement; Pledge and Security Agreement; pertaining to the Natchitoches, Louisiana, plant. These documents were filed as Exhibits to the Company's Form 10-K for the fiscal year ended January 2, 1993 and are incorporated by reference.\n$75,000,000 Credit Agreement date as of October 12, 1993. This document was filed as an exhibit to the Company's Form 10-Q for the quarter ended October 2, 1993 and is incorporated herein by reference.\nAmendment to Reimbursement Agreement; Pledge and Security Agreement; pertaining to the Natchitoches, Louisiana plant.\nStock Purchase and Resale Agreement.\n(11) Statement regarding computation of per share earnings. The information required by Exhibit (11) is included under the caption \"Net Income (Loss) Per Share\" in Note 1 to the consolidated financial statements, page 36 of this Report.\n(22) Subsidiaries of the registrant.\n(24) Consent of independent public accountants to incorporation by reference of their reports dated February 16, 1994, into the Company's Form S-8 Registration statements under the Securities Act of 1933, filed September 3, 1982 (as amended) (Registration No. 2-79209), February 26, 1985 (Registration No. 2-96065), February 27, 1985 (as amended) (Registration No. 2-96821), April 8, 1985 (Registration No. 2-96964), April 10, 1986 (Registration No. 33-4704), May 31, 1990 (as amended) (Registration No. 33- 21870), May 23, 1988 (as amended) (Registration No. 33- 22186), and November 13, 1992 (Registration No. 33-54582).\n(25) Powers of Attorney.\nAll other Exhibits are omitted since they are not applicable or not required.\n(b) Reports on Form 8-K.\nNo current reports on Form 8-K have been filed during the fourth quarter of 1992.\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.\nTJ INTERNATIONAL, INC., Registrant\nBy \/s\/ Walter C. Minnick ----------------------------------------------------------------- Walter C. Minnick - President, Chief Executive Officer, Director and Attorney-in-Fact for Directors listed below.\nBy \/s\/ Valerie A. Heusinkveld ----------------------------------------------------------------- Valerie A. Heusinkveld - Vice President, Finance and Chief Financial Officer\nEach of the above signatures is affixed as of March 25, 1994. Those Directors of TJ International, Inc. listed below executed powers of attorney appointing Walter C. Minnick their attorney-in-fact, empowering him to sign this report on their behalf.\nHarold S. Eastman Robert B. Findlay Robert V. Hansberger Robert G. Linville, Jr. J. L. Scott Harold E. Thomas Arthur L. Troutner J. Robert Tullis Steven C. Wheelwright\nSECURITIES AND EXCHANGE COMMISSION\nWashington, D.C. 20549\nEXHIBITS TO FORM 10-K\nAnnual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934\nFor the fiscal year ended January 1, 1994 Commission File Number 0-7469\nTJ INTERNATIONAL, INC.\nINDEX TO FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS\nThe following documents are filed as part of this Report: PAGES IN THIS REPORT -------------------- (1) FINANCIAL STATEMENTS: ---------------------\nSelected Financial Data.............................................25\nManagement's Discussion and Analysis................................26\nMarket and Dividend Information.....................................29\nQuarterly Financial Data (Unaudited)................................30\nConsolidated Balance Sheets at January 1, 1994, January 2, 1993 and December 28, 1991....................................31\nConsolidated Statements of Income (Loss) for the three years ended January 1, 1994......................................32\nConsolidated Statements of Stockholders' Equity for the three years ended January 1, 1994................................33\nConsolidated Statements of Cash Flow for the three years ended January 1, 1994............................................34\nNotes to Consolidated Financial Statements..........................35\nReport of Independent Public Accountants............................42\n(2) FINANCIAL STATEMENTS SCHEDULES ------------------------------\nReport of Independent Public Accountants............................43\nV. Property, Plant and Equipment..................................44\nVI. Accumulated Depreciation and Amortization of Property, Plant and Equipment..................................45\nIX. Short-term Borrowings..........................................46\nThe following documents are filed as part of this Report: Pages in this Report --------------------\n(3) EXHIBITS -------- (10) Amendment to Reimbursement Agreement; Pledge and Security Agreements; pertaining to the Natchitoches, Louisiana plant.......................Document 2\n(10) Stock Purchase and Resale Agreement......................Document 3\n(21) Subsidiaries of the Registrant...........................Document 4\n(24) Consent of Independent Public Accountants................Document 5\n(25) Powers of Attorney.......................................Document 6\nAll other schedules are omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto.\nSELECTED FINANCIAL DATA\nThe following table summarizes selected financial data for the 10 fiscal years ended January 1, 1994, and should be read in conjunction with the more detailed Consolidated Financial Statements included herein.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGENERAL\nThe company's operations are strongly influenced by the cyclicality and seasonality of residential housing construction. This industry experiences fluctuations resulting from a number of factors, including the general economy, consumer confidence, credit availability, and interest rates. The seasonality of this industry, which is particularly pronounced in the colder climates of Canada and the northern United States, has an especially significant impact on the company's window operations. These are predominantly located in northern climates. As a result of this seasonal pattern, the company's sales have historically tended to be lowest in the first and fourth quarters and highest in the second and third quarters of each year.\nThe company's engineered lumber products are gaining increased market acceptance as high-quality substitutes for large-dimension structural lumber. The reduced availability and increased price of quality, large-dimension structural lumber have in part spurred this conversion. As well, the consistent quality, superior strength, lighter weight, and ease of installation of engineered lumber products are causing an increasing number of builders and other wood users to choose engineered lumber over traditional solid-sawn lumber. The Company believes this trend should continue through the 1990's.\nNo other company possesses the range of engineered lumber products, nor the second generation of TimberStrand-TM- laminated strand lumber (LSL) or Parallam-R- parallel strand lumber (PSL) technologies. However, a number of companies, including several large forest products companies, now produce look-alike wood I-joist products and laminated veneer lumber (LVL) products. These are manufactured using processes similar to the company's oldest generation technologies. The Company believes its system of manufacturing plants and multiple technologies position it as the low-cost producer of engineered lumber. While competition helps expand the market for engineered wood products, including those manufactured by the Company, it may also make the existing markets more price competitive. It is likely these trends of increased competition in engineered lumber products will continue for the foreseeable future.\nPARTNERSHIP\nThe Company and MacMillan Bloedel, through MBA, established the Partnership in October of 1991. The Company has a 51 percent interest in the Partnership and serves as general partner, with authority to manage and control the daily operations of the Partnership. Partnership income and losses through 1993 were allocated on a formula basis as agreed to by the partners and in accordance with the Partnership Agreement. These formulas allocated most of the losses associated with the start-up of the partnership's Deerwood LSL plant, Vancouver PSL plant, and Colbert PSL plant to MacMillan Bloedel, and most of the remaining income or loss to the Partnership to the Company. The percentage of start-up losses allocated in MacMillan Bloedel has declined over time. The company's allocation of the remaining percentage of income or loss, after such start-up losses, also declines over time. As a result of these provisions, MacMillan Bloedel was allocated $11.9 million and $6.5 million of losses in 1992 and 1991, respectively, and $10.1 million of income in 1993. These allocations are reflected as adjustments to costs and expenses in the consolidated statements of income under \"Minority interest in Partnership\" and also affect the partner's capital accounts in the Partnership.\nDuring 1993, MacMillan Bloedel was allocated the maximum $7 million of start-up losses related to the company's TimberStrand-TM- LSL plant in Deerwood, Minnesota. The Company was allocated two-thirds of the remaining partnership income. In accordance with the Partnership Agreement, the Company will be allocated 51 percent of all income or losses of the Partnership in 1994 and thereafter.\nThe Partnership Agreement also specifies a formula allocation for accelerated tax depreciation through the end of 1993. Tax benefits to the Company of $1.3 million in 1993, $4.3 million in 1992, and $0.5 million in 1991 have been included in income taxes (benefits) in the consolidated statements of income pursuant to this allocation.\n1983 COMPARED TO 1992\nSales for the year ended January 1, 1994, increased by $151 million or 38 percent from the corresponding period last year. The company's sales increase continued to outpace new housing construction, which posted a 5 percent increase in North American housing starts. In the combined eastern Canadian provinces of Quebec, Ontario, and the Maritimes, housing starts decreased 14 percent.\nEngineered lumber product sales for 1993 were $437 million, a 51 percent increase over the same period in 1992. Growing acceptance of the company's engineered lumber products as a substitute for commodity sawn lumber was the primary\nfactor behind the increased sales. The company's three major product groups (industrial, light commercial, and residential) all participated in the sales growth, with residential products contributing the strongest performance. Sales of residential products per North American housing start increased 49 percent to $246 for 1993 from $165 per start in 1992. Unit volume increases accounted for the majority of this improvement.\nWindow and patio door sales were $114 million through January 1, 1994, as compared to $111 million for the same period in 1992. Despite an increasingly competitive market and a reduced market opportunity in eastern Canada, sales of these products maintained market share in 1993, declining slightly to $86 per North American housing start in 1993 as compared to $88 for the same period in 1992. Both sales and order file levels for the company's Teton wood window and patio door products manufactured at its new Twin Falls, Idaho, plant were higher for 1993 than in the comparable period in 1992. Sales from the company's Canadian subsidiaries were slightly lower than the prior year.\nSales for the fourth quarter of 1993 increased by 45 percent over the comparative quarter for 1992. Structural product sales posted a 63 percent gain while window sales decreased 4 percent. These structural sales gains in the fourth quarter reflect the improved market conditions and increased market share for the company's products. The window sales decrease reflects the continued downturn in the eastern Canadian market.\nThe company's net income was materially reduced from levels that would otherwise have been achieved because of losses incurred in its window subsidiaries. These losses were caused primarily by increases in the cost of raw materials that the Company was unable to reflect in price increases. Also contributing to these results were a lower than anticipated increase in sales of the company's window products, which resulted in part from continued weakness in the eastern Canadian and California markets, and start-up expenses incurred by the Company in connection with the establishment of its new Teton wood window manufacturing facility. The Company reviewed its window operations and is implementing a plan aimed at reducing these continuing losses.\nThe company's gross margins for the year ended January 1, 1994, improved to 26 percent from 21 percent in 1992. Price increases for engineered lumber products realized in the second, third, and fourth quarters of 1993 more than offset higher raw material costs. The increased demand for the company's engineered lumber products resulted in higher production volumes in its manufacturing facilities, which allowed for more efficient manufacturing schedules and better absorption of manufacturing overheads. Reduced margins for the company's window and patio door products offset these gains somewhat.\nAlso contributing to improved margins was a reduction of start-up losses at the company's new technology plants. Although the Parallam-R- PSL facilities incurred start-up losses during the first part of 1992, they were profitable for 1993. Losses at the company's TimberStrand-TM- LSL facility in Deerwood, Minnesota, have been reduced from the previous year. The Deerwood plant experienced losses for all quarters in 1993. The strategic decision to focus the plant on achieving manufacturing efficiencies in higher-value TimberStrand- TM- LSL products contributed to the losses in the second half of 1993.\nSelling and administrative expenses increased $18.9 million for 1993, from the comparable period in 1992 because of higher operating levels. As a percent of sales, they decreased from 23 percent in 1992 to 20 percent in 1993. The reduction was primarily a result of the use of existing capacity in the sales and distribution network and the administrative infrastructure to accommodate significate volume increases.\nMinority interest in Partnership represents in net effect of the start-up losses allocated to MacMillan Bloedel offset by the allocation of MacMillan Bloedel's share of partnership profits exclusive of the allocated start-up losses. For 1993, MacMillan Bloedel was allocated $10.1 million in net profits as compared to an allocation of $11.9 million of net losses in 1992. The transition from allocating losses to profits is primarily the result of lower start-up losses and improving operating results in 1993 as compared to 1992. In addition, under the formula allocations specified in the Partnership Agreement, MacMillan Bloedel was allocated 70 percent of TimberStrand-TM- LSL start-up losses in 1993 compared to 80 percent of the total TimberStrand-TM- LSL and Parallam-R- PSL losses for 1992. The remaining profits were allocated one-third to MacMillan Bloedel in 1993 and 15 percent in 1992.\nAs contemplated in the Partnership Agreement, the Company was also allocated tax depreciation deductions that will not reverse to the Company in future years. The Company has recorded tax benefits related to this tax depreciation of $1.3 million and $4.3 million in 1993 and 1992, respectively.\n1992 COMPARED TO 1991\nSales for 1992 increased $117 million, or 41 percent, over 1991. This increase significantly outpaced the overall improvement in new housing construction, which posted a 17 percent increase in the United States and Canada combined. The increases during 1992 for both\nstructural and window product lines were predominantely from growth in unit volume rather than price increases. Increasing acceptance of the company's engineered lumber products in the residential construction market was the largest contributor to this increase. Engineered lumber product sales for 1992 were $289 million, a 42 percent increase from 1991 structural product sales of $203 million. Sales per North American housing start for these products in 1992 increased to $165, a 42 percent increase over the 1991 level of $116.\nWindow sales were $111 million in 1992 as compared to $80 million in 1991, an increase of 39 percent. Window sales posted strong market share gains in 1992, increasing 21 percent from $73 per North American housing start in 1991 to $88 per start in 1992. The increases resulted from a combination of the introduction of the new premium-quality Teton window in the western United States, the acquistion of R. Laflamme & Frere in Quebec, and increasing sales of the SiteLine-TM- window through existing and growing distribution.\nThe company's gross margins were 21 percent in 1992 after having been 25 percent for 1991. Gross margins for 1992 were pressured by three factors. First, the start-up losses related to the new Parallam-R- PSL and TimberStrand-TM- LSL technologies reduced gross margins. The start-ups of these two new technologies was disproportionately large compared to all other start-up previously undertaken by the Company. During 1992, the Company succeeded in turning the Parallam-R- PSL technology from a loss position to a positive gross margin contributor. The TimberStrand-TM- LSL facility experienced start-up losses throughout 1992. Start-up losses were also incurred for Teton wood window capacity expansion.\nSecond, gross margins were reduced by under-absorbed production capacity at the company's eastern Canadian window manufacturing facilities. The continuing severe recession in this geographic area has significantly reduced housing construction activity. The company's resulting low sales volumes led to losses from operations in 1992 and 1991. A third factor pressuring margins was rapidly rising wood costs. In the latter part of the year, this reduced operating margins as price increases lagged raw material cost increases.\nSelling and administrative expenses increased $18.5 million for 1992 from the comparable period in 1991. This was attributable to higher operating levels and a full year of partnership overhead in 1992 compared to only one quarter in 1991. However, these expenses decreased from 25 percent of sales in 1991 to 23 percent in 1992. The reduction was primarily a result of a program designed to improve the effectiveness of the company's sales organization coupled with a broadening of wholesale distribution which allowed the Company to spread its relatively fixed selling costs over a larger base.\nMinority interest in Partnership represents the net effect of the start-up losses allocated to MacMillan Bloedel for the Parallam-R- PSL and TimberStrand-TM- LSL plants. This was offset somewhat by the allocation of MacMillan Bloedel's share of partnership profits exclusive of the allocated start-up losses. In 1992 and 1991, 80 percent of the start-up losses were allocated to MacMillan Bloedel. The remaining profits were allocated 15 percent to MacMillan Bloedel in 1992 and 10 percent to MacMillan Bloedel in the fourth quarter of 1991.\nOperating income in 1992 was $3.6 million compared to an operating loss of $4.3 million in 1991. The 1991 loss resulted largely from restructuring and other one-time charges totaling $8.1 million.\nDuring 1992, the Company adopted Statement No. 109 of the Financial Accounting Standards Board to account for its income taxes. The cumulative effect of this change resulted in a positive adjustment of $0.9 million, or $0.07 per fully diluted share. As comtemplated in the Partnership Agreement with MacMillan Bloedel, the Company was allocated tax depreciation deductions that will not reverse to the Company in future years. The Company recorded tax benefits related to this tax depreciation of $4.3 million and $0.5 million in 1992 and 1991, respectively.\nIn 1992, the Company reversed $1.6 million of excess income tax reserves provided in prior years. Income tax benefits also included $1.8 million of net operating loss carryforwards resulting from 1992 losses at the Canadian structural products subsidiaries. The Company believes that future taxable income of these Canadian subsidiaries will be sufficient to realize those benefits before the carryforward period expires in 1999.\nLIQUIDITY AND CAPITAL RESOURCES\nWorking capital increased by $102 million to $126 million at January 1, 1994, from $24 million at January 2, 1993. This increase was primarily the result of the company's sale of 3,500,000 common shares in November 1995. (See Footnote 7 in the accompanying financial statements.)\nCash provided by operating activities was $40.8 million, $3.2 million, and $10.5 million in fiscal years 1993, 1992, and 1991, respectively. Capital expenditures were $35.4 million for the fiscal year ended January 1, 1994, $19.7 million for the fiscal year ended January 2, 1993, and $8.9 million for the fiscal year ended December 28, 1991.\nThe Company entered into a $75 million Revolving Credit Facility (the Credit Facility) on October 12, 1993, provided by a syndicate of\nbanks. The Credit Facility includes various customary financial covenants. These include a limitation on indebtedness equal to 50 percent of total capitalization (including Minority interest in Partnership) and requirements to maintain (i) a minimum net worth, and (ii) ratios of cash flow compared to indebtedness and debt service. The Company initially used borrowings under the Credit Facility to pay $13.6 million of the company's short-term notes payable. Upon completion of the common stock offering, the Company paid all amounts outstanding under the Credit Facility. Short-term debt at the end of 1993 is related to lines of credit used primarily for cash management purposes.\nThe company's Board of Directors has approved a two-year capital expansion program. Pursuant to the capital expansion program, the Company intends to construct a plant near Hazard, Kentucky, that will manufacture TimberStrand-TM- LSL products. Construction commenced in the fall of 1993 with an expected cost of $100 million. The capital expansion program also provides for capital expenditures of approximately $25 million to expand capacity at its existing MICRO=LAM-R- LVL and Parallam-R- PSL facilities. In addition, the company's Board of Directors approved construction of a plant that will manufacture both MICRO=LAM-R- LVL and Parallam-R- PSL near Buckhannon, West Virginia, at an expected cost of $85 million. The Company is evaluating potential sites for a third TimberStrand-TM- LSL plant, or an additional combination LVL and PSL plant, but has not determined whether or when to proceed with that plant.\nMacMillan Bloedel's Board of Directors has authorized a $49 million capital contribution to the Partnership to help fund the capacity expansion program. The Company expects the contribution to be made as the Partnership experiences negative cash flow resulting from expenditures for capital expansion over the next six to nine months. However, there is no provision in the Partnership Agreement, or in any other agreement requiring the partners to contribute funds.\nThe Company believes that cash generated from operations, borrowings under the Credit Facility, net proceeds from the stock offering, and the $49 million contribution authorized by MacMillan Bloedel will be sufficient to meet the company's working capital needs and capital expansion program approved by the company's Board of Directors. The Company also believes that additional or expanded lines of credit or appropriate long-term capital can be obtained to fund capital expenditures or working capital requirements as they arise, or to fund an acquisition.\nA substantial majority of the company's assets is held, and revenues generated, by the Partnership. Distributions of cash by the Partnership to the Company require the unanimous consent of the members of the Partnership's Management Board, which includes members of both the Company and MacMillan Bloedel. Accordingly, there can be no assurance that distributions by the Partnership will be approved for the payment of dividends to fund the company's other operations, or for other purposes.\nMARKET AND DIVIDEND INFORMATION\nThe company's stock is traded on the over-the-counter market and is listed with the National Association of Security Dealers Automated Quotation (NASDAQ) under the symbol TJCO.\nThe high and low quoted sales prices (closing) and dividends paid per common share for each quarterly period during 1993 and 1992 were as follows:\nRESULTS OF QUARTERLY OPERATIONS\nUnaudited results of operations by quarter for 1993, 1992, and 1991 are as follows:\nCONSOLIDATED BALANCE SHEETS\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nCONSOLIDATED STATEMENTS OF INCOME\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nTHE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCONSOLIDATION\nThe consolidated financial statements include the accounts of the Company and subsidiaries, including the company's 51 percent interest in Trus Joist MacMillan a Limited Partnership (the Partnership). All significant intercompany balances and transactions have been eliminated. FISCAL YEAR\nThe company's 52\/53 week fiscal year ends on the Saturday closest to December 31 of each year. The additional week, which occurs approximately every fifth year, does not materially affect the comparability of operations between years.\nFOREIGN TRANSLATION\nThe accounts of the company's Canadian subsidiaries are measured using the Canadian dollar as functional currency. These financial statements are translated into U.S. dollars using exchange rates in effect at year-end for assets and liabilities and the average exchange rate during the period for results of operations. The resulting translation adjustments are made directly to the cumulative translation adjustments component of Stockholders' Equity.\nCASH, CASH EQUIVALENTS, AND MARKETABLE SECURITIES\nThe Company considers cash on hand, cash in banks, and all highly liquid investments with maturities of three months or less when purchased to be cash equivalents. These securities are recorded at cost, which approximates fair value, and totaled $66,319,000 at January 1, 1994, $176,000 at January 2, 1993, and $156,000 at December 28, 1991. Marketable securities include tax-exempt municipal bonds and preferred stocks. These securities are recorded at cost, which approximates fair value based on quoted market prices.\nINVENTORIES Inventories are valued at the lower of cost or market and include material, labor, and production overhead costs. Inventories consisted of the following:\nThe last-in, first-out (LIFO) method is used for determining the cost of lumber, veneer, MICRO=LAM-R- lumber, TJI-R- joists, and open-web trusses. Approximately 38 percent of total inventories at the end of 1993 and 32 percent at the end of 1992 and 1991 were valued using the LIFO method. The first-in, first-out (FIFO) method is used to determine the cost of all other inventories.\nPROPERTY\nProperty and equipment are recorded at cost. Additions, betterments, and replacements of major units of property are capitalized. Maintenance, repairs, and minor replacements are expensed as incurred and approximated $15,900,000 in 1993, $13,928,000 in 1992, and $8,464,000 in 1991. The net book value of property sold or retired is removed from the asset and related depreciation accounts, and any resulting gain or loss is included in income. The provision for depreciation on certain MICRO=LAM-R- LVL, Parallam-R- PSL, and TimberStrand-TM- LSL manufacturing equipment is computed on the units-of-production method. Virtually all other property and equipment is depreciated on the straight-line method. Estimated useful lives of the principal items of property and equipment range from three to thirty years.\nCAPITALIZED INTEREST\nThe Company capitalizes interest on qualifying assets. Interest expense and income capitalized into property and equipment approximated:\nRESEARCH AND DEVELOPMENT\nResearch and development costs are expensed as incurred. Research and development costs charged to expense were approximately $2,758,000 in 1993, $3,929,000 in 1992, and $1,906,000 in 1991.\nCUMULATIVE EFFECT ON PRIOR YEARS OF CHANGE IN ACCOUNTING PRINCIPLE\nDuring the fourth quarter of 1992, the Company adopted the accounting for income taxes as required by Statement No. 109 of the Financial Accounting Standards Board (Statement No. 109). As required, the cumulative effect of the change as of the beginning of 1992 is presented separately in the consolidated statements of income. Prior year financial statements have not been restated.\nNET INCOME (LOSS) PER SHARE\nPrimary net income (loss) per common share is based on net income (loss) adjusted for preferred stock dividends and related tax benefits divided by the weighted average number of common shares outstanding after giving effect to stock options as common stock equivalents, if dilutive. Fully diluted net income (loss) per common share assumes conversion of the ESOP convertible preferred stock (ESOP preferred stock) into common stock at the beginning of the year.\nPrimary and fully diluted net income (loss) were calculated as follows:\nFully diluted net income (loss) per share for 1992 and 1991 are the same as primary net income (loss) per share since the effect of the assumed conversion of the ESOP preferred stock is anti-dilutive.\nMINORITY INTEREST IN TRUS JOIST MACMILLAN\nThe Company has a 51 percent interest in the Partnership. Income and losses through January 1, 1994, are allocated on a formula basis as agreed to by the partners and in accordance with the Partnership Agreement. As a result, the minority owner of the 49 percent interest in the Partnership was allocated $10,149,000 of income in 1993, $11,855,000 of losses in 1992, and $6,464,000 of losses in 1991. These allocations are reflected as adjustments to costs and expenses in the consolidated statements of income as Minority interest in Partnership. The minority partner's interest in the Partnership's accumulated equity is included in the consolidated balance sheet as Minority interest in Partnership. In addition, the Partnership Agreement calls for a favorable allocation to the Company of the benefits arising from accelerated tax depreciation through the end of 1993. These benefits of $1,320,000 in 1993, $4,317,000 in 1992, and $543,000 in 1991 have been included in income taxes (benefits) in the consolidated statements of income.\nOTHER COSTS AND EXPENSES\nIn the fourth quarter of 1991, the Company started \"Project Profit,\" which was designed to reduce overheads, stimulate sales, and maximize the company's competitiveness in the future. \"Other\" in the consolidated statements of income consists of the related restructuring and other one-time charges including the consolidation of several operating divisions, closure of a plant and four warehouse distribution facilities, mothballing of two facilities, severance and relocation costs, as well as inventory and other asset write-offs and reserves. The Company also provided one-time charges related principally to accounts receivable and product warranties at one of its restructured divisions.\n2 THE PARTNERSHIP\nOn September 29, 1991, the Company and MacMillan Bloedel of America, Inc. (MBA), a wholly owned subsidiary of MacMillan Bloedel Limited (MB), formed Trus Joist MacMillan a Limited Partnership. The Company contributed to the Partnership all of its North American structural wood products manufacturing facilities and sales offices for a 51 percent interest in the Partnership. MBA and MB contributed to the Partnership all of their North American engineered lumber manufacturing facilities for a 49 percent interest in the Partnership. The Company, MBA, and MB also contributed to the Partnership patents and trademarks relating to their combined engineered lumber products business. The contribution of the MBA and MB assets has been accounted for under the purchase method of accounting. The assets and liabilities have been recorded based on estimates of fair market value. The assets and liabilities contributed by MBA and MB are as follows (expressed in thousands):\nBecause the company's assets and liabilities contributed to the Partnership have been reflected at historical cost, the $43,014,000 excess of the estimated fair value of the MB assets contributed to the Partnership over MB's 49 percent interest in the equity of the Partnership has been credited to paid-in capital. The accounts of the Partnership have been included in the company's consolidated financial statements since September 29, 1991. Goodwill recognized in the transaction is being amortized using the straight-line method over 25 years. As of January 1, 1994, a total of $2,340,000 of this goodwill has been amortized. The goodwill amount expensed was $1,040,000 in 1993, $1,040,000 in 1992, and $260,000 in 1991. If the formation of the Partnership had occurred as of the beginning of 1991, net sales would have been $294,461,000, net loss would have been $4,126,000, and net loss per fully diluted share would have been $.38. These summarized, unaudited, pro forma results have been prepared for comparative purposes only. They do not purport to be indicative of the results of operations that would have resulted had the transaction been consummated at the beginning of 1991 or that may occur in the future.\n3 DEBT\nThe Company entered into a $75 million Revolving Credit Facility (the Credit Facility) on October 12, 1993, provided by a syndicate of banks. The Credit Facility provides several interest rate options, none of which exceed prime, and matures on October 11, 1996. The Credit Facility includes both facility and committment fees and also includes various customary financial covenants. These include a limitation of indebtness equal to 50 percent of total capitalization (including minority interest) and requirements to maintain (i) a minimum of net worth, and (ii) ratios of cash flow compared to indebtness and debt service. The company's other long-term debt agreements also include customary financial conventants. Under the most restrictive of these agreements, retained earnings available for cash dividends at January 1, 1994, was $61,869,000. At year-end, the Company also has available unsecured, committed lines of credit totaling $17,546,000 with foreign and domestic banks. The interest rate on any loan, determined at the time of the borrowing, would not exceed the lending bank's prevailing prime rate. Arrangements with the domestic banks provide for a commitment fee of 1\/4 percent. At January 1, 1994, approximately $4,007,000 at 3.58 percent was borrowed under these agreements.\nLong-term debt consisted of the following:\nAll of the industrial revenue bonds are secured by the property and equipment acquired with the bond proceeds and any unexpended bond funds. At January 1, 1994, the net book value of such property and equipment was approximately $33,600,000. On March 30, 1992, the Company, through its wholly owned subsidiary Dashwood Industries Limited, acquired all of the shares of R. Laflamme & Frere, Inc. Related to the acquisition, $7,950,000 of additional long-term debt was incurred. The scheduled payments of long-term debt are $1,891,000 in 1994, $1,438,000 in 1995, $1,472,000 in 1996, $1,874,000 in 1997, $1,904,000 in 1998, and $24,189,000 thereafter. The company's variable rate demand bonds are supported by irrevocable letters of credit. These letters of credit, together with the company's revolving line of credit, allow the Company to borrow for periods in excess of one year, if drawn upon to repay bondholders.\n4 ACCRUED LIABILITIES\nAccrued liabilities consisted of the following:\n5 INCOME TAXES\nIncome (loss) before income taxes and income taxes (benefits) include the following:\nThe company's effective income tax rate varied from the U.S. federal statutory income tax rate for the following reasons:\nThe deferred tax liabilities and assets included in the consolidated balance sheets as of January 1, 1994, and January 2, 1993, computed under Statement No. 109 are comprised of the following:\nAs of January 1, 1994, the Company had deferred tax assets of $5,220,000 arising from tax benefits to be realized from net operating losses available to offset future taxable income. For financial reporting purposes, the Company had valuation reserves and deferred tax credits available to recognize $3,992,000 of these benefits. The remaining $1,228,000 is applicable to losses of Canadian subsidiaries which expire beginning in 1998. The Company believes future taxable income in Canada will be adequate to realize these benefits as these Canadian subsidiaries are expected to regain their historical profitability under current forecasted conditions. The Company also had tax credits of $3,997,000 at January 1, 1994, available indefinitely to be used to the extent that future U.S. federal income taxes exceed alternative minimum taxes. The deferred portion of income taxes (benefits) included in the consolidated statements of income and computed under the accounting method required prior to Statement No. 109 for 1991 arises from the following timing differences:\n6 RETIREMENT PLANS AND INCENTIVE BONUS PROGRAMS\nMost of the company's employees are covered under defined contribution retirement plans and are also participants in the company's Employee Stock Ownership Plan (ESOP). Benefits under these plans are limited to each individual's fund balances. In September 1990, the ESOP borrowed $15 million at a 9 percent interest rate from the Company. This term loan matures on March 31, 2011, and has no prepayment penalties. Proceeds from the loan were used by the ESOP to purchase 1,269,842 shares of newly issued ESOP preferred stock from the Company. The ESOP preferred stock is described in Note 7. In connection with the above transactions, the Company has guaranteed that over the term of the loan, it will make sufficient contributions to the ESOP to allow the ESOP to repay the loan to the Company. This guarantee has been recorded as Guaranteed ESOP benefit in Stockholders' Equity. The company's annual contributions to the ESOP are based on a formula. The contributions, together with all dividends on the ESOP preferred shares, will be used by the ESOP to make the necessary interest payments and any principal prepayments. With each loan payment, a portion of the ESOP preferred stock is released and allocated to the employees' accounts in the ESOP. The Guaranteed ESOP benefit is amortized based on the shares allocated method of calculating expense. The annual expense associated with the ESOP was approximately $995,000 in 1993, $1,334,000 in 1992, and $602,000 in 1991. The Company matches certain contributions of participating associates to its retirement plans and in 1992 made additional contributions based on a formula. Contributions to these plans were approximately $8,617,000 in 1993, $6,436,000 in 1992, and $4,330,000 in 1991, of which approximately 57 percent, 64 percent, and 74 percent, respectively, resulted from company contributions made under the compensation reduction agreement provision of the plans. Substantially all of the company's officers and key employees participate in incentive bonus programs that are based on formulas or are discretionary. Amounts charged to income under the programs were approximately $2,824,000 in 1993, $1,748,000 in 1992, and $1,227,000 in 1991.\n7 STOCKHOLDERS' EQUITY\nAt January 2, 1993, there were 40,000,000 shares of common stock ($1.00 par value) and 2,000,000 shares of preferred stock ($1.00 par value) authorized. In September 1990, the Company issued 1,269,842 shares of $1.00 par value ESOP preferred stock at $11.8125 per share (liquidation preference) to the ESOP. Each share of the ESOP preferred stock is convertible into the company's common stock at the higher of the liquidation preference or the fair market value of the underlying common stock. The Company has the option to satisfy any conversion in cash, common stock, or any combination thereof. The ESOP preferred stock has voting rights equal to one vote per share and is entitled to preferential dividends of $1.065 per share each year. The ESOP preferred stock is redeemable at the company's option in certain situations. On August 26, 1993, the company's Board of Directors declared a two-for-one stock split in the form of a 100 percent stock dividend. On October 1, 1993, one share of common stock was issued for each share outstanding as of September 7, 1993. The stock split was recorded in accordance with the declaration whereby retained earnings was charged and common stock was credited with $6,612,094, representing the aggregate of the par value of the shares issued. All per share information included in these financial statements and notes is based on the increased number of shares of common stock after giving retroactive effect to the stock split. The company's Board of Directors on August 26, 1993, also authorized the retirement of 1,272,675 shares of treasury stock. The retirement of treasury stock was recorded in accordance with the authorization whereby retained earnings and common stock were charged $17,343,947 and $1,272,675, respectively, and treasury stock was credited with $18,616,622, representing the aggregate cost of the treasury stock. In September 1990, the company's Board of Directors authorized a program to repurchase up to $15,000,000 of its own stock at market price. At January 1, 1994, $2,935,000 of additional stock could be acquired under this program. In November 1993, the Company completed a public offering of 3,500,000 shares of common stock at $28.50 per share. The net proceeds of the stock offering after deducting applicable issuance costs and expenses were $94,450,000. The proceeds were used to repay $18,848,000 of short-term debt under line of credit arrangements. The balance of the proceeds will be used for other general corporate purposes, including the company's announced capacity expansion in its engineered lumber business, working capital, and acquisitions, which the Company reviews from time to time in the regular course of business. In 1989, the Company issued common stock purchase rights to each stockholder. These rights generally become exercisable 10 days following the public announcement of the acquisition by a person or group of 20 percent or more of the company's common stock or a tender offer being made for 30 percent or more of the common stock. With certain exceptions, if the Company is thereafter involved in a merger or other business combination, or more than 50 percent of the company's assets or earning power are sold, the rights permit each holder to purchase common stock of the acquiring company at 50 percent of its market value. If the rights are triggered and the Company is the surviving corporation in a merger, the rights permit holders, other than the person or group that triggered exercisability of the rights, to purchase shares of the company's common stock at a 50 percent discount from the then current market value. The rights, which expire in September 1999, are non-voting and may be redeemed by the Company at $.005 per right at any time until 10 days following the date the rights are triggered. Under certain circumstances, the Board of Directors may extend the redemption period beyond the 10 days, and may amend certain provisions of the rights plan. In connection with these rights, the Board of Directors has reserved for issuance the same number of shares as are outstanding at any point of time.\nThe Company has five stock option plans in effect for officers and key associates. At January 1, 1994, 1,456,968 shares were reserved for issuance under these plans. Under the terms of these plans, which have been approved by the company's stockholders, incentive stock options may be issued at an exercise price of not less than the fair market value of the stock on date of grant and nonstatutory options may be issued at a $1.00 exercise price. The outstanding options and exercise prices are adjusted to reflect any stock splits, stock dividends, and the like. The incentive stock options become exercisable three years after date of grant, and, depending upon Board of Director determination at the time of grant, the nonstatutory options either become exercisable three years after date of grant or in 20 percent annual installments commencing five years after date of grant. All unexercised options expire 10 years after date of grant. At January 1, 1994, a total of 182,770 incentive stock options and 867,976 nonstatutory options were outstanding under the plans. The ability to grant options under the existing plans expires at various dates to February 2003.\nStock option transactions are summarized as follows: (after giving retroactive effect to the stock split):\nFor nonstatutory stock options, the excess of the fair market value over the exercise price on date of grant is accrued ratably as compensation expense from the date of grant to the exercisable date. No accounting entries are made for incentive stock options until they are exercised.\n8 LEASES\nBasic or minimum rental expenses for operating and month-to-month leases amounted to $5,540,000 in 1993, $5,511,000 in 1992, and $4,533,000 in 1991. The Company has various operating leases with initial or remaining terms of more than one year. These lease have minimum lease payment requirements of $4,359,000 in 1994, $3,294,000 in 1995, $2,432,000 in 1996, $2,036,000 in 1997, and $1,521,000 in 1998. In addition to minimum rentals, certain mobile equipment lease agreements provide for usage charges and cost-of- living increases. Lease agreements related to real property have fixed payment terms based upon the lapse of time. Certain lease agreements provide the Company with the option to purchase the leased property at the end of the lease term at approximately fair market value. Additionally, certain lease agreements contain renewal options of up to three years with substantially the same terms.\n9. RELATED PARTY TRANSACTIONS\nThe Partnership sells to MacMillan Bloedel Building Materials (MBBM), a division of MB, on terms comparable to other Company distributors. Sales of MBBM were $104,376,000, $52,379,000, and $5,401,000 in 1993, 1992, and 1991, respectively. Accounts receivable from MBBM at January 1, 1994, were $8,098,000, at January 2, 1993 were $1,859,000, and at December 28,1991, were $706,000. Amounts due from MBBM are included in receivables in the accompanying consolidated balance sheets. MB provides certain technological and research assistance and computer services support to the Partnership. Amounts incurred under this arrangement with MB were $1,223,000, $2,851,000, and $491,000 for 1993, 1992, and 1991, respectively. Quarterly, the Partnership makes cash distributions to the partners in lieu of state and federal income taxes. Payments of $4,455,000 and $445,000 were made to MBA in 1993 and 1992, respectively. Certain employees who perform services for the Partnership at the former MB facilities remain on the payroll of MB. The Partnership Agreement provides the MB will be reimbursed for its actual payroll and related benefit costs relating to these employees. Payroll reimbursements to MB for 1993, 1992, and 1991 were $5,164,000, $4,539,000 and $2,638,000, respectively. MB also provides patent administration, computer services support, and engineering designs at the request of the Partnership. Amounts incurred under these arrangements were $91,000, $414,000, and $255,000 for 1993, 1992, and 1991, respectively. Total payables to MB and MBA for such services and tax distributions at January 1, 1994, January 2, 1993, and December 28, 1991, were $3,120,000, $1,519,000, and $2,365,000, respectively.\nThe Partnership Agreement provides that MB will make cash capital contributions to the Partnership, up to $19,000,000, to maintain its ownership percentage as its capital account was reduced for start-up losses allocated to MB. The Partnership received $13,083,000 related to 1992 and $5,917,000 related to 1991 pursuant to this provision of the agreement. Receivables from MB relating to this provision were $2,327,000 and $5,917,000 at January 2, 1993, and December 28, 1991, respectively. In accordance with the terms of the Partnership Agreement, all capital expenditures made by MBA subsequent to June 30, 1991, and through the completion of the construction of the Deerwood, Minnesota, TimberStand-TM- lumber manufacturing facility were payable by the Partnership. The liability of the Partnership was in the form of a note payable to MBA, which totaled $11,668,000 at December 28, 1991. On March 30, 1992, the Partnership paid MBA $12,229,000 of principal and $253,000 of interest. At January 2, 1993, the net of the amounts described above, except for the receivable from MBBM, is included in receivable from MacMillan Bloedel net in the accompanying consolidated balance sheets. At January 1, 1994, and December 28, 1991, the net amount is included in payable to MacMillan Bloedel, net.\n10 GEOGRAPHIC INFORMATION\nThe primary business of the Company is the manufacture and marketing of specialty building products for buildings in the light-construction industry. More than 90 percent of the company's sales are derived from this activity. The Company operates primarily in two countries, the United States and Canada; the majority of all sales are made domestically in those countries. Geographic information about the company's operations for the three years ended January 1, 1994, is as follows:\nCertain products are transferred between the United States and Canada for further manufacture and marketing; these transfers between geographic areas totaled approximately $23,344,000 in 1993, $11,872,000 in 1992, and $5,873,000 in 1991. The transfer price is approximately the same price charged to similar customers. - ------------------------------------------------------------------------------\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the stockholders of TJ International, Inc.:\nWe have audited the accompanying consolidated balance sheets of TJ International, Inc. (a Delaware corporation) and subsidiaries as of January 1, 1994, January 2, 1993, and December 28, 1991, and the related consolidated statements of income, stockholder's equity, 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 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 TJ International, Inc. and subsidiaries as of January 1, 1994, January 2, 1993, and December 28, 1991, and the results of their operations and their cash flows for the years then ended in conformity with generally accepted accounting principles. As discussed in Note 1 to the consolidated financial statements, effective December 29, 1991, the Company changed its method of accounting for income taxes in accordance with Statement No. 109 of the Financial Accounting Standards Board.\n\/S\/\/Arthur Andersen & Co.\nBoise, Idaho February 16, 1994\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo TJ International, Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in TJ International, Inc.'s annual report to stockholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 16, 1994. Our audit was made for the purpose of forming an opinion on those statements taken as a whole. The schedules listed in Part IV, 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 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.\n\/s\/ Arthur Andersen & Co. - ---------------------------------\nBoise, Idaho February 16, 1994\nSCHEDULE V\nTJ INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE V - PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED DECEMBER 28, 1991, JANUARY 2, 1993 AND JANUARY 1, 1994\nSCHEDULE VI\nTJ INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE VI - ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED DECEMBER 28, 1991, JANUARY 2, 1993 AND JANUARY 1, 1994\nSCHEDULE IX\nTJ INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE IX - SHORT-TERM BORROWINGS FOR THE YEARS ENDED DECEMBER 28, 1991, JANUARY 2, 1993 AND JANUARY 1, 1994","section_15":""}
{"filename":"22301_1994.txt","cik":"22301","year":"1994","section_1":"ITEM 1 BUSINESS\nComcast Corporation and its subsidiaries (the \"Company\") is engaged in the development, management and operation of cable and cellular telephone communications systems and the production and distribution of cable programming (see \"General Developments of Business\"). The Company's consolidated domestic cable operations served more than 3.3 million subscribers and passed more than 5.5 million homes as of December 31, 1994. The Company owns a 50% interest in Garden State Cablevision L.P. (\"Garden State\"), a cable communications company serving approximately 195,000 subscribers and passing approximately 288,000 homes. In the United Kingdom (\"UK\"), a subsidiary of the Company, Comcast UK Cable Partners Limited (\"Comcast UK Cable\"), is constructing a cable telecommunications network that will pass approximately 229,000 homes and holds investments in cable television and telecommunications companies which have the potential to serve an additional 1.2 million homes. The Company provides cellular telephone communications services pursuant to licenses granted by the Federal Communications Commission (\"FCC\") in markets with a population of over 7.9 million, including the area in and around the City of Philadelphia, Pennsylvania, the State of Delaware and a significant portion of the State of New Jersey.\nThe Company was organized in 1969 under the laws of the Commonwealth of Pennsylvania and has its principal executive offices at 1500 Market Street, Philadelphia, Pennsylvania, 19102-2148, (215) 665-1700.\nFINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS\nSee Note 12 to the Company's consolidated financial statements for information about the Company's operations by industry segment.\nGENERAL DEVELOPMENTS OF BUSINESS\nQVC\nIn February 1995, the Company and Tele-Communications, Inc. (\"TCI\") acquired all of the outstanding stock of QVC, Inc. (\"QVC\") for $46, in cash, per share. The total cost of acquiring the outstanding shares of QVC not previously owned by the Company and TCI (approximately 65% of such shares on a fully diluted basis) was approximately $1.4 billion. Following the acquisition, the Company and TCI own, through their respective subsidiaries, 57.45% and 42.55%, respectively, of QVC. The Company will account for the QVC acquisition under the purchase method of accounting and QVC will be consolidated with the Company beginning in February 1995.\nThe acquisition of QVC, including the exercise of certain warrants held by the Company, was financed with cash contributions from the Company and TCI of $296.3 million and $6.6 million, respectively, borrowings of $1.1 billion under a $1.2 billion QVC credit facility and existing cash and cash equivalents held by QVC.\nQVC is a nationwide general merchandise retailer, operating as one of the leading televised shopping retailers in the United States. Through its merchandise-focused television programs (the \"QVC Service\"), QVC sells a wide variety of products directly to consumers. The QVC Service currently reaches approximately 50 million cable television subscribers in the United States.\nThe day to day operations of QVC will, except in certain limited circumstances, be managed by the Company. With certain exceptions, direct or indirect transfers to unaffiliated third parties by the Company or TCI of any stock in QVC are subject to certain restrictions and rights in favor of the other.\nLiberty Media Corporation (\"Liberty\"), a wholly-owned subsidiary of TCI, may, at certain times following February 9, 2000, trigger the exercise of certain exit rights. If the exit rights are triggered, the Company has first right to purchase Liberty's stock in QVC at Liberty's pro rata portion of the fair market value (on a going concern or liquidation basis, whichever is higher, as determined by an appraisal process) of QVC. The Company may pay Liberty for such stock, subject to certain rights of Liberty to consummate the purchase in the most tax-efficient method available, in cash, the Company's promissory note maturing not more than three years after issuance, the Company's equity securities or any combination thereof. If the Company elects not to purchase the stock of QVC held by Liberty, then Liberty will have a similar right to purchase the stock of QVC held by the Company. If Liberty elects not to purchase the stock of QVC held by the Company, then Liberty and the Company will use their best efforts to sell QVC.\nMaclean Hunter\nOn December 22, 1994, the Company, through Comcast MHCP Holdings, L.L.C. (the \"LLC\"), acquired the U.S. cable television and alternate access operations of Maclean Hunter Limited (\"Maclean Hunter\") from Rogers Communications Inc. and all of the outstanding shares of Barden Communications, Inc. (collectively, such acquisitions are referred to as the \"Maclean Hunter Acquisition\") for approximately $1.2 billion (subject to certain adjustments) in cash. The Company and the California Public Employees' Retirement System (\"CalPERS\") invested approximately $305.0 million and $250.0 million, respectively, in the LLC, which is owned 55% by a wholly-owned subsidiary of the Company and 45% by CalPERS, and is managed by the Company. The Maclean Hunter Acquisition, including certain transaction costs, was financed with cash contributions from the LLC of $555.0 million and borrowings of $715.0 million under an $850.0 million Maclean Hunter credit facility. At any time after December 18, 2001, CalPERS may elect to liquidate its interest in the LLC at a price based upon the fair value of CalPERS' interest in the LLC, adjusted, under certain circumstances, for certain performance criteria relating to the fair value of the LLC or to the Company's common stock. Except in certain limited circumstances, the Company, at its option, may satisfy this liquidity arrangement by purchasing CalPERS' interest for cash, through the issuance of the Company's common stock (subject to certain limitations) or by selling the LLC. The Maclean Hunter Acquisition was accounted for under the purchase method of accounting and Maclean Hunter is consolidated with the Company as of December 31, 1994.\nComcast UK Cable\nOn September 27, 1994, Comcast UK Cable consummated an initial public offering (the \"IPO\") of 15 million of its Class A Common Shares for net proceeds of $209.4 million. Contemporaneously with the IPO, the Company and UK Cable Partners Limited (\"UKCPL\"), which is owned by Warburg, Pincus Investors, L.P. and Bankers Trust Investments PLC, restructured their interests in Comcast UK Cable and terminated UKCPL's right to exchange its equity interests in Comcast UK Cable for convertible debt of the Company (the \"Exchange Option\"). As a result of the IPO and the restructuring, the Company beneficially owns approximately 31.2% of the total outstanding Comcast UK Cable common shares. Because the Class A Common Shares are entitled to one vote per share and the Class B Common Shares are entitled to ten votes per share, the Company, through its ownership of the Class B Common Shares, controls approximately 81.9% of the total voting power of all outstanding Comcast UK Cable common shares and continues to consolidate Comcast UK Cable. As a result of the termination of the Exchange Option and consummation of the IPO, the Company recorded an aggregate minority interest liability in Comcast UK Cable of $261.4 million. The Company has recorded the increase in its proportionate share of Comcast UK Cable's net assets as an increase in additional capital of $59.3 million.\nHeritage\nOn January 26, 1995, the Company exchanged its interest in Heritage Communications, Inc. with TCI for Class A common shares of TCI with a fair market value of approximately $290 million. Shortly thereafter, the Company sold certain of these shares for total proceeds of approximately $188 million. As a result of these transactions, the Company will recognize a pre-tax gain of $141 million in the first quarter of 1995.\nTelecommunications Joint Venture\nOn October 25, 1994, the Company announced a joint venture (\"WirelessCo\") with Sprint Corporation (\"Sprint\"), TCI and Cox Cable Communications, Inc. (\"Cox\") to provide wireless communications services. WirelessCo is owned 40% by Sprint, 30% by TCI and 15% each by the Company and Cox. WirelessCo is participating in the first of several FCC auctions of blocks of spectrum for licenses to provide Personal Communications Services (\"PCS\"), having filed an application to participate in 39 of 51 Major Trading Area (\"MTA\") markets nationwide. As of February 21, 1995, WirelessCo's aggregate bids for 38 licenses covering a total population of 168 million were $1.975 billion. There can be no assurances that WirelessCo will be successful in bidding for or otherwise obtaining PCS licenses for these or other MTAs. The Company has obtained letter of credit commitments sufficient to cover its 15% share of the cost of PCS licenses for which WirelessCo is the successful bidder. The Company may have material additional capital requirements relating to the buildout of PCS systems if WirelessCo is successful in the PCS bidding process. WirelessCo is accounted for under the equity method of accounting.\nThe parties have also signed a joint venture formation agreement which provides the basis upon which they will develop definitive agreements for their local wireline telecommunications activities. The parties anticipate that the wireline joint venture will be owned in the same percentages as WirelessCo. The parties' ability to provide such local services on a nationwide basis, and the timing thereof, will depend upon, among other things, the removal or modification of legal barriers to local telephone competition. The parties anticipate that Teleport Communications Group (\"TCG\"), which is owned 20% by the Company and by other cable television operators, including TCI and Cox, will be contributed to the local telephone venture. TCG is an alternative provider of local telephone services. The contribution of TCG to the venture is expected to be subject to certain conditions, including obtaining necessary governmental and other approvals.\nCable Rate Regulation Developments\nOn March 30, 1994, the FCC: (i) modified its existing benchmark methodology to require, absent a successful cost-of-service showing, reductions of approximately 17% in the rates for regulated cable services in effect on September 30, 1992, adjusted for inflation, channel modifications, equipment costs and increases in certain operating costs. The modified benchmarks and regulations are generally designed to cause an additional 7% reduction in the rates for regulated cable services on top of the rate reductions implemented by the Company in September 1993 under the prior FCC benchmarks and regulations; (ii) adopted interim regulations to govern cost-of-service showings by cable operators, establishing an industry-wide 11.25% after tax rate of return and a rebuttable presumption that acquisition costs above original historic book value of tangible assets should be excluded from the rate base; and (iii) reconsidered, among other matters, its regulations concerning rates for the addition of regulated services and the treatment of packages of \"a la carte\" channels (see \"Legislation and Regulation\").\nIn July 1994, the Company reduced rates for regulated services in the majority of its cable systems to comply with the modified benchmarks and regulations. In addition, the Company is currently seeking to justify existing rates in certain other of its cable systems on the basis of cost-of-service showings; however, the interim cost-of-service regulations promulgated by the FCC do not support positions taken by the Company in its cost-of-service filings to date. The Company's reported cable service income reflects the estimated effects of cable regulation. The Company is seeking reconsideration by the FCC of the interim cost-of-service regulations and, if unsuccessful in justifying existing rates under cost-of-service regulations, intends to seek judicial relief. However, no assurance can be given that the Company will be able to offset, to any substantial degree, the adverse impact of rate reductions in compliance with the modified benchmarks and regulations or that it will be successful in cost-of-service proceedings. If the Company is not successful in such efforts, and there is no legislative, administrative or judicial relief in these matters, the FCC regulations will continue to adversely affect the Company's results of operations.\nOn November 10, 1994, the FCC announced modified \"Going Forward\" rules which, among other things, permit cable operators to charge an additional $0.20 per month per channel for channels added to the cable programming services tier, up to a maximum of six channels, and to recover an additional $0.30 in monthly fees paid to programmers for such channels. The ruling applies to channels added between May 15, 1994 and December 31, 1996 and became effective January 1, 1995. The FCC concurrently announced regulations permitting cable operators to create new product tiers which would generally not be subject to rate regulation. The Company is currently reviewing the ruling and is unable to predict the effect on its future results of operations.\nDESCRIPTION OF THE COMPANY'S BUSINESSES\nCable Communications\nGeneral\nA cable communications system receives signals by means of special antennae, microwave relay systems and earth stations. The system amplifies such signals, provides locally originated programs and ancillary services and distributes programs to subscribers through a fiber optic and coaxial cable system.\nCable communications systems generally offer subscribers the signals of all national television networks; local and distant independent, specialty and educational television stations; satellite-delivered non-broadcast channels; locally originated programs; educational programs; home shopping and public service announcements. In addition, each of the Company's systems offer, for an extra monthly charge, one or more special services (\"Pay Cable\") such as Home\nBox Office (Registered Trademark), Cinemax (Registered Trademark), Showtime (Registered Trademark), The Movie Channel (Trademark) and The (Copyright)Disney Channel, which generally offer, without commercial interruption, feature motion pictures, live and taped sports events, concerts and other special features. A majority of the Company's systems offer pay per view services, which permit a subscriber to order, for a separate fee, movies and individual events.\nCable communications systems are generally constructed and operated under non-exclusive franchises granted by state or local governmental authorities. Franchises typically contain many conditions, such as time limitations on commencement or completion of construction; conditions of service, including number of channels, types of programming and free service to schools and other public institutions; and the maintenance of insurance and indemnity bonds. The provisions of franchises are subject to both the 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\"-and together with the 1984 Cable Act, the \"Cable Acts\" -- see \"Legislation and Regulation\").\nThe Company's franchises typically provide for periodic payments to the governmental authority of franchise fees of up to 5% of revenues derived from the operation of the cable system. Franchises are generally nontransferable without the consent of the governmental authority. The Company's franchises generally were granted for an initial term of 15 years. Although franchises historically have been renewed and, under the Cable Acts, should continue to be renewed for companies that have provided adequate service and have complied generally with franchise terms, renewal may be more difficult as a result of the 1992 Cable Act and may include less favorable terms and conditions. Furthermore, the governmental authority may choose to award additional franchises to competing companies at any time (see \"Competition\" and \"Legislation and Regulation\").\nCompany's Systems\nThe table below sets forth a summary of Homes Passed and Cable Subscriber information for the Company's domestic cable communications systems for the five years ended December 31, 1994, including the consolidated systems of Maclean Hunter as of December 31, 1994. This table does not reflect Homes Passed or subscriber information for the Company's investment in Garden State.\nRevenue Sources\nThe Company's cable communications systems offer varying levels of service, depending primarily on their respective channel capacities. At December 31, 1994, substantially all of the Company's systems had the capacity to carry in excess of 35 channels.\nMonthly service rates and related charges vary in accordance with the type of service selected by the subscriber. The Company may receive an additional monthly fee for Pay Cable service, the charge for which varies with the type and level of service selected by the subscriber. Additional charges are often imposed for installation services, commercial subscribers, program guides and other services. The Company also generates revenue from pay per view services and advertising sales. Subscribers typically pay on a monthly basis and generally may discontinue services at any time (see \"Legislation and Regulation\").\nProgramming and Suppliers\nThe Company generally pays either a monthly fee per subscriber or a percentage of the Company's gross receipts for basic services, cable programming services and premium programming services. Some of the programming suppliers provide volume discount pricing structures or offer marketing support to the Company.\nNational manufacturers are the primary sources of supplies, equipment and materials utilized in the construction and upgrading of the Company's cable communications systems. Construction, rebuild and upgrade costs for these systems have increased during recent years and are expected to continue to increase as a result of the need to construct increasingly complex systems, overall demand for labor and other factors.\nUK Activities\nThe Company beneficially owns an approximate 31.2% equity interest and controls approximately 81.9% of the total voting power of Comcast UK Cable. Comcast UK Cable owns interests in three operating companies (the \"Operating Companies\"): Birmingham Cable Corporation Limited (\"Birmingham Cable\"), in which Comcast UK Cable owns a 27.5% interest, Cable London PLC (\"Cable London\"), in which Comcast UK Cable owns a 48.9% interest, and Cambridge Holding Company Limited (\"Cambridge Cable\"), in which Comcast UK Cable owns a 50.0% interest. The Operating Companies provide integrated cable television, residential telephone and business telecommunications services to subscribers in their respective franchise areas. In addition, on June 20, 1994, Comcast UK Cable acquired the franchises for Darlington and Teesside (collectively, the \"Teesside Franchises\") which comprise an area with approximately 229,000 homes. In January 1995, Cambridge Cable was awarded licenses to provide cable communications services to an additional 205,000 homes.\nOperating Companies' Systems\nThe table below sets forth Homes Passed, Cable Subscriber and Telephony Subscriber information for the Operating Companies' cable communications systems for the five years ended December 31, 1994.\nDevelopment and construction of the cable\/telephony systems of the Teesside Franchises commenced in the third quarter of 1994. Based on its December 31, 1994 proportionate ownership interests in the Operating Companies, including the Teesside Franchises, Comcast UK Cable's interests represent approximately 700,000 homes.\nCompetition\nCable communications systems face competition from alternative methods of receiving and distributing television signals and from other sources of news, information and entertainment such as off-air television broadcast programming, newspapers, movie theaters, live sporting events, interactive computer programs and home video products, including videotape cassette recorders. The extent to which cable service is competitive depends, in part, upon the cable system's ability to provide, at a reasonable price to consumers, a greater variety of programming than that available off-air or through other alternative delivery sources (see \"Legislation and Regulation\").\nRecent FCC and judicial decisions, if upheld by appellate courts, will enable local telephone companies to provide a wide variety of \"video dialtone\" services competitive with services provided by cable systems and to provide cable services directly to subscribers (see \"Legislation and Regulation\"). Various local telephone companies have requested regulatory approval for the initiation of video programming services. Cable systems could be placed at a competitive disadvantage if the delivery of video programming services by local telephone companies becomes widespread since cable systems are required to obtain local franchises to provide cable service and must comply with a variety of obligations under such franchises. Issues of cross-subsidization by monopoly local telephone companies pose strategic disadvantages for cable operators seeking to compete with local telephone companies who provide video services. The Company cannot predict at this time the likelihood of success of video programming ventures by local telephone companies or the impact on the Company of such competitive ventures.\nCable systems generally operate pursuant to franchises granted on a non-exclusive basis. The 1992 Cable Act gives local franchising authorities control over basic cable service rates, prohibits franchising authorities from unreasonably denying requests for additional franchises and permits franchising authorities to operate cable systems (see \"Legislation and Regulation\"). Well-financed businesses from outside the cable industry (such as the public utilities\nwhich own certain of the poles on which cable is attached) may become competitors for franchises or providers of competing services. The costs of operating a cable system where a competing service exists (referred to in the cable industry as an \"overbuild\") will be substantially greater than if there were no competition present. Actual and potential overbuilds exist in several of the Company's systems.\nCable operators face additional competition from private satellite master antenna television (\"SMATV\") systems that serve condominiums, apartment complexes and private residential developments. The operators of these SMATV systems often enter into exclusive agreements with apartment building owners or homeowners' associations. While the 1984 Cable Act gives a franchised cable operator the right to use existing compatible easements within its franchise area on nondiscriminatory terms and conditions, there have been conflicting judicial decisions interpreting the scope of the access right granted to serve such private property. Various states have enacted laws to provide franchised cable systems access to such private residential complexes. These laws have been challenged in the courts with varying results. Due to the widespread availability of reasonably priced earth stations, SMATV systems now can offer both improved reception of local television stations and many of the same satellite-delivered program services offered by franchised cable systems. The ability of the Company to compete for subscribers in communities served by SMATV operators is uncertain.\nThe availability of reasonably-priced home satellite dish earth stations (\"HSD\") enables individual households to receive many of the satellite-delivered program services formerly available only to cable subscribers. Furthermore, the 1992 Cable Act contains provisions, which the FCC has implemented with regulations, to enhance the ability of HSD owners and other cable competitors to purchase certain satellite-delivered cable programming at competitive costs.\nIn recent years, the FCC has adopted policies providing a more favorable operating environment for new and existing technologies that provide, or have the potential to provide, substantial competition to cable systems. These technologies include, among others, the direct broadcast satellite (\"DBS\") service whereby signals are transmitted by satellite to receiving facilities located on the premises of subscribers. Programming is currently available to the owners of HSDs through conventional, medium and high-powered satellites. One consortium comprised of cable operators, including the Company and a satellite company, commenced operation in 1990 of a medium-power DBS satellite system using the Ku portion of the frequency spectrum and currently provides service consisting of approximately 65 channels of programming, including broadcast signals and pay-per-view services. Two companies began offering nationwide DBS service in 1994 accompanied by extensive marketing efforts. Several other companies are preparing to have high-power DBS systems in place. DBS systems are expected to use video compression technology to increase the channel capacity of their systems to provide movies, broadcast stations and other program services competitive to those of cable systems. The extent to which DBS systems are competitive to the service provided by cable systems depends, among other things, on the availability of reception equipment at reasonable prices and on the ability of DBS operators to provide competitive programming.\nCable communications systems also compete with wireless program distribution services such as multichannel, multipoint distribution service (\"MMDS\") which use low power microwave frequencies to transmit video programming over-the-air to subscribers. There are MMDS operators who are authorized to provide or are providing broadcast and satellite programming to subscribers in areas served by the Company's cable systems. Additionally, the FCC recently initiated a rulemaking proceeding in which it proposed to allocate frequencies in the 28 GHz band for a new multichannel wireless video service similar to MMDS. The Company is unable to predict whether wireless video services will have a material impact on its operations.\nOther new technologies may become competitive with non-entertainment services that cable communications systems can offer. The FCC has authorized television broadcast stations to transmit textual and graphic information useful both to consumers and to businesses. The FCC also permits commercial and non-commercial FM stations to use their subcarrier frequencies to provide non-broadcast services including data transmissions. The FCC established an over-the-air Interactive Video and Data Service that will permit two-way interaction with commercial and educational programming along with informational and data services. Telephone companies and other common carriers also provide facilities for the transmission and distribution of data and other non-video services. The FCC is currently conducting spectrum auctions for licenses to provide PCS. PCS could enable license holders, including cable operators, to provide voice and data services as well as video programming (see \"Cellular Telephone Communications\").\nAdvances in communications technology as well as changes in the marketplace and the regulatory and legislative environment are constantly occurring. Thus, it is not possible to predict the effect that ongoing or future developments might have on the cable industry.\nLegislation and Regulation\nThe cable communications industry currently is regulated by the FCC, some state governments and most local governments. In addition, legislative and regulatory proposals by the Congress and federal agencies may materially affect the cable communications industry. The following is a summary of federal laws and regulations materially affecting the growth and operation of the cable communications industry and a description of certain state and local laws.\nThe Cable Acts, both of which amended the Communications Act of 1934 (the \"Communications Act\"), establish a national policy to guide the development and regulation of cable systems. Principal responsibility for implementing the policies of the Cable Acts is allocated between the FCC and state or local franchising authorities.\nRate Regulation. Prior to April 1, 1993, virtually all of the Company's cable systems were free to adjust cable rates without first obtaining governmental approval. The 1992 Cable Act authorizes rate regulation for cable communications services and equipment in communities that are not subject to \"effective competition,\" as defined in the 1992 Cable Act. Virtually all cable communications systems are now subject to rate regulation for basic cable service and equipment by local officials under the oversight of the FCC, which has prescribed detailed criteria for such rate regulation. The 1992 Cable Act also requires the FCC to resolve complaints about rates for nonbasic cable programming services (other than programming offered on a per channel or per program basis, which programming is not subject to rate regulation) and to reduce any such rates found to be unreasonable. The 1992 Cable Act limits the ability of cable systems to raise rates for basic cable service and certain nonbasic cable programming services (collectively, the \"Regulated Services\").\nOn April 1, 1993, the FCC adopted regulations in accordance with the 1992 Cable Act governing rates that may be charged to subscribers for Regulated Services and ordered an interim freeze on existing rates. The FCC's rate regulations became effective on September 1, 1993 and the FCC's rate freeze was extended until the earlier of February 15, 1994 or the date on which a cable system's basic cable service rate was regulated by a franchising authority.\nIn implementing the 1992 Cable Act, the FCC adopted a benchmark methodology as the principal method of regulating rates for Regulated Services. Cable operators were also permitted to justify rates using a cost-of-service methodology. As of September 1, 1993, cable operators whose then current rates were above FCC benchmark levels were required, absent a successful cost-of-service showing, to reduce such rates to the benchmark level or by up to 10% of those rates in effect on September 30, 1992, whichever reduction was less, adjusted for equipment costs, inflation and programming modifications occurring subsequent to September 30, 1992. Effective May 15, 1994, the FCC modified its benchmark methodology to require reductions of up to 17% of the rates for Regulated Services in effect on September 30, 1992, adjusted for inflation, programming modifications, equipment costs and increases in certain operating costs. The FCC's modified benchmark regulations were designed to cause an additional 7% reduction in the rates for Regulated Services on top of any rate reductions implemented under the FCC's initial benchmark regulations.\nThe FCC's initial \"Going Forward\" regulations limited rate increases for Regulated Services to an inflation-indexed amount plus increases for channel additions and certain external costs beyond the cable operator's control, such as franchise fees, taxes and increased programming costs. Under these regulations, cable operators are entitled to take a 7.5% mark-up on certain programming cost increases. On November 10, 1994, the FCC modified these regulations and instituted a three-year flat fee mark-up plan for charges relating to new channels added to the cable programming service tier. As of January 1, 1995, cable operators may charge subscribers for channels added to the cable programming service tier after May 14, 1994, at a monthly rate of up to 20 cents per added channel, but may not make adjustments to monthly rates totalling more than $1.20 plus an additional 30 cents for programming license fees per subscriber over the first two years of the three-year period. Cable operators may charge an additional 20 cents plus the cost of the programming in the third year (1997) for one additional channel added in that year. Operators must make a one-time election to use either the 20 cents per channel adjustment or the 7.5% mark-up on programming cost increases for all channels added after December 31, 1994. The FCC is currently considering\nwhether to modify or eliminate the regulation allowing operators to receive the 7.5% mark-up on increases in existing programming license fees.\nOn November 10, 1994, the FCC adopted regulations permitting cable operators to create new product tiers (\"NPT\") that will not be subject to rate regulation if certain conditions are met. The FCC also revised its previously adopted policy and concluded that packages of a la carte services are subject to rate regulation by the FCC as cable programming service tiers. Because of the uncertainty created by the FCC's prior a la carte package guidelines, the FCC will allow cable operators, including the Company, under certain circumstances, to treat previously offered a la carte packages as NPTs.\nFranchising authorities are empowered to regulate the rates charged for additional outlets and for the installation, lease and sale of equipment used by subscribers to receive the basic cable service tier, such as converter boxes and remote control units. The FCC's rules require franchising authorities to regulate these rates on the basis of actual cost plus a reasonable profit, as defined by the FCC. Cable operators required to reduce rates may also be required to refund overcharges with interest.\nRate reductions will not be required where a cable operator can demonstrate that existing rates for Regulated Services are justified and reasonable using cost-of-service guidelines. On November 24, 1993, the FCC ruled that operators choosing to justify rates through a cost-of-service submission must do so for all Regulated Services. On February 22, 1994, the FCC adopted interim cost-of-service regulations establishing, among other things, an industry-wide 11.25% after tax rate of return on an operator's allowable rate base and a rebuttable presumption that acquisition costs above original historic book value of tangible assets should be excluded from the allowable rate base. The FCC is conducting a further rulemaking to determine whether these interim standards and regulations should be made permanent.\nIn July 1994, the Company reduced rates for Regulated Services in the majority of its cable systems to comply with the FCC's modified benchmarks and regulations. In addition, the Company is seeking to justify existing rates in certain of its cable systems in the States of Connecticut and New Jersey on the basis of cost-of-service showings for both its basic cable service tier (at the franchising authority) and its cable programming service tier (at the FCC); however, the FCC's interim cost-of-service regulations do not support positions taken by the Company in its cost-of-service filings to date. The Company is seeking FCC reconsideration of the interim cost-of-service regulations, FCC review of various adverse decisions issued by franchising authorities on its basic cable service rates and a determination by the FCC of the validity of cost-of-service rates for cable programming services in various systems. If unsuccessful in such efforts, the Company intends to seek judicial relief. However, no assurance can be given that the Company will be able to offset, to any substantial degree, the adverse impact of rate reductions in compliance with the FCC's modified benchmarks and regulations, or that it will be successful in cost-of-service proceedings. If the Company is not successful in such efforts, and there is no legislative, administrative or judicial relief in these matters, the FCC regulations will continue to adversely affect the Company's results of operations.\n\"Anti-Buy Through\" Provisions. The 1992 Cable Act requires cable systems to permit subscribers to purchase video programming offered by the operator on a per channel or a per program basis without the necessity of subscribing to any tier of service, other than the basic cable service tier, unless the system's lack of addressable converter boxes or other technological limitations does not permit it to do so. The statutory exemption for cable systems that do not have the technological capability to offer programming in the manner required by the statute is available until a system obtains such capability, but not later than December 2002. The FCC may waive such time periods, if deemed necessary. Most of the Company's systems do not have the technological capability to offer programming in the manner required by the statute and thus currently are exempt from complying with the requirement.\nMust Carry\/Retransmission Consent. The 1992 Cable Act contains broadcast signal carriage requirements that allow local commercial television broadcast stations to elect once every three years to require a cable system to carry the station, subject to certain exceptions, or to negotiate for \"retransmission consent\" to carry the station. A cable system generally is required to devote up to one-third of its activated channel capacity for the mandatory carriage of local commercial television stations. Local non-commercial television stations are also given mandatory carriage rights; however, such stations are not given the option to negotiate retransmission consent for the carriage of their signals by cable systems. Additionally, cable systems are required to obtain retransmission consent for all \"distant\" commercial television stations (except for commercial satellite-delivered independent \"superstations\" such as WTBS), commercial radio stations and certain low power television stations carried by such systems after October 6, 1993.\nOn April 8, 1993, a special three-judge federal district court issued a decision upholding the constitutional validity of the mandatory signal carriage requirements. In June 1994, the United States Supreme Court vacated this decision and remanded it to the district court to determine, among other matters, whether the statutory carriage requirements are necessary to preserve the economic viability of the broadcast industry. The mandatory broadcast signal carriage requirements remain in effect pending the outcome of the further proceedings in the district court.\nDesignated Channels. The 1984 Cable Act permits franchising authorities to require cable operators to set aside certain channels for public, educational and governmental access programming. The 1984 Cable Act also requires a cable system with 36 or more channels to designate a portion of its channel capacity for commercial leased access by third parties to provide programming that may compete with services offered by the cable operator. The FCC has adopted rules regulating: (i) the maximum reasonable rate a cable operator may charge for commercial use of the designated channel capacity; (ii) the terms and conditions for commercial use of such channels; and (iii) the procedures for the expedited resolution of disputes concerning rates or commercial use of the designated channel capacity.\nFranchise Procedures. The 1984 Cable Act affirms the right of franchising authorities (state or local, depending on the practice in individual states) to award one or more franchises within their jurisdictions and prohibits non-grandfathered cable systems from operating without a franchise in such jurisdictions. The 1992 Cable Act encourages competition with existing cable systems by (i) allowing municipalities to operate their own cable systems without franchises; (ii) preventing franchising authorities from granting exclusive franchises or from unreasonably refusing to award additional franchises covering an existing cable system's service area; and (iii) prohibiting (with limited exceptions) the common ownership of cable systems and co-located MMDS or SMATV systems. The 1984 Cable Act also provides that in granting or renewing franchises, local authorities may establish requirements for cable-related facilities and equipment, but not for video programming or information services other than in broad categories. Among the more significant provisions of the 1984 Cable Act is a limitation on the payment of franchise fees to 5% of cable system revenues and the opportunity for the cable operator to obtain modification of franchise requirements by the franchise authority or judicial action if warranted by changed circumstances. The Company's franchises typically provide for payment of fees to franchising authorities of 5% of \"revenues\" (as defined by each franchise agreement).\nThe 1984 Cable Act contains renewal procedures designed to protect incumbent franchisees against arbitrary denials of renewal. The 1992 Cable Act makes several changes to the renewal process which could make it easier for a franchising authority to deny renewal. Moreover, even if the franchise is renewed, the franchising authority may seek to impose new and more onerous requirements such as significant upgrades in facilities and services or increased franchise fees as a condition of renewal. Similarly, if a franchising authority's consent is required for the purchase or sale of a cable system or franchise, such authority may attempt to impose more burdensome or onerous franchise requirements in connection with a request for such consent. Historically, franchises have been renewed for cable operators that have provided satisfactory services and have complied with the terms of their franchises. The Company believes that it has generally met the terms of its franchises and has provided quality levels of service and it anticipates that its future franchise renewal prospects generally will be favorable.\nVarious courts have considered whether franchising authorities have the legal right to limit franchise awards to a single cable operator and to impose certain substantive franchise requirements (e.g., access channels, universal service and other technical requirements). These decisions have been somewhat inconsistent and, until the United States Supreme Court rules definitively on the scope of cable operators' First Amendment protections, the legality of the franchising process generally and of various specific franchise requirements is likely to be in a state of flux.\nOwnership Limitations. The 1984 Cable Act and the FCC's regulations prohibit the common ownership, operation, control or interest in a cable system and a local television broadcast station whose predicted grade B contour (a measure of significant signal strength as defined by the FCC's rules) covers any portion of the community served by the cable system. In June 1992, the FCC revised its cross-ownership rules to permit national television networks to own cable systems under certain circumstances. As a part of the same action, the FCC also voted to recommend to Congress that the broadcast\/cable cross-ownership restrictions contained in the 1984 Cable Act be repealed. Pursuant to the 1992 Cable Act, the FCC adopted rules prescribing national subscriber limits and limits on the number of channels that can be occupied on a cable system by a video programmer in which the operator has an attributable interest. The effectiveness of these FCC horizontal ownership limits has been stayed because a federal district court found the statutory limitation to be unconstitutional.\nTelephone Company Ownership of Cable Systems. The 1984 Cable Act, FCC regulations, and the 1982 federal court consent decree (the \"MFJ\") that settled the antitrust suit against AT&T regulate the provision of video programming and other information services by telephone companies. The 1984 Cable Act codified FCC cross-ownership regulations that, in part, prohibit local exchange telephone companies, including the seven Bell Operating Companies (\"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 telephone companies already own much of the plant necessary for cable communications operations, such as poles, underground conduit and associated rights-of-way. Many of the BOCs have initiated federal court actions challenging the statutory \"telco-cable\" cross-ownership restriction of the 1984 Cable Act and various federal district and appellate courts have concluded that the cross-ownership restriction violates local telephone companies' constitutional rights. Further judicial review of these decisions can be anticipated.\nIn 1992, the FCC modified its regulations to enable local telephone companies to provide a \"video dialtone\" service that would provide access for consumers to a wide variety of services now provided by cable systems, as well as new services that may develop. The FCC determined that local telephone companies must provide consumers access to video dialtone services of others on a common carrier basis and may provide directly to their telephone customers their own non-video dialtone and non-video services, subject to certain cross-subsidization safeguards. The FCC also decided to recommend to Congress that the statutory telco-cable cross-ownership restriction should be repealed and that local telephone companies should be permitted to provide video programming directly to subscribers subject to appropriate safeguards. Various parties have appealed the FCC's decision.\nIn its video dialtone proceeding the FCC also determined that the 1984 Cable Act and the FCC's regulatory cross-ownership restrictions do not prohibit interexchange carriers (i.e., long distance telephone companies) from entering into joint ventures with cable operators or from acquiring cable communications systems in areas where such interexchange carriers provide long distance telephone services. The FCC also concluded that local telephone companies offering broadband common carrier services to distribute video programming to subscribers and the third party programmers using such common carrier services are not required by federal law to obtain franchises from local franchising authorities in order to provide such video programming services to the public.\nThe ultimate outcome of the FCC's video dialtone proceeding, the BOC litigation, the FCC decisions on the video dialtone proposals of various BOCs and other local telephone companies or the appeals of the FCC's decisions described above, or the ultimate impact on the Company or its business of these judicial and administrative proceedings cannot be determined at this time.\nIn July 1991, the U.S. District Court responsible for the MFJ issued an opinion lifting the MFJ prohibition on the provision of information services by the BOCs. This decision was upheld on appeal and enables the BOCs to acquire or construct cable communications systems outside of their own service areas. Independent telephone companies currently may provide cable communications service outside of their service areas under the 1984 Cable Act.\nThe telephone industry continues to lobby Congress for legislation that will permit local telephone companies to provide video programming directly to consumers, and legislation has been introduced in Congress that would permit local telephone companies, among other things, to provide such services under certain conditions. The outcome of these FCC, legislative or judicial proceedings and proposals or the effect of such outcome on cable system operations cannot be predicted.\nPole Attachment. The Communications Act requires the FCC to regulate the rates, terms and conditions imposed by public utilities for cable systems' use of utility pole and conduit space unless state authorities can demonstrate that they adequately regulate pole attachment rates, as is the case in certain states in which the Company operates. In the absence of state regulation, the FCC administers pole attachment rates on a formula basis. In some cases, utility companies have increased pole attachment fees for cable systems that have installed fiber optic cables and that are using such cables for the distribution of non-video services. The FCC concluded that, in the absence of state regulation, it has jurisdiction to determine whether utility companies have justified their demand for additional rental fees and that the Communications Act does not permit disparate rates based on the type of service provided over the equipment attached to the utility's pole.\nOther Statutory Provisions. The 1992 Cable Act precludes video programmers affiliated with cable companies from favoring cable operators over competitors and requires such programmers to sell their programming to other\nmultichannel video distributors. This provision limits the ability of cable program suppliers affiliated with cable companies to offer exclusive programming arrangements to cable companies. The Communications Act also includes provisions, among others, concerning horizontal and vertical ownership of cable systems, customer service, subscriber privacy, commercial leased access channels, marketing practices, equal employment opportunity, franchise renewal and transfer, award of franchises, obscene or indecent programming, regulation of technical standards and equipment compatibility. The FCC has adopted regulations implementing many of these statutory provisions and it has received numerous petitions requesting reconsideration of various aspects of its rulemaking proceedings.\nOther FCC Regulations. In addition to the FCC regulations noted above, there are other FCC regulations covering such areas as equal employment opportunity, syndicated program exclusivity, network program non-duplication, registration of cable systems, maintenance of various records and public inspection files, microwave frequency usage, lockbox availability, origination cablecasting and sponsorship identification, antenna structure notification, marking and lighting, carriage of local sports programming, application of the fairness doctrine and rules governing political broadcasts, limitations on advertising contained in non-broadcast children's programming, consumer protection and customer service, leased commercial access, ownership of home wiring, indecent programming, programmer access to cable systems, programming agreements, technical standards, consumer electronics equipment compatibility and DBS implementation. The FCC has the authority to enforce its regulations through the imposition of substantial fines, the issuance of cease and desist orders and\/or the imposition of other administrative sanctions, such as the revocation of FCC licenses needed to operate certain transmission facilities often used in connection with cable operations.\nOther bills and administrative proposals pertaining to cable television have previously been introduced in Congress or considered by other governmental bodies over the past several years on matters such as rate regulation, customer service standards, sports programming, franchising, copyright and telephone company provision of cable services. It is probable that further attempts will be made by Congress and other governmental bodies relating to the delivery of communications services.\nCopyright. Cable communications systems are subject to federal copyright licensing covering carriage of television and radio broadcast signals. In exchange for filing certain reports and contributing a percentage of their revenues to a federal copyright royalty pool, cable operators can obtain blanket permission to retransmit copyrighted material on broadcast signals. The nature and amount of future payments for broadcast signal carriage cannot be predicted at this time. The possible simplification, modification or elimination of the compulsory copyright license is the subject of continuing legislative review. The elimination or substantial modification of the cable compulsory license could adversely affect the Company's ability to obtain suitable programming and could substantially increase the cost of programming that remained available for distribution to the Company's subscribers. The Company cannot predict the outcome of this legislative activity.\nIn October 1989, the special rate court of the U.S. District Court for the Southern District of New York imposed interim rates on the cable industry's use of ASCAP-controlled music. Payment of these rates by cable programmers secures licenses that cover the use of the music licensed by ASCAP by both the cable programmers and their cable operator affiliates. The other major music performing rights society, BMI, is not subject to rate-setting procedures in the rate court. Both ASCAP and BMI historically have maintained that the transmission of programming by cable programmers to cable operators and by cable operators to their subscribers are separate public performances and should therefore be subject to separate license agreements. Two federal court decisions, however, have held that ASCAP and BMI cannot insist on separate licenses for programmers and operators for cable network programming. Under these decisions, ASCAP and BMI must make available to cable programming networks licenses that cover the transmission of music all the way to the cable subscriber. BMI has petitioned the Department of Justice to grant BMI the right to come under a special rate court, like the one for ASCAP, for rate setting purposes. Negotiations are in process concerning the obligation, if any, for cable operators to compensate the music industry for the use of music in local origination and pay-per-view programs.\nState and Local Regulation\nBecause a cable communications system uses local streets and rights-of-way, cable systems are subject to state and local regulation, typically imposed through the franchising process. Cable communications systems generally are operated pursuant to nonexclusive franchises, permits or licenses granted by a municipality or other state or local government entity. Franchises generally are granted for fixed terms and in many cases are terminable if the franchisee fails to comply with material provisions. The terms and conditions of franchises vary materially from\njurisdiction to jurisdiction. Each franchise generally contains provisions governing cable service rates, franchise fees, franchise term, system construction and maintenance obligations, system channel capacity, design and technical performance, customer service standards, franchise renewal, sale or transfer of the franchise, territory of the franchisee, indemnification of the franchising authority, use and occupancy of public streets and types of cable services provided. A number of states subject cable communications systems to the jurisdiction of centralized state governmental agencies, some of which impose regulation of a character similar to that of a public utility. Attempts in other states to regulate cable communications systems are continuing and can be expected to increase. To date, those states in which the Company operates that have enacted such state level regulation are Connecticut, New Jersey and Delaware. State and local franchising jurisdiction is not unlimited, however, and must be exercised consistently with federal law. The 1992 Cable Act immunizes franchising authorities from monetary damage awards arising from regulation of cable systems or decisions made on franchise grants, renewals, transfers and amendments.\nThe foregoing does not purport to describe all present and proposed federal, state, and local regulations and legislation affecting the cable industry. Other existing federal regulations, copyright licensing, and, in many jurisdictions, state and local franchise requirements, are currently the subject of judicial proceedings, legislative hearings and administrative proposals which could change, in varying degrees, the manner in which cable communications systems operate. Neither the outcome of these proceedings nor their impact upon the cable communications industry or the Company can be predicted at this time.\nUK Regulation\nThe operation of a cable television\/telephony system in the UK is regulated under both the Broadcasting Act 1990 (the \"Broadcasting Act\") (which replaced the Cable and Broadcasting Act 1984 (the \"UK Cable Act\")) and the Telecommunications Act 1984 (the \"Telecommunications Act\"). The operator of a cable\/telephony franchise covering over 1,000 homes must hold two principal licenses: (i) a license (a \"cable television license\") issued in the past under the UK Cable Act or since 1990 under the Broadcasting Act, which allows the operator to provide cable television services in the franchise area, and (ii) a telecommunications license issued under the Telecommunications Act, which allows the operator to operate and use the physical network necessary to provide cable television and telecommunications services. The Independent Television Commission (\"ITC\") is responsible for the licensing and regulation of cable television. The Department of Trade and Industry (\"DTI\") is responsible for issuing, and the Office of Telecommunications (\"OFTEL\") is responsible for regulating the holders of, the telecommunications licenses. In addition, an operator is required to hold a license under the Wireless Telegraphy Acts of 1949-67 for the use of microwave distribution systems.\nThe cable television licenses held by the relevant subsidiaries of the Operating Companies were issued under the UK Cable Act for 15-year periods and are scheduled to expire beginning in late 2004. The telecommunications licenses held by these subsidiaries of the Operating Companies are, in general, for 23-year periods and are scheduled to expire beginning in late 2012. The cable television licenses held by the Teesside Franchises were issued under the UK Cable Act for 15-year periods and are scheduled to expire in late 2005. The telecommunications licenses held by the Teesside Franchises are for 15-year periods which can be extended to 23-year periods in certain circumstances.\nCellular Telephone Communications\nGeneral\nThe Company is engaged in the development, management and operation of cellular telephone communications systems in various service areas pursuant to licenses granted by the FCC. Each service area is divided into segments referred to as \"cells\" equipped with a receiver, signaling equipment and a low power transmitter. The use of low power transmitters and the placement of cells close to one another permits re-use of frequencies, thus substantially increasing the volume of calls capable of being handled simultaneously over the number handled by conventional mobile telephone systems. Each cell has a coverage area generally ranging from two to more than 25 miles. A cellular telephone system includes a computerized central switching facility known as the mobile telephone switching office (\"MTSO\") which controls the automatic transfer of calls, coordinates calls to and from cellular telephones and connects calls to the local exchange carrier or to an interexchange carrier. The MTSO also records information on system usage and subscriber statistics.\nEach cell's facilities monitor the strength of the signal returned from the subscriber's cellular telephone. When the signal strength declines to a predetermined level and the transmission strength is greater at another cell in or interconnected with the system, the MTSO automatically and instantaneously passes the mobile user's call in progress to the other cell without disconnecting the call (\"hand off\"). Interconnection agreements between cellular telephone system operators and various local exchange carriers and interexchange carriers establish the manner in which the cellular telephone system integrates with other telecommunications systems.\nAs required by the FCC, all cellular telephones are designed for compatibility with cellular systems in all markets within the United States so that a cellular telephone may be used wherever cellular service is available. Each cellular telephone system in the United States uses one of two groups of channels, termed \"Block A\" and \"Block B,\" which the FCC has allotted for cellular service. Minor adjustments to cellular telephones may be required to enable the subscriber to change from a cellular system on one frequency block to a cellular system on the other frequency block.\nWhile most MTSOs process information digitally, most radio transmission of cellular telephone calls is done on an analog basis. Digital transmission of cellular telephone calls offers advantages, including improved voice quality under certain conditions, larger system capacity and the potential for lower incremental costs for additional subscribers. The FCC allows carriers to provide digital service and requires cellular carriers to provide analog service. The conversion from analog to digital radio technology is expected to take a number of years.\nThe Company provides services to its cellular telephone subscribers similar to those provided by conventional landline telephone systems, including custom calling features such as call forwarding, call waiting, conference calling, directory assistance and voice mail. The Company is responsible for the quality, pricing and packaging of cellular telephone service for each of the systems it owns and controls.\nReciprocal agreements among cellular telephone system operators allow their respective subscribers (\"roamers\") to place and receive calls in most service areas throughout the country. Roamers are charged rates which are generally at a premium to the regular service rate. In recent years, cellular carriers have experienced increased fraud associated with roamer service, including Electronic Serial Number (\"ESN\") cloning. The Company and other carriers have taken steps to combat roamer fraud, but it is uncertain to what extent roamer fraud will continue.\nAllegations of harmful effects from the use of hand-held cellular phones have caused the cellular industry to fund additional research to review and update previous studies concerning the safety of the emissions of electromagnetic energy from cellular phones. In August 1993, the FCC adopted a notice of proposed rulemaking to consider the incorporation of the new standard for radiofrequency exposure adopted by the American National Standards Institute in association with the Institute of Electrical and Electronic Engineers, Inc. The FCC is considering the application of the new standard to low power devices such as hand-held mobile transceivers. In addition, the FCC is considering how the new standard should apply to cellular transmitter sites.\nCompany's Systems\nThe table below sets forth summary information regarding the total population (\"Pops\") in the markets served by the Company's systems by Metropolitan Statistical Area (\"MSAs\") and Rural Service Area (\"RSAs\") and aggregate subscriber information as of December 31, 1994.\nAt December 31, 1994, the Company's cellular telephone business had approximately 465,000 net subscribers in the markets listed above.\n- ----------- Source: 1995 Rand McNally Commercial Atlas & Marketing Guide\nCompetition\nThe cellular telephone business is currently a regulated duopoly. The FCC has divided the United States into 734 separate markets and generally grants two licenses to operate cellular telephone systems in each market. One of the two licenses was initially awarded to a company or group affiliated with the local landline telephone carriers in the market (the \"Wireline\" license), and the other license was initially awarded to a company, individual, or group not affiliated with any landline telephone carrier (the \"Non-Wireline\" license).\nThe Company's systems are all Non-Wireline systems and compete directly with the Wireline licensee in each market in attracting and retaining cellular telephone customers and dealers. Competition between the two licensees in each market is principally on the basis of services and enhancements offered, technical quality of the system, quality and responsiveness of customer service, price and coverage area. The Wireline licensees in the Company's principal markets are Bell Atlantic Mobile Systems, Inc., a subsidiary of Bell Atlantic Corp., and NYNEX Mobile Communications Co., a subsidiary of NYNEX Corp. The Company's principal Wireline competitors are significantly larger and may have access to more substantial financial resources than the Company. Also, Bell Atlantic Corp. and NYNEX Corp. have sought FCC approval to consolidate their cellular holdings and to create a fully integrated wireless system with their landline systems. The request for FCC approval is pending. FCC approval may increase competition in the Company's markets.\nThe FCC requires cellular licensees to provide service to resellers of cellular service which purchase cellular service from licensees, usually in the form of blocks of numbers, then resell the service to the public. Thus, a reseller may be both a customer and a competitor of a licensed cellular operator. The FCC is currently considering a proposal to permit resellers to install separate switching facilities in cellular systems and receive direct assignments of telephone numbers from local exchange carriers.\nCellular telephone systems, including the Company's systems, also face actual or potential competition from other current and developing technologies. Specialized Mobile Radio (\"SMR\") systems, such as those used by taxicabs, as well as other forms of mobile communications service, may provide competition in certain markets. SMR systems are permitted by FCC rules to be interconnected to the public switched telephone network and are significantly less expensive to build and operate than cellular telephone systems. SMR systems are, however, licensed to operate on substantially fewer channels per system than cellular telephone systems and generally lack cellular's ability to expand capacity through frequency reuse by using many low-power transmitters and to hand-off calls. The Company holds an equity interest in and is represented on the Board of Directors of Nextel Communications, Inc. (\"Nextel\"), which has begun to implement its proposal to use its available SMR spectrum in various metropolitan areas more efficiently to increase capacity and to provide a broad range of mobile radio communications services. This proposal, known as ESMR service, could provide additional competition to existing cellular carriers, including the Company. In 1994, the FCC decided to license SMR systems in the 800 MHz bands for wide-area use, thus increasing potential competition with cellular. The FCC is currently considering consolidation of the SMR spectrum into contiguous blocks, which action would further the competitive potential of SMR services.\nOne-way paging or beeper services that feature voice message, data services and tones are also available in the Company's markets. These services may provide adequate capacity and sufficient mobile capabilities for some potential cellular subscribers.\nCertain new technologies and regulatory proposals potentially could affect the competitive position of cellular. The most prominent is PCS, which includes a variety of digital, wireless communications systems currently primarily suited for use in densely populated areas. At the power levels that the FCC's rules now provide, each cell of a PCS system would have more limited coverage than a cell in a cellular telephone system. Current proposals for PCS include advanced cordless telephones, or CT-2, mobile data networks, and personal communications networks that might provide services similar to those provided by cellular at costs lower than those currently charged by cellular system operators. The FCC has allocated spectrum and adopted rules for both narrow and broadband PCS services. In 1994, the FCC completed a spectrum auction for nationwide narrowband PCS licenses, undertook the first regional narrowband PCS auction, and began the first auction of broadband PCS spectrum (see \"General Developments of Business - Telecommunications Joint Venture\"). Broadband PCS service likely will become a direct competitor to cellular service.\nApplicants have received and others are seeking FCC authorization to construct and operate global satellite networks to provide domestic and international mobile communications services from geostationary and low earth orbit satellites. In addition, the Omnibus Budget Reconciliation Act of 1993 (\"1993 Budget Act\") provided, among other things, for the release of 200 MHz of Federal government spectrum for commercial use over a fifteen year period. The 1993 Budget Act also authorized the FCC to conduct competitive bidding for certain radio spectrum licenses and required the FCC to adopt new rules that eliminate the regulatory distinctions between common and private carriers for those private carriers who interconnect with the public switched telephone network and make their services available to a substantial portion of the public for profit. These developments and further technological advances may make available other alternatives to cellular service thereby creating additional sources of competition.\nRegulation\nFCC Regulation\nThe FCC regulates the licensing, construction, operation and acquisition of cellular telephone systems pursuant to the Communications Act. For licensing purposes, the FCC divided the United States into separate markets: 306 MSAs and 428 RSAs. In each market, the allocated cellular frequencies are divided into two blocks: Block A, initially awarded for utilization by Non-Wireline entities such as the Company, and Block B, initially awarded for utilization by affiliates of local Wireline telephone companies. There is no technical or operational difference between Wireline and Non-Wireline systems other than different frequencies.\nUnder the Communications Act, no party may transfer control of or assign a cellular license without first obtaining FCC consent. FCC rules (i) prohibit an entity controlling one system in a market from holding any interest in the competing system in the market and (ii) prohibit an entity from holding non-controlling interests in more than one system in any market, if the common ownership interests present anticompetitive concerns under FCC policies. Cellular radio licenses generally expire on October 1 of the tenth year following grant of the license in the particular market and are renewable for periods of ten years upon application to the FCC. The Company's first license expiration date is October 1, 1995, which includes the license for the Philadelphia MSA. Licenses may be revoked for cause and license renewal applications denied if the FCC determines that a renewal would not serve the public interest. Current FCC rules provide that competing renewal applications for cellular licenses will be considered in comparative hearings, and establish the qualifications for competing applications and the standards to be applied in such hearings. Under current policies, the FCC will grant incumbent cellular licensees a \"renewal expectancy\" if the licensee has provided substantial service to the public, substantially complied with applicable FCC rules and policies and the Communications Act and is otherwise qualified to hold an FCC license. The Company believes that it will receive such a \"renewal expectancy\" for the Philadelphia MSA.\nThe FCC requires landline telephone companies in each market to offer reasonable terms and facilities for the interconnection of both cellular telephone systems in that market to the landline telephone company's network. Cellular telephone companies affiliated with the local exchange company are required to disclose how their systems will interconnect with the landline network. The licensee not affiliated with the local exchange company has the right to interconnect with the landline network in a manner no less favorable than that of the licensee affiliated with the local exchange company; and it may, at its discretion, request reasonable interconnection arrangements that are different than those provided to the affiliated licensee in that market, and the landline telephone company must negotiate such requests in good faith. The FCC reiterated its position on interconnection issues in a declaratory ruling which clarified that landline operators are expected to provide within a reasonable time the agreed-upon form of interconnection.\nThe FCC regulates the ability of cellular operators to bundle the provision of service with hardware, the resale of cellular service by third parties and the coordination of frequency usage with other cellular licensees. The FCC also regulates the height and power of base station transmitting facilities and signal emissions in the cellular system. Cellular systems also are subject to Federal Aviation Administration and FCC regulations concerning the siting, construction, marking and lighting of cellular transmitter towers and antennae. In addition, the FCC also regulates the employment practices of cellular operators.\nThe Communications Act currently restricts foreign ownership or control over commercial mobile radio licenses, which include cellular radio service licenses. The FCC recently has proposed to consider the opportunities that other nations provide to United States companies in their communications industries as a factor in deciding whether to permit higher levels of indirect foreign ownership in companies controlling common carrier and certain other radio licenses.\nOn February 3, 1994, the FCC adopted rules implementing the 1993 Budget Act and creating the Commercial Mobile Radio Services (\"CMRS\") category. Under the new rules, almost all current common carrier mobile radio services, including cellular radio, and many current private mobile radio services will be subject to similar regulatory burdens as CMRS. The FCC decided not to require tariffs from cellular licensees or other CMRS providers.\nThe FCC has proposed new rules that would impose requirements that cellular carriers provide equal access to all interexchange carriers. At present, only cellular systems affiliated with AT&T or BOCs have to provide equal access. The FCC also is proposing that all CMRS providers provide interconnection to all other CMRS providers.\nState Regulation and Local Approvals\nExcept for the State of Illinois, the states in which the Company presently operates currently do not regulate cellular telephone service. In the 1993 Budget Act, Congress gave the FCC the authority to preempt states from regulating rates or entry into CMRS, including cellular. In the CMRS order, described above, the FCC preempted the states and established a procedure for states to petition the FCC for authority to regulate rates and entry into CMRS. The scope of the allowable level of state regulation under the CMRS order is unclear.\nEMPLOYEES\nAs of December 31, 1994, the Company had 6,700 employees, excluding employees in managed operations. Of these employees, 5,600 were associated with cable communications and 800 were associated with cellular telephone communications. The Company believes that its relationships with its employees are good.\nAs of December 31, 1994, QVC had 4,700 employees. The Company believes that QVC's relationships with its employees are good.\nITEM 2","section_1A":"","section_1B":"","section_2":"ITEM 2 PROPERTIES\nThe principal physical assets of a cable communications system consist of a central receiving apparatus, distribution cables, converters and local business offices. The Company owns or leases the receiving and distribution equipment of each system and owns or leases parcels of real property for the receiving sites and local business offices. The physical components of cable communications systems require maintenance and require periodic upgrading and rebuilding to keep pace with technological advances. It is anticipated that a significant number of the Company's systems will be upgraded or rebuilt over the next several years.\nThe principal physical assets of a cellular telephone system include cell sites and central switching equipment. The Company primarily leases its sites used for its transmission facilities and its administrative offices. The physical components of a cellular telephone system require maintenance and upgrading to keep pace with technological advances. It is anticipated that the Company's systems will be upgraded or rebuilt to digital technology over the next several years.\nThe Company's management believes that substantially all of its physical assets are in good operating condition.\nITEM 3","section_3":"ITEM 3 LEGAL PROCEEDINGS\n1. In May 1994, the Company filed an appeal with the U.S. Court of Appeals for the District of Columbia Circuit challenging the legality of various FCC rate regulation Orders. The Company has also intervened in similar pending actions. The Company intends to continue to assess the impact of the FCC's rate regulations and to develop additional strategies to minimize the adverse impact of such regulations and the other provisions of the 1992 Cable Act on the Company's business.\n2. In June 1994, eight state attorneys general each filed similar civil actions in state courts challenging the processes used by the Company to implement changes in rates for services on September 1, 1993. Each of these actions contends that the Company used improper \"negative option\" billing practices, notwithstanding the Company's belief that it had complied with federal policy and that the FCC had exclusive jurisdiction over such issues at that time. The Company sued in federal court to enjoin the actions of the state attorney general that coordinated the state proceedings. While the FCC has subsequently issued determinations supportive of the Company's position, no assurance can be given that the Company will succeed in each of these cases. If the Company is not successful in such efforts, the Company may be instructed to adjust certain of its cable rates and may be liable for additional damages in a manner that may have an adverse impact on the Company's operations.\n3. In June 1994, Bell Atlantic Corp. filed applications before the FCC seeking authority to construct, and to amend a prior application to construct, video dialtone facilities throughout substantial areas of their telephone service area. The Company now provides cable television service in certain areas encompassed by those applications. In July 1994, the Company opposed grant of the applications on grounds they fail to comply with FCC rules. No assurance can be given that the Company will succeed in this matter. Grant of the applications as currently proposed and the construction and operation of such video dialtone facilities may have an adverse impact on the Company's operations in the affected areas.\n4. The Company is involved in lawsuits and administrative proceedings regarding the ownership, operation and the transfer of the license for the cellular telephone system in the Atlantic City, New Jersey MSA (\"Atlantic City MSA\"). Although the Company cannot predict the ultimate outcome of these proceedings, management of the Company, based upon its investigation to date, believes that it has meritorious defenses in these proceedings,\nand that the amount of ultimate liability, if any, will not materially affect the financial position of the Company. Such proceedings include: (i) a hearing at the FCC to determine the conduct and the qualifications of the current Atlantic City MSA licensee and the Company; (ii) litigation in state court in Oregon to determine, among other matters, contractual rights of the Atlantic City MSA licensee and various claims against the Company, including claims seeking punitive damages; and (iii) litigation in the United States District Court for the District of Columbia based primarily upon claims against the Company for tortious interference with prospective business advantage involving the Atlantic City MSA.\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 a solicitation of proxies or otherwise, during the fourth quarter of the year ended December 31, 1994.\nITEM 4A EXECUTIVE OFFICERS OF THE REGISTRANT\nThe current term of office of each of the officers expires at the first meeting of the Board of Directors of the Company following the next Annual Meeting of Shareholders, presently scheduled to be held in June 1995, or as soon thereafter as each of their successors is duly elected and qualified.\nThe following table sets forth certain information concerning the principal executive officers of the Company, including their ages, positions and tenure as of February 22, 1995.\nRalph J. Roberts has served as a Director and Chairman of the Board of Directors of the Company for more than five years. Mr. Roberts has been the President and a Director of Sural Corporation, a privately-held investment company (\"Sural\"), the Company's largest shareholder, for more than five years. Mr. Roberts devotes a major portion of his time to the business and affairs of the Company. The shares of the Company owned by Sural constitute approximately 78% of the voting power of the two classes of the Company's voting common stock combined. Mr. Roberts has voting control of Sural. Mr. Roberts is also a Director of Comcast UK Cable Partners Limited, Cablevision Investment of Detroit, Inc. and Storer Communications, Inc.\nJulian A. Brodsky has served as Vice Chairman of the Board of Directors for more than five years. Mr. Brodsky presently serves as the Treasurer and a Director of Sural. Mr. Brodsky devotes a major portion of his time to the business and affairs of the Company. Mr. Brodsky is a Director of Comcast UK Cable Partners Limited, Cablevision Investment of Detroit, Inc., Storer Communications, Inc., RBB Fund, Inc. and Nextel Communications, Inc.\nBrian L. Roberts has served as President of the Company and as a Director for more than five years. Mr. Roberts presently serves as Vice President and a Director of Sural. Mr. Roberts devotes a major portion of his time to the affairs of the Company. Mr. Roberts is also a Director of Turner Broadcasting System, Inc., Comcast UK Cable Partners Limited, Cablevision Investment of Detroit, Inc. and Storer Communications, Inc. He is a son of Ralph J. Roberts.\nJohn R. Alchin has served as Treasurer and Senior Vice President of the Company for more than five years. Mr. Alchin is a Director of Comcast UK Cable Partners Limited.\nLawrence S. Smith has served as Senior Vice President of the Company for more than five years. Mr. Smith is the Principal Accounting Officer of the Company. Mr. Smith is a Director of Comcast UK Cable Partners Limited.\nStanley L. Wang has served as Senior Vice President, Secretary and General Counsel of the Company for more than five years. Mr. Wang is a Director of Cablevision Investment of Detroit, Inc. and Storer Communications, Inc.\nPART II\nITEM 5","section_5":"ITEM 5 MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Class A Special Common Stock and Class A Common Stock of the Company are traded in the over-the-counter market and are included on the Nasdaq National Market (\"Nasdaq\") under the symbols CMCSK and CMCSA, respectively. There is no established public trading market for the Class B Common Stock of the Company. The Class B Common Stock is convertible, on a share for share basis, into Class A Special or Class A Common Stock. The following table sets forth, for the indicated periods, the closing price range of the Class A Special and Class A Common Stock as furnished by Nasdaq. Such price ranges have been adjusted for the Company's three-for-two stock split effective February 2, 1994 and rounded to the nearest one-eighth.\nThe Company began paying quarterly cash dividends on its Class A Common Stock in 1977. Since 1978, the Company has paid equal dividends on shares of both the Class A Common Stock and the Class B Common Stock. Since December 1986, when the Class A Special Common Stock was issued, the Company has paid equal dividends on shares of the Class A Special, Class A and Class B Common Stock. The Company declared dividends of $.0933 for each of the years ended December 31, 1994 and 1993 on shares of Class A Special, Class A and Class B Common Stock (as adjusted for the Company's three-for-two stock split effective February 2, 1994).\nIt is the intention of the Board of Directors to continue to pay regular quarterly cash dividends on all classes of the Company's stock; however, the declaration and payment of future dividends and their amount depend upon the results of operations, financial condition and capital needs of the Company, contractual restrictions of the Company and its subsidiaries and other factors.\nAs of February 1, 1995, there were 2,407 record holders of the Company's Class A Special Common Stock and 1,854 record holders of the Company's Class A Common Stock. Sural Corporation is the sole record holder of the Company's Class B Common Stock.\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\nThe Company has experienced significant growth in recent years both through strategic acquisitions and growth in its existing businesses. The Company has historically met its cash needs for operations through its cash flows from operating activities. Cash requirements for acquisitions and capital expenditures have been provided through the Company's financing activities as well as its existing cash and cash equivalents and short-term investments.\nGeneral Developments of Business\nQVC\nIn February 1995, the Company and Tele-Communications, Inc. (\"TCI\") acquired all of the outstanding stock of QVC, Inc. (\"QVC\") for $46, in cash, per share. The total cost of acquiring the outstanding shares of QVC not previously owned by the Company and TCI (approximately 65% of such shares on a fully diluted basis) was approximately $1.4 billion. Following the acquisition, the Company and TCI own, through their respective subsidiaries, 57.45% and 42.55%, respectively, of QVC. The Company will account for the QVC acquisition under the purchase method of accounting and QVC will be consolidated with the Company beginning in February 1995.\nThe acquisition of QVC, including the exercise of certain warrants held by the Company, was financed with cash contributions from the Company and TCI of $296.3 million and $6.6 million, respectively, borrowings of $1.1 billion under a $1.2 billion QVC credit facility and existing cash and cash equivalents held by QVC.\nQVC is a nationwide general merchandise retailer, operating as one of the leading televised shopping retailers in the United States. Through its merchandise-focused television programs (the \"QVC Service\"), QVC sells a wide variety of products directly to consumers. The QVC Service currently reaches approximately 50 million cable television subscribers in the United States.\nThe day to day operations of QVC will, except in certain limited circumstances, be managed by the Company. With certain exceptions, direct or indirect transfers to unaffiliated third parties by the Company or TCI of any stock in QVC are subject to certain restrictions and rights in favor of the other.\nMaclean Hunter\nOn December 22, 1994, the Company, through Comcast MHCP Holdings, L.L.C. (the \"LLC\"), acquired the U.S. cable television and alternate access operations of Maclean Hunter Limited (\"Maclean Hunter\") from Rogers Communications Inc. and all of the outstanding shares of Barden Communications, Inc. (collectively, such acquisitions are referred to as the \"Maclean Hunter Acquisition\") for approximately $1.2 billion (subject to certain adjustments) in cash. The Company and the California Public Employees' Retirement System (\"CalPERS\") invested approximately $305.0 million and $250.0 million, respectively, in the LLC, which is owned 55% by a wholly-owned subsidiary of the Company and 45% by CalPERS, and is managed by the Company. The Maclean Hunter Acquisition, including certain transaction costs, was financed with cash contributions from the LLC of $555.0 million and borrowings of $715.0 million under an $850.0 million Maclean Hunter credit facility. At any time after December 18, 2001, CalPERS may elect to liquidate its interest in the LLC at a price based upon the fair value of CalPERS' interest in the LLC, adjusted, under certain circumstances, for certain performance criteria relating to the fair value of the LLC or to the Company's common stock. Except in certain limited circumstances, the Company, at its option, may satisfy this liquidity arrangement by purchasing CalPERS' interest for cash, through the issuance of the Company's common stock (subject to certain limitations) or by selling the LLC. The Maclean Hunter Acquisition was accounted for under the purchase method of accounting and Maclean Hunter is consolidated with the Company as of December 31, 1994.\nTelecommunications Joint Venture\nOn October 25, 1994, the Company announced a joint venture (\"WirelessCo\") with Sprint Corporation (\"Sprint\"), TCI and Cox Cable Communications, Inc. (\"Cox\") to provide wireless communications services. WirelessCo is owned 40% by Sprint, 30% by TCI and 15% each by the Company and Cox. WirelessCo is participating in the first of several Federal Communications Commission (\"FCC\") auctions of blocks of spectrum for licenses to provide Personal Communications Services (\"PCS\"), having filed an application to participate in 39 of 51 Major Trading Area\n(\"MTA\") markets nationwide. As of February 21, 1995, WirelessCo's aggregate bids for 38 licenses covering a total population of 168 million were $1.975 billion. There can be no assurances that WirelessCo will be successful in bidding for or otherwise obtaining PCS licenses for these or other MTAs. The Company has obtained letter of credit commitments sufficient to cover its 15% share of the cost of PCS licenses for which WirelessCo is the successful bidder. The Company may have material additional capital requirements relating to the buildout of PCS systems if WirelessCo is successful in the PCS bidding process. WirelessCo is accounted for under the equity method of accounting.\nThe parties have also signed a joint venture formation agreement which provides the basis upon which they will develop definitive agreements for their local wireline telecommunications activities. The parties anticipate that the wireline joint venture will be owned in the same percentages as WirelessCo. The parties' ability to provide such local services on a nationwide basis, and the timing thereof, will depend upon, among other things, the removal or modification of legal barriers to local telephone competition. The parties anticipate that Teleport Communications Group (\"TCG\"), which is owned 20% by the Company and by other cable television operators, including TCI and Cox, will be contributed to the local telephone venture. TCG is an alternative provider of local telephone services. The contribution of TCG to the venture is expected to be subject to certain conditions, including obtaining necessary governmental and other approvals.\nStorer\nPrior to December 2, 1992, the Company held a 50% ownership interest in SCI Holdings, Inc. (\"SCI\"), the parent company of Storer Communications, Inc. (\"Storer\"). On December 2, 1992, the Company completed certain transactions pursuant to which (i) the value of SCI was divided proportionately between its two 50% shareholders (the \"Split-off\") and (ii) SCI refinanced its indebtedness (the \"Refinancing Plan\"). In connection with the Split-off, SCI was merged into Storer and the Company became the sole shareholder of Storer.\nAWACS\nOn March 5, 1992, the Company acquired from Metromedia Company (\"Metromedia\") a 50.01% direct and a 49.99% indirect interest in AWACS, Inc. (\"AWACS\"), the non-wireline cellular telephone system serving the Philadelphia Metropolitan Statistical Area, which includes eight counties in Pennsylvania and New Jersey and contained a population of approximately 4.9 million people at that date. Concurrently, the Company also acquired from Metromedia the outstanding interests not owned by the Company in two New Jersey cellular telephone systems which served a total population of approximately 1.3 million people at that date.\n-------------------------\nLiquidity and Capital Resources\nThe Company has traditionally maintained significant levels of cash and cash equivalents and short-term investments to meet its short-term needs. Cash and cash equivalents and short-term investments as of December 31, 1994 and 1993 were $465.5 million and $679.8 million, respectively.\nThe Company's cash and cash equivalents and short-term investments are recorded at cost which approximates their fair value. At December 31, 1994, the Company's short-term investments of $130.1 million had a weighted average maturity of approximately 16 months. However, due to the high degree of liquidity and the intent of management to use these investments as needed to fund its commitments, the Company considers these as current assets.\nIt is anticipated that during 1995 the domestic operations of the Company will incur approximately $500 million of capital expenditures, including $250 million for the upgrading and rebuilding of certain of the Company's cable communications systems and $200 million for the upgrading of the Company's cellular communications systems. The amount of such capital expenditures for years subsequent to 1995 will depend on numerous factors, many of which are beyond the Company's control. These factors include whether competition in a particular market necessitates a system upgrade, whether a particular system has sufficient capacity to handle new product offerings including the offering of cable telephony and telecommunications services, whether and to what extent the Company will be able to recover its investment under FCC rate guidelines and whether the Company acquires additional systems in need of upgrading or rebuilding. The Company, however, anticipates capital expenditures for years subsequent to 1995 will continue to be significant.\nThe Company has historically utilized a strategy of financing its acquisitions through senior debt at the acquired operating subsidiary level. Additional financing has also been obtained by the Company through the issuance of subordinated debt at the intermediate holding company and parent company levels. At December 31, 1994 and 1993, the Company's long-term debt was $4.811 billion and $4.155 billion, respectively. Maturities of long-term debt for the five years commencing in 1995 are $182.9 million, $309.5 million, $388.1 million, $802.4 million and $518.8 million. As of December 31, 1994, certain subsidiaries of the Company had unused lines of credit of $553.0 million. The Company used $100.0 million of such available funds through February 21, 1995, principally to fund the acquisition of QVC.\nOn September 27, 1994, Comcast UK Cable Partners Limited (\"Comcast UK Cable\"), a subsidiary of the Company, consummated an initial public offering (the \"IPO\") of 15 million of its Class A Common Shares for net proceeds of $209.4 million. Comcast UK Cable converted $109.4 million of these proceeds to its functional currency and the remaining $100.0 million was protected from currency risk through the purchase of foreign exchange forward contracts. The net proceeds from the IPO will be utilized by Comcast UK Cable for future advances and capital contributions to its equity investees and subsidiary primarily relating to the buildout of their telecommunications networks in the United Kingdom.\nOn January 26, 1995, the Company exchanged its interest in Heritage Communications, Inc. with TCI for Class A common shares of TCI with a fair market value of approximately $290 million. Shortly thereafter, the Company sold certain of these shares for total proceeds of approximately $188 million. As a result of these transactions, the Company will recognize a pre-tax gain of $141 million in the first quarter of 1995.\nIn June 1994, the Company entered into an Exchange Agreement with McCaw Cellular Communications, Inc. to acquire the entity that holds the Ocean County, NJ RSA cellular license (450,000 Pops) in exchange for the Company's Hunterdon County, NJ RSA license and approximately $52.5 million in cash. The transaction is expected to close in 1995.\nThe Company expects to continue to recognize significant losses and to continue to pay dividends; therefore, it anticipates that it will continue to have a deficiency in stockholders' equity that will increase for the foreseeable future. The telecommunications industry, including cable and cellular communications, is experiencing increasing competition and rapid technological changes. The Company's future results of operations will be affected by its ability to react to changes in the competitive environment and by its ability to implement new technologies. However, management believes that competition, technological changes and its deficiency in stockholders' equity will not significantly affect its ability to obtain financing.\nThe Company has entered into certain foreign exchange forward contracts and interest rate swap and cap agreements as a normal part of its risk and interest rate management efforts.\nForeign exchange forward contracts, which mature at various times through 1996, are used by Comcast UK Cable to hedge against the risk that monetary assets held or denominated in currencies other than its functional currency are devalued as a result of changes in exchange rates. The amount of these contracts was $100.0 million as of December 31, 1994. Foreign exchange contracts provide an effective hedge against such monetary assets held since gains and losses realized on the contracts are offset against gains or losses realized on the underlying hedged assets.\nThe Company has entered into interest rate swap and cap agreements to limit the Company's exposure to loss from adverse fluctuations in interest rates. At December 31, 1994 and 1993, $415.0 million and $635.0 million, respectively, of the Company's variable rate debt was protected by these products. Such agreements mature on various dates in 1995 and the related differentials to be paid or received are recognized over the terms of the agreements. The estimated fair value of such instruments, based on discounted future cash flows of the differentials, was not significant to the Company as of December 31, 1994 and 1993.\nDuring 1994, the Company entered into other interest rate swap agreements to manage its overall interest expense. At December 31, 1994, the Company had swapped $400.0 million notional amount of fixed rate debt for variable rate products (effective rates of 4.13% through 6.93% at December 31, 1994) which mature between 2000 and 2004. Since these products are designated as matched with certain of the Company's fixed rate debt, the differentials paid or received are recognized as a component of interest expense over the terms of the related agreements. Certain of these agreements have extensions, at the option of the counterparty, or indexed amortization provisions which may extend the lives of the agreements from three to five years. The estimated liability to settle these instruments was\n$39 million as of December 31, 1994. The estimated liability to settle the extension and indexed amortization features for certain of these instruments is not significant to the Company.\nThe credit risks associated with the Company's derivative financial instruments are controlled through the evaluation and continual monitoring of the creditworthiness of the counterparties. Although the Company may be exposed to losses in the event of nonperformance by the counterparties, the Company does not expect such losses, if any, to be significant.\nThe Company's long-term debt had a carrying amount of $4.993 billion and an estimated fair value of $4.768 billion as of December 31, 1994. The difference between the carrying value and estimated fair value of the Company's long-term debt was not significant as of December 31, 1993. The Company's weighted average interest rate was approximately 7.75%, 8.45% and 9% for the years ended December 31, 1994, 1993 and 1992, respectively. The Company continually evaluates its debt structure with the intention of reducing its debt service requirements when desirable.\nThe Company believes that it will be able to meet its current and long-term liquidity and capital requirements, including its fixed charges, through its cash flows from operating activities, existing cash and cash equivalents, short-term investments, lines of credit and other external financing.\nStatement of Cash Flows\nCash and cash equivalents increased $174.9 million at December 31, 1994 from December 31, 1993 and decreased $53.0 million at December 31, 1993 from December 31, 1992. Changes in cash and cash equivalents resulted from cash flows from operating, financing and investing activities which are explained below.\nNet cash provided by operating activities amounted to $369.0 million, $345.9 million and $252.3 million for the years ended December 31, 1994, 1993 and 1992, respectively. The increase of $23.1 million in net cash provided by operating activities from 1993 to 1994 was principally due to a decrease in the Company's net cash interest expense primarily from the effects of lower levels of debt outstanding and a lower average cost of debt and changes in working capital as a result of the timing of receipts and disbursements. The $93.6 million increase in net cash provided by operating activities from 1992 to 1993 includes $99.1 million from the Split-off.\nNet cash provided by financing activities, which includes the issuances of securities as well as borrowings, was $1.115 billion, $437.2 million and $1.730 billion for the years ended December 31, 1994, 1993 and 1992, respectively. Proceeds of borrowings of $1.201 billion in 1994 included $1.015 billion relating to the Maclean Hunter Acquisition. During 1994, the Company repurchased or redeemed and retired $509.0 million of its long-term debt including the Company's $150.0 million, 11-7\/8% Senior subordinated debentures due 2004. Additionally, net cash provided by financing activities excludes the conversion of $186.2 million of long-term debt into 16.8 million shares of Class A Special Common Stock of the Company. In 1994, the Company received an equity contribution to a subsidiary of $250.0 million in connection with the Maclean Hunter Acquisition and received proceeds from the issuance of common stock of Comcast UK Cable of $209.4 million. During 1993, proceeds from borrowings of $954.0 million included $200 million principal amount of 9-1\/2% Senior subordinated debentures due 2008, $250 million principal amount of 3-3\/8% \/ 5-1\/2% Step-up convertible subordinated debentures due 2005 and net proceeds of $300 million from the issuance of $541.9 million principal amount of its 1-1\/8% Discount convertible subordinated debentures due 2007. During 1993, the Company retired $493.0 million of long-term debt. Additionally, net cash provided by financing activities excludes the conversion of $185.4 million of long-term debt into 17.3 million shares of Class A Special Common Stock of the Company. During 1992, the Company sold 6.0 million shares of its Class A Special Common Stock resulting in net proceeds of $101.3 million, issued $300.0 million principal amount of 10-5\/8% Senior subordinated debentures due 2012 and obtained $1.720 billion in borrowings relating to the AWACS acquisition and the Split-off. The Company repaid $386.1 million of its long-term debt in 1992.\nNet cash used in investing activities was $1.309 billion, $836.1 million and $1.894 billion for the years ended December 31, 1994, 1993 and 1992, respectively. Acquisitions in 1994 consisted principally of $1.2 billion paid, including certain transaction costs, in connection with the Maclean Hunter Acquisition. Net proceeds of $389.3 million from the sale of short-term investments during 1994 were used principally to redeem and retire long-term debt. In addition, during 1994, the Company made capital expenditures of $269.9 million and made additional cash investments in affiliates of $125.0 million. During 1993, the Company purchased $384.9 million of short-term investments, made $158.4 million of capital expenditures and made long-term investments of $272.5 million. Investments in 1993 included the purchase of an interest in and loans made to TCG of $77.8 million, the purchase\nof additional interests in Nextel Communications, Inc. (\"Nextel\") totalling $118.2 million and the purchase of additional shares of QVC totalling $32.1 million. Cash flows used in investing activities in 1992 included the AWACS acquisition of $567 million and the Split-off of $1.4 billion.\nResults of Operations\nThe effects of the QVC and Maclean Hunter acquisitions will be, and the effects of the Split-off, AWACS acquisition and other acquisitions made in prior years have been, to increase significantly the Company's service income and expenses resulting in substantial increases in its operating income before depreciation and amortization, depreciation and amortization expense and net interest expense. The Split-off has the effect of reducing the Company's net losses for years after 1992 primarily because Storer's interest expense and preferred stock dividend requirements were reduced as a result of the Refinancing Plan. However, it is expected that because of the depreciation and amortization and interest expense associated with these acquisitions and their financing, the Company will continue to realize substantial losses for the foreseeable future.\nFor the years ended December 31, 1994, 1993 and 1992, the Company realized operating income before depreciation and amortization (commonly referred to in the Company's businesses as \"operating cash flow\") of $576.3 million, $606.4 million and $397.2 million, respectively, representing a decrease of $30.1 million or 5% from 1993 to 1994 and an increase of $209.2 million or 53% from 1992 to 1993. These changes are a result of the items discussed below. Operating cash flow is a measure of a company's ability to generate cash to service its obligations, including debt service obligations, and to finance capital and other expenditures. In part due to the capital intensive nature of the Company's businesses and the resulting significant level of non-cash depreciation and amortization expense, operating cash flow is frequently used as one of the bases for comparing cable and cellular businesses. Operating cash flow does not purport to represent net income or net cash provided by operating activities, as those terms are defined under generally accepted accounting principles, and should not be considered as an alternative to such measurements as an indicator of the Company's performance. See \"Statement of Cash Flows\" above for a discussion of net cash provided by operating activities.\nThe Company realized service income of $1.375 billion, $1.338 billion and $900.3 million for the years ended December 31, 1994, 1993 and 1992, respectively, representing increases of $37.1 million or 3% from 1993 to 1994 and $437.9 million or 49% from 1992 to 1993. For the years ended December 31, 1994, 1993 and 1992, approximately 77%, 82% and 81%, respectively, of the Company's service income related to its cable division and 21%, 15% and 16%, respectively, related to its cellular division.\nOperating, selling, general and administrative expenses were $799.0 million, $731.8 million and $503.2 million for the years ended December 31, 1994, 1993 and 1992, respectively, representing increases of $67.2 million or 9% from 1993 to 1994 and $228.6 million or 45% from 1992 to 1993. For the years ended December 31, 1994, 1993 and 1992, approximately 69%, 74% and 73%, respectively, of the Company's operating, selling, general and administrative expenses related to its cable division and 21%, 15% and 16%, respectively, related to its cellular division.\nDepreciation and amortization expense was $336.5 million, $341.5 million and $232.0 million for the years ended December 31, 1994, 1993 and 1992, respectively, representing a decrease of $5.0 million or 1% from 1993 to 1994 and an increase of $109.5 million or 47% in 1993 from 1992. The decrease from 1993 to 1994 is due to certain of the Company's assets becoming fully depreciated in 1993, partially offset by the effects of capital expenditures. The increase in 1993 from 1992 is primarily due to the effects of the Split-off and the effects of capital expenditures.\nInterest expense to third parties was $313.5 million, $347.4 million and $231.3 million for the years ended December 31, 1994, 1993 and 1992, respectively, representing a decrease of $33.9 million or 10% from 1993 to 1994 and an increase of $116.1 million or 50% from 1992 to 1993. The decrease from 1993 to 1994 is due to the effects of lower levels of debt outstanding and a lower average cost of debt. The increase in 1993 was due to a higher level of debt outstanding primarily associated with the Split-off and the AWACS acquisition. At December 31, 1994, the Company had approximately $3.070 billion or 61% of its debt at variable rates.\nFor the years ended December 31, 1994, 1993 and 1992, the Company's earnings before cumulative effect of accounting changes, extraordinary items, income taxes (benefit), equity in net losses of affiliates and fixed charges (interest expense and interest expense and preferred stock dividend requirement of a subsidiary to an affiliate) were $269.8 million, $292.7 million and $212.7 million, respectively. These earnings were not adequate to cover the Company's fixed charges of $313.5 million, $347.4 million and $312.3 million for the years ended December 31,\n1994, 1993 and 1992, respectively. These fixed charges include non-cash interest and non-cash dividends (1992 only) of $53.5 million, $62.3 million and $98.0 million for the years ended December 31, 1994, 1993 and 1992, respectively. The inadequacy of these earnings to cover fixed charges is primarily due to the substantial non-cash charges for depreciation and amortization expense of $336.5 million, $341.5 million and $232.0 million for the years ended December 31, 1994, 1993 and 1992, respectively.\nThe Company believes that its losses and inadequacy of earnings to cover fixed charges will not significantly affect the performance of its normal business activities because of its existing cash and cash equivalents, short-term investments, its ability to generate operating income before depreciation and amortization and its ability to obtain external financing.\nThe Company recognized income taxes (benefit) of ($9.2) million, $15.2 million and $14.0 million for the years ended December 31, 1994, 1993 and 1992, respectively. Effective January 1, 1993, the Company changed its method of accounting for income taxes to Statement of Financial Accounting Standards (\"SFAS\") No. 109 from Accounting Principles Board Opinion No. 11 (see Note 6 to the Company's consolidated financial statements). The tax provision for 1993 includes an increase in income tax expense of approximately $21 million relating to the federal income tax rate change from 34% to 35%.\nThe Company anticipates that, for the foreseeable future, interest expense will be a significant cost to the Company and will have a significant adverse effect on the Company's ability to realize net earnings. The Company believes it will continue to be able to meet its obligations through its ability both to generate operating income before depreciation and amortization and to obtain external financing.\nThe Company recognized losses before extraordinary items and cumulative effect of accounting changes of $75.3 million, $98.9 million and $217.9 million for the years ended December 31, 1994, 1993 and 1992, respectively. These results of operations include equity in net losses of affiliates of $40.9 million, $28.9 million and $104.3 million, respectively, for those years. The Company's 1992 equity in net loss includes $27.5 million as its portion of Storer's redemption premium on preferred stock redeemed in connection with the Refinancing Plan.\nThe Company paid premiums and expensed unamortized debt acquisition costs totalling $18.0 million during 1994, primarily as a result of the redemption of its $150.0 million, 11-7\/8% Senior subordinated debentures due 2004, resulting in the Company recording an extraordinary loss, net of tax, of $11.7 million or $.05 per share. The Company paid similar premiums of $27.1 million during 1993 in connection with the redemption of certain of its debt resulting in the Company recording an extraordinary loss, net of tax, of $17.6 million or $.08 per share. On January 1, 1993, the Company recorded a one time non-cash charge resulting from the adoption of SFAS No. 109, SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits,\" totalling $742.7 million or $3.47 per share, net of tax. In 1992, the Company recorded an extraordinary loss of $52.3 million or $.26 per share as its portion of Storer's loss from its early extinguishment of debt.\nThe Company believes that its operations are not materially affected by inflation.\nCable Communications\nThe Company's cable division realized service income of $1.065 billion, $1.093 billion and $725.7 million for the years ended December 31, 1994, 1993 and 1992, respectively, representing a decrease of $27.4 million or 3% from 1993 to 1994 and an increase of $367.1 million or 51% from 1992 to 1993. The cable division's reduction in service income from 1993 to 1994 includes the estimated effects on regulated rates as a result of cable rate regulation of $82.0 million in 1994 offset, in part, by the effects of subscriber growth and new product offerings of $54.6 million. The increase in the cable division's service income from 1992 to 1993 includes $326.2 million resulting from the Split-off. The remaining increase of $40.9 million is attributable to the net effects of increased rates of $15.9 million and additional subscribers and new product offerings of $25.0 million.\nOperating, selling, general and administrative expenses for the Company's cable division were $547.8 million, $540.8 million and $369.4 million for the years ended December 31, 1994, 1993 and 1992, respectively, representing increases of $7.0 million or 1% from 1993 to 1994 and $171.4 million or 46% from 1992 to 1993. The Split-off accounted for $157.9 million or 92% of the increase from 1992 to 1993. The increase from 1993 to 1994 and the remaining increase from 1992 to 1993 is attributable to increases in the costs of labor, billing and cable programming as a result of subscriber growth, partially offset by a reduction of franchise fee expense. Franchise fees were reported\nby the Company as a component of operating expenses prior to the implementation of the Cable Television Consumer Protection and Competition Act of 1992 (\"1992 Cable Act\"). Effective September 1, 1993, the Company commenced charging subscribers directly for such fees as permitted under the 1992 Cable Act and recording amounts charged as an offset to operating expenses resulting in a decrease in franchise fee expense of $15.9 million and $6.5 million from 1993 to 1994 and from 1992 to 1993, respectively. It is anticipated that the Company's cost of cable programming will increase in the future as cable programming rates increase and additional sources of cable programming become available.\nCellular Communications\nThe Company's cellular division realized service income of $286.1 million, $202.0 million and $142.9 million for the years ended December 31, 1994, 1993 and 1992, respectively, representing increases of $84.1 million or 42% from 1993 to 1994 and $59.1 million or 41% from 1992 to 1993. The increase from 1992 to 1993 includes $13.7 million due to increased service income from AWACS. The increase from 1993 to 1994 and the remaining increase from 1992 to 1993 is attributable to subscriber growth partially offset by the effects of a decrease in the average minutes-of-use per cellular subscriber in both years. The Company expects the decrease in average minutes-of-use per cellular subscriber to continue in the future.\nOperating, selling, general and administrative expenses for the Company's cellular division were $169.8 million, $109.9 million and $80.8 million for the years ended December 31, 1994, 1993 and 1992, respectively, representing increases of $59.9 million or 55% from 1993 to 1994 and $29.1 million or 36% from 1992 to 1993. These increases are primarily due to increases in marketing and commissions as a result of subscriber growth.\nCable Rate Regulation Developments\nOn March 30, 1994, the FCC: (i) modified its existing benchmark methodology to require, absent a successful cost-of-service showing, reductions of approximately 17% in the rates for regulated cable services in effect on September 30, 1992, adjusted for inflation, channel modifications, equipment costs and increases in certain operating costs. The modified benchmarks and regulations are generally designed to cause an additional 7% reduction in the rates for regulated cable services on top of the rate reductions implemented by the Company in September 1993 under the prior FCC benchmarks and regulations; (ii) adopted interim regulations to govern cost-of-service showings by cable operators, establishing an industry-wide 11.25% after tax rate of return and a rebuttable presumption that acquisition costs above original historic book value of tangible assets should be excluded from the rate base; and (iii) reconsidered, among other matters, its regulations concerning rates for the addition of regulated services and the treatment of packages of \"a la carte\" channels.\nIn July 1994, the Company reduced rates for regulated services in the majority of its cable systems to comply with the modified benchmarks and regulations. In addition, the Company is currently seeking to justify existing rates in certain other of its cable systems on the basis of cost-of-service showings; however, the interim cost-of-service regulations promulgated by the FCC do not support positions taken by the Company in its cost-of-service filings to date. The Company's reported cable service income reflects the estimated effects of cable regulation. The Company is seeking reconsideration by the FCC of the interim cost-of-service regulations and, if unsuccessful in justifying existing rates under cost-of-service regulations, intends to seek judicial relief. However, no assurance can be given that the Company will be able to offset, to any substantial degree, the adverse impact of rate reductions in compliance with the modified benchmarks and regulations or that it will be successful in cost-of-service proceedings. If the Company is not successful in such efforts, and there is no legislative, administrative or judicial relief in these matters, the FCC regulations will continue to adversely affect the Company's results of operations.\nOn November 10, 1994, the FCC announced modified \"Going Forward\" rules which, among other things, permit cable operators to charge an additional $0.20 per month per channel for channels added to the cable programming services tier, up to a maximum of six channels, and to recover an additional $0.30 in monthly fees paid to programmers for such channels. The ruling applies to channels added between May 15, 1994 and December 31, 1996 and became effective January 1, 1995. The FCC concurrently announced regulations permitting cable operators to create new product tiers which would generally not be subject to rate regulation. The Company is currently reviewing the ruling and is unable to predict the effect on its future results of operations.\nITEM 8","section_7A":"","section_8":"ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Comcast Corporation Philadelphia, Pennsylvania\nWe have audited the accompanying consolidated balance sheet of Comcast Corporation and its subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity (deficiency) and of cash flows for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(b)(i). These financial statements and the financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the financial statement schedule based on our audits. We did not audit the consolidated financial statements of Storer Communications, Inc. (\"Storer\") as of and for the year ended December 31, 1992, the consolidated financial statements of Comcast International Holdings, Inc. (\"International\") as of and for each of the two years in the period ended December 31, 1994 and the financial statements of Garden State Cablevision L.P. (\"Garden State\") as of December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994. International is consolidated with the Company. The Company's investments in Storer and Garden State have been accounted for under the equity method, except that subsequent to December 2, 1992, Storer was consolidated with the Company. The Company's combined equity in the net assets of International and Garden State of $111.1 million and $43.8 million at December 31, 1994 and 1993, respectively, and the Company's combined equity in the net losses of Storer (through December 31, 1992), International (for the years ended December 31, 1994 and 1993) and Garden State for the years ended December 31, 1994, 1993 and 1992, of $38.7 million, $32.8 million and $145.1 million, respectively, are included in the Company's consolidated financial statements. The financial statements of Storer, International and Garden State were audited by other auditors whose reports have been furnished to us, and our opinion, insofar as it relates to the amounts included in the Company's consolidated financial statements for Storer (through December 31, 1992), International (as of and for each of the two years in the period ended December 31, 1994) and Garden State, is based solely upon the reports 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 reports of other auditors provide a reasonable basis for our opinion.\nIn our opinion, based on our audits and the reports of other auditors, such consolidated financial statements present fairly, in all material respects, the financial position of Comcast Corporation and its subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in our opinion, the 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.\nAs discussed in the notes to consolidated financial statements, the Company changed its method of accounting for income taxes effective January 1, 1993 to conform with Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\"\n\/s\/ Deloitte & Touche LLP\nPhiladelphia, Pennsylvania February 21, 1995\nCOMCAST CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEET DECEMBER 31, 1994 AND 1993 (Dollars in thousands)\nSee notes to consolidated financial statements.\nCOMCAST CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF OPERATIONS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Amounts in thousands, except per share data)\nSee notes to consolidated financial statements.\nCOMCAST CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Dollars in thousands)\nSee notes to consolidated financial statements.\nCOMCAST CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIENCY) YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Dollars in thousands)\nSee notes to consolidated financial statements.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBasis of Consolidation The consolidated financial statements include the accounts of Comcast Corporation and all wholly owned, majority-owned and controlled subsidiaries (the \"Company\"). The Company is engaged in the development, management and operation of cable and cellular telephone communications systems and the production and distribution of cable programming. All significant intercompany accounts and transactions among the consolidated entities have been eliminated.\nCash Equivalents and Short-term Investments Cash equivalents consist principally of U.S. Government obligations, commercial paper, repurchase agreements and certificates of deposit with a maturity of three months or less when purchased. Short-term investments consist principally of U.S. Government obligations, commercial paper, repurchase agreements and certificates of deposit with a maturity greater than three months when purchased. The carrying amounts of the Company's cash equivalents and short-term investments, classified as trading securities, approximates their fair values, which are based on quoted market prices, at December 31, 1994 and 1993.\nInvestments, Principally in Affiliates Investments are accounted for on the equity method based on the Company's ability to exercise significant influence over the operating and financial policies of the investee. Equity method investments are recorded at original cost and adjusted periodically to recognize the Company's proportionate share of the investees' income or losses after the date of investment, and additional contributions made and dividends received. Unrestricted publicly traded investments, classified as available for sale, are recorded at their fair value as of December 31, 1994 and at cost as of December 31, 1993. Restricted publicly traded investments and investments in privately held companies are stated at cost adjusted for any known diminution in value.\nInvestment Income Investment income includes interest income and gains, net of losses, on the sales of marketable securities. Gross realized gains and losses are recognized using the specific identification method and are not significant to the Company's results of operations.\nProperty and Equipment Property and equipment are stated at cost. Depreciation is provided by the straight-line method over estimated useful lives as follows:\nBuildings 15-40 years Operating facilities 5-20 years Other equipment 2-10 years\nDeferred Charges Franchise and license acquisition costs are being amortized on a straight-line basis over their legal or estimated useful lives up to 40 years. The costs of acquired businesses in excess of amounts allocated to specific assets, based on their fair market values, are being amortized over their estimated useful lives of up to 40 years. The Company periodically evaluates the recoverability of its deferred charges using objective methodologies. Such methodologies may include evaluations based on the cash flows generated by the underlying assets or other determinants of fair value.\nLoss per Share For the years ended December 31, 1994, 1993 and 1992, the Company's common stock equivalents have an antidilutive effect on the loss per share and therefore, have not been used in determining the total weighted average number of common shares outstanding. Fully diluted loss per share for 1994, 1993 and 1992 is antidilutive and, therefore, has not been presented.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nStock Split On December 21, 1993, the Company's board of directors authorized a three-for-two stock split in the form of a 50% stock dividend payable on February 2, 1994 to shareholders of record on January 12, 1994. The dividend was paid in Class A Special Common Stock to the holders of Class A Common, Class A Special Common and Class B Common Stock. Average number of shares outstanding and related prices, per share amounts, share conversion and stock option data have been retroactively restated to reflect the stock split. In addition, the December 31, 1993 Stockholders' Deficiency section of the Balance Sheet has been adjusted to reflect the stock split.\nFair Values The estimated fair value amounts presented in these notes to consolidated financial statements have been determined by the Company using available market information and appropriate methodologies. However, considerable judgment is required in interpreting market data to develop the estimates of fair value. The estimates presented herein are not necessarily indicative of the amounts that 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. Such fair value estimates are based on pertinent information available to management as of December 31, 1994 and 1993, and have not been comprehensively revalued for purposes of these consolidated financial statements since such dates. Current estimates of fair value may differ significantly from the amounts presented herein.\nNew Accounting Pronouncements Effective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\" (see Note 6), SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" (see Note 7) and SFAS No. 112, \"Employers' Accounting for Postemployment Benefits\" (see Note 8).\nEffective January 1, 1994, the Company adopted the provisions of SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (see Note 3).\nReclassifications Certain reclassifications have been made to the prior years consolidated financial statements to conform to those classifications used in 1994.\n2. ACQUISITIONS AND OTHER SIGNIFICANT EVENTS\nQVC\nIn February 1995, the Company and Tele-Communications, Inc. (\"TCI\") acquired all of the outstanding stock of QVC, Inc. (\"QVC\") for $46, in cash, per share. The total cost of acquiring the outstanding shares of QVC not previously owned by the Company and TCI (approximately 65% of such shares on a fully diluted basis) was approximately $1.4 billion. Following the acquisition, the Company and TCI own, through their respective subsidiaries, 57.45% and 42.55%, respectively, of QVC. The Company will account for the QVC acquisition under the purchase method of accounting and QVC will be consolidated with the Company beginning in February 1995.\nThe acquisition of QVC, including the exercise of certain warrants held by the Company, was financed with cash contributions from the Company and TCI of $296.3 million and $6.6 million, respectively, borrowings of $1.1 billion under a $1.2 billion QVC credit facility and existing cash and cash equivalents held by QVC.\nQVC is a nationwide general merchandise retailer, operating as one of the leading televised shopping retailers in the United States. Through its merchandise-focused television programs (the \"QVC Service\"), QVC sells a wide variety of products directly to consumers. The QVC Service currently reaches approximately 50 million cable television subscribers in the United States.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nThe day to day operations of QVC will, except in certain limited circumstances, be managed by the Company. With certain exceptions, direct or indirect transfers to unaffiliated third parties by the Company or TCI of any stock in QVC are subject to certain restrictions and rights in favor of the other.\nLiberty Media Corporation (\"Liberty\"), a wholly-owned subsidiary of TCI, may, at certain times following February 9, 2000, trigger the exercise of certain exit rights. If the exit rights are triggered, the Company has first right to purchase Liberty's stock in QVC at Liberty's pro rata portion of the fair market value (on a going concern or liquidation basis, whichever is higher, as determined by an appraisal process) of QVC. The Company may pay Liberty for such stock, subject to certain rights of Liberty to consummate the purchase in the most tax-efficient method available, in cash, the Company's promissory note maturing not more than three years after issuance, the Company's equity securities or any combination thereof. If the Company elects not to purchase the stock of QVC held by Liberty, then Liberty will have a similar right to purchase the stock of QVC held by the Company. If Liberty elects not to purchase the stock of QVC held by the Company, then Liberty and the Company will use their best efforts to sell QVC.\nMaclean Hunter\nOn December 22, 1994, the Company, through Comcast MHCP Holdings, L.L.C. (the \"LLC\"), acquired the U.S. cable television and alternate access operations of Maclean Hunter Limited (\"Maclean Hunter\") from Rogers Communications Inc. (\"RCI\") and all of the outstanding shares of Barden Communications, Inc. (\"BCI,\" and collectively, such acquisitions are referred to as the \"Maclean Hunter Acquisition\") for approximately $1.2 billion (subject to certain adjustments) in cash. The Company and the California Public Employees' Retirement System (\"CalPERS\") invested approximately $305.0 million and $250.0 million, respectively, in the LLC, which is owned 55% by a wholly-owned subsidiary of the Company and 45% by CalPERS, and is managed by the Company. The Maclean Hunter Acquisition, including certain transaction costs, was financed with cash contributions from the LLC of $555.0 million and borrowings of $715.0 million under an $850.0 million Maclean Hunter credit facility. At any time after December 18, 2001, CalPERS may elect to liquidate its interest in the LLC at a price based upon the fair value of CalPERS' interest in the LLC, adjusted, under certain circumstances, for certain performance criteria relating to the fair value of the LLC or to the Company's common stock. Except in certain limited circumstances, the Company, at its option, may satisfy this liquidity arrangement by purchasing CalPERS' interest for cash, through the issuance of the Company's common stock (subject to certain limitations) or by selling the LLC. The Maclean Hunter Acquisition was accounted for under the purchase method of accounting and Maclean Hunter is consolidated with the Company as of December 31, 1994.\nThe allocation of the purchase price to the assets and liabilities of Maclean Hunter is preliminary pending, among other things, the final purchase price adjustment between the Company and RCI. The terms of the Maclean Hunter Acquisition provide for, among other things, the indemnification of the Company by RCI for certain liabilities, including tax liabilities, relating to Maclean Hunter prior to the acquisition date.\nTelecommunications Joint Venture\nOn October 25, 1994, the Company announced a joint venture (\"WirelessCo\") with Sprint Corporation (\"Sprint\"), TCI and Cox Cable Communications, Inc. (\"Cox\") to provide wireless communications services. WirelessCo is owned 40% by Sprint, 30% by TCI and 15% each by the Company and Cox. WirelessCo is participating in the first of several Federal Communications Commission (\"FCC\") auctions of blocks of spectrum for licenses to provide Personal Communications Services (\"PCS\"), having filed an application to participate in 39 of 51 Major Trading Area (\"MTA\") markets nationwide. As of February 21, 1995, WirelessCo's aggregate bids for 38 licenses covering a total population of 168 million were $1.975 billion. There can be no assurances that WirelessCo will be successful in bidding for or otherwise obtaining PCS licenses for these or other MTAs. The Company has obtained letter of credit commitments sufficient to cover its 15% share of the cost of PCS licenses for which WirelessCo is the successful bidder. The Company may have material additional capital requirements\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nrelating to the buildout of PCS systems if WirelessCo is successful in the PCS bidding process. WirelessCo is accounted for under the equity method of accounting.\nThe parties have also signed a joint venture formation agreement which provides the basis upon which they will develop definitive agreements for their local wireline telecommunications activities. The parties anticipate that the wireline joint venture will be owned in the same percentages as WirelessCo. The parties' ability to provide such local services on a nationwide basis, and the timing thereof, will depend upon, among other things, the removal or modification of legal barriers to local telephone competition. The parties anticipate that Teleport Communications Group (\"TCG\"), which is owned 20% by the Company and by other cable television operators, including TCI and Cox, will be contributed to the local telephone venture. TCG is an alternative provider of local telephone services. The contribution of TCG to the venture is expected to be subject to certain conditions, including obtaining necessary governmental and other approvals.\nStorer\nPrior to December 2, 1992, the Company held a 50% ownership interest in SCI Holdings, Inc. (\"SCI\"), the parent company of Storer Communications, Inc. (\"Storer\"). On December 2, 1992, the Company completed certain transactions pursuant to which (i) the value of SCI was divided proportionately between its two 50% shareholders (the \"Split-off\") and (ii) SCI refinanced its indebtedness (the \"Refinancing Plan\"). In connection with the Split-off, SCI was merged into Storer and the Company became the sole shareholder of Storer.\nTo effect the Split-off and Refinancing Plan, the Company and SCI's other 50% shareholder each made capital contributions to SCI of $1.1 billion. In addition, the Company redeemed $275 million of its long-term debt held by Storer (the \"Finance Sub Securities\") and assumed $119 million of Storer's outstanding debt. Effective December 2, 1992, the remaining Finance Sub Securities became intercompany securities and have been eliminated in consolidation. The other 50% shareholder redeemed all of its outstanding Finance Sub Debt Securities. Storer used these proceeds to pay off its outstanding bank debt, 15% twelve year Senior subordinated debentures, and a majority of its Serial Zero Coupon Senior Notes. In connection with these redemptions, the Company recognized as an extraordinary item its 50% share of the premiums paid (net of tax) of $52.3 million.\nIn addition, on December 2, 1992, holders of the Storer preferred stock were given the required thirty days notice of intent to redeem. The cash required to fund the redemption was part of the capital contributions discussed above. On January 4, 1993, $746.9 million was paid to redeem the preferred stock, which included a redemption premium and accrued dividends. The redemption of the preferred stock was presented as if it had been consummated on December 31, 1992. Management believes such presentation more accurately reflected the Company's financial position and capital structure at December 31, 1992. The Company's equity in Storer's net loss before extraordinary item for 1992 includes $27.5 million for its portion of Storer's redemption premium on its preferred stock.\nIn connection with the Split-off, the Company and the former 50% shareholder of Storer entered into various agreements providing for, among other things, the sharing and cross indemnification of certain liabilities, including tax liabilities and benefits relating to the pre-Split-off period.\nAWACS\nOn March 5, 1992, the Company acquired from Metromedia Company (\"Metromedia\") a 50.01% direct and a 49.99% indirect interest in AWACS, Inc. (\"AWACS\"), the non-wireline cellular telephone system serving the Philadelphia Metropolitan Statistical Area, which includes eight counties in Pennsylvania and New Jersey containing a population of approximately 4.9 million people at that date (the \"AWACS Acquisition\"). The Company also acquired the minority interests in two New Jersey cellular telephone systems serving a total population of approximately 1.3 million people at that date, the balance of which systems were owned by the Company. The Company acquired these interests in exchange for (i) zero coupon notes issued by a subsidiary of the Company, which are due March 5, 2000, and have an aggregate face amount payable at maturity of\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\napproximately $1 billion, accreting from $425 million at 11% per annum (if at maturity or an earlier redemption date 35%, subject to reduction in certain circumstances, of the private market value, as determined by applicable procedures, of the Company's cellular subsidiaries is greater than the accreted value plus certain premiums, then such greater amount will constitute the redemption price), (ii) approximately $567 million in cash and (iii) participating preferred stock issued by a subsidiary of the Company (described below).\nThe 49.99% indirect interest was obtained through the purchase of the Class A Redeemable Preferred Stock (\"LCH Preferred Stock\") of LCH Communications, Inc. (\"LCH\"), an indirect subsidiary of LIN Broadcasting Corporation. The 49.99% of the AWACS Common Stock was owned by LIN Cellular Communications Corporation (\"LIN-Penn\"), a wholly-owned subsidiary of LCH. LCH, through LIN-Penn, indirectly owned the remaining 49.99% of the common stock of AWACS. LCH was required to redeem the LCH Preferred Stock (which redemption was not expected to occur before 1996) for either, at its option, (a) an amount in cash (the \"Cash Redemption Price\") equal to the sum of (i) all accrued and unpaid dividends and (ii) the greater of (A) $850 million and (B) the fair market value of the capital stock of LIN-Penn and 15% of the value of LCH's operating business (the \"Operating Business Portion\"), or (b) the capital stock of LIN-Penn and an amount in cash equal to the Operating Business Portion.\nOn June 24, 1994, in connection with the settlement of certain disputes between LCH and the Company, LCH redeemed the LCH Preferred Stock through the transfer to the Company of 100% of the capital stock of LIN-Penn. As a result of such redemption, the Company owns 100% of the common stock of AWACS. Since the Company has historically accounted for the purchase of AWACS as if it acquired a 100% direct interest, the redemption of the LCH Preferred Stock has no effect on the Company's accounting for AWACS.\nIn addition to the interest in AWACS, the redemption of the LCH Preferred Stock entitles the Company to an interest in certain publishing and broadcasting operations. A subsidiary of the Company has issued to Metromedia participating preferred stock which has economic attributes based on the performance and ultimate value of the publishing and broadcasting operations. Accordingly, these operations are excluded from the Company's consolidated financial statements.\nPro forma Results\nThe Company would have reported unaudited revenues of $1.634 billion and $1.597 billion, unaudited loss before extraordinary items and cumulative effect of accounting changes of $123.3 million and $143.6 million, unaudited net loss of $135.0 million and $898.9 million and unaudited net loss per share of $.57 and $4.20 for the years ended December 31, 1994 and 1993, respectively, had the Maclean Hunter Acquisition occurred at the beginning of each period. This unaudited pro forma information is based on historical results of operations adjusted for acquisition costs, and in the opinion of management, is not necessarily indicative of what the results would have been had the Company operated the acquired entities since the beginning of 1993.\n3. INVESTMENTS\nInvestments consist of the following components:\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nInvestments - Equity Method\nSummarized financial information for equity method investments, excluding the operations of Storer as described below, for 1994, 1993 and 1992 is as follows (Dollars in thousands):\nAs of December 31, 1994 and 1993, equity method investments include the Company's interest in Garden State Cablevision L.P. (\"Garden State\") and interests in its United Kingdom (\"UK\") cable television and telecommunications businesses. In addition, effective January 1, 1994, the Company commenced accounting for QVC (see Note 2-QVC), TCG (see Note 2-Telecommunications Joint Venture) and certain other investments under the equity method of accounting due to changes in the nature of the relationships between the Company and the investees which allow the Company to exercise significant influence over their operating and financial policies. The Company's prior year financial statements have not been restated due to the insignificance of the Company's proportionate ownership interests in the net income or loss of the investees for those periods. The differences between the Company's recorded investments and its proportionate interests in the book value of the investees' net assets are being amortized to equity in net income or loss, primarily over a period of twenty years, which is consistent with the estimated lives of the underlying assets. In addition, QVC's fiscal year end is January 31 and therefore, the Company records its equity in QVC's net income or loss two months in arrears.\nThe original cost of investments accounted for under the equity method of accounting totalled approximately $565.4 million and $253.4 million at December 31, 1994 and 1993, respectively.\nAs of December 31, 1994 and 1993, the Company held 6.2 million shares and 5.9 million shares, respectively, of QVC Class A Common Stock representing a 15.1% and 14.8% interest in QVC's then outstanding common stock. In addition, the Company held 72,050 shares of QVC Class C Preferred Stock as of December 31, 1994 and 1993. The historical cost of the Class A Common Stock and Class C Preferred Stock held by the Company as of December 31, 1994 and 1993 was $69.6 million and $66.5 million, respectively, with an estimated fair value of $291.8 million and $259.8 million, respectively. In addition, as of December 31, 1994 and 1993, the Company held\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nwarrants to purchase 1.7 million and 2.0 million shares of QVC Class A Common Stock, respectively, at prices ranging from $9.64 to $17.49 with estimated fair values of $44.0 million and $49.6 million at such dates.\nOn December 11, 1992, the Company contributed its interests in certain UK cable television and telecommunications businesses to a majority owned subsidiary (\"Comcast UK Cable\"). Comcast UK Cable holds, among other things, the Company's investments in UK affiliates: Birmingham Cable Corporation Limited, Cable London PLC, Cambridge Holding Company Limited and Cable Programme Partners-1 Limited Partnership. On that date, Comcast UK Cable's other shareholder, UK Cable Partners Limited (\"UKCPL\"), which is owned by Warburg, Pincus Investors L.P. and Bankers Trust Investments PLC, committed to invest an aggregate of up to UK (pound)70.0 million in Comcast UK Cable, of which approximately UK (pound)57.2 million was invested through September 27, 1994. The Company made equal investments, including the cost of its investments previously contributed to Comcast UK Cable. On September 27, 1994, Comcast UK Cable consummated an initial public offering (the \"IPO\") of 15.0 million of its Class A Common Shares for net proceeds of $209.4 million. Contemporaneously with the IPO, the Company and UKCPL restructured their interests in Comcast UK Cable and terminated UKCPL's right to exchange its equity interests in Comcast UK Cable for convertible debt of the Company (the \"Exchange Option\"). As a result of the IPO and the restructuring, the Company beneficially owns approximately 31.2% of the total outstanding Comcast UK Cable common shares. Because the Class A Common Shares are entitled to one vote per share and the Class B Common Shares are entitled to ten votes per share, the Company, through its ownership of the Class B Common Shares, controls approximately 81.9% of the total voting power of all outstanding Comcast UK Cable common shares and continues to consolidate Comcast UK Cable. As a result of the termination of the Exchange Option and consummation of the IPO, the Company recorded an aggregate minority interest liability in Comcast UK Cable of $261.4 million. The Company has recorded the increase in its proportionate share of Comcast UK Cable's net assets as an increase in additional capital of $59.3 million.\nThe Company holds a 20% interest in TCG with an original cost of $66.2 million and $66.1 million at December 31, 1994 and 1993, respectively. The Company also had loans to TCG totaling $39.5 million and $11.7 million at December 31, 1994 and 1993, respectively. TCG operates fiber optic networks serving communities across the United States providing point-to-point digital communication links to telecommunication-intensive businesses and long-distance carriers. The Company accounted for its investment in TCG under the cost method of accounting prior to 1994.\nThrough December 2, 1992, the Company recorded its 50% investment in Storer under the equity method of accounting. Subsequent to December 2, 1992, the Company consolidates the financial position and results of operations of Storer.\nThe results of operations of Storer for 1992 (through December 2, 1992) are as follows (Dollars in thousands):\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nThe net loss of $324.3 million for 1992 (through December 2, 1992) separately reported by Storer differs from the net loss of $260.6 million for 1992 utilized by the Company to record its equity in the net loss of Storer. This difference is due to Storer not recognizing interest and dividend income from securities issued by the Company and the other 50% investor to Storer due to the related party nature of the securities. However, the Company has recorded the interest and dividend requirements as an expense in its consolidated statement of operations. Therefore, this method of reporting presents the Company's equity in the net loss of Storer as if it were consolidated with the Company.\nThrough December 2, 1992, the Company, pursuant to a consulting agreement, had oversight responsibility for Storer systems serving approximately one-half of the Storer subscribers. For its consulting services, the Company received a fee of 3-1\/2% of revenues of the systems it managed. For the year ended December 31, 1992, the fee under the consulting agreement was $10.8 million.\nInvestments - Public Companies\nAs of December 31, 1994 and 1993, the Company held 11.3 million shares of common stock of Nextel Communications, Inc. (\"Nextel\") representing a 10.7% and 12.9% interest in Nextel's then outstanding common stock. Nextel is a Specialized Mobile Radio (\"SMR\") licensee developing an enhanced service capability (\"ESMR\"). Assuming satisfactory technical performance of Nextel's systems in Los Angeles and San Francisco and satisfaction of certain other conditions, an additional $35 million investment will be made on June 30, 1995 at a per share price of 90% of the then market price for Nextel common stock. Effective September 30, 1994, certain restrictions under prior agreements with Nextel relating to the Company's ability to sell or otherwise transfer its investment in Nextel were removed. As a result of the removal of such restrictions, the Company has recorded its investment in Nextel common stock, with an historical cost of $175.9 million at December 31, 1994, at its estimated fair value, resulting in an unrealized pre-tax loss of $14.0 million as of December 31, 1994. As of December 31, 1993, the Company's investment in Nextel common stock had an estimated fair value of $419.7 million and was reported at its historical cost of $174.2 million. As of December 31, 1994 and 1993, the Company owns options to acquire approximately 25.2 million shares of Nextel common stock, principally at $16 per share, with an estimated fair value of $149.2 million and $660.0 million, respectively, which are recorded at their historical cost of $23.5 million. Investments in options have been valued using the Black-Scholes Option Pricing method.\nThe Company holds unrestricted equity investments in certain other publicly traded companies with an historical cost of $10.7 million at December 31, 1994 and 1993. As of December 31, 1994, the Company has recorded these investments at their estimated fair value of $30.6 million, resulting in an unrealized pre-tax gain of $19.9 million. As of December 31, 1993, such investments, with an estimated fair value of $50.1 million at that date, were reported at their historical cost.\nInvestments - Privately Held Companies\nOn January 26, 1995, the Company exchanged its interest in Heritage Communications, Inc. (\"Heritage\") with TCI for Class A common shares of TCI with a fair market value of approximately $290.0 million. Shortly thereafter, the Company sold certain of these shares for total proceeds of approximately $188.0 million. As a result of these transactions, the Company will recognize a pre-tax gain of $141.0 million in the first quarter of 1995.\nIt is not practicable to estimate the fair value of the Company's other investments in privately held companies with a recorded cost, excluding Heritage, of $50.3 million and $141.5 million at December 31, 1994 and 1993, respectively, due to a lack of quoted market prices and excessive costs involved in determining such fair value.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\n4. LONG-TERM DEBT\nThe maturities of long-term debt outstanding as of December 31, 1994 for the four years after 1995 are as follows:\n(Dollars in thousands) 1996............................. $309,530 1997............................. 388,074 1998............................. 802,428 1999............................. 518,848\nThe holders of the Senior participating redeemable zero coupon notes due 2000 have the right, upon request of the holders of the majority of the notes, to require the Company to redeem such notes at any time on or after March 5, 1998. The accreted value of such notes, without giving effect to the alternative formula based on the private market value of the cellular business (see Note 2 - AWACS), of $361.5 million has been presented above as a 1998 maturity. Approximately $169.3 million accreted value of Series A notes is payable, at the Company's option, either in cash or the Company's Class A Special Common Stock.\nThe following is a summary of the Company's convertible subordinated debt:\n(1) The Zero coupon convertible subordinated notes due 1995 are convertible, at the option of the holder, into Class A Special Common Stock of the Company at a conversion price of $11.02 per share, based on the face value of the debentures converted. The notes were issued at a 39% discount, resulting in an effective annual yield to maturity of 7.2%. During 1994 and 1993, $34.1 million and $48.6 million, respectively, of notes were converted into approximately 3.3 million and 4.8 million shares of Class A Special Common Stock of the Company. In January 1995, the remaining principal amount of the notes were converted by the holders into 396,000 shares of Class A Special Common Stock of the Company.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\n(2) The 3-3\/8% \/ 5-1\/2% Step-up convertible subordinated debentures due 2005 are convertible into Class A Special Common Stock of the Company at a conversion price of $24.50 per share. Interest on the debentures accrues at a rate per annum of 3-3\/8% from and including the date of issuance to and including September 8, 1997, from and after such time the Company will have the right to redeem the debentures for cash. Interest will accrue at a rate per annum of 5-1\/2% from and including September 9, 1997 to maturity, or earlier redemption.\n(3) The 1-1\/8% Discount convertible subordinated debentures due 2007 are convertible into Class A Special Common Stock of the Company at a conversion rate equal to 19.3125 shares per $1,000 principal amount at maturity. The conversion price will not be adjusted for accrued interest or original issue discount. The debentures were issued at 55.363% of their principal amount of $541.9 million at maturity resulting in a 6% effective annual yield to maturity. At any time on or after October 15, 1997, the Company may redeem such debentures for cash.\n(4) The 7% Convertible subordinated debentures due 2001 were redeemed on February 27, 1994. In connection with such redemption, substantially all of the debentures were converted into approximately 13.5 million shares of Class A Special Common Stock of the Company.\nOn March 1, 1994, the Company redeemed for cash its 11-7\/8% Senior subordinated debentures at a redemption price of 105.0% of their principal amount.\nThe Company paid premiums and expensed unamortized debt acquisition costs totalling $18.0 million during 1994, primarily as a result of the redemption of its $150 million, 11-7\/8% Senior subordinated debentures due 2004, resulting in the Company recording an extraordinary loss, net of tax, of $11.7 million or $.05 per share. The Company paid similar premiums of $27.1 million during 1993 in connection with the redemption of certain of its debt resulting in the Company recording an extraordinary loss, net of tax, of $17.6 million or $.08 per share.\nFixed interest rates on notes payable to banks and insurance companies range from 8.6% to 10.57%. Bank debt interest rates vary based upon one or more of the following rates at the option of the Company:\nPrime rate to prime plus 1%; London Interbank Offered Rate (LIBOR) plus 3\/4% to 2%; and Certificate of deposit rate plus 7\/8% to 2-1\/8%.\nAs of December 31, 1994 and 1993, the Company's effective weighted average interest rate on its variable rate bank and insurance company debt outstanding was 7.63% and 4.73%, respectively.\nThe Company has entered into interest rate swap and cap agreements to limit the Company's exposure to loss from adverse fluctuations in interest rates. At December 31, 1994 and 1993, $415.0 million and $635.0 million, respectively, of the Company's variable rate debt was protected by these products. Such agreements mature on various dates in 1995 and the related differentials to be paid or received are recognized over the terms of the agreements.\nDuring 1994, the Company entered into other interest rate swap agreements to manage its overall interest expense. At December 31, 1994, the Company had swapped $400.0 million notional amount of fixed rate debt for variable rate products (effective rates of 4.13% through 6.93% at December 31, 1994) which mature between 2000 and 2004. Since these products are designated as matched with certain of the Company's fixed rate debt, the differentials paid or received are recognized as a component of interest expense over the terms of the related agreements. Certain of these agreements have extensions, at the option of the counterparty, or indexed amortization provisions which may extend the lives of the agreements from three to five years.\nThe credit risks associated with the Company's derivative financial instruments are controlled through the evaluation and continual monitoring of the creditworthiness of the counterparties. Although the Company may\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nbe exposed to losses in the event of nonperformance by the counterparties, the Company does not expect such losses, if any, to be significant.\nCertain of the Company's subsidiaries' loan agreements contain restrictive covenants which limit the subsidiaries' ability to enter into arrangements for the acquisition of property and equipment, investments, mergers and the incurrence of additional debt. Certain of these agreements require that certain ratios and cash flow levels be maintained and contain certain restrictions on dividend payments and advances of funds to the Company. The Company and its subsidiaries were in compliance with such restrictive covenants for all periods presented. In addition, the stock of certain subsidiary companies is pledged as collateral for the notes payable to banks and insurance companies.\nAs of December 31, 1994, certain subsidiaries of the Company had unused lines of credit of $553.0 million, of which $100.0 million was used through February 21, 1995, principally to fund the acquisition of QVC.\nAs of December 31, 1994, the Company and certain of its subsidiaries had unused irrevocable standby letters of credit totalling $401.9 million to cover potential fundings associated with several projects.\n5. STOCKHOLDERS' EQUITY (DEFICIENCY)\nThe Company is authorized to issue, in one or more series, up to a maximum of 20.0 million shares of preferred stock without par value. The shares can be issued with such designations, preferences, qualifications, privileges, limitations, restrictions, options, conversion rights and other special or related rights as the Board of Directors shall from time to time fix by resolution.\nClass A Special Common Stock is nonvoting and each share of Class A Common Stock is entitled to one vote. Each share of Class B Common Stock is entitled to fifteen votes and is convertible, share for share, into Class A or Class A Special Common Stock, subject to certain restrictions.\nAs of December 31, 1994, 21.1 million shares of Class A Special Common Stock were reserved for issuance upon conversion of the Company's convertible debentures.\nThe Company maintains qualified and nonqualified stock option plans for employees, directors and other persons under which the option prices are not less than the fair market value of the shares at the date of grant. Under these plans, 16.5 million shares of Class A Special Common Stock, 362,000 shares of Class A Common Stock and 658,000 shares of Class B Common Stock were reserved as of December 31, 1994. Option terms are from five to ten years with options becoming exercisable at various dates.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nChanges in the number of shares subject to outstanding but unexercised options under the Company's option plans for the years ended December 31, 1994, 1993 and 1992 were as follows:\nAs of December 31, 1994, options to purchase 5.0 million shares of Class A Special Common Stock, 206,000 shares of Class A Common Stock and 304,000 shares of Class B Common Stock were exercisable.\nThe Company has a restricted stock program whereby management employees may be granted restricted shares of the Company's Class A Special Common Stock. Shares are subject to certain vesting provisions. The shares awarded do not have voting or dividend rights until vesting occurs. Restrictions on the award expire annually, over a period not to exceed five years from the date of the award. The Company recognizes compensation expense over the vesting period. As of December 31, 1994, there were 1.3 million unvested shares granted under the program of which 284,000 vested in January 1995. Total compensation expense recognized in 1994, 1993 and 1992 under this program was $4.4 million, $3.4 million and $2.6 million, respectively.\n6. INCOME TAXES\nEffective January 1, 1993, the Company adopted SFAS No. 109 which generally provides that deferred tax assets and liabilities be recognized for temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities and expected benefits of utilizing net operating loss carryforwards. The impact on deferred taxes of changes in tax rates and laws, if any, applied to the years during which temporary differences are expected to be settled are reflected in the financial statements in the period of enactment.\nPursuant to the deferred method under Accounting Principles Board Opinion No. 11, which was applied in 1992 and prior years, deferred income taxes were 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.\nThe cumulative effect of the adoption of SFAS No. 109 increased the net loss for the year ended December 31, 1993 by $731.8 million, or $3.42 per share, and is reported as part of the cumulative effect of accounting changes in the Company's Consolidated Statement of Operations for the year ended December 31, 1993.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nProperty and equipment and deferred charges were increased by $171.1 million in order to adjust prior business combinations from net-of-tax to pre-tax amounts as required by SFAS No. 109. As a result of the adoption of SFAS No. 109, depreciation and amortization expense increased in 1993 from 1992 by approximately $13.6 million or $.06 per share and income tax expense decreased by approximately $35.0 million or $.16 per share, resulting in a net decrease in the loss before extraordinary items and cumulative effect of accounting changes of approximately $21.4 million or $.10 per share. Prior year financial statements were not restated to apply the provisions of SFAS No. 109.\nAs a result of the Maclean Hunter Acquisition, the Company's deferred income tax liability was increased by approximately $488.0 million for temporary differences between the financial reporting basis and the income tax reporting basis of the assets of Maclean Hunter and BCI at the date of acquisition. Deferred charges were increased by the same amount as prescribed by SFAS No. 109.\nThe redemption of the LCH Preferred Stock by LCH caused the Company's direct ownership of the common stock of AWACS to increase from 50.01% to 100%. As of the date of the redemption, AWACS will join with the Company in filing consolidated federal income tax returns.\nIncome tax expense (benefit) consists of the following components:\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nThe effective income tax expense (benefit) of the Company differs from the statutory amount because of the effect of the following items:\nDeferred income tax expense (benefit) resulted from the following differences between financial and income tax reporting:\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\nSignificant components of the Company's net deferred tax liability are as follows:\nThe Company's valuation allowance against deferred tax assets includes approximately $120.0 million for which any subsequent tax benefits recognized will be allocated to reduce goodwill and other noncurrent intangible assets. For income tax reporting purposes, the Company has net operating loss carryforwards of approximately $30.0 million for which a deferred tax asset has been recorded, which expire primarily between 2001 and 2007.\n7. POSTRETIREMENT BENEFITS OTHER THAN PENSIONS\nEffective January 1, 1993, the Company adopted SFAS No. 106. This statement requires the Company to accrue the estimated cost of retiree benefits earned during the years the employee provides services. The Company previously expensed the cost of these benefits as claims were incurred. The Company recorded the cumulative effect of the obligation, which is unfunded, as of January 1, 1993, resulting in an increase in the Company's accrued postretirement health care liability of approximately $13.5 million and net loss of approximately $8.9 million or $.04 per share, net of tax. The effect of SFAS No. 106 on loss before extraordinary items and the cumulative effect of accounting changes was not significant to the Company's results of operations.\n8. POSTEMPLOYMENT BENEFITS\nEffective January 1, 1993, the Company adopted SFAS No. 112. This statement requires the Company to accrue the estimated costs of benefits for former or inactive employees after employment but before retirement. The effect of SFAS No. 112 on loss before extraordinary items and the cumulative effect of accounting changes was not significant to the Company's results of operations.\n9. STATEMENT OF CASH FLOWS - SUPPLEMENTAL INFORMATION\nThe Company made cash payments for interest of approximately $261.6 million, $278.6 million and $198.2 million during the years ended December 31, 1994, 1993 and 1992, respectively.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\n10. COMMITMENTS AND CONTINGENCIES\nCommitments During 1994, a subsidiary of the Company, Comcast UK Cable, entered into certain foreign exchange forward contracts as a normal part of its risk management efforts. Foreign exchange contracts, which mature at various times through 1996, are used to protect Comcast UK Cable from the risk that monetary assets held or denominated in currencies other than its functional currency are devalued as a result of changes in exchange rates. The amount of these contracts was $100.0 million as of December 31, 1994. Foreign exchange contracts provide an effective hedge against such monetary assets held since gains and losses realized on the contracts are offset against gains or losses realized on the underlying hedged assets.\nMinimum annual rental commitments for office space and equipment under noncancellable operating leases are as follows:\n(Dollars in thousands)\n1995 $12,217 1996 10,385 1997 9,661 1998 8,759 1999 7,782 Thereafter 31,967\nRental expense of $21.9 million, $19.3 million and $13.2 million for 1994, 1993 and 1992, respectively, has been charged to operations.\nContingencies The Company is subject to claims which arise in the ordinary course of its business and other legal proceedings. In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the financial position or results of operations of the Company.\nThe Company is currently seeking to justify existing rates in certain of its cable systems on the basis of cost-of-service showings; however, the interim cost-of-service regulations promulgated by the FCC do not support positions taken by the Company in its cost-of-service filings to date. The Company's reported cable service income reflects the estimated effects of cable regulation. The Company is seeking reconsideration by the FCC of the interim cost-of-service regulations and, if unsuccessful in justifying existing rates under cost-of-service regulations, intends to seek judicial relief. However, no assurance can be given that the Company will be successful in cost-of-service proceedings. If the Company is not successful in such efforts, and there is no legislative, administrative or judicial relief in these matters, the FCC regulations will continue to adversely affect the Company's results of operations.\nGarden State's auditors' report discloses a material uncertainty with respect to the Cable Television Consumer Protection and Competition Act of 1992. Management believes that the ultimate resolution of this uncertainty will not have a material impact on the Company's financial position or results of operations.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\n11. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe following summary table of the estimated fair value of the Company's financial instruments is made in accordance with the provisions of SFAS No. 107, \"Disclosures About Fair Value of Financial Instruments.\" See Note 1 for a description of methodologies used for such disclosures.\nThe Company's long-term debt had a carrying amount of $4.993 billion and an estimated fair value of $4.768 billion as of December 31, 1994. The difference between the carrying value and estimated fair value of the Company's long-term debt was not significant as of December 31, 1993. The estimated fair value of the Company's publicly traded debt is based on quoted market prices for that debt. Interest rates that are currently available to the Company for issuance of the debt with similar terms and remaining maturities are used to estimate fair value for debt issues for which quoted market prices are not available.\nThe estimated liability to settle the Company's interest rate swap and cap agreements was $39 million as of December 31, 1994. The estimated liability to settle the extension and indexed amortization features for certain of these instruments is not significant to the Company. The estimated liability to settle the Company's interest rate swap and cap agreements as of December 31, 1993 was not significant to the Company.\nThe difference between the carrying amount and the estimated fair value of the Company's foreign exchange forward contracts is not significant at December 31, 1994.\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Continued)\n12. FINANCIAL DATA BY BUSINESS SEGMENT (Dollars in thousands)\nCOMCAST CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (Concluded)\n13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nITEM 9","section_9":"ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nThe information called for by Item 10, Directors and Executive Officers of the Registrant (except for the information regarding executive officers called for by Item 401 of Regulation S-K which is included in Part I hereof as Item 4A in accordance with General Instruction G(3)), 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 Registrant's definitive Proxy Statement for its Annual Meeting of Shareholders presently scheduled to be held in June 1995, which shall be filed with the Securities and Exchange Commission within 120 days of the end of the Registrant's latest fiscal year.\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 Consolidated Financial Statements of the Company are included in Part II, Item 8:\nAll other schedules are omitted because they are not applicable, not required or the required information is included in the financial statements or notes thereto.\n(ii) The following consolidated financial statements of Storer Communications, Inc. (\"Storer\") for the year ended December 31, 1992 are required to be filed by Item 14(d)(1) of Form 10-K and are incorporated by reference to Storer's Annual Report on Form 10-K for the year ended December 31, 1993.\nStorer Communications, Inc.\nIndependent Auditors' Report Consolidated Statements of Operations Consolidated Statements of Stockholder's Equity (Deficit) Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements\nAll schedules are omitted because they are not applicable, not required or the required information is included in the financial statements or notes thereto.\n(c) Exhibits required to be filed by Item 601 of Regulation S-K:\n3.1(a) Amended and Restated Articles of Incorporation filed on July 24, 1990 (incorporated by reference to Exhibit 3(i)(1) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994).\n3.1(b) Amendment to Articles of Incorporation filed on July 14, 1994 (incorporated by reference to Exhibit 3(i)(2) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994).\n3.2 Amended and Restated By-Laws (incorporated by reference to Exhibit 3(ii) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n4.1 Specimen Class A Common Stock Certificate (incorporated by reference to Exhibit 2(a) to the Company's Registration Statement on Form S-7 filed with the Commission on September 17, 1980, File No. 2-69178).\n4.2 Specimen Class A Special Common Stock Certificate (incorporated by reference to Exhibit 4(2) to the Company's Annual Report on Form 10-K for the year ended December 31, 1986).\n4.3(a) Indenture (including form of Note), dated as of May 15, 1983, between Storer Communications, Inc. and The Chase Manhattan Bank, N.A., as Trustee, relating to 10% Subordinated Debentures due May 2003 of Storer Communications, Inc. (incorporated by reference to Exhibit 4.6 to the Registration Statement on Form S-1 (File No. 2-98938) of SCI Holdings, Inc.).\n4.3(b) First Supplemental Indenture, dated December 3, 1986 (incorporated by reference to Exhibit 4.5 to the Current Report on Form 8-K of Storer Communications, Inc. dated December 3, 1986).\n4.4 Amended and Restated Indenture dated as of June 5, 1992 among Comcast Cellular Corporation, the Company and The Bank of New York, as Trustee, relating to $500,493,000 Series A Senior Participating Redeemable Zero Coupon Notes due 2000 and $500,493,000 Series B Senior Participating Redeemable Zero Coupon Notes due 2000 (incorporated by reference to Exhibit 4.3 to the Registration Statement on Form S-1 (File No. 33-46863) of Comcast Cellular Corporation).\n4.5 Indenture, dated as of October 17, 1991, between the Company and Morgan Guaranty Trust Company of New York, as Trustee (incorporated by reference to Exhibit 2 to the Company's Current Report on Form 8-K filed with the Commission on October 31, 1991).\n4.6 Form of Debenture relating to the Company's 10-1\/4% Senior Subordinated Debentures due 2001 (incorporated by reference to Exhibit 4(19) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n4.7 Form of Debenture relating to the Company's $300,000,000 10-5\/8% Senior Subordinated Debentures due 2012 (incorporated by reference to Exhibit 4(17) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n4.8 Form of Debenture relating to the Company's $200,000,000 9-1\/2% Senior Subordinated Debentures due 2008 (incorporated by reference to Exhibit 4(18) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n4.9 Indenture, dated as of February 20, 1991, between the Company and Bankers Trust Company, as Trustee (incorporated by reference to Exhibit 4.3 to the Company's Registration Statement on Form S-3, File No. 33-32830, filed with the Commission on January 11, 1990).\n4.10 Form of Debenture relating the Company's 3-3\/8% \/ 5-1\/2% Step-up Convertible Subordinated Debentures Due 2005 (incorporated by reference to Exhibit 4(14) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n4.11 Form of Debenture relating to the Company's 1-1\/8% Discount Convertible Subordinated Debentures Due 2007 (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed with the Commission on November 15, 1993).\n10.1(a) Credit Agreement, dated as of March 1, 1991, between Comcast Holdings, Inc., The Chase Manhattan Bank (National Association), as Agent, and various banks, and related agreements included therein (incorporated by reference to Exhibit 10(1) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed April 16, 1991).\n10.1(b) Amendment No. 1, dated as of January 11, 1994, among Comcast Holdings, Inc., the Chase Manhattan Bank (National Association), the banks named therein, and for limited purposes, Comcast Corporation and Comcast Cable Communications, Inc (incorporated by reference to Exhibit 10(1)(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.1(c) Copies of promissory notes delivered to Banks (incorporated by reference to Exhibit 10(1)(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.1(d) Consent and Amendment, dated as of January 13, 1994, among Comcast Holdings, Inc., the Lenders named therein, and for limited purposes, Comcast Corporation and Comcast Cable Communications, Inc. (incorporated by reference to Exhibit 10(1)(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.1(e) Consent and Amendment, dated as of January 13, 1994, among Comcast Holdings, Inc., the Nippon Credit Bank, Ltd., and for limited purposes, Comcast Corporation and Comcast Cable Communications, Inc. (incorporated by reference to Exhibit 10(1)(e) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.1(f) Amendment No. 2, dated as of May 15, 1994, to the Credit Agreement dated as of March 1, 1991, between Comcast Holdings, Inc., The Chase Manhattan Bank (National Association) as Agent, and the Lenders therein, and, for limited purposes, Comcast Corporation, Comcast Cable Communications, Inc. and Corestates Bank, N.A., as 1987 Collateral Agent and 1991 Collateral Agent (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed on November 2, 1994).\n10.1(g) Second Consent and Amendment, dated as of May 15, 1994, to the Credit Agreement dated as of March 1, 1991, among Comcast Holdings, Inc., the Lenders named therein, and for limited purposes, Comcast Corporation and Comcast Cable Communications, Inc.(incorporated by reference to Exhibit 10.6 to the Company's Current Report on Form 8-K filed on November 2, 1994).\n10.1(h) Second Consent and Amendment, dated as of May 15, 1994, to the Credit Agreement dated as of March 1, 1991, among Comcast Holdings, Inc., the Nippon Credit Bank, Ltd. and for limited purposes, Comcast Corporation and Comcast Cable Communications, Inc. (incorporated by reference to Exhibit 10.7 to the Company's Current Report on Form 8-K filed on November 2, 1994).\n10.2(a) Loan Agreements, dated as of March 31, 1987, among Comcast Holdings, Inc. and certain lenders, and related agreements included therein (incorporated by reference to Exhibit 10(29) to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n10.2(b) Amendment Agreements, dated as of March 1, 1991, among Comcast Holdings, Inc. and certain lenders, and related agreements included therein (incorporated by reference to Exhibit 10(2)(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed April 16, 1991).\n10.3 Guaranty by the Company to the City of Philadelphia, dated as of October 30, 1987, (incorporated by reference to Exhibit 10(31) to the Company's Annual Report on Form 10-K for the year ended December 31, 1987).\n10.4* 1982 Incentive Stock Option Plan, as amended (incorporated by reference to Exhibit 10(12) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.5(a)*1986 Amended and Restated Non-Qualified Stock Option Plan (incorporated by reference to Exhibit 10(11) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.5(b)*Amendment to 1986 Nonqualified Stock Option Plan, dated September 16, 1994.\n10.6(a)*Comcast Corporation 1987 Stock Option Plan, as amended and restated (incorporated by reference to Exhibit 99 to the Company's Registration Statement on Form S-8 filed on December 16, 1994).\n10.6(b)* Amendment to 1987 Stock Option Plan, dated September 16, 1994.\n__________ *Constitutes a management contract or compensatory plan or arrangement.\n10.7(a) Retirement-Investment Plan, as amended, including Amendment Nos. 1, 2 and 3 (incorporated by reference to Exhibit 10(17) to the Company's Annual Report on Form 10-K for the year ended December 31, 1990, as amended by Form 8 filed April 16, 1991).\n10.7(b) Amendment Nos. 4, 5 and 6 to the Retirement-Investment Plan (incorporated by reference to Exhibit 10(14) to the Company's Annual Report on Form 10-K for the year ended December 31, 1991).\n10.7(c) Amendment No. 7 to the Retirement-Investment Plan (incorporated by reference to Exhibit 10(9)(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.7(d) Amendment No. 8 to the Retirement-Investment Plan (incorporated by reference to Exhibit 10(9)(d) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.8* Amended and Restated Deferred Compensation Plan, dated January 1, 1995.\n10.9* 1990 Restricted Stock Plan, as amended and restated on November 11, 1994.\n10.10* 1992 Executive Split Dollar Insurance Plan (incorporated by reference to Exhibit 10(12) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.11* Form of Compensation and Deferred Compensation Agreement and Stock Appreciation Bonus Plan for Ralph J. Roberts (incorporated by reference to Exhibit 10(13) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.12 Note Purchase Agreement, dated as of April 27, 1989, by and among Comcast Cable of Maryland, Inc., Comcast Cablevision of Maryland Limited Partnership, COM Maryland, Inc. and the Purchasers Named on Schedule I Thereto relating to $178,000,000 10.57% Senior Notes due 1999 (incorporated by reference to Exhibit 10(25) to the Company's Annual Report on Form 10-K for the year ended December 31, 1989).\n10.13(a) Credit Agreement, dated as of March 4, 1992, among Comcast Cellular Communications, Inc., The Bank of New York, Barclays Bank, PLC, The Chase Manhattan Bank (National Association), Provident National Bank, and The Toronto-Dominion Bank (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed with the Commission on March 19, 1992, as amended by Form 8 dated April 24, 1992).\n10.13(b) Amendment No. 1 to the Credit Agreement, dated as of September 21, 1992, between Comcast Cellular Communications, Inc., the banks named therein and The Toronto-Dominion Bank Trust Company, as Administrative Agent (incorporated by reference to Exhibit (17)(b) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992).\n10.13(c) Amendment No. 2 to the Credit Agreement, dated April 12, 1993, between Comcast Cellular Communications, Inc., the banks named therein and the Toronto-Dominion Bank Trust Company, as administrative agent (incorporated by reference to Exhibit 10(18)(c) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n10.13(d) Amendment No. 3, dated as of September 2, 1994, to the Credit Agreement dated as of March 4, 1992, between Comcast Cellular Communications, Inc., the banks therein and the Toronto-Dominion Bank Trust Company, as administrative agent (incorporated by reference to Exhibit 10.4 to the Current Report on Form 8-K of the Company filed on November 2, 1994).\n10.14 Tax Sharing Agreement, dated as of December 2, 1992, among Storer Communications, Inc., TKR Cable I, Inc., TKR Cable II, Inc., TKR Cable III, Inc., Tele-Communications, Inc., the Company and each of the Departing Subsidiaries that are signatories thereto (incorporated by reference to Exhibit 4 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n_______________ *Constitutes a management contract or compensatory plan or arrangement.\n10.15 Credit Agreement, dated as of December 2, 1992, among Comcast Storer, Inc. and The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce, The Chase Manhattan Bank (National Association), Chemical Bank, LTCB Trust Company and The Toronto-Dominion Bank, as managing agents, and The Bank of New York, as administrative agent (incorporated by reference to Exhibit 5 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.16 Note Purchase Agreement, dated as of November 15, 1992, among Comcast Storer, Inc., Storer Communications, Inc., Comcast Storer Finance Sub, Inc. and each of the respective purchasers named therein (incorporated by reference to Exhibit 6 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.17 Payment Agreement, dated December 2, 1992, among the Company, Comcast Storer, Inc., SCI Holdings, Inc., Storer Communications, Inc. and each of the Remaining Subsidiaries that are signatories thereto (incorporated by reference to Exhibit 7 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.18 Intercreditor and Collateral Agency Agreement, dated as of December 2, 1992, among Comcast Storer, Inc., Comcast Cable Communications, Inc., Storer Communications, Inc., the banks party to the Credit Agreement dated as of December 2, 1992, the purchasers of the Senior Notes under the separate Note Purchase Agreements each dated as of November 15, 1992, the Senior Lenders (as defined therein) and The Bank of New York as collateral agent for the Senior Lenders (incorporated by reference to Exhibit 8 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.19 Tax Sharing Agreement, dated December 2, 1992, between the Company and Comcast Storer, Inc. (incorporated by reference to Exhibit 9 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.20 Pledge Agreement, dated as of December 2, 1992, between Comcast Cable Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 10 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.21 Pledge Agreement, dated as of December 2, 1992, between Comcast Storer, Inc. and The Bank of New York (incorporated by reference to Exhibit 11 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.22 Pledge Agreement, dated as of December 2, 1992, between Storer Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 12 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.23 Note Pledge Agreement, dated as of December 2, 1992, between Comcast Storer, Inc. and The Bank of New York (incorporated by reference to Exhibit 13 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.24 Guaranty Agreement, dated as of December 2, 1992, between Storer Communications, Inc. and The Bank of New York (incorporated by reference to Exhibit 14 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.25 Guaranty Agreement, dated as of December 2, 1992, between Comcast Storer Finance Sub, Inc. and The Bank of New York (incorporated by reference to Exhibit 15 to the Company's Current Report on Form 8-K filed with the Commission on December 17, 1992, as amended by Form 8 filed January 8, 1993).\n10.26(a) Stock Purchase Agreement, dated September 14, 1992, among the Company, Comcast FCI, Inc. and Fleet Call, Inc. (incorporated by reference to Exhibit A to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.26(b) Letter Agreement, dated October 28, 1992, amending Stock Purchase Agreement (incorporated by reference to Exhibit L to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.26(c) Letter Agreement, dated November 24, 1992, amending Stock Purchase Agreement (incorporated by reference to Exhibit M to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.26(d) Notice, dated February 15, 1993, from Fleet Call, Inc. to the Company pursuant to the Stock Purchase Agreement (incorporated by reference to Exhibit N to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.26(e) Acknowledgement, dated February 15, 1993, among the Company, Comcast FCI, Inc. and Fleet Call, Inc. (incorporated by reference to Exhibit O to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.26(f) Letter Agreement, dated February 15, 1993, amending the Stock Purchase Agreement (incorporated by reference to Exhibit P to Amendment No. 2 to the Company's Schedule 13D dated February 23, 1993 filed with respect to Fleet Call, Inc.).\n10.26(g) Letter Agreement, dated July 22, 1993, among the Company, Comcast FCI, Inc. and Nextel Communications, Inc. (formerly Fleet Call, Inc.) (incorporated by reference to Exhibit A to Amendment No. 3 to Schedule 13D dated July 27, 1993 filed by the Company with respect to Nextel Communications, Inc.).\n10.26(h) Amendment, dated August 4, 1994, to Stock Purchase Agreement dated as of September 14, 1992 among Comcast Corporation, Comcast FCI, Inc. and Nextel Communications, Inc. (incorporated by reference to Exhibit C to Amendment No. 7 to the Schedule 13D of Comcast Corporation relating to common stock of Nextel Communications, Inc. filed on August 9, 1994).\n10.27 Option Agreement, dated September 14, 1992, between Fleet Call, Inc. and Comcast FCI, Inc. (incorporated by reference to Exhibit B to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.28 Promissory Note, dated September 14, 1992, issued by Comcast FCI, Inc. in favor of Fleet Call, Inc. (incorporated by reference to Exhibit C to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.29 Stock Pledge Agreement, dated September 14, 1992, between Comcast FCI, Inc. and Fleet Call, Inc. (incorporated by reference to Exhibit D to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.30 Stockholders' Voting Agreement, dated September 14, 1992, among Comcast FCI, Inc. and the other parties named therein (incorporated by reference to Exhibit E to Amendment No. 1 to the Company's Schedule 13D dated September 22, 1992 filed with respect to Fleet Call, Inc.).\n10.31(a) Share Purchase Agreement, dated June 18, 1994, between Comcast Corporation and Rogers Communications Inc. (incorporated by reference to Exhibit 10(3) to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994).\n10.31(b) First Amendment to Share Purchase Agreement, dated as of December 22, 1994, by and between Comcast Corporation and Rogers Communications Inc., to the Share Purchase Agreement dated June 18, 1994 (incorporated by reference to Exhibit 10.9 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.32(a) Agreement and Plan of Merger, dated August 4, 1994, among Comcast Corporation, Liberty Media Corporation, Comcast QMerger, Inc. and QVC, Inc. (incorporated by reference to Exhibit 99.49 to Amendment No. 21 to the Schedule 13D of Comcast Corporation relating to common stock of QVC, Inc. filed on August 8, 1994).\n10.32(b) First Amendment to Agreement and Plan of Merger, dated as of February 3, 1995, (incorporated by reference to Exhibit (c)(35) to Amendment No. 17 to the Tender Offer Statement on Schedule 14D-1 filed with the Securities and Exchange Commission on February 6, 1995 by QVC Programming Holdings, Inc., Comcast Corporation and Tele-Communications, Inc. with respect to the tender offer for all outstanding shares of QVC, Inc.).\n10.33 CreditAgreement, dated as of February 15, 1995, among QVC, Inc. and the Banks listed therein (incorporated by reference to Exhibit (b)(6) to Amendment No. 21 to the Tender Offer Statement on Schedule 14D-1 filed with the Securities and Exchange Commission on February 17, 1995 by QVC Programming Holdings, Inc., Comcast Corporation and Tele-Communications, Inc. with respect to the tender offer for all outstanding shares of QVC, Inc.).\n10.34 Storer Communications Retirement Savings Plan, dated January 1, 1993, (incorporated by reference to Exhibit 4.1 to the Form S-8 of Comcast Corporation filed on June 29, 1994).\n10.35 Credit Agreement, dated as of September 14, 1994, among Comcast Cable Tri-Holdings, Inc., The Bank of New York, The Chase Manhattan Bank (National Association), PNC Bank, National Association, as Managing Agents, and the Bank of New York, as Administrative Agent, and the banks named therein (incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K of the Company filed on November 2, 1994).\n10.36 Comcast MHCP Holdings, L.L.C. Amended and Restated Limited Liability Company Agreement, dated as of December 18, 1994, among Comcast Cable Communications, Inc., The California Public Employees' Retirement System and, for certain limited purposes, Comcast Corporation (incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.37 Credit Agreement, dated as of December 22, 1994, among Comcast MH Holdings, Inc., the banks listed therein, The Chase Manhattan Bank (National Association), NationsBank of Texas, N.A. and the Toronto-Dominion Bank, as Arranging Agents, The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Morgan Guaranty Trust Company of New York, as Managing Agents and NationsBank of Texas, N.A., as Administrative Agent (incorporated by reference to Exhibit 10.2 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.38 Pledge Agreement, dated as of December 22, 1994, between Comcast MH Holdings, Inc. and NationsBank of Texas, N.A., as the secured party (incorporated by reference to Exhibit 10.3 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.39 Pledge Agreement, dated as of December 22, 1994, between Comcast Communications Properties, Inc. and NationsBank of Texas, N.A., as the Secured Party (incorporated by reference to Exhibit 10.4 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.40 Affiliate Subordination Agreement (as the same may be amended, modified, supplemented, waived, extended or restated from time to time, this \"Agreement\"), dated as of December 22, 1994, among Comcast Corporation, Comcast MH Holdings, Inc., (the \"Borrower\"), any affiliate of the Borrower that shall have become a party thereto and NationsBank of Texas, N.A., as Administrative Agent under the Credit Agreement dated as of December 22, 1994, among the Borrower, the Banks listed therein, The Chase Manhattan Bank (National Association), NationsBank of Texas, N.A. and The Toronto-Dominion Bank, as Arranging Agents, The Bank of New York, The Bank of Nova Scotia, Canadian Imperial Bank of Commerce and Morgan Guaranty Trust Company of New York, as Managing Agents, and the Administrative Agent (incorporated by reference to Exhibit 10.5 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.41 Registration Rights and Price Protection Agreement, dated as of December 22, 1994, by and between Comcast Corporation and The California Public Employees' Retirement System (incorporated by reference to Exhibit 10.8 to the Company's Current Report on Form 8-K filed on January 6, 1995).\n10.42 Agreement of Limited Partnership of WirelessCo, L.P., a Delaware Limited Partnership, dated as of October 24, 1994, by and among Sprint Spectrum, Inc., TCI Network, Inc., Comcast Telephony Services and Cox Communications Wireless, Inc., each as a General Partner and a Limited Partner.\n10.43\/*\/ Credit Agreement, dated as of November 18, 1994, among Comcast Corporation and The Bank of New York, Chemical Bank and The Toronto-Dominion Bank, as Managing Agents and Issuing Banks, The Bank of New York and Chemical Bank, as Co-Administrative Agents, The Toronto-Dominion Bank, as Documentation Agent and The Bank of New York, as Paying Agent, and the Banks listed therein.\n10.44\/*\/ Guaranty Agreement, dated as of November 18, 1994, between Comcast Cable Communications, Inc., and The Bank of New York, as paying agent on behalf of itself, the Banks, the Managing Agents, the Issuing Banks, the Co-Administrative Agents and the Documentation Agent under and as defined in the Credit Agreement dated as of November 18, 1994.\n10.45\/*\/ Pledge Agreement, dated as of January 1, 1996, between Comcast Corporation and The Bank of New York, as the Secured Party.\n10.46\/*\/ Affiliate Subordination Agreement, dated as of November 18, 1994, among Comcast Cable Communications, Inc., Comcast Financial Corporation, and any affiliate of the borrower or Comcast that shall have become a party hereto and The Bank of New York, as Paying Agent under the Credit Agreement dated as of November 18, 1994.\n21 List of Subsidiaries.\n23 Accountants' Consents.\n27 Financial Data Schedule.\n99.1 Report of Independent Public Accountants to Garden State Cablevision L.P., as of December 31, 1994 and 1993 and for the years then ended.\n99.2 Report of Independent Public Accountants to Garden State Cablevision L.P., as of December 31, 1993 and 1992 and for the years then ended (incorporated by reference to Exhibit 99(1) to the Company's Annual Report on Form 10-K for the year ended December 31, 1993).\n99.3 Report of Independent Public Accountants to Comcast International Holdings, Inc., as of December 31, 1994 and 1993 and for the years then ended.\n\/*\/ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish a copy of the referenced agreement to the Commission upon request.\n(c) Reports on Form 8-K\nThe Company filed a Current Report on Form 8-K under Item 5 on November 2, 1994 which included the Company's Unaudited Pro Forma Condensed Consolidated Financial Statements and the Combined Financial Statements for the U.S. Cable Television Operations of Maclean Hunter as well as the Consolidated Financial Statements for QVC, Inc. (formerly, QVC Network, Inc.) for the year ended January 31, 1994 and for the quarter ended April 30, 1994, which were incorporated by reference to QVC, Inc.'s Annual Report on Form 10-K and Quarterly Report on Form 10-Q for those periods, respectively.\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 Philadelphia, Pennsylvania on February 22, 1995.\nComcast Corporation\nBy: \/s\/ BRIAN L. ROBERTS -------------------------- Brian L. Roberts President 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.\nCOMCAST CORPORATION AND SUBSIDIARIES\nSCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(Dollars in thousands)\nINDEX TO EXHIBITS Exhibit Number Exhibit\n10.5(b)* Amendment to 1986 Nonqualified Stock Option Plan, dated September 16, 1994.\n10.6(b)* Amendment to 1987 Stock Option Plan, dated September 16, 1994.\n10.8* Amended and Restated Deferred Compensation Plan, dated January 1, 1995.\n10.9* 1990 Restricted Stock Plan, as amended and restated on November 11, 1994.\n10.42 Agreement of Limited Partnership of WirelessCo, L.P., a Delaware Limited Partnership, dated as of October 24, 1994, by and among Sprint Spectrum, Inc., TCI Network, Inc., Comcast Telephony Services and Cox Communications Wireless, Inc., each as a General Partner and a Limited Partner.\n10.43\/*\/ Credit Agreement, as of November 18, 1994, among Comcast Corporation, The Bank of New York, Chemical Bank and The Toronto-Dominion Bank, as Managing Agents and Issuing Banks, The Bank of New York and Chemical Bank, as Co-Administrative Agents, The Toronto-Dominion Bank, as Documentation Agent and The Bank of New York, as Paying Agent, and the Banks listed therein.\n10.44\/*\/ Guaranty Agreement, dated as of November 18, 1994, between Comcast Cable Communications, Inc., and The Bank of New York, as paying agent on behalf of itself, the Banks, the Managing Agents, the Issuing Banks, the Co-Administrative Agents and the Documentation Agent under and as defined in the Credit Agreement dated as of November 18, 1994.\n10.45\/*\/ Pledge Agreement, dated as of January 1, 1996, between Comcast Corporation and The Bank of New York, as the Secured Party.\n10.46\/*\/ Affiliate Subordination Agreement, dated as of November 18, 1994, among Comcast Cable Communications, Inc., Comcast Financial Corporation, and any affiliate of the borrower or Comcast that shall have become a party hereto and The Bank of New York, as Paying Agent under the Credit Agreement dated as of November 18, 1994.\n21 List of Subsidiaries.\n23 Accountants' Consents.\n27 Financial Data Schedule.\n99.1 Report of Independent Public Accountants to Garden State Cablevision L.P., as of December 31, 1994 and 1993 and for the years then ended.\n99.3 Report of Independent Public Accountants to Comcast International Holdings, Inc., as of December 31, 1994 and 1993 and for the years then ended.\n- -------------- * Constitutes a management contract or compensatory plan or arrangement.\n\/*\/ Pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K, the Registrant agrees to furnish a copy of the referenced agreement to the Commission upon request.","section_15":""}
{"filename":"314727_1994.txt","cik":"314727","year":"1994","section_1":"Item 1. BUSINESS\nHandleman Company, a Michigan corporation (herein referred to as the \"Company\" or \"Handleman\" or \"Registrant\"), which has its executive office in Troy, Michigan, is the successor to a proprietorship formed in 1934, and to a partnership formed in 1937.\nDESCRIPTION OF BUSINESS: - ------------------------\nHandleman Company is engaged in the sale and distribution of prerecorded music, video, hardcover and paperback books, and personal computer software primarily to mass merchants throughout the United States and Canada. In fiscal 1994 the Registrant established a distribution company with headquarters in Mexico City to supply music and video products to retail outlets throughout Mexico. In addition, the Company provides various services as a specialized merchandiser (rackjobber) to these accounts. The Company is also in the business of acquiring video licenses, giving it exclusive rights to manufacture and distribute certain video products.\nThe following table sets forth net sales, and the approximate percentage contribution to consolidated sales, for the fiscal years ended April 30, 1994, May 1, 1993 and May 2, 1992, for the prerecorded music, video, books, and personal computer software product lines of the Company.\nBusiness Segments -----------------\nThe Company operates in one business segment, selling home entertainment software to mass merchant and specialty chain stores, drugstores and supermarkets. The Company has both United States and Canadian operations which are set forth below. Operations in Mexico were not material in fiscal 1994.\nGENERAL -------\nThe Company is a link between manufacturers of home entertainment software products and mass merchant chain stores. Customers purchase from Handleman due to the value-added benefits the Company adds to the basic product, and due to the benefit of only dealing with one vendor. Manufacturers utilize the Company's services to avoid the necessity of distributing to thousands of individual stores throughout a vast geographic range. Information regarding the number of active vendors from which the Company purchases, number of titles the Company is currently distributing and number of retail departments presently serviced follows:\nThe Company is also engaged in acquiring licenses providing exclusive rights for the duplication and distribution of certain video products. These activities are conducted by Video Treasures, Inc., a wholly owned subsidiary of the Company. Video Treasures' fiscal 1994 sales, including $13.7 million in sales to Handleman Company, were $34.8 million, compared to $33.2 million in the prior year. Video Treasures currently has over 2,000 titles available for distribution in its catalog. Video Treasures is continuously seeking to expand its product catalog with budget and selected frontline titles.\nVendors -------\nAn important reason the Company's customers utilize its services is due to the multitude of vendors offering products for-sale, the complexity of vendor programs, the \"hits\" nature of the business, and the high risk of inventory obsolescence.\nThe Company must anticipate consumer demand for individual titles. In order to maximize sales, the Company must be able to immediately react to \"breakout\" titles, while simultaneously minimizing inventory exposure for artists or titles which do not sell. In addition, because the Company distributes throughout the U.S. and Canada, it must adapt selections it offers to local tastes. This is accomplished via a coordination of national and local purchasing responsibility, both monitored by inventory control programs.\nThe Company purchases from many different vendors. The volume of purchases from individual vendors fluctuates from year-to-year based upon the saleability of selections being offered by such vendor. Though within each product line a small number of major, financially sound vendors account for a high percentage of purchases, product must be selected from a variety of vendors in order to maintain an adequate selection for consumers. The Company must closely monitor its inventory exposure and accounts payable balances with smaller vendors which may not have the financial resources to honor their return commitments. At this time, the high risk vendors which require close monitoring tend to be concentrated in the video and software product lines.\nSince the public's taste in prerecorded music, video, books, and personal computer software is broad and varied, Handleman is required to maintain large inventories to satisfy diverse tastes. The Company minimizes the effect of obsolescence through planned purchasing methods and computerized inventory controls. Since substantially all vendors from which the Company purchases product offer some level of return allowances and price protection, the Company's exposure to markdown risk is limited unless vendors are unable to fulfill their return obligation or non-saleable product purchases exceed vendor return limitations. It is possible that the Company may possess in its inventories certain product that it cannot utilize in the ordinary course of business and may only be returnable with cost penalties or may be non-returnable until the Company can comply with the provisions of the vendor's return policies. Vendors offer a variety of return programs, ranging from 100% returns to zero return allowance. Other vendors offer incentive and penalty arrangements to restrict returns.\nHandleman generally does not have distribution contracts with manufacturers or suppliers; consequently, its relationships with them may be discontinued at any time by such manufacturers or suppliers, or by Handleman.\nCustomers ---------\nHandleman Company's customers utilize its services for a variety of reasons. The Company selects products from a multitude of vendors offering numerous titles, different formats (e.g., cassettes, compact discs) and different payment and return arrangements. As a result, customers avoid most of the risks inherent in product selection and the risk of inventory obsolescence.\nHandleman also offers its customers a variety of \"value-added\" services:\nSTORE SERVICE: Sales representatives visit individual retail stores and meet with store management to discuss upcoming promotions, special merchandising efforts, department changes, current programs, or breaking releases which will increase sales. They also monitor inventory levels, check merchandise displays, and install point-of-purchase advertising materials.\nADVERTISING: Handleman supplies point-of-purchase materials and assists customers in preparing radio, television and print advertisements.\nFIXTURING: Handleman provides specially designed fixtures that emphasize product visibility and accessibility.\nFREIGHT: Handleman coordinates delivery of product to each store.\nPRODUCT EXCHANGE: Handleman protects its continuing customers against product markdowns by offering the privilege of exchanging slower-selling product for best sellers.\nThe nature of the Company's business lends itself to computerized ordering and distribution techniques, which the Company pioneered and implemented in the United States and Canada through development of its computerized system, known as Retail Inventory Management Systems (RIMS). RIMS is refined continuously to meet the more sophisticated needs of its customer base. RIMS captures consumer demand and integrates retail inventory control with ordering and distributing functions. RIMS can also accept transmissions of customer point-of-sale data so as to immediately react to store selling patterns. Using RIMS, the Company is able to tailor the inventories of individual stores to reflect the customer profile of each store and to adjust inventory levels, product mix and selections according to seasonal and current selling trends.\nThe Company determines the selections to be offered in its customers' retail stores, and ships these selections to the stores from one of its distribution centers located throughout North America. Slow selling items are removed from the stores by the Company and are recycled for redistribution or returned to the manufacturers. Returns from customer stores occur for a variety of reasons, including new releases which did not achieve their expected sales potential, ad product to be returned after the ad has run, regularly scheduled realignment pick-ups and customer directed returns. The Company provides a reserve for the gross profit margin impact of expected customer returns.\nDuring the fiscal year ended April 30, 1994, one customer, Kmart Corporation, accounted for approximately 41% of the Company's consolidated sales, while a second customer, Wal-Mart, accounted for approximately 26%. Handleman may not have contracts with its customers, and such relationships may be discontinued at any time by the customers or Handleman; the discontinuance of the relationships with either of the two largest customers would have a materially adverse effect upon the Company's future sales and earnings.\nOperations ----------\nThe Company distributes products from facilities throughout the U.S. and Canada. Besides economies of scale and through-put considerations in determining the number of facilities it operates, the Company must also consider freight costs to and from customers' stores and the importance of timely delivery of new releases. Due to the nature of the home entertainment software business, display of new releases close to authorized \"street dates\" is an important driver of both retail sales and customer satisfaction.\nThe Company also operates four regional return centers in the United States as a means to expedite the processing of customer returns. In order to minimize inventory investment, customer returns must be sorted and identified for either redistribution or return to vendors as expeditiously as possible. An item returned from one store may actually be required for shipment to another store. Therefore, timely recycling prevents purchasing duplicate product for a store whose order could be filled from returns from other stores.\nThe Registrant has established a distribution company, with its headquarters and warehouse in Mexico City, to supply music and video products to retail outlets throughout Mexico\nOn June 9, 1994, the Company announced that it was realigning its Western region by replacing certain distribution centers with a new automated distribution center (\"ADC\") to be located in Sparks, Nevada. The implementation of the ADC will reduce operating costs and decrease inventory levels, while improving the Company's speed and reliability in supplying products to its customers. See Note 4, Provision for Facility Realignment, on page 24 under Item 8, for additional information regarding the facility realignment.\nThe Company is installing a new proprietary inventory management system (\"PRISM\"). As of April 30, 1994, PRISM had been installed in three branches, and it is scheduled to be installed in the remaining U.S. and Canadian, music and video shipping branches and return centers during fiscal 1995. PRISM automates and integrates the functions of ordering product, receiving, warehousing, order fulfillment, ticket printing, perpetual inventory maintenance and accounts payable. PRISM also provides the basis to develop title specific billing to allow the Company to better serve its customers.\nCompetition -----------\nHandleman is primarily a specialized merchandiser (rackjobber) of prerecorded music, video, books and personal computer software. The business of the Company is highly competitive as to both price and alternative supply arrangements in all of its product lines. The Company's customers compete with alternative sources from which consumers could purchase the same product, such as (1) record and book clubs, (2) video rental outlets, and (3) specialty retail outlets. The Company competes directly for sales to its customers with (1) manufacturers which bypass wholesalers and sell directly to retailers, (2) independent distributors, and (3) other specialized merchandisers. In addition, some large mass merchants have \"vertically integrated\" so as to provide their own rackjobbing. Some of these companies, however, also purchase from independent rackjobbers.\nThe Company believes that the distribution of home entertainment software will remain highly competitive. The Company believes that customer service and continual progress in operational efficiencies are the keys to growth in this competitive environment.\nIndustry Outlook ----------------\nThe following are some statistics from various industry sources.\n. According to the Electronic Industries Association (\"EIA\"), compact disc hardware sales increased 27% to 20.5 million units in 1993 from 16.1 million units in 1992. As a result, penetration into U.S. households has reached 43%.\n. Video cassette recorder (\"VCR\") penetration into U.S. households reached 82% in 1993, and is expected to grow to approximately 90% by 1997, according to Veronis, Suhler & Associates (\"Veronis\").\n. According to the EIA, sales of personal computers increased 10% to 7.8 million units in 1993, and are expected to increase an additional 11% in 1994.\nWhile Handleman does not market home electronic hardware, its business is closely correlated to the health of the consumer electronics market and developments within that industry. The Company's expertise lies in the selection of the best product available from the multitude of suppliers for each hardware format.\nInformation regarding industry outlook by product line follows:\nMusic - -----\nAccording to the Recording Industry Association of America (RIAA), the U.S. music industry posted sales, at list price, of $10.0 billion in 1993, growing 11% from $9.0 billion in 1992. According to Veronis, the U.S. market is expected to grow at a 7.4% compound annual rate through 1997, to a total market size of approximately $13 billion, at list.\nCompact discs (\"CDs\") remained the catalyst of music industry growth in 1993. In 1993, net revenues from CD sales increased over 22% to $6.5 billion for the year.\nDespite the growing dominance of CDs, cassettes still remain a popular format. Industry-wide sales of cassettes, including cassette singles, were $3.2 billion in calendar 1993. Car stereos and portable systems, two areas where CDs have had very little impact, still rely almost entirely on the analog cassette. The size, cost and convenience of cassettes are also important factors in the continuing popularity of this music format.\nThe Canadian Recording Industry Association reported results similar to its U.S. counterpart. Net revenues rose 12% from $467 million in 1992 to $525 million in 1993. This increase is again due to the continued growth in CDs, sales of which increased 21% in 1993 to $368 million.\nVideo - -----\nThe continued success of VCR hardware has translated directly into increased sell-through revenues. According to Veronis, for-sale home video in the United States was a $4.2 billion business in 1993, at retail, growing 12% from 1992. Media analysts Paul Kagan Associates project industry video sales to be $7 billion by 1997, at retail.\nThe Company is monitoring developments within the Pay Per View (PPV) market, but does not perceive such developments as a near term threat to the sell-through video market. From a longer-term perspective, the Company believes PPV, in some way, shape or form, is probably inevitable. However, PPV replacing video sell- through is not believed to be inevitable. There are numerous reasons why the Company and many industry experts feel this way. First is cost. The cost of PPV systems will be high and for many consumers, prohibitive. Second, PPV is perceived to be a substitute for rental more than it is for sell-through. In fact, some feel that PPV will serve to increase the sell-through market by increasing consumer awareness of video product. Finally, PPV's impact on sell- through will be limited because PPV cannot replace the appealing characteristics of video sell-through. Sell-through offers consumers the shopping experience, the ability to collect and display, and the option to give a video as a gift.\nBooks - -----\nConsumer interest in reading continues to remain strong according to industry sources. Book industry sales grew 7.0% in 1993 to $14.4 billion, according to Veronis. In addition, consumer books are projected to grow at a 7.4% compound annual rate to $19.2 billion by 1997.\nThe book industry is a more mature market, and thus a less volatile market, than either the music or video industry. However, mass media promotions have helped spur increased interest and consumer demand. Both paperbacks and hardcovers are being promoted via print and television advertising, and many talk show programs profile authors and their books. In addition, mega-star authors such as John Grisham, Stephen King and Danielle Steel continue to produce best sellers which are purchased by their loyal readers.\nSoftware - --------\nApproximately 7.8 million personal computers (\"PCs\") were sold to dealers in 1993, up 715,000 units from 1992, according to the EIA. This growth is expected to carry forward to 1994, with a further 12% increase in PC sales projected by the EIA. These growth rates are indicative of the strong demand for personal computers and the software to operate them.\nOne of the factors helping propel PC sales has been the steady decrease in PC per unit prices. For example, a state-of-the-art PC in January 1990 could have had a retail price up to $5,995. In June 1994, a comparable PC cost less than $1,000. The retail price of a PC is now in the price range where a typical mass merchant shopper is able to purchase a PC and this accordingly spurs sales of software products at the mass merchant outlet.\nThe vast majority of PC sales in the U.S. are IBM compatible units which utilize a DOS operating system. However, a new operating system, Windows, is quickly growing in popularity. The advent of this new technology is exciting for software manufacturers, distributors and retailers, because as PC owners switch to Windows, they often purchase the Windows version of their current software. This effect is similar to music buyers rebuilding their libraries with CDs.\n* * * * *\nSee Management's Discussion and Analysis of Financial Condition and Results of Operations and Note 2, Acquisition of Business, on page 24 under Item 8, for additional information regarding the Company's activities.\nThe Company's sales and earnings are of a seasonal nature. Note 10, Quarterly Financial Summary (Unaudited), on page 28 under Item 8 discloses quarterly results which indicate the seasonality of the Company's business.\nThe Company has approximately 3,742 employees, of whom approximately 490 are members of various local unions.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nThe Company leases 6 warehouses in the United States and 3 in Canada. The U.S. leased warehouses are located in the states of Missouri, New York, Ohio, Oregon, Indiana, and Maryland. The Company also leases satellite sales offices in Massachusetts (381 sq. ft.) and Minnesota (6,000 sq. ft.). In Canada, leased warehouses are located in the provinces of Alberta, Ontario and Quebec. The Company owns warehouses in Sparks, Nevada; Brighton, Michigan; Chicago, Illinois; Dallas, Texas; Los Angeles, California; Atlanta, Georgia; Little Rock, Arkansas; Tampa, Florida; Baltimore, Maryland; Cincinnati, Ohio and Denver, Colorado. The Company owns two buildings in Troy, Michigan; one facility is the 130,000 square feet corporate office building, and the second facility is the 20,000 square feet building which houses the Company's print shop. The Atlanta, Little Rock and Troy buildings are encumbered by Economic Development Corporation Revenue Bonds as explained in Note 6 to Handleman's Consolidated Financial Statements under Item 8. The bonds were issued in connection with the construction of these buildings.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Registrant or any of its subsidiaries is a party other than ordinary routine litigation incidental to the business.\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\nThe Company's common stock is traded on the New York Stock Exchange, Chicago Stock Exchange, and Pacific Stock Exchange.\nBelow is a summary of the market price of the Company's common stock as traded on the New York Stock Exchange:\nAs of July 15, 1994, the Company had 3,423 shareholders of record.\nBelow is a summary of the dividends declared during the past two fiscal years:\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nHANDLEMAN COMPANY FIVE YEAR REVIEW (amounts in thousands except per share data and ratios) -----------------\n* Inventory turnover ratio has been restated for prior years to conform with current year calculation method.\nNote: See Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nCOMPARISON OF 1994 WITH 1993 - ----------------------------\nNet sales for fiscal 1994 were $1.07 billion versus $1.12 billion last year, a decrease of $55.1 million or 5%. Following is a discussion regarding each of the Company's four major product lines.\nMUSIC - Sales for fiscal 1994 were $571.6 million, compared to $626.9 million in fiscal 1993, a decrease of $55.3 million or 9%. The Company attributes the decline in sales of music product to two primary factors. First was the impact of customer inventory concerns, which resulted in reduced sales volume and increased merchandise returns. The second factor was a reduction in the number of departments serviced.\nWithin the music category, the proportion of compact disc (\"CD\") sales to the overall sales mix continues to increase. According to the Recording Industry Association of America (\"RIAA\"), a music industry trade association, industry- wide CD shipments at list price reached 65% of total music revenue in calendar 1993. Handleman's CD sales for fiscal 1994 were $278.1 million, or 49% of its music sales. In fiscal 1993, CD's accounted for 46% of Handleman's music sales. CD sales growth, like any software product, is influenced by growth in the underlying hardware. In 1993, the installed base of CD players was 43% of U.S. households, according to the Electronic Industries Association (\"EIA\"). As CD hardware continues to be purchased by middle-income Americans, who tend to be shoppers at mass merchant outlets (the Company's primary customer), Handleman's sales of CDs should continue to grow.\nThe gross profit margin percentage on CD sales is lower than on cassette sales. As a result of CD unit sales prices, however, being greater than cassette unit sales prices, gross profit dollars per CD unit sold are higher than gross profit dollars per cassette unit sold.\nMusic sales are driven by a continuous supply of releases from popular artists, as well as emerging new artists. Below is a summary of Handleman's music sales by genre, as a percent to total music sales dollars.\nMUSIC SALES BY GENRE YEAR ENDED _____________________\nApril April April 1994 1993 1992 ----- ----- -----\nCountry music continues to be popular. Mass merchant stores serviced by Handleman sell more country music as a percentage of total music volume than do specialty music stores. Rock music continues to be the largest sales category for both Handleman and the music industry.\nA statistical overview of the U.S music industry as contained in the RIAA 1993 annual report showed that music buyers are continuing to spend more at mass merchant and discount stores than in past years. The mass merchant share of music sales increased to 24% in 1993, from 16% in 1989. During the same time period, the specialty music store market share decreased from 72% to 60%.\nVeronis, Suhler & Associates (\"Veronis\"), an entertainment industry investment banker, forecasted in July 1993 that the U.S. music market will register sales growth at a 7.4% compounded annual rate through 1997.\nVIDEO - Sales for fiscal 1994 were $389.5 million, compared to $378.6 million in fiscal 1993, a $10.9 million or 3% increase. This sales level of video product was the highest for any year in the Company's history.\nMovies, including G-rated family oriented features, and children's product are the largest unit sales categories for Handleman, representing approximately 80% of unit sales. However, a full catalog assortment is necessary to achieve maximum sales. The Company maintains a commitment to its video program with approximately 5,700 titles in its catalog.\nThe continued penetration of video cassette recorders (\"VCR\") into U.S. households has helped increase sell-through video revenue. The VCR's penetration into U.S. households reached an estimated 82% in 1993; furthermore 20% of households with a VCR now own a second VCR. Much of this growth has been due to the steady decline of VCR prices. In 1979 the average price of a VCR was approximately $1,200. According to the EIA, the average retail price of a VCR dropped to $294 by 1987 and to $231 by 1993. Although growth is predictably slowing, Veronis forecasts that an installed base of 90% of U.S. households should be achieved by 1996. This penetration level represents a base capable of supporting expansion of the home video market through the 1990's.\nThe continual release of movie box office hits builds consumer awareness of for- sale videos, which drives sales not only for those titles but for other videos as well. Articles appearing in both Billboard and Video Store Magazine state that calendar 1994 will be an excellent year for direct-to-sell-through titles as movie studios are increasingly willing to by-pass the rental market as the first window of opportunity for a title. Further, instead of releasing the majority of titles for the Christmas selling season, studios are scheduling major titles for release throughout the year.\nVeronis projects that calendar 1993 industry video sales hit a record high of $4.2 billion, at retail, a 12% increase over calendar 1992. According to media analysts Paul Kagan Associates, industry video sales are projected to be $7 billion by 1997, at retail.\nBOOKS - Sales for fiscal year 1994 were $66.1 million, compared to $70.9 million last year, a decrease of $4.8 million or 7%. This decrease was primarily due to a reduction in the number of departments supplied.\nConsumer interest in reading continues to remain strong according to industry sources. Book industry sales grew an estimated 7.0% to $14.4 billion at retail in 1993. According to Veronis, consumer books are projected to grow at a 7.4% compounded annual rate to $19.2 billion at retail by 1997. Much of this growth appears to be fueled by increased reading habits by a larger segment of the population, increasing literacy among Americans, and the ability of the book publishing industry to better define and target consumer markets.\nPERSONAL COMPUTER SOFTWARE - Sales for fiscal 1994 were $39.4 million, compared to $45.3 million for fiscal 1993, a decrease of $5.9 million or 13%. The decline in sales was primarily due to the loss of two customers in the third quarter this year, who switched to suppliers that do not provide in-store service.\nPersonal computers (\"PCs\") continue to gain acceptance in U.S. households as computers become more user friendly. According to the EIA, the installed base of computers has increased from 7% in 1983 to 37% of households at the end of 1993. The installed base is expected to increase to 40% by 1995. Mass merchants increasingly play an important role in the growth of this market. Handleman is expected to benefit as more middle-income Americans, the typical shoppers at stores supplied by Handleman, purchase computers.\nOne of the factors helping propel PC sales has been a steady decrease in PC unit prices. For example, a state-of-the-art PC in January 1990 could have had a retail price up to $5,995. In June 1994, a comparable PC cost less than $1,000. The retail price of a PC is now in the price range where a typical mass merchant shopper is able to purchase a PC and this accordingly spurs sales of software products at the mass merchant outlet.\nThe retail price of PC software is rapidly declining due to strong competition among software companies trying to capture market share in their respective categories. For example, retail prices for many productivity software packages have fallen from an introductory price of $300 - $500 to less than $100. In fiscal 1994, over 70% of Handleman's unit sales were for software titles with suggested retail prices under $15. This trend should benefit mass merchants, as their shoppers are more likely to purchase the lower-priced software.\nOTHER DATA - The gross profit margin percentage for fiscal year 1994 was 23.3%, compared to 24.8% for fiscal year 1993. The reduction in gross profit margin percentage was primarily due to an increase in mega-hit video sales, which carry lower gross profit margins than other products, and a decrease in music gross profit margin partially attributable to a decline in sales of high margin budget products and to an increasing percentage of sales of CDs.\nSelling, general and administrative expenses for fiscal year 1994 declined $4.9 million, to $186.2 million or 17.5% of net sales, from $191.1 million or 17.0% of net sales last year. The decrease in selling, general and administrative expense dollars was primarily due to cost reductions initiated by Company management and the lower sales volume. Except for the first quarter of fiscal 1994, selling, general and administrative expenses, as a percent of net sales, were lower in each fiscal quarter compared to the corresponding quarter in fiscal 1993. Selling, general and administrative expenses exclude the amortization of costs associated with prior year acquisitions which amounted to $7,536,000 in fiscal 1994.\nOn June 9, 1994, the Company announced that it was realigning its Western region by replacing certain distribution centers with a new automated distribution center (\"ADC\") to be located in Sparks, Nevada. The Company recorded a $2.0 million pre-tax charge against fourth quarter fiscal 1994 results related to costs associated with the transition from the current distribution structure to the ADC. This charge included costs for disposal of certain facilities as well as relocation expenses and certain compensation costs. The implementation of the ADC will reduce operating costs and decrease inventory levels, while improving the Company's speed and reliability in supplying products to its customers.\nNet interest expense for fiscal 1994 was $6,211,000, compared to $6,713,000 in fiscal 1993. The decline in net interest expense was primarily the result of lower interest rates in fiscal 1994 compared to fiscal 1993.\nNet income for fiscal 1994 was $27.7 million or $.83 per share, compared to $43.7 million or $1.32 per share for fiscal 1993. The reduction in net income was primarily attributable to the reduction in sales and the decrease in gross profit margin percentage.\nCOMPARISON OF 1993 WITH 1992 - ----------------------------\nNet sales for fiscal 1993 were $1.12 billion versus $1.02 billion in fiscal 1992, an increase of $101.5 million or 10%. The first quarter of fiscal 1993 included sales of approximately $40.0 million to customers gained following the July 26, 1991 purchase of assets from Lieberman Enterprises. The first quarter of fiscal 1992 did not include sales to such customers since the transaction did not occur until the end of the first quarter of fiscal 1992. The Company's fiscal year ends on the Saturday closest to April 30th; as a result, fiscal 1992 was a 53 week year while fiscal 1993 was a 52 week year. Following is a discussion regarding each of the Company's four major product lines.\nMUSIC - Sales for fiscal 1993 were $626.9 million, compared to $542.3 million in fiscal 1992, an increase of $84.6 million or 16%. The increase in music sales was achieved primarily through increased sales of compact discs (\"CD\") and the continued popularity of country music. The Company benefits from the strength in country music sales since its market share of the country music segment of the industry exceeds its share of overall music industry sales.\nThe Company's fiscal 1993 CD sales of $287 million represented a 38% increase over the prior year's CD sales volume. CDs accounted for 46% of Handleman's music sales in fiscal 1993 versus 38% of the Company's music sales in fiscal 1992.\nVIDEO - Sales for fiscal 1993 were $378.6 million, compared to $387.3 million in fiscal 1992, a decrease of 2%. The decline in video sales was primarily due to lower sales of Disney products. In July 1992, Disney began selling its video products directly to Handleman's largest customer. Excluding Disney, sales of other video products in fiscal 1993 would have increased approximately 5% over fiscal 1992 video sales. Pricing on Disney product is so competitive that such products have the lowest gross profit margin percentages of any Handleman- supplied video product.\nBOOKS - Sales for fiscal 1993 were $70.9 million. The increase of $17.8 million or 33% over fiscal 1992 sales was primarily due to approximately 750 departments being added to the Company's book service program during fiscal 1993.\nPERSONAL COMPUTER SOFTWARE - Sales for fiscal 1993 were $45.3 million, compared to $37.5 million in fiscal 1992, an increase of $7.8 million or 21%. Software sales continued to benefit from the penetration of personal computers into U.S. households.\nOTHER DATA - The gross profit margin percentage for fiscal 1993 was 24.8%, compared to 25.3% for fiscal 1992. The gross profit margin percentage for the video product line improved in fiscal 1993 as a result of the decline in sales of low-margin Disney products. The music gross profit margin percentage declined slightly in fiscal 1993 as CDs (which carry lower gross profit margin percentages than cassettes) became a proportionately larger share of the Company's music sales mix. Declines during fiscal 1993 in book and personal computer software gross profit margin percentages were the primary reason for the overall decline in gross profit margin percentage in fiscal 1993, compared to fiscal 1992. The decline in book and personal computer software gross profit margin percentages was partially attributable to increased sales to certain customers with whom the Company earns a lower gross profit margin percentage because of the non-service nature of the sales arrangement. An increase in the proportion of book and personal computer software sales to total Company sales also contributed to the overall decline in gross profit margin percentage since these product lines carry gross profit margin percentages lower than the Company's overall margin percentage.\nSelling, general and administrative expenses for fiscal 1993 were $191.1 million (17.0% of net sales), compared to $176.4 million (17.3% of net sales) in fiscal 1992. The dollar increase was primarily due to increases in variable expenses related to the higher sales level. However, the higher net sales provided the opportunity for efficiencies which lowered expenses as a percentage of net sales. Selling, general and administrative expenses exclude the amortization of costs associated with prior year acquisitions which amounted to $8,679,000 in fiscal 1993.\nNet interest expense for fiscal 1993 was $6,713,000, compared to $7,340,000 for fiscal 1992. The decrease was the result of both lower average borrowings throughout the period and lower average interest rates in fiscal 1993 compared to fiscal 1992.\nNet income for fiscal 1993 was $43.7 million, or $1.32 per share, compared to $40.0 million or $1.21 per share for fiscal 1992.\nLIQUIDITY AND CAPITAL RESOURCES - Working capital at April 30, 1994 was $216 million, compared to $241 million at May 1, 1993, a decrease of $25 million or 10%. The decrease in working capital resulted primarily from a $16 million increase in the amount of senior notes classified as current liabilities. The working capital ratio was 1.8 to 1 at April 30, 1994 and 1.9 to 1 at May 1, 1993. The Company's capital assets consist primarily of display fixtures and facilities. The Company also acquires licenses for video, music and software products which it distributes. Purchases of these assets are expected to be funded primarily by cash flows from operations.\nIn July 1994, the Company replaced its $147 million revolving credit agreement with a five year, $250 million unsecured revolving credit agreement entered into with a group of banks. Under the new agreement, the Company may elect to pay interest under a variety of formulae tied principally to either prime or \"LIBOR\". During the first three years of the agreement, the Company may elect to enter into term loans with maturities not to exceed five years in length and having a final maturity not later than July 12, 2001 for amounts up to an aggregate of $150 million. Interest on these term loans will be based upon a pre-determined formula. The agreement also provides for issuance of standby letters of credit for maturities not to exceed one year. The Company expects to use proceeds from the new credit agreement to pay-off the $31 million of senior notes due on October 1, 1994 which bear an 8.44% annual interest rate.\nEFFECTS OF INFLATION ON OPERATIONS - ----------------------------------\nThe Company's financial statements have reported amounts based on historical costs which represent dollars of varying purchasing power and do not measure the effects of inflation. If the financial statements had been restated for inflation, net income would have been lower because depreciation expense would have to be increased to reflect the most current costs.\nItem 8.","section_7A":"","section_8":"Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements and supplementary data are filed as a part of this report:\nReport of Independent Accountants\nConsolidated Balance Sheet at April 30, 1994, May 1, 1993 and May 2, 1992.\nConsolidated Statement of Income - Years Ended April 30, 1994, May 1, 1993 and May 2, 1992.\nConsolidated Statement of Shareholders' Equity - Years Ended April 30, 1994, May 1, 1993 and May 2, 1992.\nConsolidated Statement of Cash Flows - Years Ended April 30, 1994, May 1, 1993 and May 2, 1992.\nNotes to Consolidated Financial Statements\nReport of Independent Accountants\nTo the Board of Directors and Shareholders of Handleman Company:\nWe have audited the consolidated financial statements and the financial statement schedules listed in Item 14(a) of this Form 10-K of Handleman Company and Subsidiaries. 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 Handleman Company and Subsidiaries as of April 30, 1994, May 1, 1993 and May 2, 1992, and the consolidated results of their operations and their cash flows for the years then ended, 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\nDetroit, Michigan June 16, 1994\nHANDLEMAN COMPANY CONSOLIDATED BALANCE SHEET APRIL 30, 1994, MAY 1, 1993 AND MAY 2, 1992 (amounts in thousands except share data) ----------------\nThe accompanying notes are an integral part of the consolidated financial statements.\nHANDLEMAN COMPANY CONSOLIDATED STATEMENT OF INCOME YEARS ENDED APRIL 30, 1994, MAY 1, 1993 AND MAY 2, 1992 (amounts in thousands except per share data)\nThe accompanying notes are an integral part of the consolidated financial statements.\nHANDLEMAN COMPANY CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY YEARS ENDED APRIL 30, 1994, MAY 1, 1993 AND MAY 2, 1992 (amounts in thousands except per share data) ----------------\nThe accompanying notes are an integral part of the consolidated financial statements.\nHANDLEMAN COMPANY CONSOLIDATED STATEMENT OF CASH FLOWS YEARS ENDED APRIL 30, 1994, MAY 1, 1993 AND MAY 2, 1992 (amounts in thousands) ----------------\nThe accompanying notes are an integral part of the consolidated financial statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS ----------------\n1. Accounting Policies: -------------------\nBusiness\nThe Company operates principally in one business segment: selling prerecorded music, video, hardcover and paperback books and personal computer software products primarily to mass merchants, and also to specialty chain stores, drugstores and supermarkets.\nAnnual Closing Date\nThe Company's fiscal year ends on the Saturday closest to April 30th. Fiscal years 1994 and 1993 consisted of 52 weeks, whereas fiscal 1992 consisted of 53 weeks.\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned domestic and Canadian subsidiaries. All material intercompany accounts and transactions have been eliminated.\nForeign Currency Translation\nThe Company utilizes the policies outlined in Statement of Financial Accounting Standards No. 52, \"Foreign Currency Translation\", to convert the balance sheet and operations of its Canadian subsidiary to United States dollars.\nRecognition of Revenue and Future Returns\nRevenues are recognized upon shipment of the merchandise. The Company reduces gross sales and cost of sales for expected returns at the time the merchandise is sold.\nIncome Taxes\nThe Company employs the method required by Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Under this method, deferred taxes arise from differences between financial reporting and tax reporting.\nPension Plan\nThe Company has a noncontributory defined benefit pension plan covering substantially all hourly and salaried employees. Pension benefits are based upon length of service and average annual compensation for the five highest years of compensation in the last 10 years of employment. Net periodic pension cost is accrued on a current basis, and funded as permitted or required by applicable regulations.\nInventory Valuation\nMerchandise inventories are stated at the lower of cost (first-in, first-out method) or market. The Company accounts for inventories using the full cost method which includes costs associated with acquiring and preparing inventory for distribution. Costs associated with acquiring and preparing inventory for distribution of $16,289,000, $17,618,000 and $15,942,000 were incurred during the years ended April 30, 1994, May 1, 1993 and May 2, 1992, respectively. Merchandise inventories as of April 30, 1994, May 1, 1993 and May 2, 1992 include $3,621,000, $3,503,000, and $3,127,000, respectively, of such costs.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued) ----------------\n1. Accounting Policies: (continued) -------------------\nProperty and Equipment\nProperty and equipment is recorded at cost. Upon retirement or disposal, the asset cost and related accumulated depreciation are eliminated from the respective accounts and the resulting gain or loss is included in the consolidated statement of income for the period. Repair costs are charged to expense as incurred. Display fixtures placed in customers' stores have minimum value, if any, outside of the store departments in which they are initially placed.\nDepreciation\nDepreciation is computed using primarily the straight-line method based on the following estimated useful lives:\nBuildings and improvements 10-40 years Display fixtures, equipment, furniture and other 3-10 years Leasehold improvements Lesser of lease term or useful life\nLicenses --------\nThe Company acquires video licenses giving it exclusive rights to manufacture and distribute certain prerecorded video products. The licenses are included in other assets in the consolidated balance sheet and are amortized over a period which is the lesser of the license agreement or its expected useful life. As of April 30, 1994, May 1, 1993 and May 2, 1992, licenses, net of amortization, amounted to $21,285,000, $7,474,000, and $8,299,000, respectively.\nIntangible Assets\nIntangible assets, included in other assets in the consolidated balance sheet, consist of excess cost over net assets of businesses acquired and non-competition and other ancillary agreements. These assets are amortized over periods ranging from 5 to 40 years using the straight-line method. As of April 30, 1994, the weighted average period remaining to be amortized was approximately 9 years.\nCash Flows\nThe Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nFinancial Instruments\nThe Company has evaluated the fair value of those assets and liabilities identified as financial instruments by Statement of Financial Accounting Standards No. 107. As of April 30, 1994, the Company has determined that the fair value approximated the carrying values. Fair values have been determined through information obtained from market sources and management estimates.\nReclassifications\nCertain 1993 and 1992 amounts have been reclassified to conform with presentations adopted in 1994.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)\n----------------\n2. Acquisition of Business: -----------------------\nOn July 26, 1991, the Company acquired certain assets of Lieberman Enterprises, Inc. (Lieberman), a specialty merchandiser of prerecorded music and video. Assets acquired aggregating $74,655,000 consisted primarily of inventory and supplies, display fixtures, certain warehouse equipment and non-competition and other agreements (of the total purchase price, approximately $21,700,000 was allocated to non-competition and other agreements). Costs of $1,323,000 which were incurred in connection with the acquisition and integration of these assets were charged against results of operations during fiscal 1992.\n3. Sales and Accounts Receivable: -----------------------------\nThe Company's customers are comprised mainly of mass merchant retail chains located in the United States and Canada. For the years ended April 30, 1994, May 1, 1993 and May 2, 1992, one customer accounted for approximately 41 percent, 38 percent and 37 percent of the Company's net sales, and a second customer accounted for approximately 26 percent, 24 percent and 23 percent of the Company's net sales, respectively. Collectively, these customers accounted for approximately 69 percent, 54 percent and 51 percent of accounts receivable at April 30, 1994, May 1, 1993 and May 2, 1992, respectively.\n4. Provision for Facility Realignment ----------------------------------\nThe Company is realigning its Western region by replacing certain existing distribution centers with a new automated distribution center (ADC). The Company recorded a $2,000,000 pre-tax charge against fourth quarter fiscal 1994 results related to costs associated with the transition from the current distribution structure to the ADC. This charge included costs for disposal of certain existing facilities, as well as relocation expenses and certain compensation costs.\n5. Pension Plan: ------------\nThe Handleman Company Pension Plan's funded status, the components of net pension expense, and the amount which is recorded in the Company's consolidated balance sheet at April 30, 1994, May 1, 1993 and May 2, 1992 are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)\n----------------\n5. Pension Plan (continued) ------------------------\nWeighted average discount rates of 8.0 percent, 8.0 percent and 8.5 percent at April 30, 1994, May 1, 1993 and May 2, 1992, respectively, and a rate of increase in future compensation levels of 5.0 percent for all periods were used in determining the actuarial present value of the projected benefit obligation.\nThe expected long-term rate of return on assets was 8.5 percent for all years. The assets are invested in various pooled investment funds and mutual funds maintained by the Plan trustee and common stock of the Company.\n6. Debt: ----\nIn November 1991, the Company entered into a $46,000,000 senior note agreement with a group of institutional lenders, of which $15,000,000 was repaid on October 1, 1993. The $31,000,000 balance of the note is due October 1, 1994 and bears an 8.44% annual interest rate.\nIn June 1991, the Company entered into a contractually-committed, four year, $175,000,000 revolving credit arrangement with a consortium of banks. In June 1993, the credit arrangement was amended and reduced to $147,000,000. As of April 30, 1994, $70,100,000 was outstanding under the revolving credit arrangement, at interest rates ranging from 4.44% to 6.75%. As the Company intends to extend the maturities of the outstanding balance beyond one year, and has the ability to do so, the debt has been classified as non-current. Borrowings outstanding are due on the termination date of the arrangement.\nScheduled maturities for the senior note, revolving credit arrangement, and Economic Development Corporation (EDC) limited obligation revenue bonds are as follows:\nThe EDC bonds, senior note and the borrowings under the revolving credit arrangement all contain certain restrictions, including working capital, debt limitations and net worth. The EDC bonds are collateralized by land, buildings and equipment with an aggregate net book value of approximately $16,333,000 at April 30, 1994.\nInterest expense for the years ended April 30, 1994, May 1, 1993 and May 2, 1992, was $7,029,000, $8,004,000 and $8,871,000, respectively. Interest paid for the years ended April 30, 1994, May 1, 1993 and May 2, 1992 was $7,262,000, $8,514,000 and $7,992,000, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued)\n_______________\n7. Income Taxes: ------------\nThe domestic and foreign components of income before income taxes for the years ended April 30, 1994, May 1, 1993 and May 2, 1992 are as follows:\nProvisions for income taxes for the years ended April 30, 1994, May 1, 1993 and May 2, 1992 consist of the following:\nThe following table provides a reconciliation of the Company's effective income tax rate to the statutory federal income tax rate:\nItems that gave rise to significant portions of the deferred tax accounts at April 30, 1994, May 1, 1993 and May 2, 1992 are as follows:\nThe undistributed earnings of the Canadian subsidiary for which no U.S. federal income tax liabilities have been recorded were $22,892,000 at April 30, 1994. The Company intends to reinvest indefinitely the undistributed earnings of its foreign subsidiary. Due to the availability of foreign tax credits, no significant U.S. federal income tax liabilities are expected to result if such earnings were distributed.\nIncome taxes paid in 1994, 1993 and 1992 were approximately $25,204,000, $26,095,000 and $17,018,000, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued) ----------\n9. Stock Plans: -----------\nThe Company's shareholders approved the adoption of the Handleman Company 1992 Performance Incentive Plan (the \"Plan\"), which authorizes the granting of stock options, stock appreciation rights and restricted stock. At any given time, the maximum number of shares of stock which may be issued pursuant to restricted stock awards or granted pursuant to stock options or stock appreciation rights shall not exceed 5% of the number of shares of the Company's common stock outstanding as of the immediately preceding fiscal year end, less restricted stock, options and awards issued or granted under the Plan since adoption in September 1992. As of April 30, 1994, 1,217,420 shares of the Company's stock are available for use under the Plan.\nPursuant to the restricted stock provisions of the Plan, the Company issued, net of forfeitures, 185,521 shares of common stock during the year ended April 30, 1994. These restricted shares are held in the custody of the Company and vest only if specified performance goals are achieved. These shares are treated as outstanding for purpose of calculating earnings per share and payment of dividends. If the minimum performance goals under which an award is issued are not satisfied, the shares are forfeited. If performance goals are exceeded, a maximum of 144,875 additional shares can be issued. The number of shares which may vest will be prorated to the extent actual results are between minimum and maximum performance goals. The Company did not record any compensation expense related to the restricted stock in 1994 because minimum performance goals were not achieved.\nInformation with respect to options outstanding under the previous and current stock option plans for the years ended May 2, 1992, May, 1 1993 and April 30, 1994 is set forth below. Options were granted during such years at no less than fair market value at the date of grant.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS, (continued) ----------------\n* Earnings per common share were improved by $.07, $.06 and $.05 for the fourth quarters of fiscal 1994, 1993 and 1992, respectively, resulting from various year-end adjustments to previous accrual estimates.\nItem 9.","section_9":"Item 9. DISAGREEMENTS 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 REGISTRANT\nItem 10, with the exception of the following information regarding executive officers of the Registrant required by Item 10, is contained in the Handleman Company Definitive Proxy Statement for its 1994 Annual Meeting of Shareholders to be filed on or before August 18, 1994, and such information is incorporated herein by reference. All officers serve at the discretion of the Board of Directors.\n1. Stephen Strome has served as President since March 1990. On May 1, 1991, Mr. Strome was named Chief Executive Officer. In September 1989 Mr. Strome was named Chief Operating Officer. In September of 1987, Mr. Strome was elected Executive Vice President.\n2. Peter J. Cline has served as Executive Vice President\/President of Distribution since joining the Company in April, 1994. Prior to joining Handleman Company, Mr. Cline was employed by the Snacks and International Consumer Products Division of Borden, Inc. from August 1990 until April 1994 where he served in various executive positions, most recently as Group Vice President - North American Snacks. Previously, Mr. Cline was employed by The Stroh Brewery Company from July 1986 to August 1990 where he served in a variety of executive positions, including Senior Vice President - Sales and Marketing from August 1989 to August 1990.\n3. Lawrence R. Hicks has served as a Vice President since January 1982. Mr. Hicks was elected Senior Vice President in June 1988, and Executive Vice President in April 1994.\n4. Louis A. Kircos was elected Executive Vice President in April 1994. Mr. Kircos was elected Senior Vice President - Corporate Development and Subsidiaries in March 1993. In March 1990, Mr. Kircos was elected Senior Vice President - Finance. Mr. Kircos was elected Vice President - Finance in September 1987. In July 1986, Mr. Kircos was elected Treasurer and Secretary, and served as Treasurer until February 1992, and as Secretary until August 1993.\n5. Richard J. Morris has served as Vice President\/Finance, Secretary and Chief Financial Officer since August 1993. In April 1994, Mr. Morris was elected Senior Vice President. Prior to joining Handleman Company, Mr. Morris was employed by PolyGram Holding, Inc., where he served as Senior Vice President, Finance from January 1983 until July 1993.\n6. Mario DeFilippo has served as a Vice President since January 1983. In June 1988, Mr. DeFilippo was elected Senior Vice President. Mr. DeFilippo retired on June 30, 1994.\n7. Samuel J. Milicia has served as Vice President since June 1990. In June 1988, Mr. Milicia was named Assistant Vice President - Eastern Region Branch Operations.\n8. Jerry L. Lauer has served as Vice President since June 1986.\n9. Thomas C. Braum, Jr. has served as Corporate Controller since June 1988. In February 1992, Mr. Braum was elected Vice President.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nInformation required by this item is contained in the Handleman Company definitive Proxy Statement for its 1994 Annual Meeting of Shareholders, to be filed on or before August 18, 1994 and such information is incorporated herein by reference.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nInformation required by this item is contained in the Handleman Company definitive Proxy Statement for its 1994 Annual Meeting of Shareholders, to be filed on or before August 18, 1994 and such information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nInformation required by this item is contained in the Handleman Company definitive Proxy Statement for its 1994 Annual Meeting of Shareholders, to be filed on or before August 18, 1994 and such 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) 1. The following financial statements and supplementary data are filed as a part of this report under Item 8.:\nReport of Independent Accountants\nConsolidated Balance Sheet at April 30, 1994, May 1, 1993 and May 2, 1992.\nConsolidated Statement of Income - Years Ended April 30, 1994, May 1, 1993 and May 2, 1992.\nConsolidated Statement of Shareholders' Equity - Years Ended April 30, 1994, May 1, 1993 and May 2, 1992.\nConsolidated Statement of Cash Flows - Years Ended April 30, 1994, May 1, 1993 and May 2, 1992.\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nII. Amounts Receivable from Related Parties and Underwriters, Promoters, and Employees Other Than Related Parties VIII. Valuation and Qualifying Accounts and Reserves IX. Short-term Borrowings\nAll other schedules for Handleman Company have been omitted since the required information is not present or not present in an amount sufficient to require submission of the schedule, or because the information required is included in the financial statements or the notes thereto.\n3. Exhibits as required by Item 601 of Regulation S-K.\nS-K Item 601 (3)\nThe Registrant's Restated Articles of Incorporation dated June 30, 1989 and Revised Bylaws adopted March 7, 1990 and Amendments to the Bylaws adopted June 16, 1993, were filed with the Form 10-K dated May 1, 1993, and are incorporated herein by reference.\nS-K Item 601 (10)\nConsulting contract for director Mr. Paul Handleman was filed with the Commission in the Form 10-K dated July 31, 1975, and is incorporated herein by reference. Such contract has been extended to December l, 1994. Mr. Paul Handleman retired from the Board of Directors on June 16, 1993.\nThe Registrant's 1975 Stock Option Plan was filed with the Commission in Form S-8, dated November 17, 1977, File No. 2-60162. The Registrant's 1983 Stock Option Plan was filed with the Commission in Form S-8 dated January 18, 1985, File No. 2-95421. The first amendment to the 1983 Stock Option Plan, adopted on March 11, 1987, was filed with the Commission with the Form 10-K for the year ended May 2, 1987. Both plans are incorporated herein by reference.\nThe Registrant's 1992 Performance Incentive Plan was filed with the Commission in Form S-8, dated March 5, 1993, File No. 33-59100.\nThe advisory agreement with David Handleman was filed with the Form 10-K for the year ended April 28, 1990.\nThe Credit Agreement among Handleman Company, Certain Banks And NBD Bank, N.A., As Agent dated June 24, 1991 was filed with the Form 10-K for the year ended May 2, 1992.\nThe Note Agreement dated October 1, 1991 was filed with the Form 10-K for the year ended May 2, 1992.\nS-K Item 601 (21) - Subsidiaries of the Registrant:\nHandleman Company of Canada Limited, an Ontario Corporation Video Treasures, Inc., a Michigan Corporation Entertainment Zone, Inc., a Michigan Corporation Scorpio Productions, Inc., a Texas Corporation Hanley Advertising Company, a Michigan Corporation Softprime, Inc., a Michigan Corporation Rackjobbing, S.A. de C.V. Rackjobbing Services, S.A. de C.V. New Licenses, S.A. de C.V. Handleman Technical Services, Inc., a Michigan Corporation\nS-K Item 601 (23) - Consent of Independent Accountants: Filed with this report.\n(b) No reports on Form 8-K have been filed during the last quarter of the period covered by this report.\nNote: The Exhibits attached to this report will be furnished to requesting security holders upon payment of a reasonable fee to reimburse the Registrant for expenses incurred by Registrant in furnishing such Exhibits.\nExhibit (23)\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe consent to the incorporation by reference in the registration statements of Handleman Company and Subsidiaries on Form S-3 (File Nos. 33-16553, 33-26456, 33-33797 and 33-42018) and Form S-8 (File Nos. 2-60162, 2-95421, 33-59100 and 33-69030) of our report dated June 16, 1994, on our audits of the consolidated financial statements and financial statement schedules of Handleman Company and Subsidiaries as of April 30, 1994, May 1, 1993 and May 2, 1992 and for the years then ended, which report is included in this Annual Report on Form 10-K.\nCoopers & Lybrand\nDetroit, Michigan July 27, 1994\nSCHEDULE II - AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES YEARS ENDED MAY 2, 1992, MAY 1, 1993 AND APRIL 30, 1994\nThe Company is an equity participant in HGV Video Productions, Inc. (HGV), an Ontario, Canada corporation, which was established to manufacture and distribute licensed video product in Canada.\nThe Company is an equity participant in Mode Video Distribution, Inc. (Mode), a Quebec, Canada corporation engaged in the distribution of video products.\nThe Company is a partner in SRT Video, Ltd. (SRT), a partnership formed to purchase and resell cut-out or surplus video cassettes.\nThe Company is an equity participant in Sofsource, Inc., a U.S. based manufacturer and distributor of personal computer software products.\n(1) The Company funds working capital requirements of HGV, Mode, SRT and Sofsource, and such advances accrue interest at various rates ranging from the prime rate to prime plus one percent.\nSCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES YEARS ENDED MAY 2, 1992, MAY 1, 1993 AND APRIL 30, 1994\nSCHEDULE IX - SHORT-TERM BORROWINGS YEARS ENDED APRIL 30, 1994, MAY 1, 1993 AND May 2, 1992\n(1) The average amount outstanding during the period represents total daily borrowings divided by the number of days such borrowings were outstanding.\n(2) The weighted average interest rate represents the annualized effect of short-term interest expense divided by the average debt outstanding.\nShort-term borrowings are unsecured borrowings under bank lines of credit at interest rates on an as offered basis not to exceed prime.\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.","section_15":""}
{"filename":"85627_1994.txt","cik":"85627","year":"1994","section_1":"ITEM 1. BUSINESS -------------------------\nGeneral -------\nRegistrant was incorporated under the laws of the State of Ohio in 1920. Registrant and its subsidiaries operate in one industry segment which consists of the manufacture, marketing, selling, and distribution of plastic and rubber products consumed primarily by the end-user in the consumer, commercial, industrial, agricultural, office, marine, automotive accessories, contract, and juvenile markets. They include such items as housewares; home horticulture products; decorative coverings; leisure and recreational products; infant and children's toys; furniture, office, and industrial products; and products used in food service, health care, and sanitary maintenance. Registrant's products are distributed through its own sales personnel and manufacturers' agents to a variety of retailers and wholesalers, including mass merchandisers, toy stores, catalog showrooms, and distributors serving institutional markets.\nRegistrant's basic philosophy is to offer products of high value and quality to the user. Value is that best combination of price, quality, service, timeliness and innovation as perceived by consumers and customers. The Corporate objectives, since the late-1970's, have been, and continue to be, to increase sales, earnings, and earnings per share 15% per year, compounded annually. This growth is expected to come from a combination of maximizing core businesses through product line and market extensions, new product introductions, global expansion of the business, and selective acquisitions.\nRegistrant's primary focus is to achieve its earnings and earnings per share growth objective of 15%, compounded annually. Initially, the sales growth objective was based on certain fundamental assumptions: an increase of 3-5% in U. S. Gross Domestic Product (GDP); inflation of 2-4% in Registrant's pricing; and, unit volume growth averaging around 11%. Since Gross Domestic Product increases have been below this assumption and Registrant's pricing was essentially flat for the past several years, sales growth was less than the 15% targeted increase although Registrant was successful in implementing cost reductions and productivity improvement programs to leverage the sales growth towards the earnings goals.\nIn 1994, in recognition of this changed macro-economic environment, Registrant announced two new strategic initiatives aimed at achieving above-GDP growth to reach its primary objectives of 15% sales and earnings growth; this, despite a forecast of price inflation averaging only 1-2% over the next five years. The first initiative is a value improvement process aimed at increasing value and productivity. The second initiative is to invest those value improvements and cost savings to accelerate Registrant's worldwide growth enhancements of accelerated new product introductions, quicker entry into new markets, increased competitiveness, new business development, and the globalization of core businesses.\nAmong the businesses acquired by Registrant are The Little Tikes Company (1984); Gott Corporation (1985); Seco Industries, Inc. (1986); MicroComputer Accessories, Inc. (1986); Viking Brush Limited (1987); EWU (AG) (1990); Eldon Industries, Inc. (1990); CIPSA (1992); Iron Mountain Forge Corporation (1992); Empire Brushes, Inc. (1994); Carex Inc. (1994); and Glenwood Systems Pty. Ltd (Ausplay)(1994).\nThe companies acquired by Registrant shared many common characteristics with Registrant including a high-quality image, emphasis on new product development and customer service, similar materials and\/or manufacturing processes, and similar distribution channels.\nCIPSA, the leading plastic housewares manufacturer and marketer in Mexico operates as Rubbermaid de Mexico and is a part of the Home Products Division.\nEmpire Brushes, Inc., now Rubbermaid Cleaning Products Inc., which reports to the Home Products Division is a leading manufacturer and marketer of brushes, brooms, and mops for home and commercial use resulting from the integration of Empire Brushes' products and facilities with Registrant's existing household cleaning products business.\nIn 1994, Registrant sold its 40% interest in the Curver Rubbermaid European housewares joint venture to DSM who held the remaining 60%. On March 1, 1995, Registrant acquired Injectaplastic S.A., a French manufacturer and marketer of plastic housewares and other products which will provide a vehicle for re-entry into the European housewares market.\nIron Mountain Forge Corporation, which reports to The Little Tikes Company, is a leading manufacturer and marketer of commercial playground equipment. Registrant expects that the synergy with Little Tikes will increase Iron Mountain Forge's strengths in the parks, schools and recreational areas and accelerate the development of the attractive growing child care market. Ausplay, a leading marketer and designer of commercial playground equipment in Australia expands the geographic distribution of commercial play structures and will enhance future growth capabilities in additional geographic markets and new products.\nCarex is a growing manufacturer and marketer of bath safety products, personal care accessories, daily living aids, and other products designed to assist the aging and physically challenged. Registrant expects to stimulate further sales growth by integrating Carex to enhance product development and product line offerings.\nIn April 1994, Registrant completed a joint venture with Richell Corporation, a leading Japanese housewares manufacturer. The joint venture, Rubbermaid Japan Inc., develops, markets, and sells housewares, leisure, and specialty products for the Japanese market. Registrant initially held a 40% equity interest in the venture and, in October 1994, exercised an option to increase its equity interest to 51%.\nIn January, 1995, Registrant formed Royal Rubbermaid Structures Ltd., a joint venture with Royal Plastics Group Limited of Canada, for the manufacture and marketing of modular, plastic components, and kits for small structures, such as storage buildings and sheds, in consumer, industrial, commercial, and agricultural markets. Each partner owns 50% of the joint venture. Sale of joint venture products are expected to commence by mid-year 1995.\nAdditional expansion has come from new operations formed from existing businesses to focus on specific segments of their markets.\nRubbermaid Specialty Products Inc. was formed in 1988 to consolidate seasonal products with similar channels of distribution into one operation. The GOTT line of insulated products and BLUE ICE refreezable ice substitute were also integrated into this business and rebranded with the Rubbermaid name. This creates the opportunity to utilize seasonal product synergies which, coupled with the Rubbermaid brand, increase critical marketing mass at the trade level. In 1994, the casual outdoor resin furniture business of Specialty Products, including the\nmanufacturing facility in Stanley, North Carolina, was sold. This will allow Specialty Products to focus its resources and management more effectively on its core competencies.\nDuring 1988 Registrant established an Office Products Division which combined the activities of home office products from the Home Products Division, commercial office products from Rubbermaid Commercial Products Inc., and MicroComputer Accessories, Inc. The Division enhanced service for traditional customers while capitalizing on the emerging distribution trends in the industry with concentrated marketing and distribution and a complete and diversified line of products. Early in 1991, the Office Products Division and Eldon Industries, Inc., were combined to form Rubbermaid Office Products Inc., located in Maryville, Tennessee, to capitalize on their many synergies and to improve support and service to customers. During 1994, Registrant sold the Davson Division of Rubbermaid Office Products Inc. because the Davson product line was not considered a long term strategic fit for the business and merged the MicroComputer Accessories, Inc. company into Rubbermaid Office Products Inc.\nRaw Materials -------------\nThe principal raw materials used in the manufacture of Registrant's products are various plastic resins and synthetic rubber (all of which are derivatives of petroleum or natural gas liquids) and color concentrates. All of these items are available from numerous competitive sources. Even though a significant portion of Registrant's raw materials are derivatives of natural gas, the increase in crude oil costs during 1990 resulting from the Persian Gulf crisis was reflected in Registrant's costs of raw materials. As crude oil costs returned to lower levels, so did resin prices. From 1990 until 1994, resin costs remained at a more stable supply\/demand level. In 1994, resin costs began to escalate rapidly late in the year, as demand for resin increased and supply tightened. Registrant expects to obtain adequate resins for its needs and has accelerated its continuing program of substituting available or reformulated resins where practical and consistent with quality considerations.\nPatents and Trademarks ----------------------\nThere are no patents or licenses considered material to the business. Registrant is of the opinion that through sustained advertising and use, the trademark RUBBERMAID has become of value in the identification and acceptance of its products, especially in North America. In addition, Registrant has many well-known brands such as CON-TACT (pressure sensitive decorative coverings), ELDON (office products), LITTLE TIKES (toys), and SECO (floor maintenance products) that compete in domestic and international markets.\nSeasonality -----------\nHistorically, the year-end holiday season records the highest sales volume for the toy industry; however, the Little Tikes spring and summer products have served to more evenly balance monthly shipments. Rubbermaid Specialty Products concentrates its efforts on product categories of a seasonal nature, including insulated products, planters, and bird feeders. Insulated product sales are highest during the first six months of the year, and inventories are built during the other periods of the year in order to more easily accommodate demand. No material portion of Registrant's other businesses is of a highly seasonal nature.\nWorking Capital ---------------\nWorking capital requirements of the business increase generally as sales volumes increase. There are normally no unusual working capital needs existent at any one time in the ordinary course of business. Dating programs offering extended terms are carried on by the various operating companies as part of their normal marketing activities.\nCustomers ---------\nSales are made to a broad range of customers, one of which accounted for 15%, 14%, and 13% of net sales in 1994, 1993, and 1992, respectively. Due in part to Registrant's perception that consumers are loyal to Registrant's brand names, Registrant does not believe that the loss of any one customer would have a materially adverse effect on its business.\nBacklog -------\nRegistrant produces to and sells from inventory for the majority of its products. The amount of backlog existent at any one time is not a significant factor in the business.\nCompetition -----------\nAll markets served by Registrant and its subsidiaries are competitive as to price, service, and product performance. Most of Registrant's products compete not only with those of other manufacturers using similar raw materials but also with products manufactured from other materials. Many of the competitor companies are either closely held or are divisions of larger entities. Registrant is recognized as a strong competitive factor in the marketplace, but there is no reliable quantitative manner in which the aggregate competitive position of Registrant can be determined.\nResearch and Development ------------------------\nRegistrant expended approximately $27,747,000, $28,202,000, and $25,951,000 during 1994, 1993, and 1992, respectively, on research activities related to product, process and materials development, and mold design. These costs are charged to operations as incurred.\nEnvironmental Matters ---------------------\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, is not expected to have an adverse effect upon the capital expenditures, earnings, or competitive position of Registrant and its subsidiaries. Reference is made to page 35 of the 1994 Annual Report to Shareholders, which is contained in Exhibit 13 hereof, concerning further information regarding Registrant's Environmental Program.\nEmployees ---------\nThe average number of persons employed by Registrant and its subsidiaries during 1994 was 12,939.\nForeign Operations ------------------\nReference is made to page 33 of the 1994 Annual Report to Shareholders, which is contained in Exhibit 13 hereof, for information concerning Registrant's operations in different geographical areas. Export sales are not material and are, therefore, not separately stated.\nTo accelerate international growth, foreign businesses were repositioned in January 1990 to provide direct line reporting relationships with their counterpart domestic operation. The management of Rubbermaid businesses around the world, plus the coordination of sales in foreign markets, are the responsibility of the respective core operating companies. The Corporate role is to develop and coordinate with the core businesses strategic plans, priorities, and global operations. To improve efficiencies in the new regions being developed, staff functions are centralized, while the line functions are decentralized to each core business.\nRegistrant uses a variety of approaches to expand and develop international markets. To initiate market development in certain geographic areas, particularly new and developing markets, emphasis is placed on exporting from existing manufacturing facilities. Where market size and economics justify, manufacturing facilities are established - for example, Canada, Europe and Mexico. In markets where it is deemed appropriate to gain immediate access to manufacturing facilities or distribution, Registrant may make selective acquisitions. Licensing arrangements are used in those markets where the costs of importing are prohibitive and where Company-owned manufacturing is not economically justified. In addition, Registrant may use a combination of any or all of these approaches. Today, Rubbermaid products are distributed worldwide.\nNo greater known significant risk is attendant to the foreign business than to the domestic business conducted by Registrant and its subsidiaries.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ---------------------------\nRegistrant and its subsidiaries have manufacturing and\/or warehousing locations in 14 states and 9 foreign countries.\nMajor plant and warehouse locations of Registrant are as follows:\nHome Products Division - Wooster and Akron, Ohio; Phoenix, Arizona; Sparks, Nevada (leased); Cortland, New York; Greenville, Robersonville, and Statesville, North Carolina; Cleburne and Greenville, Texas; Suffolk, Virginia (leased); Mississauga, Ontario and Montreal, Quebec (leased), Canada; Toyama, Japan; and Mexico City, Mexico.\nRubbermaid Specialty Products Inc. - Goddard and Winfield, Kansas.\nThe Little Tikes Company - Hudson and Sebring, Ohio; City of Industry, California (leased); Aurora and Farmington, Missouri; Shippensburg, Pennsylvania; Melbourne, Australia (leased); Guelph, Ontario, Canada (leased); Dublin, Ireland; and Differdange, Luxembourg.\nRubbermaid Commercial Products Inc. - Winchester, Virginia; Phoenix, Arizona (leased); Centerville, Iowa; Cleveland, Tennessee; Birmingham, England (leased); and Dietzenbach, Germany (leased).\nRubbermaid Office Products Inc. - Maryville, Tennessee; Carson, California (leased); Silverwater, Australia (leased); Markham, Ontario, Canada (leased); Shefford, England (leased); and Coignieres, France (leased).\nCarex Inc. - Newark, New Jersey (leased)\nCertain portions of the Cortland, New York facility are leased from Industrial Development Authorities pursuant to industrial development bond financing; however, Registrant will own the facilities upon repayment of such financing. Certain other facilities are subject to mortgages securing industrial revenue bond financing.\nThe properties and facilities of Registrant and its subsidiaries are modern and suitable to the requirements of the business. On an overall basis, these facilities, with certain exceptions due primarily to general economic slowdowns, have been operated near capacity. As a general rule, continuing capital expenditures are required each year to provide the necessary plant, equipment, and tooling to support the growth of the business. To supplement its own facilities, Registrant has followed a practice of sourcing a portion of its production and warehousing requirements from third parties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS ----------------------------------\nThere are no material pending legal proceedings to which Registrant or any of its subsidiaries is a party.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS --------------------------------------------------------------------\nDuring the fourth quarter of the fiscal year covered by this Form 10-K, no matter was submitted to a vote of Registrant's shareholders, through the solicitation of proxies or otherwise.\nAll executive officers who are officers of Registrant are elected for a one-year term.\nPART II -------\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER ------------------------------------------------------------------------------ MATTERS -------\nRegistrant's Common Shares are traded on the New York Stock Exchange under the symbol RBD. As of January 31, 1995, Registrant had approximately 31,000 shareholders of record. Reference is made to page 33 of the 1994 Annual Report to Shareholders, which is contained in Exhibit 13 hereof, for information concerning sales prices for and dividends paid on Registrant's Common Shares during 1994 and 1993.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA ----------------------------------------\nReference is made to pages 36 and 37 of the 1994 Annual Report to Shareholders, which are contained in Exhibit 13 hereof, which pages include the selected financial data for the five years ended December 31, 1994 as part of Registrant's \"Consolidated Financial Summary\", which information is incorporated by reference herein.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION ---------------------------------------------------------------------------- AND RESULTS OF OPERATIONS -------------------------\nReference is made to pages 34 and 35 of the 1994 Annual Report to Shareholders, which are contained in Exhibit 13 hereto, which include \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" for the years 1994, 1993, and 1992, which information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ------------------------------------------------------------\nReference is made to pages 25 through 33 of the 1994 Annual Report to Shareholders, which are contained in Exhibit 13 hereto, which include the consolidated financial statements and the notes thereto as of December 31, 1994 and 1993, and for each of the years in the three year period ended December 31, 1994, together with the independent auditors' report thereon of KPMG Peat Marwick LLP dated January 31, 1995, which information is incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING ---------------------------------------------------------------------------- AND FINANCIAL DISCLOSURE ------------------------\nRegistrant has not changed its independent auditors, and there have been no reportable disagreements with such auditors regarding accounting principles or practices or financial disclosure matters.\nPART III --------\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT ---------------------------------------------------------------\nInformation regarding the directors of Registrant is included under the caption \"Information as to Board of Directors and Nominees\" in Registrant's proxy statement dated March 10, 1995, and is incorporated herein by reference. Information regarding the executive officers of Registrant is included under a separate caption in Part I hereof and is incorporated by reference, in accordance with General Instruction G(3) to Form 10-K and Instruction 3 to Item 401(b) of Regulation S-K.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION ---------------------------------------\nInformation regarding the above is included under the caption \"Executive Compensation\" in Registrant's proxy statement dated March 10, 1995, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT -------------------------------------------------------------------------------\nInformation regarding the above is included under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Ownership By Management\" in Registrant's proxy statement dated March 10, 1995, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS ---------------------------------------------------------------\nInformation regarding the above is included under the caption \"Security Ownership of Certain Beneficial Owners\" in Registrant's proxy statement dated March 10, 1995, 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 part of this Form 10-K Report.\n(1) The financial statements referred to in Item 8 above which are contained in Exhibit 13 hereto and which are incorporated by reference thereto.\n(2) Exhibits 10(a) through 10(f) to this Item 14 constitute each executive compensation plan and arrangement of Registrant.\nAll schedules have been omitted because the material is not applicable, or is not required, or because the required information is shown in the consolidated financial statements or in the notes thereto, or is not otherwise material to the consolidated financial statements.\n(b) There were no reports on Form 8-K filed for the quarter ended December 31, 1994.\n(c) Exhibits (numbered in accordance with Item 601 of Regulation S-K).\n(3a, 4a) Amended Articles of Incorporation of Rubbermaid Incorporated. Incorporated by reference from Exhibits 3a and 4a to Form 10-K for the year ended December 31, 1992.\n(3b, 4b) Regulations of Rubbermaid Incorporated. Incorporated by reference from Exhibits 3b and 4b to Form 10-K for the year ended December 31, 1992.\n(4c) Amended and Restated Rights Agreement between Rubbermaid Incorporated and The First National Bank of Boston. Incorporated by reference from Exhibit 4 to Form 8 filed with the Commission on October 26, 1989.\n(10a) Rubbermaid Incorporated Management Incentive Plan. Incorporated by reference from Exhibit 10a to Form 10-K for the year ended December 31, 1992.\n(10b) Rubbermaid Incorporated Amended 1989 Restricted Stock Incentive and Option Plan. Incorporated by reference from Exhibit A to Proxy Statement for April 26, 1994 Annual Meeting of Shareholders.\n(10c) Rubbermaid Incorporated Supplemental Executive Retirement Plan, as amended. Incorporated by reference from Exhibit 10(d) to Form 10-K for the year ended December 31, 1993.\n(10d) Rubbermaid Incorporated Supplemental Retirement Plan. Incorporated by reference from Exhibit 10(e) to Form 10-K for the year ended December 31, 1991.\n(10e) Change-Of-Control Employment Agreements - Identical agreements have been entered into with Charles A. Carroll, Richard D. Gates, Fred S. Grunewald, Lucius W. Hoffa, Jr., Gary E. Kleinjan, Gary F. Mattison, James A. Morgan, Michael E. Naylor, Joseph M. Ramos, David L. Robertson, Wolfgang R. Schmitt, Carol S. Troyer, and George C. Weigand. Incorporated by reference from Exhibit 10(i) to Form 10-K for the year ended December 31, 1991.\n(10f) Rubbermaid Incorporated 1993 Deferred Compensation Plan. Incorporated by reference to Exhibit A to Proxy Statement for April 27, 1993 Annual Meeting of Shareholders.\n(13) Consolidated financial statements and other data from pages 25 to 37 of 1994 Annual Report to Shareholders.\n(21) Subsidiaries of Registrant.\n(23) Consent of KPMG Peat Marwick LLP.\n(24) Power of Attorney.\n(27) Financial Data Schedule.\nSIGNATURE ---------\nPursuant to the requirements of the Securities Exchange Act of 1934, Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.\nDate: March 24, 1995 RUBBERMAID INCORPORATED\nBy: \/s\/Wolfgang R. Schmitt ------------------------------- Wolfgang R. Schmitt 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 Registrant and in the capacities indicated on March 24, 1995.\n\/s\/ Wolfgang R. Schmitt Director, Chairman of the Board and ---------------------------------- Chief Executive Officer Wolfgang R. Schmitt\n\/s\/ George C. Weigand Senior Vice President and ---------------------------------- Chief Financial Officer George C. Weigand\n\/s\/ John L. Theler Vice President and Corporate ---------------------------------- Controller John L. Theler (Principal Accounting Officer)\nTom H. Barrett Director\nCharles A. Carroll Director\nZoe Coulson Director\nRobert O. Ebert Director\nStanley C. Gault Director\nRobert M. Gerrity Director By: \/s\/ James A. Morgan -------------------------- Karen N. Horn Director James A. Morgan Attorney-in-Fact William D. Marohn Director\nSteven A. Minter Director\nJan Nicholson Director\nPaul G. Schloemer Director","section_15":""}
{"filename":"790650_1994.txt","cik":"790650","year":"1994","section_1":"Item 1. Business\nGENERAL\nSouthern New England Telecommunications Corporation (\"Corporation\") was incorporated in 1986 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 Corporation is a holding company engaged through its subsidiaries in operations principally in the State of Connecticut: The Southern New England Telephone Company (providing, for the most part, regulated telecommunications services and directory publishing and advertising services); SNET Cellular, Inc., SNET Mobility, Inc. and SNET Paging, Inc. (providing wireless communications services); SNET America, Inc. (providing national and international long-distance services to Connecticut customers); SNET Diversified Group, Inc. (primarily engaged in the sale and leasing of communications equipment to residential and business customers; and providing other telecommunications services not subject to regulation); and SNET Real Estate, Inc. (engaging in leasing commercial real estate). The Corporation furnishes financial and strategic planning, and shareholder relations functions on its own behalf and on behalf of its subsidiaries.\nTHE SOUTHERN NEW ENGLAND TELEPHONE COMPANY\nThe Southern New England Telephone Company (\"Telephone Company\"), a local exchange carrier (\"LEC\"), was incorporated in 1882 under the laws of the State of Connecticut and 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 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. The publishing division also develops and provides electronic publishing services.\nIn 1994, approximately 74% of the Corporation's consolidated revenues and sales were derived from the Telephone Company's rate regulated telecommunication services. The remainder was derived principally from the Corporation's other subsidiaries, 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.\nThe Telephone Company is subject to the jurisdiction of the Federal Communications Commission (\"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\nFCC has adopted accounting and cost allocation rules for the separation of costs of regulated from non-regulated telecommunications services for interstate ratemaking purposes.\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 accounting and cost allocation rules for intrastate ratemaking purposes, similar to those adopted by the FCC, for the separation of costs of regulated from non-regulated activities.\nCompetition\nOn May 26, 1994, Public Act 94-83 (\"Act\") was enacted providing a new regulatory framework for the Connecticut telecommunications industry. The Act which took effect on July 1, 1994 represents a broad strategic response to the changes facing the telecommunications industry in Connecticut based on the premise that broader participation in the Connecticut telecommunications market will be more beneficial to the public than will broader regulation. The Act opens Connecticut telecommunications services to full competition, including local phone service currently provided primarily by the Telephone Company and encourages the DPUC to adopt alternative forms of regulation for telephone companies', including the Telephone Company's, noncompetitive and emerging competitive services.\nThe DPUC has opened a number of proceedings to determine an appropriate vision for Connecticut's telecommunications infrastructure and to address in the competitive phase: local exchange service competition; universal service and lifeline program policy issues; unbundling of LECs' local networks; and reclassification of LECs' products and services into competitive, emerging competitive and noncompetitive categories. During the alternative regulation phase, also underway, the Telephone Company intends to submit to the DPUC an alternative regulation plan suggesting regulatory flexibilities to replace rate of return regulation with price regulation for noncompetitive and emerging competitive services. The alternative regulation phase will also involve a complete financial review of the Telephone Company and will address cost of service, capital recovery and service standards.\nThe Telephone Company's regulated operations are subject to competition from companies and carriers, including competitive access providers, that construct and operate their own communications systems and networks for the provision of services to others as well as from companies that resell the telecommunications services of underlying carriers. Since the July 1, 1993 effective date of \"10XXX\" competition, over 40 telecommunications providers have received approval from the DPUC to offer \"10XXX\" or other competitive intrastate long- distance services. In addition, over 20 companies have filed for initial certificates of public convenience and necessity and are awaiting DPUC approval. Increasing competition in intrastate long-distance service and the Telephone Company's reduction in intrastate toll rates will continue to place significant downward pressure on the Telephone Company's intrastate toll revenues as will the implementation of intrastate equal access, which is required to be implemented for all dual preferred interexchange carrier (\"PIC\") capable switches no later than December 1, 1996. No balloting of customers is required. Although the DPUC ordered the Company to bear its proportionate share of the costs to deploy the dual PIC technology, the DPUC added the estimated 1996 average net toll revenue loss\nto the cost recovery formula. These costs will be recovered through an intrastate equal access rate element on the presubscribed lines of all carriers unless the Office of Consumer Counsel's December 7, 1994 Petition for Administrative Appeal to the Superior Court results in a change.\nSince the introduction of \"10XXX\" competition, AT&T and MCI have increased their marketing efforts in Connecticut to sell intrastate long-distance services primarily to residential customers. In response to AT&T's, MCI's and other competitors' efforts, the Telephone Company has undertaken a number of initiatives. The Telephone Company remains focused on providing excellent customer service and quality products and has made several changes to its product lines to provide creative options and flexible packages that meet and exceed customers' expectations. Over the past year, the Telephone Company has introduced a volume aggregation feature providing steeper discounts to several of its long-distance services that provides customers with the ability to combine their in- state long-distance calling for all of their \"800\" and WATS- like services. The Telephone Company has also introduced term options to several products and services that enable customers to gain additional discounts and rate stability in return for committing to the service for a longer time period.\nConcerning competition for local exchange service, 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 utilize its own facilities to provide services directly to customers. Pending DPUC approval, these services are expected to be available in Connecticut within one to two years. On January 26, 1994, MCI Metro Access Transmission Services, Inc. (\"MCI Metro\") was approved by the DPUC to offer non-switched, in- state long-distance private line services in Connecticut and has offered high capacity private line services to customers in Connecticut since February 1994. On December 20, 1994, MCI Metro filed an application with the DPUC to provide local exchange telecommunications services to business customers in Connecticut by 1996 with the expansion to residential customers thereafter. In addition to the expected facilities- based local service competition, AT&T has requested that the Telephone Company provide for the resale of its services including local service.\nCompetitive access providers continue to deploy fiber-ring technology throughout Connecticut. Their initial goal is to provide access and private line services with the intent to migrate customers to switched services. During 1994, the Telephone Company reached an agreement to lease part of its existing digital fiber-optic-ring network in the Hartford and Stamford metropolitan areas to MFS Communications Company, Inc. (\"MFS\"). This agreement will allow MFS to provide services to large business customers on an intraexchange basis utilizing the Telephone Company's facilities and eliminates the need for MFS to construct its own facilities.\nIn February 1994, pursuant to FCC orders, the Telephone Company's tariff for switched access expanded interconnection (i.e., collocation) service became effective. This tariff allows access customers, including interexchange carriers and competitive access providers, to collocate their own facilities in the Telephone Company's central offices and connect to the Telephone Company's switched access services. In June 1994, the FCC required LECs to provide a new form of interconnection that offers signaling information from LECs' end offices, allowing competitive access providers to offer tandem switching services in competition with the LECs. The Telephone Company filed its tariffs for tandem signaling in September 1994, for effect on January 24, 1995. The FCC has allowed the Telephone Company increased pricing flexibility coincident with the operation of interconnection that will allow it to compete with competitive access providers for\nspecial access services. At this time, in accordance with the DPUC's May 5, 1994 decision, the Telephone Company's federal access tariff structure is also being utilized for the provision of intrastate access service.\nThe Telephone Company expects to see continued movement toward a fully competitive telecommunications marketplace, both on an interexchange and intraexchange basis. The Telephone Company's ability to compete is dependent upon regulatory reform that will allow pricing flexibility to meet competition and provide a level playing field with similar regulations for similar services and with reduced regulation to reflect an emerging competitive marketplace. The legislation and regulatory proceedings that flow from it should produce a telecommunications marketplace in Connecticut that, by providing equal opportunity to all competitors, will work to benefit Connecticut consumers.\nRegulatory Matters\nState Regulation Initiatives and New Services\nOn December 6, 1994, the Telephone Company received approval from the DPUC to begin offering, in January 1995, a new voice messaging service called SNET MessageWorks[SM]. SNET MessageWorks is a voice messaging system that enables communication via recorded messages and is intended to meet the telephone answering and voice messaging needs of both residential and business customers.\nOn February 15, 1995, the DPUC lifted a nine-year-old restriction on the Corporation's total investment in unregulated business. The restriction prohibited the Corporation from investing more than 25% of its total assets in unregulated diversified activities without approval of the DPUC. The DPUC provided the Corporation greater flexibility to diversify into new markets up to 40% of total consolidated assets.\nOn May 24, 1993, the DPUC issued a 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 the 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 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 evolving 1993 issues of: (i) 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 had 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 $39.4 million effective July 7, 1993. The Telephone Company was authorized previously to earn a 12.75% ROE. The increase in intrastate revenue of $39.4 million was offset virtually by the approximate $40 million increase in capital recovery granted on May 24, 1993. 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.\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) a change in basic local service 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 customers; (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 and directory assistance calls along with an interim surcharge on the remaining products and services with authorized increases including local exchange. The surcharge was in effect until October 9, 1993, when the remaining new rates became effective, including an average increase in residential basic local service rates of $.32 a month while business basic local service rates decreased by $.07 a month.\nOn July 9, 1994, the second and final phase of new rates became effective. Residential basic local service rates increased $.26 a month and business basic local service rates decreased between $.69 and $1.23 a month depending on the type of local service selected. At December 31, 1994, the Telephone Company's intrastate ROE was below the authorized 11.65%.\nFederal Regulation Initiatives\nOn January 19, 1994, the Telephone Company filed suit in the U.S. District Court (\"Court\") in New Haven requesting the Court find that the Cable Communications Policy Act of 1984 (\"Cable Act\") violates the Telephone Company's First and Fifth Amendment rights. The Cable Act restricts in-territory provision of cable programming by LECs and prohibits LECs from owning more than 5% of any company that provides cable programming in their local service area. Several district courts and the Fourth and Ninth Circuit Courts of Appeal have rendered decisions consistent with the Telephone Company's position.\nEffective July 1, 1991, the Telephone Company elected the FCC's price cap regulation, which replaced traditional rate of return regulation. Under price cap 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, FCC cost separation rules, and tax laws. The treatment of exogenous 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 on the Telephone Company's ability 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. 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.\nOn April 1, 1994, the Telephone Company filed with the FCC its 1994 annual interstate access tariff under price cap regulation for effect on July 1, 1994. The Telephone Company maintained its selection of the 3.3% productivity factor and is allowed to earn up to a 12.25% interstate rate of return annually before any sharing occurs. The filing, which was approved by the FCC, incorporated rate reductions of approximately $7 million in decreased annual interstate network access revenues for the period July 1, 1994 to June 30, 1995. Management expects this decrease to be fully offset by increased demand. As of December 31, 1994, the Telephone Company's interstate rate of return was below the 12.25% threshold.\nOn July 12, 1994, the Court reversed and remanded to the FCC a ruling addressing the exogenous treatment of certain incremental postretirement costs incurred by price cap carriers, including the Telephone Company. The Telephone Company's tariffs, which took effect on July 2, 1993 and were subject to FCC further investigation, could be affected by the Court's decision. The Telephone Company's tariffs which took effect on July 1, 1994 could also be affected by the Court's decision. The Telephone Company expects the impact of this decision to be immaterial to total revenues.\nThe Telephone Company will file its 1995 annual interstate access tariff filing on April 3, 1995 under price cap regulation to become effective July 1, 1995. The filing will adjust interstate access rates for an experienced rate of inflation, the FCC's productivity target and exogenous cost changes, if any. The Telephone Company does not anticipate changing its election for the next tariff period.\nIn February 1994, the FCC began its scheduled inquiry into the price cap plan for LECs to determine whether to revise the current plan to improve LECs' performance in meeting the FCC's objectives. Results of this inquiry are expected in early 1995.\nIn July 1993, the FCC granted the Telephone Company increased interstate depreciation rates in connection with its triennial review of depreciation. The new depreciation rates were effective retroactive to January 1, 1993 and increased depreciation expense by approximately $11 million. However, under current price cap regulation applicable to the Telephone Company, any changes in depreciation rates cannot be reflected in interstate access rates.\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 1993 indicating it is in compliance with its CAM, and is currently undergoing an audit for the year 1994.\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:\n1994 1993 1992 1991 1990\nNetwork Access Lines in Service (thousands) 2,009 1,964 1,937 1,922 1,904\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[SM] in Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe principal properties of the Corporation and its subsidiaries do not lend themselves to a detailed description by character and location. The majority of telecommunications property, plant and equipment of the Corporation and its subsidiaries is owned by the Telephone Company. Of the Corporation's investment in telecommunications property, plant and equipment at December 31, 1994, 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 35%; land and buildings (occupied principally by central offices) represented 11%; telephone instruments and related wiring and equipment, including private branch exchanges, substantially all of which are on the premises of customers, represented 2%; 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 Corporation has a significant investment in the properties, facilities and equipment necessary to conduct its business with the overwhelming majority of this investment relating to telephone operations. Management believes that the Corporation's facilities and equipment are suitable and adequate for the business.\nIn 1993, the Telephone Company announced its intention to invest $4.5 billion over the next 15 years to build I-SNET, a statewide information superhighway. 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 160,000 residences and businesses by the end of 1995. 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. At this time, the Telephone Company does not plan to request a rate increase for this investment.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Corporation and certain of its subsidiaries are 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 Corporation or its subsidiaries.\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 in the fourth quarter of the fiscal year covered by this report.\nExecutive Officers of the Registrant (1) (as of February 28, 1995)\nExecutive Officer Name Age(2) Position Since\nDaniel J. Miglio 54 Chairman, President and Chief Executive Officer 1\/86\nJean M. LaVecchia 42 Senior Vice President- Organization Development 8\/94\nRonald M. Serrano 39 Senior Vice President- Corporate Development 1\/93\nDonald R. Shassian 39 Senior Vice President and Chief Financial Officer 12\/93\nMadelyn M. DeMatteo 46 Vice President, General Counsel and Secretary 5\/90\nJohn A. Sadek 61 Vice President and Comptroller 1\/86\n(1) Includes executive officers subject to Section 16 of the Securities Exchange Act of 1934. (2) As of December 31, 1994.\nMr. Miglio, Ms. LaVecchia, Ms. DeMatteo and Mr. Sadek have held high level managerial positions with the Corporation or its subsidiaries for more than the past five years. Mr. Serrano was a Vice President of Mercer Management Consulting, Inc., (formerly Strategic Planning Associates) for more than five years prior to joining the Corporation. Mr. Shassian was a partner with Arthur Andersen & Co., independent accountants, for more than five years prior to joining the Corporation.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nThe common stock of the Corporation is listed on the New York and Pacific stock exchanges and the number of holders of record, computed on the basis of registered accounts, was 55,302 as of February 28, 1995. Information with respect to the quarterly high and low sales price for the Corporation's common stock and quarterly cash dividends declared is included in the registrant's Annual Report to Shareholders on page 48 under the caption \"Market and Dividend Data\" and is incorporated herein by reference pursuant to General Instruction G(2).\nItems 6 through 8.\nInformation required under Items 6 through 8 is included in the registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994 on pages 18 through 47 in their entirety and is incorporated herein by reference pursuant to General Instruction G(2).\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\nNo changes in or disagreements with accountants on any accounting or financial disclosure occurred during the period covered by this report.\nPART III\nItems 10 through 13.\nInformation required under Items 10 through 13 is included in the registrant's Proxy Statement dated March 27, 1995 on pages 1 (commencing under the caption \"Proxy Statement\") through 8 and pages 13 through 17. Such information is incorporated herein by reference.\nInformation regarding executive officers of the registrant required by Item 401(b) and (e) of Regulation S-K is included in Part I of this Annual Report on Form 10-K, following Item 4.\nPART IV\nItem 14.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"Item 14. Exhibits, Financial Statement Schedule, and Reports on Form 8-K\n(a) Documents filed as part of the report: Page\n(1) Report on Consolidated Financial Statements *\nReport of Audit Committee *\nReport of Independent Accountants *\nConsolidated Financial Statements:\nConsolidated Statement of Income (Loss) - for the years ended December 31, 1994, 1993 and 1992 *\nConsolidated Balance Sheet - as of December 31, 1994 and 1993 *\nConsolidated Statement of Changes in Stockholders' Equity - for the years ended December 31, 1994, 1993 and 1992 *\nConsolidated Statement of Cash Flows - for the years ended December 31, 1994, 1993 and 1992 *\nNotes to Consolidated Financial Statements *\n(2) Consolidated Financial Statement Schedule for the year ended December 31, 1994\nReport of Independent Accountants 24\nII - Valuation and Qualifying Accounts 25\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* Incorporated herein by reference to the appropriate portions of the registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994 [see Part II].\n(3) Exhibits:\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto. Exhibits numbered 10(iii)(A)1 through 10(iii)(A)14 are management contracts or compensatory plans required to be filed as exhibits pursuant to Item 14(c) of Form 10-K.\nExhibit Number\n3a Amended and Restated Certificate of Incorporation of the registrant as filed June 14, 1990 (Exhibit 3-A to Form SE dated 3\/15\/91, File No. 1-9157).\n3b By-Laws of the registrant as amended and restated through October 10, 1990 (Exhibit 3 to Form 8-K dated 10\/10\/90, File No. 1-9157).\n4a Rights Agreement dated February 11, 1987 between Southern New England Telecommunications Corporation and The State Street Bank and Trust Company, as Rights Agent (Exhibit 1 to Form SE dated 2\/13\/87-1, File No. 1-9157). Amendment No. 1 dated December 13, 1989 (Exhibit 4 to Form SE dated 12\/28\/89, File No. 1-9157). Amendment No. 2 dated October 10, 1990 (Exhibit 4 to Form SE dated 10\/12\/90, File No. 1-9157).\n4b Indenture dated December 13, 1993 between The Southern New England Telephone Company and Shawmut Bank Connecticut, National Association, Trustee, issued in connection with the sale of $200,000,000 of 6 1\/8% Medium-Term Notes, Series C, due December 15, 2003 and $245,000,000 of 7 1\/4% Medium-Term Notes, Series C, due December 15, 2033.\n10(iii)(A)1 SNET Short Term Incentive Plan as amended February 8, 1995.\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. 1-9157).\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). Amendment dated December 8, 1993 (Exhibit 10 (iii)(A)5 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157). Amendment dated February 8, 1995.\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. 1-9157). 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). Amendments dated June 1, 1994 through November 16, 1994.\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. 1-9157).\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). Amendment 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. 1-9157).\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. 1-9157).\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). Amendment dated January 1, 1994.\n10(iii)(A)13 SNET Non-Employee Director Stock Plan effective January 1, 1994 (Exhibit 4.4 to Registration 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.\n(3) Exhibits (continued):\nExhibit Number\n13 Pages 18 through 48 of the registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994.\n21 Subsidiaries of the Corporation.\n23 Consent of Independent Accountants.\n24a Powers of Attorney.\n24b Board of Directors' Resolution.\n27 Financial Data Schedule\n99a Annual Report on Form 11-K for the plan year ended December 31, 1994 for the SNET Management Retirement Savings Plan will be filed as an amendment prior to June 30, 1995.\n99b Annual Report on Form 11-K for the plan year ended December 31, 1994 for the SNET Bargaining Unit Retirement Savings Plan will be filed as an amendment prior to June 30, 1995.\nThe Corporation will furnish, without charge, to a stockholder upon request a copy of the Annual Report to Shareholders and Proxy Statement, portions of which are incorporated by reference, and will furnish any other exhibit at cost.\n(b) Reports on Form 8-K:\nOn October 26, 1994, the Corporation and the Telephone Company filed, separately, reports on Form 8-K, dated October 26, 1994 announcing the Corporation's financial results for the third quarter of 1994.\nOn November 22, 1994, the Corporation filed a report on Form 8- K, dated November 22, 1994, announcing that it had reached definitive agreements with Bell Atlantic Corporation and NYNEX Corporation to purchase certain cellular properties that are within or contiguous to areas served by SNET Mobility, Inc., a wholly-owned subsidiary of the Corporation. The properties to be purchased include all of Rhode Island and the New Bedford, Massachusetts area now owned by Bell Atlantic as well as NYNEX's ownership of 80% of the Pittsfield, Massachusetts market and a 16.1% interest in a cellular partnership currently 82.5% owned and managed by the Corporation.\nOn January 25, 1995, the Corporation and the Telephone Company filed, separately, reports on Form 8-K, dated January 24, 1995, announcing the Corporation's 1994 financial results and the change in credit ratings by Standard & Poor's on the Corporation's senior unsecured debt to A+ from AA and commercial paper rating to A-1 from A-1+.\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 NEW ENGLAND TELECOMMUNICATIONS CORPORATION\nBy \/s\/ J. A. Sadek J. A. Sadek, Vice President and Comptroller, March 10, 1995\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* Robert L. Bennett* Barry M. Bloom* March 10, 1995 F. J. Connor* William R. Fenoglio* Claire L. Gaudiani* J. R. Greenfield* Burton G. Malkiel* Frank R. O'Keefe, Jr.* * by power of attorney\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Stockholders of Southern New England Telecommunications Corporation:\nOur report on the consolidated financial statements of Southern New England Telecommunications Corporation has been incorporated by reference in this Form 10-K from the 1994 Annual Report to Stockholders of Southern New England Telecommunications Corporation on page 29 therein. In connection with our audits of such financial statements, we have also audited the related financial statement schedule for each of the three years in the period ended December 31, 1994 listed in Item 14 (a) (2) of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nHartford, Connecticut COOPERS & LYBRAND L.L.P. January 24, 1995\nSOUTHERN NEW ENGLAND TELECOMMUNICATIONS CORPORATION\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS (Millions of Dollars)\nCOL. A COL. B COL. C(1) COL. C(2) COL. D COL. E\nAdditions\nBalance at Charged to Balance beginning Charged to other accounts Deductions at end Description of period expense - Note(a) - Note(b) of period\nAllowance for Uncollectible Accounts Receivable:\nYear 1994 $26.7 $20.7 $6.3 $25.5 $ 28.2 Year 1993 21.8 28.9 3.6 27.6 26.7 Year 1992 16.3 33.3 3.9 31.7 21.8\nAllowance for Uncollectible Direct-Financing Lease Notes Receivable of Discontinued Operations:\nYear 1994 $ 11.7 $ 1.7 $ - $ 5.0 $ 8.4 Year 1993 8.2 15.6 - 12.1 11.7 Year 1992 4.6 9.2 - 5.6 8.2\n(a) Includes amounts previously written off that were credited directly to this account when recovered and miscellaneous debits and credits.\n(b) Includes amounts written off as uncollectible.\nAdditions Balance at Balance beginning Charged to Charged to Deductions at end Description of period expense other accounts -Note(a) of period\nRestructuring Charge:\nYear 1994 $355.0 $ - $ - $90.1 $264.9 Year 1993 - 355.0 - - 355.0\n(a) Amount represents costs incurred that were charged against the restructuring reserve.\nEXHIBIT INDEX\nExhibits identified in parentheses below, on file with the SEC, are incorporated herein by reference as exhibits hereto. Exhibits numbered 10(iii)(A)1 through 10(iii)(A)14 are management contracts or compensatory plans required to be filed as exhibits pursuant to Item 14(c) of Form 10-K.\nExhibit Number\n3a Amended and Restated Certificate of Incorporation of the registrant as filed June 14, 1990 (Exhibit 3-A to Form SE dated 3\/15\/91, File No. 1-9157).\n3b By-Laws of the registrant as amended and restated through October 10, 1990 (Exhibit 3 to Form 8-K dated 10\/10\/90, File No. 1-9157).\n4a Rights Agreement dated February 11, 1987 between Southern New England Telecommunications Corporation and The State Street Bank and Trust Company, as Rights Agent (Exhibit 1 to Form SE dated 2\/13\/87-1, File No. 1-9157). Amendment No. 1 dated December 13, 1989 (Exhibit 4 to Form SE dated 12\/28\/89, File No. 1-9157). Amendment No. 2 dated October 10, 1990 (Exhibit 4 to Form SE dated 10\/12\/90, File No. 1-9157).\n4b Indenture dated December 13, 1993 between The Southern New England Telephone Company and Shawmut Bank Connecticut, National Association, Trustee, issued in connection with the sale of $200,000,000 of 6 1\/8% Medium-Term Notes, Series C, due December 15, 2003 and $245,000,000 of 7 1\/4% Medium-Term Notes, Series C, due December 15, 2033.\n10(iii)(A)1 SNET Short Term Incentive Plan as amended February 8, 1995.\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. 1-9157).\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). Amendment dated December 8, 1993 (Exhibit 10 (iii)(A)5 to 1993 Form 10-K dated 3\/23\/94, File No. 1-9157). Amendment dated February 8, 1995.\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. 1-9157). 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). Amendments dated June 1, 1994 through November 16, 1994.\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. 1-9157).\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). Amendment 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. 1-9157).\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. 1-9157).\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). Amendment dated January 1, 1994.\n10(iii)(A)13 SNET Non-Employee Director Stock Plan effective January 1, 1994 (Exhibit 4.4 to Registration 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.\n13 Pages 18 through 48 of the registrant's Annual Report to Shareholders for the fiscal year ended December 31, 1994.\n21 Subsidiaries of the Corporation.\n23 Consent of Independent Accountants.\n24a Powers of Attorney.\n24b Board of Directors' Resolution.\n27 Financial Data Schedule\n99a Annual Report on Form 11-K for the plan year ended December 31, 1994 for the SNET Management Retirement Savings Plan will be filed as an amendment prior to June 30, 1995.\n99b Annual Report on Form 11-K for the plan year ended December 31, 1994 for the SNET Bargaining Unit Retirement Savings Plan will be filed as an amendment prior to June 30, 1995.","section_15":""}
{"filename":"832101_1994.txt","cik":"832101","year":"1994","section_1":"ITEM 1. BUSINESS.\nIDEX (\"IDEX\" or the \"Company\") designs, manufactures and markets a broad range of fluid handling and industrial products serving a diverse customer base in the United States and internationally. IDEX competes with relatively few major manufacturers in most of its markets, and believes that each of its ten principal subsidiaries ( the \"Subsidiaries\") has a significant domestic market share in its principal product area. The Company manufactures proprietary products of its own design with an engineering content. Generally, all of the Company's businesses compete on the basis of performance, quality, service and price.\nFLUID HANDLING GROUP\nThe Fluid Handling Group, which in 1994 accounted for 69% of the Company's total sales, manufactures a wide variety of industrial pumps and controls, fire-fighting pumps and rescue equipment, small horsepower compressors, and lubrication systems. In 1994, approximately 30% of this Group's sales were to customers outside the U.S. The six business units comprising this Group are described below.\nCORKEN. Corken, headquartered in Oklahoma City, Oklahoma, with a sales office in Singapore, produces small horsepower compressors, vane and turbine pumps and valves used for the transfer of liquified petroleum gas (\"LPG\"), compressed natural gas, and other gaseous substances.\nManagement believes Corken has approximately 50% of the market for pumps and small horsepower compressors used in LPG distribution. Its principal competitor in this market is the Blackmer division of Dover Corporation. Corken faces many significant competitors in the industrial (non-LPG distribution) segment of its business. Most of Corken's sales are made through domestic and international distributors which incorporate Corken's products in engineered packages sold to ultimate users. Repair and after-market sales account for approximately 40% of Corken's total sales volume. Shipments outside the United States represent approximately 35% of total Corken sales.\nHALE PRODUCTS. Hale Products, acquired by IDEX in May 1994, is the newest business in the Fluid Handling Group, and has its headquarters and a manufacturing facility in Conshohocken, Pennsylvania. It also has production facilities in Shelby, North Carolina; St. Joseph, Tennessee; and Warwick, England; and service and distribution centers in Dieburg, Germany and Singapore.\nHale Products is the world's leading manufacturer of truck-mounted fire-fighting pumps and manufactures fire truck pumps under both the U.S. and European design standards. Hale complements its line of fire truck pumps with a range of portable, mobile and freestanding pumping units and also manufactures products which form the Hurst Jaws of Life(R) rescue system. It is estimated to have a 50% share of the U.S. and an 80% share of the U.K. markets for truck-mounted fire pumps and a 60% share of the U.S. market for rescue tools. Hale's principal competitor in the U.S. truck-mounted fire pump market is the Waterous Company, a subsidiary of American Cast Iron Pipe Company.\nSales of Hale's truck-mounted fire pumps are made directly to manufacturers of fire trucks, while portable pumps and rescue tools are generally sold through independent distributors. Approximately 40% of Hale's sales occur outside the United States.\nLUBRIQUIP. Lubriquip is headquartered in Warrensville Heights, Ohio and also has manufacturing plants in McKees Rocks, Pennsylvania, and Madison, Wisconsin and a sales office in Singapore. Its products include a wide range of centralized oil and grease lubrication systems and force-feed lubricators marketed under the Trabon, Manzel, Grease Jockey, Kipp and OPCO trademarks for use in general industrial and transportation applications. Lubriquip offers a wide variety of customized systems using selected standard components to meet specific customer requirements. Lubriquip is subject to competition from several companies in both the domestic and international markets; however, management estimates that Lubriquip is the largest producer of such systems with approximately one-third of the domestic market for centralized lubricating systems.\nLubriquip's system components include pumps and pump packages for pneumatic, mechanical, electric and hydraulic operation; metering devices, electronic controllers, monitors and timers, and accessories. These systems are sold through independent distributors to a wide range of industrial markets, including machine tools (both automotive and general purpose), chemical processing, construction equipment, food processing machinery, engine and compressor, railroad, and over-the-road truck industries. Lubriquip's products are available worldwide through over 100 independent distributors, with international sales representing approximately 15% of total shipments. Through these networks, Lubriquip also provides an extensive support system of application engineering, service and repair parts for its products.\nPULSAFEEDER. Pulsafeeder, acquired by IDEX in May 1992, has its headquarters and a manufacturing facility in Rochester, New York. It also manufactures products in Punta Gorda, Florida, and Muskogee, Oklahoma, and has sales offices in Singapore and Beijing, China. Pulsafeeder designs and markets a wide range of metering pumps and controls. These products precisely regulate the flow of liquids in mixing and blending applications. Primary markets served are water and wastewater treatment, chemical and hydrocarbon processing, food processing, and warewash institutional.\nPulsafeeder products are grouped into three categories: engineered pumps, standard pumps and electronic controls. Engineered pumps, designed and manufactured in Rochester, New York, include positive displacement, hydraulically-actuated diaphragm pumps used in precise metering applications in such industries as electric\/gas utilities, chemical process, petroleum refining and pharmaceuticals, as well as specialty pumps targeted at niche markets, including pumps designed to handle highly corrosive chemicals. Standard pumps, manufactured in Punta Gorda, Florida, represent a growing portion of Pulsafeeder's business, and include metering pumps designed for water treatment and water conditioning applications. Electronic controls, manufactured in Muskogee, Oklahoma, are of advanced microprocessor-based design, and are used to control the chemical composition of fluids being pumped, including such applications as recirculating systems for cooling towers and boilers in the water treatment market.\nPulsafeeder pumps are sold through an extensive network of company sales personnel and independent representatives. Management believes that Pulsafeeder has approximately 35% of the domestic market for metering pumps used in the process industries and water treatment markets. Approximately 20% of its sales are outside of the United States. Pulsafeeder's principal competitor is Milton Roy Company, a subsidiary of Sunstrand Corporation.\nVIKING PUMP. Viking Pump, headquartered in Cedar Falls, Iowa, is the largest business unit in the Company's Fluid Handling Group and is one of the largest producers of positive displacement rotary internal gear pumps (Viking's main product) and spur gear pumps. Management believes that Viking pumps, which are classified as rotary pumps, represent approximately 25% of the domestic rotary pump market and 45% of the domestic rotary pump market in chemical processing. Viking's principal rotary pump competitors are Roper Industries and the Blackmer division of Dover Corporation. Viking's other products include rotary lobe and metering pumps, speed reducers, flow dividers and basket-type line strainers.\nViking pumps are used by numerous industries such as the chemical, petroleum, food, pulp and paper, machinery and construction industries. Viking is not dependent on any one industry for a substantial percentage of its sales. Sales of Viking pumps and replacement parts are made through approximately 100 independent distributors and directly to original equipment manufacturers. Approximately 30% of Viking's sales occur outside of the United States. In addition to its facilities in Cedar Falls, Iowa, Viking also maintains manufacturing facilities in Eastbourne, England; Windsor, Ontario; Shannon, Ireland; participates in a joint venture in Mexico; and has sales offices in Amsterdam; Singapore; Woodbridge, Ontario; and Beijing, China.\nViking operates two foundries in Cedar Falls, Iowa which supply a majority of Viking's castings requirements. In addition, these foundries sell a variety of castings to outside customers.\nWARREN RUPP. Warren Rupp is a producer of air-operated and motor-driven double-diaphragm pumps, generally sold under the SandPIPER tradename. This business unit is headquartered in Mansfield, Ohio and has a distribution facility in Shannon, Ireland to serve the European market and a sales office in Singapore. Warren Rupp's principal competitor is Wilden Pump and Engineering Co. Management believes that Warren Rupp has approximately one-third of the domestic market for air-operated double-diaphragm pumps.\nWarren Rupp's pumps are well suited for pumping liquids, slurries and solids in suspension. Its pump models are made from cast iron, stainless steel and non-metallic composites to meet requirements to pump various types of material. End-user markets include the paint, chemical, mining, construction, and automotive service industries. Warren Rupp pumps are sold through a network of independent distributors and directly to a small number of original equipment manufacturers. Sales outside of the United States represent approximately 40% of total Warren Rupp sales.\nINDUSTRIAL PRODUCTS GROUP\nThe Industrial Products Group, which in 1994 accounted for 31% of the Company's total sales, manufactures sheet metal fabricating equipment and tooling, stainless steel banding and clamping devices, vibration control devices, and sign-mounting products and systems. In 1994, approximately 36% of this Group's sales were to customers outside the U.S. The four business units comprising this Group are described below.\nBAND-IT. Band-It, headquartered in Denver, Colorado, is one of the largest worldwide producers of stainless steel bands, buckles and preformed clamps and related installation tools. Its clamps are used to secure hoses to nipples, devices to pipes and poles, signs to sign standards, fences to posts, insulation to pipes, and for hundreds of other industrial clamping functions. Band-It also has developed an exclusive line of tools for installing its clamping devices.\nBand-It is subject to competition from several companies in both the domestic and international markets; however, management believes that Band-It has approximately 50% of the domestic market for quality stainless steel bands and buckles. Band-It markets its products domestically and internationally. It has manufacturing and distribution facilities in Staveley, England and in Singapore to serve the European and Pacific Basin markets. International sales account for approximately 45% of Band-It's sales. Its products are sold through a worldwide network of nearly 4,000 distributors to a wide range of markets, including the transportation, utilities, mining, oil and gas, industrial maintenance, construction, communication and electronics industries.\nSIGNFIX. Signfix, acquired by IDEX in November 1993, has its headquarters and a manufacturing facility near Bristol, England, with another manufacturing facility in Tipton, England. Signfix also has distribution facilities in France and Germany.\nSignfix is the leading U.K.-based manufacturer of sign-mounting devices and related equipment with an estimated 45% U.K. market share. Signfix products include road, traffic and commercial sign-mounting systems and stainless steel bands and clamps for various municipal, commercial and industrial applications. Management estimates that 20% of Signfix sales are to customers outside the U.K.\nSTRIPPIT. Strippit, headquartered in Akron, New York, with sales and service offices in Swindon, England; Paris, France; Singapore and Beijing, China, is the largest business unit in the Company's Industrial Products Group and is a manufacturer of a broad range of sheet metal fabricating equipment and tooling. Strippit produces equipment which incorporates a high proportion of state-of-the-art technology and has numerous active patents in machine tool technology, none of which is individually material to its operations. Strippit's products include single station semi-automatic fabricators; advanced computer-controlled turret punching machines (including models with plasma arc or laser cutting heads); punches, dies and related tooling items; load\/unload systems for use in conjunction with Strippit's equipment; and hand-operated metal forming machines for use in industries which utilize light gauges of sheet metal. Strippit also is a distributor of Burgmaster metal-cutting machines and parts. Strippit's products are sold through a combination of direct sales and independent distributors and agents to a large and diverse customer base, including customers in the electronics, office, farm and hospital equipment markets. Approximately 25% of Strippit's total sales are to customers outside the U.S.\nStrippit is one of the largest domestic producers of its type of metal fabricating equipment, and management believes it has approximately 30% of the domestic market for numerically controlled punching machines. Its principal competitor, U.S. Amada, Ltd., is a Japanese firm which, based on its combined domestic production and imports, is currently believed to have a somewhat larger share of the numerically controlled punching machine market in the United States.\nVIBRATECH. Vibratech, headquartered in Buffalo, New York, produces a broad line of engineered long-life mechanical energy absorption devices, providing vibration and motion control for transportation equipment, machinery manufacturers and other users. Vibratech's three major product lines are: viscous torsional vibration dampers used primarily for heavy duty diesel engines and transmissions; fluid and friction ride control products for rail, truck and vehicle manufacturers; and specialized aircraft vibration and motion control dampers. In addition, Vibratech produces viscous torsional vibration dampers for motorsport engines. The largest portion of its sales are made directly to original equipment manufacturers who also service the replacement parts market.\nVibratech's principal competitor in the viscous torsional vibration damper market for heavy duty diesel engines is a United Kingdom-based subsidiary of Cummins Engine, Inc., which serves the damper requirements of Cummins in the United States market. Management believes that Vibratech has approximately 40% of the domestic market for viscous torsional vibration dampers, including that portion serviced by captive producers. Sales outside the United States are approximately 10% of Vibratech's total sales.\nGENERAL ASPECTS APPLICABLE TO THE COMPANY'S BUSINESS GROUPS\nEMPLOYEES. At December 31, 1994, IDEX had approximately 3,000 employees, of which approximately one-third were represented by labor unions with various contracts expiring from January 1996 through November 1998. Management believes that its relationship with its employees generally is good and that it will be able to satisfactorily renegotiate its collective bargaining agreements upon their expiration.\nSUPPLIERS. IDEX manufactures many of the materials and components used in its products. Substantially all materials and components purchased by IDEX are available from multiple sources.\nINVENTORY AND BACKLOG. Backlog does not have any material significance in either of the Company's business segments. The Company regularly and systematically adjusts production schedules and quantities based on the flow of incoming orders. While total inventory levels may also be affected by changes in orders, the Company generally tries to maintain relatively stable inventory levels based on its assessment of the requirements of the various industries served.\nSEGMENT INFORMATION. For segment financial information for the years 1994, 1993 and 1992 see the table presented on page 17 under \"Management's Discussion and Analysis of Financial Condition and Results of Operations,\" as set forth in the 1994 Annual Report and incorporated herein by reference, and Note 11 of the Notes to Consolidated Financial Statements on page 28 of the 1994 Annual Report, which is incorporated herein by reference.\nEXPORTS. For export information for the years 1994, 1993 and 1992, see Note 11 of the Notes to Consolidated Financial Statements on page 28 of the 1994 Annual Report, which is incorporated herein by reference.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth the names of the executive officers of the Company, their ages, the positions and offices with the Company held by them, and their business experience during the past 5 years.\nPosition with IDEX and Name Business Experience - ---- ---------------------- Donald N. Boyce (Age 56) Chairman of the Board, President and Chief Executive Officer since prior to January 1990.\nFrank J. Hansen (Age 53) Senior Vice President - Operations and Chief Operating Officer since August 1994; Vice President-Group Executive from January 1993 to July 1994; President of Viking Pump, Inc. from prior to January 1990 to July 1994.\nWayne P. Sayatovic (Age 49) Senior Vice President - Finance, Chief Financial Officer and Secretary since August 1994; Vice President - Finance, Chief Financial Officer and Secretary from January 1992 to July 1994; Vice President, Treasurer and Secretary from prior to January 1990 to December 1991.\nJerry N. Derck (Age 48) Vice President - Human Resources since November 1992; Vice President - Human Resources, North America of Tupperware Corporation, a subsidiary of Premark International from May 1990 to October 1992; Vice President, Quality and Human Resources of Schlegel Corporation from prior to January 1990 to May 1990.\nWade H. Roberts, Jr. (Age 48) Vice President - Group Executive since January 1993; President of Hale Products, Inc. since May 1994; President of Strippit, Inc. from August 1990 to May 1994.\nMark W. Baker (Age 47) Vice President - Group Executive since August 1994; President of Lubriquip, Inc. from prior to January 1990.\nThe Company's executive officers are elected at a meeting of the Board of Directors immediately following the annual meeting of shareholders, and they serve until the next annual meeting of the Board, or until their successors are duly elected.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's executive offices occupy approximately 10,000 square feet of leased space in Northbrook, Illinois. The Company's principal manufacturing facilities are listed below and are considered to be suitable and adequate for their operations. Management believes that, in general, approximately 50% to 80% of its manufacturing capacity is currently utilized in each facility.\nFLUID HANDLING GROUP\nINDUSTRIAL PRODUCTS GROUP\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company and the Subsidiaries are party to various legal proceedings arising in the ordinary course of business, none of which is expected to have a material adverse effect on the Company's business or financial condition.\nThe Subsidiaries are subject to extensive federal, state and local laws, rules and regulations pertaining to environmental, waste management and health and safety matters. Permits are or may be required for some of the Subsidiaries' facilities and waste-handling activities and these permits are subject to revocation, modification and renewal. In addition, risks of substantial costs and liabilities are inherent in the Subsidiaries' operations and facilities, as they are with other companies engaged in similar industries, and there can be no assurance that such costs and liabilities will not be incurred. The Company is not aware of any environmental, health or safety matter which could, individually or in the aggregate, materially adversely affect the financial condition of the Company or any of the Subsidiaries.\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 SHAREHOLDER MATTERS.\nInformation regarding the prices of and dividends on the Common Stock, and certain related matters, is incorporated herein by reference to \"Shareholder Information\" at inside back cover of the 1994 Annual Report.\nThe principal market for the Common Stock is the New York Stock Exchange. As of March 14, 1995, the Common Stock was held by 1,390 shareholders and there were 19,080,621 shares of Common Stock outstanding.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information set forth under \"Historical Data\" at page 15 of the 1994 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 set forth under \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" at pages 16 to 19 of the 1994 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 IDEX, including the notes thereto, together with the report thereon of Deloitte & Touche LLP at pages 20 to 30 of the 1994 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.\nCertain information regarding the directors of the Company is incorporated herein by reference to the information set forth under \"Election of Directors\" at pages 2 to 5 of the 1995 Proxy Statement.\nInformation regarding executive officers of the Company is incorporated herein by reference to Item 1 of this report under the caption \"Executive Officers of the Registrant\" at page 5.\nCertain information regarding compliance with Section 16(a) of the Securities and Exchange Act of 1934, as amended, is incorporated herein by reference to the information set forth under \"Compliance with Section 16(a) of the Exchange Act\" at page 18 of the 1995 Proxy Statement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation regarding executive compensation is incorporated by reference to the materials under the caption \"Compensation of Directors and Executive Officers\" at pages 7 to 14 of the 1995 Proxy Statement.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation regarding security ownership of certain beneficial owners and management is incorporated herein by reference to the information set forth under \"Principal Shareholders\" at pages 15 to 17 of the 1995 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation regarding certain relationships and related transactions is incorporated herein by reference to the information set forth under \"Election of Directors -- Certain Interests\" and \"Compensation of Directors and Executive Officers -- Compensation Committee Interlocks and Insider Participation\" at pages 6 and 9 of the 1995 Proxy Statement.\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 financial statements are incorporated herein by reference to the 1994 Annual Report.\n1994 Annual Report Page -----------\nConsolidated Balance Sheets as of December 31, 18 1994 and 1993\nStatements of Consolidated Operations for the 19 Years Ended December 31, 1994, 1993 and 1992\nStatements of Consolidated Shareholders' Equity 20 for the Years Ended December 31, 1994, 1993 and 1992\nStatements of Consolidated Cash Flows for the 21 Years Ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements 22\n2. Financial Statement Schedules\nThe financial statement schedule filed with this report are listed on the \"Index to Financial Statement Schedules.\"\n3. Exhibits\nThe exhibits filed with this report are listed on the \"Exhibit Index.\"\n(b) Reports on Form 8-K\nIn a report filed on Form 8-K dated December 12, 1994, the Company reported that its Board of Directors authorized a three-for-two common stock split and approved a cash dividend on common stock. The three-for-two split is effected in the form of a 50 percent stock dividend, to be distributed on January 31, 1995, to shareholders of record as of January 17, 1995. The cash dividend on the post-split shares has been initially set at 14 cents per common share per calendar quarter. The first cash dividend was paid on January 31, 1995, to shareholders of record on January 17, 1995.\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 14th DAY OF MARCH, 1995.\nIDEX CORPORATION\nBy \/s\/ WAYNE P. SAYATOVIC Wayne P. Sayatovic Senior Vice President - Finance, Chief Financial Officer and Secretary\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:\nII-1\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nPage ---- Independent Auditors' Report S-2 Schedule II - Valuation and Qualifying Accounts S-3\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the Consolidated Financial Statements of IDEX or the Notes thereto.\nS-1\nINDEPENDENT AUDITORS' REPORT\nIDEX Corporation:\nWe have audited the financial statements of IDEX Corporation and its Subsidiaries as of December 31, 1994 and 1993 and for each of the three years in the period ended December 31, 1994, and have issued our report thereon dated January 16, 1995; such financial statements and report are included in your 1994 Annual Report to Shareholders and are incorporated herein by reference. Our audits also included the financial statement schedule of IDEX Corporation, listed in Item 14. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In 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.\nDELOITTE & TOUCHE LLP Chicago, lllinois\nJanuary 16, 1995\nS-2\nIDEX CORPORATION AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS)\n-------------------- (1) Represents uncollectible accounts, net of recoveries.\nS-3\nE-1\nE-2\nE-3\n----------------- * Filed herewith. ** Management contract or compensatory plan or arrangement.\nE-4","section_15":""}
{"filename":"805080_1994.txt","cik":"805080","year":"1994","section_1":"ITEM 1. BUSINESS\nREGISTRANT AND ITS SUBSIDIARIES\nWest Suburban Bancorp, Inc., an Illinois corporation (the \"Company\"), is a multi-bank holding company registered under the Bank Holding Company Act of 1956, as amended (the \"BHC Act\"), and a thrift holding company registered under the Home Owner's Loan Act, as amended (the \"HOLA\"). The Company's operating subsidiaries consist of: West Suburban Bank, Lombard, Illinois; West Suburban Bank of Downers Grove\/Lombard, Downers Grove, Illinois; West Suburban Bank of Darien, Darien, Illinois; West Suburban Bank of Carol Stream\/Stratford Square, Bloomingdale, Illinois; and West Suburban Bank of Aurora, F.S.B. Aurora, Illinois. West Suburban Bank, West Suburban Bank of Downers Grove\/Lombard, West Suburban Bank of Darien and West Suburban Bank of Carol Stream\/Stratford Square may be referred to collectively as the \"Bank Subsidiaries,\" West Suburban Bank of Aurora, F.S.B. may be referred to as \"WSB Aurora\" and the Bank Subsidiaries and WSB Aurora may be referred to collectively as the \"Subsidiaries.\"\nThe Company was incorporated in 1986 and became the parent bank holding company of the Bank Subsidiaries in 1988. On July 13, 1990, the Company acquired WSB Aurora, a federally-chartered thrift, thereby also becoming a thrift holding company.\nThe Subsidiaries are headquartered in the near western suburbs of Chicago among some of the faster growing areas in Illinois. Due to the nature of the market areas served by the Subsidiaries, the Subsidiaries provide a wide range of financial services to individuals and small and medium sized businesses. The western suburbs of Chicago have a diversified economy, with many new corporate headquarters and numerous small and medium sized industrial and non-industrial businesses providing employment.\nThe Subsidiaries engage in a general full service retail banking business and offer a broad variety of consumer and commercial products and services. The Subsidiaries also offer trust services, safe deposit boxes and extended banking hours, including Sunday hours and 24-hour banking through either a proprietary network of 33 automated teller machines (\"ATMs\") or Tele-Bank 24, a bank-by- phone system. Other consumer related services are available including financial services and a competitively priced VISA card through West Suburban Bank Card Services.\nAlthough each Subsidiary operates under the direction of its own board of directors, the Company has standard operating policies regarding asset\/liability management, liquidity management, investment management, lending practices and deposit structure management. The Company has historically centralized certain operations where economies of scale can be achieved.\nThe following table sets forth financial and other information concerning the subsidiaries as of December 31, 1994:\nSUBSIDIARIES OF WEST SUBURBAN BANCORP, INC. (1) (Dollars in thousands)\nCOMPETITION\nThe Company encounters competition in all areas of its business pursuits. It competes for loans, deposits, fiduciary and other services with financial and other institutions located both within and outside of its market area. In order to compete effectively, to develop its market base, to maintain flexibility and to move in pace with changing economic and social conditions, the Company continuously refines and develops its products and services. The principal methods of competition in the financial services industry are price, service and convenience.\nEMPLOYEES\nThe Company employed 601 persons (476 full time equivalent employees) on December 31, 1994. The Company believes that its relations with its employees are good.\nSUPERVISION AND REGULATION\nGeneral\nThe growth and earnings performance of the Company can be affected not only by management decisions and general economic conditions, but also by the policies of various governmental regulatory authorities including, but not limited to, the Board of Governors of the Federal Reserve System (the \"FRB\"), the Federal Deposit Insurance Corporation (the \"FDIC\"), the Illinois Commissioner of Banks and Trust Companies (the \"Commissioner\"), the Office of Thrift Supervision (the \"OTS\"), the Internal Revenue Service and state taxing authorities and the Securities and Exchange Commission (the \"SEC\"). Financial institutions and their holding companies are extensively regulated under federal and state law. The effect of such statutes, regulations and policies can be significant, and cannot be predicted with a high degree of certainty.\nFederal and state laws and regulations generally applicable to financial institutions, such as the Company regulate, among other things, the scope of business, investments, loans, deposit insurance, reserves against deposits, capital adequacy, the establishment of branches, mergers, consolidations, dividends and other aspects of their operations. The system of supervision and regulation applicable to the Company and the Subsidiaries establishes a comprehensive framework for the operations of the Company and the Subsidiaries and is intended primarily for the protection of the FDIC's deposit insurance funds and the depositors, rather than the shareholders, of financial institutions.\nThe following references to material statutes and regulations affecting the Company and the Subsidiaries are brief summaries thereof and do not purport to be complete, and are qualified in their entirety by reference to such statutes and regulations. Any change in applicable law or regulations may have a material effect on the business of the Company.\nRecent Regulatory Developments\nOn September 23, 1994, the \"Riegle Community Development and Regulatory Improvement Act of 1994\" (the \"Riegle Act\") was signed into law. The provisions of Title III of the Riegle Act are intended to reduce the paperwork and regulatory burdens of federally-insured financial institutions and their holding companies. These provisions require the federal banking regulators, among other things: (i) to consider the burdens and benefits to depository institutions and their customers of proposed regulatory and administrative requirements; (ii) within two years of the enactment of the Riegle Act, to eliminate from their regulations and written supervisory policies regulatory inconsistencies, outmoded or duplicative requirements and unwarranted constraints on credit availability and to adopt uniform requirements to implement common statutory schemes or regulatory concerns; (iii) to create a unified examination process for financial institutions subject to the jurisdiction of more than one regulator; (iv) within six months of enactment of the Riegle Act, to establish an internal regulatory appeals process by which regulated institutions may obtain review of agency determinations relating to such matters as examination ratings, adequacy of loan loss reserves and significant loan classifications; (v) to streamline the quarterly call report format; and (vi) in considering revisions to risk-based capital requirements, to ensure that the standards take into account the size, activities and reporting burdens of institutions. The Riegle Act also gives the federal banking agencies greater flexibility with respect to the implementation and enforcement of certain provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), including the FDICIA provisions regarding safety and soundness standards, examination frequency and independent audit requirements. Because the federal banking regulators have not yet taken action to implement the regulatory reforms contemplated by the Riegle Act, it is not possible at this time to determine the impact of these reforms on the Company.\nOn September 29, 1994, the \"Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994\" (the \"Riegle-Neal Act\") was signed into law. Effective September 29, 1995, the Riegle-Neal Act allows bank holding companies to acquire banks located in any state in the United States without regard to geographic restrictions or reciprocity requirements imposed by state law, but subject to certain\nconditions, including limitations on the aggregate amount of deposits that may be held by the acquiring holding company and all of its insured depository institution affiliates. Effective June 1, 1997 (or earlier if expressly authorized by applicable state law), the Riegle-Neal Act allows banks to establish interstate branch networks through acquisitions of other banks, subject to certain conditions, including certain limitations on the aggregate amount of deposits that may be held by the surviving bank and all of its insured depository institution affiliates. The establishment of DE NOVO interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) is allowed by the Riegle-Neal Act only if specifically authorized by state law. The legislation allows individual states to \"opt-out\" of certain provisions of the Riegle-Neal Act by enacting appropriate legislation prior to June 1, 1997. As a result of the delayed effective dates of the interstate banking provisions of the Riegle-Neal Act, and the fact that presently no state authorizes the establishment of DE NOVO branches by out of state banks, the Riegle-Neal Act is not expected to have an immediate significant impact on the Company. Over time, however, the provisions of the Riegle-Neal Act may increase competition in the market served by the Company. Federal savings associations, such as WSB Aurora, currently have the ability under OTS regulations to establish interstate branch networks.\nThe Company\nGENERAL. The Company, as the sole shareholder of the Bank Subsidiaries, is a bank holding company. As a bank holding company, the Company is registered with, and is subject to regulation by, the FRB under the BHC Act. In accordance with FRB policy, the Company is expected to act as a source of financial strength to the Bank Subsidiaries and to commit resources to support the Bank Subsidiaries in circumstances where the Company might not do so absent such policy. Under the BHC Act, the Company is subject to periodic examination by the FRB and is required to file periodic reports of its operations and such additional information as the FRB may require.\nBecause the Company's principal place of business is in Illinois, the Company is also subject to the requirements of the Illinois Bank Holding Company Act. Further, due to the Company's ownership of WSB Aurora, a federally chartered savings association, the Company is a savings and loan holding company within the meaning of the HOLA and, as such, is subject to the examination, supervision, reporting and enforcement requirements of the OTS.\nINVESTMENTS AND ACTIVITIES. Under the BHC Act, a bank holding company must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company.\nPursuant to the BHC Act, as presently in effect, the FRB will prohibit any direct or indirect acquisition by a bank holding company of more than 5% of the voting shares, or of all or substantially all of the assets, of a bank located outside of the state in which the operations of the bank holding company's banking subsidiaries are principally located unless the laws of the state in which the bank to be acquired is located specifically authorize such an acquisition. Some of the interstate banking statutes enacted by individual states are regional in nature, permitting the enacting state's banks to be acquired by banking organizations located in specific states within the enacting state's region, in some cases only if the specified states have reciprocal statutes which allow banks in such states to be acquired by banking organizations in the enacting state. A number of states have enacted nationwide interstate banking laws which allow the enacting state's banks to be acquired by banking organizations located in any other state (again, in some cases, subject to the condition that the laws of the other states permit reciprocal acquisitions by banking organizations within the enacting state). Illinois law permits bank holding companies located in any state of the United States to acquire banks or bank holding companies located in Illinois, subject to certain conditions, including the requirement that the laws of the state in which the acquiror is located permit bank holding companies located in Illinois to acquire\nbanks or bank holding companies in the acquiror's state. Effective September 29, 1995, the FRB may allow a bank holding company to acquire banks located in any state in the United States without regard to such reciprocity requirements but subject to certain conditions, including certain deposit concentration limits. See \"Recent Regulatory Developments.\"\nThe BHC Act also prohibits, with certain exceptions noted below, the Company 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, except that bank holding companies may engage in, and may own shares of companies engaged in, certain businesses found by the FRB to be \"so closely related to banking ... as to be a proper incident thereto.\" Under current regulations of the FRB, the Company and any non-bank subsidiaries are permitted to engage in, among other activities, such banking-related businesses as the operation of a thrift, sales and consumer finance, equipment leasing, the operation of a computer service bureau, including software development, and mortgage banking and brokerage. The BHC Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies.\nThe HOLA prohibits a savings and loan holding company, such as the Company, directly or indirectly or through any subsidiary, from: acquiring control of, or acquiring by merger or purchase of assets, another savings association or savings and loan holding company without the prior written approval of the OTS; acquiring or retaining, with certain exceptions, more than 5% of the voting shares of a non-subsidiary savings association, a non-subsidiary savings and loan holding company, or a non-subsidiary company engaged in activities other than those permitted by the HOLA; or acquiring or retaining control of a depository institution that is not federally insured.\nFederal legislation also prohibits acquisition of \"control\" of a bank or bank holding company, such as the Company, without prior notice to certain federal bank regulators. \"Control\" is defined in certain cases as acquisition of 10% of the outstanding shares of a bank or bank holding company.\nCAPITAL REQUIREMENTS. The FRB uses capital adequacy guidelines in its examination and regulation of bank holding companies. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.\nThe FRB's capital guidelines establish the following minimum regulatory capital requirements for bank holding companies: a risk-based requirement expressed as a percentage of total risk-weighted assets, and a leverage requirement expressed as a percentage of total assets. The risk-based requirement consists of a minimum ratio of total capital to total risk-weighted assets of 8%, of which at least one-half must be Tier 1 capital (which consists principally of stockholders' equity). The leverage requirement consists of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly rated companies, with a minimum requirement of 4% to 5% for all others.\nThe risk-based and leverage standards presently used by the FRB are minimum requirements, and higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual banking organizations. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (I.E., Tier 1 capital less all intangible assets), well above the minimum levels.\nAs of December 31, 1994, the Company had regulatory capital in excess of the FRB's minimum requirements, with a tier 1 risk-based capital ratio of 11.60%, a total risk-based capital ratio of 12.11% and a leverage ratio of 9.41%.\nDIVIDENDS. The FRB has issued a policy statement on the payment of cash dividends by bank holding companies. In the policy statement, the FRB expressed its view that a bank holding company experiencing earnings weaknesses should not pay cash dividends exceeding its net income or which\ncould only be funded in ways that weakened the bank holding company's financial health, such as by borrowing. Additionally, the FRB possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.\nIn addition to the restrictions on dividends imposed by the FRB, the Illinois Business Corporation Act, as amended, prohibits the Company from paying a dividend if, after giving effect to the dividend, the Company would be insolvent or the net assets of the Company would be less than zero or less than the maximum amount then payable to shareholders of the Company who would have preferential distribution rights if the Company were liquidated.\nFEDERAL SECURITIES REGULATION. The Company's common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"). Consequently, the Company is subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.\nThe Subsidiaries\nGENERAL. The Bank Subsidiaries are Illinois-chartered banks, the deposit accounts of which are insured by the Bank Insurance Fund (the \"BIF\") of the FDIC. As BIF-insured, Illinois-chartered banks, the Bank Subsidiaries are subject to the examination, supervision, reporting and enforcement requirements of the Commissioner, as the chartering authority for Illinois banks, and the FDIC, as administrator of the BIF.\nWSB Aurora is a federally chartered savings association, the deposits of which are insured by the Savings Association Insurance Fund (the \"SAIF\") of the FDIC. As a SAIF-insured, federally chartered savings association, WSB Aurora is subject to the examination, supervision, reporting and enforcement requirements of the OTS, as the chartering authority for federal savings associations, and the FDIC as administrator of the SAIF. WSB Aurora is also a member of the Federal Home Loan Bank System, which provides a central credit facility primarily for member institutions.\nDEPOSIT INSURANCE. As FDIC-insured institutions, the Bank Subsidiaries and WSB Aurora are required to pay deposit insurance premium assessments to the FDIC. Pursuant to FDICIA, the FDIC adopted a risk-based assessment system under which all insured depository institutions are placed into one of nine categories and assessed insurance premiums, ranging from .23% to .31% of deposits, based upon their level of capital and supervisory evaluation. Institutions classified as well-capitalized (as defined by the FDIC) and considered healthy pay the lowest premium while institutions that are less than adequately capitalized (as defined by the FDIC) and considered of substantial supervisory concern pay the highest premium. Risk classification of all insured institutions is made by the FDIC for each semi-annual assessment period.\nDuring 1994, each of the Bank Subsidiaries and WSB Aurora was assessed at the rate of .23% of deposits. Each of the Bank Subsidiaries and WSB Aurora has been advised by the FDIC that it will continue to be assessed at this rate for the first six months of 1995.\nThe FDIC has issued a proposal to amend its regulations to change the range of deposit insurance assessments for BIF members from the current range of between .23% and .31% of deposits to a range of between .04% and .31% of deposits. Under the FDIC's proposal, the revised rates would apply to the semi-annual period in which the BIF reserve ratio (I.E., the ratio of the net worth of the BIF to the aggregate amount of BIF-insured deposits) reaches 1.25% (which the FDIC presently expects will occur between May 1, 1995 and July 31, 1995). Although it is not possible at this time to predict whether the proposed amendment will be adopted, assuming BIF assessment rates are modified as proposed and assuming each of the Bank Subsidiaries continues to be assigned to the same risk assessment category it currently occupies, the proposed change in assessment rates would significantly reduce the deposit insurance assessments each of the Bank Subsidiaries pays to the FDIC. However, because the FDIC's\nproposal addresses only the assessment rates charged BIF members, the adoption of the proposal would not affect the assessment rates of SAIF insured institutions such as WSB Aurora.\nThe FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, order, or any condition imposed in writing by, or written agreement with, the FDIC. The FDIC may also suspend deposit insurance temporarily during the hearing process for a permanent termination of insurance if the institution has no tangible capital. Management of the Company is not aware of any activity or condition that could result in termination of the deposit insurance of any of the Bank Subsidiaries or WSB Aurora.\nCAPITAL REQUIREMENTS. The FDIC has established the following minimum capital standards for state-chartered insured non-member banks, such as the Bank Subsidiaries: a leverage requirement consisting of a minimum ratio of Tier 1 capital to total assets of 3% for the most highly-rated banks with minimum requirements of 4% to 5% for all others and a total risk-based capital requirement consisting of a minimum ratio of total capital to total risk- weighted assets of 8%, at least one-half of which must be Tier 1 capital.\nThe OTS has established the following minimum capital standards for savings associations, such as WSB Aurora: a core capital requirement, consisting of a minimum ratio of core capital (consisting primarily of stockholders' equity) to total assets of 3%; a tangible capital requirement consisting of a minimum ratio of tangible capital (defined as core capital minus all intangible assets other than a specified amount of purchased mortgage servicing rights and purchased credit card relationships) to total assets of 1.5%; and a risk-based capital requirement, consisting of a minimum ratio of total capital to total risk- weighted assets of 8%, at least one-half of which must consist of core capital.\nThe capital requirements described above are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual institutions. For example, the regulations of the FDIC and the OTS provide that additional capital may be required to take adequate account of the risks posed by concentrations of credit, nontraditional activities and the institution's ability to manage such risks.\nFurther, a savings association may be required to maintain additional capital to account for its interest rate risk (\"IRR\") exposure. Under OTS regulations, the OTS quantifies each savings association's level of IRR exposure based on data reported by each association, using an OTS model designed to measure the change in the net present value of the association's assets, liabilities and off- balance sheet positions resulting from a hypothetical 200 basis point increase or decrease in interest rates. IRR exposure, as measured by the OTS, is used as the basis for determining whether the association must hold additional risk- based capital to account for IRR.\nSimilarly, FDICIA requires the federal banking regulators to amend their risk- based capital standards to take into account interest rate risk (\"IRR\") exposure. On September 14, 1993, the FDIC, the FRB and the Office of the Comptroller of the Currency, the primary federal regulator of national banks (the \"OCC\"), issued a joint proposal which would generally require banks to quantify their level of IRR exposure using a measurement system developed by the regulators that weights a bank's assets, liabilities and off-balance sheet positions by risk factors designed to reflect the approximate change in each instrument's value that would result from specified changes in interest rates (a 200 basis point increase and decline in rates under the proposal). Any bank with a level of IRR exposure in excess of a specified threshold (1% of total assets under the proposal) would be required to maintain additional capital against its IRR exposure. Although it is not presently possible to predict whether, or in what form, the proposal will be adopted, assuming IRR capital rules were to be adopted in substantially the form proposed, it is not anticipated that such rules would have a material adverse effect on the ability of the Bank Subsidiaries to maintain compliance with applicable capital requirements.\nDuring the year ended December 31, 1994, none of the Bank Subsidiaries or WSB Aurora was required by the FDIC or the OTS, respectively, to increase its capital to an amount in excess of the minimum regulatory requirement. Nonetheless, as of December 31, 1994, each of the Bank Subsidiaries and WSB Aurora exceeded its minimum regulatory capital requirements.\nThe following table sets forth selected regulatory capital ratios of the Bank Subsidiaries at December 31, 1994:\nAt December 31, 1994, WSB Aurora maintained a core capital ratio of 10.22%, a tangible capital ratio of 12.56% and a total risk-based capital ratio of 13.66%.\nFDICIA provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators' powers depends on whether the institution in question is \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" or \"critically undercapitalized.\" Depending upon the capital category to which an institution is assigned, the regulators' corrective powers include: requiring the submission of a capital restoration plan; placing limits on asset growth and restrictions on activities; requiring the institution to issue additional capital stock (including additional voting stock) or to be acquired; restricting transactions with affiliates; restricting the interest rate the institution may pay on deposits; ordering a new election of directors of the institution; requiring that senior executive officers or directors be dismissed; prohibiting the institution from accepting deposits from correspondent banks; requiring the institution to divest certain subsidiaries; prohibiting the payment of principal or interest on subordinated debt; and ultimately, appointing a receiver for the institution.\nAdditionally, institutions insured by the FDIC may be liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of commonly controlled FDIC insured depository institutions or any assistance provided by the FDIC to commonly controlled FDIC insured depository institutions in danger of default.\nDIVIDENDS. Under the Illinois Banking Act, Illinois-chartered banks may not pay, without prior regulatory approval, dividends in excess of their adjusted profits.\nOTS regulations impose limitations upon all capital distributions by thrifts, including cash dividends. The rule establishes three tiers of institutions. An institution that exceeds all fully phased-in capital requirements before and after the proposed capital distribution (\"Tier 1 Institution\") could, after prior notice to, but without the approval of, the OTS, make capital distributions during a calendar year of up to the higher of (i) 100% of its net income to date during the calendar year plus the amount that would reduce by one-half its \"surplus capital ratio\" (the excess capital over its fully phased-in capital requirements) at the beginning of the calendar year, or (ii) 75% of its net income over the most recent preceding four quarter period. Any additional capital distributions would require prior regulatory approval. As of December 31, 1994, WSB Aurora was a Tier 1 Institution.\nThe payment of dividends by any financial institution or its holding company is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations. As described above, the Company, the Bank Subsidiaries and WSB Aurora each exceeded its minimum capital requirements under applicable guidelines as of December 31, 1994. As of December 31, 1994, approximately $17.4 million was available to be paid as dividends to the Company by the Bank Subsidiaries and WSB Aurora.\nINSIDER TRANSACTIONS. The Bank Subsidiaries and WSB Aurora are subject to certain restrictions imposed by the Federal Reserve Act on any extensions of credit to the Company and its subsidiaries, on investments in the stock or other securities of the Company and its subsidiaries and the acceptance of the stock or other securities of the Company or its subsidiaries as collateral for loans. Certain limitations and reporting requirements are also placed on extensions of credit by the Bank Subsidiaries and WSB Aurora to their respective directors and officers, to directors and officers of the Company and its subsidiaries, to principal stockholders of the Company, and to \"related interests\" of such directors, officers and principal stockholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a director or officer of the Company or one of its subsidiaries or a principal stockholder of the Company may obtain credit from banks with which one of the Bank Subsidiaries or WSB Aurora maintains a correspondent relationship.\nSAFETY AND SOUNDNESS STANDARDS. On November 18, 1994, the FDIC, the OTS, the FRB and the OCC published for comment proposed rules implementing the FDICIA requirement that the federal banking agencies establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The proposal would establish standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, and compensation, fees and benefits. In general, the standards set forth in the proposal consist of the goals to be achieved in each area, and each institution would be responsible for establishing its own procedures to achieve those goals. Additionally, the proposal would establish a maximum permissible ratio of classified assets to capital and a minimum required earnings ratio. If an institution failed to comply with any of the standards set forth in the proposal, the institution would be required to submit to its primary federal regulator a plan for achieving and maintaining compliance. Failure to submit an acceptable plan, or failure to comply with a plan that has been accepted by the appropriate regulator, would constitute grounds for further enforcement action. Based upon a review of the proposal, management of the Company believes that the proposal, if adopted in substantially the form proposed, will not have a material adverse effect on the Company or its subsidiaries. Under the Riegle Act, the federal banking regulators may elect to set safety and soundness standards relating to asset quality, earnings and stock valuation through agency guidelines rather than by regulation and, if established by guidelines, the agencies are not required to compel institutions that fail to meet such guidelines to submit compliance plans.\nTRUTH-IN-SAVINGS ACT. FDICIA requires the FRB to adopt regulations implementing the Truth-in-Savings Act. The Federal Reserve Board's Truth-in-Savings regulations took effect on June 21, 1993, and contain, as key elements: (i) a requirement that institutions disclose yields, fees, penalties and costs for all interest-bearing accounts; (ii) a requirement that institutions use the term \"annual percentage yield\" in advertisements; (iii) a requirement that institutions provide 30 days notice prior to reducing rates on most accounts; and (iv) a requirement that interest be paid on entire balances rather than investable funds.\nBRANCHING AUTHORITY. All banks located in Illinois have traditionally been restricted as to the number and geographic location of branches which they may establish. On June 7, 1994, Governor Edgar signed into law legislation eliminating all branching restrictions. Accordingly, as of that date, the Bank Subsidiaries were allowed to establish branches anywhere in Illinois without regard to the location of other bank main offices or the number of branches previously maintained by the Bank Subsidiaries establishing the branch. Federal savings associations, such as WSB Aurora, have for some time had similar branching rights.\nUnder the Riegle-Neal Act, the Bank Subsidiaries may, in the future, be able to establish branches in states other than Illinois. See \"Recent Regulatory Developments.\" Under the HOLA and OTS regulations, federal savings associations have for some time had nationwide branching authority, subject to OTS approval.\nSTATE BANK ACTIVITIES. Under FDICIA, as implemented by final regulations adopted by the FDIC, FDIC insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. FDICIA, as implemented by FDIC regulations, also prohibits FDIC insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank or its subsidiary, respectively, unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines the activity would not pose a significant risk to the deposit insurance fund of which the bank is a member. Impermissible investments and activities must be divested or discontinued within certain time frames set by the FDIC in accordance with FDICIA. These restrictions have not had, and are no currently expected to have, a material impact on the operations of the Bank Subsidiaries.\nQUALIFIED THRIFT LENDER TEST. Under the current qualified thrift lender (\"QTL\") test, which became effective upon the enactment of FDICIA, WSB Aurora generally is required to invest at least 65% of its portfolio assets in \"qualified thrift investments,\" as measured on a monthly average basis in nine out of every 12 months. Qualified thrift investments for purposes of the current QTL test consist principally of residential mortgage loans, mortgage-backed securities and other housing and consumer-related investments. The term \"portfolio assets\" is statutorily defined to mean a savings association's total assets less goodwill and other intangible assets, the association's business property and a limited amount of its liquid assets. As of December 31, 1994, WSB Aurora satisfied the QTL test.\nLIQUIDITY REQUIREMENTS. OTS regulations currently require each savings association to maintain, for each calendar month, an average daily balance of liquid assets (including cash, certain time deposits, bankers' acceptances, and specified United States Government, state or federal agency obligations) equal to at least 5% of the average daily balance of its net withdrawable accounts plus short-term borrowings (I.E., those repayable in 12 months or less) during the preceding calendar month. This liquidity requirement may be changed from time to time by the OTS to an amount within a range of 4% to 10% of such accounts and borrowings, depending upon economic conditions and the deposit flows of savings associations. OTS regulations also require each savings association to maintain, for each calendar month, an average daily balance of short-term liquid assets (generally liquid assets having maturities of 12 months or less) equal to at least 1% of the average daily balance of its net withdrawable accounts plus short-term borrowings during the preceding calendar month. Penalties may be imposed for failure to meet liquidity ratio requirements. At December 31, 1994, WSB Aurora was in compliance with OTS liquidity requirements, with an overall liquidity ratio of 7.06% and a short- term liquidity ratio of 4.42%.\nEXECUTIVE OFFICERS OF THE COMPANY\nThe names and ages of the executive officers of the Company, along with a brief description of the business experience of each such person, during the past five years, and certain other information is set forth below:\nName (Age) and Position and Offices with the Company Principal Occupations and Employment (year first elected to office) for Past Five Years and Other Information ------------------------------ -----------------------------------------\nKevin J. Acker (45) Director and President of West Suburban Chairman of the Board and Vice Bank of Carol Stream\/Stratford Square. President (1986)\nJohn A. Clark (46) Director and Executive Vice President of President and Chief Executive West Suburban Bank since 1984, Vice Officer (1986) President Loans for West Suburban Bank of Downers Grove\/Lombard, West Suburban Bank of Darien and West Suburban Bank of Carol Stream\/Stratford Square since 1988. Director and President of WSB Aurora from July 13, 1990 to January, 1992 and Director and Executive Vice President of WSB Aurora since January, 1992.\nCraig R. Acker (42) Director, President and Chairman of the Chief Operating Officer (1993) Board of West Suburban Bank of Downers Grove\/Lombard.\nDuane G. Debs (38) Vice President and Comptroller of the Chief Financial Officer, Vice Bank Subsidiaries since 1987 and of WSB President, Secretary and Treasurer Aurora since 1990. Director of West (1993) Suburban Bank of Downers Grove\/Lombard since 1993.\nSTATISTICAL DATA\nThe statistical data required by Securities and Exchange Act of 1934 Industry Guide 3, \"Statistical Disclosure By Bank Holding Companies,\" has been incorporated by reference from the Company's 1994 Annual Report to Shareholders (attached as Exhibit 13.1 hereto) or is set forth below. This data should be read in conjunction with the Company's 1994 Consolidated Financial Statements and related notes, and the discussion included in Management's Discussion and Analysis of Financial Condition and Results of Operations as set forth in the Company's 1994 Annual Report to Shareholders. All dollar amounts of the statistical data included below are expressed in thousands.\nSecurities\nThe following table sets forth by category the amortized cost of securities at December 31 (dollars in thousands):\nThe amortized cost of mortgage-backed securities was $128, $17,559 and $25,321 at December 31, 1994, 1993, and 1992 respectively. The mortgage-backed securities portfolio was sold during 1994 in connection with the retirement of the Real Estate Mortgage Investment Conduit (REMIC) bonds. The mortgage-backed securities portfolio did not have a single maturity date.\nThe following table sets forth by contractual maturity the amortized cost and weighted average yield (not tax-effected) of investment securities available for sale at December 31 (dollars in thousands):\nThe following table sets forth, by contractual maturity, the amortized cost and weighted average yield of investment securities held to maturity at December 31, 1994. Yields on tax-exempt securities represent actual coupon yields (dollars in thousands):\nLoan Portfolio\nThe following table sets forth the major loan categories at December 31 (dollars in thousands):\nThe following table sets forth the maturity and interest rate sensitivity of selected loan categories at December 31, 1994 (dollars in thousands):\nThe Company had approximately $21,800, $23,500 and $11,400 of irrevocable letters of credit outstanding at December 31, 1994, 1993 and 1992, respectively.\nNonperforming Loans\nThe following table sets forth the aggregate amount of nonperforming loans and selected ratios at December 31 (dollars in thousands):\nThe Company makes commercial, personal and residential loans primarily to customers throughout the western suburbs of Chicago. At December 31, 1994 and 1993, the Company's loan portfolio did not include any single borrower or industry concentration in excess of 10% of total loans, except for loans to the construction and land development industries which represented 10.2% and 6.8% of total loans at December 31, 1994 and 1993, respectively. The Company's real estate construction loans are generally made within the market areas of the subsidiaries. The Company manages this exposure by continually reviewing local market conditions and closely monitoring collateral values. No unusual losses are anticipated as a result of these concentrations.\nThe Company's normal policy is to discontinue accruing interest on a loan when it becomes 90 days past due or when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of principal or interest is doubtful. In some circumstances a loan that is more than 90 days past due can remain on accrual status if it can be established that payment will be received within another 90 days or if it is adequately secured. When a loan has been placed on nonaccrual status, interest that has been earned but not collected is charged back to the appropriate interest income account. When payments are received on nonaccrual loans they are first applied to principal, then to expenses incurred for collection and finally to interest income. The gross amount of interest that would have been recorded if all nonperforming loans had been accruing interest at their original terms was $15 for the year ended December 31, 1994 and no interest was recorded in operations for the year ended December 31, 1994.\nAs of December 31, 1994, due to information regarding possible credit problems of borrowers or possible deficits in the cash flow of property given as collateral, management had doubts as to the ability of certain borrowers to comply with the present repayment terms of loans with an aggregate principal amount of $223. Accordingly, management may be required to categorize some or all of the loans as non-performing assets in the future.\nAllowance for Loan Losses\nThe allowance for loan losses reduces the level of gross loans outstanding by an estimate of uncollectible loans. When management determines that loans are uncollectible, they are charged-off against the allowance. Periodically, a provision for loan losses is charged against current income. Management attempts to maintain the allowance for loan losses at a level adequate to absorb anticipated loan losses. The amount of the allowance is established based upon past loan loss experience and other factors which, in management's judgment, deserve consideration in estimating loan losses. Other factors considered by management in this regard include growth and composition\nof the loan portfolio, the relationship of the allowance for loan losses to outstanding loans and economic conditions in the Company's market area. Based on such reviews, management at this time does not anticipate any increase in nonperforming assets that will have a significant effect on its operations because the estimated exposure to losses has already been substantially reflected in its allowance for loan losses. This could, however, change dramatically if a significant decline in the real estate market area served by the Company occurs.\nThe following table sets forth allowance for loan loss activity for the years ended and at December 31 (dollars in thousands):\nAllocation of Allowance for Loan Losses (continued)\nThe entire allowance for loan losses is available to absorb losses in any particular category of loans, notwithstanding management's allocation of the allowance. The following table sets forth the allocation of allowance for loan losses and the percentage of loans in each category to total loans at December 31 (dollars in thousands):\nDeposits\nThe following table sets forth by category average daily deposits and rates for the years ended December 31 (dollars in thousands):\nThe following table sets forth by maturity time deposits $100 and over at December 31 (dollars in thousands):\nReturn on Equity and Assets and Other Financial Ratios\nThe following table sets forth selected financial ratios at and for the years ended December 31:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company and the Subsidiaries occupy a total of approximately 206,000 square feet in 28 locations. The Company's principal offices are located in approximately 32,500 square feet of office space at 711 South Meyers Road in Lombard, Illinois. As indicated below, West Suburban Bank also operates the facility located at 711 South Meyers Road, Lombard, Illinois as a branch.\nThe following table sets forth certain information concerning the facilities of the Subsidiaries.\nLocation of Approximate Name of Subsidiary Facilities Square Feet Status ------------------ ---------- ----------- ------\nWest Suburban Bank 711 S. Meyers Rd. 32,500 Owned Lombard, IL\nWest Suburban Bank 701 S. Meyers Rd. 5,200 Owned Lombard, IL\nWest Suburban Bank 717 S. Meyers Rd. 7,100 Owned Lombard, IL\nWest Suburban Bank 100 S. Main St. 325 Owned Lombard, IL\nWest Suburban Bank Mr. Z's 100 Lease 401 S. Main St. expires Lombard, IL 1998\nWest Suburban Bank 707 N. Main St. 4,100 Owned Lombard, IL\nWest Suburban Bank 29 E. St. Charles Rd. 3,200 Lease Villa Park, IL expires\nWest Suburban Bank 17 W. 754 22nd St. 6,100 Owned Oakbrook, IL\nWest Suburban Bank Lexington Square 100 Lease 400 W. Butterfield Rd. expires Elmhurst, IL 1996\nWest Suburban Bank 210 W. Wesley St. 700 Lease Wheaton, IL expires\nWest Suburban Bank 879 Geneva Rd. 3,550 Lease Carol Stream, Il expires\nWest Suburban Bank 2800 S. Finley Rd. 10,700 Owned of Downers Grove\/ Downers Grove, IL Lombard\nLocation of Approximate Name of Subsidiary Facilities Square Feet Status ------------------ ---------- ----------- ------\nWest Suburban Bank Route 59 and 1,800 Lease of Downers Grove\/ Meadow Ave. expires Lombard Warrenville, IL 1999\nWest Suburban Bank Beacon Hill 100 Lease of Downers Grove\/ 2400 S. Finley Rd. expires Lombard Lombard, IL 1995\nWest Suburban Bank Lexington Square 100 Lease of Downers Grove\/ 555 Foxworth Blvd. expires Lombard Lombard, IL 1996\nWest Suburban Bank 100 S. Main St. 325 Owned of Downers Grove\/ Lombard, IL Lombard\nWest Suburban Bank 1122 S. Main St. 6,400 Owned of Downers Grove\/ Lombard, IL Lombard\nWest Suburban Bank 8001 S. Cass Ave. 17,800 Owned of Darien Darien, IL\nWest Suburban Bank 1005 75th St. 800 Owned of Darien Darien, IL\nWest Suburban Bank 672 E. Boughton Rd. 7,100 Owned of Darien Bolingbrook, IL\nWest Suburban Bank 355 W. Army Trail Rd. 10,700 Owned of Carol Stream\/ Bloomingdale, IL Stratford Square\nWest Suburban Bank 401 N. Gary Ave. 6,400 Owned of Carol Stream\/ Carol Stream, IL Stratford Square\nWest Suburban Bank 1380 Army Trail Rd. 2,300 Lease of Carol Stream\/ Carol Stream, IL expires Stratford Square 1995\nWest Suburban Bank 1657 Bloomingdale Rd. 4,100 Owned of Carol Stream\/ Glendale Heights, IL Stratford Square\nWest Suburban Bank 1061 W. Stearns Rd. 3,400 Owned of Carol Stream\/ Bartlett, IL Stratford Square\nLocation of Approximate Name of Subsidiary Facilities Square Feet Status ------------------ ---------- ----------- ------\nWest Suburban Bank 315 S. Randall Rd. 1,400 Owned of Carol Stream\/ St. Charles, IL Stratford Square\nWest Suburban Bank 101 N. Lake St. 19,000 Owned of Aurora, F.S.B. Aurora, IL\nWest Suburban Bank 2000 W. Galena Blvd. 48,000 Owned of Aurora, F.S.B Aurora, IL\nWest Suburban Bank 1830 Douglas St. 2,500 Owned of Aurora, F.S.B. Montgomery, IL\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings to which the Company or the Subsidiaries is a party other than ordinary routine litigation incidental to their respective businesses.\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 Company's authorized and outstanding equity securities consist of Class A Common Stock, no par value, and Class B Common Stock, no par value. Except as required by law, rights and privileges of the holders of the Class A Common Stock and Class B Common Stock are identical.\nThe Company's per share book value as of the end of each quarter and dividend information for each quarter is set forth in the following table:\nThe Company's common stock is not traded on any national or regional exchange. While there is no established trading market for the Company's common stock, the Company is aware that from time to time limited or infrequent quotations are made with respect to the Company's common stock and that there occurs limited trading in the Company's common stock resulting from private transactions not involving brokers or dealers. Transactions in Company's common stock have been infrequent. As of March 15, 1995, the Company had 347,015 shares of Class A Common Stock outstanding and approximately 1,423 shareholders of record, and had 85,480 shares of Class B Common Shares outstanding and approximately 706 shareholders of record. Management is aware of approximately 26 transactions during 1994 involving the sale of approximately 1,310 shares of Class A Common Stock and approximately 3 transactions during 1994 involving the sale of approximately 15 shares of Class B Common Stock. The average sale price in such transactions was approximately $229.53.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe Company hereby incorporates by reference the information called for by Item 6 of this Form 10-K from the section entitled \"Selected Financial Data\" of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994 (attached as Exhibit 13.1 hereto).\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nThe Company hereby incorporates by reference the information called for by Item 7 of this Form 10-K from the section entitled \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" of the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994 (attached as Exhibit 13.1 hereto).\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe Company hereby incorporates by reference the information called for by Item 8 of this Form 10-K from the Consolidated Financial Statements and from the section entitled \"Selected Quarterly Financial Data\" as set forth in the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994 (attached as Exhibit 13.1 hereto).\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL MATTERS\nThe Company hereby incorporates by reference the information called for by Item 9 of this Form 10-K from the Form 8-K and the Form 8-K\/A, both dated October 21, 1993 filed by the Company with the SEC in connection with the dismissal of Bansley & Kiener as the Company's independent auditors and the Form 8-K dated November 12, 1993, filed by the Company in connection with the engagement of Deloitte & Touche as the Company's independent auditors for the fiscal year ending December 31, 1993 (Exhibits 99.1, 99.2 and 99.3 to this form 10-K).\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe Company hereby incorporates by reference the information called for by Item 10 of this Form 10-K regarding directors of the Company from the section entitled \"Election of Directors\" of the Company's 1994 Proxy Statement.\nSection 16(a) of the Securities Exchange Act of 1934 requires that the Company's executive officers and directors and persons who own more than 10% of their Company's Common Stock file reports of ownership and changes in ownership with the Securities and Exchange Commission and with the exchange on which the Company's shares of Common Stock are traded. Such persons are also required to furnish the Company with copies of all Section 16(a) forms they file. Based solely on the Company's review of the copies of such forms furnished to the Company and, if appropriate, representations made to the Company by any such reporting person concerning whether a Form 5 was required to be filed for the 1994 fiscal year, the Company is not aware that any of its directors and executive officers or 10% shareholders failed to comply with the filing requirements of Section 16(a) during the period commencing January 1, 1994 through December 31, 1994 except that Mr. Acker failed to file his Form 4 reporting February, 1994 transactions on a timely basis and Ms. Locicero and Mr. Howard failed to file their Form 3s in May, 1994 on a timely basis.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Company hereby incorporates by reference the information called for by Item 11 of this Form 10-K from the section entitled \"Executive Compensation\" of the Company's 1995 Proxy Statement; provided, however, Report of the Board of Directors on Executive Compensation is specifically not incorporated into this Form 10-K.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe Company hereby incorporates by reference the information called for by Item 12 of this Form 10-K from the section entitled \"Security Ownership Of Certain Beneficial Owners\" of the Company's 1995 Proxy Statement.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe Company hereby incorporates by reference the information called for by Item 13 of this Form 10-K from the section entitled \"Transactions with Directors, Officers and Associates\" of the Company's 1995 Proxy Statement.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K\nITEM (a)1 AND 2. FINANCIAL STATEMENTS\nWEST SUBURBAN BANCORP, INC. AND SUBSIDIARIES LIST OF FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nThe following audited Consolidated Financial Statements of the Company and its subsidiaries and related notes and independent auditors' report are incorporated by reference from the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994 (attached as Exhibit 13.1 hereto).\nAnnual Report Page No. --------------\nReport of Independent Auditors 5\nConsolidated Balance Sheets- December 31, 1994 and 1993 6\nConsolidated Statements of Income- Years Ended December 31, 1994, 1993, and 1992 7\nConsolidated Statements of Changes in Shareholders' Equity- Years Ended December 31, 1994, 1993 and 1992 8\nConsolidated Statements of Cash Flows- Years Ended December 31, 1994, 1993, and 1992 9\nNotes to Consolidated Financial Statements 11\nThe following Condensed Financial Information-Parent Only is incorporated by reference from Note 18 to the Company's audited Consolidated Financial Statements as set forth in the Company's Annual Report to Shareholders for the fiscal year ended December 31, 1994 (attached as Exhibit 13.1).\nAnnual Report Page No. --------------\nCondensed Balance Sheets - December 31, 1994 and 1993 21\nCondensed Statements of Income - Years Ended December 31, 1994, 1993 and 1992 22\nCondensed Statements of Cash Flows - Years Ended December 31, 1994, 1993, and 1992 22\nSCHEDULES\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 incorporated by reference or notes thereto.\nITEM 14(a)3. EXHIBITS\nThe exhibits required by Item 601 of Regulation S-K are included with this Form 10-K and are listed on the \"Index to Exhibits\" immediately following the signature page.\nITEM 14(b). REPORTS ON FORM 8-K\nNone\n***\nUpon written request to the Chairman of the Board of West Suburban Bancorp, Inc., 711 S. Meyers Road, Lombard Il, 60148, copies of the exhibits listed above are available to shareholders of the Company by specifically identifying each exhibit desired in the request. A fee of $ .20 per page of exhibit will be charged to shareholders requesting copies of exhibits to cover copying and mailing costs.\nFORM 10-K SIGNATURE PAGE\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.\nWEST SUBURBAN BANCORP, INC. (Registrant)\nBy \/s\/ John A. Clark ------------------------------ John A. Clark Chief Executive Officer\nDate: March 28, 1995 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on the 28th day of March, 1995.\nSIGNATURE TITLE --------- -----\n\/s\/ Kevin J. Acker 3\/28\/95 Chairman of the Board and ---------------------------------- ----------- Director Kevin J. Acker Date\n\/s\/ John A. Clark 3\/28\/95 Chief Executive Officer and ---------------------------------- ----------- Director John A. Clark Date\n\/s\/ Duane G. Debs 3\/28\/95 Chief Financial ---------------------------------- ----------- Officer and Chief Duane G. Debs Date Accounting Officer\n\/s\/ James Bell 3\/28\/95 Director ---------------------------------- ----------- James Bell Date\n\/s\/ Peggy Locicero 3\/28\/95 Director ---------------------------------- ----------- Peggy Locicero Date\n\/s\/ Charles Howard 3\/28\/95 Director ---------------------------------- ----------- Charles Howard Date\nThe foregoing include all of the Board of Directors of the Company.\nINDEX TO EXHIBITS\nExhibit Sequential Number Description Page No. ------- ----------- ----------\n3.1 Articles of Incorporation - Incorporated by reference N\/A from Exhibit 3.1 of Form S-1 of the Company dated November 10, 1988, under Registration No. 33-25225\n3.2 Form of Certificate of Amendment to Articles of N\/A Incorporation - Incorporated by reference from Exhibit 3.2 of Form S-1 of the Company dated November 10, 1988, under Registration No. 33-25225\n3.3 Certificate of Amendment to Articles of Incorporation N\/A dated May 10, 1990 - Incorporated by reference from Exhibit 3.3 of the Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n3.4 By-Laws - Incorporated by reference to Exhibit 3.3 of N\/A Form S-1 of the Company dated November 10, 1988, Registration No. 33-25225\n4.1 Specimen of Class A Common Stock certificate - N\/A Incorporated by reference from Exhibit 4.1 of the Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n4.2 Specimen of Class B Common Stock certificate - N\/A Incorporated by reference from Exhibit 4.1 of the Form S-1 of the Company dated November 10, 1988, Registration No. 33-25225\n4.3 Articles of Incorporation of the Company N\/A (see Exhibits 3.1, 3.2, 3.3 and 3.4 above)\n4.4 By-Laws of the Company (see Exhibit 3.4 above) N\/A\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. ------- ----------- ----------\n10.1 Employment Agreement between one of the N\/A Company's subsidiaries and Ralph Acker, dated December 31, 1985 - Incorporated by reference from Exhibit 10.1 of Form S-1 of the Company dated November 10, 1988, Registration No. 33-25225\n10.2 Employment Agreement between one of the N\/A Company's subsidiaries and John A. Clark, dated May 10, 1989 - Incorporated by reference from Exhibit 10.2 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.3 Employment Agreement between one of the N\/A Company's subsidiaries and Keith W. Acker, dated November 10, 1989 - Incorporated by reference from Exhibit 10.3 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.4 Employment Agreement between one of the N\/A Company's subsidiaries and Craig R. Acker, dated May 10, 1989 - Incorporated by reference from Exhibit 10.4 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.5 Employment Agreement between one of the N\/A Company's subsidiaries and Alana S. Acker, dated May 9, 1989 - Incorporated by reference to Exhibit 10.5 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. ------- ----------- ----------\n10.6 Employment Agreement between one of the N\/A Company's subsidiaries and Kevin J. Acker, dated May 9, 1989 - Incorporated by reference from Exhibit 10.6 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.7 Employment Agreement between one of the N\/A Company's subsidiaries and Gregory Ruffolo, dated May 9, 1989 - Incorporated by reference from Exhibit 10.7 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.8 Employment Agreement between one of the N\/A Company's subsidiaries and Michael P. Brosnahan, dated May 10, 1989 - Incorporated by reference from Exhibit 10.8 of Form 10-K of the Company dated March 28, 1990, Commission File No. 0-17609\n10.9 Employment Agreement between one of the N\/A Company's subsidiaries and Gregory L. Young, dated November 14, 1990 - Incorporated by reference from Exhibit 10.9 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.10 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and John A. Clark, dated November 14, 1990 - Incorporated by reference from Exhibit 10.10 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.11 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Keith W. Acker, dated November 14, 1990 - Incorporated by reference from Exhibit 10.11 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. ------- ----------- ----------\n10.12 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Craig R. Acker, dated November 14, 1990 - Incorporated by reference from Exhibit 10.12 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.13 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Michael P. Brosnahan, dated November 14, 1990 - Incorporated by reference from Exhibit 10.13 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.14 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Gregory L. Young, dated November 14, 1990 - Incorporated by reference from Exhibit 10.14 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.15 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Alana S. Acker, dated November 13, 1990 - Incorporated by reference from Exhibit 10.15 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.16 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Gregory M. Ruffolo, dated November 13, 1990 - Incorporated by reference from Exhibit 10.16 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. ------- ----------- ----------\n10.17 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Kevin J. Acker, dated November 13, 1990 - Incorporated by reference from Exhibit 10.17 of Form 10-K of the Company dated March 28, 1991, Commission File No. 0-17609\n10.18 Employment Agreement between one of the N\/A Company's subsidiaries and Stanley C. Celner, Jr., dated December 10, 1991 - Incorporated by reference from Exhibit 10.18 of Form 10-K of the Company dated March 28, 1992, Commission File No. 0-17609\n10.19 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Stanley C. Celner, Jr., dated December 10, 1991 - Incorporated by reference from Exhibit 10.19 of Form 10-K of the Company dated March 28, 1992, Commission File No. 0-17609\n10.20 Employment Agreement between one of the N\/A Company's subsidiaries and Duane G. Debs, dated as of March 8, 1993\n10.21 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Duane G. Debs, dated as of March 8, 1993\n10.22 Employment Agreement between one of the Company's N\/A subsidiaries and Jacqueline R. Weigand, dated as of March 8, 1993\n10.23 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Jacqueline R. Weigand, dated as of March 8, 1993\n10.24 Employment Agreement between one of the Company's N\/A subsidiaries and Timothy P. Dineen, dated as of March 8, 1993\nINDEX TO EXHIBITS (continued)\nExhibit Sequential Number Description Page No. ------- ----------- ----------\n10.25 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Timothy P. Dineen, dated as of March 8, 1993\n10.26 Employment Agreement between one of the N\/A Company's subsidiaries and Pamela N. Greening, dated as of March 8, 1993\n10.27 Deferred Compensation Agreement between one of N\/A the Company's subsidiaries and Pamela N. Greening, dated as of March 8, 1993\n10.28 Employment Agreement between one of the Company's N\/A subsidiaries and Steven A. Jennrich, dated as of January 12, 1994\n10.29 Deferred Compensation Agreement between one of the N\/A Company's subsidiaries and Steven A. Jennrich, dated as of January 12, 1994\n10.30 Amended Employment Agreement between one of the 36 Company's subsidiaries and Jacqueline R. Weigand, dated as of August 9, 1994\n10.31 Amended Employment Agreement between one of the 37 Company's subsidiaries and Timothy P. Dineen, dated as of August 9, 1994\n10.32 Employment Agreement between one of the 39 Company's subsidiaries and George E. Ranstead, dated as of November 9, 1994\n10.33 Deferred Compensation Agreement between one 46 Company's subsidiaries and George E. Ranstead, dated as of November 9, 1994\n10.34 Employment Agreement between one of the 51 Company's subsidiaries and David S. Orr, dated as of November 9, 1994\n10.35 Deferred Compensation Agreement between one of 58 the Company's subsidiaries and David S. Orr, dated as of November 9, 1994\n11.1 Statement regarding computations of earnings per 64 share for the Registrant\n13.1 Annual Report to Shareholders of the 65 Company for fiscal year ended December 31, 1994\n21.1 Subsidiaries of Registrant 106\n23.1 Manually Signed Opinion of Bansley & Kiener 107 concerning financial statements\n27. Financial Data Schedule 108\n99.1 Form 8-K, dated October 21, 1993 - Incorporated by reference from Exhibit 99.1 of form 10-K of the Company dated March 28, 1994, Commission file No. 0-17609 N\/A\n99.2 Form 8-K\/A, dated October 21, 1993 - Incorporated by reference from Exhibit 99.2 of Form 10-K of the Company dated March 28, 1994, Commission No. 0-17609 N\/A\n99.3 Form 8-K, dated November 12, 1993 - Incorporated by reference from Exhibit 99.3 if Form 10K of the Company dated March 28, 1994, Commission No. 0-17609 N\/A","section_15":""}
{"filename":"277577_1994.txt","cik":"277577","year":"1994","section_1":"ITEM 1. BUSINESS (Continued)\nManagement of the Trust (Continued)\nTarragon has provided advisory services to the Trust since April 1, 1994 under an advisory agreement, dated February 15, 1994, approved by the Trust's Board of Trustees. William S. Friedman, President, Chief Executive Officer and Trustee of the Trust, serves as a Director and Chief Executive Officer of Tarragon. Tarragon is owned by Lucy N. Friedman, Mr. Friedman's wife, and John A. Doyle, who serves as a Director, President and Chief Operating Officer of Tarragon and Executive Vice President of the Trust. The Friedman and Doyle families together own approximately 32% of the outstanding shares of the Trust. A majority of the Officers of the Trust are also officers of Tarragon.\nBasic Capital Management (\"BCM\") served as the Trust's advisor from March 28, 1989 through March 31, 1994 when BCM resigned as advisor to the Trust. Mr. Friedman was President of BCM until May 1, 1993. BCM is beneficially owned by a trust for the benefit of the children of Gene E. Phillips, who served as a Trustee of the Trust until December 31, 1992.\nTarragon and BCM are more fully described in ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\".\nThe Trust has no employees. Employees of Tarragon render services to the Trust.\nProperty Management\nSince April 1, 1994, Tarragon has provided property management services to the Trust for a fee of 4.5% of the monthly gross rents collected on apartment properties and of 1.5% to 4% of the monthly gross rents collected on commercial properties. Tarragon subcontracts with other entities for the provision of most of the property-level management services to the Trust.\nFrom February 1, 1990 until March 31, 1994, affiliates of BCM provided property management services to the Trust for a fee of 5% or less of the monthly gross rents collected on the properties under management. In many cases, these affiliates of BCM subcontracted with other entities for the provision of the property-level management services to the Trust at various rates, as more fully described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\nThrough March 31, 1994, affiliates of BCM also received real estate brokerage commissions in accordance with the terms of a non-exclusive brokerage agreement as discussed in ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor.\"\nCompetition\nThe real estate business is highly competitive and the Trust 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 Trust. The Trust's management believes that success in real estate investment is primarily dependent upon general market conditions; geographic location; the performance of asset and property managers in marketing, collection and controlling operating expenses; the amount of new construction in the area; and the maintenance and appearance of the property, rather than the activities of competitors. Additional competitive factors with respect to commercial and industrial properties are the ease of access to the property,\nITEM 1. BUSINESS (Continued)\nCompetition (Continued)\nthe adequacy of related facilities, such as parking, and sensitivity to market conditions in setting rental rates. 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.\nTo the extent that the Trust seeks to sell any of its real estate portfolio, the sales price 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\", most of the Trustees and Officers of the Trust also serve as officers or trustees of Tarragon and Vinland Property Trust (\"VPT\"). The Trust's Officers and Trustees owe fiduciary duties to such other entities as well as to the Trust. In determining to which entity a particular investment opportunity will be allocated, the Trustees and Tarragon consider 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. To monitor the effectiveness of the foregoing investment allocation policy, Tarragon has agreed to make periodic reports to a special committee of the Trust's Board on all real estate acquisitions made by it or any affiliate, whether or not such acquisitions were deemed by Tarragon as suitable for the Trust.\nIn addition, also as described in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships\", the Trust also competes with other entities which may have investment objectives similar to the Trust's and that may compete with the Trust in purchasing, selling, leasing and financing real estate and real estate related investments. In resolving any potential conflicts of interest which may arise, Tarragon has informed the Trust that it intends 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 Trust 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 the 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 Trust or Tarragon. The illiquidity of real estate investments generally may impair the ability of the Trust to respond promptly to changing circumstances. The Trust's management believes that such risks are partially mitigated by the diversification by geographic region and property type of the Trust's real estate and mortgage notes receivable portfolios. However, to the extent new equity investments are concentrated in any particular region, the advantages of geographic diversification will be mitigated.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Trust's principal offices are located at 280 Park Avenue, East Building, 20th Floor, New York, New York 10017. In the opinion of the Trust's management, the Trust's offices are suitable and adequate for its present operations.\nDetails of the Trust's real estate and mortgage notes receivable portfolios at December 31, 1994, are set forth in Schedules III and IV, respectively, to the Consolidated Financial Statements and NOTE 2. \"NOTES AND INTEREST RECEIVABLE\" and NOTE 4. \"REAL ESTATE AND DEPRECIATION\" of the Notes to the Consolidated Financial Statements, all included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\". The discussions set forth below under the headings \"Real Estate\" and \"Mortgage Loans\" provide certain summary information concerning the Trust's real estate and mortgage notes receivable portfolios.\nAt December 31, 1994, 85.3% of the Trust's assets consisted of equity investments in real estate, 5.1% consisted of investments in partnerships and 4.6% consisted of mortgage notes and interest receivable. The remaining 5.0% of the Trust's assets at December 31, 1994, were cash, cash equivalents and other assets. It should be noted, however, that the percentage of the Trust's assets invested in any one category at any particular time is subject to change and no assurance can be given that the composition of the Trust's assets in the future will approximate the percentages listed above.\nAt December 31, 1994, the Trust held mortgage notes receivable secured by real estate located in several geographic regions of the continental United States, with a concentration in the Southeast, as shown more specifically in the table under \"Mortgage Loans\" below. The Trust's real estate is also geographically diverse. At December 31, 1994, the Trust held investments in apartments and commercial real estate in each of the geographic regions of the continental United States, although its apartments are concentrated in the Southeast, as shown more specifically in the table under \"Real Estate\" below.\nTo continue to qualify for federal taxation as a REIT under the Internal Revenue Code of 1986, as amended, the Trust will, among other things, be required to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year.\n[This space intentionally left blank.]\nITEM 2. PROPERTIES (Continued)\nGeographic Regions\nThe Trust has divided the continental United States into the following six geographic regions.\n[MAP]\n[Northeast 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, 1994, the Trust's real estate portfolio consisted of 52 properties, 44 of which are held for investment. The remaining eight properties, primarily obtained through foreclosure of the Trust's mortgage notes receivable, are held for sale. The Century Centre II Office Building located in San Mateo, California exceeds 10% of the Trust's assets. Ten of the Trust's properties and the Trust's entire mortgage portfolio are held free and clear. All other Trust properties are pledged to secure first mortgage debt totaling $135.2 million at December 31, 1994.\nTypes of Real Estate Investments. The Trust's real estate consists of apartments and commercial properties, primarily office buildings and shopping centers, or similar properties having established income-producing capabilities. In selecting real estate, the location, age 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 Trust may acquire properties subject to, or assume, existing debt and may mortgage, pledge or otherwise obtain financing for a portion of its real estate. The Trust's Board of Trustees may alter the types of and criteria for selecting new equity investments and for obtaining financing without a vote of shareholders to the extent such policies are not governed by the Declaration of Trust.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nAlthough the Trust has typically invested in developed real estate, the Trust intends to invest increasing amounts in major apartment renovations and new construction or development either directly or in partnership with unaffiliated partners. To the extent that the Trust invests in construction and development projects, the Trust would be subject to business risks, such as cost overruns and delays, associated with such higher risk activities.\nIn the opinion of the Trust's management, the real estate owned by the Trust is adequately covered by insurance.\nThe following table sets forth the percentages, by property type and geographic region, of the Trust's real estate (other than the unimproved land and a single-family residence described below) at December 31, 1994.\nThe foregoing table is based solely on the number of apartment units and amount of commercial square footage owned by the Trust and does not reflect the value of the Trust's investment in each region. The Trust also owns one parcel of unimproved land of 46.27 acres located in the Southeast region and one single-family residence located in the Southwest region.\nA summary of activity in the Trust's owned real estate portfolio during 1994 is as follows:\n_______________ * Includes an office\/retail center which is now reported separately as an office building and a retail center.\n[This space intentionally left blank.]\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nProperties Held for Investment. Set forth below are the Trust's properties held for investment and the annual net rental revenue for apartments and commercial properties and occupancy thereof at December 31, 1994 and 1993. Net rental revenue represents gross revenue per property, net of rental losses.\n_____________________________________________________ (A) Property acquired during 1994.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nOccupancy presented above and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.\nProperties Held for Sale. Set forth below are the Trust's properties held for sale (primarily obtained through foreclosure), except for a single-family residence, and the annual net rental revenue for apartments and commercial properties and occupancy thereof at December 31, 1994 and 1993. Net rental revenue represents gross revenue per property, net of rental losses.\n____________________________________________________________________________ (A) Property is shut down. (B) Property acquired in December 1994 by deed in lieu of foreclosure.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nPartnership Properties. The Trust, in partnership with Continental Mortgage and Equity Trust (\"CMET\"), owns Sacramento Nine (\"SAC 9\"), which currently owns two office buildings in the vicinity of Sacramento, California. The Trust has a 70% interest in the partnership. The SAC 9 partnership agreement requires the consent of both the Trust and CMET for any material changes in the operations of the partnership's properties, including sales, refinancings and changes in the property manager. Therefore, the Trust is a noncontrolling partner and accounts for its investment in the partnership under the equity method.\nThe Trust and CMET are also partners in Income Special Associates (\"ISA\"), a joint venture partnership in which the Trust has a 40% partnership interest. ISA owns a 100% interest in Indcon, L.P. (\"Indcon\"), formerly known as Adams Properties Associates (\"APA\"), which owns 32 industrial warehouses. The Trust accounts for its investment in the Indcon partnership under the equity method.\nOn July 1, 1993, the Trust made an additional capital contribution to English Village Partners, L.P. (\"English Village\") of $464,000 to increase its limited partnership ownership interest to 49% and to acquire a 1% general partnership interest in the partnership, which owns a 300-unit apartment property. The Trust, as a noncontrolling partner, accounts for its investment in English Village under the equity method.\nSet forth below are the Trust's investments in partnership properties and the annual net rental revenue and occupancy thereof at December 31, 1994 and 1993. Net rental revenue represents gross revenue per property, net of rental losses.\nMortgage Loans\nAt December 31, 1994, the Trust held 7 mortgage loans with an aggregate outstanding balance of $15.9 million, secured by income-producing properties located throughout the United States, one mortgage loan with an outstanding balance of $256,000 secured by a retirement center in Tucson, Arizona, and 3 mortgage loans with an outstanding balance of $206,000 secured by single-family residences located in the Southwest region of the United States, which together with accrued interest, net of reserves, represented 4.6% of the Trust's assets at such time.\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nTypes of Properties Subject to Mortgages. The properties securing the Trust's mortgage portfolio at December 31, 1994, consisted of apartments, office buildings, shopping centers, single-family residences, a retirement home and developed land. To the extent the Declaration of Trust does not control such matters, the Trust's Board of Trustees may alter the types of mortgages in which the Trust invests without a vote of the Trust's shareholders. In addition to restricting the types of collateral and priority of mortgages, the Declaration of Trust imposes certain restrictions on transactions with related parties which limits the entities to which the Trust may make a mortgage, as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\nThe following table sets forth the percentages (based on the note receivable carrying value), by both property type and geographic region, of the properties that serve as collateral for the Trust's outstanding mortgages at December 31, 1994. The table does not include the $206,000 in single-family mortgages or the $256,000 mortgage secured by the retirement center.\nA summary of activity in the Trust's mortgage notes receivable portfolio during 1994 is as follows:\nThe Trust's policy, at present, is to make mortgage loans only in connection with, and to facilitate the sale or acquisition of, real estate. As existing mortgages are paid off, the Trust's portfolio of mortgage notes receivable is, accordingly, expected to continue to decline.\n[This space intentionally left blank.]\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOlive Litigation\nIn February 1990, the Trust, together with CMET, Income Opportunity Realty Trust (\"IORT\") and Transcontinental Realty Advisors, Inc. (\"TCI\"), three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Trust, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., relating to the operation and management of each of the entities. On April 23, 1990, the court granted final approval of the terms of the original settlement.\nOn May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\"), which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994 and final court approval was entered on December 12, 1994. The effective date of the Modification is January 11, 1995.\nThe Modification, among other things, provided for the addition of at least three new unaffiliated members to the Trust's Board of Trustees and set forth new requirements for the approval of any transactions with affiliates over the next five years. In accordance with the procedures set forth in the Modification, Irving E. Cohen, Lance Liebman, Sally Hernandez-Pinero and L. G. Schafran have been appointed to the Board. In addition, BCM, Gene E. Phillips and William S. Friedman have agreed to pay a total of $1.2 million to the Trust, CMET, IORT and TCI, of which the Trust's share is $150,000.\nUnder the Modification, the Trust, CMET, IORT, TCI and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust, CMET, IORT and TCI also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Trust held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all current Board members that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new Board members appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.\nThe Modification also terminated a number of the provisions of the Stipulation of Settlement, including the requirement that the Trust, CMET, IORT and TCI maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court will retain jurisdiction to enforce the Modification.\nAlso, see ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT\" - Trustees for a description of the Modification as it relates to certain changes in Members of the Board of Trustees.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nDuring the fourth quarter of the calendar year covered by this report, no matter was submitted to a vote of security holders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND RELATED SHAREHOLDER MATTERS\nThe Trust's shares of beneficial interest, no par value (the \"Shares\" and each a \"Share\"), are traded in the over-the-counter market on the National Association of Securities Dealers Automated Quotation (\"NASDAQ\") system using the symbol \"NIRTS\". Over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commissions, and may not necessarily represent actual transactions. The following table sets forth the high and low bid quotations of the Shares as reported by the NASDAQ system for the periods indicated:\nFor the first quarter of 1995 through March 10, 1995, the high and low bid quotations of the Shares, as reported by the NASDAQ system were $11 3\/4 and $11 5\/8, respectively. Also as of March 10, 1995, the closing bid price of the Shares was $11 3\/4 per Share and there were 6,947 holders of record as of such date.\nBased on the performance of the Trust's properties, the Trust's Board of Trustees, at their July 1993 meeting, voted to resume regular quarterly distributions. The per share cash distributions paid in 1994 and 1993 were as follows:\nThe Trust also paid a 10% share dividend to its shareholders in each of 1994 and 1993.\nDuring 1994 and 1993, the Trust repurchased 192,000 Shares and 280,038 Shares at a total cost to the Trust of $2.3 million and $2.4 million, respectively. A repurchase program was originally announced by the Trust on December 5, 1989, authorizing the Trust to repurchase a total of 1,026,667 Shares, of which all 1,026,667 Shares had been repurchased as of August 1994. On May 19, 1994, the Trust's Board of Trustees authorized the Trust to repurchase up to an additional 300,000 Shares, of which 59,202 Shares were repurchased as of December 31, 1994.\n[This space intentionally left blank.]\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nITEM 6. SELECTED FINANCIAL DATA (Continued)\n(1) Funds from operations, as defined by National Association of Real Estate Investment Trusts (\"NAREIT\"), equals net income (loss) (computed in accordance with generally accepted accounting principles), excluding gains (or losses) from debt restructuring and sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Funds from operations does not represent cash flow from operating activities and should not be considered as an alternative to net income as an indicator of the Trust's operating performance or to cash flow as a measure of liquidity or the ability to pay dividends. \"Funds from operations - equity affiliates\" is calculated to reflect funds from operations in the same manner. (2) Share and per share data have been restated to give effect to 10% share dividends declared in September 1994 and July 1993 and the one-for-three reverse share split effected March 26, 1990.\n[This space intentionally left blank.]\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nIntroduction\nNational Income Realty Trust (the \"Trust\") invests in real estate through acquisitions, leases and partnerships and, to a lesser extent, in mortgages on real estate. The Trust was organized on October 31, 1978 and commenced operations on March 27, 1979.\nThe Trust's real estate portfolio at December 31, 1994 consisted of 52 properties located throughout the United States, with concentrations in the Southeast, 8 of which are held for sale and 44 held for investment. These properties consist of 30 apartment complexes, 14 shopping centers, 4 office buildings, three parcels of land and one single-family residence. All of the Trust's real estate, except ten properties, is pledged to secure first mortgage notes payable.\nThe Trust's management plans to continue its successful efforts of enhancing the long-term value of shareholder investments through efficient asset and property management, as well as selective investments in underperforming apartment properties in the same geographical regions that the Trust currently operates. Additionally, management intends to raise capital through refinancings and dispositions of certain assets and sustain and increase cash distributions to shareholders after making adequate provisions for capital investments of the Trust's existing portfolio and share repurchases.\nLiquidity and Capital Resources\nCash and cash equivalents aggregated $3.5 million at December 31, 1994 compared with $1.1 million at December 31, 1993. The Trust's principal sources of cash have been and will continue to be property operations, proceeds from property sales, the collection of mortgage notes receivable and borrowings. The Trust expects that funds from operations, collection of mortgage notes receivable and from anticipated external sources, such as property sales and refinancings, will be sufficient to meet the Trust's various cash needs, including debt service obligations, property maintenance and improvements and continuation of regular distributions, as more fully discussed in the paragraphs below.\nOperating Activities\nThe Trust's cash flow from property operations (rentals collected less payments for property operating expenses) increased from $14.4 million in 1993 to $14.9 million for 1994. This increase is primarily attributable to two apartment complexes acquired through foreclosure in 1993, and the acquisition of five apartment complexes in 1994. This increase was partially offset by an increase in property tax payments due to payment of prior year taxes in 1994. Property tax payments totaled approximately $3.7 million in 1993 as compared to $5.0 million in 1994. Cash flows from property operations increased from $10.1 million in 1992 to $14.4 million in 1993. This increase in cash flow from property operations is primarily attributable to four apartment complexes purchased in November 1992 and two apartment complexes obtained through foreclosure in March 1993.\nThe Trust's interest collected increased from $1.5 million in 1993 to $1.6 million in 1994. As described in Note 2. \"NOTES AND INTEREST RECEIVABLE\", the Trust received $1.3 million in settlement of the Alder Creek mortgage note receivable, of which $391,000 was recorded as interest collected, for a total of $442,000 interest collected on the Alder Creek note during 1994 as compared to $200,000 interest collected on the same note in 1993. The increase is offset by a $213,000 decrease in interest collected due to the payoff or foreclosure of three notes receivable in 1993 and three mortgage notes receivable in 1994. Interest collected in 1992 totaled ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nOperating Activities (Continued)\n$2.1 million compared with $1.5 million in 1993. Of this decrease, $245,000 is due to a note which was paid in full in March 1993 and $221,000 is due to interest payments received in 1992 on a cash flow mortgage, but not received in 1993. Interest collections are expected to continue to decline in 1995 due to the $2.4 million and $1.8 million in loans paid off in 1993 and 1994, respectively.\nInterest paid on the Trust's indebtedness increased from $9.3 million in 1993 to $9.8 million in 1994. Interest payments increased $554,000 due to mortgage interest paid associated with the apartment complexes acquired in 1993 and 1994. Interest payments also increased by $438,000 due to five Trust properties refinanced in 1994 and the Trust obtaining first mortgage financing on one property in June 1993. The Trust refinanced five apartment properties, one of which was acquired through foreclosure in 1993, with existing mortgage debt of $15.8 million and obtained new first mortgage financing totaling $22.8 million during 1994. In June 1993, the Trust obtained financing on a previously unencumbered property in the amount of $2.1 million. Also, in November and December 1994, the Trust refinanced two additional, previously unencumbered, properties and obtained first mortgage financing of $4.1 million. Interest paid also increased due to mortgage payments on the first mortgage secured by the Emerson Center Office Building, which commenced in June 1994, increasing interest payments $165,000. These increases are partially offset by a $129,000 decrease in the interest paid on the mortgage note payable secured by the Pinecrest Apartments, due to a reduction in the variable interest rate. Also, interest payments decreased due to the mortgage secured by the Century Centre II Office Building, which was restructured in 1993 in accordance with the confirmed Plan of Reorganization. See NOTE 7. \"NOTES, DEBENTURES AND INTEREST PAYABLE\".\nInterest paid increased from $7.7 million in 1992 to $9.3 million in 1993. Of this increase, $1.3 million is due to interest paid on mortgages secured by properties acquired by the Trust during 1992 and 1993 and an additional $723,000 of the increase is attributable to interest paid on the mortgage secured by the Century Centre II Office Building, on which the Trust made a $1.0 million payment of accrued interest in accordance with the confirmed Plan of Reorganization as discussed in NOTE 7. \"NOTES, DEBENTURES AND INTEREST PAYABLE.\" These increases were partially offset by a decrease in interest of $314,000 due to the mortgage secured by Pinecrest Apartments, whose variable interest rate decreased from 1992 to 1993.\nInvesting Activities\nDuring 1994, the Trust acquired five apartment complexes, comprising over 1,000 units, in furtherance with management's objective of increasing the Trust's multi-family portfolio. Three of the new properties, Bryan Hill, Forest Oaks and Martins Landing, were acquired together when the Trust paid $300,000 in cash to exercise its option, obtained in November 1992, to acquire the limited partnerships which owned these properties. The properties were subject to existing mortgage debt totaling $10.3 million, which was in default. In November 1994, the Trust paid $1.1 million in cash to reinstate and bring current two of the existing mortgages and anticipates reinstatement or payoff of the third mortgage during the first half of 1995. The Trust recorded the acquisitions in November 1994 when, at the same time, the Trust began recording the operations of the three properties.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nInvesting Activities (Continued)\nIn March 1994, the Trust purchased the Summit on the Lake Apartments located in Fort Worth, Texas for $675,000 in cash, and the property is subject to an existing first mortgage of $3.7 million, which matures September 2007. The Trust purchased the unoccupied Woodlake Run Apartments, also in Fort Worth, Texas, in December 1994 for $836,000 in cash. The Trust plans to rehabilitate and expand the property, at an estimated cost of $5.0 million, and anticipates it will be completed by the end of 1996. The Trust paid Tarragon acquisition commissions of $184,000 based on the purchase price of the above properties. The Trust has also entered into contracts for the purchase of four other apartment properties in Dallas, Texas; Miami, Florida; Baton Rouge, Louisiana; and Los Angeles, California. Each pending acquisition is in a market in which the Trust presently participates.\nThe Trust did not purchase any properties during 1993. The Trust acquired four properties and two notes receivable during 1992, for which the Trust paid $1.2 million in cash, with the remainder financed through the assumption of mortgages totaling $13.2 million.\nThe Trust made $2.5 million of capital improvements to its properties in 1994 compared to $2.8 million in 1993 and $4.6 million in 1992. Capital improvement expenditures are anticipated to total $3.4 million in 1995, of which $2.2 million was escrowed with lenders at December 31, 1994. In addition, the Trust received $1.3 million in cash as settlement of the Alder Creek mortgage note receivable, of which $856,000 was recorded against the Trust's carrying value and the remaining as interest income, as discussed above. See NOTE 2. \"NOTES AND INTEREST RECEIVABLE\". The Trust also received payments of $913,000 in satisfaction of two other mortgage notes receivable during 1994. The Trust received $2.4 million in cash as payment in full and other principal payments on the Trust's mortgage notes receivable during 1993 and $2.2 million as payment in full and other principal payments on the Trust's mortgage notes receivable during 1992.\nThe Trust and Continental Mortgage and Equity Trust (\"CMET\") are partners in Income Special Associates (\"ISA\"), a joint venture partnership in which the Trust has a 40% interest in earnings, losses and distributions. ISA in turn owns a 100% interest in Indcon, L.P. (\"Indcon\"), formerly known as Adams Properties Associates, which owns 32 industrial warehouses. In May 1994, Indcon sold a warehouse for $4.4 million. Indcon received $2.2 million in cash, of which the Trust's equity share was $871,000. At different times during 1994, three current Trustees and three former Trustees of the Trust concurrently served as Trustees of CMET. The Trust received $410,000 and $368,000 in net cash from the sale of three foreclosed properties during 1993 and 1992, respectively.\nIn June 1994, the Trust sold 15,000 shares of beneficial interest of CMET for $210,000. At December 31, 1994, the Trust owned 39,500 shares of beneficial interest of CMET, which had a market value at that date of $593,000. Such shares were sold during the first quarter of 1995 for $593,000, and, as a result, the Trust recorded a gain on sale of investments of $411,200.\nDuring 1993, Sacramento Nine (\"SAC 9\"), a partnership in which the Trust owns a 70% interest, sold 3 of its office buildings for $2.5 million in cash, of which the Trust's equity share was $1.7 million.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nFinancing Activities\nDuring 1994, the Trust obtained first mortgage financing on seven Trust properties totaling $26.9 million, receiving net cash proceeds of $9.4 million after the payoff of $15.8 million in existing debt ($7.0 million of which would have matured during 1994). The remainder of the financing proceeds were used to fund escrows for replacements and repairs and to pay closing costs associated with the refinancing. In addition, the Trust made other mortgage note payments of $4.1 million during 1994, including the first mortgage principal payoffs of $143,000 secured by the Stewart Square Shopping Center, and $940,000 secured by the Mountain View Shopping Center, both in Las Vegas, Nevada.\nIn November 1994, the Trust extended the maturity date of the $732,000 mortgage note payable secured by the Sandstone Apartments for two years to November 1996. In addition, during 1994 the Trust extended the maturity date of the $3.1 million mortgage note secured by Rancho Sorrento Business Park to August 2000. The note was originally scheduled to mature in August 1995.\nIn June 1993, the Trust obtained first mortgage financing secured by the Bayfront Apartments in the amount of $2.1 million, of which the Trust received net cash of $1.8 million from the financing proceeds.\nIn October 1992, the Trust borrowed $1.6 million from a bank secured by a $1.6 million unsecured note receivable of the Trust. The note payable was paid in full on its maturity date in March 1993 from the collection of the note receivable.\nPrincipal payments on the Trust's mortgage notes payable of $7.3 million are due in 1995, of which $2.3 million represents the principal portion of the regular monthly mortgage payments and $5.0 million represents balloon payments on mortgages maturities. It is the Trust's intention to either pay the mortgages when due or seek to extend the due dates one, two or more years while attempting to obtain long-term financing. However, while management is confident of its ability to acquire refinancing as needed, there is no assurance that the Trust will continue to be successful in its efforts in this regard.\nAs scheduled, in January 1995, the Trust paid $236,000 in full payment of the mortgage note payable secured by the Lakeview Mall.\nDuring 1994, the Trust repurchased 192,000 of its shares of beneficial interest at a cost to the Trust of $2.3 million, and during 1993, the Trust repurchased 280,038 of its shares of beneficial interest at a cost of $2.4 million. On May 19, 1994, the Trust's Board of Trustees approved an authorization for the Trust to repurchase up to 300,000 additional shares of beneficial interest through open market or negotiated transactions, of which 59,202 shares have been purchased as of December 31, 1994.\n[This space intentionally left blank.]\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations\nBased on the performance of the Trust's properties, the Trust's Board of Trustees voted in July 1993 to resume the payment of regular quarterly distributions to shareholders. The Trust paid distributions totaling $2.2 million or $0.67 per share during 1994 and $617,000 or $0.20 per share to its shareholders in 1993. The Trust also paid a 10% share dividend to its shareholders in 1994 and 1993.\nOn a quarterly basis, the Trust's management reviews the carrying value of the Trust's mortgages, 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 Trust's properties 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 the mortgage loans. 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.\n1994 COMPARED TO 1993. For the year ended December 31, 1994, the Trust's operating loss significantly decreased from $4.0 million in 1993 to $780,000 in 1994. The primary factors contributing to this decrease are discussed in the following paragraphs. In addition, due to a 1993 extraordinary gain of $8.9 million, the Trust reported net income of $5.8 million for the year ended December 31, 1993 as compared with a net loss of $254,000 for the year ended December 31, 1994.\nNet rental income (rental income less property operating expenses) increased from $14.6 million for the year ended December 31, 1993 to $16.1 million for the year ended December 31, 1994. Of this increase, $537,000 is attributable to five apartment complexes acquired during 1994, one of which was foreclosed by the Trust, and an additional $577,000 is due to the two apartment complexes acquired through foreclosure in March 1993. Net rental income increased $426,000 for Trust properties held in both 1993 and 1994. While occupancy levels remained stable for these properties from 1993 to 1994, the Trust increased rental rates $1.3 million on these Trust properties, primarily apartment properties in the Southeast and Mountain regions of the United States. This increase was offset by a $674,000 increase in operating expenses due to 1994 repair and maintenance expenditures as compared to 1993, in an effort to upgrade the properties in order to increase occupancy and rent levels in 1995.\nInterest income increased from $1.6 million for the year ended December 31, 1993 to $1.7 million for the year ended December 31, 1994. As more fully described in NOTE 2. \"NOTES AND INTEREST RECEIVABLE\", interest income related to the Alder Creek mortgage note receivable increased $354,000 primarily due to the 1994 settlement of this note balance. This increase was partially offset by a decrease of interest income of $208,000 related to the payoff or foreclosure of three notes receivable in 1993 and 1994.\nInterest expense increased from $9.7 million for the year ended December 31, 1993 to $10.5 million for the year ended December 31, 1994. Interest expense increased $739,000 related to the apartment complexes acquired during 1993 and 1994. Additionally, the refinancing of six properties in 1994 and one property in 1993 increased interest expense by $384,000. Partially offsetting these increases was a $200,000 decrease in the interest expense on the mortgage secured by the Pinecrest Apartments due to a reduction in the variable interest\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nrate during 1993. The Trust also ceased accruing interest on the mortgage note secured by the Pepperkorn Building in April 1994 due to pending litigation, accounting for a $151,000 decrease in interest expense.\nDepreciation expense increased from $4.6 million for the year ended December 31, 1993 to $5.0 million for the year ended December 31, 1994. Of this increase, $184,000 relates to the two properties acquired through foreclosure in 1993 and the seven properties acquired during 1994, two of which were also acquired through foreclosure. Depreciation expense also increased due to improvements made to Trust properties of $2.8 million in 1993 and $2.5 million in 1994.\nAdvisory fees to Basic Capital Management, Inc. (\"BCM\") were $468,000 in 1994 and $1.5 million in 1993. Advisory fees to Tarragon were $909,000 in 1994. Under the BCM advisory agreement, the Trust paid a monthly fee equal to .0625% per month of the average gross asset value of the Trust. In addition, the Trust paid BCM an incentive fee equal to 7.5% per annum of the Trust's net income for each year which BCM provided services. Under the Tarragon advisory agreement, the Trust paid a base annual advisory fee of $100,000 plus an incentive fee equal to 16% per annum of funds from operations, as defined in the new advisory agreement dated February 15, 1994. Under each of the advisory agreements (as required by the Trust's Declaration of Trust), all or a portion of the annual advisory fee must be refunded by the advisor to the Trust if the operating expenses of the Trust (as defined in the Trust's Declaration of Trust) exceed certain limits based on the book value, net asset value and the net income of the Trust during such fiscal year. The operating expenses of the Trust did not exceed such limitation in 1994, 1993 or 1992.\nGeneral and administrative expenses increased from $1.8 million for the year ended December 31, 1993 to $1.9 million for the year ended December 31, 1994. This increase is due to an increase in cost reimbursements to Tarragon during 1994 as compared to reimbursements to BCM during 1993. Partially offsetting this increase is a reduction in legal fees related to the Olive litigation, as more fully discussed in NOTE 15. \"COMMITMENTS AND CONTINGENCIES\".\nFor the year ended December 31, 1994, the Trust reported gains on sales of real estate of $385,000 related to the sale of a warehouse by Indcon in May 1994. In addition, the Trust recognized a gain on the sale of investments of $141,000 related to the sale of the 15,000 shares of beneficial interest of CMET.\n1993 COMPARED TO 1992. For the year ended December 31, 1993, the Trust's operating loss decreased from $8.3 million in 1992 to $4.0 million in 1993, as more fully discussed in the following paragraphs. Additionally, as the result of an extraordinary gain of $8.9 million recorded in 1993, the Trust reported net income of $5.8 million for the year ended December 31, 1993.\nNet rental income (rental income less property operating expenses) increased from $9.4 million in 1992 to $14.6 million in 1993. Of this increase, $1.3 million is due to four apartment complexes acquired in November 1992 and an additional $654,000 is due to two apartment complexes obtained through foreclosure in 1993. An additional $618,000 is due to a decrease in the amortization of free rent at the Century Centre II Office Building and $295,000 is due to a decrease in replacements at Park Dale Gardens, the renovation of which was completed in 1992. The remaining increase is due to increased occupancy and rental rates at the Trust's apartment complexes, primarily in the Southeast and Southwest regions, and overall expense control at certain of the Trust's apartment and commercial properties.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nInterest income decreased from $2.5 million in 1992 to $1.6 million in 1993. Of this decrease, $553,000 is due to loans which were placed on nonaccrual status or loans on which the collateral securing the loan was foreclosed in 1993. In addition, a decrease of $245,000 is due to a note which was paid in full in March 1993 and a decrease of $221,000 is due to interest payments received in 1993 compared to 1992 on a mortgage where interest is recognized on the cash flow basis.\nThe Trust's equity in income (losses) of partnerships was income of $204,000 in 1992 compared to a loss of $34,000 in 1993. This decrease in operating results is primarily due to the sale of three properties by the SAC 9 partnership in the second quarter of 1993.\nInterest expense decreased from $10.4 million in 1992 to $9.7 million in 1993. A decrease of $1.2 million is attributable to a reduction in the interest rate on the first mortgage secured by the Century Centre II Office Building and the purchase of the second mortgage at a significant discount. An additional decrease of $163,000 is due to a reduction in the variable interest rate on the note payable secured by Pinecrest Apartments and $414,000 is due to interest expense on the underlying note payable associated with one of the Trust's wraparound mortgage notes receivable, which was foreclosed and immediately sold in 1993. These decreases were partially offset by an increase of $857,000 due to interest expense recorded on mortgages secured by four apartment complexes which were acquired in November 1992 and an additional $416,000 is attributable to interest expense recorded on the underlying mortgage secured by a property acquired through foreclosure in March 1993. See NOTE 7. \"NOTES, DEBENTURES AND INTEREST PAYABLE.\"\nDepreciation expense increased from $4.0 million in 1992 to $4.6 million in 1993, primarily due to the acquisition of four apartment complexes in November 1992 and two additional apartment complexes acquired through foreclosure in March 1993.\nAdvisory fees increased from $1.4 million in 1992 to $1.5 million in 1993, as a result of an increase in the average monthly gross assets of the Trust, calculated in accordance with the terms of the advisory agreement.\nGeneral and administrative expenses decreased from $2.2 million in 1992 to $1.8 million in 1993. Of this decrease, $250,000 is due to a reduction in legal fees, an additional $123,000 is related to the Trust's March 1992 annual meeting of shareholders and the February 1992 Rights redemption and $198,000 is due to a decrease in professional fees related to the reduced level of property acquisitions in 1993 compared to 1992.\nIn 1993, the Trust expensed $1.0 million for the issuance of a $1.0 million convertible subordinated debenture to John A. Doyle, Executive Vice President of the Trust, in exchange for his 10% participation in the profits of the Consolidated Capital Properties II (\"CCP II\") assets, which were acquired in November 1992. This participation was granted as consideration for Mr. Doyle's services to the Trust in connection with the acquisition of the CCP II portfolio. See NOTE 7. \"NOTES, DEBENTURES AND INTEREST PAYABLE.\"\nFor 1993, the Trust recorded a provision for losses of $1.4 million to provide for estimated losses on one of the Trust's properties held for sale and one of the Trust's first lien mortgage notes. A provision for losses of $2.4 million was recorded in 1992 to reserve against certain junior mortgage notes receivable.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nFor the year ended December 31, 1993, the Trust recognized gains on sales of real estate of $851,000 related to the sale of three properties by SAC 9 and $94,000 on the sale of the Plaza Jardin Office Building, one of the CCP II assets. No gains on sales of real estate were recognized in 1992.\nAlso for the year 1993, the Trust recorded an extraordinary gain on the forgiveness of debt of $8.9 million related to the discounted purchase of the second lien mortgage secured by Century Centre II Office Building, which was purchased by the Trust for $300,000 as part of a bankruptcy Plan of Reorganization. The Trust recorded no extraordinary gain in 1992.\nEnvironmental Matters\nUnder various federal, state and local environmental laws, ordinances and regulations, the Trust 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 Trust for personal injury associated with such materials.\nThe Trust's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Trust's business, assets or results of operations.\nInflation\nThe effects of inflation on the Trust's operations are not quantifiable. Revenues from property operations fluctuate proportionately with increases and decreases in housing costs. Fluctuations in the rate of inflation also affect the sales values of properties, mortgage interest rates and, correspondingly, the ultimate gains to be realized by the Trust from property sales. Inflation also has an effect on the Trust's earnings from short-term investments.\nTax Matters\nFor the years ended December 31, 1994, 1993 and 1992, the Trust elected, and in the opinion of the Trust's management, qualified to be taxed as a Real Estate Investment Trust (\"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, as defined in Section 857 of the Code, on an annual basis to shareholders.\nRecent Accounting Pronouncements\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") 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 notes receivable be considered impaired when \"based on current information and events, it is probable that a creditor will be unable to collect all amounts due, both principal and ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nRecent Accounting Pronouncements (Continued)\ninterest, according to the contractual terms of the loan agreement\". Impairment is to be measured either on the present value of expected future cash flows discounted at the note's effective interest rate or, if the note is collateral dependent, on the fair value of the collateral. In October 1994, the FASB issued SFAS No. 118 - \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure\", which amends SFAS No. 114. SFAS No. 118 eliminates the income recognition provisions of SFAS No. 114, substituting disclosure of the creditor's policy of income recognition on impaired notes. SFAS No. 114 and SFAS No. 118 are both effective for fiscal years beginning after December 15, 1994. The Trust's management has not fully evaluated the effects of implementing these statements, but expects that they will not affect the Trust's interest income recognition policy but may require the classification of certain otherwise performing loans as impaired.\n[This space intentionally left blank.]\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\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 PUBLIC ACCOUNTANTS\nTo the Board of Trustees of National Income Realty Trust\nWe have audited the accompanying consolidated balance sheet of National Income Realty Trust and Subsidiaries as of December 31, 1994, and the related statements of operations, shareholders' equity and cash flows for the year then ended. These financial statements and the schedules referred to below are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements and 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 and schedules. 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 National Income Realty Trust and subsidiaries as of December 31, 1994, and the results of their operations and their cash flows for the year then ended 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 Supplemental Schedules III, and IV 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 LLP Dallas, Texas March 24, 1995\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nTo the Board of Trustees of National Income Realty Trust\nWe have audited the accompanying consolidated balance sheet of National Income Realty Trust and Subsidiaries as of December 31, 1993 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the two 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 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 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 statements referred to above present fairly, in all material respects, the consolidated financial position of National Income Realty Trust and Subsidiaries as of December 31, 1993, and the consolidated results of their operations and their cash flows for each of the two 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.\nBDO Seidman\nDallas, Texas March 25, 1994\nNATIONAL INCOME REALTY TRUST CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL INCOME REALTY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe accompanying Consolidated Financial Statements of National Income Realty Trust and Subsidiaries (the \"Trust\") 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 1992 and 1993 have been reclassified to conform to the 1994 presentation.\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Trust business. National Income Realty Trust (\"NIRT\"), is a California business trust organized on October 31, 1978. The Trust was formed to invest in real estate, including commercial and apartment properties and, to a lesser extent, to finance real estate through mortgage notes. Since 1991, the Trust has sought only to make equity investments and accordingly, its mortgage note receivable portfolio represents a diminishing portion of the Trust's assets.\nBasis of consolidation. The Consolidated Financial Statements include the accounts of NIRT and partnerships and subsidiaries which it controls. All intercompany transactions and balances have been eliminated.\nForeclosed real estate. Foreclosed real estate is initially recorded at new cost, defined as the lower of the Trust's note receivable carrying value or fair value of the collateral property minus estimated costs of sale. Properties are depreciated in accordance with the Trust's established depreciation policies. See \"Real estate and depreciation\" below.\nAt least annually, all properties held for sale are reviewed by the Trust'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) Trust management has no intent to dispose of the property within the next twelve months; (iii) the property is a \"qualifying asset\" as defined in the Internal Revenue Code of 1986, as amended; (iv) property improvements have been funded; and (v) the Trust'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 income (loss).\nReal estate and depreciation. Real estate is carried at the lower of cost or estimated net realizable value. The Trust capitalizes property improvements and major rehabilitation projects which increase the value of the respective property and have a useful life greater than one year, except for individual expenditures less than $10,000 which are not part of a planned renovation project. Prepaid leasing commissions are included in the carrying value of the Trust's real estate and amortized on the straight-line method over the related lease term. Such amortization is included in property operating expenses. Depreciation is provided for by the straight-line method over the estimated useful lives of the assets, which range from 5 to 40 years.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES (Continued)\nInterest recognition on notes receivable. It is the Trust'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 net realizable value of the underlying collateral exceeds the carrying value of the receivable.\nAllowance for estimated losses. Valuation allowances are provided for estimated losses on properties and mortgage notes receivable to the extent that the investment in the properties or notes exceeds the Trust's estimate of net realizable value of the property or collateral securing each note, or fair value of the collateral if foreclosure is probable. In estimating net realizable value, consideration is given to the current estimated property or collateral value adjusted for costs to complete or improve, hold or dispose. 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 can be reasonably estimated.\nPresent value premiums\/discounts. The Trust 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 effective 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 note.\nCash equivalents. The Trust considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nRestricted cash. Restricted cash represents the Trust's escrow accounts, held by the lenders on certain of the Trust's mortgage notes payable, for taxes, insurance and property repairs.\nOther Assets. Other assets consist primarily of tenant accounts receivable and deferred borrowing costs. Deferred borrowing costs are amortized over the terms of the related loan agreements and included in interest expense.\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 profit recognition have been met, transactions are accounted for using either the deposit, installment, cost recovery or the financing method, whichever is appropriate.\nInvestment in noncontrolled partnerships. The Trust uses the equity method to account for investments in partnerships which the Trust does not control. Under the equity method, the Trust's initial investment is increased by the Trust's proportionate share of the partnership's operating income and additional advances and decreased by the Trust's proportionate share of the partnership's operating losses and distributions received.\nMarketable equity securities. Marketable equity securities are considered to be available-for-sale and are carried at fair value, defined as year end closing market value. Net unrealized holding gains and losses are reported as a separate component of shareholders' equity.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SIGNIFICANT ACCOUNTING POLICIES (Continued)\nEarnings per share. Income (loss) per share of beneficial interest (the \"Shares\" and each a \"Share\") is computed based upon the weighted average number of Shares outstanding during each year.\nFair value of financial instruments. The carrying value of the Trust's cash and cash equivalents approximate fair value. The Trust has used the following assumptions in estimating the fair value of its notes receivable 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 Trust's interest in the collateral property was used. For notes payable, the fair value was estimated using current rates for mortgages with similar terms and maturities. The estimated fair values presented do not purport to present amounts to be ultimately realized by the Trust. The amounts ultimately realized may vary significantly from the estimated fair values presented.\nConcentration of Credit Risk. Financial instruments which potentially subject the Trust to credit risk consist primarily of cash and cash equivalents, accounts receivable and notes receivable. The Trust restricts investment of cash and cash equivalents to federally insured accounts or to high credit quality financial institutions. Credit risk on accounts receivable is generally diversified due to the large number of tenants in the Trust's properties. The Trust's notes receivable are generally secured by real estate, but the Trust could be subject to a loss on its notes receivable if the carrying amount of the note receivable exceeds the fair value of the collateral property . See NOTE 2. \"NOTES AND INTEREST RECEIVABLE\".\nNOTE 2. NOTES AND INTEREST RECEIVABLE\nNotes and interest receivable consisted of the following:\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)\nThe Trust 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 1994, 1993 and 1992, unrecognized interest income on nonperforming notes totaled $470,000, $654,000 and $867,000, respectively. Interest income on nonperforming notes receivable was recorded to the extent of cash received of $555,000, $215,000 and $252,000 during 1994, 1993 and 1992, respectively.\nNotes receivable at December 31, 1994 mature from 1995 through 2016, with interest rates ranging from 5.7% to 18% and an effective weighted average interest rate on performing notes of 6.9%. Notes receivable are generally nonrecourse and are generally collateralized by real estate. Scheduled principal maturities of $10.2 million are due in 1995, including $1.2 million related to two mortgage notes receivable classified as nonperforming at December 31, 1994, as more fully discussed below.\nIn September 1994, the Trust agreed to a discounted settlement of a previously nonperforming first mortgage loan with a carrying value of $856,000 and a legal balance of $1.5 million at such date. The Trust received payments totaling $1.3 million in cash and released all of the collateral securing the mortgage loan.\nIn December 1994, the Trust reached a settlement regarding three nonperforming wraparound mortgage notes with an aggregate carrying value of $1.3 million, which represented the Trust's net equity in these notes. All three loans are secured by shopping centers, net leased to a major national tenant. The Trust recorded no losses on this settlement in excess of previously established reserves, as more fully discussed below.\nThe Trust accepted a deed in lieu of foreclosure on the $430,000 mortgage loan, secured by a K-Mart Shopping Center in Indianapolis, Indiana and subject to an existing first lien mortgage of $1.8 million. This mortgage note accrues interest at 9.75% per annum, calls for monthly principal and interest payments of $21,800 and matures September 2006.\nAlso, the Trust sold the wraparound mortgage note secured by the K-Mart Shopping Center in Racine, Wisconsin for $100,000 and, in accordance with the terms of the sale, received $50,000 in cash in January 1995. The Trust accepted an unsecured promissory note which bears interest at 8% per annum and matures May 1996 for the remaining $50,000 balance.\nAdditionally, the Trust restructured the wraparound mortgage secured by the K-Mart Shopping Center in Fairbault, Minnesota. At December 31, 1994, the carrying value of this note was $276,000 and represented the Trust's net equity in this note. Under the terms of the restructured agreement, interest will accrue at the rate of 7.58% per annum and the Trust is to receive monthly principal and interest payments equal to the lesser of (i) $20,140 or (ii) the amount by which, on an annual basis, the shopping center rents less certain fees and expenses exceeds the amounts due under the first mortgage loan. The Trust expects the payments due under this note will be approximately $2,000 per year. Any deferred amounts shall accrue to the principal balance of the note and be payable upon maturity in January 2003, at which time the first mortgage will have been fully amortized.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)\nAt December 31, 1994, the Trust continues to classify the $1.0 million first mortgage loan, secured by the Casa Bonita Apartments in Paris, Texas, as nonperforming. The Trust obtained a judgment against the three individual guarantors of this note and continues to negotiate with the borrowers on a discounted payout of the judgment. Regardless of these negotiations, the Trust does not anticipate incurring any additional loss, as the note has been previously fully reserved.\nThe Trust also continues to classify the $256,000 junior mortgage note secured by a retirement center in Tucson, Arizona as nonperforming at December 31, 1994. The borrower on this note, Eldercare Housing Foundation, and the Trust are negotiating a settlement of the outstanding note balance. The Trust does not anticipate incurring a loss on this note in excess of previously established reserves. Ted P. Stokely, a former Trustee of the Trust, was employed as a real estate consultant for Eldercare from April 1992 to December 1993.\nThe Trust also received payment in full on two other mortgage loans during 1994 and three mortgage loans during 1993 totaling $913,000 and $2.4 million, respectively. The Trust foreclosed on one additional mortgage loan with a carrying value of $297,000 in 1994 and three mortgage loans with principal balances totaling $6.2 million in 1993. These transactions resulted in no loss to the Trust in 1994 or 1993 as all losses had been previously provided. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nIn May 1993, the Trust foreclosed on the Plaza Jardin mortgage receivable. Immediately following the foreclosure, the Trust sold the property for $200,000 in cash subject to the $3.3 million underlying mortgage. The Trust recognized a $94,000 gain on the sale of the property.\nNOTE 3. ALLOWANCE FOR ESTIMATED LOSSES\nActivity in the allowance for estimated losses was as follows:\nNOTE 4. REAL ESTATE AND DEPRECIATION\nIn December 1994, the Trust's management performed a review of the Trust's real estate portfolio and reclassified the following apartment properties from properties held for sale to properties held for investment: Lake Point, Huntington Green and Mariposa Manor.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. REAL ESTATE AND DEPRECIATION (Continued)\nIn 1994, the Trust paid $300,000 in cash to exercise its option, which was obtained in November 1992, to acquire, through a transfer of general partner interests and stock of limited partners, certain limited partnerships which own three residential properties. Bryan Hill Apartments (232 units) in Bethany, Oklahoma; Forest Oaks Apartments (154 units) in Lexington, Kentucky; and Martins Landing Apartments (236 units) in Lakeland, Florida were subject to existing first mortgage debt totaling $10.3 million, which was then in default. The Trust submitted proposals to the Department of Housing and Urban Development (\"HUD\") to reinstate the existing mortgages through contributions from the Trust and the application of certain escrow balances, as well as, requesting the transfer of physical assets. In November 1994, the Trust was granted approval for the transfer of physical assets pending curing the mortgage delinquencies, which was completed by the Trust on two of the three properties with a $1.1 million cash payment. The Trust anticipates making additional payments to cure or payoff the other mortgage loan default. In conjunction with the additional contributions, the Trust recorded the acquisition of the three properties in November 1994. See NOTE 7. \"NOTES, DEBENTURES AND INTEREST PAYABLE\" for a more detailed discussion of the related mortgage notes.\nIn March 1994, the Trust purchased the Summit on the Lake Apartments (198 units) located in Fort Worth, Texas for $675,000 in cash and the property is subject to an existing first mortgage of $3.7 million. This nonrecourse mortgage has an effective interest rate of 8.6% per annum, requires monthly principal and interest payments of approximately $31,000 and matures September 2007. In connection with the acquisition, the Trust paid $176,000 of real estate brokerage and acquisition commissions, based upon the $4.4 million purchase price of the property, to Tarragon Realty Advisors, Inc. (\"Tarragon\"), the Trust's advisor. William S. Friedman, the President and a Trustee of the Trust, serves as Director and Chief Executive Officer of Tarragon. Tarragon is owned by Lucy N. Friedman, Mr. Friedman's wife, and John A. Doyle, who serves as Director, President and Chief Operating Officer of Tarragon, and Executive Vice President of the Trust. The Friedman and Doyle families own approximately 32% of the outstanding shares of the Trust.\nIn September 1994, the Trust recorded the acquisition of the Mariposa Manor Apartments, obtained through a deed in lieu of foreclosure on a $297,000 nonperforming second lien mortgage note receivable. The property, a 41 unit apartment complex in Los Angeles, California, had an estimated fair value of $1.1 million as of the date of acquisition and is subject to an existing $788,000 first lien mortgage, which was modified and assumed on a nonrecourse basis by the Trust. The modified note initially accrues interest at 6% per annum and, thereafter, is periodically adjusted based on a defined variable rate plus 3.25% per annum, with the highest note interest rate not to exceed 15.5% per annum. Initial monthly principal and interest payments of $5,000 are called for under the provisions of this note which matures April 1, 2002. The Trust has included this property in \"Real Estate - Held for investment\" in the Consolidated Financial Statements.\nIn December 1994, the Trust purchased the Woodlake Run Apartments, a 185-unit, vacant complex in Fort Worth, Texas for $836,000 in cash. The Trust intends to rehabilitate and expand the property at an approximate cost of $5.0 million, with completion estimated by 1996. In connection with the acquisition, the Trust paid Tarragon an $8,400 acquisition commission based on the purchase price of the property.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. REAL ESTATE AND DEPRECIATION (Continued)\nAlso in December 1994, the Trust obtained the K-Mart Shopping Center in Indianapolis, Indiana through a deed in lieu of foreclosure of a $430,000 nonperforming note receivable, as more fully discussed in NOTE 2. \"NOTES AND INTEREST RECEIVABLE\". The shopping center, net leased to K-Mart, had an estimated fair value of $2.3 million as of the date of acquisition and is encumbered by an existing $1.8 million first lien mortgage. The nonrecourse mortgage note accrues interest at 9.75%, calls for monthly principal and interest payments of $21,800 and matures in September 2006. The Trust included this property in \"Real Estate - Held for sale\" in the Consolidated Financial Statements.\nIn January 1993, the Trust ceased operations at the Lake Highland Apartments in Dallas, Texas due to a change in zoning of the property. The Trust was not able to operate the property as an apartment complex in the future and, therefore, has demolished the apartment buildings. The $3.9 million carrying value of the property was charged against previously established reserves. Negotiations are ongoing to sell the land and, based on the land value under current zoning, the Trust does not anticipate incurring a loss.\nIn March 1993, the Trust recorded the insubstance foreclosure of Lake Point Apartments in Memphis, Tennessee and Huntington Green Apartments in West Town, Pennsylvania. Lake Point Apartments, a 540-unit complex, had an estimated fair value of $8.3 million at the date of foreclosure. In connection with this insubstance foreclosure, the Trust recorded the $6.7 million mortgage payable secured by the property. Huntington Green Apartments, an 80-unit complex, had an estimated fair value (minus estimated costs of sale) of $1.8 million at the date of foreclosure. These foreclosures resulted in no losses to the Trust in excess of previously established reserves.\nIn 1993, the State of Wisconsin commenced eminent domain proceedings to acquire the Pepperkorn Building, located in Manitowoc, Wisconsin, for highway development. The State of Wisconsin's initial offer was $175,000, which is being appealed by the Trust. There is no assurance that the Trust's appeal will be successful or of the amount, if any, of additional compensation that it may receive. In addition, the Trust ceased making the required monthly payments on the $1.0 million note payable issued in connection with the original 1991 acquisition of the Pepperkorn Building. The matter is presently in litigation and a tentative trial date has been scheduled for June 1995. Based on the information presently available, the Trust does not anticipate incurring any losses in excess of previously established reserves.\n[This space intentionally left blank.]\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 5. INVESTMENT IN EQUITY METHOD PARTNERSHIPS\nThe Trust's investment in equity method partnerships consisted of the following:\nThe Trust, in partnership with Continental Mortgage and Equity Trust (\"CMET\"), owns SAC 9, which currently owns two office buildings in the vicinity of Sacramento, California. The Trust has a 70% interest in the partnership's earnings, losses and distributions. The SAC 9 partnership agreement requires unanimous consent of both the Trust and CMET for any material changes in the operations of the partnership's properties, including sales, refinancings and changes in property management. The Trust, as a noncontrolling partner, accounts for its investment in the partnership under the equity method. At different times during 1994, three current Trustees and three former Trustees of the Trust concurrently served as trustees of CMET.\nIn April 1993, SAC 9 sold one of its office buildings for $1.2 million. SAC 9 received $123,000 in cash, of which the Trust's equity share was $86,000, after the payoff of an existing first mortgage with a principal balance of $685,000. SAC 9 provided $356,000 of purchase money financing. The note receivable bears interest at a rate of 9% per annum, requires monthly payments of principal and interest and matures in June 1998. SAC 9 recognized a gain of $59,000 on the sale, of which the Trust's equity share was $41,000.\nIn June 1993, SAC 9 sold two other of its office buildings. One was sold for $1.3 million in cash, of which the Trust's equity share was $910,000. SAC 9 recognized a gain of $437,000 on the sale, of which the Trust's equity share was $306,000. The other office building was sold for $2.0 million. SAC 9 received $1.1 million in cash, of which the Trust's equity share was $750,000, and provided $887,000 of purchase money financing. One note receivable with a principal balance of $410,000 bore interest at a variable interest rate, required monthly interest only payments and was paid in full in September 1994. A second note receivable with a principal balance of $477,000 bore interest at 10% per annum, and all principal and accrued interest were paid in October 1993. SAC 9 recognized a gain of $720,000 on the sale, of which the Trust's equity share was $504,000.\nThe Trust and CMET are also partners in Income Special Associates (\"ISA\"), a joint venture partnership in which the Trust has a 40% interest in earnings, losses and distributions. ISA in turn owns a 100% interest in Indcon, L.P. (\"Indcon\"), formerly known as Adams Properties Associates, which owned 32 industrial warehouses at December 31, 1994. The Trust, as a noncontrolling partner, accounts for its investment in Indcon using the equity method.\nIn May 1994, Indcon sold a warehouse located in Dallas, Texas for $4.4 million in cash. Indcon received net cash of $2.2 million, of which the Trust's equity share was $871,000, after the payoff of the existing first mortgage. Indcon recognized a gain on the sale of $962,000, of which the Trust's equity share was $385,000. In connection with the sale, a brokerage commission of $26,100 was paid to Tarragon.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 5. INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)\nIn November 1992, the Trust acquired all of the general and limited partnership interests in CCP II, whose assets included a 23% limited partnership interest in English Village Partners, L.P. (\"English Village\"). English Village owns a 300 unit apartment complex located in Memphis, Tennessee. On July 1, 1993, CCP II made an additional capital contribution to English Village of $464,000 to increase its limited partnership ownership interest to 49% and to acquire a 1% general partnership interest in the partnership. The Trust continues to account for its investment in English Village under the equity method.\nSet forth below are summarized financial data for all partnerships the Trust accounts for using the equity method (unaudited):\nNOTE 6. INVESTMENTS IN MARKETABLE SECURITIES\nAt December 31, 1993, the Trust owned 54,500 shares of beneficial interest of CMET, purchased through open market transactions, at a total cost to the Trust of $250,000. In June 1994, the Trust sold 15,000 shares of beneficial interest of CMET for $210,000 and, as a result, recorded a $141,000 gain on sale of investments in the second quarter of 1994. At December 31, 1994, the market value of the remaining 39,500 shares held by the Trust was $593,000. These shares represented 1.35% of the outstanding shares of beneficial interest of CMET at such time.\n[This space intentionally left blank.]\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES, DEBENTURES AND INTEREST PAYABLE\nNotes, debentures and interest payable consisted of the following:\nNotes payable at December 31, 1994 bear interest at rates ranging from 4.2% to 19.7% and mature from 1995 through 2022. These notes payable are nonrecourse and are collateralized by deeds of trust on real estate with a carrying value of $176.4 million.\nDuring 1994, the Trust obtained first mortgage financing on seven Trust properties totaling $26.9 million, receiving net cash proceeds of $9.4 million after the payoff of $15.8 million in existing debt ($7.0 million of which matured in 1994). The remainder of the financing proceeds were used to fund escrows for replacements and repairs and to pay closing costs associated with the refinancings. In June 1993, the Trust obtained first mortgage financing secured by the Bayfront Apartments in the amount of $2.1 million, of which the Trust received net cash of $1.8 million from the financing proceeds. In connection with these financings, the Trust paid commissions of $103,000 to BCM and $83,000 to Tarragon, based upon the new $26.9 million mortgage loans.\n[This space intentionally left blank.]\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES, DEBENTURES AND INTEREST PAYABLE (Continued)\nThese transactions are illustrated in the following table:\n(a) Interest accrues at the London Interbank Offering Rate (\"LIBOR\") plus 3.25% per annum. Future payments will equal the greater of accrued interest or $33,750 per month. (b) Interest accrues at LIBOR plus 3.25% per annum. Future payments will equal the greater of accrued interest or $22,500 per month. (c) Interest accrues at LIBOR plus 3% per annum, with LIBOR capped at 9% per annum. Future payments will be interest only until July 1995 and thereafter accrued interest plus principal reduction of $6,250. (d) Interest accrues at the Bank's Base Rate, as defined in the deed of trust, plus 2% per annum. Future payments will be accrued interest plus principal reduction of $2,770 until February 1996 and thereafter accrued interest plus principal reduction of $3,075. (e) Debt service amounts represent average monthly debt service.\nScheduled principal payments on notes payable are due as follows:\nIn November 1994, the $732,000 first mortgage secured by the Sandstone Apartments, which matured in 1994, was extended to November 1996. In December 1994, the Trust modified the $3.1 million mortgage note secured by the Rancho Sorrento Business Park, which was scheduled to mature in August 1995. The modification extended the maturity by five years to August 2000 and reduced the interest rate from 10% to 9% per annum.\nAlso during 1994, the Trust paid in full the mortgages totaling $1.1 million secured by the Stewart Square Shopping Center and the Mountain View Shopping Center, both in Las Vegas, Nevada.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES, DEBENTURES AND INTEREST PAYABLE (Continued)\nIn October 1991, after determining that further investment in the Century Centre II Office Building could not be justified without a substantial modification of the mortgage debt, the property was placed in bankruptcy. A plan of reorganization (the \"Plan\") was filed with the bankruptcy court in March 1993 and the bankruptcy court confirmed the Plan in November 1993. The Plan reduced the interest rate on the $21 million first mortgage to 1.5% above LIBOR, which currently results in an interest rate of 7.6% per annum. The reduced interest rate was retroactively applied as of October 15, 1991. The Plan also extended the note's maturity from November 1993 to November 1995, with three consecutive one-year extension options.\nIn conjunction with confirmation of the Plan, in December 1993, the Trust paid the lender $1.0 million in cash for accrued and unpaid interest, 1993 property taxes and the associated closing costs. The Trust also pledged one of its properties held for sale, Stewart Square Shopping Center, as additional collateral on the first mortgage. In accordance with the terms of the Plan, the Trust has maintained a $200,000 escrow balance, held with the lender, during 1994. Additionally pursuant to the Plan, in 1993, the Trust acquired the $7.5 million second mortgage plus all accrued but unpaid interest of $1.7 million, for $300,000 cash. As a result, the Trust recognized an extraordinary gain of $8.9 million in connection with the debt modification and discounted debt purchase.\nIn 1992, the Trust acquired all of the general and limited partnership interest in Consolidated Capital Properties II (\"CCP II\") for $2.6 million. CCP II's assets included cash of $1.6 million, four apartment complexes, a partnership interest, a note receivable participation and a note receivable. In December 1993, the Trust issued Mr. John A. Doyle, Executive Vice President of the Trust, a $1.0 million convertible subordinated debenture, in exchange for the participation interest held, as consideration for his services to the Trust in connection with the acquisition of the CCP II portfolio. This debenture bears interest at a rate of 6% per annum, matures in December 1999 and is convertible into 84,615 Shares.\nNOTE 8. DISTRIBUTIONS\nThe Trust's Board of Trustees voted at their July 1993 meeting to resume the payment of regular quarterly distributions. The first quarterly distribution of $.10 per Share and a 10% share dividend was paid on September 1, 1993 to shareholders of record on August 16, 1993. On December 21, 1993, the Trust paid a distribution of $.10 per Share to shareholders of record on December 6, 1993.\nOn August 17, 1994, the Trust's Board of Trustees approved the payment of a 10% share dividend, which was paid September 21, 1994 to shareholders of record on September 1, 1994. As a result of the share dividend, an additional 282,151 shares were issued. The Trust also paid cash distributions during 1994 totaling $2.2 million or $0.67 per share.\nNo distributions were declared or paid in 1992.\nThe Trust reported to the Internal Revenue Service that 100% of the distribution paid in 1993 was taxable to Trust shareholders as ordinary income and 100% of the 1994 distribution represented a return of capital.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 9. ADVISORY AGREEMENT\nAlthough the Trust's Board of Trustees is directly responsible for managing the affairs of the Trust and for setting the policies which guide it, the day-to-day operations of the Trust are performed by a contractual advisory firm under the supervision of the Trust's Board of Trustees. 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 Trust. The advisor also serves as a consultant in connection with the business plan and investment policy decisions made by the Trust's Board of Trustees.\nOn February 10, 1994, the Trust's Board of Trustees selected Tarragon to replace BCM as the Trust's advisor. Since April 1, 1994, Tarragon has provided advisory services to the Trust under an advisory agreement. Mr. Friedman, President, Chief Executive Officer and Trustee of the Trust, serves as a Director and Chief Executive Officer of Tarragon. Tarragon is owned by Lucy N. Friedman, Mr. Friedman's wife, and Mr. Doyle, who serves as a Director, President and Chief Operating Officer of Tarragon and Executive Vice President of the Trust. The Friedman and Doyle families together own approximately 32% of the outstanding shares of the Trust.\nBasic Capital Management (\"BCM\") served as the Trust's advisor from March 1989 to March 31, 1994. Mr. Friedman was President of BCM until May 1, 1993. BCM is beneficially owned by a trust for the benefit of the children of Mr. Gene Phillips, who served as a Trustee of the Trust until December 31, 1992. BCM resigned as advisor to the Trust effective March 31, 1994.\nThe provisions of the Trust's Advisory Agreement with Tarragon are substantially the same as those of the BCM advisory agreement except for the annual base advisory fee and the elimination of the net income fee. The Tarragon advisory agreement calls for an annual base advisory fee of $100,000 plus an incentive advisory fee equal to 16% of the Trust's adjusted funds from operations before deduction of the advisory fee. Adjusted funds from operations is defined as net income (loss) before gains or losses from the sales of properties and debt restructurings, plus depreciation and amortization, plus any loss due to the write-down or sale of any real property or mortgage loan acquired prior to January 1, 1989. Tarragon receives commissions of 1% based upon (i) acquisition cost of real estate, (ii) mortgage loans acquired, and (iii) mortgage loans obtained or refinanced. Tarragon is also entitled to receive an incentive fee equal to 10% of the amount, if any, by which sales consideration exceeds a defined amount.\nAlso under the advisory agreement, Tarragon is to receive reimbursement of certain expenses incurred by it in the performance of the advisory services to the Trust. Under the advisory agreement (as required by the Trust's Declaration of Trust), all or a portion of the annual advisory fee must be refunded by the advisor to the Trust if the Operating Expenses of the Trust (as defined in the Trust's Declaration of Trust) exceeds certain limits specified in the Declaration of Trust based on the book value, net asset value and net income of the Trust during such fiscal year.\nFor additional information on compensation paid to Tarragon, see ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\".\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 10. PROPERTY MANAGEMENT\nSince April 1, 1994, Tarragon has provided property management services to the Trust for a fee of 4.5% of the monthly gross rents collected on apartment properties and of 1.5% to 4% of the monthly gross rents collected on commercial properties. Tarragon subcontracts with other entities for the provision of much of the property-level management services for the Trust.\nFrom February 1, 1990 through March 31, 1994, affiliates of BCM provided, under contracts approved by the Trust's Board of Trustees, property management services to the Trust for a fee of 5% or less of the monthly gross rents collected on the properties under management. Carmel, Ltd. provided such property management services. In many cases, Carmel, Ltd. subcontracted with other entities for the provision of some of the property-level management services to the Trust at various rates (generally 4%). 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. subcontracted the property-level management and leasing of several of the Trust's commercial properties to Carmel Realty, Inc. which is owned by SWI.\nNOTE 11. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.\nFees and cost reimbursements to Tarragon and BCM are as follows:\n* Net of property management fees paid to subcontractors.\nNOTE 12. INCOME TAXES\nFor the years 1994, 1993 and 1992, the Trust has elected and qualified to be treated as a Real Estate Investment Trust (\"REIT\"), as defined in Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"), and as such, will not be taxed for federal income tax purposes on that portion of its taxable income which is distributed to shareholders, provided that at least 95% of its REIT taxable income, plus 95% of its taxable income from foreclosure property as defined in Section 857 of the Code, is distributed. See NOTE 8. \"DISTRIBUTIONS.\"\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 12. INCOME TAXES (Continued)\nThe Trust had a net loss for federal income tax purposes in 1994, 1993 and 1992; therefore, the Trust recorded no provision for income taxes.\nThe Trust's tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties and investments in joint venture partnerships. At December 31, 1994, the Trust's tax basis in its net assets exceeded its basis for financial statement purposes by $55.3 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes, and the Trust will be able to maintain its REIT status without distributing 95% of its financial statement income. Additionally, at December 31, 1994, the Trust had a tax net operating loss carryforward of $42 million expiring through 2007.\nAs a result of the Trust's election to be treated as a REIT for income tax purposes and of its intention to distribute its taxable income, no deferred tax asset, liability or valuation allowance was recorded.\nNOTE 13. RENTALS UNDER OPERATING LEASES\nThe Trust's rental operations include the leasing of office buildings and shopping centers. The leases thereon expire at various dates through 2005. The following is a schedule of minimum future rentals on non-cancelable operating leases as of December 31, 1994:\nNOTE 14. EXTRAORDINARY GAIN\nIn 1993, the Trust acquired the $7.5 million second mortgage secured by its Century Center II Office Building for $300,000. In addition, the first lien holder retroactively reduced the interest rate on the debt owed by the Trust. The Trust recognized an extraordinary gain of $8.9 million in connection with the debt modification and discounted debt purchase. See NOTE 7. \"NOTES, DEBENTURES AND INTEREST PAYABLE.\"\nNOTE 15. COMMITMENTS AND CONTINGENCIES\nOlive Litigation. In February 1990, the Trust, together with CMET, Income Opportunity Realty Trust (\"IORT\") and Transcontinental Realty Investors, Inc. (\"TCI\"), three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Trust, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., relating to the operation and management of each of the entities. On April 23, 1990, the court granted final approval of the terms of the original settlement.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)\nOn May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\"), which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994 and final court approval was entered on December 12, 1994. The effective date of the Modification is January 11, 1995.\nThe Modification, among other things, provided for the addition of at least three new unaffiliated members to the Trust's Board of Trustees and set forth new requirements for the approval of any transactions with affiliates over the next five years. In accordance with the procedures set forth in the Modification, Irving E. Cohen, Lance Liebman, Sally Hernandez-Pinero and L. G. Schafran have been appointed to the Board. In addition, BCM, Gene E. Phillips and William S. Friedman have agreed to pay a total of $1.2 million to the Trust, CMET, IORT and TCI, of which the Trust's share is $150,000.\nUnder the Modification, the Trust, CMET, IORT, TCI and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust, CMET, IORT and TCI also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Trust held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all current Board members that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new Board members appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.\nThe Modification also terminated a number of the provisions of the Stipulation of Settlement, including the requirement that the Trust, CMET, IORT and TCI maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court will retain jurisdiction to enforce the Modification.\nOther litigation. The Trust is also involved in various lawsuits arising in the ordinary course of business. The Trust's management is of the opinion that the outcome of these lawsuits would have no material impact on the Trust's financial condition.\nNOTE 16. SUBSEQUENT EVENTS\nIn January 1995, the Trust agreed to a modification of the terms of a $1.5 million first mortgage note receivable, secured by 4.5 acres of land (subject to a ground lease) in Dallas, Texas. The Trust released part of the land securing the loan, approximately a 15,000 square foot parcel, and in exchange the ground lease was terminated. In addition, the interest rate was increased to 18% per annum and the maturity date was shortened 20 months to January 1996.\nAlso in January 1995, the Trust obtained first mortgage financing on both the Cross Creek Apartments in Lexington, Kentucky and the Woodcreek Apartments in Jacksonville, Florida. The Trust received aggregate net refinancing proceeds of $1.8 million after the payoff of $3.6 million in existing debt. The remaining refinancing proceeds were used to fund escrows for replacements and repairs and to pay closing costs associated with the refinancings. The Trust paid Tarragon mortgage brokerage and equity refinancing fees of $58,000 related to these refinancings, as more fully described below.\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 16. SUBSEQUENT EVENTS (Continued)\nCross Creek Apartments secures a $2.0 million nonrecourse mortgage loan which bears interest at 9.8% per annum, calls for monthly principal and interest payments of $17,850 and matures in February 2000. Woodcreek Apartments secures a $3.8 million nonrecourse mortgage loan that bears interest at 9.7% per annum, calls for monthly principal and interest payments of $33,810 and matures in February 2005.\nIn February 1995, the Trust purchased the Park Side Apartments, a 39-unit apartment complex in Los Angeles, California for $376,000 in cash. In connection with acquisition, the Trust paid Tarragon a real estate commission of $3,750.\nIn January and February 1995, the Trust sold the remaining 39,500 shares of beneficial interest of CMET for $593,000 and recorded a gain on sale of investments of $411,200.\nNOTE 17. QUARTERLY RESULTS OF OPERATIONS\nThe following is a tabulation of the quarterly results of operations for the years ended December 31, 1994 and 1993 (unaudited):\nNATIONAL INCOME REALTY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 17. QUARTERLY RESULTS OF OPERATIONS (Continued)\nFourth quarter results include a charge against earnings of $1.4 million to provide for estimated losses on one of the Trust's properties held for sale and one of the Trust's first lien notes receivable. In addition, $1.0 million was charged to operations in the fourth quarter in connection with the issuance of a $1.0 million convertible subordinated debenture in exchange for the buyout of the CCP II profit participation. See NOTE 7. \"NOTES, DEBENTURES AND INTEREST PAYABLE.\"\n[This space intentionally left blank.]\nSCHEDULE III NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1994\nSCHEDULE III (Continued) NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1994\nSCHEDULE III (Continued) NATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1994\n[This space intentionally left blank.]\nSCHEDULE III (Continued)\nNATIONAL INCOME REALTY TRUST REAL ESTATE ACCUMULATED DEPRECIATION DECEMBER 31, 1994\n___________________________ (1) The aggregate cost for federal income tax purposes is $217,348. (2) Basis charged against reserve previously provided. (3) Represents property improvements and write-down of properties to estimated net realizable value.\nSCHEDULE III (Continued)\nNATIONAL INCOME REALTY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION\nSCHEDULE IV NATIONAL INCOME REALTY TRUST MORTGAGE LOANS ON REAL ESTATE December 31, 1994\nSCHEDULE IV (Continued) NATIONAL INCOME REALTY TRUST MORTGAGE LOANS ON REAL ESTATE December 31, 1994\n_______________________ (1) The aggregate cost for federal income tax purposes is $16,420.\nSCHEDULE IV (Continued)\nNATIONAL INCOME REALTY TRUST MORTGAGE LOANS ON REAL ESTATE\n(1) Note receivable carrying value in excess of sales price. Remaining amount reclassed to other assets.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nAs previously reported on Form 8-K filed May 26, 1994, and amended by Form 8-K\/A on June 3, 1994, on May 19, 1994, the Trust's Board of Trustees selected Arthur Andersen LLP to serve the Trust as its independent accountant to audit the Trust's financial statements for the year ended December 31, 1994. BDO Seidman served as the independent accountant previously engaged as the principal accountant to audit the financial statements of the Trust for the year ended December 31, 1993. The failure of the Board of Trustees to select BDO Seidman as the Trust's independent accountant to audit the financial statements for the year ending December 31, 1994 constituted BDO Seidman being \"dismissed\" (as such term is used in Item 304 of Regulation S-K).\nBDO Seidman's report on the Trust's financial statements for the year ended December 31, 1993 did not contain any adverse opinion or disclaimer of opinion and was not qualified or modified as to uncertainty, audit scope, or accounting principles. During the year BDO Seidman served as independent accountants to audit the financial statements of the Trust for the year ended December 31, 1993, and thereafter through the date hereof, the Trust has not had any disagreement with BDO Seidman on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure which disagreement, if not resolved to the satisfaction of BDO Seidman, would have caused BDO Seidman to make reference to the subject matter of the disagreement in connection with its report.\n______________________________________\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT\nTrustees\nThe affairs of National Income Realty Trust (the \"Trust\" or the \"Registrant\") are managed by an 8-member Board of Trustees. The Trustees are elected at the annual meeting of shareholders or appointed by the incumbent Board of Trustees and serve until the next annual meeting of shareholders or until a successor has been elected or approved.\nOn May 4, 1994, the Trust, together with CMET, IORT and TCI, entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\"), which settled subsequent claims of breaches of the settlement which were asserted by plaintiffs and modified certain provisions of a 1990 settlement of the action styled Olive, et al v. National Income Realty Trust, et al (the \"Olive Case\"). The original settlement, approved April 23, 1990 by the Court, related to the operation and management of each of the entities. The Modification was preliminarily approved by the court on July 1, 1994 and final court approval was entered on December 12, 1994. The effective date of the Modification is January 11, 1995.\nThe Modification, among other things, provided for the resignation of certain Trustees, the addition of at least three new, unaffiliated members to be appointed to the Trust's Board of Trustees, and set forth new requirements for approval of any transactions with affiliates over the next five years. Under the Modification, the Trust, the other entities, and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust and other entities also agreed to waive any demand requirement for plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nTrustees (Continued)\nthat any shares of the Trust held by Mr. Friedman or his affiliates shall be voted (i) in favor of the re-election of all current Board members that stand for re-election during the two calendar years following January 11, 1995, the effective date of the Modification, and (ii) in favor of all new Board members appointed pursuant to the terms of the Modification that stand for re-election during the three calendar years following January 11, 1995. The Modification also terminated a number of provisions of the original Stipulation of Settlement, including the requirement that the Trust or the other entities maintain a Related Party Transaction Committee and a Litigation Committee of the Board (see \"Board Committees\" below).\nIn anticipation of the effectiveness of the Modification, the Trust did not hold an Annual Meeting of Shareholders in 1994. John A. Doyle (a Trustee since February 1994) resigned as a Trustee in April 1994, Ted. P. Stokely (a Trustee since April 1990) resigned as a Trustee in August 1994, A. Bob Jordan (a Trustee since October 1992) resigned as a Trustee in June 1994, Bennett B. Sims (a Trustee since April 1990) resigned as a Trustee in August 1994, Willie K. Davis (a Trustee since October 1988) retired as a Trustee in March 1995, and Geoffrey C. Etnire (a Trustee since January 1993) ceased to be a Trustee in March 1995. Carl B. Weisbrod (a Trustee since February 1994) was elected Chairman of the Board on March 9, 1995, to replace William S. Friedman, who remains as President, Chief Executive Officer and Trustee of the Trust. During the period from May 1994 to March 1995, the Board appointed four new, independent Trustees to replace a number of those who resigned and the number of members of the Board of Trustees was decreased from ten at December 31, 1993, to eight at March 31, 1995. Independent Trustees appointed are Irving E. Cohen (June 1994), Lance Liebman (March 1995), Sally Hernandez-Pinero (May 1994), and L. G. Schafran (March 1995). Messrs. Friedman, Johnston, Schrag and Weisbrod have continued as Trustees.\nThe Trustees of the Trust are listed below, together with their ages, terms of service, all positions and offices with the Trust, Tarragon or BCM, their principal occupations, business experience and directorships with other companies during the last five years or more. The designation \"Affiliated\", when used below with respect to a Trustee, means that the Trustee is an officer, director or employee of Tarragon or an officer or employee of the Trust. The designation \"Independent\", when used below with respect to a Trustee, means that the Trustee is neither an officer or employee of the Trust nor a director, officer or employee of Tarragon, although the Trust may have certain business or professional relationships with such Trustee as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships.\"\nIRVING E. COHEN: Age 48, Trustee (Independent) (since June 1994).\nManaging Director, CPR Group, a real estate consulting company (since 1994); Managing Partner, Fuller Corporate Realty Partners (from 1990 to 1994); Director of Real Estate Consulting Services, Price Waterhouse (from 1989 to 1990); Special Advisor (from 1988 to 1989) and Trustee (from 1985 to 1989), Mellon Participating Mortgage Trust; and Executive Vice President, E.F. Hutton Properties, Inc. (from 1983 to 1987).\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nTrustees (Continued)\nWILLIAM S. FRIEDMAN: Age 51, Trustee (Affiliated).\nTrustee (since March 1988), Chief Executive Officer (since December 1993), President (since December 1988), Acting Chief Financial Officer (May 1990 to February 1991), Treasurer (August to September 1989) and Acting Principal Financial and Accounting Officer (December 1988 to August 1989) of the Trust and VPT; Trustee or Director (March 1988 to February 1994), Chief Executive Officer (December 1993 to February 1994), President (December 1988 to February 1994), Acting Chief Financial Officer (May 1990 to February 1991), Treasurer (August to September 1989) and Acting Principal Accounting Officer (December 1988 to August 1989) of CMET, IORT and TCI; Director and Chief Executive Officer (since December 1990) of Tarragon; President (February 1989 to March 1993) and Director (February to December 1989) of BCM; General Partner (1987 to March 1994) of Syntek Asset Management, L.P. (\"SAMLP\"), which is the General Partner of National Realty, L.P. (\"NRLP\") and National Operating, L.P. (\"NOLP\"); Director and President (March 1989 to February 1994)) and Secretary (March 1989 to December 1990) of Syntek Asset Management, Inc. (\"SAMI\"), the Managing General Partner of SAMLP and a corporation owned by BCM; President (1982 to October 1990) of Syntek Investment Properties, Inc. (\"SIPI\"), which has invested in, developed and syndicated real estate through its subsidiaries and other related entities since 1973; Director and President (1982 to October 1990) of Syntek West, Inc. (\"SWI\"); Vice President (1984 to October 1990) of Syntek Finance Corporation; Director (1981 to December 1992), President (July 1991 to December 1992), Vice President and Treasurer (January 1987 to July 1991) and Acting Chief Financial Officer (May 1990 to February 1991) of American Realty Trust, Inc. (\"ART\"); practicing Attorney (since 1971); Director and Treasurer (November 1989 to February 1991) of Carmel Realty Services, Inc. (\"CRSI\"); Limited Partner (January 1991 to December 1992) of Carmel Realty Services, Ltd. (\"Carmel, Ltd.\").\nSALLY HERNANDEZ-PINERO: Age 42, Trustee (Independent) (since May 1994).\nOf Counsel, Kalkines, Arky, Zall and Bernstein (since October 1994); Chairwoman (February 1992 to April 1994) New York City Housing Authority; Deputy Mayor (January 1990 to February 1992) for Finance and Economic Development, City of New York; Commissioner\/Chairwoman of the Board of Directors (February 1988 to December 1989) Financial Services Corporation of New York City; Member of the Board of Directors (since July 1994) of Consolidated Edison; Member of the Board of Directors (since April 1994) of Dime Savings Bank; Attorney at Law (since 1978).\nDAN L. JOHNSTON: Age 56, Trustee (Independent) (April 1990 to June 1990 and since February 1991).\nPartner in Johnston, Kaplan and Lombardi (since 1995); Attorney in solo practice, New York, New York (since 1991); Director (since 1992) of the Complex Drug Investigation and Prosecution Project for the Jefferson Institute for Justice Studies; Chief Counsel, Subcommittee on Criminal Justice, U.S. House of Representatives (June 1990 to January 1991); Executive Director (1986 to 1990) of Prosecuting Attorneys' Research Council, a nationwide organization of metropolitan prosecutors which acts to further research to improve the prosecutorial function; Consultant (February 1985 to June 1990) to the Edna McConnell Clark Foundation, which supports efforts of District Attorneys to reduce jail and prison overcrowding; Member (October 1987 to June 1990) of the Civilian Complaint Review\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nTrustees (Continued)\nBoard of the New York City Police Department; Director or Trustee (April 1990 to June 1990 and from February 1991 to January 1995) of CMET, IORT and TCI; and Trustee (since December 1992) of VPT.\nLANCE LIEBMAN: Age 53, Trustee (Independent) (since March 1995).\nDean and Lucy G. Moses Professor of Law (since 1991) Columbia Law School, New York City; Professor of Law (1976 to 1991) and Associate Dean (1981 to 1984) Harvard Law School; Lecturer on Law (1990) Tokyo University Law Faculty, Japan; Director, Greater New York Insurance Co. (both mutual and stock companies) (since 1991); Attorney at Law (since 1967).\nL. G. SCHAFRAN: Age 56, Trustee (Independent) (since March 1995).\nDirector (since 1993), Chairman of the Executive Committee, The Dart Group (inclusive of the Dart Group Corporation, Truck Auto Corporation and Crown Brooks Corporation) (since 1995); Managing General Partner (since 1984) L.G. Schafran & Associates, a real estate investment and development firm in New York City; Director, Publicker Industries (since 1986) NYSE; Capsule Holdings Corp. (since 1986) NYSE; Oxigene, Inc. (since 1993) OTC; and Director (since 1993) Glasstech, OTC.\nRAYMOND V.J. SCHRAG: Age 49, Trustee (Independent) (since October 1988).\nAttorney, New York, New York (since 1975); Trustee (1986 to December 1989) of Hidden Strength Mutual Funds; Trustee (since October 1988) of VPT; and Director or Trustee (from October 1988 to August 1994) of CMET, IORT and TCI.\nCARL B. WEISBROD: Age 50, Trustee (Independent) (since February 1994).\nPresident, Alliance for Downtown New York, Inc. (since 1994); Trustee (since February 1994) of VPT; President and Chief Executive Officer (April 1990 to 1994) of New York City Economic Development Corporation; President (May 1987 to April 1990) of 42nd Street Development Project, Inc., a subsidiary of the New York State Urban Development Corporation; Executive Director (March 1986 to May 1987) of Department of City Planning of the City of New York; and Executive Director (July 1984 to March 1986) of City Volunteer Corps of the City of New York.\nLitigation and Claims Involving Mr. Friedman Related to Southmark Corporation\nUntil January 1989, William S. Friedman, the President, Chief Executive Officer and a Trustee of the Trust, was an executive officer and director of Southmark Corporation (\"Southmark\"), serving as Vice Chairman of the Board (since 1982), Director (since 1980) and Secretary (since 1984) of Southmark. As a result of a deadlock on Southmark's Board of Directors, Mr. Friedman and Gene E. Phillips (who served as Trustee of the Trust until December 31, 1992) reached a series of related agreements (later modified) with Southmark on January 17, 1989 (collectively, the \"Separation Agreement\"), whereby Messrs. Friedman and Phillips resigned their position with Southmark and certain of Southmark's subsidiaries and affiliates. Southmark filed a voluntary petition in bankruptcy under Chapter 11 of the United States Bankruptcy Code on July 14, 1989. Subsequent to the filing\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nTrustees (Continued)\nof the Southmark bankruptcy, several lawsuits were filed against Southmark, its former officers and directors (including Mr. Friedman) and others, alleging, among other things, that such persons and entities misrepresented the financial condition of Southmark. Mr. Friedman denied all of such allegations. Those lawsuits in which Mr. Friedman was also a defendant were settled or dismissed in 1993. The Trust was not a defendant in any of such lawsuits.\nSan Jacinto Savings Association. On November 30, 1990, San Jacinto Savings Association (\"SJSA\"), a savings institution that had been owned by Southmark since 1983, was placed under conservatorship of the Resolution Trust Corporation (\"RTC\") by federal banking authorities. The Office of Thrift Supervision (\"OTS\") also conducted a formal investigation of SJSA and its affilitates. During late November 1994, Mr. Friedman entered into certain agreements with the RTC and OTS settling all claims relating to his involvement with SJSA. Pursuant to such arrangements, Mr. Friedman and certain other respondents (including Mr. Phillips) agreed to pay restitution in the amount of $20 million. Mr. Friedman consented to an order prohibiting him from participating in the conduct of the affairs of an insured depository institution without the prior written approval of the Director of OTS, and agreed to submit certain information to the OTS on a periodic basis. Such arrangements constitute an order limiting Mr. Friedman from engaging in a type of business practice.\nBoard Committees\nThe Trust's Board of Trustees held eight meetings and acted by written consent four times during 1994. For such year, no incumbent Trustee attended fewer than 75% of the aggregate of (i) the total number of meetings held by the Board of Trustees during the period for which he had been a Trustee and (ii) the total number of meetings held by all committees of the Board of Trustees on which he served during the periods that he served.\nThe Trust's Board of Trustees has an Audit Committee, the function of which is to review the Trust's operating and accounting procedures. The current members of the Audit Committee, all of whom are Independent Trustees, are Messrs. Schrag (Chairman), Johnston and Weisbrod. The Audit Committee met one time during 1994.\nIn March 1995, the Board established a permanent Advisory Review Committee to monitor actions taken by the Advisor which have the potential for a conflict of interest, in particular, decisions relating to the allocation of investment opportunities between the Trust and other entities affiliated with the Advisor. The Committee consists of Mr. Weisbrod (Chairman), Ms. Hernandez-Pinero and Mr. Cohen.\nUntil February 1995, the Trust's Board of Trustees had a Related Party Transaction Committee, which reviewed and made recommendations to the Board of Trustees with respect to transactions involving the Trust and any other party or parties related to or affiliated with the Trust, any of its Trustees or any of their affiliates, and a Litigation Committee, which reviewed litigation involving Messrs. Friedman and Phillips. Such committees were disbanded in February 1995, and their responsibilities assumed by the Independent Trustees. Messrs. Johnston (Chairman), Davis, Etnire, Schrag, Sims and Stokely, all of whom were Independent Trustees, were the members of the Related Party Transaction Committee, while Messrs. Johnston (Chairman), Etnire, Jordan, Schrag, Sims and Stokely comprised the Litigation Committee. During 1994, the Related Party Transaction Committee met three times and the Litigation Committee met three times.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nBoard Committees (Continued)\nThe Trust's Board of Trustees does not have Nominating or Compensation Committees.\nExecutive Officers\nThe following persons currently serve as executive officers of the Trust: William S. Friedman, President and Chief Executive Officer; John A. Doyle, Executive Vice President; and Ivan Roth, Treasurer and Chief Financial Officer. Their positions with the Trust are not subject to a vote of shareholders. The age, terms of service, all positions and offices with the Trust, Tarragon or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more of Mr. Friedman is set forth above. Corresponding information regarding Messrs. Doyle and Roth is set forth below.\nJOHN A. DOYLE: Age 37, Executive Vice President (since February 1994)\nExecutive Vice President and Trustee (since February 1994) of VPT; Director, President, Chief Operating Officer and 50% shareholder (since February 1994) of Tarragon; President and Chairman of the Board (since December 1993) of Investors General Acquisition Corp., which owns 100% of the shares of Investor General, Inc.; Director, President and Chief Executive Officer (since June 1992) of Garden Capital Incorporated; Director and Chief Operating Officer (October 1990 to December 1991) of ConCap Equities, Inc.; President, Chief Executive Officer, Chief Operating Officer and sole Director (April 1989 to October 1990) of Consolidated Capital Equities Corporation (\"CCEC\"); and Certified Public Accountant (since 1985).\nIVAN ROTH: Age 59, Treasurer and Chief Financial Officer (since February 1994).\nTreasurer and Chief Financial Officer (since February 1994) of VPT; Treasurer (from February 1994 to November 1994) of Tarragon; Treasurer (since February 1994) of Tarragon Capital Corporation; Treasurer and Chief Financial Officer (1978 to 1992) of Servico, Inc.; Financial Controller (1970 to 1978) of New York Motel Enterprises, Inc.; General Manager (1968 to 1970) of Affiliated Financial Corporation; and Certified Public Accountant (since 1968).\nOn September 19, 1990, Servico, Inc. filed a voluntary petition under Chapter 11 of the United States Bankruptcy Code and was reorganized effective August 5, 1992.\nOfficers\nAlthough not executive officers of the Trust, the following persons currently serve as officers of the Trust: John C. Stricklin, Senior Vice President - Real Estate; Chris Clinton - Senior Vice President; Todd Minor - Senior Vice President; Katie Jackson - Vice President and Chief Accounting Officer; and Mary Montagnino, Secretary. Their positions with the Trust are not subject to a vote of shareholders. Their ages, terms of services, all positions and offices with the Trust, Tarragon or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below:\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nOfficers (Continued)\nJOHN C. STRICKLIN: Age 48, Senior Vice President - Real Estate (since May 1994).\nVice President - Real Estate (from February 1994 to April 1994) of the Trust; Vice President - Real Estate (since January 1994) of VPT; Executive Vice President (since February 1994) of Tarragon; Vice President (June 1992 to January 1994) of Carmel Realty, Inc.; Real Estate Broker (June 1989 to May 1992) with Carmel, Ltd.; Executive Vice President (June 1980 to May 1989) of Windsor Financial Corporation; and Vice President (June 1975 to June 1980) of Syntek Corporation.\nCHRIS W. CLINTON: Age 47, Senior Vice President - Commercial Asset Management (since March 1994).\nSenior Vice President - Commercial Asset Management (since March 1994) of VPT; Senior Vice President (since March 1994) of Tarragon; Vice President (October 1988 to March 1994) of the Trust, ART, CMET, IORT, TCI, VPT and BCM.\nTODD C. MINOR: Age 36, Senior Vice President - Finance (since March 1994 and from July 1993 to January 1994).\nSenior Vice President - Finance (since March 1994 and from July 1993 to January 1994) of VPT; Senior Vice President (since March 1994) of Tarragon; Senior Vice President - Finance (from July 1993 to March 1994) of BCM, ART, CMET, IORT and TCI; Vice President (from January 1989 to July 1993) of BCM and (from April 1991 to July 1993) of the Trust, ART, CMET, IORT, TCI and VPT.\nKATIE JACKSON: Age 33, Vice President and Chief Accounting Officer (since March 1994).\nVice President and Chief Accounting Officer (since March 1994) of VPT and Tarragon; Accounting Manager for BCM (October 1990 to March 1994); Financial Analyst of DSC Communications Corp. (August 1987 to October 1990); Certified Public Accountant (since 1988).\nMARY E. MONTAGNINO: Age 36, Secretary (since February 1994).\nSecretary (since February 1994) of VPT; Secretary and Paralegal (since February 1994) of Tarragon; Paralegal (1989 to February 1994) of BCM.\nIn addition to the foregoing officers, the Trust has other officers who are not listed herein.\nCompliance with Section 16(a) of the Securities and Exchange Act of 1934\nUnder the securities laws of the United States, the Trust's Trustees, executive officers, and any persons holding more than ten percent of the Trust's shares of beneficial interest are required to report their ownership of the Trust'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 Trust is required to report any failure to file by these dates during fiscal 1994. All of these filing requirements, except as noted below, were satisfied by its Trustees and executive officers and ten percent holders. In making these statements, the\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nTrust has relied on the written representations of its incumbent Trustees and executive officers and its ten percent holders and copies of the reports that they have filed with the Commission. The following reports filed under Section 16(a) of the Securities Exchange Act of 1934 during or with respect to the fiscal year ended December 31, 1994, were not filed on a timely basis: Initial Forms 3 of John A. Doyle, Ivan Roth, John C. Stricklin, Chris W. Clinton and Katie Jackson.\nThe Advisor\nAlthough the Trust's Board of Trustees is directly responsible for managing the affairs of the Trust and for setting the policies which guide it, the day-to-day operations of the Trust have traditionally been performed by a contractual advisory firm under the supervision of the Trust's Board of Trustees. The stated 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 Trust. The advisor also serves as a consultant in connection with the business plan and investment policy decisions made by the Trust's Board of Trustees.\nCCEC was the sponsor of and original advisor of the Trust. CCEC was replaced as advisor on August 1, 1988, by Consolidated Advisors, Inc. (\"CAI\"), the parent of CCEC. On December 2, 1988, CCEC filed a petition seeking reorganization under Chapter 11 of the United States Bankruptcy Code in the United States District Court for the Northern District of Texas. Mr. Friedman was a director of CCEC and CAI from March 1988 through January 1989. Mr. Doyle was President, Chief Executive Officer, Chief Operating Officer and sole director of CCEC from 1989 through October 1990. Southmark was a controlling shareholder of The Consolidated Companies, the parent of CAI, from March 1988 through February 1989.\nBCM served as the Trust's advisor from March 1989 through March 1994. Mr. Friedman served as President of BCM until May 1, 1993. BCM is beneficially owned by a trust for the benefit of the children of Mr. Phillips, who served as a Trustee of the Trust until December 31, 1992. At the Trust's annual meeting of shareholders held on April 26, 1993, the Trust's shareholders approved the renewal of the Trust's Advisory Agreement with BCM. BCM resigned as advisor to the Trust effective March 31, 1994.\nBCM also serves as advisor to CMET, IORT and TCI. Certain Trustees of the Trust were also Trustees of CMET, IORT and TCI, but have since resigned their positions. BCM served as advisor to VPT until February 28, 1994. Several of the Trustees of the Trust are also directors or trustees of VPT. Mr. Friedman, President of the Trust, also serves as President of VPT. Mr. Friedman was general partner of the general partner of NRLP. BCM performs certain administrative functions for NRLP and NOLP, the operating partnership of NRLP, on a cost-reimbursement basis. BCM also serves as advisor to ART. Messrs. Friedman and Phillips served as executive officers and directors of ART until November 6, 1992 and December 31, 1992, respectively. Mr. Friedman resigned from his positions with CMET, IORT and TCI in February 1994 and from his position with NRLP in March 1994 to concentrate his attention on the Trust, VPT and Tarragon.\nOn February 10, 1994, the Trust's Board of Trustees selected Tarragon to replace BCM as the Trust's advisor. Since April 1, 1994, Tarragon has provided advisory services to the Trust under an advisory agreement. Mr. Friedman serves as a Director and Chief Executive Officer of Tarragon. Tarragon is owned by Lucy N. Friedman, Mr. Friedman's wife, and Mr. Doyle, who serves as a Director, President and Chief Operating Officer of Tarragon and Executive Vice President of the Trust. The Friedman and Doyle families together own approximately 32% of the outstanding shares of the Trust.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nThe provisions of the Trust's Advisory Agreement with Tarragon are substantially the same to those of the BCM advisory agreement, except for the annual base advisory fee and the elimination of the net income fee. The BCM advisory agreement provided for BCM to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Trust (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Trust's net income.\nThe advisory agreement with Tarragon provides for a base advisory fee of $100,000, which was paid upon the execution of the Advisory Agreement on April 1, 1994. Tarragon is also to receive an incentive advisory fee equal to 16% per annum of the Trust's adjusted funds from operations before deduction of the advisory fee. Adjusted funds from operations is defined as net income (loss) before gains or losses from the sales of properties and debt restructurings plus depreciation and amortization plus any loss due to the write-down or sale of any real property or mortgage loan acquired prior to January 1, 1989. The incentive fee is cumulative within any fiscal year to maintain the 16% per annum rate.\nThe following provisions are included in both the Tarragon and BCM advisory agreements:\n(1) the advisor or an affiliate of the advisor is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Trust equal to the lesser of (i) up to 1% of the cost of acquisition, inclusive of commissions, if any, paid to non-affiliated brokers or (ii) the compensation customarily charged in arm's-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property; provided that the purchase price of each property (including acquisition commissions and all real estate brokerage fees) may not exceed such property's appraised value at acquisition.\n(2) the advisor is to receive an incentive sales compensation equal to 10% of the amount, if any, by which the aggregate sales consideration for all real estate sold by the Trust during such fiscal year exceeds the sum of (i) the cost of each such property as originally recorded in the Trust's books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (ii) capital improvements made to such assets during the period owned by the Trust and (iii) all closing costs (including real estate commissions) incurred in the sale of such property. However, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8% simple annual return of the Trust's net investment including capital improvements, calculated over the Trust's holding period before depreciation and inclusive of operating income and sales consideration and (b) the aggregate net operating income from all real estate owned by the Trust for each of the prior and current fiscal years shall be at least 5% higher in the current fiscal year than in the prior fiscal year.\n(3) the advisor or an affiliate of the advisor is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase from an unaffiliated party of an existing mortgage or loan by the Trust equal to the lesser of (i) 1% of the amount of the mortgage or loan purchased or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding by the Trust of any mortgage loan.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\n(4) the advisor or an affiliate of the advisor is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Trust or refinancing on Trust properties equal to the lesser of (i) 1% of the amount of the loan or the amount refinanced or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from the Advisor or an Affiliate of the Advisor without the approval of the Trust's Board of Trustees. No fee shall be paid on loan extensions.\n(5) the advisor or any affiliate of the advisor must pay to the Trust one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Trust, provided, however, that the compensation retained by the advisor or any affiliate of the advisor shall not exceed the lesser of (i) 2% of the amount of the loan committed by the Trust or (ii) a loan brokerage commitment fee which is reasonable and fair under the circumstances.\n(6) the advisor is required to formulate and submit annually for approval by the Trust's Board of Trustees a budget and business plan for the Trust containing a twelve-month forecast of operations and cash flow, a general plan for asset sales or acquisitions, lending, foreclosure and borrowing activity, and other investments, and the advisor is required to report quarterly to the Trust's Board of Trustees on the Trust's performance against the business plan. In addition, all transactions or investments by the Trust shall require prior approval by the Trust's Board of Trustees unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the advisor by the Trust's Board of Trustees.\n(7) prior approval of the Trust's Board of Trustees is required for retention of all consultants and third party professionals, other than legal counsel. The advisory agreement provides that the advisor shall be deemed to be in a fiduciary relationship to the Trust's shareholders; contains a broad standard governing the advisor's liability for losses by the Trust; and contains guidelines for the advisor's allocation of investment opportunities as among itself, the Trust and other entities it advises.\nAs required by the Trust's Declaration of Trust, all or a portion of the annual advisory fee must be refunded by the advisor to the Trust if the Operating Expenses of the Trust (as defined in the Trust's Declaration of Trust) exceed certain limits specified in the Declaration of Trust based on book value, net asset value and net income of the Trust during such fiscal year. The operating expenses of the Trust did not exceed such limitation in 1992, 1993 or 1994.\nAlso under the advisory agreements, the advisor is to receive reimbursement of certain expenses incurred by it in the performance of the Advisory services to the Trust.\nAlso, if the Trust were to request that the advisor render services to the Trust other than those required by the advisory agreement, the advisor or an affiliate of the advisor would be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed below under \"Property Management\", in the past, the Trust had hired Carmel, Ltd., an affiliate of BCM, to provide property management services for the Trust's properties. Since April 1, 1994, Tarragon has provided property management services for the Trust's properties. Also, as discussed under \"Real Estate Brokerage\", the Trust engaged, on a non-exclusive basis, Carmel Realty, Inc. (\"Carmel Realty\"), also an affiliate of BCM, to perform\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nbrokerage services for the Trust until March 31, 1994.\nApproval, and any renewal, of the Tarragon Advisory Agreement is required by the Trust's shareholders.\nThe Advisory Agreement may only be assigned with the prior consent of the Trust.\nThe directors and principal officers of Tarragon are set forth below:\nWILLIAM S. FRIEDMAN: Director and Chief Executive Officer\nJOHN A. DOYLE: Director, President and Chief Operating Officer\nJOHN C. STRICKLIN: Executive Vice President\nCHRIS W. CLINTON: Senior Vice President\nROBERT W. LOCKHART: Senior Vice President\nTODD C. MINOR: Senior Vice President\nKATIE JACKSON: Vice President - Chief Accounting Officer\nDAVID L. MILLER: Vice President - Legal\nMARY E. MONTAGNINO: Secretary\nProperty Management\nFrom February 1, 1990 to March 31, 1994, affiliates of BCM have provided property management services to the Trust. Carmel, Ltd. provided 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. subcontracted with other entities for the provision of the property-level management services to the Trust 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. subcontracted the property-level management and leasing of eleven of the Trust's commercial properties and the commercial properties owned by two of the real estate partnerships in which the Trust is a partner to Carmel Realty, which is owned by SWI. Carmel, Ltd. resigned as property manager for the Trust's properties effective March 31, 1994.\nTarragon has provided property management services to the Trust since April 1, 1994 for a fee of 4.5% of the monthly gross rents collected on apartment properties and of 1.5% to 4% of the monthly gross rents collected on commercial properties. Tarragon subcontracts with other entities for the provision of most of the property-level management services to the Trust.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nReal Estate Brokerage\nPrior to December 1, 1992, affiliates of BCM provided brokerage services to the Trust and received brokerage commissions in accordance with the advisory agreement. Effective December 1, 1992, the Trust's Board of Trustees approved the non-exclusive engagement by the Trust of Carmel Realty to provide brokerage services for the Trust. Such agreement terminated March 31, 1994. Carmel Realty was entitled to receive a real estate acquisition commission for locating and negotiating the lease or purchase by the Trust of any property equal to the lesser of (i) up to 3% of the purchase price, inclusive of commissions, if any, paid by the Trust to other brokers or (ii) the compensation customarily charged in arm's-length transactions by others rendering similar property acquisition services in the same geographical location and for comparable property. Any commission paid to Carmel Realty by the seller was to be credited against the commission to be paid by the Trust.\nCarmel Realty was also entitled to receive a real estate sales commission for the sale of each Trust property equal to the lesser of (i) 3% (inclusive of fees, if any, paid by the Trust to other brokers) of the sales price of each property or (ii) the compensation customarily charged in arm's-length transactions paid by others rendering similar services in the same geographic location for comparable property.\nAt their March 9, 1995 meeting, the Trustees approved a new revised form of Advisory Agreement to be effective April 1, 1995 and to be submitted to shareholders for their approval at the next meeting of shareholders, whether annual or special. In addition to technical changes designed to clarify the responsibilities and rights of the Advisor, the new agreement eliminates the $100,000 base annual fee and all incentive sales compensation. Moreover, it provides that real estate commissions shall be payable to the Advisor and its affiliates only following specific Board approval for each transaction rather than pursuant to a general agreement.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Trust has no employees, payroll or benefit plans and pays no direct compensation to the Officers of the Trust. The Trustees and Officers of the Trust who are also officers or employees of the Trust's Advisor are compensated by the Advisor, except as noted below. Such affiliated Trustees and Officers of the Trust perform a variety of services for the Advisor and the amount of their compensation is determined solely by the Advisor. Compensation of Trust Officers responsible for legal and accounting services is allocated among the various entities for which Tarragon serves as advisor and none of those individual's annual salary exceeds $100,000. See ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\" for a more detailed discussion of the compensation payable to Tarragon by the Trust.\nThe only direct remuneration paid by the Trust is to the Trustees who are not officers or directors of Tarragon or their affiliated companies. The Independent Trustees (i) review the business plan of the Trust to determine that it is in the best interest of the Trust's shareholders, (ii) review the Trust's contract with the advisor, (iii) supervise the performance of the Trust's advisor and review the reasonableness of the compensation which the Trust pays to its advisor in terms of the nature and quality of services performed, (iv) review the reasonableness of the total fees and expenses of the Trust and (v) select, when necessary, a qualified independent real estate appraiser to appraise properties acquired by the Trust. During 1994, the Independent Trustees received compensation in the amount of $6,000 per year, plus reimbursement for expenses. In addition, each Independent Trustee received (i) $3,000 per year for each committee of the Board of Trustees on which he serves, (ii) $2,500 per year for each committee chairmanship and (iii) $1,000 per day for any special services\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nrendered by him to the Trust outside of his ordinary duties as Trustee, plus reimbursement for expenses, provided such services are specifically requested by the Board.\nDuring 1994, $42,750 were paid to the Independent Trustees in total Trustees' fees for all services, including 1994 special service fees: Willie K. Davis, $4,500 (a Trustee from October 1988 to March 1995); Geoffrey C. Etnire, $6,000 (a Trustee from January 1993 to March 1995); Dan L. Johnston, $12,000; Raymond V.J. Schrag, $7,250; Bennett B. Sims, $3,000 (a Trustee from April 1990 to August 1994); Ted P. Stokely, $3,000 (a Trustee from April 1990 to August 1994); and Carl Weisbrod, $7,000. Also during 1994, Trustees' fees paid related to 1995 services totaled $12,000 and included; Irving E. Cohen, $6,000, and Sally Hernandez-Pinero, $6,000.\nMessrs. Davis and Schrag served on the Fairness Committee of NRLP (for which they each received $4,000 in 1993) whose function is to review certain transactions between NRLP and its general partner and affiliates of such general partner.\nTMC, a company of which Mr. Randall K. Gonzalez, a Trustee of the Trust until February 18, 1994, is the Managing Partner and President, provided property-level management services until April 1994, as a sub-contractor to Carmel, Ltd., for certain properties owned by the Trust. In 1994, TMC earned fees of $19,750 for performing such services.\nTMC also provides property-level management services, as a subcontractor to Carmel, Ltd., for properties owned by ART, CMET, NOLP and TCI and through April 1993, for a property owned by a partnership which includes IORT and TCI. Christon, a company for which Mr. Gonzalez serves as Vice President, provides property leasing services, as a subcontractor to Carmel, Ltd., to such partnership. Mr. Gonzalez is the son of Al Gonzalez, an ART director not affiliated with BCM.\nSince January 1, 1993, FMS, a company of which Mr. Davis is Chairman, President and sole shareholder, has been providing property-level management services, as a subcontractor to Carmel, Ltd., for two properties owned by the Trust. In 1994, FMS earned fees of $55,886 for performing such services.\nDuring 1994, Mr. Jordan (a Trustee from October 1992 to June 1994) performed legal services for the Trust and was paid $5,400 in legal fees and cost reimbursements.\nThe Trust believes that such fees received by FMS, TMC and Mr. Jordan were at least as favorable to the Trust as those that would be paid to unaffiliated third parties for the performance of similar services.\nEffective March 9, 1995, the Trust will pay the Independent Trustees as follows: (i) $15,000 annual fee, (ii) $2,000 per year for each committee of the Board of Trustees on which he (she) serves and an additional $1,000 per year for the Chair of each committee, (iii) $25,000 per year to the Chairman of the Board of Trustees (Mr. Weisbrod), inclusive of any committee fees and (iv) $1,000 per day for any special services rendered to the Trust outside of the ordinary duties as Trustee, plus reimbursement for expenses, provided such services are specifically requested by the Board.\n[This space intentionally left blank.]\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nPerformance Graph\nThe following performance graph compares the cumulative total shareholder return on the Trust's shares of beneficial interest with the Standard & Poor's 500 Stock Index (\"S&P 500 Index\") and the National Association of Real Estate Investment Trusts, Inc. (\"NAREIT\") Hybrid REIT Total Return Index (\"REIT Index\"). The comparison assumes that $100 was invested on December 31, 1989 in the Trust's shares of beneficial interest and in each of the indices and further assumes the reinvestment of all dividends. Past performance is not necessarily an indicator of future performance.\nCOMPARISON OF FIVE FISCAL YEARS ENDED DECEMBER 31, 1994 COMPARATIVE TOTAL RETURN\n[GRAPH]\nThe data set forth in the above graph and related table was obtained from NAREIT. All of the data is based upon the last closing price of the month for all tax-qualified REITs listed on the New York Stock Exchange (\"NYSE\"), American Stock Exchange (\"AMEX\") and the NASDAQ National Market System. The data is market weighted. The total return calculation is based upon the weighting at the beginning of the period. Dividends are included in the month based upon their payment date. The total return index includes dividends reinvested on a monthly basis. At month-end December 1994, there were 21 tax-qualified REITs in the NAREIT Hybrid REIT Total Return Index with a total market capitalization of $3.0 billion.\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 Trust's shares of beneficial interest, both beneficially and of record, both individually and in the aggregate for those persons or entities known by the Trust to be beneficial owners of more than 5% of its shares of beneficial interest as of the close of business on March 10, 1995.\n-----------------------\n(1) Percentages are based upon 3,178,267 shares of beneficial interest outstanding at March 10, 1995.\n(2) Includes 13,873 shares owned by Lucy N. Friedman's husband, William S. Friedman.\n(3) Includes 668,064 shares owned by Lucy N. Friedman.\n(4) Does not include 54,883 shares owned by Lucy N. Friedman's adult son, Ezra Friedman, and 18,264 shares owned by Lucy N. Friedman's adult daughter, Tanya Friedman. Mrs. Friedman disclaims beneficial ownership of such shares.\n(5) Includes 26,336 shares owned by a trust for the benefit of the children and grandchildren of Samuel Friedman, deceased, William S. Friedman's father, for which Robert A. Friedman and Gerald C. Friedman, siblings of William S. Friedman, and Ruth Friedman, his mother, are the trustees. Lucy N. Friedman disclaims beneficial ownership of such shares.\n(6) Includes 36,300 shares owned by Tarragon Capital Corporation, of which Lucy N. Friedman and William S. Friedman are executive officers and directors and 22,000 shares owned by Tarragon Partners, Ltd., of which Lucy N. Friedman and William S. Friedman are limited partners. Mr. Friedman disclaims beneficial ownership of such shares.\n(7) Includes 8,567 shares and 8,684 shares owned by William S. Friedman's minor sons, Gideon and Samuel Friedman. Mr. Friedman disclaims beneficial ownership of such shares. It also includes 120,000 shares owned by Beachwold Partners, L. P., in which L. N. Friedman is the general partner and her four children are the limited partners. Mr. Friedman disclaims beneficial ownership of such shares.\n(8) Includes 13,015 shares held by William S. Friedman Grantor Trust for benefit of the children of William S. Friedman, of which Mrs. Friedman is the Trustee. Mrs. Friedman disclaims beneficial interest of such shares.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued)\nSecurity Ownership of Management. The following table sets forth the ownership of the Trust's shares of beneficial interest, both beneficial and of record, both individually and in the aggregate for the Trustees and executive officers of the Trust as of the close of business on March 10, 1995. (Those individual Trustees not named in the table below own no shares of beneficial interest of the Trust.)\n---------------------------\n* Less than 1%.\n(1) Percentages are based upon 3,178,267 shares of beneficial interest outstanding at March 10, 1995.\n(2) Mr. Friedman owns 13,873 shares of beneficial interest personally.\n(3) Includes 668,064 shares owned by William S. Friedman's wife, Lucy Friedman. Mr. Friedman disclaims beneficial ownership of such shares.\n(4) Does not include 54,883 shares owned by William S. Friedman's adult son, Ezra Friedman, and 18,264 shares owned by William S. Friedman's adult daughter, Tanya Friedman. Mr. Friedman disclaims beneficial ownership of such shares.\n(5) Includes 26,336 shares owned by a trust for the benefit of the children and grandchildren of Samuel Friedman, deceased, William S. Friedman's father, for which Robert A. Friedman and Gerald C. Friedman, siblings of William S. Friedman, and Ruth Friedman, his mother, are the trustees. Mr. Friedman disclaims beneficial ownership of such shares.\nITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT (Continued)\n(6) Includes 36,300 shares owned by Tarragon Capital Corporation, of which Lucy N. Friedman and William S. Friedman are executive officers and directors.\n(7) Includes 22,000 shares owned by Tarragon Partners, Ltd., of which Lucy N. Friedman and William S. Friedman are limited partners. Mr. Friedman disclaims beneficial ownership of such shares.\n(8) Includes 84,615 shares which Mr. Doyle has beneficial interest as a result of a $1.0 million subordinated debenture which is convertible to 84,615 of the Trust's shares. John A. Doyle also owns 3,146 shares personally.\n(9) Raymond V.J. Schrag owns 5,025 shares personally.\n(10) Includes 8,567 shares and 8,684 shares owned by William S. Friedman's minor sons, Gideon and Samuel Friedman. Mr. Friedman disclaims beneficial ownership of such shares. It also includes 120,000 shares owned by Beachwold Partners, L. P., in which L. N. Friedman is the general partner and her four children are the limited partners. Mr. Friedman disclaims beneficial ownership of such shares.\n(11) Includes 13,015 shares held by William S. Friedman Grantor Trust for benefit of the children of William S. Friedman, of which Mrs. Friedman is the Trustee. Mrs. Friedman disclaims beneficial interest of such shares.\n(12) Carl B. Weisbrod owns 220 shares jointly with Jody Weisbrod, his spouse.\n(13) Dan L. Johnston owns 96 shares personally.\n(14) Irving E. Cohen owns 453 shares in an IRA account.\n(15) Ivan Roth owns 330 shares jointly with Gerda Roth, his spouse.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain Business Relationships\nFrom March 1989 through March 31, 1994, BCM was retained as the Trust's advisor as discussed in ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor.\" Messrs. Phillips and Friedman served as directors of BCM until December 22, 1989. Mr. Phillips served as Chief Executive Officer of BCM until September 1, 1992 and Mr. Friedman served as President of BCM until May 1, 1993. BCM is beneficially owned by a trust for the benefit of the children of Mr. Phillips.\nOn February 10, 1994, the Trust's Board of Trustees selected Tarragon to replace BCM as the Trust's advisor. Since April 1, 1994, Tarragon has provided advisory services to the Trust under an advisory agreement. Mr. Friedman serves as director and Chief Executive Officer of Tarragon. Tarragon is owned by Lucy N. Friedman, Mr. Friedman's wife, and Mr. Doyle, who serves as President and Chief Operating Officer of Tarragon and Executive Vice President of the Trust. The Friedman and Doyle families together own approximately 32% of the outstanding shares of the Trust.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nCertain Business Relationships (Continued)\nAlso on February 10, 1994, VPT's Board of Trustees selected Tarragon to replace BCM as VPT's advisor commencing March 1, 1994. Messrs. Friedman, Johnston, Schrag and Weisbrod, Trustees of the Trust, serve as trustees of VPT. The Trust's Trustees owe fiduciary duties to VPT as well as to the Trust under applicable law. VPT has the same relationship with Tarragon as the Trust.\nTarragon occupies office space at VPT's One Turtle Creek Office\/Retail Complex.\nSince February 1, 1990, Carmel, Ltd., an affiliate of BCM, has provided property management services to the Trust for a fee of 5% or less of the monthly gross rents collected on the properties under management. In many cases, Carmel, Ltd. subcontracted with other entities for the property-level management services to the Trust 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. subcontracted the property-level management and leasing of eleven of the Trust's commercial properties and the commercial properties owned by two of the real estate partnerships in which the Trust is a partner to Carmel Realty, which is owned by SWI. Carmel, Ltd. resigned as property manager for the Trust's properties effective March 31, 1994. Commencing April 1, 1994, Tarragon has provided property management services to the Trust.\nPrior to December 1, 1992, affiliates of BCM provided brokerage services to the Trust and received brokerage commissions in accordance with the advisory agreement. Effective December 1, 1992, the Trust engaged Carmel Realty, on a non-exclusive basis, to provide brokerage services for the Trust. Carmel Realty is owned by SWI. Such agreement terminated March 31, 1994.\nAs discussed in ITEM 11. \"EXECUTIVE COMPENSATION,\" Messrs. Davis and Schrag served on the Fairness Committee of NRLP, whose function is to review certain transactions between NRLP and its general partner and affiliates of such general partner. TMC, a company of which Mr. Gonzalez, a trustee of the Trust until February 18, 1994, is the Managing Partner and President, provided property-level management services as a subcontractor to Carmel, Ltd. for certain properties owned by ART, CMET, NOLP, TCI and the Trust and through April 30, 1993, for a property owned by a partnership which includes IORT and TCI. Christon, a company of which Mr. Gonzalez serves as Vice President, provided property leasing services, as a subcontractor to Carmel, Ltd., for such partnership property. Mr. Randall K. Gonzalez is the son of Al Gonzalez, a director of ART.\nFrom April 1992 to December 31, 1993, Mr. Stokely, a Trustee of the Trust until August 1, 1994, was employed as a Real Estate Consultant for Eldercare, a nonprofit corporation engaged in the acquisition of low income and elderly housing. Eldercare has a revolving loan commitment from SWI which is owned by Mr. Phillips and affiliated with BCM. In addition, in November 1991, the Trust funded a $230,000 loan to Eldercare. Eldercare filed for bankruptcy protection in October 1993. At December 31, 1994, the Trust's loan to Eldercare was in default.\nDuring 1993, Mr. Jordan performed legal services for BCM and its affiliates, as well as for TCI, ART and the Trust.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRelated Party Transactions\nHistorically, the Trust has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. All related party transactions entered into by the Trust must be approved by a majority of the Trust's Board of Trustees, including a majority of the Independent Trustees. Under the Modification to Settlement, such transactions (other than the Advisory Agreement and property management arrangements) require unanimous approval of the Independent Trustees and a finding that such transaction is more beneficial to the Trust than any available alternative. It is now the policy of the Trust to discourage related party transactions unless clearly more beneficial than alternatives or essential in order to eliminate existing affiliated relationships.\nAs more fully described in NOTE 5. \"INVESTMENT IN EQUITY PARTNERSHIPS\", the Trust is a partner with CMET in Sacramento Nine and Indcon.\nOn December 10, 1990, the Trust's Board of Trustees, based on the recommendation of its Related Party Transaction Committee, authorized the purchase of up to $1.0 million of the shares of beneficial interest of CMET through negotiated or open market transactions. At December 31, 1993, the Trust owned 54,500 shares of beneficial interest of CMET which it purchased in 1990 and 1991 through open market transactions, at a total cost to the Trust of $250,000. In June 1994, the Trust sold 15,000 shares of beneficial interest of CMET for $210,000 through open market transactions and, as a result, recorded a $141,000 gain on sale of investments in the second quarter of 1994. The market value of the remaining 39,500 shares held by the Trust was $593,000 at December 31, 1994. In the first quarter of 1995, the remaining shares were sold through open market transactions for $593,000 and, as a result, the Trust recorded a $411,200 gain on sale of investments.\nIn December 1993, the Trust's Board of Trustees approved the issuance of a $1.0 million convertible subordinated debenture to Mr. Doyle, Executive Vice President of the Trust since February 1994, in exchange for his 10% participation in the profits of the Consolidated Capital Properties II (\"CCP II\") assets, which the Trust had acquired in November 1992. This participation was granted as consideration for Mr. Doyle's services to the Trust in connection with the CCP II portfolio. The debenture bears interest at a rate of 6% per annum, matures in December 1999 and is convertible into 84,615 shares of beneficial interest of the Trust. Mr. Doyle also serves as Director, President and Chief Operating Officer and is a 50% shareholder of Tarragon Realty Advisors, Inc. (\"Tarragon\"), the Trust's advisor since April 1, 1994. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nIn 1994, the Trust paid Tarragon $909,000 in advisory fees, $267,000 in real estate and mortgage brokerage commissions and $285,000 in property management fees and leasing commissions. In addition, as provided in the advisory agreement, Tarragon received cost reimbursements from the Trust of $999,000 in 1994.\nIn 1994, the Trust paid BCM and its affiliates $468,000 in advisory fees, $103,000 in real estate and mortgage brokerage commissions and $112,000 in property management fees and leasing commissions for their services during the period ending March 31, 1994. In addition, as provided in the advisory agreement, BCM received cost reimbursements from the Trust of $140,000 in 1994.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRestrictions on Related Party Transactions\nThe Trust's Declaration of Trust provides that:\n\"[t]he Trustees shall not . . . purchase, sell or lease any Real Properties or Mortgages to or from . . . the Advisor or any of [its] Affiliates,\" and that \"[t]he Trustees shall not . . . make any loan to . . . the Advisor or any of [its] Affiliates.\"\nMoreover, the Declaration of Trust further provides that:\n[t]he Trust shall not purchase or lease, directly or indirectly, any Real Property or purchase any Mortgage from the Advisor or any affiliated Person, or any partnership in which any of the foregoing may also be a general partner, and the Trust will not sell or lease, directly or indirectly, any of its Real Property or sell any Mortgage to any of the foregoing Persons.\" The Declaration of Trust further provides that \"the Trust shall not directly or indirectly, engage in any transaction with any Trustee, officer or employee of the Trust or any director, officer or employee of the Advisor . . . or of any company or other organization of which any of the foregoing is an Affiliate, except for . . . [among other things] transactions with . . . the Advisor or Affiliates thereof involving loans, real estate brokerage services, real property management services, the servicing of Mortgages, the leasing of real or personal property, or other services, provided such transactions are on terms not less favorable to the Trust than the terms on which nonaffiliated parties are then making similar loans or performing similar services for comparable entities in the same area and are not entered into on an exclusive basis.\nThe Declaration of Trust defines \"Affiliate\" as follows:\n[A]s to any Person, any other Person who owns beneficially, directly, or indirectly, 1% or more of the outstanding capital stock, shares, or equity interests of such Person or of any other Person which controls, is controlled by, or is under common control with, such Person or is an officer, retired officer, director, employee, partner, or trustee (excluding independent trustees not otherwise affiliated with the entity) of such Person or of any other Person which controls, is controlled by, or is under common control with, such Person.\nThe Declaration of Trust further provides that:\nThe Trustees shall not . . . invest in any equity Security, including the shares of other REITs for a period in excess of 18 months, except for shares of a qualified REIT subsidiary, as defined in Section 856(i) of the Internal Revenue Code, and regular or residual interests in REMICs . . . [or] acquire Securities in any company holding investments or engaging in activities prohibited by this Section . . .\nAs discussed in \"Related Party Transactions,\" above, since September 1990, the Trust has invested in shares of CMET. As of December 31, 1994, the Trust owned 39,500 shares of CMET. CMET had the same advisor as the Trust until March 31, 1994, and certain of its Trustees were also trustees of CMET. As noted above, under the terms of its Declaration of Trust, the Trust is prohibited from investing in equity securities for a period in excess of 18 months. The Trust's shareholders approved an amendment to the Trust's Declaration of Trust allowing the Trust to hold these shares of CMET until July 30, 1996. In the first quarter of 1995, the remaining shares were sold through open market transactions for $593,000 and, as a result, the Trust recorded a $411,200 gain on sale of investments.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRestrictions on Related Party Transactions (Continued)\nPrior to January 11, 1995, all related party transactions that the Trust contemplated were to be reviewed by the Related Party Transaction Committee of the Trust's Board of Trustees to determine whether such transactions were (i) fair to the Trust and (ii) permitted by the Trust's governing documents. Each of the members of the Related Party Transaction Committee was a Trustee who is not an officer, director or employee of the Trust's advisor, Tarragon, and is not an officer or employee of the Trust. Such committee was disbanded in February 1995 and its responsibilities assumed by the Independent Trustees.\nPursuant to the terms of the Modification in the Olive case, which became effective on January 11, 1995, any related party transaction which the Trust may enter into prior to April 27, 1999, will require the unanimous approval of the Trust's Board of Trustees. In addition, related party transactions may only be entered into in exceptional circumstances and after a determination by the Trust's Board of Trustees that the transaction is in the best interests of the Trust and that no other opportunity exists that is as good as the opportunity presented by such transaction.\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\nReports of Independent Public Accountants - BDO Seidman - Arthur Andersen LLP\nConsolidated Balance Sheets - December 31, 1994 and 1993\nConsolidated Statements of Operations - Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Shareholders' Equity - Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows - Years Ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\n2. Financial Statement Schedules\nSchedule III - Real Estate and Accumulated Depreciation\nSchedule IV - Mortgage Loans on Real Estate\nAll other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the notes thereto.\n3. Exhibits\nThe following documents are filed as Exhibits to this report:\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\n(b) Reports on Form 8-K.\nDuring the last quarter of the period covered by this report, no reports on Form 8-K were filed on behalf of the Trust.\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.\nNATIONAL INCOME REALTY TRUST\nDated: March 30, 1995 By: \/s\/ William S. Friedman ------------------------------ -------------------------- William S. Friedman President, Chief Executive Officer and Trustee\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.\nINDEX TO EXHIBITS","section_15":""}
{"filename":"99830_1994.txt","cik":"99830","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nTriton Energy Corporation is an independent energy company primarily engaged in international oil and gas exploration and production through wholly- owned and partly-owned subsidiaries and affiliates. The Company's principal properties and operations are located in Colombia and Malaysia-Thailand. The Company also has oil and gas interests in other Latin American and Asian countries, Europe, Australia and North America.\nDuring fiscal year 1994, the Company had two reportable industry segments: (i) the crude oil and natural gas exploration and production industry; and (ii) about the Company's reportable industry segments, see note 20 of Notes to Consolidated Financial Statements.\nTriton was incorporated in Texas in 1962. The Company's principal executive offices are located at 6688 North Central Expressway, Suite 1400, Dallas, Texas 75206, and its telephone number is 214\/691-5200. The terms \"Company\" and \"Triton\" when used herein mean Triton Energy Corporation and its subsidiaries and other affiliates through which Triton conducts its business, unless the context otherwise implies.\nOIL AND GAS OPERATIONS\nGENERAL\nOil and gas exploration and development activities are, or have been, conducted in Colombia by the Company's wholly-owned subsidiaries, Triton Colombia, Inc. and Triton Resources Colombia, Inc. (collectively, \"Triton Colombia\"); in Malaysia-Thailand by the Company's wholly-owned subsidiary, Triton Oil Company of Thailand (\"Triton Thailand\"); in Argentina primarily by the Company's wholly-owned subsidiary, Triton Argentina, Inc. (\"Triton Argentina\"); in Europe by the Company's wholly-owned (but until March 31, 1994, 59.5% owned) subsidiary, Triton Europe, plc (\"Triton Europe\"); in Indonesia by the Company's wholly-owned subsidiary Triton Indonesia, Inc. (\"Triton Indonesia\") and the Company's 63.7% (at May 31, 1994, but since reduced to 33.7%) owned subsidiary, New Zealand Petroleum Company Limited (\"New Zealand Petroleum\"); in the United States by Triton Oil & Gas Corp. (\"Triton Oil\") and the Company's 49.9% owned affiliate, Crusader Limited (\"Crusader\"); in New Zealand by New Zealand Petroleum and Crusader; in Canada by Crusader (and Triton Canada Resources Ltd. (\"Triton Canada\") until August 1993); and in Australia by Crusader.\nA significant portion of Triton's reserves are held through its wholly- owned subsidiaries Triton Colombia and Triton Europe. Additional reserves are held through Triton's publicly-held affiliate, Crusader. Except for Crusader, the financial data for each of these companies is consolidated with Triton's financial data. For further information relating to the Company's oil and gas business activities, see Item 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nOIL AND GAS\nCOLOMBIA\nThrough its wholly-owned subsidiary, Triton Colombia, the Company has varying participation interests in six contract areas in Colombia.\nCUSIANA AND CUPIAGUA FIELDS\nCONTRACT TERMS. In the Llanos Basin area of eastern Colombia, Triton Colombia holds a working interest in the Rio Chitamena, SDLA and Tauramena contract areas, covering approximately 11,600, 66,000 and 35,900 acres, respectively, where an active appraisal and development program is being carried out in the Cusiana and Cupiagua Fields. Triton's partners in these areas are Empresa Colombiana De Petroleos (\"Ecopetrol\"), the Colombian national oil company, with a 50% working interest, and BP Exploration Company (Colombia) Limited (\"BP\"), the operator, and TOTAL Exploratie en Produktie MIJ B.V. (\"TOTAL\"), each with a 19% working interest. In 1993, Ecopetrol declared the Cusiana and Cupiagua Fields to be commercial and exercised its right to acquire a 50% working interest. Triton's net revenue interest is approximately 9.6% after governmental royalties, reduced further by up to 0.36% pursuant to an agreement with an original co-investor, subject to Triton being reimbursed for a proportionate share of expenditures relating thereto.\nThe Company and its partners have secured the right to produce oil and gas from the SDLA and Tauramena contract areas through the years 2010 and 2016, respectively, and from the Rio Chitamena contract area through 2015 or 2019 depending on contract interpretation. On July 19, 1994, Triton Colombia, BP, TOTAL and Ecopetrol entered into an Integral Plan for the Unified Exploitation of the Cusiana Oil Structure in the SDLA, Tauramena and Rio Chitamena Association Contract Areas. Under the plan, the parties have agreed to develop the Cusiana oil structure in a technically efficient and cooperative manner during three consecutive periods of time. During the initial period, petroleum produced from the unified area will be owned by the parties according to their respective undivided interests in each contract area.\nWithin the first quarter of 2005, an independent determination of the unified area and under each association contract will be made, as a result of which a \"tract factor\" will be calculated for each association contract. Each tract factor will be the amount of original BOEs of petroleum in place under the particular association contract as a percentage of the total original BOEs under the unified area. Each party's unified area interest during the second period (commencing from the expiration of the SDLA association contract in 2010) and final period (commencing from the termination of the second association contract to terminate) will be the aggregate of that party's interest in each remaining association contract multiplied by the tract factor for each such contract.\nRECENT DRILLING RESULTS. Triton and its working interest partners have recently tested an appraisal well in the Cupiagua Field, the Cupiagua-3. A single test in the Upper Mirador formation, at a depth of between 14,504 and 14,668 feet, flowed oil at a rate of 3,400 barrels per day and gas at\na rate of 12 million cubic feet per day. The gas-to-oil ratio was 3,500 and the oil API 42 degrees. The test was conducted through a three-quarter inch choke. The well confirmed the northern extent of the Cupiagua Field and drilling has now been suspended. The well will be completed as a production well.\nA second Cupiagua appraisal well, the Cupiagua-2, has experienced mechanical failure after two unsuccessful sidetrack attempts and has been suspended with a view to resuming drilling at a later date.\nThe wells are expected to be followed by two new appraisal wells in the Cupiagua Field and 3D seismic is planned for late 1994. Although drilling of the Cupiagua-2 and Cupiagua-3 wells has taken over a year, and each has been among the most expensive wells drilled in the Cusiana or Cupiagua Fields, drilling of more recently spudded wells in the Cusiana Field have been considerably less expensive and time consuming.\nTRANSPORTATION. Since the beginning of fiscal 1994, the first two of four production units of the Cusiana Field central processing facility have been substantially completed in anticipation of increased production by year end. In addition, a new 35 kilometer (22 mile) 20 inch pipeline connecting the central processing facilities to the El Porvenir pump station on the Central Llanos pipeline system has been completed, and pipeline looping and pump station upgrades, including 92 kilometers (57 miles) of 30 inch pipeline from La Belleza to the Oleoducto de Colombia pipeline and then to the Caribbean port of Covenas, are near completion.\nAdditional pipeline capacity is needed to meet the transportation needs associated with the full field development of the Cusiana and Cupiagua Fields. To that end, on July 15, 1994, Triton Colombia executed a memorandum of and IPL Energy (Colombia) Ltd., regarding the proposed formation of a joint stock company to finance and own a pipeline and port facilities to be constructed and operated for the transport of crude oil from the Cusiana and Cupiagua Fields to the port of Covenas. Triton's equity participation under this agreement would be approximately 9.6%. Formation of the joint stock company is subject to numerous conditions, including negotiation and execution of definitive agreements and board approvals.\nThe project covered by the memorandum of understanding consists of a 793 kilometer (495 mile) pipeline system from the Cusiana Field to the Port of Covenas. With the exception of the new 35 kilometer (22 mile) pipeline from Cusiana to El Porvenir referred to above, the system generally follows the route of, and loops two existing pipelines, the Central Llanos from El Porvenir to Vasconia and the Oleoducto de Colombia running from Vasconia to Covenas.\nConstruction of a part of the system (the Cusiana to El Porvenir pipeline) has been completed, and another 92 kilometer (57 mile) segment from La Belleza to Vasconia is expected to be completed by year end. These assets, together with on-going investment in pump stations at El Porvenir and Miraflores, would be contributed to the new joint stock company. Construction of the remainder of the system is currently projected to be completed by the end of 1997.\nOTHER COLOMBIA AREAS\nTriton also owns rights in three additional contract areas in Colombia located in the middle and upper Magdalena River valley north and southwest of Bogota, respectively. In the El Pinal contract area, covering approximately 142,250 acres, Triton owns a 100% working interest (before certain revenue interests and government participation). Seismic work has been conducted on this acreage and a field was discovered with the drilling of the La Liebre 1 discovery well. After additional seismic was shot in the area of the La Liebre 1 well, the La Liebre 2 well was drilled and tested, confirming the discovery. Testing and evaluation of the discovery, including the drilling of a third well, is planned.\nIn the Tolima-B and San Luis contract areas, Triton Colombia has 45% and 40% interests in 131,300 acres and 129,100 acres, respectively (before certain revenue interests and government participation). HOCOL S.A., a unit of Royal Dutch\/Shell, is operator and has had commerciality of one well approved in the Tolima-B contract area. Also in the Tolima-B contract area, the operator has completed a 3D seismic program. The operator has received commerciality for one gas well in the San Luis contract area, on which a 2D seismic program has been completed.\nMALAYSIA-THAILAND\nTriton Thailand has an interest in a contract area located offshore in which encompasses over 700,000 acres, had been the subject of overlapping claims between Malaysia and Thailand. Triton Thailand's interest was in the form of a concession from Thailand until April 1994, when it executed a production sharing contract with the Malaysia-Thailand Joint Authority that has been established by treaty to administer the Joint Development Area, and with the Malaysian national oil company.\nSimultaneously with the execution of the production sharing contract, the parties executed a joint operating agreement governing Block A-18 operations. The operating agreement designates as operator a newly formed company owned equally by Triton Thailand and the Malaysian national oil company.\nThe Company anticipates that the first phase of Block A-18 operations, which it expects will continue through mid-1996, will include seismic surveys covering approximately 5,700 kilometers (3,542 miles) and data analysis, and the drilling of at least four wells. The wells are expected to be drilled in water depths of less than 200 feet. The nature and extent of phase two development and appraisal of the area, which is expected to include 3D seismic surveys and further drilling, will depend on the parties' assessment of phase one results.\nARGENTINA\nTriton Argentina holds a working interest in six blocks in Argentina. In the oil and gas producing Neuquen Basin in west central Argentina, Triton Argentina holds a 100% working interest in the Agua Botada, Cerro Dona Juana, Loma Cortaderal, and Sierra Azul Sur Blocks of\napproximately 50,000 acres each, and a 75% working interest in the 219,672 acre Malargue Sur Block. Triton Argentina has completed a workover program in the Agua Botada Block and a 548 kilometer (341 miles) seismic acquisition program in Malargue Sur. Further seismic acquisitions will commence in late 1994 with two exploration wells planned for 1995.\nTriton Argentina also has a 20% working interest in the 2,122,095 acre Buen Pasto Block located in the northern portion of the oil producing San Jorge Basin in south central Argentina. Regional seismic lines along with gravity and magnetics data are being acquired in this frontier area.\nEUROPE\nOn March 31, 1994, the Company purchased the 40.5% of Triton Europe's shares not already owned by the Company.\nFRANCE. The Company's activities in France are conducted through Triton France, S.A. (\"Triton France\"), a wholly-owned subsidiary of Triton Europe. Triton France has an interest in the non-operated Villeperdue, Fontaine-au-Bron, Hautefeuille and La Motte Noire concessions, which provided the majority of Triton's French production during the year. The Company is assisting Coparex S.A., a French firm which became the operator of these licenses when it purchased Totalex S.A. in December 1993, in identifying further development and Paris Basin exploration permits, and one exploration permit in the Alps. These permits are currently under review as part of the Company's strategy to re- direct its exploration effort towards a more balanced European portfolio. During the 1994 fiscal year, Triton France sold its interests in four operated production licenses (Saint-Germain, Sivry, Maincy, les Bagneaux) in the Paris Basin for approximately $1.5 million.\nITALY. Triton Mediterranean Oil & Gas, N.V., a wholly-owned subsidiary of Triton Europe, holds an interest (10.91%) in the onshore Monte Caruso license on which one unsuccessful well was drilled in fiscal 1994. Triton Mediterranean Oil & Gas, N.V. has acquired an interest (40%) in DR71 and DR72 licenses operated by Enterprise Oil, plc, in the offshore Italian Adriatic Sea.\nCRUSADER\nOil and gas activities in Australia are conducted through the Company's 49.9% owned affiliate, Crusader, whose shares are publicly traded in Australia. Crusader has an interest in the Cooper Basin Gas and Liquids Unit of South Australia. Crusader holds varying interests in several permits in Queensland, including an interest in oil production from the Taylor field in the Surat Basin. Within the Gippsland and Otway Basins of Victoria, Crusader has interests in two offshore and two onshore exploration licenses, respectively. Crusader has an approximate 48.9% equity interest in Australian Hydrocarbons Limited (\"AHY\"), a publicly-traded Australian company. Three Crusader directors are members of the five-member AHY Board of Directors and Crusader consolidates AHY in its financial and reserve disclosures. AHY owns various interests in oil and gas exploration projects both in Australia and in the United States.\nIn addition, Crusader is involved in oil and gas exploration and production and gas processing in Canada, through its wholly-owned subsidiary, Ausquacan Energy Limited. Crusader is also engaged in exploration in Argentina and exploration and production in the United States.\nINDONESIA\nTriton Indonesia is the operator of a secondary recovery\/rehabilitation project on the southeastern portion of the island of Sumatra. New Zealand Petroleum has a 6% interest in this project.\nUNITED STATES\nIn fiscal 1994, the Company sold substantially all of its working interests in oil and gas reserves in the the United States, retaining only various royalty and mineral interests.\nRESERVES\nThe following tables set forth the estimated oil and gas reserves of the Company and the estimated discounted future net cash inflows before income taxes at May 31, 1994. The first table is a summary of separate reports of estimates of the Company's net proved reserves, estimated by the independent petroleum engineers, DeGolyer and MacNaughton, with respect to all proved undeveloped Associates Consultants Ltd., for Crusader's Canadian reserves; and by the Company's own petroleum engineers with respect to all other reserves. This table sets forth the estimated net quantities of proved developed and undeveloped oil and gas reserves and total proved oil and gas reserves owned by the Company and its consolidated subsidiaries in Colombia, France, Indonesia and the United States and its proportionate interest in reserves owned in Australia, Canada and the United States by Crusader. The second table sets forth, for the net quantities so reported, the future net cash inflows (by reserve categories and country of location) discounted to present value at an annual rate of 10%. The discounted future net cash inflows were calculated in accordance with current Securities and Exchange Commission (\"Commission\") guidelines concerning the use of constant oil and gas prices and operating costs in reserve evaluations. Future income tax expenses have not been taken into account in estimating the future net cash inflows. At May 31, 1994, the Company had no proved developed or proved undeveloped reserves in Malaysia-Thailand, Argentina, the United Kingdom or other areas. See note 23 of Notes to Consolidated Financial Statements.\nApplicable Commission guidelines do not permit disclosure in documents filed with the Commission of oil and gas reserves other than those classified as proved developed or proved undeveloped.\nThe estimated reserves and future net cash inflows set forth in the tables below include information attributable to the 36.3% (at May 31, 1994) minority interest in New Zealand Petroleum and the Company's 49.9% ownership interest in Crusader (which includes the minority interests in Crusader's consolidated subsidiaries). Data as to oil reserves include natural gas liquids and condensate.\nNet Proved Reserves at May 31, 1994:\nFuture net cash inflows before income taxes discounted at 10% per annum at May 31, 1994 (in thousands of dollars):\nFuture net cash inflows from reserves at May 31, 1994, were calculated on the basis of prices in effect on that date. The prices used in such calculation by country were as follows:\nRevenue and costs associated with the French, Canadian and Australian reserves are reported in US dollar equivalents based on exchange values of French franc equivalent to US$0.17241; Canadian $1 equivalent to US$0.7230; and Australian $1 equivalent to US$0.7375. The Colombian and Indonesian reserves are evaluated in United States dollars.\nThe foregoing estimated pretax discounted future net cash inflow figures relate only to the reserves tabulated above. The estimates were prepared without consideration of income taxes and indirect costs such as interest and administrative expenses, and are not to be construed as representative of the fair market values of the properties to which they relate.\nReserve estimates are imprecise and may be expected to change as additional information becomes available. Furthermore, estimates of oil and gas reserves, of necessity, are projections based on engineering data, and there are uncertainties inherent in the interpretation of such data as well as the projection of future rates of production and the timing of development expenditures. Reserve engineering is a subjective process of estimating underground accumulations of oil and gas that cannot be measured in an exact way, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. Accordingly, there can be no assurance that the reserves set forth herein will reserves will be developed within the periods anticipated. The Company emphasizes with respect to the estimates prepared by independent petroleum engineers, as well as those estimates prepared by the Company's engineers, that the discounted future net cash inflows should not be construed as representative of the fair market value of the proved oil and gas properties belonging to the Company, since discounted future net cash inflows are based upon projected cash inflows which do not provide for changes in oil and gas prices nor for escalation of expenses and capital costs. The meaningfulness of such estimates is highly dependent upon the accuracy of the assumptions upon which they were based. For further information, see note 23 of Notes to Consolidated Financial Statements.\nNo estimates of total proved net oil or gas reserves have been filed by the Company with, or included in any report to, any United States authority or agency pertaining to the Company's individual reserves since the beginning of the Company's last fiscal year.\nACREAGE\nThe following table shows the total gross and net developed and undeveloped oil and gas acreage (including acreage attributable to mineral, royalty and overriding royalty interests) held by Triton at May 31, 1994, including acreage attributable to the 36.3% (at May 31, 1994) minority interest in New Zealand Petroleum and the Company's 49.9% ownership interest in Crusader (which includes the minority interests in Crusader's consolidated subsidiaries). \"Gross\" refers to the total number of acres in an area in which the Company holds any interest without adjustment to reflect the actual percentage interest held therein by the Company. \"Net\" refers to the gross acreage as adjusted for interests owned by parties other than the Company.\n\"Developed\" acreage is acreage spaced or assignable to productive wells. \"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.\nPRODUCTIVE WELLS AND DRILLING ACTIVITY\nIn this section, \"gross\" as it relates to wells refers to the total number of wells drilled in an area in which the Company holds any interest without adjustment to reflect the actual ownership interest held. \"Net\" refers to the gross number of wells drilled as adjusted for interests owned by parties other minority interest in New Zealand Petroleum, and the Company's 49.9% ownership interest in Crusader (which includes the minority interests in Crusader's consolidated subsidiaries).\nThe following table summarizes the approximate total gross and net interests held by Triton in productive wells at May 31, 1994:\nThe following tables set forth the results of the oil and gas well drilling activity on a gross basis for wells in which the Company held an interest for each of the three fiscal years ended May 31, 1994:\nGROSS EXPLORATORY WELLS\nGROSS DEVELOPMENT WELLS\nThe following tables set forth the results of drilling activity on a net basis for wells in which the Company held an interest for each of the three fiscal years ended May 31, 1994 (those wells acquired or disposed of since May 31, 1991 are reflected in the following tables only since or up to the effective dates of their respective acquisitions or sales, as the case may be):\nNET EXPLORATORY WELLS\nNET DEVELOPMENT WELLS\nOTHER\nIn connection with its aviation related services, the Company's aviation service facilities are predominantly leased under multi-year agreements with the City of Dallas where the aviation service operations are located. The unexpired terms of the Company's aviation service leases extend up to more than 30 years.\nThe Company owns or has interests in numerous oil and gas production facilities relating to its oil and gas production operations throughout the world. In addition, the Company leases or owns office space, manufacturing and other properties for its various operations throughout the world.\nFor additional information on the Company's leases, including its office leases, see note 18 of Notes to Consolidated Financial Statements.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nVERONEX LITIGATION\nOn January 30, 1990, Nordell International Resources, Ltd. (\"Nordell\"), c\/o Veronex Resources, Ltd. (\"Veronex\"), its parent, filed a Demand for Arbitration against the Company and Triton Indonesia. An arbitration was held before an American Arbitration Association panel (\"AAA Panel\") during October 1990 in Singapore. The arbitration concerned disputes between Nordell and Veronex, on the one hand, and the Company and Triton Indonesia, on the other, arising from a farm-out agreement regarding secondary recovery\/rehabilitation operations in Indonesia (the \"Project\").\nOn December 13, 1990, the AAA Panel issued an award granting to the Company Nordell's 40% participating interest in the Project, converting Nordell's Nordell and Veronex. In addition, the AAA Panel awarded the Company damages in an amount exceeding $900,000, enforceable against both Nordell and Veronex.\nThe award has been upheld on appeal and is final insofar as it pertains to Nordell and its interest in the Project. The damage award against Veronex, however, has been reversed by the United States District Court for the Central District of California, which found that Veronex was not Nordell's \"alter ego\", and that Veronex did not consent to the jurisdiction of the AAA Panel over it. The Company has appealed the District Court's \"alter ego\" and consent ruling to the United States Court of Appeals for the Ninth Circuit.\nIn other efforts to collect the damages awarded by the AAA Panel, the Company has obtained a default judgment from a state district court in Dallas against Joseph Laferty, an executive officer of Veronex and Nordell, and has a motion for summary judgment pending in the United States District Court for the Northern District of Texas against David Hite, chief executive officer of Veronex and Nordell, based on their ratifications of Nordell's obligations to the Company; has filed an action in state district court in Dallas (since removed to federal district court) against Veronex to enforce its ratification of Nordell's obligation; has seized approximately $100,000 in payments on Nordell's 5% net profit interest; and has initiated foreclosure proceedings with respect to the balance of Nordell's interest.\nMeanwhile, Veronex, speaking through Mr. Hite, has repeatedly threatened to bring a fraud or racketeering action against the Company seeking \"very, very large\" damages, and has asserted that Veronex's ability to do so is at issue in an appeal pending before the Ninth Circuit concerning a ruling by the United States District Court for the Central District of California in 1991 dismissing a third party action for fraud filed against the Company by Veronex in a securities fraud claim filed against Veronex by a purchaser of its securities. The securities fraud claim to which Veronex alleges its third party claim was settled by Veronex for $10,000. The Company believes that any such action asserted by Veronex against the Company would be without factual merit and subject to several legal defenses.\nREGULATORY MATTER\nThe Company continues to cooperate with inquiries by the Securities and Exchange Commission and the Department of Justice regarding possible violations of the Foreign Corrupt Practices Act in connection with the Company's operations in Indonesia. Based upon the information available to the Company to date, the Company believes that it will be able to resolve any issues that either agency ultimately might raise concerning these matters in a manner that would not have\nOTHER LITIGATION\nOn or about June 22, 1994, the Company and numerous other defendants were served by the State of Nevada, Division of Environmental Protection (the \"NDEP\") in a state court proceeding in Clark County, Nevada. The action seeks to hold the defendants responsible for remediation of certain underground water contamination at the McCarran International Airport and seeks civil penalties of up to $25,000 per day. The Company has been advised by the NDEP that the action was filed to toll the running of the statute of limitations on certain potential causes of action. The Company denies responsibility for the contamination at issue and does not believe that the action will have a material adverse affect on its consolidated financial condition.\nThe Company is also subject to ordinary litigation that is incidental to its business, none of which is expected to have a material adverse effect on the Company's consolidated financial condition.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matter was submitted by the Company during the fourth quarter of the fiscal year covered by this report to 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\nTriton's Common Stock is listed on the New York Stock Exchange and traded under the symbol OIL. Triton's Common Stock is also listed on the Toronto Stock Exchange. The high and low closing sales prices as reported on the New York Stock Exchange Composite Tape for a period including the two fiscal years ended May 31, 1994, are:\nsince fiscal 1990. The Company's current intent is to retain earnings for use in the Company's business and the financing of its capital requirements. The payment of any future cash dividends is necessarily dependent upon the earnings and financial needs of the Company, along with applicable legal and contractual restrictions.\nThe payment of dividends on the Company's capital stock is restricted pursuant to the indentures under which its publicly traded notes were issued.\nUnder applicable corporate law, the Company may pay dividends or make other distributions to its shareholders if (i) it would be solvent after giving effect to the distribution and (ii) the distribution would not exceed the Company's surplus. \"Surplus\" is defined as the excess of the net assets of the Company over its stated capital (stated capital being the total par value of the Company's outstanding capital stock plus all amounts transferred to stated capital, minus legal reductions from such sum).\nIn connection with the acquisition in March 1994 of the common shares of Triton Europe not owned by Triton, the Company issued 522,460 shares of its 5% Convertible Preferred Stock (\"5% preferred stock\") to the former holders of the Triton Europe common shares. Each share of the 5% preferred stock may be converted into one share of Triton Common Stock at any time on or after October 1, 1994. Each share of 5% preferred stock bears a cash dividend, which has priority over dividends on Triton's Common Stock, equal to 5% per annum on the redemption price of $34.41 per share, payable semi-annually on March 30 and September 30, commencing on September 30, 1994. The 5% preferred stock has priority over Triton Common Stock upon liquidation, and may be redeemed at Triton's option at any time on or after March 30, 1998 (or such earlier date as at least 75% of the shares originally issued have been converted into Common Stock) for cash equal to the redemption price. Any shares of 5% preferred stock that remain outstanding on March 30, 2004 must be redeemed at the redemption price either for cash or, at the Company's option, for shares of Triton Common Stock. See note 14 of Notes to Consolidated Financial Statements.\nIn June 1990, the Board of Directors of the Company adopted a Shareholder Rights Plan under which preferred stock rights were issued to holders of its Common Stock at the rate of one right for each share of Common Stock held as of the close of business on June 26, 1990.\nGenerally, the rights become exercisable only if a person acquires beneficial ownership of 15% or more of Triton's Common Stock or announces a tender offer for 15% or more of the Common Stock. If, among other events, any person becomes the beneficial owner of 15% or more of Triton's Common Stock, number of shares of Common Stock of the Company, which is equal to the amount obtained by dividing the right's exercise price (currently $40) by 50% of the market price of the Common Stock on the date of the first occurrence. In addition, if the Company is subsequently merged or certain other extraordinary business transactions are consummated, each right generally becomes a right to purchase such number of shares of common stock of the acquiring person which is equal to the amount obtained by dividing the right's exercise price by 50% of the market price of the Common Stock on the date of the first occurrence. Under certain circumstances, the Company's directors may determine that a tender offer or merger is fair to all shareholders and prevent the rights from being exercised. The Company will be entitled to redeem the rights at $0.01 per right at any time until the 10th day following the public announcement that a 15% position has been acquired. The rights will expire on June 26, 2000.\nAt August 18, 1994, there were 7,070 record holders of the Company's Common Stock.\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\nGENERAL\nBeginning in fiscal 1993, the Company initiated several strategic changes with respect to its exploration and development programs and non-oil and gas businesses. As a result, the Company is focusing its resources on what it regards as high potential exploration and development opportunities such as those in Colombia, Malaysia-Thailand and other areas. Producing properties, publicly owned subsidiaries and affiliates and non-oil and gas assets have been re-evaluated, and in some cases sold or restructured, in order to sharpen this focus.\nLIQUIDITY AND CAPITAL RESOURCES\nNet working capital was $116.8 million, $42.8 million and $14.7 million at May 31, 1994, 1993 and 1992, respectively, while the Company's debt as a percentage of total capital was 53% at May 31, 1994 and 41% at May 31, 1993. The Company has substantially reduced its cost of borrowing as evidenced by the lower interest rate of 9 3\/4% realized on the Company's debt offering in December 1993.\nFor the year ended May 31, 1994, funding requirements for operating expenses, capital expenditures and debt retirement were provided by proceeds from the sale of assets ($100 million) and approximately $124 million from the issuance of $170 million in principal amount of 9 3\/4% Senior Subordinated Discount Notes (\"9 3\/4% Notes\") due December 2000. Net cash used by operating activities in fiscal 1994 was $25 million, including $7.6 million used in discontinued operations.\nOn March 31, 1994, the Company acquired all of the outstanding shares of Triton Europe, not owned by the Company, representing the minority shareholders' 5% preferred stock, which added approximately $18 million to shareholders' equity.\nProceeds of approximately $126 million from the issuance of $240 million in principal amount of 12 1\/2% Senior Subordinated Discount Notes (\"1997 Notes\") due November 1997 and asset sales ($29.4 million) were the primary sources of funds required during 1993 for the Company's capital expenditures, operating expenses and debt retirement. Funding requirements for the year ended May 31, 1992 were met from cash flow provided by operating activities ($22.5 million) and the issuance of common stock in 1991 ($120.5 million).\nThe Company incurred capital expenditures and other capital investments of $86.8 million, $124.9 million and $98.4 million during the years ended May 31, 1994, 1993, and 1992, respectively, primarily resulting from exploration and development of the Cusiana and Cupiagua Fields in Colombia.\nCAPITAL REQUIREMENTS AND FUNDING ALTERNATIVES\nContinued funding for development of the oil fields in Colombia, including drilling and production facilities, as well as commitments for seismic, drilling and other exploration expenditures under various license, production sharing and other agreements, will require significant capital. At May 31, 1994, the Company had approximately $161.3 million in cash and marketable securities on hand, which the Company believes will be sufficient to fund currently anticipated capital expenditures into 1995. In addition, the Company has received a commitment from the Export-Import Bank of the United States (Eximbank) for a guarantee of up to $35 million of borrowings to purchase United States-sourced capital equipment under credit facilities to be negotiated. The Company's capital budget for the seven months ending December 31, 1994 (the Company's new fiscal year end) is approximately $110 million, excluding capitalized interest, of which approximately $85 million relates to Colombia.\nTotal capital requirements for full field development of the Cusiana and Cupiagua Fields in Colombia have not been finally determined, although they are expected to continue at substantial levels into 1997. A substantial portion of the Company's capital expenditures in Colombia have been, and for the foreseeable future are expected to be, for exploration and development activities relating to the Cusiana and Cupiagua Fields pursuant to contracts under which the Company is not the operator. For this reason, and because the geological characteristics of the fields are relatively complex and unpredictable, the Company's capital requirements, while substantial, are relatively difficult to predict.\nIn addition to drilling expenditures, significant capital will be necessary to finance the construction of needed additional Colombian transportation by many factors, including the partners' assessment of the fields' production potential and the participation of third party investors.\nA memorandum of understanding relating to the formation of a jointly owned and financed pipeline company has been entered into among the Company and the other working interest owners, and TransCanada PipeLines Colombia Limited and IPL Energy (Colombia) Ltd., but the memorandum is not binding on the parties unless and until definitive agreements relating to financing, throughput and other matters are negotiated. Moreover, the level and terms of the Company's capital contributions to the pipeline company would be affected by the capital structure of the pipeline company. The Company currently expects that approximately 70% of the pipeline company's capital structure will be debt.\nThe remaining additional indebtedness that may be incurred under debt limitation covenants relating to the Company's senior subordinated notes is expected to be substantially utilized by borrowings incurred in connection with the Eximbank guaranteed borrowings described above and similar export credit agency borrowings under facilities to be negotiated. The Company expects to meet the balance of its direct capital needs in 1995 and later years with cash on hand, marketable securities, increasing cash flow from Colombian operations, proceeds from asset sales, and possibly the issuance of equity securities.\nRESULTS OF OPERATIONS\nThe Company reported a net loss from continuing operations of $8.7 million in 1994, $81.8 million in 1993 and $91.6 million in 1992. The improvement, from 1993 to 1994, resulted principally from gains realized on the sale of Triton Canada common stock and other assets and lower writedowns of oil and gas properties, depreciation and depletion and equity losses from affiliates. The 1993 results improved compared to 1992 despite higher writedowns of oil and gas properties and other assets and lower oil and gas volumes, primarily due to lower losses in the aviation segment and income tax benefits resulting from the writedown of oil and gas properties in France and recognition of a deferred tax asset in the United States.\nThe Company has elected to change its fiscal year end from May 31 to December 31, commencing December 31, 1994. Management expects that the Company's results of operations for the seven month transition period ending December 31, 1994, will be less favorable than for the fiscal year May 31, 1994 or than would have been expected for a twelve month period ending May 31, 1995, primarily because the Company does not expect a material improvement in results of operations until the anticipated significant increase in Colombian production occurs.\nREVENUES\nSales and other operating revenues were $56.1 million in 1994, $104.3 $37.8 million from 1993 to 1994 while aviation sales and services decreased $7 million due to the divestiture of Triton Canada and non-core assets. Total revenues in 1994 include a $47.9 million gain on the sale of the Company's investment in Triton Canada. Other income increased during 1994 due to a $7 million gain on the sale of United States oil and gas properties, a $1.5 million gain on the sale of Aero Services International, Inc. (\"Aero\") and higher interest income of $2.4 million. The decrease in sales and operating revenues in 1993 compared to 1992 resulted from declines in oil and gas revenues ($5.1 million ) and aviation sales and services ($8.8 million).\nCOSTS AND EXPENSES\nOperating expenses of $41.6 million for the year ended May 31, 1994 decreased $14.4 million from the previous year, primarily due to oil and gas operations ($8.3 million), aviation operations ($2.1 million) and gas gathering and pipeline operations ($3.8 million) which have been sold. Operating expenses decreased $10.1 million from 1992 to 1993 principally due to lower aviation operating expenses of $10.6 million.\nGeneral and administrative expenses decreased $5.9 million from 1993 to 1994 as lower expenses in the oil and gas and aviation segments were partially offset by increases in personnel at the corporate office. General and administrative expenses during 1993 increased compared to 1992 due to severance costs and corporate staff increases, offset by staff reductions in the United States, Indonesia, France and Canada and lower directors' compensation. The decrease in directors' compensation resulted from a decline in both the shares and market value of outstanding stock appreciation rights.\nDepreciation, depletion and amortization of $20.5 million in 1994 decreased $25.9 million from 1993 due to lower depletion related to oil and gas operations. The increase from 1992 to 1993 was also related to oil and gas operations.\nWritedown of assets and loss provisions were $45.8 million, $103.4 million and $55.4 million for 1994, 1993 and 1992, respectively. Writedowns of oil and gas properties totaled $44.4 million in 1994, $91.2 million in 1993 and $35.8 million in 1992. Writedowns of aviation assets were $3.5 million and $6.3 million in 1993 and 1992, respectively. The Company also recorded loss provisions of $5.5 million in 1993 and $10 million in 1992 relating to the cost of actual or contemplated settlements and legal costs associated with pending litigation during those years.\nThe increase in interest expense since 1992 was due to higher outstanding debt resulting from the issuance of the 1997 Notes in November 1992 and the 9 3\/4% Notes in December 1993, offset by capitalized interest.\nEquity in earnings (loss) of affiliates was comprised of the following (in thousands):\nCrusader's 1994 earnings improvement resulted from a decrease in losses from the smokeless fuel operation in Ireland of $3.4 million and lower writedowns of $4.4 million. The 1993 Crusader loss was primarily a result of pre-operating costs associated with the smokeless fuel operation in Ireland ($8.4 million) and writedowns of its United States oil and gas properties ($5.3 million). The 1992 loss at Crusader resulted from writedowns of $9.8 million, of which $6.3 million pertained to coal properties and $3.5 million related to other property and equipment.\nFor the years ended May 31, 1993 and 1992, the Company's equity in the losses of Aero reflected loss provisions of $7.3 million and $11.8 million, respectively. These loss provisions reduced the carrying amounts of preferred stock, common stock, outstanding loans from the Company and receivables. The Company's investment in Aero was carried at zero cost during 1994.\nINCOME TAXES\nThe Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes\", effective June 1, 1992. The cumulative benefit of the change to the liability based method under SFAS No. 109 in 1993 was $4 million, or $.12 per share.\nThe income tax benefit of $6.5 million in 1994 was due to a foreign tax benefit of $10.7 million resulting from the ceiling test writedown of oil and gas properties in France, a gain of $1 million relating to a refund collected for taxes paid in connection with the 1991 sale of the North Sea properties and a $2 million refund due in France for the usage of net operating losses. These benefits were partially offset by $6.7 million of Canadian taxes due following the sale of the Company's investment in Triton Canada. Also included in the 1994 tax provision is deferred tax expense of $10 million related to Colombia and Argentina and a deferred tax benefit of $9.4 million related to the United States. The Company will continue to incur deferred taxes in foreign jurisdictions as capital investments are made without the continuing benefit from United States net operating losses.\nto a foreign tax benefit resulting from the writedown of oil properties in France and recognition of a $25 million net deferred tax asset in the United States.\nAt May 31, 1994, the Company had net operating loss and depletion loss carryforwards for United States tax purposes of approximately $212.3 million and $6.8 million, respectively. The net operating losses expire from 1996 through 2008 but the depletion carryforwards are available indefinitely. Corresponding net operating losses and depletion loss carryforwards at May 31, 1993 were $186.5 million and $6.8 million, respectively. The Company recorded a deferred tax asset of $34.4 million and $25 million at May 31, 1994 and 1993, respectively. The minimum amount of future taxable income necessary to realize the deferred tax asset is approximately $98 million. It is anticipated that future taxable income from Colombian operations and tax planning strategies involving the Company's corporate structure will be sufficient to realize the deferred tax asset.\nMINORITY INTEREST IN LOSS OF SUBSIDIARIES\nThe changes in minority interest corresponded with movements in operating losses realized by Triton Europe in 1992, 1993 and up until March 31, 1994, the date on which the Company acquired the minority interest shares in Triton Europe.\nDISCONTINUED OPERATIONS\nThe results of operations for the wholesale fuel products segment have been reported as discontinued operations due to the Company's decision to sell these businesses. The 1994 losses were offset against a loss provision recorded of $16.1 million, net of tax, at May 31, 1993. An additional accrual of $.7 million, net of tax, was recorded at May 31, 1994 to cover estimated operating losses associated with the final disposition of this segment. Also reported as a discontinued operation during fiscal 1992 were the results of operations for the Company's seismic equipment sales and services segment. The Company realized a net gain of $13.8 million during its first quarter of 1993 as a result of this sale. The Company's equity in the earnings of Input\/Output, Inc. was $2.1 million in 1992.\nThe following table and related discussion summarize the results of discontinued operations for the wholesale fuel products segment:\nFor the wholesale fuel products segment, both sales and expenses increased substantially during 1993 and 1992. This was due to the acquisition of three wholesale products distributors during those years. Also contributing was the establishment of gas and diesel operations in Texas and the Southeast. A resulting change in product mix led to lower margins during those years as non- aviation related sales increased in relation to total sales. The writedown of assets during 1993 related primarily to goodwill. The 1994 results have been affected by the divestitures that have taken place.\nINVESTMENTS IN MARKETABLE SECURITIES\nEffective May 31, 1994, the Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", which requires that investments in certain marketable debt securities be reported at fair value except for those investments in debt securities which management has the positive intent and ability to hold to maturity. Unrealized gains or losses related to trading investments are recorded in the income statement while unrealized gains or losses related to investments available-for-sale are recorded as a separate component of shareholders' equity. At May 31, 1994, the Company recorded a valuation reserve of $1 million in shareholders' equity representing the cumulative effect of adopting this standard.\nENVIRONMENTAL MATTERS\nThe Company is subject to extensive environmental laws and regulations. These laws regulate the discharge of materials into the environment and may require the Company to remove or mitigate\nthe environmental effects of the disposal or release of petroleum substances at various sites. Also, the Company remains liable for certain environmental in the storage, handling and sale of hazardous materials, including fuel storage in underground tanks. The Company believes that the level of future expenditures for environmental matters, including clean-up obligations, is impractical to determine with any reliable degree of accuracy. Management believes that such costs, when finally determined, will not have a material adverse effect on the Company's consolidated financial position. During the years ended May 31, 1994, 1993 and 1992, the Company accrued $4.4 million, nil and $1.2 million, respectively, for environmental costs. See Item 1. \"Business - - - - Oil and Gas Operations\", \"Business - Litigation\" and note 18 of Notes to Consolidated Financial Statements.\nSEGMENT REVIEW\nThe following table and related discussion summarize the contributions to operating loss by the Company's industry segments for the three years ended May 31, 1994. Operating loss represents sales and other operating revenues, less total costs and expenses (including writedowns of operating assets) and excludes, among other items, interest and other income\/expense and general corporate expenses.\nOIL AND GAS ACTIVITIES\nOil and gas sales decreased by $37.8 million in 1994 compared to 1993 primarily due to the sale of the Company's investment in Triton Canada ($14.5 million), sale of United States working interests ($8.6 million) and lower revenues in France resulting from a drop in production. The lower production reflects a continuing natural decline in the Villeperdue field. Average oil prices per barrel dropped by $3.88 between 1993 and 1994, resulting in an $8.1 million decrease in revenues during 1994, principally from price decreases in France ($4.46 per barrel or a $4.7 million effect). Price decreases in Indonesia, the United States and Colombia had a lesser impact, representing in the aggregate a $3.3 million effect in 1994. Colombian production increased to 467,000 barrels in 1994 from 219,000 barrels in 1993.\nOil and gas production costs were $26.6 million in 1994, $34.9 million in 1993, and $34.3 million in 1992. The decrease in 1994 was principally due to the sale of Triton Canada and United States properties ($9 million effect) and lower production in France ($3.1 million effect) partially offset by increased production in Colombia ($1.8 million effect) and an accrual for environmental 1992 was principally due to startup costs in Colombia and additional workover costs in Indonesia and France. These cost increases were partially offset by the lower production volumes during 1993. Average production costs per equivalent barrel of oil and gas production were $8.83 in 1994, $5.95 in 1993 and $5.35 in 1992. The increase per barrel in 1994 was primarily due to the United States environmental cleanup costs and lower United States production from the sale of working interest properties. Average production costs per equivalent barrel are expected to decrease once production increases in Colombia.\nGeneral and administrative expenses in this segment have decreased from $18 million in 1992 and 1993 to $11 million in 1994. Lower expenses in 1994 were primarily due to the restructuring in Europe ($4.6 million effect), the sale of Canada ($1.4 million effect), and higher capitalization ($2 million effect) caused by increased activity in Malaysia-Thailand. Affecting 1993 and 1992 were severance costs and other restructuring related expenses in Europe in 1993 and Canada in 1992 and growth in activity and personnel in Colombia. These were offset partially by the effect of staff reductions in the United States, Canada and Indonesia.\nOperating profits for this segment were significantly affected by writedowns of $43.2 million and $74.9 million in Europe during 1994 and 1993, respectively. During 1994, the writedowns related to SEC ceiling limitation requirements for the French cost pool. The 1993 writedowns reflected a decision to eliminate certain future development activities in the Villeperdue field, for which the Company recorded a significant decrease in its proved undeveloped reserves. A resulting drop in the Securities and Exchange Commission (\"SEC\") ceiling limitation for these properties led to a $55.7 million writedown of costs associated with the Company's proved oil properties. Additionally, in connection with Triton Europe's decision to eliminate certain exploration activities in both France and the United Kingdom, approximately $19.2 million of unevaluated properties were considered to be impaired. These costs were associated with various license areas that were relinquished or allowed to expire. Further, writedowns occurred in the United Kingdom, New Zealand and Indonesia during both 1992 and 1993 because of lower prices, downward adjustments\nof reserves or impairment. The 1992 writedown in Gabon resulted from the Company's relinquishment of its license area due to a lack of exploration success.\nAVIATION SALES AND SERVICES\nSales and operating expenses in this segment continued to decrease principally from the divestiture of three fixed based operations and a reduction in charter and maintenance revenues in 1994. The decreases in 1993 compared to and 1991 divestitures. Writedowns were recorded during 1993 and 1992 in order to reflect the permanent impairment of value or contemplation of various asset sales, pursuant to a restructuring plan initiated during 1990.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements required by this item begin at page hereof.\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 relating to the Company's directors and nominees for election as directors of the Company is incorporated herein by reference from the Company's Proxy Statement (herein so called) for its 1994 Annual Meeting of Shareholders, specifically the discussion under the heading \"Election of Directors\". It is currently anticipated that the Proxy Statement will be publicly available and mailed to shareholders in September 1994. Certain information as to executive officers is included herein under Item 1. \"Business - - - - Executive Officers\".\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe discussion under \"Management Compensation\" in the Company's Proxy Statement is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe discussion under \"Voting and Principal Shareholders\" in the Company's Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe discussion under \"Management Compensation\" in the Company's 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\n(a) The following documents are filed as part of this Annual Report on Form 10-K:\n1. Financial Statements: The financial statements filed as part of this report are listed in the \"Index to Financial Statements and Schedules\" on page hereof.\n2. Financial Statement Schedules: The financial statement schedules filed as part of this report are listed in the \"Index to Financial Statements and Schedules\" on page hereof.\n3. Exhibits required to be filed by Item 601 of Regulation S-K. (Where the amount of securities authorized to be issued under any of Crusader's long- term debt agreements does not exceed 10% of the Company's assets, pursuant to paragraph (b)(4) of Item 601 of Regulation S-K, in lieu of filing such as an exhibits, the Company hereby agrees to furnish to the Commission upon request a copy of any agreement with respect to such long-term debt.)\n3.2 Amended and Restated Bylaws of Triton Energy Corporation.(1)\n4.1 Specimen Stock Certificate of Common Stock, $1.00 par value, of the Company.(3)\n4.4 Rights Agreement dated as of June 26, 1990, between Triton and NationsBank of Texas, N.A. (f\/k\/a NCNB Texas National Bank), as Rights Agent.(3)\n4.5 Statement of Cancellation of Redeemable Shares, dated October 1, 1991. (7) 4.6 Form of Debt Securities.(12)\n4.7 Proposed Form of Senior Indenture.(12)\n4.8 Proposed Form of Senior Subordinated Indenture.(12)\n4.9 Senior Subordinated Indenture by and between the Company and United States Trust Company of New York, dated as of December 15, 1993.(11)\n4.10 First Supplemental Indenture by and between the Company and United States Trust Company of New York, dated as of December 15, 1993.(11)\n4.11 Statement of Resolution Establishing and Designating a Series of Shares of the Company, 5 % Convertible Preferred Stock, no par value, dated as of March 30, 1994.(13)\n10.1 Triton Energy Corporation Amended and Restated Retirement Income Plan.(11)\n10.2 Triton Energy Corporation Amended and Restated Supplemental Executive Retirement Income Plan.(11)\n10.3 1981 Employee Non-Qualified Stock Option Plan of Triton Energy Corporation.(2)\n10.4 Amendment No. 1 to the 1981 Employee Non-Qualified Stock Option Plan of Triton Energy Corporation.(6)\n10.5 Amendment No. 2 to the 1981 Employee Non-Qualified Stock Option Plan of Triton Energy Corporation.(2)\n10.6 Amendment No. 3 to the 1981 Employee Non-Qualified Stock Option Plan of Triton Energy Corporation.(11)\n10.7 1985 Stock Option Plan of Triton Energy Corporation.(3)\n10.8 Amendment No. 1 to the 1985 Stock Option Plan of Triton Energy Corporation.(2)\n10.9 Amendment No. 2 to the 1985 Stock Option Plan of Triton Energy Corporation.(11)\n10.10 Triton Energy Corporation Amended and Restated 1986 Convertible Debenture Plan.(11)\n10.11 1988 Stock Appreciation Rights Plan of Triton Energy Corporation.(5)\n10.12 Triton Energy Corporation 1989 Stock Option Plan.(8)\n10.13 Amendment No. 1 to the Triton Energy Corporation 1989 Stock Option Plan.(2)\n10.14 Amendment No. 2 to the Triton Energy Corporation 1989 Stock Option Plan.(11)\n10.15 Triton Energy Amended and Restated 1992 Stock Option Plan .(11)\n10.16 Form of Amended and Restated Employment Agreement by and among Triton Energy Corporation and certain officers of\n10.17 Triton Energy Amended and Restated Restricted Stock Plan.(11)\n10.18 Deed of Trust Note dated April 11, 1988, executed by Triton Aviation Services, Inc. and API Terminal, Inc. and related documents, including Guaranty of Triton Energy Corporation.(5)\n10.19 Triton Energy Corporation Executive Life Insurance Plan.(4)\n10.20 Triton Energy Corporation Long Term Disability Income Plan.(4)\n10.21 Triton Energy Corporation Amended and Restated Retirement Plan for Directors.(3)\n10.22 Indenture dated as of November 13, 1992 between Triton and Chemical Bank, with respect to the issuance of Senior Subordinated Discount Notes due 1997.(9)\n10.23 Supplemental Indenture dated as of July 1, 1993 between Triton Energy Corporation and Chemical Bank.(5)\n10.24 Supplemental Indenture dated as of August 16, 1993 between Triton Energy Corporation and Chemical Bank.(5)\n10.25 Underwriting Agreement dated June 18, 1993 among Triton Canada Resources Ltd., Triton Energy Corporation and the underwriters named therein.(10)\n10.26 Purchase and Sale Agreement among Triton Oil and Gas Corp., Triton Energy Corporation and Torch Energy Advisors Incorporated dated effective as of January 1, 1993.(5)\n10.27 Agreement for Purchase and Sale of Assets Among Triton Fuel Group, Inc. and AVFUEL Corporation dated August 25, 1993.(5)\n10.28 Contract for Exploration and Exploitation for Santiago de Atalayas I with an effective date of July 1, 1982, between Triton Colombia, Inc., and Empresa Colombiana De Petroleos.(5)\n10.29 Contract for Exploration and Exploitation for Tauramena with an effective date of July 4, 1988, between Triton Colombia, Inc., and Empresa Colombiana De Petroleos.(5)\n10.30 Summary of Assignment legalized by Public Instrument No. 1255 dated September 15, 1987 (Assignment is in Spanish language).(5)\n10.31 Summary of Assignment legalized by Public Instrument No. 1602 dated June 11, 1990 (Assignment is in Spanish language).(5)\n10.32 Summary of Assignment legalized by Public Instrument No. 2586 dated September 9, 1992 (Assignment is in Spanish language).(5)\n10.33 Guaranty between the company and Comerica Bank Texas.(11)\n10.34 Triton Energy Corporation 401(K) Savings Plan.(11)\n10.36 Contract between Malaysia-Thailand and Joint Authority and Petronas Carigali SDN.BHD. and Triton Oil Company of Thailand relating to Exploration and Production of Block A-18.(15)\n21.1 Subsidiaries of the Company.(1)\n23.1 Consent of Price Waterhouse, L.L.P.(1)\n23.2 Consent of KPMG Peat Marwick, L.L.P., Dallas, Texas.(1)\n23.3 Consent of KPMG Peat Marwick, Brisbane, Australia.(1)\n23.4 Consent of DeGolyer and MacNaughton.(1)\n23.5 Consents of McDaniel & Associates Consultants, Ltd.(1)\n24.1 The power of attorney of officers and directors of the Company as set forth on the signature page hereof.(1)\n99.1 Rio Chitamena Association Contract.(15)\n99.2 Rio Chitamena Purchase and Sale Agreement.(15)\n99.3 Integral Plan - Cusiana Oil Structure.(15)\n99.4 Letter Agreements with co-investor in Colombia.(15)\n99.5 Colombia Pipeline Memorandum of Understanding.(15)\n(1) Filed herewith. (2) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1992 and incorporated herein by reference. (3) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1990 and incorporated herein by reference. (4) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1991 and incorporated herein by reference. (5) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1993 and incorporated by reference herein. (6) Previously filed as an exhibit to the Company's Annual Report on Form 10-K for the fiscal year ended May 31, 1989 and incorporated by reference herein. (7) Previously filed as an exhibit to the Company's Registration Statement on Form S-3 (No. 33-42430) and incorporated herein by reference. (8) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1988 and incorporated herein by reference. (9) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1992 and incorporated herein by reference. (10) Previously filed as an exhibit to the Company's Current Report on Form 8-K dated as of July 14, 1993 and incorporated herein by reference. (11) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended November 30, 1993 and incorporated by reference herein. (12) Previously filed as an exhibit to the Company's Registration Statement on Form S-3 (No. 33-69230) and incorporated herein by reference. (13) Previously filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended February 28, 1994 and incorporated by reference herein. (14) Previously filed as an exhibit to the Company's current report on Form 8-K (15) Previously filed as an exhibit to the Company's current report on Form 8 -K\/A dated July 15, 1994 and incorporated by reference herein.\n(b) Reports on Form 8-K. On March 3, 1994, the Company filed a Current Report on Form 8-K, with respect to Item 5 of said Form, relating to the approval by state and federal district courts in Dallas of the settlement of all pending shareholder lawsuits against the Company and the approval of the minority shareholders of Triton Europe plc to the Company's purchase of their shares in Triton Europe plc. On March 15, 1994, the Company filed a Current Report on Form 8-K, with respect to Item 5 of said Form, relating to the finalization of agreements for commencement of joint petroleum operations in Block 18, located in the Malaysia-Thailand Joint Development Area. On April 14, 1994, the Company filed a Current Report on Form 8-K, with respect to Item 5 of said Form, relating to the approval of the Company's Board of Directors of the sale to a group of senior officers of $6.3 million aggregate principal amount of convertible subordinated debentures. On April 21, 1994, the Company filed a Current Report on Form 8-K, with respect to Item 5 of said Form, relating to the execution of a production sharing contract with the Malaysia-Thailand Joint Authority and the Malaysian National Oil Company. On April 28, 1994, the Company filed a current Report on Form 8-K, with respect to Item 5 of said Form, relating to the completion of a private placement of $41 million principal amount of ten year exchangeable notes by Crusader Limited, a 49.9% owned affiliate of the Company. On\nMay 25, 1994, the Company filed a Current Report on Form 8-K, with respect to Item 8 of said Form, relating to the change in fiscal year end of the Company.\n(c) See subitem (a) above.\n(d) See subitem (a) 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 Annual Report to be signed by the undersigned thereunto duly authorized on the 29th day of August, 1994.\nTRITON ENERGY CORPORATION\nBy: \/s\/ Thomas G. Finck -------------------------- Thomas G. Finck President and Chief Executive Officer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each of the undersigned officers and directors of Triton Energy Corporation (the \"Company\") hereby constitutes and appoints Thomas G. Finck, Robert B. Holland, III, and Peter Rugg, or any of them fact and agent, with full power of substitution, for him and on his behalf and in his name, place and stead, in any and all capacities, to sign, execute, and file any and all documents relating to the Company's Form 10-K for the fiscal year ended May 31, 1994, including any and all amendments and supplements thereto, with any regulatory authority, granting unto said attorneys, 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 in order to effectuate the same as fully to all intents and purposes as he himself might or could do if personally present, 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.\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 on behalf of the Registrant and in the capacities indicated on the 29th day of August, 1994.\nSignature Title --------- -----\n\/s\/ Thomas G. Finck President, Chief Executive Officer and Director ----------------------- Thomas G. Finck\n\/s\/ Peter Rugg Senior Vice President and Chief Financial --------------------- Officer Peter Rugg\n________________________________ Director Herbert L. Brewer\n\/s\/ Ernest E. Cook Director ------------------ Ernest E. Cook\n\/s\/ Ray H. Eubank Director ------------------ Ray H. Eubank\n\/s\/ Jesse E. Hendricks Director ---------------------- Jesse E. Hendricks\n\/s\/ William I. Lee Director ---------------------- William I. Lee\n\/s\/ John P. Lewis Director ---------------------- John P. Lewis\n- - - -------------------------------- Director Michael E. McMahon\n- - - -------------------------------- Director Graeme O. Morris\n- - - --------------------------------- Director Wellslake D. Morse, Jr.\n- - - --------------------------------- Director J.G.A. Tucker\n\/s\/ Fitzgerald S. Hudson ------------------------ Director Fitzgerald S. Hudson\n\/s\/ J. Otis Winters ------------------------- Director J. Otis Winters\nTRITON ENERGY CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS AND SCHEDULES\nAll other schedules are omitted as the required information is inapplicable or\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Triton Energy Corporation\nIn our opinion, the consolidated financial statements as of and for the years ended May 31, 1994 and 1993 listed in the accompanying index present fairly, in all material respects, the financial position of Triton Energy Corporation and its subsidiaries at May 31, 1994 and 1993, and the results of their operations and their cash flows for the years then ended 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.\nAs discussed in notes 1 and 3, the Company decided to discontinue its wholesale fuel products segment in 1993. We have audited the adjustments that were applied to restate the 1992 financial statements. In our opinion, such adjustments are appropriate and have been properly applied to the 1992 financial statements.\nAs discussed in note 1, the Company changed its method of accounting for investments in marketable securities at May 31, 1994 and its accounting for income taxes in 1993.\nPRICE WATERHOUSE LLP\nDallas, Texas July 19, 1994\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Triton Energy Corporation\nWe have audited the consolidated statements of operations, shareholders' equity and cash flows of Triton Energy Corporation and subsidiaries for the year ended May 31, 1992 (before restatement for discontinued wholesale fuel products operations). In connection with our audit of the consolidated financial statements, we also have audited the financial statement schedules as listed in the accompanying index for the year ended May 31, 1992. 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 financial statements and financial statement schedules based on our audit.\nWe conducted our audit in accordance with generally accepted auditing standards. 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 Triton Energy Corporation and subsidiaries for the year ended May 31, 1992, 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 LLP\nDallas, Texas August 14, 1992\nTRITON ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee accompanying notes to consolidated financial statements.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MAY 31, 1994 and 1993 (IN THOUSANDS, EXCEPT SHARE DATA )\nThe Company uses the full cost method to account for its oil and gas producing activities. See accompanying notes to consolidated financial statements.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS, EXCEPT SHARE DATA)\nSee accompanying notes to consolidated financial statements.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBUSINESS ACTIVITIES AND PRINCIPLES OF CONSOLIDATION\nTriton Energy Corporation (together with its majority-owned subsidiaries, the \"Company\") is an international energy company primarily engaged in oil and gas exploration activities. The Company's principal producing properties and development operations are located in Colombia, Argentina, France, Malaysia-Thailand and Australia, with a significant portion of its proved reserves located in Colombia.\nThe consolidated financial statements include the accounts of the Company. All significant intercompany balances and transactions have been in which the Company exercises significant influence over operating and financial policies are accounted for using the equity method. Investments in less than 20% owned affiliates are accounted for using the cost method.\nCASH EQUIVALENTS\nCash equivalents are highly liquid investments purchased with an original maturity of three months or less.\nINVESTMENTS IN MARKETABLE SECURITIES\nEffective May 31, 1994, the Company adopted Statement of Financial Accounting Standards (\"SFAS\") No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\", which requires that all investments in debt securities and certain investments in equity securities be reported at fair value except for those investments which management has the positive intent and the ability to hold to maturity. Investments available-for-sale are classified based on the stated maturity of the securities and changes in fair value are reported as a separate component of shareholders' equity. Trading investments are classified as current regardless of the stated maturity of the underlying securities and changes in fair value are reported in other income. Investments that will be held-to-maturity are classified based on the stated maturity of the securities. The cumulative effect of adopting this standard of $955,000 has been recorded as a valuation reserve in shareholders' equity. Prior to the adoption of SFAS No. 115, the Company accounted for its investments in debt securities at amortized cost and classified such investments according to the stated maturity of the underlying securities.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nINVENTORIES\nInventories are stated at the lower of cost (principally average cost) or market and primarily consist of equipment and supplies.\nPROPERTY AND EQUIPMENT\nThe Company follows the full cost method of accounting for exploration and development of oil and gas reserves, whereby all productive and nonproductive costs are capitalized. Individual countries are designated as separate cost centers. All capitalized costs plus the undiscounted future development costs of proved reserves are depleted using the unit of production method based on total proved reserves applicable to each country. A gain or loss is recognized on sales of oil and gas properties only when the sale involves significant reserves.\nCosts related to acquisition, holding and initial exploration of concessions in countries with no proved reserves are initially capitalized internal costs directly identified with acquisition, exploration and development activities and does not include costs related to production, general overhead or similar activities.\nThe net capitalized costs of oil and gas properties for each cost center, less related deferred income taxes, cannot exceed the sum of (i) the estimated future net revenues from the properties, discounted at 10%; (ii) unevaluated costs not being amortized; and (iii) the lower of cost or estimated fair value of unproved properties being amortized; less (iv) income tax effects related to differences between the financial statement basis and tax basis of oil and gas properties.\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 operations are accrued during production and classified as a long-term liability.\nSupport equipment and facilities are depreciated using the unit of production method based on total reserves of the field related to the support equipment and facilities. Other property and equipment, which includes furniture and fixtures, vehicles, aircraft and leasehold improvements, are depreciated principally on a straight-line basis over estimated useful lives ranging from 3 to 30 years.\nRepairs and maintenance are expensed as incurred and renewals and improvements are capitalized.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nENVIRONMENTAL MATTERS\nEnvironmental costs are expensed or capitalized depending on their future economic benefit. Costs that relate to an existing condition caused by past operations and have no future economic benefit are expensed. Liabilities for future expenditures of a noncapital nature are recorded when future environmental expenditures and\/or remediation is deemed probable, and the costs can be reasonably estimated.\nINCOME TAXES\nEffective June 1, 1992, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\", which requires deferred tax liabilities or assets be recognized for the anticipated future tax effects of temporary differences between the financial statement basis and the tax basis of the Company's assets and liabilities using the enacted tax rates in effect at year-end. This standard also requires a valuation allowance for deferred tax assets in certain circumstances. The cumulative benefit of the change to the June 1, 1992, the Company deferred the tax effects of timing differences between financial reporting and taxable income.\nFOREIGN CURRENCY TRANSLATION\nThe accounts of the Company's foreign operations are translated into United States dollars in accordance with SFAS No. 52. The United States dollar is the designated functional currency for all of the Company's foreign operations, except for those in Australia, Canada and New Zealand, where the local currencies are used as the functional currency. The cumulative translation effects from translating balance sheet accounts from the functional currency into United States dollars at current exchange rates are included as a separate component of shareholders' equity.\nDISCONTINUED OPERATIONS AND RECLASSIFICATIONS\nDuring 1993, the Company decided to discontinue its wholesale fuel products segment. The results of operations for this segment have been reported separately as discontinued operations in the Consolidated Statements of Operations.\nCertain other previously reported financial information has been reclassified to conform to the current year's presentation.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nISSUANCE OF STOCK\nThe Company recognizes gain or loss on issuances of common stock by subsidiaries and equity affiliates in the Consolidated Statements of Operations. Gain recognition is subject to the transaction not being part of a broader corporate reorganization and an objective determination of the value of the proceeds.\nEARNINGS (LOSS) PER COMMON SHARE\nEarnings (loss) applicable to common stock is based on the weighted average number of shares of common stock and common stock equivalents outstanding, unless the inclusion of common stock equivalents has an antidilutive effect. The Company's proportionate shares owned by Crusader Limited (\"Crusader\") are not considered outstanding for purposes of determining weighted average number of shares outstanding. Fully diluted earnings (loss) per common share is not presented due to the antidilutive effect of including all potentially dilutive securities.\n2. PURCHASE OF THE TRITON EUROPE MINORITY INTEREST\nOn March 31, 1994, the Company acquired all of the outstanding shares not owned by the Company, representing the minority shareholders' 40.5% interest in Triton Europe plc (\"Triton Europe\"), in exchange for 522,460 shares of the Company's 5% Convertible Preferred Stock (\"5% preferred stock\"), with a value of $17,978,000, and $2,551,000 in cash, including Company's common stock on a one for one basis and has a stated value of $34.41. The transaction was recorded as a purchase and accordingly, 100% of Triton Europe's operating results have been included in the Company's results of operations since March 31, 1994. The excess of the purchase price over the carrying value of the minority interest in Triton Europe of $3,485,000 has been allocated to the full cost pools within Triton Europe.\n3. DIVESTITURES AND DISCONTINUED OPERATIONS\nOn May 20, 1994, the Company sold all of its interest in Aero Services International, Inc. (\"Aero\") except for 134,592 shares of Series A preferred stock. The Company received proceeds of $1,500,000 and recorded a gain for the same amount.\nIn the first quarter, the Company completed the sale of its 76% interest in the common stock of Triton Canada Resources Ltd. (\"Triton Canada\"). The Company received net proceeds of $59,029,000 on September 10, 1993 and recorded a gain of $47,865,000.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nIn August and October 1993, the Company sold its United States working interest properties for net proceeds of $19,502,000, resulting in a gain of $7,028,000. The properties that were sold accounted for approximately 55.7% of discounted future net revenues associated with United States proved properties at May 31, 1993.\nIn fiscal 1993, the Company initiated a plan to discontinue its remaining operations in the wholesale fuel products segment. An accrual for $16,077,000 was recorded at May 31, 1993 as an estimate of the results of operations for discontinued operations during fiscal 1994 and the anticipated loss on disposal of the segment. Substantially all operations of the wholesale fuel products segment have been sold as of May 31, 1994 for proceeds totalling approximately $18,450,000. An additional accrual of $650,000 was recorded at May 31, 1994 to cover estimated operating losses caused by closing the sale of several operating divisions later than originally anticipated. The final sale of the remaining operations is imminent.\nSummarized information for the wholesale fuel products segment portion of discontinued operations follows:\nOn August 12, 1992, the Company sold its remaining 26.9% interest in Input\/Output, Inc. through a secondary public offering. The net proceeds from the offering were $24,144,000 and resulted in a net gain on the disposition of $13,841,000. The Company's equity in the earnings of Input\/Output, Inc. of $25,000 and $2,105,000 for fiscal 1993 and 1992, respectively, has been included in discontinued operations.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n4. WRITEDOWN OF ASSETS AND LOSS PROVISIONS\nWritedown of assets and loss provisions are summarized as follows:\nproperties in France were written down by $43,201,000 through application of the ceiling limitation prescribed by the Securities and Exchange Commission (the \"Commission\" or \"SEC\") principally as a result of a temporary drop in oil prices and a downward revision in estimated reserves.\nIncluded in the writedowns of evaluated and unevaluated properties during 1993 were $55,741,000 and $11,024,000, respectively, of costs associated with operations in France and an $8,185,000 writedown of unevaluated costs associated with onshore properties in the United Kingdom. These writedowns resulted from Triton Europe's decision to curtail certain exploration and development activities in Europe. As such, proved undeveloped reserves in Europe were reduced, thereby triggering a writedown of evaluated costs under the SEC ceiling limitation for these properties. The writedowns of unevaluated costs in both France and the United Kingdom were associated with various license areas that were relinquished or allowed to expire.\nSimilar cutbacks in Indonesia resulted in writedowns of costs associated with evaluated properties of $8,734,000 in 1993 and $13,672,000 in 1992. Also, during 1992 writedowns were recorded in Gabon (unevaluated, $7,021,000), the United States (evaluated, $2,169,000) and Canada (evaluated, $6,824,000).\nIn fiscal 1993, the Company settled or reached agreement to settle a number of lawsuits for which a loss provision of $5,500,000 was recorded.\nIn August 1992, the Company's share of a lawsuit settlement with the Company's former controller was $9,500,000. A loss provision of $9,950,000, including an estimate of outstanding legal fees and other expenses, was recorded in fiscal 1992.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n5. INVESTMENTS IN MARKETABLE SECURITIES\nThe amortized cost and estimated fair value of marketable securities are as follows:\nAt May 31, 1994, all securities categorized as held-to-maturity are classified as short-term investments. The maturities for the securities available-for-sale range from one to four years with the exception of one floating rate investment totalling $2,023,000 which matures after ten years. Investments categorized as trading at May 31, 1994 total $24,903,000 and are reported at fair value.\n6. INVESTMENTS IN UNCONSOLIDATED AFFILIATES\nA summary of investments in unconsolidated affiliates accounted for by the equity method follows:\nCRUSADER\nCrusader is an Australian public company engaged in oil and gas exploration and production, coal processing and mining, and gas processing in Australia, Canada, Ireland, the United States and other areas. The Company's investment in Crusader's common stock was $29,272,000 and $29,882,000 at May 31, 1994 and 1993, respectively. At May 31, 1994 and\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n1993, the Company's investment in Crusader also included $7,537,000 and $7,055,000, respectively, of convertible subordinated debentures issued by The quoted market value of the Company's investment in Crusader's common stock and convertible subordinated debentures at May 31, 1994 was $35,795,000 and $7,780,000, respectively.\nAt May 31, 1994 and 1993, Crusader owned approximately 3% of the Company's common stock. Crusader's investment in the Company, using the cost method of accounting, was $11,583,000 and $10,832,000 at May 31, 1994 and 1993, respectively. The Company's investment in Crusader and additional paid-in capital have each been reduced in order to eliminate the Company's proportionate share of its common stock owned by Crusader. During 1993 and 1992, Crusader recognized gains of $4,629,000 and $8,698,000, respectively, on the sale of 245,000 and 400,647 shares, respectively, of the Company's common stock. The Company's share of the sale proceeds has been credited to additional paid-in capital.\nOn April 28, 1994, Crusader issued $40,941,000 aggregate principal amount of 6% Exchangeable Senior Notes due February 14, 2004 (the \"6% Notes\"). The 6% Notes are exchangeable at the option of the holder after July 27, 1994 into the shares of the Company's common stock held by Crusader at a price of $36.75 per share upon certain terms.\nSummarized financial information for Crusader follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nSummarized financial information for Crusader, continued:\nThe Company's equity in undistributed earnings of Crusader accounted for by the equity method was approximately $25,000,000 at May 31, 1994.\nAERO\nAero is a public company that provides aviation related services. The Company sold all of its common stock interest in Aero as of May 20, 1994. The Company loaned to Aero $420,000 in 1994, $2,700,000 in 1993 and $2,000,000 in 1992 and during 1994 retired a $6,910,000 loan of Aero's which the Company had previously guaranteed and collateralized. No loans were outstanding at May 31, 1994. The Company's equity in Aero's loss (based on Aero's results for each of the three years in the period ended March 31, 1994) was nil in 1994, $9,481,000 in 1993 and $14,088,000 in 1992. The Company's equity in Aero's loss included loss provisions of investment in Aero's common and preferred stock and receivables from Aero.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n7. PROPERTY AND EQUIPMENT\nProperty and equipment at cost, are summarized as follows:\nThe Company capitalizes interest on qualifying assets, principally unevaluated oil and gas properties. Capitalized interest amounted to $16,863,000 in 1994, $6,407,000 in 1993 and $6,529,000 in 1992. The Company capitalized general and administrative expenses of $11,186,000 in 1994, $8,985,000 in 1993 and $10,410,000 in 1992.\n8. OTHER ASSETS\nOther assets consist of the following:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nIn 1994 and 1993, Triton Colombia, Inc., (\"Triton Colombia\") a wholly-owned subsidiary of the Company, purchased interests totaling approximately 6.6% in Oleoducto de Colombia S.A. (\"ODC\"), a pipeline company in Colombia, for total consideration of $11,108,000. The purchases were made to secure the transport capacity for the Company's oil production in Colombia.\nAs part of the purchase, the Company has agreed to assume by counter guarantee, directly and proportionally to part of the interest purchased, the guarantees granted to bank creditors of ODC through Shell Petroleum Company Ltd. and Shell Overseas Trading Limited.\nTriton Colombia, along with its joint venture partners in the Company's Cusiana and Cupiagua fields in Colombia, has committed to upgrade the capacity of the Central Llanos pipeline which is owned by Empresa Colombiana de Petroleos (\"Ecopetrol\"). The Company has advanced total costs of $10,930,000 through May 31, 1994 on this project, including $2,132,000 reflected in receivables. The Company will recover this cost through lower pipeline tariffs as crude oil is transported through this pipeline.\nThe Company amortizes debt issue costs using the interest method over the life of the notes. Amortization related to the Company's debt issue costs was $1,479,000 in 1994, $461,000 in 1993 and $65,000 in 1992.\n9. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES\nAccounts payable and accrued liabilities are summarized as follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n10. LONG-TERM DEBT\nA summary of long-term debt follows:\nThe Company completed the sale of $170,000,000 in principal amount of 9 3\/4% Senior Subordinated Discount Notes (\"9 3\/4% Notes\") due December 15, 2000, in December 1993, providing net proceeds to the Company of approximately $124,000,000. The original issue price was 75.1% of par, 9 3\/4% Notes during the first three years of issue. Commencing December 15, 1996, interest on the 9 3\/4% Notes will accrue at the rate of 9 3\/4% per annum and will be payable semi-annually on June 15 and December 15, beginning on June 15, 1997. The Indenture for the 9 3\/4% Notes contains financial covenants which include certain limitations on indebtedness, dividends, certain investments, transactions with affiliates, and engaging in mergers and consolidations. Additional provisions include optional and mandatory redemptions, and requirements associated with changes in control.\nOn November 13, 1992, the Company completed the sale of $240,000,000 in principal amount of Senior Subordinated Discount Notes (\"1997 Notes\") due November 1, 1997, providing net proceeds to the Company of approximately $126,000,000. The original issue price was 54.76% of par, representing a yield to maturity of 12 1\/2% per annum compounded on a semi-annual basis without periodic payments of interest. The Indenture, as amended, for the 1997 Notes contains financial covenants including certain limitations on indebtedness, dividends, certain investments, transactions with affiliates, mergers and consolidations, and maintenance of at least $225,000,000 in net worth. Additional provisions include optional and mandatory redemptions, and requirements associated with changes in control.\nAs of May 31, 1994, Triton Europe had a revolving credit facility with a group of foreign banks with a nominal amount of up to $30,000,000 and a conditional acquisition facility of up to $50,000,000. At May 31, 1994, the facility had a borrowing base of $11,135,000, based\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\non the discounted present value of Triton Europe's future net oil and gas production for use in its exploration and development in Europe, bearing interest at the London Interbank Offered Rate (4 5\/16% at May 31, 1994) plus 1\/2% to 5\/8%. Certain restrictive covenants in the agreement limit Triton Europe's ability to incur or guarantee indebtedness, dispose of certain assets and pay dividends. At May 31, 1994, Triton Europe had entered into negotiations to cancel the conditional acquisition facility, to reduce the nominal amount of the revolving credit facility to $20,000,000 and to include the Company as a borrower.\nAt May 31, 1993, Triton Canada had a C$24,000,000 bank credit facility, bearing interest at the bank's prime rate (6% at May 31, 1993) plus 1\/4%.\nThe aggregate maturities of long-term debt for the five years ending May 1997 - $259; 1998 - $158,879; and $263 for 1999. The 1998 amount excludes accretion of interest on the 1997 Notes.\n11. INCOME TAXES\nThe Company's provision for income taxes for 1994 and 1993 has been calculated in accordance with SFAS 109. For 1992 the provision was calculated in accordance with Accounting Principles Board Opinion No. 11.\nThe components of income (loss) from continuing operations before income taxes, minority interest, and cumulative effect of accounting change and the related income tax expense (benefit) follow:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nA reconciliation of the differences between the United States federal statutory tax rate and the Company's effective income tax rate follows:\nThe deferred income tax provision for 1992 resulted primarily from timing differences in the capitalization, depletion and writedown of costs relating to oil and gas properties.\nThe components of the net deferred tax asset and liability are as follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in tables in thousands)\nAt May 31, 1994, the Company had net operating loss and depletion carryforwards for United States tax purposes of approximately $212,338,000 and $6,800,000, respectively. In addition, at May 31, 1994, certain subsidiaries had separate return limitation year operating loss and depletion carryforwards of approximately $62,102,000 and $13,500,000, respectively, which are available to offset only the future taxable income of those subsidiaries. The depletion carryforwards are available indefinitely, and the net operating loss carryforwards expire principally from 1996 through 2008 and the separate return limitation year operating loss carryforwards expire from 1994 through 2000.\nIf certain changes in the Company's ownership should occur, there would be an annual limitation on the amount of carryforwards which can be utilized. To the extent a change in ownership does occur, the limitation is not expected to materially impact the utilization of such carryforwards.\nThe change in valuation allowance primarily reflects the increase in the Company's United States net operating loss carryforward, the effect of structure and a reduction in taxable temporary differences in France caused by 1994 writedowns under the SEC ceiling limitation.\nThe Company's share of the cumulative undistributed earnings of its consolidated foreign subsidiaries which is intended to be permanently reinvested, and on which no United States taxes have been provided, was approximately $5,615,000 at May 31, 1994. Unrecognized deferred taxes on remittance of these funds are not expected to be material.\nIn 1993, the Company added $3,920,000 to additional paid-in capital for United States tax benefits attributable to the utilization of net operating loss carryforwards. These carryforwards related to periods prior to the Company's corporate readjustments.\n12. EMPLOYEE BENEFITS\nPENSION PLANS\nThe Company has a defined benefit pension plan covering substantially all employees in the United States. The benefits are based on years of service and the employee's final average monthly compensation. Contributions are intended to provide for benefits attributed to past and future services. The Company also has a supplemental executive retirement plan (\"SERP\") which is unfunded and provides supplemental pension benefits to a select group of management or key employees. The funding status of the plans follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nA summary of the components of pension expense follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS, EXCEPT SHARE DATA)\nThe projected benefit obligations assume a 7% discount rate and a 5% and 6% rate of increase in compensation expense for 1994 and 1993, respectively. The impact of the change from 6% to 5% reduced the projected benefit obligation of the defined benefit plan and SERP by $540,000 and $294,000, respectively. The expected long-term rate of return on assets is 9% for the defined benefit plan.\nEMPLOYEE STOCK OWNERSHIP PLAN\nEffective January 1, 1994, the Company amended and restated the employee stock ownership plan to form a 401(k) plan (\"the plan\"). The Company recognizes expense relating to the plan based on actual amounts contributed since January 1, 1994 ($184,000) and the shares allocated method prior to the amendment ($312,000 in 1993 and $1,301,000 in 1992).\n13. REDEEMABLE PREFERRED STOCK OF SUBSIDIARY\nRedeemable preferred stock of Triton Canada, a former subsidiary, for 1993 was shown net of the unamortized discounts recorded at the date of acquisition. Dividends on the redeemable preferred stocks are included in minority interest in the accompanying consolidated statements of operations. The principal terms and changes in the redeemable preferred stocks are summarized as follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n14. SHAREHOLDERS' EQUITY\nPREFERRED STOCK\nIn connection with the aquisition of the minority interest in Triton Europe, the Company designated a series of 550,000 preferred shares (522,460 shares issued) as 5% preferred stock, no par value, with a stated value of $34.41 per share. Each share of the Company's 5% preferred stock series is convertible into one common share, subject to adjustment in certain events. The 5% preferred stock is convertible anytime on or after October 1, 1994 and bears a fixed cumulative cash dividend of 5% per annum payable semi-annually on March 30 and September 30, commencing September 30, 1994. If not converted earlier, each 5% preferred share will be redeemed on March 30, 2004, either for cash, or at the option of the Company, for the Company's common stock.\nCORPORATE READJUSTMENTS\nbeing penalized by an accumulated deficit, Article 4.13B of the Texas Business Corporation Act formerly provided that a company may, subject to its board of directors' approval, eliminate that deficit through application of additional paid-in capital. Pursuant to board of directors' approvals on January 12, 1987 and August 6, 1986, the Company eliminated accumulated deficits of $5,253,000 at November 30, 1986 and $28,653,000 at May 31, 1986.\nSTOCK OPTIONS\nOptions to purchase the Company's common stock have been granted to officers and employees under various stock option plans. Grants generally become exercisable in 25% cumulative annual increments beginning one year from the date of issuance and expire at the end of ten years. At May 31, 1994, 1,424,394 shares were available for grant under the plans. Pursuant to the 1992 stock option plan, each nonemployee director receives an option to purchase 15,000 shares each year. A summary of option transactions follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS, EXCEPT SHARE DATA)\nThe weighted average exercise price of options outstanding at May 31, 1994 was $33.52.\nCONVERTIBLE DEBENTURE PLAN\nThe Company has a convertible debenture plan under which key management personnel, consultants and other persons providing service to the Company may purchase debentures that are convertible into shares of the Company's common stock. The aggregate number of common shares issuable upon conversion of the debentures cannot exceed 1,000,000 shares, subject to adjustment in certain events. Each debenture represents an unsecured, subordinated obligation due in seven to ten years and may be redeemed after three years at a redemption price of 120% of the principal amounts. The debentures bear interest at the prime rate, have conversion dates ranging from one to three years following the date of issuance and may be converted into the Company's common stock at prices ranging from $8.00 to $25.13 per share, subject to adjustment in certain events. At May 31, 1994, 253,977 shares were available for grant under the plan.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS, EXCEPT SHARE DATA)\nThe participants in the plan purchased debentures by delivery of promissory notes to the Company. The promissory notes are secured by the debentures which are held as security by the Company, are due on the earlier of 2004 or termination of employment and require annual interest payments equal to prime plus 1\/8%. The debentures are reflected as a noncurrent liability, net of the related promissory notes, in the Consolidated Balance Sheets as follows:\nSHAREHOLDER RIGHTS PLAN\nIn June 1990, the Company's board of directors adopted a Shareholder Rights Plan pursuant to which preferred stock purchase rights were issued to holders of its common stock at the rate of one right for each share of common stock held as of the record date, June 26, 1990. The rights become exercisable only if a holder acquires beneficial ownership of 15% or more or announces a tender offer for 15% or more of the Company's common stock. Each right not owned by such 15% holder entitles the holder under such circumstance to purchase shares of common stock having a value equal to twice the $40 exercise price. The Company may redeem the rights at $.01 per right at any time until the 10th day following the public announcement that a 15% position has been acquired. Unless the rights become exercisable, they will expire on June 26, 2000.\nSTOCK APPRECIATION RIGHTS PLAN\nThe Company has a stock appreciation rights (\"SARs\") plan which authorizes the granting of SARs to nonemployee directors of the Company. Upon exercise, SARs allow the holder to receive the difference between the SARs' exercise price and the fair market value of the common shares covered by SARs on the exercise date and expire at the earlier of ten years or a date based on the termination of the holder's membership on the board of directors. At May 31, 1994, 1993 and 1992 SARs covering 55,454, 65,604 and 85,604 common shares, respectively, were outstanding. At May 31, 1994, exercise prices ranged from $8.00 to $13.20 per share, 55,454 shares were exercisable and 17,940 shares were available for future grant. Compensation expense (benefit) of $(340,000) in 1994, $850,000 in 1993 and $3,356,000 in 1992 was recorded based on the quoted market value of the shares and the exercise provisions.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nRESTRICTED STOCK PLAN\nThe Company has a restricted stock plan which provides for the award of up to 50,000 common shares to eligible key officers and employees. At the November 11, 1993 annual meeting, this plan was amended to also serve as an employee stock purchase plan. At May 31, 1994, 48,030 shares were available for issuance under the plan.\n15. CREDIT RISK CONCENTRATIONS AND FAIR VALUE OF FINANCIAL INSTRUMENTS\nSFAS No. 107 \"Disclosure About Fair Value of Financial Instruments\" requires disclosure, to the extent practicable, of the fair value of financial instruments which are recognized or unrecognized in the balance representative of the amount that could be realized or settled, nor does the fair value amount consider the tax consequences, if any, of realization or settlement. The table below reflects the financial instruments other than investments in marketable securities (see note 5) for which the fair value differs from the carrying amount of such financial instruments in the Company's balance sheet:\nThe fair value of the 1997 Notes is higher than the carrying amount in both 1994 and 1993 by $12,382,000 and $14,819,000, respectively, due to the improvements in the market for the Company's 1997 Notes reflecting investor demand. The fair value of the 9 3\/4% Notes is lower than the carrying amount in 1994 by $7,705,000 due to increases in interest rates following the notes offering. The fair value of redeemable preferred stock is based on market prices.\nThe Company entered into a foreign exchange contract to purchase C$8,600,000 which matured in July 1994 to hedge exposure to Canadian tax liabilities resulting from the sale of Triton Canada common stock. The fair value of the foreign exchange contract is based on year-end quoted rates for contracts with similar terms and maturity dates; however, such fair value is offset by gains on the tax liability hedged by the contract so that there is no significant difference between the recorded value and the fair value of the Company's net foreign exchange position.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nFinancial instruments that are potentially subject to concentrations of equivalents consist of high credit quality financial instruments. At May 31, 1994 and 1993, no receivable from any customer exceeded 5% of shareholders' equity and, except for the purchasers of the Company's oil production in France and Indonesia during 1994 and in France during 1993 and 1992, no customer accounted for more than 5% of sales and other operating revenues. See note 20. Receivables, principally trade, are shown on the balance sheet net of allowances of $873,000 and $1,162,000 at May 31, 1994 and 1993, respectively.\n16. OTHER INCOME\nOther income is summarized as follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n17. STATEMENTS OF CASH FLOWS\nSupplemental disclosures of cash payments and noncash investing and financial information follow:\n18. COMMITMENTS AND CONTINGENCIES\nCOMMITMENTS\nTests of the first eight wells in the Company's Cusiana and Cupiagua fields in Colombia indicate significant oil discoveries on which the Company expects to incur significant capital expenditures in the seven months ended December 31, 1994 for exploratory and development drilling, pipeline and production facilities and related activities. The Company's capital budget for the seven months ended December 31, 1994 is approximately $110,000,000, excluding capitalized interest, of which approximately $85,000,000 relates to Colombia. The seven-month budget period corresponds with the Company's intent to change its fiscal year-end to a calendar year-end beginning December 31, 1994, as announced on May 25, 1994. The Company believes that current working capital plus anticipated cash flows and asset sales will be sufficient to fund necessary expenditures into at least mid-1995.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nDuring the normal course of business, the Company is subject to the terms of various operating agreements and capital commitments associated with the exploration and development of its oil and gas properties. Many of these commitments are discretionary on the part of the Company. It is management's belief that such commitments, including the capital requirements in Colombia, discussed above, will be met without any material adverse effect on the Company's consolidated financial condition.\nThe Company leases office space, other facilities and equipment under various operating leases expiring through 2009. Total rental expense was $2,648,000 in 1994, $3,957,000 in 1993 and $4,987,000 in 1992, including 1993 and 1992, respectively. At May 31, 1994, the minimum payments required, including discontinued operations are as follows (thousands of dollars): 1995 - $3,543; 1996 - $3,843; 1997 - $3,552; 1998 - $3,139; 1999 - $2,878 and thereafter - $4,174.\nGUARANTEES\nAt May 31, 1994, the Company had guaranteed approximately $8,555,000 of loans related to its ownership in a Colombian pipeline and $1,695,000 for exploration in Italy. The Company has also guaranteed up to $1,300,000 in indebtedness that may be incurred by the chief executive officer of the Company to finance the construction of his primary residence.\nREGULATORY MATTERS\nThe Company continues to cooperate with inquiries by the Commission and the Department of Justice (the \"Department\") regarding possible violations of the Foreign Corrupt Practices Act in connection with the Company's operations in Indonesia. Based upon the information available to the Company to date, the Company believes that it will be able to resolve any issues that either the Commission or the Department ultimately might raise concerning these matters in a manner that would not have a material adverse effect on the Company's consolidated financial condition.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nENVIRONMENTAL MATTERS\nThe Company is subject to extensive environmental laws and regulations. These laws regulate the discharge of materials into the environment and may require the Company to remove or mitigate the environmental effects of the disposal or release of petroleum substances at various sites. Also, the Company remains liable for certain environmental matters that may arise from formerly owned fuel businesses which were involved in the storage, handling and sale of hazardous materials, including fuel storage in underground tanks. The Company believes that the level of future expenditures for environmental matters, including clean-up obligations, is impracticable to determine with a precise and reliable degree of accuracy. Management believes that such costs, when finally determined, will not have a material adverse effect on the Company's consolidated financial position. During the years ended May 31, 1994, 1993 and 1992, the Company accrued $4,400,000, nil and $1,234,000, respectively, for environmental costs.\nLITIGATION\nThe Company is also subject to ordinary litigation that is incidental to its business, none of which is expected to have a material adverse effect on the Company's consolidated financial condition.\n19. RELATED PARTY TRANSACTIONS\naffiliates at May 31, 1992 included $1,880,000 and $1,744,000, respectively, due from Aero for fuel purchases. Total fuel sales to Aero were $1,030,000 in 1994, $3,960,000 in 1993 and $2,941,000 in 1992. In fiscal 1992, the Company purchased certain equipment from Aero for $547,000 and leased the equipment back to Aero pursuant to an operating lease with annual rentals of $147,000 over a five-year term.\nThe Company charged Crusader $585,000 in 1994, 1993 and 1992 for administrative services. Also during 1994, the Company was paid $1,200,000 by Crusader for acting as agent in issuing its 6% Notes and recorded $620,000 as other income.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in tables in thousands)\n20. SEGMENT AND GEOGRAPHIC DATA\nThe Company is an independent energy company engaged in oil and gas exploration and production in 11 countries. The Company also provides aviation related products and services.\nSegment data follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Amounts in tables in thousands)\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nInformation about the Company's operations by geographic area follows:\nSubstantially all oil sales in France were to Societe Nationale Elf Aquitaine, which is principally owned by the French government. All oil sales in Indonesia are sold to Pertamina, the Indonesian government oil company.\n21. SUBSEQUENT EVENTS (UNAUDITED)\nOn July 26, 1994, the Export-Import Bank of the United States authorized a final commitment for a comprehensive guarantee of approximately $35 million for certain financing related to the Company's interest in initial field development of its Cusiana project in Colombia. The guarantee covers expenditures for oilfield equipment and other machinery manufactured in the United States for export to the Colombian project. The effective date for coverage is retroactive for purchases made since March 3, 1993.\nEffective July 19, 1994, the Company's wholly-owned subsidiary, Triton Colombia, purchased from BP Exploration Company (Colombia) Limited (\"BP\") and Total Exploratie En Produktie Maatschappij B.V. (\"TOTAL\") an undivided 1% and 11% interest, respectively, in the Association Contract for Sector Rio Chitamena for $9,800,000. Additional consideration of $1,100,000 is to be paid upon the occurrence of certain conditions, but not before January 3, 1995.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nOn July 19, 1994, Triton Colombia, BP, TOTAL and Ecopetrol entered into an Integral Plan for the Unified Exploitation of the Cusiana Oil Structure in the Santiago de las Atalayas (\"SDLA\"), Tauramena and Rio Chitamena Association Contract Areas. Under the plan, the parties have agreed to develop the Cusiana oil structure in a technically efficient and cooperative manner during the three consecutive periods of time represented by the successive expirations of the three association contract areas covering the extent of the Cusiana oil structure. During each period, petroleum produced from the unified area will be owned by the parties according to their respective undivided interests in each unexpired contract area based on the original barrels of oil equivalent in place under each contract area.\nOn July 15, 1994, Triton Colombia executed a memorandum of understanding with Ecopetrol, BP, TOTAL, TransCanada PipeLines Colombia Limited and IPL Energy (Colombia) Ltd., regarding the proposed formation of a joint stock company to finance and own a pipeline and port facilities. This project is Cusiana and Cupiagua fields to the port of Covenas. The Company's equity participation under this agreement would be approximately 9.6%. Formation of the joint stock company is subject to numerous conditions, including negotiation and execution of definitive agreements and board approvals.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\n22. QUARTERLY FINANCIAL DATA (UNAUDITED)\nGross profit (loss) consists of sales and other operating revenues less operating expenses, depreciation, depletion and amortization and writedowns pertaining to operating assets.\nIn the fourth quarter of 1994, the Company recorded writedowns of $6,845,000, primarily resulting from application of the SEC ceiling limitation caused by a downward revision in the estimated reserves for France. The Company also recognized a gain of $1,500,000 on the sale of its investment in Aero.\nIn the fourth quarter of 1993, the Company recorded a loss provision of $16,077,000 on the discontinued operations of the wholesale fuel segment. $3,920,000 was booked to additional paid-in capital, with the adoption of SFAS No. 109 due to the then pending sale of Triton Canada, the sale of certain domestic properties and anticipated income from Colombian operations.\n23. OIL AND GAS DATA\nThe following tables provide additional information about the Company's oil and gas exploration and production activities. Equity affiliate amounts reflect only the Company's proportionate interest in Crusader.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nRESULTS OF OPERATIONS\nThe results of operations for oil and gas producing activities, considering direct costs only, follow:\nThe Company's equity share of Crusader's results of operations for oil and gas producing activities follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nCOSTS INCURRED AND CAPITALIZED COSTS\nThe costs incurred in oil and gas acquisition, exploration and development activities and related capitalized costs follow:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nA summary of costs excluded from depletion at May 31, 1994 by year incurred follows:\nThe Company has significant property acquisition and exploration costs which have not been evaluated and are not currently subject to depletion. At this time the Company is unable to predict either the timing of the inclusion of those costs and the related oil and gas reserves in its depletion computation or their potential future impact on depletion rates. Drilling or other exploration activities are being conducted in each of these cost centers. The major development project relates solely to Cusiana and is expected to be placed in service within one year.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nThe Company's equity share of costs incurred by Crusader follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nOIL AND GAS RESERVE DATA (UNAUDITED)\nThe following tables present the Company's estimates of its proved oil and gas reserves. These estimates were prepared by the Company's independent and internal petroleum reservoir engineers. The Company emphasizes that reserve estimates are inherently imprecise and are expected to change as future information becomes available. Oil reserves are stated in thousands of barrels and gas reserves are stated in millions of cubic feet. The largest portion of the Company's reserves relate to the SDLA and Tauramena contract areas in Colombia. The Company had a 20% and 50% interest in the reserves of SDLA and Tauramena, respectively, for 1992 and 1991. The reserves for 1994 and 1993 reflect the equalization of these interests to 24% and Ecopetrol's decision to exercise its contractual right to acquire 50% of the working interest through the declaration of commerciality. The Company consequently has a 9.6% working interest in these areas after 20% governmental royalties.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nThe Company's proportional equity interest in Crusader's estimated proved developed and undeveloped oil and gas reserves at May 31 follows:\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH INFLOWS AND CHANGES THEREIN (UNAUDITED)\nThe following table presents a standardized measure of discounted future net cash inflows relating to proved oil and gas reserves. Future cash inflows were computed by applying year-end prices of oil and gas relating to the Company's proved reserves to the estimated year-end quantities of those reserves. Future price changes were considered only to the extent provided by contractual agreements in existence at year-end. Future production and development costs were computed by estimating those expenditures expected to occur in developing and producing the proved oil and gas reserves at the end of the year, based on year-end costs. Actual future cash inflows may vary considerably and the standardized measure does not necessarily represent the fair value of the Company's oil and gas reserves.\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nThe Company's proportional equity interest in Crusader's standardized measure of discounted future net cash inflows follows:\nTRITON ENERGY CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (AMOUNTS IN TABLES IN THOUSANDS)\nChanges in the standardized measure of discounted future net cash inflows follow:\nAt May 31, 1994, 1993 and 1992, nil, $33,426,000 and $61,364,000, respectively, of the consolidated standardized measure of discounted future net cash inflows was attributable to minority interests in consolidated subsidiaries. The Company's weighted average oil price per barrel during 1994 and at May 31, 1994 was $15.38 and $16.64, respectively.\nSCHEDULE II\nTRITON ENERGY CORPORATION AND SUBSIDIARIES AMOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS, AND EMPLOYEES OTHER THAN RELATED PARTIES THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS)\nSCHEDULE V\nTRITON ENERGY CORPORATION AND SUBSIDIARIES PROPERTY AND EQUIPMENT THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS)\nSCHEDULE VI\nTRITON ENERGY CORPORATION AND SUBSIDIARIES ACCUMULATED DEPRECIATION AND DEPLETION OF PROPERTY AND EQUIPMENT THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS)\nSCHEDULE VIII\nTRITON ENERGY CORPORATION AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS)\nSCHEDULE IX\nTRITON ENERGY CORPORATION AND SUBSIDIARIES SHORT-TERM BORROWINGS THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS, EXCEPT PERCENTAGES)\nSCHEDULE X\nTRITON ENERGY CORPORATION AND SUBSIDIARIES SUPPLEMENTAL STATEMENTS OF OPERATIONS INFORMATION THREE YEARS ENDED MAY 31, 1994 (IN THOUSANDS)\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors of Crusader Limited\nWe have audited the consolidated financial statements of Crusader Limited and 1(a), have been prepared on the basis of accounting principles accepted in the United States by restating the primary consolidated financial statements of Crusader Limited which are denominated in Australian dollars and prepared in accordance with Australian Accounting Standards. In connection with our audit of the consolidated financial statements, we also audited the 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 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 Crusader Limited and subsidiaries for the year ended May 31, 1992, in conformity with accounting principles generally accepted in the United States. 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\nBrisbane, Australia August 14, 1992\nCRUSADER LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EARNINGS YEAR ENDED MAY 31, 1992 (IN THOUSANDS, EXCEPT SHARE DATA)\nSee accompanying notes to consolidated financial statements.\nCRUSADER LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY YEAR ENDED MAY 31, 1992 (IN THOUSANDS, EXCEPT SHARE DATA)\nSee accompanying notes to consolidated financial statements.\nCRUSADER LIMITED AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS YEAR ENDED MAY 31, 1992 (IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\n(a) PRINCIPLES OF PRESENTATION AND CONSOLIDATION\nCrusader Limited is incorporated in Queensland, Australia. The primary consolidated financial statements of Crusader Limited and its subsidiaries (the \"Company\") are denominated in Australian dollars and prepared in accordance with Australian Accounting Standards.\nThe accompanying consolidated financial statements reflect the result of restating the primary consolidated financial statements of the Company into United States dollars and in accordance with United States generally accepted accounting principles for inclusion as supplementary information in the Form 10-K of Triton Energy Corporation (\"Triton\") which at May 31, 1992 owned approximately 49.9% of the issued common stock of the Company.\nAll significant intercompany balances and transactions have been eliminated in consolidation.\n(b) INVENTORIES\nInventories are stated at the lower of cost (first-in, first-out or average) or market value.\n(c) PROPERTY AND EQUIPMENT\nThe Company follows the full cost method of accounting for costs of exploration and development of oil and gas reserves, whereby all productive and nonproductive costs, including costs applicable to internal technical personnel directly associated with these efforts, are capitalized. Individual countries are designated as separate cost centers. All capitalized costs plus the undiscounted future development costs of proved reserves are depleted on the unit-of-production method based on total proved reserves applicable to each country. Gain or loss is recognized only on sale of oil and gas properties involving significant reserves.\nCosts related to acquisition, holding and initial exploration of areas in which proved reserves have not been established are capitalized and periodically evaluated for possible impairment.\nCosts related to exploration and development of hardrock mineral properties are capitalized in respect of each separate area of interest until such time as a discovery is made or the area is abandoned. Exploration and development expenditures which are not expected to be recovered from future production or those associated with abandoned properties are charged to producing areas are amortized on the units-of-production method based on total reserves applicable to the area.\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nRestoration work is carried out progressively during the course of mining. Provision is made over the life of the mine for the cost of finally restoring distributed areas after mining is completed.\nSubstantially all depreciation of other property is provided at rates based on the estimated useful lives of the property.\nThe Company capitalizes interest on qualifying assets, principally coal briquetting plant and unevaluated oil and gas properties. Interest capitalized was $2,161,000 in 1992.\nThe coal briquetting plant was constructed during fiscal 1992 and will commence commercial production during fiscal 1993.\nRepairs and maintenance are expensed as incurred and renewals and betterments are capitalized.\n(d) FOREIGN CURRENCY TRANSLATION\nThe Company's primary financial statements have been translated into United States dollars in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 52. Exchange adjustments resulting from foreign currency transactions are recognized in income, whereas adjustments resulting from translations of financial statements are reflected as a separate component of shareholders' equity. Local currencies are used as the functional currencies.\n(e) INCOME TAXES\nDeferred income taxes are provided for the tax effect of timing differences in the recognition of revenue and expense for income tax and financial accounting purposes.\nIn February 1992, the Financial Accounting Standards Board issued SFAS No. 109, \"Accounting for Income Taxes,\" which will require the Company to change its method of accounting for income taxes. The Company currently accounts for income taxes under APB 11, having elected not to adopt SFAS No. 96 prior to its required effective date. SFAS No. 109 will change the Company's method of accounting for income taxes from the deferred method required by APB 11 to the asset and liability method. The Company is currently required to adopt the provisions on either a prospective or retroactive basis during its fiscal year ending May 31, 1994. The Company has not yet determined the effects of adopting the new statement, nor whether the statement will be prospectively or retroactively applied.\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n(f) EARNINGS PER COMMON SHARE\naverage shares outstanding. Shares issuable upon conversion of the convertible notes issued during 1989 are excluded from the computation as the effect is antidilutive.\n(g) STATEMENT OF CASH FLOWS\nThe Company generally considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents.\n2. INVESTMENTS\nINVESTMENT IN TRITON ENERGY CORPORATION\nAt May 31, 1992, the Company owned approximately 4% of Triton's common stock. The Company's investment in Triton, using the cost method, was $14,632,000 at May 31, 1992. During 1989, a subsidiary of the Company advanced to Triton from surplus U.S. dollar funds an amount of $7,000,000, bearing interest at 12.5%, and repayable in four equal installments commencing February 1990. The unpaid balance of the advances was nil and $3,500,000 at May 31, 1992 and 1991, respectively. Triton also performs administrative services on behalf of the Company. Fees for these services amounted to $585,000 in 1992.\nIn February and May, 1992, the Company sold 400,647 shares of Triton common stock for $14,084,000, resulting in a gain of $8,698,000.\nINVESTMENT IN AUSTRALIAN HYDROCARBONS N.L. (\"AHY\")\nAt May 31, 1992 the Company owned approximately 49% of AHY, a company which operates in the oil and gas industry in Australia and the United States. As a result of the ownership and majority representation on the AHY Board of Directors, the Company began consolidating its interest in AHY during 1991. The results of AHY's operations are not material to the Company's consolidated financial statements.\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n3. INCOME TAXES\nThe components of income tax expense consisted of the following for the year ended May 31, 1992 (in thousands):\nA reconciliation of the differences between the amounts computed by applying the Australian federal statutory tax rate of 39% to loss before income taxes and minority interest and the actual income taxes for the year ended May 31, 1992 follows (in thousands):\nDeferred taxes arose primarily due to deferred income for financial statement purposes and variations in the Company's capitalization policies concerning exploration expenditures and related depletion for income tax and financial reporting purposes.\n4. RETIREMENT PLANS\nThe Company contributes to a defined benefit retirement plan administered by a Board of Trustees, covering substantially all employees. Contributions and benefits are actuarially determined. A subsidiary of the Company also contributes to a defined contribution retirement plan, administered by a Board of Trustees, covering substantially all its employees. Another subsidiary contributes to a deferred profit sharing plan administered by a Board of Trustees covering substantially all of its employees. Total plan contributions were $511,000 in 1992.\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n5. COMMITMENTS AND CONTINGENCIES\nThe Company leases office facilities, motor vehicles and plant with minimum average annual rentals of approximately $633,000 under terms of various leases expiring from 1992 through 1996.\nThe Company has an interest in the Cooper Basin Gas and Liquids Unit of South Australia. The owners' participation factors in production, capital investment and certain operating expenses are periodically reviewed in relation to each party's interest in the reserves of the unit. In fiscal 1990, the Company recorded adjustments to reflect a downward adjustment of its interest in the unit, to approximately 6% which was retroactive to January 1, 1987. The 6% interest has been utilized in the financial statements for 1992.\nOn June 18, 1991, the Supreme Court of South Australia decided that this January 1, 1987 review and adjustment was invalid. The effect of this decision is that the January 1, 1987 review and adjustment will be redone and meanwhile each party will be restored to their pre-January 1, 1987 retroactive to January 1, 1989 and January 1, 1991, have been suspended pending the outcome of the January 1, 1987 review and adjustment.\nAs a result of the above, net revenue totaling $23,750,000 has been deferred for the period January 1, 1987 to May 31, 1992.\nThe Company is presently undergoing an audit by the Australian Taxation Office (\"ATO\") in respect of the 1989 and 1990 fiscal years as part of the ATO's program to audit all major Australian public companies. Discussions are continuing between the Company, its advisors and the ATO, particularly in respect of submissions made by the ATO regarding interest on certain intercompany offshore loans.\nThe outcome of the audit is uncertain at this point in time and the Company is presently unable to estimate the likely amount of any additional or penalty taxes that may be assessed to the Company. Any such taxes will be vigorously disputed by the Company. Although the outcome of this matter cannot presently be determined, the Company does not believe that it would be material to its financial condition.\n6. FINANCIAL INSTRUMENTS AND CREDIT RISK CONCENTRATIONS\nFinancial instruments that are potentially subject to concentration of credit risk consist principally of cash equivalents and receivables. Cash equivalents consist of high credit quality financial instruments. At May 31, 1992, no receivable from any customer exceeded 5% of shareholders' equity and, except for two purchasers of the Company's gas production in Australia and two purchasers of the Company's coal production, no customer accounted for more than 5% of sales and other operating revenues in 1992. See note 7 regarding concentration of receivables by business segment and geographic area at May 31, 1992.\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n7. SEGMENT DATA\nThe Company is engaged principally in oil and gas exploration and production, coal mining, coal processing and gas processing. Segment data follows for 1992 (thousands of dollars):\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nContracts with two unaffiliated customers accounted for approximately $8,829,000 and $6,484,000 in 1992 of gas sales in Australia. Most of the Company's coal production is exported to Japan and Europe under short-term contracts. Two unaffiliated customers, accounted for sales of approximately $9,214,000 and $8,826,000 in 1992.\nGeographical segment information follows for 1992 (thousands of dollars):\nOther is grouped with Australia in all years.\nsubsidiaries which conducted its coal operations in South East Asia for $5,160,000 in cash. The cash proceeds are to be used to improve working capital. The loss resulting from this sale of $3,135,000 has been reflected in the writedown of unevaluated coal properties in the year ended May 31, 1992.\nWritedown of assets for the year ended May 31, 1992 included $2,353,000 relating to proved coal properties and plant, $4,020,000 relating to unevaluated coal properties and $3,503,000 relating to other property and equipment.\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n8. OIL AND GAS DATA\nThe following tables provide additional information about the Company's oil and gas exploration and production activities for 1992:\nRESULTS OF OPERATIONS\nThe results of operations considering direct costs only for oil and gas producing activities follow (thousands of dollars):\nCOSTS INCURRED AND CAPITALIZED COSTS\nThe total costs incurred in oil and gas property acquisition, exploration and development activities and related capitalized costs follow (thousands of dollars, except per barrel data):\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nOIL AND GAS RESERVE DATA (UNAUDITED)\nThe following table presents the Company's estimates of its proved oil and gas reserves. These estimates were prepared by the Company's independent petroleum reservoir engineers. The Company emphasizes that reserve estimates are inherently imprecise and are expected to change as future information becomes available. Liquid reserves are stated in thousands of barrels and gas reserves are stated in millions of cubic feet.\nSTANDARDIZED MEASURE OF DISCOUNTED FUTURE NET CASH FLOWS AND CHANGES THEREIN (UNAUDITED)\nThe following table (thousands of dollars) presents a standardized measure of discounted future net cash flows and changes therein relating to proved oil and gas reserves. Future cash inflows were computed by applying year-end prices of oil and gas relating to the Company's proved reserves to the estimated year-end quantities of these reserves. Future price changes were considered only to the extent provided by contractual agreements in existence at year-end. Future production and development costs were computed 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. The standardized measure of discounted future cash flows represents the present value of estimated future net cash flows using a discount rate of 10% per annum. Actual future cash inflows may vary considerably and the standardized measure does not necessarily represent the fair value of the Company's oil and gas reserves.\nCRUSADER LIMITED AND SUBSIDIARIES\nChanges in the standardized measure of discounted future cash flows follow (thousands of dollars):\n9. RELATED PARTY DISCLOSURES\nA subsidiary of the Company has entered into an agreement with PT Karimtanisa Utama (\"Karimtanisa\"), a company in which the wife of a director of the subsidiary has an interest. Under the agreement the subsidiary will farm into exploration areas in Indonesia in which Karimtanisa has interests. These agreements were, in the main, entered into before the director became so related and all before he became a director. They require the subsidiary to fund exploration and development (if any) and to pay certain sums to Karimtanisa in the future at various stages if the subsidiary chooses to proceed to commercially develop any of these interests. Subsequent to May 31, 1992, the Company sold this subsidiary. In addition, the director has resigned subsequent to May 31, 1992.\nCRUSADER LIMITED AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nTriton owns 49.9% of Crusader's 12% Convertible Subordinated Unsecured Notes on which Triton received $957,000 in interest during fiscal 1992.\n10. EVENTS (UNAUDITED) SUBSEQUENT TO THE DATE OF THE REPORT OF INDEPENDENT ACCOUNTANTS\nIn February 1993, a settlement of the January 1, 1987 Review and Adjustment dispute (see note 5) was reached in principle between Crusader and Santos Limited. Under the terms of the settlement, Crusader's interest in an expanded area of interest is fixed at 4.75%. Previously, Crusader's interests have been limited to the Cooper Basin Unit and the Nappacoongee Murteree Block. Under the terms of the settlement agreement, Crusader's interests would be expanded to include certain additional leases. Also in connection with this arrangement the total of net revenues that were deferred by Crusader since January 1, 1987, was remitted to the Unit Operator.\nThe audit by the Australian Taxation Office (ATO) (see note 5) has been completed and as a result an additional tax expense of approximately US$800,300 was recorded in the 1993 fiscal year.\nThe coal briquetting plant commenced production during the first quarter of fiscal 1994.\nSCHEDULE V CRUSADER LIMITED AND SUBSIDIARIES PROPERTY AND EQUIPMENT YEAR ENDED MAY 31, 1992 (IN THOUSANDS)\n- - - -------------------------- Note - Other changes principally represent foreign currency translation adjustments.\nSCHEDULE VI CRUSADER LIMITED AND SUBSIDIARIES ACCUMULATED DEPRECIATION AND DEPLETION OF PROPERTY AND EQUIPMENT YEAR ENDED MAY 31, 1992 (IN THOUSANDS)\n- - - ------------------------- adjustments.\nSCHEDULE IX\nCRUSADER LIMITED AND SUBSIDIARIES SHORT-TERM BORROWINGS YEAR ENDED MAY 31, 1992 (IN THOUSANDS, EXCEPT PERCENTAGES)\n- - - ------------------------ Notes: (1) Loans represent short-term money market borrowings at varying interest rates, which are partially secured. (2) Sum of balance outstanding at month end\/12 months. (3) Actual interest expense\/average borrowings.\nSCHEDULE X CRUSADER LIMITED AND SUBSIDIARIES SUPPLEMENTAL STATEMENT OF EARNINGS INFORMATION YEAR ENDED MAY 31, 1992 (IN THOUSANDS)","section_15":""}
{"filename":"60357_1994.txt","cik":"60357","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL DESCRIPTION OF BUSINESS\nLoral Corporation (the \"Company\" or \"Loral\") was incorporated in New York in 1948. Through its subsidiaries and divisions, the Company is a leading supplier of defense electronics systems, components and services to U.S. and allied defense departments. The Company's principal business areas are: electronic combat; training and simulation; command, control, communications and intelligence (\"C3I\")\/reconnaissance; tactical weapons; systems integration; and space systems. The Company has achieved an incumbent position on a wide range of existing programs through internal growth and development and a series of acquisitions focused on its core technologies. Loral's business strategy is to emphasize upgrades of existing weapons systems, concentrate on further developing its core of advanced technologies, generate an increasing proportion of its sales from foreign customers and selectively extend the Company's proprietary technologies into non-military applications, such as systems integration, satellite-based telecommunications, medical diagnostic imaging systems, network management, data archiving, and information systems and services.\nEffective January 1, 1994, Loral acquired Federal Systems Company, a division of International Business Machines Corporation, for $1,503,500,000 in cash, not including acquisition costs. Federal Systems is a leading systems integrator and supplier of advanced information technology products and services to defense and non-defense agencies worldwide.\nBUSINESS SEGMENTS\nThe Company operates primarily in one industry segment, defense electronics.\nPRODUCTS\nElectronic Combat\nLoral is a leading producer of systems that detect, jam and deceive hostile radars and radar and infrared guided weapons and detect and analyze surface and submarine threats. Loral's electronic combat systems are used in the protection of U.S. and allied aircraft and antisubmarine warfare, antisurface warfare, airborne early warning, and for electronic support measures.\nLoral manufactures the ALR-56 family of advanced, programmable radar warning systems. The ALR-56C and ALR-56M are utilized aboard U.S. Air Force and allied and jet fighter aircraft, respectively. Loral has sold its Rapport II and III (ALQ-178) fully integrated airborne radar warning and electronic jamming systems to Israel, Belgium and Turkey for the, and has developed an advanced version called the ALQ-202.\nLoral supplies the Forward-Looking Infrared (FLIR) targeting and weapon delivery pod aboard U.S. and allied F\/A-18 strike jets. This system permits aircrews to deliver smart weapons to selectively identified high value targets through laser rangers and target designators.\nLoral is the prime contractor for the U.S. Navy's LAMPS MK III helicopter for antisubmarine warfare, antisurface warfare and airborne early warning, and for a similar system, the EH101\/Merlin, for the United Kingdom's Ministry of Defence. The Company also produces the Electronic Support Measures system for the U.S. Air Force's B-2 stealth bomber; a day\/night adverse weather missions system for the MC-130H Combat Talon II aircraft; and the central computer for the.\nLoral's AAR-47 uses infrared sensing technologies to warn U.S. Navy and Marine helicopters of hostile missile threats. Loral's ALQ-157, Matador and Challenger infrared countermeasures systems emit infrared energy pulses that counter heat-seeking missiles by directing them away from aircraft, naval vessels and\narmored ground vehicles. Loral also produces antenna assemblies and systems for airborne warning aboard tactical aircraft, such as the E-2C.\nTraining and Simulation\nLoral's training systems provide simulated, realistic battlefield environments that assist air, land and sea forces in achieving and maintaining combat readiness as well as aiding in the establishment and validation of requirements for new systems and upgrades. Loral produces a variety of simulators, including weapons systems simulators, virtual reality simulators, and distributed interactive simulators.\nLoral's operational flight and weapons systems trainers simulate andE jet aircraft avionics under combat conditions. Loral is also developing a comprehensive family of weapons systems trainers, courseware and mission rehearsal devices for the Special Operations Forces Aircrew Training System (SOF-ATS). The Company has a contract to assess pilot training requirements for the U.S. Air Force's new fighter. Loral is developing full mission simulators that combine flight weapon systems and mission training for Sweden's JAS-39 multi-role combat aircraft.\nLoral's Multiple Integrated Laser Engagement System (MILES) is at the forefront of a family of laser-based training systems, including the Air-to-Ground Engagement System (AGES), the Precision Gunnery Training System (PGTS), Simulated Area Weapons Effect (SAWE), Precision Range Integrated Maneuver Exercise (PRIME) and Mobile Automated Instrumentation Suite (MAIS). These systems are used to train and evaluate ground combat troops and military equipment. The equipment simulates the effect of weapons fire through eye-safe, encoded laser beams. Detector cells and electronic decoding systems replicate target vulnerability. Data is transmitted to a central station to allow review of combat performance.\nLoral is a principal developer of netted simulators for the U.S. Army. Loral operates and maintains simulator networks for ground vehicle and airborne platform training at Fort Knox and Fort Rucker under the Army's Advanced Distributed Simulation Technology Program. These simulators are linked to each other and to combat training ranges including ranges operated by the Company.\nLoral's Close Combat Tactical Trainer (CCTT) provides the U.S. Army with a computer-based trainer that simulates vehicles, weapon systems and dismounted infantry in a virtual battlefield environment. The Company is prime contractor for the MATBAT tank gunnery training system to provide realistic battlefield conditions for the Israeli Defense Forces.\nLoral has developed for the U.S. Navy a laser-guided training round, which simulates the operation of the Paveway II bomb, providing live-fire training for A-6 and F\/A-18 aircrews at one-fifth the cost of an actual round.\nLoral operates and maintains the U.S. Navy's and Air Force's primary pilot training ranges and electronic warfare ranges, provides instructors for classroom training, and supplies sophisticated avionics and undersea simulators. Loral's Simulator Device Development Support program is upgrading electronic warfare simulators at the Naval Weapons Center at China Lake.\nCommand, Control, Communications and Intelligence\/Reconnaissance\nLoral offers systems integration, operations management and engineering services, post-deployment systems support, military satellite communication terminals, information processing and display hardware, information management software, secure tactical communications instruments and telemetry equipment to address a broad spectrum of strategic and tactical C3I requirements.\nLoral is the principal technical support contractor for the Space Defense Operations Center at Cheyenne Mountain for the U.S. Space Command, which monitors orbiting space systems to alert the U.S. and its allies to potential attack. Loral is producing the Rapid Execution and Combat Targeting system, which is modernizing the Minuteman missile launch control centers. Loral is also providing engineering support, systems integration, and operations and maintenance for the worldwide Air Force Satellite Control Network. Loral is developing the communications element of the All-Source Analysis System, a tactical intelligence\nfusion system that will receive, process and display battlefield information to tactical commanders on a near real-time basis.\nLoral provides hardware support, software maintenance, sustaining engineering and on-site operational services in support of the U.S. Air Force's Global Positioning System. Loral is also responsible for system development, software maintenance, and engineering support for the U.S. Air Force's fixed and mobile Launch Detection System.\nLoral produces mil-spec and ruggedized general-purpose computers and processors used in military systems, such as ground-launched and sea-launched cruise missiles, the Trident AFLOAT System and the MILSTAR communications programs. Loral also produces the Associative Processor (ASPRO), a parallel processing computer for command and control aboard the E-2C aircraft and for over-the-horizon targeting by U.S. submarines. Loral supplies antisubmarine warfare and combat control systems for submarines and surface ships, including the AN\/BSY-1 combat system for the U.S. Navy's SSN 688 class attack submarines and portions of the AN\/BSY-2 combat control system for the Navy's SSN-21 attack submarines, the Combat Control System MK3 for the Royal Australian Navy's Type 471 SSK submarines, and elements of the SQQ-89 surface ship ASW combat control system.\nLoral's information and graphics display systems provide interactive access to real-time information on ground and shipboard platforms as well as aircraft, such as the E-2C, P-3C, S-3, and other U.S. Navy aircraft. Loral's EMR and instrumentation telemetry systems include airborne transmitters, receivers, data links, transponders and signal encoders, which are used in tracking, ranging, data acquisition and command and control for operations of space vehicles and missiles. Loral's instrumentation products, primarily the System 500, provide high-speed real-time processing in testing and analyzing data from advanced avionics as well as from missile and satellite sources.\nLoral's reconnaissance systems utilize advanced electronic imaging, communications and information processing technologies to provide integrated tactical battlefield information and navigation and targeting capability in airborne platforms for the U.S. Air Force, Navy and Marines. Loral employs mercury cadmium telluride, platinum silicide and charge-coupled device technologies required for the infrared (\"IR\") and electro optical (\"EO\") focal plane arrays that are at the heart of night vision and all-weather cameras. Loral's sensing and imaging products are a major component of the Advanced Tactical Air Reconnaissance System (ATARS), the Long-Range Oblique Photography System (LOROPS), the tactical reconnaissance pod and a tactical reconnaissance system for German Tornado aircraft.\nLoral also manufactures and sells commercial data and voice recorders, the indestructible \"black boxes\" mandated by the FAA for commercial and general aviation aircraft.\nLoral is producing the Medical Diagnostic Imaging System which extends the Company's high-volume data storage and retrieval technologies into the medical marketplace for DoD, VA and commercial hospitals.\nTactical Weapons\nLoral produces the Multiple Launch Rocket System (MLRS) for the U. S. Army. This weapon system spreads submunitions over a one kilometer area and was used extensively in Operation Desert Storm. Loral also produces the Army Tactical Missile System (ATACMS). Fired from the MLRS launcher, ATACMS provides a long range tactical missile. Loral will also test a long-range ship-fired version of ATACMS so the U.S. Navy can evaluate the missile for fire support missions. MLRS has substantial international markets, and has been purchased by France, Germany, the United Kingdom, Italy, the Netherlands, Turkey, Bahrain and Japan. The Company also expects an international market for ATACMS.\nLoral has developed the Extended Range Intercepter missile (ERINT), a kinetic energy, high-altitude anti-missile missile that destroys its target through force of impact without explosives. The system has been selected by the U.S. Army for its PAC-3 Theater Missile Defense upgrade of the Patriot Missile System. Loral is also developing the LOSAT missile, a low-cost kinetic energy antitank missile.\nLoral's EO and IR sensors, processing technologies and advanced algorithms are employed in a wide range of tactical weapons and weapons guidance systems. Loral's IR sensors have been selected for the Theater High-Altitude Area Defense (THAAD) anti-tactical missile detection and interception system.\nLoral's guidance programs include the Digital Scene Matching Area Correlation (DSMAC) system, which permits Tomahawk cruise missiles to direct themselves for long distances over enemy terrain, complete missile guidance control units for air-defense systems and gyro-optic assemblies for thermal imaging missiles, and air-to-ground weapons. Loral is also a prime contractor for sales to certain U.S. allies of the Chaparral air-defense system, for which it manufactures the entire missile and fire control system. Loral also produces the Sidewinder air-to-air missile; the AIM 9M and the AIM 9P.\nLoral is under contract from the U. S. Marine Corps to develop a short-range antitank weapon, the Predator, which is a man-portable fire-and-forget weapon system. The Company's Vertical Launch Antisubmarine Rocket (VLA) is in production for the U. S. Navy and Japan.\nSystems Integration\nLoral is a leading provider of systems integration services focused on integrating complex hardware and software systems. Loral serves the U.S. Department of Defense and a broad range of federal and foreign government organizations, including the Federal Aviation Administration, the U.S. Department of Justice, the Internal Revenue Service, the U.S. Postal Service and the United Kingdom's Civil Aviation Authority.\nAmong Loral's programs are the Advanced Automation System, the next-generation air traffic control system for the Federal Aviation Administration (see Note 8 to Consolidated Financial Statements), and the United Kingdom's New En Route Centre air traffic control system. Loral is also under contract to produce a number of systems for non-DoD government agencies, including the Document Processing System that will image and store tax returns and correspondence for the Internal Revenue Service, a bar code-based mail sorting system for the U.S. Postal Service, network and database systems for the administrative offices of the U.S. Courts and an image processing system for the U.S. Environmental Protection Agency to allow its regional offices across the country to convert paper documents into digitized data stored on optical disks.\nLoral has developed systems for managing and tracking the nationwide real estate inventory of the Resolution Trust Corporation (RTC) and is currently supporting RTC's wide area networks and telecommunications efforts. Loral is the prime contractor for the U.S. Army's Sustaining Base Information Services program, which is a comprehensive information support system that will be used for all Army base management information and administrative processing. This includes personnel management, payroll, financial accounting and control, authorization documentation, supply and services and medical records management.\nSpace Systems\nLoral and Space Systems\/Loral, Inc. (\"SS\/L\"), an unconsolidated affiliate, both participate in various aspects of space technology and systems. Loral provides engineering services supporting mission control systems for both manned and unmanned space flight and develops and manufactures scientific instruments, sensors, cameras and power systems for space systems applications. SS\/L produces geosynchronous satellites and subsystems for telecommunications and earth sensing and is the prime contractor for the Globalstar low-earth-orbit mobile telecommunications system.\nLoral designs, develops and integrates systems for the Space Shuttle's on board hardware and flight control software. Loral also provides systems engineering, safety engineering, reliability and engineering support to Johnson Space Center, and is modernizing its Mission Systems Control in support of manned space missions, including the Space Shuttle.\nIn space science, Loral is developing the Atmospheric Infrared Sounder (AIRS), a scientific instrument that will fly on NASA's Earth Observing System platform in the next century. At NASA's Goddard Space Flight Center, Loral is developing the computer system to store, archive and distribute data collected from the EOSDIS system.\nSS\/L designs and fabricates geostationary and low-earth-orbiting satellites for space communications and remote earth sensing. SS\/L's INTELSAT VII satellite will carry international telephone traffic for the International Telecommunications Satellite consortium. The first of a series of nine satellites was launched in October, 1993. SS\/L is the prime contractor for a series of Geostationary Operational Environmental Satellites (GOES), which are being built to conduct imaging of clouds and the earth's surface and sounding of water vapor fields, and to monitor the space environment, collect data from terrestrial sensors and relay aircraft and maritime distress signals. The first GOES satellite was launched in April 1994. SS\/L has supplied Japan's Space Communications Corporation with the Superbird communications satellites, and is building two N-STAR satellites for Nippon Telegraph and Telephone of Japan. SS\/L also has a contract to supply two direct-to-home broadcast television satellites to TEMPO, a subsidiary of Tele-Communications, Inc.\nLoral has contracts to supply video systems and provide systems engineering and integration for Space Station Freedom, and SS\/L has contracts to supply subsystems and components, including power systems, for Space Station Freedom.\nLoral is the managing general partner of Globalstar L.P., an international venture formed to design and operate a global satellite communications system in conjunction with the following strategic partners, who have collectively committed to invest $275 million of initial equity capital toward a total $1.8 billion funding requirement: Alcatel N.V.; Alenia Spazio, S.p.A.; DACOM Corporation; Hyundai Electronics Industries Company; QUALCOMM Incorporated; Vodafone Group; and AirTouch Communications (formerly PacTel). Globalstar will deploy and operate a worldwide, low-earth-orbit mobile satellite-based communications system using CDMA technology. The system, employing a constellation of 48 satellites, subject to receiving local licensing authority such as is pending before the Federal Communications Commission, is expected to be operational in 1998 and will offer low-cost worldwide digital wireless telecommunications services, including voice, data, paging, facsimile and geolocation services, to telephones and data terminals in areas currently not served or underserved by existing telecommunications systems. The system will allow existing cellular carriers to extend and enhance their provision of telecommunications services to new and current users.\nCUSTOMERS\nSubstantially all of the Company's products are sold to agencies of the United States Government, primarily the Department of Defense, to foreign government agencies or to prime contractors or subcontractors thereof. In fiscal 1994, approximately 90% of the Company's sales was derived directly or indirectly from defense contracts for end use by the United States and foreign governments. Sales to domestic customers represented 86% of total revenue in fiscal 1994 and 1993. Sales to the U.S. Army, Air Force and Navy accounted for 23%, 18% and 11%, respectively, of the Company's consolidated sales for fiscal 1994, and 21%, 22% and 9%, respectively, for fiscal 1993. The majority of the Company's remaining domestic sales were to prime contractors for end use by the U.S. Government and other U.S. Government agencies.\nFor information concerning international programs and sales to foreign governments, see Foreign Sales below.\nBACKLOG\nBacklog at March 31, 1994, was approximately $6.5 billion, compared with $3.9 billion at March 31, 1993. Approximately 55% of the backlog at March 31, 1994, is expected to be shipped during fiscal 1995.\nOf the backlog at March 31, 1994, approximately $3.5 billion was directly or indirectly for defense contracts for end use by the U.S. Government and an additional $530 million for contracts to other U.S. Government agencies. Backlog for the U.S. Army, Air Force and Navy accounted for 17%, 13% and 9%, respectively, of total backlog at March 31, 1994.\nApproximately $2.5 billion of the backlog consisted of orders by foreign governments and contractors, primarily for defense contracts in various allied nations, representing 38% of total backlog at March 31, 1994.\nCOMPETITION\nThe Company faces intense competition in all its product areas. A number of the Company's competitors are, or are controlled by, companies that are larger and have greater financial resources than the Company.\nThe Company's position depends largely upon the quality, design and pricing of its products and services and the timeliness of deliveries. The Company must design products that meet or exceed rigid specifications and that are subjected to stringent testing procedures. A substantial portion of the Company's business is obtained through the submission of competitive proposals.\nGOVERNMENT CONTRACTS\nThe Company's government contracts are normally for production, service or development. Such contracts are typically of the fixed-price or cost-type variety. Development contracts historically have been less profitable than production contracts, and the Company has at times experienced cost overruns on them.\nFixed-price contracts may provide for a firm fixed-price or they may be fixed-price incentive contracts. Under the firm fixed-price contracts, the Company agrees to perform for an agreed price and, accordingly, derives benefits from cost savings, but bears the entire risk of cost overruns. Under the fixed-price incentive contract, if actual costs incurred are less than estimated costs for the contract, the savings are apportioned between the Government and the Company. However, if actual costs under such a contract exceed estimated costs, excess costs are apportioned between the Government and the Company up to a ceiling. The Company bears all costs that exceed the ceiling. Some firm fixed-price contracts and fixed-price incentive contracts also provide for price adjustments in the event inflation differs from specified measurement indices, or in the event performance exceeds specified objectives or schedules.\nSome cost-type contracts provide for reimbursement of the Company's actual costs, to the extent such costs are allowable, and additional compensation in the form of a fixed, incentive or award fee. Under cost-sharing contracts, costs are apportioned between the Government and the Company according to an agreed formula. Cost-type contracts contain cost ceilings and the Company is not obligated to incur costs in excess of such ceilings.\nAll domestic defense contracts and subcontracts to which the Company is a party are subject to audit, various cost controls and standard provisions for termination at the convenience of the Government. Multi-year Government contracts and related orders are subject to cancellation if funds for contract performance for any subsequent year become unavailable. Upon termination other than for a contractor's default, the contractor is normally entitled to reimbursement for allowable costs, but not necessarily all costs, and to an allowance for the proportionate share of fees or earnings for the work completed. Foreign defense contracts generally contain comparable provisions relating to termination for the convenience of the government.\nCompanies engaged primarily in supplying defense-related equipment to the Government are subject to certain business risks peculiar to the defense industry. These risks include the ability of the Government to unilaterally suspend the Company from receiving new contracts pending resolution of alleged violations of procurement laws or regulations.\nIn addition, all defense businesses are subject to risks associated with dependence on Government appropriations, changes in Government procurement policies, obtaining required Government export licenses for international sales, uncertain cost factors related to technologically scarce skills and exotic components, the frequent need to bid on programs in advance of design completion (which may result in unforeseen technological difficulties and, or cost overruns), design complexity and rapid obsolescence, and the constant necessity for design improvement.\nUnited States Government expenditures for defense products are likely to continue to decline. These reductions may or may not have an effect on the Company's programs; however, in the event expenditures for products of the type manufactured by the Company are reduced, and not offset by greater foreign sales or other new programs or products, or acquisitions, there will be a reduction in the volume of contracts or\nsubcontracts awarded to the Company. Such reductions unless offset will have an adverse effect upon the Company's earnings.\nPATENTS AND LICENSES\nAlthough the Company owns some patents and has filed applications for additional patents, it does not believe that its operations depend upon its patents. In addition, the Company's U.S. Government contracts generally license it to use patents owned by others. Similar provisions in the U.S. Government contracts awarded to other companies make it impossible for the Company to prevent the use by other companies of its patents in most domestic defense work.\nRESEARCH AND DEVELOPMENT\nThe Company employs scientific, engineering and other personnel to improve its existing product lines and to develop new products and technologies in the same or related fields. The largest portion of this work is performed under specific U.S. Government contracts. At March 31, 1994, the Company employed approximately 10,800 engineers (of whom 2,750 held advanced degrees), of which approximately 1,230 (including 360 holding advanced degrees) devote all or part of their effort to Company-sponsored research projects.\nThe amounts of research and development performed under customer-funded contracts and Company-sponsored research projects, including bid and proposal costs, for the three most recent fiscal years were as follows:\nPERSONNEL\nAt March 31, 1994, the Company employed approximately 32,600 persons. A significant part of its operations is dependent upon professional, technical and engineering personnel whose tenure is not generally secured by employment contracts. The Company has agreements with labor organizations representing certain hourly employees.\nFOREIGN SALES\nLoral products currently sold in the international marketplace include the ALQ-178 Rapport, ALR-56C, ALR-56M, FLIR targeting and weapon delivery system for the F\/A-18 strike jet, EH 101\/Merlin, AAR-47, Challenger, Matador, E-2C displays, shipboard chaff and flare countermeasures, Romeo submarine sonar, Multiple Launch Rocket System, Vertical Launch Antisubmarine Rocket, guidance control systems for the Sidewinder missile, Chaparral air-defense system, tactical reconnaissance pod, JAS-39 full mission simulator, MILES, TCM-620 tactical communications system and air traffic control systems. Through SS\/L, Loral is also supplying the INTELSAT VII, Superbird and N-Star satellites for the international marketplace. Certain other Loral programs have export potential, including ATACMS, the ASPRO computer, tactical displays, LOROPS and AIRS.\nForeign sales accounted for approximately 14% of the Company's sales in fiscal 1994 and 1993. Foreign sales and income are subject to changes in United States and foreign government policies, regulations, embargoes and international hostilities. Foreign sales generally require export licenses granted on a case-by-case basis by the United States Department of State. The exchange risk inherent in foreign contracts not denominated in U.S. dollars is mitigated by currency hedging where deemed appropriate.\nForeign sales comprise the following:\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company operates in a number of plants and office facilities in the United States and abroad.\nAt March 31, 1994, the Company's manufacturing, engineering, research, administrative, warehousing and sales facilities aggregated approximately 21.4 million square feet, of which 51% is owned and 49% is leased. Substantially all the Company's facilities are located in the United States. Management believes the Company's facilities are adequate for its current level of business.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Company is a defendant in a number of lawsuits or claims incidental to its business including those related to environmental issues (see Note 8 to Consolidated Financial Statements). In the opinion of management, the ultimate liability on these matters, if any, 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 THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS\n(a) MARKET PRICE AND DIVIDEND INFORMATION\nThe Company's Common Stock is listed on the New York Stock Exchange (\"NYSE\") under the symbol LOR. The following table sets forth the high and low sales prices per share as reported on the NYSE Composite Tape, and the dividends paid per share during those periods.\n- - - --------------- * Adjusted to reflect two-for-one stock split distributed on October 7, 1993.\n(b) APPROXIMATE NUMBER OF HOLDERS OF COMMON STOCK\nAs of April 29, 1994, there were approximately 4,500 holders of record of the Company's common stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe selected financial data has been derived from, and should be read in conjunction with, the related Consolidated Financial Statements.\n- - - --------------- (a) Reflects the acquisition of Federal Systems Company effective January 1, 1994, which had substantial effect on the balance sheet data in 1994.\n(b) Reflects (i) the acquisition of the missile business of LTV Aerospace and Defense Company effective August 31, 1992 and (ii) the acquisition of the minority partners' equity interest in Loral Aerospace Holdings, Inc. (\"LAH\"), effective June 1, 1992, through the issuance of 12,313,810 shares of the Company's common stock and 627.3 shares of Series S Preferred Stock of LAH.\nEffective April 1, 1992, the Company 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.\" Prior years' results have not been restated to reflect these accounting changes.\nNet income (loss) includes (i) a non-operating extraordinary charge (loss on extinguishment of debt) of $28.2 million pre-tax, $17.8 after-tax, or $.23 per share, and (ii) a non-recurring charge of $330.5 million pre-tax, $233.4 million after-tax, or $3.03 per share, as the cumulative effect of the accounting change for SFAS 106.\n(c) Reflects the acquisition of Ford Aerospace Corporation effective October 1, 1990, which had substantial effect on the operating and balance sheet data in 1991.\n(d) Adjusted to reflect two-for-one stock split distributed October 7, 1993.\nSee Management's Discussion and Analysis of Results of Operations and Financial Condition and Notes to Consolidated Financial Statements.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION\nBUSINESS ENVIRONMENT\nLoral's core business areas are electronic combat, training and simulation, C3I\/reconnaissance, tactical weapons, systems integration and space systems. The U.S. defense budget has been declining in real terms since the mid 1980s, resulting in program delays, cancellations and scope reductions for defense contractors generally. The U.S. defense budget for 1995 will again likely show a decline versus the previous year. Loral's business areas focus primarily on U.S. and allied essential defense requirements. Management believes that to the extent a higher proportion of available funds will be allocated to the improvement of existing weapons systems and electronics on military platforms, rather than to new program starts, Loral is likely to benefit from its substantial incumbency in existing weapons systems and its experience in systems upgrades. Loral also believes its range of programs and systems are well suited for, and provide growth opportunities in, the international market place. In addition, Loral has a diverse base of programs, none of which is expected to account for more than 7% of fiscal 1995 revenues. In light of these factors, management believes Loral's program base is more resistant to declining U.S. defense spending than other contractors with significant dependence on new program starts or a less diverse program base.\nIn addition, the areas of the Company's expertise provide opportunities to selectively apply the Company's proprietary technologies to non-military applications; primary examples include systems integration programs for civilian agencies such as the FAA, the U.S. Postal Service and the U.S. Treasury Department and satellite based systems, particularly Globalstar, a low-earth-orbit mobile telecommunications system.\nRESULTS OF OPERATIONS\nIn fiscal 1993 and 1994, major acquisitions made by the Company significantly affected results of operations. The acquisitions have been accounted for as purchases and, as such, the results of operations are included from the respective effective dates of acquisitions. (See Note 2 to Consolidated Financial Statements.)\nEffective January 1, 1994, the Company, through Loral Federal Systems Company (\"LFS\"), acquired substantially all the assets and liabilities of the Federal Systems Company, a division of International Business Machines Corporation. LFS, headquartered in Bethesda, Maryland, is a leading systems integrator and supplier of advanced information technology products and services to defense and non-defense agencies worldwide and employs about 10,000 people. Historical operating results of Federal Systems Company for its fiscal year ended December 31, 1993 include sales of $2.292 billion, operating income of $117.5 million and funded backlog at December 31, 1993 of $3.215 billion.\nOn August 31, 1992, the Company, through Loral Vought Systems Corporation (\"LVS\"), acquired the missile business of LTV Aerospace and Defense Company. LVS, headquartered in Dallas, Texas, designs and manufactures missile systems primarily for the U.S. Army and employs about 4,000 people. Historical operating results of the missile business for its fiscal year ended December 31, 1991 include sales of $750.1 million, operating income of $36.2 million and acquired funded backlog at August 31, 1992 of $1.134 billion.\nOn October 7, 1993, the Company completed a two-for-one stock split in the form of a 100% stock distribution payable to stockholders of record on September 28, 1993. Accordingly, all share and per share amounts have been adjusted to reflect the stock split. (See Note 7 to Consolidated Financial Statements.)\nEffective April 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\"). (See Note 9 to Consolidated Financial Statements.) The results of operations for the fiscal year ended March 31, 1992 have not been restated to reflect this accounting change.\nFISCAL YEAR ENDED MARCH 31, 1994 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 1993\nDuring fiscal 1994, sales increased to $4.009 billion from $3.335 billion the prior year. Income increased to $228.3 million, or $2.72 per share, compared with $159.1 million, or $2.06 per share in the prior year, before an extraordinary item and the cumulative effect of adopting SFAS 106.\nEarnings per share for fiscal 1994 is based on 83.9 million primary weighted average shares outstanding, compared with 77.0 million in the prior year.\nThe sales increase was attributable to the results of the acquired LFS and LVS businesses from their respective dates of acquisition. Sales also include higher volume on Vertical Launch Antisubmarine Rocket (VLA) and ALR-56M radar warning systems; offset by lower volume on Simulated Area Weapons Effect (SAWE) training system, Sidewinder air-to-air missiles, ALQ-178 radar warning and electronic countermeasures systems for foreign aircraft and AN\/BSY-2 combat control system for the U.S. Navy's SSN-21 attack submarine.\nOperating income increased to $401.4 million from $296.3 million in the prior year. Operating income as a percentage of sales increased to 10.0% in fiscal 1994 from 8.9% in fiscal 1993, due primarily to net improved margins of the acquired LVS business, the full-year impact of lower pension costs resulting from acquired pension plans and lower postretirement health care and life insurance costs due to various plan amendments (see Note 9 to Consolidated Financial Statements), offset by lower margins of the acquired LFS business. Excluding the effect of the acquisitions of LFS and LVS, operating income, as a percentage of sales increased to 9.6% in fiscal 1994 from 9.2% in fiscal 1993.\nAfter the full-year impact of debt incurred as a result of the acquisition of LVS and interest expense from the effective date of acquisition of LFS, net interest expense decreased by $1.7 million from the prior year, due primarily to the benefits from continued strong cash flow and lower overall interest costs as a result of a series of debt reshaping steps in the second half of last year. The Company's free cash flow (net cash from operating activities, less net capital expenditures, plus proceeds of stock purchases by employee benefit plans and exercises of stock options) was $284.3 million and $221.8 million in 1994 and 1993, respectively.\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 was signed into law, including a provision that increased the Federal corporate income tax rate by 1%, to 35%, effective January 1, 1993. This increase was partially offset by the benefit resulting from revaluing deferred tax assets at the higher rate. As a result the Company's effective tax rate increased to 37.3% from 37% in the prior year. (See Note 6 to Consolidated Financial Statements.)\nThe minority interest charge was eliminated due to the Company's acquisition, effective June 1, 1992, of the minority partners' interest in Loral Aerospace Holdings, Inc. (\"LAH\"). (See Note 2 to Consolidated Financial Statements.)\nFISCAL YEAR ENDED MARCH 31, 1993 COMPARED WITH FISCAL YEAR ENDED MARCH 31, 1992\nDuring fiscal 1993, sales increased to $3.335 billion from $2.882 billion the prior year. Income, before extraordinary item and the cumulative effect of adopting SFAS 106, increased to $159.1 million, or $2.06 per share, compared with $121.8 million, or $2.00 per share, in the prior year.\nEarnings per share for fiscal 1993 is based on 77.0 million primary weighted average shares outstanding, compared with 61.0 million in the prior year.\nThe sales increase was attributable to the results of the acquired LVS business from the effective date of acquisition. Sales also include higher volume on Simulated Area Weapons Effect (SAWE) training system, sonar systems for Romeo class submarines, Rapid Execution and Combat Targeting (REACT) launch control system, Vertical Launch Antisubmarine Rocket (VLA) and AN\/BSY-2 combat control system for the U.S. Navy's SSN-21 attack submarine; offset by lower volume on F\/A-18 Forward-Looking Infrared (FLIR) targeting and weapon delivery system, Chaparral air-defense systems, ALQ-178 radar warning and electronic countermeasures systems for foreign aircraft, Mk-48 antisubmarine torpedoes, Automated Remote Tracking Station (ARTS) and Mk-30\/Ex-30 antisubmarine training targets.\nOperating income increased to $296.3 million from $292.2 million in the prior year. Operating income as a percentage of sales declined from 10.1% in fiscal 1992 to 8.9% in fiscal 1993, due primarily to the current year effect of adopting SFAS 106 and lower margins of the acquired LVS business, partially offset by lower pension costs recorded in fiscal 1993 resulting from acquired pension plans. (See Note 9 to Consolidated Financial Statements.) Excluding the current year effect of adopting SFAS 106 and the effect of the acquisition of LVS, operating income as a percentage of sales increased to 10.3% in fiscal 1993 from 10.1% in fiscal 1992.\nNet interest expense decreased by $10.5 million from the prior year, due primarily to the full-year effect of the long-term debt repayments from the proceeds of the common stock issued in June 1991, strong cash flow and lower overall interest costs due to lower market interest rates and a series of debt reshaping steps, offset by the impact of debt incurred as a result of the acquisition of LVS. The Company's free cash flow was $221.8 million and $187.3 million in 1993 and 1992, respectively.\nThe minority interest charge was reduced by $26.1 million, compared with the prior year, due to the Company's acquisition, effective June 1, 1992, of the minority partners' interest in LAH. (See Note 2 to Consolidated Financial Statements.)\nIn March 1993, retroactive to April 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" which did not have a material effect on the results of operations. The effective tax rate remained constant at 37% in both fiscal years. (See Note 6 to Consolidated Financial Statements.)\nAs a result of the early redemption of certain long-term debt issues and the cancellation of an existing credit facility, the Company recorded an extraordinary charge of $28.2 million pre-tax, $17.8 million after-tax, or $.23 per share. The extraordinary charge consisted of redemption premiums and the write-off of unamortized discounts and financing costs. (See Note 5 to Consolidated Financial Statements.)\nAs a result of adopting SFAS 106, the Company recorded charges for the cumulative effect of the accounting change effective April 1, 1992 of $330.5 million pre-tax, $233.4 million after-tax, or $3.03 per share.\nFINANCIAL CONDITION AND LIQUIDITY\nCASH PROVIDED AND USED\nNET CASH PROVIDED BY OPERATING ACTIVITIES: Cash provided by operating activities was $360.0 million in fiscal 1994, an increase of $88.1 million or 32% over fiscal 1993. The increase was due primarily to higher earnings in fiscal 1994. Earnings after adjustment for non-cash items provided $437.0 million, offset by changes in operating assets and liabilities which used $77.0 million.\nContracts in process, before reduction for unliquidated progress payments, increased by $888.4 million to $2.88 billion at March 31, 1994, primarily due to the acquisition of LFS. (See Notes 1, 2 and 3 to Consolidated Financial Statements.) As is customary in the defense industry, unbilled contract receivables and inventoried costs are partially financed by progress payments. The unliquidated balance of such progress payments increased by $610.5 million to $1.55 billion at March 31, 1994, compared with $943.5 million in the prior year. As a result, net contracts in process increased to $1.33 billion in fiscal 1994 from $1.05 billion in the prior year.\nThe Company's current ratio declined to 1.4:1 at March 31, 1994, from 1.8:1 at March 31, 1993 as a result of the LFS acquisition. The Company expects the current ratio to improve in the early part of fiscal 1995 based on its intent to refinance in the capital markets a portion of the debt incurred for the LFS acquisition, which will be used in part to repay the $173.5 million of commercial paper borrowings that are classified as current portion of debt.\nNET CASH USED IN INVESTING ACTIVITIES: Cash used in investing activities increased $1.18 billion to $1.53 billion in fiscal 1994. The acquisition cost, net of cash acquired, was $1.40 billion in 1994 for LFS and $253.0 million in 1993 for LVS. Investment in affiliates in fiscal 1994 was $25.3 million, reflecting the initial investment in Globalstar. (See Note 2 to Consolidated Financial Statements.) Net fixed asset additions in fiscal 1994 totaled $96.5 million, compared with $89.0 million in fiscal 1993. Fixed asset additions were primarily for manufacturing and test equipment, facility expansion and renovation.\nNET CASH PROVIDED BY FINANCING ACTIVITIES: Cash provided by financing activities was $1.29 billion for fiscal 1994, due primarily to cash borrowed to finance the acquisition of LFS.\nThe Company's debt (net of cash) to equity ratio increased to 1.13:1 at March 31, 1994 from .35:1 at March 31, 1993, due primarily to the debt incurred for the LFS acquisition, offset by strong cash flow during the year. The LFS purchase price was initially financed through cash on hand and commercial paper borrowings which are backed up by revolving credit facilities totaling $1.7 billion. It is the Company's intent to refinance a portion of this debt in order to fix interest costs and lengthen maturities. (See Note 5 to Consolidated Financial Statements.) Based on the financial condition of the Company following the LFS acquisition, management believes that the internal cash flows of the combined operations will be adequate to fund the future growth of the Company while servicing the interest and retiring the principal of the debt.\nBACKLOG\nThe Company's funded backlog at March 31, 1994, including the funded backlog of LFS ($3.2 billion at the January 1, 1994 effective date of acquisition), totalled $6.5 billion, compared with $3.9 billion at March 31, 1993. New orders in fiscal 1994 totalled $3.5 billion, compared with $3.1 billion in fiscal 1993. It is expected that 55% of the March 31, 1994 backlog will be shipped in fiscal 1995. Approximately 53% of the total backlog was directly or indirectly for defense contracts for end use by the U.S. Government and an additional 8% for contracts to other U.S. Government agencies; foreign customers account for about 38%. The exchange risk inherent in foreign contracts not denominated in U.S. dollars is mitigated by currency hedging where deemed appropriate.\nRESEARCH AND DEVELOPMENT\nCompany-sponsored research and development, including bid and proposal costs, increased to $172.6 million from $124.7 million the prior year. In addition, customer-funded research and development was $844.0 million for fiscal 1994, compared with $488.5 million for the prior year. The increase in customer-funded research and development is due primarily to the acquisition of LFS.\nENVIRONMENTAL MATTERS\nManagement is continually assessing its obligations with respect to applicable environmental protection laws. While it is difficult to determine the timing and ultimate cost to be incurred by the Company in order to comply with these laws, based upon available internal and external assessments, the Company believes that even without considering potential insurance recoveries, if any, there are no environmental loss contingencies that, individually or in the aggregate, are material. The Company accrues for these contingencies when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company has been named a Potentially Responsible Party (\"PRP\") at a number of sites. In several of these situations Loral acquired the site pursuant to a purchase agreement which provided that the seller would retain liability for environmental remediation and related costs arising from occurrences prior to the sale. In other situations the Company is party to an interim or final allocation plan that has been accepted by other PRPs whose size and current financial condition make it probable that they will be able to pay the environmental costs apportioned to them. The Company believes that it has adequately accrued for future expenditures in connection with environmental matters and that such expenditures will not have a material adverse effect on its financial condition or results of operations.\nINFLATION\nThe effect of inflation on the Company's sales and earnings is minimal. Although a majority of the Company's sales are made under long-term contracts, the selling prices of such contracts, established for deliveries in the future, generally reflect estimated costs to be incurred in these future periods. In addition, some contracts provide for price adjustments through escalation clauses.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee Financial Statements and Financial Statement Schedules beginning on page.\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\nDIRECTORS\nInformation required for this item is set forth in the Company's 1994 definitive proxy statement which is incorporated herein by reference.\nEXECUTIVE 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 required under Items 11, 12 and 13, is set forth in the Company's 1994 definitive proxy statement 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 Statement Schedules not listed herein are either not required or the information required to be included therein is reflected in the Consolidated Financial Statements.\n3. Exhibits\nUnless otherwise indicated, each of the following exhibits has been previously filed with the Securities and Exchange Commission and is located in file number 1-4238. Exhibits 10.1 through 10.18 are management contracts or compensation plans.\nNote: Certain instruments with respect to issues of long-term debt have not been filed as Exhibits to this report since the authorized principal amount of any one of such issues does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis as of March 31, 1994. Such indebtedness is described in general terms in Note 5 to Consolidated Financial Statements included herein. The Registrant agrees to furnish to the Commission a copy of each instrument upon its request.\n(b) Reports 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.\nLORAL CORPORATION\nBy: BERNARD L. SCHWARTZ ----------------------------- Bernard L. Schwartz (Chairman of the Board and Chief Executive Officer) Date: May 12, 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.\nINDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES\nREPORT OF INDEPENDENT AUDITORS\nTo the Shareholders and Board of Directors of Loral Corporation:\nWe have audited the consolidated financial statements and the financial statement schedules of Loral Corporation and Subsidiaries (the \"Company\") listed under Items 14(a)1 and 14(a)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 Loral Corporation and Subsidiaries as of March 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended March 31, 1994 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 6 and 9 to the consolidated financial statements, in 1993 the Company changed its methods of accounting for income taxes and postretirement benefits other than pensions.\nCOOPERS & LYBRAND\n1301 Avenue of the Americas New York, New York 10019 May 12, 1994\nLORAL CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nSee notes to consolidated financial statements.\nLORAL CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nSee notes to consolidated financial statements.\nLORAL CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nFOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992\n- - - --------------- * Adjusted to reflect two-for-one stock split distributed on October 7, 1993, see Note 7.\nSee notes to consolidated financial statements.\nLORAL CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nSee Notes 1 and 2 for additional information.\nSee notes to consolidated financial statements.\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:\nBASIS OF PRESENTATION:\nThe consolidated financial statements include the accounts of Loral Corporation and its subsidiaries (\"Loral\" or the \"Company\"). The Company's investments in its affiliates are carried on the equity method of accounting. All significant intercompany balances and transactions have been eliminated.\nSTATEMENTS OF CASH FLOWS:\nThe Company classifies investments that are readily convertible into cash, and have original maturities of three months or less as cash equivalents.\nChanges in operating assets and liabilities are net of the impact of acquisitions and final purchase price allocations. Investing activities do not include certain marketable securities transactions in 1993 which were not settled in cash.\nFINANCIAL INSTRUMENTS:\nThe carrying amount of cash and cash equivalents approximates fair value. Except as discussed in Notes 5 and 11, all other financial instruments are not material.\nCONTRACTS IN PROCESS:\nSales on long-term production-type contracts are recorded as units are shipped; profits applicable to such shipments are recorded pro rata, based upon estimated total profit at completion of the contract. Sales and profits on cost reimbursable contracts are recognized as costs are incurred. Sales and estimated profits under other long-term contracts are recognized under the percentage of completion method of accounting using the cost to cost method. Amounts representing contract change orders or claims are included in sales only when they can be reliably estimated and realization is probable.\nCosts accumulated under long-term contracts include applicable amounts of selling, general and administrative expenses. Losses on contracts are immediately recognized in full when determinable. Revisions in profit estimates are reflected in the period in which the facts which require the revision become known.\nIn accordance with industry practice, contracts in process contain amounts relating to contracts and programs with long production cycles, a portion of which may not be realized within one year.\nPROPERTY, PLANT AND EQUIPMENT:\nProperty, plant and equipment are stated at cost. Depreciation is provided primarily on the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over the shorter of the lease term or the estimated useful life of the improvements.\nCOST IN EXCESS OF NET ASSETS ACQUIRED:\nThe excess of the cost of purchased businesses over the fair value of the net assets acquired is being amortized using a straight-line method generally over a 40-year period. Accumulated amortization amounted to $70,207,000 and $49,456,000 at March 31, 1994 and 1993, respectively.\nThe carrying amount of the cost in excess of net assets acquired is evaluated on a recurring basis. Current and future profitability as well as current and future undiscounted cash flows, excluding financing costs, of the acquired businesses are primary indicators of recoverability. For the three years ended March 31, 1994, there were no adjustments to the carrying amount of the cost in excess of net assets acquired resulting from these evaluations.\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nFOREIGN CURRENCY:\nAssets and liabilities of foreign operations are translated into U.S. dollars at year-end rates and income and expenses are translated at average exchange rates during the year. The effects of the translation adjustments recorded as a component of Equity Adjustments in Shareholders' Equity aggregated $1,904,000, $367,000 and $447,000 at March 31, 1994, 1993 and 1992, respectively. Foreign currency transaction gains and losses for the three years ended March 31, 1994 were not material. The Company enters into forward exchange contracts to hedge the effect of foreign currency fluctuations on certain transactions and commitments denominated in foreign currencies. Gains and losses on commitment hedges are deferred and included in the basis of the transaction underlying the commitment.\nEARNINGS PER SHARE:\nPrimary earnings per share are computed based upon the weighted average number of common stock and common stock equivalents (stock options) outstanding. Fully diluted earnings per share also reflect additional dilution related to stock options due to the use of the market price at the end of the period, when higher than the average price for the period. In 1993 and 1992, fully diluted earnings per share assume the conversion of certain convertible debentures, giving effect to the resultant reduction in interest costs, net of the tax effect thereon, through the redemption date. In 1993, the impact of the extraordinary item and cumulative effect of changes in accounting on the fully diluted calculation is anti-dilutive, resulting in the net fully diluted amount equalling the net primary amount.\nINCOME TAXES:\nEffective April 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). See Note 6, Income Taxes.\nPOSTRETIREMENT BENEFITS OTHER THAN PENSIONS:\nEffective April 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\"). See Note 9, Pensions and Other Employee Benefits.\nRECLASSIFICATIONS:\nCertain reclassifications have been made to conform prior-year amounts to the current-year presentation.\n2. ACQUISITIONS AND INVESTMENT IN AFFILIATES:\nACQUISITIONS:\nOn March 1, 1994, effective January 1, 1994, the Company, through its newly formed wholly owned subsidiary Loral Federal Systems Company (\"LFS\"), acquired substantially all the assets and liabilities of the Federal Systems Company, a division of International Business Machines Corporation, for $1,503,500,000 in cash, plus acquisition costs of $8,000,000. The assets and liabilities recorded in connection with the purchase price allocation were $1,925,194,000 and $413,694,000, respectively. The acquisition was financed through cash on hand and commercial paper borrowings.\nOn August 31, 1992, the Company, through its newly formed wholly owned subsidiary Loral Vought Systems Corporation (\"LVS\"), acquired substantially all the assets and liabilities of the missile business of LTV Aerospace and Defense Company for $261,250,000 in cash, plus acquisition costs of $2,000,000. The purchase price was subsequently reduced by a $9,000,000 purchase price adjustment paid in cash to the Company in December 1992. The assets and liabilities recorded in connection with the purchase price\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nallocation were $564,502,000 and $310,252,000, respectively. The acquisition was financed through cash on hand and borrowings under existing credit facilities.\nIn October 1990, Loral Aerospace Holdings, Inc. (\"LAH\"), a company owned by the Company and certain partnerships affiliated with Lehman Brothers Holdings Inc. (the \"Lehman Partnerships\"), acquired substantially all the businesses of Ford Aerospace Corporation (\"FAC\"). The FAC businesses were acquired by separate subsidiaries of LAH; Loral Aerospace Corp. (\"Loral Aerospace\") purchased all the businesses other than FAC's Space Systems Division, which was in effect purchased by Space Systems\/Loral, Inc. (\"SS\/L\").\nEffective June 1, 1992, the Company acquired the Lehman Partnerships' equity interest in LAH through the issuance of 12,313,810 shares of Loral Common Stock (as adjusted for two-for-one stock split, see Note 7) and 627.3 shares of LAH Series S Preferred Stock. Each share of Series S Preferred Stock represents a beneficial interest in one share of common stock of SS\/L. As a result of the issuance of the Series S Preferred Stock, the Lehman Partnerships have no economic interest in LAH other than with respect to the SS\/L operations. This transaction increased shareholders' equity by $195,179,000, eliminated minority interest, decreased the investment in affiliate by $86,907,000 and increased cost in excess of net assets acquired by $159,960,000. If the Lehman Partnerships continue to hold Series S Preferred Stock after January 1, 1998, or after a change in control of Loral, they will have the right to request that the Company purchase their Series S Preferred Stock at an appraised fair market value. In such event, the Company may elect to purchase such Series S Preferred Stock at appraised fair market value, or if the Company elects not to purchase the stock, the Lehman Partnerships may require the combined interests of the Company and the Lehman Partnerships in SS\/L to be sold to a third party.\nIn April 1993, the Company acquired the advanced simulation business of Bolt Beranek and Newman Inc. for $6,000,000 in cash. In September 1993, the Company acquired certain assets and assumed certain liabilities of Quintron Corporation for $21,422,000 in cash. These acquisitions are not expected to have a material effect on the operations of the Company.\nThe acquisitions of LFS, LVS and the Lehman Partnerships' equity interest in LAH have been accounted for as purchases. As such, Loral's consolidated financial statements reflect the results of operations of the acquired entities and the elimination of the minority interest from the respective effective dates of acquisition.\nPerformance under acquired contracts in process, the accounting for which is described in Note 3, contributed after-tax income of $49,061,000, $43,283,000 and $24,843,000, net of after-tax interest cost on debt related to the acquisitions and incremental amortization of cost in excess of net assets acquired aggregating $29,125,000, $18,653,000 and $14,765,000 for 1994, 1993, and 1992, respectively.\nHad the acquisitions of LFS, LVS and the Lehman Partnerships' equity interest in LAH occurred on April 1, 1992, the unaudited proforma sales, income before extraordinary item and cumulative effect of changes in accounting and related earnings per share data for the years ended March 31, 1994 and 1993 would have been: $5,853,700,000 and $5,954,900,000; $228,000,000 and $177,000,000; and $2.72 and $2.24, respectively. The results, which are based on various assumptions, are not necessarily indicative of what would have occurred had the acquisitions been consummated as of April 1, 1992.\nINVESTMENT IN AFFILIATES:\nIn April 1991, SS\/L sold 49% of its common stock to three European space systems manufacturers for $171,500,000. At that time LAH made an additional capital contribution of $3,500,000 to SS\/L. In November 1992, a fourth European investor acquired 12 1\/4% of SS\/L's common stock from SS\/L for $57,167,000. In order to maintain the 51% interest in SS\/L, Loral Aerospace purchased additional shares of SS\/L common stock for $59,500,000, consisting of $9,500,000 in cash and the contribution of a $50,000,000\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nsubordinated note and warrant issued in March 1992 by SS\/L to Loral Aerospace for cash. In December 1992, the Lehman Partnerships purchased an additional 104.55 shares of Series S Preferred Stock from LAH for $12,197,500 in cash. As a result of these transactions, Loral has an effective 32.7% economic interest in SS\/L. No gain or loss was realized by Loral in connection with the sale of any SS\/L common stock or Series S Preferred Stock.\nLAH and Loral Aerospace retain 51% of the outstanding common stock of SS\/L, but have agreed not to cause SS\/L to take certain actions without the concurrence of three, or in some cases, all of the SS\/L directors appointed by the four European investors. Accordingly, the Company's investment in SS\/L is classified as \"Investment in affiliates,\" and the results of operations of SS\/L are included in \"Equity in net income (loss) of affiliate.\"\nIn March 1994, the Company and seven other partners made capital commitments totalling $275,000,000 to Globalstar, L.P., a limited partnership of which the Company is the managing general partner, which plans to design and operate a worldwide satellite-based telecommunications network. The Globalstar network, consisting of 48 low-earth-orbiting satellites, subject to receiving local licensing authority such as is pending before the Federal Communications Commission, will offer voice, data, paging and geolocation services to both handheld and fixed terminals. Total system cost through 1998, the expected in-service date, is expected to total approximately $1,800,000,000, which Globalstar intends to finance through sales of additional equity, advance payments from service providers, and debt financing.\nAt March 31, 1994, the Company has an effective 42% equity interest in Globalstar and has a total capital commitment of $107,000,000, of which $25,288,000 has been funded. The remaining commitment is expected to be funded in two installments, in September 1994 and March 1995. Through SS\/L, the Company has an additional 2% indirect equity interest in Globalstar. By sales of its equity interest to other strategic partners and through subsequent Globalstar equity offerings, the Company expects to reduce its direct and indirect equity interest to approximately 25%.\nGlobalstar has awarded SS\/L, the prime contract to design, construct and launch the satellite constellation. SS\/L has and expects to award subcontracts to third parties, including other investors in Globalstar, for substantial portions of its obligations under the contract.\nAs managing general partner of Globalstar, the Company is entitled to receive a management fee determined in accordance with the partnership agreement.\n3. CONTRACTS IN PROCESS:\nBillings and accumulated costs and profits on long-term contracts, principally U.S. Government, comprise the following:\nUnbilled contract receivables represent accumulated costs and profits earned but not yet billed to customers at year-end. The Company expects that substantially all such amounts will be billed and collected within one year.\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe following data has been used in the determination of costs and expense:\nIn connection with the determination of the fair value of assets acquired (Note 2) and pursuant to the provisions of Accounting Principles Board Opinion No. 16, the Company has valued acquired contracts in process at contract price, minus the estimated cost to complete and an allowance for the Company's normal profit on its effort to complete such contracts.\n4. PROPERTY, PLANT AND EQUIPMENT:\nDepreciation and amortization expense in 1994, 1993 and 1992 was $141,853,000, $113,447,000, and $100,954,000, respectively.\n5. DEBT:\nIn February 1994, the Company entered into a five-year, $1,200,000,000 revolving credit facility and a 364-day, $500,000,000 revolving credit facility with a group of banks replacing an existing three-year revolving credit facility. The revolving credit facilities serve to back up the Company's commercial paper borrowings. The amount available for borrowing under the facilities is reduced by the outstanding commercial paper. Borrowings under the facilities are unsecured and bear interest, at the Company's option, at various rates based on the base rate, or on margins over the CD rate or EuroDollar rate. The Company pays a commitment\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nfee on the unused portion. The margins and the commitment fee are subject to adjustment. Borrowings are prepayable at any time and are due at maturity. The agreements contain financial covenants requiring the Company to maintain certain levels of net worth and an interest coverage ratio, as well as a limitation on indebtedness and dividends.\nThe outstanding commercial paper borrowings at March 31, 1994, supported by the Company's five-year revolving credit facility are classified as long-term since the Company intends to refinance these borrowings through long-term borrowings, rollover of commercial paper borrowings or utilization of the revolving credit facilities.\nIn September 1993, the Company issued $200,000,000 7% Senior Debentures. The 7%, 8 3\/8% and 9 1\/8% Senior Debentures are not redeemable prior to maturity and are not subject to any sinking fund provisions.\nIn October 1993, the Securities and Exchange Commission declared effective a shelf registration statement which enables the Company to issue up to $300,000,000 of additional debt securities.\nIn anticipation of refinancing a portion of the revolving credit facilities, the Company entered into several interest rate hedge agreements, maturing in April and June 1994, with a principal amount of $500,000,000.\nIn fiscal 1993, the Company recorded an extraordinary charge of $28,216,000 pre-tax, $17,776,000 after-tax, or $.23 per share for the early redemption of certain long-term debt issues and the cancellation of an existing credit facility. The extraordinary charge consisted of redemption premiums and the write-off of unamortized discounts and financing costs. In connection with the redemption of $69,694,000 principal amount of certain convertible debentures, the Company issued 3,149,710 shares of Loral Common Stock (as adjusted for two-for-one stock split, see Note 7).\nThe aggregate maturities of long-term debt, excluding commercial paper borrowings classified as long-term, for the years 1995 through 1999 are as follows: $173,928,000, $329,000, $10,626,000, $1,106,000 and $859,000.\nThe fair value of the Company's total debt and the interest rate hedges, based on quoted market prices or on current rates for similar debt with the same maturities, was approximately $1,762,000,000 and $554,500,000 at March 31, 1994 and 1993, respectively.\n6. INCOME TAXES:\nIn 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"), which changed the method of accounting for income taxes from the deferred method to the liability method. Under the liability method, deferred tax assets and liabilities are recognized based on the temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and income tax purposes using currently enacted tax rates. The adoption of SFAS 109 did not have a material effect on the financial position or results of operations for the year ended March 31, 1993.\nThe components of the provision for income taxes are as follows:\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe effective income tax rate differs from the statutory Federal income tax rate for the following reasons:\nOn August 10, 1993, the Omnibus Budget Reconciliation Act of 1993 was signed into law, including a provision that increased the Federal corporate income tax rate by 1%, to 35%, effective January 1, 1993. This increase was partially offset by the additional tax benefit resulting from revaluing deferred tax assets at the higher rate.\nThe provision for income taxes excludes: current tax benefits related to the exercise of stock options, credited directly to Shareholders' Equity, of $3,643,000 and $10,237,000 for 1994 and 1993, respectively; a deferred tax benefit of $10,261,000, related to the additional minimum pension liability debited directly to Shareholders' Equity for 1994; and, in 1993, the tax benefit of $10,440,000, related to the extraordinary item and the deferred tax benefit of $97,122,000, related to the cumulative effect of the change in accounting for SFAS 106.\nThe significant components of the net deferred income tax asset are:\nThe net deferred income tax asset is classified as follows:\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. SHAREHOLDERS' EQUITY:\nIn September 1993, the shareholders approved an increase in the number of authorized shares of common stock from 70,000,000 shares to 150,000,000 shares.\nOn October 7, 1993, the Company completed a two-for-one stock split in the form of a 100% stock distribution payable to shareholders of record on September 28, 1993. Accordingly, all share and per share amounts have been adjusted to reflect the stock split.\nThe Company has 2,000,000 authorized and unissued shares of preferred stock (par value $1.00). The designation of terms, conditions and amounts of such preferred stock may be set by the Board of Directors.\nUnder the Company's various stock option plans, options may be granted at prices determined by the Compensation and Stock Option Committee. The Committee determines the exercise and expiration dates of the options, which may not be later than 10 years from the date of grant. For options granted at less than 75% of the fair market value at date of grant, the plans provide for return of stock issued on exercise of these options on a ratable basis should the recipient leave the Company's employment under certain circumstances within six years of the grant of these options. Unearned compensation with respect to options granted at less than fair market value at date of grant, included as a component of Equity Adjustments in Shareholders' Equity, aggregated $13,644,000, $8,424,000 and $13,632,000 at March 31, 1994, 1993 and 1992, respectively, and is being amortized over the period that the options vest.\nOptions outstanding have been granted at prices ranging from $4.50 to $37.63 per share.\nA summary of the option transactions follows:\nThere were 51,026 shares, 1,859,140 shares and 3,081,690 shares of common stock available for future option grants at March 31, 1994, 1993, and 1992, respectively.\nUnder the Company's Restricted Stock Purchase Plan, established in 1988, 2,000,000 shares of the Company's common stock were issued under the Plan, upon payment by the employee of the par value per share. The total number of shares earned under the Plan each year equals 3% of the Company's pre-tax profit divided by the grant value (currently $105.00 per share) of restricted shares outstanding. Any shares not earned at the earlier of completion of the seventh year after grant or termination of employment will be essentially forfeited by being repurchased by the Company at par value. Under the Plan, 104,846 shares, 341,714 shares and 420,986 shares were earned for the years ended March 31, 1994, 1993 and 1992, respectively. At March 31, 1994, 147,738 shares of common stock are still to be earned and 13,060 shares of common stock are available for future grants under this Plan. Unearned compensation related to these shares, included as a component of Equity Adjustments in Shareholders' Equity, aggregated $5,521,000, $7,504,000 and $4,935,000 at March 31, 1994, 1993, and 1992 respectively, and is amortized as the shares are earned.\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. COMMITMENTS AND CONTINGENCIES:\nThe Company leases certain facilities and equipment under agreements expiring at various dates through 2080. At March 31, 1994, future minimum payments for noncancellable operating and capital leases with initial or remaining terms in excess of one year are as follows:\nReal estate lease commitments have been reduced by minimum sublease rentals of $27,399,000 due in the future under noncancellable subleases. The present value of the minimum lease payments for capital leases is $16,729,000, net of imputed interest of $9,265,000.\nLeases covering major items of real estate and equipment contain renewal and or purchase options which may be exercised by the Company. Rent expense, net of sublease income of $4,180,000, $2,378,000 and $5,218,000, was $65,239,000, $50,539,000 and $44,281,000, in 1994, 1993 and 1992, respectively.\nAt March 31, 1994, outstanding letters of credit were approximately $392,000,000.\nAt acquisition, LFS's contracts in process included a systems integration contract with the Federal Aviation Administration (\"FAA\") for the modernization of the U.S. air traffic control system. Prior to the acquisition, discussions were held between LFS and FAA officials with respect to modifying certain terms and conditions of the contract. This contract has also been the subject of considerable public and media attention in the past year and in December 1993, the FAA initiated a comprehensive review of the contract. The extent of the contract modifications, if any, as a result of the comprehensive review, as well as future negotiations with the FAA, is not determinable at this time. The final purchase price of LFS is subject to a reduction, up to a specified limit, based upon the outcome of these matters. (See Current Report on Form 8-K dated March 1, 1994, Exhibit 10.2.) In the opinion of management, and in light of the potential adjustment of the LFS purchase price and reserves provided, the ultimate outcome of this matter will not have a material adverse effect on the financial position or results of operations of the Company.\nManagement is continually assessing its obligations with respect to applicable environmental protection laws. While it is difficult to determine the timing and ultimate cost to be incurred by the Company in order to comply with these laws, based upon available internal and external assessments, the Company believes that even without considering potential insurance recoveries, if any, there are no environmental loss contingencies that, individually or in the aggregate, are material. The Company accrues for these contingencies when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. The Company has been named a Potentially Responsible Party (\"PRP\") at a number of sites. In several of these situations Loral acquired the site pursuant to a purchase agreement which provided that the seller would retain liability for environmental remediation and related costs arising from occurrences prior to the sale. In other situations the Company is party to an interim or final allocation plan that has been accepted by other PRPs whose size and current financial condition make it probable that they will be able to pay the environmental costs apportioned to them. The Company believes that it has adequately accrued for future expenditures in\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nconnection with environmental matters and that such expenditures will not have a material adverse effect on its financial condition or results of operations.\nThere are a number of lawsuits or claims pending against the Company and incidental to its business. However, in the opinion of management, the ultimate liability on these matters, if any, will not have a material adverse effect on the financial position or results of operations of the Company.\n9. PENSIONS AND OTHER EMPLOYEE BENEFITS:\nPENSIONS:\nThe Company maintains several pension plans, both contributory and noncontributory, covering certain employees. Eligibility for participation in these plans varies and benefits are generally based on members' compensation and years of service. The Company's funding policy is generally to contribute annually the maximum amount that can be deducted for Federal income tax purposes. Plan assets are invested primarily in U.S. government and agency obligations and listed stocks and bonds.\nPension (credit) cost included the following components:\nThe following presents the plans' funded status and amounts recognized in the balance sheet:\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe principal actuarial assumptions were:\nPOSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFITS:\nIn addition to providing pension benefits, the Company provides certain health care and life insurance benefits for retired employees and dependents at certain locations. Participants are eligible for these benefits when they retire from active service and meet the eligibility requirements for the Company's pension plans. These benefits are funded primarily on a pay-as-you-go basis with the retiree generally paying a portion of the cost through contributions, deductibles and coinsurance provisions.\nEffective April 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (\"SFAS 106\"). SFAS 106 requires employers to recognize the cost of postretirement health and welfare obligations in their financial statements over the years of employee service. These costs were previously expensed on a pay-as-you-go basis. The Company elected to immediately recognize the accumulated postretirement obligation upon adoption of SFAS 106. A non-recurring charge of $330,499,000 pre-tax, $233,377,000, after-tax, or $3.03 per share, was recorded as the cumulative effect of the accounting change. Total postretirement health care and life insurance costs were $41,570,000 and $57,353,000 for 1994 and 1993, respectively under SFAS 106. These costs for 1992, which were recorded on a cash basis, and have not been restated, were $17,455,000.\nIn March 1993 and March 1994, the Company adopted various plan amendments which are being amortized as prior service cost commencing in the quarter following adoption.\nPostretirement health care and life insurance costs included the following components:\nThe following table presents the amounts recognized in the balance sheet at:\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nActuarial assumptions used in determining the accumulated postretirement benefit obligation include a discount rate of 7.75% and 9% for 1994 and 1993, respectively, and an assumed health care cost trend rate of 12.4% decreasing gradually to an ultimate rate of 6% by the year 2003. Changing the assumed health care cost trend rate by 1% in each year would change the accumulated postretirement benefit obligation at March 31, 1994 by approximately $50,000,000 and the aggregate service and interest cost components for 1994 by approximately $6,500,000.\nEMPLOYEE SAVINGS PLANS:\nUnder its various employee savings plans, the Company matches the contributions of participating employees up to a designated level. The extent of the match, vesting terms and the form of the matching contribution vary among the plans. Under these plans, the matching contributions, in cash, Loral common stock or both, for 1994, 1993 and 1992 were $22,929,000, $18,625,000 and $19,179,000, respectively.\nPOSTEMPLOYMENT BENEFITS:\nIn November 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 112, \"Employers' Accounting for Postemployment Benefits\" (\"SFAS 112\"). The Company is required to adopt SFAS 112 by fiscal 1995 and based on preliminary estimates does not expect any material impact to the financial position or results of operations of the Company.\n10. SALES TO PRINCIPAL CUSTOMERS:\nThe Company operates primarily in one industry segment, defense electronics. Sales to principal customers are as follows:\nForeign sales comprise the following:\n11. RELATED PARTY TRANSACTIONS:\nThe Company charges SS\/L a fee for providing SS\/L with management services under an agreement among the Company, LAH, SS\/L and the four European investors. The management fee was $2,981,000, $2,576,000 and $1,953,000 in 1994, 1993 and 1992, respectively. The Company and LAH allocate certain\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\noverhead costs and expenses to SS\/L and SS\/L charges LAH certain overhead costs. The net allocated expenses charged to SS\/L were $9,446,000, $10,448,000, and $10,414,000 in 1994, 1993 and 1992, respectively. In addition, the Company sells products to SS\/L. Net sales to SS\/L were $15,769,000, $11,574,000 and $8,513,000 in 1994, 1993 and 1992, respectively. Included in other current assets are advances to SS\/L of $8,207,000 and $6,832,000 at March 31, 1994 and 1993, respectively. LAH and SS\/L have a tax sharing agreement whereby certain tax liabilities and benefits are shared equitably. For the year ended March 31, 1992, LAH paid $10,239,000 to SS\/L pursuant to this agreement. LAH has guaranteed performance of SS\/L under certain commercial contracts. To date, SS\/L has performed satisfactorily under these contracts, and management believes that they will be successfully completed.\nIn 1989, the Company sold its Aircraft Braking Systems and Engineered Fabrics divisions to K&F Industries, Inc. (\"K&F\"), of which the Chairman of Loral owns 35% of the capital stock and certain executive officers of Loral own rights to purchase 4% of the capital stock. In connection with the sale, K&F issued to the Company a $30,000,000 14 3\/4% paid-in-kind subordinated convertible debenture due 2004 (the \"Debenture\") convertible into 15% of the common equity of K&F. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 81, the value of the Debenture has not been recognized by the Company. Because the Debenture is not publicly traded its fair value is not readily determinable. However, the Company believes that the Debenture has a fair value less than the publicly traded K&F subordinated debentures, which have rights superior to the Debenture and pay interest currently, and are trading at approximately 92% of face value.\nThe Company and K&F have agreements covering various real property occupancy arrangements and agreements under which the Company and K&F provide certain services, such as benefits administration, treasury, accounting and legal services to each other. The charges for these services, as agreed to by the Company and K&F, are based upon the actual cost incurred in providing the services without a profit. These transactions between the Company and K&F were not significant. Sales to K&F were $6,785,000, $4,796,000 and $8,828,000 in 1994, 1993 and 1992, respectively.\nLORAL CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n12. QUARTERLY FINANCIAL INFORMATION (UNAUDITED):\n- - - --------------- * Earnings per share is computed independently for each of the periods presented and therefore the quarters may not sum to the total for the year. Adjusted to reflect two-for-one stock split distributed October 7, 1993.\nLORAL CORPORATION AND SUBSIDIARIES\nSCHEDULE II -- ACCOUNTS RECEIVABLE FROM RELATED PARTIES AND UNDERWRITERS, PROMOTERS AND EMPLOYEES OTHER THAN RELATED PARTIES FOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992 (IN THOUSANDS)\n- - - ---------------\nNotes: (a) The loan was charged interest at 5% and was not collateralized. The loan was paid in full in June 1993.\n(b) The loan was charged interest at 7% and was collateralized. The loan was paid in full in March 1994.\n(c) No interest was charged and the loan was not collateralized. The loan was paid in full in May 1991.\nS-1\nLORAL CORPORATION AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992 (IN THOUSANDS)\n- - - --------------- Notes:\n(a) Includes the following amounts acquired through business acquisitions:\n(b) Primarily reclassifications among asset categories, in addition to other minor adjustments. Fiscal 1992 includes final purchase price allocations of $46,518.\nS-2\nLORAL CORPORATION AND SUBSIDIARIES\nSCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT FOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992 (IN THOUSANDS)\n- - - --------------- Notes:\n(a) Primarily reclassifications among asset categories, in addition to other minor adjustments.\nDepreciation and amortization:\nThe annual provisions for depreciation and amortization have been computed principally in accordance with the following range of years (provided primarily on the straight-line method):\nBuildings and improvements -- 5 to 45 years\nMachinery, equipment, furniture and fixtures -- 3 to 13 years\nLeasehold improvements -- Lesser of asset life or lease term.\nS-3\nLORAL CORPORATION AND SUBSIDIARIES\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION FOR THE YEARS ENDED MARCH 31, 1994, 1993 AND 1992 (IN THOUSANDS)\n- - - --------------- * Amounts are not presented because such amounts are less than one percent of total sales.\nS-4\nEXHIBIT INDEX\nNote: Certain instruments with respect to issues of long-term debt have not been filed as Exhibits to this report since the authorized principal amount of any one of such issues does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis as of March 31, 1994. Such indebtedness is described in general terms in Note 5 to Consolidated Financial Statements included herein. The Registrant agrees to furnish to the Commission a copy of each instrument upon its request.","section_15":""}
{"filename":"315256_1994.txt","cik":"315256","year":"1994","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. The System furnishes retail electric service in Connecticut, New Hampshire and western Massachusetts 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]). In addition to their retail electric service, CL&P, PSNH, WMECO and HWP (including its wholly-owned subsidiary, Holyoke Power and Electric Company [HPE]) (the System companies) together furnish firm wholesale electric service to eight municipal electric systems and investor-owned 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 as measured by revenues.\nNorth Atlantic Energy Corporation (NAEC) is a special purpose subsidiary of NU, which sells its share of the capacity and output of the Seabrook nuclear generating facility (Seabrook) in Seabrook, New Hampshire, to PSNH under two life-of-unit, full cost recovery contracts. NU's subsidiary North Atlantic Energy Service Corporation (North Atlantic or NAESCO) has operational responsibility for Seabrook.\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 the Millstone nuclear generating facilities in Connecticut. North Atlantic acts as agent for the System companies and other New England utilities in operating Seabrook. Three 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 other forms of non-utility generation and in exempt wholesale generators (\"EWGs\")(collectively, \"NUGs\") and foreign utility companies (\"FUCOs\") as permitted under the Energy Policy Act of 1992 (Energy Policy Act). HEC provides energy management services for commercial, industrial and institutional electric customers. See \"Nonutility Businesses.\"\nA reorganization of NU entailing realignment into two core business groups became effective on January 1, 1994. The first group, the energy resources group, is devoted to energy resource acquisition and wholesale marketing and focuses on nuclear, fossil and hydroelectric generation and wholesale power marketing. The other 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 is undergoing a corporate reengineering process to assist in identifying opportunities to become more competitive while improving customer service and maintaining a high level of operational performance.\nPUBLIC UTILITY REGULATION\nNU is a registered electric utility holding company under the Public Utility Holding Company Act of 1935 (1935 Act). Accordingly, the Securities and Exchange Commission (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. The 1935 Act limits the System, with certain exceptions, to the business of being an electric utility in the Northeastern region of the country.\nThe System companies are subject to the Federal Power Act as administered by the Federal Energy Regulatory Commission (FERC). The Energy Policy Act amended this act to authorize FERC to order wholesale transmission wheeling services and under certain circumstances to require electric utilities to enlarge transmission capacity necessary to provide such services. 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 laws governing the retail marketing areas of electric utilities.\nIn addition, the Nuclear Regulatory Commission (NRC) has broad jurisdiction over the System's nuclear units and each of the System companies is subject to broad regulation by its respective state and\/or local regulatory authorities with jurisdiction over the service areas in which each company operates. The System incurs substantial capital expenditures and operating expenses to identify and comply with environmental, energy, licensing and other regulatory requirements, including those described herein, and it expects to incur additional costs to satisfy further requirements in these and other areas of regulation. See generally \"Rates,\" \"Electric Operations\" and \"Regulatory and Environmental Matters.\"\nCOMPETITION AND MARKETING\nCompetitive forces within the electric utility industry are continuing to increase due to a variety of influences, including legislative and regulatory actions, technological advances and changes in consumer demands. In response, the System 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. The System also benefits from a diverse retail base. The System has no significant dependence on any one retail customer or industry.\nTHE ECONOMY\nIn 1994, the System experienced its most significant retail sales growth in six years, due in large part to the economic recovery in New England. Employment levels have risen, particularly in New Hampshire, unemployment rates have fallen, and personal income has increased in all three states comprising the System's retail service territory. The System's 1994 retail sales, which comprise 77 percent of all kilowatt-hour sales, rose by a total of 2.9 percent or 867 million kilowatt-hours over 1993. Retail sales growth was consistent across all major customer classes, with residential sales rising by 2.8 percent, commercial sales by 3.2 percent and industrial sales by 2.6 percent. Retail sales growth was strongest for CL&P, which recorded an increase of 3.4 percent, and weakest for WMECO, which experienced a 1.4 percent increase. At PSNH, retail sales rose by 2.0 percent. Overall, weather had little effect on sales volume, with mild weather after mid-August offsetting unusually cold weather in January and hot weather in late June and July.\nIn 1995, the System expects little retail sales growth from 1994, primarily because of the effects of higher interest rates on the regional economy and further cutbacks in defense-related industries in Connecticut. Over the longer term, retail sales growth is expected to be strongest in New Hampshire, which by some measures has the fastest-growing economy in New England. In 1994, many businesses announced plans to expand in New Hampshire. The System estimates that PSNH will have compounded annual sales growth of 1.9 percent from 1994 through 1999, compared with 1.4 percent for CL&P and 0.9 percent for WMECO.\nWholesale sales, which comprised the remaining 23 percent of all sales, rose 0.8 percent or 75 million kilowatt-hours in 1994, due to aggressive marketing efforts and the opening of new wholesale markets as a result of increased wholesale competition, including the addition of Madison, Maine as a wholesale customer.\nRETAIL MARKETING\nRetail sales growth and the System's success in lowering operating costs were the primary reasons for the improvement in NU's financial performance in 1994. Because the System has surplus generating capacity, additional demand can be easily met from existing generation. As a result, the additional costs of serving expanding load--principally the cost of additional fuel--are far less than the revenues received from the additional kilowatt-hour sales.\nThe System companies continue to operate predominantly in state-approved franchise territories under traditional cost-of-service regulation. Retail wheeling, under which a retail customer would be permitted to select an electricity supplier other than its local electric utility and require the local electric utility to transmit the power to the customer's site, is not required in any of the System's jurisdictions. In 1994, Connecticut regulators reviewed the desirability of retail wheeling and determined that it was not in the best interest of the state until new generating capacity is needed, which the System projects to be in 2009. The Connecticut Department of Public Utility Control (DPUC) is presently conducting a generic proceeding studying the restructuring of the electric industry and competition in order to develop findings and recommendations to be presented to policymakers at the legislative level. A decision in this proceeding is expected in mid-1995.\nIn New Hampshire, several bills related to retail wheeling have been introduced in the legislature. The chairman of the New Hampshire Public Utilities Commission (NHPUC) has set up a roundtable discussion with legislators, utilities and large customers on how to deal with a more competitive market. In addition, a new entity, Freedom Electric Power Company (FEPCO), has filed with the NHPUC for permission to do business as an electric utility to serve selected large PSNH customers. PSNH and other New Hampshire utilities are opposing FEPCO's petition before the NHPUC.\nThere also have been several bills introduced in Massachusetts that involve the potential for retail wheeling, electric utility industry restructuring and regulatory reform. To date, none of these bills have been enacted. On February 10, 1995, the Massachusetts Department of Public Utilities (DPU) initiated an investigation into various ways in which the electric utility industry in Massachusetts could be restructured. The DPU has asked interested parties to comment on numerous topics such as competition and customer choice by March 31, 1995. It is not known when the DPU will issue an order in this proceeding.\nWhile retail wheeling is not required in the System's retail service territory, competitive forces nonetheless are influencing retail pricing. These include competition from alternate fuels such as natural gas, competition from customer-owned generation and regional competition for business retention and expansion. The System's retail business group is continuing to work with customers to address their concerns. Since the fall of 1991, the System companies have reached approximately 230 special rate agreements with customers to increase or retain their electricity purchases from the System, including 124 CL&P customers, 54 PSNH customers and 44 WMECO customers through the end of 1994. These agreements include 135 agreements to retain existing customers and 87 agreements for new customers and account for approximately four percent of System 1994 retail revenues.\nIn general, these special rate agreements have terms of approximately five years. Most of CL&P's agreements have been entered pursuant to general rate riders approved by the DPUC. Most of PSNH's special contracts require individual approval from the NHPUC. The DPU requires individual approval of some special contracts, but in 1994 the DPU also authorized WMECO to reduce rates by five percent for all customers whose demand exceeds one megawatt (MW) as long as those customers agree to give WMECO at least five years' notice before generating their own power or purchasing it from an alternative supplier. As of December 31, 1994, ten WMECO customers had signed up for this service extension discount.\nMany of the special rate agreements were reached individually on a customer-by-customer basis. However, three significant groups of customers also entered agreements with certain of the System companies over the past two years. In 1993, HWP entered ten-year contracts with all of its approximately 40 retail industrial customers, which accounted for approximately $7 million of revenue in 1994. PSNH entered into long-term contracts with approximately 30 sawmill operators and nine ski resorts in 1994.\nNegotiated retail rate reductions for System customers under rate agreements in effect for 1994 amounted to approximately $20 million, including $11 million for CL&P, $3 million for PSNH, $4 million for WMECO and $2 million for HWP. Management believes that the aggregate amount of retail rate reductions will increase in 1995, but that such agreements will continue to provide significant benefits to the System including the preservation of approximately four percent of retail revenues.\nSpecial rate agreements represent only a portion of the System's response to the new competitive forces in the energy marketplace. The System spent approximately $46 million in 1994 on demand side management (DSM) programs. Over 60 percent of DSM program costs were targeted to the commercial and industrial sectors. These programs help customers improve the efficiency of their electric lighting, manufacturing, and heating, ventilating and air conditioning systems, making them more competitive in their own markets, which in turn enables them to be more viable employers in the System's service territories. DSM program costs are recovered from customers through various cost recovery adjustment mechanisms. For further information on DSM programs, see \"Rates - Connecticut Retail Rates - Demand Side Management\" and \"Rates - Massachusetts Retail Rates - Demand Side Management.\" System companies also are increasingly working with customers to improve reliability and power quality within commercial and industrial facilities.\nMany of the System's programs for residential customers are targeted at improving the efficiency of lighting and electric space heating, as well as the energy efficiency of new homes. Residential space heating represents approximately five percent of the System's retail electric sales, and suppliers of alternative fuels, such as natural gas, have actively recruited residential customers to convert their heating systems from electric heat. In 1994, an increase in the number of CL&P's space heating customers offset decreases in the numbers of WMECO's and PSNH's space heating customers.\nWHOLESALE MARKETING\nThe System acts as both a buyer and a seller of electricity in the highly competitive wholesale electricity market in the Northeastern United States (Northeast). Many of the sales contracts signed by the System companies in the late 1980's have expired or will expire in the mid-1990's, and much of the revenue produced by such contracts has not been replaced through new wholesale power arrangements. In 1994, wholesale sales, including firm wholesale service and other bulk supply transactions, accounted for approximately $331 million, or approximately 9.2 percent, of System revenues, down from approximately $383 million in 1993, due in large part to the loss of one major customer and the increased competitiveness of the wholesale market. Unless prices on the wholesale market improve, revenues are expected to fall further in 1995 before stabilizing in late 1996 and 1997. Wholesale sales are made primarily to investor-owned utilities and municipal systems or cooperative electric systems in the Northeast. The System will be increasing its efforts to increase wholesale sales through intensified marketing efforts. The System's power marketing efforts benefit from the interconnection of its transmission system with all of the major utilities in New England, as well as with three of the largest electric utilities in New York state.\nThe System's 1994 firm wholesale sales were approximately 1.3 million megawatt-hours. In 1994, firm wholesale electric service accounted for approximately 2.5 percent of the System's revenues (approximately 1.4 percent of CL&P's operating revenue, 6 percent of PSNH's operating revenue and a negligible amount of WMECO's operating revenue).\nIn 1994, the System companies commenced service under six long-term sales contracts with municipal electric systems, including five in Massachusetts and one in Maine. These power sales contracts have terms which range from five to ten years. The related revenues, which amounted to approximately $4 million in 1994, are expected to increase over the coming years. The System also sold an average of approximately 400 MW of power during 1994 in short-term sales to four utilities in New York State. Those sales ranged in duration from a week to six months and accounted for approximately $54 million in System revenues in 1994.\nThe System owns approximately one-half of the 2,000 MW of surplus capacity in New England. This surplus and the resulting competition for business has caused the System to renegotiate some of its arrangements with its existing wholesale customers. For example, in 1994 CL&P began serving the City of Chicopee, Massachusetts under a new ten-year arrangement. Furthermore, CL&P and the Town of Wallingford, Connecticut signed a contract for service of Wallingford's approximate 110 MW load for a ten-year period beginning in 1995. The new arrangement was coordinated through the Connecticut Municipal Electric Energy Cooperative, an organization that assists municipalities with their energy needs, and supersedes CL&P's current firm wholesale contract with Wallingford. In these cases, due to wholesale competition, the customers were able to secure prices lower than those that would have been paid under traditional cost-of-service ratemaking. Similarly, long-term agreements were renegotiated before 1994 with the New Hampshire Electric Cooperative and several other municipal and small investor-owned electric systems in Connecticut, New Hampshire and Massachusetts.\nThe System's transmission system is an open access wholesale transmission system: other parties, either utilities or independent power producers, can use NU's transmission system to move power from a seller to a wholesale buyer at FERC-approved rates, provided adequate capacity across those lines is available and service reliability is not endangered. In 1994, the System companies collected approximately $42 million in transmission revenues for transmission of power sales emanating from either the System or from other generating plants. See \"Electric Operations - Generation and Transmission\" for further information on 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.\"\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. Connecticut 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.\nThe DPUC issued a decision in CL&P's most recent rate case in June 1993 (1993 Decision) approving a multi-year rate plan that provides for annual retail 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 rate increases were implemented as scheduled in 1993 and 1994. For more information regarding the 1993 Decision, see \"Legal Proceedings.\"\nCL&P ADJUSTMENT CLAUSES\nCL&P has a fossil fuel and purchased power adjustment clause pursuant to which CL&P, subject to periodic review by the DPUC, recovers or refunds substantially all prudently incurred expenses and credits applicable to its retail electric rates on a current basis.\nCL&P's current retail rates also assume that the nuclear units in which CL&P has entitlements will operate at a 72 percent composite capacity factor. A generation utilization adjustment clause (GUAC) levels the effect on rates of fuel costs incurred or avoided due to variations in nuclear generation above and below that performance level. Because nuclear fuel is less expensive than any other fuel utilized by the System, 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 each twelve-month period ending July 31, these net variations from the costs reflected in base rates are, with DPUC approval, generally refunded to or collected from customers over the subsequent twelve-month period beginning September 1.\nOn January 5, 1994, the DPUC issued a decision ordering CL&P not to include a GUAC amount in customers' bills through August 1994. The DPUC found that CL&P overrecovered its fuel costs during the 1992-1993 GUAC period and offset the amount of the overrecovery against the unrecovered GUAC balance. The effect of the order was a disallowance of $7.9 million. On March 4, 1994, CL&P appealed this decision to Hartford Superior Court and expects a decision in the spring of 1995.\nIn the most recent GUAC period, which ended July 31, 1994, the actual level of nuclear generating performance was 68.2 percent, resulting in a GUAC deferral of $23.7 million to be collected from customers beginning in September 1994. On December 30, 1994, the DPUC ordered CL&P to collect from customers over the ensuing eight months only $15.9 million of the $23.7 million GUAC deferral accrued during the 1993-1994 GUAC year. The DPUC disallowed $7.8 million of the deferral, finding that CL&P had overrecovered that amount through base rate fuel recoveries. The DPUC further stated that it would follow a similar course in the future. CL&P has also appealed this order.\nFor the GUAC year ended July 31, 1995, CL&P expects to defer in excess of $50 million of GUAC fuel costs for projected nuclear performance below 72 percent. As of December 31, 1994, CL&P has reserved $13 million against this amount based on the methodology applied by the DPUC in previous GUAC decisions.\nThe DPUC has conducted several reviews to examine the prudence of certain costs, including purchased power costs, incurred in connection with outages at various nuclear units located in Connecticut, which occurred during the period October 1990 - February 1992. Three of these prudence reviews are either on appeal or still pending at the DPUC. Approximately $92 million of costs are at issue in these remaining cases, some or all of which may be disallowed. Management believes its actions with respect to these outages have been prudent and does not expect the outcome of the appeals to result in material disallowances. For further information on these prudence reviews, see \"Nuclear Performance\" in the notes to NU's and CL&P's financial statements.\nDEMAND SIDE MANAGEMENT\nCL&P participates in a collaborative process for the development and implementation of DSM programs for its residential, commercial and industrial customers. CL&P is allowed to recover conservation costs in excess of costs reflected in base rates over periods ranging from 3.85 to 10 years.\nIn June 1994, the DPUC issued an order approving a reduction in the amortization period from eight years to 3.85 years for CL&P's 1994 DSM expenditures, which will allow CL&P to recover its total 1994 program budget of $40 million over 3.85 years beginning in 1994.\nOn October 31, 1994, CL&P filed an application with the DPUC regarding CL&P's 1995 DSM expenditures, program designs, performance incentive mechanism and lost fixed-cost recovery. CL&P proposed a budget level of $36.7 million for 1995 DSM expenditures and an amortization period for new expenditures of 3.93 years. The DPUC began hearings on the proposed budget and programs during November 1994. CL&P's unrecovered DSM costs at December 31, 1994, excluding carrying costs, which are collected currently, were approximately $116 million.\nNEW HAMPSHIRE RETAIL RATES\nRATE AGREEMENT AND FPPAC\nPSNH's 1989 Rate Agreement with the State of New Hampshire provides for seven base rate increases of 5.5 percent per year beginning in 1990 and a comprehensive fuel and purchased power adjustment clause (FPPAC). The first five base rate increases went into effect as scheduled and the remaining two base rate increases will be put in effect on June 1, 1995 and June 1, 1996, concurrently with semi-annual adjustments in the FPPAC. Political and economic pressures, caused by historically high retail electric rates in New Hampshire, may inhibit additional rate increases, including FPPAC increases, above 5.5 percent per year during the next two years, may lead to challenges to the Rate Agreement in the future and may limit rate recoveries after the period for the seven 5.5 percent increases has ended. In accordance with the schedule for rate increases under the Rate Agreement, PSNH increased its average retail electric rates by about 5.5 percent in June 1994.\nThe FPPAC provides for the recovery or refund by PSNH, for the ten-year period beginning on May 16, 1991, of the difference between its actual prudent energy and purchased power costs and the estimated amounts of such costs included in base rates established by the Rate Agreement. The FPPAC amount is calculated for a six-month period based on forecasted data and is reconciled to actual data in subsequent FPPAC billing periods.\nFor the period December 1, 1993 through May 31, 1994, the NHPUC approved an increase in the FPPAC rate which resulted in a 1.8% increase in overall base rates. For the period June 1, 1994 through November 30, 1994, the NHPUC approved an increase in the FPPAC rate consistent with an overall increase in base rates of 5.5% For the period December 1, 1994 through May 31, 1995, the NHPUC approved a continuation of the current FPPAC rate. This rate treatment allowed PSNH to limit overall rate increases in 1994 to a level that did not exceed 5.5%, while maintaining an FPPAC rate level sufficient to collect the Seabrook refueling costs over four periods through rates by the end of November 30, 1995. The FPPAC rate is not expected to increase in 1995.\nThe costs associated with purchases by PSNH from certain NUGs at prices over the level assumed in rates and a portion of the payments to New Hampshire Electric Cooperative, Inc. (NHEC) for PSNH's buyback of NHEC's Seabrook entitlement are deferred and recovered through the FPPAC over ten years. As of December 31, 1994, NUG and NHEC deferrals totaled approximately $174 and $20.3 million, respectively.\nUnder the Rate Agreement, PSNH has an obligation to use its best efforts to renegotiate burdensome purchase power arrangements with 13 specified NUGs that were selling their output to PSNH under long term rate orders. In general, PSNH has been attempting to exchange present cash payments for relief from high-cost purchased power obligations to the NUGs, with such payments and an associated return being recoverable from customers over a future amortization period. For more information regarding the Rate Agreement, see \"PSNH Rate Agreement\" in the notes to NU's and PSNH's financial statements.\nOn April 19, 1994, the NHPUC approved new purchase power agreements with five hydroelectric NUGs. These agreements were effective retroactive to January 1993. Management anticipates that the initial decrease in payments to these NUGs during a year with normal water flow will average approximately 14 percent or $1.4 million per year. PSNH will flow the savings resulting from these new agreements through the FPPAC to its customers. The first of these new power purchase agreements will expire in 2022. The NHPUC deferred action on whether PSNH had exercised its best effort to renegotiate the agreements.\nIn addition, PSNH has been involved in negotiations with eight wood-fired NUGs. On September 23, 1994, the NHPUC approved settlement agreements with two wood-fired NUGs covering approximately 20 MW of capacity. Pursuant to the settlement agreements, PSNH paid the owners approximately $40 million in exchange for the cancellation of the rate orders under which these NUGs sold their entire output at rates in excess of PSNH's replacement power costs. These NUGs also agreed not to compete with PSNH or other NU subsidiaries. Under New Hampshire legislation passed in May 1994, PSNH and the remaining six wood-fired NUGs were directed to continue negotiations concerning their power sales arrangements. Absent successful negotiations, the parties were directed to enter into a mediation process to be completed by November 14, 1994. The legislation required the parties to attempt to agree on a settlement under which the payments PSNH made for the NUGs' power would be lowered but the plants would continue to operate. At a January 4, 1995 status hearing, the NHPUC directed further mediation to take place with a representative from the State of New Hampshire assisting the parties. Only one agreement emerged from the mediation process, which calls for a payment of $52 million in return for a substantial reduction in the rates charged to PSNH. This agreement was filed with the NHPUC in February 1995.\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 its non-Seabrook assets and the value assigned to Seabrook. The unrecovered balance of the regulatory asset at December 31, 1994 was approximately $679 million. In accordance with the Rate Agreement, approximately $204 million of the remaining regulatory asset is scheduled to be amortized and recovered through rates by 1998, and the remaining amount, approximately $475 million, is being amortized and recovered through rates by 2011. PSNH earns a return each year on the unamortized portion of the asset. For more information regarding PSNH's recovery of this regulatory asset after 1997, see \"Regulatory Asset-PSNH\" in the notes to NU's financial statements and \"Regulatory Asset\" in the notes to PSNH's financial statements.\nSEABROOK POWER CONTRACT\nPSNH and NAEC entered into the Seabrook Power Contract (Contract) in June 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 1-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. At December 31, 1994, NAEC's net utility plant investment in Seabrook 1 was approximately $718 million.\nIf Seabrook 1 were retired prior to the expiration of its NRC operating license term, NAEC would continue to be entitled under the Contract to recover its remaining Seabrook investment and a return on that investment and its other Seabrook-related costs for 39 years, less the period during which Seabrook 1 has operated.\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 and a portion of the initial investment) is calculated based on NAEC's actual capitalization 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 has increased annually since May 1991 and will reach 100 percent by 1997. As of December 31, 1994, 70 percent of the initial 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, together with a return on it, will be recovered between 1997 and 2001. At December 31, 1994, the amount of this deferred return was $131.5 million. For additional information regarding the Contract and a similar contract, which involves NAEC's acquisition of Vermont Electric Generation and Transmission Cooperative, Inc.'s ownership interest in Seabrook, see \"Seabrook Power Contract\" in the notes to PSNH's financial statements.\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.\nOn May 26, 1994, the DPU approved a settlement offer from WMECO and the Massachusetts Attorney General that, among other things, provided that: (1) all pending WMECO generating unit performance review proceedings regarding unit outages from mid-1987 through mid-1993 would be terminated without findings; (2) WMECO's customers' overall bills will be reduced by approximately $13.3 million over the 20-month period June 1, 1994 to January 31, 1996; (3) WMECO will not file for increased base rates effective before February 1, 1996; (4) WMECO will amortize post-retirement benefits other than pensions costs over a three-year period starting July 1, 1994; and (5) WMECO will offer a five percent rate reduction to its largest customers who agree not to self-generate or take electricity from another provider for five years. The settlement did not have a significant adverse impact on WMECO's 1994 earnings.\nDEMAND SIDE MANAGEMENT\nIn 1992, the DPU established a conservation charge (CC) to be included in WMECO's customers' bills. The CC includes incremental DSM program costs above or below base rate recovery levels, lost fixed cost recovery adjustments, and the provision for a DSM incentive mechanism. On January 21, 1994 the DPU approved a settlement offer from WMECO, the Massachusetts Attorney General, the Massachusetts Division of Energy Resources (DOER), the Conservation Law Foundation (CLF) and the Massachusetts Public Interest Research Group (MASSPIRG) pre-approving DSM funding levels for 1994 and 1995 of $14.2 million and $15.8 million, respectively. The settlement also provides for cost recovery adjustments and an incentive mechanism if certain implementation objectives are met.\nIn a subsequent proceeding, the DPU established a CC for each rate class at least through 1994 (and ordered deferred recovery of conservation-related costs in connection with two rate classes) and examined the level of conservation savings delivered by WMECO programs in prior years (and disallowed certain claimed conservation savings). On January 11, 1995, the DPU initiated hearings to set CCs for 1995, review the claimed level of conservation savings delivered and review the mechanism for determining lost fixed-cost recovery. Recently, in proceedings involving two other utilities, the DPU changed its policy to limit recovery of lost revenues due to implementation of conservation measures to a fixed period. If such a policy is implemented for WMECO, WMECO could lose several millions of dollars of revenues starting in 1996 and possibly as early as 1995. Further hearings for WMECO's docket are scheduled for March 1995. Management cannot predict when the DPU will issue a decision in this case.\nWMECO FUEL ADJUSTMENT CLAUSE AND GENERATING UNIT OPERATING PERFORMANCE\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 on a system-wide basis 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. 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. 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 operating units (the Yankee plants) in which WMECO has ownership interests.\nSubsequent to the May 26, 1994 settlement between WMECO and the DPU, the DPU initiated a review of WMECO's 1993-1994 generating unit performance. Hearings have not begun in that proceeding and it is not known when the DPU may issue a decision.\nRESOURCE PLANS\nCONSTRUCTION\nThe System's construction program expenditures, including allowance for funds used during construction (AFUDC), in the period 1995 through 1999 are estimated to be as follows:\n1995 1996 1997 1998 1999 (Millions)\nCL&P $148 $136 $144 $145 $145\nPSNH 51 36 32 39 39\nWMECO 36 28 29 39 39\nNAEC 5 8 7 6 6\nOTHER 14 10 10 10 10 ---- ---- ---- ---- ----\nTOTAL $254 $218 $222 $239 $239 ==== ==== ==== ==== ====\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. The construction program's main focus is maintaining and upgrading the existing transmission and distribution system, as well as nuclear and fossil-generating facilities.\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 periodically updates its long-range resource needs through its integrated demand and supply planning process. The System does not foresee the need for any new major generating facilities at least until 2009.\nThe System's long-term plans rely, in part, on certain DSM programs. These System company sponsored measures, including installations to date, are projected to lower the System summer peak load in 2009 by over 650 MW. See \"Rates - Connecticut Retail Rates - Demand Side Management\" and \"Rates - Massachusetts Retail Rates - Demand Side Management\" for information about rate treatment of DSM costs.\nIn addition, System companies have long-term arrangements to purchase the output from certain NUGs under federal and state laws, regulations and orders mandating such purchases. NUGs supplied 680 MW of firm capacity in 1994. This is the maximum amount that the System companies expect to purchase from NUGs for the foreseeable future. See \"New Hampshire Retail Rates - Rate Agreement and FPPAC\" for information concerning PSNH's efforts to renegotiate its agreements with thirteen NUGs.\nThe System's long-term resource plan also considers the economic viability of continuing the operation of certain of the System's fossil fuel generating units beyond their current book retirement dates and possibly repowering certain of the System's older fossil plants. Continued operation of existing fossil fuel units past their book retirement dates (and replacing certain critically located peaking units if they fail) is expected to provide approximately 1900 MW of resources by 2009 that would otherwise have been retired. In addition, repowering of some of the System's retired generating plants could provide the System with approximately 900 MW of capacity. The capacity could be brought on line in various increments timed with the year of need.\nThe System's need for new resources may be affected by unscheduled retirements of its existing generating units, regulatory approval of the continued operation of fossil fuel units and nuclear units past scheduled retirement dates and deactivation of plants resulting from environmental compliance or licensing decisions. For information regarding the agreement concerning NOX emissions at the Merrimack units, see \"Regulatory and Environmental Matters - Environmental Regulation - Air Quality Requirements.\" See \"Electric Operations - Nuclear Generation - Nuclear Plant Licensing and NRC Regulation\" and - \"Nuclear Performance\" 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 the 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.\nThe System's long-term resource plan also anticipates that the System's nuclear units will continue to run through the scheduled terms of their respective operating licenses. For information regarding the early retirement of one of the System's nuclear units, see \"Electric Operations - Nuclear Generation - Nuclear Performance\" and - \"Decommissioning.\"\nFINANCING PROGRAM\n1994 FINANCINGS\nIn 1994, CL&P and WMECO issued $535 and $90 million, respectively, of first mortgage bonds. In virtually all cases, new issues of first mortgage bonds were of smaller principal amounts than the issues that were retired with the proceeds of such issuances, with cash derived from operations making up the balance of funds needed to effect the retirements. This was done as part of NU's overall effort to reduce the System companies' debt levels. Total debt, including short-term and capitalized leased obligations, was $4.54 billion as of December 31, 1994, compared with $4.88 billion as of December 31, 1993 and $5.21 billion as of December 31, 1992. For more information regarding 1994 financings, see Notes to Consolidated Statements of Capitalization of NU and \"Long-Term Debt\" in the notes to CL&P's, PSNH's, WMECO's and NAEC's financial statements. 1995 FINANCING REQUIREMENTS\nIn addition to financing the construction requirements described under \"Resource Plans - Construction,\" the System companies are obligated to meet $1.3 billion of long-term debt maturities and cash sinking fund requirements and $124.9 million of preferred stock cash sinking fund requirements in 1995 through 1999. In 1995, long-term debt maturity and cash sinking fund requirements will be $175.8 million, consisting of $11.9 million of cash sinking fund requirements to be met by CL&P, $94 million of cash sinking fund requirements to be met by PSNH, $35.8 million of long-term debt maturities and cash sinking fund requirements to be met by WMECO, $20 million of cash sinking fund requirements to be met by NAEC and $14.1 million of cash sinking fund requirements to be met by other subsidiaries.\nThe System's aggregate capital requirements for 1995, exclusive of requirements under the Niantic Bay Fuel Trust (NBFT), are as follows:\nTotal CL&P PSNH WMECO NAEC Other System (Millions of Dollars) Construction (including AFUDC)..... $148 $51 $36 $ 5 $14 $254 Nuclear Fuel (excluding AFUDC).. 47 1 11 9 - 68 Maturities.............. - - 35 - - 35 Cash Sinking Funds.. 12 94 1 20 14 141 ---- ---- --- --- --- ----\nTotal........... $207 $146 $83 $34 $28 $498 ==== ==== === === === ====\nFor further information on NBFT and the System's financing of its nuclear fuel requirements, see \"Leases\" in the notes to NU's, CL&P's and WMECO's financial statements.\n1995 FINANCING PLANS\nThe System companies currently expect to finance their 1995 requirements through internal cash flow and short-term debt. This estimate excludes the nuclear fuel requirements financed through the NBFT. In addition to financing their 1995 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. On January 23, 1995, CL&P issued, through an affiliate, $100 million of 9.3 percent Monthly Income Preferred Securities, to help finance the retirement of approximately $125 million of preferred stock.\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 1935 Act.\nThe following table shows the amount of short-term borrowings authorized by the SEC for each company as of January 1, 1995 and the amounts of outstanding short-term debt of those companies at the end of 1994.\nMaximum Authorized Short-Term Debt Short-Term Debt Outstanding at 12\/31\/94* (Millions) NU.................. $ 150 $ 104 CL&P ............... 325 179 PSNH ............... 175 - WMECO............... 60 - HWP................. 5 - NAEC................ 50 - NNECO............... 50 6 RRR................. 22 17 Quinnehtuk.......... 8 5 HEC................. 11 2 -----\nTotal $ 313 =====\n----------------- * 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 $190 million at December 31, 1994.\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, 1995, 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, 1994, CL&P's charter would permit CL&P to incur an additional $450.3 million of unsecured debt and WMECO's charter would permit it to incur an additional $145.5 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, 1994, CL&P's common equity ratio was 42.0 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, 1994, NU's common equity ratio was 33.4 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 23 percent of total capitalization (as defined) 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 1.75 to 1 at the end of each fiscal quarter for the remaining term of the agreement. At December 31, 1994, PSNH's common equity ratio was 32.7 percent and its operating income to interest expense ratio for the twelve-month period was 2.69 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, PSNH's and WMECO'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.\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, 1994, 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.\nSEC 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 and 1994, PSNH did not pay dividends, to allow it to build up the common equity portion of its capitalization and to fund the buyout of certain NUGs operating in New Hampshire. See \"Rates - New Hampshire Retail Rates - Rate Agreement and FPPAC.\" NAEC paid dividends of $5 million in each of the third and fourth quarters of 1994. If PSNH does not fund its pro rata share of NU's dividend requirements, NU expects to fund that portion of its dividend requirements with the proceeds of borrowings or the issuance of additional common shares under the dividend reinvestment plan.\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, 1994, CL&P had $225.6 million, WMECO had $90.1 million and PSNH had $125.0 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, 1994, $69.2 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. At December 31, 1994, $162 million was available to be paid under these provisions.\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 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 4.0 million (2.5 million in Connecticut, 959,000 in New Hampshire and 582,000 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 1994, CL&P furnished retail electric service to approximately 1.1 million customers in Connecticut, PSNH provided retail electric service to approximately 400,000 customers in New Hampshire and WMECO served approximately 194,000 retail electric customers in Massachusetts. HWP serves 46 retail customers in Holyoke, Massachusetts.\nThe following table shows the sources of 1994 electric revenues based on categories of customers:\nCL&P PSNH WMECO NAEC Total System Residential........... 41% 35% 38% - 40% Commercial............ 34 28 31 - 33 Industrial ........... 14 18 19 - 16 Wholesale* ........... 9 16 9 100% 9 Other ................ 2 3 3 - 2 ---- ---- ---- ---- ---- Total ................ 100% 100% 100% 100% 100% * Includes capacity sales.\nNAEC's 1994 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, 1994, the all-time maximum demand on the System was 6339 MW, which occurred on July 21, 1994. The System was also selling approximately 896 MW of capacity to other utilities at that time. At the time of the peak, the System's generating capacity, including capacity purchases, was 8948 MW.\nSystem energy requirements were met in 1993 and 1994 as set forth below:\nSource 1994 1993\nNuclear .................................... 54% 62% Oil ........................................ 7 7 Coal ....................................... 8 10 Hydroelectric .............................. 4 3 Natural gas ................................ 3 2 NUGs ....................................... 14 14 Purchased power............................. 10 2 ----- ---\n100% 100%\nThe actual changes in kilowatt-hour sales for the last two years and the forecasted sales growth estimates for the 10-year period 1994 through 2004, in each case exclusive of bulk power sales, for the System, CL&P, PSNH and WMECO are set forth below:\n1994 over 1993 over Forecast 1994-2004 1993 (under) 1992 Compound Rate of Growth\nSystem......... 2.50% 10.9%(1) 1.2% CL&P........... 3.66% (0.3)% 1.1% PSNH........... 1.56% 1.0% 1.5% WMECO....... 1.47% 0.1% 1.2%\n(1) The percent increase in System 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 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 kilowatt-hour 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:\n1994 over (under) 1993 1993 over (under) 1992\nSystem ................... 2.37% 11.8% CL&P ..................... 3.33% 1.2% PSNH ..................... (1.35)% (9.3)% WMECO .................... 5.58% 13.5%\nFor a discussion of trends in bulk power sales, see \"Competition and Marketing.\"\nThe System's total kilowatt-hour sales grew 2.5% in 1994 because of economic growth. The growth was broad-based and was not dominated by any particular industry or sector. Partially offsetting the gains in the economy were continued curtailments in the defense and insurance industries, which particularly affected the CL&P service area. Such curtailments should continue into 1995, which, combined with the efforts of the Federal Reserve to slow the national recovery, have the potential to further thwart New England's recovery. Moreover, 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 more information on the effect of competition on sales growth rates, see \"Competition and Marketing.\"\nIn spite of further defense and insurance curtailments moderate growth is forecasted to resume over the next ten years. The System forecasts a 1.2% growth rate of sales over this period. This growth rate is significantly below historic rates because of anticipated labor force constraints and, in part, because of forecasted savings from System sponsored DSM programs that 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 0.5% higher if the System did not pursue DSM programs at the forecasted levels. See \"Rates - Connecticut Retail Rates\" and \"Rates - Massachusetts Retail Rates\" for information about rate treatment of DSM costs. With the System's generating capacity of 8,241 MW as of January 1, 1995 (including the net of capacity sales to and purchases from other utilities, and approximately 688 MW of capacity purchased from NUGs under existing contracts), the System expects to meet reliably its projected annual peak load growth of 1.2 percent until at least the year 2009.\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. 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 or purchases from other utilities that are not subject to firm commitments, the System's installed reserve is expected to be approximately 1,700 MW in the summer of 1995. For further information on the effect of competition on sales of surplus capacity, see \"Competition and Marketing.\"\nThe System companies operate and dispatch their generation as provided in the New England Power Pool (NEPOOL) Agreement. In 1994, the peak demand on the NEPOOL system was 20,519 MW in July, which was 949 MW above the 1993 peak load of 19,570 MW in July of that year. NEPOOL has projected that there will be a decrease in demand in 1995 and estimates that the summer 1995 peak load could reach 20,425 MW. NEPOOL projects that sufficient capacity will be available to meet this anticipated demand.\nGENERATION AND TRANSMISSION\nThe System companies and most other New England utilities with electric generating facilities are parties to the NEPOOL Agreement. Under the NEPOOL Agreement, planning and operation of the region's generation and transmission facilities are coordinated. 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. NEPOOL's objectives are to assure that the bulk power supply of New England and adjoining areas conforms to proper standards of reliability, to attain maximum practical economy in the bulk power supply system consistent with such reliability standards and to provide for equitable sharing of the resulting benefits and costs.\nThe System companies, except PSNH and NAEC, pool their electric production costs and the costs of their principal transmission facilities under the Northeast Utilities Generation and Transmission Agreement (NUG&T). In addition, a ten-year agreement, expiring in June 2002, 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 January 1992, FERC issued a decision approving NU's acquisition of PSNH, provided that the combined system accord transmission access to other utilities and non-utility generators that need to use the NU-PSNH transmission system to buy or sell electricity. FERC noted that NU system customers should remain harmless from the granting of such access. In accordance with the January 1992 decision, in April and August 1992, NU made compliance filings with FERC, including transmission tariffs implementing such conditions. FERC has made all tariffs effective as of the merger date based on interim rates and terms of service established by FERC pursuant to summary determinations (without hearing). NU 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. For information regarding the appeal of FERC's approval of NU's acquisition of PSNH, see \"Legal Proceedings.\"\nThe terms on which wheeling transactions are to be effected in New England have stimulated a series of negotiations among utilities, regulators, power brokers and marketers and non-utility generators, directed at the possible development of a regional transmission group within New England. Any arrangement would require widespread support by the parties and be subject to approval by FERC.\nFOSSIL FUELS\nThe System's residual oil-fired generation stations used approximately six million barrels of oil in 1994. The System obtained the majority of its oil requirements in 1994 through contracts with two large, independent oil companies. Those contracts allow for some spot purchases when market conditions warrant, but spot purchases represented less than 10 percent of the System's fuel oil purchases in 1994. The contracts expire annually or biennially. The System currently does not anticipate any difficulties in obtaining necessary fuel oil supplies on economic terms.\nThe System converted CL&P's Devon Units 7 and 8 into oil and gas dual-fuel generating units in July 1994. The System now has five generating stations, aggregating approximately 800 MW, which can burn either residual oil or natural gas as economics, environmental concerns or other factors dictate. CL&P, PSNH and WMECO all have contracts with the local gas distribution companies where the dual-fuel generating units are located, under which natural gas is made available by those companies on an interruptible basis. In addition, gas for the Devon units is being purchased directly from producers and brokers on an interruptible basis and transported through the interstate pipeline system and the local gas distribution company. The System expects that interruptible natural gas will continue to be available for its dual-fuel electric generating units on economic terms and will continue to supplement fuel oil requirements.\nSee \"Derivative Financial Instruments\" in the notes to NU's and CL&P's financial statements for information about CL&P's oil and natural gas swap agreements to hedge against fuel price risk on certain long-term fixed-price energy contracts.\nThe System companies obtain their coal through long-term supply contracts and spot market purchases. The System companies currently have an adequate supply of coal. Because of changes in federal and state air quality requirements, the System expects to use lower sulfur coal in its plants in the future. See \"Regulatory and Environmental Matters - Environmental Regulation - Air Quality Requirements.\"\nNUCLEAR GENERATION\nGENERAL\nThe System companies have interests in seven operating nuclear units: Millstone 1, 2 and 3, Seabrook 1 and three other units, Connecticut Yankee (CY), Maine Yankee (MY), and Vermont Yankee (VY), owned by regional nuclear generating companies (the Yankee companies). System companies operate the three Millstone units and Seabrook 1 and have operational responsibility for CY. The System companies also have interests in Yankee Rowe owned by the Yankee Atomic Electric Company (YAEC), 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 52.93 percent, PSNH's ownership interest in the unit is 2.85 percent and WMECO's interest is 12.24 percent. NAEC and CL&P have 35.98 percent and 4.06 percent ownership interests, respectively, in Seabrook. The Millstone 3 and Seabrook joint ownership agreements provide for pro rata sharing by the owners of each unit of the construction and operating costs, the electrical output and the associated transmission costs.\nCL&P and NAEC have been affected at times by the inability of certain 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, began bankruptcy proceedings in February 1991. On November 11, 1994, a final plan of reorganization of GBPC was confirmed by the United States Bankruptcy Court. Under the plan of reorganization's financing agreement, on November 22, 1994 a group of investors purchased 60 percent of the reorganized GBPC's common stock for an investment of $35 million and repaid CL&P $7.3 million for advances which CL&P made to cover GBPC's shortfalls in funding its share of operating costs of Seabrook during the bankruptcy.\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 in the Yankee companies are set forth below:\nCL&P PSNH WMECO System Connecticut Yankee Atomic Power Company (CYAPC) ...... 34.5% 5.0% 9.5% 49.0% Maine Yankee Atomic Power Company (MYAPC) ............ 12.0% 5.0% 3.0% 20.0% Vermont Yankee Nuclear Power Corporation (VYNPC)... 9.5% 4.0% 2.5% 16.0% Yankee Atomic Electric Company (YAEC) ............ 24.5% 7.0% 7.0% 38.5%\nCL&P, PSNH and WMECO are obligated to provide their percentages of any additional equity capital necessary for the Yankee companies, but do not expect to contribute additional equity capital in the future. CL&P, PSNH and WMECO believe that the Yankee companies, excluding YAEC, could require additional external financing in the next several years to finance construction expenditures, nuclear fuel and for other purposes. Although the ways in which each Yankee company would attempt to finance these expenditures, if they are needed, 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. NUCLEAR PLANT LICENSING AND NRC REGULATION\nThe operators of Millstone 1, 2 and 3, CY, MY, VY and Seabrook 1 hold full power operating licenses from the NRC. As holders of licenses to operate nuclear reactors, CL&P, WMECO, NAESCO, 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. The NRC issues 40-year initial operating licenses to nuclear units and NRC regulations permit renewal of licenses for an additional 20 year period.\nIn addition, activities related to nuclear plant operation are routinely inspected by the NRC for compliance with NRC regulations. The NRC has authority to enforce its regulations through various mechanisms which include the issuance of notices of violation (NOV) and civil monetary penalties. Several regulatory enforcement actions, with associated civil monetary penalties aggregating $357,500, were taken by the NRC in 1994 for certain violations which occurred at Millstone Station. However, approximately $270,000 of such amounts related to violations that occurred prior to 1994.\nThe NRC also regularly conducts generic reviews of technical and other issues, a number of which may affect the nuclear plants in which System companies have interests. 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. One such issue that has received considerable attention from the NRC in the last several years concerns the ability and willingness of nuclear plant workers to raise nuclear safety concerns without fear of retaliation for doing so. The NRC has identified the Millstone Station in particular as a site where workers have expressed concern with their ability to raise nuclear safety issues to company supervisors and managers. Management is aware of the NRC's concerns in this area, and is taking steps to ensure that the environment at Millstone is one where workers feel free to raise issues without fear of retaliation.\nNUCLEAR PLANT PERFORMANCE\nCapacity factor is a ratio that compares a unit's actual generating output for a period with the unit's maximum potential output. The average capacity factor for operating nuclear units in the United States was 73.2 percent for January through September 1994, and 67.5 percent for the five nuclear units operated by the System in 1994, compared with 80.8 percent for 1993. The lower 1994 capacity factor was primarily due to extended refueling and maintenance outages at Millstone 1, Millstone 2 and Seabrook and unexpected technical and operating difficulties at Millstone 2, Seabrook and CY.\nThe System anticipates total expenditures in 1995 of approximately $477.5 million for operations and maintenance and $82.2 million in capital improvements for the five nuclear plants that it operates. The Performance Enhancement Program (PEP), initiated in 1992 by the System's nuclear organization, was designed in response to a declining performance trend noted in the early 1990's. Seven PEP action plans were completed in 1994. The System companies spent $25.2 million on PEP in 1994 and have budgeted $21.7 million (included in the 1995 operations and maintenance annual budget) for 1995 PEP action plans. The remaining nine action plans are expected to be completed by the end of 1997.\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 replacement power costs is permitted, subject to prudence reviews, through the GUAC for CL&P, through FPPAC for PSNH and through a retail fuel adjustment clause for WMECO. 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 - New Hampshire Retail Rates\" and \"Rates - Massachusetts Retail Rates.\"\nMILLSTONE UNITS\nFor the twelve months ended December 31, 1994, the three Millstone units' composite capacity factor was 66.4 percent, compared with a composite capacity factor of 79.3 percent for the twelve months ended December 31, 1993 and 53.1 percent for the same period in 1992.\nMillstone 1, a 660 MW boiling water reactor, has a license expiration date of October 6, 2010. In 1994, Millstone 1 operated at a 58.3 percent capacity factor. The unit began a 71 day planned refueling and maintenance outage on January 15, 1994. Millstone 1 returned to service on May 20, 1994, for an outage duration of 125 days. The delay in completing the outage on schedule was primarily attributable to unanticipated work associated with the service water systems, certain system valves and surveillance testing. The next refueling outage is scheduled for October 1995.\nMillstone 2, a 870 MW pressurized water reactor, has a license expiration date of July 31, 2015. In 1994 Millstone 2 operated at a 48.2 percent capacity factor. The unit began a planned 63-day refueling and maintenance outage on October 1, 1994. Subsequent events have added substantially to the duration of the refueling outage and at present, the unit is not expected return to service before mid-April 1995. Earlier in 1994, Millstone 2 experienced a 57-day unplanned maintenance outage which ended on June 18, 1994 and a second unplanned outage to repair the reactor coolant pump oil collection system from July 27, 1994 to September 3, 1994. The recovery of replacement power operation and maintenance costs incurred during these outages are subject to prudence reviews in both Connecticut and Massachusetts.\nA recent report issued by the NRC for the Millstone Station noted significant weaknesses in Millstone 2's operations and maintenance. Subsequently, a senior NRC official expressed disappointment with the continued weaknesses in Millstone 2's performance. The primary cause of the NRC's disappointment with Millstone 2's performance appears to be that, despite significant management attention and action over a period of years, the NRC does not believe it has seen enough objective evidence of improvement in reducing procedural noncompliance and other human errors. Management has acknowledged the basis for the NRC's concern with Millstone 2 and has been devoting increased attention to resolving these issues. Management and the NRC expect to continue to closely monitor performance at Millstone 2.\nMillstone 3, a 1154 MW pressurized water reactor, has a license expiration date of November 25, 2025. In 1994, Millstone 3 operated at a 94 percent capacity factor. The unit had no planned refueling and maintenance outages in 1994. Millstone 3 experienced one unplanned outage in 1994 which lasted from September 8, 1994 to September 22, 1994. The next refueling outage is scheduled to begin on April 14, 1995, with a planned duration of 54 days. SEABROOK\nSeabrook 1, a 1148 MW pressurized water reactor, has a license expiration date of October 17, 2026. The Seabrook operating license expires 40 years from the date of issuance of authorization to load fuel, which was about three and a half years before Seabrook's full power operating license was issued. The System will determine at the appropriate time whether to seek recapture of this period from the NRC and thus add an additional three and a half years to the operating term for Seabrook. In 1994, Seabrook operated at a capacity factor of 61.6 percent. The unit began a scheduled refueling and maintenance outage on April 9, 1994. The unexpected discovery of reactor coolant pump locking cups and a bolt in the reactor vessel contributed substantially to the duration of the outage. The unit returned to service on August 1, 1994 for an outage duration of 114 days. Seabrook experienced one unplanned outage in 1994 which lasted from January 26 to February 17, 1994 when a main steam isolation valve closed during quarterly surveillance testing. The next refueling outage is scheduled for November 1995.\nYANKEE UNITS\nCONNECTICUT YANKEE\nCY, a 582 MW pressurized water reactor, has a license expiration date of June 29, 2007. In 1994 CY operated at a capacity factor of 75.4 percent. CY experienced two unplanned outages with durations greater than two weeks in 1994. The first such outage began in February 1994 and lasted 44 days in order to repair and replace service water piping. On July 11, 1994 the unit began a second forced outage to upgrade the oil collection system for the reactor coolant pumps. The unit returned to service on August 17, 1994. CY began a planned refueling and maintenance outage on January 28, 1995, with a scheduled duration of 51 days.\nMAINE YANKEE\nMY, a 870 MW pressurized water reactor, has a license expiration date of October 21, 2008. MY's operating license expires 40 years from the date of issuance of the construction permit, which was about four years before MY's full power operating license was issued. At the appropriate time, MYAPC will determine whether to seek recapture of this construction period from the NRC and add it to the term of the MY operating license. In 1994, MY operated at a capacity factor of 85.9 percent. The current refueling outage began in January 1995.\nVERMONT YANKEE\nVY, a 514 MW boiling water reactor, has a license expiration date of March 21, 2012. In 1994, VY operated at a capacity factor of 94.4 percent. The current refueling outage began on March 17, 1995.\nYANKEE ROWE\nIn February 1992, YAEC's owners voted to shut down Yankee Rowe permanently 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 certain regulatory requirements. The power contracts between CL&P, PSNH and WMECO and YAEC permit YAEC to recover from each its proportional share of the Yankee Rowe shutdown and decommissioning costs. For more information regarding recovery of decommissioning costs for Yankee Rowe, see \"Electric Operations - Nuclear Generation - Decommissioning.\"\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 rule 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. For more information regarding nuclear insurance, see \"Nuclear Insurance Contingencies\" in the notes of NU's, CL&P's, PSNH's, WMECO's and NAEC's financial statements.\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. The System companies have maintained diversified sources of supply for these materials and services, relying on no single source of supply for any one component of the fuel cycle. The majority of the System companies' uranium enrichment services requirements are provided under a long term contract with the U.S. Enrichment Corporation, a wholly-owned government corporation. The majority of Seabrook 1's uranium enrichment services requirements, however, are furnished by a Russian trading company. 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. commercial nuclear power industry is required to pay to the DOE, via a special assessment for the costs of the decontamination and decommissioning of uranium enrichment plants owned by the U.S. government, no more than $150 million for 15 years beginning in 1993. Each domestic nuclear utility will make a payment based on its pro rata share of all enrichment services received by the U.S. commercial nuclear power industry from the U.S. Government through October 1992. Each year, the U. S. Department of Energy (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 $51 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 a regulatory asset, with a corresponding obligation on its balance sheet.\nCosts associated with nuclear plant operations include amounts for disposal of nuclear waste, 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 FERC-approved wholesale charges. Such provisions include amortization and recovery in rates of previously unrecovered disposal costs of accumulated spent nuclear fuel.\nHIGH-LEVEL RADIOACTIVE WASTE\nThe Nuclear Waste Policy Act of 1982 (NWPA), provides that the federal government is responsible for the permanent disposal of spent nuclear reactor fuel and high-level waste. As required by the NWPA, electric utilities generating spent nuclear fuel and high-level waste are obligated to pay fees into a fund which would be used to cover the cost of siting, constructing, developing and operating a permanent disposal facility for this waste. The System companies have been paying for such services for fuel burned starting in April 1983 on a quarterly basis since July 1983. The DPUC, the NHPUC and the DPU permit the fee to be recovered through rates.\nIn return for payment of the fees prescribed by the NWPA, the federal government is to take title to and dispose of the utilities' high-level wastes and spent nuclear fuel. The NWPA provides that a disposal facility be operational and for the DOE to accept nuclear waste for permanent disposal in 1998. In late 1993 and 1994, DOE indicated that it was not likely to meet its statutory and contractual obligations to accept spent fuel in 1998.\nIn June 1994, the DPUC joined with the Connecticut and Massachusetts Attorneys General and a number of states in a lawsuit filed in federal court against the DOE, seeking a declaratory judgment that the DOE has a statutory obligation to take high-level nuclear waste from utilities in 1998 and to establish judicially administered milestones to enforce that obligation. The State of New Hampshire, among others, subsequently joined in this lawsuit. NU and its affiliates did not join a companion lawsuit filed by fourteen utilities seeking similar relief. Nuclear utilities and state regulators are presently considering additional steps which they might take to ensure that the DOE is able to meet its obligations with regard to nuclear waste disposal as soon as possible.\nUntil the federal government begins accepting nuclear waste for disposal, 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. 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.\nMY'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. On March 15, 1994, the NRC authorized this plan. MYAPC believes that the replacement of the fuel racks will provide adequate storage capacity through MY's current licensed operating life.\nThe storage capacity of the spent fuel pool at VY is expected to be reached in 2005, and the available capacity of the pool is expected to be able to accommodate full-core removal until 2001.\nBecause the Yankee Rowe plant was permanently shut down effective February 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 WASTE\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 low-level radioactive wastes (LLRW) from outside its compact region. On July 1, 1994, the Barnwell, South Carolina LLRW facility ceased accepting LLRW for disposal from states situated outside its compact region. The NU System is currently implementing plans for the temporary on-site storage of LLRW generated at its nuclear facilities. The costs associated with temporary on-site storage of LLRW are not material. The System has plans that will allow for the storage of LLRW until a permanent disposal facility becomes available. The System can manage its Connecticut LLRW by volume reduction, storage or shipment at least through 1999. In addition, an NRC policy memorandum provides additional guidance on interim LLRW storage by removing any time limitations on the on-site storage of LLRW and by allowing for modification and expansion of storage facilities without prior NRC approval. The Millstone units and CY incurred approximately $6.8 million in off-site disposal costs in 1994.\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. On February 1, 1993, the Connecticut legislature approved a 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 through 1996. The Service's activities in this regard are funded by assessments on Connecticut's LLRW generators. Due to the change to a volunteer process, there was no assessment for the 1994-1995 fiscal year and the state projects no assessment for the 1995-1996 and 1996-1997 fiscal years. Management cannot predict whether and when a disposal site will be designated in Connecticut. The Service currently projects that a disposal site will be designated by 2002.\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 $2.0 million in off-site disposal costs in 1994. New Hampshire is pursuing options for out-of-state disposal of LLRW generated at Seabrook. 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 implementing an agreement with Texas to provide access to a LLRW facility that is to be developed in that state.\nDECOMMISSIONING\nBased upon the System's most recent comprehensive site-specific updates of the decommissioning costs for each of the three Millstone units and for Seabrook, the recommended decommissioning method 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, 1994 dollars, and include costs allocable to NAEC's share of Seabrook acquired from VEG&T.\nCL&P PSNH WMECO NAEC System (Millions) Millstone 1 $332.8 $ - $ 78.1 $ - $ 410.9 Millstone 2 267.3 - 62.7 - 330.0 Millstone 3 237.5 12.8 54.9 - 305.2 Seabrook 1* 15.5 - - 137.3 52.8 ------ ----- ------ ------ --------\nTotal $853.1 $12.8 $195.7 $137.3 $1,198.9 ====== ===== ====== ====== ========\n--------------- * The Seabrook decommissioning estimate currently is under review by the New Hampshire Nuclear Decommissioning Finance Committee (NDFC).\nAs of December 31, 1994, the balances (at market) in certain external decommissioning trust funds, as discussed more fully below, were as follows:\nCL&P PSNH WMECO NAEC System (Millions)\nMillstone 1 $ 81.5 $ - $ 27.4 $ - $108.9 Millstone 2 52.1 - 18.5 - 70.6 Millstone 3 37.2 1.8 10.2 - 49.2 Seabrook 1 1.2 - - 10.3 11.5 ------ ---- ------ ----- ------\nTotal $172.0 $1.8 $ 56.1 $10.3 $240.2 ====== ==== ===== ===== ======\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 System cost of decommissioning the Millstone units is approximately $1.05 billion in December 1994 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, collections from customers in future years will need to increase 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 NDFC established approximately $323 million (in 1991 dollars) as the decommissioning cost estimate for immediate and complete dismantlement of Seabrook 1 upon its retirement. North Atlantic prepared a revised decommissioning estimate in 1994. The revised estimate is currently under review by the NDFC. Public hearings were held in the fourth quarter of 1994. Approval of the estimate is expected in late April, 1995. On the basis of North Atlantic's 1994 revised estimate, the total System decommissioning cost for Seabrook 1 is $152.8 million in December 1994 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.\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. The estimates are based on the latest site studies, escalated to December 31, 1994 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 System (Millions)\nVY $ 31.3 $13.2 $ 8.2 $ 52.7 Yankee Rowe* 100.0 28.6 28.6 157.2 CY 124.9 18.1 34.4 177.4 MY 40.6 16.9 10.1 67.6 ------ ----- ----- -----\nTotal $298.8 $76.8 $81.3 $454.9 ====== ===== ===== ======\n--------------- * The costs shown include all decommissioning costs as well as other closing costs associated with the early retirement of Yankee Rowe.\nAs of December 31, 1994, the balances (at market) in the external decommissioning trust funds for the Yankee Units were as follows:\nCL&P PSNH WMECO System (Millions) VY $ 10.8 $ 4.5 $ 2.8 $ 18.1 Yankee Rowe 26.4 7.6 7.6 41.6 CY 51.6 7.5 14.2 73.3 MY 13.0 5.4 3.3 21.7 ------ ----- ----- -----\nTotal $101.8 $25.0 $27.9 $154.7 ====== ===== ===== ======\nIn October 1994, YAEC submitted a decommissioning cost estimate as part of its decommissioning plan with the NRC. Following the receipt of NRC approval, this estimate will be filed with FERC. The estimate increased the system's ownership share of decommissioning YAEC's nuclear facility by approximately $36 million in January 1, 1994 dollars. At December 31, 1994, the estimated remaining costs amounted to $408.2 million, of which the System's share was approximately $157.1 million. Management expects that CL&P, PSNH and WMECO will continue to be allowed to recover such FERC approved costs from their customers.\nYAEC has begun component removal activities related to the decommissioning of its nuclear facility. Based on the revised decommissioning estimate and the remaining decommissioning costs in 1994 dollars, approximately nine percent of such removal activities has been completed. Management believes that, although Yankee Rowe was shut down eight years before the end of the unit's operating license, CL&P, PSNH and WMECO will recover their investments in YAEC, along with any other associated costs.\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 $362.0 million in year-end 1994 dollars. In May 1993, FERC approved a settlement agreement in a CYAPC rate proceeding allowing a revised decommissioning estimate of $294.2 million (in July 1992 dollars) to be recovered in rates beginning on June 1, 1993. This amount will increase by a stated amount each year for inflation.\nMYAPC estimates the cost of decommissioning MY at $338.3 million in December 31, 1994 dollars based on a study completed in July 1993. VYNPC estimates the cost of decommissioning VY at $329.6 million in December 31, 1994 dollars based on a study completed in March 1994.\nFor further information regarding the decommissioning of the System nuclear units, see \"Nuclear Decommissioning\" in the notes to NU's, CL&P's, PSNH's, WMECO's and NAEC's financial statements.\nNON-UTILITY BUSINESSES\nGENERAL In 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 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 EWG and FUCO power projects anywhere in the world. 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.\nCharter Oak has made strategic alliances with several experienced developers to pursue development opportunities nationwide and internationally. Charter 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. Charter Oak also owns 56 MW of the 1,875 MW Teesside natural gas-fired cogeneration facility in the United Kingdom.\nCharter 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, Latin America and the Pacific Rim. Specifically, Charter Oak is engaged in constructing a 114 MW natural gas-fired project located in the Republic of Argentina (Argentina) and plans to begin construction of a 20 MW wind project in Costa Rica in the spring of 1995. Charter Oak's share of these projects is 38 MW and 13 MW, respectively.\nAlthough Charter Oak has no full-time employees, nine NUSCO employees are dedicated to Charter Oak activities on a full-time basis. Other NUSCO employees provide services as required. NU's total investment in Charter Oak was approximately $31.0 million as of December 31, 1994. NU currently is committed to invest an additional $15 million in Charter Oak to fund completion of the natural gas-fired project in Argentina.\nENERGY MANAGEMENT SERVICES\nIn 1990, NU organized a subsidiary corporation, HEC, to acquire 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' energy costs and\/or conserve energy and other 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. NU's initial equity investment in HEC was approximately $4 million and NU has made additional capital contributions of approximately $300,000 through December 31, 1994.\nREGULATORY AND ENVIRONMENTAL MATTERS\nENVIRONMENTAL REGULATION\nGENERAL\nThe System and its subsidiaries are subject to federal, state and local regulations with respect to water quality, air quality, toxic substances, hazardous waste and other environmental matters. Similarly, the System's major generation or transmission facilities may not be constructed or significantly modified without a review by the applicable state agency of the environmental impact of the proposed construction or modification. 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. 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 the U.S. Environmental Protection Agency (EPA) or state environmental agency specifying the allowable quantity and characteristics of its effluent. The System's steam-electric generating plants have all required NPDES permits in effect. Compliance with NPDES and state water discharge permits 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, the Connecticut Department of Environmental Protection (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. On January 14, 1994, CDEP approved the Millstone feasibility report submitted to it in 1993 and required 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 NPDES 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.\nThe Merrimack permit also requires PSNH to perform further biological studies because significant numbers of migratory fish are being restored to lower reaches of the Merrimack River. These studies are in progress and will be completed in 1995. If they 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 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 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 nontransportation-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. The Coast Guard has completed its final review process and issued its approval of these plans. The EPA has issued its approval of all facility plans except PSNH's Schiller Station, where the EPA has authorized continued operation pending its 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\nThe Clean Air Act Amendments of 1990 (CAAA) made extensive revisions and additions to the federal 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.\nNitrogen Oxide. The CAAA identifies NOX emissions as a precursor of ambient ozone for the northeastern region of the United States, which currently exceeds ambient air quality standard for ozone. Pursuant to the CAAA, Connecticut, New Hampshire and Massachusetts must implement plans to address ozone nonattainment. All three states have issued final regulations to implement Phase I (RACT) reduction requirements. The System has developed compliance strategies and estimates of costs. The capital cost to comply with Phase I requirements will cost the System a total of approximately $41 million: $10 million for CL&P, $27 million for PSNH, $1 million for WMECO and $3 million for HWP. Compliance will be achieved using currently available technology and combustion efficiency improvements. Compliance costs for Phase II, effective in 1999, are expected to result in an additional cost of $10 to $15 million. These Phase II costs take into consideration capital expenditures during Phase I and expanded capital costs for available technology.\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 was submitted to the New Hampshire Air Resources Division (NHARD) in the form of proposed regulations. The 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. More stringent emission rate limits equivalent to the range of 0.1 to 0.4 pounds of NOX per million Btu, however, are required for the unit by that date. On May 20, 1994, NHARD promulgated the New Hampshire NOX reduction rule. The System will comply with the requirements of this rule by installing controls on the units. The additional requirements for Merrimack Unit 2 for 1999 will be attained through increased catalytic reduction of NOX at an additional estimated cost of $5 to 7 million.\nSulfur Dioxide. The CAAA mandates reductions in SO2 emissions to control acid rain. These reductions are to occur in two phases. First, certain 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. All Phase I units will be allocated SO2 allowances for the period 1995-1999. 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.\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. The System expects that its allocated allowances will substantially exceed its expected SO2 emissions for 2000 and subsequent years. Current estimates indicate the System will have approximately 25,000 tradeable SO2 allowances available annually at a market value of approximately $150 per allowance. On July 20, 1994 the DPUC issued an order that, with some restrictions, allows CL&P to retain for its shareholders 15 percent of the net proceeds from the sale of SO2 allowances.\nNew Hampshire and Massachusetts have each instituted acid rain control laws that limit SO2 emissions. The System expects to meet the new SO2 limitations by using natural gas and lower sulfur 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. In addition, management believes that Title IV (acid rain) requirements for NOX limitations will not have a significant impact on System costs due to the more stringent state NOX limitations discussed above.\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. The System could incur additional costs to meet these requirements, which costs cannot be estimated at this time.\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.\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.\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. The System disposes of solid wastes containing PCBs in secure chemical waste landfills.\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. Asbestos costs for the System are typically several million dollars annually. These costs are already included in capital and operation and maintenance budgets.\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. 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 is expecting that EPA and DEP will approve clean closure for CL&P's Montville and Middletown Stations' former surface impoundments. For the Norwalk Harbor and Devon sites, CL&P has applied for post-closure permits and is awaiting approval from EPA and DEP. The System estimates that it will incur approximately $2 million in total costs of 30-year maintenance 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. To reduce its environmental and financial liabilities, the System has been permanently removing 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, fuel oils, gasoline and other hazardous materials 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 risks. The System has recorded a liability for what it believes is, based upon currently available information, its estimated environmental remediation costs for waste disposal sites for which the System companies expect to bear legal liability, and 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. At December 31, 1994, the liability recorded by the System for its estimated environmental remediation costs for known sites needing remediation including those sites described below, exclusive of recoveries from insurance or third parties, was approximately $11 million. The costs for these known sites could rise to as much as $16 million if alternative remedies become necessary.\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 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. System companies are in compliance with these reporting and notification requirements.\nThe System currently is involved in one Superfund site in Kentucky and three 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 standards 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.\nThe System is no longer involved with the Beacon Heights, Connecticut Superfund site, at which a coalition of major parties had attempted to join \"Northeast Utilities (Connecticut Light and Power)\" as defendants. In January 1994, the Beacon Heights Coalition filed a response with the federal district court indicating that it would not continue to pursue NU (CL&P) as a defendant in this litigation. Accordingly, it is not likely that CL&P will incur any cleanup costs for this site.\nEPA has issued a notice of potential liability to NNECO and CYAPC as potentially responsible parties (PRPs) at the Maxey Flats nuclear waste disposal site in Fleming County, Kentucky. The System had sent a substantial volume of LLRW from Millstone 1, Millstone 2 and CY to this site. 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 as well as the Commonwealth of Kentucky have reached a tentative settlement with EPA embodied in a consent decree. NUSCO, on behalf of NNECO and CYAPC, signed the consent decree in March 1995. The System has recorded a liability for future remediation costs for this site based on its best estimate of its share of ultimate remediation costs under the tentative agreement. To date, the costs have not been material with respect to System earnings or financial position.\nPSNH has committed approximately $280,000 as its share of the costs to clean up Superfund sites at municipal landfills in Dover and North Hampton, New Hampshire. Some additional costs may be incurred at these sites and at the Somersworth site but they are not expected to be significant.\nAs discussed below, in addition to the remediation efforts for the above- mentioned Superfund sites, the System has been named as a PRP and is monitoring developments in connection with several state environmental actions.\nIn 1987, Connecticut Department of Environmental Protection (CDEP) published a list of 567 hazardous waste disposal sites in Connecticut. The System owns two sites on this list, which are also listed on the EPA's list of hazardous waste sites. The System has spent approximately $600,000 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. The need for site remediation is being evaluated. The level of cleanup will be established in cooperation with CDEP, which 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. These options include institutional controls, excavation and limited removal of contamination, which would reduce the potential environmental and health risks and secure the site. The estimated costs of remediation and institutional controls range from $5 to $13 million.\nThe second site is a 3.5 acre former coal gasification facility that currently serves as an active substation in Rockville, Connecticut. Site investigations have located creosote and other polyaromatic hydrocarbon contaminants which will require remediation. Several options are being evaluated to process surface soils and degrade subsurface contamination to remediate the site. Levels of cleanup will be coordinated with the CDEP.\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). CL&P agreed to accept liability for required cleanup for the three sites it retained. These three sites include Stamford and Rockville (discussed above) and Torrington, Connecticut. At the Torrington site, investigations have been completed and the cost of any remediation, if necessary, is not expected to be material. CL&P and Yankee Gas also share a site in Winsted, Connecticut and any liability for required cleanup there. 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.\nPSNH contacted NHDES in December 1993 concerning possible coal tar contamination in Laconia, New Hampshire in Lake Opechee and the Winnipesaukee River near an area where PSNH formerly owned and operated a coal gasification plant which was sold in 1945. PSNH completed a site investigation in December 1994. Results indicate that off-site coal tar\/creosote contamination is present in the adjacent water bodies. The cost of remediation at this site is estimated at $1.8 million. A second coal gasification facility formerly owned and operated by a predecessor company to PSNH is located in Keene, New Hampshire. The NHDES has been notified of the presence of coal tar contamination and further site investigations are planned in 1995. Other New Hampshire sites include a municipal landfill in Peterborough and the inactive Dover Point site owned by PSNH in Dover, New Hampshire. PSNH's liability at the landfill is not expected to be significant and its liability at the Dover Point site cannot be estimated at this time.\nIn Massachusetts, System companies have been designated by the Massachusetts Department of Environmental Protection (MDEP) as PRPs for twelve sites under MDEP's hazardous waste and spill remediation program. Except for the Holyoke site, the System does not expect that its share of the remaining remediation costs for most of these sites will be material. HWP has been identified by MDEP as one of three PRPs in a coal tar site in Holyoke, Massachusetts. HWP owned and operated the Holyoke Gas Works from 1859 to 1902. 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 designated both the land and river deposit areas as 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. 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 $400,000 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. The estimated costs for remediation of this site range from $2 to $3 million.\nIn the past, the 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 may 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. Most researchers, as well as scientific review panels considering all significant EMF epidemiological and laboratory research to date, agree that current information remains inconclusive, inconsistent and insufficient for risk assessment of EMF exposures. Based on this information management does not believe that a causal relationship has been established or that significant capital expenditures are appropriate to minimize unsubstantiated risks. NU is closely monitoring research and government policy developments.\nThe 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.\nThe Connecticut Interagency EMF Task Force (Task Force) provided a report to the state legislature in January 1995. The Task Force advocates 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. The Connecticut Siting Council previously adopted a set of EMF \"best management practices,\" which are now considered in the justification, siting and design of new transmission lines and substations. The Siting Council also opened a generic docket in 1994 to conduct a life-cycle cost analysis of overhead and underground transmission lines, which was mandated by PA-176. This Act was adopted by the General Assembly in part due to public EMF concerns.\nEMF has become increasingly important as a factor in facility siting decisions in many states. Several bills involving EMF were introduced in Massachusetts in 1994, with no action taken. These bills were similar to ones introduced in previous years, on which no action was taken.\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, are 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. Upon the expiration of a license, any hydroelectric project so licensed is subject to reissuance by FERC to the existing licensee or to others 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.\nThe System companies hold FERC licenses for thirteen hydroelectric projects located in Connecticut, Massachusetts and New Hampshire. Four of the System licenses expired on December 31, 1993 (WMECO's Gardners Falls Project and PSNH's Ayers Island, Smith and Gorham Projects). On August 1, 1994, FERC issued new 30-year licenses to PSNH for the continued operation of the Smith and Gorham Projects. Although rehearing requests on these new licenses are pending with FERC, it is anticipated that it will be economic for PSNH to continue operation of these projects. FERC has issued annual licenses allowing the Gardners Falls and Ayers Island Projects to continue operations pending completion of the relicensing process. It is not known whether FERC will require any substantial changes in the operation or design of these two projects if and when it issues new licenses.\nThe license for HWP's Holyoke Project expires in late 1999. The relicensing process for this project began in 1994.\nAt the time of relicensing and for certain matters during the term of an existing license, FERC can direct changes in hydro project operation, maintenance and design to accommodate environmental, recreational, or navigational needs. At present, the U.S. Fish and Wildlife Service is considering a petition to place the Atlantic Salmon on the endangered species list. If such designation is granted, System hydroelectric projects along the Connecticut River, the Merrimack River and their tributaries may be required to make operational and\/or design changes to mitigate any adverse effects on the Atlantic Salmon. The System cannot estimate the cost of such mitigation actions at this time.\nFERC recently issued a notice indicating that it has authority to order project licensees to decommission projects that are no longer economic to operate. FERC has not required any such project decommissioning to date; the potential costs of decommissioning a project, however, could be substantial. It is likely that this FERC decision will be appealed at an appropriate time.\nEMPLOYEES\nAs of December 31, 1994, the System companies had approximately 9,395 full and part time employees on their payrolls, of which approximately 2,601 were employed by CL&P, approximately 1,390 by PSNH, approximately 619 by WMECO, approximately 112 by HWP, approximately 1,312 by NNECO, approximately 2,456 by NUSCO and approximately 905 by North Atlantic. NU, NAEC and Charter Oak have no employees. Approximately 2,325 employees of CL&P, PSNH, WMECO, North Atlantic and HWP are covered by union agreements, which expire between October 1994 and May 1996. The two union agreements that expired on October 1, 1994 cover 370 employees of WMECO and HWP and are currently under negotiation. Management cannot predict the timing or terms of these new contracts.\nSUBSEQUENT EVENTS\nCOMPETITION AND MARKETING - RETAIL MARKETING\nOn March 23, 1995, the Energy and Technology Committee of the Connecticut General Assembly passed a bill that would create a task force to study restructuring of the electric industry in Connecticut. If enacted, the bill would require a preliminary report to the committee by February 1, 1996, and a final report by January 1, 1997. The bill now goes to the state Senate and House of Representatives where CL&P will be proposing changes.\nRATES\nCONNECTICUT RETAIL RATES\nOn March 22, 1995, the System introduced its plan, entitled \"Path to a Competitive Future,\" for the future of the electric industry and related regulation in Connecticut in a filing submitted to the DPUC in its investigation into the potential restructuring of the electric utility industry initiated earlier this year. The plan is a comprehensive four-phase approach to enhancing CL&P's customer satisfaction and market efficiency in Connecticut. It calls for several significant changes in electricity pricing, in the ability to introduce new products and services, in methods of rate-setting, and in the composition of NEPOOL. The two-year first phase began in early 1995. The second and third phases, which involve the transition to a more efficient market, would each last an estimated four to six years. The final stage--a fully competitive market for electricity--could begin once all issues relating to traditional utility regulation have been thoroughly addressed and relevant transition costs have been recovered from customers. Other similar approaches, tailored to the specific needs of their service territories, are to be introduced this spring by NU's other operating company subsidiaries, PSNH and WMECO, in ongoing restructuring proceedings in New Hampshire and Massachusetts, respectively.\nNEW HAMPSHIRE RETAIL RATES\nOn March 17, 1995 a status conference was held with the NHPUC relating to PSNH's negotiations with the wood-fired NUGs. The parties reported that an agreement in principle had been reached with all but one of the owners of the wood-fired NUGs. It is expected that settlement agreements and purchase power contracts with the settling owners will be drafted, executed and filed with the NHPUC as soon as possible. The NHPUC will consider approval of the settlements in proceedings to begin in the late Spring of 1995. Negotiations are continuing with the nonsettling owner, who owns two plants.\nFINANCING PROGRAM - FINANCING LIMITATIONS\nThe amount, in millions, of short-term debt outstanding as of March 20, 1995 was $91.5 for NU, $88.3 for CL&P, $0 for PSNH, $14.3 for WMECO, $0 for HWP, $0 for NAEC, $0 for NNECO, $17.2 for RRR, $4.5 for Quinnehtuk and $2.2 for HEC, or a total of $218.\nELECTRIC OPERATIONS - NUCLEAR GENERATION\nNUCLEAR PLANT PERFORMANCE\nThe average capacity factor for the operating nuclear units in the United States for calendar 1994 was 72.5 percent.\nMILLSTONE UNITS Management's ongoing evaluation of the current Millstone 2 extended refueling and maintenance outage, which has been under way since October 1, 1994, has concluded that based on currently available information, the unit is now expected to resume operations in May 1995, following an NRC assessment of the unit's readiness to restart.\nCONNECTICUT YANKEE\nThe CY planned refueling and maintenance outage which began on January 28, 1995 has been extended for approximately two weeks due to overall work progress and emergent work. The plant is expected to return to service in early April 1995.\nMAINE YANKEE\nMY, like other pressurized water reactors, has been experiencing degradation of its steam generator tubes, principally in the form of circumferential cracking which, until early 1995, was believed to be limited to a relatively small number of steam generator tubes. In the past the detection of defects has resulted in the plugging of those tubes to prevent their subsequent use. During the refueling and maintenance shutdown that commenced in early February 1995, MYAPC detected an increased rate of degradation of MY's steam generator tubes, in excess of the number expected, and is currently evaluating several courses of action to address the matter. This circumstance is likely to adversely affect the operation of MY and may result in substantial cost to MYAPC. MYAPC cannot now predict what course of action it will choose or to what extent the operation of MY will be affected. See \"Nuclear Generation- General\" for information about the ownership interests of CL&P, PSNH and WMECO in MYAPC.\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 35.98 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 companies' lines are located on or under streets or highways, or on properties either owned or leased, or in which the company has appropriate rights, easements, or permits from the owners.\nCL&P's properties are subject to the lien of its 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 Bonds 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 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' and NAEC's properties are well maintained and are in good operating condition.\nTransmission and Distribution System\nAt December 31, 1994, the System companies owned 103 transmission and 429 distribution substations that had an aggregate transformer capacity of 25,001,996 kilovoltamperes (kVa) and 9,145,129 kVa, respectively; 3,054 circuit miles of overhead transmission lines ranging from 69 kilovolt (kV) to 345 kV, and 194 cable miles of underground transmission lines ranging from 69 kV to 138 kV; 32,507 pole miles of overhead and 1,893 conduit bank miles of underground distribution lines; and 384,367 line transformers in service with an aggregate capacity of 15,625,000 kVa.\nElectric Generating Plants\nAs of December 31, 1994, the electric generating plants of the System companies and NAEC, and the System companies' entitlements in the generating plants of the three operating Yankee regional nuclear generating companies were as follows (See \"Item 1. Business - Electric Operations, Nuclear Generation\" for information on ownership and operating results for the year.):\nClaimed Plant name Year Capability* Owner (location) Type Installed (kilowatts) ----- ---------- ---- --------- ----------- CL&P Millstone(Waterford,CT) Unit 1 Nuclear 1970 524,637 Unit 2 Nuclear 1975 708,345 Unit 3 Nuclear 1986 606,453 Seabrook (Seabrook,NH) Nuclear 1990 46,688 CT Yankee (Haddam,CT) Nuclear 1968 201,204 ME Yankee (Wiscasset,ME) Nuclear 1972 94,832 VT Yankee (Vernon,VT) Nuclear 1972 44,570 --------- Total Nuclear-Steam Plants (7 units) 2,226,729 Total Fossil-Steam Plants (9 units) 1954-73 1,803,000 Total Hydro-Conventional (25 units) 1903-55 98,930 Total Hydro-Pumped Storage (7 units) 1928-73 905,150 Total Internal Combustion (16 units) 1966-86 413,200 --------- Total CL&P Generating Plant (64 units) 5,447,009 =========\nPSNH Millstone(Waterford,CT) Unit 3 Nuclear 1986 32,624 CT Yankee (Haddam,CT) Nuclear 1968 29,160 ME Yankee (Wiscasset,ME) Nuclear 1972 39,514 VT Yankee (Vernon,VT) Nuclear 1972 18,737 --------- Total Nuclear-Steam Plants (4 units) 120,035 Total Fossil-Steam Plants (7 units) 1952-78 1,004,065 Total Hydro-Conventional (20 units) 1917-83 67,510 Total Internal Combustion (5 units) 1968-70 107,050 --------- Total PSNH Generating Plant (36 units) 1,298,660 =========\nClaimed Plant name Year Capability* Owner (location) Type Installed (kilowatts) ----- ---------- ---- --------- ----------- WMECO Millstone(Waterford,CT) Unit 1 Nuclear 1970 123,063 Unit 2 Nuclear 1975 166,155 Unit 3 Nuclear 1986 140,216 CT Yankee (Haddam,CT) Nuclear 1968 55,404 ME Yankee (Wiscasset,ME) Nuclear 1972 23,708 VT Yankee (Vernon,VT) Nuclear 1972 11,741 --------- Total Nuclear-Steam Plants (6 units) 520,287 Total Fossil-Steam Plants (1 unit) 1957 107,000 Total Hydro-Conventional (27 units) 1904-34 110,910** Total Hydro-Pumped Storage(4 units) 1972-73 205,200 Total Internal Combustion (3 units) 1968-69 63,500 --------- Total WMECO Generating Plant (41 units) 1,006,897 =========\nNAEC Seabrook (Seabrook,NH) Nuclear 1990 413,793 =========\nHWP Mt. Tom (Holyoke,MA) Fossil-Steam 1960 147,000 Total Hydro-Conventional (15 units) 1905-83 43,560 --------- Total HWP Generating Plant (16 units) 190,560 =========\nNU Millstone(Waterford,CT) SYSTEM Unit 1 Nuclear 1970 647,700 Unit 2 Nuclear 1975 874,500 Unit 3 Nuclear 1986 779,293 Seabrook (Seabrook,NH) Nuclear 1990 460,481 CT Yankee (Haddam,CT) Nuclear 1968 285,768 ME Yankee (Wiscasset,ME) Nuclear 1972 158,054 VT Yankee (Vernon,VT) Nuclear 1972 75,048 --------- Total Nuclear-Steam Plants (7 units) 3,280,844 Total Fossil-Steam Plants (18 units) 1952-78 3,061,065 Total Hydro-Conventional (87 units) 1903-83 320,910** Total Hydro-Pumped Storage (7 units) 1928-73 1,110,350 Total Internal Combustion (24 units) 1966-86 583,750 --------- Total NU SYSTEM Generating Plant Including Regional Yankees (143 units) 8,356,919 =========\nExcluding Regional Yankees (140 units) 7,838,049 ========= *Claimed capability represents winter ratings as of December 31, 1994. **Total Hydro-Conventional capability includes the Cobble Mtn. plant's 33,960 kW which is leased from the City of Springfield, MA.\nFranchises\nNU's operating subsidiaries hold numerous franchises in the territories served by them.\nCL&P. Subject to the power of alteration, amendment or repeal by the General Assembly of Connecticut and subject to certain approvals, permits and consents of public authority and others prescribed by statute, CL&P has, subject to certain exceptions not deemed material, valid franchises free from burdensome restrictions to sell electricity in the respective areas in which it is now supplying such service.\nIn addition to the right to sell electricity as set forth above, the franchises of CL&P include, among others, rights and powers to manufacture, generate, purchase, transmit and distribute electricity, to sell electricity at wholesale to other utility companies and municipalities and to erect and maintain certain facilities on public highways and grounds, all subject to such consents and approvals of public authority and others as may be required by law. The franchises of CL&P include the power of eminent domain.\nPSNH. Subject to the power of alteration, amendment or repeal by the General Court (legislature) of the State of New Hampshire and subject to certain approvals, permits and consents of public authority and others prescribed by statute, PSNH has, subject to certain exceptions not deemed material, valid franchises free from burdensome restrictions to sell electricity in the respective areas in which it is now supplying such service.\nIn addition to the right to sell electricity as set forth above, the franchises of PSNH include, among others, rights and powers to manufacture, generate, purchase, transmit and distribute electricity, to sell electricity at wholesale to other utility companies and municipalities and to erect and maintain certain facilities on certain public highways and grounds, all subject to such consents and approvals of public authority and others as may be required by law. The franchises of PSNH include the power of eminent domain.\nNNECO. Subject to the power of alteration, amendment or repeal by the General Assembly of Connecticut and subject to certain approvals, permits and consents of public authority and others prescribed by statute, NNECO has a valid franchise free from burdensome restrictions to sell electricity to utility companies doing an electric business in Connecticut and other states.\nIn addition to the right to sell electricity as set forth above, the franchise of NNECO includes, among others, rights and powers to manufacture, generate and transmit electricity, and to erect and maintain facilities on certain public highways and grounds, all subject to such consents and approvals of public authority and others as may be required by law.\nWMECO. WMECO is authorized by its charter to conduct its electric business in the territories served by it, and has locations in the public highways for transmission and distribution lines. Such locations are granted pursuant to the laws of Massachusetts by the Department of Public Works of Massachusetts or local municipal authorities and are of unlimited duration, but the rights thereby granted are not vested. Such locations are for specific lines only, and, for extensions of lines in public highways, further similar locations must be obtained from the Department of Public Works of Massachusetts or the local municipal authorities. In addition, WMECO has been granted easements for its lines in the Massachusetts Turnpike by the Massachusetts Turnpike Authority.\nHWP and Holyoke Power and Electric Company (HP&E). HWP, and its wholly owned subsidiary HP&E, are authorized by their charters to conduct their businesses in the territories served by them. HWP's electric business is subject to the restriction that sales be made by written contract in amounts of not less than 100 horsepower, except for municipal customers in the counties of Hampden or Hampshire, Massachusetts and except for customers who occupy property in which HWP has a financial interest, by ownership or purchase money mortgage. HWP also has certain dam and canal and related rights, all subject to such consents and approvals of public authorities and others as may be required by law. The two companies have locations in the public highways for their transmission and distribution lines. Such locations are granted pursuant to the laws of Massachusetts by the Department of Public Works of Massachusetts or local municipal authorities and are of unlimited duration, but the rights thereby granted are not vested. Such locations are for specific lines only and, for extensions of lines in public highways, further similar locations must be obtained from the Department of Public Works of Massachusetts or the local municipal authorities. The two companies have no other utility franchises.\nNAEC. NAEC is authorized by the NHPUC to own and operate its interest in Seabrook 1.\nItem 3","section_3":"Item 3 - Legal Proceedings\n1. Litigation Relating to Electric and Magnetic Fields\nIn December 1991, NU and CL&P were sued in Connecticut Superior Court by Melissa Bullock, a nineteen-year old woman, and her mother, Suzanne Bullock, both residents of 28 Meadow Street in Guilford, Connecticut. The plaintiffs allege that they have lived in close proximity to CL&P's Meadow Street substation and distribution lines since 1979. The suit claims that Melissa Bullock suffers from a form of brain cancer and related physical and psychological injuries, which were \"brought on as a result of exposure in her home to electromagnetic radiation generated by the defendants.\" Suzanne Bullock claims various physical and psychological injuries, and a diminution in the value of her property. The various counts against NU and CL&P include allegations of negligence, product liability, nuisance, unfair trade practices and strict liability. The suit seeks monetary damages, both compensatory and punitive, in as-yet unspecified amounts, as well as an injunction to cease emission of \"dangerous levels\" of electric and magnetic fields (EMF) into the plaintiffs' home.\nThe plaintiffs are represented in part by counsel with a nationwide emphasis on similar litigation, and management considers this lawsuit to be a test case. The case is presently in the pre-trial discovery process. Trial is not anticipated until 1996 at the earliest.\nIn January 1992, a related lawsuit by two other plaintiffs also alleging cancer from EMF emanating from CL&P's Meadow Street substation and distribution lines was served on CL&P and NU. The plaintiffs are represented by the same counsel as the Bullocks, and the claims are nearly identical to the Bullocks' suit. This case is also in the pretrial discovery process; a trial date is not yet known.\nManagement believes that the allegations that EMF caused or contributed to the plaintiffs' illnesses are not supported by current scientific studies. NU and CL&P intend to defend the lawsuits vigorously. For information on EMF studies and state and federal initiatives, see \"Item 1. Business - Regulatory and Environmental Matters - Electric and Magnetic Fields.\"\n2. Massachusetts Municipal Wholesale Electric Company \/ 30th Amendment to NEPOOL Agreement Settlement\nNU's operating subsidiaries, CL&P, PSNH, WMECO, HWP and HP&E (collectively, the Company) and a number of other utilities that are members of NEPOOL, as defendants, are involved in two pending actions relating to pool planning and future transmission service issues under the NEPOOL Agreement. An action in Suffolk Superior Court in Massachusetts was brought by a number of the Massachusetts electric municipal systems and the Massachusetts Municipal Wholesale Electric Company requesting damages and injunctive relief. FERC subsequently commenced an action when the Company and 26 other participants filed an amendment to the NEPOOL Agreement with FERC that concerns many of the issues raised in the Massachusetts litigation.\nOn February 10, 1995, FERC issued an order accepting a withdrawal of the amendment to the NEPOOL Agreement. The withdrawal was part of a settlement agreement signed by substantially all of the parties and intervenors, which will also result in the withdrawal by the settling plaintiffs of their Superior Court complaint after the FERC action is terminated and no longer subject to appeal. The 30-day period in which to appeal from the FERC order expired without the filing of requests for rehearing, and the order has become final.\n3. Southeastern Connecticut Regional Resources Recovery Authority (SCRRRA) - Application of the Municipal Rate\nThis matter involves three separate disputes over the rates that apply to CL&P's purchases of the generation of the SCRRRA project in Preston, Connecticut.\nMunicipal Rate Litigation: In 1990, CL&P initiated a challenge -------------------------- district court to the DPUC's approval of an electricity purchase contract for the SCRRRA project under Connecticut's so-called \"municipal rate law.\" Under this law, CL&P would be required to purchase a portion of the electricity from the resource recovery facility at a rate equal to the retail rate that CL&P charges municipalities for electricity (\"municipal rate\"), which is significantly higher than CL&P's avoided costs. The district court subsequently ordered the parties to seek FERC's resolution of this matter. On January 11, 1995, FERC ruled that a state cannot require an electric utility to enter into a contract paying a qualifying facility more than the utility's avoided costs. The FERC decision is subject to rehearing and can be appealed to the United States Court of Appeals. In early February 1995, several petitions for rehearing were filed. Should CL&P ultimately prevail, the benefits to CL&P customers would be approximately $13 million.\nNon-Participant Towns: CL&P also contested SCRRRA's claim that CL&P must ---------------------\npay the municipal rate for the portion of the project's electricity that is derived from the trash of towns that are not long-term participants in the project. On April 20, 1994, the DPUC granted SCRRRA's request that the municipal rate be made applicable to the non-participant's portion of electricity.\nOn June 9, 1994, CL&P filed an appeal of the DPUC's ruling in the Hartford Superior Court. A total of approximately $3.5 million is in dispute for the years 1992 through 1994. The rate CL&P would be required to pay would also be substantially higher in later years if the DPUC's ruling is upheld. On February 6, 1995, the Superior Court granted the SCRRRA's motion to stay this proceeding until FERC issues a final decision on the municipal rate law. This case could be moot once the FERC decision is final.\nExcess Capacity: CL&P also contested SCRRRA's claim that CL&P must ---------------\npurchase at the applicable contract rates (each of which is higher than CL&P's current avoided costs) any excess of the project's generation above 13.85 MW per hour. On May 3, 1994, the Connecticut Appellate Court affirmed a Superior Court's ruling that the DPUC should decide this issue. CL&P has answered interrogatories issued by the DPUC and further DPUC proceedings on this dispute are expected. The amount in dispute for the period 1992 through August 1994 is approximately $470,000. However, assuming SCRRRA were permitted to charge the municipal rate for an assumed project generation of 14.5 MW per hour (i.e., 5% greater than 13.85 MW), the amount in dispute could be as much as $4.5 million (cumulative present value) for the remaining term of the contract with SCRRRA. This dispute will not be resolved by the FERC decision on the municipal rate statute because each of the contract rates is greater than CL&P's current avoided costs.\nOn June 20, 1994, the Connecticut General Assembly overrode Governor Weicker's veto of a bill that purportedly resolves the non-participant towns and excess capacity disputes against CL&P. CL&P has a number of options in response to this legislation including challenging its constitutionality in either federal or state court. The law took effect on October 1, 1994, but has not yet been applied against CL&P in either of these proceedings.\n4. CL&P's 1992-1993 Retail Rate Case\nIn June 1993, the DPUC issued a decision approving a multi-year rate plan for CL&P. Two appeals have been filed from the 1993 Decision, one by CL&P and the other by the Connecticut Office of Consumer Counsel (OCC) and the City of Hartford (City). The two appeals were consolidated. On May 9, 1994, the City's appeal was dismissed by the Hartford Superior Court on jurisdictional grounds, and the City appealed that dismissal to the Connecticut Appellate Court. The Supreme Court of Connecticut transferred the jurisdictional issue to itself on August 2, 1994. Oral argument is expected to be scheduled in the spring of 1995, and a decision is expected by September 1995.\n5. Connecticut Indian Land Claims\nNumerous lawsuits asserting land claims in Connecticut have been filed in either state and federal court or threatened by a group called the Golden Hill Paugussett Tribe of Indians (the Paugussetts). These actions could impact the title to certain NU system real estate in the eight affected Connecticut towns. Title to the properties of thousands of other owners, including homeowners, has been similarly threatened. However, the only case to specifically name CL&P as a defendant, a class action suit affecting approximately 1,500 property owners in Southbury, was dismissed by the trial court, and the dismissal was subsequently upheld on appeal by the Connecticut Supreme Court on the grounds that the plaintiff lacked standing to act on behalf of the Paugussetts. The outcome of the present or potential litigation either by the Paugussetts or by other groups claiming to be \"Indian tribes\" cannot be predicted at this time. However, a number of possible defenses exist to Indian land claims in Connecticut, and the Paugussetts' success on the merits appears unlikely.\n6. FERC - PSNH Acquisition Case\nIn 1992, FERC's approval of NU's acquisition of PSNH was appealed to the United States Court of Appeals for the First Circuit. The Court affirmed the decision approving the merger but ordered FERC to address whether, if FERC had applied a more stringent \"public interest standard\" to the Seabrook power contract, any modifications would have been necessary. Purporting to apply this standard, FERC reaffirmed certain modifications to the contract, interpreting the standard liberally to allow it to intervene in contracts on behalf of non-parties to the contract. NU requested rehearing, arguing that FERC had not applied the appropriate standard, which request was denied by FERC on July 8, 1994. On September 6, 1994, NU filed a Petition for Review with the First Circuit Court of Appeals concerning FERC's application of a \"public interest standard\" to the Seabrook Power Contract, which Petition is expected to be heard April 3, 1995.\n7. Other Legal Proceedings\nThe following sections of Item 1 \"Business\" discuss additional legal proceedings: \"Rates\" for information about CL&P's rate and fuel clause adjustment clause proceedings and the Seabrook Power Contract; \"Electric Operations -- Generation and Transmission\" for information about proceedings relating to power transmission issues; \"Electric Operations -- Nuclear Generation\" for information related to Seabrook joint owners, high-level and low-level radioactive waste disposal, decommissioning matters and NRC regulation; \"Regulatory and Environmental Matters\" for information about proceedings involving surface water and air quality, toxic substances and hazardous waste, electric and magnetic fields, licensing of hydroelectric projects, and other matters; and \"FINANCIAL CONDITION -- Property Taxes\" in the NU 1994 Annual Report for information about proceedings involving utility property tax appeal matters.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo Event that would be described in response to this item occurred with respect to NU, CL&P, WMECO, PSNH or NAEC.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrants' Common Equity and Related Shareholder Matters\nNU. The common shares of NU are listed on the New York Stock Exchange. The ticker symbol is \"NU,\" although it is frequently presented as \"Noeast Util\" in various financial publications. The high and low sales prices for the past two years, by quarters, are shown below.\nYear Quarter High Low ---- ------- ---- --- 1994 First $25 3\/4 23 Second 24 7\/8 21 1\/4 Third 24 5\/8 20 3\/8 Fourth 23 3\/8 21 1\/4\n1993 First $28 7\/8 $25 1\/2 Second 28 3\/4 25 1\/4 Third 28 1\/8 26 1\/4 Fourth 27 3\/8 22\nAs of January 31, 1995, there were 137,978 common shareholders of record of NU. As of the same date, there were a total of 134,210,261 common shares issued, including approximately 9.1 million shares held in an ESOP trust.\nNU declared and paid quarterly dividends of $0.44 in 1994 and $0.44 in 1993. On January 24, 1995, the Board of Trustees declared a dividend of $0.44 per share, payable on March 31, 1995 to holders of record on March 1, 1995. The declaration of future dividends may vary depending on capital requirements and income as well as financial and other conditions existing at the time.\nInformation with respect to dividend restrictions for NU and its subsidiaries is contained in Item 1. Business under the caption \"Financing Program--Financing Limitations\" and in Note (b) to the \"Consolidated Statements of Common Shareholders' Equity\" on page 32 of NU's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P, PSNH, WMECO, and NAEC. The information required by this item is not applicable because the common stock of CL&P, PSNH, WMECO, and NAEC is held solely by NU.\nItem 6.","section_6":"Item 6. Selected Financial Data\nNU. Reference is made to information under the heading \"Selected Consolidated Financial Data\" contained on pages 48 and 49 of NU's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the heading \"Selected Financial Data\" contained on page 40 of CL&P's 1994 Annual Report, which information is incorporated herein by reference.\nPSNH. Reference is made to information under the heading \"Selected Financial Data\" contained on pages 37 and 38 of PSNH's 1994 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the heading \"Selected Financial Data\" contained on page 33 of WMECO's 1994 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the heading \"Selected Financial Data\" contained on page 21 of NAEC's 1994 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\nNU. Reference is made to information under the heading \"Management's Discussion and Analysis\" contained on pages 16 through 23 in NU's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 32 through 39 in CL&P's 1994 Annual Report, which information is incorporated herein by reference.\nPSNH. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 29 through 35 in PSNH's 1994 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 27 through 32 in WMECO's 1994 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the heading \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" contained on pages 18 through 20 in NAEC's 1994 Annual Report, which information is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nNU. Reference is made to information under the headings \"Company Report,\" \"Report of Independent Public Accountants,\" \"Consolidated Statements of Income,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Statements of Income Taxes,\" \"Consolidated Balance Sheets,\" \"Consolidated Statements of Capitalization,\" \"Consolidated Statements of Common Shareholders' Equity,\" \"Notes to Consolidated Financial Statements,\" and \"Consolidated Statements of Quarterly Financial Data\" contained on pages 24 through 47 in NU's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCL&P. Reference is made to information under the headings \"Consolidated Balance Sheets,\" \"Consolidated Statements of Income,\" \"Consolidated Statements of Cash Flows,\" \"Consolidated Statements of Common Stockholder's Equity,\" \"Notes to Consolidated Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statements of Quarterly Financial Data\" contained on pages 1 through 31 and page 40 in CL&P's 1994 Annual Report, which information is incorporated herein by reference. PSNH. Reference is made to information under the headings \"Balance Sheets,\" \"Statements of Income,\" \"Statements of Cash Flows,\" Statements of Common Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" \"Independent Auditors' Report,\" and \"Statements of Quarterly Financial Data\" contained on pages 1 through 28 and page 39 in PSNH's 1994 Annual Report, which information is incorporated herein by reference.\nWMECO. Reference is made to information under the headings \"Balance Sheets,\" \"Statements of Income,\" \"Statements of Cash Flows,\" \"Statements of Common Stockholder's Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statements of Quarterly Financial Data\" contained on pages 1 through 26 and page 33 in WMECO's 1994 Annual Report, which information is incorporated herein by reference.\nNAEC. Reference is made to information under the headings \"Balance Sheet,\" \"Statement of Income,\" \"Statement of Cash Flows,\" \"Statement of Common Stockholder's Equity,\" \"Notes to Financial Statements,\" \"Report of Independent Public Accountants,\" and \"Statement of Quarterly Financial Data\" contained on pages 1 through 17 and page 21 in NAEC's 1994 Annual 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\nNo event that would be described in response to this item has occurred with respect to NU, CL&P, PSNH, WMECO, or NAEC.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS\nNU.\nIn addition to the information provided below concerning the executive officers of NU, incorporated herein by reference are pages 1 through 13 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 3, 1995 and filed with the Commission pursuant to Rule 14a-6 under the Securities Exchange Act of 1934 (the Act).\nFirst First Positions Elected Elected Name Held an Officer a Trustee --------------------- --------- ---------- ---------\nWilliam B. Ellis CHB, T 06\/15\/76 04\/26\/77 Bernard M. Fox P, CEO, T 05\/01\/83 05\/20\/86\nCL&P. First First Positions Elected Elected Name Held an Officer a Director --------------------- --------- ---------- ----------\nRobert G. Abair D - 01\/01\/89 Robert E. Busch EVP, CFO, D 06\/01\/87 06\/01\/87 William B. Ellis CH, D 06\/15\/76 06\/15\/76 Bernard M. Fox VC, D 05\/15\/81 05\/01\/83 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, D 06\/01\/91 01\/01\/94 John B. Keane VP, T, D 08\/01\/92 08\/01\/92 Francis L. Kinney SVP 04\/24\/74 - Hugh C. MacKenzie P, D 07\/01\/88 06\/06\/90 John W. Noyes 07\/01\/87 - John F. Opeka D - 06\/10\/85\nPSNH. First First Positions Elected Elected Name Held an Officer a Director ------------------- --------- ---------- ----------\nRobert E. Busch EVP, CFO 06\/05\/92 John C. Collins D - 10\/19\/92 William B. Ellis CH, D 06\/05\/92 06\/05\/92 William T. Frain, Jr. P, COO, D 03\/18\/71 02\/01\/94 Bernard M. Fox VC, CEO, D 06\/05\/92 06\/05\/92 Cheryl W. Grise D 02\/06\/95 Gerald Letendre D - 10\/19\/92 Hugh C. MacKenzie D - 02\/01\/94 Jane E. Newman D - 10\/19\/92 John W. Noyes VP, CONT 06\/05\/92 - Robert P. Wax VP, SEC, GC, D 08\/01\/92 02\/01\/93\nWMECO. First First Positions Elected Elected Name Held an Officer a Director ------------------- --------- ---------- ----------\nRobert G. Abair VP, CAD, D 09\/06\/88 01\/01\/89 Robert E. Busch EVP, CFO, D 06\/01\/87 06\/01\/87 William B. Ellis CH, D 06\/15\/76 06\/15\/76 Bernard M. Fox VC, D 05\/15\/81 05\/01\/83 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, D 06\/01\/91 01\/01\/94 John B. Keane VP, TR, D 08\/01\/92 08\/01\/92 Francis L. Kinney SVP 04\/24\/74 - Hugh C. MacKenzie P, D 07\/01\/88 06\/06\/90 John W. Noyes VP, CONT 04\/01\/92 - John F. Opeka D - 06\/10\/85\nNAEC. First First Positions Elected Elected Name Held an Officer a Director --------------------- --------- ---------- ----------\nRobert E. Busch P, CFO, D 10\/21\/91 10\/16\/91 William B. Ellis CH, D 10\/21\/91 10\/16\/91 Ted C. Feigenbaum SVP, D 10\/21\/91 10\/16\/91 Bernard M. Fox VC, CEO, D 10\/21\/91 10\/16\/91 William T. Frain, Jr. D - 02\/01\/94 Cheryl W. Grise SVP, D 10\/21\/91 01\/01\/94 Francis L. Kinney SVP 10\/21\/91 - John B. Keane VP, TR, D 08\/01\/92 08\/01\/92 Hugh C. MacKenzie D - 01\/01\/94 John W. Noyes VP, CONT 10\/21\/91 - John F. Opeka EVP, D 10\/21\/91 10\/16\/91\nKEY: CAO - Chief Administrative Office EVP - Executive Vice President CEO - Chief Executive Officer GC - General Counsel CFO - Chief Financial Officer P - President CH - Chairman SEC - Secretary CHB - Chairman of the Board SVP - Senior Vice President COO - Chief Operating Officer T - Trustee CONT - Controller TR - Treasurer D - Director VC - Vice Chairman VP - Vice President\nName Age Business Experience During Past 5 Years ----------------- --- ---------------------------------------\nRobert G. Abair (1) 56 Elected Vice President and Chief Administrative Officer of WMECO in 1988.\nRobert E. Busch (2) 48 Elected President and Chief Financial Officer of NAEC in 1994; elected Executive Vice President and Chief Financial Officer of NU, CL&P, PSNH, and WMECO in 1992; previously Executive Vice President and Chief Financial Officer of NAEC since 1992; Senior Vice President and Chief Financial Officer of NU, CL&P and WMECO since 1990.\nJohn C. Collins (3) 50 Chief Executive Officer, The Hitchcock Clinic, Dartmouth - Hitchcock Medical Center since 1977.\nWilliam B. Ellis (4) 54 Elected Chairman of the Board of NU in 1993; elected Chairman of CL&P, NAEC, PSNH and WMECO in 1993; previously Chairman of the Board and Chief Executive Officer of NU and Chairman and Chief Executive Officer of CL&P and WMECO since 1987, NAEC since 1991 and PSNH since 1992.\nTed C. Feigenbaum (5) 44 Elected Senior Vice President of NAEC in 1991; previously Senior Vice President and Chief Nuclear Officer of PSNH June, 1992 to August, 1992; previously President and Chief Executive Officer - New Hampshire Yankee Division of PSNH October, 1990 to June, 1992 and Chief Nuclear Production Officer of PSNH January, 1990 to June, 1992; Senior Vice President and Chief Operating Officer - New Hampshire Yankee Division of PSNH (1989-1990).\nBernard M. Fox (6) 52 Elected Vice Chairman of CL&P and WMECO, and Vice Chairman and Chief Executive Officer of NAEC, in 1994; previously Chief Executive Officer of NU, CL&P, PSNH, WMECO and NAEC in 1993; previously President and Chief Operating Officer of NU, CL&P and WMECO in 1990 and NAEC since 1991; Vice Chairman of PSNH since 1992; previously President and Chief Operating and Financial Officer of NU, CL&P and WMECO since 1987.\nWilliam T. Frain, Jr.(7) 53 Elected President and Chief Operating Officer of PSNH in 1994; previously Senior Vice President of PSNH since 1992; previously Treasurer of PSNH since 1991 and Vice President of PSNH since 1982.\nCheryl W. Grise 42 Elected Senior Vice President-Human Resources and Administrative Services of CL&P, WMECO and NAEC in 1994; previously Vice President-Human Resources of NAEC since 1992 and of CL&P and WMECO since 1991.\nJohn B. Keane (8) 48 Elected Vice President and Treasurer of NU, CL&P, PSNH, WMECO and NAEC in 1993; previously Vice President, Secretary and General Counsel- Corporate of NU, CL&P, PSNH, WMECO and NAEC since February 1, 1993; previously Vice President, Assistant Secretary and General Counsel-Corporate of PSNH and NAEC, Vice President, Secretary and General Counsel- Corporate of NU and CL&P, and Vice President, Secretary, Assistant Clerk and General Counsel- Corporate of WMECO since 1992; previously Associate General Counsel of NUSCO since 1985.\nFrancis L. Kinney (9) 62 Elected Senior Vice President-Governmental Affairs of CL&P, WMECO and NAEC in 1994; previously Vice President-Public Affairs of NAEC since 1992 and of CL&P and WMECO since 1978.\nGerald Letendre 53 President, Diamond Casting & Machine Co., Inc. since 1972.\nHugh C. MacKenzie (10) 52 Elected President of CL&P and WMECO in 1994; previously Senior Vice President-Customer Service Operations of CL&P and WMECO since 1990.\nJane E. Newman (11) 49 President, Coastal Broadcasting Corporation since 1992; previously Assistant to the President of the United States for Management and Administration from 1989 to 1991.\nJohn W. Noyes 47 Elected Vice President and Controller of NU, CL&P, PSNH, WMECO and NAEC in 1992; previously Vice President of CL&P and WMECO since 1987.\nJohn F. Opeka (12) 54 Elected Executive Vice President - Nuclear of NAEC in 1991 and of NUSCO in 1986, previously Executive Vice President - Nuclear of CL&P and WMECO from 1986 to 1993.\nRobert P. Wax 46 Elected Vice President, Secretary and General Counsel of PSNH and NAEC in 1994; elected Vice President, Secretary and General Counsel of NU and CL&P and Vice President, Secretary, Assistant Clerk and General Counsel of WMECO in 1993; previously Vice President, Assistant Secretary and General Counsel of PSNH and NAEC since 1993; previously Vice President and General Counsel-Regulatory of NU, CL&P, PSNH, WMECO and NAEC since 1992; previously Associate General Counsel of NUSCO since 1985.\n(1) Trustee of Easthampton Savings Bank. (2) Director Connecticut Yankee Atomic Power Company. (3) Director of Fleet Bank - New Hampshire. (4) Director of Nuclear Electric Insurance Limited, Connecticut Mutual Life Insurance Company, The Hartford Steam Boiler Inspection and Insurance Company and Radian Corporation (a subsidiary of Hartford Steam Boiler) and the Greater Hartford Chamber of Commerce; Chairman of the Board of the Capitol Region Growth Council, Inc.; Director Emeritus of Connecticut Yankee Atomic Power Company; Member of The National Museum of Natural History of The Smithsonian Institution and the Science Advisory Board of The Nature Conservancy. (5) Director of Maine Yankee Atomic Power Company. (6) Director of The Institute of Living, The Institute of Nuclear Power Operations, The Connecticut Business and Industry Association, Mount Holyoke College, Shawmut National Corp., CIGNA Corporation, Connecticut Yankee Atomic Power Company and The Dexter Corporation. (7) Director of Connecticut Yankee Atomic Power Company, the Business and Industry Association of New Hampshire, the Greater Manchester Chamber of Commerce; Trustee of Optima Health, Inc. (8) Director of Maine Yankee Atomic Power Company, Vermont Yankee Nuclear Power Corporation, Yankee Atomic Electric Company and Connecticut Yankee Atomic Power Company. (9) Director of Mid-Conn Bank. (10) Director of Connecticut Yankee Atomic Power Company. (11) Director of Perini Corporation, NYNEX Telecommunications and Consumers Water Company. (12) Director of Connecticut Yankee Atomic Power Company and Yankee Atomic Electric Company.\nThere are no family relationships between any director or executive officer and any other director or executive officer of NU, CL&P, PSNH, WMECO or NAEC.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nNU.\nIncorporated herein by reference are pages 8 through 13 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 3, 1995 and filed with the Commission pursuant to Rule 14a-6 under the Act. SUMMARY COMPENSATION TABLE\nThe following table presents the cash and non-cash compensation received by the five highest-paid executive officers of Northeast Utilities, in accordance with rules of the SEC:\nNotes:\n1. Awards under the 1992 short-term program of the Northeast Utilities Executive Incentive Plan (EIP) were paid in 1993 in the form of unrestricted stock. Awards under the 1993 short-term EIP program were paid in 1994 in the form of cash. In accordance with the requirements of the SEC, these awards are included as \"bonus\" in the years earned.\n2. \"All Other Compensation\" consists of employer matching contributions under the 401(k) Plan, generally available to all eligible employees.\n3. Awards under the short-term program of the EIP have typically been made by the 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. Busch, Opeka and MacKenzie 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 - $303,000; Mr. Ellis - $127,000; Mr. Busch - $165,000; Mr. Opeka - $81,000; and Mr. MacKenzie - $108,000.\n4. Mr. Fox served as President and Chief Operating Officer until July 1, 1993, when he became President and Chief Executive Officer. Mr. Ellis served as Chairman of the Board and Chief Executive Officer until July 1, 1993, when he became Chairman of the Board.\n5. The titles for these executive officers are listed by company in \"Item 10. Directors and Executive Officers of the Registrants.\"\nPENSION BENEFITS The following table shows the estimated annual retirement benefits payable to an executive officer of Northeast Utilities 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 Board of Trustees to participate in the target benefit and who remain in the employ of Northeast Utilities companies until at least age 60 (unless the Board of Trustees sets an earlier age). Each of the executive officers of Northeast Utilities 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.\nFINAL YEARS OF CREDITED SERVICE AVERAGE COMPENSATION\n15 20 25 30 35 $200,000 $72,000 $96,000 $120,000 $120,000 $120,000\n250,000 90,000 120,000 150,000 150,000 150,000\n300,000 108,000 144,000 180,000 180,000 180,000\n350,000 126,000 168,000 210,000 210,000 210,000\n400,000 144,000 192,000 240,000 240,000 240,000\n450,000 162,000 216,000 270,000 270,000 270,000\n500,000 180,000 240,000 300,000 300,000 300,000\n600,000 216,000 288,000 360,000 360,000 360,000\n700,000 252,000 336,000 420,000 420,000 420,000\n800,000 288,000 384,000 480,000 480,000 480,000\n900,000 324,000 432,000 540,000 540,000 540,000\n1,000,000 360,000 480,000 600,000 600,000 600,000\n1,100,000 396,000 528,000 660,000 660,000 660,000\n1,200,000 432,000 576,000 720,000 720,000 720,000\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 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 Northeast Utilities and its subsidiaries under long term disability plans and policies.\nAs of December 31, 1994, the five executive officers named in the Summary Compensation Table above had the following years of credited service for retirement compensation purposes: Mr. Fox - 30, Mr. Ellis - 18, Mr. Busch - 21, Mr. Opeka - 24, and Mr. MacKenzie - 29. Assuming that retirement were to occur at age 65 for these officers, retirement would occur with 43, 29, 38, 35 and 41 years of credited service, respectively.\nIn 1992 Northeast Utilities entered into agreements with Messrs. Ellis and Fox to provide for an orderly Chief Executive Officer succession. The agreement with Mr. Ellis calls for him to work with the Board 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 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 Northeast Utilities 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 Northeast Utilities 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 the Committee and the Board in accordance with their customary practices.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nNU.\nIncorporated herein by reference are pages 6 through 13 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 3, 1995 and filed with the Commission pursuant to Rule 14a-6 under the Act.\nCL&P, PSNH, WMECO AND NAEC.\nNU owns 100% of the outstanding common stock of registrants CL&P, PSNH, WMECO and NAEC. As of February 28, 1995, the Directors of CL&P, PSNH, WMECO and NAEC, beneficially owned the number of shares of each class of equity securities of NU listed below. No equity securities of CL&P, PSNH, WMECO or NAEC are owned by the Directors and Executive Officers of their respective companies.\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) 5,323 shares NU Common Robert E. Busch(4) 7,301 shares NU Common John C. Collins (5)(6) 25 shares NU Common William B. Ellis (7) 10,360 shares NU Common Ted C. Feigenbaum(8) 299 shares NU Common Bernard M. Fox (9) 19,911 shares NU Common William T. Frain, Jr. 1,108 shares NU Common Cheryl W. Grise 2,291 shares NU Common John B. Keane (4) 1,374 shares NU Common Francis L. Kinney (10) 2,415 shares NU Common Gerald Letendre (5) 0 shares NU Common Hugh C. MacKenzie(11)(12) 5,902 shares NU Common Jane E. Newman (5) 0 shares NU Common John W. Noyes 3,272 shares NU Common John F. Opeka (4)(11)(13) 18,271 shares NU Common Robert P. Wax (5) 1,963 shares\nAmount beneficially owned by Directors and Executive Officers as a group - CL&P 77,528 shares - PSNH 70,404 shares - WMECO 77,528 shares - NAEC 72,504 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, 1995 there were 134,210,358 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) Messrs. Busch, Keane and Opeka are Directors of CL&P, WMECO and NAEC only.\n(5) Messrs. Collins, Letendre and Wax and Ms. Newman are Directors of PSNH only. (6) Mr. Collins shares voting and investment power with his wife for 25 shares.\n(7) Mr. Ellis shares voting and investment power with his wife for 1,208 shares.\n(8) Mr. Feigenbaum is a Director and an Executive Officer of NAEC only.\n(9) 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(10) Mr. Kinney shares voting and investment power with his wife for 525 shares.\n(11) Messrs. MacKenzie and Opeka are not officers of PSNH, but in their capacity as officers (with their stated titles) of NUSCO, an affiliate of PSNH, they perform policy-making functions for PSNH.\n(12) Mr. MacKenzie shares voting and investment power with his wife for 1,361 shares.\n(13) 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 15 of the definitive proxy statement for solicitation of proxies by NU's Board of Trustees, dated April 3, 1995 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 1994 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\"). Report of Independent Public Accountants on Schedules S-1\nConsent of Independent Public Accountants S-2\n2. Schedules:\nFinancial Statement Schedules for NU (Parent), NU and Subsidiaries, CL&P and Subsidiaries, PSNH and WMECO are listed in the Index to Financial Statement Schedules S-3\n3. Exhibits Index E-1\n(b) Reports on Form 8-K:\nDuring the fourth quarter of 1994, the companies filed Form 8-Ks dated December 31, 1994 disclosing the following:\no The primary reasons for lower composite nuclear capacity factors in 1994.\nNORTHEAST UTILITIES 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.\nNORTHEAST UTILITIES ------------------- (Registrant)\nDate: March 23, 1995 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 23, 1995 Trustee and Chairman \/s\/William B. Ellis -------------- of the Board ------------------------- William B. Ellis\nMarch 23, 1995 Trustee, President \/s\/Bernard M. Fox -------------- and Chief Executive ------------------------- Officer Bernard M. Fox\nMarch 23, 1995 Executive Vice \/s\/Robert E. Busch -------------- President and Chief ------------------------- Financial Officer Robert E. Busch\nMarch 23, 1995 Vice President and \/s\/John B. Keane -------------- Treasurer ------------------------- John B. Keane\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller ------------------------- John W. Noyes\nNORTHEAST UTILITIES\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- --------- March 23, 1995 Trustee \/s\/Cotton Mather Cleveland -------------- --------------------------- Cotton Mather Cleveland\nMarch 23, 1995 Trustee \/s\/George David -------------- --------------------------- George David\nMarch 23, 1995 Trustee \/s\/Donald J. Donahue -------------- --------------------------- Donald J. Donahue\nMarch 23, 1995 Trustee \/s\/Eugene D. Jones -------------- --------------------------- Eugene D. Jones\nMarch 23, 1995 Trustee \/s\/Gaynor N. Kelley -------------- --------------------------- Gaynor N. Kelley\nMarch 23, 1995 Trustee \/s\/Elizabeth T. Kennan -------------- --------------------------- Elizabeth T. Kennan\nMarch 23, 1995 Trustee \/s\/Denham C. Lunt, Jr. -------------- --------------------------- Denham C. Lunt, Jr.\nMarch 23, 1995 Trustee \/s\/William J. Pape II -------------- --------------------------- William J. Pape II\nMarch 23, 1995 Trustee \/s\/Robert E. Patricelli -------------- --------------------------- Robert E. Patricelli\nNORTHEAST UTILITIES\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 23, 1995 Trustee \/s\/Norman C. Rasmussen -------------- --------------------------- Norman C. Rasmussen\nMarch 23, 1995 Trustee \/s\/John F. Swope -------------- --------------------------- 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 23, 1995 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 23, 1995 Chairman and Director \/s\/William B. Ellis -------------- -------------------------- William B. Ellis\nMarch 23, 1995 Vice Chairman and \/s\/Bernard M. Fox -------------- Director -------------------------- Bernard M. Fox\nMarch 23, 1995 President and Director \/s\/Hugh C. MacKenzie -------------- -------------------------- Hugh C. MacKenzie\nMarch 23, 1995 Executive Vice \/s\/Robert E. Busch -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller -------------------------- John W. Noyes\nTHE CONNECTICUT LIGHT AND POWER COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 23, 1995 Director \/s\/Robert G. Abair -------------- -------------------------- Robert G. Abair\nMarch 23, 1995 Director \/s\/William T. Frain, Jr. -------------- -------------------------- William T. Frain, Jr.\nMarch 23, 1995 Director \/s\/Cheryl W. Grise -------------- -------------------------- Cheryl W. Grise\nMarch 23, 1995 Director \/s\/John B. Keane -------------- -------------------------- John B. Keane\nMarch 23, 1995 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 23, 1995 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 23, 1995 Chairman and Director \/s\/William B. Ellis -------------- -------------------------- William B. Ellis\nMarch 23, 1995 Vice Chairman, Chief \/s\/Bernard M. Fox -------------- Executive Officer and -------------------------- Director Bernard M. Fox\nMarch 23, 1995 President, Chief \/s\/William T. Frain, Jr. -------------- Operating Officer -------------------------- and Director William T. Frain, Jr.\nMarch 23, 1995 Executive Vice -------------- President and \/s\/Robert E. Busch Chief Financial -------------------------- Officer Robert E. Busch\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller -------------------------- John W. Noyes\nPUBLIC SERVICE COMPANY OF NEW HAMPSHIRE\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 23, 1995 Director \/s\/John C. Collins -------------- -------------------------- John C. Collins\nMarch 23, 1995 Director \/s\/Cheryl W. Grise -------------- -------------------------- Cheryl W. Grise\nDirector -------------- -------------------------- Gerald Letendre\nMarch 23, 1995 Director \/s\/Hugh C. MacKenzie -------------- -------------------------- Hugh C. MacKenzie\nMarch 23, 1995 Director \/s\/Jane E. Newman -------------- -------------------------- Jane E. Newman\nMarch 23, 1995 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 23, 1995 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 23, 1995 Chairman and Director \/s\/William B. Ellis -------------- -------------------------- William B. Ellis\nMarch 23, 1995 Vice Chairman and \/s\/Bernard M. Fox -------------- Director -------------------------- Bernard M. Fox\nMarch 23, 1995 President and Director \/s\/Hugh C. MacKenzie -------------- -------------------------- Hugh C. MacKenzie\nMarch 23, 1995 Executive Vice \/s\/Robert E. Busch -------------- President, Chief -------------------------- Financial Officer Robert E. Busch and Director\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller -------------------------- John W. Noyes\nWESTERN MASSACHUSETTS ELECTRIC COMPANY\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- --------- March 23, 1995 Director \/s\/Robert G. Abair -------------- -------------------------- Robert G. Abair\nMarch 23, 1995 Director \/s\/William T. Frain, Jr. -------------- -------------------------- William T. Frain, Jr.\nMarch 23, 1995 Director \/s\/Cheryl W. Grise -------------- -------------------------- Cheryl W. Grise\nMarch 23, 1995 Director \/s\/John B. Keane -------------- -------------------------- John B. Keane\nMarch 23, 1995 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 23, 1995 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 23, 1995 Chairman and Director \/s\/William B. Ellis -------------- -------------------------- William B. Ellis\nMarch 23, 1995 Vice Chairman, Chief \/s\/Bernard M. Fox -------------- Executive Officer and -------------------------- Director Bernard M. Fox\nMarch 23, 1995 President, Chief \/s\/Robert E. Busch -------------- Financial Officer -------------------------- and Director Robert E. Busch\nMarch 23, 1995 Vice President and \/s\/John W. Noyes -------------- Controller -------------------------- John W. Noyes\nNORTH ATLANTIC ENERGY CORPORATION\nSIGNATURES (CONT'D)\nDate Title Signature ---- ----- ---------\nMarch 23, 1995 \/s\/Ted C. Feigenbaum -------------- Director -------------------------- Ted C. Feigenbaum\nMarch 23, 1995 Director \/s\/William T. Frain, Jr. -------------- -------------------------- William T. Frain, Jr.\nMarch 23, 1995 Director \/s\/Cheryl W. Grise -------------- -------------------------- Cheryl W. Grise\nMarch 23, 1995 Director \/s\/John B. Keane -------------- -------------------------- John B. Keane\nMarch 23, 1995 Director \/s\/Hugh C. MacKenzie -------------- -------------------------- Hugh C. MacKenzie\nMarch 23, 1995 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 17, 1995. 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, and employee stock ownership plans, if applicable to each company, as described in notes 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 accompanying index 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. These 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 LLP\nARTHUR ANDERSEN LLP\nHartford, Connecticut February 17, 1995\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. 33-55279 of The Connecticut Light and Power Company, No. 33-56537 of CL&P Capital, LP, No. 33-51185 of Western Massachusetts Electric Company, and No. 33-34622, No. 33-44814, and No. 33-40156 of Northeast Utilities.\n\/s\/ ARTHUR ANDERSEN LLP\nARTHUR ANDERSEN LLP\nHartford, Connecticut March 10, 1995\nINDEX TO FINANCIAL STATEMENT SCHEDULES\nSchedule Page -------- ----\nI. Financial Information of Registrant:\nNortheast Utilities (Parent) Balance Sheets 1994 and 1993 S-4\nNortheast Utilities (Parent) Statements of Income 1994, 1993, and 1992 S-5\nNortheast Utilities (Parent) Statements of Cash Flows 1994, 1993, and 1992 S-6 II. Valuation and Qualifying Accounts and Reserves 1994, 1993, and 1992:\nNortheast Utilities and Subsidiaries S-7 -- S-9 The Connecticut Light and Power Company and Subsidiaries S-10 -- S-12 Public Service Company of New Hampshire S-13 -- S-16 Western Massachusetts Electric Company S-17 -- S-19\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.\nSCHEDULE I NORTHEAST UTILITIES (PARENT)\nFINANCIAL INFORMATION OF REGISTRANT\nBALANCE SHEETS\nAT DECEMBER 31, 1994 AND 1993\n(Thousands of Dollars)\nSCHEDULE I NORTHEAST UTILITIES (PARENT)\nFINANCIAL INFORMATION OF REGISTRANT\nSTATEMENTS OF INCOME\nYEARS ENDED DECEMBER 31, 1994, 1993, AND 1992\n(Thousands of Dollars Except Share Information)\nSCHEDULE I NORTHEAST UTILITIES (PARENT) FINANCIAL INFORMATION OF REGISTRANT STATEMENT OF CASH FLOWS YEARS ENDED DECEMBER 31, 1994, 1993, 1992 (Thousands of Dollars)\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 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 NU Form 10-K, File No. 1-5324 into the 1994 Annual Reports on Form 10-K for CL&P, PSNH, WMECO and NAEC.\n# - Filed with the 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 NU Form 10-K, File No. 1-5324 into the 1994 Annual Report on Form 10-K for CL&P.\n@ - Filed with the 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 NU Form 10-K, File No. 1-5324 into the 1994 Annual Report on Form 10-K for PSNH.\n** - Filed with the 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 NU Form 10-K, File No. 1-5324 into the 1994 Annual Report on Form 10-K for WMECO.\n## - Filed with the 1994 Annual Report on Form 10-K for NU and herein incorporated by reference from the 1994 Form 10-K, File No. 1-5324 into the 1994 Annual Report on Form 10-K for NAEC.\nExhibit Number Description 3 Articles of Incorporation and By-Laws\n3.1 Northeast Utilities\n3.1.1 Declaration of Trust of NU, as amended through May 24,\n1988. (Exhibit 3.1.1, 1988 NU Form 10-K, File No. 1-5324)\n3.2 The Connecticut Light and Power Company\n3.2.1 Certificate of Incorporation of CL&P,restated to March 22, 1994. (Exhibit 3.2.1, 1993 NU Form 10-K, File No. 1-\n5324)\n3.2.2 By-laws of CL&P, as amended to March 1, 1982. (Exhibit\n3.2.2, 1993 NU Form 10-K, File No. 1-5324)\n3.3 Public Service Company of New Hampshire\n3.3.1 Articles of Incorporation, as amended to May 16, 1991.\n(Exhibit 3.3.1, 1993 NU Form 10-K, File No. 1-5324)\n3.3.2 By-laws of PSNH, as amended to November 1, 1993. (Exhibit 3.3.2, 1993 NU Form 10-K, File No. 1-5324)\n3.4 Western Massachusetts Electric Company\n** 3.4.1 Articles of Organization of WMECO, restated to February 23, 1995.\n** 3.4.2 By-laws of WMECO, as amended to February 13, 1995.\n3.5 North Atlantic Energy Corporation\n3.5.1 Articles of Incorporation of NAEC dated September 20, 1991. (Exhibit 3.5.1, 1993 NU Form 10-K, File No. 1-5324)\n3.5.2 Articles of Amendment dated October 16, 1991 and June 2, 1992 to Articles of Incorporation of NAEC. (Exhibit 3.5.2, 1993 NU Form 10-K, File No. 1-5324)\n3.5.3 By-laws of NAEC, as amended to November 8, 1993. (Exhibit 3.5.3, 1993 NU Form 10-K, File No. 1-5324)\n4 Instruments defining the rights of security holders, including indentures\n4.1 Northeast Utilities 4.1.1 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)\n4.1.4 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) Supplemental 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 December 1, 1989. (Exhibit 4.1.26, 1989 NU Form 10-K, File No. 1-5324)\n4.2.7 April 1, 1992. (Exhibit 4.30, File No. 33-59430)\n4.2.8 July 1, 1992. (Exhibit 4.31, File No. 33-59430)\n4.2.9 October 1, 1992. (Exhibit 4.32, File No. 33-59430)\n4.2.10 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n4.2.11 July 1, 1993. (Exhibit A.10(b), File No. 70-8249)\n4.2.12 December 1, 1993. (Exhibit 4.2.14, 1993 NU Form 10-K, File No. 1-5324)\n4.2.13 February 1, 1994. 1(Exhibit 4.2.15, 1993 NU Form 10-K, File No. 1-5324)\n4.2.14 February 1, 1994. (Exhibit 4.2.16, 1993 NU Form 10-K, File No. 1-5324)\n# 4.2.15 June 1, 1994.\n# 4.2.16 October 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) 4.2.18 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)\n4.2.21 Series A (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.2.21, 1993 NU Form 10-K, File No. 1-5324)\n4.2.22 Series B (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and CL&P (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.2.22, 1993 NU Form 10-K, File No. 1-5324)\n4.2.23 Series A (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.2.23, 1993 NU Form 10-K, File No. 1-5324)\n4.2.24 Series B (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.2.24, 1993 NU Form 10-K, File No. 1-5324)\n4.2.25 Amended and Restated Limited Partnership Agreement (CL&P Capital, L.P.) among CL&P, NUSCO, and the persons who became limited partners of CL&P Capital, L.P. in accordance with the provisions thereof dated as of January 23, 1995(MIPS). (Exhibit A.1 (Execution Copy), File No. 70-8451)\n4.2.26 Indenture between CL&P and Bankers Trust Company, Trustee (Series A Subordinated Debentures), dated as of January 1, 1995 (MIPS). (Exhibit B.1 (Execution Copy), File No. 70-8451)\n4.2.27 Payment and Guaranty Agreement of CL&P dated as of January 23, 1995 (MIPS). (Exhibit B.3 (Execution Copy), File No. 70-8451)\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)\n4.3.1.1 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)\n4.3.8.1 First Supplement to Series E (Tax Exempt Refunding Issue) PCRB Loan and Trust Agreement dated as of December 1, 1993. (Exhibit 4.3.8.1, 1993 NU Form 10-K, File No. 1-5324)\n4.3.9 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. (Exhibit 4.3.9, 1993 NU Form 10-K, File No. 1-5324)\n4.3.9.1 Amended and Restated Letter of Credit dated December 17, 1992. (Exhibit 4.3.9.1, 1993 NU Form 10-K, File No. 1-5324)\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)\n4.3.10.1 Amended and Restated Letter of Credit dated December 15, 1993. (Exhibit 4.3.10.1, 1993 NU Form 10-K, File No. 1-5324)\n4.4 Western Massachusetts Electric Company\n4.4.1 First Mortgage Indenture and Deed of Trust between WMECO and Old Colony Trust Company, Trustee, dated as of August 1, 1954. (Exhibit 4.4.1, 1993 NU Form 10-K, File No. 1- 5324)\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 September 1, 1990. (Exhibit 4.3.15, 1990 NU Form 10-K, File No. 1-5324.)\n4.4.5 December 1, 1992. (Exhibit 4.15, File No. 33-55772)\n4.4.6 January 1, 1993. (Exhibit 4.5.13, 1992 NU Form 10-K, File No. 1-5324)\n4.4.7 March 1, 1994. (Exhibit 4.4.11, 1993 NU Form 10-K, File No. 1-5324)\n4.4.8 March 1, 1994. (Exhibit 4.4.12, 1993 NU Form 10-K, File No. 1-5324)\n4.4.9 Series A (Tax Exempt Refunding) PCRB Loan Agreement between Connecticut Development Authority and WMECO (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.4.13, 1993 NU Form 10-K, File No. 1-5324)\n4.4.10 Series A (Tax Exempt Refunding) PCRB Letter of Credit and Reimbursement Agreement (Pollution Control Bonds) dated as of September 1, 1993. (Exhibit 4.4.14, 1993 NU Form 10-K, File No. 1-5324)\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)\n4.5.3 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\n#@** 10.1 Stockholder Agreement dated as of July 1, 1964 among the stockholders of Connecticut Yankee Atomic Power Company (CYAPC).\n#@** 10.2 Form of Power Contract dated as of July 1, 1964 between CYAPC and each of CL&P, HELCO, PSNH and WMECO.\n#@** 10.2.1 Form of Additional Power Contract dated as of April 30, 1984, between CYAPC and each of CL&P, PSNH and WMECO.\n10.2.2 Form of 1987 Supplementary Power Contract dated as of April 1, 1987, between CYAPC and each (Exhibit 10.2.6, 1987 NU Form 10-K, File No. 1-5324)\n#@** 10.3 Capital Funds Agreement dated as of September 1, 1964 between CYAPC and CL&P, HELCO, PSNH and WMECO.\n10.4 Stockholder Agreement dated December 10, 1958 between Yankee Atomic Electric Company (YAEC) and CL&P, HELCO, PSNH and WMECO. (Exhibit 10.4, 1993 NU Form 10-K, File No. 1-5324)\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.) 10.5.1 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)\n10.5.4 Form of Amendment No. 7 to Power Contract, dated February 1, 1992, between YAEC and each of CL&P, PSNH and WMECO. (Exhibit 10.5.4, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.7.1 Form of Amendment No. 1 to Power Contract dated as of March 1, 1983 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.1, 1993 NU Form 10-K, File No. 1-5324)\n10.7.2 Form of Amendment No. 2 to Power Contract dated as of January 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.2, 1993 NU Form 10-K, File No. 1- 5324)\n#@** 10.7.3 Form of Amendment No. 3 to Power Contract dated as of October 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO.\n10.7.4 Form of Additional Power Contract dated as of February 1, 1984 between MYAPC and each of CL&P, PSNH and WMECO. (Exhibit 10.7.4, 1993 NU Form 10-K, File No. 1-5324)\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)\n#@** 10.8.1 Amendment No. 1 to Capital Funds Agreement, dated as of August 1, 1985, between MYAPC, CL&P, PSNH and WMECO.\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) 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. (Exhibit 10.10.2, 1993 NU Form 10-K, File No. 1-5324)\n#@** 10.10.3 Form of Third Amendment to Power Contract dated as of April 24, 1985 between VYNPC and each of CL&P, PSNH and WMECO.\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. 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)\n10.10.7 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)\n10.10.9 Form of Additional Power Contract dated as of February 1, 1984 between VYNPC and each of CL&P, PSNH and WMECO. (Exhibit 10.10.9, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.11.2 Form of Second Amendment to Capital Funds Agreement dated as of September 1, 1993 between VYNPC and CL&P, HELCO, PSNH and WMECO. (Exhibit 10.11.2, 1993 NU Form 10-K, File No. 1-5324)\n#** 10.12 Amended and Restated Millstone Plant Agreement dated as of December 1, 1984 by and among CL&P, WMECO and Northeast Nuclear Energy Company (NNECO).\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) 10.13.1 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)\n* 10.17 Agreement (composite) for joint ownership, construction and operation of New Hampshire nuclear, as amended through the November 1, 1990 twenty-third amendment.\n10.17.1 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)\n10.17.2 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)\n10.17.2.1 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)\n10.18.2 Form (Composite) of Second Amendment to Exhibit 10.18. (Exhibit 10.18.2, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.20 Form of Service Contract dated as of July 1, 1966 between each of NU, CL&P and WMECO and the Service Company. (Exhibit 10.20, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.20.2 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)\n10.20.3 Form of Annual Renewal of Service Contract. (Exhibit 10.20.3, 1993 NU Form 10-K, File No. 1-5324)\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) 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. (Exhibit 10.21.1, 1993 NU Form 10-K, File No. 1-5324)\n**#10.21.2 Amendment to Memorandum of Understanding between CL&P, HELCO, HP&E, HWP and WMECO dated as of January 1, 1984 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)\n10.22.4 Twenty-ninth Amendment to Exhibit 10.22 dated as of May 1, 1993. (Exhibit 10.22.4, 1993 NU Form 10-K, File No. 1-5324)\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)\n#@**10.25 Simulator Financing Lease Agreement, dated as of February 1, 1985, by and between ComPlan and NNECO.\n#@**10.26 Simulator Financing Lease Agreement, dated as of May 2, 1985, by and between The Prudential Insurance Company of America and NNECO.\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 dated 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)\n10.28 Millstone Technical Building Note Agreement dated as of December 21, 1993 between, by and between The Prudential Insurance Company of America and NNECO. (Exhibit 10.28, 1993 NU Form 10-K, File No. 1-5324)\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)\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) 10.33 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)\n10.35.1 Amendment 1 to Exhibit 10.35, effective as of August 1, 1993. (Exhibit 10.35.1, 1993 NU Form 10-K, File No. 1-5324)\n10.35.2 Amendment 2 to Exhibit 10.35, effective as of January 1, 1994. (Exhibit 10.35.2, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.36.1 First Amendment to Exhibit 10.36 dated February 7, 1992. (Exhibit 10.36.1, 1993 NU Form 10-K, File No. 1-5324)\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)\n10.36.3 Second Amendment to Exhibit 10.36 dated April 9, 1992. (Exhibit 10.36.3, 1993 NU Form 10-K, File No. 1-5324)\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.)\n* 13.1 Portions of the Annual Report to Shareholders of NU (pages 16 - 50) that have been incorporated by reference into this Form 10-K.\n13.2 Annual Report of CL&P. 13.3 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)\n27 Financial Data Schedules (Each Financial Data Schedule is filed only with the Form 10-K of that respective registrant.)\n27.1 Financial Data Schedule of NU.\n27.2 Financial Data Schedule of CL&P.\n27.3 Financial Data Schedule of WMECO.","section_15":""}
{"filename":"25095_1994.txt","cik":"25095","year":"1994","section_1":"ITEM 1. BUSINESS.\nCotter & Company (the \"Company\") was organized as a Delaware corporation in 1953. Upon its organization, it succeeded to the business of Cotter & Company, an Illinois corporation organized in 1948. The Company's principal executive offices are located at 2740 North Clybourn Avenue, Chicago, Illinois, 60614. Its telephone number is (312) 975-2700.\nThe Company is a Member-owned wholesaler of hardware, variety and related merchandise. It is the largest wholesaler of hardware and related items in the United States. The Company also manufactures paint, paint applicators, outdoor power equipment, heaters and hardware related products. For reporting purposes, the Company operates in a single industry as a Member-owned wholesaler cooperative.\nMembership entitles a Member to use certain Company trademarks and trade names, including the federally registered collective membership trademarks indicating membership in \"True Value Hardware Stores\" and \"V&S Variety Stores\". The \"True Value\" collective membership mark has a present expiration date of January 2, 2003 and the \"V&S Variety Stores\" collective membership mark has a present expiration date of July 22, 1995.\nThe Company serves approximately 7,500 True Value Hardware Stores throughout the United States, including approximately 900 combination True Value Hardware and V&S Variety Stores and 1,000 V&S Variety Stores. Primary concentrations of Members exist in California (approximately 8%), New York (approximately 7%), Illinois (approximately 6%), Pennsylvania and Texas (approximately 5% each) and Michigan and Ohio (approximately 4% each).\nThe Company's total sales of merchandise to its U.S. Members were divided among the following general classes of merchandise:\nThe Company serves its Members by purchasing products in quantity lots and selling them to Members in smaller lots, passing along any savings to Members in the form of lower prices and\/or patronage dividends. The Company holds conventions and meetings for its Members in order to keep them better informed as to industry trends and as to new merchandise available. The Company also provides each of its Members with an illustrated price catalog showing the products available from the Company. The Company's sales to its Members are divided into three categories, as follows: (1) warehouse shipment sales (approximately 47% of total sales); (2) direct (drop shipment) sales (approximately 41% of total sales); and (3) relay sales (approximately 12% of total sales). Warehouse shipment sales are sales of products purchased, warehoused, and resold by the Company upon orders from the Members. Direct shipment sales are sales of products purchased by the Company but delivered directly to Members from manufacturers. Relay sales are sales of products purchased by the Company in response to the requests of several Members for a product which is not normally held in inventory and is not susceptible to direct shipment. Generally, the Company will give notice to all Members of its intention to purchase products for relay shipment and then purchases only so many of such products as the Members order. When the product shipment arrives at the Company, it is not warehoused; rather, the Company breaks up the shipment and \"relays\" the appropriate quantities to the Members who placed orders.\nThe Company also manufactures paint, paint applicators, outdoor power equipment, heaters and hardware related products. The principal raw materials used by the Company include chemicals, engines and steel. All raw materials are purchased from outside sources. The Company has been able to obtain adequate sources of raw materials and other items used in production and no shortages of such materials which will materially impact operations are currently anticipated.\nThe Company annually sponsors two \"markets\" (one in the Spring and one in the Fall). In fiscal year 1994, these markets will be held in St. Louis, Missouri. Members are invited to the markets and generally place substantial orders for delivery during the period prior to the next market. During such markets, new merchandise and seasonal merchandise for the coming season is displayed to attending Members.\nAs of February 26, 1994 and February 27, 1993, the Company had a comparable backlog of orders (including relay orders) believed to be firm of approximately $23,000,000. It is anticipated that the entire backlog existing at February 26, 1994 will be filled by April 30, 1994. The Company's backlog at any given time is made up of two principal components: (i) normal resupply orders and (ii) market orders for future delivery. Resupply orders are orders from Members for merchandise to keep inventories at normal levels. Generally, such orders are filled the day following receipt, except that relay orders for future delivery (which are in the nature of resupply orders) are not intended to be filled for several months. Market orders for future delivery are orders for new or seasonal merchandise given by Members during the Company's two markets, for delivery during the several months subsequent to the markets. Thus, the Company will have a relatively high backlog at the end of each market which will diminish in subsequent months until the next market.\nThe retail hardware and variety industry is characterized by intense competition. Independent retail hardware and variety businesses, as served by the Company, have met increased competition from chain stores, discount stores, home centers, and warehouse operations. Increased operating expenses for the retail stores, including increased costs due to longer open-store hours and higher rental costs of shopping center locations, have cut into operating margins and brought pressures for lower merchandise costs, to which the Company has been responsive. The Company competes with other Member-owned and non-member-owned wholesalers as a source of supply and merchandising support for independent retailers. Competitive factors considered by independent retailers in choosing a source of supply include pricing, servicing capabilities, promotional support and merchandise quality. General increased operating costs and decreased margins have resulted in the withdrawal from business of several non-member-owned wholesalers or conversion to Member-owned status.\nDuring fiscal year 1992, the Company acquired a majority equity interest in Cotter Canada Hardware and Variety Cooperative, Inc., a Canadian wholesaler of hardware, variety and related merchandise. This cooperative serves 336 MacLeod's True Value and Stedman's V&S Variety Stores, all located in Canada. The cooperative has approximately 330 employees and generated less than 5% of the Company's consolidated revenue in fiscal year 1993.\nThe Company operates several other subsidiaries, most of which are engaged in businesses providing additional services to the Company's Members. In the aggregate, these subsidiaries are not significant to the Company's results of operations.\nThe Company employs approximately 4,300 persons in the United States on a full-time basis. Due to the widespread geographical distribution of the Company's operations, employee relations are governed by the practices prevailing in the particular area and are generally dealt with locally. Approximately 40% of the Company's hourly-wage employees are covered by collective bargaining agreements which are generally effective for periods of three years. In general, the Company considers its relationship with its employees to be good.\nDISTRIBUTION OF PATRONAGE DIVIDENDS\nThe Company operates on a cooperative basis with respect to business done with or for Members. All Members are entitled to receive patronage dividend distributions from the Company on the basis of gross margins of merchandise and\/or services purchased by each Member. In accordance with the Company's By-Laws, the annual patronage dividend is paid to Members out of the gross margins from operations and\nother patronage source income, after deduction for expenses and provisions authorized by the Board of Directors.\nPatronage dividends are usually paid to Members within 60 days after the close of the Company's fiscal year; however, the Internal Revenue Code permits distribution of patronage dividends as late as the 15th day of the ninth month after the close of the Company's fiscal year, and the Company may elect to distribute the annual patronage dividend at a later time than usual in accordance with the provisions of the Internal Revenue Code.\nThe Company's By-Laws provide for the payment of year-end patronage dividends, after payment of at least 20% of such patronage dividends in cash, in qualified written notices of allocation including (i) Class B nonvoting Common Stock based on book value thereof, to a maximum of 2% of the Member's net purchases of merchandise from the Company for the year (except in unusual circumstances of individual hardships, in which case the Board of Directors reserves the right to make payments in cash), (ii) Promissory (Subordinated) Notes, and (iii) other property. The Company may also issue nonqualified written notices of allocation to its Members as part of its annual patronage dividend.\nA Member's required investment in Class B Common Stock of the Company is currently limited to an amount in the aggregate not exceeding an amount (computed on the basis of par value thereof and to the nearest multiple of $100) equal to (i) two percent (2%) of a Member's net purchases of direct (drop shipment) sales from the Company and purchases of direct (drop shipment) sales of 'Competitive Edge Program Lumber' materials computed separately at one percent (1%), (ii) four percent (4%) of a Member's net purchases of relay sales from the Company and (iii) eight percent (8%) of a Member's net warehouse purchases from the Company in the year of the highest total net purchases of the three preceding years. The Board of Directors anticipates maintaining these percentages. In that each member has equal voting power (voting rights being limited to Class A Common Stock), acquisition of Class B Common Stock as patronage dividends results in the larger volume Members having greater Common Stock equity in the Company but a lesser proportionate voting power per dollar of Common Stock owned than smaller volume Members.\nPAYMENT OF PATRONAGE DIVIDENDS IN ACCORDANCE WITH THE INTERNAL REVENUE CODE\nThe Internal Revenue Code (the 'Code') specifically provides for the taxation of cooperatives (such as the Company) and their patrons (such as the Company's Members) so as to ensure that the business earnings of cooperatives are currently taxable either to the cooperatives or to the patrons.\nThe shares of Class B Common Stock and the Promissory (Subordinated) Notes distributed by the Company to its Members as partial payment of the patronage dividend are 'written notices of allocation' within the meaning of that term as used in the Code. In order that such written notices of allocation shall be deducted from earnings in determining taxable income of the Company, it is necessary that the Company pay 20% or more of the annual patronage dividend in cash and that the Members consent to having the allocations (at their stated dollar amount) treated as being constructively received by them and includable in their gross income. These conditions being met, the shares of Class B Common Stock and the Promissory (Subordinated) Notes distributed in payment of patronage dividends become 'qualified written notices of allocation' as that term is used in the Code. Section 1385(a) of the Code provides, in substance, that the amount of any patronage dividend which is paid in money or in qualified written notices of allocation shall be included in the gross income of the patron (Member) for the taxable year in which he receives such money or such qualified written notices of allocation.\nThus, every year each Member will receive, as part of the Member's patronage dividend, non-cash items ('written notices of allocation') including Class B Common Stock and Promissory (Subordinated) Notes, the stated dollar amount of which must be recognized as gross income for the taxable year in which received. The portion of the patronage dividend paid in cash (at least 20%) may be insufficient, depending on the tax bracket in each Member's case, to provide funds for the payment of income taxes for which the Member will be liable as a result of the receipt of the entire patronage dividend, including cash, Class B Common Stock and Promissory (Subordinated) Notes.\nIn response to the provisions of the Code, the Company's By-Laws provide for the treatment of the shares of Class B Common Stock, Promissory (Subordinated) Notes and such other notices as the Board of Directors may determine, distributed in payment of patronage dividends as 'qualified written notices of allocation.' The By-Laws provide in effect:\n(i) for payment of patronage dividends partly in cash, partly in qualified written notices of allocation (including the Class B Common Stock and Promissory (Subordinated) Notes as described above), other property or in nonqualified written notices of allocation, and\n(ii) that membership in the organization (i.e. the status of being a Member of the Company) shall constitute consent by the Member to take the qualified written notices of allocation or other property into account in the Member's gross income as provided in Section 1385(a) of the Code.\nUnder the provisions of the Code, persons who become or became Members of the Company or who retained their status as Members after adoption of the By-Laws providing that membership in the organization constitutes consent, and after receiving written notification and a copy of the By-Laws are deemed to have consented to the tax treatment of the cash and the qualified written notices of allocation in which the patronage dividends are paid, in accordance with Section 1385(a) of the Code. Written notification of the adoption of the By-Laws and its significance, and a copy of the By-Laws, were sent to each then existing Member and have been, and will continue to be, delivered to each party that became, or becomes a Member thereafter. Such consent is then effective except as to patronage occurring after the distributee ceases to be a Member of the organization or after the By-Laws of the organization cease to contain the provision with respect to the above described consent.\nEach year since 1978, the Company has paid its Members 30% of the annual patronage dividend in cash in respect to patronage (excluding nonqualified written notices of allocation) occurring in the preceding year. It is the judgment of management that the payment of 30% of patronage dividends in cash will not have a material adverse effect on the operations of the Company or its ability to maintain adequate working capital for the normal requirements of its business. However, the Company is obligated to distribute only 20% of the annual patronage dividend (excluding nonqualified written notices of allocation) in cash and it may distribute this lesser percentage in future years.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe Company's national headquarters is located at 2740 North Clybourn Avenue, Chicago, Illinois. Information with respect to the Company's owned and leased warehousing and office facilities is set forth below:\nNo location owned by the Company (with the exception of Woodland) is subject to a mortgage.\nIn December 1983, the Company completed construction of a 150,000 square foot addition to its regional distribution center in Manchester, New Hampshire. This addition was financed with the proceeds from the sale of $4,000,000 State of New Hampshire Industrial Development Authority Revenue Bonds (Cotter & Company Project) Series 1982. The 5.94% interest rate will be adjusted based on a bond index on October 1, 1994 and every three-year period thereafter. These bonds may be redeemed at face value at either the option of the Company or the bondholders on October 1, 1994 and every three-year period thereafter until maturity in 2003.\nIn July 1985, the Company completed construction of a regional distribution center in Woodland, California. The construction of the regional distribution center was financed with the proceeds from the sale of Industrial Development Revenue Bonds issued by the City of Woodland, California. At January 1, 1994, the total outstanding debt was $1,150,000. These bonds bear interest at 8.25%. Final principal payment of $1,150,000 is due in fiscal year 1994.\nIn February 1993, the Company completed the sale of a facility that it previously owned in Pomona, California.\nThe Company's facility in Denver, Colorado is currently leased through June 30, 1994. The Company is moving this operation to a 360,000 square feet facility in Denver, Colorado, that is leased through June 30, 1999.\nInformation with respect to the Company's manufacturing facilities is set forth below:\nThe Company's facilities are suitable for their respective uses and are, in general, adequate for the Company's present needs.\nThe Company owns and leases transportation equipment for use at its regional distribution centers for the primary purpose of delivering merchandise from the Company's regional distribution centers to its Members. Additional information concerning these leases can be found in Notes 3 and 5 to the consolidated financial statements included elsewhere herein.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, 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.\nNone.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nThere is no existing market for the Common Stock of the Company and there is no expectation that any market will develop. The Company's Class A Common Stock is owned almost exclusively by retailers of hardware, variety and related products each of whom is a Member of the Company and purchases ten shares of the Company's Class A Common Stock (the only class of voting stock) upon becoming a Member. The Company is organized and operates as a cooperative corporation. The shares of the Company's Class B Common Stock now outstanding were issued to Members in partial payment of the annual patronage dividend to which they became entitled as a result of patronage business done by such Members with the Company. In accordance with the Company's By-Laws, the annual patronage dividend is paid to Members out of the gross margins from operations and other patronage source income, after deduction for expenses and provisions authorized by the Board of Directors.\nThe number of holders of record (as of February 26, 1994) of each class of stock of the Company is as follows:\nDividends (other than patronage dividends) upon the Class A Common Stock and Class B Common Stock, subject to the provisions of the Company's Certificate of Incorporation, may be declared out of gross margins of the Company, other than gross margins from operations with or for Members and other patronage\nsource income, after deduction for expenses and provisions authorized by the Board of Directors. Dividends may be paid in cash, in property, or in shares of the Common Stock, subject to the provisions of the Certificate of Incorporation. Other than the payment of patronage dividends, including the redemption of all nonqualified written notices of allocation, the Company has not paid dividends on its Class A Common Stock or Class B Common Stock. The Board of Directors does not plan to pay dividends on either of said classes of stock. See the discussion of patronage dividends under Item 1 - -Business.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nSELECTED FINANCIAL DATA\n- --------------- (a) The book value per share of the Company's Class A Common Stock and Class B Common Stock is the value, determined in accordance with generally accepted accounting principles, of such shares as shown by the respective year-end consolidated balance sheets of the Company, included elsewhere herein as reported on by the Company's independent auditors, after eliminating therefrom all value for goodwill, and other intangible assets and any retained earnings specifically appropriated by the Company's Board of Directors.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nRESULTS OF OPERATIONS\nFISCAL YEAR 1993 COMPARED TO FISCAL YEAR 1992\nRevenues increased $64,259,000 or 2.7% compared to the previous year. The majority of this revenue gain resulted from increased direct shipment sales to Members. Contributing to the increased direct shipments were strong increases of 15.6% from Lumber and Building Materials and a 20.5% increase from the Company's manufacturing division, General Power Equipment Company. Another significant portion of the Company's revenue increase was due to Cotter Canada Hardware and Variety Cooperative, Inc. (\"Cotter Canada\"). With its growth in membership and its first full year of operations, Cotter Canada shipments to Canadian members increased by 36.4%.\nConsolidated gross margins increased $1,313,000 but as a percentage of revenue decreased to 9.0% from 9.2% reflecting the change in sales mix from warehouse to direct shipments.\nWarehouse, general and administrative expenses increased by $9,430,000 or 7.7% due to higher manufacturing and logistic costs, increases associated with a full year of operations at Cotter Canada and\nnon-recurring expenses related to the decentralization of functions previously performed at the Company's National Headquarters.\nInterest paid to Members decreased $1,258,000 or 4.9% primarily due to a lower average interest rate.\nOther interest expense increased by $156,000 or 2.1% due to a long-term financing agreement entered into by the Company during the second quarter of fiscal year 1992 to finance the expansion of the Company's distribution network and entry into Canada. This increase was partially offset by a decrease in short-term borrowings and the average rate of interest compared to the corresponding period last year.\nThe gain on sale of properties owned of $5,985,000 and the corresponding increase in income tax expense of $2,193,000 resulted primarily from the disposition of a regional distribution center in Pomona, California and real estate located in Chicago, Illinois.\nNet margins were $57,023,000 for the year ended January 1, 1994 compared to $60,629,000 for the year ended January 2, 1993.\nFISCAL YEAR 1992 COMPARED TO FISCAL YEAR 1991\nRevenues for fiscal year 1992 increased by $216,581,000 or 10.1%. This represents the highest single year dollar increase in the Company's history. The majority of the revenue growth resulted from a 7.8% increase in merchandise shipments to the True Value and V&S Variety Members from the Company's regional distribution network and manufacturing facilities. All general classes of merchandise experienced revenue gains, reflecting Member confidence in merchandising programs and regional assortments. Another significant influence on revenues was the Company's expansion into the Canadian market. Shipments to Canadian Members by Cotter Canada exceeded $65,000,000.\nGross margins increased by $18,863,000 or 9.5%. As a percentage of revenues, gross margins remained comparable to last year.\nWarehouse, general and administrative expenses increased by $11,404,000 or 10.2% but as a percentage of revenues remained comparable with the prior year. The Company was able to maintain this percentage, even though the Company increased the number of items stocked in regional distribution centers and member ordering patterns continued to shift away from direct (drop shipment) sales. Additionally, fiscal year 1992 was the first full fiscal year of operating the Kingman, Arizona regional distribution center, and the year the Company began its Canadian operation.\nInterest paid to Members decreased slightly due to a decrease in the average interest rate partially offset by an increase in the balance of the promissory (subordinated) and instalment notes.\nOther interest expense increased by $4,807,000 due to long-term financing agreements entered into by the Company during fiscal year 1992, to finance the expansion of the Company's distribution network and entry into Canada.\nOther income, net decreased by $1,502,000 due to a reduction in interest income compared to fiscal year 1991. Interest income decreased due to a reduction in the notes receivable and short-term investment amounts held during the year as well as lower rates of interest earned on these balances.\nNet margins were $60,629,000 and $59,425,000 for fiscal years 1992 and 1991, respectively. The difference resulted primarily from increased merchandise shipments to Members.\nLIQUIDITY AND CAPITAL RESOURCES\nAt January 1, 1994, net working capital decreased to $225.2 million from $230.2 million at January 2, 1993. The current ratio increased to 1.57 in fiscal year 1993 compared to 1.56 in fiscal year 1992. Current assets decreased $18.0 million, primarily due to the Company's change in cash position, offset by an increase of $22.2 million in receivables due to increased sales and offering Members favorable payment terms received by the Company from its vendors. Current liabilities decreased $13.0 million primarily due to a decrease in\naccounts payable as a result of decreased wholesale merchandise inventory offset by an increase in current maturities of long-term obligations and short-term borrowings.\nHistorically, cash flow from operations together with proceeds of short-term borrowings have sufficiently funded the Company's operations. In an attempt to improve Members' cash flow, the Company continued to offer Members extended terms on purchases during fiscal year 1993 thereby increasing extended term receivables by 24.7%. During fiscal year 1994, the Company anticipates that cash provided by operating activities will increase due to forecasted improvement in the relationship between inventories and accounts payable.\nCash and cash equivalents decreased to $1.3 million at January 1, 1994 compared to $37.6 million at January 2, 1993. Short-term lines of credit available under informal agreements with lending banks, cancelable by either party under specific circumstances, amounted to $56.5 million at January 1, 1994. There were $23.3 million of borrowings outstanding under these agreements at January 1, 1994 compared to $0.3 million at January 2, 1993.\nThe Company's capital is primarily derived from redeemable Class A Common Stock and retained earnings, together with promissory (subordinated) notes and redeemable nonvoting Class B Common Stock issued in connection with the Company's annual patronage dividend. Funds derived from these capital resources are usually sufficient to satisfy long-term capital needs.\nNet capital expenditures, including those made under capital leases, were $5.6 million in fiscal year 1993 compared to $27.0 million in fiscal year 1992 and $30.5 million in fiscal year 1991. These capital expenditures were principally related to additional equipment and technological improvements at the regional distribution centers and National Headquarters. Additionally, a wholly-owned subsidiary of the Company acquired certain assets of a hardware and variety wholesaler based in Canada for approximately $13.1 million in fiscal year 1992. In fiscal year 1991, capital expenditures included the construction of a new regional distribution center in Kingman, Arizona. Funding of capital expenditures in fiscal year 1994 is anticipated to come from operations and external sources, if necessary.\nThe effects of all recent tax legislation have not had a material effect on the Company's financial position and results of operations.\nEffective January 3, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\". As permitted under the new rules, prior years' financial statements have not been restated. The cumulative effect of this adoption does not have a material effect on the consolidated financial statements. Additionally, the Company has reviewed the impact of all new accounting standards issued as of the filing date of this report, that will be adopted at a future date, and has determined that these will not have a material impact on the Company's operating results and financial position.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nConsolidated financial statements and consolidated financial statement schedules covered by the report of the Company's independent auditors are listed on Page.\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 the Company are:\n- --------------- During the past five years, the principal occupation of each director of the Company, other than Daniel A. Cotter, was the operation of retail hardware stores.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nPENSION AND COMPENSATION COMMITTEE\nThe Pension and Compensation Committee of the Board of Directors (the \"Committee\") consists of three non-employee directors: Kenneth O. Cayce, Jr. (Chairman), Lewis W. Moore and Michael P. Cole. In addition, Jerrald T. Kabelin, Chairman of the Board of Directors, and Daniel A. Cotter, President and Chief Executive Officer, served as ex-officio members of the Committee. The Committee assists the Board of Directors in fulfilling its responsibilities for setting and administering the policies which govern annual compensation and monitoring the Company's pension plans. It meets in executive session and with ex-officio members and the Chief Financial Officer concerning executive compensation matters. The Committee calls upon outside consultants for assistance, as necessary.\nThe Committee meets at least annually. In fiscal year 1993, the Committee met on four occasions. Primary responsibilities of the Committee include:\n- Establishing the President's salary and annual and long-term incentive opportunities.\n- Approving other executive officer salaries recommended by the President.\n- Setting performance goals for the annual incentive plan and long-term incentive plan.\n- Assessing performance achievement relative to goals and approving incentive payments.\n- Determining which individuals, upon recommendation of the President, will participate in the annual incentive plan and the long-term incentive plan and the level of incentive awards which will be available to each participant.\n- Approving any revisions proposed for executive compensation.\nThe Committee makes recommendations to the Board of Directors regarding compensation of the Company's executive officers. The philosophy of the Committee is to maintain an executive compensation program to help the Company attract, retain and motivate the executive resources it needs to maintain industry leadership, provide high levels of service to Members, and achieve the financial objectives as determined by the Board of Directors.\nTo achieve its stated goals, the Company has developed three executive compensation policies.\n- The Company provides levels of salaried compensation that are competitive.\n- The Company provides annual incentive compensation for executives that vary in a consistent and predictable manner with the performance of the Company.\n- The Company provides an incentive program which enables selected executives to achieve incentive awards based on the long-term (multiple year) performance of the Company.\nThe combination of these three compensation policies is intended to provide competitive earnings opportunities when performance reaches desired levels. The annual incentive program and the long-term incentive program are cancelable by the Board of Directors at any time.\nThe Company provides salary levels that are competitive with the median (50th percentile) of the executive marketplace. The industry comparison groups used to evaluate competitiveness include: member owned organizations, wholesale distribution firms, mass merchandising firms and general industry and manufacturing organizations. Competitiveness is measured using data from a number of sources, including published information, proxies and surveys by consulting firms.\nThe annual incentive plan is designed to ensure that executive compensation varies in relation to achievement of annual performance goals. In fiscal year 1993, the plan's overall Company goal was based on achieving Member payout objectives. Each executive had at least a portion of their incentive award determined by Member payout results. The President's entire incentive award is based upon Member payout results. Those executives with departmental responsibilities are measured against department goals in addition to Member payout.\nThe long-term incentive plan assures a continuing focus on the Company's future. Goals are set for performance achievement over three-year intervals. A new performance period starts each year and goals for each three-year cycle currently underway are related to achievement of revenue growth.\nEXECUTIVE COMPENSATION\nThe following table sets forth the total annual compensation paid to the Company's five most highly compensated executive officers during fiscal year 1993 and Paul F. Fee, who ceased to be an officer of the\nCompany, during fiscal year 1993, and the total compensation paid to each such individual for the Company's two previous fiscal years:\nSUMMARY COMPENSATION TABLE\n- --------------- (1) Annual bonus amounts are earned and accrued during the fiscal years indicated, and paid subsequent to the end of each fiscal year.\n(2) Other compensation consists primarily of Company contributions to the Cotter & Company Employee's Savings and Compensation Deferral Plan (the \"Savings Plan\"). Under the Savings Plan, each participant may elect to make a contribution in an amount of up to ten percent (10%) of his annual compensation, not to exceed $30,000 (including Company contributions) a year, of which $8,994 of the executive officer's salary in fiscal year 1993 may be deferred. The Company's contribution to the Savings Plan is equal to seventy-five percent (75%) of the participant's contribution, but not to exceed four and one-half percent (4 1\/2%) of the participant's annual compensation. Mr. Fee's other compensation in fiscal year 1993 consists of payments pursuant to an employment agreement. Mr. Nolawski's other compensation includes $4,443 and $27,427 of relocation payments in fiscal year 1992 and 1993, respectively. Mr. Porter's other compensation consists of $11,944 of relocation payments in fiscal year 1993.\n(3) Mr. Cotter and Mr. Fee earned transition awards during the initial first two fiscal years of the long-term incentive program initiated in fiscal year 1991. No long-term incentive awards were earned in fiscal year 1993.\nDaniel A. Cotter is employed under a long-term contract which commenced January 1, 1985 for a period of 15 years terminating December 31, 1999. Mr. Cotter agreed, in 1990, to revise his contract to conform his compensation to that applicable to all other executives. His base salary has not changed since 1990.\nThe Company has a severance policy providing termination benefits based upon annual compensation and years of service.\nNo reportable loans were made by the Company to its executive officers or to its directors during the last three fiscal years.\nLONG-TERM PERFORMANCE CASH AWARDS\nBeginning in fiscal year 1991, the Board of Directors adopted a long-term incentive program for selected senior executive officers of the Company. The plan covers three-year periods beginning in 1991 through 1993. Senior executives of the Company are eligible for cash payouts ranging from 20% to 50% of their average annual salary if performance goals established for the plan are met. Performance goals for the current plans relate to the achievement of revenue growth.\nA new plan starts each year with goals set for the next three-year period. A range of estimated payouts which could be earned by the individuals listed in the Summary Compensation Table in fiscal year 1994, and paid in fiscal year 1995 is shown in the following table:\nDEFINED BENEFIT RETIREMENT PLANS\nThe Company has a defined benefit pension plan, the Cotter & Company Pension Plan (the \"Plan\"), which is qualified under the Internal Revenue Code. The amount of the Company's annual contribution to the Plan is determined for the total of all participants covered by the Plan, and the amount of payment with respect to a specified person is not and cannot readily be separated or individually calculated by the actuaries for the Plan. The Plan provides fully vested unreduced monthly benefits to eligible employees who have retired at or after age 65 or served a minimum of five years of service and reached age 62. Each of the executive officers listed in the foregoing Summary Compensation Table is a participant in the Plan. The Plan has been amended to be a Social Security \"excess\" plan instead of being a Social Security \"integrated\" plan. The benefits provided by the Plan are calculated in the form of a single annuity.\nThe formula of the benefit for the service completed before January 1, 1989 is one and two-thirds percent of the participant's \"average compensation\" multiplied by the person's years of service thru December 31, 1988 up to a maximum of thirty such years, minus one and two-thirds percent of the participant's primary Social Security benefit multiplied by the person's years of service thru December 31, 1988 up to a maximum of thirty such years.\nFor service completed after January 1, 1989, the benefit formula is one and one-twentieth percent of the participant's \"average compensation\" equal to one-third of the retirement year Taxable Wage Base multiplied by the person's years of service after January 1, 1989 up to a maximum of thirty such years, plus one and one-half percent of the participant's \"average compensation\" over one-third of the retirement year Taxable Wage Base multiplied by the person's years of service after January 1, 1989 up to a maximum of thirty such years.\nA third benefit formula for service completed prior to January 1, 1992 is one and two-thirds percent of the participant's \"average compensation\" multiplied by the person's years of service thru December 31, 1991 up to a maximum of thirty such years, minus one and two-thirds percent of the participant's primary Social Security benefit multiplied by the person's years of service thru December 31, 1991 up to a maximum of thirty such years. The third formula will be used only if the benefit calculated is higher than the combination of the first two formulas.\n\"Average compensation\" means the average of the compensation received by an eligible employee during the five highest consecutive calendar years within the ten consecutive calendar years immediately preceding the date of termination of employment. Compensation considered in determining benefits includes salary, overtime pay, commissions, bonuses and deferral contributions under the Savings Plan. The average compensation does not differ substantially from all of the compensation for the officers listed in the Summary Compensation Table.\nThe Company amended and restated in 1991 a Supplemental Retirement Plan (the \"Supplemental Plan\") for certain employees as designated by the Company's President and Chief Executive Officer. The benefits provided by the Supplemental Plan are calculated in the form of a single annuity in an amount per year which is equal to three percent of the participant's \"average compensation\" multiplied by years of service up to a maximum of twenty such years, minus any benefits provided to the participants by the Plan, and minus the participant's primary Social Security benefit. \"Average Compensation\" for the Supplemental Plan is defined the same as for the Plan, as discussed above. The Supplemental Retirement Plan is not a qualified plan under the Internal Revenue Code. Benefits payable under the Supplemental Plan will be financed through internal operations.\nThe estimated annual retirement benefits which may be payable pursuant to the Plan to the officers named in the Summary Compensation Table (except Mr. Cotter and Mr. Nolawski) is currently limited under the Tax Equity and Fiscal Responsibility Act of 1982 (\"TEFRA\") to $118,800 at retirement under various assumed conditions. Beginning in 1983, \"TEFRA\" limited the maximum annual retirement benefits payable to an individual under the Pension Plan to the higher of (a) $90,000 or (b) the participant's accrued benefits under the Pension Plan as of December 31, 1982. The limits of the \"TEFRA\" maximum annual retirement benefits are subject to the cost-of-living adjustments in 1994 for post-1986 cost-of-living increases.\nThe following table reflects the estimated annual retirement benefits which may be payable pursuant to the Plan to the officers named in the Summary Compensation Table (except to those officers currently limited under \"TEFRA,\" as previously explained) at retirement under various assumed conditions. The benefit amounts are not subject to deduction for Social Security except as provided by the aforesaid benefit formula nor are said amounts subject to any other offset.\nThe present credited years of service for the officers listed in the above table are as follows: Daniel A. Cotter, 30 years; Paul F. Fee, 21 years; Robert A. Nolawski, 30 years; Kerry J. Kirby, 18 years, Daniel T. Burns, 13 years, and Steven J. Porter, 1 year.\nThere is no existing market for the Company's Common Stock and there is no expectation that any market will develop. There are no broad market or peer group indexes the Company believes would render meaningful comparisons. Accordingly, a performance graph of the Company's cumulative total shareholders return for the previous five years, with a performance indicator of the overall stock market for the Company's peer group, has not been prepared.\nIn fiscal year 1993 directors of the Company were each paid $1,000 per month. The Chairman of the Board is paid $1,000 per day to a maximum of $104,000 per year, when serving in the capacity as Chairman.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nAs of February 26, 1994, each of the directors of the Company was the beneficial owner of 10 shares of Class A Common Stock of the Company comprising .2% of such shares issued and outstanding. Other than Daniel A. Cotter, no executive officer owns any shares of Class A Common Stock.\nThe directors own in the aggregate approximately 1.5% of Class B Common Stock as of February 26, 1994. No executive officer owns any shares of Class B Common Stock.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Company uses Galaxy Travel Agency, Inc., a company engaged in providing normal travel business services, for Company officers, directors, employees, and Members. Daniel A. Cotter and his brother each own a one-half interest of Galaxy Travel. The total bookings placed by the Company with Galaxy Travel in fiscal year 1993 were approximately $2,300,000 and are estimated to be approximately the same in fiscal year 1994.\nThe Company believes the foregoing transactions are on no-less favorable terms to it than could have been obtained from an independent party.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.\n(A) 1. FINANCIAL STATEMENTS\nThe consolidated financial statements listed in the accompanying index (page) to the consolidated financial statements are filed as part of this annual report.\n2. FINANCIAL STATEMENT SCHEDULES\nThe consolidated financial statement schedules listed in the accompanying index (page) to the consolidated financial statements are filed as part of this annual report.\n3. EXHIBITS\nThe exhibits listed on the accompanying index to exhibits (pages E-1 and E-2) are filed as part of this annual report.\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 ANNUAL REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.\nCOTTER & COMPANY\nBy: \/s\/ KERRY J. KIRBY --------------------------------------- Kerry J. Kirby, Vice President, Secretary, Treasurer and DATED: March 17, 1994 Chief Financial 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 THE REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED.\nITEM 14(A). INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND CONSOLIDATED FINANCIAL STATEMENT SCHEDULES.\nAll other schedules have been omitted because the required information is not applicable or is not material in amounts sufficient to require submission of the schedule or because the required information is included in the consolidated financial statements or the notes thereto.\n------------------------------------- THIS PAGE INTENTIONALLY LEFT BLANK -------------------------------------\nREPORT OF INDEPENDENT AUDITORS\nTo the Members and the Board of Directors Cotter & Company\nWe have audited the accompanying consolidated balance sheets of Cotter & Company as of January 1, 1994 and January 2, 1993, and the related consolidated statements of operations, cash flows and capital stock and retained earnings for each of the three years in the period ended January 1, 1994. Our audits also included the consolidated 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 Cotter & Company at January 1, 1994 and January 2, 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended January 1, 1994 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\nChicago, Illinois February 9, 1994\nCOTTER & COMPANY\n------------------\nCONSOLIDATED BALANCE SHEET\nASSETS\nSee Notes to Consolidated Financial Statements.\nCOTTER & COMPANY\n------------------\nCONSOLIDATED BALANCE SHEET\nLIABILITIES AND CAPITALIZATION\nSee Notes to Consolidated Financial Statements.\nCOTTER & COMPANY\n------------------\nCONSOLIDATED STATEMENT OF OPERATIONS\nSee Notes to Consolidated Financial Statements.\nCOTTER & COMPANY\n------------------\nCONSOLIDATED STATEMENT OF CASH FLOWS\nSee Notes to Consolidated Financial Statements.\nCOTTER & COMPANY\n------------------\nCONSOLIDATED STATEMENT OF CAPITAL STOCK AND RETAINED EARNINGS\nFOR THE THREE YEARS ENDED JANUARY 1, 1994\n- --------------- Subscribed Class A common stock amounts are net of unpaid amounts of $14,000 at January 1, 1994, $27,000 at January 2, 1993 and December 28, 1991, and $32,000 at December 29, 1990 (for 590, 760, 880, and 1,200 shares subscribed, respectively).\nSee Notes to Consolidated Financial Statements.\nCOTTER & COMPANY\n------------------\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1--DESCRIPTION OF BUSINESS AND ACCOUNTING POLICIES\nCotter & Company (the Company) is a member-owned wholesaler of hardware, variety and related merchandise. The Company also manufactures paint, paint applicators, outdoor power equipment, heaters and hardware related products. The Company's goods and services are sold predominantly within the United States, primarily to retailers of hardware, variety and related lines, each of whom has purchased ten shares of the Company's Class A common stock on becoming a Member. The Company operates in a single industry as a member-owned wholesaler cooperative. In accordance with the Company's By-laws, the annual patronage dividend is paid to Members out of gross margins from operations and other patronage source income, after deduction for expenses and provisions authorized by the Board of Directors. The significant accounting policies of the Company are summarized below.\nConsolidation. The consolidated financial statements include the accounts of the Company and all wholly-owned subsidiaries. In fiscal years 1992 and 1993, the consolidated financial statements also include the accounts of Cotter Canada Hardware and Variety Cooperative, Inc., a Canadian member-owned wholesaler of hardware, variety and related merchandise, in which the Company has a majority equity interest.\nCapitalization. The Company's capital (Capitalization) is derived from redeemable Class A voting common stock and retained earnings, together with promissory (subordinated) notes and redeemable Class B nonvoting common stock issued in connection with the Company's annual patronage dividend. The By-laws provide for partially meeting the Company's capital requirements by payment of the year-end patronage dividend, of which at least twenty percent must be paid in cash, and the balance in promissory (subordinated) notes and redeemable $100 par value Class B common stock.\nMembership may be terminated without cause by either the Company or the Member on sixty days written notice. In the event membership is terminated, the Company undertakes to purchase, and the Member is required to sell to the Company, all of the Member's Class A common stock and Class B common stock at book value. Payment for the Class A common stock will be in cash. Payment for the Class B common stock will be a note payable in five equal annual instalments bearing interest at the same rate per annum as the promissory (subordinated) notes most recently issued as part of the Company's patronage dividend.\nCash equivalents. The Company classifies its temporary investments in highly liquid debt instruments, with an original maturity of three months or less, as cash equivalents. The carrying amount reported in the consolidated balance sheets for cash and cash equivalents approximates fair value.\nInventories. Inventories are stated at the lower of cost, determined on the \"first-in, first-out\" basis, or market.\nProperties. Properties are recorded at cost. Depreciation and amortization are computed by using the straight-line method over the following estimated useful lives: buildings and improvements--10 to 40 years; machinery, warehouse and office equipment--5 to 10 years; transportation equipment--3 to 7 years; and leasehold improvements--the life of the lease without regard to options for renewal.\nIncome Taxes. The Company adopted Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes,\" effective January 3, 1993. Under this standard, the liability method is used whereby deferred income taxes are recognized for the tax consequences of temporary differences by applying enacted statutory rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of existing assets and liabilities adjusting for the impact of tax credit carryforwards.\nRetirement plans. The Company sponsors two noncontributory defined benefit retirement plans covering substantially all of its employees. Company contributions to union-sponsored defined contribution plans are\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nbased on collectively bargained rates times hours worked. The Company's policy is to fund annually all tax-qualified plans to the extent deductible for income tax purposes.\nReporting year. The Company's reporting year-end is the Saturday closest to December 31.\nNOTE 2--INVENTORIES\nInventories consisted of:\nNOTE 3--PROPERTIES\nProperties owned or leased under capital leases consisted of:\nNOTE 4--LONG-TERM DEBT AND BORROWING ARRANGEMENTS\nLong-term debt consisted of:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nThe proceeds from the 8.60% senior note were used for operations. Principal payments starting in 1995 are due in increasing amounts through maturity in 2007. Under the senior note agreement, the Company is required to meet certain financial ratios and covenants.\nThe two term loans relate to the Canadian acquisition and are due in 1997.\nThe 5.94% issuance of bonds relates to financing the expansion of a distribution center. On October 1, 1994 and every three-year period thereafter, the interest rate will be adjusted based on a bond index. These bonds may be redeemed at face value at either the option of the Company or the bondholders at October 1, 1994 and every three-year period thereafter until maturity in 2003. The 8.25% issuance of bonds relates to financing the construction of a distribution center.\nTotal maturities of long-term debt for fiscal years 1994, 1995, 1996, 1997, 1998, and thereafter are $1,150,000, $1,000,000, $2,000,000, $12,977,000, $4,000,000 and $44,000,000 respectively.\nIn addition, the Company has various short-term lines of credit available under informal agreements with lending banks, cancelable by either party under specific circumstances, which amount to $56,500,000 at January 1, 1994. There were $23,287,000 borrowings under these agreements at January 1, 1994. The Company pays commitment fees for these lines.\nThe fair value of the 8.6% senior note was approximately $54,375,000 and $51,250,000 at January 1, 1994 and January 2, 1993, respectively. The fair value was estimated using discounted cash flow analyses, based on the Company's incremental borrowing rate for similar borrowings. The carrying amounts of the Company's other long term borrowings and short-term lines of credit approximate fair value.\nNOTE 5--CAPITAL LEASES AND OTHER LEASE COMMITMENTS\nCapitalized leases expire at various dates and generally provide for purchase options but not renewals. Purchase options provide for purchase prices at either fair market value or a stated value which is related to the lessor's book value at expiration of the lease term.\nThe following is a schedule of future minimum lease payments under capital leases, together with the present value of the net minimum lease payments, as of January 1, 1994:\nThe Company also is committed under cancelable operating leases for certain transportation equipment which, in certain cases, also provide for contingent rental arrangements and purchase options. The Company made contingent rental payments relating to operating leases of $575,000, $616,000 and $483,000 for fiscal years 1993, 1992 and 1991, respectively. Rental expense under operating leases for fiscal years 1993, 1992, and 1991 was $7,536,000, $6,850,000 and $5,583,000, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nNOTE 6--CAPITALIZATION\nPromissory (subordinated) and instalment notes consisted of:\nThe promissory notes are issued principally in payment of the annual patronage dividend. Promissory notes are subordinated to indebtedness to banking institutions, trade creditors and other indebtedness of the Company as specified by its Board of Directors. Notes to be issued relate to the patronage dividend which is distributed after the end of the year. Prior experience indicates that the maturities of a substantial portion of the notes due within one year are extended, for a three year period, at interest rates substantially equivalent to competitive market rates of comparable instruments. The Company anticipates that this practice will continue.\nDue to the uncertainty of the ultimate maturities of the promissory notes, management believes it is impracticable to estimate their fair value. The carrying amount of the instalment notes at January 1, 1994 and January 2, 1993 approximates fair value.\nTotal maturities of promissory and instalment notes for fiscal years 1994, 1995, 1996, 1997, 1998, and thereafter are $58,292,000, $58,826,000, $56,812,000, $18,513,000, $29,266,000 and $54,579,000, respectively.\nNOTE 7--INCOME TAXES\nEffective January 3, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes\" (See Note 1). As permitted under the new rules, prior years' financial statements have not been restated.\nThe cumulative effect of adopting SFAS No. 109 as of January 3, 1993 was not material to the consolidated financial statements of the Company.\nAt January 1, 1994, the Company has alternative minimum tax credit carryforwards of approximately $1,000,000 which do not expire. The carryforwards are available to offset future federal tax liabilities.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSignificant components of the Company's deferred tax assets and liabilities as of January 1, 1994 resulted primarily from alternative minimum tax credit carryforwards and temporary differences between income tax and financial reporting for depreciation, vacation pay and contributions to fund retirement plans.\nSignificant components of the provision (benefit) for income taxes are as follows:\nThe Company operates as a nonexempt cooperative and is allowed a deduction in determining its taxable income for amounts paid as patronage dividend based on margins from business done with or for Members. The reconciliation of income tax expense to income tax computed at the U.S. federal statutory tax rate of 35% in fiscal year 1993 and 34% in 1992 and 1991 is as follows:\nNOTE 8--CASH FLOW\nThe Company's noncash financing and investing activities in fiscal years 1992 and 1991 include acquisitions of transportation and warehouse equipment by entering into capital leases. In fiscal year 1992, ownership of a distribution center previously under capital lease was transferred to the Company. Also in fiscal year 1992, a wholly-owned subsidiary of the Company acquired certain assets, in part, by assuming debt. In fiscal year 1991, the Company acquired a new distribution center by assuming debt. These transactions aggregate $12,527,000 and $11,382,000 in fiscal years 1992 and 1991, respectively. In addition, the annual\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\npatronage dividend and promissory (subordinated) note renewals relating to noncash operating and financing activities are as follows:\nCash paid for interest during fiscal years 1993, 1992 and 1991, totalled $32,056,000, $31,638,000 and $28,668,000, respectively. Cash paid for income taxes during fiscal years 1993, 1992 and 1991 totalled $1,387,000, $1,771,000 and $2,380, 000, respectively.\nNOTE 9--RETIREMENT PLANS\nThe components of net pension cost for the Company administered pension plans consisted of:\nThe discount rate and the rate of increase in future compensation levels used in determining the actuarial present value of the projected benefit obligation were 7 1\/2% and 4 1\/2%, respectively, in fiscal year 1993 compared to 9% and 6%, respectively, in fiscal years 1992 and 1991. These changes in actuarial assumptions did not have a material impact on net pension cost for fiscal year 1993 and the Company does not anticipate that these changes will have a material impact on net pension cost in future years. In fiscal years 1993, 1992 and 1991, the expected long-term rate of return on assets was 9 1\/2%.\nPlan assets are composed primarily of corporate equity and debt securities. Benefits are based on years of service and the employee's compensation during the last ten years of employment, offset by a percentage of\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)\nSocial Security retirement benefits. Trusteed net assets and actuarially computed benefit obligations for the Company administered pension plans are presented below:\nThe Company also participates in union-sponsored defined contribution plans. Pension costs related to these plans were $702,000, $556,000 and $522,000 for fiscal years 1993, 1992 and 1991, respectively.\nCOTTER & COMPANY ------------------------\nSCHEDULE IV - INDEBTEDNESS OF AND TO RELATED PARTIES - NOT CURRENT\nFOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JANUARY 1, 1994 (000'S OMITTED)\n- --------------- (1) Consists of notes receivable.\n(2) Consists of promissory (subordinated) notes and installment notes.\n(3) Consists of amounts reclassed to current.\n(4) Includes promissory notes to be issued in payment of patronage dividends of $26,752, $28,863 and $30,707 in fiscal 1993, 1992 and 1991, respectively. Also includes installment notes related to the conversion of Class B stock of $3,444, $2,886 and $3,330 in fiscal 1993, 1992 and 1991, respectively.\n(5) Includes amounts reclassed to current of $58,292, $45,240 and $35,406 in fiscal 1993, 1992 and 1991, respectively. Also includes amounts applied against member indebtedness of $5,876, $6,192 and $3,763 in fiscal 1993, 1992 and 1991, respectively.\nCOTTER & COMPANY ------------------\nSCHEDULE V--PROPERTY, PLANT AND EQUIPMENT\nFOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JANUARY 1, 1994 (000'S OMITTED)\nOWNED\nLEASED UNDER CAPITAL LEASES\n- --------------- (a) Deductions are due to the effect of exchange rate changes on translating property, plant, and equipment of foreign subsidiaries in accordance with FASB Statement No. 52 \"Foreign Currency Translation.\"\nCOTTER & COMPANY ------------------\nSCHEDULE VI--ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY, PLANT AND EQUIPMENT\nFOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JANUARY 1, 1994 (000'S OMITTED)\nOWNED\nLEASED UNDER CAPITAL LEASES\n- --------------- (a) Deductions are due to the effect of exchange rate changes on translating property, plant, and equipment of foreign subsidiaries in accordance with FASB Statement No. 52 \"Foreign Currency Translation.\"\nCOTTER & COMPANY\n------------------\nSCHEDULE IX--SHORT-TERM BORROWINGS FOR EACH OF THE THREE YEARS IN THE PERIOD ENDED JANUARY 1, 1994 (000'S OMITTED)\n- --------------- (a) For fiscal year 1992, the balance and weighted average interest rate at the end of the year is for borrowing by Cotter Canada Hardware and Variety Cooperative, Inc. for its Canadian operations.\nThe average amount outstanding for fiscal years 1993, 1992, and 1991 was computed by averaging the daily balances during the fiscal year. The weighted average interest rates were computed by dividing interest expense by the average amount outstanding.\nINDEX TO EXHIBITS\nE-1\nE-2","section_15":""}
{"filename":"201493_1994.txt","cik":"201493","year":"1994","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 1994 Annual Report to its shareholders and the information in Note 11 of the Notes to Financial Statements of Coltec's 1994 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 operating units, 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, Fokker and other aircraft, Coltec has been awarded a contract to supply a completely integrated landing gear system for the Boeing 737-700 aircraft and derivatives. In addition, Coltec successfully began deliveries of the main landing gear for the Fokker 70 and Fokker 100 aircrafts in 1994. 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 Division, Walbar and Delavan subsidiaries. See \"Aerospace Controls\", \"Aircraft Engine Components\" and \"Gas Turbine Products\" below.\nIn most of the operating units 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 Division and its Canadian subsidiaries, Menasco Aerospace Ltd. and Menasco Aviation Services 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. Landing gear, including components, parts, and overhaul services for landing gear, accounted for approximately 89% of Menasco's sales and 11% of Coltec's sales during 1994. For the years 1994, 1993 and 1992, commercial sales accounted for 64%, 62% and 73%, respectively, of Menasco's total sales.\nMenasco has been awarded contracts to supply the main and nose landing gear for the Boeing 777 aircraft and as of December 31, 1994, 16 shipsets have been delivered on schedule to The Boeing Company (\"Boeing\"). Delivery of landing gear for the Boeing 777 aircraft commenced in 1993. Boeing has announced that 147 firm orders and options for an additional 108 of its 777 aircraft have been placed as of December 31, 1994 and commenced with full scale production in 1994. Menasco has been selected to replace a competitor as the supplier of the main landing gear for the Fokker 100 aircraft as well as to supply the main landing gear and flight controls for the Fokker 70. Menasco has supplied most of the flight controls for the Fokker 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 existing Boeing 737 aircraft and the new 737-700 and 737-800 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-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 Air Superiority Fighter. In addition, Menasco is supplying the nose landing gear and drag brace for the Bell\/Boeing V-22 Osprey including engineering and test support. Other military programs for which Menasco is currently producing landing gear and\nflight 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 production 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.\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.\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 AlliedSignal Inc. (\"AlliedSignal\"). The principal foreign competitor is Messier-Dowty of France, England and Canada. 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 a reliable supplier base.\nAEROSPACE CONTROLS\nColtec, through its Chandler Evans Control Systems Division (\"Chandler Evans\"), manufactures a variety of aircraft engine fuel control systems, fuel pumps and engine and aircraft components for the aerospace industry. Chandler Evans' products are highly engineered and contain proprietary technology. Principal customers for the products include gas turbine engine manufacturers, aircraft manufacturers, domestic and foreign airlines, commercial fleet operators and the military services. For the years 1994, 1993 and 1992, commercial sales accounted for 74%, 67% and 71%, respectively, of Chandler Evans' total sales.\nFor sale to the commercial aircraft engine market, Chandler Evans produces 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 Full Authority Digital Electronic Fuel Control System (\"FADEC\") for the AlliedSignal Engines LF507 engine used on the British Aerospace BAE 146 aircraft. Chandler Evans was selected to develop and manufacture a FADEC for the Allison 250 engine. Delivery of this system is scheduled to begin in early 1995. Also, Chandler Evans has developed a\nFADEC for the LHTEC T800 helicopter engine, a joint venture of Allison Engine Company and AlliedSignal Garrett and was selected to develop the FADEC for the Allison LTS- 800 commercial engine.\nFor sale to the military aircraft engine market, Chandler Evans produces the main and afterburner fuel pumps for the General Electric engine used on the McDonnell Douglas aircraft. The main fuel pump for the General Electric engine is currently in development. FADEC systems are produced for AlliedSignal Engine's T-55 engines for the Boeing Chinook helicopters in service with the U.S. Army, the UK Royal Air Force and the Royal Netherlands Air Force. The Hydromechanical Fuel Control Systems for AlliedSignal Engine's T-53 engine continues in service on the Bell UH-1, Cobra and Kaman K-MAX helicopters.\nChandler Evans is the sole source for the pumps and fuel systems described above and supports these products with aftermarket sales of spare units, parts and overhaul service. For the year 1994, approximately one-half of Chandler Evans revenues were attributable to the aftermarket. Aftermarket sales are very significant, because 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 AlliedSignal Bendix Division of AlliedSignal and the Hamilton Standard Division of United Technologies Corporation in fuel controls.\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. During 1994, a new coating service center in South Carolina became operational for coatings applied to land based turbine engine blades. Coltec believes that Walbar is one of the leading independent manufacturers of blades, turbine vanes and nozzle segments, impellers and rotating components for jet engines.\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, the TPE 331 AlliedSignal engine used in the Jetstream Aircraft and the AlliedSignal 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 1994, 1993 and 1992, commercial sales accounted for approximately 78%, 85% and 74%, 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\naircraft, the McDonnell Douglas aircraft and the Lockheed aircraft, the GE LM 2500 used on the U.S. Navy's Spruance class destroyers, AlliedSignal Engine's 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 custom engineered fuel injectors, afterburner spraybars and other fuel distribution accessories for commercial and military gas turbine engines. The primary market niche is injection equipment for the commuter and regional airline engine market, and Delavan has a sole or dual source position on all of the top ten commuter aircraft as measured by 1993 available seat capacity.\nDelavan's products are designed and developed to customer specifications using computer-aided design and manufacturing processes and are marketed directly to engine manufacturers pursuant to production orders. Principal customers for this business segment include the General Electric Company, AlliedSignal Engine, Pratt & Whitney Canada and the Allison Engine Company. Delavan supports these products with aftermarket sales of spare parts and overhaul services, both to the engine manufacturers and the airline users, and this is the fastest growing segment of the business. A third business segment involves the sale of fuel injection components and spare parts directly to military logistics commands in support of gas turbine engines currently in the Defense Department inventory such as the Allison T56 and the General Electric. For the years 1994, 1993 and 1992, commercial sales accounted for 78%, 69% and 58%, respectively, of Delavan's total sales.\nDelavan competes worldwide with Parker-Hannifin Corporation and Fuel Systems Textron. Competitive pressure is focused on price in the original equipment manufacturer (\"OEM\") segment of the business and on price and delivery in the aftermarket segment. While not a major factor in the large, commercial airline engine market, Delavan has, by far, the leading market share position in the commuter and regional airline engine fuel injection market segment. This position is being strengthened through negotiation of long term partnering and price agreements with the manufacturers who supply the engines for this segment of the market.\nAIRCRAFT INSTRUMENTATION\nColtec, through its Lewis Engineering Company, designs, develops and produces electro-mechanical and electronic instrumentation for aircraft cockpits and temperature sensors for aircraft and engine systems. The products are used in commercial, general aviation and military markets. 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.\nFairbanks 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. In 1994, 73% of Fairbanks Morse's sales were for replacement parts and service for Fairbanks Morse engines.\nLarge heavy-duty diesel engines are sold to shipbuilders for the U.S. Navy and Coast Guard and to electric utilities, municipal power plants, oil and gas producers, firms engaged in commercial marine, 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 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. Fairbanks Morse has received a firm order to produce twelve 10- cylinder PC4.2 engines for the first three ships in the U.S. Navy's Sealift Program with options for an additional three to five ships. Three of the four engines for the first ship are scheduled to be delivered in 1995 with succeeding engines currently scheduled to be shipped through 1997.\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 Products 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\"). Fairbanks Morse manufactures and sells engines and aftermarket parts for Alco diesel engines used in power plants and marine markets. While GE Transportation has retained 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. In 1995, Fairbanks Morse is scheduled to deliver the first of its Alco locomotive engines to the Pakistan Railway.\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 original equipment manufacturers and the replacement parts market. The operating units, 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, modulators and electronic solenoid actuators, 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 engine induction components and systems, electrohydraulic control devices for transmissions, suspensions and steering systems, 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 vehicles including Chrysler Voyager and Dodge Caravan minivans. Holley also is the sole source of the upper intake module assembly for the Chrysler LH mid-size sedans (the Chrysler\nConcorde, New Yorker and LHS, Dodge Intrepid and Eagle Vision) equipped with the 3.5 liter engine. Holley supplies the throttle body assemblies for the newly introduced four-cylinder 2.4 liter and six-cylinder 2.5 liter Chrysler Stratus and Dodge Cirrus.\nIn the non-fuel area, significant business has been obtained as a result of Holley's development of modulators and electronic solenoid actuators. Holley currently supplies high volumes of aneroid and non-aneroid modulators to the General Motors Powertrain Division. Applications in the transmission controls area include Saturn vehicles equipped with automatic transmission, Ford Mondeo, Contour and Mercury Mystique and General Motors Cadillac, Aurora, light trucks and front-wheel drive passenger cars.\nIn 1994 Holley provided its first suspension solenoids for Sachs Automotive of America and Firestone Industrial Products, suppliers of an adaptive suspension system for Ford's Lincoln Continental vehicles. Late in the 1995 model year, Holley will also be supplying a suspension solenoid to Fichtel & Sachs in Europe. This will be Holley's first penetration of the European market for OEM suspension solenoids.\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. This pump currently is used mainly in truck and van applications, and to a lesser extent in passenger car lines as part of an emission control system designed to meet federal \"clean air\" regulations. Applications for this product line have been declining since the mid-1980's as automotive manufacturers have improved fuel delivery systems to give cleaner engine burn. Coltec Automotive is the sole independent domestic supplier of automotive mechanical air pumps. Major customers are Ford, Chrysler and General Motors. Coltec Automotive has also developed an advanced electric air pump designed to cope with increasingly stringent emission standards. This pump has been designated by Ford for use with the new 4.6 liter modular engine in the 1995 model year Lincoln Continental. Additional applications beginning with the 1996 model include the Lincoln Town Car, Lincoln Mark VIII, Ford Mustang, Ford Taurus and Mercury Sable.\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 the modular V-8, Zetec and Duratec V-6 engines being introduced for the 1995 model year.\nColtec, through Holley Performance Products, 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 units, 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 OEM's, 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, these Divisions compete 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 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 operating units, 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, through its Garlock Inc subsidiary (\"Garlock\"), 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, valves 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 advanced 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 1994, 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 its 80% owned subsidiary Garlock Bearings Inc, 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,\nindustrial and home heating markets. These products are sold to OEM's, distributors and other end-users throughout the world. Coltec believes that Delavan Commercial Products Division is one of the leading manufacturers of spray nozzles for residential oil-fired burners.\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 OEM's 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 OEM's located in major industrial centers throughout the United States, Canada, Mexico and the Pacific Rim.\nIn the domestic market for small, industrial, 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, through its Menasco Aviation Services Ltd. subsidiary, 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,\nmanufactures 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 16 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 1994 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 an adverse effect on Coltec.\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 11%, 14% and 15% of total Coltec sales in 1994, 1993 and 1992, 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 1994, 1993 and 1992, sales of landing gear systems constituted 11%, 11% and 12%, respectively, of total Coltec sales.\nBACKLOG\nAt December 31, 1994, Coltec's backlog of firm unfilled orders was $668.8 million compared with $669.7 million at December 31, 1993. Of the $668.8 million backlog at December 31, 1994, approximately $250.8 million is scheduled to be shipped after 1995.\nCONTRACT RISKS\nColtec, through its various operating units, 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\nproposals, 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 provide 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 for 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 $23.8 million for 1994, $22.1 million for 1993 and $22.9 million for 1992. 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 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, 1994, Coltec had approximately 9,800 employees, of whom approximately 4,000 were salaried. Approximately 40% of the hourly employees are represented by\nunions 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.\nFour collective bargaining agreements covering approximately 450 hourly employees which expired in 1994 have been renegotiated. In 1995, one collective bargaining agreement covering approximately 170 hourly employees is 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 result 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.\"\nEXECUTIVE OFFICERS OF THE REGISTRANT\nBecause the Proxy Statement for Coltec's Annual Meeting of Shareholders will not contain information with respect to all executive officers of Coltec, set forth below is the information with respect to the executive officers of Coltec required by Item 401 of Regulation S-K. Unless otherwise indicated, each occupation set forth opposite an individual's name refers to employment with 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 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nColtec operates 59 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 and Longview, Texas. The Industrial segment has leased facilities located in Quincy, Illinois. 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 6,100,000 square feet of floor area of which approximately 5,300,000 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.\nASBESTOS LITIGATION\nAs of December 31, 1994 and 1993, two subsidiaries of Coltec were among a number of defendants (typically 15 to 40) in approximately 76,700 and 68,500 actions, respectively, (including approximately 3,300 and 6,100 actions, respectively, in advanced stages of processing) filed in various states by plaintiffs alleging injury or death as a result of asbestos fibers. Through December 31, 1994, approximately 110,200 of the approximately 186,900 total actions brought have been settled or otherwise disposed.\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, it appears, based on advice of counsel, 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 is currently receiving payments pursuant to an interim agreement with certain of its excess carriers. Coltec believes that a final agreement can be achieved without litigation, and on substantially the same basis that it has resolved the issues with its primary and first-level carriers.\nSettlements are generally made on a group basis with payments made to individual claimants over periods of one to four years. During 1994 and 1993, two subsidiaries of Coltec received approximately 29,800 and 27,400 new actions, respectively, with a comparable number of actions received in 1992. Payments were made with respect to asbestos liability and related costs aggregating $46.4 million in 1994, $38.7 million in 1993 and $39.8 million in 1992, 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, 1994, 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 $42.3 million and Coltec expects that this cost will be substantially covered by insurance.\nWith respect to the 73,400 outstanding actions as of December 31, 1994 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 potential 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 permit 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 have been changing from those traditionally associated with Coltec's asbestos- related actions. Coltec is not able to determine with reasonable certainty whether this trend will\ncontinue. 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 its subsidiaries are 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 actions are not likely to have a material effect on Coltec's results of operations and financial condition.\nAlthough the insurance coverage which Coltec has is substantial, it should be noted that insurance coverage for asbestos claims is not available to cover exposures initially occurring on and after July 1, 1984. Coltec's subsidiaries continue to be named as defendants in new cases, some of which allege initial exposure after July 1, 1984.\nIn addition to claims for personal injury, Coltec's subsidiaries were among 40 or more defendants in 34 cases involving property damage claims based upon asbestos-containing materials found in schools, public facilities and private commercial buildings. The subsidiaries have been dismissed without payment in 31 of these cases. One school case was settled for an amount that is not material and two cases remain unresolved as against one subsidiary only. However, based upon the proceedings to date in these cases, it appears that the subsidiary has no liability in those two 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 regulate emissions at certain of Coltec's facilities that were previously unregulated. Most significantly, certain existing and many newly constructed or modified facilities will be required to obtain air emission permits that were not previously required. Although many of the standards under the Clean Air Amendments have not yet been promulgated, Coltec has made a preliminary determination of their impact on its operations. Based upon this determination, Coltec believes that it will not be at a competitive disadvantage in complying with the Clean Air Amendments and that any costs to comply with the Clean Air Amendments will not have a material effect on Coltec's results of operations and financial condition.\nColtec and its subsidiaries are also 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\nseveral liability for the costs of investigating and remediating properties contaminated by 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: Clare Municipal Well Fields, Clare, Michigan; Quincy Municipal Landfills #2 and #3, Quincy, Illinois; Byron Barrel and Drum, Byron, New York; Operating Industries, Inc., Monterey Park, California; San Fernando Valley Site, Glendale, California; and Hardage Landfill, Criner, Oklahoma. Coltec is also working with various state authorities to investigate and remediate certain properties that are or were the site of Coltec's operations. Among such sites are the following: Holley Automotive property, Water Valley, Mississippi; Fairbanks Morse Engine property, Beloit, Wisconsin; Walbar Inc property, Peabody, Massachusetts; former Precision Seals property, Gastonia, North Carolina; and former Central Moloney properties in Arcadia, Florida, and Pine Bluff, Arkansas. Based on the progress to date in the investigation, cleanup and allocation of responsibility for these sites, Coltec has estimated that its costs in connection with all except one of these sites approximates $20.0 million at December 31, 1994, and has accrued for this amount in the Consolidated Balance Sheet as of December 31, 1994. Although Coltec is pursuing insurance recovery in connection with certain of these matters, Coltec has not recorded a receivable with respect to any potential recovery of costs in connection with any environmental matter. While 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 its potential financial responsibility at this site, 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. $14.0 million in damages, and Menasco Canada has filed a cross-claim for Cdn. $21.0 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 Western District of Pennsylvania, 86-cv-02021). 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\nadditional findings of fact. On February 10, 1994, the District Court dismissed the plaintiffs' complaint and the plaintiffs appealed to the Third Circuit Court of Appeals. On September 26, 1994, the Third Circuit Court of Appeals remanded the case to the District Court and on November 4, 1994 denied the defendant's request for a rehearing. Coltec has petitioned to the U.S. Supreme Court for a writ of certiorari. 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 concluding that it lacked jurisdiction of the subject matter, which decision was affirmed by the Superior Court of Pennsylvania. The plaintiffs' appeal to the Supreme Court of Pennsylvania was denied on June 7, 1994. Plaintiffs' petition to the U.S. Supreme Court for a writ of certiorari is being held in that court pending compliance with rules of the U.S. Supreme Court. 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. Coltec does not believe that these proceedings will have a material effect on Coltec's results of operations and financial condition.\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 common 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 for each quarter during 1994 and 1993, based on the Composite Tape, were as follows:\nAt December 31, 1994, there were 523 shareholders of record. No dividends were paid in 1994 and 1993, and no dividends are expected to be paid in 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe five year tabular presentation under the caption \"Selected Financial Data\" of Coltec's 1994 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 1994 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 1994 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, Report of Management and the Report of Independent Public Accountants of Coltec's 1994 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 information under the caption \"Election of Directors\" in Coltec's Proxy Statement for its 1995 Annual Meeting of Shareholders is herein incorporated by reference. In respect of information as to Coltec's executive officers, see the information under the caption \"Executive Officers of the Registrant\" under Item 1 of Part I hereof.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe text and tabular information under the caption \"Executive Compensation and Other Information\" in Coltec's Proxy Statement for its 1995 Annual Meeting of Shareholders is herein incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information under the captions \"Security Ownership of Certain Beneficial Owners\" and \"Security Ownership of Management\" in Coltec's Proxy Statement for its 1995 Annual Meeting of Shareholders is herein incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information under the caption \"Compensation Committee Interlocks and Insider Participation\" in Coltec's Proxy Statement for its 1995 Annual Meeting of Shareholders is herein 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 part of this report:\n(b) No reports on Form 8-K were filed by Coltec during the last quarter of the period ending December 31, 1994.\n(c) Exhibits 3.2, 4.15, 10.9, 12.1, 13.1, 21.1, 23.1 and 27.1 are filed herewith.\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.\nColtec Industries Inc (Registrant)\nDate: March 15, 1995 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 , 1995.\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 23, 1995. Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to financial statement schedules is the responsibility of the Company's management and is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states 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 LLP New York, N.Y. January 23, 1995\nS-1\nSCHEDULE II 1994, 1993 AND 1992\nCOLTEC INDUSTRIES INC AND SUBSIDIARIES\nSCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 (IN THOUSANDS)\nS-2\nINDEX TO EXHIBITS\nI-1\nI-2\nI-3\nI-4","section_15":""}
{"filename":"72423_1994.txt","cik":"72423","year":"1994","section_1":"Item 1. Business\nThe Company is a diversified manufacturer of residential and commercial building products, operating within three principal product groups: the Residential Building Products Group; the Air Conditioning and Heating (\"HVAC\") Products Group; and the Plumbing Products Group. Through these product groups, the Company manufactures and sells, primarily in the United States and Canada, a wide variety of products for the residential and commercial construction, manufactured housing, and the do-it-yourself and professional remodeling and renovation markets. (As used in this report, the term \"Company\" refers to Nortek, Inc., together with its subsidiaries, unless the context indicates otherwise.)\nThe Company's performance is dependent to a significant extent upon the levels of new residential construction, residential replacement and remodeling and non-residential construction, all of which are affected by such factors as interest rates, inflation and unemployment. In recent periods, the Company's product groups have operated in an environment of increasing levels of construction and remodeling activity, particularly new housing starts which increased approximately 20% between 1990 and 1994. New residential construction housing starts, however, remain below the levels experienced in the mid-1980's. The Company's operations have been affected by the difficult economic conditions in the Northeastern United States, California and Canada. However, the actions taken to reduce production costs and overhead levels and improve the efficiency and profitability of the Company's operations have enabled it to significantly increase operating earnings, as well as to position the Company for growth. In the near term, the Company expects to operate in an environment of relatively stable levels of construction and remodeling activity. However, recent increases in interest rates could have a negative impact on the level of housing construction and remodeling activity.\nInflation has not had a material effect on the Company's results of operations and financial condition until mid-1994, when the Company experienced significant increases in certain costs and expenses including raw material costs. There can be no assurance that the Company will be able to sufficiently increase its sales prices if these cost increases persist.\nAdditional information concerning the Company's business is set forth in Management's Discussion and Analysis of Financial Condition and Results of Operations, Item 7, Part II of this report (pages 14 through 25) and incorporated herein by reference.\nResidential Building Products Group\nThe Residential Building Products Group manufactures and distributes built- in products primarily for the residential new construction, do-it-yourself and professional remodeling and renovation markets. The principal products sold by the Group are kitchen range hoods, bath fans, combination units (fan, heater and light combinations) and bath cabinets. The Group is one of the largest suppliers in the United States and Canada of range hoods, bath fans and combination units. Products are sold under the Broan(R), Nautilus(R) and Air Care (TM) brand names, among others, to distributors and dealers of electrical and lighting products, kitchen and bath dealers, retail home centers and OEMs (original equipment manufacturers). Other products sold by this Group include, among others, wireless security products, garage door openers, built-in home intercoms and entertainment systems, home automation systems, door chimes and central vacuum systems.\nCustomers for the Group's products include residential and electrical contractors, professional remodelers and do-it-yourself homeowners. The Group's products are sold on a wholesale basis through distributors and dealers of electrical and lighting products, on a retail basis through building supply centers and to OEMs for inclusion in their product lines.\nA key component of the Group's operating strategy is the introduction of new products which capitalize on the strong Broan (R), Nautilus(R) and Air Care (TM) brand names and the extensive distribution system of the Group's businesses. Recent product introductions under these brand names include: indoor air quality systems for continuous and intermittent home ventilation; down-draft ventilating systems for cooking ranges; SensAire (R) (humidity and motion sensing) bath fans; and the Rangemaster(R) line of commercial-style range hoods for use in the home. Consumer preferences are important in developing new products and establishing marketing strategies, and the Company believes that the Group's ability to develop new and improved product styles and features provides a significant competitive advantage.\nWith respect to certain product lines, several private label customers account for a substantial portion of revenues. In 1994, approximately 13.2% of the total sales of such product lines were made to private label customers.\nProduction generally consists of fabrication from coil and sheet steel and formed metal utilizing stamping, pressing and welding methods, assembly with components and subassemblies purchased from outside sources (motors, fan blades, heating elements, wiring harnesses, controlling devices, glass mirrors, lighting fixtures, lumber, wood and polyethylene components, speakers, grilles and similar electronic components, and compact disc and tape player mechanisms) and painting, finishing and packaging.\nThe Group offers a broad array of products with various features and styles across a range of price points. The Company believes that the Group's variety of product offerings helps the Group maintain and improve its market position for its principal products. At the same time, the Company believes that the Group's status as a low-cost producer, in large part as a result of cost reduction initiatives, provides the Group with a competitive advantage.\nWith respect to range hoods, bath fans, combination units and radio intercoms, the Company believes that the Group's primary competitor is NuTone, a subsidiary of Williams Holdings Companies. The market for bath cabinets is highly fragmented with no single dominant supplier. The Group's other products compete with many domestic and international suppliers in their various markets. The Group competes with suppliers of competitive products primarily on the basis of quality, distribution, delivery and price. Although the Group believes it competes favorably with respect to each of these factors, competition among suppliers of the Group's products is intense and certain of these suppliers have greater financial and marketing resources than the Group.\nThe Group has eight manufacturing plants and employed 1,804 full-time people as of December 31, 1994, 85 of whom are covered by a collective bargaining agreement which expires in 1996. The Company believes that the Group's relationships with its employees are satisfactory.\nAir Conditioning and Heating Products Group\nThe Air Conditioning and Heating Products Group manufactures and sells HVAC systems for custom-designed commercial applications and for manufactured and site-built residential housing. The Group's commercial products consist of HVAC systems which are custom-designed to meet customer specifications for commercial offices, manufacturing and educational facilities, hospitals, retail stores and governmental buildings. Such systems are primarily designed to operate on building rooftops (including large self-contained walk-in-units) or on individual floors within a building, and range from 40 to 600 tons of cooling capacity. The Group markets its commercial products under the Governair(R), Mammoth(R) and Temtrol(TM) brand names. For manufactured and site-built residential housing, the Group's products include central air conditioners, heat pumps, furnaces and a wide range of accessories marketed under the Intertherm(R) and Miller(R) brand names. Residential central air conditioning products range from 1.5 to 5 tons of cooling capacity and furnaces range from 45,000 BTU's to 144,000 BTU's of heating capacity. The Group's residential products also include portable and permanent electric baseboard heating products.\nCommercial Products. The Group's commercial products include packaged rooftop units and air handlers, custom walk-in units, individual floor units and heat pumps. The market for commercial HVAC equipment is segmented between standard and custom-designed equipment. Standard equipment can be manufactured at a lower cost and therefore offered at substantially lower initial prices than custom-designed equipment. As a result, suppliers of standard equipment generally have a larger share of the overall commercial HVAC market than suppliers of custom-designed equipment, including the Group. However, because of certain building designs, shapes or other characteristics, the Company believes there are many applications for which custom-designed equipment is required or is more cost effective over the life of the building. Unlike standard equipment, the Group's commercial HVAC equipment can be designed to match the exact space, capacity and performance requirements of the customer. The Group sells its commercial products primarily to contractors, owners and developers of commercial office buildings, manufacturing and educational facilities, hospitals, retail stores and government buildings. The Group seeks to maintain strong relationships nationwide with design engineers, owners and developers, the persons who are most likely to value the benefits and long-term cost efficiencies of the Group's custom-designed equipment.\nThe Company estimates that more than half of the Group's commercial sales in 1994 were attributable to replacement and retrofit activity, which typically is less cyclical than new construction activity and generally commands higher margins. The Group continues to develop product and marketing programs to increase penetration in the growing replacement and retrofit market.\nFor many commercial applications, the ability to provide a custom-designed system is the principal concern of the customer. The Group's packaged rooftop and self-contained walk-in units maximize a building's rentable floor space because they are located outside the building. In addition, factors relating to the manner of construction and timing of installation of commercial HVAC equipment can often favor custom-designed rather than standard systems. As compared with site-built HVAC systems, the Group's systems are factory assembled and then installed, rather than assembled on site, permitting extensive testing prior to shipment. As a result, the Group's commercial systems can be installed later in the construction process than site-built systems, thereby saving the owner or developer construction and labor costs. The Group's individual floor units offer flexibility in metering and billing, a substantial advantage if a building is to be occupied in stages or where HVAC usage varies significantly from floor to floor.\nThe Group's commercial products are marketed through independently owned manufacturers' representatives and an in-house sales, marketing and engineering group of 55 persons as of December 31, 1994. The independent representatives are typically HVAC engineers, a factor which is significant in marketing the Group's commercial products because of the design intensive nature of the market segment in which the Group competes.\nThe Company believes that the Group is among the largest suppliers of custom-designed commercial HVAC products in the United States. The Group's five largest competitors in the commercial HVAC market are Brod & McClung, Inc. (which sells under the \"Pace\" tradename), Carrier Corporation, McQuay (a division of Snyder-General Corporation), Miller-Picking (a division of York International Corporation) and The Trane Company (a subsidiary of American Standard Inc.). The Group competes primarily on the basis of engineering support, quality, flexibility in design and construction and total installed system cost. Although the Company believes that the Group competes favorably with respect to certain of these factors, most of the Group's competitors have greater financial and marketing resources than the Group and enjoy greater brand awareness. However, the Company believes that the Group's ability to produce equipment that meets the performance characteristics required by the particular product application provides it with advantages not enjoyed by certain of these competitors.\nResidential Products. The Group is one of the largest suppliers of air conditioners, heat pumps and furnaces to the manufactured housing market in the United States. In addition, the Group manufactures and markets HVAC products for site-built homes, a business it entered in 1987.\nThe principal factors affecting the market for the Group's residential HVAC products are the levels of manufactured housing shipments and housing starts and the demand for replacement and modernization of existing equipment. The Company anticipates that the replacement market will continue to expand as a large number of previously installed heating and cooling products become outdated or reach the end of their useful lives during the 1990s. This growth may be accelerated by a tendency among consumers to replace older heating and cooling products with higher efficiency models prior to the end of such equipment's useful life. The Company estimates that slightly less than half of the Group's net sales of residential HVAC products in 1994 were attributable to the replacement market, which tends to be less cyclical than the new construction market. The market for residential cooling products, including those sold by the Group, is affected by spring and summer temperatures. The Group does not sell window air conditioners, a segment of the market which is highly seasonal and especially affected by spring and summer temperatures. The Company believes that the Group's ability to offer both heating and cooling products helps offset the effects of seasonality of the Group's sales.\nThe Group sells its manufactured housing products to builders of manufactured housing and, through distributors, to manufactured housing dealers and owners of such housing. The majority of sales to builders of manufactured housing consist of furnaces designed and engineered to meet or exceed certain standards mandated by federal agencies. These standards differ in several important respects from the standards for furnaces used in site-built residential homes. The after market channel of distribution includes sales of both new and replacement air conditioning units and heat pumps and furnaces.\nA substantial portion of site-built residential products have been introduced in the past several years, including a new line of furances and a reengineered line of high efficiency air conditioners and heat pumps. Residential HVAC products for use in site-built homes are sold through independently-owned distributors who sell to HVAC dealers and contractors.\nThe Company believes that the Group has one major competitor in this market, Evcon Industries, which markets its products under the \"Evcon\/Coleman\" name. Competition in the site-built residential HVAC market is intense, and many suppliers of such equipment have substantially greater financial and marketing resources than the Group and enjoy greater brand awareness. In these markets, the Group competes with, among others, Carrier Corporation, Lennox Industries, The Trane Company and York International Corporation. The Group competes in both the manufactured housing and site-built markets on the basis of breadth and quality of its product line, distribution, product availability and price. The Company believes that the Group competes favorably with respect to these factors.\nThe Group has six manufacturing plants and employed 1,861 full-time people as of December 31, 1994, 192 of whom are covered under a collective bargaining agreement which expires in 1995. The Company believes that the Group's relationships with its employees are satisfactory.\nPlumbing Products Group\nThe Plumbing Products Group manufactures and sells vitreous china bathroom fixtures (including lavatories, toilet bowls, flush tanks, bidets and urinals), fiberglass and acrylic bathtubs, shower stalls and whirlpools, brass and die cast faucets, bath cabinets and vanities and shower doors, and also markets stainless steel and enameled steel tubs and sinks. In addition to its standard product offerings, the Group also sells designer bathroom fixtures, 1.6 gallon water-efficient toilets and a variety of products that are accessible to physically challenged individuals. Products are sold under the URC(TM), Universal-Rundle(R), CareFree(R), Milwaukee Faucets(TM) and Raphael(R) brand names principally to wholesale plumbing distributors and retail home centers. End customers of the Group's products are generally home builders, do-it- yourself homeowners, remodeling contractors and commercial builders.\nThe Group sells its products to distributors and home centers primarily through independently owned manufacturer's representatives supported by 54 sales and marketing personnel employed by the Group as of December 31, 1994.\nThe Group competes with many suppliers of plumbing and related products, several of which have greater financial and marketing resources than the Group and greater brand awareness. The Group's competitors include American Standard Inc., Eljer Industries and Kohler Company. The Group competes primarily on the basis of service, price, quality, and breadth of product line offerings. The Group believes it competes favorably by offering quality products and customer service at a reasonable price and by developing products using new technologies.\nThe Plumbing Products Group has eight manufacturing facilities and employed 1,340 full-time people as of December 31, 1994, approximately 936 of whom are covered by collective bargaining agreements which expire in 1996 and 1997. The Company believes that the Group's relationships with its employees are satisfactory.\nRECENT DEVELOPMENTS\nDisposition\nOn March 31, 1994, the Company sold its Dixieline Lumber Company business (a chain of ten retail home centers in the greater San Diego area). See Note 9, Notes to Consolidated Financial Statements, Item 8 of Part II of this report, incorporated herein by reference.\nGENERAL CONSIDERATIONS\nEmployees\nThe Company employed approximately 5,317 persons at December 31, 1994.\nBacklog\nBacklog expected to be filled during 1995 was approximately $111,705,000 at December 31, 1994 ($95,839,000 at December 31, 1993). Backlog is not regarded as a significant factor for operations where orders are generally for prompt delivery. While backlog stated for December 31, 1994 is believed to be firm, the possibility of cancellations makes it difficult to assess the firmness of backlog with certainty.\nResearch and Development\nThe Company's research and development activities are principally new product development and do not involve significant expenditures.\nPatents and Trademarks\nThe Company holds numerous design and process patents that it considers important, but no single patent is material to the overall conduct of its business. It is the Company's policy to obtain and protect patents whenever such action would be beneficial to the Company. The Company owns several trademarks that it considers material to the marketing of its products, including Broan(R), Nautilus(R), Air Care(TM), Governair(R), Mammoth(R), Temtrol(TM), Miller(R), Intertherm(R), Softheat(R), Powermiser(R), URC(TM) and Universal-Rundle(R). The Company believes that its rights in these trademarks are adequately protected.\nRaw Materials\nThe Company purchases raw materials and most components used in its various manufacturing processes. The principal raw materials purchased by the Company are rolled sheet, formed and galvanized steel, copper, aluminum, plate mirror glass, silica, lumber, plywood, paints, chemicals, resins and plastics. The materials, molds and dies, subassemblies and components purchased from other manufacturers, and other materials and supplies used in manufacturing processes have generally been available from a variety of sources. Whenever practical, the Company establishes multiple sources for the purchase of raw materials and components to achieve competitive pricing, ensure flexibility and protect against supply disruption. However, recent increases in raw material costs may affect future supply availability due in part to raw material demands by other industries.\nWorking Capital\nThe carrying of inventories to support distributors and to permit prompt delivery of finished goods requires substantial working capital. Substantial working capital is also required to carry receivables. See \"Liquidity and Capital Resources\" in Management's Discussion and Analysis of Financial Condition and Results of Operations, beginning on Page 21 of this report, incorporated herein by reference.\nExecutive Officers of the Registrant\nName Age Position\nRichard L. Bready 50 Chairman, President and Chief Executive Officer\nAlmon C. Hall 48 Vice President, Controller and Chief Accounting Officer\nRichard J. Harris 58 Vice President and Treasurer\nSiegfried Molnar 54 Senior Vice President - Group Operations\nKenneth J. Ortman 59 Senior Vice President - Group Operations\nKevin W. Donnelly 40 Vice President, General Counsel and Secretary\nThe executive officers have served in the same or substantially similar executive positions with the Company for at least the past five years, except Mr. Bready, who became Chairman and Chief Executive Officer in 1990 after serving as President, Chief Operating and Chief Financial Officer of the Company for more than the past five years.\nExecutive Officers are elected annually by the Board of Directors of the Company and serve until their successors are chosen and qualified. Mr. Bready has an employment agreement with the Company providing for his employment as Chief Executive Officer through 1998. The Company's executive officers include only those officers of the Company who perform policy-making functions for the Company as a whole and have managerial responsibility for major aspects of the Company's overall operations. A number of other individuals who serve as officers of the Company or its subsidiaries perform policy-making functions and have managerial responsibilities for the subsidiary or division by which they are employed, although not for the Company overall. Certain of these individuals could, depending on earnings of such unit, be more highly compensated than some executive officers of the Company.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nSet forth below is a brief description of the location and general character of the principal administrative and manufacturing facilities and other material real properties of the Company, all of which the Company considers to be in satisfactory repair. All properties are owned, except for those indicated by an asterisk, which are leased. Approximate Location Description Square Feet\nUnion, IL Manufacturing\/Warehouse\/Administrative 174,000* Hartford, WI Manufacturing\/Warehouse\/Administrative 402,000 Old Forge, PA Warehouse\/Administrative 40,000 Bensenville, IL Warehouse\/Administrative 69,000* Mississauga, ONT Manufacturing\/Administrative 108,000 Dallas, TX Manufacturing\/Administrative 71,000 Carlsbad, CA Administrative 30,000 Hong Kong Manufacturing 30,000* Waupaca, WI Manufacturing 35,000 St. Peters, MO Warehouse\/Administrative 250,000* St. Louis, MO Manufacturing 214,000 Boonville, MO Manufacturing 250,000* Chaska, MN Manufacturing\/Administrative 230,000* Oklahoma City, OK Manufacturing\/Administrative 122,000 Okarche, OK Manufacturing\/Administrative 112,000 Los Angeles, CA Manufacturing\/Administrative 177,000 New Castle, PA Manufacturing\/Administrative 420,000 Hondo, TX Manufacturing\/Administrative 404,000 Monroe, GA Manufacturing\/Administrative 414,000 Union Point, GA Manufacturing\/Administrative 191,000 Ottumwa, IA Manufacturing\/Administrative 85,000 Milwaukee, WI Manufacturing\/Administrative 76,000 Rensselaer, IN Manufacturing\/Administrative 165,000 Chicago, IL Manufacturing\/Administrative 100,000 Providence, RI Administrative 31,000*\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Company and its operating units are subject to numerous federal, state and local laws and regulations, including environmental laws and regulations that impose limitations on the discharge of pollutants into the air and water and establish standards for the treatment, storage and disposal of solid and hazardous wastes. The Company believes that it is in substantial compliance with the material laws and regulations applicable to it. The Company and its subsidiaries or former subsidiaries are involved in current, and may become involved in future, remedial actions under federal and state environmental laws and regulations which impose liability on companies to clean up, or contribute to the cost of cleaning up, sites at which their hazardous wastes or materials were disposed of or released. Such claims may relate to properties or business lines acquired by the Company after a release has occurred. In other instances, the Company may be partially liable under law or contract to other parties that have acquired businesses or assets from the Company for past practices relating to hazardous substances management. The Company believes that all such claims asserted against it, or such obligations incurred by it, will not have a material adverse effect upon the Company's financial condition or results of operations. Expenditures in 1993 and 1994 to evaluate and remediate such sites were not material. However, the Company is presently unable to estimate accurately its ultimate financial exposure in connection with identified or yet to be identified remedial actions due among other reasons to: (i) uncertainties surrounding the nature and application of environmental regulations, (ii) the Company's lack of information about additional sites at which it may be listed as a potentially responsible party (\"PRP\"), (iii) the level of clean-up that may be required at specific sites and choices concerning the technologies to be applied in corrective actions and (iv) the time periods over which remediation may occur. Furthermore, since liability for site remediation is joint and several, each PRP is potentially wholly liable for other PRPs that become insolvent or bankrupt. Thus, the solvency of other PRPs could directly affect the Company's ultimate aggregate clean-up costs. In certain circumstances, the Company's liability for clean-up costs may be covered in whole or in part by insurance or indemnification obligations of third parties.\nIn addition to the legal matters described above, the Company and its subsidiaries are parties to various legal proceedings incident to the conduct of their businesses. None of these proceedings is expected to have a material adverse effect, either individually or in the aggregate, on the Company's financial position or results of operations. See Note 7, Notes to Consolidated Financial Statements, Item 8 of Part II of this report, incorporated herein by reference.\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 Stock and Related Stockholder Matters\nStockholders of record of Nortek Common and Special Common Stock at February 17, 1995, numbered approximately 4,166 and 3,115, respectively. There were no dividends declared on the Common and Special Common in 1993 or 1994. The high and low sales prices of Nortek's Common Stock traded on the New York Stock Exchange in each quarter of 1993 and 1994 were:\nQuarter High Low\nFirst 13 1\/2 7 7\/8 Second 9 7\/8 7 7\/8 Third 12 5\/8 9 1\/8 Fourth 12 5\/8 10 1\/4\nQuarter High Low\nFirst 6 1\/8 4 7\/8 Second 5 1\/2 4 3\/4 Third 6 4 3\/8 Fourth 9 6\nSee Note 5, Notes to Consolidated Financial Statements.\nItem 6.","section_6":"Item 6. Consolidated Selected Financial Data Nortek, Inc. and Subsidiaries For the Five Years Ended December 31, 1994\n1994 1993 1992 1991 1990 ---- ---- ---- ---- ---- (In Thousands Except Per Share Amounts)\nConsolidated Summary of Operations: Net sales $737,160 $744,113 $799,979 $917,049 $1,037,239 Operating earnings (loss) 50,017 30,346 20,436 11,015 (16,512) Loss on businesses sold (1,750) (20,300) (14,500) (15,200) --- Earnings (loss) from continuing operations 17,200 (12,600) (21,000) (34,700) (41,400) Loss from discontinued operations --- --- (3,300) --- (6,600) Extraordinary gain (loss) from debt retirements 200 (6,100) 100 7,600 9,900 Cumulative effect of accounting changes 400 (2,100) --- --- --- Net earnings (loss) 17,800 (20,800) (24,200) (27,100) (38,100)\nFinancial Position: Unrestricted cash, invest- ments and marketable securities $105,080 $ 82,498 $ 73,748 $ 42,919 $ 61,098 Working capital 173,459 117,926 132,587 139,657 176,742 Total assets 519,217 509,209 515,373 582,372 715,427 Total debt-- Current 4,629 37,539 6,810 4,875 68,483 Long-term 219,951 178,210 201,863 232,581 284,323 Current ratio 2.1:1 1.6:1 1.9:1 1.9:1 1.9:1 Debt to equity ratio 1.9:1 2.1:1 1.6:1 1.6:1 2.0:1 Depreciation and amorti- zation 17,960 20,726 23,644 28,373 31,050 Capital expenditures 19,424 10,809 8,804 16,015 24,523 Stockholders' investment 117,790 104,007 126,906 152,929 180,743 Common and special common shares outstanding 12,550 12,542 12,526 13,079 13,512\nPer Share: Earnings (loss) from continuing operations-- Primary $ 1.35 $ (1.00) $ (1.67) $ (2.57) $ (3.07) Fully diluted 1.34 (1.00) (1.67) (2.57) (3.07) Net earnings (loss)-- Primary 1.40 (1.66) (1.92) (2.01) (2.83) Fully diluted 1.39 (1.66) (1.92) (2.01) (2.83) Cash dividends-- Common --- --- --- --- .10 Special common --- --- --- --- .04 Stockholders' investment 9.39 8.29 10.13 11.69 13.38\nSee Notes 7 to 12 and Note 14 of the Notes to Consolidated Financial Statements, and Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, Page 14, regarding the effect on operating results of businesses sold and other matters.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThe Company is a diversified manufacturer of residential and commercial building products, operating within three principal product groups: the Residential Building Products Group; the Air Conditioning and Heating Products Group; and the Plumbing Products Group. Through these product groups, the Company manufactures and sells, primarily in the United States and Canada, a wide variety of products for the residential and commercial construction, manufactured housing, and the do-it-yourself and professional remodeling and renovation markets.\nIn March 1994, the Company sold its Retail Home Center Operations (\"Dixieline\") and for purposes of this Management's Discussion and Analysis of Financial Condition and Results of Operations, the results of operations attributable to Dixieline have been excluded from all data reported as ongoing operations, including net sales, cost of products sold, selling, general and administrative expense and segment earnings. Total consolidated operating results of the Company, however, include the operating results of Dixieline through October 2, 1993, the date that such business was accounted for as a business held for sale. (See Notes 1 and 9 of the Notes to Consolidated Financial Statements.)\nResults of Operations\nThe following tables set forth, for the three years ended December 31, 1994, (a) certain consolidated operating results, (b) the percentage change of such results as compared to the prior year, (c) the percentage which such results bears to net sales and (d) the change of such percentages as compared to the prior year: Percentage Change -------------- Year Ended December 31, 1993 1992 ----------------------- to to 1994 1993 1992 1994 1993 ---- ---- ---- ---- ---- (Amounts in Millions)\nNet sales $737.2 $744.1 $800.0 (.9)% (7.0)% Cost of products sold 520.4 532.5 595.2 2.3 10.5 Selling, general and admini- strative expense 166.8 181.3 184.4 8.0 1.7 Operating earnings 50.0 30.3 20.4 65.0 48.5 Interest expense (26.2) (26.5) (29.2) 1.1 9.3 Interest income 5.3 3.2 4.4 65.6 (27.3) Net gain on investment and marketable securities --- 1.7 .9 (100.0) 88.9 Loss on businesses sold (1.7) (20.3) (14.5) 91.6 (40.0) Earnings (loss) from continuing operations before provision for income taxes 27.4 (11.6) (18.0) --- 35.6 Provision for income taxes 10.2 1.0 3.0 (920.0) 66.7 Earnings (loss) from continuing operations 17.2 (12.6) (21.0) --- 40.0 Loss from discontinued operations --- --- (3.3) --- 100.0 Extraordinary gain (loss) from debt retirements .2 (6.1) .1 --- --- Cumulative effect of accounting changes .4 (2.1) --- --- --- Net earnings (loss) 17.8 (20.8) (24.2) --- 14.1\nPercentage Percentage of Net Sales Change -------------- Year Ended December 31, 1993 1992 ----------------------- to to 1994 1993 1992 1994 1993 ---- ---- ---- ---- ----\nNet sales 100.0% 100.0% 100.0% --- --- Cost of products sold 70.6 71.5 74.4 .9 2.9 Selling, general and admini- strative expense 22.6 24.4 23.0 1.8 (1.4) Operating earnings 6.8 4.1 2.6 2.7 1.5 Interest expense (3.6) (3.6) (3.7) --- .1 Interest income .7 .4 .6 .3 (.2) Net gain on investment and marketable securities --- .2 --- (.2) .2 Loss on businesses sold (.2) (2.7) (1.8) 2.5 (.9) Earnings (loss) from continuing operations before provision for income taxes 3.7 (1.6) (2.3) 5.3 .7 Provision for income taxes 1.4 .1 .3 (1.3) .2 Earnings (loss) from continuing operations 2.3 (1.7) (2.6) 4.0 .9 Loss from discontinued operations --- --- (.4) --- .4 Extraordinary gain (loss) from debt retirements --- (.8) --- .8 (.8) Cumulative effect of accounting changes .1 (.3) --- .4 (.3) Net earnings (loss) 2.4 (2.8) (3.0) 5.2 .2\nThe following table presents the net sales for the Company's principal product groups for the three years ended December 31, 1994, and the percentage change of such results as compared to the prior year:\nPercentage Change ------ 1993 1992 Year Ended December 31, to to ----------------------- 1994 1993 1992 1994 1993 (Amounts in Millions) ---- ---- ---- ---- ---- Net sales: Residential Building Products $265.2 $257.2 $249.2 3.1% 3.2% Air Conditioning and Heating Products 338.0 275.6 237.0 22.6 16.3 Plumbing Products 134.0 128.1 126.1 4.6 1.6 ----- ----- ----- ----- ----- Net sales from ongoing operations 737.2 660.9 612.3 11.5 7.9 Businesses sold --- 83.2 187.7 (100.0) (55.7) ----- ----- ----- ----- ----- $737.2 $744.1 $800.0 (.9)% (7.0)% ===== ===== ===== ===== =====\nYear Ended December 31, 1994 as Compared to the Year Ended December 31, 1993\nNet sales from ongoing operations increased approximately $76,300,000, or 11.5%, as compared to 1993. Total net sales decreased approximately $6,900,000, or approximately .9%, in 1994 as compared to 1993, as a result of the sale of Dixieline, partially offset by the following factors. Net sales from ongoing operations increased principally as a result of increased sales volume of residential air conditioning and heating (\"HVAC\") products, increased shipments of new and replacement HVAC products to manufactured housing customers and increased sales levels of commercial and industrial HVAC products. Increased sales of the Plumbing Products Group are principally due to increased shipments of water efficient toilets, partially offset by decreased sales levels (approximately $7,100,000) of bathroom fixtures as a result of the restructure of certain product lines in the fourth quarter of 1993.\nCost of products sold from ongoing operations as a percentage of net sales from ongoing operations decreased from approximately 71.1% in 1993 to approximately 70.6% in 1994. Total cost of products sold as a percentage of total net sales decreased from approximately 71.5% in 1993 to approximately 70.6% in 1994, as a result of the factors described below and the effect of Dixieline which operated at higher cost levels than the Company's other product groups. The decrease in cost of products sold as a percentage of net sales from ongoing operations were primarily attributable to an increase in Plumbing Products Group net sales and increased sales of residential and commercial HVAC products in the Air Conditioning and Heating Products Group, all without a proportionate increase in costs. To a lesser extent, these decreases in the percentage were partially offset by slightly higher cost levels in the Residential Building Products Group, in part, due to the effect of increased competition and the impact of consolidating certain manufacturing facilities. The overall improvement in cost levels is due, in part, to the Company's ongoing cost control efforts.\nSelling, general and administrative expense from ongoing operations as a percentage of net sales from ongoing operations decreased from approximately 24.3% in 1993 to approximately 22.6% in 1994. Total selling, general and administrative expense as a percentage of total net sales decreased from approximately 24.4% in 1993 to approximately 22.6% in 1994, as a result of the factors described below and the effect of Dixieline which operated at higher expense levels than the Company's other product groups. The decrease in selling, general and administrative expense from ongoing operations as a percentage of net sales from ongoing operations in 1994 was principally due to lower non-segment expense, the effect of 1993 pre-tax losses of approximately $2,800,000 from the restructure of certain product lines in the Plumbing Products Group, approximately $1,600,000 as a result of the sale in October 1993 of certain real property and $700,000 in connection with the consolidation of certain manufacturing facilities by the Company's Building Products Group, and approximately $3,200,000 of income from the settlement of insurance claims and disputes in 1994, combined with the effect of increased net sales from ongoing operations in 1994. The effect of the percentage increase in net sales in the Air Conditioning and Heating Products Group in excess of the percentage increases in net sales by the Company's other product groups was also a factor in the overall decrease in the percentage of ongoing net sales, since this group operates at lower expense levels than the total expense level of ongoing operations. These improvements in the percentage were partially offset by the effect of approximately $11,300,000 of expenses relating to the implementation of certain cost reduction activities and manufacturing process improvements in\nYear Ended December 31, 1994 as Compared to the Year Ended December 31, 1993 (Continued)\neach of the Company's operating groups, the cost of installing new system marketing expenses as a result of competitive conditions and expenses of certain litigation and other matters in dispute. Approximately $2,600,000 of expenses relating to certain cost reduction activities and manufacturing process improvements were incurred in 1993.\nSegment earnings from ongoing operations were approximately $61,300,000 for 1994, as compared to approximately $47,200,000 for 1993. Total segment earnings were approximately $61,300,000 for 1994, as compared to approximately $46,900,000 for 1993 as a result of the effect of Dixieline and the following factors. Segment earnings are operating earnings plus corporate and other expenses not directly attributable to the Company's operating activities. The increase in segment earnings from ongoing operations principally was due to increased sales levels in the Air Conditioning and Heating Products and Plumbing Products Groups, without a proportionate increase in cost and from the effect of 1993 pre-tax losses of approximately $2,800,000, $1,600,000 and $700,000 described above. Approximately $1,500,000 of the increase in segment earnings in 1994 related to income from the settlement of insurance claims. The increase in segment earnings was partially offset by the effect of approximately $10,000,000 in 1994, of expenses incurred in connection with the implementation of certain cost reduction activities and manufacturing process improvements in each of the Company's operating groups, the cost of installing new systems, and marketing expenses as a result of competitive conditions in the Residential Building Products Group. Expenses incurred in connection with cost reduction activities and manufacturing process improvements in 1993 were approximately $2,600,000.\nForeign segment earnings, consisting primarily of the results of operations of the Company's Canadian subsidiary which manufactures built-in ventilating products, declined to approximately 7% of segment earnings from ongoing operations in 1994 from approximately 11% of such earnings in 1993. This decline was primarily due to an approximate 36% increase in domestic segment earnings from ongoing operations in 1994, as well as an approximate 20% decrease in foreign segment earnings in 1994. The decrease in foreign segment earnings was primarily the result of the continued weakness in the residential construction market in Canada.\nOperating earnings in 1994 increased approximately $19,700,000, or approximately 65%, as compared to 1993 primarily as a result of the factors discussed above and the effect of Dixieline's operating results. Operating earnings also include approximately $1,700,000 of non-segment income from the settlement in 1994 of insurance claims and disputes, partially offset by approximately $1,300,000 of non-segment expense of certain litigation and other matters in dispute in 1994. Dixieline's loss included in the Company's consolidated operating results was approximately $300,000 in 1993. Dixieline's operating results were no longer included in the Company's consolidated operating results in 1994. (See Notes 1 and 9 of the Notes to Consolidated Financial Statements included elsewhere herein.)\nInterest expense decreased approximately $300,000, or approximately 1.1% in 1994, as compared to 1993. In February 1994, the Company sold in a public offering $218,500,000 of its 9 7\/8% Senior Subordinated Notes due 2004 (\"9 7\/8% Notes\") and used the proceeds to redeem approximately $153,000,000 of certain of the Company's outstanding indebtedness. Interest expense (net of interest\nYear Ended December 31, 1994 as Compared to the Year Ended December 31, 1993 (Continued)\nincome) was approximately $1,300,000 greater in 1994 than it would have been had the debt redemption occurred on the same day as the financing. This increase was partially offset by the effect of the redemption of certain other outstanding indebtedness in January 1994. The decrease in interest expense was primarily due to the redemption and financing discussed above. (See Note 4 of the Notes to Consolidated Financial Statements included elsewhere herein.)\nInterest income in 1994 increased approximately $2,100,000, or approximately 65.6%, as compared to 1993. The increases were principally due to higher average invested balances of short-term investments, marketable securities and other investments, and the effect of slightly higher yields earned on investment and marketable securities.\nThe net gain on investment and marketable securities was approximately $1,650,000 for 1993, a portion of which were unrealized gains recorded in the Company's Statement of Operations in 1993. Due to the adoption in 1994 of Statement of Financial Accounting Standards (\"SFAS\") No. 115, such unrealized gains and losses are now recorded as adjustments to stockholders' investment. (See Note 11 of the Notes to Consolidated Financial Statements included elsewhere herein.)\nThe pre-tax loss on businesses sold of approximately $1,750,000 in 1994 was significantly lower than the approximate $20,300,000 loss in 1993, which was related to Dixieline. (See Note 9 of Notes to Consolidated Financial Statements included elsewhere herein.)\nThe provision for income taxes was approximately $10,200,000 for 1994, as compared to approximately $1,000,000 for 1993. The provision for income taxes as a percentage of the pre-tax earnings from continuing operations was approximately 37.2% in 1994 and approximately 8.6% of the pre-tax loss from continuing operations in 1993. The provision for income taxes in 1994 has been reduced by approximately $1,600,000, principally reflecting the reversal of tax valuation reserves as a result of the realization of certain tax assets. The effect of nondeductible losses on businesses sold in both years and an increase in income tax valuation reserves in 1993 were significant factors in the percentages. The income tax rates also differ from the United States federal statutory rate of 35% as a result of the effect of foreign income tax on foreign source income, state income taxes and nondeductible amortization expense (for tax purposes). (See Note 3 of the Notes to Consolidated Financial Statements included elsewhere herein.)\nThe Company recorded an extraordinary gain of approximately $200,000 in 1994 resulting from the call for redemption and purchases in the open market of the Company's 7 1\/2% Convertible Debentures compared to an approximate $6,100,000 loss in 1993. The loss in 1993 resulted primarily from the call for redemption on February 22, 1994 of certain of the Company's various Notes and Debentures in connection with the refinancing described in Note 4 of Notes to Consolidated Financial Statements.\nThe cumulative effect of accounting changes resulted in earnings of approximately $400,000 in 1994 and a loss of approximately $2,100,000 in 1993 from the adoption of SFAS No. 115 and No. 106, respectively. (See Notes 11 and 6 of the Notes to Consolidated Financial Statements included elsewhere herein.)\nYear Ended December 31, 1994 as Compared to the Year Ended December 31, 1993 (Continued)\nIn 1994, the Company incurred increased marketing expenses, principally in its Residential Building Products Group, as a result of competitive conditions. There can be no assurance that such conditions will not continue in the future or what effect such conditions, if they persist, may have on future operations.\nYear Ended December 31, 1993 as Compared to the Year Ended December 31, 1992\nNet sales from ongoing operations increased approximately $48,598,000, or approximately 7.9%, in 1993 as compared to 1992. Total net sales decreased approximately $55,866,000, or approximately 7.0%, in 1993 as compared to 1992 as a result of businesses sold in 1992 and the effect of Dixieline, partially offset by the following factors. Net sales from ongoing operations increased principally as a result of increased sales volume of residential air conditioning and heating products (in part, as a result of the addition of certain distributors) and increased shipments of new and replacement air conditioning and heating products to manufactured housing customers by the Air Conditioning and Heating Products Group. To a lesser extent, increased sales levels in the Residential Building Products Group and increased sales levels of bathroom fixtures (principally vitreous china products) by the Plumbing Products Group were also a factor.\nCost of products sold from ongoing operations as a percentage of net sales from ongoing operations decreased from approximately 72.5% in 1992 to approximately 71.1% in 1993. Total cost of products sold as a percentage of total net sales decreased from approximately 74.4% in 1992 to approximately 71.5% in 1993 as a result of the effect of businesses sold in 1992, which was partially offset by the effect of increases in cost of products sold as a percentage of net sales at Dixieline and the following factors. The decrease in cost of products sold from ongoing operations as a percentage of net sales from ongoing operations primarily was attributable to increased sales levels and a reduction in cost in the Plumbing Products Group and, to a lesser extent, increased sales in the Residential Building Products Group and the Air Conditioning and Heating Products Group, in both cases, without a proportionate increase in costs. The improvement in cost levels was due, in part, to the Company's ongoing cost control efforts.\nSelling, general and administrative expense from ongoing operations, as a percentage of net sales from ongoing operations increased from approximately 23.3% in 1992 to approximately 24.3% in 1993. Total selling, general and administrative expense, as a percentage of total net sales increased from approximately 23.0% in 1992 to approximately 24.4% in 1993 as a result of the factors described below and the effect of businesses sold in 1992, which sold businesses operated at lower expense levels than the Company's other product groups, partially offset by lower expense levels at Dixieline. The increase in the percentage of net sales from ongoing operations in 1993 was principally due to the effect of a pre-tax loss in the fourth quarter of 1993 of approximately $2,800,000 in connection with the restructure of certain product lines by the Company's Plumbing Products Group and the effect of pre-tax losses in the third quarter of 1993 of approximately $1,600,000 as a result of the sale in October 1993 of certain real property and approximately $700,000 in connection with the consolidation of certain manufacturing facilities by the Company's Residential Building Products Group. The increase in the percentage of net sales from ongoing operations was partially offset by the effect of increased sales volume\nYear Ended December 31, 1993 as Compared to the Year Ended December 31, 1992 (Continued)\nof residential and manufactured housing air conditioning and heating products by the Air Conditioning and Heating Products Group, without proportionate increases in expense.\nSegment earnings from ongoing operations were approximately $47,200,000 for 1993, as compared to approximately $38,100,000 for 1992. Total segment earnings were approximately $46,900,000 for 1993, as compared to approximately $32,700,000 for 1992 as a result of the effect of changes in the results of Dixieline and a business sold in 1992 and the following factors. The increase in segment earnings from ongoing operations principally was due to the increased sales level and reduced costs in the Plumbing Products Group, in part, due to the Company's ongoing cost control efforts, and increased sales volume of residential and manufactured housing air conditioning and heating products by the Air Conditioning and Heating Products Group and increased sales level in the Residential Building Products Group, without a proportionate increase in cost and expense. The increase in segment earnings from ongoing operations was partially offset by the effect of 1993 pre-tax losses of approximately $2,800,000, $1,600,000 and $700,000 described above.\nForeign segment earnings, consisting primarily of the results of operations of the Company's Canadian subsidiary, which manufactures built-in ventilating products, declined to approximately 11% of segment earnings from ongoing operations in 1993 from approximately 16% of such earnings in 1992. This decline was primarily due to an approximate 30% increase in domestic segment earnings from ongoing operations in 1993, as well as an approximate 11% decrease in foreign segment earnings in 1993. The decrease in foreign segment earnings was primarily the result of the continued weakness in the residential construction market in Canada.\nDixieline's operating loss decreased by approximately $700,000 to a loss of approximately $300,000 in 1993. Net sales of Dixieline were approximately $83,200,000 in 1993 and approximately $94,800,000 in 1992. Total consolidated operating results of the Company include the operating results of Dixieline through October 2, 1993. Weakness in the San Diego area residential construction market and increased competition continued to affect Dixieline's results adversely.\nOperating earnings in 1993 increased approximately $9,900,000, or approximately 48.5%, as compared to 1992, primarily as a result of the factors discussed above and include the effect of the results of Dixieline and a business sold in 1992.\nInterest expense in 1993 decreased approximately $2,700,000, or approximately 9.3%, as compared to 1992, primarily as a result of purchases, at a discount, in open market and negotiated transactions of the Company's debentures and notes in 1992 and the payment of current maturities of long-term debt.\nInterest income in 1993 decreased approximately $1,200,000, or approximately 27.3%, as compared to 1992, principally due to lower average invested balances of short-term investments, marketable securities and other investments (in\nYear Ended December 31, 1993 as Compared to the Year Ended December 31, 1992 (Continued)\npart, due to a reduction in indebtedness), and lower yields earned on investment and marketable securities.\nThe net gain on investment and marketable securities was approximately $1,650,000 for 1993, as compared to approximately $850,000 for 1992.\nThe pre-tax loss on businesses sold of approximately $20,300,000 in 1993 and approximately $14,500,000 in 1992 resulted in the approximate $11,600,000 loss before provision for income taxes in 1993 and was the primary reason for the approximate $18,000,000 loss before provision for income taxes in 1992. The pre-tax loss on businesses sold in 1993 resulted from the Company's decision to sell Dixieline and therefore to reduce the Company's net investment in such business to estimated net realizable value. (See Notes 1 and 9 of Notes to Consolidated Financial Statements.)\nThe provision for income taxes was approximately $1,000,000 for 1993, as compared to approximately $3,000,000 for 1992. The provision for income taxes as a percentage of the pre-tax loss from continuing operations was approximately 8.6% in 1993 as compared to approximately 16.7% in 1992. The income tax rates differed from the United States federal statutory rate of 35% in 1993 and 34% in 1992 as a result of the effect of an increase in income tax valuation reserves in 1993 and higher foreign income tax on foreign source income, a limited amount of state income tax benefits recorded, and nondeductible amortization expense (for tax purposes) in both years, and, in 1992, as a result of certain nondeductible costs associated with a business sold and unrecorded income tax credits relating to capital loss carryforwards since the income tax benefits attributable thereto may not be realized. (See Note 3 of the Notes to Consolidated Financial Statements.)\nAn extraordinary loss of approximately $6,100,000 in 1993 compared to an approximate $100,000 gain in 1992. The loss in 1993 resulted primarily from the call for redemption on February 22, 1994 of certain of the Company's various Notes and Debentures in connection with the financing described in Note 4 of Notes to Consolidated Financial Statements.\nThe charge to operations in 1993 from the cumulative effect of an accounting change of approximately $2,100,000 resulted from the adoption of Statement of Financial Accounting Standards (\"SFAS\") No. 106. (See Note 6 of Notes to Consolidated Financial Statements.)\nLiquidity and Capital Resources\nThe Company's primary sources of liquidity in 1994 have been funds provided by the sale of Notes (See Note 4 of the Notes to the Consolidated Financial Statements) and proceeds from a business sold and, in 1994 and 1993, subsidiary operations, unrestricted investments and marketable securities. The Company's Canadian subsidiary, Broan Limited, has a $20,100,000 Canadian (approximately $14,300,000 U. S. at exchange rates prevailing at December 31, 1994) secured line of credit, of which approximately $14,800,000 Canadian (approximately $10,550,000 U. S. at exchange rates prevailing at February 17, 1995), in the aggregate, is available to the Company (the \"Line of Credit\") at February 17, 1995.\nLiquidity and Capital Resources (Continued)\nBorrowings under the Line of Credit are available for working capital and other general corporate purposes. The Line of Credit contains covenants requiring Broan Limited to maintain (i) a ratio of earnings before interest and taxes to interest of at least 2 to 1, (ii) a working capital ratio of at least 1.5 to 1 and (iii) a debt to equity ratio of no higher than 3 to 1. The Line of Credit also limits the annual amount of capital expenditures which Broan Limited may make to $1,000,000 Canadian (approximately $713,000 U. S. at exchange rates prevailing at December 31, 1994). Broan Limited pays a commitment fee of .25% per annum on the unutilized portion of the Line of Credit payable monthly on a pro rata basis, and the Line of Credit is subject to an annual review by the lender in April of each year. As of February 17, 1995, there were no outstanding borrowings under the Line of Credit.\nIn March 1994, the Company sold Dixieline for approximately $18,800,000 in cash and $6,000,000 of preferred stock of the purchaser. (See Note 9 of Notes to Consolidated Financial Statements.)\nOn January 14, 1994, the Company redeemed $22,600,000 principal amount of its 11 1\/2% Senior Subordinated Debentures due May 1994, which were called for redemption in December 1993. In February 1994, the Company sold in a public offering $218,500,000 of its 9 7\/8% Senior Subordinated Notes due 2004 (\"9 7\/8% Notes\") at a slight discount. A portion of the net proceeds from the sale of the 9 7\/8% Notes was used to redeem, on March 24, 1994, approximately $153,000,000 of certain of the Company's outstanding principal amount of indebtedness and to pay accrued interest. (See Note 4 of Notes to Consolidated Financial Statements.)\nIn October 1994, the Company's 9 7\/8% Notes were upgraded on an unsolicited basis by a major rating agency.\nThe indenture governing the 9 7\/8% Notes restricts, among other things, the payment of cash dividends, repurchase of the Company's capital stock and the making of certain other restricted payments, the incurrence of additional indebtedness, the making of certain investments, mergers, consolidations and sale of assets (all as defined in the indenture). Upon certain asset sales (as defined in the indenture), the Company will be required to offer to purchase, at 100% principal amount plus accrued interest to the date of purchase, 9 7\/8% Notes in a principal amount equal to any net cash proceeds (as defined in the indenture) that are not invested in properties and assets used primarily in the same or related business to those owned and operated by the Company at the issue date of the 9 7\/8% Notes or at the date of such asset sale and such net cash proceeds were not applied to permanently reduce Senior Indebtedness (as defined in the indenture).\nAt December 31, 1994, approximately $28,800,000 was available for the payment of cash dividends or stock payments under the terms of the Company's indenture governing the 9 7\/8% Notes.\nDuring 1992, a former subsidiary of the Company (sold in 1984) defaulted on certain principal and interest payments relating to obligations under which the Company was contingently liable. In March 1994, the Company paid approximately $1,594,000 of interest payments through that date on such obligations. In the third and fourth quarter of 1994, the Company purchased at a slight discount,\nLiquidity and Capital Resources (Continued)\napproximately $6,640,000 principal amount of such obligations (consisting of all of such obligations) from several holders. The Company did not record any losses in 1994 in connection with the settlement of these contingent obligations. (See Note 7 of Notes to Consolidated Financial Statements.)\nUnrestricted cash and investments were approximately $105,080,000 at December 31, 1994.\nThe Company believes that cash flow from subsidiary operations, unrestricted cash and marketable securities and borrowings under the Line of Credit or under new credit facilities or arrangements which may be entered into will provide sufficient liquidity to meet the Company's working capital, capital expenditure, debt service and other ongoing business needs through the next 12 months. Capital expenditures were approximately $19,400,000 in 1994, and are expected to be approximately $18,000,000 in 1995.\nThe Company's investment in marketable securities at December 31, 1994 consisted primarily of investments in United States Treasury securities. (See Note 11 of Notes to Consolidated Financial Statements.) At December 31, 1994, approximately $9,337,000 of the Company's cash and investments were pledged as collateral with insurance companies and were classified as restricted in current assets in the Company's accompanying consolidated balance sheet.\nThe Company's working capital and current ratio increased from approximately $117,926,000 and approximately 1.6:1, respectively, at December 31, 1993 to approximately $173,459,000 and approximately 2.1:1, respectively, at December 31, 1994, principally as a result of the reduction of current indebtedness and the factors described below.\nAccounts receivable increased approximately $6,844,000, or approximately 8.1%, between December 31, 1993 and December 31, 1994, while net sales from ongoing operations were approximately $9,088,000, or 5.4% greater in the fourth quarter of 1994 as compared to the fourth quarter of 1993. The increase in accounts receivable is principally as a result of increased net sales of new and replacement products from residential and manufactured housing customers by the Air Conditioning and Heating Products Group. The rate of change in accounts receivable in certain periods may be different than the rate of change in sales in such periods principally due to the timing of net sales. Significant net sales near the end of any period generally result in significant amounts of accounts receivable on the date of the balance sheet at the end of such period. In recent periods, the Company has not experienced any significant changes in credit terms, collection efforts, credit utilization or delinquency.\nInventories increased approximately $13,335,000, or approximately 16.3%, between December 31, 1993 and December 31, 1994.\nAccounts payable increased approximately $5,774,000, or approximately 12.3%, between December 31, 1993 and December 31, 1994.\nUnrestricted cash and investments increased approximately $20,500,000 from December 31, 1993 to December 31, 1994, principally as a result of cash\nLiquidity and Capital Resources (Continued)\nprovided by (used in) the following: Condensed Consolidated Cash Flows ---------- Operating activities-- Cash flow from operations, net $40,710,000 Increase in accounts receivable, net (5,501,000) Increase in inventories (12,593,000) Increase in trade accounts payable 6,364,000 Change in accrued expenses, taxes, prepaids, other assets, liabilities, and other, net (2,801,000) Investing activities-- Net cash proceeds relating to businesses sold 12,465,000 Purchase of marketable securities (5,032,000) Capital expenditures (19,424,000) Change in restricted cash and investments (2,475,000) Financing activities-- Increases in borrowings, net of payments, including purchase of debentures 8,651,000 All other, net 136,000 ------------ $20,500,000 ==========\nThe Company's debt-to-equity ratio decreased from approximately 2.1:1 at December 31, 1993 to approximately 1.9:1 at December 31, 1994, primarily as a result of the effect of increased stockholders' investment as a result of net earnings in 1994, partially offset by a net increase in indebtedness of approximately $8,800,000. (See Note 4 of Notes to Consolidated Financial Statements.)\nThe Company's St. Louis, Missouri plant, which is part of the Company's Air Conditioning and Heating Products Group and manufactures products for the residential site-built and manufactured housing markets, experienced damage as a result of the flooding of the Mississippi River in July 1993. The plant was closed for several weeks, but returned to full operation in late August 1993. In the second quarter of 1994, the Company settled its claims with its insurance carrier with respect to this matter and recorded approximately $1,500,000 of income.\nAt December 31, 1994, the Company has approximately $3,000,000 of net U. S. Federal prepaid income tax assets which are expected to be realized through future operating earnings. (See Note 3 of Notes to the Consolidated Financial Statements.)\nThe Company believes that its growth will be generated largely by internal growth in each of its product groups, augmented by strategic acquisitions. The Company regularly reviews potential acquisitions which would increase or expand the market penetration of, or otherwise complement, its current product lines, although there are no pending agreements for any material acquisitions and the Company has made no material acquisitions since early 1988.\nInflation, Trends and General Considerations\nThe Company's performance is dependent to a significant extent upon the levels of new residential construction, residential replacement and remodeling and non- residential construction, all of which are affected by such factors as interest rates, inflation and unemployment. In recent periods, the Company's product groups have operated in an environment of increasing levels of construction and remodeling activity, particularly new housing starts which increased approximately 20% between 1990 and 1994. New residential construction housing starts, however, remain below the levels experienced in the mid-1980s. The Company's operations have been affected by the difficult economic conditions in the Northeastern United States, California and Canada. However, the actions taken to reduce production costs and overhead levels and improve the efficiency and profitability of the Company's operations have enabled it to significantly increase operating earnings, as well as to position the Company for growth. In the near term, the Company expects to operate in an environment of relatively stable levels of construction and remodeling activity. However, recent increases in interest rates could have a negative impact on the level of housing construction and remodeling activity.\nInflation has not had a material effect on the Company's results of operations and financial condition until mid-1994, when the Company experienced significant increases in certain costs and expenses including raw material costs. There can be no assurance that the Company will be able to sufficiently increase its sales prices if these cost increases persist.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nFinancial statements and supplementary data required by this Item 8 are set forth at the pages indicated in Item 14(a) included elsewhere herein.\nItem 9.","section_9":"Item 9. Disagreements 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\nSee Election of Directors in the definitive Proxy Statement for the Company's 1995 Annual Meeting of Stockholders, incorporated herein by reference. See also Part I, Item 1, Business-General Considerations-Executive Officers of the Registrant.\nItem 11.","section_11":"Item 11. Executive Compensation\nSee Executive Compensation in the definitive Proxy Statement for the Company's 1995 Annual Meeting of Stockholders, incorporated herein by reference.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nSee Security Ownership of Certain Beneficial Owners and Management in the definitive Proxy Statement for the Company's 1995 Annual Meeting of Stockholders, incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nSee Election of Directors in the definitive Proxy Statement for the Company's 1995 Annual Meeting of Stockholders, 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\nThe following documents are filed as part of this report:\n1. Financial Statements: Page No.\nConsolidated Statement of Operations for the three years ended December 31, 1994 29 Consolidated Balance Sheet as of December 31, 1994 and 1993 30 Consolidated Statement of Cash Flows for the three years ended December 31, 1994 32 Consolidated Statement of Stockholders' Investment for the three years ended December 31, 1994 33 Notes to Consolidated Financial Statements 34 Report of Independent Public Accountants 53\n2. Financial Statement Schedules:\nSchedule II Valuation and Qualifying Accounts 54\nSchedules I, III, IV and V, are omitted as not applicable or not required under the rules of Regulation S-X.\n3. The exhibits are listed in the Exhibit Index, which is incorporated herein by reference.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed by the Registrant 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 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 6, 1995.\nNORTEK, INC.\nBy: \/s\/Richard L. Bready -------------------- Richard L. Bready 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 indicated, as of March 6, 1995.\n\/s\/Richard L. Bready \/s\/D. Stevens McVoy - ------------------------------- ---------------------------------- Richard L. Bready, Chairman D. Stevens McVoy, Director of the Board and President (principal executive officer)\n\/s\/Richard J. Harris \/s\/J. Peter Lyons - ------------------------------- ---------------------------------- Richard J. Harris, Vice President J. Peter Lyons, Director and Treasurer (principal financial officer) and Director\n\/s\/Almon C. Hall \/s\/Dennis J. McGillicuddy - ------------------------------- ---------------------------------- Almon C. Hall, Vice President Dennis J. McGillicuddy, Director and Controller (principal accounting officer)\n\/s\/Philip B. Brooks \/s\/Barry Silverstein - ------------------------------- ---------------------------------- Philip B. Brooks, Director Barry Silverstein, Director\nNortek, Inc. and Subsidiaries Consolidated Statement of Operations For the Three Years Ended December 31, 1994\n1994 1993 1992 ---- ---- ---- (In Thousands Except Per Share Amounts)\nNet Sales $737,160 $744,113 $799,979 ------- ------- ------- Costs and Expenses: Cost of products sold 520,328 532,488 595,177 Selling, general and administrative expense 166,815 181,279 184,366 ------- ------- ------- 687,143 713,767 779,543 ------- ------- ------- Operating earnings 50,017 30,346 20,436 Interest expense (26,162) (26,519) (29,232) Interest income 5,295 3,223 4,446 Net gain on investment and marketable securities --- 1,650 850 Loss on businesses sold (1,750) (20,300) (14,500) ------- ------- ------- Earnings (loss) from continuing operations before provision for income taxes 27,400 (11,600) (18,000) Provision for income taxes 10,200 1,000 3,000 ------- ------- ------- Earnings (loss) from continuing operations 17,200 (12,600) (21,000) Loss from discontinued operations --- --- (3,300) ------- ------- ------- Earnings (loss) before extraordinary gain (loss) 17,200 (12,600) (24,300) Extraordinary gain (loss) from debt retirements 200 (6,100) 100 ------- ------- ------- Earnings (loss) before the cumulative effect of accounting changes 17,400 (18,700) (24,200) Cumulative effect of accounting changes 400 (2,100) --- ------- ------- ------- Net Earnings (Loss) $17,800 $(20,800) $(24,200) ======= ======= ======= Net Earnings (Loss) Per Share: Continuing operations Primary $1.35 $ (1.00) $ (1.67) ------- ------- ------- Fully diluted $1.34 $ (1.00) $ (1.67) ------- ------- ------- Discontinued operations Primary --- --- (.26) ------- ------ ------- Fully diluted --- --- (.26) ------- ------- ------- Earnings (loss) before extraordinary gain (loss) Primary 1.35 (1.00) (1.93) Fully diluted 1.34 (1.00) (1.93) Extraordinary gain (loss) Primary .02 (.49) .01 Fully diluted .02 (.49) .01 Cumulative Effect of Accounting Changes Primary .03 (.17) --- ------- ------- ------- Fully diluted .03 (.17) --- ------- ------- ------- Net Earnings (Loss) Primary $1.40 $ (1.66) $ (1.92) ======= ======= ======= Fully diluted $1.39 $ (1.66) $ (1.92) ======= ======= ======= Weighted Average Number of Shares: Primary 12,707 12,622 12,645 ======= ======= ======= Fully diluted 13,144 13,362 13,411 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nNortek, Inc. and Subsidiaries Consolidated Balance Sheet December 31, 1994 and 1993\nAssets 1994 1993 ---- ---- (Amounts in Thousands) Current Assets: Unrestricted Cash and investments at cost which approximates market $ 77,106 $ 56,606 Marketable securities available for sale 27,974 25,892 Restricted Cash, investments and marketable securities at cost which approximates market 9,337 6,687 Accounts receivable, less allowances of $4,030,000 and $4,198,000 91,687 84,843 Inventories Raw materials 32,660 27,603 Work in process 9,497 9,227 Finished goods 53,191 45,183 ------- ------- 95,348 82,013 ------- ------- Current assets of a business sold --- 23,736 Insurance claims receivable --- 14,500 Prepaid expenses and other current assets 7,542 7,541 U. S. Federal prepaid income taxes 19,800 17,000 ------- ------- Total current assets 328,794 318,818 ------- ------- Property and Equipment, at cost: Land 6,069 5,833 Buildings and improvements 55,639 52,309 Machinery and equipment 123,848 108,983 ------- ------- 185,556 167,125 Less accumulated depreciation 87,475 76,546 ------- ------- Total property and equipment, net 98,081 90,579 ------- ------- Other Assets: Goodwill, less accumulated amortization of $21,459,000 and $19,180,000 72,682 75,599 Non-current assets of a business sold --- 11,987 Deferred debt expense 8,502 563 Other 11,158 11,663 ------- ------- 92,342 99,812 ------- ------- $519,217 $509,209 ======= =======\nThe accompanying notes are an integral part of these financial statements.\nNortek, Inc. and Subsidiaries Consolidated Balance Sheet December 31, 1994 and 1993\n1994 1993 ---- ---- (Amounts in Thousands) Liabilities and Stockholders' Investment\nCurrent Liabilities: Notes payable, current maturities of long-term debt and other short-term obligations $ 4,629 $ 14,957 11 1\/2% Senior Subordinated Debentures, net --- 22,582 Accounts payable 52,697 46,923 Accrued expenses and taxes, net 98,009 91,422 Current liabilities of a business sold --- 11,769 Insurance claims advances --- 13,239 ------- ------- Total current liabilities 155,335 200,892 ------- ------- Other Liabilities: Deferred income taxes 18,232 18,000 Other 7,909 8,100 ------- ------- 26,141 26,100 ------- ------- Notes, Mortgage Notes and Debentures Payable, Less Current Maturities 219,951 169,664 ------- -------\nMortgage Notes Payable of a business sold --- 8,546 ------- -------\nCommitments and Contingencies (Note 7)\nStockholders' Investment: Preference stock, $1 par value; authorized 7,000,000 shares, none issued --- --- Common stock, $1 par value; authorized 40,000,000 shares, 15,814,246 and 15,758,974 shares issued 15,814 15,759 Special common stock, $1 par value; authorized 5,000,000 shares, 802,097 and 849,575 shares issued 802 849 Additional paid-in capital 134,627 134,627 Retained earnings (accumulated deficit) 766 (17,034) Cumulative translation, pension and other adjustments (6,168) (2,143) Less --treasury common stock at cost, 3,795,028 shares (26,371) (26,371) --treasury special common stock at cost, 271,574 shares (1,680) (1,680) ------- ------- Total stockholders' investment 117,790 104,007 ------- ------- $519,217 $509,209 ======= =======\nThe accompanying notes are an integral part of these financial statements.\nNortek, Inc. and Subsidiaries Consolidated Statement of Cash Flows For the Three Years Ended December 31, 1994\n1994 1993 1992 ---- ---- ---- (Amounts in Thousands) Cash flows from operating activities: Net earnings (loss) $17,800 $(20,800) $(24,200) ------ ------- -------\nAdjustments to reconcile net earnings (loss) to cash: Depreciation and amortization 17,960 20,726 23,644 Gain on marketable securities --- (1,650) (850) Extraordinary (gain) loss from debt retirements (250) 9,275 (150) Loss on businesses sold 1,750 20,300 19,500 Cumulative effect of accounting changes (400) 3,100 --- Deferred federal income tax provision (credit) from continuing operations 300 (6,300) (1,700) Deferred federal income tax provision on discontinued operations 2,200 --- --- Deferred federal income tax provision (credit) on extraordinary items 1,350 (3,175) --- Changes in certain assets and liabilities, net of effects from acquisitions and dispositions: Accounts receivable, net (5,501) (11,033) (7,323) Prepaids and other current assets (4,361) (937) 2,443 U. S. Federal income tax refund --- --- 1,803 Inventories (12,593) (2,854) (2,807) Accounts payable 6,364 4,360 (1,638) Accrued expenses and taxes 4,242 (3,913) 3,398 Long-term assets, liabilities and other, net (2,682) 5,326 (21) ------- ------- ------- Total adjustments to net earnings (loss) 8,379 33,225 36,299 ------- ------- ------- Net cash provided by operating activities 26,179 12,425 12,099 ------- ------- ------- Cash Flows from investing activities: Capital expenditures (19,424) (10,436) (8,804) Proceeds from the sale of property and equipment 114 5,242 1,045 Purchase of investments and marketable securities (5,032) (87,922) (94,671) Proceeds from the sale of investments and marketable securities --- 113,961 72,280 Net cash proceeds (payments) relating to businesses sold or discontinued 12,465 (2,420) 38,813 Change in restricted cash and investments (2,475) 2,552 13,030 Other, net 51 (777) 1,080 ------- ------- ------- Net cash provided by (used in) investing activities (14,301) 20,200 22,773 ------- ------- ------- Cash Flows from financing activities: Sale of Notes, net 209,195 --- --- Purchase of debentures and notes payable (191,582) (1,383) (21,693) Increase in borrowings --- 7,348 4,197 Payment of borrowings (8,962) (4,124) (5,692) Purchase of Nortek Common and Special Common Stock --- --- (2,006) Other, net (29) (1,327) (2,720) ------- ------- ------- Net cash provided by (used in) financing activities 8,622 514 (27,914) ------- ------- ------- Net increase in unrestricted cash and investments 20,500 33,139 6,958 Unrestricted cash and investments at the beginning of the year 56,606 23,467 16,509 ------- ------- ------- Unrestricted cash and investments at the end of the year $77,106 $56,606 $ 23,467 ======= ======= =======\nThe accompanying notes are an integral part of these financial statements.\nNortek, Inc. and Subsidiaries Consolidated Statement of Stockholders' Investment For the Three Years Ended December 31, 1994 Cumulative Translation, Addi- Retained Pension Special tional Earnings and Other Common Common Paid-in (Accumulat- Adjust-Treasury Stock Stock Capital ed Deficit) ments Stock ------ ------ ------- ---------- -------- ------- (Amounts in Thousands) Balance, December 31, 1991 $15,438 $1,077 $134,493 $ 27,966 $--- $(26,045) 86,345 shares of special common stock converted into 86,345 shares of common stock 87 (87) --- --- --- --- 631,701 shares of common treasury stock acquired, net --- --- --- --- --- (2,006) 77,837 shares of common stock issued upon exercise of stock options 77 --- 106 --- --- --- Net loss --- --- --- (24,200) --- --- ------ ------ ------- ------- ------ ------- Balance, December 31, 1992 15,602 990 134,599 3,766 --- (28,051) 140,432 shares of special common stock converted into 140,432 shares of common stock 141 (141) --- --- --- --- 16,400 shares of common stock issued upon exercise of stock options 16 --- 28 --- --- --- Translation adjustment --- --- --- --- (1,337) --- Pension adjustment --- --- --- --- (806) --- Net loss --- --- --- (20,800) --- --- ------ ------ ------- ------- ------ ------- Balance, December 31, 1993 15,759 849 134,627 (17,034) (2,143) (28,051) 47,478 shares of special common stock converted into 47,478 shares of common stock 47 (47) --- --- --- --- 7,794 shares of common stock issued upon exercise of stock options 8 --- --- --- --- --- Translation adjustment --- --- --- --- (780) --- Pension adjustment --- --- --- --- 134 --- Cumulative effect of an accounting change --- --- --- --- (400) --- Unrealized decline in marketable securities --- --- --- --- (2,979) --- Net earnings --- --- --- 17,800 --- --- ------ ------ ------- ------- ------ ------- Balance, December 31, 1994 $15,814 $ 802 $134,627 $ 766 $(6,168) $(28,051) ====== ====== ======= ======= ====== =======\nThe accompanying notes are an integral part of these financial statements.\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements\n1. Summary of Significant Accounting Policies\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of Nortek, Inc. and all of its significant wholly-owned subsidiaries (the \"Company\" or \"Nortek\") after elimination of intercompany accounts and transactions. Certain amounts in the prior years' financial statements have been reclassified to conform to the presentation at December 31, 1994. On October 2, 1993, the Company began to account for its Dixieline Lumber Company, Inc. subsidiary (\"Dixieline\") as a business held for sale. As a result, Dixieline's assets and liabilities have been separately reflected in the Company's accompanying consolidated balance sheet, and Dixieline's operating results through October 2, 1993 have been included in the Company's consolidated statement of operations for the year ended December 31, 1993. Dixieline's operating results were no longer included in the Company's consolidated operating results subsequent to October 2, 1993. The Company sold this business on March 31, 1994.(See Note 9.)\nCash, Investments and Marketable Securities\nInvestments consist of short-term highly liquid investments which are readily convertible into cash. Investments and marketable securities are carried at approximate market price.\nThe Company has classified as restricted, certain cash, investments and marketable securities that are not fully available for use in its operations. At December 31, 1994, approximately $9,337,000 of cash, investments and marketable securities has been pledged as collateral for insurance and other requirements and is classified as restricted in current assets in the accompanying consolidated balance sheet.\nDisclosures About Fair Value of Financial Instruments\nThe following methods and assumptions were used to estimate fair value of each class of financial instruments for which it is practicable to estimate that value:\nCash and Investments-- The carrying amount approximates fair value because of the short maturity of those instruments.\nMarketable Securities-- The fair value of marketable securities is based on quoted market prices. At December 31, 1994, the fair value of marketable securities approximated the amount on the Company's consolidated balance sheet.\nLong-Term Debt-- At December 31, 1994, the fair value of long-term indebtedness was approximately $26,765,000 lower than the amount on the Company's consolidated balance sheet, based on quoted market prices. (See Note 4.)\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nInventories\nInventories in the accompanying consolidated balance sheet are valued at the lower of cost or market. At December 31, 1994 and 1993, approximately $64,589,000 and $53,154,000 of total inventories, respectively, were valued on the last-in, first-out method (LIFO). Under the first-in, first-out method (FIFO) of accounting, such inventories would have been approximately $6,710,000 and $4,982,000 greater at December 31, 1994 and 1993, respectively. All other inventories were valued under the FIFO method.\nSales Recognition\nThe Company recognizes sales upon the shipment of its products net of applicable provisions for discounts and allowances. The Company also provides for its estimate of warranty and bad debts at the time of shipment as selling, general and administrative expense.\nForeign Currency Translation\nThe Company translates the assets and liabilities of its foreign subsidiaries at the exchange rates in effect at year-end. Net sales and expenses are translated using exchange rates in effect during the year. Gains and losses from foreign currency translation are credited or charged to cumulative translation adjustment included in stockholders' investment in the accompanying consolidated balance sheet. Gains and losses from foreign currency translation were not material in 1992.\nDepreciation and Amortization\nDepreciation and amortization of property and equipment is provided on a straight-line basis over the estimated useful lives, which are generally as follows:\nBuildings and improvements 10-35 years Machinery and equipment, including leases 3-15 years Leasehold improvements term of lease\nExpenditures for maintenance and repairs are expensed when incurred. Expenditures for renewals and betterments are capitalized. When assets are sold, or otherwise disposed of, the cost and accumulated depreciation are eliminated and the resulting gain or loss is recognized.\nGoodwill\nThe Company has classified as goodwill the cost in excess of fair value of the net assets (including tax attributes) of companies acquired in purchase transactions. Goodwill is being amortized on a straight-line method over 40 years. Amortization charged to continuing operations amounted to $2,407,000, $2,418,000 and $2,548,000 for 1994, 1993 and 1992, respectively. At each balance sheet date, the Company evaluates the realizability of goodwill based on expectations of non-discounted cash flows and operating income for each subsidiary having a material goodwill balance. Based on its most recent\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nanalysis, the Company believes that no material impairment of goodwill exists at December 31, 1994.\nNet Earnings (Loss) Per Share\nNet earnings (loss) per share amounts have been computed using the weighted average number of common and common equivalent shares outstanding during each year. Earnings (loss) per share calculations for 1993 and 1992 do not include the effect of common stock equivalents or convertible debentures (and the reduction in related interest expense) because the assumed exercise of stock options and conversion of debentures is anti-dilutive for the net loss per share amounts. Special Common Stock is treated as the equivalent of Common Stock in determining earnings per share results.\n2. Cash Flows\nInterest paid was $22,119,000, $26,981,000 and $27,436,000 in 1994, 1993 and 1992, respectively.\nThe following table summarizes the activity of businesses sold or discontinued included in the accompanying consolidated statement of cash flows:\nYear Ended December 31, ----------------------- 1994 1993 1992 ---- ---- ---- (Amounts in Thousands)\nFair value of assets sold $39,439 $ --- $ 52,793 Liabilities assumed by the purchaser (16,143) --- (13,329) Notes receivable and other non-cash proceeds received as part of the proceeds (6,000) --- (316) Cash payments relating to businesses sold or discontinued, net (4,831) (2,420) (335) ------ ------ ------ Net cash proceeds (payments) relating to businesses sold or discontinued $12,465 $(2,420) $38,813 ======= ====== ======\nNon-cash financing and investing activities excluded from the accompanying consolidated statement of cash flows consisted of approximately $2,979,000 of unrealized loss on investment in marketable securities in 1994 (see Note 11).\nNon-cash financing and investing activities were not significant for the year ended December 31, 1993.\nThe following summarizes other non-cash financing and investing activities for 1992: (Amounts in Thousands) Use of restricted cash and investments in settlement of certain litigation (see Note 7) $11,800 Exchange of debentures (see Note 7) 4,050 Settlement of 11% subordinated notes receivable (see Note 7) 2,576 Other 1,556\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\n3. Income Taxes\nIn the first quarter of 1993, the Company adopted SFAS No. 109, as a change in accounting method. The effect of this change in the accounting method was not material. Prior year financial statements have not been restated to reflect the new accounting method. The effect of adopting this new accounting method in the first quarter of 1993 was not significant to the provision for income taxes as compared to the prior accounting method. For the year ended December 31, 1992, the provision (credit) for income taxes was computed in accordance with the comprehensive income tax allocation method, which recognizes the tax effects of all income and expense transactions included in each year's consolidated statement of operations, regardless of the year the transactions are reported for tax purposes.\nThe tax effect of temporary differences which gave rise to significant portions of deferred income tax assets and liabilities as of December 31, 1994 and December 31, 1993 are as follows:\nDec. 31, Dec. 31, 1994 1993 ------ ------ (Amounts in Thousands) U. S. Federal Prepaid (Deferred) Income Tax Assets Arising From: Accounts receivable $ 1,399 $ 1,387 Inventory (468) (666) Insurance reserves 7,688 4,576 Other reserves, liabilities and assets, net 11,181 11,703 ------ ------ $19,800 $17,000 ====== ====== Deferred (Prepaid) Income Tax Liabilities Arising From: Property and equipment, net $12,406 $11,709 Prepaid pension assets 1,230 1,666 Unamortized debt discount --- 102 Insurance reserves (643) (1,025) Other reserves, liabilities and assets, net 2,476 2,504 Capital loss carryforward (6,217) (6,217) Unrealized loss on business sold (604) (3,405) Other tax assets (3,642) (1,660) Valuation allowances 13,226 14,326 ------ ------ $18,232 $18,000 ====== ======\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nAt December 31, 1994, the Company has a capital loss carryforward of approximately $17,700,000, which expires in the year 1997. The Company has provided a valuation allowance equal to the tax effect of capital loss carryforwards and certain other tax assets, since realization of these tax assets cannot be reasonably assured. At December 31, 1994, the Company has approximately $3,000,000 of net U.S. Federal prepaid income tax assets which are expected to be realized through future operating earnings.\nThe following is a summary of the components of earnings (loss) from continuing operations before income tax credit:\nYear Ended December 31, ----------------------- 1994 1993 1992 ---- ---- ---- (Amounts in Thousands)\nDomestic $23,100 $(17,000) $(24,400) Foreign 4,300 5,400 6,400 ------ ------- ------- $27,400 $(11,600) $(18,000) ====== ======= =======\nThe following is a summary of the provision (credit) for income taxes from continuing operations included in the accompanying consolidated statement of operations: Year Ended December 31, ------------------------ 1994 1993 1992 ---- ---- ---- (Amounts in Thousands) Federal income taxes-- Current $ 7,125 $2,800 $ 600 Deferred 300 (6,300) (1,700) ----- ------ ------- 7,425 (3,500) (1,100) Foreign 1,500 2,600 3,200 State 1,275 1,900 900 ----- ------ ------- $10,200 $1,000 $ 3,000 ====== ===== ======\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nIncome tax payments, net of refunds, were approximately $10,895,000, $11,950,000 and $1,600,000 in 1994, 1993 and 1992, respectively.\nThe table below reconciles the federal statutory income tax rate to the effective tax rate from continuing operations of approximately 37.2%, 8.6% and 16.7% in 1994, 1993 and 1992, respectively.\nYear Ended December 31, ----------------------- 1994 1993 1992 ---- ---- ---- (Amounts in Thousands) Income tax provision (credit) from continuing operations at the Federal statutory rate $ 9,590 $(4,060) $(6,120) Net change from statutory rate: Change in valuation reserve, net (1,625) 2,618 --- Effect of unrecognized capital losses --- --- 3,990 State taxes, net of federal tax effect 829 1,235 594 Amortization not deductible for tax purposes 737 746 552 Businesses sold 613 (172) 2,827 Foreign source deemed income --- 700 648 Tax effect on foreign income 164 196 479 Other, net (108) (263) 30 ----- ------ -------\n$10,200 $ 1,000 $ 3,000 ===== ====== =======\nThe Company recorded a $1,000,000 income tax credit (principally deferred) in the first quarter of 1993 relating to the cumulative effect of an accounting change for certain post-retirement benefits. In the fourth quarter of 1993, the Company recorded a $3,175,000 deferred income tax credit relating to the extraordinary loss, arising from indebtedness called for redemption. (See Note 4.)\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\n4. Notes, Mortgage Notes and Debentures Payable\nNotes, mortgage notes and debentures payable in the accompanying consolidated balance sheet at December 31, 1994 and 1993 consist of the following:\nDecember 31, ------------- 1994 1993 ---- ---- (Amounts in Thousands)\nNotes payable to banks $ 51 $ 7,348 Mortgage notes payable 6,774 8,188 Other 887 1,141 9 7\/8% Senior Subordinated Notes due 2004 (\"9 7\/8% Notes\"), net of unamortized original issue discount of $1,632,000 216,868 --- 9 3\/4% Senior Notes due 1997 (\"9 3\/4% Senior Notes\"), net of unamortized original issue discount of $293,000 --- 51,152 13 1\/2% Senior Subordinated Debentures due 1997 (\"13 1\/2% Debentures\"), net of unamortized original issue discount of $53,000 --- 79,305 11 1\/2% Senior Subordinated Debentures due 1994 (\"11 1\/2% Debentures\"), net of unamortized original issue discount of $18,000 --- 22,582 11% Subordinated Sinking Fund Debentures due 2004 (\"11% Debentures\"), net of unamortized debt discount of $18,000 --- 19,406 10% Subordinated Sinking Fund Debentures due 1999 (\"10% Debentures\"), net of unamortized debt discount of $8,000 --- 2,587 7 1\/2% Convertible Sinking Fund Debentures due 2006 (\"7 1\/2% Convertible Debentures\") --- 15,494 ------- ------- 224,580 207,203 Less amounts included in current liabilities 4,629 37,539 ------- ------- $219,951 $169,664 ======= =======\nOn January 14, 1994, the Company redeemed $22,600,000 principal amount of its 11 1\/2% Debentures, which were called for redemption in December 1993 and were classified as a current liability in the accompanying consolidated balance sheet. In February 1994, the Company sold in a public offering $218,500,000 of\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nits 9 7\/8% Senior Subordinated Notes due 2004 (\"9 7\/8% Notes\") at a discount of approximately $1,717,000, which is being amortized over the life of the issue. Net proceeds from the sale of the 9 7\/8% Notes, after deducting underwriting commissions and expenses, amounted to approximately $207,695,000, and a portion of such proceeds was used to redeem, on March 24, 1994, the Company's outstanding principal amount of indebtedness and to pay accrued interest on $51,445,000 of its 9 3\/4% Senior Notes, $79,358,000 of its 13 1\/2% Debentures, $2,595,000 of its 10% Debentures, and $19,424,000 of its 11% Debentures, all of which were called for redemption on February 22, 1994. The 13 1\/2% Debentures were redeemed at 101.5% of the outstanding principal amount thereof, while the other issues were redeemed at par. Interest expense, net of interest income, in the first quarter of 1994 was approximately $1,300,000 greater than it would have been had the debt redemption occurred on the same day as the financing. The call for these debt redemptions resulted in an extraordinary loss of approximately $6,100,000 ($.49 per share) net of an income tax credit of approximately $3,175,000, which was recorded in the fourth quarter of 1993. See Note 9 with respect to the pro forma effect of the debt redemptions.\nThe indenture governing the 9 7\/8% Notes restricts, among other things, the payment of cash dividends, repurchase of the Company's capital stock and the making of certain other restricted payments, the incurrence of additional indebtedness, the making of certain investments, mergers, consolidations and sale of assets (all as defined in the indenture). Upon certain asset sales (as defined in the indenture), the Company will be required to offer to purchase, at 100% principal amount plus accrued interest to the date of purchase, 9 7\/8% Notes in a principal amount equal to any net cash proceeds (as defined in the indenture) that are not invested in properties and assets used primarily in the same or related business to those owned and operated by the Company at the issue date of the 9 7\/8% Notes or at the date of such asset sale and such net cash proceeds were not applied to permanently reduce Senior Indebtedness (as defined in the indenture). The 9 7\/8% Notes are redeemable at the option of the Company, in whole or in part, at any time and from time to time, at 104.214% on March 1, 1999, declining to 100% on March 1, 2002 and thereafter.\nIn the first half of 1994, the Company purchased $9,121,000 principal amount of 7 1\/2% Convertible Debentures, which resulted in an extraordinary gain of approximately $300,000, net of income taxes of approximately $150,000. On October 24, 1994, the Company redeemed its remaining outstanding $6,373,000 principal amount of 7 1\/2% Convertible Debentures, plus paid accrued interest and a slight redemption premium. This redemption resulted in an extraordinary loss of approximately $100,000, net of income taxes of $100,000 in the third quarter of 1994. These purchases and redemptions resulted in a net extraordinary gain of $200,000 ($.02 per share) for the year ended December 31, 1994.\nDiscount and deferred costs relating to various notes and debentures in 1993 were principally being amortized over the original life of those issues. Such amortization of discount and deferred costs was approximately $1,400,000, $2,100,000 and $2,000,000 in 1994, 1993 and 1992, respectively. In the fourth quarter of 1993, as a result of the call for redemption of certain of the Company's indebtedness described above, the Company wrote off approximately $8,100,000 of unamortized deferred debt expense and debt discount and provided a redemption premium of approximately $1,175,000, both of which were recorded\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nas an extraordinary loss.\nAt December 31, 1994, approximately $28,800,000 was available for the payment of cash dividends or stock payments under the terms of the Company's Indenture governing the 9 7\/8% Notes.\nThe Company's Canadian subsidiary has a $14,300,000 secured line of credit, of which approximately $10,550,000 in the aggregate is available to the Company. At December 31, 1994, there was approximately $51,000 outstanding under this secured line of credit bearing interest at rates that approximate the prime rate of interest. The line of credit facility is subject to review in April of each year. The Canadian subsidiary pays a commitment fee of .25% per annum on the unutilized portion of the line of credit payable monthly on a pro rata basis.\nMortgage notes payable include various mortgage notes and other related indebtedness payable in installments through 2009 and bearing interest at rates ranging from 8.4% to 11.5%. Approximately $6,774,000 of such indebtedness is collateralized by property and equipment with an aggregate net book value of approximately $5,254,000 at December 31, 1994.\nOther obligations include borrowings relating to equipment purchases and other borrowings bearing interest from 2% to 12.45% and maturing at various dates through 2001. Approximately $887,000 of such indebtedness is collateralized by property and equipment with an aggregate net book value of approximately $700,000 at December 31, 1994.\nThere were no material short-term borrowings during 1994.\nThe following is a summary of maturities of all of the Company's debt obligations, excluding unamortized debt discount, due after December 31, 1995:\n(Amounts in Thousands) 1996 $ 527 1997 547 1998 549 1999 205 Thereafter 219,755 ------- $221,583 =======\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\n5. Common Stock, Special Common Stock, Stock Options and Deferred Compensation\nEach share of Special Common Stock has 10 votes on all matters submitted to a stockholder vote, except that the holders of Common Stock, voting separately as a class, have the right to elect 25% of the directors to be elected at a meeting, with the remaining 75% being elected by the combined vote of both classes. Shares of Special Common Stock are generally non-transferable, but are freely convertible on a share-for-share basis into shares of Common Stock.\nThe Company has a rights plan which provides for the right to purchase for $75, one one-hundredth of a share of $1.00 par value Series A Participating Preference Stock for each right held. The rights that are not currently exercisable, are attached to each share of Common Stock and may be redeemed by the Directors at $.01 per share at any time. After a shareholder acquires beneficial ownership of 17% or more of the Company's Common Stock and Special Common Stock, the rights will trade separately and become exercisable entitling a rights holder to acquire additional shares of the Company's Common Stock having a market value equal to twice the amount of the exercise price of the right. In addition, after a person or group (\"Acquiring Company\") commences a tender offer or announces an intention to acquire 30% or more of the Company's Common Stock and Special Common Stock, the rights will trade separately and, under certain circumstances, will permit each rights holder to acquire common stock of the Acquiring Company, having a market value equal to twice the amount of the exercise price of the right.\nAt December 31, 1994, a total of 1,584,597 shares of Common Stock was reserved as follows:\nStock option plans 782,500 Conversion of Special Common Stock 802,097 ---------- 1,584,597 =========\nAt December 31, 1994, a total of 43,500 shares of Special Common Stock was reserved for stock option plans.\nThe Company has several stock option plans which provide for the granting of options to certain officers, employees and non-employee directors of the Company. Options granted under the plans vest over periods ranging up to five years and expire from eight to ten years from the date of grant. At December 31, 1994, the total options granted and available for grant under these plans is 782,500, and there were options outstanding covering 494,100 shares of Common and Special Common Stock, of which 261,500 options are currently exercisable.\nOptions for 50,100 and 65,100 shares of Common and Special Common Stock became exercisable during 1994 and 1993, respectively. Proceeds from options exercised are credited to common stock and additional paid-in capital.\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nThe following table summarizes all Common and Special Common Stock option transactions for the three years ended December 31, 1994:\nNumber Option Price of Shares Per Share Total --------- --------- ----- Options outstanding at December 31, 1991 376,500 $2.25-$15.69 $1,593,459 Exercised (85,700) 2.25-2.88 (240,613) Canceled (50,500) 2.25-8.69 (288,008) ------- ----------- --------- Options outstanding at December 31, 1992 240,300 $2.25-$15.69 $1,064,838 Granted 280,000 8.75 2,450,000 Exercised (16,400) 2.25-2.875 (44,000) ------- ----------- --------- Options outstanding at December 31, 1993 503,900 $2.25-$15.69 $3,470,838 Exercised (9,800) 2.875 (28,175) ------- ----------- --------- Options outstanding at December 31, 1994 494,100 $2.25-$15.69 $3,442,663 ======= =========== =========\nOn January 31, 1992, the Company acquired 625,000 shares of its Common Stock in a negotiated transaction for approximately $1,975,000 including expenses. (See Note 4 with respect to limitations on the payment of cash dividends and stock payments.)\n6. Pension, Retirement, Profit Sharing Plans and Post-Retirement Benefits\nThe Company and its subsidiaries have various pension, retirement and profit sharing plans requiring contributions to qualified trusts and union administered funds. Pension and profit sharing expense charged to operations aggregated approximately $2,883,000 in 1994, $1,683,000 in 1993 and $2,130,000 in 1992. The Company's policy is to fund currently the actuarially determined annual contribution.\nThe Company's net pension expense for its defined benefit plans for 1994, 1993 and 1992 consists of the following components: Year Ended December 31, ----------------------- 1994 1993 1992 ---- ---- ---- (Amounts in Thousands)\nService costs $1,647 $1,685 $1,584 Interest cost 2,261 1,989 1,967 Actual net income on plan assets (2,155) (3,295) (3,173) Net amortization and deferred items 10 822 1,070 ----- ----- ----- $1,763 $1,201 $1,448 ===== ===== =====\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nThe following tables set forth the funded status of the Company's defined benefit plans and amounts recognized in the Company's consolidated balance sheet at December 31, 1994 and 1993: Plan Assets Exceeding Benefit Obligation ------------------ 1994 1993 ---- ---- (Amounts in Thousands) Actuarial present value of benefit obligations at September 30: Vested benefits $18,149 $17,799 Non-vested benefits 630 434 ------ ------ Accumulated benefit obligation 18,779 18,233 Effect of projected future compensation levels 5,373 5,936 ------ ------ Projected benefit obligation 24,152 24,169 Plan assets at fair value at September 30 24,486 24,055 ------ ------ Plan assets in excess of (less than) the projected benefit obligation 334 (114) Unrecognized net loss 5,401 7,294 Unrecognized net assets (2,412) (2,971) Unrecognized prior service costs (129) 312 ------ ------ $ 3,194 $ 4,521 ====== ======\nAccumulated Benefit Obligation Exceeding Plan Assets --------------------- 1994 1993 ==== ==== (Amounts in Thousands) Actuarial present value of benefit obligations at September 30: Vested benefits $ 4,199 $ 4,221 Non-vested benefits 232 305 ------ ------ Accumulated benefit obligation 4,431 4,526 Effect of projected future compensation levels --- --- ------ ------ Projected benefit obligation 4,431 4,526 Plan assets at fair value at September 30 3,691 3,678 ------ ------ Plan assets less than the projected benefit obligation (740) (848) Unrecognized net loss 807 806 Unrecognized prior service costs 602 652 Additional minimum liability (1,409) (1,458) ------ ------ $ (740) $ (848) ====== ======\nPlan assets include commingled funds, marketable securities, insurance contracts and cash and short-term investments. 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 8 percent and 5 1\/2 percent, respectively, in 1994, 7 1\/8 percent and 5 1\/2 percent, respectively, in 1993 and 8 percent and 6 percent, respectively, in 1992. The expected long-term rate of return on assets was 8 1\/2 percent in 1994 and 1993 and 9 1\/2 percent in 1992.\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nIn 1994 and 1993, a minimum pension liability and an intangible asset for certain plans was recognized, resulting in a reduction in the Company's stockholders' investment of approximately $672,000 and $806,000, respectively.\nOn January 1, 1993, the Company adopted the accounting requirements of Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Post-Retirement Benefits Other Than Pensions\" and recorded, as a charge to operations, the accumulated post-retirement benefit obligation (\"APBO\") of approximately $3,100,000, before income tax credit of approximately $1,000,000 ($.17 per share, net of tax), as the cumulative effect of an accounting change. Previously, health care and related benefits for qualified active and retired beneficiaries were charged to operating results in the period that such benefits were paid. The remaining liability of approximately $1,200,000 at December 31, 1994 related to these benefits is not significant to the Company's financial position.\n7. Commitments and Contingencies\nThe Company provides accruals for all direct and indirect costs associated with the estimated resolution of contingencies at the earliest date at which the incurrence of a liability is deemed probable and the amount of such liability can be reasonably estimated.\nAt December 31, 1994, the Company and its subsidiaries are obligated under lease agreements for the rental of certain real estate and machinery and equipment used in its operations. Minimum annual rental expense aggregates approximately $26,598,000 at December 31, 1994. The obligations are payable as follows:\n1995 $ 4,130,000 1996 3,393,000 1997 2,907,000 1998 2,596,000 1999 1,880,000 Thereafter 11,692,000\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nCertain of these lease agreements provide for increased payments based on changes in the consumer price index. Rental expense, from continuing operations in the accompanying consolidated statement of operations, excluding Dixieline, for the years ended December 31, 1994, 1993 and 1992 was approximately $7,000,000, $6,600,000 and $8,700,000, respectively. Under certain of these lease agreements, the Company and its subsidiaries are also obligated to pay insurance and taxes.\nDuring 1992, a former subsidiary of the Company (sold in 1984) defaulted on certain principal and interest payments relating to obligations under which the Company was contingently liable. In March 1994, the Company paid approximately $1,594,000 of interest payments through that date on such obligations. In the third and fourth quarter of 1994, the Company purchased, at a slight discount, approximately $6,640,000 principal amount of such obligations (consisting of all of such obligations) from several holders. The Company did not record any losses in 1994 in connection with the settlement of these contingent obligations.\nIn July 1992, derivative litigation against the Company and its directors challenging the transactions involving the retirement in 1990 of the Company's former Chairman was settled. In connection with the settlement, the Company recorded a net after-tax gain on discontinued operations, in the third quarter, of approximately $900,000 ($.07 per share).\nThe Company is subject to other contingencies, including additional legal proceedings and claims arising out of its businesses that cover a wide range of matters, including, among others, environmental matters, contract and employment claims, product liability, warranty and modification, adjustment or replacement of component parts of units sold, which may include product recalls. The Company has used various substances in its products and manufacturing operations which have been or may be deemed to be hazardous or dangerous, and the extent of its potential liability, if any, under environmental, product liability and worker's compensation statutes, rules, regulations and case law is unclear. Further, due to the lack of adequate information and the potential impact of present regulations and any future regulations, there are certain circumstances in which no range of potential exposure may be reasonably estimated.\nWhile it is impossible to ascertain the ultimate legal and financial liability with respect to contingent liabilities, including lawsuits, the Company believes that the aggregate amount of such liabilities, if any, in excess of amounts provided, will not have a material adverse effect on the consolidated financial position or results of operations of the Company.\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\n8. Operating Segment Information and Concentration of Credit Risk\nThe Company operates in one industry segment, Residential and Commercial Building Products. No single customer accounts for 10% or more of consolidated net sales. More than 90% of net sales and identifiable segment assets are related to the Company's domestic operations.\nFinancial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments and trade receivables. The Company places its temporary cash investments with high credit quality financial institutions and 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 geographical regions. At December 31, 1994, the Company had no significant concentrations of credit risk.\n9. Businesses Sold\nOn March 31, 1994, the Company sold all the capital stock of Dixieline for approximately $18,800,000 in cash and $6,000,000 in preferred stock of the purchaser. In the third quarter of 1993, the Company provided a valuation reserve of approximately $20,300,000 ($1.19 per share, net of tax) to reduce the Company's net investment in Dixieline to estimated net realizable value. No additional loss in 1994 was incurred in connection with this sale. In January 1995, the Company paid approximately $1,750,000 ($.14 per share, net of tax) as a final purchase price adjustment related to one of its businesses sold and recorded a charge to earnings in the fourth quarter of 1994.\nThe following table presents the approximate unaudited pro forma operating results of the Company for the year ended December 31, 1994 and December 31, 1993, as adjusted for the debt financing, debt redemptions (see Note 4) and the pro forma effect of businesses sold including the sale of Dixieline:\nYear Ended December 31, ----------------------- 1994 1993 ---- ---- (Amounts in Thousands except per share amounts)\nNet sales $737,160 $660,908 Earnings from continuing operations 19,900 3,500 Fully diluted earnings per share 1.55 .28\nIn computing the pro forma earnings from continuing operations, interest expense on the indebtedness redeemed during the period that such indebtedness was outstanding was excluded from operating results at an average interest rate of approximately 13.5% (including amortization of debt discount and deferred debt expense) for the periods presented, net of the tax effect. Interest expense was included on the Notes at a rate of approximately 9 7\/8%, plus amortization of deferred debt expense and debt discount, for the periods presented, net of tax effect. The net after-tax loss recorded in the third quarter of 1993 from the valuation reserve recorded to reduce the Company's net investment in Dixieline to\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nnet realizable value and the $1,750,000 in 1994, noted above, was also excluded. Investment income was assumed earned on the remaining cash proceeds from the debt financing at a rate of 3.5%. No investment income was assumed earned on the proceeds from the sale of Dixieline.\nOn January 2, 1992, the Company's Dixieline Products, Inc. subsidiary sold the assets, subject to certain liabilities of its subsidiary, L. J. Smith, Inc. (\"L. J. Smith\") for approximately $24,000,000. The Company recorded a pre-tax gain on the sale of L. J. Smith of approximately $8,000,000 ($.34 per share, net of tax) in the first quarter of 1992. On October 2, 1992, the Company sold all of the capital stock of its wholly-owned subsidiary, Bend Millwork Systems, Inc. (\"Bend\") for approximately $17,200,000 in cash and recorded a pre-tax loss on sale in the third quarter of 1992 of approximately $20,500,000 ($1.43 per share, net of tax). In the fourth quarter of 1992, the Company provided additional reserves of approximately $2,000,000 ($.17 per share, net of tax) in connection with the sale of Bend related to purchase price negotiations and settlements.\nThe combined unaudited net sales and pre-tax loss for all businesses sold in 1993 and 1992 included in the consolidated statement of operations of the Company were approximately $83,205,000 and $600,000, respectively, for the year ended December 31, 1993, and approximately $187,700,000 and $2,250,000, respectively, for the year ended December 31, 1992.\n10. Discontinued Operations\nResults of discontinued operations include other income and expense items relating to businesses discontinued in prior years, including an increase in reserves of approximately $1,400,000 in the third quarter and $5,000,000 in the fourth quarter of 1992.\n11. Net Gain (Loss) on Investment and Marketable Securities\nOn January 1, 1994, the Company adopted the accounting requirements of SFAS No. 115 \"Accounting for Certain Investments in Debt and Equity Securities\", and recorded as income the accumulated unrealized marketable security reserve recorded at December 31, 1993 of approximately $400,000 ($.03 per share) as the cumulative effect of an accounting change. Under the new accounting method, the Company will record unrealized gains or losses on such investment securities as adjustments to stockholders' investment. Previously, such gains or losses were recorded in the Company's statement of operations. At December 31, 1994, the reduction in the Company's stockholders' investment under the new accounting method for gross unrealized losses was approximately $3,379,000. At December 31, 1994, there were no gross unrealized gains on the Company's marketable securities. Prior periods have not been restated.\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nThe Company's marketable securities at December 31, 1994 consist of U. S. Government Treasury Notes due as follows: Fair Principal Market Due Amount Cost Value ------ ---- ----- (Amounts in Thousands)\n1-5 years $16,000 $16,004 $14,712 5-10 years 15,000 15,349 13,262 ------ ------ ------ $31,000 $31,353 $27,974 ====== ====== ======\nIn 1994, there were no realized gains or losses on marketable securities.\nDuring 1993, the Company recorded a pre-tax gain on investment and marketable securities of $1,000,000 ($.05 per share, net of tax) in the first quarter, a pre-tax gain of $450,000 ($.02 per share, net of tax) in the second quarter, a $900,000 pre-tax gain ($.05 per share, net of tax) in the third quarter and a pre-tax loss of $700,000 ($.04 per share, net of tax) in the fourth quarter.\nDuring 1992, the Company recorded a pre-tax loss on investment and marketable securities of $500,000 ($.03 per share, net of tax) in the first quarter, a pre- tax gain of $850,000 ($.04 per share, net of tax) in the second quarter, a $1,050,000 pre-tax gain ($.06 per share, net of tax) in the third quarter and a pre-tax loss of $550,000 ($.04 per share, net of tax) in the fourth quarter.\n12. Selling, General and Administrative Expense\nDuring 1994, the Company incurred net after-tax charges of approximately $6,600,000 principally relating to expenses of certain cost reduction activities and manufacturing process improvements in each of the Company's operating groups, marketing expenses as a result of competitive conditions and expenses of certain litigation and other matters in dispute. The effect of these costs and expenses was partially offset in the second quarter of 1994 by approximately $1,900,000 of after-tax income resulting from the settlement of certain insurance claims and disputes. Net after-tax charges of approximately $1,500,000 in 1993 were incurred in connection with cost reduction activities and manufacturing process improvements.\nIn the fourth quarter of 1993, the Company's Plumbing Products Group recorded a pre-tax loss of approximately $2,800,000 ($.15 per share, net of tax) in connection with the restructure of certain product lines. In the third quarter of 1993, the Company recorded a pre-tax loss of approximately $1,600,000 ($.08 per share, net of tax) as a result of the sale in October 1993 of certain real property and provided a pre-tax reserve of approximately $700,000 ($.04 per share, net of tax) in connection with the consolidation of certain of its manufacturing facilities.\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\n13. Accrued Expenses and Taxes, Net\nAccrued expenses and taxes, net, consist of the following at December 31, 1994 and 1993: December 31, ------------- 1994 1993 ---- ---- (Amounts in Thousands)\nInterest $ 7,446 $ 4,759 Insurance 23,483 17,677 Payroll, management incentive and accrued employee benefits 14,609 11,647 Businesses sold or discontinued 1,750 8,650 Other, net 50,721 48,689 ------- ------ $98,009 $91,422 ======= ======\n14. Summarized Quarterly Financial Data (Unaudited)\nThe following summarizes unaudited quarterly financial data for the years ended December 31, 1994 and December 31, 1993:\nFor the Quarters Ended ---------------------- April 2 July 2 Oct. 1 Dec. 31 ------- ------- ------ ------- (In Thousands Except Per Share Amounts) Net sales $169,020 $193,722 $197,012 $177,406 Gross profit 49,718 57,678 58,075 51,361 Earnings from continuing operations 700 5,500 6,400 4,600\nNet earnings 1,500 5,400 6,300 4,600\nEarnings per share from continuing operations: Primary .06 .44 .50 .36 Fully diluted .06 .43 .50 .36\nNet earnings per share: Primary .12 .43 .49 .36 Fully diluted .12 .42 .49 .36\nNortek, Inc. and Subsidiaries Notes to Consolidated Financial Statements (Continued)\nFor the Quarters Ended ---------------------- April 3 July 3 Oct. 2 Dec. 31 ------- ------- ------ ------- (In Thousands Except Per Share Amounts) Net sales $178,707 $195,058 $202,030 $168,318 Gross profit 49,545 54,665 56,985 50,430 Earnings (loss) from continuing operations (1,400) 1,500 (12,900) 200\nNet earnings (loss) (3,500) 1,500 (12,900) (5,900)\nEarnings (loss) per share from continuing operations: Primary (.11) .12 (1.03) .02 Fully diluted (.11) .12 (1.03) .02\nNet earnings (loss) per share: Primary (.28) .12 (1.03) (.47) Fully diluted (.28) .12 (1.03) (.47)\nThe Company's earnings (loss) from continuing operations in 1993 includes an approximate $14,900,000 net after-tax loss ($1.19 per share) in the third quarter relating to a valuation reserve to reduce the Company's investment in Dixieline to estimated net realizable value. (See Notes 1 and 9.) The net earnings (loss) in 1993 also includes an approximate $2,100,000 net after-tax loss ($.17 per share) related to the cumulative effect of an accounting change in the first quarter (see Note 6), and an approximate $6,100,000 after-tax extraordinary loss ($.49 per share) in the fourth quarter related to the call for debt redemption in the first quarter of 1994. (See Note 4.)\nSee Notes 4, 6, 9, 11 and 12 regarding certain other quarterly transactions included in the operating results in the above table.\nLower net sales in 1994 and 1993, as compared to the prior year principally reflect the effect of businesses sold, partially offset by increased net sales of ongoing operations, in part, resulting from the overall improvement in the residential housing market. (See Management's Discussion and Analysis of Financial Condition and Results of Operations).\nReport of Independent Public Accountants\nTo Nortek, Inc.:\nWe have audited the accompanying consolidated financial statements of Nortek, Inc. (a Delaware corporation) and subsidiaries listed in Item 14(a)(1) of this Form 10-K. These financial statements and the schedule referred to below 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 financial position of Nortek, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs explained in Note 6 to the consolidated financial statements, effective January 1, 1993, the Company changed its method of accounting for post- retirement benefits other than pensions. As explained in Note 11 to the consolidated financial statements, effective January 1, 1994, the Company changed its method of accounting for marketable securities.\nOur audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in Item 14(a)(2) is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states 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 LLP\nBoston, Massachusetts, February 28, 1995\nSCHEDULE II\nNORTEK, INC. AND SUBSIDIARIES VALUATION AND QUALIFYING ACCOUNTS\nBALANCE CHARGED AT TO COSTS CHARGED DEDUCTIONS BALANCE BEGINNING AND TO OTHER FROM AT END CLASSIFICATION OF YEAR EXPENSES ACCOUNTS RESERVES OF YEAR - -------------- --------- -------- -------- ---------- ------- (Amounts in Thousands)\nFor the year ended December 31, 1992:\nAllowances for doubtful accounts and sales allowances $4,633 $2,362 $ (573)(b)$(2,354)(a) $4,068 ===== ===== ===== ====== =====\nFor the year ended December 31, 1993:\nAllowances for doubtful accounts and sales allowances $4,068 $1,832 $ (125)(c)$(1,577)(a) $4,198 ===== ===== ===== ====== =====\nFor the year ended December 31, 1994:\nAllowances for doubtful accounts and sales allowances $4,198 $ 762 $ 147 (d)$(1,077)(a) $4,030 ===== ===== ===== ====== =====\n(a) Amounts written off, net of recoveries. (b) Sale of businesses. (c) Transfer of allowances for doubtful accounts of Dixieline to current assets of business held for sale. (d) Other\nEXHIBIT INDEX\nExhibits marked with an asterisk are filed herewith. The remainder of the exhibits have heretofore been filed with the Commission and are incorporated herein by reference. Exhibits marked with a double asterisk identify each management contract or compensatory plan or arrangement.\n3.1 Restated Certificate of Incorporation of Nortek, Inc. (Exhibit 2 to Form 8-K filed April 23, 1987, File No. 1-6112).\n3.2 Amendment to Restated Certificate of Incorporation of Nortek, Inc. effective May 10, 1989 (Exhibit 3.2 to Form 10-K filed March 30, 1990, File No. 1-6112).\n3.3 By-laws of Nortek, Inc. (as amended through November 30, 1993) (Exhibit 3.3 to Form 10-K filed March 25, 1994, File No. 1-6112).\n4.1 Rights Agreement dated as of March 31, 1986 as amended and restated as of March 18, 1991 between the Company and State Street Bank and Trust Company, as Rights Agent (Exhibit 1 to Form 8-K filed March 26, 1991, File No. 1-6112).\n4.2 Amendment No. 1 dated as of October 6, 1993 to Amended and Restated Rights Agreement dated as of March 18, 1991 (Exhibit 1 to Form 8-K filed October 12, 1993, File No. 1-6112).\n4.3 Indenture dated as of February 14, 1994 between the Company and State Street Bank and Trust Company, as Trustee, relating to the 9 7\/8% Senior Subordinated Notes due 2004 (Exhibit 4.5 to Form 10-K filed March 25, 1994, File No. 1-6112).\n**10.1 Employment Agreement between Richard L. Bready and the Company, dated as of January 1, 1984 (Exhibit 10.2 to Form 10-K filed March 31, 1986, File No. 1-6112).\n**10.2 Amendment dated as of March 3, 1988 to Employment Agreement between Richard L. Bready and the Company dated as of January 1, 1984 (Exhibit 19.2 to Form 10-Q filed May 17, 1988, File No. 1-6112).\n**10.3 Second Amendment dated as of November 1, 1990 to Employment Agreement between Richard L. Bready and the Company dated as of January 1, 1984 (Exhibit 10.3 to Form 10-K filed April 1, 1991, File No. 1-6112).\n**10.4 Deferred Compensation Agreement dated March 7, 1983 between Richard L. Bready and the Company (Exhibit 10.4 to Registration Statement No. 33-69778 filed February 9, 1994).\n**10.5 Deferred Compensation Agreement dated March 7, 1983 between Almon C. Hall and the Company (Exhibit 10.5 to Registration Statement No. 33-69778 filed February 9, 1994.\n**10.6 Deferred Compensation Agreement dated March 7, 1983 between Richard J. Harris and the Company (Exhibit 10.6 to Registration Statement No. 33-69778 filed February 9, 1994).\n**10.7 1984 Stock Option Plan, as amended through May 27, 1987 (Exhibit 28.2 to Registration Statement No. 33-22527 filed June 15, 1988).\n**10.8 Change in Control Severance Benefit Plan for Key Employees adopted February 10, 1986, and form of agreement with employees (Exhibit 10.19 to Form 10-K filed March 31, 1986, File No. 1-6112).\n**10.9 1987 Stock Option Plan (Exhibit 28.3 to Registration Statement No. 33-22527 filed June 15, 1988).\n**10.10 Form of Indemnification Agreement between the Company and its directors and certain officers (Appendix C to Proxy Statement dated March 23, 1987 for Annual Meeting of Nortek Stockholders, File No. 1-6112).\n**10.11 1988 General Stock Option Plan (Appendix A to Proxy Statement dated April 1, 1988 for Annual Meeting of Nortek Stockholders, File No. 1-6112).\n**10.12 1988 General Stock Option Plan III (Appendix C to Proxy Statement dated April 12, 1989 for Annual Meeting of Nortek Stockholders, File No. 1-6112).\n10.13 Registration Rights Agreement dated as of October 31, 1990 between the Company and Bready Associates (Exhibit 4 to Schedule 13D filed November 13, 1990 by Bready Associates relating to the Common Stock, par value $1.00 per share, of the Company).\n**10.14 1990 General Stock Option Plan (Appendix A to Proxy Statement dated April 17, 1991 for Annual Meeting of Nortek Stockholders, File No. 1-6112).\n*11.1 Calculation of Shares Used in Determining Earnings Per Share.\n*21.1 List of subsidiaries.\n*23.1 Consent of Independent Public Accountants\n*27.1 Financial Data Schedule.","section_15":""}
{"filename":"860521_1994.txt","cik":"860521","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nMarine Drilling Companies, Inc. (collectively with its subsidiaries, the \"Company\") was incorporated in Texas in January 1990. Since 1966, the Company or its predecessors has been engaged in offshore contract drilling of oil and gas wells for independent and major oil and gas companies. As of March 6, 1995, the Company owned and operated a fleet of thirteen mobile offshore jack-up drilling rigs, consisting of four independent leg cantilever jack-ups and nine mat supported jack-ups. On that date, eleven of the Company's thirteen rigs were located in the U.S. Gulf of Mexico, one was in the Bay of Campeche and one was in transit to the U.S. Gulf of Mexico from Southeast Asia. The Company currently derives substantially all of its revenues from offshore drilling in the U.S. Gulf of Mexico and in the Bay of Campeche. The Company's rigs could, with certain modifications, work in other areas, however, the Company's rigs are not suitable for those areas, such as the North Sea, that require hostile environment operating capabilities.\nThe Company's strategy is to strive to maintain its position as a significant provider of offshore drilling services in its present markets and to continue to diversify, insofar as financially and operationally practicable, into other international offshore drilling markets. The Company also intends to seek business combinations and to make acquisitions of additional drilling rigs which, over the long term, the Company believes will benefit its shareholders.\nThe Company was significantly restructured and recapitalized in 1992 and early 1993 (the \"Recapitalization\"). See Item 7 \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- The Recapitalization\" for further information.\nINDUSTRY CONDITIONS AND COMPETITION\nDemand for offshore drilling services is primarily driven by the economics of oil and gas exploration, development and production, which in turn, are closely tied to oil and gas prices. Since the mid-1980's oil and gas prices have been volatile and generally lower than prices experienced during the early 1980's. As a result, demand for offshore drilling services has been volatile and generally lower than during the early 1980's. In addition, during the late 1970's and early 1980's, the industry built a substantial number of new offshore drilling rigs. The combination of (i) generally lower oil and gas prices, (ii) increased rig supply and (iii) lower demand for offshore drilling services has resulted in many periods of depressed pricing and utilization for most of the world's offshore drilling markets.\nPricing and rig water depth capabilities are generally the most important competitive factors in the drilling industry. Other competitive factors include the technical capabilities of specialized drilling equipment and personnel, operational experience, rig suitability, efficiency, equipment condition, safety record, reputation and customer relations. The Company believes that it competes favorably with respect to these factors.\nThe magnitude of the Company's contract drilling revenues is dependent upon rig utilization and pricing. These variables are affected by competitive conditions and the amount of exploration and development activity conducted by oil and gas companies. As previously stated, this activity is strongly influenced by the current and projected prices of oil and natural gas. To provide a recent historical perspective, oil and gas prices for 1990 through 1994 are set forth in the following graph:\nOIL AND NATURAL GAS PRICES\n[GRAPH]\nFive year history of Oil and Natural Gas Prices by quarters from January 1, 1990 through December 31, 1994.\nSource: Offshore Data Services Natural Gas Prices -- Offshore Louisiana Spot Gas Oil Prices -- West Texas Intermediate\nWorldwide Offshore Market Conditions\nAs the following graph illustrates, from the beginning of 1992 to the end of 1994, the number of jack-up rigs available worldwide has declined only slightly (approximately 2.5%). Jack-up rig demand during that period has varied from a low of 257 rigs (64% utilization) during the second quarter of 1992 to a high of 312 rigs (80% utilization). During 1994, the average worldwide supply, demand and utilization of jack-up rigs was 391, 296 and 75%, respectively, as compared to 1993 during which these statistics were 393, 308 and 78%, respectively. Although it would appear that the small variance between the statistics for 1994 and 1993 might imply a minimal decrease in day rates in 1994, other trends emerge due to the mobile nature of jack-up rigs. As discussed later in this section, there was a significant movement of jack-up rigs during 1993 and 1994 into the U.S. Gulf of Mexico from other worldwide drilling markets. These mobilizations generally occurred for two reasons -- (i) strong natural gas prices throughout 1993 and early 1994 led to increased demand for jack-ups in the U.S. Gulf of Mexico and (ii) oil prices were generally weak during the latter half of 1993 and the first quarter of 1994 which had a depressing effect on the demand for drilling services in many jack-up markets outside the U.S. Gulf of Mexico.\nThe following graph includes data regarding worldwide jack-up rig supply (including non-marketed rigs), demand and utilization for 1992 through 1994:\nWORLDWIDE JACK-UP RIG STATISTICS\n[GRAPH]\nStatistics for Jack-Up Rigs Worldwide consisting of the total rigs, working rigs, and rig utilization by quarters from January 1, 1992 through December 31, 1994.\nSource: Offshore Data Services\nDue to the extremely competitive nature of the offshore drilling business, changes in the demand for drilling services among different markets cause many drilling contractors to react by moving several rigs away from their weaker markets to stronger markets, thereby creating an increased supply of rigs in the stronger market. This increased rig supply in the stronger market will quickly cause day rates to deteriorate unless rig demand increases at or above the rate of growth in rig supply. It seems that the participants in the offshore drilling industry often have a tendency to move too many rigs into the stronger market -- causing it to suffer utilization and day rate deterioration. The tendency of the offshore drilling industry to \"over-mobilize\" rigs among markets has been exacerbated by the volatile nature of oil and gas prices since the mid-1980's. As the prices of these commodities fluctuate, oil and gas companies quickly adjust their drilling budgets to reflect the changed economics of exploration and production. Thus, a drilling market which is driven primarily by the exploration and production of only one of those commodities will generally see a change in the demand for drilling services triggered by the change in the price of the underlying commodity. These changes in demand for drilling services often occur quickly and can have significant magnitude. For example, the weak price of natural gas during most of 1991 and early 1992 had a significant depressing effect on jack-up demand during 1991 and early 1992.\nDuring the periods discussed herein, the Company operated primarily in the U.S. Gulf of Mexico and the Bay of Campeche, offshore Mexico. These markets are further discussed below. The profitability of offshore drilling in these markets, as well as most of the world's offshore drilling markets, has been volatile since the mid-1980's and is expected to remain volatile until the supply of jack-up rigs and demand therefor move closer to equilibrium levels. The Company is unable to predict future oil and gas prices or future levels of offshore drilling activity.\nU.S. Gulf of Mexico\nThe following graphs illustrate the relationship among working jack-up rigs, jack-up rig utilization and jack-up rig supplies based upon all rigs, as well as \"marketed\" rigs.\nU.S. GULF OF MEXICO JACK-UP RIG STATISTICS -- ALL RIGS\n[GRAPH]\nStatistics for Jack-Up Rigs in the U.S. Gulf of Mexico consisting of the total rigs, working rigs, and rig utilization by quarters from January 1, 1992 through December 31, 1994.\nSource: Offshore Data Services\nU.S. GULF OF MEXICO JACK-UP RIG STATISTICS -- MARKETED RIGS\n[GRAPH]\nStatistics for marketed Jack-Up Rigs in the U.S. Gulf of Mexico consisting of the marketed rigs, working rigs, and rig utilization by quarters from January 1, 1992 through December 31, 1994.\nSource: Offshore Data Services\nThe jack-up drilling market in the U.S. Gulf of Mexico is highly competitive. A significant number of offshore drilling companies have rigs in this market and, as a result, no one contractor is able to materially affect pricing levels. Indeed, day rates can and have exhibited major changes on relatively small changes in the rig supply and demand situation in this market.\nAs illustrated in the preceding graphs, since 1992, demand for jack-up rigs in this market has shown general improvement. Day rates during this period generally increased until late 1993, however, they began to decline thereafter. The decline in day rates during 1994 was due primarily to the supply of marketed jack-up rigs growing faster than the rate of growth of jack-up rig demand. The \"Marketed Rigs\" graph illustrates the variance in the growth in the supply of marketed rigs versus working rigs. As noted on that graph, during 1992, 1993 and 1994, the average utilization of marketed rigs was approximately 71%, 90% and 81%, respectively. The growth in the marketed jack-up rig supply was due to two factors -- (i) net rig mobilizations into this market and (ii) reactivations (primarily during 1993) of previously noncompetitive rigs.\nIn late 1994 and early 1995, the price of natural gas continued to deteriorate due to a mild winter in the U.S. As a result, jack-up rig demand in the U.S. Gulf of Mexico has shown a significant decline since year-end 1994. According to Offshore Data Services, as of February 28, 1995, there were 141 jack-up rigs in the U.S. Gulf of Mexico of which 90 were contracted (a 64% utilization rate). Day rates during early 1995 have also deteriorated and may decline further. Moreover, as previously discussed, jack-up rigs are mobile and competitors could move additional rigs from other markets to the U.S. Gulf of Mexico. In addition, there are additional non-marketed rigs stacked in the U.S. Gulf of Mexico which, subject to some expenditure, have been or could be reactivated. Such movement or reactivation could further depress pricing levels.\nBay of Campeche, Offshore Mexico\nBAY OF CAMPECHE JACK-UP RIG STATISTICS\n[GRAPH]\nStatistics for Jack-Up Rigs in the Bay of Campeche, Offshore Mexico, consisting of the total rigs, working rigs, and rig utilization by quarters from January 1, 1992 through December 31, 1994.\nSource: Offshore Data Services\nThe Bay of Campeche drilling market experienced rapid growth in rig demand during the period from late 1992 to mid-1993. Since that time, the market has shown general deterioration. The Company was able to contract two of its rigs (the MARINE 301 and MARINE 303) into this market in late 1992 and another in mid-1993. The first two rigs completed their contracts in late 1993 and early 1994, respectively, and subsequently returned to the U.S. Gulf of Mexico. The third rig (the MARINE 300) continues to operate in this market at the present time pursuant to extensions of the initial contract. The Company currently expects that contract to expire in June 1995 and intends, if no additional jobs are available in this market at that time, to mobilize that rig to the U.S. Gulf of Mexico or other international markets.\nAll of the rigs in the Bay of Campeche are performing drilling services for Petroleos Mexicanos (\"Pemex\"), the national oil company of the Republic of Mexico. Of the rigs working for Pemex in the Bay of Campeche, some are subject to contracts between the respective drilling contractors and Pemex and the other rigs are working for turnkey companies which, in turn, have entered into turnkey drilling contracts with Pemex. The MARINE 300 is contracted to Industrial Perforadora, S.A. de CV (\"IPC\") which, in turn, is supplying the rig and its services to Pemex pursuant to a contract between Pemex and IPC.\nRecently, Mexico's currency, the peso, has suffered a significant devaluation. If this devaluation were to adversely affect Pemex's drilling programs, the demand for jack-up rigs in this market could further deteriorate. The Company is unable at this time to predict the effect of this occurrence on the Company's operations.\nThe following table sets forth certain industry and Company historical data for the periods indicated:\n(1) Average of weekly data published by Offshore Data Services.\n(2) The numbers included in the table represent the average number of rigs (rounded to the nearest whole number) operated by the Company for the periods indicated.\n(3) From January 1 to March 12, 1990, the Company operated 16 rigs. In March 1990, the Company acquired four additional rigs and assumed charter agreements covering three additional rigs. The Company's rig fleet was substantially reduced during 1991 and 1992. See Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nRIG FLEET\nAll of the Company's rigs are jack-up rigs, which are mobile self-elevating drilling platforms equipped with legs that can be lowered to the ocean floor until a foundation is established to support the drilling platform. The Company owns and operates thirteen rigs, nine of which are mat supported rigs (i.e., they have a lower hull attached to the rig legs) and four are of independent leg design. Five of the mat supported rigs and one of the independent leg rigs are slot type jack-up units which are configured for the drilling operations to take place through a slot in the hull. The Company's other four mat supported rigs and three of the independent leg rigs have a cantilever feature which allows the extension of the drilling equipment over a customer's platform to perform development drilling or workover operations. The Company's rigs are currently capable of drilling to depths of 20,000 to 30,000 feet in maximum water depths ranging from 200 to 300 feet. Three of the Company's rigs are presently configured to work in international markets outside the U.S. Gulf of Mexico. The Company's other rigs could, if applicable modifications were made and certifications obtained, operate in certain non-hostile areas outside of their current markets. The Company believes that all of its rigs are in good operating condition and have been well maintained.\n[PICTURE]\nMat Supported Rig -- This type of rig consists of a floating upper hull with three legs which are attached to a lower hull commonly referred to as a mat. After being towed to the drilling location, the legs are lowered until the mat contacts the seabed and the upper hull is jacked to the desired elevation above sea level. One advantage of mat supported rigs is the ability to operate in areas having soft seabed conditions where independent leg rigs are prone to have excessive penetration and subject to leg damage.\nIndependent Leg Rig -- This type of rig consists of a floating hull with three independent elevated legs. After being towed to the drilling location, the legs are lowered until they penetrate the seabed and the hull is jacked to the desired elevation above sea level.\n[PICTURE]\nThe following table describes the Company's drilling rigs as of February 24, 1995:\n(a) Can be modified to provide for 300 foot water depth capacity. (b) Designed to operate in environmentally sensitive areas such as Mobile Bay. (c) Equipped with top drive drilling system. (d) Configured for international operations. (e) Year of construction -- 1976 (f) In transit from Singapore to the U.S. Gulf of Mexico (g) Year of construction -- 1969 * Friede & Goldman. ** Marathon LeTourneau\nThe Company's fleet was substantially reduced in 1991 and 1992, during which the Company reduced the number of rigs from twenty-one to eleven. See Item 7 \" -- The Recapitalization.\" In August 1993, the Company acquired and refurbished the MARINE 304. Later in 1993, the Company refurbished and reactivated the MARINE 225 (previously named the MARINE 1). During the fourth quarter of 1994, the Company acquired the MARINE 3 (which the Company had chartered from its former owner since early 1993) for approximately $5,500,000. In addition, the Company acquired the MARINE 201 in December 1994 for approximately $7,000,000.\nOTHER PROPERTY\nThe Company leases approximately 28,000 square feet of office space in Sugar Land, Texas for its headquarters. Due to the pending expiration of this lease in May 1995, the Company has leased approximately 19,000 square feet in an office building in Sugar Land and plans to move thereto in April 1995. In addition, the Company leases a warehouse, storage and repair facility, including approximately 31 acres of land and 60,000 square feet of buildings, in Rosharon, Texas (near Houston).\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nGENERAL\nVarious claims have been filed against the Company and its subsidiaries in the ordinary course of business, particularly claims alleging personal injuries. Management believes that the Company has established adequate reserves for any liabilities which may reasonably be expected to result from these claims. In the opinion of management, no pending claims, actions or proceedings against the Company or its subsidiaries are expected to have a material adverse effect on its financial position or 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 the fiscal year covered by this report.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS\nThe Company's common stock, par value $.01 per share (the \"Common Stock\"), trades on the Nasdaq Stock Market under the symbol \"MDCO.\" The following table sets forth the range of high and low sale prices per share of the Common Stock as reported by the Nasdaq Stock Market for the periods indicated.\nThe last sale price of the Common Stock as reported by the Nasdaq Stock Market on March 6, 1995 was $2 5\/8 per share and there were approximately 500 holders of record.\nThe Company has not paid cash dividends on its Common Stock in the past and does not intend to pay dividends on the Common Stock in the foreseeable future. See Item 7 \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and the Consolidated Financial Statements and Notes thereto included in Item 8 of this report.\nITEM 6.","section_6":"ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA\nThe following table sets forth selected consolidated financial data of the Company as of and for each of the periods indicated. The selected financial data for each of the five years in the period ended December 31, 1994 are derived from the Company's audited consolidated financial statements. The information presented below should be read in conjunction with Item 7","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION -- GENERAL\nThe following is a discussion of the Company's financial condition, results of operations, historical financial resources and working capital. This discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto included in Item 8","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Marine Drilling Companies, Inc.:\nWe have audited the consolidated financial statements of Marine Drilling Companies, Inc. and subsidiaries as listed in Item 14 on page 44. In connection with our audits of the consolidated financial statements, we also have audited the financial statement schedules as listed in Item 14 on page 44. 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 Marine Drilling Companies, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, 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 LLP\nHouston, Texas February 3, 1995\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)\nSee notes to consolidated financial statements. MARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE DATA)\nSee notes to consolidated financial statements. MARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE DATA)\nYEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nSee notes to consolidated financial statements. MARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)\n[Continued]\nSee notes to consolidated financial statements. MARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS -- (CONTINUED) (IN THOUSANDS, EXCEPT SHARE DATA)\nSee notes to consolidated financial statements. MARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN THOUSANDS, EXCEPT SHARE DATA)\n(1) BASIS OF PRESENTATION AND RECAPITALIZATION TRANSACTIONS\nBasis of Presentation\nReferences herein to the \"Company\" refer to Marine Drilling Companies, Inc. (\"Parent\") and its wholly-owned subsidiaries, Marine Drilling Management Company (\"MDMC\"), Keyes Holding Corporation (\"KHC\") and Marine Drilling International, Inc. unless the context otherwise requires a reference only to the Parent.\nRecapitalization Transactions\nOn June 19, 1992, the Company entered into an agreement with certain of its lenders and preferred shareholders providing for a significant recapitalization (\"Recapitalization\"). On June 19, 1992, $500 was paid to one of the lenders in exchange for the discharge of approximately $13,942 of bank indebtedness. On October 29, 1992, the Recapitalization was approved by the Company's shareholders and, as a result, the Company's debt (including interest) and preferred stock obligations were reduced during 1992 by approximately $187,000 and the Company's rig fleet was substantially reduced. The Recapitalization included a one-for-twenty-five reverse split of the Company's $.10 par value common stock into $.01 par value common stock (\"Common Stock\").\nIn connection with the approval of the Recapitalization, the Company's remaining bank indebtedness and related interest totalling approximately $51,919 as of September 30, 1992 was completely discharged for approximately 5,000,000 shares of Common Stock which were issued to a group of the Company's lenders. The Recapitalization also included the reclassification of the Company's 14% cumulative exchangeable preferred stock, par value $1.00 per share (\"Old Preferred Stock\") with a liquidation preference as of October 29, 1992 of approximately $65,582 into 19,369,893 shares of Common Stock.\nThe Company sold 9,638,214 shares of Common Stock of which 4,800,000 shares were purchased by three of the Company's principal shareholders pursuant to a rights offering (\"Rights Offering\"). The Rights Offering was closed in December 1992 with the Company receiving net proceeds of approximately $11,537.\nAs part of the Recapitalization, the Company entered into a $4,000 bridge loan facility with three of its principal shareholders which was intended to fund the Company's operations through the completion thereof. On October 29, 1992, the $4,000 principal amount and interest thereon were exchanged for shares of Common Stock at an exchange price of $1.25 per share.\nDuring 1992 the Company defaulted on all series of its U.S. Government guaranteed Title XI (\"Title XI\") ship financing bonds owed by two of its subsidiaries. The Company transferred custody and financial responsibility for seven of its eight Title XI financed rigs to the Maritime Administration of the United States Department of Transportation (\"MarAd\"), agreed to pay to MarAd certain additional amounts in connection with certain litigation (see below), proposed to restructure approximately $2,300 in debt and pay approximately $460 in consideration for the discharge of approximately $63,019 in debt and related interest. In September 1992, some of the Company's subsidiaries and MarAd entered into an agreement (the \"Storm Drilling Restructuring\"). MarAd agreed to (i) release one of the subsidiaries from its limited guarantee of interest on another subsidiary's Title XI debt, (ii) not to take adverse actions against the Company or its other subsidiaries or affiliates with respect to any deficiencies remaining on the Title XI debt after the foreclosure or sale of the subsidiary's rigs and (iii) take custody of the subsidiary's rigs. In addition to the foregoing, MDMC paid approximately $3,802 to MarAd from litigation involving the MARINE 7.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nQuasi-Reorganization\nOn December 31, 1992, the Company adopted quasi-reorganization accounting procedures. Quasi-reorganization accounting allowed the Company to eliminate the accumulated deficit against additional paid-in capital and to revalue assets and liabilities to estimated fair values. Therefore, the adoption of quasi-reorganization accounting procedures following the Recapitalization gave the Company a \"fresh start\" for accounting purposes.\nThe adoption of quasi-reorganization accounting procedures resulted in a decrease to property and equipment of $56,051, a decrease in assets held for sale of $240, a decrease in other assets of $9,043, a decrease in debt of $8,054, a decrease in deferred expenses of $145, a decrease in receivables of $112 and an increase in other liabilities of $25.\n(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND OPERATIONS\nPrinciples of Consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.\nOperations\nAs of December 31, 1994, the Company's fleet consisted of 13 jack-up rigs.\nProperty and Equipment\nProperty and equipment are stated at historical cost or the cost assigned to the assets at December 31, 1992 in connection with the adoption of quasi-reorganization accounting procedures. Depreciation is provided on the straight-line method over the estimated remaining useful lives of the assets which are as follows:\nMaintenance and repairs amounted to $8,600, $8,030 and $1,943 in 1994, 1993 and 1992, respectively. Expenditures for major renewals and betterments are capitalized. Expenditures for normal maintenance and repairs are charged to expense as incurred. When property or equipment is retired, the related assets and accumulated depreciation are removed from the accounts and a gain or loss is reflected in other income (expense). The Company continues to depreciate idle drilling equipment using the same rates as while operating.\nEmployer's Liability Claims\nEmployer's liability claims, principally arising from actual or alleged personal injuries, are estimates of the Company's liabilities for such occurrences. These claims are classified as current or long-term based upon the periods in which such claims are expected to be funded.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nDeferred Financing Costs\nDeferred financing costs are amortized over the life of the related debt. Deferred financing costs were $228 at December 31, 1994. Deferred financing costs in 1992 of $1,003 were eliminated at December 31, 1992 in connection with the adoption of quasi- reorganization accounting procedures or were written off in connection with early extinguishments of debt.\nIncome Taxes\nIn February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Statement 109 required 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 December 31, 1992, in conjunction with the adoption of quasi-reorganization accounting procedures, the Company adopted Statement 109. The change in the method of accounting for income taxes had no cumulative effect on the 1992 consolidated statements of operations. Pursuant to the deferred method under APB Opinion 11, which was applied during 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.\nRevenue Recognition\nDrilling revenues are recorded pursuant to day rate contracts, under which the Company receives a fixed amount per day for providing drilling services using the rigs it operates.\nCash Equivalents\nCash equivalents of $18,531 and $21,396 at December 31, 1994 and 1993, respectively, consist of loan participations, Eurodollar investments, mortgage backed and corporate debt securities. Their carrying value is a reasonable approximation of their fair value. For purposes of the statement of cash flows, the Company generally considers all investments with an original maturity of three months or less at date of purchase and other highly liquid investments readily convertible to determinable amounts of cash, excluding restricted cash investments, to be cash equivalents.\nShort-Term Investments\nShort-term investments consist of corporate debt securities, mortgage-backed securities and corporate paper. The Company classifies its short-term investments as held-to-maturity securities. Held-to-maturity securities are those securities in which the Company has the ability and intent to hold the security until maturity. Held-to-maturity securities are recorded at amortized cost, adjusted for the amortization or accretion of premiums or discounts. Premiums and discounts are amortized or accreted over the life of the related held-to-maturity security as an adjustment to yield using the effective interest method. Dividend and interest income are recognized when earned. The fair value of the short-term investments at December 31, 1994 was $18,133.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nIncome (Loss) Per Common Share\nIncome (loss) per common share is based on the weighted average number of common shares outstanding and common stock equivalents, if dilutive. For the year ended December 31, 1992, the net income (loss) applicable to common shareholders has been adjusted to reflect the dividends on and the accretion of discount on Old Preferred Stock. Net income per common share for the years ended December 31, 1994 and 1993 do not include the effect of outstanding stock options as the potential dilution from their exercise is less than three percent.\nReclassification of Accounts\nCertain reclassifications have been made to the 1993 and 1992 consolidated financial statements to conform with the current presentation.\nConcentrations of Credit Risk\nThe market for the Company's services and products in the offshore oil and gas industry, and the Company's customers consist primarily of independent and major oil and gas companies. The Company performs ongoing credit evaluations of its customers and obtains collateral security as deemed prudent. The Company has established an adequate allowance for bad debts, and such losses have been within management's expectations (see Note 9).\nAt December 31, 1994 and 1993, the Company had cash deposits concentrated primarily in one major bank. In addition, the Company had certificates of deposits, commercial paper and Eurodollar time deposits with a variety of companies and financial institutions with strong credit ratings, and such securities are held until maturity. The Company believes that credit and market risk in such instruments is minimal.\n(3) PROPERTY AND EQUIPMENT\nProperty and equipment are stated at historical cost or the cost assigned to the assets at December 31, 1992 in connection with the adoption of quasi-reorganization accounting procedures, and are summarized as follows:\nDepreciation expense was $7,733, $5,312 and $11,030 for the years ended December 31, 1994, 1993 and 1992, respectively. The Company rents drilling rigs, certain equipment and other property under operating leases. Rental expense was $1,707, $936 and $1,013 in 1994, 1993 and 1992, respectively.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(4) ACCOUNTS PAYABLE AND ACCRUED EXPENSES\nAccounts payable and accrued expenses are summarized as follows:\n(5) LONG-TERM DEBT\nLong-term debt is summarized as follows:\nKHC - Note Payable to Lender\nOn December 1, 1994, KHC entered into a $35,000 revolving\/term loan agreement (the \"Loan\") with a U.S. financial institution (\"Lender\"). As of December 31, 1994, the related debt outstanding was $15,000 and the amount of unused line of credit subject to the Loan was $20,000. Loan proceeds may be used to purchase additional jack-up drilling rigs or to make capital improvements to the Company's existing drilling rig fleet. The Company is a guarantor for up to an aggregate of $8,750 under the Loan. On June 1, 1996, all amounts borrowed under the Loan may be converted to a term loan.\nIf converted, the term loan will be due in thirty-six (36) consecutive monthly installments, beginning July 1, 1996 and ending June 1, 1999 amortizing at the rate of 20% of the term loan balance per year with the remaining 40% principal balance due and payable concurrently with the last payment. KHC must maintain a minimum borrowing of $10,000 (the \"minimum borrowing\") on the Loan after June 1, 1996. If the Company's average borrowings under the revolving loan or the term loan are less than the minimum borrowing, KHC will be required to pay a non-utilization fee of 2% of the difference between the actual average borrowed balance and the minimum borrowing. The term loan may be prepaid at any time after the eighteenth payment (December 1, 1997). A prepayment premium of 1% of the prepaid principal amount will be due with each such prepayment. Repayments may not be re-borrowed during the term loan period.\nInterest is due monthly on the outstanding principal balance at the London Interbank Offered Rate (\"LIBOR\") plus 2.5%. The interest rate as of December 31, 1994 was 7.938%. A revolving loan fee is due quarterly during the revolving loan period based on the unused credit facility at .25%.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe note is secured by a first preferred fleet mortgage on the MARINE 300, 301 and 303 drilling rigs. The three drilling rigs must be appraised on the term loan conversion date, June 1, 1996. The term loan will be limited to 50% of the appraised value of the rigs. The Company and KHC are required to comply with various covenants, including, but not limited to, the maintenance of financial ratios related to (i) debt to total equity and (ii) working capital to fixed expenses and projected debt services.\nInterest payments on the loan amounted to $70 for the year ended December 31, 1994, including a revolving loan fee of $5. A facility fee of $175 was paid to the lender during the fourth quarter 1994 and will be amortized over the life of the loan.\nThe scheduled repayment of long-term debt as of December 31, 1994 is as follows:\n(6) INCOME TAXES\nIncome taxes consist of the following:\nAs a result of the adoption of quasi-reorganization accounting procedures on December 31, 1992, the tax effect of the realization of tax attributes generated prior thereto are recorded directly to shareholders' equity and are not reflected as a reduction of income tax expense.\nFor the years ended December 31, 1994 and 1993, the effective tax rate for financial reporting purposes approximates the U.S. federal statutory rate of 35%.\nMARINE DRILLING COMPANIES, INC. 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 deferred tax liabilities at December 31, 1994 and 1993 are presented below.\nThe valuation allowance for deferred tax assets as of December 31, 1994 and 1993 was $38,649 and $42,209, respectively. The net change in the total valuation allowance for the years ended December 31, 1994 and 1993 was a decrease of $3,560 and an increase of $2,615, respectively. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon projections for future taxable income over the periods which the deferred tax assets are deductible and the Section 382 limitation as discussed below, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 1994.\nAt December 31, 1994, the Company had net operating loss carryforwards for federal income tax purposes of $82,296 which are available to offset future federal taxable income, if any, through 2007. The Company also had investment tax credit and general business credit carryforwards for federal income tax purposes of approximately $13,410 (including $1,844 which are subject to the limitation as to their use imposed in connection with the 1989 Ownership Change as discussed below) at December 31, 1994 which are available to reduce future federal income taxes, if any, through 2000.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nThe Company has taken the position that the Recapitalization did not cause an ownership change under Section 382 of the Internal Revenue Code of 1986, as amended (\"Code\"). The Company's position is based on the applicability of Section 382(l)(3)(C) of the Code, which provides generally that any change in the proportionate ownership attributable solely to fluctuations in relative fair market value of different classes of stock are not to be taken into account for purposes of Section 382. To date, neither the Internal Revenue Service nor the United States Department of Treasury has established any rules or guidance as to how such Section will be interpreted or applied to situations similar to the Recapitalization. Accordingly, there can be no assurance that an ownership change for purposes of Section 382 will not be deemed to have occurred as a result of the Recapitalization. If an ownership change were deemed to have occurred, the utilization of the Company's net operating losses, against its future income, if any, would be limited annually to approximately $1,500. Since such limitation would be less than the Section 382 limitation (approximately $9,000) imposed as a result of the Company's 1989 sale of Common Stock which resulted in an ownership change (\"1989 Ownership Change\") pursuant to Section 382 of the Code, the Section 382 limitation imposed in connection with the Recapitalization would apply to all net operating losses applicable to the period before the Recapitalization.\n(7) LONG TERM INCENTIVE PLANS\nOn September 14, 1992, the Company's Board of Directors adopted the Marine Drilling 1992 Long Term Incentive Plan (\"1992 Plan\"), which was subsequently approved by the shareholders on October 29, 1992. Pursuant to the terms of the 1992 Plan, an aggregate of 10,000,000 shares (subject to the restrictions described herein) of Common Stock are available for distribution pursuant to stock options, SARs and restricted stock. The number of shares of Common Stock available for distribution as described above is further limited in that no stock options, SARs or restricted stock may be issued if, immediately after such issuance, the number of shares subject to outstanding stock options, SARs and restricted stock awards would exceed 5% of the Common Stock then outstanding. The shares of Common Stock subject to any stock option or SAR that terminates without a payment being made in the form of Common Stock would again become available for distribution pursuant to the 1992 Plan. During 1994 and 1993, respectively, the Company issued 83,000 and 385,000 shares of restricted Common Stock. Compensation expense related to the issuance of restricted Common Stock for the years ended December 31, 1994 and 1993 was $318 and $233, respectively. During 1994 and 1993, respectively, 31,250 and 30,000 shares of restricted Common Stock were forfeited.\nHolders of SARs and options granted under the plans existing prior to the adoption of the 1992 Plan surrendered such SARs and options in exchange for options under the 1992 Plan and those prior plans have been terminated.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nDuring the fourth quarter 1992, 1,440 SARs and 21,640 shares subject to options outstanding under prior plans were exchanged for 23,080 shares subject to option at $1.25 per share under the 1992 Plan. Additionally, options for 1,590,000 shares exercisable at $1.25 were granted on November 3, 1992, options for 190,000 shares exercisable at $6.00 were granted on June 29, 1993 and options for 75,000 shares exercisable at $4.25 were granted on October 12, 1994. All such options expire November 2002, June 2003 and October 2004, respectively, unless earlier exercised. During 1993, 261,030 shares were exercised at $1.25 per share and options for 1,400 shares were forfeited. During 1994, 10,000 shares were exercised at $1.25 per share and options for 30,000 shares were forfeited.\nThe following table sets forth the shares subject to options outstanding under the 1992 Plan at December 31, 1994:\nBased upon Common Stock outstanding as of December 31, 1994 and 1993 and shares reserved for issuance as set forth above, the number of shares then available for future stock options, SARs and restricted stock grants was 432,721 and 423,028 shares, respectively.\n(8) RELATED PARTY TRANSACTIONS\nThe Company has performed services directly for Newfield Exploration Company (\"Newfield\") and indirectly for Newfield's customers. Amounts received directly from Newfield were $515 during 1992. Amounts received indirectly from Newfield's customers were approximately $526 and $774 during 1993 and 1992, respectively. One of the Company's directors is also a director of Newfield.\nThe Company has performed services for Houston Exploration Company, Inc. (\"Houston\"), the operator of certain oil and gas properties with respect to which Smith Offshore Exploration Company (\"Smith\") participates as a working interest owner. During 1994, 1993 and 1992, the Company recorded revenues of $1,581, $5,658 and $1,356, respectively, from Houston. Aeneas, a principal shareholder of the Company, is a principal shareholder and creditor of Smith.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nIn connection with the Recapitalization, the Company entered into a loan agreement (\"Bridge Loan\") with three of its significant shareholders. The Bridge Loan provided for the Company to borrow up to $4,000 at 10%. On October 29, 1992, concurrently with the Recapitalization, the Company issued 3,270,054 shares of Common Stock in full satisfaction of the loan balance of $4,000 and accrued interest thereon.\n(9) GEOGRAPHIC AREA ANALYSIS AND MAJOR CUSTOMERS\nThe following table summarizes geographic area operating revenues and operating income for the years ended December 31, 1994 and 1993, and identifiable assets by geographic area at year-end 1994 and 1993:\nThere were no significant international operations during 1992.\nThe Company conducts business in one industry segment, oil and gas well contract drilling. The Company negotiates drilling contracts with a number of customers for varying terms, and management believes it is not dependent upon any single customer. For the years 1994, 1993 and 1992, sales to customers that represented 10% or more of consolidated drilling revenues were as follows:\n* Less than 10%\nAs is typical in the industry, the Company does business with a relatively small number of customers at any given time. The loss of any one of such customers could, at least on a short-term basis, have a material adverse effect on the Company's profitability. Management believes, however, that at current levels of drilling activity, the Company would have alternative customers for its services if it lost any single customer and that the loss of any one customer would not have a material adverse effect on the Company on a long-term basis.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n(10) COMMITMENTS\nOperating Leases\nAggregate future minimum rental payments relating to operating leases are as follows:\nEmployee 401(k) Profit Sharing Plan\nThe Company has a 401(k) Profit Sharing Plan (the \"Plan\") covering substantially all of its employees who have been employed at least three months. The Company matches employees' contributions to the Plan on a dollar-for- dollar basis, in the form of Company common stock, up to 5% of their eligible compensation. During 1994 and 1993, the Company made matching contributions with the Company's common stock totaling $744 and $354, respectively. During 1992, the Company made no matching contributions.\n(11) UNAUDITED QUARTERLY FINANCIAL DATA\nA summary of unaudited quarterly consolidated financial information for 1994 and 1993 is as follows:\n(1) Quarterly net income per common share may not total to annual results due to rounding. (2) \"Average day rate\" is determined by dividing the total gross revenue earned by the Company's rigs during a given period by the total number of days that the Company's rigs were under contract during that period.\nMARINE DRILLING COMPANIES, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\nIn 1994, the average day rates earned by the Company's rigs generally declined throughout the year, however, the adverse effects of these declines were partially offset by sequentially higher rig utilization rates through those quarters. The decline in day rates during 1994 was due primarily to (i) increased competition in the U.S. Gulf of Mexico arising from an increased supply of jack-up rigs in that market and (ii) reduced activity levels in Mexico's Bay of Campeche.\nQuarterly results during 1993 were virtually the reverse of 1994's due to general day rate increases occurring throughout the year experienced concurrently with consistently high levels of rig utilization. These attributes were the results of (i) a better balance between jack-up rig supply and demand in the U.S. Gulf of Mexico and (ii) high activity levels in the Bay of Campeche.\n(12) SUBSEQUENT EVENTS (UNAUDITED)\nOn November 2, 1994, the Company and Falcon Drilling Company, Inc. (\"Falcon\") signed a letter of intent to merge. On February 15, 1995, Falcon and the Company agreed to terminate the letter of intent and related discussions because then current market conditions led both parties to conclude that a definitive agreement could not be reached at that time.\nOn February 28, 1995, the Company repaid $5,000 of the revolving credit facility associated with the Loan described in Note 5 hereto. The Company anticipates that amount will be re-borrowed in addition to other borrowings in 1995 to fund capital expenditures.\nWeakness in natural gas prices contributed to a substantial downturn in U.S. Gulf of Mexico drilling activity in early 1995. As a result, the Company's operations and cash flow have been adversely affected. In response to these conditions, the Company has elected to temporarily deactivate some of its rigs and may deactivate additional rigs until market conditions improve.\nOn March 7, 1995, the Company announced that its Board of Directors had authorized the repurchase of up to 4,000,000 shares of the Company's Common Stock. The purchases may be effected, from time to time, in accordance with applicable securities laws, through solicited or unsolicited transactions in the market or in privately negotiated transactions. No limit was placed on the duration of the repurchase program. Subject to applicable securities laws, such repurchases shall be at such times and in such amounts as the Company deems appropriate. The Company will fund such repurchases from working capital.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNot applicable.\nPART III\nThe information called for by Part III, Items 10 through 13, of Form 10-K is incorporated by reference from the Registrant's Proxy Statements relating to its annual meeting of Shareholders to be held May 2, 1995, 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.","section_9A":"","section_9B":"","section_10":"","section_11":"","section_12":"","section_13":"","section_14":"ITEM 14. EXHIBITS AND REPORTS ON FORM 8-K\n(a) The following documents are included in Part II, Item 8:\n(1) Consolidated Financial Statements\nAll other schedules are omitted as the information is not required or is not applicable.\n(3) Exhibits:\nExhibit Number\n3.1 Restated Articles of Incorporation of Marine Drilling Companies, Inc. (Incorporated by reference to Exhibit 28.17 to the Current Report on Form 8-K of the Registrant dated October 30, 1992.)\n3.2 Amended and Restated Bylaws of Marine Drilling Companies, Inc. (Incorporated by reference to Exhibit 28.18 to the Current Report on Form 8-K of the Registrant dated October 30, 1992.)\n++10.18 The Marine Drilling 1992 Long-Term Incentive Plan. (Incorporated by reference to Exhibit 10.26 of the Company's Registration Statement No. 33-52470 on Form S-1).\n10.20 Registration Rights Agreement, dated October 29, 1992, among Marine Drilling Companies, Inc., The Chase Manhattan Bank (National Association), Corpus Christi National Bank, Bank One, Texas, N.A., Energy Management Corporation, Randall D. Smith, Trustee, Kathryn Sladek Smith Trust Article Third B, II of Last Will and Testament of Kathryn Sladek Smith, Warburg, Pincus Capital Company, L.P., Aeneas Venture Corporation, Capricorn Investors, L.P. and William O. Keyes. (Incorporated by reference to Exhibit 28.19 to the Current Report on Form 8-K of the Registrant dated October 30, 1992.)\n10.21 Shareholders' Agreement, dated October 29, 1992, among Marine Drilling Companies, Inc., The Chase Manhattan Bank (National Association), Warburg, Pincus Capital Company, L.P., Aeneas Venture Corporation, Capricorn Investors, L.P. and William O. Keyes. (Incorporated by reference to Exhibit 28.20 to the Current Report on Form 8-K of the Registrant dated October 30, 1992.)\n10.22 Termination and Amendment Agreement (respecting the Shareholders' Agreement dated October 29, 1992) dated as of June 18, 1993 by and among Marine Drilling Companies, Inc., The Chase Manhattan Bank (National Association), Warburg, Pincus Capital Company, L.P., Aeneas Venture Corporation, Capricorn Investors, L.P. and William O. Keyes. (Incorporated by reference to Exhibit 10.22 to the Annual Report on Form 10-K of the Registrant for the year ended December 31, 1993.)\n* 10.23 Loan Agreement and related documents among The CIT Group\/Equipment Financing, Inc., as Lender, Marine Drilling Companies, Inc., as Guarantor, and Keyes Holding Corporation, as Borrower, dated as of December 1, 1994.\n* 21.1 Subsidiaries of the Registrant.\n* 23.1 Consent of Independent Certified Public Accountants.\n* 24.1 Powers of attorney.\n* 27.1 Financial Data Schedule\n_________________________\n++ Management contract or compensation plan or arrangement required to be filed as an exhibit to this report.\n* Filed herewith.\n(b) Reports on Form 8-K:\nThree reports on Form 8-K were filed during the fourth quarter of 1994 --\n(1) Report of the Company dated November 4, 1994 disclosing that it entered into a letter of intent with Falcon Drilling Company, Inc. to merge the two companies.\n(2) Report of the Company dated November 23, 1994 disclosing its consummation of the acquisition of the MARINE 3 jack-up drilling rig.\n(3) Report of the Company dated December 6, 1994 disclosing its acquisition of the MARINE 201 (formerly the Nordic Explorer) jack-up drilling rig and the closing of a $35 million credit facility with The CIT Group\/Capital Equipment Financing, Inc.\nSCHEDULE I\nMARINE DRILLING COMPANIES, INC. CONDENSED BALANCE SHEETS (DOLLARS IN THOUSANDS)\nSee accompanying notes and the notes to the Condensed Financial Statements\nSCHEDULE I (CONTINUED)\nMARINE DRILLING COMPANIES, INC. CONDENSED STATEMENTS OF OPERATIONS (DOLLARS IN THOUSANDS)\nSee accompanying notes and the notes to the Condensed Financial Statements\nSCHEDULE I (CONTINUED)\nMARINE DRILLING COMPANIES, INC. CONDENSED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS)\n[Continued]\nSee accompanying notes and the notes to the Condensed Financial Statements\nSCHEDULE I (CONTINUED)\nMARINE DRILLING COMPANIES, INC. CONDENSED STATEMENTS OF CASH FLOWS -- (CONTINUED) (DOLLARS IN THOUSANDS)\nSee accompanying notes and the notes to the Condensed Financial Statements\nSCHEDULE I (CONTINUED)\nMARINE DRILLING COMPANIES, INC. NOTES TO CONDENSED FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(1) SOURCES OF FUNDING AND SUBSIDIARIES' FUNDING REQUIREMENTS\nThe Company's primary source of funding consists of dividends, distributions and repayments of intercompany advances and loans by its subsidiaries.\nTo the extent that the Company's subsidiaries have funding requirements in excess of amounts available from operations (if any), those subsidiaries' primary source of funding is from the Company.\n(2) INVESTMENT IN AND AMOUNTS DUE FROM SUBSIDIARIES\nDue to the restrictions on intercompany payments, amounts due from certain subsidiaries have been classified as non-current assets.\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 SUGAR LAND, STATE OF TEXAS, ON THIS 7TH DAY OF MARCH 1995.\nMARINE DRILLING COMPANIES, INC.\nBy \/s\/ William O. Keyes ----------------------------------- William O. Keyes 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:\nINDEX TO EXHIBITS","section_15":""}
{"filename":"843023_1994.txt","cik":"843023","year":"1994","section_1":"ITEM 1. BUSINESS.\nGeneral IDS\/Shurgard Income Growth Partners L.P. II was organized under the laws of the State of Washington on November 15, 1988. The General Partner is Shurgard Associates L.P. II. The Partnership will terminate December 31, 2030, unless terminated at an earlier date.\nThe business of the Partnership is to acquire, develop and operate storage centers. The principal investment objectives of the Partnership are to provide the Limited Partners with regular quarterly cash distributions which, for Taxable Limited Partners, are expected to be partially tax-sheltered; to obtain long-term appreciation in the value of its properties; and to preserve and protect the Limited Partners' capital. The Partnership began operations during 1989, at which time it obtained approximately $10.3 million in short-term financing for the purchase of two existing storage facilities. The offering was completed in April 1990 with total proceeds raised through the sale of limited partnership interest of approximately $28.8 million. This enabled the Partnership to retire the short-term loans and purchase an additional five existing storage centers and one partially completed facility. For more information regarding the properties owned by the Partnership at December 31, 1994, see Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nThe following table lists each of the Partnership's storage centers at December 31, 1994, the metropolitan area they serve, the respective rentable space, the acquisition or completion date, and the square foot occupancy at December 31, 1994, 1993 and 1992.\nShurgard of Kennydale was purchased from an affiliated partnership after approval by a majority vote of limited partners. The Houston, Texas center was purchased from Shurgard Incorporated at its net cost. The remaining six centers were purchased from unaffiliated sellers.\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.\n(a) Market information. There is no established public market for the Partnership's units of limited partnership interest. Transfers of limited partner interests are restricted in certain circumstances. Transfers which would result in the termination of the Partnership under Section 708 of the Internal Revenue Code, transfers of fractional units, and transfers which result in a limited partner owning less than the minimum number of units are restricted. There is a fee charged for transfers.\n(b) Holders. As of February 6, 1994, there was one general partner and approximately 4,200 limited partners in the Partnership.\n(c) Distributions. During the fiscal years ended December 31, 1993 and 1994, the Partnership distributed $15.62 and $15.78 respectively, per $250 unit of limited partnership interest. In February 1995, the Partnership distributed $4.06 per $250 unit of limited partnership interest. As of December 31, 1994, total distributions of $9,036,743 are greater than total earnings on a basis consistent with generally accepted accounting principles by $3,145,188. Therefore, the partners' original investment has been reduced by that amount for financial reporting purposes.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information called for by this item is incorporated by reference of the Annual Report to Security Holders for the fiscal year ended December 31, 1994, a copy of which is filed as Exhibit 13.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND THE RESULTS OF OPERATIONS.\nThe information called for by this item is incorporated by reference of the Annual Report to Security Holders for the fiscal year ended December 31, 1994, a copy of which is filed as Exhibit 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nThe information called for by this item is incorporated by reference of the Annual Report to Security Holders for the fiscal year ended December 31, 1994, a copy of which is 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 Partnership's General Partner is Shurgard Associates L.P. II, a Washington limited partnership. Shurgard Associates L.P. II is managed by the directors and executive officers of Shurgard General Partner, Inc., the corporate General Partner, and by the Individual General Partners. Shurgard Incorporated and IDS Partnership Services Corporation (IPSC), a Minnesota corporation, are limited partners of Shurgard Associates L.P. II, and as such, do not control the day-to-day affairs of the General Partner or, through the General Partner, the Partnership. Management of the operations of Partnership projects is performed by Shurgard Incorporated pursuant to the Management Services Agreement.\nThe directors of Shurgard General Partner, Inc. have been elected to serve until their successors are duly elected and qualified. As the sole shareholder of Shurgard General Partner, Inc., Charles K. Barbo is in a position to control the election of directors. Mr. Barbo is a party to a business agreement whereby he shall use his best efforts to cause Donald B. Daniels to be elected a vice president and director of Shurgard General Partner, Inc., so long as Mr. Daniels is willing to serve in such positions.\nThe directors and officers of Shurgard General Partner, Inc., are required to devote only so much of their time to the Partnership's affairs as is necessary or required for the effective conduct and operation of the Partnership's business. The Individual General Partners devote their individual time to the Partnership to the extent they deem advisable in view of the participation of Shurgard Incorporated in Partnership affairs and such other factors as they consider relevant.\nThe Individual General Partners of Shurgard Associates L.P. II and the executive officers, directors and certain key personnel of Shurgard General Partner, Inc., and Shurgard Incorporated are as follows:\nName Age Company Office and Date of Election ------------------ --- ---------------------------- --------------------------- Charles K. Barbo 53 Shurgard Associates L.P. II Individual General Partner (1988) Shurgard Incorporated President (1992), Chairman of the Board (1979) Shurgard General Partner, President (1992), Chairman Inc. of the Board (1983)\nArthur W. Buerk 58 Shurgard Associates L.P. II Individual General Partner (1988) Shurgard Incorporated Director (1982) Shurgard General Partner, Director (1979) Inc.\nDonald B. Daniels 56 Shurgard Incorporated Vice President (1983), Director (1972) Shurgard General Partner, Vice President (1983), Inc. Director (1979)\nKristin H. Stred 36 Shurgard Incorporated Secretary (1992) Shurgard General Partner, Secretary (1992) Inc.\nMichael Rowe 38 Shurgard Incorporated Executive Vice President (1993) Harrell Beck 38 Shurgard Incorporated Treasurer (1992) Shurgard General Partner, Treasurer (1992) Inc.\nDavid Grant 41 Shurgard Incorporated Executive Vice President (1993)\nOn March 24, 1995, Shurgard Incorporated was merged into Shurgard Storage Centers, Inc. (\"SSCI\"). Pursuant to this merger, Shurgard Storage Centers, Inc. succeeds to rights and responsibilities of Shurgard Incorporated and will perform all the duties previously performed by Shurgard Incorporated, including supervision of the operation of the Partnership projects. The directors, executive officers and key personnel of Shurgard Storage Centers, Inc. are as follows:\nCharles K. Barbo has been involved as a principal in the real estate investment industry since 1969. Mr. Barbo is one of the co-founders of Shurgard Incorporated, which was organized in 1972 to provide property management services for self-service storage facilities and other real estate and commercial ventures. Mr. Barbo was also a co-founder of Shurgard General Partner, Inc. Upon Mr. Buerk's resignation on January 1, 1992, Mr. Barbo assumed the responsibilities of President of Shurgard Incorporated until March 24, 1995 and Shurgard General Partner, Inc. Mr. Barbo is also a general partner in a number of other public real estate partnerships. On March 24, 1995, Mr. Barbo was named the Chairman of the Board, President and Chief Executive Officer of Shurgard Storage Centers, Inc.\nArthur W. Buerk joined Shurgard Incorporated in 1977. During the ensuing years, Mr. Buerk shared with Messrs. Barbo and Daniels (see below) the various executive management functions within Shurgard Incorporated. Mr. Buerk served as President of Shurgard Incorporated from 1979 to 1991 and Shurgard General Partner, Inc. from 1983 to 1991. Effective January 1, 1992, Mr. Buerk resigned as President of both Shurgard Incorporated and Shurgard General Partner, Inc. to pursue other avenues of interest. He remains a director of Shurgard General Partner Inc. as well as a general partner of Shurgard Associates L.P. II and until March 24, 1995, remained a director of Shurgard Incorporated. Mr. Buerk is also a general partner in a number of other public real estate partnerships. Mr. Buerk holds no office in Shurgard Storage Centers, Inc.\nDonald B. Daniels has been involved in the real estate investment industry since 1971 and in the self-service storage industry since 1974. Mr. Daniels is one of the co-founders of Shurgard Incorporated. He is a director of Shurgard General Partner, Inc. and was a director of Shurgard Incorporated until March 24,1995. Mr. Daniels is also a general partner in a number of other real estate partnerships. Mr. Daniels holds no office in Shurgard Storage Centers, Inc.\nKristin H. Stred joined Shurgard Incorporated in 1992. She served as General Counsel and Secretary of Shurgard Incorporated until March 24, 1995 and currently serves as Secretary of Shurgard General Partner, Inc. Ms. Stred served as a corporate attorney in the broadcasting and aerospace industries from 1987 to 1992. On March 24, 1995, Ms. Stred was named Senior Vice President of Shurgard Storage Centers, Inc. She also serves as Secretary and general counsel of Shurgard Storage Centers, Inc.\nMichael Rowe came to Shurgard Incorporated as Controller in 1982. In 1983, he became a Vice President and, in 1987, was named Director of Operations of Shurgard Incorporated. Mr. Rowe served as Treasurer of both Shurgard Incorporated and Shurgard General Partner, Inc. from 1983 to 1992. He served as Executive Vice President of Shurgard Incorporated from 1993 until March 24, 1995. Mr. Rowe currently serves as Executive Vice President of Shurgard Storage Centers, Inc.\nHarrell Beck joined Shurgard Incorporated in April 1986 as the Eastern Regional Operations Manager and, in 1990, he became the Chief Financial Officer. Mr. Beck served as Treasurer of Shurgard Incorporated from 1992 until March 24, 1995. He currently serves as Director, Treasurer and CFO of Shurgard Storage Centers, Inc. as well as Treasurer of Shurgard General Partner, Inc. On March 24, 1995, Mr. Beck was named Senior Vice President of Shurgard Storage Centers, Inc.\nDavid K. Grant joined Shurgard Incorporated in November 1985 as Director of Real Estate Investment. Mr. Grant was elected Vice President of Shurgard Incorporated in 1992 and Executive Vice President in 1993. On March 24, 1995, Mr. Grant was named Executive Vice President of Shurgard Storage Centers, Inc.\nDan Kourkoumelis has served as a director of Shurgard Storage Centers, Inc. since March 1994. He is the President, Chief Operating Officer and a director of Quality Food Centers, Inc. (\"QFC\"), a publicly held corporation that operates the largest independent supermarket chain in the Seattle area. Mr. Kourkoumelis joined QFC in 1967 and has held a variety of positions since then. He served as Executive Vice President from 1983 to 1987, when he also became Chief Operating Officer, and became President in 1989 and a director in 1991.\nDonald W. Lusk has served as a director of Shurgard Storage Centers, Inc. since March 1994. He is the President of Lusk Consulting Group, which is engaged in general management consulting, as well as the formation and delivery of management development programs in Western Canada. From 1974 to 1991, Mr. Lusk was Regional Managing Partner of Management Action Programs in the Pacific Northwest.\nWendell J. Smith has served as a director of Shurgard Storage Centers, Inc. since March 1994. He retired in 1991 from the State of California Public Employees Retirement System (\"Calpers\") after 27 years of employment, the last 21 in charge of all real estate equities and mortgage acquisitions for Calpers. During those 21 years, Calpers invested over $8 billion in real estate and mortgages. In 1991, Mr. Smith established W.J.S. & Associates, which provides advisory and consulting services for pension funds and pension fund advisors.\nPursuant to Articles 16 and 17 of the Agreement of Limited Partnership, a copy of which is filed as an exhibit to the Partnership's Registration Statement, each of the general partners continues to serve until (i) death, insanity, insolvency, bankruptcy or dissolution, (ii) withdrawal with the consent of the other general partners (if any) and a majority vote of the limited partners, or (iii) removal by a majority vote of the limited partners.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nNumber of Capacities Persons in in which Cash Group Served Compensation ----------------------------------- --------------- 1 General Partner 95,600*\n*The General Partner has a 5% interest in cash distributions made by the Partnership, which is disproportionate to its share of the capital of the Partnership, which is .0035%. This amount represents the portion of cash distributions made to the General Partner during the fiscal year ended December 31, 1994, which is in excess of what a proportionate share of distributions would have been.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. (a) Security ownership of certain beneficial owners as of February 6, 1995: None owning more than 5% of the Partnership's voting securities.\n(b) Security ownership of management as of February 6, 1995: Management's security ownership in Shurgard Associates L.P. II as of February 6, 1995 was as follows:\nTitle of Name of Percent Class Beneficial Owner of Class -------- ------------------------------- --------- General Shurgard General Partner, Inc.1,2 .2% Partners' Charles K. Barbo2 9.9% Interest Arthur W. Buerk2 9.9% Shurgard Incorporated3,4 40.0% IDS Partnership Services Corporation3 40.0% ---- 100.0% ====\n1 Charles K. Barbo owns 100% of the stock of Shurgard General Partner, Inc. 2 Owner is a General Partner of Shurgard Associates L.P. II. 3 Owner is a Limited Partner of Shurgard Associates L.P. II. 4 On March 24, 1995, these interests were transferred to Shurgard Storage Centers, Inc. pursuant to the merger. Although Shurgard Storage Centers, Inc. acquired through the merger Shurgard Incorporated's interest in the General Partner, substantially all of the appreciation in the value of that interest during the next five years will inure to the benefit of the shareholders of Shurgard Incorporated in the form of additional shares of Shurgard Storage Centers, Inc. As a consequence, the future benefits to be derived from the interest in the General Partner (except current operating cash flow and appreciation after five years), if any, will be received by the shareholders of Shurgard Incorporated (including members of management of Shurgard Storage Centers, Inc.) and not by Shurgard Storage Centers, Inc. or its shareholders.\"\n(c) Changes in control: On March 24, 1995, Shurgard Incorporated was acquired by Shurgard Storage Centers, Inc. Pursuant to this merger, Shurgard Storage Centers, Inc. will perform all the duties previously performed by Shurgard Incorporated, including supervision of the operation of the Partnership projects. For the directors, executive officers, key personnel of Shurgard Storage Centers, Inc. and a description of the circumstances under which the General Partner may be removed, see Item 10 of this form 10K.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe Partnership agreement provides a fee payable to Shurgard Incorporated for property management services equal to 6% of gross revenues from self-service storage operations for day-to-day professional property management services. The monthly fee for management services will be reduced to 3% if leasing services are performed by a party other than Shurgard Incorporated. Payments to Shurgard Incorporated for such management totaled $242,259 for the year ended December 31, 1994. Subsequent to March 24, 1995, the property management services will be performed by Shurgard Storage Centers, Inc.\nNote C at page 9 of the Annual Report to Security Holders for the year ended December 31, 1994, a copy of which is included as Exhibit 13, is incorporated by reference. In addition, Shurgard Incorporated will receive fees from the Partnership as specified in the Agreement of Limited Partnership, reference to which is made as Exhibit 3(a), and in the Management Services Agreement, reference to which is made as Exhibit 10(a), both of which documents are incorporated by reference. Shurgard Storage Centers, Inc. will succeed Shurgard Incorporated with respect to these agreements. On March 24, 1995 pursuant to the merger, the shareholders of Shurgard Incorporated received shares of Shurgard Storage Centers, Inc. The following persons owned approximately the designated percentages of the named corporation's outstanding common stock.\nOwnership Ownership of Shurgard of Person Relationship to Partnership Inc. SSCI (1) ----- -------------------------------- ---------- ---------\nCharles K. Barbo Individual General Partner of Shurgard Associates L.P. President and Chairman of the Board of Shurgard General Partner, Inc. 48% 4%\nArthur W. Buerk Individual General Partner of Shurgard Associates L.P. 25% * Director of Shurgard General Partner, Inc.\nDonald B. Daniels Director and Vice President of Shurgard General Partner, Inc. 13% *\nAs shareholders of the named corporation these individuals may benefit indirectly from the transactions disclosed in this item.\n(1) Pursuant to the terms of the merger, Shurgard Incorporated shareholders will be entitled to receive additional Shurgard Storage Centers, Inc. shares based on (i) the extent to which, during the five years following the closing of the merger, Shurgard Storage Centers, Inc. realized value as a result of certain transactions relating to, among others, Shurgard Storage Centers, Inc.'s interest in the General Partner and (ii) the value, at the end of five years or in the event of a change of control, of any remaining interests in the General Partner as determined by independent appraisal. The ownership percentages in SSCI above do not reflect theses additional shares.\n* Mr. Buerk and Mr. Daniels each own less than 1% of SSCI.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8- -K.\n(a) 1. Financial statements:\nThe following financial statements of IDS\/Shurgard Income Growth Partners L.P. II are incorporated by reference in Part II and are filed as Exhibit 13:\nBalance sheets - December 31, 1994 and 1993 Statements of earnings - Three years ended December 31, 1994 Statements of partners' equity (deficit) - Three years ended December 31, 1994 Statements of cash flows - Three years ended December 31, 1994 Notes to combined financial statements - Three years ended December 31, 1994 Independent auditors' report\n2. All schedules are omitted because either they are not applicable or the required information is shown in the financial statements or notes thereto.\n3. Exhibits:\nAll exhibits to this report are listed in the Exhibit Index.\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.\nDate: March 29, 1995 IDS\/SHURGARD INCOME GROWTH PARTNERS L.P. II\nBy: Shurgard Associates L.P. II, General Partner\nBy: Shurgard General Partner, Inc. General Partner\nBy: HARRELL BECK Harrell Beck, Treasurer\nBy: CHARLES K. BARBO Charles K. Barbo, General Partner\nBy: ARTHUR W. BUERK Arthur W. Buerk, General Partner\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 ---------------- ---------------------------------- ---------------\nCHARLES K. BARBO President, Chairman of the Board and March 29, 1995 Charles K. Barbo Director of Shurgard General Partner, Inc. (principal executive officer)\nARTHUR W. BUERK Director of Shurgard General Partner, Inc. March 29, 1995 Arthur W. Buerk (principal executive officer)\nHARRELL BECK Treasurer of Shurgard General Partner, Inc. March 29, 1995 Harrell Beck (principal financial officer and principal accounting officer)\nExhibit Index\nExhibit Reference or Sequential Page Number ----------------------------------- ------------------------------------ 3. Articles of incorporation and by-laws Filed as Exhibit 3 to Form S-11 for (a) Agreement of Limited Partnership Registration No. 33-25729 4. Instruments defining the rights of See Exhibit 3(a), above security holders, including indentures 10. Material contracts: Filed as Exhibit 10(a) to Form S-11 (a) Management Services Agreement for Registration No. 33-25729 13. Annual report to security holders Filed as Exhibit 13 to Form 10 K for Registration No. 33-25729 21. Subsidiaries of the registrant See Item 1 of this Form 10-K\n27. Financial Data Schedule Filed as Exhibit 27 to Form 10 K for Registration No. 33-25729","section_15":""}
{"filename":"72316_1994.txt","cik":"72316","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nNord Resources Corporation (\"Company\") is a natural resource company primarily engaged in the mining and processing of industrial minerals -- kaolin and titanium dioxide (rutile and ilmenite). The Company owns an 80% interest in the kaolin operation and a 50% interest in the titanium dioxide operation. The Company's investments include 35% ownership of Nord Pacific Limited (\"Pacific\"), a company engaged in the exploration of precious metal, base metal and strategic mineral properties and in the production of copper.\nIn January 1995, the mining location of the titanium dioxide operation (\"SRL\") in Sierra Leone, West Africa was attacked by non-government forces. As a result of concern for the safety of SRL's employees, the minesite was evacuated. Mining operations are currently suspended as there continues to be civil disturbances in Sierra Leone. It has been reported to the Company that military activity between government and non-government forces has continued in and around the SRL mining location since the initial attack. As a result, SRL employees have not been able to assess any damage which likely has occurred to mine assets. The Company and its 50% joint venture partner are continuing to assess the future of the mining operation, including political, military and security situations in Sierra Leone. Until security in Sierra Leone improves, SRL will not be able to determine when it will be able to recommence operations in Sierra Leone, or the extent of loss in the value of its property and equipment due to damage, looting or general deterioration due to lack of maintenance. In addition, until SRL is able to assess the status of the production facilities, it cannot determine the costs it will incur to reestablish operations, including the cost of replacing supplies, training its work-force and recommissioning the facilities. The Company will assess the need for an impairment reserve and the accrual of start-up cost when information becomes available. If the civil disturbances in Sierra Leone do not cease or the estimated costs of reestablishment of SRL's operations in Sierra Leone are prohibitive, the Company may have to record an impairment reserve against a significant portion or possibly all of its investment in SRL, which is carried at $64.4 million (Company's cost plus undistributed earnings less certain indebtedness with effective recourse to the Company) at December 31, 1994. The Company carries certain levels of insurance against certain political risks, as is further discussed under the heading \"Political and Other Risks\" of this Form 10-K.\nIn February 1994, Pacific completed a public offering in Australia and raised $14.3 million through the sale of its common stock. In connection with this transaction, the Company converted $2,900,000 of its outstanding advances to Pacific to 3,488,721 common shares of Pacific. As a result of these transactions, the Company's ownership in Pacific decreased from 47% at December 31, 1993 to 35% at the effective date of the Pacific offering. The Company's ownership could be further diluted in the future as each\nshareholder who purchased a share in the above noted public offering also received an option, exercisable through June 30, 1995, to purchase an additional share of Pacific common stock at $.97 ($1.25 Australian) per share. The Company did not receive any options in connection with the conversion of its advance to Pacific.\nDuring 1993, the Company sold a 20% interest in its kaolin operation and a 50% interest in its titanium dioxide operation. Proceeds from the sales were used to repay indebtedness and for working capital. Also during 1993, the Company disposed of its holdings in Nord Perlite Company. The financial statements of the Company include the accounts of Nord Perlite Company as discontinued operations.\nFinancial information with respect to each of the Company's industry segments and foreign and domestic operations is presented in the \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" and Note T -- Industry Segments of \"Notes to Financial Statements\" of this Form 10-K.\nKAOLIN\nGENERAL\nThe Company is engaged in the mining and processing of kaolin in Jeffersonville, Ga., through Nord Kaolin Company (\"NKC\"). Since the acquisition of the kaolin operation in January 1978, NKC has expanded and modernized the production facilities to enhance the production capability for products that are used as coating or filling pigments by the paper industry. NKC's annual production capacity for these \"conventional type\" products has increased from 100,000 tons in 1978 to 310,000 tons currently. Through 1990, NKC's sales consisted almost exclusively of these \"conventional type\" products which carry relatively low per ton prices and profit margins. Even though profit margins were low, because of efficiency in production methods and cost controls, NKC was able to generate operating profits through 1988. Since 1988, NKC has experienced operating losses because of an oversupply of these conventional products and significant costs associated with the introduction of a new line of structured pigment products (Norplex[REGISTERED TRADEMARK]).\nDuring 1985, NKC embarked on a research program to evaluate new products directed toward enhancing profit margins and strengthening its competitive position in the market. The research efforts resulted in the development of Norplex[REGISTERED TRADEMARK] products, which are high-bulking composite pigments made from kaolin and other minerals. These composite pigments can be custom designed to meet specific needs of the paper industry, such as increased paper opacity and brightness, often at reduced cost. The ability to custom design a pigment for a particular application or even for a particular customer is unique. It is important because, for example, a filler pigment used in newsprint is different than one used in copy paper or lightweight publication grades. In another example, a coating pigment for packaging board is different than that used for magazine paper. Each segment of the paper industry has its own individual needs. Certain of these needs can be satisfied by supplying high-bulking composite pigments such as Norplex[REGISTERED TRADEMARK]. Norplex[REGISTERED TRADEMARK] products are produced using an evolving technology which can create products to meet\nspecific customer requirements at various prices and profit margins for NKC.\nIn 1987, a decision was made to proceed with a capital expansion program to enhance the cost effectiveness of the current plant facilities and to establish new facilities for the production of Norplex[REGISTERED TRADEMARK]. A program began in 1988 to expand production capacity and to enable NKC to produce Norplex[REGISTERED TRADEMARK] and another kaolin based product (calcined clay -- Norcal[REGISTERED TRADEMARK]). In connection with the expansion, NKC expended $23.8 million and entered into leasing arrangements for an additional $17.6 million of equipment.\nProduction of Norplex[REGISTERED TRADEMARK] commenced during the first quarter of 1990 and was used primarily in customer trials. Sales of Norplex[REGISTERED TRADEMARK] products occurred on a limited basis through 1992, as the rigorous and lengthy evaluation by the paper industry and the severe negative pressures on the economy due to the recession caused a delay in market penetration of Norplex[REGISTERED TRADEMARK] products. Sales of Norplex[REGISTERED TRADEMARK] products began increasing in 1993, with this trend continuing into 1994. A number of paper companies are now purchasing Norplex[REGISTERED TRADEMARK] products on a regular basis. In addition, production trialing of various Norplex[REGISTERED TRADEMARK] products at a number of potential customers locations indicates continued interest in market acceptance of Norplex[REGISTERED TRADEMARK].\nNKC has an ongoing program for development of new kaolin-based products for the paper industry and potentially other industries. Recently developed products being introduced include Norplex[REGISTERED TRADEMARK] products which can be used as a primary opacifying pigment in alkaline paper filling. In addition a kaolin-based product has been developed for use in the paper recycling industry to remove certain impurities in recycled paper.\nNKC's operations are subject to local and environmental regulations which require among other things, reclamation of mined areas, purification of production waste water and maintenance of dust emission control. The Company believes that NKC's mining and production operations comply with applicable local and environmental laws.\nRESERVES\nNKC owns and leases land with crude kaolin reserves and owns mineral rights to additional reserves, all located within 35 miles of the Jeffersonville facility. Estimated recoverable crude kaolin reserves as of December 31, 1994 are 31 million tons. Considering the mining and processing recovery rates associated with current and future product mix, total reserves constitute over a 25 year supply of kaolin feedstock. Substantially all reserves held under existing leases are anticipated to be mined prior to expiration of lease terms. NKC continues to seek new reserves in the Jeffersonville area, although it faces heavy competition for such reserves from other large kaolin producers. The estimated recoverable reserves have been prepared by employees of NKC and have not been independently verified since 1989. During 1994, NKC purchased almost half of its crude ore requirements from one source. This enables NKC to further extend its owned or leased reserves available for the production of conventional type products. NKC anticipates that this source of crude ore will continue to be available for purchase for at least the next 2-4 years.\nLICENSES AND TRADEMARKS\nDuring 1990, NKC had Norplex[REGISTERED TRADEMARK] registered as a Federal Trademark. This registration will expire 10 years from date of issuance. It can be renewed after that period with the proper application. NKC had Norcal[REGISTERED TRADEMARK] registered as a Federal Trademark in November 1993.\nNKC has entered into a license agreement to produce and sell products produced using the Norplex [REGISTERED TRADEMARK] technology. The license extends through June 1998, with NKC having an option to extend the license for two successive five year periods. The license allows NKC exclusive rights through 1999, with a five year extension of exclusive rights available to NKC if certain levels of Norplex[REGISTERED TRADEMARK] product revenues are attained. The license agreement requires payment of an annual royalty of 1 1\/2% on Norplex[REGISTERED TRADEMARK] product revenues up to $60 million and 2% on any Norplex[REGISTERED TRADEMARK] product revenues in excess of $60 million. NKC is required to pay minimum monthly royalties of approximately $34,200, adjusted annually by the change in the United States Bureau of Labor Statistics Consumer Price Index. NKC may terminate the license agreement upon 30 days notice to the licensor.\nSALES AND COMPETITION\nSubstantially all of NKC's production of conventional kaolin, Norcal[REGISTERED TRADEMARK] and Norplex[REGISTERED TRADEMARK] products are sold to the paper manufacturing industry. To the best of NKC's knowledge, there are no take or pay long-term contracts between a supplier of kaolin and a paper manufacturer. However, there are signed letters of intent regarding annual kaolin requirements. Sales are made in response to current orders at competitive prices. This lack of long-term contracts subjects NKC to reduction of orders based on general economic conditions. Any material reduction in orders or the loss of a significant customer would have a material adverse effect on the results of operations. Following is a summary of tons sold by NKC (in 000's).\nNKC's revenues in 1994 include sales to one customer in excess of 10% of the Company's revenues. NKC has had a long-term relationship with this customer and although there is no indication the current relationship is likely to change, in the event the customer is lost or significantly reduces its orders, such loss or significant reduction could have a material adverse effect upon the financial condition and results of operations of the Company. During 1994, 96% of sales were to domestic customers and 4% were for export, compared to 92% domestic and 8% export in 1993 and 88% domestic and 12% export in 1992.\nKaolin frequently constitutes a significant percentage of the material in paper used in magazines, annual reports, advertising brochures and similar publications that employ glossy paper and yet represents only a modest percentage of the cost of the paper. The Company is not aware of any commercial substitute for kaolin in the coating applications of paper; however, because a number of paper manufacturers have converted to the alkaline process, calcium carbonate can be substituted for kaolin in certain filling applications. The Company believes that the paper industry will continue to attempt to use kaolin in the production of paper to a maximum extent practicable. However, consumption of paper products in which kaolin is primarily used is sensitive to general economic conditions and paper and kaolin production could decline in periods of recession or economic difficulty.\nNKC's competitors, all located in middle Georgia, have production capacity for conventional type products several times that of NKC. The Company believes that excess capacity of kaolin producers and conversion by paper manufacturers to the alkaline process for production of certain grades of paper have had a negative impact on NKC's conventional type product prices and sales volume in the last five years.\nThe Company believes that NKC is presently the only company in its industry which is producing Norplex[REGISTERED TRADEMARK] type products for sale to the paper industry. Certain Norplex[REGISTERED TRADEMARK] products are marketed to customers for use in coating and filling applications that require high opacity pigments. While there are companies with greater market maturity with products, such as titanium dioxide pigments, in direct competition with these Norplex[REGISTERED TRADEMARK] products, the Company believes the Norplex[REGISTERED TRADEMARK] products have performance and cost advantages that will result in continued market penetration and sales to the paper industry.\nEMPLOYEES\nAt December 31, 1994, NKC employed a total of 163 persons, including 61 salaried personnel and 102 hourly employees. The mining and manufacturing employees are represented by the United Paperworkers International Union under a contract which expires in November 1996. The Jeffersonville facility has not been the subject of a strike or labor disturbance and NKC considers its labor relations to be satisfactory.\nRUTILE GENERAL\nOn November 17, 1993 the Company sold a 50% interest in its rutile operations to Consolidated Rutile Limited, an Australian company. The data contained in the following discussion relate to 100% of these rutile operations.\nSierra Rutile Limited (\"SRL\") is engaged in the mining and processing of titanium dioxide minerals (rutile and ilmenite) in Sierra Leone, West Africa and the marketing of these products. Both rutile and ilmenite are used in the production of more highly concentrated titanium dioxide, which in turn is used as a pigment in the manufacture of paint and many types of paper and plastic products. Titanium dioxide is also used in the production of fiberglass, enamels and coated fabrics. Rutile is used to a lesser extent in welding rod electrode coatings and in the production of titanium metal.\nSRL has leased from the government of Sierra Leone a total of 224 square miles until the year 2009, when the lease is subject to a renewal option of fifteen years on terms to be established at the time of renewal.\nIn January 1995, the mining location of the titanium dioxide operation (\"SRL\") in Sierra Leone, West Africa was attacked by non-government forces. As a result of concern for the safety of SRL's employees, the minesite was evacuated. Mining operations are currently suspended as there continues to be civil disturbances in Sierra Leone. It has been reported to the Company that military activity between government and non-government forces has continued in and around the SRL mining location since the initial attack. As a result, SRL employees have not been able to assess any damage which likely has occurred to mine assets. The Company and its 50% joint venture partner are continuing to assess the future of the mining operation, including political, military and security situations in Sierra Leone. Until security in Sierra Leone improves, SRL will not be able to determine when it will be able to recommence operations in Sierra Leone, or the extent of loss in the value of its property and equipment due to damage, looting or general deterioration due to lack of maintenance. In addition, until SRL is able to assess the status of the production facilities, it cannot determine the costs it will incur to reestablish operations, including the cost of replacing supplies, training its work-force and recommissioning the facilities. The Company will assess the need for an impairment reserve and the accrual of start-up cost when information becomes available. If the civil disturbances in Sierra Leone do not cease or the estimated costs of reestablishment of SRL's operations in Sierra Leone are prohibitive, the Company may have to record an impairment reserve against a significant portion or possibly all of its investment in SRL, which is carried at $64.4 million (Company's cost plus undistributed earnings less certain indebtedness with effective recourse to the Company) at December 31, 1994. The Company carries certain levels of insurance against certain political risks, as is further discussed under the heading \"Political and Other Risks\" of this Form 10-K.\nPRODUCTION FACILITIES\nSRL's production facilities presently include a bucket-ladder dredge equipped with 68 buckets, each with a capacity of 28 cubic feet. The average digging rate of the bucket-ladder dredge under good conditions is about 1,100 metric tonnes (\"tonnes\":2,204.6 pounds) per hour. Production from this dredge in 1995 was projected to approximate 1994 levels of 140,000 tonnes. Beginning in 1996, annual production levels were projected to decline to ranges near the 100,000 tonne level, due to change in ore grade. Additional production capacity is available through use of a smaller, bucket-wheel dredge, with an annual digging rate under good conditions of about 500 tonnes per hour. This dredge did not operate in 1994 and is currently on stand-by. Annual production is dependent on the ore grade and other recovery factors inherent in the deposits, as well as down time for maintenance and equipment installation.\nThe concentrating of the crude ore, which has a titanium dioxide content of between 1.5% and 2.0%, begins on the bucket-ladder dredge. The first stages of processing consist of primary and secondary scrubbing and two stages of screening. The bucket-wheel dredge pumps reclaimed ore to a supplemental wet processing plant where primary and secondary scrubbing and two stage screening are also carried out. The screened material, containing 2.7% to 3.0% titanium dioxide, is then pumped to the floating wet plant where slimes are removed by cyclones. The cyclone discharge, consisting of screened, deslimed sand containing about 4% titanium dioxide is then pumped to the concentrating section, consisting of banks of spiral separators. These increase the titanium dioxide content of this wet semi-concentrate to about 50%, which is pumped to shore for dewatering. From there it is transported by truck to the table plant where shaking tables are used to concentrate the material to a grade of about 60% titanium dioxide. This material is then fed to the dry plant where, following drying to less than 0.1% moisture, electrostatic and magnetic separation complete the process, producing a final rutile product containing about 96% titanium dioxide and an ilmenite by-product containing about 64% titanium dioxide.\nDuring 1993, SRL began a production expansion and facilities improvement program, primarily the construction of a third dredge and a new power generating facility. The dredge is expected to cost $30 million and was targeted for commissioning during the fourth quarter of 1995 and was expected to be producing at capacity by January 1996. The expected annual production capacity of the dredge is over 100,000 tonnes of rutile to be mined from the Gangama ore body, where it will initially begin production. However, due to the current suspension of mining operations, a revised construction schedule for the dredge cannot be determined. The new power generating facility, consisting of two 5 megawatt diesel generators which have been delivered to the minesite in Sierra Leone, was initially expected to be on-line in mid-1995 at a cost of $19 million. The power generated by this facility is anticipated to be available to the third dredge, as described above, and to supplement the existing power generating equipment. The Company is not able to determine when this facility will be operational due to the present suspension of mining operations.\nOther physical assets of SRL include support plant and equipment including a power plant, workshops, tugs, barges, concentrate loading facilities, administrative buildings and a \"company town\" of furnished homes for senior and intermediate staff.\nRESERVES\nBased on drill hole testing and geological analysis carried out by SRL personnel in 1993 and revised for amounts extracted in 1994, proven reserves as of December 31, 1994 are 271,585,000 tonnes of ore, averaging 1.48% recoverable rutile in the size ranges from which recovery is possible, which computes to 4,006,000 tonnes of recoverable rutile. Actual recovery has steadily improved and is now estimated at 80% of recoverable rutile, or about 3,200,000 tonnes. SRL's estimate of ore reserves as of December 31, 1991 were reviewed and verified by independent consulting geologists in early 1993. The data below are derived directly therefrom.\nReserves are located in five separate deposits. The five areas, the tonnes of crude ore they contain, recoverable rutile grade and tonnes of recoverable rutile at December 31, 1994 are as follows (tonnes in 000's):\nThe above amounts represent a decrease of 8,359,000 tonnes of crude ore and 158,000 tonnes of recoverable rutile over December 31, 1993 figures, due primarily to 1994 production. The average recoverable rutile grade decreased from 1.49% in 1993 to 1.48% in 1994.\nSRL remains of the view that additional exploration in the lease areas, or in other nearby areas for which exploration concessions may be obtained and in which there are indications of rutile mineralization, may identify additional reserves. The reserves at Sembehun are located in the Northern portion of SRL's mining concession, which is approximately 15 miles from the present plant location and the other 4 deposits. The dredging operations in 1994 were exclusively in the Lanti North deposit, which is adjacent to the Lanti South and Gbeni deposits. The dredge presently under construction is expected to initially operate in the Gangama deposit.\nSALES AND COMPETITION\nFollowing is a summary of sales for SRL:\nThe potential customers for SRL's products consist primarily of six major companies, five of which were customers of SRL in 1994. All of SRL's major customers in 1994 have been long time customers and all currently have long-term supply agreements with SRL, which are periodically subject to renewal. During 1994, the Company's share of SRL's sales to two of these customers exceeded 10% of the Company's revenues. SRL has been successful in negotiating sales agreements which, had the mine been in sustained production during 1995, would have resulted in the sale of its entire expected 1995 production, plus a portion of its inventory available at December 31, 1994. The sales agreements generally provide for a fixed rutile tonnage that each customer is expected to purchase. Historically, each of the customers has purchased at least the minimum amounts required in their respective sales agreements. Although there is no indication that the current relationships with these customers is likely to change, in the event a major customer is lost or significantly reduces its orders, such loss or significant reduction could have a material adverse effect upon the financial condition and results of operations of the Company.\nAs long as operations at the mine are suspended for reasons beyond the control of SRL, it will not produce rutile for delivery to its customers. These missed deliveries are generally subject to cancellation by SRL, or the customer, for reasons of force majeure, without affecting future shipments.\nThe two principal minerals mined by titanium raw material producers are natural rutile (concentrated to 93% to 96% titanium dioxide) and ilmenite (concentrated to between 40% and 70% titanium dioxide, with an accompanying high iron content). SRL is one of the world's largest producers of natural rutile, accounting for about 25% of the total. About 60% of the world's total is produced by companies in Australia, some of whom have greater financial resources than SRL, and about 15% is produced in South Africa. Minor production comes from the United States, India and Sri Lanka and nominal amounts from other sources.\nThe world's known reserves of natural rutile are not sufficient to supply the world's raw material need for high titanium dioxide raw materials required for pigment. As a result, processes have been developed to upgrade ilmenite to provide high-content titanium dioxide substitutes known as \"slag\" and \"synthetic\" rutile, containing 85% - 92% or more titanium dioxide. However, since natural rutile remains a higher grade raw material source and contains less waste, it continues to be the preferred feedstock for the production of paint pigment. Any significant improvement in the economics of upgrading lower grade titanium minerals to higher grade titanium products other than \"slag\" and \"synthetic rutile\" could adversely affect SRL's competitive position.\nPrior to suspension of operations SRL had undertaken a program to increase annual production to about 190,000 tonnes of natural rutile concentrate, which would represent about 30% of the world's annual production. SRL's ability to meet such objectives is partially dependent upon world economic conditions and the availability of financial resources. Economic conditions have allowed SRL to obtain contracts for the sale of over 95% of its planned expanded production through 1997. However, the timing and potentially the cost of the expansion may be adversely affected by the suspension of mining operations. It is not possible to predict at this time what the effect will be on the expansion.\nEMPLOYEES\nAt December 31, 1994, SRL employed a total of 1,810 persons including 174 senior staff, 215 intermediate and junior staff, and 1,421 hourly rated employees. All but 24 of SRL's employees are nationals of Sierra Leone. SRL is one of that country's largest private employers. Subsequent to year end, as a result of the suspension of mining operations in Sierra Leone, SRL terminated all of its personnel except for a core staff of senior expatriates and senior Sierra Leone nationals.\nPOLITICAL AND OTHER RISKS\nSierra Leone is an independent republic on the West African coast. A former British colony, it is pro-western and retains ties to Great Britain through its membership in the Commonwealth. The economy of Sierra Leone is based largely on agriculture, fishing and the mining of rutile, bauxite, gold and diamonds.\nAs has been previously discussed, Sierra Leone is presently in a general state of\ncivil unrest. Certain non-government factions have been involved in military actions which have resulted in the suspension of operations at the SRL mine and at a bauxite mine, located 10 miles from SRL's mine. SRL believes that at least 3 of its employees have been taken hostage by these forces. It has been reported to SRL that numerous other expatriate and Sierra Leone nationals may have also been taken hostage and that fighting between government and non- government forces is continuing in many parts of Sierra Leone. Neither the Company nor SRL is able to estimate when the political conditions in Sierra Leone will stabilize to enable SRL to resume its mining operations.\nSierra Leone's former one-party government was overthrown in late May 1992, in a nearly bloodless coup, by a group of young military officers, headed by Captain Valentine Strasser who is now Head of State of Sierra Leone. The ruling body is known as the National Provincial Ruling Council (the \"NPRC\"). The NPRC has pledged to return the Government to civilian rule with elections after its has ended disruption caused by dissidents along the border with Liberia and restructured the Government. The NPRC is working closely with the International Monetary Fund (\"IMF\") and currently has an IMF Structural Adjustment Program in place, the objective of which is to help strengthen the economy. The present Government is receiving considerable economic support from multi-lateral international agencies including the World Bank, the European Economic Community and the IMF.\nUnder the 1989 Agreement between SRL and the Government of Sierra Leone, the Government has an option to purchase a 47% ownership interest in SRL on or after January 1, 2000 at a purchase price of $57.4 million. Both shareholders of SRL would sell equal interests in SRL if this purchase option is exercised. Under the Agreement, SRL continues to maintain its currency outside of Sierra Leone and will not be subject to withholding tax on any shareholder dividend payments until the year 2000, after which the Government has the right to impose a 10% withholding tax on dividends. The Agreement also defines the rate at which income tax, royalty and mining lease payments are to be made by SRL. The Agreement was reaffirmed by the NPRC by decree.\nAs Sierra Leone is a third-world country, the Company's investment in SRL is subject, at any time, to the potentially volatile effects of political instability and economic uncertainty often present in such countries, including civil strife and expropriation, excessive taxation and other forms of government interference. As a precaution to a change in political climate, the Company is insured by Overseas Private Investment Corporation (\"OPIC\") (1) for loss of its 50% share of SRL's property due to political violence in an amount up to $15.7 million and, (2) expropriation of its Sierra Leone assets in an amount up to $23.7 million. In addition to the OPIC coverage, the Company has coverage through a private insurer for expropriation in an amount up to $8.4 million. Both insurance coverages are renewable annually, contain certain limitations and requirements and do not provide coverage for loss of revenues. The private insurer elected to not renew its coverage when the policy expired on March 31, 1995. The Company has advised both of the above noted insurers that it may have potential claims under the policies as a result of the present situation in Sierra Leone. However, the Company is not presently able to predict the extent or timing of claims which may be made under the above policies or the insurance proceeds which may ultimately be realized by the Company.\nNON-SEGMENT BUSINESSES\nThe Company owns 35% of Nord Pacific Limited (\"Pacific\") (NASDAQ-NORPF), a company involved in the exploration of precious metal, base metal and strategic mineral properties. Pacific's currently producing operation consists of a 40% interest in a copper mine located in Australia. The mine began production in mid-1993 and projects that at its present production rate it can sustain production from its present reserves through 1999. Pacific is engaged in a program to explore for additional copper reserves in and around its present mining operation, although no proven reserves have been identified to date. If Pacific is successful in identifying additional reserves, the operating life of the present mining operation could be extended. Pacific owns 40% of a nickel- cobalt-chromium property and 100% of a gold prospect, both located in Papua New Guinea. The nickel-cobalt-chromium project requires more stable prices and additional test work and engineering before undertaking development, due to its substantial capital costs and fairly lengthy engineering and construction period. Pacific has agreed to reduce its interest to 40% in this property in exchange for its venture partner funding 100% of the cost of further exploration and initial development work. Pacific also has interests in other properties which will require additional exploration to determine the existence of commercial mineral deposits, primarily gold.\nThe Company has a 40% interest in a venture which owns an undeveloped parcel of over 200 acres of real property located in Manatee County, Florida. The venture intends to either sell this property or have it developed by others.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nReference is made to Item 1 of this Form 10-K for information concerning the nature and location of the properties of the Company and identification of the major segments in which such properties are used. Management believes that the Company's facilities are generally adequate for its operations and are maintained in a good state of repair other than any as yet undetermined damage which may have occurred to the equipment at SRL.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOn January 31, 1990 the Company's wholly-owned subsidiary, Sierra Rutile Limited (\"SRL\"), filed a Demand for Arbitration against Bomar Resources, Inc. (\"Bomar\"). The arbitration provision in the agreement between SRL and Bomar required arbitration in New York City under the rules of the American Arbitration Association. SRL demanded arbitration of various disputes arising out of a written exclusive agency agreement dated November 15, 1983 and asserted that Bomar failed to properly account for sales proceeds in connection with rutile entrusted to it and committed fraudulent acts by which SRL was\ndamaged in amounts believed to exceed $10,000,000. Bomar denied the allegations contained in SRL's arbitration demand and asserted in written counterclaims that SRL was obligated to it for (1) failing and refusing to pay commissions on purchase orders executed before cancellation of the exclusive agency agreement effective December 31, 1988, for delivery of rutile subsequent to such date (in excess of $5,000,000), (2) commissions on purchase contracts executed in 1989 with respect to which Bomar allegedly provided assistance (no amount set forth), and (3) interference with contracts of affreightment allegedly depriving Bomar of certain profits which would have been made by way of payments from ocean carriers had Bomar been able to transport SRL's rutile shipped in 1990 (in excess of $1,000,000). In proceedings in the United States District Court for the Southern District of New York captioned SIERRA RUTILE LIMITED v. BOMAR RESOURCES, INC., 90 Civ. 835 (JFK), (the \"SRL Proceeding\"), Bomar disputed its obligation to arbitrate matters relating to 1989 transactions and that objection was overruled by the Court in an Opinion and Order dated February 21, 1990, in which the District Judge compelled arbitration as to all disputes. On March 7, 1990, Bomar moved for reargument before the District Judge. On June 12, 1990, its motion was denied and SRL's cross-motion for a hearing on its application for a preliminary injunction was granted. On the motion for reargument, Bomar advised that it was now known as Brinc, Ltd. and that its affiliated company, Rivson International Inc. was now known as Bomar Resources, Inc. (\"New Bomar\").\nHearings in the arbitration were held in April and May 1991. On November 15, 1991, the arbitration panel rendered an award in favor of SRL and against Bomar. The arbitration decision adjudged Bomar liable to SRL for breach of the exclusive agency agreement and awarded damages in the determined amount of approximately $3,700,000, and directed an accounting to SRL for various transactions found to have been improper. The arbitration decision trebled the entire award under the provisions of the Federal Racketeer Influenced and Corruption Organizations Act (RICO). It also awarded SRL legal fees, expenses and interest. All of Bomar's counterclaims for post termination sales commissions, unjust enrichment and alleged interference by SRL with contracts of affreightment were denied in all respects.\nOn April 2, 1992, the arbitration panel rendered a final arbitration award in favor of SRL for an amount in excess of $50 million. SRL was awarded $13.8 million in connection with various transactions found by the arbitrators to have been improper and fraudulent as to SRL. SRL was also awarded interest totaling in excess of $4.5 million on all amounts. The award trebles damages under the provisions of RICO. SRL was also awarded its counsel fees and costs. On August 20, 1992 the United States District Court for the Southern District of New York confirmed the arbitration award in SRL's favor and on August 25, 1992 entered a judgment in favor of SRL and against Bomar in an amount of $56.7 million.\nOn July 5, 1990, SRL instituted an action in the Supreme Court of the State of New York, County of New York captioned SIERRA RUTILE LIMITED v. SIMON Y. KATZ, ET AL. against Bomar's principals and a number of persons and entities not bound to arbitrate under the terminated restated exclusive agency agreement dated November 15, 1983 between SRL and Bomar and who are alleged to have participated in, and benefited from, the acts of\nwhich SRL has complained. The SRL complaint transcended the arbitrable issues and among other things, also sought damages against various corporate entities on various legal theories including transferred liability and alter ego\/piercing the corporate veil, in addition to claims under the Racketeer Influence and Corrupt Organization Act, 18 U.S.C. Para. 1961, ET SEQ. and the laws of the State of New York (\"SRL Lawsuit\"). On July 25, 1990, certain defendants in the SRL Lawsuit removed the action to the United States District Court for the Southern District of New York where it has been assigned to the Honorable John F. Kennan, 90 Civ. 4913 (JFK). On September 9, 1992, the District Court denied motions to dismiss advanced by various defendants holding that SRL's claims had been properly pleaded and that the Court had personal jurisdiction over all of the defendants, including the London based Berisford International plc, the Amsterdam based Eggerding & Co., and London residents Ephraim Margulies, Harold Wiltshire and Patrice Klein.\nOn October 30, 1992, SRL entered into a settlement with several defendants in the SRL Lawsuit, to wit, certain officers and directors of Bomar. The settling defendants agreed to pay $2 million to SRL of which $1.5 million has already been collected. They also agreed to cooperate in SRL's prosecution of the SRL Lawsuit against the other defendants. Concurrently, Brinc Ltd.'s and New Bomar's complaint in the \"Bomar Lawsuit\" was dismissed in its entirety with prejudice. An application was filed by one of the defendants in the SRL Lawsuit seeking to void or modify the terms of the above settlement and the Company believes that the application is without any substance. During January and April 1993, two other defendants settled with SRL by agreeing to make payments to SRL in the aggregate of $2.65 million, of which $1.9 million has already been collected.\nIn January 1993, SRL filed a second amended complaint bringing in additional defendants, including a Liechtensteinian Anstalt known as Ferraris Establishment, claiming fraudulent transfer in sums exceeding $15 million. In September 1993, a settlement was reached with several defendants, including Ferraris Establishment, for $3.2 million, which has been collected.\nThe Company has now reached settlements totaling approximately $7.85 million with all principal defendants in the above action except for the London based Berisford International plc, various Berisford subdivisions and various Berisford designees to Bomar's Board of Directors.\nIn June 1994, the Company was granted permission to assert additional claims against Tradeco Holdings Limited and Bomar International Limited, Cayman Island entities alleged by SRL to be controlled by Berisford International PLC, on a guaranty and fraudulent conveyance claim. An answer denying SRL's allegations was filed on behalf of those entities and on August 4, 1994, an Amended Answer, including counterclaims against SRL, cross-claims and purported third party claims against the Company and other defendants was filed. The counterclaim and third party claims assert, among other things, that the acts complained of by SRL and upon which its judgment in arbitration was predicated, was not only known to SRL but also participated in by the Company and others and constituted a fraud on Tradeco for which SRL and the Company have liability or responsibility. The Company intends to vigorously oppose the counterclaims and third\nparty claims asserted against it, which it regards without merit. The Company has been advised by its counsel that based on the facts known to it, Tradeco's asserted claims both by counterclaim and\/or by third party claims are without merit and the Company has moved to dismiss the counterclaims and third party claims and its motions are pending before the Court.\nThe amended class action entitled IN RE NORD RESOURCES CORPORATION, SECURITIES LITIGATION, filed in the United States District Court for the Southern District of Ohio (Dayton); (Civil Action No. C-3-90-391) against the Company, Messrs. Edgar F. Cruft, Richard L. Steinberger, Terence H. Lang, Leonard Lichter, Donald L. Roettele, Harrison Schmitt and Karl Frydryk, which is discussed in detail in the Company's Form 10-K for the fiscal year ended December 31, 1993, was settled by the Company paying $4,750,000, which was comprised of $500,000 in cash and $4,250,000 in stock. In addition, the Company paid costs of notice and administration of $76,000.\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) The following table sets forth, for the calendar periods indicated, the high and low closing sale price of the Company's Common Stock on the New York Stock Exchange Composite Tape.\n(B) Approximate number of equity security holders at December 31, 1994:\nNUMBER OF TITLE OF CLASS HOLDERS OF RECORD -------------- -----------------\nCommon Stock 1,800\n(C) The Company has never paid cash dividends on its Common Stock and does not expect to do so in the immediate future.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following summary of certain financial information relating to the Company for the five years ended December 31, 1994 has been derived from the financial statements of the Company. Such information should be read in conjunction with the financial statements and the report of Deloitte & Touche LLP, appearing elsewhere in this Form 10-K.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nLIQUIDITY AND CAPITAL RESOURCES\nDuring the three year period ended December 31, 1994, the Company required substantial funds for capital expenditures, debt payments and other long-term asset additions totaling $36.4 million, $45.4 million and $7.4 million, respectively. The Company's operating activities provided $32.6 million of cash while additional debt totaling $32.3 million was incurred during the three year period, primarily for capital expenditures and to pay other indebtedness. In March 1993, Nord Kaolin Company (\"NKC\") sold a 20% minority interest to an investor for $4.95 million in cash and received an additional $5.05 million of raw materials from the investor. During November 1993, the Company sold a 50% interest in its rutile operations to an Australian mining company and received initial gross proceeds of $54.8 million, of which $20 million was used to retire a convertible debenture. Of the remaining proceeds received, the Company used $13.6 million to repay other indebtedness.\nDuring 1994 and 1993, the Company converted $2.9 million and $2.5 million, respectively, of its advances to Nord Pacific Limited (\"Pacific\") to shares of Pacific's common stock. In 1994, the Company did not receive dividends on its investment in Pacific.\nThe Company anticipates that its domestic (non-rutile) operations will use cash in its operations during 1995. Operations at NKC are projected to improve so that by the fourth quarter of 1995 NKC could generate cash to repay a portion of the advances previously made by the Company. This improvement in cash flow of the kaolin segment is expected to result from increasing levels of sales of its Norplex[REGISTERED TRADEMARK] line of products, the amount and timing of which cannot be projected with any certainty. To conserve cash, the Company does not anticipate making significant expenditures related to domestic capital programs unless warranted by improving product market conditions. Also, an additional $2 million received from the settlement of the purchase price of the 1993 sale of 50% of the rutile operations and over $1 million expected to be collected from defendants in a legal proceeding who have settled will supplement the Company's cash position in 1995. Sufficient funds are expected to be available for the Company to continue its existing operations throughout 1995 by utilization of a portion of its cash balances at December 31, 1994. However, if the Company is required to fund any activities at the rutile segment, as discussed below, or if operations at the kaolin segment do not continue to improve in 1995, the Company's cash reserves could be inadequate.\nDue to civil disturbances in Sierra Leone, operations of the Company's 50% owned rutile segment were suspended in January 1995. The Company cannot estimate when operations will recommence in Sierra Leone nor can it determine the amount of funds which may ultimately be required by SRL to restart the operations. SRL has instituted steps to minimize its cash requirements during the suspension of its operations, including\ntermination of substantially all of its work force and delaying vendor payments. However, its available cash reserves are not expected to be adequate to satisfy all of its current obligations and to sustain its remaining operations for an extended period of time. In addition, SRL is not in compliance with certain financial and operational covenants under its financing agreements at December 31, 1994. The lenders have agreed to forebear through May 15, 1995 from calling a default and thereby accelerating payment of the outstanding indebtedness, to enable SRL to assess the situation in Sierra Leone. If the default conditions exist at May 15, 1995, the Company anticipates that SRL will request a continued forbearance from the lenders and possibly changes in the timing of the repayment of amounts due to the lenders. The Company cannot determine the willingness of the lenders to grant any additional relief to SRL after May 15, 1995. At December 31, 1994, the Company's share of SRL's debt outstanding is $23 million, which is partially secured by $2.9 million required to be carried by SRL in a restricted cash account.\nUnder the financing agreements, until SRL's capital expansion program attains \"project completion\" the lenders can require the Company to provide 50% of any funds which may be needed by SRL to fulfill its financial obligations, including repayment of the above indebtedness. In addition, under the agreement with the lenders, the Company is required to provide funds due from its 50% joint venture partner if the partner does not provide its share of funds. However, the partner has an agreement with the Company to provide its 50% share of funds required by SRL. If the lenders request acceleration of repayment of the indebtedness by SRL or SRL requires funds for vendor payments for its remaining operations, the funds will more than likely have to be provided by the Company and its partner. The Company may not have an adequate amount of funds currently available to sustain SRL, including funds required to reestablish its operations. As a result, it may need to seek funds through additional bank financing or from other undetermined sources. One source of funds which may be available to the Company is proceeds from foreign political risk insurance policies. One policy provides up to $15.7 million of insurance to the Company for loss of property due to political violence. However, the amount of recoveries, if any, is not yet determinable and may not be sufficient to fund all of the Company's portion of cash required by SRL. The Company is unable to determine the amount of funds which could be required by SRL or if adequate funds will be available from the above or other undetermined sources on conditions acceptable to the Company.\nPayments under lease agreements at NKC are guaranteed by the Company. Under the terms of the guaranty, the Company is required to maintain minimum levels of tangible net worth compared to total liabilities and of cash flow relative to current maturities of long-term debt beginning March 31, 1995. If a covenant violation occurs the Company has the right through September 11, 1995 to cure a default by securing a letter of credit, within 30 days of the event of default, in the name of the lessors which, as of December 31, 1994, would be in the amount of $21 million. The lease agreements also place restrictions on the amount of cash which NKC may transfer to its owners and limitations on the repayment of advances previously made by the Company to NKC. The Company's ability to comply with the financial covenants will more than likely be adversely impacted by the suspension\nof SRL's operations. Should the Company fail to comply with the covenants or provide a letter of credit as noted above, the lessors would have certain rights under the lease including the ability to require liquidating damages ($17 million at December 31, 1994) and could also elect to retain ownership of the leased equipment. If a default occurs, the Company would initiate discussions with the lessors to seek appropriate modifications of the lease terms. However, the Company cannot determine the willingness of the lessors to agree to any modifications, if necessary, on terms which would be acceptable to the Company.\nThe financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. If the political climate in Sierra Leone continues to be disruptive to business operations, the cost to reestablish operations is economically prohibitive or funding for repairs and start-up cost is not available, the Company may not be able to recover its investment in SRL. Because the lenders have not waived the SRL loan covenant violations beyond May 15, 1995, the amount due under the loan agreements ($23,234,000) has been classified as a current liability. As a result, the Company has a working capital deficiency at December 31, 1994. Also, NKC continues to operate at a loss and to generate negative cash flows from operations. In addition, the Company is required to comply with various financial covenants contained in certain of its lease agreements at NKC. These factors raise substantial doubt about the Company's ability to continue as a going concern for a reasonable period of time.\nThe financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms and covenants of its financing agreements, to obtain additional financing or refinancing as may be required and ultimately to attain successful operations. Management of the Company and SRL are continuing their efforts to obtain control of the rutile mining operation and to assure that sufficient funds are available by working with current lenders, so that the Company can meet its obligations and sustain its operations. Management of the Company believes that improved markets for its kaolin products will result in increased sales levels and ultimately operating profits. However, management cannot provide any assurance that these events will occur.\nThe Company's principal financial requirements and anticipated sources and uses of funds for 1995 on a segment basis are described below.\nRUTILE (SRL)\nActivity reported below includes 100% of the amounts recorded by SRL and parenthetically the amount recorded in the Company's financial statements (reflecting the sale of 50% of SRL in November 1993).\nPlease refer to comments made in the above discussion regarding financing at SRL relative to the current suspension of mining operations in Sierra Leone.\nDuring the three year period ended December 31, 1994, SRL utilized $50.1 million ($33.4 million) of its operational cash flow for capital expenditures, primarily for completion of the Lanti deposit development, enhancement and expansion of production and recovery processes and purchase of earth moving equipment, while $37.5 million ($31.9 million) was borrowed under the financing agreements. During the three year period, SRL made debt principal payments of $15.7 million ($11.9 million) and paid $15 million in dividends to the Company. At December 31, 1994, SRL had outstanding debt totaling $46.4 million ($23.2 million), the long-term portion of which ($19.7 million) is classified as a current liability due to the default of a covenant at December 31, 1994.\nAt December 31, 1994, SRL had $10.5 million available to borrow under financing agreements with four international development banks to fund capital expenditures. Due to the suspension of mining operations in Sierra Leone, SRL is currently not able to borrow any funds under these agreements. In addition to the financial covenants and cash escrow requirements previously noted, the financing agreements contain restrictions on SRL's ability to declare dividends and also place limitations on the amount of cash transfers from SRL to its owners. Under the terms of the financing agreements, SRL is required to complete a capital improvement program totaling $83.3 million by December 1996, of which SRL expended $58 million through December 31, 1994. SRL is presently unable to determine the extent to which this capital expansion program has been affected by the situation in Sierra Leone, although it is likely that major modifications will have to be made to the program once mining operations recommence. Any such modifications would require approval of the current SRL lenders and no assurance can be given that SRL would be successful if it sought such modifications.\nKAOLIN (NKC)\nDuring the three year period ended December 31, 1994, NKC's capital expenditures have been primarily for the acquisition of mineral properties and recurring type items. During this period, NKC repaid $16.6 million of indebtedness, primarily by borrowing funds from the Company. NKC does not anticipate that it will expend significant amounts for capital additions during 1995. At December 31, 1994, NKC had outstanding debt totaling $5.2 million. Based on current cash flow projections, NKC does not anticipate that it will be able to make any distributions to its owners in 1995 but expects to reimburse the Company for certain cash expenses paid by the Company on behalf of NKC.\nRESULTS OF OPERATIONS\nThe Company incurred a loss from continuing operations of $15.6 million in 1994 compared to a loss of $8.4 million in 1993. Operating results from the kaolin and rutile segments are discussed individually below. Operating results included $1.6 million as the Company's share of earnings from an affiliate compared to a $1.3 million loss from the affiliate in 1993. In addition, the final settlement of the Company's sale of 50% of its rutile segment resulted in a $1.5 million gain in 1994. Interest expense decreased to $1.6 million in 1994 compared to $6.3 million in 1993 as the Company retired a substantial portion of debt in November 1993 and capitalized $609,000 of interest in 1994. Included in the 1993 loss was $4.75 million for the settlement of litigation against the Company and certain of its officers and a $3.1 million provision for impairment. The Company recognized $950,000 of other income in 1994 compared to $4.2 million in 1993 in connection with settlements received from defendants of litigation instituted by SRL. Selling, general and administrative expense in 1994 included a $1 million payment to the government of Sierra Leone to resolve certain claims made against SRL.\nThe Company incurred a loss from continuing operations of $8.4 million in 1993 compared to a loss of $7.2 million in 1992. Operating results of the kaolin and rutile segments are discussed individually below. The New Jersey zircon operation was terminated in early 1993 with no impact on operations, while it incurred an operating loss of $1 million in 1992. Operations were favorably impacted by recognition of $4.2 million of other revenue in 1993 compared to $1.45 million in 1992 in connection with settlements received from defendants of litigation instituted by SRL. Selling, general and administrative expenses increased by $832,000, primarily at the kaolin segment, as a result of costs associated with the development and market introduction of the Company's Norplex[REGISTERED TRADEMARK] products. Interest expense increased in 1993 as a result of higher levels of borrowing during most of 1993 and a $382,000 decrease in interest capitalized in 1993 compared to 1992. Included in the 1993 loss is $4.75 million for the settlement of litigation against the Company and certain of its officers and directors. Also, the Company recorded a provision for impairment of $3.1 million in the fourth quarter of 1993 to reduce its investment in a real estate joint venture and certain idle equipment to net realizable value. Operating results in 1993 include an increase in the net loss incurred from affiliates, while a minority owner was allocated $1.2 million of the net loss from the kaolin operation in 1993. An income tax benefit of $1.6 million was recognized in 1993 compared to an income tax expense of $3.9 million recorded in 1992, which is further discussed below.\nIncome tax expense is calculated in accordance with the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" (SFAS 109) which requires the Company to recognize the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. The Company's domestic income tax expense\nin 1993 includes the tax effect of certain differences between financial statement amounts and amounts to be included in the Company's federal income tax return. These differences consist of a tax deduction related to previously granted stock options and awards and taxable income on the sale of a 20% interest in Nord Kaolin Company, which is recorded as a component of additional paid-in capital in 1993. Also included in 1993 domestic tax expense is a $1.0 million payment of Alternative Minimum Tax.\nThe Company's foreign income tax expense (benefit) consists primarily of taxes related to earnings of SRL in Sierra Leone, where SRL's effective income tax rate is 37.5%, with a minimum amount of income tax paid equal to 3.5% of sales. The $23.5 million cumulative effect of the adoption of SFAS 109 recorded in 1992 is generated primarily by the differences between financial and tax depreciation for the Sierra Leone tax jurisdiction. Sierra Leone's method of depreciation is different from domestic tax law in that it allows SRL to elect when to take a depreciation deduction and there is no time limitation as to when any unused depreciation may be deducted. SRL enjoyed a tax holiday in Sierra Leone through June 1987 and during that holiday, it was not required to use any tax depreciation, creating a substantial difference between financial statement and tax depreciation. In 1993, the Company determined that SRL would not be required to utilize tax deductions of $18.8 million for prior periods, for which the tax effect of over $7.1 million has been included as a reduction of tax expense and an increase in the Company's deferred tax asset during the fourth quarter of 1993. As a result of the suspension of mining operations at SRL, the Company has determined that a valuation allowance is required for SRL's deferred tax assets. Accordingly, the Company's tax provision for 1994 includes a charge of $14.1 million for this valuation allowance.\nThe Company's operating results in the fourth quarter of 1994 include a $1.5 million gain on sale of 50% of the rutile segment and income tax of $14.1 million related to recording the valuation allowance at the rutile segment. During the fourth quarter of 1993, operating results include revisions of estimates made during the year for certain costs and expenses at SRL, the effect of which was to increase net earnings by $875,000 in the fourth quarter. In addition, operating results in that quarter include $765,000 of selling, general and administrative costs and $2.1 million of domestic income tax expense related to the Company's sale of a 50% interest in SRL. Also the Company recorded a provision for impairment totaling $3.1 million related to an investment in a real estate joint venture and certain equipment and recorded a tax benefit of $7.1 million at SRL due to an increase in allowable tax deduction carry forwards from years prior to 1993. The impact of the above transactions was to increase net earnings before extraordinary item by $2 million during the fourth quarter of 1993.\nDiscussion of the changes in revenue, cost of sales and operating earnings on a segment basis follows below.\nRUTILE (SRL)\nAs previously discussed, the mining operations of this segment were suspended in January 1995 due to civil disturbances in Sierra Leone. The Company cannot estimate when SRL may be able to recommence its mining operations or what changes in the operations may occur due to this situation. In March, SRL terminated all but a small core of its work force, with the remaining employees available to perform various administrative tasks related to the operations of this segment.\nThe amounts disclosed for SRL include 100% of SRL's operations through November 17, 1993 and 50% from November 17, 1993 through December 31, 1994.\nThe Company's share of SRL revenues declined in 1994 compared to 1993 due to the above noted 1993 change in ownership. For 100% of SRL's operations, average sales prices declined by 5.6% while tonnes (2,204.6 lbs.) of rutile sold increased by 6.1% in 1994 compared to 1993. Revenues in 1993 decreased compared to 1992 revenues as, in addition to lower revenues recorded as a result of the sale of 50% of SRL's operations in November 1993, average sales prices and tonnes of rutile sold for 100% of SRL's operations declined by 9.2% and 6.1%, respectively. Revenues in 1993 include $3.7 million of proceeds from the partial settlement of legal proceedings brought by SRL against its former sales agent and others. After November 17, 1993, the Company is responsible for all costs of this litigation and receives any settlement proceeds. Included in 1992 revenues was $1.5 million from the legal proceedings noted above and $465,000 of gain from disposal of equipment. Included in revenues are sales to individual customers which exceeded 10% of the Company's revenues during 1994, 1993 and 1992, as disclosed in Note T -- Industry Segments to the Financial Statements.\nCost of sales as a percentage of sales was 78.7%, 75.1% and 77.5% in 1994, 1993 and 1992, respectively. Cost of sales as a percentage of sales increased in 1994 compared to 1993 due primarily to the effect of lower average prices received in 1994 and an increase in cost of maintenance. Despite the lower average rutile prices received during 1993, the cost of sales percentage decreased compared to 1992. This was due to lower cost of production as a consequence of mining in higher grade ore, together with lower maintenance costs and the curtailment of certain high-cost supplemental mining activities in late 1992, with the suspension of operations of a secondary dredge. Because of improved mining conditions, the primary dredge was able to supply the required amount of rutile production.\nOperating earnings from this segment, before interest expense and income taxes, were $3.8 million, $14.6 million and $14.1 million in 1994, 1993 and 1992, respectively. The Company's share of operating earnings from this segment decreased in 1994 compared to 1993 due in part to the aforementioned 1993 change in ownership. In comparing 100% of this segment's operation in 1994 to 1993, lower operating earnings were realized due to higher cost of sales as noted above. In addition, selling, general and administrative expense in 1994 includes a payment of $1 million to the government of Sierra Leone to resolve certain claims made by the government against SRL for late payment of duties. Operating earnings increased in 1993 compared to 1992, primarily due to lower production costs and the larger settlement received in 1993 from the previously noted litigation, which more than offset lower earnings due to fewer tonnes sold and lower average selling prices. The Company's share of operating results of SRL in 1993,\nexclusive of the litigation settlement, were generally comparable to those of 1992, after adjusting for the impact of the sale of 50% of SRL in November 1993.\nKAOLIN (NKC)\nRevenues increased by 28.7% in 1994 compared to 1993, as revenues in 1994 include $28.8 million from sales of the Company's Norplex[REGISTERED TRADEMARK] and Norcal[REGISTERED TRADEMARK] products compared to $21.3 million in 1993. In 1994 the Company sold 33% more tons of Norplex[REGISTERED TRADEMARK] and 5% more tons of Norcal[REGISTERED TRADEMARK] compared to 1993. Revenues for Norplex[REGISTERED TRADEMARK] increased by 44% due to the increased tons sold plus an increase of 8% in average selling prices. Norcal[REGISTERED TRADEMARK] revenues increased by 10% as average prices increased by 5%. The Company's conventional products revenue also increased by 15% due to a 12% increase in tons sold and a 3% average increase in selling price. The increase in sales volume and price in 1994 for all products enabled the Company to recover its cost of sales. It is the Company's intention to continue to emphasize sales of the Norplex[REGISTERED TRADEMARK] and Norcal[REGISTERED TRADEMARK] products. Included in revenues are sales to one customer which exceeded 10% of the Company's revenues during 1994 and 1993 as disclosed in Note T -- Industry Segments to the Financial Statements. Revenues increased by 17.9% in 1993 compared to 1992, as revenues in 1993 include $21.3 million from sales of the Company's Norplex[REGISTERED TRADEMARK] and Norcal[REGISTERED TRADEMARK] products compared to $12.9 million in 1992. In 1993 the Company sold 81% more tons of Norplex[REGISTERED TRADEMARK] and 47% more tons or Norcal[REGISTERED TRADEMARK] compared to 1992. Revenues for Norplex[REGISTERED TRADEMARK] increased by 77% although average selling prices decreased by 2% due to product mix and a decline in sales prices. Norcal[REGISTERED TRADEMARK] revenues increased by 37% as average prices also declined by 7%. The increase in sales volume in 1993 of Norplex[REGISTERED TRADEMARK] and Norcal[REGISTERED TRADEMARK] products enabled the Company to generate a gross profit for these new products. A decline in sales volume of 23% and sales prices in 1993 averaging 2% less than in 1992 resulted in a 25% decrease in sales revenue for the Company's conventional products.\nCost of sales as a percentage of sales was 96.5%, 107.5% and 112.4% in 1994, 1993 and 1992, respectively. The decrease in the cost of sales percentage in 1994 was due to the increased sales volume and price of all products and a decrease in certain production costs. The increase in sales volume in 1993 of Norcal[REGISTERED TRADEMARK] and Norplex[REGISTERED TRADEMARK] was sufficient to improve the cost of sales percentage in 1993, although the Company experienced declines in sales volume of conventional products.\nNKC's operating loss was $4.7 million, $9.7 million and $9.4 million in 1994, 1993 and 1992, respectively. The decrease in operating loss in 1994 compared to 1993 resulted from the lower cost of sales and reductions in general and administrative costs. A continued emphasis on new product development and introduction contributed to the increased operating loss in 1993 compared to 1992.\nNKC has incurred annual operating losses beginning in 1989 due primarily to the costs associated with development and market introduction of its Norplex[REGISTERED TRADEMARK] products and a longer than anticipated new product introduction period. In addition, in the early 1990's lower demand and prices for certain of its products as a result of the recession contributed to NKC's operating losses. As a result of the above circumstances, NKC had not been\nable to generate sufficient sales volume at adequate prices to recover its fixed and variable costs of production during this period. This situation has improved during 1994 and the sales volume and prices of Norplex[REGISTERED TRADEMARK] and Norcal[REGISTERED TRADEMARK] products have reached levels sufficient to recover the fixed and variable production costs and to begin to fund the selling, general and administrative costs of NKC. However, NKC generated a net loss in 1994 and until the level of Norplex[REGISTERED TRADEMARK] sales volume and prices improve, NKC expects to continue to experience operating losses. The Company cannot precisely estimate when or if adequate sales levels of Norplex[REGISTERED TRADEMARK] products will be achieved or the level of operating losses which will be incurred during the future periods. Based upon recent conversions of customers to the Norplex[REGISTERED TRADEMARK] products and probable future testing and conversion at a number of different customer locations, the Company believes the above noted improvement in sales levels and operating results is likely to occur.\nINFLATION\nThe Company has not been significantly affected by inflation in recent years. Although the Company anticipates that it will not be significantly affected by inflation during 1995, volatility in the cost of energy, particularly petroleum, could have an impact on the Company's operations. The Company is not expected to be affected by changes in interest rates as a majority of its indebtedness is at fixed rates of interest.\nECONOMIC OUTLOOK\nThe Company's two operating segments (SRL and NKC) target their marketing strategy toward the paint and paper industries. SRL's and NKC's operating results are hinged very closely to the general economic conditions in the United States and most of the western world.\nHistorically, demand for titanium based feedstocks, for the titanium dioxide pigment industry (the market for Sierra Rutile Limited products) has followed the major global business and economic cycles and generally have followed or exceeded regional GDP in their growth and consumption rates. The foundation for supply and demand and pricing for natural rutile is based to a significant degree on the world wide consumption of the titanium dioxide pigments. These pigments represent the largest single application for titanium dioxide raw material feedstock, representing over 90% of world wide annual consumption of Ti0(2) feedstock. The global Ti0(2) industry began recovering in 1994 after 3 years of declining prices caused by demand bottoming out in 1991 corresponding with the onset of unfortunately ill-timed implementation of new pigment plant capacities. The Ti0(2) pigment industry and high Ti0(2) feedstocks in 1994 did not experience any noticeable improvement in price, however, 1995 appears to be a different story. The price for Ti0(2) pigments and feedstocks have realized some price improvement in early 1995 and this is expected to continue into 1996.\nThe rutile segment was poised to take advantage of the increased demand for high level titanium feedstocks in 1995 and had implemented a program to increase its overall production of Ti0(2) feedstocks from its current level of approximately 150,000 tonnes annually to approximately 200,000 tonnes with a scheduled start-up of this increased production capability in the fourth quarter of 1995. Unfortunately during January 1995, the\nrutile operations in Sierra Leone, West Africa came under military attack from alleged non-government forces and essentially were overrun by such forces. The Company and its other 50% owner (Consolidated Rutile Limited) have suspended all operations at the minesite. It is evident that resumption of mining operations will not be possible until security improves.\nThe Company's financial results will be negatively impacted in 1995 by continuance of the situation at its rutile operation in Sierra Leone, West Africa. The Company's 50% owned rutile operation will be suspended until such time as security in Sierra Leone improves. Until such time, SRL will not be able to determine when it will be able to recommence operations in Sierra Leone. Company management is unable to predict at this time when this event will occur.\nThe Company's other operating segment NKC, markets its products primarily to the U.S. Paper Industry. Pulp, paper and paper board production in the U.S. is forecast to grow faster than the overall economy in 1995. Although the expansion of the U.S. economy is likely to be slower this year than in 1994 because of increasing interest rates, domestic demands for most grades of paper will remain strong. At the same time, world wide demand for U.S. exports will rise because of accelerating growth and increases in paper consumption in Europe, Asia and Latin America. Paper industry analysts are predicting industry production gains of 3 to 3 1\/2% in 1995 compared to overall economic growth of 2.8% in the United States.\nThe recovery of the U.S. paper industry gained momentum all through 1994. The turnaround was fast and much stronger than most analysts predicted. As a result, much of the industry is now operating at nearly full capacity, and the high level of demand for such products as chemical pulp, coated papers and kraft liner board is straining capacity at most U.S. mills.\nAgain, NKC's Norplex[REGISTERED TRADEMARK] product line, whose primary market is the U.S. paper industry, continued on a slower than expected pace in 1994, although tons of Norplex[REGISTERED TRADEMARK] products sold in 1994 were 30% greater than the 1993 levels. Due to the fact that 1995 overall demand for paper products is forecasted to improve at a greater rate than the overall U.S. economic growth rate, NKC is hopeful that some price increase will be realized on its Norplex[REGISTERED TRADEMARK] and calcined products in 1995. It is anticipated that operating losses at NKC will continue in 1995 but at a lesser amount than experienced in 1994. As in 1994, it is also projected that the volume of Norplex[REGISTERED TRADEMARK] products sold in 1995 will increase over the 1994 volume.\nNKC should continue to gain market share with its Norplex[REGISTERED TRADEMARK] products and overall operating results from that segment should improve over that achieved during 1993. As noted above, the markets that NKC serves are affected directly by the overall economic growth world wide and in particular in the U.S. NKC's results will directly relate to the strength of those economies.\nThe Company also has a 35% ownership interest in Nord Pacific Limited. Nord Pacific Limited is engaged in the production of copper and in the exploration for gold, copper, nickel, cobalt and other minerals in Australia, Papua new Guinea and North America including Mexico. Nord Pacific Limited's only operation at this time is a copper mining and processing facility in eastern Australia. The earnings of this operation are\ndirectly affected by world economic growth and the increase or decrease in demand for copper. The above is qualified to the extent that Nord Pacific Limited's copper hedging contracts guarantee a minimum price of $0.94 per pound through June 30, 1995 and a minimum price of $1.17 per pound for the period July through December 1995, with additional upside potential above $1.02 per pound and $1.20 per pound, respectively. The price for copper rose steadily from the end of 1993 and increased dramatically throughout 1994. At the end of 1994 it stood at $1.34\/lb. compared to a low of $.78 per lb. towards the end of 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO FINANCIAL STATEMENTS: PAGE ----\nIndependent Auditors' Report 32 Consolidated Balance Sheets 34 Consolidated Statements of Operations 35 Consolidated Statements of Stockholders' Equity 36 Consolidated Statements of Cash Flows 37 Notes to Consolidated Financial Statements 38\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Nord Resources Corporation Dayton, Ohio\nWe have audited the accompanying consolidated balance sheets of Nord Resources Corporation and subsidiaries (\"Company\") as of December 31, 1994 and 1993, and the related statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express (or disclaim) an opinion on these statements based on our audits. We did not audit the financial statements of Sierra Rutile Limited (a 50% owned subsidiary) and related rutile segment entities (together the \"Rutile Segment\") for the year ended December 31, 1994, the Company's investment in which is accounted for by proportionate consolidation through December 31, 1994 and on the cost basis as of December 31, 1994. Such statements reflect assets and revenues constituting 47% and 42%, respectively, of the related totals for that year in the accompanying 1994 consolidated financial statements. The financial statements of the Rutile Segment, prepared in accordance with accounting principles generally accepted in the United Kingdom, were audited by other auditors whose report has been furnished to us, and our report, insofar as it relates to the amounts included for the Rutile Segment for the year ended December 31, 1994, is based solely on the report of such auditors. The other auditors' report stated that they were unable to express an opinion on the 1994 financial statements of the Rutile Segment since they were unable to complete substantial auditing procedures and because of the uncertain impact on the financial statement carrying amounts following civil unrest near the mine facilities of the Rutile Segment.\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 report.\nIn our opinion, the consolidated financial statements as of December 31, 1993 and for each of the two years in the period then ended present fairly, in all material respects, the financial position of Nord Resources Corporation and its subsidiaries as of December 31, 1993, and the results of their operations and their cash flows for each of the two years in the period then ended in conformity with generally accepted accounting principles.\nThe accompanying 1994 financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes A and C to the consolidated financial statements, operations of the Rutile Segment have been suspended subsequent to December 31, 1994 because of civil war activities in the area near the Rutile Segment's mine in Sierra Leone. Funds for repairs to mine assets and restart costs may be required of the Company in 1995; the amount and availability of such funds cannot be presently determined. Also as described in Note A, the Company is not in compliance with provisions of various loan agreements and, as a result of the classification of the related obligations as current liabilities, the Company has negative working capital; and, the kaolin segment continues to operate at a loss and to generate negative cash flows from operations. In addition, as further described in Note M, the Company's ability to comply with the financial covenants in several lease agreements will more than likely be adversely impacted by the suspension of operations at the Rutile Segment. These matters raise substantial doubt about the Company's ability to continue as a going concern. Management's plans concerning these matters are also described in Note A. The financial statements do not include any adjustments that might result from the outcome of these uncertainties.\nBecause of the possible material effects of the uncertainties referred to in the preceding paragraph, and the inability of the other auditors to express an opinion on the financial statements of the Rutile Segment, we are unable to express, and we do not express, an opinion on the Company's consolidated financial statements for 1994.\nAs discussed in Note A to the consolidated financial statements, the Company changed its method of accounting for its investment in the Rutile Segment to the cost basis of accounting at December 31, 1994. As discussed in Note P to the consolidated financial statements, the Company changed its method of accounting for income taxes in 1992.\nDELOITTE & TOUCHE LLP\nDayton, Ohio April 7, 1995\nNORD RESOURCES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS, DECEMBER 31, 1994 AND 1993 (In thousands except share and per share amounts)\nSee notes to consolidated financial statements.\nNORD RESOURCES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS\nFOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (In thousands except per share amounts)\nSee notes to consolidated financial statements.\nNORD RESOURCES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (In thousands except shares)\nSee notes to consolidated financial statements.\nNORD RESOURCES CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (In thousands)\nSee notes to consolidated financial statements.\nNORD RESOURCES CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nA. BASIS OF PRESENTATION\nThe Company is engaged in operating natural resource properties primarily for production of kaolin and rutile (titanium dioxide). Kaolin produced by the Company is sold primarily to the paper industry and rutile is sold primarily to the paint pigment industry. The Company has a normal business cycle which occurs over an extended period of time.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of Nord Resources Corporation, its majority-owned subsidiaries and its 50% interest in a rutile mining operation (\"SRL\") (the \"Company\"). All significant intercompany transactions and balances are eliminated.\nSRL as used in these financial statements includes Sierra Rutile Holdings, Sierra Rutile Limited (the mining operation) and other subsidiaries of the Company and Sierra Rutile Holdings which are economically dependent on the mining operation. See Note C for summarized financial information regarding SRL.\nFinancial statement amounts relating to SRL represent the Company's proportionate share in each of the assets, liabilities and operations of SRL, which were 100% owned by the Company through November 17, 1993 and 50% owned thereafter. As a result of the situation described below, the Company's 50% investment in SRL is carried at the cost basis of accounting (which includes original cost plus undistributed earnings through December 31, 1994 except for certain SRL indebtedness with effective recourse to the Company and related restricted cash) in the consolidated balance sheet at December 31, 1994.\nInvestments in 20% to 40%-owned affiliates and joint ventures and in affiliates or joint ventures in which the Company's investment may temporarily be in excess of 40% are carried using the equity method.\nINVESTMENT IN RUTILE SEGMENT\nIn January 1995, the Company's 50% owned rutile mining operation in Sierra Leone, located in West Africa, came under armed attack from non-government forces. As a result, SRL was forced to suspend mining operations and subsequently terminated all nonessential personnel. SRL has received reports of fighting between government and non-government forces at a number of locations in Sierra Leone. There is considerable uncertainty surrounding the future of the rutile mining operation, given the ongoing civil unrest and the uncertain political environment in Sierra Leone.\nManagement of SRL intends to resume operations upon restoration of political stability in Sierra Leone, but at the present time it is not possible to estimate when this might be achieved or the extent of damage and deterioration to SRL's facilities which might occur during the period of suspension of operations. When SRL is able to recommence operations, it will likely incur costs to reestablish and train a workforce, replenish supplies and restore and recommission facilities. Until the current security situation improves and SRL personnel can return to the minesite, it is not possible to estimate these costs without knowledge of the condition of the facilities and equipment.\nPrior to December 31, 1994, the Company proportionately consolidated its share in each of the assets, liabilities and operations of SRL. As of December 31, 1994, the Company adopted the cost basis of accounting (which includes original cost plus undistributed earnings through December 31, 1994) for its investment in SRL, except for certain SRL indebtedness with effective recourse to the Company which is reported as a separate liability and related restricted cash (see Note C), because the Company no longer controlled SRL's operations following the attack by non-government forces. The consolidated statements of operations and cash flows include the Company's proportionate share of operations of SRL through December 31, 1994. The Company intends to resume proportional consolidation when it regains control of the mine.\nFINANCIAL STATEMENT PRESENTATION\nThe accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. If the political climate in Sierra Leone continues to be disruptive to business operations, the cost to reestablish operations is economically prohibitive or funding for repairs and start-up cost is not available, the Company may not be able to recover its investment in SRL. In\naddition, the kaolin segment (Note T) continues to operate at a loss and to generate negative cash flows from operations. Also the Company is required to comply with various financial covenants contained in certain of its lease agreements, as further described in Note M. As described in Note G, the Company is not in compliance with several provisions of various loan agreements and because the lender has not waived the violations beyond May 15, 1995, the amount due under these borrowings ($23,234,000) has been classified as a current liability. As a result, the Company has a working capital deficiency at December 31, 1994. These factors raise substantial doubt about the Company's ability to continue as a going concern for a reasonable period of time.\nThe operations of the kaolin segment have incurred losses during the past several years, primarily due to slower than anticipated market acceptance of a new product line. For the year ended December 31, 1994, the operating loss at the kaolin segment is lower than in prior years. Operating losses at this segment will likely continue until such time as sufficient sales levels of the new products are attained, the timing of which is not determinable by the Company.\nThe consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's continuation as a going concern is dependent upon its ability to generate sufficient cash flow to meet its obligations on a timely basis, to comply with the terms and covenants of its financing agreements, to obtain additional financing or refinancing as may be required and ultimately to attain successful operations. Management of the Company and SRL are continuing their efforts to obtain control of the rutile mining operation and to assure that sufficient funds are available by working with current lenders so that the Company can meet its obligations and sustain its operations. Management of the Company believes that improved markets for its kaolin products will result in increased sales levels and, ultimately, operating profits. However, management cannot provide any assurance that these events will occur.\nB. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nUSE OF ESTIMATES\nManagement of the Company is responsible for the preparation, objectivity and integrity of the consolidated financial statements, including the determination of estimates and judgments used in the preparation of the consolidated financial statements. These estimates include rates of return on investments and rates of discounting and salary escalation used to evaluate retirement and postretirement benefits. Estimates of mineral reserves are used as a basis for amortization of certain of the Company's long-term assets.\nCASH EQUIVALENTS\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nINVENTORIES\nInventories are carried at the lower of cost (first-in, first-out method) or market.\nPROPERTY, PLANT AND EQUIPMENT\nPlant and equipment is depreciated using the straight-line method over the estimated useful lives of the assets ranging from two to thirty years. Minerals and mineral rights and dams and deposit development are depleted by the units- of-production method over the estimated reserves.\nMINE DEVELOPMENT COSTS\nThe Company defers costs directly attributable to the development of reserves. Such costs are amortized by the units-of-production method over the estimated reserves.\nLONG-TERM ASSETS\nA significant amount of the Company's assets are of a long-term nature. In the preparation of its financial statements, the Company evaluates the carrying amount of these assets through application of a number of techniques including analysis of future cash flows, review of third party transactions with the Company, obtaining third party valuations of assets and review of the underlying operations of its affiliates. Any assets which may be deemed impaired are written down to their estimated recoverable amount under a going concern assumption.\nNET EARNINGS (LOSS) PER COMMON AND COMMON EQUIVALENT SHARE\nPrimary earnings (loss) per common and common equivalent share are computed by dividing net earnings (loss) by the weighted average number of common shares outstanding during the year adjusted for the dilutive effect of common stock equivalents when applicable. Fully diluted earnings per common and common equivalent share assumes conversion of the 8% convertible debentures which were retired in November 1993. For 1992, equivalent shares are increased by an additional 3,027,092 shares, and net earnings is adjusted to eliminate interest expense of $1,600,000. The effect of conversion of the 8% convertible debentures into the Company's Common Stock was anti-dilutive in 1993.\nRECLASSIFICATIONS\nCertain reclassifications have been made in the 1993 and 1992 consolidated financial statements to conform to the classifications used in 1994. These reclassifications had no effect on results of operations or stockholders' equity as previously reported.\nC. RUTILE SEGMENT\nThe Company sold 50% of its equity interest in its rutile segment (\"SRL\") in November 1993 for initial proceeds of $54,800,000 of which $20,000,000 was used to retire its debenture. In connection with this sale in 1993, $13,600,000 of debt was also repaid and $826,000 of debt issuance costs were written off as a loss from early extinquishment of debt which is reported as an extraordinary item. The Company recognized a gain of $1,527,000 in the fourth quarter of 1994 as a result of receiving an additional $2,000,000 as a final payment from this sale.\nAs explained in Note A, as of December 31, 1994 the Company has adopted the cost basis of accounting for its investment in SRL. The consolidated statements of operations and cash flows includes the Company's proportionate share of operations and cash flows of the accounts of the rutile segment through December 31, 1994.\nThe following summarized financial information of the Company's share of the rutile segment has been prepared assuming the Company will continue as a going concern. The Company will assess the need for an impairment reserve and the accrual of start-up cost when information becomes available. If the civil disturbances in Sierra Leone do not cease or the estimated costs of reestablishment of SRL's operations in Sierra Leone are prohibitive, the Company may have to record an impairment\nreserve against a portion or possibly all of its investment in SRL. Although SRL will likely incur costs to restart the operations, the amount of impairment and costs to restart the operations cannot be estimated currently.\nThe following is summarized operating data for the Company's share of operations of the rutile segment. Amounts in 1994 represent 50% of the rutile segment. Amounts in 1993 represent 100% of the rutile segment through November 17, 1993 (date of sale) and 50% from the date of sale to December 31, 1993. Amounts in 1992 represent 100% of the rutile segment.\nPROPERTY, PLANT AND EQUIPMENT -- SRL\nMining equipment with a net carrying amount of $2,530,000 at December 31, 1994 is temporarily idle due to market conditions. In the opinion of SRL management, there has been no impairment of value with respect to this idle equipment at December 31, 1994.\nOTHER ASSETS -- SRL\nINCOME TAXES -- SRL\nThe principal current and long-term deferred tax assets and (liabilities) are as follows:\nThe SRL income tax asset is generated primarily by the differences between financial and tax depreciation for the Sierra Leone tax jurisdiction. Sierra Leone's method of depreciation is different from domestic tax law in that it allows SRL to elect when to take a depreciation deduction and there is no time limitation as to when the unused depreciation may be deducted. SRL enjoyed a tax holiday in Sierra Leone through June 1987 and during that holiday, it was not required to use any tax deduction for depreciation, creating a substantial difference between financial statement and tax depreciation. As a result of the suspension of mining operations as described in Note A, the Company has determined that under the provisions of Statement of Financial Accounting Standards No. 109, a valuation allowance is required for these deferred tax assets. Accordingly, the income taxes of $14,645,000 in the Company's statement of operations for the year ended December 31, 1994 includes a charge of $14,095,000 to increase the valuation allowance pertaining to SRL deferred tax assets.\nCOMMITMENTS -- SRL\nIn connection with the settlement of certain claims asserted by the government of Sierra Leone (government), SRL has agreed to commit $6 million for projects for the benefit of Sierra Leone. The projects, to be mutually agreed upon by the government and SRL, will be phased over a period not less than 3 years beginning in 1996. The Company anticipates that the capital projects, once they are determined, will benefit Sierra Leone and become an integral part of the mining operations of SRL.\nOPERATING LEASES -- SRL\nA mining concession is leased by SRL for its rutile operation through 2009, subject to renewal for an additional fifteen years. The Company's 50% share of estimated annual lease payments is $138,000, based upon the area occupied by SRL. In addition, a royalty is paid based on sales. For the years ended December 31, 1994, 1993 and 1992, $1,161,000, $2,226,000, and $2,671,000, respectively, was recorded by the Company as its share of mining lease and royalty expense.\nCONTINGENCIES -- SRL\nThe government of Sierra Leone has an option to acquire 47% of the shares of SRL beginning January 2000 at a purchase price of $57,352,000. Each of the shareholders of SRL would sell equal interests in SRL if this purchase option is exercised.\nThe Company carries varying levels of insurance to cover risk of loss on its investment in SRL due to political violence and expropriation of SRL's assets. Under an insurance policy provided by an agency of the United States government, political violence coverage is provided to cover the Company's share of damage to property. Coverage by the same insurer is provided for loss due to expropriation (any actions taken by a government which prevents the Company from exercising rights or control over its investment). Collection under the above policy is limited to $15.7 million for damages resulting from political violence; however, policy limits are $23.7 million for losses which include expropriation. Another political risk policy carried by the Company for up to $8.4 million of coverage with a private insurer includes expropriation coverage but specifically excludes losses resulting from political violence. This policy expired on March 31, 1995 and the insurer has elected not to renew the coverage. The Company has advised both insurers that it may have claims under these political risk policies. However, the Company cannot estimate the extent of claims which may be asserted under either of these policies or the timing or amount of recoveries which may ultimately be available to the Company.\nD. INVESTMENTS IN AND ADVANCES TO AFFILIATES\nNORD PACIFIC LIMITED (\"Pacific\")\nIn February 1994, Pacific declared a stock bonus of seven additional shares for each share outstanding (in effect an 8 for 1 stock split) prior to completing a public offering in Australia. In connection with the public offering, the Company converted $2,900,000 of its advances to Pacific into 3,488,721 shares of common stock of Pacific, at a price of $.83 per share. As a result of these transactions the Company's ownership in Pacific decreased from 47% at December 31, 1993 to 35.3% currently. During 1993, the Company converted $2,500,000 of its advances to Pacific into 2,962,960 shares of Pacific's common stock, at a market price of $.84 per share, increasing its ownership from 42% to 47%. The Company's share of equity in net assets in excess of its investment is being amortized over ten years.\nThe aggregate market value of the Company's investment in Pacific at December 31, 1994, based on the average of the bid and asked price of Pacific common stock (NASDAQ bid and asked) at December 31, 1994 of $.84 per share, was $14,112,000.\nThe following is summarized information from the audited financial statements of Pacific. The independent auditors' report covering those consolidated financial statements contains an explanatory paragraph indicating that the realization of deferred exploration and development costs is dependent upon future events.\nThe deferred exploration, development and other costs appearing on the balance sheet of Pacific relate primarily to three properties. The Company has obtained financial analyses of each of these properties from Pacific and based on review of the information supplied by Pacific and the position expressed by Pacific as to the expected recovery of its investment in these key properties, the Company believes that it will recover its investment in Pacific.\nThe consolidated financial statements of Pacific include Pacific's 40% proportionate interest in the assets, liabilities and costs and expenses of the joint venture related to the copper property.\nMANATEE GATEWAY\nThe Company, through its wholly-owned subsidiary, Nord Manatee Ltd., has an interest in an inactive joint venture which holds approximately 200 acres of undeveloped real property in Manatee County, Florida. Contributions to the venture are required in the same ratios as the participants' interests. Based on a 1993 review of the underlying real estate and potential uses, the Company believed that its investment in Nord Manatee Ltd. was impaired. Accordingly, the Company recorded a $2,219,000 provision for impairment during the fourth quarter of 1993. The carrying amount recorded by the joint venture for the undeveloped real property at December 31, 1994 is $8,110,000.\nE. PROPERTY, PLANT AND EQUIPMENT\nAmounts relating to SRL are excluded from the amounts below at December 31, 1994 (see Note C).\nEquipment with a net carrying amount of approximately $4,016,000 is temporarily idle at December 31, 1994 due to market conditions. In the opinion of management, there has been no impairment of value with respect to this equipment.\nCapital leases included in property and equipment consist of:\nF. OTHER ASSETS\nAmounts relating to SRL are excluded from the amounts below at December 31, 1994 (see Note C).\nG. INDEBTEDNESS\nMaturities of long-term debt (in thousands) for the next five years are:\nSRL (100%, WITH THE COMPANY'S SHARE NOTED PARENTHETICALLY)\nSRL has financing lines of credit provided by four financial institutions, primarily to fund capital expenditures. As of December 31, 1994, SRL had $32,994,000 ($16,497,000) outstanding at rates ranging from 9% to 11% per annum and $10,480,000 is available under these lines of credit. SRL has agreed to pay commitment fees of up to 1% per annum on any unused amount of the lines. The suspension of the rutile mining operation as described in Note A constitutes an event of default under all of SRL's loan agreements. The lenders have agreed to forebear from accelerating the maturities of the loans or enforcing their rights against any collateral until May 15, 1995 to allow SRL time to determine the damage to the mining operation, to assess the political situation in Sierra Leone and to develop and present a plan for refinancing, rehabilitating and reopening the mining operation. During this period of forebearance, the financial institutions have exercised their right under the financing agreements to suspend their disbursement obligation under the lines of credit and prohibit any dividend payment or any other payments by SRL to the Company except for reimbursement of operating or administrative expenses for the benefit of SRL. If the present situation in Sierra Leone has not improved by May 15, 1995, the Company anticipates that SRL will request a continued forebearance from the lenders and a moratorium on repayment of amounts due to the lenders. The Company cannot determine the willingness of the lenders to grant any additional relief to SRL after May 15, 1995. If the lenders request acceleration of payment of the indebtedness by SRL, funds for which will be provided by the Company and its partner, the Company will likely be required to seek additional funds from as yet undetermined sources. As of December 31, 1994, all debt in default has been classified in the balance sheet as a current liability.\nUnder these financing arrangements, SRL has committed to complete an $83,300,000 capital expansion program of which $57,999,000 had been expended through December 31, 1994. The financing agreements contain restrictive covenants relating to SRL including minimum current and debt coverage ratios and a limit on indebtedness compared to net worth. In addition, SRL is restricted as to the amount of dividends it may declare in any one year to 90% of its cash balance as of the prior year\nend, with a maximum annual dividend of $7,500,000 ($3,750,000) prior to \"project completion\", as defined. SRL must also be in compliance with its financial covenants in order to pay a dividend. Additional covenants under these agreements include restrictions on change of control of SRL and limitations on additional indebtedness at SRL. In addition to the previously noted default, SRL was also in default of a debt coverage ratio under the financing arrangements.\nAmounts borrowed are payable in semi-annual installments over 6-8 year periods, with early payments subject to prepayment penalties. During the term of the indebtedness, SRL is required to maintain a balance in a cash escrow account equal to the total amount of payments (including principal, interest and fees) required to be made in the subsequent six months under these financing arrangements and under the bank financing noted below. At December 31, 1994, SRL escrowed $5,869,000 ($2,934,500) under this requirement.\nSRL has $13,475,000 ($6,737,500) of non-interest bearing bank financing. This loan is also in default similiar to the above noted loans and at December 31, 1994 has been classified in the balance sheet as a current liability. This bank is also a party to the above mentioned forebearance agreement. Prior to December 31, 1994, this debt was discounted at 11% and imputed interest on non- interest bearing debt was recorded on the balance sheets, as there were no fixed and determinable payment terms for this financing agreement at the time of its acquisition.\nUnder the above loan agreements, prior to \"project completion\", the Company has agreed to provide 50% of any funds which may be required by SRL to fulfill its financial obligations, including payment of the above indebtedness. In addition, the Company is required to provide the 50% share of funds which would be due from its joint venture partner if the partner does not make such funds available (including funds for payment of the indebtedness). If it is required to provide the partner's funds, the Company would seek reimbursement from the joint venture partner, as prescribed under an agreement with the joint venture partner. The completion of certain events are required for SRL to attain \"project completion\" including construction or procurement of certain capital assets, attainment of certain production and sales levels, generation of minimum amounts of net earnings and net worth and maintenance of certain financial ratios.\nNORD KAOLIN COMPANY (NKC)\nIn June 1994, NKC refinanced $1.9 million in Industrial Development Bonds. The new bonds contain a variable interest rate (5.70% at December 31, 1994) and are payable in ten annual payments of $190,000 beginning July 1995. The Company has secured payment of the bonds by obtaining a letter of credit in an amount equal to 120% of the amount of the bonds outstanding plus six months interest. The letter of credit is secured by funds invested by the Company which are restricted as to withdrawal.\nOTHER\nThe Company's share of net assets of SRL, which are restricted under debt agreements as to transfer to the Company, is $41,632,000 at December 31, 1994.\nThe fair value and related carrying value of the above debt, excluding capital leases, at December 31, 1994 and 1993 was $25,215,000 and $20,494,000, respectively.\nH. RETIREMENT BENEFITS\nThe Company has an unfunded non-contributory defined benefit plan for certain of its executive officers and management personnel (\"Management Plan\"). The Company also has a qualified non-contributory defined benefit plan covering its domestic bargaining hourly employees (\"Hourly Plan\"). The Company's funding policy has been to contribute an amount in excess of the minimum required by Federal regulations.\nThe following sets forth the funded status and amounts recognized in the Company's balance sheets at December 31:\nStatement of Financial Accounting Standard No. 87, \"Employers' Accounting for Pensions,\" requires recognition of a minimum pension liability. A corresponding amount is recognized as either an asset or a reduction of equity. As of December 31, 1994, the Company recorded a minimum pension liability of $213,000, an asset of $78,000 and an equity reduction of $135,000.\nNet pension expense consists of the following components:\nThe discount rate, the estimated rate at which the Hourly Plan could settle its liabilities, and the expected long-term rate of return on plan assets was 8% in 1994, 7% in 1993 and 9% in 1992. The assumed discount rate for the Management Plan was 8% in 1994, 7% in 1993 and 8% in 1992. The assumed rate of future pay increases was 5%.\nI. POSTRETIREMENT BENEFITS\nThe Company provides certain supplementary medical insurance to bargaining hourly employees upon retirement. These benefits are expensed during the years an employee provides service.\nThe following table sets forth the supplemental medical insurance plan's funded status (in thousands):\nNet postretirement benefit expense consists of the following components (in thousands):\nThe assumed health care cost trend rate used in measuring the accumulated postretirement benefit obligation at December 31, 1994 was 10% for 1995 decreasing linearly each successive year until it reaches 6.5% in 2005, after which it remains constant. A one percentage point increase in the assumed health care cost trend rate for each year would increase the accumulated postretirement benefit obligation and net postretirement health care cost by approximately 30% at December 31, 1994. The assumed discount rate used in determining the accumulated postretirement benefit obligation was 8% in 1994 and 7% in 1993.\nJ. LITIGATION\nSTOCKHOLDER\nDuring 1993, the plaintiffs and defendants agreed to the settlement of a class action complaint, filed initially in 1990, against the Company and certain of its officers and directors. The final settlement was approved by the United States District Court in December 1994 and the case was dismissed. The Company settled the litigation through issuance of 690,159 shares of its common stock at a value of $4,250,000 and payment of $500,000 in cash, plus the payment of notice and administration costs of $76,000. The amount of the settlement was recorded in the financial statements at December 31, 1993. The number of shares to be issued as part of the settlement was determined and included in shares outstanding in the fourth quarter of 1994 and distribution of the shares occurred in January 1995.\nRECOVERIES\nA final arbitration award was rendered in 1992 by an arbitration panel of the American Arbitration Association in favor of the Company's then wholly-owned subsidiary, Sierra Rutile Limited, (\"SRL\") for approximately $57,000,000 plus interest against Bomar Resources Inc. (now known as Brinc Ltd.) (\"Bomar\"), including trebled damages awarded under the provisions of the Federal Racketeer Influenced and Corrupt Organizations Act (RICO). The award has been confirmed by the United States District Court for the Southern District of New York. It is believed that Bomar does not have sufficient assets to satisfy the award, as Bomar has filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code. SRL initiated civil action in the United States District Court, against those allegedly responsible for the acts and conduct complained of and is presently proceeding against various defendants. The action seeks damages against various individuals and corporate entities on various legal theories, including transferee liability and alter ego\/piercing the corporate veil. SRL has reached settlement agreements for amounts in excess of $7,850,000 with all principal defendants in the civil action, except for London based Beresford International PLC, various Beresford subsidiaries, various Beresford designees to Bomar's Board of Directors and entities allegedly controlled by Beresford (all\nherein referred to as \"Beresford\"). The Company has asserted various claims against Beresford and an answer denying SRL's allegations was filed by Beresford. On August 4, 1994, an amended answer was filed by Beresford, including counterclaims against SRL, cross-claims and purported third party claims against the Company and other defendants. The counterclaim and third party claims assert, among other things, that the acts complained of by SRL and upon which its judgment in arbitration was predicated, was not only known to SRL but also participated in by the Company and others and constituted a fraud on Beresford for which SRL and the Company have liability or responsibility. The Company intends to vigorously oppose the counterclaims and third party claims asserted against it which it regards without merit. The Company has been advised by its counsel that based on the facts known to it, Beresford's asserted claims both by counterclaim and\/or by third party claim are without merit and the Company has moved to dismiss the counterclaims and the third party claims and its motions are pending before the Court. Through December 31, 1994, $6,600,000 of the settlements have been received, with remaining amounts due through February 1996. The remainder of the settlements will be included in earnings upon perfection of collateral or when collection is assured. Under an agreement signed in conjunction with the sale of 50% of SRL, beginning November 18, 1993, the Company is responsible for all costs of this litigation and will receive all settlement proceeds.\nThe Company is a party to other claims and lawsuits incidental to its business. In the opinion of management, after consultation with legal counsel, the ultimate outcome of such matters, in the aggregate, will not have a material effect upon the Company's financial position or results of operations.\nK. COMMITMENTS\nThe Company has agreements with certain employees of the Company or its affiliates which contain change in control provisions which would entitle two employees to receive three times their salary in the event of a change in control of the Company (as defined) and three other employees to receive two times their salary in the event of a change in control and a change in certain conditions of their employment. The maximum contingent liability under these agreements is approximately $2,800,000 at December 31, 1994. In addition, the Company has an agreement with its salaried employees which would entitle a covered employee to receive up to six months of salary in the event of a change in their employment status resulting from a change in control of the Company or its sale of a business unit.\nL. ROYALTY AGREEMENT\nNKC has entered into a license agreement to produce and sell products using the Norplex (R) technology. The license extends through June 1998, with NKC having the option to extend the license for two successive five year periods. The license allows NKC exclusive rights through 1999, with a five year extension of exclusive rights available to NKC if certain levels of Norplex (R) product revenues are attained. The license agreement requires payment of an annual royalty of 1 1\/2% on Norplex (R) product revenues up to $60 million and 2% on Norplex (R) product revenues in excess of $60 million. NKC is required to pay minimum monthly royalties of $34,200, adjusted annually by the change in the United States Bureau of Labor Statistics Consumer Price Index. NKC may terminate the license agreement upon 30 days notice to the licensor. To date the Company has paid the minimum monthly royalty required by this agreement. NKC has paid $403,000 through December 31, 1994, related to obtaining foreign patents for the licensor and these payments are available to reduce future payments in excess of the minimum required under the agreement.\nM. LEASES\nAmounts relating to SRL are excluded from the amounts below at December 31, 1994 (see Note C).\nRail cars used to transport the Company's products are leased for periods up to ten years and generally contain renewal options. Lease payments are reduced by credits earned for rail car usage on a mileage basis. The Company had no net cost in 1994, 1993 and 1992, for these rail car leases, after reduction for mileage usage credits.\nNKC entered into a master lease agreement under which $21,725,000 of equipment has been provided to NKC. Approximately $16,700,000 of equipment was provided under operating leases which require payments over a 10-year period, with payments in the initial five years at a lesser amount than in the final five years. NKC has recognized the lease expense on a straight-line basis over the term of the lease, with the resulting difference recorded as a long-term liability of $493,000 at December 31, 1994. NKC has an option to purchase the equipment at the end of the initial lease term at the greater of its fair value or 20% of original cost. An additional $5,025,000 of equipment has been provided under two capital leases which require payments over 7-1\/2 and 10-year periods with options to purchase the equipment at the greater of its fair value or 20% of original cost and 17.5% of original cost, respectively, at the end of the lease term. If the options to purchase are not exercised under the leases, the lessors may elect to extend the leases for an additional eighteen months at the existing lease rates.\nPayments under these lease agreements are guaranteed by the Company. The guarantee contains certain restrictive covenants to be maintained by the Company beginning March 31, 1995, requiring a minimum cash flow coverage to current maturities of 1.5 to 1.0 and a liabilities to tangible net worth ratio not to exceed 1.5 to 1.0. The Company's ability to comply with the financial covenants will more than likely be adversely impacted by the suspension of SRL's operations. Should the Company fail to comply with the covenants or provide a letter of credit as noted below, the lessors would have certain rights including the ability to recover liquidating damages under the lease ($17 million at December 31, 1994) and could also elect to retain ownership of the leased equipment. At such time the Company would initiate discussions with the lessors to seek appropriate modifications of the terms. However, the Company cannot determine the willingness of the lessors to agree to any modifications, if necessary, on terms which would be acceptable to the Company. The Company, however, has the right through September 11, 1995 to cure a covenant default by securing a letter of credit, within thirty days following the notice of default, in the name of the lessors which, as of December 31, 1994, would have to be in the amount of $21 million. The lease agreements also place restrictions on the amount of cash which NKC may transfer to its owners and limitations on the repayment of advances previously made by the Company to NKC.\nMinimum annual lease payments at December 31, 1994 are as follows:\nTotal rent expense for leases other than rail car leases during the years ended December 31, 1994, 1993 and 1992 was $3,922,000, $4,159,000 and $4,101,000, respectively.\nThe Company operates eleven kaolin open pit mines, of which eight are on leased property, and controls or owns a number of other leasehold interests and properties containing reserve deposits. The lease terms range from one to twenty-six years and generally contain renewal options. The Company is obligated to pay the lessors minimum royalties of $171,000 in 1995 whether the properties are mined or not. A substantial portion of these leases containing minimum royalty requirements may be canceled at the Company's option on thirty days notice.\nN. MINORITY INTEREST\nIn March 1993, the Company and a subsidiary entered into a Stock Purchase Agreement (\"Agreement\") under which a 20% interest in Norplex, Inc. (\"Norplex\"), which owns NKC, was sold to an investor. Under the terms of the agreement, Norplex received $4,950,000 in cash at closing, with the remainder of the investment made by the investor supplying Norplex with certain raw materials. As a result of this sale of a minority interest in Norplex, the Company's equity in net assets of Norplex increased by $3,056,000. The investor also received an option to purchase an additional 31% interest in Norplex from the Company at a price which increases from $27,000,000 during 1995 to $36,000,000 during 1997, after which it expires if unexercised. Under this option, the price received by the Company would be reduced by an amount, determined at exercise date, equal to the cumulative amount of temporary tax differences of Norplex plus operating losses used by the Company multiplied by Norplex's marginal tax rate and the percentage of Norplex owned by the investor after exercise. This amount is estimated to be $5,066,000 at December 31, 1994, if the investor had exercised the 31% option at that date.\nAs a condition to this investment in Norplex, the license agreement between NKC and the licensor of certain products produced and sold by NKC was also amended. Under the amendment, NKC is no longer permitted to reduce future royalty payments by previous minimum royalty payments. As a result, the Company's equity in net assets of NKC was reduced by $1,512,000 of previously deferred minimum royalty payments.\nThe gain of $3,056,000 from the sale of a minority interest and the reduction of $1,512,000 of deferred royalty payments as a result of this sale along with $216,000 of legal and organizational costs, net of income tax of $535,000, have been included in 1993 as a net increase in additional paid-in capital of $793,000.\nRelated party transactions with the minority investor in Norplex include the following (in thousands):\nO. STOCKHOLDERS' EQUITY\nIn connection with the settlement of the stockholder class action litigation (see Note J), the Company issued 690,159 shares of its Common Stock in January 1995. Because the number of shares in this settlement was determined during the fourth quarter of 1994, the shares have been considered to be outstanding at December 31, 1994.\nUnder the Company's various stock option plans, options have been granted at market price at date of grant (incentive stock options) and at less than market price at date of grant (non-qualified stock options). Options are generally exercisable beginning one year from date of grant and expire ten years from date of grant.\nA summary of the option transactions is as follows:\nAll outstanding options are exercisable at December 31, 1994 except 139,700 options at a purchase price of $5.13 per share. In addition, 361,059 shares are available for future option grants.\nThe Company also has granted options to a consultant to purchase 150,000 shares of common stock at a purchase price of $5.63 per share and 50,000 shares of common stock at a purchase price of $7.00 per share, both of which expire on July 1, 1997.\nA total of 1,997,438 shares are reserved for exercise of the above described stock options.\nRetained earnings are not available for dividends since retained earnings of the Company are comprised of the cumulative amount of undistributed earnings of foreign subsidiaries, the distribution of which is limited under the terms of the financing lines of credit.\nP. INCOME TAX\nIncome tax expense (benefit) includes the following:\nAs a result of the suspension of mining operations as described in Note A, the Company has determined that under the provisions of Statement of Financial Accounting Standards No. 109, a valuation allowance is required for SRL's deferred tax assets. Accordingly, the income tax expense of $14,645,000 in the statement of operations for the year ended December 31, 1994 includes a charge of $14,095,000 to increase the valuation allowance pertaining to SRL deferred tax assets.\nThe principal current and long-term deferred tax assets and (liabilities) are as follows:\nThe domestic valuation allowance for deferred tax assets represents a 100% valuation allowance. Based upon the earnings history of the Company's domestic operations, it is more likely than not that the Company will be unable to generate enough income to take advantage of the net operating loss carryforwards and related tax credits.\nDomestic income taxes have not been provided on undistributed earnings of SRL aggregating $43,150,000 at December 31, 1994 which the Company intends to reinvest in SRL. The unrecognized domestic deferred tax liability for the temporary differences related to the Company's investment in SRL was $11,600,000 at December 31, 1994.\nIncome taxes differ from the amount computed by applying the U.S. statutory federal income tax rate as follows:\nFEDERAL\nAt December 31, 1994, the Company had a net operating loss carryforward for domestic income tax purposes totaling $22,576,000 available to be carried forward to future periods. This carryforward expires from 2006 to 2009. The Company also had general business credit carryforwards of $578,000 which expire from 1995 to 2009, and foreign tax credits of $1,910,000, which expire in 1997 and 1998, available to reduce the Company's future tax liability.\nThe Alternative Minimum Tax (AMT) requires a separate tax computation from regular tax, based on a 20% rate. For AMT purposes, net operating loss carryforwards are adjusted by certain tax preference items, including the percentage depletion deduction previously taken by the Company. The Company has paid $1,040,000 of AMT and such amount is available to be used as a credit in future years to the extent that regular tax exceeds the AMT.\nFOREIGN\nThe Company's principal foreign interest is a 50% subsidiary (SRL) which is assessed income tax at a 37.5% rate with a minimum tax payment equal to 3.5% of net sales. SRL has received notification from tax authorities in Sierra Leone regarding their acceptance of income tax returns filed through 1988. As a result, $18,842,000 of tax deductions for depreciation which had previously been utilized became available and the Company increased its deferred tax asset by $7,066,000 and recognized the corresponding income tax benefit in 1993.\nACCOUNTING CHANGE\nEffective January 1, 1992, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting For Income Taxes.\" The statement requires that income tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credit and loss carryforwards. The cumulative effect of this change in accounting for income taxes of $23,480,000 ($1.55 per share) is determined as of January 1, 1992, and is reported separately in the statement of operations for the year ended December 31, 1992.\nQ. DISCONTINUED OPERATIONS\nIn August 1993 the Company disposed of the perlite operations for $1,270,000 in cash, for a gain of $106,000. The loss from discontinued operations includes the following amounts:\nDuring 1993 and 1992, the Company charged $931,000 and $1,546,000, respectively, for operating losses of the perlite operations to the provision for operating losses.\nSales from the perlite operations of $2,424,000 and $3,710,000 for the years ended December 31, 1993 and 1992, respectively, have been excluded from continuing operations.\nR. RESEARCH AND DEVELOPMENT\nResearch and development costs were $1,042,000 for 1994, $1,071,000 for 1993, and $1,028,000 for 1992. These costs are primarily associated with new product development at NKC.\nS. CASH FLOW STATEMENTS\nT. INDUSTRY SEGMENTS\nThe Company's reportable industry segments are its domestic kaolin operation and its Sierra Leone, Africa, rutile operation. Financial data by reportable industry segment are as follows:\nU. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe quarterly results of operations are shown below:\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\nThe information required by the above Items 10-13 is incorporated by reference from the Company's Proxy Statement to be dated April 25, 1995.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K\n(a) 1. Financial Statements: The following financial statements of Nord Resources Corporation are included in Part II, Item 8 of this Form 10-K\nPAGE ---- (a) 2. Financial Statement Schedules:\nIndependent Auditors' Report 74\nSchedule I - Condensed financial information of Registrant, Nord Resources Corporation 75\nSchedule II - Valuation and qualifying accounts 78\nNord Pacific Limited: Independent Auditors' Report 79 Consolidated Balance Sheets 80 Consolidated Statements of Operations 82 Consolidated Statements of Shareholders' Equity 83 Consolidated Statements of Cash Flows 84 Notes to Consolidated Financial Statements 85\n(a) 3. Exhibits: See INDEX TO EXHIBITS\n(b) Reports on Form 8-K:\nNo reports on Form 8-K were filed by the Company during the quarter ended December 31, 1994.\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Stockholders Nord Resources Corporation Dayton, Ohio\nWe have audited the consolidated financial statements of Nord Resources Corporation and subsidiaries as of December 31, 1994 and 1993, and for each of the three years in the period ended December 31, 1994; and have issued our report thereon dated April 7, 1995, which report disclaims an opinion on the consolidated financial statements as of December 31, 1994 and for the year then ended because of uncertainties relating to the ability of the Company to continue as a going concern and includes an explanatory paragraph as to the Company changing its method of accounting for its investment in the Rutile Segment to the cost basis at December 31, 1994; such report is included elsewhere in this Form 10-K. Our audits also included the consolidated financial statement schedules of Nord Resources Corporation and subsidiaries, listed in Item 14. These consolidated financial statement schedules are the responsibility of the Company's management. Our responsibility is to express (or disclaim) an opinion based on our audits. In our opinion, the consolidated financial statement schedules as of December 31, 1993 and 1992 and for each of the two years in the period then ended December 31, 1993, 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. As explained in the fifth paragraph of our report, we are unable to express, and we do not express, an opinion on the Company's consolidated financial statements for 1994. Accordingly, we are unable to express, and we do not express, an opinion on the consolidated financial statement schedules as of December 31, 1994 and for the year then ended.\nDELOITTE & TOUCHE LLP\nDayton, Ohio April 7, 1995\nNORD RESOURCES CORPORATION\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT, NORD RESOURCES CORPORATION BALANCE SHEETS, DECEMBER 31, 1994 AND 1993 (In thousands)\nNORD RESOURCES CORPORATION\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT, NORD RESOURCES CORPORATION STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (In thousands)\nNORD RESOURCES CORPORATION\nSCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT, NORD RESOURCES CORPORATION STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (In thousands)\nNORD RESOURCES CORPORATION AND SUBSIDIARIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (In thousands)\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Nord Pacific Limited Hamilton, Bermuda\nWe have audited the accompanying consolidated balance sheets of Nord Pacific Limited and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994 (all expressed in U.S. dollars). 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 auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. 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 Nord Pacific Limited and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with accounting principles generally accepted in the United States of America.\nAs discussed in Note D to the consolidated financial statements, the Company has deferred exploration and development costs related to exploration prospects aggregating $9,308,000 and $7,763,000 at December 31, 1994 and 1993, respectively. Realization of these costs is dependent upon future events.\nDeloitte & Touche Chartered Accountants Hamilton, Bermuda March 9, 1995\nNORD PACIFIC LIMITED AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS, DECEMBER 31, 1994 AND 1993 - ------------------------------------------------------- (IN THOUSANDS OF U.S. DOLLARS)\nSee notes to consolidated financial statements.\nNORD PACIFIC LIMITED AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS, DECEMBER 31, 1994 AND 1993 - ------------------------------------------------------- (IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARE AND PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nNORD PACIFIC LIMITED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 - ---------------------------------------------------- (IN THOUSANDS OF U.S. DOLLARS, EXCEPT PER SHARE AMOUNTS)\nSee notes to consolidated financial statements.\nNORD PACIFIC LIMITED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 - ---------------------------------------------------- (IN THOUSANDS OF U.S. DOLLARS, EXCEPT SHARES)\nSee notes to consolidated financial statements.\nNORD PACIFIC LIMITED AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 - ---------------------------------------------------- (IN THOUSANDS OF U.S. DOLLARS)\nSee notes to consolidated financial statements.\nNORD PACIFIC LIMITED AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN U.S. DOLLARS)\nA. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCOMPANY DESCRIPTION\nNord Pacific Limited (the \"Company\") operates in a single industry segment which includes the exploration for and development and production of precious and base metals and strategic mineral properties primarily in Australia and Papua New Guinea. Exploration activity is also carried on in North America, primarily for gold.\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries, and its 40% interest in the Girilambone copper property (\"Girilambone\") in Australia. Financial statement amounts relating to Girilambone represent the Company's proportionate interest in the assets, liabilities and operations of Girilambone. All significant intercompany transactions are eliminated.\nCASH AND CASH EQUIVALENTS\nThe Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.\nINVENTORIES\nInventories are valued at the lower of cost (first-in, first-out method) or market.\nDEFERRED COSTS ASSOCIATED WITH ORE UNDER LEACH\nCosts at Girilambone incurred with respect to ore under leach are deferred and amortized using the units of production method over the estimated reserves. Copper is projected to be recovered during the next 4 1\/2 year period, based on the present proven reserves. The Company will continually evaluate and refine estimates used to determine the amortization and carrying amount of deferred costs associated with ore under leach based upon actual copper recoveries and operating plans.\nPROPERTY, PLANT AND EQUIPMENT\nNon-mining property, plant and equipment is depreciated using the straight-line method over the estimated useful lives of the assets. Property, plant and equipment related to Girilambone is depreciated by the units of production method over the estimated reserves.\nDEFERRED EXPLORATION AND DEVELOPMENT COSTS\nAll costs directly attributable to prospecting, exploration and development are deferred. Costs related to producing properties are amortized by the units-of- production method over the estimated reserves. Deferred costs are carried at cost, not in excess of anticipated future recoverable value, and are expensed when a project is no longer considered commercially viable.\nDEBT ISSUANCE COSTS\nProfessional fees and expenses relating to the issuance of debt are capitalized and amortized over the term of the related borrowings.\nFOREIGN CURRENCY TRANSLATION\nThe functional currency for operations conducted in Australia was changed to the U.S. dollar on April 1, 1993 due to changes in economic facts and circumstances pertaining to the Company's Australian operations, including obtaining additional U.S. dollar denominated indebtedness and entering into certain forward currency exchange contracts. Adjustments to U.S. dollar balances as a result of changes in the exchange rate between U.S. dollars and Australian dollars are recognized currently in the statement of operations as foreign currency transaction gains and losses.\nFor the period through March 31, 1993, the Australian dollar was the functional currency for the Company's operations conducted in Australia. The assets and liabilities of the Australian operations were translated into United States dollars at current exchange rates. Revenue and expense accounts were translated into United States dollars at the average exchange rate for the period. The resulting translation adjustments were accumulated as a separate component of shareholders' equity through March 31, 1993.\nFINANCIAL INSTRUMENTS\nGains and losses related to qualifying hedges of anticipated copper sales are deferred and recognized in the statement of operations at the settlement date.\nRealized and unrealized gains and losses on forward currency exchange contracts that do not qualify as hedges are recognized currently in the statement of operations. Net unrealized gains and losses are included as assets or liabilities in the balance sheet. (See Note F)\nNET EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE\nNet earnings per common and common equivalent share are computed on a modified treasury stock method as options outstanding exceed 20% of the Company's shares outstanding at December 31,1994. Under this method of computation, all options outstanding are presumed exercised, and proceeds are deemed to be applied to reduce borrowing with any excess proceeds applied to the purchase of U.S. government securities. Net earnings and average common and common equivalent shares are adjusted to include the effect of the above calculation in determining the Company's net earnings per common and common equivalent share.\nRECLASSIFICATIONS\nCertain reclassifications have been made in the 1993 and 1992 consolidated financial statements to conform to the classifications used in 1994. These reclassifications had no effect on results of operations or shareholders' equity as previously reported.\nB. GIRILAMBONE\nThe Company is a 40% joint venturer in Girilambone which commenced production in May 1993. All costs incurred during mine development have been capitalized and are being amortized using the units of production method over the estimated reserves. Following is summarized balance sheet information of Girilambone:\nDebt incurred for the development and construction of Girilambone is the separate responsibility of each venturer and is not included in the joint venture's financial statements. The Company has $7,133,000 of debt outstanding at December 31, 1994, which was incurred to fund the construction and development of Girilambone.\nCopper production is distributed to each venturer based on its respective ownership interest. Sale of copper is the responsibility of each venturer. Cost and expense information related to the operation of the mine is as follows:\nC. PROPERTY, PLANT & EQUIPMENT\nD. DEFERRED EXPLORATION AND DEVELOPMENT COSTS\nExploration prospects include the following:\nRAMU\nIn May 1992 the Company entered into an agreement with its Ramu joint venturer to dilute its interest to 40%. In return, the joint venturer is required to fund the next 5,000,000 Kina (Papua New Guinea currency) of expenditures on the project. As of December 31, 1994, approximately 3,600,000 Kina has been expended by the joint venturer toward the required expenditure, and the Company is maintaining a 40% interest until the completion of the sole funding by the joint venturer. Thereafter, the Company will be required to contribute its proportionate share of exploration costs or will dilute its interest below 40%. The Company currently does not have sufficient capital to fund its share of Ramu development and construction costs, and would need to obtain additional funding for such costs. The Kina has approximately equaled the U.S. dollar until its devaluation in 1994. The exchange rate at December 31, 1994, was 1.00 Kina equals U.S. $0.85.\nAnother party, Eastern Pacific Mines, may elect within 180 days of receiving details of any proposed commercial development of Ramu to participate in such development up to 10%. The interest is to be acquired from the joint venturer if the Company's interest is 51% or greater, and otherwise from the Company and the joint venturer in proportion to their interests.\nTABAR ISLANDS\nOn August 30, 1993, the Company entered into an agreement to increase its interest in the Tabar Islands project from 29% to 100%. The remaining purchase price of $1,474,000 (A$1,900,000) is payable in installments of $698,000 (A$900,000) in June 1995 and $776,000 (A$1,000,000) two years after the granting of a mining lease by the government of Papua New Guinea.\nThe sellers have an option to reacquire 50% of the project if feasibility studies indicate that the project could produce 150,000 ounces or more of gold annually. Exercise of the option would require payment to the Company of 2 1\/2 times its cumulative expenditures for mine development from July 1994 to the date the option is exercised. Expenditures from July 1994, through December 31, 1994 totaled approximately $480,000.\nGIRILAMBONE EXPLORATION AREA\nThe Company has a 50% interest in an exploration joint venture related to areas adjacent to its Girilambone copper mine. Under the venture the Company is required to fund its 50% share of exploration costs.\nAdditional efforts on each of the prospects in the adjacent area, including further drilling and feasibility studies incorporating all relevant technical and economic factors, will be required in order to determine the extent to which resources will be commercially viable and whether the deferred exploration and development costs ultimately will be realizable.\nE. INDEBTEDNESS\nGIRILAMBONE FINANCING AGREEMENT\nThe Company borrowed $10,000,000, of which $7,133,000 was outstanding at December 31, 1994, under a financing agreement to fund its share of the development and construction costs of Girilambone. The lender holds a security interest in the Company's 40% interest in Girilambone. The loan bears interest at LIBOR plus 1.85% (8.35% at December 31, 1994). Minimum principal payments of $3,960,000 are required under the financing agreement in 1995; however, repayment amounts may be higher based on available cash flow of Girilambone. Amounts not repaid in 1995 will be repaid in 1996. In August 1994, a principal payment of $1,000,000 was made in accordance with the financing agreement using funds previously held to cover cost overruns. Additional principal payments during 1994 totaled $1,867,000.\nDuring the period the loan is outstanding, the Company is required to maintain a minimum $1,000,000 reserve account with the lender. All cash proceeds generated from Girilambone operations are required to be deposited with the lender and must be used to pay any project costs, bank fees, interest, principal, and funding required in the reserve account before any cash is available to the Company.\nSUBORDINATED DEMAND NOTE - NORD RESOURCES CORP. (\"RESOURCES\")\nThe Company and Resources previously entered into an agreement under which Resources had provided the Company advances of up to $3,000,000 which were payable on demand. In February 1994, simultaneous with the closing of the Australian Offering, Resources converted $2,900,000, the amount of the subordinated demand note, into 3,488,721 shares of the common stock of the Company at a price of approximately $.83 per share. There are currently no loan agreements between the Company and Resources.\nF. FINANCIAL INSTRUMENTS\nThe Company utilizes certain financial instruments, primarily copper hedging agreements and forward currency exchange contracts. These financial instruments are utilized to reduce the risk associated with the volatility of commodity prices and fluctuations in foreign currency exchange rates, particularly the Australian dollar. The Company does not hold or issue financial instruments for trading purposes.\nCOPPER HEDGING AGREEMENTS\nTo hedge the effect of price changes on substantially all of its expected copper sales through December 31, 1995, the Company has entered into both swap and call option agreements. The swap agreements lock in a fixed forward price as a floor, with the purchase of call options above the floor permitting the Company to benefit from an increase in copper price above the call price. The copper hedging agreements qualify as hedges, and gains and losses under these agreements are reflected as a component of sales when each contract settles.\nUnder one hedging arrangement, the Company entered into both swap and call option agreements on a total of 5.6 million pounds of copper that generally settle ratably each month through June 1995. Under this arrangement, at the settlement date for each copper contract, the Company receives $.94 per pound plus the excess of market price (as determined by the London Metals Exchange) over $1.02 per pound. If market price is less than $1.02 per pound, the Company receives $.94 per pound. Sales for the year ended December 31, 1994 and 1993 are net of $27,000 of losses and $616,000 gains, respectively, that were paid\/received in settlement of the copper hedging contracts.\nThe Company entered into a second copper hedging agreement in December 1994, effective in July 1995, which contains both swap and call option agreements on a total of 6.6 million pounds of copper that settle ratably each month from July through December 1995. Under this arrangement, at the settlement date for each copper contract, the Company will receive $1.17 per pound plus the excess of market price (as determined by the London Metals Exchange) over $1.20 per pound. If market price is less than $1.20 per pound, the Company will receive $1.17 per pound. The cost to the Company for the hedge is $.06 per pound of copper which is recognized as an adjustment to sales ratably over the life of the contracts.\nFORWARD CURRENCY EXCHANGE CONTRACTS\nThe Company has entered into forward exchange contracts, expiring at various times through July 1996, to hedge against potential Australian currency fluctuations related to payment of a portion of the expected operating costs of Girilambone. Realized and unrealized gains and losses on these contracts are included currently in the results of operations. For the year ended December 31, 1994 the Company recognized a gain of $2,535,000 compared to a gain of $14,000 in 1993. At December 31, 1994, the unrealized gain totaled $2,113,000 on the outstanding contracts of $14,600,000 (A$21,900,000); at December 31, 1993 outstanding contracts totaled $19,500,000 (A$29,300,000).\nThe Company is exposed to copper price fluctuations and currency risks in the event of nonperformance by the counterparties to the various agreements described above but has no off balance sheet risk of accounting loss. The Company anticipates, however, that the counterparties will be able to fully satisfy their obligations under the agreements. The Company does not obtain collateral or other security to support financial instruments subject to credit risk.\nG. NORD RESOURCES CORPORATION (\"RESOURCES\")\nIn February 1994, simultaneous with the closing of the Australian Offering, Resources converted $2,900,000 owed to it by the Company into 3,488,721 shares of common stock of the Company at $.83 per share. In September 1993, Resources exchanged $2,500,000 of amounts owed to it by the Company for 2,962,960 shares of the Company's common stock at $.84 per share, the closing bid price on NASDAQ on the date of the exchange. Interest expense under previous loans from Resources was $24,000, $243,000, and $235,000 for the years ended December 31, 1994, 1993, and 1992, respectively. Resources provides certain services to the Company under a management agreement. Resources is reimbursed for all direct expenses and a portion of its overhead associated with the operations of the Company. At December 31, 1994, Resources owned approximately 35% of the outstanding common stock of the Company.\nH. OPERATING LEASES\nThe Company leases its office space and certain equipment under operating leases with terms ranging from one to five years. Certain of the leases contain renewal options and escalation clauses. Minimum annual lease payments under non-cancelable lease obligations for the years ended December 31 are as follows:\nRent expense for operating leases was $239,000, $284,000, $278,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nI. SHAREHOLDERS' EQUITY\nSTOCK OPTION PLANS AND OTHER OPTION GRANTS\nUnder the Company's two stock option plans, options have been granted at market price at date of grant (incentive stock options) and at or less than fair market value at date of grant (non-qualified options). In addition, during 1994 and 1993, non-plan options totaling 1,320,000 and 1,040,000 shares, respectively, have also been granted to officers and directors of the Company at or in excess of fair market value at date of grant. Options are generally exercisable beginning one to three years from date of grant and expire over a five to ten year period from date of grant. During 1994, a non-plan option for 120,000 shares which expires three years from date of grant was issued to a consultant to the Company.\nA summary of the option transactions is as follows:\nAt December 31, 1994, 19,472,000 options were exercisable at prices ranging from $.38 to $.97 per share and 365,390 shares are available for future grant under the Stock Option Plans.\nSTOCK BONUS PLAN\nThe 1990 Stock Bonus Plan provides for the issuance of up to 400,000 shares of common stock as incentive bonuses. At December 31, 1994, 366,400 shares have been awarded and 33,600 shares are available for future award under this plan.\nPUBLIC OFFERING\nOn February 15, 1994, the Company completed an offering of its common stock in Australia. The offering consisted of 16,000,000 shares of the Company's common stock at $.89 per share (A$1.25 converted at the February 15, 1994, exchange rate) together with 16,000,000 detachable options, expiring June 30, 1995, to purchase additional shares of the Company's common stock at $.97 per share (A$1.25 converted at the December 31, 1994, exchange rate). Concurrent with the completion of the offering, the Board of Directors declared a stock bonus to existing shareholders of seven shares for every existing share. The stock bonus and an increase in the authorized shares to 100,000,000 were approved by the Company's shareholders on January 7, 1994. All share and per share data presented in the accompanying consolidated financial statements have been restated retroactively to reflect the stock bonus.\nA total of 21,108,990 shares have been reserved for exercise of stock options, including the 16,000,000 options issued under the Australian offering, and for award under the Stock Bonus Plan.\nOTHER\nIn April 1992, the Company issued 80,000 shares of restricted stock to each of the Chairman and President of the Company.\n1995 STOCK OPTION PLAN\nIn January 1995, the Company's Board of Directors approved the adoption of the 1995 Stock Option Plan subject to approval by shareholders, which sets aside 3,000,000 options of which 1,440,000 are to be reserved for directors.\nJ. SIGNIFICANT CUSTOMERS\nSales in 1994 include copper sales to two customers of $9,622,000 and $1,543,000. Sales in 1993 include copper sales to one customer of $3,873,000.\nK. INCOME TAXES\nUnder Bermuda law, the Company is not required to pay any taxes in Bermuda on either income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that in the event any such taxes are imposed, the Company will be exempted from taxation until the year 2016. Although the Company is not subject to income taxes, it has subsidiaries which are subject to income taxes in their respective foreign countries.\nNet operating loss carryforwards of $3,300,000 which expire from 2005 through 2008 are available in the United States. These carryforwards are available only to reduce the separate taxable income of the Company's United States subsidiary.\nExploration cost carryforwards of $4,200,000 and development cost carryforwards of $5,500,000 are available in Australia. Trading loss carryforwards of $600,000 are also available in Australia. These carryforwards, subject to certain restrictions, are available indefinitely only to reduce the separate taxable income of the Company's Australian operations.\nExploration cost carryforwards of $6,300,000 which expire from 1995 through 2004 are available in Papua New Guinea, provided sufficient projects are developed in that country. These carryforwards, which expire $300,000 in 1995, $546,000 in 1996, $692,000 in 1997, and the remainder, thereafter, are available only to reduce the separate taxable income of the Company's Papua New Guinean operations.\nThe principal deferred tax assets and (liabilities) for the United States, Australia and Papua New Guinea are as follows:\nA valuation allowance has been provided for 100% of the Company's net deferred tax assets based on the history of operating losses for the Company and limitations on use of the above carryforwards.\nThe Company had taxable income during 1994 from its operations in Australia, which utilized a portion of its trading loss carryforwards, as follows:\nL. PENSION PLANS\nThe Company has a defined contribution pension plan covering certain employees of its Australian operations. Under the terms of the plan, the Company contributes an amount equal to 10% of the employees wages. Pension costs were $59,000, $83,000, and $98,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nThe Company is obligated to pay a lump sum benefit that matches the difference, if any, between the present value of an executive's retirement benefit under a previous plan and the cash value of an insurance policy at retirement. At December 31, 1994 and 1993, the cash surrender value of $135,400 and $105,400, respectively, has been offset against the accrued retirement benefits liability. Pension expense for the years ended December 31, 1994, 1993 and 1992 was $76,000, $50,000, and $49,000, respectively. Pension expense for 1994, 1993 and 1992 included $62,000, $38,000, and $40,000, respectively, of service cost and $14,000, $12,000, and $9,000, respectively, of interest on the accrued benefit obligation. The projected benefit obligation at December 31, 1994 and 1993 was $320,000 and $289,000, respectively. The assumed discount rate, the estimated rate at which the plan could settle its liabilities, was 8% in 1994 and 7% in 1993. The assumed rate of future pay increase was 5%.\nM. EMPLOYMENT AGREEMENTS\nThe Company has agreements with two of its officers which contain change in control provisions which would entitle one officer to receive 50% of his salary and the other officer to receive 200% of his salary in the event of a change in control of the Company and a change in certain conditions of their employment. The maximum contingent liability under these agreements is approximately $445,000 at December 31, 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.\nNORD RESOURCES CORPORATION\nBY:\/s\/EDGAR F. CRUFT ------------------------------ EDGAR F. CRUFT CHAIRMAN OF THE BOARD (CHIEF EXECUTIVE OFFICER), PRESIDENT AND DIRECTOR\nAPRIL 7, 1995\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.\nAPRIL 7, 1995 \/s\/TERENCE H. LANG - --------------------------------- \/s\/LEONARD LICHTER TERENCE H. LANG ------------------------------- SENIOR VICE PRESIDENT -- FINANCE LEONARD LICHTER (CHIEF FINANCIAL OFFICER), DIRECTOR TREASURER AND DIRECTOR\nAPRIL 7, 1995 APRIL 7, 1995 \/s\/W. PIERCE CARSON ------------------------------- W. PIERCE CARSON \/s\/DONALD L. ROETTELE DIRECTOR - -------------------------------- DONALD L. ROETTELE DIRECTOR APRIL 7, 1995\nAPRIL 7, 1995\n\/s\/KARL A. FRYDRYK - -------------------------------- KARL A. FRYDRYK SECRETARY AND VICE PRESIDENT-- CONTROLLER (CHIEF ACCOUNTING OFFICER)\nAPRIL 7, 1995\n\/s\/WALTER T. BELOUS - -------------------------------- WALTER T. BELOUS DIRECTOR\nINDEX TO EXHIBITS\nPAGE NUMBER ------ 2. PLAN OF ACQUISITION, REORGANIZATION, ARRANGEMENT, LIQUIDATION OR SUCCESSION\n2.1 Stock Purchase Agreement dated March 11, 1993 by and among Nord Kaolin Corporation (\"NK Corp\"), Nord Resources Corporation (\"NRC\"), Norplex, Inc. (\"Norplex\") and Kemira Holdings, Inc. (\"Kemira\"). Reference is made to Exhibit 2.1 of Registrant's Current Report on Form 8-K dated March 11, 1993, which exhibit is incorporated herein by reference. **\n2.2 Stock Purchase Agreement dated June 28, 1993 by and between Nord Resources Corporation and Consolidated Rutile Limited. Reference is made to Exhibit 2.2 of Registrant's Report on Form 8-K dated June 28, 1993, which exhibit is incorporated herein by reference. **\n3. ARTICLES OF INCORPORATION AND BY-LAWS\n3.1 Certificate of Incorporation (as amended) of Regis- trant. Reference is made to Exhibit 3.1 of Regis- trant's Report on Form 10-K for the year ended December 31,1987, which exhibit is incorporated herein by reference. **\n3.2 Amended and Restated By-Laws of Registrant. E-1\n10. MATERIAL CONTRACTS\n10.1 Loan Agreement between Development Authority of the City of Jeffersonville and of Twiggs County and Nord Kaolin Company, dated as of June 1, 1994. E-25\n10.2 Shareholders Agreement dated March 11, 1993 by and among Norplex, Kemira, NK Corp. and NRC. Reference is made to Exhibit 10.1 of Registrant's Report on Form 8-K dated March 11, 1993, which exhibit is incorporated herein by reference. **\nPAGE NUMBER ------\n10.3 Agreement By and Between Nord Kaolin Company and United Paperworkers International Union, AFL-CIO (effective November 16, 1993 to November 15, 1996). Reference is made to Exhibit 10.7 of Registrant's Report on Form 10-K for the year ended December 31, 1993, which exhibit is incorporated herein by reference. **\n10.4 Lease Agreement dated May 15, 1988 between ATEL Financial Corporation and Nord Kaolin Company. Reference is made to Exhibit 10.31 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.5 Guaranty of Lease dated May 15, 1988 given by Regis- trant to ATEL Financial Corporation. Reference is made to Exhibit 10.32 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.6 Amendment and Waivers dated August, 1991 of Guaranty of Lease dated May 15, 1988 given by Registrant to ATEL Financial Corporation. Reference is made to Exhibit 19.6 of Registrant's Report on form 10-Q for the period ended September 30, 1991, which exhibit is incorporated herein by reference. **\n10.7 Amendments and Waivers dated November, 1991 of Guaranty of Lease dated May 15, 1988 given by Registrant to ATEL Financial Corporation. Reference is made to Exhibit 10.75 of Registrant's Report on Form 10-K for the year ended December 31, 1991, which exhibit is incorporated herein by reference. **\n10.8 Waiver, Consent and Agreement made March 11,1993 by and between Nord Kaolin Company and entities under ATEL Financial Corporation Lease Agreement. Reference is made to Exhibit 10.12 of Registrant's Report on Form 10-K for the year ended December 31, 1993, which exhibit is incorporated herein by reference **\nPAGE NUMBER ------\n10.9 License for Proprietary Pigment Technologies dated September 1, 1986 between Nord Kaolin Company and Industrial Progress, Inc. Reference is made to Exhibit 10.33 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.10 Addendum to License for Proprietary Pigment Technologies dated December, 1987. Reference is made to Exhibit 10.34 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.11 Stock Option Agreement and Second Addendum to License for Proprietary Pigment Technologies between Nord Kaolin Company and Industrial Progress, Inc., dated February 1, 1990. Reference is made to Exhibit 10.53 of Registrant's Report on Form 10-K for the year ended December 31, 1990, which exhibit is incorporated herein by reference. **\n10.12 Second Stock Option Agreement and Third Addendum to License for Proprietary Pigment Technology dated as of July 9, 1992 by and between Nord Kaolin Company and Industrial Progress, Inc. Reference is made to Exhibit 10.94 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.13 Joint Venture Agreement between Nord Southern Dolomite Company and Istria, N. V. forming Manatee Gateway No. I. Reference is made to Exhibit (10)(d) (i) of Registrant's Registration Statement on Form S-2 (No. 33-00961), which exhibit is incorporated herein by reference. **\nPAGE NUMBER ------\n10.14 Nord Resources Corporation Non-Qualified Stock Option Plan. Reference is made to Exhibit 10.16 to Registrant's Registration Statement on Forms S-3\/S-8 (No. 2-92415), which exhibit is incorporated herein by reference. **\n10.15 Nord Resources Corporation 1982 Nord Incentive Stock Option Plan. Reference is made to Exhibit 10.17 to Registrant's Registration Statement on Forms S-3\/S-8 (No. 2-92415), which exhibit is incorporated herein by reference. **\n10.16 Amendment No. 1 to Nord Resources Corporation 1982 Nord Incentive Stock Option Plan. Reference is made to Exhibit 10.32 of Registrant's Report on Form 10-K for the year ended December 31, 1987, which exhibit is incor- porated herein by reference. **\n10.17 Amendment No. 2 to Nord Resources Corporation 1982 Nord Incentive Stock Option Plan. E-68\n10.18 Amendment No. 3 to Nord Resources Corporation 1982 Nord Incentive Stock Option Plan. E-69\n10.19 Nord Resources Corporation 1987 Nord Incentive Stock Option Plan. Reference is made to Exhibit 10.33 of Registrant's Report on Form 10-K for the year ended December 31, 1987, which exhibit is incorporated herein by reference. **\n10.20 Amendment No. 1 to Nord Resources Corporation 1987 Nord Incentive Stock Option Plan. E-70\n10.21 Nord Resources Corporation 1989 Stock Option Plan. Reference is made to Exhibit 10.33 of Regis- trant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.22 Amendment No. 1 to Nord Resources Corporation 1989 Stock Option Plan. Reference is made to Exhibit 10.55 of Registrant's Report on Form 10-K\nPAGE NUMBER ------\nfor the year ended December 31, 1990, which exhibit is incorporated herein by reference. **\n10.23 Amendment No. 2 to Nord Resources Corporation 1989 Stock Option Plan. E-71\n10.24 Nord Resources Corporation 1991 Stock Option Plan. Reference is made to Exhibit 10.24 of Registrant's Report on Form 10-K for the year ended December 31, 1993, which exhibit is incorporated herein by reference. **\n10.25 Amendment No. 1 to Nord Resources Corporation 1991 Stock Option Plan. E-72\n10.26 Restated Deferred Compensation Agreement dated May 10, 1989 between Registrant and Terence H. Lang. Reference is made to Exhibit 10.9 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated by reference. **\n10.27 Restated Deferred Compensation Agreement dated May 10, 1989 between Registrant and Richard L. Steinberger. Reference is made to Exhibit 10.10 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incor- porated herein by reference. **\n10.28 Restated Deferred Compensation Agreement dated May 10, 1989 between Registrant and Edgar F. Cruft. Reference is made to Exhibit 10.11 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.29 Nord Resources Corporation Trust Agreement for Key Executives, dated May 10, 1989. Reference is made to Exhibit 10.12 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\nPAGE NUMBER ------\n10.30 Split-Dollar Life Insurance and Supplemental Com- pensation agreement between Karl A. Frydryk and Registrant dated July 22, 1988. Reference is made to Exhibit 10.29 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.31 Nord Resources Corporation Split-Dollar Life Insurance and Supplemental Compensation Plan Trust Agreement, December 5, 1988. Reference is made to Exhibit 10.35 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.32 Executive Severance Agreement between Registrant and Edgar F. Cruft, dated May 10, 1989. Reference is made to Exhibit 10.27 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.33 Executive Severance Agreement between Registrant and Terence H. Lang, dated May 10, 1989. Reference is made to Exhibit 10.29 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.34 Nord Resources Corporation Trust Agreement for Executive Severance Agreements, dated May 10, 1989. Reference is made to Exhibit 10.30 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.35 Executive Severance Agreement between Registrant and J. Peter Davies, dated December 13, 1989. Ref- erence is made to Exhibit 10.31 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.36 Executive Severance Agreement between Registrant and Karl A. Frydryk, dated May 10, 1989. Reference\nPAGE NUMBER ------\nis made to Exhibit 10.32 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.37 Executive Severance Agreement between Registrant and William W. Wilcox, dated March 9, 1990. Reference is made to Exhibit 10.57 of Registrant's Report on Form 10-K for the year ended December 31, 1990, which exhibit is incorporated herein by reference. **\n10.38 Executive Severance Agreement between Registrant and James T. Booth, dated June 8, 1994. E-73\n10.39 Executive Loan Agreement dated September 10, 1987 between Terence H. Lang and Registrant. Reference is made to Exhibit 10.40 of Registrant's Report on Form 10-K for the year ended December 31, 1987, which exhibit is incorporated herein by reference. **\n10.40 Executive Loan Agreement dated August 8, 1988 between Edgar F. Cruft and Registrant. Reference is made to Exhibit 10.26 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.41 Executive Loan Agreement dated December 31, 1988 between Terence H. Lang and Registrant. Reference is made to Exhibit 10.27 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.42 Executive Loan Agreement dated September 19, 1989 between Edgar F. Cruft and Registrant. Reference is made to Exhibit 10.17 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.43 Indemnification Agreement dated June 15,1990, between Registrant and Edgar F. Cruft, Terence H. Lang, Leonard Lichter, William W. Wilcox, Spitzer & Feldman P.C. and Ronald Offenkrantz. Reference\nPAGE NUMBER ------\nis made to Exhibit 10.56 of Registrant's Report on Form 10-K for the year ended December 31, 1990, which exhibit is incorporated herein by reference. **\n10.44 Agreement between The Government of the Republic of Sierra Leone and Sierra Rutile Limited (\"SRL\"), dated November 3, 1989. Reference is made to Exhibit 10.4 of Registrant's Report on Form 10-K for the year ended December 31, 1989, which exhibit is incorporated herein by reference. **\n10.45 Agreement dated November 17, 1992 amending Fifth Amend- ment to and Restatement of the Financing Agreement and Second Amendment and Restatement of Credit between SRL and Export-Import Bank of the United States (\"Eximbank\"). Reference is made to Exhibit 10.5 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.46 Fifth Amendment to and Restatement of the Financing Agree- ment dated as of November 24, 1986 between SRL and Eximbank. Reference is made to Exhibit 4.14 of Registrant's Report on Form 10-K for the year ended December 31, 1988, which exhibit is incorporated herein by reference. **\n10.47 Second Amendment and Restatement of Credit Agreement dated as of December 1, 1982 between SRL and Eximbank. Reference is made to Exhibit 10(e)B(v) of Registrant's Registration Statement on Form S-2 (33-00961), which exhibit is incorporated herein by reference. **\n10.48 Letter Agreement dated October 12, 1993 between SRL and Eximbank. Reference is made to Exhibit 10.10 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.49 Letter Agreement dated November 17, 1993 between SRL and Eximbank. Reference is made to Exhibit 10.11 of Registrant's Report on Form 8-K dated Nov-\nPAGE NUMBER ------\nember 17, 1993, which exhibit is incorporated herein by reference. **\n10.50 Loan Agreement dated August 6, 1992 between DEG - Deutsche Investitions - Und Entwicklungsgesell Schaft MBH (\"DEG\") and SRL. Reference is made to Exhibit 10.73 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.51 First Amendment dated November 20, 1992 to the Loan Agreement between DEG and SRL. Reference in made to Exhibit 10.74 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.52 Amendatory Agreement dated November 17, 1993 between SRL and DEG. Reference is made to Exhibit 10.12 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.53 Investment Agreement dated June 30, 1992 between SRL and International Finance Corporation (\"IFC\"). Reference is made to Exhibit 10.75 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.54 Amendment No. 1 dated November 18, 1992 to Invest- ment Agreement between SRL and IFC. Reference is made to Exhibit 10.76 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.55 Amendatory Agreement dated November 17, 1993 bet- ween SRL and IFC. Reference is made to Exhibit 10.9 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.56 Loan Agreement dated January 24, 1992 between SRL and Commonwealth Development Corporation (\"CDC\").\nPAGE NUMBER ------\nReference is made to Exhibit 10.77 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.57 Amendment dated November 17, 1992 of the Loan Agree- ment between SRL and CDC. Reference is made to Exhibit 10.78 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.58 Amendatory Agreement dated November 5, 1993 between SRL and CDC. Reference is made to Exhibit 10.13 of Reg- istrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.59 Waiver Letter dated October 22, 1993 from CDC to SRL. Reference is made to Exhibit 10.14 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.60 Finance Agreement dated August 11, 1992 between SRL and Overseas Private Investment Corporation (\"OPIC\"). Reference is made to Exhibit 10.79 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.61 First Amendment dated November 24, 1992 to Finance Agreement between SRL and OPIC. Reference is made to Exhibit 10.80 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.62 Agreement of Wavier and Second Amendment to Finance Agreement dated as of September 21, 1993 between SRL and OPIC. Reference is made to Exhibit 10.6 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.63 Third Amendment to Finance Agreement dated as of November 17, 1993 between SRL and OPIC. Reference is made to Exhibit\nPAGE NUMBER ------\n10.7 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.64 Funding Agreement dated February 16, 1993 among SRL, OPIC and PNC Bank, National Association (\"PNC\"). Ref- erence is made to Exhibit 10.70 of Registrant's Report on Form 10-K for the year ended December 31, 1993, which exhibit is incorporated herein by reference. **\n10.65 First Amendment to Funding Agreement dated November 12, 1993 among SRL, OPIC and PNC. Reference is made to Exhibit 10.8 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.66 Debenture dated November 17, 1992 made by SRL in favor of CDC, DEG, Eximbank, IFC and OPIC. Reference is made to Exhibit 10.81 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.67 Debenture dated November 17, 1992 made by SRL in favor of DEG, Eximbank, IFC, OPIC and CDC. Reference is made to Exhibit 10.85 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.68 First Amendment and Restatement of Project Funds Agreement dated as of November 17, 1993 among Registrant, CRL, Holdings, SRL, CDC, DEG, Eximbank, IFC and OPIC. Reference is made to Exhibit 10.17 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.69 Share Retention Agreement dated November 17, 1992 among CDC, DEG, Eximbank, IFC and OPIC and Registrant, Nord Rutile Company and SRL. Reference is made to Exhibit 10.83 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\nPAGE NUMBER ------\n10.70 First Amendment to Share Retention Agreement dated as of November 17, 1993 among Registrant, NR Company, CRL, Holdings, CDC, DEG, IFC, OPIC and Eximbank. Reference is made to Exhibit 10.18 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.71 Pledge Agreement dated November 17, 1992 between SRL and DEG, Eximbank, IFC, OPIC and CDC. Reference is made to Exhibit 10.84 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.72 Cash Collateral Charge dated November 17, 1992 made by SRL in favor of DEG, Eximbank, IFC, OPIC and CDC. Reference is made to Exhibit 10.86 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.73 Trust Deed between Standard Chartered Bank Sierra Leone Limited, Financing Institutions and SRL. Reference is made to Exhibit 10.87 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.74 Security Sharing and Intercreditor Agreement dated November 17, 1992 among DEG, Eximbank, IFC, OPIC and CDC. Reference is made to Exhibit 10.88 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.75 Security Agreement dated November 17, 1992 among SRL and DEG, Eximbank, IFC, OPIC and CDC. Reference is made to Exhibit 10.90 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.76 Subordination Agreement dated November 17, 1992 among DEG, Eximbank, IFC, OPIC and CDC and Registrant, Nord Rutile Corporation, Nord Rutile Company and SRL. Reference\nPAGE NUMBER ------\nis made to Exhibit 10.89 of Registrant's Report on Form 10-K for the year ended December 31, 1992, which exhibit is incor- porated herein by reference. **\n10.77 First Amendment to Subordination Agreement dated as of November 17, 1993 among Registrant, NR Company, CRL, Holdings, CDC, DEG, IFC, OPIC and Eximbank. Reference is made to Exhibit 10.19 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.78 Arm's Length Agreement dated as of November 17, 1993 between CRL and SRL. Reference is made to Exhibit 10.15 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.79 First Amendment to Arm's Length Agreement dated as of November 17, 1993 between Registrant and SRL. Reference is made to Exhibit 10.16 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.80 Joint Venture Agreement dated as of November 17, 1993 among CRL, Registrant, NR Company and Holdings. Reference is made to Exhibit 10.1 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.81 Marketing Agreement dated as of November 17, 1993 among CRL, Registrant, NR Company, SRL, Holdings and TMMI. Reference is made to Exhibit 10.2 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.82 U.S. Marketing Agreement dated as of November 17, 1993 among CRL, Registrant, NR Company, SRL, Holdings and U.S. Partnership. Reference is made to Exhibit 10.3 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein\nPAGE NUMBER ------\nby reference. **\n10.83 General Partnership Agreement dated as of November 17, 1993 among CRL, CRL Delaware and Registrant. Reference is made to Exhibit 10.4 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incorporated herein by reference. **\n10.84 Employment Agreement dated as of November 17, 1993 between U.S. Partnership and Richard L. Steinberger. Reference is made to Exhibit 10.5 of Registrant's Report on Form 8-K dated November 17, 1993, which exhibit is incor- porated herein by reference. **\n10.85 Amendment to Mining Lease dated September 17, 1991 from the Ministry of Mines of the Government of Sierra Leone. Reference is made to Exhibit 10.12 of Amendment No. 2 to Registrant's Report on Form S-3 dated July 20, 1993, which exhibit is incorporated herein by reference. **\n10.86 Agreement between Sierra Rutile Limited and the Government of Sierra Leone dated 3 January, 1995. E-86\n10.87 Pledge Agreement dated February 4, 1993 among Registrant, Haythe & Curley and Rothschild Australia Limited. Reference is made to Exhibit 10.1 of Amend- ment No. 2 to Registrant's Report on Form S-3 dated July 20, 1993, which exhibit is incorporated herein by reference. **\n10.88 Girilambone Facility Agreement among Nord Pacific Limited, Nord Gold Company Limited, Nord Resources (Pacific) Pty Ltd., Nord Australex Nominees Pty Ltd. and R & I Bank of Western Australia Ltd. dated January 12, 1993. Reference is made to Exhibit 10.41 of Nord Pacific Limited's Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.89 Girilambone US$ Advance and Letter of Credit Facility Agreement among Nord Pacific Limited, Nord Resources\nPAGE NUMBER ------\n(Pacific) Pty Ltd., Nord Gold Company Limited, Nord Australex Nominees Pty Ltd. and Rothschild Australia Limited dated February 5, 1993. Reference is made to Exhibit 10.42 of Nord Pacific Limited's Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.90 Commodity Swap Agreement between Nord Australex Nominees Pty Ltd. and R & I Bank of Western Australia Limited dated February 5, 1993. Reference is made to Exhibit 10.43 of Nord Pacific Limited's Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.91 Commodity Options Agreement between Nord Australex Nominees Pty Ltd. and R & I Bank of Western Australia Ltd. dated February 5, 1993. Reference is made to Exhibit 10.44 of Nord Pacific Limited's Form 10-K for the year ended December 31, 1992, which exhibit is incorporated herein by reference. **\n10.92 Letter dated February 22, 1995 regarding Sierra Rutile Limited Development Bank Financing. E-88\n10.93 Agreement and Fourth Amending Agreement dated March 24, 1995 between Consolidated Rutile Limited and Registrant E-94\n21. SUBSIDIARIES OF REGISTRANT\nJurisdiction in Name of Subsidiary Which Incorporated ------------------ ------------------\nSierra Rutile Limited Sierra Leone, West Africa\nNord Kaolin Company Georgia\nPAGE NUMBER ------\n23. CONSENTS OF EXPERTS AND COUNSEL\n23.1 Consent of Deloitte & Touche LLP E-97\n23.2 Consent of KPMG E-98\n27. FINANCIAL DATA SCHEDULE E-99\n99. ADDITIONAL EXHIBITS\n99.1 Independent Auditors' Report to the Board of Directors and Shareholders, Sierra Rutile Limited, April 3, 1995 E-100\n99.2 Independent Auditors' Report to the Board of Directors and Shareholders, Sierra Rutile America Inc., April 3, 1995 E-101\n99.3 Independent Auditors' Report to the Board of Directors and Shareholders, Plainfield (Jersey) Limited, April 3, 1995 E-102\n99.4 Independent Auditors' Report to the Board of Directors and Shareholders, Sierra Rutile Services Limited, April 3, 1995 E-103\n99.5 Independent Auditors' Report to the Board of Directors and Shareholders, Sierra Rutile Holdings Limited (BVI), April 3, 1995 E-104\n99.6 Independent Auditors' Report to the Board of Directors and Shareholders, TMMI Limited (BVI), April 3, 1995 E-105\n99.7 Independent Auditors' Report to the Board of Directors and Shareholders, TMMI USA Marketing Partnership, April 3, 1995 E-106\n** Indicates that the exhibit is incorporated by reference in this Annual Report on Form 10-K from a previous filing with the Commission.","section_15":""}
{"filename":"803649_1994.txt","cik":"803649","year":"1994","section_1":"Item 1. Business.\nThe Company. Health and Retirement Properties Trust (the \"Company\") was organized on October 9, 1986 as a Maryland real estate investment trust. The Company primarily invests in nursing homes, retirement complexes and other income producing health care related real estate. The Company's investments, to date, have been principally in nursing homes and other long-term care facilities, assisted living facilities, retirement complexes and facilities that provide subacute services. In March 1995, in a one time transaction, the Company invested $179.4 million in 21 hotel properties managed by an affiliate of Marriott International, Inc. (Marriott). See \"Developments since January 1, 1994\". The facilities in which the Company has made investments by mortgage, purchase lease or merger transactions shall hereinafter be referred to individually as a \"Property\" and collectively as \"Properties\".\nAs of December 31, 1994, the Company owned 80 Properties acquired for an aggregate of $673.1 million and had mortgage investments in 61 Properties aggregating $133.5 million, for total real estate investments of approximately $806.6 million in 141 Properties located in 27 states. The Properties are described in \"Business -- Developments Since January 1, 1994\" and \"Properties\".\nThe Company's principal executive offices are located at 400 Centre Street, Newton, Massachusetts 02158, and its telephone number is (617) 332-3990.\nInvestment Policy and Method of Operation. The Company's investment goals are current income for distribution to shareholders, capital growth resulting from appreciation in the residual value of owned Properties, and preservation and protection of shareholders' capital. The Company's income is derived primarily from minimum rent and minimum interest payments under its leases and mortgages and from additional rent and additional interest payments based upon revenue increases at the leased and mortgaged Properties.\nThe Company's day-to-day operations are conducted by HRPT Advisors, Inc., the Company's investment advisor (the \"Advisor\"). The Advisor originates and presents investment opportunities to the Company's Board of Trustees (the \"Trustees\"). In evaluating potential investments, the Company considers such factors as: the adequacy of current and anticipated cash flow from the property to meet operational needs and financing obligations and to provide a competitive market return on investment to the Company; the growth, tax and regulatory environments of the community in which the property is located; the quality, experience, and credit worthiness of the property's operator; an appraisal of the property, if available; occupancy and demand for similar facilities in the same or nearby communities; the mix of private and government sponsored patients; the mix of cost-based and charge-based revenues; the construction quality, condition and design of the property; and the geographic area and type of property.\nThe Trustees have established a policy that the Company will not purchase or mortgage finance a facility for an amount which exceeds the appraised value of such facility. Prior to investing in properties, the Company obtains title commitments or policies of title insurance insuring that the Company holds title to or has mortgage interests in such properties, free of material liens and encumbrances.\nThe Company's investments may be structured using leases with minimum and additional rent and escalator provisions, loans with fixed or floating rates, joint ventures and partnerships with affiliated or unaffiliated parties, commitments or options to purchase interests in real estate, mergers or any combination of the foregoing that will best suit the particular investment.\nIn connection with its revolving credit facility, the Company has agreed to obtain bank approval before exceeding certain investment concentrations. Among these are that no more than 40% of its properties be operated by any single tenant or mortgagor, that investment in rehabilitation treatment, acute care and United Kingdom properties not exceed 40%, 15% and 10%, respectively, of total investments and that no new psychiatric care or hotel investments be made. In addition to these restrictions, the Trustees may establish limitations as they deem\nappropriate from time to time. No limits have been set on the number of properties in which the Company will seek to invest, or on the concentration of investments involving any one facility or geographical area; however, the Trustees consider concentration of investments in determining whether to make new or increase existing investments. The Company's Declaration of Trust (the \"Declaration\") and operating policies provide that any investment in facilities owned or operated by the Advisor, persons expressly permitted under the Declaration to own more than 8.5% of the Company's shares, or any company affiliated with any of the foregoing must, however, be approved by a majority of the Trustees not affiliated with any of the foregoing (the \"Independent Trustees\").\nThe Company has in the past and may in the future consider, from time to time, the acquisition of or merger with other companies engaged in the same business as the Company; however, the Company has no present agreements or understandings concerning any such acquisition or merger. The Company has no intention of investing in the securities of others for the purpose of exercising control.\nBorrowing Policy. In addition to the use of equity, the Company utilizes short-term and long-term borrowings to finance investments. During 1994, the Company obtained investment grade ratings on its long term debt from Moody's Investor Services (\"Moody's\"), Standard and Poor's Corporation (\"S&P\") and Fitch Investor Services, Inc. (\"Fitch\") in connection with the issuance of $200 million of floating rate notes. The notes were issued in two series. The Series A notes may be called, at the Company's option, beginning in April 1995. The Series B notes, which were issued at a discount, may be called, at the Companys option, beginning in July 1996. The notes bear interest at a spread over LIBOR and mature in July 1999. At December 31, 1994, the Company had a revolving credit facility available to it totalling $170 million. Availability under this revolver was increased to $200 million effective March 15, 1995. As of March 15, 1995, $10 million of this amount was outstanding, and $190 million was available to be drawn. All but $17.6 million of outstanding indebtedness is at variable interest rates determined by formulae based upon the London Interbank Offered Rate (\"LIBOR\"), prime or some other generally recognized interest rate standard. Fluctuations in interest rates on $200 million of variable rate outstanding term indebtedness have been limited by hedging arrangements so that the maximum average rates payable on the $200 million of indebtedness is 6.85% per annum. The maturities of the hedge agreements range from 1995 through 1998.\nThe Company's borrowing guidelines established by its Trustees and covenants in various debt agreements prohibit the Company from maintaining a debt to equity ratio of greater than 1 to 1. At December 31, 1994, the Company's debt to equity ratio was .36 to 1. The Declaration prohibits the Company from incurring secured and unsecured indebtedness which in the aggregate exceeds 300% of the net assets of the Company, unless approved by a majority of the Independent Trustees. There can be no assurance that debt capital will in the future be available at reasonable rates to fund the Company's operations or growth.\nDevelopments Since January 1, 1994.\nHorizon\/Greenery Merger. In February 1994, the merger transaction (the \"Horizon\/Greenery Merger\") between Horizon Healthcare Corporation (\"Horizon\") and Greenery Rehabilitation Group, Inc. (\"Greenery\") was consummated. In connection with this merger, the Company sold to Horizon for $28.4 million three facilities that had been leased to Greenery. The Company realized a gain of approximately $4.0 million on the sale of these properties. In addition, Horizon leased seven facilities previously leased to Greenery, on substantially similar terms except the leases were extended through 2005. The Company has also granted Horizon a ten year option to buy the seven leased facilities, at the rate of no more than one facility per consecutive twelve months. Also, the Company leased the three remaining Greenery facilities to a newly formed corporation, Connecticut Subacute Corporation, II (\"CSC II\"), an affiliate of the Advisor. These facilities are being managed by and the lease payments are guaranteed by Horizon for a term of up to five years. The terms of these lease arrangements are substantially similar to the original lease arrangements with Greenery.\nOn February 11, 1994, in connection with the Horizon-Greenery merger, the Company provided Horizon with $9.4 million first mortgage financing for two facilities. One of the facilities previously was owned by the Company and leased to Greenery. The mortgage notes bear interest at 11.5% per annum and mature December 31, 2000.\nIn January 1995, Horizon exercised its option and purchased one of the seven leased properties from the Company for $24.5 million resulting in a gain of $2.5 million. The Company provided Horizon a 16 year $19.5 million mortgage in connection with this sale in 1995.\nNew Revolving Credit Facility. During 1994 and early 1995, the Company amended its revolving credit facility from a syndicate of banks (the \"Credit Facility\"). The Credit Facility which allows borrowing of up to $200 million, will mature in 1998, unless extended by the parties. Borrowings on the Credit Facility will bear interest, at the Company's option, at prime or a spread over or LIBOR.\nMay Share Offering. During the second quarter of 1994, the Company sold 12,650,000 Shares in a public offering and received net proceeds of approximately $174 million. The proceeds were used, in part, to prepay $73 million in outstanding indebtedness and, in part, to fund the transactions described below.\nJuly Floating Rate Note Offering. In July 1994, the Company issued $200 million floating rate notes in a public offering and received net proceeds after financing costs of approximately $197 million. The notes were issued in two series; Series A issued at par and Series B issued at a discount. The Series A and B notes mature in July 1999, but may be called, at the Company's option, beginning in April 1995 and July 1996, respectively. The notes bear interest at a spread over the three month LIBOR. The proceeds of the note offering were used, in part, to fund the Marriott retirement communities transaction described below.\nMarriott Retirement Communities Transaction. On September 9, 1994, the Company completed its previously announced transaction with Host Marriott Corporation (\"Host Marriott\") to acquire 14 retirement communities containing 3,952 residences or beds for $320 million. These communities are triple net leased through December 31, 2013 to a wholly owned subsidiary of Marriott. The leases provide for fixed rent and additional rentals equal to a percentage of annual revenues from operations in excess of base amounts determined on a facility by facility basis. All of the leases are subject to cross default provisions and are guaranteed by Marriott. This transaction was funded from cash on hand, the proceeds of the equity offering discussed above, drawings under the Company's Credit Facility, assumption of $17.6 million of existing debt bearing interest at 7.75% and a portion of the proceeds from a floating rate note offering described above.\n1995 Commitments; Hotel Transaction. Since January 1, 1995, the Company has made or committed to make real estate investments in four separate transactions involving 41 healthcare facilities totalling approximately $109 million. Of this amount, approximately $14 million represents mortgage financings and $95 million represents acquisitions of healthcare facilities.\nIn addition, the Company entered into a purchase and lease agreement with a subsidiary of Host Marriott for 21 Courtyard by Marriott hotel properties for approximately $179.4 million, subject to adjustment. The properties have been leased for an initial term of 12 years, with renewal options of an additional 37 years to a subsidiary of Host Marriott, and are being managed by a subsidiary of Marriott International. An amount equal to one year's rent was withheld from the purchase price to secure the tenant's obligations to the Company. The transaction closed in March 1995.\nAlthough the Company's investments are no longer exclusively in healthcare, retirement and related properties, the Company's investment in hotel properties does not represent a change in the Company's strategy of focusing on investments in long term care and retirement facilities. Rather, this investment, structured as a triple net lease, will represent only approximately 15% of the Company's portfolio, including the commitments noted above as of March 24, 1995. The facilities are new, having been constructed within the last five years, and occupancy and cash flow coverage are strong. Following the announcement of this investment, Moody's downgraded the Company's debt rating and S&P and Fitch maintained their ratings. The Company believes, despite the negative reaction by Moody's, that this transaction will enhance the security and growth potential of its funds from operations.\nThe Advisor. The Advisor is wholly owned by Gerard M. Martin and Barry M. Portnoy. Messrs. Martin, Portnoy and Mark J. Finkelstein are the directors of the Advisor, Mr. Finkelstein is the President and Chief Executive Officer, David J. Hegarty is the Executive Vice President, Chief Financial Officer and Secretary and John G. Murray is the Treasurer of the Company. Effective April 1, 1995, Mr. Finkelstein will resign to pursue his interests in operating nursing homes and will become president of Subacute Management Corporation of America, Inc.\nThe Company's Board of Trustees has elected David J. Hegarty President, Chief Operating Officer and Secretary, John G. Murray, Executive Vice President and Chief Financial Officer and Ajay Saini, Treasurer. These officers of the Advisor are also officers of the Company. The Advisor provides management services and investment advice to the Company. The Advisor's principal executive offices are located at 400 Centre Street, Newton, Massachusetts 02158, and its telephone number is (617) 332-3990.\nEmployees. As of March 14, 1995, the Company had no employees. The Advisor, which administers the day-to-day operations of the Company, has 9 full-time employees and two active directors.\nRegulation and Reimbursement; Competition. Compliance with federal, state and local statutes and regulations governing health care facilities is a prerequisite to continuation of health care operations at the Properties. In addition, the health care industry depends significantly upon federal and federal\/state programs for revenues and, as a result, is vulnerable to the budgetary policies of both the federal and state governments.\nCertificate of Need and Licensure. Most states in which the Company has or may invest require certificates of need (\"CONs\") prior to expansion of beds or services, certain capital expenditures, and in some states, a change in ownership. CON requirements are not uniform throughout the United States. Changes in CON requirements may affect competition, profitability of the Properties and the Company's opportunities for investment in health care facilities.\nState licensure requirements, including regulations providing that commonly controlled facilities are subject to delicensure if one such facility is delicensed, also affect facilities in which the Company invests. The Company believes that each facility in which it has invested is appropriately licensed. Although each of the facilities may from time to time receive notices of non-compliance with certain standards, and certain facilities in Connecticut and Massachusetts are subject to provisional or probationary licenses, the Company believes that such actions have not, in fiscal year 1994 and through the date hereof, had any material adverse effect on the operations of the Company. Horizon's licenses to operate the Massachusetts facilities leased to it are probationary subject to certain conditions.\nAn increasing number of legislative proposals have been introduced in Congress that would effect major reforms of the health care system. Such proposals include universal health coverage, employer mandated insurance, and a single government health insurance plan. Following the failure of the Clinton administration's proposed Health Security Act or other major health care reform legislation to become law in 1994, legislative proposals for more incremental reforms have also been introduced, such as group health insurance plans for small businesses, health insurance industry reforms, health care anti-fraud legislation, and Medicare and Medicaid reforms and cost containment measures. The Company cannot predict whether any such legislative proposals will be adopted and, if adopted, what effect, if any, such proposals would have on the business of the lessees, the mortgagors or the Company. New regulations adopted by the Health Care Finance Administration governing\nMedicare and Medicaid nursing facility surveys, certification, and enforcement, are scheduled to be effective on July 1, 1995. The regulations require the states to implement a wide range of enforcement remedies, and penalties for noncompliance with Medicare\/Medicaid standards may increase in the future. An adverse determination concerning licensure or eligibility for government reimbursement of any operator could materially adversely affect that operator, its affiliates and the Company. In addition, federal and state civil and criminal anti-fraud and anti-kickback laws and regulations govern financial activities of health care providers and enforcement proceedings have increased. If any operator of the Company's Properties were to fail to comply with such laws or regulations, it, and therefore the Company, could be materially adversely affected unless and until any such property of properties were returned to compliance or the Company were able to re-lease or sell the affected Property or Properties on favorable terms.\nReimbursement. Reimbursement for health care services derives principally form the following sources: Medicare, a federal health insurance program for the aged and certain chronically disabled individuals; Medicaid, a medical assistance program for indigent persons operated by individual states with the financial participation of the federal government; health and other insurance plans, including health maintenance organizations; and private funds. These reimbursement sources are generally contingent upon compliance with state CON and licensure regulations and with extensive federal requirements for Medicare and Medicaid participation.\nMedicaid programs provide significant current revenues of nursing facilities. Medicare is not presently a major source of revenue for the Company's lessees and mortgagors. The Medicaid program is subject to change and affected by state and federal budget shortfalls and funding restrictions which may materially decrease rates of payment or delay payment. There is no assurance that Medicaid or Medicare payments will remain constant or be sufficient to cover costs allocable to Medicare and Medicaid patients. The operators of the Properties appeal reimbursement rates from time to time. The Company cannot predict whether such appeals, if decided adversely, would have any material effect upon the respective financial positions of the operators.\nOther. Federal law limits Medicare and Medicaid reimbursement for capital costs related to increases in the valuation of capital assets solely as a result of a change of ownership of nursing facilities, and numerous states use more restrictive standards to limit Medicaid reimbursement of capital costs. Effective in October of 1993, Medicare eliminated reimbursement of return on equity capital for Medicare skilled nursing homes. Some state Medicaid programs also do not provide for return on equity capital. In addition, a seller is liable to the Medicare program, and in certain states may also be liable to the Medicaid program, for recaptured depreciation. Such limitations may adversely affect the resale value of some Properties owned or financed by the Company.\nEffective in October of 1992, DHHS issued final regulations which limit the amount of Medicare reimbursement available to a facility for\nrental or lease expenses paid after a purchase lease transaction to that amount which would have been reimbursed as capital costs had the provider retained legal title to the facility. Limitations on rental expenses contained in the regulations may adversely affect the financial feasibility of future purchase lease transactions by denying Medicare and Medicaid reimbursement for additional rental expenses.\nIt is not possible to predict the content, scope or impact of future legislation, regulations or changes in reimbursement or insurance coverage policies which might affect the health care industry.\nCompetition. The Company is one of several REITs currently investing primarily in health care related real estate. The REITs compete with one another in that each is continually seeking attractive investment opportunities in health care facilities. The Company also competes with banks, non-bank finance companies, leasing companies and insurance companies.\nIn addition, the Company competes with the operators of its Properties in connection with the expansion of their businesses. Although each of the operators may offer investment opportunities to the Company, each of the operators or its affiliates will, in fact, compete with the Company (as well as with others) for investment opportunities. The operators may own facilities that are not mortgaged or leased to the Company. An operator, or an affiliate thereof, could preferentially place patients or operate special service programs in facilities other than those included among the Properties. Such preferential treatment and\/or new programs could adversely affect the revenues derived by the Company under its mortgages and leases.\nFederal Income Tax Considerations. The Company believes that it is and it intends to be and remain qualified as a real estate investment trust (\"REIT\") under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). These Code provisions are highly technical and complex. Each shareholder therefore is urged to consult his own tax advisor with respect to the federal income tax and other tax consequences of the purchase, holding and sale of shares of beneficial interest of the Company.\nThe Company has obtained legal opinions that the Company has been organized in conformity with the requirements for qualification as a REIT, has qualified as a REIT for its 1987, 1988, 1989, 1990, 1991, 1992, 1993 and 1994 taxable years, and that its current and anticipated investments and its plan of operation will enable it to continue to meet the requirements for qualification and taxation as a REIT under the Code. Actual qualification of the Company as a REIT, however, will depend upon the Company's continued ability to meet, and its meeting, through actual annual operating results, the various qualification tests imposed under the Code. No assurance can be given that the actual results of the Company's operation for any one taxable year will satisfy such requirements.\nTaxation of the Company. If the Company qualifies for taxation as a REIT and distributes to its shareholders at least 95% of its \"real estate investment trust taxable income\", it generally will not be\nsubject to federal corporate income taxes on the amount distributed. However, a REIT is subject to special taxes on the net income derived from \"prohibited transactions.\" In addition, property acquired by the Company as the result of a default or imminent default on a lease or mortgage is classified as \"foreclosure property\". Certain net income from foreclosure property held by the Company for sale is taxable to it at the highest corporate marginal tax rate then prevailing.\nSection 856(a) of the Code defines a REIT as a corporation, trust or association: (1) which is managed by one or more trustees or directors; (2) the beneficial ownership of which is evidenced by transferable shares or by transferable certificates of beneficial interest; (3) which would be taxable, but for Sections 856 through 859 of the Code, as a domestic corporation; (4) which is neither a financial institution nor an insurance company subject to certain provisions of the Code; (5) the beneficial ownership of which is held by 100 or more persons; (6) which is not closely held as determined under the personal holding company stock ownership test (as applied with one modification); and (7) which meets certain other tests, described below. Section 856(b) of the Code provides that conditions (1) to (4), inclusive, must be met during the entire taxable year and that condition (5) must be met during at least 335 days of a taxable year of 12 months, or during a proportionate part of a taxable year of less than 12 months. By reason of condition (6) above, the Company will fail to qualify as a REIT for a taxable year if at any time during the last half of such year more than 50% in value of its outstanding Shares are owned directly or indirectly by five or fewer individuals. To help maintain conformity with condition (6), the Company's Declaration of Trust (the \"Declaration\") contains certain provisions restricting share transfers and giving the Board of Trustees power to redeem shares involuntarily.\nIt is the expectation of the Company that it will have at least 100 shareholders during the requisite period for each of its taxable years. There can, however, be no assurance in this connection and, if the Company has fewer than 100 shareholders during the requisite period, condition (5) described above will not be satisfied, and the Company would not qualify as a REIT during such taxable year.\nFor taxable years beginning after 1993, the rule that an entity will fail to qualify as a REIT for a taxable year if at any time during the last half of such year more than 50% in value of its outstanding shares is owned directly or indirectly by five or fewer individuals has been liberalized in the case of a qualified pension trust owning shares in a REIT. Under the new rule, the requirement is applied by treating shares in a REIT held by such a pension trust as held directly by its beneficiaries in proportion to their actuarial interests in the pension trust. Consequently, five or fewer pension trusts could own more than 50% of the interests in an entity without jeopardizing its qualification as a REIT. However, if a REIT is a \"pension-held REIT\" as defined in the new law, each pension trust holding more than 10% of its shares (by value) generally will be taxable on a portion of the dividends it receives from the REIT, based on the ratio of the REIT's gross income for the year which would be unrelated trade or business income if the REIT were a qualified pension trust to the total gross income of the REIT for the year. A \"pension-held REIT\" is one in which at least one\nqualified pension trust holds more than 25% (by value) of the interests by value, or a combination of qualified pension trusts each of which owns more than 10% by value of the REIT together holds more than 50% of the REIT interests by value.\nTo qualify as a REIT for a taxable year under the Code, the Company must elect to be so treated and must meet other requirements, certain of which are summarized below, including percentage tests relating to the sources of its gross income, the nature of the Company's assets, and the distribution of its income to shareholders. The Company has made such election for 1987 (its first full year of operations) and such election, assuming continuing compliance with the qualification tests discussed herein, continues in effect for subsequent years.\nThere are three gross income requirements. First, at least 75% of the Company's gross income (excluding gross income from certain sales of property held primarily for sale) must be derived directly or indirectly from investments relating to real property (including \"rents from real property\") or mortgages on real property. When the Company receives new capital in exchange for its shares (other than dividend reinvestment amounts) or in a public offering of five-year or longer debt instruments, income attributable to the temporary investment of such new capital in stock or a debt instrument, if received or accrued within one year of the Company's receipt of the new capital, is qualifying income under the 75% test. Second, at least 95% of the Company's gross income (excluding gross income from certain sales of property held primarily for sale) must be derived from such real property investments, dividends, interest, certain payments under interest rate swap or cap agreements, and gain from the sale or disposition of stock, securities, or real property or from any combination of the foregoing. Third, short-term gain from the sale or other disposition of stock or securities, including, without limitation, stock in other REITs, dispositions of interest rate swap or cap agreements, and gain from certain prohibited transactions or other dispositions of real property held for less than four years (apart from involuntary conversions and sales of foreclosure property) must represent less than 30% of the Company's gross income. (This rule does not apply for a year in which the REIT is completely liquidated, as to dispositions occurring after the adoption of a plan of complete liquidation.) For purposes of these rules, income derived from a \"shared appreciation provision\" is treated as gain recognized on the sale of the property to which it relates. Even though the Company's present mortgages do not contain shared appreciation provisions, the Company may make mortgage loans which include such provisions.\nThe Company temporarily invests working capital in short-term investments, including shares in other REITs. Although the Company will use its best efforts to ensure that its income generated by these investments will be of a type which satisfies the 75% and 95% gross income tests, there can be no assurance in this regard (see discussion above of the \"new capital\" rule under the 75% test). Moreover, the Company may realize short-term capital gain upon sale or exchange of such investments, and such short-term capital gain would be subject to the limitations imposed by the 30% gross income test.\nIn order to qualify as \"rents from real property,\" the amount of rent received generally must not be determined from the income or profits of any person, but may be based on receipts or sales. The Code also provides that rents will not qualify as \"rents from real property,\" in satisfying the gross income tests, if the REIT owns 10% or more of the tenant, whether directly or under certain attribution rules. The Company intends not to lease property to any party if rents from such property would not so qualify. Application of the 10% ownership rule is, however, dependent upon complex attribution rules provided in the Code and circumstances beyond the control of the Company. Ownership, directly or by attribution, by an unaffiliated third party of more than 10% of the Company's shares and more than 10% of the stock of a lessee would result in lessee rents not qualifying as \"rents from real property\". The Declaration provides that transfers or purported acquisitions, directly or by attribution, of shares that could result in disqualification of the Company as a REIT are null and void and permits the Trustees to repurchase shares to the extent necessary to maintain the Company's status as a REIT. Nevertheless, there can be no assurance such provisions in the Declaration will be effective to prevent the Company's REIT status from being jeopardized under the 10% rule. Furthermore, there can be no assurance that the Company will be able to monitor and enforce such restrictions, nor will shareholders necessarily be aware of share holdings attributed to them under the attribution rules.\nIn addition, the Company must not manage the property or furnish or render services to the tenants of such property, except through an independent contractor from whom the company derives no income. There is an exception to this rule permitting a REIT to perform certain customary tenant services of the sort which a tax-exempt organization could perform without being considered in receipt of \"unrelated business taxable income.\"\nIf rent attributable to personal property leased in connection with a lease of real property is greater than 15% of the total rent received under the lease, then the portion of rent attributable to such personal property will not qualify as \"rents from real property.\" The portion of rental income treated as attributable to personal property is determined according to the ratio of the tax basis of the personal property to the total tax basis of the property which is rented. If rent payments do not qualify, for the reasons discussed above, as rents from real property for the purposes of Section 856 of the Code, it will be more difficult for the Company to meet the 95% or 75% gross income tests and to qualify as a REIT. Finally, in order to qualify as mortgage interest on real property for purposes of the 75% test, interest must derive from a mortgage loan secured by real property with a fair market value at least equal to the amount of the loan. If the amount of the loan exceeds the fair market value of the real property, the interest will be treated as interest on a mortgage loan in a ratio equal to the ratio of the fair market value of the real property to the total amount of the mortgage loan.\nIf the Company fails to satisfy one or both of the 75% or 95% gross income tests for any taxable year, it may nevertheless qualify as a REIT for such year if its failure to meet such test was due to reasonable\ncause and not due to willful neglect, it attaches a schedule of the sources of its income to its return, and any incorrect information on the schedule was not due to fraud with intent to evade tax. It is not possible, however, to state whether in all circumstances the Company would be entitled to the benefit of these relief provisions. If these relief provisions apply, a special tax generally equal to 100% is imposed upon the greater of the amount by which the Company failed the 75% test or the 95% test, less an amount which generally reflects the expenses attributable to earning the non-qualified income.\nAt the close of each quarter of the Company's taxable year, it must also satisfy three tests relating to the nature of its assets. First, at least 75% of the value of the Company's total assets must consist of real estate assets (including its allocable share of real estate assets held by joint ventures or partnerships in which the Company participates), cash, cash items and government securities. Second, not more than 25% of the Company's total assets may be represented by securities (other than those includable in the 75% asset class). Finally, of the investments included in the 25% asset class, the value of any one issuer's securities owned by the Company may not exceed 5% of the value of the Company's total assets, and the Company may not own more than 10% of any one issuer's outstanding voting securities.\nWhere a failure to satisfy the 25% asset test results from an acquisition of securities or other property during a quarter, the failure can be cured by disposition of sufficient non-qualifying assets within 30 days after the close of such quarter. The Company intends to maintain adequate records of the value of its assets to maintain compliance with the 25% asset test, and to take such action as may be required to cure any failure to satisfy the test within 30 days after the close of any quarter.\nThe Company, in order to qualify as a REIT, is required to distribute dividends (other than capital gain dividends) to its shareholders in an amount equal to or greater than the excess of (A) the sum of (i) 95% of the Company's \"real estate investment trust taxable income\" (computed without regard to the dividends paid deduction and the Company's net capital gain) and (ii) 95% of the net income, if any, (after tax) from foreclosure property, over (B) the sum of certain non-cash income (from certain imputed rental income and income from transactions inadvertently failing to qualify as like-king exchanges). These requirements may be waived by the IRS if the REIT establishes that it failed to meet them by reason of distributions previously made to meet the requirements of the 4% excise tax discussed below. To the extent that the Company does not distribute all of its net long-term capital gain and all of its \"real estate investment trust taxable income\", it will be subject to tax thereon. In addition, the Company will be subject to a 4% excise tax to the extent it fails within a calendar year to make \"required distributions\" to its shareholders of 85% of its ordinary income and 95% of its capital gain net income plus the excess, if any, of the \"grossed up required distribution\" for the preceding calendar year over the amount treated as distributed for such preceding calendar year. For this purpose, the term \"grossed up required distribution\" for any\ncalendar year is the sum of the taxable income of the Company for the calendar year (without regard to the deduction for dividends paid) and all amounts from earlier years that are not treated as having been distributed under the provision. Dividends declared in October, November, or December and paid during the following January will be treated as having been paid and received on December 31.\nIt is possible but highly unlikely, that the Company, from time to time, may not have sufficient cash or other liquid assets to meet the 95% distribution requirements, due to timing differences between the actual receipt of income and actual payment of deductible expenses or dividends on the one hand and the inclusion of such income and deduction of such expenses or dividends in arriving at \"real estate investment trust taxable income\" of the Company on the other hand. The problem of inadequate cash to make required distributions could also occur as a result of the repayment in cash of principal amounts due on the Company's outstanding debt, particularly in the case of \"balloon\" repayments or as a result of capital losses on short-term investments of working capital. Therefore, the Company might find it necessary to arrange for short-term, or possibly long-term, borrowing, or new equity financing. If the Company were unable to arrange such borrowing or financing as might be necessary to provide funds for required distributions, its REIT status could be jeopardized.\nUnder certain circumstances, the Company may be able to rectify a failure to meet the distribution requirement for a year by paying \"deficiency dividends\" to shareholders in a later year, which may be included in the Company's deduction for dividends paid for the earlier year. The Company may be able to avoid being taxed on amounts distributed as deficiency dividends; however, the Company may in certain circumstances remain liable for the 4% excise tax discussed above.\nThe Company is also required to request annually from record holders of certain significant percentages of its shares certain information regarding the ownership of such shares. Under the Declaration, shareholders are required to respond to such requests for information.\nFederal Income Tax Treatment of Leases. The availability to the Company of, among other things, depreciation deductions with respect to the facilities owned and leased by the Company will depend upon the treatment of the Company as the owner of the facilities and the classification of the leases of the facilities as true leases, rather than as sales or financing arrangements, for Federal income tax purposes. As to the approximately 5% of the leased facilities which constitutes personal property, it is less clear that the Company will be treated as the owner of such personal property and that the leases will be treated as true leases with respect to such property. The Company plans to insure its compliance with the 95% distribution requirement (and the \"required distribution\" requirement) by making distributions on the assumption that it is not entitled to depreciation deductions for the 5% of the leased facilities which constitute personal property, but to report the amount of income taxable to its shareholders by taking into account such depreciation.\nOther Issues. In the case of certain sale-leaseback arrangements, the IRS could assert that the Company realized prepaid rental income in the year of purchase to the extent that the value of a leased property exceeds the purchase price paid by the Company for that property. In litigated cases involving sale-leasebacks which have considered this issue, courts have concluded that buyers have realized prepaid rent where both parties acknowledged that the purported purchase price for the property was substantially less than fair market value and the purported rents were substantially less than the fair market rentals. Because of the lack of clear precedent, complete assurance cannot be given that the IRS could not successfully assert the existence of prepaid rental income.\nAdditionally, it should be noted that Code Section 467 (concerning leases with increasing rents) would apply to the leases because many of the leases provide for rents that increase from one period to the next. Section 467 provides that in the case of a so-called \"disqualified leaseback agreement,\" rental income must be accrued at a constant rate. If such constant rent accrual were required, the Company would recognize rental income in excess of cash rents and, as a result, may fail to meet the 95% dividend distribution requirement. \"Disqualified leaseback agreements\" include leaseback transactions where a principal purpose for providing increasing rent under the agreement is the avoidance of Federal income tax. Because Section 467 directs the Treasury to issue regulations providing that rents will not be treated as increasing for tax avoidance purposes where the increases are based upon a fixed percentage of lessee receipts, the additional rent provisions of the leases should not cause the leases to be \"disqualified leaseback agreements\". In addition, the legislative history of Section 467 indicates that the Treasury should issue regulations under which leases providing for fluctuations in rents by no more than a reasonable percentage from the average rent payable over the term of the lease will be deemed not motivated by tax avoidance; this legislative history indicated that a standard allowing a 10% fluctuation in rents may be too restrictive for real estate leases.\nDepreciation of Properties. For tax purposes, the Company's real property generally is depreciated on a straight-line basis over 40 years and personal property owned by the Company generally is depreciated over 12 years.\nFailure to Qualify. If the Company fails to qualify for taxation as a REIT in any taxable year, and the relief provisions do not apply, the Company will be subject to tax on its taxable income at regular corporate rates (plus any applicable minimum tax). Distributions to shareholders in any year in which the Company fails to qualify will not be deductible by the Company nor will they be required to be made. In such event, to the extent of current and accumulated earnings and profits, all distributions to shareholders will be taxable as ordinary income and, subject to certain limitations in the Code, eligible for the 70% dividends received deduction for corporations. Unless entitled to relief under specific statutory provisions, the Company will also be disqualified from taxation as a REIT for the following four taxable years. It is not possible to state whether in all circumstances the Company would be entitled to statutory relief from such\ndisqualification. Failure to qualify for even one year could result in the Company's incurring substantial indebtedness (to the extent borrowings are feasible) or liquidating substantial investments in order to pay the resulting taxes.\nTaxation of United States Shareholders--Generally. As long as the Company qualifies as a REIT, distributions (including reinvestments pursuant to the Company's dividend reinvestment plan) made to the Company's shareholders out of current or accumulated earnings and profits will be taken into account by them as ordinary income (which will not be eligible for the 70% dividends received deduction for corporations). Distributions that are designated as capital gain dividends will be taxed as long-term capital gains to the extent they do not exceed the Company's actual net capital gain for the taxable year although corporate shareholders may be required to treat up to 20% of any such capital gain dividend as ordinary income pursuant to Section 291 of the Code. For purposes of computing the Company's earnings and profits, depreciation on real estate is computed on a straight-line basis (over 40 years for property acquired after 1986). Distributions in excess of current or accumulated earnings and profits will not be taxable to a shareholder to the extent that they do not exceed the adjusted basis of the shareholder's shares, but will reduce the basis of the shareholder's shares. To the extent that such distributions exceed the adjusted basis of a shareholder's shares they will be included in income as long-term capital gain (or short-term capital gain if the shares have been held for not more than one year) assuming the shares are a capital asset in the hands of the shareholder. Shareholders may not include in their individual income tax returns any net operating losses or capital losses of the Company.\nDividends declared by the Company in October, November or December of a taxable year to shareholders of record on a date in such month, will be deemed to have been received by such shareholders on December 31, provided the Company actually pays such dividends during the following January. The Company has, however, generally declared dividends for the quarter ended December 31 in January of the following year and paid these dividends in the following February. As a result, for tax purposes, the dividend for any calendar year will generally include the dividends for the first three quarters of that year plus the dividend for the fourth quarter of the prior year. For tax purposes, dividends paid in 1987, 1988, 1989, 1990, 1991, 1992, 1993 and 1994 aggregated $1.085, $.840, $1.13, $1.16, $1.22, $1.25, $1.29 and $1.32 respectively, of which $.289, $.065, $.332, $.267, $.104, $.218, $.335 and $.081, respectively, represented a return of capital.\nA sale of a share will result in recognition of gain or loss to the holder in an amount equal to the difference between the amount realized and its adjusted basis. Such a gain or loss will be capital gain or loss, provided the share is a capital asset in the hands of the seller. In general, any loss upon a sale or exchange of shares by a shareholder who has held such shares for not more than one year (after applying certain rules), will be treated as a long-term capital loss to the extent of distributions from the Company required to be treated by such shareholders as long-term capital gain.\nInvestors (other than certain corporations) who borrow funds to finance their acquisition of Shares in the Company could be limited in the amount of deductions allowed for the interest paid on the indebtedness incurred in such an arrangement. Under Code Section 163(d), interest paid or accrued on indebtedness incurred or continued to purchase or carry property held for investment is generally deductible only to the extent of the taxpayer's net investment income. An investor's net investment income will include the dividend and capital gain dividend distributions he receives from the Company; however, distributions treated as a nontaxable return of the shareholder's basis will not enter into the computation of net investment income.\nIn Revenue Ruling 66-106, the IRS ruled that amounts distributed by a real estate investment trust to a tax-exempt employee's pension trust did not constitute \"unrelated business taxable income\". Revenue rulings are interpretive in nature and subject to revocation or modification by the IRS. However, based upon Revenue Ruling 66-106 and the analysis therein, the Company has received an opinion of counsel that distributions by the Company to qualified pension plans (including individual retirement accounts) and other tax-exempt entities should not constitute \"unrelated business taxable income,\" except as explained above in the case of a pension trust which holds more than 10% by value of a \"pension-held REIT\". This Revenue Ruling may not apply if a shareholder has borrowed money to acquire shares.\nUnder Section 469 of the Code, taxpayers (other than certain corporations) generally will not be entitled to deduct losses from so-called passive activities except to the extent of their income from passive activities. For purposes of these rules, distributions received by a shareholder from the Company will not be treated as income from a passive activity and thus will not be available to offset a shareholder's passive activity losses.\nTax preference and other items which are treated differently for regular and alternative minimum tax purposes are to be allocated between a REIT and its shareholders under regulations which are to be prescribed. It is likely that these regulations would require tax preference items to be allocated to the Company's shareholders with respect to any accelerated depreciation claimed by the Company, but the Company has not claimed accelerated depreciation with respect to its existing Properties.\nSpecial Tax Considerations for Foreign Shareholders\nThe rules governing United States income taxation of nonresident alien individuals, foreign corporations, foreign partnerships, and foreign trusts and estates (collectively, \"Non-U.S. Shareholders\") are complex, and the following discussion is intended only as a summary of such rules. Prospective Non-U.S. Shareholders should consult with their own tax advisors to determine the impact of Federal, state, and local income\ntax laws on an investment in the Company, including any reporting requirements.\nIn general, a Non-U.S. Shareholder will be subject to regular United States income tax with respect to its investment in the Company if such investment is \"effectively connected\" with the Non-U.S. Shareholder's conduct of a trade or business in the United States, or if the Non-U.S. Shareholder is a nonresident alien individual who is present in the United States for 183 days or more during the taxable year. A corporate Non-U.S. Shareholder that receives income that is (or is treated as) effectively connected with a U.S. trade or business may also be subject to the branch profits tax under Section 884 of the Code, which is payable in addition to regular United States corporate income tax. The following discussion will apply to Non-U.S. Shareholders whose investment in the Company is not so effectively connected.\nA distribution by the Company that is not attributable to gain from the sale or exchange by the Company of a United States real property interest and that is not designated by the Company as a capital gain dividend will be treated as an ordinary income dividend to the extent that it is made out of current or accumulated earnings and profits. Generally, unless the dividend is effectively connected with the Non- U.S. Shareholder's conduct of a trade or business, such a dividend will be subject to a United States withholding tax equal to 30% of the gross amount of the dividend unless such withholding is reduced by an applicable tax treaty. A distribution of cash in excess of the Company's earnings and profits will be treated first as a nontaxable return of capital that will reduce a Non-U.S. Shareholder's basis in its shares (but not below zero) and then as gain from the disposition of such shares, the tax treatment of which is described under the rules discussed below with respect to disposition of shares. A distribution in excess of the Company's earnings and profits may be subject to 30% dividend withholding if at the time of the distribution it cannot be determined whether the distribution will be in an amount in excess of the Company's current and accumulated earnings and profits. If its subsequently determined that such distribution is, in fact, in excess of current and accumulated earnings and profits, the Non-U.S. Shareholder may seek a refund from the IRS. The Company expects to withhold United States income tax at the rate of 30% on the gross amount of any such distributions made to a Non-U.S. Shareholder unless (i) a lower tax treaty applies and the required form evidencing eligibility for that reduced rate is filed with the Company or (ii) the Non-U.S. Shareholder files IRS Form 4224 with the Company claiming that the distribution is \"effectively connected\" income.\nFor any year in which the Company qualifies as a REIT, distributions by the Company that are attributable to gain from the sale or exchange of a United States real property interest will be taxed to a Non-U.S. Shareholder in accordance with the Foreign Investment in Real Property Tax Act of 1980 (\"FIRPTA\"). Under FIRPTA, such distributions are taxed to a Non-U.S. Shareholder as if such distributions were gains \"effectively connected\" with a United States trade or business. Accordingly, a Non-U.S. Shareholder will be taxed at the normal capital gain rates applicable to a U.S. Shareholder (subject to any applicable alternative minimum tax and a special alternative minimum tax in the\ncase of non-resident alien individuals). Distributions subject to FIRPTA may also be subject to a 30% branch profits tax in the hands of a foreign corporate shareholder that is not entitled to treaty exemption. The Company will be required to withhold from distributions to Non-U.S. Shareholders, and remit to the IRS, 35% of the amount of any distribution that could be designated as capital gain dividends.\nTax treaties may reduce the Company's withholding obligations. If the amount of tax withheld by the Company with respect to a distribution to a Non-U.S. Shareholder exceeds the shareholder's United States liability with respect to such distribution, the Non-U.S. Shareholder may file for a refund of such excess from the IRS. It should be noted that the 35% withholding tax rate on capital gain dividends corresponds to the maximum income tax rate applicable to corporations but is higher than the 28% maximum rate on capital gains of individuals.\nIf the Shares fail to constitute a \"United States real property interest\" within the meaning of FIRPTA, a sale of the Shares by a Non- U.S. Shareholder generally will not be subject to United States taxation unless (i) investment in the Shares is effectively connected with the Non-U.S. Shareholder's United States trade or business, in which case, as discussed above, the Non-U.S. Shareholder would be subject to the same treatment as U.S. Shareholders on such gain or (ii) the Non-U.S. Shareholder is a nonresident alien individual who was present in the United States for 183 days or more during the taxable year, in which case the nonresident alien individual will be subject to a 30% tax on the individual's capital gains.\nThe Shares will not constitute a United States real property interest if the Company is a \"domestically controlled REIT\". A domestically controlled REIT is a REIT in which at all times during a specified testing period less than 50% in value of its shares is held directly or indirectly by Non-U.S. Shareholders. It is currently anticipated that the Company will be a domestically controlled REIT, and therefore that the sale of Shares will not be subject to taxation under FIRPTA. However, because the Shares will be publicly traded, no assurance can be given that the Company will continue to be a domestically controlled REIT. If the Company did not constitute a domestically controlled REIT, whether a Non-U.S. Shareholder's sale of Shares would be subject to tax under FIRPTA as a sale of a United States real property interest would depend on whether the Shares were \"regularly traded\" (as defined by applicable Treasury Regulations) on an established securities market (e.g., the New York Stock Exchange, on which the Shares are listed) and on the size of the selling shareholder's interest in the Company. If the gain on the sale of the Shares were subject to taxation under FIRPTA, the Non-U.S. Shareholder would be subject to the same treatment as a U.S. Shareholder with respect to such gain (subject to applicable alternative minimum tax and a special alternative minimum tax in the case of nonresident alien individuals). In any event, a purchaser of Shares from a Non-U.S. Shareholder will not be required under FIRPTA to withhold on the purchase price if the purchased Shares are \"regularly traded\" on an established securities market or if the Company is a domestically controlled REIT. Otherwise, under FIRPTA, the purchaser of Shares may be required to withhold 10% of the purchase price and to remit such amount to the IRS.\nFederal Estate Tax\nShares owned or treated as owned by an individual who is not a citizen or resident (as defined for United States federal estate tax purposes) of the United States at the time of death will be includible in the individual's gross estate for United States federal estate tax purposes unless an applicable estate tax treaty provides otherwise.\nBackup Withholding and Information Reporting Requirements\nThe Company must report annually to the IRS and to each Non-U.S. Shareholder the amount of dividends paid to and the tax withheld with respect to such holder. These information reporting requirements apply regardless of whether withholding was reduced or eliminated by an applicable tax treaty. Copies of these information returns may also be made available under the provisions of a specific treaty or agreement to the tax authorities in the country in which the Non-U.S. Shareholder resides. United States backup withholding tax (which generally is a withholding tax imposed at the rate of 31% on certain payments to persons that fail to furnish the information required under the United States information reporting requirements) will generally not apply to dividends paid on Shares to a Non-U.S. Shareholder at an address outside the United States.\nThe payment of the proceeds from the disposition of Shares to or through the United States office of a broker will be subject to information reporting and backup withholding at a rate of 31% unless the owner, under penalties of perjury, certifies, among other things, its status as a Non-U.S. Shareholder, or otherwise establishes an exemption. The payment of the proceeds from the disposition of Shares to or through a non-U.S. office of a broker generally will not be subject to backup withholding and information reporting. In the case of proceeds from a disposition of Shares paid to or through a non-U.S. office of a U.S. broker or paid to or through a non-U.S. office of a non-U.S. broker that is (i) a \"controlled foreign corporation\" for United States federal income tax purposes or (ii) a person 50% or more of whose gross income from all sources for a certain three-year period was effectively connected with a United States trade or business, (a) backup withholding will not apply unless the broker has actual knowledge that the owner is not a Non-U.S. Shareholder, and (b) information reporting will not apply if the broker has documentary evidence in its files that the owner is a Non-U.S. Shareholder (unless the broker has actual knowledge to the contrary).\nAny amounts withheld under the backup withholding rules from a payment to a Non-U.S. Shareholder will be refunded (or credited against the Non- U.S. Shareholder's United States federal income tax liability, if any), provided that the required information is furnished to the IRS.\nOther Tax Consequences. The Company and its shareholders may be subject to state or local taxation in various state or local jurisdictions, including those in which it or they transact business or reside.\nThere may be other Federal, state, local or foreign income, or estate and gift, tax considerations applicable to the circumstances of a particular investor. Shareholders should consult their own tax advisors with respect to such matters.\nERISA Plans, Keogh Plans and Individual Retirement Accounts\nGeneral Fiduciary Obligations. Fiduciaries of a pension, profit-sharing or other employee benefit plan subject to Title I of the Employee Retirement Income Security Act of 1974 (\"ERISA\") (\"ERISA Plan\") must consider whether their investment in the Company's shares satisfies the diversification requirements of ERISA, whether the investment is prudent in light of possible limitations on the marketability of the shares, whether such fiduciaries have authority to acquire such shares under the appropriate governing instrument and Title I of ERISA, and whether such investment is otherwise consistent with their fiduciary responsibilities. Any ERISA Plan fiduciary should also consider ERISA's prohibition on improper delegation of control over or responsibility for \"plan assets.\" Trustees and other fiduciaries of an ERISA plan may incur personal liability for any loss suffered by the plan on account of a violation of their fiduciary responsibilities. In addition, such fiduciaries may be subject to a civil penalty of up to 20% of any amount recovered by the plan on account of such a violation (the \"Fiduciary Penalty\"). Also, fiduciaries of any Individual Retirement Account (\"IRA\"), Keogh Plan or other qualified retirement plan not subject to Title I of ERISA because it does not cover common law employees (\"Non-ERISA Plan\") should consider that such an IRA or non-ERISA Plan may only make investments that are authorized by the appropriate governing instrument. Fiduciary shareholders should consult their own legal advisers if they have any concern as to whether the investment is inconsistent with any of the foregoing criteria.\nProhibited Transactions. Fiduciaries of ERISA Plans and persons making the investment decision for an IRA or other Non-ERISA Plan should also consider the application of the prohibited transaction provisions of ERISA and the Code in making their investment decision. Sales and certain other transactions between an ERISA Plan, IRA, or other Non-ERISA Plan and certain persons related to it are prohibited transactions. The particular facts concerning the sponsorship, operations and other investments of an ERISA Plan, IRA, or other Non-ERISA Plan may cause a wide range of other persons to be treated as disqualified persons or parties in interest with respect to it. A prohibited transaction, in addition to imposing potential personal liability upon fiduciaries of ERISA Plans, may also result in the imposition of an excise tax under the Code or a penalty under ERISA upon the disqualified person or party in interest with respect to the ERISA or Non-ERISA Plan or IRA. If the disqualified person who engages in the transaction is the individual on behalf of whom an IRA is maintained (or his beneficiary), the IRA may lose its tax-exempt status and its assets may be deemed to have been distributed to such individual in a taxable distribution (and no excise tax will be imposed) on account of the prohibited transaction. Fiduciary shareholders should consult their own legal advisers if they have any concern as to whether the investment is a prohibited transaction.\nSpecial Fiduciary and Prohibited Transactions Considerations. On November 13, 1986 the Department of Labor (\"DOL\"), which has certain administrative responsibility over ERISA Plans as well as over IRAs and other Non-ERISA Plans, issued a final regulation defining \"plan assets.\" The regulation generally provides that when an ERISA or non-ERISA Plan or IRA acquires a security that is an equity interest in an entity and that security is neither a \"publicly offered security\" nor a security issued by an investment company registered under the Investment Company Act of 1940, the ERISA or Non-ERISA Plan's or IRA's assets include both the equity interest and an undivided interest in each of the underlying assets of the entity, unless it is established either that the entity is an operating company or that equity participation in the entity by benefit plan investors is not significant.\nThe regulation defines a publicly offered security as a security that is \"widely held,\" \"freely transferable\" and either part of a class of securities registered under the Securities Exchange Act of 1934, or sold pursuant to an effective registration statement under the Securities Act of 1933 (provided the securities are registered under the Securities Exchange Act of 1934 within 120 days after the end of the fiscal year of the issuer during which the offering occurred). The Company's shares have been registered under the Securities Exchange Act of 1934.\nThe regulation provides that a security is \"widely held\" only if it is part of a class of securities that is owned by 100 or more investors independent of the issuer and of one another. However, a security will not fail to be \"widely held\" because the number of independent investors falls below 100 subsequent to the initial public offering as a result of events beyond the issuer's control.\nThe regulation provides that whether a security is \"freely transferable\" is a factual question to be determined on the basis of all relevant facts and circumstances. The regulation further provides that, where a security is part of an offering in which the minimum investment is $10,000 or less, certain restrictions ordinarily will not, alone or in combination, affect a finding that such securities are freely transferable. The restrictions on transfer enumerated in the regulation as not affecting that finding include: any restriction on or prohibition against any transfer or assignment which would result in a termination or reclassification of the Company for Federal or state tax purposes, or would otherwise violate any state or Federal law or court order; any requirement that advance notice of a transfer or assignment be given to the Company and any requirement that either the transferor or transferee, or both, execute documentation setting forth representations as to compliance with any restrictions on transfer which are among those enumerated in the regulation as not affecting free transferability, including those described in the preceding clause of this sentence; any administrative procedure which establishes an effective date, or an event prior to which a transfer or assignment will not be effective; and any limitation or restriction on transfer or assignment which is not imposed by the issuer or a person acting on behalf of the issuer. The Company believes that the restrictions imposed under the Declaration on the transfer of shares do not result in the failure of the shares to be \"freely transferable.\" Furthermore, the Company believes that at\npresent there exist no other facts or circumstances limiting the transferability of the shares which are not included among those enumerated as not affecting their free transferability under the regulation, and the Company does not expect or intend to impose in the future (or to permit any person to impose on its behalf) any limitations or restrictions on transfer which would not be among the enumerated permissible limitations or restrictions. However, the final regulation only establishes a presumption in favor of a finding of free transferability, and no guarantee can be given that the DOL or the Treasury Department will not reach a contrary conclusion.\nAssuming that the shares will be \"widely held\" and that no other facts and circumstances exist which restrict transferability of the shares, the Company has received an opinion of counsel that the shares should not fail to be \"freely transferable\" for purposes of the regulation due to the restrictions on transfer of the shares under the Declaration and that under the regulation the shares are publicly offered securities and the assets of the Company will not be deemed to be \"plan assets\" of any ERISA Plan, IRA or other Non-ERISA Plan that invests in the shares.\nIf the assets of the Company are deemed to be plan assets under ERISA, (i) the prudence standards and other provisions of Part 4 of Title I of ERISA would be applicable to investments made by the Company; (ii) the person or persons having investment discretion over the assets of ERISA Plans which invest in the Company would be liable under the aforementioned Part 4 of Title I of ERISA for investments made by the Company which do not conform to such ERISA standards unless the Advisor registers as an investment adviser under the Investment Advisers Act of 1940 and certain other conditions are satisfied; and (iii) certain transactions that the Company might enter into in the ordinary course of its business and operation might constitute \"prohibited transactions\" under ERISA and the Code.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nGeneral. Approximately 77% of the Company's total investments are in nursing homes retirement centers and assisted living centers providing long-term care, 21% of the Company's total investments are in nursing homes with subacute and other specialty rehabilitation services and 2% are in other healthcare facilities. The Company believes that the physical plant of each of the facilities in which it has invested is suitable and adequate for its present and any currently proposed uses. At December 31, 1994, the Company had total real estate investments of approximately $807 million in 141 properties located in 27 states and with approximately 27 different lessees and mortgagors.\nThe following table summarizes certain information about the Properties as of December 31, 1994. All dollar figures are in thousands.\n* Amounts represent or include notes receivable related to improvements to owned property, above.\nItem 3.","section_3":"Item 3. Legal Proceedings.\nThe Company may be subject to routine litigation in the ordinary course of business. It is not presently subject to any legal proceedings which would result in material losses to the Company. The Company knows of no proceedings contemplated by governmental authorities relating to the Company.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nNo matters were submitted to a vote of shareholders during the fourth quarter of the year covered by this Form 10-K.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe Company's Shares are traded on the New York Stock Exchange (symbol: HRP). The following table sets forth for the periods indicated the high and low sale prices for the Shares as reported in the New York Stock Exchange Composite Transactions reports.\nHigh Low First Quarter........... 15 11 3\/8 Second Quarter.......... 14 12 Third Quarter........... 15 1\/8 12 1\/2 Fourth Quarter.......... 16 3\/4 14\nFirst Quarter........... 16 3\/8 14 3\/8 Second Quarter.......... 15 3\/8 14 Third Quarter........... 15 3\/4 14 1\/4 Fourth Quarter.......... 14 7\/8 13\nThe closing price of the Shares on the New York Stock Exchange on March 3, 1995 was $14.50.\nAs of March 3, 1995, there were 3,815 holders of record of the Shares and the Company estimates that as of such date there were in excess of 60,000 beneficial owners of the Shares.\nDividends declared with respect to each period for the two most recent fiscal years and the amount of such dividends and the respective annualized rates are set forth in the following table.\nAnnualized Dividend Dividend Per Share Rate\nFirst Quarter...... $.32 $1.28 Second Quarter..... .32 1.28 Third Quarter...... .33 1.32 Fourth Quarter..... .33 1.32\nFirst Quarter...... .33 1.32 Second Quarter..... .33 1.32 Third Quarter...... .33 1.32 Fourth Quarter..... .34 1.36\nAll dividends declared have been paid. The Company intends to continue to declare and pay future dividends on a quarterly basis.\nIn order to qualify for the beneficial tax treatment accorded to REITs by Sections 856 through 860 of the Code, the Company is required to make distributions to shareholders which annually will be at least 95% of the Company's \"real estate investment trust taxable income\" (as defined in the Code). All distributions will be made by the Company at the discretion of the Board of Trustees and will depend on the earnings of the Company, funds from operations, the financial condition of the Company and such other factors as the Board of Trustees deems relevant. The Company has in the past distributed, and intends to continue to distribute, substantially all of its \"real estate investment trust taxable income\" to its shareholders.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nSet forth below are selected financial data for the Company for the periods and dates indicated. This data should be read in conjunction with, and is qualified in its entirety by reference to, the financial statements and accompanying notes included elsewhere in this Form 10-K. Amounts are in thousands, except per Share information.\n(1) Funds from operations does not equal cash flow from operating activities as defined by generally accepted accounting principles and should not be considered an alternative to net income as an indication of the Company's performance or to cash as a measure of liquidity. Funds from operations means income before gain (loss) on sale of properties and extraordinary items plus depreciation and other non-cash items. Dividends in excess of net income generally constitute a return of capital.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial\nCondition and Results of Operations.\nResults of Operations\nYear Ended December 31, 1994 compared to Year Ended December 31, 1993\nTotal revenues for the year ended December 31, 1994 were $86.7 million, an increase of $30.2 million or 53% over the year ended December 31, 1993. Rental income increased to $63.9 million from $46.1 million and interest income increased to $22.8 million from $10.4 million. Rental income increased as a result of new purchase and lease investments, primarily a $33.4 million transaction in December 1993 and the $320 million retirement community transaction with Marriott International, Inc. (Marriott) in 1994. The growth in interest income is primarily the result of the full year impact of three loan pool acquisitions in 1993 and a mortgage transaction of $26.6 million in December 1993.\nTotal expenses for 1994 increased to $28.8 million, from $18.7 million, in the comparable 1993 period. The increase of $10.1 million was due primarily to increases in interest of $2.7 million, advisory fees of $1.5 million, and depreciation and amortization of $5.6 million. The increases in advisory fees and depreciation and amortization are directly related to the Company's increased investments whereas interest increased due to both higher interest rates during the second half of 1994 and the issuance of $200 million senior notes in July 1994 in connection with the Marriott transaction.\nIncome before gain (loss) on sale of properties and extraordinary items for 1994 increased to $57.9 million, or $1.10 per share, from $37.7 million, or $1.10 per share, in 1993. Per share amounts remained flat reflecting the issuance of nine million new shares of the Company's stock in December 1993 and 13.3 million new shares in 1994, as well as negative interest arbitrage resulting from unusually high cash balances caused by timing differences between receipt of proceeds from the note offering and the investment of those proceeds in real estate.\nIncome before extraordinary items and net income in 1994 was $51.9 million ($.98 per share) and $49.9 million ($.95 per share), respectively, versus $37.7 million ($1.10 per share) and $33.4 million ($.97 per share), respectively, in 1993. On a per share basis, income before extraordinary items and net income decreased during 1994 primarily as a result of the new share issuances noted above and negative arbitrage noted above and the $10 million provision for the potential loss on the sale of two psychiatric hospitals. These two hospitals are HRP's only investments in the psychiatric industry and the loss is due to the general decline in value of such property.\nThe Company's business plan is to maximize funds from operations rather than net income. The Company's Board of Trustees considers funds from operations, among other factors, when determining dividends to be paid to shareholders. Funds from operations means net income excluding gains or losses from debt restructuring and sales of property, plus depreciation. Cash flow provided by operating activities may not necessarily equal funds from operations as the cash flow of the Company\nis affected by other factors not included in the funds from operations calculation such as changes in assets and liabilities. Funds from operations for the year ended December 31, 1994, was $73.9 million, or $1.40 per share, versus $47.6 million, or $1.38 per share, in 1993. Funds from operations for 1994 increased $26.3 million or 55% over the prior year. However, funds from operations per share increased only slightly as a result of nine million new shares of the Company's stock issued in December 1993 and 13.3 million new shares issued in 1994 and the negative arbitrage from large cash balances previously discussed. Dividends declared for the years ended December 31, 1994 and 1993 were $1.33 per share and $1.30 per share, respectively. Dividends in excess of net income constitute a return of capital. For 1994, the return of capital portion reported was 6.1% of dividends and 12.6% of dividends was considered a long term capital gain.\nCash flow provided by (used for) operating, investing and financing activities were $78.3 million, ($261.8 million) and $229.4 million, respectively, for the year ended December 31, 1994 and $47.2 million, ($175.4 million) and $128.0 million, respectively in 1993.\nYear Ended December 31, 1993 compared to Year Ended December 31, 1992\nTotal revenues for the year ended December 31, 1993 were $56.5 million, an increase of $7.8 million or 16% over the year ended December 31, 1992. Rental income increased to $46.1 million from $43.0 million and interest income increased to $10.4 million from $5.7 million. Rental income increased as a result of new purchase lease investments, increases in additional rent, and improvement financings during 1993. The growth in interest income is primarily the result of the acquisition since December 1, 1992, of four pools of performing mortgage loans for $133.7 million with a principal balance at the time of acquisition of approximately $148.2 million.\nNet income for 1993 increased to $33.4 million, or $.97 per share, from $27.2 million, or $1.02 per share in the comparable 1992 period. The increase in net income of $6.2 million or 23% during the 1993 period was primarily the result of new investments discussed above and a decrease in total expenses of $2.7 million. On a per share basis, net income decreased slightly during 1993 primarily as a result of non- recurring charges related to the early extinguishment of debt. Debt was retired with the proceeds from the issuance of 10.35 million and nine million new shares of the Company's stock during the first and fourth quarters, respectively, of 1993. Total expenses for 1993 were $18.7 million, a decrease of 13% from $21.5 million for the comparable 1992 period. Interest expense decreased $3.2 million as a result of lower average bank borrowings and lower interest rates during the comparable periods. Depreciation and amortization expense remained flat reflecting the fact that the new mortgage investments occurred throughout the year and the significant purchase lease investments occurred near year end.\nThe Company's funds from operations for the years ended December 31, 1993, and 1992 was $47.6 million ($1.38 per share) and $36.9 million ($1.38 per share), respectively. Total funds from operations for 1993 increased $10.7 million or 29% over the prior year. However, on a per share basis, funds from operations remained unchanged, primarily as a result of the 19.4 million new shares of the Company's stock issued in 1993. Dividends declared for the years ended December 31, 1993 and 1992 were $1.30 per share and $1.26 per share, respectively. Dividends in excess of net income constitute a return of capital. For 1993, the return of capital portion was 26% of the dividends.\nCash flow provided by (used for) operations, investing and financing activities were $47.2 million, ($175.4 million) and $128.0 million, respectively, for the year ended December 31, 1993, and $42.0 million, ($71.9 million) and $1.9 million, respectively, for the year ended December 31, 1992.\nLiquidity and Capital Resources\nAssets increased to $840.2 million as of December 31, 1994, from $527.7 million as of December 31, 1993. The increase of $312.5 million or 59% is primarily attributable to the increases in real estate properties, net, and cash and cash equivalents of $283.7 million and $45.9 million, respectively, net of a decrease in real estate mortgages and notes, net, of $23.8 million. The increase in real estate properties is the net result of the acquisition of 14 retirement communities in connection with the Marriott transaction, and the sale of three properties in connection with the February 11, 1994 merger of Greenery Rehabilitation Group, Inc. (Greenery) into Horizon Healthcare Corporation (Horizon). Cash increased as a result of mortgage prepayments and excess proceeds from the July debt offering. Real estate mortgages and notes, net, decreased principally due to the prepayment of mortgage investments totalling $48.7 million, net of new mortgage financings of $14.5 million.\nOn February 11, 1994, in connection with the Horizon-Greenery merger, the Company sold to Horizon for $28.4 million three facilities that had been leased to Greenery. The Company realized a capital gain of approximately $4.0 million on the sale of these properties. In addition, Horizon has leased seven facilities previously leased to Greenery, on substantially similar terms except the leases were extended through 2005. The Company has granted Horizon a ten year option to buy the seven leased facilities, at the rate of no more than one facility per consecutive twelve months. The Company leased the three remaining Greenery facilities to a newly formed corporation, Connecticut Subacute Corporation, II (CSC II), an affiliate of HRPT Advisors, Inc. (Advisor). These facilities are being managed by and the lease payments are guaranteed by Horizon for a term of up to five years. The terms of these lease arrangements are substantially similar to the original lease arrangements with Greenery.\nIn January 1995 Horizon exercised its option and purchased one of the seven leased properties from the Company for $24.5 million resulting in a capital gain of $2.5 million. The Company provided Horizon a 16 year $19.5 million mortgage in connection with this sale in 1995.\nOn February 11, 1994, in connection with the Horizon-Greenery merger, the Company provided Horizon with $9.4 million first mortgage financing for two facilities. One of the facilities previously was owned by the Company and leased to Greenery. The mortgage notes bear interest at 11.5% per annum and mature December 31, 2000.\nDuring 1994 the Company received net proceeds of approximately $182.4 million from the public offering of 13,251,500 shares of beneficial interest (including the underwriter's over-allotment). A portion of the proceeds were used to repay the outstanding balance of $73 million on the Company's revolving credit facility and the remainder was used to fund part of the Marriott transaction.\nOn September 9, 1994, the Company completed its acquisition of 14 retirement communities containing 3,952 residencies or beds for $320 million. These communities are triple net leased through December 31, 2013 to a wholly owned subsidiary of Marriott International Inc. The leases provide for fixed rent and additional rentals equal to a percentage of annual revenues from operations in excess of base amounts determined on a facility by facility basis. All of the leases are subject to cross default provisions and are guaranteed by Marriott. This transaction was funded from cash on hand, the proceeds of an equity offering discussed above, drawings under the Company's revolving credit facility, assumption of $17.6 million of existing debt bearing interest at 7.75% and a portion of the proceeds from a note offering described below.\nOn July 13, 1994, the Company received net proceeds of $197.3 million from the offering of $200 million floating rate senior notes due in 1999. The notes were issued in two series, A and B, which may be called by the Company beginning April 13, 1995 and July 13, 1996, respectively. The weighted average interest rate is LIBOR plus 84 basis points. A portion of these proceeds were used to fund part of the Marriott transaction and to repay $56 million in borrowings under the Company's revolving credit facility. The Company retained the balance to fund future real estate acquisitions. The Company has interest rate cap agreements which provide for maximum weighted average interest rates of approximately 6.85% on its variable rate debt.\nThis senior note offering was drawn under a shelf registration statement for the offering of up to $345 million of debt securities, preferred shares of beneficial interest, common shares of beneficial interest and common share warrants. An additional $145 million of securities may be issued under this registration statement.\nAt December 31, 1994, the Company had $59.8 million of cash and cash equivalents. The Company's $170 million revolving credit facility was undrawn at December 31, 1994. The facility matures in 1997 and bears interest at a spread over LIBOR.\nAs of December 31, 1994, the Company had extended commitments to provide financing totalling approximately $58.1 million. In addition to completing certain of these committed transactions in early 1995 as described below, the Company also entered into several additional commitments.\nOn January 24, 1995, the Company provided first mortgage financing of $11.5 million due in 2007, secured by four assisted living properties and operated by a newly created health care operating company. The borrower has provided a $1 million cash security deposit, to guarantee its obligations to the Company.\nOn January 31, 1995, the Company acquired nine nursing facilities for approximately $32 million. The facilities have been leased to two newly formed corporations which are affiliates of the Company. The purchase price paid was approximately $8.1 million in cash and 1.8 million shares of the Company's common stock.\nThe Company entered into a commitment to purchase and lease 11 nursing properties for $18 million and provide first mortgage financing of $2 million secured by three nursing properties, to a subsidiary of an existing tenant, on terms substantially similar to the Company's existing lease and mortgage agreements with that tenant. The acquisition is expected to close in April 1995.\nThe Company entered into an commitment to purchase and lease 14 nursing properties for approximately $45 million subject to adjustment, located in the United Kingdom, on terms substantially similar to the Company's existing lease agreements. The Company expects to fund this investment by borrowing in British sterling and has recently amended its bank credit facility to permit such borrowings. By borrowing in the same currency as it invests in, the Company believes it can reduce the impact of fluctuations in relative currency values. The acquisition is expected to close in installments beginning in April 1995 with the entire transaction being completed by December 1995.\nThe Company entered into a purchase and lease agreement with Host Marriott Corporation (Host Marriott) for 21 Courtyard by Marriott hotel properties for approximately $179.4 million, subject to adjustment. The properties are leased for an initial term of 12 years, with renewal options of an additional 37 years to a subsidiary of Host Marriott and are managed by a subsidiary of Marriott International. An amount equal to one year's rent was withheld from the purchase price to secure the tenant's obligations to the Company. The transaction closed in March 1995.\nThe Company funded and intends to fund these commitments with a combination of cash on hand, amounts available under its existing credit facilities, proceeds of mortgage prepayments, if any, and\/or proceeds of other financings such as the possible issuance of additional securities in connection with the shelf registration statement described above.\nThe Company's investment in hotel properties does not represent a change in the Company's strategy of focusing on investments in long term care and retirement facilities. Rather, this investment, structured as a triple net lease, will represent only approximately 15% of the portfolio upon closing. The facilities are new, having been constructed within the last five years, and occupancy and cash flow coverage are strong. Following the announcement of this investment, Moody's downgraded the Company's debt rating and S&P and Fitch maintained their\nratings. The Company believes, despite the negative reaction by Moody's, that this transaction will enhance the security and growth potential of its funds from operations.\nThe Company continues to seek new investments to expand and diversify its portfolio of leased and mortgaged health care, retirement and related real estate. The Company believes that the transactions described above improve the security of its future cash flow and dividends. The Company intends to balance the use of debt and equity in such a manner that the long term cost of funds borrowed to acquire or mortgage finance facilities is appropriately matched, to the extent practicable, with the terms of the investments made with such borrowed funds. As of December 31, 1994, the Company's debt as a percentage of total capitalization was approximately 26%.\nImpact of Inflation\nManagement believes that the Company is not adversely affected by inflation. In the real estate market, inflation tends to increase the value of the Company's underlying real estate which may be realized at the end of the lessees' fixed terms. In the health care and hotel industries, inflation increases the lessees' and mortgagors' revenues, thereby increasing the Company's additional rent or interest. At December 31, 1994, increases in interest rates on all of the Company's outstanding debt were capped by the use of interest rate cap agreements. The Company has interest rate cap agreements which provide for maximum weighted average interest rates of approximately 6.85% on its variable rate debt.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements and related notes and report of independent auditors for the Company are included following Part IV, beginning on page, and identified in the index appearing at Item 14(a). The financial statements for Marriott are incorporated by reference to Marriott's Annual Report on Form 10-K for the year ended December 30, 1994, Commission File No. 1-12188. The financial statements and financial statement schedules for Horizon are incorporated by reference to Horizon's Annual Report on Form 10-K for the year ended May 31, 1994, Commission File No. 1-9369 and Horizon's Quarterly Report on Form 10-Q for the quarter ended November 30, 1994, Commission File No. 1-9369. The financial statements and financial statement schedules for Grancare are incorporated by reference to Grancare's Annual Report on Form 10-K for the year ended December 31, 1994, Commission File No. 0- 19571.\nItem 9.","section_9":"Item 9. Changes in and Disagreements on Accounting and Financial Disclosure\nNot applicable\nPART III\nThe information in Part III (Items, 10, 11, 12 and 13) is incorporated by reference to the Company's definitive Proxy Statement, which will be filed not later than 120 days after the end of the Company's fiscal year.\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 and Financial Statement Schedules\nHEALTH AND RETIREMENT PROPERTIES TRUST\nPage\nReport of Ernst & Young LLP, Independent Auditors Balance Sheets as of December 31, 1993 and 1994 Statements of Income for the years ended December 31, 1992, 1993 and 1994 Statements of Shareholders' Equity for the years ended December 31, 1992, 1993 and 1994 Statements of Cash Flows for the years ended December 31, 1992, 1993 and 1994 Notes to Financial Statements\nThe following financial schedules are included:\nIII -- Real Estate and Accumulated Depreciation IV -- Mortgage Loans on Real Estate\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 or are inapplicable, and therefore have been omitted.\nExhibits:\n3.1 - July 1994 Amended and Restated Declaration of Trust (3) 3.2 - Amended and Restated By-Laws (1) 4.1 - Form of Series A Note (2) 4.2 - Form of Series B Note (2) 4.3 - Shawmut Bank, N.A. Indenture dated as of June 1, 1994 (2) 4.4 - Supplemental Shawmut Bank, N.A., Indenture dated as of June 29, 1994 (2) 9.1 - AMS Voting Trust Agreement (9) 9.2 - Amended and Restated AMS Voting Trust Agreement (4) 10.1 - Advisory Agreement, as amended (10)(+) 10.2 - Second Amendment to Advisory Agreement (5)(+) 10.3 - Incentive Share Award Plan (6)(+) 10.4 - Master Lease Document (8) 10.5 - HRPT Shares Pledge Agreement (8) 10.6 - AMS Properties Security Agreement (8) 10.7 - AMS Subordination Agreement (8)\n10.8 - AMS Guaranty (8) 10.9 - AMS Pledge Agreement (pledging shares of AMSP) (8) 10.10 - AMS Holding Co. Pledge Agreement (pledging shares of AMS) (7) 10.11 - Amended and Restated Renovation Funding Agreement (7) 10.12 - Amendment to AMS Transaction Documents (7) 10.13 - GCI Master Lease Document (6) 10.14 - Amended and Restated HRP Shares Pledge Agreement (6) 10.15 - Guaranty, Cross-Default and Cross-Collateralization Agreement (6) 10.16 - CSC $8,000,000 Working Capital Promissory Note (6) 10.17 - Marriott Senior Living Services Purchase and Sale Agreement (5) 10.18 - Connecticut Subacute Corporation II Lease Document Waterbury (1) 10.19 - Connecticut Subacute Corporation II Lease Document - Cheshire (1) 10.20 - Connecticut Subacute Corporation II Lease Document - New Haven (1) 10.21 - Vermont Subacute\/New Hampshire Subacute Corporation Master Lease Agreement (Chapple) (1) 10.22 - Amended and Restated Agreement and Plan of Reorganization (Chapple) (1) 10.23 - March 1995 Second Amended and Restated Revolving Loan Agreement (1) 10.24 - Purchase Option Agreement (1) 12.1 - Earnings to Fixed Charges (1) 21.1 - Subsidiaries of the Registrant (1) 23.1 - Consent of Ernst & Young (1) 23.2 - Consent of Arthur Andersen LLP (Horizon) (1) 25.1 - Powers of Attorney (1) 27.1 - Financial Data Schedule (1)\n(+) Management contract or compensatory plan or arrangement\n(1) Filed herewith.\n(2) Incorporated by reference to the Company's Registration Statement on Form 8-A dated July 11, 1994.\n(3) Incorporated by reference to the Company's Current Report on Form 8-K dated July 1, 1994 and amendments thereto.\n(4) Incorporated by reference to the Company's Registration Statement on Form S-3 dated June 2, 1994.\n(5) Incorporated by reference to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1993.\n(6) Incorporated by reference to the Company's Registration Statement No. 33-55684 on Form S-11 dated December 23, 1992 and amendments thereto.\n(7) Incorporated by reference to the Company's Annual Report on Form 10-K for its fiscal year ended December 31, 1991.\n(8) Incorporated by reference to the Company's Current Report on Form 8-K dated December 28, 1990 and amendments thereto.\n(9) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the Quarter ended September 30, 1990 and amendments thereto.\n(10) Incorporated by reference to the Company's Registration Statement No. 33-16799 on Form S-11 dated August 27, 1987 and amendments thereto.\n(b) Reports on Form 8-K\nNo reports on Form 8-K were filed during the last quarter of the period covered by this report.\nREPORT OF INDEPENDENT AUDITORS\nTo the Trustees and Shareholders Health and Retirement Properties Trust\nWe have audited the accompanying balance sheets of Health and Retirement Properties Trust as of December 31, 1994 and 1993, and the related statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1994. 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 financial position of Health and Retirement Properties Trust at December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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 LLP\nBoston, Massachusetts February 9, 1995\nSee accompanying notes\nSee accompanying notes\nSee accompanying notes\nSee accompanying notes\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nNote 1. Organization\nHealth and Retirement Properties Trust (formerly known as Health and Rehabilitation Properties Trust), a Maryland real estate investment trust (the Company), was organized on October 9, 1986. The Company invests in income-producing real estate, primarily health care related properties.\nNote 2. Summary of Significant Accounting Policies\nReal estate properties and mortgages. Real estate properties and mortgages are recorded at cost. Depreciation is provided for on a straight-line basis over the estimated useful lives ranging up to 40 years. If the estimated net realizable value of an investment is less than the carrying value, an allowance for possible investment loss is established. The determination of net realizable value includes consideration of many factors including income to be earned from the investment, holding costs, estimated selling prices, and prevailing economic conditions.\nCash and cash equivalents. Cash, over-night repurchase agreements and short-term investments with maturities of three months or less at date of purchase are carried at cost plus accrued interest.\nDeferred interest and finance costs. Costs incurred to secure certain borrowings are capitalized and amortized over the terms of their respective loans.\nInterest rate hedging arrangements. The Company enters into interest rate hedging arrangements to limit the exposure to increasing interest rates with respect to its bank borrowings and notes payable. Their cost is included in interest expense ratably over the terms of the respective agreements. Amounts receivable from hedging arrangements are accrued as an adjustment to interest expense. The unamortized cost of these agreements is included in other assets.\nRevenue recognition. Rental income from operating leases is recognized on a straight line basis over the life of the lease agreements. Interest income is recognized as earned over the terms of the real estate mortgages. Additional rent and interest revenue is recognized as earned.\nNet income per share. Net income per share is computed using the weighted average number of shares outstanding during the period. Supplemental earnings per share for the years ended December 31, 1993 and 1994, was $.91 and $.93, respectively, based on the assumption that the issuance of shares in the Company's public offerings during 1993 and 1994, and the related repayment of outstanding bank borrowings, took place at the beginning of each year.\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nReclassifications. Certain reclassifications have been made to the prior year financial statements to conform with the current year's presentation.\nFederal income taxes. The Company is a real estate investment trust under the Internal Revenue Code of 1986, as amended. Accordingly, the Company expects not to be subject to federal income taxes on amounts distributed to shareholders provided it distributes at least 95% of its real estate investment trust taxable income and meets certain other requirements for qualifying as a real estate investment trust.\nNote 3. Real estate properties.\nThe Company's real estate properties are leased pursuant to noncancellable, fixed term operating leases expiring from 1996 to 2013. The leases generally provide for renewal terms at existing rates followed by several market rate renewal terms. Each lease is a triple net lease and generally requires the lessee to pay minimum rent, additional rent based upon increases in net patient revenues and all operating costs associated with the leased property. Additional rent and interest for the years ended December 31, 1992, 1993 and 1994 were $1,809, $2,312, and $2,768, respectively.\nDuring 1994, the Company acquired 14 retirement communities, two nursing properties and a medical laboratory building for an aggregate purchase price of approximately $326,350. The 14 retirement communities are leased to a subsidiary of Marriott International, Inc. (together with its subsidiaries, \"Marriott\") and the lease obligation is guaranteed by Marriott through the year 2013.\nThe obligations of Marriott are cross defaulted, cross guaranteed and cross secured. In the event Marriott's debt rating decreases to below \"investment grade\", Marriott is required to provide the Company a cash security deposit of approximately $6,911.\nIn addition, during 1994 the Company terminated the leases on thirteen properties. Seven of these properties have been leased to Horizon Healthcare Corporation (Horizon) on substantially similar terms, with the leases extended through 2005, and the Company has granted Horizon a ten year option to buy the seven properties, at the rate of no more than one property per consecutive twelve month period. Three of the properties have been leased to a newly formed corporation, an affiliate of HRPT Advisors, Inc. (\"Advisor\"), on substantially similar terms. These three properties are being managed by, and the lease payments are guaranteed by, Horizon for a term of up to five years. The three remaining properties were sold for approximately $28,400. The Company realized a gain of approximately $3,994 on the sale. In January, 1995, Horizon purchased one of the seven leased properties from\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nthe Company for $24,500 and the Company realized a gain of approximately $2,476. The Company provided Horizon a $19,500 mortgage with a maturity of 2010 in connection with the sale of the property. The various leases and mortgages with another lessee, GranCare, Inc. (together with its subsidiaries, \"GranCare\") are secured by the pledge to the Company of 1,000,000 shares of the Company's common stock held by Grancare and substantially all the assets of the special operating subsidiaries. All obligations of GranCare are cross defaulted, cross guaranteed and cross secured.\nThe leases, mortgages and note due to the Company by Community Care of America (\"CCA\") and its subsidiaries are secured by a $3,800 cash security deposit, by a pledge of substantially all the assets of certain of the operating CCA subsidiaries and by a guarantee from the parent corporation. Substantially all of the CCA obligations are cross defaulted, cross guaranteed and cross secured.\nThe future minimum lease payments to be received by the Company during the current terms of the leases as of December 31, 1994, are approximately $70,422 in 1995, $70,397 in 1996, $65,305 in 1997, $65,046 in 1998, $60,640 in 1999 and $636,377 thereafter.\nNote 4. Real Estate Mortgages and Notes, net\nDecember 31, 1993 1994 Mortgage notes receivable, net of discounts of $11,951 and $5,817, respectively, due July 1995 through December 2016 $124,367 $ 92,560 Mortgage note receivable due December 2016 13,600 13,600 Amount due on investment held for sale, net of reserve of $10,000 - 9,947 Mortgage note receivable due December 2000 10,283 9,683 Secured note due December 2016 7,000 7,000 Other secured notes receivable 816 687 Loan to an affiliate 1,215 - $157,281 $133,477\nAt December 31, 1994, the interest rates on the mortgages range from 6.6% to 13.75%.\nDuring 1994, the Company provided two mortgage loans secured by two properties for $9,400. One of these properties was previously owned by the Company. In addition, 23 mortgage loans, secured by 19 properties,\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nwith outstanding principal balances aggregating approximately $48,667 were repaid.\nIn the fourth quarter of 1994, the Company agreed to sell its two psychiatric properties to the current operator, with a financial effect of September 1, 1994 (\"Sale Date\"). The sales price is being determined by a judicially supervised appraisal process and payments made to the Company, subsequent to Sale Date, on this investment, are being classified as interest and principal. Accordingly, at December 31, 1994, the Company has classified these properties as a mortgage receivable and has made a provision for a loss on this investment of approximately $10,000.\nNote 5. Shareholders' Equity\nDuring January 1994 and May 1994, the Company issued 601,500 and 12,650,000 common shares of beneficial interest, respectively, and received net proceeds of approximately $8,301 and $174,065, respectively.\nIn October, 1994, the Company adopted a Shareholders Rights Plan (\"Plan\") and declared a dividend of one right for each outstanding common share of beneficial interest (\"Right\"). Each Right entitles the holder to purchase one one-hundredth of a preferred share of beneficial interest, $.01 par value, or in certain circumstances, to receive cash, property, common shares or other securities of the Company, at a purchase price of $50 per one-hundredth of a preferred share, subject to adjustment. Upon the occurrence of certain events the holder of the Right will be entitled to acquire common shares at 50% of the then current market value of the shares. The Rights expire on October 17, 2004 and are redeemable at the Company's option at any time at $.01 per Right.\nThe Company has reserved 1,000,000 shares of the Company's stock, under the terms of the 1992 Incentive Share Award Plan (\"Award Plan\"). The Award Plan provides for the grant of the Company's stock to selected officers, Trustees and others rendering valuable services to the Company. During 1992, 1993 and 1994, 6,000, 6,000 and 11,000 shares, respectively, were granted to officers of the Company and certain employees of Advisors and 500 shares, annually, were granted to each of the three Independent Trustees, as part of their annual fee. The shares granted to the Trustees vest immediately. The shares granted to others vest over a three year period. At December 31, 1994, 972,500 shares of the Company remain reserved for issuance under the Award Plan.\nNote 6. Financing Commitments\nAt December 31, 1994, the Company had total commitments aggregating $58,148, of which $8,603 is committed to finance improvements to certain\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nproperties leased or mortgaged by the Company. During 1994, the Company funded approximately $11,088 of such improvements.\nNote 7. Transactions With Affiliates\nThe Company has an agreement with the Advisor whereby the Advisor provides investment, management and administrative services to the Company. The Advisor is owned by Gerard M. Martin and Barry M. Portnoy. Messrs. Martin and Portnoy are directors of Horizon, shareholders of Connecticut Subacute Corporation (\"CSC\") and Connecticut Subacute Corporation II (\"CSCII\"), lessees of the Company, and are Managing- Trustees of the Company. The Company has extended a $4,000 line of credit to CSC until June 30, 1995. At December 31, 1994, there were no amounts outstanding under this agreement. Mr. Portnoy is a partner in the law firm which provides legal services to the Company and was a minority shareholder of the owner of Continuing Health Care Corporation, a company which formerly leased or mortgaged properties from the Company. Mr. Martin, until February 1994, was the majority shareholder of Greenery Rehabilitation Group, Inc. (\"Greenery\"), one of the Company's original sponsors and major tenant.\nThe Advisor is compensated at an annual rate equal to .7% of the Company's real estate investments up to $250 million and .5% of such investments thereafter. The Advisor is entitled to an incentive fee comprised of restricted shares of the Company's common stock based on a formula. Advisory fees for the years ended December 31, 1992, 1993 and 1994 were $2,231, $2,591 and $3,839, respectively. Incentive fees for 1994 were $239 which represents approximately 17,869 common shares. At December 31, 1994, the Advisor owned 996,250 common shares.\nAmounts resulting from transactions with affiliates included in the accompanying statements of income, shareholders' equity and cash flows are as follows:\nDuring 1994, the Company entered into a new revolving credit arrangement, aggregating $170,000, and repaid borrowings then outstanding. In connection with the prepayments, the Company terminated certain interest rate hedge arrangements, wrote off certain deferred costs related to the prepayment and recorded an extraordinary charge of approximately $1,953. In addition, the Company received net proceeds\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nafter financing costs of $197,270 from the issuance of $200,000 Series A and Series B Senior Notes, issued at par and at a discount, respectively. The Series A notes may be called, at the Company's option, beginning in April 1995. The Series B notes may be called, at the Company's option, beginning in July 1996.\nIn association with the purchase of the Marriott properties, the Company assumed bonds payable of $17,620. These notes are secured by first mortgage liens on two retirement communities having an aggregate net book value of $67,997 at December 31, 1994, and by a $17,802 letter of credit.\nAt December 31, 1994, the Company had interest rate hedge agreements which cap interest rates on up to $200,000 of borrowings. The maximum average rates payable on such borrowings under these arrangements is 6.85% per annum over the terms of the agreements. The maturities of the hedge agreements range from 1995 through 1998.\nThe required principal payments for the next five years of $200,000 are due in 1999.\nNote 9. Concentration of credit risk\nSubstantially all of the Company's assets are invested in income producing health care related real estate. At December 31, 1994, the Company's significant lessees and mortgagors are as follows:\nNote 10. Fair value of financial instruments.\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nAt December 31, 1994, the carrying amounts and fair values of the Company's financial instruments are as follows:\nCash and cash equivalents, security deposits and financing commitments approximate fair values. Interest rate hedging agreements are based on quoted market prices. The fair values of notes and bonds payable are based on estimates using discounted cash flow analysis and currently prevailing rates. The fair value of the letter of credit is based on fees currently charged to enter into similar agreements taking into account the remaining term and the counter party's credit standing.\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nNote 11. Selected Quarterly Financial Data (Unaudited)\nThe following is a summary of the unaudited quarterly results of operations of the Company for 1993 and 1994.\nNote 12. Subsequent Events and Pro Forma Information (Unaudited)\nOn January 24, 1995, the Company provided first mortgage financing of $11,500, due in 2007, secured by four assisted living properties and operated by a newly created health care operating company. The borrower has provided a $1,000 cash security deposit to guarantee its obligations to the Company.\nIn addition, on January 31, 1995, the Company acquired nine nursing facilities for approximately $32,000. The facilities have been leased to a newly formed corporation which is an affiliate of the Company. The purchase price paid was approximately $8,132 in cash and 1,777,768 shares of the Company's common stock.\nThe Company entered into a commitment to purchase and lease 11 nursing properties for $18,000 and provide first mortgage financing of $2,045, secured by three nursing properties, to a subsidiary of an existing tenant, on terms substantially similar to the Company's existing lease and mortgage agreements. The acquisition is expected to close on or about April 1, 1995.\nThe Company has entered into a commitment of approximately $45,000, subject to adjustment, to purchase and lease 14 nursing properties located in the United Kingdom, on terms substantially similar to the Company's existing lease agreements. This investment will be funded in British Sterling. The acquisition is expected to close in installments beginning in April 1995 with the entire transaction completed by December 31, 1995.\nThe Company entered into a purchase and lease agreement with a subsidiary of Host Marriott Corporation (\"Host Marriott\") for 21 Courtyard by Marriott hotel properties for approximately $179,400, subject to adjustment. The properties will be leased for an initial term of 12 years, with renewal options of an additional 37 years to a subsidiary of Host Marriott, and will be managed by a subsidiary of\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nMarriott International. A portion of the purchase price equal to one year's rent will be withheld by the Company to guarantee the rent obligations to the Company. The acquisition is expected to close in March 1995.\nThe following summarized Pro Forma Statements of Income assume that the 1994 transactions described in Notes 3 and 4, the issuance of the Company's common shares and senior notes during 1994 and the transactions described above had occurred on January 1, 1993, and give effect to the Company's borrowing rates throughout the periods indicated.\nThe summarized Pro Forma Balance Sheet is intended to present the financial position of the Company as if the transactions described in Note 14 had occurred on December 31, 1994.\nThese pro forma statements are not necessarily indicative of the expected results of operations or the Company's financial position for any future period. Differences could result from, but are not\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nlimited to, additional property investments, changes in interest rates and changes in the debt and\/or equity structure of the Company.\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\nHEALTH AND RETIREMENT PROPERTIES TRUST NOTES TO FINANCIAL STATEMENTS\n(Dollars in thousands, except per share amounts)\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, thereunto duly authorized.\nHEALTH AND RETIREMENT PROPERTIES TRUST\nBy:\/S\/ David J. Hegarty David J. Hegarty Executive Vice President and Chief Financial Officer Dated: March 30, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons, or by their attorney-in-fact, in the capacities and on the dates indicated.","section_15":""}
{"filename":"35469_1994.txt","cik":"35469","year":"1994","section_1":"Item 1. Business\nGeneral The registrant was incorporated under the laws of Delaware in 1953. The registrant operates a single segment business in the textile industry and is principally involved in the manufacture and sale of home furnishing products.\nOn July 30, 1993 the registrant completed the sale of its carpet and rug division to Mohawk Industries, Inc. for approximately $148 million. The sale resulted in an after-tax net income of $9.2 million. On November 24, 1993 a newly formed and wholly owned subsidiary of the registrant completed a tender offer for all of the outstanding shares of Amoskeag Company (\"Amoskeag\") for a cash price of $40 per share, or an aggregate of approximately $141.9 million including certain costs. The acquisition has been accounted for as a purchase by the Company of the net assets of Amoskeag held for sale at their net realizable values and as the purchase of treasury stock. Amoskeag owned 3,606,400 shares of the registrant's common stock which has been assigned a cost of $117.2 million after a preliminary allocation of $24.7 million to the net assets of Amoskeag. The registrant is in the process of selling all of the operating assets of Amoskeag, and the valuation includes anticipated costs during a one year disposal period. These assets are primarily the Bangor and Aroostook Railroad and certain real estate properties.\nThe registrant and its consolidated subsidiaries design, manufacture and market a broad range of household textile products consisting of towels, sheets, blankets, comforters and bath rugs. The registrant is vertically integrated in that it buys the basic raw materials consisting principally of cotton and synthetic fibers and manufactures a finished consumer product. These products are marketed primarily by the Company's own sales and marketing staff and distributed nationally to customers for ultimate retail sale. Customers consist principally of department stores, chain stores, mass merchants, specialty home furnishing stores, catalog warehouse clubs and other retail outlets, and institutional, government and contract accounts.\nIn 1993 nearly all of the registrant's total sales were comprised of home furnishings products. Approximately 90% of the Company's 1993 net sales were from sales of products carrying the registrant's principal brand names of \"Fieldcrest,\" \"Royal Velvet,\" \"Charisma,\" \"St. Marys,\" \"Cannon,\" \"Monticello,\" and \"Royal Family,\"; the remaining 10% were from sales of private label products.\nRaw Materials\nThe registrant's basic raw materials are cotton and synthetic fibers. These materials are generally available from a wide variety of sources, and no significant shortage of such materials is currently anticipated. The registrant uses significant quantities of cotton which is subject to ongoing price fluctuations. The registrant in the ordinary course of business may arrange for purchase commitments with vendors for future cotton requirements.\nPatents and Licenses\nThe registrant holds various patents and licenses resulting from company-sponsored research and development, and others are obtained that are deemed advantageous to company operations. The registrant is only partially dependent upon such patents and licenses in certain product lines, and the loss of any exclusiveness in these areas would not materially adversely affect overall profitability.\nSeasonality in the Company's Business\nPrimarily because the Company's retail customers have higher sales in the second half of the calendar year, the Company also experiences greater sales volume in the last three quarters of the calendar year. It is likely that the Company's operating performance in the first quarter of a given calendar year will be less favorable than operating performance in the last three quarters.\nThe registrant carries normal inventory levels to meet delivery requirements of customers, and customer returns of merchandise shipped are not material. Payment terms on customer invoices are generally 30 to 60 days.\nCustomers\nThe registrant's customers consist principally of department stores, chain stores, specialty stores, mass merchants, warehouse clubs, other retail outlets and institutional, government and contract accounts. For the year ended December 31, 1993, the Company's five largest customers accounted for approximately 35% of net sales. Sales to one customer (Wal-Mart Stores and its affiliates) represented 17.4% of total sales of the Company. Although management of the Company believes that the Company's relationship with Wal-Mart is excellent and the loss of this customer is unlikely, the loss of Wal-Mart as a customer would have a material adverse effect on the Company's business. No other single customer accounted for more than 10% of net sales in 1993.\nOrder Backlog\nThe registrant had normal unfilled order backlogs as of December 31, 1993 and 1992 amounting to approximately $87 million and $73 million, respectively. The majority of these unfilled orders are shipped during the first quarter of the subsequent fiscal year.\nThe increase in unfilled orders in 1993 compared to 1992 is believed to be primarily due to the timing of new orders. Unfilled orders have become less of an indicator of future sales as customers have trended toward placing orders as stock is required. Many orders are placed using electronic data interchange, and the Company has filled such orders on a quick response basis.\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 Government.\nCompetition\nThe home furnishing textile industry continues to be highly competitive. Among the registrant's competitors are a number of domestic and foreign companies with significant financial resources, experience, manufacturing capabilities and brand name identity.\nThe registrant competes with numerous other domestic manufacturers in each of its principal markets. The domestic towel, sheet, blanket and bath rug markets are each comprised of three to five principal manufacturers (including the registrant) and several smaller domestic manufacturers.\nThe registrant's principal methods of competition are price, design, service and product quality. The Company believes that large, low-cost producers with established brand names, efficient distribution networks and good customer service will profit in this competitive environment. The Company's ability to operate profitably in this environment will depend substantially on continued market acceptance of the Company's products and the Company's efforts to control costs and produce new and innovative products in response to competitive pressures and changes in consumer demand.\nEnvironmental Controls The registrant does not anticipate that compliance with federal, state and local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will have a material effect upon the capital expenditures, earnings and competitive position of the registrant and its subsidiaries.\nEmployees\nTotal employment of the Company and its subsidiaries was 14,090 as of December 31, 1993. Approximately 29% of the Company's hourly employees are subject to collective bargaining agreements with the Amalgamated Clothing and Textile Workers Union or the United Textile Workers of America.\nForeign Sales\nThe registrant is not currently engaged in significant operations in foreign countries. Approximately 5% of the registrant's consolidated net sales were exported to foreign customers in 1993 compared to 6% in 1992.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nThe registrant has 18 principal manufacturing plants, all located in the United States; 13 are in North Carolina, 1 in South Carolina, 1 in Georgia, 2 in Alabama and 1 in Virginia. In addition, there are 18 warehousing and distribution centers located in the manufacturing states, plus Texas and California. The manufacturing\/warehousing and distribution centers aggregate a floor area of approximately 16,659,000 square feet. All of the facilities are owned except: (1) 2 locations totaling approximately 618,000 square feet, which are financed with Industrial Revenue Bonds; the properties are accounted for as \"owned\" but Development Authority holds title to property which will pass to the registrant upon retirement of Bonds; and (2) 1 location, totaling approximately 124,000 square feet, where the machinery and equipment is owned and the building is under a long-term lease.\nThe registrant owns corporate administrative buildings in Eden, North Carolina, which contain approximately 96,000 square feet. The Company also owns one vacant office building in Eden which contains approximately 48,000 square feet and is currently for sale. The principal marketing headquarters for the bed and bath division and certain executive offices (totaling approximately 64,000 square feet) are located in New York City under long-term leases.\nAll other properties owned or controlled by the registrant aggregate approximately 537,000 square feet and are used for miscellaneous support services or for sales and marketing.\nPlants and equipment of the registrant are considered to be in excellent condition; substantial capital expenditures for new plants, modernization and improvements have been made in recent years. The plants generally operate on either a three shift basis for a five-day week or a four shift basis for a seven-day week during 50 weeks a year except during periods of curtailment. In the opinion of the registrant, all plants and properties are adequately covered by insurance.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe registrant is involved in various claims and lawsuits incidental to its business. In the opinion of the registrant based in part on the advice of legal counsel, however, the outcome of these suits will not have a material effect on the registrant's financial position.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders (a). The Company solicitated written consents of stockholders in lieu of a special meeting on November 4, 1993.\n(b). Not applicable.\n(c). Holders of Common Stock (one vote per share) and Class B Common Stock (ten votes per share) voted through written consent on the following matters, each as described in detail in the Registrant's consent statement dated November 4, 1993.\nI. Amend the Registrant's Certificate of Incorporation to authorize 10,000,000 shares of undesignated preferred stock:\nVotes (thousands)\nCommon Stock Class B Common Stock\nFor 1,313 36,116\nAgainst 1,436 12\nAbstain 18 1\nII. Authorize the issuance of up to 1,800,000 shares of preferred stock of the Registrant:\nVotes (thousands)\nCommon Stock Class B Common Stock\nFor 2,018 36,116\nAgainst 732 12\nAbstain 18 1\nIdentification of Executive Officers of the Registrant\nNone of the executive officers are related by blood, marriage or adoption to any other executive officer of the registrant or any director or executive officer of a parent, subsidiary, or affiliate of the registrant. With the exception of Mr. Fitzgibbons each executive officer has been employed by the registrant for more than five years. Prior to becoming Chief Executive Officer and Chairman of the Board of Directors of the registrant on October 15, 1990, Mr. Fitzgibbons was President of Amoskeag Company and was previously an executive officer of Amoskeag Company for more than five years.\nPART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters\nIncorporated by reference from the market and dividend data section of the 1993 Annual Report to Shareowners, page 14.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected financial and statistical data for the years 1989 to 1993 appearing under the captions \"Net sales\", \"Income (loss) from continuing operations\", \"Per share of common stock\", \"Total assets\" and \"Long-term obligations\" are incorporated by reference from the 1993 Annual Report to Shareowners, page 32.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nIncorporated by reference from the 1993 Annual Report to Shareowners, pages 11 through 14.\nItem 8.","section_7A":"","section_8":"Item 8. Consolidated Financial Statements and Supplementary Data\nConsolidated financial statements and supplementary data of the registrant are incorporated by reference from the 1993 Annual Report to Shareowners, pages 15 through 31.\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, Executive Officers, Promoters and Control Persons of the Registrant\nInformation regarding the Directors is incorporated herein by reference from the registrant's proxy statement for the annual meeting of shareowners to be held on May 16, 1994, pages 2 and 3.\nFor information regarding the Executive Officers of the registrant, see Part I at page 7.\nItem 11.","section_11":"Item 11. Executive Compensation\nIncorporated herein by reference from sections of the registrant's proxy statement for the annual meeting of shareowners to be held on May 16, 1994 entitled Compensation of Directors at page 7 and Executive Compensation, pages 7 through 10.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nIncorporated herein by reference from the Security Ownership section of the registrant's proxy statement for the annual meeting of shareowners to be held on May 16, 1994, pages 4 through 6.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nIncorporated herein by reference from the registrant's proxy statement for the annual meeting of shareowners to be held May 16, 1994, pages 7 and 8, Executive Compensation.\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 listed in the accompanying index to financial statements are filed as part of this annual report.\n3. Exhibits\nThe exhibits listed as applicable on the accompanying Exhibit Index at page 17 are filed as part of this annual report. Exhibit numbers (10)1. through (10)12. represent management contracts or compensatory plans or arrangements required to be filed as an exhibit by Item 601 of Regulation S-K.\n(b) Reports on Form 8-K\nNone.\nFIELDCREST CANNON, INC.\nAND FINANCIAL STATEMENT SCHEDULES\n(Item 14(a) 1 & 2)\nPage Numbers of the Annual report to Shareowners\nConsolidated statement of financial position at 18 December 31, 1993 and 1992\nConsolidated statement of income and retained earnings 17 for each of the three years in the period ended December 31, 1993\nConsolidated statement of cash flows for each of the 19 three years in the period ended December 31, 1993\nNotes to consolidated financial statements 20-30\nReport of independent auditors 31\nPage Numbers to this Form 10-K\nSchedules for each of the three years in the period ended December 31, 1993:\nV - Consolidated plant and equipment 11\nVI - Consolidated accumulated depreciation of 12 plant and equipment\nIX - Short-term borrowings 13\nX - Supplementary income statement information 14\nAll other schedules are omitted because the required information is not applicable 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 consolidated financial statements listed in the above index which are included in the Annual Report to Shareowners of Fieldcrest Cannon, Inc. for the year ended December 31, 1993 are hereby incorporated by reference. With exception of the pages listed in the above index and the Items referred to in Part II, Items 5, 6, 7 and 8, the 1993 Annual Report to Shareowners is not to be deemed filed as part of this report.\nFIELDCREST CANNON, INC.\nSCHEDULE V - CONSOLIDATED PLANT AND EQUIPMENT (In Thousands)\n(1) In 1993 the Company sold its carpet and rug operations.\nDepreciation is provided on a straight-line basis on estimated useful lives; buildings - 15 to 33 years; equipment - 5 to 15 years.\nFIELDCREST CANNON, INC.\nSCHEDULE VI - CONSOLIDATED ACCUMULATED DEPRECIATION OF PLANT AND EQUIPMENT\n(In Thousands)\n(1) In 1993 the Company sold its carpet and rug operations.\nFIELDCREST CANNON, INC.\nSCHEDULE IX - SHORT-TERM BORROWINGS\nYEARS ENDED DECEMBER 31, 1993, 1992 AND 1991 (In Thousands)\n(1) Notes payable represent seasonal borrowing requirements during the year under the Company's revolving credit facility and during 1993 and 1992 bank borrowings to finance the purchase of raw cotton and wool. The revolving credit facility is also utilized for long-term financing. Effective May 6, 1992, the Company obtained a new revolving credit facility which allowed the Company to borrow up to $235 million through January 3, 1996. The Company elected to reduce the facility to $150 million from $235 million in November 1993 because of reduced borrowing requirements. The new facility replaced a $235 million bank term debt agreement that would have matured December 31, 1992. Accordingly, borrowings under the revolving credit facility were classified as long- term debt in 1993 and 1992 and as short-term debt in 1991. Interest rates on the revolving term debt were, at the Company's option, at the prime rate fixed by The First National Bank of Boston plus 1%, or at a Euromarket-based rate plus 2.5%. The average interest rate on the revolving term debt was 6.3% on December 31, 1993.\n(2) The average amount outstanding during the period was computed by averaging the month-end balances during the year. The weighted average interest rate was computed by dividing the interest expense by the average daily amount outstanding.\nFIELDCREST CANNON, INC.\nSCHEDULE X - SUPPLEMENTARY INCOME STATEMENT INFORMATION YEARS ENDED DECEMBER 31, 1993, 1992 and 1991\n(In Thousands)\nCharged to Costs and Expenses\n1993 1992 1991\nAdvertising Costs $16,547 $17,652 $17,625\nMaintenance and repairs $20,892 $19,555 $16,890\nDepreciation and amortization of intangible assets, preoperating costs and similar deferrals (1) (1) (1)\nTaxes, other than payroll and income taxes (1) (1) (1)\nRoyalties (1) (1) (1)\n(1) Less than 1% of total sales\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.\nFIELDCREST CANNON, INC.\nMarch 2, 1994 By: Charles G. Horn, President and Chief Operating Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report signed below by the following persons on behalf of the registrant and in the capacities on the dates indicated.\nMarch 2, 1994 James M. Fitzgibbons Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer)\nMarch 2, 1994 Charles G. Horn, President and Chief Operating Officer and Director\nMarch 2, 1994 M. Kenneth Doss Vice President and Secretary\nMarch 2, 1994 Thomas R. Staab Vice President and Chief Financial Officer (Principal Financial Officer)\nMarch 2, 1994 Clifford D. Paulsen Controller (Principal Accounting Officer)\nMarch 2, 1994 Tom H. Barrett Director\nMarch 2, 1994 C. R. Charbonnier Director\nMarch 2, 1994 William E. Ford Director\nMarch 2, 1994 John C. Harned Director\nMarch 2, 1994 S. Roger Horchow Director\nMarch 2, 1994 W. Duke Kimbrell Director\nMarch 2, 1994 C. J. Kjorlien Director\nEXHIBIT INDEX TO\nANNUAL REPORT ON FORM 10-K FOR FIELDCREST CANNON, INC.\nFOR THE YEAR 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.\nFIELDCREST CANNON, INC.\nMarch 3, 1993 By: \/s\/ Charles G. Horn Charles G. Horn, President and Chief Operating Officer\nPursuant to the requirements of the Securities Exchange Act of 1934, this report signed below by the following persons on behalf of the registrant and in the capacities on the dates indicated.\n\/s\/ James M. Fitzgibbons March 2, 1994 James M. Fitzgibbons Chairman of the Board of Directors and Chief Executive Officer (Principal Executive Officer)\n\/s\/ Charles G. Horn March 2, 1994 Charles G. Horn, President and Chief Operating Officer and Director\n\/s\/ M. Kenneth Doss March 2, 1994 M. Kenneth Doss Vice President and Secretary\n\/s\/ Thomas R. Staab March 2, 1994 Thomas R. Staab Vice President and Chief Financial Officer (Principal Financial Officer)\n\/s\/ Clifford D. Paulsen March 2, 1994 Clifford D. Paulsen Controller (Principal Accounting Officer)\n\/s\/ Tom H. Barrett March 2, 1994 Tom H. Barrett Director\n\/s\/ C. R. Charbonnier March 2, 1994 C. R. Charbonnier Director\n\/s\/ William E. Ford March 2, 1994 William E. Ford Director\n\/s\/ John C. Harned March 2, 1994 John C. Harned Director\n\/s\/ S. Roger Horchow March 2, 1994 S. Roger Horchow Director\n\/s\/ W. Duke Kimbrell March 2, 1994 W. Duke Kimbrell Director\n\/s\/ C. J. Kjorlien March 2, 1994 C. J. Kjorlien Director","section_15":""}
{"filename":"796838_1994.txt","cik":"796838","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nThe Pacific Lumber Company and its subsidiaries (collectively referred to herein as the \"Company\" or \"Pacific Lumber,\" unless the context indicates otherwise) engage in all principal aspects of the lumber industry--the growing and harvesting of redwood and Douglas-fir timber, the milling of logs into lumber products and the manufacturing of lumber into a variety of value-added finished products. The Company has been in continuous operation for over 125 years.\nThe Company is an indirect wholly owned subsidiary of MAXXAM Group Inc. (\"MGI\"). MGI is a wholly owned subsidiary of MAXXAM Inc. (\"MAXXAM\").\nTIMBERLANDS\nThe Company owns and manages approximately 189,000 acres of commercial timberlands in Humboldt County in northern California. These timberlands contain approximately three-quarters redwood and one-quarter Douglas-fir timber. The Company's acreage is virtually contiguous, is located in close proximity to its sawmills and contains an extensive (1,100 mile) network of roads. These factors significantly reduce harvesting costs and facilitate the Company's forest management techniques. The extensive roads throughout the Company's timberlands facilitate log hauling, serve as fire breaks and allow the Company's foresters access to employ forest stewardship techniques which protect the trees from forest fires, erosion, insects and other damage.\nApproximately 179,000 acres of the Company's timberlands are owned by Scotia Pacific Holding Company (the \"SPHC Timberlands\"), a special purpose Delaware corporation and wholly owned subsidiary of Pacific Lumber (\"SPHC\"). Pacific Lumber has the exclusive right to harvest (the \"Pacific Lumber Harvest Rights\") approximately 8,000 non-contiguous acres of the SPHC Timberlands consisting substantially of virgin old growth redwood and virgin old growth Douglas-fir timber located on numerous small parcels throughout the SPHC Timberlands. Substantially all of SPHC's assets, including the SPHC Timberlands and the GIS (defined below), are pledged as security for SPHC's 7.95% Timber Collateralized Notes due 2015 (the \"Timber Notes\"). Pacific Lumber harvests and purchases from SPHC all or substantially all of the logs harvested from the SPHC Timberlands. See \"-- Relationships With SPHC and Britt Lumber\" for a description of this and other relationships among Pacific Lumber, SPHC and Britt Lumber Co., Inc. (\"Britt\"), an affiliate of the Company.\nThe forest products industry grades lumber in various classifications according to quality. The two broad categories within which all grades fall, based on the absence or presence of knots, are called \"upper\" and \"common\" grades, respectively. \"Old growth\" trees, often defined as trees which have been growing for approximately 200 years or longer, have a higher percentage of upper grade lumber than \"young growth\" trees (those which have been growing for less than 200 years). \"Virgin\" old growth trees are located in timber stands that have not previously been harvested. \"Residual\" old growth trees are located in timber stands which have been selectively harvested in the past.\nThe Company has engaged in extensive efforts, at relatively low cost, to supplement the natural regeneration of timber and increase the amount of timber on its timberlands. Regeneration of redwood timber generally is accomplished through the natural growth of new redwood sprouts from the stump remaining after a redwood tree is harvested. Such new redwood sprouts grow quickly, thriving on existing mature root systems. In addition, the Company supplements natural redwood regeneration by planting redwood seedlings. Douglas-fir timber grown on the Company's timberlands is regenerated almost entirely by planting seedlings. During the\n1993-94 planting season (December through March), the Company planted approximately 554,000 redwood and Douglas-fir seedlings.\nHARVESTING PRACTICES\nThe ability of the Company to sell logs or lumber products will depend, in part, upon its ability to obtain regulatory approval of timber harvesting plans (\"THPs\"). THPs are required to be filed with the California Department of Forestry (\"CDF\") prior to the harvesting of timber and are designed to comply with existing environmental laws and regulations. The CDF's evaluation of proposed THPs incorporates review and analysis of such THPs by several California and federal agencies and public comments received with respect to such THPs. An approved THP is applicable to specific acreage and specifies the harvesting method and other conditions relating to the harvesting of the timber covered by such THP. The method of harvesting as set forth in a THP is chosen from among a number of accepted methods based upon suitability to the particular site conditions. The Company maintains a detailed geographical information system covering its timberlands (the \"GIS\"). The GIS covers numerous aspects of the Company's properties, including timber type, tree class, wildlife data, roads, rivers and streams. By carefully monitoring and updating this data base, the Company's foresters are able to develop detailed THPs which are required to be filed with and approved by the CDF prior to the harvesting of timber. The Company also utilizes a Global Positioning System (\"GPS\") which allows precise location of geographic features through satellite positioning. Use of the GPS greatly enhances the quality and efficiency of GIS data.\nThe Company principally harvests trees through selective harvesting, which harvests only a portion of the trees in a given area, as opposed to clearcutting, which harvests an entire area of trees in one logging operation. Selective harvesting generally accounts for over 90% (by volume on a net board foot basis) of the Company's timber harvest in any given year. Harvesting by clearcutting is used only when selective harvesting methods are impractical due to unique conditions. Selective harvesting allows the remaining trees to obtain more light, nutrients and water thereby promoting faster growth rates. Due to the size of its timberlands and conservative harvesting practices, the Company has historically conducted harvesting operations on approximately 5% of its timberlands in any given year.\nSee also Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends.\"\nPRODUCTION FACILITIES\nThe Company owns four highly mechanized sawmills and related facilities located in Scotia, Fortuna and Carlotta, California. The sawmills historically have been supplied almost entirely from timber harvested from the Company's timberlands. Since 1986, the Company has implemented numerous technological advances which have increased the operating efficiency of its production facilities and the recovery of finished products from its timber. Over the past three years, the Company's annual lumber production has averaged approximately 259 million board feet, with approximately 286, 228 and 264 million board feet produced in 1994, 1993 and 1992, respectively. The Company operates a finishing plant which processes rough lumber into a variety of finished products such as trim, fascia, siding and paneling. These finished products include the industry's largest variety of customized trim and fascia patterns. The Company also enhances the value of some grades of common grade lumber by cutting out knot-free pieces and reassembling them into longer or wider pieces in the Company's state-of-the-art end and edge glue plant. The result is a standard sized upper grade product which can be sold at a significant premium over common grade products.\nThe Company dries the majority of its upper grade lumber before it is sold. Upper grades of redwood lumber are generally air-dried for six to eighteen months and then kiln-dried for seven to twenty-four days to produce a dimensionally stable and high quality product which generally commands higher prices than \"green\" lumber (which is lumber sold before it has been dried). Upper grade Douglas-fir lumber is generally kiln-dried immediately after it is cut. The Company owns and operates 34 kilns, having an annual capacity of approximately 95 million board feet, to dry its upper grades of lumber efficiently in order to produce a quality, premium product. The Company also maintains several large enclosed storage sheds which hold approximately 25 million board feet of lumber.\nIn addition, the Company owns and operates a modern 25-megawatt cogeneration power plant which is fueled almost entirely by the wood residue from the Company's milling and finishing operations. This power plant generates substantially all of the energy requirements of Scotia, California, the town adjacent to the Company's timberlands owned by the Company where several of its manufacturing facilities are located. The Company sells surplus power to Pacific Gas and Electric Company. In 1994, the sale of surplus power to Pacific Gas and Electric Company accounted for approximately 2% of the Company's total revenues.\nPRODUCTS\nLumber The Company primarily produces and markets lumber. In 1994, the Company sold approximately 272 million board feet of lumber, which accounted for approximately 82% of the Company's total revenues. Lumber products vary greatly by the species and quality of the timber from which it is produced. Lumber is sold not only by grade (such as \"upper\" grade versus \"common\" grade), but also by board size and the drying process associated with the lumber.\nRedwood lumber is the Company's largest product category, constituting approximately 77% of the Company's total lumber revenues and 63% of the Company's total revenues in 1994. Redwood is commercially grown only along the northern coast of California and possesses certain unique characteristics which permit it to be sold at a premium to many other wood products. Such characteristics include its natural beauty, superior ability to retain paint and other finishes, dimensional stability and innate resistance to decay, insects and chemicals. Typical applications include exterior siding, trim and fascia for both residential and commercial construction, outdoor furniture, decks, planters, retaining walls and other specialty applications. Redwood also has a variety of industrial applications because of its chemical resistance and because it does not impart any taste or odor to liquids or solids.\nUpper grade redwood lumber, which is derived primarily from old growth trees and is characterized by an absence of knots and other defects and a very fine grain, is used primarily in more costly and distinctive interior and exterior applications. During 1994, upper grade redwood lumber products accounted for approximately 17% of the Company's total lumber production volume (on a net board foot basis), 41% of its total lumber revenues and 33% of its total revenues.\nCommon grade redwood lumber, the Company's largest volume product, has many of the same aesthetic and structural qualities of redwood uppers, but has some knots, sapwood and a coarser grain. Such lumber is commonly used for construction purposes, including outdoor structures such as decks, hot tubs and fencing. In 1994, common grade redwood lumber accounted for approximately 58% of the Company's total lumber production volume (on a net board foot basis), 36% of its total lumber revenues and 29% of its total revenues.\nDouglas-fir lumber is used primarily for new construction and some decorative purposes and is widely recognized for its strength, hard surface and attractive appearance. Douglas-fir is grown commercially along the west coast of North America and in Chile and New Zealand. Upper grade Douglas-fir lumber is derived primarily from old growth Douglas-fir timber and is used principally in finished carpentry applications. In 1994, upper grade Douglas-fir lumber accounted for approximately 3% of the Company's total lumber production volume (on a net board foot basis), 7% of its total lumber revenues and 5% of its total revenues. Common grade Douglas-fir lumber is used for a variety of general construction purposes and is largely interchangeable with common grades of other whitewood lumber. In 1994, common grade Douglas-fir lumber accounted for approximately 20% of the Company's total lumber production volume, 13% of its total lumber revenues and 10% of its total revenues.\nLogs The Company currently sells certain logs that, due to their size or quality, cannot be efficiently processed by its mills into lumber. The purchasers of these logs are largely Britt, an affiliate of the Company, and surrounding mills which do not own sufficient timberlands to support their mill operations. In 1994, log sales accounted for approximately 9% of the Company's total revenues. See \"--Relationships With SPHC and Britt Lumber\" below. Except for the agreement with Britt described below, the Company does not have any significant contractual relationships with any third parties relating to the purchase of logs. The Company has historically not purchased significant quantities of logs from third parties; however, the Company may from time to time purchase logs from third parties for processing in its mills or for resale to third parties if, in the opinion of management, economic factors are advantageous to the Company. See also Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Results of Operations-- Operating Income\" for a description of 1993 log purchases by the Company due to inclement weather conditions.\nWood Chips In 1990, the Company installed a whole-log chipper to produce wood chips from hardwood trees which were previously left as waste. These chips primarily are sold to third parties for the production of facsimile and other specialty papers. In 1994, hardwood chips accounted for approximately 4% of the Company's total revenues. The Company also produces softwood chips from the wood residue and waste from its milling and finishing operations. These chips are sold to third parties for the production of wood pulp and paper products. In 1994, softwood chips accounted for approximately 4% of the Company's total revenues.\nBACKLOG AND SEASONALITY\nThe Company's backlog of sales orders at December 31, 1994 and 1993 was approximately $11.9 million and $16.0 million, respectively, the substantial portion of which was delivered in the first quarter of the succeeding fiscal year. The Company has historically experienced lower first and fourth quarter sales due largely to the general decline in construction-related activity during the winter months. As a result, the Company's results in any one quarter are not necessarily indicative of results to be expected for the full year.\nMARKETING\nThe housing, construction and remodeling markets are the primary markets for the Company's lumber products. The Company's policy is to maintain a wide distribution of its products both geographically and in terms of the number of customers. The Company sells its lumber products throughout the country to a variety of accounts, the large majority of which are wholesalers, followed by retailers, industrial users, exporters and manufacturers. Upper grades of redwood and Douglas-fir lumber are sold throughout the entire United States, as well as to export markets. Common grades of redwood lumber are sold principally west of the Mississippi\nRiver, with California accounting for approximately 55% of these sales in 1994. Common grades of Douglas-fir lumber are sold primarily in California. In 1994, no single customer accounted for more than 4% of the Company's total revenues. Exports of lumber accounted for approximately 4% of the Company's total lumber revenues in 1994. The Company markets its products through its own sales staff which focuses primarily on domestic sales.\nThe Company actively follows trends in the housing, construction and remodeling markets in order to maintain an appropriate level of inventory and assortment of product. Due to its high quality products, large inventory, competitive prices and long history, the Company believes that it has a strong degree of customer loyalty.\nCOMPETITION\nThe Company's lumber is sold in highly competitive markets. Competition is generally based upon a combination of price, service and product quality. The Company's products compete not only with other wood products but with metals, masonry, plastic and other construction materials made from non-renewable resources. The level of demand for the Company's products is dependent on such broad factors as overall economic conditions, interest rates and demographic trends. In addition, competitive considerations, such as total industry production and competitors' pricing, as well as the price of other construction products, affect the sales prices for the Company's lumber products. The Company currently enjoys a competitive advantage in the upper grade redwood lumber market due to the quality of its timber holdings and relatively low cost production operations. Competition in the common grade redwood and Douglas-fir lumber market is more intense, and the Company competes with numerous large and small lumber producers.\nEMPLOYEES\nAs of March 1, 1995, the Company had approximately 1,520 employees.\nRELATIONSHIPS WITH SPHC AND BRITT LUMBER\nIn March 1993, Pacific Lumber consummated its offering of $235 million of 10-1\/2% Senior Notes due 2003 (the \"Senior Notes\") and SPHC consummated its offering of $385 million of Timber Notes. Upon the closing of such offerings, Pacific Lumber, SPHC and Britt entered into a variety of agreements. Pacific Lumber and SPHC entered into a Services Agreement (the \"Services Agreement\") and an Additional Services Agreement (the \"Additional Services Agreement\"). Pursuant to the Services Agreement, Pacific Lumber provides operational, management and related services with respect to the SPHC Timberlands containing timber of SPHC (\"SPHC Timber\") not performed by SPHC's own employees. Such services include the furnishing of all equipment, personnel and expertise not within SPHC's possession and reasonably necessary for the operation and maintenance of the SPHC Timberlands containing SPHC Timber. In particular, Pacific Lumber is required to regenerate SPHC Timber, prevent and control loss of SPHC Timber by fires, maintain a system of roads throughout the SPHC Timberlands, take measures to control the spread of disease and insect infestation affecting SPHC Timber and comply with environmental laws and regulations, including measures with respect to waterways, habitat, hatcheries and endangered species. Pacific Lumber is also required (to the extent necessary) to assist SPHC personnel in updating the GIS and to prepare and file, on SPHC's behalf, all pleadings and motions and otherwise diligently pursue appeals of any denial of any THP and related matters. As compensation for these and the other services to be provided by the Company, SPHC pays a fee which is adjusted on January 1 of each year based on a specified government index relating to wood products. The fee was $114,000 per month in 1994 and is expected to be approximately $115,000 per month in 1995. Pursuant to the Additional\nServices Agreement, SPHC provides Pacific Lumber with a variety of services, including (a) assisting Pacific Lumber to operate, maintain and harvest its own timber properties, (b) updating and providing access to the GIS with respect to information concerning the Pacific Lumber's own timber properties, and (c) assisting Pacific Lumber with its statutory and regulatory compliance. Pacific Lumber pays SPHC a fee for such services equal to the actual cost of providing such services, as determined in accordance with generally accepted accounting principles.\nPacific Lumber and SPHC also entered into a Master Purchase Agreement (the \"Master Purchase Agreement\"). The Master Purchase Agreement governs all purchases of logs by Pacific Lumber from SPHC. Each purchase of logs by Pacific Lumber from SPHC is made pursuant to a separate log purchase agreement (which incorporates the terms of the Master Purchase Agreement) for the SPHC Timber covered by an approved THP. Each log purchase agreement generally constitutes an exclusive agreement with respect to the timber covered thereby, subject to certain limited exceptions. The purchase price must be at least equal to the SBE Price (as defined below). The Master Purchase Agreement provides that if the purchase price equals or exceeds (i) the price for such species and category thereof set forth on the structuring schedule applicable to the Timber Notes and (ii) the SBE Price, then such price shall be deemed to be the fair market value of such logs. The Master Purchase Agreement defines the \"SBE Price,\" for any species and category of timber, as the stumpage price for such species and category as set forth in the most recent \"Harvest Value Schedule\" published by the California State Board of Equalization (\"SBE\") applicable to the timber sold during the period covered by such Harvest Value Schedule. Such Harvest Value Schedules are published for purposes of computing yield taxes and generally are released every six months. As the Company purchases logs from SPHC pursuant to the Master Purchase Agreement, Pacific Lumber is responsible, at its own expense, for harvesting and removing the standing SPHC Timber covered by approved THPs and, thus, the purchase price thereof is based upon \"stumpage prices.\" Title to the harvested logs does not pass to Pacific Lumber until the logs are transported to Pacific Lumber's log decks and measured. Substantially all of SPHC's revenues are derived from the sale of logs to Pacific Lumber under the Master Purchase Agreement.\nPacific Lumber, SPHC and Salmon Creek Corporation (\"Salmon Creek,\" a wholly owned subsidiary of Pacific Lumber) also entered into a Reciprocal Rights Agreement granting to each other certain reciprocal rights of egress and ingress through their respective properties in connection with the operation and maintenance of such properties and their respective businesses. In addition, Pacific Lumber entered into an Environmental Indemnification Agreement with SPHC pursuant to which Pacific Lumber agreed to indemnify SPHC from and against certain present and future liabilities arising with respect to hazardous materials, hazardous materials contamination or disposal sites, or under environmental laws with respect to the SPHC Timberlands.\nPacific Lumber entered into an agreement with Britt (the \"Britt Agreement\") which governs the sale of logs by Pacific Lumber and Britt to each other, the sale of hog fuel (wood residue) by Britt to Pacific Lumber for use in Pacific Lumber's cogeneration plant, the sale of lumber by Pacific Lumber and Britt to each other, and the provision by Pacific Lumber of certain administrative services to Britt (including accounting, purchasing, data processing, safety and human resources services). The logs which Pacific Lumber sells to Britt and which are used in Britt's manufacturing operations are sold at approximately 75% of applicable SBE prices (to reflect the lower quality of these logs). Logs which either Pacific Lumber or Britt purchases from third parties and which are then sold to each other are transferred at the actual cost of such logs. Hog fuel is sold at applicable market prices, and administrative services are provided by Pacific Lumber based on Pacific Lumber's actual costs and an allocable share of Pacific Lumber's overhead expenses consistent with past practice.\nREGULATORY AND ENVIRONMENTAL FACTORS\nRegulatory and environmental issues play a significant role in the Company's forest products operations. The Company's forest products operations are subject to a variety of California, and in some cases, federal laws and regulations dealing with timber harvesting, endangered species, and air and water quality. These laws include the California Forest Practice Act (the \"Forest Practice Act\"), which requires that timber harvesting operations be conducted in accordance with detailed requirements set forth in the Forest Practice Act and in the regulations promulgated thereunder by the California Board of Forestry (the \"BOF\"). The federal Endangered Species Act (the \"ESA\") and California Endangered Species Act (the \"CESA\") provide in general for the protection and conservation of specifically listed fish, wildlife and plants which have been declared to be endangered or threatened. The California Environmental Quality Act (\"CEQA\") provides, in general, for protection of the environment of the state, including protection of air and water quality and of fish and wildlife. In addition, the California Water Quality Act requires, in part, that the Company's operations be conducted so as to reasonably protect the water quality of nearby rivers and streams. The regulations under certain of these laws are periodically modified. For instance, in March and May 1994, the BOF approved additional rules providing for among other things, inclusion of additional information in THPs (concerning, among other things, timber generation systems, the presence or absence of fish, wildlife and plant systems, potentially impacted watersheds and compliance with long term sustained yield objectives) and modification of certain timber harvesting practices (including the creation of buffer zones between harvest areas and increases in the amount of timber required to be retained in a harvest area). See also Item 7. \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Trends\" for a description of the sustained yield regulations. The Company does not expect that compliance with such existing laws and regulations will have a material adverse effect on its timber harvesting practices or future operating results. There can be no assurance, however, that future legislation, governmental regulations or judicial or administrative decisions would not adversely affect the Company.\nVarious groups and individuals have filed objections with the CDF regarding the CDF's actions and rulings with respect to certain of the Company's THPs, and the Company expects that such groups and individuals will continue to file objections to certain of the Company's THPs. In addition, lawsuits are pending which seek to prevent the Company from implementing certain of its approved THPs. These challenges have severely restricted the Company's ability to harvest virgin old growth timber on its property during the past few years. To date, litigation with respect to the Company's THPs relating to young growth and residual old growth timber has been limited; however, no assurance can be given as to the extent of such litigation in the future. See Item 3. \"Legal Proceedings--Timber Harvesting Litigation.\"\nIn June 1990, the U.S. Fish and Wildlife Service (the \"USFWS\") designated the northern spotted owl as threatened under the ESA. The owl's range includes all of the Company's timberlands. The ESA and its implementing regulations (and related California regulations) generally prohibit harvesting operations in which individual owls might be killed, displaced or injured or which result in significant habitat modification that could impair the survival of individual owls or the species as a whole. Since 1988, biologists have conducted inventory and habitat utilization studies of northern spotted owls on the Company's timberlands. The Company has developed and the USFWS has given its full concurrence to a comprehensive wildlife management plan for the northern spotted owl (the \"Owl Plan\"). By incorporating the Owl Plan into each THP filed with the CDF the Company is able to expedite the approval process with respect to its THPs. Both federal and state agencies continue to review and consider possible additional regulations regarding the northern spotted owl. It is uncertain if such additional regulations will become effective or their ultimate content.\nIn March 1992, the marbled murrelet was approved for listing as endangered under the CESA. The Company has incorporated, and will continue to incorporate as required, additional mitigation measures into its THPs to protect and maintain habitat for marbled murrelets on its timberlands. The California Department of Fish and Game (the \"CDFG\") requires the Company to conduct pre-harvest marbled murrelet surveys and to provide certain other site specific mitigations in connection with its THPs covering virgin old growth timber and unusually dense stands of residual old growth timber. Such surveys can only be conducted during April to July, the murrelets' nesting and breeding season. Accordingly, such surveys are expected to delay the review and approval process with respect to certain of the THPs filed by the Company. The results of such surveys could prevent the Company from conducting certain of its harvesting operations. In October 1992, the USFWS issued its final rule listing the marbled murrelet as a threatened species under the ESA in the tri-state area of Washington, Oregon and California. In January 1994, the USFWS proposed designation of critical habitat for the marbled murrelet under the ESA. This proposal is subject to public comment, hearings and possible future modification. Both federal and state agencies continue to review and consider possible additional regulations regarding the marbled murrelet. It is uncertain if such additional regulations will become effective or their ultimate content.\nThe Company's wildlife biologist is conducting research concerning the marbled murrelet on Pacific Lumber's timberlands and is currently developing a comprehensive management plan for the marbled murrelet (the \"Murrelet Plan\") similar to the Owl Plan. The Company is continuing to work with the USFWS and the other government agencies on the Murrelet Plan. It is uncertain when the Murrelet Plan will be completed.\nLaws and regulations dealing with the Company's operations are subject to change and new laws and regulations are frequently introduced concerning the California timber industry. From time to time, bills are introduced in the California legislature and the U.S. Congress which relate to the business of the Company, including the protection and acquisition of old growth and other timberlands, endangered species, environmental protection and the restriction, regulation and administration of timber harvesting practices. Because such bills are subject to amendment, it is premature to assess the ultimate content of these bills, the likelihood of any of the bills passing or the impact of any of these bills on the financial position or results of operations of the Company. Furthermore, any bills which are passed are subject to executive veto and court challenge. In addition to existing and possible new or modified statutory enactments, regulatory requirements and administrative and legal actions, the California timber industry remains subject to potential California or local ballot initiatives and evolving federal and California case law which could affect timber harvesting practices. It is, however, impossible to assess the effect of such matters on the future operating results or financial position of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nA description of the Company's properties is included under Item 1 above.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nMERGER LITIGATION\nAs a result of the below-described settlement of the In Re Ivan F. Boesky Multidistrict Securities Litigation (the \"Boesky Settlement\"), all material stockholder claims against the Company and other defendants have been resolved and have been dismissed or are in the process of being dismissed.\nDuring the mid-to-late 1980's, Pacific Lumber was named as defendant along with several other entities and individuals, including MAXXAM and MGI, in various class, derivative and other actions brought in the Superior Court of Humboldt County by former stockholders of Pacific Lumber relating to the cash tender offer (the \"Tender Offer\") for the shares of Pacific Lumber by a subsidiary of MGI and the subsequent merger (the \"Merger\"), as a result of which Pacific Lumber became a wholly owned subsidiary of MGI (the \"Humboldt County Lawsuits\"). As of the date the Court approved the Boesky Settlement, the Humboldt County Lawsuits which remained open were captioned: Fries, et al. v. Carpenter, et al. (No. 76328) (\"Fries State\"); Omicini, et al. v. The Pacific Lumber Company, et al. (No. 76974) (\"Omicini\"); Thompson, et al. v. Elam, et al. (No. 78467) (\"Thompson State\"); and Russ, et al. v. Milken, et al. (No. DR-85429) (\"Russ\"). The Humboldt County Lawsuits generally alleged, among other things, that in documents filed with the Securities and Exchange Commission (the \"Commission\"), the defendants made false statements concerning, among other things, the estimated value of Pacific Lumber's assets, financing for the Tender Offer and the Merger and minority stockholders' appraisal rights, and that the individual directors of Pacific Lumber breached certain fiduciary duties owed stockholders and other constituencies of Pacific Lumber. MGI and MAXXAM were alleged to have aided and abetted these violations and committed other wrongs. The Thompson State, Omicini and Fries State suits sought compensatory damages in excess of $1 billion, exemplary damages in excess of $750 million, rescission and other relief. The Russ suit did not specify the amount of damages sought.\nIn 1988, two lawsuits similar to the Humboldt County Lawsuits were filed in the United States District Court, Central District of California--Fries, et al. v. Hurwitz, et al. (No. 88-3493 RMT) (\"Fries Federal\") and Thompson, et al. v. MAXXAM Group Inc., et al. (No. 88-06274) (\"Thompson Federal\"). These actions sought damages and relief similar to that sought in the Humboldt County Lawsuits. In May 1989, the Thompson Federal and Fries Federal actions were consolidated in the In re Ivan F. Boesky Multidistrict Securities Litigation in the United States District Court, Southern District of New York (MDL No. 732 M 21-45-MP) (\"Boesky\"). An additional action filed in November 1989, entitled American Red Cross, et al. v. Hurwitz, et al. (No. 89 Civ 7722) (\"American Red Cross\"), was also consolidated with the Boesky action. The American Red Cross action contained allegations and sought damages and relief similar to that contained in the Humboldt County Lawsuits.\nAt a fairness hearing held on November 17, 1994, the Court approved a settlement of, and dismissed with prejudice, the pending federal actions against the settling defendants. The actions dismissed with prejudice include specifically: In Re Ivan F. Boesky Multidistrict Securities Litigation; the Fries Federal action; the Thompson Federal action; and the American Red Cross, et al. v. Hurwitz, et al. action. The court's order also provides for the dismissal of all other shareholder claims against the defendants, including dismissal of the Fries State, Omicini, and Russ actions in their entirety, and all shareholder claims in the Thompson State action. Of the approximately $52 million settlement, approximately $33 million was paid by insurance carriers of MAXXAM, MGI and the Company, approximately $14.8 million was paid by the Company and the balance was paid by the other defendants and through the assignment of certain claims. Dismissals have already been entered or are in process with respect to all of the dismissed actions.\nIn September 1989, seven past and present employees of Pacific Lumber brought an action against Pacific Lumber, MAXXAM, MGI, certain current and former directors and officers of Pacific Lumber, MAXXAM\nand MGI, and First Executive Life Insurance Company (\"First Executive\") (subsequently dismissed as a defendant) in the United States District Court, Northern District of California, entitled Kayes, et al. v. Pacific Lumber Company, et al. (No. C89-3500) (\"Kayes\"). Plaintiffs purport to be participants in or beneficiaries of Pacific Lumber's former Retirement Plan (the \"Retirement Plan\") for whom a group annuity contract was purchased from Executive Life Insurance Company (\"Executive Life\") in 1986 after termination of the Retirement Plan. The Kayes action alleges that the Pacific Lumber, MAXXAM and MGI defendants breached their ERISA fiduciary duties to participants and beneficiaries of the Retirement Plan by purchasing the group annuity contract from First Executive and selecting First Executive to administer the annuity payments. Plaintiffs seek, among other things, a new group annuity contract on behalf of the Retirement Plan participants and beneficiaries. This case was dismissed on April 14, 1993 and was refiled as Jack Miller, et al. v. Pacific Lumber Company, et al. (No. C-89-3500-SBA) (\"Miller\") on April 26, 1993; the Miller case was dismissed on May 14, 1993. These dismissals have been appealed. On October 3, 1994, the U.S. House of Representatives approved a bill amending ERISA, which had previously been passed by the U.S. Senate, and is intended, in part, to overturn the U.S. District Court's dismissal of the Miller action and to make available certain remedies not previously provided under ERISA. On October 22, 1994, the President signed this legislation (the Pension Annuitants' Protection Act of 1994). As a result of the passage of this legislation, the Miller plaintiffs have asked the U.S. Ninth Circuit Court of Appeals to vacate the U. S. District Court judgment dismissing their case and to remand the case to the U.S. District Court; defendants have opposed this request. It is uncertain what effect, if any, this legislation will have on the pending appeal or the final disposition of this case. The defendants and plaintiff in the DOL civil action have invited the Miller plaintiffs to participate in the court- supervised settlement discussions concerning the Miller and DOL civil actions.\nIn June 1991, the U.S. Department of Labor filed a civil action entitled Lynn Martin, Secretary of the U.S. Department of Labor v. The Pacific Lumber Company, et al. (No. 91-1812-RHS) (\"DOL civil action\") in the United States District Court, Northern District of California, against Pacific Lumber, MAXXAM, MGI and certain of their current and former officers and directors. The allegations in the DOL civil action are substantially similar to that in the Kayes action. The DOL civil action has been stayed pending resolution of the Kayes and Miller appeals. Formal settlement negotiations continue to be overseen by the court in this matter.\nManagement is of the opinion that the outcome of the foregoing litigation should not have a material adverse effect on the Company's consolidated financial position or results of operations.\nTIMBER HARVESTING LITIGATION\nVarious actions, similar to each other, have been filed against Pacific Lumber, MAXXAM, MGI, various state officials and others, alleging, among other things, violations of the Forest Practice Act, the CEQA, ESA, CESA, and\/or related regulations. These actions seek to prevent Pacific Lumber from harvesting certain of its THPs.\nThe EPIC v. The California Department of Forestry, et al. (No. 90CP0341) action in Superior Court of Humboldt County, filed by the Environmental Protection Information Center (\"EPIC\") in May 1990, relates to a THP for approximately 378 acres of virgin old growth timber. A nearly identical action in Superior Court of Humboldt County, entitled Sierra Club v. The California Department of Forestry, et al. (No. 90CP0405), was brought by the Sierra Club in June 1990. These actions were subsequently consolidated and after a trial on the merits, the Superior Court in June 1992 issued its judgment in favor of Pacific Lumber and affirming the BOF's approval of this THP. The trial court's decision was appealed by the Company; however,\nthe Company has decided to withdraw the THP involved in the above-referenced litigation and moot the appeal.\nThe EPIC, et al. v. California State Board of Forestry, et al. (No. 91CP244) action in the Superior Court of Humboldt County, filed by the Sierra Club and EPIC in 1991, related to a THP for approximately 237 acres of virgin old growth timber (\"THP 90-237\"). After the Superior Court reversed the BOF's approval of this THP, certain modifications were made to the THP which was then unanimously approved by the BOF. The Superior Court later issued judgment in favor of Pacific Lumber. On appeal, the Court of Appeal in October 1993 affirmed the trial court's judgment approving THP 90-237. In April 1993, EPIC filed another action with respect to THP 90- 237 entitled Marbled Murrelet, et al. v. Bruce Babbitt, Secretary, Department of Interior, et al. (No. C93-1400) in the U.S. District Court for the Northern District of California, alleging an unlawful \"taking\" of the marbled murrelet under the ESA. The Court dismissed the federal and state agency defendants and limited plaintiffs' claims against Pacific Lumber. In January 1994, plaintiffs appealed the dismissal of the state and federal defendants. Harvesting was stayed pending outcome of a trial which commenced in August 1994 and concluded in September 1994. On February 24, 1995, the judge ruled that THP 237 is occupied by the marbled murrelet and permanently enjoined implementation of THP 237 in order to protect the marbled murrelet.\nOn March 10, 1995, the Sierra Club and EPIC filed an action entitled Sierra Club and EPIC v. The California Department of Forestry, Scotia Pacific Holding Co., et al. (No. 95 DR 0072) in Superior Court of Humboldt County. This action relates to an exemption for forest health which SPHC had previously filed covering SPHC timberlands. The plaintiffs allege, among other things, that the defendants have violated the CEQA, the CESA and the Forest Practice Act and seek, among other things, to stay all operations authorized by the exemption.\nPacific Lumber's management believes that the matters described above are unlikely to have a material adverse effect on Pacific Lumber's financial position or results of operations. See Item 1. \"Business-- egulatory and Environmental Factors\" above for a description of regulatory and similar matters which could affect Pacific Lumber's timber harvesting practices and future operating results.\nOTHER LITIGATION MATTERS\nThe Company is involved in various other claims, lawsuits and other proceedings relating to a wide variety of matters. While uncertainties are inherent in the final outcome of such matters and it is presently impossible to determine the actual costs that ultimately may be incurred, management believes that the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position or results of operations.\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 indirectly held entirely by MGI, which is a wholly owned subsidiary of MAXXAM. Accordingly, the Company's common stock is not traded on any stock exchange and has no established public trading market. The Company declared and paid dividends on its common stock in the amount of $24.5 million and $25.0 million in 1994 and 1993, respectively. As of December 31, 1994, approximately $20.8 million of dividends could be paid by the Company. See Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations-- Financial Condition and Investing and Financing Activities\" and Note 4 to the Consolidated Financial Statements appearing in Item 8.\nAll of the Company's issued and outstanding common stock is pledged as collateral for MGI's 11-1\/4% Senior Secured Notes due 2003 and 12-1\/4% Senior Secured Discount Notes due 2003 (collectively referred to herein as the \"MGI Notes\"). See Item 7, \"Management's Discussion and Analysis of Financial Condition and Results of Operations--Financial Condition and Investing and Financing Activities\" and Note 7 to the Consolidated Financial Statements appearing in Item 8.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nNot applicable.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nRESULTS OF OPERATIONS\nThe following should be read in conjunction with the Company's Consolidated Financial Statements and the Notes thereto appearing in Item 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo the Board of Directors and Stockholder of The Pacific Lumber Company:\nWe have audited the accompanying consolidated balance sheets of The Pacific Lumber Company (a Delaware corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, cash flows and stockholder's equity for each of the three years in the period ended December 31, 1994. 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 financial position of The Pacific Lumber Company and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nAs explained in Notes 5 and 6 to the financial statements, effective January 1, 1993, the Company changed its method of accounting for income taxes and postretirement benefits other than pensions.\nARTHUR ANDERSEN LLP\nSan Francisco, California January 27, 1995\nCONSOLIDATED BALANCE SHEET\nCONSOLIDATED STATEMENT OF OPERATIONS\nCONSOLIDATED STATEMENT OF CASH FLOWS\nCONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS OF DOLLARS)\n1. BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nThe consolidated financial statements include the accounts of The Pacific Lumber Company and its wholly owned subsidiaries, collectively referred to herein as the \"Company.\" The Company is an indirect wholly owned subsidiary of MAXXAM Group Inc. (\"MGI\"). MGI is a wholly owned subsidiary of MAXXAM Inc. (\"MAXXAM\").\nSUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nCash Equivalents Cash equivalents consist of highly liquid money market instruments with original maturities of three months or less.\nMarketable Securities On December 31, 1993, the Company adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities (\"SFAS 115\"). In accordance with the provisions of SFAS 115, marketable securities are carried at fair value beginning on December 31, 1993. Prior to that date, marketable securities portfolios were carried at the lower of cost or market at the balance sheet date. The cost of the securities sold is determined using the first-in, first-out method. Included in investment, interest and other income for each of the three years ended December 31, 1994 were: 1994 - a decrease in net unrealized holding gains of $264 and net realized gains of $1,248; 1993 - net realized gains of $1,046 and net unrealized gains of $264; and 1992 - net realized gains of $717 and the recovery of $123 of net unrealized losses. Net unrealized losses represent the amount required to reduce the short-term marketable securities portfolios from cost to market value prior to December 31, 1993. Subsequent to the adoption of SFAS 115, purchases and sales of marketable securities are presented as cash flows from operating activities in the Consolidated Statement of Cash Flows.\nInventories Inventories are stated at the lower of cost or market value. Cost is determined using the last-in, first-out (LIFO) method.\nTimber and Timberlands Depletion is computed utilizing the unit-of-production method based upon estimates of timber values and quantities.\nProperty, Plant and Equipment Property, plant and equipment, including capitalized interest, is stated at cost, net of accumulated depreciation. Depreciation is computed utilizing the straight-line method at rates based upon the estimated useful lives of the various classes of assets.\nDeferred Financing Costs Costs incurred to obtain financing are deferred and amortized over the term of the related borrowing.\nRestricted Cash and Concentrations of Credit Risk Restricted cash represents the amount initially deposited into an account (the \"Liquidity Account\") held by the trustee under the indenture governing the 7.95% Timber Collateralized Notes due 2015 (the \"Timber Notes\") as described in Note 4. The Liquidity Account is not available, except under certain limited circumstances, for working capital purposes; however, it is available to pay the Rated Amortization (as defined in Note 4) and interest on the Timber Notes if and to the extent that cash flows are insufficient to make such payments. The required Liquidity Account balance will generally decline as principal payments are made on the Timber Notes. Investment, interest and other income for the years ended December 31, 1994 and 1993 includes approximately $2,490 and $2,101, respectively, attributable to an investment rate agreement (at 7.95% per annum) with the financial institution which holds the Liquidity Account.\nAt December 31, 1994 and 1993, cash and cash equivalents includes $19,439 and $20,280, respectively, (the \"Payment Account\") which is reserved for debt service payments on the Timber Notes (see Note 4). The Payment Account and the Liquidity Account are each held by a different financial institution. In the event of nonperformance by such financial institutions, the Company's exposure to credit loss is represented by the amounts deposited plus any unpaid accrued interest thereon. The Company mitigates its concentrations of credit risk with respect to these restricted cash deposits by maintaining them at high credit quality financial institutions and monitoring the credit ratings of these institutions.\nInvestment, Interest and Other Income In February 1994, the Company received a franchise tax refund of $7,243, the substantial portion of which represents interest, from the State of California relating to tax years 1972 through 1985. This amount is included in investment, interest and other income for the year ended December 31, 1994.\nItems Related to 1992 Earthquake In 1993 and 1992, the Company recorded reductions in cost of sales of $1,200 and $3,300, respectively, from business interruption insurance claims for reimbursement of higher operating costs and the related loss of revenues resulting from the April 1992 earthquake. In 1992, the Company recorded a $1,600 gain in investment, interest and other income on a casualty insurance claim for the loss of certain commercial property due to the earthquake. Other receivables at December 31, 1994 and 1993 included $1,684 and $1,235, respectively, related to these and other earthquake related insurance claims.\nFair Value of Financial Instruments The carrying amounts of cash and cash equivalents and restricted cash approximate fair value. The fair value of marketable securities is determined based on quoted market prices. The estimated fair value of long-term debt is determined based on the quoted market prices for the Timber Notes and the 10-1\/2% Senior Notes due 2003 (the \"Senior Notes\"), and on the current rates offered for borrowings similar to the other debt. The Timber Notes and the Senior Notes are thinly traded financial instruments; accordingly, their market prices at any balance sheet date may not be representative of the prices which would be derived from a more active market.\nThe estimated fair values of the Company's financial instruments, along with the carrying amounts of the related assets (liabilities), are as follows:\nReclassifications Certain reclassifications have been made to prior years' financial statements to be consistent with the presentation in the current year.\n2. INVENTORIES\nInventories consist of the following:\nDuring 1993 and 1992, inventory quantities were reduced. These reductions resulted in the liquidation of LIFO inventory quantities carried at prevailing costs from prior years which were higher than the current cost of inventory in 1993 and lower than current costs in 1992. The effects of these inventory liquidations increased cost of goods sold by approximately $222 for the year ended December 31, 1993 and decreased cost of goods sold by approximately $372 for the year ended December 31, 1992.\n3. PROPERTY, PLANT AND EQUIPMENT\nThe major classes of property, plant and equipment are as follows:\nDepreciation expense for the years ended December 31, 1994, 1993 and 1992 was $8,808, $8,233 and $8,189, respectively.\n4. LONG-TERM DEBT\nLong-term debt consists of the following:\nPursuant to the principles of Accounting Principles Board Opinion No. 11, Accounting for Income Taxes (\"APB 11\"), the Company did not record a credit in lieu of income taxes for 1992 due to the uncertainty of realizing the benefit of the 1992 net operating loss in future periods.\nThe 1994 deferred federal provision in lieu of income taxes of $1,748 includes a credit relating to reserves the Company no longer believes are necessary. The 1993 deferred federal credit in lieu of income taxes of $1,913 includes an $850 benefit for increasing net deferred income tax assets (liabilities) as of the date of enactment (August 10, 1993) of the Omnibus Budget Reconciliation Act of 1993 which retroactively increased the federal statutory income tax rate from 34% to 35% for periods beginning on or after January 1, 1993.\nA reconciliation between the credit (provision) in lieu of income taxes and the amount computed by applying the federal statutory income tax rate to income (loss) before income taxes, extraordinary items and cumulative effect of changes in accounting principles is as follows:\nAs shown in the Consolidated Statement of Operations for the year ended December 31, 1994, the Company recorded an extraordinary loss related to the settlement of litigation in connection with MGI's acquisition of the Company (see Note 8). The Company reported the loss net of related deferred income taxes of $6,312 which is less than the federal and state statutory income tax rates due to expenses for which no tax benefit was recognized.\nAs shown in the Consolidated Statement of Operations for the year ended December 31, 1993, the Company reported an extraordinary loss related to the early extinguishment of debt. The Company reported the loss net of related deferred income taxes of $5,566 which approximated the federal statutory income tax rate in effect on the date the transaction occurred.\nEffective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes (\"SFAS 109\"). The adoption of SFAS 109 changed the Company's method of accounting for income taxes to an asset and liability approach from the deferral method prescribed by APB 11. The asset and liability approach requires the recognition of deferred income tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company's financial statements or tax returns. Under this method, deferred income tax assets and liabilities are determined based on the temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates. The cumulative effect of the change in accounting principle, as of January 1, 1993, increased the Company's results of operations by $4,973. The implementation of SFAS 109 required the Company to restate certain assets and liabilities to their pre-tax amounts from their net-of-tax amounts originally recorded in connection with the acquisition of the Company in 1986. As a result of restating these assets and liabilities, the loss before income taxes, extraordinary item and cumulative effect of changes in accounting principles for the year ended December 31, 1993 was decreased by $875.\nThe components of the Company's net deferred income tax assets (liabilities) are as follows:\nA principal component of the net deferred income tax assets listed above relates to the excess of the tax basis over financial statement basis with respect to timber and timberlands. The Company believes that it is more likely than not that this net deferred income tax asset will be realized, based primarily upon the estimated value of its timber and timberlands which is well in excess of its tax basis. The valuation allowances listed above relate primarily to loss and credit carryforwards. The Company evaluated all appropriate factors to determine the proper valuation allowances for loss and credit carryforwards. These factors included any limitations concerning use of the carryforwards, the year the carryforwards expire and the levels of taxable income necessary for utilization. The Company has concluded that it will more likely than not generate sufficient taxable income to realize the benefit attributable to the loss and credit carryforwards for which valuation allowances were not provided.\nIncluded in the net deferred income tax assets listed above are $33,540 and $36,056 at December 31, 1994 and 1993, respectively, which are recorded pursuant to the tax allocation agreements with MAXXAM.\nThe following table presents the Company's estimated tax attributes, for federal income tax purposes, under the terms of the Amended Tax Allocation Agreement at December 31, 1994.\n6. EMPLOYEE BENEFIT PLANS\nThe Company has a defined benefit plan which covers all employees of the Company. Under the plan, employees are eligible for benefits at age 65 or earlier, if certain provisions are met. The benefits are determined under a career average formula based on each year of service with the Company and the employee's compensation for that year. The Company's funding policy is to contribute annually an amount at least equal to the minimum cash contribution required by The Employee Retirement Income Security Act of 1974, as amended.\nA summary of the components of net periodic pension cost is as follows:\nThe following table sets forth the funded status and amounts recognized in the Consolidated Balance Sheet:\nThe Company has an unfunded defined benefit plan for certain postretirement and other benefits which covers substantially all employees of the Company. Participants of the plan are eligible for certain health care benefits upon termination of employment and retirement and commencement of pension benefits. Participants make contributions for a portion of the cost of their health care benefits.\nThe Company adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions (\"SFAS 106\") as of January 1, 1993. The costs of postretirement benefits other than pensions are now accrued over the period the employees provide services to the date of their full eligibility for such benefits. Previously, such costs were expensed as actual claims were incurred. The cumulative effect of the change in accounting principle for the adoption of SFAS 106 was recorded as a charge to results of operations of $2,348, net of related income taxes of $1,566. The deferred income tax benefit related to the adoption of SFAS 106 was recorded at the federal and state statutory rates in effect on the date SFAS 106 was adopted.\nA summary of the components of net periodic postretirement benefit cost is as follows:\nThe adoption of SFAS 106 increased the Company's loss before extraordinary item and cumulative effect of changes in accounting principles by $212 ($360 before tax) for the year ended December 31, 1993.\nThe postretirement benefit liability recognized in the Company's Consolidated Balance Sheet is as follows:\nThe annual assumed rate of increase in the per capita cost of covered benefits (i.e., health care cost trend rate) is 13.0% for 1995 and is assumed to decrease gradually to 5.5% for 2008 and remain at that level thereafter. Each one percentage point increase in the assumed health care cost trend rate would increase the accumulated postretirement benefit obligation as of December 31, 1994 by approximately $512 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by approximately $85.\nThe discount rates used in determining the accumulated postretirement benefit obligation were 8.5% and 7.5% at December 31, 1994 and 1993, respectively.\nSubsequent to December 31, 1993, the Company's employees were eligible to participate in a defined contribution savings plan sponsored by MAXXAM. This plan is designed to enhance the existing retirement programs of participating employees. Employees may elect to contribute up to 16% of their compensation to the plan. For those participants who have elected to make voluntary contributions to the plan, the Company's contributions consist of a matching contribution of up to 4% of the compensation of participants for each calendar quarter. The cost to the Company of this plan was $1,215 for the year ended December 31, 1994.\nThe Company is self-insured for workers' compensation benefits. Included in accrued compensation and related benefits and other noncurrent liabilities are accruals for workers' compensation claims amounting to $9,233 and $7,008 at December 31, 1994 and 1993, respectively. Workers' compensation expenses amounted to $3,698, $3,317 and $2,944 for the years ended December 31, 1994, 1993 and 1992, respectively.\n7. RELATED PARTY TRANSACTIONS\nMAXXAM provides the Company with personnel, insurance, legal, accounting, financial, and certain other services. MAXXAM is compensated by the Company through the payment of a fee representing the reimbursement of actual out-of-pocket expenses incurred by MAXXAM, including, but not limited to, labor costs of personnel of MAXXAM rendering services to the Company. Charges by MAXXAM for such services were $1,744, $2,598 and $2,735 for the years ended December 31, 1994, 1993 and 1992, respectively.\nNet sales for the years ended December 31, 1994, 1993 and 1992 include revenues of $10,326, $9,198 and $6,942, respectively, from Britt Lumber Co., Inc., an indirect wholly owned subsidiary of MGI. The Company\nrecognized operating income of $5,571, $1,972 and $1,335 on these revenues for the years ended December 31, 1994, 1993 and 1992, respectively. At December 31, 1994 and 1993, receivables include $1,283 and $178, respectively, related to these affiliate sales.\nOn August 4, 1993, all of the Company's issued and outstanding common stock was pledged as collateral for MGI's $100.0 million 11-1\/4% Senior Secured Notes due 2003 and $126.7 million 12-1\/4% Senior Secured Discount Notes due 2003 (collectively, the \"MGI Notes\"). MGI conducts its operations primarily through subsidiary companies. The Company represents the substantial portion of MGI's assets and operations. The indenture governing the MGI Notes requires the Company's board of directors to declare and pay dividends on the Company's common stock to the maximum extent permitted by any consensual restriction or encumbrance on the Company's ability to declare and pay dividends, unless the Board determines in good faith that such declaration and payment would be detrimental to the capital or other operating needs of the Company.\nIn 1994, in connection with the litigation settlement described in Note 8, the Company paid approximately $3,185 to a law firm in which a director of the Company is also a partner. In 1993, the Company paid approximately $1,931 in connection with the offering of the Senior Notes and the Timber Notes to this same law firm.\n8. LOSS ON LITIGATION SETTLEMENT AND CONTINGENCIES\nDuring 1994, MAXXAM, the Company and others agreed to a settlement, subsequently approved by the Court, of class and related individual claims brought by former stockholders of the Company against MAXXAM, MGI, the Company, former directors of the Company and others concerning MGI's acquisition of the Company. Of the approximately $52,000 settlement, approximately $33,000 was paid by insurance carriers of MAXXAM and the Company, approximately $14,800 was paid by the Company and the balance was paid by other defendants and through the assignment of certain claims. In 1994, the Company recorded an extraordinary loss of $14,866 related to the settlement and associated costs, net of benefits for federal and state income taxes of $6,312.\nThe Company's operations are subject to a variety of California and, in some cases, federal laws and regulations dealing with timber harvesting, endangered species, water quality and air and water pollution. The Company does not expect that compliance with such existing laws and regulations will have a material adverse effect on the Company's future operating results or financial position. There can be no assurance, however, that future legislation, governmental regulations or judicial or administrative decisions would not adversely affect the Company or its ability to sell lumber, logs or timber.\nVarious groups and individuals have filed objections with the California Department of Forestry (\"CDF\") regarding the CDF's actions and rulings with respect to certain of the Company's timber harvesting plans (\"THPs\"), and the Company expects that such groups and individuals will continue to file objections to the Company's THPs. In addition, lawsuits are pending which seek to prevent the Company from implementing certain of its approved THPs. These challenges have severely restricted the Company's ability to harvest virgin old growth redwood timber on its property during the past few years, as well as substantial amounts of virgin Douglas-fir timber which are located in virgin old growth redwood stands. No assurance can be given as to the extent of such litigation in the future. The Company believes that environmentally focused challenges to its THPs are likely to occur in the future. Although such challenges have delayed or prevented the Company from conducting a portion of its operations, to date such challenges have not had a material adverse effect on the Company's consolidated financial position or results of operations. It is, however, impossible to predict the future nature or degree of such challenges or their ultimate impact on the operating results or consolidated financial position of the Company.\nThe Company is also involved in various claims, lawsuits and proceedings relating to a wide variety of other matters. While there are uncertainties inherent in the ultimate outcome of such matters and it is impossible to presently determine the ultimate costs that may be incurred, management believes the resolution of such uncertainties and the incurrence of such costs should not have a material adverse effect on the Company's consolidated financial position or results of operations.\n9. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)\nSummary quarterly financial information for the years ended December 31, 1994 and 1993 is as follows:\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nNone.\nPART III\nNot applicable.\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\n2. FINANCIAL STATEMENT SCHEDULES:\nSchedules are inapplicable or the required information is included in the consolidated financial statements or the notes thereto.\n(B) REPORTS ON FORM 8-K\nNone.\n(C) EXHIBITS\nReference is made to the Index of Exhibits immediately preceding the exhibits hereto (beginning on page 40), which index is 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. THE PACIFIC LUMBER COMPANY\nDate: March 24, 1995 By: PAUL N. SCHWARTZ Paul N. Schwartz Vice President and Chief Financial Officer (Principal Financial Officer)\nDate: March 24, 1995 By: GARY L. CLARK Gary L. Clark Vice President - Finance and Administration (Principal Accounting Officer) 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 dates indicated.\nDate: March 24, 1995 By: JOHN A. CAMPBELL John A. Campbell President, Chief Executive Officer and Director\nDate: March 24, 1995 By: PAUL N. SCHWARTZ Paul N. Schwartz Vice President, Chief Financial Officer and Director\nDate: March 24, 1995 By: JOHN T. LA DUC John T. La Duc Vice President and Director\nDate: March 24, 1995 By: EZRA G. LEVIN Ezra G. Levin Director\nDate: March 24, 1995 By: ANTHONY R. PIERNO Anthony R. Pierno Vice President, General Counsel and Director\nDate: March 24, 1995 By: WILLIAM S. RIEGEL William S. Riegel Vice President - Sales and Director\nTHE PACIFIC LUMBER COMPANY\nINDEX OF EXHIBITS\nExhibit Number Description\n3.1 Articles of Incorporation of The Pacific Lumber Company (the \"Company\" or \"Pacific Lumber\") (incorporated herein by reference to Exhibit 3.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992)\n3.2 By-laws of the Company, as amended (incorporated herein by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992)\n4.1 Indenture between the Company and The First National Bank of Boston, as Trustee, regarding Pacific Lumber's 10-1\/2% Senior Notes due 2003 (incorporated herein by reference to Exhibit 4.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993)\n4.2 Indenture between Scotia Pacific Holding Company (\"SPHC\") and The First National Bank of Boston, as Trustee, regarding SPHC's 7.95% Timber Collateralized Notes due 2015 (incorporated herein by reference to Exhibit 4.1 to SPHC's Annual Report on Form 10-K for the fiscal year ended December 31, 1993; the \"SPHC 1993 Form 10-K\")\n4.3 Revolving Credit Agreement dated as of June 23, 1993 (the \"Revolving Credit Agreement\") between the Company and Bank of America National Trust and Savings Association (incorporated herein by reference to Exhibit 4.19 to Amendment No. 2 to the Form S-2 Registration Statement of MAXXAM Group Inc., Registration No. 33-56332)\n4.4 Letter Amendment, dated October 5, 1993, to the Revolving Credit Agreement (incorporated herein by reference to Exhibit 4.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1993)\n4.5 Second Amendment, dated as of May 26, 1994, to the Revolving Credit Agreement (incorporated herein by reference to Exhibit 4.2 to the Quarterly Report on Form 10-Q of MAXXAM Inc. for the quarter ended June 30, 1994; File No. 1-3924)\nNote: Pursuant to Regulation Section 229.601, Item 601(b)(4)(iii) of Regulation S-K, upon request of the Securities and Exchange Commission, the Company hereby agrees to furnish a copy of any unfiled instrument which defines the rights of holders of long-term debt of the Company and its consolidated subsidiaries (and for any of its unconsolidated subsidiaries for which financial statements are required to be filed) wherein the total amount of securities authorized thereunder does not exceed 10 percent of the total consolidated assets of the Company.\n10.1 Agreement dated December 20, 1985 between the Company and General Electric Company (the \"1985 GE Agreement\") (incorporated herein by reference to Exhibit 10(m) to the Registration Statement of Pacific Lumber on Form S-1, Registration No. 33-5549)\n10.2 Amendment No. 1 to Agreement between the Company and General Electric Company dated July 29, 1986 relating to the 1985 GE Agreement (incorporated herein by reference to Exhibit 10.4 to Pacific Lumber's Annual Report on Form 10-K for the fiscal year ended December 31, 1988)\n10.3 Power Purchase Agreement dated January 17, 1986 between the Company and Pacific Gas and Electric Company (incorporated herein by reference to Exhibit 10(n) to the Registration Statement of the Company on Form S-1, Registration No. 33-5549)\n10.4 Tax Allocation Agreement dated as of May 21, 1988 among MAXXAM Inc., MAXXAM Group Inc., the Company and the corporations signatory thereto (incorporated herein by reference to Exhibit 10.8 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1988)\n10.5 Tax Allocation Agreement among the Company, SPHC, Salmon Creek Corporation and MAXXAM Inc. dated March 23, 1993 (incorporated herein by reference to Exhibit 10.1 to Amendment No. 3 to the Form S-1 Registration Statement of SPHC, Registration No. 33-55538)\n10.6 Deed of Trust, Security Agreement, Financing Statement, Fixture Filing and Assignment among SPHC, The First National Bank of Boston, as Trustee, and The First National Bank of Boston, as the Collateral Agent (incorporated herein by reference to Exhibit 4.2 to the SPHC 1993 Form 10-K)\n10.7 Master Purchase Agreement between the Company and SPHC (incorporated herein by reference to Exhibit 10.1 to the SPHC 1993 Form 10-K)\n10.8 Services Agreement between the Company and SPHC (incorporated herein by reference to Exhibit 10.2 to the SPHC 1993 Form 10-K)\n10.9 Additional Services Agreement between the Company and SPHC (incorporated herein by reference to Exhibit 10.3 to the SPHC 1993 Form 10-K)\n10.10 Reciprocal Rights Agreement among the Company, SPHC and Salmon Creek Corporation (incorporated herein by reference to Exhibit 10.4 to the SPHC 1993 Form 10-K)\n10.11 Environmental Indemnification Agreement between the Company and SPHC (incorporated herein by reference to Exhibit 10.5 to the SPHC 1993 Form 10-K)\n10.12 Purchase and Services Agreement between the Company and Britt Lumber Co., Inc. (incorporated herein by reference to Exhibit 10.17 to Amendment No. 2 to the Form S-2 Registration Statement of Pacific Lumber, Registration Statement No. 33-56332)\n10.13 Investment Management Agreement, dated as of December 1, 1991, by and among the Company, MAXXAM Inc. and certain related corporations (incorporated herein by reference to Exhibit 10.23 to Amendment No. 5 to the Registration Statement on Form S-2 of MAXXAM Group Inc., Registration No. 33-64042)\n*27 Financial Data Schedule\n* Included with this filing.","section_15":""}
{"filename":"792369_1994.txt","cik":"792369","year":"1994","section_1":"Item 1. Business\nGeneral Eagle Financial Corp. (\"Eagle\" or the \"Company\") is the holding company of Eagle Federal Savings Bank (\"Eagle Federal\" or the \"Bank\"). Eagle was organized in 1986 under Delaware law for the purpose of becoming the holding company of First Federal Savings and Loan Association of Torrington, Connecticut (\"Torrington\") upon its conversion to a stock company in 1987. In 1988, BFS Bancorp, Inc., the holding company of Bristol Federal Savings Bank, Bristol, Connecticut (\"Bristol\"), merged into Eagle in a combination structured as a merger of equals and accounted for as a pooling-of-interests. Bristol had converted to a stock company in 1987. Torrington and Bristol have operated as savings institutions since 1919 and 1924, respectively. In January 1993, Eagle merged Bristol with Torrington under the new name Eagle Federal Savings Bank. Unless otherwise stated, all references herein to Eagle or the Company include Eagle Federal and other subsidiaries on a consolidated basis.\nEagle, at September 30, 1994, had total assets of $1.07 billion, net loans receivable of $810.7 million, deposits of $948.8 million and shareholders' equity of $66.3 million. Through Eagle Federal, the Company provides consumer banking services through 23 banking offices in Connecticut, serving the Torrington, Bristol, Danbury and Hartford market regions. As a community oriented savings bank, Eagle Federal focuses on the financial needs of its customers in these local markets, seeking to develop long-term deposit and lending relationships. In its lending activities, the Bank stresses asset quality through its emphasis on 1-4 family residential first mortgage lending in its local markets and the use of conservative loan underwriting standards. Deposit accounts at the Bank are insured by the Federal Deposit Insurance Corporation (the \"FDIC\").\nEagle's net income has increased each of the previous six fiscal years from $3.5 million, or $1.17 per share, in fiscal 1989 to $7.6 million, or $2.34 per share, in fiscal 1994.\nEagle intends to continue to concentrate on increasing its earnings, maintaining high asset quality, meeting customer needs in its existing local markets, and expanding through selected future acquisitions.\nEagle's principal executive office is located at 222 Main Street, Bristol, Connecticut 06010 and its telephone number is (203) 584-3600.\nRecent Acquisitions. In recent periods, Eagle has significantly expanded its operations through three federally assisted acquisitions in which Eagle Federal acquired certain assets and assumed deposit liabilities from the FDIC or the Resolution Trust Corporation (\"RTC\"), as shown below. Substantially all of the loans acquired in these acquisitions consisted of 1-4 family residential first mortgage loans and home equity loans. In The Bank of Hartford, Inc. (\"Bank of Hartford\") acquisition, Eagle Federal also acquired $72.7 million of investment securities, substantially all of which were U.S. Treasury and government agency obligations, and loan servicing rights on $80.5 million of loans with an average loan servicing fee of 0.375%. In addition to these assisted acquisitions, Eagle Federal in July 1993 purchased from another savings institution a banking office in Brookfield, Connecticut with $8.2 million in deposits, and relocated its previously acquired Brookfield office to that location.\nEagle has pursued acquisitions which complement its existing operations and market area. Each of the assisted acquisitions made by the Bank has had a positive impact on the Company's net income and allowed it to maintain asset quality. By primarily pursuing assisted acquisitions involving the FDIC or the RTC, the Company believes that it has successfully expanded at a reasonable cost and without dilution to shareholder value.\nEagle's expansion strategy is reflected in its recent acquisition of The Bank of Hartford, which represents a natural extension of Eagle's existing markets since many residents of Bristol and Torrington commute to the Hartford area. The Hartford market area is contiguous to Eagle's current market areas, and has a higher population density and is generally more affluent than the Bristol and Torrington markets. The Company believes that its expansion into the Hartford market area creates an additional opportunity for loan originations. In addition, the combination of size, geographical proximity and cost of the acquired banking offices is expected to have a positive impact on the Company's efficiency ratio.\nBusiness. As a holding company, the business operations of Eagle are conducted through the Bank. The Bank primarily is engaged in the business of accepting deposits from the general public and using such funds in the origination of first mortgage loans for the purchase, refinance or construction of 1-4 family homes. At September 30, 1994, 99.2%, or $814.9 million, of the Bank's $821.2 million total loans receivable was secured by real estate. The Bank's real estate loans included $712.0 million of first mortgage loans secured by 1-4 family residential real estate (86.7% of total loans receivable), $63.0 million of home equity loans, secured by second deeds of trust on residential real estate (7.6% of total loans receivable), $39.9 million of multi-family, commercial real estate, and land loans (4.9% of total loans receivable). The remaining $6.3 million of loans (0.8% of total loans receivable) were consumer loans, primarily loans secured by deposits and personal loans.\nEagle has experienced increased loan originations (excluding purchased loans), with $219.9 million of originations in fiscal 1994, compared to $209.9 million in fiscal 1993. Increased loan origination activity during fiscal 1994 is due in substantial part to refinancings of mortgage loans in reaction to generally low market interest rates. However, as a result of recent increases in mortgage interest rates, Eagle anticipates a decline in 1-4 family mortgage loan originations and, beginning in fiscal 1995, intends to implement strategies which will put additional emphasis on originating commercial real estate loans within its primary market areas, predominantly on existing structures. This will involve hiring additional personnel with proven experience in commercial real estate loan products. Eagle also intends to put additional emphasis on its multi-family and consumer lending programs. See \"Lending Activities -- General.\" The marketing of these loans will focus on Eagle's existing customer base, as well as new relationships within Eagle's primary market areas.\nBased on its lending strategy, Eagle has been able to maintain relatively stable asset quality. Total non-performing assets of Eagle were $10.4 million at September 30, 1992, $12.0 million at September 30, 1993 and $12.3 million (or $9.1 million excluding $3.2 million of non-performing assets acquired in the Bank of Hartford transaction) at September 30, 1994. At those dates, non-performing assets constituted 1.81%, 1.81% and 1.51%, respectively, of total loans receivable and real estate owned. At September 30, 1994, Eagle's allowance for loan losses totaled $8.3 million, or 104% of total non-performing loans. Eagle Federal's funding strategy is focused primarily on developing core deposits such as regular savings and checking accounts, and attracting long-term certificates of deposit. The Bank also supplements its retail deposits with FHL Bank advances.\nEagle also makes available to its customers various investment products through Liberty Securities Corporation, a registered broker-dealer not affiliated with Eagle. These products include mutual funds, unit investment trusts and fixed- and variable-rate annuity contracts, as well as discount brokerage services.\nRegulation. Eagle, as a unitary thrift holding company, and Eagle Federal, as its wholly-owned subsidiary, are subject to comprehensive regulation, supervision and examination by the Office of Thrift Supervision (\"OTS\"), as the primary federal regulator of the Bank. The FDIC also has significant regulatory authority over the Bank. The Board of Governors of the Federal Reserve System (\"FRB\") has regulatory authority as to certain matters concerning the Bank. Eagle Federal is a member of the Federal Home Loan Bank (\"FHLB\") System. FHLB advances are a source of funds for the Bank. See \"Regulation.\"\nLending Activities\nGeneral. Eagle traditionally has concentrated its lending activities on the origination and purchase of loans secured by first mortgage liens for the purchase, refinancing or construction of residential real property. At September 30, 1994, mortgage loans, including those secured by 1-4 family residential units, multi-family residential units, commercial real estate and land, aggregated $751.9 million or 91.6% of Eagle's loans receivable portfolio. At September 30, 1993 and 1992, such mortgage loans aggregated $614.5 million, or 92.5%, and $527.7 million, or 91.4%, respectively. The remaining loans in Eagle's portfolio consist of consumer loans, primarily home equity loans. At September 30, 1994, over 96.3% of Eagle's loans secured by real estate were secured by property located in Connecticut. Substantially all of the remaining real estate secured loans were originated prior to 1982.\nThe following tables set forth the composition of the total loan portfolio of Eagle, in dollar amounts and in percentages at the dates shown, and a reconciliation of loans receivable, net.\nAt September 30, 1994, the Company's largest loan relationship aggregated $8.3 million. That relationship represents seven loans, of which $2.9 million are secured by multi-family properties and $5.4 million are secured by commercial properties. At that date, the next largest lending relationship was $3.1 million, representing four loans secured by multi-family residential properties. Each other lending relationship aggregated less than $3.0 million.\nAt September 30, 1994, 60.2% of Eagle's net loans receivable portfolio consisted of adjustable-rate mortgage and home equity loans, compared to 59.0% and 65.5% at September 30, 1993 and 1992, respectively.\nAs a result of generally higher mortgage interest rates and a lower demand for loan refinancing, Eagle anticipates a decline in demand for 1-4 family residential mortgages and, beginning in fiscal 1995, intends to implement strategies which will put more emphasis on originating commercial real estate loans, predominantly on existing structures. This will involve hiring additional personnel with proven experience in commercial real estate loan products. Eagle also intends to put more emphasis on its multi-family and consumer lending programs. The marketing of these loans will focus on Eagle's existing customer base, as well as new relationships within Eagle's primary market areas. By increasing originations of commercial real estate, multi-family and consumer loans, Eagle's goal is to increase the yield on its loan portfolio while offsetting the anticipated decline in 1-4 family residential loan originations. Eagle also anticipates that these loan products generally will be more interest-rate sensitive.\nAt September 30, 1994 commercial real estate loans totaled $15.9 million, consisting of 73 loans with an average balance of $217,000 and secured by a mix of retail and professional office properties. In order to implement its anticipated commercial real estate lending strategies, Eagle recently hired an experienced senior commercial lender and is seeking to hire a commercial loan credit analyst and support personnel. In the first year of a commercial real estate lending program, Eagle expects such program to have a negligible impact on results of operations. Thereafter, commercial real estate lending is expected to contribute positively to Eagle's net income.\nAt September 30, 1994, consumer loans totaled $69.2 million and multi-family loans totaled $17.5 million. Over the next three fiscal years, Eagle plans to place greater emphasis on these loan products, with a three year goal to increase consumer loans outstanding by 50% and multi-family loans by 100%. Eagle intends to continue emphasizing home equity loans (91.0% of consumer loans or 7.6% of total loans before net items at September 30, 1994), as well as automobile and personal loans. The increase in multi-family loans is expected to develop from an increase in demand for rental units in Eagle's primary market areas. As to both consumer and multi-family lending, Eagle intends to utilize its existing credit programs and personnel, although multi-family lending personnel will be supplemented by the credit analyst expected to be hired for commercial real estate lending.\nThe following table sets forth certain information at September 30, 1994 regarding the dollar amount of loans maturing in Eagle's loan portfolio based on scheduled payments to maturity. Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.\nThe following table sets forth as of September 30, 1994 the dollar amount of all loans of Eagle due after one year which have predetermined interest rates and floating or adjustable interest rates.\nAt September 30, 1994 Eagle had total nonperforming assets in the amount of $12.3 million, or 1.15% of total assets, including $8.0 million in nonperforming loans (i.e., loans delinquent for 90 days or more) and $4.3 million in real estate owned and in-substance foreclosures. The ratio of nonperforming loans to total assets was .75% at that date.\nOne-to-Four Family First Mortgage Loans. At September 30, 1994, first mortgage loans (including construction loans) secured by one-to-four family homes comprised 86.7% of Eagle's portfolio, before net items. The savings and loan and mortgage banking industries have generally used a 12- year average loan life as an approximation in calculations calling for a prepayment assumption. Management believes that the loan prepayment experience of Eagle has approximated the 12-year average loan life assumption. From time to time Eagle has experienced more rapid loan prepayments, primarily during periods of, and as a result of, a rapid decline in mortgage interest rates.\nFederally chartered institutions, such as Eagle Federal, have substantial flexibility in structuring the terms of mortgage loans to adjust to changes in interest rates. Federal regulations permit mortgage loans to be written for varying maturities and at adjustable and fixed interest rates. See \"Lending Activities -- Purchase and Sale of Loans and Loan Servicing.\"\nEagle currently offers a one-year adjustable-rate loan with a limit on the maximum change per interest-rate adjustment of 2% and a limit on the total interest-rate adjustments during the life of the loan ranging from 5.0% to 6.0% depending on the initial rate of the loan. Eagle also offers three-to-one and five-to-one loans which have an initial loan rate for three and five years, respectively, after which the loans convert to a one-year adjustable-rate loan. Once these loans have converted, they have a 2% limit on the maximum change per interest-rate adjustment and a 5% limit on the total interest-rate adjustments over the life of the loan. Interest-rate adjustments currently are based on changes in the rates on comparable maturity U.S. Treasury securities. There are no prepayment penalties for any of these adjustable-rate loans. Origination fees ranging from no fees to 2% of the loan amount are charged on such loans.\nAlthough adjustable-rate mortgage loans allow Eagle to increase the sensitivity of its asset base to changes in interest rates, the extent of this interest-sensitivity is limited by the interest-rate \"caps\" contained in adjustable-rate loans. The terms of such loans may also increase the likelihood of delinquencies in periods of high interest rates, particularly if such loans are originated at discounted interest rates. Under regulations adopted by the Federal Reserve Board, although no specific interest rate limit is set, lenders are required to impose interest-rate caps on all adjustable-rate mortgage loans and all dwelling-secured consumer loans, including home equity loans, which provide for interest-rate adjustments.\nThe rates offered on adjustable-rate mortgage loans are set at levels that are intended to be competitive in the market areas served by Eagle and to produce a yield that provides an acceptable first-year profit margin over the cost of funds. Eagle from time to time offers mortgage loans at an initial, discounted interest rate (i.e., a rate which is less than the then-current index plus margin) until the first loan repricing period, at which time the interest rate generally is adjusted to equal the index plus margin. Eagle generally qualifies the borrower at the rate which would be in effect after one year, assuming the maximum upward adjustment. At September 30, 1994, Eagle did not have residential mortgage loans with balloon payments or any negative amortization or equity participation loans in its portfolio.\nMost of the fixed-rate mortgage loans originated by Eagle include a \"due-on-sale\" clause, which is a provision giving Eagle the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells or otherwise disposes of the real property subject to the mortgage and the loan is not repaid. Due-on-sale clauses are an important means of increasing the rate on existing fixed-rate mortgage loans during periods of rising interest rates, and Eagle actively enforces such clauses.\nMulti-Family Residential and Commercial Mortgage Loans. Eagle also makes loans secured by mortgages on multi-family residential and commercial properties and land loans. At September 30, 1994, these loans totaled $39.9 million or 4.9% of the total loan portfolio, before net items. Multifamily residential loans generally are originated on a one-year, adjustable rate basis. Commercial real estate loans, secured by properties such as office buildings, are generally one-year or three-year adjustable rate loans, and the interest rates and fees are often negotiated with the borrower.\nLoans secured by commercial and multi-family residential properties can involve greater risks than single-family residential mortgage lending. Such loans generally are substantially larger than single-family residential mortgage loans, and repayment of the loan generally depends on cash flow generated by the property. Because the payment experience on loans secured by such property is often dependent on successful operation or management of the security property, repayment of the loan may be subject to a greater extent to adverse conditions in the real estate market or the economy generally than is the case with one- to four-family residential mortgage loans. The commercial real estate business is cyclical and subject to downturns, overbuilding and local economic conditions. Eagle seeks to limit these risks in a variety of ways, including, among others, limiting the size of its commercial and multi-family real estate loans, generally requiring a personal guaranty from the borrower, limiting such loans to a lower maximum loan-to-value ratio and generally lending on the security of property located within its market areas. At September 30, 1994, multi-family residential and commercial real estate loans comprised 2.2% and 1.9%, respectively, of the total loan portfolio, before net items, compared to 2.8% and 1.6%, respectively, at September 30, 1993.\nConstruction Loans. Eagle makes a limited number of construction loans to individuals and, to a lesser extent, to professional builders who wish to construct one-to-four family residential properties, either as a primary residence or for investment or resale. The construction loans made by Eagle are typically construction\/permanent loans that automatically convert to a permanent first mortgage loan at the end of the construction phase. At September 30, 1994, construction loans totaled $7.1 million or 0.9% of the total mortgage loan portfolio of Eagle, before net items, compared to $5.7 million or 0.9% at September 30, 1993.\nConsumer Loans. At September 30, 1994, the consumer and second mortgage loan portfolio of Eagle included loans secured by deposit accounts, home improvement and home equity loans, education, personal and automobile loans and totaled $69.2 million or 8.4% of the total loan portfolio of Eagle before net items. The home equity loans and home improvement loans are secured by the equity in a borrower's home.\nLoan Originations. Loan originations come from a number of sources. Residential loan originations are attributable primarily to walk-in customers and referrals from real estate brokers and builders. From time to time Eagle also originates mortgage loans through independent mortgage brokers in Connecticut.\nEagle's adjustable rate mortgage loans are secured by property located primarily in Connecticut and are serviced by Eagle Federal. Short-term construction loan originations are obtained primarily from builders who have previously borrowed from Eagle Federal. Multi-family and commercial real estate loan originations are currently obtained primarily from direct contacts with Eagle. Eagle seeks to attract consumer loans by direct advertising and solicitation of its customers. Loan originations (excluding purchased loans and participations) were $219.9 million for the year ended September 30, 1994 compared to $209.9 million in fiscal 1993. Loan originations increased during 1994 due in large part to the high level of refinanced loan activity prompted by the low interest rate market. Also, in June 1994, the Bank acquired $80.8 million of loans in the Bank of Hartford transaction. See \"Lending Activities -- Purchase and Sale of Loans and Loan Servicing\" for information regarding Eagle's loan purchases.\nEagle makes single-family conventional first mortgage loans with up to a 95% loan-to-value ratio. In the case of loans with a higher loan-to-value ratio than 80%, the policy of Eagle is to require private mortgage insurance for a specified percentage of the amount of the outstanding principal balance of the loan. Eagle makes multi-family and commercial real estate loans with up to a 75% loan-to-value ratio. See \"Lending Activities -- Purchase and Sale of Loans and Loan Servicing.\"\nAll property securing real estate loans originated by Eagle is appraised by one of several professionally qualified appraisers who have been pre-approved by Eagle. For all real estate loans, Eagle requires the borrower to obtain fire and extended casualty insurance and, where appropriate, flood insurance and loss of rents coverage. Eagle also requires either title insurance or a title opinion from an attorney experienced with title matters.\nEagle issues 30 to 90-day commitments to prospective borrowers to make loans subject to various conditions. Loan commitments generally are issued for long-term loans to finance residential properties and for construction and combined construction\/permanent loans secured by multi-family residential and commercial properties. With respect to adjustable rate, single-family residential loans, it is the practice of Eagle to make commitments to lend at the rate of interest and the loan origination fee quoted to the borrower at the time of application. The proportion of the total value of commitments derived from any particular category of loan varies from time to time and depends on market conditions. At September 30, 1994 and September 30, 1993, loan commitments of $46.0 million and $36.8 million, respectively, were outstanding. These amounts include approximately $24.9 million and $19.5 million, respectively, in unadvanced home equity credit lines. The $24.9 million of loan commitments outstanding at September 30, 1994, which includes the unadvanced portion of home equity credit lines, represented only local originations.\nEagle encounters certain environmental risks in its lending activities. Under federal and state environmental laws, lenders may become liable for the costs of cleaning up hazardous materials found on security properties. Certain states may also impose liens with higher priorities than first mortgages on properties to recover funds used in such efforts. Although the foregoing environmental risks are more usually associated with industrial and commercial loans, environmental risks may be substantial for residential lenders, like Eagle Federal, since environmental contamination may render the security property unsuitable for residential use. In addition, the value of residential properties may become substantially diminished by contamination of nearby properties. In accordance with the guidelines of FNMA and FHLMC, appraisals for single-family homes on which Eagle Federal lends include comment on environmental influences and conditions. Eagle attempts to control its exposure to environmental risks with respect to loans secured by larger properties by training its underwriters to recognize the signs of environmental problems when they inspect properties; by requiring borrowers to represent and warrant that properties securing loans do not contain hazardous waste, asbestos or other such substances; by requiring borrowers to indemnify the lending bank, with personal recourse, against environmental losses; by obtaining environmental reviews and tests on all loans secured by nonresidential properties. No assurance can be given, however, that the value of properties securing loans in Eagle's portfolio will not be adversely affected by the presence of hazardous materials or that future changes in federal or state laws will not increase Eagle's exposure to liability for environmental cleanup.\nPurchase and Sale of Loans and Loan Servicing. Because available funds may from time to time exceed local loan demand, Eagle purchases mortgage loans and loan participations secured primarily by one-to four family residential properties throughout the United States although loan purchases in recent years have been minimal. The purchase of loans reduces certain administrative costs related to originating and servicing loans, and the purchase of adjustable rate loans has increased the interest sensitivity of the loan portfolio of Eagle. In June 1994, Eagle Federal acquired from The Bank of Hartford, $80.8 million of loans (substantially all of which were 1-4 family first mortgage and home equity loans) and an additional $3.5 million allowance for loan losses recorded in connection with such loans. Additionally, there were $2.5 million of loans purchased in 1994 and no loans purchased in fiscal 1993. At September 30, 1994, $29.6 million, or 3.6% of total loans receivable, before net items, consisted of purchased loans and loan participations, compared to 5.3% at September 30, 1993 and 7.3% at September 30, 1992.\nThere can be significant risks associated with the purchase of loans secured by properties located outside a savings institution's local lending territory. The purchaser may be unfamiliar with the local economy in the area where the security properties are located and is generally dependent on the loan seller to service the loan and deal with delinquencies and foreclosures. In order to reduce the risks associated with purchased loans, Eagle employs a variety of criteria in evaluating the possible purchases of loans. Under such criteria, Eagle seeks to purchase loans: (i) in diverse geographic areas; (ii) secured by one-to-four family, owner-occupied residences; and (iii) generally in accordance with underwriting standards set by FNMA and FHLMC. Each loan proposed for purchase is generally reviewed to determine whether the loan complies with underwriting practices, and a physical inspection of properties is made where management believes such inspection is warranted. In addition, loans are generally purchased from many different sellers, including other savings institutions and mortgage companies.\nIn recent years, Eagle generally has discontinued its practice of purchasing real estate development loans and participations. A limited amount of loans of this type were purchased in 1984, and at September 30, 1994 real estate acquired through foreclosure (or by deed in lieu of foreclosure) included no property resulting from these out-of-state real estate development loan purchases. Of the $29.6 million of purchased loans and loan participations in Eagle's loan portfolio at September 30, 1994, approximately $26.6 million or 89.9% were secured by one- to-four family residential properties.\nAs of September 30, 1994, $29.6 million, or 3.6%, of Eagle's total loan portfolio was serviced by others. In addition to servicing its own loans, Eagle services loans owned by others, which loans had a balance at September 30, 1994 and 1993 of $95.1 million and $11.8 million, respectively. Included in the September 30, 1994 balance of loans serviced for the benefit of others are approximately $80.5 million of mortgage loans for which Eagle purchased servicing rights in connection with the Bank of Hartford acquisition. Servicing fees have not historically been a significant source of income for Eagle.\nWhile Eagle has not sold a significant amount of loans in recent years, the Company sold $10.0 million of residential, fixed rate mortgage loans to the Federal Home Loan Mortgage Corporation in fiscal 1994. The primary purpose for the loan sale was to maintain an acceptable level of fixed rate loans in Eagle's overall loan portfolio.\nThe table below shows Eagle's mortgage loan origination, purchase, sale and repayment activities for the periods indicated.\nConsumer Loan Activities. The following table shows consumer loan originations and principal reductions of Eagle for the periods indicated.\nFee Income from Lending Activities. Currently, Eagle charges origination fees ranging from no fee to 2% of the amount of the loan, depending on the type of loan involved. Higher fees may be charged for construction financing or for loans secured by properties which are not owner-occupied. Fees for loan modifications, late payments, changes of property ownership and for related miscellaneous services are also charged. Income realized from these activities can vary significantly with the volume and type of loans in the portfolio and in response to competitive factors.\nLoan origination fees and certain direct loan origination costs are being deferred and the net amount amortized as an adjustment to the related loan's yield. This amount is generally amortized over the contractual life of the related loans. At September 30, 1994, Eagle had deferred net loan fees of $2.3 million.\nUsury Limitations. Federal legislation first enacted in 1980 has preempted all state usury laws concerning residential first mortgage loans unless the state legislature acted to override the preemption by April 1, 1983. The Connecticut State Legislature did not act to override the federal preemption. Connecticut law imposes no ceiling on interest rates on the types of loans currently originated by Eagle Federal.\nNon-performing Assets\nAll mortgage and home equity loans generally are placed on a non-accrual basis when a loan is contractually delinquent for more than three complete calendar months, when collectability is doubtful or when legal action has been instituted. Unsecured consumer loans are placed on a non-accrual basis when a payment default has existed for more than 60 days or when collectability is doubtful or when legal action has been instituted; such loans are fully charged-off when a payment default has existed for 90 days.\nAt September 30, 1994, the Company's total non-performing assets, including non-performing (or non-accrual) loans, real estate owned as a result of foreclosure or deed in lieu thereof and in-substance foreclosures, was $12.3 million or 1.15% of total assets. Non-performing assets were $9.1 million or .85% of total assets (without giving effect to the $3.2 million of non-performing assets relating to the Bank of Hartford transaction). This compares to non-performing assets of $12.0 million, or 1.51% of total assets, at September 30, 1993 and $10.4 million, or 1.38% of total assets, at September 30, 1992. Exclusive of the non-performing assets acquired in the Bank of Hartford transaction, the amount of non-performing assets has declined during fiscal 1994. Management believes this trend reflects the stabilization in the real estate market and economy in Connecticut over the past 12-18 months.\nThe following table sets forth information regarding Eagle's non-performing assets at the dates indicated. At each date indicated, Eagle had no troubled debt restructurings.\nAt September 30, 1994, non-performing assets (including the $3.2 million relating to the Bank of Hartford transaction) included $8.0 million in non-performing loans (consisting of loans delinquent 90 days or more) and $4.3 million in real estate owned and in-substance foreclosures. Approximately $37,000 in interest income was recognized on non-performing loans during the year ended September 30, 1994. If these loans had been performing in accordance with their original terms, approximately $503,000 would have been received during fiscal 1994. At September 30, 1993, non-performing assets included $6.5 million in non-performing loans and $5.5 million in real estate owned and in-substance foreclosures. At September 30, 1992, non-performing assets included $4.0 million in non-performing loans and $6.4 million in real estate owned and in-substance foreclosures.\nAlthough the level of non-performing loans declined in the year ended September 30, 1994 (before giving effect to the non-performing loans acquired in the Bank of Hartford transaction), management expects a number of the non-performing loans to become real estate owned. The overall level of real estate owned will depend on the number of loans which can be resolved prior to foreclosure and the ability of Eagle to sell properties which it owns. The Company strives to aggressively market properties and has been able to decrease the level of real estate owned during fiscal 1994.\nWith respect to mortgage loans, when a borrower fails to make a required payment by the 15th day after payment is due, Eagle attempts to cause the deficiency to be cured by corresponding with the borrower. If the deficiency continues, Eagle corresponds further with the borrower and, through telephone calls and letters, attempts to determine the reason for and cure the delinquency. If the deficiency cannot be cured, Eagle generally institutes appropriate legal action through an approved collection attorney. Real estate acquired through foreclosure or by deed in lieu of foreclosure is placed on the books at the lower of the carrying value of the loan or the fair market value of the real estate based upon a current appraisal, less selling costs. Any reduction below the value previously recorded on the books is charged against income or against a valuation reserve. Any loss in excess of the reserve is charged against income. With respect to consumer loans, the borrower receives correspondence from Eagle after the loan is 10 to 15 days past due. If it appears, after further communications with the borrower, that the delinquency cannot be cured, legal action is instituted. These procedures may be accelerated further in certain cases, such as chronic delinquencies or unsecured loans.\nAt September 30, 1994, real estate acquired in settlement of loans and in-substance foreclosures had a book balance of $4.3 million, most of which is in residential properties except for three local pieces of commercial real estate with an aggregate book value of $486,000.\nAllowance for Loan Losses\nAt September 30, 1994, Eagle's allowance for loan losses totaled $8.3 million, compared to $5.0 million at September 30, 1993, and $4.0 million at September 30, 1992. During the year ended September 30, 1994, in addition to a $1.2 million provision for loan losses, Eagle increased the allowance by $3.5 million in connection with the acquisition of $80.6 million of loans in the Bank of Hartford transaction. During fiscal 1992, in addition to a $1.6 million provision for loan losses, Eagle increased the allowance by $1.8 million in connection with the acquisition of $86.8 million of loans in the Danbury Federal transaction.\nThe following table sets forth an analysis of the Bank's allowance for loan losses for the periods indicated.\nManagement monitors the adequacy of the allowance for loan losses and periodically makes additions in the form of provisions for loan losses based upon an ongoing assessment of the loan portfolio. These provisions are based on an evaluation of the loan portfolio, past loan loss experience, current market and economic conditions, volume, growth and composition of the loan portfolio, and other relevant factors. The provisions are computed quarterly based on a review of the loan portfolio. The additional $3.5 million and $1.8 million of allowance for loan losses that were booked as part of The Bank of Hartford and Danbury Federal transactions, respectively, were based on management's evaluation of the loans acquired in these transactions. Such evaluation included an analysis of the loss on all delinquent loans as well as the risk of the remaining 1-4 family and consumer loans acquired. The additional allowances were accounted for as an adjustment to the premium paid by Eagle in The Bank of Hartford and Danbury Federal transactions.\nThe following table presents an allocation of Eagle's allowance for loan losses by loan category and presents the percent of each loan category to the total loan portfolio at the dates indicated.\nThe ratio of allowance for loan losses to non-performing loans was 104%, 77% and 100% at September 30, 1994, September 30, 1993 and September 30, 1992, respectively. This coverage ratio will vary from time to time based upon the composition of, and management's analysis of the risk elements in the loan portfolio, as well as the composition of problem loans. The allowance for loan losses is not based on a percentage of non-performing loans, but on the total portfolio classified by risk group plus estimated losses on individual problem loans. The following table sets forth the amount of accruing loans delinquent 60-89 days, the amount of non-accrual loans, the balance of the Company's allowance for loan losses and the coverage ratio of such allowance to the total of loans at the dates indicated. See \"-Non-performing Assets\" above for definition of non-accrual loans.\nAt September 30, 1994, loans delinquent 60 days or more (including non-performing loans) totaled $5.9 million (before giving effect to $3.6 million of such loans acquired in the Bank of Hartford transaction), compared to $8.9 million at September 30, 1993 and $6.3 million at September 30, 1992. Eagle's progress in reducing loans delinquent 60 days or more during fiscal 1994 is attributable to a stabilized Connecticut economy coupled with the Bank's increased collection efforts earlier in the collection cycle.\nVarious regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for losses on loans and real estate owned. Such agencies may require the Bank to recognize additions to the allowances based on their judgments of information available to them at the time of their examination. The OTS completed a regularly scheduled examination of the Bank during 1994 and no changes to the allowance for loan losses were required at that time.\nInvestment Activities\nFederally chartered savings institutions have authority to invest in various types of liquid assets, including United States Treasury obligations, securities of federal agencies, certificates of deposit of federally insured banks and savings institutions, bankers' acceptances and federal funds. Subject to various restrictions, federally chartered savings institutions may also invest a portion of their assets in commercial paper, corporate debt securities, and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly. Federal laws and regulations also require savings institutions to maintain liquid assets at minimum levels which vary from time to time. See \"Regulation -- Savings Institution Regulation -- Liquidity.\" Eagle Federal purchases debt securities with the intent and the ability to hold such securities to maturity for the purpose of earning interest income.\nEagle, as a Delaware corporation, has authority to invest in any type of investment permitted under Delaware law. As a savings and loan holding company, however, Eagle's investments are subject to certain regulatory restrictions described under \"Regulation -- Savings and Loan Holding Company Regulation.\" Eagle Federal maintains an investment portfolio that provides not only a source of income but also a source of liquidity to meet lending demands and fluctuations in deposit flows. The relative mix of investment securities and loans in these investment portfolios is dependent upon management's judgment from time to time as to the attractiveness of yields available on loans as compared to investment securities. Neither Eagle, nor Eagle Federal invest in below-investment grade corporate bonds and notes.\nThe Company's total holdings of mortgage-backed and investment securities increased to $182.9 million at September 30, 1994 from $88.4 million at September 30, 1993, having previously decreased from $117.7 million at September 30, 1992. The increase from fiscal year end 1993 to 1994 reflects the purchase of investment securities funded with matching FHLB advances, as well as the acquisition of $72.7 million of investment securities, substantially all of which are U.S. Treasury and agency securities, in the Bank of Hartford transaction. The decrease from fiscal year end 1992 to 1993 reflects the use of proceeds from maturities and amortization, as well as the sale of $12.0 million of investment securities, to fund the Bank's strong loan origination activity in 1993.\nThe Company's investment securities portfolio at September 30, 1994 was comprised primarily of U.S. Treasury and government agency securities and other investment securities rated in the top grade by at least one nationally recognized rating agency. Mortgage-backed securities are investments generally secured by pools of government-insured or government-guaranteed, fixed rate or adjustable rate mortgage loans. The payments of interest and principal on such loans are passed through to the securities holders after deducting a servicing fee. The collateralized mortgage obligation portion of the investment portfolio contains no derivative investment securities such as interest only tranches, principal only tranches or strips. The mortgage-backed securities held by Eagle are subject to interest rate and prepayment risks customarily associated with such securities. The average weighted life of mortgage-backed securities will differ from contractual maturities, depending upon the rate of prepayments. Borrowers on the underlying mortgages may have the right to prepay their loans with or without prepayment penalties. In a declining interest rate environment, more borrowers than would otherwise be anticipated may choose to prepay their loans in order to refinance the loans at lower rates. As a result, the actual yield on mortgage-backed securities may be less than the expected yields based upon prepayment experience.\nAt September 30, 1994, there were no investments in any issuer, excluding securities of the U.S. government and its agencies and corporations, the aggregate book value or market value of which exceeded 10% of Eagle's shareholders' equity.\nThe following table sets forth the composition of Eagle's mortgage-backed and investment securities portfolio at the dates indicated.\nThe following table sets forth the maturities of Eagle's mortgage- backed and investment securities at September 30, 1994 and the weighted average yields of such securities. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.\nThe aggregate carrying amounts and market values of Eagle's mortgage-backed and investment securities at September 30, 1994 are as follows:\nSources of Funds\nGeneral. Deposits are the primary source of funds for use in the lending and investment activities of Eagle. In addition, funds are derived from loan payments (including interest, amortization of principal and prepayments), earnings on investments, maturing investments and FHL Bank advances. Historically, Eagle has not relied on sales of loans and investment securities as sources of funds. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by prevailing interest rates on alternative products and general economic conditions. Borrowings may be used on a short-term basis to compensate for reductions in normal sources of funds or on a longer term basis to support expanded lending activities.\nDeposits increased to $948.8 million at September 30, 1994 from $706.2 million at September 30, 1993 and $677.7 million at September 30, 1992. The growth in deposits includes the July 1993 purchase of a banking office located in Brookfield, Connecticut with $8.2 million in deposits and the assumption of $272.8 million of deposits of the Bank of Hartford in June 1994. Total borrowings increased to $39.6 million at September 30, 1994 from $16.3 million at September 30, 1993 and $7.3 million at September 30, 1992. The increase in borrowed money in fiscal 1994 and in fiscal 1993 reflects the use of FHLB advances to fund a portion of loan originations and to purchase investment securities with matching durations. Loan originations also were funded with loan repayments and deposits.\nDeposit Activities. Eagle has developed a variety of deposit products ranging in maturity from demand-type accounts to certificates with maturities of up to five years. Deposits are primarily derived from the areas in which the offices of Eagle Federal's are located. Eagle does not actively solicit deposits outside the State of Connecticut or use brokers to obtain deposits. Eagle does occasionally use premiums and promotions to attract deposits.\nIn response to the low interest rate environment during the first part of 1994, the trend by depositors at Eagle was to withdraw funds in maturing short-term certificates (original term of one year or less) and either extend the term of their certificate to obtain a higher yield or transfer the funds into a money market or passbook account in anticipation of a future rise in interest rates. More recently, as interest rates have risen, depositors have begun to shift funds out of money market and passbook accounts. The deregulation of various federal controls on insured deposits has allowed Eagle to be more competitive in the acquisition and retention of funds, but has also resulted in a more volatile cost of funds. Federal regulations no longer require Eagle to impose interest penalties for early withdrawal of deposits. However, to assist in maintaining the maturity and cost structure of their deposits, Eagle continues to impose such penalties. The deposit accounts offered by Eagle are reviewed on a systematic basis in order to determine whether such accounts continue to meet asset\/liability management goals. Eagle attempts to control the flow of funds in its deposit accounts according to the need for funds and the cost of alternative sources of funds. The flow of funds is controlled primarily by the pricing of deposits, which is influenced to a large extent by competitive factors in the market area. Interest rates paid by Eagle generally are competitive with the rates offered by other institutions in its primary market areas. Eagle has maintained a strong liquidity position and has generally maintained its deposit base, but has not actively competed for deposits when funds were available from other sources or when its existing funds were sufficient to meet their liquidity needs.\nThe following table describes the deposit accounts offered by Eagle at September 30, 1994.\nEagle prices its deposits to take advantage of opportunities for profitable investment of the funds through regular lending activities, and to a lesser amount to encourage deposits in longer term accounts. Interest rates are primarily based on prevailing market conditions, the need for funds and ability to pay.\nThe following table sets forth the deposit flows for Eagle during the periods indicated.\nThe following table sets forth the deposit accounts of Eagle in dollar amounts and as percentages of total deposits at the dates indicated.\nThe following table presents, by various interest rate categories, the amounts of certificate accounts at Eagle as of the dates indicated.\nAt September 30, 1994 1993 ---- ---- (In thousands)\nLess than 4.01%..................................... $ 228,638 $ 171,582 4.01 - 6.00%........................................ 253,076 111,486 6.01-10.00%......................................... 55,269 104,119 ------ ------- $ 536,983 $ 387,187 ======= =======\nThe following table sets forth the amount and remaining maturities by interest rate of time deposits at September 30, 1994.\nCertain information regarding the deposit accounts at Eagle in amounts of $100,000 or more at September 30, 1994 is shown in the table below.\nBorrowings. The FHL Bank System functions in a reserve credit capacity for savings institutions and certain other home financing institutions. Members of the FHL Bank System are required to own capital stock in the FHL Bank. Members are authorized to apply for advances on the security of such stock and certain of their home mortgages and other assets (principally securities which are obligations of, or guaranteed by, the United States) provided certain creditworthiness standards have been met. See \"Regulation -- Federal Home Loan Bank System.\" Under its current credit policies, the FHL Bank limits advances based on the value of a member's qualified collateral that has not been pledged to outside sources. Historically, Eagle Federal has not relied on FHL Bank advances and other borrowings to any significant extent as a source of funds. At September 30, 1994, Eagle Federal had authority to borrow up to $613 million from the FHL Bank of Boston, and will continue to use this source of funds. Outstanding FHL Bank advances at September 30, 1994 totaled $31.8 million compared to $15.5 million at September 30, 1993 and $5.5 million at September 30, 1992. The weighted average interest rate on FHL Bank advances outstanding at September 30, 1994, 1993 and 1992 was 5.44%, 5.91% and 7.82% respectively.\nEagle had an average outstanding balance in short-term advances (i.e. maturing in one year or less) of approximately $3.9 million, $8.5 million and $2.2 million during fiscal 1994, 1993 and 1992, respectively, at approximate weighted-average interest rates of 5.26%, 7.58% and 8.75%, respectively. The maximum amount outstanding at any month-end during fiscal 1994, 1993 and 1992 was $31.8 million, $15.5 million and $8.5 million, respectively.\nOn a consolidated basis, Eagle had other borrowed money in the amount of $7.8 million at September 30, 1994 compared to $752,000 at September 30, 1993. The 1994 figure includes a $7.4 million reverse repurchase agreement maturing on October 26, 1994 at a cost of 5.09%, and $467,000 of payments due on Eagle's ESOP loans at an average cost of 7.50%. The 1993 figure represents $752,000 of payments due on Eagle's ESOP loans at an average cost of 5.78%. In April 1987, Eagle's ESOP borrowed $1.2 million to fund the purchase of 100,000 shares of newly issued Eagle stock. The term note matures in 1997 with interest due quarterly at 82.5% of the lender's floating prime rate. In 1991, the ESOP borrowed an additional $759,000 to purchase shares of the Company's outstanding common stock under a term note maturing in 1997 with interest due quarterly at the lender's floating prime rate plus .25%. Eagle and Eagle Federal have the discretion to make contributions to the ESOP each year. Eagle Federal intends to make annual contributions to the ESOP equal to the debt service of the borrowings by the ESOP. Eagle has guaranteed the payment of the loans and secured that guarantee with certain marketable securities.\nThe following table sets forth the amount of interest-earning assets and interest-earning liabilities outstanding as of September 30, 1994 which are expected to mature or reprice in each of the time periods shown:\nThe following assumptions were determined by management in order to prepare the gap table set forth above. Non-amortizing investment securities are shown in the period in which they contractually mature. The table generally assumes a 15% annual prepayment rate for adjustable-rate, residential mortgage loans based on the Bank's historical prepayment experience. A 10% rate generally is assumed for 30 year fixed-rate mortgages, based primarily on the Bank's historical prepayment rates for such loans. All other residential and non-residential mortgages are assigned an annual prepayment rate based on the Bank's historical experience. Estimated decay rates on all deposit accounts are based primarily upon the Bank's historical experience.\nThe interest rate sensitivity of the Company's assets and liabilities could vary substantially if different assumptions were used or if actual experience differs from the assumptions used. For example, if all passbook deposits were assumed to reprice in one year or less, the Company's one-year cumulative gap to total assets would be negative 10.9%\nThe following table sets forth certain information relating to the Company's average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and the average cost of liabilities for the periods and at the dates indicated. During the periods indicated, non-accrual loans are included in the loans receivable category.\nThe following table allocates the period-to-period changes in the Company's various categories of interest income and interest expense between changes due to changes in volume (calculated by multiplying the change in average volume of the related interest-earning asset or interest-bearing liability category by the prior year's rate), changes due to changes in rate (change in rate multiplied by prior year's volume) and changes due to changes in rate-volume (changes in rate multiplied by changes in volume).\nThe Company's dividend payout ratio (i.e., dividends declared per share divided by net income per share) was 32.48%, 31.98% and 32.35% for the fiscal years ended 1994, 1993 and 1992, respectively. Information concerning the Company's return on assets, return on equity and equity to assets ratio for fiscal 1994, 1993 and 1992 is included the selected financial information incorporated by reference under Item 6 below.\nService Corporation Activities\nFederal regulations permit a federally chartered savings institution to invest an amount up to 2% of its assets in the stock, paid-in surplus, and unsecured obligations of subsidiary service corporations engaged in certain activities, and an additional 1% of its assets when the additional funds are used primarily for community or inner-city development or investment. In addition, federal regulations generally authorize such institutions which meet minimum regulatory capital requirements to invest up to 50% of regulatory capital in conforming first mortgage loans to service corporations. At September 30, 1994, Eagle Federal's direct investment (capital stock) in its service corporation, Eagle Service Corp., was $1,000. Eagle Service Corp. administers the securities brokerage and investment services made available to Eagle Federal's customers.\nEmployees\nAt September 30, 1994, Eagle had 376 employees (including 108 part-time employees), all of whom are employed by Eagle Federal. None of these employees are represented by a collective bargaining group. Employee benefits for full-time employees include reimbursement of approved, business-related educational expenses, a pension plan and life, health and disability insurance. Management considers that Eagle's relations with its employees are good.\nMARKET AREA AND COMPETITION\nEagle Federal is headquartered in Bristol, Connecticut and conducts business from four offices in Bristol, two offices in Hartford, and one office each in Avon, Bloomfield, Canton, Rocky Hill and West Hartford (all of which are in Hartford County), three offices in Danbury, two offices in Torrington, one office each in Litchfield, Terryville and Winsted (all of which are in Litchfield County), and one office each in Brookfield, New Fairfield, Ridgefield and Newtown (all of which are in Fairfield County). Bristol, located in central Connecticut 18 miles west of Hartford, is a city of approximately 60,000 people with a broad-based economy. Over 100 manufacturing firms of all sizes operate in or near Bristol. The city of Torrington is located 27 miles west of Hartford at the northern end of the Route 8 corridor which runs from the northwest corner of Connecticut to the New Haven and Bridgeport metropolitan areas. Torrington has an estimated population of 30,000 and is the largest city in Litchfield County. Torrington benefits from its close proximity to the Hartford metropolitan area. Danbury is located in the far western portion of Fairfield County. Danbury has a population of approximately 60,000 and has a broad-based economy. Hartford, the capital of Connecticut, has a population of approximately 140,000 and is the governmental and economic center of Central Connecticut.\nEagle Federal faces substantial competition for deposits and loans throughout its market area. The primary factors stressed by Eagle Federal in competing for deposits are interest rates, personalized services, the quality and range of financial services, convenience of office locations and office hours. Competition for deposits comes primarily from other savings institutions, commercial banks, credit unions, money market funds and other investment alternatives. The primary factors in competing for loans are interest rates, loan origination fees, the quality and range of lending services and personalized service. Competition for origination of first mortgage loans comes primarily from other savings institutions, mortgage banking firms, commercial banks and insurance companies. In Torrington, competition for loans and deposits comes primarily from other savings institutions as well as from mortgage companies headquartered outside Torrington which are active in the area. Eagle Federal experiences more intense competition in the Canton area, in part as a result of the larger number of financial institutions in operation there and its closer proximity to Hartford. Eagle Federal competes with three commercial banks and thrift institutions headquartered in Bristol, as well as with out-of-state financial institutions which have opened loan production facilities (especially mortgage banking offices) in the Bristol area. In Danbury, Eagle Federal competes with three other local savings institutions along with many commercial banks and credit unions.\nThe Connecticut Interstate Banking Act permits Connecticut bank holding companies to engage in stock acquisitions of depository institutions in other New England states with reciprocal legislation. All New England states currently have some form of reciprocal legislation. This law also allows bank holding companies from any state to establish non-bank offices (including loan production offices) in Connecticut on a limited basis. The United States Supreme Court has upheld the Connecticut statute, as well as a similar Massachusetts law. Several interstate mergers involving large Connecticut banks and banks headquartered in Massachusetts have since been completed. The impact of such mergers (and of the possible increase in the number or size of the financial institutions in its market area) may be to significantly increase the competition faced by Eagle. The Connecticut legislature also has enacted legislation which reduces the home office protection enjoyed by Connecticut-chartered savings institutions and commercial banks. This and other legislative and regulatory changes may increase the size of the banking institutions competing in the general market area of Eagle.\nThe OTS's statement of policy on branching by federally chartered savings institutions permits a federal association to branch into any state or territory of the United States, except as otherwise prohibited under federal law. The OTS statement of policy expressly preempts any contrary state law. Under the OTS's prior policy statement, a federal savings institution could only branch across state lines to the same extent permitted under state law to a state-chartered institution. These provisions may increase competition from other financial institutions within Eagle Federal's market area.\nThe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (\"FIRREA\") expressly authorizes the Federal Reserve Board to approve acquisitions of savings institutions by bank holding companies, and prohibits the Federal Reserve Board from imposing restrictions on transactions between the acquired savings institution and its holding company affiliates, except as otherwise required by applicable statutes (such as the statutory restrictions on transactions between a bank and its affiliates set forth in the Federal Reserve Act. See \"Regulation -- Savings and Loan Holding Company Regulation\"). Additionally, FIRREA permits the acquired savings institution to be converted to a bank, or merged with a bank subsidiary of the acquiring bank holding company, under certain circumstances. These provisions of FIRREA have increased competition from other financial institutions within the market area of Eagle.\nEffective September 29, 1995, the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (\"IBBEA\"), amends the Bank Holding Company Act of 1956 (the \"BHCA\") to permit a bank holding company to acquire a bank located in any state, provided that the acquisition does not result in the bank holding company controlling more than 10% of the deposits in the United States, or 30% of deposits in the state in which the bank to be acquired is located (unless the state waives the 30% deposit limitation). IBBEA permits individual states to restrict the ability of an out-of-state bank holding company or bank to acquire an in-state bank that has been in existence for less than five years and to establish a state concentration limit of less than 30% if such reduced limit does not discriminate against out-of-state bank holding companies or banks.\nEffective June 1, 1997, an \"adequately capitalized\" bank, with the approval of the appropriate federal banking agency, may merge with another adequately capitalized bank in any state that has not opted out of interstate branching and operate the target's offices as branches if certain conditions are satisfied. The same national (10%) and state (30%) deposit concentration limits and any applicable state minimum-existence restrictions (up to a maximum of 5 years) apply to interstate mergers as to interstate acquisitions. The applicant also must comply with any nondiscriminatory host state filing and notice requirements and demonstrate a record of compliance with applicable federal and state community reinvestment laws. A state may opt out of interstate branching by enacting a law between September 29, 1994 and June 1, 1997 expressly prohibiting interstate merger transactions.\nUnder IBBEA, the resulting bank to an interstate merger may establish or acquire additional branches at any location in a state where any of the banks involved in the merger could have established or acquired a branch. A bank also may acquire one or more branches of an out-of state bank without acquiring the target out-of-state bank if the law of the target's home state permits such a transaction. In addition, IBBEA permits a bank to establish a de novo branch in another state if the host state by statute expressly permits de novo interstate branching.\nIBBEA also permits a bank subsidiary of a bank holding company to act as agent for other depository institutions owned by the same holding company for purposes of receiving deposits, renewing time deposits, closing or servicing loans, and receiving loan payments effective as of September 29, 1995. Under IBBEA, a savings association may perform similar agency services for affiliated banks to the extent that the savings association was affiliated with a bank on July 1, 1994 and satisfies certain additional requirements.\nThe foregoing provisions of IBBEA are expected to further increase competition within Eagle's existing market area.\nREGULATION\nGeneral\nThe Company, as a savings institution holding company, and the Bank, as a federally chartered savings bank, are subject to extensive regulation, supervision and examination by the OTS as their primary federal regulator. The Bank is also subject to regulation, supervision and examination by the FDIC and as to certain matters by the Board of Governors of the Federal Reserve System (the \"Federal Reserve Board\").\nIn recent years there have been a significant number of changes in the manner in which insured depository institutions and their holding companies are regulated. Such changes have imposed additional regulatory restrictions on the operations of insured depository institutions and their holding companies. In particular, regulatory capital requirements for insured depository institutions have increased significantly. The Federal Deposit Insurance Corporation Improvement Act of 1991 (the \"FDICIA\") requires the bank regulatory agencies to impose certain sanctions on insured depository institutions which fail to meet minimum capital requirements. In addition, the deposit premiums paid by insured depository institutions have increased significantly in recent years and will most likely increase in the future.\nSavings and Loan Holding Company Regulation\nGeneral. Under the Home Owners Loan Act (the \"HOLA\"), the Director of the OTS has regulatory jurisdiction over savings and loan holding companies. Eagle, as a savings and loan holding company within the meaning of the HOLA, is subject to regulation, supervision and examination by, and the reporting requirements of, the Director of the OTS.\nThe HOLA prohibits a savings and loan holding company such as Eagle, directly or indirectly, or through one or more subsidiaries, from (i) acquiring control of, or acquiring by merger or purchase of assets another savings institution or savings and loan holding company without the prior written approval of the Director of the OTS; (ii) acquiring more than 5% of the issued and outstanding shares of voting stock of another savings institution or savings and loan holding company (subject to certain limited exceptions); or (iii) acquiring or retaining control of a financial institution that does not have SAIF or BIF insurance of accounts. The HOLA also allows the Director of the OTS to approve transactions resulting in the creation of multiple savings and loan holding companies controlling savings institutions located in more than one state in both supervisory and non-supervisory transactions, subject to the requirement that, in non-supervisory transactions, the law of the state in which the savings institution to be acquired is located must specifically authorize the proposed acquisition, by language to that effect and not merely by implication. As a result, the Company may, with the prior approval of the Director of the OTS, acquire control of savings institutions located in states other than Connecticut if the acquisition is expressly permitted by the laws of the state in which the savings institution to be acquired is located. Restrictions relating to service as an officer or director of an unaffiliated holding company or savings institution are applicable to the directors and officers of Eagle and its savings institution subsidiaries under the Depository Institutions Management Interlocks Act.\nRestrictions on Activities of Multiple Savings and Loan Holding Companies. As a unitary holding company, the Company generally is not restricted under existing laws as to the types of business activities in which it may engage, provided that Eagle Federal continues to qualify as qualified thrift lender (\"QTL\"). Eagle could be prohibited from engaging in any activity (including those otherwise permitted under the HOLA) not allowed for bank holding companies if Eagle fails to constitute a QTL. See \"Regulation -- Savings Institution Regulation -Qualified Thrift Lender Requirement.\"\nIf Eagle subsequently becomes a multiple savings and loan holding company, Eagle would be prohibited from engaging in any activities other than (i) furnishing or providing management services for its subsidiary savings associations; (ii) conducting an insurance agency or escrow business; (iii) holding, managing or liquidating assets owned or acquired from its subsidiary savings associations; (iv) holding or managing properties used or occupied by its subsidiary savings associations; (v) acting as trustee under deeds of trust; (vi) engaging in any other activity in which multiple savings and loan holding companies were authorized by regulation to engage as of March 5, 1987; and (vii) engaging in any activity which the Federal Reserve Board by regulation has determined to be permissible for bank holding companies under Section 4(c) of the BHCA (unless the Director of the OTS, by regulation, prohibits or limits any such activity for savings and loan holding companies). The activities in which multiple savings and loan holding companies were authorized by regulation to engage as of March 5, 1987, consist of activities similar to those permitted for service corporations of federally chartered savings institutions and include, among other things, various types of lending activities, furnishing or performing clerical, accounting and internal audit services primarily for affiliates, certain real estate development and leasing activities and underwriting credit life or credit health and accident insurance in connection with extension of credit by savings institutions or their affiliates. The activities which the Federal Reserve Board by regulation has permitted for bank holding companies under Section 4(c) of BHCA generally consist of those activities that the Federal Reserve Board has found to be so closely related to banking or managing or controlling banks as to be a proper incident thereto, and include, among other things, various lending activities, certain real and personal property leasing activities, certain securities brokerage activities, acting as an investment or financial advisor subject to certain conditions, and providing management consulting to depository institutions subject to certain conditions. OTS regulations do not limit the extent to which savings and loan holding companies and their non-savings institution subsidiaries may engage in activities permitted for bank holding companies pursuant to section 4(c)(8) of the BHCA, although prior OTS approval is required to commence any such activity.\nSavings Institution Regulation\nGeneral. As a SAIF-insured savings institution, Eagle Federal is subject to supervision and regulation by the Director of the OTS. Under OTS regulations, Eagle Federal is required to obtain audits by an independent accountant and to be examined periodically by the Director of the OTS. Examinations must be conducted no less frequently than every 12 months. Eagle Federal is subject to assessments by the OTS and FDIC to cover the costs of such examinations. The OTS may revalue assets of Eagle Federal, based upon appraisals, and require the establishment of specific reserves in amounts equal to the difference between such revaluation and the book value of the assets. The Director of the OTS also is authorized to promulgate regulations to ensure the safe and sound operations of savings institutions and may impose various requirements and restrictions on the activities of savings institutions. See \"Safety and Soundness Regulations.\"\nEagle Federal, as a member of the SAIF, also is subject to regulation and supervision by the FDIC, in its capacity as administrator of the SAIF, to ensure the safety and soundness of the SAIF. See \"Regulation -- Savings Institution Regulation -- Insurance of Deposits.\"\nCapital Requirements. Eagle Federal is subject to the capital adequacy regulations adopted by the OTS. Eagle Federal's ability to pay dividends to the Company and expand its business can be restricted if its capital falls below levels established by the OTS. OTS capital regulations provide for three separate capital measures.\n(1) Tangible Capital Requirement. Each savings institution must maintain a level of tangible capital equal to at least 1.5% of its adjusted total assets (which, under OTS regulations, consist of the institution's total assets as determined on a consolidated basis in accordance with generally accepted principles, subject to certain adjustments). Tangible capital consists of common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, nonwithdrawable accounts and pledged deposits meeting certain regulatory criteria, and minority interests in the equity accounts of consolidated subsidiaries. In calculating tangible capital, savings associations are required to deduct from assets, and thus from capital, amounts invested in, and loaned to, subsidiaries engaged as principal in activities not permitted for national banks (subject to certain exceptions). Additionally, for purposes of calculating tangible capital, savings associations are required to deduct all intangible assets other than purchased mortgage servicing rights (subject to certain conditions) in an amount equal to the lesser of (i) 90% of their fair market value, (ii) 90% of their original cost or (iii) their amortized book value determined under generally accepted accounting principles.\n(2) Leverage Requirement. Each savings association must maintain a level of core or Tier 1 capital equal to at least 3% of its adjusted total assets. Core capital consists of the same components, and is determined in the same manner, as tangible capital, except that the following are not considered intangible assets for purposes of calculating core capital and, therefore, do not have to be deducted from assets (or thus from capital) in computing core capital: (i) certain amounts of supervisory goodwill (i.e., goodwill resulting from an acquisition of an insolvent or problem institution) existing as of April 12, 1989 and (ii) identifiable intangible assets that meet certain criteria establishing their separability, marketability and liquidity, but only in an amount of up to 25% of core capital. The Office of the Comptroller the Currency (the \"OCC\") has adopted a regulation indicating that only the most highly rated banks should maintain a leverage ratio of 3% and that most should instead maintain ratios of 4% or 5% of assets. The OTS issued but subsequently withdrew a proposed regulation that would have had the same effect. However, under the OTS prompt corrective action regulation (discussed below), all but the most highly rated savings associations must maintain a minimum of leverage ratio of 4% to be consider \"adequately capitalized\" and 5% or greater to be considered \"well capitalized\").\n(3) Risk-Based Capital Requirement. Each savings association must maintain a level of total capital equal to 8% of total risk-weighted assets and a minimum ratio of core capital to total risk-weighted assets of 4.0%. Total capital, for purposes of the risk-based capital requirement consists of the sum of core capital (as defined for purposes of the leverage requirement) and supplementary capital. Supplementary capital includes such items as cumulative perpetual preferred stock, long-term and intermediate-term preferred stock, subordinated debt, and general loan and lease loss allowances (but only in an amount up to 1.25% of total risk-weighted assets). The maximum amount of supplementary capital that may be counted towards satisfaction of the total capital requirement is limited to 100% of core capital. Additionally, in calculating total capital for purposes of the risk-based capital requirement, investments in equity securities, equity investments in real estate (other than real estate held for office facilities or acquired in satisfaction of a debt previously contracted in good faith), and that portion of land loans and non-residential construction loans in excess of an 80% loan-to-value ratio are required to be deducted from assets (and thus from capital). A savings association's risk-weighted assets are determined by (i) converting each of its off-balance sheet items to an on-balance sheet credit equivalent amount, (ii) assigning each on-balance sheet asset and the credit equivalent amount of each off-balance sheet liability to one of the five risk categories established in the OTS regulations, and (iii) multiplying the amounts in each category by the risk factor assigned to that category. The sum of the resulting amounts constitutes total risk-weighted assets.\nEffective January 1, 1994, the OTS revised its risk-based capital standard to incorporate an interest-rate risk component. Under the revised regulation, an institution is considered to have excess interest-rate-risk if, based upon a 200 basis point change in market interest rates, the market value of an institution's capital changes by more than 2%.\nCapital requirements higher than the generally applicable minimum requirement may be established for a particular savings institution if the OTS determines that the institution's capital was or may become inadequate in view of its particular circumstances. Individual minimum capital requirements may be appropriate where the savings institution is receiving special supervisory attention, has a high degree of exposure to interest rate risk, or poses other safety or soundness concerns. Effective December 15, 1994, the OTS revised its risk-based capital standards, pursuant to FDICIA, to provide that a savings association's concentration of credit risk and nontraditional activities would also be considered in determining whether a higher individual capital requirement should be imposed. No such requirement has been established for Eagle.\nThe following table sets forth the actual and required minimum levels of regulatory capital for Eagle Federal under applicable OTS regulations as of September 30, 1994.\nThe following is a reconciliation of Eagle Federal's equity capital under GAAP to regulatory capital at September 30, 1994.\nSanctions for Failing Capital Standards. Pursuant to FDICIA, the federal banking agencies have established by regulation, for each capital measure, the levels at which an insured institution is well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, and to take prompt corrective action with respect to insured institutions which fall below minimum capital standards. The degree of regulatory intervention mandated by FDICIA is tied to an insured institution's capital category, with increasing scrutiny and more stringent restrictions being imposed as an institution's capital declines. The prompt corrective actions specified by FDICIA for undercapitalized institutions include increased monitoring and periodic review of capital compliance efforts, a requirement to submit a capital plan, restrictions on dividends and total asset growth, and limitations on certain new activities (such as opening new branch offices and engaging in acquisitions and new lines of business) without OTS approval.\nSavings institutions that are \"significantly undercapitalized\" or \"critically undercapitalized\" are subject to additional restrictions under OTS regulations. The OTS generally will be required to appoint a conservator or receiver for a critically undercapitalized institution no later than 90 days after the institution becomes critically undercapitalized, subject to a limited exception for institutions that are in compliance with an approved capital restoration plan and the OTS and FDIC certify are not likely to fail.\nUnder the prompt corrective action regulation adopted by the OTS, an institution is considered (i) \"well capitalized\" if the institution has a total risk-based capital ratio of 10% or greater, a Tier 1 or core capital to risk-weighted assets ratio of 6% or greater, and a leverage ratio of 5% or greater (provided that the institution is not subject to an order, written agreement, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure); (ii) \"adequately capitalized\" if the institution has capital ratios described in clause (i) of 8%, 4% and 4%, respectively; (iii) \"undercapitalized\" if the institution has capital ratios described in clause (i) of less than 8%, 4% and 4%, respectively; (iv) \"critically undercapitalized\" if the institution has capital ratios described in clause (i) of less than 6%, 3% and 3%, respectively; and (v) \"critically undercapitalized\" if the institution has a ratio of tangible equity to total assets that is less than or equal to 2%. The regulation also permits the OTS to determine that a savings institution should be classified in a lower category based on other information, such as the institution's examination report, after written notice. At September 30, 1994, Eagle Federal met the requirements for a \"well-capitalized\" institution based on its capital ratios as of such date.\nUnder applicable FDIC regulations, only well-capitalized depository institutions may solicit and accept, renew or roll over any brokered deposit. Adequately-capitalized institutions may accept brokered deposits only after obtaining a waiver from the FDIC. Institutions that are not well capitalized (including those that meet minimum capital standards) are subject to limits on rates of interest they may pay on brokered and other deposits. In addition, institutions that are not well capitalized are subject to increased deposit insurance premium assessments. See \"Insurance of Deposits.\"\nFDICIA requires any company that has control of an \"undercapitalized\" depository institution, in connection with the submission of a capital restoration plan by the depository institution, to guarantee that the institution will comply with the plan and provide appropriate assurances of performance. The aggregate liability of any such controlling company under such guaranty is limited to the lesser of (i) 5% of the depository institution's assets at the time it became undercapitalized; or (ii) the amount necessary to bring the depository institution into capital compliance at the time the institution fails to comply with the terms of its capital plan. Under FDICIA, if Eagle Federal were to become \"undercapitalized\", the Company would be required to guarantee performance of any capital restoration plan submitted under FDICIA as a condition to OTS approval of that plan.\nAn institution which fails to meet applicable capital standards is required to give the OTS 30 days' notice of the appointment of any new director or senior executive officer. The OTS may disapprove any such appointment if the competence, experience or integrity of the individual indicates that it would not be in the best interests of the public to permit the appointment. Deficient capital may also result in suspension of an institution's deposit insurance.\nRestrictions on Dividends and Other Capital Distributions. The OTS capital distribution regulation places limits upon Eagle Federal's ability to pay dividends and make certain other capital distributions depending on its capital level and supervisory condition. For purposes of the OTS capital distribution regulation, a savings association is classified as a tier 1 institution, a tier 2 institution or a tier 3 institution, depending on its level of regulatory capital both before and after giving effect to a proposed capital distribution. A tier 1 institution (i.e., one that both before and after a proposed capital distribution has net capital equal to or in excess of its fully phased-in regulatory capital requirement applicable as of January 1, 1995) may, subject to any otherwise applicable statutory or regulatory requirements or agreements entered into with the regulators, make capital distributions in any calendar year up to 100% of its net income to date during the calendar year plus the amount that would reduce by one-half its \"surplus capital ratio\" (i.e., the percentage by which the association's capital-to-assets ratio exceeds the ratio of its fully phased-in capital requirement to its assets) at the beginning of the calendar year. No regulatory approval of the capital distribution is required, but prior notice must be given to the OTS. A tier 2 institution (i.e., one that both before and after a proposed capital distribution has net capital equal to its then-applicable minimum capital requirement but which fails to meet its fully phased-in capital requirement either before or after the distribution) may, after prior notice but without the approval of the OTS, make capital distributions of up to: (i) 75% of its net income over the most recent four quarter period if it satisfies the risk-based capital standard computed based on its current portfolio. In calculating an institution's permissible percentage of capital distributions, previous distributions made during the previous four quarter period must be included. Tier 2 institutions may not make capital distributions in excess of the above limitations without the prior written approval of the OTS. A tier 3 institution (i.e., one that either before or after a proposed capital distribution fails to meet its then-applicable minimum capital requirement) may not make any capital distributions without the prior written approval of the OTS. In addition, the OTS may prohibit a proposed capital distribution, which would otherwise be permitted by the regulation, if the OTS determines that such distribution would constitute an unsafe or unsound practice. Also, an institution meeting the tier 1 criteria which has been notified that it needs more than normal supervision will be treated as a tier 2 or tier 3 institution, unless the OTS deems otherwise. For purposes of this regulation, as of September 30, 1994, Eagle Federal believes that it qualifies as a tier 1 institution.\nFDICIA prohibits an insured depository institution from declaring any dividend, making any other capital distribution, or paying a management fee to a controlling person if, following the distribution or payment, the institution would be classified as undercapitalized. The OTS has indicated that it intends to review its existing capital distribution regulations to determine whether amendments are necessary based on FDICIA. The OTS has proposed amending its capital distribution regulation to incorporate certain definitions from its prompt corrective action regulation and to permit certain adequately capitalized savings associations with composite examination ratings of 1 or 2 that do not have a holding company to make capital distributions without notice to the OTS.\nSafety and Soundness Regulations. Under FDICIA, the OTS is required to prescribe safety and soundness regulations relating to (i) internal controls, information systems, and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) interest rate exposure; (v) asset growth; and (vi) compensation and benefit standards for officers, directors, employees and principal shareholders. The HOLA requires that all regulations and policies of the Director of the OTS for the safe and sound operations of savings institutions are to be no less stringent than those established by the OCC for national banks. The OTS has proposed safety and soundness regulations that contain general guidelines relating to the foregoing operational, managerial and compensation issues that holding companies and insured depository institutions are to follow to ensure that they are operating in a safe and sound manner. The proposed safety and soundness regulations also require that an institution continue to meet minimum capital standards assuming that any losses experienced over the past four quarters were to continue over the next four quarters. If an institution has an aggregate net loss over the past four quarters, the institution's capital ratios would be recalculated under the assumption that those losses will continue over the next four quarters. Eagle Federal reported net income for each quarter in fiscal 1994.\nFDICIA also requires the bank regulations to adopt regulations specifying: (i) a maximum ratio of classified assets to capital; (ii) minimum earnings sufficient to absorb losses without impairing capital; and (iii) to the extent feasible, a minimum ratio of market value to book value for publicly traded shares of institutions and holding companies. The proposed safety and soundness regulations would establish a maximum ratio of classified assets to total capital (which for this purpose would include any allowances for loan losses that would otherwise be excluded from total capital under the risk-based capital guidelines) of 1.0. For purposes of the proposed regulation, classified assets include assets classified as substandard, doubtful and loss (but only to the extent that losses have not been recognized). At September 30, 1994, Eagle Federal had a ratio of classified assets to total capital (as so calculated) of 0.55. The banking agencies have determined that establishing a minimum market value to book value ratio is not a feasible means to address the safety and soundness concerns identified by Congress in adopting FDICIA and do not propose to take any further action with respect to such ratio.\nQualified Thrift Lender Requirement. In order for Eagle Federal to exercise the powers granted to federally chartered savings institutions, and maintain full access to FHL Bank advances, Eagle Federal must constitute a \"qualified thrift lender\" (\"QTL\"). Any savings institution that is not a QTL must either convert to a bank charter or limit its future investments and activities (including branching and payments of dividends) to those permitted for both savings institutions and national banks. Additionally, any such savings institution that does not convert to a bank charter will be ineligible to receive further FHL Bank advances and beginning three years after the loss of QTL status, will be required to repay all outstanding FHL Bank advances and dispose of or discontinue any preexisting investment or activities not permitted for both savings institutions and national banks. Further, within one year of the loss of QTL status, the holding company of a savings institution that does not convert to a bank charter must register as a bank holding company and will be subject to all statutes applicable to bank holding companies.\nA savings institution will constitute a QTL if the savings institution's qualified thrift investments continue to equal or exceed 65% of the savings association's portfolio assets on a monthly average basis in 9 out of every 12 months. Qualified thrift investments generally consist of (i) various housing related loans and investments (such as residential construction and mortgage loans, home improvement loans, mobile home loans, home equity loans and mortgage-backed securities), (ii) certain obligations of the FDIC, the FSLIC Resolution Fund and the Resolution Trust Corporation (\"RTC\") (for limited periods of time), and (iii) shares of stock issued by any Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation or the Federal National Mortgage Corporation. In addition, the following assets may be categorized as qualified thrift investments in an amount not to exceed 20% in the aggregate of portfolio assets: (i) 50% of the dollar amount of residential mortgage loans originated and sold within 90 days of origination; (ii) investments in securities of a service corporation that derives at least 80% of its income from residential housing finance; (iii) 200% of loans and investments made to acquire, develop or construct starter homes or homes in credit needy areas (subject to certain conditions); (iv) loans for the purchase or construction of churches, schools, nursing homes and hospitals; and (v) consumer loans (in an amount up to 20% of portfolio assets). For purposes of the QTL test, the term \"portfolio assets\" means the savings institution's total assets minus goodwill and other intangible assets, the value of property used by the savings institution to conduct its business, and liquid assets held by the savings institution in an amount up to 20% of its total assets.\nAt September 30, 1994, qualified thrift investments as a percentage of portfolio assets for Eagle Federal was 86.6%. The qualified thrift investments of Eagle Federal equaled or exceeded 65% of its portfolio assets on a monthly average basis for at least 9 months during the fiscal year ended September 30, 1994.\nLiquidity. Under OTS regulations, savings institutions are required to maintain an average daily balance of liquid assets (including cash, certain time deposits, certain bankers' acceptances, certain corporate debt securities and highly rated commercial paper, securities of certain mutual funds and specified United States government, state or federal agency obligations) equal to a monthly average of not less than a specified percentage of the average daily balance of the savings institution's net withdrawable deposits plus short-term borrowings. Under the HOLA, this liquidity requirement may be changed from time to time by the Director of the OTS to any amount within the range of 4% to 10% depending upon economic conditions and the deposit flows of member institutions, and currently is 5%. Savings institutions are also required to maintain an average daily balance of short term liquid assets at a specified percentage (currently 1%) of the total of the average daily balance of its net withdrawable deposits and short-term borrowings. At September 30, 1994, Eagle Federal was in compliance with these liquidity requirements.\nLoans to One Borrower Limitations. The HOLA generally requires savings institutions to comply with the loans to one borrower limitations applicable to national banks. In general, national banks may make loans to one borrower in amounts up to 15% of the bank's unimpaired capital and surplus, plus an additional 10% of capital and surplus for loans secured by readily marketable collateral. The HOLA provides certain exceptions under which a savings association may make loans to one borrower in excess of the generally applicable national bank limits. A savings association may make loans to one borrower of up to $500,000 for any purpose. A savings association may make loans to one borrower of up to the lesser of $30 million or 30% of unimpaired capital and unimpaired surplus to develop domestic residential housing units, provided certain conditions are satisfied. FIRREA provided that a savings association could make loans to one borrower to finance the sale of real property acquired in satisfaction of debts previously contracted in good faith in amounts up to 50% of unimpaired capital and unimpaired surplus. However, pursuant to its authority to impose more stringent requirements on savings associations to protect safety and soundness, the OTS has promulgated a rule limiting loans to one borrower to finance the sale of real property acquired in satisfaction of debts to 15% of unimpaired capital and surplus. The rule provides, however, that purchase money mortgages received by a savings association to finance the sale of such real property do not constitute \"loans\" (provided no new funds are advanced and the savings association is not placed in a more detrimental position holding the note than holding the real estate) and, therefore, are not subject to the loans to one borrower limitations. At September 30, 1994, Eagle Federal had a loan-to-one borrower limit of approximately $9.9 million.\nLimitation on Investments and Activities. Various provisions of federal statutes and regulations limit the extent to which savings associations may engage in certain types of investments and activities. Some of the more significant limitations include the following:\n(1) Commercial Loans. Under HOLA, Eagle Federal may invest in loans for commercial, corporate, business or agricultural purposes in an amount not to exceed 10% of its total assets. At September 30, 1994, Eagle Federal's commercial loan portfolio was within the amount permitted by this limitation.\n(2) Commercial Real Property Loans. HOLA limits the aggregate amount of commercial real estate loans that a federal savings institution may make to an amount not in excess of 400% of the savings institution's capital (as compared with the 40% of assets limitation in effect prior to the enactment of FIRREA). However, the new limit does not require the divestiture of loans made prior to enactment of FIRREA. The OTS is given the authority to grant exceptions to the limit if the additional amount will not pose a significant risk to the safe or sound operation of the savings institution involved, and is consistent with prudent operating practices. At September 30, 1994, Eagle Federal's commercial real estate portfolio was within the amount permitted by this limitation.\n(3) Limitation on Certain Investments. As a federally-chartered savings association, Eagle Federal generally is prohibited from investing directly in equity securities and real estate (other than that used for offices and related facilities or acquired through, or in lieu of, foreclosure or on which a contract purchaser has defaulted). In addition, OTS regulations limit the aggregate investment by savings institutions in certain investments, including service corporations. At September 30, 1994, Eagle Federal was in compliance with these requirements.\n(4) Activities of Subsidiaries. A savings institution seeking to establish a new subsidiary, acquire control of an existing company (after which it would be a subsidiary), or conduct a new activity through a subsidiary, must provide 30 days prior notice to the FDIC and the Director of the OTS and conduct any activities of the subsidiary in accordance with regulations and orders of the OTS. The OTS has the power to require a savings institution to divest any subsidiary or terminate any activity conducted by a subsidiary that the Director of the OTS determines is a serious threat to the financial safety; soundness or stability of such savings institution or is otherwise inconsistent with sound banking practices.\nTransactions With Affiliates. Transactions engaged in by a savings association or one of its subsidiaries with affiliates of the savings institution generally are subject to the affiliate transaction restrictions contained in Sections 23A and 23B of the Federal Reserve Act in the same manner and to the same extent as such restrictions now apply to transactions engaged in by a member bank or one of its subsidiaries with affiliates of the member bank. Section 23A of the Federal Reserve Act imposes both quantitative and qualitative restrictions on transactions engaged in by a member bank or one of its subsidiaries with an affiliate, while Section 23B of the Federal Reserve Act requires, among other things that all transactions with affiliates be on terms substantially the same, and at least as favorable to the member bank or its subsidiary, as the terms that would apply to, or would be offered in, a comparable transaction with an unaffiliated party. Exemptions from, and waivers of, the provisions of Sections 23A and 23B of the Federal Reserve Act may be granted only by the Federal Reserve Board. HOLA contains certain other restrictions on loans and extension of credit to affiliates, and the Director of the OTS may impose additional restrictions on transactions with affiliates if the Director determines such restrictions are necessary to ensure the safety and soundness of any savings institution. Current OTS regulations are similar to Sections 23A and 23B of the Federal Reserve Act.\nCertain affiliate transactions are subject to conflict of interest regulations enforced by the OTS. These regulations require regulatory approvals for transactions by Eagle Federal and its subsidiaries with affiliated persons involving the sale, purchase or lease of property. Affiliated persons include officers, directors and controlling stockholders. These conflict of interest regulations also impose restrictions on loans to affiliated persons.\nInsurance of Deposits. Federal deposit insurance is required for all federal and state chartered savings institutions. Savings institutions' deposits will continue to be insured to a maximum of $100,000 for each insured depositor by the Federal Deposit Insurance Corporation (\"FDIC\") through the Savings Association Insurance Fund (\"SAIF\"). As a SAIF-insured institution, Eagle Federal is subject to regulation and supervision by the FDIC, to the extent deemed necessary by the FDIC to ensure the safety and soundness of the SAIF. The FDIC is entitled to have access to reports of examination of Eagle Federal made by the Director of the OTS and all reports of condition filed by Eagle Federal with the Director of the OTS, and may require the Bank to file such additional reports as the FDIC determines to be advisable for insurance purposes. The FDIC may determine by regulation or order that any specific activity poses a serious threat to the SAIF and that no SAIF member may engage in the activity directly. The FDIC is also authorized to issue and enforce such regulations or orders as it deems necessary to prevent actions of savings institutions that pose a serious threat to SAIF.\nIn accordance with FDICIA, the FDIC has established a risk-based deposit insurance assessment system. Deposit insurance assessment rates are currently within a range of .23% to .31% of insured deposits, depending on the assessment risk classification assigned to each institution. The FDIC is required to set SAIF and BIF assessment rates in an amount sufficient to increase the reserve ratio of each fund to 1.25% of insured deposits over a period of 15 years. The assessment rate is currently the same for SAIF and BIF members. The FDIC places each institution into one of nine assessment risk classifications based on the institution's capital and supervisory classification. FDICIA also authorizes the FDIC to establish a higher reserve ratio and to impose special assessments to pay for the costs of authorized borrowings.\nEagle Federal's deposit insurance premiums did not increase as a result of implementation of the risk-based assessment system. There can be no assurance that Eagle Federal's insurance premiums will not increase in the future. Future semiannual assessments imposed on Eagle Federal may be higher or lower depending on the risk classification applied to Eagle Federal, SAIF and BIF revenue and expense levels, the reserve levels established by the FDIC, and the amount and interest rates of borrowings by the insurance funds.\nAs a result of FDICIA, BIF and SAIF insured institutions may merge, consolidate or engage in asset transfer and liability assumption transactions. The resulting institution may continue to be subject to BIF and SAIF assessments in relation to that portion of its combined deposit base which is attributable to the deposit base of its respective predecessor BIF and SAIF institutions or may apply to the FDIC to convert all of its deposits to either insurance fund upon payment of the then applicable entrance and exit fees for each fund.\nInsurance of deposits may be terminated by the FDIC after notice and hearing, upon finding by the FDIC that the savings institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, rule, regulation, order or condition imposed by, or written agreement with, the FDIC. Additionally, if insurance termination proceedings are initiated against a savings institution, the FDIC may temporarily suspend insurance on new deposits received by an institution under certain circumstances.\nFederal Home Loan Bank System\nThe Federal Home Loan Bank System consists of 12 regional FHL Banks, each subject to supervision and regulation by the Federal Housing Finance Board (the \"FHFB\"). The FHL Banks provide a central credit facility for member savings institutions. Eagle Federal, as a member of the FHL Bank of Boston, is required to own shares of capital stock in that FHL Bank in an amount at least equal to 1% of the aggregate principal amount of their unpaid residential mortgage loans, home purchase contracts and similar obligations at the beginning of each year, or 1\/20 of their advances (borrowings) from the FHL Bank, whichever is greater. Eagle Federal is in compliance with this requirement. The maximum amount which the FHL Bank of Boston will advance fluctuates from time to time in accordance with changes in policies of the FHFB and the FHL Bank of Boston, and the maximum amount generally is reduced by borrowings from any other source. In addition, the amount of FHL Bank advances that a savings institution may obtain will be restricted in the event the institution fails to constitute a QTL. See \"Regulation -- Savings Institution Regulation -- Qualified Thrift Lender Requirement.\"\nFederal Reserve System\nThe Federal Reserve Board has adopted regulations that require savings institutions to maintain nonearning reserves against their transaction accounts (primarily NOW and regular checking accounts) and nonpersonal time deposits (those which are transferable or held by a person other than a natural person) with an original maturity of less than 1 1\/2 years. At September 30, 1993, Eagle Federal was in compliance with these requirements. These reserves may be used to satisfy liquidity requirements imposed by the Director of the OTS. Because required reserves must be maintained in the form of vault cash or a non-interest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce the amount of the institution's interest-earning assets.\nSavings institutions also have the authority to borrow from the Federal Reserve \"discount window.\" Federal Reserve Board regulations, however, require savings institutions to exhaust all FHL Bank sources before borrowing from a Federal Reserve Bank. FDICIA prevents Federal Reserve Banks from providing a discount window advance to an undercapitalized institution for more than 60 days in a 120-day period, except in limited circumstances.\nTaxation\nFederal. Eagle, on behalf of itself and its subsidiaries, files a September 30 tax year consolidated federal income tax return. Eagle and its subsidiaries report their income and expenses using the accrual method of accounting.\nSavings institutions are generally taxed in the same manner as other corporations. Unlike other corporations, however, qualifying savings institutions such as Eagle Federal, that meet certain definitional tests relating to the nature of their supervision, income, assets and business operations are allowed to establish a reserve for bad debts and for each tax year are permitted to deduct additions to that reserve for losses on \"qualifying real property loans\" using the more favorable of the following two alternative methods: (i) a method based on the institution's actual loss experience (the \"experience method\") or (ii) a method based on a specified percentage of an institution's taxable income (the \"percentage of taxable income method\"). \"Qualifying real property loans\" are, in general, loans secured by interests in improved real property. The addition to the reserve for losses on nonqualifying real property loans must be computed under the experience method.\nUnder the percentage of taxable income method, qualifying institutions such as Eagle Federal may deduct up to 8% of their taxable income after certain adjustments and subject to certain limitations discussed below. The net effect of the percentage of taxable income method deduction is that the maximum effective federal income tax rate on income computed without regard to actual bad debts and certain other factors for qualifying institutions using the percentage of taxable income method is 31.28% (and at least 32.2% on taxable income above $10 million).\nThe amount of the bad debt deduction that a savings institution may claim with respect to additions to its reserve for bad debts is subject to certain limitations. First, the percentage of taxable income or experience method deduction will be eliminated entirely, the existing reserve will be recaptured into taxable income and the institution will be permitted a deduction only for specific charge-offs, unless at least 60% of the savings institution's assets fall within certain designated categories. Second, the bad debt deduction attributable to \"qualifying real property loans\" cannot exceed the greater of (i) the amount deductible under the experience method or (ii) the amount which, when added to the bad debt deduction for nonqualifying loans, equals the amount by which 12% of the sum of the total deposits or withdrawable accounts at the end of the taxable year exceeds the sum of the surplus, undivided profits and reserves at the beginning of the taxable year. Third, the amount of the bad debt deduction attributable to qualifying real property loans computed using the percentage of taxable income method is permitted only to the extent that the institution's reserve for losses on qualifying real property loans at the close of the taxable year, taking into account the addition to that reserve for that taxable year, does not exceed 6% of such loans outstanding at such time. Fourth, the deduction is reduced, but not below zero, by the amount of the addition to reserves for losses on nonqualifying loans for the taxable year. Finally, a savings institution that computes its bad debt deduction using the percentage of taxable income method and files its federal income tax return as part of a consolidated group is required to reduce proportionately its bad debt deduction for losses attributable to activities of nonsavings institution members of the consolidated group that are \"functionally related\" to the savings institution member. The savings institution member is permitted, however, to proportionately increase its bad debt deduction in subsequent years to recover any such reduction to the extent the nonsavings institution members realize income in subsequent years from their \"functionally related\" activities. Eagle Federal expects that these various restrictions will not operate to limit significantly the amounts of their otherwise allowable bad debt deductions in the near future.\nTo the extent that (i) the reserves for losses on qualifying real property loans established by Eagle Federal using the percentage of taxable income method exceed the amount that would have been allowed under the experience method and (ii) Eagle Federal makes distributions to its shareholder that are considered to result in withdrawals from that institution's excess bad debt reserve, then the amounts considered to be withdrawn will be included in Eagle Federal's taxable income. The amount considered to be withdrawn by a distribution will be the amount of the distribution plus the amount necessary to pay the federal income tax with respect to the withdrawal. Dividends paid out of Eagle Federal's current or accumulated earnings and profits as calculated for federal income tax purposes, however, will not be considered to result in withdrawals from its bad debt reserve. Distributions in excess of Eagle Federal's current and accumulated earnings and profits, distributions in redemption of stock, and distributions in partial or complete liquidation, will generally be considered to result in withdrawals from its bad debt reserve. At September 30, 1993, Eagle Federal had approximately $8.9 million in earnings and profits for tax purposes that would be unavailable for distribution to Eagle because of the imposition of this additional tax on the institutions. Additionally, there are certain regulatory restrictions on Eagle Federal's ability to pay dividends to Eagle.\nThe federal income tax returns for Eagle Federal's predecessor savings institutions have been examined and audited or closed without audit by the IRS for tax years through September 30, 1989.\nSavings institutions are also entitled to limited special tax treatment with respect to the deductibility of interest expense relating to certain tax-exempt obligations. Savings institutions are entitled to deduct 100% of their interest expense allocable to the purchase or carrying of tax-exempt obligations acquired before 1983. The deduction is reduced to 80% with respect to obligations acquired after 1982. For taxable years after 1986, the Tax Reform Act of 1986 eliminates the deduction entirely for obligations purchased after August 7, 1986 (except for certain issues by small municipal issuers).\nDepending on the composition of its items of income and expense, a savings institution may be subject to the alternative minimum tax. For tax years beginning after 1986, a savings institution must pay an alternative minimum tax equal to the amount (if any) by which 20% of alternative minimum taxable income (\"AMTI\"), as reduced by an exemption varying with AMTI, exceeds the regular tax due. AMTI equals regular taxable income increased or decreased by certain adjustments and increased by certain tax preferences. Adjustments and preferences include depreciation deductions in excess of those allowable for alternative minimum tax purposes, tax-exempt interest on most private activity bonds issued after August 7, 1986 (reduced by any related interest expense disallowed for regular tax purposes), the amount of the bad debt reserve deduction claimed in excess of the deduction based on the experience method and, for 1990 and succeeding years, 75% of the excess of adjusted current earnings (\"ACE\") over AMTI. ACE equals pre-adjustment AMTI (\"PAMTI\") increased or decreased by certain ACE adjustments, which include tax-exempt interest on municipal bonds for tax purposes, depreciation deductions in excess of those allowable for ACE purposes and the dividend received deduction. PAMTI equals AMTI computed with all the preferences and adjustments other than the ACE adjustment and the alternative minimum tax net operating loss (AMTNOL). AMTI may be reduced only up to 90% by AMTNOL carryovers. The payment of alternative minimum tax will give rise to a minimum tax credit which will be available with an indefinite carryforward period available to reduce federal income taxes of the institution in future years (but not below the level of alternative minimum tax arising in each of the carryforward years).\nState. State income taxation is in accordance with the corporate income tax laws of Connecticut. As a thrift, Eagle Federal is required to pay taxes equal to the larger of $250, 11.5% (scheduled to decrease in increments to 10% by 1998) of the year's taxable income (which, with certain exceptions, is equal to taxable income for federal purposes) or an amount equal to 4% for each year of the amount of interest or dividends credited by them on savings accounts of depositors or account holders during the taxable year preceding that in which the tax becomes due, provided that, in determining such amount, interest or dividends credited to the savings account of a depositor or account holder are deemed to be the lesser of the actual interest or dividends credited or the interest or dividend that would have been credited if it had been computed and credited at the rate of one-eighth of 1% per annum. The statutory Connecticut corporate rate is scheduled to decrease to 11.5% for Eagle effective for its fiscal year ending September 30, 1994.\nIncome Tax Accounting Standard. During February 1992 the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes.\" This SFAS establishes financial accounting and reporting standards for the effects of income taxes that result from an enterprise's activities during the current and preceding years. It requires the use of the asset and liability method in determining the tax effect of temporary differences and the recognition of items of income and expense reported in the financial statements and those reported for income tax purposes. This SFAS is effective for fiscal years beginning after December 15, 1992, although earlier application is encouraged. The Company adopted the statement for the fiscal year beginning October 1, 1993. The cumulative effect of the change in accounting for income taxes resulted in a tax benefit of approximately $1.27 million in the first quarter of fiscal 1994. Unlike its predecessor SFAS NO. 96, SFAS No. 109 requires consideration of future taxable income and other available evidence in connection with the recognition of a deferred tax asset and any related valuation allowance.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nEagle's 23 offices are located in Hartford, Litchfield and northern Fairfield counties. Automated teller machines (\"ATM\") are located in 18 of the 23 offices. Eagle's ATM's participate in the recently merged \"Yankee 24\/NYCE\" ATM network which permits access to funds at approximately 13,200 locations and 57,000 \"point-of-sale\" terminals throughout the Northeast. Data processing services for Eagle are provided by Connecticut On-Line Computer Center, a data processing company jointly owned by a number of New England savings institutions (including Eagle Federal).\nThe following table sets forth certain information concerning the business offices of Eagle at September 30, 1994.\nThe total net book value of properties owned and used for offices by Eagle at September 30, 1994 and the aggregate net book value of leasehold improvements on properties used for offices was $6.9 million.\nItem 3.","section_3":"Item 3. Legal Proceedings\nAs of September 30, 1994, there were no material pending legal proceedings to which Eagle, Eagle Federal or Eagle Savings Corp. was a party or to which any of their property was subject.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nNo matters were submitted to a vote of Eagle shareholders during the fourth quarter of the fiscal year ended September 30, 1994.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Stock and Related Stockholder Matters\nInformation as to the principal market on which the Company's common stock is traded, the approximate number of holders of record as of September 30, 1994, the Company's dividend policy, and the high and low bid quotations or sales prices, as applicable, for each calendar quarter during the two most recent fiscal years is incorporated herein by reference to page 40 of the 1994 Annual Report to Shareholders.\nItem 6.","section_6":"Item 6. Selected Financial Data\nSelected consolidated financial data for the five years ended September 30, 1994 on page 1 of the 1994 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\nManagement's Discussion and Analysis of Financial Condition and Results of Operations on pages 7 to 14 of the 1994 Annual Report to Shareholders is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nCertain of the information required by this Item is incorporated by reference to pages 15 to 37 of the 1994 Annual Report to Shareholders. The independent auditors' report of Ernst & Young LLP with respect to the Company's statements of income, shareholders' equity and cash flows for the year ended September 30, 1992 and the independent auditors' report of KPMG Peat Marwick LLP with respect to the Company's balance sheets at September 30, 1994 and 1993 and the statements of income, shareholders' equity and cash flows for the years ended September 30, 1994 and 1993 are filed as Exhibits 99.1 and 99.2, respectively, and are incorporated herein by reference.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure\nReference is made to the information set forth under the caption \"Change in Independent Auditors\" appearing in the Company's definitive proxy statement dated December 27, 1994, which information is incorporated herein by reference.\nPART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\nReference is made to the information set forth under the captions \"Election of Directors\" and \"Management -- Executive Officers\" appearing in the Company's definitive proxy statement dated December 27, 1994, which information is incorporated herein by reference.\nItem 11.","section_11":"Item 11. Executive Compensation\nReference is made to the information set forth under the caption \"Management -- Executive Compensation\" appearing in the Company's definitive proxy statement dated December 27, 1994, which information is incorporated herein by reference..\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nReference is made to the information set forth under the captions \"Stock Owned by Management\" and \"Principal Holders of Voting Securities of Eagle\" appearing in the Company's definitive proxy statement dated December 27, 1994, which information is incorporated herein by reference.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nReference is made to the information set forth under the caption \"Management -- Certain Transactions\" appearing in the Company's definitive proxy statement dated December 27, 1994, which information is incorporated herein by reference..\nPART I\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 registrant and its subsidiaries and report of independent auditors are included in Item 8 hereof.\nReport of Independent Auditors.\nConsolidated Balance Sheets - September 30, 1994 and 1993.\nConsolidated Statements of Income - Years Ended September 30, 1994, 1993 and 1992.\nConsolidated Statements of Shareholders' Equity - Years Ended September 30, 1994, 1993 and 1992.\nConsolidated Statements of Cash Flows - Years Ended September 30, 1994, 1993 and 1992.\nNotes to Consolidated Financial Statements.\n(a)(2) All schedules 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.\n(a)(3) The following exhibits are either filed with this Report or are incorporated herein by reference:\n3.1 Certificate of Incorporation, as amended, incorporated herein by reference from Pre-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-1 (No. 33-9166), filed with the SEC on December 24, 1986.\n3.2 By-laws of the Company, as amended to date (incorporated by reference from the Company's Current Report on Form 8-K, as filed with the SEC on November 12, 1993).\n10.1 Eagle Financial Corp. Stock Option Plan (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended September 30, 1987, as filed with the SEC on December 22, 1987).\n10.2 BFS Bancorp, Inc. Stock Option Plan (incorporated by reference from the Company's Registration Statement on Form S-8 (Reg. No. 33-28403) filed with the SEC on April 28, 1989).\n10.3 Eagle Financial Corp. 1988 Stock Option Plan (incorporated by reference from the Company's definitive Proxy Statement dated December 21, 1988 for the 1989 Annual Meeting of Shareholders, as filed with the SEC on December 22, 1988).\n10.4 Employment Agreement dated April 1, 1994 among the Company, the Bank and Ralph T. Linsley (incorporated by reference from Pre-effective Amendment No. 1 to the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on September 12, 1994).\n10.5 Consulting Agreement dated August 25, 1988 between the Company and Ralph T. Linsley (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended September 30, 1988, as filed with the SEC on December 29, 1988).\n10.6 Employment Agreement dated April 1, 1994 among the Company, the Bank and Robert J. Britton (incorporated by reference from Pre-effective Amendment No. 1 to the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on September 12, 1994).\n10.7 Employment Agreement dated April 1, 1994 among the Company, the Bank and Ercole J. Labadia (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.8 Employment Agreement dated April 1, 1994 among the Company, the Bank and Mark J. Blum (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.9 Employment Agreement dated April 1, 1994 among the Company, the Bank and Irene K. Hricko (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.10 Employment Agreement dated April 1, 1994, among the Company, the Bank and Barbara S. Mills (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.11 The Bank deferred compensation plan (incorporated by reference from Pre-Effective Amendment No. 1 to the Company's Registration Statement on Form S-4 (No. 33-21122) filed with the SEC on May 17, 1988).\n10.12 Deferred Compensation Plan for Non-Employee Directors (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended September 30, 1988, as filed with the SEC on December 29, 1988).\n10.13 Outside Directors Post Retirement Plan, dated July 26, 1994 (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.14 Guarantee and Pledge Agreement dated November 1, 1990 between the Company and Bank of Boston Connecticut (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended September 30, 1990, as filed with the SEC on December 28, 1990).\n10.15 Annual Incentive Compensation Plan (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.16 Amendment to Employment Agreement dated July 26, 1994 among the Company, the Bank and Ralph T. Linsley (incorporated by reference from Pre-effective Amendment No. 1 to the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on September 12, 1994).\n10.17 Amendment to Employment Agreement dated July 26, 1994 among the Company, the Bank and Robert J. Britton (incorporated by reference from Pre-effective Amendment No. 1 to the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on September 12, 1994).\n13 1994 Annual Report to Shareholders, portions of which have been incorporated by reference into this Form 10-K.\n22 Subsidiaries of the Registrant.\n23.1 Consent of Ernst & Young LLP.\n23.2 Consent of KPMG Peat Marwick LLP.\n27 Financial Data Schedule (Article 9)\n99.1 Independent auditors' report of Ernst & Young LLP.\n99.2 Independent auditors' report of KPMG Peat Marwick LLP.\n(b) The Registrant did not file any Current Reports on Form 8-K during the fourth quarter of its fiscal year ended September 30, 1994.\n(c) Exhibits to this Form 10-K are attached.\n(d) Not 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 as of the 30th day of December, 1994. EAGLE FINANCIAL CORP.\nEAGLE FINANCIAL CORP. ----------------------------- Registrant\nBy: \/s\/ Ralph T. Linsley ---------------------------- Ralph T. Linsley Vice 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 indicated as of December 30, 1994.\nSignature Title\n\/s\/ Frank J. Pascale Chairman of the Board Frank J. Pascale\n\/s\/ Ralph T. Linsley Vice Chairman of the Board Ralph T. Linsley\n\/s\/ Robert J. Britton Chief Executive Officer, President and Director Robert J. Britton (principal executive officer)\n\/s\/ Mark J. Blum Vice President and Chief Financial Officer Mark J. Blum (principal financial and accounting officer)\n\/s\/ Richard H. Alden Director Richard H. Alden\n\/s\/ George T. Carpenter Director George T. Carpenter\n\/s\/ Theodore M. Donovan Director Theodore M. Donovan\n\/s\/ Steven E. Lasewicz, Jr. Director Steven E. Lasewicz, Jr.\n\/s\/ Thomas V. LaPorta Director Thomas V. LaPorta\n\/s\/ John F. McCarthy Director John F. McCarthy\n\/s\/ Ernest J. Torizzo Director Ernest J. Torizzo\nEXHIBIT INDEX\n3.1 Certificate of Incorporation, as amended, incorporated herein by reference from Pre-Effective Amendment No. 2 to the Registrant's Registration Statement on Form S-1 (No. 33-9166), filed with the SEC on December 24, 1986.\n3.2 By-laws of the Company, as amended to date (incorporated by reference from the Company's Current Report on Form 8-K, as filed with the SEC on November 12, 1993).\n10.1 Eagle Financial Corp. Stock Option Plan (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended September 30, 1987, as filed with the SEC on December 22, 1987).\n10.2 BFS Bancorp, Inc. Stock Option Plan (incorporated by reference from the Company's Registration Statement on Form S-8 (Reg. No. 33-28403) filed with the SEC on April 28, 1989).\n10.3 Eagle Financial Corp. 1988 Stock Option Plan (incorporated by reference from the Company's definitive Proxy Statement dated December 21, 1988 for the 1989 Annual Meeting of Shareholders, as filed with the SEC on December 22, 1988).\n10.4 Employment Agreement dated April 1, 1994 among the Company, the Bank and Ralph T. Linsley (incorporated by reference from Pre-effective Amendment No. 1 to the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on September 12, 1994).\n10.5 Consulting Agreement dated August 25, 1988 between the Company and Ralph T. Linsley (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended September 30, 1988, as filed with the SEC on December 29, 1988).\n10.6 Employment Agreement dated April 1, 1994 among the Company, the Bank and Robert J. Britton (incorporated by reference from Pre-effective Amendment No. 1 to the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on September 12, 1994).\n10.7 Employment Agreement dated April 1, 1994 among the Company, the Bank and Ercole J. Labadia (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.8 Employment Agreement dated April 1, 1994 among the Company, the Bank and Mark J. Blum (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.9 Employment Agreement dated April 1, 1994 among the Company, the Bank and Irene K. Hricko (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.10 Employment Agreement dated April 1, 1994, among the Company, the Bank and Barbara S. Mills (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.11 The Bank deferred compensation plan (incorporated by reference from Pre-Effective Amendment No. 1 to the Company's Registration Statement on Form S-4 (No. 33-21122) filed with the SEC on May 17, 1988).\n10.12 Deferred Compensation Plan for Non-Employee Directors (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended September 30, 1988, as filed with the SEC on December 29, 1988).\n10.13 Outside Directors Post Retirement Plan, dated July 26, 1994 (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.14 Guarantee and Pledge Agreement dated November 1, 1990 between the Company and Bank of Boston Connecticut (incorporated by reference from the Company's Annual Report on Form 10-K for the year ended September 30, 1990, as filed with the SEC on December 28, 1990).\n10.15 Annual Incentive Plan (incorporated by reference from the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on August 9, 1994).\n10.16 Amendment to Employment Agreement dated July 26, 1994 among the Company, the Bank and Ralph T. Linsley (incorporated by reference from Pre-effective Amendment No. 1 to the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on September 12, 1994).\n10.17 Amendment to Employment Agreement dated July 26, 1994 among the Company, the Bank and Robert J. Britton (incorporated by reference from Pre-effective Amendment No. 1 to the Company's Registration Statement on Form S-2 (Reg. No. 33-54981) filed with the SEC on September 12, 1994).\n13 1994 Annual Report to Shareholders, portions of which have been incorporated by reference into this Form 10-K.\n22 Subsidiaries of the Registrant.\n23.1 Consent of Ernst & Young LLP.\n23.2 Consent of KPMG Peat Marwick LLP\n27 Financial Data Schedule\n99.1 Independent auditors' report of Ernst & Young LLP.\n99.2 Independent auditors' report of KPMG Peat Marwick LLP.","section_15":""}
{"filename":"350667_1994.txt","cik":"350667","year":"1994","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 - XI (the \"Partnership\"), is a limited partnership formed in 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 $137,500,000 in Limited Partnership Interests (the \"Interests\") to the public commencing on May 8, 1981 pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933 (Registration No. 2-70724). A total 137,500 Interests were sold to the public at $1,000 per Interest. The offering closed on May 5, 1982. 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, 2031. 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 on a quarterly basis in the table set forth in Item 2","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Partnership owns directly or through joint venture partnerships the properties or interests in the properties referred to under Item 1 above to which reference is hereby made for a description of said properties.\nThe following is a listing of principal businesses or occupations carried on in and approximate occupancy levels by quarter during fiscal years 1994 and 1993 for the Partnership's investment properties owned during 1994:\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThe Partnership is not subject to any pending material legal proceedings, other than ordinary litigation incidental to the business of 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 1993 and 1994.\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, 1994, there were 13,856 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 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 May 8, 1981, the Partnership commenced an offering of $125,000,000 (subject to increase by up to $12,500,000) in Limited Partnership Interests (\"Interests\") pursuant to a Registration Statement on Form S-11 under the Securities Act of 1933. All Interests were subscribed and issued between May 8, 1981 and May 5, 1982 pursuant to the public offering from which the Partnership received gross proceeds of $137,500,000. After deducting selling expenses and other offering costs, the Partnership had approximately $121,936,000 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, 1994, the Partnership and its consolidated ventures had cash and cash equivalents of approximately $2,103,000 and short-term investments of approximately $1,393,000. Such funds are available for future distributions to partners, and for working capital requirements including the Partnership's portion of the anticipated net cash flow deficits at the 767 Third Avenue Office Building and the National City Center Office Building. The Partnership and its consolidated ventures have currently budgeted in 1995 approximately $3,302,000 for tenant improvements and other capital expenditures. The Partnership's share of such items and its share of such similar items for its unconsolidated ventures in 1995 is currently budgeted to be approximately $2,174,000. Actual amounts expended in 1995 may vary depending on a number of factors including actual leasing activity, results of property operations, liquidity considerations and other market conditions over the course of the year. Certain of the Partnership's investment properties and properties in which the Partnership has a security interest currently operate in overbuilt markets which are characterized by lower than normal occupancies and\/or reduced rent levels. Such competitive conditions will contribute to the anticipated net cash flow deficits described above. The sources of capital for such items and for future short-term and long-term liquidity and distributions to partners are expected to be from net cash generated by the Partnership's investment properties and through the sale of such investments. In such regard, reference is made to the Partnership's property specific discussions below and also the Partnership's disclosure of certain property lease expirations in Item 6. The Partnership does not consider the mortgage notes receivable arising from the previous sale of the Partnership's investment property to be a source of future liquidity as collection of any past due or future payments on the Partnership's notes is considered unlikely. Reference is made to Note 7(a). 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.\nThe Partnership currently has adequate cash and cash equivalents to maintain the operations of the Partnership. However, based upon estimated operations of certain of the Partnership's investment properties, the Partnership decided to suspend distributions to the Limited and General Partners effective as of the second quarter of 1991. In addition, the Partnership has deferred cash distributions and partnership management fees related to the first quarter of 1991 as discussed in Note 9. These amounts, which do not bear interest, are approximately $19,000 and are expected to be paid in future periods.\nAs described more fully in Note 4(b), the Partnership is seeking or has received mortgage loan modifications on certain of its properties. If the Partnership is unable to secure new or additional modifications to the loans, based upon current market conditions, the Partnership may not commit any significant additional amounts to any of the properties which are incurring, or in the future do incur, operating deficits or deficits to underlying mortgage holders. This would result in the Partnership no longer having an ownership (or security) interest in such properties. Such decisions will be made on a property-by-property basis and may result in a gain to the Partnership for financial reporting and Federal income tax purposes, with no corresponding distributable proceeds.\nThe lender of the existing long-term mortgage notes secured by the Scotland Yard-Phase I and II, South Point, and El Dorado View apartment complexes required the establishment of an escrow account, initially of approximately $980,000 in the aggregate, to be used towards the purchase of major capital items at the apartment complexes. The lender also required $150,000 of the proceeds from the sale of the South Point Apartments, as more fully discussed in Note 7(f), to be added to the escrow account. As of December 31, 1994, the Partnership has been reimbursed from the escrow account approximately $959,000 for capital improvements at the above- referenced apartment complexes. Additionally, the lender has the right to call the remaining loans at any time after January 1, 1996. In this regard, the Partnership is currently marketing the Scotland Yard Phase I and II and the El Dorado View apartment complexes for sale. If the Partnership is unsuccessful in selling the properties prior to January 1, 1996 and the lender exercises its right to call the loans, the Partnership would recognize a gain for financial reporting and Federal income tax purposes with no corresponding distributable proceeds. Reference is made to Note 4(c).\nWood Forest Glen Apartments\nDuring 1991, the Partnership continued to negotiate with the lender to further modify the long-term mortgage note secured by the Wood Forest Glen Apartments. During these negotiations, the Partnership continued to pay debt service at the previously modified terms through December 1990 and, effective January 1991, began to pay debt service on a cash flow basis. In December 1991, the Partnership was notified that the lender sold its mortgage note to a third party. The Partnership pursued discussions with the new lender concerning modifications to the mortgage loan and a possible sale of the property. The Partnership was not successful in securing such modifications; however, in April 1992, the Partnership sold its interest in the property to the new lender for approximately $213,000 in excess of the existing mortgage balance. As a result of the sale, the Partnership recognized a gain on sale in 1992 of $6,470,625 and $7,058,574 for financial reporting and Federal income tax purposes, respectively. Reference is made to Note 4(b).\nBitter Creek Apartments\nDuring February 1992, the Bitter Creek venture received an additional modification to the long-term mortgage notes. The venture was required to pay down approximately $436,000 of the principal balance of the mortgage loan in exchange for the lender forgiving all deferred interest and extending the term of the modification. The Partnership's share of the required principal payment was approximately $58,000. The new modified interest accrual and payment rate averaging 7% for the period June 15, 1991 to June 9, 1992 was based upon the lender's prime rate. The additional mortgage modification provided that payments of interest be paid monthly and the principal balance and any accrued interest be due and payable on December 15, 1992.\nOn June 9, 1992, the venture sold the land and related assets of the Bitter Creek apartment complex for $10,250,000 in cash (before selling costs and prorations). A major portion of the sales proceeds was utilized to retire the related underlying mortgage note of approximately $9,064,000. The Partnership and the venture partner received approximately $339,000 and $681,000, respectively, from the sale of the property after deducting expenses in connection with the sale and the mortgage loan retirement. The Partnership recognized a gain in 1992 of $142,967 and $2,808,159 for financial reporting and Federal income tax purposes, respectively. Reference is made to Note 7(e).\n767 Third Avenue Office Building\nOccupancy at the property is 89% at December 31, 1994, up from 83% in 1993. The 767 Third Avenue venture is aggressively marketing the remaining vacant space. The Partnership is obligated to fund its share of the net cash flow deficits resulting from costs associated with any leasing activity at the property.\nDuring 1991 and 1992, the leases for approximately 67% of the space at the 767 Third Avenue Office Building expired (substantially all of which have been released as of December 1994 but at lower effective rents). During the first quarter of 1994, a tenant vacated a portion of its space (approximately 6,450 square feet or 2% of the building's leasable space) prior to its lease expiration of January 1997. The venture reached an agreement with the tenant whereby the lease obligation was terminated in return for an $800,000 payment to the venture. This space was subsequently released to a new tenant. Vacancy rates in Midtown Manhattan (the sub- market for this property) remain high and the increased competition for tenants has resulted in lower effective rental rates (contract rates less the amortization of tenant improvements and free rent concessions). The adverse market conditions and the negative impact of effective rental rates are expected to continue over the next few years. While this building is in a premier location, it has been adversely impacted by the lower effective rental rates upon leasing and by releasing costs. In order to reduce debt service payments during the tenant turnover period, the 767 Third Avenue joint venture obtained from the existing lender, in May 1992, a replacement mortgage loan bearing a substantially lower interest rate than the original loan. In connection with the replacement mortgage loan, 767 Third Avenue was required to fund $8,000,000 into an escrow account to fund any future leasing costs and debt shortfalls resulting from anticipated tenant turnover. At the inception of the escrow agreement, the venture was allowed to reduce the required reserve contributions by approximately $2,600,000 to reflect certain leasing costs that had already been incurred. The Partnership's joint venture partner loaned $5,000,000 to the joint venture in order to fund the net escrow reserve account. The Partnership purchased a 50% interest in this loan in June 1993. Reference is made to Note 4(b). In 1993, the reserve account was depleted and the venture (by way of partner contributions) continues to fund required leasing costs and debt service shortfalls. During 1994, the venture partner approached the Partnership regarding purchasing the Partnership's 50% interest in 767 Third Avenue. However, upon review of the proposed terms, the Partnership did not believe the offer to be in its best interest and the offer was rejected.\n824 Market Street\nOccupancy at the 824 Market Street Office building located in Wilmington, Delaware had risen to 56% during 1994, up from 49% at December 31, 1993. The 824 Market Street venture was aggressively seeking replacement tenants for the vacant space; however, competition had risen significantly due to new office building development in the area over the last few years and the contraction of tenants in the financial services industry, resulting in lower effective rental rates. In order to reduce debt service payments during the tenant turnover period, the venture had negotiated with the first mortgage lender for a possible modification to the mortgage note. Such negotiations were unsuccessful and the venture received a notice of default. Accordingly, for financial reporting purposes, the underlying debt of approximately $13,515,000 was reflected as a current liability in the accompanying consolidated financial statements at December 31, 1993. The first mortgage lender commenced proceedings to realize upon its security and was the successful bidder at the foreclosure sale held in October 1994. The deed was conveyed to the first mortgage lender on December 12, 1994. As a result of the disposition of the property, the Partnership recognized a gain in 1994 for financial reporting and Federal income tax purposes of $3,689,195 and $6,805,134, respectively, with no corresponding distributable proceeds.\nRiverfront Office Building\nOn August 28, 1990, the Riverfront joint venture acquired additional financing by way of a $5,800,000 fourth mortgage note in order to fund the costs associated with leasing vacant space. As of the date of this report, the joint venture has received approximately $5,730,000 in proceeds. The balance of the proceeds, a $70,000 engineering holdback, is payable to the joint venture upon completion of certain structural repairs, the extent of which are being negotiated with the lender but which are not expected to exceed the holdback amount. Though physical occupancy at the property increased from 85% at December 31, 1993 to 95% at December 31, 1994, average rent paying occupancy decreased due to (i) a major tenant, (vacating approximately 25% of the building in July 1992 due to a downsizing of its operations) continuing to pay rent through the remaining terms of its leases which expired in April 1993 and (ii) a second major tenant downsizing its operations in April 1993 by approximately 36,000 square feet or 11% of the building and receiving a rent reduction of approximately 23% on its remaining leased space. The property began operating at a deficit in 1992 and, as a result, debt service payments since July 1992 were made on a delayed basis. At December 31, 1994, the February 1993 through December 1994 debt service payments are delinquent by approximately $6,724,000. Accordingly, the loan balances of approximately $34,298,000 have been reflected as a current liability in the consolidated financial statements. In order to reduce debt service payments, the joint venture has initiated discussions with the lender to negotiate possible modifications to the mortgage notes. In this regard, the joint venture has entered into a non-binding letter of intent with the existing lender for a restructure of its mortgage loans. The proposed terms of the loan restructure would retroactively reduce the interest rate payable on the loans and reduce the term of the loan from its present maturity date of September 2018 to December 2007. The loans (which currently bear interest at rates ranging from 10% to 14% per annum) would bear interest at 6% per annum for the period January 1, 1993 through December 31, 1997. Thereafter, the interest rate per annum shall be the greater of the rate derived using the \"Coverage Formula\" (as defined) or 7% from January 1, 1998 to December 31, 1999; 8.25% from January 1, 2000 to December 31, 2002; and 9% from January 1, 2003 to December 31, 2007. In addition, the lender is entitled to earn a minimum internal rate of return of 10.5% per annum calculated over the restructured loan term. The proposed loan restructure would also require that net cash flow after debt service and capital be paid into an escrow account controlled by the lender to be used for operating shortfalls and costs associated with additional leasing as approved by the lender. In addition, the property operates under a ground lease and the joint venture has not made the scheduled ground lease payments since February 1993. The ground lessor is a general partner of the venture partner. At December 31, 1994, the total amount of ground lease payments in arrears is approximately $343,000. In this regard, the proposed loan restructure discussed above would provide for the waiver of any and all ground lease payments since the first missed payment in February 1993 until the earlier of any future mortgage loan prepayment date (resulting from a sale or refinancing of the property) or December 31, 2007. The proposed loan restructure also provides that if, during calendar year 1997, projections of gross rental revenue approved by the lender during the year are not less than $9 million per year for each of the next five calendar years, annual payments of ground rent would resume, but in a reduced amount (as defined). There can be no assurances that the restructure will be obtained. If the joint venture is unable to secure any modifications to the mortgage notes, the joint venture would likely decide, based upon current and anticipated future market conditions, not to commit any significant additional amounts to this property. This would result in the Partnership no longer having an ownership interest in this property and would result in a gain for financial reporting and Federal income tax purposes to the Partnership with no corresponding distributable proceeds.\nYerba Buena West Office Building\nIn 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.\nBased upon the conditions at the Yerba Buena West Office Building, including tenant disputes following the October 17, 1989 San Francisco earthquake, the venture had not made the debt service payments to the underlying lender, commencing with the January 1990 payment. The Partnership and Affiliated Partners had decided, based upon an analysis of current market conditions and the probability of large future cash deficits, not to fund future venture cash deficits. The venture was unable to negotiate a loan modification to pay for expected future cash deficits whereby the venture retained ownership of the property, and in June 1992, the 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, until June 1995, the venture will have a right of first opportunity to purchase the property if the lender chooses to sell. 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 in 1992 for financial reporting and Federal income tax purposes of $1,614,369 and $964,406, respectively, with no corresponding distributable proceeds.\nMall of Memphis\nAlthough occupancy had been increasing, in order for the Mall of Memphis to maintain its competitive position in the marketplace, the Mall of Memphis venture completed a mall renovation in 1991. The renovation costs had been funded by the venture until additional financing was in place. The Partnership contributed approximately $2,252,000 in addition to foregoing their share of 1990 and a portion of the 1991 distributable cash flow from the property to cover their portion of the renovation costs. In March 1993, the venture finalized additional financing of a $7,600,000 ten year loan at a rate of 10%. The Partnership's share of the funding in 1993 was $4,719,095 (net of closing costs). Of the amount funded, the Partnership was required to deposit $1,000,000 in an escrow account as security against any currently undiscovered environmental issues. The venture would have been entitled to additional proceeds of $2,025,000 if the property had achieved certain occupancy levels and debt coverage ratios by September 30, 1994, however, the venture did not qualify for such additional proceeds as leasing did not achieve budgeted goals. Reference is made to Note 4(b). In May 1994, an affiliate of the General Partners assumed property management and leasing services. Property management fees are calculated as 3% of base rent (as defined) and leasing commissions are calculated at a rate, which approximates market, based on the terms of the related lease. In addition, the venture partner has approached the Partnership regarding selling its 36.94% interest in the Mall of Memphis to the Partnership. The Partnership is analyzing the proposal and there can be no assurances that such transaction will be consummated.\nMeadowcrest Apartments\nOn June 30, 1992, the second mortgage note secured by the Meadowcrest Apartments complex, located in Dallas, Texas, was scheduled to mature. In October 1991, the Partnership entered into a contract with a prospective buyer for the sale of the property. On June 9, 1992, the Partnership sold the land, building and related improvements and personal property of the Meadowcrest Apartment Complex for $9,575,000 in cash (before selling costs and prorations). A portion of the sales proceeds was utilized to retire the related underlying mortgage notes of approximately $8,445,000. The Partnership received approximately $861,000 from the sale of the property after deducting expenses in connection with the sale and the mortgage loan retirement. As a result of the sale, the Partnership has recognized in 1992 a gain of $562,806 and $5,255,084 for financial reporting and Federal income tax purposes, respectively. Reference is made to Note 7(d).\nSouth Point Apartments\nIn July 1993, the Partnership sold South Point Apartments to an unaffiliated buyer for approximately $1,145,000 (before closing costs and lender participation) in excess of the existing mortgage balance. As a result of the sale, the Partnership recognized a gain on sale in 1993 of $1,433,916 and $3,512,797 for financial reporting and Federal income tax purposes, respectively. Reference is made to Note 7(f).\nGeneral\nThere are certain risks associated with the Partnership's investments made through joint ventures including the possibility that the Partnership's joint venture partner(s) in an investment might become unable or unwilling to fulfill its (their) financial or other obligations, or that such joint venture partner(s) may have economic or business interests or goals that are inconsistent with those of the Partnership.\nThough the economy has recently shown signs of improvement and financing is generally becoming more available for certain types of higher- quality properties in healthy markets, real estate lenders are typically requiring a lower loan-to-value ratio for mortgage financing than in the past. This has made it difficult for owners to refinance real estate assets at their current debt levels unless the value of the underlying property has appreciated significantly. As a consequence, and due to the weakness of some of the local real estate markets in which the Partnership's properties operate, 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. Although sale proceeds from the disposition of the Partnership's remaining assets are expected, in light of the current severely depressed real estate markets, without a dramatic improvement in market conditions, the Limited Partners will not receive a full return of their original investment.\nResults of Operations\nThe aggregate decrease in cash and cash equivalents and short-term investments at December 31, 1994 as compared to December 31, 1993 is primarily due to cash retained at the 824 Market Street office building due to the suspension of debt service payments during 1993 and the remittance of such cash to the lender in conjunction with the lender realizing upon its security in the property in December 1994 as more fully discussed in Note 4(b).\nThe decrease in rents and other receivables at December 31, 1994 as compared to December 31, 1993 is primarily due to (i) the lender realizing upon its security in the 824 Market Street office building in December 1994, as more fully discussed in Note 4(b), (ii) a decrease in unbilled receivables related to 1994 at the Riverfront office building and (iii) an increase in the allowance for doubtful accounts related to certain tenants at the 767 Third Avenue office building.\nThe decrease in escrow deposits at December 31, 1994 as compared to December 31, 1993 is primarily due to the $312,486 reimbursement from the capital improvement escrow (as approved by the lender for the Partnership's apartment complexes) during 1994 for balcony repairs at the Scotland Yard I apartments. Reference is made to Note 4(c).\nThe decrease in prepaid expenses at December 31, 1994 as compared to December 31, 1993 is primarily due to the lender realizing upon its security in the 824 Market Street office building in December 1994, as more fully discussed in Note 4(b), and a $110,811 reduction in prepaid real estate taxes at the 767 Third Avenue office building due to a reduction in the property's assessed value.\nThe decrease in land and buildings and improvements at December 31, 1994 as compared to December 31, 1993 is primarily due to the lender realizing upon its security in the 824 Market Street office building in December 1994, as more fully discussed in Note 4(b), partially offset by tenant improvements resulting from 1994 leasing activity at the Mall of Memphis and the 767 Third Avenue and Riverfront office buildings and balcony repairs in 1994 at the Scotland Yard I and II apartments.\nThe increase in accumulated depreciation at December 31, 1994 as compared to December 31, 1993 and the corresponding increase in depreciation expense for 1994 as compared to 1993 is primarily due to the full amortization of tenant improvements in 1994 due to a change in estimate with respect to such tenant improvements related to space formerly occupied by two major tenants, Saddlebrook and IBM, who had vacated the Riverfront office building in 1989 and 1993, respectively. Such space was subsequently released during 1993 and 1994, respectively, resulting in the demolition of the existing improvements and the installation of new improvements. Such increase was partially offset by the lender realizing upon its security in the 824 Market Street office building in December 1994 as more fully discussed in Note 4(b).\nThe decrease in deferred expenses and the decrease in current portion of long-term debt at December 31, 1994 as compared to December 31, 1993 is primarily due to the lender realizing upon its security in the 824 Market Street office building in December 1994, as more fully discussed in Note 4(b).\nThe increase in the venture partners' deficit in ventures at December 31, 1994 as compared to December 31, 1993 is primarily due to continuing operating deficits during 1994 and the 1994 write-off of tenant improvements at the Riverfront office building, as more fully discussed above. Reference is made to Note 4(b).\nThe increase in accounts payable at December 31, 1994 as compared to December 31, 1993 is primarily due to the timing of payment of operating expenses at the Partnership's investment properties.\nThe decrease in unearned rents at December 31, 1994 as compared to December 31, 1993 is primarily due to the timing of receipt of rental income primarily at the Mall of Memphis.\nThe decrease in accrued interest at December 31, 1994 as compared to December 31, 1993 is primarily due to the lender realizing upon its security in the 824 Market Street office building in December 1994, as more fully discussed in Note 4(b) partially offset by the interest accruals associated with the non-recourse mortgage loans secured by the Riverfront office building. The Partnership is delinquent in debt service payments at the Riverfront office building, as more fully discussed in Note 4(b).\nThe decrease in due to affiliates at December 31, 1994 as compared to December 31, 1993 is primarily due to the payment in 1994 of salary and overhead reimbursements related to Partnership operations for the years 1991, 1992 and 1993 which had been previously deferred.\nThe decrease in tenant security deposits at December 31, 1994 as compared to December 31, 1993 is primarily due to a reduction in occupancy during 1994 at the Mall of Memphis and the Scotland Yard I and II apartments.\nThe increase in long-term debt, less current portion at December 31, 1994 as compared to December 31, 1993 is primarily due to the accrual of participation interest which the lender is entitled to under the terms of the mortgages related to the Partnership's apartment complexes, as more fully discussed in Note 4(c).\nThe decrease in the venture partners' subordinated equity in ventures at December 31, 1994 as compared to December 31, 1993 is primarily due to the lender realizing upon its security in the 824 Market Street office building in December 1994 and the venture partner's share of the 1994 operating deficits at the 767 Third Avenue office building. Reference is made to Note 4(b).\nThe decrease in rental income for 1994 as compared to 1993 is primarily due to the sale of the South Point apartments in July 1993, as more fully discussed in Note 7(f), a reduction in rent paying occupancy at the 824 Market Street office building during 1994 (the lender realized upon its security in the building in December 1994), partially offset by an increase in rent paying occupancy at the 767 Third Avenue office building during 1994 and an increase in expense recoveries resulting from an increase in certain expenses at the Mall of Memphis. The decrease in rental income for 1993 as compared to 1992 is primarily due to the sale of the South Point apartments in July 1993.\nThe decrease in interest income for 1994 as compared to 1993 and for 1993 as compared to 1992 is primarily due to the decreased average investment in interest bearing U.S. Government obligations resulting from the Partnership's funding of the operating deficits at the 767 Third Avenue office building during 1993 and 1994.\nThe increase in mortgage and other interest for 1994 as compared to 1993 is primarily due to the accrual of participation interest which the lender is entitled to under the terms of the mortgages related to the Partnership's apartment complexes, as more fully discussed in Note 4(c), partially offset by the sale of the South Point apartments in July 1993, as more fully discussed in Note 7(f). The increase in mortgage and other interest for 1993 as compared to 1992 is primarily due to interest related to the additional financing secured by the Mall of Memphis during 1993, as more fully discussed in Note 4(b), and the accrual of participation interest related to the Partnership's apartment complexes. This increase is partially offset by the sale of the Wood Forest Glen apartments in April 1992, the sale of the Meadowcrest apartments and the Bitter Creek apartments in June 1992 and the sale of the South Point apartments in July 1993.\nThe decrease in property operating expenses for 1994 as compared to 1993 is primarily due to (i) the sale of the South Point apartments in July 1993, (ii) the establishment of a $527,774 reserve at December 31, 1993 due to the uncertainty of collection of the Partnership's mortgage notes receivable, as more fully discussed in Note 7(a), (iii) receipt in 1994 of a $178,835 1993 tax refund at the Riverfront office building due to a reduction in the property's 1993 assessed value, (iv) a reduction in 1994 real estate taxes of approximately $226,000 at the Riverfront office building due to a reduction in the property's 1994 assessed value and (v) the provision for doubtful accounts recorded in 1993 related to rents due from the former tenant and second mortgage lender at the 824 Market Street office building. The increase in property operating expenses for 1993 as compared to 1992 is primarily due to the reserve recorded at September 30, 1993 related to the mortgage notes receivable and the provision for doubtful accounts related to a former tenant at the 824 Market Street office building as more fully discussed above.\nThe decrease in professional services for 1994 as compared to 1993 is primarily due to a reduction in 1994 in Partnership legal expenses.\nThe increase in amortization of deferred expenses for 1994 and 1993 as compared to 1992 is primarily due to increased amortization relating to capitalized leasing costs at the 767 Third Avenue office building and the Riverfront office building, as more fully discussed in Note 4(b).\nThe decrease in Partnership's share of operations in unconsolidated ventures for 1994 and 1993 as compared to 1992 is primarily due to the disposition of the Partnership's interest in the Yerba Buena West office building in June 1992, as more fully discussed in Note 3(b).\nThe increase in the venture partners' share of loss of ventures' operations for 1994 as compared to 1993 is primarily due to continuing operating deficits during 1994 and the 1994 write-off of tenant improvements at the Riverfront office building, as more fully discussed above, partially offset by a reduction in operating deficits at the 767 Third Avenue office building due to an increase in occupancy during 1994. The increase in the venture partners' share of loss of ventures' operations for 1993 as compared to 1992 is primarily due to operating deficits incurred at the Mall of Memphis and Riverfront office building during 1993.\nThe gain from sale or disposition of investment properties for 1994 resulted from the lender realizing upon its security in the 824 Market Street office building; 1993 resulted from the sale of the South Point apartments; and 1992 resulted from the sale of the Wood Forest Glen apartments, the Meadowcrest apartments and the Bitter Creek apartments and the disposition of the Partnership's interest in the Yerba Buena West office building.\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 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, certain 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 - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nINDEX\nIndependent Auditors' Report\nConsolidated Balance Sheets, December 31, 1994 and 1993\nConsolidated Statements of Operations, years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Partners' Capital Accounts (Deficit), years ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows, years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nSchedule --------\nConsolidated Real Estate and Accumulated Depreciation III\nSCHEDULES NOT FILED:\nAll schedules other than the one indicated in the index have been omitted as the required information is inapplicable or the information is presented in the financial statements or related notes.\nINDEPENDENT AUDITORS' REPORT\nThe Partners CARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI:\nWe have audited the consolidated financial statements of Carlyle Real Estate Limited Partnership - XI (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 schedule as listed in the accompanying index. These consolidated financial statements and financial statement schedule 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 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 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 - XI and consolidated ventures at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles. Also in our opinion, the related 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 LLP\nChicago, Illinois March 25, 1995\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDECEMBER 31, 1994, 1993 AND 1992\n(1) BASIS OF ACCOUNTING\nThe accompanying consolidated financial statements include the accounts of the Partnership and the following of its ventures (note 3): GP- 1 Partners, Ltd. (\"Bitter Creek\") (property sold in June 1992, see note 7(e)), Mall of Memphis Associates (\"Mall of Memphis\"), 767 Third Avenue Associates (\"767 Third Avenue\"), Riverfront Office Park Joint Venture (\"Riverfront\") and Excelsior Associates, LP (\"824 Market Street\") (property transferred to lender in December 1994, see note 4(b)). The effect of all transactions between the Partnership and the ventures has been eliminated. The equity method of accounting has been applied in the accompanying consolidated financial statements with respect to the Partnership's interest in Carlyle\/National City Associates (\"Carlyle\/National City\") and Carlyle Yerba Buena Limited Partnership (\"Yerba Buena\") (property transferred to lender in June 1992, see note 3(b)(1)). Accordingly, the accompanying consolidated financial statements do not include the accounts of Carlyle\/National City or Yerba Buena.\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 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. 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 - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nThe net loss per limited partnership interest is based upon the Limited Partnership Interests outstanding at the end of each period. 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. The Partnership records amounts held in U.S. Government obligations at cost, which approximates market. 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 ($1,932,366 and $0 at December 31, 1994 and 1993, respectively) as cash equivalents with any remaining amounts (generally with original maturities of one year or less) reflected as short-term investments being held to maturity.\nDeferred expenses consist primarily of leasing and financing fees incurred in connection with the acquisition and operation of the properties. Deferred leasing fees are amortized using the straight-line method over the terms stipulated in the related agreements. Deferred financing fees are amortized over the related commitment periods.\nAlthough certain leases of the Partnership provide for tenant occupancy during periods for which no rent is due, the Partnership accrues rental income over the full period of occupancy on a straight-line basis.\nCertain reclassifications have been made to the 1993 and 1992 consolidated financial statements to conform with the 1994 presentation.\nStatement of Financial Accounting Standards No. 107 (\"SFAS 107\"), \"Disclosures about Fair Value of Financial Instruments\", requires entities with total assets exceeding $150 million 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. As the debt secured by the Riverfront Office Building has been classified by the Partnership as a current liability at December 31, 1994 and 1993 as a result of default (see note 4(b)) and because resolution of such default is uncertain, the Partnership considers the disclosure of the SFAS 107 value of such long-term debt to be impracticable. The remaining debt, with a carrying balance of $108,685,311 has been calculated to have an SFAS 107 value of $106,716,115 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.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (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 tax authorities amounts representing withholding from distributions paid to partners.\n(2) INVESTMENT PROPERTIES\n(a) General\nThe Partnership acquired, either directly or through joint venture (note 3), ten apartment complexes, eight office buildings, and an enclosed shopping mall. During 1984, the Partnership sold its Arlington, Texas and its Red Bank, Tennessee apartment complexes. During 1986, the Partnership sold its interest in Am-Car Real Estate Partnership-I joint venture (\"AM- CAR\"), which had ownership interests in the Pavillion Towers office complex located in Aurora, Colorado and the Coast Federal Office Building located in Pasadena, California. During 1988, the Partnership (through Somerset Lake Associates) sold its Indianapolis, Indiana apartment complex. During 1991, the Partnership disposed of its interest in the Gatehall Plaza office building located in Parsippany, New Jersey. During 1992, the Partnership sold its interest in the Wood Forest Glen Apartments, the Meadowcrest Apartments and the Bitter Creek Apartments. In addition, during 1992, the lender realized upon its security and took title to the Yerba Buena West Office Building. During 1993, the Partnership sold its interest in the South Point Apartments. During 1994, the lender realized upon its security and took title to the 824 Market Street Office Building. All of the properties owned at December 31, 1994 were operating. The cost of the investment properties represents the total cost to the Partnership or its ventures plus miscellaneous acquisition costs.\nDepreciation on the operating properties has been provided over estimated useful lives of 5 to 30 years using the straight-line method.\nAll investment properties are pledged as security for the long-term debt, for which there is generally no recourse to the Partnership. The Partnership continues to make payments on its existing mortgage indebtedness related to its remaining investment properties, except as described in note 4 below.\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, 1994 is a party to four operating joint venture agreements. Pursuant to such venture agreements, the Partnership made initial capital contributions of approximately $51,345,000 before legal and other acquisition costs and its share of operating deficits as discussed below. In general, the Partnership's joint venture partners, who are either the sellers (or their affiliates) of the property investments 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,\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nwhich 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, an enclosed shopping mall and three office buildings. 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 excesses. The venture properties have been financed under various long-term debt arrangements as described in note 4.\nThe Partnership generally has a cumulative preferred interest in net cash receipts (as defined) from the properties. 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. During 1994, 1993 and 1992, one of the ventures produced net cash receipts available for distribution to the Partnership. The Partnership 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.\nIn general, operating profits and losses are shared in the same ratio as net cash receipts; however, if there are no net cash receipts, profits or losses are allocated to the partners based upon their respective economic interests.\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) Unconsolidated Ventures\n(1) Yerba Buena\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 included Carlyle Real Estate Limited Partnership-XII (\"Carlyle-XII\") 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\"). Yerba Buena transferred title to the property to the lender in June 1992 as described below.\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 owned a 23.36% interest in the property. The Partnership was generally entitled to 23.36% of Yerba Buena's annual net cash flow, net sale or refinancing proceeds and profits or losses. The Partnership's cash investment in connection with this property was approximately $4,000,000.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nBased upon the conditions at Yerba Buena, including tenant disputes following the October 17, 1989 San Francisco earthquake, the venture had not made the debt service payments to the underlying lender commencing with the January 1990 payment. The Partnership and Affiliated Partners had decided, based upon an analyses of current market conditions and the probability of large future cash deficits, not to fund future joint venture cash deficits. The joint venture was unable to negotiate a loan modification to pay for expected future cash deficits whereby the joint venture retained ownership of the property and in June 1992, the joint venture transferred title of 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, until June 1995, the joint venture will have a right of first opportunity to purchase the property if the lender chooses to sell. 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 in 1992 a gain for financial reporting and Federal income tax purposes of $1,614,369 and $964,406, respectively, with no corresponding distributable proceeds.\n(2) Carlyle\/National City\nIn July 1983, the Partnership acquired, through Carlyle\/National City (a joint venture with Carlyle-XII), an interest in an existing thirty-five story office building in Cleveland, Ohio.\nThe Partnership made an initial contribution of $5,445,257 to Carlyle\/National City. The terms of the Carlyle\/National City venture agreement provide that the capital contributions, annual cash flow, net proceeds from sale or refinancing and profit or loss will be allocated or distributed 13.7255% to the Partnership. The Partnership's cash investment in the property was $3,341,583 after distributions resulting from the increase in the first mortgage loan.\nIn January 1994, the debt service payments under the existing mortgage for the National City Center Office Building increased from 9-5\/8% to 11- 7\/8% until the scheduled maturity of the loan in December 1995. Carlyle\/National City reached an agreement with the current mortgage lender to refinance the existing mortgage effective April 28, 1994, with an interest rate of 8.5%. The loan will be amortized over 22 years with a balloon payment due at maturity on April 10, 2001. Carlyle\/National City paid a refundable loan commitment fee of $1,164,524 in 1993 in conjunction with the refinancing. The fee was applied to accrued interest and the prepayment penalty of $580,586 based on the outstanding mortgage balance at the time of refinancing, with the balance of $238,215 refunded to Carlyle\/National City in 1994. In addition, the lender required an escrow account of $612,000 to be established at the inception of the refinancing for future tenant improvements costs at the property. The lender also requires the tenant costs related to a major tenant (Baker & Hostetler) lease to be escrowed. The venture is required to escrow approximately $313,000 per year from 1994 through 1996 and approximately $236,000 per year in 1997 and 1998.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nFive year maturities of long-term debt are as follows:\n1995 . . . . . . . . . . . $34,720,167 1996 . . . . . . . . . . . 467,357 1997 . . . . . . . . . . . 517,419 1998 . . . . . . . . . . . 3,072,897 1999 . . . . . . . . . . . 74,819,044 ===========\n(b) Long-Term Debt Modifications and Refinancings\nGeneral\nAs described below, the Partnership is seeking or has received mortgage note modifications on certain properties. Upon expiration of such modifications or scheduled maturity of the loans, should the Partnership not seek or be unable to secure new or additional modifications to the loans, based upon current and anticipated future market conditions, the Partnership may not commit any significant additional amounts to these properties. This would likely result in the Partnership no longer having an ownership (or security interest) in such properties. Such decisions will be made on a property-by-property basis and could result in a gain for financial reporting and Federal income tax purposes to the Partnership with no corresponding distributable proceeds.\nWood Forest Glen Apartments\nThe modification of the existing long-term mortgage note secured by the Wood Forest Glen apartment complex located in Houston, Texas expired on June 30, 1990. The Partnership continued to negotiate for further modifications to the mortgage loan but was unsuccessful. In December 1991, the Partnership was notified that the lender sold its mortgage note to a third party. The Partnership pursued discussions with the new lender concerning modifications to the mortgage loan and a possible sale of the property. The Partnership was not successful in securing such modifications; however, in April 1992, the Partnership sold its interest in the property to the new lender for approximately $213,000 in excess of the existing mortgage balance (see note 7(c)). As a result of the sale, the Partnership recognized in 1992 a gain on sale of $6,470,625 and $7,058,574 for financial reporting and Federal income tax purposes, respectively.\nBitter Creek Apartments\nOn June 10, 1992, the venture sold the property as more fully discussed in note 7(e).\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nDuring February 1992, the Bitter Creek venture received an additional modification to the long-term mortgage notes. The venture was required to pay down approximately $436,000 of the principal balance of the mortgage loan in exchange for the lender forgiving all deferred interest and extending the term of the modification. The Partnership's share of the required principal payment was approximately $58,000. The new modified interest accrual and payment rate (averaging 7% for the period June 15, 1991 to June 9, 1992) was based upon the lender's prime rate. The additional mortgage modification provided that payments of interest be paid monthly and the principal balance and any accrued interest would be due and payable on December 15, 1992.\n767 Third Avenue Office Building\nOccupancy at the property is 89% at December 31, 1994, up from 83% in 1993. The 767 Third Avenue venture is aggressively marketing the remaining vacant space. The Partnership is obligated to fund its share of the net cash flow deficits resulting from costs associated with any leasing activity at the property.\nDuring 1991 and 1992, the leases for approximately 67% of the space at the 767 Third Avenue office building located in New York, New York expired (substantially all of which have been released as of December 1994 but at lower effective rents). In order to reduce debt service payments during the tenant turnover period, the 767 Third Avenue venture obtained from the existing lender, in May 1992, a replacement mortgage loan which matures in May 1998 and bears a substantially lower interest rate (10%) than the original loan (12 3\/8%). In connection with the replacement mortgage loan, 767 Third Avenue was required to fund $8,000,000 into an escrow account for future leasing costs and debt service shortfalls resulting from anticipated tenant turnover. At the inception of the escrow agreement, the venture was allowed to reduce the required escrow contributions by approximately $2,600,000 to reflect that certain leasing costs (described above) had already been incurred. 767 Third Avenue had been reserving the property's cash flow beginning with the second quarter of 1990; however, such amounts were less than the net required reserve. The Partnership's venture partner loaned $5,000,000 to the venture in order to fund the net escrow reserve account. In 1993, the reserve account was depleted and the venture (by way of partner contributions) continues to fund required leasing costs and debt service shortfalls. The loan funded by the Partnership's venture partner earns interest at an adjustable rate (10.5% at December 31, 1994) and provides for repayment of principal and interest out of the available cash flow from property operations and sale or refinancing proceeds. In June 1993, the Partnership purchased a 50% interest in the venture partner's loan including the related accrued interest. Accordingly, the Partnership's 50% interest in the principal portion of the loan ($2,500,000) is reflected as a decrease in long-term debt, less current portion in the consolidated financial statements. In conjunction with the agreement with the venture partner to loan the amounts necessary to fund the escrow account, because the Partnership did not purchase its share of the $5,000,000 loan by December 31, 1992, the Partnership's preferential return was removed from the calculation of the allocation of sale or refinancing proceeds. In addition, during 1994, the venture partner approached the Partnership regarding purchasing the Partnership's 50% interest in 767 Third Avenue, however, upon review of the proposed terms, the Partnership did not believe the offer to be in its best interest and the offer was rejected.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n824 Market Street Office Building\nOccupancy at the 824 Market Street office building located in Wilmington, Delaware had risen to 56% during 1994, up from 49% at December 31, 1993. The 824 Market Street venture was aggressively seeking replacement tenants for the vacant space; however, competition had risen significantly due to new office building development in the area over the last few years and the contraction of tenants in the financial services industry, resulting in lower effective rental rates. In order to reduce debt service payments during the tenant turnover period, the venture had negotiated with the first mortgage lender for a possible modification to the mortgage note. Such negotiations were unsuccessful and the venture received notice of default. Accordingly, for financial reporting purposes, the underlying debt of approximately $13,515,000 was reflected as a current liability in the accompanying consolidated financial statements at December 31, 1993. The first mortgage lender commenced proceedings to realize upon its security and was the successful bidder at the foreclosure sale held in October 1994. The deed was conveyed to the first mortgage lender on December 12, 1994. As a result of the disposition of the property, the Partnership recognized a gain in 1994 for financial reporting purposes and Federal income tax purposes of $3,689,195 and $6,805,134, respectively, with no corresponding distributable proceeds.\nRiverfront Office Building\nOn August 28, 1990, the Riverfront joint venture acquired additional financing by way of a $5,800,000 fourth mortgage note in order to fund the costs associated with leasing vacant space. As of the date of this report, the joint venture has received approximately $5,730,000 in proceeds. The balance of the proceeds, a $70,000 engineering holdback, is payable to the joint venture upon completion of certain structural repairs, the extent of which are being negotiated with the lender but which are not expected to exceed the holdback amount. Though occupancy at the property has increased from 85% at December 31, 1993 to 95% at December 31, 1994, average rent paying occupancy decreased due to (i) a major tenant (vacating approximately 25% of the building in July 1992 due to a downsizing of its operations) continuing to pay rent through the remaining terms of its leases which expired in April 1993 and (ii) a second major tenant downsizing its operations in April 1993 by approximately 36,000 square feet or 11% of the building and receiving a rent reduction of approximately 23% on its remaining leased space. The property began operating at a deficit in 1992 and, as a result, debt service payments since July 1992 were made on a delayed basis. At December 31, 1994, the February 1993 through December 1994 debt service payments are delinquent by approximately $6,724,000. Accordingly, the loan balances of approximately $34,298,000 have been reflected as a current liability in the consolidated financial statements. In order to reduce debt service payments, the joint venture has initiated discussions with the lender to negotiate possible modifications to the mortgage notes. In this regard, the joint venture has entered into a non-binding letter of intent with the existing lender for a restructure of its mortgage loans. The proposed terms of the loan restructure would retroactively reduce the interest rate payable on the loans and reduce the term of the loan from its present maturity date of September 2018 to December 2007. The loans (which currently bear interest\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nat rates ranging from 10% to 14% per annum) would bear interest at 6% per annum for the period January 1, 1993 through December 31, 1997. Thereafter, the interest rate per annum shall be the greater of the rate derived using the \"Coverage Formula\" (as defined) or 7% from January 1, 1998 to December 31, 1999; 8.25% from January 1, 2000 to December 31, 2002; and 9% from January 1, 2003 to December 31, 2007. In addition, the lender is entitled to earn a minimum internal rate of return of 10.5% per annum calculated over the restructured loan term. The proposed loan restructure would also require that net cash flow after debt service and capital be paid into an escrow account controlled by the lender to be used for operating shortfalls and costs associated with additional leasing as approved by the lender. There can be no assurances that any restructure will be obtained. In addition, the property operates under a ground lease and the joint venture has not made the scheduled ground lease payments since February 1993. The ground lessor is a general partner of the venture partner. At December 31, 1994, the total amount of ground lease payments in arrears is approximately $343,000. In this regard, the proposed loan restructure discussed above would provide for the waiver of any and all ground lease payments since the first missed payment in February 1993 until the earlier of any future mortgage loan prepayment date (resulting from a sale or refinancing of the property) or December 31, 2007. The proposed loan restructure also provides that if, during calendar year 1997, projections of gross rental revenue approved by the lender during the year are not less than $9 million per year for each of the next five calendar years, annual payments of ground rent would resume, but in a reduced amount (as defined). If the joint venture is unable to secure any modifications to the mortgage notes, the joint venture would likely decide, based upon current and anticipated future market conditions, not to commit any significant additional amounts to this property. This would result in the Partnership no longer having an ownership interest in this property and would result in a gain for financial reporting and Federal income tax purposes to the Partnership with no corresponding distributable proceeds.\nMall of Memphis\nAlthough occupancy had been increasing, in order for the Mall of Memphis to maintain is competitive position in the marketplace, the Mall of Memphis venture completed a mall renovation in 1991. The renovation costs had been funded by the venture until additional financing was in place. The Partnership contributed approximately $2,252,000 in addition to foregoing their share of 1990 and a portion of the 1991 distributable cash flow from the property to cover their portion of the renovation costs. In March 1993, the venture finalized additional financing of a $7,600,000 ten year loan at a rate of 10%. The Partnership's share of the funding was $4,719,095 (net of closing costs). Of the amount funded, the Partnership was required to deposit $1,000,000 in an escrow account as security against any currently undiscovered environmental issues. The venture would have been entitled to additional proceeds of $2,025,000 if the property had achieved certain occupancy levels and debt coverage ratios by September 30, 1994, however, the venture did not qualify for such additional proceeds as leasing did not achieve budgeted goals. In May 1994, an affiliate of the General Partners assumed property management and leasing services. Property management fees are calculated as 3% of base rent (as defined) and leasing commissions are calculated at a rate, which approximates market, based on the terms of the related lease. In addition, the venture partner has approached the Partnership regarding selling its 36.94% interest in the Mall of Memphis to the Partnership, however, there can be no assurances that such transaction will be consummated.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(c) Refinancings\nIn December 1990, the Partnership obtained replacement mortgage loans from an institutional lender to retire in full satisfaction, at an aggregate discount, the previously modified existing long-term mortgage notes secured by the Scotland Yard - Phase I and II, South Point and El Dorado View apartment complexes. Commencing April 1, 1992, the loans provide for payment of contingent interest equal to 35% of the amount by which gross receipts attributable to a fiscal year (all as defined) exceed a base amount. For the fiscal years 1994, 1993 and 1992, contingent interest aggregated approximately $257,000, $293,000 and $281,000, respectively. In the event that these properties are sold before the maturity date of the loans, the lender is entitled to a prepayment penalty of 6% of the mortgage principal and, in general, the higher of 65% of the sale proceeds or ten times the highest contingent interest amount in any of the three full fiscal years preceding the sale (all as defined). The Partnership sold South Point Apartments in July 1993, as further discussed in note 7(f). The lender has the right to call the remaining loans at any time after January 1, 1996. In this regard, the Partnership is currently marketing the Scotland Yard Phase I and II and the El Dorado View apartment complexes for sale. If the Partnership is unsuccessful in selling the properties prior to January 1, 1996 and the lender exercises its right to call the loans, the Partnership would recognize a gain for financial reporting and Federal income tax purposes with no corresponding distributable proceeds. The lender required the establishment of an escrow account, initially of approximately $980,000 in the aggregate, to be used towards the purchase of major capital items at the apartment complexes. Additionally, the lender required $150,000 of the sale proceeds from South Point Apartments to be added to the escrow account. As of December 31, 1994, the Partnership has been reimbursed from the escrow account approximately $959,000 for capital improvements at the above-referenced apartment complexes. Finally, the modification provides for the lender to participate in the net proceeds from the sale or refinancing of the properties in the form of additional contingent interest. The Partnership has recorded an accrual for such participation of $3,605,840 and $1,061,103 as deferred accrued interest included in the balance of long-term debt in the accompanying consolidated financial statements at December 31, 1994 and 1993, 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 are allocated first to the General Partners in an amount equal to the greater of the amount distributable to the General Partners from the proceeds of any such sale (as described below) or 1% of the profits from the sale. Losses from the sale or other disposition of investment properties will be allocated 1% to the General Partners. The remaining sale 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 which 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\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nshall 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 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.\nThe General Partners are not required to make any capital contribu- tions except under certain limited circumstances upon dissolution and termination of the Partnership. Distributions of \"net cash receipts\" of the Partnership are 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).\nThe Partnership Agreement provides that the Limited Partners shall receive 99% and the General Partners shall receive 1% of the sale or refinancing proceeds of a real property (net after expenses and retained working capital) until the Limited Partners (i) have received cash distributions of sale or refinancing proceeds in an amount equal to the Limited Partners' aggregate initial capital investment in the Partnership, and (ii) have received cumulative cash distributions from the Partnership's operations which when combined with sale or refinancing proceeds previously distributed, equal a 6% annual return on the Limited Partners' average capital investment for each year (their initial capital investment as reduced by sale or refinancing proceeds previously distributed) commencing with the first fiscal quarter of 1983. After such distributions, the General Partners shall receive (to the extent not previously received) proceeds up to 3% of the aggregate sales price of properties previously sold by the Partnership with any remaining proceeds allocated 85% to the Limited Partners and 15% General Partners. The Limited Partners have not yet received cash distributions of sale or refinancing proceeds in an amount equal to their initial capital investment. Therefore, no sale proceeds are distributable to the General Partners pursuant to the distribution levels described above.\nAllocations among the partners in the accompanying accrual basis consolidated financial statements have been made in accordance with the provisions of the Partnership Agreement and the venture agreements (see note 3). The allocation percentages may differ from year to year based on future events. Differences may therefore result between allocations among the partners on the GAAP basis and the tax basis. Such differences would have no significant effect on total assets, total partners' capital or net loss.\n(6) MANAGEMENT AGREEMENTS\nIn May 1994, an affiliate of the General Partners assumed property management and leasing services at the Mall of Memphis from an affiliate of the venture partner. Leasing commissions at the Mall of Memphis are calculated at a rate, which approximates market, based on the terms of the related lease.\nCertain of the Partnership's properties are managed by affiliates of the General Partners or their assignees for fees computed as a percentage of certain rents received by the properties. In December 1994, one of the affiliated property managers sold substantially all of its assets and assigned its interest in its management contracts to an unaffiliated third party. In addition, certain of the management personnel of the property manager became management personnel of the purchaser and its affiliates. The successor to the affiliated property manager's assets is acting as the property manager of the Scotland Yard-Phase I and II Apartments and the El Dorado View Apartments after the sale on the same terms that existed prior to the sale.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n(7) SALES OF INVESTMENT PROPERTIES\n(a) Pavillion Towers, Aurora, Colorado\nDuring April 1986, the Partnership sold its interest in Am-Car Real Estate Partnership-I (\"Am-Car\") (which owns the Pavillion Towers office complex located in Aurora, Colorado) to its venture partners for $1,000,000 in cash, promissory notes aggregating $3,750,000 and the venture partners' assumption of the Partnership's share of the debt encumbering the property. The two promissory notes of $3,000,000 and $750,000 bear interest at various rates and are due in April 1996. Beginning in 1991, the Partnership has not received the scheduled interest payments of $15,000 on the $750,000 note and as of the date of this report, the Partnership has not received the 1993 or 1994 scheduled interest payment of $60,000 on the $3,000,000 note. Collection of all past due and future amounts from these notes are considered unlikely; however, the Partnership is evaluating all of its legal options. Due to the uncertainty of collection of all past due and future amounts from these notes, a $527,774 reserve was established at December 31, 1993 to reduce the mortgage notes receivable balance to an amount not to exceed the related deferred gain on sale.\nThe sale was accounted for by the installment method whereby the gain on sale of $3,057,695 (net of discount on the promissory notes receivable of $1,682,305) was recognized as collections of principal were received. Effective January 1, 1990, the Partnership adopted the cost recovery method of accounting. The interest received in 1992 ($60,000) was applied against the outstanding principal balance. No profit was recognized in 1994, 1993 or 1992.\n(b) Mortgage notes receivable relating to the above sale consist of the following:\n1994 1993 ------------ ---------- Promissory note secured by personal guarantees of the buyers of the Part- nership's interest in the Pavillion Tower office complex located in Aurora, Colorado. Payable interest only (aggregating $150,000 over the ten-year period) at various rates. The entire unpaid principal balance is due April 24, 1996. Balance is net of $199,406 of unamortized discount at December 31, 1994 and 1993 based on an imputed rate of 8-1\/2% . . . . . . . . . . . . $ 543,094 543,094 Promissory note secured by personal guarantees of the buyers of the Partnership's interest in the Pavillion Tower office complex located in Aurora, Colorado. Payable interest only (aggregating $600,000 over the ten-year period) at various rates. The entire unpaid principal balance is due April 24, 1996. Balance is net of $797,625 of unamortized discount at December 31, 1994 and 1993 based on an imputed rate of 8-1\/2% . . . . . . . . . . . . 2,052,375 2,052,375 ---------- --------- CARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\n1994 1993 ------------ ------------\nTotal long-term notes receivable . . . . 2,595,469 2,595,469 Reserve for uncollectibility . . . . . . (527,774) (527,774) ---------- --------- Total long-term notes receivable (net of reserve for uncollectibility). . . . . . . . . . . $2,067,695 2,067,695 ========== =========\n(c) Wood Forest Glen Apartments\nOn April 2, 1992, the Partnership sold its interest in the Wood Forest Glen Apartments to the lender for approximately $213,000 in excess of the existing mortgage balance ($11,138,170 at the date of sale). The Partnership recognized in 1992 a gain of $6,470,625 and $7,058,574 for financial reporting and Federal income tax purposes, respectively.\n(d) Meadowcrest Apartments\nOn June 9, 1992, the Partnership sold the land, building and related improvements and personal property of the Meadowcrest apartment complex located in Dallas, Texas for $9,575,000 in cash before selling costs and prorations. A major portion of the sales proceeds was utilized to retire the related underlying mortgage notes of approximately $8,445,000 (a portion of which were scheduled to mature June 30, 1992). The Partnership received approximately $861,000 from the sale of the property after deducting expenses in connection with the sale and the mortgage loan. As a result of the sale, the Partnership recognized in 1992 a gain of $562,806 and $5,255,084 for financial reporting and Federal income tax purposes, respectively.\n(e) Bitter Creek Apartments\nOn June 10, 1992, the Partnership, through the Bitter Creek venture, sold the land, building and related improvements and personal property of the Bitter Creek apartment complex for $10,250,000 in cash before selling costs and prorations. A major portion of the sales proceeds was utilized to retire the related underlying mortgage note of approximately $9,064,000 (note 4(b)). In addition, pursuant to the venture partner agreement, the Partnership and venture partner were allocated $338,709 and $681,423 of net sales proceeds, respectively. The venture agreement generally provides that the gain of $1,024,264 from the sale of the entire property will be first allocated to the joint venture partners' respective negative capital accounts. Any amounts remaining will be allocated 50% to the Partnership and 50% to the venture partner. The venture partner's share of the gain was $881,297. The Partnership recognized in 1992 a gain of $142,967 and $2,808,159 for financial reporting and Federal income tax purposes, respectively.\n(f) South Point Apartments\nOn July 29, 1993, the Partnership sold the land, buildings and related improvements and personal property of the South Point apartments complex located in Houston, Texas to an unaffiliated buyer at a sales price determined by arm's-length negotiations. The sales price of the property was $5,600,000 (before closing costs and prorations). A major portion of the sales proceeds was utilized to retire the related underlying mortgage principal of $4,455,000. The Partnership received in connection with the sale, after all fees and expenses, approximately $932,000. Of this amount,\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\nthe lender was entitled to approximately $606,000 as participation in the sales proceeds. From the sale, the Partnership received a net amount of cash of approximately $326,000, of which $150,000 was required by the lender to be escrowed for the benefit of the Partnership's other properties financed by the lender, as more fully discussed in note 4(c). As a result of the sale, the Partnership has recognized in 1993 a gain of $1,433,916 and $3,512,797 for financial reporting purposes and for Federal income tax purposes, respectively.\n(8) LEASES\n(a) As Property Lessor\nAt December 31, 1994, the Partnership's and its consolidated ventures' principal assets are two office buildings, one enclosed shopping mall and three apartment complexes. 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 the cost of land, is depreciated over their estimated useful lives. Leases with office building and shopping center tenants range in term from one to twenty-four years and provide for fixed minimum rent and partial reimbursement of operating costs. In addition, leases with shopping center tenants provide for additional rent based upon percentages of tenant 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, 1994 are generally for a term of one year or less and provide for annual rents of approximately $5,429,000.\nCost of the leased assets net of accumulated depreciation are summarized as follows at December 31, 1994:\nShopping mall: Cost . . . . . . . . . . . . . . . $ 55,382,829 Accumulated depreciation . . . . . (19,097,888) ------------ 36,284,941 ------------ Office buildings: Cost . . . . . . . . . . . . . . . 115,532,291 Accumulated depreciation . . . . . (45,021,172) ------------ 70,511,119 ------------ Apartment complexes: Cost . . . . . . . . . . . . . . . 26,734,127 Accumulated depreciation . . . . . (11,309,050) ------------ 15,425,077 ------------ Total. . . . . . . . . . . . . . . . $122,221,137 ============\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED\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:\n1995 . . . . . . . . . . . . . . . . $ 20,085,961 1996 . . . . . . . . . . . . . . . . 18,490,744 1997 . . . . . . . . . . . . . . . . 14,657,147 1998 . . . . . . . . . . . . . . . . 10,819,146 1999 . . . . . . . . . . . . . . . . 8,151,826 Thereafter . . . . . . . . . . . . . 34,360,468 ------------\nTotal. . . . . . . . . . . . . . . . $106,565,292 ============\nAdditional contingent rent (based on sales by property tenants) included in consolidated rental income was as follows for the years ended December 31, 1994, 1993 and 1992:\n1992 . . . . . . . . . . . . . . . . $424,211 1993 . . . . . . . . . . . . . . . . 352,862 1994 . . . . . . . . . . . . . . . . 277,151 ========\n(b) As Property Lessee\nThe following lease agreement has been determined to be an operating lease.\nThe Riverfront venture owns a net leasehold interest which expires in 2061 (subject to a 19-year extension) in the land underlying the Cambridge, Massachusetts office building. The lease provides for annual rent equal to the greater of 2% of gross income from the property or a minimum amount (which increases on a fixed schedule from $132,700 at inception,to $298,575 for the years 2007 through 2080). The joint venture has not made the scheduled ground lease payments since February 1993. At December 31, 1994, the total amount of ground lease payments in arrears is approximately $343,000. Reference is made to note 4(b) regarding the potential waiver of any and all scheduled ground rent payments due under the lease since February 1993 in conjunction with a proposed loan restructure with the mortgage lender.\nFuture minimum rental commitments under this lease are as follows:\n1995 . . . . . . . . . . . $ 179,145 1996 . . . . . . . . . . . 187,417 1997 . . . . . . . . . . . 212,230 1998 . . . . . . . . . . . 212,230 1999 . . . . . . . . . . . 212,230 Thereafter . . . . . . . . 18,053,679 -----------\nTotal. . . . . . . . . . . $19,056,931 ===========\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI (A LIMITED PARTNERSHIP) AND CONSOLIDATED VENTURES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONCLUDED\nThe Corporate General Partner has deferred payment of partnership management fees as set forth in the above table. In addition, distributions to the General Partners of the first quarter 1991 net cash flow of the Partnership aggregating $7,161 have also been deferred. These amounts do not bear interest and are expected to be paid in future periods.\n(10) COMMITMENTS AND CONTINGENCIES\nThe Partnership is a defendant in several actions brought against it arising in the ordinary course of business. It is the belief of the Corporate General Partner, based on its knowledge of facts and advice of counsel, that the claims made against the Partnership in such actions will not result in a material adverse effect on the Partnership's consolidated financial position or results of operations.\n(11) INVESTMENT IN UNCONSOLIDATED VENTURE\nFor the Yerba Buena venture (note 3(b)(1)) for the year ended December 31, 1992, total income was $1,431,864, expenses applicable to operating loss were $3,523,650 and net income was $4,254,514.\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 years 1994 and 1993.\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 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-XI, 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. 0-10494) dated March 19, 1993.\nThe names, positions held and length of service therein of each director, executive officer and certain officers of the Corporate General Partner are as follows: SERVED 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 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 Executive Vice President 1\/02\/87 Chief Executive Officer 8\/01\/93 Glenn E. Emig Executive Vice President 1\/01\/93 Chief Operating Officer 1\/01\/95 Jeffrey R. Rosenthal Managing Director-Corporate 4\/22\/91 Chief Financial Officer 8\/01\/93 Douglas H. Cameron Executive Vice President 1\/01\/95 Gary Nickele Executive Vice President 1\/01\/92 and General Counsel 2\/27\/84 Gailen J. Hull Senior Vice President 6\/01\/88 Ira J. Schulman Executive Vice President 6\/01\/88 Howard Kogen Senior Vice President 1\/02\/86 Treasurer 1\/01\/91\nThere 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, 1995. 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, 1995. 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-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 Income-XIII\"). Most of the foregoing officers and directors 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-XII, 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 57) is an individual general partner of JMB Income-IV and JMB Income-V. Mr. Malkin has been associated with JMB since October, 1969. Mr. Malkin is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers, and a director of Catellus Development Corporation, a major diversified real estate development company. He is a Certified Public Accountant.\nNeil G. Bluhm (age 57) is an individual general partner of JMB Income- IV and JMB Income-V. Mr. Bluhm has been associated with JMB since August, 1970. Mr. Bluhm is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. He is a member of the Bar of the State of Illinois and a Certified Public Accountant.\nBurton E. Glazov (age 56) 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 53) has been associated with JMB since July, 1972. Mr. Nathan is also a director of Sportmart, Inc., a retailer of sporting goods. He is a member of the Bar of the State of Illinois.\nA. Lee Sacks (age 61) (President and Director of JMB Insurance Agency, Inc.) has been associated with JMB since December, 1972.\nJohn G. Schreiber (age 48) has been associated with JMB since December, 1970 and served as an Executive Vice President of JMB until December 1990. Mr. Schreiber is a director of Urban Shopping Centers, Inc., an affiliate of JMB that is a real estate investment trust in the business of owning, managing and developing shopping centers. Mr. Schreiber is President of Schreiber Investments, Inc., a company which is engaged in the real estate investment business. He is also a senior advisor and partner of Blackstone Real Estate Partners, an affiliate of the Blackstone Group, L.P. Since 1994, Mr. Schreiber has also served as a Trustee of Amli Residential Property Trust, a publicly-traded real estate investment trust that invests in multi-family properties. He is also a director of a number of investment companies advised or managed by T. Rowe Price Associates and its affiliates. He holds a Masters degree in Business Administration from Harvard University Graduate School of Business.\nH. Rigel Barber (age 45) 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.\nGlenn E. Emig (age 47) has been associated with JMB since December, 1979. Prior to becoming Executive Vice President of JMB in 1993, Mr. Emig was Executive Vice President and Treasurer of JMB Institutional Realty Corporation. He holds a Masters degree in Business Administration from the Harvard University Graduate School of Business and is a Certified Public Accountant.\nJeffrey R. Rosenthal (age 43) has been associated with JMB since December, 1987. He is a Certified Public Accountant.\nDouglas H. Cameron (age 45) has been associated with JMB since April, 1977. Prior to becoming Executive Vice President of JMB in 1995, Mr. Cameron was Managing Director of Capital Markets - Property Sales from June 1990. He holds a Masters degree in Business Administration from the University of Southern California.\nGary Nickele (age 42) 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 43) 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 46) 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 59) 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 117-119, \"Allocation of Profits or Losses for Tax Purposes\" at page 117 and \"Distributions and Compensations; Allocations of Profits and Losses\" at pages A-5 to A-10 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. 0-10494) dated March 19, 1993. Reference is also made to Notes 5 and 9 for a description of such transactions, distributions and allocations. In 1994, 1993, and 1992, no cash distributions were paid to the General Partners. In 1991, the General Partners deferred distributions of $7,161 and management fees of $11,936.\nJMB Properties Company, (which had been an affiliate of the Corporate General Partner until it was sold to an unaffiliated third party in December 1994 (see Note 6)), provided property management services to the Partnership through November 1994 for the El Dorado View Apartments in Webster, Texas, Scotland Yard - Phase I and Scotland Yard-Phase II in Houston, Texas. Fees were calculated at 5% of gross income for the apartment complexes. Such affiliate earned property management fees amounting to $255,865 in 1994, all of which were paid at December 31, 1994. In May 1994, JMB Retail Properties, Co., an affiliate of the General Partners, assumed property management and leasing services at the Mall of Memphis from an affiliate of the venture partner. Such affiliate earned property management fees amounting to $125,945 in 1994 of which $40,194 were unpaid at December 31, 1994. 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 5% of the gross income from a property), 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 and received insurance brokerage commissions in 1994 aggregating $32,821 in connection with the provision 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 and salaries relating to the administration of the Partnership and the acquisition and operation of the Partnership's real property investments. In 1994, the Corporate General Partner of the Partnership was due reimbursement for such expenses in the amount of $181,955. Cumulative amounts unpaid at December 31, 1994 were $69,635.\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-12 to A-17 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- 10494) dated March 19, 1993. The relationship of the Corporate General Partner to its affiliates is set forth above in Item 10.\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.\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 May 8, 1981, as supplemented on July 27, 1981, October 9, 1981, November 5, 1981, December 10, 1981, February 19, 1982 and April 23, 1982, as filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Pages 6-14, 117-119, A-5 to A-10 and A-12 to A-17 are hereby incorporated herein by reference.\n3-B.* Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, which agreement is hereby incorporated herein by reference.\n4-A. Long-term debt modification relating to the 767 Third Avenue Office Building in New York, New York is hereby incorporated herein by reference.\n4-B. Mortgage loan documents secured by the Mall of Memphis in Memphis, Tennessee are hereby incorporated by reference to the Partnership's Registration Statement on Post-Effective Amendment No. 2 to Form S-11 (File No. 2-70724) dated May 8, 1981.\n4-C. First through third mortgage loan documents secured by the Riverfront Office Building in Cambridge, Massachusetts are hereby incorporated by reference to the Partnership's Registration Statement on Post- Effective Amendment No. 3 to Form S-11 (File No. 2- 70724) dated May 8, 1981.\n4-D.* Fourth mortgage loan document secured by the Riverfront Office Building in Cambridge, Massachusetts is hereby incorporated herein by reference.\n4-E Deed of trust note document dated March 31, 1993 secured by the Mall of Memphis in Memphis, Tennessee is hereby incorporated by reference.\n10-A. Acquisition documents relating to the purchase by the Partnership of an interest in the 767 Third Avenue Office Building in New York, New York are hereby incorporated by reference to the Partnership's Registration Statement on Post-Effective Amendment No. 2 to Form S-11 (File No. 2-70724) dated May 8, 1981.\n10-B. Acquisition Documents relating to the purchase by the Partnership of an interest in the Mall of Memphis in Memphis, Tennessee are hereby incorporated by reference to the Partnership's Registration Statement on Post- Effective Amendment No. 2 to Form S-11 (File No. 2- 70724) dated May 8, 1981.\n10-C. Acquisition documents relating to the purchase by the Partnership of an interest in the Riverfront Office Building in Cambridge, Massachusetts are hereby incorporated by reference to the Partnership's Registration Statement on Post-Effective Amendment No. 3 to Form S-11 (File No. 2-70724) dated May 8, 1981.\n21. List of Subsidiaries.\n24. Powers of Attorney\n27. Financial Data Schedule\n99-A. The Partnership's Report on Form 8-K (File No. 0-10494) dated December 23, 1994 describing the December 12, 1994 disposition of the 824 Market Street Office Building and exhibit thereto are hereby incorporated herein by reference. _____________\n* Previously filed in Exhibits 3-A, 3-B and 4-D to the Partnership's Report on Form 10-K for December 31, 1992 of the Securities Exchange Act of 1934 (File No. 0-10494) filed on March 19, 1993.\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 Securities and Exchange Commission upon request.\n(b) The following on Form 8-K was filed since the beginning of the last quarter of the period covered by this report:\nThe Partnership's Report on Form 8-K (File No. 0-10494) dated December 23, 1994 describing the December 12, 1994 disposition of the 824 Market Street Office Building and exhibit thereto are hereby incorporated herein by reference.\nNo annual report or proxy material for the fiscal year 1994 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.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI\nBy: JMB Realty Corporation Corporate General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: March 27, 1995\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 27, 1995\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date: March 27, 1995\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date: March 27, 1995\nGLENN E. EMIG* By: Glenn E. Emig, Chief Operating Officer Date: March 27, 1995\nJEFFREY R. ROSENTHAL* By: Jeffrey R. Rosenthal, Chief Financial Officer Principal Financial Officer Date: March 27, 1995\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date: March 27, 1995\nA. LEE SACKS* By: A. Lee Sacks, Director Date: March 27, 1995\nSTUART C. NATHAN* By: Stuart C. Nathan, Executive Vice President and Director Date: March 27, 1995\n*By: GAILEN J. HULL, Pursuant to a Power of Attorney\nGAILEN J. HULL By: Gailen J. Hull, Attorney-in-Fact Date: March 27, 1995\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------ ----\n3-A. Pages 6-14, 117-119, A-5 to A-10, A-12 to A-17 of the Prospectus of the Partnership dated May 8, 1981 Yes\n3-B. Amended and Restated Agreement of Limited Partnership Yes\n4-A. Mortgage loan documents secured by the 767 Third Avenue Office Building Yes\n4-B. Mortgage loan documents secured by the Mall of Memphis Yes\n4-C. First through third mortgage loan documents secured by the Riverfront Office Building Yes\n4-D. Fourth mortgage loan document secured by the Riverfront Office Building Yes\n4-E. Deed of trust note dated March 31, 1993 secured by the Mall of Memphis Yes\n10-A. Acquisition documents related to the 767 Third Avenue Office Building Yes\n10-B. Acquisition documents related to the Mall of Memphis Yes\n10-C. Acquisition documents related to the Riverfront Office Building Yes\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No\n99-A. Form 8-K for December 12, 1994 Yes","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.\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 May 8, 1981, as supplemented on July 27, 1981, October 9, 1981, November 5, 1981, December 10, 1981, February 19, 1982 and April 23, 1982, as filed with the Commission pursuant to Rules 424(b) and 424(c), is hereby incorporated herein by reference. Pages 6-14, 117-119, A-5 to A-10 and A-12 to A-17 are hereby incorporated herein by reference.\n3-B.* Amended and Restated Agreement of Limited Partnership set forth as Exhibit A to the Prospectus, which agreement is hereby incorporated herein by reference.\n4-A. Long-term debt modification relating to the 767 Third Avenue Office Building in New York, New York is hereby incorporated herein by reference.\n4-B. Mortgage loan documents secured by the Mall of Memphis in Memphis, Tennessee are hereby incorporated by reference to the Partnership's Registration Statement on Post-Effective Amendment No. 2 to Form S-11 (File No. 2-70724) dated May 8, 1981.\n4-C. First through third mortgage loan documents secured by the Riverfront Office Building in Cambridge, Massachusetts are hereby incorporated by reference to the Partnership's Registration Statement on Post- Effective Amendment No. 3 to Form S-11 (File No. 2- 70724) dated May 8, 1981.\n4-D.* Fourth mortgage loan document secured by the Riverfront Office Building in Cambridge, Massachusetts is hereby incorporated herein by reference.\n4-E Deed of trust note document dated March 31, 1993 secured by the Mall of Memphis in Memphis, Tennessee is hereby incorporated by reference.\n10-A. Acquisition documents relating to the purchase by the Partnership of an interest in the 767 Third Avenue Office Building in New York, New York are hereby incorporated by reference to the Partnership's Registration Statement on Post-Effective Amendment No. 2 to Form S-11 (File No. 2-70724) dated May 8, 1981.\n10-B. Acquisition Documents relating to the purchase by the Partnership of an interest in the Mall of Memphis in Memphis, Tennessee are hereby incorporated by reference to the Partnership's Registration Statement on Post- Effective Amendment No. 2 to Form S-11 (File No. 2- 70724) dated May 8, 1981.\n10-C. Acquisition documents relating to the purchase by the Partnership of an interest in the Riverfront Office Building in Cambridge, Massachusetts are hereby incorporated by reference to the Partnership's Registration Statement on Post-Effective Amendment No. 3 to Form S-11 (File No. 2-70724) dated May 8, 1981.\n21. List of Subsidiaries.\n24. Powers of Attorney\n27. Financial Data Schedule\n99-A. The Partnership's Report on Form 8-K (File No. 0-10494) dated December 23, 1994 describing the December 12, 1994 disposition of the 824 Market Street Office Building and exhibit thereto are hereby incorporated herein by reference. _____________\n* Previously filed in Exhibits 3-A, 3-B and 4-D to the Partnership's Report on Form 10-K for December 31, 1992 of the Securities Exchange Act of 1934 (File No. 0-10494) filed on March 19, 1993.\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 Securities and Exchange Commission upon request.\n(b) The following on Form 8-K was filed since the beginning of the last quarter of the period covered by this report:\nThe Partnership's Report on Form 8-K (File No. 0-10494) dated December 23, 1994 describing the December 12, 1994 disposition of the 824 Market Street Office Building and exhibit thereto are hereby incorporated herein by reference.\nNo annual report or proxy material for the fiscal year 1994 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.\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI\nBy: JMB Realty Corporation Corporate General Partner\nGAILEN J. HULL By: Gailen J. Hull Senior Vice President Date: March 27, 1995\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 27, 1995\nNEIL G. BLUHM* By: Neil G. Bluhm, President and Director Date: March 27, 1995\nH. RIGEL BARBER* By: H. Rigel Barber, Chief Executive Officer Date: March 27, 1995\nGLENN E. EMIG* By: Glenn E. Emig, Chief Operating Officer Date: March 27, 1995\nJEFFREY R. ROSENTHAL* By: Jeffrey R. Rosenthal, Chief Financial Officer Principal Financial Officer Date: March 27, 1995\nGAILEN J. HULL By: Gailen J. Hull, Senior Vice President Principal Accounting Officer Date: March 27, 1995\nA. LEE SACKS* By: A. Lee Sacks, Director Date: March 27, 1995\nSTUART C. NATHAN* By: Stuart C. Nathan, Executive Vice President and Director Date: March 27, 1995\n*By: GAILEN J. HULL, Pursuant to a Power of Attorney\nGAILEN J. HULL By: Gailen J. Hull, Attorney-in-Fact Date: March 27, 1995\nCARLYLE REAL ESTATE LIMITED PARTNERSHIP - XI\nEXHIBIT INDEX\nDOCUMENT INCORPORATED BY REFERENCE PAGE ------------ ----\n3-A. Pages 6-14, 117-119, A-5 to A-10, A-12 to A-17 of the Prospectus of the Partnership dated May 8, 1981 Yes\n3-B. Amended and Restated Agreement of Limited Partnership Yes\n4-A. Mortgage loan documents secured by the 767 Third Avenue Office Building Yes\n4-B. Mortgage loan documents secured by the Mall of Memphis Yes\n4-C. First through third mortgage loan documents secured by the Riverfront Office Building Yes\n4-D. Fourth mortgage loan document secured by the Riverfront Office Building Yes\n4-E. Deed of trust note dated March 31, 1993 secured by the Mall of Memphis Yes\n10-A. Acquisition documents related to the 767 Third Avenue Office Building Yes\n10-B. Acquisition documents related to the Mall of Memphis Yes\n10-C. Acquisition documents related to the Riverfront Office Building Yes\n21. List of Subsidiaries No\n24. Powers of Attorney No\n27. Financial Data Schedule No\n99-A. Form 8-K for December 12, 1994 Yes","section_15":""}
{"filename":"10497_1994.txt","cik":"10497","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL COMPANY INFORMATION\nAs used herein, the \"Company\" means BayBanks, Inc. alone or BayBanks, Inc. together with its consolidated subsidiaries, depending on the context, and the \"BayBanks\" means the Company's three bank subsidiaries.\nBayBanks, Inc., established in 1928, is one of the largest bank holding companies in New England and is headquartered in Boston, Massachusetts. At December 31, 1994, the Company had total assets of $10.8 billion, total deposits of $9.0 billion, total stockholders' equity of $789 million, and 5,654 full-time equivalent employees. The Company's largest subsidiary is BayBank, a Massachusetts commercial bank based in Burlington, Massachusetts, that had total assets of $9.7 billion at December 31, 1994. BayBank Boston, N.A. is based in Boston, Massachusetts and BayBank Connecticut, N.A. is located in Hartford, Connecticut. The Company also maintains a loan production office in Portland, Maine.\nThe Company has an extensive banking network with 205 full-service offices and 366 automated banking facilities serving 151 cities and towns in Massachusetts and two in Connecticut. The hallmark of the Company's operating approach is its use of advanced banking technology, featuring state-of-the-art computer and telecommunications technology to process customer transactions, provide customer information, and increase the efficiency of its data processing activities. BayBank Systems, Inc., a nonbank subsidiary of the Company, engages in data processing, product and systems development, and other technologically oriented operations, principally for the Company but also for franchisees and correspondents. In particular, BayBank Systems, Inc., operates the proprietary X-Press 24(R) and X-Press 24 Cash(R) automated teller machine (\"ATM\") networks. BayBanks Credit Corp. (a subsidiary of BayBank Systems, Inc.) and BayBanks Mortgage Corp. (a subsidiary of BayBank) provide instalment loan, credit card, and mortgage loan operations and services. BayBanks Mortgage Corp. also services approximately $1.9 billion of residential mortgage loans originated by the BayBanks that have been placed in the secondary market. Other subsidiaries provide brokerage, investment management, and general management services to the BayBanks and other affiliates.\nThe following presents selected financial information for the Company's three banking subsidiaries:\nGENERAL BANKING BUSINESS\nThe Company provides a complete range of banking and related financial services, with particular emphasis on consumer and middle market business customers. In addition to its normal deposit and lending activities, the Company aggressively pursues fee income opportunities, both in traditional and automated banking services and in the investment field, including acting as investment adviser and shareholder servicing agent for BayFunds(R), a proprietary mutual fund family.\nConsumer Banking\nThe Company -- a recognized leader in consumer banking -- has the largest consumer market share in Massachusetts. More households in Massachusetts do business with the BayBanks than with any other banking organization. The Company offers a wide variety of consumer banking products, including FDIC-insured checking, money market, savings, and time deposit accounts; credit cards; home mortgages and home equity financing; instalment loans; and trust and private banking services.\nThe Company operates over 1,000 ATMs in Massachusetts and Connecticut, including 200 cash machines located in retail stores, and processes approximately 11 million transactions per month; the Company has over 1 million ATM cards in use. More than 90 nonaffiliated financial institutions add an additional 280 ATMs to the X-Press 24 network. X-Press 24 cardholders can perform automated banking transactions at over 130,000 CIRRUS(R) and NYCE(R) terminals worldwide. Cardholders can also use their cards to make point-of-sale purchases at retail establishments worldwide, including grocery stores, automobile service stations and, through BayBank X-Press Check(R), anywhere a MasterCard(R) is accepted. The Company provides a broad range of support and maintenance services to the X-Press 24 network member institutions. In addition to its branch and ATM networks, the Company operates a state-of-the-art customer sales and service center twenty-four hours a day, seven days a week, that provides customer service and product information, opens consumer bank accounts, and arranges consumer loans.\nCorporate Banking\nThe Company provides a comprehensive range of cash management, credit, deposit, international banking, and related services to businesses, hospitals, educational institutions, and local governments, with particular emphasis on the middle market. Specialized products available to BayBanks' business and governmental customers include personal computer-based cash management services with which a customer may perform a range of deposit account transactions; X-Press Trade(R), offering automated international letter of credit services; BayBank X-Press Tax(R) for automated payroll tax depositing; a Collateralized Municipal Money Market Account; and the Escrow Client Account Service. BayBank also acts as trustee or custodian for employee benefit and pension plans.\nSpecific lending groups focus on healthcare and educational institutions, municipalities, automobile dealers, construction and contracting companies, retailers, emerging technology companies, and international trade finance. The Company also provides secured financing, in the form of asset-based lending, leasing, and real estate lending, for commercial customers. The Company's general corporate lending activities are directed toward small and middle market companies in the New England region, with a primary emphasis on Massachusetts and southern New Hampshire enterprises.\nInvestment Services\nThe Company's subsidiaries offer a wide range of investment services to individuals and business customers. The government and municipal securities dealerships at BayBank Boston, N.A., participate in the underwriting of Massachusetts municipal obligations and engage in private placement activities. BayBanks Brokerage Services, Inc., provides retail brokerage services. BayBanks Investment Management, Inc., a registered investment adviser, provides portfolio advice and asset management for individuals and businesses and manages the BayBank trust department's common trust funds. As of December 31, 1994, the BayBank trust department had total assets with a book value of $5.3 billion under management or in custody. BayBanks Investment Management, Inc., and BayBank Boston, N.A. act as investment advisers to BayFunds(R), the Company's proprietary mutual fund family, which consists of money market, equity, and bond portfolios with aggregate assets of more than $1.3 billon at year-end 1994.\nPROPOSED ACQUISITION\nIn December 1994, the Company executed an agreement to acquire NFS Financial Corp. (\"NFS\"), a southern New Hampshire-based holding company with total assets of $619 million. The acquisition is subject to approval of the shareholders of NFS and of various federal and state bank regulatory authorities and is targeted for consummation in the third quarter of 1995. As a result, NFS, which owns two federal savings banks, would become a wholly-owned subsidiary of the Company. This will permit the Company to expand its operations directly into the New Hampshire market through NFS's existing branch systems and relationships. This will be a natural extension of the Company's already strong presence in the Massachusetts portion of the Merrimack Valley.\nCOMPETITION\nThe BayBanks operate in a highly competitive banking market. All of the banks compete with other commercial banks in their respective service areas, with several large commercial banks located in the City of Boston, and with a number of large regional and national commercial banks located throughout the country. Legislation enacted in recent years and changing regulatory interpretations have substantially increased the geographic and product competition among commercial banks, thrift institutions, mortgage companies, leasing companies, credit unions, finance companies, and nonbanking institutions, including mutual funds, insurance companies, brokerage firms, investment banks, and a variety of financial services and advisory companies. In the international business, the BayBanks compete with other domestic banks having foreign operations and with major foreign banks and other financial institutions.\nGOVERNMENT MONETARY POLICY\nThe earnings and growth of the banking industry in general are affected by the policies of regulatory authorities, including the Board of Governors of the Federal Reserve System (\"Federal Reserve Board\"). An important function of the Federal Reserve Board is to regulate the national money supply. 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 rates on member bank borrowings, and changes in amount or methods of calculating reserve requirements against member banks' deposits. These means, used in varying combinations, influence the overall growth of bank loans, investments, and deposits as well as the rates charged on loans or paid for deposits. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of commercial banks in the past and are expected to continue to have such an effect in the future. The effect of such policies upon the future business and earnings of the Company cannot be predicted.\nGENERAL BANKING REGULATION\nThe Company is a bank holding company subject to supervision and regulation by the Federal Reserve Board under the Bank Holding Company Act of 1956. As a bank holding company, the activities of the Company and its bank and nonbank subsidiaries are limited to the business of banking and activities closely related or incidental to banking. The Company may not acquire the ownership or control of more than 5% of any class of voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Federal Reserve Board. The Company is also subject to the Massachusetts and Connecticut bank holding company laws that, respectively require the Company to obtain the prior approval of the Massachusetts Board of Bank Incorporation and the Connecticut Banking Commissioner for holding company mergers and bank acquisitions.\nThe Company's largest subsidiary bank, BayBank, is subject to supervision and examination by the Federal Deposit Insurance Corporation (\"FDIC\") and the Commissioner of Banks of the Commonwealth of Massachusetts (\"Bank Commissioner\"). BayBank Boston, N.A. and BayBank Connecticut, N.A., are national banking associations subject to supervision and examination by the Office of the Comptroller of the Currency (\"OCC\"). All of the Company's subsidiary banks are insured by and subject to certain regulations of the FDIC. They are also subject to various requirements and restrictions under federal and state law, which include requirements to obtain regulatory approval of certain business transactions, including establishing and\nclosing bank branches; requirements to maintain reserves against deposits; restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon; and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of the Company's subsidiary banks.\nUnder the Financial Institutions Reform, Recovery and Enforcement Act of 1989, 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 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. Because the Company is a holding company, its right to participate in the assets of any subsidiary upon the latter's liquidation or reorganization will be subject to the prior claims of the subsidiary's creditors (including depositors in the case of bank subsidiaries), except to the extent that the Company may itself be a creditor with recognized claims against the subsidiary.\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\") provided for increased funding for FDIC deposit insurance and for expanded regulation of the banking industry.\nAmong other things, FDICIA requires the federal banking regulators to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital ratio categories: \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized,\" and \"critically undercapitalized.\"\nA depository institution is 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 the regulations. The critical capital level must be a level of tangible equity equal to at least 2% of total assets, but may be fixed at a higher level by regulation. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating and may be reclassified to a lower category by action based on other supervisory criteria. For an institution to be well capitalized it must have a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 6%, and a leverage ratio of at least 5% and not be subject to any specific capital order or directive. For an institution to be adequately capitalized it must have a total risk-based capital ratio of at least 8%, a Tier 1 risk-based capital ratio of at least 4%, and a leverage ratio of at least 4% (3% in some cases).\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 increased regulatory monitoring and growth limitations and are required to submit capital restoration plans. A depository institution's holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution's assets at the time it becomes undercapitalized or the amount needed to comply with the plan. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. Significantly 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, and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator.\nEach of the bank subsidiaries of the Company exceeds current minimum regulatory capital requirements and qualify as well capitalized under the regulations relating to prompt corrective action (see \"Regulatory Capital Requirements\").\nThe FDIC has adopted regulations governing the receipt of brokered deposits that require certain banks, depending on their capital ratios and other factors, to obtain a waiver from the FDIC before they may accept brokered deposits, and that limit the interest rates certain banks can offer on deposits. Although the Company\ndoes not solicit brokered deposits, all of its bank subsidiaries are free to do so without restraint under the regulation.\nUnder FDIC's risk-based deposit insurance premium system for the Bank Insurance Fund (\"BIF\"), which went into effect on January 1, 1993, banks currently pay within a range of 23 cents per $100 of domestic deposits (the prior rate for all institutions) to 31 cents per $100 of domestic deposits, depending on their risk classification. The FDIC has proposed a potential reduction in these rates in 1995. To arrive at a risk-based assessment for each bank, the FDIC places the bank in one of nine risk categories, using a two-step process based first on capital ratios and then on other relevant supervisory information. Each institution is assigned to one of three groups (well capitalized, adequately capitalized, or undercapitalized) based on its capital ratios. For these purposes, a well capitalized institution is one that has at least a 10% total risk-based capital ratio, a 6% Tier 1 risk-based capital ratio, and a 5% Tier 1 leverage capital ratio. An adequately capitalized institution must have at least an 8% total risk-based capital ratio, a 4% Tier 1 risk-based capital ratio, and a 4% Tier 1 leverage capital ratio. An undercapitalized institution is one that does not meet either of the foregoing definitions. Each institution is also assigned to one of three supervisory subgroups based on an evaluation of the risk posed by the institution to the BIF. Well capitalized banks presenting the lowest risk to the BIF pay the lowest assessment rate, while undercapitalized banks presenting the highest risk pay the highest rate. The BayBanks' capital ratios at December 31, 1994, placed all of them in the well capitalized category for assessment purposes. The assessment will depend upon the level of deposit balances and the BayBanks' applicable risk categories (see \"Regulatory Capital Requirements\").\nOther significant provisions of FDICIA require federal banking regulators to draft standards in a number of areas to assure bank safety and soundness, including internal controls; credit underwriting; asset growth; management compensation; ratios of classified assets to capital; and earnings. The legislation also contains provisions that require the adoption of capital guidelines applicable to interest rate risks; tighten independent auditing requirements; restrict the activities and investments of state-chartered insured banks; strengthen various consumer banking laws; limit the ability of undercapitalized banks to borrow from the Federal Reserve's discount window; and require regulators to perform annual on-site bank examinations and set standards for real estate lending.\nREGULATORY CAPITAL REQUIREMENTS\nUnder the risk-based capital measures for banks and bank holding companies, a banking organization's reported balance sheet is converted to risk-based amounts by assigning each asset to a risk category, which is then multiplied by the risk weight for that category. Off-balance sheet exposures are converted to risk-based amounts through a two-step process. First, off-balance sheet assets and credit equivalent amounts (e.g., interest rate swaps) are multiplied by a credit conversion factor depending on the defined categorization of the particular item. Then the converted items are assigned to a risk category that weights the items according to their relative risk.\nThe total of the risk-weighted on-and off-balance sheet amounts represents a banking organization's risk-adjusted assets for purposes of determining capital ratios under the risk-based guidelines. Risk-adjusted assets can either exceed or be less than reported assets, depending on the risk profile of the banking organization. Risk-adjusted assets for institutions such as the Company will generally be less than reported assets because retail banking activities include proportionally more residential real estate loans with a lower risk rating and a relatively small off-balance sheet position.\nA banking organization's total qualifying capital includes two components, core capital (Tier 1 capital) and supplementary capital (Tier 2 capital). Core capital, which must comprise at least half of total capital, includes common stockholders' equity, qualifying perpetual preferred stock, and minority interests, less goodwill. Supplementary capital includes the allowance for loan losses (subject to certain limitations), other perpetual preferred stock, certain other capital instruments, and term subordinated debt, which is discounted at 20% a year during its final five years of maturity. The Company's major capital components include stockholders' equity in core capital, and the allowance for loan losses and grandfathered floating rate notes (subject to a 60% discount) in supplementary capital.\nAt December 31, 1994, the minimum risk-based capital requirements were 4.00% for core capital and 8.00% for total capital. Federal banking regulators have also adopted leverage capital guidelines to supplement the risk-based measures. The leverage ratio is determined by dividing Tier 1 capital as defined under the risk-based guidelines by average total assets (not risk-adjusted) for the preceding quarter. The minimum leverage ratio is 3.00%, although banking organizations are expected to exceed that amount by 100 or 200 basis points or more, depending upon their circumstances.\nAt December 31, 1994, the Company's consolidated risk-based capital ratios were 11.51% for core capital and 13.06% for total capital, and at December 31, 1993, were 10.68% and 12.40%, respectively. The Company's consolidated leverage ratio was 7.35% at December 31, 1994, and 7.26% at December 31, 1993. These ratios exceeded the minimum regulatory guidelines.\nThe following table presents the risk-based and leverage capital ratios required for depository institutions to be considered well capitalized under applicable federal regulations and the reported capital ratios of the Company and its bank subsidiaries at December 31, 1994:\nThe Company increased its quarterly dividend in 1994, a trend that began with the reinstatement of the quarterly dividend in the first quarter of 1993. For the first and second quarters of 1994, a dividend of $.35 per share was paid. The quarterly dividend was increased to $.45 per share for the third and fourth quarters of 1994. On January 26, 1995, the Board of Directors declared a first quarter dividend of $.50 per share, payable on March 1, 1995.\nSTATISTICAL DISCLOSURES\nSecurities Act Guide 3, Statistical Disclosure by Bank Holding Companies, requires certain statistical disclosures. As indicated in the index below, the statistical information required is either presented in statistical tables within this section, presented elsewhere in this report, or is not applicable. This information should be read in conjunction with the Financial Review under Item 7 and the consolidated financial statements and related notes under Item 8 in this report.\nAVERAGE YIELDS, RATES PAID, AND NET INTEREST MARGIN (TAX EQUIVALENT BASIS)\nANALYSIS OF NET INTEREST INCOME\n- ---------------\n(1) The rate\/volume variance is allocated to the Change in Balances category. (2) Presented on a tax equivalent basis at the combined statutory federal and state tax rate of 43.2% for 1994 and 1993. (3) Loan income includes loan fees, primarily related to commercial and residential real estate loans, of $6.3 million in 1994, $6.2 million in 1993 and $6.8 million in 1992.\nSECURITIES AVAILABLE FOR SALE AT DECEMBER 31\n- ---------------\n* Balance sheet carrying value.\nINVESTMENT SECURITIES AT DECEMBER 31\n- ---------------\n* Balance sheet carrying value.\nDISTRIBUTION OF LOANS\nMATURITY DISTRIBUTION OF COMMERCIAL AND COMMERCIAL REAL ESTATE LOANS AT DECEMBER 31, 1994\n- ---------------\n(1) Of the total commercial and commercial real estate loans above with remaining maturities in excess of one year, 49% have adjustable rates of interest.\n(2) Excludes $17,480 of commercial and $26,638 of commercial real estate nonperforming loans.\nNONPERFORMING ASSETS; RESTRUCTURED, ACCRUING LOANS; AND ACCRUING LOANS 90 DAYS OR MORE PAST DUE\nSUMMARY OF LOAN LOSS EXPERIENCE\nDISTRIBUTION OF ALLOWANCE FOR LOAN LOSSES (1)\nREMAINING MATURITIES OF TIME DEPOSITS -- $100,000 OR MORE AT DECEMBER 31, 1994\n- ---------------\n(1) Included in this amount are $176 million of corporate certificates of deposits and $14 million of consumer certificates of deposit of $100,000 or more.\nSHORT-TERM BORROWINGS\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nBayBanks, Inc., and its subsidiaries occupy both owned and leased premises. The offices occupied by the Company in Boston, Massachusetts include its principal executive offices and are leased from nonaffiliated companies. Property occupied by the three subsidiary banks represents the majority of the Company's property, and is generally considered to be in good condition and adequate for the purpose for which it is used. Bank properties include bank buildings and branches and free-standing automated banking facilities. BayBank, the Company's principal bank subsidiary, owns the 11-story 208,000 square foot headquarters building, of which 8% is leased to nonaffiliates. Of the 205 branch offices of the subsidiary banks at December 31, 1994, 92 were located in owned buildings and 113 were located in leased buildings. In addition, the Company leases sites for 366 automated banking facilities.\nBayBank Systems, Inc., the Company's principal nonbank subsidiary, occupies a 185,000 square foot technology center. The Company has relocated personnel from various leased and owned locations into this owned building, thereby increasing operating efficiency. BayBank Systems recently updated an adjoining 121,000 square foot owned facility that houses its principal data processing equipment. At December 31, 1994, there was an aggregate $38 million mortgage on these facilities to an affiliated bank at market terms and in conformity with banking regulations that cover transactions between affiliated parties.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThere were no material pending legal proceedings other than ordinary routine litigation incidental to the conduct of the Company's business.\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 1994.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\n(a) The stock of BayBanks, Inc. is traded over the counter through the Nasdaq National Market under the symbol BBNK. The quarterly share data information is presented in Note 18 to the consolidated financial statements under Item 8.\n(b) As of February 28, 1995, there were approximately 4,500 holders of record of the Company's common stock.\n(c) The Company paid dividends of $1.60 per share during 1994 and $.90 per share during 1993. The Company paid a dividend quarterly from 1928 through 1990. During 1991 and 1992, the Company did not pay any dividends. For additional information on dividend payments, reference is made to the CAPITAL AND DIVIDENDS section of Management's Discussion and Analysis under Item 7 and Note 1 to the consolidated financial statements under Item 8.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nAVERAGE BALANCES\n- --------------- (1) Substantially all balances are derived from daily averages. In certain instances, a method approximating daily averages was used.\n(2) Includes interest-bearing deposits in other banks, federal funds sold, securities purchased under agreement to resell, bankers' acceptances purchased, and trading account assets.\n(3) Nonperforming loans are included in the average balances. Interest income is recorded on an accrual basis. Thus, loans that are nonperforming do not contribute to net interest income and affect the net interest margin.\n(4) Includes federal funds purchased, securities sold under agreement to repurchase, and demand notes issued to the U.S. Treasury.\n(5) Other liabilities include guarantee of ESOP indebtedness in 1990 - 1994.\n(6) The risk-based capital ratios and the leverage capital ratio were phased in as of December 31, 1990.\nSUMMARY OF OPERATIONS\n- ---------------\n(7) Certain items in the summary that are tax-exempt have been restated to include the federal tax benefit derived from income on obligations of state and local governments, industrial revenue bonds, and certain other securities, thus facilitating the comparison between returns on alternative types of earning assets and between totals that contain varying mixtures of fully taxable and federal tax-exempt income. Because of the interplay of federal and Massachusetts income taxes, $1.00 of federal tax-exempt income was the fully taxable equivalent of $1.51 in 1994.\n(8) In 1990, the Company recognized a $4.8 million pension settlement gain and a $1.2 million gain from the sale of its payroll processing service. In 1989, the Company recognized a $2.5 million gain from liquidation of loans acquired at a discount in 1987.\n(9) For 1989-1994, the difference between earnings (loss) per share as reported and fully diluted was less than 3%.\n(10) Based on net income after accounting change. The per share effect of the cumulative accounting change was $.05 per share.\n(11) 1994 includes the impact of the average unrealized gain on the securities available for sale portfolio.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS.\nFINANCIAL REVIEW\nEARNINGS ANALYSIS\nOPERATING INCOME\nOperating income, presented in Table A, is on a tax equivalent basis, excludes net securities gains and the provisions for loan losses and the other real estate owned (OREO) reserve, and is before income taxes and the cumulative effect of an accounting change. Operating income was $223.0 million in 1994, compared with $181.0 million in 1993 and $175.2 million in 1992. The 23% increase in 1994 from 1993 resulted primarily from a 10% increase in net interest income and a 4% increase in noninterest income, combined with operating expenses that were only 2% above 1993 levels.\nTABLE A SUMMARY OF OPERATIONS TAX EQUIVALENT BASIS\nNET INTEREST INCOME (TAX EQUIVALENT BASIS)\nNet interest income (TABLE B, page 18) was $472.9 million in 1994, compared with $429.2 million in 1993 and $420.7 million in 1992.\nNet interest income and the net interest margin are affected by the quantity and mix of interest-bearing assets and liabilities and movements in interest rates.\nThe growth in net interest income in 1994 compared with 1993 was primarily the result of a 9% increase in average earning assets and an increase in interest rates. Instalment lending played a significant role in earning asset increases for the year as a whole, while commercial lending activity was particularly strong in the second half of 1994 (TABLE E, page 22). In addition, growth was affected by the general expansion of the securities portfolios over the course of the year.\nThe yield on earning assets was 7.10% in 1994, compared with 6.94% in 1993, as the result of higher rates on the commercial and commercial real estate loan portfolios as market rates increased and to some increases in yields on securities as maturities were reinvested at higher rates.\nBayBanks' funding costs during 1994 increased due to an increased volume of purchased funds and an atmosphere of rising interest rates. Rates on core deposits (which include money market deposit accounts and consumer certificates of deposit) steadily increased during 1994, albeit at a much slower rate than general market rates. The cost of total interest-bearing liabilities (as a percentage of average earning assets) increased 12 basis points to 2.06% in 1994 compared with 1993.\nTABLE B ANALYSIS OF NET INTEREST INCOME\nFEES, SERVICE CHARGES, AND OTHER NONINTEREST INCOME\nNoninterest income consists primarily of service charges and fees on deposit accounts and fees from credit and non-credit services and is well diversified among consumer, corporate, and small business banking activities. Noninterest income (TABLE C, page 19) increased to $207.3 million in 1994 from $198.5 million in 1993 and $183.9 million in 1992.\nService charges and fees on deposit accounts continued to provide over one-half of noninterest income. Total service charges and fees on deposits increased 4% to $109.9 million in 1994, compared with $105.2 million in 1993. An increase in the number of consumer accounts and selected repricings resulted in higher service charges and fees from consumer accounts. These increases were partially offset by a decline in corporate service charges resulting from higher earnings credit rates on compensating deposit balances.\nOther components of noninterest income experienced growth during 1994. Processing fees increased 17% to $16.2 million in 1994 from $13.8 million in 1993 primarily as the result of an increased volume of point of sale transactions. Investment management and brokerage fees increased 31% to $8.3 million in 1994 from $6.3 million in 1993 due primarily to investment advisory fees from higher BayFunds(R) balances on average in 1994 as compared with 1993. The total amount of assets under management in BayFunds was $1.3 billion at\nDecember 31, 1994, compared with $1.1 billion at December 31, 1993, and $243 million at December 31, 1992.\nMortgage banking fees were $7.2 million in 1994, compared with $12.0 million in 1993 and $10.2 million in 1992. A decrease in refinance volumes in 1994, as market interest rates increased, resulted in lower fee income.\nStudent loan sales gains were $4.5 million in 1994, compared with $1.8 million in 1993 and $1.0 million in 1992, resulting from a higher volume of sales and more favorable pricing.\nTABLE C NONINTEREST INCOME\nOPERATING EXPENSES\nOperating expenses, excluding OREO and legal expenses related to loan workouts (TABLE D, page 20), were $447.3 million in 1994, compared with $429.2 million in 1993 and $410.9 million in 1992.\nSalaries and benefits increased 8% to $229.6 million in 1994, compared with $213.0 million in 1993, primarily as the result of normal salary increases, additional staffing requirements, and higher accruals for performance awards.\nMarketing and public relations increased due to higher promotional activity related to corporate and consumer lending, as well as community banking programs. Service bureau and other data processing expenses increased 5% to $17.4 million in 1994, compared with $16.5 million in 1993, as a result of updating processing systems. Professional services declined 21% in 1994 to $10.8 million from $13.7 million in 1993, primarily due to lower utilization of outside staffing services in the Company's mortgage banking operations. Courier expenses increased due primarily to an increase in armored carrier costs associated with additional remote ATMs and extended branch hours. Legal and consulting expenses reflect increased costs for consumer business projects as well as an increase in general legal costs in 1994 compared with 1993. The cost of administering, managing, and disposing of OREO properties and legal expenses related to such workouts was $9.8 million in 1994, compared with $17.5 million in 1993, reflecting the continued disposition of OREO and the resolution of workout credits.\nTABLE D OPERATING EXPENSES\nPROVISIONS FOR LOAN LOSSES AND THE OREO RESERVE\nThe provisions for loan losses and the OREO reserve (TABLE A, page 17) declined substantially in 1994 to $33.4 million, compared with $61.3 million in 1993 and $152.3 million in 1992, reflecting continued improvements in credit quality. The provision for loan losses was $24.0 million in 1994, compared with $36.5 million in 1993 and $106.8 million in 1992. The provision for the OREO reserve was $9.4 million in 1994, compared with $24.8 million in 1993 and $45.5 million in 1992. The OREO provision includes net gains on sales of properties of $6.3 million in 1994, $7.6 million in 1993, and $54 thousand in 1992.\nINCOME TAXES\nThe Company reported a provision for income taxes of $73.5 million in 1994, compared with $47.1 million in 1993. The effective tax rate in 1994 was 40.4%, compared with 41.0% in 1993.\nDuring 1993, the Internal Revenue Service (IRS) completed a review of the Company's tax returns for the years 1986 through 1990 and proposed certain adjustments that related to the timing of income and expense recognition for tax purposes. The Company resolved the majority of these adjustments during 1994 through the appeals process, and finalization of the settlement is expected during the second quarter of 1995. The tax and interest payments associated with the adjustments did not have a material effect on BayBanks' financial statements.\nBALANCE SHEET REVIEW\nTRENDS IN EARNING ASSETS\nAverage earning assets increased to $9.4 billion in 1994, compared with $8.6 billion in 1993. The increase was, in part, the result of growth in average loan balances to $6.2 billion during 1994, as compared with $5.9 billion in 1993, and is the first overall increase since 1989. In addition, earning assets increased due to the expansion of the average securities portfolios from $2.7 billion to $3.2 billion.\nLOAN PORTFOLIO\nIn the loan portfolio of the Company, consumer loans represented 63% of the year-end loan portfolio, with $2.8 billion in various types of instalment loan balances and $1.3 billion in residential loan balances. Consumer lending activities are focused primarily on the Massachusetts market. Commercial and commercial real estate loans were 37% of the portfolio; the majority of these loans were to New England-based companies, primarily local middle-market companies and small businesses in Massachusetts.\nThe Company originates fixed- and adjustable-rate residential mortgage loans. The majority of fixed-rate residential real estate loan originations are securitized and sold to the secondary market with servicing retained. The remainder of the fixed-rate and floating-rate residential real estate loan originations are held in the loan portfolio or may be securitized and transferred to the securities available for sale portfolio. Student loans are originated and held in the loan portfolio while they are in a deferred payment status and are periodically sold when they are no longer in a deferred payment status.\nAn analysis of the changes in major loan categories for 1994 and 1993 is presented in TABLE E (page 22). Although net business volume was $1.0 billion in 1994, compared with $1.2 billion in 1993, the components of net loan business volume were more balanced in 1994 between corporate and consumer product lines. Corporate loans, which include time and demand loans and commercial real estate, contributed 26% of the total net business volume, and residential mortgages and instalment loans each contributed 37% to total net business volume. Residential real estate loan volume in 1994 was principally the result of purchase money mortgages, primarily adjustable rate, as mortgage refinance activity continued to decline. The Company underwrote and sold $270 million of fixed-rate residential real estate loans during 1994, compared with $816 million in 1993. At December 31, 1994, loans held for resale were $5 million, compared with $139 million at December 31, 1993. Instalment loan net business volume was $389 million in 1994, compared with $441 million in 1993. The decrease is due to a decline in automobile lending from an all-time record year in 1993; the volume in 1994 was the second highest in BayBanks' history. Higher student loan and home equity volumes offset the automobile lending decline. Net business volume in the commercial real estate portfolio was $55 million during 1994, compared with negative $60 million during 1993. A significant portion of 1994's growth was the result of growth in the Company's lending to real estate investment trusts. Commercial loan volume was $216 million, primarily related to auto dealer financing, construction and contracting, and loans to major retailers in the Company's market area. The Company also had an increase in its international portfolio, which is focused primarily on Mexico and South America. At December 31, 1994, these international facilities, which are trade related and primarily with well-known and established foreign banks, totaled $160 million, compared with $88 million at the end of 1993. These loans are subject to the Company's normal review process.\nTABLE E CHANGES IN THE LOAN PORTFOLIO AT YEAR-END -- 1994 VS. 1993\n- --------------- * Includes residential mortgage loans held for sale of $5 million in 1994.\nSECURITIES PORTFOLIOS\nThe securities portfolio (TABLE F, page 23) was $2.9 billion at December 31, 1994, $3.0 billion at December 31, 1993, and $2.8 billion at December 31, 1992. The weighted average maturity of the securities portfolio was 1.6 years at December 31, 1994, compared with .8 years at December 31, 1993, and 1.0 years at December 31, 1992.\nShort-term investments were $166 million at December 31, 1994, compared with $803 million at December 31, 1993, and $1.1 billion at December 31, 1992. The decline reflects the reinvestment of proceeds from maturing short-term investments into the securities available for sale and investment securities portfolios.\nSecurities available for sale, consisting principally of debt securities, are stated at market value in 1994 and at the lower of aggregate cost or market for previous periods. Decisions to purchase or sell these securities as part of the Company's ongoing asset and liability management process are based on management's assessment of changes in economic and financial market conditions, interest rate environments, the Company's balance sheet and its interest sensitivity position, liquidity, and capital. During 1994, the proceeds from the sales and maturities of securities available for sale were reinvested in the investment portfolio and loan portfolio.\nAt December 31, 1994, securities available for sale had gross unrealized gains of $484 thousand and gross unrealized losses of $14 thousand.\nThe investment securities portfolio, consisting principally of debt securities, is stated at amortized cost. This basis for valuation reflects management's intention and ability to hold these securities until maturity. The Company's investment securities portfolio was $2.6 billion at December 31, 1994, $1.6 billion at December 31, 1993, and $156 million at December 31, 1992. At December 31, 1994, gross unrealized gains were $99 thousand, and gross unrealized losses were $75 million.\nThe Company's investment securities portfolio contains U.S. Government securities, state and local government securities, asset-backed securities, mortgage-backed securities, and industrial revenue bonds. The total state and local government portfolio, which is primarily concentrated in Massachusetts, was $171 million\nat December 31, 1994, with the single largest issue being approximately $5 million. All securities were either rated investment grade or, in the case of unrated securities, were determined by management to be equivalent to investment grade.\nTrading account securities, consisting of debt securities, are recorded at market value, which was $27 million at December 31, 1994. Trading account gains were $2.1 million in 1994 and $2.3 million in 1993.\nTABLE F SECURITIES PORTFOLIOS AT DECEMBER 31\n- --------------- * The weighted average maturity calculation excludes amortizing IRBs and reflects estimated prepayments for mortgage-backed securities.\nDEPOSITS AND OTHER SOURCES OF FUNDS\nThe Company's extensive product lines, important Customer Sales and Service Center, and banking network of 205 full-service offices and 366 automated banking facilities generate significant core deposits, which accounted for 99% of total average deposits during 1994 and 1993.\nCore deposits include transaction accounts (demand, NOW, and savings accounts), money market deposit accounts (MMDAs), and consumer time certificates. Average core deposits were $8.5 billion in 1994, compared with $8.6 billion in 1993. However, average transaction accounts increased to $4.9 billion in 1994, compared with $4.6 billion in 1993, reflecting certain customers' preferences to maintain significant balances in lower-yielding transaction accounts, thus having a positive impact on the Company's net interest margin. Money market deposit accounts and consumer certificates of deposit declined to $3.7 billion in 1994, compared with $4.0 billion in 1993. Average MMDAs declined to $2.7 billion in 1994 from $2.9 billion in 1993, and average consumer time deposits declined to $1.0 billion in 1994 from $1.1 billion in 1993. However, during the second half of 1994, customers began to move towards certificates of deposit as interest rates\ncontinued to rise, and as of December 31, 1994, consumer time deposits were $1.1 billion, compared with $1.0 billion at December 31, 1993. Average corporate certificates of deposit in excess of $100 thousand (CDs), which represent a small portion of the Company's total funding, were $91 million in 1994, compared with $33 million in 1993.\nAverage purchased funds were $839 million in 1994, compared with $151 million in 1993, as the average loans and securities portfolios increased, as discussed in the TRENDS IN EARNING ASSETS section on page 20.\nINTEREST RATE RISK MANAGEMENT AND LIQUIDITY\nBayBanks' Capital Markets Committee monitors and manages the Company's overall balance sheet interest sensitivity position, the securities portfolios, funding, and liquidity. Interest sensitivity, as measured by the Company's gap position, is affected by the level and direction of interest rates and current liquidity preferences of its customers. These factors, as well as projected balance sheet growth, current and potential pricing actions, competitive influences, national monetary and fiscal policy, and the national and regional economic environment, are considered in the asset and liability management decision process.\nThe Company's interest sensitivity gap position, as shown in TABLE G, is first presented based on contractual maturities and repricing opportunities; however, in a period of rising or falling interest rates, this basis of presentation does not reflect lags that may occur in the repricing of certain loans and deposits. For example, in 1994 the costs of certain interest-bearing core deposit categories lagged changes in market interest rates, although the Company contractually can change the interest rates on these deposits at any time. A management adjustment provides for the expected repricing lags and for the notion that interest rate changes in many of these core deposit categories, particularly certain transaction accounts, are not as sensitive to changes in market interest rates.\nAt December 31, 1994, the Company's adjusted gap for the total within-180-day period had moved from a positive $116 million at December 31, 1993, to a positive $76 million. The total within-one-year gap moved from a positive $132 million at December 31, 1993, to a positive $648 million at December 31, 1994. The increase in the positive adjusted gap position reflects the fact that experience in 1994 suggests certain core deposit categories are not repricing as quickly as general market rates.\nIn addition to the gap analysis presented in the table, the Company also uses a simulation model that incorporates varying interest rate scenarios, including the effect of rapid changes (both increases and decreases up to 200 basis points) in interest rates on its net interest income and net interest margin. The Company's policy is to minimize volatility in its net interest income and net interest margin.\nTABLE G INTEREST RATE SENSITIVITY POSITION AT DECEMBER 31, 1994\nLiquidity, for commercial banking activities, is the ability to respond to maturing obligations, deposit withdrawals, and loan demand. The liquidity positions of the Company's bank subsidiaries are closely monitored by the Company's Capital Markets Committee. BayBanks' distribution network provides a stable base of in-market core deposits and limits the need to raise funds from the national market.\nThe Company's net liquidity position (short-term investments, securities available for sale, and investment securities, less pledged securities, large CDs, and purchased funds) was $1.6 billion, or 16% of total deposits and borrowings, at December 31, 1994, compared with $2.2 billion, or 24% of total deposits and borrowings, at December 31, 1993. The decreased liquidity position, although still strong at December 31, 1994, resulted from the expansion of the loan portfolio. The Company also has additional liquidity flexibility due to the relatively short average maturity (1.6 years) of its securities portfolios (page 23).\nThe statement of cash flows provides additional information on liquidity. The statement presents the results of the Company's operating, investing, and financing activities. Operating activities include $107.4 million in net income for 1994, before adjustment of noncash items. Investing activities consist primarily of both proceeds from sales and purchases of short-term investments and securities and net loan originations. Financing activities consist primarily of the net activity in the Company's various deposit accounts and short-term borrowings, as well as dividends paid.\nCash and cash equivalents were $633 million at December 31, 1993. During 1994, net cash used in investing activities totaled $772 million, net cash provided by operating activities was $437 million, and net cash provided by financing activities was $531 million. Cash and cash equivalents were $829 million at December 31, 1994.\nThe parent company's sources of liquidity are dividend and interest income received from its subsidiaries and income earned on its securities portfolios. The most significant uses of the parent company's resources are capital contributions to banking and other subsidiaries when appropriate and dividends paid to stockholders. During 1994 the parent company did not contribute any capital to its subsidiaries. Dividends received from bank subsidiaries were $25 million and dividends from nonbank subsidiaries were $10 million. During 1994, the parent company paid $30 million in dividends to its stockholders. At December 31, 1994, the parent company had $82 million in cash, short-term investments, and other securities.\nCREDIT QUALITY REVIEW\nOVERVIEW\nThe Company continually monitors the credit quality of its loan portfolio. Employing a standard system for grading loans, individual account officers assign their loans a grade, or risk rating, and, if necessary, a specific loan loss reserve. An independent Loan Review Department periodically reviews loan grades and specific loan loss reserves. Any loan or portion of a loan determined to be uncollectible is charged off. On a quarterly basis, senior management reviews the loan portfolio, with particular emphasis on higher-risk loans, to assess the credit quality and loss potential inherent in the portfolio. Also considered in this review are delinquency trends and the adequacy of reserves. The size of the allowance for loan losses, the OREO reserve, and the related provisions reflect this analysis.\nNonperforming assets (which exclude restructured, accruing loans and accruing loans 90 days or more past due) include nonperforming loans and OREO and were $122 million at December 31, 1994, a 45% decrease from $224 million at December 31, 1993, continuing the favorable trend that began in 1991.\nThe decline in nonperforming assets is shown in TABLE H (page 26). This result was achieved by successful workout activities that included property sales, payments on nonperforming loans, and loans that qualified for, and were returned to, accrual status. Favorable resolutions were $140 million in 1994, or 63% of nonperforming assets at the beginning of the period. Additions to nonperforming assets were $74 million in 1994, a decrease of 30% compared with $106 million in 1993. As of December 31, 1994, the Company had OREO property sales pending of $6.8 million.\nTABLE H CHANGES IN ASSET QUALITY\n- --------------- * Nonperforming assets include nonperforming loans and OREO and exclude restructured, accruing loans and accruing loans 90 days or more past due.\nNONPERFORMING LOANS\nTotal nonperforming loans (TABLE I) declined 50% to $55 million at December 31, 1994, compared with $110 million at December 31, 1993. Nonperforming commercial loans decreased 63% to $17 million at December 31, 1994, compared with $48 million at December 31, 1993; commercial real estate nonperforming loans declined 46% during the same period to $27 million at December 31, 1994, compared with $49 million at December 31, 1993. The nonperforming loans in the consumer portfolio, which includes residential mortgages and instalment loans, decreased 21% to $11 million at December 31, 1994, from $13 million at December 31, 1993.\nTABLE I NONPERFORMING LOANS AT DECEMBER 31\nOTHER REAL ESTATE OWNED (OREO)\nOREO consists of foreclosed properties and in-substance foreclosures. Foreclosed properties are being prepared for sale or are currently listed for sale. The Company is involved in managing in-substance foreclosures, taking operating control to stabilize values while the properties are being prepared for sale, or working closely with borrowers to obtain new equity. OREO (net of reserve) declined 41% to $67 million at December 31, 1994, from $114 million at December 31, 1993, primarily as the result of property sales.\nIMPAIRED LOANS\nOn January 1, 1995, $33 million of assets with $9 million of reserves classified as in-substance foreclosures at December 31, 1994 (TABLE J), were reclassified to the loan portfolio and allowance for loan loss accounts, pursuant to the adoption of Statement of Financial Accounting Standards (SFAS) No. 114, \"Accounting by Creditors for Impairment of a Loan,\" (further discussed under Impending Accounting Changes, page 29). The Company's procedures for managing these assets, as described above, will remain the same.\nTABLE J CREDIT QUALITY -- PRO FORMA PRESENTATION\nRESTRUCTURED, ACCRUING LOANS\nThe Company restructures credits with borrowers experiencing a period of financial difficulty if such arrangements are likely to minimize losses the Company may otherwise incur on a particular credit. Loans that have been restructured remain on nonaccrual status until the customer has demonstrated a period of performance under the new contractual terms. Restructured, accruing loans were $14 million at December 31, 1994, compared with $18 million at December 31, 1993, and $12 million at December 31, 1992.\nACCRUING LOANS 90 DAYS OR MORE PAST DUE\nAccruing loans 90 days or more past due, presented in TABLE K (page 28), declined 30% to $36 million at December 31, 1994, compared with $52 million at December 31, 1993. Of the $36 million in accruing loans 90 days or more past due at December 31, 1994, residential real estate and instalment loans together represented 86% of the total. Residential real estate and instalment loans by their nature include a large number of smaller loans. Of the $10 million in residential real estate loans, $9 million were in owner-occupied properties.\nTABLE K ACCRUING LOANS 90 DAYS OR MORE PAST DUE AT DECEMBER 31\nALLOWANCE FOR LOAN LOSSES\nSince older problem assets are being resolved and the rate of emerging problem assets continued to decline, the allowance for loan losses was not replenished to the full extent of charge-offs. While the overall allowance for loan losses declined, its coverage of nonperforming loans increased to 269% at December 31, 1994, from 156% at December 31, 1993.\nThe allowance for loan losses (TABLE L) consists of both allocated and unallocated portions. The allocated portion represents amounts within the total allowance assigned to specifically identified problem loans. The unallocated portion is the amount set aside to cover the risk of loss that is not specifically identified as to any individual loan, but that is inherent in any loan portfolio. The unallocated allowance is calculated by migrating each loan category by that category's recent loan loss experience. The process involves analysis of loan grade loss histories and trends for each type of loan. Economic factors and trends are also considered when determining the total unallocated portion of the allowance. Statistical modeling is the primary methodology for determining the amount of the allowance apportioned to the consumer portfolios (residential and instalment loans). However, the apportioned amount is considered unallocated in nature.\nTABLE L ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES AT DECEMBER 31, 1994\nCAPITAL AND DIVIDENDS\nBayBanks' consolidated risk-based capital ratios were 13.06% for total capital and 11.51% for core capital at December 31, 1994, compared with 12.40% and 10.68% at December 31, 1993. The leverage ratio was 7.35% at December 31, 1994, and 7.26% at December 31, 1993. These ratios exceed regulatory capital guidelines.\nOn January 26, 1995, BayBanks declared a quarterly dividend of $.50 per share payable March 1, 1995. Total dividends declared for 1994 were $1.60, a 78% increase over the 1993 dividends declared of $.90. The\nclosing price of BayBanks' stock on December 31, 1994, was $52.75, compared with $50.75 at December 31, 1993, an increase of 3.9%.\nIMPENDING ACCOUNTING CHANGES\nIn May 1993, the Financial Accounting Standards Board (FASB) issued SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" which was amended by SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures,\" issued in October 1994. The pro forma effects of adoption of SFAS No. 114 are presented in TABLE J (page 27). These statements are effective for fiscal years beginning after December 15, 1994, and will require changes in the disclosure of nonperforming assets. Loans currently reported as nonperforming and in-substance foreclosures will be reported as impaired loans in a financial statement footnote. Restructured loans, reported as restructured accruing loans prior to the adoption of SFAS No. 114, will not be regarded as impaired loans when the statement is adopted if they are performing under the restructured terms. Restructured, accruing loans entered into after the adoption of SFAS No. 114 will be accounted for as impaired loans until the year subsequent to restructure, provided that the loan bears a market rate of interest at the time of restructure and is performing under the restructured terms.\nThe amount of impairment will be determined by the difference between the present value of the expected cash flows related to the loan, using the contractual interest rate and its recorded value, or, as a practical expedient in the case of collateralized loans, the difference between the appraised value of the collateral and the recorded amount of the loan. Any additional impairment will be recorded as an adjustment to the existing allowance for loan losses account. Effective January 1, 1995, the Company adopted these statements and reclassified $33 million of in-substance foreclosures and related reserves of $9 million to loans and the allowance for loan losses, respectively.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nINDEPENDENT AUDITORS' REPORT\nKPMG Peat Marwick LLP Certified Public Accountants One Boston Place Boston, MA 02108\nTo the Board of Directors and Stockholders of BayBanks, Inc.:\nWe have audited the accompanying consolidated balance sheets of BayBanks, Inc., and subsidiaries as of December 31, 1994 and 1993, 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, 1994. These consolidated 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 financial position of BayBanks, Inc., and subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles.\n\/s\/ KPMG Peat Marwick LLP\nJanuary 24, 1995\nBAYBANKS, INC. CONSOLIDATED BALANCE SHEET\nThe accompanying notes are an integral part of these consolidated financial statements.\nBAYBANKS, INC. CONSOLIDATED STATEMENT OF INCOME\nThe accompanying notes are an integral part of these consolidated financial statements.\nBAYBANKS, INC. CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY\nThe accompanying notes are an integral part of these consolidated financial statements.\nBAYBANKS, INC. CONSOLIDATED STATEMENT OF CASH FLOWS\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1. CONDENSED FINANCIAL INFORMATION OF THE PARENT\nThe condensed balance sheet is presented for 1994 and 1993, and a statement of income and statement of cash flows are presented for the years 1992 through 1994, for BayBanks, Inc. (the parent company).\nBALANCE SHEET\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nSTATEMENT OF INCOME\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nSTATEMENT OF CASH FLOWS\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nA significant source of funds used by BayBanks, Inc., the parent company, for the payment of dividends to shareholders is dividends received from its banking and other subsidiaries.\nThe payment of dividends by national and state banks is generally limited by statute to their retained earnings, after deducting losses and statutorily defined bad debts in excess of established allowances for loan losses. The payment of dividends by national banks is further limited by statute to the current year's net income plus the undistributed net income of the two preceding years. The Company's bank subsidiaries are also required to achieve and maintain certain minimum capital ratios under applicable regulatory guidelines. Banking regulators have authority to prohibit banks and bank holding companies from paying dividends if they deem payment to be an unsafe or unsound practice. As of December 31, 1994, the Company's bank subsidiaries could have declared additional dividends of approximately $91 million while remaining in compliance with the foregoing statutory limitations and remaining \"well capitalized\" under regulatory capital guidelines. Any decision to declare a dividend by the Company or any of its subsidiaries also considers additional factors, including the amount of current period net income, liquidity, asset quality, and economic conditions and trends.\nFederal law imposes limitations on the extent to which the Company's bank subsidiaries may finance or otherwise supply funds to the Company and its nonbank subsidiaries. Such transactions with the Company and each of its nonbank subsidiaries are limited to 10% of each subsidiary bank's capital and surplus. There is also a 20% limit on each bank's aggregate covered transactions with the Company and all of its nonbank subsidiaries. At December 31, 1994, the Company had no borrowings outstanding from any of its subsidiaries, and one of the Company's nonbank subsidiaries had a secured loan of $37,549,000 outstanding from a bank subsidiary, representing 5.6% of the aggregate capital and surplus of the bank subsidiaries.\nThe parent company has not sold commercial paper and does not have any revolving credit lines or other short-term debt outstanding that relies on credit ratings from public rating agencies.\nThe Company has a Stockholders Rights Plan under which stock purchase rights have been distributed to the Company's stockholders. The rights may become exercisable in the event of certain unsolicited attempts to acquire the Company. The rights, which expire in December 1998, become exercisable 10 business days after a person, including a group, acquires 20% or more of the Company's outstanding common stock or commences a tender offer that would result in such person owning 25% or more of such stock or the Board of Directors determines that a person owning 10% or more of such stock is an \"adverse person.\" If any person becomes the owner of 25% or more of the outstanding common stock or the Board determines that a person is an adverse person, the rights of holders other than such owner or adverse person become rights to buy shares of common stock of the Company (or of the acquiring company if the Company is acquired in certain mergers or other business combinations) having a market value of twice the exercise price of each right, with the result that such owner's or adverse person's interest in the Company would be substantially diluted. The Company may redeem the right, at a price of $.01 per right, until 10 business days after a person acquires 20% or more of the outstanding common stock or the Board has determined that a person is an adverse person.\nNOTE 2. SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION -- The consolidated financial statements of the Company and its subsidiaries follow generally accepted accounting principles and reporting practices applicable to the banking industry. Material intercompany transactions have been eliminated. Certain prior years' amounts have been reclassified to conform with the current year presentation.\nINTEREST-BEARING DEPOSITS AND OTHER SHORT-TERM INVESTMENTS -- Consists of federal funds sold and securities purchased under resale agreements of $89,216,000 and $541,260,000 in 1994 and 1993, respectively, and money market mutual funds and other short-term deposits.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nTRADING ACCOUNT SECURITIES -- Consists primarily of municipal securities held for resale to customers. These securities are recorded at market value; realized and unrealized gains and losses on trading securities are recorded in the current period in noninterest income.\nSECURITIES -- Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 115, \"Accounting for Certain Investments in Debt and Equity Securities.\" SFAS No. 115 requires that changes in the market value of the securities available for sale portfolio be recorded directly to a separate category of stockholders' equity, net of deferred income taxes. Prior to the adoption of SFAS No. 115, securities available for sale were valued at the lower of aggregate cost or market value, and changes therein were recorded directly to earnings, net of income taxes. At adoption, the market value of the securities available for sale portfolio exceeded its amortized cost by $4,443,000, or $2,500,000 on an after-tax basis. At December 31, 1994, the market value of the securities available for sale portfolio exceeded its amortized cost by $470,000, or $276,000 on an after-tax basis, reflected in stockholders' equity. Decisions to purchase or sell these securities as part of the Company's ongoing asset and liability management process are based on management's assessment of changes in economic and financial market conditions, interest rate environments, the Company's balance sheet and its interest sensitivity position, liquidity, and capital. The cost of securities sold is determined by the specific identification method.\nThe investment securities portfolio, principally debt securities, is stated at cost, adjusted for amortization of premium and accretion of discount using a level yield method. This basis for valuation reflects management's intention and ability to hold these securities until maturity.\nINTEREST RATE SWAP AGREEMENTS -- The Company occasionally uses interest rate swap agreements to manage its interest rate exposure. The net differential paid or received on the swaps is accounted for as an adjustment to the yield on the item hedged.\nLOANS -- Interest income on most loans is accrued on the principal amount of loans outstanding. Unearned income on leases and loans, $24,717,000 at year-end 1994 and $24,086,000 at year-end 1993, is credited to interest income on a basis that results in approximately level rates of return over the term of the lease or loan. Certain loan fees and credit card fees, net of certain qualifying origination costs, are deferred and amortized over the life of the related loan or commitment period. Deferred loan and credit card fees, included in unearned income, were $9,861,000 and $11,353,000 at year-end 1994 and 1993, respectively.\nThe Company engages in certain mortgage banking activities through a mortgage subsidiary. Mortgage loans originated and held for sale are carried at the lower of aggregate cost or market value. Gains and losses on loans sold are determined using the specific identification method. Gains and losses on loans sold with servicing rights retained are adjusted to reflect the difference between the present value of future service fee income and a normal service fee. The resulting excess mortgage servicing rights are amortized using the level yield method as a reduction of service fee income over the remaining lives of the loans. Actual prepayment experience is reviewed periodically, and the excess mortgage servicing rights are adjusted accordingly to reflect current circumstances. At December 31, 1994 and 1993, mortgage loans held for sale were $4,571,000 and $138,764,000, respectively; excess mortgage servicing rights were $3,610,000 and $4,213,000, respectively. Loans serviced for others were $1.9 billion, $2.0 billion, and $1.8 billion at December 31, 1994, 1993, and 1992, respectively.\nLoans are placed on nonaccrual and are considered nonperforming when payment of principal or interest is considered to be in doubt. In addition, all loans past due 90 days or more as to principal or interest are placed on nonaccrual status except for certain consumer loans and those loans which, in management's judgment, are adequately secured and for which collection is probable. Previously accrued income that has not been collected is reversed from current income, and subsequent cash receipts are applied to reduce the unpaid principal balance. Loans are returned to accrual status when collection of all contractual principal and interest is reasonably assured and there has been sustained repayment performance. Nonperforming loans were $54,627,000 at year-end 1994 and $110,001,000 at year-end 1993. Interest income earned during the year on year-end nonperforming loans was approximately $568,000; if these loans had been performing under\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\ncontractual terms, interest would have been approximately $4,485,000. In 1993, these amounts were $960,000 and $8,300,000, respectively.\nLoans are classified as restructured, accruing loans, after a period of performance, when the Company has granted, for economic or legal reasons related to the borrower's financial difficulties, a concession to the customer that the Company would not otherwise consider. Such concessions can be any one or a combination of the following modifications to the terms of the debt: the reduction of the stated interest rate for the remaining original life of the debt; extension of the maturity date at a stated interest rate lower than the current market rate for new debt with similar risk; reduction of the face amount or maturity amount of the debt as stated in the debt instrument; and reduction of accrued interest. In accordance with guidance issued by banking regulators, restructured, accruing loans that are performing in accordance with the restructured terms and bear a market rate of interest at the time of restructure are removed from the disclosure in years subsequent to the restructure. Restructured, accruing loans were $13,537,000 and $18,398,000 at December 31, 1994 and 1993, respectively. During 1994 and 1993, interest income recorded on these loans approximated a market interest rate and in the aggregate was not significantly different had these loans performed according to their original terms. There are no commitments to lend additional funds to these borrowers.\nALLOWANCE FOR LOAN LOSSES -- Loans considered to be uncollectible are charged to the allowance for loan losses. Additions to the allowance are provided by recoveries of previously charged-off loans and by the provision for loan losses in amounts sufficient to maintain the adequacy of the allowance. The adequacy is determined by management's evaluation of potential losses in the portfolio, economic conditions, historical net charge-offs, and anticipated portfolio growth. Included in the allowance are amounts allocated to specific loans, amounts allocated to other loans that may become uncollectible but cannot be individually identified, and unallocated amounts. Management believes that the allowance for loan losses is adequate.\nVarious regulatory agencies, as an integral part of their examination process, periodically review the allowance for loan losses of the Company's subsidiaries. Such agencies can require the Company to recognize additions to the allowance based on regulatory judgments of information available at the time of their examination.\nOn January 1, 1995, the Company adopted SFAS No. 114, \"Accounting by Creditors for Impairment of a Loan,\" and SFAS No. 118, \"Accounting by Creditors for Impairment of a Loan -- Income Recognition and Disclosures.\" These statements specify certain methods for calculating the allowance related to impaired loans. A loan is impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The adoption of these statements, which will be accounted for prospectively, is not expected to change the overall amount of the allowance for loan losses and the other real estate owned reserve and is not expected to have a material effect on the Company's reported results of operations or financial condition.\nOTHER REAL ESTATE OWNED -- Other real estate owned (OREO) consists of foreclosed properties and in-substance foreclosures. Loans are classified as in-substance foreclosures under the following circumstances: when the debtor has little or no equity in the collateral, considering the current fair value of the collateral; and when proceeds for repayment of the loan can be expected to come only from the operation or sale of the collateral; and when the debtor has either formally or effectively abandoned control of the collateral to the creditor or retained control of the collateral, but, because of the current financial condition of the debtor, or the economic prospects for the debtor and\/or the collateral in the foreseeable future, it is doubtful that the debtor will be able to rebuild equity in the collateral or otherwise repay the loan in the foreseeable future.\nThe adoption of SFAS No. 114 impacts the accounting for in-substance foreclosures beginning January 1, 1995. SFAS No. 114 has narrowed the definition of in-substance foreclosures to assets for which the Company has received physical possession of the collateral. Upon adoption of this statement on January 1, 1995, the Company reclassified $33,173,000 of in-substance foreclosures and $8,669,000 of related reserves to loans and the allowance for loan losses, respectively.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nOREO is recorded at the lower of the book value of the loan or the fair value of the asset acquired, less estimated disposition costs. The excess, if any, of the loan amount over the fair value of the asset acquired is charged off against the allowance for loan losses. Pursuant to the adoption of accounting Statement of Position (SOP) 92-3, \"Accounting for Foreclosed Assets,\" which became effective for periods ending after December 15, 1992, subsequent changes in the value of OREO (including in-substance foreclosures) are recorded directly to an OREO reserve. These changes in the OREO reserve are included in total operating expenses. Proceeds in excess of the carrying value at the time of sale are recorded as a reduction in the provision for the OREO reserve. Prior to the adoption of SOP 92-3, changes in the value of OREO were recorded directly to the value of the property. Expenses to administer these properties are charged to operating expense as incurred.\nINCOME TAXES -- Effective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes.\"\nSFAS No. 109 changed the Company's method of accounting for income taxes from the deferred method to the asset and liability method. The objective of the asset and liability method is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. A valuation allowance, if necessary, is established to provide for deferred tax assets that are not expected to be realized. Adoption of SFAS No. 109 did not have a material effect on the Company's results of operations or financial condition.\nPrior to adoption of SFAS No. 109, the Company accounted for income taxes under Accounting Principles Board (APB) Opinion No. 11. Under APB Opinion No. 11, deferred taxes were provided for all significant items of income and expense that were recognized in different periods for financial reporting and income tax purposes.\nEARNINGS PER SHARE -- Earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding and dilutive common stock equivalents (stock options) for each period presented. Average dilutive common stock equivalents were 303,286 for 1994 and 282,175 for 1993. The dual presentation of primary and fully diluted earnings per common share is not presented, since the difference in earnings per share is less than 3%.\nNOTE 3. FEDERAL RESERVE ACCOUNT BALANCES\nThe Company's banks are required to maintain average reserve balances with the Federal Reserve Bank. These balances can be in the form of either vault cash or funds left on deposit with the Federal Reserve Bank. The average amount of these balances was $309,821,000 for 1994 and $305,379,000 for 1993.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 4. SECURITIES PORTFOLIOS\nThe amortized cost, gross unrealized gains and losses, market values, and weighted average yields of the following securities portfolios by maturity (excluding interest-bearing deposits and other short-term investments) were:\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nThe year-end maturity distribution excludes industrial revenue bonds, which are not regarded as principal debt securities, mortgage-backed securities, asset-backed securities, and other securities that do not have a stated maturity.\nThe book value of securities pledged to secure public and trust deposits and to meet other legal requirements was $1,137,115 at December 31, 1994.\nDuring 1994, proceeds from sales of securities available for sale were $313,796,000, resulting in gross realized gains of $518,000. There was $3,000 in gross realized losses from the sales of these securities. Proceeds from sales of investment securities within 90 days of maturity, regarded as maturities in accordance with generally accepted accounting principles, were $313,459,000, resulting in gross realized losses of $312,000.\nDuring 1993, proceeds from sales of securities available for sale were $449,217,000, resulting in gross realized gains of $439,000. There was $28,000 in gross realized losses from the sales of these securities.\nDuring 1992, proceeds from sales of securities available for sale were $1,192,000,000, and proceeds from sales of investment securities were $1,262,000,000, resulting in gross realized gains of $41,123,000 and $37,506,000, respectively. There was $1,700,000 in gross realized losses from the sales of investment securities.\nDuring 1994, BayBank, the Company's principal bank subsidiary, became a member of the Federal Home Loan Bank of Boston (FHLB). As a member of the FHLB, BayBank is required to invest in the stock of the FHLB in an amount equal to the greater of 1% of residential mortgage loans or 3\/10 of 1% of total assets. As of December 31, 1994, $27,556,000 in the stock of the FHLB is included in the securities available for sale portfolio in the other category at cost, which approximates market value.\nOn January 1, 1994, the Company adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" as more fully discussed in Note 2.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 5. LOANS TO RELATED PARTIES\nLoans outstanding to related parties of the Company and its principal subsidiaries consist primarily of loans made to executive officers and business interests related to certain directors; these loans totaled $18,899,000 and $32,045,000 at December 31, 1994, and December 31, 1993, respectively. Activity during the year on loans outstanding at year-end was as follows:\nThese loans were made in the ordinary course of business under normal credit terms, including collateralization and interest rates prevailing at the time for comparable transactions with other persons, and do not represent more than a normal risk of collection.\nNOTE 6. ALLOWANCE FOR LOAN LOSSES AND OREO RESERVE\nActivity in the allowance for loan loss account was:\nActivity in the OREO reserve account was:\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 7. PREMISES AND EQUIPMENT\nPremises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation on buildings is computed primarily on a straight-line basis with estimated lives ranging from 25 to 50 years. Furniture and equipment useful lives generally range from 3 to 10 years. Leasehold improvements are amortized over their useful lives or lease terms, whichever is shorter. Premises and equipment were comprised of the following:\nDepreciation and amortization expense of premises, equipment, and leasehold improvements was $24,365,000 in 1994, $24,218,000 in 1993, and $24,246,000 in 1992.\nTotal rental expense was $24,967,000 in 1994, $26,346,000 in 1993, and $27,367,000 in 1992, net of $1,473,000, $1,705,000, and $2,232,000 in rental income from subleases, respectively. Contingent rentals were negligible. As of December 31, 1994, the Company and its subsidiaries were obligated, under noncancelable operating leases (primarily for premises), for minimum rentals in future periods as follows:\nMost leases contain escalation of rent clauses based on increases in real estate taxes or equipment usage. Many leases include renewal provisions.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 8. FEDERAL FUNDS PURCHASED AND OTHER SHORT-TERM BORROWINGS\nBalances outstanding as of December 31, 1994 and 1993, consisted of the following:\nNOTE 9. LONG-TERM DEBT\nIn September 1985, the Company issued $50,000,000 in floating-rate notes. The notes will mature on September 30, 1997, and pay interest at a rate, adjusted quarterly, of 1\/8 of 1% above the London Interbank Offered Rate (LIBOR) for three-month Eurodollar deposits. During 1994 the weighted average rate paid was 4.44%, and at December 31, 1994, the rate was 6.44%. The proceeds were used in the funding of the affiliate banks on identical terms. The notes may be redeemed by the Company in whole or in part at any time at 100% of the principal amount plus accrued interest.\nThe balance of long-term debt at December 31, 1994, includes mortgage debt at two subsidiaries totaling $823,000. The monthly payment amounts of the mortgages totaled $7,000 in 1994 with final maturities from 1997 to 2013. Obligations on capitalized leases totaled $331,000 at December 31, 1994.\nNOTE 10. EMPLOYEE STOCK OPTION PLANS\nThe Company offers shares of common stock to key employees under stock option plans. Options are awarded by a committee of the Board of Directors. The following is a summary of the changes in options outstanding for the last three years:\nPrices of shares under option at December 31, 1994, ranged from $13.75 to $45.00, and options for 362,584 shares were exercisable. Unless exercised, the options will expire at varying dates through 2003. There was no compensation expense recorded in the years presented related to stock options.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nIn addition to the above, the Company has a restricted stock plan that was adopted in 1994. A total of 500,000 shares may be awarded under the plan, which expires in 2004. As of December 31, 1994, 112,000 shares had been awarded. The Company also had a restricted stock plan that expired in 1992. Under this plan, 400,000 shares were awarded. Certificates for shares awarded are issued in the name of the employee, who has all the rights of a shareholder, with the shares subject to certain restrictions. At December 31, 1994, such restrictions remained on 237,543 shares outstanding from these plans. The certificates are held by the Company until the restrictions lapse or the shares are forfeited. Restriction periods vary from 1 to 10 years from the date of grant. During 1994, restrictions on 50,652 shares lapsed, and 5,200 shares were forfeited. The fair market value of awarded shares was previously recorded as deferred compensation as a segregation of surplus that is amortized to benefits expense over the restriction period. The unamortized amounts were $6,150,000 at December 31, 1994, $1,451,000 at December 31, 1993, and $2,952,000 at December 31, 1992. Compensation expense related to restricted stock grants, net of forfeitures, was $1,553,000 in 1994, $1,099,000 in 1993, and $2,243,000 in 1992.\nNOTE 11. BENEFITS\nThe Company and its subsidiaries provide a noncontributory defined benefit pension plan that covers substantially all employees. Benefits are based upon length of service and qualifying compensation during the final years of employment. Contributions are made to the plan as costs are accrued. Assets held by the plan consist primarily of government securities and common stock.\nThe table below sets forth the plan's funded status and amounts recognized at December 31:\nAssumptions used in determining the actuarial present value of the projected benefit obligation as of December 31 are as follows:\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nNet periodic pension expense consisted of the following:\nIn addition to the above, the Company maintains a nonqualified, supplemental retirement plan for certain officers. The benefits provided under this plan are unfunded, and any payments to plan participants are made by the Company. As of December 31, 1994 and 1993, $4,269,000 and $1,962,000, respectively, were included in accrued expense and other liabilities for this plan.\nThe expense associated with this plan as of December 31 was as follows:\nAssumptions used in determining the net pension expense and supplemental retirement expense were as follows:\nThe Company has a savings and profit sharing plan that is interrelated with an employee stock ownership plan (ESOP). Employees are eligible to participate in these plans if they meet certain service requirements. Benefits are based on the Company's financial performance. A portion of these benefits is payable under the ESOP in shares of the Company's common stock.\nIn 1990, the ESOP borrowed $18,600,000 from a third party to purchase 800,000 shares of the Company's common stock. This loan, unconditionally guaranteed by the Company, bears interest at a rate equal to Reserve Adjusted LIBOR plus .35% and is payable in eight annual instalments ending January 31, 1997. At December 31, 1994, the balance of the ESOP loan was $9,451,000 at an interest rate of 6.54%, and unallocated ESOP shares were 406,495.\nDuring 1994, ESOP expense included an accrual of $2,450,000 to cover the loan payment due on January 31, 1995, and interest expense, net of dividends, on the ESOP loan of $473,000. The dividends used to service the ESOP debt, which were paid on shares held by the ESOP, were $1,188,000 in 1994 and $697,000 in 1993; there were no dividends in 1992. The Company accrued additional contributions to the savings and profit sharing plan of $2,100,000 in 1994; the Company accrued no such additional contributions in 1993 or 1992.\nThe Company has a plan providing severance benefits for certain employees of the Company and its subsidiaries with respect to certain terminations of employment within two years after a change in control of the Company. Approximately 3,800 employees are potentially eligible for benefits under the plan. Existing\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\ncompensation and benefit plans have been amended to protect previously earned compensation and future benefits in the event of a change in control of the Company.\nThe Company adopted SFAS No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" as of January 1, 1993. SFAS No. 106 requires a calculation of the present value of expected benefits to be paid to employees after their retirement and an allocation of those benefits to the periods in which employees render service to earn the benefits. For employees retiring prior to December 31, 1993, the Company provided $5,000 of life insurance and a Medicare premium supplement and permitted those under 65 to participate in the Company's medical plan by paying the full group rate; full-time employees pay approximately 25% of the group rate. Those retiring after December 31, 1993, will not receive the Medicare supplement and will pay premiums for life and medical insurance reflecting the Company's full cost of coverage for retirees.\nThe initial transition obligation associated with the adoption of SFAS No. 106 was $3,600,000. In accordance with the statement, the Company will recognize this liability over the remaining service periods of plan participants. Since eligibility for these Company-subsidized benefits ceased at December 31, 1993, this period ranges from approximately three years for the medical insurance to thirteen years for the life insurance and Medicare supplements.\nThe table below sets forth the status of the Company's accumulated postretirement benefit obligation, which was unfunded as of December 31:\nAccumulated Postretirement Benefit Obligation:\nPostretirement benefit expense was $613,000 in 1994 and $619,000 in 1993.\nIncreasing the health care cost trend by 1% in each year would not materially affect the accumulated postretirement benefit obligation as of December 31, 1994, or the aggregate of the service and interest components of the net periodic postretirement benefit cost for the twelve months ended December 31, 1994. The present value of the accumulated benefit obligation assumed a 8.50% discount rate compounded annually.\nEffective January 1, 1994, the Company adopted SFAS No. 112, \"Employers' Accounting for Postemployment Benefits.\" SFAS No. 112 covers all postemployment benefits not already covered by the two prior accounting pronouncements. Adoption of SFAS No. 112 resulted in additional postemployment benefits of $1,615,000, which were recorded in the first quarter of 1994 at $932,000 on an after-tax basis. The annual cost of postemployment benefits to former employees for 1994 was $1,851,000.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nNOTE 12. OTHER NONINTEREST INCOME\nThe major components of other noninterest income were:\nNOTE 13. OTHER OPERATING EXPENSES\nThe major components of other operating expenses were:\nNOTE 14. INCOME TAXES\nThe provision for income taxes was comprised of the following:\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nThe current and deferred components of the provision were as follows:\nThe major components of deferred income tax expense (benefit) were as follows:\nThe differences between the effective income tax rate and the nominal federal tax rate on income before taxes are reconciled as follows:\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nAt December 31, 1994 and 1993, and January 1, 1993, the Company had gross deferred tax assets and gross deferred tax liabilities as follows:\nIt is expected that the existing net deductible temporary differences, which give rise to the net deferred tax asset, will be realized.\nNOTE 15. FINANCIAL INSTRUMENTS WITH CREDIT RISK AND OFF-BALANCE SHEET RISK AND DERIVATIVE FINANCIAL INSTRUMENTS\nCONCENTRATION OF CREDIT RISK -- The Company is a commercial banking organization, providing diversified financial services to individuals, businesses, governmental units, and other banks. The Company provides a comprehensive range of credit, non-credit, and international banking products and services to the New England region, with particular emphasis in the Commonwealth of Massachusetts, and accordingly is affected by general economic conditions in the region.\nOFF-BALANCE SHEET RISK -- In the normal course of business, the Company occasionally uses various off-balance sheet commitments and financial instruments for interest rate risk management purposes and to accommodate certain financing requirements of customers. These commitments and financial instruments may include loan commitments, interest rate swaps and options, standby letters of credit, loans sold with recourse, letters of credit, forward contracts, interest rate caps, and interest rate floors. These instruments involve varying degrees of credit and market risk in excess of the amounts included in the consolidated balance sheet. The contract or notional amounts of these instruments reflect the extent of the Company's involvement in each particular class of financial instrument. The Company's exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees under recourse arrangements is represented by the contractual amount of those instruments. The Company uses the same credit policies in extending commitments and conditional obligations as it does for on-balance sheet instruments. For interest rate swaps, caps, and floors, the contract or notional amounts do not represent an exposure to credit loss. The Company controls the credit risk of its interest rate swap agreements through credit approvals, limits, and monitoring procedures in conjunction with its interest rate risk management activities. Unless otherwise noted, the Company does not require collateral or other security to support financial instruments with credit risk.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nDERIVATIVE FINANCIAL INSTRUMENTS -- The Company has only limited involvement with derivative financial instruments for interest rate risk management and trading purposes.\nOff-balance sheet and derivative financial instruments at December 31, 1994 and 1993, were as follows:\nLOAN COMMITMENTS, LETTERS OF CREDIT, AND STANDBY LETTERS OF CREDIT -- Loan commitments and letters of credit are granted under the same credit policies used for on-balance sheet outstandings. Commitments are subject to various terms and conditions that have to be met before being drawn upon and have a fixed expiration date. The nature of many commitments is such that they are expected to expire without being drawn upon, thus not requiring future funding by the Company. The fair value of loan commitments was $3,500,000 and $2,100,000 at December 31, 1994 and 1993, respectively.\nLetters of credit are documents, principally related to export and import trade transactions, issued by the Company on behalf of its customers in favor of third parties, who can present demands on the Company within specified terms and conditions. Standby letters of credit are conditional commitments to guarantee the performance of a customer to a third party. The fair value of letters of credit was $177,000 and $175,000 at December 31, 1994 and 1993, respectively.\nFOREIGN EXCHANGE CONTRACTS -- The Company enters into offsetting agreements to purchase foreign currency and, in turn, to sell it to customers. Credit risk exists because in the event that a customer fails to take delivery of the foreign currency, the Company is required to resell it to the market. The fair value of foreign exchange contracts was $780,000 and $552,000 at December 31, 1994 and 1993, respectively.\nLOANS SOLD WITH RECOURSE -- The Company sells residential mortgage loans to the secondary market in connection with its mortgage banking business. While the majority of these loans are sold on a nonrecourse basis, there is a nominal dollar amount of recourse loans. All residential mortgage loans are subject to the same credit policies, and off-balance sheet loans with recourse have the same credit risk as on-balance sheet loans. If a borrower defaults on a loan sold with recourse, it is sold back to the Company to initiate normal collection efforts.\nFORWARD COMMITMENTS -- The Company enters into forward contract commitments to reduce the market risk associated with originating residential mortgage loans for sale. Contractual terms of forward commitments specify the aggregate amount of the contract, the interest rate or prices at which loans are to be delivered, and the period covered. The market risk to the Company is the potential inability to originate loans at prices specified in the contract within the commitment period, thus resulting in a potential difference between loan origination requirements under contract terms and those loans acquired at market prices to fulfill the commitment. The Company also enters into a limited number of forward rate options with commercial customers, which in turn are hedged in their entirety.\nSECURITIES PURCHASE AND SELL COMMITMENTS -- In connection with its capital markets activities, the Company regularly commits to purchase and sell securities.\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nINTEREST RATE SWAPS AND OPTIONS -- The Company uses interest rate swap contracts and options in conjunction with asset and liability management activities and to adjust interest rate risk associated with specific customer transactions. These agreements allow the Company to exchange fixed or variable interest rate payment amounts on existing assets or liabilities without changing the terms or amount of the underlying principal. Interest rate swaps are stated in notional terms, which represent the aggregate amount of the specific asset or liability being hedged by the interest rate swap transaction. However, the actual exposure to credit risk is the stream of interest payments under the contractual terms of the swap, not the notional amount. The Company manages the credit risk by entering into interest rate swap agreements only with highly regarded counterparties after a credit review process.\nMUNICIPAL NOTE PURCHASE AGREEMENTS -- In connection with its capital markets activities, the Company has committed to purchase certain municipal securities from investors in the event that the issuing municipality fails to pay principal or interest when due.\nNOTE 16. DISCLOSURES ABOUT THE FAIR VALUE OF FINANCIAL INSTRUMENTS\nUnder the provisions of SFAS No. 107, \"Disclosures about the Fair Value of Financial Instruments,\" the Company is required to estimate and disclose the fair value of certain of its on- and off-balance sheet financial instruments. SFAS No. 107 defines what constitutes a financial instrument and recommends general methodologies to determine fair value.\nThe fair value of a financial instrument as defined in SFAS No. 107 is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Quoted market prices are used to establish fair value when they are available for a particular financial instrument, and present value and other valuation techniques are utilized to estimate the fair value of financial instruments that do not have quoted market prices.\nThe following methods and assumptions were used to estimate the fair value of each class of financial instrument for which disclosure is required by SFAS No. 107.\nCASH AND DUE FROM BANKS AND INTEREST-BEARING DEPOSITS AND OTHER SHORT-TERM INVESTMENTS -- The current fair value of these financial instruments is defined as the amount recorded in the balance sheet categories.\nSECURITIES PORTFOLIOS -- Securities available for sale, investment securities, and trading account securities are financial instruments that are usually traded in broad markets. Fair values are based upon market prices and dealer quotes. If a quoted market price is not available for a particular security, the fair value is determined by reference to quoted market prices for securities with similar characteristics.\nLOANS -- For certain homogeneous categories of instalment loans, including student loans and credit card receivables, fair value has been estimated using quoted market prices for similar loans. The fair value of other instalment loans, including automobile financing, was determined by discounted cash flow techniques using interest rates for similar loans at December 31, 1994 and 1993. Credit risk factors were incorporated in the discount rates used for these loans and are reflected in the market prices obtained for homogeneous loans.\nThe fair value of residential mortgage loans, including ARMs and fixed-rate loans, was determined using discounted cash flow techniques with year-end interest rates, and by comparison with quoted market prices for mortgage-backed securities with similar interest rates and terms. The analysis also reflected estimated prepayment factors.\nThe fair value of both fixed- and variable-rate commercial and commercial real estate loans was determined by discounted cash flow techniques. Year-end 1994 and 1993 interest rates were used that incorporated the risk of credit loss associated with each type of loan, based on an evaluation performed as of December 31, 1994 and 1993.\nOTHER ASSETS -- Financial instruments classified as other assets that are subject to the disclosure requirements of SFAS No. 107 consist principally of interest receivable, excess mortgage servicing rights, and required\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\ninvestments in low-income housing limited partnerships. The carrying amounts of these financial instruments approximate their fair value.\nDEPOSITS -- The fair value of demand deposits, NOW and savings accounts, and money market deposits is defined by SFAS No. 107 as the amount payable on demand at the reporting date. Therefore, for these financial instruments, the amounts recorded in the balance sheet are also reported as their fair value under the provisions of the statement, and no core deposit value was derived for fair value disclosure purposes.\nThe fair value of certificates of deposit with fixed interest rates was estimated by the use of present value techniques. These techniques consider the cash flow related to these certificates, year-end interest rates at which similar certificates were issued with similar remaining maturities, and the probability of early withdrawal if interest rates were to rise.\nSHORT-TERM BORROWINGS -- The carrying amounts of federal funds purchased and other short-term borrowings are defined to approximate their fair values.\nLONG-TERM DEBT -- The fair value of long-term debt was established by market prices of the debt and present value techniques that consider the debt's remaining maturity and yield and the current credit ratings of the Company.\nACCRUED EXPENSES AND OTHER ACCOUNTS PAYABLE -- Financial instruments included in accrued expenses and other accounts payable that are subject to the disclosure requirements of SFAS No. 107 consist principally of interest payable. The carrying value of interest payable approximates its fair value.\nOFF-BALANCE SHEET FINANCIAL INSTRUMENTS -- The estimated fair values of loan commitments, standby letters of credit, and foreign exchange contracts are disclosed in Note 15. The fair values of all other off-balance sheet financial instruments were not considered to be material. These financial instruments generally are not sold or traded, and there is no standard methodology for determining their fair values. The Company's loan commitments are not beyond normal market terms and do not include fees or conditions other than those associated with customary market practices. The fair value of loan commitments was calculated by determining the discounted present value of the remaining contractual fees over the unexpired commitment period, generally not more than one year. The fair value of securities purchase and sell commitments was determined by reference to the price of the underlying securities. The fair value of standby letters of credit was determined by reference to the current fees charged to issue similar letters of credit. The fair value of forward commitments, foreign exchange contracts, and interest rate swaps was determined by reference to the market for similar instruments.\nThe fair values of the financial instruments presented, and as determined under the guidelines established by SFAS No. 107 as previously described, depend highly on assumptions as they existed as of December 31, 1994 and 1993, and on the related methodologies applied and do not purport to represent actual economic value in a bona fide transaction with a legitimate buyer under normal market conditions. It should also be noted that different financial institutions will use different assumptions and methodologies in determining fair values such that comparisons between institutions may be difficult. The Company did not attempt to determine the fair value of its substantial base of core deposits, as their disclosure is not required and due to the lack of generally accepted, industry-wide methodology for determining such values. With that understand-\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\ning, the financial statement amounts and estimated fair values of financial instruments at December 31, 1994 and 1993, were as follows:\nNOTE 17. CONTINGENCIES\nThe Company and its subsidiaries are involved in a number of legal proceedings arising in the normal course of business. After reviewing such matters, the Company believes that their resolution will not materially affect its results of operations or financial position.\nNOTE 18. QUARTERLY DATA (UNAUDITED)\nSummarized quarterly financial data for years 1992 through 1994 are as follows:\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\nNOTES TO FINANCIAL STATEMENTS -- (CONTINUED)\n- ---------------\n* The sum of the quarters' earnings per share for 1994 and 1992 does not equal the full-year amount due to the effect of the issuance of common stock.\nNOTE 19. PENDING ACQUISITION OF A FINANCIAL INSTITUTION\nOn December 23, 1994, the Company announced that it had agreed to acquire the southern New Hampshire-based holding company NFS Financial Corp. (NFS), parent company of NFS Savings Bank, FSB and Plaistow Cooperative Bank, FSB. The stockholders of NFS will receive $20.15 in cash and .2038 shares of BayBanks, Inc., common stock for each share of NFS common stock held. The merger consideration is subject to adjustment under certain circumstances if the market value of the Company's stock at the closing date is less than $43.50 or more than $63.00 per share. The acquisition, approved by the boards of directors of both companies, is subject to approval by the stockholders of NFS and various federal and state regulatory agencies. NFS had total assets of approximately $619,000,000 at December 31, 1994. The acquisition will be accounted for as a purchase.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nThere have been no changes in or matters of disagreement on accounting and financial disclosure with the Company's independent auditors.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.\nInformation concerning directors is presented in the section titled \"Board of Directors\" of the Company's proxy statement for the annual meeting to be held on April 27, 1995, and is incorporated herein by reference. The following are the executive officers of the registrant as of February 28, 1995:\nMr. Crozier has been an officer of BayBanks, Inc. since 1967 and was elected Chairman of the Board and Director in 1974. In 1977, Mr. Crozier was elected to the additional post of President.\nMr. Isaacs was elected Vice Chairman of the Board in 1992, Executive Vice President in 1985, Senior Vice President in 1979, and Vice President in 1978, and joined the Company in 1974. Mr. Isaacs is also the Chairman of the Board of BayBank Systems, Inc., the Company's technology subsidiary.\nMr. Pollard was elected Vice Chairman of the Board and Director in 1983 and Executive Vice President in 1979 and had been a Senior Vice President since 1976. Mr. Pollard is also President and CEO of BayBank Boston, N.A. and Chairman of the Board of BayBank Connecticut, N.A., and is the senior lending officer of the Company.\nMs. Beal was elected Secretary in 1991, Executive Vice President in 1985, Senior Vice President in 1979, and Vice President in 1977, and has been with the Company since 1972.\nMr. Vasily was elected Chief Financial Officer in 1991, Executive Vice President in 1987, Senior Vice President in 1980, and Vice President upon joining the Company in 1978, and was the Controller of the Company from 1983 to 1989.\nMs. Tonra was elected Senior Vice President of BayBanks, Inc., in 1985 and Controller in 1989, and joined the Company in 1985. She is the Principal Accounting Officer of the Company.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nInformation concerning management remuneration and transactions is presented in the section titled \"Executive Compensation\" of the Company's proxy statement for the annual meeting to be held on April 27, 1995, and is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nInformation concerning securities ownership of management and concerning securities ownership of certain beneficial owners is presented in the sections titled \"Board of Directors\" and \"Ownership of Common Stock\" of the Company's proxy statement for the annual meeting to be held on April 27, 1995, and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nInformation concerning relationships and transactions of the Company's executive officers and directors is presented in the section titled \"Board of Directors\" of the Company's proxy statement for the annual meeting to be held on April 27, 1995, 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\nThe following financial statements of the Company and its subsidiaries are presented in Item 8:\nIndependent Auditors' Report\nConsolidated Balance Sheet-December 31, 1994 and 1993\nConsolidated Statement of Income-Years Ended December 31, 1994, 1993, and 1992\nConsolidated Statement of Changes in Stockholders' Equity-Years Ended December 31, 1994, 1993, and 1992\nConsolidated Statement of Cash Flows-Years Ended December 31, 1994, 1993, and 1992\nNotes to Financial Statements\n2. Financial Statement Schedules\nAll schedules are omitted because either the required information is shown in the financial statements or notes incorporated by reference, or they are not applicable, or the data is not significant.\n3. Exhibits\nSee the Exhibit List and Index on pages 62 and 63.\n(b) Reports on Form 8-K\nThere were no reports on Form 8-K filed during the fourth quarter of 1994.\nA report on Form 8-K was filed on January 4, 1995, reporting the execution of an Acquisition Agreement on December 22, 1994, under which the Company would acquire NFS Financial Corp. (\"NFS\"), and a related Option Agreement under which NFS granted to the Company an option to purchase up to 9.9% of the outstanding shares of NFS Common Stock.\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.\nBAYBANKS, INC. (Registrant)\nBy: \/s\/ MICHAEL W. VASILY MICHAEL W. VASILY Executive Vice President\nFebruary 23, 1995\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below on February 23, 1995, by the following persons on behalf of the registrant and in the capacities indicated.\nBAYBANKS, INC.\nEXHIBIT LIST AND INDEX\n- ---------------\n* Incorporated by reference to the document indicated in parentheses.","section_15":""}
{"filename":"9626_1994.txt","cik":"9626","year":"1994","section_1":"ITEM 1. BUSINESS -----------------\nThe business of The Bank of New York Company, Inc. (the \"Company\") and its subsidiaries is described in the \"Business Review\" section of the Company's 1994 Annual Report to Shareholders which description is included in Exhibit 13 to this report and incorporated herein by reference. Also, the \"Management's Discussion and Analysis\" section included in Exhibit 13 contains financial and statistical information on the operations of the Company. Such information is herein incorporated by reference.\nCOMPETITION\nThe retail and commercial businesses in which the Company operates are very competitive. Competition is provided by both unregulated and regulated financial services organizations, whose products and services span the local, national, and global markets in which the Company conducts operations.\nSavings banks, savings and loan associations, and credit unions actively compete for deposits, and money market funds and brokerage houses offer deposit-like services. These institutions, as well as consumer and commercial finance companies, national retail chains, factors, insurance companies and pension trusts, are important competitors for various types of loans. Issuers of commercial paper compete actively for funds and reduce demand for bank loans. For personal and corporate trust services and investment counseling services, insurance companies, investment counseling firms, and other business firms and individuals offer active competition.\nCERTAIN REGULATORY CONSIDERATIONS\nGeneral\nAs a bank holding company, the Company is subject to the regulation and supervision of the Federal Reserve Board under the Bank Holding Company Act (\"BHC Act\"). The Company is also subject to regulation by the New York State Department of Banking. Under the BHC Act, bank holding companies may not directly or indirectly acquire the ownership or control of more than 5% of the voting shares or substantially all of the assets of any company, including a bank, without the prior approval of the Federal Reserve Board. In addition, bank holding companies are generally prohibited under the BHC Act from engaging in nonbanking activities, subject to certain exceptions.\nThe Company's subsidiary banks are subject to supervision and examination by applicable federal and state banking agencies. The Bank of New York (\"BNY\") is a state-chartered New York banking corporation and a member of the Federal Reserve System and is subject to regulation and supervision principally by the Federal Reserve Board. The Bank of New York (Delaware) (\"BNY Del.\") is a Delaware chartered FDIC insured non-member bank and therefore is subject to regulation and supervision principally by the FDIC. The Bank of New York National Association (\"BNYNA\") is organized as a national association under the laws of the United States and therefore is subject to regulation and supervision principally by the Comptroller of the Currency (\"Comptroller\").\nCapital Adequacy\nBank regulators have adopted risk-based capital guidelines for bank holding companies and banks. The minimum ratio of qualifying total capital to risk-weighted assets (including certain off-balance sheet items) is 8%. At least half of the total capital is to be comprised of common stock, retained earnings, noncumulative perpetual preferred stocks, minority interests and for bank holding companies, a limited amount of qualifying cumulative perpetual preferred stock, less certain intangibles including goodwill (\"Tier I capital\"). The remainder (\"Tier II capital\") may consist of other preferred stock, certain other instruments, and limited amounts of subordinated debt and the loan and lease loss allowance.\nIn addition, the Federal Reserve Board has established minimum Leverage Ratio (Tier I capital to average total assets) guidelines for bank holding companies and banks. These guidelines provide for a minimum leverage ratio of 3% for bank holding companies and banks that meet certain specified criteria, including that they have the highest regulatory rating. All other banking organizations will be required to maintain a leverage ratio of 3% plus an additional cushion of at least 100 to 200 basis points. The guidelines also provide that banking organizations 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 guidelines indicate that the Federal Reserve Board will continue to consider a \"Tangible Tier I Leverage Ratio\" in evaluating proposals for expansion or new activities. The Tangible Tier I Leverage Ratio is the ratio of Tier I capital, less intangibles not deducted from Tier I capital, to average total assets. The Federal Reserve Board has not advised the Company of any specific minimum leverage ratio applicable to it.\nFederal banking agencies have proposed regulations that would modify existing rules related to risk-based and leverage capital ratios. The Company does not believe that the aggregate impact of these modifications would have a significant impact on its capital position.\nBank regulators continue to indicate their desire to raise capital requirements applicable to banking organizations beyond their current levels. However, management is unable to predict whether and when higher capital requirements would be imposed and, if so, at what level and on what schedule.\nFDICIA\nThe Federal Deposit Insurance Corporation Improvement Act of 1991 (\"FDICIA\"), substantially revised the depository institution regulatory and funding provisions of the Federal Deposit Insurance Act (\"FDIA\") and made revisions to several other federal banking statutes. Among other things, FDICIA requires the federal banking regulators to take prompt corrective action in respect of FDIC-insured depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: \"well capitalized,\" \"adequately capitalized,\" \"undercapitalized,\" \"significantly undercapitalized\" and \"critically undercapitalized.\" Under applicable regulations, an FDIC-insured bank is defined to be well capitalized if it maintains a Leverage Ratio of at least 5%, a Tier I Capital Ratio of at least 6% and a Total Capital Ratio of at least 10% and is not otherwise in a \"troubled condition\" as specified by its appropriate federal regulatory agency. A bank is generally considered to be adequately capitalized if it is not defined to be well capitalized but meets all of its minimum capital requirements, i.e., if it has a Total Capital Ratio of 8% or greater, a Tier I Capital Ratio of 4% or greater and a Leverage Ratio of 4% or greater. A bank will be considered undercapitalized if it fails to meet any minimum required measure, significantly undercapitalized if it is significantly below such measure and critically undercapitalized if it maintains a level of tangible equity capital equal to or less than 2% of total assets. A bank may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating.\nFDICIA generally prohibits an FDIC-insured depository institution from making any capital distribution (including payment of dividends) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System. In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans. For an undercapitalized depository institution's capital restoration plan to be acceptable, its holding company must guarantee the capital plan up to an amount equal to the lesser of 5% of the depository 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. In the event of the parent holding company's bankruptcy, such guarantee would take priority over the parent's general unsecured creditors. The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution's capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.\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 and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator.\nThe Company's significant banking subsidiaries are well capitalized.\nThe table below indicates capital ratios of the Company and its significant banking subsidiaries at December 31, 1994 and 1993 and the respective guidelines for well capitalized institutions under FDICIA.\nDecember 31, 1994 December 31, 1993\nBNY BNY Company BNY Del. BNYNA Company BNY Del. BNYNA ------- --- ---- ----- ------- --- ---- ----- Well Capitalized Guidelines -----------\nTier I 8.45% 8.26% 7.27% 18.04% 8.87% 8.21% 7.53% 13.90% 6% Total Capital 13.43 12.36 11.34 19.30 13.65 12.82 11.00 15.17 10 Leverage 7.89 7.28 7.72 8.58 7.99 7.22 8.09 6.43 5 Tangible Common Equity 7.39 7.66 7.28 8.76 7.00 7.74 7.87 6.48\nAt December 31, 1994, the amounts of capital by which the Company and its significant banking subsidiaries exceed the guidelines are as follows:\nWell Capitalized\nBNY Company BNY Del. BNYNA (in millions) ------- --- ---- -----\nTier I $1,167 $839 $ 97 $247 Total Capital 1,634 877 103 191 Leverage 1,475 961 196 155\nThe following table presents the components of the Company's risk-based capital at December 31, 1994 and 1993:\n(in millions) 1994 1993 ---- ---- Common Stock $4,234 $3,778 Preferred Stock 119 294 Less: Intangibles 329 317 ----- ------ Tier 1 Capital 4,024 3,755\nQualifying Long-term Debt 1,774 1,489 Qualifying Allowance for Loan Losses 597 534 ------ ------ Tier 2 Capital 2,371 2,023 ------ ------ Total Risk-based Capital $6,395 $5,778 ====== ======\nThe following table presents the components of the Company's risk adjusted assets at December 31, 1994 and 1993: 1994 1993 ------------------ ------------------ Balance Balance sheet\/ Risk sheet\/ Risk notional adjusted notional adjusted (in millions) amount balance amount balance -------- -------- -------- -------- Assets ------ Cash, Due From Banks and Interest- Bearing Deposits in Banks $ 3,895 $ 567 $ 4,780 $ 318 Securities 4,651 671 5,597 571 Trading Assets 940 124 1,325 270 Fed Funds Sold and Securities Purchased Under Resale Agreements 3,019 3 36 5 Loans 33,083 30,814 30,570 27,954 Allowance for Loan Losses (792) - (970) - Other Assets 4,083 3,273 4,208 3,425 ------- ------- ------- ------- Total Assets $48,879 35,452 $45,546 32,543 ======= ------- ======= ------- Off-Balance Sheet Exposures --------------------------- Commitments to Extend Credit $ 37,771 7,520 $ 30,877 6,167 Securities Lending Indemnifications 15,326 - 15,005 - Standby Letters of Credit and Other Guarantees 7,240 4,515 5,699 3,685 Interest Rate Contracts 28,632 81 36,834 145 Foreign Exchange Contracts 51,021 236 39,878 225 -------- ------- -------- ------- Total Off-Balance Sheet Exposures $139,990 12,352 $128,293 10,222 ======== ------- ======== ------- Gross Risk Adjusted Assets 47,804 42,765\nLess: Allowance for Loan Losses not Qualifying as Risk Based Capital 195 436 ------- ------- Risk Adjusted Assets $47,609 $42,329 ======= =======\nA discussion of the Company's capital position is incorporated by reference from the caption \"Capital Resources\" in the \"Management's Discussion and Analysis\" section of Exhibit 13.\nBrokered Deposits\nThe FDIC has adopted regulations under FDICIA governing the receipt of brokered deposits. Under the regulations, a bank cannot accept, rollover or renew brokered deposits unless (i) it is well capitalized or (ii) it is adequately capitalized and receives a waiver from the FDIC. A bank that cannot receive brokered deposits also cannot offer \"pass-through\" insurance on certain employee benefit accounts. Whether or not it has obtained such a waiver, an adequately capitalized bank may not pay an interest rate on any deposits in excess of 75 basis points over certain prevailing market rates specified by regulation. There are no such restrictions on a bank that is well capitalized. Because BNY and BNY Del. are well capitalized, the Company believes the brokered deposits regulation will have no material effect on the funding or liquidity of BNY and BNY Del. BNYNA is well capitalized, but has no brokered deposits.\nFDIC Insurance Assessments\nBNY, BNY Del., and BNYNA are subject to FDIC deposit insurance assessments. As required by FDICIA, the FDIC adopted a risk-based premium schedule to determine the assessment rates for most FDIC-insured depository institutions. Under the schedule, the premiums initially range from $.23 to $.31 for every $100 of deposits. Each financial institution is assigned to one of three capital groups --- well capitalized, adequately capitalized, or undercapitalized --- and further assigned to one of three subgroups within a capital group, on the basis of supervisory evaluations by the institution's primary federal and, if applicable, state supervisors and other information relevant to the institution's financial condition and the risk posed to the applicable insurance fund. The actual assessment rate applicable to a particular institution will, therefore, depend in part upon the risk assessment classification so assigned to the institution by the FDIC. In February 1995, the FDIC issued a proposal to change the premium range from $.04 to $0.31 for every $100 of deposits. If implemented, this proposal would result in a significant reduction in FDIC insurance assessments of BNY, BNY Delaware and BNYNA.\nThe FDIC is authorized to raise insurance premiums in certain circumstances. Any increase in premiums would have an adverse effect on the Company's earnings.\nUnder the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order, or condition imposed by a bank's federal regulatory agency.\nDepositor Preference\nThe Omnibus Budget Reconciliation Act of 1993 provides for a national depositor preference on amounts realized from the liquidation or other resolution of any depository institution insured by the FDIC. That act requires claims to be paid in the following order of priority: the receiver's administrative expenses; deposits; other general or senior liabilities of the institution; obligations subordinated to depositors or general creditors; and obligations to shareholders. Under an FDIC interim rule, which became effective August 13, 1993, \"administrative expenses of the receiver\" are defined as those incurred by the receiver in liquidating or resolving the affairs of a failed insured depository institution.\nAcquisitions\nThe BHC Act generally limits acquisitions by the Company to commercial banks and companies engaged in activities that the Federal Reserve Board has determined to be so closely related to banking as to be a proper incident thereto. The Company's direct activities are generally limited to furnishing to its subsidiaries services that qualify under the \"closely related\" and \"proper incident\" tests. Prior Federal Reserve Board approval is required under the BHC Act for new activities and acquisitions of most nonbanking companies.\nThe BHC Act, the Federal Bank Merger Act, and the New York Banking Law regulate the acquisition of commercial banks. The BHC Act requires the prior approval of the Federal Reserve Board for the direct or indirect acquisition of more than 5% of the voting shares of a commercial bank. The BHC Act generally prohibits the acquisition of a domestic bank located outside the Company's state of principal operations, New York State, unless authorized by the law of the state of the target bank. Most states have enacted interstate banking laws that permit the Company to acquire banks located in their states, but some states (particularly in the Southeast) presently do not permit entry by New York bank holding companies. The New York Banking Law requires state regulatory approval before the Company can acquire more than 5% of the voting shares of a commercial bank in New York.\nThe Riegle-Neal Interstate banking and Branching Efficiency Act of 1994 which was enacted in September, 1994, authorizes (i) bank holding companies to engage in interstate acquisitions of banks beginning one year after the date of its enactment, (ii) interstate branching through interstate bank mergers beginning June 1, 1997 (subject to the ability of states to \"opt-in\" and thereby permit such mergers earlier or to \"opt-out\" and thereby prohibit them), (iii) de novo interstate branching provided that such action is specifically authorized by the law of the state in which the branch is to be located and (iv) banks to receive deposits, close and service loans, and receive payments on loans and other obligations as agent for a bank affiliate in the same or a different state beginning September 29, 1995. One effect of this legislation, subject to the state authority described above, will be to permit the Company to merge two or more of its banking subsidiaries which, as a result, may create greater efficiency in its operations.\nThe merger of BNY with another bank would require the approval of the Federal Reserve Board or other federal bank regulatory authority and, if the surviving bank is a state bank, the New York Superintendent of Banks. With respect to BNYNA, the approval of the Comptroller is required for branching of national banks, purchasing the assets of other banks and for bank mergers in which the continuing bank is a national bank.\nIn reviewing bank acquisition and merger applications, the bank regulatory authorities will consider, among other things, the competitive effect and public benefits of the transactions, the capital position of the combined organization, and the applicant's record under the Community Reinvestment Act.\nUnder Federal Reserve Board policy, the Company is expected to act as a source of financial strength to its banks and to commit resources to support such banks in circumstances where it might not do so absent such policy. In addition, any loans by the Company to its banks would be subordinate in right of payment to deposits and to certain other indebtedness of its banks.\nRegulated Banking Subsidiaries\nAs a New York State chartered bank and a member of the Federal Reserve System, BNY is subject to the supervision of, and is regularly examined by, the New York State Banking Department and the Federal Reserve Board. As a bank insured by the FDIC, BNY is also subject to examination by that agency. BNY Del. is subject to the supervision of, and is regularly examined by, the FDIC and the Office of State Bank Commissioner of the State of Delaware. BNYNA is a national bank subject to the regulation and supervision of, and regular examination by, the Comptroller and subject to regulations of the FDIC and Federal Reserve Board.\nBoth federal and state laws extensively regulate various aspects of the banking business, such as permissible types and amounts of loans and investments, permissible activities, and reserve requirements. These regulations are intended primarily for the protection of depositors rather than the Company's stockholders.\nRestrictions on Transfer of Funds\nRestrictions on the transfer of funds to the Company are discussed in Note 9 to the Consolidated Financial Statements included in Exhibit 13. Such discussion is incorporated herein by reference.\nFIRREA\nA depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with (i) the default of a commonly controlled 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.\nGOVERNMENT MONETARY POLICIES\nThe Federal Reserve Board has the primary responsibility for monetary policy; accordingly, its actions have an important influence on the demand for credit and investments and the level of interest rates.\nADDITIONAL FINANCIAL INFORMATION ------------------------------------------------------------------------------ Average Balances and Rates on a Taxable Equivalent Basis (dollars in millions) 1994 1993 1992 ============================================================================== Aver- Aver- Aver- Average Inter- age Average Inter- age Average Inter- age Balance est Rate Balance est Rate Balance est Rate ----------------------------------------------------------------- Assets ------ Interest -Bearing Deposits in Banks (Primarily Foreign) $ 1,266 $ 68 5.33% $ 452 $ 24 5.42% $ 753 $ 76 10.14% Federal Funds Sold and Securities Purchased Under Resale Agreements 3,653 161 4.39 3,149 97 3.06 2,379 85 3.54 Loans Domestic Offices Consumer 9,549 1,015 10.62 8,259 806 9.76 7,016 704 10.04 Commercial 12,340 833 6.76 11,998 741 6.18 11,643 755 6.48 Foreign Offices 10,140 564 5.56 10,170 485 4.77 11,686 651 5.57 ------- ------ ------- ------ ------- ------ Total Loans 32,029 2,412* 7.53 30,427 2,032* 6.68 30,345 2,110* 6.95 ------- ------ ------- ------ ------- ------ Securities U.S. Government Obligations 3,516 197 5.61 3,732 215 5.78 3,611 240 6.66 Obligations of States and Political Subdivisions 893 89 10.02 1,070 110 10.29 1,224 135 11.04 Other Securities, including Trading Securities Domestic Offices 1,341 70 5.25 1,358 64 4.74 1,190 91 7.65 Foreign Offices 191 11 5.64 192 14 7.36 177 17 9.44 ------- ------ ------- ------ ------- ------ Total Other Securities 1,532 81 5.30 1,550 78 5.06 1,367 108 7.88 ------- ------ ------- ------ ------- ------ Total Securities 5,941 367 6.19 6,352 403 6.36 6,202 483 7.79 ------- ------ ------- ------ ------- ------ Total Interest- Earning Assets 42,889 $3,008 7.01% 40,380 $2,556 6.33% 39,679 $2,754 6.94% ====== ====== ====== Allowance for Loan Losses (906) (1,045) (1,057) Cash and Due from Banks 2,827 2,735 2,522 Other Assets 5,470 4,574 5,083 ------- ------- ------- Total Assets $50,280 $46,644 $46,227 ======= ======= ======= Assets Attributable to Foreign Offices 24.30% 24.37% 28.63% ===== ===== =====\n*Includes fees of $118 million in 1994, $103 million in 1993, and $96 million in 1992. Nonaccrual loans are included in the average loan balance; the associated income, recognized on the cash basis, is included in interest. Taxable equivalent adjustments were $46 million in 1994, $54 million in 1993, and $66 million in 1992, and are based on the federal statutory tax rate (35% in 1994 and 1993, and 34% in 1992) and applicable state and local taxes.\nContinued on page 10\nAverage Balances and Rates on a Taxable Equivalent Basis (dollars in millions)\n1994 1993 1992 =============================================================================== Aver- Aver- Aver- Average Inter- age Average Inter- age Average Inter- age Balance est Rate Balance est Rate Balance est Rate ------------------------------------------------------------- Liabilities and Shareholders' Equity --------------- Interest-Bearing Deposits Domestic Offices Money Market Rate Accounts $ 3,593 $ 108 3.01% $ 3,666 $ 91 2.48% $ 3,468 $ 108 3.11% Savings 8,166 190 2.32 8,379 198 2.37 7,189 216 3.01 Certificates of Deposit of $100,000 or More 1,041 42 4.03 1,189 36 3.00 1,709 64 3.75 Other Time Deposits 2,296 97 4.24 2,701 119 4.39 2,965 152 5.15 ------- ------ ------- ------ ------- ------ Total Domestic Offices 15,096 437 2.90 15,935 444 2.78 15,331 540 3.53 ------- ------ ------- ------ ------- ------ Foreign Offices Banks in Foreign Countries 2,917 125 4.30 2,829 93 3.28 4,018 204 5.07 Government and Official Institutions 1,384 60 4.37 1,306 57 4.34 1,270 61 4.81 Other Time and Savings 5,689 220 3.84 3,752 107 2.87 4,716 200 4.24 ------- ------ ------- ------ ------- ------ Total Foreign Offices 9,990 405 4.05 7,887 257 3.26 10,004 465 4.64 ------- ------ ------- ------ ------- ------ Total Interest- Bearing Deposits 25,086 842 3.35 23,822 701 2.94 25,335 1,005 3.97 ------- ------ ------- ------ ------- ------ Federal Funds Purchased and Securities Sold Under Repurchase Agreements 2,843 106 3.73 3,467 102 2.94 4,001 136 3.40 Other Borrowed Funds 4,135 191 4.63 2,348 86 3.66 2,045 85 4.13 Long-Term Debt 1,530 106 6.93 1,729 117 6.79 1,386 94 6.77 ------- ------ ------- ------ ------- ------ Total Interest- Bearing Liabilities 33,594 $1,245 3.71% 31,366 $1,006 3.21% 32,767 $1,320 4.03% ======= ======= ======= Noninterest- Bearing Deposits Domestic Offices 8,897 8,946 7,797 Foreign Offices 58 69 105 ------- ------- ------- Total Noninterest- Bearing Deposits 8,955 9,015 7,902 ------- ------- ------- Other Liabilities 3,594 2,366 2,153 Preferred Stock 157 334 409 Common Shareholders' Equity 3,980 3,563 2,996 ------- ------- ------- Total Liabilities and Shareholders' Equity $50,280 $46,644 $46,227 ======= ======= ======= Net Interest Earnings and Interest Rate Spread $1,763 3.30 $1,550 3.12 $1,434 2.91 ====== ====== ====== Net Yield on Interest-Earning Assets 4.11% 3.84% 3.61% ==== ==== ==== Liabilities Attributable to Foreign Offices 22.79% 19.74% 24.91% ===== ===== =====\nRate\/Volume Analysis on a Taxable Equivalent Basis (in millions) ---------------------------------------------------------------- 1994 vs. 1993 1993 vs. 1992 ---------------------------------------------------------------------------- Increase (Decrease) Increase (Decrease) due to change in: due to change in: ---------------- Total ----------------- Total Average Average Increase Average Average Increase Balance Rate (Decrease) Balance Rate (Decrease) ------- ------- ---------- ------- ------- --------- Interest Income --------------- Interest-Bearing Deposits in Banks $ 44 $ - $ 44 $ (24) $ (28) $ (52) Federal Funds Sold and Securities Purchased Under Resale Agreements 17 47 64 25 (13) 12 Loans Domestic Offices Consumer 134 75 209 122 (20) 102 Commercial 22 70 92 23 (37) (14) Foreign Offices (1) 80 79 (79) (87) (166) ----- ----- ----- ------ ------ ------ Total Loans 155 225 380 66 (144) (78) Securities U.S. Government Obligations (12) (6) (18) 8 (33) (25) Obligations of States and Political Subdivisions (18) (3) (21) (16) (9) (25) Other Securities, including Trading Assets Domestic Offices (1) 7 6 12 (39) (27) Foreign Offices - (3) (3) 1 (4) (3) ----- ----- ----- ----- ----- ------ Total Other Securities (1) 4 3 13 (43) (30) ----- ----- ----- ----- ----- ------ Total Securities (31) (5) (36) 5 (85) (80) ----- ----- ----- ----- ----- ------ Total Interest Income 185 267 452 72 (270) (198) ----- ----- ----- ----- ----- ------ Interest Expense ---------------- Interest-Bearing Deposits Domestic Offices Money Market Rate Accounts (2) 19 17 6 (23) (17) Savings (5) (3) (8) 32 (50) (18) Certificate of Deposits of $100,000 or More (5) 11 6 (17) (11) (28) Other Time Deposits (18) (4) (22) (12) (21) (33) ----- ----- ----- ----- ----- ------ Total Domestic Offices (30) 23 (7) 9 (105) (96) ----- ----- ----- ----- ----- ------ Foreign Offices Banks in Foreign Countries 3 29 32 (51) (60) (111) Government and Official Institutions 3 - 3 2 (6) (4) Other Time and Savings 67 46 113 (37) (56) (93) ----- ----- ----- ----- ----- ------ Total Foreign Offices 73 75 148 (86) (122) (208) ----- ----- ----- ----- ----- ------ Total Interest- Bearing Deposits 43 98 141 (77) (227) (304) Federal Funds Purchased and Securities Sold Under Repurchase Agreements (20) 24 4 (17) (17) (34) Other Borrowed Funds 77 28 105 11 (10) 1 Long-Term Debt (13) 2 (11) 23 - 23 ----- ----- ----- ----- ----- ------ Total Interest Expense 87 152 239 (60) (254) (314) ----- ----- ----- ----- ----- ------ Change in Net Interest Income $ 98 $ 115 $ 213 $ 132 $ (16) $ 116 ===== ===== ===== ===== ===== ======\nChanges which are not solely due to balance changes or rate changes are allocated to such categories on the basis of the respective percentage changes in average balances and average rates.\nInterest-Rate Sensitivity -------------------------\nThe Company actively manages interest-rate sensitivity (the exposure of net interest income to interest rate movements). The relationship of interest-earning assets and interest-bearing liabilities between repricing dates is closely monitored, yet the Company's policies are flexible enough to capitalize on profit opportunities, while minimizing adverse effects on earnings when changes in short-term and long-term interest rates occur. The Company uses complex simulation models to adjust the structure of its assets and liabilities in response to interest rate exposures. The Company uses three basic scenarios to model interest rate sensitivity, these include base line, high rate, and low rate. The base line scenario is the Company's estimated most likely path for future short-term interest rates. The base line scenario forecast in January 1995 assumes rising rates. The \"high rate\" scenario assumes a 79 basis point increase from the base line scenario (already a rising rate scenario). The \"low rate\" scenario assumes the average rate declines 121 basis points under the base line scenario. Additionally, other scenarios are reviewed to examine the impact of other interest rate changes. The Company quantifies interest rate sensitivity by calculating the change in net interest income between the three scenarios over a 12 month policy measurement period. Net interest income as calculated by the earnings simulation model under the base line scenario becomes the standard. The measurement of interest rate sensitivity is the percentage change in net interest income calculated by the model under high rate versus base-line scenario and under low rate versus base-line scenario. The scenarios do not include the adjustments that management would make as rate expectations change. The Company's policy limit for fluctuations in net interest income resulting from either the high rate or low rate scenario is 6 percent. Based upon the January 1995 outlook, if interest rates were to rise to follow the high rate scenario, then net interest income during the policy measurement period would be positively affected by 1.82% percent (assuming management took no actions.) If interest rates were to follow the low rate scenario, then net interest income would be negatively affected by 1.94% In addition to the policy limit discussed above, the Company also has a global mismatch limit to control the impact of interest rate fluctuations on the Company's earnings. The Company's global mismatch is defined as the absolute value of the Company's asset repricings less liability repricings in 24 maturity bands ranging from one day to over 10 years. Off balance sheet instruments, such as swaps and futures used to hedge balance sheet items are included in the calculation of the global mismatch. Each year the Company's Board of Directors approves specific mismatch limits. The global mismatch is reviewed weekly by senior management. The following table reflects the year-end position of the Company's interest-earning assets and interest-bearing liabilities that either reprice or mature within the designated time periods. Further, within each time period assets and liabilities reprice on different dates and at different levels. Interest sensitivity gaps change daily. A positive interest sensitivity gap, for a particular time period, is one in which more assets reprice or mature than liabilities. A negative interest sensitivity gap results from a greater amount of liabilities repricing or maturing. A positive gap implies that there are more rate sensitive assets than liabilities which suggests that as interest rates rise, the return on assets will rise faster than the funding costs. Conversely, a negative gap indicates a higher ratio of rate sensitive liabilities than assets. In such cases, if interest rates rise, then funding costs will rise at a faster rate than the return on assets. Finally, the cumulative gap is the sum of the dollar gap for sequential time periods.\nDecember 31, 1994 ----------------------------------------------- Within Greater Within Within Within 7-12 Than 1 Mo. 2-3 Mos. 4-6 Mos. Mos. 12 Mos. Total ------ -------- -------- ------ ------- ------- (in millions) Interest-Earning Assets ----------------------- Foreign Offices $ 5,840 $ 4,025 $1,677 $ 196 $ 217 $11,955 Domestic Offices Loans 16,976 471 392 564 4,387 22,790 Securities 131 60 93 309 3,380 3,973 Trading Assets 686 - - - - 686 Federal Funds Sold and Securities Purchased Under Resale Agreement 3,019 - - - - 3,019 ------- ------- ------ ------ ------ ------- 26,652 4,556 2,162 1,069 7,984 $42,423 ------- ------- ------ ------ ------ =======\nInterest-Bearing Liabilities ---------------------------- Foreign Offices 8,323 1,614 625 488 32 11,082 Domestic Offices Interest-Bearing Deposits Money Market Rate Accounts 3,330 - - - - 3,330 Savings 6,444 - - 13 1,296 7,753 Certificates of Deposit of $100,000 or More 493 399 224 304 901 2,321 Other Time Deposits 335 235 322 219 355 1,466 ------- ------- ------ ------ ------ ------- Total Interest-Bearing Deposits 18,925 2,248 1,171 1,024 2,584 25,952 ------- ------- ------ ------ ------ ------- Federal Funds Purchased and Other Borrowed Funds 4,344 737 147 555 17 5,800 Long-Term Debt - - 64 - 1,710 1,774 ------- ------- ------ ------ ------ -------\nNoninterest-Bearing Sources of Funds 3,581 25 38 76 5,177 8,897 --------------------------- ------- ------- ------ ------ ------ ------- Total 26,850 3,010 1,420 1,655 9,488 $42,423 ======= Effect of Financial Futures and Swaps 933 (2,401) (396) 1,055 809 --------------------------- ------- ------- ------ ------ ------ Interest-Sensitive Gap $ 735 $ (855) $ 346 $ 469 $ (695) ---------------------- ======= ======= ====== ====== ====== Cumulative Interest- Sensitivity Gap $ 735 $ (120) $ 226 $ 695 $ - -------------------- ======= ======= ====== ====== ======\nPROVISION AND ALLOWANCE FOR LOAN LOSSES ---------------------------------------\nAt December 31, 1994, the domestic commercial real estate portfolio had approximately 76% of its loans in New York and New Jersey, 5% in California, 5% in Pennsylvania, 3% in New England, and 1% in Florida; no other state accounts for more than 1% of the portfolio. This portfolio consists of the following types of properties:\nBusiness loans secured by real estate 45% Offices 28 Retail 8 Hotels 5 Mixed-Used 4 Land 2 Condominiums and cooperatives 1 Industrial\/Warehouse 1 Other 6 ---- 100% ====\nAt December 31, 1994 and 1993, the Company's nonperforming real estate loans and real estate acquired in satisfaction of loans aggregated $119 million and $171 million, respectively. Net charge-offs of real estate loans were $6 million in 1994 and $69 million in 1993. In addition, other real estate charges were $11 million and $53 million in 1994 and 1993. A discussion of other real estate charges under \"Noninterest Expense and Income Taxes\" in the \"Management's Discussion and Analysis\" section included in Exhibit 13 is incorporated herein by reference.\nAt December 31, 1994, the Company's LDC exposures consisted of $78 million in medium-term loans (and no material commitments), $334 million in short-term loans, $14 million in accrued interest, and $48 million in equity investments. At December 31, 1994, the allowance for loan losses associated with LDC loans was $98 million. In addition, the Company has $318 million of debt securities to emerging market countries, including $270 million (book value) of bonds whose principal payments are collateralized by U.S. Treasury zero coupon obligations and whose interest payments are partially collateralized.\nThe Company's consumer loan portfolio is comprised principally of credit card, other installment, and residential loans. Residential and auto loans are collateralized, thereby reducing the risk. Credit card net charge-offs were $149 million in 1994 compared to $121 million in 1993. The 1994 and 1993 amounts exclude $32 million and $56 million in net charge-offs related to the portion of the portfolio that is securitized. As a percentage of average credit card outstandings, net charge-offs were to 2.47% in 1994 compared to 2.88% in 1993. On a managed receivables basis, net charge-offs as a percentage of average outstandings were 2.68% in 1994 compared to 3.19% in 1993. Other consumer net charge-offs were $7 million in 1994 and $23 million in 1993.\nLending to the utility industry is concentrated in investor-owned electric utilities. The Company also makes loans to gas and telephone utilities. Nonperforming loans in this industry amounted to $2 million at year-end 1994 and 1993. There were no charge-offs in 1994 and 1993.\nThe Company's loans to the communications, entertainment, and publishing industries primarily consist of credits with cable television operators, broadcasters, magazine and newspaper publishers and motion picture theaters. There were no nonperforming communications loans at December 31, 1994 and 1993. Charge-offs of communications loans were $1 million in 1993. There were no charge-off in 1994.\nThe Company's portfolio of loans for purchasing or carrying securities is comprised largely of overnight loans which are fully collateralized, with appropriate margins, by marketable securities. Throughout its many years of experience in this area, the Company has rarely experienced a loss.\nThe Company makes short-term, collateralized loans to mortgage bankers to fund mortgages sold to investors. Nonperforming loans and charge-offs have not been significant.\nBased on an evaluation of individual credits, historical loan losses, and global economic factors, the Company has allocated its allowance for loan losses as follows:\n1994 1993 1992 1991 1990 ---- ---- ---- ---- ---- Real Estate Loans 9% 8% 9% 10% 11% HLT Loans 5 6 7 11 17 Other Domestic Commercial and Industrial Loans 51 58 57 51 38 Consumer Loans 16 10 9 10 8 Foreign Loans (excluding medium-term LDC loans) 7 6 6 6 6 LDC Loans 12 12 12 12 20 ---- ---- ---- ---- ---- 100% 100% 100% 100% 100% ==== ==== ==== ==== ====\nSuch an allocation is inherently judgmental, and the entire allowance for loan losses is available to absorb loan losses regardless of the nature of the loan.\nThe following table details changes in the Company's allowance for loan losses for the last five years.\n(dollars in millions) 1994 1993 1992 1991 1990 ---- ---- ---- ---- ---- Loans Outstanding, December 31, $33,083 $30,570 $29,497 $30,335 $35,776 Average Loans Outstanding 32,029 30,427 30,345 32,719 38,139\nAllowance for Loan Losses ------------------------- Balance, January 1 Regular Domestic $ 794 $ 878 $ 889 $ 831 $ 593 Foreign 60 70 60 62 24 Less Developed Countries 116 124 135 218 537* ------- ------- ------- ------- ------- Total, January 1 970 1,072 1,084 1,111 1,154 ------- ------- ------- ------- ------- Allowance of Acquired Companies and Other Changes - - 56 (10) 1 Credit Card Securitizations 14 1 - (18) - Charge-Offs Domestic Commercial and Industrial (158) (142) (311) (358) (111) Real Estate & Construction (6) (71) (103) (165) (45) Consumer Loans (191) (173) (181) (226) (157) Foreign (38) (54) (20) (32) (9) Less Developed Countries (18) (9) (13) (39) (270) ------- ------- ------- ------- ------- Total (411) (449) (628) (820) (592) ------- ------- ------- ------- ------- Recoveries Domestic Commercial and Industrial 14 28 66 11 35 Real Estate & Construction - 2 13 1 - Consumer Loans 35 29 26 21 16 Foreign 8 2 10 4 1 Less Developed Countries - 1 2 6 1 ------- ------- ------- ------- ------- Total 57 62 117 43 53 Net Charge-Offs (354) (387) (511) (777) (539) ------- ------- ------- ------- ------- Provision Domestic 135 242 423 742 449 Foreign 27 42 20 36 46 ------- ------- ------- ------- ------- Total 162 284 443 778 495 ------- ------- ------- ------- ------- Balance, December 31, Regular Domestic 637 794 878 889* 831* Foreign 57 60 70 60 62 Less Developed Countries 98 116 124 135* 218* ------- ------- ------- ------- ------- Total, December 31, $ 792 $ 970 $ 1,072 $ 1,084 $ 1,111 ======= ======= ======= ======= ======= Ratios ------ Net Charge-Offs to Average Loans Outstandings 1.11% 1.27% 1.68% 2.37% 1.41% ======= ======= ======= ======= ======= Net Charge-Offs to Total Allowance 44.70% 39.90% 47.67% 71.68% 48.51% ======= ======= ======= ======= ======= Total Allowance to Year-End Loans Outstanding 2.40% 3.17% 3.63% 3.57% 3.11% ====== ====== ===== ====== ======\n*Each year includes a $50 million transfer from the LDC Allowance for Loan Losses to the Regular Allowance.\nNonperforming Assets -------------------- A summary of nonperforming assets is presented in the following table.\n(in millions) December 31,\n1994 1993 1992 1991 1990 ---- ---- ---- ---- ---- Nonaccrual ---------- Domestic $ 220 $ 408 $ 581 $1,014 $1,294 Foreign (including Medium-term LDC) 77 130 198 146 86 ----- ------ ------ ------ ------ 297 538 779 1,160 1,380\nReduced Rate (Domestic) - 2 9 13 15 ------------ ----- ------ ------ ------ ------ 297 540 788 1,173 1,395\nReal Estate Acquired in ----------------------- Satisfaction of Loans 56 99 268 369 355 --------------------- ----- ------ ------ ------ ------\n$ 353 $ 639 $1,056 $1,542 $1,750 ===== ====== ====== ====== ====== Past Due 90 Days or More ------------------------ and Still Accruing Interest --------------------------- Domestic $ 163 $ 156 $ 218 $ 178 $ 215 Foreign - - - 66 11 ----- ------ ------ ------ ------ $ 163 $ 156 $ 218 $ 244 $ 226 ===== ====== ====== ====== ======\nSecurities ---------- The following table shows the maturity distribution by carrying amount and yield (not on a taxable equivalent basis) of the Company's securities portfolio at December 31, 1994.\nStates and U.S. Government Political U.S. Government Agency Subdivisions --------------- ---------------- ------------- Amount Yield Amount Yield Amount Yield ------ ----- ------ ----- ------ ----- (dollars in millions)\nSecurities Held- ---------------- to-Maturity ----------- One Year or Less $ 256 5.47% $ 1 6.04% $ 264 5.44% Over 1 through 5 Years 736 4.99 153 5.08 119 6.94 Over 5 through 10 Years 436 5.63 - - 111 7.78 Over 10 years - - - - 275 7.53 Mortgage-Backed Securities - - - - - - ------ ----- ------ $1,428 5.27 $ 154 5.08 $ 769 6.76 ====== ===== ====== Securities Available- -------------------- for-Sale ---------- One Year or Less $ 25 5.50% $ - -% $ - -% Over 1 through 5 Years 958 5.87 - - 2 5.23 Over 5 through 10 Years 436 6.10 - - 2 5.34 Over 10 years 7 11.19 - - 3 5.74 Equity Securities - - - - - - ------ ----- ----- $1,426 5.96 $ - - $ 7 5.45 ====== ===== =====\nOther Bonds, Mortgage-Backed Notes and and Equity Debentures Securities ------------- ------------ Amount Yield Amount Yield Total ------ ----- ------ ----- ----- (dollars in millions)\nSecurities Held- ---------------- to-Maturity ----------- One Year or Less $ 28 5.13% $ - - % $ 549 Over 1 through 5 Years 39 6.19 - - 1,047 Over 5 through 10 Years 53 5.90 - - 600 Over 10 years 294 7.07 - - 569 Mortgage-Backed Securities - - 165 7.49 165 ---- ---- ------ $414 6.70 $165 7.49 $2,930 ==== ==== ====== Securities Available- -------------------- for-Sale ---------- One Year or Less $ 2 -% $ - -% $ 27 Over 1 through 5 Years 7 - - - 967 Over 5 through 10 Years 3 - - - 441 Over 10 years 10 5.22 - - 20 Equity Securities - - 266 4.77 266 ----- ---- ------ $ 22 2.48 $266 4.77 $1,721 ===== ==== ======\nLoans -----\nThe following table shows the maturity structure of the Company's commercial loan portfolio at December 31, 1994. Over 1 Year 1 Year Through Over or Less 5 Years 5 Years Total ------ ----------- ------- ----- (in millions) Domestic -------- Real Estate, Excluding Loans Collateralized by 1-4 Family Residential Properties $ 599 $1,392 $ 876 $ 2,867 Commercial and Industrial Loans 3,755 4,131 3,263 11,149 Other, Excluding Loans to Individuals and those Collateralized by 1-4 Family Residential Properties 3,154 340 184 3,678 ------ ------ ------ ------- 7,508 5,863 4,323 17,694 Foreign 1,425 695 1,531 3,651 ------- ------ ------ ------ ------- Total $8,933 $6,558 $5,854 $21,345 ====== ====== ====== =======\nLoans with: Predetermined Interest Rates $ 437 $ 193 $1,109 $ 1,739 Floating Interest Rates 8,496 6,365 4,745 19,606 ------ ------ ------ ------- Total $8,933 $6,558 $5,854 $21,345 ====== ====== ====== =======\nDeposits --------\nThe aggregate amount of deposits by foreign customers in domestic offices was $875 million, $739 million, and $789 million at December 31, 1994, 1993, and 1992.\nThe following table shows the maturity breakdown of domestic time deposits of $100,000 or more at December 31, 1994.\nTime (in millions) Certificates Deposits- of Deposits Other Total ------------------------------------------------\n3 Months or Less $ 842 $654 $1,496 Over 3 Through 6 Months 224 5 229 Over 6 Through 12 Months 374 5 379 Over 12 Months 881 19 900 ------ ---- ------ Total $2,321 $683 $3,004 ====== ==== ======\nThe majority of deposits in foreign offices are time deposits in denominations of $100,000 or more.\nOther Borrowed Funds --------------------- Information related to other borrowed funds in 1994, 1993, and 1992 is presented in the table below. 1994 1993 1992 --------------- --------------- -------------- (dollars in millions) Average Average Average Amount Rate Amount Rate Amount Rate ------ ------- ------ ------- ------ -------\nFederal Funds Purchased and --------------------------- Securities Sold Under --------------------- Repurchase Agreements --------------------- At December 31 $1,502 4.91% $2,711 2.85% $1,773 2.81% Average During Year 2,843 3.73 3,467 2.94 4,001 3.40 Maximum Month-End Balance During Year 6,415 3.36 4,894 2.80 5,467 3.88\nOther* ----- At December 31 4,176 5.79% 2,781 3.61 3,029 3.82 Average During Year 4,135 4.63 2,348 3.66 2,045 4.13 Maximum Month-End Balance During Year 5,639 4.57 3,161 3.60 3,029 3.82\n*Other borrowings consist primarily of commercial paper, bank notes, extended federal funds purchased, and amounts owed to the U.S. Treasury.\nForeign Assets -------------- The only foreign country in which the Company's assets exceed .75% of year end total assets was the United Kingdom in 1993 ($351 million). There were no foreign countries in which the Company's assets exceeded .75% of year end total assets in 1994. However, at December 31, 1994 the Company had outstanding commitments to extend credit to customers in the United Kingdom amounting to $651 million.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES ------------------- In New York City, the Company owns the thirty story building housing its executive headquarters at 48 Wall Street, a forty-nine story office building at One Wall Street, and an operations center at 101 Barclay Street. In addition, the Company owns and\/or leases administrative and operations facilities in New York City; various locations in New Jersey; Harrison, New York; Newark, Delaware; London, England; and Utica, New York. Other real properties owned or leased by the Company, when considered in the aggregate, are not material to its operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS -------------------------- Litigation regarding Northeast Bancorp., Inc. is described in Note 12 to the Consolidated Financial Statements included in Exhibit 13, and such description is incorporated herein by reference.\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 of the registrant during the fourth quarter of 1994.\nPART II ------- ITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND -------------------------------------------------- RELATED STOCKHOLDER MATTERS --------------------------- Information with respect to the market for the Company's common equity and related stockholder matters is incorporated herein by reference from the \"Quarterly Data\" section included in Exhibit 13. The Company's securities that are listed on the New York Stock Exchange (NYSE), are indicated as such on the front cover of this report. The NYSE symbol for the Company's Common Stock is BK. The Warrants (to purchase the Company's Common Stock) are traded over the counter. All of the Company's other securities are not currently listed. The Company had 26,473 common shareholders of record at February 28, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA -------------------------------- Selected financial data are incorporated herein by reference from the \"Financial Highlights\" section included in Exhibit 13.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL ---------------------------------------------------------- CONDITION AND RESULTS OF OPERATIONS ----------------------------------- Management's discussion and analysis of financial condition and results of operations is incorporated herein by reference from the corresponding section of Exhibit 13.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ---------------------------------------------------- Consolidated financial statements and notes and the independent auditors' report are incorporated herein by reference from Exhibit 13 to this report.\nThe report of Independent Public Accountants for National Community Banks, Inc. is incorporated herein by reference from Exhibit 99 to this report.\nSupplementary financial information is incorporated herein by reference from the \"Quarterly Data\" section included in Exhibit 13.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND ------------------------------------------------------------------------ FINANCIAL DISCLOSURE -------------------- There have been no events which require disclosure under 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 directors of the registrant are identified on pages 27 and 28 of this report. Additional material responsive to this item is contained in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders, which information is incorporated herein by reference.\nEXECUTIVE OFFICERS OF THE REGISTRANT AND BUSINESS EXPERIENCE DURING THE PAST ---------------------------------------------------------------------------- FIVE YEARS ----------\nCompany Officer Name Office and Experience Age Since ---- --------------------- --- -----\nJ. Carter Bacot 1990-1995 Chairman and Chief Executive 62 1975 Officer of the Company and the Bank\nThomas A. Renyi 1994-1995 President of the Company and 49 1992 President and Chief Operating Officer of the Bank 1992-1994 President of the Company and Vice Chairman of the Bank 1990-1992 Senior Executive Vice President and Chief Credit Officer of the Bank\nAlan R. Griffith 1994-1995 Vice Chairman of the Company and 53 1990 the Bank 1990-1994 Senior Executive Vice President of the Company, and President and Chief Operating Officer of the Bank\nSamuel F. Chevalier 1990-1995 Vice Chairman of the Company and 61 1989 the Bank 1990 Chief Operating Officer and President of Irving Bank Corporation\nDeno D. Papageorge 1990-1995 Senior Executive Vice President of 56 1980 the Company, Senior Executive Vice President and Chief Financial Officer of the Bank\nRichard D. Field 1990-1995 Executive Vice President of the 54 1987 Company, Senior Executive Vice President of the Bank\nRobert E. Keilman 1990-1995 Comptroller of the Company and the 49 1984 Bank, Senior Vice President of the Bank\nPhebe C. Miller 1995 Secretary and Chief Legal Officer 45 1995 of the Company, Senior Vice President and Chief Legal Officer of the Bank 1994-1995 Senior Vice President of the Bank 1991-1994 Managing Director, General Counsel and Secretary, Discount Corporation of New York 1990-1991 Vice President and Counsel, Discount Corporation of New York\nRobert J. Goebert 1990-1995 Auditor of the Company, Senior Vice 53 1982 President of the Bank\nOfficers of BNY who perform major policy making functions: Bank Executive Officer Name Office and Experience Age Since ---- --------------------- --- ------\nGerald L. Hassell 1994-1995 Senior Executive Vice President 43 1990 and Chief Commercial Banking Officer 1992-1994 Executive Vice President - Special Industries Banking 1990-1991 Executive Vice President - Communications, Entertainment, and Publishing Division\nRobert J. Mueller 1992-1995 Senior Executive Vice President - 53 1989 Chief Credit Policy Officer 1990-1992 Executive Vice President - Mortgage & Construction Lending\nRichard A. Pace 1990-1995 Executive Vice President and Chief 49 1989 Technologist\nThere are no family relationships between the executive officers of the Company. The terms of office of the executive officers of the Company extend until the annual organizational meeting of the Board of Directors.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION --------------------------------\nThe material responsive to such item in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders is incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ------------------------------------------------------------------------\nThe material responsive to such item in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders is incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS --------------------------------------------------------\nThe material responsive to such item in the Company's definitive Proxy Statement for its 1995 Annual Meeting of Shareholders is incorporated by reference.\nPART IV -------\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K -------------------------------------------------------------------------- (a) 1 Financial Statements:\nSee Item 8.\n(a) 2 Financial Statement Schedules:\nFinancial statement schedules are omitted since the required information is either not applicable, not deemed material, or is shown in the respective financial statements or in the notes thereto.\n(a) 3 Listing of Exhibits:\nExhibit No. Per Regulation S-K Description -------------- -----------\n3 (a) The By-Laws of The Bank of New York Company, Inc. as amended through October 13, 1987. (Filed as Exhibit 3(a) to the Company's 1987 Annual Report on Form 10-K Form 10-K and incorporated herein by reference.)\n(b) Restated Certificate of Incorporation of The Bank of New York Company, Inc. dated July 20, 1994. (Filed as Exhibit 4 to Form 10-Q filed by the Company on November 10, 1994 and incorporated herein by reference.)\n4 (a) None of the outstanding instruments defining the rights of holders of long-term debt of the Company represent long-term debt in excess of 10% of the total assets of the Company. The Company hereby agrees to furnish to the Commission, upon request, a copy of any of such instruments.\n(b) Rights Agreement, including form of Preferred Stock Purchase Rights, incorporated herein by reference to the Company's Registration Statement on Form 8-A dated December 18, 1985.\n(c) First Amendment, dated as of June 13, 1989, to the Rights Agreement, including form of Preferred Stock Purchase Right, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent, incorporated by reference to the amendment on Form 8, dated June 14, 1989, to the registrant's Registration Statement on Form 8-A, dated December 18, 1985.\n(d) Second Amendment, dated as of April 30, 1993, to the Rights Agreement, including form of Preferred Stock Purchase Right, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent, incorporated by reference to the amendment on Form 8-A\/A, dated April 30, 1993, to the registrant's Registration Statement on Form 8-A dated December 18, 1985.\n(e) Third Amendment, dated as of March 8, 1994, to the Rights Agreement, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent, Incorporated by reference to Exhibit 4(a) to the Company's Current Report on Form 8-K for the Report Date March 8, 1994.\n10 (a) 1984 Stock Option Plan of The Bank of New York Company, Inc. as amended through February 23, 1988. (Filed as Exhibit 10(a) to the Company's 1988 Annual Report on Form 10-K and incorporated herein by reference.)*\n(b) Amendment dated October 11, 1994 to 1984 Stock Option Plan of The Bank of New York Company, Inc.*\n(c) The Bank of New York Company, Inc. Excess Contribution Plan as amended through July 10, 1990. (Filed as Exhibit 10(b) to the Company's 1990 Annual Report on Form 10-K and incorporated herein by reference.)*\n(d) Amendments to The Bank of New York Company, Inc. Excess Contribution Plan dated February 23, 1994 and November 9, 1993. (Filed as Exhibit 10(c) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\nExhibit No. Per Regulation S-K Description -------------- -----------\n10 (e) The Bank of New York Company, Inc. Excess Benefit Plan as amended through December 8, 1992. (Filed as Exhibit 10(d) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference.)*\n(f) Amendments to The Bank of New York Company, Inc. Excess Benefit Plan dated February 23, 1994 and November 9, 1993. (Filed as Exhibit 10(e) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(g) Amendment dated May 10, 1994 to The Bank of New York Company, Inc. Excess Benefit Plan.*\n(h) 1994 Management Incentive Compensation Plan of The Bank of New York Company, Inc. (Filed as Exhibit 10(g) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(i) 1988 Long-Term Incentive Plan as amended through December 8, 1992. (Filed as Exhibit 10(f) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference.)*\n(j) Amendment dated October 11, 1994 to the 1988 Long-Term Incentive Plan of The Bank of New York Company, Inc.*\n(k) The Bank of New York Company, Inc. 1993 Long-Term Incentive Plan. (Filed as Exhibit 10(m) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference.)*\n(l) Amendment dated October 11, 1994 to the 1993 Long-Term Incentive Plan of The Bank of New York Company, Inc.*\n(m) The Bank of New York Company, Inc. Supplemental Executive Retirement Plan. (Filed as Exhibit 10(n) to the Company's 1992 Annual Report on Form 10-K and incorporated herein by reference.)*\n(n) Amendment to The Bank of New York Company, Inc. Supplemental Executive Retirement Plan dated March 9, 1993. (Filed as Exhibit 10(k) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(o) Amendment dated October 11, 1994 to The Bank of New York Company, Inc. Supplemental Executive Retirement Plan.*\n(p) Trust Agreement dated April 19, 1988 related to certain executive compensation plans and agreements. (Filed as Exhibit 10(h) to the Company's 1988 Annual Report on Form 10-K and incorporated herein by reference.)*\n(q) Trust Agreement dated November 16, 1993 related to certain executive compensation plans and agreements. (Filed as Exhibit 10(m) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(r) Amendment dated October 11, 1994 to Trust Agreement dated November 16, 1993, related to certain executive compensation plans and agreements.*\nExhibit No. Per Regulation S-K Description -------------- -----------\n10 (s) Trust Agreement dated December 15, 1994 related to certain executive compensation plans and agreements.*\n(t) Form of Remuneration Agreement between the Company and two of the five most highly compensated executive officers of the Company. (Filed as Exhibit 10 to the Company's 1982 Annual Report on Form 10-K and incorporated herein by reference.)*\n(u) Form of Tax Reimbursement Agreement dated as of July 13, 1994 between the Company and two of the five most highly compensated executive officers of the Company.*\n(v) Form of Remuneration Agreement dated October 11, 1994 between the Company and three of the five most highly compensated officers of the Company.*\n(w) The Bank of New York Company, Inc. Retirement Plan for Non- Employee Directors. (Filed as Exhibit 10(r) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(x) Amendment dated November 8, 1994 to The Bank of New York Company, Inc. Retirement Plan for Non-Employee Directors.*\n(y) Deferred Compensation Plan for Non-Employee Directors of The Bank of New York Company, Inc. (Filed as Exhibit 10(s) to the Company's 1993 Annual Report on Form 10-K and incorporated herein by reference.)*\n(z) Amendment dated November 8, 1994 to the Deferred Compensation Plan for Non-Employee Directors of The Bank of New York Company, Inc.*\n11 Statement - Re: Computation of Per Common Share Earnings\n12 Statement - Re: Computation of Earnings to Fixed Charges Ratios\n13 Portions of the 1994 Annual Report to Shareholders\n21 Subsidiaries of the Registrant\n23.1 Consent of Deloitte & Touche LLP\n23.2 Consent of Arthur Andersen LLP\n27 Financial Data Schedule\n99 Report of Independent Public Accountants for National Community Banks, Inc. -------------------- * Indicates a management contract or compensatory plan or arrangement.\n(b) Reports on Form 8-K:\nOctober 13, 1994: Unaudited interim financial information and accompanying discussion for the third quarter of 1994.\nDecember 6, 1994: An Underwriting Agreement dated December 6, 1994, a Form of Note, an Officers' Certificate, an Opinion of Counsel, and a Consent of Counsel in connection with a Registration Statement on Form S-3 (File Nos. 33-51984 and 33-50333) covering the Company's 8.50% Subordinated Notes Due 2004 issuable under an Indenture dated October 1, 1993.\nJanuary 17, 1995: Unaudited interim financial information and accompanying discussion for the fourth quarter of 1994.\n(c) Exhibits:\nSubmitted as a separate section of this report.\n(d) Financial Statements Schedules:\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 New York, New York, on the 27th day of March, 1995.\nTHE BANK OF NEW YORK COMPANY, INC.\nBy: \\s\\ Deno D. Papageorge ------------------------------------- (Deno D. Papageorge Senior Executive Vice President)\nPursuant to the requirements of the Securities Exchange Act of 1934, this report has been duly signed below by the following persons on behalf of the registrant and in the capacities indicated on the 27th day of March, 1995.\nSignature Title --------- -----\n\\s\\J. Carter Bacot Chairman and ----------------------------------- Chief Executive Officer (J. Carter Bacot) (principal executive officer)\n\\s\\ Deno D. Papageorge Senior Executive Vice President ----------------------------------- (principal financial officer) (Deno D. Papageorge)\n\\s\\ Robert E. Keilman Comptroller ------------------------------------ (principal accounting officer) (Robert E. Keilman)\nDirector ------------------------------------ (Richard Barth)\n\\s\\ William R. Chaney Director ------------------------------------ (William R. Chaney)\n\\s\\ Samuel F. Chevalier Vice Chairman and Director ------------------------------------ (Samuel F. Chevalier)\nDirector ------------------------------------ (Anthony P. Gammie)\n\\s\\ Ralph E. Gomory Director ------------------------------------ (Ralph E. Gomory)\n\\s\\ Alan R. Griffith Vice Chairman ------------------------------------ and Director (Alan R. Griffith)\n\\s\\ Edward L. Hennessy, Jr. Director\n------------------------------------ (Edward L. Hennessy, Jr.)\n\\s\\ John C. Malone Director ------------------------------------ (John C. Malone)\n\\s\\ Donald L. Miller Director ------------------------------------ (Donald L. Miller)\n\\s\\ H. Barclay Morley Director ------------------------------------ (H. Barclay Morley)\n\\s\\ Martha T. Muse Director ------------------------------------ (Martha T. Muse)\n\\s\\ Catherine A. Rein Director ------------------------------------ (Catherine A. Rein)\n\\s\\ Thomas A. Renyi President and ------------------------------------ Director (Thomas A. Renyi)\n\\s\\ Harold E. Sells Director ------------------------------------ (Harold E. Sells)\n\\s\\ Delbert C. Staley Director ------------------------------------ (Delbert C. Staley)\n\\s\\ W. S. White, Jr. Director ------------------------------------ (W. S. White, Jr.)\n\\s\\ Samuel H. Woolley Director ------------------------------------ (Samuel H. Woolley)\nINDEX TO EXHIBITS Exhibit No. ------------ 3 (a) The By-Laws of The Bank of New York Company, Inc. as amended through October 13, 1987.*\n(b) Restated Certificate of Incorporation of The Bank of New York Company, Inc. dated July 20, 1994.*\n4 (a) None of the outstanding instruments defining the rights of holders of long-term debt of the Company represent long-term debt in excess of 10% of the total assets of the Company. The Company hereby agrees to furnish to the Commission, upon request, a copy of any of such instruments.\n(b) Rights Agreement, including form of Preferred Stock Purchase Rights.*\n(c) First Amendment, dated as of June 13, 1989, to the Rights Agreement, including form of Preferred Stock Purchase Right, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent.*\n(d) Second Amendment, dated as of April 30, 1993, to the Rights Agreement, including form of Preferred Stock Purchase Right, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent.*\n(e) Third Amendment, dated as of March 8, 1994, to the Rights Agreement, dated as of December 10, 1985, between The Bank of New York Company, Inc. and The Bank of New York, as Rights Agent.*\n10 (a) 1984 Stock Option Plan of The Bank of New York Company, Inc. as amended through February 23, 1988.*\n(b) Amendment dated October 11, 1994 to 1984 Stock Option Plan of The Bank of New York Company, Inc.\n(c) The Bank of New York Company, Inc. Excess Contribution Plan as amended through July 10, 1990.*\n(d) Amendments to The Bank of New York Company, Inc. Excess Contribution Plan dated February 23, 1994 and November 9, 1993.*\n(e) The Bank of New York Company, Inc. Excess Benefit Plan as amended through December 8, 1992.*\n(f) Amendments to The Bank of New York Company, Inc. Excess Benefit Plan dated February 23, 1994 and November 9, 1993.*\n(g) Amendment dated May 10, 1994 to The Bank of New York Co., Inc. Excess Benefit Plan.\n(h) 1994 Management Incentive Compensation Plan of The Bank of New York Company, Inc.*\n(i) 1988 Long-Term Incentive Plan as amended through December 8, 1992.*\n(j) Amendment dated October 11, 1994 to the 1988 Long-Term Incentive Plan of The Bank of New York Company, Inc.\n(k) The Bank of New York Company, Inc. 1993 Long-Term Incentive Plan.*\n(l) Amendment dated October 11, 1994 to the 1993 Long-Term Incentive Plan of The Bank of New York Company, Inc.\n(m) The Bank of New York Company, Inc. Supplemental Executive Retirement Plan.*\nINDEX TO EXHIBITS Exhibit No. ------------ 10 (n) Amendment to The Bank of New York Company, Inc. Supplemental Executive Retirement Plan dated March 9, 1993.*\n(o) Amendment dated October 11, 1994 to The Bank of New York Company, Inc. Supplemental Executive Retirement Plan.\n(p) Trust Agreement dated April 19, 1988 related to deferred compensation plans.*\n(q) Trust Agreement dated November 16, 1993 related to deferred compensation plans.*\n(r) Amendment dated October 11, 1994 to Trust Agreement dated Novemeber 16, 1993, related to deferred compensation plans.\n(s) Trust Agreement dated December 15, 1994 related to certain executive compensation plans and agreements.\n(t) Form of Remuneration Agreement between the Company and two of the five most highly compensated executive officers of the Company.*\n(u) Form of Tax Reimbursement Agreement dated as of July 13, 1994 between the Company and two of the five most highly compensated executive officers of the Company.\n(v) Form of Remuneration Agreement dated October 11, 1994 between the Company and three of the five most highly compensated officers of the Company.\n(w) The Bank of New York Company, Inc. Retirement Plan for Non- Employee Directors.*\n(x) Amendment dated November 8, 1994 to The Bank of New York Company, Inc. Retirement Plan for Non-Employee Directors.\n(y) Deferred Compensation Plan for Non-Employee Directors of The Bank of New York Company, Inc.*\n(z) Amendment dated November 8, 1994 to the Deferred Compensation Plan for Non-Employee Directors of The Bank of New York Company, Inc.\n11 Statement - Re: Computation of Per Common Share Earnings\n12 Statement - Re: Computation of Earnings to Fixed Charges Ratios\n13 Portions of the 1994 Annual Report to Shareholders\n21 Subsidiaries of the Registrant\n23.1 Consent of Deloitte & Touche LLP\n23.2 Consent of Arthur Andersen LLP\n27 Financial Data Schedule\n99 Report of Independent Public Accountants for National Community Banks, Inc. ------------------- * Incorporated by reference","section_15":""}
{"filename":"762129_1994.txt","cik":"762129","year":"1994","section_1":"Item 1. Business \t \t \t THE COMPANY AND ITS SUBSIDIARIES\nCILCORP Inc. (CILCORP or the Company) was incorporated as a holding company in the state of Illinois in 1985. The financial condition and operating results of CILCORP primarily reflect the operations of Central Illinois Light Company (CILCO), the Company's principal business subsidiary. The Company's other core business subsidiary is Environmental Science & Engineering, Inc. (ESE). The Company also has two other first-tier subsidiaries, CILCORP Investment Management Inc. (CIM) and CILCORP Ventures Inc. (CVI), whose operations, combined with those of the holding company itself, are collectively referred to herein as Other Businesses.\nThe Company owns 100% of the common stock of CILCO. CILCO is engaged in the generation, transmission, distribution and sale of electric energy in an area of approximately 3,700 square miles in central and east- central Illinois, and the purchase, distribution, transportation and sale of natural gas in an area of approximately 4,500 square miles in central and east-central Illinois.\nESE, a wholly-owned subsidiary, was formed in February 1990 to conduct the environmental consulting and analytical services businesses acquired from Hunter Environmental Services, Inc. (Hunter) during that year. ESE provides engineering and environmental consulting, analysis and laboratory services to a variety of governmental and private customers. ESE has nine wholly-owned subsidiaries: Keck Instruments, Inc., which manufactures geophysical instruments used in environmental applications; Chemrox, Inc., which has reduced its presence in the ethylene oxide and chlorofluorocarbon control-equipment market by maintaining only a minimal staff, primarily to concentrate on warranty work; Keck Consulting Services, Inc., which is inactive; ESE Biosciences, Inc., whose on-site biological treatment of contaminated soil and groundwater is now performed by ESE; ESE Architectural Services, Inc., which provides architecture and design services; National Professional Casualty Co., which provides professional liability insurance to ESE; ESE International Ltd., which provides engineering and consulting services in foreign countries; ESE Michigan, Inc. which formerly conducted business as ESE Environmental Science and Engineering, Inc., provides the same services as its parent, ESE; and, Savannah Resources Inc., which acquired land that will be remediated and sold.\nCIM, a wholly-owned subsidiary, manages the Company's investment portfolio. CIM manages seven leveraged lease investments through three wholly-owned subsidiaries: CILCORP Lease Management Inc. which was formed in 1985, and CIM Leasing Inc. and CIM Air Leasing Inc., which were both formed in 1993. CIM's other wholly-owned subsidiary is CIM Energy Investments Inc., which was formed in 1989 to invest in non- regulated, independent power production facilities (see Other Businesses).\nCVI, a wholly-owned subsidiary, is a venture capital company which pursues investment opportunities in new ventures and the expansion of existing ventures in environmental services, biotechnology and health care. CVI has an 80% interest in Agricultural Research and Development Corporation and one wholly-owned subsidiary, CILCORP Energy Services, Inc. (CESI). CESI's primary business is the sale of carbon monoxide detectors to utilities for resale to their customers.\nCILCORP Development Services Inc. (CDS) was organized to construct a steam production plant in Pekin, Illinois, which, following necessary regulatory approvals, was to be owned and operated by CILCO. CILCO now owns and operates this facility. CDS was dissolved voluntarily on December 28, 1994.\nThe following table summarizes the relative contribution of each business group to consolidated assets, revenue and net income for the year ended December 31, 1994.\nCILCORP is an intrastate exempt holding company under the Public Utility Holding Company Act of 1935 (PUHCA). In 1989, the Securities and Exchange Commission (SEC) issued proposed rules, which, if adopted, would require CILCORP to apply for a formal exemptive order from the SEC or come within one of the proposed safe harbors by either seeking passage of Illinois legislation permitting diversification or reducing its interest in non-utility businesses to less than 10% of consolidated assets. The SEC has not taken any public action towards adopting final diversification rules since the proposed rules were issued. On November 3, 1994, the SEC issued a concept release soliciting comments on modernization of utility regulation under the PUHCA. This is part of a continuing effort by the SEC to evaluate the regulatory structure of the utility industry. Both regulatory and legislative changes are possible but cannot be predicted at this time. On February 6, 1995, the Company joined with several other companies in commenting on the concept release.\n\t\tBUSINESS OF CILCO\nCILCO was incorporated under the laws of Illinois in 1913. CILCO's principal business is the generation, transmission, distribution and sale of electric energy in an area of approximately 3,700 square miles in central and east-central Illinois, and the purchase, distribution, transportation and sale of natural gas in an area of approximately 4,500 square miles in central and east-central Illinois.\nIn addition to its principal business, CILCO has two wholly-owned subsidiaries, CILCO Exploration and Development Company (CEDCO) and CILCO Energy Corporation (CECO). CEDCO was formed to engage in the exploration and development of gas, oil, coal and other mineral resources. CECO was formed to research and develop new sources of energy, including the conversion of coal and other minerals into gas. The operations of these subsidiaries are not currently significant.\nCILCO is continuing to experience, in varying degrees, the impact of developments common to the electric and gas utility industries. These include uncertainties as to the future demand for electricity and natural gas, structural and competitive changes in the markets for these commodities, the high cost of compliance with environmental and safety laws and regulations and uncertainties in regulatory and political processes. At the same time, CILCO has sought to provide reliable service at reasonable rates for its customers and a fair return for its investors.\nELECTRIC SERVICE\nCILCO furnishes electric service to retail customers in 138 Illinois communities (including Peoria, East Peoria, Pekin, Lincoln and Morton). At December 31, 1994, CILCO had approximately 192,000 retail electric customers.\nIn 1994, 68% of CILCO's total operating revenue was derived from the sale of electricity. Approximately 38% of electric revenue resulted from residential sales, 30% from commercial sales, 28% from industrial sales, 3% from sales for resale and 1% from other sales. Electric sales, particularly residential and commercial sales during the summer months, fluctuate based on weather conditions.\nThe electric operating revenues of CILCO were derived from the following sources:\nCILCO owns and operates two coal-fired base load generating plants and two natural gas combustion turbine-generators which are used for peaking service. A 21 megawatt (MW) cogeneration plant at Midwest Grain Products, Inc. (MWG) is scheduled to begin generating electricity in June 1995 (see Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties \t\t\t CILCO\nCILCO owns and operates two steam-electric generating plants and two combustion turbine-generators. These facilities had an available summer capability of 1,136 MW in 1994. In December 1993, CILCORP announced an agreement with MWG to develop a gas-fired cogeneration plant. The cogeneration plant at MWG began producing steam heat at that facility in December 1994. Installation of the 21 MW turbine-generator will be completed by mid-1995. The turbine generator will have an expected available summer capability of 16 MW. (See Electric Service under Item 1. Business.)\nThe major generating facilities of CILCO (representing 96.0% of CILCO's available summer generating capability projected for 1995), all of which are fueled with coal, are as follows:\nCILCO's transmission system includes approximately 285 circuit miles operating at 138,000 volts, 48 circuit miles operating at 345,000 volts and 14 principal substations with an installed capacity of 3,364,200 kilovolt-amperes.\nThe electric distribution system includes approximately 6,212 miles of overhead pole and tower lines and 1,941 miles of underground distribution cables. The distribution system also includes 105 substations with an installed capacity of 2,003,485 kilovolt-amperes.\nThe gas system includes approximately 3,425 miles of transmission and distribution mains.\nCILCO has an underground gas storage facility located about ten miles southwest of Peoria near Glasford, Illinois. The facility has a present recoverable capacity of approximately 4.5 billion cubic feet (BCF). An additional storage facility near Lincoln, Illinois, has a present recoverable capacity of approximately 5.2 BCF.\n\t\t\t ESE\nESE owns approximately 55 acres of land in Gainesville, Florida, containing 110,000 square feet of offices, laboratory and other space. In Peoria, Illinois, ESE owns approximately 27,000 square feet of offices, laboratory and other space and leases approximately 21,000 square feet of additional space for offices. ESE and its subsidiaries lease additional facilities for offices, laboratories and warehouse space in 29 cities throughout the United States. ESE believes its facilities are suitable and adequate for its current businesses and does not expect to make any material acquisitions of real property in the near future. However, in 1995 ESE plans to spend $1.9 million to expand its Gainesville, Florida, laboratory by approximately 8,000 square feet.\nItem 3.","section_3":"Item 3. Legal Proceedings\nReference is made to the captions \"Environmental Matters\" and \"Gas Pipeline Supplier Transition Costs\" of Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations of CILCORP's 1994 Annual Report to Shareholders incorporated herein by reference, for certain pending legal proceedings and\/or proceedings known to be contemplated by governmental authorities. Reference is also made to Note 9 - Rate Matters, included herein. Pursuant to CILCO's By- Laws, CILCO has advanced legal and other expenses actually and reasonably incurred by employees, and former employees, in connection with the investigation of CILCO's Springfield gas operations described in Note 9 - Rate Matters.\n\t\t\t CILCO\nOn July 6, 1994, a lawsuit was filed against CILCO in a United States District Court by the current property owner, Vector-Springfield Properties, Ltd., seeking damages related to alleged coal tar contamination from a gas manufacturing plant formerly located at the site which was owned but never operated by CILCO. The lawsuit seeks cost recovery of more than $3 million related to coal tar investigation expenses, operating losses and diminution of market value. CILCO intends to vigorously defend these claims. For a further discussion of gas manufacturing plant sites refer to the caption \"Environmental Matters\" of Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations on page 20 of CILCORP's 1994 Annual Report to Shareholders which is incorporated herein by reference. Management cannot currently determine the outcome of this litigation, but does not believe it will have a material adverse impact on CILCO's financial position or results of operations.\n\t\t\t ESE\nIn June 1994, CILCORP, ESE and the lessor of a building in Shelton, Connecticut, concluded settlement negotiations which released ESE from future lease obligations and litigation related to that lease.\nAt the request of the South Carolina Department of Health and Environmental Control, the U.S. Department of Justice (DOJ) initiated an investigation into an alleged record-keeping violation at an office operated by ESE in Greenville, South Carolina. The office was closed in May 1993. Following its investigation, the DOJ referred this matter to the Attorney General of South Carolina for disposition as a civil matter. Management does not believe that this matter will have a material adverse impact on the Company's financial position or results of operations.\nThe Company and its subsidiaries are subject to certain claims and lawsuits in connection with work performed in the ordinary course of their businesses. Except as otherwise disclosed or referred to in this section, in the opinion of management, all such claims currently pending either will not result in a material adverse effect on the financial position and results of operations of the Company or are adequately covered by: (i) insurance; (ii) contractual or statutory indemnification, or (iii) reserves for potential losses.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\n\t\t\t CILCORP\nThere were no matters submitted to a vote of security holders during the fourth quarter of 1994.\n\t\t CILCO\nThere were no matters submitted to a vote of security holders during the fourth quarter of 1994.\n\t\t Executive Officers of CILCORP\n\t\t Age at Positions Held During Initial Name 3\/31\/95 Past Five Years Effective Date(2) \t\t\t R. O. Viets 51 President and Chief \t\t Executive Officer February 1, 1988 \t\t\t J. G. Sahn(1) 48 Vice President, General March 1, 1994 \t\t\t Counsel and Secretary \t\t\t Vice President \t\t\t and General Counsel February 1, 1989\nR. J. Sprowls 37 Treasurer and \t\t\t Assistant Secretary October 1, 1990 \t\t\t Treasurer - CILCO February 1, 1988 \t\t\t T. D. Hutchinson 40 Controller February 1, 1988 \t\t\t Notes:\n(1) M. J. Murray served as Secretary and Assistant Treasurer from \tJanuary 22, 1985, until February 28, 1994, when he retired and \twas replaced as Secretary by J. G. Sahn.\n(2) The term of each executive officer extends to the organization \tmeeting of CILCORP's Board of Directors following the next annual \telection of Directors.\n\t\t Executive Officers of CILCO\n\t\t Age as of Positions Held During Initial Name 3\/31\/95 Past Five Years(1) Effective Date(2)\nR. W. Slone 59 Chairman of the Board, \t\t\t President and Chief \t\t\t Executive Officer April 23, 1991 \t\t\t President and Chief \t\t\t Executive Officer February 1, 1988(3)\nT. S. Kurtz 47 Vice President November 1, 1988(4)\nT. S. Romanowski 45 Vice President October 1, 1986(4)\nW. M. Shay 42 Vice President January 1, 1993(4)(5)\nJ. F. Vergon 47 Vice President October 1, 1986(4)(5)\nW. R. Dodds 40 Treasurer and Manager \t\t\t of Treasury Department October 1, 1990 \t\t\t Controller and Manager \t\t\t of Accounting February 1, 1988 \t\t\t\t R. L. Beetschen 49 Controller and Manager \t\t\t of Accounting October 1, 1990 \t\t\t Supervisor - General \t\t\t Accounting May 1, 1988\nJ. G. Sahn 48 Secretary March 1, 1993\nNotes:\n(1) The officers listed have been employed by CILCO in executive or \tmanagement positions for more than five years except Mr. Shay and \tMr. Sahn. Mr. Shay was Vice President and Chief Financial Officer \tof CILCO's parent, CILCORP Inc., from August 15, 1988, through \tDecember 31, 1992. Mr. Sahn also serves as Vice President and \tGeneral Counsel of CILCORP Inc., a position he has held since \tFebruary 1, 1989. He was elected Secretary and Assistant \tTreasurer of CILCORP effective March 1, 1994.\n(2) The term of each executive officer extends to the organization \tmeeting of CILCO's Board of Directors following the next annual \telection of Directors.\n(3) R. W. Slone will retire from CILCO effective April 1, 1995. He will be replaced by R. O. Viets as Chairman and Chief Executive \tOfficer. Mr. Viets was previously Chairman of the Board of CILCO \tand also serves as President and Chief Executive Officer of \tCILCORP Inc.\n(4) T. S. Kurtz, T. S. Romanowski, W. M. Shay and J. F. Vergon head the \tElectric Production Group, the Finance and Administrative Services \tGroup, the Electric Operations Group and the Gas Operations Group, respectively. T. S. Romanowski also serves as CILCO's Principal \tFinancial Officer. J. F. Vergon also serves as Chairman of the \tBoard, President and Chief Executive Officer of CILCORP Investment \tManagement Inc.\n(5) Effective April 1, 1995, Mr. Shay and Mr. Vergon will become Group \tPresidents of Electric Operations and Gas Operations, respectively.\n\t\t\t PART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related \tStockholder Matters\n\t\t\t CILCORP\nThe Company's common stock is listed on the New York and Chicago Stock Exchanges (ticker symbol CER). At December 31, 1994, there were 15,095 holders of record of the Company's common stock. The following table sets forth, for the periods indicated, the dividends per share of common stock and the high and low prices of the common stock as reported in New York Stock Exchange Composite Transactions.\nThe number of common shareholders of record as of March 10, 1995, was 14,954.\n\t\t\t CILCO\nCILCO's common stock is not traded on any market. As of March 10, 1995, 13,563,871 shares of CILCO's Common Stock, no par value, were issued, and outstanding and privately held, beneficially and of record, by CILCORP Inc.\nCILCO's requirement for retained earnings before common stock dividends may be paid as described in Note 5 of CILCO's Notes to Financial Statements contained in Item 8. Financial Statements and Supplementary Data.\nItem 6.","section_6":"Item 6. Selected Financial Data\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and \tResults of Operations\nThe information under the heading Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 18 through 27 of CILCORP's 1994 Annual Report to Shareholders is incorporated herein by reference.\nItem 8.","section_7A":"","section_8":"Item 8.: Financial Statements and Supplementary Data\nThe financial statements on pages 29 through 44 and Management's Report to the Stockholders of CILCORP Inc. on page 28 of CILCORP's 1994 Annual Report to Shareholders are incorporated herein by reference.\nIndex to Financial Statements: \t\t\t CILCORP\t\t\t\t\t\t\t Page\nReport of Independent Public Accountants on Schedules 30\n\t\t\t\t CILCO Management's Report 31 Report of Independent Public Accountants 32 Consolidated Statements of Income 33 Consolidated Balance Sheets 34-35 Consolidated Statements of Cash Flows 36-37 Consolidated Statements of Retained Earnings 38 Statements of Segments of Business 39-40 Notes to Consolidated Financial Statements 41-52\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS ON SCHEDULES\nTo CILCORP Inc.:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements included in CILCORP Inc.'s Annual Report to Shareholders incorporated by reference in this Form 10-K, and have issued our report thereon dated February 3, 1995. Our audits were made for the purpose of forming an opinion on those 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 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.\nOur report on the financial statements includes an explanatory paragraph with respect to the change in the method of accounting for income taxes, effective January 1, 1993, as discussed in Note 2 to the financial statements.\n\t\t\t\t\t ARTHUR ANDERSEN LLP\nChicago, Illinois February 3, 1995\nMANAGEMENT'S REPORT\nThe accompanying financial statements and notes for CILCO and its consolidated subsidiaries have been prepared by management in accordance with generally accepted accounting principles. Estimates and judgments used in developing these statements are the responsibility of management. Financial data presented throughout this report is consistent with these statements.\nCILCO maintains a system of internal accounting controls which management believes is adequate to provide reasonable assurance as to the integrity of accounting records and the protection of assets. Such controls include established policies and procedures, a program of internal audit and the careful selection and training of qualified personnel.\nThe financial statements have been audited by CILCO's independent public accountants, Arthur Andersen LLP. Their audit was conducted in accordance with generally accepted auditing standards and included an assessment of selected internal accounting controls only to determine the scope of their audit procedures. The report of the independent public accountants is contained in this Form 10-K annual report.\nThe Audit Committee of the CILCORP Inc. Board of Directors, consisting solely of outside directors, meets periodically with the independent public accountants, internal auditors and management to review accounting, auditing, internal accounting control and financial reporting matters. The independent public accountants have direct access to the Audit Committee. The Audit Committee meets separately with the independent public accountants.\n\t\t \t\t\t\t R. W. Slone \t\t R. W. Slone \t\t\t\t Chairman of the Board, \t\t\t\t President and Chief \t\t\t\t\t Executive Officer\n\t\t\t\t T. S. Romanowski \t\t\t\t T. S. Romanowski \t\t\t\t Vice President and Chief \t\t\t\t\t Financial Officer\n\t\t\t\t R. L. Beetschen \t\t\t\t R. L. Beetschen \t\t\t\t Controller and Manager of \t\t\t\t\t Accounting\n\t\t REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo Central Illinois Light Company:\nWe have audited the accompanying consolidated balance sheets of Central Illinois Light Company (an Illinois corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, cash flows, segments of business, and retained earnings for each of the three years in the period ended December 31, 1994. 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 Central Illinois Light Company and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nOur audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The financial statement schedules listed in Item 14(a)2 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 financial statement schedules have been subjected to the auditing procedures applied in our 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.\nAs explained in Note 2 to the Financial Statements, effective January 1, 1993, the Company changed its method of accounting for income taxes.\n\t\t\t\t\t ARTHUR ANDERSEN LLP Chicago, Illinois February 3, 1995\nCentral Illinois Light Company Consolidated Statements of Income\n\tCENTRAL ILLINOIS LIGHT COMPANY \tNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS\nNOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION\nThe consolidated financial statements of CILCO include the accounts of CILCO and its subsidiaries, CILCO Exploration and Development Company and CILCO Energy Corporation. CILCO is a subsidiary of CILCORP Inc. Prior year amounts have been reclassified on a basis consistent with the 1994 presentation.\nREGULATION\nCILCO is a public utility subject to regulation by the Illinois Commerce Commission and the Federal Energy Regulatory Commission with respect to accounting matters, and maintains its accounts in accordance with the Uniform System of Accounts prescribed by these agencies.\nAs a regulated public utility, CILCO is subject to the provisions of Statement of Financial Accounting Standards No. 71, \"Accounting for the Effects of Certain Types of Regulation.\" Regulatory assets represent the probable future revenues to CILCO resulting from the ratemaking action of regulatory agencies. Net regulatory liabilities are approximately $60 million (see Note 2). At December 31, 1994, and 1993, the regulatory assets included on the Consolidated Balance Sheets were as follows:\nOPERATING REVENUES, FUEL COSTS AND COST OF GAS\nElectric and gas revenues include service provided but unbilled at year end. Substantially all electric rates and gas system sales rates of CILCO include a fuel adjustment clause and a purchased gas adjustment clause, respectively. These clauses provide for the recovery of changes in electric fuel costs, excluding coal transportation, and changes in the cost of gas on a current basis in billings to customers. CILCO adjusts the cost of fuel and cost of gas to recognize over or under recoveries of allowable costs. The cumulative effects are deferred on the Balance Sheets as a current asset or current liability (see Regulation, above) and adjusted by refunds or collections through future billings to customers.\nCONCENTRATION OF CREDIT RISK\nCILCO, as a public utility, must provide service to customers within its defined service territory and may not discontinue service to residential customers when certain weather conditions exist. CILCO continually reviews customers' credit worthiness and requests deposits or refunds deposits based on that review. At December 31, 1994, CILCO had net receivables of $30.5 million, of which approximately $5.1 million was due from its major industrial customers.\nTRANSACTIONS WITH AFFILIATES\nCILCO, which is a subsidiary of CILCORP, incurs certain corporate expenses such as legal, shareholder and accounting fees on behalf of CILCORP and its other subsidiaries. These expenses are billed monthly to CILCORP and its other subsidiaries based on specific identification of costs except for shareholder-related costs which are based on the relative equity percentages of CILCORP and its subsidiary corporations. A return on CILCO assets used by CILCORP and its other subsidiaries is also calculated and billed monthly. Total billings to CILCORP and its other subsidiaries amounted to $2.4 million, $2.3 million and $3.3 million in 1994, 1993 and 1992, respectively.\nALLOWANCE FOR FUNDS USED DURING CONSTRUCTION (AFUDC)\nThe allowance, representing the cost of equity and borrowed funds used to finance construction, is capitalized as a component of the cost of utility plant. The amount of the allowance varies depending on the rate used and the size and length of the construction program. The Uniform System of Accounts defines AFUDC, a non-cash item, as the net cost for the period of construction of borrowed funds used for construction purposes and a reasonable rate upon other funds when so used. On the income statement, the cost of borrowed funds capitalized is reported as a reduction of total interest expense and the cost of equity funds capitalized is reported as other income. In accordance with the FERC formula, the composite AFUDC rates used in 1994, 1993 and 1992 were 8.0%, 3.5% and 5.7%, respectively.\nDEPRECIATION AND MAINTENANCE\nProvisions for depreciation of utility property for financial reporting purposes are based on straight-line composite rates. The annual provisions for utility plant depreciation, expressed as a percentage of average depreciable utility property, were as follows:\nUtility maintenance and repair costs are charged directly to expense. Renewals of units of property are charged to the utility plant account, and the original cost of depreciable property replaced or retired, together with the removal cost less salvage, is charged to the accumulated provision for depreciation.\nINCOME TAXES\nCILCO follows a policy of comprehensive interperiod income tax allocation. Investment tax credits related to utility property have been deferred and are being amortized over the estimated useful lives of the related property. CILCORP and its subsidiaries file a consolidated federal income tax return. Income taxes are allocated to the individual companies based on their respective taxable income or loss.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nCILCO considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents for purposes of the Consolidated Statements of Cash Flows.\nCILCO-OWNED LIFE INSURANCE POLICIES\nThe following amounts related to CILCO-owned life insurance contracts, issued by one major insurance company, are recorded on the Consolidated Balance Sheets:\nInterest expense related to borrowings against CILCO-owned life insurance, included in CILCO-owned Life Insurance, Net on the Consolidated Statements of Income, was $2 million, $1.4 million and $.9 million for 1994, 1993 and 1992, respectively.\nNOTE 2 - INCOME TAXES\nCILCO adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (SFAS 109), on January 1, 1993. SFAS 109 requires the use of the liability method to account for income taxes. Under the liability method, deferred income taxes are recognized at currently enacted income tax rates to reflect the tax effect of temporary differences between the financial reporting basis and the tax basis of assets and liabilities. Temporary differences occur because the income tax law either requires or permits certain items to be reported on CILCO's income tax return in a different year than they are reported in the financial statements. Adoption of SFAS 109 did not have a material impact on CILCO's financial position, results of operations or cash flows; however, the adoption of SFAS 109 required reclassification of accumulated deferred income taxes on CILCO's Balance Sheet. CILCO established a regulatory liability to account for the net effect of expected future regulatory actions related to unamortized investment tax credits, income tax liabilities initially recorded at tax rates in excess of current rates, the equity component of Allowance for Funds Used During Construction and other items for which deferred taxes had not previously been provided. The temporary differences related to the consolidated net deferred income tax liability at December 31, 1994, December 31, 1993 and January 1, 1993, were as follows:\nOf the $6,888,000 increase in the net deferred income tax liability at December 31, 1994, from December 31, 1993, $2,592,000 is due to current year deferred federal and state income tax expense. The remainder is attributable to the decrease in the net regulatory deferred tax liability which is principally due to changes in temporary differences for which deferred taxes were not previously provided.\nNOTE 3 - POSTEMPLOYMENT BENEFITS\nPOSTEMPLOYMENT BENEFITS OTHER THAN PENSIONS AND HEALTH CARE\nOn January 1, 1994, CILCO adopted Statement of Financial Accounting Standards No. 112, \"Employer's Accounting for Postemployment Benefits\" (SFAS 112). This standard requires accrual of benefits other than pensions or health care provided to former or inactive employees. CILCO recorded a liability of approximately $1.5 million of which $1 million represents the cumulative effect of applying SFAS 112. Of the $1.5 million, $.4 million has been capitalized.\nPENSION BENEFITS\nSubstantially all of CILCO's full-time employees, including those assigned to the Holding Company, are covered by trusteed, non-contributory defined benefit pension plans. Benefits under these qualified plans reflect the employee's years of service, age at retirement and maximum total compensation for any consecutive sixty-month period prior to retirement. CILCO also has an unfunded nonqualified plan for certain employees.\nProvisions for pension expense are determined under the rules prescribed by Statement of Financial Accounting Standards No. 87, \"Employers' Accounting for Pensions\" (SFAS 87), including the use of the projected unit credit actuarial cost method. SFAS 87 requires employers to recognize an additional minimum liability on the Balance Sheets for plans in which the accumulated benefit obligation exceeds the fair value of plan assets.\nPOSTEMPLOYMENT HEALTH CARE BENEFITS\nProvisions for postemployment benefits expenses are determined under the rules of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" (SFAS 106).\nSubstantially all of CILCO's full-time employees, including those assigned to the Holding Company, are currently covered by a trusteed, non-contributory defined benefit postemployment health care plan. The plan pays stated percentages of most necessary medical expenses incurred by retirees, after subtracting payments by Medicare or other providers and after a stated deductible has been met. Participants become eligible for the benefits if they retire from CILCO after reaching age 55 with 10 or more years of service.\nFor measurement purposes, a health care cost trend rate of 9% annually was assumed for 1994; the rate was assumed to decrease to 8% for 1995, then decrease gradually to 6% by 2020 and remain at that level thereafter.\nIncreasing the assumed health care cost trend rate by 1% in each year would increase the accumulated postemployment benefit obligation at December 31, 1994, by $2.9 million and the aggregate of the service and interest cost components of net postemployment health care cost for 1994 by $265,000. The discount rate used in determining the accumulated postemployment benefit obligation at December 31, 1994, was 8% and at December 31, 1993, was 7%. The weighted average expected return on assets net of taxes was 8.1%, where taxes are assumed to decrease return by 0.4%.\nNOTE 4 - SHORT-TERM DEBT\nCILCO had arrangements for bank lines of credit totaling $30.4 million at December 31, 1994, all of which were unused. These lines of credit consisted of $7 million maintained by compensating balances and $23.4 million maintained by commitment fees ranging from 1\/16 to 2\/16 of 1% per annum in lieu of balances. The compensating bank balance arrangements provide that CILCO maintain bank deposits to average annually 3% to 5% of the line, such balances being available to CILCO for operating purposes and as compensation to the bank for other bank services. These bank lines of credit also support CILCO's issuance of commercial paper. Short-term borrowings consisted of commercial paper totaling $23.4 million and $12.4 million at December 31, 1994 and 1993, respectively.\nNOTE 5 - RETAINED EARNINGS\nCILCO's Articles of Incorporation provide that no dividends shall be paid on the common stock if, at the time of declaration, the balance of retained earnings does not equal at least two times the annual dividend requirement on all outstanding shares of preferred stock. The amount of retained earnings so required at December 31, 1994, was $6.7 million.\nNOTE 6 - PREFERRED STOCK\nAll classes of preferred stock are entitled to receive cumulative dividends and rank equally as to dividends and assets, according to their respective terms.\nThe total annual dividend requirement for preferred stock outstanding at December 31, 1994, is $3.3 million, assuming a continuation of the auction dividend rate at December 31, 1994, for the flexible auction rate series.\nPREFERRED STOCK WITHOUT MANDATORY REDEMPTION\nThe call provisions of preferred stock redeemable at CILCO's option outstanding at December 31, 1994, are as follows:\nPREFERRED STOCK WITH MANDATORY REDEMPTION\nCILCO's 5.85% Class A preferred stock may be redeemed in 2003 at $100 per share. A mandatory redemption fund must be established on July 1, 2003. The fund will provide for the redemption of 11,000 shares for $1.1 million on July 1 of each year through July 1, 2007. On July 1, 2008, the remaining 165,000 shares will be retired for $16.5 million.\nPREFERENCE STOCK, CUMULATIVE\nNo Par Value, Authorized 2,000,000 shares, of which none have been issued.\nNOTE 7 - LONG-TERM DEBT\nCILCO's first mortgage bonds are secured by a lien on substantially all of its property and franchises. Unamortized borrowing expense, premium and discount on outstanding long-term debt are being amortized over the lives of the respective issues.\nScheduled maturities of long-term debt for 1996-1999 are $16 million, $20 million, $10.6 million and $0, respectively.\nThe 1995 maturities of long-term borrowings have been classified as current liabilities.\nNOTE 8 - COMMITMENTS & CONTINGENCIES\nCILCO's 1995 capital expenditures for utility plant are estimated to be $69 million, in connection with which CILCO has normal and customary purchase commitments at December 31, 1994.\nCILCO's policy is to act as a self-insurer for certain insurable risks resulting from employee health and life insurance programs.\nIn August 1990, CILCO entered into a firm, wholesale power purchase agreement with Central Illinois Public Service Company (CIPS). This agreement, which expires in 1998, provides for an initial purchase of 30 megawatts (MW) of capacity, increasing to 90 MW in 1997. CILCO can increase purchases to a maximum of 100 MW during the contract period, provided CIPS then has the additional capacity available. In November 1992, CILCO entered into a limited-term power agreement to purchase 100 MW of CIPS's capacity from June 1998 through May 2002. At CILCO's request, purchases may be increased to a maximum of 150 MW during the contract period, provided CIPS has the additional capacity available.\nFor a discussion of former gas manufacturing sites, refer to the caption \"Environmental Matters\" of Item 7 of Management's Discussion and Analysis of Financial Condition and Results of Operations on page 20 of CILCORP's 1994 Annual Report which is incorporated herein by reference.\nNOTE 9 - RATE MATTERS\nIn December 1994, the Illinois Commerce Commission (ICC) issued a rate order designed to grant CILCO a $10.6 million, or 6.7% annual increase in gas base rate revenues. The order represents approximately 75% of CILCO's original rate increase request filed in January 1994. The new rates, designed to yield an 11.82% return on common equity and a 9.24% return on rate base, were effective the week of December 12, 1994. The ICC denied requests for rehearing which had been filed by CILCO and other parties. No party has appealed the ICC order, and the time for appeal has expired.\nAs a part of its rate order, the ICC disallowed approximately $7.5 million of CILCO's $24 million investment in the Springfield, Illinois, cast iron main renewal project. To reflect the disallowance, CILCO recorded a pre-tax charge of approximately $7.5 million ($4.5 million after-tax) against 1994 earnings.\nIn mid-1992, after a significant number of leaks were detected in CILCO's Springfield cast iron gas distribution system, CILCO began a detailed examination of its Springfield gas distribution system and related operating practices and procedures. CILCO thereafter began an aggressive program to renew its Springfield gas cast iron main system. This project was substantially completed by September 30, 1993.\nThe ICC staff began an informal review of CILCO's Springfield gas operations and record-keeping practices in September 1992. Subsequently, the U.S. Department of Transportation (DOT) and the U.S. Department of Justice (DOJ) began conducting investigations of CILCO which were also focused principally on CILCO's Springfield gas operations and its record-keeping practices.\nOn September 16, 1994, CILCO entered into a federal court civil consent decree with the DOJ which concluded the DOT and DOJ investigations of CILCO. As a part of the settlement with the DOJ, CILCO accepted adjustments recommended by the ICC staff which resulted in a net disallowance from CILCO's gas rate base of approximately $4.6 million of the cost of the Springfield cast iron main renewal project. This charge is part of the $7.5 million disallowance included in the December 1994 rate order. In addition to the rate base disallowance, CILCO agreed to pay an $844,000 civil fine to the United States and agreed to reimburse the ICC, the DOT and the DOJ $156,000 for the costs of their investigations. CILCO also agreed to underwrite the reasonable expense of an outside expert, to be selected by the ICC, to examine its gas operations manuals and systems to ensure they are in compliance with all applicable statutes and regulations. CILCO estimates the cost of the audit will be $350,000. Management expects the audit to conclude by the end of 1995.\nThe DOJ agreed not to seek any additional civil or criminal penalties from CILCO or the Company. The ICC staff also agreed not to seek any additional enforcement penalties from CILCO or the Company. CILCO agreed to continue to cooperate with the DOJ in its investigation and prosecution of any individuals who may be responsible for willful violations of any applicable statute or regulation.\nFor a discussion of other gas and electric rate matters refer to information under the heading Management's Discussion and Analysis of Financial Condition and Results of Operations of CILCORP's 1994 Annual Report to Shareholders, which is incorporated herein by reference.\nNOTE 10 - LEASES\nCILCO leases certain equipment, buildings and other facilities under capital and operating leases. Minimum future rental payments under non-cancelable capital and operating leases having remaining terms in excess of one year as of December 31, 1994, are $21 million in total. Payments due during the years ending December 31, 1995, through December 31, 1999, are $5.3 million, $3.5 million, $2.9 million, $2.8 million and $2.7 million, respectively.\nNOTE 11 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following quarterly operating results are unaudited, but, in the opinion of management, include all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of CILCO's operating results for the periods indicated. The results of operations for each of the fiscal quarters are not necessarily comparable to, or indicative of, the results of an entire year due to the seasonal nature of CILCO's business.\nItem 9.","section_9":"Item 9. Changes in and Disagreements with Accountants on Accounting and \t Financial Disclosure\n\t\t\t CILCORP\nNot applicable. \t\t\t CILCO\nNot applicable.\n\t\t\t PART III\nItem 10.","section_9A":"","section_9B":"","section_10":"Item 10. Directors and Executive Officers of the Registrant\n\t\t\t CILCORP\nThe information required by Item 10 relating to directors is set forth in the Company's definitive proxy statement for its 1995 Annual Meeting of Stockholders filed with the Commission pursuant to Regulation 14A. Such information is incorporated herein by reference to the material appearing under the caption \"Election of Directors\" of such proxy statement. Information required by Item 10 relating to executive officers of the Company is set forth under a separate caption in Part I hereof.\n\t\t\t CILCO\nThe information required by Item 10 relating to directors is set forth in CILCO's definitive proxy statement for its 1995 Annual Meeting of Stockholders filed with the Commission pursuant to Regulation 14A. Such information is incorporated herein by reference to the material appearing under the caption \"Election of Directors\" of such proxy statement. Information required by Item 10 relating to executive officers of CILCO is set forth under a separate caption in Part I hereof.\nItem 11.","section_11":"Item 11. Executive Compensation\n\t\t\t CILCORP\nThe Company has filed with the Commission a definitive proxy statement pursuant to Regulation 14A. The information required by Item 11 is incorporated herein by reference to the material appearing under the caption \"Executive Compensation\" of such proxy statement.\n\t\t\t CILCO\nCILCO has filed with the Commission a definitive proxy statement pursuant to Regulation 14A. The information required by Item 11 is incorporated herein by reference to the material appearing under the caption \"Executive Compensation\" of such proxy statement.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and \t Management \t\t\t CILCORP\nThe Company has filed with the Commission a definitive proxy statement pursuant to Regulation 14A. The information required by Item 12 is incorporated herein by reference to the material appearing under the caption \"Voting Securities and Principal Holders\" of such proxy statement.\n\t\t\t CILCO\nCILCO has filed with the Commission a definitive proxy statement pursuant to Regulation 14A. The information required by Item 12 is incorporated herein by reference to the material appearing under the caption \"Voting Securities and Principal Holders\" of such proxy statement.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\n\t\t\t CILCORP\nCILCORP Inc. (CILCORP or Company), a holding company, is the parent of its direct subsidiaries Central Illinois Light Company (CILCO), CILCORP Investment Management Inc., CILCORP Ventures Inc. and Environmental Science & Engineering, Inc. (ESE). In the course of business, the Company carries on certain relations with affiliated companies such as shared facilities, utilization of employees and other business transactions. Central Illinois Light Company is reimbursed at cost by the Company and the other subsidiaries for any services it provides.\nESE and the Holding Company entered into an agreement to consolidate ESE's outstanding debt. Under this agreement, ESE can draw on a $15 million revolving line of credit which expires May 2, 1996. At December 31, 1994, ESE had $5.6 million borrowed from CILCORP under this agreement. ESE also borrowed $20 million from the Holding Company on a term credit basis with the principal due May 2, 1998.\nAt December 31, 1994, CILCORP guaranteed $21 million of outstanding debt of CILCORP Lease Management Inc. CILCORP receives a fee for the guarantee.\nCIM has guaranteed the performance of CIM Leasing Inc. and CIM Air Leasing Inc. with respect to certain obligations arising from the leveraged lease investments held by these subsidiaries.\n\t\t\t CILCO\nCertain members of the Board of Directors of CILCORP Inc. are also members of the Board of Directors of CILCO and the Secretary of CILCO is also Vice President, General Counsel and Secretary of CILCORP Inc.\n\t\t\t PART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedules, and Reports on Form \t 8-K\n\t\t\t CILCORP \t\t\t\t \t\t\t Page in \t\t\t\t\t\t\t Annual Report to \t\t\t\t\t\t Shareholders (a) 1. Financial Statements \t The following statements are included in \t Exhibit 13 of this filing and are incorporated \t herein by reference from CILCORP Inc.'s 1994 \t Annual Report:\n\t Management's Report 28 \t Report of Independent Public Accountants 28 \t Consolidated Statements of Income for the three \t years ended December 31, 1994 29\n\t Consolidated Balance Sheets as of \t December 31, 1994, and December 31, 1993 30-31 \t \t Consolidated Statements of Segments of Business for \t the three years ended December 31, 1994 32-33 \t\t\t\t \t Consolidated Statements of Cash Flows for the three \t years ended December 31, 1994 34 \t\t\t \t Consolidated Statements of Common Stockholders' Equity \t for the three years ended December 31, 1994 35 \t\t \t Notes to the Consolidated Financial Statements 36-44\n(a) 2. Financial Statement Schedules\n\t The following schedules are included herein: Page No. \t\t\t\t\t\t\t Form 10-K \t \t Schedule II - Valuation and Qualifying Accounts \t\t\t and Reserves for the three years \t\t\t ended December 31, 1994 59\n\t Schedule XIII -Investment in Leveraged Leases at \t\t\t December 31, 1994 61\n\t Other schedules are omitted because of the absence of \t conditions under which they are required or because the \t required information is given in the financial statements \t or notes thereto.\n(a) 3. Exhibits\n*(3) Articles of Incorporation (Designated in Form 10-K for the \t year ended December 31, 1991, File No. 1-8946, as Exhibit \t3)).\n(3)a By-laws as amended effective August 20, 1993.\n***(4) Instruments defining the rights of security holders, including \tindentures\n*(10) CILCO Executive Deferral Plan as amended through February 22, \t1994. (Designated in Form 10-K for the year ended December 31, 1993, File No. 1-8946, as Exhibit (10)). \t *(10)a Executive Deferral Plan II (Designated in Form 10-K for the \t year ended December 31, 1989, File No. 1-8946, as Exhibit \t(10)b). \t (10)b CILCORP Economic Value Added Incentive Compensation Plan \t (Adopted February 29, 1989 & Revised January 29, 1991.)\n(10)c CILCORP Compensation Protection Plan. (Adopted June 28, 1994.)\n*(10)d CILCO Benefit Replacement Plan (Designated in Form 10-K for the \tyear ended December 31, 1991, File No. 1-8946, as Exhibit \t(10)e).\n*(10)e CILCORP Deferred Compensation Stock Plan (Designated in Form \t10-K for the year ended December 31, 1991, File No. 1-8946, as \t Exhibit (10)f).\n*(10)f Shareholder Return Incentive Compensation Plan (included as \tpart of Company's definitive proxy in 1993 Annual Meeting of \tStockholders, filed with the Commission on March 26, 1993.)\n(12) Computation of Ratio of Earnings to Combined Fixed Charges and \tPreferred Stock Dividends \t\t\t\t\t\t\t Page No. \t\t\t\t\t\t\t Form 10-K\n(13) Annual Report to Security Holders 66\n(24) Consent of Arthur Andersen LLP 67\n(25) Power of Attorney\n(27) CILCORP Inc. Consolidated Financial Data Schedule\n(b) 3. Reports on Form 8-K \tForm 8-K was filed on December 12, 1994, to disclose the \tissuance by the ICC of a rate order designed to grant CILCO a \t$10.6 million, or 6.7%, annual increase in gas base rate \trevenues.\n* These exhibits have been previously filed with the Securities and Exchange Commission (SEC) as exhibits to registration statements or to other filings of CILCORP or CILCO with the SEC and are incorporated herein as exhibits by reference. The file number and exhibit number of each such exhibit (where applicable) are stated in the description of such exhibit.\n*** Pursuant to Paragraph (b)(4)(iii)(A) of Item 601 of Regulation S-K, the Company has not filed as an exhibit to this Form 10-K any instrument with respect to long-term debt as the total amount of securities authorized thereunder does not exceed 10 percent of the total assets of the Company and its subsidiaries on a consolidated basis, but hereby agrees to furnish to the SEC on request any such instruments.\n\t\t\t CILCO\n\t\t\t\t\t\t\t Page No. \t\t\t\t\t\t\t Form 10-K (a) 1. Financial Statements\n\tThe following are included herein:\n\tManagement's Report 31\n\tReport of Independent Public Accountants 32\n\tConsolidated Statements of Income for the three years \t ended December 31, 1994 33\n\tConsolidated Balance Sheets as of December 31, 1994 and \t December 31, 1994 34-35 \t\t\t \tConsolidated Statements of Cash Flows for the three \t years ended December 31, 1994 36-37 \t\t\t \tConsolidated Statements of Retained Earnings for the \t three years ended December 31, 1994 38\n\tConsolidated Statements of Segments of Business for \t the three years ended December 31, 1994 39-40 \t\t\t \tNotes to the Consolidated Financial Statements 41-52\n(a) 2. Financial Statement Schedules \tThe following schedule is included herein:\n\tSchedule II - Valuation and Qualifying Accounts and \t\t\tReserves for the three years ended \t\t\tDecember 31, 1994 60\n\tOther schedules are omitted because of the absence of \tconditions under which they are required or because the \trequired information is given in the financial statements \tor notes thereto.\n(a) 3. Exhibits\n(3) Articles of Incorporation as amended July 26, 1993.\n(3)a Bylaws as amended effective April 26, 1994.\n*(4) Indenture of Mortgage and Deed of Trust between Illinois Power \tCompany and Bankers Trust Company, as Trustee, dated as of \tApril 1, 1933, Supplemental Indenture between the same parties \tdated as of June 30, 1933, Supplemental Indenture between the \tCompany and Bankers Trust Company, as Trustee, dated as of \tJuly 1, 1933 and Supplemental Indenture between the same \tparties dated as of January 1, 1935, securing First Mortgage \tBonds, and indentures supplemental to the foregoing through \tNovember 1, 1994. (Designated in Registration No. 2-1937 as \t Exhibit B-1, in Registration No. 2-2093 as Exhibit B-1(a), in \tForm 8-K for April 1940, File No. 1-2732-2, as Exhibit A, in \tForm 8-K for December 1949, File No. 1-2732-2, as Exhibit A, \tin Form 8-K for December 1951, File No. 1-2732, as Exhibit A, \tin Form 8-K for July 1957, File No. 1-2732, as Exhibit A, in \tForm 8-K for July 1958, File No. 1-2732, as Exhibit A, in Form \t8-K for March 1960, File No. 1-2732, as Exhibit A, in Form 8-K \tfor September 1961, File No. 1-2732, as Exhibit B, in Form 8-K \tfor March 1963, File No. 1-2732, as Exhibit A, in Form 8-K for \tFebruary 1966, File No. 1-2732, as Exhibit A, in Form 8-K for \tMarch 1967, File No. 1-2732, as Exhibit A, in Form 8-K for \tAugust 1970, File No. 1-2732, as Exhibit A, in Form 8-K for \tSeptember 1971, File No. 1-2732, as Exhibit A, in Form 8-K for \tSeptember 1972, File No. 1-2732, as Exhibit A, in Form 8-K for \tApril 1974, File No. 1-2732, as Exhibit 2(b), in Form 8-K for \tJune 1974, File No. 1-2732, as Exhibit A, in Form 8-K for \tMarch 1975, File No. 1-2732, as Exhibit A, in Form 8-K for May \t1976, File No. 1-2732, as Exhibit A, in Form 10-Q for the \t quarter ended June 30, 1978, File No. 1-2732, as Exhibit 2, in \tForm 10-K for the year ended December 31, 1982, File No. 1- \t2732, as Exhibit (4)(b), in Form 8-K dated January 30, 1992, \tFile No. 1-2732, as Exhibit (4) in Form 8-K dated January 29, \t1993, File No. 1-2732, as Exhibit (4) and in Form 8-K dated \tDecember 2, 1994, File No. 1-2732, as Exhibit (4).)\n*(4)a Supplemental Indenture dated November 1, 1994. (Designated in \tForm 8-K dated November 1, 1994, File No. 1-2732, as Exhibit \t(4).)\n*(10) CILCO Executive Deferral Plan as amended February 22, 1994. \t(Designated in Form 10-K for the year ended December 31, 1993, \tFile No. 1-2732, as Exhibit (10).)\n*(10)a Executive Deferral Plan II. (Designated in Form 10-K for the \t year ended December 31, 1989, File No. 1-2732, as Exhibit \t(10)b.)\n*(10)b CILCO Compensation Protection Plan. (Designated in Form 10-K \tfor the year ended December 31, 1990, File No. 1-2732, as \tExhibit (10)c.)\n*(10)c CILCO Deferred Compensation Stock Plan. (Designated in Form \t10-K for the year ended December 31, 1990, File No. 1-2732, as Exhibit (10)d.)\n*(10)d CILCO Economic Value Added Incentive Compensation Plan. \t(Designated in Form 10-K for the year ended December 31, 1990, \tFile No. 1-2732, as Exhibit (10)e.)\n*(10)e Benefit Replacement Plan. (Designated in Form 10-K for the \tyear ended December 31, 1991, File No. 1-2732, as Exhibit \t(10)f.)\n*(10)f Shareholder Return Incentive Compensation Plan (included as part of CILCORP Inc.'s definitive proxy in 1993 Annual Meeting \tof Stockholders, filed with the Commission on March 26, 1993.)\n(12) Computation of Ratio of Earnings to Fixed Charges\n(25) Power of Attorney\n(27) Central Illinois Light Company Financial Data Schedule\n(b) 3. Reports on Form 8-K \t\t \tA Form 8-K was filed on December 2, 1994, to disclose a Form \tof Distribution Agreement and Supplemental Indenture dated as \tof November 1, 1994.\n\tA Form 8-K was filed on December 12, 1994, to disclose the \tissuance by the ICC of a rate order designed to grant CILCO a \t$10.6 million, or 6.7%, annual increase in gas base rate \trevenues.\n*These exhibits have been previously filed with the Securities and Exchange Commission (SEC) as exhibits to registration statements or to other filings of CILCO with the SEC and are incorporated herein as exhibits by reference. The file number and exhibit number of each such exhibit (where applicable) are stated in the description of such exhibit.\nSCHEDULE II\n\t\t\t\nSCHEDULE II\nSCHEDULE XIII\n\t\t\t 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.\n\t \t\t\t\t\t CILCORP INC.\nMarch 13, 1995 By R. O. Viets \t\t\t\t\t\t R. O. Viets \t\t\t\t\t\t President and Chief \t\t\t\t\t\t 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.\nSignature Title Date\n(i) and (ii) Principal executive officer, director and principal financial officer: \t R. O. Viets R. O. Viets President, Chief March 13, 1995 \t\t\t Executive Officer \t\t\t\t and Director\n(iii) Controller \t\t T. D. Hutchinson T. D. Hutchinson Controller March 13, 1995\n(iv) A majority of the Directors \t(including the director named above): M. Alexis* Director March 13, 1995 J. R. Brazil* Director March 13, 1995 W. Bunn III* Director March 13, 1995 D. E. Connor* Director March 13, 1995 H. J. Holland* Director March 13, 1995 H. S. Peacock* Director March 13, 1995 R. W. Slone* Director March 13, 1995 K. E. Smith* Director March 13, 1995 R. M. Ullman* Director March 13, 1995 M. M. Yeomans* Director March 13, 1995\nR. O. Viets R. O. Viets Director March 13, 1995\n*By\n\tR. O. Viets \tR. O. Viets \t Attorney-in-fact\n\t\t\t\t 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.\n\t\t\t\t \tCENTRAL ILLINOIS LIGHT COMPANY\nMarch 13, 1995 By R. W. Slone \t \t\t\t\t\t R. W. Slone \t\t\t\t\t\t Chairman of the Board, \t\t\t\t\t\t President and Chief \t\t\t\t\t\t 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.\nSignature Title Date\n(i) Principal executive officer and director:\nR. W. Slone R. W. Slone Chairman of the Board, March 13, 1995 \t\t\t President, Chief \t\t\t Executive Officer \t\t\t\t and Director\n(ii) Principal financial officer:\nT. S. Romanowski T. S. Romanowski Vice President March 13, 1995\n(iii) Controller\nR. L. Beetschen R. L. Beetschen Controller and March 13, 1995 \t\t\t Manager of Accounting\n(iv) A majority of the Directors \t(including the director named above):\nM. Alexis* Director March 13, 1995 J. R. Brazil* Director March 13, 1995 W. Bunn III* Director March 13, 1995 D. E. Connor* Director March 13, 1995 W. M. Shay* Director March 13, 1995 K. E. Smith* Director March 13, 1995 R. N. Ullman* Director March 13, 1995 J. F. Vergon* Director March 13, 1995 M. M. Yeomans* Director March 13, 1995\nR. W. Slone R. W. Slone Director March 13, 1995\n*By R. W. Slone R. W. Slone Attorney-in-fact\nEXHIBIT (12)\nEXHIBIT (12)\nNOTICE\nThis copy of CILCORP Inc.'s and Central Illinois Light Company's Form 10-K does not include our 1994 Consolidated Annual Report. If you have not received our 1994 Consolidated Annual Report and would like one, please let us know.\nTelephone: \tIn Peoria 675-8808 \tElsewhere in Illinois 1-800-322-3569 \tOutside Illinois 1-800-622-5514 \tTDD 1-309-675-8892\nOr you can write to us at: \tInvestor Relations Department \tCILCORP Inc. \t300 Hamilton Blvd. \tSuite 300 Peoria, IL 61602-1238\nEXHIBIT 24\nCONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS\nAs independent public accountants, we hereby consent to the incorporation by reference of our reports, dated February 3, 1995, included herein or incorporated by reference in this Form 10-K, into CILCORP Inc.'s previously filed Registration Statements File No. 33-45318, 33-51315 and 33-51241.\n\t\t\t\t ARTHUR ANDERSEN LLP\nChicago, Illinois March 8, 1995","section_15":""}
{"filename":"808369_1994.txt","cik":"808369","year":"1994","section_1":"ITEM 1. BUSINESS\nGeneral. The registrant, ML\/EQ Real Estate Portfolio, L.P. (the \"Partnership\"), is a limited partnership formed on December 22, 1986 under the Revised Uniform Limited Partnership Act of the State of Delaware. The Partnership operates pursuant to the Amended and Restated Agreement of Limited Partnership dated as of April 23, 1987 as amended as of February 9, 1988 (the \"Partnership Agreement\"), which is included as an exhibit to this annual report. Capitalized terms used in this annual report that are not defined herein have the same meaning as in the Partnership Agreement.\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 affiliate 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 (the \"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.\" 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 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. The Partnership considers its business to represent one industry segment, investment in real property. The Partnership does not segregate revenues by geographical region and such a presentation would not be material to an understanding of the Partnership's business taken as a whole.\nFollowing its investor closings, the Partnership contributed the net proceeds of the 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 acquired a diversified portfolio of real properties and mortgage loans secured by real properties. Based on original acquisition prices, approximately 52% of the Venture's original contributed capital was invested in existing income-producing real properties acquired without permanent mortgage indebtedness (the \"Properties\"), approximately 25% of such capital was invested in zero coupon or similar mortgage notes (the \"Zero Notes\"), and the balance was invested in fixed-rate first mortgage loans (the \"Fixed-Rate Mortgage Loans;\" together with the Zero Notes, the \"Mortgage Loans\"). The Properties and the properties that secure the Mortgage Loans include commercial, industrial, residential and warehouse\/distribution properties.\nAt December 31, 1994, the Venture owned ten Properties (one of which consists of two adjacent office buildings) and one undivided interest in a Property (Northland Center) as a tenant in common with Equitable. All references herein to the Venture's ownership of Northland Center shall be deemed to refer to the Venture's undivided interest as a tenant in common with Equitable unless otherwise indicated. Nine of the Properties were purchased at an aggregate cost of approximately $68.1 million. The other two Properties, Northland Center and The Bank of Delaware Building (originally properties that secured a Zero Note and a Fixed-Rate Mortgage Loan, respectively), were transferred to the Venture during 1994 in separate deed in lieu of foreclosure transactions. The fair market value of the Venture's undivided interest in the Northland Center Zero Coupon Mortgage Note Receivable immediately preceding the transfer was approximately $32.2 million and the fair market value of the Bank of Delaware Building Mortgage Note immediately preceding the transfer was approximately $8.5 million. In addition, at December 31, 1994, the Venture owned an interest in one remaining Zero Note representing principal and accrued interest on the date of acquisition of approximately $12.3 million and one remaining Fixed-Rate Mortgage Loan in the principal amount of $6.0 million. (Amounts identified are exclusive of closing costs.) Reference is made to Item 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES for information concerning the Properties and the Mortgage Loans.\nReal estate investments are recorded at historical cost less accumulated depreciation. For purposes of financial statement presentation, the Properties are stated at cost, unless it is determined that the value of the Properties has been impaired to a level below depreciated cost. Impairment is determined by calculating the sum of undiscounted future cash flows including the projected undiscounted future net proceeds from sale of the Property. In the event this sum is less than the depreciated cost of the Property, the Property will be recorded on the financial statements at this amount. With respect to Mortgage Loans, management reviews the valuation of the underlying security as determined by third party appraisals when available. In addition, management reviews the underlying security through a reinspection process that occurs at least once every three years. This review process includes an estimate of future cash flows produced by the security.\nNeither the Partnership nor the Venture has any real property investments located outside the United States. The Partnership has no employees.\nLeasing Information. See Item 2. PROPERTIES for information regarding percentages of space under lease for each of the Properties and the properties that secure the Mortgage Loans, as well as information relating to the percentage of rentable space at each Property covered by leases that are scheduled to expire in each of the years 1995 to 1997.\nCompetition. The Properties and the properties that secure the Mortgage Loans may compete with other properties in the areas in which they are located for, among other things, desirable tenants. Competitors may include properties owned or managed directly or indirectly by Equitable or its subsidiaries or affiliates or by affiliates of the Associate General Partner. Owners of some of these properties may have greater resources than the Venture or the owners of the properties that secure the Mortgage Loans and\/or may be willing or able to make greater concessions (e.g., lower rent or higher allowances for tenant improvements) to attract tenants. Similarly, tenants of the Properties and the properties that secure the Mortgage Loans may compete for business with other businesses in the area. Such competition may adversely affect the business (and, in some cases, the viability) of such tenants and, particularly in the case of retail tenants, may reduce the amount of rent received by the Venture under percentage rent provisions. See Item 2. PROPERTIES for a discussion of competition pressures experienced by the Partnership's Richland Mall Property.\nCurrently, many areas of the country, including some in which one or more of the Properties or properties that secure the Mortgage Loans are located, are experiencing relatively high vacancy rates 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). The Venture's income from Properties may be affected by many factors, including reductions in rental income due to an inability to maintain occupancy levels, adverse changes in general economic conditions, adverse local conditions (such as\ndecreases in demand for similar or competing facilities or competitive over-building, adverse changes in tax, real estate, zoning and environmental laws or decreases in employment), energy shortages or increased energy costs, or acts of God (such as earthquakes and floods). In addition, the ability of the borrowers on the Mortgage Loans to meet their obligations under such loans will be affected by these same factors. See Item 2. PROPERTIES for a description of difficulties experienced by certain of the Properties and the properties that secure the Mortgage Loans.\nThe holding period for the Properties was originally intended to be 7 to 10 years and the Partnership currently does not anticipate that the Properties will be sold prior to that time unless market conditions demand that earlier action be taken. The Partnership can not state whether or not the Properties will be sold within this original period. It is anticipated that the holding period for the Northland Center will be approximately 3 to 6 years from July 22, 1994, the acquisition date. The ability of the Venture to dispose of its Properties will be influenced by, among other things, prevailing interest rates and the availability of mortgage financing at the time that the Properties are sought to be sold. For example, if high interest rates or shortages of mortgage funds were prevailing at the time the Venture was attempting to dispose of a Property, the sale or other disposition of such Property might be rendered difficult or the Venture might be required to assume credit risks if it becomes necessary to extend mortgage financing to buyers. Similarly, such factors may affect the ability of borrowers under Mortgage Loans held by the Venture which are scheduled to mature in June 1995 and February 1999 to sell or refinance the properties that secure such loans, which may adversely affect the ability of borrowers to pay such loans at maturity. In this regard, it should be noted that many lenders have continued to curtail extending credit to many businesses and industries, including real estate owners and developers. The reasons for such action include, but are not limited to, defaults experienced on such loans. There can be no assurance whether or when the availability of credit for real estate financing will increase. Liquidation or dissolution of the Venture will be delayed until the Mortgage Loans held by the Venture (other than purchase money notes from the sale of a property) are paid or sold, but not beyond December 31, 2002. See INVESTMENT GUARANTY AGREEMENT AND RELATED MATTERS below.\nConflicts of Interest. Equitable and its subsidiaries and affiliates are among the largest managers of real estate assets in the country and certain activities in which they currently or in the future may engage will be competitive with the Partnership and the Venture. As Managing General Partner of the managing partner of the Venture, EREIM Managers Corp. may encounter various conflicts of interest in managing the Partnership's and the Venture's businesses. These conflicts may, for example, arise in connection with the allocation of leasing or sale opportunities, selection of service providers such as property managers (including whether to retain an affiliate or a non-affiliate), determination to exercise or forbear exercise of certain rights (e.g., eviction or foreclosure), or the timing of investment dispositions or liquidations. While EREIM Managers Corp. believes that it will be able to resolve such conflicts in an equitable manner, it is possible that such conflicts may not be resolved in favor of the Partnership or the Venture.\nPresently nine Properties are managed by Compass Management and Leasing, Inc. (\"Compass\") and Compass Retail, Inc. (\"Compass Retail\"), affiliates of Equitable. The property management agreements are at market rates but not in excess of the rates permitted under the Partnership Agreement.\nWorking Capital Reserves. The Partnership intends to maintain adequate working capital reserves to meet short and long-term commitments. The Partnership's reserves may be increased or decreased from time to time based upon the Managing General Partner's determination as to their adequacy; provided, however, that such working capital reserves may not be decreased below 1% of gross offering proceeds prior to the time that the Partnership enters its liquidation phase. Working capital reserves as of December 31, 1994, including the Partnership's allocable share of Venture cash reserves, are approximately 15% of the Partnership's gross offering proceeds. See Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nInsurance. The Properties are covered under insurance contracts which provide comprehensive general liability as well as physical damage protection. Such insurance contracts also cover other properties in accounts which are advised or managed by Equitable or its subsidiaries as well as certain properties in which Equitable, its subsidiaries or its insurance company separate accounts have an ownership interest.\nAlthough the Venture carries comprehensive insurance on the Properties and the terms of each of the Venture's Mortgage Loans require the borrower to obtain and maintain general liability, property damage and certain other insurance in specified amounts, there are certain risks (such as earthquakes, floods and wars) which may be uninsurable or not fully insurable at a cost believed to be economically feasible. Moreover, there can be no assurance that particular risks that are currently insurable will continue to be so, or that current levels of coverage will continue to be available at a cost believed to be economically feasible. The Managing General Partner, on behalf of the Partnership as managing partner of the Venture, will use its discretion in determining the scope of coverage, limits and deductible provisions on insurance, with a view to maintaining appropriate insurance on the Properties at an appropriate cost. Similarly, the Managing General Partner will use its discretion in determining whether and when to permit borrowers under the Mortgage Loans to obtain and maintain coverage that differs from the requirements of the mortgages, with a view to requiring appropriate insurance on the properties which secure the Mortgage Loans in light of prevailing insurance market, economic and other factors. This may result in insurance which will not cover the full extent of a loss or claim.\nInvestment Guaranty Agreement and Related Matters. Under an investment guaranty agreement dated March 10, 1988 by and between EREIM LP Associates and the Venture (the \"Guaranty Agreement\"), EREIM LP Associates has guaranteed to pay the Venture, if necessary, ninety days after the earlier of the sale, retirement or other disposition of all of the Mortgage Loans and Properties or the liquidation of the Partnership, an amount which when added to all distributions from the Partnership to the holders of BACs (\"BAC Holders\") will enable the Partnership to provide the BAC Holders with a minimum return (the \"Minimum Return\") equal to their Capital Contributions plus a simple annual return equal to 9.75% multiplied by their Adjusted Capital Contributions (as defined in the Guaranty Agreement), calculated from the investor closing at which the BAC Holder acquired its BACs.\nThe Venture has assigned the Guaranty Agreement to the Partnership in exchange for the Partnership's assumption of the Venture's obligations, including the obligation to pay the Guaranty Fee. Any moneys distributed by the Partnership to BAC Holders and\/or limited partners of the Partnership (\"Limited Partners\") on account of payments made under the Guaranty Agreement will be distributed to BAC Holders and\/or Limited Partners based on the total number of BACs or Interests owned by each BAC Holder and\/or Limited Partner as of the date the Minimum Return is calculated.\nIf the Venture holds a purchase money note from the sale of a Property at the time all other investments of the Partnership and the Venture have been disposed of and the proceeds distributed, any remaining obligation of EREIM LP Associates under the Guaranty Agreement will be reduced by (i) the aggregate amount of all cash payments to BAC Holders and Limited Partners and (ii) the discounted value (at the market rate of interest of a U.S. Treasury security having a comparable term) of principal and interest payments on the purchase money note. EREIM LP Associates will be required to either purchase the purchase money note from the Venture at its discounted value or guarantee timely payment of principal and interest under the note, but only to the extent such note reduces obligations under the Guaranty Agreement and so long as the note does not reduce obligations below zero. If the Venture sells a purchase money note at a premium over the discounted value of the note, the premium will be paid to EREIM LP Associates to the extent of any payments made under the Guaranty Agreement. Moreover, EREIM LP Associates will be entitled to receive any cash payments paid to the Partnership (other than payments from a purchase money note guaranteed by EREIM LP Associates) to the extent that it has made any payment under the Guaranty Agreement.\nThe obligation of EREIM LP Associates to pay the Minimum Return is subject to reduction for (i) any Federal, state or local corporate income or franchise tax imposed upon the Partnership or the Venture, and (ii) any Federal, state or local income, gross receipts, value-added, excise or similar tax imposed on the Partnership or the Venture not imposed under law at the time of the Offering, other than any such local tax imposed as a result of owning real property in the locality. All distributions from the Partnership to BAC Holders from whatever source will reduce the amount of EREIM LP Associates' obligation under the Guaranty Agreement. The obligations of EREIM LP Associates under the Guaranty Agreement will terminate in the event that upon the written consent or the affirmative vote of BAC Holders or Limited Partners owning more than 50% of the Interests either (i) EREIM Managers Corp. is removed as the Managing General Partner of the Partnership or (ii) the Partnership is dissolved without the consent of EREIM Managers Corp. The maximum liability of EREIM LP Associates under the Guaranty Agreement is $271,211,250. Subject to the foregoing, the obligations of EREIM LP Associates under the Guaranty Agreement as of December 31, 1994 are limited to $249,485,801 plus the value of EREIM LP Associates' interest in the Venture less any amounts contributed by EREIM LP Associates to the Venture to fund cash deficits.\nAs described above, the general partners of EREIM LP Associates are EREIM LP Corp., a wholly-owned subsidiary of Equitable, and Equitable. The obligations of EREIM LP Associates under the Guaranty Agreement are nonrecourse to Equitable but are recourse as to EREIM LP Corp. Equitable has entered into an agreement dated as of March 10, 1988 (the \"Keep Well Agreement\") with EREIM LP Corp. which provides that Equitable will make capital contributions to EREIM LP Corp. in such amounts as to permit EREIM LP Corp. to pay its obligations with respect to the Guaranty Agreement as they become due; provided, however, that the maximum liability of Equitable under the Keep Well Agreement is an amount equal to the lesser of (i) two percent of the total admitted assets of Equitable (as determined in accordance with New York Insurance Law) or (ii) $271,211,250. The Keep Well Agreement provides that only EREIM LP Corp. and its successors will have the right to enforce Equitable's obligations thereunder.\nThe Keep Well Agreement is an unsecured contractual liability of Equitable and is not a policy of insurance. Since the Guaranty Agreement is nonrecourse as to Equitable and the obligation under the Keep Well Agreement to pay all obligations of EREIM LP Corp. is not for the benefit of third parties, including the Partnership and BAC Holders, BAC Holders will have no direct cause of action against Equitable to enforce the obligations of Equitable under the Keep Well Agreement. However, if the assets of EREIM LP Associates and EREIM LP Corp. are insufficient to satisfy EREIM LP Associates' obligations under the Guaranty Agreement, a proceeding in bankruptcy could be commenced against EREIM LP Corp. In such event the debtor-in-possession or trustee in bankruptcy would have a claim against Equitable to compel performance under the Keep Well Agreement. If the Managing General Partner, which is an affiliate of Equitable, did not commence an involuntary bankruptcy proceeding against EREIM LP Corp. on behalf of the Partnership, MLH Real Estate Assignor Inc., the initial limited partner of the Partnership (the \"Initial Limited Partner\"), on behalf of BAC Holders would have a right to compel the Partnership to commence such involuntary bankruptcy proceeding.\nThe New York Insurance Law contains provisions limiting the amount of an investment by a New York life insurance company, such as Equitable, in certain of its subsidiaries and in real estate. The Keep Well Agreement provides that Equitable's obligation thereunder is subject to compliance with any applicable limitation on investment contained in the New York Insurance Law.\nAt December 31, 1994, 1993 and 1992, Equitable's total surplus, calculated in accordance with the statutory method of accounting, was approximately $2.12 billion, $1.83 billion, and $1.64 billion, respectively. At December 31, 1994, 1993 and 1992, Equitable's total capital, calculated in accordance with the statutory method of accounting and consisting of surplus and the Asset Valuation Reserve, was approximately $3.11 billion, $3.10 billion and $2.27 billion, respectively.\nThe Equitable Companies Incorporated (the \"Holding Company\"), a Delaware corporation, owns all of Equitable's outstanding capital stock. The Holding Company is subject to the informational requirements under the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), and in accordance therewith files reports and other information, including financial statements, with the Securities Exchange Commission\nunder Commission File No. 1-11166. Such reports and other information filed by the Holding Company 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.\nEquitable is a diversified financial service organization serving a broad spectrum of insurance, investment management and investment banking customers. It has been in business since 1859. In 1992, it converted from a mutual life insurance company into a stock life insurance company through a process called \"demutualization.\"\nITEM 2. PROPERTIES\nAt December 31, 1994, approximately 87.8% of the aggregate rentable square feet of the Venture's Properties was leased. Leases covering approximately 7.5%, 7.3% and 4.8% of the Properties rentable square feet are scheduled to expire in 1995, 1996, and 1997 respectively.\nSet forth below is a brief description of each of the Venture's investments at December 31, 1994. Reference is made to Notes 3, 4, 5 and 9 of the Notes to Consolidated Financial Statements in Item 8. FINANCIAL STATEMENTS. The Venture has fee ownership of the land and improvements relating to each of the Properties.\nProjected Annual Aggregate Lease Payments to be Received (in dollars)*\nRange of Lease Expirations\nMajor Tenants\nThe following list sets forth major tenants for certain Properties together with percentage of space used by such tenants:\n-------------------------------- * Lease payments to be received under noncancelable operating leases in effect as of December 31, 1994.\nAll of the remaining Properties are leased in their entirety to their respective tenants.\nDescription of Properties\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, 1994, 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. 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. All payments due under the lease to date have been made.\nRichland Mall is a one-level enclosed mall located in Richland Township, Pennsylvania. Tenants include Bon Ton Department Store (formerly Hess Department Store), Clemens Market, Footlocker, and Radio Shack. At December 31, 1994, the Mall was approximately 88.9% leased with approximately 20,000 square feet vacant. Excluding the two anchor stores, the Mall was 71.8% leased. Leases covering approximately 1.0%, 28.5% and 1.0% of the space are scheduled to expire in 1995, 1996 and 1997, 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. The Hess Department store chain, including the anchor store at Richland Mall, was purchased in 1994 by Bon Ton department stores. The change is considered positive for Richland Mall and preliminary discussions with Bon Ton representatives indicate that the store will remain open and operating.\nOver 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 and cancellations by virtue of tenant bankruptcies. Management continues to aggressively pursue tenants for the remaining vacant space. Wal-Mart Stores, a national discount retailer, has announced plans 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 Bon Ton Department Store and other specialty retail stores within Richland Mall. The current competitive leasing environment and weak retail economy create significant obstacles to maintaining the current level of performance of this Property. Management may attempt to market the property for sale or may decide to undertake a significant renovation of the property. A definite plan of action has not yet been formulated.\n16\/18 Sentry Park West are two four-story office buildings that together contain 190,616 rentable square feet. Tenants include Martin Marietta (formerly General Electric), Liberty Mutual Insurance Company and The Prudential Insurance Company. At December 31, 1994, the property was approximately 73.0% leased. Leases covering approximately 4.3%, 11.9% and 12.1% of the space are scheduled to expire in 1995, 1996 and 1997, respectively. In order to lease the vacant space, the Venture is continuing to incur expenditures for tenant improvements and leasing commissions. 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.\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, 1994, all of the buildings were 100% leased. Tenants include Triangle Engineered Products, Co., Hi Performance, Inc. and Precise Data Service. One lease comprising 37.7% of available space is scheduled to expire in 1995. 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.\n1850 Westfork Drive is a one-story warehouse\/distribution facility located approximately 15 miles west of the Atlanta central business district. At December 31, 1994 the Property was 100% leased to Treadway Exports Limited. 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.\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, 1994 the property was 100% leased. One lease covering approximately 23.5% of the space is schedule to expire in 1996. Tenants include Gruner & Jahr Printing and Publishing, Stericycle, Inc., National Distribution Agency, Jay-N Company, and OKI Supply Company. 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.\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. This reflects a renewal of the previous lease which otherwise would have expired in January 1994. The lease requires the tenant to pay 100% of real estate taxes, insurance, and certain maintenance costs.\nNorthland Center is a regional enclosed mall located in Southfield, Michigan which was transferred to the Venture and Equitable by a deed in lieu of foreclosure on July 22, 1994. Tenants include J.C. Penney, Hudsons, Kohl's and Montgomery Ward. As of December 31, 1994, the Center was approximately 86.4% leased. Leases covering approximately 1.6%, 3.3%, and 10.5% are scheduled to expire in 1995, 1996 and 1997, respectively. A renovation program has commenced at Northland Center in order to improve the marketability of the Center and attract tenants. The construction costs of the renovations are expected to be approximately $12.0 million, of which the Venture's share is expected to be approximately $8.6 million. As of December 31, 1994, approximately $5.2 million of these costs had been expended, of which the Venture's share was approximately $3.7 million. Approximately $4.1 million in capital costs have been accrued but not paid as of December 31, 1994 of which the Venture's share is approximately $2.9 million. The program is expected to be complete in May 1995.\nOn February 17, 1995, Equitable Real Estate, on behalf of the Venture and Equitable, as tenants in common, signed an agreement whereby Kohl's Department Store would be allowed to terminate its lease obligation at Northland Mall. The agreement provides for a payment by Kohl's to the Venture and Equitable totaling $1,750,000 (of which the Venture's share is approximately $1,400,000), in satisfaction of its remaining lease obligations. On March 10, 1995, Equitable, the Venture and Dayton Hudson Corporation signed an agreement allowing Target to locate a store at Northland. Target is a division of Dayton Hudson, which currently operates a Hudson's Department\nStore at Northland. Equitable and the Venture agreed to expend funds in the amount of $1,700,000 (of which the Venture's share is approximately $1,200,000) to ready a site for the Target store and to partially demolish the Kohl's store and redemise the remaining portion of Kohl's into mall shops. Management believes that this transaction is positive for the Center. Target will build its own store, and is considered a more appropriate retailer for the Northland market.\nThe Bank of Delaware Building is a seventeen story office building in Wilmington, Delaware which was transferred to the Venture and Equitable by deed in lieu of foreclosure on November 15, 1994. PNC Bank, a major tenant, occupies 115,085 square feet or 38.1% of the building. PNC's lease expires in May 2005 and contains an option to renew. PNC's rent is substantially below market rates. As of December 31, 1994, the building was approximately 60.5% leased. Leasing the 119,429 square feet of currently vacant space may require substantial renovation expenditures as asbestos is present in a majority of such space. The Venture is currently analyzing the costs of such renovation and cannot make a reasonable prediction as to the extent of such costs. Leases covering approximately 10.1%, 4.2% and 8.0% are scheduled to expire in 1995, 1996 and 1997, respectively.\nMortgage Loans --------------\nOutstanding Mortgage Loans\nBrookdale Zero Note is a first mortgage note secured by Brookdale Center, a regional shopping mall located approximately five miles northwest of the central business district of Minneapolis, Minnesota. The Venture holds a 71.66% participation interest in the zero mortgage note. The Venture acquired its participation interest in 1988 from Equitable which holds the remaining 28.34% interest. The Venture's participation interest had a fair value (including accrued interest) at the time of acquisition of $12,278,885. The borrower is Midwest Real Estate Shopping Center L.P. (\"Midwest\"), a publicly traded limited partnership (formerly Equitable Real Estate Shopping Centers L.P.). The note has an implicit interest rate of 10.2% compounded semiannually with the Venture's portion of the entire amount of principal and accrued interest totaling $25,345,353 due on June 30, 1995. The note provides that the borrower may elect to pay interest currently; however, no interest has been paid to\n--------------------------------------------\n1 Represents the value of the Venture's 71.66% participation interest in principal and accrued interest on the date of acquisition.\n2 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.\ndate. As part of the Northland Center transaction (discussed below), the Brookdale mortgage was modified on July 22, 1994 to provide that if Midwest sells Brookdale Center prior to June 30, 1995, the outstanding principal and accrued interest of the zero note will be paid at the time of sale, together with a defeasance fee equal to 75% of the amount, if any, by which the sale price of Brookdale Center exceeds $45,000,000. For additional information concerning the Brookdale Note and the Brookdale Center, see \"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 Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, all of which information is included as exhibits to this annual report.\nAlthough Midwest is currently attempting to sell the Brookdale Center to a third party, there are currently no agreements, arrangements or understandings with respect to such sale. The Partnership believes that it is unlikely that Midwest would be able to refinance the Brookdale Zero Note between the date hereof and June 30, 1995. Accordingly, if Midwest is unable to consummate a sale of Brookdale Center and repay the Brookdale Zero Note prior to June 30, 1995, the Brookdale Zero Note will be in default.\nMidwest is subject to the informational requirements under the Exchange Act, 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 Midwest 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.\nAt December 31, 1994, Brookdale Center was 80% leased (excluding its anchor stores all of which are in operation). Although the Carson Pirie and Scott chain has recently entered bankruptcy, it continues to operate its anchor store (144,546 sq. ft.) in the Brookdale Center and is, to date, fulfilling its lease obligations.\nJericho Village Loan is a first mortgage loan to the Wilcon Company 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 maturity of the loan on February 1, 1999. 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, 1994 the property was approximately 99% 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.\nMortgage Loans Pursuant to which the Venture Acquired Properties in 1994\nNorthland Zero Note was a first mortgage note secured by Northland Center, a regional enclosed mall which is located outside of Detroit, Michigan. The Venture acquired its 71.66% participation interest in 1988 from Equitable which held the remaining 28.34% interest. The Venture's participation interest had a fair value (including accrued interest) at the time of acquisition of $20,774,985. The borrower was Midwest. The note had an implicit interest rate of 10.2% compounded semiannually with the Venture's portion of the principal and accrued interest totaling $42,882,504 due June 30, 1995. The note provided that the borrower could elect to pay interest currently; however, no interest was paid through July 22, 1994.\nManagement discontinued the accrual of interest on the Northland note during the quarter ended June 30, 1993 as the accreted value of the mortgage approximated the underlying value of the Northland Center. The Northland mortgage note and first mortgage were accounted for as an in-substance\nforeclosure at December 31, 1993 and the zero mortgage note was reclassified as an other real estate asset. The Venture recognized a loss of $7,628,000 as of December 31, 1993 to record Northland Center at its fair market value. This amount included $4,730,000 reserved by the Venture as its share of the $6.6 million to be paid to Midwest on the transfer of Northland Center (see below).\nOn July 22, 1994, Midwest transferred Northland Center to the Venture and Equitable in proportion to their respective undivided interests in the Northland mortgage. Following the transfer which was retroactive as of January 1, 1994, Northland Center was reclassified from other real estate assets to rental properties and income and expenses were recorded from that date. The Venture records its proportionate share of the assets, liabilities, revenues, and expenses of the undivided interests in the Northland Center in accordance with the tenancy in common arrangements set forth in the Participation Agreement dated September 27, 1988 between the Venture and Equitable, which is included as an exhibit to this annual report. The Venture and Equitable paid the owner $6.6 million at the time of transfer (an amount which was determined to approximate the net present value of the anticipated cash flow from Northland Center, subject to closing adjustments, for the period from January 1, 1994 through June 30, 1995, the date the Northland mortgage would have matured). As part of the transaction, the Brookdale mortgage was modified as discussed above.\nFor additional information concerning the Northland Note, reference is made to the information under \"REAL PROPERTY INVESTMENTS--The Zero Notes\" and \"REAL PROPERTY INVESTMENT--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 Quarterly Report of Form 10-Q for the Quarter ended June 30, 1988, all of which information are included as exhibits to this annual report.\nBank of Delaware Building Loan was a first mortgage loan secured by a 17-story office building in the Wilmington central business district. The owners of The Bank of Delaware Building defaulted on the mortgage loan receivable and the Venture accounted for the transaction as an in-substance foreclosure at December 31, 1993. Accordingly, the mortgage loan receivable was reclassified to other real estate assets at its estimated fair market value as of that date and the Venture began recording operating revenues and expenses of the building. In the third quarter, 1994, the Venture recognized a loss of $1,000,000 due to valuing The Bank of Delaware Building at the most recent estimated fair market value. Subsequently, on November 15, 1994, the Venture acquired title to The Bank of Delaware Building by a deed in lieu of foreclosure. In connection with the deed in lieu transaction, the Venture received a $350,000 cash payment plus the property's operating cash account, which reduced the loss on the transaction to approximately $380,000.\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.\nOn December 29, 1994, a class action suit was filed in United States District Court, Southern District of New York (94 Civ. 9293), against Midwest, the general partner of Midwest, the members of the Board of Directors of such general partner, Equitable and Equitable Real Estate. The complaint alleges that defendants breached their fiduciary duties and violated federal securities laws in connection with the Midwest's sale of Northland Center to the Venture and Equitable. Neither the Venture nor the Partnership has been named as a party to the lawsuit.\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 REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER 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. However, Merrill Lynch, Pierce, Fenner & Smith Incorporated (\"MLPF&S\") offers a 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 BACs or Interests.\nBACs are transferable as provided in Article Seven of the Partnership Agreement. 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 March 13, 1995 was 12,454.\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 are entitled to receive cash distributions, allocations of taxable income and tax loss and guaranty proceeds as provided in Article Four of the Partnership Agreement. For information regarding the Guaranty Agreement, see Item 1. BUSINESS. Since inception, the Partnership has made the following distributions:\nThe distribution made on August 31, 1992 to holders of record as of June 30, 1992 includes a $0.162 distribution of Sale or Financing Proceeds associated with the termination of the lease with Saab-Scania of America, Inc. (\"Saab\") at 1550 Westfork Drive.\nAll of the distributions made in 1994 and 1995 constitute distributions of Sale or Financing Proceeds derived from a portion of the proceeds from the pay-off of the Mortgage Loan to the Second Merritt Seven Joint Venture (the \"201 Merritt Seven Loan\") on November 22, 1993. See Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for further information regarding cash distributions.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nThe following sets forth the selected financial data for the Partnership on a consolidated basis for the years ended December 31, 1990, 1991, 1992, 1993 and 1994:\nThe above selected financial data for the years 1992 through 1994 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, 1994, the Partnership had cash and short-term investments of approximately $1.8 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 Northland Center renovation program, and for capital needs at the Venture's other Properties. 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.\nIn addition, the Partnership owns an 80% interest in the Venture. At December 31, 1994, the Venture owned ten real properties, one undivided interest in a real property as a tenant in common with Equitable and two Mortgage Loans on real properties (including a Zero Note). Nine of the Properties were purchased at an aggregate cost of approximately $68.1 million. The other two Properties, Northland Center and The Bank of Delaware Building (originally properties that secured a Zero Note and a Fixed-Rate Mortgage Loan, respectively), were transferred to the Venture during 1994 in separate deed in lieu of foreclosure transactions. The fair market value of the Venture's undivided interest in the Northland Center Zero Coupon Mortgage Note Receivable immediately preceding the transfer was approximately $32.2 million and the fair market value of The Bank of Delaware Building Mortgage Note immediately preceding the transfer was $8.5 million. At December 31, 1994 the Venture also had approximately $19.7 million in cash and short-term investments which is intended to be utilized primarily to create reserves to complete the Northland Center renovation program, fund capital improvements at the Venture's other Properties, cover general working capital requirements, and make distributions to the Venture partners. Reserves may also be utilized to complete renovations at Richland Mall. For 1992, 1993 and 1994, the Partnership received distributions from the Venture totaling $7,176,400, $3,040,000 and $1,084,996, respectively.\nAll 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 Fixed-Rate Mortgage Loan 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. Under the terms of the Brookdale Zero Note, principal and interest in the aggregate amount of $25,345,353 is due in June 1995.\nCash received from tenant-related revenues increased approximately $14.1 million from 1993 to 1994. This increase is due to the cash flow for the period from January 1, 1994 to December 31, 1994 for Northland Center and The Bank of Delaware Building of approximately $12.6 million and $1.7 million, respectively.\nInterest received decreased approximately $1.7 million from 1993 to 1994 due to the fact that subsequent to the December 31, 1993 interest payment made in January 1994, the previous owners of The Bank of Delaware Building defaulted on their mortgage by not paying the monthly interest payments of approximately $82,000 for the remainder of 1994. Additionally, approximately $1.3 million of interest relating to the 201 Merritt Seven Mortgage Loan was received in 1993. However, due to the early payoff of the Mortgage Loan in the fourth quarter of 1993, no such interest was received in 1994. This decrease in interest received is offset by an increase in interest received from cash and short-term investments of approximately $500,000 which is directly related to the increased balance in cash short-term investments and an increase in the interest rates in the later part of 1994.\nCash paid for operating activities increased approximately $9.6 million from 1993 to 1994. This increase is due primarily to the cash outflows for the period from January 1, 1994 to December 31, 1994 for Northland Center and The Bank of Delaware Building of approximately $7.6 million and $1.6 million, respectively.\nDistributable Cash from operations is distributed in accordance with the terms of the Partnership Agreement, which provides 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 semiannual 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 made on February 28, 1991 at the rate of $0.25 per BAC. A semiannual distribution of Distributable Cash, for the period ended June 30, 1991, was made on August 30, 1991 at the rate of $0.50 per BAC and another semiannual 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 semiannual 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 semiannual 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 semiannual period that would have been made in August 1993. There were no distributions of Distributable Cash from operations during 1994. The determination to withhold such distributions 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, including but not limited to renovations which may be required at the Bank of Delaware Building as well as at Richland Mall.\nIt is anticipated that the Partnership will not make distributions of Distributable Cash from operations in 1995. 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\nvacant space at certain of its Properties, most significantly at 16 and 18 Sentry Park West, Richland Mall, Northland Center, and The Bank of Delaware Building. 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 income allocated to a BAC Holder may substantially exceed the amounts, if any, distributed to such BAC Holder.\nThe Partnership's share of Sale or Financing Proceeds in the amount of $0.162 per BAC associated with the termination of its lease with Saab at 1850 Westfork Drive was distributed to BAC Holders and Limited Partners on August 31, 1992. In addition, the Partnership received $8.4 million during 1993 in connection with the pay-off of the 201 Merritt Seven Loan which also constitutes Sale or Financing Proceeds. In connection with the Northland Mall transaction, the Venture received approximately $498,691 for early lease termination payments of which the Partnership's share is approximately $398,952. This amount is classified as Sale or Financing Proceeds and is being held as reserve for future improvements on the Properties. Portions of the Sale or Financing Proceeds associated with the 201 Merritt Seven Loan pay-off were distributed to the BAC Holders and Limited Partners in 1994 and 1995. See Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. 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.\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 or 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 a minimum return equal to their original capital contributions plus a simple annual return equal to 9.75% simple interest per annum 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. Capital contributions by the BAC Holders totaled $108,484,500. As of December 31, 1994, the cumulative 9.75% simple annual return was $71,541,224. As of December 31, 1994, cumulative distributions by the Partnership to the BAC Holders totaled $13,626,224, of which $11,662,621 is attributable to income from operations and $1,963,603 is attributable to sales of Venture assets, principal payments on Mortgage Loans and other capital events. Another $813,671 in capital proceeds was distributed to the BAC Holders in February 1995.\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 Offering, 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 increased approximately $11.8 million in 1994 as compared to 1993. A large portion of this increase is due to the Northland Center transaction and renovation program. The Venture's portion of the $6.6 million paid to the previous owners of Northland Center for the cash flows from January 1, 1994 to July 22, 1994 (the transfer date) was approximately $4.7 million. Additionally, as a result of the renovation program in place at Northland Center, the Venture has capitalized approximately $6.6 million in improvements to the Center. Other properties which incurred significant improvements during 1994 as an effort to lease vacant space were 16\/18 Sentry Park West and 1345 Doolittle Drive, each of which had\napproximately $600,000 in improvements during the year. These increases are offset by the $1.0 million write-down on The Bank of Delaware Building and an approximately $2.2 million increase in accumulated depreciation.\nOther assets increased in 1994 as compared to 1993 primarily due to the tenant rentals receivable at December 31, 1994 for Northland Center which was approximately $1.3 million.\nTotal liabilities increased in 1994 as compared to 1993 due partially to the renovation program at Northland Center which resulted in accrued capital expenditures at December 31, 1994 of approximately $2.9 million. Additionally, the accrued liabilities relating to the operations at Northland Center and The Bank of Delaware Building at December 31, 1994 were approximately $1.3 million and $200,000, respectively. Also, the distribution declared as of December 31, 1994 was approximately $271,000 greater than the distribution declared as of December 31, 1993.\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. Over the past several years, the rate of inflation has exceeded the rate of rental rate growth in many of the Venture's properties. During the recent real estate downturn, rental rates have dropped, indicating a negative growth rate. This negative growth appears to have ceased, and rental rates have stopped dropping in many of the Properties' markets. Real recovery in rental rates, if achieved at all, will likely occur over an extended period of time.\nResults of Operations\nRental income for 1994 increased approximately $15.1 million as compared to 1993. This change is primarily the result of Northland Center and The Bank of Delaware Building generating rental income of approximately $14.1 and $1.9, respectively. These increases are partially offset by a decrease in rental income due to a vacancy at 16\/18 Sentry Park West which occurred during the fourth quarter 1993 and which was not completely released during 1994. Rental income for 1993 decreased approximately $1.1 million as compared to 1992. This change is primarily a result of the receipt of $1.1 million pursuant to an agreement between the tenant and Venture regarding the termination of the lease on 1850 Westfork Drive.\nInterest on Zero Notes receivable decreased in 1994 as compared to 1993, and in 1993 as compared to 1992, due to the non-accrual of interest beginning June 1993 on the Northland Zero Note and the transfer of Northland Center to the Venture and Equitable during 1994. The non-accrual of interest offset an increase in interest attributable to the compounding effect typical of these types of investments for the full year 1994 and 1993 for the Brookdale Zero Note and for the first half of the year in 1993 for the Northland Zero Note.\nAs stated above, interest on Mortgage Loans decreased in 1994 as compared to 1993 due to the fact that subsequent to the December 1993 payment made in January 1994, the previous owner of The Bank of Delaware Building defaulted on its mortgage by not paying the monthly interest payments on the mortgage of approximately $82,000 per month for the remainder of 1994. Additionally, approximately $1.3 million of interest relating to the 201 Merritt Seven Loan was received in 1993. However, due to the early payoff of the Mortgage Loan in the fourth quarter of 1993, no such interest was received in 1994. Interest on Mortgage Loans remained fairly constant from 1992 to 1993.\nAlso stated above, interest from short-term investments increased in 1994 and compared to 1993 primarily as a result of having a large cash and short-term investments balance for the whole year due to the creation of reserves for Northland Center and an increase in interest rates in the later part of 1994. Additionally, interest income from a money market account at Northland Center which earned approximately $100,000 for the period from January 1, 1994 to December 31, 1994. Interest on short-term investments remained fairly constant from 1992 to 1993.\nOperating expenses excluding the realized loss on mortgage loan receivable, loss on write-down of zero coupon mortgage, and loss on write-down of other real estate assets increased from 1993 to 1994 primarily as a result of the operating expenses of Northland Center and The Bank of Delaware Building from the period from January 1, 1994 to December 31, 1994 of approximately $9.1 million and $1.7 million, respectively. Operating expenses excluding the realized loss on mortgage loan receivable, loss on write-down of zero coupon mortgage, and loss on write-down of other real estate assets remained fairly constant from 1992 to 1993.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe following financial statements are included in Item 14 of this annual report:\nIndependent Auditors' Report.\nConsolidated Balance Sheets, December 31, 1994 and 1993.\nConsolidated Statements of Operations for the years ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Partners' Capital for the years ended December 31, 1994, 1993 and 1992.\nConsolidated Statements of Cash Flows for the years ended December 31, 1994, 1993 and 1992.\nNotes to Consolidated Financial Statements.\nSelected Quarterly Financial Data (included in Note 11 to the Notes to Consolidated Financial Statements).\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 is a limited partnership and has no directors or officers.\nFor informational purposes only, 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, which is a wholly-owned subsidiary of the Holding Company.\nThe names and titles of the directors and officers of the Managing General Partner as of March 15, 1995 are as follows:\nThe business experience of the directors and executive officers of the Managing General Partner is set forth below.\nGeorge R. Puskar has been Chairman of the Board of the Managing General Partner since December 1986 and Chairman and Chief Executive Officer of Equitable Real Estate since August 1988. He is also a Vice President of Equitable.\nPaul J. Dolinoy has been President, Chief Executive Officer and a Director of the Managing General Partner since December 1986 and 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 has been Executive Vice President, Chief Operating Officer and a director of the Managing General Partner since December 1986 and 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.\nHarry D. Pierandri has been an Executive Vice President of the Managing General Partner since March 1987 and 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.\nEdward G. Smith has been an Executive Vice President of the Managing General Partner since March 1987 and has been an Executive Vice President of Equitable Real Estate since 1988. Mr. Smith currently heads the commercial mortgage origination business unit of Equitable Real Estate.\nTimothy J. Welch has been an Executive Vice President of the Managing General Partner since March 1987 and is a Senior Executive Vice President of Equitable Real Estate in charge of its relationship with the Equitable's General Account Real Estate Portfolio. Prior thereto, Mr. Welch was in charge of Equitable's New York office.\nB. Stanton Breon has been Vice President and Secretary of the Managing General Partner since September 1993. He 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. Prior thereto, Mr. Breon was a Director of Appraisal for the Philadelphia regional office of Equitable Real Estate, responsible for valuation of real estate portfolios as well as coordination of the Commercial Loan Restructuring\/Workout division of the office.\nPeter J. Urdanick has been Vice President and Assistant Treasurer of the Managing General Partner since January 1995. Prior thereto, Mr. Urdanick was Vice President, Controller and Treasurer of the Managing General Partner since December 1986. Mr. Urdanick is also 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.\nCharles R. Beaver has been a Vice President of the Managing General Partner since June 1994, and is an Executive Vice President of Equitable Real Estate. Mr. Beaver is in charge of the Chicago regional office of Equitable Real Estate. Prior thereto, Mr. Beaver was in charge of the Denver regional office of Equitable Real Estate.\nPatricia C. Snedeker has been Chief Financial Officer of the Managing General Partner since June 1994 and Vice President and Controller since January 1995. Mrs. Snedeker is also a Senior Vice President of Equitable Real Estate, responsible for overseeing the Institutional Advisors real estate accounting area of the organization. Mrs. Snedeker has been with Equitable Real Estate since October 1982.\nAssociate General Partner\nThe Associate General Partner is a limited partnership and has no directors or officers. The 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, 1995 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 has been Chairman, Chief Executive Officer and a director of the Associate General Partner since September 1991 and President and Chief Operating Officer of the Associate General Partner since January 1995. Mr. Brunson joined Merrill Lynch in 1986 and was elected Chairman and Chief Executive Officer of MLH in August 1991. From 1986 to 1990, he served as Treasurer of Merrill Lynch and subsequently he coordinated Merrill Lynch's restructuring activities.\nThomas J. Brown has been Executive Vice President and Director of the Associate General Partner since December 1986, 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 has been Senior Vice President and Director of the Associate General Partner since December 1986, joined MLPF&S in 1975 and is a Senior Vice President of MLH and Manager of its Real Estate Acquisitions and Dispositions Group.\nMichael A. Karmelin joined MLH in 1994 and is a Vice President and Chief Financial Officer of MLH, responsible for its accounting, treasury and tax functions. Prior to joining MLH, Mr. Karmelin held several senior financial positions with Merrill Lynch since 1985.\nGeorge I. Wagner joined MLH in 1993 and is a Senior Vice President of MLH and is responsible for managing its information systems and the Investor Services and Human Resources functions. Prior to joining MLH, Mr. Wagner worked in various information systems management positions at Merrill Lynch since 1987.\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 Partner 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\nforth 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). 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. MLPF&S is the record owner of approximately 79% 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.\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.\n(a) 1. The following financial statements are filed with this report on the pages indicated:\n2. The following audited financial statement schedules are filed with this report on the pages indicated:\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.\n3. Exhibits\nSee Item 14(c) below.\n(b) The Partnership filed no Current Reports on Form 8-K during the last quarter of the period covered by this Report.\n(c) Exhibits.\n4. (a) Amended and Restated Agreement of Limited Partnership dated April 23, 1987. Included as an Exhibit to the Prospectus (see Exhibit 99(a)).\n(b) Amendment to Amended and Restated Agreement of Limited Partnership dated February 9, 1988 (incorporated by reference to Exhibit 4(b) to the Partnership's Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1987 (File No. 33-11064) (the \"1987 10-K\")).\n10. Material Contracts.\n(a) Form of Beneficial Assignee Certificate (incorporated by reference to Exhibit 10(a) to Pre-Effective Amendment No. 1 to the Registration Statement of the Partnership (File No. 33-11064)).\n(b) Agreement Between General Partners (incorporated by reference to Exhibit 10(c) to the 1987 10-K).\n(c) Joint Venture Agreement of EML Associates (incorporated by reference to Exhibit 10(d) to the 1987 10-K).\n(d) Investment Guaranty Agreement between the Venture and EREIM LP Associates (incorporated by reference to Exhibit 10(e) to the 1987 10-K).\n(e) Assignment Agreement between Registrant and Venture (incorporated by reference to Exhibit 10(f) to the 1987 10-K).\n(f) Keep Well Agreement between The Equitable Life Assurance Society of the United States and EREIM LP Corp. (incorporated by reference to Exhibit 10(g) to the 1987 10-K).\n(g) Amended and Restated Agreement of General Partnership of EREIM LP Associates (incorporated by reference to Exhibit 10(h) to the 1987 10-K).\n(h) Promissory Notes and Mortgages Relating to Brookdale and Northland (incorporated by reference to Exhibit 10(i) to Pre-Effective Amendment No. 1 to the Registration Statement of the Partnership (File No. 33-11064)).\n(i) Contract to Purchase 1200 Whipple Road, Union City, California (incorporated by reference to Exhibit 10(j)) to Post-Effective Amendment No. 1 to the Registration Statement of the Partnership (File No. 33-11064)).\n(j) Lease Agreement Pertaining to 1200 Whipple Road, Union City, California (incorporated by reference to Exhibit 10(k) to Post-Effective Amendment No. 1 to the Registration Statement of the Partnership (File No. 33-11064)).\n(k) Participation Agreements relating to Brookdale and Northland Notes (incorporated by reference to Exhibit 10(1) to the 1987 10-K).\n(l) Amendments to Participation Agreements relating to Brookdale and Northland Notes (incorporated by reference to Exhibit 10(1) to Annual Report on Form 10-K for the Fiscal Year Ended December 31, 1988 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064) (the \"1988 10-K\").\n(m) Agreement of Sale between Richland Mall Associates and EML Associates dated July 19, 1988 (incorporated by reference to Exhibit No. 1 to Form 8-K dated July 19, 1988 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).\n(n) Note and Mortgage dated September 27, 1988 relating to the loan by EML to Second Merritt Seven (incorporated by reference to Exhibit No. 1 to Form 8-K dated September 27, 1988 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).\n(o) Form of Participation Agreement between The Equitable Life Assurance Society of The United States and EML Associates dated September 27, 1988 (incorporated by reference to Exhibit No. 2 to Form 8-K dated September 27, 1988 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).\n(p) Agreement of Sale among EML, Blue Bell Office Campus Associates, a Pennsylvania limited partnership, E. F. Hansen Jr. and G. Eileen Hansen dated December 2, 1988 (incorporated by reference to Exhibit No. 1 to Form 8-K dated December 2, 1988 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).\n(q) Agreement of Sale between Provident Mutual Life Insurance Company of Philadelphia and EML Associates dated December 27, 1988 (incorporated by reference to Exhibit No. 1 to Form 8-K dated December 27, 1988 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).\n(r) Agreement of Sale between Anderson Partners (Southside\/Corporate Lakes) L.P., Gene Anderson, Auerbach Associates Ltd. and EML Associates dated as of December 31, 1988 (incorporated by reference to Exhibit No. 2 to Form 8-K dated December 27, 1988 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).\n(s) Note and Mortgage and Security Agreement dated January 31, 1989 relating to loan by EML to The Wilcon Company (incorporated by reference to Exhibit No. 4 to Form 8-K dated December 27, 1988 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).\n(t) Note and Mortgage dated February 28, 1989 relating to the loan by EML to 300 Delaware Avenue Associates (incorporated by reference to Exhibit 10(u) to the 1988 10-K.)\n(u) Agreement of Sale among Lincoln San Leandro IV Limited Partnership, Patrician Associates, Inc. and EML Associates dated April 21, 1989 (incorporated by reference to Exhibit (c)1 to Form 8-K dated May 18, 1989 of ML\/EQ Real Estate Portfolio, L.P. (File No. 33-11064)).\n(v) Agreement dated March 25, 1994 between The Equitable Life Assurance Society of the United States and Midwest Real Estate Shopping Centers L.P. (formerly Equitable Real Estate Shopping Centers L.P.) (incorporated by reference to Item 10(v) to Form 10-K dated December 31, 1994 of EREIM LP Associates (the \"1994 10-K\")).\n(w) Deed in Lieu of Foreclosure Agreement dated November 15, 1994 by and between Three Hundred Delaware Avenue Associates, L.P. and EML Associates (incorporated by reference to Exhibit 10(w) to the 1994 10-K).\n(x) Lease Termination Agreement dated as of January 27, 1995 by and between The Equitable Life Assurance Society of the United States and Kohl's Department Stores, Inc. (incorporated by reference to Exhibit 10(x) to the 1994 10-K).\n(y) Amendment to Lease Termination Agreement dated as of February 17, 1995 by and between The Equitable Life Assurance Society of the United States and Kohl's Department Stores, Inc. (incorporated by reference to Exhibit 10(y) to the 1994 10-K).\n(z) Purchase Agreement dated as of March 10, 1995 by and among The Equitable Life Assurance Society of the United States, the Venture and Dayton Hudson Corporation (incorporated by reference to Exhibit 10(z) to the 1994 10-K).\n27. Financial Data Schedule\n99. Additional Exhibits.\n(a) Prospectus dated April 23, 1987, as supplemented by supplements dated December 29, 1987, March 3, 1988 and March 17, 1988 (incorporated by reference to Exhibit 28 to the 1987 10-K).\n(b) Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 (incorporated by reference to File No. 33-11064).\n(c) Current Report on Form 8-K of the Partnership dated July 19, 1988 (incorporated by reference to File No. 33-11064).\n(d) Current Report on Form 8-K of the Partnership dated September 27, 1988 (incorporated by reference to File No. 33-11064).\n(e) Current Report on Form 8-K of the Partnership dated December 2, 1988 (incorporated by reference to File No. 33-11064).\n(f) Current Report on Form 8-K of the Partnership dated December 27, 1988 (incorporated by reference to File No. 33-11064).\n(g) Current Report on Form 8-K of the Partnership dated May 18, 1989 (incorporated by reference to File No. 33-11064).\n(h) Audited Financial Statements of Midwest Shopping Center, L.P. (incorporated by reference to Exhibit 10(h) to 1994 10-K).\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, 1994 and 1993, and the related consolidated statements of operations, partners' capital, and cash flows for each of the three years ended December 31, 1994, 1993 and 1992. 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, 1994 and 1993 and the results of its operations and its cash flows for each of the three years ended December 31, 1994, 1993 and 1992 in conformity with generally accepted accounting principles.\nOur audits also comprehended the consolidated supplemental schedules of the Partnership as of December 31, 1994 and for each of the three years ended December 31, 1994, 1993 and 1992. 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 --------------------- February 14, 1995 (February 17, 1995 as to Note 12) Atlanta, Georgia\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1994 and 1993\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993, and 1992\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 1994, 1993, and 1992\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993, and 1992\nSee notes to consolidated financial statements.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1994, 1993, and 1992\nSUPPLEMENTAL INFORMATION REGARDING NONCASH INVESTING ACTIVITIES\nThe Venture accrued $2,948,006 and $225,000 in capital expenditures that were not paid before December 31, 1994 and 1993, respectively.\nThe Venture reclassified $27,517,363 relating to Northland Center from other real estate assets to rental properties as a result of the deed in lieu of foreclosure transaction executed on July 22, 1994.\nDuring 1994, the Venture took a $1,000,000 write-down on other real estate assets which reduced other real estate assets relating to The Bank of Delaware Building to $8,500,000. On November 15, 1994, a deed in lieu of foreclosure was executed resulting in a reclassification of the remaining $8,500,000 from other real estate assets to rental properties.\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\"). The 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.\nThe Managing General Partner of the Partnership is EREIM Managers Corp., (the \"Managing General Partner\"), an affiliate of 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 dated April 23, 1987 as amended on February 9, 1988 (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 partnership 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 at which time 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.\nThe Venture records it's proportionate share of the assets, liabilities, revenues, and expenses of the undivided interests in Northland Center.\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\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\ngeneral 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.\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 five to 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 note receivable and The Bank of Delaware Building mortgage loan receivable at the date such receivables were considered to be in-substance foreclosures (see Notes 4 and 5). Subsequent to such determination, operating revenues and expenses were recorded for Northland Center and The Bank of Delaware Building. During 1994, both Northland Center and The Bank of Delaware Building were acquired through separate deed in lieu of foreclosure transactions and the related assets were reclassified to rental properties.\nZero Coupon Mortgage Note Receivable\nThe zero coupon mortgage note receivable is carried at the present value which is equal to the discounted principal plus accrued interest. Interest income is recognized ratably over the term of the note using the constant rate of interest implicit in the note (Note 4).\nMortgage Loan Receivable\nThe mortgage loan receivable is stated at cost (Note 5).\nOffering Costs\nOffering costs, including the acquistion\/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.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\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).\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 1994 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 the Partnership's financial instruments, including the mortgage loan receivable, have terms such that the book value approximates fair value. There is no readily available source of zero coupon mortgage financing and, therefore, Management has determined that the estimation of a fair value of the zero coupon note is not practicable. See Note 4 regarding the write-down of the Northland zero coupon mortgage note and Note 5 regarding the write-down of other real estate assets relating to The Bank of Delaware Building.\n3. RENTAL PROPERTIES\nAs of December 31, 1994, 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 below. The Bank of Delaware Building and Northland Center properties are not included in the 1993 amounts presented below. Refer to Notes 4 and 5 for further discussion of these properties.\n4. ZERO COUPON MORTGAGE NOTES RECEIVABLE\nThe Venture holds a 71.66% participation interest in a zero coupon mortgage note. The property which secures this first mortgage note is Brookdale Center which is located outside of Minneapolis, Minnesota. The Venture acquired its participation interest in 1988 from Equitable which holds the remaining 28.34% interest. The Venture's participation interest had a fair value (including accrued interest) at the time of acquisition of $12,278,885. The borrower is Midwest Real Estate Shopping Center L.P. (\"Midwest\"), a publicly traded limited partnership, (formerly Equitable Real Estate Shopping Centers, L.P.). The note has an implicit interest rate of 10.2% compounded semiannually with the Venture's portion of the entire amount of principal and accrued interest totaling $25,345,353 due on June 30, 1995. The note provides that the borrower may elect to pay interest currently; however, no interest has been paid to date. As part of the Northland Center transaction (discussed below), the Brookdale mortgage was modified on July 22, 1994 to provide that if\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nMidwest sells Brookdale Center prior to June 30, 1995, the outstanding principal and accrued interest of the zero note will be paid at the time of sale, together with a defeasance fee equal to 75% of the amount, if any, by which the sale price of Brookdale Center exceeds $45 million.\nUntil July 22, 1994 the Venture also held a 71.66% participation interest in a zero coupon mortgage note and the first mortgage on Northland Center which is located outside of Detroit, Michigan. The Venture acquired its participation interest in 1988 from Equitable which held the remaining 28.34% interest. The Venture's participation interest had a fair value (including accrued interest) at the time of acquisition of $20,774,985. The borrower was Midwest. The note had an implicit interest rate of 10.2% compounded semiannually with the Venture's portion of the entire amount of principal and accrued interest totaling $42,882,504 due on June 30, 1995. The note provided that the borrower could elect to pay interest currently; however, no interest was paid through July 22, 1994.\nManagement discontinued the accrual of interest on the Northland note during the quarter ended June 30, 1993 as the accreted value of the mortgage approximated the underlying value of the Northland Center. The Northland mortgage note and first mortgage were accounted for as an in-substance foreclosure at December 31, 1993 and the zero coupon mortgage note was reclassified as an other real estate asset. The Venture recognized a loss of $7,628,000 as of December 31,1993 to record Northland Center at its fair market value. This amount included $4,730,000 reserved by the Venture as its share of the $6.6 million to be paid to Midwest on the transfer of Northland Center (see below).\nOn July 22, 1994, Midwest transferred Northland Center to the Venture and Equitable in proportion to their respective undivided interests in the Northland mortgage. Following the transfer, which was retroactive as of January 1, 1994, Northland Center was reclassified from other real estate assets to rental properties and income and expenses were recorded from that date. The Venture records its proportionate share of the assets, liabilities, revenues, and expenses of the undivided interests in Northland Center in accordance with the tenancy in common arrangements in the Participation Agreement between the Venture and Equitable. The Venture and Equitable paid the owner $6.6 million at the time of transfer (an amount which was determined to approximate the net present value of the anticipated cash flow from Northland Center, subject to closing adjustments for the period from January 1, 1994 through June 30, 1995, the date the Northland mortgage would have matured). As part of the transaction, the Brookdale mortgage was modified as discussed above.\nIn connection with the transfer of Northland Center, the Venture and Equitable modified their agreement with Dayton Hudson, which operates one of the anchor stores at Northland Center, and entered into an agreement to add Montgomery Ward as an additional anchor. Montgomery Ward has since been added. The Venture and Equitable have also commenced a renovation program at Northland Center. The construction costs of the renovations are expected to be approximately $12.0 million, of which the Venture's share is expected to be approximately $8.6 million. As of December 31, 1994, approximately $5.2 million of these costs had been expended, of which the Venture's share was approximately $3.7 million. Approximately $4.1 million in capital costs have been accrued but not paid as of December 31, 1994 of which the Venture's share is approximately $2.9 million.\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 in value of the underlying security for the loan. In\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nreceiving $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 was collateralized by a seventeen-story office building in Wilmington, Delaware. The loan was bearing interest at 10.375% per annum with interest only of $82,135 due monthly to the maturity date of March 1999. The owners of The Bank of Delaware Building defaulted on the mortgage loan receivable and the Venture accounted for this transaction as an in-substance foreclosure at December 31, 1993. Accordingly, the mortgage loan receivable was reclassified to other real estate assets at its estimated fair market value as of that date and the Venture began recording operating revenues and expenses of the building. In the third quarter, 1994, the Venture recognized a loss of $1,000,000 due to valuing The Bank of Delaware Building to the most recent estimated fair market value. Subsequently, on November 15, 1994, the Venture acquired title to The Bank of Delaware Building by a deed in lieu of foreclosure. In connection with the deed in lieu transaction, the Venture received a $350,000 cash payment plus the property's operating cash account which reduced the loss on the transaction to approximately $380,000.\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. Payments on the guaranty are due 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 sale or financing proceeds, and funds in reserves, as defined in the Partnership Agreement. The limited partners' original cash contributions have been adjusted by that portion of distributions paid through December 31, 1994, 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 under the guaranty agreement as of December 31, 1994 is limited to $249,485,801, plus the value of EREIM LP Associates' Interest in the Venture less any amounts contributed by EREIM LP Associates to the Venture to fund cash deficits.\nCapital contributions by the BAC Holders totaled $108,484,500. As of December 31, 1994, the cumulative 9.75% simple annual return was $71,541,224. As of December 31, 1994, cumulative distributions by the Partnership to the BAC Holders totaled $13,626,224, of which $11,662,621 is attributable to income from operations and $1,963,603 is attributable to sales of Venture assets, principal payments on Mortgage Loans and other capital events. Another $813,671 in capital proceeds was distributed to the BAC Holders in February 1995.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\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, 1994, 1993 and 1992, the total expense for this fee was $502,682, $409,710, and $409,710, respectively.\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, 1994, 1993 and 1992 the total expense for this fee was $58,492, $100,086, and $100,086, respectively.\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, 1994, 1993 and 1992, the total expense for this fee was $160,460, $161,409, and $162,066, respectively.\nProperty Management Fees\nProperties are managed and leased by either third-party managing and leasing agents or by affiliates of Equitable Real Estate, Compass Management and Leasing, Inc. (\"Compass\") and Compass Retail, Inc. (\"Compass Retail\"). Property management fees are generally established at specified percentages of 1% to\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n5% of the gross receipts of the properties as defined in the management agreements. Property management fees for properties managed by Compass and Compass Retail were $217,513, $39,137, and $14,842 in 1994, 1993, and 1992, respectively.\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 has been assigned to EREIM LP Associates. For the years ended December 31, 1994, 1993 and 1992, the total expense for this fee was $642,645, $644,871, and $646,405, 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 distributed 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.\nTaxable income and loss will generally be allocated 1% to the general partners and 99% to the limited partners. Distributions 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, 1994 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, percentage rents. Contingent rentals, which include percentage rents included in rental income for the years ended December 31, 1994, 1993, and 1992, totaled $525,673, $93,065, and $133,109, respectively. The amount of escalation charges included in rental income totaled $9,007,436, $1,249,544, and $1,269,548 for the years ended December 31, 1994, 1993, and 1992, 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 an annual base rent of $1,026,156 under a lease which expires in August 2003.\nMartin Marietta (formerly General Electric) occupies approximately 48.2% of 16 Sentry Park West at an annual base rent of $348,360 under two six month extensions of their lease which expired in December 1993. Martin Marietta signed a third six month extension of their lease effective January 1, 1995 which expires June 30, 1995. Liberty Mutual Insurance Group occupies approximately 30.1% (28,355 square feet) of 18 Sentry Park West at an annual base rent of $343,927 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 ending August 1995 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 44.1% (143,852 square feet) of 1345 Doolittle Drive at an annual base rent of $473,868 under a lease which expires in August 1998.\nThe buildings located at 701 Maple Lane, 733 Maple Lane, 7550 Plaza Court and 800 Hollywood are 100% leased as of December 31, 1994. One lease comprising approximately 27.3% of the available space is scheduled to expire in November 1995.\nML\/EQ REAL ESTATE PORTFOLIO, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nHudson's department store (a division of Dayton-Hudson) occupies approximately 35.6% (487,035 square feet) of Northland Center under a lease which expires January 2004. Additionally, Montgomery Ward operates a 117,750 square foot store at Northland Center under a ground lease. This store, constructed by Montgomery Ward, is not included in the gross leasable area of the mall.\nPNC Bank occupies approximately 38.1% of the Three Hundred Delaware Building at an annual rent of $350,000. The lease expires in May 2005.\nBon Ton Department Store (formerly Hess) occupies approximately 46.3% (84,405 square feet) of Richland Mall, under a lease which expires in December 2006. Additionally, Clemens Markets (a regional grocer) occupies approximately 14.3% (25,988 square feet) of Richland Mall under a lease which expires May 1996.\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 1994 and 1993 is summarized as follows:\n(A) In the second quarter, 1994 operating results became available to record the operating revenues and expenses of Northland Center which had been classified as an in-substance foreclosure as of December 31, 1993. Prior to such quarter, the Partnership did not record operating results due to the lack of reliable estimates. Therefore, six months of operating activity for Northland Center was recorded in the second quarter of 1994. Total income and net income for the six month period ended June 30, 1994 for Northland Center was $7,058,996 and $2,566,734, respectively.\n(B) In the third quarter 1994, a write-down of $1,000,000 was taken on other real estate assets relating to The Bank of Delaware Building based on the most recent estimated fair value of the property.\n(C) The net income from The Bank of Delaware Building was estimated to be immaterial to the overall financial statements for the first three quarters of 1994, therefore, a detailed break-out of the revenues and expenses was not provided. Detailed estimates became available after the deed in lieu of foreclosure transaction was executed in the fourth quarter 1994. Total income and net income (loss) recorded in the fourth quarter 1994 was $1,853,630 and $(248,506), respectively.\n(D) In connection with the deed in lieu of foreclosure on The Bank of Delaware Building in the fourth quarter 1994, cash of $350,000 was received in addition to the operating cash account of the property which resulted in a reduction of $620,105 to the $1,000,000 loss previously recorded in the third quarter.\n(E) In the fourth quarter 1993, 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.\n12. SUBSEQUENT EVENT\nPursuant to an agreement with Kohl's Department Stores, Inc. (\"Kohl's\") finalized on February 17, 1995, Equitable agreed to accept $1,750,000 in connection with the termination of the Kohl's lease on behalf of the tenancy in common arrangement between the Venture and Equitable. The Venture's portion of the termination payment is approximately $1,400,000 which will be recognized by the Venture in the first quarter of 1995. Upon termination of the lease, Kohl's is released from any remaining lease obligation under the original lease agreement. Such agreement is subject to the tenancy in common executing an agreement to lease or build-out the vacated space.\nSCHEDULE III\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1994\nSCHEDULE IV\nML\/EQ REAL ESTATE PORTFOLIO, L.P. CONSOLIDATED SCHEDULE OF REAL ESTATE AND ACCUMULATED DEPRECIATION DECEMBER 31, 1994\nNotes:\n(a) Interest at the imputed rate shown is compounded semiannually 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 $9,823,108 of the zero coupon mortgage note 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.\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 24th day of March, 1995.\nML\/EQ REAL ESTATE PORTFOLIO, L.P.\nBy: EREIM MANAGERS CORP. (Managing General Partner)\nBy: \/s\/ Eugene F. Conway ------------------------- Eugene F. Conway Executive Vice President\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 indicated on March 24,1995.\nEXHIBIT INDEX","section_15":""}
{"filename":"105729_1994.txt","cik":"105729","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nWesco Financial Corporation (\"Wesco\") was incorporated in Delaware on March 19, 1959. The principal businesses of Wesco, conducted by wholly owned subsidiaries, are (1) the property and casualty insurance business, through Wesco-Financial Insurance Company (\"Wes-FIC\"), which was incorporated in 1985, and (2) the steel service center business, through Precision Steel Warehouse, Inc. (\"Precision Steel\"), which was begun in 1940 and acquired by Wesco in 1979. Through approximately 1993 yearend, Wesco also engaged in the savings and loan business, through Mutual Savings and Loan Association (\"Mutual Savings\"), which was incorporated in California in 1925, gave up its status as a regulated thrift institution after disposing of its savings accounts and most of its real estate loans in October 1993, and, in a statutory merger effective January 1, 1994, merged into Wes-FIC.\nWesco's operations also include, through MS Property Company (\"MS Property\"), the ownership and management of commercial real estate transferred to MS Property by Wesco, and the development and liquidation of foreclosed real estate and delinquent real estate loans transferred to MS Property by Mutual Savings, all in December 1993, when MS Property began its operations. Wesco's operations, through mid-1993, also included the manufacture of electrical equipment through New America Electrical Corporation (\"New America Electric\"), which was organized in 1982 and was approximately 80%-owned by Wesco from December 1988 through mid-1993.\nSince 1973, Wesco has been 80.1% owned by Blue Chip Stamps (or its predecessor by the same name), a wholly owned subsidiary of Berkshire Hathaway Inc. (\"Berkshire\"). Wesco and its subsidiaries are thus controlled by Blue Chip Stamps and Berkshire. All of these companies may also be deemed to be controlled by Warren E. Buffett, who is Berkshire's chairman and chief executive officer and owner of 40.7% of its stock. Charles T. Munger, the chairman of Wesco, is also vice chairman of Berkshire, and consults with Mr. Buffett with respect to Wesco's investment decisions and major capital allocations, but Mr. Buffett has no active participation in Wesco's management.\nWesco's activities, through 1993 yearend, fell into three business segments -- financial, insurance, and industrial. The financial segment included the savings and loan business operated by Mutual Savings as well as other activities more closely associated with the savings and loan business than any of Wesco's other principal businesses, namely, investment activity other than Wes-FIC's and parent company operations. The insurance segment consisted of Wes-FIC's insurance business. The industrial segment comprised Precision Steel's steel service center operations and, until mid-1993, the manufacture of electrical products by New America Electric.\nEffective with the beginning of 1994, following Mutual Savings' discontinuance as a regulated savings and loan association late in 1993 and its subsequent statutory merger into Wes-FIC, the financial segment classification no longer served a useful purpose and was discontinued. The insurance segment was expanded to reflect Wes-FIC's absorption of the portion of Mutual Savings' business that in recent years had employed the majority of its assets in terms of market value: the indirect real estate lending business engaged in through ownership of 7.2 million shares of common stock of Federal Home Loan Mortgage Corporation (\"Freddie Mac\") and mortgage-backed securities. Other, relatively insignificant operations previously included in the financial segment are no longer identified with any specific business segment; these include (1) investment activity other than Wes-FIC's, (2) management of owned commercial real estate, (3) development and liquidation of foreclosed real estate and delinquent loans formerly owned by Mutual Savings, and (4) parent company operations.\nThe amounts of revenues, operating profit and identifiable assets attributable to each of Wesco's business segments are included in Note 8 to the accompanying consolidated financial statements.\nINSURANCE SEGMENT\nWes-FIC was incorporated in 1985 to engage in the property and casualty insurance and reinsurance business. On January 1, 1994, Wes-FIC's shareholders' equity (net worth) increased from $329 million to $569 million as a result of the absorption of Mutual Savings' remaining net assets through merger.\nIn 1985, Wes-FIC entered into an arrangement whereby it reinsured -- through a Berkshire insurance subsidiary, National Indemnity Company (\"NICO\"), as intermediary-without-profit -- 2% of the entire book of insurance business of the long-established Fireman's Fund Insurance Companies (\"Fireman's Fund\"). Wes-FIC thus assumed the benefits and burdens of Fireman's Fund's prices, costs and losses under a contract covering all insurance premiums earned by Fireman's Fund during a four-year coverage period that expired on August 31, 1989. The arrangement put Wes-FIC in virtually the same position it would have been in if it, instead of Fireman's Fund, had directly written the business reinsured. Differences in results under this arrangement have occurred principally from the investment of premiums, as Wes-FIC, instead of Fireman's Fund, has invested funds from \"float\" (funds set aside and invested pending payment of claims). Wes-FIC will remain liable for its share of unpaid losses and loss expenses, which have been reflected on Wesco's balance sheet, and will continue to invest funds offset by loss reserves until runoff is complete, perhaps many years hence.\nIn 1990 and 1991, Wes-FIC reinsured 50% of the book of workers' compensation insurance business of Cypress Insurance Company (\"Cypress\"), a wholly owned subsidiary of Berkshire, under a contract patterned generally after that with Fireman's Fund. As with the Fireman's Fund contract, Wes-FIC will remain liable for its share of unpaid losses and loss adjustment expenses, as well as policyholder dividends.\nDuring 1992, Wes-FIC entered into another arrangement with NICO whereby NICO retroceded to it 50% of certain personal lines reinsurance business NICO had assumed. The arrangement was terminated in mid-1993, when the original source of the reinsurance stopped making cessions to NICO.\nIn recent years, financial failures in the insurance industry have received considerable attention from news media, regulatory authorities, rating agencies and Congress. As one result, industry participants and the public have been made more aware of the benefits derived from dealing with insurers whose financial resources support their promises with significant margins of safety against adversity. In this respect Wes-FIC is competitively well positioned, inasmuch as its premiums written in 1994 amounted to approximately 1% of its statutory surplus compared to an industry average of about 130% based on figures reported for 1993.\nStandard & Poor's Corporation, in 1994, recognized Wes-FIC's strong competitive position as a part of the Berkshire Hathaway insurance group, and its unusual capital strength, and assigned its highest rating, AAA, to Wes-FIC's claims-paying ability. This rating recognized the commitment of Wes-FIC's management to a disciplined approach to underwriting and reserving, as well as Wes-FIC's extremely strong capital base.\nWes-FIC's traditional strength, made even greater by the absorption of Mutual Savings, enabled it to enter into the business of \"super-catastrophe\" reinsurance, through six subcontracts retroceded by NICO at favorable terms in 1994. Super-catastrophe reinsurance is the insurance that insurance companies buy from other insurance companies to protect themselves against major catastrophic losses. An insurer in this business must have large net worth in relation to annual premiums in order to remain solvent when called upon to pay claims when a large super catastrophe occurs.\nBerkshire has indicated that its insurance subsidiaries may from time to time be offered super-catastrophe reinsurance business that is somewhat larger than it wishes to retain and may make a portion of the business available to Wes-FIC, as NICO did in 1994. Wesco's and Wes-FIC's boards of directors have authorized automatic acceptance of future retrocessions of reinsurance offered by wholly owned subsidiaries of Berkshire provided the following guidelines and limitations are complied\nwith: (1) in order not to delay the acceptance process, the retrocession will be accepted without delay in writing in Nebraska by agents of Wes-FIC who are salaried employees of Berkshire subsidiaries; (2) the Berkshire subsidiary will receive a ceding commission of 3% of premiums, probably less than the Berkshire subsidiary could get in the marketplace; (3) Wes-FIC will assume 20% or less of the risk (before taking into account effects of the ceding commission); (4) wholly owned Berkshire subsidiaries will retain at least 80% of the identical risk (again, before taking into account effects of the ceding commission); and (5) the aggregate premiums from this type of business in any twelve-month period will not exceed 10% of Wes-FIC's net worth.\nWes-FIC is licensed to write direct business, as distinguished from reinsurance, in Nebraska, Utah and Iowa. It wrote a very small volume of such insurance during 1994 and earned $15,000 in direct premiums.\nWesco's and Wes-FIC's boards are hopeful, but have no assurance, that additional reinsurance retrocessions or other insurance arrangements, including those similar to the Fireman's Fund contract, will become available to Wes-FIC.\nInsurance companies are subject to regulation by the departments of insurance of the various states in which they operate. Regulations relate to, among other things, capital requirements, shareholder and policyholder dividend restrictions, reporting requirements, annual audits by independent accountants, periodic regulatory examinations, and limitations on the size and types of investments that can be made.\nINDUSTRIAL SEGMENT\nPrecision Steel, acquired in 1979 for approximately $15 million, operates a well-established steel service center business at two locations: one in Franklin Park, Illinois, near Chicago; the other, operated by a wholly owned subsidiary, in Charlotte, North Carolina. The service centers buy low carbon sheet and strip steel, coated metals, spring steels, stainless steel, brass, phosphor bronze, aluminum and other metals, cut these metals to order, and sell them to a wide variety of customers.\nThe service center business is highly competitive. Precision Steel's annual sales volume of approximately 30 thousand tons compares with the steel service industry's annual volume of over 20 million tons. Precision Steel competes not only with other service centers but also with mills which supply metal to the service centers. Competition exists in the areas of price, quality, availability of products and speed of delivery. Because it is willing to sell in relatively small quantities, Precision Steel has been able to compete in geographic areas distant from its service center facilities. Competitive pressure is intensified by imports and by a tendency of domestic manufacturers to substitute less costly components for parts traditionally made of steel.\nPrecision Brand Products, Inc. (\"Precision Brand\"), a wholly owned subsidiary of Precision Steel, manufactures shim stock and other tool room specialty items, as well as hose and muffler clamps, and sells them under its own brand names nationwide, generally through industrial distributors. This business is highly competitive. Precision Brand's share of the toolroom specialty products market is believed to approximate 0.5%; statistics are not available with respect to its share of the market for hose and muffler clamps.\nSteel service raw materials are obtained principally from major domestic steel mills, and their availability is considered good. Precision Steel's service centers maintain extensive inventories in order to meet customer demand for prompt deliveries. Typically, an order is filled and the processed metals delivered to the customer within two weeks. Precision Brand normally maintains inventories adequate to allow for off-the-shelf service to customers within 24 hours.\nThe steel service businesses are subject to economic cycles. These businesses are not dependent on a few large customers. The backlog of steel service orders increased to approximately $6.1 million as of December 31, 1994 from $5.2 million as of December 31, 1993.\nApproximately 250 full-time employees are engaged in the steel service businesses, about 40% of whom are members of unions. Management considers labor relations to be good.\nFINANCIAL SEGMENT\nStarting with the late 1970s, the savings and loan business was a difficult business in which to engage, as was explained in detail in previous annual reports. Mutual Savings and Wesco dealt with increasing savings and loan regulations and regulatory pressures, with the result that management decided late in 1992 that Mutual Savings would give up its status as a regulated savings and loan association. The decision was prompted, in part, by regulatory insistence that Mutual Savings make additional changes in its business above and beyond those previously made. Management believed such additional changes, if implemented, would further increase operating expenses, and possibly narrow the spread between interest income and interest expense, thereby resulting in an unacceptable return to its owners. Accordingly, following receipt of regulatory approvals, Mutual Savings on October 8, 1993 transferred its savings accounts and certain other liabilities (totaling about $220 million), offset by substantially all of its real estate loans and certain other non-cash assets (about $86 million, combined) and cash (about $134 million), to CenFed Bank, A Federal Savings Bank (\"CenFed\"). Wesco loaned $4 million to CenFed's parent corporation for a three-year period. In addition, Mutual Savings and Wesco jointly agreed to indemnify CenFed to the extent of at least 90% with respect to any losses that might be sustained on the loans transferred. After provision for such indemnification, the CenFed transaction resulted in an after-tax gain of $906,000, or $.13 per Wesco share, in 1993.\nFollowing completion of the foregoing transaction, and the withdrawal by Mutual Savings and by Wesco from savings and loan regulation, (1) Mutual Savings transferred all of its foreclosed real estate, and the few real estate loans that were not sold to CenFed, to MS Property, which is continuing the slow liquidation of those assets begun by Mutual Savings, and (2) Wesco transferred its commercial real estate property in Pasadena, California, to MS Property, which is now managing it.\nMutual Savings retained a majority (at market value) of its former assets, consisting mostly of stock of Freddie Mac (market approximately $359 million versus cost of about $72 million at 1993 yearend) and approximately $46 million of securitized mortgages. Immediately after 1993 yearend, Mutual Savings merged into Wes-FIC, which continues to engage in indirect lending activities. This business is regulated by the Nebraska Department of Insurance, replacing federal and California thrift regulators, and is now included in the insurance segment.\nWesco, while it seeks suitable businesses to acquire and explores ways to expand its existing operations, invests in marketable securities of unaffiliated companies. (See Note 2 to the accompanying consolidated financial statements for summaries of investments.)\nFollowing Mutual Savings' merger into Wes-FIC, the financial segment disappeared. Starting with 1994, extraneous, relatively insignificant operations that were previously included in the financial segment because they were indirectly related to operation of the savings and loan association are no longer identified with any segment as they do not in any way relate to the two remaining segments. These extraneous operations include (1) investment activity other than Wes-FIC's, (2) management of owned commercial real estate, (3) development and liquidation of foreclosed real estate and delinquent loans formerly owned by Mutual Savings, and (4) parent company operations.\nTen full-time employees are engaged in the activities of Wesco and MS Property.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nMS Property owns a business block in downtown Pasadena, California, which is improved with a nine-story office building that was constructed in 1964 and has approximately 125,000 square feet of net rentable area, as well as three commercial store buildings and a multistory garage with space for 425 automobiles. Of the 125,000 square feet of office space, approximately 3,000 square feet are used by Wesco and MS Property as their headquarters. Most of the remainder is leased to outside\nparties, including CenFed, law firms and others, under agreements expiring at various dates to 2008. MS Property also owns a parking lot with space for approximately 100 automobiles across the street from the multistory structure.\nWes-FIC uses as its place of business the Omaha, Nebraska headquarters office of NICO.\nMS Property holds real estate acquired by Mutual Savings or itself through foreclosure. The most valuable parcel, acquired in 1966, consists of 22 acres of largely oceanfront land near Santa Barbara, California, where a luxury development consisting of 20 townhomes and 12 residential lots has been under construction, with several sales recorded to date. Other properties include several buildings in a small shopping center in Upland, California, which are leased to various small businesses, and several single-family residences in Southern California, presently listed for sale.\nPrecision Steel and its subsidiaries own three buildings housing their plant and office facilities, having usable area approximately as follows: 138,000 square feet in Franklin Park, Illinois; 63,000 square feet in Charlotte, North Carolina; and 59,000 square feet in Downers Grove, Illinois.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nWesco and its subsidiaries are not involved in any legal proceedings which are expected to result in material loss.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nNo matters were submitted to a vote of Wesco's shareholders subsequent to the annual meeting held in May 1994.\nPART II\nITEM 5.","section_5":"ITEM 5.\nWesco's common stock is traded on the American Stock Exchange and the Pacific Stock Exchange.\nThe following table sets forth the ranges of stock prices reported in The Wall Street Journal for Wesco's shares trading on the American Stock Exchange, by quarter, for 1994 and 1993, as well as cash dividends paid by Wesco on each outstanding share:\nThere were approximately 825 shareholders of record of Wesco's capital stock as of the close of business on March 8, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSet forth below and on the following page are selected consolidated financial data for Wesco and its subsidiaries. For additional financial information, attention is directed to Wesco's audited 1994 consolidated financial statements appearing elsewhere in this report. (Amounts are in thousands except for amounts per share.)\n---------------\n* Wesco adopted SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" effective at 1993 yearend, with the result that all marketable equity securities owned by Wesco and its subsidiaries at 1994 and 1993 yearends are stated above at fair value, with the aggregate net unrealized gain added to shareholders' equity net of deemed applicable income taxes. Due to a change in classification in 1994, the reporting of securities with fixed maturities was changed to conform it to that of marketable equity securities; the 1994 yearend balances also reflect that change. (See Note 2 to the accompanying consolidated financial statements for further details.)\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nFINANCIAL CONDITION\nThe financial condition of Wesco Financial Corporation (\"Wesco\") continues to be very sound. Its net worth is greater than ever due mainly to continued successful operations as well as continued appreciation of marketable securities. Its liquidity in terms of cash equivalents is adequate for all operating and other current needs. Other resources are available such as liquidation of marketable securities and borrowings from banks and others.\nWesco adopted the provisions of SFAS No. 115, \"Accounting for Certain investments in Debt and Equity Securities\", effective at 1993 yearend. As a result, all marketable equity securities began to be carried in the consolidated financial statements at market value. Previously only those owned by Wesco's Wesco-Financial Insurance Company (\"Wes-FIC\") subsidiary could be written up to market. Those owned by Wesco and its other subsidiaries were required to be carried at the lower of aggregate cost or market; because for many years aggregate cost had been below aggregate market, they had invariably been carried at cost. Securities with fixed maturities, on the other hand, continued to be carried at amortized cost at 1993 yearend as mandated by SFAS No. 115, because such investments were deemed to be held-to-maturity. However, in 1994, Wesco's management reclassified its fixed-maturity investments to available-for-sale; under SFAS No. 115 fixed-maturity investments so classified had to be carried at fair value, and thus their reporting was conformed to that of marketable equity securities, without material effect in relation to Wesco's reported net worth. See Note 2 to the accompanying consolidated financial statements for additional information as to the investments owned by Wesco and its subsidiaries.\nFollowing is a calculation of the pro forma shareholders' equity (net worth) figures that would have been reported beginning with 1990 yearend if SFAS No.115 had been available for adoption by Wesco in 1990 instead of 1993 and if Wesco had viewed its fixed-maturity securities as available for sale commencing with 1990. (Amounts are in millions.)\nIt should be borne in mind that neither the inclusion nor the exclusion of appreciation in the carrying value of investments has any effect on Wesco's true financial condition, nor its intrinsic value to shareholders.\nBorrowings from banks and others have been available to Wesco and its subsidiaries under attractive terms for a number of years. In May 1994, in recognition of the sound financial condition of Wesco and of its Wes-FIC insurance subsidiary, Standard & Poor's Corporation raised its credit rating on Wesco's $30 million of Notes due November 1999 from AA+ to AAA, its highest rating, and also assigned Wes-FIC a rating of AAA as to its claims-paying ability.\nWesco's Mutual Savings and Loan Association (\"Mutual Savings\") subsidiary, prior to sale of most of its real estate loans in October 1993, did not suffer the crippling loan losses reported by much of the savings and loan industry in recent years. Mutual Savings did, however, experience some loan losses and some increasing deterioration of collateral value due mainly to recessionary economic conditions and decreasing real estate values in Southern California. Recessionary conditions are continuing to affect the marketing of foreclosed real estate now owned by Wesco's MS Property Company (\"MS Property\") subsidiary.\nMutual Savings, in connection with its sale of $81 million of real estate loans late in 1993, indemnified CenFed against any losses that might ultimately be sustained to the extent of at least 90% of each loss. Management of Wesco does not believe that the indemnification will have a significant effect on Wesco's financial condition, principally because (1) the loans are first-mortgage real estate loans mainly on owner-occupied, single-family residences, and (2) Mutual Savings' seriously delinquent loans were not sold to CenFed but rather transferred to MS Property. Management of CenFed has reported that, with the exception of only one loan subsequently repurchased from it by MS Property, all such loans are essentially current and trouble-free.\nMS Property is in process of selling off several foreclosed real estate properties. The most significant of these is a 22-acre parcel of largely oceanfront land in Montecito, near Santa Barbara, California, which Mutual Savings and more recently MS Property have been developing on an upscale basis and marketing over a period of several years. After deducting writedowns to estimated net realizable value of $2 million in 1993 and $3 million in 1994, the property's carrying value at 1994 yearend was approximately $19 million. The market for homes and residential lots of the type comprising MS Property's Montecito development appears to be improving after several years of weakness. Other foreclosed properties and real estate loans were carried on the books at 1994 yearend at approximately $10 million, net of reserves.\nWesco is not now suffering from inflation, but its insurance and industrial segments have potential exposure. Very large unanticipated changes in the rate of inflation could adversely impact the insurance business, because premium rates are established well in advance of incurrence of the related costs. Precision Steel's steel service businesses are competitive and operate on tight gross profit margins, and thus its earnings are susceptible to bad effects from inflationary cost increases.\nRESULTS OF OPERATIONS\nWesco, which had started essentially as a savings and loan holding company, began to diversify its operations in the 1970s mainly in response to perceived uncertainties and turmoil in the savings and loan industry. Mutual Savings' activities declined both in size and in relative importance to Wesco's consolidated operations until, finally, its savings deposits and most loans were disposed of in late 1993, and it merged into Wesco's insurance subsidiary effective January 1, 1994. As the portfolio of investment securities has grown, mostly inside the savings and loan and insurance subsidiaries, dividend and interest income and realized and unrealized gains on securities have increased in importance to Wesco. Steel service operations were added in 1979, property and casualty insurance operations were added in 1985, and electrical equipment manufacturing operations (sold in mid-1993) were added at 1988 yearend. (See Item 1, Business, for further discussion of Wesco's operations.)\nThe following summary sets forth the contribution to consolidated net income of each of Wesco's business segments -- insurance, industrial and, through yearend 1993, financial -- and of Wesco's nonsegment activities. In each case unusual items are shown separately from \"normal\" net operating income. (Amounts are in thousands, all after income tax effect.)\n---------------\n(1) Represents writedown of investment in preferred stock of USAir Group, Inc., explained in Note 2 to the accompanying consolidated financial statements.\n(2) Consists of cumulative effect of change in accounting for income taxes upon adoption of SFAS No. 109 and effect of subsequent change in income tax rate on deferred tax liabilities and assets. (See Note 5 to accompanying consolidated financial statements for further information.)\n(3) Consists of income tax provision required to be recorded due to the triggering of recapture of special bad debt tax deductions when it was decided to give up Mutual Savings' status as a regulated savings and loan association. (See Note 5 to accompanying consolidated financial statements for further information.)\n(4) Amounts for 1993 and 1992 have been reclassified to facilitate comparison; in past years these items were included in the financial segment in Item 7 presentations, because they were more closely associated with activities of the then-used financial segment than the other two segments.\nIn the following sections the \"normal\" net operating income data set forth in the foregoing summary on an after-tax basis is broken down and discussed. Attention is directed to Note 8 to the accompanying consolidated financial statements for information as to operating profit before taxes.\nInsurance Segment\nWesco entered into the property and casualty insurance business in 1985 through Wes-FIC, a newly formed subsidiary. Substantially all of its insurance business to date has been derived through relatively short-lived quota share and excess of loss reinsurance arrangements with National Indemnity Company (\"NICO\") and Cypress Insurance Company (\"Cypress\"), wholly owned subsidiaries of Berkshire, Wesco's ultimate parent. Under the arrangements, Wes-FIC has been ceded portions of\nthe property and casualty reinsurance business of NICO and has reinsured workers' compensation business written by Cypress.\nQuota share reinsurance provides indemnification to ceding companies of specified portions of the ceding companies' own losses. Excess of loss reinsurance provides indemnification to ceding companies for all or part of covered losses in excess of specified retentions (or deductibles).\nWes-FIC's arrangements with NICO to date have comprised principally (1) reinsurance of NICO's quota share reinsurance contract under which Wes-FIC reinsured 2% of the property and casualty insurance business of the Fireman's Fund Insurance Companies during a four-year coverage period that expired on August 31, 1989, (2) reinsurance of another quota share contract under which Wes-FIC reinsured 50% of certain personal lines reinsurance business that NICO had assumed in an arrangement that accounted for substantially all of Wes-FIC's earned premiums in 1992 and 1993, and which terminated in mid-1993 when the original source of the reinsurance stopped making cessions to NICO, and (3) reinsurance of 5% to 20% of several catastrophic excess of loss (\"super-cat\") reinsurance contracts beginning in 1994. Wes-FIC has also written small amounts of direct insurance business.\nWes-FIC's entry into the business of super-cat reinsurance followed a large increase in its net worth, from $329 million as of 1993 yearend to $569 million as of January 1, 1994, when it absorbed Mutual Savings and Loan Association (\"Mutual Savings\") through merger. (See Item 1, Business, for further information on Wes-FIC, NICO, Cypress, Berkshire, Fireman's Fund and Mutual Savings.)\nThe \"normal\" net operating income of Wes-FIC (i.e., income before securities gains and losses, and unusual income tax charges) represents the combination of its underwriting results with the interest and dividend income from its investment and other activities. Following is a summary of such data (in thousands):\nInsurance premiums are recognized as earned revenues by Wes-FIC pro rata over the term of the contract on all forms of insurance except for super-cat reinsurance. Premiums on super-cat reinsurance are not recognized as earned until the earlier of a loss occurrence or policy expiration, in order to avoid premature recognition of underwriting profits. The super-cat reinsurance contracts referred to above expire at various dates beginning in the first quarter of 1995. Four of the contracts representing approximately half of the reinsurance volume have been renewed.\nAn underwriting loss has typically been reported by Wes-FIC each year. The underwriting gain reported for 1994 resulted mainly from a reduction of liabilities for losses and loss expenses with respect to business written in earlier years. Liabilities for losses and loss expenses are estimates and thus are subject to estimation error; revisions of such estimates are reflected in underwriting results of the current accounting period. The 1994 adjustment, while not insignificant in terms of its effect on Wesco's net income for the year, was not material in relation to the cumulative insurance business previously written by Wes-FIC or in terms of its effect on Wesco's net worth.\nWes-FIC's revenues and net income for 1994 benefited from its absorption of Mutual Savings, inasmuch as dividend and interest income previously reported as revenue of Wesco's financial segment is now included in Wes-FIC's revenues.\nWes-FIC's relatively low volume of insurance and reinsurance premiums in recent years has been attributable mainly to management's perception that the opportunity to write more business at sensible rates has not been available, given the generally competitive industry-wide conditions. Meanwhile, Wes-FIC has been actively pursuing other insurance and reinsurance opportunities.\nWes-FIC remains liable for runoff of its share of the losses and loss expenses covered by the insurance arrangements summarized above. As claims are paid over many future years, the liability (approximately $40 million as of December 31, 1994) will decline, as will the funds set aside and invested pending payment of claims (\"float\").\nDividend and interest income has been earned by Wes-FIC principally (1) on insurance premium float, (2) on capital contributed to the insurance business by Wesco (approximately $100 million through 1993), (3) on earnings retained and reinvested, and (4) on the assets (approximately $400 million at market value) added by the merger of Mutual Savings on January 1, 1994.\nThe income tax provision of Wes-FIC has fluctuated as a percentage of its pre-tax income in each of the periods presented in the foregoing table. These fluctuations have been caused by fluctuations in the relationship of substantially tax-exempt components of income to total pre-tax income.\nInsurance losses and loss expenses, and the related liabilities reflected on Wesco's consolidated balance sheet, because they are based in large part upon estimates, are subject to estimation error. Revisions of such estimates in future periods could significantly affect the results of operations reported for future periods. However, Wes-FIC has maintained a capital position strong enough not only to absorb adverse estimation corrections but also to enable it to accept other insurance contracts. Although additional reinsurance retrocessions from Berkshire subsidiaries, or other attractive reinsurance or insurance arrangements would be welcome, the timing and extent of any increase in Wes- FIC's insurance underwriting activity cannot presently be predicted.\nIndustrial Segment\nFollowing is a summary of the \"normal\" net operating results of the industrial segment, whose operations have included the businesses of Precision Steel Warehouse, Inc. and its subsidiaries (\"Precision Steel\") and New America Electrical Corporation (\"New America Electric\"), until the latter sold its electrical equipment manufacturing operations effective July 1, 1993 and liquidated shortly thereafter (in thousands):\nRevenues of the industrial segment for the past three years, as set forth above, included electrical equipment manufacturing revenues of $3.5 million in 1993 and $7.4 million in 1992. Revenues of Precision Steel's businesses increased moderately from year to year due mainly to improving economic conditions in the industrial sector of the economy.\nIncome before income taxes and normal net operating income of the industrial segment were negatively affected in 1993 and 1992 as a result of the inclusion of the operating results of New\nAmerica Electric. Had it not been for Wesco's equity of $213,000 and $243,000 in New America Electric's after-tax operating losses in 1993 and 1992, the industrial segment would have reported normal net operating income of $2,189,000 and $2,075,000 for those years. The improvement in these earnings figures was attributable mainly to the following: increases in sales; reductions in operating expenses; and, in 1994, a reduction in cost of products sold as a percentage of steel service revenues. (This percentage was 79.6%, 81.2% and 80.6% for 1994, 1993 and 1992.) The cost percentage typically fluctuates slightly from year to year as a result of changes in product mix, price competition among suppliers and at the retail level, and availability of favorable quantity order prices on materials purchased.\nFinancial Segment\nThrough 1993, Wesco had a financial segment, which included revenues and expenses of Mutual Savings as well as revenues and expenses of other activities more closely associated with the savings and loan business than any of Wesco's other businesses, namely, investment activity other than Wes-FIC's and parent company operations.\nIn October 1993, Mutual Savings discontinued as a regulated savings and loan association, and, effective January 1, 1994, it merged into Wes-FIC (see Item 1, Business, for further information). As a result, (1) several traditional items of revenue and expense -- notably interest income on loans, interest expense on savings accounts and operating expenses -- have wholly or partially disappeared, with the remaining items such as income from indirect mortgage lending transferred to the insurance segment, and (2) revenues and expenses of other Wesco entities previously included in the financial segment are no longer identified with any specific business segment (see next section).\nFollowing is a summary of the components of Mutual Savings' \"normal\" net operating income (in thousands) for the years 1993 and 1992:\nAs shown in the foregoing table, had it not been for a significant increase in provision for losses on loans and real estate held for sale in 1993 (mainly a $2 million pre-tax writedown of the Montecito development at the end of 1993), Mutual Savings' \"normal\" net operating income for 1993 would have been comparable to that of 1992.\nOther Than Identified Business Segments\nSet forth below is a summary of \"normal\" net operating income for items not identified with any business segment -- insurance, industrial, or (formerly) financial (amounts are in thousands):\nAs explained more fully in the fourth and fifth paragraphs of Item 1, Business, effective with the beginning of 1994, the financial segment was discontinued, and certain relatively insignificant activities previously included in that segment are no longer identified with any specific business segment. These activities include (1) investment activity other than Wes-FIC's, (2) management of owned commercial real estate, (3) development and liquidation of foreclosed real estate and delinquent loans formerly owned by Mutual Savings, and (4) parent company operations. The 1994 figures shown in the foregoing table reflect the new classification.\nIn addition, to facilitate comparison, extraneous amounts that were included in the financial segment in 1993 and 1992 because they were more closely related to that segment than the other two business segments have been removed from financial segment operating figures and included in the foregoing table. These include amounts relating to (1) investment activity other than Wes-FIC's and Mutual Savings', (2) management of owned commercial real estate, and (3) other operations of the parent company and, after activation late in 1993, MS Property.\nIn reclassifying figures for 1993 and 1992, however, revenues and expenses that were integral to Mutual Savings' operation have not been removed from the financial segment and included in the foregoing table. As a result, general and administrative expenses and other items applicable to development and liquidation of foreclosed real estate and delinquent loans are included in the 1994 figures in the foregoing table but not those of 1993 and 1992. Also, the provision for losses on loans and real estate of $3.0 million in 1994 has no prior year counterparts in the foregoing table; the 1993 and 1992 loss provisions were $2.9 million and $0.7 million, as shown in the financial segment table on the previous page.\nNonsegment interest expense was much higher in 1994 than in either of the preceding years principally as a result of borrowings from Wes-FIC made late in 1993 to facilitate the transfer of loans and foreclosed properties to MS Property; 1994 insurance segment income benefited accordingly.\nRental income declined in each of the last two years due mainly to the change in major tenant: Mutual Savings' large headquarters operation was replaced by a smaller CenFed branch operation.\nThe income tax provision or benefit on Wesco's nonsegment activities has fluctuated as a percentage of the pre-tax income or loss from such activities. These fluctuations have been caused mainly by fluctuations in the relationship of substantially tax-exempt dividend income to total pre-tax income or loss from such activities.\n* * * * *\nManagement's long-term goal is to maximize gain in Wesco's intrinsic business value per share, with little regard to earnings recorded in any given year. There is no particular strategy as to the timing of sales of investments or the realization of securities gains. Securities may be sold for a variety of reasons, including (1) the belief that prospects for future appreciation of a particular investment are less attractive than the prospects for reinvestment of the after-tax proceeds from its sale, or (2) the desire for funds for an acquisition or repayment of debt.\nRealized gains and losses on investments have been an element of Wesco's net income for a number of years. The amounts of these gains or losses, recorded when securities are sold or when a decline in market value of an investment is considered to be other than temporary, tend to fluctuate significantly from period to period. The varying effect upon Wesco's pre-tax income is evident on the face of the consolidated statement of income. The amount of realized gain or loss has no predictive value, and variations in amount from period to period have no practical analytical value, particularly in view of the existence of substantial net unrealized price appreciation in Wesco's consolidated investment portfolio.\nIn 1994 Wesco realized net after-tax gains on sales of securities of $0.2 million; it also wrote down the carrying value of an investment believed to have declined in market value other than temporarily by $5.9 million after income tax effect (see Note 2 to Wesco's consolidated financial statements for further information as to Wesco's investment in preferred stock of USAir Group, Inc.). Realized securities gains amounted to $1.2 million and $0.1 million after income taxes in 1993 and 1992.\nAs explained in the second paragraph of this Item 7, unrealized appreciation of all Wesco's marketable equity securities -- not just those of its Wes-FIC insurance subsidiary, as in the past -- is included in the consolidated balance sheet net of deemed applicable income taxes, effective as of 1993 yearend. The Financial Accounting Standards Board required (in SFAS No. 115) that the net writeup be credited directly to shareholders' equity without figuring in any way in the determination of net income, the same, sensible procedure that had been followed for insurance entities. However, in another pronouncement (SFAS No. 109) -- which required, among other things, adjusting deferred income tax liabilities to reflect tax rate changes -- the FASB directed that all such tax adjustments not bypass net income; thus, Wesco's 1993 net income was penalized by $1.6 million due to an increase in the federal rate from 34% to 35% on Wes-FIC's unrealized appreciation, notwithstanding the fact that the appreciation had never benefited net income.\nWesco's consolidated revenues include significant amounts of substantially tax-exempt dividend income from preferred and common stocks as well as fully tax-exempt interest on state and municipal bonds. Fluctuations in the proportion of these components to total consolidated pre-tax income -- plus a special tax provision of $17.5 million recorded as of 1992 yearend, and $2.1 million in 1993 to give effect to the tax rate increase applicable to deferred tax items (including the $1.6 million discussed in the preceding paragraph) -- have resulted in tax provisions as percentages of pre-tax income before cumulative effect of change in accounting principle of 8.6%, 21.3% and 80.7% in 1994, 1993 and 1992. (See Note 5 to the accompanying consolidated financial statements for further information on income taxes.)\nConsolidated revenues, expenses and earnings set forth in Item 6, Selected Financial Data, and in Wesco's consolidated statement of income, are not necessarily indicative of future revenues, expenses and earnings, in that they are subject to significant variations in amount and timing of securities gains and losses and the possible occurrence of other unusual items. In addition, as explained above, in October 1993, Mutual Savings, after transferring savings accounts and some mortgage loans to CenFed, gave up its status as a regulated savings and loan association. Then, on January 1, 1994, Mutual Savings merged into Wes-FIC, which continues to engage in the indirect mortgage lending business. The merger not only resulted in elimination of nonproductive overhead needed to maintain compliance with savings and loan laws and regulations, but also increased reinsurance capacity and asset-deployment options, enabling Wes-FIC to enter into the business of\nsuper-cat reinsurance in 1994. It is hoped that the restructuring of Wesco's consolidated operations will result in further benefits in the future.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS\nFollowing is an index to financial statements and related schedules appearing in this report:\nThe data appearing on the financial statement schedules listed below should be read in conjunction with the consolidated financial statements and notes of Wesco Financial Corporation and the independent auditors' report referred to above. Schedules not included with these financial statement schedules have been omitted because they are not applicable or the required 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, as there were no such changes or disagreements.\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\" appearing in the definitive combined notice of annual meeting and proxy statement of Wesco Financial Corporation for its 1995 annual meeting of shareholders (the \"1995 Proxy Statement\") is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth in the section \"Compensation of Directors and Executive Officers\" in the 1995 Proxy Statement 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 section \"Voting Securities and Holders Thereof\" in the 1995 Proxy Statement is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain information set forth in the sections \"Election of Directors,\" \"Board of Director Interlocks and Insider Participation\" and \"Compensation of Directors and Executive Officers\" in the 1995 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\nThe following exhibits (listed by numbers corresponding to Table 1 of Item 601 of Regulation S-K) are filed as part of this Annual Report on Form 10-K or are incorporated herein by reference:\n3a. Articles of Incorporation and By-Laws of Wesco Financial Corporation.\n4.1 Form of Indenture dated October 2, 1989 (incorporated by reference to Exhibit 4.1 to report on Form 8-K of Wesco Financial Corporation dated October 31, 1989, File No. 33-31290).\n4.2 Form of Supplemental Indenture dated October 15, 1989 (incorporated by reference to Exhibit 4.1 to report on Form 8-K of Wesco Financial Corporation dated October 31, 1989, File No. 33-31290).\nInstruments defining the rights of holders of long-term debt of registrant and its subsidiaries are not being filed since the total amount of securities authorized by all such instruments does not exceed 10% of the total assets of the Registrant and its subsidiaries on a consolidated basis as of December 31, 1994. The Registrant hereby agrees to furnish to the Commission upon request a copy of any such debt instrument to which it is a party.\n10.1 Purchase of Assets and Liability Assumption Agreement dated May 10, 1993, among Mutual Savings and Loan Association, Wesco Financial Corporation and CenFed Bank, A Federal Savings Bank (incorporated by reference to Wesco's Quarterly Report on Form 10-Q for the quarter ended March 31, 1993).\n22. Subsidiaries.\nThe index to financial statements and related schedules set forth in Item 8 of this report is incorporated herein by reference.\nNo reports on Form 8-K were filed during the quarter ended December 31, 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.\nWESCO FINANCIAL 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.\nINDEPENDENT AUDITORS' REPORT\nTo the Board of Directors and Shareholders of Wesco Financial Corporation\nWe have audited the accompanying consolidated balance sheets of Wesco Financial Corporation and subsidiaries as of December 31, 1994 and 1993, 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, 1994. Our audits also included the financial statement schedule listed in the index at Item 8. These financial statements and the financial statement schedule are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these 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 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 Wesco Financial Corporation and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the 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 1 to the consolidated financial statements, in 1993 the Company changed its methods of accounting for income taxes and investments to conform with recent pronouncements of the Financial Accounting Standards Board.\nDeloitte & Touche LLP\nLos Angeles, California March 9, 1995\nWESCO FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEET (DOLLAR AMOUNTS IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nWESCO FINANCIAL CORPORATION CONSOLIDATED STATEMENT OF INCOME AND RETAINED EARNINGS\n(DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR AMOUNTS PER SHARE)\nSee accompanying notes to consolidated financial statements.\nWESCO FINANCIAL CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS (DOLLAR AMOUNTS IN THOUSANDS)\nSee accompanying notes to consolidated financial statements.\nWESCO FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR AMOUNTS PER SHARE)\nNOTE 1. PRESENTATION AND CONSOLIDATION\nWesco Financial Corporation (\"Wesco\") is 80.1%-owned by Blue Chip Stamps (\"Blue Chip\"), which in turn is wholly owned by Berkshire Hathaway Inc. (\"Berkshire\").\nThe 1994 consolidated financial statements of Wesco include the accounts of Wesco and its subsidiaries, which are all either directly or indirectly wholly owned. These subsidiaries -- most importantly , Wesco-Financial Insurance Company (\"Wes-FIC\"), Precision Steel Warehouse, Inc. (\"Precision Steel\") and MS Property Company (\"MS Property\") -- are engaged in diverse businesses. The 1993 and 1992 consolidated financial statements include the results of operations of wholly owned Mutual Savings and Loan Association (\"Mutual Savings\" -- see below) and approximately 80%-owned New America Electrical Corporation (\"New America Electric\"); the latter sold its business assets in mid-1993 and liquidated shortly thereafter, with Wesco realizing an after-tax loss of $1,617, or $.23 per share. See Note 8 for Wesco's consolidated financial information classified by business segment.\nOn October 8, 1993, Mutual Savings consummated an agreement with CenFed Bank, A Federal Savings Bank (\"CenFed\"), following receipt of regulatory approvals. Mutual Savings transferred its savings accounts and certain other liabilities (totaling about $220,000) to CenFed, offset by (1) substantially all of its real estate loans and certain other non-cash assets (about $86,000, combined) and cash (about $134,000). Pursuant to the agreement, Wesco loaned $4,000 to CenFed's parent corporation for a three-year period, with interest at prime rate initially, at 7% beginning in October 1994, and at 8% beginning in October 1995. In addition, Mutual Savings and Wesco jointly agreed to indemnify CenFed to the extent of at least 90% with respect to any losses that might be sustained on the loans transferred. After provision for indemnification for any such losses, the CenFed transaction resulted in an after-tax gain of $906, or $.13 per Wesco share.\nFollowing completion of the foregoing transaction, (1) Mutual Savings transferred certain assets, consisting principally of Mutual Savings' foreclosed real estate and several real estate loans that were not sold to CenFed, to MS Property, which is continuing the liquidation of those assets, and (2) Wesco transferred to MS Property its commercial real estate property in Pasadena, California.\nMutual Savings retained a majority (at market value) of its former assets, consisting mostly of stock of Federal Home Loan Mortgage Corporation (\"Freddie Mac\") and indirect loans in the form of securitized mortgages. Immediately after 1993 yearend Mutual Savings merged into Wes-FIC, which continues to engage in indirect real estate lending.\nLate in 1993, Mutual Savings gave up its regulatory savings and loan status. The decision to do so, which was made late in 1992, subjected to income taxes $47,314 of earnings that had been previously sheltered due to the availability of special savings and loan tax-basis bad debt deductions. Wesco's 1992 net income was therefore negatively impacted by the large related income tax expense of $17,500, or $2.46 per share (see Note 5).\nEffective January 1, 1993, Wesco adopted SFAS No. 109, \"Accounting for Income Taxes.\" One result was a $1,023 ($.14 per share) credit set forth separately on the 1993 statement of income and retained earnings as the cumulative effect of a change in accounting for income taxes. Adoption of SFAS No. 109 resulted also in an increase in the 1993 provision for income taxes, and a reduction in 1993 net income of $2,107, or $.30 per share (see Note 5).\nAnother accounting pronouncement, SFAS No. 115, \"Accounting for Certain Investments in Debt and Equity Securities,\" had a very significant impact on Wesco's consolidated balance sheet at 1993 yearend. Marketable equity securities of all Wesco entities -- not just its Wes-FIC insurance\nsubsidiary, as in the past -- were written up to market value rather than stated at the lower of aggregate cost or market. The unrealized appreciation recorded by the non-insurance entities, less deemed applicable income taxes, was credited directly to shareholders' equity, which thereby increased $188,780, or $26.51 per share (see Note 2).\nAll material intercompany balances and transactions have been eliminated in the preparation of the accompanying consolidated financial statements.\nNOTE 2. INVESTMENTS\nTemporary cash investments consist of funds invested in money-market accounts and other highly liquid investments maturing in less than three months from date acquired.\nManagement determines the appropriate classifications of investments in securities with fixed maturities and marketable equity securities at the time of purchase and reevaluates such designations as of each balance sheet date. There are three permissible classifications: held-to-maturity; available-for-sale; and trading. Securities are deemed to be held-to-maturity securities when both the ability and the positive intent to hold them to maturity are present; they are carried on the consolidated balance sheet at cost and adjusted for any accretion of discount or amortization of premium using a method that produces approximately level yield. Available-for-sale securities are carried at fair value, with unrealized gains and losses, net of deemed applicable income taxes, reported in a separate component of shareholders' equity; there is no effect on net income, except to reflect changes in income tax rates relating to such unrealized gains and losses (see Note 5 re recording of rate changes in 1993). Realized gains and losses on sales of investments, determined on a specific identification basis, are included in the consolidated statement of income, as are other-than-temporary declines in fair value.\nInvestments in securities with fixed maturities, effective with the first quarter of 1994, have been classified as available-for-sale and, accordingly, carried at fair value, with the net unrealized gain or loss included in the component of shareholders' equity previously established for unrealized appreciation of securities. As of December 31, 1993, they were classified as held-to-maturity. The change in classification of these investments conformed Wesco's financial reporting for such investments to its financial reporting for marketable equity securities and resulted in an increase in Wesco's shareholders' equity ($3,482 or $.49 per share as of yearend 1994). There was no effect on Wesco's net income. No investments were held for trading purposes at December 31, 1994 or 1993.\nDollar amounts in thousands except for amounts per share\nFollowing is a summary of securities with fixed maturities:\n---------------\n*Net of writedown (see below).\nThe preferred stocks were acquired in conjunction with purchases made by other subsidiaries of Berkshire, and are all convertible into common stock and subject to various contractual terms and conditions. Salomon Inc must redeem 20% of its preferred stock on October 31 each year commencing in 1995, to the extent still outstanding. Champion International Corporation must redeem its preferred stock by December 6, 1999 if not previously called or converted. USAir Group, Inc.'s redemption requirement is stated below.\nThe USAir Group, Inc. investment -- 12,000 shares of USAir Group, Inc. Series A Cumulative Convertible Preferred Stock (\"USAir Preferred Shares\") -- was made in 1989 for $12,000 as part of a $358,000 investment in 358,000 shares in which other subsidiaries of Berkshire participated. If not called or converted prior to August 7, 1999, the USAir Preferred Shares are mandatorily redeemable by USAir Group, Inc. (\"USAir\") at $1,000 per share ($358,000 in the aggregate, of which Wesco's share would be $12,000), plus accrued dividends.\nOn September 29, 1994, USAir announced that it was deferring the quarterly dividend payment due September 30, 1994 on the USAir Preferred Shares. As of March 7, 1995, neither that dividend nor the quarterly dividend due December 31, 1994 had been received. USAir has publicly stated that its ability to survive in the low fare competitive environment is contingent upon USAir's ability permanently to reduce its operating costs through reductions in personnel costs and other cost saving initiatives. USAir management is currently engaged in discussions with the leadership of its unionized employees to achieve its goal of reducing personnel costs. While USAir's management has stated it is committed to reaching an agreement with the labor groups, both the timing and the outcome of the negotiations are uncertain.\nDollar amounts in thousands except for amounts per share\nAs a result of the extended period of losses and the uncertainty surrounding the outcome of the labor negotiations, Berkshire and Wesco management have concluded that an other-than-temporary decline in the value of the USAir Preferred Shares has arisen. Accordingly, Wesco's 1994 consolidated statement of income includes a charge of $9,000, or $5,850 after income taxes, to reflect the decline. The $5,850 net charge to earnings was recorded in the fourth quarter of 1994. Shareholders' equity, however, had already been reduced by the same after-tax amount in earlier 1994 reporting periods: (1) at March 31, 1994, when securities with fixed maturities were first carried at fair value (see third paragraph of Note 2 above), the carrying value of the USAir Preferred Shares was adjusted downward to reflect its then estimated fair value of $6,000, and the after-tax effect of the resulting $6,000 reduction was charged to the separate component of shareholders' equity established for unrealized appreciation; (2) at September 30, 1994, an additional downward adjustment of the shareholders' equity component was made to reflect a further reduction of estimated fair value of the investment to $3,000, which also represents its estimated fair value as of December 31, 1994.\nFollowing is a summary of marketable equity securities:\nAt 1994 and 1993 yearends, the market values of marketable equity securities contained $152 and $139 of unrealized losses.\nNOTE 3. REAL ESTATE HELD FOR SALE\nReal estate held for sale represents property owned by MS Property and acquired through foreclosure by Mutual Savings or itself. It is stated on the accompanying consolidated balance sheet at cost, less any writedowns and valuation allowances. The principal property is a 22-acre parcel of largely oceanfront land near Santa Barbara, California, where a luxury development consisting of townhomes and residential lots has been in process of construction and sale for a number of years. The net book value of the project decreased to $18,816 at 1994 yearend from $23,238 one year earlier, reflecting mainly a $3,000 writedown of the development to estimated net realizable value, following a similar $2,000 writedown in 1993.\nDollar amounts in thousands except for amounts per share\nNOTE 4. INSURANCE LIABILITIES\nWes-FIC's insurance business to date has consisted mainly of participations in property and casualty reinsurance contracts of Berkshire's principal insurance subsidiary.\nWes-FIC recognizes insurance premiums as earned revenues pro rata over the term of each contract on all forms of insurance except for catastrophic excess of loss (\"super-cat\") reinsurance contracts. Premiums on super-cat reinsurance contracts are not recognized as earned until the earlier of a loss occurrence or contract expiration, in order to avoid premature recognition of underwriting profits.\nFollowing is a summary of Wes-FIC's liabilities for unpaid losses and loss adjustment expenses for each of the past three years:\n---------------\n* Includes adjustments of estimated losses provided for in prior years.\nUnearned insurance premiums of $8,872 and $1,015 at December 31, 1994 and 1993 are included in other liabilities on the accompanying consolidated balance sheet.\nNOTE 5. TAXES ON INCOME\nFollowing is a breakdown of income taxes payable at 1994 and 1993 yearends:\nEffective January 1, 1993, Wesco adopted SFAS No. 109, \"Accounting for Income Taxes.\" This statement requires that income taxes be calculated under the asset and liability method, rather than the deferred method used in prior years. Under the deferred method, differences between financial reporting and tax-return reporting in the timing of revenues and expenses were multiplied by tax rates then in effect, and the resulting taxes or benefits were deferred on the financial statements as income taxes payable or prepaid income taxes; the financial statements were not adjusted subsequently to reflect changes in tax rates. Under the asset and liability method, balances of revenue and expense timing differences at a balance sheet date (i.e., amounts of these temporary differences that will disappear in the future) are multiplied by the tax rates in effect at the balance sheet date, with the results deferred on the financial statements as net deferred tax liabilities or assets; thus, under this method the financial statements are automatically adjusted for changes in tax rates when they occur.\nThe cumulative effect of adopting SFAS No. 109 on Wesco's consolidated financial statements caused a reduction in the liability for deferred income taxes and an increase in after-tax income of\nDollar amounts in thousands except for amounts per share\n$1,023 ($.14 per share) as of January 1, 1993. This amount is reported on the accompanying consolidated statement of income and retained earnings as the cumulative effect of a change in accounting principle. Prior year financial statements have not been restated.\nIn August 1993, the federal corporate tax rate was raised from 34% to 35% retroactive to January 1, 1993. SFAS No. 109 requires that the entire effect of a change in tax rate be recognized in the determination of net income in the period enacted. Accordingly, Wesco's tax provision and, thus, net income for the current year include not only the relatively minor effect of the one-percentage- point increase in the federal rate on 1993 pre-tax income, but also charges for the effect of the rate increase on two deferred tax liabilities that originated in prior years: (1) $1,607 associated with unrealized appreciation of marketable equity securities of Wes-FIC (notwithstanding that the gains, themselves, have not yet figured in the determination of consolidated net income); and (2) $500 associated with the recapture of Mutual Savings' special bad debt tax deductions (see below).\nThe consolidated statement of income contains a provision for income taxes (before the $1,023 cumulative effect of change in accounting for income taxes recorded in 1993) as follows:\nSFAS No. 109 required certain disclosures relating to deferred tax assets and liabilities, effective with its adoption by Wesco in 1993, as set forth in the next table. The table following that presents certain prior information still required under the former rule.\nFollowing is a summary of the tax effects of temporary differences that give rise to significant portions of deferred tax liabilities and deferred tax assets as of 1994 and 1993 yearends:\nFollowing is a summary of the tax effects of timing differences for the year ended December 31, 1992:\nDollar amounts in thousands except for amounts per share\nWesco's 1992 net income was negatively impacted by an unusual $17,500 increase in income tax expense resulting from Mutual Savings' decision in late 1992 to give up its status as a regulated savings and loan association. The tax provision related to $47,314 of undistributed retained earnings of Mutual Savings that had not been taxed due to the availability of special bad debt tax deductions to savings and loan associations. These deductions were not related to amounts of losses actually anticipated and were not charged against income for financial reporting purposes; if the association ceased to qualify as a regulated savings and loan association, such action would necessitate accrual and payment of income taxes. The tax liability is being paid over several years.\nFollowing is a reconciliation of the statutory federal income tax rate with the effective income tax rate resulting in the provision for income taxes (before the $1,023 cumulative effect of change in accounting for income taxes recorded in 1993) appearing on the consolidated statement of income:\nWesco and its subsidiaries join with other Berkshire subsidiaries in the filing of consolidated federal income tax returns for the Berkshire group. The consolidated federal tax liability is apportioned among group members pursuant to methods that result in each member of the group paying or receiving an amount that approximates the increase or decrease in consolidated taxes attributable to that member.\nFederal income tax returns through 1988 have been examined by and settled with the Internal Revenue Service. A previously reported disagreement with the California Franchise Tax Board with respect to state issues affecting years 1980 through 1987 has been tentatively resolved, but not yet finalized, without significant effect on Wesco's consolidated financial statements.\nDollar amounts in thousands except for amounts per share\nNOTE 6. NOTES PAYABLE\nFollowing is a list of notes payable, at yearend:\nNotes payable at 1994 yearend mature as follows: 1995, $187; 1996, $205; 1997, $225; 1998, $1,282; 1999, $30,270; thereafter, $5,388.\nAgreements relating to the 8 7\/8% notes contain covenants, among others, enabling the lenders to require Wesco to redeem the notes at par in the event Wesco ceases to be controlled by Berkshire. Wesco is in compliance with all of the covenants.\nEstimated fair market values of the foregoing notes payable at December 31, 1994 and payable at December 31, 1993 were approximately $38,000 and $43,200. These figures were computed using discounted cash flow computations based upon estimates as to interest rates prevailing on those dates for comparable borrowings.\nDollar amounts in thousands except for amounts per share\nNOTE 7. QUARTERLY FINANCIAL INFORMATION\nUnaudited quarterly financial information for 1994 and 1993 follows:\n---------------\n(1) Mainly, effect of adjustment of carrying value of investment in preferred stock of US Air Group, Inc. (see Note 2).\n(2) Gains (losses) on sales of marketable securities and foreclosed properties.\n(3) Gain on disposition by Mutual Savings of savings deposits and some loans (see Note 1).\n(4) Mainly, effect of change in income tax rate on net deferred tax liabilities (see Note 5).\n(5) Loss on disposition of interest in New America Electric (see Note 1).\n(6) Cumulative effect of adopting SFAS No. 109 (see Note 5).\nDollar amounts in thousands except for amounts per share\nNOTE 8. BUSINESS SEGMENT DATA\nConsolidated financial information for each of the three most recent years is presented below, broken down as to Wesco's business segments.\nThe insurance segment includes the accounts of Wes-FIC.\nThe industrial segment includes the operating accounts of Precision Steel and its subsidiaries and, prior to July 1, 1993, of New America Electric.\nPrior to 1994, there was also a financial segment, which included the accounts of Mutual Savings as well as accounts of other Wesco entities that, although not directly connected with an identified business segment, were more closely associated with the savings and loan business than any of Wesco's other businesses.\nIn October 1993, Mutual Savings discontinued as a regulated savings and loan association, and, effective January 1, 1994, it merged into Wes-FIC (see Note 1). As a result, several traditional financial institution items -- notably loans and savings accounts, together with related interest income and expense -- partially or wholly disappeared. Most of the remaining items were transferred to the insurance segment, while foreclosed real estate and troubled loans, together with related losses, expenses and revenues, were dissociated from either of the two remaining business segments. Also, other items previously included in the financial segment because they were more closely related to that segment than to the insurance or industrial segments disappeared or became relatively insignificant and are no longer identified with a business segment; these include (1) investments other than Wes-FIC's, together with related interest and dividend income and securities gains and losses, (2) commercial real estate properties, together with related revenues and expenses, and (3) the assets, revenues and expenses of the parent company.\nDollar amounts in thousands except for amounts per share\nThe above revenue and pre-tax operating profit data include net gains (losses) on sales or writedowns of securities and foreclosed property, including, notably, the $9,000 writedown of USAir preferred stock explained in Note 2, as follows:\nAdditional business segment data follow:\nDollar amounts in thousands except for amounts per share\nWESCO FINANCIAL CORPORATION SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nBALANCE SHEET (DOLLAR AMOUNTS IN THOUSANDS)\nSee notes to consolidated financial statements.\nWESCO FINANCIAL CORPORATION SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nSTATEMENT OF INCOME AND RETAINED EARNINGS (DOLLAR AMOUNTS IN THOUSANDS)\nSee notes to consolidated financial statements.\nWESCO FINANCIAL CORPORATION SCHEDULE I -- CONDENSED FINANCIAL INFORMATION OF REGISTRANT\nSTATEMENT OF CASH FLOWS (DOLLAR AMOUNTS IN THOUSANDS)\nSee notes to consolidated financial statements.","section_15":""}
{"filename":"764587_1994.txt","cik":"764587","year":"1994","section_1":"ITEM 1. BUSINESS\nGENERAL\nAirship International Ltd. (the \"Company\") operates lighter-than-air airships, also commonly known as blimps, which are used to advertise and promote the products and services of the Company's clients. The Company currently operates one airship (the \"Airship\"). The Company's clients utilize its airships at major sporting and special events and over urban and beach locations as an informative advertising and promotional vehicle. The Airship which was operating during 1994 was under an aerial advertising contract with Anheuser-Busch Companies, Inc. (\"Anheuser Busch\") to promote the products of Anheuser-Busch (the \"Bud One Airship\"). In addition, on December 15, 1994 the Company and its wholly-owned subsidiary Airship Operations, Inc. (\"AOI\") consummated an Aircraft Lease Agreement (the \"Argentina Lease Agreement\") and an Airship Operations Agreement (the \"Argentina Operations Agreement\"), respectively, with Mastellone Hnos. S.A. (\"Mastellone\") for the promotion of the products of Mastellone (the \"Argentina Airship\"). Subsequently, on May 24, 1995, prior to commencement of operations of the Argentina Airship and pursuant to an Aircraft Purchase and Lease Assignment and Assumption (the \"Purchase and Assignment Agreement\") between the Company and First Security Bank of Utah, as trustee (\"First Security\") for the benefit of Aviation Support Group Ltd. (\"Aviation\"), the Argentina Airship was sold and the Argentina Lease Agreement was assigned to First Security. In consideration for such sale and assignment, First Security assumed the Company's obligations under the Argentina Lease Agreement.\nIn addition, the Company had the option, by notifying First Security prior to December 15, 1995, to repurchase the Airship for 120% of the out-of-pocket expenses and the assumption of all liabilities incurred by First Security and Aviation in connection with the Argentina Airship. The exercise period of such option was extended to January 15, 1996, at which time such option expired unexercised.\nConcurrently with the execution and delivery of the Purchase and Assumption Agreement, the Company sold to Aviation all of the issued and outstanding shares of the capital stock of AOI. Mr. Julian Benscher, who held, indirectly through designees, approximately 4.0% of the Company's common stock, is an officer and stockholder of Aviation. See \"Certain Relationships and Related Transactions\".\nIn addition to providing clients with aerial advertising and promotion with its airships, the Company also has acquired assets enabling it to construct additional airships either to service existing or potential clients of the Company or for lease or purchase by other parties. To date, the Company has assembled four airships. In November 1990, the Company acquired a substantial amount of airship related assets from the receivers of its former competitor, Airship Industries (UK) Limited (\"Airship UK\"). The Company believes that this acquisition enhanced the Company's ability to construct future airships and maintain its existing fleet. In December 1992 and in 1993, the Company purchased certain assets (but not the business) of the airship maintenance and assembly operations (the \"Slingsby Assets\") of Slingsby Aviation Ltd. (\"Slingsby\"), a division of ML Holdings Ltd., a United Kingdom company. The Company believes that the acquisition of these assets has enhanced the Company's self-maintenance capabilities and reduced maintenance, replacement and assembly costs.\nA maintenance facility in Weeksville, North Carolina that the Company had rented on a per diem basis was destroyed in a fire during 1995. The facility was owned by Westinghouse Airship, Inc. (\"Westinghouse\"), and used as a storage facility for airship spare parts. As Westinghouse's inventory of such\nspare parts was destroyed, the Company believes that it is currently one of few available sources in the United States with a significant inventory of such spare parts.\nThe Company was incorporated in New York on June 9, 1982 and commenced operations in August 1985 following the completion of the Company's initial public offering in June 1985. The Company's principal executive offices are located at 7380 Sand Lake Road, Suite 350, Orlando, Florida 32819 and its telephone number is (407) 351-0011. The Company also maintains a small office in New York, New York.\nAIRSHIPS\nThe Company's Airships were each approximately 194 feet long, 67 feet high and 50 feet wide. Each has an approximate volume of 235,000 cubic feet and is inflated with helium, a nonflammable gas. The Company's Airships were among the world's largest commercial airships available for advertising.\nThe Company's airships, when fully assembled and operational, can be used as both daytime and nighttime advertising and promotional vehicles. The Argentina Airship is equipped on both sides with a computerized night sign, approximately 118 feet long and 29 feet high (\"NightSign`tm'\"). A NightSign`tm' is multicolored, contains approximately 8,500 bulbs and is designed to depict messages, logos, animation, cartoons and other designs. The fast-moving logos and visual effects, which can be seen from over a mile away, are used for twilight and night displays. Although not carrying a NightSign`tm', the Bud One Airship had a fixed NightSign`tm' depicting the client's name.\nFor daytime advertising, each of the Airships and its ground support vehicles were generally painted with the name and logo of the respective client. In addition, the Company's operating personnel wore uniforms carrying the client's logo or name.\nThe Company's clients have utilized its Airships as an aerial ambassador and network- television camera platform for numerous major events.\nThe Company's clients have utilized its airships at major sporting and special events (to maximize its exposure as a television \"eye-in-the-sky\"), as well as over urban and beach locations, as an innovative advertising and public relations goodwill ambassador. Generally, the Company's clients provided the television networks with the use of one of the Airships as a television camera platform in order to televise major sporting and other events and in return the client received certain on-the-air advertising exposure during the event. Although the Company did not receive any direct compensation for this usage, the Company believes that it benefited from the media coverage that the Airships received as a result.\nEach of the Company's airships was operated by a team employed by the Company which included U.S. Federal Aviation Administration (\"FAA\") certified airship pilots, mechanics, technicians and crew. The team supervised and executed the flight schedule and activities which the client specified. The team was supported by specially equipped ground support vehicles owned by the Company, which were used in the operation and maintenance of the Airships. The flight schedule of an airship could have included flights over a several hundred mile geographical area. The Company could accommodate such requirements because an airship's mooring support facilities are mobile and will travel with the ground crew to each of the landing sites. The Company believes that this mobility provides the flexibility for the use of the airships and implementation of a client's promotional campaign. No specialized facility is required for use as a landing site.\nHistorically, substantially all of the Company's revenues have been derived from the operation of the Airships pursuant to aerial advertising contracts with its clients. Fees were generally paid to the Company on a monthly basis and the respective Airships are flown according to a flight schedule provided by\nthe client, subject to weather conditions, government regulations and maintenance requirements. In the absence of availability of suitable replacements and\/or rights of the Company to terminate outstanding advertising contracts, Termination of or substantial reduction in fees provided by the Company's operating Airships has had a material adverse impact on the Company's revenues.\nAERIAL ADVERTISING AND OTHER CONTRACTS\nSet forth below are descriptions of the Company's aerial advertising contracts which were in effect during the fiscal year ended December 31, 1994 (for further detail see \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Comparison of Revenue and Operating Costs -- 1994 to 1993\").\n600.05 AERIAL ADVERTISING AGREEMENT. On January 18, 1994,the Company entered into an Aerial Advertising Agreement (the \"600.05 Aerial Advertising Agreement\") with Kingstreet Tours Limited (\"Kingstreet Tours\") for the use of an airship (the \"600.05 Airship\"), to promote Pink Floyd. Pursuant to this agreement, the 600.05 Airship operated for approximately three months from March through May 1994. The 600.05 Airship was operated as the Met Life airship pursuant to an aerial advertising agreement ( the \"Met Life Contract\") with Metropolitan Life Insurance Company (\"Met Life\") from 1989 through October 1993. On June 20, 1994, subsequent to the termination of the 600.05 Aerial Advertising Agreement, the 600.05 Airship was damaged in a storm. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nGULF OIL CONTRACT. On May 28,1993, the Company entered into an Aerial Advertising Agreement, which was amended in October 1993 (the \"Gulf Oil Contract\"), with Catamount Petroleum Limited Partnership, (\"Catamount\" now known as Gulf Oil Limited Partnership (\"Gulf Oil\")) for the use of an airship to promote Gulf Oil Company (the \"Gulf Oil Airship\"). The Gulf Oil Contract had a three-year term ending on June 15, 1996 subject to an annual right of termination by either party; however, pursuant to the terms of the Gulf Oil Contract, the Gulf Oil Airship was not operated from November 1993 to April 14, 1994 and no operating fees for the Gulf Oil Airship were received by the Company for this period. The Gulf Oil Airship was then operated from April 15, 1994 until September 11, 1994, when it was damaged in an accident. As a result, as provided for in the Gulf Oil Contract, Gulf Oil terminated the Gulf Oil Contract as of October 15, 1994. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nBUD ONE CONTRACT. On March 12, 1992, the Company entered into an agreement (the \"Bud One Contract\") with Anheuser-Busch for the use of the Bud One Airship. In March 1994, the Company and Anheuser-Busch agreed to reduce flight time and monthly fees under the Bud One Contract by approximately 50%, effective February 1994 through July 1994 (the \"March Amendment\").\nOn July 8, 1994 the Bud One Contract was amended and restated, pursuant to which amendment the Bud One Airship was to be operated from September 1, 1994 through December 31, 1996. Thereafter, Anheuser-Busch had the option to extend the agreement for one year. The airship was to be operated, in all material respects, in the same manner as it had been operated in the past, with contract payments being substantially equivalent to those under the Bud One Contract prior to the March Amendment. The Bud One Contract contained restrictions on the Company's ability to operate airships for potential clients which are competitive with Anheuser-Busch.\nARGENTINA AGREEMENTS. On December 15, 1994 the Company and AOI consummated the Argentina Lease Agreement and the Argentina Operations Agreement, respectively, with Mastellone, an Argentinean dairy company, for the promotion of the products of Mastellone.\nSubsequently, on May 24, 1995, prior to commencement of flight operations of the Argentina Airship and pursuant to the Purchase and Assignment Agreement, the Argentina Airship and related equipment were sold and the Argentina Lease Agreement was assigned to First Security. In consideration for such sale and assignment, First Security assumed the Company's obligations under the Argentina Lease Agreement. The initial terms of the Agreements were for a period of four months, and commenced in July 1995. Such initial terms were extended for a ten-month period by Mastellone pursuant to the provisions of the Agreements.\nIn addition, the Company had the option to repurchase the Airship for 120% of the out-of-pocket expenses and the assumption of all liabilities incurred by First Security and Aviation in connection with the Argentina Airship. Such option expired unexercised on January 15, 1995.\nSEA WORLD PASSENGER CONTRACT. Following the cessation on June 30, 1993 of its previous contract with Anheuser-Busch covering an airship, (the \"Sea World Airship\") and the conclusion of flights thereunder in December 1993, the Company and Anheuser-Busch entered into a Limited Passenger Airship Agreement, dated as of January 2, 1994 (the \"Sea World Passenger Contract\"), pursuant to which the Company was able to use the Sea World Airship to provide passenger flights and to display advertising. This contract did not provide for usage fees or for a monthly operating fee, but permitted the Company to use this airship while it still Carried Sea World's logos\/markings. The term of this agreement was to expire on December 31, 1994; however, the Company exercised its right under the contract to voluntarily suspend operations of the Airship in April 1994.\nThe Company's revenues were historically dependent on the Company's aerial advertising contracts. For the years ended December 31, 1994 and 1993, 52% and 67%, respectively, of the Company's revenues were derived from Anheuser-Busch and 29% and 10% respectively, of the Company's revenues were derived from Gulf Oil. In addition, 19% of 1994 revenues were derived from Kingstreet Tours, and 23% of 1993 revenues were derived from the Met Life Contract which was terminated in October 1993. The Company has been adversely affected during the period between the time that any particular aerial advertising agreement terminated and the time a new contract commenced.\nACQUISITIONS, LEASES AND FINANCINGS\nSet forth below is a description of the Company's financing arrangements in effect during the year ended December 31, 1994 and for the period from December 31, 1994 through August 24, 1997.\nORIX LEASE\nIn 1989 the Company executed, as lessee, an airship lease (the \"Orix Lease\") with Orix USA, Inc. then known as Orix Commercial Credit Corporation (\"Orix\") for the 600.05 Airship, which provided for an initial three year term with two three-year renewal options. Pursuant to the Orix Lease, the Company was obligated to pay a monthly lease payment of $121,000 (through November 1995), and $35,000 per month from December 1995 to November 1998. As a result of the termination of the Met Life Contract in October 1993, the Company and Orix entered into amendments to the Orix Lease in January and May 1994 to restructure the monthly payments. As a result of the reduced fees under the Bud One Contract and the suspension of operations of the Gulf Oil Airship, several required payments were not made. The Company again renegotiated its arrangement with Orix and in October, 1995, entered into an Amended and Restated Lease Agreement in the form of a Conditional Sales Contract effective as of June 2, 1995 (the \"Amended Lease\"). Pursuant to the Amended Lease, the payments to Orix are $20,000 per month for the first year, $40,000 plus interest per month for the next 6 months, $60,000 plus interest per month for the next 6 months and thereafter the greater of $80,000 per month or 50% of annual cash flow for the proceeding 12 month period. The Amended Lease expires June 2, 2002 at which time the Company can purchase the Airship for $1.00. The Airship which is the\nsubject of the Amended Lease is not currently operational, at it requires a new envelope. To date, the envelope has not been replaced.\nAs security for the Company's obligations under the Orix Lease and the Amended Lease, Louis J. Pearlman, Chairman of the Board, President and Chief Executive and Operating Officer of the Company (\"Mr. Pearlman\"), has personally guaranteed the payment and performance of the obligations of the Company. In addition, the Company's obligations to Orix are guaranteed by TransContinental Airlines, Inc., an affiliate of the Company, which received common stock of the Company in exchange for such guaranty. See \"Certain Relationships and Related Transactions.\"\nWDL LEASE\nPursuant to an agreement effective May 16, 1993 (the \"WDL Lease\"), the Company leased from Westdeutsche Luftwerbung Theodor Wullenkemper GMBH (\"Westdeutsche\") a used type WDL IB airship equipped with a NightSign`tm' system. The Company entered into the WDL Lease to procure an airship to fulfill its obligations under the Gulf Oil Contract when it became apparent that the proposed acquisition of the assets of Slingsby could not be completed in time to provide an additional airship to fulfill the Company's obligations under the Gulf Oil Contract. The Company began operating this airship as the Gulf Oil Airship on June 25, 1993. On September 11, 1994, the Gulf Oil Airship was damaged in an accident and its operations ended. As a result of the damage to the Gulf Oil Airship, the Company sustained a loss of $1,978,000, representing the cost of the airship less insurance proceeds and credits allowed, including salvage value, when the airship was returned to WDL in September 1994. At December 31, 1994, the Company owed WDL a total of $2,866,000 under the WDL Lease including the $1,978,000 described above plus lease and other operating costs through September 11, 1994. Pursuant to the WDL Lease, the Company was to maintain a security deposit of $2,500,000 in a cash account (the \"Cash Escrow Account\") with Trans Continental Airlines Inc., an affiliate of the Company (\"Trans Continental\") (see Note C to the Financial Statements included elsewhere herein). The Cash Escrow Account, from which the Company may withdraw its funds at any time upon demand, enabled the Company to maintain a lower amount of insurance coverage on the Gulf Oil Airship than otherwise would have been required under the WDL Lease. During the fiscal year ended December 31, 1995, the Company had withdrawn the funds from the Cash Escrow Account to pay certain obligations owing to WDL. As a result of the payment to WDL of such funds, the Company is currently indebted to WDL in the approximate amount of $1,000,000. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nALLSTATE LOAN\nOn November 16, 1994, the Company entered into an Aircraft Collateral Funding Repayment Agreement (the \"Allstate Agreement\") with Allstate Financial Corporation (\"Allstate\"). Pursuant to the Allstate Agreement, on December 6, 1994, the Company borrowed $1,500,000, (the \"Allstate Loan\") and as of December 31, 1994, the Company owed Allstate $1,250,000 plus approximately $47,000 of accrued interest. The Allstate Loan bore interest at the rate of 37.5% annually and required a minimum payment of $75,000 each month, the first payment of $75,000 having been made on January 5, 1995. The Allstate Loan was guaranteed by both Mr. Pearlman and Trans Continental. See \"Certain Relationships and Related Transactions.\" The guarantors agreed to subordinate any payments due to them from the Company while the Allstate Loan is outstanding, and any payments that would otherwise be paid to the guarantors is to be paid to Allstate and applied against the Allstate Loan.\nSubsequently on June 22, 1995 the Allstate Loan was repaid when Transcontinental Leasing, Inc. (\"TLI\"), a wholly-owned subsidiary of Transcontinental Airlines, Inc., (\"Transcontinental\"), an affiliate of the Company, entered into a Sale-Leaseback Agreement the (\"S\/L Agreement\") with the Company pursuant to\nwhich the Bud One Airship was sold by the Company to TLI for the purchase price of $2,060,000, which in turn leased such airship back to the Company. TLI borrowed the purchase price for the airship (the \"Phoenixcor Loan\") from Phoenixcor, Inc. (\"Phoenixcor\"), which was granted a pledge of the lease and a lien on the Bud One Airship. In addition, the Phoenixcor Loan was guaranteed by the Company and Transcontinental. The lease payments to be made under the S\/L Agreement are equal to the payments to be made under the Phoenixcor Loan. As TLI has no source of income other than the rental stream generated by lease of the airship to the Company, it is likely that a default in such lease payments would result in TLI's default under the Phoenixcor Loan and a foreclosure by Phoenixcor of its lien on the Bud One Airship and a potential sale of such airship.\nThe Company has entered into an arrangement with Senstar Capital Corporation, (\"Senstar\") pursuant to which the sale leaseback arrangement with TLI has been reversed with the result that the Company reacquired Bud One Airship and the Company has borrowed a total of $3,500,000 from Senstar (the \"Senstar Loan\"), part of which has been used to repay the Phoenixcor Loan. The loan from Senstar is repayable over 5 years in sixty monthly payments of approximately $63,371.06 each, with a balance due at the end of the five year term of approximately $700,000, and is secured by a lien on the Airship and a guaranty by Transcontinental. The Senstar Loan provided approximately $1,337,207.31 to the Company after payment of the Phoenixcor Loan. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\".\nThe Phoenixcor Loan was structured as a sale-leaseback for financing purposes only.\nADDITIONAL AIRSHIPS; AIRSHIP ASSEMBLY\nIn addition to providing clients with aerial advertising and promotion with its airships, the Company also has acquired assets enabling it to partially construct additional airships either to service existing or potential clients of the Company or for lease or purchase by other parties. The Company owns substantial airship replacement components and its experience in airship assembly includes the assembly of four airships. The airship components that the Company currently has in inventory, plus approximately $1,000,000 of additional capital per airship, would enable the Company to construct up to five additional airships. The Company believes that its inventory of spare airship components will significantly reduce its cost for initial airship assembly and future maintenance expenditures, should future clients be obtained. There can be no assurance, however, that the Company would be able to obtain the financing necessary to complete construction of any additional airships, or that it would be able to consummate aerial advertising agreements with respect to any such airships. See \"Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources.\"\nAIRSHIP OPERATIONS\nOperation of the Company's airships is subject to suitable weather conditions and an absence of mechanical failures, either of which could damage or destroy an airship. During 1994, the 600.05 Airship was damaged in a storm while attached to its mast and the Gulf Oil Airship was damaged in an accident. Airships can be operated only in warm climates. Accordingly, during the winter months airships can only operate in the southern states and west coast states. Furthermore, maintenance of an airship requires that it cease operations for an aggregate of approximately one month each year, including approximately two weeks of in-hangar maintenance. During 1994, the Company rented a hangar facility in Weeksville, North Carolina from Westinghouse Airship, Inc. (\"Westinghouse\") and used a Santa Ana, California hangar owned by the U.S. Government for a nominal per diem fee. See \"Properties\".\nDuring 1994, each airship's annual in-hangar maintenance was performed in the late summer by the Company's employees and routine maintenance was performed on an as-needed basis by the Company's employees wherever the airship was located. The Company also leases a warehouse in Kissimmee, Florida which is being used to store spare parts, including the components needed for additional airships.\nMARKETING\nThe Company markets its airship services directly to potential clients through a sales effort conducted by its management, including a Director of Marketing. During 1994, the Company was in negotiations with several potential new clients, both for aerial advertising contracts and for the purchase of new airships; none of such contracts or purchases was consummated.\nSUPPLIERS\nAirships are manufactured by a limited number of suppliers worldwide. The 600.05 and Argentina Airships were manufactured by Airship UK, a United Kingdom supplier no longer doing business. The Bud One Airship was manufactured by Slingsby and assembled by the Company. Due to asset purchases and expertise described above in \"Additional Airships; Airship Assembly,\" the Company is in a position to manufacture or assemble up to five additional airships, subject to financing requirements.\nBLIMP PORT USA`tm'\nThe Company had been to considering the construction of an airship hangar and maintenance facility to be called \"Blimp Port USA,\"`tm' which would be located at a site near its Orlando, Florida base of operations. Construction of Blimp Port USA`tm' was dependent upon the availability of additional financing and an increase in the number of aerial advertising contracts for the Company's airships, none of which materialized. Accordingly, the Company subsequently determined to forgo any further development of this project and that the $479,000 it spent in 1993 on architectural design services for the project should be written off in 1994.\nCOMPETITION\nHistorically, the Company's direct competition has been limited to those companies which have an airship legally permitted to operate in the United States. The Company competed with Airship Management Service (AMS), the operator of the Fuji airship, and Icarus Aircraft, Inc. (\"IAI\"), a privately-held firm which operates lightships, which are small airships approximately 1\/3 the size of the Company's airships. Currently, IAI is operating for MetLife. The Lightship Group, Inc. (formerly Virgin Lightships Inc. and American Blimp Company) owns and operates the smaller airships on behalf of numerous advertising clients in the United States. MetLife is a former client of the Company which did not renew its agreement with the Company in 1993, at least in part due to these alternative airship providers.\nIn addition, Goodyear Tire & Rubber Company (\"Goodyear\") manufactures, owns and operates on a regular basis three airships in the United States. However, for over 30 years Goodyear has used its airships to advertise only its own products and has not leased or sold its airships to others. It is unknown at this time whether Goodyear will sell or lease the use of its airships to other companies or permit such entities to use Goodyear's airships for advertising.\nIn addition to the direct competition with other airship companies, the Company competes with other forms of aerial advertising, such as small-scale blimps, hot air balloons, aerostats (tethered blimps), skywriting and banner towing by fixed-wing aircraft, and with other forms of advertising and public relations media, such as print (including magazines and newspapers) and television and radio.\nGOVERNMENTAL REGULATION\nOperation of airships in the United States is regulated by the Federal aviation laws of the United States. The Company currently holds all necessary Federal Aviation Administration (\"FAA\") and U.S. Department of Transportation authorizations to operate all of its existing airships, including a Standard airworthiness Certificate issued by the FAA with respect to each of the airships. In addition, the Company holds an FAA \"Type Certificate\" which certifies that the design for the Company's airships meets air-worthiness requirements of Federal aviation regulations, and an FAA facilities license which permits the Company to assemble, repair and maintain airships. However, there can be no assurance that the federal government will not impose additional requirements on the operation of airships in the future, which might require the Company to incur additional expense, or which might otherwise have a material adverse effect on the Company's operations.\nIn addition, the Argentina Airship is subject to regulation by the Argentinean equivalent of the FAA. The Company is currently in compliance with the requirements of such governmental authority, and anticipates that it will be able to maintain such compliance in the foreseeable future.\nEMPLOYEES\nAs of March 31, 1995, the Company had approximately 30 full-time employees, 11 of whom are administrative, 3 of whom are pilots and the balance of whom are field operating personnel including mechanics and others who have a high degree of knowledge and expertise in the airship industry as well as field workers who accompany and maintain the Airships. The number of employees fluctuates based in part on the number of Airships conducting flight operations.\nThe Company's employees are not represented by any union. The Company considers its employee relations to be good.\nINSURANCE\nThere are risks inherent in the ownership and operation of airships. The Company has maintained insurance in such amounts and for such coverage as management has determined to be appropriate and as has been required from time to time under its contracts with Orix and various financing companies and airship aerial advertisers. Currently, the Company maintains insurance for its spare parts, as well as property coverage and general liability insurance. The Company has also maintained Aircraft Hull All Risk Insurance for the periods when its Airships are operational.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company had leased its principal executive offices pursuant to the terms of a five-year lease, which commenced May 7, 1991 and ended May 6, 1996, for approximately 7,000 square feet in Orlando, Florida, the home base of the Company. The annual rent under such lease was approximately $132,000. Since May 7, 1996, the Company has subleased approximately 2,000 square feet of such facility from\nTrans Continental Airlines, Inc. on a month-to-month basis for monthly rental payments of approximately $1,800. The Company also maintains a small office in New York City for which it pays minimal rent. In December 1994, the Company renewed for one year a lease for a warehouse of approximately 5,000 square feet in Kissimmee, Florida for approximately $15,000 per year. The Company stores various spare parts for its existing airships at this warehouse and intends to do so for the foreseeable future.\nIn May 1991, the Company and Westinghouse entered into a contract for the Company to use Westinghouse's Weeksville, North Carolina hangar for repair, renovation, maintenance, and related uses. The Westinghouse facility was destroyed in a fire during the third quarter of 1995. The Company rents space as available in Lakehurst, New Jersey, if needed, to perform maintenance and related functions previously performed at the Westinghouse facility.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTenerten and Drake, Inc. On September 15, 1994, Tenerten and Drake, Inc. (\"TDI\") filed a complaint against the Company. The complaint alleges that the Company failed to pay certain sums of money due and owing to TDI under an agreement to perform advertising and related services for the Company. The Company filed its answer and raised its affirmative defenses to said complaint alleging that the services allegedly performed by TDI were defective in numerous respects. On June 13, 1995, the parties entered into a Settlement Stipulation whereby the Company agreed to make certain payments to Tenerten and Drake, Inc. On July 20, 1995, Tenerten And Drake, Inc. filed its Motion for Final Judgment alleging that the Company failed to make a payment under the Settlement Stipulation. A Final Judgment was entered against the Company on July 20, 1995. The Company filed its Notice of Appeal on September 19, 1995 and posted a cash bond in the amount of $24,190.76. The Company filed Appellant's Initial Brief on January 8, 1996, contending that the Company's payment was made in a timely manner as required by the Settlement Stipulation. The Circuit Court of the Eighteenth Judicial Circuit in and for Seminole County, Florida is reviewing the Briefs filed by the parties and no opinion has been received as of this date.\nWestinghouse. On September 14, 1994, Westinghouse Airships,Inc. filed a complaint against Airship International Ltd. (\"AIL\"). The Complaint alleges that AIL breached an agreement to purchase two Gondolas from WAI. Specifically, the complaint alleges that WAI delivered both Gondolas at issue and AIL failed to make certain installments to WAI under the Agreement. The complaint also alleges that AIL breached a sub-lease to occupy certain hangar space located at Elizabeth City, North Carolina. On October 31, 1994, WAI filed its Second Amended Complaint. On November 31, 1994, AIL filed its answer and raised its affirmative defenses to said complaint alleging payment, fraudulent concealment by WAI and estoppel. On June 19, 1995, the parties entered into Defendant's Consent to Entry of Judgment in the amount of $320,240.00. The Company has paid all sums of money due and owing under said Consent to Entry of Judgment. On July 27, 1995, a Satisfaction of Judgment was filed with the Court.\nWatermark. In January, 1993, a second amended complaint to a lawsuit, which was initially commenced in March 1991 and subsequently dismissed twice without prejudice, was filed in the Circuit Court of the State of Florida against the Company and its President by Watermark Group PLC and Von Tech Corporation, as general partners of Company Communications (collectively, the \"WNT Plaintiffs\") alleging breach of an alleged joint venture agreement involving Company Communications and Airship Enterprises Ltd. (a company that was owned by Mr. Pearlman and that was not in any way owned or controlled by the Company), breach of an alleged agreement by the Company regarding the lease and operation of a particular airship; and breach of an alleged oral commission agreement by the Company relating to the Company's acquisition of two airships it presently owns. The WNT Plaintiffs seek various legal and equitable remedies, including monetary damages against the Company and Mr. Pearlman in excess of $800,000 together with a claim for some portion of the advertising revenue the Company has received, and will continue to receive, from\nthe operation of some of its airships. On October 3, 1995, the parties entered into a Mutual Release and Joint Stipulation for Settlement whereby the Company agreed to make payments to Watermark in the total amount of $40,000. Such payments were made during 1995 and 1996.\nIn March 1993, the second amended complaint was dismissed without prejudice. Since the Company denies any involvement with any of the transactions set forth in the second amended complaint, the Company believes that its liability, if any, on the claims made by the WNT Plaintiffs will not be material.\nSequel. In November 1992, Sequel Capital Corporation (\"Sequel\") filed an action against the Company asserting breach of an alleged contract to enter into a sale lease back agreement and a claim of fraudulently inducing Sequel to make a loan to the Company. Such action sought damages in excess of $3 million from the Company and Louis J. Pearlman, its President. In July 1993, the Federal District Court in Chicago entered a judgement on the jury verdict in the amount of $602,000 in favor of Sequel. In September 1993 the Company settled this lawsuit for the amount of $386,000. Total expenses after legal fees and other related costs were $742,000, which amounts were paid and expensed during 1993.\nCapital Funding Group Ltd. In February 1992, Capital Funding Group Ltd. (\"CFG\") commenced an action against the Company and others in excess of $1,000,000 in damages based on the alleged failure by the Company to provide adequate collateral and security in connection with certain alleged financial agreements with CFG. The Company retained CFG in July 1991, paid a commitment fee (which was written off in 1991) and received a commitment from CFG which then failed to provide the funding. The Company and the other defendants answered the complaint in February 1992 by denying all of the substantive allegations and asserting several affirmative defenses. In addition, the Company asserted certain counterclaims against CFG and its two principals for breach of a commitment letter pursuant to which CFG was to arrange for a $9 million loan to the Company, breach of a compromise agreement accepted by CFG in January 1992, pursuant to which CFG was to provide funding to the Company in the amount of $7 million, breach of an escrow agreement, pursuant to which CFG was to return $200,000 of the commitment fee paid by the Company and various other counterclaims. In March 1993, the Company was awarded a default judgment of $8,000,000 against CFG and the complaint against the Company was dismissed. No balances have been returned to the Company as of December 31, 1994.\nDue to the weakening financial position of the Company at the time, the Company was unable to complete its audit for the year ended December 31, 1994 or to conduct audits for the years ended December 31, 1995 and 1996. Accordingly, the Company had not filed any periodic reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, for the quarterly and annual periods ended December 31, 1994 through March 31, 1997 or any Current Reports on Form 8-K during such periods until July 11, 1997, on which date the Company filed its Current Report on Form 8-K reporting a change of accountants. On July 18, 1997, the Company entered into a Consent and Undertaking with the Securities and Exchange Commission pursuant to which the Company agreed, among other things, to file this Annual Report on Form 10-K, Annual Reports on Form 10-K for the years ended December 31, 1995 and 1996 and all reports due under Sections 13 and 15 of the Securities Exchange Act of 1934, as amended, for all subsequent periods. Judgement was entered on August 21, 1997.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Company's annual meeting of stockholders for the year ended December 31, 1993 was held on January 6, 1994. In connection with such meeting, a proxy statement was sent to the Company's stockholders with respect to the following items: (1) election of the Company's Board of Directors (2) ratification of Grant Thornton, as independent accountants of the Company, for the fiscal year ended December 31, 1993.\nAt the meeting, the Company's directors were elected. For Louis Pearlman 26,122,020 shares were voted for and 463,159 shares were withheld, for Roy Belotti 26,116,454 shares were voted for and 468,725 shares were withheld; for Marvin Palmquist 26,115,863 shares were voted for and 469,316 shares were withheld for James Ryan 26,124,454 shares were voted for and 460,725 shares were withheld; and for Alan Siegel 26,126,574 shares were voted for and 458,605 shares were withheld. The appointment for Grant Thornton as the Company's independent accountants for the fiscal year was approved with 26,060,801 shares being cast for, 373,979 shares cast against, 114,899 shares abstaining, and 35,500 shares not voted.\nThe Company's annual meeting of stockholders for the year ended December 31, 1994 was held on April 11, 1995. In connection with such meeting, a proxy statement was sent to the Company's stockholders with respect to the following items: (1) election of the Company's Board of Directors (2) ratification of Grant Thornton, as independent accountants of the Company, for the fiscal year ended December 31, 1994. (3) approval of a reverse stock split pursuant to which 100 shares of the Company's Common Stock would be combined into one share of Common Stock and 100 shares of the Company's Preferred Stock would be combined into one share of Preferred Stock (the \"Reverse Stock Split\"); (4) adoption of an Employee Share Purchase Plan of the Company to be effective as of November 1, 1994 (the \"Share Purchase Plan\") and (5) approval of a proposal to issue options to purchase Common Stock to certain employees of the Company (the \"Employee Options\").\nAt the meeting, the Company's directors were elected. For Louis Pearlman 18,396,603 shares were voted for and 1,266,328 shares were withheld, for Roy Belotti 18,510,594 shares were voted for and 1,152,337 shares were withheld; for Marvin Palmquist 18,540,217 shares were voted for and 1,122,714 shares were withheld; for James Ryan 18,554,134 shares were voted for and 1,108,747 shares were withheld; and for Alan Siegel 18,556,117 shares were voted for and 1,106,814 shares were withheld. The appointment for Grant Thornton as the Company's independent accountants for the fiscal year was approved with 18,487,369 shares being cast for, 526,545 shares cast against and 648,908 shares abstaining. The Reverse Stock Split was defeated, with 11,517,471 shares being cast for, 7,487,272 shares cast against, and 498,213 shares abstaining.\nThe Employee Share Purchase Plan was approved, with 16,677,446 shares being cast for, 2,487,272 shares cast against and 498,213 shares abstaining. The issuance of the Employee Options was approved, with 14,465,208 shares being cast for 4,653,011 shares cast against and 544,712 shares abstaining.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nThe Company's Common Stock, Preferred Stock, Class A Warrants and Class B Warrants had been listed on the Nasdaq SmallCap Market under the symbols BLMP, BLMPP, BLMPW and BLMPL, respectively, until Nasdaq's delisting of the Company's securities on July 5, 1995 (the \"Delisting\") as a result of the Company's failure to timely file this Annual Report on Form 10-K. Since the Delisting, the Company's Common Stock and Preferred Stock have traded on the over-the-counter market under the symbols \"BLMPE\" and \"BLMPPE,\" respectively. The price ranges presented below represent the highest and lowest quoted bid prices during each quarter reported by the Nasdaq SmallCap Market for periods prior to the Delisting and periods subsequent to the quarter of 1995, and as obtained from the National Quotation Bureau, Inc for the third quarter of 1995. The Nasdaq quotes represent prices between dealers and do not reflect mark-ups, markdowns or commissions and therefore may not necessarily represent actual transactions.\nCommon Stock:\n- -------- * Prior to the Delisting. Price ranges during the third quarter of 1995 include quotations on NASDAQ SmallCap Market up to such date. The Common Stock and the Preferred Stock are currently traded on the Nasdaq OTC Electronic Bulletin Board. N\/A Not available.\nAs reported by the Nasdaq OTC Bulletin Board, on August 21, 1997 the closing bid price of the Common Stock was $0.081 per share and the closing bid price of the Preferred Stock was $0.38.\nAs of August 21, 1997, there were 1,496 holders of record of the Company's Common Stock and 83 holders of record of the Preferred Stock, respectively.\nNo dividends were declared or paid on the Common Stock during the foregoing periods and the Company does not anticipate paying any dividends on its Common Stock in the foreseeable future.\nDividends on the Preferred Stock are payable quarterly on February 15, May 15, August 15 and November 15 of each year (each such date a \"Dividend Payment Date\") and accrue at the annual rate of $.48 per share, to the extent payable in cash and $.60 per share, to the extent payable in shares of Common Stock. The first four dividend payments were paid 50% in cash and 50% in registered shares of Common Stock computed on an annual basis, the last such dividend payment being made on February 15, 1994. The cash portion of such dividend payments was paid with a portion of the proceeds of the 1993 Offering, which had been reserved for such purposes. Beginning May 15, 1994, dividends were payable in cash from the available cash derived from the adjusted earnings of the Company for the fiscal quarter immediately preceding the Dividend Payment Date to the extent available, according to a formula based on adjusted earnings. Such formula provides that the available cash will be determined as one half of the difference between airship operating revenues and the sum of operating costs, interest and principal payments on debt, selling, general and administrative expenses (limited to a ceiling based on historical numbers with stated annual percentage increases thereafter) and airship related capital expenditures (limited to $2,000,000 in any given year). The components of the above formula are to be determined in accordance with generally accepted accounting principles as applied in the Company's financial statements as filed with the Securities and Exchange Commission (the \"Commission\"). At its option, the Company may pay cash dividends in excess of the available cash determined by the above formula. The May 15, 1994 dividend was paid in registered shares of Common Stock. The Company has deferred and accrued the cash dividend on the Preferred Stock due on August 15, 1994 and subsequent quarterly dividends until a later payment date. The Company does not anticipate paying such dividends in the near future, and intends to continue to defer and accrue such dividends.\nConcern has been expressed by management and various shareholders of the Company over the dilutive effects of issuances of shares of Common Stock in payment of dividends accrued on the Preferred Stock. The Company is currently exploring possible alternatives to such issuances, including submitting to the Company's shareholders a proposal to amend the terms of the Preferred Stock.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA [1994 NUMBERS MUST BE REVISED BASED UPON AUDIT NUMBERS.]\nThe following selected financial data should be read in conjunction with the Company's financial statements and related notes and Management's Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere herein.\nOPERATING STATEMENT DATA:\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nGOING CONCERN AND MANAGEMENT'S PLANS\nAs shown in the accompanying financial statements, the Company has experienced significant operating losses and negative cash flow from operations in recent years and has an accumulated deficit of $39,977,000, at December 31, 1994. During the year ended December 31, 1994, the Company generated revenues from airship operations; however, it reported a net loss of $20,645,000 and has negative working capital of $9,754,000. These conditions raise substantial doubt about the Company's ability to continue as a going concern.\nManagement's plans to improve the financial position and operations with the goal of sustaining the Company's operations for the next twelve months and beyond include:\nArranging with Trans Continental Airlines, Inc. or other related parties common directorship and ownership, to provide funds on a monthly basis as a loan and acquiring assets and operations of one or more entities, with which the Company has been in negotiation. The expectation is that such business combination, if completed, would provide additional cash flow and net income to the Company.\nThough management believes the Company will secure additional capital and\/or attain one or more of the above goals, there can be no assurance that any acquisition, financing or other plan will be effected. Any acquisition or securities offering is subject to the Company's due diligence, the state of the general securities markets and of the specific market for the Company's securities, and any necessary regulatory review.\nWhile the Company believes that its plans for additional funding or possible business combination have the reasonable capability of improving the Company's financial situation and ensuring the continuation of its business, there can be no assurance that the Company will be successful in carrying out its plans and the failure to achieve them could have a material adverse effect on the Company.\nOVERALL FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles, WHICH CONTEMPLATE CONTINUATION OF THE COMPANY AS A GOING CONCERN. For its year ended December 31, 1993, the Company incurred a loss of $5,406,000 and had negative cash flows of $2,956,000 from operations. For its year ended December 31, 1994, the Company incurred a loss of $20,645,000 and had negative cash-flows of $2,144,000 from operations. The accompanying financial statements do not include any adjustments that might result from the Company's current liquidity shortage, including any adjustments relating to the values that would be realized from the Company's assets.\nThe Company's stockholders' deficit at December 31, 1994 was $3,861,000, a decrease of $21,500,000 from stockholders' equity of $18,235,000 at December 31, 1993. The decrease was due primarily to the net loss of $20,645,000 in fiscal 1994. Issuance of Common Stock less the payment of cash dividends on Preferred Stock decreased equity by $852,000. As a result of these equity changes, during 1994 the Company's assets decreased $16,300,000 while liabilities increased $5,300,000. Compared to the year ended December 31, 1993, revenues, selling, general and administrative costs decreased 59.3% and 27.7%, respectively, while operating costs increased 75.2%. Interest expense less other income for 1994 was $599,000, an increase of $77,000 or 14.8%. In 1993 the Company incurred a nonrecurring cost of $741,000 in connection with the settlement of a lawsuit by a lender and related expenses and a $478,000 cost on disposition of airship components, while in 1994 the Company incurred losses of $3,443,000 when two airships were damaged. These changes in revenues and costs, as explained in more detail below, resulted in a net loss for fiscal 1994 of $20,645,000 compared to a net loss of $5,406,000 in fiscal 1993.\nThe Company continues to experience negative cash flows from operating activities. Cash flow was adversely affected in 1994 through the termination, at the end of 1993, of contracts relating to the Met Life and Sea World Airships, and through the temporary cessation of flights and fees under the Gulf Oil Contract and its subsequent termination in 1994, as well as by the modification in certain terms of the Bud One Contract pursuant to the March Amendment. Cash flows for 1995 will also be adversely affected by the termination of the Gulf Oil Contract as liabilities at December 31, 1994 related to its termination and the damage to the Gulf Oil Airship approximates $3,220,000.\nThe Company has made changes in its management, office and airship crew operations (the \"Restructuring\"). The Restructuring includes the reduction of salaries of certain of its management, office, and operations personnel (\"Personnel\"); the reduction of Personnel; the reduction of insurance costs and the reduction of recurring costs throughout its operations; (collectively, the \"Cost Savings\"). Certain of the Restructuring considerations were the result of the cessation of operations under both the 600.05 Aerial Advertising Agreement and the Sea World Passenger Contract. Additional Personnel reductions were made, and operating costs ceased, when the Gulf Oil Airship was destroyed in an accident on September 11, 1994.\nComparison of Revenue and Operating Costs 1994 to 1993.\nAirship revenues for 1994 were $3,980,000, a decrease of $5,776,000 (or 59.2%) compared to revenues of $9,748,000 for 1993, primarily due to $3,454,000 of decreased revenues from the Sea World Airship contract which terminated on December 31, 1993. In addition, monthly fees under the Bud One Contract were reduced for a period of six months effective February 1994. The 600.05 Airship, formerly the\nMet Life airship, operated for only three months during 1994, while the Met Life airship operated for six months during 1993, reducing revenues for 1994, as compared to 1993. These decreases were partially offset by approximately four months of revenues earned from operating the Gulf Oil Airship in 1994 compared to its operation for just over three months during 1993 when operations of that airship first began.\nOperating costs for 1994 were $17,453,000, an increase of $7,488,000 or 75.2% compared to 1993. This increase was primarily due to a write down in its airships and airship components by $9,634,000. See Note A to the financial statements \"Impairment of Long-Lived Assets.\" Costs to operate the 600.05 Airship until it was damaged on June 20, 1994, primarily in connection with the 600.05 Aerial Advertising Agreement, were $1,349,000 lower than costs to operate that airship during 1993 under the former Met Life contract. The cost savings resulted primarily from a decrease in costs to operate the Bud One Airship of $710,000,or 34% compared to the 1993 fiscal year. Costs to operate the Sea World Airship declined 61% or $1,471,000 compared to the 1993 fiscal year as it began limited operations under the Sea World Passenger Contract beginning January 1994. These cost reductions were offset in part by cost increases resulting primarily from operation and lease of the Gulf Oil Airship of $231,000, and secondarily due to increased warehouse costs of $69,000, related to depreciation on airship components purchased during 1993. In addition, increased depreciation charges of $1,156,000 related to changes in accounting estimates and writedowns of $479,000 related to construction in progress were taken during 1994.\nSelling, General and Administrative expense Comparison 1994 to 1993.\nSelling, general and administrative costs were $2,480,000 for 1994, a decrease of $1,841,000 or 30.2% compared to 1993, primarily due to the non-recurrence of accounting, legal and other costs incurred in 1993 related to the Company's public offering of its Preferred Stock (the \"1993 Offering\") and the acquisition of the Slingsby Assets ($687,000). The Cost Savings reduced salaries and certain other costs by approximately $710,000. These savings were partially offset by restructuring costs of $135,000 and a net increase in other costs, primarily in connection with late fees incurred with respect to the Orix Lease plus costs incurred in connection with the Allstate Loan. Such costs resulted from the Company's liquidity shortage. See \"Liquidity and Capital Resources\", below.\nInterest Expense\nInterest expense in 1994 was $805,000, a decrease of $108,000 or 12.4% compared to 1993. Debt that was fully repaid in 1993 reduced interest costs by $102,000 in 1994 compared to 1993. Interest costs related to the Orix Lease and Mr. Pearlman's loan to the Company decreased $88,000 compared to 1993 as payments were made in both 1993 and 1994, (including the reduction of Mr. Pearlman's loan in connection with the June 1993 Loan. See \"Certain Relationships and Related Transactions\"). These decreases were partially offset by interest costs related to the Allstate Loan and the short term loans from private investors received and repaid in 1994 (See Note E to the Financial Statements included elsewhere herein). Ongoing interest expense, at the end of 1994, relates to the Orix Lease plus other loans payable and capital leases, mainly for vehicles, the loan from Mr. Pearlman and the Allstate Loan.\nOther Income (Expense)\nInterest and other income in 1994 was $206,000, a decrease of $185,000 or 47.3% compared to 1993. In 1993, proceeds from the 1993 Offering were placed in certificates of deposit and utilized throughout 1993 and interest was earned in 1993 on a receivable related to a sale of airship components in 1992.\nComparison of Revenue and Operating Costs 1993 to 1992.\nRevenues for 1993 were $9,748,000, an increase of $2,490,000 or 34.3% compared to revenues of $7,258,000 for 1992. The increase was primarily due to (i) revenues from the operation of the Bud One Airship for all of 1993 compared to its use as the Bud One Airship beginning May 1992 and as a passenger airship during the first quarter of 1992; (ii) revenues from the operation of the Gulf Oil Airship for approximately fourteen weeks between June and October 1993; (iii) revenues from the operation of the Met Life Airship until its contract ended in October 1993, compared to its operation for approximately four and one-half months in 1992 as the airship was in the hangar for repairs due to damage, plus (iv) increases in monthly revenues from operation of the Sea World Airship.\nOperating costs in 1993 were $9,964,000, an increase of $3,465,000 or 53.3% compared to 1992. Operation of the Gulf Oil Airship began in 1993 increasing costs by $2,014,000. Gulf Oil Airship costs included (i) $451,000 of net costs (after $100,000 was reimbursed to the Company by Catamount) to ship the airship from Germany and assemble it in the United States; (ii) $450,000 of lease payments on the airship from the time it was shipped from Germany until the end of 1993, representing approximately thirty one weeks compared to its operation for Catamount for fourteen weeks. The Company also maintained a full operating crew for the Gulf Oil Airship through the end of 1993. As a result of these costs, the 1993 operating costs for the Gulf Oil Airship exceeded 1993 revenues by $1,042,000.\nOperation of the Met Life airship increased operating costs by $855,000 or 53.4% in 1993 compared to 1992, mainly as a result of the airship being in the hangar for repairs from June 1, 1992 until October 15, 1992, for which time the Company received insurance proceeds of $585,000 for loss of use of the airship. The Company maintained a full operating crew through the end of 1993 since these employees were subsequently needed to operate the airship under the 600.05 Aerial Advertising Agreement in 1994. As a result of these net cost increases and reduced revenues in 1993 when the Met Life Contract ended, operating costs for the Met Life airship, including non-cash depreciation charges of $469,000, exceeded revenues by $180,000.\nOperating costs for the Sea World Airship increased by $242,000, or 11.2%, compared to 1992, including $83,000 in increased insurance costs due to the addition of loss of use coverage in 1993. For 1993, revenues exceeded operating costs (including non-cash depreciation charges of $270,000) by $1,053,000. The Sea World contract had ended on June 30, 1993 and the airship was operated under the terms of the expired contract until December 31, 1993 when such operations terminated.\nOperating costs for the Bud One Airship in 1993 were similar to those in 1992 when the airship was utilized as both a passenger airship and as the Bud One Airship beginning May 1992. Cost increases for normal maintenance of the airship plus insurance, including the addition of loss of use coverage, were offset by travel cost reimbursements beginning February 1993.\nSpace rented at warehouse facilities in North Carolina and Florida increased costs by $373,000. These increases were mainly for payroll costs to service the airships, including the Gulf Oil Airship added in 1993, plus travel costs related to the acquisition of the Slingsby Assets. Airship components, parts and equipment purchases, including the acquisition of the Slingsby Assets in 1993 and the assets acquired in 1990 from Airship UK, resulted in a major increase in airship components and spare parts that are being stored. As a result, depreciation and insurance related to warehouse operations increased a total of $196,000.\nSelling, General, and Administrative Expense Comparison 1993 to 1992.\nThese costs were $3,449,000 in 1993, an increase of $1,040,000 or 43.2% compared to 1992. Costs associated with the delay in filing the Company's annual report on Form 10-K for the year ended\nDecember 31, 1992, mainly for accounting professional services, plus increases related to the change in accountants, increased costs approximately $350,000. Costs incurred with respect to the 1993 Offering increased costs by $112,000, mainly for travel, as compared to costs incurred during 1992 related to previous registration statements filed by the Company. Legal suits increased costs $69,000 and consulting fees related to the acquisition of the Slingsby Assets increased costs by $135,000. All other costs increased $374,000, or 15.5%. The primary increases in these other costs relate to (i) payroll ($233,000), including the addition of a sales manager and a manager for the Company's merchandising and mini blimp promotion programs, plus increases in health insurance and an average increase of 5.3% in all other payroll related costs; (ii) travel costs ($80,000), related to increased corporate activity including the acquisition of the Slingsby Assets, the operation of the Gulf Oil Airship and the related WDL Lease, (iii) a net increase in all other administrative costs ($67,000), related to the increased corporate activity plus increased rent costs.\nInflation.\nSince the formation of the Company in August 1985, the rate of inflation has remained low and the cost of the Company's operations has not been significantly affected by inflationary trends in the economy. The Company has incorporated adjustments for inflation in its contract with Anheuser-Busch.\nLiquidity and Capital Resources.\nIn 1993 the Company completed the 1993 Offering, obtaining net proceeds of approximately $14,471,000. The 1993 Offering proceeds have been utilized to date: to repay short term debt ($3,600,000) and related interest ($120,000), for architectural and design services for Blimp Port USA(TM) ($479,000); to acquire parts for the assembly of an additional airship, including a Nightsign(TM) ($823,000); to acquire additional airship assets ($2,500,000); to fund a portion of dividend payments on the Preferred Stock ($600,000); and for working capital ($1,455,000). Of the 1993 Offering proceeds to be used for the purchase of land and a hangar for Blimp Port USA(TM) a significant portion had been used instead for working capital purposes due to net losses sustained by the Company.\nThe Company continues to experience negative cash flows from operating activities. During 1994, the Company sustained a net change in cash and cash equivalents of ($623,000), with a reduction of $2,070,000 from operating activities. At December 31, 1994, available cash balances were represented by the $542,000 in cash plus $1,809,000 in funds contained in the Cash Escrow Account. The balance of the funds in the Cash Escrow Account were subsequently used by the Company to repay certain obligations owing to WDL. See \"Business--WDL Lease\". Cash flow has been adversely affected by the temporary cessation in November 1993 of flights and fees under the Gulf Oil Contract which recommenced on April 15, 1994 and which ended on September 11, 1994, the cessation of flights and fees under the 600.05 Aerial Advertising Agreement in April 1994, and by the changes in terms of both the Sea World and Bud One Contracts.\nThe Gulf Oil Airship did not recommence operations until April 15, 1994, causing an approximate $650,000 negative cash flow. The accident involving the Gulf Oil Airship and its subsequent suspension of operations on September 11, 1994 resulted in a further negative operating cash flow for 1994 of approximately $400,000. The Gulf Oil Airship was returned to WDL in September 1994. Approximately $610,000 of the negative cash flow sustained in connection with the Gulf Oil Airship during 1994 resulted from rental and other costs due WDL. Including similar costs for 1993, the Company owed WDL $2,866,000 at December 31, 1994 including $1,978,000 representing the loss incurred when the Gulf Oil Airship was damaged. The Company will not incur additional operating cash costs relating to the Gulf Oil Airship. However, the Company's liability to WDL at December 31, 1994 was $2,866,000. Of such amount, approximately $1,800,000 was repaid to WDL from the Cash Escrow Account during 1995, leaving a balance owing from the Company to WDL of approximately $1,000,000.\nThe Sea World Airship commenced limited operations under the Sea World Passenger Contract, causing a $659,000 negative cash flow during 1994, including maintenance costs when it was disassembled for shipment to Argentina for use as the Argentina Airship. The 600.05 Airship was operated under an aerial advertising contract only during ____ months of 1994, causing a $128,000 negative cash flow for 1994. The 600.05 Airship was disassembled in June 1994, and ongoing cash costs will be minimal for this airship.\nThe Company's negative cash flow for 1994 was $622,000. Operating activities utilized $2,144,000 principally as a result of the net loss for the period, which includes non-cash charges of approximately $14,122,000. In addition, the change in operating assets and liabilities offset the negative cash flow effect of the net loss by approximately $4,379,000 as liabilities at December 31, 1994 increased to approximately $13,070,000. All but approximately $1,000,000 of these liabilities are payable in 1995. Investing activities contributed $455,000 in the form of funds taken from the Cash Escrow Account. Financing activities contributed $1,067,000 principally from proceeds of the Allstate Loan, partially offset by the payment of dividends and repayment of loans.\nThe Company has not had existing bank lines of credit available to provide additional working capital due to the Company's negative cash flow and existing encumbrances on assets, and has previously received substantial financing from Mr. Pearlman in the form of loans and guarantees which supplement the funds available from the Company's operations. There can be no assurance that Mr. Pearlman will make additional cash advances or loans or give personal guarantees if the Company requires additional capital. At December 31, 1994, the Company owed Mr. Pearlman $950,000 net of unauthorized discount and after offsetting $785,000 with respect to a loan made by the Company and guaranteed by Mr. Pearlman. As of December 31, 1994, the Company owed Mr. Pearlman $950,000 net of unamortized discount. The entire unpaid principal balance of the loan from Mr. Pearlman, together with all accrued and unpaid interest, becomes due and payable on May 31, 1997.\nIn addition, Trans Continental has guaranteed the Company's obligations under the Allstate Loan and the Phoenixcor Loan. In consideration for these and other guarantees of the Company's obligations, Trans Continental has been granted 10% of the issued and outstanding common stock of the Company. See \"Certain Relationships and Related Transactions.\" There can be no assurance that Trans Continental will continue to guaranty the Company's obligations in connection with any future financings.\nThe Company is currently taking steps to improve its liquidity. On July 8, 1994, the Bud One Contract was amended, as explained in Note I to the Financial Statements included herein, on terms more favorable to the Company than those contained in the March Amendment. In addition, the Company has renegotiated the Orix Lease, and has completed refinancing of the Phoenixcor Loan. See \"Business-Acquisitions, Leases and Financings.\" Cost Savings in operations and administration were instituted in 1994. Management has eliminated its hull insurance on certain airships and continues to attempt to renegotiate certain long term obligations. In addition, the Company anticipates decreases in ongoing costs resulting from the acquisition in 1993 of certain airship assets, and is seeking new aerial advertising contracts, although there can be no assurance that these anticipated results will be achieved.\nTo date the Company has never paid a dividend on its Common Stock and does not anticipate paying one on its Common Stock in the foreseeable future.\nDividends on the Company's Preferred Stock are payable in cash to the extent of available cash derived from the adjusted earnings of the Company for the fiscal quarter immediately preceding the Dividend Payment Date (according to a formula based on adjusted earnings). The Company has deferred and\naccrued the cash dividend on the Preferred Stock due on August 15, 1994, and all subsequent quarterly dividend payment dates, until a later payment date.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SCHEDULES\nThe report of the Company's Independent Auditor, Financial Statements, Notes to Financial Statements and Financial Statement Schedules appear herein commencing on Page.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE\nOn May 27, 1993, the Company and Wiss & Co. (\"Wiss\"), mutually agreed that Wiss would no longer serve as the Company's outside auditors. The Company had determined that in light of the fact that it is a growing public company, it would be more appropriate to seek a larger, full-service national accounting firm to serve as its outside auditors. This decision was approved by the Company's Board of Directors.\nOn August 23, 1993, the Company engaged Grant Thornton as its new independent accountants. In April 1993, pursuant to discussions between the Company and its former independent auditor, the Company engaged Grant Thornton to examine the issue of revenue recognition described below. The Company and Wiss subsequently reached an agreement on this matter before Grant Thornton was in a position to reach a conclusion. Accordingly, no oral advice or written opinions on the issue in dispute were given by Grant Thornton.\nFor further information relating to the replacement of Wiss by Grant Thornton, including an exchange of letters between Wiss and the Company, see the current Report on form 8-K-A filed by the Company with the Commission on July 12, 1993.\nIn connection with their audit of the Company's financial statements for the year ended December 31, 1992, the Company and Wiss had a disagreement regarding gain recognition for a transaction that occurred in the fourth quarter of 1992. As reported on its reports on Form 8-K filed with the Securities and Exchange Commission (the \"Commission\") on April 16 and May 18, 1993, this disagreement was resolved to the satisfaction of both the Company and Wiss. In connection with their audit of the Company's financial statement for the year ended December 31, 1992, Wiss had preliminarily indicated to the Company their agreement with the Company's proposed accounting treatment that recognized that the gain on a sale of airship components could be recognized in 1992. However, shortly before the due date for the filing of the Company's annual report on Form 10-K with the Commission, Wiss indicated that they disagreed with the Company's position on the gain recognition and indicated instead that the gain should be recognized in 1993. After several discussions between Wiss and the Company and following the receipt of additional supporting documents and audit evidence, Wiss concluded that the gain could be recognized in 1992. Therefore, the Company's financial statements for the year ended December 31, 1992 were filed with the Company's Annual Report on Form 10-K (which was filed with the Commission on May 20, 1993) as originally prepared.\nThe Company became delinquent in its financial filings subsequent to filing its Form 10-Q for the period ending September 30, 1994. In June 1997 the Company retained Charlie Meeks, C.P.A., P.A. as its independent auditor due to the added expense of continuing with a large audit firm such as Grant Thornton.\nThe Company authorized Wiss to respond fully to inquiries of Grant Thornton concerning the aforementioned disagreement. The Wiss report on the Company's 1991 financial statements included a going concern qualification. However, the 1992 financial statements contained no such qualification.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT\nThe following table sets forth information, as of August 21, 1997, relating to each director and executive officer of the Company.**\n- --------------------\n(1) Mr. Bobet resigned as Chief Financial Officer in June 1995. Mr. Pearlman now acts as Chief Financial Officer of the Company.\nThe following sets forth the business experience of each director, executive officer, including principal occupations, at present and for at least the past five years.\nLouis J. Pearlman has been Chairman of the Board, President, Chief Executive and Operating Officer and Treasurer of the Company since June 1982. Since November 1976, Mr. Pearlman has been President and Chief Operating Officer, a director and a 21% shareholder of Trans Continental. See \"Certain Relationships and Related Transactions.\" Mr. Pearlman currently devotes approximately 10% of his time to Trans Continental and the remainder of his time to the Company.\nMarvin Palmquist has been a director of the Company since November 1984. Since August 1967, Mr. Palmquist has been Chairman of the Board of Directors and President of Lloyd American Corporation (\"LAC\") and its subsidiaries, including Lloyd Communications Group, Inc. which develops, owns and operates local television stations and a satellite receiving center associated with the Independent Network System. LAC also owns and operates the Midway Theater, an historic theater located in Rockford, Illinois.\n- -------- ** Mr. Roy Belotti, a director since November 1984, passed away in May, 1995. To date the Company's Board of Directors has not chosen a director to fill the vacancy on the Board created by Mr. Belotti's death.\nSeth M. Bobet was appointed Vice President of Finance in February 1990. From June 1987 through February 1990, Mr. Bobet was the controller of the Company. Mr. Bobet graduated in June 1985 with a Bachelor of Science Degree in Accounting from the State University of New York.\nJames J. Ryan has been a director of the Company since July 1986. Until 1994 for more than 20 years he had been employed with Alexander and Alexander Inc., an international insurance brokerage firm and its predecessor firm, where he most recently held the title of Senior Vice President of the Aviation and Aerospace Division. Mr. Ryan is currently Executive Director of Sedgwick Aviation of North America, an international insurance brokerage firm.\nAlan A. Siegel has been a director of the Company since December 1991 and Secretary of the Company since October 1989. From 1985 to 1989, Mr. Siegel was Senior Account Manager of the Company and since 1989 has served as the Company's General Manager. Mr. Siegel has also been Senior Account Manager for Trans Continental since 1986.\nThe Company's directors are elected for a period of one year and until their successors are duly elected and qualified. Directors who are not employees of the Company are compensated at a rate of $500 for each meeting of the full Board of Directors which they attend in person, up to a maximum of $2,000 in any one year, plus expenses for attending such meetings. Officers are appointed annually by the Board of Directors and serve at the discretion of the Board.\nTo the knowledge of management of the Company, except as set forth above, no director of the Company holds any directorship in any other company with a class of securities registered pursuant to Section 12, or subject to the requirements of Section 15(d), of the Securities Exchange Act of 1934 or in any company registered as an investment company under the Investment Company Act of 1940.\nThere are currently four members of the Board of Directors. The Company and its principal shareholders have agreed to use their best efforts to elect two designees of the underwriters of the 1993 Offering to the Company's Board of Directors. Due to the Company's failure to pay a specified portion of dividends on the Preferred Stock in cash, the holders of the Preferred Stock, voting as a class, have the right to designate two additional members of the Company's Board of Directors.\nCOMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT. Section 16(a) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), requires officers and directors of the Company and persons who own more than ten percent of the Common Stock or the Preferred Stock, to file initial statements of beneficial ownership (Form 3), and statements of changes in beneficial ownership (Forms 4 or 5), of the Common Stock and the Preferred Stock with the Securities and Exchange Commission (the \"SEC\"). Officers, directors and greater than ten percent shareholders are required by SEC regulation to furnish the Company with copies of all such forms they file.\nTo the Company's knowledge, based solely on its review of the copies of such forms received by it, or written representations from certain reporting persons that no additional forms were required for those persons, the Company believes that during 1994 all filing requirements applicable to its officers, directors, and greater than ten percent beneficial owners were complied with. Mr. Pearlman filed one late Statement of Changes of Beneficial Ownership of Securities on Form 4 for the month of August 1994.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe following table summarizes all compensation earned by or paid to the Company's Chief Executive Officer for services rendered in all capacities to the Company for the three years ended December 31, 1994. No other executive officer's annual salary and bonus exceeded $100,000 during the Company's past three fiscal years.\nSUMMARY COMPENSATION TABLE\n(1) Mr. Pearlman had agreed to voluntarily defer approximately $100,000 of his salary for 1994, to which he is entitled pursuant to his employment agreement with the Company. On December 31, 1994, such deferred compensation was applied by the Company as an offset against the exercise price payable with respect to the exercise by Mr. Pearlman of certain options on such date. (See \"Other Options\").\nINCENTIVE STOCK OPTION PLAN\nOn November 1, 1984, the Company adopted an Incentive Stock Option Plan (the \"Plan\") for all management and other key employees. The Plan was intended to qualify under Section 422 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Board of Directors has sole authority to select participating employees. On December 22, 1991 the Plan was amended, increasing the number of shares reserved for issuance under the Plan to 750,000. The aggregate fair market value (determined as of the date the options are granted) of the shares for which an employee is granted options which are exercisable for the first time by the employee in any calendar year (granted pursuant to all of the stock option plans of the Company or any parent or subsidiary of the Company) may not exceed $100,000.\nThese options may have a term of up to ten years (five years in the case of a 10% shareholder or director) and the Board may provide for the exercise of such options in installments over a period of up to ten years (five years in the case of a 10% shareholder or director). The option price may not be less than the fair market value of the shares on the date of grant (110% of such value in the case of a 10% shareholder or director). The Plan terminated on October 31, 1994.\nThe following options have been granted under the Plan to the following persons:\nNo options have been granted under the Plan since fiscal year 1992.\n1994 EMPLOYEE SHARE PURCHASE PLAN\nThe Company has an employee share option plan (the \"Plan\") for employees of the Company and any present or future \"subsidiary corporations.\" The Company intends the Plan to be an \"employee stock purchase plan\" as defined in Section 423 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Plan, approved by the Company's shareholders on April __, 1995, was effective November 1, 1994. All employees are eligible to participate in the Plan, except that the Company's appointed committee may exclude any or all of the following groups of employees from any offering: (i) employees who have been employed for less than 2 years; (ii) employees whose customary employment is 20 hours or less per week; (iii) employees whose customary employment is not more than 5 months in any calendar year; and (iv) highly compensated employees (within the meaning of Code Section 414(q). The shares issuable under the Plan shall be common shares of the Company subject to certain restrictions up to a maximum of 1,000,000 shares. The committee shall determine the length of each offering but no offering may exceed 27 months. The option price for options granted in each offering may not be less than the less of (i) 85% of the fair value of the shares on the day of the offering, or (ii) 85% of the fair market value of the shares at the time the option is exercised.\nOPTIONS\/SAR GRANTS IN LAST FISCAL YEAR\nThe following table sets forth certain information regarding individual options granted in fiscal year 1994 to the Chief Executive Officer. In accordance with the rules of the Securities and Exchange Commission (the \"Commission\"), the table sets forth the hypothetical gains or \"options spreads\" that would exist for the options at the end of their respective terms. These gains are based on assumed rates of annual compound stock price appreciation of 5% and 10% from the date the option was granted to the end of the option term.\nOPTION GRANTS IN 1994\n- ----------\n(1) On August 11, 1994, the Company issued to Mr. Pearlman five-year options to purchase 5,000,000 shares of Common Stock at an exercise price of $.125 per share, which was the closing market value of the Common Stock on August 10, 1994. These options were non-compensatory in nature and were issued in connection with Mr. Pearlman's guaranty of certain obligations pursuant to a restructuring of the Company's indebtedness. Thereafter, Mr. Pearlman personally guaranteed the Company's obligations under an Airship Lease Agreement between the Company and Mastellone Hnos. S.A. dated December 15, 1994, and in connection therewith the Company's Board of Directors lowered the exercise price of such options to $.02 per share. The closing market value of the Common Stock on such date was $.125. These options were granted in connection with the guaranty of certain obligations of the Company by Mr. Pearlman and were not issued as compensation.\n(2) Based upon the closing price of the Company's Common Stock on the National Association of Securities Dealers Automated Quotation System on August 11, 1994.\n(3) Mr. Pearlman exercised these options on December 31, 1994. (See Summary Compensation Table).\nAGGREGATED OPTION EXERCISE IN 1994 AND 1994 FISCAL YEAR-END OPTION VALUES\n- ----------\n(1) The option exercised by Mr. Pearlman was issued in consideration of Mr. Pearlman's guaranty of certain obligations of the Company. See \" - Other Options.\"\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe Board of Directors of the Company does not have a compensation committee. Messrs. Pearlman and Siegel determine executive compensation, based on corporate performance and market conditions. The compensation of Mr. Pearlman, the Chief Executive and Operating Officer of the Company, is based solely upon the terms of his employment agreement with the Company. Similarly, the compensation of Mr. Siegel, the Secretary of the Company, is fixed by the terms of his employment agreement with the Company. See \"Employment Agreements.\"\nEMPLOYMENT AGREEMENTS\nThe Company entered into an employment agreement as of February 15, 1993 with Louis J. Pearlman, superseding his prior agreement which was to expire December 31, 1994. Both agreements contemplate an annual salary to Mr. Pearlman of $200,000 during 1989 and for annual increases thereafter in an amount equal to the greater of 5% of his previous year's salary or the increase, if any, in the Consumer Price Index for All Urban Consumers, Central Florida 1967 - 100. The agreement also provided for an annual profit bonus payable to Mr. Pearlman in an amount equal to 4% of the first $1 million of the Company's net after-tax profits for such fiscal year. Pursuant to the agreement, Mr. Pearlman's annual compensation, including salary and bonus was limited to $340,000 per year. In addition, Mr. Pearlman agreed in 1993 not to receive a bonus for the 1993 fiscal year. Mr. Pearlman received a bonus of $254,000 (including $100,000 applied to exercise of options) for the 1994 fiscal year. See \"Option Grants in 1994.\" The Company is presently negotiating a new employment agreement with Mr. Pearlman.\nThe Company entered into an employment agreement as of December 31, 1992 with Alan A. Siegel. Mr. Siegel's agreement expires on January 1, 1998. Mr. Siegel's agreement provides for an annual salary of $75,000 for the first year of the agreement and for annual increases thereafter in an amount equal to the greater of 5% of his previous year's salary or the increase, if any, in the Consumer Price Index for All Urban Consumers, Central Florida 1967 -- 100. The agreement also provides for an annual bonus payable to Mr. Siegel in an amount equal to 1 1\/2% of the Company's net after-tax profits for such fiscal year plus an amount determined in the discretion of the Board.\nPERFORMANCE GRAPH\nSet forth below is a line graph comparing the cumulative total shareholder return of the Company's Common Stock, based on the market price of the Common Stock, with the cumulative total return of companies on the Nasdaq Market Index. Because of the unique nature of the Company's business, the Company has been unable to identify a peer group consisting of companies in a similar line of business, and instead has provided a comparison with a \"peer group\" of companies with a similar market capitalization. Such peer group is comprised of companies with market capitalizations of between one million and ten million dollars on December 31, 1994 and whose stock is traded on Nasdaq.\n[INTENTIONALLY LEFT BLANK]\n[GRAPHIC]\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth the number and percentage of shares of Common Stock beneficially owned, as of the Record Date, by (i) all persons known by the Company to be the beneficial owner of more than 5% of the outstanding Common Stock or Preferred Stock, (ii) each of the Company's directors, (iii) the Company's Chief Executive Officer and (iv) all executive officers and directors of the Company as a group (5 persons).\n- ---------- * Denotes less than 1%.\n(1) Mr. Pearlman has an address at: c\/o Airship International Ltd., 7380 Sand Lake Road, Suite 350, Orlando, Florida 32819.\n(2) Includes 50,000 options granted under the Company's Incentive Stock Option Plan.\n(3) Includes a warrant to purchase 67,000 shares of Common Stock. See \"Certain Relationships and Related Transactions.\"\n(4) Such shares of Common Stock were granted to Transcontinental Airlines, Inc. in consideration for its guaranty of the Company's obligations under the Allstate Loan, the Phoenixcor Loan, the Senstar Loan, the Argentina Lease Agreement and the Argentina Operations Agreement, and a corporate credit card issued for the Company's benefit. See \"Certain Relationships and Related Transactions\".\n(5) Includes the options described in footnotes (2) through (3), above.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nAs of January 1, 1993, the Company owed Mr. Pearlman an aggregate amount of approximately $1,900,000 which amount represented accrued and unpaid salary and bonus, and principal and accrued and unpaid interest on loans made to the Company by Mr. Pearlman for general operation purposes. On June 30,1993, the Company made a $789,000 loan (the \"June 1993 Loan\") to an individual who had previously facilitated financing for the Company. Mr. Pearlman has guaranteed repayment of the Loan and in addition, has agreed that the Company's obligation to repay principal and interest on Mr. Pearlman's loan to the\nCompany shall be reduced proportionately to reflect the amount of the then outstanding Loan for so long as the Loan shall remain outstanding. The loan from Mr. Pearlman bears interest at the rate of 8.5%. In consideration for Mr. Pearlman's guaranteeing repayment of the Loan and agreeing that the Loan can be offset against his loan, the Company has treated the $789,000 as a reduction of the amount due to Mr. Pearlman.\nAs the result of further interest accruing on the amounts owing to Mr. Pearlman by the Company, at December 31, 1994, and after allowing for the offset described above with respect to the Loan, the Company owed Mr. Pearlman $950,000 net of unamortized discount. As of December 31, 1994 the Company owed Mr. Pearlman $950,000 net of unamortized discount.\nDuring the year ended December 31, 1994, the Company earned $164,000 of interest income on advances (the \"Trans Continental Account\") previously made to Trans Continental Airlines, Inc. (\"Trans Continental\"). Mr. Louis J. Pearlman owns 21% of Trans Continental and is the Company's Chairman of the Board, President and principal shareholder. The advances were made to obtain higher yields and, at December 31, 1994, totaled $1,809,000. Trans Continental has pledged a $2,500,000 money market account as collateral for this advance. This advance is returnable to the Company upon demand, and during the year ended December 31, 1994, an aggregate amount of $881,000 of the advances were returned to the Company including interest earned. The balance of the advances were returned to the Company during 1995 and were used by the Company to pay outstanding amounts owing to WDL.\nOn October 9, 1995 the Company granted to Transcontinental 3,666,862 shares of Common Stock representing 10% of the issued and outstanding Common Stock of the Company. Such grant was made in consideration of Transcontinental's guaranty of the Company's obligations under the Allstate Loan, the Phoenixcor Loan and the Senstar Loan and the Argentina Lease and Operations Agreements. In addition, Transcontinental has procured, for the Company's benefit, a corporate credit card.\nThe Company advanced Airship Airways, Inc. (\"AAI\") $137,500 in August 1994. At such time, Mr. Pearlman was a principal stockholder of AAI, owning approximately 44% of its stock. Subsequent to such transaction Mr. Pearlman has reduced his ownership interest in AAI to approximately 4%. The advance was made in connection with a proposed merger (the \"Merger\") transaction between the Company and AAI. At the present time the Company believes that it is unlikely that the Merger will be consummated. In connection with the advance, AAI issued to the Company its promissory note (the \"AAI Note\") in the amount of $137,500 in October 1994. The AAI Note is secured by certain aircraft and equipment owned by AAI. The AAI Note bore interest at the rate of 8% per annum, and was due and payable on or before February 23,1995. On February 8, 1995 AAI repaid the AAI Note in full by paying the Company $82,100 and cancelling two promissory notes that had been issued by the Company to AAI in the respective principal amounts of $25,000 and $30,400. These notes had been issued in connection with expenses incurred in connection with the Merger, and reductions in rental payments on office space obtained with the cooperation of AAI, and which were due and payable on February 23, 1995 and May 1, 1996, respectively.\nPursuant to an Agreement dated December 7, 1993, the Company made a $75,000 unsecured loan to Superbound Limited (\"Superbound\"), a United Kingdom corporation controlled by James Stuart Tucker, the former President of Slingsby. The loan bears interest at an annual rate of 10%. Principal is payable in two equal installments of $37,500 each on the first two anniversaries of the date the loan proceeds were paid to Superbound (within seven days of December 7, 1993). Mr. Tucker is a guarantor of this loan. During 1994 Mr. Tucker was able to procure, without cost to the Company, required maintenance service and parts which would otherwise have cost the Company over $100,000. In exchange for his services, $37,500 of the loan was cancelled as of December 3, 1994 and interest of $7,500 was received in February 1995. The remaining balance of the loan was subsequently repaid.\nOn December 31, 1991, Mr. Julian Benscher and the Company entered into a Line of Credit Agreement, pursuant to which Mr. Benscher loaned the Company $ 1,000,000 in 1992. As partial consideration for making these loans, the Company issued to Mr. Benscher warrants to purchase 775,000 shares of Common Stock and issued additional warrants to purchase 325,000 shares of Common Stock to certain parties designated by Mr. Benscher. The Company has granted Mr. Benscher registration rights with respect to all shares of Common Stock and warrants owned by him. These warrants were to expire on December 31, 1994; however, for continued assistance provided to the Company by Mr. Benscher, the Company extended the expiration date of these warrants to December 31,1995, on which date the warrants expired unexercised.\nThe Company sold the Argentina Airship to First Security for the benefit of Aviation, in June, 1995 in consideration for First Security's assumption of the Company's liabilities under the Argentina Lease Agreement and AOI's obligations under the Argentina Operations Agreement. In connection with such sale, the Company assigned the Argentina Lease Agreement to First Security, and Aviation purchased all of the issued and outstanding Capital Stock of AOI. See \"Business-Aerial Advertising and Other Contracts-Argentina Airship.\"\nThe Company has purchased hull insurance for the Company's airships through Sedgwick Aviation of North America, an international insurance brokerage firm of which Mr. James J. Ryan is the Executive Director. For assisting in reducing the Company's insurance costs, on April 7, 1990, Mr. Ryan was granted a five year warrant to purchase 67,000 shares of Common Stock at $2.20 per share.\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.\nAIRSHIP INTERNATIONAL LTD.\nDated: August 25, 1997 By: \/s\/ LOUIS J. PEARLMAN -------------------------- Louis J. Pearlman Chairman of the Board of Directors, President and Treasurer (Principal Executive and Financial Officer)\nDated: August 25, 1997 By: \/s\/ Alan A. Siegel -------------------------- Alan A. Siegel Secretary & Director\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.\nDated: August 25, 1997 By: \/s\/ Marvin Palmquist -------------------------- Marvin Palmquist Director\nDated: August 25, 1997 By: \/s\/ James J. Ryan -------------------------- James J. Ryan Director\nItem 14","section_14":"Item 14 - Exhibits, Financial Statements, Schedules and Reports on Form 8-K\nThe accompanying notes are an integral part of these statements.\nAirship International Ltd. Statements of Operations For the Year Ended December 31,\nThe accompanying notes are an integral part of these statements.\nAirship International Ltd. Statements of Changes in Stockholders' Equity (Deficit) For the Year Ended December 31,\nThe accompanying notes are an integral part of these statements.\nAirship International Ltd. Statements of Changes in Stockholders' Equity (Deficit) For the Year Ended December 31,\nThe accompanying notes are an integral part of these statements. Airship International Ltd. Statements of Cash Flows - Continued For the Year Ended December 31,\nIncrease (decrease) in cash and cash equivalents\nThe accompanying notes are an integral part of these statements.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nNature of Business - The Company operates lighter-than-air airships used to advertise and promote the products and services of the Company's clients. At December 31, 1994, the Company operated two airships.\nCash and Equivalents - The Company considers unrestricted short-term, highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.\nRevenue Recognition - Airship revenues are being recognized during the period in which services are provided. Whenever significant flight time is owed to a customer, the incremental cost of providing services is accrued. No amounts are accrued at December 31, 1994 or 1993.\nFlight Crew Training Costs - Significant flight crew training costs for new blimps are amortized over twelve months from the date related revenues commence.\nAirships and Related Equipment - Property and Equipment are stated at cost. Depreciation is provided by the straight line method over the estimated useful lives of the assets - 10 to 20 years (airships), 4 to 8 years (vehicles), 3 to 5 years (parts and equipment) and 2 to 3 years (improvements). Airship components are not depreciated until placed in service.\nConstruction in Progress - The Company has abandoned its plans to build a manufacturing complex and aviation hangar to be called Blimp Port USA'tm' which will be located at a site near its Orlando, Florida base of operations. The Company intended to use this facility to manufacture, assemble and maintain airships for commercial and governmental use and provide offices for technical and executive personnel. The Company has acquired a Federal Aviation Administration (FAA) license necessary for the assembly and maintenance of airships. Capitalized costs, including interest, relating to the facilities amounted to $479,000 were written off during the year ended December 31, 1994. Such costs included incremental costs directly identifiable with the facility, such as land lease rental, property taxes, insurance and other costs directly associated with the acquisition, development and construction of the project. To date costs capitalized represent consulting, architectural and design fees.\nDeferred Financing and Offering Costs - Costs incurred to obtain debt financing are capitalized and amortized over the terms of the related loans. Such costs include incremental payments to consultants, lenders and other out of pocket expenses, as well as the fair value of options and warrants issued to persons other than lenders. The fair value of options and warrants issued to lenders are reported as debt discount and amortized over the term of the related loan. In determining the fair value of warrants issued, substantial discounts have been provided for the effects of restrictions on sale, the volume of shares involved and other factors.\nUse of Estimates - The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Continued\nIncome Taxes - The Company follows the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting For Income Taxes\", which requires the recognition of deferred tax liabilities and assets for 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 when these differences are expected to reverse. Valuation allowances are established when appropriate, to reduce deferred tax assets to the amount expected to be realized.\nImpairment of Long-Lived Assets - In March 1995, the Financial Accounting Standards Board (\"FASB\") issued Statement of Financial Accounting Standards No. 121, \"Accounting for the Impairment of Long-Lived Assets to be Disposed Of (\"SFAS 121\"). SFAS 121 requires that long-lived assets held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The adoption of this standard in the fourth quarter of the fiscal year ended December 31, 1994 resulted in an adjustment $9,634,000 to the Company's financial statements. The Company obtained an independent appraisal on its airship components in August 1997, which reflects a range of values from $2,174,000 (on a liquidation sale value) to $5,096,000 (on a market value basis). Based on the fact that the Company had two airships in operation at December 31, 1994, the Company adjusted the carrying value to $3,635,000 or the midpoint of the above range. The Company reviews all of its long-lived assets for impairment in accordance with SFAS 121. Prior to the adoption of SFAS 121, all long-lived assets, were reviewed for impairment by comparing the carrying value of such assets to future expected net cash flows.\nChange in Accounting Estimate - Effective April 1, 1994, the Company revised its estimate of useful lives of airships and airship components. Previously, airship envelopes and Nightsigns'tm' on operating airships were depreciated over 20 years. The Company has changed the useful lives to 4'pp'1\/2 on airship envelopes years and 10 years for Nightsigns'tm' resulting in an additional charge to income of $774,000 or $.03 per share.\nNet Income (Loss) Per Share - Net income (loss) per share is based on the weighted average number of shares outstanding during the periods. When losses have been incurred, warrants and options are not included since the effect would dilute loss per share, however, preferred stock dividends are included in the loss per share calculation. When net income is reported, warrants and options are included using the treasury stock method, provided exercise prices are less than the average market price; warrants convertible into common stock are included when such inclusion results in further dilution.\nRecently Issued Pronouncements - In October 1995, the FASB issued Statement of Financial Accounting Standards No. 123, \"Accounting for Stock-Based Compensation\", (\"SFAS 123\") which sets forth accounting and disclosure requirements for stock-based compensation arrangements. The new statement encourages, but does not require, companies to measure stock-based compensation cost using a fair-value method, rather than the intrinsic-value method prescribed by Accounting Principles Board Opinion No. 25 (\"APB Opinion 25\"). The Company will adopt the disclosure requirements of SFAS 123 in 1995 and will elect to continue to record stock-based compensation expense using the intrinsic-value approach prescribed by APB Opinion 25. Accordingly, the Company computes compensation cost for each employee stock option granted as the amount by which the quoted market price of the Company's Common Stock on the date of grant exceeds the\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE A - NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Continued\namount the employee must pay to acquire the stock. The amount of compensation costs, if any, will be charged to operations over the vesting period.\nIn February 1997, the FASB issued Statement of Financial Accounting Standards No. 128, \"Earnings Per Share\" (\"SFAS 128\") and Statement of Financial Accounting Standards No. 129, \"Disclosure of Information about Capital Structure (\"SFAS 129\"). SFAS 128 specifies the computation of earnings per share, and SFAS 129 specifies the presentation and disclosure requirements about an entity's capital structure. Both SFAS 128 and 129 shall be adopted in the fourth quarter of 1997 with restatement back to January 1, 1997. The initial adoption of these standards are not expected to have a material effect on the Company's earnings per share as disclosed.\nNOTE B - SIGNIFICANT UNCERTAINTIES AND MANAGEMENT'S PLANS TO OVERCOME OPERATING DIFFICULTIES AND MEET CASH REQUIREMENTS\nThe accompanying financial statements have been prepared in conformity with generally accepted accounting principles, which contemplate continuation of the Company as a going concern. For its year ended December 31, 1994 and 1993, the Company incurred losses of $20,571,000 and $5,406,000, respectively, and had negative cash flows of $ 2,144,000 and $2,956,000, respectively, from operations.\nManagement believes that additional contracts, if obtained, may be sufficient to achieve positive cash flow. However, there can be no assurances that such positive cash flows would be achieved.\nAs a result of the losses during the year, plus cancellation and modification of advertising agreements with clients, the Company postponed its original plans for purchase of land and the hangar for Blimp Port USA'tm' (a hangar and maintenance facility). Losses for 1993, which continuing into 1994, were funded by proceeds from the offering previously designated as capital expenditures for Blimp Port USA'tm'. In addition, the Company made the additional deposit of $1,940,000 and made a $789,000 loan to an individual who had previously facilitated financing for the Company (see disussion in Note C). The accompanying financial statements do not include any adjustments that might result from such matters.\nNOTE C - TRANSACTIONS WITH STOCKHOLDERS, RELATED PARTIES AND OTHERS\nDue from Affiliate - At December 31, 1994 and 1993, the Company made advances of $1,809,000 and $2,526,000, respectively, to Transcontinental Airlines, Inc. (\"Transcontinental\"), an affiliated aircraft leasing company. Louis J. Pearlman (\"Mr. Pearlman\") owns 21% of Transcontinental and is the Company's Chairman of the Board, President and Principal Stockholder. Transcontinental has pledged a $2,500,000 money market account as collateral for this advance. The deposit may be returned to the Company upon demand. Interest earned on this deposit amounted to $164,000, $107,000 and $131,000 for years ended December 31, 1994, 1993 and 1992, respectively.\nPersonal Guarantees - Mr. Pearlman has personally guaranteed all capital leases and loans of the Company (see Note E).\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE C - TRANSACTIONS WITH STOCKHOLDERS, RELATED PARTIES AND OTHERS - Continued\nLoans from Principal Stockholder - In May 1992, all amounts due to Mr. Pearlman, consisting of 10% notes payable, accrued salaries, bonuses and interest were consolidated into one single loan of $1,845,000. The loan was payable in equal quarterly installments of $135,000 per year including interest at 8 1\/2% per annum, and commenced in July 1992. This payment schedule continued until a loan payable to a bank for the SeaWorld airship was paid (with the preferred stock proceeds - see Note H), at which time the loan became payable at the discretion of the Company. All unpaid principal and interest is due in May 1997 and has been deferred by Mr. Pearlman for an indefinite period of time. If the Company's income before taxes had exceeded $500,000 in any of the three years ending December 31, 1994, the Company would have been required to pay Mr. Pearlman an amount equal to 20% of such annual pre-tax profit as a prepayment on this loan. Interest on the loan payable was $105,000, $144,000, and $167,000 for the years ended 1994, 1993, and 1992, respectively.\nOn June 30, 1993, the Company made a $789,000 loan (the \"Loan\") to an individual who had previously facilitated financing for the Company. Mr. Pearlman has guaranteed repayment of the Loan. The Loan is being repaid by Mr. Pearlman in equal monthly installments of $6,209 per month, including interest at the rate of 8.75%. The remaining unpaid principal balance of the Loan is due no later than June 30, 1995. Mr. Pearlman has guaranteed repayment of the Loan. In addition, it has been agreed that the Company's obligation to repay principal and interest on the loan to Mr. Pearlman shall be reduced to reflect the outstanding balance on this Loan for so long as it shall remain outstanding. Amounts due to Mr. Pearlman at December 31, 1994 and 1993 totaled $950,000 and $846,000, respectively, net of unamortized discount.\nTransactions with Stockholder and His Affiliate - Mr. Julian Benscher (\"Mr. Benscher\") beneficially owned 4.0% of the common stock of the Company at December 31, 1994. Mr. Benscher is also a stockholder and director of J&B Enterprises Limited (UK) Corp. (\"J&B\"). The Company and Mr. Benscher have been involved in certain transactions as follows:\nSale of Airship Components - The following transactions involve the sale of unassembled airship components acquired in the 1990 asset acquisition from Airship UK:\n1. In December 1992, the Company entered into two agreements with J&B to sell for $2,790,000 ($2,721,000 net of imputed interest) an unassembled airship and its related components which had a cost basis to the Company of $355,000. The Company received a $500,000 initial payment in December 1992. The balance of the purchase price was paid in February and November 1993 and bore interest at the LIBOR rate. The unpaid balance of the purchase price was collateralized by the respective airship components and such other security as the parties were to mutually agree to be reasonable and guaranteed by Mr. Benscher.\nIn addition, certain real property located in the United Kingdom and owned by a director of J&B who is a relative of Mr. Benscher was pledged and accepted by the Company in satisfaction of the unspecified collateral stated in the December 1992 agreement. Certain components at this time continue to remain in a warehouse leased by the Company in Florida. J&B reimburses the Company for occupancy costs for storage of the components.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE C - TRANSACTIONS WITH STOCKHOLDERS, RELATED PARTIES and OTHERS - Continued\n2. In September 1992, the Company sold to Mr. Benscher a gondola, tail fins and certain other airship components for $1,150,000. Payment consisted of offsetting the $1,000,000 loan payable (and related interest) due to Mr. Benscher pursuant to the loans under a line-of-credit agreement discussed below. The transaction resulted in a gain of $1,077,000.\nRental Arrangement and Travel Agency Service - Transcontinental serves as the Company's travel agent for substantially all of its travel arrangements and the Company is its principal customer. In the opinion of management, the terms and prices received from the corporation are similar to those available from other travel agencies. The Company paid the agency $6,000 and $115,000 for travel expenses in 1993 and 1992, respectively. During 1994 and 1993, the Company utilized the travel agency services for reservations, while primarily paying certain costs directly to the provider.\nHull and Liability Insurance - The Company purchases hull and liability insurance with respect to the Company's airships through Alexander and Howden, Inc., an international insurance brokerage firm of which James J. Ryan is the Senior Vice President of its Aviation Aerospace Division. Mr. Ryan is also a director of the Company and, in 1990, was granted a five-year warrant to purchase 67,000 shares of common stock at $2.20 per share. Insurance expense for Alexander and Howden was $72,000, $1,319,000 and $1,072,000 in 1994, 1993, and 1992, respectively.\nWarrants - Reference should be made to Note H for warrants issued in connection with certain of the above transactions.\nTransaction with Slingsby Aviation Limited (\"Slingsby\") - On January 29, 1992, Slingsby exchanged the aforementioned airship components it had acquired from Airship UK for certain of the Airship components the Company had acquired from Airship UK. In connection with this exchange, Slingsby agreed to provide the Company storage for the components at no cost, not to increase certain prices to assemble that airship by more than 5% for twelve months and certain other items. The Company did not recognize gain or loss on this nonmonetary transaction as this was not considered the culmination of an earnings process.\nOn December 31, 1992, Transcontinental, on behalf of the Company, paid $2,000,000 to Slingsby in connection with an understanding to acquire Slingsby airship components (the 'Slingsby Asset Purchase'). Slingsby had indicated that the Company was to receive airship parts with a fair market value equal to at least this sum if a definitive agreement was not entered into by March 31, 1993. During 1993, the Company concluded its acquisition of airship components from Slingsby for a total of $5,457,000.\nAirship international Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE C - TRANSACTIONS WITH STOCKHOLDERS, RELATED PARTIES and OTHERS - Continued\nUnderwriter - Emanuel and Company (\"Emanuel\"), one of the two representatives of the several underwriters for the offering of Preferred Stock which was sold in February 1993 (see Note H) is a beneficial owner of 4.0% of the Company's common stock. Emanuel received warrants to purchase 1,450,000 shares of common stock at $1 per share for arranging the sale in April 1992 of 1,048,000 common shares to private investors. The private investors received three year warrants to purchase 1,048,000 shares of common stock at an exercise price of $1.25 per share, subject to adjustment. Emanuel will receive a 7% commission from the Company upon the exercise of the warrants held by the private investors.\nIn addition, Emanuel is the custodian of the collateral pledged as security for amounts due from Transcontinental.\nCorporate Offices - The Company provides office space to affiliates free of charge. The Company is reimbursed by the affiliates for telephone charges.\nLoan Receivable - During 1993 the Company made an unsecured loan of $75,000 to a company controlled by and guaranteed by the former president of Slingsby. This loan bears interest at 10%, payable quarterly. Principal payments of $37,500 are due on December 7, 1995.\nNOTE D - INCOME TAXES\nAt December 31, 1994, the Company had net operating loss carryforwards for income taxes of approximately $29,949,000 available as offsets against future taxable income. During 1991, the Company experienced changes in the Company's ownership as defined in Section 382 of the Internal Revenue Code (\"IRC\"). The effect of these changes in ownership is to limit the utilization of certain existing net operating loss carryforwards for income tax purposes. Operating losses incurred after the ownership change are not limited. As a result, only approximately $15,268,000 of the operating losses which occurred after the ownership change are not limited. The operating losses incurred prior to the ownership change are limited to a certain dollar amount each year. The net operating loss carryforwards expire during the years 2000 to 2011. The company also has unused investment tax credits of $140,000 which expire principally in the year 2000.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE D - INCOME TAXES - Continued\nThe tax effect of temporary differences that give rise to significant positions of the deferred tax assets and deferred tax liabilities, consist of the following at December 31:\nThe net change in the valuation allowance was approximately $277,000 relating to net operating losses from 1994.\nNOTE E - CAPITAL LEASES AND LOANS PAYABLE\nCapital leases payable consist of the following:\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE E - CAPITAL LEASES AND LOANS PAYABLE - Continued\nThe following is a schedule by year of future minimum lease payments pursuant to the capital leases together with the present value of the net minimum lease payments as of December 31, 1994:\nCapital Leases - In October 1989, the Company purchased a new Skyship 600 Series airship (the \"MetLife airship\") from Airship UK. The MetLife airship and related equipment were financed primarily by net proceeds of $6,200,000 from a capital lease obtained through ORIX Commercial Credit Corp. (\"ORIX\"). The capital lease initially required monthly payments of $135,000 through November 1992. In December 1992, the lease was renewed for an additional three-year term at monthly payments of $121,000. At the end of the additional three year term the Company had the option to purchase this airship for $1,000,000 or renew the lease for another three year term at monthly payments of $35,000. At the completion of the third lease term, title is to be transferred to the Company upon payment of $1. On January 11, 1994 the Company renegotiated the lease to reduce the $121,000 payments. Even after the payment modifications the Company was unable to make the payments and went into default. Effective June 2, 1995 the lease was renegotiated again calling for payments of $20,000 for twelve months, $40,000 for the next six months, $60,000 for an additional six months and the higher of $80,000 for the remaining term until the lease is paid off or a larger payment based upon the annual cash flow of the year. Based upon the revised payment schedule, the payments are not sufficient to cover the interest expense. Thus negative amortization results in 1994 and 1995 and the ending principal balance is increased.\nThe airship and related equipment financed by the capital leases have a cost of $6,687,000 and accumulated depreciation of $1,077,000 at December 31, 1993. During 1994 the leased airship was damaged and taken out of service. A cost of $2,699,000 and accumulated depreciation of $1,232,000 were written off due to the damage. The remaining cost basis of approximately $3,500,000 was transferred to spare parts and airship components. The resulting net book value was later analyzed as part of the SFAS 121 writedown as described in Note A.\nLoan Payable to Allstate - The Company entered into an accounts receivable factoring security agreement on September 19, 1994 which was modified on November 16, 1994 and November 23, 1994. The maximum borrowing amount under the November 23rd agreement was $1,500,000. The loan balance was to be reduced by $75,000 per month beginning December 1, 1994. A fee of 0.125% per month is payable each month on the higher of funds outstanding or $1,500,000. The loan was used to pay off certain liabilities and provide a source of working capital. The balance due to Allstate as of December 31, 1994 amounted to $1,250,000. The loan was secured by accounts receivable, inventory, certain airships and equipment.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE E - CAPITAL LEASES AND LOANS PAYABLE - Continued\nSubsequently on June 22, 1995, the Allstate loan was repaid when Transcontinental Leasing, Inc. (\"TLI\"), a wholly-owned subsidiary of Transcontinental, an affiliate of the Company, entered into a sale-leaseback agreement with the Company pursuant to which the Bud One Airship was sold by the Company to TLI for the purchase price of $2,060,000, which in turn was leased back to the Company.\nSubsequently on November 30, 1995, the Company entered into an arrangement with Senstar Capital Corporation (\"Senstar\") pursuant to which the sale-leaseback arrangement with TLI was reversed. The Company borrowed a total of $3,500,000 from Senstar, part of which has been used to repay the loan from Phoenixcor, Inc., the lender for TLI's transaction. The loan from Senstar is repayable over 5 years in sixty monthly payments of approximately $63,000 each, with a balance due at the end of the five year term of approximately $700,000, and secured by a lien on the Airship and is guaranteed by Transcontinental.\nWarrants - Reference should be made to Note H for warrants issued in connection with certain of these transactions.\nNOTE F - LEGAL PROCEEDINGS\nCapital Funding Group Ltd. - In February 1992, Capital Funding Group Ltd. (\"CFG\") commenced an action against the Company and others seeking in excess of $1,000,000 in damages based on the alleged failure by the Company to provide adequate collateral and security in connection with certain alleged financial agreements with CFG. The Company retained CFG in July 1991, paid a commitment fee (which was written off in 1991) and received a commitment from CFG which then failed to provide the funding. The Company and the other defendants answered the complaint in February 1992 by denying all of the substantive allegations and asserting several affirmative defenses. In addition, the Company asserted certain counterclaims against CFG and its two principals for breach of a commitment letter pursuant to which CFG was to arrange for a $9 million loan to the Company, breach of a compromise agreement accepted by CFG in January 1992, pursuant to which CFG was to provide funding to the Company in the amount of $7 million, breach of an escrow agreement, pursuant to which CFG was to return $200,000 of the commitment fee paid by the Company and various other counterclaims. In March 1993, the Company was awarded a default judgment against CFG. No balances have been returned to the Company as of December 31, 1994.\nWatermark Group PLC and Von Tech Corporation - In January 1993, a second amended complaint to a lawsuit, which was initially commenced in March 1991 and subsequently dismissed twice without prejudice, was filed against the Company and Mr. Pearlman by Watermark Group PLC and Von Tech Corporation, a general partners of Company communications (collectively the \"W\/VT Plaintiffs\") alleging breach of an alleged joint venture agreement involving Company Communications and Airship Enterprises Ltd. (a company that was owned by Mr. Pearlman and that was not in any way owned or controlled by the Company); breach of an alleged agreement by the Company regarding the lease and operation of a particular\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE F - LEGAL PROCEEDINGS - Continued\nairship; and breach of an alleged oral commission agreement by the Company relating to the Company's acquisition of two airships it presently owns. The W\/VT Plaintiffs seek various legal and equitable remedies, including monetary damages against the Company and Mr. Pearlman in excess of $800,000 together with a claim for some portion of the advertising revenue the Company has received, and will continue to receive, from the operation of some of its airships. In March 1993, the second amended complaint filed against the Company and Mr. Pearlman by W\/VT Plaintiffs was dismissed without prejudice. Since the Company denies any involvement with any of the transactions set forth in the second amended complaint, the Company believes that its liability, if any, on the claims made by the W\/VT Plaintiffs will not be material. This case was settled on October 3, 1995 for $40,000.\nSequel Capital Corporation - In December 1992 a lawsuit was filed against the Company, Mr. Pearlman and an advertising customer of the Company by Sequel Capital Corporation (\"Sequel\"). The complaint (as amended) contains claims for default on an $800,000 loan from Sequel (the \"Sequel Loan\") as a result of an alleged failure to provide collateral consisting of monthly payments being made to the Company by a third party on an airship advertising agreement. The proceeds of the Sequel Loan, which was personally guaranteed by Mr. Pearlman, were applied by the Company towards the purchase of a new airship from the Seoul Olympic Sports Promotion Foundation. The amended complaint also includes a claim for breach of an alleged contract to enter into a sale leaseback agreement with respect to one of the company's airships and a claim for allegedly fraudulently inducing Sequel to make the Loan to the Company. This claim was settled by the Company in 1993 for approximately $741,000 including legal expenses.\nTenerten and Drake, Inc. - On September 15, 1994, Tenerten and Drake, Inc. (\"TDI\") filed a complaint against the Company. The complaint alleges that the Company failed to pay certain sums of money due to TDI under an agreement to perform advertising and related services for the Company. The Company filed its answer and raised its affirmative defenses to said complaint alleging that the services allegedly performed by TDI were defective in numerous respects. A final judgment was entered against the Company on July 20, 1995 in the amount of $24,000.\nWestinghouse Airships, Inc. - On September 14, 1994, Westinghouse Airships, Inc. (\"WAI\") filed a complaint against the Company alleging that the Company and Mr. Pearlman breached an agreement to purchase two gondolas from WAI. Specifically, the complaint alleges that WAI delivered both gondolas at issue and that the Company failed to make certain installments to WAI under the agreement. The complaint also alleges that the Company breached a sub-lease to occupy certain hanger space located in North Carolina. On June 19, 1995, the Company and WAI agreed to settle the case for $32,000.\nOther Proceedings - The Company is a defendant in a number of other legal proceedings which occurred in the ordinary course of its business. Those cases in which the ultimate settlement is known or estimable have been accrued in the financial statements. It is not possible at this time to predict the outcome of the unsettled legal actions; however, in the opinion of management and informal advice of counsel, the disposition of these other lawsuits will not have a material effect on the financial statements.\nAirship international Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE G - COMMITMENTS AND CONTINGENCIES\nPossible Future Tax Claims - Because blimp advertising services differ from many other forms of advertising, state and local tax authorities may assert claims based on interpretations of law which differ from interpretations by management. In the opinion of management, its positions are consistent with similar entities.\nThe State of Florida completed a sales tax audit of the Company in March 1992 covering all periods through December 31, 1991 and assessed the Company approximately $12,000, which was paid in March 1992.\nEmployment Agreements - In 1993 the Company and Mr. Pearlman entered into an employment agreement which expires in December 1994. The agreement provides for an annual salary to Mr. Pearlman of $200,000 for the first year of the agreement and for annual increases thereafter in an amount equal to the greater of 5% of his previous year's salary or the increase, if any, in the Consumer Price Index for All Urban Consumers, Central Florida. The agreement also provides for an annual bonus payable to Mr. Pearlman in an amount equal to 4% of the first $1 million of the Company's net after-tax profits for such fiscal year. Pursuant to this agreement, Mr. Pearlman's annual compensation, including salary and bonus is limited to $340,000 per year. Accrued and unpaid salaries through December 31, 1994 are $391,000 and are included in amounts due to related party.\nOn March 1, 1994 the Company agreed to reimburse Mr. Pearlman $4,000 per month in expenses, effective January 1, 1993, due to Mr. Pearlman's out-of-pocket expenses for the Company's business.\nThe Company entered into employment agreements as of January 1, 1993 with each of two officers and another employee. Each agreement expires on January 1, 1998 and provides for annual salaries of $75,000 for the first year of the agreement and annual increases thereafter in an amount equal to the greater of 5% of his previous years salary or the increase, if any, in the Consumer Price Index for All Urban Consumers, Central Florida. Each agreement also provides for an annual bonus payable in an amount equal to 1 1\/2% of the Company's net after tax profits for such fiscal year plus an additional amount determined at the discretion of the Board of Directors.\nOperating Leases - The Company has various operating leases which will expire at various dates through May 1996 with unrelated parties for its executive offices, warehouse space, maintenance facility, and the Gulf airship discussed in Note I.\nFuture minimum payments under these operating leases at December 31, 1993 are as follows:\n1994 $ 634,000 1995 93,000 1996 31,000 ---------- $ 758,000 ==========\nRent expense was approximately $577,000 in 1993.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE H - STOCKHOLDERS' EQUITY\nCommon Stock - In February 1991, the Company completed a public offering (the \"Offering\") of its units (the \"Units\"), consisting of two shares of Common Stock, two Class A Common Stock Purchase Warrants and two Class B Common Stock Purchase Warrants. Each Class A Warrant entitles the holder to purchase one share of Common Stock at a price of $1.50 until February 6, 1994. Each Class B Warrant entitles the, holder to purchase one share of Common Stock at a price of $2.00 until February 6, 1995. The warrants may be redeemed by the Company at a price of $.10 per Warrant at any time upon at lease 30 days, prior written notice if the closing bid price of the Common Stock during 20 of the 30 preceding trading days exceeds the exercise price of the Warrants by at least 40%.\nConvertible Subordinated Notes - In connection with a private placement of the Company's 15% Convertible Subordinated Notes (the \"Notes\") completed in December 1990, the placement agent received a commission of 10% of the aggregate principal amount of the notes sold and three-year warrants to purchase a total of 374,000 shares of common stock (254,000 and 120,000 shares of common stock at $1 and $.75 per share, respectively).\nIn addition, the placement agent received a commission of 9% of the principal amount of each note converted to common stock and, upon exercise of each related warrant will receive a commission equal to 7% of the exercise price. For accounting purposes, the proceeds of the notes were allocated based upon the fair value of the debt and warrants. The resulting debt discount was amortized over the term of the debt and the amount of $22,000 assigned to the warrants was credited to capital in excess of par value. Substantially all of the above warrants were exercised as of December 31, 1993.\nThe Company borrowed $100,000 in December 1990 at 10% interest per quarter plus three-year warrants to purchase 30,000 shares of common stock at $.75 per share, subject to anti-dilution adjustments. Effective December 31, 1990, the noteholder converted the $100,000 loan into 100,000 shares of common stock. In connection with this transaction, the placement agent received three-year warrants to purchase 30,000 shares of common stock at $.75 per share, subject to anti-dilution adjustments. All such warrants were exercised during 1992.\nPreferred Stock - In February 1993, the Company completed a public offering (\"the Offering\") of 2,875,000 shares of its Class A 8% Cumulative Convertible Voting Preferred Stock (\"Preferred Stock\") at $6.00 per share.\nEach share of Preferred Stock is convertible, at any time after the earlier of February 16, 1994 or a date determined by the underwriters at their sole discretion (which date was not to be prior to April 19, 1993), into 6 shares of common stock, subject to future adjustment. Dividends on the Preferred Stock are payable quarterly and the first four dividends were paid, on an annualized basis, 50% in cash and 50% in shares of the Company's common stock. The Preferred Stock accrues dividends at the annual rate of $.60 per share for dividends paid in shares of common stock, and $.48 per share for dividends paid in cash. If available cash is not sufficient to pay any or all of the subsequent dividend payments, the balance of the dividend will be paid in shares of the common stock.\nThe Preferred Stock is redeemable at the option of the Company, in whole or in part, at $6.60, together with all accrued and unpaid dividends, at any time after February 16, 1996. The liquidation preference of the Preferred Stock is $6.00 per share.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE H - STOCKHOLDERS' EQUITY - Continued\nIn connection with the offering, the Company issued to the two representatives of the several underwriters, warrants to purchase an additional 10% of the Preferred Stock sold in the Offering. The Preferred Stock warrants are exercisable for four years commencing February 1994 at an exercise price equal to 165% of the initial offering price of the Preferred Stock, subject to certain anti-dilution provisions.\nPrivate Placement of Common Stock - During the first and second quarters of 1994, the Company sold common stock to certain investors pursuant to a share subscription agreement. The number of shares initially sold were 5,301,164 at an average purchase price of $.20 per share. These shares were not sold pursuant to a formal offering memorandum. Therefore, the Company offered a right of recession, which the majority of the purchasers of the common stock exercised.\nWarrants and Options - Outstanding warrants and options at December 31, 1994, all of which are currently exercisable, after giving effect to adjustments through such date for anti-dilution provisions and exercisable price reductions are as follows:\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE H - STOCKHOLDERS' EQUITY - Continued\nThe Company has an incentive stock option plan (the \"Plan\") for key employees under which it may grant options to purchase the Company's common stock over a term of up to ten years at the fair market value at the time of the grant. Options granted to a ten percent or more shareholder, an officer, or a director, may not be for less than 110% of fair market value and must be exercised within five years. The Plan was amended in December 1991 increasing to 750,000 the number of shares reserved for issuance. The Plan terminated on October 31, 1994.\nOptions under the Plan are summarized as follows:\nSince inception, 24,000 options granted under the Plan have been exercised (none in 1994, 1993 or 1992). The Plan terminated on October 31, 1994.\nEmployee Share Purchase Plan - The Company has an employee share option plan (the \"Plan\") for employees of the Company and any present or future \"subsidiary corporations.\" The Company intends the Plan to be an \"employee stock purchase plan\" as defined in Section 423 of the Internal Revenue Code of 1986, as amended (the \"Code\"). The Plan was effective November 1, 1994. All employees are eligible to participate in the Plan, except that the Company's appointed committee may exclude any or all of the following groups of employees from any offering: (i) employees who have been employed for less than 2 years; (ii) employees whose customary employment is 20 hours or less per week; (iii) employees whose customary employment is not more that 5 months in any calendar year; and (iv) highly compensated employees (within the meaning of Code Section 414(q). The shares issuable under the Plan shall be common\nAirship International, Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE H - STOCKHOLDERS' EQUITY - Continued\nshares of the Company subject to certain restrictions up to a maximum of 1,000,000 shares. The committee shall determine the length of each offering but no offering may exceed 27 months. The option price for options granted in each offering may not be less than the less of (i) 85% of the fair value of the shares on the day of the offering, or (ii) 85% of the fair market value of the shares at the time the option is exercised.\nNOTE I - AIRSHIP REVENUES, MAJOR CUSTOMERS AND CREDIT CONCENTRATION\nMetropolitan Life - During 1993, the Company derived airship revenue from Metropolitan Life Insurance Company (\"MetLife\") pursuant to an amended aerial advertising agreement which expired in October 1993. The agreement provided for minimum monthly revenues plus travel expense reimbursements. The Company was responsible for all costs associated with the ownership, use or operation of the MetLife airship, including repairs, maintenance supplies, insurance and taxes.\nIn January 1994, the Company entered into an advertising agreement with Kingstreet Tours Limited (UK) for the use of the MetLife airship promoting Pink Floyd. The term of the agreement was originally for six months commencing January 18, 1994. The Company was responsible for all costs associated with the operations of the airship, including travel costs, repairs, maintenance, insurance and taxes. On June 20, 1994, the MetLife airship was damaged in a storm and the contract was cancelled (See Note E).\nNo revenues were earned on the MetLife airship during the period subsequent to the airship accident described below until October 15, 1992. The Company collected $585,000 of business interruption insurance proceeds relating to the loss of revenues during the months that the MetLife airship was under repair due to damage.\nAnheuser-Busch\/Sea World - In April 1990, the Company entered into an aerial advertising agreement with Anheuser-Busch Companies, Inc. (\"Anheuser-Busch\") granting Anheuser-Busch the exclusive use of the Sea World airship to advertise and promote Anheuser-Busch's products and business. The agreement was replaced in April 1991 (retroactive to January 1, 1991) to include the payment of $540,000 to the Company in January 1991 as an advance against the fees for the next 18 months. The $540,000 advance was recognized as airship revenue at the rate of $30,000 per month over the period of January 1, 1991 to June 30, 1992. The agreement also provided for additional monthly revenues through the expiration of the agreement on June 30, 1993. The Company continued to operate the airship for a monthly fee through December 1993, after which the lease was terminated.\nThe Company was responsible for all costs associated with the ownership, use or operation of the airship, including repairs, maintenance supplies, insurance and taxes.\nThe Company is also entitled to receive royalties from Anheuser-Busch on monthly sales of merchandise shaped like or containing an image of the airship and bearing Anheuser-Busch's trademarks during the term of the Sea World Contract and for two years thereafter. The amount of royalties recognized as revenue amounted to $7,000 and $18,000 for the years ended December 31, 1993 and 1992, respectively.\nAirship International Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE I - AIRSHIP REVENUES, MAJOR CUSTOMERS AND CREDIT CONCENTRATION - Continued\nOn January 2, 1994 the Company entered into an agreement with Anheuser-Busch, whereby the Company was permitted to provide passenger rides and to display advertising. The contract did not provide for usage fees or for a monthly operating fee, but permits the Company to use this airship while it still carries Sea World's logos\/markings. The term of this agreement was to expire on December 31, 1994. However, the Company exercised its right under the contract to voluntarily suspend operations of the airship in April 1994.\nAnheuser-Busch\/Bud One - In March 1992, the Company entered into an agreement similar to the above with Anheuser-Busch for the use of the Bud One airship. Pursuant to this agreement, the Company agreed to convert the Bud One airship (then being used as a passenger airship) into an airship operated to promote the goods and products of Anheuser-Busch. The agreement provides for an initial term of six months with renewals for additional terms totaling three years. Anheuser-Busch may terminate the agreement during the first or at the end of the second annual period by giving proper notice to the Company (see Note L). The Company had operated this airship to advertise and promote the Sea World theme park from September 1991 to March 1992 under a prior agreement with Anheuser-Busch which enabled the Company to operate sightseeing tours for passengers on a fee basis at Kissimmee Airport.\nPursuant to an amendment dated March 4, 1994, monthly fees under the Bud One agreement were reduced by 50% effective February 1994 through July 1994.\nCatamount Petroleum Corporation\/Gulf Oil - In May 1993, the Company entered into an agreement with Catamount Petroleum Corporation for the use of the Gulf airship. The initial term of the agreement is for three years. Notwithstanding this term, the agreement may be terminated by either party upon proper written notice. During 1993, the airship was in operation from July through October upon which, at the request of Catamount, the agreement was suspended through April 1994 when the airship will resume operations through October 1994.\nThe Company is responsible for all costs associated with the operation of the Gulf airship, including repairs, maintenance, insurance and taxes.\nMastellone Hnos, S.A. - On December 15, 1994, the Company and its wholly-owned subsidiary Airship Operations, Inc. consummated an Aircraft Lease Agreement (the \"Argentina Lease Agreement\") and an Airship Operations Agreement (the \"Argentina Operations Agreement\"), respectively, with Mastellone Hnos, S.A. (\"Mastellone\") for the promotion of the products of Mastellone (the \"Argentina Airship\"). The Company received a deposit from Mastellone in the amount of $500,000. The operations for the Argentina Airship were never commenced by the Company due to a transaction with First Security Bank of Utah, as described below.\nSubsequently, on May 24, 1995, prior to commencement of operations of the Argentina Airship and pursuant to an Aircraft Purchase and Lease Assignment and Assumption between the Company and First Security Bank of Utah, as trustee for the benefit of Aviation Support Group, Ltd. (\"Aviation\"), the Argentina Airship was sold and the Argentina Lease Agreement was assigned to First Security. In consideration for such sale and assignment, First Security assumed the Company's obligations under the Argentina Lease Agreement. The Company is entitled to receive, during a ten-month renewal term provided for in the Argentina Lease and Argentina Operations Agreements, a portion of the rental income generated should Mastellone exercise its right to extend the terms of such agreement.\nAirship international Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE I - AIRSHIP REVENUES, MAJOR CUSTOMERS AND CREDIT CONCENTRATION - Continued\nIn addition, by notifying First Security prior to December 15, 1995 (extended to January 15, 1996), the Company had the right to repurchase the airship for 120% of the out-of-pocket expenses and the assumption of all liabilities incurred by First Security and Aviation in connection with the Argentina Airship. The Company did not exercise the right to repurchase the airship.\nConcurrently with the execution and delivery of the Purchase and Assumption Agreement, the Company sold to Aviation all of the issued and outstanding shares of the capital stock of Airship Operations, Inc. Mr. Benscher, who holds indirectly through designees approximately 4.0% of the Company's common stock, is a principal stockholder of Aviation. See Note C - Transactions With Stockholders, Related Parties And Others.\nOther Credit Concentrations - Reference should be made to Note C for advances to affiliate and deposit with Slingsby.\nIn June 1992, the Company's MetLife airship was damaged during a test flight. The airship was in the hangar in North Carolina through October 15, 1992 undergoing repairs as a result of the damage, during which time no related airship revenues were received. In August 1992, the Company received $1,850,000 from its insurance carrier in settlement of such damages to the airship and loss of revenues from interruption of operations. The Company wrote off the net book value of the damaged components ($760,000, principally related to the envelope) and costs to repair the airship, including the cost of replacement components, of $321,000. The Company provided most of the replacement components from its existing stock. The cost of the new envelope ($711,000) and other reassembly costs were capitalized and totaled approximately $1,201,000.\nNOTE J - EMPLOYEE SAVINGS PLAN\nThe Company has an employee savings plan (the \"Savings Plan\") that qualifies as a deferred salary arrangement under Section 401(k) of the Internal Revenue Code. Under the Savings Plan, participating employees may defer a portion of their pretax earnings, up to the Internal Revenue Service annual contribution limit of 15% of the employee's salary. The Company matches 5% of each employee's contributions, depending on length of service, up to a maximum of 6% of the employee's earnings. The Company's matching contributions to the Savings Plan was $11,000 for 1994. There were no matching contributions for 1992.\nAirship international Ltd. NOTES TO FINANCIAL STATEMENTS December 31, 1994, 1993 and 1992\nNOTE K - SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION\nNOTE L - SUBSEQUENT EVENTS\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULES\nBoard of Directors and Stockholders Airship International Ltd.\nIn connection with our audit of the financial statements of Airship International Ltd. referred to in our report dated August 22, 1997 (that contains an explanatory paragraph pertaining to a going concern and other uncertainties), which is included in the Annual Report on SEC Form 10-K for the year ended December 31, 1994, we have also audited Schedules II, IV, V, VI, IX, and X for the year ended December 31, 1994. In our opinion, these schedules present fairly, in all material respects, the information required to be set forth therein.\nCHARLIE M. MEEKS, C.P.A., P.A.\nOrlando, Florida August 22, 1994\n(b) Exhibits listed in the Exhibit Index below have been filed as part of this report:\n*Filed herewith.\n(1) The Company's Registration Statement on Form S 18 Registration No. 2.96334 NY as filed with the Securities and Exchange Commission (the \"SEC\") on March 9, 1985. (2) The Company's Registration Statement on Form S-1 Registration No. 33-7830, as filed with the SEC on August 7, 1986. (3) The Company's Annual Report on Form 10-K for fiscal year ended December 31, 1988. (4) The Company's Annual Report on Form 10-K for fiscal year ended December 31, 1991. (5) The Company's Registration Statement on Form S-2, Registration No. 33-32619, as filed with the SEC on December 18, 1989. (6) The Company's Post-effective Amendment No. 1 on Form S-3 to Form S-2, Registration No. 33-38076, as filed with the SEC on May 14,1 992. (7) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1987. (8) The Company's Report on Form 8 dated August 14, 1991. (9) The Company's Report on Form 8-K dated February 27, 1990. (10) The Company's Registration Statement on Form S-2, Registration No. 33038076. as filed with the SEC on December 5. 1990.\n(11) The Company's Registration Statement on Form S-1, Registration No. 33-56382, as filed with the SEC on February 16, 1993. (12) The Company's Registration Statement on Form 8-A, as filed with SEC on March 16, 1993. (13) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992. (14) The Company's Report on Form 8-K dated July 9, 1993. (15) The Company's Annual Report on Form 10-K for the fiscal year ended December31, 1993. (16) The Company's Report on Form 8-K, as filed with the SEC on July11, 1997. (17) The Company's Report on Form 8-K\/A, as filed with the SEC on July22, 1997. (18) The Company's Proxy Statement, as filed with the SEC on March 20, 1995.\n(b) The Company had not filed any reports on form 8-K during the last quarter of the period covered by this report.\nSTATEMENT OF REFERENCES The copyright symbol shall be expressed as.............................`c' The registered trademark symbol shall be expressed as..................`r' The trademark symbol shall be expressed as.............................`tm' Characters normally expressed as superscript shall be preceded by.......`pp'","section_15":""}
{"filename":"50916_1994.txt","cik":"50916","year":"1994","section_1":"ITEM 1. BUSINESS:\n(a) General Development of Business.\nInter-Regional Financial Group, Inc. (the \"Company\") is a holding company, formed in 1973 and based in Minneapolis, Minnesota. The Company offers regional securities broker-dealer and investment banking services through its wholly owned subsidiaries, Dain Bosworth Incorporated (\"Dain Bosworth\"), headquartered in Minneapolis, Minnesota, and Rauscher Pierce Refsnes, Inc. (\"Rauscher Pierce Refsnes\"), headquartered in Dallas, Texas. The Company's largest subsidiary, Dain Bosworth, serves the Midwest, Rocky Mountain and Pacific Northwest regions of the United States. In October 1994, Dain Bosworth acquired Chicago-based Clayton Brown Holding Company (\"Clayton Brown\"), a privately held firm specializing in the sale, trading and origination of fixed income securities through its wholly owned brokerage subsidiary, Clayton Brown & Associates, Inc. Such acquisition together with retail employees hired in 1994 provides the Company with a base for expansion in the Illinois market. At December 31, 1994, Dain Bosworth had 1,916 employees located in 18 states. Rauscher Pierce Refsnes primarily serves the Southwest region of the United States. At December 31, 1994, Rauscher Pierce Refsnes had 1,058 employees located in eight states. Each of Dain Bosworth and Rauscher Pierce Refsnes, as well as 130 correspondent brokerage firms serviced through Rauscher Pierce Refsnes' RPR Clearing Services unit (\"RPR Clearing Services\"), based in St. Louis, Missouri, clears and settles all securities trades on a fully disclosed basis through Regional Operations Group, Inc. (\"ROG\"), a third wholly owned subsidiary and registered broker- dealer based in Minneapolis. ROG, which also provides data processing and information services to IFG and its subsidiaries, had 308 employees at December 31, 1994. IFG Asset Management Services, Inc. (\"AMS\"), formerly known as Insight Investment Management, Inc., the Company's wholly owned money management subsidiary, manages a series of mutual funds, Great Hall Investment Funds, and also provides fixed income portfolio management services through its Insight Investment Management (\"Insight Management\") division. AMS, which was formed in January 1995, has also begun to develop services to support the sale by Dain Bosworth and Rauscher Pierce Refsnes investment executives of externally managed mutual funds and cash management products. The Company is a Delaware corporation with its executive offices located at Dain Bosworth Plaza, 60 South Sixth Street, Minneapolis, Minnesota 55402-4422. Its telephone number is (612) 371-7750.\n(b) Financial Information About Industry Segments\nThe Company, through its principal subsidiaries, operates in a single segment, the securities broker-dealer and investment banking business.\nThe following table lists the Company's revenues by source for the last three years. Because these classes of services use the same distribution personnel and facilities and the same support services, it is impractical to identify the cost, expenses and profitability of each class of service.\n(c) Narrative Description of Business\nSecurities Business\nGeneral. The securities broker-dealer and investment banking activities of the Company are conducted through Dain Bosworth and Rauscher Pierce Refsnes. Both Dain Bosworth and Rauscher Pierce Refsnes deal in securities of and are market-makers for entities based throughout the United States. In general, research and investment banking activities are concentrated on entities based in their respective regions. At December 31, 1994, Dain Bosworth had 854 retail sales representatives and 87 institutional sales representatives in 67 offices located in 18 states and Rauscher Pierce Refsnes had 324 retail sales representatives and 49 institutional sales representatives in 28 offices located in seven states. Both firms are member firms of the New York Stock Exchange (\"NYSE\") and are registered in the NASDAQ system as market makers. At December 31, 1994, Dain Bosworth was registered as a market maker for 412 companies and Rauscher Pierce Refsnes was registered as a market maker for 270 companies.\nDain Bosworth's and Rauscher Pierce Refsnes' operating results are sensitive to many factors outside the control of the Company, including volatility of securities prices and interest rates, trading volume of securities, income and capital gains tax legislation and demand for investment banking services. Economic conditions in the regions in which Dain Bosworth and Rauscher Pierce Refsnes operate also affect operating results.\nPrincipal Transactions. Dain Bosworth and Rauscher Pierce Refsnes are dealers in corporate, tax-exempt and governmental fixed income securities and corporate equity securities and may recognize profits or losses on transactions in, or fluctuations in the value of, such securities held in inventory. These inventories require the commitment of substantial capital and expose the companies to the risk of a loss if market prices of the securities held in inventory decrease. General market conditions, interest rates and the financial prospects for issuers of such securities may affect the market price of securities held in inventory. Internal guidelines intended to limit the size and risk of inventories maintained have been established and are periodically reviewed.\nCommission Business. As securities brokers, Dain Bosworth and Rauscher Pierce Refsnes act as agents in the purchase and sale of securities, options, commodities and futures contracts traded on various securities and commodities exchanges or in the over-the- counter (\"OTC\") market. Dain Bosworth and Rauscher Pierce Refsnes charge a brokerage commission when acting as agent for the purchaser or seller of a security. If the security is listed on an exchange, the transaction is generally effected through Dain Bosworth's or Rauscher Pierce Refsnes' own floor broker or a floor broker who is unaffiliated with either of them. If the security is traded in the OTC market, transactions are generally effected with a market maker in the security. In addition, Dain Bosworth and Rauscher Pierce Refsnes also earn commissions from transactions involving various other financial products including mutual funds. Dain Bosworth's and Rauscher Pierce Refsnes' commission business is derived primarily from individual investors. However, commission revenues from institutional investors have increased in recent years and both companies are investing resources to develop more fully their institutional businesses.\nInvestment Banking Activities. Dain Bosworth and Rauscher Pierce Refsnes earn investment banking revenues by assisting clients in planning to meet their financial needs and advising them on the most advantageous means of raising capital. Such plans are sometimes implemented by managing or co-managing public offerings of securities or by arranging private placements of securities with institutional or individual investors. The syndicate departments coordinate the distribution of managed and co-managed corporate equity underwritings, accept invitations to participate in competitive or negotiated underwritings managed by other investment banking firms, and allocate and merchandise Dain Bosworth's and Rauscher Pierce Refsnes' selling allotments to their branch office systems, to institutional clients and to other broker-dealers. Both companies are also among the leaders in their respective regions in the origination, syndication and distribution of securities of municipalities, state and local agencies, health care organizations and financial institutions. Participation in underwritings can expose the companies to material risk since the possibility exists that securities they have committed to purchase cannot be sold at the initial offering price. Federal and state securities laws and regulations also affect the activities of underwriters and impose substantial potential liabilities for violations in connection with sales of securities by underwriters to the public. In addition to public offerings and private placements, Dain Bosworth and Rauscher Pierce Refsnes provide other consulting services, including providing valuations of securities and companies, arranging and evaluating mergers and acquisitions and advising clients with respect to financing plans and related matters.\nCustomer Financing. A significant portion of Dain Bosworth's and Rauscher Pierce Refsnes' profitability is derived from net interest income, the major portion of which relates to customer balances. Customer transactions are effected on either a cash or margin basis. Purchases on a cash basis require full payment by the designated settlement date, generally the fifth business day following the transaction date. (Beginning in June 1995, most securities will settle on the third business day following the transaction date.) ROG carries all customer balances of each of Dain Bosworth, Rauscher Pierce Refsnes and the correspondent introducing firms serviced by RPRCS and allocates interest income and expense related to customers, as well as uncollectible amounts due from customers, back to Dain Bosworth and Rauscher Pierce Refsnes and, through Rauscher Pierce Refsnes, to such correspondent introducing firms. Both Dain Bosworth and Rauscher Pierce Refsnes are at risk in the event a customer fails to settle a trade and the value of the securities declines subsequent to the transaction date. When a purchase is made on a margin basis, Dain Bosworth or Rauscher Pierce Refsnes, through ROG, extends credit to the customer for a portion of the purchase price. The amount of the loan is subject to margin regulations of the Federal Reserve Board, the NYSE and the internal policies of Dain Bosworth, Rauscher Pierce Refsnes and ROG, which are generally more stringent than applicable regulations. In permitting customers to purchase on margin, Dain Bosworth and Rauscher Pierce Refsnes, through ROG, take the risk that a market decline could reduce the value of the collateral securing the margin loan below the amount of the customer's indebtedness and that the customer might be unable to repay the indebtedness. Interest is charged at a floating rate based on amounts borrowed by customers to finance purchases on margin. The rate charged is dependent on the average net debit balance in the customer's accounts, the activity level in the accounts and the applicable cost of funds.\nCustomers will at times accumulate credit balances in their accounts. Such balances result from payment of dividends, interest or principal on securities held for such customers, from funds received in connection with sales of a customer's securities and from cash deposits made by customers pending investment. Pending investment of such funds or reimbursement upon the customer's request, ROG pays interest on those credit balances on behalf of Dain Bosworth and Rauscher Pierce Refsnes. ROG uses available credit balances to lend funds to Dain Bosworth and Rauscher Pierce Refsnes customers purchasing securities on margin. Excess customer credit balances are invested in short- term securities in accordance with applicable regulations and are segregated for the exclusive benefit of customers. Both Dain Bosworth and Rauscher Pierce Refsnes generate net interest income through ROG from the positive interest rate spread between the rate earned from margin lending and alternative short-term investments and the rate paid on customer credit balances.\nDain Bosworth, Rauscher Pierce Refsnes and ROG are members of the Securities Investor Protection Corporation (\"SIPC\"), which insures customer accounts up to specified limits in the event of liquidation. Additionally, all three firms maintain insurance coverage in order to insure customer accounts to specified amounts in excess of SIPC coverage.\nSecurity Repurchase Activities. Dain Bosworth and Rauscher Pierce Refsnes act as principals in the purchase and sale to their customers of securities of the United States Government and its agencies, including repurchase agreements in such securities and certain other money market instruments. Dain Bosworth and Rauscher Pierce Refsnes may match purchases and sales of these securities. Dain Bosworth and Rauscher Pierce Refsnes are at risk to the extent that they do not properly match the contracts or their customers are unable to meet their obligations, especially during periods of rapidly changing interest rates and fluctuations in market conditions. All positions are collateralized. Dain Bosworth and Rauscher Pierce Refsnes generally take physical possession of securities purchased under agreements to resell. Such agreements provide Dain Bosworth and Rauscher Pierce Refsnes with the right to maintain the relationship between the market value of the collateral and the receivable. Typically, these contracts are entered into only with clients of substantial size and credit-worthiness. Dain Bosworth and Rauscher Pierce Refsnes also periodically utilize securities sold under repurchase agreements as a means of financing portions of their trading inventories and facilitating hedging transactions.\nSecurities Lending and Borrowing Activities. Securities brokers and dealers, including ROG, borrow securities from and lend securities to other brokers and dealers to facilitate clearance and delivery of securities that have been sold when customers fail to deliver securities prior to settlement date. ROG also will act as a conduit by arranging securities lending transactions between brokers wishing to lend securities and those wishing to borrow the same securities. When such transactions occur, the lending broker provides excess customer margin securities to the borrowing broker in return for a cash deposit that is generally equivalent to 102 percent of the market value of the securities loaned. Both the lending and borrowing brokers have the right to mark the securities to market in order to maintain the relationship between the market value of the securities loaned and the cash collateral deposited. When the securities are no longer needed by the borrowing firm, they are returned to the lending broker, which returns the cash deposit held, plus interest, to the borrowing broker. When engaging in such securities lending and borrowing activities, ROG collects cash deposits from brokers that collateralize the securities loaned, invests the cash deposit and profits from the spread between the interest rate paid to the borrowing broker on the cash deposit and the rate earned by ROG. In all securities lending transactions, ROG is at risk to the extent that it does not maintain the relationship between the market value of securities loaned and the value of the cash deposit held. ROG is also at risk to the extent that securities it borrows decline in value and the loaning broker fails to return ROG's cash deposit.\nResearch Activities. Both Dain Bosworth and Rauscher Pierce Refsnes have research departments which provide analysis, investment recommendations and market information with an emphasis on companies located in their respective regions. At December 31, 1994, Dain Bosworth had 16 securities analysts and Rauscher Pierce Refsnes had 11. Both companies also purchase certain research products from independent research organizations to supplement their internal research activities.\nRegulation. The securities industry is subject to comprehensive regulation by federal and state governments, the various securities and commodities exchanges and other self-regulatory bodies. The regulations cover all aspects of the securities business including sales methods, registration and distribution of securities, trade practices among broker-dealers, transactions with affiliates, conflicts of interest, uses and safekeeping of customers' funds and securities, capital levels of securities firms, record keeping and the conduct of employees. Violations of these rules and regulations can result in censure, fines, suspensions, revocation of the right to do business and private rights of action for damages. Dain Bosworth, Rauscher Pierce Refsnes, ROG and AMS believe they have operated in compliance with applicable rules and regulations in all material respects.\nUniform Net Capital Rule. As broker-dealers and member firms of the NYSE, Dain Bosworth, Rauscher Pierce Refsnes and ROG are subject to the Uniform Net Capital Rule (the \"Rule\") promulgated by the Securities and Exchange Commission (the \"Commission\"). The Rule is designed to measure the general financial integrity and liquidity of a broker-dealer and the minimum net capital deemed necessary to meet the broker-dealer's continuing commitments to its customers. The Rule provides for two methods of computing net capital. ROG, which carries all of the customer accounts of Dain Bosworth, Rauscher Pierce Refsnes and the correspondent firms serviced through RPR Clearing Services, currently uses what is generally referred to as the alternative method. Minimum net capital is defined under this method to be equal to 2 percent of customer debit balances, as defined. The NYSE may also require a member organization to reduce its business if net capital is less than 4 percent of such aggregate debit items and may prohibit a member firm from expanding its business and declaring cash dividends if its net capital is less than 5 percent of such aggregate debit items. In computing net capital, various adjustments are made to exclude assets which are not readily convertible into cash and to provide a conservative valuation of other assets such as a company's trading securities. Failure to maintain the required net capital may subject a firm to suspension or expulsion by the NYSE, the Commission and other regulatory bodies and may ultimately require its liquidation. Dain Bosworth and Rauscher Pierce Refsnes, which do not carry customer accounts, must maintain minimum net capital of $1 million each. At all times, Dain Bosworth, Rauscher Pierce Refsnes and ROG have maintained their net capital above the required levels. See Note K to \"Consolidated Financial Statements.\"\nMoney Management\nAMS was formed in January 1995 as a new financial services organization supporting all mutual fund and cash management products sold by Dain Bosworth and Rauscher Pierce Refsnes as well as mutual fund vendor relations. In addition, AMS, a registered investment advisor, will continue to conduct the portfolio management business of Insight Investment Management, now a division of AMS, including the provision of fixed income portfolio management services to Great Hall Investments Funds, Inc., (\"Great Hall\") and to individual and institutional clients. Great Hall is an open-end management investment company that currently offers shares in five series, each of which is, in essence, a separate mutual fund. Three of the Great Hall series are \"money market\" funds and the remaining two series invest primarily in longer-term municipal securities. Although Insight Management's expertise has historically been in the tax-exempt fixed-income area, AMS plans to develop and expand the division's taxable fixed income management capabilities and to market such expanded services primarily to institutional investors.\nSince 1993 AMS has also introduced and sponsored four series of Great Hall Value Ten Trusts, unit investment trusts offering units in a portfolio of \"blue chip\" equity securities, and two series of Great Hall Equity Trusts, one focusing on stocks of issuers located within the Rocky Mountain region of the U.S. and the other focusing on common and preferred stocks of utility companies. AMS has no current plans to sponsor additional unit investment trusts.\nClearing and Other Services\nIn April 1993 ROG began clearing and settling trades on a fully disclosed basis for Dain Bosworth, Rauscher Pierce Refsnes and the correspondent introducing firms previously clearing through them. RPR Clearing Services, a division of Rauscher Pierce Refsnes, is in the business of marketing correspondent clearing services provided by ROG. As of December 31, 1994, ROG provided clearing services to 130 correspondent introducing firms introduced through RPR Clearing Services and one correspondent introducing firm introduced through Dain Bosworth. ROG also provides data processing services to the Company and its subsidiaries. Correspondent firms introduced through RPR Clearing Services or otherwise and cleared through ROG are charged fees based on their use of services.\nReal Estate Services\nPrior to its dissolution in 1994, Minneapolis-based Dain Corporation provided real estate investment and portfolio management services. Prior to 1989, Dain Corporation sold participation interests in the partnerships to individual and institutional investors primarily through the sales representatives of Dain Bosworth, Rauscher Pierce Refsnes and other financial services firms. However, as a result of federal tax reform, depressed market values and extremely tight credit conditions that dramatically affected the real estate industry, Dain Corporation raised its last capital for new property syndications in 1988. Since that time Dain Corporation focused its resources on managing the portfolio of properties owned by partnerships in which it served as general partner and on selling partnership properties as it deemed appropriate, subject to the approval of the limited partners. During 1994 Dain Corporation sold the remaining properties owned by partnerships in which it served as general partner and is now inactive.\nCompetition\nDain Bosworth, Rauscher Pierce Refsnes and AMS encounter intense competition in their businesses and compete directly with numerous firms, many of which have substantially greater capital and other resources. Such subsidiaries also encounter competition from banks, insurance companies and financial institutions in many elements of their businesses. Legislative proposals currently under consideration would permit banks to offer additional services which have traditionally been provided only by securities and money management firms. Additionally, competition among securities firms and other competitors for successful sales representatives, securities traders and investment bankers is intense and continuous.\nDain Bosworth and Rauscher Pierce Refsnes compete with other securities firms and with banks, insurance companies and other financial institutions principally on the basis of service, product selection, location and reputation in local markets. Dain Bosworth and Rauscher Pierce Refsnes operate at a price disadvantage to discount brokerage firms that do not offer equivalent services.\nRPR Clearing Services competes for the business of correspondent introducing brokers on the basis of service, product selection, reputation and price.\nAMS' Insight Management division competes with other fixed income portfolio managers principally on the basis of portfolio performance, price and convenience.\nEmployees\nAt December 31, 1994, the Company had approximately 3,340 full- time employees. Of these, 1,916 were employed by Dain Bosworth, 1,058 were employed by Rauscher Pierce Refsnes, 308 were employed by ROG and the rest were employed in other activities. None of the Company's employees is represented by a collective bargaining unit.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES:\nThe headquarters and administrative offices of the Company, Dain Bosworth, AMS and ROG are located in three buildings in downtown Minneapolis, Minnesota, including the Dain Bosworth Plaza. The Company began occupying space in the new Dain Bosworth Plaza under a long-term operating lease in January 1992. The Company's office space in a second building remains under a long-term lease commitment and was renovated in 1992 to facilitate the consolidation of the Company's clearance and settlement functions into ROG (see \"Clearing and Other Services\"). Additional space in a third building in Minneapolis was obtained in 1994 by ROG under an operating lease to facilitate growth. Rauscher Pierce Refsnes leases office space in Dallas, Texas that is used as its corporate headquarters. During 1994 Rauscher Pierce Refsnes entered into a long-term operating lease for new headquarters space in Dallas, Texas which it will occupy commencing during the 1995 third quarter. Both Dain Bosworth and Rauscher Pierce Refsnes have extensive branch office systems which lease space in various locations throughout their regions. As a result of its acquisition of Clayton Brown in October 1992, Dain Bosworth also has a long-term lease commitment for Clayton Brown's former headquarters in Chicago. The Company believes that its facilities are suitable and adequate to meet its needs and that such facilities have sufficient productive capacity and are appropriately utilized.\nFurther information about the lease obligations of the Company is provided in Note I to the \"Consolidated Financial Statements.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS:\nDain Bosworth and Rauscher Pierce Refsnes are defendants in numerous civil actions and arbitrations incidental to their business involving alleged violations of federal and state securities laws and other laws. Some of these actions, including certain actions against Rauscher Pierce Refsnes described in more detail in previous filings and below, have been brought on behalf of purported classes of plaintiffs claiming substantial damages relating to underwritings of securities.\nOn September 26, 1994, a Settlement Agreement was entered into by certain settling plaintiffs and settling defendants in connection with the multi-district proceeding, In Re Taxable Bond Securities Litigation (MDL 863), in which Rauscher Pierce Refsnes is named as a defendant. As described in detail in previous filings, this action resulted from Rauscher Pierce Refsnes' participation in the underwriting syndicates for seven taxable municipal bond offerings for an aggregate of $1.55 billion. Rauscher Pierce Refsnes underwrote an aggregate of $57.8 million of such bonds and served as a co-manager of one $200 million bond offering. Rauscher Pierce's portion of the underwriting syndicates' contribution to the settlement fund was approximately $870,000. Such funds are being held in escrow pending satisfaction of certain requirements contained in the Settlement Agreement, including, among others, a requirement that the United States District Court for the Eastern District of Louisiana hold a hearing and determine that the settlement should be approved as fair, reasonable and adequate. In addition, the settlement may be terminated if the aggregate amount of the claims of members of the plaintiff class who elect not to participate in the settlement exceeds certain specified limits. Rauscher Pierce Refsnes believes that it has substantial and meritorious defenses to the claims raised by the plaintiffs. If the settlement is not consummated or is consummated but the plaintiffs in any of the actions in which Rauscher Pierce is a defendant elect to not to participate in the settlement, Rauscher Pierce will vigorously defend itself against such actions.\nRauscher Pierce Refsnes is one of 13 broker-dealer defendants named in a purported class action, Smith, et al. v. Merrill Lynch & Co., Inc., et al. (SA CV-94-1063-LIIM), pending in the United States District Court for the Central District of California. The case arises out of the issuance of debt securities by Orange County, California (\"the County\") and participants in the Orange County Investment Pool (\"the Pool Participants\") between July 1992 and December 1994 (\"the class period\"). The County and the Orange County Investment Pool each commenced Chapter 9 bankruptcy proceedings on December 6, 1994. Several class action complaints against Merrill Lynch and certain other defendants were filed shortly thereafter; the cases were subsequently consolidated and amended to name additional brokerage firm defendants, including Rauscher Pierce Refsnes. Rauscher Pierce Refsnes was first served with the amended consolidated complaint on March 7, 1995. The named plaintiffs allegedly purchased securities in numerous issues over the class period, two of which involved Rauscher Pierce Refsnes: a $299.7 million one-year tax and revenue anticipation note issue by a group of school districts in the name of the County in July 1994, in which Rauscher Pierce Refsnes was the financial advisor, and a $119.2 million long-term special tax bond issue by a community facilities district in July 1992 in which Rauscher Pierce Refsnes served as a co-managing underwriter along with two other brokerage firms. Plaintiffs purport also to represent purchasers of other securities issued by the County or Pool Participants during the class period, including securities issued in additional transactions in which Rauscher Pierce Refsnes was an underwriter or financial advisor. Plaintiffs allege violations of federal and state securities laws. They seek an unspecified amount of compensatory damages, rescission and other relief. Rauscher Pierce Refsnes believes that it has substantial and meritorious defenses available and plans to defend itself vigorously in this action.\nWhile the outcome of any litigation is uncertain, management, based in part upon consultation with legal counsel as to certain of the actions pending against Dain Bosworth and Rauscher Pierce Refsnes, believes that the resolution of all such matters will not have a material adverse effect on the Company's consolidated financial condition.\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 ended December 31, 1994.\nEXECUTIVE OFFICERS OF THE REGISTRANT\nThe following officers have been designated by the Board of Directors of the Company as its current \"executive officers\" for SEC reporting purposes. All officers are generally elected annually at the Board meeting held in conjunction with the Company's Annual Stockholders meeting and hold such offices until the following year, subject to their earlier death, resignation or removal.\nPrincipal Occupation and Business Experience Name Age for the Past Five Years - ----- --- ----------------------- John C. Appel 46 President and Chief Operating Officer, Dain Bosworth Incorporated since February 1994; Executive Vice President and Chief Financial Officer, Dain Bosworth Incorporated, April 1990 to February 1994; Executive Vice President, IFG since April 1990; Senior Vice President, IFG, from May 1986 to April 1990; Chief Financial Officer, IFG, from May 1986 to February 1994. Member IFG Executive Committee.\nAngela M. Chicoine 32 Controller, IFG, since March 1995. Vice President and Director of Corporate Audit, IFG, since June 1993. Field Audit Manager, Honeywell Inc., from January 1992 to June 1993. Audit Manager, Coopers & Lybrand from June 1989 to January 1992.\nJerry W. Hayes 49 President and Chief Executive Officer, Regional Operations Group, Inc. since May 1992. Senior Vice President of Dain Bosworth Incorporated, from May 1992 to November 1992; Senior Vice President, Marquette Bank, Minneapolis from December 1989 to April 1992. Member of IFG Executive Committee.\nRichard D. McFarland 65 Chairman of the Board, IFG since June 1985; Chief Executive Officer, IFG, from June 1985 to December 1989; President of IFG from January 1982 to June 1985. Mr. McFarland has announced intention to retire as Chairman of the Board effective May 1995.\nMary M. Melbo 44 Executive Vice President - Human Resources of IFG since January 1995. Executive Vice President - Director of Human Resources of Dain Bosworth Incorporated from February 1994 to January 1995. Senior Vice President - Director of Human Resources of Dain Bosworth Incorporated from January 1991 to February 1994. Vice President - Human Resources, Commercial and Investment Banking, First Bank System, Inc. from September 1987 to November 1990. Member of IFG Executive Committee.\nDaniel J. Reuss 39 Acting Chief Financial Officer, IFG, since February 1994; Senior Vice President, IFG since May 1991; Vice President, IFG April 1987 to May 1991; Treasurer, IFG since May 1989; Corporate Controller, IFG February 1985 to March 1995. Appointed Executive Vice President and Chief Financial Officer, Dain Bosworth effective January 1, 1995, however, Mr. Reuss continues to serve in his IFG role as Chief Financial Officer and Treasurer on an interim basis.\nCarla J. Smith 37 Senior Vice President, IFG, since May 1994; General Counsel and Secretary, IFG, since January 1991; Partner, Dorsey & Whitney, from January 1989 to June 1990; Associate, Dorsey & Whitney, from May 1981 to December 1988.\nDavid A. Smith 48 Chief Executive Officer, Rauscher Pierce Refsnes since May 1983; President, Rauscher Pierce Refsnes since January 1985; Chairman of the Board, Rauscher Pierce Refsnes since January 1990; Executive Vice President of IFG since May 1991. Member of IFG Executive Committee.\nJ. Scott Spiker 39 President, IFG Asset Management Services, Inc. and Chief Executive Officer of its Insight Investment Management division since January 1995. Senior Vice President and Director of Strategic Planning and Corporate Development, IFG from February 1994 to December 1994; Senior Vice President and Manager Employee Benefit Services, Norwest Bank Minnesota, N.A., June 1989 to January 1994; Vice President, Strategic Planning and Acquisitions, Norwest Corporation, December 1987 to June 1989. Member of IFG Executive Committee.\nIrving Weiser 47 Chief Executive Officer, IFG since January 1990; President, IFG since July 1985; Chief Executive Officer, Dain Bosworth Incorporated since April 1990; Chairman of the Board, Dain Bosworth Incorporated since April 1990; President, Dain Bosworth Incorporated from April 1990 to February 1994. Member of IFG Executive Committee.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET PRICE OF AND DIVIDENDS ON THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS:\n(a) Market Information.\nThe Company's common stock trades on the NYSE under the symbol \"IFG.\" The high and low sales prices per share of the Company's common stock by quarter for the last two years were as follows:\n(b) Holders.\nAt February 28, 1995, there were approximately 5,700 shareholders of the Company's common stock. The number of shareholders was determined by adding the number of recordholders to the estimated number of proxies to be sent to street name holders.\n(c) Dividends.\nCash dividends per common share paid by the Company by quarter for the last two years were as follows:\nThe determination of the amount of future cash dividends, if any, to be declared and paid will depend on the Company's future financial condition, earnings and available funds.\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:\nBusiness Environment\nThe Company's subsidiaries are principally engaged in securities brokerage, investment banking and trading as principals in equity and fixed income securities. All of these activities are highly competitive and sensitive to many factors outside the control of the Company, including volatility of securities prices and interest rates, trading volume of securities, economic conditions in the regions in which the Company does business, income tax legislation and demand for investment banking services. While revenues are dependent upon the level of trading volume, which may fluctuate significantly, a large portion of the Company's expenses remain fixed. Consequently, net earnings can vary significantly from period to period.\nThree Years Ended December 31, 1994 Summary of Operating Results\nNet earnings totaled $25.5 million in 1994, a decrease of $22.2 million or 47 percent from the record earnings achieved in 1993. Net revenues (revenues less interest expense) for 1994 were $457.4 million, $25.6 million or 5 percent less than in the previous year. During 1994 the financial markets in which the Company and its competitors operate deteriorated, chiefly as a result of a series of interest rate increases that began late in the first quarter. Six successive interest rate increases by the Federal Reserve Board during the year led to lower and more volatile securities prices, particularly in fixed income securities, reduced levels of municipal and corporate underwritings and general uncertainty on the part of investors. Industry profitability declined in 1994, particularly at firms with significant dependence upon the fixed income business. The Company's broker-dealer subsidiaries have substantial fixed income operations and, consequently, 1994 results were negatively impacted by the volatility in the fixed income markets. During the year the Company made significant investments in long-term growth initiatives within its core businesses, including its fixed income business. Management estimates that Dain Bosworth's October 1994 acquisition of Clayton Brown had a negative impact on the Company's 1994 fourth quarter and full-year net earnings of approximately $800,000 or $.10 per share (see \"Liquidity and Capital Resources\"). While this investment and others, including growth in the retail sales forces, enhanced net revenues during 1994, such incremental revenues were more than offset by increased expenses. The 1994 growth initiatives increased the Company's future production capability, yet adversely affected 1994 profit margins.\nDuring 1993 net earnings totaled $47.6 million, an increase of $13.1 million or 38 percent over the prior year. Net earnings and net revenues for 1993 represented the highest achieved in the Company's history. The Company, along with the rest of the securities industry, benefited in 1993 from continued strong financial markets, low interest rates, high securities prices and increased levels of municipal and corporate underwritings. As a result of the favorable economic environment and, in management's opinion, actions taken during the two to three years prior to 1993, the Company's core securities brokerage and investment banking businesses within Dain Bosworth and Rauscher Pierce Refsnes all posted record results for 1993.\nComparative Net Revenues and Expenses Summary. The following is a summary of the year-to-year increases (decreases) in categories of net revenues and operating expenses:\nPrincipal Transactions\nPrincipal transactions revenue declined less than 1 percent from 1993 to 1994. While over-the-counter equity and tax-exempt fixed income trading revenues increased 6 percent over the prior year, revenues from the trading of taxable fixed income products declined 15 percent. With the presence of rising interest rates, the 1994 trading environment for fixed income products, in particular, was much more volatile and difficult than in 1993 resulting in reduced trading profits in 1994. However, individual investor demand for and revenues from certain fixed income products, particularly tax-exempt securities increased due to comparatively larger Dain Bosworth and Rauscher Pierce Refsnes sales forces, as well as comparatively higher yields offered by such fixed income investments than in the prior year.\nThe 10-percent increase in revenues from principal transactions in 1993 over 1992 was due primarily to higher transaction volumes, declining interest rates and improved trading results in over-the-counter equity and fixed income securities (both taxable and tax-exempt).\nCommissions\nThe $7.6 million or 5-percent decrease in commission revenues from 1993 to 1994 was due principally to lower sales of mutual fund and listed securities to individual and institutional investors and lower securities prices. The decline was partially offset by the effects of 11-percent increases in both the average number of investment executives and the New York Stock Exchange average daily trading volume.\nCommission revenues increased 17 percent in 1993 over 1992, due chiefly to higher sales of mutual funds and listed securities. Contributing to the increase was a 7-percent rise in the average number of investment executives, as well as a 30-percent increase in the New York Stock Exchange's average daily trading volume and higher securities prices.\nInvestment Banking and Underwriting\nInvestment banking and underwriting revenues declined $32.9 million or 25 percent in 1994 from the prior year as rising interest rates significantly increased the costs of raising capital for Dain Bosworth's and Rauscher Pierce Refsnes' underwriting clients, thereby reducing the demand for such municipal and corporate underwritings. Revenues and pretax profits derived from municipal refundings fell from approximately $41 million and $13 million, respectively, in 1993 to $17 million and $2 million, respectively, in 1994, as anticipated by the Company. The effects of the decline in municipal refunding transactions, however, were partially offset by increases at both Dain Bosworth and Rauscher Pierce Refsnes in fee-based investment banking revenues, most significantly mergers and acquisitions, restructuring and private placement services performed for corporate clients.\nInvestment banking and underwriting revenues increased 23 percent from 1992 to 1993 as Dain Bosworth and Rauscher Pierce Refsnes clients issued greater quantities of corporate and municipal securities in order to take advantage of the then-favorable market conditions for raising capital. During 1993 investment banking revenues benefited from an increased number of initial public offerings underwritten for corporate clients, as well as the aforementioned volumes of municipal refundings.\nNet Interest Income\nThe major sources of interest revenues and expenses for the past three years are:\nShort-term investments segregated for regulatory purposes and margin loans to customers, both financed primarily by credit balances in customer accounts, comprise the majority of the Company's interest-earning assets. Fixed income trading inventories, which are generally financed with short-term bank borrowings or repurchase agreements, also generated significant net interest income. The Company's net interest income is dependent upon the level of customer balances and trading inventories, as well as the spread between the rate it earns on those assets compared with its cost of funds.\nNet interest income accounted for 8 percent of the Company's net revenues in 1994 versus 5 percent in 1993 and 6 percent in 1992. The majority of the 1994 increase was due to a 35-percent rise in margin loan balances, which resulted largely from the 11-percent increase in the average number of investment executives. Also, a portion of the increase was the result of increasing spreads on all customer balances, as well as increases in stock borrow and stock loan activities. See \"Liquidity and Capital Resources.\"\nAs long as favorable interest rate spreads are maintained and the level of interest-bearing accounts remains stable, the Company expects net interest income to continue to be a significant component of its earnings. The Company continues to examine alternative cash management products and services that it may offer to customers with credit balances in their accounts. Management believes that implementation of new cash management products and services would not have a material effect on net earnings.\nAverage balances and interest rates for 1992 through 1994 are:\nAsset Management\nAsset management revenues increased 48 percent in 1994 from 1993 and 36 percent from 1992 to 1993 as a result of 34-percent and 12-percent increases, respectively, in assets under management at AMS, as well as increased revenues from larger volumes of assets in fee-based, managed account programs at Dain Bosworth and Rauscher Pierce Refsnes.\nCorrespondent Clearing\nCorrespondent clearing revenues increased less than 1 percent from 1993 to 1994 as the positive effect of increased trade volumes handled by RPR Clearing Services, the Rauscher Pierce Refsnes unit that markets correspondent clearing services and coordinates clearing for 130 correspondent brokerage firms, was offset by the 1994 loss of a significant RPR Clearing Services correspondent. Such revenues increased $1.9 million or 19 percent from 1992 to 1993 primarily as a result of increased trade volumes and a 13-percent increase in the number of correspondents handled by RPR Clearing Services.\nOther Revenues\nThe 1994 decline and 1993 increase in other revenues was primarily the result of a one-time gain in 1993 of approximately $5.2 million from the sale of the Minneapolis Energy Center, a district heating and cooling company owned by a partnership in which Dain Bosworth was the general partner. Net of expenses, this transaction increased the Company's 1993 pretax earnings by $4.0 million, net earnings by $2.4 million and earnings per share by $.29. Partially offsetting the absence of this gain in 1994 were increased revenues from sales of insurance products and fees earned from Individual Retirement Accounts and other types of accounts.\nCompensation and Benefits\nCompensation and benefits expense is generally affected by the level of operating revenues, earnings and the number of employees. While the largely variable components of compensation and benefits expense (commissions and incentive compensation) were lower in 1994 than 1993 due to reduced operating revenues and earnings, the fixed component increased from the prior year due to a 12-percent increase in the average number of employees, as well as increased expense from the amortization of forgivable loans issued in the recruitment of revenue-producing employees. The compensation and benefits expense increase from 1992 to 1993 of 16 percent was comprised primarily of commissions, incentive compensation and related benefits that rose in conjunction with operating revenues and earnings, as well as an 8-percent increase in the average number of employees.\nOther Expenses\nDuring 1994 expenses other than compensation and benefits increased $10.9 million or 10 percent largely as the result of volume and headcount-driven increases in communications, market data and clearing services; increased occupancy costs related to the addition of 14 operating office locations and expansion of several others during 1994, including the expansion of space in the Company's Minneapolis headquarters; increased costs associated with recruiting and the generation of new business; and the acquisition of Clayton Brown (see \"Liquidity and Capital Resources\").\nDuring 1993 expenses other than compensation and benefits and interest increased $13.6 million or 14 percent from 1992 principally as a result of volume-driven increases in the use of communications, market data and clearing services; increased travel costs associated with the generation of new business; increased reserves; and increased occupancy expenses related to higher real estate and operating costs at the Company's Minneapolis headquarters, the net addition of nine operating office locations and the expansion of several others.\nIn light of the difficult market conditions in which the Company is currently operating, management has taken steps to selectively pare expenses and reduce spending in areas not related to revenue production. Nonetheless, management anticipates operating expenses to be somewhat higher in 1995 than in 1994 due to the full-year effect of significant growth investments made during 1994. Management also anticipates delaying, where possible, most future growth initiatives until the market environment in which the Company operates improves.\nInflation\nSince the Company's assets are primarily liquid in nature and experience a high rate of turnover, they are not significantly affected by inflation. However, the rate of inflation does affect many of the Company's operating costs which may not be readily recoverable through price increases on services offered by the Company.\nLiquidity and Capital Resources\nThe Company's assets are substantially liquid in nature and consist mainly of cash or assets readily convertible into cash. These assets are financed primarily by interest-bearing and non- interest bearing customer credit balances, repurchase agreements, other payables, short-term and subordinated bank borrowings and equity capital. Changes in the amount of trading securities owned by the Company, customer and broker receivables and securities purchased under agreements to resell directly affect the amount of the Company's financing requirements.\nThe Company has various sources of capital for operations and growth. In addition to capital provided by earnings, Regional Operations Group maintains uncommitted lines of credit from a number of banks to finance transactions (principally trading and underwriting positions of Dain Bosworth and Rauscher Pierce Refsnes) when internally generated capital is not sufficient. The majority of these uncommitted lines of credit are collateralized by trading securities and customers' margin securities. On February 28, 1995, approximately $220 million of a total of $425 million in uncommitted lines of credit were unused. Also, the Company has a $15 million, committed, unsecured revolving credit facility that is used for advances to its subsidiaries, irrevocable letters of credit and general corporate purposes. On February 28, 1995, $15 million of this revolving credit facility was unused.\nDain Bosworth and Rauscher Pierce Refsnes must comply with certain regulations of the Securities and Exchange Commission measuring capitalization and liquidity and restricting amounts of capital that may be transferred to affiliates. Regional Operations Group clears and settles trades for Dain Bosworth and Rauscher Pierce Refsnes (including the accounts of RPR Clearing Services). Regional Operations Group carries all customer accounts, extends margin credit to customers, pays interest on credit balances of customers and invests any excess customer balances. As a result, Regional Operations Group is subject to similar Securities and Exchange Commission regulations. During 1994 Dain Bosworth, Rauscher Pierce Refsnes and Regional Operations Group all operated above the minimum net capital standards. At December 31, 1994, regulatory net capital was $48.4 million at Regional Operations Group, which was 6.5 percent of aggregate debit balances and $11.2 million in excess of the 5- percent requirement. Dain Bosworth's and Rauscher Pierce Refsnes' net capital requirement is $1 million for each company as neither firm carries customer balances. At December 31, 1994, Dain Bosworth and Rauscher Pierce Refsnes had net capital of $26.9 million and $20.1 million, respectively, in excess of the $1 million requirement.\nThe Company paid a special cash dividend of $.16 per share on the Company's common stock during the first quarter of 1992 and regular quarterly cash dividends of $.04 per share thereafter through the first quarter of 1993. In the second quarter of 1993, the regular quarterly dividend was increased to $.08 per share and was subsequently increased to $.16 per share in the second quarter of 1994. The determination of future cash dividends, if any, to be declared and paid will depend on the Company's future financial condition, earnings and available funds.\nIn April 1994 the Company's Board of Directors authorized a plan to repurchase up to 400,000 shares of the Company's common stock. Purchases of the common stock will be made from time to time at prevailing prices in the open market, by block purchases, or in privately negotiated transactions. The repurchased shares will be used for the Company's employee stock option and other benefit plans, or for other corporate purposes. Through February 28, 1995, the Company had repurchased 162,500 shares in accordance with this program at a cost of $3.6 million.\nDain Bosworth and Rauscher Pierce Refsnes are dealers in corporate, tax-exempt and governmental fixed income securities which are carried in inventory primarily for distribution to Dain Bosworth's and Rauscher Pierce Refsnes' retail and institutional clients in order to meet those clients' needs. Periodically Dain Bosworth and Rauscher Pierce Refsnes buy, sell or position in trading inventories mortgage-derivative securities or structured notes. Holdings of high-yield securities are not material. Each of the Company's securities subsidiaries maintains comprehensive risk management policies encompassing position limits, agings, duration and credit. These policies are intended to limit the size of and risk in the Company's trading inventories.\nIn September 1994 Dain Bosworth and Rauscher Pierce Refsnes, respectively, entered into $10 million and $7 million four-year subordinated bank loans. The loans require monthly, interest- only payments throughout the four-year term, with equal quarterly principal payments during years two through four. Proceeds of the loans qualify as regulatory capital and will be used to support current and future growth in the number of operating office locations and forgivable loans issued as part of the recruitment of investment executives and other revenue-producing employees.\nIn order to finance its October 1994 acquisition of Clayton Brown for an aggregate cash purchase price of approximately $24 million, Dain Bosworth entered into an additional $10 million four-year subordinated bank loan. Proceeds of the loan qualify as regulatory capital. The loan requires monthly, interest-only payments throughout the four-year term, with equal quarterly principal payments during years two through four.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nIndex to Consolidated Financial Statements As of December 31, 1994 and 1993, and for each of the years in the three-year period ended December 31, 1994 and Supplementary Data\nPage ---- Independent Auditors' Report 19\nConsolidated Financial Statements:\nConsolidated statements of operations 20\nConsolidated balance sheets 21\nConsolidated statements of shareholders' equity 22\nConsolidated statements of cash flows 23\nNotes to consolidated financial statements 24\nQuarterly Financial Information 33\nINDEPENDENT AUDITORS' REPORT\nBoard of Directors and Shareholders Inter-Regional Financial Group, Inc.:\nWe have audited the accompanying consolidated balance sheets of Inter-Regional Financial Group, Inc. and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of operations, shareholders' equity and cash flows for each of the years in the three-year period ended December 31, 1994. In connection with our audits of the consolidated financial statements, we have also audited the financial statement schedule listed in the table of contents on page 38 hereof. These consolidated financial statements and financial statement schedule are the responsibility of the Company'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 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 Inter-Regional Financial Group, Inc. and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles. Also, in our opinion, the related 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 LLP\nMinneapolis, Minnesota February 1, 1995, except as to Note I which is as of March 7, 1995\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 1994, 1993 and 1992\nInter-Regional Financial Group, Inc. and Subsidiaries\nA. Summary of Significant Accounting Policies\nBasis of Presentation: The consolidated financial statements include the Company and its subsidiaries, all of which are wholly owned. All material inter-company balances and transactions have been eliminated in consolidation. Certain prior-year amounts in the financial statements have been reclassified to conform to the 1994 presentation.\nCash and Cash Equivalents: Cash and cash equivalents include cash on hand, cash in depository accounts with other financial institutions and money market investments with original maturities of 90 days or less.\nSecurities: Securities transactions and the related commission revenues and expenses are recorded on settlement date, which is not materially different than if transactions were recorded on trade date.\nTrading securities owned and trading securities sold, but not yet purchased, are stated at market value. Unrealized gains and losses on such securities are recognized currently in revenues. Market value is determined by using public market quotations, quote prices from dealers or recent market transactions, depending upon the underlying security.\nRepurchase Transactions: Securities purchased under agreements to resell (reverse repurchase agreements) and securities sold under repurchase agreements are accounted for as financing transactions and are recorded at the contract amount at which the securities will subsequently be resold or reacquired, plus accrued interest.\nOther Receivables: Included in other receivables are forgiveable loans made to investment executives and other revenue-producing employees, typically in connection with their recruitment. Such forgiveable loans are amortized over the life of the loan, which is generally three to five years, using the straight-line method.\nDepreciation and Amortization: Equipment is depreciated using the straight-line method over estimated useful lives of two to eight years. Leasehold improvements are amortized over the lesser of the estimated useful life of the improvement or the life of the lease. Buildings are depreciated using the straight-line method over an estimated useful life of 25 years.\nIncome Taxes: Effective January 1, 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" Under this method, deferred tax liabilities and assets and the resultant provision for income taxes 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. Financial statements for 1992 have not been restated and the cumulative effect of the accounting change was not material. (See note M.)\nIn 1992 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.\nFair Values of Financial Instruments: Substantially all of the Company's financial assets and liabilities are carried at market value or at amounts which, because of their short-term nature, approximate current fair value. The Company's borrowings, if recalculated based on current interest rates, would not differ significantly from the amounts recorded at December 31, 1994.\nEarnings Per Share: Primary earnings per share are based upon the weighted average number of common shares outstanding and the dilutive effect of common stock options and, in 1992, the assumed conversion of the Series 10% and 12% convertible preferred stock.\nFully diluted earnings per share for 1992 reflect the additional dilutive effect of the assumed conversion of convertible subordinated debentures. The weighted average number of shares used in the primary and fully diluted computations, respectively, are: 1994 - 8,361,084 and 8,361,084; 1993 - 8,404,501 and 8,466,797; and 1992 - 8,573,507 and 8,960,560.\nB. Acquisition\nOn October 7, 1994, the Company acquired all of the issued and outstanding common stock of Clayton Brown Holding Company (Clayton Brown), the holding company for Clayton Brown & Associates, a registered broker-dealer in Chicago, Illinois, specializing in fixed income securities, for a cost of $24.2 million, which approximated the net book value of Clayton Brown. The transaction was accounted for under the purchase method of accounting and, accordingly, the revenues and operating results of Clayton Brown have been included in the consolidated statement of operations for the period from October 7, 1994, through December 31, 1994.\nC. Receivable from and Payable to Customers\nThe amounts receivable from and payable to customers result from cash and margin transactions. Securities owned by customers and held as collateral for receivables and securities sold short by customers are not reflected in the consolidated financial statements. Included in payable to customers are customer funds on deposit for reinvestment totaling $674 million and $709 million as of December 31, 1994 and 1993, respectively. The Company pays interest on such funds at varying rates, the weighted average of which was 4.9 percent at December 31, 1994.\nD. Receivable from and Payable to Brokers and Dealers\nSecurities failed to deliver and receive represent the contract value of securities which have not been delivered or received subsequent to settlement date. Securities borrowed and securities loaned are recorded at the amount of cash collateral advanced or received in connection with the transaction. Securities borrowed transactions require the Company to deposit cash or other collateral with the lender. With respect to securities loaned, the Company receives cash or other collateral. The initial collateral advanced or received has a market value equal to or greater than the market value of the securities borrowed or loaned. The Company monitors the market value of the securities borrowed and loaned on a daily basis and requests additional collateral or returns excess collateral, as appropriate.\nE. Trading Securities\nThe market values of trading security positions are summarized as follows:\nF. Short-Term Borrowings\nThe loans to the securities subsidiaries consist of bank borrowings on uncommitted lines of credit, the majority of which are collateralized by trading securities owned and customers' margin securities, and have a floating rate of interest approximately .50 percent above the Federal Funds rate. The market value of trading securities pledged as collateral at December 31, 1994 was $140 million. At December 31, 1994, approximately $290 million of additional credit was available under uncommitted credit lines.\nRevolving credit loan borrowings and irrevocable letters of credit are available under a commitment totaling $15 million (100 percent of which was used as of December 31, 1994) which expires June 30, 1995. Loans under this facility are unsecured and bear interest at a floating rate of Federal Funds plus 1.125 percent. The Company must maintain certain levels of net worth under the agreement.\nG. Subordinated and Other Debt\nDuring 1994 Dain Bosworth and Rauscher Pierce Refsnes entered into a series of four-year subordinated bank loans totaling $27 million. Proceeds of the loans qualify as regulatory capital. The loans require monthly, interest-only payments throughout the four-year terms, with equal quarterly principal payments during years two through four. The outstanding subordinated debt bears a floating rate of interest of approximately 2.5 percent to 2.75 percent above the London Interbank Offered Rates. At December 31, 1994, the weighted average interest rate on all of the Company's subordinated debt was 8.8 percent.\nOther debt is used primarily to finance equipment and building improvements, is payable in monthly or quarterly installments and bears interest at floating rates which approximated 6.9 percent at December 31, 1994. The Company must maintain certain levels of net worth under one of the debt agreements.\nAnnual principal payments on subordinated bank loans and other debt (excluding obligations under capital leases) during the next five years are as follows: 1995-$4,255,000; 1996-$13,333,000; 1997-$12,977,000; 1998-$9,107,000; 1999-$54,000.\nH. Shareholders' Equity\nCommon Stock: The common stock has a par value of $.125 per share; 20,000,000 shares are authorized. During 1994 the Company's Board of Directors authorized a plan to repurchase up to 400,000 shares of the Company's common stock. Purchases of the common stock are made from time to time at prevailing prices in the open market, by block purchases, or in privately negotiated transactions. The repurchased shares will be used for the Company's employee stock option and other benefit plans, or for other corporate purposes. During 1994 the Company repurchased 162,500 shares in accordance with this program at a cost of $3.6 million.\nAt December 31, 1994, 1,683,000 shares of the Company's common stock were reserved for the 1986 Stock Option Plan, 106,000 shares were reserved for issuance to the IFG Stock Bonus Plan and 100,000 shares were reserved for issuance to the IFG Restricted Stock Plan for Non-Employee Directors.\nDividends: The Company paid a special cash dividend of $.16 per share during the first quarter of 1992 and regular quarterly cash dividends of $.04 per share each quarter thereafter through the first quarter of 1993. In the second quarter of 1993 the regular quarterly dividend was increased to $.08 per share and was subsequently increased to $.16 per share in the second quarter of 1994. The determination of the amount of future cash dividends, if any, to be declared and paid will depend on the Company's future financial condition, earnings and available funds.\nStock Options: The Company maintains a stock option plan, under which key employees and outside directors may be granted options to purchase common stock at not less than 100 percent of the fair market value of the shares at the date of grant for incentive stock options or 50 percent for non-qualified options. Options generally become exercisable at rates of 20, 50 and 100 percent as of two, three and four years, respectively, after the date of grant and expire ten years from date of grant. Options granted to outside directors become exercisable six months after grant date and expire five years after grant date. At December 31, 1994, 814,000 shares of common stock were available for grant.\nThe following table summarizes the activity related to the Company's stock option plan for each of the last three years:\nAll outstanding options were granted at 100 percent of the fair market value of the shares at the date of grant. The Company's closing stock price on December 31, 1994, was $22.50.\nI. Commitments and Contingent Liabilities\nLeases: The Company and its subsidiaries lease office space, furniture and communications and data processing equipment under several noncancelable leases. Most office space leases are subject to escalation and provide for the payment of real estate taxes, insurance and other expenses of occupancy, in addition to rent.\nAggregate minimum rental commitments as of December 31, 1994, are as follows:\nRental expense for operating leases was $22,414,000, $19,085,000 and $18,741,000, for the years ended December 31, 1994, 1993 and 1992, respectively. Included in net equipment, leasehold improvements and buildings at December 31, 1994 and 1993, is $5,037,000 and $5,952,000, respectively, for leases which have been capitalized.\nLitigation: The Company's securities subsidiaries are defendants in numerous civil actions and arbitrations incidental to their business involving alleged violations of federal and state securities laws, and other laws. Some of these actions have been brought on behalf of purported classes of plaintiffs claiming substantial damages relating to underwritings of securities.\nRauscher Pierce Refsnes is one of 13 broker-dealer defendants named in a purported class action arising out of the issuance of debt securities by Orange County, California (\"the County\") and participants in the Orange County Investment Pool (\"the Pool Participants\") between July 1992 and December 1994 (\"the class period\"). The County and the Orange County Investment Pool each commenced Chapter 9 bankruptcy proceedings on December 6, 1994. The named plaintiffs allegedly purchased securities in numerous issues over the class period, two of which involved Rauscher Pierce Refsnes: a $299.7 million one-year tax and revenue anticipation note issue by a group of school districts in the name of the County in July 1994, in which Rauscher Pierce Refsnes was the financial advisor, and a $119.2 million long-term special tax bond issue in July 1992 co-managed by Rauscher Pierce Refsnes. Plaintiffs purport also to represent purchasers of other securities issued by the County or Pool Participants during the class period, including securities issued in additional transactions in which Rauscher Pierce Refsnes was an underwriter or financial advisor. Plaintiffs allege violations of federal and state securities laws. They seek an unspecified amount of compensatory damages, rescission and other relief. Rauscher Pierce Refsnes believes that it has substantial and meritorious defenses available and plans to defend itself vigorously in this action.\nWhile the outcome of any litigation is uncertain, management, based in part upon consultation with legal counsel as to certain of these actions, believes that the resolution of these matters will not have a material adverse effect on the Company's consolidated financial condition.\nJ. Trading Activities and Financial Instruments with Off-Balance- Sheet Risk\nDain Bosworth and Rauscher Pierce Refsnes are dealers in corporate, tax-exempt and governmental fixed income securities and corporate equity securities and may recognize profits or losses on transactions in, or fluctuations in the value of, such securities held in inventory. Internal guidelines intended to limit the size and risk of inventories maintained have been established and are periodically reviewed. These inventories are positioned primarily for distribution to Dain Bosworth's and Rauscher Pierce Refsnes' individual and institutional clients in order to meet those clients' needs. Revenues from principal transactions for the year ended December 31, 1994, originate from the following:\nDain Bosworth and Rauscher Pierce Refsnes sell securities not yet purchased (short sales) for their own accounts primarily to hedge their fixed income trading inventories. The establishment of short positions exposes the Company to off-balance-sheet risk in the event prices increase, as the Company may be obligated to acquire the securities at prevailing market prices.\nThe Company may periodically hedge its fixed income trading inventories with financial futures or interest-rate option contracts. These contracts expose the Company to off-balance- sheet risk in the event that the changes in interest rates do not closely correlate with the change in the inventory price. At December 31, 1994, the Company had open commitments under financial futures contracts with a notional amount of $9.7 million. At December 31, 1994, the fair market value of these financial futures and option contracts was not material. Also, the average fair market value and trading revenues associated with these contracts during 1994 was not material.\nThe Company does not enter into interest-rate swap agreements, foreign currency contracts or other off-balance-sheet derivative financial instruments.\nIn the normal course of business the Company's activities involve the execution, settlement and financing of various securities transactions. These activities may expose the Company to off- balance-sheet credit and market risks in the event the customer or counterparty is unable to fulfill its contractual obligations. Such risks may be increased by volatile trading markets.\nIn the normal course of business the securities subsidiaries enter into when-issued underwriting and purchase commitments. Transactions relating to such commitments open at year end and subsequently settled had no material effect on the consolidated financial statements.\nThe Company seeks to control the risks associated with its customer activities by requiring customers to maintain margin collateral in compliance with various regulatory and internal guidelines. The Company monitors required margin levels daily and, pursuant to such guidelines, requires customers to deposit additional collateral or to reduce positions when necessary. Market declines could, however, reduce the value of collateral below the amount loaned, plus accrued interest, before the collateral could be sold.\nA portion of the Company's customer activity involves the sale of securities not yet purchased (short sales) and the writing of option contracts. Such transactions may require the Company to purchase or sell financial instruments at prevailing market prices in order to fulfill the customer's obligations.\nThe Company lends money subject to reverse repurchase agreements. All positions are collateralized, primarily with U.S. government or U.S. government agency securities. The Company generally takes physical possession of securities purchased under agreements to resell. Such transactions may expose the Company to risk in the event such borrowers do not repay the loans and the value of collateral held is less than that of the underlying receivable. These agreements provide the Company with the right to maintain the relationship between market value of the collateral and the receivable.\nThe Company may pledge firm or customer margin securities for bank loans, repurchase agreements, securities loaned or to satisfy margin deposits of clearing organizations. In the event the counterparty is unable to return such securities pledged, the Company may be exposed to the risks of acquiring the securities at prevailing market prices or holding collateral possessing a market value less than that of the related pledged securities. The Company seeks to control these risks by monitoring the market value of securities pledged and requiring adjustments of collateral levels where necessary. At December 31, 1994, the market value of such securities pledged approximated the borrowings outstanding.\nK. Regulatory Requirements\nDain Bosworth and Rauscher Pierce Refsnes are subject to the Securities and Exchange Commission's Uniform Net Capital Rule. Regional Operations Group, the Company's operations subsidiary, clears and settles trades for Dain Bosworth and Rauscher Pierce Refsnes (including the customers of RPR Clearing Services). Regional Operations Group carries all customer accounts, extends margin credit to customers, pays interest on credit balances of customers and invests any excess customer balances. As a result, Regional Operations Group is subject to the Uniform Net Capital Rule whereby net capital of not less than 2 percent of aggregate debit items must be maintained. The New York Stock Exchange, Inc. also may require a member organization to reduce its business if regulatory net capital is less than 4 percent of such aggregate debit items, and may prohibit a member firm from expanding its business and declaring cash dividends if its regulatory net capital is less than 5 percent of such aggregate debit items. At December 31, 1994, net capital was $48.4 million at Regional Operations Group, which was 6.5 percent of aggregate debit balances and $11.2 million in excess of the 5-percent requirement. Dain Bosworth's and Rauscher Pierce Refsnes' net capital requirement is $1 million for each company as neither firm carries customer balances on its balance sheet. At December 31, 1994, Dain Bosworth and Rauscher Pierce Refsnes had net capital of $26.9 million and $20.1 million, respectively, in excess of the $1 million requirement.\nRule 15c3-3 of the Securities Exchange Act of 1934 specifies certain conditions under which brokers and dealers carrying customer accounts are required to maintain cash or qualified securities in a special reserve account for the exclusive benefit of customers. Amounts to be maintained are computed in accordance with a formula defined in the Rule. At December 31, 1994, Regional Operations Group had $338.0 million segregated in special reserve accounts. This amount consisted of qualified securities purchased under agreements to resell and was collateralized by U.S. government or government agency securities.\nL. Employee Benefit Plans\nThe Company and its participating subsidiaries have profit sharing and stock bonus plans which cover substantially all full- time employees who are at least 21 years of age and have been employed for at least one year (six months beginning January 1, 1995).\nPrior to January 1, 1995, participants could contribute on a pretax basis up to 5 percent of eligible compensation to the stock bonus plan and up to 10 percent to the profit sharing plan subject to certain aggregate limitations. The Company and its participating subsidiaries matched all participant contributions to the stock bonus plan at a 50-percent rate. The Company also matched participant contributions to the profit sharing plan at a 25-percent rate up to 5 percent of eligible compensation (less any amounts contributed to the stock bonus plan). All matching contributions were paid to the stock bonus plan. All stock bonus plan contributions were used to purchase the common stock of the Company. Company contributions to the profit sharing plan equaled 3 percent of eligible compensation paid on a quarterly basis plus a discretionary annual contribution determined by each participating company's board of directors at year end.\nBeginning January 1, 1995, participants may contribute on a pretax basis up to 12 percent of eligible compensation to either or both plans; the Company will match up to 5 percent of eligible compensation at a 40-percent rate. Matching contributions will be limited to $3,000 per employee annually and will continue to be paid to the stock bonus plan. At the end of each calendar year, a contribution to the profit sharing plan will be determined by each participating company's board of directors. The minimum contribution will be 3 percent of eligible compensation.\nThe Company's policy is to fund currently profit sharing and stock bonus plan costs. Earnings have been charged for contributions, net of forfeitures, to the above plans as follows:\nM. Income Taxes\nIncome tax expense consists of the following:\nA reconciliation of ordinary federal income taxes (based on rates of 35 percent for 1994 and 1993 and 34 percent for 1992) with the actual tax expense provided on earnings is as follows:\nDeferred income tax expenses\/benefits resulted from differences in the timing of revenue and expense recognition for financial statement and tax reporting purposes in 1992. The sources and tax effect of the changes in deferred taxes were:\nThe tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities are:\nThe Company has determined that it is not required to establish a valuation allowance for the deferred tax asset since it is more likely than not that the deferred tax asset will be realized principally through carryback to taxable income in prior years, and future reversals of existing taxable temporary differences, and, to a lesser extent, future taxable income. The Company's conclusion that it is \"more likely than not\" that the deferred tax asset will be realized is based on federal taxable income of over $190 million in the carryback period, substantial state taxable income in the carryback period, as well as prospects for continued earnings.\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 Part I, Item 4 of this Annual Report for information with respect to executive officers of the Company. Other information required in Item 10 will be contained in the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the close of the fiscal year for which this Report is filed and is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION:\nThe information required in Item 11 will be contained in the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the close of the fiscal year for which this Report is filed and is incorporated herein by reference, except that, pursuant to Item 402(a)(8) of Regulation S-K, the information to be contained in the Company's definitive Proxy Statement in response to paragraphs (k) and (l) of Item 402 is not incorporated by reference herein.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT:\nThe information required in Item 12 will be contained in the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the close of the fiscal year for which this Report is filed and is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:\nThe information required in Item 13 will be contained in the Company's definitive Proxy Statement to be filed pursuant to Regulation 14A within 120 days after the close of the fiscal year for which this Report is filed and is incorporated herein by reference.\nPART IV\nITEM 14","section_14":"ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K:\n(a) Documents filed as part of this Report: Page ---- 1. Financial statements:\nReference is made to the table of contents to financial statements and financial statement schedule hereinafter contained 38\n2. Financial statement schedules: Reference is made to the table of contents to financial statements and financial statement schedule hereinafter contained for all other financial statement schedules 38\n3. Exhibits:\nItem No. Item Method of Filing - ------- ---- ----------------\n3.1 Restated Certificate of Incorporated by reference Incorporation of the to Exhibit 4.1 to the Company. Company's Registration Statement on Form S-8 dated March 14, 1995, File No. 33-58069.\n3.2 Amended and Restated Incorporated by reference Bylaws of the Company. to Exhibit 4.2 to the Company's Registration Statement on Form S-8 dated March 14, 1995, File No. 33-58069.\n4.1 Credit Agreement dated Incorporated by reference June 23, 1993. to Exhibit 4(a) to the Company's Current Report on Form 8-K dated July 15, 1993.\n4.2 First Amendment to Incorporated by reference Credit Agreement dated to Exhibit 4(a) to the November 30, 1993. Company's Current Report on Form 8-K dated February 11, 1994.\n4.3 Second Amendment to Incorporated by reference Credit Agreement dated to Exhibit 4(a) to the June 27, 1994. Company's Current Report on Form 10-Q dated June 30, 1994.\n4.4 Third Amendment to Incorporated by reference Credit Agreement dated to Exhibit 4(a) to the September 30, 1994. Company's Current Report on Form 8-K dated September 26, 1994.\n4.5 Term Loan Agreement Incorporated by reference dated October 16, 1992. to Exhibit 4(e) to the Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n4.6 First Amendment to Term Incorporated by reference Loan Agreement dated to Exhibit 4(g) to the March 12, 1993. Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n4.7 Second Amendment to Incorporated by reference Term Loan Agreement dated to Exhibit 4(b) to the June 23, 1993. Company's Current Report on Form 8-K dated July 15, 1993.\n4.8 Third Amendment to Term Incorporated by reference Loan Agreement dated to Exhibit 4(b) to the November 30, 1993. Company's Current Report on Form 8-K dated February 11, 1994.\n4.9 Fourth Amendment to Incorporated by reference Term Loan Agreement dated to Exhibit 4 (b) to the June 27, 1994. Company's Current Report on Form 10-Q dated June 30, 1994.\n4.10 Fifth Amendment to Incorporated by reference Term-Loan Agreement dated to Exhibit 4 (b) to the September 30, 1994. Company's Current Report on Form 8-K dated September 26, 1994.\n10.1* 1986 Stock Option Incorporated by reference Plan, as amended on to Exhibit 10(b) to the April 24, 1987, May 9, Company's Current Report 1990, March 3, 1993 on Form 8-K dated July 15, and April 27, 1993. 1993.\n10.2 Form of Indemnity Incorporated by reference Agreement with Directors to Exhibit 10(c) to the and Officers of the Company. Company's Annual Report on Form 10-K for the year ended December 31, 1990.\n10.3* Form of Non-Employee Incorporated by reference Director Retirement to Exhibit 10(g) to the Compensation Agreement. Company's Annual Report on Form 10-K for the year ended December 31, 1992.\n10.4* IFG Executive Incorporated by reference Deferred Compensation Plan to Exhibit 10(a) to the dated March 31, 1993. Company's Current Report on Form 8-K dated July 15, 1993.\n10.5 Trust Agreement for Filed herewith. IFG Executive Deferred Compensation Plan dated February 11, 1994.\n11 Computation of net Filed herewith. earnings per share.\n22 List of subsidiaries. Filed herewith.\n23 Independent Auditors' Filed herewith. consent.\n24 Power of attorney. Filed herewith.\n27 Financial Data Schedule Filed herewith.\n* Management contract or compensatory plan or arrangement required to be filed as an exhibit pursuant to Item 14(c) of this report.\n(b) One report on Form 8-K was filed during the fourth quarter of1994.\nItems Reported\nItem 5 - Other events (Dain Bosworth acquisition of Clayton Brown Holding Company; tentative settlement of In Re Taxable Municipal Bond Securities Litigation)\nItem 7 - Financial Statement and Exhibits\nExhibit 4(a) Third Amendment to Credit Agreement dated September 30, 1994\nExhibit 4(b) Fifth Amendment to Term-Loan Agreement dated September 30, 1994.\nDate of earliest event reported - September 26, 1994.\nFinancial Statements Filed - None\nREPORT FOR EMPLOYEE STOCK PURCHASE PLAN:\nThe financial statements required by Form 11-K with respect to the Company's Stock Bonus Plan will be filed by amendment hereto within 180 days of such plan's fiscal year end as permitted by Rule 15d-21.\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.\nINTER-REGIONAL FINANCIAL GROUP, INC.\nBy: Daniel J. Reuss -------------------- Daniel J. Reuss Senior Vice President and Treasurer Dated: March 23, 1995\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:\nSignature Title - --------- -----\nIrving Weiser President, Chief Executive Officer - ------------------------- (Principal Execitive Officer) Irving Weiser and Director Daniel J. Reuss Senior Vice President, and - ------------------------- Treasurer (Principal Financial Daniel J. Reuss and Accounting Officer)\nSusan S. Boren Director - ------------------------- Susan S. Boren\nF. Gregory Fitz-Gerald Director By Daniel J. Reuss - ------------------------- ---------------- F. Gregory Fitz-Gerald Daniel J. Reuss Pro Se and as Attorney-in-Fact Richard D. McFarland Chairman of Dated: March 23, 1995 - ------------------------- the Board Richard D. McFarland and Director\nLawrence Perlman Director - ------------------------- Lawrence Perlman\nC.A. Rundell, Jr. Director - ------------------------- C.A. Rundell, Jr.\nRobert L. Ryan Director - ------------------------- Robert L. Ryan\nArthur R. Schulze, Jr. Director - ------------------------- Arthur R. Schulze, Jr.\nDavid A. Smith Executive Vice President - ------------------------- and Director David A. Smith\nINTER-REGIONAL FINANCIAL GROUP, INC. AND SUBSIDIARIES FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE\nAs of December 31, 1994 and 1993 and for each of the years in the three-year period ended December 31, 1994\nPage ---- Independent Auditors' Report 19\nConsolidated Financial Statements:\nConsolidated statements of operations 20\nConsolidated balance sheets 21\nConsolidated statements of shareholders' equity 22 Consolidated statements of cash flows 23\nNotes to consolidated financial statements 24\nFinancial Statement Schedule:\nSchedule III - Condensed financial information of the registrant 39\nSchedules not listed above have been omitted because they are either not applicable or the required information has been provided in the consolidated financial statements or notes thereto.\nSCHEDULE III __ CONDENSED FINANCIAL INFORMATION OF THE REGISTRANT __ (Continued)\nINTER-REGIONAL FINANCIAL GROUP, INC. (Parent Company)\nNOTES TO CONDENSED FINANCIAL INFORMATION\nA. The condensed financial statements of Inter-Regional Financial Group, Inc. (Parent Company), should be read in conjunction with the consolidated financial statements of Inter- Regional Financial Group, Inc., and the notes thereto beginning on Page 20.\nB. Investments in subsidiaries are carried at cost plus equity in undistributed earnings. See Note K to consolidated financial statements for information regarding net capital requirements of the broker-dealer subsidiaries which could result in restriction on the ability of the subsidiaries to transfer funds to the parent in the form of loans, advances or cash dividends.\nDuring 1993, the Parent Company received $52 million in loans from two of its subsidiary broker-dealers, Dain Bosworth and Rauscher Pierce Refsnes, in order to capitalize its third broker- dealer, Regional Operations Group, Inc. During 1994 the Parent received $8 million in loans from Dain Bosworth and Rauscher Pierce Refsnes in order to add to Regional Operations Group's capital. See Item 1(c) \"Securities Business - Customer Financing\" and \"Securities Business - Uniform Net Capital Rule.\"\nC. Other Debt:\nOther debt is used primarily to finance equipment and building improvements and is payable in monthly and quarterly installments and bears interest at floating rates which approximated 6.9 percent at December 31, 1994. The Parent Company must maintain certain levels of net worth under one of the debt agreements.\nAnnual principal payments on other debt (excluding obligations under capital leases) during the next five years are as follows: 1995 - $1,546,000; 1996 - $1,621,000; 1997 - $1,260,000; 1998 - $17,000; 1999 - $-0-.\nD. Commitments:\nThe Parent Company has guaranteed $27 million of four-year subordinated bank debt incurred by Dain Bosworth and Rauscher Pierce Refsnes in September and October 1994. See Note G to the consolidated financial statements.\nAggregate minimum rental commitments as of December 31, 1994, are as follows:","section_15":""}
{"filename":"319416_1994.txt","cik":"319416","year":"1994","section_1":"ITEM 1. BUSINESS (Continued)\nManagement of the Trust (Continued)\nsales opportunities as well as financing and refinancing sources for the Trust. The Advisor also serves as a consultant in connection with the Trust's business plan and investment policy decisions made by the Trust's Board of Trustees.\nBCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Trustee of the Trust until December 31, 1992. Mr. Phillips also 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 his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust. BCM is more fully described in ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\".\nBCM has been providing advisory services to the Trust since March 28, 1989. Renewal of BCM's advisory agreement with the Trust was approved at the annual meeting of the Trust's shareholders held on March 7, 1995. BCM also serves as advisor to Income Opportunity Realty Trust (\"IORT\") and Transcontinental Realty Investors, Inc. (\"TCI\"). The Trustees of the Trust are also directors or trustees of IORT and TCI and the officers of the Trust are also officers of IORT and TCI. Mr. Phillips is a general partner of Syntek Asset Management, L.P. (\"SAMLP\"), the general partner of National Realty, L.P. (\"NRLP\") and National Operating, L.P. (\"NOLP\"), the operating partnership of NRLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to American Realty Trust, Inc. (\"ART\"). Mr. Phillips served as a director and Chairman of the Board of ART until November 16, 1992. Oscar W. Cashwell, President of the Trust, also serves as the President of BCM, IORT, TCI, as a director of ART and as the President and director of Syntek Asset Management, Inc. (\"SAMI\"), which is the managing general partner of SAMLP. The officers of the Trust, other than Mr. Cashwell, are also officers of ART. As of March 17, 1995, ART and BCM owned approximately 35% and 8%, respectively, of the Trust's outstanding shares of beneficial interest and BCM and the Trust owned approximately 41% and 7%, respectively, of ART's outstanding shares of common stock.\nSince February 1, 1990, affiliates of BCM have provided property management services to the Trust. Currently, Carmel Realty Services, Ltd. (\"Carmel, Ltd.\") provides such property management services. Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Trust. 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 and leasing of nine of the Trust's commercial properties and the industrial warehouse facilities owned by a real estate partnership in which the Trust is a partner to Carmel Realty, Inc. (\"Carmel Realty\"), which is a company owned by SWI. Carmel Realty is entitled to\nITEM 1. BUSINESS (Continued)\nManagement of the Trust (Continued)\nreceive property and construction management fees and leasing commissions in accordance with the terms of its property- level management agreement with Carmel, Ltd.\nCarmel Realty is also entitled to receive real estate brokerage commissions in accordance with the terms of a nonexclusive brokerage agreement as discussed in ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR TO THE REGISTRANT - The Advisor.\"\nThe Trust has no employees. Employees of the Advisor render services to the Trust.\nCompetition\nThe real estate business is highly competitive and the Trust 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 Trust. The Trust'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, collection 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 and industrial 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 apartments, competition is also based upon the design and mix of the units and the ability to provide a community atmosphere for the tenants. The Trust's management believes that general economic circumstances and trends and new or renovated properties in the vicinity of each of the Trust's properties are also competitive factors.\nTo the extent that the Trust seeks to sell any of its properties, the sales prices for such properties may be affected by competition from other real estate entities also attempting to sell their properties and governmental agencies and financial institutions, whose assets are located in areas in which the Trust's properties are located, and are seeking to liquidate foreclosed properties.\nAs described above and in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Related Party Transactions\", certain of the officers and Trustees of the Trust also serve as officers and directors or trustees of certain other entities, each of which is also advised by BCM, and each of which has business objectives similar to the Trust's. The Trust's Trustees, officers and Advisor owe fiduciary duties to such other entities as well as to the Trust under applicable law. In determining to which entity a particular investment opportunity will be allocated, the officers, trustees or directors and the Advisor consider the respective investment objectives of each such entity and the appropriateness of a particular investment in light of each such\nITEM 1. BUSINESS (Continued)\nCompetition (Continued)\nentity'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 Trust also competes with other entities which are affiliates of the Advisor and which may have investment objectives similar to the Trust's and that may compete with the Trust 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 Trust 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 Trust 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 the 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 Trust's management or Advisor. The illiquidity of real estate investments generally may impair the ability of the Trust to respond promptly to changing circumstances. The Trust's management believes that such risks are partially mitigated by the diversification by geographic region and property type of the Trust'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 diversification may be mitigated.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Trust's principal offices are located at 10670 North Central Expressway, Suite 300, Dallas, Texas 75231. In the opinion of the Trust's management, the Trust's offices are suitable and adequate for its present operations.\nDetails of the Trust's real estate and mortgage notes receivable portfolios at December 31, 1994, are set forth in Schedules III and IV, respectively, to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\". The discussions set\nITEM 2. PROPERTIES (Continued)\nforth below under the headings \"Real Estate\" and \"Mortgage Loans\" provide certain summary information concerning the Trust's real estate and mortgage notes receivable portfolios.\nThe Trust's real estate portfolio consists of properties held for investment, investments in partnerships and properties held for sale. All of the properties held for sale were obtained through foreclosure of the collateral securing mortgage notes receivable. The discussion set forth below under the heading \"Real Estate\" provides certain summary information concerning the Trust's real estate and further summary information with respect to the Trust's properties held for investment, properties held for sale and investments in partnerships.\nAt December 31, 1994, none of the Trust's properties, partnership investments or mortgage notes receivable other than Sunset Towers Apartments, exceeded 10% of the Trust's total assets. At December 31, 1994, 68% of the Trust's assets consisted of properties held for investment, 11% consisted of properties held for sale, 8% consisted of investments in partnerships and 4% consisted of mortgage notes and interest receivable. The remaining 9% of the Trust's assets were cash, cash equivalents, marketable equity securities and other assets. It should be noted, however, that the percentage of the Trust's assets invested in any one category is subject to change and that no assurance can be given that the composition of the Trust's assets in the future will approximate the percentages listed above.\nThe Trust's real estate is geographically diversified. At December 31, 1994, the Trust held investments in apartments and commercial real estate (office buildings, industrial facilities and shopping centers) in each of the geographic regions of the continental United States. However, the Trust's apartment and commercial properties are concentrated in the Southeast, Southwest and Midwest regions. At December 31, 1994, the Trust held mortgage notes receivable secured by real estate located in the Southeast, Southwest and Midwest regions of the continental United States with a concentration in the Southeast and Midwest regions, as shown more specifically in the table under \"Mortgage Loans\" below.\nTo continue to qualify for federal taxation as a REIT under the Internal Revenue Code of 1986, as amended, the Trust is required, among other things, to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 2. PROPERTIES (Continued)\nGeographic Regions\nThe Trust has divided the continental United States into the following geographic regions.\nNortheast region comprised of the states of Connecticut, Delaware, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Pennsylvania, Rhode Island and Vermont, and the District of Columbia. The Trust has 1 apartment in this region.\nSoutheast region comprised of the states of Alabama, Florida, Georgia, Mississippi, North Carolina, South Carolina, Tennessee and Virginia. The Trust has 3 apartments and 3 commercial properties in this region.\nSouthwest region comprised of the states of Arizona, Arkansas, Louisiana, New Mexico, Oklahoma and Texas. The Trust has 15 apartments and 4 commercial properties in this region.\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. The Trust has 2 apartments and 2 commercial properties in this region.\nMountain region comprised of the states of Colorado, Idaho, Montana, Nevada, Utah and Wyoming. The Trust has 3 apartments and 1 commercial property in this region.\nPacific region comprised of the states of California, Oregon and Washington. The Trust has 2 apartments in this region.\nReal Estate\nAt December 31, 1994, nearly 90% of the Trust's assets were invested in real estate. The Trust invests in real estate located throughout the continental United States, either on a leveraged or nonleveraged basis. The Trust's real estate portfolio consists of properties held for investment, investments in partnerships, foreclosed properties held for sale, and investments in the equity securities of real estate entities.\nTypes of Real Estate Investments. The Trust's real estate consists of commercial properties (office buildings, industrial facilities and shopping centers) and apartments or similar properties having established income-producing capabilities. In selecting new real estate investments, the location, age and type of property, gross rentals,\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nlease terms, financial and business standing of tenants, operating expenses, fixed charges, land values and physical condition are among the factors considered. The Trust may acquire properties subject to or assume existing debt and may mortgage, pledge or otherwise obtain financing for its properties. The Trust's Board of Trustees may alter the types of and criteria for selecting new real estate investments and for obtaining financing without a vote of shareholders to the extent such policies are not governed by the Trust's Declaration of Trust.\nAs of December 31, 1994, the Trust did not have any properties on which significant capital improvements were in process.\nIn the opinion of the Trust's management, the properties owned by the Trust are adequately covered by insurance.\nThe following table sets forth the percentages, by property type and geographic region, of the Trust's real estate (other than unimproved land and a single-family residence described below) at December 31, 1994.\nThe foregoing table is based solely on the number of apartment units and amount of commercial square footage owned by the Trust and does not reflect the value of the Trust's investment in each region. The Trust also owns three parcels of unimproved land, 5 acres located in the Southeast region, 128 acres and 6 acres in the Southwest region and one single- family residence located in the Southwest region. See Schedule III to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for a more detailed description of the Trust's real estate portfolio.\nA summary of the activity in the Trust's owned real estate portfolio during 1994 is as follows:\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nProperties Held for Investment. Set forth below are the Trust's properties held for investment and the monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1994 and 1993:\n_______________________ * Property was purchased in 1994.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nOccupancy presented above and throughout this ITEM 2. is without reference to whether leases in effect are at, below or above market rates.\nIn January 1994, the Trust obtained mortgage financing secured by the previously unencumbered Park Lane Apartments in Dallas, Texas, in the amount of $1.3 million. The Trust received net cash of $1.1 million. The remainder of the financing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the financing. The $1.3 million mortgage bears interest at a rate of 8.66% per annum through January 2004 and at a variable rate thereafter and requires monthly payments of principal and interest, currently $10,000. The note matures in February 2019. The Trust paid a mortgage brokerage and equity refinancing fee of $4,000 to BCM based upon the new mortgage of $1.3 million.\nIn February 1994, the Trust purchased the Fountain Lake Apartments, a 166 unit apartment complex in Texas City, Texas, for $3.3 million. The Trust paid $237,000 in cash, assumed an existing mortgage of $2.5 million and the seller provided additional financing of $402,000. The $2.5 million first mortgage bears interest at a variable rate, currently 5.9% per annum, requires monthly payments of principal and interest of $15,000 and matures in November 1998. The $402,000 seller financing is secured by a second lien mortgage on another of the Trust's properties, Windsor Plaza Office Building, in Windcrest, Texas. This mortgage bears interest at a variable rate, currently 6.6% per annum, requires monthly payments of principal and interest of $3,000 and also matures in November 1998. The Trust paid a real estate brokerage commission of $118,000 to Carmel Realty and an acquisition fee of $32,000 to BCM based on the $3.3 million purchase price of the property.\nIn March 1994, the Trust purchased the McCallum Crossing Apartments, a 322 unit apartment complex in Dallas, Texas, for $7.7 million. The Trust paid $1.4 million in cash and the seller provided $6.3 million in mortgage financing. The mortgage bears interest at rates ranging from 6.5% to 7.5% per annum, requires monthly payments of interest only through March 1, 1998 and principal and interest payments of $46,000 thereafter and matures in March 2004. The Trust paid a real estate brokerage commission of $224,000 to Carmel Realty and an acquisition fee of $77,000 to BCM based on the $7.7 million purchase price of the property.\nIn April 1994, the Trust obtained mortgage financing secured by the previously unencumbered Southgate Apartments in Roundrock, Texas, in the amount of $3.0 million. The Trust received net cash of $2.9 million. The remainder of the financing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the financing. The $3.0 million mortgage bears interest at a rate of 9.625% per annum, requires monthly payments of principal and interest of $26,000 and matures in May 2004. The Trust paid a mortgage brokerage and equity refinancing fee of $30,000 to BCM based upon the new mortgage of $3.0 million.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nIn May 1994, the Trust purchased the Willow Creek Apartments, a 112 unit apartment complex in El Paso, Texas, for $2.3 million in cash. The Trust paid a real estate brokerage commission of $89,000 to Carmel Realty and an acquisition fee of $23,000 to BCM based on the $2.3 million purchase price of the property. In December 1994, the Trust obtained mortgage financing secured by the property in the amount of $1.8 million. The Trust received net cash of $1.6 million after the payment of various closing costs associated with the financing. The $1.8 million mortgage bears interest at a rate of 10.25% per annum, requires monthly payments of principal and interest of $17,000 and matures in January 2002. The Trust paid a mortgage brokerage and equity refinancing fee of $18,000 to BCM based upon the new mortgage of $1.8 million.\nAlso in May 1994, the Trust obtained mortgage financing secured by the previously unencumbered 4242 Cedar Springs Apartments in Dallas, Texas, in the amount of $1.4 million. The Trust received net cash of $1.3 million after the payment of various closing costs associated with the financing. The $1.4 million mortgage bears interest at a rate of 9.9% per annum, requires monthly payments of principal and interest of $13,000 and matures in June 2004. The Trust paid a mortgage brokerage and equity refinancing fee of $14,000 to BCM based upon the new mortgage of $1.4 million.\nIn June 1994, the Trust purchased the Park Avenue Apartments, a 108 unit apartment complex in Clute, Texas, for $855,000 in cash. The Trust paid a real estate brokerage commission of $34,000 to Carmel Realty and an acquisition fee of $8,000 to BCM based on the $855,000 purchase price of the property.\nIn July 1994, the Trust obtained new mortgage financing secured by the Stone Oak Place Apartments in San Antonio, Texas, in the amount of $3.3 million. The Trust received net cash of $577,000 after the payoff of $2.5 million in existing mortgage debt that was scheduled to mature in April 1995. The remainder of the refinancing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the refinancing. The new $3.3 million mortgage bears interest at a rate of 9.9% per annum, requires monthly principal and interest payments of $31,000 and matures in August 2004. The Trust paid a mortgage brokerage and equity refinancing fee of $33,000 to BCM based upon the new first mortgage financing of $3.3 million.\nIn August 1994, the Trust purchased the Parkwood Knoll Apartments, a 178 unit apartment complex in San Bernardino, California, for $6.4 million. The Trust paid $1.2 million in cash and assumed the existing mortgage of $5.2 million. The mortgage bears interest at a rate of 8.0% per annum, requires monthly payments of principal and interest of $40,000 and matures in February 2004. The Trust paid a real estate brokerage commission of $197,000 to Carmel Realty and an acquisition fee of $64,000 to BCM based on the $6.4 million purchase price of the property.\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nIn September 1994, the Trust purchased the Pierce Towers Apartments, a 57 unit apartment complex in Denver, Colorado, for $2.7 million. The Trust paid $678,000 in cash and assumed the existing mortgage of $2.0 million. The mortgage bears interest at a rate of 8.4% per annum, requires monthly payments of principal and interest of $15,000 and matures in December 2000. The Trust paid a real estate brokerage commission of $100,000 to Carmel Realty and an acquisition fee of $27,000 to BCM based on the $2.7 million purchase price of the property.\nAlso in September 1994, the Trust purchased the McLeod Commerce Center, a 111,115 square foot industrial facility in Orlando, Florida, for $3.2 million. The Trust paid $1.0 million in cash and the seller provided mortgage financing of $2.2 million. The mortgage bears interest at a rate of 9.5% per annum, requires monthly payments of principal and interest of $19,000 and matures in October 2001. The Trust paid a real estate brokerage commission of $116,000 to Carmel Realty and an acquisition fee of $32,000 to BCM based on the $3.2 million purchase price of the property.\nIn December 1994, the Trust purchased The Pines Apartments, a 242 unit apartment complex in Gainesville, Florida, for $6.2 million. The Trust paid $923,000 in cash, assumed the existing mortgage of $2.7 million and the seller provided additional financing of $2.7 million. The first mortgage bears interest at 9.6% per annum, requires monthly payments of principal and interest of $27,000 and matures in July 2011. The $2.7 million second mortgage bears interest at 9.5% per annum, requires monthly payments of interest only through September 1995 and monthly payments of principal and interest of $23,000 thereafter, and matures in December 1997. The Trust paid a real estate brokerage commission of $193,000 to Carmel Realty and an acquisition fee of $62,000 to BCM based on the $6.2 million purchase price of the property.\nIn February 1995, the Trust purchased the Sullyfield Commerce Center, a 243,813 square foot industrial facility in Chantilly, Virginia, for $11.0 million. The Trust paid $2.2 million in cash and the seller provided mortgage financing of $8.8 million. The mortgage bears interest at a rate of 6% per annum through December 1996 and 9% per annum thereafter, requires monthly payments of interest only through January 1999 and principal and interest payments of $73,000 thereafter and matures in January 2001. The Trust paid a real estate brokerage commission of $285,000 to Carmel Realty and an acquisition fee of $110,000 to BCM based on the $11.0 million purchase price of the property.\nIn February 1995, after determining that further investment in Genesee Towers, an office building in Flint, Michigan, could not be justified without a substantial modification of the mortgage debt, the Trust ceased making debt service payments on the $8.8 million nonrecourse mortgage secured by the property. The Trust is attempting to negotiate with the lender to modify the mortgage. However, there can be no assurance that such negotiations will be successful or that the Trust will continue to own the property. Accordingly, as of December\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\n31, 1994, the carrying value of the property was written down by $1.2 million, which is included in the 1994 provision for losses, to the amount of the nonrecourse mortgage.\nIn March 1995, the Trust purchased the Zane May Warehouses, six industrial warehouse facilities with a total of 330,334 square feet in Dallas, Texas, for $5.4 million. The Trust paid $696,000 in cash, obtained new mortgage financing of $4.6 million and the seller provided additional financing of $403,000. The $4.6 million mortgage bears interest at a variable rate, currently 9.25% per annum, requires monthly payments of interest only and matures in July 1999. The $403,000 of seller financings bear interest at rates ranging from 6% to 8% per annum, require monthly payments of principal and interest totaling $3,000 and mature in July 1999. The Trust paid a real estate brokerage commission of $178,000 to Carmel Realty and an acquisition fee of $54,000 to BCM based on the $5.4 million purchase price.\nPartnership Properties. Set forth below are the properties owned by the partnerships in which the Trust is an equity investee and the average annual rental rate and occupancy thereof at December 31, 1994 and 1993:\nThe Trust, in partnership with National Income Realty Trust (\"NIRT\"), owns Sacramento Nine (\"SAC 9\") which in turn owns two office buildings in the vicinity of Sacramento, California. The Trust has a 30% general partner interest in the partnership. The Trust accounts for its investment in the partnership using the equity method. Until March 1995, Geoffrey C. Etnire, a Trustee of the Trust, served as a Trustee of NIRT. Until August 1994, Bennett B. Sims and Ted P. Stokely, Trustees of the Trust, also served as Trustees of NIRT. Until March 31, 1994, BCM served as advisor to NIRT. See ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nThe Trust and NIRT are also the partners in Income Special Associates (\"ISA\"), a joint venture partnership in which the Trust has a 60% partnership interest. ISA in turn owns a 100% interest in Indcon, L.P. (\"Indcon\"), formerly known as Adams Properties Associates. Indcon owns 32 industrial warehouse facilities. The Indcon partnership agreement requires consent of both the Trust and NIRT for any material changes in the operations of the partnership's properties, including sales, refinancings and changes in property manager. Therefore, the Trust is a noncontrolling partner and accounts for its investment in Indcon using the equity method. See ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\"\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nIn May 1994, Indcon sold one of its industrial warehouses for $4.4 million in cash. Indcon received net cash of $2.1 million, of which the Trust's equity share was $1.3 million, after the payoff of an existing mortgage with a principal balance of $1.8 million and the payment a $133,000 prepayment penalty. Indcon recognized a gain of $962,000 on the sale, of which the Trust's equity share was $577,000. Indcon paid a real estate sales commission of $104,000 to Carmel Realty based upon the $4.4 million sales price of the property.\nForeclosed Properties Held for Sale. Set forth below are the Trust's foreclosed properties held for sale (except for a single-family residence) and monthly rental rate for apartments and the average annual rental rate for commercial properties and occupancy thereof at December 31, 1994 and 1993:\n* Properties obtained through foreclosure in 1994.\nIn September 1994, the Trust recorded the insubstance foreclosure of the Circletree Apartments, a 414 unit apartment complex in Waukegan, Illinois. The Circletree Apartments had an estimated fair value, less estimated costs of sale, of $8.1 million at the date of foreclosure, which approximated the carrying value of the Trust's mortgage note receivable. The foreclosure resulted in no loss to the Trust. Foreclosure proceedings were completed in October 1994.\nAlso in September 1994, the Trust recorded the insubstance foreclosure of the Woodbridge Apartments, a 194 unit apartment complex in Westminster, Colorado. The Woodbridge Apartments had an estimated fair value, less estimated costs of sale, of $3.3 million at the date of foreclosure,\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nwhich exceeded the carrying value of the Trust's mortgage note receivable. The foreclosure resulted in no loss to the Trust. Foreclosure proceedings were completed in February 1995.\nIn February 1994, the Trust sold the Kimberly Square Shopping Center, a foreclosed property held for sale in Fort Lauderdale, Florida, for $1.0 million in cash. No loss in excess of the reserve previously provided was incurred. The Trust paid a real estate sales commission of $30,000 to Carmel Realty based upon the $1.0 million sales price of the property.\nIn May 1994, the Trust sold the retail portion of Forest Ridge, a foreclosed apartment and retail property held for sale in Denton, Texas. The property was sold for $365,000, with the Trust providing purchase money financing for the entire sales price. The Trust recognized neither a gain or loss on the sale. The mortgage note receivable bears interest at a rate of 7.5% per annum for the first three years, increasing to 8.3% per annum from May 1997 until maturity in May 2001. The note requires monthly payments of principal and interest, currently $3,000. The Trust paid a real estate sales commission of $15,000 to Carmel Realty based upon the $365,000 sales price of the property.\nIn June 1994, the Trust sold a 546 acre tract of foreclosed undeveloped land held for sale in Morgan, Utah for $110,000 in cash. No loss in excess of the reserve previously provided was incurred. The Trust paid a real estate sales commission of $4,000 to Carmel Realty based upon the $110,000 sales price of the property.\nAlso in June 1994, the Trust sold the Oak Forest Apartments, a foreclosed property held for sale in Tampa, Florida, for $900,000 in cash. The Trust recognized a loss on the sale of $200,000 in excess of previously provided reserves, which was provided by a direct charge against earnings in the first quarter of 1994. The Trust paid a real estate sales commission of $36,000 to Carmel Realty based upon the $900,000 sales price of the property.\nIn December 1994, the Trust sold two single family residences located in Arizona and South Dakota, which it had obtained through foreclosure. The Trust received $155,000 in cash from the sales. No loss in excess of the reserves previously provided was incurred.\nThe three parcels of unimproved land owned by the Trust were each obtained through foreclosure. Two were obtained through foreclosure of a mortgage note secured primarily by office buildings. The third and largest, the Round Mountain parcel, was intended to be developed in 1983 when the Trust funded the mortgage loan secured by the land.\nThe Trust intends to hold these parcels of unimproved land until the market conditions in the areas in which the properties are located improve, at which time the Trust intends to offer the properties for sale. The Declaration of Trust provides that the Trust may not invest in unimproved real estate or make mortgage loans secured by unimproved\nITEM 2. PROPERTIES (Continued)\nReal Estate (Continued)\nreal estate unless the property is being or is expected to be developed within a reasonable period of time or unless the unimproved real estate serves as additional security on a permitted type of mortgage loan.\nDuring 1994, many of the real estate markets where the Trust owns foreclosed property, particularly in Texas, continued to stabilize and the Trust intends to increase its emphasis on the sale of foreclosed properties in 1995. However, because of increasing interest rates in 1994, it is often difficult for potential buyers to obtain financing even for performing properties because, among other factors, traditional real estate lenders remain extremely cautious in approving new mortgage loans.\nMortgage Loans\nIn addition to real estate, a substantial portion of the Trust's assets are invested in mortgage notes receivable, principally those secured by income-producing properties. The Trust expects that the percentage of its assets invested in mortgage notes will decrease, as it has determined that it will no longer seek to fund or acquire new mortgage notes, other than those which it may originate in conjunction with providing purchase money financing in conjunction with a property sale. The Trust does intend, however, to service and hold for investment the mortgage notes currently in its portfolio. The Trust's mortgage notes receivable consist of first mortgage loans and junior mortgage loans.\nTypes of Mortgage Activity. In the past, the Trust has originated its own mortgage loans as well as acquired existing mortgage notes either directly from builders, developers or property owners, or through mortgage banking firms, commercial banks or other qualified brokers. The Trust is not considering new mortgage lending, except in connection with purchase money financing offered to facilitate the sale of Trust properties. BCM, in its capacity as a mortgage servicer, services the Trust's mortgage notes. The Trust's investment policy is described in ITEM 1. \"BUSINESS - Business Plan and Investment Policy\".\nTypes of Properties Subject to Mortgages. The properties securing the Trust's mortgage notes receivable portfolio at December 31, 1994, consisted of office buildings, apartments and single-family residences. To the extent that the Declaration of Trust does not control such matters, the Trust's Board of Trustees may alter the types of properties subject to mortgage loans in which the Trust invests without a vote of the Trust's shareholders. In addition to restricting the types of collateral and priority of mortgages, the Declaration of Trust imposes certain restrictions on transactions with related parties, as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\".\nAt December 31, 1994, the Trust's mortgage notes receivable portfolio included ten mortgage loans with an aggregate outstanding balance of $10.3 million secured by income-producing real estate located throughout the United States and seven mortgage loans with an outstanding balance\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nof $667,000 secured by single-family residences also located throughout the United States. At December 31, 1994, 4% of the Trust's assets were invested in mortgage notes (3% in first mortgage loans and 1% in junior mortgage loans).\nThe following table sets forth the percentages (based on the outstanding mortgage note balance) , by both property type and geographic region, of the properties that serve as collateral for the Trust's outstanding mortgage notes receivable portfolio at December 31, 1994. The table does not include the $667,000 in mortgage notes secured by single-family residences discussed in the preceding paragraph. See Schedule IV to the Consolidated Financial Statements included at ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\" for further details of the Trust's mortgage notes receivable portfolio.\nA summary of the activity in the Trust's mortgage notes receivable portfolio during 1994 is as follows:\nFirst Mortgage Loans. The Trust has invested in first mortgage notes, with either short, medium or long-term maturities. First mortgage 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 amortization of principal and a \"balloon\" principal payment at maturity. With respect to first mortgage loans, it was the Trust's general policy to require that the borrower provide a mortgagee's title policy or an acceptable legal title opinion 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 Trust may grant to other lenders participations in first mortgage loans originated by the Trust.\nThe following discussion briefly describes the first mortgage loans that the Trust originated or otherwise acquired, as well as events that affected previously funded first mortgage loans, during 1994.\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nDuring 1994, the Trust foreclosed on a single-family residence in South Dakota securing one of its mortgage notes. No loss was recorded on the foreclosure. The property was sold in December 1994, as discussed under \"Real Estate\" above. At December 31, 1994, seven mortgage notes secured by single family residences, with principal balances totaling $667,000, remained in the Trust's mortgage note receivable portfolio.\nAs discussed under \"Real Estate\" above, in May 1994, the Trust sold the retail portion of Forest Ridge, a foreclosed apartment and retail property held for sale in Denton, Texas. The property was sold for $365,000, with the Trust providing purchase money financing for the entire sales price. The mortgage note receivable bears interest at a rate of 7.5% per annum for the first three years, increasing to 8.3% per annum from May 1997 until maturity in May 2001. The note requires monthly payments of principal and interest, currently $3,000.\nIn December 1994, as discussed below, the Trust accepted the assignment of a first mortgage note in settlement of the profit participation as provided in the wraparound mortgage secured by the Fountainview Retirement Center.\nAt December 31, 1994, a $700,000 first mortgage note secured by an office building in Titusville, Florida, an $891,000 first mortgage note secured by an apartment in Detroit, Michigan and an $1.5 million first mortgage secured by another apartment in Detroit, Michigan were in default. The Trust is currently evaluating its options with respect to foreclosure of the collateral properties securing these notes. If the Trust forecloses the collateral properties, the Trust does not anticipate incurring losses in excess of previously established reserves.\nAlso at December 31, 1994, a $1.5 million first mortgage secured by a ranch located in Henderson County, Texas, was in default. In February 1994, the Trust and the borrower agreed to modify and extend the note. In exchange for the Trust agreeing to extend the maturity date to November 1, 1995, the borrower paid all past due interest and made a $127,000 paydown on the principal balance of the note. The borrower was also required to make an additional $200,000 principal paydown on November 1, 1994, which had not been made as of March 17, 1995. The borrower is currently negotiating with the Trust for an 18 month extension of the note in return for a principal paydown and a pledge of additional collateral to secure the note. If negotiations are unsuccessful and the Trust forecloses on the collateral property, it does not anticipate incurring a loss, as the estimated fair value of the property securing the note is in excess of the carrying value of the note.\nWraparound Mortgage Loans. The Trust has invested in wraparound mortgage loans, sometimes called all-inclusive loans, made on real estate subject to prior mortgage indebtedness. A wraparound mortgage\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nloan is a mortgage loan having an original principal amount equal to the outstanding balance under the prior existing mortgage loan(s) plus the amount actually advanced under the wraparound mortgage loan.\nWraparound mortgage loans may provide for full, partial or no amortization of principal. The Trust's policy was to make wraparound mortgage loans in amounts and on properties as to which it would otherwise make first mortgage loans. The Trust did not originate or acquire any wraparound mortgage loans during 1994. The following discussion briefly describes the events that affected previously funded wraparound mortgage loans during 1994.\nIn December 1994, the Trust received payment in full on the wraparound mortgage note secured by the Fountainview Retirement Center. The Trust received $5.0 million in cash, equal to the Trust's equity in the wraparound mortgage note.\nIn addition, the note agreement required that the debtor make an additional profit participation payment equal to 62.5% of the amount by which the fair market value of the property on the maturity date of the loan exceeded the original loan principal balance. In settlement of the profit participation, the borrower assigned a $1.8 million first mortgage note, secured by Cypress Creek Executive Court, an office building in Ft. Lauderdale, Florida, to the Trust, for which the Trust paid $283,000 in cash. The first mortgage bears interest at rates ranging from 8.0% to 9.0% per annum, requires monthly payments of principal and interest, currently $15,000, and matures in June 2009. The Trust discounted the note to yield 12.0% per annum. The Trust recognized $1.1 million gain on the settlement of the profit participation.\nIn January 1994, the borrower on a $7.9 million wraparound mortgage loan secured by the Circletree Apartments in Waukegan, Illinois filed for bankruptcy protection and in September 1994, the Trust recorded the insubstance foreclosure of the apartment complex securing the wraparound mortgage note receivable. The foreclosure resulted in no loss to the Trust. See \"Real Estate,\" above.\nJunior Mortgage Loans. The Trust has invested in junior mortgage loans. Such loans 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 loans ordinarily includes the real estate on which the loan is made, other collateral and personal guarantees by the borrower. The Trust's Declaration of Trust restricts investment in junior mortgage loans, excluding wraparound mortgage loans, to not more than 10% of the Trust's assets. At December 31, 1994, 1% of the Trust's assets were invested in junior mortgage loans.\nThe Trust did not originate or acquire any junior mortgage loans during 1994. The following discussion briefly describes the events that affected previously funded junior mortgage loans during 1994.\nITEM 2. PROPERTIES (Continued)\nMortgage Loans (Continued)\nIn September 1994, the Trust recorded the insubstance foreclosure of the Woodbridge Apartments in Westminster, Colorado, which secured a $1.9 million junior mortgage note receivable. The foreclosure resulted in no loss to the Trust. See \"Real Estate,\" above.\nIn September 1991, the Trust funded a $2.0 million junior mortgage loan, secured by the Aspen Village Townhomes, located in Hartland, Wisconsin. The note accrues interest at the default interest rate of 18% per annum. The note had an extended maturity date of April 27, 1992. On March 27, 1992, the Trust funded an additional $150,000 junior lien mortgage loan, also secured by the Aspen Village Townhomes. This note also bears interest at the default interest rate of 18% per annum. This note had an extended maturity of September 23, 1992. The borrower failed to make the required principal payments to the Trust on the maturity dates. The Trust continues to negotiate with the borrower to restructure the notes, with the borrower providing additional collateral to secure these loans. If the negotiations are unsuccessful and the Trust forecloses on the collateral property, it does not anticipate incurring a loss in excess of previously established reserves.\nEquity Investments in Real Estate Entities\nIn September 1990, the Trust's Board of Trustees authorized the purchase of up to $2.0 million of the common stock of ART through negotiated or open market transactions. The officers of the Trust serve as officers or directors of ART and BCM, the Trust's advisor, also serves as advisor to ART. At March 17, 1995, ART owned approximately 35% of the Trust's outstanding shares of beneficial interest. At December 31, 1994, the Trust owned 204,522 shares of ART's common stock, approximately 7% of ART's outstanding shares of common stock, which the Trust had purchased in open market transactions in 1990 and 1991, at a total cost to the Trust of $1.6 million. The ART common stock owned by the Trust is considered to be available for sale and accordingly, is carried at fair value defined as the period end closing market value. At December 31, 1994, the market value of the ART shares was $2.7 million. See ITEM 8. \"FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\"\nIn December 1990, the Trust's Board of Trustees authorized the purchase of up to $1.0 million of the shares of beneficial interest of NIRT, a REIT that until March 31, 1994, was also advised by BCM, and up to $1.0 million of the shares of common stock of TCI through negotiated or open market transactions. The Trustees of the Trust serve as directors of TCI and the officers of the Trust also serve as officers of TCI. BCM, the Trust's advisor, serves as advisor to TCI. At December 31, 1994, the Trust owned 76,893 shares of beneficial interest of NIRT acquired at a total cost to the Trust of $415,000 and 53,000 shares of common stock of TCI acquired at a total cost to the Trust of $235,000 all of which shares the Trust had purchased in open market transactions in 1990 and 1991. The Trust's investment in these entities is also considered as available for sale and is also carried at fair value. At December 31, 1994, the market value of the Trust's investment in NIRT and TCI shares was $894,000 and $788,000, respectively.\nITEM 2. PROPERTIES (Continued)\nEquity Investments in Real Estate Entities (Continued)\nUnder the original terms of the Declaration of Trust, the Trust was prohibited from investing in equity securities for a period in excess of 18 months. However, pursuant to an amendment to the Trust's Declaration of Trust approved by the Trust's shareholders, the Trust may hold these shares of ART, NIRT and TCI until July 30, 1996.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nOlive Litigation\nIn February 1990, the Trust, together with IORT, NIRT and TCI, three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Trust, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al., relating to the operation and management of each of such entities. On April 23, 1990, the court granted final approval of the terms of the settlement.\nOn May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\") which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994 and final court approval was entered on December 12, 1994. The effective date of the Modification is January 11, 1995.\nThe Modification, among other things, provided for the addition of three new unaffiliated members to the Trust's Board of Trustees and set forth new requirements for the approval of any transactions with affiliates over the next five years. In addition, BCM, the Trust's advisor, Mr. Phillips and William S. Friedman, who served as President and Trustee of the Trust until February 24, 1994, President of BCM until May 1, 1993 and director of BCM until December 22, 1989, agreed to pay a total of $1.2 million to the Trust, IORT, NIRT and TCI, of which the Trust's share is $750,000. The Trust received $187,000 in May 1994. The remaining $563,000 is to be paid in 18 monthly installments which began February 1, 1995.\nUnder the Modification, the Trust, IORT, NIRT, TCI and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust, IORT, NIRT and TCI also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Trust held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all current members of the Trust's Board of Trustees that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new members of the Trust's Board of Trustees appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.\nITEM 3. LEGAL PROCEEDINGS\nOlive Litigation\nPursuant to the terms of the Modification, any related party transaction which the Trust may enter into prior to April 27, 1999, will require the unanimous approval of the Trust's Board of Trustees. In addition, related party transactions may only be entered into in exceptional circumstances and after a determination by the Trust's Board of Trustees that the transaction is in the best interests of the Trust and that no other opportunity exists that is as good as the opportunity presented by such transaction.\nThe Modification also terminated a number of the provisions of the settlement, including the requirement that the Trust, IORT, NIRT and TCI maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court retained jurisdiction to enforce the Modification.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThe Trust held its annual meeting of shareholders on March 7, 1995, at which meeting the Trust's shareholders were asked to consider and vote upon (i) the election of Trustees of the Trust and (ii) the renewal of the Trust's advisory agreement with BCM.\nAt such meeting the Trust's shareholders elected the following individuals as Trustees of the Trust:\nAlso at such meeting the Trust's shareholders approved the renewal of the Trust's advisory agreement with BCM until the next annual meeting of the Trust's shareholders with 2,276,340 votes for the proposal, 50,469 votes against the proposal and 58,487 votes abstaining.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND RELATED SHAREHOLDER MATTERS\nThe Trust's shares of beneficial interest are traded on The Nasdaq Stock Market (\"Nasdaq\") using the symbol \"CMETs\". The following table sets forth the high and low prices as reported by the Nasdaq.\nAs of March 17, 1995, the closing price of the Trust's shares of beneficial interest on the Nasdaq was $15.00 per share.\nAs of March 17, 1995, the Trust's shares of beneficial interest were held by 7,484 holders of record.\nBased on the performance of the Trust's properties, in January 1993, the Trust's Board of Trustees approved the resumption of quarterly shareholder distributions. The Trust paid distributions in 1994 and 1993 as follows:\nOn December 5, 1989, the Trust's Board of Trustees approved a program for the Trust to repurchase its shares of beneficial interest. The Trust's Board of Trustees has authorized the Trust to repurchase a total of 976,667 of its shares of beneficial interest pursuant to such program. Through March 17, 1995, the Trust had repurchased 785,150 of its shares at a total cost to the Trust of $5.0 million. The Trust purchased 6,000 of its shares of beneficial interest during 1994 at a total cost to the Trust of $84,000.\nITEM 5. MARKET FOR THE REGISTRANT'S SHARES OF BENEFICIAL INTEREST AND RELATED SHAREHOLDER MATTERS (Continued)\nOn March 24, 1989, the Trust distributed one share purchase right for each outstanding share of beneficial interest of the Trust. On December 10, 1991, the Trust's Board of Trustees voted to redeem the rights, having determined that the rights were no longer necessary to protect the Trust from coercive tender offers. In connection with such redemption, Messrs. Phillips and Friedman and their affiliates, who owned approximately 28% of the Trust's outstanding shares of beneficial interest at the time, agreed not to acquire more than 40% of the Trust's outstanding shares of beneficial interest without the prior action of the Trust's Board of Trustees to the effect that they do not object to such increased ownership.\nOn August 23, 1994, the Trust's Board of Trustees took action to the effect that they do not object to the acquisition of up to 49% of the Trust's outstanding shares of beneficial interest by Mr. Phillips and his affiliates. In determining total ownership, shares of beneficial interest of the Trust, if any, owned by Mr. Friedman and his affiliates are no longer to be included. Pursuant to this action, Mr. Phillips and his affiliates may not acquire more than 49% of the Trust's outstanding shares of beneficial interest without the prior action of the Trust's Board of Trustees to the effect that they do not object to such increased ownership. At March 17, 1995, Mr. Phillips and his affiliates, primarily ART and BCM, owned approximately 43% of the Trust's outstanding shares of beneficial interest.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\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\nIntroduction\nContinental Mortgage and Equity Trust (the \"Trust\") was formed to invest in real estate through acquisitions, leases and partnerships and in mortgage loans on real estate, including wraparound, first and junior mortgage loans. The Trust was organized on August 27, 1980 and commenced operations on December 3, 1980.\nLiquidity and Capital Resources\nCash and cash equivalents aggregated $7.5 million at December 31, 1994 compared with $1.8 million at December 31, 1993. The principal reasons for this increase in cash are discussed in the paragraphs below.\nThe Trust's principal sources of cash have been and will continue to be from property operations, proceeds from property sales, principal payments on mortgage notes receivable and borrowings. The Trust expects that funds from operations and from anticipated external sources, such as property sales, financings and refinancings, will be sufficient to meet the Trust's various cash needs in 1995, including, but not limited to, the payment of distributions, debt service obligations coming due and property maintenance and improvements, as more fully discussed in the paragraphs below.\nThe Trust's cash flow from property operations (rentals collected less payments for property operating expenses) has continually increased over the past three years from $6.1 million in 1992 to $8.4 million in 1993 to $10.7 million in 1994. Of this $4.6 million net increase from 1992 to 1994, $4.2 million is the result of the Trust having acquired additional income producing properties, both through purchase and foreclosure, and the remainder of $400,000 is due to increased occupancy and rental rates, primarily at its apartments, and the Trust's control of operating expenses. The Trust's management believes that this trend will continue, particularly in the Trust's apartments, if the economy remains stable or improves.\nInterest collected on mortgage notes receivable decreased over the past three years from $3.2 million in 1992 to $2.4 million in 1993 to $2.2 million in 1994. These decreases are primarily attributable to the foreclosure of the collateral property securing mortgage notes receivable and the payoff of mortgage notes receivable in 1993 and 1994.\nInterest will continue to decrease as a source of cash to the Trust as a result of the payoff of mortgage notes receivable and the foreclosure of the collateral property securing mortgage notes receivable in 1994 and 1993. In addition, the Trust has determined not to originate new mortgage loans, other than those resulting from Trust provided purchase money financing in connection with property sales.\nThe Trust was involved in significant investing activities during 1994. The Trust purchased seven apartments and one commercial property during 1994, for which the Trust paid a total of $33.5 million. The Trust paid $9.9 million in cash, with an additional $23.6 million\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\nfinanced through mortgage debt. The Trust also made improvements to its other properties totaling $729,000 and received $2.2 million in cash from the sale of five of its properties and an additional $1.3 million in cash from the sale of a property by one of the Trust's equity method partnerships. In addition, the Trust collected $5.6 million on notes receivable, primarily from the payoff of two mortgage notes receivable totaling $5.4 million, with the remainder collected from scheduled paydowns on the Trust's other mortgage notes receivable.\nDuring 1994, the Trust received net financing proceeds of $6.9 million from mortgage financing secured by four previously unencumbered apartment complexes. In addition, the Trust refinanced the mortgage secured by another apartment complex from which the Trust received $646,000 in net cash proceeds after the payoff of $2.5 million in existing mortgage debt. Also during 1994, the Trust made scheduled principal payments on mortgages totaling $1.1 million.\nThe Trust's distribution policy had provided for an annual determination of distributions after the Trust's year end until such time as property operations stabilized at a level producing cash flow from property operations in excess of anticipated needs. In January 1993, the Trust's Board of Trustees approved the resumption of quarterly distributions. In 1994, the Trust paid distributions to shareholders totaling $1.8 million ($.60 per share). The Trust paid distributions to shareholders totaling $1.5 million ($.50 per share) in 1993.\nDuring the first quarter of 1995, the Trust has continued to be an active investor. The Trust has purchased two industrial facilities, for which the Trust paid a total of $2.9 million in cash with an additional $13.8 million financed through mortgage debt. The Trust derived the cash portions of the purchase prices from its cash on hand at December 31, 1994.\nDuring 1994, the Trust repurchased 6,000 of its shares of beneficial interest at a cost of $84,000, pursuant to a repurchase program originally announced by the Trust on December 5, 1989. The Trust's Board of Trustees have authorized the Trust to repurchase a total of 976,667 of its shares of beneficial interest under such repurchase program, of which 191,517 shares remain to be purchased as of March 17, 1995.\nOn a quarterly basis, the Trust's management reviews the carrying value of the Trust's mortgage notes receivable, properties held for investment and properties held for sale. Generally accepted accounting principles require that the carrying value of an investment 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 Trust's properties or notes are less than the carrying value thereof at the time of evaluation, a provision for loss is recorded by a charge against earnings. Estimated net realizable value of mortgage notes receivable is based on the Trust's management's review and evaluation of the\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nLiquidity and Capital Resources (Continued)\ncollateral properties securing such notes. The property 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 maintenance requirements, discussions with the manager of the property and a review of properties in the surrounding area.\nResults of Operations\n1994 compared to 1993. For the year 1994, the Trust had a net loss of $833,000, as compared to net income of $615,000 for the year 1993. The primary factors contributing to the decrease in the Trust's net income are discussed in the following paragraphs.\nNet rental income (rental income less property operating expenses) increased from $8.2 million in 1993 to $10.2 million in 1994. Of this increase, $1.5 million is due to the acquisition of seven apartment complexes and one commercial property in 1994. An additional $284,000 of the increase is attributable to two apartment complexes obtained through foreclosure in 1994 and $1.1 million is due to the acquisition of three apartment complexes and one commercial property in 1993. An additional increase of approximately $400,000 is attributable to generally higher rents and occupancy at the Trust's properties. These increases are offset in part by a $1.3 million decrease in net rental income at four of the Trust's commercial properties and three of the Trust's apartment complexes due to a decrease in occupancy and higher operating expenses incurred in an effort to increase occupancy. Net rental income is expected to continue to increase in 1994, primarily from a full year of operations from the seven apartment complexes and one commercial property acquired in 1994 and from the anticipated purchase of additional real estate in 1995.\nInterest income decreased from $3.3 million in 1993 to $2.7 million in 1994. Of this decrease, $356,000 is attributable to a loan on which the borrower filed for bankruptcy protection in November 1993 and began making cash flow only payments in April 1994. The Trust completed foreclosure of the property securing this loan in October 1994. Of the decrease, an additional $191,000 is attributable to three loans which were paid off subsequent to August 1993 and $38,000 is attributable to loans which were classified as nonperforming in 1994. Interest income is expected to decline further in 1995 due to a $14.0 million wraparound mortgage note receivable being paid in full in December 1994 and due to the foreclosure during 1994 of two properties securing two of the Trust's other mortgage notes receivable. Further, the Trust is not considering new mortgage lending except in connection with purchase money financing of sales of the Trust's properties.\nThe Trust's equity in losses of partnerships decreased from $578,000 in 1993 to $479,000 in 1994. This decrease in equity losses is primarily due to higher rents and occupancy at the 32 industrial warehouse\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nResults of Operations (Continued)\nfacilities owned by Indcon, L.P. (\"Indcon\"), a joint venture partnership in which the Trust owns a 60% interest.\nInterest expense increased from $5.5 million in 1993 to $7.7 million in 1994. Of this increase, $1.5 million is due to interest expense recorded on mortgages secured by properties acquired in 1993 and 1994. An additional $597,000 is due to interest expense on a borrowing in September 1993 and four borrowings in 1994, all secured by mortgages on previously unencumbered apartment complexes.\nDepreciation expense increased from $2.4 million in 1993 to $3.2 million in 1994. This increase is due to the acquisition of seven apartment complexes and one commercial property in 1994 and four apartment complexes and one commercial property in 1993.\nA provision for losses of $1.2 million was recorded in 1994 to write down the Genesee Towers, an office building, to the amount of the nonrecourse mortgage debt. In addition, a provision for losses of $200,000 was recorded in 1994 to provide for the loss on the sale of Oak Forest Apartments, one of the Trust's foreclosed properties held for sale. (See NOTE 4. \"REAL ESTATE.\") A provision for loss of $221,000 was recorded in 1993 to provide for the loss on the sale of English Hills Apartments, also a foreclosed property held for sale.\nAdvisory fee to affiliate increased from $1.2 million in 1993 to $1.3 million in 1994. This increase is due to an increase in the Trust's gross assets, the basis for the advisory fee, as a result of the Trust's acquisition of eight properties in 1994 and five properties in 1993. The advisory fee is expected to continue to increase as the Trust makes additional property acquisitions.\nGeneral and administrative expenses decreased from $1.3 million in 1993 to $1.2 million in 1994. A decrease in legal fees and expenses incurred in connection with the Trust's annual meeting were offset in part by an increase in cost reimbursements to the Trust's advisor.\nFor the year 1994, the Trust recognized a gain on the sale of real estate of $577,000 related to the sale of an industrial warehouse facility by Indcon, a joint venture partnership in which the Trust owns a 60% interest. In addition, the Trust recognized a gain of $1.1 million on the settlement of a profit participation related to the 1994 payoff of one of the Trust's notes receivable. For the year 1993, the Trust recognized gains on sale of real estate of $365,000 related to the sale of three properties by Sacramento Nine (\"SAC 9\"), a joint venture partnership in which the Trust owns a 30% interest.\n1993 compared to 1992. For the year 1993, the Trust had net income of $615,000, as compared to net income of $758,000 for the year 1992. The primary factors contributing to the decrease in the Trust's net income are discussed in the following paragraphs.\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) increased from $6.3 million in 1992 to $8.2 million in 1993. Of this increase, $1.3 million is due to the acquisition of five apartment complexes, one office building and one industrial facility in 1992 and 1993, and an additional $165,000 is due to a decrease in operating expenses at Applecreek Apartments, the renovation of which was completed in 1992. The remaining increase is attributable to generally higher rental and occupancy rates, primarily at the Trust properties in the Southwest and Southeast, and reduced operating expenses at the Trust's apartment complexes.\nInterest income decreased from $4.2 million in 1992 to $3.3 million in 1993. Of this decrease, $502,000 is due to loans which were paid in full in 1992 and 1993 and an additional $312,000 is due to interest income recorded on loans which were foreclosed or settled in 1992 and 1993. The remaining decrease is due to loans which were placed on nonaccrual in 1993.\nThe Trust's equity in losses of partnerships increased from losses of $344,000 in 1992 to losses of $578,000 in 1993. This increase is primarily due to decreased operating results in the SAC 9 partnership as a result of the sale of three properties in the second quarter of 1993.\nInterest expense increased from $5.1 million in 1992 to $5.5 million in 1993. Of this increase, $847,000 is due to interest expense incurred on mortgages secured by properties which were acquired in late 1992 and in 1993. An additional increase of $73,000 is due to interest expense recorded on a first mortgage obtained in September 1993, secured by a previously unencumbered apartment property. These increases were partially offset by a decrease in interest expense of $458,000 attributable to a mortgage modification in November 1992 and an underlying mortgage debt related to a wraparound mortgage note receivable which was paid off in December 1992.\nDepreciation expense increased from $2.0 million in 1992 to $2.4 million in 1993. This increase is primarily due to the acquisition of five apartment complexes and two commercial properties in late 1992 and in 1993.\nA provision for loss of $221,000 was recorded in 1993 to provide for the loss on the sale of English Hills Apartments, a foreclosed property held for sale. No provision for loss was recorded in 1992.\nGeneral and administrative expenses decreased from $1.4 million in 1992 to $1.3 million in 1993. This decrease is due to a decrease of $100,000 related to costs incurred in connection with the Trust's March 1992 annual meeting of shareholders and the February 1992 Rights redemption and a decrease in litigation expense.\nFor the year 1993, the Trust recognized gains on sale of real estate of $365,000 related to the sale of three properties by SAC 9, a joint venture partnership in which the Trust owns a 30% interest.\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\nEnvironmental Matters\nUnder various federal, state and local environmental laws, ordinances and regulations, the Trust 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 Trust for personal injury associated with such materials.\nThe Trust's management is not aware of any environmental liability relating to the above matters that would have a material adverse effect on the Trust's business, assets or results of operations.\nInflation\nThe effects of inflation on the Trust's operations are not quantifiable. Revenues from property operations fluctuate proportionately with 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 Trust from property sales. Inflation also has an effect on the Trust's earnings from short-term investments.\nTax Matters\nFor the years ended December 31, 1994, 1993 and 1992, the Trust elected and in the opinion of the Trust's management, qualified to be treated as a REIT as defined under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"). To continue to qualify for federal taxation as a REIT under the Code, the Trust is required to hold at least 75% of the value of its total assets in real estate assets, government securities, cash and cash equivalents at the close of each quarter of each taxable year. The Code also requires a REIT to distribute at least 95% of its REIT taxable income plus 95% of its net income from foreclosure property, as defined in Section 857 of the Code, on an annual basis to shareholders.\nRecent Accounting Pronouncements\nIn May 1993, the Financial Accounting Standards Board (\"FASB\") 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 notes receivable be considered impaired when \"based on current information and events, it is probable that a creditor will be unable to collect all amounts due, both principal and interest, according to the contractual terms of the loan agreement\". Impairment is to be measured either on the present value of expected future cash flows discounted at the note's effective interest rate or if the note is\nITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued)\ncollateral dependent, on the fair value of the collateral. In October 1994, the FASB issued SFAS No. 118 - \"Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosure\" which amends SFAS No. 114. SFAS No. 118 eliminates the income recognition provisions of SFAS No. 114, substituting disclosure of the creditor's policy of income recognition on impaired notes. SFAS No. 114 and SFAS No. 118 are both effective for fiscal years beginning after December 15, 1994. The Trust's management has not fully evaluated the effects of implementing these statements, but expects that they will not affect the Trust's interest income recognition policy but may require the classification of otherwise performing loans as impaired.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nAll other schedules are omitted because they are not required, are not applicable or the information required is included in the Financial Statements or the notes thereto.\nREPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS\nBoard of Trustees of Continental Mortgage and Equity Trust\nWe have audited the accompanying consolidated balance sheets of Continental Mortgage and Equity Trust and Subsidiaries as of December 31, 1994 and 1993 and the related consolidated statements of operations, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994. We have also audited the schedules listed in the accompanying index. 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 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 Continental Mortgage and Equity Trust and Subsidiaries as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, 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.\nBDO SEIDMAN\nDallas, Texas March 21, 1995\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED BALANCE SHEETS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF OPERATIONS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nThe accompanying notes are an integral part of these Consolidated Financial Statements.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nThe accompanying Consolidated Financial Statements of Continental Mortgage and Equity Trust and consolidated entities (the \"Trust\") 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 the 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 1993 and 1992 have been reclassified to conform to the 1994 presentation.\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nOrganization and Trust business. Continental Mortgage and Equity Trust (\"CMET\") is a California business trust organized on August 27, 1980. The Trust may invest in real estate through direct ownership, leases and partnerships and it may also invest in mortgage loans on real estate, including first, wraparound and junior mortgage loans.\nBasis of consolidation. The Consolidated Financial Statements include the accounts of CMET and partnerships and subsidiaries which it controls. All intercompany transactions and balances have been eliminated.\nInterest recognition on notes receivable. It is the Trust'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 net realizable value of the 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 Trust's estimate of net realizable value of the property or collateral securing each 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 5.0% and 4.7% as of December 31, 1994 and 1993, 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.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\nForeclosed real estate held for sale. Foreclosed real estate is initially recorded at new cost, defined as the lower of original cost or fair 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 Trust's established depreciation policies. See \"Real estate and depreciation\" below.\nAnnually, all foreclosed properties held for sale are reviewed by the Trust'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) Trust management has no intent to dispose of the property within the next twelve months; (iii) the property is a \"qualifying asset\" as defined in the Internal Revenue Code of 1986, as amended; (iv) property improvements have been funded; and (v) the Trust'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 income.\nReal estate and depreciation. Real estate is carried at the lower of cost or estimated net realizable value, except for foreclosed properties held for sale, which are recorded initially at the lower of original cost or fair value minus estimated costs of sale. Depreciation is provided for by the straight-line method over the estimated useful lives of the assets, which range from 5 to 40 years.\nPresent value premiums\/discounts. The Trust 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 notes receivable include the borrower's credit standing, nature of the collateral and payment terms of the note.\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 profit recognition have been met, transactions are accounted for using either the deposit, the installment, the cost recovery or the financing method, whichever is appropriate.\nInvestment in noncontrolled partnerships. The Trust uses the equity method to account for investments in partnerships which it does not\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)\ncontrol. Under the equity method, the Trust's initial investment, recorded at cost, is increased by the Trust's proportionate share of the partnership's operating income and additional advances and decreased by the Trust's share of the partnership's operating losses and distributions received.\nMarketable equity securities. Marketable equity securities are considered to be available-for-sale and are carried at fair value, defined as period end closing market value. Net unrealized holding gains and losses are reported as a separate component of shareholders' equity until realized.\nFair value of financial instruments. The Trust 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 Trust'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 Trust. 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 Trust considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nEarnings per share. Income (loss) per share of beneficial interest is computed based upon the weighted average number of shares of beneficial interest outstanding during each year.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE\nNotes and interest receivable consisted of the following:\nThe Trust 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 1994, 1993 and 1992, unrecognized interest income on nonperforming notes totaled $1.3 million, $681,000 and $302,000, respectively.\nNotes receivable at December 31, 1994 mature from 1995 through 2018, with interest rates ranging from 6.5% to 18.0% and a weighted average rate of 7.8%. The discount is based on an imputed interest rate of 12% and premiums are based on imputed interest rates of 10%. Notes receivable are nonrecourse and are collateralized by real estate.\nIn May 1994, the Trust sold the retail portion of Forest Ridge, a foreclosed apartment and retail property held for sale, financing the sale through acceptance of a $365,000 purchase money mortgage. The mortgage note bears interest at a rate of 7.5% per annum for the first three years, increasing to 8.3% per annum from May 1997 until maturity in May 2001. The note requires monthly payments of principal and interest, currently $3,000. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nIn December 1994, the Trust received payment in full on the wraparound mortgage note secured by the Fountainview Retirement Center. The Trust received $5.0 million in cash, equal to the Trust's equity in the wraparound mortgage note.\nIn addition, the note agreement required that the debtor make an additional profit participation payment equal to 62.5% of the amount by which the fair market value of the property on the maturity date of the loan exceeded the original loan principal balance. In settlement of the profit participation, the borrower assigned a $1.8 million first mortgage, secured by Cypress Creek Executive Court, an office building in Ft. Lauderdale, Florida, to the Trust for which the Trust paid $283,000 in cash. The first mortgage bears interest at rates ranging from 8.0% to 9.0% per annum, requires monthly payments of principal and\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)\ninterest, currently $15,000, and matures in June 2009. The Trust discounted the note to yield 12.0% per annum. The Trust recognized a $1.1 million gain on the settlement of the profit participation.\nIn September 1994, the Trust recorded the insubstance foreclosure of the Circletree Apartments and the Woodbridge Apartments, the collateral properties securing two of the Trust's mortgage notes receivable. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nIn July 1993, the Trust sold the English Hills Apartments and financed the sale in part through the acceptance of a $590,000 purchase money mortgage. The note bears interest at rates ranging from 8.5% to 9%, requires monthly payments of interest only from November 1993 to June 1995, payments of principal and interest thereafter and matures in June 1999. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nThe Trust received title to an office building and a 6 acre tract of land in Houston, Texas in settlement of a $1.2 million mortgage note receivable during 1993. This settlement resulted in no loss to the Trust. See NOTE 4. \"REAL ESTATE AND DEPRECIATION.\"\nDuring 1993, the Trust received cash of $1.6 million in full payment of four mortgage notes, including the related party note described in \"Related party transaction\" below.\nIn September 1991, the Trust funded a $2.0 million junior mortgage loan, secured by the Aspen Village Townhomes, located in Hartland, Wisconsin. The note accrues interest at the default interest rate of 18% per annum. The note had an extended maturity date of April 27, 1992. On March 27, 1992, the Trust funded an additional $150,000 junior lien mortgage loan, also secured by the Aspen Village Townhomes. This note also bears interest at the default interest rate of 18% per annum. This note had an extended maturity date of September 23, 1992. The borrower failed to make the required principal payments to the Trust on the maturity dates. The Trust continues to negotiate with the borrower to restructure the note, with the borrower providing additional collateral to secure these loans. If the negotiations are unsuccessful and the Trust forecloses on the collateral property, it does not anticipate incurring a loss in excess of previously established reserves.\nAt December 31, 1994, four other of the Trust's mortgage notes receivable with principal balances totaling $4.5 million were in default. One of the notes, with a principal balance of $1.4 million at December 31, 1994, required a principal paydown of $200,000 in November 1994, which had not been made as of March 17, 1995. The borrower is currently negotiating with the Trust for an 18 month extension of the note in return for a principal paydown and a pledge of additional collateral to secure the note. The Trust does not anticipate incurring a loss on this note as the estimated value of the property securing the note is in excess of the carrying value of the note. The Trust is\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 2. NOTES AND INTEREST RECEIVABLE (Continued)\nevaluating its options with respect to foreclosure of the collateral properties securing the remaining three notes, and the Trust does not anticipate incurring losses on these notes in excess of previously established reserves.\nRelated party transaction. In December 1990, the Trust funded a $1.4 million first mortgage loan to Rivertrails Development Associates, Inc., a wholly-owned subsidiary of ART, secured by 198 developed residential lots in Ft. Worth, Texas. The loan was paid in full in August 1993. The Trust's advisor also serves as advisor to ART and as of March 17, 1995, ART owned approximately 35% of the Trust's outstanding shares of beneficial interest.\nNOTE 3. ALLOWANCE FOR ESTIMATED LOSSES\nActivity in the allowance for estimated losses was as follows:\nThe provision for losses in the accompanying Consolidated Statements of Operations consists of a $1.2 million write down of the carrying value of the Genesee Towers office building to the amount of the nonrecourse mortgage and a $200,000 loss on the sale of a foreclosed property held for sale in 1994, and a $221,000 loss on the sale of a foreclosed property held for sale in 1993. See NOTE 4. \"REAL ESTATE AND DEPRECIATION\" and NOTE 7. \"NOTES AND INTEREST PAYABLE.\"\nNOTE 4. REAL ESTATE AND DEPRECIATION\nIn February 1994, the Trust purchased the Fountain Lake Apartments, a 166 unit apartment complex in Texas City, Texas, for $3.3 million. The Trust paid $237,000 in cash, assumed an existing mortgage of $2.5 million and the seller provided additional financing of $402,000. The $2.5 million first mortgage bears interest at a variable rate, currently 5.9% per annum, requires monthly payments of principal and interest of $15,000 and matures in November 1998. The $402,000 seller financing is secured by a second lien mortgage on another of the Trust's properties, Windsor Plaza Office Building, in Windcrest, Texas. This mortgage bears interest at a variable rate, currently 6.6% per annum, requires monthly payments of principal and interest of $3,000 and also matures in November 1998.\nIn March 1994, the Trust purchased the McCallum Crossing Apartments, a 322 unit apartment complex in Dallas, Texas, for $7.7 million. The Trust paid $1.4 million in cash and the seller provided $6.3 million in mortgage financing. The mortgage bears interest at rates ranging from\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. REAL ESTATE AND DEPRECIATION (Continued)\n6.5% to 7.5% per annum, requires monthly payments of interest only through March 1, 1998 and principal and interest payments of $46,000 thereafter, and matures in March 2004.\nIn May 1994, the Trust purchased the Willowcreek Apartments, a 112 unit apartment complex in El Paso, Texas, for $2.3 million in cash.\nIn June 1994, the Trust purchased the Park Avenue Apartments, a 108 unit apartment complex in Clute, Texas, for $855,000 in cash.\nIn August 1994, the Trust purchased the Parkwood Knoll Apartments, a 178 unit apartment complex in San Bernardino, California, for $6.4 million. The Trust paid $1.2 million in cash and assumed the existing mortgage of $5.2 million. The mortgage bears interest at a rate of 8.0% per annum, requires monthly payments of principal and interest of $40,000 and matures in February 2004.\nIn September 1994, the Trust purchased the Pierce Towers Apartments, a 57 unit apartment complex in Denver, Colorado, for $2.7 million. The Trust paid $678,000 in cash and assumed the existing mortgage of $2.0 million. The mortgage bears interest at a rate of 8.4% per annum, requires monthly payments of principal and interest of $15,000 and matures in December 2000.\nAlso in September 1994, the Trust purchased the McLeod Commerce Center, a 111,115 square foot industrial facility in Orlando, Florida, for $3.2 million. The Trust paid $1.0 million in cash and the seller provided mortgage financing of $2.2 million. The mortgage bears interest at a rate of 9.5% per annum, requires monthly payments of principal and interest of $19,000 and matures in October 2001.\nIn December 1994, the Trust purchased The Pines Apartments, a 242 unit apartment complex in Gainesville, Florida, for $6.2 million. The Trust paid $923,000 in cash, assumed the existing first mortgage of $2.7 million and the seller provided additional financing of $2.7 million. The first mortgage bears interest at 9.6% per annum, requires monthly payments of principal and interest of $27,000 and matures in July 2011. The $2.7 million second mortgage bears interest at 9.5% per annum, requires monthly payments of interest only through September 1995 and monthly payments of principal and interest of $23,000 thereafter, and matures in December 1997.\nIn February 1995, the Trust purchased the Sullyfield Commerce Center, a 243,813 square foot industrial facility in Chantilly, Virginia, for $11.0 million. The Trust paid $2.2 million in cash and the seller provided mortgage financing of $8.8 million. The mortgage bears interest at a rate of 6% per annum through December 1996 and 9% per annum thereafter, requires monthly payments of interest only through January 1999 and principal and interest payments of $73,000 thereafter, and matures in January 2001.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. REAL ESTATE AND DEPRECIATION (Continued)\nIn March 1995, the Trust purchased the Zane May Warehouses, six industrial warehouse facilities with a total of 330,334 square feet in Dallas, Texas, for $5.4 million. The Trust paid $696,000 in cash, obtained new mortgage financing of $4.6 million and the seller provided additional financing of $403,000. The $4.6 million mortgage bears interest at a variable rate, currently 9.25% per annum, requires monthly payments of interest only and matures in July 1999. The $403,000 seller financings bear interest at rates ranging from 6% to 8% per annum, require monthly payments of principal and interest totaling $3,000 and mature in July 1999.\nIn September 1994, the Trust recorded the insubstance foreclosure of the Circletree Apartments, a 414 unit apartment complex in Waukegan, Illinois. The Circletree Apartments had an estimated fair value, less estimated costs of sale, of $8.1 million at the date of foreclosure, which approximated the carrying value of the Trust's note receivable. The foreclosure resulted in no loss to the Trust. Foreclosure proceedings were completed in October 1994.\nAlso in September 1994, the Trust recorded the insubstance foreclosure of Woodbridge Apartments, a 194 unit apartment complex in Westminster, Colorado. The Woodbridge Apartments had an estimated fair value, less estimated costs of sale, of $3.3 million at the date of foreclosure, which exceeded the carrying value of the Trust's mortgage note receivable. The insubstance foreclosure resulted in no loss to the Trust. Foreclosure proceedings were completed in February 1995.\nIn February 1994, the Trust sold the Kimberly Square Shopping Center, a foreclosed property held for sale in Fort Lauderdale, Florida, for $1.0 million in cash. No loss in excess of the reserve previously provided was incurred.\nIn May 1994, the Trust sold the retail portion of Forest Ridge, a foreclosed apartment and retail property held for sale in Denton, Texas. The property was sold for $365,000, with the Trust providing purchase money financing for the entire sales price. The Trust recognized neither a gain or loss on the sale. The terms of the mortgage note receivable are discussed in NOTE 3. \"NOTES AND INTEREST RECEIVABLE.\"\nIn June 1994, the Trust sold a 546 acre tract of foreclosed undeveloped land held for sale in Morgan, Utah, for $110,000 in cash. No loss in excess of the reserve previously provided was incurred.\nAlso in June 1994, the Trust sold the Oak Forest Apartments, a foreclosed property held for sale in Tampa, Florida, for $900,000 in cash. The Trust recognized a loss on the sale of $200,000 in excess of previously provided reserves, which was provided by a direct charge against earnings. See NOTE 3. \"ALLOWANCE FOR ESTIMATED LOSSES.\"\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 4. REAL ESTATE AND DEPRECIATION (Continued)\nIn December 1994, the Trust sold two single family residences located in Arizona and South Dakota, which it had obtained through foreclosure. The Trust received $155,000 in cash from the sales. No loss in excess of the reserves previously established was incurred.\nIn March 1993, the Trust purchased the Fairways Apartments, a 152 unit apartment complex in Longview, Texas, for $2.1 million. The Trust paid $446,000 in cash, assumed an existing mortgage of $1.2 million and the seller provided additional financing of $480,000.\nIn April 1993, the Trust purchased the Country Crossing Apartments, a 227 unit apartment complex in Tampa, Florida, for $3.1 million. The Trust paid $239,000 in cash and assumed an existing mortgage of $2.7 million. The Trust also made a principal paydown of $100,000 on the mortgage on the date of acquisition.\nIn August 1993, the Trust purchased the Camelot Apartments, a 120 unit apartment complex in Largo, Florida, for $3.9 million. The Trust paid $757,000 in cash and assumed an existing mortgage of $3.1 million.\nIn November 1993, the Trust purchased the Northgate Distribution Center, a 208,386 square foot industrial facility in Marietta, Georgia, for $4.2 million. The Trust paid $889,000 in cash and obtained first mortgage financing for an additional $3.3 million.\nIn December 1993, the Trust purchased the Somerset Apartments, a 200 unit apartment complex in Texas City, Texas, for $3.6 million. The Trust paid $920,000 in cash and assumed an existing first mortgage of $2.7 million.\nAlso in 1993, the Trust obtained title, through the settlement of a mortgage note receivable, to Pinemont, a 19,685 square foot office building in Houston, Texas and title to a 6 acre tract of land also in Houston, Texas. See NOTE 2. \"NOTES AND INTEREST RECEIVABLE.\"\nIn June 1993, the Trust sold Northwest Plaza, a shopping center held for sale in Duncan, Oklahoma, for $115,000 in cash. No loss in excess of the reserve previously established was incurred. In July 1993, the Trust sold English Hills Apartments, a foreclosed apartment complex held for sale in Tampa, Florida. The Trust received $47,000 in cash and provided $590,000 of purchase money financing. The Trust recognized a loss of $221,000 on the sale, which was provided by a direct charge against earnings. See NOTE 2. \"NOTES AND INTEREST RECEIVABLE\" and NOTE 3. \"ALLOWANCE FOR ESTIMATED LOSSES.\"\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 5. INVESTMENT IN MARKETABLE EQUITY SECURITIES\nThe Trust's investments in marketable equity securities consisted of the following:\nThe Trust's marketable equity securities are considered available-for-sale and are carried at fair value (period end market value). The Trustees of the Trust are also directors of TCI and certain officers of the Trust are also officers of ART and TCI. The President of the Trust also serves as President of TCI and as a director of ART. The Trust's advisor serves as advisor to ART and TCI. Prior to March 31, 1994, the Trust's advisor also served as advisor to NIRT.\nSection 5.3(g) of the Trust's Declaration of Trust limits to 18 months the period of time that the Trust can hold an investment in an equity security. The Trust's shareholders approved an amendment to the Trust's Declaration of Trust allowing the Trust to hold these shares of ART, NIRT and TCI until July 30, 1996.\nThe Trust has margin arrangements with brokerage firms which provide for borrowings of up to 50% of the market value of equity securities. The borrowings under such margin arrangement are secured by equity securities of ART, NIRT and TCI and bear interest at a rate of 6.2%. Margin borrowings were $500,000 at December 31, 1994 and 1993 and are included in other liabilities in the accompanying Consolidated Balance Sheets.\nNOTE 6. INVESTMENT IN EQUITY METHOD PARTNERSHIPS\nThe Trust's investment in equity method partnerships consists of the following:\nThe Trust, in partnership with NIRT, owns SAC 9, which in turn currently owns two office buildings in the vicinity of Sacramento, California. The Trust has a 30% interest in the partnership's earnings, losses and distributions.\nIn 1993, SAC 9 sold three of its office buildings for a total of $4.5 million. SAC 9 received net cash of $2.5 million, of which the Trust's equity share was $748,000, after the payoff of an existing mortgage\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 6. INVESTMENT IN EQUITY METHOD PARTNERSHIPS (Continued)\nwith a principal balance of $685,000. SAC 9 also provided $356,000 of purchase money financing in conjunction with the sale of one of the buildings and provided $887,000 of purchase money financing in conjunction with the sale of another of the buildings. SAC 9 recognized gains totaling $1.2 million on the sales, of which the Trust's equity share was $365,000.\nThe Trust and NIRT are also partners in Income Special Associates (\"ISA\"), a joint venture partnership in which the Trust has a 60% interest in earnings, losses and distributions. ISA in turn owns a 100% interest in Indcon, formerly known as Adams Properties Associates, which owns 32 industrial warehouse facilities. The Indcon partnership agreement requires the consent of both the Trust and NIRT for any material changes in the operations of the partnership's properties, including sales, refinancings and changes in property management. The Trust, as a noncontrolling partner, accounts for its investment in Indcon using the equity method.\nIn May 1994, Indcon sold one of its industrial warehouses for $4.4 million in cash. Indcon received net cash of $2.1 million, of which the Trust's equity share was $1.3 million, after the payoff of an existing mortgage with a principal balance of $1.8 million and the payment of a $133,000 prepayment penalty. Indcon recognized a gain of $962,000 on the sale, of which the Trust's equity share was $577,000.\nSet forth below are summarized financial data for the partnerships the Trust accounts for using the equity method (unaudited):\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES AND INTEREST PAYABLE\nNotes and interest payable consisted of the following:\nScheduled principal payments on notes payable are due as follows:\nNotes payable at December 31, 1994 bear interest at rates ranging from 3.0% to 10.8% and mature between 1995 and 2024. These notes payable are nonrecourse and are collateralized by deeds of trust on real estate with a carrying value of $132.1 million.\nIn February 1995, after determining that further investment in Genesee Towers, an office building in Flint, Michigan, could not be justified without a substantial modification of the mortgage debt, the Trust ceased making debt service payments on the $8.8 million nonrecourse mortgage secured by the property. The Trust is attempting to negotiate with the lender to modify the mortgage. However, there can be no assurance that such negotiations will be successful or that the Trust will continue to own the property. Accordingly, as of December 31, 1994, the carrying value of the property was written down by $1.2 million, which is included in the 1994 provision for losses, to the amount of the nonrecourse mortgage.\nIn January 1994, the Trust obtained mortgage financing secured by the previously unencumbered Park Lane Apartments in Dallas, Texas, in the amount of $1.3 million. The Trust received net cash of $1.1 million. The remainder of the financing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the financing. The $1.3 million mortgage bears interest at a rate of 8.66% per annum through January 2004 and at a variable rate thereafter and requires monthly payments of principal and interest, currently $10,000. The note matures in February 2019.\nIn April 1994, the Trust obtained mortgage financing secured by the previously unencumbered Southgate Apartments in Roundrock, Texas, in the\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 7. NOTES AND INTEREST PAYABLE (Continued)\namount of $3.0 million. The Trust received net cash of $2.9 million. The remainder of the financing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the financing. The $3.0 million mortgage bears interest at a rate of 9.625% per annum, requires monthly payments of principal and interest of $26,000 and matures in May 2004.\nIn May 1994, the Trust obtained mortgage financing secured by the previously unencumbered 4242 Cedar Springs Apartments in Dallas, Texas, in the amount of $1.4 million. The Trust received net cash of $1.3 million after the payment of various closing costs associated with the financing. The $1.4 million mortgage bears interest at a rate of 9.9% per annum, requires monthly payments of principal and interest of $13,000 and matures in June 2004.\nIn July 1994, the Trust obtained new mortgage financing secured by the Stone Oak Place Apartments in San Antonio, Texas, in the amount of $3.3 million. The Trust received net cash of $577,000 after the payoff of $2.5 million in existing mortgage debt that was scheduled to mature in April 1995. The remainder of the refinancing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the refinancing. The new $3.3 million mortgage bears interest at a rate of 9.9% per annum, requires monthly principal and interest payments of $31,000 and matures in August 2004.\nIn December 1994, the Trust obtained mortgage financing secured by the previously unencumbered Willow Creek Apartments in El Paso, Texas, in the amount of $1.8 million. The Trust received net cash of $1.6 million after the payment of various closing costs associated with the financing. The $1.8 million mortgage bears interest at a rate of 10.25% per annum, requires monthly payments of principal and interest of $17,000 and matures in January 2002.\nIn September 1993, the Trust obtained mortgage financing secured by the previously unencumbered El Chapparal Apartments in San Antonio, Texas, in the amount of $2.7 million. The Trust received net cash of $2.4 million. The remainder of the financing proceeds were used to fund escrows for replacements and repairs and to pay various closing costs associated with the financings.\nNOTE 8. DISTRIBUTIONS\nIn January 1993, the Trust's Board of Trustees approved the resumption of the payment of quarterly distributions to shareholders. In 1994, the Trust paid distributions of $.60 per share of beneficial interest aggregating $1.8 million. In 1993, the Trust paid distributions of $.50 per share of beneficial interest aggregating $1.5 million.\nNo distributions were declared or paid in 1992.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 8. DISTRIBUTIONS (Continued)\nThe Trust reported to the Internal Revenue Service that 100% of the distributions paid in 1994 and 1993 represented a return of capital.\nNOTE 9. ADVISORY AGREEMENT\nBasic Capital Management, Inc. (\"BCM\" or the \"Advisor\") has served as advisor to the Trust since March 28, 1989. BCM is a company owned by a trust for the benefit of the children of Gene E. Phillips. Mr. Phillips served as a Trustee of the Trust until December 31, 1992, as 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 his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust.\nAt the Trust's annual meeting of shareholders held on March 7, 1995, the Trust's shareholders approved the renewal of the Trust's Advisory Agreement with BCM through the next annual meeting of the Trust's shareholders. Subsequent renewals of the Trust's Advisory Agreement with BCM require the approval of the Trust's shareholders.\nUnder the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Trust's Board of Trustees a budget and business plan for the Trust containing a twelve-month forecast of operations and cash flow, a general plan for asset sales or acquisitions, lending, foreclosure and borrowing activity, and other investments, and the Advisor is required to report quarterly to the Trust's Board of Trustees on the Trust's performance against the business plan. In addition, all transactions or investments by the Trust shall require prior approval by the Trust's Board of Trustees unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Trust's Board of Trustees.\nThe Advisory Agreement also requires prior approval of the Trust's Board of Trustees for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that the Advisor shall be deemed to be in a fiduciary relationship to the Trust's shareholders; contains a broad standard governing the Advisor's liability for losses by the Trust; and contains guidelines for the Advisor's allocation of investment opportunities as among itself, the Trust and other entities it advises.\nThe Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Trust and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Trust (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Trust's net income.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 9. ADVISORY AGREEMENT (Continued)\nThe Advisory Agreement also provides for BCM to receive an annual incentive sales fee equal to 10% of the amount, if any, by which the aggregate sales consideration for all real estate sold by the Trust during such fiscal year exceeds the sum of: (i) the cost of each such property as originally recorded in the Trust's books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (ii) capital improvements made to such assets during the period owned by the Trust, and (iii) all closing costs, (including real estate commissions) incurred in the sale of such property; provided, however, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8% simple annual return on the Trust's net investment including capital improvements, calculated over the Trust's holding period before depreciation and inclusive of operating income and sales consideration and (b) the aggregate net operating income from all real estate owned by the Trust for each of the prior and current fiscal years shall be at least 5% higher in the current fiscal year than in the prior fiscal year.\nAdditionally, pursuant to the Advisory Agreement, BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Trust equal to the lesser of (i) up to 1% of the cost of acquisition, inclusive of commissions, if any, paid to nonaffiliated brokers or (ii) the compensation customarily charged in arm's-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property; provided that the aggregate purchase price of each property (including acquisition fees and all real estate brokerage commissions) may not exceed such property's appraised value at acquisition.\nThe Advisory Agreement requires BCM or any affiliate of BCM to pay to the Trust one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Trust; provided, however, that the compensation retained by BCM or any affiliate of BCM shall not exceed the lesser of (i) 2% of the amount of the loan committed by the Trust or (ii) a loan brokerage and commitment fee which is reasonable and fair under the circumstances.\nThe Advisory Agreement also provides that BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Trust equal to the lesser of (i) 1% of the amount of the loan purchased or (ii) a loan brokerage or commitment fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding by the Trust of any mortgage loan.\nUnder the Advisory Agreement, BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Trust or refinancing on Trust properties equal to the\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 9. ADVISORY AGREEMENT (Continued)\nlesser of (i) 1% of the amount of the loan or the amount refinanced or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from BCM or an affiliate of BCM without the approval of the Trust's Board of Trustees. No fee shall be paid on loan extensions.\nUnder the Advisory Agreement, BCM is to receive reimbursement of certain expenses incurred by it, in the performance of advisory services to the Trust.\nUnder the Advisory Agreement (as required by the Trust's Declaration of Trust), all or a portion of the annual advisory fee must be refunded by the Advisor to the Trust if the Operating Expenses of the Trust (as defined in the Trust's Declaration of Trust) exceed certain limits specified in the Declaration of Trust based on the book value, net asset value and net income of the Trust during such fiscal year. The operating expenses of the Trust did not exceed such limitation in 1994, 1993 or 1992.\nAdditionally, if the Trust were to request that BCM render services to the Trust other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed in NOTE 10. \"PROPERTY MANAGEMENT\", the Trust has hired Carmel Realty Services, Ltd. (\"Carmel\", Ltd.), an affiliate of BCM, to provide property management for the Trust's properties and, as discussed in NOTE 11. \"REAL ESTATE BROKERAGE\" the Trust has engaged Carmel Realty, Inc. (\"Carmel Realty\"), also an affiliate of BCM, on a non-exclusive basis, to provide brokerage services for the Trust.\nNOTE 10. PROPERTY MANAGEMENT\nSince February 1, 1990, affiliates of BCM have provided property management services to the Trust. Currently Carmel, Ltd. provides such property management services for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the property-level management services to the Trust 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 and leasing of nine of the Trust's commercial properties and the industrial warehouse facilities owned by one of the real estate partnerships in which the Trust and NIRT are partners to Carmel Realty, which is owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 11. REAL ESTATE BROKERAGE\nPrior to December 1, 1992, affiliates of BCM provided brokerage services to the Trust and received brokerage commissions in accordance with the terms of the advisory agreement. Effective December 1, 1992, the Trust's Board of Trustees approved the non-exclusive engagement by the Trust of Carmel Realty to perform brokerage services for the Trust. Carmel Realty is entitled to receive a commission for property acquisitions and sales by the Trust in accordance with the following sliding scale of total fees to be paid by the Trust: (i) maximum fee of 5% on the first $2.0 million of any purchase or sale transaction of which no more than 4% would be paid to Carmel Realty or affiliates; (ii) maximum fee of 4% on transaction amounts between $2.0 million - $5.0 million of which no more than 3% would be paid to Carmel Realty or affiliates; (iii) maximum fee of 3% on transaction amounts between $5.0 million - $10.0 million of which no more than 2% would be paid to Carmel Realty or affiliates; and, (iv) maximum fee of 2% on transaction amounts in excess of $10.0 million of which no more than 1 1\/2% would be paid to Carmel Realty or affiliates.\nNOTE 12. ADVISORY FEES, PROPERTY MANAGEMENT FEES, ETC.\nFees and cost reimbursements to BCM, the Trust's advisor, and its affiliates:\n________________________\n* Net of property management fees paid to subcontractors, other than Carmel Realty.\nNOTE 13. RENTALS UNDER OPERATING LEASES\nThe Trust's rental operations include the leasing of office buildings, industrial facilities and shopping centers. The leases thereon\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 13. RENTALS UNDER OPERATING LEASES (Continued)\nexpire at various dates through 2005. The following is a schedule of minimum future rentals on non-cancelable operating leases as of December 31, 1994:\nNOTE 14. INCOME TAXES\nFor the years 1994, 1993 and 1992, the Trust has elected and qualified to be treated as a Real Estate Investment Trust (\"REIT\"), as defined in Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the \"Code\"), and as such, will not be taxed for federal income tax purposes on that portion of its taxable income which is distributed to shareholders, provided that at least 95% of its REIT taxable income, plus 95% of its taxable income from foreclosure property as defined in Section 857 of the Code, is distributed. See NOTE 8. \"DISTRIBUTIONS.\"\nThe Trust had a loss for federal income tax purposes in 1994, 1993 and 1992; therefore, the Trust recorded no provision for income taxes.\nThe Trust's tax basis in its net assets differs from the amount at which its net assets are reported for financial statement purposes, principally due to the accounting for gains and losses on property sales, the difference in the allowance for estimated losses, depreciation on owned properties and investments in joint venture partnerships. At December 31, 1994, the Trust's tax basis in its net assets exceeded its basis for financial statement purposes by $2.1 million. As a result, aggregate future income for income tax purposes will be less than such amount for financial statement purposes, and the Trust would be able to maintain its REIT status without distributing 95% of its financial statement income. Additionally, at December 31, 1994, the Trust had a tax net operating loss carryforward of $50.5 million expiring through 2009.\nAs a result of the Trust's election to be treated as a REIT for income tax purposes and of its intention to distribute its taxable income, if any, in future years, no deferred tax asset, liability or valuation allowance was recorded.\nNOTE 15. COMMITMENTS AND CONTINGENCIES\nOlive Litigation. In February 1990, the Trust, together with Income Opportunity Realty Trust (\"IORT\"), NIRT and TCI, three real estate entities with, at the time, the same officers, directors or trustees and advisor as the Trust, entered into a settlement of a class and derivative action entitled Olive et al. v. National Income Realty Trust et al. relating to the operation and management of each of the entities. On April 23, 1990, the court granted final approval of the terms of the settlement.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)\nOn May 4, 1994, the parties entered into a Modification of Stipulation of Settlement dated April 27, 1994 (the \"Modification\") which settled subsequent claims of breaches of the settlement which were asserted by the plaintiffs and modified certain provisions of the April 1990 settlement. The Modification was preliminarily approved by the court on July 1, 1994 and final court approval was entered on December 12, 1994. The effective date of the Modification is January 11, 1995.\nThe Modification, among other things, provided for the addition of three new unaffiliated members to the Trust's Board of Trustees and sets forth new requirements for the approval of any transactions with affiliates over the next five years. In addition, BCM, the Trust's advisor, Mr. Phillips and William S. Friedman, the President and Trustee of the Trust until February 24, 1994, President of BCM until May 1, 1993 and director of BCM until December 22, 1989, agreed to pay a total of $1.2 million to the Trust, IORT, NIRT and TCI, of which the Trust's share is $750,000. The Trust received $187,000 in May 1994. The remaining $563,000 is to be paid in 18 monthly installments which began February 1, 1995.\nUnder the Modification, the Trust, IORT, NIRT, TCI and their shareholders released the defendants from any claims relating to the plaintiffs' allegations. The Trust, IORT, NIRT and TCI also agreed to waive any demand requirement for the plaintiffs to pursue claims on behalf of each of them against certain persons or entities. The Modification also requires that any shares of the Trust held by Messrs. Phillips, Friedman or their affiliates shall be (i) voted in favor of the reelection of all current members of the Trust's Board of Trustees that stand for reelection during the two calendar years following the effective date of the Modification and (ii) voted in favor of all new members of the Trust's Board of Trustees appointed pursuant to the terms of the Modification that stand for reelection during the three calendar years following the effective date of the Modification.\nPursuant to the terms of the Modification, any related party transaction which the Trust may enter into prior to April 27, 1999, will require the unanimous approval of the Trust's Board of Trustees. In addition, related party transactions may only be entered into in exceptional circumstances and after a determination by the Trust's Board of Trustees that the transaction is in the best interests of the Trust and that no other opportunity exists that is as good as the opportunity presented by such transaction.\nThe Modification also terminated a number of the provisions of the settlement, including the requirement that the Trust, IORT, NIRT and TCI maintain a Related Party Transaction Committee and a Litigation Committee of their respective Boards. The court retained jurisdiction to enforce the Modification.\nCONTINENTAL MORTGAGE AND EQUITY TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)\nNOTE 15. COMMITMENTS AND CONTINGENCIES (Continued)\nOther litigation. The Trust is also involved in various lawsuits arising in the ordinary course of business. The Trust's management is of the opinion that the outcome of these lawsuits would have no material impact on the Trust's financial condition.\nCONTINENTAL MORTGAGE AND EQUITY TRUST SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION December 31, 1994\nCONTINENTAL MORTGAGE AND EQUITY TRUST SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued) December 31, 1994\nCONTINENTAL MORTGAGE AND EQUITY TRUST SCHEDULE III REAL ESTATE AND ACCUMULATED DEPRECIATION (Continued) December 31, 1994\n_____________________________\n(1) The aggregate cost for federal income tax purposes is $165,261.\nSCHEDULE III (Continued)\nCONTINENTAL MORTGAGE AND EQUITY TRUST REAL ESTATE AND ACCUMULATED DEPRECIATION\nSCHEDULE IV\nCONTINENTAL MORTGAGE AND EQUITY TRUST MORTGAGE LOANS ON REAL ESTATE December 31, 1994\nSCHEDULE IV (Continued)\nCONTINENTAL MORTGAGE AND EQUITY TRUST MORTGAGE LOANS ON REAL ESTATE December 31, 1994\n__________________________\n(1) The aggregate cost for federal income tax purposes is $11,696.\nSCHEDULE IV (Continued)\nCONTINENTAL MORTGAGE AND EQUITY TRUST 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. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT\nTrustees\nThe affairs of Continental Mortgage and Equity Trust (the \"Trust\" or the \"Registrant\") are managed by a seven- member Board of Trustees. The Trustees are elected at the annual meeting of shareholders or appointed by the incumbent Board of Trustees and serve until the next annual meeting of shareholders or until a successor has been elected or approved.\nThe Trustees of the Trust are listed below, together with their ages, terms of service, all positions and offices with the Trust 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 \"Affiliated\", when used below with respect to a Trustee, means that the Trustee is an officer, director or employee of the Advisor or an officer or employee of the Trust. The designation \"Independent\", when used below with respect to a Trustee, means that the Trustee is neither an officer or employee of the Trust nor a director, officer or employee of the Advisor, although the Trust may have certain business or professional relationships with such Trustee as discussed in ITEM 13. \"CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS - Certain Business Relationships\".\nGEOFFREY C. ETNIRE: Age 46, Trustee (Independent) (since January 1993).\nAttorney engaged in private practice of real estate law in Pleasanton, California (since 1981); Licensed Real Estate Broker in California (since 1985); Director (1985 to 1989) of Mission Valley Bancorp; Director (1984 to 1989) and Chairman (1986 to 1989) of Bank of Pleasanton; Managing Partner (1981 to 1988) with Smith, Etnire, Polson & Scott law firm; Trustee (January 1993 to March 1995) of National Income Realty Trust (\"NIRT\"); Trustee (since January 1993) of Income Opportunity Realty Trust (\"IORT\"); and Director (since January 1993) of Transcontinental Realty Investors, Inc. (\"TCI\").\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nTrustees (Continued)\nHAROLD FURST, PH.D.: Age 78, Trustee (Independent) (since January 1995).\nExecutive Vice President (since 1992) of SONY Signatures; Independent business consultant (since 1975) with emphasis on economic and financial matters; President (1973 to 1975) of Gerson Bakar & Associates, a property development, ownership and management company; Former Senior Vice President of Bank of America, N.T. and S.A. (retired 1972); Trustee (since January 1995) of IORT; and Director (since January 1995) of TCI.\nJOHN P. PARSONS: Age 66, Trustee (Independent) (since January 1995).\nChairman and Chief Executive Officer (since 1984) of Pierpont Corporation; Director of Zentrum Holdings Limited (NZ) (since 1984), the Pickford Foundation (since 1980), International Divertissments, Ltd. (since 1986), and Lifehouse International, Ltd.(since 1990); Trustee (since January 1995) of IORT; and Director (since January 1995) of TCI.\nBENNETT B. SIMS: Age 62, Trustee (Independent) (since April 1990).\nProducer (since January 1994) for Blue Train Pictures; Author (since 1964); Screen and Television Writer (since 1960); Independent Marketing Consultant (since 1980) for various companies; Professor of Dramatic Writing (since September 1987) at Tisch School of the Arts, New York University; Trustee (April 1990 to August 1994) of NIRT; Trustee (December 1992 to August 1994) of Vinland Property Trust (\"VPT\"); Trustee (since April 1990) of IORT; and Director (since April 1990) of TCI.\nTED P. STOKELY: Age 61, Trustee (Independent) (since April 1990) and Chairman of the Board (since January 1995).\nGeneral Manager (since January 1993) of Minority and Elderly Housing Assistance Foundation, Inc., a nonprofit corporation; Part-time unpaid Consultant (since January 1993) and paid Consultant (April 1992 to December 1992) of Eldercare Housing Foundation (\"Eldercare\"), a nonprofit corporation engaged in the acquisition of low income and elderly housing; President (April 1992 to April 1994) of PSA Group (real estate management and consulting); Executive Vice President (1987 to 1991) of Key Companies Inc., a publicly traded company that develops, acquires and sells water and minerals; Trustee (April 1990 to August 1994) of NIRT; Trustee (since April 1990) and Chairman of the Board (since January 1995) of IORT; and Director (since April 1990) and Chairman of the Board (since January 1995) of TCI.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nTrustees (Continued)\nMARTIN L. WHITE: Age 55, Trustee (Independent) (since January 1995).\nChairman and Chief Executive Officer (since 1993) of North American Trading Company Ltd.; President and Chief Operating Officer (since 1992) of Community Based Developers, Inc.; Development Officer and Loan Manager (1986 to 1992) of the City of San Jose, California; Vice President and Director of Programs (1967 to 1986) of Arpact, Inc., a government contractor for small business development and trade; Trustee (since January 1995) of IORT; and Director (since January 1995) of TCI.\nEDWARD G. ZAMPA: Age 60, Trustee (Independent) (since January 1995).\nGeneral Partner (since 1976) of Edward G. Zampa and Company; Trustee (since January 1995) of IORT; and Director (since January 1995) of TCI.\nLitigation and Claims Involving Mr. Phillips\nGene E. Phillips served as a Trustee of the Trust until December 22, 1992, and as a director until December 31, 1989 and Chief Executive Officer until September 1, 1992 of BCM. Although Mr. Phillips no longer serves as an officer or director of BCM or as a Trustee of the Trust, he does serve as a representative of the trust established for the benefit of his children which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services for the Trust.\nSouthmark Bankruptcy. Until January 1989, Mr. Phillips served as Chairman of the Board and Director (since 1980) and President and Chief Executive Officer (since 1981) of Southmark Corporation (\"Southmark\"). As a result of a deadlock on Southmark's Board of Directors, Mr. Phillips, among others, reached an agreement with Southmark on January 17, 1989, whereby Mr. Phillips resigned his positions with Southmark and certain of Southmark's subsidiaries and affiliates. Southmark filed a voluntary petition in bankruptcy under Chapter 11 of the United States Bankruptcy Code on July 14, 1989.\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. 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\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nLitigation and Claims Involving Mr. Phillips (Continued)\ndirectors abdicated their responsibility for reviewing loans during the same period. The Office of Thrift Supervision (\"OTS\") also conducted a formal examination of SJSA and its affiliates.\nOn November 21, 1994, Mr. Phillips entered into an agreement with the RTC and OTS settling all claims relating to his involvement with SJSA.\nLitigation Against Southmark and its Affiliates Alleging Fraud or Mismanagement. There were several lawsuits filed against Southmark, its former officers and directors (including Mr. Phillips) 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. All such lawsuits have been settled or dismissed without any findings or admissions of wrongdoing by Mr. Phillips. THE TRUST WAS NOT A DEFENDANT IN ANY OF THESE LAWSUITS.\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 alleged that Charles H. Keating, Jr. and other persons, including Mr. Phillips, fraudulently diverted funds from Lincoln.\nThe RTC alleged 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 alleged that Lincoln and\/or ACC engaged in three illegal transactions with Southmark or its affiliates while Mr. Phillips was affiliated with Southmark. Southmark was not a defendant in this action.\nThe RTC alleged 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 Organizations Act (\"RICO\") statutes, violations of Arizona felony statutes, common law fraud, civil conspiracy and breach of fiduciary duty. The RTC sought to recover from the defendants more than $1 billion, as well as treble damages under the federal RICO statute, punitive damages of at least $100 million and attorneys' fees and costs.\nOn November 21, 1994, Mr. Phillips entered into an agreement with the RTC settling all claims relating to his involvement with Lincoln.\nSouthmark Partnership Litigation. One of Southmark's principal businesses was real estate syndication, and from 1981 to 1987 Southmark\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nLitigation and Claims Involving Mr. Phillips (Continued)\nraised over $500 million in investments from limited partners of several hundred limited partnerships. The following two lawsuits related to and involved such activities.\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, alleged that the defendants violated the partnership agreements by charging certain administrative costs and expenses to the plaintiffs. The complaint alleged claims for breach of fiduciary duty, fraud and conspiracy to commit to fraud and sought to recover actual damages of approximately $12.6 million plus punitive damages and attorneys' fees and costs. The defendants included, among others, Mr. Phillips. In October 1993, the court granted partial summary judgment in favor of Mr. Phillips on the plaintiffs' breach of fiduciary duty claims. Notice of non-suit in favor of Mr. Phillips was entered on March 9, 1994.\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, alleged a claim for breach of fiduciary duty in connection with the 1988 transfer of certain property by the partnership. The plaintiff sought damages in an unspecified amount, plus costs and attorneys' fees. The plaintiff also sought to quiet title to the property at issue. The defendants included, among others, Mr. Phillips. The lawsuit was settled in November 1994.\nBoard Committees\nThe Trust's Board of Trustees held eleven meetings during 1994. For such year, no incumbent Trustee attended fewer than 75% of the aggregate of (i) the total number of meetings held by the Board of Trustees during the period for which he had been a Trustee and (ii) the total number of meetings held by all committees of the Board of Trustees on which he served during the period that he served, except for Willie K. Davis and Randall K. Gonzalez, who each attended only one of the meetings held by the Audit Committee.\nThe Trust's Board of Trustees has an Audit Committee, the function of which is to review the Trust's operating and accounting procedures. The current members of the Audit Committee, all of whom are Independent Trustees, are Messrs. Etnire (Chairman), Parsons, Stokely and White. The Audit Committee met twice during 1994.\nThe Trust's Board of Trustees does not have Nominating or Compensation Committees.\nUntil January 11, 1995, the Trust's Board of Trustees had a Related Party Transaction Committee which reviewed and made recommendations to the Board of Trustees with respect to transactions involving the Trust\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nBoard Committees (Continued)\nand any other party or parties related to or affiliated with the Trust, any of its Trustees or any of their affiliates, and a Litigation Committee which reviewed litigation involving Mr. Phillips. The members of each such committee were Independent Trustees of the Trust. During 1994, the Related Party Transaction Committee met eight times and the Litigation Committee met four times.\nThe Litigation Committee evaluated the nature and quality of the allegations made in any litigations or investigations involving Mr. Phillips in order to assess whether BCM should continue to act as the advisor to the Trust. The Litigation Committee, while not needing to duplicate the adjudicatory process, was required to conduct any investigation that was appropriate and necessary to discharge the above obligations.\nThe Related Party Transaction Committee and the Litigation Committee were formed in 1990 pursuant to the settlement of the Olive litigation, as more fully discussed in ITEM 3. \"LEGAL PROCEEDINGS - Olive Litigation.\" In December 1994, the court approved a Modification of Stipulation of Settlement which relieved the Trust of the requirement to maintain the two committees. Accordingly, both of the committees were terminated by the Trust's Board of Trustees on January 11, 1995.\nExecutive Officers\nThe following persons currently serve as executive officers of the Trust: Oscar W. Cashwell, President; Karl L. Blaha, Executive Vice President and Director of Commercial Management; Bruce A. Endendyk, Executive Vice President; Randall M. Paulson, Executive Vice President; and Hamilton P. Schrauff, Executive Vice President and Chief Financial Officer. Their positions with the Trust are not subject to a vote of shareholders. Their ages, terms of service, all positions and offices with the Trust or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.\nOSCAR W. CASHWELL: Age 67, President (since February 1994).\nPresident (since February 1994) of IORT and TCI; President and Director of Property and Asset Management (since January 1994) and 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 is the general partner of National Realty, L.P. (\"NRLP\") and National Operating, L.P. (\"NOLP\"), and a company owned by BCM; Assistant to the President, Real Estate Operations (March 1982 to June 1989) of Southmark; and Director (since November 1992) of American Realty Trust, Inc. (\"ART\").\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nExecutive Officers (Continued)\nKARL L. BLAHA: Age 46, Executive Vice President and Director of Commercial Management (since April 1992).\nPresident (since October 1993) and Executive Vice President and Director of Commercial Management (April 1992 to September 1993) of ART; Executive Vice President and Director of Commercial Management (since April 1992) of BCM, SAMI, IORT and TCI; Executive Vice President (since October 1992) of Carmel Realty, Inc. (\"Carmel Realty\"), a company owned by Syntek West, Inc. (\"SWI\"); 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).\nBRUCE A. ENDENDYK: Age 46, Executive Vice President (since January 1995).\nPresident (since January 1995) of Carmel Realty; Executive Vice President (since January 1995) of BCM, SAMI, ART, IORT and TCI; Management Consultant (November 1990 to December 1994); Executive Vice President (January 1989 to November 1990) of Southmark; President and Chief Executive Officer (March 1988 to January 1989) of Southmark Equities Corporation; and Vice President\/Resident Manager (December 1975 to March 1988) of Coldwell Banker Commercial\/Real Estate Services in Houston, Texas.\nRANDALL M. PAULSON: Age 48, Executive Vice President (since January 1995).\nExecutive Vice President (since January 1995) of SAMI, ART, IORT and TCI and (since October 1994) of BCM; Vice President (1993 to 1994) of GSSW, LP, a joint venture of Great Southern Life and Southwestern Life; Vice President (1990 to 1993) of Property Company of America Realty, Inc.; President (1990) of Paulson Realty Group; President (1983 to 1989) of Johnstown Management Company; and Vice President (1979 to 1982) of Lexton-Ancira.\nHAMILTON P. SCHRAUFF: Age 59, Executive Vice President and Chief Financial Officer (since October 1991).\nExecutive Vice President and Chief Financial Officer (since October 1991) of BCM, SAMI, ART, IORT and TCI; Executive Vice President and Chief Financial Officer (October 1991 to February 1994) of NIRT and VPT; Executive Vice President - Finance of Partnership Investments, Hallwood Group (December 1990 to October 1991); Vice President - Finance and Treasurer (Octobe 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.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nOfficers\nAlthough not executive officers of the Trust, the following persons currently serve as officers of the Trust: Thomas A. Holland, Senior Vice President and Chief Accounting Officer; Robert A. Waldman, Senior Vice President, General Counsel and Secretary; and Drew D. Potera, Treasurer. Their positions with the Trust are not subject to a vote of shareholders. Their ages, terms of service, all positions and offices with the Trust or BCM, other principal occupations, business experience and directorships with other companies during the last five years or more are set forth below.\nTHOMAS A. HOLLAND: Age 52, Senior Vice President and Chief Accounting Officer (since July 1990).\nSenior Vice President and Chief Accounting Officer (since July 1990) of BCM, SAMI, ART, IORT and TCI; Senior Vice President and Chief Accounting Officer (July 1990 to February 1994) of NIRT and VPT; Vice President and Controller (December 1986 to June 1990) of Southmark; Vice President-Finance (January 1986 to December 1986) of Diamond Shamrock Chemical Company; Assistant Controller (May 1976 to January 1986) of Maxus Energy Corporation (formerly Diamond Shamrock Corporation); Trustee (August 1989 to June 1990) of Arlington Realty Investors; and Certified Public Accountant (since 1970).\nROBERT A. WALDMAN: Age 42, Senior Vice President and General Counsel (since January 1995), Vice President (December 1990 to January 1995) and Secretary (since December 1993).\nSenior Vice President and General Counsel (since January 1995); Vice President (December 1990 to January 1995) and Secretary (since December 1993) of IORT and TCI; Senior Vice President and General Counsel (since January 1995), Vice President (January 1993 to January 1995) and Secretary (since December 1989) of ART; Senior Vice President and General Counsel (since November 1994), Vice President and Corporate Counsel (November 1989 to November 1994) and Secretary (since November 1989) of BCM; Senior Vice President and General Counsel (since January 1995), Vice President (April 1990 to January 1995) and Secretary (since December 1990) of SAMI; Vice President (December 1990 to February 1994) and Secretary (December 1993 to February 1994) of NIRT and VPT; Director (February 1987 to October 1989) and 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.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nOfficers (Continued)\nDREW D. POTERA: Age 35, Treasurer (since December 1990).\nTreasurer (since December 1990) of IORT and TCI; Treasurer (since August 1991) and Assistant Treasurer (December 1990 to August 1991) of ART; Vice President, Treasurer and Securities Manager (since July 1990) of BCM; Vice President and Treasurer (since February 1992) of SAMI; Treasurer (December 1990 to February 1994) of NIRT and VPT; and Financial Consultant with Merrill Lynch, Pierce, Fenner & Smith Incorporated (June 1985 to June 1990).\nIn addition to the foregoing officers, the Trust 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 Trust's Trustees, executive officers, and any persons holding more than ten percent of the Trust's shares of beneficial interest are required to report their ownership of the Trust'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 Trust is required to report any failure to file by these dates during 1994. All of these filing requirements were satisfied by its Trustees and executive officers and ten percent holders. In making these statements, the Trust has relied on the written representations of its incumbent Trustees and executive officers and its ten percent holders and copies of the reports that they have filed with the Commission.\nThe Advisor\nAlthough the Trust's Board of Trustees is directly responsible for managing the affairs of the Trust and for setting the policies which guide it, the day-to-day operations of the Trust are performed by a contractual advisor under the supervision of the Trust's Board of Trustees. The duties of the advisor include, among other things, locating, investigating, evaluating and recommending real estate and mortgage note investment and sales opportunities for the Trust. The advisor also serves as a consultant to the Trusts' Board of Trustees in connection with the business plan and investment policy decisions.\nBCM has served as the Trust's advisor since March 1989. BCM is a corporation of which Messrs. Cashwell, Blaha, Endendyk, Paulson and Schrauff serve as executive officers. BCM is owned by a trust for the benefit of the children of Mr. Phillips. Prior to December 22, 1989, Mr. Phillips also served as a director of BCM, and until September 1, 1992, as Chief Executive Officer of BCM. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust.\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nAt the Trust's annual meeting of shareholders held on March 7, 1995, the Trust's shareholders approved the renewal of the Trust's Advisory Agreement with BCM through the next annual meeting of the Trust's shareholders. Subsequent renewals of the Trust's Advisory Agreement with BCM require the approval of the Trust's shareholders.\nUnder the Advisory Agreement, the Advisor is required to formulate and submit annually for approval by the Trust's Board of Trustees a budget and business plan for the Trust containing a twelve-month forecast of operations and cash flow, a general plan for asset sales or acquisitions, lending, foreclosure and borrowing activity, and other investments, and the Advisor is required to report quarterly to the Trust's Board of Trustees on the Trust's performance against the business plan. In addition, all transactions or investments by the Trust shall require prior approval by the Trust's Board of Trustees unless they are explicitly provided for in the approved business plan or are made pursuant to authority expressly delegated to the Advisor by the Trust's Board of Trustees.\nThe Advisory Agreement also requires prior approval of the Trust's Board of Trustees for the retention of all consultants and third party professionals, other than legal counsel. The Advisory Agreement provides that the Advisor shall be deemed to be in a fiduciary relationship to the Trust's shareholders; contains a broad standard governing the Advisor's liability for losses by the Trust; and contains guidelines for the Advisor's allocation of investment opportunities as among itself, the Trust and other entities it advises.\nThe Advisory Agreement provides for BCM to be responsible for the day-to-day operations of the Trust and to receive an advisory fee comprised of a gross asset fee of .0625% per month (.75% per annum) of the average of the gross asset value of the Trust (total assets less allowance for amortization, depreciation or depletion and valuation reserves) and an annual net income fee equal to 7.5% per annum of the Trust's net income.\nThe Advisory Agreement also provides for BCM to receive an annual incentive sales fee equal to 10% of the amount, if any, by which the aggregate sales consideration for all real estate sold by the Trust during such fiscal year exceeds the sum of: (i) the cost of each such property as originally recorded in the Trust's books for tax purposes (without deduction for depreciation, amortization or reserve for losses), (ii) capital improvements made to such assets during the period owned by the Trust, and (iii) all closing costs, (including real estate commissions) incurred in the sale of such property; provided, however, no incentive fee shall be paid unless (a) such real estate sold in such fiscal year, in the aggregate, has produced an 8% simple annual return on the Trust's net investment including capital improvements, calculated over the Trust's holding period before depreciation and inclusive of operating income and sales consideration and (b) the aggregate net\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\noperating income from all real estate owned by the Trust for each of the prior and current fiscal years shall be at least 5% higher in the current fiscal year than in the prior fiscal year.\nAdditionally, pursuant to the Advisory Agreement, BCM or an affiliate of BCM is to receive an acquisition commission for supervising the acquisition, purchase or long-term lease of real estate for the Trust equal to the lesser of (i) up to 1% of the cost of acquisition, inclusive of commissions, if any, paid to nonaffiliated brokers or (ii) the compensation customarily charged in arm's-length transactions by others rendering similar property acquisition services as an ongoing public activity in the same geographical location and for comparable property; provided that the aggregate purchase price of each property (including acquisition fees and all real estate brokerage commissions) may not exceed such property's appraised value at acquisition.\nThe Advisory Agreement requires BCM or any affiliate of BCM to pay to the Trust one-half of any compensation received from third parties with respect to the origination, placement or brokerage of any loan made by the Trust; provided, however, that the compensation retained by BCM or any affiliate of BCM shall not exceed the lesser of (i) 2% of the amount of the loan committed by the Trust or (ii) a loan brokerage and commitment fee which is reasonable and fair under the circumstances.\nThe Advisory Agreement also provides that BCM or an affiliate of BCM is to receive a mortgage or loan acquisition fee with respect to the acquisition or purchase of any existing mortgage loan by the Trust equal to the lesser of (i) 1% of the amount of the loan purchased or (ii) a loan brokerage or commitment fee which is reasonable and fair under the circumstances. Such fee will not be paid in connection with the origination or funding by the Trust of any mortgage loan.\nUnder the Advisory Agreement, BCM or an affiliate of BCM is also to receive a mortgage brokerage and equity refinancing fee for obtaining loans to the Trust or refinancing on Trust properties equal to the lesser of (i) 1% of the amount of the loan or the amount refinanced or (ii) a brokerage or refinancing fee which is reasonable and fair under the circumstances; provided, however, that no such fee shall be paid on loans from BCM or an affiliate of BCM without the approval of the Trust's Board of Trustees. No fee shall be paid on loan extensions.\nUnder the Advisory Agreement, BCM is to receive reimbursement of certain expenses incurred by it, in the performance of advisory services to the Trust.\nUnder the Advisory Agreement (as required by the Trust's Declaration of Trust), all or a portion of the annual advisory fee must be refunded by the Advisor to the Trust if the Operating Expenses of the Trust (as defined in the Trust's Declaration of Trust) exceed certain limits specified in the Declaration of Trust based on the book value, net asset\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nvalue and net income of the Trust during such fiscal year. The operating expenses of the Trust did not exceed such limitation in 1994, 1993 or 1992.\nAdditionally, if the Trust were to request that BCM render services to the Trust other than those required by the Advisory Agreement, BCM or an affiliate of BCM will be separately compensated for such additional services on terms to be agreed upon from time to time. As discussed below, under \"Property Management\", the Trust has hired Carmel Realty Services, Ltd. (\"Carmel, Ltd.\"), an affiliate of BCM, to provide property management for the Trust's properties. Also as discussed below, under \"Real Estate Brokerage\" the Trust has engaged Carmel Realty, also an affiliate of BCM, on a non-exclusive basis, to perform brokerage services for the Trust.\nBCM may only assign the Advisory Agreement with the prior consent of the Trust.\nThe directors and principal officers of BCM are set forth below.\nRyan T. Phillips is Gene E. Phillips' son. Gene E. Phillips serves as a representative of the trust established for the benefit of his\nITEM 10. TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT (Continued)\nThe Advisor (Continued)\nchildren 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 Trust.\nProperty Management\nSince February 1, 1990, affiliates of BCM have provided property management services to the Trust. Currently Carmel, Ltd. provides such property management services for a fee of 5% or less of the monthly gross rents collected on the properties under its management. Carmel, Ltd. subcontracts with other entities for the provision of the property-level management services to the Trust 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. subcontracts the property-level management and leasing of nine of the Trust's commercial properties and the industrial warehouse facilities owned by one of the real estate partnerships in which the Trust and NIRT are partners to Carmel Realty which is a company owned by SWI. Carmel Realty is entitled to receive property and construction management fees and leasing commissions in accordance with the terms of its property-level management agreement with Carmel, Ltd.\nReal Estate Brokerage\nPrior to December 1, 1992, affiliates of BCM provided brokerage services to the Trust and received brokerage commissions in accordance with the terms of the advisory agreement. Effective December 1, 1992, the Trust's Board of Trustees approved the non-exclusive engagement by the Trust of Carmel Realty to perform brokerage services for the Trust. Carmel Realty is entitled to receive a commission for property acquisitions and sales by the Trust in accordance with the following sliding scale of total fees to be paid by the Trust: (i) maximum fee of 5% on the first $2.0 million of any purchase or sale transaction of which no more than 4% would be paid to Carmel Realty or affiliates; (ii) maximum fee of 4% on transaction amounts between $2.0 million - $5.0 million of which no more than 3% would be paid to Carmel Realty or affiliates; (iii) maximum fee of 3% on transaction amounts between $5.0 million - $10.0 million of which no more than 2% would be paid to Carmel Realty or affiliates; and, (iv) maximum fee of 2% on transaction amounts in excess of $10.0 million of which no more than 1 1\/2% would be paid to Carmel Realty or affiliates.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe Trust has no employees, payroll or benefit plans and pays no compensation to the executive officers of the Trust. The executive officers of the Trust who are also officers or employees of BCM, the Trust's Advisor, are compensated by the Advisor. Such executive officers of the Trust perform a variety of services for the Advisor and the\nITEM 11. EXECUTIVE COMPENSATION (Continued)\namount 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. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor\" for a more detailed discussion of the compensation payable to BCM by the Trust.\nThe only remuneration paid by the Trust is to the Trustees who are not officers or directors of BCM or its affiliated companies. The Independent Trustees (i) review the business plan of the Trust to determine that it is in the best interest of the Trust's shareholders, (ii) review the Trust's contract with the advisor, (iii) supervise the performance of the Trust's advisor and review the reasonableness of the compensation which the Trust pays to its advisor in terms of the nature and quality of services performed, (iv) review the reasonableness of the total fees and expenses of the Trust and (v) select, when necessary, a qualified independent real estate appraiser to appraise properties acquired by the Trust. The Independent Trustees receive compensation in the amount of $6,000 per year, plus reimbursement for expenses. In addition, each Independent Trustee receives (i) $3,000 per year for each committee of the Trust's Board of Trustees on which he serves, (ii) $2,500 per year for each committee chairmanship and (iii) $1,000 per day for any special services rendered by him to the Trust outside of his ordinary duties as Trustee, plus reimbursement of expenses.\nDuring 1994, the Trust's Board of Trustees established a Screening Committee for the purpose of interviewing candidates for nomination to the Trust's Board of Trustees pursuant to the Modification of Stipulation of Settlement of the Olive Litigation. In connection with such services each member of the Screening Committee received a $5,000 fee.\nDuring 1994, $91,500 was paid to the Independent Trustees in total Trustees' fees for all services, including the annual fee for service during the period June 1, 1994 through May 31, 1995, and 1994 special service fees as follows: Willie K. Davis, $13,250; Geoffrey C. Etnire, $16,250; Randall K. Gonzalez, $10,500; Dan L. Johnston, $8,500; A. Bob Jordan, $10,250; Raymond V.J. Schrag, $8,750; Bennett B. Sims, $12,000; and Ted P. Stokely, $12,000.\n[THIS SPACE INTENTIONALLY LEFT BLANK.]\nITEM 11. EXECUTIVE COMPENSATION (Continued)\nPerformance Graph\nThe following performance graph compares the cumulative total shareholder return on the Trust's shares of beneficial interest with the Standard & Poor's 500 Stock Index (\"S&P 500 Index\") and the National Association of Real Estate Investment Trusts, Inc. Hybrid REIT Total Return Index (\"REIT Index\"). The comparison assumes that $100 was invested on December 31, 1989 in the Trust's shares of beneficial interest and in each of the indices and further assumes the reinvestment of all dividends. Past performance is not necessarily an indicator of future performance.\nCOMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN\n(CHART)\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 Trust's shares of beneficial interest, both beneficially and of record, both individually and in the aggregate, for those persons or entities known by the Trust to be beneficial owners of more than 5% of its shares of beneficial interest as of the close of business on March 17, 1995.\n_________________________\n(1) Percentages are based upon 2,918,121 shares of beneficial interest outstanding at March 17, 1995.\nSecurity Ownership of Management. The following table sets forth the ownership of the Trust's shares of beneficial interest, both beneficially and of record, both individually and in the aggregate for the Trustees and executive officers of the Trust as of the close of business on March 17, 1995.\n___________________________\n* Less than 1%.\n(1) Percentage is based upon 2,918,121 shares of beneficial interest issued and outstanding at March 17, 1995.\n(2) Includes 1,029,010 shares owned by ART and 237,699 shares owned by BCM of which the executive officers of the Trust may be deemed to be beneficial owners by virtue of their positions as executive officers or director of ART and BCM. The Trust's executive officers disclaim beneficial ownership of such shares.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nCertain Business Relationships\nIn February 1989, the Trust's Board of Trustees voted to retain BCM as the Trust's advisor. See ITEM 10. \"TRUSTEES, EXECUTIVE OFFICERS AND ADVISOR OF THE REGISTRANT - The Advisor.\" BCM is a company of which Messrs. Cashwell, Blaha, Endendyk, Paulson and Schrauff serve as executive officers. Mr. Phillips served as a director of BCM until December 22, 1989 and 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. Mr. Phillips serves as a representative of his children's trust which owns BCM and, in such capacity, has substantial contact with the management of BCM and input with respect to its performance of advisory services to the Trust.\nSince February 1, 1991, affiliates of BCM have provided property management services to the Trust. 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, 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 and leasing of nine of the Trust's commercial properties and the industrial warehouse facilities owned by one of the real estate partnerships in which the Trust and NIRT are partners to Carmel Realty, which is a company owned by SWI.\nPrior to December 1, 1992, affiliates of BCM provided brokerage services to the Trust and received brokerage commissions in accordance with the advisory agreement. Since December 1, 1992, the Trust has engaged, on a non-exclusive basis, Carmel Realty to perform brokerage services to the Trust. Carmel Realty is a company owned by SWI.\nThe Trustees and officers of the Trust also serve as trustees or directors and officers of IORT and TCI. The Trustees owe fiduciary duties to such entities as well as to the Trust under applicable law. IORT and TCI have the same relationship with BCM as the Trust. Mr. Phillips is a general partner of SAMLP, the general partner of NRLP and NOLP. BCM performs certain administrative functions for NRLP and NOLP on a cost-reimbursement basis. BCM also serves as advisor to ART. Mr. Phillips served as Chairman of the Board and as a director of ART until November 16, 1992. Messrs. Blaha, Endendyk, Paulson and Schrauff serve as executive officers of ART and Mr. Cashwell serves as a director of ART.\nFrom April 1992 to December 31, 1992, Mr. Stokely was employed as a paid Consultant and since January 1, 1993 as a part-time unpaid Consultant for Eldercare, a nonprofit corporation engaged in the acquisition of low income and elderly housing. Eldercare has a revolving loan commitment from SWI, of which Mr. Phillips is the sole shareholder. Eldercare filed for bankruptcy protection in July 1993, and was dismissed from bankruptcy on October 12, 1994.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRelated Party Transactions\nHistorically, the Trust has engaged in and may continue to engage in business transactions, including real estate partnerships, with related parties. The Trust's management believes that all of the related party transactions represented the best investments available at the time and were at least as advantageous to the Trust as could have been obtained from unrelated third parties.\nAs more fully described in ITEM 2. \"PROPERTIES - Real Estate,\" the Trust is engaged with NIRT in the Sacramento Nine and Indcon, L.P. partnerships.\nIn September 1990, the Trust's Board of Trustees authorized the purchase of up to $2.0 million of the common shares of ART through negotiated or open market transactions. The Trust's advisor also serves as advisor to ART and at March 17, 1995 ART owned approximately 35% of the Trust's outstanding shares of beneficial interest. At December 31, 1994, the Trust owned 204,522 shares of ART common stock which the Trust had purchased in open market transactions in 1990 and 1991 at a total cost to the Trust of $1.6 million. At December 31, 1991, the market value of such shares of ART common stock had declined to $1.1 million. The Trust determined that such decline represented an other than temporary decline in the market value of the ART common stock and accordingly, recognized a loss of $521,000. At December 31, 1994, the market value of the ART shares was $2.7 million. See ITEM 2. \"PROPERTIES -Equity Investments in Real Estate Entities.\"\nIn December 1990, the Trust's Board of Trustees authorized the purchase of up to $1.0 million of the shares of beneficial interest of NIRT and up to $1.0 million of the shares of TCI common stock through negotiated or open market transactions. The Trustees of the Trust serve as directors of TCI. The officers of the Trust also serve as officers of TCI. BCM, the Trust's advisor, also serves as advisor to TCI. Until March 31, 1994, BCM served as advisor to NIRT. At December 31, 1994, the Trust owned 76,893 shares of beneficial interest of NIRT at a total cost of $415,000 and 53,000 shares of TCI common stock at a total cost of $235,000 all of which the Trust had purchased in open market transactions in 1990 and 1991. At December 31, 1994, the market value of the NIRT shares was $894,000 and the market value of the TCI common stock was $788,000. See ITEM 2. \"PROPERTIES - Equity Investments in Real Estate Entities.\"\nIn 1994, the Trust paid BCM and its affiliates $1.3 million in advisory fees, $1.6 million in real estate and mortgage brokerage commissions and $570,000 in property and construction management fees and leasing commissions (net of property management fees paid to subcontractors, other than Carmel Realty). In addition, also as provided in the Advisory Agreement, BCM received cost reimbursements from the Trust of $524,000 in 1994.\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRestrictions on Related Party Transactions\nThe Trust's Declaration of Trust provides that:\n\"The Trustees shall not...purchase, sell or lease any Real Properties or Mortgages to or from...the Advisor or any of [its] Affiliates,\" and that [t]he Trustees shall not...make any loan to...the Advisor or any of [its] Affiliates.\"\nThe Declaration of Trust further provides that:\n\"The Trust shall not purchase or lease, directly or indirectly, any Real Property or purchase any Mortgage from the Advisor or any affiliated Person, or any partnership in which any of the foregoing may also be a general partner, and the Trust will not sell or lease, directly or indirectly, any of its Real Property or sell any Mortgage to any of the foregoing Persons.\" The Declaration of Trust further provides that \"the Trust shall not directly or indirectly, engage in any transaction with any Trustee, officer or employee of the Trust or any director, officer or employee of the Advisor...or of any company or other organization of which any of the foregoing is an Affiliate, except for...[among other things] transactions with...the Advisor or Affiliates thereof involving loans, real estate brokerage services, real property management services, the servicing of Mortgages, the leasing of real or personal property, or other services, provided such transactions are on terms not less favorable to the Trust than the terms on which nonaffiliated parties are then making similar loans or performing similar services for comparable entities in the same area and are not entered into on an exclusive basis.\"\nThe Declaration of Trust further provides that:\n\"The Trustees shall not...invest in any equity Security, including the shares of other REITs for a period in excess of 18 months, except for shares of a qualified REIT subsidiary, as defined in Section 856(i) of the Internal Revenue Code, and regular or residual interests in REMICs...[or] acquire Securities in any company holding investments or engaging in activities prohibited by this Section...\"\nThe Declaration of Trust defines \"Affiliate\" as follows:\n\"As to any Person, any other Person who owns beneficially, directly or indirectly, 1% or more of the outstanding capital stock, shares, or equity interests of such Person or of any other Person which controls, is controlled by, or is under common control with, such Person or is an officer, retired officer, director, employee, partner, or trustee (excluding independent trustees not otherwise affiliated with the entity) of such Person or of any other Person which controls, is controlled by, or is under common control with, such Person.\"\nITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS (Continued)\nRestrictions on Related Party Transactions (Continued)\nFrom 1990 until January 1995, all related party transactions that the Trust entered into were required to be reviewed by the Related Party Transaction Committee of the Trust's Board of Trustees to determine whether such transactions were (i) fair to the Trust and (ii) were permitted by the Trust's governing documents. Each of the members of the Related Party Transaction Committee was a Trustee who was not an officer, director or employee of BCM, the Trust's advisor, and was not an officer or employee of the Trust. The Related Party Transaction Committee was terminated by the Trust's Board of Trustees on January 11, 1995.\nPursuant to the terms of the Modification of Stipulation of Settlement of the Olive Litigation, which became effective on January 11, 1995, any related party transaction which the Trust may enter into prior to April 27, 1999, will require the unanimous approval of the Trust's Board of Trustees. In addition, related party transactions may only be entered into in exceptional circumstances and after a determination by the Trust's Board of Trustees that the transaction is in the best interests of the Trust and that no other opportunity exists that is as good as the opportunity presented by such transaction.\n___________________________________\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, 1994 and 1993\nConsolidated Statements of Operations - Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Shareholders' Equity - Years Ended December 31, 1994, 1993 and 1992\nConsolidated Statements of Cash Flows - Years Ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\n2. Financial Statement Schedules\nSchedule III - Real Estate and Accumulated Depreciation\nSchedule IV - Mortgage Loans on Real Estate\nAll other schedules are omitted because they are not applicable or because the required information is shown in the Consolidated Financial Statements or the notes thereto.\n3. Exhibits\nThe following documents are filed as Exhibits to this report:\nITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES, AND REPORTS ON FORM 8-K (Continued)\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 date indicated.\nCONTINENTAL MORTGAGE AND EQUITY TRUST\nEXHIBITS TO ANNUAL REPORT ON FORM 10-K\nFor the Year Ended December 31, 1994","section_15":""}
{"filename":"101105_1994.txt","cik":"101105","year":"1994","section_1":"ITEM 1. BUSINESS GENERAL United Cities Gas Company (Cities) was incorporated under the laws of the State of Illinois on September 21, 1929. Cities' predominant business is the distribution of natural gas. As of December 31, 1994, Cities supplied natural gas service to approximately 301,000 customers. In addition to its business of natural gas distribution, Cities sells and installs gas appliances and performs certain appliance service work.\nSince 1984, Cities has significantly increased its customer base by adding approximately 178,000 new customers to its natural gas distribution system. The table below reflects the areas of growth through acquisitions and internal marketing efforts, including population growth within Cities' service areas.\nCities has two wholly-owned subsidiaries. One subsidiary, United Cities Gas Storage Company (UCG Storage), was formed as a Delaware corporation in December, 1989 to provide natural gas storage services. In 1989, a natural gas storage field was purchased in Kentucky to supplement natural gas used by Cities' customers in Tennessee and Illinois. In addition, natural gas storage fields located in Kansas and included in Cities' 1989 acquisition of Union Gas System, Inc. were sold to UCG Storage. These fields are used to supplement natural gas used by Cities' Kansas customers.\nThe other subsidiary, UCG Energy Corporation (UCG Energy), incorporated under the laws of Delaware in 1965, is primarily a broker procuring natural gas for Cities, certain of Cities' industrial customers, local distribution companies and others, and is engaged in exploration and production activities. In addition, UCG Energy leases appliances, real estate, equipment and vehicles to Cities and others.\nUCG Energy has two wholly-owned subsidiaries, United Cities Propane Gas of Tennessee, Inc. and UCG Leasing, Inc. United Cities Propane Gas of Tennessee, Inc., incorporated under the laws of Tennessee in 1976, is engaged in the retail distribution of propane (LP) gas. As of December 31, 1994, the propane operation served approximately 22,000 customers in Tennessee, Virginia and North Carolina. UCG Leasing, Inc. was incorporated under the laws of Georgia in 1987 and leases vehicles, equipment and real estate to Cities.\nCities and its subsidiaries, UCG Storage and UCG Energy and its subsidiaries, are hereinafter referred to collectively as the \"company\".\nThe following table summarizes certain information regarding the operation of each segment of the company's business for the last three years ended December 31,\n(1) Sales to affiliated companies described under \"Subsidiary Operations\".\nUTILITY OPERATIONS GENERAL Cities distributes natural gas under regulated rates to approximately 301,000 customers in the states of Tennessee, Kansas, Georgia, Illinois, Virginia, Missouri, Iowa and South Carolina. Total operating revenues for the year ended December 31, 1994 were $280,984,000, of which approximately 46% was derived from residential customers, 27% from industrial customers, 26% from commercial customers and 1% from other sources. The ten largest customers of Cities accounted for 6.7% of operating revenues in 1994 and the largest of these customers accounted for 2.0%. Cities serves a diverse industrial load with customers engaged in the manufacture of cars, car parts, munitions, wire, textiles, food products, metal fabrication and electronics, among others. Cities also serves several colleges in a major army base.\nCities is currently structured into four operating divisions. The percent of revenues contributed by each division for the three years ended December 31 is as follows:\nThe following table contains information regarding the residential customers and estimated number of households in each service area.\n(1) See page 15 for the map and listing of operating areas by division. (2) Approximate number of households represents management's best estimate using information provided by local Chambers of Commerce, census data, and other available information. (3) See page 10 for detail of total average number of customers by class.\nNATURAL GAS SUPPLY To encourage more competition among natural gas suppliers, the Federal Energy Regulatory Commission (FERC) issued Orders 636, 636-A and 636-B (collectively, Order 636) in 1992. Order 636 required interstate pipelines to unbundle or separate gas sales, transportation and storage services by the 1993-1994 winter heating season. The pipeline sales services were previously combined and sold as a single service. With the implementation of Order 636, the pipelines discontinued their traditional merchant function. Each distribution company is now responsible for obtaining all of its gas supply in the open market. The unbundling of these services allows Cities more flexibility in selecting and managing the type of services required to provide its customers with the lowest possible priced gas while maintaining a reliable gas supply. However, this also places an additional responsibility on Cities to obtain its natural gas supply in the open market on a timely basis to fulfill its commitments during peak demand periods. Management believes that, to date, Cities has been successful in managing its portfolio of spot and term supplies that it purchases from producers and marketers in the open market on the thirteen interstate pipelines on which it operates, resulting in reliable supplies at a competitive price.\nAnother aspect of Order 636 allowed the pipelines to set rates to recover a higher portion of their fixed costs through monthly demand charges. As a result, Cities is charged a higher fixed amount each month, regardless of through-put. Since Cities must contract for pipeline capacity to meet peak demand, this has the effect of increasing Cities' fixed cost of gas. Many elements such as company owned gas storage facilities, peak shaving plants and the liquefied natural gas (LNG) plant and, in some instances, storage contracts with Cities' suppliers are being utilized to reduce these higher pipeline demand charges. Order 636 also required pipelines to set up capacity release mechanisms on their systems to allow holders of firm capacity and firm storage to release these services when they are not needed. Cities is active in releasing capacity during off peak periods and the majority of revenues generated by this activity is used to offset pipeline demand charges. In addition, Cities is promoting competition among pipelines to the maximum extent possible. Various projects are in the planning stages to add additional pipeline suppliers in several of Cities' operating areas. Adding alternatives will provide bargaining power which should, over time, decrease Cities' pipeline capacity costs. Purchased Gas Adjustment (PGA) clauses in effect in each state allow Cities to pass through to its customers, subject to prudency and\/or administrative reviews, any increase or decrease in rates charged to Cities related to the purchase and transportation of natural gas.\nConsiderable planning is required to project demand for the winter period. In order to provide natural gas at the lowest possible price and to meet peak demand, Cities must have a sufficient volume of natural gas in underground storage with its pipeline suppliers, natural gas in UCG Storage's underground storage facilities, and propane and LNG in its own facilities. Cities normally injects gas into pipeline storage systems and UCG Storage's storage system during the summer months and withdraws it in the winter months. At the present time, the underground storage facilities of UCG Storage have a maximum daily output capability of approximately 53,000 Mcf.\nOther storage facilities owned by Cities are used to provide short-term supplies to meet peak demand. Cities has ten propane peak shaving plants with a total capacity of approximately 1,950,000 gallons that can produce an equivalent of 33,859 Mcf daily and a LNG storage facility with a capacity of 500,000 Mcf which can inject a daily volume of 30,000 Mcf in the system. Cities has the ability to serve approximately 60% of its peak day load through the use of company owned storage facilities, storage contracts with Cities' suppliers and peaking facilities throughout the system. This ability provides the operational flexibility and security of supply required to meet the needs of the highly weather sensitive firm market.\nREGULATION In each state in which Cities operates, its rates, services and operations as a natural gas distribution company are subject to general regulation by the state public service commission. Cities' pipeline suppliers, but not Cities, are subject to regulation by the FERC (see \"Utility Operations-Natural Gas Supply\"). Cities' rates, which vary in its different regulatory jurisdictions, are determined by the cost of purchased gas to Cities, rate of return, type of service and volume of use by the customer. In addition, the issuance of securities by Cities is subject to approval by the state commissions, except in South Carolina and Iowa. Missouri only regulates the issuance of debt securities.\nCities operates in each community where necessary under a franchise granted by the municipality for a fixed term of years. To date, Cities has been able to renew franchises and expects to continue to do so in the future. Cities considers the franchises held valid and adequate for the conduct of its business. In each of the service areas where it operates, Cities considers that its rights to maintain gas lines through unincorporated communities over private rights-of-way are, as a group or system, satisfactory for the adequate conduct of the business of Cities. Cities also has all required certificates of convenience and necessity for the operation of its properties and the conduct of its business from the appropriate state public utility regulatory agencies.\nThe Tennessee and Georgia Public Service Commissions approved the implementation of Weather Normalization Adjustments (WNAs) effective in late 1991 and 1990, respectively. The WNAs, effective October through May in Georgia and November through April in Tennessee, allow Cities to increase the base rate portion of bills when weather is warmer than normal and decrease the base rate when weather is colder than normal.\nEffective April 1, 1993, the Virginia State Corporation Commission issued an order stating that Cities' current authorized rates in that state be considered interim and subject to refund pending an investigation to determine whether Cities was earning more than its authorized rate of return and whether the authorized rate of return at that time was appropriate. In addition, the commission staff alleged that Cities overcollected gross receipts tax from its customers for the years 1988 through mid-1993. In an order issued in November, 1994, the commission reduced the company's authorized rate of return in Virginia from 11.26% to 10.26%, resulting in a reduction in annual revenues of $218,000. This reduction was effective April 1, 1993. Excess revenues of approximately $370,000, plus interest, collected under interim rates through December 31, 1994, are to be refunded to Cities' customers. In addition, the commission concluded that Cities had overcollected gross receipts tax from its customers from 1988 through mid-1993 and ordered a refund of $301,000, plus interest. Cities has adequate reserves to cover its liability related to the order.\nIn 1991, the Illinois Commerce Commission ordered Cities to refund approximately $260,000 related to the reconciliation of the PGA recovery mechanism for 1988. Cities filed an appeal with the Appellate Court of Illinois which in September, 1992, issued a decision upholding the commission's decision. Cities filed an appeal with the Illinois Supreme Court which in September, 1994, upheld the commission's and lower court's decision. Cities asked for rehearing of this decision which was subsequently denied. Cities will refund the $260,000, plus interest, beginning in 1995 and has adequate reserves to cover its liability.\nEffective February 7, 1995, Cities received an annual rate increase of $253,000 in the state of South Carolina. Cities had filed on August 8, 1994, to increase rates by $341,000 on an annual basis.\nOn January 27, 1995, Cities filed to increase rates on an annual basis by $4,200,000 in the state of Kansas. On November 8, 1994, Cities filed to increase rates by $1,100,000 on an annual basis in the state of Missouri. Cities expects that any increase granted in these two states will be effective by the third quarter of 1995.\nEffective July, 1993, the Missouri Public Service Commission authorized an annual rate increase in the amount of $425,000 in Missouri. Cities had filed to increase rates by $1,200,000 on an annual basis. Effective January 12, 1993, Cities received an annual rate increase of $915,000 in the state of Kansas. Cities had filed to increase rates by $6,300,000 on an annual basis.\nEffective November 1, 1992, Cities was granted an annual rate increase of $1,900,000 in Georgia. This amount included an annual increase of $1,475,000 in revenue and a rider for an additional $425,000 to be collected in each of the three years after November 1, 1992, related to the response action costs incurred at a manufactured gas plant site. Cities had requested an increase of $3,200,000 in Georgia.\nEffective October 1, 1992, Cities received an annual rate increase of $1,700,000 in the state of Tennessee. Cities had filed to increase rates by $2,900,000 on an annual basis. As a part of a settlement agreement entered into in connection with the rate increase, Cities agreed to a management audit. The management audit report was issued in 1994. Management agreed with a majority of the recommendations made by the auditors and a number of recommendations are currently in the process of being implemented. Other recommendations are being evaluated and may be implemented in the future. In April, 1995, Cities will report to the Tennessee Public Service Commission its progress in addressing the issues raised by the auditors. Management does not believe that the implementation of the recommendations will have a material effect on the company's results of operations or financial condition.\nIn 1990, Cities received an order from the Kansas State Corporation Commission allowing Cities to defer, pending approval in rate cases, certain safety-related costs, depreciation on safety-related capital expenditures, and carrying charges on the total. As of December 31, 1991, costs totaling $1,378,000 and $2,706,000 were deferred for the years 1991 and 1990, respectively. The Kansas commission approved in rates effective January, 1993, deferral and recovery of $949,000 and $1,275,000 related to 1991 and 1990, respectively. Each of these amounts are being amortized over a five year period. The difference in the approved cost and the cost previously deferred was expensed in 1992.\nIn addition, in 1990 and 1992, the Missouri Public Service Commission issued orders allowing Cities to defer, pending approval in rate cases, similar safety-related costs. In 1989 through 1992, costs of $833,000 were deferred. After reaching stipulated agreements in rate proceedings, Cities discontinued deferring these costs and began amortizing $600,000 in 1992 and $233,000 in 1993 over five year periods.\nThe FERC has permitted pipelines to recover from their customers, including Cities, the prudently incurred costs of implementing Order 636, referred to as transition costs. As of December 31, 1994 and 1993, based on current pipeline transition cost filings with the FERC, Cities had accrued and deferred $6,739,000 and $1,845,000, respectively, as its estimated share of the remaining liability related to these transition costs. Because there are pipeline requests not yet filed with the FERC, the 1994 estimate may differ from the final amount of future transition costs recovered from Cities. Cities has been granted permission through approved PGA filings or specific orders in all the states in which it operates to recover these transition costs from its customers.\nCities' pipeline suppliers have liabilities to producers for payments under purchase contracts for quantities of gas for which deliveries have not been taken. Pipeline suppliers received permission from the FERC to recover from their customers, including Cities, a portion of their take-or-pay liabilities. Cities has been granted permission in all of the states in which it operates to recover from its customers any take-or-pay costs. Total deferred but unrecovered take-or-pay costs were $2,415,000 and $2,384,000 as of December 31, 1994 and 1993, respectively.\nIn December, 1990, the FASB issued Statement No. 106 (SFAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The company adopted the statement effective January 1, 1993. The statement requires the company to record the expected costs of postretirement health and life insurance benefits during the years the employees render service. This was a change from the company's previous policy of recognizing these costs on a cash basis. The annual cash payments for such benefits were $807,000 in 1992. Costs related to these benefits calculated in accordance with SFAS 106 amounted to $1,649,000 and $1,331,000 in 1994 and 1993, respectively. The accumulated benefit obligation of $8,894,000 existing at January 1, 1993, is being amortized over a twenty year period as allowed by SFAS 106.\nCities has received approval to recover SFAS 106 costs in South Carolina, Kansas, Iowa and Illinois. The Tennessee commission has approved the recovery of these costs and is allowing Cities to defer the difference between cash payments and SFAS 106 expense until the next rate proceeding in that state. The Virginia commission has approved the recovery of SFAS 106 costs in rates. However, the accumulated benefit obligation will be recovered over forty years as opposed to the twenty year amortization period allowed by SFAS 106. The Georgia and Missouri commissions did not render decisions on SFAS 106 in Cities' last rate proceedings in those states. However, the Missouri legislature has subsequently passed a statute allowing utilities to recover SFAS 106 costs. As required by some commissions, Cities has established a trust fund to accumulate the difference between the cash payments for postretirement benefits and SFAS 106 expense.\nSet forth below is a table containing information relating to the state regulatory bodies which have jurisdiction over Cities and its rates. Amounts realized from rate increases may differ significantly from amounts authorized depending on volumes of gas sold and customer mix.\n- -------------------------------------------------------------------------- (1) The court awarded an additional increase in rates which were effective October, 1992. (2) Because the 1993 rate case was stipulated, the returns on investment and equity were not agreed upon. These rates represent the last authorized rates for the entity acquired by Cities.\nUTILITY OPERATING STATISTICS\n(1) Residential, industrial firm and certain commercial customers are entitled to receive gas service on a continuous, uninterrupted basis subject to the application of their priority classification in the event of gas shortages. Industrial interruptible and certain commercial customers receive a low cost, load balancing service, which permits Cities to interrupt service and which is limited to users with alternative fuel sources for use when service is interrupted. Interruptible rates are generally lower than firm rates.\n(2) The following table classifies the effect of changes in volumes (Mcfs) of natural gas delivered during 1994, 1993 and 1992.\nACQUISITIONS Effective March 1, 1994, the company purchased the natural gas system in Palmyra, Missouri from Western Resources, Inc. for approximately $665,000. The company also obtained a ten year non-compete agreement. Consideration for the agreement is contingent upon volumes sold to a certain industrial customer with payments made over a three year period, not to exceed $720,000. The system serves approximately 1,400 natural gas customers.\nSEASONAL NATURE OF BUSINESS Cities' business is highly seasonal in nature and heavily dependent upon weather due to Cities' substantial heating load. In order to moderate the impact of weather on the financial results of the utility operation, Cities sought and received approval from the Tennessee and Georgia commissions to implement Weather Normalization Adjustments (WNAs). See \"Utility Operations-Regulation\" for additional information concerning WNAs. Cities' business will still be seasonal in nature resulting in greater earnings during the winter months and will continue to be dependent upon weather, especially in those states where a WNA has not been implemented. However, Cities seeks to minimize the quarterly variations in sales volumes and earnings by sales to industrial customers and the diversified activities of its unregulated subsidiaries. See chart of quarterly earnings on page 44 for the years 1994 and 1993.\nOTHER UTILITY OPERATIONS In addition to its sales of natural gas, Cities engages in direct merchandising and repair of gas appliances. The following table summarizes revenues from these sources for 1994, 1993 and 1992.\nSUBSIDIARY OPERATIONS\nUNITED CITIES GAS STORAGE COMPANY\nUCG Storage is engaged in constructing, maintaining and operating gas wells for natural gas storage. UCG Storage owns and operates storage fields in Kentucky and Kansas. The storage fields provide a mechanism to purchase and store gas for distribution during the winter. In addition to providing peak shaving gas, the storage facilities can also be used to balance gas supplies, allowing extra gas to be diverted into the field when contract demand is not needed and withdrawn when gas usage exceeds contract demand. Included in the revenues of UCG Storage are affiliated revenues of $7,037,000, $8,749,000 and $7,613,000 in 1994, 1993 and 1992, respectively, for storage services and natural gas provided to Cities' customers in Tennessee, Kansas and Illinois.\nThe following table provides information about the storage fields.\nUCG ENERGY CORPORATION AND SUBSIDIARIES\nThe activities of UCG Energy and its subsidiaries are described below.\nPROPANE DIVISION\nThe Propane Division currently operates through United Cities Propane Gas of Tennessee, Inc. (UCPT), a wholly-owned subsidiary of UCG Energy. In addition to the retail distribution of propane (LP) gas, the Propane Division engages in direct merchandising and repair of propane gas appliances. Each town operation has its own storage facility with a total Propane Division storage capacity of 1,746,000 gallons.\nThe following table contains information, as of December 31, 1994, regarding the number of customers.\nEffective January 1, 1995, UCPT purchased substantially all the assets of Harrell Propane, Inc. for approximately $1,383,000. In addition, UCPT entered into ten year non-compete agreements with the prior owners for $250,000, to be paid over an eight year period. This acquisition added approximately 1,300 customers in the Murfreesboro, Tennessee area.\nEffective April 14, 1994, UCPT purchased all the assets of Hurley's Propane Gas for approximately $938,000. In addition, UCPT entered into ten year non-compete agreements with the prior owners for $100,000, to be paid over a five year period. This acquisition added approximately 700 customers in the Morristown, Tennessee area.\nEffective August 1, 1993, UCPT purchased the issued and outstanding shares of common stock of High Country Propane, Inc. for $1,600,000, less liabilities assumed of $820,000. In addition, UCPT obtained a ten year non-compete agreement for $100,000, to be paid over a five year period. This acquisition added approximately 1,400 customers in the Boone, North Carolina area.\nIn 1994, 1993 and 1992, the Propane Division contributed 54%, 47% and 52%, respectively, of UCG Energy's total revenues. Of UCG Energy's gross properties at December 31, 1994, approximately 37% was related to the Propane Division.\nRENTAL DIVISION\nUCG Energy's Rental Division, which includes UCG Leasing, Inc., leases real estate, vehicles, and other equipment to Cities and real estate and appliances to non-affiliated third parties. The Rental Division's revenues were approximately 17% in 1994, 17% in 1993 and 20% in 1992, of UCG Energy's total revenues. Included in the revenues of the Rental Division are affiliated revenues of $5,827,000, $6,042,000 and $5,805,000 for the years 1994, 1993 and 1992, respectively, representing rental charges to Cities for transportation equipment and office facilities. Of UCG Energy's gross properties at December 31, 1994, approximately 63% was related to the Rental Division.\nUTILITY SERVICES DIVISION\nUCG Energy's Utility Services Division is active in other energy related activities. The Utility Services Division is primarily a broker procuring natural gas for Cities, certain of Cities' industrial customers, local distribution companies and others, and is engaged in exploration and production activities. The revenues from these activities were approximately 29% in 1994, 36% in 1993 and 28% in 1992, of UCG Energy's total revenues. Included in the Utility Services Division's revenues are affiliated revenues of $701,000, $1,139,000 and $1,519,000 for the years 1994, 1993 and 1992, respectively. These revenues represent purchases by Cities of energy-related products from the Utility Services Division. A decision to discontinue the distribution of energy-related products by the Utility Services Division was made by management in 1994. The discontinuance of this activity of the Utility Services Division is not expected to materially affect the results of operations or financial condition of the company and is expected to be completed by mid-1995.\nDuring the first quarter of 1995, UCG Energy purchased a 45% interest in certain contracts related to the gas marketing business of Woodward Marketing, Inc. (WMI), a Texas corporation. In exchange for the acquired interest, the shareholders of WMI will receive $5,000,000 in Cities' common stock, pending regulatory approval, and $750,000 in cash and may, if certain earnings targets are met, receive an additional payment of $1,000,000 to be paid over a five year period. In exchange for its own gas marketing contracts and the acquired 45% interest in the WMI gas marketing contracts, UCG Energy received a 45% interest in a newly formed limited liability company, Woodward Marketing, L.L.C. (WMLLC). WMI received a 55% interest in WMLLC in exchange for its remaining 55% interest in the WMI gas marketing contracts. WMLLC will provide gas marketing services to industrial customers, municipalities and local distribution companies. UCG Energy will utilize equity accounting, effective January 1, 1995, for the acquisition.\nCOMPETITION Cities distributes natural gas primarily to residential, commercial and high-priority industrial users and intends to aggressively seek additional numbers of such customers. Competition exists between natural gas and other forms of energy available to customers. Cities is experiencing competition for each class of customer; electricity is the primary competition for residential and commercial customers, and #2 and #6 fuel oil is the primary competition for industrial customers. In addition, certain customers, primarily industrial, may have the ability to by-pass Cities' distribution system by connecting directly with a pipeline.\nCities has received approval from all the public service commissions in the states in which it operates, except Iowa, to place into effect a negotiated tariff rate which allows Cities to maintain industrial loads at lower margin rates. Iowa has rules which allow for flexible rates. These rates are competitive with the price of alternative fuels. In addition, certain industrial customers have changed from firm to interruptible rate schedules in order to obtain natural gas at a lower cost rather than change to an alternative fuel source. Additionally, Cities has received approval from all state commissions to provide transportation service of customer-owned gas to end users (see Item 1. Business. \"Utility Operations-Natural Gas Supply\").\nUCG Energy's propane subsidiary is in competition with other suppliers of propane, natural gas and electricity. Competition exists in the areas of price and service. The wholesale cost of propane is subject to fluctuations primarily based on demand, availability of supply and product transportation costs. Propane storage facilities can be utilized to store purchased gas when the cost is more economical, thus enabling UCG Energy to more competitively price its product. However, during periods of colder than normal weather, when demand is high, UCG Energy may have to replace its supply of gas at higher costs, which may require UCG Energy to sell at reduced margins to match its competition.\nThe Utility Services Division of UCG Energy competes with other natural gas brokers in obtaining natural gas supplies for customers. The Rental Division competes with other rental companies.\nUCG Storage charges rates to Cities that are subject to review by the various commissions in the states within which the storage service is provided to Cities. Therefore, UCG Storage's rates must be competitive with other storage facilities. UCG Storage also stores natural gas for unrelated third parties. As a result, UCG Storage is in competition with other companies that store natural gas as to rates charged and deliverability of natural gas. Storage agreements between UCG Storage and Cities give Cities first priority to any storage services.\nPERSONNEL At December 31, 1994, the company employed 1,343 full time employees, including 102 who are represented by a union. An election is scheduled for April 7, 1995, in Columbus, Georgia for 96 employees to determine if they would like to be represented by a union. Of the full time employees, 243 are engaged in the operations of the Illinois\/Tennessee\/Missouri Division, 281 in the Virginia\/East Tennessee Division, 241 in the Georgia\/South Carolina Division, 284 in the Kansas\/Iowa\/Missouri Division, 174 administrative and supervisory personnel in the corporate office, and 120 in UCG Energy's operating locations. At December 31, 1994, there were 587 employees participating in the employee stock purchase plan and 1,024 employees participating in the company's 401k savings plan. The company considers its employee relations to be excellent. All corporate general and administrative functions, as well as the overseeing of engineering, marketing, accounting, finance, operations and human resources are handled at the company's corporate offices in Brentwood and Franklin, Tennessee. Direct functions dealing with engineering, marketing, accounting, operations and human resources for the service locations of each division are handled at the division levels.\nEXECUTIVE OFFICERS OF THE COMPANY\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES Cities' properties are located in operating areas as indicated on page 15, and consist primarily of approximately 7,064 miles of distribution and transmission mains and approximately 5,353 miles of service lines connecting the mains to customers' premises. The company also owns and operates ten peak shaving plants and a LNG plant, as well as underground storage fields which are used to supplement the supply of natural gas in periods of peak demand (see Item 1. Business. \"Utility Operations-Natural Gas Supply\").\nSubstantially all of Cities' property is subject to the lien of the Indenture of Mortgage securing Cities' First Mortgage Bonds. The following table sets forth the percentages of property located in the various operating divisions.\nThe capital budget for the company for 1995 is approximately $41,700,000 (utility, $36,900,000 and non-utility, $4,800,000). Cities is constructing a twenty-eight mile main which will connect two of its fastest growing distribution systems located in Middle Tennessee and is designed to provide Cities' current customers with the lowest possible priced gas through increased gas supply flexibility. Included in the 1995 utility budget is approximately $5,000,000 related to this project, which is scheduled to be completed by the fall heating season of 1995. The company anticipates capital expenditures of approximately $28,400,000 in 1996 and $30,400,000 in 1997. These reflect the normal growth in Cities' service areas along with the increased demands for natural gas and propane (LP) service.\nCities follows a regular program of improvements and additions to its properties. Utility plant additions during 1994 amounted to approximately $30,888,000 for system upgrading, relocations, and providing new mains, service lines and metering equipment. In addition, included in the 1994 capital expenditures is $3,700,000 related to the construction of the twenty-eight mile main in Middle Tennessee. Total utility property at December 31, 1994 amounted to $403,121,000.\nNon-utility property additions during 1994 amounted to approximately $4,228,000 (UCG Energy, $4,111,000 and UCG Storage, $117,000). The majority of UCG Energy's 1994 additions are related to transportation equipment, rental equipment and facilities and propane related equipment. The upgrading of underground storage facilities accounts for the majority of property additions for UCG Storage. Gross non-utility property as of December 31, 1994 amounted to $71,222,000 (UCG Energy, $52,557,000 and UCG Storage, $18,665,000).\nThe following table sets forth information with respect to utility property additions, excluding acquisitions, made by Cities during each of the five years ended December 31.\nThe company believes its facilities are suitable and adequate for the purpose of serving the needs of its customers.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. Except as set forth in Item 1. Business, \"Utility Operations-Regulation\" and below, there is no material litigation involving the company as of December 31, 1994. There are certain claims which are adequately covered by liability insurance or reserves.\nThe company was named, along with 26 other defendants, in a class action, anti-trust case filed March 5, 1993 in the United States District Court for the Eastern District of Tennessee, Knoxville Division (the Court). This action involves alleged price-fixing in the 1980's in eastern Tennessee. The Court denied the plaintiffs' class certification motions, but granted the plaintiffs the right to pursue individual claims against the defendants, including the company. The Tennessee Attorney General also filed a motion for class certification on behalf of all individuals and businesses in the east Tennessee area. In February, 1995, the company reached a settlement agreement with the Tennessee Attorney General, pending the Court's approval, in the amount of $80,000. The settlement agreement\nITEM 3. LEGAL PROCEEDINGS (CONTINUED) includes a provision which allows the company to cancel the settlement if 10% or more of the individual class members or business class members option out of the settlement class. The company has adequate reserves to cover the settlement of this case. However, management cannot predict the number, if any, of individual claims that may subsequently be filed related to this case. In management's opinion, the resolution of any individual claim subsequently filed will not have a material effect on the results of operations or financial condition of the company.\nDuring 1994, Cities discovered defects in the polyethylene piping installed in certain of its service areas. Cities has notified both the manufacturers of the defective piping and the state regulatory commissions in such service areas. An independent laboratory is conducting a study of the matter at the request of the gas industry and the manufacturers. Cities also continues to conduct its own investigation into the issue. Cities is unable to predict the extent of the problem or the expense which will be incurred to repair the defective piping but anticipates recovering the cost from the manufacturers or through the ratemaking process as a normal maintenance expense.\nCities is the owner or previous owner of manufactured gas plant sites which were used to supply gas prior to the availability of natural gas. Manufactured gas was an inexpensive source of fuel for lighting and heating nationwide. As a result of the gas manufacturing process, certain by-products and waste materials, including coal-tar, were produced and may have been accumulated at the plant sites. This was an acceptable and satisfactory process at the time of operations. Under current environmental protection laws and regulations, Cities may be responsible for response action with respect to such materials, if response action is necessary.\nCities identified a site in Columbus, Georgia, and along with other responsible parties, has performed response action. Cities' share of response action costs at this site totaled approximately $1,324,000. Of this amount, $1,275,000 was requested and approved to be recovered over a three year period in rates which were effective November, 1992. The approved amount did not include carrying costs on the deferred balance. Cities will request and expects approval to recover the remaining costs either in its next rate proceeding in Georgia or as an extension of the rider.\nCities has joined with three other potentially responsible parties (PRPs) to fund a response investigation and feasibility study of a site in Keokuk, Iowa. Cities has incurred costs totaling $129,000 and has, based on available current information, accrued an additional $644,000 for its share of possible response action. Cities has deferred $494,000 of the accrued amount and expects approval for recovery in its next rate proceeding in Iowa. Cities has estimated that it may incur, if certain adverse conditions are found to exist, an additional $856,000 of response action costs at this site.\nCities owns or may be the successor in interest to the previous owner of four additional former manufactured gas plant sites. Cities is unaware of any information which suggests that these sites give rise to a present health or environmental risk as a result of the manufactured gas process or that any response action will be necessary. Accordingly, Cities has not accrued any liabilities associated with these four sites.\nPursuant to the Tennessee Petroleum Underground Storage Tank Act (the Act), Cities is required to upgrade or remove certain underground storage tanks (USTs) situated in Tennessee. As of December 31, 1994, Cities has identified eight USTs in this category in Tennessee and has incurred $30,000 and, based on available current information, accrued an additional $70,000 for the upgrade or removal of these USTs. Cities has estimated that it may incur, if certain adverse conditions are found to exist, additional costs of up to $380,000 to bring the sites into compliance with the Act. On October 4, 1994, the Tennessee Public Service Commission granted Cities permission to defer, until its next rate case, all costs incurred in connection with state and federally mandated environmental control requirements. In addition, Cities may be able to recover a portion of the corrective action costs from the State of Tennessee Trust Fund for all of the UST sites in Tennessee.\nCities has identified three USTs in Virginia and has, based on available current information, accrued and deferred for recovery $23,000 as of December 31, 1994, for the closure of these sites. Cities has estimated that it may incur, if certain adverse conditions are found to exist, additional costs of up to $202,000 in responding to these sites. Cities expects recovery of any costs incurred related to the closure of these sites.\nCities has reviewed and commented on a proposed Consent Order from the Kansas Department of Health and Environment (KDHE) regarding mercury contamination at gas pipeline sites. The KDHE has identified the need to investigate gas industry activities which utilize mercury equipment in Kansas. Cities is cooperating with the KDHE in preparing a Consent Order and a Work Plan for responding to mercury contamination at any site which is identified as exceeding the KDHE's established acceptable concentration levels. As of December 31, 1994, Cities has identified approximately 720 meter sites where mercury may have been used and has incurred $20,000 and, based on available current information, accrued and deferred for recovery an additional $280,000 for the investigation of these sites. Cities has estimated that it may incur an additional amount of up to $4,100,000 over the next seven years in responding\nITEM 3. LEGAL PROCEEDINGS (CONTINUED) to a future administrative order for those sites, if any, that exceed the KDHE's established acceptable concentration levels. Based on a recent decision by the Kansas State Corporation Commission concerning the recovery of environmental response action costs incurred by another company, Cities expects recovery of the costs involved in the investigation and response action associated with the mercury meter sites in Kansas.\nManagement expects that future expenditures related to response action at any site will be recovered through rates or insurance, or shared among other PRPs. Therefore, the costs of responding to these sites are not expected to materially affect the results of operations or financial condition of the company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.\nPART II ITEM 5.","section_5":"ITEM 5. MARKET FOR CITIES' COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.\nAPPROXIMATE NUMBER OF STOCKHOLDERS\nThe Common Stock of Cities is traded over-the-counter on the NASDAQ National Market System under the symbol UCIT. The high and low closing sales prices compiled from quotations supplied by the NASDAQ National Market System Statistical Report were as follows:\nAt its regularly scheduled meeting held on January 28, 1995, the Board of Directors declared a quarterly dividend of $.255 per share. Dividends have been paid by Cities' for the past 158 consecutive quarters.\nThe Common Stock is entitled to dividends when, as and if declared by the Board of Directors, subject to various limitations on the declaration or payment of dividends imposed by the provisions of Cities' Indenture of Mortgage and Articles of Incorporation. Under these provisions, none of the company's retained earnings at December 31, 1994, was unavailable to pay dividends on the Common Stock.\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- - -\nThe company is primarily a distributor of natural and propane gas serving approximately 325,000 customers in parts of ten states. The financial condition and results of operations of the company are significantly affected by the weather and the regulatory environment in the eight states in which it distributes natural gas. The following discussion focuses on the financial condition and results of operations for the company for the past three years and its future plans.\nLIQUIDITY AND CAPITAL RESOURCES At December 31, 1994, the company's capitalization ratios consisted of 45% common stock equity and 55% long-term debt. The company's goal is to have a common stock equity ratio of approximately 50%. This will enable the company to maintain its current credit integrity and continue to allow access to relatively low cost financing. The company plans to achieve its goal by the issuance of stock through public stock offerings and the employee stock purchase, customer stock purchase, dividend reinvestment and long-term stock plans; and increased retained earnings. A substantial portion of the company's cash requirements is to fund its ongoing construction program in order to provide natural gas services to a growing customer base. Capital expenditures for the company's utility and non-utility operations totaled $35,100,000, $31,000,000 and $28,900,000 in 1994, 1993 and 1992, respectively. In addition to its ongoing construction program, the company is constructing a twenty-eight mile main which will connect two of its fastest growing distribution systems located in Middle Tennessee and is designed to provide the company's current customers with the lowest possible priced gas through increased gas supply flexibility. Included in the 1994 utility capital expenditures stated above is $3,700,000 related to this project. Capital expenditures totaling $36,900,000 for the utility operations and $4,800,000 for the non-utility operations are budgeted for 1995. Included in the 1995 utility budget is approximately $5,000,000 related to the Middle Tennessee project, which is scheduled to be completed by the fall heating season of 1995. Total capital expenditures for 1996 and 1997 are expected to be approximately $28,400,000 and $30,400,000, respectively. The nature of the company's business is highly seasonal and weather sensitive. During 1994, 71% of the company's revenues were attributable to gas sold in the first and fourth quarters. During the non-heating season, the company uses short-term debt as a means of funding its ongoing construction program and working capital requirements, which includes the purchase of gas for storage to be used during the heating season. The short-term debt is retired with cash from operations or long-term securities, whichever management deems appropriate. At December 31, 1994, the company had total short-term lines of credit of $84,000,000 in the form of master and banker's acceptance notes bearing interest primarily at the lesser of prime or a negotiated rate during the term of each borrowing. Under these arrangements, $46,188,000 in short-term debt was outstanding at December 31, 1994. The company has filed a shelf registration statement with the Securities and Exchange Commission (SEC) and the appropriate regulatory authorities which, when declared effective by the SEC and approved by such regulatory authorities, will give the company the flexibility to issue from time to time in one or more public offerings up to $200,000,000 of its securities which may include common stock, unsecured notes and\/or first mortgage bonds. Proceeds from the issuance of securities under the company's shelf registration statement may be used to retire long-term debt, repay short-term borrowings, finance the company's construction program and for other corporate purposes. The company plans to issue between $45,000,000 and $55,000,000 in securities under the shelf registration statement during 1995. In 1994, the company implemented a customer stock purchase plan whereby residents in the company's service territory can make a one-time purchase of common stock at a 5% discount below the average market value. A participant can invest any amount ranging from $250 to $10,000. During 1994, 147,148 shares of common stock were issued under the new plan resulting in net proceeds to the company of approximately $2,099,000. In May, 1992, the company issued 1,380,000 shares of common stock in a public offering, resulting in net proceeds of approximately $17,400,000. The proceeds from this offering were used to repay short-term borrowings, finance the company's construction program and for other corporate purposes. The company did not issue any long-term debt in 1994. In 1993 and 1992, the company issued long-term debt of $150,000 and $43,750,000, respectively. The proceeds of long-term debt in 1992 included the issuance of Series U and V First Mortgage Bonds totaling $30,000,000, a senior secured term note of $5,500,000 in United Cities Gas Storage Company, and $8,250,000 of long-term debt in UCG Energy Corporation. The proceeds of these debt issuances were used to repay short-term borrowings, finance the company's ongoing construction program and for other corporate purposes. At December 31, 1994, the company had bondable property to support a first mortgage bond issuance of approximately $41,300,000. In connection with the filing of the shelf registration statement, the company plans to enter into an indenture\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n- - - under which the company may issue, without limitation as to aggregate principal amount, unsecured notes. In 1995, capital expenditures, long-term debt maturities, sinking fund requirements and dividend payments are expected to be provided by internally generated cash, issuance of stock through the company's various stock purchase plans, short-term borrowings and issuances of securities under the shelf registration statement.\nREGULATORY MATTERS Effective April 1, 1993, the Virginia State Corporation Commission issued an order stating that the company's current authorized rates in that state be considered interim and subject to refund pending an investigation to determine whether the company was earning more than its authorized rate of return and whether the authorized rate of return at that time was appropriate. In addition, the commission staff alleged that the company overcollected gross receipts tax from its customers for the years 1988 through mid-1993. In an order issued in November, 1994, the commission reduced the company's authorized rate of return in Virginia from 11.26% to 10.26%, resulting in a reduction in annual revenues of $218,000. This reduction was effective April 1, 1993. Excess revenues of approximately $370,000, plus interest, collected under interim rates through December 31, 1994, are to be refunded to the company's customers. In addition, the commission concluded that the company had overcollected gross receipts tax from its customers from 1988 through mid-1993 and ordered a refund of $301,000, plus interest. The company has adequate reserves to cover its liability related to the order. In 1991, the Illinois Commerce Commission ordered the company to refund approximately $260,000 related to the reconciliation of the Purchased Gas Adjustment (PGA) recovery mechanism for 1988. The company filed an appeal with the Appellate Court of Illinois which in September, 1992, issued a decision upholding the commission's decision. The company filed an appeal with the Illinois Supreme Court which in September, 1994, upheld the commission's and lower court's decision. The company asked for rehearing of this decision which was subsequently denied. The company will refund the $260,000, plus interest, beginning in 1995 and has adequate reserves to cover its liability. Effective February 7, 1995, the company received an annual rate increase of $253,000 in the state of South Carolina. The company had filed on August 8, 1994, to increase rates by $341,000 on an annual basis. On January 27, 1995, the company filed to increase rates on an annual basis by $4,200,000 in the state of Kansas. On November 8, 1994, the company filed to increase rates by $1,100,000 on an annual basis in the state of Missouri. The company expects that any increase granted in these two states will be effective by the third quarter of 1995. Effective July, 1993, the Missouri Public Service Commission authorized an annual rate increase in the amount of $425,000 in Missouri. The company had filed to increase rates by $1,200,000 on an annual basis. Effective January 12, 1993, the company received an annual rate increase of $915,000 in the state of Kansas. The company had filed to increase rates by $6,300,000 on an annual basis. Effective November 1, 1992, the company was granted an annual rate increase of $1,900,000 in Georgia. This amount included an annual increase of $1,475,000 in revenue and a rider for an additional $425,000 to be collected in each of the three years after November 1, 1992, related to the response action costs incurred at a manufactured gas plant site. The company had requested an increase of $3,200,000 in Georgia. Effective October 1, 1992, the company received an annual rate increase of $1,700,000 in the state of Tennessee. The company had filed to increase rates by $2,900,000 on an annual basis. As a part of a settlement agreement entered into in connection with the rate increase, the company agreed to a management audit. The management audit report was issued in 1994. Management agreed with a majority of the recommendations made by the auditors and a number of recommendations are currently in the process of being implemented. Other recommendations are being evaluated and may be implemented in the future. In April, 1995, the company will report to the Tennessee Public Service Commission its progress in addressing the issues raised by the auditors. Management does not believe that the implementation of the recommendations will have a material effect on the company's results of operations or financial condition. In 1990, the company received an order from the Kansas State Corporation Commission allowing the company to defer, pending approval in rate cases, certain safety-related costs, depreciation on safety-related capital expenditures, and carrying charges on the total. As of December 31, 1991, costs totaling $1,378,000 and $2,706,000 were deferred for the years 1991 and 1990, respectively. The Kansas commission approved in rates effective January, 1993, deferral and recovery of $949,000 and $1,275,000 related to 1991 and 1990, respectively. Each of these amounts are being amortized over a five year period. The company expensed in 1992 the difference in the approved cost and the cost previously deferred. In addition, in 1990 and 1992, the Missouri Public Service Commission issued orders allowing the\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n- - -\ncompany to defer, pending approval in rate cases, similar safety-related costs. In 1989 through 1992, costs of $833,000 were deferred. After reaching stipulated agreements in rate proceedings, the company discontinued deferring these costs and began amortizing $600,000 in 1992 and $233,000 in 1993 over five year periods. The Georgia and Tennessee Public Service Commissions have approved Weather Normalization Adjustments (WNAs). The WNAs, effective October through May each year in Georgia and November through April each year in Tennessee, allow the company to increase the base rate portion of customers' bills when weather is warmer than normal and decrease the base rate when weather is colder than normal. The net effect of the WNAs was an increase in revenues of $2,050,000, $324,000 and $1,038,000 in 1994, 1993 and 1992, respectively.\nENVIRONMENTAL MATTERS The company is the owner or previous owner of manufactured gas plant sites which were used to supply gas prior to the availability of natural gas. Manufactured gas was an inexpensive source of fuel for lighting and heating nationwide. As a result of the gas manufacturing process, certain by-products and waste materials, including coal-tar, were produced and may have been accumulated at the plant sites. This was an acceptable and satisfactory process at the time of operations. Under current environmental protection laws and regulations, the company may be responsible for response action with respect to such materials, if response action is necessary. The company identified a site in Columbus, Georgia, and along with other responsible parties, has performed response action. The company's share of response action costs at this site totaled approximately $1,324,000. Of this amount, $1,275,000 was requested and approved to be recovered over a three year period in rates which were effective November, 1992. The approved amount did not include carrying costs on the deferred balance. The company will request and expects approval to recover the remaining costs either in its next rate proceeding in Georgia or as an extension of the rider. The company has joined with three other potentially responsible parties (PRPs) to fund a response investigation and feasibility study of a site in Keokuk, Iowa. The company has incurred costs totaling $129,000 and has, based on available current information, accrued an additional $644,000 for its share of possible response action. The company has deferred $494,000 of the accrued amount and expects approval for recovery in its next rate proceeding in Iowa. The company has estimated that it may incur, if certain adverse conditions are found to exist, an additional $856,000 of response action costs at this site. The company owns or may be the successor in interest to the previous owner of four additional former manufactured gas plant sites. The company is unaware of any information which suggests that these sites give rise to a present health or environmental risk as a result of the manufactured gas process or that any response action will be necessary. Accordingly, the company has not accrued any liabilities associated with these four sites. Pursuant to the Tennessee Petroleum Underground Storage Tank Act (the Act), the company is required to upgrade or remove certain underground storage tanks (USTs) situated in Tennessee. As of December 31, 1994, the company has identified eight USTs in this category in Tennessee and has incurred $30,000 and, based on available current information, accrued an additional $70,000 for the upgrade or removal of these USTs. The company has estimated that it may incur, if certain adverse conditions are found to exist, additional costs of up to $380,000 to bring the sites into compliance with the Act. On October 4, 1994, the Tennessee Public Service Commission granted the company permission to defer, until its next rate case, all costs incurred in connection with state and federally mandated environmental control requirements. In addition, the company may be able to recover a portion of the corrective action costs from the State of Tennessee Trust Fund for all of the UST sites in Tennessee. The company has identified three USTs in Virginia and has, based on available current information, accrued and deferred for recovery $23,000 as of December 31, 1994, for the closure of these sites. The company has estimated that it may incur, if certain adverse conditions are found to exist, additional costs of up to $202,000 in responding to these sites. The company expects recovery of any costs incurred related to the closure of these sites. The company has reviewed and commented on a proposed Consent Order from the Kansas Department of Health and Environment (KDHE) regarding mercury contamination at gas pipeline sites. The KDHE has identified the need to investigate gas industry activities which utilize mercury equipment in Kansas. The company is cooperating with the KDHE in preparing a Consent Order and a Work Plan for responding to mercury contamination at any site which is identified as exceeding the KDHE's established acceptable concentration levels. As of December 31, 1994, the company has identified approximately 720 meter sites where mercury may have been used and has incurred $20,000 and, based on available current information,\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n- - -\naccrued and deferred for recovery an additional $280,000 for the investigation of these sites. The company has estimated that it may incur an additional amount of up to $4,100,000 over the next seven years in responding to a future administration order for those sites, if any, that exceed the KDHE's established acceptable concentration levels. Based on a recent decision by the Kansas State Corporation Commission concerning the recovery of environmental response action costs incurred by another company, the company expects to be allowed recovery of the costs involved in the investigation and response action associated with the mercury meter sites in Kansas. Management expects that future expenditures related to response action at any site will be recovered through rates or insurance, or shared among other PRPs. Therefore, the costs of responding to these sites are not expected to materially affect the results of operations or financial condition of the company.\nGAS SUPPLY In 1992, the Federal Energy Regulatory Commission (FERC) issued Orders 636, 636-A, and 636-B. These orders required interstate pipelines to unbundle or separate gas sales, transportation and storage services by the 1993-1994 winter season. The pipeline sales services were previously combined and sold as a single service. The unbundling of these services has allowed the company more flexibility in selecting and managing the type of services required to provide its customers with the lowest possible priced gas while maintaining reliable gas supply. The FERC has permitted pipelines to recover from their customers, including the company, the prudently incurred costs of implementing these orders, referred to as transition costs. As of December 31, 1994 and 1993, based on current pipeline transition cost filings with the FERC, the company had accrued and deferred $6,739,000 and $1,845,000, respectively, as its estimated share of the remaining liability related to these transition costs. Because there are pipeline requests not yet filed with the FERC, the 1994 estimate may differ from the final amount of future transition costs recovered from the company. The company has been granted permission through approved PGA filings or specific orders in all the states in which it operates to recover these transition costs from its customers. The company's pipeline suppliers have liabilities to producers for payments under purchase contracts for quantities of gas for which deliveries have not been taken. Pipeline suppliers received permission from the FERC to recover from their customers, including the company, a portion of their take-or-pay liabilities. The company has been granted permission in all of the states in which it operates to recover from its customers any take-or-pay costs. Total deferred but unrecovered take-or-pay costs were $2,415,000 and $2,384,000 as of December 31, 1994 and 1993, respectively.\nACQUISITIONS During the first quarter of 1995, UCG Energy purchased a 45% interest in certain contracts related to the gas marketing business of Woodward Marketing, Inc. (WMI), a Texas corporation. In exchange for the acquired interest, the shareholders of WMI will receive $5,000,000 in the company's common stock, pending regulatory approval, and $750,000 in cash and may, if certain earnings targets are met, receive an additional payment of $1,000,000 to be paid over a five year period. In exchange for its own gas marketing contracts and the acquired 45% interest in the WMI gas marketing contracts, UCG Energy received a 45% interest in a newly formed limited liability company, Woodward Marketing, L.L.C. (WMLLC). WMI received a 55% interest in WMLLC in exchange for its remaining 55% interest in the WMI gas marketing contracts. WMLLC will provide gas marketing services to industrial customers, municipalities and local distribution companies. UCG Energy will utilize equity accounting, effective January 1, 1995, for the acquisition. Effective January 1, 1995, United Cities Propane Gas of Tennessee, Inc. (UCPT), a wholly owned subsidiary of UCG Energy, purchased substantially all of the assets of Harrell Propane, Inc. for approximately $1,383,000. In addition, the subsidiary entered into ten year non-compete agreements with the prior owners for $250,000, to be paid over an eight year period. This acquisition added approximately 1,300 propane customers in the Murfreesboro, Tennessee area. Effective April 14, 1994, UCPT purchased all of the assets of Hurley's Propane Gas for approximately $938,000. In addition, the subsidiary entered into ten year non-compete agreements with the prior owners for $100,000, to be paid over a five year period. This acquisition added approximately 700 propane customers in the Morristown, Tennessee area. Effective March 1, 1994, the company purchased the natural gas system in Palmyra, Missouri from Western Resources, Inc. for approximately $665,000. The company also obtained a ten year non-compete agreement. Consideration for the agreement is contingent upon volumes sold to a certain industrial customer with payments made over a three year period, not to exceed $720,000. The system serves approximately 1,400 natural gas customers.\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n- - -\nEffective August 1, 1993, UCPT purchased the issued and outstanding shares of common stock of High Country Propane, Inc. for $1,600,000, less liabilities assumed of $820,000. Additionally, the subsidiary obtained a ten year non-compete agreement for $100,000, to be paid over a five year period. This acquisition added approximately 1,400 propane customers in the Boone, North Carolina area.\nACCOUNTING PRONOUNCEMENTS In November, 1992, the Financial Accounting Standards Board (FASB) issued Statement No. 112 (SFAS 112), \"Employers' Accounting for Postemployment Benefits.\" This statement, which the company adopted effective January 1, 1994, requires the company to accrue any obligations which may exist to provide benefits to former or inactive employees after employment but before retirement. Due to the limited nature of the postemployment benefits provided by the company, most of which were already being accrued, the implementation of SFAS 112 did not have a material effect on the company's results of operations or financial condition. In February, 1992, the FASB issued Statement No. 109 (SFAS 109), \"Accounting for Income Taxes.\" The company adopted SFAS 109 in 1993 and did not restate prior periods. Implementation of SFAS 109 required conversion to the liability method of accounting for deferred income taxes. Lower income tax rates resulting from the Tax Reform Act of 1986 resulted in excess accumulated deferred income taxes (ADIT) which are being amortized to reduce tax expense for accounting and ratemaking purposes. Tax law requires that excess ADIT related to accelerated depreciation be used to reduce tax expense over the lives of the related assets. There is no such normalization requirement for nonregulated excess ADIT and the related deferred tax liability was reversed in accordance with the new statement. The cumulative increase in net income resulting from the change in the accounting method for income taxes was approximately $443,000, and was included in UCG Energy's net income in 1993. In December, 1990, the FASB issued Statement No. 106 (SFAS 106), \"Employers Accounting for Postretirement Benefits Other Than Pensions.\" The company adopted the statement effective January 1, 1993. The statement requires the company to record the expected costs of postretirement health and life insurance benefits during the years the employees render service. This was a change from the company's previous policy of recognizing these costs on a cash basis. The annual cash payments for such benefits were $807,000 in 1992. Costs related to these benefits calculated in accordance with SFAS 106 amounted to $1,649,000 and $1,331,000 in 1994 and 1993, respectively. The accumulated benefit obligation of $8,894,000 existing at January 1, 1993, is being amortized over a twenty year period as allowed by SFAS 106. The company has received approval to recover SFAS 106 costs in South Carolina, Kansas, Iowa and Illinois. The Tennessee commission has approved the recovery of these costs and is allowing the company to defer the difference between cash payments and SFAS 106 expense until the next rate proceeding in that state. The Virginia commission has approved the recovery of SFAS 106 costs in rates. However, the accumulated benefit obligation will be recovered over forty years as opposed to the twenty year amortization period allowed by SFAS 106. The Georgia and Missouri commissions did not render decisions on SFAS 106 in the company's last rate proceedings in those states. However, the Missouri legislature has subsequently passed a statute allowing utilities to recover SFAS 106 costs. As required by some commissions, the company has established a trust fund to accumulate the difference between the cash payments for postretirement benefits and SFAS 106 expense.\nINTERNAL REVENUE SERVICE AUDIT The Internal Revenue Service (IRS) is currently reviewing the company's consolidated federal income tax returns for the years 1991 through 1993. As of December 31, 1994, the revenue agent had not issued a report. Management does not believe that the revenue agent's report, when issued, will contain any adjustments that will materially affect the results of operations or financial condition of the company. The IRS has reviewed the consolidated federal income tax returns of the company for the years 1986 through 1990. The company was assessed additional tax of $3,100,000 and interest of $1,400,000 for the periods reviewed. A substantial amount of the tax assessments were related to items which were timing differences. The company will be able to deduct these items in future periods. Timing differences have no effect on the results of operations of the company. In 1993, the company expensed the interest related to the tax assessments.\nCONTINGENCIES The company was named, along with 26 other defendants, in a class action, anti-trust case filed March 5, 1993 in the United States District Court for the Eastern District of Tennessee, Knoxville Division (the Court). This action involves alleged price-fixing in the 1980s in eastern Tennessee. The Court denied the plaintiffs' class certification motions, but granted the plaintiffs the right to pursue individual claims against\nMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\n- - - the defendants, including the company. The Tennessee Attorney General also filed a motion for class certification on behalf of all individuals and businesses in the east Tennessee area. In February, 1995, the company reached a settlement agreement with the Tennessee Attorney General, pending the Court's approval, in the amount of $80,000. The settlement agreement includes a provision which allows the company to cancel the settlement if 10% or more of the individual class members or business class members option out of the settlement class. The company has adequate reserves to cover the settlement of this case. However, management cannot predict the number, if any, of individual claims that may subsequently be filed related to this case. In management's opinion, the resolution of any individual claim subsequently filed will not have a material effect on the results of operations or financial condition of the company. During 1994, the company discovered defects in the polyethylene piping installed in certain of its service areas. An independent laboratory is conducting a study of the matter at the request of the gas industry and the manufacturers. The company also continues to conduct its own investigation into the issue. The company is unable to predict the extent of the problem or the expense which will be incurred to repair the defective piping but anticipates recovering the cost from the manufacturers or through the ratemaking process as a normal maintenance expense. The company is involved in other legal or administrative proceedings before various courts and agencies with respect to rates and other matters. Although unable to predict the outcome of these matters, it is management's opinion that final disposition of these proceedings will not have a material effect on the company's results of operations or financial condition.\nIMPACT OF INFLATION The company experiences the effect of inflation primarily through the cost of materials, labor and related employee benefits, and services. Since the company can only adjust its rates to recover these additional costs in the utility operation through the regulatory process, increased costs may have a significant impact on its results of operations. Management continually assesses the need to file for rate increases in each of the states in which the company operates. The company has purchased gas adjustment clauses which permit any fluctuations in gas costs to be passed through to its customers, subject to prudency and\/or administrative reviews by the commissions in the states in which the company operates.\nRESULTS OF OPERATIONS CONSOLIDATED COMMON STOCK EARNINGS AND DIVIDENDS The company had consolidated common stock earnings of $12,093,000 or $1.16 per share in 1994, a decrease of $27,000 or $0.03 per share from 1993 earnings. Earnings of $12,120,000 or $1.19 per share in 1993 represented an increase of $2,016,000 or $0.12 per share from 1992. The increase from 1992 to 1993 can be attributed primarily to colder weather and rate increases granted. The company's annual dividend paid per share was $1.005 in 1994. Effective with the fourth quarter of 1994, the company increased its quarterly dividend rate from $0.25 to $0.255 per share. This change increased the anticipated annual dividend rate to $1.02 per share.\nOPERATING MARGIN Although natural gas volumes decreased because of warmer weather in 1994 as compared to 1993, the operating margin of $108,016,000 in 1994 represented an increase of $1,517,000 over the 1993 margin of $106,499,000. The increase in operating margin was a result of volumes sold to new residential and commercial customers; the additional revenues from certain interruptible customers who did not go off the company's system when curtailed during the first quarter of 1994; the rate increase effective July, 1993 in Missouri; and the Palmyra acquisition in March, 1994. The effect of these increases was partially offset by warmer weather in those states where rates are not weather normalized. The operating margin increased $7,199,000 from 1992 to 1993. The increase was due primarily to increased volumes sold as a result of colder weather and rate increases in Missouri and Kansas in 1993 and in Tennessee and Georgia in 1992.\nOPERATING EXPENSES Operations and maintenance expenses increased $382,000 from $56,922,000 in 1993 to $57,304,000 in 1994. Operations and maintenance expenses also increased from $56,288,000 in 1992 to $56,922,000 in 1993. The additional expenses in both years were primarily due to normal increases in operating expenses, partially offset by a reduction in medical expenses. Depreciation and amortization expense increased $830,000 in 1994 and $1,416,000 in 1993 from the prior year periods primarily due to additional plant in service. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - -\nINTEREST Interest expense decreased from $15,048,000 in 1993 to $14,087,000 in 1994. Interest on long-term debt decreased $405,000 due to the retirement of long-term debt. Other interest charges decreased $556,000 primarily because of the 1993 assessment of interest related to the settlement of the Internal Revenue Service Audit for the years 1986 through 1990, partially offset by increased interest on short-term debt during 1994. Interest on long-term debt increased $1,023,000 in 1993 from 1992 due to interest on Series U and V First Mortgage Bonds issued in 1992, partially offset by the retirement of other long-term debt. Other interest charges increased $1,326,000 in 1993 primarily because of the assessment of interest related to the settlement of the Internal Revenue Service Audit.\nSUBSIDIARY OPERATIONS Subsidiary operations contributed 35.4%, 35.0% and 42.0% of the company's common stock earnings in 1994, 1993 and 1992, respectively. The following is a discussion of the results of operations of the company's subsidiaries, UCG Energy Corporation and United Cities Gas Storage Company.\nUCG ENERGY CORPORATION Revenues decreased from $38,909,000 in 1993 to $38,383,000 in 1994 primarily due to a decrease in gas brokerage sales to municipalities, industrial and other customers and secondarily, a decrease in the sale of energy-related products in the Utility Services Division. This decrease was partially offset by an increase in revenues in the Propane Division generated by additional wholesale volumes sold as well as additional volumes sold resulting from the acquisitions of Hurley's Propane Gas in April, 1994, and High Country Propane, Inc. in August, 1993. The Rental Division had a moderate decrease in revenues due to lower rental rates on certain rental units in service. Revenues increased from $32,483,000 in 1992 to $38,909,000 in 1993 primarily due to an increase in gas brokerage sales to municipalities, industrial and other customers by the Utility Services Division. The Rental Division had a moderate increase in revenues on additional rental units placed into service. Revenues in the Propane Division increased as a result of additional volumes sold due to colder weather and the acquisition of High Country Propane, Inc., as well as increased prices on volumes sold. Operating expenses decreased from $28,784,000 in 1993 to $27,986,000 in 1994. This $798,000 decrease can largely be attributed to the decrease in the cost of sales as a result of reduced sales in the Utility Services Division. This decrease was partially offset by an increase in cost of sales in the Propane Division on additional wholesale volumes sold, as well as additional volumes sold due to the acquisitions of Hurley's Propane Gas and High Country Propane, Inc. Operating expenses increased from $22,360,000 in 1992 to $28,784,000 in 1993. This increase was generally due to the cost of additional gas brokerage sales in the Utility Services Division. The increase in operating expenses in the Propane Division was a combination of additional volumes sold, an increase in the wholesale cost of those volumes and the acquisition of High Country Propane, Inc. Interest expense decreased from $1,049,000 in 1993 to $773,000 in 1994. This decrease was primarily the result of the assessment of interest related to the settlement of the Internal Revenue Service Audit which occurred in 1993. In addition, long-term interest expense decreased in all divisions due to the retirement of certain long-term debt. Interest expense increased from $882,000 in 1992 to $1,049,000 in 1993 principally due to the assessment of interest related to the settlement of the Internal Revenue Service Audit. A decision to discontinue the distribution of energy-related products by the Utility Services Division was made by management in June, 1994. The discontinuance of this activity is not expected to materially affect the results of operations or financial condition of the company and is expected to be completed by mid-1995. Net income for UCG Energy was $3,750,000, $3,775,000 and $3,681,000 in 1994, 1993 and 1992, respectively.\nUNITED CITIES GAS STORAGE COMPANY United Cities Gas Storage Company's net income increased from $468,000 in 1993 to $526,000 in 1994. The $58,000 increase was primarily a result of increased revenues for storage services provided primarily to the utility company, partially offset by increased operating expenses. Net income was $468,000 in 1993 compared to $558,000 in 1992. The decrease in income from 1992 to 1993 was primarily a result of increased operating and depreciation expenses.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\nPART III ITEM 10, 11, 12, AND 13, constituting Part III of the Form 10-K, have been omitted from this annual report pursuant to the provisions of Instruction G to Form 10-K, since a definitive proxy statement, which is incorporated herein by reference, except for the report of the compensation committee of the board of directors and the performance graph, will be filed on or about March 30, 1995. Information required for executive officers is included in Part I, Item 1.\nPART IV ITEM 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) (1) Financial Statements: See Part II, Item 8\n(2) Financial Statement Schedules: Page ---- Report of Independent Public Accountants..................... 51 Schedule Number -------- II Reserves............................................ 52 III Condensed Financial Information of Registrant....... 53\nAll other schedules are not submitted because they are not applicable or because the required information is included in the financial statements or notes thereto.\nIndividual financial statements of United Cities Gas Company are omitted as Cities is primarily an operating company and the subsidiaries (UCG Energy Corporation, United Cities Propane Gas of Tennessee, Inc., UCG Leasing, Inc., and United Cities Gas Storage Company) included in the consolidated financial statements are wholly-owned.\n(3) Exhibits filed:\nA complete listing of exhibits required is given in the Exhibit Index (page 54) which precedes the exhibits filed with this report. A list of the compensation plans is set forth below.\n10.01 Annual Incentive Compensation Plan effective January 1, 1989, as revised.\n10.02 Supplemental Executive Retirement Compensation Agreement, as revised, (filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).\n10.03 Long-Term Stock Plan of 1989, (filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1989 and incorporated herein by reference).\n10.04 Directors' Deferred Compensation Plan effective February 1, 1992, (filed with the Registrant's Annual Report on Form 10-K for the year ended December 31, 1992 and incorporated herein by reference).\n(b) Reports filed on Form 8-K: The Company was not required to file any reports on Form 8-K for the quarter ended December 31, 1994.\n(c) Exhibits filed: A complete listing of exhibits required is given in the Exhibit Index (page 54) which precedes the exhibits filed with this report.\n(d) Financial Statements Omitted from Annual Report to Security Holders: None.\nThe accompanying notes are an integral part of these consolidated statements.\nThe accompanying notes are an integral part of these consolidated statements.\nThe accompanying notes are an integral part of these consolidated balance sheets.\nThe accompanying notes are an integral part of these consolidated statements.\nThe accompanying notes are an integral part of these consolidated statements.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries\n- - - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nPRINCIPLES OF CONSOLIDATION-- The consolidated financial statements include the accounts of United Cities Gas Company (Cities) and its subsidiaries (collectively, the company). The operations of UCG Energy Corporation (UCG Energy) and United Cities Gas Storage Company (UCG Storage), wholly-owned subsidiaries of Cities, shown in the accompanying Consolidated Statements of Income, include affiliated revenues of $13,565,000, $15,930,000, and $14,937,000 for the years 1994, 1993 and 1992, respectively. The affiliated revenues of UCG Energy represent rental charges to Cities for transportation equipment and office facilities and the sale of gas-related equipment to Cities. The affiliated revenues for UCG Storage consist of charges for natural gas storage services and natural gas sales to Cities. In management's opinion, such intercompany charges compare favorably with terms which Cities could obtain from other sources under comparable conditions.\nSYSTEM OF ACCOUNTS-- Cities is a public utility which distributes natural gas in Tennessee, Kansas, Georgia, Virginia, Illinois, Missouri, Iowa and South Carolina. Cities is subject to regulation with respect to rates, service, maintenance of accounting records and various other matters by the respective regulatory authorities in the states in which it operates. The utility financial statements are based on generally accepted accounting principles which give appropriate recognition to the ratemaking and accounting practices and policies of the various regulatory commissions.\nUTILITY PLANT-- Utility plant is stated at the historical cost of construction.Such costs include direct construction costs, payroll related costs (taxes, pensions and other fringe benefits), administrative and general costs, and the estimated cost of allowance for funds used during construction.The estimated cost of allowance for funds is as follows:\nThe debt portion of the cost of funds is reflected as a credit to \"Other interest charges\" in the amounts of $183,000, $246,000 and $323,000 in 1994, 1993 and 1992, respectively. The equity portion of the cost of funds is reflected in \"Other income (expense), net\" in the amounts of $111,000, $81,000 and $92,000 in 1994, 1993 and 1992, respectively.\nDEPRECIATION AND MAINTENANCE-- Depreciation is provided in the accounts based on straight-line composite rates of 3.4%, 3.6% and 3.5% of the cost of depreciable utility plant in service in 1994, 1993 and 1992, respectively. Cities follows the practice of charging to maintenance the cost of normal repairs of property and the replacements and renewals of items considered to be less than units of property. Replacements and renewals of items considered to be units of property are charged to utility plant accounts, and units of property replaced or retired are credited to the utility plant accounts and charged to accumulated depreciation.\nCUSTOMER RECEIVABLES AND OPERATING REVENUES-- The company is primarily engaged in the distribution and sale of natural and propane gas to a diverse base of residential, commercial and industrial customers in 44 operating areas in the states of Tennessee, Kansas, Georgia, Virginia, Illinois, Missouri, Iowa, South Carolina and North Carolina. Cities' operating revenues are based on rates approved by the regulatory commissions in the states in which it operates. Cities follows the practice of accruing for services rendered but unbilled at the end of the accounting period. The Georgia and Tennessee Public Service Commissions have approved the implementation of Weather Normalization Adjustments (WNAs). The WNAs, effective October through May each year in Georgia and November through April each year in Tennessee, allow the company to increase the base rate portion of customers' bills when weather is warmer than normal and decrease the base rate when weather is colder than normal. The net effect of the WNAs was an increase in revenues of $2,050,000, $324,000 and $1,038,000 in 1994, 1993 and 1992, respectively.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries\n- - - - - - REFUNDABLE OR RECOVERABLE GAS COSTS-- Refunds from pipeline suppliers and changes in cost of gas delivered to customers which are different from the amounts recovered through rates, are deferred and are being refunded or recovered in accordance with procedures approved by the state commissions.\nINVENTORIES-- Inventories consist primarily of materials and supplies and gas in storage. Materials and supplies include merchandise and appliances and are valued at average cost. Cities' liquefied natural gas and propane inventories and gas stored underground are valued on a first-in, first-out basis. Propane owned by UCG Energy is priced at average cost. Gas stored underground and owned by UCG Storage is valued on a last-in, first-out (LIFO) basis. In accordance with Cities' Purchased Gas Adjustment (PGA) clauses, the liquidation of a LIFO layer would be reflected in subsequent gas adjustments in customer rates and does not affect the results of operations.\nEARNINGS PER SHARE-- Primary earnings per share have been computed on the basis of the weighted average number of shares of common stock outstanding during the year. Fully diluted earnings per share for 1993 and 1992 give effect to conversion of the 11 1\/2% Cumulative Redeemable Convertible Preference Stock. Fully diluted earnings per share are not materially different from primary earnings per share.\nFAIR VALUE OF FINANCIAL INSTRUMENTS-- The carrying amounts of cash and temporary investments, short-term debt and accrued interest approximate fair value because of the short-term nature of these items. Based on the current market rates offered for similar debt of the same maturities, the fair value of the company's long-term debt, including the current portion, exceeded the carrying amount by approximately $5,300,000 and $37,000,000 at December 31, 1994 and 1993, respectively. Management believes that the prepayment provisions of the company's first mortgage bonds do not make it economically feasible to refinance the long-term debt at this time.\nSTATEMENTS OF CASH FLOWS-- For the purpose of the statements of cash flows, the company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents.\nRECLASSIFICATIONS-- Certain reclassifications were made conforming prior years' financial statements with 1994 financial statement presentation.\nREGULATORY MATTERS Effective April 1, 1993, the Virginia State Corporation Commission issued an order stating that Cities' current authorized rates in that state be considered interim and subject to refund pending an investigation to determine whether Cities was earning more than its authorized rate of return and whether the authorized rate of return at that time was appropriate. In addition, the commission staff alleged that Cities overcollected gross receipts tax from its customers for the years 1988 through mid-1993. In an order issued in November, 1994, the commission reduced Cities' authorized rate of return in Virginia from 11.26% to 10.26%, resulting in a reduction in annual revenues of $218,000. This reduction was effective April 1, 1993. Excess revenues of approximately $370,000, plus interest, collected under interim rates through December 31, 1994, are to be refunded to Cities' customers. In addition, the commission concluded that Cities had overcollected gross receipts tax from its customers from 1988 through mid-1993 and ordered the refund of $301,000, plus interest. Cities has adequate reserves to cover its liability related to the order.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries\n- - -\nIn 1991, the Illinois Commerce Commission ordered Cities to refund approximately $260,000 related to the reconciliation of the PGA recovery mechanism for 1988. Cities filed an appeal with the Appellate Court of Illinois which in September, 1992, issued a decision upholding the commission's decision. Cities filed an appeal with the Illinois Supreme Court which in September, 1994, upheld the commission's and lower court's decision. Cities asked for rehearing of this decision which was subsequently denied. Cities will refund the $260,000, plus interest, beginning in 1995 and has adequate reserves to cover its liability. As a part of a settlement agreement in the 1992 rate proceeding in Tennessee, Cities agreed to a management audit. The management audit report was issued in 1994. Management agreed with a majority of the recommendations made by the auditors and a number of recommendations are currently in the process of being implemented. Other recommendations are being evaluated and may be implemented in the future. In April, 1995, Cities will report to the Tennessee Public Service Commission its progress in addressing the issues raised by the auditors. Management does not believe that the implementation of the recommendations will have a material effect on the company's results of operations or financial condition. In 1992, the Federal Energy Regulatory Commission (FERC) issued Orders 636, 636-A and 636-B. These orders required interstate pipelines to unbundle or separate gas sales, transportation and storage services by the 1993-1994 winter season. The pipelines sales services were previously combined and sold as a single service. The FERC has permitted pipelines to recover from their customers, including Cities, the prudently incurred costs of implementing these orders, referred to as transition costs. As of December 31, 1994 and 1993, based on current pipeline transition cost filings with the FERC, Cities had accrued and deferred $6,739,000 and $1,845,000, respectively, as its estimated share of the remaining liability related to these transition costs. Because there are pipeline requests not yet filed with the FERC, the 1994 estimate may differ from the final amount of future transition costs recovered from Cities. These estimated amounts are included as a liability in \"Accounts payable for gas costs\" and as a regulatory asset in \"Gas costs to be billed in the future.\" Cities has been granted permission through approved PGA filings or specific orders in all the states in which it operates to recover these transition costs from its customers. Cities' pipeline suppliers have liabilities to producers for payments under purchase contracts for quantities of gas for which deliveries have not been taken. Pipeline suppliers received permission from the FERC to recover from its customers, including Cities, a portion of their take-or-pay liabilities. Cities has been granted permission in all of the states in which it operates to recover from its customers any take-or-pay costs. Total deferred but unrecovered take-or-pay costs were $2,415,000 and $2,384,000 as of December 31, 1994 and 1993, respectively. These amounts are included as a regulatory asset in \"Gas costs to be billed in the future.\" In 1990, Cities received an order from the Kansas State Corporation Commission allowing Cities to defer, pending approval in rates cases, certain safety-related costs, depreciation on safety-related capital expenditures, and carrying charges on the total. As of December 31, 1991, costs totaling $1,378,000 and $2,706,000 were deferred for the years 1991 and 1990, respectively. The Kansas commission approved in rates effective January, 1993, deferral and recovery of $949,000 and $1,275,000 related to 1991 and 1990, respectively. Each of these amounts are being amortized over a five year period. The difference in the approved cost and the cost previously deferred was expensed in 1992. In addition, in 1990 and 1992, the Missouri Public Service Commission issued orders allowing Cities to defer, pending approval in rate cases, similar safety-related costs. In 1989 through 1992, costs of $833,000 were deferred. After reaching stipulated agreements in rate proceedings, Cities discontinued deferring these costs and began amortizing $600,000 in 1992 and $233,000 in 1993 over five year periods.\nEMPLOYEE BENEFIT PLANS\nPENSION-- The company has a trusteed noncontributory defined benefit pension plan which covers substantially all full-time employees. The plan provides benefits based on years of credited service and final average salary. The plan assets consist principally of marketable equity securities, corporate and government debt securities, and deposits with insurance companies. The company's policy is to fund the plan in accordance with the requirements of the Employee Retirement Income Security Act. Actuarial assumptions used for the plan are as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries\n- - - - - -\nNet periodic pension expense for the plan in fiscal 1994, 1993 and 1992 consists of the following components:\nA reconciliation of the funded status of the plan to the amounts recognized in the company's consolidated financial statements at December 31, 1994 and 1993, is presented below:\nPOSTRETIREMENT BENEFITS-- The company provides postretirement health care benefits and life insurance benefits for retired employees. Substantially all of the company's employees will become eligible for those benefits if they reach the normal retirement age while working for the company. Effective January 1, 1993, the company made certain revisions to its postretirement benefits plan which limit the company's contributions to the plan for employees retiring after December 31, 1997. In December, 1990, the Financial Accounting Standards Board (FASB) issued Statement No. 106 (SFAS 106), \"Employers' Accounting for Postretirement Benefits Other Than Pensions.\" The company adopted the statement effective January 1, 1993. The statement requires the company to record the expected costs of postretirement health and life insurance benefits during the years the employees render service. This was a change from the company's previous policy of recognizing these costs on a cash basis. The annual cash payments for such benefits were $807,000 in 1992. Net periodic postretirement benefit expense for the company's plan in fiscal 1994 and 1993 consists of the following components:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries\n- - -\nA reconciliation of the funded status of the plan to the amounts recognized in the company's consolidated financial statements at December 31, 1994 and 1993, is presented below:\nActuarial assumptions used for the plan are as follows:\nFor measurement purposes, a 12% and 15% annual rate of increase in the per capita cost of covered health care benefits was assumed for 1994 and 1993, respectively. The rates were assumed to decrease gradually to 5.5% over twelve years 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 one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1994 by $1,019,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for the year ended by $83,000. Cities has received approval to recover SFAS 106 costs in South Carolina, Kansas, Iowa and Illinois. The Tennessee commission has approved the recovery of these costs and is allowing Cities to defer the difference between cash payments and SFAS 106 expense until the next rate proceeding in that state. The Virginia commission has approved the recovery of SFAS 106 costs in rates. However, the accumulated benefit obligation will be recovered over forty years as opposed to the twenty year amortization period allowed by SFAS 106. The Georgia and Missouri commissions did not render decisions on SFAS 106 in Cities' recent rate proceedings in those states. However, the Missouri legislature has subsequently passed a statute allowing utilities to recover SFAS 106 costs. As required by some commissions, Cities has established a trust fund to accumulate the difference between the cash payments for postretirement benefits and SFAS 106 expense.\nPOSTEMPLOYMENT BENEFITS AND OTHER-- In November, 1992, the FASB issued Statement No. 112 (SFAS 112), \"Employers' Accounting for Postemployment Benefits.\" This statement, which the company adopted effective January 1, 1994, requires the company to accrue any obligations which may exist to provide benefits to former or inactive employees after employment but before retirement. Due to the limited nature of the postemployment benefits provided by the company, most of which were already being accrued, the implementation of SFAS 112 did not have a material effect on the company's results of operations or financial condition. The company's 401(k) savings plan allows participants to make contributions toward retirement savings. Each participant may contribute up to 15% of qualified compensation. For employee contributions up to 6% of the participant's qualified compensation, the company will contribute 30% of the employee's contribution. The company may also contribute up to an additional 20% of the employee's contribution based on certain criteria specified in the plan.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries\n- - - - - - INCOME TAXES A detail of the federal and state income tax provision is set forth below:\nIncome taxes differ from amounts computed by applying the statutory rates to pre-tax income as follows:\nThe elements comprising the deferred federal and state income tax provision are as follows:\nInvestment tax credits are deferred and amortized over the average life of the property which gave rise to the credits. The Internal Revenue Service (IRS) is currently reviewing the company's consolidated federal income tax returns for the years 1991 through 1993. As of December 31, 1994, the revenue agent had not issued a report. Management does not believe that the revenue agent's report, when issued, will contain any adjustments that will materially affect the results of operations or financial condition of the company. The IRS has reviewed the consolidated federal income tax returns of the company for the years 1986 through 1990. The company was assessed additional tax of $3,100,000 and interest of $1,400,000 for the periods reviewed. A substantial amount of the tax assessments were related to items which were timing differences. The company will be able to deduct these items in future periods. Timing differences have no effect on the results of operations of the company. In 1993, the company expensed the interest related to the tax assessments. In February, 1992, the FASB issued Statement No. 109 (SFAS 109), \"Accounting for Income Taxes.\" The company adopted SFAS 109 in 1993 and did not restate prior periods. Implementation of SFAS 109 required conversion to the liability method of accounting for deferred income taxes. Lower income tax rates resulting from the Tax Reform Act of 1986 resulted in excess accumulated deferred income taxes (ADIT) which are being amortized to reduce tax expense for accounting and ratemaking purposes. Tax law requires that excess ADIT related to accelerated depreciation be used to reduce tax expense over the lives of the related assets. There is no such normalization requirement for nonregulated excess ADIT and the related deferred tax liability was reversed in accordance with the new statement. The cumulative increase in net income resulting from the change in the accounting method for income taxes was approximately $443,000, and was included in UCG Energy's net income in 1993.\nENVIRONMENTAL ISSUES Cities is the owner or previous owner of manufactured gas plant sites which were used to supply gas prior to the availability of natural gas. Manufactured gas was an inexpensive source of fuel for lighting and heating nationwide. As a result of the gas manufacturing process, certain by-products and waste materials, including coal-tar, were produced and may have been accumulated at the plant sites. This was an acceptable and satisfactory process at the time of operations. Under current environmental protection laws and regulations, Cities may be responsible for response action with respect to such materials, if response action is necessary. Cities identified a site in Columbus, Georgia, and along with other responsible parties, has performed response action. Cities' share of response action costs at this site totaled approximately $1,324,000. Of this amount, $1,275,000 was requested and approved to be recovered over a three year period in rates which were effective November, 1992. The approved amount did not include carrying costs on the deferred balance. Cities will request and expects approval to recover the remaining costs either in its next rate proceeding in Georgia or as an extension of the rider. Cities has joined with three other potentially responsible parties (PRPs) to fund a response investigation and feasibility study of a site in Keokuk, Iowa. Cities has incurred costs totaling $129,000 and has, based on available current information, accrued an additional $644,000 for its share of possible response action. Cities has deferred $494,000 of the accrued amount and expects approval for recovery in its next rate proceeding in Iowa. Cities has estimated that it may incur, if certain adverse conditions are found to exist, an additional $856,000 of response action costs at this site.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries - - - - - - Cities owns or may be the successor in interest to the previous owner of four additional former manufactured gas plant sites. Cities is unaware of any information which suggests that these sites give rise to a present health or environmental risk as a result of the manufactured gas process or that any response action will be necessary. Accordingly, Cities has not accrued any liabilities associated with these four sites. Pursuant to the Tennessee Petroleum Underground Storage Tank Act (the Act), Cities is required to upgrade or remove certain underground storage tanks (USTs) situated in Tennessee. As of December 31, 1994, Cities has identified eight USTs in this category in Tennessee and has incurred $30,000 and, based on available current information, accrued an additional $70,000 for the upgrade or removal of these USTs. Cities has estimated that it may incur, if certain adverse conditions are found to exist, additional costs of up to $380,000 to bring the sites into compliance with the Act. On October 4, 1994, the Tennessee Public Service Commission granted Cities permission to defer, until its next rate case, all costs incurred in connection with state and federally mandated environmental control requirements. In addition, Cities may be able to recover a portion of the corrective action costs from the State of Tennessee Trust Fund for all of the UST sites in Tennessee. Cities has identified three USTs in Virginia and has, based on available current information, accrued and deferred for recovery $23,000 as of December 31, 1994, for the closure of these sites. Cities has estimated that it may incur, if certain adverse conditions are found to exist, additional costs of up to $202,000 in responding to these sites. Cities expects recovery of any costs incurred related to the closure of these sites. Cities has reviewed and commented on a proposed Consent Order from the Kansas Department of Health and Environment (KDHE) regarding mercury contamination at gas pipeline sites. The KDHE has identified the need to investigate gas industry activities which utilize mercury equipment in Kansas. Cities is cooperating with the KDHE in preparing a Consent Order and a Work Plan for responding to mercury contamination at any site which is identified as exceeding the KDHE's established acceptable concentration levels. As of December 31, 1994, Cities has identified approximately 720 meter sites where mercury may have been used and has incurred $20,000 and, based on available current information, accrued and deferred for recovery an additional $280,000 for the investigation of these sites. Cities has estimated that it may incur an additional amount of up to $4,100,000 over the next seven years in responding to a future administrative order for those sites, if any, that exceed the KDHE's established acceptable concentration levels. Based on a recent decision by the Kansas State Corporation Commission concerning the recovery of environmental response action costs incurred by another company, Cities expects recovery of the costs involved in the investigation and response action associated with the mercury meter sites in Kansas. Management expects that future expenditures related to response action at any site will be recovered through rates or insurance, or shared among other PRPs. Therefore, the costs of responding to these sites are not expected to materially affect the results of operations or financial condition of the company.\nCAPITAL STOCK\n11 1\/2% CUMULATIVE REDEEMABLE CONVERTIBLE PREFERENCE STOCK-- The Preference Stock was convertible to common stock at the option of the holder at $7.00 per common share and contained a redemption feature. During 1993, 5,307 shares of the Preference Stock were converted into 75,777 shares of common stock. Of the 6,364 shares of Preference Stock outstanding at December 31, 1992, the remaining 1,057 shares that were not converted into common stock were redeemed at $100 per share in mid-1993.\nCOMMON STOCK-- As of December 31, 1994, the company had 800,097 shares of common stock reserved for issuance under the company's employee and customer stock purchase plans, the company's dividend reinvestment and stock purchase plan, the company's 401(k) savings plan, and the company's long-term stock plan of 1989.\nACQUISITIONS Effective April 14, 1994, United Cities Propane Gas of Tennessee, Inc. (UCPT), a wholly owned subsidiary of UCG Energy, purchased all of the assets of Hurley's Propane Gas for approximately $938,000. In addition, the subsidiary entered into ten year non-compete agreements with the prior owners for $100,000, to be paid over a five year period. This acquisition added approximately 700 propane customers in the Morristown, Tennessee area.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries - - - Effective March 1, 1994, the company purchased the natural gas system in Palmyra, Missouri from Western Resources, Inc. for approximately $665,000. The company also obtained a ten year non-compete agreement. Consideration for the agreement is contingent upon volumes sold to a certain industrial customer with payments made over a three year period, not to exceed $720,000. The system serves approximately 1,400 natural gas customers. Effective August 1, 1993, UCPT purchased the issued and outstanding shares of common stock of High Country Propane, Inc. for $1,600,000, less liabilities assumed of $820,000. Additionally, the subsidiary obtained a ten year non-compete agreement for $100,000, to be paid over a five year period. This acquisition added approximately 1,400 propane customers in the Boone, North Carolina area.\nLONG-TERM DEBT The company's mortgage dated as of July 15, 1959, as amended and supplemented, securing the first mortgage bonds issued by the company constitutes a direct first lien on substantially all of Cities' fixed property and franchises. The company was in compliance with the requirements of its indentures during 1994. The company's senior secured storage term notes bear interest at a rate of 8.67% and are secured by storage plant assets. The weighted-average interest rate of the company's other long-term debt was approximately 7.30% at December 31, 1994. Annual maturities and sinking fund requirements of the company's First Mortgage Bonds and other long-term debt for the years 1995 through 1999 are $6,068,000, $8,609,000, $9,994,000, $6,994,000 and $7,119,000, respectively.\nINTERIM FINANCING The company has arrangements with several banks which provide, through mid-1995, a total line of credit of $84,000,000 in the form of master and banker's acceptance notes bearing interest primarily at the lesser of the prime rate or a negotiated rate during the term of each borrowing. Under these arrangements at December 31, 1994 and 1993, the company had short-term debt outstanding of $46,188,000 and $22,863,000, respectively, with a weighted-average interest rate of 6.60% and 4.07%, respectively.\nCOMMITMENTS AND CONTINGENCIES The company was named, along with 26 other defendants, in a class action, anti-trust case filed March 5, 1993 in the United States District Court for the Eastern District of Tennessee, Knoxville Division (the Court). This action involves alleged price-fixing in the 1980's in eastern Tennessee. The Court denied the plaintiffs' class certification motions, but granted the plaintiffs the right to pursue individual claims against the defendants, including the company. The Tennessee Attorney General also filed a motion for class certification on behalf of all individuals and businesses in the east Tennessee area. In February, 1995, the company reached a settlement agreement with the Tennessee Attorney General, pending the Court's approval, in the amount of $80,000. The settlement agreement includes a provision which allows the company to cancel the settlement if 10% or more of the individual class members or business class members option out of the settlement class. The company has adequate reserves to cover the settlement of this case. However, management cannot predict the number, if any, of individual claims that may subsequently be filed related to this case. In management's opinion, the resolution of any individual claim subsequently filed will not have a material effect on the results of operations or financial condition of the company. During 1994, Cities discovered defects in the polyethylene piping installed in certain of its service areas. Cities has notified both the manufacturers of the defective piping and the state regulatory commissions in such service areas. An independent laboratory is conducting a study of the matter at the request of the gas industry and the manufacturers. Cities also continues to conduct its own investigation into the issue. Cities is unable to predict the extent of the problem or the expense which will be incurred to repair the defective piping but anticipates recovering the cost from the manufacturers or through the ratemaking process as a normal maintenance expense. The company is involved in other legal or administrative proceedings before various courts and agencies with respect to rates and other matters. Although unable to predict the outcome of these matters, it is management's opinion that final disposition of these proceedings will not have a material effect on the company's results of operations or financial condition.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS United Cities Gas Company & Subsidiaries - - - - - - SUBSEQUENT EVENTS (UNAUDITED) During the first quarter of 1995, UCG Energy purchased a 45% interest in certain contracts related to the gas marketing business of Woodward Marketing, Inc. (WMI), a Texas corporation. In exchange for the acquired interest, the shareholders of WMI will receive $5,000,000 in the company's common stock, pending regulatory approval, and $750,000 in cash and may, if certain earnings targets are met, receive an additional payment of $1,000,000 to be paid over a five year period. In exchange for its own gas marketing contracts and the acquired 45% interest in the WMI gas marketing contracts, UCG Energy received a 45% interest in a newly formed limited liability company, Woodward Marketing, L.L.C. (WMLLC). WMI received a 55% interest in WMLLC in exchange for its remaining 55% interest in the WMI gas marketing contracts. WMLLC will provide gas marketing services to industrial customers, municipalities and local distribution companies. UCG Energy will utilize equity accounting, effective January 1, 1995, for the acquisition. Effective January 1, 1995, UCPT purchased substantially all of the assets of Harrell Propane, Inc. for approximately $1,383,000. In addition, the subsidiary entered into ten year non-compete agreements with the prior owners for $250,000, to be paid over an eight year period. This acquisition added approximately 1,300 propane customers in the Murfreesboro, Tennessee area.\nQUARTERLY FINANCIAL DATA (UNAUDITED) (In Thousands, except per share data)\n(a) The pattern of quarterly earnings (loss) is the result of the highly seasonal nature of the business as variations in weather conditions generally result in greater earnings during the winter months. (b) May not add to year-end results due to changes in average number of outstanding common shares between periods.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS United Cities Gas Company & Subsidiaries - - - REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and the Board of Directors of United Cities Gas Company:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of United Cities Gas Company (an Illinois corporation) and subsidiaries as of December 31, 1994 and 1993, and the related consolidated statements of income, retained earnings, capital surplus and common stock and cash flows for each of the three years in the period ended December 31, 1994. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Cities Gas Company and subsidiaries as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. As discussed in the notes to the consolidated financial statements, effective January 1, 1993, the Company changed its methods of accounting for postretirement benefits other than pensions and income taxes.\nNashville, Tennessee Arthur Andersen LLP February 16, 1995\n*In thousands\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, thereto duly authorized.\nUNITED CITIES GAS COMPANY (Registrant)\nBy: \/s\/ GENE C. KOONCE ------------------ Gene C. Koonce President Dated: March 17, 1995\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.\nREPORT OF INDEPENDENT PUBLIC ACCOUNTANTS\nTo United Cities Gas Company:\nWe have audited in accordance with generally accepted auditing standards, the consolidated financial statements of United Cities Gas Company and subsidiaries included in this Form 10-K, and have issued our report thereon dated February 16, 1995. Our audit was made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the 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 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 LLP\nNashville, Tennessee, February 16, 1995\nUNITED CITIES GAS COMPANY AND SUBSIDIARIES\nSCHEDULE II-RESERVES FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\n(a) Represents write-off of accounts considered to be uncollectible, less collection of accounts previously written off.\nUNITED CITIES GAS COMPANY AND SUBSIDIARIES\nSCHEDULE III - CONDENSED FINANCIAL INFORMATION OF REGISTRANT FOR THE YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992\nDIVIDENDS FROM SUBSIDIARIES.\nCash dividends paid to Cities from the registrant's wholly-owned subsidiaries were $1,350,000 in 1994 and $1,100,000 in both 1993 and 1992.\nLIST OF EXHIBITS","section_15":""}
{"filename":"312655_1994.txt","cik":"312655","year":"1994","section_1":"ITEM 1. BUSINESS\nAmerican Medical Holdings, Inc. (\"Holdings\") was organized in July, 1989 to acquire American Medical International, Inc. (\"AMI\" and, together with Holdings, the \"Company\"). As a result of this acquisition, Holdings is the owner of all of the outstanding shares of common stock of AMI.\nAMI was incorporated in 1957 and in 1960 became the first investor-owned hospital company. Today, the Company is one of the leading hospital management companies in the United States. As of August 31, 1994 AMI operated 36 acute care and one psychiatric hospital containing a total of 9,021 licensed beds. Subsequent to August 31, 1994, AMI, in partnership with unaffiliated third parties, acquired an additional acute care hospital, increasing the total acute care hospitals operated by AMI to 37. AMI focuses on delivering value to its patients and its communities with a full range of quality inpatient and outpatient services including medical, surgical, obstetric, diagnostic, specialty and home health care. The Company also operates ancillary facilities at each of its hospitals, such as ambulatory, occupational and rural healthcare clinics. The Company's hospitals are principally located in the suburbs of major metropolitan areas in 13 states including Texas, Florida and California.\nHoldings and AMI are Delaware corporations with principal executive offices located at 14001 Dallas Parkway, Suite 200, P.O. Box 809088, Dallas, Texas 75380-9088. The telephone number for Holdings and AMI at such address is (214) 789-2200.\nRECENT DEVELOPMENTS\nOn October 10, 1994, Holdings, National Medical Enterprises, Inc, a Nevada corporation (\"NME\") and a wholly-owned subsidiary of NME (\"Merger Sub\"), executed an Agreement and Plan of Merger (the \"Merger Agreement\"). Pursuant to the Merger Agreement, Merger Sub will merge with and into Holdings (the \"Merger\"). As a result of the Merger, Holdings will become a wholly-owned subsidiary of NME and the combined company will be the second-largest healthcare services company in the nation. Under terms of the Merger Agreement each share of common stock of Holdings will be converted into (i) $19.00 in cash, if the closing occurs on or before March 31, 1995, and $19.25 thereafter and (ii) 0.42 of a newly issued share of NME common stock. Under the Merger Agreement, Holdings will pay a special dividend of $0.10 per share before the effective date of the Merger. Following the Merger, Holdings will have the right to nominate three members to the 13 member board of directors of the combined company. The transaction has been approved by shareholders of approximately 61.4% of Holdings' outstanding shares of common stock and, therefore, further action by Holdings' shareholders is not required. The transaction, which is currently anticipated to close in the first quarter of calendar 1995, is subject to certain conditions including, among other things, expiration of any applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.\nManagement believes that the position of the Company's hospitals in each of their markets, the established physician networks and the alliances being developed with other healthcare providers will be further enhanced by the Merger. Holdings and NME each have a portfolio of hospitals in Florida and California which will strengthen the combined company's presence in each of these markets. The combined company will be strategically positioned to develop new comprehensive healthcare delivery systems with physicians and other healthcare providers in targeted communities and to deal with the current and future changes in the healthcare industry.\nOn September 1, 1994, a limited partnership, of which AMI is the general partner, acquired Hilton Head Hospital in Hilton Head, South Carolina containing 68 beds. In connection with the Company's efforts to re-establish a presence in Europe, the Company has entered into a joint venture agreement with a community organization (the \"Burgergemeinde\") located in Cham, Canton Zug, Switzerland. The joint venture will be owned 90% by the Company and 10% by the Burgergemeinde. Under the terms of the proposed transaction, the Company has entered into a long term lease for the land where the existing hospital is located and will then construct a new 56 bed acute care wing, convert an existing structure into a medical office building and renovate and remodel the existing\nacute care facility. In addition, the Company plans to contract to provide management, food, physical therapy and rehabilitation services to the hospital, an on-site nursing home and an affiliated retirement community.\nPROPERTIES\nAs of August 31, 1994, the Company owned or leased and operated the following 36 acute care hospitals and one psychiatric hospital. The Company also owned and managed medical office buildings and related healthcare facilities associated with its hospitals, as well as certain undeveloped properties.\nEMPLOYEES\nAs of August 31, 1994, the Company had approximately 30,200 employees, of which approximately 68% were full time employees. Two of the Company's hospitals had labor contracts covering approximately 5% of the Company's employees. Management believes that its relations with its employees are satisfactory.\nMEDICAL STAFFS\nThe medical staff at each hospital generally consists of non-employee physicians. In certain markets, the Company's hospitals have employed physicians to further strengthen and expand the Company's managed care contracting ability. Medical staff members of the Company-owned hospitals who are not employees often serve on the medical staffs of hospitals not owned by the Company and may terminate their relationships with the Company-owned hospitals at any time.\nRules and regulations concerning the medical aspects of each hospital's operations are adopted and enforced by its medical staff. Such rules and regulations provide that the members of the staff elect officers who, together with additional physicians selected by them, supervise all medical and surgical procedures and services. Their supervision is subject to the general oversight of the hospital's Governing Board.\nQUALITY OF SERVICES\nManagement believes the quality of healthcare services is critical in order to attract and retain top physicians and increase the market share of the Company's hospitals. One of the key mechanisms used to monitor the quality of care at the Company's hospitals is a quality assurance program designed to measure patient satisfaction, the Patient Satisfaction Monitoring System (\"PSMS\").\nPSMS utilizes the results of interviews performed by an independent research company of a statistically determined sample group of discharged patients at each hospital to gather patient responses regarding the hospital services provided. Management uses the results as a tool to improve the quality of patient services and satisfaction and believes PSMS has assisted the Company in successfully maintaining and improving the quality of healthcare as perceived by patients and their physicians and thereby contributing to improved net revenues. PSMS is also used by the Company as one of the bases upon which hospital executive directors and other employees are compensated under the Company's incentive compensation program. Management believes that the Company was the first in the industry to directly tie compensation to the attainment of qualitative performance targets.\nThe Company has also developed and implemented at several of the Company's hospitals systems similar to PSMS designed to (i) measure physician satisfaction, the MD Satisfaction Survey and (ii) emergency room services, Emergency Room PSMS.\nCOMPETITION\nThe Company operates its hospitals in competitive markets where other investor-owned and non-profit hospitals operate and provide services that are similar to those offered by the Company's hospitals. Competition among the Company's hospitals and other healthcare providers in the United States has increased in recent years due to a decline in occupancy rates resulting from among other things, changes in government regulation and reimbursement, other cost containment pressures, technology, and most recently, various healthcare reform plans pending in Congress. Additionally, hospitals owned by government agencies or other tax-exempt entities benefit from advantages (e.g., endowments, charitable contributions and tax-exempt financing) which are not available to the Company's hospitals.\nManagement believes that a hospital's competitive position within local markets is affected by various factors including the quality of healthcare services provided, pricing of healthcare services, the hospital's location and the types of services offered. The Company expects to improve the performance of its hospitals by (i) expanding physician network relationships, thereby attracting and retaining quality physician and medical personnel, (ii) increasing its emphasis on managed care contracting, (iii) developing and marketing new healthcare services targeted to the particular needs of the communities served by its hospitals, (iv) expanding profitable outpatient services, and (v) expanding geographic coverage by developing affiliations and alliances with other providers of service. In addition, the Company will continue to pursue opportunities for growth through acquisitions.\nThe competitive position of a hospital is also increasingly affected by its ability to negotiate contracts for healthcare services with managed care organizations, including health maintenance organizations (\"HMOs\"), preferred provider organizations (\"PPOs\") and other purchasers of group healthcare services. HMOs and PPOs attempt to direct and control use of hospital services through strict utilization management programs and by negotiating provider contracts with only one or a limited number of hospitals in each market area. The importance of negotiating with managed care organizations varies from market to market depending on the market strength of such organizations. In some situations, hospitals have agreed to fixed payments based on the number of managed care enrollees, resulting in the hospital and, in some cases, the physician assuming utilization risk (such contracts are referred to as capitated contracts). Managed care organizations are generally able to obtain, through the use of various contracting mechanisms including capitated contracts, significant discounts from hospital established charges. Management believes that the Company is able to compete effectively for managed care business in part because of its relationships with local physicians, its hospital management teams, its attention to cost controls and quality of service and its strategies to establish service niches in markets served by other hospitals.\nSOURCES OF REVENUE\nThe primary sources of the Company's hospital revenues are room and board and the provision of ancillary medical services. Room and board represents the basic charges for the hospital room and related services, such as general nursing care and meals. Ancillary medical services represent the\ncharges related to the medical support activities performed by the hospital, such as X-rays, physical therapy and laboratory procedures. The Company receives payments for services rendered to patients from the federal government under Medicare programs and the Civilian Health and Medical Program of Uniformed Services (\"CHAMPUS\"), state governments under their respective Medicaid programs, managed care organizations (\"contracted services\"), private insurers, self-insured employers and directly from patients. In addition to revenues received from such programs and patients, the Company receives other non-patient revenues (e.g. cafeteria and gift shop revenues).\nThe following table presents the percentage of net revenues for fiscal 1994, 1993 and 1992 under each of the following programs:\nThe Company's hospital revenues received under Medicare, Medicaid, CHAMPUS, Blue Cross and from payers of contracted services are generally less than customary charges for the services covered. The increased percentage of government paid care subjects providers to greater risk associated with reduced government reimbursement. Managed care programs which offer prepaid and discounted medical service packages account for a significant share of the market and have reduced the historical rate of growth of hospital revenues. As a result, new kinds of healthcare strategies and provider networks (e.g. physician networks) are continuing to emerge.\nPatients are generally not responsible for any difference between customary hospital charges and amounts reimbursed under Medicare, Medicaid, CHAMPUS and some Blue Cross plans or by payers of contracted services for such services, except to the extent of any exclusions, deductibles or co-insurance features of their coverage. In recent years insurers and other payers have increased the amount of such exclusions, deductibles and co-insurance generally increasing the patient's financial responsibility to directly pay for some services. The increase in the self-pay portion of a patient's financial responsibility may also increase the amount of the Company's uncollectible accounts.\nMEDICARE PROGRAM\nUnder the Medicare program the Company receives reimbursement under a prospective payment system (\"PPS\") for the routine and ancillary operating costs of most Medicare inpatient hospital services. Psychiatric, long-term care, rehabilitation, pediatric and certain designated cancer research hospitals, as well as psychiatric or rehabilitation units that are distinct parts of a hospital, are currently exempt from PPS and are reimbursed on a cost based system, subject to certain cost caps. It is uncertain what impact, if any, the federal efforts to reform the healthcare system will have on the current method of Medicare reimbursement.\nUnder PPS, fixed payment amounts per inpatient discharge were established based on the patient's assigned diagnosis related group (\"DRG\"). DRG's classify patients' treatments for illnesses according to the estimated intensity of hospital resources necessary to furnish care for each principal diagnosis. DRG rates have been established for each individual hospital participating in the Medicare program and are based upon a statistically normal distribution of severity. Patients falling well outside the normal distribution are afforded additional payments and defined as \"outliers\". Under PPS, hospitals may retain payments in excess of costs but must absorb costs in excess of such payments; therefore hospitals are encouraged to operate at greater efficiency.\nDRG rates are updated and recalibrated periodically and have been affected by several recent federal enactments. The index used by the Health Care Financing Administration (\"HCFA\") to adjust the DRG rates gives consideration to the inflation experienced by hospitals in purchasing goods and services (\"market basket\"). However, for several years the percentage increases to the DRG rates\nhave been lower than the percentage increases in the costs of goods and services purchased by hospitals. The market basket is adjusted each federal fiscal year (\"FY\") which begins on October 1. The market basket for FY 1993 was 4.1%, FY 1994 was 4.3% and for FY 1995 is 3.6%.\nThe Omnibus Budget Reconciliation Act of 1993 (\"OBRA-93\") extended the reduction enacted by the Omnibus Budget Reconciliation Act of 1990 (\"OBRA-90\") in the Medicare DRG payments to healthcare providers through 1997. A substantial number of AMI's hospitals are classified as urban hospitals for reimbursement purposes. The net updates of DRG rates for large urban and other urban hospitals are established as follows: FY 1994 and FY 1995 market basket, minus 2.5%; FY 1996 market basket, minus 2%; and FY 1997 market basket, minus 0.5%. Management cannot predict how future adjustments by Congress and HCFA will affect the profitability of its healthcare facilities.\nThe Omnibus Budget Reconciliation Act of 1990 required the Secretary of the Department of Health and Human Services (\"HHS\") to develop a proposal for a PPS for all hospital-based outpatient services and inpatient psychiatric care. The Secretary of HHS' report, which was due on September 1, 1991, has not been submitted. Until such time as the Secretary of HHS has developed a PPS for all hospital-based outpatient services, OBRA-90 directs that payments for the reasonable cost of outpatient hospital services (other than for capital related costs) be reimbursed at 94.2% of such reasonable costs for cost reporting periods falling within FY 1991 through FY 1995. OBRA-93 extended this reduction from FY 1995 through FY 1998.\nMEDICARE REIMBURSEMENT FOR CAPITAL COSTS\nSubsequent to September 30, 1991 and through FY 1995, capital related payments for inpatient hospital services are made at the rate of 90% of reasonable capital costs until capital PPS becomes applicable at the hospital. The PPS capital costs reimbursement applies an estimated national average of FY 1989 Medicare capital costs per patient discharge updated to FY 1992 by the estimated increase in Medicare capital costs per discharge (the \"Federal Rate\"). Capital PPS is applicable to cost reports beginning on or after October 1, 1991. Under capital PPS reimbursement a 10 year transition period has been established. A hospital is paid under one of the following two different payment methodologies during this transition period: (i) hospital with a hospital-specific rate (the rate established for a hospital based on the cost report ending on or before December 31, 1990) below the Federal Rate would be paid on a fully prospective payment methodology and (ii) hospitals with a hospital-specific rate above the Federal Rate would be paid based on a hold-harmless payment methodology or 100% of the Federal Rate whichever results in a higher payment. A hospital is paid under one methodology throughout the entire transition. After the transition period, all hospitals would be paid the Federal Rate.\nThe impact of PPS capital reimbursement in the first two years has not been material to Medicare capital reimbursement. The hospital-specific rates for FY 1994 decreased 2.16%. The established Federal Rate for FY 1994 was reduced by 9.33% to $378.34 per patient discharge and for FY 1995 was reduced by 0.4% to $376.83 per patient discharge. Management believes that the decrease in the rate of reimbursement for capital costs will not have a material adverse effect on the Company's results of operations.\nMEDICAID PROGRAM\nThe Medicaid program, created by the Social Security Act, is designed to provide medical assistance to individuals unable to afford care. Medicaid is a joint federal and state program in which states voluntarily participate. Reimbursement rates under the Medicaid program are set by each participating state, and rates and covered services may vary from state to state. Depending on the average income per person in a state, at least 50% of Medicaid funding comes from the federal government, with the balance shared by the state and local governments. The amount of the federal share is called Federal Financial Participation (\"FFP\"). Each of the Company's facilities is currently an eligible Medicaid provider, although certain of the Company's hospitals do not currently participate as providers of services in their respective state Medicaid programs.\nThe Omnibus Reconciliation Act of 1981 permitted each state to determine new reimbursement rates for Medicaid inpatient hospital services that are reasonable and adequate to meet the costs which must be incurred by efficiently and economically operated facilities and to assure access to inpatient hospital services by Medicaid recipients. Providers must accept Medicaid payment as payment in full for healthcare services provided to Medicaid patients. Actual payment rates and the methodologies for determining such rates vary from state to state. For example, in Texas, Medicaid inpatient services are reimbursed on a DRG based system, while in Florida, Medicaid inpatient services are reimbursed on a per diem prospective payment system. In many instances, Medicaid reimbursement does not cover a hospital's costs in providing services to Medicaid recipients.\nThe Company operates hospitals in some states that currently levy taxes on healthcare providers or use healthcare provider donations to meet the state's share of medical assistance expenditures. HCFA issued a final rule on September 13, 1993 whereby funds donated from Medicaid providers and expenditures that are attributable to provider-specific state taxes be offset from Medicaid expenditures incurred on or after January 1, 1992, before calculating the amount of the federal share of FFP. The Company has historically participated in such programs and has received reimbursement to offset a portion of the cost of services provided to indigent patients. Although management believes that as a result of the final rule such reimbursement will be reduced, steps have been taken to offset the anticipated reduction in reimbursement.\nThe Medicare and Medicaid programs have been subject to continual modification through legislative acts and both federal and state administrative initiatives. The federal or state governments might in the future reduce the funds available under these programs or require more stringent utilization review of hospital facilities. Such actions could have a material adverse impact on the Company's financial condition and results of operations.\nCHAMPUS\nThe Company's hospitals are reimbursed by the federal government's CHAMPUS program for care provided to United States military retirees and dependents. CHAMPUS pays for inpatient acute hospital care on the basis of a prospectively determined rate applied on a per discharge basis using DRGs similar to the Medicare system. At this time, inpatient psychiatric hospital services are reimbursed on an individual hospital's per diem rate calculated based upon the hospital's prior cost experience. There can be no assurance that the CHAMPUS program will continue per diem reimbursement for psychiatric hospital services in the future.\nCONTRACTED BUSINESS\nManaged care arrangements have typically reimbursed providers based on a percent of charges or on a per diem basis with stop-loss provisions for high severity cases. In more developed markets such as California and Florida, the Company's hospitals are now entering into risk sharing, or capitated, arrangements. These arrangements reimburse the hospital based on a fixed fee per participant in a managed care plan with the hospital assuming the cost of services provided, regardless of the level of utilization. If utilization is higher than anticipated and\/or costs are not effectively controlled, such arrangements could produce low or negative operating margins.\nCOMMERCIAL INSURANCE\nThe Company's hospitals provide services to individuals covered by private healthcare insurance. Private insurance carriers either reimburse their policy holders or make direct payment to the Company's hospitals based upon the particular hospital's established charges and the particular coverage provided in the insurance policy. Blue Cross is a healthcare financing program that provides its subscribers with hospital benefits through independent organizations that vary from state to state. The Company's hospitals are paid directly by local Blue Cross organizations on the basis agreed to by each hospital and Blue Cross by a written contract. In some states, the local Blue Cross affiliate is believed to be experiencing financial difficulty; however, management does not believe that such difficulties represent a material financial exposure to the Company.\nRecently, several commercial insurers have undertaken efforts to limit the costs of hospital services by adopting PPS or DRG based systems. To the extent such efforts are successful, and to the extent that the insurers' systems fail to reimburse hospitals for the costs of providing services to their beneficiaries, such efforts may have a negative impact on the hospitals' net revenue.\nREGULATION\nLICENSURE, CERTIFICATION AND ACCREDITATION\nHealthcare facility construction and operation is subject to federal, state and local regulation relating to the adequacy of medical care, equipment, personnel, operating policies and procedures, fire prevention, rate-setting and compliance with building codes and environmental protection laws. Facilities are subject to periodic inspection by governmental and other authorities to assure continued compliance with the various standards necessary for licensing and accreditation. Management believes that all of the Company's healthcare facilities are properly licensed under appropriate state laws and are certified under the Medicare program or are accredited by the Joint Commission on Accreditation of Health Care Organizations (\"Joint Commission\"), the effect of which is to permit the facilities to participate in the Medicare and Medicaid programs. Should any facility lose its Joint Commission accreditation, or otherwise lose its certification under the Medicare program, the facility would be unable to receive reimbursement from the Medicare and Medicaid programs. Management believes that the Company's facilities are in substantial compliance with applicable federal, state, local and independent review body regulations and standards. The requirements for licensure, certification and accreditation are subject to change and, in order to remain qualified, it may be necessary for the Company to effect changes in its facilities, equipment, personnel and services. Although the Company intends to continue its qualification, there is no assurance that its hospitals will be able to comply in the future.\nCERTIFICATES OF NEED\nThe construction of new facilities, the acquisition of existing facilities, and the addition of new beds or services may be reviewable by state regulatory agencies under a program frequently referred to as a Certificate of Need. The Company operates hospitals in nine states that require state approval under the Certificate of Need program. Such laws generally require appropriate state agency determination of public need and approval prior to beds or services being added, or a related capital amount being spent. Failure to obtain necessary state approval can result in the inability to complete an acquisition or change of ownership, the imposition of civil or, in some cases, criminal sanctions, the inability to receive Medicare or Medicaid reimbursement and\/or the revocation of a facility's license.\nUTILIZATION REVIEW\nIn order to ensure efficient utilization of facilities and services, federal regulations require that admissions to and the utilization of facilities by Medicare and Medicaid patients be reviewed periodically by a federally funded Peer Review Organization (\"PRO\"). Pursuant to federal law, the PRO must review the need for hospitalization and the utilization of services, and may, where appropriate, deny payment for services provided. Each of the Company's facilities has contracted with a PRO and has had in effect a quality assurance program that provides for retrospective patient care evaluation and utilization review. While no PRO has taken adverse action against any of the Company's hospitals to date, PRO review can result in denial of payment for services, recoupment of monies paid to the hospital, assessment of fines or exclusion from the Medicare and Medicaid programs.\nSTATE RATE-SETTING ACTIVITY\nThe Company currently operates five facilities in Florida wherein the state has mandated hospital rate-setting. Under Florida law, the maximum annual percentage any hospital may increase its revenue per admission is limited to the hospital's prior year actual revenue per adjusted admission inflated forward by the hospital's applicable current year's maximum allowable rate of increase (\"MARI\") or the Health Care Cost Containment Board-approved budgeted revenue per adjusted admission. The MARI is the maximum rate at which a hospital is expected to increase its average revenue per adjusted admission for a given period. The Health Care Cost Containment Board, using\nthe most recent audited actual experience for each hospital, calculates the MARI for each hospital based on the projected rate of increase in the market basket index, adjusted by the hospital's percentage of Medicare, Medicaid and charity care days plus two percentage points. As a result, in Florida, the Company's ability to increase its rates to compensate for increased costs per admission is limited, and the Company's operating margin at Florida facilities may be adversely affected. There can be no assurance that other states in which the Company operates hospitals will not enact rate-setting provisions as well.\nFEDERAL LEGISLATION AND RULE-MAKING\nThe Medicare and Medicaid Antifraud and Abuse Amendments (the \"Amendments\") are codified under Section 1128B of the Social Security Act. The Amendments provide criminal penalties for individuals or entities that knowingly and willfully offer, pay, solicit or receive remuneration of any kind in order to induce referrals for goods or services reimbursed under the Medicare or state Medicaid programs. The statute on its face is very broad with the types of remuneration covered including kickbacks, bribes and rebates made directly or indirectly, overtly or otherwise, in cash or in kind. In addition, prohibited conduct includes remuneration intended to induce the purchasing, leasing, ordering or arranging for any good, facility or service paid for by Medicare or state Medicaid programs. In addition to criminal penalties (fines of up to $25,000 and imprisonment for up to five years per referral), the Amendments also establish civil monetary penalties and sanctions of excluding violators from Medicare and Medicaid participation. The Office of the Inspector General (\"OIG\") has taken the position that where physicians hold other than bona fide ownership interests in healthcare providers (e.g., where such ownership is intended to encourage the physicians to utilize the services of the entity in which they have invested) such ownership arrangements violate the Amendments.\nIn recent years, the courts have suggested that any direct or indirect payment or other financial benefit conferred upon a physician or other referral source may violate the statute if one purpose of any portion of the payment is to induce the physician to refer patients to the entity providing the benefit. Healthcare providers are concerned that many relatively innocuous, or even beneficial, commercial arrangements are technically covered by the Amendments and are, therefore, subject to potential criminal prosecution. The Medicare and Medicaid Patient and Program Protection Act of 1987 added two new provisions specifically addressing the anti-kickback statute. They first authorized the OIG to exclude an individual or entity from participation in the Medicare and Medicaid programs if it is determined through an administrative process that the party has engaged in a prohibited remuneration scheme. In addition, Congress directed the HHS to develop regulations specifying those payment practices that will not be subject to criminal prosecution and not provide a basis for exclusion from the Medicare and Medicaid programs (\"safe harbors\"). Final regulations were published on July 29, 1991 in the Federal Register. Additional safe harbors were proposed, with a 60 day public comment period, on September 21, 1993. The proposed rule offers protection for investment interests in rural areas, ambulatory surgical centers, and group practices composed exclusively of active investors; practitioner recruitment in rural areas; obstetrical malpractice insurance subsidies; referral arrangements for specialty services; and cooperative hospital service organizations.\nAmong the criteria contained in the final regulations are criteria for investments, leasing, purchasing and ordering arrangements which would apply to the Company's facilities. The additional proposed regulations will also provide a safe harbor for physician recruitment by facilities in certain rural areas. If adopted, such a safe harbor provision would apply to certain of the Company's facilities. Arrangements with referring physicians involving leasing, purchasing, ordering and recruitment would not constitute illegal remuneration so long as all of the criteria set forth in the safe harbors are met. However, the fact that each provision of such arrangements does not fall within one of the applicable safe harbor criteria does not necessarily mean that the arrangement is illegal.\nIn order to prevent hospitals from entering into arrangements with physicians that increase the physician payment from Medicare or Medicaid, in January 1991, the OIG issued a management advisory report identifying potential violations of the antifraud and abuse statute with respect to\ncertain financial arrangements between hospitals and hospital-based physicians. Specifically, the report stated that financial agreements that require physicians to pay more than the fair market value for services provided by the hospital or that compensate physicians for less than the fair market value of goods and services that they provide to hospitals create potential liability for physicians and hospitals engaged in these actions.\nIn May 1992, the OIG issued a special fraud alert regarding hospital incentives to physicians. The alert identified the following incentive arrangements which, if present, are indications of potentially unlawful activity: (a) payment of any sort of incentive by the hospital each time a physician refers a patient to the hospital, (b) the use of free or significantly discounted office space or equipment (in facilities usually located close to the hospital), (c) provision of free or significantly discounted billing, nursing or other staff services, (d) free training for a physician's office staff in areas such as management techniques, CPT coding and laboratory techniques, (e) guarantees which provide that, if the physician's income fails to reach a predetermined level, the hospital will supplement the remainder up to a certain amount, (f) low-interest or interest-free loans, or loans which may be \"forgiven\" if a physician refers patients (or some number of patients) to the hospital, (g) payment of the costs of a physician's travel and expenses for conferences, (h) coverage on hospital's group health insurance plans at an inappropriately low cost to the physician and (i) payment for services (which may include consultations at the hospital) which require few, if any, substantive duties by the physician, or payment for services in excess of the fair market value of services rendered.\nCertain of the Company's current financial arrangements with physicians, including joint ventures, may not qualify for the current safe harbor exemptions and, as a result, such arrangements risk scrutiny by the OIG and may be subject to enforcement action. As indicated above, the failure of these arrangements to satisfy all of the conditions of the applicable safe harbor criteria does not mean that the arrangements are illegal. Nevertheless, certain of the Company's current financial arrangements with physicians, including joint ventures, and the Company's future development of joint ventures and other financial arrangements with physicians, could be adversely affected by the failure of such arrangements to comply with the safe harbor regulations, or the future adoption of other legislation or regulation in these areas.\nUnder provisions of the Omnibus Budget Reconciliation Act of 1989 and OBRA-90, referrals of Medicare and Medicaid patients to clinical laboratories with which a referring physician has a financial relationship are prohibited effective January 1, 1991. As of January 1, 1992, any claim for payment submitted to Medicare by a provider must identify the name and provider number of the referring physician and must indicate whether the physician has an ownership or other financial arrangement with the provider. Under the provisions of OBRA-93, referrals of Medicare and Medicaid patients to certain \"designated health services\" with which a referring physician has a financial relationship will be prohibited as of January 1, 1995. These designated health services include the following: clinical laboratory; physical and occupational therapy services; radiology or other diagnostic services; radiation therapy services; durable medical equipment; parenteral and enteral nutrients, equipment and supplies; prosthetics, orthotics and prosthetic devices; home health services; outpatient prescription drugs; and inpatient and outpatient hospital services. There are a number of exceptions that may apply to the compensation arrangements under which the Company's facility contracts with certain of its physicians including exceptions for bona fide employment relationships, personal service arrangements, and physician recruitment arrangements.\nThe Social Security Act also imposes criminal and civil penalties for making false claims to Medicare and Medicaid for services not rendered or for misrepresenting actual services rendered in order to obtain higher reimbursement. Like the antifraud and abuse statute, this statute is very broad. Careful and accurate coding of claims for reimbursement must be performed to avoid liability under the false claims statutes.\nManagement exercises care in an effort to structure its arrangements with physicians to comply in all material respects with these laws, and management believes that the Company is in compliance\nwith the Amendments, however, there can be no assurance that (i) government officials charged with responsibility for enforcing the prohibitions of the Amendments will not assert that the Company or certain transactions in which it is involved are in violation of the Amendments, or (ii) courts will interpret the Amendments in a manner consistent with the practices of the Company.\nSTATE LEGISLATION\nCertain states in which the Company's facilities are located also have enacted statutes which prohibit the payment of kickbacks, bribes and rebates for the referral of patients. Many of these statutes have provisions that closely follow the federal statutes described above, and there have been few actions or interpretations made under such provisions. Management believes that the Company is in substantial compliance with such laws; however, there can be no assurance that government officials who have the responsibility for enforcing such laws will not assert that the Company or certain transactions in which the Company is involved are in violation of such laws, or that such laws will ultimately be interpreted by the government officials in a manner consistent with the practices of the Company.\nGENERAL REGULATION\nThe Company is committed to providing its employees with an equal opportunity work environment that is free from discrimination. In keeping with this commitment, the Company ensures that all human resource programs are administered without regard to race, religion, color, national origin, sex or age. Furthermore, the Company embraces and complies with the American Disabilities Act of 1990 (ADA) and the 1993 Family and Medical Leave Act. Such human resource programs include, but are not limited to, compensation, benefits, application of Company policies, company-sponsored training, educational, social and recreational programs.\nThe Company is subject to various federal, state and local statutes and ordinances regulating the discharge of materials into the environment, including, without limitation, the disposal of certain medical waste and by-products. Management does not believe that the Company will be required to expend any material amounts in order to comply with these laws and regulations or that compliance will materially affect its capital expenditures, earnings or competitive position.\nPROFESSIONAL LIABILITY\nAs is typical in the healthcare industry, the Company is subject to claims and legal actions by patients in the ordinary course of business. The Company self-insures the professional and general liability claims for nine of its hospitals up to $500,000 per occurrence and for 26 of its hospitals up to $3 million per occurrence. Prior to June, 1993 the self-insured retention was $5 million per occurrence. Coverage for professional and general liability claims for the Company's two remaining hospitals is maintained with outside insurance carriers.\nThe Company owns a 35% equity interest in an insurance company which insures the excess professional and general liability risks for those hospitals which are self-insured. The excess coverage provided by this insurance company is limited to $25 million per claim. The Company purchases additional excess insurance from a commercial carrier. For the period from January 1986 to February 1991, the Company had no excess coverage for the majority of its hospitals. However, in March 1991, the Company purchased prior acts coverage which substantially reduces the uninsured liability for risks during this period.\nThe Company maintains an unfunded reserve for its professional liability risks which is based, in part, on actuarial estimates calculated and evaluated by an independent actuary. Actual hospital professional and general liability costs for a particular period are not normally known for several years after the period has ended. The delay in determining the actual cost associated with a particular period is due to the time between the occurrence of an incident, the reporting thereof and the settlement of related claims. As a result, reserves for losses and related expenses are estimated using expected loss reporting patterns determined in conjunction with the actuary and are discounted using a rate of 9% to their present value. Adjustments to the total reserves are determined in conjunction\nwith the actuary and on an annual basis are recorded by the Company as an increase or decrease in the current year's earnings. Management considers such reserves to be adequate for professional liability risks. Any losses incurred in excess of the established reserves will be recorded as a charge to the earnings of the Company. Any losses incurred within the Company's self-insured limits will be paid out of the Company's cash from operations. While the Company's cash from operations has been adequate to provide for alleged and unforeseen liability claims in the past, there can be no assurance that the Company's cash flow will continue to be adequate to cover such claims.\nSEGMENT OPERATING INFORMATION\nHoldings' only material business segment is \"healthcare,\" which contributed substantially all of its revenues and operating profits in fiscal 1994. The Company's healthcare business is conducted in the United States.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nSee \"ITEM 1. BUSINESS.\"\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nLITIGATION RELATING TO THE MERGER.\nTo date, a total of nine purported class action suits (the \"Class Actions\") have been filed against Holdings and the directors of Holdings (and in two cases against NME). Seven of such Class Actions have been filed in the Delaware Court of Chancery and are entitled (i) JEFFREY STARK AND GARY PLOTKIN V. ROBERT W. O'LEARY, ROBERT J. BUCHANAN, JOHN T. CASEY, ROBERT B. CALHOUN, HARRY J. GRAY, HAROLD J. [SIC] HANDELSMAN, SHELDON S. KING, MELVYN N. KLEIN, DAN W. LUFKIN, WILLIAM E. MAYER AND HAROLD S. WILLIAMS (THE \"HOLDINGS DIRECTORS\") AND HOLDINGS, C.A. NO. 13792, (ii) 7457 Partners v. the Holdings Directors and Holdings, C.A. No. 13793, (iii) MOISE KATZ V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13794, (iv) CONSTANTINOS KAFALAS V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13795, (v) F. RICHARD MANSON V. THE HOLDINGS DIRECTORS, NME AND HOLDINGS, C.A. NO. 13797, (vi) LISBETH GREENFELD V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13799 and (vii) JOSEPH FRANKEL V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13800 and two purported Class Actions have been filed in the Superior Court of the State of California, County of Los Angeles, entitled RUTH LEWINTER AND RAYMOND CAYUSO V. THE HOLDINGS DIRECTORS (WITH THE EXCEPTION OF HAROLD S. WILLIAMS), NME AND HOLDINGS, CASE NO. BC115206 AND DAVID F. AND SYLVIA GOLDSTEIN V. O'LEARY, NME, AMI, ET AL., CASE NO. BC116104. The seven Class Actions filed in the Delaware Court of Chancery have been consolidated The complaints filed in each of the Class Actions are substantially similar, are brought by purported stockholders of Holdings and, in general, allege that the defendants breached their fiduciary duties to the plaintiffs and other members of the purported class. One of the Class Actions alleges that the defendants have committed or aided and abetted a gross abuse of trust. The complaints further allege that the directors of Holdings wrongfully failed to hold an open auction and encourage bona fide bids for Holdings and failed to take action to maximize value for Holdings stockholders. The complaints seek preliminary and permanent injunctions against the proposed transaction until such time as a transaction to be entered into between Holdings and NME results from bona fide arms' length negotiation and\/or requiring a fair auction for Holdings. In addition, if the Merger is consummated, the complaints seek recision or recessionary damages and two of the Class Actions seek an accounting of all profits realized and to be realized by the defendants in connection with the Merger and the imposition of a constructive trust for the benefit of the plaintiffs and other members of the purported classes pending such an accounting. The complaints also seek monetary damages of an unspecified amount together with prejudgment interest and attorneys' and experts' fees. Holdings and NME believe that the complaints are without merit and intend to defend them vigorously.\nIn addition, Holdings and AMI are subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of all pending legal proceedings will not have a material adverse effect on the business, results of operations or financial condition of Holdings or AMI.\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.\nHoldings' common stock is traded on the New York Stock Exchange. Holdings owns all of AMI's issued and outstanding common stock and such shares are no longer publicly traded. The following table indicates the quarterly high and low sales prices of Holdings' common stock for the period from September 1, 1992 through August 31, 1994. Certain covenants in the Company's bank credit and other financing agreements restrict the payment of cash dividends on Holdings' common stock (See Item 14(a), Note 5 to the Financial Statements). No dividends were paid on Holdings' common stock for the periods presented. (See \"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources\").\nThere were 9,134 holders of record of Holdings' shares as of November 9, 1994.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE YEAR FINANCIAL SUMMARY (IN MILLIONS, EXCEPT PER SHARE AMOUNTS)\nSEE 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\nThe Company's cash and cash equivalents were $31.9 million at August 31, 1994 compared to $44.3 million at August 31, 1993. Net cash provided by operating activities increased $12.4 million to $269.6 million for the year ended August 31, 1994 when compared to the same period in the prior year. In May 1994, the Company received $72.4 million related to the disposition of AMI's interest in EPIC Holdings, Inc. as a result of the merger of EPIC Holdings, Inc. with HealthTrust, Inc. -- the Hospital Company. The Company paid income taxes of $86.0 million for the year ended August 31, 1994 of which $25.9 million related to the disposition of AMI's interest in EPIC Holdings, Inc. The long-term debt balance (including current maturities) at August 31, 1994 was $1,297.7 million compared to $1,335.0 million at August 31, 1993.\nIn fiscal 1994, the Company invested $112.2 million in capital expenditures (excluding acquisitions) and as of August 31, 1994, had approximately $19.5 million of capital expenditure commitments outstanding. Capital expenditures made by the Company are for new construction and renovations to facilitate and accommodate new inpatient and outpatient programs and to develop and acquire new or additional lines of business, including home health, surgery centers and physician practices. In May 1994, the Company completed the purchase of Saint Francis Hospital located in Memphis, Tennessee for a purchase price of approximately $92.0 million. In conjunction with this purchase, in June 1994 the Company completed the acquisition of a management services organization in the Memphis area.\nThe Company intends to continue to invest in new and existing operations within the healthcare industry. On September 1, 1994, a limited partnership, of which a wholly-owned subsidiary of AMI is the general partner, completed the purchase of Hilton Head Hospital, located in Hilton Head, South Carolina for a purchase price of approximately $23.6 million. Through its subsidiary AMI owns 70% of the limited partnership. In connection with the Company's efforts to re-establish a presence in Europe, the Company has entered into a joint venture agreement with a community organization (the \"Burgergemeinde\") located in Cham, Canton Zug, Switzerland. The joint venture will be owned 90% by the Company and 10% by the Burgergemeinde. Under the terms of the proposed transaction, the Company will enter into a long term lease for the land where the existing hospital is located and will then construct a new 56 bed acute care wing, convert an existing structure into a medical office building and renovate and remodel the existing acute care facility. In addition, the Company plans to contract to provide management, food, physical therapy and rehabilitation services to the hospital, an on-site nursing home and an affiliated retirement community.\nIn June 1994, the Company amended its credit facility (\"Reducing Revolving Credit Facility\") extending the term of the bank commitments thereunder until September 1999 and reducing the rate of interest applicable to amounts outstanding thereunder to, at the option of AMI, (i) adjusted LIBOR plus .875% (subject to reduction upon the satisfaction of certain conditions) or (ii) the alternative base rate specified for the Reducing Revolving Credit Facility. Upon completion of the fiscal 1994 loan compliance report, anticipated to be prior to the end of the first quarter of fiscal 1995, the rate at which interest accrues based on LIBOR will be reduced to LIBOR plus .75%.\nThe Company repaid (excluding repayments on the Reducing Revolving Credit Facility) $62.2 million of long-term debt during the year ended August 31, 1994 from cash provided by operating activities. During fiscal 1994, the Company (i) made repayments of $28.0 million for the redemption of the remaining principal amount of the 6 3\/4% Swiss franc\/dollar dual currency senior notes due 1997, (ii) repurchased $15.4 million principal amount of the 15% Junior Subordinated Discount Debentures, Due 2005 and (iii) made repayments of approximately $18.8 million on certain other indebtedness. The amount outstanding under the Reducing Revolving Credit Facility decreased to $266.0 million as of August 31, 1994, from $287.0 million outstanding as of August 31, 1993. Under the Reducing Revolving Credit Facility, $31.3 million in letters of credit were outstanding as of August 31, 1994.\nManagement believes that sufficient funds will be generated from operations, augmented by borrowings under the Reducing Revolving Credit Facility, to finance operations, capital expenditures and service debt. Scheduled principal payments, excluding amounts that may become due on the Reducing Revolving Credit Facility, are $156.0 million in fiscal 1995, $57.0 million in fiscal 1996, $182.1 million in fiscal 1997, $2.3 million in fiscal 1998, and $2.3 million in fiscal 1999.\nThe terms of certain indebtedness of the Company impose operating and financial restrictions requiring the Company to maintain certain financial ratios and restrict the Company's ability to incur additional indebtedness and enter into leases and guarantees of debt; to make capital expenditures; to make loans and investments; to pay dividends or repurchase shares of stock; to repurchase, retire or refinance indebtedness prior to maturity; and to purchase or sell assets. The Company has pledged the capital stock of certain direct (first tier) subsidiaries as security for its obligations under the Reducing Revolving Credit Facility and certain other senior indebtedness. In addition, the Company has granted a security interest in its accounts receivable as security for its obligations under the Reducing Revolving Credit Facility. Management believes that the Company is currently in compliance with all covenants and restrictions contained in all financing agreements.\nUpon completion of the acquisition of the Company by a wholly-owned subsidiary of National Medical Enterprises, Inc., management believes that the combined company's liquidity will be adequate to finance the Company's hospital operations, capital expenditures and future developments.\nRESULTS OF OPERATIONS\nGENERAL TRENDS\nThe Company's net revenues have increased as compared with the same period of the prior year as a result of the continued increase in volume from outpatient and inpatient services, the expansion of patient care services and general price increases. The Company has experienced an increase in outpatient volume as compared to the prior year as a result of (i) advanced medical technology and (ii) cost containment pressures from payers to direct more patients from inpatient facilities to less expensive outpatient facilities. Accordingly, several of the Company's hospitals continue to expand or redesign their outpatient facilities and services to accommodate the increased utilization of such facilities. The growth rate of the Company's outpatient revenue realized from the shift of inpatient care services to outpatient care services is expected to occur at a slower pace in the future from the rate experienced in the past, as the use of such services matures. As a result of increased demand for specialized healthcare for both inpatient and outpatient care, the Company has established specialized programs (e.g. long-term care, rehabilitation units, home health) within separate units in the Company's existing hospitals. Regulations are currently being proposed by the Health Care Financing Administration that, if enacted, would limit the opportunity provided by the development of these specialized programs.\nMedicare and Medicaid revenues are expected to continue to increase in the future as a larger portion of the general population qualifies for coverage as a result of the aging of the population and expanded state Medicaid programs. This in turn may decrease the Company's overall rate of revenue growth as a result of (i) a corresponding change in payer mix and (ii) the disparity between the rate of increase in the Company's established billing rates and the government's reimbursement rate. The Medicare program reimburses the Company's hospitals primarily based on established rates by a diagnosis related group for acute care hospitals. While Medicare payment rates are indexed for inflation annually, the increases have historically lagged behind actual inflation.\nIn addition to the Medicare program, states and insurance companies continue to actively negotiate the amounts they will pay for services performed, rather than simply paying healthcare providers their established billing rates. The maturity of managed care environments varies in the markets in which the Company operates. The Company's hospitals that operate in mature managed care markets typically have contributed smaller profit margins than some of the Company's hospitals which operate in less mature markets. Management believes that through cost-containment efforts, the Company is positioned to have a competitive edge in pursuing market share in the managed care environment.\nCompetition among hospitals and other healthcare providers in the United States has increased over the past several years due to changes in government regulation and reimbursement, various other third party payer cost containment pressures and medical technology. As these factors continue to affect healthcare providers, along with the pending proposals for healthcare reform, the healthcare industry continues to experience a significant increase in the number of mergers and acquisitions occurring between both investor-owned and non-profit hospitals in an effort to further reduce the cost of delivering high quality care.\nTo offset these factors which may limit net revenue growth, the Company continues to look at providing an increasing array of healthcare services by expanding the Company's operations and by integrating broad healthcare networks. As a result, the Company is developing physician networks and alliances with other healthcare providers to create fully integrated healthcare delivery systems. In addition to expanding services, management believes that its cost containment efforts have been critical in improving and maintaining operating margins while providing a high level of patient care.\nA significant portion of the Company's operating costs and expenses are subject to inflationary increases. Since the healthcare industry is labor intensive, salaries and benefits are continually affected by inflation. To control labor costs, the Company has and will continue to monitor, at the hospital level, the daily staff coverage. To control increases in supply costs, management continues to focus on managing such utilization through various mechanisms including (i) improved contract compliance, (ii) development of pharmaceutical formularies to control the usage of new drugs and (iii) aggressive negotiation of supply purchase contracts. To further control costs, the Company continues to expand its case management (i.e. review of associated costs for patient care for specific treatment) in its hospitals. The Company's ability to pass on a certain portion of the increased costs associated with providing healthcare to Medicare\/Medicaid patients may be limited by existing government reimbursement programs for healthcare services unless the federal and state governments correspondingly increase the rates of payments under these programs. Although the Company cannot predict its ability to continue to cover future cost increases, management believes that through the continued adherence to the cost containment programs, labor management and reasonable price increases, inflation is not expected to have a material adverse effect on operating margins.\nHEALTHCARE REFORM\nAlthough substantive federal healthcare reform has not been legislated, the healthcare industry will continue to be faced with federal and state efforts to reform the delivery system. Any substantive reform is likely to encompass healthcare coverage for an increasing percentage of the U.S. population and could contain provisions which would impose among other things, cost controls on healthcare providers, insurance market reforms to increase the availability of group health insurance to small businesses, requirements that all businesses offer health insurance coverage to their employees, and the creation of a single government health insurance plan (to reduce administrative costs) that would cover all citizens. Reform proposals may also contain significant reductions in the amount of reimbursement received under the Medicare\/Medicaid programs. In addition to the proposed healthcare reform, some states, including Florida, have already enacted reforms and continue to consider additional reforms. The type and impact of such reform continues to be debated at both the federal and state levels.\nManagement believes that some form of federal healthcare reform may occur; however, until such reform is finalized, management cannot predict which proposals will be adopted, if any, and until adopted the impact of any such proposals on the Company's business, results of operations or financial condition.\nYEARS ENDED AUGUST 31, 1994, 1993 AND 1992\nThe following table summarizes certain consolidated results of the Company. AMI's results of operations are the same as that of the Company's; therefore, separate results of operations and a discussion and analysis for AMI are not presented.\nThe following table sets forth certain operating statistics of the Company's hospitals for the three years ended August 31, 1994.\nNet revenues for the year ended August 31, 1994 increased 6.4% to $2,382 million from $2,238 million for the year ended August 31, 1993 as a result of new patient care services, higher utilization of outpatient and ancillary services and higher third party reimbursement rates. Net revenues for the year ended August 31, 1992 of $2,238 million included a benefit of approximately $10 million relating to a Medicare settlement and $69 million relating to facilities sold during fiscal 1992.\nA shift in volume from inpatient services to outpatient services over the past three years, the development of home health services and the addition of ancillary facilities at certain of the Company's hospitals have contributed to net revenues from outpatient services accounting for a larger percent of total net patient revenues in recent years. Net revenues from outpatient services accounted for 29.6%, 29.4% and 27.6% of total net patient revenues for the years ended August 31, 1994, 1993 and 1992, respectively. For the year ended August 31, 1994, the Company experienced a greater increase in admissions (5.5% as compared to the year ended August 31, 1993) than seen in prior years, due primarily to the addition of Saint Francis Hospital. Admissions, which were impacted by the addition of Encino Hospital in fiscal 1993 and the disposition of hospitals during fiscal 1992, decreased 1.5% for the year ended August 31, 1993 when compared to the year ended August 31, 1992. Net revenues from inpatient services accounted for 70.4%, 70.6% and 72.4% of total net patient revenues for the years ended August 31, 1994, 1993, and 1992, respectively.\nNet revenues derived from Medicare\/Medicaid programs for the year ended August 31, 1994, increased 19.1% as compared to the year ended August 31, 1993 as a greater portion of the population continues to qualify for such coverage. Saint Francis Hospital, which derives a large portion of its business from Medicare patients, contributed to the increase in net revenues derived from Medicare\/ Medicaid programs. An increasing number of various third party payers, including states, insurance\ncompanies and employers' networks, are negotiating contracted amounts paid for services rendered, accounting for the increase in contracted business and a corresponding decline in non-contracted business.\nExpense management continues to be a significant factor in maintaining the operating margin experienced by the Company (13.7% for the years ended August 31, 1994 and 1993 and 12.1% for the year ended August 31, 1992). The sale of facilities during fiscal 1992, which operated at a slightly lower margin, also contributed to the increase in the Company's operating margin for the year ended August 31, 1993. The Company's adherence to the cost control program implemented by management in fiscal 1992 has continued to stabilize operating costs and expenses as a percent of net revenues. Labor management (i.e. hospital staffing monitored with volume) and the decline in benefit costs as a result of changes implemented in the employee benefits program has decreased labor costs for the years ended August 31, 1994 and 1993 as a percent of net revenues compared to the year ended August 31, 1992.\nFor the year ended August 31, 1994 operating expenses (excluding depreciation and amortization) increased 6.4% over the year ended August 31, 1993. Approximately one-third of the overall increase is due to operating expenses associated with Saint Francis Hospital. As a percent of net revenues, operating expenses for the year ended August 31, 1994 remained flat as compared to the year ended August 31, 1993. The decrease in total operating costs and expenses for the year ended August 31, 1993 as compared to the year ended August 31, 1992 was primarily due to the following adjustments recognized during fiscal 1992: (i) the disposition of hospitals during fiscal 1992, (ii) an $11.0 million adjustment to salaries and benefits to increase reserves associated with workers' compensation liabilities as a result of adverse development on claims arising from prior periods, (iii) the impact of an adverse adjustment to the provision for uncollectible accounts for the refinement in procedures used to estimate bad debts and (iv) a foreign currency translation loss of $7.8 million. Foreign currency translation was immaterial for the years ended August 31, 1994 and 1993.\nThe gains on the sales of securities for the years ended August 31, 1994 and 1992 are the result of the sale of various securities of EPIC Holdings, Inc. and EPIC Healthcare Group, Inc.\nInterest expense, net decreased to $154 million for the year ended August 31, 1994 from $166 million for the year ended August 31, 1993 and $204 million for the year ended August 31, 1992 as a result of debt refinancings in fiscal 1994 and 1993 and the use of cash from operations and the proceeds from the sale of facilities in fiscal 1992 to reduce outstanding indebtedness. The year ended August 31, 1993 includes a refund of $8.6 million for excess interest paid to the Internal Revenue Service in prior periods.\nThe tax provision for each of the years ended August 31, 1994, 1993 and 1992 is greater than that which would occur using the Company's marginal tax rate against its income before taxes, minority equity interest and extraordinary loss, due in large part to the amortization of cost in excess of net assets acquired not being deductible for tax provision purposes. In August 1993, the Revenue Reconciliation Act of 1993 was enacted increasing the corporate income tax rate to 35% from 34% effective January 1, 1993.\nThe extraordinary loss on early extinguishment of debt is a result of the redemption or repurchase of debt prior to its stated maturity.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nThe financial statements and supplementary data set forth in the Index to Financial Statements and Financial Statement Schedules on page are filed as part 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.\nPART III\nITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF HOLDINGS AND AMI\nDIRECTORS OF HOLDINGS AND AMI\nCertain information concerning each director of Holdings and AMI is set forth below:\nARRANGEMENTS WITH RESPECT TO THE ELECTION OF DIRECTORS\nPursuant to the amended and restated stockholders agreement (the \"Stockholders Agreement\") as currently in effect, by and among Holdings, the GKH Investments, L.P., a Delaware limited partnership (the \"Fund\"), GKH Private Limited (\"GKHPL\"), Mellon Bank, N.A., as trustee of First Plaza Group Trust, a trust organized under New York law (\"First Plaza\"), MBLP, MIP, certain management investors as defined in the Stockholders Agreement the (\"Management Investors\") and others, the Fund, together with GKHPL, has the power to designate a majority of the nominees for Holdings' board of directors (the \"Board\") and thereby effectively control the selection of executive officers and other key employees and the establishment of Holdings' and AMI's operating policies. MBLP and MIP are entitled to designate up to two nominees for Holdings' Board and the Management Investors are entitled to designate at least one (but not more than two) of the nominees for Holdings' Board. The Stockholders Agreement also requires each of the parties to vote all shares of common stock held thereby for all of the persons nominated pursuant to the Stockholders Agreement. The rights and obligations of the parties to designate and vote for nominees for Holdings' Board terminate as to a party under certain circumstances, including the failure to maintain its ownership of Holdings' common stock at specified levels.\nARRANGEMENTS WITH RESPECT TO OTHER MATTERS\nIn addition to the provisions with respect to the election of directors discussed above, the Stockholders Agreement also restricts the ability of Holdings and AMI to take certain corporate actions, including amending their respective charter documents without the consent of certain of the parties thereto. The Stockholders Agreement also provides for certain rights-of-first-refusal, contains restrictions on dispositions of common stock and requires the parties thereto to sell their shares of common stock in certain circumstances if the Fund proposes to sell all of its shares of common stock by way of merger or similar transaction. By maintaining their percentage ownership of common stock, the Fund and its permitted transferees as defined in the Stockholders Agreement (\"Permitted Transferees\") and MBLP and its Permitted Transferees may effectively have the power to determine the policies of Holdings and AMI, the persons constituting their management and the outcome of corporate actions requiring stockholder approval by majority action. Certain benefits to each party under the Stockholders Agreement terminate if such party no longer owns specified minimum amounts of common stock.\nCOMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION\nThe compensation and stock option committee of the Board currently is comprised of Messrs. Williams, King and Mayer. None of the individuals who were members of the compensation and stock option committees of the Board during fiscal 1994 are present or former officers or employees of Holdings or AMI. See \"Directors and Executive Officers of Holdings and AMI.\" Corporations wholly owned by two members of the compensation and stock option committee, Messrs. Klein and Lufkin, serve as general partners of GKH. A corporation wholly owned by another member of the compensation and stock option committee, Mr. Gray, is a limited partner of GKH.\nGKH rendered certain consulting services to Holdings during fiscal 1994 in connection with the sale of AMI's interest in EPIC Holdings, Inc. for which GKH received compensation of approximately $2.3 million. The Company believes that the amount of fees it paid to GKH is equivalent to or less than customary fees paid or that would have been by the Company to unaffiliated third parties for comparable services. See \"Certain Relationships and Related Transactions -- Sale of a Business.\" In years prior to fiscal 1993, GKH rendered certain management and financial services to Holdings for which it received compensation on terms customary in the investment banking business. Holdings is not presently under any obligation to retain GKH in the future although it may choose to do so at any time and from time to time. As of November 9, 1994, the Fund and GKHPL owned an aggregate of 25,653,764 shares of common stock, or approximately 32%, of the outstanding common stock. See \"Security Ownership of Certain Beneficial Owners and Management;\" \"Arrangements with Respect to the Election of Directors;\" and \"Arrangements with Respect to Other Matters.\"\nHoldings, the Fund, GKHPL, MBLP, MIP and First Plaza, among others, entered into a registration rights agreement dated as of October 26, 1989 and as subsequently amended (the \"Registration Rights Agreement\"), pursuant to which the Fund, together with GKHPL, MBLP, MIP and\/or First Plaza and their respective Permitted Transferees, have, at specified times, certain rights to demand that Holdings register all or part of their shares of common stock under the Securities Act of 1933, as amended (the \"Securities Act\"). Upon exercise of these rights, Holdings will generally be obligated to register such shares at its own expense. In addition, if Holdings proposes to register any of its equity securities under the Securities Act (except for, among other things, equity securities registered for issuance pursuant to employee benefit plans), the parties to the Registration Rights Agreement may include shares of common stock in such registration, subject, however, to pro rata reduction to the extent Holdings determines it is necessary.\nEXECUTIVE OFFICERS OF HOLDINGS AND AMI\nCertain information concerning the executive officers of Holdings and AMI is set forth below:\nCOMPLIANCE WITH SECTION 16(A) OF THE SECURITIES ACT OF 1934\nSection 16(a) of the Securities Exchange Act of 1934, as amended (the \"Exchange Act\"), requires Holdings' executive officers and directors and persons who beneficially own more than 10% of the common stock to file reports of initial ownership and changes in ownership of common stock with the Commission. Based solely on a review of such reports furnished to Holdings, Holdings believes that during fiscal 1994, its executive officers, directors and beneficial owners of more than 10% of the common stock complied with all Section 16(a) filing requirements.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nHoldings is a holding company, all of whose business activities are conducted by its operating subsidiaries. Accordingly, executive officers of Holdings hold identical positions with AMI.\nThe following table sets forth certain information with respect to the compensation paid by Holdings during the last three fiscal years ended August 31, 1994 to its Chief Executive Officer and to each of its four other most highly compensated executive officers (collectively with the Chief Executive Officer, the \"named executive officers\"):\nSUMMARY COMPENSATION TABLE\nOPTIONS GRANTS IN LAST FISCAL YEAR\nAGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR END OPTION VALUES\nThe following table provides information on the value of unexercised options held by each of the named executive officers at August 31, 1994. None of the named executive officers exercised any options during fiscal 1994.\nLONG-TERM INCENTIVE PLAN -- AWARDS IN LAST FISCAL YEAR\nThe following table provides information on long-term incentive plan awards to each of the named executive officers in fiscal 1994.\nPENSION PLAN\nThe following table shows the estimated annual benefits payable upon normal retirement to participating employees, including, without limitation, the named executive officers, pursuant to AMI's basic Pension Plan (the \"Pension Plan\") as augmented by either the Supplemental Executive Retirement Plan, with respect to employees who become eligible collectively to participate prior to July 1989 or the Supplemental Benefit Plan, which is substantially identical with respect to employees who become eligible to participate in or after July 1989 (collectively \"SERP\") and Social Security for persons in specified remuneration and years of service classifications.\nANNUAL BENEFITS FOR YEARS OF SERVICE INDICATED\nUnder the Pension Plan, a retiring participant receives a percentage of his \"earnings\" (as defined under the Pension Plan) at the time of his last day of active employment with Holdings and AMI which, if calculated as of the date hereof for the named executive officers, would equal the rate used to determine the amount shown for each such person in the 1994 \"Salary\" column of Holdings Summary Compensation Table. Benefits are computed on a straight life annuity, contingent annuitant basis or years certain in life, at the election of the named executive officer, and are not subject to any deduction for Social Security amounts.\nCertain key executives of AMI, including all of the named executive officers, are eligible under SERP for supplemental annual retirement benefits upon retirement at age 65 generally after at least 10 years of service. The amount of a covered executive's benefit is computed in accordance with a formula based on such individual's final average earnings and his years of service up to 20 years. The benefits are subject to deduction for estimated primary Social Security benefits payable at age 65 and further reduction for benefits vested under the AMI Pension Plan.\nParticipants are generally 100% vested after they have reached 10 years of service. SERP provides for early retirement for terminated participants with 10 to 15 years of service at age 55 with reduced benefits. Those with 16 or more years of service retire at age 55 with unreduced benefits.\nAs of August 31, 1994, Messrs. O'Leary, Casey, Chamison, French and Smith, have 4, 3, 3, 2, 16 credited years, respectively, of service under the basic Pension Plan, and 8,8,8,3 and 20 credited years, respectively, of service under SERP. In connection with the Merger, Holdings has entered into an agreement with each of the named executive officers that provides each of such executive officers, full vesting in and 20 years of service under the SERP upon a change of control (which term would include consummation of the Merger). As a result of the Merger, each of such individuals will be entitled to maximum benefits under the SERP. See \"Certain Relationships and Related Transactions -- Actions Taken in Connection with the Merger.\"\nDIRECTORS' COMPENSATION\nDuring fiscal 1994, all directors of Holdings who were not employees of Holdings or any of its subsidiaries received compensation for serving on the Board or on a committee thereof. Such directors received $25,000 for serving on the Board. In addition, such directors received $1,000 for each meeting they attended and $500 for each telephonic meeting in which they participated. Mr. Williams received $10,000 for his services as the Chairman of the Audit Committee.\nUnder Holdings' Directors' Retirement Plan, an outside director who has served on the Board for at least five full years, or an employee director (regardless of whether he later becomes an outside director) who has served on the Board for at least ten full years is entitled, after reaching the age of 65 and upon retirement from the Board, to receive an annual retirement benefit in an amount equal to the annual director's fee in effect at the time of retirement. For purposes of this plan, an outside director is one who is not, at the time of his retirement from the Board, an employee of Holdings or any of its subsidiaries or affiliates. In fiscal 1994, the Directors' Retirement Plan was amended to provide that all individuals who were outside directors on September 1, 1994 (specifically, Messrs. Buchanan, Calhoun, Gray, Handelsman, King, Klein, Lufkin, Mayer and Williams) were eligible to participate in the Directors' Retirement Plan regardless of their respective years of service as a member of the Board of Directors. Outside directors, including retired directors, may be covered by AMI's basic health insurance plan. AMI also maintains a Directors' Deferred Compensation Plan pursuant to which directors are permitted to defer a portion of their directors' fees. Amounts deferred accrue interest at stipulated rates and are payable upon retirement from the Board.\nEMPLOYMENT AGREEMENTS\nHoldings has entered into a letter of understanding, as amended to date, with Robert W. O'Leary pursuant to which Mr. O'Leary serves as a director and Chairman of the Board and Chief Executive Officer of each of Holdings and AMI. Under this agreement, Mr. O'Leary receives an annual base salary of $750,000, which may be increased from time to time, and participates in the Incentive Plan. Pursuant to this agreement, Holdings made a $600,000 interest-free loan to Mr. O'Leary during fiscal 1992. The loan is forgiven by Holdings in monthly increments of $16,667 commencing September 30, 1991 and as of August 31, 1994 the total amount of the loan was forgiven. Holdings has agreed to pay to Mr. O'Leary, in the event his employment as Chairman and Chief Executive Officer is terminated for any reason other than \"cause,\" an amount equal to 15 months base compensation (excluding bonus) determined on the basis of his annual salary for the fiscal year then most recently commenced. Additionally, pursuant to his agreement with Holdings, Mr. O'Leary is entitled to receive, in the event of a \"Change of Control\" (as defined therein), the above-referenced severance payment, acceleration of all benefits payable to him pursuant to the Incentive Plan and certain specified payments in respect of all unexercised options then held by him. Consummation of the Merger will constitute a Change of Control under this Agreement.\nHoldings has entered into a letter of understanding, as amended to date, with John T. Casey pursuant to which Mr. Casey serves as the President and Chief Operating Officer of each of Holdings and AMI. Under this agreement, Mr. Casey receives an annual base salary of $362,000, which may be increased from time to time, and participates in the Incentive Plan. During fiscal 1993, Holdings made a $375,000 interest-free loan to Mr. Casey. The loan, which is due and payable 10 days after the termination of Mr. Casey's employment, is forgiven by the Company in monthly increments of $10,417 commencing August 31, 1993 and continuing for so long as Mr. Casey serves as President and Chief Operating Officer of Holdings. See the Summary Compensation Table on page 27 for the amount forgiven during fiscal 1994. Holdings has agreed to pay to Mr. Casey, in the event his employment as the President and Chief Operating Officer of the Company is terminated for any reason other than \"cause,\" an amount equal to 12 months base compensation (excluding bonus) determined on the basis of his annual salary for the fiscal year then most recently commenced. Additionally, pursuant to his agreement with Holdings, Mr. Casey is entitled to receive, in the event of a \"Change of Control\" (as defined therein), the above-referenced severance payment, acceleration of all benefits payable to him pursuant to the Incentive Plan and certain specified payments in respect of all unexercised options\nthen held by him and forgiveness of any then outstanding balance under the above-referenced loan. Consummation of the Merger will constitute a Change of Control under this Agreement. Mr. Casey's Management Stock Agreement generally provides certain \"Put\" and \"Call\" rights to him and Holdings, respectively, with respect to certain shares of his common stock upon termination of his employment with Holdings. See \"Certain Relationships and Other Transactions -- Management Investors.\"\nHoldings has entered into a letter of understanding, as amended to date, with Alan J. Chamison pursuant to which Mr. Chamison serves as an Executive Vice President of each of Holdings and AMI. Under this agreement, Mr. Chamison receives an annual base salary of $362,000, which may be increased from time to time, and participates in the Incentive Plan. Pursuant to this agreement, Holdings made a $375,000 interest-free loan to Mr. Chamison during 1991. This loan, which is due and payable 10 days after the termination of Mr. Chamison's employment, is forgiven by Holdings in monthly increments of $10,417 commencing October 31, 1991, and as of August 31, 1994, the total amount of the loan was forgiven. Holdings has agreed to pay to Mr. Chamison, in the event his employment as an Executive Vice President of the Company is terminated for any reason other than \"cause,\" an amount equal to 12 months base compensation (excluding bonus) determined on the basis of his annual salary for the fiscal year then most recently commenced. Additionally, pursuant to his agreement with Holdings, Mr. Chamison is entitled to receive, in the event of a \"Change of Control\" (as defined therein), the above-referenced severance payment, acceleration of all benefits payable to him pursuant to the Incentive Plan and certain specified payments in respect of all unexercised options then held by him. Consummation of the Merger will constitute a Change of Control under this Agreement.\nHoldings has entered into a letter of understanding, as amended, with O. Edwin French pursuant to which Mr. French serves as a Senior Vice President of each of Holdings and AMI. Under this Agreement, Mr. French receives an annual base salary of $225,000, which may be increased from time to time, and participates in the Incentive Plan. Holdings has agreed to pay to Mr. French, in the event his employment as Senior Vice President of Holdings is terminated for any reason other than \"cause,\" an amount equal to 12 months base compensation (excluding bonus) determined on the basis of his annual salary for the fiscal year then most recently commenced. Additionally, pursuant to his agreement with Holdings, Mr. French is entitled to receive, in the event of the occurrence of a \"Change of Control\" (as defined therein), the above-referenced severance payment, acceleration of all benefits payable to him pursuant to the Incentive Plan and certain specified payments in respect of all unexercised options then held by him. Consummation of the Merger will constitute a Change of Control under this Agreement.\nAMI has also entered into an agreement with Mr. W. Randolph Smith. The terms of such agreement provide that under certain circumstances, upon termination, Mr. Smith will be entitled to receive one year's salary and benefits. Mr. Smith's agreement does not provide for any change of control payments. Mr. Smith's Management Stock Agreement generally provides certain \"Put\" and \"Call\" rights to him and Holdings, respectively, with respect to certain shares of his common stock upon termination of his employment with Holdings. See \"Certain Relationships and Other Transactions -- Management Investors.\"\nCHANGE OF CONTROL ARRANGEMENTS\nOn October 10, 1994, Holdings and NME jointly announced the signing of a definitive merger agreement pursuant to which a wholly-owned subsidiary of NME will be merged with and into Holdings, with Holdings continuing as the surviving corporation. As a result of the Merger, each share of common stock of Holdings will be converted into the right to receive $19.00 (if the closing occurs on or before March 31, 1995, otherwise $19.25) and 0.42 of a share of common stock of NME. Under the terms of the merger agreement, Holdings will pay a dividend of $0.10 per share prior to consummation of the Merger and Holdings will be entitled to nominate three individuals to be elected to the 13 member board of directors of the surviving corporation. In connection with the Merger, the Company has entered into certain agreements with members of the Company's management. In addition, certain existing arrangements and agreements between the Company and members of its management and Board of Directors will be affected by the Merger. See \"Certain Relationships and Related Transactions -- Actions Taken in Connection with the Merger.\"\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe following table sets forth certain information, as of November 9, 1994, regarding the beneficial ownership of Common Stock by (i) each stockholder known by the Company to be the beneficial owner of more than 5% of the Common Stock, (ii) all directors, (iii) each of the named executive officers and (iv) all directors and executive officers as a group. Unless otherwise noted, the persons named in the table have sole voting and investment power with respect to all shares shown as beneficially owned by them.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nACTIONS TAKEN IN CONNECTION WITH THE MERGER\nUpon the occurrence of the Merger, certain executive officers of Holdings, including the named executive officers may be subject to the potential imposition of excise tax under Section 4999 of the Code to the extent that payments received by such executive officers as the result of the Merger are deemed to constitute excess parachute payments under Section 280G of the Code. Holdings has agreed to make payments to such affected executive officers in an amount equal to all excise taxes payable by each such executive officer on such deemed excess parachute payments (the \"Gross-Up Payment\"), including any excise tax payable by reason of the Gross Up Payment; provided however, that the maximum aggregate Gross-Up Payments which Holdings may be obligated to pay shall in no event exceed $8 million, which, if necessary, will be divided pro rata among the affected executive officers. In order for an executive officer to be eligible to receive Gross-Up Payments, such affected executive officer must agree in writing to accept the merger consideration (including the mix of cash and securities, if applicable) payable to Holdings' stockholders in general upon consummation of the Merger, with respect to any Holdings' stock options then held by the affected executive officer, nothwithstanding any provision in the executive's employment or stock option agreement or the Holdings Stock Option Plans to the contrary regarding payment in cash.\nHoldings has agreed that if, in connection with or subsequent to a change of control (which term would include the consummation of the Merger), the employment of certain executive officers of Holdings is terminated for any reason, or the membership of a current director on the Company's Board of Directors is terminated for any reason, then such affected individual shall be entitled to continue coverage under the terms of Holdings' group health insurance plan until the earlier of the date such affected individual (a) becomes eligible for Medicare, or (b) otherwise fails to pay any applicable premium. This coverage is in addition to any continuation coverage that may otherwise be required by law.\nHoldings has entered into an agreement with each of Messrs. O'Leary, Casey, Chamison, French, Kugelman, Sabatino, Bailey and Murdock pursuant to which such individuals, upon a change in control (which term has been defined to include consummation of the Merger), will be fully vested in all amounts payable under the Incentive Plans, including all deferred amounts. Additionally, each of these individuals will be deemed to have satisfied their respective maximum fiscal 1995 target performance goals under the Incentive Plans entitling each of them to 100% of their fiscal 1995 awards. The maximum award for which each of Messrs. O'Leary, Casey, Chamison, French, Kugelman, Sabatino, Bailey and Murdock may be entitled under the Incentive Plans for fiscal 1995 is $479,115, $227,136, $227,136, $117,219, $219,625, $81,120, $65,572 and $65,572, respectively, and the amount\ncurrently deferred for each of such individuals is $374,815, $207,840, $207,840, $107,894, $35,607, $56,390, $57,832, and $57,832, respectively. See \"Executive Compensation -- Long-Term Incentive Plan -- Awards in Last Fiscal Year.\"\nFirst Boston and GKH rendered consulting services to Holdings in relation to the Merger for which First Boston and GKH each will receive compensation of $5.0 million plus reasonable out-of-pocket costs. The Company believes that the amount of fees to be paid to First Boston and GKH is equivalent to or less than customary fees that would be paid by the Company to unaffiliated third parties for comparable services.\nSALE OF BUSINESS\nIn May 1994, the Company sold AMI's interest in EPIC Holdings, Inc. pursuant to a merger of EPIC Holdings, Inc. with HealthTrust, Inc -- the Hospital Company. As a result of this disposition, the Company received $72.4 million and paid $2.3 million in compensation to GKH, for representing the Company in connection with the transaction. See \"Security Ownership of Certain Beneficial Owners and Management.\"\nLETTERS OF CREDIT\nDalfort Corporation, an entity associated with HGM Associates, a Nevada limited partnership and a general partner of GKH (\"Dalfort\"), agreed to provide credit support (the \"L\/C Commitment\") to domestic hospital subsidiaries of AMI in the form of guaranties by Dalfort to issuers of standby letters of credit, bonds and other surety type instruments for the account of any domestic hospital subsidiary of AMI (the \"L\/C Guarantees\"). The L\/C Commitment extended only to L\/C Guarantees with a term not exceeding twelve months and in an aggregate face amount not exceeding $30 million outstanding at any time. Holdings and its subsidiaries were jointly and severally liable to reimburse Dalfort for any amounts paid pursuant to the L\/C Commitment. The L\/C Commitment was replaced on August 18, 1993 with other financing extended by an unaffiliated third party. AMI paid Dalfort a fee of $750,000 during fiscal 1993.\nFIRST BOSTON AND AFFILIATES\nThe Company is not presently under any obligation to retain First Boston for advisory or other services although it may choose to do so at any time and from time to time. As of November 9, 1994, certain affiliates of First Boston owned an aggregate of 11,305,450 shares of Common Stock, or approximately 15%, of the outstanding Common Stock. See \"Security Ownership of Certain Beneficial Owners and Management;\" \"Arrangements with Respect to the Election of Directors;\" and \"Arrangements with Respect to Other Matters.\"\nMANAGEMENT INVESTORS\nPursuant to certain Management Stock Subscription Agreements (the \"Management Stock Agreements\") entered into in connection with and subsequent to the acquisition of AMI by Holdings (the \"Acquisition\"), certain current and former officers and key employees of AMI and its subsidiaries (collectively, the \"Management Investors\") purchased shares of common stock and, in most cases, were granted options pursuant to the Key Plan. The Management Investors, except for John T. Casey and a former officer of Holdings, used, among other funds, amounts received in consideration of the cancellation of options to purchase shares of AMI common stock (\"AMI Shares\") in connection with the Acquisition, to purchase the shares of common stock.\nPursuant to the Management Stock Agreements, upon termination of a Management Investor's employment with AMI or its subsidiaries prior to the fifth anniversary of the Acquisition, Holdings had the right to require such Management Investor to sell his shares of common stock to Holdings (the \"Call\"), and, upon certain events resulting in the termination of a Management Investor's employment with Holdings or its subsidiaries, the Management Investor had the right to require Holdings to\nrepurchase his shares of Common Stock (the \"Put\"), in each case at a price determined by a formula generally based on fair value and the factual circumstances giving rise to the exercise of either the Put or Call. The fifth anniversary of the Acquisition was October 26, 1994. The Put right will not be available to any Management Investor whose employment is terminated for \"cause\" (as defined in the Management Stock Agreements). In addition, Holdings may defer its obligation to purchase Common Stock pursuant to the exercise of a Call or a Put if the consummation of such purchase would violate any law or regulation or would cause Holdings to be in default under the terms of any of its indebtedness. Upon exercise of a Call or Put, any unexercised options held by the Management Investor will be terminated upon payment by Holdings to the Management Investor of the price specified in such Management Investor's Management Stock Agreement.\nPursuant to the Management Stock Agreements, the Management Investors have agreed not to transfer their common stock, except for certain permitted transfers, for five years after their purchase thereof, and, in addition, have granted Holdings, first, and the other parties to the Stockholders Agreement, second, a right of first refusal in respect of third party offers to purchase the common stock received by the Management Investors after the expiration of such five year period.\nDuring fiscal 1994, Holdings paid an aggregate of $19,996 to one Management Investor in satisfaction of its obligations upon exercise of Put rights under such person's Management Stock Agreement.\nLOANS TO EXECUTIVE OFFICERS\nIn prior fiscal years, Holdings made interest-free loans of $600,000, $375,000 and $375,000 to Messrs. O'Leary, Casey and Chamison, respectively, which loans are forgiven in equal monthly increments. As of November 9, 1994, the remaining balances of $199,992 and $135,409 on interest-free loans made by Holdings to Messrs. O'Leary and Chamison, respectively, where forgiven in full. As of November 9, 1994, the interest-free loan to Mr. Casey had an outstanding principal balance of $213,536 and is being forgiven by Holdings in equal monthly increments of $10,417. In the event of the occurrence of a \"Change of Control\" (as defined in the letter of understanding between Holdings and Mr. Casey), which includes consummation of the Merger, the remaining balance of the loan will be forgiven. The largest aggregate amount outstanding during fiscal 1994 to each of Messrs. O'Leary, Casey and Chamison pursuant to such loans were $199,992, $135,409 and $364,583, respectively. See \"Executive Compensation -- Employment Agreements.\"\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 set forth in the Index to Financial Statements and Financial Statement Schedules on page are filed as part of this Annual Report on Form 10-K.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K have been filed during the last quarter of fiscal 1994.\n(c) List of Exhibits.\nSIGNATURES\nPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934 the registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized, in the City of Dallas, State of Texas, on the day of November, 1994. The following officers and directors have executed this report as of November 16, 1994.\nAMERICAN MEDICAL HOLDINGS, INC. AMERICAN MEDICAL INTERNATIONAL, INC.\nBy \/s\/ ALAN J. CHAMISON\n-------------------------------------- Alan J. Chamison 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 in the capacities indicated:\nSIGNATURE TITLE - ----------------------------------- -----------------------------------------\n\/s\/ ROBERT W. O'LEARY* - ----------------------------------- Chairman and Chief Executive Officer Robert W. O'Leary (Principal Executive Officer)\n\/s\/ ALAN J. CHAMISON Executive Vice President and - ----------------------------------- Chief Financial Officer Alan J. Chamison (Principal Financial Officer)\n\/s\/ BARY G. BAILEY - ----------------------------------- Vice President, Controller Bary G. Bailey (Principal Accounting Officer)\n\/s\/ J. ROBERT BUCHANAN, M.D.* - ----------------------------------- Director J. Robert Buchanan, M.D.\n\/s\/ ROBERT B. CALHOUN, JR.* - ----------------------------------- Director Robert B. Calhoun, Jr.\n\/s\/ JOHN T. CASEY* - ----------------------------------- Director John T. Casey\n\/s\/ HARRY J. GRAY* - ----------------------------------- Director Harry J. Gray\nSIGNATURE TITLE - ----------------------------------- -----------------------------------------\n\/s\/ HAROLD S. HANDELSMAN* - ----------------------------------- Director Harold S. Handelsman\n\/s\/ SHELDON S. KING* - ----------------------------------- Director Sheldon S. King\n\/s\/ MELVYN N. KLEIN* - ----------------------------------- Director Melvyn N. Klein\n\/s\/ DAN W. LUFKIN* - ----------------------------------- Director Dan W. Lufkin\n\/s\/ WILLIAM E. MAYER* - ----------------------------------- Director William E. Mayer\n\/s\/ ROBERT W. O'LEARY* - ----------------------------------- Director Robert W. O'Leary\n\/s\/ HAROLD M. WILLIAMS* - ----------------------------------- Director Harold M. Williams\n*By: \/s\/ BARY G. BAILEY - ----------------------------------- Bary G. Bailey As Attorney-In-Fact\nAND FINANCIAL STATEMENT SCHEDULES\nITEM 14(A).\nAll other schedules are not submitted because they are not applicable, not required, or the information is included in the consolidated financial statements or notes thereto.\nSeparate financial statements of the parent company have been omitted since restricted net assets of consolidated subsidiaries are less than 25% of consolidated net assets.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo The Boards of Directors and Shareholders of American Medical Holdings, Inc. and American Medical International, Inc.\nIn our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of cash flows and of shareholders' equity present fairly, in all material respects, the financial position of American Medical Holdings, Inc. and subsidiaries and American Medical International, Inc. and subsidiaries at August 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Companies' 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 LLP\nDallas, Texas October 20, 1994\n[This page has been intentionally left blank]\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) ASSETS\nSee Notes to Consolidated Financial Statements.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) LIABILITIES AND SHAREHOLDERS' EQUITY\nSee Notes to Consolidated Financial Statements.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF INCOME\n(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nSee Notes to Consolidated Financial Statements.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF CASH FLOWS\n(IN THOUSANDS)\nSee Notes to Consolidated Financial Statements.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES\nCONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY\n(IN THOUSANDS)\nFOR THE THREE YEARS ENDED AUGUST 31, 1994\nSee Notes to Consolidated Financial Statements\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES\nBASIS OF PRESENTATION\nAmerican Medical Holdings, Inc. (\"Holdings\") was organized in July 1989 to acquire American Medical International, Inc. (\"AMI\" and, together with Holdings, the \"Company\"). As a result of this transaction, Holdings is the owner of all of the outstanding shares of common stock of AMI.\nThe accompanying consolidated financial statements include the accounts of Holdings, AMI and all majority owned subsidiary companies and have been prepared in accordance with generally accepted accounting principles. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to prior years' financial statements to be consistent with the fiscal 1994 presentation.\nAMI's financial statements are the same as Holdings' financial statements, except for the components of shareholders' equity, and for the years ended August 31, 1993 and 1992 the impact of Holdings' common stock subject to repurchase obligations (See Note 9 Capital Stock).\nCASH AND CASH EQUIVALENTS\nAll highly liquid debt instruments purchased with an original maturity of three months or less are considered to be cash equivalents.\nACCOUNTS RECEIVABLE\nThe Company receives payment for services rendered to patients from (i) the federal and state governments under the Medicare, Medicaid and CHAMPUS programs, (ii) privately sponsored managed care programs for which payment is made based on terms defined under contracts and (iii) other payers. As of August 31, 1994 and 1993, government patient receivables represented approximately 37% and 30%, respectively, contracted patient receivables represented approximately 32% and 35%, respectively, and other third party payer receivables represented approximately 31% and 35%, respectively of net patient receivables.\nReceivables from government agencies represent a concentrated group of credit for the Company; however, management does not believe that there are any credit risks associated with these governmental agencies. The only other significant credit concentration is with various Blue Cross affiliates. The remaining balance of payers including entities and individuals involved in diverse activities, and subject to differing economic conditions, do not represent any known concentrated credit risks to the Company. Furthermore, management continually monitors and adjusts its reserves and allowances associated with these receivables.\nINVENTORY OF SUPPLIES\nInventories are stated at the lower of cost (first-in, first-out) or market.\nPROPERTY AND EQUIPMENT\nAmounts capitalized as part of property and equipment, including additions and improvements to existing facilities, are recorded at cost, including interest capitalized during construction which is computed at the cost of funds borrowed. Maintenance costs and repairs are expensed as incurred. Buildings and improvements and equipment are depreciated using the straight-line method of depreciation over their estimated useful lives. The estimated lives of buildings and improvements are generally 20 to 25 years and equipment is 3 to 15 years.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INVESTMENTS\nInvestments are accounted for under either the equity method or the cost method. Investments accounted for under the cost method are stated at the lower of cost or market in the accompanying financial statements.\nCOST IN EXCESS OF NET ASSETS ACQUIRED\nCost in excess of net assets acquired is being amortized over 40 years from the original acquisition date of AMI resulting in an annual amortization of approximately $32.0 million. The cumulative amortization of cost in excess of net assets acquired as of August 31, 1994 and 1993 is $157.2 million and $125.2 million, respectively.\nDEFERRED COSTS\nDeferred financing costs are amortized under the interest method over the term of the expected life of the debt. Costs incurred prior to the opening of new facilities and costs incurred in the development of data processing systems are deferred and amortized on a straight-line basis over a two to five-year period.\nINCOME TAXES\nIncome taxes are computed in accordance with Statement of Financial Accounting Standards (\"SFAS\") No. 109, \"Accounting for Income Taxes,\" which requires deferred tax liabilities or assets be recognized for the anticipated tax effects of temporary differences that arise as a result of differences in the book basis and tax basis of assets and liabilities.\nNET REVENUES\nThe Company's sources of revenues are primarily provided from patient services and are presented net of reserves to recognize the difference between the hospitals' established billing rates for covered services and the amounts paid by third party or private payers. Patient revenues received under government and privately sponsored insurance programs are based on cost as defined under the programs or at predetermined rates based upon the diagnosis, plus capital costs, return on equity and other adjustments rather than customary charges. Adjustments are recorded in the period the services are rendered based on estimated amounts to be reimbursed and contract interpretations, however, such adjustments are generally subject to final audit and settlement. Net revenues include adjustments for the years ended August 31, 1994, 1993 and 1992 of $2.1 billion, $1.9 billion and $1.8 billion, respectively. In management's opinion, the reserves established are adequate to cover the ultimate liabilities that may result from final settlements.\nThe Company provides healthcare services free of charge to individuals who meet certain financial or economic criteria (i.e. charity care). The billings for such services have not been recognized as receivables or revenues in the financial statements since they are not expected to result in cash flows.\nTRANSLATION OF FOREIGN CURRENCIES\nRevaluation gains or losses on assets and liabilities denominated in currencies other than the functional currency are included in the determination of income. Revaluation gains or losses for debt denominated in foreign currencies for the years ended August 31, 1994 and 1993 were immaterial. Revaluation losses for debt denominated in foreign currencies for the year ended August 31, 1992 totaled $7.8 million. As of September 1, 1992, substantially all of the Company's foreign denominated debt obligations have been redeemed or the Company has entered into swap agreements that hedge\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) against any future fluctuations and, therefore, eliminated any future material revaluation gains or losses associated with the applicable debt obligations (See Note 5 Long Term Debt -- Swap Agreements).\n2. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company uses the following methods and assumptions to estimate the fair value of its financial instruments at August 31, 1994:\nCASH AND CASH EQUIVALENTS\nThe carrying value of cash and cash equivalents approximates fair value due to the short-term nature of these instruments.\nINVESTMENTS\nThe Company has various investments for which the determination of the fair value is not practicable.\nLONG-TERM DEBT\nFair values of publicly traded notes have been determined using the quoted market prices at August 31, 1994. The fair value of certain non-publicly traded notes is based on cash flows discounted using interest rates found on comparable traded securities. The aggregate carrying value of long-term debt at August 31, 1994, of $1,297.7 million had an estimated fair value of $1,392.3 million.\n3. ACQUISITIONS Effective May 1, 1994, the Company completed the purchase of Saint Francis Hospital located in Memphis, Tennessee. In conjunction with this purchase, in June 1994 the Company completed the acquisition of a management services organization in the Memphis area. During fiscal 1994, the Company also acquired additional outpatient businesses, including home health, diagnostic centers and physician practices.\nDuring fiscal 1993, the Company merged the operations of AMI's Tarzana Regional Medical Center with the operations of HealthTrust, Inc. -- The Hospital Company's (\"HealthTrust\") Encino Hospital. AMI owns 75% of the combined hospital operations and therefore the results of operations for the hospitals are fully consolidated with the results of operations of the Company for periods subsequent to January 1, 1993.\n4. DISPOSITIONS During 1994, AMI recognized a $69.3 million pre-tax gain ($43.4 million net of tax), related to the sale of the Company's interest in EPIC Holdings, Inc. During fiscal 1992, the Company completed the sale of $89.3 million principal amount of Zero Coupon Notes Due 2001, issued by EPIC Healthcare Group, Inc. in September 1988 as partial consideration for AMI's sale of certain hospitals. AMI also completed the sale of its investment in EPIC Holdings, Inc. Class A and Class B Preferred Stock for aggregate cash proceeds of $130 million. The total pre-tax gain recorded in fiscal 1992 from these transactions was $119.8 million ($80.7 million, net of tax). The gains on the sale of the EPIC securities in fiscal 1994 and 1992 is presented in the accompanying financial statements as \"Gains on sales of securities.\"\nDuring fiscal 1992, the Company sold four domestic acute care hospitals for aggregate cash proceeds of approximately $100.1 million. These assets were valued at their respective sales prices, and therefore, no gains or losses were recognized from these sales in fiscal 1992.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5. LONG-TERM DEBT The components of Holding's and AMI's long-term debt at August 31, 1994 and 1993 are summarized as follows (in thousands):\nREVOLVING CREDIT FACILITY\nThe Company's $600 million revolving credit facility (\"Reducing Revolving Credit Facility\") was amended in June 1994 extending the term to September 1999 and reducing the rate at which interest accrues. Amounts outstanding under the Reducing Revolving Credit Facility will accrue interest, at the option of AMI, at (i) adjusted LIBOR plus .875% (subject to reduction upon the satisfaction of certain conditions) or (ii) at the alternative base rate specified for the Reducing Revolving Credit Facility. Upon completion of the fiscal 1994 loan compliance report, anticipated to be prior to the end of the first quarter of fiscal 1995, the rate at which interest accrues based on LIBOR will be reduced to LIBOR plus .75%. Under the Reducing Revolving Credit Facility, $31.3 million in letters of credit were outstanding as of August 31, 1994.\nSWAP AGREEMENTS\nAMI has entered into swap agreements which hedge any foreign currency gains or losses on the L37 million senior notes, face amount $62.7 million, and the SFr.78 million bonds, face amount $52.4 million. At August 31, 1994 no loss would be recognized if the counter parties to these swap agreements failed to perform their obligations.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n5. LONG-TERM DEBT (CONTINUED) DEBT COVENANTS\nThe terms of certain of the Company's indebtedness impose operating and financial restrictions requiring the Company to maintain certain financial ratios and restrict the Company's ability to incur additional indebtedness and enter into leases and guarantees of debt; to make capital expenditures; to make loans and investments; to pay dividends or repurchase shares of stock; to repurchase, retire or refinance indebtedness prior to maturity, and to purchase or sell assets. The Company has pledged the capital stock of certain direct (first tier) subsidiaries as security its obligations under the Reducing Revolving Credit Facility and certain other senior indebtedness. In addition, the Company has granted a security interest in its accounts receivable as security for its obligations under the Reducing Revolving Credit Facility. Management believes that the Company is currently in compliance with all covenants and restrictions contained in all financing agreements.\nMATURITIES OF LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS\nAs of August 31, 1994 the maturities of long-term debt, including capital lease obligations, for the five years ending August 31, 1999 are $156.0 million in fiscal 1995, $57.0 million in fiscal 1996, $182.1 million in fiscal 1997, $2.3 million in fiscal 1998 and $2.3 million in fiscal 1999.\nCONVERTIBLE SUBORDINATED DEBT\nConvertible subordinated debentures are unsecured obligations of the Company and are redeemable at declining premiums prior to their respective payment dates. The 9 1\/2% Convertible Subordinated Debentures Due 2001, of which $3.4 million and $3.3 million was outstanding at August 31, 1994 and 1993, respectively, are convertible at $24.38 per share into 209,639 shares of Holdings' common stock at August 31, 1994, net of unamortized discount of $1.7 million. The 8 1\/4% Convertible Subordinated Debentures Due 2008 of which $7.3 million and $7.2 million was outstanding at August 31, 1994 and 1993, respectively, are convertible at $40.00 per share into 361,400 shares of Holdings' common stock at August 31, 1994 net of unamortized discount of $7.1 million.\n6. BENEFIT PLANS\nPENSION PLANS\nThe Company has defined benefit pension plans (the \"Plans\") covering substantially all of the Company's employees. The benefits are based on years of service and the employee's base compensation as defined in the Plans. The Company's policy is to fund pension costs accrued within the limits allowed under federal income tax regulations. Contributions are intended to provide not only for benefits attributed to credited service to date, but also for those expected to be earned in the future.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. BENEFIT PLANS (CONTINUED) In accordance with SFAS No. 87 Holdings and AMI have recorded an adjustment to recognize a minimum pension liability. The following table sets forth the funded status of the Plans and amounts recognized in the consolidated financial statements as of August 31, 1994 and 1993 (in thousands):\nHoldings' and AMI's net pension cost for the years ended August 31, 1994, 1993 and 1992 includes the following components (in thousands):\nIn addition, Holdings and AMI have a unfunded supplemental defined benefit retirement plan for Company executives (\"SERP\"). The following table sets forth the amounts recognized for the unfunded SERP in the consolidated financial statements as of August 31, 1994 and 1993 (in thousands):\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n6. BENEFIT PLANS (CONTINUED) Holdings' and AMI's net cost of the SERP plan for the years ended August 31, 1994, 1993 and 1992 includes the following components (in thousands):\nThe weighted-average discount rate used in determining the actuarial present value of the projected benefit obligation for the SERP and the pension plan approximated 8.75% and 7.5% as of August 31, 1994 and 1993, respectively. The rate of increase in future compensation levels for the pension plan was 5.0%, 3.5% and 5.0% for the years ended August 31, 1994, 1993 and 1992, respectively. The rate of increase in future compensation levels for the SERP was 6.0%, 5.0% and 8.0% for the years ended August 31, 1994, 1993 and 1992, respectively. The expected long-term rate of return on assets was 10.0% for the years ended August 31, 1994 and 1993, for the pension plan.\nDEFERRED SAVINGS PLAN\nThe Company also has a tax deferred savings plan. Expenses relating to this plan were $8.8 million, $7.3 million and $5.6 million for the years ended August 31, 1994, 1993 and 1992, respectively, for Holdings and AMI.\nOTHER\nThe Company does not provide any post-retirement or post-employment healthcare or life insurance benefits to retired or former employees.\nDisclosures for the Company's Options Plans and the Employee Stock Purchase Plan are included in Note 9 Capital Stock.\n7. PROFESSIONAL LIABILITY RISKS As is typical in the healthcare industry, the Company is subject to claims and legal actions by patients in the ordinary course of business. The Company self-insures the professional and general liability claims for nine of its hospitals up to $500,000 per occurrence and for 26 of its hospitals up to $3 million per occurrence. Prior to June 1993, the self-insured retention was $5 million per occurrence. Coverage for professional and general liability claims for the Company's two remaining hospitals is maintained with outside insurance carriers.\nThe Company owns a 35% equity interest in an insurance company which insures excess professional and general liability risks for those hospitals which are self-insured. The excess coverage provided by this insurance company is limited to $25 million per claim. The Company purchases additional excess insurance from a commercial carrier. For the period from January 1986 to February 1991, the Company had no excess coverage for the majority of its hospitals. However, in March 1991 the Company purchased prior acts coverage which substantially reduces the uninsured liability for claims during this period. For the years ended August 31, 1994, 1993 and 1992, the Company paid $4.3 million, $5.0 million and $4.6 million, respectively, in premiums to this insurance company. In fiscal 1993 and 1992, the Company received distributions of prior year premiums of $2.4 million and $3.8 million, respectively, from this insurance company. In fiscal 1994, the Company received no distributions of prior years premiums. The Company also received dividends of $3.5 million, $2.7 million and $4.7 million from this insurance company in fiscal 1994, 1993 and 1992, respectively.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n7. PROFESSIONAL LIABILITY RISKS (CONTINUED) The Company maintains an unfunded reserve for its professional liability risks which is based, in part, on actuarial estimates calculated and evaluated by an independent actuary. Actual hospital professional and general liability costs for a particular period are not normally known for several years after the period has ended. The delay in determining the actual cost associated with a particular period is due to the amount of lapsed time between the occurrence of an incident, the reporting thereof and the settlement of related claims. As a result, reserves for losses and related expenses are estimated using expected loss reporting patterns determined in conjunction with the actuary and are discounted using a rate of 9% to their present value. Adjustments to the total reserves are determined in conjunction with the actuary and on an annual basis are recorded by the Company as an increase or decrease in the current year's earnings.\nAs of August 31, 1994 and 1993, the unfunded reserve for self insurance was $118.8 million and $117.6 million, respectively, of which $15.7 and $17.0 million in fiscal 1994 and 1993, respectively is included in current liabilities. For the fiscal years ended August 31, 1994, 1993 and 1992, payments for claims and expenses totaled $15.7 million, $19.3 million and $17.1 million, respectively. For the fiscal years ended August 31, 1994, 1993 and 1992, the Company recorded self insurance expense of $16.9 million, $19.7 million and $13.5 million, respectively.\n8. COMMITMENTS AND CONTINGENCIES\nLEASES\nThe Company leases certain office space, office equipment and medical equipment. Future minimum payments under these operating leases for fiscal 1995, 1996, 1997, 1998, 1999 and thereafter are $35.3 million, $22.2 million, $17.4 million, $13.9 million, $10.0 million and $38.2 million, respectively. Future minimum payments for six acute care hospitals leased under a REIT agreement are $36.9 million for each of the years ended fiscal 1995, 1996, 1997, and 1998, $23.3 million for fiscal 1999 and $43.5 million for the remaining years thereafter. In addition, the Company incurs certain additional rents (contingency rents), in relation to the REIT agreements, based on a percentage of the increase in net revenues. These additional rents were $6.7 million, $6.4 million and $5.7 million for the years ended August 31, 1994, 1993 and 1992, respectively.\nCONSTRUCTION COMMITMENTS\nThe Company has approximately $19.5 million of construction commitments outstanding for new construction and renovations as of August 31, 1994.\nGUARANTEES\nThe Company has guaranteed long-term debt and lease obligations of unconsolidated subsidiaries and affiliates aggregating $30.8 million at August 31, 1994.\nLEGAL PROCEEDINGS\nLITIGATION RELATING TO THE MERGER (SEE NOTE 17 SUBSEQUENT EVENTS). To date, a total of nine purported class action suits (the \"Class Actions\") have been filed against Holdings and the directors of Holdings (and in two cases against NME). Seven of such Class Actions have been filed in the Delaware Court of Chancery and are entitled (i) JEFFREY STARK AND GARY PLOTKIN V. ROBERT W. O'LEARY, ROBERT J. BUCHANAN, JOHN T. CASEY, ROBERT B. CALHOUN, HARRY J. GRAY, HAROLD J. [SIC] HANDELSMAN, SHELDON S. KING, MELVYN N. KLEIN, DAN W. LUFKIN, WILLIAM E. MAYER AND HAROLD S. WILLIAMS (THE \"HOLDINGS DIRECTORS\") AND HOLDINGS, C.A. NO. 13792, (ii)7457 Partners v. the Holdings Directors and Holdings, C.A. No. 13793, (iii) MOISE KATZ V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13794, (iv) CONSTANTINOS KAFALAS V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13795, (v) F. RICHARD MANSON V. THE HOLDINGS DIRECTORS, NME AND HOLDINGS, C.A. NO. 13797, (vi) LISBETH GREENFELD V. THE\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n8. COMMITMENTS AND CONTINGENCIES (CONTINUED) HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13799 and (vii) JOSEPH FRANKEL V. THE HOLDINGS DIRECTORS AND HOLDINGS, C.A. NO. 13800 and two purported Class Actions have been filed in the Superior Court of the State of California, County of Los Angeles, entitled RUTH LEWINTER AND RAYMOND CAYUSO V. THE HOLDINGS DIRECTORS (WITH THE EXCEPTION OF HAROLD S. WILLIAMS), NME AND HOLDINGS, CASE NO. BC115206 AND DAVID F. AND SYLVIA GOLDSTEIN V. O'LEARY, NME, AMI, ET AL., CASE NO. BC116104. The complaints filed in each of the Class Actions are substantially similar, are brought by purported stockholders of Holdings and, in general, allege that the defendants breached their fiduciary duties to the plaintiffs and other members of the purported class. One of the Class Actions alleges that the defendants have committed or aided and abetted a gross abuse of trust. The complaints further allege that the directors of Holdings wrongfully failed to hold an open auction and encourage bona fide bids for Holdings and failed to take action to maximize value for Holdings stockholders. The complaints seek preliminary and permanent injunctions against the proposed transaction until such time as a transaction to be entered into between Holdings and NME results from bona fide arms' length negotiation and\/or requiring a fair auction for Holdings. In addition, if the Merger is consummated, the complaints seek recision or recessionary damages and two of the Class Actions seek an accounting of all profits realized and to be realized by the defendants in connection with the Merger and the imposition of a constructive trust for the benefit of the plaintiffs and other members of the purported classes pending such an accounting. The complaints also seek monetary damages of an unspecified amount together with prejudgment interest and attorneys' and experts' fees. Holdings and NME believe that the complaints are without merit and intend to defend them vigorously.\nIn addition, Holdings and AMI are subject to claims and suits arising in the ordinary course of business. In the opinion of management, the ultimate resolution of all pending legal proceedings will not have a material adverse effect on the business, results of operations or financial condition of Holdings and AMI.\n9. CAPITAL STOCK\nOPTION PLANS\nThe Company maintains two stock option plans, the Nonqualified Employee Stock Option Plan (the \"Option Plan\") and the Nonqualified Performance Stock Option Plan for Key Employees (the \"Key Employees Plan\"), pursuant to which employees of Holdings and its subsidiaries are eligible to receive stock options to purchase shares of common stock.\nThe table below summarizes the transactions in the Company's stock option plans for the years ended August 31, 1994, 1993 and 1992 (shares of common stock):\nThe Option Plan generally provides options that are exercisable at prices ranging from $7.03 to $19.21 per share, vest over a period of five years and expire ten years from the date of grant. The Key\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n9. CAPITAL STOCK (CONTINUED) Employees Plan generally provides options that are exercisable at prices ranging from $7.03 to $22.17 per share, vest over a period of five to ten years based on the attainment of specified performance goals and expire ten years from the date of grant.\nEMPLOYEE STOCK PURCHASE PLAN\nIn January 1993 the Company adopted an Employee Stock Purchase Plan (the \"Plan\"). The purpose of the Plan is to provide an incentive for employees of the Company to own Holdings' common stock. The plan allows eligible employees to contribute up to 10% of their base earnings to purchase Holdings' common stock quarterly, through payroll deductions, at 85% of the lower of the closing price on the first or last day of the Plan quarter. The Company has reserved 2,300,000 shares of Holdings' common stock for the Plan.\nCOMMON STOCK SUBJECT TO REPURCHASE OBLIGATIONS\nThe Company's obligation to repurchase shares of Holdings' common stock held by certain executive officers no longer exists. Accordingly, the amount related to common stock subject to repurchase obligations was recognized as shareholders' equity as of August 31, 1994. As of August 31, 1993 and 1992, shares of Holdings' common stock subject to repurchase obligations were 431,858 and 445,976, respectively.\n10. RELATED PARTY TRANSACTIONS In connection with the sale of the Company's interest in EPIC Holdings, Inc., during fiscal 1994 the Company was represented by and paid a fee of approximately $2.3 million to a major shareholder.\nIn fiscal 1992, an affiliate of a major shareholder served as the lead managing underwriter of the public offering of 16.2 million shares of Holdings common stock, the issuance of the 13 1\/2% Senior Subordinated Notes Due 2001 and the 11% Senior Notes Due 2000. This related party received underwriting fees of $.9 million and in addition received advisory fees of $1.3 million in connection with divestitures during fiscal 1992.\nAn entity associated with a general partner of a major shareholder agreed to provide credit support to domestic hospital subsidiaries of AMI for which such entity received an annual fee in fiscal 1993 and 1992 of $750,000. The credit support commitment was replaced with the fiscal 1993 refinancing of the bank credit facility.\n11. EARNINGS PER SHARE Holdings' earnings per share for the years ended August 31, 1994, 1993 and 1992 is based upon the weighted average number of shares of Holdings' common stock outstanding. The impact of common stock equivalents is not considered since they either have an anti-dilutive effect or the effect on dilution is less than three percent.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n12. INCOME TAXES (Provision) benefit for income taxes, excluding the tax effect of minority equity interest and the extraordinary loss, for the years ended August 31, 1994, 1993 and 1992 for Holdings and AMI consists of the following (in thousands):\nThe net tax effects of temporary differences and carryforwards that give rise to deferred tax assets and liabilities as of August 31, 1994 and 1993 are as follows (in thousands):\nThe net deferred tax liability of $158.3 million and $173.1 million as of August 31, 1994 and 1993, respectively, includes a current asset of $60.3 million and $38.4 million, respectively, and a noncurrent liability of $218.6 million and $211.5 million, respectively. No valuation allowance has been recorded against any deferred tax asset.\nIn August 1993, the Revenue Reconciliation Act of 1993 was enacted. Among other tax law changes, such law increased the corporate income tax rate from 34% to 35% effective for the period beginning on or after January 1, 1993. For the year ended August 31, 1994, the U.S. statutory tax rate for the Company is 35%.\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n12. INCOME TAXES (CONTINUED) Holdings' and AMI's income tax provision differed from the amount computed using the U.S. statutory rate for the years ended August 31, 1994, 1993 and 1992 for the following reasons (in thousands):\nPrior to fiscal 1992, Holdings had operating loss and capital loss carryforwards for tax purposes of $42 million and $9 million, respectively, which were fully utilized against net income and capital gains arising in fiscal 1992 and against capital gains on assets sold prior to the acquisition of AMI.\n13. EXTRAORDINARY LOSSES ON EARLY EXTINGUISHMENT OF DEBT The Company has recognized extraordinary losses on early extinguishment of debt in fiscal 1994, 1993, and 1992. Fiscal 1994 includes an extraordinary loss of $1.9 million ($3.0 million pre-tax) from the repurchase of $15.4 million principal amount of the 15% Junior Subordinated Discount Debentures Due 2005. Fiscal 1993 includes an extraordinary loss of $25.4 million ($41.0 million pre- tax) from the repurchase or redemption of $146.8 million principal amount of outstanding indebtedness. Fiscal 1992 includes an extraordinary loss of $10.0 million ($15.6 million pre-tax) from the repurchase or redemption of $159.0 million of senior indebtedness and $55.4 million of the 9 7\/8% unsecured loan stock due 2011.\n14. SUPPLEMENTAL CASH FLOW INFORMATION The Company paid income taxes (net of refunds) of $86.0 million and $83.6 million for the years ended August 31, 1994 and 1993, respectively, and received income tax refunds (net of payments) of $22.5 million for the year ended August 31, 1992. The Company paid interest (net of capitalized costs) for the years ended August 31, 1994, 1993 and 1992 of $108.3 million, $120.5 million and $154.1 million, respectively. Capitalized interest costs were $3.5 million, $1.4 million and $2.6 million for August 31, 1994, 1993 and 1992. Interest income was $2.7 million, $13.9 million and $10.0 million for the years ended August 31, 1994, 1993 and 1992.\nNON-CASH TRANSACTIONS\nDuring fiscal 1994, the Company assumed net assets of approximately $92.0 million related to the purchase of Saint Francis Hospital and during fiscal 1993, the Company assumed net assets of approximately $8.0 million as a result of the merger of AMI's Tarzana Regional Medical Center and HealthTrust's Encino Hospital.\nFor the years ended August 31, 1993 and 1992 an $8.2 million and $9.3 million loss, net of tax, respectively, was recognized as a result of the write-off of the discounts and deferred financing costs associated with the early extinguishment of debt.\nFor the year ended August 31, 1994 approximately $6.0 million was recognized as an increase in shareholders' equity of Holdings due to the elimination of common stock subject to repurchase\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n14. SUPPLEMENTAL CASH FLOW INFORMATION (CONTINUED) obligations. For the year ended August 31, 1993 $1.8 million was recognized as a decrease in shareholders' equity of Holdings for the common stock subject to repurchase obligations due to market price changes. For the year ended August 31, 1992, there was no market price change and, therefore, no effect on the value of the common stock subject to repurchase obligations.\nIn fiscal 1992, the Company recognized $27.1 million of debt as a result of the acquisition of the remaining interest in an entity that was previously unconsolidated.\n15. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) Quarterly financial information for Holdings and AMI for the two years ended August 31, 1994 is summarized below (in millions, except per share amounts):\nThe third quarter of fiscal 1994 includes the gain on sale of securities of $43.4 million, net of tax, (See Note 4 Dispositions). The results of operations of Saint Francis Hospital were consolidated with the Company's results of operations effective May 1, 1994.\nThe fourth quarter of fiscal 1993 reflects a charge of $3.5 million for costs incurred related to the relocation of the Houston regional office to the Dallas headquarters. Additional charges totaling $3.0 million were recognized in previous quarters offset by benefits. Income before extraordinary loss includes an $8.6 million refund of interest paid to the Internal Revenue Service in prior periods. Additionally in the fourth quarter of fiscal 1993, the provision for income taxes includes the impact of a $5.1 million increase in the provision for income taxes due to the enactment of the Revenue Reconciliation Act of 1993 which increased the corporate income tax rate.\n16. BUSINESS SEGMENT The Company's only material business segment is \"healthcare\" which accounted for substantially all of its revenues and operating results for each of the periods presented.\n17. SUBSEQUENT EVENTS On October 10, 1994, Holdings, National Medical Enterprises, Inc, a Nevada corporation (\"NME\") and a wholly-owned subsidiary of NME (\"Merger Sub\"), executed an Agreement and Plan of Merger (the \"Merger Agreement\"). Pursuant to the Merger Agreement, Merger Sub will merge with and into Holdings (the \"Merger\"). As a result of the Merger, Holdings will become a wholly-owned subsidiary of NME and the resulting company will be the second-largest healthcare services company in the nation. Under terms of the Merger Agreement each share of common stock of Holdings will be converted into (i) $19.00 in cash, if the closing occurs on or before March 31, 1995,\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)\n17. SUBSEQUENT EVENTS (CONTINUED) and $19.25 thereafter and (ii) 0.42 of a newly issued share of NME common stock. Under the Merger Agreement, Holdings will pay a special dividend of $0.10 per share before the effective date of the Merger. Following the Merger, Holdings will have the right to nominate three members to the 13 member board of the combined company. Approximately 50% of the Company's indebtedness contains put provisions whereby the holders of such debt have the right to require repayment following a change of control of the Company. The transaction has been approved by shareholders of approximately 61.4% of Holdings' outstanding shares of common stock and, therefore, further action by Holdings' shareholders is not required. The transaction, which is currently anticipated to close in the first quarter of calendar 1995, is subject to certain conditions including, among other things, expiration of any applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended.\nOn September 1, 1994, a limited partnership, of which AMI is the general partner, acquired Hilton Head Hospital in Hilton Head, South Carolina containing 68 beds. In connection with the Company's efforts to re-establish a presence in Europe, the Company has entered into a joint venture agreement with a community organization (the \"Burgergemeinde\") located in Cham, Canton Zug, Switzerland. The joint venture will be owned 90% by the Company and 10% by the Burgergemeinde. Under the terms of the proposed transaction, the Company has entered into a long term lease for the land where the existing hospital is located and will then construct a new 56 bed acute care wing, convert an existing structure into a medical office building and renovate and remodel the existing acute care facility. In addition, the Company plans to contract to provide management, food, physical therapy and rehabilitation services to the hospital, an on-site nursing home and an affiliated retirement community.\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULES\nTo the Board of Directors of American Medical Holdings, Inc. and American Medical International, Inc.\nOur audits of the consolidated financial statements referred to in our report dated October 20, 1994 appearing on page of this Annual Report on Form 10-K also included an audit of the Financial Statement Schedules of American Medical Holdings, Inc. (Holdings) and American Medical International, Inc. (AMI) as of and for the years ended August 31, 1994, August 31, 1993 and August 31, 1992 as listed in Item 14(a) of the 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 LLP\nDallas, Texas October 20, 1994\nS-1\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE II -- AMOUNTS RECEIVABLE FROM DIRECTORS, OFFICERS AND EMPLOYEES\nFOR THE THREE YEARS ENDED AUGUST 31, 1994\nS-2\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES\nSCHEDULE V -- PROPERTY AND EQUIPMENT\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)\nS-3\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES\nSCHEDULE VI -- ACCUMULATED DEPRECIATION OF PROPERTY AND EQUIPMENT\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)\nS-4\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES\nSCHEDULE VIII -- RESERVES FOR UNCOLLECTIBLE ACCOUNTS\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)\nS-5\nAMERICAN MEDICAL HOLDINGS, INC. AND SUBSIDIARIES AMERICAN MEDICAL INTERNATIONAL, INC. AND SUBSIDIARIES\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION\nFOR THE YEARS ENDED AUGUST 31, 1994, 1993 AND 1992 (DOLLARS IN THOUSANDS)\nS-6","section_15":""}
{"filename":"819793_1994.txt","cik":"819793","year":"1994","section_1":"ITEM 1. BUSINESS\nThe Registrant designs, manufactures and markets paper machine clothing for each section of the paper machine. It is the largest producer of paper machine clothing in the world. Paper machine clothing consists of large continuous belts of custom designed and custom manufactured, engineered fabrics that are installed on paper machines and carry the paper stock through each stage of the paper production process. Paper machine clothing is a consumable product of technologically sophisticated design that is made with synthetic monofilament and fiber materials. The Registrant produces a substantial portion of its monofilament requirements. The design and material composition of paper machine clothing can have a considerable effect on the quality of paper products produced and the efficiency of the paper machines on which it is used. In addition to paper machine clothing, the Registrant manufactures other engineered fabrics which include fabrics for the non-woven industry, corrugator belts, filtration media and rapid roll doors.\nPractically all press fabrics are woven tubular or endless from monofilament yarns. After weaving, the base press fabric goes to a needling operation where a thick fiber layer, called a batt, is laid on the base just before passing through the needling machine. The needles are equipped with tiny barbs that grab batt fibers locking them into the body of the fabric. After needling, the fabrics are usually washed, and water is removed. The fabric then is heat set, treatments may be applied, and it is measured and trimmed.\nThe Registrant's manufacturing process is similar for forming fabrics and drying fabrics. Monofilament screens are woven on a loom. The fabrics are seamed to produce an endless loop, and heat stabilized by running them around two large cylinders under heat and drawn out by tension. After heat setting, the fabrics are seamed and boxed.\nINDUSTRY FACTORS\nThere are approximately 1,250 paper machines in the United States located in approximately 490 paper mills. It is estimated that, excluding China, there are 8,100 paper machines in the world and more than 5,000, mostly very small, paper machines in China. Demand for paper machine clothing is tied to the volume of paper production, which in turn reflects economic growth. According to published data, world production volumes have grown in excess of 4% annually over the last ten years. The Registrant anticipates continued growth for the long-term in world paper production. The profitability of the paper machine clothing business has generally been less cyclical than the profitability of the papermaking industry. Papermaking capacity utilization does not vary significantly because in periods of declining demand for paper, paper mills still operate near capacity but at lower profitability.\nBecause the paper industry has been characterized by an evolving but essentially stable manufacturing technology based on the wet forming papermaking process, which requires a very large capital investment, the Registrant does not believe that a commercially feasible substitute technology that does not employ paper machine clothing is likely to be developed and incorporated into the paper production process by paper manufacturers in the foreseeable future. Accordingly, the prospects for continued stability of industry demand for paper machine clothing appear excellent.\nOver the last few years, paper manufacturers have generally reduced the number of suppliers of paper machine clothing per machine position. This trend has increased opportunities for market leaders to expand their market share.\nINTERNATIONAL OPERATIONS\nThe Registrant maintains wholly-owned manufacturing facilities in Australia, Brazil, Canada, Finland, France, Germany, Great Britain, Holland, Mexico, Sweden and the United States. The Registrant has a 50% interest in a partnership in South Africa which is engaged primarily in the paper machine clothing business (see Note 1 of Notes to Consolidated Financial Statements).\nThe Registrant's geographically diversified operations allow it to serve the world's paper markets more efficiently and to provide superior technical service to its customers. The Registrant benefits from the transfer of research and development product innovations between geographic regions. The worldwide scope of the Registrant's manufacturing and marketing efforts also limits the impact on the Registrant of economic downturns that are limited to a geographic region.\nThe Registrant's widespread presence subjects it to certain risks, including controls on foreign exchange and the repatriation of funds. However, the Registrant has been able to repatriate earnings in excess of working capital requirements from each of the countries in which it operates without substantial governmental restrictions and does not foresee any material changes in its ability to continue to do so in the future. In addition, the Registrant believes that the risks associated with its operations and locations outside the United States are those normally associated with doing business in these locations. In countries in which the Registrant operates that have experienced high inflation rates, the Registrant frequently reprices its products. This practice has enabled the Registrant to quickly pass on to its customers most of the increased costs due to local inflation. Although government imposed price freezes have occasionally occurred in some of the Registrant's markets, including the United States, neither controls nor high inflation rates have had a long-term material adverse impact on the Registrant's operating results.\nMARKETING, CUSTOMERS AND BACKLOG\nPaper machine clothing is custom designed for each user depending upon the type, size and speed of the papermaking machine, the machine section, the grade of paper being produced, and the quality of the pulp stock used. Judgment and experience are critical in designing the appropriate clothing for each position on the machine. As a result, the Registrant employs highly skilled sales and technical service personnel in 24 countries who work directly with paper mill operating management. The Registrant's technical service program in the United States gives its service engineers field access to the measurement and analysis equipment needed for troubleshooting and application engineering. Sales, service and technical expenses are major cost components of the Registrant. The Registrant employs approximately 900 people in the sales and technical functions combined, many of whom have engineering degrees or paper mill experience.\nThe forming and pressing sections of the papermaking process have been characterized by a greater frequency of technological and design innovations that improve performance than has the drying section. The Registrant's market leadership position in forming and pressing fabrics and the 1993 acquisition of Mount Vernon which produces dryer fabrics, reflects the Registrant's commitment to technological innovation.\nTypically, the Registrant experiences its highest quarterly sales levels in the fourth quarter of each fiscal year and its lowest levels in the first quarter. The Registrant believes that this pattern only partially reflects seasonal shifts in demand for its products but is more directly related to purchasing policies of the Registrant's customers.\nPayment terms granted to customers reflect general competitive practices. Terms vary with product and competitive conditions, but generally require payment within 30 to 90 days, depending on the country of operation. Historically, bad debts have been insignificant. No single customer, or group of related customers, accounted for more than 5% of the Registrant's sales of paper machine clothing in any of the past three years. Management does not believe that the loss of any one customer would have a material adverse effect on the Registrant's business.\nThe Registrant's order backlogs at December 31, 1994 and 1993 were approximately $446 million and $407 million, respectively. Orders recorded at December 31, 1994 are expected to be invoiced during the next 12 months.\nRESEARCH AND DEVELOPMENT\nThe Registrant invests heavily in research, new product development and technical analysis to maintain its leadership in the paper machine clothing industry. The Registrant's expenditures fall\ninto two primary categories, research and development and technical expenditures. Research and development expenses totaled $18.4 million in 1994, $17.6 million in 1993 and $18.5 million in 1992. While most research activity supports existing products, the Registrant engages in research for new products. New product research has focused primarily on more sophisticated paper machine clothing and has resulted in a stream of products such as DUOTEX-Registered Trademark- and TRIOTEX-TM- forming fabrics, for which the technology has been licensed to several competitors, the patented, on-machine-seamed press fabric, long nip press belts which are essential to water removal in the press section and Thermonetics-TM- a dryer fabric. Technical expenditures, primarily at the plant level, totaled $22.5 million in 1994, $21.4 million in 1993, and $22.9 million in 1992. Technical expenditures are focused on design, quality assurance and customer support.\nAlthough the Registrant has focused most of its research and development efforts on paper machine clothing products and design, the Registrant also has made progress in developing non-paper machine clothing products. Through its major research facility in Mansfield, Massachusetts, the Registrant conducts research under contract for the U.S. government and major corporations. In addition to its Mansfield facility, the Registrant has four other research and development centers located at manufacturing locations in Halmstad, Sweden; Selestat, France; Albany, New York; and Menasha, Wisconsin.\nThe Registrant has developed and is developing proprietary processes for manufacturing structural and insulation products using polyimide and other fibers, which have potential applications in aircraft, automotive and other industries. A number of products that include properties such as thermal stability, non-flammability, non-melting and low generation of smoke and toxic gasses at high temperatures are currently being tested.\nAnother innovative engineered fabric development unrelated to paper machine clothing is Primaloft-Registered Trademark-, a synthetic down which is believed to have properties superior to goose down. This product continues to gain acceptance in the marketplace for cold weather clothing and bedding.\nThe Registrant holds a number of patents, trademarks and licenses, none of which are material to the continuation of the Registrant's business. Consistent with industry practice, the Registrant frequently licenses its patents to competitors primarily to enhance customer acceptance of the new products. The revenue from such licenses is less than 1 percent of consolidated net sales.\nCOMPETITION\nWhile there are more than 50 paper machine clothing suppliers worldwide, only six major paper machine clothing companies compete on a global basis. Market shares vary depending on the country and the type of paper machine clothing produced. In the paper machine clothing market, the Registrant believes that it has a market share of approximately 27% in the United States and Canadian markets, taken together, 17% in the rest of the world and approximately 21% in the world overall. Together, the United States and Canada constitute approximately 38% of the total world market for paper machine clothing.\nCompetition is intense in all areas of the Registrant's business. While price competition is, of course, a factor, the primary bases for competition are the performance characteristics of the Registrant's products, which are principally technology-driven, and the quality of customer service. The Registrant, like its competitors, provides diverse services to customers through its sales and technical service personnel including: (1) consulting on performance of the paper machine; (2) consulting on paper machine configurations, both new and rebuilt; (3) selection and custom manufacture of the appropriate paper machine clothing; and (4) storing fabrics for delivery to the user.\nEMPLOYEES\nThe Registrant employs 5,404 persons, of whom approximately 75% are engaged in manufacturing the Registrant's products. Wages and benefits are competitive with those of other manufacturers in the geographic areas in which the Registrant's facilities are located. The Registrant considers its relations with its employees in general to be excellent.\nEXECUTIVE OFFICERS OF REGISTRANT\nThe following table sets forth certain information with respect to the executive officers of the Registrant:\nJ. SPENCER STANDISH joined the Registrant in 1952. He has served the Registrant as Chairman of the Board since 1984, Vice Chairman from 1976 to 1984, Executive Vice President from 1974 to 1976, and Vice President from 1972 to 1974. He has been a Director of the Registrant since 1958. He is a director of Berkshire Life Insurance Company.\nFRANCIS L. MCKONE joined the Registrant in 1964. He has served the Registrant as Chief Executive Officer since 1993, President since 1984, Executive Vice President from 1983 to 1984, Group Vice President -- Papermaking Products Group from 1979 to 1983, and prior to 1979 as a Vice President of the Registrant and Division President -- Papermaking Products U.S. He has been a Director of the Registrant since 1983.\nMICHAEL C. NAHL joined the Registrant in 1981. He has served the Registrant as Senior Vice President and Chief Financial Officer since 1983 and prior to 1983 as Group Vice President.\nJ. WELDON COLE joined the Registrant as Senior Vice President on January 1, 1995. From 1988 until December 1994 he held various management positions, most recently as President and Director of Beloit Corporation, an international manufacturer of pulp and papermaking equipment. He is a director of Rock Financial Corporation.\nMANFRED F. KINCAID joined the Registrant in 1960. He has served the Registrant as Senior Vice President since 1983, Vice President -- Papermaking Products Europe from 1981 to 1983, and prior to 1981 as Vice President and General Manager of the Appleton Wire Division.\nTHOMAS H. RICHARDSON joined the Registrant in 1965. He has served the Registrant since 1993 as Senior Vice President -- International. Prior to 1993, he served as Vice President and General\nManager of Euroscan from 1986 to 1993, as Senior Vice President -- Canada and Europe from 1983 to 1986, as Senior Vice President -- International from 1981 to 1983, and prior to 1981 as General Manager of Albany International Industria e Comercio Ltda. in Brazil.\nFRANK R. SCHMELER joined the Registrant in 1964. He has served the Registrant as Senior Vice President since 1988, as Vice President and General Manager of the Felt Division from 1984 to 1988, as Division Vice President and General Manager, Albany International Canada from 1978 to 1984 and as Vice President of Marketing, Albany International Canada from 1976 to 1978.\nEDWARD WALTHER joined the Registrant in 1994. He has served the Registrant as Senior Vice President since 1995 and as Vice President and General Manager -- Continental Europe since 1994. Prior to joining the Registrant, he held various marketing and managerial positions with a company in the paper machine clothing business.\nCHARLES B. BUCHANAN joined the Registrant in 1957. He has served the Registrant as Vice President and Secretary since 1980 and as Vice President and Assistant to the President from 1976 to 1980. He has been a Director of the Registrant since 1969. He is a Director of Fox Valley Corporation and of CMP Industries, Inc.\nRICHARD A. CARLSTROM joined the Registrant in 1972. He has served the Registrant as Vice President -- Controller since 1993, as Controller since 1980, as Controller of a U.S. division from 1975 to 1980, and prior to 1975 as Financial Controller of Albany International Pty. in Australia.\nRAYMOND D. DUFRESNE joined the Registrant in 1973. He has served the Registrant as Vice President -- Treasurer since 1993, as Treasurer since 1985, as Business Analyst and Assistant Treasurer from 1978 to 1985 and Financial Manager of Albany International Industria e Comercio Ltda. in Brazil from 1975 to 1977.\nWILLIAM H. DUTT joined the Registrant in 1958. He has served the Registrant since 1983 as Vice President -- Technical, and prior to 1983 he served in various technical, engineering, and research capacities including Director of Research and Development and Vice President -- Operations for Albany Felt.\nHUGH A. MCGLINCHEY joined the Registrant in 1991. He has served the Registrant as Vice President -- Information Systems since 1993 and from 1991 to 1993 as Director -- Information Systems. Prior to 1991 he served as Director -- Corporate Information and Communications Systems for Avery Dennison Corporation.\nJAMES W. SHERRER, SR. joined the Registrant in 1992. He has served the Registrant since 1993 as Vice President -- Administration and from 1992 to 1993 as Vice President. Prior to joining the Registrant, he held various technical and managerial positions with a company in the paper machine clothing business.\nTHOMAS H. HAGOORT joined the Registrant as General Counsel on January 1, 1991. From 1968 until December 31, 1990 he was a partner in Cleary, Gottlieb, Steen and Hamilton, an international law firm with headquarters in New York City, to which he became of counsel on January 1, 1991.\nRAW MATERIALS AND INVENTORY\nPrimary raw materials for the Registrant's products are synthetic fibers, which are generally available from a number of suppliers. The Registrant, therefore, is not required to maintain inventories in excess of its current needs to assure availability. In addition, the Registrant manufactures monofilament, a basic raw material for all types of paper machine clothing, at its facility in Homer, New York, which supplies approximately 25% of its world-wide monofilament requirements. This manufacturing capability assists the Registrant in its negotiations with monofilament producers for the balance of its supply requirements, and enhances the ability of the Registrant to develop proprietary products.\nThe Registrant believes it is in compliance with all Federal, State and local provisions which have been enacted or adopted regarding the discharge of materials into the environment, or otherwise relating to the protection of the environment, and does not have knowledge of environmental regulations which do or might have a material effect on future capital expenditures, earnings, or competitive position.\nThe Registrant is incorporated under the laws of the State of Delaware and is the successor to a New York corporation which was originally incorporated in 1895 and which was merged into the Registrant in August 1987 solely for the purpose of changing the domicile of the corporation. Upon such merger, each outstanding share of Class B Common Stock of the predecessor New York corporation was changed into one share of Class B Common Stock of the Registrant. References to the Registrant that relate to any time prior to the August 1987 merger should be understood to refer to the predecessor New York corporation.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Registrant's principal manufacturing facilities are located in the United States, Canada, Europe, Brazil, Mexico and Australia. The aggregate square footage of the Registrant's facilities in the United States and Canada is approximately 2,437,000, of which 2,327,000 square feet are owned and 110,000 square feet are leased. Most of the leased facilities in the United States are used for the warehousing of finished goods. The Registrant's facilities located outside the United States and Canada comprise approximately 2,715,200 square feet, of which 2,517,100 square feet are owned and 198,100 square feet are leased. The Registrant considers these facilities to be in good condition and suitable for their purpose. The capacity associated with these facilities is adequate to meet production levels required and anticipated through 1995. The Registrant's capital expenditures are expected to approximate $40 million during 1995 in order to meet anticipated sales growth.\nThe Registrant believes it has modern, efficient production equipment. In the last five years, it has spent $238 million on new plants and equipment or upgrading existing facilities, including the completion of new forming fabric plants in Sweden and Holland and new press fabric plants in Sweden and Finland.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nThere are no material pending legal proceedings, other than ordinary routine litigation incidental to the business.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS\nThere were no matters submitted during the fourth quarter of 1994 to a vote of security holders.\nPART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\n\"Stock and Shareholders\" and \"Quarterly Financial Data\" on page 23 of the Annual Report are incorporated herein by reference.\nRestrictions on dividends and other distributions are described in Note 6, on pages 12 and 13 of the Annual Report. Such description is incorporated herein by reference.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\n\"Eleven Year Summary\" on page 24 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\n\"Review of Operations\" on pages 20 to 22 of the Annual Report 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 Registrant and its subsidiaries, included on pages 6 to 19 in the Annual Report, are incorporated herein by reference:\nConsolidated Statements of Income and Retained Earnings -- years ended December 31, 1994, 1993 and 1992\nConsolidated Balance Sheets -- December 31, 1994 and 1993\nConsolidated Statements of Cash Flows -- years ended December 31, 1994, 1993 and 1992\nNotes to Consolidated Financial Statements\nReport of Independent Accountants\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\na) DIRECTORS. The information set out in the section captioned \"Election of Directors\" of the Proxy Statement is incorporated herein by reference.\nb) EXECUTIVE OFFICERS OF REGISTRANT. Information about the officers of the Registrant is set forth in Item 1 above.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information set forth in the sections of the Proxy Statement captioned \"Executive Compensation\", \"Summary Compensation Table\", \"Option\/SAR Grants in Last Fiscal Year\", \"Option\/SAR Exercises during 1994 and Year-End Value\", \"Pension Plan Table\", \"Compensation and Stock Option Committee Report on Executive Compensation\" and \"Stock Performance Graph\" is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe information set out in the section captioned \"Share Ownership\" of the 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 STATEMENTS SCHEDULE AND REPORTS ON FORM 8-K\na)(1) FINANCIAL STATEMENTS. The consolidated financial statements included in the Annual Report are incorporated by reference in Item 8.\na)(2) SCHEDULE. The following consolidated financial statements schedule for each of the three years in the period ended December 31, 1994 is included pursuant to Item 14(d):\nReport of Independent Accountants on Financial Statements Schedule\nSchedule VIII -- Valuation and qualifying accounts\na)(3)(b) No reports on Form 8-K were filed during the quarter ended December 31, 1994.\n(3) EXHIBITS\nAll other schedules and exhibits are not required or are inapplicable and, therefore, have been omitted.\n(1) Previously filed as an Exhibit to the Company's Registration Statement on Form S-1, No. 33-16254, as amended, declared effective by the Securities and Exchange Commission on September 30, 1987, which previously-filed Exhibit is incorporated by reference herein.\n(2) Previously filed as an Exhibit to the Company's Registration Statement on Form S-1, No. 33-20650, declared effective by the Securities and Exchange Commission on March 29, 1988, which previously-filed Exhibit is incorporated by reference herein.\n(3) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated August 8, 1988, which previously-filed Exhibit is incorporated by reference herein.\n(4) Previously filed as an Exhibit to the Registrant's Registration Statement on Form 8-A, File No. 1-10026, declared effective by the Securities and Exchange Commission on August 26, 1988 (as to The Pacific Stock Exchange, Inc.), and on September 7, 1988 (as to The New York Stock Exchange, Inc.), which previously-filed Exhibit is incorporated by reference herein.\n(5) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated January 6, 1989, which previously-filed Exhibit is incorporated by reference herein.\n(6) Previously filed as an Exhibit to the Registrant's Registration Statement on Form S-1, No. 33-30581, declared effective by the Securities and Exchange Commission on September 26, 1989, which previously-filed Exhibit is incorporated by reference herein.\n(7) Previously filed as an Exhibit to the Registrant's Annual Report on Form 10-K for the fiscal year ended December 31, 1989, which previously-filed Exhibit is incorporated by reference herein.\n(8) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated June 29, 1990, which previously-filed Exhibit is incorporated by reference herein.\n(9) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated February 28, 1991, which previously-filed Exhibit is incorporated by reference herein.\n(10) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated April 8, 1991, which previously-filed Exhibit is incorporated by reference herein.\n(11) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated May 28, 1991, which previously-filed Exhibit is incorporated by reference herein.\n(12) Previously filed as an Exhibit to the Registrant's Quarterly Report on Form 10Q dated November 8, 1991, which previously-filed Exhibit is incorporated by reference herein.\n(13) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated January 18, 1993, which previously-filed Exhibit is incorporated by reference herein.\n(14) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated July 21, 1993, which previously-filed Exhibit is incorporated by reference herein.\n(15) Previously filed as an Exhibit to the Registrant's Current Report on Form 8-K dated June 30, 1994, which previously-filed Exhibit is incorporated by reference herein.\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.\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 20th day of March, 1995.\nALBANY INTERNATIONAL CORP.\nby \/s\/ MICHAEL C. NAHL\n-------------------------------------- Michael C. Nahl Principal Financial Officer Senior Vice President and Chief Financial Officer\nSCHEDULE\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENTS SCHEDULE\nTo The Shareholders and Board of Directors Albany International Corp.\nOur report on the consolidated financial statements of Albany International Corp. has been incorporated by reference in this form 10-K from page 6 of the 1994 Annual Report to Shareholders of Albany International Corp. In connection with our audits of such financial statements, we have also audited the related financial statements schedule listed in the index on page 8 of this Form 10-K.\nIn our opinion, the financial statements schedule 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 L.L.P.\nAlbany, New York January 26, 1995\nSCHEDULE VIII\nALBANY INTERNATIONAL CORP. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS (DOLLARS IN THOUSANDS)","section_15":""}
{"filename":"353718_1994.txt","cik":"353718","year":"1994","section_1":"ITEM 1. BUSINESS\nCarl Karcher Enterprises, Inc. (\"Enterprises\" or the \"Company\"), is a California business begun in the mid-1950's that operates, franchises and licenses a quick-service restaurant chain under the name \"Carl's Jr.\" Located primarily in the Western United States, the Carl's Jr. chain consisted of 648 restaurants as of January 31, 1994, of which 376 were operated by Enterprises, 255 were operated by its franchisees and 17 were operated by its international licensees.\nIn January 1994, Enterprises acquired from Boston Chicken, Inc. (\"BCI\"), franchisors and operators of a fast-growing rotisserie-roasted chicken concept, the rights to develop, own and operate up to 300 Boston Chicken stores in Southern California and metropolitan Sacramento, the first of which is scheduled to open in the summer of 1994. In February 1994, Boston Pacific, Inc. (\"Boston Pacific\"), a California corporation, was formed by the Company to conduct these Boston Chicken operations. At the upcoming Annual Meeting, the shareholders of Enterprises will vote upon a proposed reincorporation transaction whereby Enterprises and Boston Pacific will become wholly-owned subsidiaries of CKE Restaurants, Inc. (\"CKE Restaurants\"), a Delaware holding company formed to provide overall strategic direction to both Enterprises and Boston Pacific. Since neither Boston Pacific nor CKE Restaurants were operating prior to January 31, 1994, the financial information in this report and the discussion and analysis herein relates solely to Enterprises, unless otherwise indicated.\nRECENT DEVELOPMENTS\nThe Company believes that it has two significant opportunities for growth. First, the Company has implemented an aggressive strategic program designed to increase restaurant sales and improve the cost structure of its Carl's Jr. restaurant operations. This program includes marketing and pricing strategies designed to improve consumer perceptions of value while at the same time maintaining the Carl's Jr. reputation for superior food, service and cleanliness. Second, the Company, through Boston Pacific, anticipates an accelerated development of its Boston Chicken stores by initially converting a number of selected Carl's Jr. restaurants.\nSTRATEGIC PROGRAM\nThe Company recruited a new president and chief executive officer in December 1992. Recessionary economic conditions and a changing competitive environment had resulted in a decline in the frequency of visits by fast-food users at Carl's Jr. restaurants. With a team comprised of existing senior management and several new executives, the Company implemented a strategic program, which was based upon extensive analyses of Company operations and consumer research. The strategic program's three main elements are to increase restaurant sales by developing and implementing consumer-driven and research-based marketing programs, to aggressively improve the restaurant-level cost structure and to realign and invest in the organization and efficiency of its human resources.\nThe program has yielded significant results to date. As part of its new marketing and advertising strategy, the Company has hired a new advertising agency to improve its advertising effectiveness and increased its spending on radio and television media. In addition, the Company has strengthened its consumer research and has recently introduced a simplified menu and a new pricing structure designed to promote consumer perceptions of quality and value. Through new labor-scheduling guidelines and enhanced technology, increased outsourcing and downsizing, and improved safety programs and incentives, the Company has also significantly reduced operating costs. As part of its organizational realignment, the management structure from the restaurant level through the regional vice president level has been streamlined, the headquarters organization has been restructured, and key personnel have been added to marketing and product development.\nBOSTON CHICKEN AGREEMENT\nThe Company's agreement with BCI is the largest area development agreement to date between BCI and a franchisee. Boston Pacific plans to open 60 Boston Chicken stores by the end of fiscal 1996 and at least 200 by January 1999. Boston Chicken stores specialize in complete meals featuring rotisserie-roasted chicken, fresh vegetables and other side dishes. Boston Chicken stores offer the convenience and value associated with fast food, and the quality and freshness associated with traditional home cooking. Management believes that the Boston Chicken store concept is well-suited to California consumer tastes. The agreement with BCI provides the Company with the opportunity to participate in one of the fastest-growing segments in the restaurant industry and to attract a consumer market segment that is distinct from Carl's Jr. restaurant customers.\nCARL'S JR.\nCOMPANY OPERATIONS\nOVERVIEW\nThe Company believes that it is one of the leaders in offering a wide variety of food in a quick-service restaurant with comfortable dining rooms and partial table service. The Company was among the first to offer self-service salad bars and all-you-can-drink beverage bars. The Carl's Jr. menu is relatively uniform throughout the chain and features several charbroiled hamburgers and chicken sandwiches, including the Famous Big Star, Western Bacon Cheeseburger(R) and Charbroiler Chicken Sandwiches(R). Other entrees include a fish sandwich, several baked potatoes and prepackaged salads. Side orders, such as french fries, onion rings and fried zucchini, are also offered. Most restaurants also have a breakfast menu including eggs, bacon, sausage, french toast dips, orange juice, the Sunrise Sandwich(R) and the Breakfast Burrito.\nThe Company strives to maintain high standards in all materials used by its restaurants as well as the operations related to food preparation, service and cleanliness. Hamburgers and chicken sandwiches at Carl's Jr. restaurants are generally prepared or assembled after the customer has placed an order and served promptly. Hamburger patties and chicken breasts are charbroiled in a gas-fired double broiler that sears the meat on both sides. The meat is conveyed through the broiler automatically to maintain uniform heating and cooking time.\nEach Company-operated restaurant is operated by a manager who has received 13 to 17 weeks of management training. This training program involves a combination of classroom instruction and on-the-job training in specially designated training restaurants. Other restaurant employees are trained by the restaurant managers in accordance with Company guidelines. Restaurant managers are supervised by a district manager, responsible for eleven to fourteen restaurants. Approximately 30 district managers are under the supervision of four regional vice presidents, all of whom regularly inspect the operations in their respective districts and regions.\nCOST-REDUCTION PROGRAM; ELIMINATION OF NON-ESSENTIAL OPERATIONS\nThe Company's strategic program has focused on improving the restaurant-level cost structure in order to enhance margins and fund consumer-related investments, such as value pricing. Historically, the Company manufactured many of its food products as a means of insuring high quality standards. During fiscal year 1993, however, it was determined that overall food costs could be lowered by purchasing food products from third party suppliers without sacrificing these quality standards. Therefore, the Company initiated a program to lower food costs through the termination of its manufacturing operations. Sales of products to outside parties were also eliminated at this time.\nThrough the elimination of non-essential operations and increased outsourcing to selected third parties, the Company reduced the cost of providing maintenance and repair services to its restaurants. In addition, the Company redefined its cash management activities and liquidated a substantial portion of its former investment portfolio, utilizing the proceeds to reduce overall bank debt.\nMARKETING\nAdvertising has become increasingly important to the Company. Management believes that in order to successfully compete in today's quick-service environment, the Company must complement its strong reputation for product quality with a consumer perception of price value. In an effort to promote the quality and value concept, the Company will allocate more of its advertising budget to media spending. In April 1994, the Company initiated a broad-based marketing campaign to promote the Carl's Jr. concept as the same great food at lower everyday prices. The Company completed a review of its advertising efforts in fiscal 1994 and retained a new advertising agency, whose compensation is a combination of base remuneration plus incentives based on increases in Carl's Jr. restaurant sales. The initial savings in advertising agency fees that will result from this new arrangement will be reallocated to its budget for media advertisements, such as radio and television commercials. Several steps have also been taken to improve the Company's media advertising effectiveness. For instance, recent Carl's Jr. television commercials feature more contemporary castings and settings designed to appeal more to younger audiences. It is the Company's intention to continue to target these customers because they are the highest frequency fast-food users.\nFRANCHISED AND LICENSED OPERATIONS\nThe Company's franchise strategy is designed to further the development of the Carl's Jr. chain and reduce the total capital required of the Company for development of new restaurants. Franchise arrangements with franchisees, who operate in Arizona, California, Nevada, Oregon and Utah, generally provide for initial fees and continuing royalty payments to the Company based upon a percentage of sales. Additionally, franchisees may purchase food, paper and other supplies from the Company. Franchisees may also be obligated to remit lease payments for the use of Company-owned or leased restaurant facilities. Under the terms of these leases, they are required to pay related occupancy costs, which include maintenance, insurance and property taxes.\nThe Company receives notes from franchisees in connection with the sales of Company-operated restaurants. Generally, these notes bear interest at 12.5%, mature in five to 15 years and are secured by an interest in the restaurant equipment sold.\nThe Company's franchising philosophy is such that only candidates with appropriate experience are considered for the program. Specific net worth and liquidity requirements must also be satisfied. Absentee ownership is not permitted and franchise owners are encouraged to live within a one-hour drive of their restaurants. Area development agreements generally require franchisees to open a specified number of Carl's Jr. restaurants in a designated geographic area.\nIn order to stimulate development of restaurants in underpenetrated markets, the Company initiated a conversion program during fiscal 1991 under which Company-operated restaurants were sold to franchisees. During fiscal 1993, the Company sold 33 of its greater San Francisco Bay Area restaurants to franchisees, substantially completing the conversion of this region. Two additional such sales occurred during fiscal 1994. In total, since program inception the Company has completed 70 such sales.\nIn an effort to expand the Carl's Jr. presence internationally, the Company has entered into nine exclusive licensing agreements that allow licensees the use of the Carl's Jr. name and trademarks and provide for initial fees and continuing royalties based upon a percent of sales. As of January 31, 1994, there were 11 licensed restaurants in operation in Mexico, 2 licensed restaurants in operation in Japan and 4 licensed restaurants in operation in Malaysia. None of the Company's licensing agreements generated material royalties in the year ended January 31, 1994.\nDISTRIBUTION CENTERS\nThe Company operates a distribution center at its corporate headquarters in Anaheim, California and a smaller distribution facility in Manteca, California. Produce, frozen meat patties, dairy and other food and supply items, excluding bakery products, are distributed to Company-operated Carl's Jr. restaurants generally twice a week. Many of these products are sold to franchisees, and in some cases, to certain licensees. These\ndistribution centers are subject to frequent inspection by representatives of the United States Department of Agriculture.\nBOSTON CHICKEN\nIn January 1994, the Company entered into a Development Agreement with BCI granting rights to the Company, as a franchisee of BCI, to develop and operate 200 Boston Chicken stores (with an option, at the Company's election, to develop 100 more stores, as discussed below) in three designated areas of California (the \"Designated Markets\"). The Designated Markets comprise a specified market area around Sacramento, the County of San Diego and nine counties in the Los Angeles area (including the counties of Los Angeles, Orange, Riverside, Santa Barbara and San Bernardino). Boston Pacific plans to achieve a rapid and cost- effective roll-out of Boston Chicken stores by first converting a number of Carl's Jr. restaurants. Of its first 50 Boston Chicken stores, Boston Pacific anticipates that between 10 and 15 will be converted Carl's Jr. restaurants. By converting these selected Carl's Jr. restaurants, management's strategy is designed to accelerate the development of Boston Chicken stores in the Designated Markets and to achieve a sales and profit shift to surrounding Carl's Jr. locations and eliminate certain underperforming Carl's Jr. restaurants. The Company does not currently anticipate converting any additional Carl's Jr. restaurants to Boston Chicken stores after the initial 10 to 15 conversions are completed.\nThe Boston Chicken menu features rotisserie-roasted chicken, fresh-baked chicken pot pies, a variety of chicken sandwiches, chicken soup and fresh vegetables, salads and other side dishes, including mashed potatoes made from scratch, corn, stuffing and creamed spinach, as well as beverages and desserts. The signature menu item is chicken that is marinated and then slow-roasted in rotisserie ovens in full view of the customer. The Company believes that the Boston Chicken store formula has proven to be successful to date in other areas of the United States.\nThe first Boston Chicken store was opened in Newton, Massachusetts in 1985. As of March 21, 1994, there were 257 Boston Chicken stores system-wide. By the end of 1994, BCI expects to have approximately 450 restaurants in operation system-wide. There can be no assurance that BCI or its area developers will be able to achieve this goal.\nThe Company estimates that the initial investment for a Boston Chicken store currently is approximately $800,000. This estimate includes development and franchise fees, professional fees, deposits, leasehold improvements, furniture, fixtures, equipment, opening inventory and supplies, architectural and engineering fees, pre-opening costs, permit and impact fees, grand opening expenses, computer and software expenses, and initial working capital. This estimate does not include any land or additional costs which will depend on the location and the nature of the site. The actual cost depends on, among other factors, the size and location of the store, the type and quantity of equipment installed, the level of pre-opening expenditures, and the amount of improvements, less any applicable construction allowance. Costs of converting existing Carl's Jr. restaurants to Boston Chicken stores are estimated to be approximately $600,000 per restaurant.\nAREA DEVELOPMENT AGREEMENT\nPursuant to the Development Agreement, Boston Pacific is obligated and intends to develop and operate 200 Boston Chicken stores by January 15, 1999. The Development Agreement requires Boston Pacific to open a number of Boston Chicken stores in each Designated Market according to a specified schedule as of January 15 and July 15 of each year, commencing on January 15, 1995 and ending on January 15, 1999. Boston Pacific is obligated to open an aggregate of 20 Boston Chicken stores in the three Designated Markets by January 15, 1995, 60 by January 15, 1996, 110 by January 15, 1997, 160 by January 15, 1998 and 200 by January 15, 1999. The Company anticipates that its first Boston Chicken store will open in the summer of 1994.\nIn consideration of the rights granted to the Company by BCI under the Development Agreement, the Company paid Boston Chicken an initial fee of $1,000,000 ($5,000 per planned Boston Chicken store). The Company also paid to BCI a non-refundable deposit of $1,000,000, which will be applied as a credit of $5,000 towards the Company's obligation to pay $35,000 to BCI as an initial franchise fee upon the opening of each Boston Chicken store by the Company. Upon opening a Boston Chicken store, the Company is obligated to\nenter into a franchise agreement with BCI and pay BCI an annual royalty fee of 5% of the gross sales of that store.\nThe Development Agreement generally prohibits the Company, or any affiliate, from engaging or having any interest in any business that competes with Boston Chicken stores. The operation of Carl's Jr. restaurants is expressly deemed not to be a business that competes with Boston Chicken stores so long as such restaurants do not offer rotisserie chicken or other products prepared in accordance with BCI's recipes or specifications.\nThe Development Agreement can be terminated by BCI upon the occurrence of certain events that include, among others: (1) Boston Pacific's failure to comply with its scheduled development of Boston Chicken stores in the Designated Markets; (2) the Company's engaging in misconduct that adversely affects the reputation of Boston Chicken stores or the goodwill associated with the BCI trademarks; (3) the Company's violation of the prohibition on engaging in competitive businesses, described above; (4) the failure by the Company to comply with other provisions of the Development Agreement; and (5) the insolvency of the Company.\nThe Company has an option, exercisable at least 12 months prior to the expiration of the initial development term on January 15, 1999 (or, if earlier, the date by which Boston Pacific has opened the required number of Boston Chicken stores in each Designated Market), to develop an additional 100 Boston Chicken stores in the Designated Markets. If the Company exercises this option, the Company and BCI will, at that time, determine the appropriate allocation of the additional 100 Boston Chicken stores among the Designated Markets and the appropriate time schedule for developing those restaurants. After the expiration of the term of the Development Agreement, BCI, or any third party to whom it grants development rights, will be entitled to develop Boston Chicken stores in the Designated Markets, subject to certain negotiation rights the Company has during the first 12 months after the expiration of such term.\nFRANCHISE AGREEMENT\nThe form of franchise agreement to be entered into between the Company and BCI upon the opening of each Boston Chicken store provides for a term of 15 years and also provides for payment of a $35,000 per store franchise fee (less the $5,000 deposit), a 5% royalty on gross sales (minus sales\/service taxes, customer refunds and coupons, and the portion of employee meals not charged to the employee), a 2% national advertising fund contribution, 3.5% local advertising fund contribution, and a $10,000 grand opening expenditure. The agreement also permits, upon notice from BCI, an annual 0.25% increase in the local advertising fund requirement so long as the local advertising fund contribution does not exceed 5% of sales.\nThe franchise agreement provides for an area of limited exclusivity surrounding each Boston Chicken store in which BCI may neither develop nor grant to others the right to develop additional Boston Chicken stores, except that BCI reserves the right to engage in special distribution arrangements and, in the event that the Company does not choose to develop them, to develop regional shopping mall sites and sites acquired by BCI from others and held for two years which meet the standards for a Boston Chicken store within the Company's designated territory. Specified territories in suburban locations are generally a one-mile radius surrounding the Boston Chicken store, while urban locations generally have a smaller (e.g., one-half mile) radius or a trade-area-specific designated territory.\nThe franchise agreement requires that the stores be operated in accordance with the operating procedures and menu established by BCI. BCI will conduct regular inspections of the Company's Boston Chicken stores to determine whether the stores meet applicable quality, service and cleanliness standards, will work with Boston Pacific to improve substandard performance or any items of non-compliance revealed in the course of its inspection, and may terminate the franchise agreement if the Company does not comply with such standards.\nThe Company has prepared the information herein concerning BCI from its own analyses and publicly available historical information regarding BCI. BCI has no responsibility for the Company's statements, estimates, projections, or disclosures concerning the Company's proposed Boston Chicken operations or the results or timing thereof.\nSOURCES OF RAW MATERIALS\nThe Company's ability to maintain consistent quality throughout the Carl's Jr. chain depends in part upon its ability to acquire and distribute food products, restaurant equipment, signs, fixtures and supplies from reliable sources in accordance with Company specifications. The Company, its franchisees and its licensees have not experienced any material shortages of these items which the Company purchases from numerous independent suppliers. Alternate sources of these items are generally available.\nTRADEMARKS AND PATENTS\nThe Company has registered trademarks and service marks which are of material importance to the Company's business, including the \"Carl's Jr.\" name, the \"Star\" logo and proprietary names for a number of the Carl's Jr. menu items. \"Boston Chicken\" and the Boston Chicken logo are registered trademarks of BCI which may be utilized by the Company in accordance with applicable provisions of the Development Agreement and franchise agreements thereunder.\nSEASONALITY\nThe Company's Carl's Jr. business is moderately seasonal. Average restaurant sales are normally higher in the summer months than during the winter months.\nWORKING CAPITAL PRACTICES\nHistorically, current assets included marketable securities and restaurant property costs to be sold and leased back. Subsequent to January 25, 1993, as part of its strategic initiatives, the Company began liquidating a significant portion of its former investment portfolio, using the proceeds to repay its borrowings under the Company's revolving credit line. The sale\/leaseback program is no longer emphasized, and thus existing inventories of restaurant property costs to be sold and leased back have been significantly reduced.\nThe Company does not carry significant amounts of inventory, experience material returns of merchandise, or generally provide extended payment terms to its franchisees or licensees. Cash from operations, along with cash, cash equivalents and marketable securities on hand, should enable the Company to meet its financing requirements.\nCUSTOMERS\nNo material part of the Company's business is dependent upon a single customer or a few customers.\nBACKLOG\nBacklog orders are not material to the Company's business.\nGOVERNMENT CONTRACTS\nThe Company has no material contracts with the United States government or any of its agencies.\nCOMPETITION\nMajor chains, which have substantially greater financial resources than the Company, dominate the quick-service restaurant industry. Certain of these major chains have increasingly offered selected food items and combination meals, temporarily or permanently at discounted prices. A change in the pricing or other marketing strategies of one or more of these competitors could have an adverse impact on the Company's Carl's Jr. sales and earnings in affected markets.\nThe Company believes that its particular emphasis on higher quality foods that appeal to a broad consumer base, allows the Company to compete effectively with significantly larger quick-service restaurant chains. Careful attention to dining accommodations, including periodic upgrading of existing facilities, also plays an important role.\nRESEARCH AND DEVELOPMENT\nThe Company maintains a test kitchen for its Carl's Jr. operations at its headquarters in which new products and production concepts are developed on an ongoing basis. While these efforts are critical to the Company, amounts expended for these activities are not considered material. There are no customer sponsored research and development activities.\nENVIRONMENTAL MATTERS\nCompliance with federal, state and local environmental provisions regulating the discharge of materials into the environment or otherwise relating to the protection of the environment did not have a material effect on capital expenditures, earnings or the competitive position of the Company in fiscal 1994. The Company cannot predict the effect on its operations from possible future legislation or regulation.\nNUMBER OF EMPLOYEES\nThe Company employs approximately 10,400 persons in its Carl's Jr. operations, of whom approximately 9,800 are hourly restaurant, distribution or clerical employees, and approximately 600 are managerial, salaried employees engaged in administrative and supervisory capacities. A majority of the hourly employees are employed on a part-time basis to provide service necessary during peak periods of restaurant operations.\nNone of the Company's employees are currently covered by a collective bargaining agreement. The Company has never experienced a work stoppage attributable to labor disputes and believes its employee relations to be good.\nThe Company is subject to the Fair Labor Standards Act, which governs such matters as minimum wage requirements, overtime and other working conditions. A large portion of the Company's food service personnel are paid at a minimum wage level and, accordingly, increases in the federal or state minimum wage affect the Company's labor costs. The California minimum wage is currently $4.25 and is equal to the established federal minimum wage.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES.\nMost Carl's Jr. restaurants are freestanding, ranging in size from 2,500 to 4,000 square feet, with a seating capacity of 65 to 115 persons. Some restaurants are located in shopping malls and other in-line facilities. Currently, several building plan types are in use system-wide, depending upon operational needs. Most restaurants are constructed with drive-thru facilities.\nA majority of Company-operated restaurants are leased from others. The following table sets forth the type of real estate interest that the Company had in its Carl's Jr. restaurants in operation at January 31, 1994:\nThe Company subleases certain sites to its franchisees and owns an additional 33 restaurant properties which are leased primarily to franchisees.\nThe terms of the Company's leases or subleases generally range between three and 35 years and primarily expire through fiscal 2026. The expiration of these leases is not expected to have a material impact on the Company's operations in any particular year as the expiration dates are staggered over a number of years and many of the leases contain renewal options.\nOnce a potential Carl's Jr. restaurant site is identified, the Company's real estate personnel either seek to negotiate with the owner to construct a restaurant to the Company's specifications and enter into a long-term lease of the premises, or the site is purchased. Spaces for restaurants in shopping malls and in-line buildings are typically leased and developed to the Company's specifications with the Company owning the leasehold improvements. The Company generally performs the construction management function while utilizing outside general contractors to construct its buildings.\nThe following table summarizes the California regions in which the Company's Carl's Jr. restaurants are located:\nThe Company's corporate headquarters and distribution center, located in Anaheim, California, are leased and occupy approximately 78,000 and 102,000 square feet, respectively. The Manteca, California distribution facility has 42,000 square feet and is owned by the Company.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS.\nThe Company is involved in various lawsuits incidental to its business. Management does not believe that the outcome of such litigation will have a material adverse effect upon the operations or financial condition 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 COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS.\nAs of April 25, 1994, shares of the Company's Common Stock were traded on the New York Stock Exchange under the symbol \"CKR.\" Prior to that date, the Company's Common Stock was regularly quoted on the NASDAQ National Market System under the symbol \"CARL.\" At January 31, 1994, there were approximately 2,600 record holders of the Company's Common Stock. The high and low closing prices, during each quarter, for the last two fiscal years were as follows:\nDuring fiscal 1994 and 1993, the Company paid four consecutive quarterly dividends of $.02 per share of Common Stock, for a total of $.08 per share per year. The Company recently changed its dividend policy to provide for semi-annual payments of dividends.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nThe information set forth below should be read in conjunction with the financial statements and related notes and \"Management's Discussion and Analysis of Financial Condition and Results of Operations\" included elsewhere in this Form 10-K.\nSELECTED FINANCIAL DATA\n(DOLLARS IN THOUSANDS EXCEPT PER SHARE DATA)\n- - ---------------\n(1) Prior year amounts have been reclassified to conform with the fiscal 1994 presentation.\n(2) Debt, as defined in this computation, includes long-term debt, capital lease obligations and their related current portions.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.\nThe following discussion should be read in conjunction with the financial statements and related notes and \"Selected Financial Data\" included elsewhere in this Form 10-K.\nOVERVIEW\nNet income for fiscal 1994, a 53-week reporting period, was $3.7 million, or $.20 per share, compared with a net loss in fiscal 1993, a 52-week reporting period, of $5.5 million, or ($.31) per share. Fiscal 1994 included a nonrecurring, pre-tax charge of $3.0 million related to an arbitration settlement for an alleged breach of contract involving an investor group which had been negotiating for the purchase of several existing Carl's Jr. restaurants. Fiscal 1993 included an $11.1 million pre-tax, nonrecurring charge related to the\nCompany's strategic initiatives, workforce reductions and certain lease subsidies (see Results of Operations -- General and Administrative Expenses) as well as a $5.1 million pre-tax charge resulting from a Company-commissioned independent actuarial valuation of the Company's self-insured workers' compensation reserve during that year. Excluding the effects of all of these charges, operating income increased $4.5 million, or 50.5%, to $13.5 million in fiscal 1994 from fiscal 1993.\nThe key components of the Company's strategic program, which was largely initiated in January 1993 and aggressively pursued throughout fiscal 1994, were as follows:\n- To develop and implement new marketing programs that rely upon extensive consumer research and are designed to improve consumers' price\/value perceptions and, in turn, improve restaurant sales trends. This effort included better coordination of consumer research with the product development and pricing process and a more contemporary, compelling advertising approach;\n- To improve the Company's restaurant-level margin and cost structure by, among other things, increasing restaurant labor productivity and decreasing repair and maintenance and other costs; and\n- To streamline and consolidate the Company's workforce, eliminate non-essential business activities and increase the organizational effectiveness of the Company.\nThe aim of two of the components of this strategic program, improving the restaurant-level cost structure and streamlining the Company's workforce and eliminating non-essential business activities, was to reduce operating costs, primarily salaries and wages, by approximately $10 million during fiscal 1994.\nAlthough the full benefits of the strategic program have yet to be realized, implementation of this program allowed the Company to achieve the $10 million cost reduction goal, returning it to profitability and significantly increasing its operating earnings in fiscal 1994. In addition, ongoing test-marketing activities and consumer research have led to the development of a new value-pricing program and simplified menu that is currently being introduced throughout the Carl's Jr. system. A new advertising agency selected in December 1993 has been assisting the Company in its repositioning of the Carl's Jr. chain.\nThe most significant evidence of the Company's progress in fiscal 1994 was the substantial reduction in the costs associated with operating its Carl's Jr. restaurants. Although the Company operated 11 fewer restaurants on a weighted-average basis in fiscal 1994 and same-store sales fell 6.5% from fiscal 1993, restaurant operating profits increased 25.8% to $65.2 million in fiscal 1994. The Company-restaurant operating profit margin increased in fiscal 1994 to 17.1% from 12.5% in fiscal 1993.\nThe following table summarizes the improvement in Company-restaurant operating profits for fiscal years 1994, 1993 and 1992:\nMajor cost savings were achieved during fiscal 1994 in several areas. The Company reduced its direct labor costs in part through new labor-scheduling guidelines and enhanced restaurant-level technology, which were implemented during the second quarter of fiscal 1994. As a percentage of restaurant sales, these costs\ndecreased to 19.9% in the fourth quarter of fiscal 1994 from 22.4% in the same prior year period. In addition, workers' compensation costs (exclusive of the $5.1 million charge related to the independent actuarial valuation commissioned in fiscal 1993) were reduced an additional $2.8 million largely through new safety programs and other awareness and incentive programs. Total repair and maintenance costs were reduced by $5.2 million, or 27.6%, through outsourcing and down-sizing. Further cost savings were achieved through the elimination of the Company's manufacturing operations and the outsourcing of products to third party suppliers.\nThe total system-wide number of Carl's Jr. restaurants in operation during each of the years in the three-year period ended January 31, 1994 were as follows:\nIn January 1994, the Company acquired the rights to develop and operate up to 300 Boston Chicken stores in Southern California and metropolitan Sacramento. Boston Pacific, Inc. (\"Boston Pacific\") was formed in February 1994 to develop, own and operate these Boston Chicken stores. A reincorporation transaction in which the Company and Boston Pacific will become wholly-owned subsidiaries of a new holding company, CKE Restaurants, Inc. (\"CKE Restaurants\"), and the shareholders of the Company will become stockholders of CKE Restaurants, will be submitted for approval at the Company's upcoming Annual Meeting of shareholders. CKE Restaurants, as a successor to the Company, will provide overall strategic direction to Enterprises, which will continue to operate and franchise Carl's Jr. restaurants, and Boston Pacific, which will operate Boston Chicken stores. The Company's first Boston Chicken store is scheduled to open in the summer of 1994.\nRESULTS OF OPERATIONS REVENUES\nThe following table presents information regarding the components of the Company's revenues:\nCOMPANY-OPERATED RESTAURANTS\nSales by Company-operated restaurants fell 7.9% in fiscal 1994 to $381.7 million and 11.1% in fiscal 1993 to $414.5 million due to lower average sales per restaurant and fewer restaurants in operation in both fiscal 1994 and 1993. On a same-store basis, these sales, which are calculated using only restaurants open for the full two years being compared, declined 6.5% in fiscal 1994 to $366.2 million, following a 5.6% decrease during fiscal 1993 to $376.0 million from $398.1 million in fiscal 1992. The Company's restaurant sales were adversely affected in both fiscal 1994 and fiscal 1993 by aggressive promotions and price reductions by the Company's principal competitors, and the continued weakness in the California economy. During 1993, the major quick-service restaurant chains intensified their promotions of value-priced meals and continued to discount prices of selected menu items.\nFRANCHISED AND LICENSED RESTAURANTS\nRevenues from franchised and licensed restaurants in both fiscal 1994 and fiscal 1993 were mainly comprised of sales of food and supplies to franchisees, initial franchise fees, annual franchise royalties and rents and other occupancy-related amounts collected from many of the Company's franchisees. Overall, these revenues increased 4.5% to $78.6 million in fiscal 1994, following a 25.4% increase to $75.3 million in fiscal 1993. These changes were largely due to 21 and 63 more franchised restaurants in operation on a weighted- average basis in fiscal 1994 and fiscal 1993, respectively.\nOTHER OUTSIDE PARTIES\nRevenues from other outside parties were eliminated in fiscal 1993 in connection with the Company's strategy to focus on its core business of operating and franchising Carl's Jr. restaurants, and to eliminate non-essential lines of business such as its manufacturing and outside sales operations.\nOPERATING COSTS AND EXPENSES\nCOMPANY-OPERATED RESTAURANTS\nCompany-operated restaurant costs decreased 12.7% to $316.5 million in fiscal 1994 due to several factors. First, the Company operated, on a weighted-average basis, 2.8% fewer restaurants in fiscal 1994. Second, Company initiatives led to a 3.1% reduction in payroll and other employee benefit expenses as a percentage of Company-operated restaurant sales and a 1.0% reduction in occupancy expenses as a percentage of these sales. These labor and payroll expense decreases were due in part to improved labor productivity related to the Company's strategic program. Also contributing to the improvement in Company-operated restaurant costs were decreases in food and packaging expenses of 9.2% and 15.4% in fiscal 1994 and fiscal 1993, respectively.\nFood and packaging costs as a percentage of Company-operated restaurant sales were 30.2%, 30.7% and 32.2% in fiscal years 1994, 1993 and 1992, respectively. The reductions in these costs from 1992 to 1993 were a result of the Company's outsourcing program initiated in fiscal 1993. The Company's decision to exit the manufacturing business was an initiative of the strategic program begun in fiscal 1993 and continued in fiscal 1994.\nAs a percentage of sales by Company-operated restaurants, payroll and other employee benefits were 31.1%, 34.2% and 31.5% in fiscal years 1994, 1993 and 1992, respectively. Reductions in the direct labor component of payroll and other employee benefits over the past three years have been due to cost and productivity efficiencies, offset by an increase in workers' compensation costs in fiscal 1993. As a result of a study of claims and reserve levels by an independent actuary during fiscal 1993, the Company increased its workers' compensation reserve by $5.1 million in the fourth quarter of fiscal 1993. Management is encouraged by a drop in the incident rate of 41.2% in its workers' compensation claims during fiscal 1994.\nOccupancy and other operating expenses as a percentage of sales were 21.6%, 22.6% and 21.7% in fiscal years 1994, 1993 and 1992, respectively. With fewer restaurants in operation and reductions in repair and\nmaintenance costs, occupancy and other costs have decreased, more than offsetting selected rent and other increases. In fiscal year 1993, however, these generally fixed costs increased as a percentage of sales due to the drop in Company-operated restaurant sales.\nFRANCHISED AND LICENSED RESTAURANTS\nFranchised and licensed restaurant costs are closely tied to franchise revenues. These costs increased 8.8% in fiscal 1994 to $73.6 million, following a 28.9% increase in fiscal 1993 to $67.6 million due primarily to the increase in the number of franchised restaurants. The margins on sales of food and supplies to franchisees declined over the past three years, particularly in fiscal 1994, as a result of the lowering of prices of food and other products supplied to franchisees. These prices were significantly reduced in fiscal 1993 following the outsourcing of the Company's manufacturing business in late fiscal 1993. Also contributing to the increases in these costs in both fiscal 1993 and fiscal 1994 were increases in occupancy costs associated with the leasing or subleasing of restaurants to franchisees.\nOTHER OUTSIDE PARTIES\nCosts associated with the revenues from other outside parties were eliminated in fiscal 1993 with the termination of this line of business in that year.\nADVERTISING EXPENSES\nAs a percentage of Company-operated restaurant sales, advertising expenses were 5.0%, 4.6% and 4.3%, in fiscal years 1994, 1993 and 1992, respectively. Advertising expenditures have become increasingly important in the current competitive environment and have therefore grown as a percentage of Company- operated restaurant sales over the past three years. As discussed in the Overview section above, a key component of the Company's strategic program is the enhancement of consumer research activities and a revamping of the Company's overall marketing strategy, aimed at more effectively promoting its high-quality menu items at competitive prices.\nGENERAL AND ADMINISTRATIVE EXPENSES\nFiscal 1994 general and administrative expenses included a $1.7 million charge representing the net present value of future retirement benefits granted to Carl N. Karcher in October 1993. Fiscal 1993 general and administrative expenses included an $11.1 million restructuring charge related primarily to the Company's strategic initiatives described in the Overview section above.\nExcluding the effects of these nonrecurring charges, general and administrative expenses amounted to $36.0 million, $36.6 million and $36.2 million in fiscal years 1994, 1993 and 1992, respectively, which represented 7.8%, 7.3% and 6.7% of total revenues in those years. These costs are not solely related to fluctuations in sales volumes as a substantial portion of these expenses are compensation and benefits for management and administrative personnel.\nThe Company's strategic program generated a net savings in general and administrative expenses of approximately $2.4 million in fiscal 1994. These savings were largely offset by selected additions to management in the areas of strategic planning, information systems and marketing.\nThere have been no material changes to the strategic measures and other restructuring activities contemplated by the fiscal 1993 restructuring charge or the costs associated with these measures. The components of this $11.1 million charge were as follows:\nCorporate Severance and Outplacement Costs -- Severance and outplacement costs related to the termination of 53 corporate employees in January 1993 amounted to $1.9 million, including an $843,000 noncash charge arising from the extension and remeasurement of stock options granted to former key management personnel. These terminated employees were identified and the termination plan was approved by the Company's Board of Directors on January 20, 1993. Substantially all of these required severance and outplacement payments were made in fiscal 1994.\nLease Subsidies -- In prior years, the Company initiated restructuring programs to dispose of or franchise its Arizona and Texas operations. As of January 31, 1994 and 1993, $11.5 million and $12.6 million was accrued for these reserves, respectively. These balances were mainly comprised of estimated losses on equipment and estimated lease subsidies. The lease subsidy component of the restructuring charges represents the net present value of the excess of future lease payments over estimated sublease income. The remaining unamortized discount to present value of these lease subsidies at January 31, 1994 was $9.5 million and will be amortized to operations over the remaining sublease terms, which range up to 22 years. The carrying value of the related equipment represents the net realizable value of these assets as of January 31, 1994 and 1993. The estimate of certain Arizona lease subsidies (to be paid over the remaining lease terms ranging from one to 17 years) was increased $4.9 million as part of the fiscal 1993 restructuring charge because the Company reduced its sublease rental income projections associated with these restaurants. These projections are based entirely upon the restaurant sales of the franchisees, which have been declining as a result of the continued softness in the Arizona economy.\nStore Closures -- A total of $2.3 million of estimated equipment losses and appropriate lease subsidies was recognized related to the closure of certain underperforming restaurants, which should be completed in fiscal 1995. The equipment cannot be used in the Company's operations any longer and provides no future utility to the Company.\nElimination of Manufacturing Operations -- The elimination of the Company's manufacturing operations, which was largely completed during fiscal 1993, included losses on the disposition of the equipment previously used in that operation and severance costs related to the termination of 232 manufacturing employees, and required a $2.0 million charge in fiscal 1993.\nARBITRATION SETTLEMENT\nAs discussed in the Overview section above, in fiscal 1994 the Company incurred a $3.0 million charge in connection with the settlement of an arbitration proceeding.\nINTEREST EXPENSE\nLower average debt levels throughout fiscal 1994 and fiscal 1993 resulted in a $3.2 million, or 23.8%, decrease in interest expense in fiscal 1994 and a $3.1 million, or 18.4% decrease in fiscal 1993. Declining interest rates in fiscal 1993 also contributed to the decrease in that year.\nOTHER INCOME, NET\nOther income, net, decreased 54.8% in fiscal 1994 to $6.1 million and 12.5% in fiscal 1993 to $13.6 million. The fiscal 1994 decrease was due largely to a decrease in investment income resulting from the redefining of the Company's cash management activities in connection with its strategic program (see Financial Condition -- Overview). The fiscal 1993 decrease was mainly due to fewer gains on sales of restaurants as compared with fiscal 1992.\nCHANGES IN ACCOUNTING PRINCIPLES\nEffective as of the beginning of fiscal 1994, the Company recognized a $768,000 cumulative effect charge, net of a $512,000 tax benefit, related to a change in the method used to discount the Company's estimated workers' compensation liability (see Note 9). Effective as of the beginning of fiscal 1993, the Company adopted Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes.\" The cumulative effect of this change in accounting principle resulted in a $2.4 million charge to operations and is described further in Note 16.\nFINANCIAL CONDITION OVERVIEW\nThe Company's current ratio was 1.0 and 1.1 as of January 31, 1994 and 1993, respectively, reflecting the cash-intensive nature of the quick-service restaurant industry.\nAs of January 31, 1994, total cash available to the Company was $26.1 million, which included $13.6 million of idle cash invested in money market funds (a cash equivalent) and short-term marketable securities. As part of its strategic program, the Company redefined its cash management function and liquidated a substantial portion of its former investment portfolio during fiscal 1994. The securities on hand as of January 31, 1994 consisted primarily of holdings in investment-grade money market funds, government debt, preferred stock and mutual funds and were invested in accordance with the Company's new investment policy. This new policy is designed to maintain a diversified, highly liquid portfolio with minimal interest rate risk which will generally not include margined securities.\nRestaurant property costs to be sold and leased back were largely reclassified to property and equipment in fiscal 1994 as management no longer intends to actively pursue this means of financing new Company-operated restaurants.\nPrior to the refocusing of the Company's investing activities, the Company maintained a long-term investment portfolio, which was comprised of preferred stocks, debt and other securities valued individually at cost and written down when a decline in market value was deemed other than temporary. Long-term investments were reclassified to current marketable securities prior to the sale of such a security, which occurred primarily in connection with redemptions and tender offers made by the issuers of the securities or when the Company's long-term price objectives had been achieved.\nAs of January 31, 1994, the other current assets caption in the accompanying balance sheets included $6.8 million of additional investment securities which were held in trust by the State of California as of that date in connection with the Company's self-insured workers' compensation program. Proceeds from the liquidation of the former investment portfolio were used to purchase these securities. The State requires the Company to secure its potential workers' compensation claims each year by providing a prescribed amount either through one or more standby letters of credit or an equivalent amount of cash or investment securities. The requirement for the upcoming period beginning May 1, 1994 was decreased to $12.1 million from $14.7 million and the Company recently obtained from its bank a standby letter of credit for this entire amount. Accordingly, the $6.8 million of investment securities on deposit with the State as of January 31, 1994 was returned to the Company in April 1994.\nThe remaining proceeds from the liquidation of the former investment portfolio were largely used to repay the Company's $18.1 million revolving credit line borrowings and $2.4 million of obligations secured by marketable securities during fiscal 1994. This reduction of current liabilities was partially offset by a $3.9 million reclassification of bank debt in recognition of certain upcoming fiscal 1995 maturity dates.\nAs of January 31, 1994, the Company was not in compliance with certain of the covenants governing its revolving credit line, the $6.4 million term loan maturing in December 1994, and both of the standby letters of credit expiring in April 1994 related to the Company's workers' compensation program. In March 1994, the Company negotiated with its bank to provide a $15.0 million credit line through June 1995 under which $12.1 million will be committed to a single standby letter of credit to satisfy the State's current requirement related to the Company's workers' compensation program. This renegotiation resulted in the elimination of one of the previously issued standby letters of credit, thereby curing any of its related covenant violations. In addition, a waiver of the requirements of the remaining covenant violations was received and more favorable covenants were negotiated in their place that will apply to future measurement periods.\nLong-term debt decreased $14.3 million in fiscal 1994 largely as a result of $11.5 million of principal payments ($1.7 million of which was from the proceeds from the liquidation of the former investment portfolio) and the $3.9 million reclassification of bank debt to current portion of long-term debt. Further prepayment of long-term debt is not anticipated as the Company's remaining debt agreements require sizable prepayment penalties.\nLIQUIDITY AND CAPITAL RESOURCES\nThe need for capital arises, principally, for the construction and remodeling of Carl's Jr. restaurants, the payment of lease obligations, the repayment of debt and, beginning in fiscal 1995, the development of Boston Chicken stores. During fiscal 1994, the Company's working capital needs and other capital requirements were financed primarily through internally generated funds.\nCash flows from operating activities have generally consisted of net income or loss, adjusted for certain noncash revenues and expenses, including depreciation, amortization, restructuring charges, other nonrecurring charges and deferred taxes, as well as changes in certain current asset and liability accounts. Net cash provided by operating activities increased $3.5 million to $27.7 million in fiscal 1994, largely as a result of improved operating results for the year. Lower operating earnings in fiscal 1993 as compared with fiscal 1992 led to a $9.0 million decrease in net cash provided by operating earnings in that year.\nDuring fiscal 1994, $9.5 million of net cash was provided by investing activities, which consisted primarily of $30.2 million of proceeds from the liquidation of the Company's former investment portfolio and $4.8 million of notes receivable collections, offset by $13.9 million of purchases of property and equipment and the reinvestment of $12.7 million of idle cash in accordance with the Company's new investment policy. During fiscal 1993, $3.8 million of net cash was provided by investing activities, which was due to the Company's sale\/leaseback program, which generated $4.7 million of net cash, collections of notes receivable totaling $3.6 million, the Company's former investment portfolio yielding $2.7 million of net cash and the sales of certain Company-operated restaurants, which generated $2.1 million of cash. Purchases of property and equipment totaling $9.3 million in fiscal 1993 partially offset these inflows.\nNet cash used in financing activities amounted to $31.7 million and $27.5 million in fiscal 1994 and fiscal 1993, respectively. The Company's net $18.1 million revolving credit line borrowings were repaid in fiscal 1994, and the repayment of long-term debt totaled $11.5 million in that year. Fiscal 1993 included $19.9 million of long-term debt repayments. Cash was also paid in both fiscal 1994 and fiscal 1993 principally for the repayment of obligations due brokers, which were paid in full in fiscal 1994, the repayment of capital lease obligations and dividends.\nNew Carl's Jr. restaurant openings have been slowed while management focuses on improving the sales and operating profits of its existing restaurants. A total of six new Carl's Jr. restaurants are planned for the coming fiscal year.\nUnder the terms of its development agreement with Boston Chicken, Inc., the Company is obligated to open an aggregate of 200 Boston Chicken Stores in designated markets by January 15, 1999. In order to comply with this development agreement, the Company will be required to develop 40 to 50 Boston Chicken stores per year over the next five years. The Company also has the option to develop 100 additional Boston Chicken stores in the markets designated in the development agreement, the appropriate time schedule for which will be determined upon exercise of this option.\nOf the first 50 Boston Chicken stores, the Company anticipates that it will convert approximately 10 to 15 Carl's Jr. restaurants to Boston Chicken stores. By converting these selected Carl's Jr. restaurants, management's strategy is designed to accelerate the development of Boston Chicken stores and achieve a sales and profit shift to surrounding Carl's Jr. locations and eliminate certain underperforming Carl's Jr. restaurants. The Company does not currently anticipate converting any additional Carl's Jr. restaurants to Boston Chicken stores after the initial 10 to 15 conversions are completed.\nThe Company estimates that the initial costs associated with the opening of each new Boston Chicken store will be approximately $800,000. This estimate includes, among other things, leasehold improvements, equipment, opening inventory and supplies, and initial working capital. This estimate does not include any land or additional costs which may be necessary, depending on the location and the nature of each individual site. The costs of converting existing Carl's Jr. restaurants to Boston Chicken stores are estimated to be approximately $600,000 per conversion.\nA shelf registration statement has been filed by CKE Restaurants (which assumes the reincorporation proposal described in the Overview section is completed) covering up to $75 million of debt, convertible debt or preferred stock. The Company is also currently negotiating with its bank to increase the amount available under its credit facility.\nThe Company believes that the cash generated from its operations, along with the $26.1 million of cash, cash equivalents and short-term marketable securities on hand as of January 31, 1994, the $6.8 million of investment securities recently returned to the Company from the State, and a combination of proceeds from possible offerings under the shelf registration statement and additional borrowings from banks or other financial institutions will provide the Company the funds necessary to meet all of its obligations, including the payment of maturing indebtedness and the development of Carl's Jr. restaurants and Boston Chicken stores.\nIMPACT OF INFLATION\nManagement recognizes that inflation has an impact on food, construction, labor and benefit costs, all of which can significantly affect Company operations. High interest rates can negatively affect lease payments for new restaurants, as well. Historically, the Company has been able to offset the effects of inflation through periodic price increases. However, given the competitive pressures within the quick-service restaurant industry and the recessionary environment, management has emphasized cost controls rather than price increases during fiscal 1994.\nNEW ACCOUNTING PRONOUNCEMENTS\nThe adoption of Statements of Financial Accounting Standards Nos. 112 and 114, \"Employers' Accounting for Postemployment Benefits\" and \"Accounting by Creditors for Impairment of a Loan,\" respectively, are not expected to have a material effect on the results of operations or financial condition of the Company.\nThe Company is required to adopt Statement of Financial Accounting Standards No. 115 (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities,\" as of February 1, 1994. SFAS 115 requires the inclusion in income or shareholders' equity of unrealized gains and losses resulting from the fair value accounting of investments in debt and equity securities except for debt securities intended to be held to maturity. The adoption of SFAS 115 is not expected to have a material effect on the Company's financial statements.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nSee the Index included at \"Item 14. Exhibits, Financial Statement Schedules, and Reports of Form 8-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.\nThe information appearing in the \"Information Concerning Nominees\" section of the Company's Proxy Statement prepared in connection with the Annual Meeting of Shareholders to be held in 1994, to be filed with the Commission within 120 days of January 31, 1994, is hereby incorporated by reference. The executive officers of the Company and Boston Pacific are listed below.\nDonald E. Doyle became a Director, President and Chief Executive Officer of the Company in December 1992. Prior to that time, he served as President and Chief Executive Officer of the Greater Louisville Economic Development Partnership. Mr. Doyle was employed by Kentucky Fried Chicken Corporation from 1973 until 1988 in several capacities, including, between 1984 and 1988, President of KFC-USA, the principal operating company for Kentucky Fried Chicken company-owned and franchised restaurants.\nRory J. Murphy has been the Senior Vice President, Operations, of the Company for the past two years. He has been employed by the Company in various positions for 15 years.\nLoren C. Pannier has been the Senior Vice President and Chief Financial Officer of the Company for the past 13 years and has been employed by the Company for 22 years.\nKerry W. Coin became Senior Vice President and General Manager of Boston Pacific in February 1994. Mr. Coin joined the Company as Vice President, Strategic Development in February 1993. Prior to joining the Company, he was a principal with A. T. Kearney Inc., a nationally recognized business consulting firm, for five years. While at A. T. Kearney, he was the project leader for two major consulting assignments at the Company.\nLaurie A. Ball became Vice President, Controller in January 1993, and has been employed by the Company in various positions for more than the past six years.\nRichard C. Celio joined the Company as Vice President, General Counsel in January 1989. Prior to joining the Company, he was an attorney at law and partner of the law firm of Holden, Fergus & Celio for seven years, a firm which provided various legal services, and acted as General Counsel for the Company.\nKaren B. Eadon joined the Company as Vice President, Marketing in April 1993. Prior to joining the Company, she was employed at Taco Bell Corporation for eight years, where she held various positions in advertising, product development and most recently as Vice President of Operations Services.\nJames D. Mizes joined Boston Pacific as Vice President, Operations in March 1994. Prior to joining Boston Pacific, he was employed at Taco Bell Corporation for six years, where he held various positions in operations, and most recently was Vice President of Operations Services.\nRoger D. Shively joined the Company as Vice President, Human Resources in August 1991. Prior to joining the Company, Mr. Shively was employed by Denny's, Inc. for more than seven years in several capacities, including Vice President, Human Resources.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION.\nThe information appearing in the \"Executive Compensation,\" \"Summary Compensation Table,\" \"Option Grants in Last Fiscal Year,\" \"Aggregate Option Exercises in Fiscal 1994 and Fiscal 1994 Year-End Option Values,\" \"Employment Agreements,\" \"Incentive Compensation Plan,\" \"Transactions with Officers and Directors,\" \"Key Employee Stock Option Plan\" and \"1993 Employee Stock Incentive Plan\" sections of the Company's Proxy Statement prepared in connection with the Annual Meeting of Shareholders to be held in 1994, to be filed with the Commission within 120 days of January 31, 1994, is hereby incorporated by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nThe information appearing in the \"Ownership of the Company's Securities\" section of the Company's Proxy Statement prepared in connection with the Annual Meeting of Shareholders to be held in 1994, to be filed with the Commission within 120 days of January 31, 1994, is hereby incorporated by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.\nThe information appearing in the \"Transactions with Officers and Directors\" section of the Company's Proxy Statement prepared in connection with the Annual Meeting of Shareholders to be held in 1994, to be filed with the Commission within 120 days of January 31, 1994, is hereby incorporated by reference.\nPART IV\nITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS 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.\nCARL KARCHER ENTERPRISES, INC.\nBy \/s\/ DONALD E. DOYLE Donald E. Doyle President and Chief Executive Officer\nDate April 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.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors and Shareholders Carl Karcher Enterprises, Inc.\nWe have audited the accompanying financial statements of Carl Karcher Enterprises, Inc. as listed in the accompanying index. In connection with our audits of the financial statements, we also have audited the financial statement schedules as listed in the accompanying index. 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 Carl Karcher Enterprises, Inc. as of January 31, 1994 and 1993, and the results of its operations and its cash flows for each of the years in the three-year period ended January 31, 1994 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 Note 9 to the financial statements, the Company changed the method used to discount its workers' compensation reserve in fiscal 1994.\nAs discussed in Notes 1 and 16 to the financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes,\" in fiscal 1993.\nKPMG Peat Marwick\nOrange County, California March 21, 1994\nCARL KARCHER ENTERPRISES, INC.\nBALANCE SHEETS\nASSETS\nSee accompanying notes to financial statements.\nCARL KARCHER ENTERPRISES, INC.\nSTATEMENTS OF OPERATIONS\nSee accompanying notes to financial statements.\nCARL KARCHER ENTERPRISES, INC.\nSTATEMENTS OF SHAREHOLDERS' EQUITY\nSee accompanying notes to financial statements.\nCARL KARCHER ENTERPRISES, INC.\nSTATEMENTS OF CASH FLOWS\nSee accompanying notes to financial statements.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS\nNOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES\nA summary of certain significant accounting policies not disclosed elsewhere in the footnotes to the financial statements is set forth below.\nFiscal Year -- The Company utilizes a 52-or 53-week accounting period which ends on the last Monday in January each year. The year ended January 31, 1994 was a 53-week year. The years ended January 25, 1993 and January 27, 1992 were 52-week years. For clarity of presentation, the Company has described all periods presented as if the fiscal year ended January 31.\nCash Equivalents -- The Company considers short-term investments which have an original maturity of three months or less to be cash equivalents for purposes of reporting cash flows.\nInventories -- Inventories are stated at the lower of cost (first-in, first-out) or market.\nDeferred Pre-opening Costs -- Deferred pre-opening costs consist of the direct and incremental costs associated with the opening of restaurants and are deferred and amortized over the first year a given restaurant is in operation. Such costs include uniforms and promotional costs related to the grand opening of a restaurant. Additionally, these costs include initial food, beverage, supply and direct labor costs associated with the testing of all equipment and recipes, and the simulation of other operational procedures shortly before a restaurant opens.\nDeferred pre-opening costs also include, if significant, the cost of required training classes for new managers, assistant managers and regional managers; airfare and lodging related to this training; and the salaries of these individuals during their training classes and prior to the opening of their respective Carl's Jr. restaurants or Boston Chicken stores. Such costs, including training, were not significant in the years presented. Since there is not an existing employee base from which to hire Boston Pacific store management and the training related to the opening of Boston Pacific stores is conducted outside of California, these costs are expected to be significant in future years.\nInvestment in Joint Venture -- In fiscal 1994, the Company entered into a joint venture agreement with a Mexican company to operate a Carl's Jr. restaurant in Baja California. The Company owns a 50% interest in this joint venture, which is accounted for by the equity method and is not considered material to the Company's financial statements.\nIncome Taxes -- The Company adopted Statement of Financial Accounting Standards No. 109 (\"SFAS 109\"), \"Accounting for Income Taxes,\" effective as of the beginning of fiscal 1993. Under this method, income tax assets and liabilities are recognized using enacted tax rates for the expected future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A change in tax rates is recognized in income in the period that includes the enactment date.\nPrior to fiscal 1993, 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 deferral method.\nEarnings (Loss) per Share -- Earnings (loss) per share is computed based on the weighted average number of common shares outstanding during the year, after consideration of the dilutive effect of outstanding stock options. The outstanding stock options were not included in the per share computations for fiscal 1993 as the effect would have been antidilutive. For all years presented, primary earnings per share approximate fully diluted earnings per share.\nReclassifications -- Certain prior year amounts in the accompanying financial statements have been reclassified to conform to the fiscal 1994 presentation.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 2 -- BOSTON PACIFIC, INC.\nIn January 1994, the Company acquired rights to develop, own and operate up to 300 Boston Chicken stores from Boston Chicken, Inc. In consideration for these rights, the Company paid an initial development fee of $1,000,000 and also paid a non-refundable deposit of $1,000,000, which will be applied as a credit ($5,000 per store) towards the Company's obligation to pay $35,000 as an initial franchise fee upon the opening of each Boston Chicken store by the Company. The development fee will be amortized over the five-year life of the development agreement and the franchise fees will be amortized over each individual 15-year franchise agreement. Both amounts were included in other assets as of January 31, 1994.\nUnder the development agreement, the Company is obligated to open a number of Boston Chicken stores according to a specific schedule, commencing on January 15, 1995 and ending on January 15, 1999. The stores will be located in metropolitan Sacramento, the County of San Diego, and nine counties in the greater Los Angeles area.\nNOTE 3 -- MARKETABLE SECURITIES\nDuring fiscal 1994, as part of its strategic program, the Company began liquidating a significant portion of its marketable securities. As such, as of January 31, 1993, all long-term investments were classified as current marketable securities.\nMarketable securities are stated at the lower of aggregate cost or market value. Market values are based on quoted market prices where available. For marketable securities not actively traded, market values are estimated using values obtained from independent sources. At both January 31, 1994 and 1993, marketable securities were carried at aggregate cost. The aggregate market values as of January 31, 1994 and 1993 were $9,483,000 and $34,364,000, respectively. Gross unrealized gains and unrealized (losses) as of January 31, 1994 were $480,000 and $(61,000), respectively.\nMarketable securities consist primarily of holdings in investment-grade government debt securities, preferred stock and mutual funds which largely invest in securities issued or guaranteed by the U. S. government. These securities consisted of the following:\nDividend income is recorded on the ex-dividend date and interest income is recorded as earned. Securities transactions are accounted for on the trade date, or the date the order to buy or sell is executed. Realized gains and losses from securities transactions are determined on a specific identification basis.\nThe Company is required to adopt Statement of Financial Accounting Standards No. 115, (\"SFAS 115\"), \"Accounting for Certain Investments in Debt and Equity Securities,\" as of February 1, 1994. SFAS 115 requires the inclusion in income or shareholders' equity of unrealized gains and losses resulting from the fair value accounting of investments in debt and equity securities except for debt securities intended to be held to maturity. The adoption of SFAS 115 is not expected to have a material effect on the Company's financial statements.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 4 -- ACCOUNTS RECEIVABLE AND OTHER CURRENT ASSETS\nDetails of accounts receivable and other current assets were as follows:\nNOTE 5 -- PROPERTY AND EQUIPMENT\nProperty and equipment is stated at cost less accumulated depreciation and amortization, and was comprised of the following:\nLeasehold improvements are amortized on a straight-line basis over the shorter of the useful life of the improvement or the term of the lease. Buildings and improvements and equipment, furniture and fixtures are depreciated on a straight-line basis over the estimated useful lives of these assets.\nNOTE 6 -- LEASES\nThe Company occupies land and buildings under terms of numerous lease agreements expiring on various dates primarily through 2026. Many of these leases provide for future rent escalations and renewal options. In addition, contingent rentals, determined as a percentage of sales in excess of specified levels, is often stipulated. Most of these leases obligate the Company to pay the costs of maintenance, insurance and property taxes.\nProperty under capital leases was comprised of the following:\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nAmortization is calculated on the straight-line method over the shorter of the lease term or estimated useful life of the asset.\nMinimum lease payments for all leases and the present value of net minimum lease payments for capital leases as of January 31, 1994 were as follows:\nTotal minimum lease payments have not been reduced by minimum sublease rentals of $46,370,000 due in the future under certain operating subleases.\nThe Company has leased and subleased land and buildings to others, primarily as a result of the franchising of certain restaurants. Many of these leases provide for fixed payments with contingent rent when sales exceed certain levels, while others provide for monthly rentals based on a percentage of sales. Lessees generally bear the cost of maintenance, insurance and property taxes. Components of the net investment in leases receivable, included in other assets, were as follows:\nMinimum future rentals to be received as of January 31, 1994 were as follows:\nTotal minimum future rentals do not include contingent rentals which may be received under certain leases.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe Company's investment in land under operating leases at January 31, 1994 and 1993 was $1,804,000 and $2,031,000, respectively.\nAggregate rents under noncancelable operating leases were as follows:\nNOTE 7 -- OTHER CURRENT LIABILITIES\nOther current liabilities were comprised of the following:\nIn March 1994, the Company was found liable in a $3,000,000 binding arbitration judgment for alleged breach of contract involving an investor group which had been negotiating for the purchase of several existing Carl's Jr. restaurants. The settlement, payable during fiscal 1995, was accrued in other current liabilities as of January 31, 1994.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 8 -- LONG-TERM DEBT\nLong-term debt was comprised of the following:\nNotes payable mature in fiscal years ending after January 31, 1994 as follows:\nAs of January 31, 1994, the Company was not in compliance with certain of the covenants governing its revolving credit line, the $6,417,000 term loan maturing in December 1994, and both of the standby letters of credit expiring in April 1994 related to the Company's workers' compensation program. In March 1994, the Company negotiated with its bank to provide a $15,000,000 credit line through June 1995 under which $12,148,000 will be committed to a single standby letter of credit to satisfy the State's current requirement related to the Company's workers' compensation program. This renegotiation resulted in the elimination of one of the previously issued standby letters of credit, thereby curing any of its related covenant violations. In addition, a waiver of the requirements of the remaining covenant violations was received and more favorable covenants were negotiated in their place that will apply to future measurement periods. Interest on the revolving line will be calculated at the bank's prime rate, which was 6% as of January 31, 1994, or based on the bank's offshore rate, at the option of the Company.\nSecured notes payable are collateralized by certain restaurant property deeds of trust, with a carrying value at January 31, 1994 of $19,834,000.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 9 -- OTHER LONG-TERM LIABILITIES\nOther long-term liabilities were as follows:\nA total of $16,110,000 and $15,114,000 was accrued as of January 31, 1994 and 1993, respectively, representing the current and long-term portion of the net present value of an independent actuarial valuation of the Company's workers' compensation claims in both years. These amounts are net of a discount of $1,771,000 and $3,585,000 in fiscal years 1994 and 1993, respectively. The independent actuarial valuation in the fourth quarter of fiscal 1993 resulted in a $5,114,000 increase to the workers' compensation reserve in that year.\nIn the fourth quarter of fiscal 1994, the method used by the Company to discount the actuarial projection of losses to be paid in connection with its existing workers' compensation claims was changed from its incremental borrowing rate to the Company's risk-free interest rate of 5%. The Company accounted for this change as a change in accounting principle, effective as of the beginning of fiscal 1994. The first quarter of fiscal 1994 has been restated, to reflect the cumulative effect of this adoption, which resulted in a decrease in net income of $786,000, which was net of an income tax benefit of $512,000.\nIn prior years, the Company initiated restructuring programs to dispose of or franchise its Arizona and Texas operations. As of January 31, 1994 and 1993, $11,542,000 and $12,630,000, respectively, was accrued for these reserves, including the current portion. These balances were mainly comprised of estimated losses on equipment and estimated lease subsidies. The lease subsidy component of the restructuring charges represents the net present value of the excess of future lease payments over estimated sublease income. The remaining unamortized discount to present value of these lease subsidies at January 31, 1994 was $9,537,000 and will be amortized to operations over the remaining sublease terms, which range up to 22 years. The carrying value of the related equipment represents the net realizable value of these assets at January 31, 1994 and 1993.\nIn fiscal 1993, the Company recognized an $11,124,000 charge related to its strategic initiatives, workforce reductions and certain lease subsidies. Components of this charge were as follows:\n- Severance and outplacement costs related to the termination of 53 corporate employees in January 1993 amounted to $1,918,000, including an $843,000 noncash charge arising from the extension and remeasurement of stock options to former key management personnel. These terminated employees were identified and the termination plan was approved by the Company's Board of Directors on January 20, 1993. Substantially all of these required severance and outplacements payments were made in fiscal 1994;\n- The estimate of certain Arizona lease subsidies (part of the restructuring program described above and paid over the remaining lease terms ranging from one to 17 years) was increased $4,855,000 because the Company reduced its sublease rental income projections associated with these restaurants. These projections are based entirely upon the restaurant sales of the franchisees, which have been declining as a result of the continued softness in the Arizona economy;\n- A total of $2,299,000 of estimated equipment losses and appropriate lease subsidies was recognized related to the closure of certain underperforming restaurants, which should be completed in fiscal 1995.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nThe equipment cannot be used in the Company's operations any longer and provides no future utility to the Company. A total of $967,000 remained accrued as of January 31, 1994 related to these losses; and\n- The elimination of the Company's manufacturing operations, which was largely completed during fiscal 1993, included losses on the disposition of equipment previously used in that operation and severance costs related to the termination of 232 manufacturing employees, and required a $2,052,000 charge in that year.\nNOTE 10 -- COMMON STOCK\nIn connection with his employment, the Company's President and Chief Executive Officer was awarded 12,121 shares of the Company's common stock valued at $100,000, at a market price of $8.25 per share, on January 6, 1993. These shares vest at a rate of 33 1\/3% per year on each of the three anniversaries following the grant date, therefore $33,000 was included in compensation expense during the fiscal year ended January 31, 1994.\nDuring the second quarter of fiscal 1994, the Company purchased a total of 59,750 shares from the Carl N. and Margaret M. Karcher Trust for an aggregate purchase price of $422,000. All shares purchased were canceled and retired.\nNOTE 11 -- FAIR VALUE OF FINANCIAL INSTRUMENTS\nThe estimated fair values 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, cash equivalents and financial instruments included in other current assets and other current liabilities approximated their fair values due to the short-term maturities of these instruments. The carrying amounts and fair values of the Company's other financial instruments were as follows:\nThe valuation methods and assumptions are summarized as follows:\nMarketable securities: The fair values of marketable securities were estimated using quoted market prices.\nNotes receivable: The fair values of notes receivable were estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings.\nLong-term debt: The fair value of long-term debt was estimated using rates currently available to the Company for debt with similar terms and remaining maturities.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 12 -- RELATED PARTY TRANSACTIONS\nCertain members of the Karcher family are franchisees of the Company. A total of 26 restaurants have been sold to these individuals, none of which occurred during fiscal 1994 or fiscal 1993. As part of these transactions, the Company received cash and accepted $6,480,000 of interest-bearing notes. Additionally, these franchisees regularly purchase food and other products from the Company on the same terms and conditions as other franchisees. Details of amounts outstanding were as follows:\nIn fiscal 1991, as part of its Arizona restructuring program, the Company leased six of its Arizona restaurants to a Karcher family member and former officer. The terms of the lease include an option to buy one of these restaurants and require the purchase of the remaining five restaurants, and are subject to ongoing negotiations. A total of $1,143,000 was included in the Arizona restructuring reserve (see Note 9) and remained accrued as of January 31, 1994 in anticipation of future losses to be realized as a result of this transaction.\nThe Company leases various properties, including its corporate headquarters, distribution facility and three of its restaurants, from Carl N. Karcher. Included in capital lease obligations was $5,286,000 and $5,904,000, representing the present value of lease obligations related to these various properties at January 31, 1994 and 1993, respectively. Lease payments under these leases for fiscal 1994, 1993 and 1992 amounted to $1,515,000, $1,612,000, and $1,548,000, respectively. This was net of sublease rentals of $171,000, $64,000 and $63,000 in fiscal 1994, 1993 and 1992, respectively. In November 1993, the Company purchased two restaurants from Carl N. Karcher for an aggregate purchase price of $848,000. A third restaurant site is in escrow, for which the Company has paid a $250,000 deposit.\nIn October 1993, Carl N. Karcher was granted future retirement benefits for past services consisting principally of payments of $200,000 per year for life and supplemental health benefits, which had a net present value of $1,668,000 as of that date. This amount was computed using certain actuarial assumptions, including a discount rate of 7%. A total of $1,652,000 remained accrued in other current liabilities at January 31, 1994. The Company anticipates funding these obligations as they become due.\nAs of January 31, 1993, the Company was a signatory with Carl N. Karcher on a promissory note agreement with an insurance company. The note was payable monthly through March 1993, at an interest rate of 9.25%, and was primarily secured by leased property under capital leases with a net book value of $2,295,000 at January 31, 1993. The agreement contained restrictions on working capital, incurrence of additional debt and leases, and payment of dividends. Carl N. Karcher paid the note on March 2, 1993, releasing the Company from any future obligation or signatory responsibilities.\nNOTE 13 -- FRANCHISED AND LICENSED OPERATIONS\nFranchise arrangements, with franchisees who operate in Arizona, California, Nevada, Oregon and Utah, generally provide for initial fees and continuing royalty payments to the Company based upon a percent of\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nsales. The Company generally charges an initial franchisee fee for each new franchised restaurant that is added to its system, and in some cases, an area development fee, which grants exclusive rights to develop a specified number of Carl's Jr. restaurants in a designated geographic area. Similar fees are charged in connection with the Company's international licensing operations. These fees are recognized ratably when substantially all the services required of the Company are complete and the restaurants covered by these agreements commence operations.\nFranchisees may also purchase food, paper and other supplies from the Company. Additionally, franchisees may be obligated to remit lease payments for the use of restaurant facilities owned or leased by the Company, generally for a period of 20 years. Under the terms of these leases they are required to pay related occupancy costs which include maintenance, insurance and property taxes.\nThe Company receives notes from franchisees in connection with the sales of Company-operated restaurants. Generally, these notes bear interest at 12.5%, mature in five to 15 years and are secured by an interest in the restaurant equipment sold.\nRevenues from franchised and licensed restaurants were comprised of the following:\nOperating costs and expenses for franchised and licensed restaurants were comprised of the following:\nNOTE 14 -- INTEREST EXPENSE\nInterest expense was comprised of the following:\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 15 -- OTHER INCOME, NET\nOther income, net was comprised of the following:\nNOTE 16 -- INCOME TAXES\nIn the fourth quarter of fiscal 1993, the Company adopted SFAS 109. The cumulative effect of this change in accounting principle of $2,450,000 included a $500,000 valuation allowance. Had the Company implemented SFAS 109 in the first quarter of fiscal 1993, net income and earnings per share would have been reduced by $2,450,000 and $.14, respectively. The pro forma effects on net income (loss) by adopting SFAS 109, assuming the adoption was applied retroactively to 1990, would have been to reduce the net loss in fiscal 1993 by $2,450,000, or $.14 per share, and would have been immaterial in fiscal 1992 and fiscal 1991.\nIncome tax expense (benefit) was comprised of the following:\nSignificant components of the deferred income tax benefit were as follows:\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nFor the year ended January 31, 1992, deferred income taxes resulted from differences in the timing of recognition of revenue and expenses for financial reporting and tax purposes. The sources and tax effects of those timing differences are presented below:\nA reconciliation of income tax expense (benefit) at the federal statutory rate of 34% to the Company's provision for taxes on income is as follows:\nTemporary differences and carryforwards gave rise to a significant amount of deferred tax assets and liabilities as follows:\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nBased on the Company's current and historical pre-tax earnings, management believes it is more likely than not that the Company will realize the majority of the benefit of the existing net deferred tax asset as of January 31, 1994. Taxable income generated in prior years is available to offset a portion of the net deferred asset. Recognition of the remaining balance will require generation of future taxable income over the next several years, none of which is concentrated in any given year. There can be no assurance that the Company will generate any earnings or any specific level of earnings in future years. Certain tax planning or other strategies could be implemented, if necessary, to supplement income from operations to fully realize recorded net tax benefits.\nThe Company had targeted jobs tax credit carryforwards of $2,137,000 available at January 31, 1994 which expire in 2007, 2008 and 2009.\nNOTE 17 -- RETIREMENT PLANS\nThe Company maintains a voluntary contributory profit sharing plan and a savings plan for all eligible employees other than operations hourly employees. The annual profit sharing contribution is determined at the discretion of the Company's Board of Directors and up to 4% of employee savings are matched by the Company. Total Company contributions to this plan for fiscal 1994, 1993 and 1992 were $813,000, $429,000 and $1,263,000, respectively.\nThe Company also maintains a defined benefit pension plan covering substantially all operations employees qualified as to age and service. For fiscal years 1994, 1993 and 1992, pension contributions were $442,000, $348,000 and $228,000, respectively. Under the terms of the defined benefit plan, pension expense is computed based upon an independent actuarial valuation study. Company contributions under this plan are funded quarterly. As of the start of fiscal 1994, the accumulated benefit obligation related to the plan was $1,323,000.\nNOTE 18 -- STOCK OPTION PLANS\nThe Company's 1993 stock incentive plan was approved by the shareholders in June 1993. Awards granted to employees under this plan are not restricted as to any specified form or structure, with such form, vesting and pricing provisions determined by the Compensation and Stock Option Committee of the Board of Directors. The 1993 plan also provides for the automatic award of stock options to non-employee Directors annually. These options generally have a term of five years, become exercisable at a rate of 33 1\/3% per year following the grant date and are priced at an amount equal to or greater than the fair market value at the date of grant. A total of 1,750,000 shares are available for grants of options or other awards under this plan, of which 575,751 stock options were outstanding as of January 31, 1994. The exercise price of options outstanding under this plan ranges from $7.13 per share to $8.13 per share.\nThe Company's 1982 stock option plan expired in September 1992. Under this plan, stock options were granted to key employees to purchase up to 3,000,000 shares of its common stock at a price equal to or greater than the fair market value at the date of grant. The options generally had a term of 10 years from the grant date and become exercisable at a rate of 25%, 35% and 40% per year following the grant date. The exercise price of the 796,883 options outstanding as of January 31, 1994 under this plan ranges from $5.21 per share to $13.38 per share.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nTransactions under both plans were as follows:\nNOTE 19 -- SUPPLEMENTAL CASH FLOW INFORMATION\nCash paid for interest and income taxes was as follows:\nNoncash investing and financing activities for each of the years in the three-year period ended January 31, 1994 were as follows:\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nNOTE 20 -- SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)\nThe following table presents summarized quarterly results.\nQuarterly operating results are not necessarily representative of operations for a full year for various reasons, including the seasonal nature of the quick-service restaurant industry, unpredictable adverse weather conditions which may affect sales volume and food costs, and the fact that all quarters have 12-week accounting periods, except the first quarters of fiscal years 1994 and 1993, which had 16-week accounting periods, and the fourth quarter of fiscal 1994 which had 13 weeks.\nThe first quarter of fiscal 1994 has been restated to reflect the cumulative effect of a change in accounting principle, related to a change in the method used to discount the workers' compensation reserve. The second and third quarters have been restated to reflect the impact of this adoption. See Note 9.\nOperating results for the fourth quarter of fiscal 1994 included a $3,000,000 charge in connection with the settlement of an arbitration proceeding (or $1,800,000 net of tax). See Note 7.\nThe first quarter of fiscal 1993 was restated to reflect the adoption of SFAS 109. The impact of the adoption was not material in subsequent quarters. See Note 16.\nCARL KARCHER ENTERPRISES, INC.\nNOTES TO FINANCIAL STATEMENTS (CONTINUED)\nOperating results for the fourth quarter of fiscal 1993 included a $9,192,000 charge for the Company's restructuring program and a $5,114,000 charge related to the Company's self-insured workers' compensation reserve (or $5,515,000 and $3,068,000, net of tax, respectively). See Note 9.\nNOTE 21 -- CONTINGENT LIABILITIES\nThe Company presently self-insures for group insurance, workers' compensation and fire and comprehensive protection on most equipment and certain other assets. In the opinion of management, past experience plus the wide dispersion of restaurants indicates that the Company is assuming a minimal risk by self-insuring and, if any loss should occur, it would not have a material effect on the Company's financial position or results of operations.\nSubsequent to January 31, 1994, the Company obtained a $12,148,000 standby letter of credit related to its self-insured workers' compensation program, which will expire on June 30, 1995 (see Note 8). The State of California requires that the Company provide this letter of credit each year based on its existing claims experience, or set aside a comparable amount of cash or investment securities in a trust account.\nThe Company's standby letter of credit agreements with various banks expire as follows:\nCARL KARCHER ENTERPRISES, INC.\nSCHEDULE I -- MARKETABLE SECURITIES\n- - ------------------\nNo individual issue exceeds 2% of assets.\nS-1\nCARL KARCHER ENTERPRISES, INC.\nSCHEDULE II -- AMOUNTS RECEIVABLE FROM RELATED PARTIES\n- - ------------------\n(1) Includes accounts receivable, which consists primarily of amounts due from related party franchisees for sales of food and equipment.\n(2) Related party notes receivable arise primarily from the sales of restaurants to related party franchisees. The terms of these notes range from 60 to 180 months and are due on various dates through 2002. Interest on these notes range from 12.0% to 12.5%. These notes are typically collateralized by the property and equipment sold.\nS-2\nCARL KARCHER ENTERPRISES, INC.\nSCHEDULE V -- PROPERTY AND EQUIPMENT\nS-3\nCARL KARCHER ENTERPRISES, INC.\nSCHEDULE VI -- ACCUMULATED DEPRECIATION AND AMORTIZATION OF PROPERTY AND EQUIPMENT\nS-4\nCARL KARCHER ENTERPRISES, INC.\nSCHEDULE IX -- SHORT-TERM BORROWINGS\n- - ---------------\n(1) Amount represents obligations secured by marketable securities and, prior to fiscal 1993, long-term investments.\n(2) The average amount outstanding during the period was computed by averaging the month-end balances outstanding during the year.\n(3) The weighted average interest rate during the period was computed by averaging the month-end rates in effect during the period the debt was outstanding.\nS-5\nCARL KARCHER ENTERPRISES, INC.\nSCHEDULE X -- SUPPLEMENTARY INCOME STATEMENT INFORMATION\nS-6\n- - -------------------------------------------------------------------------------- - - --------------------------------------------------------------------------------\nCARL KARCHER ENTERPRISES, INC.\nEXHIBIT INDEX\nFOR THE YEAR ENDED JANUARY 31, 1994\nFORM 10-K\nEXHIBITS\n3-2, 10-77 THROUGH 10-89, 10-91, 10-92, 11-1, 12-1, 23-1\n- - -------------------------------------------------------------------------------- - - --------------------------------------------------------------------------------\nEXHIBITS\nE-1\nE-2\nE-3\nE-4\nE-5\nE-6\nE-7\n- - ---------------\n(1) Filed herewith.\n(2) A 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(3) Incorporated by reference to Exhibit 99 to Boston Chicken, Inc.'s Registration Statement on Form S-1, file No. 33-69256, filed by Boston Chicken, Inc. on September 22, 1993.\nE-8","section_15":""}
{"filename":"822043_1994.txt","cik":"822043","year":"1994","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, 1994, the Company had average paid daily circulation of 825,784, Sunday circulation of 977,206 and nondaily circulation of 30,560.\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 1994 and 1993. Circulation revenues approximated 18% of consolidated revenues in 1994 and 19% in 1993.\nThree newsprint price increases were implemented by newsprint producers in May, August and December of 1994 as increasing advertising lineage created a greater demand for newsprint. The 1994 increases and recently announced price increases in 1995 (if actually implemented) will affect the Company's 1995 operating income. Advertising and circulation volume and rate increases, coupled with company-wide cost control programs focused on newsprint usage and all other categories of expenses have, in the past, mitigated the impact of newsprint price increases. The Company intends to continue to pursue all of these measures, however, they may not have the same effect on future results. See Part II, Item 7 for discussion of the impact of the price increases on 1994 results.\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, Washington 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. (TNN). TNN is a marketing services company that specializes in securing incremental advertising for newspapers. 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, respectively. 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 277,600 daily and 348,500 Sunday in 1994 compared to 271,700 daily and 341,000 Sunday in 1993.\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, 1994, approximately 87% of the daily and 80% of the Sunday circulation was home delivered.\nThe Sacramento Bee's advertising linage for the years ended December 31, 1994 and 1993 is set forth in the following table.\nNet revenues of The Sacramento Bee were $175,677,000 in 1994 and $165,322,000 in 1993.\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 152,300 daily and 191,000 Sunday compared to 149,900 daily and 186,800 Sunday in 1993.\nAs of December 31, 1994, approximately 89% of The Fresno Bee's daily and 87% of the Sunday circulation was home delivered. The suggested home delivery price is $10.95 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, 1994 and 1993 is set forth in the following table.\nNet revenues of The Fresno Bee were $80,982,000 in 1994 and $79,072,000 in 1993.\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 83,400 daily and 91,800 Sunday in 1994 compared to 83,000 daily and 91,900 Sunday in 1993.\nThe suggested home delivery price is $10.99 per month. The newsstand price is $0.50 for the daily paper and $1.25 for the Sunday paper. As of December 31, 1994, approximately 89% of the daily and 87% of the Sunday circulation was home delivered.\nThe Modesto Bee's advertising linage for the years ended December 31, 1994 and 1993 is set forth in the following table.\nNet revenues of The Modesto Bee were $43,788,000 in 1994 and $42,925,000 in 1993.\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 129,800 daily and 150,000 Sunday in 1994 compared to 128,600 daily and 147,800 Sunday in 1993.\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. The suggested home delivery price of The News Tribune is $10.50 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, 1994 approximately 86% of the daily and 84% of the Sunday circulation was home delivered.\nThe Tacoma News Tribune's advertising linage for the years ended December 31, 1994 and 1993 is set forth in the following table.\nNet revenues of the News Tribune were $67,807,000 in 1994 and $64,324,000 in 1993.\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. Based on the Company's records, the Daily News' average paid circulation was approximately 73,400 daily and 95,600 Sunday in 1994 compared to 73,400 daily and 97,100 Sunday in 1993.\nThe suggested home delivery price of the Anchorage Daily News is $11.50 per month for city delivery. The newsstand price of the Anchorage Daily News is $0.50 for the daily paper and $1.50 for the Sunday paper. As of December 31, 1994 approximately 72% of the daily and 62% of the Sunday circulation was home delivered.\nComparative amounts of linage for the years ended December 31, 1994 and 1993 are set forth in the following table.\nNet revenues of the Anchorage Daily News were $44,514,000 in 1994 and $41,923,000 in 1993.\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 has benefitted by the Department of Energy's efforts to clean up nuclear waste at nearby Hanford Nuclear reservation. Since 1990, 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 39,700 daily and 43,000 Sunday in 1994 compared to 38,600 daily and 41,900 Sunday in 1993.\nThe suggested home delivery price of the Tri-City Herald is $10.00 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, 1994, 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, 1994 and 1993 is set forth in the following table.\nNet revenues of the Tri-City Herald were $17,668,000 in 1994 and $15,626,000 in 1993.\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 30,800 daily and 31,300 Sunday in 1994 compared to 31,000 daily and 30,700 Sunday in 1993.\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 the Audit Bureau of Circulation was 10,872 daily and 13,757 Sunday as of March 31, 1994 compared to 10,752 daily and 13,894 Sunday as of March 31, 1993. The newsstand prices for the Herald are $0.35 daily and $0.75 Sunday and the suggested home delivery price is $8.00 per month. As of December 31, 1994, approximately 80% of the daily and 79% of the Sunday circulation was home delivered.\nAccording to the Herald's records, advertising linage for the years ended December 31, 1994 and 1993 were as follows:\nNet revenues of the Herald were $10,062,000 in 1994 and $9,514,000 in 1993.\nOTHER NEWSPAPERS\nDuring 1994 the Company published five small daily and eight nondaily community newspapers.\nThe five daily newspapers include two in South Carolina, the Island Packet on Hilton Head Island and the Beaufort Gazette in Beaufort; two in California, The Dispatch in Gilroy and the Free Lance in Hollister; and the Ellensburg Daily Record, located in Central Washington. Combined average daily circulation for these newspapers according to Company records was 38,800 in 1994 and 1993. Average Sunday circulation at the two South Carolina newspapers was 26,100 in 1994 compared to 24,900 in 1993.\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 paid circulation for this group according to Company records was 30,600 at December 31, 1994.\nRAW MATERIALS\nIn 1994 the Company consumed approximately 140,000 metric tons of newsprint compared to 137,000 metric tons in 1993. The Company currently obtains its supply of newsprint from a number of suppliers, both foreign and domestic, under long-term contracts.\nNewsprint and supplement expense accounted for approximately 17% of operating expenses in 1994 compared to 16% in 1993. Management believes its newsprint sources of supply under existing arrangements are adequate for its anticipated needs. Strengthening demand for newsprint resulting from a pick-up in advertising volumes caused three price increases in 1994 and may lead to additional price increases in 1995. 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 225,000 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. 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, 1994, the Company had 6,247 full and part-time 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 17% of the 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 with the unions are ongoing.\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, it 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, 1994, 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 1994 and 1993:\nThe Company's 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 Board of Directors and will depend upon the Company's future earnings, financial condition and requirements, and other factors considered relevant by the Board.\nThe number of record holders of Class A and Class B Common Stock at February 7, 1995 was approximately 1,326 and 23, respectively.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nFIVE-YEAR FINANCIAL SUMMARY (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)\nResults for 1994 include a $6.0 million favorable adjustment (included in the income tax provision) related to the resolution of income tax audits. Results for 1992 include a $2.6 million pre-tax charge 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 AND TRENDS\nOn May 9, 1994 the Company filed a registration statement with the Securities and Exchange Commission registering 1,581,250 shares of Class A common stock which were sold by the Company and certain stockholders in a combined primary and secondary offering to the public. Selling stockholders converted 625,000 shares of Class B common into Class A common stock and the Company converted 750,000 Class B shares held in treasury. In addition, 206,250 Class A shares were issued to cover over-allotments in the offering. As a result of the offering, the number of outstanding common shares increased by 956,250.\nIn 1994, the Company settled disputes with the Internal Revenue Service and the California Franchise Tax Board involving examinations of the Company's tax returns. The principal issues related to losses from non-newspaper operations from 1982 through 1987, and to the amortization of intangible assets acquired from 1986 through 1991. The resolution of the audits resulted in a $6,003,000 increase in net earnings (recorded as a reduction to the 1994 income tax provision).\nThree newsprint price increases were implemented by newsprint producers in May, August and December of 1994 as increasing advertising lineage created a greater demand for newsprint. The 1994 increases and recently announced price increases in 1995 (if actually implemented) will affect the Company's 1995 operating income. Advertising and circulation volume and rate increases, coupled with company-wide cost control programs focused on newsprint usage and all other categories of expenses have, in the past, mitigated the impact of newsprint price increases. The Company intends to continue to pursue all of these measures; however, they may not have the same effect on future results.\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, in the third quarter of 1993 the Company increased its tax provision by $1,088,000 or four cents per share for these retroactive adjustments.\nRESULTS OF OPERATIONS\n1994 COMPARED TO 1993\nNet income was $46.6 million or $1.58 per share. Excluding the $6.0 million favorable tax adjustment discussed above, net income was a record $40.6 million, up 27.8%. Operating income increased 10.4% to $71.9 million, primarily reflecting greater contributions from The Sacramento Bee, two Washington dailies -- The (Tacoma) News Tribune and the Tri-City Herald, and the Anchorage Daily News. Net income also benefitted from higher investment income and somewhat lower losses from the Company's joint venture in Ponderay Newsprint Company, a newsprint producer.\nNet revenues were up 5.0% to $471.4 million, mostly due to a $18.0 million gain in advertising revenues. Rate increases implemented generally in the first quarter of 1994 coupled with greater advertising volume produced a 5.1% increase in advertising revenues.\nApproximately ninety percent of the Company's advertising revenues are produced by its seven largest daily newspapers, and most of the revenues are derived from run-of-press (ROP) lineage (found in the body of the newspapers). At the seven largest dailies, full run ROP linage, distributed in all editions of the newspapers, increased 2.3%. This is the first year over year increase in full run ROP for this group since 1990 as combined classified and national linage gains offset a modest decline in retail ROP linage.\nIn other categories of advertising, part-run ROP, a smaller category of linage included in zoned editions of the newspapers, increased 7.2%. Linage in total market coverage (TMC) products (delivered to nonsubscribers) increased 2.3%, while the number of preprinted advertising inserts distributed in the newspapers grew 2.7%. Advertising in the Company's 12 other newspapers increased 5.2%.\nThe 1.5% increase in circulation revenue mirrors the increase in average paid circulation, as most of the Company's newspapers chose not to increase subscription prices for the second consecutive year. Combined average daily circulation increased 1.3% and Sunday increased 1.6%.\nThe remaining $3.0 million in revenue increases resulted from a rise in other revenues due largely to increased commercial printing at the Anchorage and Tacoma newspapers and at McClatchy Printing Company.\nNewsprint price increases in 1994 were major factors in the 4.0% increase in operating expenses. Newsprint and supplement expense were up 11.3% due to the price increases and, to a lesser degree, increased newsprint usage. Compensation expenses were held to a 1.3% increase as lower headcounts partially offset wage increases that ranged from about one to three percent. In addition, the cost of fringe benefits were held to a 1.1% increase. Other operating expenses increased 4.0% and include the costs of closing most of the Company's Senior Spectrum tabloids in March, volume related costs of higher advertising and circulation activity and the general impact of inflation. Depreciation and amortization increased 7.2%, due principally to new equipment added at The Sacramento Bee.\nNonoperating expenses declined $3.9 million as a result of a $2.8 million increase in investment income and lower losses from the Company's investment in the Ponderay newsprint mill.\nThe effective tax rate in 1994 was 41.6% (excluding the $6.0 million tax adjustment discussed above) compared to 46.0% in 1993. The higher rate last year was due partially to federal tax laws passed in August 1993 which increased the corporate tax rate to 35% retroactive to January 1993. The Company recorded tax adjustments of $1,088,000 representing additional taxes on income in the first half of 1993 and the revaluing of cumulative deferred taxes. The remaining difference relates largely to higher deductibility of amortization in 1994.\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 competing 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 modest 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 ROP linage declined 3.1% and part-run ROP linage declined 4.6%. These declines were partially offset by gains in advertising in TMC products 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.\nOperating expenses were held to a 1.5% increase over 1992 and were up 2.2% after excluding the $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 generally 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.\nLIQUIDITY AND CAPITAL RESOURCES\nThe Company generated $94.2 million of cash from operating activities in 1994 and has generated an aggregate of $260.9 million over the last three years. The Company also received $20.0 million in net proceeds from the May stock offering and received $26.3 million in proceeds from maturing debt securities. The principal uses of cash over the three year period have been to repay bank debt incurred to purchase the South Carolina-based newspapers, to invest in capital expenditures and to purchase interest bearing securities. Cash has also been used to fund its Ponderay newsprint mill investment and to pay dividends. At year end cash and cash equivalents, and short and long-term investment securities totalled $109.3 million.\nA total of $34.4 million was expended in 1994 for capital projects and equipment to improve productivity and keep pace with circulation growth, primarily at The Sacramento Bee, The (Tacoma) News Tribune and the South Carolina-based newspapers. Capital expenditures over the last three years have totalled $99.8 million and planned expenditures in 1995 are estimated to be $35.8 million.\nThe Company has a 13.5% interest in the Ponderay Newsprint Company, a general partnership that operates a newsprint mill near Spokane, Washington. The Company's share of the mill's losses over the last three years equaled $18.3 million. The Company has contributed $14.1 million to fund the mill's cash needs over this period. Ponderay's losses are expected to diminish over the next several years assuming newsprint prices continue to increase. The Company presently intends, when necessary, to contribute funds to help finance a share of the mill's cash needs. See note 3 to the consolidated financial statements.\nThe Company has an outstanding letter of credit for $4.9 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, EXCEPT SHARE AMOUNTS)\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 are engaged primarily in the publication of newspapers.\nThe consolidated financial statements include the Company and its subsidiaries. Significant intercompany items and transactions are eliminated.\nRevenue recognition -- Advertising revenues are recorded when advertisements are 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 debt investments with maturities of three months or less when acquired.\nInvestments consist of the following classified as short-term securities: $23,849,000 of commercial paper maturing through March 15, 1995 which will be held to maturity, and are valued at amortized costs; and $5,599,000 of U.S. and local government debt securities maturing through October 5, 1995, are available for sale and recorded at amortized costs because the unrecognized loss to adjust to market value is not significant by security or in total. Long-term investments consist of U.S. and local government debt securities totalling $11,303,000 maturing through November 15, 1997, which are classified as available for sale and recorded at amortized cost because the unrecognized loss to adjust to market value is not significant by security or in total. Costs for investment securities are determined by specific identification. No gains or losses were realized in 1994.\nConcentrations of credit risks -- Financial instruments which potentially subject the Company to concentrations of credit risks are principally cash and cash equivalents, short and long-term investments and trade accounts receivables. Cash and cash equivalents and investments are placed with major financial institutions and are currently invested in the highest rated commercial paper and U.S. and local 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 $2,856,000 at December 31, 1994 and $1,460,000 at December 31, 1993.\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 and $376,000 in 1992. No such interest was capitalized in 1994.\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 each of its newspaper operations.\nDeferred income taxes result from temporary differences between amounts reported for financial and income tax reporting purposes. See notes 2 and 5.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nEarnings per share are based upon the weighted average number of outstanding shares of common stock and dilutive common stock equivalents (stock options).\n2. CUMULATIVE EFFECTS OF ACCOUNTING CHANGES\nThe Company 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. The cumulative effect of this change reduced 1992 net income by $4,627,000 or $.16 per share.\nEffective January 1, 1992, the Company also 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 financial and tax reporting existing at the balance sheet date. The actual effects of tax law changes are recognized when enacted. The cumulative effect of this change increased 1992 net income by $4,286,000 or $.15 per share. The change had no significant impact on the income tax provision in 1992.\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 certain bank debt used to construct the mill (see note 9) and has committed to purchase 28,400 metric tons of annual production on a \"take-if-tendered\" basis until the debt is repaid. The Company purchased $13,083,000, $12,079,000, and $12,700,000 of newsprint from Ponderay in 1994, 1993 and 1992, respectively.\nSummarized financial data for the years ended December 31, 1994, 1993 and 1992 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 has an outstanding letter of credit for $4,861,000.\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):\nThe effective tax rate and the statutory federal income tax rate are reconciled as follows:\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe Company settled disputes with the Internal Revenue Service and the California Franchise Tax Board involving examinations of the Company's tax returns. The principal issues related to losses from non-newspaper operations from 1982 through 1987, and to the amortization of intangible assets acquired from 1986 through 1991. The resolution of the audits resulted in a $6,003,000 increase in net earnings which was recorded as a reduction to the 1994 income tax provision ($5,134,000 recognized in the third quarter).\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 1993. 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, 1994 and 1993 are (in thousands):\n6. INTANGIBLES\nIntangibles consist of (in thousands):\n7. EMPLOYEE BENEFITS\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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe elements of pension costs are as follows (in thousands):\nThe plans' funded status and amounts recognized in the Company's Consolidated Balance Sheet at December 31, 1994 and 1993 are as follows (in thousands):\nAssumptions used for valuing defined benefit obligations were:\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 $3,838,000 in 1994, $3,751,000 in 1993, and $3,455,000 in 1992.\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.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nThe elements of postretirement expenses are as follows (in thousands):\nThe plan's funded status and amounts recognized in the Company's Consolidated Balance Sheet at December 31, 1994 and 1993 are as follows (in thousands):\nAssumptions used for valuing postretirement obligations were:\nThe medical care cost trend rates are expected to decline to about 5.8% by the year 2002. A 1.0% increase in the assumed health care cost trend rate would have increased the APBO by 2.9% and the annual service and interest cost by 2.6%.\n8. CASH FLOW INFORMATION\nCash provided or used by operations was affected by changes in certain 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\nThe Company guarantees $21,643,000 of bank debt related primarily to its joint venture in the Ponderay newsprint mill.\nThe Company and its subsidiaries rent certain facilities and equipment under operating leases expiring at various dates through March 2000. Total rental expense amounted to $2,009,000 in 1994, $1,618,000 in 1993, and $1,596,000 in 1992. Minimum rental commitments under operating leases with noncancelable terms in excess of one year are (in thousands):\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\nOn May 9, 1994 the Company filed a registration statement with the Securities and Exchange Commission registering 1,581,250 shares of Class A common stock which were sold by the Company and certain stockholders in a combined primary and secondary offering to the public. Selling stockholders converted 625,000 shares of Class B common stock into Class A common stock and the Company converted 750,000 Class B shares held in treasury (at no cost). In addition, 206,250 Class A shares were issued to cover over-allotments in the offering. As a result of the offering, the number of outstanding common shares increased by 956,250.\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.\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, 1994, 444,690 shares of Class A common stock have been issued under the Purchase Plan.\nThe Company's 1987 Stock Option Plan (the 1987 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.\nOn January 26, 1994 the Board of Directors adopted the 1994 Employee Stock Option Plan (1994 Employee Plan) which was ratified by stockholders in May 1994 and reserves 650,000 Class A shares for\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)\nissuance to key employees. The terms of this plan are substantially the same as the terms of the 1987 Employee Plan.\nThe Company's stock option plan for outside (nonemployee) directors (the Directors' Plan) provides for the issuance of up to 150,000 shares of Class A stock. Under the 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 Plans. Outstanding options are summarized as follows:\nIn the 1987 Employee Plan, there are 261,725 options exercisable as of December 31, 1994. In January 1994, the Company granted 104,500 options to employees using substantially all shares reserved in the plan. In the 1994 Employee Plan 516,600 remain for future grants and none of the options are exercisable. In the Directors' Plan 26,250 shares were exercisable at December 31, 1994 and 96,000 are available for future awards.\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):\nPlease see note 5 for discussions of credits recorded in the third quarter of 1994 and charges recorded in the third quarter of 1993. In the fourth quarter of 1992 an early retirement expense of $2,593,000 was recorded.\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, 1994 and 1993, and the related consolidated statements of income, cash flows and stockholders' equity for each of the three years in the period ended December 31, 1994. Our audits also included the financial statement schedule listed in the Index at Item 14(a)(2). These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.\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, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. Also, in 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.\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.\nDELOITTE & TOUCHE LLP Sacramento, California February 1, 1995\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 1995 Annual Meeting of Stockholders is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nThe information contained under the headings \"Compensation\", \"Executive Compensation\", \"Stock Option Awards\", \"Option Exercises and Holdings\", and \"Pension Plans\" in the definitive Proxy Statement for the Company's 1995 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 1995 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--------------- ** Compensation plans or arrangements for the Company's executive officers and directors.\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 29, 1995.\nMcCLATCHY NEWSPAPERS, INC.\nBy \/s\/ JAMES B. MCCLATCHY* ------------------------------------ James B. McClatchy Chairman of the Board\n*By: \/s\/ 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.\n*By: JAMES P. SMITH ------------------------------------- James P. Smith (Attorney-in-Fact)\nSCHEDULE II\nMCCLATCHY NEWSPAPERS, INC. AND SUBSIDIARIES\nVALUATION AND QUALIFYING ACCOUNTS\nFOR THE THREE YEARS ENDED DECEMBER 31, 1994 (IN THOUSANDS)\n--------------- (1) Amounts written off net of bad debt recoveries.\nINDEX OF EXHIBITS\n--------------- * Incorporated by reference\n** Compensation plans or arrangements for the Company's executive officers and directors.","section_15":""}
{"filename":"93397_1994.txt","cik":"93397","year":"1994","section_1":"","section_1A":"","section_1B":"","section_2":"","section_3":"Item 3. Legal Proceedings\nEleven proceedings instituted by governmental authorities are pending or known to be contemplated against Amoco and certain of its subsidiaries under federal, state and local environmental laws, each of which could result in monetary sanctions in excess of $100,000. No individual proceeding is, nor are the proceedings as a group, expected to have a material adverse effect on Amoco's liquidity, consolidated financial position or results of operations. Amoco estimates that in the aggregate the monetary sanctions reasonably likely to be imposed from these proceedings amount to approximately $5.4 million.\nThe Internal Revenue Service (\"IRS\") has challenged the application of certain foreign income taxes as credits against the Corporation's U.S. taxes that otherwise would have been payable for the years 1980 through 1989. On June 18, 1992, the IRS issued a statutory Notice of Deficiency for additional taxes in the amount of $466 million, plus interest, relating to 1980 through 1982. The Corporation has filed a petition in the U.S. Tax Court contesting the IRS statutory Notice of Deficiency. Trial on the matter is scheduled to commence in April 1995. A comparable adjustment of foreign tax credits for each year has been proposed for the years 1983 through 1989 based upon subsequent IRS audits. Similar challenges could arise relating to years subsequent to 1989. The Corporation believes that the foreign income taxes have been reflected properly in its U.S. federal tax returns. The Corporation is confident that it will prevail in the litigation. Consequently, this dispute is not expected to have a material adverse effect on the liquidity, results of operations, or the consolidated financial position of the Corporation.\nOn January 21, 1994, a judgment was entered by the Superior Court of the State of California, County of Los Angeles, in favor of Amoco Chemical Company and Amoco Reinforced Plastics Company, subsidiaries of Amoco, against certain underwriters at Lloyd's of London and various other British and European insurance carriers, in AMOCO CHEMICAL COMPANY, et al, vs. CERTAIN UNDERWRITERS AT LLOYD'S OF LONDON, et al. In that case Amoco alleged that the defendant insurers wrongfully refused to pay for the defense and settlement of product liability lawsuits arising from Amoco Reinforced Plastics Company's manufacture of irrigation and sewer pipe in the 1970's. Judgment was entered for $36 million in compensatory damages and $377 million in punitive damages. Motions for a new trial and judgment notwithstanding the verdict filed by the defendants have been denied. The trial court entered a remittitur (reduction) of the punitive damages to $71 million. A modified judgment reflecting the remittitur was entered on April 15, 1994, in the amount of $110 million. The defendants have filed an appeal. Accordingly, it is impossible at this time to predict the ultimate outcome of this case, however, it is not expected to have a material effect on the liquidity or consolidated financial position of Amoco.\nAmoco has various other suits and claims pending against it among which are several class actions for substantial monetary damages which in Amoco's opinion are not meritorious. While it is impossible to estimate with certainty the ultimate legal and financial liability in respect to these other suits and claims, Amoco believes that, while the aggregate amount could be significant, it will not be material in relation to its liquidity or its consolidated 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 quarter ended December 31, 1994.\n__________________________ PART II\nItem 5.","section_5":"Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters\nThe principal public trading market for Amoco common stock is the New York Stock Exchange. Amoco common stock is also traded on the Chicago, Pacific, Toronto, and four Swiss stock exchanges. The following table sets forth the high and low share sales prices of Amoco common stock as reported on the New York Stock Exchange and cash dividends paid for the periods presented.\nMarket Prices Cash Dividends High Low Per Share First quarter . . . . . . . . . $ 56 1\/8 $ 50 7\/8 $ .55 Second quarter. . . . . . . . . $ 60 $ 51 1\/8 $ .55 Third quarter . . . . . . . . . $ 61 1\/4 $ 56 3\/4 $ .55 Fourth quarter. . . . . . . . . $ 64 1\/8 $ 57 1\/2 $ .55 First quarter . . . . . . . . . $ 58 1\/2 $ 48 1\/8 $ .55 Second quarter. . . . . . . . . $ 59 1\/4 $ 53 5\/8 $ .55 Third quarter . . . . . . . . . $ 58 3\/8 $ 52 3\/8 $ .55 Fourth quarter. . . . . . . . . $ 59 $ 51 1\/2 $ .55\nYear-end 1994 and 1993 market prices were $59 1\/8 and 52 7\/8, respectively.\nAmoco had 134,776 shareholders of record at December 31, 1994.\nOn January 24, 1995, the board of directors declared a quarterly cash dividend rate of 60 cents per share, an increase of 5 cents per share, or 9 percent, over the previous rate.\nItem 6.","section_6":"Item 6. Selected Financial Data\nThe following selected financial data, as it relates to the years 1990 through 1994, have been derived from the consolidated financial statements of Amoco, including the consolidated statement of financial position at December 31, 1994 and 1993 and the related consolidated statement of income and consolidated statement of cash flows for the three years ended December 31, 1994, and the notes thereto, appearing elsewhere herein.\n1994 1993 1992 1991 1990 (millions of dollars, except per-share amounts and ratios) Income statement data--Year ended December 31: Sales and other operating revenues (excluding consumer excise taxes) . $ 26,048 $ 25,336 $ 25,280 $ 25,325 $ 28,010 Net income (1) . . . . . $ 1,789 $ 1,820 $ 850 $ 1,173 $ 1,913 Net income per share (1) $ 3.60 $ 3.66 $ 1.71 $ 2.36 $ 3.77 Cash dividends per share $ 2.20 $ 2.20 $ 2.20 $ 2.20 $ 2.04 Ratio of earnings to fixed charges (2) . . . . 8.9 8.0 3.5 5.0 6.5 Balance sheet data-At December 31: Total assets . . . . . . $ 29,316 $ 28,486 $ 28,453 $ 30,510 $ 32,209 Long-term debt . . . . . $ 4,387 $ 4,037 $ 5,005 $ 4,470 $ 5,012 Shareholders' equity . . $ 14,382 $ 13,665 $ 12,960 $ 14,156 $ 14,068 Shareholders' equity per share . . . . . . . . . . $ 28.97 $ 27.53 $ 26.11 $ 28.52 $ 28.02\n(1) Excludes cumulative effects of accounting changes of $(924) million in 1992, or $(1.86) per share, and $311 million in 1991, or $.62 per share. (2) Earnings consist of income before income taxes and fixed charges; fixed charges include interest on indebtedness, rental expense representative of an interest factor, and adjustments for certain companies accounted for by the equity method.\nItem 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations\nThis discussion should be read in conjunction with the consolidated financial statements and accompanying notes and supplemental information.\n1994 1993 1992 (millions of dollars except per-share amounts) Income before the cumulative effects of accounting changes . . . . . . . . . . $ 1,789 $ 1,820 $ 850 Cumulative effects of accounting changes -- -- (924) Net income (loss) . . . . . . . . . . . $ 1,789 $ 1,820 $ (74) Income per share before the cumulative effects of accounting changes . . . . . $ 3.60 $ 3.66 $ 1.71 Net income (loss) per share . . . . . . $ 3.60 $ 3.66 $ (.15)\nConsolidated net income for 1994 was $1,789 million, compared with $1,820 million earned in 1993. A net loss of $74 million was incurred in 1992, after charges of $924 million related to the cumulative effects of adopting Statement of Financial Accounting Standards (\"SFAS\") No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" and SFAS No. 109, \"Accounting for Income Taxes.\"\nReturn on shareholders' equity and return on capital employed were 12.8 and 10.2 percent, respectively, in 1994, compared with 13.7 and 10.6 percent, respectively, in 1993.\nYear-to-year comparisons in net income were affected by the unusual items that are summarized in the table below:\nincr.\/(decr.) net income 1994 1993 1992 (millions of dollars) Crude oil excise tax settlement . . . $ 270 $ -- $ -- Restructurings . . . . . . . . . . . (256) (170) (805) Environmental provisions . . . . . . (60) -- -- Gains on dispositions . . . . . . . . 45 190 -- Tax obligations and other . . . . . . 62 60 90 Sharjah natural gas settlement . . . -- -- 90\nEarnings in 1994 benefited from settlements of crude oil excise taxes (\"COET\") of $270 million, a gain of $45 million related to the disposition of certain European oil and gas properties and tax adjustments relating to prior years totaling $62 million. Earnings in 1994 were reduced by charges of $256 million relating to Amoco's restructuring of operations, as discussed further on pages 31 and 32, and provisions for future environmental remediation expenditures relating to past operations totaling $60 million. Earnings for 1993 included gains of $190 million associated with the disposition of certain Canadian\nproperties and investments, and net tax benefits of $60 million. Adversely affecting 1993 results were after-tax charges of $170 million associated with the writedown of Congo exploration and production operations to current recoverable value. Excluding these items, 1994 earnings were about the same as 1993.\nResults of operations in 1994 reflected strong chemical earnings resulting from higher margins and volumes in major product lines. Refining, marketing and transportation earnings declined $408 million mainly because of lower refined product margins. Exploration and production earnings decreased in 1994 primarily as a result of lower energy prices.\nSales and other operating revenues totaled $26 billion for 1994, 3 percent higher than the $25.3 billion in 1993, primarily resulting from increased chemical and natural gas sales volumes, and higher prices for chemical products.\nCosts and expenses on a worldwide basis amounted to $27.9 billion in 1994, 7 percent above 1993. Operating expenses of $4.7 billion were essentially level with 1993. Current-year restructuring charges of $169 million related to facility closings and dispositions; higher chemical manufacturing expenses resulting from new plant acquisitions in late 1993; and increased production costs overseas, were offset by the absence of the $210 million charge in 1993 related to the writedown of Congo exploration and production operations to current recoverable value. Exploration expenses increased $104 million primarily related to drilling activity. Selling and administrative expenses for 1994 were up 20 percent, primarily resulting from second-quarter 1994 restructuring charges of $225 million related to the severance of approximately 3,800 employees most of which are expected to occur by year-end 1995. Taxes other than income taxes increased over $500 million, resulting from higher consumer excise taxes.\n1993 vs. 1992\nAdjusting for unusual items and accounting changes, 1993 earnings were 18 percent, or $265 million, above the 1992 level, as a result of higher refined product margins in refining, marketing and transportation operations and improved chemical results. Also contributing to the improvement were higher U.S. natural gas prices and volumes and lower worldwide exploration and operating expenses.\nCosts and expenses totaled $26 billion in 1993, 4 percent lower than 1992. Operating expenses declined primarily reflecting the absence of 1992 restructuring charges of $757 million associated with losses on asset dispositions, partly offset by 1993 charges of $210 million related to the writedown of Congo exploration and production operations. The decline in selling and administrative expense primarily reflected the absence of 1992 restructuring charges of $457 million mainly related to severances. Also contributing to the decline in total expenses were\nlower dry hole costs worldwide, which were $118 million lower than in 1992.\nIndustry Segments\nResults on a segment basis for the five years ended December 31, 1994 are presented below.\n*Other operations include investments in laser manufacturing, photovoltaics and biotechnology; offshore contract drilling; interests in real estate development; and other activities.\nU. S. Exploration and Production 1994 1993 1992 1991 1990 Average U.S. selling price Crude oil (dollars per barrel) . . . . . $14.82 $15.96 $17.79 $18.31 $21.60 Natural gas liquids (dollars per barrel) . . . . . 9.39 10.79 11.43 11.69 12.84 Natural gas (dollars per mcf) . . . . . . . 1.66 1.88 1.65 1.52 1.83\nIn the United States, the exploration and production segment earned $848 million in 1994, compared with $811 million in 1993 and $778 million in 1992. In those years U.S. operations were affected by several items that are summarized in the table below:\nincr.\/(decr.) earnings 1994 1993 1992 (millions of dollars) Crude oil excise tax settlement . . . . . $ 90 $ -- $ -- Environmental provisions . . . . . . . . -- (63) -- Tax obligations . . . . . . . . . . . . . -- (25) -- Restructurings . . . . . . . . . . . . . (47) -- (94)\nAdjusting the respective periods for the items shown, 1994 results were $94 million below 1993 mainly as a result of lower energy prices. Also contributing to the decline were lower crude oil production volumes. Partly offsetting were higher natural gas volumes, lower production costs, and lower depreciation, depletion and amortization expense.\nAmoco's U.S. natural gas prices averaged about $2 per thousand cubic feet (\"mcf\") during the first four months of 1994. Prices then declined throughout much of the remainder of the year, reflecting increased supply and the impact of mild winter weather on demand.\nAmoco's crude oil prices began the year around $12 per barrel and increased almost $5 per barrel by July, reflecting an improved worldwide supply-demand balance. Prices declined gradually for the remainder of the year, averaging $14.82, a decline of more than $1 per barrel compared with 1993.\nU.S. natural gas production averaged 2.5 billion cubic feet per day in 1994, 3 percent above 1993. Crude oil and natural gas liquids (\"NGL\") production averaged 292,000 barrels per day in 1994, 4 percent below 1993. NGL production in 1994 was essentially level with 1993, while crude oil production declined 6 percent, reflecting normal field declines.\nNon-U.S. Exploration and Production\nOperations outside the United States were affected by the items as shown below.\nincr.\/(decr.) earnings 1994 1993 1992 (millions of dollars) Gains on dispositions . . . . . . . . . . $ 45 $ 190 $ -- Restructurings . . . . . . . . . . . . . (20) (170) (258) Sharjah natural gas settlement . . . . . -- -- 90 Norwegian tax legislation . . . . . . . . -- -- (39)\nCanadian exploration and production operations earned $125 million in 1994. In 1993 earnings of $338 million included a gain of $120 million on the sale of 65 percent of Amoco's equity investment in Crestar Energy Inc. (\"Crestar\"). Amoco also sold a significant portion of non- core properties in 1993, benefiting results by $70 million. Excluding these items, 1994 earnings were $23 million lower than 1993 results, primarily reflecting lower crude oil and natural gas production volumes. Also contributing to the decline were higher dry hole costs and other exploration expenses of $70 million before tax. Partly offsetting were higher natural gas prices, which were about 6 percent above 1993 levels. Crude oil and NGL production, and natural gas production averaged 13 percent and 10 percent below the 1993 levels, respectively, primarily reflecting divestments of non-core Canadian properties.\nExploration and production activities in Europe incurred losses of $63 million in 1994 and $100 million in 1993. Included in 1994 results was a gain of $45 million on property dispositions. Crude oil and natural gas production in the North Sea was higher in 1994, following completion of projects in late 1993. These favorable effects and higher natural gas prices were partly offset by lower crude oil prices, higher exploration expenses of $27 million before tax, unfavorable currency effects of $29 million and higher expenses associated with activity in Eurasia. Crude and NGL production averaged 66,000 barrels per day in 1994, compared with 51,000 in 1993; natural gas production averaged 335 million cubic feet in 1994, up 29 percent compared with 1993.\nExploration and production operations in other areas earned $77 million in 1994, compared with a loss of $54 million in 1993. Included in 1993 results were charges of $170 million related to the writedown of Congo operations to current recoverable value. Exclusive of these charges, results for 1994 were $39 million below 1993 mainly due to unfavorable currency effects of $25 million, lower crude oil prices and charges of $18 million related to the relinquishment of the Myanmar concession. Partly offsetting were lower exploration expenses and increased natural gas production, which averaged 552 million cubic feet per day in 1994, 4 percent higher than 1993, reflecting increased production in Trinidad. Crude oil and NGL production averaged 237,000 barrels per day in 1994, essentially level with 1993.\n1993 vs. 1992\nUnited States exploration and production operations earned $811 million in 1993 compared with $778 million in 1992. Excluding unusual items, 1993 results were $27 million above 1992 earnings, mainly as a result of higher natural gas prices and volumes and lower exploration expenses. Partly offsetting were lower crude oil prices and production volumes.\nIn 1993 earnings outside the United States for exploration and production operations totaled $184 million, compared with $93 million in 1992. The increase in 1993 mainly resulted from gains on the divestment of a portion of the Crestar shares and other Canadian property dispositions of $190 million; decreased restructuring charges, which were $88 million lower in 1993 than in 1992; and the absence of 1992 charges of $39 million relating to the effects of Norwegian tax legislation. Partly offsetting were lower crude oil prices, unfavorable currency effects, higher expenses associated with increased activity in Eurasia and the absence of the $90 million Sharjah natural gas settlement.\nOutlook\nUncertainty and volatility in crude oil and natural gas prices will continue to affect the oil industry. While results will be influenced by energy prices, Amoco will benefit from both past and ongoing cost\nreduction programs. Amoco plans to continue to evaluate and divest marginal properties and underperforming assets. Amoco's exploration efforts will continue to target areas that offer the most potential for adding value. Amoco plans to pursue attractive new business opportunities worldwide, to adjust its actions to political and socioeconomic uncertainties, and to capitalize on its extensive natural gas resources.\nRefining, Marketing and Transportation\nUnited States 1994 1993 1992 1991 1990 Cents per gallon: Average selling price Gasoline . . . . . . . . . . 63.4 66.4 71.3 74.7 83.4 Total refined products . . . 54.5 57.5 60.9 64.9 72.9 Average cost of crude input . . 38.4 39.6 44.6 45.5 55.0 Percent: Refinery capacity utilization 97.5 96.9 95.3 90.9 91.8 Refinery yield . . . . . . . 107.2 106.8 106.9 106.9 106.3\nWorldwide refining, marketing and transportation operations, which include U.S. petroleum products and Canadian natural gas liquids activities, earned $418 million for 1994, compared with earnings of $826 million for 1993 and $462 million for 1992. Earnings in 1994 declined $408 million compared with 1993, primarily due to lower U.S. refined product margins. Refined product margins decreased almost two cents per gallon from 1993 levels, resulting in part from a very competitive U.S. market. Overall selling prices averaged 55 cents per gallon in 1994, down from 58 cents per gallon in 1993.\nAlso affecting 1994 earnings were charges of $60 million related to estimated future cost of environmental remediation activities, and restructuring charges of $41 million, primarily associated with severances. Included in 1993 earnings were unusual items favorably affecting results by $109 million.\nRefined product sales volumes in the United States averaged 1,177,000 barrels per day in 1994 compared with 1,131,000 barrels per day in 1993. Gasoline sales volumes were up 3 percent in 1994 while distillate sales increased 5 percent.\nRefining capacity utilization rate of 98 percent in 1994 compared with a 1993 utilization rate of 97 percent, reflecting continued operating efficiencies, despite unexpected disruptions and downtime in 1994.\nCanadian supply and marketing activities earned $86 million in 1994, 15 percent below 1993 results, primarily reflecting lower prices for NGL. Canadian NGL sales volumes of 173,000 barrels per day in 1994 were essentially level with 1993.\n1993 vs. 1992\nIn 1993 earnings of $826 million compared with 1992 earnings of $462 million. The 1993 earnings improvement primarily resulted from higher refined product margins and lower operating costs.\nOutlook\nIn a highly competitive environment, Amoco's operations are continually challenged to control costs and improve operating efficiencies. Amoco's earnings will continue to be affected by price volatility of crude oil and the overall industry supply-demand balance for refined products. Amoco will focus on emphasizing Amoco brand product quality and improving its position as a convenience retailer. Environmental initiatives, including a commitment to provide a product slate that is responsive to environmental concerns and regulations, will require additional investment in refining and marketing facilities. Amoco will continue to upgrade facilities and improve operating efficiencies.\nChemicals\nChemical operations earned $538 million for 1994, compared with earnings of $240 million in 1993 and a loss of $94 million in 1992. Results for 1994 included restructuring charges of $36 million, primarily related to severance costs. Adjusting for these charges, 1994 earnings improved $334 million over 1993 due to higher margins and sales volumes for major product lines, particularly purified terephthalic acid (\"PTA\") and olefins, reflecting strong consumer demand.\nSales volumes for PTA were up 11 percent in 1994, as worldwide demand for PTA continued to grow. Olefins sales volumes were 14 percent higher than last year, reflecting strong growth in both domestic and export demand. The overall chemicals capacity utilization rates were 91 percent in 1994 and 88 percent in 1993.\n1993 vs. 1992\nIn 1993 chemical operations earned $240 million compared with a loss of $94 million in 1992. Adjusting for $265 million in 1992 restructuring charges, 1993 earnings were up $69 million over 1992 resulting from the benefits of cost-containment efforts, restructuring and a strong worldwide PTA market.\nOutlook\nChemical operations are affected by the worldwide economic environment and the chemical products supply-demand balance. Amoco's\nearnings will continue to benefit from both past and ongoing process- improvement and cost-control programs. Amoco will continue to aggressively develop its international business to capitalize on the rapidly growing demand for petrochemical products in the international markets, particularly those in Asia. Amoco also plans to continue to broaden its current commodity chemical portfolio and looks to diversify into specialty chemical and polymer conversion businesses.\nOther Operations\nOther operations include investments in laser manufacturing, photovoltaics and biotechnology; offshore contract drilling; interests in real estate development; and other activities.\nOther operations incurred a loss of $155 million in 1994, compared with losses of $45 million and $179 million, respectively, for 1993 and 1992. Included in 1994 losses were restructuring charges of $78 million, primarily related to the disposition of a hazardous-waste incineration facility in Kimball, Nebraska. In late 1994, Amoco signed a letter of intent to sell this facility; the sale is anticipated to close in 1995. The higher losses in 1994 compared with 1993 also reflected lower offshore contract drilling revenues. Also, 1993 included gains on the sale of certain operations as Amoco continued its efforts to review the strategic fit of these activities. In 1993, the Corporation sold its 49 percent interest in a fertilizer manufacturing venture in Trinidad, and its interest in Ok Tedi Mining Ltd. in Papua New Guinea. Included in 1992 were charges of $99 million for anticipated losses on the disposition of non-strategic investments.\nCorporate Activities\nCorporate activities, including net interest and other corporate expenses, reported net income of $1 million for 1994, compared with net expenses of $196 million for 1993 and $210 million in 1992. The 1994 income included interest income of $180 million related to the COET settlement, favorable tax adjustments relating to prior years of $33 million and restructuring charges of $34 million; the 1993 loss included prior-year tax benefits of $101 million and losses associated with early retirement of higher interest-rate debt; and 1992 included favorable adjustments of $70 million primarily related to revised estimates of tax obligations and early retirement of debt, and charges of $38 million for work force reductions. Adjusting for these items over the years shown, net expense decreased $75 million between 1993 and 1994, primarily resulting from lower net interest expense and favorable currency effects. Net expenses increased $11 million between 1992 and 1993.\nRestructuring\nIn July 1994, Amoco announced that the organizational structure of the Corporation was being changed to improve profitability, increase\noperating flexibility and position the company for long-term growth. The Corporation's strategies are now carried out by 17 business groups. A newly created Shared Services organization provides support services to the business groups.\nApproximately 3,800 positions are expected to be eliminated by year- end 1995. Additional positions will be eliminated in 1996 as a result of ongoing process redesign to improve efficiencies in support functions. In conjunction with the restructuring, an after-tax charge of $256 million was accrued in the second quarter of 1994. Charges against the accrual associated with severance in 1994, representing approximately 2,000 employees, totaled about $64 million after tax. See Note 2 to the Consolidated Financial Statements. To date, savings resulting from the restructuring have not been material. It is anticipated that by 1996 benefits related to lower employment costs and other cost reductions could approximate $400 million after tax.\nAdditional costs of approximately $200 million after tax, which have not been accrued, are expected to be incurred through 1996 to reflect costs for system redesign, relocations, work consolidation and development of new processes in support of the reorganization. In 1994, costs related to these activities were not material. Most of these additional costs are expected to occur in 1995.\nLiquidity and Capital Resources\nIn 1994, cash flow from operating activities was $4.3 billion, compared with $3.5 billion in 1993 and $3 billion in 1992.\nTotal debt was $4.6 billion at year-end 1994. Debt as a percent of debt-plus-equity was 24.3 percent at December 31, 1994, compared with 27.1 percent at year-end 1993.\nWorking capital was $1,618 million at year-end 1994, compared with $751 million at year-end 1993. At year-end 1994, the Corporation's current ratio was 1.32 to 1 compared with the current ratio at December 31, 1993 of 1.14 to 1. As a matter of policy, Amoco practices asset and liability management techniques that are designed to minimize its investment in non-cash working capital. This does not impair operational capability or flexibility since the Corporation has ready access to both short-term and long-term debt markets.\nAmoco's short-term liquidity position is better than the reported figures indicate since the inventory component of working capital is valued in part under the LIFO method whereas other elements of working capital are reported at amounts more indicative of their current values. If inventories were valued at current replacement costs, it is estimated that inventories would have been $1,100 million higher at December 31, 1994. As a result, the level of working capital would rise and an increase in the current ratio would result.\nCash dividends paid in 1994 totaled $1,092 million, or $2.20 per share. The quarterly cash dividend was raised to 60 cents per share in January 1995, and increase of 5 cents per share, or 9 percent, over the previous rate.\nIn 1994, the Corporation completed a contract with subsidiaries of Associates Corporation of North America (\"Associates\") whereby Associates purchased certain of Amoco's receivables; Associates now issues and processes Amoco's credit cards. Proceeds from the sale of credit card receivables were largely used to reduce short-term obligations.\nThe Corporation believes its strong financial position will permit the financing of its business needs and opportunities in an orderly manner. It is anticipated that ongoing operations will be financed primarily by internally generated funds. Short-term obligations, such as commercial paper borrowings, give the Corporation the flexibility to meet short-term working capital and other temporary requirements. At December 31, 1994, bank lines of credit available to support commercial paper borrowings were $490 million, all of which were supported by commitment fees. To maintain flexibility, a $500 million shelf registration statement for debt securities remains on file with the Securities and Exchange Commission to permit ready access to capital markets.\nAmoco is routinely exposed to hydrocarbon commodity price risk. It manages a portion of that risk mainly through the use of futures and swaps contracts generally to achieve market prices on specific purchase and sales transactions. See Note 4 to the Consolidated Financial Statements. Also during 1994, Amoco used futures and swaps to fix the sales price of approximately 15 percent of the Corporation's U.S. natural gas production for the months of April through December, which benefited earnings by about $20 million after tax.\nThe Corporation has provided in its accounts for the reasonably estimable future costs of probable environmental remediation obligations. These amounts relate to various refining and marketing sites, chemical locations, and oil and gas operations, including multiparty sites at which Amoco has been identified as a potentially responsible party by the U.S. Environmental Protection Agency. Such estimated costs will be refined over time as remedial requirements and regulations become better defined. However, any additional costs cannot be reasonably estimated at this time due to uncertainty of timing, the magnitude of contamination, future technology, regulatory changes and other factors. Although future costs could be significant, they are not expected to be material in relation to Amoco's liquidity or consolidated financial position. In total, the accrued liability represents a reasonable best estimate of Amoco's remediation liability. See Notes 1 and 21 to the Consolidated Financial Statements.\nThe Corporation and its subsidiaries maintain insurance coverage for environmental pollution resulting from the sudden and accidental release of pollutants. Various deductibles of up to $50 million per occurrence could apply, depending on the type of incident involved. Coverage for\nother types of environmental obligations is not generally provided, except when required by regulation or contract. The financial statements do not reflect any significant recovery form claims under prior or current insurance coverage.\nAt December 31, 1994, the Corporation's reserves for future environmental remediation costs totaled $725 million, of which $467 million related to refining and marketing sites. The Corporation also maintains reserves associated with dismantlement, restoration and abandonment of oil and gas properties, which totaled $627 million at December 31, 1994.\nCapital expenditures resulting from existing environmental regulations, primarily related to refining and marketing sites, totaled $198 million in 1994. Excluded from that total was $479 million for operating costs and amounts spent on research and development, and $119 million of mandated and voluntary spending charged against the remediation liability. Amoco's 1995 estimated capital spending for environmental cleanup and protection projects is expected to be approximately $180 million; spending for remediation in 1995 is expected to approximate the 1994 level.\n1994 1993 1992 1991 1990 (millions of dollars) Capital and exploration expenditures Exploration and production United States . . . . . . . . . . . $ 820 $ 669$ 472 $ 965 $1,023 Canada . . . . . . . . . . . . . . 408 275 166 294 285 Europe . . . . . . . . . . . . . . 279 493 538 549 331 Other . . . . . . . . . . . . . . . 687 682 578 690 706 Refining, marketing and transportation . . . . . . . . . . . 451 685 806 689 617 Chemicals . . . . . . . . . . . . . . 467 370 320 520 582 Other operations . . . . . . . . . . 48 126 60 142 81 Corporate . . . . . . . . . . . . . . 45 46 56 82 89 Total . . . . . . . . . . . . $3,205 $3,346$2,996 $3,931 $3,714 Petroleum exploration expenditures charged to income (included above) United States . . . . . . . . . . $ 113 $ 90$ 140 $ 262 $ 230 Canada . . . . . . . . . . . . . . 117 47 72 73 89 Europe . . . . . . . . . . . . . . 178 151 150 144 99 Other . . . . . . . . . . . . . . 225 241 300 311 275 Total . . . . . . . . . . . . $ 633 $ 529$ 662 $ 790 $ 693\nCapital and exploration expenditures in 1994 totaled $3.2 billion, compared with $3.3 billion spent in 1993. Capital and exploration expenditures of $4.2 billion have been approved for 1995, an increase of 31 percent over 1994 spending. It is expected that more than half of the spending will go to upstream projects, with about 60 percent of that amount going to projects outside the United States. Areas outside the United States where Amoco continues to work on major exploration and production projects include Egypt, China, the North Sea, Trinidad and the\nformer Soviet Union. Major new expenditures for 1995 also include higher spending for development of natural gas resources in North America. The balance of capital outlays is anticipated to be used for chemicals, refining, marketing and transportation operations, including a substantial investment in construction of a chemical plant in Malaysia to produce PTA. It is anticipated that the 1995 capital and exploration expenditures budget will be financed primarily by funds generated internally. The planned expenditure level is subject to adjustment as changing economic conditions may indicate.\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplemental Information Index to Financial Statements and Supplemental Information Page\nReport of Independent Accountants . . . . . . . . . . . . . . . . . . 37 Consolidated Financial Statements: Consolidated Statement of Income . . . . . . . . . . . . . . . . . 38 Consolidated Statement of Financial Position . . . . . . . . . . . 39 Consolidated Statement of Shareholders' Equity . . . . . . . . . . 40 Consolidated Statement of Cash Flows . . . . . . . . . . . . . . . 41 Notes to Consolidated Financial Statements . . . . . . . . . . . . 42 Financial Statement Schedule: Valuation and Qualifying Accounts (Schedule VIII) . . . . . . . 83 Supplemental Information: Quarterly Results and Stock Market Data . . . . . . . . . . . . . 69 Oil and Gas Exploration and Production Activities . . . . . . . . 70\nSeparate financial statements of subsidiary companies not consolidated, and of 50 percent or less owned companies accounted for by the equity method, have been omitted since, if considered in the aggregate, they would not constitute a significant subsidiary.\nREPORT OF INDEPENDENT ACCOUNTANTS\nTo the Board of Directors and Shareholders of Amoco Corporation\nIn our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Amoco Corporation and its subsidiaries at December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles. These financial statements are the responsibility of Amoco 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.\nIn 1992, Amoco Corporation changed its method of accounting for income taxes and for postretirement benefits other than pensions, as discussed in Notes 15 and 19, respectively, to the financial statements.\nPRICE WATERHOUSE LLP\nChicago, Illinois February 28, 1995\nAMOCO CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF INCOME\n(The accompanying notes are an integral part of these statements.)\nAMOCO CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF FINANCIAL POSITION\n(The successful efforts method of accounting is followed for costs incurred in oil and gas producing activities.) (The accompanying notes are an integral part of these statements.)\nAMOCO CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY\n(The accompanying notes are an integral part of these statements.)\nAMOCO CORPORATION AND SUBSIDIARIES\nCONSOLIDATED STATEMENT OF CASH FLOWS\nYear Ended December 31 1994 1993 1992 (millions of dollars) Cash flows from operating activities: Net income (loss) . . . . . . . . . . . . . $ 1,789 $ 1,820 $ (74) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation, depletion, amortization, and retirements and abandonments . . . . . . 2,239 2,193 2,440 (Increase) decrease in receivables . . . . (137) (18) 476 (Increase) decrease in inventories . . . . 68 (89) 130 Increase (decrease) in payables and accrued liabilities . . . . . . . . . . . 492 (371) (788) Deferred taxes and other items . . . . . . (122) (44) (88) Cumulative effects of accounting changes . -- -- 924 Net cash provided by operating activities 4,329 3,491 3,020\nCash flows from investing activities: Capital expenditures . . . . . . . . . . . (2,572) (2,817) (2,334) Proceeds from dispositions of property and other assets . . . . . . . . . . . . . . . 335 594 452 New investments, advances and business acquisitions . . . . . . . . . . . . . . . (91) (200) (126) Proceeds from sales of investments . . . . 176 256 8 Other . . . . . . . . . . . . . . . . . . . (18) (2) 18 Net cash used in investing activities . . . (2,170) (2,169) (1,982)\nCash flows from financing activities: New long-term obligations . . . . . . . . . 438 1,313 3,061 Repayment of long-term obligations . . . . (138) (2,286) (3,147) Cash dividends paid . . . . . . . . . . . . (1,092) (1,092) (1,091) Issuances of common stock . . . . . . . . . 29 27 25 Acquisitions of common stock . . . . . . . (41) (32) (29) Increase (decrease) in short-term obligations . . . . . . . . . . . . . . . (783) 677 (152) Net cash used in financing activities . . . (1,587) (1,393) (1,333) Increase (decrease) in cash and marketable securities . . . . . . . . . . . . . . . . . 572 (71) (295)\nCash and marketable securities-beginning of year . . . . . . . . . . . . . . . . . . . . 1,217 1,288 1,583 Cash and marketable securities-end of year . $ 1,789 $ 1,217 $ 1,288\n(The accompanying notes are an integral part of these statements.)\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1. Accounting Policies\nPrinciples of consolidation\nThe operations of all significant subsidiaries in which the Corporation directly or indirectly owns more than 50 percent of the voting stock are included in the consolidated financial statements. The Corporation also consolidates its proportionate share of assets, liabilities and results of operations of oil and gas joint ventures and undivided interest pipeline companies. Investments in other companies in which less than a majority interest is held are generally accounted for by the equity method.\nInventories\nInventories are carried at the lower of current market value or cost. Cost is determined under the last-in, first-out (\"LIFO\") method for the majority of inventories of crude oil, petroleum products and chemical products. The costs of remaining inventories are determined on the first-in, first-out (\"FIFO\") or average cost methods.\nCosts incurred in oil and gas producing activities\nThe Corporation follows the successful efforts method of accounting. Costs of property acquisitions, successful exploratory wells, all development costs (including CO2 and certain other injected materials in enhanced recovery projects) and support equipment and facilities are capitalized. Unsuccessful exploratory wells are expensed when determined to be non-productive. Production costs, overhead and all exploration costs other than exploratory drilling are charged against income as incurred.\nDepreciation, depletion and amortization\nGenerally, depreciation of plant and equipment, other than oil and gas facilities, is computed on a straight-line basis over the estimated economic lives of the facilities. Depletion of the cost of producing oil and gas properties, amortization of related intangible drilling and development costs and depreciation of tangible lease and well equipment are recognized using the unit-of-production method.\nThe portion of costs of unproved oil and gas properties estimated to be non-productive is amortized over projected holding periods.\nThe estimated costs to dismantle, restore and abandon oil and gas properties are recognized over the properties' productive lives on the unit-of-production method.\nRetirements\nUpon normal retirement or replacement of facilities, the gross book value less salvage is charged to accumulated depreciation. Gains or losses from abnormal retirements or sales are credited or charged to income.\nMaintenance and repairs\nAll maintenance and repair costs are charged against income, while significant improvements are capitalized.\nDerivative contracts\nThe Corporation periodically enters into futures, swaps, forwards and option contracts to manage its exposure to price fluctuations on hydrocarbon transactions and its exposure to exchange rate fluctuations on its debt denominated in foreign currencies. Recognized gains, losses and cash flows from hedge contracts are reported as components of the related transactions.\nTranslation of foreign currencies\nThe U.S. dollar has been determined to be the appropriate functional currency for essentially all operations except foreign chemical operations.\nEnvironmental liabilities\nThe Corporation has provided in its accounts for the reasonably estimable future costs of probable environmental remediation obligations relating to current and past activities, including obligations for previously disposed assets or businesses. In the case of long-lived cleanup projects, the effects of inflation and other factors, such as improved application of known technologies and methodologies, are considered in determining the amount of estimated liabilities. The liability is undiscounted and primarily consists of costs such as site assessment, monitoring, equipment, utilities and soil and ground water treatment and disposal. The estimated environmental remediation obligation has not been reduced for probable recoveries from third parties, which are recorded as assets.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nNet Income Per Share\nNet income per share of common stock is based on the monthly weighted average number of shares outstanding during the year.\nNote 2. Acquisitions, Dispositions and Special Items\nIn 1994, earnings included benefits of $270 million related to final settlements with the Internal Revenue Service involving crude oil excise taxes (\"COET\") assessed in the 1980s. Of this amount, $180 million represented interest on the settlements. Earnings also included a gain of $45 million on the sale of certain European oil and gas properties.\nAs a result of the organizational restructuring, a charge of $394 million ($256 million after-tax) was accrued in the second quarter of 1994. Included in selling and administrative expenses were charges of $225 million ($146 million after-tax) related to employee-termination costs directly associated with the severance of approximately 3,800 employees expected to occur by year-end 1995. Of the 3,800 employees, approximately 2,000 represent personnel in accounting, information technology and other related support staff; the remainder are employees associated with business group operations. Approximately 75 percent of the total terminations are professionals, managers and supervisors. In 1994, charges against the accrual relating to the elimination of about 2,000 positions totaled $64 million after tax. As of December 31, 1994, the accrual balance associated with restructuring was $82 million after tax ($126 million before tax), which was considered adequate for all future severances to which the company has committed. Included in operating expenses were charges of $169 million ($110 million after-tax) related to a reduction in carrying value of assets that will be divested. Disposition of these assets, including a hazardous-waste incineration facility that is not yet in commercial production, will not have a material effect on revenues, depreciation or income.\nIn 1993, new investments, advances and business acquisitions totaled $200 million, including the purchase of Phillips Fibers Corporation. Proceeds from dispositions of property and other assets and from sales of investments totaled $850 million, including certain non-strategic properties and investments in Canada for approximately $471 million.\nEarnings in 1993 included gains of $120 million relating to the Corporation's disposition of 65 percent of the equity investment in a Canadian company, Crestar Energy Inc., in connection with its initial public offering. Also included were gains of $70 million associated with the disposition of certain Canadian properties. Earnings in 1993 included after-tax charges of $170 million associated with the writedown\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nof Congo exploration and production operations to current recoverable value.\nEarnings in 1992 were reduced by after-tax charges of $805 million, as part of a strategic reassessment of business operations. These charges included $473 million for costs of restructuring business units and related charges, including anticipated losses on the disposition of oil and gas properties and other non-strategic assets and investments; $181 million for charges related to work force reductions; and $151 million for other reserves and adjustments. Substantially all of these restructuring efforts have been completed. Earnings were favorably affected by $90 million related to the settlement of natural gas contracts in Sharjah. Also favorably affecting earnings were benefits of $90 million associated with revised estimates of tax obligations and retirement of debt.\nNote 3. Cash Flow Information\nThe Consolidated Statement of Cash Flows provides information about changes in cash and cash equivalents, including cash in excess of daily requirements that is invested in marketable securities, substantially all of which have a maturity of three months or less when acquired. The effect of foreign currency exchange rate fluctuations on total cash and marketable securities balances was not significant.\nNet cash provided by operating activities reflects cash payments for interest and income taxes as follows: 1994 1993 1992 (millions of dollars) Interest paid . . . . . . . . . . $ 297 $ 367 $ 550\nIncome taxes paid . . . . . . . . $ 903 $ 632 $ 974\nNote 4. Financial Instruments and Hedging Activities\nAll financial instruments held by the Corporation are for purposes other than trading. All derivatives are either exchange traded or with major financial institutions, and the risk of credit loss is considered remote. A significant portion of Amoco's receivables are from other oil and gas and chemical companies. Although collection of these receivables could be influenced by economic factors affecting these industries, the risk of significant loss is considered remote.\nThe carrying values of receivables, payables, marketable securities and short-term obligations approximate their fair value. The estimated\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nfair value of long-term debt outstanding as of December 31, 1994 and 1993 was $4,342 million and $4,264 million, respectively. The estimated fair value of marketable securities and debt were based on quoted market prices for the same or similar issues, or the current rates offered to the Corporation for issues with the same remaining maturities.\nThe Corporation conducts its business primarily in U.S. dollars. Significant exposures to foreign currency exchange risk are reduced through the use of financial instruments, primarily by hedging of foreign currency borrowings. The following table shows the amount of long-term debt, including current portions, denominated in foreign currencies as of December 31, 1994 and 1993, and the face amounts of foreign currency forward and option contracts that have been designated as hedges of that debt:\n1994 1993 Long-Term Long-Term Debt Hedge* Debt Hedge*\n(millions of U.S. dollars) British pound sterling . . . . . . $ 596 $ 909 $ 565 $ 873\nCanadian dollar . . . . . . . . . . $ 231 $ 348 $ 77 $ 45\n* Includes tax effects.\nThe hedge contracts generally have the same maturities as the related debt. The carrying value and fair value of the forward and option contracts were not material at December 31, 1994 and 1993.\nThe Corporation also enters into futures contracts and forward swaps to manage its exposure to price fluctuation on hydrocarbon transactions. The crude oil futures contracts generally match the pricing of specific purchase transactions to market prices at delivery dates. The net effect of natural gas futures and swaps is to convert specific sales contracts from fixed prices to market prices. Natural gas swap contracts outstanding at December 31, 1994 and 1993 totaled 151 and 24 trillion British thermal units (\"Btus\"), respectively. Most contracts are for a remaining term of less than one year, while contracts representing 43 trillion Btus of natural gas have terms that extend from one to five years. While these contracts have no carrying value, their fair value, representing the estimated amount that would have been required to terminate the swaps at year-end 1994, was an unfavorable $28 million.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nIn the normal course of business, the Corporation has entered into contracts for the purchase of transportation capacity, materials and services over terms of up to 20 years. The remaining minimum payments required under these contracts at December 31, 1994, totaled $709 million. At December 31, 1994, contingent liabilities of the Corporation included guarantees of $54 million on outstanding loans of others. The Corporation also has entered into various pipeline throughput and deficiency contracts with affiliated companies. These agreements supported an estimated $7 million of affiliated company borrowings at December 31, 1994. The fair value of these commitments is immaterial.\nNote 5. Inventories\nInventories at December 31, 1994 and 1993, are shown in the following table:\nDecember 31 1994 1993 (millions of dollars) Crude oil and petroleum products . . . . . . . $ 349 $ 415 Chemical products . . . . . . . . . . . . . . . 375 377 Other products and merchandise . . . . . . . . 24 21 Materials and supplies . . . . . . . . . . . . 294 297 Total . . . . . . . . . . . . . . . . . . . . $ 1,042 $ 1,110\nDuring the year ended December 31, 1993, the Corporation reduced certain inventory quantities which were valued at lower LIFO costs prevailing in prior years. The effect of this reduction was to increase net income by approximately $50 million. The similar effect in 1994 was not material.\nInventories carried under the LIFO method represented approximately 51 percent of total year-end inventory carrying values in 1994 and 47 percent in 1993. It is estimated that inventories would have been approximately $1,100 million higher than reported on December 31, 1994, and approximately $900 million higher on December 31, 1993, if the quantities valued on the LIFO basis were instead valued on the FIFO basis.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nNote 6. Property, Plant and Equipment\nInvestment in properties at December 31, 1994 and 1993, detailed by industry segment, was as follows:\nDecember 31 1994 1993 Gross Net Net (millions of dollars) Exploration and production: United States . . . . . . . . . . $ 15,559 $ 6,957 $ 6,935 Non-U.S. . . . . . . . . . . . . 13,771 5,037 5,008 Refining, marketing and transportation . . . . . . . . . . 9,940 5,654 5,797 Chemicals . . . . . . . . . . . . . 5,727 2,956 2,668 Other operations . . . . . . . . . 752 534 546 Corporate . . . . . . . . . . . . . 700 405 415 Total . . . . . . . . . . . . . $ 46,449 $ 21,543 $ 21,369\nNote 7. Short-Term Obligations\nAmoco's short-term obligations consist of notes payable and commercial paper. Notes payable as of December 31, 1994, totaled $7 million at an average annual interest rate of 5.7 percent, compared with $71 million at an average annual interest rate of 3.2 percent at year-end 1993. Commercial paper borrowings at December 31, 1994, were $217 million at an average annual interest rate of 5.9 percent compared with $936 million at an average annual interest rate of 3.4 percent as of December 31, 1993.\nBank lines of credit available to support commercial paper borrowings of the Corporation amounted to $490 million at both December 31, 1994 and 1993. All of these were supported by commitment fees.\nThe Corporation also maintains compensating balances with a number of banks for various purposes. Such arrangements do not legally restrict withdrawal or usage of available cash funds. In the aggregate, they are not material in relation to total liquid assets.\nNote 8. Accounts Payable\nAccounts payable at December 31, 1994 and 1993, included liabilities in the amount of $306 million and $304 million, respectively, for checks\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nissued in excess of related bank balances but not yet presented for collection.\nNote 9. Long-Term Debt\nAmoco's long-term debt resides principally with two Amoco subsidiaries--Amoco Company and Amoco Canada. Amoco Company functions as the principal holding company for substantially all of Amoco's petroleum and chemical operations, except Canadian petroleum operations and selected other activities.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe components of long-term debt and year-end rates are summarized as follows: December 31 1994 1993 (millions of dollars) Amoco Company 8 5\/8% Debentures due 2016 . . . . . . . . . . . $ 52 $ 102 9 3\/4% Debentures due 2016 . . . . . . . . . . . 58 78 9 7\/8% Debentures due 2016 . . . . . . . . . . . 25 25 Environmental and other industrial development obligations . . . . . . . . . . . . . . . . . . . 649 619 U.K. Loans-6.7% Sterling(1) . . . . . . . . . . . 596 565 -5.6% U.S. dollar(1) . . . . . . . . . 195 195 Other indebtedness . . . . . . . . . . . . . . . 535 435 Subtotal . . . . . . . . . . . . . . . . . . . 2,110 2,019 Less current maturities . . . . . . . . . . . . . 24 52 Total Amoco Company . . . . . . . . . . . . . . 2,086 1,967 Amoco Canada 6 3\/4% Debentures due 2005 . . . . . . . . . . . 299 299 7 1\/4% Notes due 2002 . . . . . . . . . . . . . . 299 299 6 3\/4% Debentures due 2023 . . . . . . . . . . . 296 296 7.95% Debentures due 2022 . . . . . . . . . . . . 296 296 7 1\/4% Notes due 2002 . . . . . . . . . . . . . . 254 254 7 3\/8% Subordinated Exchangeable Debentures (SEDs) due 2013(2) . . . . . . . . . . . . . . . . 458 457 Other . . . . . . . . . . . . . . . . . . . . . . 35 36 Subtotal . . . . . . . . . . . . . . . . . . . 1,937 1,937 Less current maturities . . . . . . . . . . . . . -- -- Total Amoco Canada . . . . . . . . . . . . . . 1,937 1,937 Other subsidiaries (less current maturities) . . . 364 133 Total long-term debt . . . . . . . . . . . . . . . $ 4,387 $ 4,037\n(1)Weighted average interest rate at December 31, 1994. (2)The SEDs are exchangeable for Amoco common stock at $52.50 per share.\nAmoco Corporation guarantees the outstanding public debt obligations of Amoco Company. Amoco Corporation and Amoco Company guarantee the notes and debentures of Amoco Canada, except for the SEDs.\nAmProp Inc., a real estate subsidiary, had long-term debt secured by real estate assets, totaling $61 million at year-end 1994, and $88 million at year-end 1993, which is not guaranteed by Amoco Corporation or Amoco Company.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nAnnual maturities of total long-term debt during the next five years, including the portion classified as current, are $24 million in 1995, $720 million in 1996, $211 million in 1997, $247 million in 1998 and $134 million in 1999.\nNote 10. Capital Stock\nThere were 800,000,000 shares of common stock without par value authorized at December 31, 1994. Details concerning share transactions are shown below:\nIn addition, there are 50 million shares of voting preferred stock and 50 million shares of non-voting preferred stock authorized. As of December 31, 1994, none of the preferred stock had been issued.\nNote 11. Leases\nThe Corporation leases various types of properties, including service stations, tankers, buildings, railcars and other facilities, some of which are subleased to others, through operating leases. Some of the leases and subleases provide for contingent rentals based on refined product throughput.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nSummarized below as of December 31, 1994, are future minimum rentals payable and related sublease rental income for operating leases.\nRentals Rental Payable Income (millions of dollars) 1995 . . . . . . . . . . . . . . . . $ 191 $ 167 1996 . . . . . . . . . . . . . . . . 163 100 1997 . . . . . . . . . . . . . . . . 146 45 1998 . . . . . . . . . . . . . . . . 135 7 1999 . . . . . . . . . . . . . . . . 126 4 After 1999 . . . . . . . . . . . . . 487 28 Total minimum rentals . . . . . . . $ 1,248 $ 351\nRental expense and related rental income applicable to operating leases for the three years ended December 31, 1994, are summarized below:\n1994 1993 1992 (millions of dollars)\nMinimum rental expense . . . . . . . . . . $ 252 $ 229 $ 253 Contingent rental expense . . . . . . . . . 19 16 23 Total . . . . . . . . . . . . . . . . . . 271 245 276 Less--Related rental income . . . . . . . . 172 84 85 Net rental expense . . . . . . . . . . . $ 99 $ 161 $ 191\nNote 12. Foreign Currency\nA foreign currency gain of $24 million was reflected in income in 1994, compared with gains of $47 million and $129 million for 1993 and 1992, respectively. In addition, a net translation gain of $32 million in 1994, and net translation losses of $18 million and $27 million for 1993 and 1992, respectively, were reflected in the foreign currency translation adjustment account in shareholders' equity.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nNote 13. Interest Expense\nThe Corporation capitalizes interest cost related to the financing of major projects under development. All other interest is expensed as incurred. The components of interest expense are summarized in the following table: 1994 1993 1992 (millions of dollars) Short-term obligations . . . . . . . . $ 19 $ 14 $ 13 Long-term obligations . . . . . . . . . 269 285 320 Total external financing . . . . . . 288 299 333 Other interest expense . . . . . . . . 30 39 (67) 318 338 266 Less--capitalized interest . . . . . . -- 13 19 Net interest expense . . . . . . . . $ 318 $ 325 $ 247\nNote 14. Research and Development Expenses\nResearch and development costs are expensed as incurred and amounted to $255 million in 1994, $292 million in 1993 and $300 million in 1992.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nNote 15. Taxes\nEffective January 1, 1992, the Corporation adopted SFAS No. 109. The cumulative effect was to increase deferred income tax liabilities as of January 1, 1992, and reduce net income by $68 million ($.14 per share). Also, 1992 net income before the cumulative effect was $215 million ($.43 per share) greater than it would have been under the previous method.\nThe aggregate federal and foreign deferred income tax balance represents the tax effect of the following items at December 31: 1994 1993 (millions of dollars) Tax credit and loss carryforwards . . . . . . $ 912 $ 630 Exploration costs . . . . . . . . . . . . . . 304 286 Postretirement benefits . . . . . . . . . . . 516 503 Environmental costs . . . . . . . . . . . . . 387 380 Other . . . . . . . . . . . . . . . . . . . . 578 507 Gross deferred tax assets . . . . . . . . . . 2,697 2,306 Deferred tax asset valuation allowance . . . (720) (573) Net deferred tax assets . . . . . . . . . . . $ 1,977 $ 1,733\nAccelerated depreciation . . . . . . . . . . $ 3,403 $ 3,367 Intangible drilling costs . . . . . . . . . . 707 679 Other . . . . . . . . . . . . . . . . . . . . 340 289 Deferred tax liabilities . . . . . . . . . . $ 4,450 $ 4,335\nThe increase in the deferred tax asset valuation allowance primarily reflects an increase in foreign tax credit carryforwards for which realization is considered unlikely.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe provision for income taxes is composed of:\n1994 1993 1992 (millions of dollars) Federal--current . . . . . . . . . . . $ 392 $ 104 $ 326 --deferred . . . . . . . . . . . (74) 162 (366) Foreign--current . . . . . . . . . . . 422 479 533 --deferred . . . . . . . . . . . (47) (77) (370) State and local . . . . . . . . . . . . 9 19 30 $ 702 $ 687 $ 153\nThe following is a reconciliation between the provision for income taxes and income taxes determined by applying the federal statutory rate to income before income taxes:\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nTaxes other than income taxes include: 1994 1993 1992 (millions of dollars) Consumer excise taxes . . . . . . . . . . . . . $ 3,409 $ 2,824 $ 2,738 Production and severance taxes United States . . . . . . . . . . . . . . . . 112 128 121 Foreign . . . . . . . . . . . . . . . . . . . 73 110 363 Property taxes . . . . . . . . . . . . . . . . 289 315 287 Social Security, corporation and other taxes . 270 271 235 $ 4,153 $ 3,648 $ 3,744\nUndistributed earnings of certain foreign subsidiaries and joint-venture companies aggregated $499 million on December 31, 1994, which, under existing law, will not be subject to U.S. tax until distributed as dividends. Since the earnings have been or are intended to be indefinitely reinvested in foreign operations, no provision has been made for any U.S. taxes that may be applicable thereto. Furthermore, any taxes paid to foreign governments on those earnings may be used in whole or in part, as credits against the U.S. tax on any dividends distributed from such earnings. It is not practicable to estimate the amount of unrecognized deferred U.S. taxes on these undistributed earnings.\nNote 16. Stock Option Plans\nThe Corporation's stock option plans approved by shareholders provide for the granting of options with or without stock appreciation rights (\"SARs\") to key, managerial and other eligible employees to buy Corporation common stock at not less than 100 percent of the fair market value at the date of grant. Such options may be incentive stock options to the extent provided in the Internal Revenue Code. Options granted under the plans prior to 1994 normally extend for 10 years and generally become exercisable two years after the date of the grant. Options granted in 1994 become exercisable 50 percent one year after the date of grant and 100 percent two years after the date of grant. Options with SARs permit holders to surrender exercisable options in exchange for payment determined by the amount by which the market value of the shares on the dates the rights are exercised exceeds the grant price. No options were granted with SARs in 1994. Such payments can be made in shares, cash or a combination at the discretion of the administering committee.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nOption plan transactions in 1993 and 1994 are summarized in the following table:\nThousands Price Range of Shares Per Share Options outstanding on Jan. 1, 1993 . . . . 9,259 $25.03 - 54.88 Granted . . . . . . . . . . . . . . 2,199 $53.69 - 57.44 Exercised . . . . . . . . . . . . . (615) $25.03 - 54.13 Surrendered or terminated . . . . . (172) $44.06 - 57.44 Canceled upon exercise of SARs . . (112) $25.03 - 52.44 Options outstanding on Dec. 31, 1993 . . . 10,559 $28.25 - 57.44 Granted . . . . . . . . . . . . . . 2,295 $55.06 - 57.88 Exercised . . . . . . . . . . . . . (684) $28.25 - 54.13 Surrendered or terminated . . . . . (454) $44.06 - 57.44 Canceled upon exercise of SARs . . (121) $28.25 - 42.50 Options outstanding on Dec. 31, 1994 . . . 11,595 $29.81 - 57.88\nOf the total options outstanding on December 31, 1994, 499,140 were with SARs. Stock options for 7,537,234 shares were exercisable at year-end 1994. No options may be granted under the current plan after December 31, 2001.\nThe Corporation's restricted stock grant plans provide for the awarding of shares of Corporation common stock to selected employees of Amoco and its participating subsidiaries, including officers and directors. Shares issued under the plans may not be sold or otherwise transferred for a minimum period as established at the time of the grant. The shares generally are subject to forfeiture if the recipient's employment terminates during the specified period unless such termination is due to death, total disability or involuntary retirement. Shares issued have dividend and voting rights identical to other outstanding shares of the Corporation's common stock. During 1994, 57,735 shares were issued under the current plans. No restricted shares may be issued under the current plan after December 31, 2001.\nNote 17. Employee Compensation Programs\nManagement incentive compensation plans approved by shareholders provide for the granting of awards to key, managerial and other eligible executives of the Corporation and certain subsidiaries. Amounts charged against earnings in anticipation of awards to be made later were $15 million in 1994, $10 million in 1993 and $8 million in 1992. Awards made in 1994, 1993 and 1992 amounted to $21 million, $13 million and $16 million, respectively.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe Amoco Performance Share Plan, which became effective in 1992, allocates Amoco stock to eligible employees when the Corporation's total return to shareholders meets or exceeds the average return achieved by a select group of competitors. In 1994, the return on Amoco stock, based on the average return for the past three years, was above the competitor three-year average. As a result, employees earned stock equal to 3.5 percent of compensation. No contributions were made on behalf of employees in 1993 as the return on Amoco common stock was below the competitor average. In 1992 the return on Amoco stock was above the competitor average, resulting in employees earning stock equal to 4.4 percent of compensation. The amounts charged to expense in 1994 and 1992 were $59 million and $77 million, respectively.\nNote 18. Retirement Plans\nThe Corporation and its subsidiaries have a number of defined benefit pension plans covering most employees. Plan benefits are generally based on employees' years of service and average final compensation. Essentially all of the cost of these plans is borne by the Corporation. The Corporation makes contributions to the plans in amounts that are intended to provide for the cost of pension benefits over the service lives of employees.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe funded status of the plans as of December 31 for 1994 and 1993 was as follows:\n* Accumulated benefits totaling $266 million and $192 million were non- vested at December 31, 1994 and 1993, respectively.\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe actuarial assumptions used for the Corporation's principal pension plans for 1994 and 1993 were as follows:\n1994 1993\nDiscount rate for service and interest cost . . . . . . 7.0% 7.5% Discount rate for the projected benefit obligation . . 8.5% 7.0% Rate of compensation increase for the projected benefit obligation . . . . . . . . . . . . . . . . . . . . . . 5.0% 5.0% Long-term rate of return on assets . . . . . . . . . . 10.0% 10.0%\nThe components of net pension cost for the past three years were as follows:\n1994 1993 1992 (millions of dollars) Service cost--benefits earned during the period . . . . . . . . . . . . . . . . . $ 113 $ 102 $ 114 Interest cost on projected benefit obligation . . . . . . . . . . . . . . . 221 204 221\nActual loss (gain) on assets . . . . . . 53 (302) (141) Less--unrecognized (loss) gain . . . . . (311) 50 (124) Recognized gain on assets . . . . . . . . (258) (252) (265) Curtailment loss (gain) . . . . . . . . . 21 -- (51) Amortization of unrecognized amounts . . 22 1 11 Net pension cost . . . . . . . . . . . . $ 119 $ 55 $ 30\nMost employees are also eligible to participate in defined contribution plans by contributing a portion of their compensation. The Corporation matches contributions up to specified percentages of each employee's compensation. Matching contributions charged to income were $99 million in 1994, $96 million in 1993 and $100 million in 1992.\nNote 19. Other Postretirement Benefits\nThe Corporation and its subsidiaries provide certain health care and life insurance benefits for retired employees. Substantially all of the Corporation's domestic employees and employees in certain foreign countries are provided these benefits through insurance companies whose premiums are based on benefits paid during the year. Effective January 1, 1992, the Corporation adopted SFAS No. 106, which requires that the cost of such benefits be recognized during employees' years of active service. The cumulative effect of the accounting change relating to benefits attributable to years of service prior to 1992 was to reduce\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\n1992 net income by $856 million ($1.72 per share). In addition, the effect of adopting SFAS No. 106 in 1992 was to reduce net income by $64 million ($.13 per share). During 1992, the Corporation approved plan amendments which reduced the accumulated obligation by $270 million, which is being amortized prospectively.\nThe status of the Corporation's unfunded plans as of December 31 for 1994 and 1993 was as follows:\n1994 1993 (millions of dollars) Accumulated benefit obligation Retirees . . . . . . . . . . . . . . . . . . . . . $ 603 $ 668 Fully eligible active plan participants . . . . . 156 116 Other active plan participants . . . . . . . . . . 281 475 Total . . . . . . . . . . . . . . . . . . . . . . 1,040 1,259 Unrecognized net gains (losses) . . . . . . . . . . . 240 (56) Unrecognized prior service gains . . . . . . . . . . 215 247 Accrued postretirement benefit cost . . . . . . . . . $ 1,495 $ 1,450\nThe actuarial assumptions used for the Corporation's principal postretirement benefit plans for 1994 and 1993 were as follows:\n1994 1993 Discount rate for service and interest cost . . . . . 7.0% 8.0% Discount rate for the accumulated benefit obligation 8.5% 7.0% Rate of compensation increase for the accumulated benefit obligation . . . . . . . . . . . . . . . . . 5.0% 5.0% Assumed current year health care cost trend rate --retirees under 65 . . . . . . . . . . . . . . . 11.1% 12.0% --Medicare eligible retirees . . . . . . . . . . . 8.5% 9.0% Assumed ultimate trend rate . . . . . . . . . . . . . 5.0% 5.0% Year ultimate health care cost rate will be achieved 2002 2002 Effect of 1% increase in health care cost trend rates (millions) --annual aggregate service and interest costs . . $ 18 $ 17 --accumulated postretirement benefit obligation . $ 93 $144\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nThe components of net postretirement benefit costs for the past three years were as follows:\n1994 1993 1992 (millions of dollars) Service cost--benefits earned during the period . . . . . . . . . . . . . . . . . $ 34 $ 32 $ 44 Interest cost on accumulated benefit obligation . . . . . . . . . . . . . . . 89 97 105 Amortization and other . . . . . . . . . (33) (22) (10) Net postretirement benefit cost . . . . . $ 90 $ 107 $ 139\nNote 20. Litigation\nThe Internal Revenue Service (\"IRS\") has challenged the application of certain foreign income taxes as credits against the Corporation's U.S. taxes that otherwise would have been payable for the years 1980 through 1989. On June 18, 1992, the IRS issued a statutory Notice of Deficiency for additional taxes in the amount of $466 million, plus interest, relating to 1980 through 1982. The Corporation has filed a petition in the U.S. Tax Court contesting the IRS statutory Notice of Deficiency. Trial on the matter is scheduled to commence in April 1995. A comparable adjustment of foreign tax credits for each year has been proposed for the years 1983 through 1989 based upon subsequent IRS audits. Similar challenges could arise relating to years subsequent to 1989. The Corporation believes that the foreign income taxes have been reflected properly in its U.S. federal tax returns. The Corporation is confident that it will prevail in the litigation. Consequently, this dispute is not expected to have a material adverse effect on liquidity, results of operations, or the consolidated financial position of the Corporation.\nNote 21. Other Contingencies\nAmoco is subject to federal, state and local environmental laws and regulations. Amoco is currently participating in the cleanup of numerous sites pursuant to such laws and regulations. The reasonably estimable future costs of probable environmental obligations, including Amoco's probable costs for obligations for which Amoco is jointly and severally liable, and for assets or businesses that were previously disposed, have been provided for in the Corporation's results of operations. These estimated costs represent the amount of expenditures expected to be incurred in the future to remediate sites with known environmental obligations. The accrued liability represents a reasonable best estimate of Amoco's remediation liability. As the scope of the obligations\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nbecomes better defined, there may be changes in the estimated future costs, which could result in charges against the company's future results of operations. The ultimate amount of any such future costs, and the range within which such costs can be expected to fall, cannot be determined. Although the costs could be significant, they are not expected to have a material effect on Amoco's liquidity or consolidated financial position.\nNote 22. Summarized Financial Data--Amoco Company\nThe Corporation's principal subsidiary, Amoco Company, is the holding company for substantially all petroleum and chemical operating subsidiaries except Amoco Canada. Amoco guarantees the outstanding public debt obligations of Amoco Company.\nSummarized financial data for Amoco Company are presented as follows: 1994 1993 1992 (millions of dollars) For the years ended December 31: Revenues (including excise taxes) . . . . $ 27,841 $ 25,930 $ 25,698 Operating profit . . . . . . . . . . . . $ 2,470 $ 2,595 $ 1,760 Net income(1) . . . . . . . . . . . . . . $ 1,878 $ 1,803 $ 1,226 At December 31: Current assets . . . . . . . . . . . . . $ 5,399 $ 4,383 $ 4,644 Total assets . . . . . . . . . . . . . . $ 24,549 $ 23,513 $ 23,645 Current liabilities . . . . . . . . . . . $ 4,142 $ 3,976 $ 3,949 Long-term obligations(2) . . . . . . . . $ 6,190 $ 1,967 $ 2,811 Deferred credits . . . . . . . . . . . . $ 4,584 $ 4,441 $ 4,257 Minority interest . . . . . . . . . . . . $ 5 $ -- $ -- Shareholder's equity(2) . . . . . . . . . $ 9,628 $ 13,129 $ 12,628\n(1) Excludes cumulative effects of accounting changes of $(702) million in 1992. (2) Change reflects dividends in 1994 to Amoco Corporation of intercompany notes receivable from subsidiaries.\nAnnual maturities of long-term debt during the next five years, including the portion classified as current, are $24 million in 1995, $658 million in 1996, $187 million in 1997, $247 million in 1998 and $134 million in 1999.\nNote 23. Segment and Geographic Data\nThe Corporation operates in several industry segments. Petroleum operations include exploration and production (\"E&P\") and refining,\nAMOCO CORPORATION AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)\nmarketing and transportation (\"RM&T\") segments. The E&P segment is engaged in exploring for, developing and producing crude oil and natural gas and extraction of natural gas liquids (\"NGL\"). The RM&T segment is responsible for petroleum refining operations, the marketing of all refined petroleum products and the transportation and wholesale marketing of NGL and domestic natural gas. This segment also encompasses transportation of crude oil to refineries via marine vessels and pipelines and associated supply and trading activities. The chemical segment manufactures and sells various petroleum-based chemical products. Other operations include investments in technology companies, offshore contract drilling, real estate interests, and other activities.\nIntersegment and intergeographic sales are accounted for at prices that approximate arm's-length market prices. Operating profits include all revenues and expenses of the reportable segment, except for income taxes and equity in earnings of unconsolidated companies. Income taxes are generally assigned to the operations that give rise to the tax effects.\nIdentifiable assets are those used in the operations of each segment or area, including intersegment or intergeographic receivables. Corporate assets consist primarily of cash, marketable securities and the unamortized cost of purchased tax benefits. Intersegment and intergeographic sales and receivables are eliminated in determining consolidated revenue and identifiable asset totals. Information by Industry Segment and Geographic Area is summarized in the tables on pages 65 to 68.\nStatement of Information by Industry Segment\n(millions of dollars) Petroleum Operations Exploration Refining, and Marketing and Chemical Production Transportation Operations Year 1994 Revenues other than intersegment sales . . . . . . . . . . . . . $ 2,568 $ 22,555 $ 4,593 Intersegment sales . . . . . . 3,892 976 69 Total revenues . . . . . . . $ 6,460 $ 23,531 $ 4,662 Operating profit . . . . . . . $ 1,585 $ 591 $ 684 Equity in earnings of others . 4 31 98 General corporate amounts . . . Interest expense . . . . . . . Income taxes . . . . . . . . . (602) (204) (244) Net income . . . . . . . . . $ 987 $ 418 $ 538 Depreciation and related charges $ 1,531 $ 444 $ 195 Capital expenditures . . . . . $ 1,561 $ 451 $ 467 Identifiable assets . . . . . . $ 13,390 $ 7,881 $ 4,375 Equity investments and related advances . . . . . . . . . . . $ 34 $ 32 $ 351\nOther Consol- Operations Corporate idated*\nYear 1994 Revenues other than intersegment sales . . . . . . . . . . . . . $ 144 $ 30,362 Intersegment sales . . . . . . -- -- Total revenues . . . . . . . $ 144 $ 30,362 Operating profit . . . . . . . $ (248) $ 2,612 Equity in earnings of others . -- 133 General corporate amounts . . . $ 64 64 Interest expense . . . . . . . (318) (318) Income taxes . . . . . . . . . 93 255 (702) Net income . . . . . . . . . $ (155) $ 1 $ 1,789 Depreciation and related charges $ 32 $ 37 $ 2,239 Capital expenditures . . . . . $ 48 $ 45 $ 2,572\nIdentifiable assets . . . . . . $ 586 $ 2,678 $ 28,896 Equity investments and related advances . . . . . . . . . . . $ 3 420 Total assets . . . . . . . . $ 29,316\n* After elimination of intersegment transactions.\nStatement of Information by Industry Segment\n(millions of dollars) Petroleum Operations Exploration Refining, and Marketing and Chemical Production Transportation Operations Year 1993 Revenues other than intersegment sales . . . . . . . . . . . . . $ 2,631 $ 22,021 $ 3,699 Intersegment sales . . . . . . 4,057 893 74 Total revenues . . . . . . . $ 6,688 $ 22,914 $ 3,773 Operating profit . . . . . . . $ 1,563 $ 1,237 $ 321 Equity in earnings of others . -- 30 60 General corporate amounts . . . Interest expense . . . . . . . Income taxes . . . . . . . . . (568) (441) (141) Net income . . . . . . . . . $ 995 $ 826 $ 240 Depreciation and related charges $ 1,518 $ 419 $ 182 Capital expenditures . . . . . $ 1,590 $ 685 $ 370 Identifiable assets . . . . . . $ 13,822 $ 8,108 $ 3,938 Equity investments and related advances . . . . . . . . . . . $ 31 $ 32 $ 234\nOther Consol- Operations Corporate idated*\nYear 1993 Revenues other than intersegment sales . . . . . . . . . . . . . $ 166 $ 28,617 Intersegment sales . . . . . . 24 -- Total revenues . . . . . . . $ 190 $ 28,617 Operating profit . . . . . . . $ (75) $ 3,046 Equity in earnings of others . (1) 89 General corporate amounts . . . $ (303) (303) Interest expense . . . . . . . (325) (325) Income taxes . . . . . . . . . 31 432 (687) Net income . . . . . . . . . $ (45) $ (196) $ 1,820 Depreciation and related charges $ 30 $ 44 $ 2,193 Capital expenditures . . . . . $ 126 $ 46 $ 2,817\nIdentifiable assets . . . . . . $ 633 $ 2,051 $ 28,185 Equity investments and related advances . . . . . . . . . . . $ 4 301 Total assets . . . . . . . . $ 28,486\n* After elimination of intersegment transactions.\nStatement of Information by Industry Segment\n(millions of dollars) Petroleum Operations Exploration Refining, and Marketing and Chemical Production Transportation Operations Year 1992 Revenues other than intersegment sales . . . . . . . . . . . . . $ 2,812 $ 21,282 $ 3,807 Intersegment sales . . . . . . 4,165 981 113 Total revenues . . . . . . . $ 6,977 $ 22,263 $ 3,920 Operating profit . . . . . . . $ 1,149 $ 664 $ (174) Equity in earnings of others . (2) 25 31 General corporate amounts . . . Interest expense . . . . . . . Income taxes . . . . . . . . . (276) (227) 49 Net income (loss) . . . . . . $ 871 $ 462 $ (94) Depreciation and related charges $ 1,751 $ 390 $ 189 Capital expenditures . . . . . $ 1,092 $ 806 $ 320 Identifiable assets . . . . . . $ 13,909 $ 8,135 $ 3,592 Equity investments and related advances . . . . . . . . . . . $ 85 $ 26 $ 188\nOther Consol- Operations Corporate idated*\nYear 1992 Revenues other than intersegment sales . . . . . . . . . . . . . $ 155 $ 28,219 Intersegment sales . . . . . . 48 -- Total revenues . . . . . . . $ 203 $ 28,219 Operating profit . . . . . . . $ (225) $ 1,414 Equity in earnings of others . (9) 45 General corporate amounts . . . $ (209) (209) Interest expense . . . . . . . (247) (247) Income taxes . . . . . . . . . 55 246 (153) Cumulative effects of accounting changes . . . . . . . . . (924) Net income (loss) . . . . . . $ (179) $ (210) $ (74) Depreciation and related charges $ 61 $ 49 $ 2,440 Capital expenditures . . . . . $ 60 $ 56 $ 2,334\nIdentifiable assets . . . . . . $ 633 $ 2,199 $ 27,951 Equity investments and related advances . . . . . . . . . . . $ 203 502 Total assets . . . . . . . . $ 28,453\n*After elimination of intersegment transactions.\n(1) After elimination of intergeographic transactions. (2) Includes cumulative effects of accounting changes of $(924) million in 1992.\nAMOCO CORPORATION AND SUBSIDIARIES\nSUPPLEMENTAL INFORMATION\n1. Quarterly Results and Stock Market Data\n2. Oil and Gas Exploration and Production Activities\nSupplemental information about oil and gas exploration and production activities is reported in compliance with SFAS No. 69, \"Disclosures about Oil and Gas Producing Activities.\"\nResults of Operations for Oil and Gas Producing Activities\nCertain data for 1993 have been reclassified.\nOil and gas production revenues reflect the market prices of net production sold or transferred, with appropriate adjustments for royalties, net profits interest and other contractual provisions. Other revenues in 1994 include the U.S. COET settlement; other revenues in 1993 include Canadian gains on dispositions of properties and investments. Taxes other than income include production and severance taxes and property taxes. Other production costs are lifting costs incurred to operate and maintain productive wells and related equipment, including such costs as operating labor, repairs and maintenance, materials, supplies and fuel consumed. Also included are operating costs of field natural gas liquids plants, because the Corporation includes the operations of these plants in the exploration and production segment. Production costs include related administrative expenses and depreciation applicable to support equipment associated with production activities.\nExploration expenses include the costs of geological and geophysical activity, carrying and retaining undeveloped properties and drilling exploratory wells determined to be non-productive. Depreciation, depletion and amortization expense relates to capitalized costs incurred in acquisition, exploration and development activities and does not include depreciation applicable to support equipment. Included in other related costs are significant, non-recurring items and purchases of natural gas for field natural gas liquids plants. Significant, non- recurring items include $102 million for restructuring in 1994; $210 million for the writedown of Congo operations to current recoverable value and U.S. environmental charges of $96 million in 1993; and restructuring charges of $566 million in 1992.\nIncome taxes are generally assigned to the operations that give rise to the tax effects. Results of operations do not include interest expense and general corporate amounts nor their associated tax effects.\nStandardized Measure of Discounted Future Net Cash Flows Relating to Proved Oil and Gas Reserves\nThe standardized measure of discounted future net cash flows relating to proved oil and gas reserves is prescribed by SFAS No. 69. The statement requires measurement of future net cash flows through assignment of a monetary value to proved reserve quantities and changes therein using a standardized formula. The amounts shown are based on prices and costs at the end of each period, legislated tax rates and a 10 percent annual discount factor. Because the calculation assumes static economic and political conditions and requires extensive judgment in estimating the timing of production, the resultant future net cash flows are not necessarily indicative of the fair market value of estimated proved reserves, but provide a reference point that may assist the user in projecting future cash flows.\nSummarized below is the standardized measure of discounted future net cash flows relating to proved oil and gas reserves at December 31, 1994, 1993 and 1992.\nFuture cash inflows are computed by applying the year-end prices of oil and gas to proved reserve quantities as reported in the tables under\nthe heading \"Estimated Proved Reserves.\" Future price changes are considered only to the extent provided by contractual arrangements. Future development and production costs are estimated expenditures to develop and produce the proved reserves based on year-end costs and assuming continuation of existing economic conditions. Future income taxes are calculated by applying appropriate statutory tax rates to future pre-tax net cash flows from proved oil and gas reserves less recovery of the tax basis of proved properties, and adjustments for permanent differences.\nStatement of Changes in Standardized Measure of Discounted Future Net Cash Flows\nThe following table details the changes in the standardized measure of discounted future net cash flows for the three years ended December 31, 1994:\nCertain data for 1993 have been reclassified.\nThe price of crude oil has fluctuated over the past several years, and price changes have had significant effects on the computed future cash flows over the period shown. Because the price of crude oil is likely to remain volatile in the future, price changes can be expected to continue to significantly affect the standardized measure of future net cash flows.\nEstimated Proved Reserves\nNet proved reserves of crude oil (including condensate), natural gas liquids (\"NGL\") and natural gas at the beginning and end of 1994, 1993 and 1992, with the detail of changes during those years, are presented below. Reported quantities include reserves in which the Corporation holds an economic interest under production-sharing and other types of operating agreements with foreign governments. The estimates were prepared by Corporation engineers and are based on current technology and economic conditions. The Corporation considers such estimates to be reasonable and consistent with current knowledge of the characteristics and extent of proved production. These estimates include only those amounts considered to be proved reserves and do not include additional amounts that may result from extensions of currently proved areas, or amounts that may result from new discoveries in the future, or from application of secondary or tertiary recovery processes not yet determined to be commercial. Proved developed reserves are those reserves that are expected to be recovered through existing wells with existing equipment and operating methods.\n*Excludes non-leasehold NGL production attributable to processing plant ownership of approximately 10 million barrels for each of 1992, 1993 and 1994.\nCapitalized Costs\nThe following table summarizes capitalized costs for oil and gas exploration and production activities, and the related accumulated depreciation, depletion and amortization.\nCosts Incurred\nProperty acquisition costs include costs incurred to purchase, lease or otherwise acquire oil and gas properties. Exploration costs include the costs of geological and geophysical activity, carrying and retaining undeveloped properties and drilling and equipping exploratory wells. Development costs include the costs of drilling and equipping development wells, CO2 and certain other injected materials for enhanced recovery projects and facilities to extract, treat and gather and store oil and gas. Exploration and development costs include administrative expenses and depreciation applicable to support equipment associated with these activities. Costs incurred summarized below include both amounts expensed and capitalized.\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 with respect to directors is incorporated by reference to pages 3-10 of Amoco's Proxy Statement dated March 13, 1995. Also, see heading \"Executive Officers of the Registrant\" on page 19 of this Form 10-K.\nItem 11.","section_11":"Item 11. Executive Compensation\nThe information required by this item is incorporated by reference to pages 11-19 of Amoco's Proxy Statement dated March 13, 1995. Information related to the Board Compensation and Organization Committee Report on Executive Compensation and the Cumulative Total Shareholder Return Five-Year Comparison graph are identified separately therein and are not incorporated herein.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nThe information required by this item is incorporated by reference to pages 3, 10, 13 and 14 of Amoco's Proxy Statement dated March 13, 1995.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nThe information required by this item is incorporated by reference to page 10 of Amoco's Proxy Statement dated March 13, 1995.\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\nSee Index to Financial Statements and Supplemental Information on page 36.\nSchedules not included in this Form 10-K have been omitted because they are either not applicable or the required information is shown in the financial statements or notes thereto.\n3. Exhibits\nSee Index to Exhibits on page 84.\n(b) Reports on Form 8-K.\nNo reports on Form 8-K were filed during the quarter ended December 31, 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, in the City of Chicago, and State of Illinois, on the 21st day of March, 1995.\nAMOCO CORPORATION (Registrant)\nJOHN L. CARL John L. Carl 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 indicated on March 21, 1995.\nSignatures Titles\nChairman of the Board, President, H. LAURANCE FULLER * and Director H. Laurance Fuller (Principal Executive Officer)\nExecutive Vice President and Chief JOHN L. CARL* Financial Officer John L. Carl (Principal Financial Officer)\nJ. R. REID Vice President and Controller J. R. Reid (Principal Accounting Officer)\nL. D. THOMAS* Vice Chairman and Director L. D. Thomas\nPATRICK J. EARLY* Vice Chairman and Director Patrick J. Early\nDONALD R. BEALL* Director Donald R. Beall\nSignatures Titles\nRUTH BLOCK* Director Ruth Block\nJOHN H. BRYAN* John H. Bryan Director\nERROLL B. DAVIS, JR.* Director Erroll B. Davis, Jr.\nRICHARD FERRIS* Director Richard Ferris\nF. A. MALJERS* Director F. A. Maljers*\nROBERT H. MALOTT* Director Robert H. Malott\nW. E. MASSEY* Director W. E. Massey\nMARTHA R. SEGER* Director Martha R. Seger\nMICHAEL WILSON* Michael Wilson Director\nRICHARD D. WOOD* Director Richard D. Wood\n*By JOHN L. CARL Individually and as Attorney-in-Fact John L. Carl\nSCHEDULE VIII\nAMOCO CORPORATION\nVALUATION AND QUALIFYING ACCOUNTS(1)\n(1) Reserves were deducted from the assets to which they apply in the Consolidated Statement of Financial Position.\n(2) Accounts written off less recoveries and other adjustments.\nAMOCO CORPORATION\nINDEX TO EXHIBITS","section_15":""}
{"filename":"357099_1994.txt","cik":"357099","year":"1994","section_1":"Item 1. Business\nGeneral Development of Business\nHutton\/ConAm Realty Investors 2 (the \"Registrant\" or the \"Partnership\") is a California limited partnership in which RI 2 Real Estate Services Inc. (\"RI 2 Services\", formerly Hutton Real Estate Services V, Inc.), a Delaware corporation, and ConAm Property Services II, Ltd., a California limited partnership (\"ConAm Services\"), are the general partners (together, the \"General Partners\").\nCommencing July 9, 1982, the Registrant began offering through E.F. Hutton & Company Inc., of the Registrant, up to a maximum of 80,000 units of limited partnership interest (the \"Units\") at $500 per Unit. Investors who purchased the Units (the \"Limited Partners\") are not required to make any additional capital contributions. The Units were registered under the Securities Act of 1933, as amended (the \"Act\"), under Registration Statement No. 2-75519, which Registration Statement was declared effective on July 9, 1982. The offering of Units was terminated on October 8, 1982. Upon termination of the offering, the Registrant had accepted subscriptions for 80,000 Units for an aggregate of $40,000,000.\nNarrative Description of Business\nThe Registrant is engaged in the business of acquiring, operating and holding for investment multifamily residential properties, which by virtue of their location and design and the nature of the local real estate market have the potential for capital appreciation and generation of current income. As of December 31, 1994, all of the proceeds available for investment in real estate were invested in four joint ventures and one limited partnership, each of which owns a specified property. Funds held as a working capital reserve are invested in unaffiliated money market funds or other highly liquid short-term investments where there is appropriate safety in principal in accordance with the Registrant's investment objectives and policies.\nThe Registrant's principal investment objectives with respect to its interests in real property are:\n(1)\tcapital appreciation;\n(2) distributions of Net Cash From Operations attributable to rental income; and\n(3)\tpreservation and protection of capital.\nDistributions of Net Cash From Operations will be the Registrant's objective during its operational phase, while preservation and appreciation of capital will be the Registrant's long-term objectives. The attainment of the Registrant's objectives will depend on many factors, including future economic conditions in the United States as a whole and, in particular, in the localities in which the Registrant's properties are located, especially with regard to achievement of capital appreciation.\nFrom time to time the Registrant expects to sell its real property investments taking into consideration such factors as the amount of appreciation in value, if any, to be realized and the possible risks of continued ownership. In consideration of these factors and improving market conditions, the General Partners have begun marketing certain of the properties and recently entered into preliminary negotiations with an institutional buyer to sell Country Place Village I. There is no assurance that a sale will be completed or that any particular price for the properties can be obtained. No property will be sold, financed or refinanced by the Registrant without the agreement of both General Partners. Proceeds from any future sale, financing or refinancing of the properties will not be reinvested and may be distributed to the Limited Partners and General Partners (sometimes referred to herein as the \"Partners\"), so that the Registrant will, in effect, be self-liquidating. If deemed ne cessary, the Registrant may retain a portion of the proceeds from any sale, financing or refinancing as capital reserves. As partial payment for properties sold, the Registrant may receive purchase money obligations secured by mortgages or deeds of trust. In such cases, the amount of such obligations will not be included in Net Proceeds From Sale or Refinancing (distributable to the Partners) until and only to the extent the obligations are realized in cash, sold or otherwise liquidated.\nSince inception, the Registrant has acquired five residential apartment complexes (collectively, the \"Properties\") through investments in joint ventures and one limited partnership. As of December 31, 1994, the Registrant had interests in the Properties as follows: (1) Creekside Oaks, a 120-unit apartment complex located in Jacksonville, Florida; (2) Ponte Vedra Beach Village I, a 122-unit apartment complex located in Ponte Vedra Beach, Florida; (3) Rancho Antigua, a 220-unit apartment complex located in the McCormick Ranch area of Scottsdale, Arizona; (4) Country Place Village I, an 88-unit apartment complex located in Clearwater, Florida; and (5) Village at the Foothills I, a 60-unit apartment complex located in Tucson, Arizona. See Item 2","section_1A":"","section_1B":"","section_2":"Item 2. Properties\nBelow is a description of the Properties and a discussion of current market conditions in each of the areas where the Properties are located. For information on the purchase of the Properties, reference is made to Note 4 to the Consolidated Financial Statements on page 7 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, which is filed as an exhibit under Item 14. Appraised values of the Partnership's real estate investments are incorporated by reference to page 14 of the Partnership's Annual Report to Unitholders. Average occupancy rates at each property are incorporated by reference to page 2 of the Partnership's Annual Report to Unitholders.\nCountry Place Village I - Clearwater, Florida This 88-unit apartment complex is situated in northeastern Clearwater, on the Gulf Coast west of Tampa. The Clearwater apartment market remains strong, with an overall average occupancy of 95% during the fourth quarter of 1994. High occupancy has permitted increases in rental rates at many complexes, and the limited availability of vacant land for new construction has constrained new development in the area.\nCreekside Oaks - Jacksonville, Florida This 120-unit apartment complex is situated ten miles west of the Intracoastal Waterway in the Baymeadows\/Deerwood section of southeast Jacksonville. Significant prior period overbuilding has left the Baymeadows\/Deerwood area highly competitive for rental properties. Although market conditions have improved steadily over the past two years, many complexes continue to offer rental concessions to attract tenants. A survey of the Baymeadows\/Deerwood submarket indicated average occupancy of area apartments has climbed to 93% as of the second quarter of 1994, and average rental rates had increased approximately 5% from a year earlier. Average occupancy is rising in the Jacksonville area, with the market in a recovery stage which is steady albeit slow. New construction, however, has remained limited, with no new permits issued in 1992 or 1993, and only 370 units permitted in 1994.\nPonte Vedra Beach Village I - Ponte Vedra Beach, Florida Ponte Vedra Beach, an oceanfront community in southeast Jacksonville, is the location of this 122-unit apartment complex. The Ponte Vedra Beach area has experienced notable population growth and limited new construction in recent years, resulting in strong occupancy for area apartment complexes. A local survey of the Ponte Vedra Beach area reported an average apartment occupancy rate of 95% in the fourth quarter of fiscal 1994. Construction of new apartments has been limited in recent years; however, two residential projects are planned which would add approximately 120 new units in the area. The completion date of these projects remains uncertain and land available for further apartment development is limited.\nRancho Antigua - Scottsdale, Arizona This 220-unit apartment community is located eight miles northeast of Phoenix in southwest Scottsdale. Strong population and job growth have characterized Phoenix in recent years, bringing about favorable market conditions for apartment complexes in the area. A survey of the Scottsdale\/Paradise Valley submarket reported average occupancy of 96% as of the third quarter of 1994, and most area complexes have instituted rent increases in 1994. Construction, while limited in recent years, picked up in 1994 and eight projects in the Scottsdale\/Paradise Valley submarket were in the planning or construction phase as of the third quarter of 1994. The new supply is likely to limit rental rate increases in the coming year, however, the area's strong population and job growth are expected to keep pace with new supply.\nVillage at the Foothills I - Tucson, Arizona This 60-unit apartment community is situated in the \"foothills\" section of Tucson. Tucson continues to experience brisk population and job growth, which have fueled strong demand for apartment housing in recent years. A local survey of metropolitan Tucson conducted in the fourth quarter of fiscal 1994 showed an average occupancy rate of 96% among multifamily properties with five or more units. While construction of new units has been minimal during the past four years, eight new complexes commenced construction in 1994. When completed, these projects can be expected to compete with Village at the Foothills I.\nFour of the Partnership's five properties are encumbered by mortgage loans. See Note 5 to the Consolidated Financial Statements for a description of such mortgage financing.\nItem 3.","section_3":"Item 3. Legal Proceedings\nThe Registrant is not a party to, nor are any of the Properties the subject of, any material pending legal proceedings.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders\nDuring the fourth quarter of the year ended December 31, 1994, 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 Registrant's Limited Partnership Units and Related Security Holder Matters\nAs of December 31, 1994, the number of Unitholders of record was 4,264.\nNo established public trading market exists for the Units, and it is not anticipated that such a market will develop in the future.\nDistributions of Net Cash Flow From Operations, when made, are paid on a quarterly basis, with distributions generally occurring approximately 45 days after the end of each quarter. Such distributions have been made primarily from net operating income with respect to the Registrant's investment in the Properties and from interest on short-term investments, and partially from excess cash reserves. For a full accounting of the cash distributions paid to the Limited Partners during the past two years, reference is made to page 3 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, which is filed as an exhibit under Item 14.\nCash distributions to the Limited Partners were suspended from the first quarter of 1992 through the second quarter of 1994 in consideration of the costs related to the refinancing of the Partnership's four mortgage loans. Although the loans were refinanced in October 1993, the amount of such refinancing proceeds was less than outstanding amounts due under the maturing loans. Partnership cash reserves were used to meet this shortfall and to pay mortgage fees and establish escrows required under the new loans. As these payments substantially depleted the Partnership's cash reserve, cash distributions remained suspended until the third quarter of 1994 at which time the General Partners determined that the cash reserve had increased to a level considered adequate to meet anticipated funding needs. Accordingly, cash distributions to investors were reinstated commencing with the third quarter 1994 distribution in the quarterly amount of $2.75 per Unit. The level of future distributions will be evaluated on a quarterly basis.\nItem 6.","section_6":"Item 6. Selected Financial Data\nIncorporated by reference to page 3 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, which is filed as an exhibit under Item 14.\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, 1994, the Partnership had cash and cash equivalents of $1,183,787 which was invested in unaffiliated money market funds, compared with $558,731 at December 31, 1993. The increase is primarily attributable to net cash from operations exceeding cash used for distributions, mortgage principal payments, building improvements and mortgage fees. The Partnership also maintained a restricted cash balance of $779,328 at December 31, 1994, compared with $781,463 at December 31, 1993. The restricted cash balance represents escrows for required insurance deductibles, real estate taxes, and property replacements and repairs, required under the terms of the current mortgage loans. The General Partners expect sufficient cash flow to be generated from operations to meet its current operating expenses and debt service requirements.\nIn light of improving market conditions in certain of the areas where the Partnership's properties are located, the General Partners have begun marketing some of the properties and recently entered into preliminary negotiations with an institutional buyer to sell Country Place Village I. There is no assurance that a sale will be completed or that any particular price for the property can be obtained. In the event that a sale is completed, the General Partners intend to distribute the net proceeds following a review of the Partnership's cash reserve requirements.\nOn October 28, 1993, the General Partners obtained replacement financing on the Partnership's mortgages secured by Creekside Oaks, Ponte Vedra Beach Village I, Country Place Village I and Rancho Antigua. Since the proceeds of the current mortgage loans were significantly less than the amounts due on the prior mortgages, the Partnership used cash reserves of approximately $1.1 million to pay down principal balances. Additionally, $491,095 of Partnership cash reserves was used to pay refinancing expenses, and $995,372 was used to fund various escrows required by the new lender. See Note 5 to the Consolidated Financial Statements for additional information concerning the terms of the replacement financing.\nCash distributions to the limited partners were suspended from the first quarter of 1992 through the second quarter of 1994 in consideration of the costs related to the refinancing of the Partnership's four mortgage loans. Although the loans were refinanced in October 1993, cash outlays associated with the refinancing discussed above substantially depleted the Partnership's cash reserve, and cash distributions remained suspended until the third quarter of 1994, at which time the General Partners determined that the cash reserve had increased to a level considered adequate to meet anticipated funding needs. Accordingly, quarterly cash distributions to investors were reinstated commencing with the third quarter 1994 distribution in the amount of $2.75 per Unit. The level of future distributions will be evaluated on a quarterly basis.\nResults of Operations\n1994 versus 1993\nPartnership operations for the year ended December 31, 1994 resulted in net income of $37,325, compared with a net loss of $527,539 in 1993. After adding back depreciation and amortization, both non-cash expenses, and subtracting mortgage amortization, operations generated cash flow of $1,001,258 for the year ended December 31, 1994, compared with cash flow of $494,769 in 1993. The increase in cash flow and change from net loss to net income in 1994 is primarily the result of increased rental income and lower interest expense.\nRental income totaled $4,669,676 for the year ended December 31, 1994 compared with $4,429,975 in 1993. The increase in 1994 reflects higher rental income at all the properties, primarily due to rental rate increases instituted over the past year.\nProperty operating expenses totaled $2,262,915 for the year ended December 31, 1994, compared with $2,069,986 in 1993. The increase primarily reflects higher expenses at Rancho Antigua as repair and maintenance expense increased due to carpet replacement, asphalt resealing and general repairs, while rental administration expenses increased primarily due to higher utilities expense. Interest expense totaled $1,110,434 for the year ended December 31, 1994, compared with $1,686,402 in 1993. The decrease is due to lower interest rates and the reduction of approximately $1.1 million of the principal balances as a result of the replacement financing secured in late 1993. General and administrative expenses totaled $144,052 for the year ended December 31, 1994, compared with $153,236 in 1993. The decrease primarily reflects one-time expenses incurred in 1993 relating to the attempt at securing a loan for the Village at the Foothills I.\n1993 versus 1992\nPartnership operations for the year ended December 31, 1993 resulted in a net loss of $527,539 compared with a net loss of $408,905 in 1992. After adding back depreciation and amortization, non-cash expenses, and subtracting mortgage amortization, operations generated cash flow of $494,769 in 1993 compared with cash flow of $560,889 in 1992. The reduced cash flow and larger net loss in 1993 are primarily a result of higher property operating costs and, to a lesser extent, higher interest expense, which more than offset increased rental income.\nRental income for the year ended December 31, 1993 was $4,429,975 compared with $4,251,122 in 1992. The approximate 4% increase in 1993 is primarily the result of higher rental income from the Rancho Antigua property, reflecting higher average occupancy during 1993.\nProperty operating expenses were $2,069,986 for the year ended December 31, 1993, compared with $1,829,468 for 1992. The increase primarily reflects higher repair and maintenance expenses at Creekside Oaks, Rancho Antigua and Country Place Village I. Interest expense totalled $1,686,402 for the year ended December 31, 1993, compared with $1,632,135 for the year ended December 31, 1992. The increase reflects the higher default interest rates which were applied to the Partnership's loans beginning at the time of their maturity in May 1993 through the closing of the refinancing in October. General and administrative expenses totalled $153,236 for the year ended December 31, 1993, compared with $179,752 for 1992. The decrease is primarily attributable to reduced legal fees and lower postage costs for investor reports.\nThe average occupancy levels at each of the Properties for the years ended December 31, 1994, 1993 and 1992, were as follows:\nTwelve Months Ended December 31, Property 1994 1993 1992 Creekside Oaks 96% 94% 94% Ponte Vedra Beach Village I 96% 96% 96% Rancho Antigua 95% 95% 91% Country Place Village I 97% 95% 97% Village at the Foothills I 96% 96% 97%\nItem 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data\nThe financial statements are incorporated by reference to pages 4 - 13 of the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, which is filed as an exhibit under Item 14. Supplementary Data is incorporated by reference to page F - 1 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\nThe Registrant has no officers or directors. RI 2 Services and ConAm Services, the co-General Partners of the Registrant, jointly manage and control the affairs of the Registrant and have general responsibility and authority in all matters affecting its business.\nRI 2 Services\nRI 2 Services (formerly Hutton Real Estate Services V, Inc.) is a Delaware Corporation, formed on October 30, 1980, and is an affiliate of Lehman Brothers, Inc. See the section captioned \"Certain Matters Involving Affiliates of RI 2 Services\" for a description of the Hutton Group's acquisition by Shearson Lehman Brothers, Inc. (\"Shearson\") and the subsequent sale of certain of Shearson's domestic retail brokerage and asset management businesses to Smith Barney, Harris Upham & Co Incorporated (\"Smith Barney\"), which was followed by a change in the general partner's name.\nCertain officers and directors of RI 2 Services 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 names and ages of, as well as the positions held by, the directors and executive officers of RI 2 Services are set forth below. There are no family relationships between any executive officers or directors.\nName Age Office\nPaul L. Abbott 49 Director, President, Chief Financial Officer and Chief Executive Officer Janet M. Hoynes 30 Vice President Kate D. Hobson 28 Vice President\nPaul L. Abbott is a Managing Director of Lehman Brothers. Mr. Abbott joined Lehman Brothers in August 1988, and is responsible for investment management of residential, commercial and retail real estate. Prior to joining Lehman Brothers, Mr. Abbott was a real estate consultant and a senior officer of a privately held company specializing in the syndication of private real estate limited partnerships. From 1974 through 1983, Mr. Abbott was an officer of two life insurance companies and a director of an insurance agency subsidiary. Mr. Abbott received his formal education in the undergraduate and graduate schools of Washington University in St. Louis.\nJanet M. Hoynes is a Vice President at Lehman Brothers in the Diversified Asset Group and is responsible for asset management of residential real estate. Prior to joining Shearson in July 1989, she was employed as an analyst in a public real estate investment trust based in California. Ms. Hoynes received a B.A. in Economics from the State University of New York at Stony Brook in 1986.\nKate D. Hobson is an Assistant Vice President of Lehman Brothers and has been a member of the Diversified Asset Group since 1992. Prior to joining Lehman Brothers, Ms. Hobson was associated with Cushman & Wakefield serving as a real estate accountant from 1990 to 1992. Prior to that, Ms. Hobson was employed by Cambridge Systematics, Inc. as a junior land planner. Ms. Hobson received a B.A. degree in sociology from Boston University in 1988.\nConAm Services\nConAm Services is a California limited partnership organized on August 30, 1982. The sole general partner of ConAm Services is Continental American Development, Inc. (\"ConAm Development\"). The names and ages of, as well as the positions held by, the directors and executive officers of ConAm Development are set forth below. There are no family relationships between any executive officers or directors.\nName Age Office\nDaniel J. Epstein 55 President and Director Nancie Larimore 55 Secretary\/Treasurer and Director E. Scott Dupree 44 Vice President Robert J. Svatos 36 Vice President Ralph W. Tilley 40 Vice President\nDaniel J. Epstein has been the President and a Director of ConAm Development and ConAm Management (or its predecessor firm) and a general partner of Continental American Properties, Ltd. (\"ConAm\"), an affiliate of ConAm Services, since their inception. Prior to that time Mr. Epstein was Vice President and a Director of American Housing Guild, which he joined in 1969. At American Housing Guild, he was responsible for the formation of the Multi-Family Division and directed its development and property management activities. Mr. Epstein holds a Bachelor of Science degree in Engineering from the University of Southern California.\nNancie Larimore has been employed by ConAm Management or its affiliates since 1976 and has been a Vice President of ConAm Management (or its predecessor firm) and the Secretary\/Treasurer and a Director of ConAm Development since their inception. Ms. Larimore's responsibilities include leasing, consumer relations, advertising and promotion. From 1972 to 1975, she held a similar position with American Housing Guild. From 1969 to 1972, she was Director of Property Management for Larwin Group, Inc. Ms. Larimore is a graduate of the University of California at Los Angeles, and holds a Master's of Business Administration degree from the University of California at Los Angeles.\nE. Scott Dupree is a Vice President and general counsel of ConAm Management responsible for negotiation, documentation, review and closing of acquisition, sale and financing proposals. Mr. Dupree also acts as principal legal advisor on general legal matters ranging from issues and contracts involving the management company to supervision of litigation and employment issues. Prior to joining ConAm Management in 1985, he was corporate counsel to Trusthouse Forte, Inc., a major international hotel and restaurant corporation. Mr. Dupree holds a B.A. from United States International University and a Juris Doctorate degree from the University of San Diego.\nRobert J. Svatos is a Vice President and Chief Financial Officer of ConAm Management, and has been with the company since 1988. His responsibilities include the accounting, treasury and data processing functions of the organization. Mr. Svatos is part of the firm's due diligence team, analyzing a broad range of projects for ConAm Management's fee client base. Prior to joining ConAm Management, he was the Chief Financial Officer for AmeriStar Financial Corporation, a nationwide mortgage banking firm. Mr. Svatos holds an M.B.A. in Finance from the University of San Diego and a Bachelor of Science degree in Accounting from the University of Illinois. Mr. Svatos is a Certified Public Accountant.\nRalph W. Tilley is a Vice President and Treasurer of ConAm Management. He is responsible for the financial aspects of syndications and acquisitions, ConAm Management's asset management portfolio and risk management activities. Prior to joining ConAm Management in 1980, he was a senior accountant with KPMG Peat Marwick, specializing in real estate. He holds a Bachelor of Science degree in Accounting from San Diego State University and is a Certified Public Accountant.\nCertain Matters Involving Affiliates of RI 2 Services\nOn January 13, 1988, SLBP Acquisition Corp. (the \"Purchaser\"), a wholly-owned subsidiary of Shearson Lehman Brothers Holding Inc., acquired the right to purchase 29,610,000 shares of stock of the Hutton Group pursuant to a cash tender offer commenced on December 7, 1987. On January 21, 1988, the Purchaser assigned its right to purchase the shares so accepted to Shearson. Shearson purchased the 29,610,000 shares which constituted approximately 90% of the outstanding shares of the Hutton Group. Shearson subsequently acquired the remaining shares of the Hutton Group. Thus, the Hutton Group became a wholly-owned subsidiary of Shearson.\nOn July 31, 1993, Shearson sold certain of its domestic retail brokerage and asset management businesses to Smith Barney. Subsequent to the sale, Shearson changed its name to \"Lehman Brothers Inc.\". The transaction did not affect the ownership of the Partnership's General Partners. However, the assets acquired by Smith Barney included the name \"Hutton.\" Consequently, the Hutton Real Estate Services general partner changed its name to \"RI 2 Real Estate Services Inc.\", and the Hutton Group changed its name to \"LB I Group Inc.\" to delete any reference to \"Hutton.\"\nItem 11.","section_11":"Item 11. Executive Compensation\nNeither of the General Partners nor any of their directors or executive officers received any compensation from the Registrant. See Item 13 below with respect to a description of certain transactions between the General Partners or their affiliates and the Registrant.\nItem 12.","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management\nAs of December 31, 1994, no person was known by the Registrant to be the beneficial owner of more than five percent of the Units of the Registrant. Nancie Larimore, Secretary\/Treasurer and a Director of ConAm Development, owned four Units as of December 31, 1994. No other directors or executive officers of the General Partners own any Units.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions\nPursuant to the Amended and Restated Certificate and Agreement of Limited Partnership of the Registrant, for the year ended December 31, 1994, $3,732 of Registrant's net income was allocated to the General Partners ($2,488 to RI 2 Services and $1,244 to ConAm Services). For a description of the share of Net Cash From Operations and the allocation of income and loss to which the General Partners are entitled, reference is made to the material contained on pages 78 through 80 of the Prospectus of the Registrant dated July 9, 1982 ( the \"Prospectus\"), contained in Amendment No. 1 to Registrant's Registration Statement No. 2-75519, filed July 9, 1982, under the section captioned \"Profit and Losses and Cash Distributions,\" which section is incorporated herein by reference thereto.\nThe Registrant has entered into property management agreements with ConAm Management pursuant to which ConAm Management has assumed direct responsibility for day-to-day management of the Properties. It is the responsibility of ConAm Management to select resident managers and local property managers, where appropriate, and monitor their performance. ConAm Management's services also include the supervision of leasing, rent collection, maintenance, budgeting, employment of personnel, payment of operating expenses, and related services. For such services, ConAm Management is entitled to receive a management fee as described on pages 33 and 34 of the Prospectus under the caption \"Investment Objectives and Policies - Management of Properties,\" which description is herein incorporated by reference. A summary of property management fees earned by ConAm Management during the past three fiscal years is incorporated by reference to Note 6 to the Consolidated Financial Statements included in the Partnership's Annual Report to Unitholders for the year ended December 31, 1994, which is filed as an exhibit under Item 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K\n(a)(1) Financial Statements: Page\nConsolidated Balance Sheets - December 31, 1994 and 1993 (1)\nConsolidated Statements of Partners' Capital (Deficit) - For the years ended December 31, 1994, 1993 and 1992 (1) \t\t Consolidated Statements of Operations - For the years ended December 31, 1994, 1993 and 1992 (1)\nConsolidated Statements of Cash Flows - For the years ended December 31, 1994, 1993 and 1992 (1)\nNotes to the Consolidated Financial Statements (1)\nReport of Independent Accountants (1)\n(a)(2) Financial Statement Schedule:\nSchedule III - Real Estate and Accumulated Depreciation\nReport of Independent Accountants\n(1) Incorporated by reference to the Partnership's Annual Report to Unitholders for the year ended December 31, 1994 filed as an exhibit under Item 14.\n\t \t(a)(3)\tExhibits:\n(3)(A) Amended and Restated Certificate and Agreement of Limited Partnership (included as, and incorporated herein by reference to, Exhibit A to the Prospectus of Registrant dated July 9, 1982 (the \"Prospectus\"), contained in Amendment No. 1 to Registration Statement, No. 2-75519, of Registrant filed July 9, 1982).\n(B) Subscription Agreement and Signature Page (included as, and incorporated herein by reference to, Exhibit B to the Prospectus).\n\t (10)(A) Settlement Agreement by and among the Managing Joint Venturers and the Epoch Joint Venturers dated July 1, 1992 (included as, and incorporated herein by reference to Exhibit 10.1 to the Registrant's Quarterly Report on Form 10-Q (Commission File No. 0-11085)).\n(B) Amended and Restated Agreement of General Partnership of Country Place Village I Joint Venture dated as of July 1, 1992 (included as, and incorporated herein by reference to Exhibit 10.2 to the Registrant's Quarterly Report on Form 10-Q (Commission File No. 0-11085)).\n(C) Amended and Restated Agreement of General Partnership of Creekside Oaks Joint Venture dated as of July 1, 1992 (included as, and incorporated herein by reference to Exhibit 10.3 to the Registrant's Quarterly Report on Form 10-Q (Commission File No. 0-11085)).\n(D) Amended and Restated Agreement of General Partnership of Ponte Vedra Beach Village I dated July 1, 1992 (included as, and incorporated herein by reference to Exhibit 10.4 of the Registrant's Quarterly Report on Form 10-Q (Commission File No. 0-11085)).\n(E) Joint Venture Agreement of Rancho Antigua (included as, and incorporated herein by reference to Exhibit 10(M) to the Registrant's 1991 Annual Report on Form 10-K for the year ended December 31, 1991 (Commission File No. 0-11085)).\n(F) Amended and Restated Agreement of General Partnership of Village at the Foothills I Joint Venture Limited Partnership dated July 1, 1992 (included as, and incorporated herein by reference to Exhibit 10.5 to the Registrant's Quarterly Report on Form 10-Q (Commission File No. 0-11085)).\n(G) Property Management Agreement between Creekside Oaks Joint Venture and ConAm Management Corporation for the Creekside Oaks property (included as, and incorporated herein by reference to Exhibit 10-G to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)).\n(H) Property Management Agreement between Ponte Vedra Beach Joint Venture and ConAm Management Corporation for the Ponte Vedra Beach Village I property (included as, and incorporated herein by reference to Exhibit 10-H to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)).\n(I) Property Management Agreement between Rancho Antigua Joint Venture and ConAm Management Corporation for the Rancho Antigua property (included as, and incorporated herein by reference to Exhibit 10-I to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)).\n(J) Property Management Agreement between Country Place Village I Joint Venture and ConAm Management Corporation for the Country Place Village I property (included as, and incorporated herein by reference to Exhibit 10-J to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)).\n(K) Property Management Agreement between Village at the Foothills I Joint Venture and ConAm Management for the Village at the Foothills I property (included as, and incorporated herein by reference to Exhibit 10-K to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)).\n(L) Loan Documents: Mortgage and Security Agreement, Promissory Note and Assignment of Rents and Leases with respect to the refinancing of Country Place Village I, between Registrant and The Penn Mutual Insurance Company (included as, and incorporated herein by reference to Exhibit 10-L to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)).\n(M) Loan Documents: Mortgage and Security Agreement, Promissory Note and Assignment of Rents and Leases with respect to the refinancing of Creekside Oaks, between Registrant and The Penn Mutual Insurance Company (included as, and incorporated herein by reference to Exhibit 10-M to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)).\n(N) Loan Documents: Mortgage and Security Agreement, Promissory Note and Assignment of Rents and Leases with respect to the refinancing of Ponte Vedra Beach Village I, between Registrant and The Penn Mutual Insurance Company (included as, and incorporated herein by reference to Exhibit 10-N to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)). \t (O) Loan Documents: Deed of Trust and Assignment of Rents with Security Agreement and Financing Statement with respect to the refinancing of Rancho Antigua, between Registrant and The Penn Mutual Insurance Company (included as, and incorporated herein by reference to Exhibit 10-O to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1993 (Commission File No. 0-11085)). \t (13) Annual Report to Unitholders for the year ended December 31, 1994.\n(21) List of Subsidiaries - Joint Ventures (included as, and incorporated herein by reference to Exhibit 22 to the Registrant's Annual Report for the year ended December 31, 1994, on Form 10-K (Commission File No. 0-11085)).\n(99) Portions of Prospectus of Registrant dated July 9, 1983 (included as, and incorporated herein by reference to Exhibit 28 of the Registrant's 1988 Annual Report filed on Form 10-K for the fiscal year ended December 31, 1988 (Commission File No. 0-11085)).\n(b)(3) Reports on Form 8-K:\nNo reports on Form 8-K were filed in the fourth quarter of 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, 1995 HUTTON\/CONAM REALTY INVESTORS 2 BY: RI 2 Real Estate Services Inc. General Partner\nBY: \/S\/ Paul L. Abbot Name: Paul L. Abbott Title: Director, President, Chief Executive Officer and Chief Financial Officer\nBY: ConAm Property Services II, Ltd. General Partner\nBY: Continental American Development, Inc. General Partner\nBY: \/S\/ Daniel J. Epstein Name: Daniel J. Epstein Title: President, Director and Principal 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 in the capabilities and on the dates indicated.\nRI 2 REAL ESTATE SERVICES INC. A General Partner\nBY: Continental American Development, Inc. General Partner\nDate: March 28, 1995 BY: \/S\/ Paul L. Abbott Paul L. Abbott Director, President, Chief Executive Officer and Chief Financial Officer\nDate: March 28, 1995 BY: \/S\/ Janet Hoynes Janet Hoynes Vice President\nDate: March 28, 1995 BY: \/S\/ Kate Hobson Kate Hobson 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 in the capacities and on the dates indicated.\nCONAM PROPERTY SERVICES II, LTD. A General Partner\nBy: Continental American Development, Inc. General Partner\nDate: March 28, 1995 BY: \/S\/ Daniel J. Epstein Daniel J. Epstein Director and President\nDate: March 28, 1995 BY: \/S\/ Nancie Larimore Nancie Larimore Secretary\/Treasurer and Director\nDate: March 28, 1995 BY: \/S\/ E. Scott Dupree E. Scott Dupree Vice President\nDate: March 28, 1995 BY: \/S\/ Robert J. Svatos Robert J. Svatos Vice President\nDate: March 28, 1995 BY: \/S\/ Ralph W. Tilley Ralph W. Tilley Vice President\nHutton\/ConAm Realty Investors 2\nExhibit 13\nHutton\/ConAm Realty Investors 2\nAnnual Report 1994\nHutton\/ConAm Realty Investors 2 is a California limited partnership formed in 1982 to acquire, operate and hold for investment multifamily housing properties. At December 31, 1994, the Partnership's portfolio consisted of five apartment properties located in Arizona and Florida.\n\t\t Average Occupancy Property Location 1994 1993 _________________________________________________________________________ Country Place Village I Clearwater, Florida 97% 95% Creekside Oaks Jacksonville, Florida 96% 94% Ponta Vedra Beach Village I Ponte Vedra Beach, Florida 96% 96% Rancho Antigua Scottsdale, Arizona 95% 95% Village at the Foothills I Tucson, Arizona 96% 96% _________________________________________________________________________\nAdministrative Inquires Performance Inquires\/Form 10-Ks Address Changes\/Transfers The Shareholder Services Group Service Data Corporation P.O.Box 1527 2424 South 130th Circle Boston, Massachusetts 02104-1527 Omaha, Nebraska 68144 Attn: Financial Communications (800) 223-3464 (800) 223-3464\nContents\n1 Message to Investors 2 Performance Summary 3 Financial Highlights 4 Consolidated Financial Statements 6 Notes to Consolidated Financial Statements 13 Report of Independent Accountants 14 Net Asset Valuation\nPresented for your review is the 1994 Annual Report for Hutton\/ConAm Realty Investors 2. In this report, we review Partnership operations and discuss general market conditions affecting the Partnership's properties. We have also included a performance summary which addresses operating results at each of the properties and financial highlights for the year.\nCash Distributions Following an evaluation of the Partnership's cash reserves, anticipated cash flow and funding needs, the General Partners reinstated cash distributions to investors commencing with the 1994 third quarter distribution. A fourth quarter distribution, in the amount of $2.75 per Unit, was credited to your brokerage account or sent directly to you on February 6, 1995. Since inception, the Partnership has paid distributions totalling $299.19 per original $500 Unit, including $200 per Unit in return of capital payments. The level of future distributions will be evaluated on a quarterly basis and will be based on cash flow generated by the Partnership. Please see page 3 of this report for a summary of cash distributions paid for the past eight quarters.\nOperations Overview The past year has witnessed a solid recovery of multifamily housing in most regions of the country. The improving economy and limited new construction in most areas have boosted occupancy levels and rental rates, while rising mortgage rates have curtailed renters from purchasing condominiums and single family homes. These favorable conditions are especially prevalent in the sunbelt states, which continue to benefit from long-term population growth.\nOperating results at the Partnership's properties reflect these strengthening market conditions. Occupancy rates at each of the properties remained competitive with local averages during 1994, and all of the properties instituted rental rate increases on lease renewals resulting in a 5% increase in rental income. While construction of new units has picked up in several areas, positive demographic trends, especially in the Florida markets, are expected to keep pace with new supply. The General Partners intend to closely monitor these conditions and will continue to make select property improvements and age-related repairs to keep the Partnership's properties competitive with newer units.\nSummary The healthy market conditions and strong performance of the Partnership's properties during 1994 bode well for their eventual sale. In light of these improving conditions the General Partners have begun marketing some of the properties and recently entered into preliminary negotiations with an institutional buyer to sell Country Place Village I. There can be no assurance that a sale will be completed or that any particular price for the property can be obtained. In the interim, the General Partners will continue to effectively manage the Partnership's properties by seeking to maintain high occupancy levels and implementing rental rate increases as conditions permit. We will keep you updated on developments affecting your investment in future reports.\nVery truly yours,\nPaul L. Abbott Daniel J. Epstein President President RI 2 Real Estate Services, Inc. Continental American Development Inc. General Partner of ConAm Property March 28, 1995 Services IV, Ltd.\nPerformance Summary\nCountry Place Village I, Clearwater, Florida. Located in the northeastern section of Clearwater, this 88-unit apartment complex boasted a 97% average occupancy rate in 1994, up two percent from 1993. The higher occupancy reflects an aggressive marketing campaign as well as strong market conditions in Clearwater. Average occupancy in the Clearwater area stood at 95% in the fourth quarter of 1994 and many area complexes, including Country Place Village I, have increased rents. Rental income at Country Place increased 8% over the previous year. Capital improvements during the year included carpet replacement and roof repairs.\nCreekside Oaks, Jacksonville, Florida Creekside Oaks, a 120-unit apartment community, is situated in the Baymeadows-Deerwood neighborhood of southeast Jacksonville. Average occupancy levels at Creekside Oaks increased to 96% during 1994, resulting in a 5% increase in rental income from 1993. While rental rate increases are being implemented on renewals, market conditions in the Baymeadows-Deerwood area remain highly competitive as a result of significant prior-period overbuilding. Property improvements included roof replacement and related repairs, as well as selected exterior painting.\nPonte Vedra Beach Village I, Ponte Vedra Beach, Florida This 122-unit property is located in an oceanside residential area south of Jacksonville. Ponte Vedra Beach Village I reported stable occupancy of 96% during 1994, unchanged from 1993. Rental income increased 3%, reflecting rate increases on most units during the year. While the local rental market remains strong, planned construction of two residential projects will add approximately 120 new units in the area that are likely to compete with the Partnership's property. The completion date of these projects remains uncertain. Capital improvements during the year were minor and included the replacement of porches on select units.\nRancho Antigua, Scottsdale, Arizona Located approximately eight miles northeast of Phoenix, this 220-unit complex achieved average occupancy of 95% in 1994, unchanged from the prior year. The healthy local economy and strong market conditions for rental properties have permitted rental increases, resulting in a 6% increase in rental income from 1993. Construction, while limited in recent years, picked up in 1994 and eight new projects in the Scottsdale\/Paradise Valley submarket were in the process of planning or construction as of the third quarter of 1994, according to an area survey. Capital improvements included carpet and tile upgrades and the replacement of aging appliances in certain units.\nVillage at the Foothills I, Tucson, Arizona This 60-unit apartment and townhouse community is located in the rugged Catalina Foothills, overlooking Tucson. Occupancy rates at this property remained steady in 1994, at 96%, and rental income increased 7% from 1993 as a result of rental increases instituted on all turnovers and renewals. While market conditions have improved notably in Tucson in recent years, eight new apartment complexes in the Foothills region recently commenced construction which are likely to provide strong competition when completed. Property improvements included carpet replacement in selected units, roof repairs and landscape upgrades.\nSelected Financial Data\nFor the Periods Ended December 31, (dollars in thousands, except per Unit data)\n1994 1993 1992 1991 1990 Total Income $4,718 $ 4,479 $ 4,316 $ 4,263 $ 4,182\nNet Income (Loss) 37 (528) (409) (513) (523)\nNet Cash Provided by (used for)Operating Activities 1,150 (180) 680 380 642 Long-term Obligations 14,219 14,418 15,636 15,750 15,853 Total Assets at Year End 24,772 25,237 26,946 27,579 28,807 Net Income (Loss) per Limited Partnership Unit 80,000 Units) .42 (6.53) (5.06) (6.34) (6.47) Distributions per Limited Partnership Unit (80,000 Units) 5.50 - - 5.20 2.20\nTotal income increased 5% from 1993 to 1994, primarily due to higher rental income at all of the Partnership's properties due to rental rate increases implemented during 1994.\nThe increase in net income and net cash provided by operating activities is attributable to the increase in rental income, as well as a decrease in interest expense due to a lower interest rate and a $1.1 million reduction of the Partnership's outstanding principal balance as a result of the replacement financing secured in late 1993. This decrease was partly offset by a 9% increase in property operating expense, reflecting higher repair and maintenance expenses and rental administration expense at Rancho Antigua.\nQuarterly Cash Distributions Per Limited Partnership Unit \t 1994 1993 First Quarter $ - $ - Second Quarter - - Third Quarter 2.75 - Fourth Quarter 2.75 -\nTotal 5.50 0\nConsolidated Balance Sheets December 31, 1994 and 1993\nAssets 1994 1993\nInvestments in real estate: Land $6,797,328 $6,797,328 Buildings and improvements 27,258,895 27,144,828\n34,056,223 33,942,156 Less- accumulated depreciation (11,699,378) (10,612,843)\n22,356,845 23,329,313 Cash and cash equivalents 1,183,787 558,731 Restricted cash 779,328 781,463 Other assets, net of accumulated amortization of $88,397 in 1994 and $11,693 in 1993 452,164 567,953\nTotal Assets $24,772,124 $25,237,460\nLiabilities and Partners' Capital\nLiabilities: Mortgages payable $14,218,948 $14,418,254 Accounts payable and accrued expenses 106,337 165,903 Due to general partners and affiliates 40,523 36,907 Security deposits 133,210 136,171 Distribution payable 244,445 -\nTotal Liabilities 14,743,463 14,757,235\nPartners' Capital (Deficit): General Partners (618,500) (573,343) Limited Partners 10,647,161 11,053,568\nTotal Partners' Capital 10,028,661 10,480,225\nTotal Liabilities and Partners' Capital $24,772,124 $25,237,460\nConsolidated Statements of Partners' Capital (Deficit) For the years ended December 31, 1994, 1993 and 1992\nGeneral Limited Total Partners' Partners' Partners'\nBalance at January 1, 1992 $(563,979) $11,980,648 $11,416,669 Net loss (4,089) (404,816) (408,905)\nBalance at December 31, 1992 (568,068) 11,575,832 11,007,764 Net loss (5,275) (522,264) (527,539)\nBalance at December 31, 1993 (573,343) 11,053,568 10,480,225 Net income 3,732 33,593 37,325 Distributions (48,889) (440,000) (488,889)\nBalance at December 31, 1994 $(618,500) $10,647,161 $10,028,661\nSee accompanying notes to the consolidated financial statements.\nConsolidated Statements of Operations For the years ended December 31, 1994, 1993 and 1992\n\t Income 1994 1993 1992\nRental $4,669,676 $4,429,975 $4,251,122 Interest 48,289 48,981 65,327\nTotal Income 4,717,965 4,478,956 4,316,449\nExpenses\nProperty operating 2,262,915 2,069,986 1,829,468 Depreciation and amortization 1,163,239 1,096,871 1,083,999 Interest 1,110,434 1,686,402 1,632,135 General and administrative 144,052 153,236 179,752\nTotal Expenses 4,680,640 5,006,495 4,725,354\nNet income (loss) $37,325 $(527,539) $(408,905)\nNet Income (Loss) Allocated:\nTo the General Partners $3,732 $(5,275) $(4,089) To the Limited Partners 33,593 (522,264) (404,816)\nNet income (loss) $37,325 $(527,539) $(408,905)\nPer limited partnership unit (80,000 outstanding) $.42 $(6.53) $(5.06)\nSee accompanying notes to the consolidated financial statements.\nConsolidated Statements of Cash Flows For the years ended December 31, 1994, 1993 and 1992\nCash Flows from Operating Activities: 1994 1993 1992\nNet income (loss) $37,325 $(527,539) $(408,905) Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Depreciation and amortization 1,163,239 1,096,871 1,083,999 Increase (decrease) in cash arising from changes in operating assets and liabilities: Fundings to restricted cash (407,336) (1,057,502) - Release of restricted cash 409,471 276,039 - Other assets 6,310 (5,317) (658) Accounts payable and accrued expenses (59,566) 40,477 6,034 Due to general partners and affiliates 3,616 (11,199) 13,071 Security deposits (2,961) 7,848 (13,968)\nNet cash provided by (used for) operating activities 1,150,098 (180,322) 679,573\nCash Flows from Investing Activities:\nAdditions to real estate (114,067) (34,711) - Acquisition of joint venture partner interests - - (36,764)\nNet cash used for investing activities (114,067) (34,711) (36,764)\nCash Flows from Financing Activities:\nDistributions (244,444) - (115,556) Mortgage principal payments (199,306) (15,667,949) (114,205) Receipt (payment) of deposit on mortgage refinancing 72,058 (74,631) - Mortgage fees (39,283) (491,095) - Mortgage proceeds - 14,450,000 -\nNet cash used for financing activities (410,975) (1,783,675) (229,761)\nNet increase (decrease) in cash and cash equivalents 625,056 (1,998,708) 413,048 Cash and cash equivalents at beginning of year 558,731 2,557,439 2,144,391\nCash and cash equivalents at end of year $1,183,787 $558,731 $2,557,439\nSupplemental Disclosure of Cash Flow Information:\nCash paid during the year for interest $1,110,434 $1,686,402 $1,632,135\nSupplemental Disclosure of Cash and Non-Cash Investing Activities:\nDuring the year ended December 31, 1992, the Partnership purchased the Joint Venture Partner interest of the co-venturers to Country Place Village I Joint Venture, Creekside Oaks Joint Venture, Ponte Vedra Beach Village I Joint Venture, and Village at the Foothills I Joint Venture. The Creekside Oaks Joint Venture included a minority interest of $10,500. Total consideration of $35,000 was paid for the purchase of such interest. In addition, $12,264 of legal costs were incurred as a result of this transaction, resulting in a net building basis adjustment of $36,764.\nSee accompanying notes to the consolidated financial statements.\nNotes to the Consolidated Financial Statements For the years ended December 31, 1994, 1993 and 1992\n1. Organization Hutton\/ConAm Realty Investors 2 (the \"Partnership\") was organized as a limited partnership under the laws of the State of California pursuant to a Certificate and Agreement of Limited Partnership (the \"Partnership Agreement\") dated December 17, 1981, as amended and restated October 8, 1982. The Partnership was formed for the purpose of acquiring and operating certain types of residential real estate. The General Partners of the Partnership are RI 2 Real Estate Services Inc., an affiliate of Lehman Brothers Inc. (see below), and ConAm Property Services II, Ltd. (\"ConAm\"), an affiliate of Continental American Properties, Ltd (the \"General Partners\"). The Partnership will continue until December 31, 2010 unless sooner terminated pursuant to the terms of the Partnership Agreement.\nOn July 31, 1993, Shearson Lehman Brothers Inc. sold certain of its domestic retail brokerage and asset management business to Smith Barney, Harris Upham & Co. Incorporated (\"Smith Barney\"). Subsequent to the sale, Shearson Lehman Brothers Inc. changed its name to Lehman Brothers Inc. (\"Lehman Brothers\"). The transaction did not affect the ownership of the General Partners. However, the assets acquired by Smith Barney included the name \"Hutton.\" Consequently, effective January 13, 1994, the Hutton Real Estate Services V, Inc. general partner changed its name to \"RI 2 Real Estate Services, Inc.\"\n2. Significant Accounting Policies Financial Statements The consolidated financial statements include the accounts of the Partnership and its affiliated ventures. The effect of transactions between the Partnership and its ventures have been eliminated in consolidation.\nReal Estate Investments Real estate investments are recorded at the lower of cost or net realizable value which includes the initial purchase price of the property, legal fees, acquisition and closing costs.\nLeases are accounted for under the operating method. Under this method, revenue is recognized as rentals are earned and expenses (including depreciation) are charged to operations when incurred. Leases are generally for terms of one year or less.\nDepreciation is computed using the straight-line method based upon the estimated useful lives of the properties. Maintenance and repairs are charged to operations as incurred. Significant betterments and improvements are capitalized and depreciated over their estimated useful lives.\nFor assets sold or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in income for the period.\nOther Assets Included in other assets are deferred mortgage costs incurred in connection with obtaining financing on four of the Partnership's properties. Such costs are amortized over the term of the loans.\nOffering Costs Costs relating to the sale of limited partnership units were deferred during the offering period and charged to the limited partners' capital accounts upon the consummation of the public offering.\nIncome Taxes No provision for income taxes has been made in the financial statements since income, losses and tax credits are passed through to the individual partners.\nCash and Cash Equivalents Cash equivalents consists of short-term highly liquid investments which have maturities of three months or less from date of issuance. Cash and cash equivalents include security deposits of $106,213 and $104,508 at December 31, 1994 and 1993, respectively, restricted under certain state statutes.\nConcentration of Credit Risk Financial instruments which potentially subject the Partnership to a concentration of credit risk principally consist of cash and cash equivalents in excess of the financial institutions' insurance limits. The Partnership invests available cash with high credit quality financial institutions.\nRestricted Cash Consists of escrows for real estate taxes, casualty insurance, and replacement reserves as required by the first mortgage lender.\n3. The Partnership Agreement The Partnership Agreement provides that net cash from operations, as defined, will be distributed quarterly, 90% to the limited partners and 10% to the General Partners.\nNet loss and all depreciation will be allocated 99% to the limited partners and 1% to the General Partners. Net income will generally be allocated in accordance with the distribution of net cash from operations.\nNet proceeds from sales or refinancing will be distributed 99% to the limited partners and 1% to the General Partners until each limited partner has received an amount equal to his adjusted capital value (as defined) and an annual, cumulative 7% return thereon. The balance, if any, will be distributed 85% to the limited partners and 15% to the General Partners. Gain from sales will be allocated to each partner having a negative capital account balance, pro-rata, to the extent of such negative balance. Thereafter, such gain will be allocated in accordance with the distribution of net proceeds from sale or refinancing, with the balance allocated to the limited partners.\n4. Real Estate Investments Real estate investments consist of five residential apartment complexes acquired through investments in joint ventures as follows:\nApartment Date Purchase Property Name Units Location Acquired Price\nCreekside Oaks 120 Jacksonville, FL 11\/18\/83 $5,960,045\nPonte Vedra Beach Village I 122 Ponte Vedra Beach, FL 2\/10\/84 6,804,000\nRancho Antigua 220 Scottsdale, AZ 3\/8\/84 10,873,757\nCountry Place Village I 88 Clearwater, FL 4\/13\/84 4,732,000\nVillage at the Foothills I 60 Tucson, AZ 2\/27\/85 3,623,741\nTo each venture, the Partnership contributed the apartment projects as its initial capital contribution.\nOn July 1, 1992, a Settlement Agreement was executed by and among the Partnership, Hutton\/ConAm Realty Investors 81, Hutton\/ConAm Realty Investors 3, Hutton\/ConAm Realty Investors 4, Hutton\/ConAm Realty Investors 5, as Managing Joint Venturers, and Epoch Properties, Inc., James H. Pugh, Jr. and John McClintock, Jr., as the Epoch Joint Venturers (the Epoch Joint Venturers being collectively referred to herein as \"Epoch\"), the Partnership's partners and co-venturers in Country Place Village I, Creekside Oaks, Ponte Vedra Beach Village I, and Village at the Foothills I.\nPursuant to the Settlement Agreement, the Partnership paid $35,000 to Epoch. Epoch withdrew as a partner in the respective Joint Ventures which owned Country Place Village I, Creekside Oaks, Ponte Vedra Beach Village I, and Village at the Foothills I. General Releases were executed between the Partnership, the Joint Ventures, Epoch and Epoch Management Corporation. While the title to these properties continues to be held by the respective Joint Ventures and limited partnership, the Partnership and its General Partners are the sole co-venturers and partners.\nIn the cases of Country Place Village I, Creekside Oaks, and Ponte Vedra Beach Village I, the Joint Venture form was retained. The Partnership has entered into amended and restated Agreements of General Partnership, dated as of July 1, 1992 with its two corporate General Partners, RI 2 Real Estate Services, Inc. and ConAm Property Services II, Ltd. In the case of Village at the Foothills I, the joint venture has been converted to a limited partnership. The Partnership has entered into an amended and restated Agreement of Limited Partnership, dated as of July 1, 1992 with its two corporate General Partners, RI 2 Real Estate Services, Inc. and ConAm Property Services II, Ltd., as General Partners and the Partnership as the sole limited partner. There has been no interruption in either management or operating activities of the Partnership as a result of this Agreement.\nThe initial joint venture agreements of Country Place Village I, Creekside Oaks, Ponte Vedra Beach Village I, Village at the Foothills and Rancho Antigua substantially provide that:\na. Net cash from operations will be distributed 100% to the Partnership until it has received an annual, noncumulative 12% return on its adjusted capital contribution. Any remaining balance will be distributed 60% to the Partnership and 40% to the co-venturer.\nb. Net income of the joint venture and gain from sale will be allocated basically in accordance with the distribution of net cash from operations, as defined, and net proceeds from sales, respectively. All net losses will be allocated 98% to 100% to the Partnership depending on the joint venture agreement.\nc. Net proceeds from a sale or refinancing will be distributed 100% to the Partnership until it has received an amount equal to 120% of its adjusted capital contribution and an annual, cumulative 12% return on its adjusted capital contribution. Thereafter, the Partnership will receive approximately 50% to 75% of the balance depending on the joint venture agreement.\nThe amended joint venture agreements and limited partnership agreements of Country Place Village I, Creekside Oaks, Ponte Vedra Beach Village I and Village at the Foothills I substantially provide that:\na. Available cash from operations will be distributed 100% to the Partnership until it has received an annual, non-cumulative preferred return, as defined. Any remaining balance will be distributed 99% to the Partnership and 1% to the corporate General Partners.\nb. Net income will be allocated first, proportionately to partners with negative capital accounts, as defined, until such capital accounts, as defined, have been increased to zero. Then, to the Partnership up to the amount of any payments made on account of its preferred return; thereafter, 99% to the Partnership and 1% to the corporate General Partners. All losses will be allocated first, to the partners with positive capital accounts, as defined, until such accounts have been reduced to zero. Then 99% to the Partnership and 1% to the corporate General Partners.\nc. Income from a sale will be allocated first, to the Partnership until the Partnership's capital accounts, as defined, are equal to the fair market value of the ventures' assets at the date of the amendments. Then, any remaining balance will be allocated 99% to the Partnership and 1% to the corporate General Partners. Net proceeds from a sale or refinancing will be distributed first to the partners with a positive capital account balance, as defined; thereafter, 99% to the Partnership and 1% to the corporate General Partners.\n5. Mortgages Payable On October 28, 1993, the extended maturity date, the Partnership obtained replacement financing on its Creekside Oaks, Ponte Vedra Beach I, Rancho Antigua and Country Place Village I properties from The Penn Mutual Life Insurance Company and a subsidiary, both unaffiliated parties. Total proceeds of $14,450,000 were received and collateralized by Mortgages and Security Agreements and Assignments of Rents and Leases Agreements encumbering the respective properties. Each of the loans is a non-recourse loan with periodic payments of principal and interest based on a twenty-five year amortization schedule with the balance of the principal due at maturity. Mortgages payable, at December 31, 1994, consist of the following first mortgage loans:\n\t\t\t\t\t \t\t\nInterest Maturity Property Principal Rate Date\nCreekside Oaks $2,607,627 7.75% 11\/01\/2000 Ponte Vedra Beach Village I $3,936,041 7.75% 11\/01\/2000 Rancho Antigua $5,608,858 7.75% 11\/01\/2000 Country Place Village I $2,066,422 7.75% 11\/01\/2000\nThe proceeds of this financing along with Partnership cash reserves were used to repay the outstanding amounts due Aetna Life Insurance Company on the Partnership's four prior mortgages.\nOriginal Interest Maturity Property Principal Rate Date\nCreekside Oaks $2,921,071 10.50% 05\/01\/93 Ponte Vedra Beach Village I $3,115,809 10.50% 05\/01\/93 Rancho Antigua $7,024,911 10.27% 05\/20\/93 Country Place Village I $2,531,595 10.50% 05\/01\/93\nPartnership cash reserves were also used to pay refinancing expenses of $491,095 and fund escrows of $995,372. The escrowed funds are applied to the payment of taxes, insurance and repairs and improvements.\nAnnual maturities of mortgage notes principal over the next five years are as follows:\nYear Amount\n1995 $215,313 1996 232,605 1997 251,287 1998 271,468 1999 293,272 Thereafter 12,955,003\n$14,218,948\n6. Transactions with related Parties The following is a summary of fees earned and reimbursable expenses for the years ended December 31, 1994, 1993, and 1992, and the unpaid portion at December 31, 1994:\nUnpaid at December 31, Earned 1994 1994 1993 1992\nReimbursement of: Out-of-pocket expenses $ - $1,390 $82 $1,918 Administrative salaries and expenses 20,612 46,124 38,103 43,632 Property operating salaries - 345,626 340,913 321,580\nProperty management fees 19,911 233,152 221,231 213,597\n$40,523 $626,292 $600,329 $580,727\nThe above amounts have been paid and\/or accrued to the General Partners and affiliates as follows:\nUnpaid at December 31, Earned 1994 1994 1993 1992\nRI 2 Real Estate Services, Inc. $20,612 $47,514 $38,185 $45,550\nConAm and affiliates 19,911 578,778 562,144 535,177\n$40,523 $626,292 $600,329 $580,727\n7. Reconciliation of Financial Statement and Tax Information The following is a reconciliation of the net income (loss) for financial statement purposes to net loss for federal income tax purposes for the years ended December 31, 1994, 1993 and 1992:\n1994 1993 1992\nNet income (loss) per financial statements $37,325 $(527,539) $(408,905)\nTax basis joint venture net loss in excess of GAAP basis joint venture net income (loss) (241,789) (339,161) (474,069)\nOther (1,438) (5,603) 10,172\nTaxable net loss $(205,902) $(872,303) $(872,802)\nThe following is a reconciliation of partners' capital for financial statement purposes to partners' capital for federal income tax purposes as of December 31, 1994, 1993 and 1992:\n1994 1993 1992\nPartners' capital per financial statements $10,028,661 $10,480,225 $11,007,764\nAdjustment for cumulative difference between tax basis loss and income (loss) per financial statements (6,062,177) (5,818,950) (5,474,186)\nPartners' capital per tax return $3,966,484 $4,661,275 $5,533,578\n8. Distributions Paid Cash distributions, per the consolidated statements of partners' capital are recorded on the accrual basis, which recognizes specific record dates for payments within each calendar year. The consolidated statements of cash flows recognize actual cash distributions paid during the calendar year. The following table discloses the annual differences as presented on the consolidated financial statements:\nDistributions Distributions Payable Distributions Distributions Payable Beginning of Year Declared Paid December 31\n1994 $- $488,889 $244,444 $244,445 1993 - - - - 1992 115,556 - 115,556 -\n9. Supplementary Information Maintenance and repairs, advertising costs, and real estate taxes included in property operating expenses for the years ended December 31, 1994, 1993 and 1992 are as follows:\n1994 1993 1992\nMaintenance and repairs $857,988 $734,408 $588,786 Advertising costs 53,878 52,017 49,607 Real estate taxes 403,670 395,830 370,950\nReport of Independent Accountants\nTo the Partners of Hutton\/ConAm Realty Investors 2:\nWe have audited the consolidated balance sheets of Hutton\/ConAm Realty Investors 2, a California limited partnership, and Consolidated Ventures, as of December 31, 1994 and 1993, and the related consolidated statements of operations, partners' capital (deficit) and cash flows for each of the three years in the period ended December 31, 1994. 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 consolidated financial position of Hutton\/ConAm Realty Investors 2, a California limited partnership, and Consolidated Ventures as of December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nCOOPERS & LYBRAND L.L.P.\nHartford, Connecticut March 9, 1995\nComparison of Acquisition Costs to Appraised Value and Determination of Net Asset Value Per $300 Unit at December 31, 1994 (Unaudited)\nAcquisition Cost (Purchase Price Partnership's Plus General Share of Partners' December 31, Acquisition 1994 Appraised Property Date of Acquisition Fees) Value (1)\nCreekside Oaks 11-18-83 $6,238,445 $5,200,000 Ponte Vedra Beach Village I 02-10-84 7,123,950 7,150,000 Rancho Antigua 03-08-84 11,446,176 11,200,000 Country Place Village I 04-13-84 4,968,222 3,800,000 Village at the Foothills I 02-27-85 3,756,741 2,400,000\n$33,533,534 $29,750,000\nCash and cash equivalents 1,963,115 Other assets 10,183\n31,723,298 Less: Total liabilities (14,743,463)\nPartnership Net Asset Value (2) $16,979,835\nNet Asset Value Allocated: Limited Partners $16,810,037 General Partners 169,798\n$16,979,835\nNet Asset Value Per Unit (80,000 units outstanding) $210.13\n(1) This represents the Partnership's share of the December 31, 1994 Appraised Values which were determined by an independent property appraisal firm.\n(2) The Net Asset Value assumes a hypothetical sale at December 31, 1994 of all the Partnership's properties at a price based upon their value as a rental property as determined by an independent property appraisal firm, and the distribution of the proceeds of such sale, combined with the Partnership's cash after liquidation of the Partnership's liabilities, to the Partners.\nLimited Partners should note that appraisals are only estimates of current value and actual values realizable upon sale may be significantly different. A significant factor in establishing an appraised value is the actual selling price for properties which the appraiser believes are comparable. In addition, the appraised value does not reflect the actual costs which would be incurred in selling the properties. As a result of these factors and the illiquid nature of an investment in Units of the Partnership, the variation between the appraised value of the Partnership's properties and the price at which Units of the Partnership could be sold may be significant. Fiduciaries of Limited Partners which are subject to ERISA or other provisions of law requiring valuations of Units should consider all relevant factors, including, but not limited to Net Asset Value per Unit, in determining the fair market value of the investment in the Partnership for such purposes.\nHUTTON\/CONAM REALTY INVESTORS 2 and Consolidated Ventures\nSchedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1994\nCost Capitalized Subsequent Initial Cost to Partnership To Acquisition\nBuildings and Buildings and Description Encumbrances Land Improvements Improvements\nResidential Property: Consolidated Ventures:\nCreekside Oaks Jacksonville, FL $2,607,627 $400,317 $5,854,636 $72,152\nPonte Vedra Beach Village I Ponte Vedra Beach, FL 3,936,041 1,015,028 6,181,290 105,430\nRancho Antigua Scottsdale, AZ 5,608,858 3,490,498 7,975,346 77,283\nCountry Village Place I Clearwater, FL 2,066,422 1,049,122 3,955,178 64,025\nVillage at the Foothills I Tucson, AZ - 798,822 3,005,280 11,816\n$14,218,948 $6,753,787 $26,971,730 $330,706\nHUTTON\/CONAM REALTY INVESTORS 2 and Consolidated Ventures\nSchedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1994\nGross Amount at Which Carried at Close of Period\nBuildings and Accumulated Description Land Improvements Total Depreciation\nResidential Property: Consolidated Ventures:\nCreekside Oaks Jacksonville, FL $403,193 $5,923,912 $6,327,105 $2,633,273\nPonte Vedra Beach Village I Ponte Vedra Beach, FL 1,045,472 6,256,276 7,301,748 2,702,791\nRancho Antigua Scottsdale, AZ 3,497,484 8,045,643 11,543,127 3,471,611\nCountry Village Place I Clearwater, FL 1,052,357 4,015,968 5,068,325 1,707,965\nVillage at the Foothills I Tucson, AZ 798,822 3,017,096 3,815,918 1,183,738\n$6,797,328 $27,258,895 $34,056,223 $11,699,378\n(1) (2)\nHUTTON\/CONAM REALTY INVESTORS 2 and Consolidated Ventures\nSchedule III - Real Estate and Accumulated Depreciation\nDecember 31, 1994\nLife on which Depreciation in Latest Date of Date Income Statements Description Construction Acquired is Computed\nResidential Property: Consolidated Ventures:\nCreekside Oaks Jacksonville, FL 1982 11\/18\/83 (3)\nPonte Vedra Beach Village I Ponte Vedra Beach, FL 1983 02\/10\/84 (3)\nRancho Antigua Scottsdale, AZ 1984 03\/08\/84 (3)\nCountry Place Village I Clearwater, FL 1984 04\/13\/84 (3)\nVillage at the Foothills Tucson, AZ 1984 02\/27\/85 (3)\n(1) Represents aggregate cost for both financial reporting and Federal income tax purposes. (2) The amount of accumulated depreciation for Federal income tax purposes is $21,675,619. (3) Buildings and improvements - 25 years; personal property - 10 years.\nA reconciliation of the carrying amount of real estate and accumulated depreciation for the years ended December 31, 1994, 1993 and 1992:\nReal Estate investments: 1994 1993 1992\nBeginning of year $33,942,156 $33,907,445 $33,870,681 Additions 114,067 34,711 36,764\nEnd of year $34,056,223 $33,942,156 $33,907,445\nAccumulated Depreciation:\nBeginning of year $10,612,843 $9,527,665 $8,443,666 Depreciation expense 1,086,535 1,085,178 1,083,999\nEnd of year $11,699,378 10,612,843 $9,527,665\n\t\t\t\nReport of Independent Accountants\nOur report on the consolidated financial statements of Hutton\/ConAm Realty Investors 2, a California limited partnership, and Consolidated Ventures has been incorporated by reference in this Form 10-K from the Annual Report to unitholders of Hutton\/ConAm Realty Investors 2 for the year ended December 31, 1994. In connection with our audits of such financial statements, we have also audited the related financial statement schedule listed in the index of this Form 10-K.\nIn our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly, in all material respects, the information required to be included therein.\nCOOPERS & LYBRAND L.L.P.\nHartford, Connecticut March 9, 1995","section_15":""}
{"filename":"318154_1994.txt","cik":"318154","year":"1994","section_1":"Item 1. BUSINESS\nOverview\nAmgen Inc. (\"Amgen\" or the \"Company\") is a global biotechnology company that develops, manufactures and markets human therapeutics based on advanced cellular and molecular biology.\nThe Company manufactures and markets two human therapeutic products, NEUPOGEN(R) (Filgrastim) and EPOGEN(R) (Epoetin alfa). NEUPOGEN(R) selectively stimulates the production of neutrophils, one type of white blood cell. The Company markets NEUPOGEN(R) in the United States, countries of the European Union (\"EU\"), Canada and Australia for use in decreasing the incidence of infection in patients undergoing myelosuppressive chemotherapy. In addition, NEUPOGEN(R) is marketed in most of these countries for use in reducing the duration of neutropenia for patients undergoing myeloablative therapy followed by bone marrow transplantation and for treating patients with severe chronic neutropenia. EPOGEN(R) stimulates the production of red blood cells and is marketed by Amgen in the United States and the People's Republic of China for the treatment of anemia associated with chronic renal failure in patients on dialysis. EPOGEN(R) is also approved for the treatment of anemia related to therapy with Zidovudine (AZT) in patients infected with the human immunodeficiency virus (\"HIV\") in the People's Republic of China.\nThe Company focuses its research on biological cell\/tissue events and its development efforts on human therapeutics in the areas of hematopoiesis, neurobiology, inflammation and soft tissue repair and regeneration. The Company has research facilities in the United States and Canada and has clinical development staff in the United States, the EU, Canada, Australia, Japan and Hong Kong. To augment internal research and development efforts the Company has established external research collaborations and has acquired certain product and technology rights.\nAmgen operates commercial manufacturing facilities for NEUPOGEN(R) and EPOGEN(R) in the United States and Puerto Rico. The facility in Puerto Rico, which performs formulation, fill and finish operations, was approved by the U.S. Food and Drug Administration (\"FDA\") in December 1994. The Company maintains a sales and marketing force in the United States, the EU, Canada, Australia and the People's Republic of China. In addition, Amgen has entered into licensing and co-promotion agreements to market NEUPOGEN(R) and EPOGEN(R) in certain geographic areas.\nThe Company was incorporated in California in 1980 and was merged into a Delaware corporation in 1987. Amgen's principal executive offices are located at 1840 Dehavilland Drive, Thousand Oaks, California 91320-1789.\nProducts and product candidates\nRecombinant human granulocyte colony-stimulating factor\nNEUPOGEN(R) (proper name - Filgrastim) is Amgen's trademark for its recombinant human granulocyte colony-stimulating factor (\"G-CSF\"), a\nprotein that selectively stimulates production of certain white blood cells known as neutrophils. Neutrophils are the body's first defense against infection. Treatments for various diseases and diseases themselves can result in extremely low numbers of neutrophils, or neutropenia. Myelosuppressive chemotherapy, one treatment option for individuals with cancer, targets cell types which grow rapidly, including tumor cells, neutrophils and other blood cells. Providing NEUPOGEN(R) as adjunct to myelosuppressive chemotherapy can reduce the duration of neutropenia and thereby reduce the potential for infection.\nCongenital neutropenia is an example of disease-related neutropenia. In congenital neutropenia, the body fails to manufacture sufficient neutrophils. Chronic administration of NEUPOGEN(R) has been shown to reduce the incidence and duration of neutropenia-related consequences such as fever and infections in patients with congenital neutropenia.\nNEUPOGEN(R) has also been shown to induce immature blood cells (progenitor cells) to migrate (mobilize) from the bone marrow into the blood circulatory system. Studies have shown that when these progenitor cells are collected from the blood, stored, and re-infused after chemotherapy (transplanted), recovery of platelets, the cells which play a critical role in blood clotting, is accelerated. In 1994, NEUPOGEN(R) received a positive opinion from the Committee for Proprietary Medicinal Products (\"CPMP\") in the EU to mobilize progenitor cells for peripheral blood progenitor cell (\"PBPC\") transplantation. PBPC transplantation is becoming an alternative to autologous bone marrow transplantation in some countries.\nIn the United States, the Company began selling NEUPOGEN(R) in February 1991 upon receiving approval of its product license application from the FDA (see \"Joint Ventures and Business Relationships - Limited Partnership\"). NEUPOGEN(R) was initially indicated to decrease the incidence of infection as manifested by febrile neutropenia for patients with non-myeloid malignancies undergoing myelosuppressive chemotherapy. In June 1994, the FDA approved a supplement to the Filgrastim product license which included a claim to reduce the duration of neutropenia for patients with non-myeloid malignancies undergoing myeloablative therapy followed by bone marrow transplantation. In December 1994, the FDA approved an additional supplement to the Filgrastim product license which included a claim to reduce the incidence and duration of neutropenia-related consequences in symptomatic patients with congenital neutropenia, cyclic neutropenia or idiopathic neutropenia. Amgen markets NEUPOGEN(R) in the United States through its national sales force.\nIn the EU, the CPMP issued an opinion in February 1991 that NEUPOGEN(R) meets the requirements for marketing authorization as an adjunct to chemotherapy entitling the Company to seek marketing approval in individual EU countries. Marketing approvals were subsequently received from all EU countries and product sales commenced in these countries. In May 1992, the CPMP issued a favorable opinion regarding the use of NEUPOGEN(R) in reducing the duration of neutropenia for patients undergoing myeloablative therapy followed by bone marrow transplantation. Substantially all of the EU countries have now approved the product for use in this indication. In September 1993, a favorable opinion was issued regarding the use of NEUPOGEN(R) in treating severe chronic neutropenia, and subsequently, a majority of the EU countries have approved the product for use in this indication. In December 1994, the CPMP issued a favorable opinion for the use of NEUPOGEN(R) in mobilizing progenitor cells for PBPC\ntransplantation. Several EU countries have approved the product for use in this additional indication. Amgen and F. Hoffmann-La Roche Ltd. (\"Roche\") jointly market NEUPOGEN(R) in the EU under a co-promotion agreement (see \"Marketing\").\nIn Canada, the Company began selling NEUPOGEN(R) in February 1992 when the product was approved for use as an adjunct to chemotherapy. In October 1993, the Canadian regulatory authorities approved NEUPOGEN(R) for treatment of severe chronic neutropenia.\nIn Australia, the Company began selling NEUPOGEN(R) in May 1992 when the product was approved for sale both as an adjunct to chemotherapy and to reduce the duration of neutropenia in patients receiving marrow-ablative therapy followed by autologous bone marrow transplantation. In July 1993, the Australian regulatory authorities approved NEUPOGEN(R) for the treatment of severe chronic neutropenia.\nIn Japan, Korea and Taiwan, Kirin Brewery Company, Limited (\"Kirin\"), was granted rights to market G-CSF under licensing agreements with Kirin- Amgen, Inc. (\"Kirin-Amgen\"). Kirin-Amgen is a joint venture between the Company and Kirin (see \"Joint Ventures and Business Relationships - Kirin Brewery Company, Limited\"). Kirin received marketing approval in Japan and Taiwan in October 1991 and August 1992, respectively, and subsequently began selling GRAN(R), Kirin's G-CSF product. GRAN(R) is approved for use to prevent febrile neutropenia in patients undergoing myelosuppressive chemotherapy, to reduce the duration of neutropenia following bone marrow transplants, for the treatment of severe chronic neutropenia, for the treatment of neutropenia accompanying aplastic anemia and for the treatment of congenital idiopathic neutropenia.\nThe Company is conducting many clinical trials with NEUPOGEN(R). Later stage trials are examining NEUPOGEN(R) as an adjunct to chemotherapy in patients with acute myelogenous leukemia, as an adjunct to dose- intensified chemotherapy in patients with various tumor types, for the treatment of neutropenia in HIV-infected patients and for the treatment of severe community-acquired pneumonia.\nFor the years ended December 31, 1994, 1993 and 1992, sales of NEUPOGEN(R) accounted for approximately 50%, 52% and 50%, respectively, of Amgen's total revenues.\nRecombinant human erythropoietin\nEPOGEN(R) (proper name - Epoetin alfa) is Amgen's trademark for its recombinant human erythropoietin product, a protein that stimulates red blood cell production. EPOGEN(R) is effective in the treatment of anemia associated with chronic renal failure for patients on dialysis and is indicated to elevate or maintain the red blood cell level (as manifested by hematocrit or hemoglobin determinations) and to decrease the need for blood transfusions in these patients.\nIn the United States, Amgen was granted rights to market recombinant human erythropoietin under a licensing agreement with Kirin-Amgen (see \"Joint Ventures and Business Relationships - Kirin Brewery Company, Limited\"). The Company began selling EPOGEN(R) in 1989 upon receiving approval of its product license application from the FDA. EPOGEN(R) is indicated for use in the treatment of anemia associated with chronic renal failure. The FDA also designated EPOGEN(R) as an orphan drug, and such\ndesignation will expire in 1996. In July 1994, the FDA approved a supplement to the Epoetin alfa product license which included an expanded target hematocrit range for patients with chronic renal failure. The target hematocrit, or percentage of red blood cells, was expanded to a range of 30 to 36 percent from the previously indicated range of 30 to 33 percent. Ongoing clinical trials are investigating whether there are additional benefits for dialysis patients in maintaining a higher, even more normal, hematocrit range. Through its national sales force, the Company markets EPOGEN(R) in the United States for dialysis patients, the market to which Amgen has maintained exclusive rights.\nAmgen has granted Ortho Pharmaceutical Corporation a license to pursue commercialization of recombinant human erythropoietin as a human therapeutic in the United States in all markets other than dialysis. (Ortho Pharmaceutical Corporation is a subsidiary of Johnson & Johnson and will be referred to hereafter as Johnson & Johnson.) In December 1990, the FDA approved a supplement to the Epoetin alfa product license to include treatment of anemia related to therapy with AZT in HIV-infected patients. Also, the FDA approved Amgen's supplement to name Johnson & Johnson a distributor of Epoetin alfa under the trademark PROCRIT(R). In January 1991, Johnson & Johnson began distributing Epoetin alfa in the United States. In April 1993, the FDA approved an additional supplement to the Epoetin alfa product license to include the treatment of anemia in patients with non-myeloid malignancies undergoing chemotherapy. The Company is engaged in arbitration proceedings regarding its license with Johnson & Johnson. For a complete discussion of this matter, see Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitration\".\nIn the People's Republic of China, the Company received government approval in September 1992 and began marketing EPOGEN(R) for treatment of anemia associated with chronic renal failure and anemia related to therapy with AZT in HIV-infected patients.\nIn Japan, Kirin was granted rights to market recombinant human erythropoietin under a licensing agreement with Kirin-Amgen (see \"Joint Ventures and Business Relationships - Kirin Brewery Company, Limited\"). In 1990, Kirin received approval from the Japanese government and began marketing ESPO(R), Kirin's recombinant human erythropoietin product. ESPO(R) is approved for treatment of anemia associated with chronic renal failure.\nIn countries other than the United States, the People's Republic of China and Japan, Johnson & Johnson was granted rights to pursue the commercialization of erythropoietin as a human therapeutic under a licensing agreement with Kirin-Amgen. Affiliates of Johnson & Johnson market erythropoietin for treatment of anemia associated with chronic renal failure under the trademark EPREX(R) in several countries.\nFor the years ended December 31, 1994, 1993 and 1992, sales of EPOGEN(R) accounted for approximately 44%, 42% and 46%, respectively, of Amgen's total revenues.\nConsensus interferon\nInterferons are a class of naturally occurring proteins with anti- viral and anti-tumor activity that also modulate the immune system. INFERGEN(TM), Amgen's consensus interferon, is a non-naturally occurring\nprotein that combines structural features of many interferon sub-types. The Company is performing clinical trials with INFERGEN(TM) for the treatment of chronic hepatitis C viral infection. Hepatitis C viral infection is a potentially deadly disease that, if not treated, may lead to cirrhosis and liver cancer. INFERGEN(TM) is also being investigated for other indications.\nHematopoiesis\nHematopoietic growth factors are proteins which influence growth, migration, and maturation of certain types of blood cells. EPOGEN(R) and NEUPOGEN(R) are hematopoietic growth factors which affect the development of red blood cells and neutrophils, respectively. Stem cell factor (\"SCF\"), another of the Company's hematopoietic growth factors in development, may influence the production, mobilization, and maturation of progenitor cells. Human clinical trials are underway to investigate the utility of SCF in combination with NEUPOGEN(R) for improved mobilization of progenitor cells prior to PBPC transplantation.\nMegakaryocyte growth and development factor (\"MGDF\"), another hematopoietic growth factor, has been shown in pre-clinical models to be useful in ameliorating the thrombocytopenia caused by intensive chemotherapy or irradiation. Thrombocytopenia, or severely depressed platelet numbers, can result in severe internal bleeding. The Company is collaborating in the development of MGDF with Kirin (see \"Joint Ventures and Business Relationships - Kirin Brewery Company, Limited\") and plans to initiate human clinical testing in 1995.\nCell therapy\nCell separation technology complements the Company's research and development efforts in hematopoiesis. Amgen's hematopoietic growth factors together with selected hematopoietic cells enable the Company to pursue the investigation of new and potentially more effective cancer therapy protocols. In 1994, Amgen acquired an equity interest in AmCell Inc. (\"AmCell\"), a U.S. company which will develop and manufacture cell separation and characterization devices based on the technology of Miltenyi Biotec GmbH. Amgen and AmCell entered into an agreement whereby AmCell will manufacture certain cell selection devices for Amgen, and Amgen will clinically develop and commercialize these devices (see \"Joint Ventures and Business Relationships - AmCell\").\nNeurobiology\nThe Company has extensive discovery programs in neurological and neuroendocrine disorders. Neurotrophic factors are proteins which play a role in nerve cell protection and regeneration and which may therefore, be useful in treating a variety of neurological disorders, including neurodegenerative diseases of the central nervous system, nerve injury or trauma. Human clinical testing of two neurotrophic factors, brain-derived neurotrophic factor (\"BDNF\") and neurotrophin-3 (\"NT-3\"), is currently being conducted in collaboration with Regeneron Pharmaceuticals, Inc. (\"Regeneron\") (see \"Joint Ventures and Business Relationships - Regeneron Pharmaceuticals, Inc.\"). BDNF is being investigated to treat amyotrophic lateral sclerosis (Lou Gehrig's disease), a fatal disorder which causes rapid degeneration of motor neurons that innervate skeletal muscles. More recently, clinical testing began with NT-3.\nGlial derived neurotrophic factor (\"GDNF\") was added to the Company's neurobiology research program through the acquisition of Synergen, Inc. (\"Synergen\") (see \"Joint Ventures and Business Relationships - Synergen acquisition\"). GDNF is being investigated as a treatment for Parkinson's disease.\nInflammation\nThe inflammatory response is essential for defense against harmful micro-organisms and for the repair of damaged tissues. The failure of control mechanisms over inflammatory response occurs in conditions such as rheumatoid arthritis, acute respiratory distress syndrome and asthma. Tumor necrosis factor binding protein (\"TNFbp\") and interleukin-1 receptor antagonist (\"IL-1ra\") are two product candidates added to the Company's inflammation research program through the acquisition of Synergen (see \"Joint Ventures and Business Relationships - Synergen acquisition\"). TNFbp is being investigated as a treatment for rheumatoid arthritis, and IL-1ra is currently in clinical testing for the same indication. The Company is also conducting research to discover and develop other molecules for the treatment of inflammatory diseases.\nSoft tissue repair and regeneration\nSoft tissue growth factors are believed to play a role in accelerating or improving tissue regeneration and wound healing. These growth or wound healing factors regulate a broad range of cellular activities. Amgen currently is conducting research on certain tissue growth factors including keratinocyte growth factor.\nOther therapeutics\nAmgen's recombinant hepatitis B vaccine and interleukin-2 (\"IL-2\") were licensed to Johnson & Johnson in 1985. In March 1991, Johnson & Johnson returned the rights to develop and market these products to Amgen (see Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitration\"). In May 1991, Johnson & Johnson assigned its FDA authorizations to conduct clinical testing of recombinant hepatitis B vaccine and IL-2 to Amgen, and the Company is currently conducting clinical development for hepatitis B vaccine and IL-2.\nJoint Ventures and Business Relationships\nThe Company intends to self-market its products where possible. From time to time it may supplement this effort by using joint ventures and other business relationships to provide additional marketing and product development capabilities. The Company also supplements its internal research and development efforts with acquisitions of product and technology rights and external research collaborations. Amgen has established the relationships described below and may establish others in the future.\nSynergen acquisition\nIn December 1994, the Company acquired Synergen, a publicly held biotechnology company engaged in the discovery and development of protein- based pharmaceuticals. The addition of Synergen's product candidates and\nresearch and development staff has allowed the Company to significantly expand its research efforts in the areas of neurobiology and inflammation. Synergen was acquired for $254,493,000, including related acquisition costs. The preliminary assignment of the purchase price among identifiable tangible and intangible assets (including in-process technology) was based on an analysis of the fair values of those assets. The value assigned to in-process technology of $116,367,000 was expensed on the acquisition date. This business combination has been accounted for using the purchase method.\nF. Hoffmann-La Roche Ltd.\nIn 1988, Amgen and Roche entered into a co-promotion agreement for the sale of NEUPOGEN(R) (Filgrastim) in the EU. Under this agreement, Amgen and Roche share the clinical development, regulatory and commercialization responsibilities for the product. Amgen manufactures NEUPOGEN(R) and the two companies share in the profits from sales of NEUPOGEN(R). This agreement allows Amgen the option to regain complete control for marketing the product in the future.\nIn 1989, Amgen and Roche entered into another agreement to commercialize NEUPOGEN(R) in certain European countries not located within the EU. Under this agreement, Roche markets NEUPOGEN(R) in these countries and pays a royalty to Amgen on these sales.\nJohnson & Johnson\nAmgen granted Johnson & Johnson a license to pursue commercialization of recombinant human erythropoietin as a human therapeutic in the United States in all markets other than dialysis. The Company is engaged in arbitration proceedings regarding this agreement. For a complete discussion of this matter, see Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitration\".\nKirin Brewery Company, Limited\nThe Company has a 50-50 joint venture (Kirin-Amgen) with Kirin. Kirin-Amgen was formed to develop and commercialize certain of the Company's technologies. Amgen and Kirin have been exclusively licensed by Kirin-Amgen to manufacture and market recombinant human erythropoietin in the United States and Japan, respectively. Kirin-Amgen has also granted Amgen an exclusive license to manufacture and market G-CSF in the United States, Europe, Canada, Australia and New Zealand. Kirin has been licensed by Kirin-Amgen with similar rights for G-CSF in Japan, Taiwan and Korea. Both Amgen and Kirin have been licensed to market recombinant human erythropoietin and G-CSF in the People's Republic of China. Marketing of these products by Amgen and Kirin in the People's Republic of China is conducted under a separate co-promotion agreement which is currently being reevaluated. In 1994, Kirin-Amgen licensed to Amgen and Kirin the rights to develop and market MGDF.\nPursuant to the terms of agreements entered into with Kirin-Amgen, the Company conducts certain research and development activities on behalf of Kirin-Amgen and is paid for such services at a negotiated rate. Included in revenues from corporate partners in the Company's Consolidated Financial Statements for the years ended December 31, 1994, 1993 and 1992, are\n$58,638,000, $41,247,000 and $24,554,000, respectively, related to these agreements.\nIn connection with its various agreements with Kirin-Amgen, the Company has been granted sole and exclusive licenses for the manufacture and sale of certain products in specified geographic areas of the world. In return for such licenses, the Company paid Kirin-Amgen stated amounts upon the receipt of the licenses and\/or pays Kirin-Amgen royalties based on sales. During the years ended December 31, 1994, 1993 and 1992, Kirin- Amgen earned royalties from Amgen of $67,526,000, $53,122,000 and $42,793,000, respectively, under such agreements.\nLimited Partnership\nAmgen Clinical Partners, L.P. (the \"Limited Partnership\"), a limited partnership, was formed to develop and commercialize products from certain technologies for human pharmaceutical use in the United States. In connection with the formation of the Limited Partnership, Amgen was granted options to purchase all of the limited partners' interests in the Limited Partnership. During 1993, Amgen exercised these options and made cash advance payments to the former limited partners aggregating $20,860,000. In addition, each former limited partner receives quarterly payments, subject to certain adjustments, equal to a stated percentage of Amgen's sales of certain products in specified geographic areas through December 31, 2005. The cash advance payments are recoverable against certain of these quarterly payments commencing in 1997.\nThe Limited Partnership and Amgen formed Amgen Ventures, a joint venture, to manufacture and market the Limited Partnership's products in the United States. Amgen was responsible for marketing and manufacturing products on behalf of the joint venture in return for an annual commission of 60% of Amgen Ventures' net product sales and was reimbursed its costs of manufacturing, as defined. Amgen consolidated the results of Amgen Ventures' operations and reflected the Limited Partnership's equity in earnings of these operations as royalty expense. During the years ended December 31, 1993 and 1992, the Limited Partnership's equity in these earnings aggregated $11,131,000 and $36,306,000, respectively.\nIn connection with the sale of limited partnership interests in 1987, Amgen issued warrants to the limited partners to purchase 18,153,000 shares of its common stock in exchange for the options to purchase the limited partners' interests in the Limited Partnership. Substantially all these warrants were exercised prior to their expiration on June 30, 1994.\nRegeneron Pharmaceuticals, Inc.\nIn 1990, the Company entered into a Collaboration Agreement with Regeneron to co-develop and commercialize BDNF and NT-3 in the United States. In addition, Regeneron licensed these potential products to Amgen for certain other countries.\nTo facilitate this collaboration, the Company and Regeneron formed Amgen-Regeneron Partners, a 50-50 partnership. Amgen-Regeneron Partners commenced operations with respect to BDNF in June 1993 upon Amgen's determination that preclinical development of BDNF by Amgen and Regeneron warranted the preparation of an Investigational New Drug Application\n(\"IND\"). Operations with respect to NT-3 began in January 1994 when Amgen determined that an IND should also be prepared for this product.\nAmCell\nDuring 1994, Amgen acquired an equity interest in AmCell, a company which will manufacture cell separation and characterization devices based on the technology of Miltenyi Biotec GmbH (\"Miltenyi\"). Amgen has an exclusive license to clinically develop and commercialize selected products of AmCell incorporating Miltenyi technology in exchange for development funding and milestone payments.\nSynergen Clinical Partners\nSynergen Clinical Partners, L.P. (\"SCP\"), a limited partnership, was formed to develop and commercialize products for human therapeutic use in certain geographic areas from Synergen's IL-1ra technology which was acquired by a wholly-owned subsidiary of Amgen (see \"Synergen acquisition\"). This wholly-owned subsidiary would be obligated to pay SCP royalties on sales of such products and a milestone payment upon receiving the first FDA marketing approval of an IL-1ra product. In connection with the formation of SCP, Synergen was granted options to purchase all of the limited partners' interests in SCP upon the occurrence of certain future events for a specified amount of consideration.\nOther business relationships\nIn February 1995, the Company reached an agreement in principle with The Rockefeller University to develop products based on a gene thought to play a key role in the regulation of body weight. In April 1994, the Company entered into a collaboration agreement with Alanex Inc. to perform research and development in the field of neurobiology. In June 1993, the Company entered into a collaboration agreement with Arris Pharmaceutical Corporation to develop synthetic cytokine mimetics. In December 1992, the Company entered into a collaboration agreement with Sugen, Inc. to perform research, development and commercialization in the fields of megakaryocytopoiesis and neurobiology. In addition, the Company has an extensive number of other corporate and academic research collaborations.\nMarketing\nWorldwide changes in health care policy are a significant source of challenge for the Company. These challenges include uncertainty regarding the outcome of U.S. health care reform and its impact on sales growth, changing reimbursement policies in worldwide markets and continued health care cost containment pressures worldwide. Market forces are also changing the economics of the human therapeutics business through voluntary limits on price increases by the U.S. pharmaceutical industry, increases in the purchasing power of large buying groups, and increased influence on medical care and treatment decisions by managed care organizations. The Company is responding to this changing health care environment through programs that optimize the use of its products for the treatment of patients and clinical trials designed to evaluate cost and quality-of-life parameters as well as clinical safety and efficacy. In addition, the Company is adapting to legislative mandates in foreign markets.\nIn the United States, the Company's sales force markets its products to physicians and pharmacists primarily in hospitals and clinics. The Company has chosen to use major wholesale distributors of pharmaceutical products as the principal means of distributing EPOGEN(R) (Epoetin alfa) and NEUPOGEN(R) (Filgrastim) to clinics, hospitals and pharmacies. Sales to Bergen Brunswig Corporation and Cardinal Distribution, two major distributors of these products, accounted for 22% and 16%, respectively, of total revenues for the year ended December 31, 1994. Sales to Bergen Brunswig Corporation and McKesson Drug Company, accounted for 23% and 10%, and 22% and 11%, of total revenues for the years ended December 31, 1993 and 1992, respectively.\nNEUPOGEN(R) is reimbursed by both public and private payors, and changes in coverage and reimbursement policies of these payors could have a material effect on sales of NEUPOGEN(R). EPOGEN(R) is primarily reimbursed by the Federal Government through the End Stage Renal Disease Program (\"ESRD\") of Medicare. The ESRD Program reimburses approved providers for 80% of allowed dialysis costs; the remainder is paid by other sources, including Medicaid, state kidney patient programs and private insurance. The reimbursement rate is established by Congress and is monitored by the Health Care Financing Administration. The reimbursement rate for EPOGEN(R) is subject to yearly review. Changes in coverage and reimbursement policies could have a material effect on the sales of EPOGEN(R). The Federal Government enacted legislation effective January 1, 1994 to lower reimbursement provided to facilities that administer EPOGEN(R) from $11 per thousand units administered to $10 per thousand units administered. This change in reimbursement has not had a material adverse effect on EPOGEN(R) sales.\nExcept for purchases by Veterans Administration hospitals, the Company does not receive any payments directly from the Federal Government nor does it have any significant supply contracts with the Federal Government. However, the consumption of NEUPOGEN(R) and EPOGEN(R) by hospitals, clinics, and physicians may be impacted by the amount and methods of reimbursement that they receive from the Federal Government.\nIn the EU, Amgen and Roche share clinical development, regulatory and commercialization responsibilities for NEUPOGEN(R) under a co-promotion agreement. In addition, Amgen manufactures NEUPOGEN(R) for sale in the EU, and the two companies share in the profits from sales of the product. NEUPOGEN(R) is distributed to wholesalers and\/or hospitals in all EU countries depending upon the distribution practice of hospital products in each country. Patients receiving NEUPOGEN(R) for approved indications are covered by government health care programs. The consumption of NEUPOGEN(R) is affected by budgetary constraints imposed by certain EU countries.\nNEUPOGEN(R) sales volumes in both the United States and Europe are influenced by a number of factors including underlying demand, government financial constraints, private sector financial constraints, seasonality of cancer chemotherapy administration, and wholesaler management practices.\nIn Canada and Australia, NEUPOGEN(R) is marketed by the Company directly to hospitals, pharmacies and medical practitioners. Distribution is handled by third party contractors.\nIn the People's Republic of China, the Company markets EPOGEN(R) directly to hospitals, pharmacies and medical practitioners. Distribution is handled by third party contractors.\nCompetition\nCompetition is intense among companies that develop and market products based on advanced cellular and molecular biology. Amgen has a number of competitors, including Chiron Corp., Chugai Pharmaceutical Co., Ltd., Immunex Corp. (a subsidiary of American Home Products), Rhone- Poulenc-Rorer, Sandoz Ltd. and Schering-Plough Corp. For products which the Company manufactures and markets, it faces significant competition from these and other biotechnology and pharmaceutical firms in the United States, Europe and elsewhere. Certain specialized biotechnology firms have also entered into cooperative arrangements with major companies for development and commercialization of products, creating an additional source of competition.\nAny products or technologies that successfully address anemias could negatively impact the market for recombinant human erythropoietin. Similarly, any products or technologies that successfully address the causes or incidence of low levels of neutrophils could negatively impact the market for G-CSF. These include products that could receive approval for indications similar to those for which NEUPOGEN(R) (Filgrastim) has been approved, development of chemotherapy treatments that are less myelosuppressive than existing treatments and the development of anti- cancer modalities that reduce the need for myelosuppressive chemotherapy.\nNEUPOGEN(R) currently faces market competition from a competing G-CSF product, from granulocyte macrophage colony-stimulating factor (\"GM-CSF\") products and from the chemoprotectant, amifostine (WR-2721). Potential future sources of competition include other GM-CSF products, PIXY 321, and PGG-glucan, among others.\nChugai Pharmaceuticals Co., Ltd. (\"Chugai\") markets a G-CSF product in Japan as an adjunct to chemotherapy and as a treatment for bone marrow transplant patients. In June 1993, Chugai and Rhone-Poulenc-Rorer received a favorable opinion from the CPMP for this G-CSF product in the adjunct to chemotherapy and bone marrow transplant settings and began market launches in certain EU countries by early 1994. Chugai, through its licensee, AMRAD, markets this G-CSF product in Australia as an adjunct to chemotherapy and for patients receiving a bone marrow transplant. Under an agreement with Amgen, Chugai is precluded from selling their G-CSF product in the United States, Canada or Mexico.\nImmunex Corp. markets GM-CSF in the United States for patients receiving a bone marrow transplant and is pursuing other indications including use as an adjunct to chemotherapy. Behringwerke AG markets this GM-CSF product in Europe in similar settings. Sandoz Ltd. markets a separate GM-CSF product for use in bone marrow transplant patients, as an adjunct to chemotherapy and as an adjunct to gancyclovir treatment of HIV- infected patients in the EU and certain other countries. This GM-CSF product is currently being developed for similar indications in the United States and Canada.\nIn 1994, amifostine received a favorable opinion from the CPMP to reduce the neutropenia-related risk of infection due to the combination regimen cyclophosphamide and cisplatinum in patients with advanced ovarian carcinoma. Schering Plough markets amifostine in the EU. U.S. Bioscience continues to develop amifostine as an adjunct to chemotherapy in the United States.\nImmunex Corp. is developing PIXY 321 in the United States as an adjunct to chemotherapy and for patients receiving a bone marrow transplant. PIXY 321 is being developed for use outside North America by American Home Products. Alpha Beta Technologies is developing PGG-glucan for the treatment of certain infectious diseases and as an adjunct to chemotherapy.\nOther products which address potential markets for G-CSF may be identified and developed by competitors in the future. Such products could also present competition in potential markets for SCF. Research and development of other hematopoietic growth factors, including MGDF, is being conducted by several companies including Genentech, Inc., ZymoGenetics, Inc. (a subsidiary of Novo Nordisk A\/S), Immunex Corp., Sandoz Ltd. and Genetics Institute, Inc.\nINFERGEN(TM) would face competition from interferons and other related products, several of which are in development or on the market. Schering- Plough Corp. and Roche are major suppliers of interferons.\nSeveral companies are developing neurotrophic factors including Cephalon Inc., Genentech, Inc. and Regeneron Pharmaceuticals, Inc. Many companies are believed to be conducting research in the area of inflammation including Celltech, Ltd., ICOS Corporation and AutoImmune. Companies believed to be developing certain tissue growth factors include Creative Biomolecules, Inc., Chiron Corp. (in collaboration with Johnson & Johnson), Genentech, Inc., Immunex Corp., Scios Nova Inc. and ZymoGenetics, Inc.\nSeveral hepatitis B vaccines are marketed in the United States, Europe, Japan and other countries. SmithKline Beecham, p.l.c., Merck & Co., Inc. and Rhone-Poulenc, S.A. are major suppliers of hepatitis B vaccines. Chiron Corp. currently markets an IL-2 product in the United States, Europe and Japan.\nResearch and Development\nThe Company's two primary sources of new product candidates are internal research and development and acquisition and licensing from third parties. Research and development expense, which includes technology license fees paid to third parties, for the years ended December 31, 1994, 1993 and 1992 were $323,629,000, $255,321,000 and $182,297,000, respectively. The amount for the year ended December 31, 1994 excludes a $116,367,000 write-off of in-process technology purchased in connection with the acquisition of Synergen (see \"Joint Ventures and Business Relationships - Synergen acquisition\").\nGovernment Regulation\nRegulation by governmental authorities in the United States and other countries is a significant factor in the production and marketing of the Company's products and its ongoing research and development activities. In order to clinically test, manufacture and market products for therapeutic use, Amgen must satisfy mandatory procedures and safety standards established by the FDA and comparable agencies in foreign countries.\nIn the United States, the Company's products are regulated primarily on a product by product basis under the U.S. Food, Drug and Cosmetic Act and Section 351(a) of the Public Health Service Act. Most of the Company's products and product candidates are or will be classified as biologics\nrather than drugs and, therefore, are subject to regulation by the Center for Biologics Evaluation and Research. Approval of a biologic for marketing requires both a license for the product and a license for the manufacturing facility.\nThe Company's products are subject to rigorous FDA approval procedures. After purification, laboratory analysis and testing in animals, a sponsor files an investigational new drug application with the FDA to begin human testing. A three-phase human clinical testing program must then be undertaken. In Phase 1, studies are conducted to determine the safety and optimal dosage for administration of the product. In Phase 2, studies are conducted to gain preliminary evidence of the efficacy of the product. In Phase 3, studies are conducted to provide sufficient data for the statistical proof of safety and efficacy. The time and expense required to perform this clinical testing can far exceed the time and expense of the research and development initially required to create the product. No action can be taken to market any therapeutic product in the United States until an appropriate product license application has been approved by the FDA. Even after initial FDA approval has been obtained, further studies may be required to provide additional data on safety and would be required to gain approval for the use of a product as a treatment for clinical indications other than those initially approved. In addition, use of products during testing and after initial marketing could reveal side effects that could delay, impede or prevent marketing approval, limit uses or expose the Company to product liability claims.\nIn addition to receiving product approval from the FDA, Amgen is required to file an establishment license application with the FDA to obtain approval of Amgen's manufacturing facilities. Prior to granting an establishment license, the FDA reviews manufacturing procedures and inspects equipment and facilities. If, after receiving approval from the FDA, a material change is made in manufacturing equipment, location or process, additional regulatory review may be needed.\nIn Europe, regulatory requirements are similar in principle to those in the United States. A two-part product approval process is required in the EU. Clinical testing and manufacturing facilities and procedures data are presented in a Marketing Authorization Application filed with the CPMP. The CPMP reviews the application in order to express an opinion that the product meets the requirements for marketing authorization. Approvals to market the product must then be obtained from the appropriate government agency of each EU country. Such government agencies may require an inspection of the manufacturing facilities.\nIn Canada, a New Drug Submission is filed with the Health Protection Branch (\"HPB\") of the Canadian government. The submission includes clinical testing, manufacturing facilities and procedures data. In a process which parallels that in the United States, the HPB reviews these data and inspects the manufacturing facilities in order to issue a Notice of Compliance which allows the Company to market the product.\nIn Australia, an application for registration of a drug is evaluated by the Therapeutic Goods Administration (\"TGA\"), which is part of the Ministry of Human Services and Health. In a process similar to that in the United States, the TGA reviews data on the manufacture, animal testing and\nclinical trials of the product and, on approval, issues a Certificate of Registration permitting the Company to market the product.\nIn the People's Republic of China, a United States free sales certificate and proven safety and efficacy data by local clinical trials are required by the Ministry of Public Health for the registration of the product.\nThe Company's present and future business in the United States will be subject to regulation under the United States Atomic Energy Act, the Clean Air Act, the Federal Water Pollution Control Act, the Environmental Protection Act, the Occupational Safety and Health Act, the National Environmental Policy Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Medical Waste Tracking Act, national restrictions and other present or possible future local, state and federal regulations. Also, Amgen's research and manufacturing activities are conducted in voluntary compliance with the National Institutes of Health Guidelines for Recombinant DNA Research. The Company's research operations in Canada are subject to a generally similar set of requirements.\nPatents and Trademarks\nPatents are very important to the Company in establishing proprietary rights to the products it has developed. The Company has filed applications for a number of patents and it has been granted patents relating to recombinant human erythropoietin, G-CSF, consensus interferon and various potential products. The Company has obtained licenses from and pays royalties to third parties. Other companies have filed patent applications or have been granted patents in areas of interest to the Company. There can be no assurance any licenses required under such patents would be available for license on reasonable terms or at all. The Company is engaged in arbitration proceedings with Johnson & Johnson and various patent litigation. For a discussion of these matters see Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitration\" and Item 3, \"Legal Proceedings\".\nThe Company has obtained U.S. registration of its EPOGEN(R) and NEUPOGEN(R) trademarks. In addition, these trademarks have been registered in several other countries. The Company has applied for registration of the INFERGEN(TM) trademark in the United States and several other countries.\nHuman Resources\nAs of February 28, 1995, the Company had 3,546 employees (including staff added in connection with the acquisition of Synergen), of which 1,632 were engaged in research and development, 572 were engaged in manufacturing and associated support, 772 were engaged in sales and marketing and 570 were engaged in finance and general administration. There can be no assurance that the Company will be able to continue attracting and retaining qualified personnel in sufficient numbers to meet its needs. None of the Company's employees are covered by a collective bargaining agreement, and the Company has experienced no work stoppages. The Company considers its employee relations to be excellent.\nGeographic Area Financial Information\nFor financial information concerning the geographic areas in which the Company operates see Note 12 to the Consolidated Financial Statements.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. PROPERTIES\nAmgen's principal executive offices and a majority of its administrative, manufacturing and research and development facilities are located in 29 buildings totaling approximately 1,440,000 square feet in Thousand Oaks, California. Twenty-five of the buildings are owned and four are leased. Adjacent to these facilities are three buildings totaling approximately 230,000 square feet that are under construction. In addition, the Company has acquired other property adjacent to these facilities in anticipation of future expansion. The Thousand Oaks, California facilities include a manufacturing plant that produces commercial quantities of Epoetin alfa and another manufacturing plant that can produce several products including commercial quantities of NEUPOGEN(R) (Filgrastim). These manufacturing plants have been licensed by various regulatory bodies.\nElsewhere in North America, Amgen owns research facilities and a pilot plant in Boulder, Colorado totaling approximately 310,000 square feet (including facilities obtained through the acquisition of Synergen) and an 80,000 square foot distribution center in Louisville, Kentucky. The Company leases additional facilities including a research facility and administrative offices in Toronto, Canada totaling 37,000 square feet, an administrative office in Washington, D.C. and five regional sales offices.\nOutside North America, the Company has a 320,000 square foot formulation, fill and finish facility in Juncos, Puerto Rico which has been licensed by various regulatory bodies. In addition, the Company has leased facilities in nine European countries, Australia, Japan, Hong Kong and the People's Republic of China for administration, marketing and research and development aggregating approximately 270,000 square feet.\nAmgen believes that its current facilities plus anticipated additions are sufficient to meet its needs for the next several years.\nItem 3.","section_3":"Item 3. LEGAL PROCEEDINGS\nThe Company is engaged in arbitration proceedings with one of its licensees. For a complete discussion of this matter see Note 5 to the Consolidated Financial Statements - \"Johnson & Johnson arbitration\". Other legal proceedings are discussed below. While it is not possible to predict accurately or to determine the eventual outcome of these matters, the Company believes that the outcome of these legal proceedings will not have a material adverse effect on the financial statements of the Company.\nSynergen litigation\nAcquisition litigation\nThe Company and its wholly-owned subsidiary, Amgen Boulder Inc. (formerly Synergen) have been named as defendants in several lawsuits filed in connection with the Company's December 1994 acquisition of Synergen (the `` Acquisition''). One suit, Stanley, et al. v. Soll, et al., was filed on November 18, 1994 by two stockholders in the Court of Chancery of the State of Delaware in New Castle County against Synergen and certain of its former\nofficers and directors. Plaintiffs, who seek to represent a class of stockholders of Synergen common stock, allege that the defendants breached their fiduciary duties by failing to maximize stockholder value. Plaintiffs seek an unspecified amount of compensatory damages, an order rescinding the Acquisition, and related equitable relief. Other stockholders seeking the same relief filed suits on November 23 and 29, 1994 in United States District Court, County of Boulder, State of Colorado. In Livergood v. Synergen, Inc., et al. and Weld, et al. v. Amgen Inc., et al., the plaintiffs allege that defendants Synergen, Amgen and certain of Synergen's former officers and directors breached their fiduciary duties and defrauded the plaintiffs by omitting to disclose allegedly material information concerning Synergen's future prospects. Plaintiffs in both cases seek to represent a class of stockholders of Synergen common stock. Another suit, Glick v. Synergen, Inc., et al., was filed in the Superior Court of the State of California, County of Los Angeles, as a class action on January 24, 1995 by plaintiffs who seek to represent all warrant holders of Synergen who claim to have been deprived of the benefit of their warrants. Plaintiffs seek general damages in the sum of $34,334,499 against Synergen, Amgen and former officers and directors of Synergen based on allegations of conspiracy, breach of duty, self-dealing, interference with prospective business advantage and unjust enrichment.\nANTRIL(TM) litigation\nSeveral lawsuits have been filed against Synergen alleging misrepresentations in connection with its research and development of ANTRIL(TM) for the treatment of sepsis. In re Synergen, Inc. Securities Litigation, a class action complaint filed on April 15, 1993 in the United States District Court for the District of Colorado, alleged violations of federal and state securities laws by various classes of Synergen's stockholders. Synergen and certain of its former officers and directors were named as defendants. The Court dismissed the state law claims on April 8, 1994 and approved a settlement of the remaining claims on March 7, 1995. The settlement involves payment by Synergen and its insurers of an amount that is not material to the Company's financial statements and the plaintiffs' agreement to dismiss the action with prejudice. In Temple, et al. v. Synergen, Inc., et al., three stockholders filed suit on November 15, 1994 in the District Court for the City and County of Denver, State of Colorado, against Synergen and a former director and executive officer, alleging violations of state securities law, fraud and misrepresentation. Plaintiffs seek an unspecified amount of compensatory damages and punitive damages. In Johnson v. Amgen Boulder, Inc., et al., suits filed on February 14, 1995 in the Superior Court for the State of Washington, King County and in the United States District Court for the Western District of Washington, plaintiff seeks rescission of certain payments made to one of the defendants (or unspecified damages not less than $50,000,000) and treble damages. Plaintiff, a limited partner of defendant Synergen Clinical Partners, L.P., seeks to represent a class of other limited partners. The complaints allege violations of federal and state securities laws, violations of other federal and state statutes, fraud, negligence, breach of contract, conspiracy and breach of fiduciary duty. The defendants include Synergen, Synergen Clinical Partners, L.P., Synergen Development Corporation and former officers and directors of Synergen.\nElanex Pharmaceuticals litigation\nIn October 1993, the Company filed a complaint for patent infringement against defendants Elanex Pharmaceuticals, Inc. (\"Elanex\"), Laboratorios Elanex De Costa Rica, S. A., Bio Sidus S.A., Merckle GmbH, Biosintetica S. A. and other unknown defendants. The complaint, filed in the United States District Court for the Western District of Washington at Seattle, seeks injunctive relief and damages for Elanex's infringement of the Company's patent for DNA sequences and host cells useful in producing recombinant erythropoietin. The complaint also alleges that the foreign defendants entered into agreements with Elanex relating to the production or sale of recombinant erythropoietin and thereby have induced Elanex's infringement.\nIn December 1993, Elanex responded to the complaint denying the material allegations thereof, and filed a counterclaim seeking a declaratory judgment that the Company's patent is invalid and that Elanex's recombinant erythropoietin technology does not infringe any valid claims of the Company's patent. The counterclaim also seeks an award of reasonable attorneys' fees and other costs of defense but does not seek damages against the Company. The case is currently in discovery.\nErythropoietin patent litigation\nAmgen has been engaged in litigation (the \"Amgen suit\") with Genetics Institute, Inc. (\"Genetics Institute\") and its commercial partner, Chugai Pharmaceutical Co., Ltd., regarding the infringement of Amgen's patent on the DNA sequence used in the production of erythropoietin (the \"Amgen Patent\") and the infringement by Amgen's erythropoietin product of a patent held by Genetics Institute.\nGenetics Institute and the Company announced on May 11, 1993 that they agreed to settle all outstanding patent disputes between them regarding erythropoietin in the United States. As part of the settlement, Genetics Institute paid the Company $13.9 million during the quarter ended September 30, 1993. An additional $2 million may be paid to the Company contingent upon the outcome of certain future events. As a result of the settlement of the litigation, Amgen expects to receive patents on the process for producing recombinant erythropoietin and on the recombinant erythropoietin product.\nIn August 1991, Johnson & Johnson, together with eleven of Johnson & Johnson's Cilag European subsidiaries, filed a suit in the United States District Court for the District of Massachusetts in Boston, the site of the Amgen suit against Genetics Institute (the \"Boston Court\"), seeking damages from Genetics Institute for infringement of the Amgen Patent (the \"Johnson & Johnson suit\") and moved to consolidate the Johnson & Johnson suit with the original suit filed by Amgen. The two suits were consolidated by the Boston Court. Amgen was allowed to intervene in the Johnson & Johnson suit for the limited purpose of seeking a summary judgment dismissing the Johnson & Johnson suit. In December 1992, the Boston Court determined that Johnson & Johnson had no standing to sue Genetics Institute and entered judgment and dismissed the Johnson & Johnson suit. Also, in December 1992, the Boston Court denied motions by Johnson & Johnson to intervene in the Amgen suit for the limited purpose of seeking a summary judgment limiting Amgen's damages against Genetics Institute. Johnson & Johnson has appealed the Boston Court's December 1992 rulings. The appeal by Johnson & Johnson, together with eleven of its Cilag European subsidiaries, is pending.\nGenetics Institute litigation\nOn June 21, 1994, Genetics Institute filed suit in the United States District Court for the District of Delaware in Wilmington, against Johnson & Johnson, a licensee and distributor of the Company, seeking damages for the alleged infringement of a recently issued U.S. Patent 5,322,837 relating to Johnson & Johnson's manufacture, use, and sale of erythropoietin.\nOn September 12, 1994, the Company filed suit in the United States District Court for the District of Massachusetts in Boston, against Genetics Institute, seeking declaratory judgment of patent non- infringement, invalidity and unenforceability against Genetics Institute in respect to U.S. Patent 5,322,837 issued to Genetics Institute, which relates to homogeneous erythropoietin. Genetics Institute answered the complaint and filed a counterclaim against the Company alleging infringement of the same patent. On February 14, 1995, the United States District Court for the District of Massachusetts granted Amgen's motion for a summary judgment enforcing a prior judgment against Genetics Institute and barring Genetics Institute from asserting its U.S. Patent 5,322,837 against Amgen's recombinant erythropoietin. On March 13, 1995, Genetics Institute filed notice of appeal.\nBiogen litigation\nOn June 15, 1994, Biogen, Inc. (\"Biogen\") filed suit in the Tokyo District Court in Japan, against Amgen K.K., a subsidiary of the Company, seeking injunctive relief for the alleged infringement of two Japanese patents relating to alpha-interferon.\nOn March 10, 1995, Biogen filed suit in the United States District Court for the District of Massachusetts seeking an unspecified amount of compensatory damages, treble damages and injunctive relief of its U.S. Patent 4,874,702 relating to vectors for expressing cloned genes. Biogen alleges that Amgen has infringed its patent by manufacturing and selling NEUPOGEN(R).\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 its fiscal year ended December 31, 1994.\nPART II\nItem 5.","section_5":"Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS\nPrice Range of Common Stock\nThe Company's common stock trades on The Nasdaq Stock Market under the symbol AMGN. As of March 15, 1995, there were approximately 11,600 holders of record of the Company's common stock. No cash dividends have been paid on the common stock to date, and the Company currently intends to retain any earnings for development of the Company's business and for repurchases of its common stock.\nThe following table sets forth, for the fiscal periods indicated, the range of high and low closing sales prices of the common stock as quoted on The Nasdaq Stock Market for the years 1994 and 1993:\nHigh Low 1994 ------- ------- 4th Quarter................... $59-3\/8 $50-7\/8 3rd Quarter................... 56-7\/8 43-1\/4 2nd Quarter................... 47-3\/16 35-23\/64 1st Quarter................... 51-3\/4 37-3\/4\n4th Quarter.................. $50-7\/8 $39-1\/4 3rd Quarter.................. 41-5\/8 31-1\/2 2nd Quarter.................. 42-1\/2 32-1\/8 1st Quarter.................. 70-3\/4 33\nItem 6.","section_6":"Item 6. SELECTED FINANCIAL DATA\nYears Ended December 31, 1990 1991 1992 1993 1994 ---- ---- ---- ---- ---- Consolidated Statement of Operations Data: Revenues: Product sales.............. $281.4 $645.3 $1,050.7 $1,306.3 $1,549.6 Other revenues............. 17.3 36.7 42.3 67.5 98.3 Total revenues.............. 298.7 682.0 1,093.0 1,373.8 1,647.9 Research and development expenses(1)............... 72.4 120.9 182.3 255.3 323.6 Write-off of in-process technology................ - - - - 116.4 Marketing and selling expenses.................. 50.1 122.2 184.5 214.1 236.9 General and administrative expenses.................. 51.1 80.4 107.7 114.3 122.9 Legal assessment (award).... - 129.1 (77.1) (13.9) - Net income(2)............... 3.9 97.9 357.6 383.3 319.7 Primary earnings per share(2) .03 .67 2.43 2.67 2.29 Cash dividends declared per share..................... - - - - -\nAt December 31, 1990 1991 1992 1993 1994 ---- ---- ---- ---- ---- Consolidated Balance Sheet Data: Working capital............ $198.1 $294.9$ 562.4 $ 642.2 $ 579.2 Total assets............... 459.5 865.5 1,374.3 1,765.5 1,994.1 Long-term debt............. 63.3 39.7 129.9 181.2 183.4 Stockholders' equity....... 309.1 531.1 933.7 1,172.0 1,274.3\n(1) Excludes $54.7 million of royalty obligation buyouts in 1990.\n(2) Includes an increase to net income of $8.7 million, or $.06 per share, to reflect the cumulative effect of a change in accounting principle to adopt Statement of Financial Accounting Standard No. 109 in 1993 (see Note 1 to Consolidated Financial Statements). Also includes the write-off of in-process technology purchased of $116.4 million, or $.83 per share, associated with the acquisition of Synergen in 1994 (see Note 2 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 provided by operating activities has been and is expected to continue to be the Company's primary source of funds. In 1994, operations provided $531.9 million of cash compared to $433.0 million in 1993. This cash was used primarily to fund the acquisition of Synergen, Inc. (\"Synergen\") ($240.8 million, net of cash acquired), capital expenditures, and the repurchase of shares of the Company's common stock. The Company had cash, cash equivalents, and marketable securities of $696.7 million at December 31, 1994, compared with $723.2 million at December 31, 1993.\nCapital expenditures totaled $130.8 million in 1994 compared with $209.9 million in 1993. The reduction in capital expenditures is due to the completion of several facilities in 1993, including the Puerto Rico fill and finish facility. Over the next few years, the Company expects to spend approximately $100 million to $200 million per year on capital projects to expand the Company's global operations.\nThe Company receives cash from the exercise of stock options and warrants. In 1994, stock options and their related tax benefits provided $67.5 million of cash compared with $56.3 million in 1993. Proceeds from the exercise of stock options and their related tax benefits will vary from period to period based upon, among other factors, fluctuations in the market value of the Company's stock relative to the exercise price of such options. In 1994, the exercise of warrants associated with Amgen Clinical Partners, L.P. provided $15.3 million of cash compared to $5.9 million in 1993. The right to exercise these warrants expired on June 30, 1994.\nThe Company has a common stock repurchase program (see Note 7 to the Consolidated Financial Statements). Since its inception in 1992 through December 31, 1994, the Company has repurchased 12.9 million shares of its common stock at a total cost of $593.8 million. The Company is currently authorized to purchase up to an additional $331.2 million of common stock through December 31, 1995.\nTo provide for financial flexibility and increased liquidity, the Company has established several sources of debt financing. The Company has filed a shelf registration statement with the Securities and Exchange Commission under which it could issue up to $200 million of Medium Term Notes. At December 31, 1994, $113 million of Medium Term Notes were outstanding which mature in two to nine years. The Company has a commercial paper program which provides for short-term borrowings up to an aggregate face amount of $200 million. At December 31, 1994, $99.7 million of commercial paper was outstanding, all with maturities of less than four months. The Company also has a $150 million revolving line of credit, principally to support the Company's commercial paper program. No borrowings on this line of credit were outstanding at December 31, 1994.\nThe Company invests its cash in accordance with a policy that seeks to maximize returns while ensuring both liquidity and minimal risk of principal loss. The policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings, and places restrictions on maturities and concentration by type and issuer.\nThe Company's fixed income investments are subject to the risk of market interest rate fluctuations, and all of the Company's investments are subject to risks associated with the ability of the issuers to perform their obligations under the instruments.\nThe Company has a program to manage certain portions of its exposure to fluctuations in foreign currency exchange rates. These exposures primarily result from European sales. The Company hedges the related receivables with foreign currency forward contracts, all of which mature within six months. The Company uses purchased foreign currency option and forward contracts to hedge anticipated future cash flows related to sales which generally expire within 12 months. At December 31, 1994, outstanding forward and option contracts totaled $31.8 million and $78.0 million, respectively. The gains and losses on these contracts were not material for 1994, 1993, and 1992.\nThe Company believes that existing funds, cash generated from operations, and existing sources of debt financing should be adequate to satisfy its working capital and capital expenditure requirements and to support its common stock repurchase program for the foreseeable future. However, the Company may raise additional capital from time to time to take advantage of favorable conditions in the markets or in connection with the Company's corporate development activities.\nResults of Operations\nProduct sales\nIn 1994, product sales increased $243.2 million or 19% over the prior year. In 1993, product sales increased $255.7 million or 24% over the prior year.\nNEUPOGEN(R) (Filgrastim)\nNEUPOGEN(R) sales were $828.9 million in 1994, an increase of $109.5 million or 15% over the prior year. In 1993, sales were $719.4 million, an increase of $175.0 million or 32% over the prior year.\nDomestic sales of NEUPOGEN(R) were $617.2 million in 1994, an increase of $71.7 million or 13% over the prior year. In 1993, domestic sales were $545.5 million, an increase of $123.3 million or 29% over the prior year. These increases were primarily due to increased penetration of the current market for colony stimulating factors.\nInternational sales of NEUPOGEN(R), primarily in Europe, were $211.7 million in 1994, an increase of $37.8 million or 22% over the prior year. In 1993, international sales were $173.9 million, an increase of $51.7 million or 42% over the prior year. Without the effect of changes in foreign currency exchange rates, annual sales volumes increased by 22% and 62% in 1994 and 1993, respectively, due to increased penetration of the market for colony-stimulating factors.\nDuring the first quarter of 1994, Rhone-Poulenc Rorer and Chugai Pharmaceutical Co., Ltd. began jointly marketing a G-CSF product in the European Union (\"EU\"). Although there has been no significant effect on the Company's worldwide NEUPOGEN(R) sales, it is not possible to predict\nthe ultimate impact this competitive product will have on future EU NEUPOGEN(R) sales.\nQuarterly NEUPOGEN(R) sales volumes in both the United States and Europe are influenced by a number of factors including underlying demand, seasonality of cancer chemotherapy administration, and wholesaler inventory management practices. The Company's experience has shown that reduced chemotherapy usage occurs in the third calendar quarter in many EU countries to varying degrees resulting in corresponding decreases in sales. In the U.S., reduced chemotherapy usage occurs in the fourth quarter. This factor along with wholesaler inventory reductions depresses Amgen sales in the first calendar quarter.\nThe Company believes that 1995 NEUPOGEN(R) sales will continue to grow at a double digit rate but lower than the 1994 growth rate. NEUPOGEN(R) sales increases are primarily dependent upon further penetration of existing markets, the timing and nature of additional indications for which the product may be approved, and the effects of competitive products. In addition, international NEUPOGEN(R) sales will continue to be subject to changes in foreign currency exchange rates and increased competition.\nEPOGEN(R) (Epoetin alfa)\nEPOGEN(R) sales were $720.6 million in 1994, an increase of $133.7 million or 23% over the prior year. In 1993, EPOGEN(R) sales were $586.9 million, an increase of $80.6 million or 16% over the prior year. These increases were primarily due to an increase in the dialysis patient population, the administration of higher average doses of EPOGEN(R) per patient, and increased penetration of the dialysis market. The federal government enacted legislation effective January 1, 1994 to lower reimbursement provided to facilities that administer EPOGEN(R) from $11 per thousand units administered to $10 per thousand units administered. This change in reimbursement did not have a material adverse effect on EPOGEN(R) sales in 1994.\nThe Company anticipates that increases in the U.S. dialysis patient population and increases in dosing will continue to drive EPOGEN(R) sales. The annual growth rate for 1995 is expected to be in double digits but lower than the 1994 growth rate. In addition, the continued growth in sales volume may be affected by future changes in reimbursement rates or the basis for reimbursement by the federal government.\nCost of sales\nCost of sales as a percentage of product sales was 15.4%, 16.8% and 17.6% for the years ended December 31, 1994, 1993 and 1992, respectively. The improvement in 1994 primarily reflects the commencement of commercial production and building of inventories at the Puerto Rico fill-and-finish facility and the commencement of commercial production at a new NEUPOGEN(R) manufacturing facility. Annual cost of sales as a percentage of product sales is not expected to vary significantly for the foreseeable future.\nResearch and development\nIn 1994 and 1993, research and development expenses increased $68.3 million or 27% and $73.0 million or 40%, respectively, compared with the\nprior years primarily due to expansion of the Company's research and development staff and increased expenditures on external research collaborations. In connection with the acquisition of Synergen, the Company increased its research and development staff in order to exploit the technologies that were acquired in those therapeutic areas of interest. Annual research and development expenses are expected to increase at a rate exceeding the anticipated annual product sales growth rate due to planned increases in internal efforts on new product discovery and development and increases in external research collaboration costs, including acquisitions of product and technology rights.\nWrite-off of in-process technology purchased\nIn December 1994, the Company completed its acquisition of Synergen, a biotechnology company engaged in the discovery and development of protein- based pharmaceuticals. Synergen was acquired for $254.5 million in cash, including related acquisition costs. The purchase price was assigned to the acquired tangible and intangible assets based on their estimated fair values at the date of acquisition. The value assigned to in-process technology of $116.4 million was expensed during the quarter ended December 31, 1994.\nMarketing and selling\nIn 1994, marketing and selling expenses increased $22.7 million or 11% compared with the prior year. This increase is primarily due to marketing efforts to expand NEUPOGEN(R) market penetration and EPOGEN(R) marketing efforts to bring more patients within the target hematocrit range. In 1993, marketing and selling expenses increased $29.7 million or 16% compared with the prior year primarily due to increases in both domestic and international sales and marketing expenses in support of NEUPOGEN(R) market penetration. The future growth rate of marketing and selling expenses is expected to be less than the anticipated annual product sales growth rate.\nGeneral and administrative\nIn 1994 and 1993, general and administrative expenses increased $8.6 million or 8% and $6.6 million or 6%, respectively, compared with the prior years. The future growth rate of general and administrative expenses is expected to be less than the anticipated annual product sales growth rate.\nLegal award\nIn June 1993, the Company recorded a $13.9 million legal award as part of the settlement with Genetics Institute for outstanding patent disputes regarding erythropoietin in the United States.\nIn September 1992, an arbitrator found that the Company was entitled to damages from Johnson & Johnson related to hepatitis B vaccine and interleukin-2, two of the three products included in an arbitration proceeding. (See Note 5 to the Consolidated Financial Statements - Johnson & Johnson arbitration.) In January 1993, the arbitrator subsequently determined the amount of the award to be $89.7 million. The Company recorded $77.1 million of this award in 1992 and deferred recognition of\n$12.6 million related to the further development of hepatitis B vaccine and interleukin-2 to future periods.\nInterest and other income\nDuring 1994, interest rates increased significantly which caused a decrease in the market value of the Company's fixed income investments. Consistent with its investment policy, the Company elected to sell certain of these investments, resulting in capital losses, in order to reposition the portfolio to improve yields and reduce risk. Further capital losses occurred in connection with the liquidation of investments to fund the Company's acquisition of Synergen in December 1994. During 1994, net losses from sales of marketable securities totaled $16.1 million, and at December 31, 1994, there were no significant unrealized losses remaining in the Company's investment portfolio. Interest income decreased in 1993 compared with the prior year primarily due to a decline in interest rates. In 1993 and 1992, there were no significant gains or losses related to the sale of fixed income investments.\nIncome taxes\nIn 1994, the Company's effective tax rate was 45.7%, which is higher than the Company's statutory rate. This is primarily due to the write-off of in-process technology purchased in connection with the Synergen acquisition, which is not deductible for income tax purposes. In 1993, the Company's effective tax rate of 36.8% reflected: 1) an increase in the federal tax rate from 34% to 35% due to federal tax law changes enacted in 1993, and 2) a decrease in the equity in earnings of an affiliated company. These items were substantially offset by a reduction related to the retroactive reinstatement to July 1, 1992 of the research and experimentation and orphan drug tax credits. In addition, the provision for state income taxes decreased in 1993 due to changes in the apportionment of taxable income among states. In 1992, the Company's effective tax rate of 36.5% reflected a reduction in state income taxes as a percentage of pretax income principally due to the legal award having no impact on taxable income for state income tax purposes.\nIn January 1995, the Company began receiving tax benefits from manufacturing products at its facility in Puerto Rico. Realization of these tax benefits is expected to result in an annualized effective tax rate of 32%-34%.\nLegal Matters\nThe Company is engaged in arbitration proceedings with one of its licensees and various legal proceedings relating to Synergen. For a complete discussion of these matters see Note 5 to the Consolidated Financial Statements.\nOutlook\nOperating in rapidly changing health care policy arenas and market environments presents many significant and unique challenges. Market forces are changing the economics of health care in the United States through voluntary limits on price increases by the pharmaceutical industry, increases in the purchasing power of large buying groups, and increased influence on medical care and treatment decisions by managed care\norganizations. The Company is meeting the challenges of this changing health care environment through programs that work to optimize the use of its products in the treatment of patients and clinical trials designed to evaluate cost and quality-of-life parameters as well as clinical safety and efficacy. In addition, the Company is adapting to legislative mandates in foreign markets.\nThe Company's current goals include achieving strong financial results and expanding its product portfolio through both increased research and development efforts and the acquisition of businesses and\/or licensing of technologies and products which meet certain strategic and financial objectives.\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 the financial statements listed in Item 14(a) of Part IV 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\nInformation concerning the directors of the Company is incorporated by reference to the section entitled \"Election of Directors\" in the Company's definitive Proxy Statement with respect to the Company's 1994 Annual Meeting to be filed with the Securities and Exchange Commission within 120 days of December 31, 1994 (the \"Proxy Statement\").\nThe executive officers of the Company, their ages as of February 28, 1995 and positions are as follows:\nMr. Gordon M. Binder, age 59, has served as a director of the Company since October 1988. He joined the Company in 1982 as Vice President- Finance and was named Senior Vice President-Finance in February 1986. In October 1988, Mr. Binder was elected Chief Executive Officer. In July 1990, Mr. Binder became Chairman of the Board.\nMr. Kevin W. Sharer, age 46, has served as a director of the Company since November 1992. He has served as President and Chief Operating Officer since October 1992. Prior to joining the Company, Mr. Sharer served as President of the Business Markets Division of MCI Communications Corporation, a telecommunications company, from April 1989 to October 1992, and served in numerous executive capacities at General Electric Company from February 1984 to March 1989. Mr. Sharer also serves as a director of Geotek Communications, Inc.\nMr. Robert S. Attiyeh, age 60, has served as Senior Vice President, Finance and Corporate Development, since joining the Company in July 1994. Prior to joining the Company, Mr. Attiyeh served as a director of McKinsey & Company, a consulting firm, in its Los Angeles, Japan and Scandinavian offices from 1967 to 1994.\nDr. N. Kirby Alton, age 44, became Senior Vice President, Development, in August 1993, having served as Senior Vice President, Therapeutic Product Development, since August 1992. Dr. Alton previously served as Vice President, Therapeutic Product Development, Responsible Head, from October 1988 to August 1992, and as Director, Therapeutic Product Development, from February 1986 to October 1988.\nDr. Dennis M. Fenton, age 43, became Senior Vice President, Operations, in January 1995, having served as Senior Vice President, Sales and Marketing, since August 1992, and having served as Vice President, Process Development, Facilities and Manufacturing Services, from July 1991 to August 1992. Dr. Fenton previously had served as Vice President, Pilot Plant Operations and Clinical Manufacturing, from October 1988 to July 1991, and as Director, Pilot Plant Operations, from 1985 to October 1988.\nMr. Daryl D. Hill, age 49, became Senior Vice President, Asia Pacific, in January 1994, having served as Vice President, Quality Assurance, from October 1988 to January 1994, and as Director of Quality Assurance from January 1984 to October 1988.\nMr. Larry A. May, age 45, became Vice President, Corporate Controller and Chief Accounting Officer in October 1991, having served as Corporate Controller and Chief Accounting Officer from October 1988 to October 1991, and as Controller from January 1983 to October 1988.\nDr. Daniel Vapnek, age 56, became Senior Vice President, Research, in October 1988, having served as Vice President, Research, since January 1986.\nMr. Thomas E. Workman, Jr., age 67, was appointed Vice President, Secretary and General Counsel in December 1992, having served as Acting General Counsel since September 1992. Prior to joining the Company, Mr. Workman was an advisory partner of Pillsbury Madison & Sutro, a law firm, from January 1992 to September 1992, and was a regular partner of Pillsbury Madison & Sutro from 1986 through December 1991.\nDr. Linda R. Wudl, age 49, became Vice President, Quality Assurance, in January 1994, having served as Director of Quality Control from April 1991 to January 1994, and as Manager of Quality Control from April 1987 to April 1991.\nItem 11.","section_11":"Item 11. EXECUTIVE COMPENSATION\nThe section labeled \"Executive Compensation\" appearing in the Company's Proxy Statement is incorporated herein by reference, except for such information as need not be incorporated by reference under rules promulgated by the Securities Exchange Commission.\nItem 12.","section_12":"Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nThe section labeled \"Security Ownership of Directors and Executive Officers and Certain Beneficial Owners\" appearing in the Company's Proxy Statement is incorporated herein by reference.\nItem 13.","section_13":"Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nThe section labeled \"Certain Transactions\" appearing in the Company's 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\n(a) 1. Index to Financial Statements\nThe following Financial Statements are included herein:\nPage Number\nReport of Ernst & Young LLP, Independent Auditors .................F-1 Consolidated Statements of Operations for each of the three years in the period ended December 31, 1994...............F-2 - Consolidated Balance Sheets at December 31, 1994 and 1993 .........F-4 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1994.....F-5 - Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1994...............F-7 - Notes to Consolidated Financial Statements .................F-9 -\n(a) 2. Index to Financial Statement Schedules\nThe following Schedules are filed as part of this Form 10-K Annual Report:\nPage Number\nVIII Valuation Accounts ......................................F-29\nAll other schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated statements or notes thereto.\n(a) 3. Exhibits\nExhibit No. Description\n3.1 Restated Certificate of Incorporation. (7) 3.2 Certificate of Amendment to Restated Certificate of Incorporation, effective as of July 24, 1991. (14) 3.3 Bylaws, as amended to date. (20)\n4.1 Indenture dated January 1, 1992 between the Company and Citibank N.A., as trustee. (15) 4.2 Forms of Commercial Paper Master Note Certificates. (19) 10.1* Company's 1991 Equity Incentive Plan, as amended. (16) 10.2* Company's 1984 Stock Option Plan, as amended, and forms of Incentive Stock Option Grant and Nonqualified Stock Option Grant used in connection therewith. (16) 10.3 Shareholder's Agreement of Kirin-Amgen, Inc., dated May 11, 1984, between the Company and Kirin Brewery Company, Limited (with certain confidential information deleted therefrom). (1) 10.4 Amendment Nos. 1, 2, and 3, dated March 19, 1985, July 29, 1985 and December 19, 1985, respectively, to the Shareholder's Agreement of Kirin-Amgen, Inc., dated May 11, 1984 (with certain confidential information deleted therefrom). (3) 10.5 Product License Agreement, dated September 30, 1985, and Technology License Agreement, dated, September 30, 1985 between the Company and Ortho Pharmaceutical Corporation (with certain confidential information deleted therefrom). (2) 10.6 Product License Agreement, dated September 30, 1985, and Technology License Agreement, dated September 30, 1985 between Kirin-Amgen, Inc. and Ortho Pharmaceutical Corporation (with certain confidential information deleted therefrom). (3) 10.7* Company's Employee Stock Purchase Plan, amended April 1, 1992. (17) 10.8 Agreement, dated February 12, 1986, between the Company and Sloan-Kettering Institute for Cancer Research (with certain confidential information deleted therefrom). (4) 10.9 Amendment No. 2, dated November 13, 1990, to Agreement, dated February 12, 1986, between the Company and Sloan-Kettering Institute for Cancer Research (with certain confidential information deleted therefrom). (13) 10.10 Research, Development Technology Disclosure and License Agreement PPO, dated January 20, 1986, by and between the Company and Kirin Brewery Co., Ltd. (4) 10.11 Research Collaboration Agreement, dated August 31, 1990, between Amgen Inc. and Regeneron Pharmaceuticals, Inc. (with certain confidential information deleted therefrom). (13) 10.12 Amendment Nos. 4 and 5, dated October 16, 1986 (effective July 1, 1986) and December 6, 1986 (effective July 1, 1986), respectively, to the Shareholders Agreement of Kirin-Amgen, Inc. dated May 11, 1984 (with certain confidential information deleted therefrom). (5) 10.13 Assignment and License Agreement, dated October 16, 1986, between the Company and Kirin-Amgen, Inc. (with certain confidential information deleted therefrom). (5) 10.14 G-CSF European License Agreement, dated December 30, 1986, between Kirin-Amgen, Inc. and the Company (with certain confidential information deleted therefrom). (5) 10.15 Research and Development Technology Disclosure and License Agreement: GM-CSF, dated March 31, 1987, between Kirin Brewery Company, Limited and the Company (with certain confidential information deleted therefrom). (5) 10.16* Company's 1987 Directors' Stock Option Plan, as amended. (13) 10.17 Cross License Agreement, dated June 1, 1987, between Amgen Inc. and Amgen Clinical Partners, L.P. (6)\n10.18 Development Agreement, dated June 1, 1987, between Amgen Inc. and Amgen Clinical Partners, L.P. (6) 10.19 Joint Venture Agreement, dated June 1, 1987, between Amgen Inc. and Amgen Clinical Partners, L.P. (6) 10.20 Partnership Purchase Option Agreement, dated June 1, 1987, between Amgen Inc. and Amgen Clinical Partners, L.P. (6) 10.21* Company's 1988 Stock Option Plan, as amended. (16) 10.22* Company's Retirement and Savings Plan, amended and restated as of January 1, 1993. (17) 10.23 Amendment, dated June 30, 1988, to Research, Development, Technology Disclosure and License Agreement: GM-CSF dated March 31, 1987, between Kirin Brewery Company, Limited and the Company. (7) 10.24 Amending Agreement, dated June 30, 1988, to Development Agreement, Partner Purchase Option Agreement, Cross License Agreement and Joint Venture Agreement, dated June 1, 1987, between the Company and Amgen Clinical Partners, L.P. (7) 10.25 Agreement on G-CSF in the EU, dated September 26, 1988, between Amgen Inc. and F. Hoffmann-La Roche & Co. Limited Company (with certain confidential information deleted therefrom). (9) 10.26 Supplementary Agreement to Agreement dated January 4, 1989 to Agreement on G-CSF in the EU, dated September 26, 1988, between the Company and F. Hoffmann-La Roche & Co. Limited Company, (with certain confidential information deleted therefrom). (9) 10.27 Agreement on G-CSF in Certain European Countries, dated January 1, 1989, between Amgen Inc. and F. Hoffmann-La Roche & Co. Limited Company (with certain confidential information deleted therefrom). (9) 10.28 Rights Agreement, dated January 24, 1989, between Amgen Inc. and American Stock Transfer and Trust Company, Rights Agent. (8) 10.29 First Amendment to Rights Agreement, dated January 22, 1991, between Amgen Inc. and American Stock Transfer and Trust Company, Rights Agent. (11) 10.30 Second Amendment to Rights Agreement, dated April 2, 1991, between Amgen Inc. and American Stock Transfer and Trust Company, Rights Agent. (12) 10.31 Credit Agreement, dated as of November 15, 1991, among Amgen Inc., The Borrowing Subsidiaries therein named, the Banks therein named, Swiss Bank Corporation, as issuing Bank and Swiss Bank Corporation and Citicorp USA, Inc., as Co-Agents. (17) 10.32 Deed of Trust and Security Agreement, dated June 1, 1989, between the Company and UNUM Life Insurance Company of America. (10) 10.33 Note, dated June 1, 1989, between the Company and UNUM Life Insurance Company of America. (10) 10.34 Agency Agreement, dated November 21, 1991, between Amgen Manufacturing, Inc. and Citicorp Financial Services Corporation. (17) 10.35 Agency Agreement, dated May 21, 1992, between Amgen Manufacturing, Inc. and Citicorp Financial Services Corporation. (17)\n10.36 Guaranty, dated July 29, 1992, by the Company in favor of Merck Sharp & Dohme Quimica de Puerto Rico, Inc. (17) 10.37 936 Promissory Note No. 01, dated December 11, 1991, issued by Amgen Manufacturing, Inc. (17) 10.38 936 Promissory Note No. 02, dated December 11, 1991, issued by Amgen Manufacturing, Inc. (17) 10.39 936 Promissory Note No. 001, dated July 29, 1992, issued by Amgen Manufacturing, Inc. (17) 10.40 936 Promissory Note No. 002, dated July 29, 1992, issued by Amgen Manufacturing, Inc. (17) 10.41 Guaranty, dated November 21, 1991, by the Company in favor of Citicorp Financial Services Corporation. (17) 10.42 First Amendment, dated as of June 16, 1992, to the Credit Agreement, dated as of November 15, 1991, among Amgen Inc., The Borrowing Subsidiaries therein named, the Banks therein named, Swiss Bank Corporation, as issuing Bank and Swiss Bank Corporation and Citicorp USA, Inc., as Co-Agents. (17) 10.43 Second Amendment, dated as of November 6, 1992, to the Credit Agreement, dated as of November 15, 1991, among Amgen Inc., The Borrowing Subsidiaries therein named, the Banks therein named, Swiss Bank Corporation, as issuing Bank and Swiss Bank Corporation and Citicorp USA, Inc., as Co-Agents. (17) 10.44 Lease and Agreement relating to Lease, dated March 27, 1986 and April 1, 1986, respectively, for 2003 Oak Terrace Lane between 2001 Hillcrest Partnership and the Company. (20) 10.45 Partnership Purchase Agreement, dated March 12, 1993, between the Company, Amgen Clinical Partners, L.P., Amgen Development Corporation, the Class A limited partners and the Class B limited partner. (18) 10.46* Amgen Supplemental Retirement Plan dated June 1, 1993. (21) 10.47 Promissory Note of Mr. Kevin W. Sharer, dated June 4, 1993. (21) 10.48 Amendment No. 3 dated June 25, 1993 to the Credit Agreement, dated November 15, 1991, among the Company, The Borrowing Subsidiaries therein named, the Banks therein named, the Swiss Bank Corporation, as issuing Bank and Swiss Bank Corporation and Citicorp USA, Inc., as Co-Agents. (21) 10.49 Promissory Note of Mr. Larry A. May, dated February 24, 1993. (22) 10.50* First Amendment dated October 26, 1993 to the Company's Retirement and Savings Plan. (22) 10.51* Amgen Performance Based Management Incentive Plan. (22) 10.52 Fourth Amendment, dated as of June 24, 1994, to the Credit Agreement, dated November 15, 1991, among the Company, The Borrowing Subsidiaries therein named, the Banks therein named, the Swiss Bank Corporation, as issuing Bank and Swiss Bank Corporation and Citicorp USA, Inc., as Co-Agents. (23) 10.53 Agreement and Plan of Merger, dated as of November 17, 1994, among Amgen Inc., Amgen Acquisition Subsidiary, Inc. and Synergen, Inc. (24) 10.54 Third Amendment to Rights Agreement, dated as of February 21, 1995, between Amgen Inc. and American Stock Transfer Trust and Trust Company (25) 11 Computation of earnings per share. 21 Subsidiaries of the Company.\n23 Consent of Ernst & Young LLP, independent auditors. The consent set forth on page 37 is incorporated herein by reference. 24 Power of Attorney. The Power of Attorney set forth on page 36 is incorporated herein by reference. 27 Financial Data Schedule. _____________\n* Management contract or compensatory plan or arrangement.\n(1) Filed as an exhibit to the Annual Report on Form 10-K for the year ended March 31, 1984 on June 26, 1984 and incorporated herein by reference. (2) Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended September 30, 1985 on November 14, 1985 and incorporated herein by reference. (3) Filed as an exhibit to Quarterly Report on Form 10-Q for the quarter ended December 31, 1985 on February 3, 1986 and incorporated herein by reference. (4) Filed as an exhibit to Amendment No. 1 to Form S-1 Registration Statement (Registration No. 33-3069) on March 11, 1986 and incorporated herein by reference. (5) Filed as an exhibit to the Form 10-K Annual Report for the year ended March 31, 1987 on May 18, 1987 and incorporated herein by reference. (6) Filed as an exhibit to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1987 on August 12, 1987 and incorporated herein by reference. (7) Filed as an exhibit to Form 8 amending the Quarterly Report on Form 10-Q for the quarter ended June 30, 1988 on August 25, 1988 and incorporated herein by reference. (8) Filed as an exhibit to the Form 8-K Current Report dated January 24, 1989 and incorporated herein by reference. (9) Filed as an exhibit to the Annual Report on Form 10-K for the year ended March 31, 1989 on June 28, 1989 and incorporated herein by reference. (10) Filed as an exhibit to the Quarterly Report on Form 10-Q for the quarter ended June 30, 1989 on August 14, 1989 and incorporated herein by reference. (11) Filed as an exhibit to the Form 8-K Current Report dated January 22, 1991 and incorporated herein by reference. (12) Filed as an exhibit to the Form 8-K Current Report dated April 12, 1991 and incorporated herein by reference. (13) Filed as an exhibit to the Annual Report on Form 10-K for the year ended March 31, 1991 on July 1, 1991 and incorporated herein by reference. (14) Filed as an exhibit to the Form 8-K Current Report dated July 24, 1991 and incorporated herein by reference. (15) Filed as an exhibit to Form S-3 Registration Statement dated December 19, 1991 and incorporated herein by reference. (16) Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1991 on March 30, 1992 and incorporated herein by reference. (17) Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1992 on March 30, 1993 and incorporated herein by reference.\n(18) Filed as an exhibit to the Form 8-A dated March 31, 1993 and incorporated herein by reference. (19) Filed as an exhibit to the Form 10-Q for the quarter ended March 31, 1993 on May 17, 1993 and incorporated herein by reference. (20) Filed as an exhibit to the Form 10-Q for the quarter ended June 30, 1993 on August 16, 1993 and incorporated herein by reference. (21) Filed as an exhibit to the Form 10-Q for the quarter ended September 30, 1993 on November 12, 1993 and incorporated herein by reference. (22) Filed as an exhibit to the Annual Report on Form 10-K for the year ended December 31, 1993 on March 25, 1994 and incorporated herein by reference. (23) Filed as an exhibit to the Form 10-Q for the ended September 30, 1994 on November 9, 1994 and incorporated herein by reference. (24) Filed as an exhibit to the Form 8-K Current Report dated November 18, 1994 on December 2, 1994 and incorporated herein by reference. (25) Filed as an exhibit to the Form 8-K Current Report dated February 21, 1995 on March 7, 1995 and incorporated herein by reference.\n(b) Reports on Form 8-K\nThe Company filed a report on Form 8-K dated November 18, 1994 reporting the execution of a definitive agreement by which the Company would acquire Synergen, Inc. and its subsidiaries. The Company subsequently filed a report on Form 8-K\/A dated November 18, 1994 amending the Form 8-K to report the completion of the acquisition of Synergen, Inc. and its subsidiaries and certain pro forma financial information regarding the Company.\nThe Company filed a report on Form 8-K dated February 21, 1995 reporting an amendment to its Rights Agreement, dated as of January 24, 1989, between Amgen Inc. and American Stock Transfer & Trust Company, as Rights Agent, as amended.\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.\nAmgen Inc. (Registrant)\nDate: 3\/28\/95 By: \/s\/ ROBERT S. ATTIYEH Robert S. Attiyeh Senior Vice President, Finance and Corporate Development, and Chief Financial Officer\nPOWER OF ATTORNEY\nKNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Robert S. Attiyeh and Larry A. May, or either of them, his attorney-in-fact, each with the power of substitution, for him in any and all capacities, to sign any amendments to this Report, and to file the same, with exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may 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 registrant and in the capacities and on the dates indicated:\n\/s\/ GORDON M. BINDER 3\/28\/95 Gordon M. Binder \/s\/ WILLIAM K. BOWES, JR. 3\/28\/95 Chairman of the Board William K. Bowes, Jr. Chief Executive Officer and Director Director (Principal Executive Officer) \/s\/ FRANKLIN P. JOHNSON, JR. 3\/28\/95 Franklin P. Johnson, Jr. Director \/s\/ KEVIN W. SHARER 3\/28\/95 Kevin W. Sharer President, Chief Operating Officer and \/s\/ STEVEN LAZARUS 3\/28\/95 Director Steven Lazarus Director\n\/s\/ ROBERT S. ATTIYEH 3\/28\/95 Robert S. Attiyeh Senior Vice President, \/s\/ EDWARD J. LEDDER 3\/28\/95 Finance and Corporate Edward J. Ledder Development, and Director Chief Financial Officer\n\/s\/ LARRY A. MAY 3\/28\/95 Larry A. May \/s\/ GILBERT S. OMENN 3\/28\/95 Vice President, Gilbert S. Omenn Corporate Controller and Director Chief Accounting Officer\n\/s\/ RAYMOND F. BADDOUR 3\/28\/95 Raymond F. Baddour \/s\/ BERNARD H. SEMLER 3\/28\/95 Director Bernard H. Semler Director\nEXHIBIT 23\nCONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nWe consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-5111) pertaining to the 1984 Stock Option Plan, 1981 Incentive Stock Option Plan and Nonqualified Stock Option Plan of Amgen Inc., in the Registration Statement (Form S-8 No. 33-24013) pertaining to the 1988 Stock Option Plan of Amgen Inc., in the Registration Statement (Form S-8 No. 33-39183) pertaining to the Amgen Employee Stock Purchase Plan, in the Registration Statement (Form S-8 No. 33-39104) pertaining to the Amgen Retirement and Savings Plan, in the Registration Statement (Form S-8 No. 33-42501) pertaining to the Amgen Inc. 1987 Directors' Stock Option Plan, in the Registration Statement (Form S-8 No. 33-42072) pertaining to the Amgen Inc. 1991 Equity Incentive Plan, in the Registration Statement (Form S-8 No. 33-47605) pertaining to the Retirement and Savings Plan for Amgen Manufacturing, Inc. and in the Registration Statements (Form S-3 No. 33-22544 and Form S-3 No. 33-44454) of Amgen Inc. and in the related Prospectuses of our report dated February 1, 1995 with respect to the consolidated financial statements and financial statement schedules of Amgen Inc. included in this Annual Report (Form 10-K) for the year ended December 31, 1994.\n\/s\/ ERNST & YOUNG LLP Los Angeles, California March 24, 1995\nREPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS\nThe Board of Directors and Stockholders of Amgen Inc.\nWe have audited the accompanying consolidated balance sheets of Amgen Inc. as of December 31, 1994 and 1993, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1994. 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 Amgen Inc. at December 31, 1994 and 1993, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, 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 LLP Los Angeles, California February 1, 1995\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS\nYears ended December 31, 1994, 1993 and 1992 (In thousands, except per share data)\n1994 1993 1992 ---------- ---------- ---------- Revenues: Product sales................ $1,549,567 $1,306,322 $1,050,654 Corporate partner revenues... 70,400 48,631 29,621 Royalty income............... 27,937 18,889 12,766 ---------- ---------- ---------- Total revenues.......... 1,647,904 1,373,842 1,093,041 ---------- ---------- ---------- Operating expenses: Cost of sales................ 238,123 220,046 184,735 Research and development..... 323,629 255,321 182,297 Write-off of in-process technology purchased...... 116,367 - - Marketing and selling........ 236,858 214,132 184,482 General and administrative... 122,936 114,295 107,656 (Earnings) loss of affiliates, net........... 31,227 12,589 (16,940) Legal award.................. - (13,900) (77,076) ---------- ---------- ---------- Total operating expenses............. 1,069,140 802,483 565,154 ---------- ---------- ---------- Operating income............... 578,764 571,359 527,887\nOther income (expense): Interest and other income.... 21,526 27,161 35,388 Interest expense, net........ (12,021) (6,150) (141) ---------- ---------- ---------- Total other income (expense)............ 9,505 21,011 35,247 ---------- ---------- ---------- Income before income taxes and cumulative effect of a change in accounting principle.................... 588,269 592,370 563,134 Provision for income taxes..... 268,604 217,795 205,534 ---------- ---------- ---------- Income before cumulative effect of a change in accounting principle......... 319,665 374,575 357,600 Cumulative effect of a change in accounting principle...... - 8,738 - ---------- ---------- ---------- Net income..................... $ 319,665 $ 383,313 $ 357,600 ========== ========== ========== See accompanying notes. (Continued on next page)\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF OPERATIONS (Continued)\nYears ended December 31, 1994, 1993 and 1992 (In thousands, except per share data)\n1994 1993 1992 ------ ------ ------ Earnings per share: Primary: Income before cumulative effect of a change in accounting principle..... $2.29 $2.61 $2.43 Cumulative effect of a change in accounting principle................ - .06 - ----- ----- ----- Net income................. $2.29 $2.67 $2.43 ===== ===== =====\nFully diluted: Income before cumulative effect of a change in accounting principle.... $2.27 $2.60 $2.42 Cumulative effect of a change in accounting principle............... - .06 - ----- ----- ----- Net income................ $2.27 $2.66 $2.42 ===== ===== =====\nShares used in calculation of: Primary earnings per share.. 139,790 143,611 147,297 Fully diluted earnings per share.................... 141,099 144,322 147,726\nSee accompanying notes.\nAMGEN CONSOLIDATED BALANCE SHEETS\nDecember 31, 1994 and 1993 (In thousands, except per share data)\n1994 1993 ---------- ---------- ASSETS Current assets: Cash and cash equivalents........... $ 211,323 $ 128,505 Marketable securities............... 485,358 594,679 Trade receivables, net of allowance for doubtful accounts of $13,284 in 1994 and $12,161 in 1993....... 194,712 164,337 Inventories......................... 98,004 74,712 Deferred tax assets, net............ 70,176 58,937 Other current assets................ 56,065 33,340 ---------- ---------- Total current assets.............. 1,115,638 1,054,510\nProperty, plant and equipment at cost, net................................. 665,314 586,912 Investments in affiliated companies.... 82,263 59,276 Other assets........................... 130,932 64,825 ---------- ---------- $1,994,147 $1,765,523 ========== ==========\nLIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.................... $ 30,476 $ 23,056 Commercial paper.................... 99,667 109,767 Accrued liabilities................. 406,287 279,438 ---------- ---------- Total current liabilities......... 536,430 412,261\nLong-term debt......................... 183,407 181,242 Contingencies Stockholders' equity: Common stock, $.0001 par value; 750,000 shares authorized; outstanding - 132,328 shares in 1994 and 134,214 in 1993.......... 13 13 Additional paid-in capital.......... 719,310 636,217 Retained earnings................... 554,987 535,790 ---------- ---------- Total stockholders' equity........ 1,274,310 1,172,020 ---------- ---------- $1,994,147 $1,765,523 ========== ==========\nSee accompanying notes.\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY\nYears ended December 31, 1994, 1993 and 1992 (In thousands)\nNumber Common Additional of Common paid-in Retained shares stock capital earnings -------- ------ --------- -------- Balance at December 31, 1991.. 131,864 $13 $442,931 $88,201 Issuance of common stock upon the exercise of stock options and in connection with an employee stock purchase plan.............. 3,844 1 36,922 - Issuance of common stock upon the exercise of warrants................... 1,985 - 17,618 - Reduction in current income tax liability related to stock options.............. - - 76,316 - Repurchases of common stock... (1,372) - - (85,870) Net income.................... - - - 357,600 ------- ----- -------- --------\nBalance at December 31, 1992.. 136,321 14 573,787 359,931 Issuance of common stock upon the exercise of stock options and in connection with an employee stock purchase plan.............. 2,329 - 21,682 - Issuance of common stock upon the exercise of warrants................... 636 - 5,913 - Reduction in current income tax liability related to stock options.............. - - 34,835 - Repurchases of common stock... (5,072) (1) - (207,454) Net income.................... - - - 383,313 ------- ----- -------- -------- Balance at December 31, 1993.. 134,214 $13 $636,217 $535,790\nSee accompanying notes. (Continued next page)\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (Continued)\nYears ended December 31, 1994, 1993 and 1992 (In thousands)\nNumber Additional of Common paid-in Retained shares stock capital earnings -------- ------ --------- -------- Balance at December 31, 1993.. 134,214 $13 $636,217 $535,790 Issuance of common stock upon the exercise of stock options and in connection with an employee stock purchase plan.............. 2,855 - 44,785 - Issuance of common stock upon the exercise of warrants................... 1,704 - 15,330 - Reduction in current income tax liability related to stock options.............. - - 22,978 - Repurchases of common stock (6,445) - - (300,468) Net income.................... - - - 319,665 ------- ----- -------- -------- Balance at December 31, 1994.. 132,328 $13 $719,310 $554,987 ======= ===== ======== ========\nSee accompanying notes.\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS\nYears ended December 31, 1994, 1993 and 1992 (In thousands)\n1994 1993 1992 -------- -------- -------- Cash flows from operating activities: Net income.......................$ 319,665 $383,313 $357,600 Write-off of in-process technology purchased........... 116,367 - - Depreciation and amortization.... 74,520 50,743 33,569 Other non-cash expenses.......... 2,794 7,933 8,670 Deferred income taxes............ 2,443 17,379 (8,012) (Earnings) loss of affiliates, net............................ 31,227 12,589 (16,940) Cash provided by (used in): Trade receivables, net......... (30,375) (8,294) (67,852) Inventories.................... (23,292) (17,911) (16,632) Other current assets........... 1,760 (4,820) (13,375) Accounts payable............... 4,550 (14,970) 8,518 Accrued liabilities............ 32,231 7,045 7,253 ---------- -------- -------- Net cash provided by operating activites....... 531,890 433,007 292,799 ---------- -------- -------- Cash flows from investing activities: Purchases of property, plant and equipment................. (130,813) (209,904) (219,775) Increase in marketable securities.................... - (131,313) (232,049) Proceeds from maturities of marketable securities......... 87,726 - - Proceeds from sales of marketable securities......... 1,505,776 - - Purchases of marketable securities.................... (1,395,139) - - Cost to acquire company, net of cash acquired................. (240,762) - - Increase in investments in affiliated companies.......... (21,824) (22,370) (7,668) Distributions from affiliated companies..................... - 673 3,074 Decrease (increase) in other assets........................ 4,042 (27,032) (15,772) ---------- -------- -------- Net cash used in investing activities............... (190,994) (389,946) (472,190) ---------- -------- -------- See accompanying notes. (Continued on next page)\nAMGEN INC.\nCONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)\nYears ended December 31, 1994, 1993 and 1992 (In thousands)\n1994 1993 1992 -------- -------- -------- Cash flows from financing activities: (Decrease) increase in commercial paper........................... (10,100) 109,767 - Proceeds from issuance of long- term debt....................... 12,490 53,054 100,997 Repayment of long-term debt....... (12,009) (1,991) (10,556) Net proceeds from issuance of common stock upon the exercise of stock options and in connection with an employee stock purchase plan............. 44,555 21,454 34,236 Tax benefit related to stock options......................... 22,978 34,835 76,316 Net proceeds from issuance of common stock upon the exercise of warrants..................... 15,330 5,913 17,618 Repurchases of common stock....... (300,468) (207,454) (85,870) Other............................. (30,854) (22,182) (7,756) -------- -------- -------- Net cash (used in) provided by financing activities.... (258,078) (6,604) 124,985 -------- -------- -------- Increase (decrease) in cash and cash equivalents....................... 82,818 36,457 (54,406) Cash and cash equivalents at beginning of period............... 128,505 92,048 146,454 -------- -------- -------- Cash and cash equivalents at end of period............................ $211,323 $128,505 $ 92,048 ======== ======== ========\nSee accompanying notes.\nAMGEN INC.\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nDecember 31, 1994\n1. Summary of significant accounting policies\nBusiness\nAmgen Inc. (\"Amgen\" or the \"Company\") is a global biotechnology company that develops, manufactures and markets human therapeutics based on advanced cellular and molecular biology.\nPrinciples of consolidation\nThe consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries as well as affiliated companies for which the Company has a controlling financial interest and exercises control over their operations (\"majority controlled affiliates\"). All material intercompany transactions and balances have been eliminated in consolidation. Investments in affiliated companies which are 50% owned and\/or where the Company exercises significant influence over operations are accounted for using the equity method. All other equity investments are accounted for under the cost method. Earnings (loss) of affiliates, net includes equity in earnings (loss) of affiliated companies and the minority interest in (earnings) loss of majority controlled affiliates.\nCash equivalents and marketable securities\nThe Company considers only those investments which are highly liquid, readily convertible to cash and which mature within three months from date of purchase as cash equivalents.\nThe Company considers its investment portfolio available-for-sale as defined in Statement of Financial Accounting Standards (\"SFAS\") No. 115. There were no material unrealized gains or losses nor any material differences between the estimated fair values and costs of securities in the investment portfolio at December 31, 1994. Realized gains and losses totaled $5,048,000 and $21,110,000, respectively, for the year ended December 31, 1994. The cost of securities sold is based on the specific identification method. The cost of the investment portfolio by type of security, contractual maturity and its classification in the balance sheet at December 31, 1994 is as follows (in thousands):\nCorporate debt securities................... $365,033 U.S. Treasury securities and obligations of U.S. government agencies.................. 170,940 Other interest bearing securities........... 151,524 -------- $687,497 ========\nMaturing in one year or less................ $411,002 Maturing after one year through three years. 132,838 Maturing after three years.................. 143,657 -------- $687,497 ========\nCash and cash equivalents................... $211,323 Marketable securities....................... 485,358 -------- 696,681 Less cash................................... (9,184) -------- $687,497 ========\nThe Company invests its cash in accordance with a policy that seeks to maximize returns while ensuring both liquidity and minimal risk of principal loss. The policy limits investments to certain types of instruments issued by institutions with investment grade credit ratings, and places restrictions on maturities and concentration by type and issuer. The Company's fixed income investments are subject to the risk of market interest rate fluctuations, and all the Company's investments are subject to risks associated with the ability of the issuers to perform their obligations under the instruments.\nInventories\nInventories are stated at the lower of cost or market. Cost is determined in a manner which approximates the first-in, first-out (FIFO) method. Inventories are shown net of applicable reserves and allowances. Inventories consist of the following (in thousands):\nDecember 31, 1994 1993 ------- ------- Raw materials.................... $10,943 $ 8,001 Work in process.................. 54,032 47,138 Finished goods................... 33,029 19,573 ------- ------- $98,004 $74,712 ======= =======\nDepreciation and amortization\nDepreciation of buildings and equipment is provided over their estimated useful lives on a straight-line basis. Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or lease terms, including periods covered by options which are expected to be exercised.\nProduct sales\nProduct sales consist of two products, EPOGEN(R) (Epoetin alfa) and NEUPOGEN(R) (Filgrastim).\nAs a result of an agreement between Amgen and Ortho Pharmaceutical Corporation, a subsidiary of Johnson & Johnson (\"Johnson & Johnson\") covering the U.S. market for the Company's Epoetin alfa product, Amgen does not recognize product sales it makes into the contractual market of Johnson & Johnson and does recognize the product sales made by Johnson & Johnson into Amgen's contractual market. These sales amounts, and adjustments thereto, are derived from third-party data on shipments to end users and their usage as the data becomes available (see Note 5, \"Contingencies - Johnson & Johnson arbitration\").\nResearch and development costs\nResearch and development costs are expensed as incurred. Payments related to the acquisition of technology rights, for which development work is in-process, are expensed and considered a component of research and development costs (Note 2).\nForeign currency transactions\nThe Company has a program to manage foreign currency risk. As part of this program, the Company has purchased foreign currency option contracts to hedge against reductions in values of anticipated foreign currency cash flows over the next 12 months, primarily resulting from its sales in Europe. At December 31, 1994, the Company had option contracts to exchange foreign currencies, primarily Swiss francs, for U.S. dollars of $77,968,000, all having maturities of less than one year. These options are designated and effective as hedges of anticipated foreign currency transactions, and accordingly, the net gains on such contracts are deferred and will be recognized primarily in product sales in the same period as the hedged transactions.\nThe Company also has foreign currency forward contracts to hedge certain exposures to foreign currency fluctuations of net monetary assets denominated in foreign currencies. At December 31, 1994, the Company had forward contracts to exchange foreign currencies, primarily Swiss francs, for U.S. dollars of $31,800,000, all having maturities of less than six months. These contracts are designated and effective as hedges, and accordingly, gains and losses on these forward contracts are recognized in the same period the offsetting gains and losses of hedged net monetary assets are realized and recognized.\nInterest rate swaps\nThe Company has two interest rate swap agreements that change the nature of the fixed rate interest paid on $50,000,000 of its medium term debt securities (\"Medium Term Notes\") outstanding (Note 4). Under the first agreement, the Company pays a variable rate (LIBOR) of interest in exchange for the receipt of fixed rate interest payments of approximately 6.1%. Under the second agreement, the Company makes fixed rate interest payments of approximately 4.7% and receives variable rate (LIBOR) interest payments at the same time payments are exchanged under the first agreement. These agreements both have notional amounts of $50,000,000, terminate in 1997, and involve the same counterparty. The differential in the fixed rate interest payments is recognized as a reduction of interest expense related to the debt. The related amounts payable to and receivable from the counterparty are recorded in accrued liabilities. The fair values of the swap agreements are not recognized in the financial statements.\nInterest\nInterest costs are expensed as incurred except to the extent such interest is related to construction in progress, in which case interest is capitalized. Interest costs capitalized for the years ended December 31, 1994, 1993 and 1992, were $3,733,000, $3,973,000, and $6,102,000, respectively.\nIncome taxes\nEffective January 1, 1993, the Company adopted SFAS No. 109, \"Accounting for Income Taxes,\" which supersedes SFAS No. 96. As permitted under this new accounting standard, prior years' financial statements have not been restated. Net income for the year ended December 31, 1993, was increased by $8,738,000, or $.06 per share on a primary and fully diluted basis, to reflect the cumulative effect of a change in accounting principle to adopt SFAS No. 109 (Note 6).\nEarnings per share\nEarnings per share are computed in accordance with the treasury stock method. Primary and fully diluted earnings per share are based upon the weighted average number of common shares and dilutive common stock equivalents outstanding. Common stock equivalents include outstanding options under the Company's stock option plans and outstanding warrants to purchase shares of the Company's common stock.\nReclassification\nCertain prior year amounts have been reclassified to conform to the current year presentation.\n2. Business combination\nOn December 22, 1994, the Company acquired the outstanding stock of Synergen, Inc. (\"Synergen\"), a publicly held biotechnology company engaged in the discovery and development of protein-based pharmaceuticals. Synergen was acquired for $254,493,000, including related acquisition costs. The preliminary assignment of the purchase price among identifiable tangible and intangible assets was based on an analysis of the fair values of those assets. Specifically, purchased in-process technology was evaluated through analysis of data concerning each of Synergen's product candidates. The fair values of the identifiable tangible and intangible assets acquired, net of liabilities assumed, exceeded the purchase price, and accordingly, the values of the noncurrent assets (including in-process technology) were reduced pro rata. The value assigned to in-process technology of $116,367,000 was expensed on the acquisition date.\nThis business combination has been accounted for using the purchase method. Therefore, the operating results of Synergen are included in the accompanying consolidated financial statements from December 22, 1994. The following unaudited pro forma consolidated financial information assumes the acquisition of Synergen occurred on January 1, 1994 and 1993, respectively (in thousands, except per share data):\n1994 1993 ---------- ---------- Revenues........... $1,662,251 $1,387,022 Net income......... 259,829 209,619 Earnings per share: Primary.......... $1.86 $1.42 Fully diluted.... $1.84 $1.41\nThe pro forma information does not purport to be indicative of the operating results which would have been achieved had the combination occurred on January 1, 1994 or 1993, respectively, and should not be construed as representative of future operating results.\n3. Related party transactions\nKirin-Amgen\nThe Company owns a 50% interest in Kirin-Amgen, Inc. (\"Kirin-Amgen\"), a corporation formed for the development and commercialization of certain products based on advanced biotechnology. Pursuant to the terms of agreements entered into with Kirin-Amgen, the Company conducts certain research and development activities on behalf of Kirin-Amgen and is paid for such services at a negotiated rate. Included in revenues from corporate partners for the years ended December 31, 1994, 1993 and 1992, are $58,638,000, $41,247,000 and $24,554,000, respectively, related to these agreements.\nIn connection with its various agreements with Kirin-Amgen, the Company has been granted sole and exclusive licenses for the manufacture and sale of certain products in specified geographic areas of the world. In return for such licenses, the Company paid Kirin-Amgen stated amounts upon the receipt of the licenses and\/or pays Kirin-Amgen royalties based on sales. During the years ended December 31, 1994, 1993 and 1992, Kirin-\nAmgen earned royalties from Amgen of $67,526,000, $53,122,000 and $42,793,000, respectively, under such agreements, which are included in cost of sales in the accompanying consolidated statements of operations.\nAt December 31, 1994, Amgen's share of Kirin-Amgen's undistributed retained earnings was approximately $39,350,000.\nLimited Partnership\nAmgen Clinical Partners, L.P. (the \"Limited Partnership\"), a limited partnership, was formed to develop and commercialize products from certain technologies for human pharmaceutical use in the United States. In connection with the formation of the Limited Partnership, Amgen was granted options to purchase all of the limited partners' interests in the Limited Partnership. During 1993, Amgen exercised these options and made cash advance payments to the former limited partners aggregating $20,860,000. In addition, each former limited partner receives quarterly payments, subject to certain adjustments, equal to a stated percentage of Amgen's sales of certain products in specified geographic areas through December 31, 2005. The cash advance payments are recoverable against certain of these quarterly payments commencing in 1997.\nThe Limited Partnership and Amgen formed Amgen Ventures, a joint venture, to manufacture and market the Limited Partnership's products in the United States. Amgen consolidated the results of Amgen Ventures' operations and reflected the Limited Partnership's equity in earnings of these operations as royalty expense. During the years ended December 31, 1993 and 1992, the Limited Partnership's equity in these earnings aggregated $11,131,000 and $36,306,000, respectively, which are included in cost of sales in the accompanying consolidated statements of operations.\n4. Debt\nThe Company has a commercial paper program which provides for unsecured short-term borrowings up to an aggregate of $200,000,000. Commercial paper issued under this program is supported by the Company's credit facility (discussed below). At December 31, 1994, $99,666,000 of commercial paper was outstanding at effective interest rates averaging 6.0% and maturities of less than four months. At December 31, 1993, $109,767,000 of commercial paper was outstanding at effective interest rates averaging 3.3% and maturities of less than three months.\nLong-term debt consists of the following (in thousands):\nDecember 31, 1994 1993 -------- -------- Medium Term Notes................ $113,000 $103,000 Promissory notes................. 68,200 68,200 Other long-term obligations...... 2,252 11,771 -------- -------- 183,452 182,971 Less current portion............. (45) (1,729) -------- -------- $183,407 $181,242 ======== ========\nThe Company has registered $200,000,000 of unsecured Medium Term Notes of which $113,000,000 were outstanding at December 31, 1994. These Medium Term Notes mature in two to nine years and bear interest at fixed rates averaging 5.8%. The Company may offer and issue these securities from time to time with terms determined by market conditions. Under the terms of these securities, the Company is required to meet certain debt to tangible net worth ratios. In addition, these securities place limitations on liens and sale\/leaseback transactions.\nThe Company's promissory notes, which mature in 1997, were issued to assist in financing the acquisition and related construction of a manufacturing facility in Puerto Rico. These notes bear interest, which is payable quarterly, at a floating rate equal to 81% of a Eurodollar base rate, not to exceed 12%. At December 31, 1994, the effective interest rate on these notes was approximately 4.3%. Amounts borrowed in connection with these promissory notes and related interest are secured by letters of credit which aggregate approximately $72,400,000.\nAt December 31, 1994, the Company had an unsecured credit facility (the \"credit facility\") which provides for up to $150,000,000 in borrowings pursuant to a revolving line of credit. The revolving line of credit expires in June 1995. At December 31, 1994, $150,000,000 was available for borrowing and to support the Company's commercial paper program. Borrowings under the line of credit bear interest at: 1) the higher of the prime rate of a major bank or the federal funds rate plus 1\/2%; or 2) a Eurodollar base rate plus 1\/2% to 3\/4%. Under the terms of the credit facility, the Company is required to meet certain working capital, debt to tangible net worth and interest coverage ratios and maintain certain levels of tangible net worth. In addition, the credit facility contains limitations on investments, liens and sale\/leaseback transactions.\nThe aggregate stated maturities of all long-term obligations due subsequent to December 31, 1994, are as follows: $45,000 - 1995; $2,207,000 - 1996; $118,200,000 - 1997; $30,000,000 - 1998; $10,000,000 - 1999 and $23,000,000 thereafter.\n5. Contingencies\nJohnson & Johnson arbitration\nIn September 1985, the Company granted Johnson & Johnson an exclusive license under certain patented technology and know how of the Company to sell erythropoietin throughout the United States for all human uses except dialysis and diagnostics.\nIn January 1989, Johnson & Johnson initiated arbitration proceedings with respect to a number of disputes which had arisen between Amgen and Johnson & Johnson as to the respective rights and obligations of the parties under the various agreements between them. Amgen filed a cross petition for arbitration raising additional disputes for resolution by the arbitrator. The scope of the arbitration covers erythropoietin, hepatitis B vaccine and interleukin-2.\nIn April 1990, the arbitrator ruled that Johnson & Johnson must purchase from Amgen all of Johnson & Johnson's actual United States sales requirements of recombinant human erythropoietin. In December 1990, the U.S. Food and Drug Administration approved Amgen's application to name Johnson & Johnson a distributor of Epoetin alfa under the trademark PROCRIT(R). In January 1991, Johnson & Johnson began distributing Epoetin alfa.\nIn June 1991, the arbitrator issued an opinion awarding Johnson & Johnson $164,000,000 on its claims regarding erythropoietin. In September 1992, the arbitrator found that Johnson & Johnson had breached its obligations regarding hepatitis B vaccine and interleukin-2, and in January 1993 awarded the Company approximately $90,000,000 in damages against Johnson & Johnson. In January 1993, the Company paid Johnson & Johnson the sum of $82,400,000, representing the difference between the damages awarded Johnson & Johnson as a result of its erythropoietin claims, and the amounts awarded Amgen against Johnson & Johnson as a result of its hepatitis B vaccine and interleukin-2 claims, plus interest. Johnson & Johnson returned to the Company the rights to develop and market hepatitis B vaccine and interleukin-2 in March 1991.\nThe Company and Johnson & Johnson are required to compensate each other for Epoetin alfa sales which either party makes into the other party's contractual market. The Company has established and is employing an accounting methodology to assign the proceeds of sales of EPOGEN(R) and PROCRIT(R) in Amgen's and Johnson & Johnson's respective contractual markets. The Company has made payments to Johnson & Johnson based upon the results of the Company's accounting methodology. Johnson & Johnson has disputed the methodology employed by the Company and is proposing an alternative methodology for adoption by the arbitrator. If, as a result of the arbitration proceeding, a methodology different from that currently employed by the Company is instituted to assign the proceeds of sales between the parties, it may yield results that are different from the results of the accounting methodology currently employed by the Company. As a result of the arbitration, it is possible that the Company would recognize a different level of EPOGEN(R) sales than are currently being recognized. As a result of the arbitration, the Company may be required to pay additional compensation to Johnson & Johnson for sales during prior periods, or Johnson & Johnson may be required to pay compensation to the Company for such prior period sales. Due to the uncertainties of any\narbitrated result, the Company has established net liabilities that exceed the amounts paid to Johnson & Johnson.\nA trial date has been set for October 2, 1995 before the arbitrator regarding the accounting methodologies and compensation for sales by Johnson & Johnson into Amgen's contractual market and sales by Amgen into Johnson & Johnson's contractual market. Discovery as to these issues is in progress.\nSynergen litigation\nAcquisition litigation\nThe Company and its wholly owned subsidiary, Amgen Boulder Inc. (formerly Synergen), have been named as defendants in several lawsuits filed in connection with the Company's December 1994 acquisition of Synergen (the ``Acquisition''). One suit, brought by plaintiffs seeking to represent a class of Synergen warrant holders who claim to have been deprived of the benefit of their warrants, includes a request for general damages in the sum of $34,334,000. The balance of the suits have been brought by plaintiffs who seek to represent a class of stockholders of Synergen common stock. These plaintiffs seek an unspecified amount of compensatory damages, an order rescinding the Acquisition and related equitable relief based upon allegations that the defendants breached their fiduciary duties by failing to maximize stockholder value and defrauded the plaintiffs by omitting to disclose allegedly material information concerning Synergen's future prospects.\nANTRIL(TM) litigation\nSeveral lawsuits have been filed against Synergen alleging misrepresentations in connection with its research and development of ANTRIL(TM) for the treatment of sepsis. One of these suits is a class action brought by various classes of Synergen stockholders alleging violations of federal and state securities laws. This suit has been approved for settlement for an amount that is not material to the Company's financial statements. Another suit brought by three Synergen stockholders alleges violations of state securities laws, fraud and misrepresentation and seeks an unspecified amount of compensatory damages and punitive damages. Two additional suits, proposed as class actions, filed by a limited partner of a partnership with which Synergen is affiliated, seek rescission of certain payments made to one of the defendants (or unspecified damages not less than $50,000,000) and treble damages based on a variety of allegations.\nWhile it is not possible to predict accurately or determine the eventual outcome of the Johnson & Johnson arbitration, the Synergen litigation or various other legal proceedings (including patent disputes) involving Amgen, the Company believes that the outcome of these proceedings will not have a material adverse effect on the financial statements of the Company.\n6. Income taxes\nThe provision for income taxes includes the following (in thousands):\nYears Ended December 31, 1994 1993 1992 -------- -------- -------- Current provision: Federal..................... $231,306 $165,822 $178,609 State....................... 34,855 25,856 34,937 -------- -------- -------- Total current provision... 266,161 191,678 213,546 -------- -------- -------- Deferred provision (benefit): Federal..................... 516 19,723 (8,012) State....................... 1,927 6,394 - -------- -------- -------- Total deferred provision (benefit).............. 2,443 26,117 (8,012) -------- -------- -------- $268,604 $217,795 $205,534 ======== ======== ========\nDeferred income taxes reflect the net tax effects of net operating loss carryforwards and 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, 1994 and 1993 are as follows (in thousands):\nDecember 31, 1994 1993 -------- ------- Deferred tax assets: Net operating loss carryforwards... $ 89,478 $ 3,913 Expense accruals................... 78,481 42,834 Fixed assets....................... 17,018 7,280 Royalty obligation buyouts......... 11,772 12,936 State income taxes................. 9,499 6,501 Research collaboration expenses.... 8,033 7,865 Other.............................. 7,215 6,969 -------- ------- Total deferred tax assets....... 221,496 88,298\nValuation allowance.................. (79,497) (17,805) -------- ------- Net deferred tax assets......... 141,999 70,493 -------- ------- Deferred tax liabilities: Purchase of technology rights...... (25,708) (9,608) Other.............................. (5,649) (1,948) -------- ------- Total deferred tax liabilities.. (31,357) (11,556) -------- ------- $110,642 $58,937 ======== =======\nThe net change in the valuation allowance for deferred tax assets during the year ended December 31, 1994 was $61,692,000. This change primarily relates to the net operating loss carryforwards acquired through the purchase of Synergen (Note 2).\nAt December 31, 1994, the Company had operating loss carryforwards available to reduce future federal and foreign taxable income which expire as follows (in thousands):\nFederal Foreign -------- -------- 1997 - 2002... $ 1,935 $35,755 2003 - 2006... 26,799 - 2007.......... 33,180 - 2008.......... 94,382 - 2009.......... 98,722 - -------- ------- $255,018 $35,755 ======== =======\nApproximately $238,000,000 of the federal operating loss carryforwards relate to the acquisition of Synergen. Utilization of these operating loss carryforwards is limited to approximately $16,000,000 per year.\nThe provision for income taxes varies from taxes based on the federal statutory rate of 35% for 1994 and 1993, and 34% for 1992 as follows (in thousands):\n1994 1993 1992 -------- -------- -------- Statutory rate applied to income before income taxes............... $205,894 $207,330 $191,466 Write-off of purchased in-process technology not deductible......... 40,728 - - State income taxes, net of federal income tax benefit................ 23,908 20,963 23,058 Retroactive effects of enacted tax law changes....................... - (9,582) - Equity in earnings of affiliated company, not taxable.............. (2,994) (3,834) (8,229) Other, net........................... 1,068 2,918 (761) -------- -------- -------- $268,604 $217,795 $205,534 ======== ======== ========\nThe tax provision for the year ended December 31, 1993 was reduced by $9,582,000 due to changes in federal tax laws enacted in August 1993. This amount principally relates to the retroactive reinstatement of research and experimentation and orphan drug tax credits to July 1, 1992.\nIncome taxes paid during the years ended December 31, 1994, 1993 and 1992, totaled $234,233,000, $146,270,000 and $134,105,000, respectively.\n7. Stockholders' equity\nOn January 24, 1989, the Company's Board of Directors declared a dividend of one common share purchase right (\"Right\") for each outstanding share of common stock. The Rights will become exercisable 10 days after a person acquires 10% or more of the common stock, or 10 days after a person announces a tender offer which would result in such person acquiring 10% or more of the common stock. Subject to certain conditions, the Rights may be redeemed by the Board of Directors. The current redemption price is $.0017 per Right, subject to adjustment. The Rights will expire on January 24, 1999.\nUnder certain circumstances, if an acquirer purchases 10% or more of the Company's outstanding common stock, each Rightholder (other than the acquirer) is entitled for a specified period to buy shares of common stock of the Company at 50% of the then current market price. The number of shares which a holder may purchase upon exercise will be determined by a formula which includes a current exercise price of $160 per share, subject to adjustment. If an acquirer purchases at least 10% of the Company's common stock, but has not achieved a 50% stake, the Board may exchange the Rights (other than the acquirer's Rights) for one share of common stock per Right. In addition, under certain circumstances, if the Company is involved in a merger or other business combination where it is not the surviving corporation, a Rightholder may buy shares of common stock of the acquiring company at 50% of the then current market value.\nIn connection with the sale of limited partnership interests in 1987, Amgen issued warrants to the limited partners to purchase 18,153,000 shares of its common stock in exchange for the options to purchase the limited partners' interests in the Limited Partnership. Substantially all warrants were exercised prior to their expiration on June 30, 1994.\nIn addition to common stock, the Company's authorized capital also includes 5,000,000 shares of preferred stock, $.0001 par value. At December 31, 1994, no shares of preferred stock were issued or outstanding.\nAt December 31, 1994, the Company has reserved 181,023,000 shares of its common stock which may be issued through its stock option and stock purchase plans and in connection with the stockholder Rights agreement.\nIn 1992, the Company initiated a program to repurchase shares of its own common stock. The program has been expanded to allow repurchases of up to an aggregate of $925,000,000 before December 31, 1995. As of December 31, 1994, $331,208,000 of this total remained available for repurchase. Stock repurchased under the program has been retired and such repurchases have partially offset the dilutive effect of the Company's stock option and stock purchase plans.\n8. Stock option and purchase plans\nThe Company's stock option plans provide for option grants designated as either nonqualified or incentive stock options. The options generally vest over a three to five year period and expire seven to ten years from the date of grant. In general, stock option grants are set at the closing price of the Company's common stock on the date of grant. As of December 31, 1994, the Company had 4,167,000 shares of common stock available for future grant under its stock option plans.\nMost U.S. employees and certain employees outside the U.S. are eligible to receive a grant of stock options periodically with the number of shares generally determined by the employee's salary grade and performance level. In addition, certain management and professional level employees normally receive a stock option grant upon hire. Non-employee directors of the Company receive a grant of stock options annually.\nThe total number of options granted to executive officers and directors and to other Amgen personnel is as follows (in thousands):\nYears ended December 31,\n1994 1993 1992\n------------- ------------- -------------- Shares % Shares % Shares % ------ ---- ------ ---- ------ ---- Executive officers and directors... 540 13% 391 10% 300 13% Other Amgen personnel....... 3,692 87% 3,621 90% 2,001 87% ------ ---- ------ ---- ------ ---- Total........... 4,232 100% 4,012 100% 2,301 100% ====== ==== ====== ==== ====== ====\nStock option information with respect to all of the Company's stock option plans follows (in thousands, except price information):\nPrice ------------------------- Weighted Shares Low High Average ------ --- ---- -------- Balance December 31, 1991, unexercised.............. 16,889 $ 3.52 $62.75 $14.13 Granted............... 2,301 $50.00 $77.75 $59.74 Exercised............. (3,803) $ 3.53 $66.25 $ 9.46 Cancelled............. (262) $ 4.50 $73.75 $18.51 ------ Balance December 31, 1992, unexercised.............. 15,125 $ 3.53 $77.75 $22.17 Granted............... 4,012 $32.13 $70.63 $37.85 Exercised............. (2,274) $ 3.53 $61.00 $ 9.23 Cancelled............. (324) $ 4.50 $76.75 $30.42 ------ Balance December 31, 1993, unexercised.............. 16,539 $ 3.53 $77.75 $27.43 Granted............... 4,232 $35.36 $59.00 $44.13 Exercised............. (2,772) $ 3.86 $56.00 $13.89 Cancelled............. (479) $ 7.38 $74.75 $43.83 ------ Balance December 31, 1994, unexercised.............. 17,520 $ 3.53 $77.75 $33.16 ======\nThe following table shows the maximum number of shares that will vest based on the number of options outstanding at December 31, 1994 (in thousands, except price range amounts):\nExercise 1994 and 1997 and Total Aggregate Price Range Prior 1995 1996 Thereafter Shares Price ---------- -------- ----- ----- ---------- ------ -------- Under $10.. 2,951 107 - - 3,058 $ 19,307 $10 - $29.. 2,627 336 56 180 3,199 48,317 $30 - $60.. 2,759 2,629 2,158 2,651 10,197 443,639 Over $60... 520 223 194 129 1,066 69,680 ----- ----- ----- ----- ------ -------- Total.... 8,857 3,295 2,408 2,960 17,520 $580,943 ===== ===== ===== ===== ====== ========\nUnless exercised, options outstanding as of December 31, 1994, will expire as follows (in thousands, except price range amounts):\nExercise 1997 and Total Aggregate Price Range 1995 1996 Thereafter Shares Price ----------- ----- ----- ---------- ------ --------- - Under $10............ 444 1,602 1,012 3,058 $ 19,307 $10 - $29............ 131 - 3,068 3,199 48,317 $30 - $60............ 78 5 10,114 10,197 443,639 Over $60............. 23 - 1,043 1,066 69,680 --- ----- ------ ------ -------- Total.............. 676 1,607 15,237 17,520 $580,943 === ===== ====== ====== ========\nThe Company has an employee stock purchase plan whereby, in accordance with Section 423 of the Internal Revenue Code, eligible employees may authorize payroll deductions of up to 10% of their salary to purchase shares of the Company's common stock at the lower of 85% of the fair market value of common stock on the first or last day of the offering period. During the years ended December 31, 1994, 1993 and 1992, respectively, 99,000, 94,000 and 81,000 shares, respectively, were purchased by employees at prices of $41.76, $42.07 and $60.03 per share, respectively. At December 31, 1994, the Company had 2,661,000 shares available for future issuance under this plan.\n9. Balance sheet accounts\nProperty, plant and equipment consist of the following (in thousands):\nDecember 31, 1994 1993 -------- -------- Land................................. $ 58,354 $ 44,984 Buildings............................ 330,172 281,917 Manufacturing equipment.............. 53,173 47,416 Laboratory equipment................. 123,624 87,389 Furniture and office equipment....... 137,646 90,152 Leasehold improvements............... 53,697 48,572 Construction in progress............. 116,708 130,231 -------- -------- 873,374 730,661 Less accumulated depreciation and amortization...................... (208,060) (143,749) -------- -------- $665,314 $586,912 ======== ========\nOther accrued liabilities consist of the following (in thousands):\nDecember 31, 1994 1993 -------- -------- Employee compensation and benefits... $ 63,357 $ 32,369 Legal costs.......................... 60,733 29,597 Sales incentives, royalties and allowances......................... 60,023 69,039 Due to affiliated companies and corporate partners................ 51,832 57,345 Income taxes......................... 35,050 24,137 Clinical costs....................... 29,874 7,703 Other................................ 105,418 59,248 -------- -------- $406,287 $279,438 ======== ========\n10. Fair values of financial instruments\nThe following is information concerning the fair values of each class of financial instruments at December 31, 1994:\nCash, cash equivalents and marketable securities\nThe carrying amounts of cash, cash equivalents and marketable securities approximate their fair values. Fair values of cash equivalents and marketable securities are based on quoted market prices.\nDebt\nThe carrying value of commercial paper approximates its fair value due to the short maturity of these liabilities. The fair value of Medium Term Notes was approximately $105,711,000. This amount was estimated based on quoted market rates for instruments with similar terms and remaining maturities. The carrying value of the promissory notes approximates its fair value since the interest rate on the notes is reset quarterly.\nInterest rate swap agreements\nThe fair values of interest rate swap agreements were not significant based on estimated amounts that the counterparty would receive or pay to terminate the swap agreements taking into account current interest rates.\nForeign currency contracts\nThe fair values of the foreign currency forward contracts and purchased foreign currency option contracts were not significant based on quoted market rates.\n11. Major customers\nAmgen has chosen to use major wholesale distributors of pharmaceutical products as the principal means of distributing the Company's products to clinics, hospitals and pharmacies. The Company performs ongoing credit evaluations of its customers' financial condition and generally requires no collateral. For the years ended December 31, 1994, 1993 and 1992, sales to two major wholesale distributors as a percentage of total revenues were 22% and 16%, 23% and 10%, and 22% and 11%, respectively.\n12. Geographic information\nInformation about the Company's operations in the United States and its possessions, Europe, and other international markets, which include Canada, Australia, China and Japan, for the years ended December 31, 1994, 1993 and 1992, is as follows (in thousands):\n1994 1993 1992 ---------- ---------- ---------- Sales to unaffiliated customers: United States and possessions.... $1,333,752 $1,130,040 $ 927,986 Europe........................... 193,019 165,746 118,841 Other............................ 22,796 10,536 3,827 Transfers between geographic areas: United States and possessions.... 15,688 5,441 4,799 Other revenue...................... 98,337 67,520 42,387 Adjustments and eliminations....... (15,688) (5,441) (4,799) ---------- ---------- ---------- Total revenues..................... $1,647,904 $1,373,842 $1,093,041 ========== ========== ==========\n1994 1993 1992 -------- -------- -------- Operating profit (loss): United States and possessions.... $624,055 $592,949 $542,851 Europe........................... 50,258 35,826 3,854 Other............................ (25,628) (14,886) (8,233) Adjustments and eliminations....... (2,809) 954 (1,941) -------- -------- -------- Total operating profit............. 645,876 614,843 536,531 Interest and other income, net..... 9,505 21,011 35,247 Earnings (loss) of affiliates, net. (31,227) (12,589) 16,940 General corporate expenses......... (35,885) (30,895) (25,584) -------- -------- -------- Income before income taxes and cumulative effect of a change in accounting principle.......... $588,269 $592,370 $563,134 ======== ======== ========\nOperating profit (loss) represents revenue less operating expenses directly related to each geographic area. Operating profit (loss) excludes interest and other income, earnings (loss) of affiliates, net and other expenses attributable to general corporate operations.\nIncluded in the operating profit for the United States and its possessions is a write-off of in-process technology purchased of $116,367,000 for the year ended December 31, 1994 and legal awards of $13,900,000 and $77,076,000, for the years ended December 31, 1993 and 1992, respectively. Earnings (loss) of affiliates, net includes the minority interest in earnings of majority controlled European affiliates of $30,854,000, $22,182,000 and $7,756,000 for the years ended December 31, 1994, 1993 and 1992, respectively.\nInformation about the Company's identifiable assets in each geographic area at December 31, 1994 and 1993 is as follows (in thousands):\nDecember 31, 1994 1993 ---------- ---------- Identifiable assets: United States and possessions...... $ 906,370 $ 792,602 Europe............................. 50,679 42,728 Other.............................. 22,348 9,936 Adjustments and eliminations.......... (2,809) 954 ---------- ---------- Total identifiable assets............. 976,588 846,220 Corporate assets including equity method investments................. 1,017,559 919,303 ---------- ---------- Total assets.......................... $1,994,147 $1,765,523 ========== ==========\nIdentifiable assets are those assets of the Company that are identified with the operations in each geographic area. Europe's identifiable assets include accounts receivable of approximately $34,400,000 and $27,500,000 as of December 31, 1994 and 1993, respectively, denominated in foreign currencies. Corporate assets, which are excluded\nfrom identifiable assets, are principally comprised of cash, cash equivalents and marketable securities. At December 31, 1994 and 1993, total international assets approximated $93,819,000 and $68,029,000, respectively, and total international liabilities approximated $16,561,000 and $12,268,000, respectively.\n13. Quarterly financial data (unaudited, in thousands, except per share data):\n1994 Quarter Ended Dec. 31 Sept. 30 June 30 Mar. 31 ------------------ -------- -------- -------- -------- Product sales..... $413,566 $401,695 $388,575 $345,731 Gross margin from product sales... 352,246 342,569 324,181 292,448 Net income........ 4,785 (1) 113,956 107,464 93,460 Earnings per share: Primary......... .03 .82 .77 .66 Fully diluted... .03 .82 .77 .66\n1993 Quarter Ended Dec. 31 Sept. 30 June 30 Mar. 31 ------------------ -------- -------- -------- -------- Product sales..... $347,289 $335,752 $327,829 $295,452 Gross margin from product sales... 289,969 277,491 274,268 244,548 Income before cumulative effect of a change in accounting principle....... 91,099 102,692 100,224 80,560 Net income........ 91,099 102,692 (2) 100,224 (3) 89,298 (4) Earnings per share: Primary: Income before cumulative effect of a change in accounting principle.. .64 .72 .70 .55 Net income... .64 .72 .70 .61 Fully diluted: Income before cumulative effect of a change in accounting principle.. .64 .72 .70 .55 Net income... .64 .72 .70 .61\n(1) During the fourth quarter of 1994, net income was reduced by $116,367,000 due to the write-off of in-process technology purchased in connection with the acquisition of Synergen (Note 2).\n(2) During the third quarter of 1993, the provision for income taxes was reduced by $9,582,000 due to changes in federal tax laws enacted during the period. This amount principally relates to the reinstatement of research and experimentation and orphan drug tax credits retroactive to July 1, 1992 (Note 6).\n(3) During the second quarter of 1993, the Company recorded a $13,900,000 legal award, which resulted in an after tax credit of $8,618,000, as part of the settlement with Genetics Institute for outstanding patent disputes regarding erythropoietin in the United States.\n(4) During the first quarter of 1993, net income was increased by $8,738,000, to reflect the cumulative effect of a change in accounting principle to adopt SFAS No. 109 (Note 1).\nSCHEDULE VIII AMGEN INC.\nVALUATION ACCOUNTS\nYears ended December 31, 1994, 1993 and 1992 (In thousands)\nBalance Additions at Charged Balance Beginning to Costs at End of and of Period Expenses Deductions Period -------- -------- ---------- ------- Year ended December 31, 1994: Allowance for doubtful accounts................ $12,161 $1,489 $ 366 $13,284 Inventory reserves........ 1,990 6,000 4,973 3,017\nYear ended December 31, 1993: Allowance for doubtful accounts................ $11,770 $ 938 $ 547 $12,161 Inventory reserves........ 1,862 128 - 1,990\nYear ended December 31, 1992: Allowance for doubtful accounts................ $ 6,988 $5,112 $ 330 $11,770 Inventory reserves........ 4,693 8 2,839 1,862","section_15":""}
{"filename":"105860_1994.txt","cik":"105860","year":"1994","section_1":"ITEM 1. BUSINESS.\nGENERAL CSW, CPL, PSO, SWEPCO and WTU CSW, incorporated under the laws of Delaware in 1925, is a registered holding company under the Holding Company Act and owns all of the outstanding shares of common stock of the Operating Companies, CSWS, CSW Credit, CSWE, CSWI and CSW Communications. In addition, CSW owns 80% of the outstanding shares of common stock of CSW Leasing. The corporate predecessors of CSW and the Electric Operating Companies date back to the 19th century.\nThe Electric Operating Companies are public utility companies engaged in generating, purchasing, transmitting, distributing and selling electricity. The Electric Operating Companies were incorporated as follows:\nState of Registrant Incorporation Year\nCPL Texas 1945 PSO Oklahoma 1913 SWEPCO Delaware 1912 WTU Texas 1927\nCPL and WTU operate in portions of south and central west Texas, respectively. PSO operates in portions of eastern and southwestern Oklahoma, and SWEPCO operates in portions of northeastern Texas, northwestern Louisiana and western Arkansas. Transok is an intrastate natural gas gathering, transmission, processing, storage and marketing company which transports for and sells natural gas to the Electric Operating Companies, principally PSO, as well as processing, transporting and selling natural gas to and for non- affiliates. CSWS performs, at cost, various accounting, engineering, tax, legal, financial, electronic data processing, centralized economic dispatching of electric power and other services for the CSW System. CSW Credit purchases accounts receivable of the Operating Companies and unaffiliated electric and gas utilities. CSWE and CSWI pursue cogeneration projects and other energy ventures within the United States and internationally. CSW Communications provides communication services to the Operating Companies and non-affiliates. CSW Leasing invests in leveraged leases.\nCPL The economic base of the service territory served by CPL includes manufacturing, metal refining, petroleum products, agriculture and tourism. In 1994, industrial customers accounted for approximately 22% of CPL'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.\nPSO The economic base of the territory served by PSO includes mining, petroleum products, manufacturing and agriculture, which provides a balanced economy. The principal industries in the territory include natural gas and oil production, oil refining, steel processing, maintenance of aircraft, the manufacture of paper and timber products, glass, chemicals, cement and aircraft components.\n1-8 SWEPCO The economic base of the service territory served by SWEPCO includes chemical processing, petroleum refining and oil and gas extraction. The primary metals and paper processing industries add balance to SWEPCO's industrial base.\nWTU The economic base of the territory served by WTU is predominantly agricultural, producing cattle, sheep, goats, cotton, wool, mohair and feed crops. Significant gains have been made in economic diversification through value added processing of these products. The natural resources of the territory include oil, natural gas, sulfur, gypsum and ceramic clays. Important manufacturing and processing plants served by WTU produce cotton seed products, oil products, electronic equipment, precision and consumer metal products, meat products and gypsum products. The territory also includes several military installations and state correctional institutions.\nCertain information relating to service provided by the Electric Operating Companies at December 31, 1994 follows:\nSERVICE AREA ESTIMATED APPROXIMATE RETAIL RURAL ELECTRIC REGISTRANT POPULATION SQUARE MILES CUSTOMERS MUNICIPALITIES COOPERATIVES CPL 1,969,000 44,000 603,000 1 5 PSO 1,021,000 30,000 470,000 2 1 SWEPCO 887,000 25,000 403,000 2 8 WTU 410,000 53,000 185,000 2 12 CSW SYSTEM 4,287,000 152,000 1,661,000 7 26\nThe largest cities served by the Electric Operating Companies at retail are shown below:\nCITY CPL PSO SWEPCO WTU\nCorpus Christi, Texas 265,000 Laredo, Texas 133,000 McAllen, Texas 88,000\nTulsa, Oklahoma 557,000 Lawton, Oklahoma 89,000 Bartlesville, Oklahoma 44,000\nShreveport\/Bossier City, Louisiana 278,000 Longview, Texas 79,000 Texarkana, Texas and Arkansas 63,000\nAbilene, Texas 112,000 San Angelo, Texas 88,000\nIn 1994, the CSW System companies contributed the following percentages to aggregate operating revenues, operating income and net income for common stock. TOTAL CPL PSO SWEPCO WTU ELECTRIC TOK OTHER TOTAL OPERATING REVENUES 34% 20% 22% 9% 85% 14% 1% 100% OPERATING INCOME 48% 15% 22% 8% 93% 7% --% 100% NET INCOME FOR COMMON STOCK 49% 17% 26% 9% 101% 6% (7)% 100%\n1-9 The relative contributions of the CSW System companies to the aggregate operating revenues, operating income and net income for common stock differ from year to year due to variations in weather, fuel costs reflected in charges to customers, timing and amount of rate changes and other factors, including changes in business conditions and the results of non-utility businesses. In 1994, approximately 62% of the CSW System's electric revenues were earned in Texas, 24% in Oklahoma, 8% in Louisiana and 6% in Arkansas.\nRestructuring In November 1993, CSW undertook a restructuring designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The restructuring is a response to two major factors, (i) a reduction in the rate of growth in the use of electricity and (ii) increasing competition among suppliers of electricity as a result of the Energy Policy Act. As a result of these changes, CSW believes that the electric utility industry faces changes in the way all electric utilities do business. The underlying goal of the restructuring is to enable the Electric Operating Companies to focus on and be accountable for serving the customer.\nIn general, the restructuring is designed to consolidate and centralize in CSWS certain functions which had been performed separately by CSW's Electric Operating Companies. In part, the restructuring shifts certain management functions relating to the operation of power plants, certain engineering activities and certain administrative and support functions from the Electric Operating Companies to CSWS, thereby reducing costs and freeing the Electric Operating Companies to focus on customer service, marketing and economic development. The restructuring is intended to standardize certain practices throughout the CSW System and to streamline management.\nTo delineate lines more clearly at the holding company level, the restructuring aligns CSW management into two principal units, CSW Electric, covering the CSW System's electric utility operations, and CSW Enterprises, covering CSW's other businesses, including Transok, CSWE, CSWI, CSW Communications, and the mergers and acquisitions and strategic planning departments. CSW Electric and CSW Enterprises are functional business designations only, not new subsidiaries.\nCSW expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies have been, and are expected to continue to be, realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs and thereby reduce the need for future rate increases.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Restructuring for further discussion about the restructuring.\nNew Business Opportunities CSW CSW continues to consider new business opportunities to expand and enhance its core electric utility business, and to expand its non- utility business. CSW's investment strategy with respect to non- utility businesses is to invest in businesses that are related to the expertise utilized in the core electric utility business. CSW's principal non-utility businesses are Transok and CSWE. During 1994, CSW formed a new corporation, CSWI, to pursue independent power initiatives abroad. In addition, CSW is considering investments in telecommunications, environmental and energy services. During 1994, CSW formed CSW Communications to provide a communications network for the CSW System as well as third-parties. CSW expects to make additional investments in non-regulated business during 1995. For additional information, see NON-UTILITY OPERATIONS below.\n1-10 Proposed Acquisition of El Paso CSW In May 1993, CSW entered into a Merger Agreement pursuant to which El Paso would emerge from bankruptcy as a wholly-owned subsidiary of CSW. El Paso is an electric utility company headquartered in El Paso, Texas, engaged principally in the generation and distribution of electricity to approximately 262,000 retail customers in west Texas and southern New Mexico. El Paso also sells electricity under contract to wholesale customers in a number of locations including southern California and Mexico. El Paso had filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code on January 8, 1992.\nOn July 30, 1993, El Paso filed the Modified Plan and a related proposed form of Disclosure Statement providing for the acquisition of El Paso by CSW. On November 15, 1993, all voting classes of creditors and shareholders of El Paso voted to approve the Modified Plan. On December 8, 1993, the Bankruptcy Court confirmed the Modified Plan.\nUnder the Modified Plan, the total value of CSW's offer to acquire El Paso is approximately $2.2 billion. The Modified Plan generally provides for El Paso creditors and shareholders to receive shares of CSW Common, cash and\/or securities of El Paso, or to have their claims cured and reinstated. The Modified Plan also provides for claims of secured creditors generally to be paid in full with debt securities of reorganized El Paso, and for unsecured creditors to receive a combination of debt securities of reorganized El Paso and CSW Common equal to 95.5 percent of their claims, and for small trade creditors to be paid in full with cash. The Modified Plan provides for El Paso's preferred shareholders to receive preferred shares of reorganized El Paso, or cash, and for options to purchase El Paso Common to be converted into options to purchase a proportionate number of shares of CSW Common. In addition, the Modified Plan provides for certain creditor classes of El Paso to accrue interest on their claims and to receive periodic interim distributions of such interest through the Effective Date or the withdrawal or revocation of the Modified Plan, subject to certain conditions and limitations set forth in the Modified Plan. To date, all such accrued interest payments to creditors have been made by El Paso on a timely basis. If, under certain circumstances, the Merger is not consummated, the Merger Agreement provides for CSW to pay El Paso for a portion of such interim interest payments paid or accrued prior to the termination of the Merger Agreement. The Merger Agreement also provides for CSW to pay for a portion of fees and expenses, including legal expenses of certain El Paso creditors under such circumstances. CSW's potential exposure as of December 31, 1994, is estimated to be approximately $17.5 million; however, the actual amount, if any, that CSW may be required to pay pursuant to these provisions depends on a number of contingencies and cannot presently be predicted.\nThe Merger is subject to numerous conditions set forth in the Merger Agreement, including but not limited to (i) the receipt of final orders with respect to all required regulatory approvals on terms that would not cause a regulatory material adverse effect as defined in the Merger Agreement, (ii) the receipt of all third party consents, (iii) the absence of a material adverse effect or facts or circumstances that could reasonably be expected to result in a material adverse effect on El Paso or the business prospects of El Paso, (iv) transfer to El Paso of good and marketable title to El Paso's share of Palo Verde, (v) performance by El Paso, CSW and CSW's acquisition subsidiary, CSW Sub, Inc., in all material respects of all covenants contained in the Merger Agreement and (vi) the occurrence of the Effective Date under the Modified Plan. Required regulatory approvals and filings in connection with the Merger include approvals of the FERC, the SEC, the Texas Commission, the New Mexico Commission, the NRC, and filings with the Department of Justice and the Federal Trade Commission under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.\nSee ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, NOTE 11 for CSW, Commitments and Contingent Liabilities, for a discussion of regulatory approval process relating to El Paso.\nCSW continues to use its best efforts to consummate the Merger. At the same time, however, CSW continues to monitor contingencies which may preclude the consummation of the Merger, including without\n1-11 limitation the potential loss of significant portions of El Paso's service area and significant El Paso customers, including Las Cruces and two military installations, Holloman Air Force Base and White Sands Missile Range, regulatory risks principally related to approval of the Merger and El Paso's request for a rate increase in Texas as well as the effects of the conditions imposed by federal or state regulatory agencies on the approval of the Merger and operating risks associated with the ownership of an interest in Palo Verde.\nBased upon El Paso's written response to the concerns identified in a September 12 letter from CSW to El Paso and the failure of El Paso to resolve the contingencies set forth above, CSW cannot predict whether, or if so when, the Merger will be consummated. In the event that the proposed Merger is not consummated, there may be ensuing litigation between El Paso and CSW or among other parties to El Paso's bankruptcy proceedings and either or both of El Paso and CSW.\nSee CSW's ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Proposed Acquisition of El Paso, and CSW's ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 11, Commitments and Contingent Liabilities, for additional information related to the proposed El Paso merger.\nCompetition CSW, CPL, PSO, SWEPCO and WTU Competitive forces at work in the electric utility industry are impacting the CSW System and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail levels in the future. As competition in the industry increases, the Electric Operating Companies will have the opportunity to seek out new customers and at the same time be at risk of losing customers to competitors. The Electric Operating Companies believe that their prices for electricity and the quality and reliability of their service currently place them in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act for EWGs and permits utilities, including registered holding companies and non-utilities, to form EWGs. EWGs are a new category of non-utility wholesale power producers that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While CSW believes that the Energy Policy Act will continue to make the wholesale markets more competitive, CSW is unable to predict the extent to which the Energy Policy Act will impact CSW System operations.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. The Electric Operating Companies compete in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nCSW is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or the CSW System. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\n1-12 CSW, CPL, SWEPCO and WTU PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. CSW is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted.\nIn Texas, electric service areas are approved by the Texas Commission. A given tract in a utility's overall service area may be singly certificated to a utility, to one of several competing electric cooperatives or to one of the competing municipal electric systems or, it may be dually or triply certificated to these entities. These certificated areas have changed only slightly since the formation of the Texas Commission in 1976.\nCSW and CPL CPL is generally singly certificated to serve inside most municipalities, and cooperatives are singly certificated to serve much of the rural areas. The suburban areas are mostly dually certificated. Since 1990, in dually certificated areas, CPL's rates have been higher than some competitors for some customers, especially small commercial and industrial customers. However, most business has been retained and some new business acquired, primarily because of service reliability and other customer service advantages. The availability of low cost natural gas and other alternative fuels, including those used in cogeneration facilities, have resulted in some losses of sales. Although there have been some losses, electricity is still the fuel of choice for most air conditioning installations. Renewable energy such as solar and wind is not now a feasible economic choice for customers of CPL in most instances. CPL believes that its rates, the quality and reliability of its service and the relatively inelastic demand for electricity for certain end uses should allow it to continue to compete in current retail markets.\nSee each of the registrants' ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Recent Developments and Trends for a discussion of competitive issues facing the utility industry.\nREGULATION AND RATES\nRegulation CSW, CPL, PSO, SWEPCO and WTU The CSW System is subject to the jurisdiction of the SEC under the Holding Company Act with respect to the issuance, acquisition and sale of securities, the acquisition and sale of certain assets or any interest in any business and accounting practices and other matters. The Holding Company Act generally limits the operations of a registered holding company to a single integrated public utility system, plus such additional businesses as are functionally related to such system.\nThe Electric Operating Companies have been classified as public utilities under the Federal Power Act and accordingly the FERC has jurisdiction in certain respects over their electric utility facilities and operations, wholesale rates, and in certain other matters.\nThe Electric Operating Companies are subject to the jurisdiction of various state commissions as to rates, accounting matters, standards of service and, in some cases, issuance of securities, certification of facilities and extensions and division of service territory.\n1-13 CPL, SWEPCO and WTU The Texas Commission has jurisdiction over accounts, certification of utility service territory, sales 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.\nCPL Ownership of an interest in a nuclear generating unit exposes CPL and indirectly CSW to regulation not common to a fossil generating unit. Under the Atomic Energy Act of 1954 and the 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 shut down a unit until compliance is achieved, depending upon its assessment of the severity of the situation.\nFor a discussion of NRC regulation and other considerations arising from the ownership of nuclear assets, see NUCLEAR-STP, below.\nOther See ENVIRONMENTAL MATTERS below, for information relating to environmental regulation.\nRates CSW, CPL, PSO, SWEPCO and WTU The retail rates of the Electric Operating Companies are subject to regulation by the state utility commissions in the states in which they operate.\nCPL, SWEPCO and WTU The Texas Commission has original jurisdiction over retail rates in the unincorporated areas of Texas. The governing bodies of incorporated municipalities have original 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.\nPSO PSO is subject to the jurisdiction of the Oklahoma Commission with respect to retail prices, accounts, issuance of certain securities and certain other matters.\nPursuant to authority granted under RESCTA, the Oklahoma Commission established service territorial boundary maps in all unincorporated areas for all regulated retail electric suppliers serving Oklahoma. In accordance with RESCTA, a retail electric supplier may not extend retail electric service into the certified territory of another supplier, except to serve its own facilities or to serve a new customer with an initial full load of 1,000 KW or more. RESCTA provides that when any territory certified to a retail electric supplier or suppliers is annexed and becomes part of an incorporated city or town, the certification becomes null and void. However, once established in the annexed territory, a supplier may generally continue to serve within the annexed area.\nSWEPCO In Arkansas, SWEPCO is subject to the jurisdiction of the Arkansas Commission as to rates, accounts, standards of service, sale or acquisition of certain utility property and issuance of securities by liens on property located in that state. In Louisiana, SWEPCO is subject to the jurisdiction of the Louisiana Commission as to rates, accounts and standards of service, but not as to the issuance of securities. In Oklahoma, SWEPCO is subject to the jurisdiction of the Oklahoma Commission only as to the issuance of evidences of indebtedness secured by liens on property located in that state.\n1-14 SWEPCO has agreements, which have been approved by the FERC, with all of its wholesale customers under which rates are based upon an agreed cost of service formula. These rates are adjusted periodically to reflect the actual cost of providing service. All of SWEPCO's contracts with its wholesale customers contain FERC approved fuel-adjustment provisions that permit it to pass actual fuel costs through to its customers.\nFuel Recovery in Texas CSW, CPL, SWEPCO and WTU Electric utilities in Texas, including CPL, SWEPCO and WTU, 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 that became effective on May 1, 1993, subject to certain transition rules, whereby each utility under its jurisdiction may petition to revise its fuel factor every six months according to a specified schedule. Fuel factors may also be revised in the case of emergencies 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. To date, the new fuel rule has not significantly changed the manner in which the Electric Operating Companies recover retail fuel costs in Texas. Fuel factors are in the nature of temporary rates and the utility's collection of revenues by such factors is subject to adjustments at the time of a fuel reconciliation. Under the procedures, at the utility's semi- annual adjustment date, a utility will be 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. 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. Final reconciliation of fuel costs is 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 that are determined unreasonably incurred in a reconciliation proceeding are not recoverable from retail customers.\nFuel Recovery in Oklahoma CSW and PSO All KWH sales to PSO's retail customers for 1994 were made under rates which include a fuel cost adjustment clause. Oklahoma law requires that an examination of PSO's retail fuel cost adjustment clause be performed annually by the Oklahoma Commission. The fuel cost adjustment is computed for each month on the basis of the average cost of fuel consumed in the month. The amount of any difference in such cost over or under a base rate is applied on a KWH basis and reflected in adjustments to customers' bills during the second month subsequent to the month in which the difference occurred.\nThe FUSER program for qualified commercial and industrial customers and the CSF program, for qualified wholesale customers, were developed to allow program participants to purchase natural gas directly from suppliers, at negotiated prices, to be delivered to and burned in PSO's gas-fired power plants, resulting in reduced prices because of the low cost spot gas fuel provided. Under these programs participants could deliver sufficient quantities of natural gas to meet 70% of their generation requirements with the remaining 30% met with PSO-supplied coal. The FUSER and CSF programs resulted in lower electric costs to all classes of PSO's customers. The FUSER program was canceled effective October 1, 1993 because changing market and supply conditions eliminated the economic viability of the program. The CSF program remains in place although no customers participated in the program during 1994.\n1-15 Fuel Recovery in Louisiana and Arkansas CSW and SWEPCO SWEPCO's retail rates currently in effect in Louisiana are adjusted based on SWEPCO's cost of fuel in accordance with a fuel cost adjustment which is applied to each billing month based on the second previous month's average cost of fuel. Provision for any over- or under-recovery of fuel costs is allowed under an automatic fuel clause.\nUnder SWEPCO's fuel adjustment rider currently in effect in Arkansas, the fuel cost adjustment is applied for each billing month on a basis which permits SWEPCO to recover the level of fuel cost experienced two months earlier.\nFuel Recovery from Wholesale Customers CSW, CPL, PSO, SWEPCO and WTU All of the Electric Operating Companies' contracts with their wholesale customers contain FERC approved fuel-adjustment provisions for recovery of fuel costs.\nOther CSW, CPL, PSO, SWEPCO and WTU In the event that the Electric Operating Companies do not recover all of their fuel costs under the procedures described above, such event could have a material adverse effect on the companies' results of operations and financial condition.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for CSW, CPL, PSO, SWEPCO and WTU, and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 10, for CSW, NOTE 9 for CPL, SWEPCO, and WTU and NOTE 8 for PSO, Litigation and Regulatory Proceedings, for further information with respect to rate proceedings including CPL's rate case and fuel reconciliation proceedings, PSO's rate proceedings, SWEPCO's fuel reconciliation proceedings, WTU's rate matters and fuel reconciliation and CPL's and WTU's deferred accounting matters.\nNUCLEAR - STP CSW and CPL CPL owns 25.2% of STP, a two-unit nuclear power plant which is located near Bay City, Texas. In addition, 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 Outage From February 1993 until May 1994 STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL.\nNuclear Decommissioning At the end of STP's service life, decommissioning is expected to be accomplished using the decontamination method, which is one of the techniques acceptable to the NRC. Using this method the decontamination activities occur as soon as possible after the end of plant operations. Contaminated equipment is cleaned or removed to a permanent disposal location and the site is generally returned to its pre-plant state.\nCPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning and is net of expected earnings on the trust fund.\n1-16 Deferred Accounting CPL was granted deferred accounting for STP Unit 1 and 2 costs by Texas Commission orders. These orders allowed CPL 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.\nSee CSW's and CPL's ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 10 for CSW and NOTE 9 for CPL, Litigation and Regulatory Proceedings, for further information with respect to CPL's rate case and fuel reconciliation proceedings, nuclear decommissioning and deferred accounting.\nOther See ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 11 for CSW and NOTE 10 for CPL, Commitments and Contingent Liabilities for further information related to nuclear insurance for STP.\n1-17 UTILITY OPERATIONS\nFacilities At December 31, 1994, the Electric Operating Companies owned electric generating plants, or portions thereof in the case of jointly-owned plants, with the following net dependable summer rating capabilities, substantially all of which were steam electric and which were located in the cities indicated:\nNet Dependable Capability Plant Name and Location Principal Fuel (MW) (b) Source (a) CSW and CPL\nBarney M. Davis, Corpus Christi, Gas 679 Texas Coleto Creek, Goliad, Texas Coal 604 Lon C. Hill, Corpus Christi, Texas Gas 549 Nueces Bay, Corpus Christi, Texas Gas 512 (c) Victoria, Victoria, Texas Gas 258 (c) La Palma, San Benito, Texas Gas 203 (c) E.S. Joslin, Point Comfort, Texas Gas 252 J. L. Bates, Mission, Texas Gas 182 Laredo, Laredo, Texas Gas 172 Eagle Pass, Eagle Pass, Texas Hydro 6 Oklaunion, Vernon, Texas (b) Coal 53 (d) STP, Bay City, Texas (b) Nuclear 630 (e)\nCPL Total 4,100 (c)\nCSW and PSO\nComanche, Lawton, Oklahoma Gas 258 Oil 4\nNortheastern, Oologah, Oklahoma Gas 632 Coal 924 Oil 4\nRiverside, Jenks, Oklahoma Gas 922 Oil 3\nSouthwestern, Washita, Oklahoma Gas 475 Oil 2\nTulsa, Tulsa, Oklahoma Gas 162 (c) Oil 8\nWeleetka, Weleetka, Oklahoma Gas 151 Oil 4\nOklaunion, Vernon, Texas (b) Coal 106 (d)\nPSO Total 3,655 (c)\n1-18 (Continued) Net Dependable Capability Plant Name and Location Principal Fuel (MW) (b) Source (a)\nCSW and SWEPCO\nArsenal Hill, Shreveport, Gas 113 Louisiana Lieberman, Mooringsport, Louisiana Gas 276 Knox Lee, Cherokee Lake, Texas Gas 501 Lone Star, Daingerfield, Texas Gas 50 Wilkes, Jefferson, Texas Gas 879 Welsh, Cason, Texas Coal 1,584 Flint Creek, Gentry, Arkansas (b) Coal 240 Henry W. Pirkey, Hallsville, Texas (b) Lignite 559 Dolet Hills, Mansfield, Texas (b) Lignite 262\nSWEPCO Total 4,464\nCSW and WTU\nAbilene, Abilene, Texas Gas 18 Paint Creek, Haskell, Texas Gas 237 Lake Pauline, Quanah, Texas Gas 46 Oak Creek, Bronte, Texas Gas 87 San Angelo, San Angelo, Texas Gas 125 Rio Pecos, Girvin, Texas Gas 140 Fort Phantom, Abilene, Texas Gas (f) 362 Presidio, Presidio, Texas Oil 2 Ft. Stockton, Ft. Stockton, Texas Gas 5 Vernon, Vernon, Texas Oil 9 Oklaunion, Vernon, Texas (b) Coal 370 (d)\nWTU Total 1,401\nCSW 13,620 Plant in storage 557 CSW Total 14,177\nFacilities Notes CSW, CPL, PSO, SWEPCO and WTU (a)Some plants have the capability of burning oil in combination with gas. Use of oil in facilities primarily designed to burn gas results in increased maintenance expense and a reduction of approximately from 5% to 15% in capability. PSO and WTU have 25 MW and 11 MW, respectively, of facilities primarily designed to burn oil. (b)Data reflects only CSW System's portion of plants which are jointly owned with non-affiliates. (c)Excludes units in storage - 34 MW at Nueces Bay, 228 MW at Victoria, 48 MW at La Palma for CPL and 247 MW at Tulsa for PSO. (d)CPL owns 7.81%, PSO owns 15.62% and WTU owns 54.69% of the 676 MW unit. The plant is operated by WTU. (e)CPL owns 25.2% of the two 1,250 MW units operated by HLP. (f)Although both Fort Phantom units burn primarily gas, Unit 1 is designed to burn fuel oil for extended periods of time before maintenance is required and Unit 2 is designed to burn fuel oil on a continuous basis.\n1-19 Plants and Properties CSW, CPL, PSO, SWEPCO and WTU All of the generating plants described above are located on land owned by the Electric Operating Companies or jointly with other participants in the case of jointly owned plants. The Electric Operating Companies' electric transmission and distribution facilities are mostly located over or under highways, streets and other public places or property owned by others, for which permits, grants, easements or licenses (which the Electric Operating Companies believe to be satisfactory, but without examination of underlying land titles) have been obtained. The principal plants and properties of the Electric Operating Companies are subject to the liens of the first mortgage indentures under which the Electric Operating Companies' bonds are issued.\nPeak Loads and System Capabilities of the Electric Operating Companies CSW, CPL, PSO, SWEPCO and WTU The following tables set forth for the last three years (i) the net system capability, including the net amounts of contracted purchases and contracted sales, at the time of peak demand, (ii) the maximum coincident system demand on a one-hour integrated basis, exclusive of sales to other electric utilities, and (iii) the respective amounts and percentages of peak demand generated by the Electric Operating Companies and net purchases and sales:\nCSW 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 13,549(3) 13,163(1)(2)(3) 13,230(1)(3) MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 11,434 11,464 10,606 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD (0.3)% 8.1% 3.9% GENERATION AT TIME OF PEAK (MW) 11,353 10,624 10,426 PERCENT OF PEAK DEMAND GENERATED 99.3% 92.7% 98.3% NET PURCHASES (SALES) AT TIME OF PEAK (MW) 81 840 180 PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK .7% 7.3% 1.7% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND JUNE 27 AUGUST 18 AUGUST 10\n(1) CSW's 1993 net system capability at the time of peak demand was less than 1992 net system capability due to unit outages. (2) Does not include 630 MW of STP capability that was not available at the 1993 peak due to the outage described in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 10 for CSW, Litigation and Regulatory Proceedings and NUCLEAR - STP, in ITEM 1.\n1-20 (3) Does not include 881 MW of system capability for 1994, 719 MW of system capability for 1993 and 1992.\nCPL 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 3,969(2) 3,850(1)(2) 4,165(2) MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 3,732 3,518 3,347 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD 6.1% 5.1% 1.7% GENERATION AT TIME OF PEAK (MW) 3,074 2,943 3,003 PERCENT OF PEAK DEMAND GENERATED 82.4% 83.7% 89.7% NET PURCHASES (SALES) AT TIME OF PEAK (MW) 658 575 344 PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK 17.6% 16.3% 10.3% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND AUGUST 18 AUGUST 25 AUGUST 11\n(1) Does not include 630 MW of STP capability that was not available at the 1993 peak due to the outage described in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - NOTE 9 for CPL, Litigation and Regulatory Proceedings and NUCLEAR - STP, in ITEM 1. (2) Does not include 310 MW of system capability in storage as described above under the heading UTILITY OPERATIONS - Facilities.\nPSO 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 3,664(1) 3,649(1) 3,721(1) MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 3,167 3,147 3,010 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD 0.6% 4.6% (2.3)% GENERATION AT TIME OF PEAK (MW) 2,645 2,609 2,788 PERCENT OF PEAK DEMAND GENERATED 83.5% 82.9% 92.6% NET PURCHASES (SALES) AT TIME OF PEAK (MW) 522 538 222 PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK 16.5% 17.1% 7.4% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND JUNE 27 AUGUST 18 AUGUST 10\n(1) Does not include 247 MW of system capability for 1994, and 409 MW of system capability for 1993 and 1992 in storage, as described above under the heading UTILITY OPERATIONS - Facilities.\nSWEPCO 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 4,464(1) 4,436 3,959 MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 3,526 3,651 3,237 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD (3.4%) 12.8% 1.2% GENERATION AT TIME OF PEAK (MW) 3,987 3,559 3,292 PERCENT OF PEAK DEMAND GENERATED 113.1% 97.5% 101.7% NET PURCHASES (SALES) AT TIME OF PEAK (MW) (461) 92 (55) PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK (13.1%) 2.5% (1.7)% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND JUNE 27 AUGUST 18 AUGUST 10\n(1) Does not include 324 MW of capability that was not available at the 1994 peak.\nWTU 1994 1993 1992 NET SYSTEM CAPABILITY (MW) 1,459 1,384 1,404 MAXIMUM COINCIDENT SYSTEM DEMAND (MW) 1,262 1,201 1,118 PERCENTAGE INCREASE (DECREASE) IN PEAK DEMAND OVER PRIOR PERIOD 5.1% 7.4% 1.9% GENERATION AT TIME OF PEAK (MW) 1,401 1,223 1,151 PERCENT OF PEAK DEMAND GENERATED 111.0% 101.8% 102.9% NET PURCHASES (SALES) AT TIME OF PEAK (MW) (139) (22) (33) PERCENT OF NET PURCHASES (SALES) AT TIME OF PEAK (11.0%) (1.8%) (2.9)% DATE OF MAXIMUM COINCIDENT SYSTEM DEMAND JUNE 27 AUGUST 11 JULY 1\nPower Purchases and Sales CSW, CPL, PSO, SWEPCO and WTU Various municipalities, electric cooperatives and public power authorities are served by the Electric Operating Companies. The Electric Operating Companies exchange power on an emergency or economy basis with various neighboring systems and engage in economy interchanges with each other. In addition, they contract with certain suppliers for the purchase or sale of power on a unit capacity basis.\nCSW and SWEPCO As part of the negotiations to acquire BREMCO, SWEPCO entered into a long-term purchased power contract with Cajun, BREMCO's previous full-requirements wholesale supplier. The contract covered the purchase of energy at a fixed price for 1993 and 1994, and the purchase of capacity and energy in subsequent years. SWEPCO is a member of the Southwest Power Pool and the Western Systems Power Pool.\n1-21 CSW, SWEPCO and WTU On April 4, 1994, the FERC issued an order pursuant to Section 211 of the Federal Power Act forcing a regional utility to transmit power to Tex-La on behalf of WTU. The order was one of the first issued by FERC under that provision, which was added by the Energy Policy Act to increase competition in wholesale power markets. On December 1, 1994, the FERC issued an order requiring a regional utility to provide this transmission service at a cost which was acceptable to Tex-La. The FERC also ordered the same regional utility to enter into an interconnection and remote control area load agreement with WTU within 30 days. This agreement was executed on January 3, 1995. On January 5, 1995, WTU began selling 92 MW of power and energy to Tex-La. Tex-La has a peak requirement of approximately 120 MWs. WTU will serve Tex-La until facilities are completed to connect Tex-La to SWEPCO, at which time SWEPCO will provide 85 MW and WTU will retain 35 MW of the Tex-La electric load.\nCSW and PSO In 1989, PSO entered into certain long-term contracts with MCPC, a cogeneration development company located in northeastern Oklahoma. These contracts include (i) an Interconnection and Interchange Agreement providing terms and conditions under which MCPC can connect its electric generating facilities to PSO's transmission system and providing for future transmission by PSO of specified amounts of MCPC's power to an unaffiliated utility, (ii) a Stock\/Asset Purchase Agreement which allows PSO under certain conditions to acquire the stock or assets of MCPC, and (iii) an Energy Conversion Agreement which requires PSO to deliver natural gas to MCPC for conversion to electrical energy to be delivered by MCPC to PSO. Under the Energy Conversion Agreement, MCPC is required to deliver at least 394,200 MWH per year of firm energy to PSO. PSO also has the right to dispatch up to 60 MWH per hour of quick-start capability.\nPSO and MCPC filed a joint application with the Oklahoma Commission seeking approval of a September 1992 Letter Agreement between PSO and MCPC which provided for MCPC granting two-year extensions to the Interconnection and Interchange Agreement and the Energy Conversion Agreement in exchange for PSO not requiring payment by MCPC of certain debt and charges related to the Energy Conversion Agreement. The Oklahoma Commission Staff subsequently filed its own application seeking a review and evaluation of the current value to PSO of the Energy Conversion Agreement. MCPC also filed an application with the Oklahoma Commission requesting additional relief through the modification of the existing Energy Conversion Agreement. An emergency order was issued under MCPC's application which increased the payment made by PSO to MCPC for energy purchases and decreased the amount of firm energy MCPC is required to deliver to PSO. The emergency order is subject to a permanent ruling. The application filed by the Oklahoma Commission Staff was subsequently withdrawn. In December 1993, PSO filed an application with an ALJ to dismiss the case filed by MCPC based on a recent ruling from the Oklahoma Supreme Court. PSO's application to dismiss was denied by the ALJ and was appealed to the Oklahoma Commission. PSO's appeal was subsequently denied. The joint application and MCPC's application are expected to be heard by the second quarter of 1995.\nIn July 1993, PSO commenced a lawsuit in the District Court of Tulsa County, Oklahoma, seeking a declaratory judgment that PSO is entitled to terminate the Energy Conversion Agreement as of August 1, 1993, because of a default committed by MCPC. In November 1993, the Court granted judgment in favor of MCPC on grounds that the Oklahoma Commission had exclusive jurisdiction of the case and also that PSO had contractually waived its cause of action. PSO has appealed the Court's ruling to the Oklahoma Supreme Court, where the case is pending.\nSWEPCO SWEPCO furnishes energy at wholesale to two municipalities and also supplies electric energy at wholesale to eight electric cooperatives operating in its territory through NTEC, Tex-La and Rayburn Country. SWEPCO also sells power to AECC and Cajun on an as- available basis.\n1-22 WTU WTU provides wholesale electricity to four electric cooperatives and one municipality for all their electric energy requirements. WTU also provides wholesale power to eight other electric cooperatives, one other municipal customer and one investor owned electric utility company. WTU's contractual obligations with thirteen of its wholesale customers require a five year notice of termination, while one wholesale customer has a three year notice period and another has a fifteen year obligation.\nSystem Interconnections CSW, CPL, PSO, SWEPCO and WTU The CSW System operates on an interstate basis to facilitate exchanges of power. PSO and WTU are interconnected through the 200 MW North HVdc Tie. In August 1992, SWEPCO and CPL entered into an agreement with HLP and TU to construct and operate an East Texas HVdc transmission interconnection which will facilitate exchanges of power for the CSW System. This interconnection will consist of a back-to- back HVdc converter station and 16 miles of 345 KV transmission line connecting transmission substations at SWEPCO's Welsh Power Plant and TU's Monticello Power Plant. In March 1993, an application for a Certificate of Convenience and Necessity for the transmission interconnection was approved by the Texas Commission. This 600 MW project is scheduled to be completed in mid-1995.\nCPL and WTU are members of ERCOT, which also includes TU, HLP, Texas Municipal Power Agency, Texas Municipal Power Pool, Lower Colorado River Authority, the municipal systems of San Antonio, Austin and Brownsville, the South Texas and Medina Electric Cooperatives, and several other interconnected systems and cooperatives. The ERCOT members interchange power and energy on a firm, economy and emergency basis.\nSeasonality CSW, CPL, PSO, SWEPCO and WTU Sales of electricity by the Electric Operating Companies tend to increase during warmer summer months and, to a lesser extent, cooler winter months, because of higher demand for power for cooling and heating purposes.\nFranchises CSW, CPL, PSO, SWEPCO and WTU The Electric Operating Companies hold franchises to provide electric service in various municipalities in their service areas. These franchises have varying provisions and expiration dates including, in some cases, termination and buy-out provisions. CSW considers the Electric Operating Companies' franchises to be adequate for the conduct of their business.\nEmployees CSW, CPL, PSO, SWEPCO and WTU At December 31, 1994, CSW had 8,055 employees, as follows:\nCSWS 1,070 CPL 1,933 PSO 1,552 SWEPCO 1,777 WTU 1,090 TRANSOK 554 CSWE 79 8,055\n1-23 Approximately 600 employees at PSO and 700 employees at SWEPCO are covered under collective bargaining agreements with the IBEW. CSW implemented a restructuring plan in 1994 which resulted in a reduction of approximately 7% of the CSW System work force.\nExecutive Officers of the Registrant The following information is included in Part I pursuant to Regulation S-K, Item 401(b), Instruction 3.\nCSW Age Name at March 16, Present Position\nE. R. Brooks 57 Chairman, President and CEO, Director\nHarry D. Mattison 58 Executive Vice President of CSW and President and CEO of Central and South West Electric, Director\nT. V. Shockley, III 50 Executive Vice President of CSW and President and CEO of Central and South West Enterprises, Director\nFerd. C. Meyer, Jr. 55 Senior Vice President and General Counsel\nGlenn D. Rosilier 47 Senior Vice President and CFO\nFrederic L. Frawley 52 Corporate Secretary and Senior Attorney\nStephen J. McDonnell 44 Treasurer\nWendy G. Hargus 37 Controller\nEach of the executive officers of CSW is elected to hold office until the first meeting of the CSW's Board of Directors after the next annual meeting of stockholders. CSW's next annual meeting of stockholders is scheduled to be held April 20, 1995. Each of the executive officers listed in the table above has been employed by CSW or an affiliate of CSW in an executive or managerial capacity for more than the last five years.\n1-24 OPERATING STATISTICS CSW CENTRAL AND SOUTH WEST CORPORATION AND SUBSIDIARY COMPANIES CONSOLIDATED ELECTRIC OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 16,368 15,903 14,593 COMMERCIAL 13,463 12,966 12,370 INDUSTRIAL 18,869 18,205 17,257 OTHER RETAIL 1,501 1,434 1,363 SALES TO RETAIL CUSTOMERS 50,201 48,508 45,583 SALES FOR RESALE 7,133 5,852 6,262 TOTAL 57,334 54,360 51,845\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD (THOUSANDS) RESIDENTIAL 1,417 1,396 1,366 COMMERCIAL 205 201 196 INDUSTRIAL 24 24 25 OTHER 15 12 12 TOTAL 1,661 1,633 1,599\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 11,665 11,541 10,786 REVENUE PER CUSTOMER(a) $824 $842 $773 REVENUE PER KWH(a)(cents) 7.06 7.29 7.17\nREVENUE PER KWH ON TOTAL SALES (a)(cents) 5.35 5.62 5.38\nFUEL COST DATA (a) AVERAGE Btu PER NET KWH 10,344 10,391 10,482 COST PER MILLION Btu $1.82 $2.11 $1.92 COST PER KWH GENERATED (cents) 1.88 2.19 2.01 COST AS A PERCENTAGE OF REVENUE 37.9% 39.6% 37.1%\n(a) These statistics reflect the outage at STP in 1993 and early 1994 as well as FUSER and CSF in 1993 and 1992.\n1-25 CPL CENTRAL POWER AND LIGHT COMPANY OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 5,954 5,612 5,408 COMMERCIAL 4,523 4,278 4,181 INDUSTRIAL 6,910 6,406 5,800 OTHER RETAIL 457 435 414 SALES TO RETAIL CUSTOMERS 17,844 16,731 15,803 SALES FOR RESALE 1,286 913 1,370 TOTAL 19,130 17,644 17,173\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD RESIDENTIAL 516,355 504,893 493,772 COMMERCIAL 76,739 74,767 73,200 INDUSTRIAL (a) 5,864 6,156 6,307 OTHER 3,577 3,538 3,561 TOTAL 602,535 589,354 576,840\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 11,729 11,298 11,133 REVENUE PER CUSTOMER (b) $935 $955 $890 REVENUE PER KWH (b) (cents) 7.97 8.45 7.99\nREVENUE PER KWH ON TOTAL SALES (b)(cents) 6.37 6.93 6.48\nFUEL COST DATA (b) AVERAGE Btu PER NET KWH 10,289 10,296 10,404 COST PER MILLION Btu $1.75 $2.17 $1.70 COST PER KWH GENERATED (cents) 1.80 2.23 1.77 COST AS A PERCENTAGE OF REVENUE 27.0% 28.6% 27.6%\n(a) The customer decrease in 1994 was due primarily to the combining of multiple customer accounts into single accounts and a decline in customers due to economic and competitive conditions. The customer decrease in 1993 was largely due to the combining of multiple customer accounts into single accounts.\n(b) These statistics reflect the outage at STP in 1993 and early 1994.\n1-26 PSO PUBLIC SERVICE COMPANY OF OKLAHOMA OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 4,749 4,714 4,139 COMMERCIAL 4,434 4,352 4,092 INDUSTRIAL 4,360 4,445 4,420 OTHER RETAIL 89 87 85 SALES TO RETAIL CUSTOMERS 13,632 13,598 12,736 SALES FOR RESALE 1,509 563 665 TOTAL 15,141 14,161 13,401\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD RESIDENTIAL 409,675 406,847 404,170 COMMERCIAL 53,454 53,166 52,215 INDUSTRIAL 5,156 5,087 5,163 OTHER 1,287 1,008 1,009 TOTAL 469,572 466,108 462,557\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 11,640 11,637 10,297 REVENUE PER CUSTOMER $726 $731 $642 REVENUE PER KWH (cents) 6.24 6.28 6.24\nREVENUE PER KWH ON TOTAL SALES (a)(cents) 4.89 5.00 4.64\nFUEL COST DATA (a) AVERAGE Btu PER NET KWH 10,231 10,220 10,305 COST PER MILLION Btu $1.96 $2.38 $2.34 COST PER KWH GENERATED(cents) 2.00 2.43 2.41 COST AS A PERCENTAGE OF REVENUE 39.5% 43.7% 40.3%\n(a) These statistics reflect FUSER and CSF in 1993 and 1992. See REGULATION AND RATES and FUEL SUPPLY.\n1-27 SWEPCO SOUTHWESTERN ELECTRIC POWER COMPANY OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 4,157 4,114 3,702 COMMERCIAL 3,378 3,249 3,039 INDUSTRIAL 6,357 6,122 5,862 OTHER RETAIL 400 390 373 SALES TO RETAIL CUSTOMERS 14,292 13,875 12,976 SALES FOR RESALE 5,189 4,508 3,854 TOTAL 19,481 18,383 16,830\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD RESIDENTIAL 346,227 340,379 325,301 COMMERCIAL 48,153 46,728 45,185 INDUSTRIAL 5,747 5,809 5,687 OTHER 2,609 2,605 2,636 TOTAL 402,736 395,521 378,809\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 12,107 12,357 11,445 REVENUE PER CUSTOMER $776 $822 $770 REVENUE PER KWH (cents) 6.41 6.65 6.73\nREVENUE PER KWH ON TOTAL SALES (cents) 4.24 4.60 4.62\nFUEL COST DATA AVERAGE Btu PER NET KWH 10,489 10,582 10,717 COST PER MILLION Btu $1.75 $1.94 $1.93 COST PER KWH GENERATED (cents) 1.84 2.05 2.07 COST AS A PERCENTAGE OF REVENUE 40.6% 42.5% 43.0%\n1-28 WTU WEST TEXAS UTILITIES COMPANY OPERATING STATISTICS\n1994 1993 1992 KILOWATT-HOUR SALES (MILLIONS) RESIDENTIAL 1,508 1,464 1,344 COMMERCIAL 1,128 1,087 1,057 INDUSTRIAL 1,241 1,231 1,175 OTHER RETAIL 556 522 491 SALES TO RETAIL CUSTOMERS 4,433 4,304 4,067 SALES FOR RESALE 2,051 2,288 1,951 TOTAL 6,484 6,592 6,018\nNUMBER OF ELECTRIC CUSTOMERS AT END OF PERIOD RESIDENTIAL 144,966 143,453 142,270 COMMERCIAL 26,618 26,001 25,714 INDUSTRIAL 7,392 7,453 7,384 OTHER 5,533 5,361 5,254 TOTAL 184,509 182,268 180,622\nRESIDENTIAL SALES AVERAGES KWH PER CUSTOMER 10,449 10,241 9,485 REVENUE PER CUSTOMER $822 $811 $752 REVENUE PER KWH (cents) 7.86 7.92 7.93\nREVENUE PER KWH ON TOTAL SALES (cents) 5.29 5.24 5.24\nFUEL COST DATA AVERAGE Btu PER NET KWH 10,424 10,491 10,445 COST PER MILLION Btu $1.88 $1.91 $1.82 COST PER KWH GENERATED (cents) 1.96 2.00 1.91 COST AS A PERCENTAGE OF REVENUE 38.3% 39.1% 38.0%\n1-29 CONSTRUCTION AND FINANCING\nCSW, CPL, PSO, SWEPCO and WTU The CSW System maintains a continuing construction program, the nature and extent of which is based upon current and estimated future loads of the system. The estimated total capital expenditures, including AFUDC, of the CSW System for the years 1995-1997 are as follows:\nCSW CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $ 47 $ 37 $ 43 $ 127 TRANSMISSION 35 85 59 179 DISTRIBUTION 146 138 131 415 FUEL 4 21 12 37 TRANSOK 63 40 40 143 OTHER 90 61 73 224 TOTAL $385 $382 $358 $1,125\nCPL CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $ 23 $ 20 $ 19 $ 62 TRANSMISSION 16 28 11 55 DISTRIBUTION 45 59 57 161 FUEL 4 21 12 37 OTHER 23 8 11 42 TOTAL $111 $136 $110 $357\nPSO CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $11 $ 9 $18 $ 38 TRANSMISSION 6 20 13 39 DISTRIBUTION 35 29 29 93 OTHER 19 13 11 43 TOTAL $71 $71 $71 $213\nSWEPCO CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $12 $ 7 $ 5 $ 24 TRANSMISSION 10 34 28 72 DISTRIBUTION 48 31 27 106 OTHER 26 22 34 82 TOTAL $96 $94 $94 $284\nWTU CONSTRUCTION 1995 1996 1997 TOTAL (MILLIONS) GENERATION $ 1 $ 1 $ 1 $ 3 TRANSMISSION 3 3 7 13 DISTRIBUTION 18 19 18 55 OTHER 15 13 11 39 TOTAL $37 $36 $37 $110\nInformation in the foregoing tables is subject to change as a result of change in the underlying assumptions from numerous factors, including the rate of load growth, escalation of construction costs, changes in lead times in manufacturing, inflation, the availability and pricing of alternatives to construction, and nuclear, environmental and other regulation, delays from regulatory hearings, the adequacy of rate relief and the\n1-30 availability of necessary external capital. Changes in these and other factors could cause each respective Electric Operating Company to defer or accelerate construction or to sell or buy more power, which would affect its cash position, revenues and income to an extent that cannot now be reliably predicted.\nIn addition, increasing competition in the electric utility industry may have an impact on the construction programs of the Electric Operating Companies. Traditionally, the Electric Operating Companies have made investments in their utility systems, filed a rate case to seek recovery of their operating and other costs and sought to earn a rate of return on their assets in rate base. Competition in the utility industry, however, is likely to lead to an increasing need to stabilize or reduce rates. At the same time, the retail regulatory environment is beginning to shift from traditional rate base regulation to incentive and performance-based regulation which are intended to encourage efficiency and increased productivity in lieu of traditional ratemaking formulas. In light of the trend toward competition and away from traditional ratemaking, the CSW System will periodically reevaluate its capital spending policies and generally seek to fund only those construction projects and investments that management believes will offer satisfactory returns in the current environment. Consistent with this strategy, the CSW System is likely to continue to make additional investments in non-utility businesses.\nCSW continues to study ways to reduce or meet future increases in customer demand, including demand-side management programs, new and efficient electric technologies, construction of various types and sizes of generation facilities, increasing the availability or efficiency of existing generation facilities, reducing transmission and distribution losses, and where feasible and economical, acquisition of reliable long-term capacity from other suppliers. The public utility commissions in some of the jurisdictions served by the Electric Operating Companies may consider on a case-by-case basis mechanisms to permit recovery of costs of demand-side management programs and a return on the related investment from ratepayers.\nThe CSW System facilities plan indicates that CSW will not require substantial additions of generating capacity until the year 2001 or beyond.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources, Capital Expenditures for each registrant, for additional information with respect to construction expenditures and financing.\nFUEL SUPPLY\nGeneral The CSW System's present net dependable summer rating power generation capabilities and the type of fuel used are set forth in UTILITY OPERATIONS - Facilities above. Additional fuel supply data is set forth in the tables presented below.\nCSW SYSTEM AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 8,246 NATURAL GAS 47% COAL AND LIGNITE 4,702 COAL AND LIGNITE 47% NUCLEAR 630 NUCLEAR 6% HYDRO and OIL 42 TOTAL 100% SUB TOTAL 13,620 PLANT IN STORAGE 557 TOTAL 14,177\n1-31 CPL AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 2,807 NATURAL GAS 56% COAL 657 COAL 24% NUCLEAR 630 NUCLEAR 20% HYDRO 6 TOTAL 100% SUB TOTAL 4,100 PLANT IN STORAGE 310 TOTAL 4,410\nPSO AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 2,600 NATURAL GAS 58% COAL 1,030 COAL 42% OIL 25 TOTAL 100% SUB TOTAL 3,655 PLANT IN STORAGE 247 TOTAL 3,902\nSWEPCO AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 1,819 NATURAL GAS 23% COAL 1,824 COAL 48% LIGNITE 821 LIGNITE 29% TOTAL 4,464 TOTAL 100%\nWTU AGGREGATE CAPABILITY GENERATION 1994 (MW) 1994 (KWH) NATURAL GAS 1,020 NATURAL GAS 59% COAL 370 COAL 41% OIL 11 TOTAL 100% TOTAL 1,401\nNatural Gas CSW The Electric Operating Companies purchase their gas from a number of suppliers operating in and around their service territories. In 1994, approximately 48% of the Electric Operating Companies' total gas purchases were made under long-term contracts and approximately 52% came from short-term contracts and spot purchases.\nCSW and CPL CPL's eight gas-fired electric generating plants are supplied by a portfolio of long-term and short-term natural gas purchase agreements through multiple natural gas pipeline systems. Approximately 68% of CPL's total gas requirements in 1994 were purchased under long-term arrangements representing both purchase obligations and discretionary purchases, with the balance of CPL's requirements being acquired under short-term arrangements from the spot market. CPL's principal gas supplies for 1994 were provided\n1-32 under agreements with Corpus Christi Gas Marketing, L.P., Onyx Pipeline Company, Enron Corporation, or their affiliates. They supplied approximately 25%, 13% and 10%, respectively, of CPL's total natural gas purchases.\nCSW and PSO PSO engages in a program to maintain adequate gas supplies necessary for operation. Natural gas for generation is provided by purchases under a number of long-term and spot market contracts. Approximately 60% of PSO's natural gas requirements were provided for under firm contracts. Transok acts as an administrator with respect to purchases of natural gas supplies. Gas is transported by Transok to PSO facilities under agreements pursuant to which PSO pays Transok for actual costs incurred in providing the services as determined on an allocated cost of service basis, including a rate of return on equity applicable between affiliates as specified by the Oklahoma Commission in PSO's most recent Oklahoma price review. See ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CSW's NOTE 10 and PSO's NOTE 8, Litigation and Regulatory Proceedings, for further information with respect to such agreements between PSO and Transok.\nCSW and SWEPCO In 1994, SWEPCO purchased approximately 99.5% of its gas requirements pursuant to spot purchase contracts with no take-or-pay obligations. The remaining 0.5% of SWEPCO's 1994 gas requirements came from a long-term take-or-pay contract which was terminated in January 1994. SWEPCO plans to continue to enter into short-term contracts with various suppliers to provide gas for peaking purposes.\nCSW and WTU WTU has gas purchase contracts with several suppliers. The largest long-term contract, which is with Lone Star, provided approximately 13% of WTU's total gas requirements in 1994. Lone Star is obligated, except during curtailments, to have gas available for 125% of the estimated annual fuel requirements of each plant served, provided the total of all plants does not exceed 110% of the estimated annual fuel requirement. The Lone Star contract, which expires in 2000, allows WTU considerable flexibility to purchase gas from other sources. Utilizing this flexibility in 1994, WTU purchased approximately 68% of its gas requirements on the spot market from many different suppliers. The remaining 19% of WTU's 1994 gas requirements came from supplemental firm contracts with several suppliers. The contracts with suppliers vary in their terms, but generally provide for periodic or other price adjustments.\nCoal and Lignite CSW The Electric Operating Companies purchase coal from a number of suppliers. In 1994, approximately 82% of the Electric Operating Companies' total coal purchases were supplied under long-term contract with the balance procured on the spot market. The coal for the CSW System plants comes primarily from Wyoming or Colorado mines which are located between 1,000 and 1,500 rail miles from the generating plants.\nProposed Railroad Merger CSW, CPL, PSO, SWEPCO and WTU In October 1994, Burlington Northern Railroad Company and the Atchison, Topeka and Santa Fe Railway Company filed an application with the Interstate Commerce Commission to merge the two railroads. These railroads currently compete for a portion of the coal transportation traffic to CPL's Coleto Creek power plant. Because of the potential elimination of such competition and other factors, CPL and the other Electric Operating Companies may be adversely affected by this merger, if approved, unless conditions mitigating the impact are included in the merger.\nOklaunion CSW, CPL, PSO and WTU The jointly-owned Oklaunion plant is supplied coal under a coal supply contract with Exxon expiring in 2006. This contract was amended and restated in December 1993 as part of a settlement of litigation with Exxon. In November 1994, Caballo Coal Company, an\n1-33 affiliate of Peabody Holding Company, Inc., purchased Exxon's Rawhide and Caballo mines in Wyoming, the sources of the Exxon coal. The long-term coal supply contract has subsequently been transferred from Exxon to Caballo Coal Company.\nApproximately 67% of the total 1994 Oklaunion coal requirements for CPL, 70% for PSO and 71% for WTU were supplied under the Exxon contract with the balance procured on the spot market.\nCPL's share of the year-end 1994 coal inventory at Oklaunion was approximately 46,000 tons, representing approximately 60 days supply. PSO's share was approximately 95,000 tons, representing approximately 21 days supply. WTU's share was approximately 250,000 tons, representing approximately 55 days supply.\nAll coal used at the Oklaunion plant is transported approximately 1,100 miles to the plant by the Burlington Northern Railroad Company pursuant to a coal transportation contract which is projected to expire during late 1995. The coal is transported under this contract in Burlington Northern supplied rail cars. WTU has instituted a rate proceeding at the Interstate Commerce Commission requesting a reasonable rate for rail transportation of coal to the Oklaunion plant, pursuant to filed tariffs, after expiration of the Burlington Northern contract.\nColeto Creek CSW and CPL At Coleto Creek, the long-term agreement expiring in 1999 with Colowyo Coal Company provided approximately 60% of the coal requirements of the plant for 1994. CPL's purchase obligation set forth in the Colowyo agreement for 1995 and through 1999 is for approximately 25% of Coleto Creek's requirements. The coal is mined in northwestern Colorado and is transported approximately 1,400 miles under long-term rail agreements with Denver & Rio Grande Western Railroad Company, the Burlington Northern Railroad Company and the Southern Pacific Transportation Company. Southern Pacific Transportation Company is currently the only rail carrier with access to the Coleto Creek plant. The balance of the Coleto Creek requirements are currently being procured on the spot market. CPL owns sufficient railcars for operation of three unit trains and has negotiated contracts with the rail carriers involved which have been filed with the Interstate Commerce Commission. CPL's rail transportation contracts for Coleto Creek expire December 31, 1995. CPL has instituted a proceeding at the Interstate Commerce Commission requesting a reasonable rate for the 16 mile movement from Coleto Creek to Victoria, Texas, a destination served by Missouri Pacific Railroad Company. After 1995, CPL intends to utilize coal from the Powder River Basin of Wyoming for a portion of the Coleto Creek plant requirements and intends to negotiate rail transportation agreements for such coal. At year-end 1994, CPL had approximately 290,000 tons of coal in inventory at Coleto Creek, representing approximately 43 days supply.\nNortheastern Station CSW and PSO PSO has a contract with Kerr-McGee Coal Corporation, which substantially covers the coal supply for PSO's Northeastern Station coal units through at least 2007, with approximately 11% of the 1994 requirements purchased on the spot market. Coal delivery is by unit trains from mines located in the Gillette, Wyoming vicinity, a distance of about 1,100 rail miles from Northeastern Station. PSO owns sufficient rail cars and spares for operation of six unit trains. Coal is transported to Northeastern Station pursuant to long- term contracts with Burlington Northern and the Missouri Pacific Railroad Company which have been filed with the Interstate Commerce Commission. In some years, including 1994, a portion of the coal has been transported pursuant to short-term contracts with other carriers. Burlington Northern has disputed PSO's right to transport coal at Northeastern Station utilizing other carriers. This dispute is the subject of pending litigation. See ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CSW NOTE 10 and PSO NOTE 8,\n1-34 Litigation and Regulatory Proceedings for further discussion. At year-end 1994, PSO had approximately 529,000 tons of coal in inventory at Northeastern representing approximately 50 days supply.\nCSW and SWEPCO The long-term supply for SWEPCO's Welsh plant and its 50 percent- owned Flint Creek plant is provided under a contract with AMAX. The current contract, executed in December 1993, replaced a prior contract between the parties as part of a settlement of litigation concerning the prior contract. The settlement has resulted in lower fuel costs to the Welsh and Flint Creek plants. Approximately 99% of the total 1994 Flint Creek coal requirements and 94% of the total 1994 Welsh coal requirements were supplied under the AMAX contract with the balance purchased on the spot market.\nCoal under the AMAX contract is mined near Gillette, Wyoming, a distance of about 1,500 and 1,100 miles, respectively, from the Welsh and Flint Creek plants. This coal is delivered to the plants under rail transportation contracts with Burlington Northern and the Kansas City Southern Railroad Company. These contracts will expire between 2001 and 2007. SWEPCO owns or leases under long-term leases sufficient cars and spares for operation of twelve unit trains. SWEPCO has supplemented its railcar fleet from time to time with short-term leases. At December 31, 1994, SWEPCO had coal inventories of 1,199,000 tons at Welsh representing 53 days supply and 552,000 tons at Flint Creek representing 80 days supply.\nSWEPCO has acquired lignite leases covering an aggregate of about 27,000 acres near the Henry W. Pirkey power plant. Sabine Mining Company is the contract miner of these reserves. At December 31, 1994, 322,000 tons of lignite were in inventory at the plant representing 33 days supply.\nAnother 25,000 acres are jointly leased in equal portions by SWEPCO and CLECO in the Dolet Hills area of Louisiana near Dolet Hills Power Plant. The Dolet Hills Mining Venture is the contract miner for these reserves. At December 31, 1994, SWEPCO had 240,000 tons of lignite in inventory at the plant representing 58 days supply.\nIn the opinion of the management of SWEPCO, the acreage under lease in these areas contains sufficient reserves to cover the anticipated lignite requirements for the estimated useful lives of the lignite-fired plants.\nNuclear Fuel CSW and CPL The supply of fuel for STP involves a complex process. This process includes the acquisition of uranium concentrate, the conversion of uranium concentrate to uranium hexafluoride, the enrichment of uranium hexafluoride in the isotope U235 and the fabrication of the enriched uranium into fuel rods and incorporation of fuel rods into fuel assemblies. The fuel assemblies are the final product loaded into the reactor core. The time associated with this process requires fuel decisions be made years in advance of the actual need to refuel the reactor. Fuel requirements for STP are being handled by the STP Management Committee, comprised of representatives of all participants in STP.\nOutages are necessary approximately every 18 months for refueling. Because STP's fuel costs are significantly lower than any of the other CPL units, CPL's average fuel costs are expected to be higher whenever an STP unit is down for refueling or maintenance.\nCPL and the other STP participants have entered into contracts with suppliers for uranium concentrate and conversion service sufficient for the operation of both STP units through 1996. Also, flexible uranium concentrate and uranium hexafluoride contracts are in place to provide approximately 50% of the uranium needed for STP from 1997 to 2000. Enrichment contracts have been secured for a 30- year period from the initial operation of each unit with the exception of the period from October of 2000 to September of 2002. The STP participants canceled the enrichment requirements for such period under a ten year no cost termination provision in the\n1-35 enrichment contract. The STP participants believe that other, lower- cost options will be available in the future. Also, fuel fabrication services have been contracted for operation through 2005 for Unit 1 and 2006 for Unit 2. Although CPL and the other STP owners cannot predict the availability of uranium and related services, CPL and the other STP owners do not currently expect to have difficulty obtaining uranium and related services required for the remaining years of STP operations.\nThe Energy Policy Act has provisions for the recovery of a portion of the costs associated with the decommissioning and decontamination of the gaseous diffusion plants used in the enrichment process. These costs are being recovered on the basis of enrichment services purchased by utilities from the DOE prior to October of 1992. The total annual assessment for all domestic utilities is limited to $150 million per federal fiscal year and assessable for 15 years. The STP assessment will be approximately $2.0 million each year with CPL's share being 25.2% of the annual STP assessment.\nThe Nuclear Waste Policy Act of 1982, as amended, requires the DOE to develop a permanent high level waste disposal facility for the storage of spent nuclear fuel by 1998. The DOE recently announced that the permanent facility will not be available until 2010. The DOE will be taking possession of all spent fuel generated at STP as a result of a contract CPL and other STP participants have entered into with the DOE. STP has on-site storage facilities with the capability to store all the spent nuclear fuel generated by the STP units over their life. Therefore, the DOE delay in providing the disposal facility will not impact the operation of the STP units. Under provisions of the Nuclear Waste Policy Act of 1992, a one-mill per KWH assessment on electricity generated and sold from nuclear reactors funds the DOE waste disposal program.\nRisks of substantial liability could arise from the operation of STP and from the use, handling, disposal and possible radioactive emissions associated with nuclear fuel. While CPL carries insurance, the availability, amount and coverage thereof is limited and may become more limited in the future. The available insurance may not cover all types or amounts of loss or expense which may be experienced in connection with the ownership of STP.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Fuel and Purchased Power for information relating to coal contract litigation.\nGovernmental Regulation CSW, CPL, PSO, SWEPCO and WTU The price and availability of each of the foregoing fuel types are significantly affected by governmental regulation. Any inability in the future to obtain adequate fuel supplies or adoption of additional regulatory measures restricting the use of such fuels for the generation of electricity might affect the CSW System's ability to economically meet the needs of its customers and could require the Electric Operating Companies to supplement or replace, prior to normal retirement, existing generating capability with units using other fuels. This would be impossible to accomplish quickly, would require substantial additional expenditures for construction and could have a significant adverse effect on CSW's and\/or the Electric Operating Companies' financial condition and results of operations.\n1-36 Fuel Costs and Consumption CSW, CPL, PSO, SWEPCO and WTU Additional fuel cost data for the CSW System appears under OPERATING STATISTICS. Average fuel costs and consumption by fuel type follow:\nAVERAGE COST PER FUEL TYPE MILLION Btu\nCSW NATURAL GAS $2.18 COAL 1.71 LIGNITE 1.34 NUCLEAR .51 FUEL TYPE 1994 CONSUMPTION (MILLIONS) All fuel types 1.82 Tons Mcfs Btus\nCPL CPL NATURAL GAS $2.10 NATURAL GAS 105 107 COAL 1.98 COAL 2 43 NUCLEAR .51 NUCLEAR * * 37 All fuel types 1.75\nPSO PSO NATURAL GAS $2.38 NATURAL GAS 83 86 COAL 1.38 COAL 4 63 All fuel types 1.96\nSWEPCO SWEPCO NATURAL GAS $1.98 NATURAL GAS 43 43 COAL 1.90 COAL and 10 148 LIGNITE LIGNITE 1.34 All fuel types 1.75\nWTU WTU NATURAL GAS $2.18 NATURAL GAS 42 42 COAL 1.42 COAL 2 28 All fuel types 1.88 * Not measured\n1-37 Future Cost of Fuel CSW, CPL, PSO, SWEPCO and WTU The registrants are unable to predict the future cost of fuel.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Rates and Regulatory Matters for each registrant, for further information concerning fuel costs.\nENVIRONMENTAL MATTERS CSW, CPL, PSO, SWEPCO and WTU The Operating Companies and CSWE are subject to regulation with respect to air and water quality and solid waste standards and other environmental matters by various federal, state and local authorities. These authorities have continuing jurisdiction in most cases to require modifications in the Electric Operating Companies' facilities and operations. Changes in environmental statutes or regulations could require substantial additional expenditures to modify the Electric Operating Companies' facilities and operations and could have a significant adverse effect on CSW's and each Electric Operating Companies' results of operations and financial condition. Violations of environmental statutes or regulations can result in fines and other costs.\nAir Quality Clean Air Act Amendments CSW, CPL, PSO, SWEPCO and WTU Air quality standards and emission limitations are subject to the jurisdiction of state regulatory authorities in each state in which the CSW System operates, with oversight by the EPA. In accordance with regulations of these state authorities, permits are required for all generating units on which construction is commenced or which are substantially modified after the effective date of the applicable regulations. None of the Electric Operating Companies has received notice from any federal or state government agency alleging that it currently is subject to an enforcement action for a material violation of existing federal or state air quality and emission regulations.\nIn November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, the Electric Operating Companies will be required to hold allowances in order to emit sulfur dioxide. The EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, CSW believes that the Electric Operating Companies' allowances are adequate to meet their needs at least through 2008. Public and private markets are developing for trading of excess allowances. CSW and the Electric Operating Companies presently have no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\nThe Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and require government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations, and the air toxics study, will have on CSW and the Electric Operating Companies cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, CSW expects to spend $4 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\n1-38 CSW, CPL and WTU Air quality standards and emission limitations are subject to the jurisdiction of the TNRCC, with oversight by the EPA. In accordance with regulations of the TNRCC, permits are required for all generating units on which construction is commenced or which are substantially modified after the effective date of the applicable regulations. CPL and WTU have not received notice from any federal or state government agency alleging that they currently are subject to an enforcement action for a material violation of existing federal or state air quality and emission regulations.\nCSW and CPL As a result of requirements imposed by the Clean Air Act, CPL expects to spend approximately $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nCSW and PSO Air quality standards and emission limitations are subject to the jurisdiction of ODEQ, with oversight by the EPA. In accordance with regulations of ODEQ, permits are required for all generating units on which construction is commenced or which are substantially modified after the effective date of the applicable regulations. PSO has not received notice from any federal or state government agency alleging that it currently is subject to an enforcement action for a material violation of existing federal or state air quality and emission regulations. As a result of requirements imposed by the Clean Air Act, PSO expects to spend approximately $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nCSW and SWEPCO Air quality standards and emission limitations are subject to the jurisdiction of the ADPCE in Arkansas, the LDEQ in Louisiana and the TNRCC in Texas, with oversight by the EPA. In accordance with regulations of the ADPCE, LDEQ and TNRCC, permits are required for all generating units on which construction is commenced or which are substantially modified after the effective date of the applicable regulations. SWEPCO has not received notice from any federal or state government agency alleging that it currently is subject to an enforcement action for a material violation of existing federal or state air quality and emission regulations. As a result of requirements imposed by the Clean Air Act, SWEPCO expects to spend approximately $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nCSW and WTU As a result of requirements imposed by the Clean Air Act, WTU expects to spend approximately $0.5 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nTransok Transok's compressor engines and other emission sources are subject to air permit requirements, including monitoring. As a result of new requirements under the Clean Air Act, seven of Transok's facilities will be subject to additional permit requirements. The Clean Air Act may also impose additional enhanced monitoring requirements on these seven facilities.\nWater Quality CSW, CPL, PSO, SWEPCO and WTU The ADPCE, LDEQ, ODEQ, TNRCC and the EPA have jurisdiction over all wastewater discharges into state waters. These authorities have jurisdiction for establishing water quality standards and issuing waste control permits covering discharges which might affect the quality of state waters. The EPA has jurisdiction over point source discharges through the National Pollutant Discharge Elimination System provisions of the Clean Water Act. CPL, PSO, SWEPCO and WTU\n1-39 have not received notice from any federal or state government agency alleging that they currently are subject to an enforcement action for a material violation of existing federal or state wastewater discharge regulations.\nRCRA, CERCLA and Related Matters RCRA CSW, CPL, PSO, SWEPCO and WTU The RCRA and the Arkansas, Louisiana, Oklahoma and Texas solid waste rules provide for comprehensive control of all solid wastes from generation to final disposal. The appropriate state regulatory authorities in the states in which the CSW System operates have received authorization from the EPA to administer the RCRA solid waste control program for their respective states. None of the Electric Operating Companies has received notice from any federal or state government agency alleging that it currently is subject to an enforcement action for a material violation of existing federal or state solid waste regulations.\nCERCLA The operations of the CSW System, like those of other utility systems, generally involve the use and disposal of substances subject to environmental laws. CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nCSW's subsidiaries incur significant costs for the handling, transportation, storage and disposal of hazardous and non-hazardous waste materials. Unit costs for waste classified as hazardous exceed by a substantial margin unit costs for waste classified as non- hazardous waste.\nThe Electric Operating Companies are also subject to various pending claims alleging that they are PRPs under federal or state remedial laws for investigating and cleaning up contaminated property. CSW anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on CSW's consolidated results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites are the volume and\/or type of waste allegedly contributed by the Electric Operating Company, the estimated amount of costs allocated to the Electric Operating Company and the participation of other parties.\nThe Electric Operating Companies, like other electric utilities, produce combustion and other generation by-products, such as sludge, slag, low-level radioactive waste and spent nuclear fuel. The Electric Operating Companies own distribution poles treated with creosote or related substances. The EPA currently exempts coal combustion by-products from regulation as hazardous wastes. Distribution poles treated with creosote or similar substances are not expected to exhibit characteristics that would cause them to be hazardous waste. In connection with their operations, the Electric Operating Companies also have used asbestos, PCBs and materials classified as hazardous waste. If additional by-products or other materials generated or used by companies in the CSW System were reclassified as hazardous wastes, or other new laws or regulations concerning hazardous wastes or other materials were put in effect, CSW System disposal and remedial costs could increase materially. The EPA is expected to issue new regulations stating whether certain other materials will be classified as hazardous.\nSol Lynn Superfund Site CSW and CPL The Sol Lynn salvage yard was declared a Superfund site by the EPA after it was found to contain a number of contaminants including PCBs. Gulf States Utilities Company remediated the site for approximately $2 million and is trying to recover a portion of the remediation costs from alleged PRPs, including CPL. CPL believes its\n1-40 liability, if any, would be as a deminimus party. CPL is negotiating with Gulf States Utilities Company to determine its share, if any, of remediation costs.\nIndustrial Road and Industrial Metals Site CSW and CPL Several lawsuits relating to the industrial road and industrial metal site in Corpus Christi, Texas, naming CPL as a defendant, are currently pending in federal and state court in Texas. Plaintiffs' claims allege property damage and clean-up activities. Although management cannot predict the outcome of these proceedings, based on the defenses that management believes are available to CPL, management believes that the ultimate resolution of these matters will not have a material adverse effect on CSW's or CPL's results of operations or financial condition.\nRose Chemical Site CSW, SWEPCO and WTU SWEPCO and WTU were named PRPs in the clean-up of the Rose Chemical Site, in Missouri, along with 750 other companies. A clean- up fund was established through payments by PRPs who agreed to a \"buyout settlement,\" and the site remediation was undertaken. The site buildings were removed and the grounds cleaned to standards acceptable to the EPA. The site remediation is virtually completed and the court settlement became final in July 1994. Remaining costs are expected to be covered by the previously collected funds and there should be no further costs to either SWEPCO or WTU.\nB&B Salvage Site CSW, SWEPCO and WTU SWEPCO and WTU are also PRPs at the B&B Salvage site. This site, located in Missouri, received scrap metal from the Rose Chemical firm. The B&B site has been remediated and SWEPCO's and WTU's share of cleaning up this site and the Rose Chemical site is not expected to have a material effect on CSW's, SWEPCO's, or WTU's results of operations or financial condition.\nPCB Litigation CSW and PSO PSO has been named a defendant in complaints filed in federal and state courts of Oklahoma in 1984, 1985, 1986 and 1993. The complaints allege, among other things, that some of the plaintiffs and the property of other plaintiffs were contaminated with PCBs and other toxic by-products following certain incidents, including transformer malfunctions in April 1982, December 1983 and May 1984. To date, complaints representing approximately $736 million of claims, including compensatory and punitive damages, have been dismissed, certain of which resulted from settlements among the parties. The settlements did not have a significant effect on CSW's or PSO's consolidated results of operations. Remaining complaints currently total approximately $395 million, of which approximately one-third is for punitive damages. Discovery with regard to the remaining complaints continues. Management cannot predict the outcome of these proceedings. However, management believes that PSO has defenses to these complaints and intends to pursue them vigorously. Moreover, management has reason to believe that PSO's insurance may cover some of the claims. Management also believes that the ultimate resolution of the remaining complaints will not have a material adverse effect on CSW's or PSO's consolidated results of operations or financial condition.\nPCB Storage Facilities CSW and PSO PSO investigated and identified PCB contamination at one of its PCB storage facilities in Sand Springs, Oklahoma. PSO made proper notification to the EPA of the contamination that was caused by spills prior to PCB spill regulations. PSO negotiated a remediation plan with the EPA. Remediation began in November 1994, and the remediation costs are estimated to be $210,000. As part of the remediation plan, the EPA has requested PSO to sample the land surrounding the PCB storage building site. The land will include an active PSO substation and an industrial area that is privately owned.\n1-41 The extent of any PCB contamination has not been determined on either site.\nCompass Industries Superfund Site CSW and PSO PSO has received notice from the EPA that it is a PRP under CERCLA and may be required to share in the reimbursement of cleanup costs for the Compass Industries Superfund site which has been remediated. PSO has been named defendant in a lawsuit filed in Federal District Court in Tulsa, Oklahoma on August 29, 1994, for reimbursement of the clean-up cost. The range of PSO's degree of responsibility, if any, as a de minimis party appears to be insignificant. Management believes the ultimate resolution of this matter will not have a material adverse effect on CSW's or PSO's consolidated results of operations or financial condition.\nAlleged Coal Gasification Plant in McAlester, Oklahoma CSW and PSO PSO has been notified by the EPA of the identification of a coal gasification plant in McAlester, Oklahoma. The EPA requested PSO to identify all properties owned by PSO currently and formerly in McAlester that had been once owned by a non-affiliated company. PSO has submitted the information to the EPA. PSO has not been able to locate the alleged coal gasification plant in McAlester, Oklahoma. PSO has had no further contact with the EPA regarding this issue.\nUSI Site CSW and PSO PSO has been identified by the ADPCE as a PRP at the USI site in Pine Bluff, Arkansas. In 1993, the ADPCE asked PSO to provide it with information regarding any transactions between USI and PSO since 1973 that involved hazardous substances. Based on a review of its records, PSO's environmentally related transactions with USI were limited to USI's provision of oil recycling services to PSO at property owned by PSO, not at the USI site. As a result, PSO's degree of responsibility, if any, at the USI site appears to be insignificant.\nCoal Mine Reclamation CSW and PSO In August 1994, PSO received approval from the Wyoming Department of Environmental Quality to begin reclamation of a coal mine in Sheridan, Wyoming owned by Ash Creek Mining Company, a wholly-owned subsidiary of PSO. Ash Creek Mining Company recorded a $3 million liability in 1993 for the estimated reclamation costs. Actual reclamation work is expected to commence in mid-1995, with completion estimated in late 1996. Surveillance monitoring will continue for ten years after final reclamation. Management believes the ultimate resolution of this matter will not have a material adverse effect on CSW's or PSO's consolidated results of operations or financial condition.\nSuspected MGP Site in Marshall, Texas CSW and SWEPCO SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\n1-42 Suspected MGP Sites in Texarkana, Texas and Arkansas and Shreveport, Louisiana CSW and SWEPCO SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\nSuspected Biloxi, Mississippi MGP Site CSW and SWEPCO SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nRochester Substation Spill CSW and WTU In September 1992, an automobile crashed into WTU's 69 KV substation in Rochester, Texas, and struck a transformer containing 1,500 gallons of 25 parts per million PCB oil. WTU responded and coordinated clean-up efforts with state officials. In December 1993, WTU contracted with a consulting firm to ascertain the impact of the spill on the area ground water and to help determine WTU's effectiveness in the clean-up effort. Total costs to date have been approximately $400,000. The consultant's report, dated June 30, 1994, concluded that the spill cleanup procedures were effective. WTU forwarded the report to the TNRCC on July 12, 1994 and requested the agency close the matter. Management believes the ultimate resolution of this matter will not have a material adverse effect on CSW's or WTU's results of operations or financial condition.\nToxic Substances Control Act of 1976 Under the TSCA, the storage, use and disposal, among other things, of PCBs are regulated. Violations of TSCA may lead to fines and penalties.\nCSW and CPL In an inspection of CPL by the EPA, the EPA alleged that CPL failed to comply with the regulations governing the reporting of leakage of PCBs from some of its equipment. The EPA has proposed a penalty of $91,000. CPL met with EPA to negotiate a reduction in the penalty. EPA responded on January 26, 1995, with a proposed potential reduced penalty of $61,000 dependent upon filing additional information with the EPA. Based on the information currently available to it, CPL expects the final penalty to be between $61,000 and $91,000.\nSee ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, CSW NOTE 10, and PSO NOTE 8, Litigation and Regulatory Proceedings for additional information related to PCB matters.\nOther Environmental CSW, CPL, PSO, SWEPCO and WTU From time to time the registrants are made aware of various other environmental issues or are named as a party to various other legal claims, actions, complaints or other proceedings related to environmental matters. Management does not expect disposition of any such pending environmental proceedings to have a material adverse effect on the registrants' results of operations or financial condition.\n1-43 See ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Environmental for each registrant and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA, CSW NOTE 10 and PSO NOTE 8, Litigation and Regulatory Proceedings and CSW NOTE 11 and SWEPCO NOTE 10, Commitments and Contingent Liabilities, for additional information relating to environmental matters.\nNON-UTILITY OPERATIONS\nCSW Transok Transok, a wholly-owned subsidiary of CSW, is an intrastate natural gas gathering, transmission, processing, storage and marketing company. Transok, incorporated in Oklahoma in 1955, was acquired by CSW in 1961 to supply natural gas to PSO's power stations. While Transok's operations in recent years have included the marketing and transportation of natural gas for third parties, it functions within the CSW System to insure reliable and economic natural gas service to the Electric Operating Companies and CSWE.\nTransok provides a variety of services to the Electric Operating Companies including acquiring and transporting natural gas to meet certain of their power generation needs. Transok's largest customer is PSO. The contract between PSO and Transok provides (i) for the transportation of PSO's natural gas fuel supply through Transok's pipeline system and (ii) for Transok to act as PSO's supply administrator in acquiring natural gas and negotiating and administering supply contracts. PSO pays Transok for such services at cost, including a return on equity applicable between affiliates as specified by the Oklahoma Commission in PSO's most recent Oklahoma price review. The contract expires on January 1, 2003, but continues for consecutive five-year terms thereafter unless either party provides two years' notice of cancellation. Under the contract, PSO has the right to require delivery of up to 546 MMcf\/d of natural gas through Transok's pipeline system. Effective January 1, 1998, PSO may adjust the transportation capacity available to it under the contract based on its projected needs. Delivery of natural gas to PSO is currently about 86 Bcf annually and is projected to increase.\nNatural Gas Transportation and Gathering Transok provides natural gas suppliers and shippers with pipeline interconnects for access to the Electric Operating Companies and other end-users throughout the United States. At December 31, 1994, Transok's pipeline system consisted of approximately 6,436 miles of gathering and transmission lines which include approximately 3,973 miles of gathering lines in Oklahoma, 275 miles in Louisiana and 214 miles in Texas. At December 31, 1994, Transok's pipeline system consisted of 200 compressors with 197,900 horsepower to provide both gathering and transmission line compression. Transok's pipeline facilities are located in the major natural gas producing basins in Oklahoma, including the Anadarko and Arkoma basins, and in the major Louisiana corridor of pipelines transporting natural gas to the northeast from the Gulf Coast and mid-continent areas. The Transok pipeline system has numerous connections with major interstate pipelines through which natural gas is transported to markets throughout the United States. In 1994, the Transok pipeline system had a throughput of 506 Bcf of natural gas.\nTransok transported more than 86 Bcf per year of natural gas for PSO in 1994 and provided administrative services to PSO to manage its supply of natural gas. Transok has been active in the development of joint gas purchase arrangements with its other CSW affiliates as well. Transok's access to diverse natural gas markets combined with the natural gas fuel needs of the Electric Operating Companies allow for natural gas opportunities at high load factors, reducing the cost of natural gas fuel for the CSW System.\nNatural Gas Processing Transok also owns and operates seven natural gas processing plants for the production of natural gas liquids. The plants have an aggregate capacity of 444 MMcf\/d. Transok is the second largest natural gas processor in Oklahoma and ranks seventeenth among natural gas liquids producers nationwide. In 1994, Transok's plants produced\n1-44 399.4 million gallons of natural gas liquids while revenue from the sale of natural gas liquids amounted to $117.9 million for the year.\nNatural Gas Storage Transok owns and operates an underground natural gas storage reservoir in Oklahoma with an aggregate storage capacity of approximately 26 billion cubic feet. Operational capabilities include injection into storage at a rate of 130 MMcf\/d and a withdrawal rate in excess of 210 MMcf\/d. In 1993, the FERC issued an order approving market-based storage rates for Transok which enables it to sell storage services to interstate customers at negotiated fees based on the value of those services in the competitive marketplace. Transok's gas storage field also allows Transok to offer peaking services, accommodate volume swings on its pipeline system, and support the natural gas requirements of the Electric Operating Companies.\nNatural Gas Marketing In 1989, Transok began its natural gas marketing program and sold 26 Bcf to a variety of customers including local distribution companies, end-users and other pipelines. In 1994, Transok's natural gas sales volumes were 257 Bcf with a sales revenue of $484.4 million. Off-system sales of natural gas accounted for 111 Bcf of the natural gas sold in 1994. This increase was the result of pipeline acquisition and construction activities combined with new customers. Transok aggregates natural gas supply into various supply pools, which provide Transok with reliable sources of natural gas at market sensitive prices, allowing Transok to meet its natural gas supply needs. Transok offers various gas supply services to provide customers with peaking and balancing alternatives utilizing Transok's gas supplies and facilities. In addition, Transok's customers have the opportunity to select various pricing options including (i) fixed or variable pricing, (ii) indexed to New York Mercantile Exchange pricing or (iii) cash quotes.\nTransok uses natural gas futures, options and basis swaps to reduce its price risk exposure arising from the purchase and sale of natural gas. Natural gas futures and options allow Transok to protect against volatility in supply costs in fulfilling fixed price contracts, meeting storage requirements and purchasing natural gas for processing operations. Natural gas futures and options are also used to protect Transok against price exposure on sales of natural gas from storage or anticipated purchases. In addition, basis swaps protect Transok against volatility in price differentials between geographic areas in matching anticipated supply and demand prices.\nIn 1992, FERC Order 636 went into effect to deregulate the natural gas industry and increase competition. Although Transok operations were not directly affected by Order 636, Transok has developed tariff services, flexible contracts and other natural gas related services in order to meet customers' needs and take advantage of new competitive opportunities.\nServices for CSWE Transok provides natural gas fuel planning and management services for CSWE. Transok assists CSWE in developing natural gas supply and transportation strategies for CSWE's non-utility electric generation projects.\nRegulation As a subsidiary of CSW, Transok is subject to regulation under the Holding Company Act. The Holding Company Act, among other things, requires that regulated companies seek prior SEC approval before entering into certain transactions including the acquisition or issuance of securities.\nTransok's pipelines are considered gathering systems or intrastate pipelines. Transok is therefore exempt from regulation by the FERC under the Natural Gas Act. However, Transok's rates for transporting gas in interstate commerce are subject to FERC regulation under the Natural Gas Policy Act of 1978. The FERC approves Transok's rates for transportation of gas in interstate commerce through Transok's pipelines in Oklahoma and Louisiana and the Texas Railroad Commission approves the rates for such transportation through pipelines in Texas. The FERC also has given\n1-45 Transok approval to charge market-based rates for storage of gas using Transok's storage facility in Oklahoma.\nWhile Transok is not subject to direct regulation by any state public utility commission, the costs that result from transactions with its affiliated Electric Operating Companies are subject to review by the state commissions regulating such affiliates and are required to meet standards for affiliate transactions to be recoverable by the Electric Operating Companies.\nCSWE CSWE, a wholly-owned subsidiary of CSW, is authorized to develop various independent power and cogeneration facilities and to own and operate such non-utility projects, subject to further regulatory approvals. CSWE has an approximate 50% interest in the Brush, Fort Lupton and Mulberry facilities which achieved commercial operation in 1994.\nBrush The 68 MW Brush project, located in Brush, Colorado, achieved commercial operation in January 1994 and provides steam and hot water to a 15-acre greenhouse and sells electricity to Public Service Company of Colorado.\nFt. Lupton The Ft. Lupton project provides steam and hot water to a 20- acre greenhouse and also sells electricity to Public Service Company of Colorado. Phase I of the Ft. Lupton project, representing 122 MWs, achieved commercial operation in June 1994. Phase II of the project commenced operations in July 1994 bringing total on-line capacity of the project to 272 MWs.\nMulberry The Mulberry facility, a 117 MW gas-fired cogeneration plant in Polk County, Florida achieved commercial operation in August 1994 and provides steam to a combined distilled water and ethanol facility and sells electricity to Florida Power Corporation and Tampa Electric Company. CSWS is providing engineering, procurement and construction management services for the Mulberry project. CSWE's operating and maintenance division is operating the plant. On December 30, 1994, the borrower, Polk Power Partners, L.P., in which CSWE is indirectly a 50% owner, was notified it was in technical default under the third party financing documents since substantial completion of the Mulberry Ethanol facility had not occurred by December 30, 1994. CSWE is in the process of discussing with the lender means of curing the technical default. Management does not expect this matter to have a material effect on CSW's consolidated results of operations or financial condition.\nOrange Cogen The Orange Cogen facility, in which CSWE holds a 50% interest, is expected to commence operation in June 1995. The 103 MW, gas fired plant in Florida will provide thermal energy to an orange juice processor and will sell electricity to Florida Power Corporation and Tampa Electric Company. CSWE's O&M division plans to operate the plant.\nOildale In November 1994, CSWE transferred its 50% interest in the 40 MW Oildale cogeneration facility to two non-affiliated third parties, Oildale Holdings, Inc. and Oildale Holdings II, Inc. The Oildale project, which was financed with third-party non-recourse project financing, had been in default of certain provisions of its loan agreement since December 1993. Under the terms of the project transfer, CSWE contributed $3 million in equity in exchange for the return of a letter of credit in the same amount in favor of a third party lender. CSWE had reserved for this liability in 1993, therefore, this transaction has no material adverse effect on CSW's or CSWE's 1994 results of operations or financial condition.\n1-46 Other Projects In addition to these projects, CSWE has another 19 projects totaling more than 5,000 MW in various stages of development, mostly in affiliation with other developers. CSWE can provide no assurances that these projects, which are subject to further negotiations and regulatory approvals, will be commenced or completed and, if they are completed, that they will provide the anticipated return on investment.\nAs a result of its participation in these projects, CSWE has contractual commitments to provide certain services and support. These commitments provide that the potential maximum liability of CSWE will be limited to $215 million. Management believes the likelihood of material liabilities under these contracts is remote.\nThe following table sets forth information about cogeneration projects CSWE is currently operating or bringing to operation:\nCSWI In November 1994, CSWI, a wholly-owned subsidiary of CSW, was formed to engage in international activities including developing, acquiring, financing and owning the securities of exempt wholesale generators and foreign utility companies.\nIn 1994, CSWI continued the Mexico initiative that CSW began in 1992. CSWI's goal is to participate in providing for Mexico's future electric power needs. The geographical location of the CSW System offers opportunities to provide bulk power sales to Mexico. The Mexico City office of CSW allows CSWI greater access to key Mexican markets, permitting CSWI to more readily evaluate opportunities as they become available. However, the recent devaluation of the Mexican peso will slow previously projected power demand for the near-term.\nCSWI is also evaluating energy-related projects in other international markets.\nCSW Communications In July 1994, CSW Communications, a wholly-owned subsidiary of CSW, was formed to provide communication services to the Operating Companies and non-affiliates. One important goal of CSW Communications is to enhance services to CSW System customers through fiber optics and other telecommunications technologies. CSW Communications will consolidate the future design, construction, maintenance and ownership of the CSW System's telecommunications networks. In 1994, CSW announced a $9 million project in Laredo, Texas, to install fiber optic lines and coaxial cable to CPL residential customers who have volunteered to take part in this pilot program. This project involving CSW Communications and CPL will demonstrate the energy efficiency and cost savings that result from giving customers greater choice and control over their electric service. These energy-efficiency services will use only a portion of the capacity of the telecommunications lines CSW Communications is installing. In the future, CSW Communications may, subject to any required regulatory approvals, seek to lease or otherwise use the remaining capacity for other services including possibly telephone service, cable television and home security systems.\n1-47 ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES. CSW, CPL, PSO, SWEPCO and WTU See ITEM 1. BUSINESS - UTILITY OPERATIONS - Facilities for a description of properties used in utility operations.\nSee ITEM 1. BUSINESS - Transok and CSWE for a description of properties used in non-utility operations.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS. CSW, CPL, PSO, SWEPCO and WTU The registrants are 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 registrants' results of operations or financial condition.\nSee ITEM 1. BUSINESS - REGULATION AND RATES, ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CSW NOTE 10, CPL NOTE 9, PSO NOTE 8, SWEPCO NOTE 9, and WTU NOTE 9, Litigation and Regulatory Proceedings, for information relating to legal and regulatory proceedings.\nSee ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for each of the registrants, for information related to fuel settlements.\nSee ITEM 1. BUSINESS - ENVIRONMENTAL MATTERS and ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Recent Developments and Trends for each of the registrants, for information relating to environmental proceedings.\nCSW and CPL See ITEM 1. BUSINESS - NUCLEAR - STP, ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS and ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA - CSW NOTE 10 and CPL NOTE 9, Litigation and Regulatory Proceedings, for information as to pending legal proceedings relating to STP.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. CSW, CPL, PSO, SWEPCO and WTU None.\n2-1 PART II\nITEM 5.","section_5":"ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. CSW Common Stock Price Range and Dividends Paid per Share 1994 1993 Market Price Dividends Market Price Dividends High Low Paid High Low Paid (cents) (cents) First Quarter $30 7\/8 $24 1\/8 42.5 $33 1\/4 $28 5\/8 40.5 Second Quarter 26 1\/4 20 1\/8 42.5 34 1\/4 28 3\/4 40.5 Third Quarter 23 1\/4 20 7\/8 42.5 33 7\/8 32 1\/4 40.5 Fourth Quarter 23 3\/4 20 1\/8 42.5 33 28 1\/4 40.5\nCommon Stock Listing CSW's common stock is traded under the ticker symbol CSR and listed on the New York Stock Exchange, Inc. and Chicago Stock Exchange, Inc.\nCommon Stock Dividends Dividends of 42.5 cents a share were paid in each quarter of 1994. All dividends paid by CSW represent taxable income to stockholders for federal income tax purposes.\nIn January 1995, CSW's board of directors increased the quarterly dividend to 43 cents per share, payable on February 28, 1995, to stockholders of record on February 8, 1995. Traditionally, the CSW board of directors has declared dividends to be payable on the last business day of February, May, August, and November. CSW has stated that it is committed to achieving a 75% payout ratio in the long-term as a key component of its corporate strategy to maximize stockholder value.\nStockholders There were approximately 74,000 record holders of CSW's common stock as of December 31, 1994.\nCPL, PSO, SWEPCO and WTU All of the outstanding shares of common stock of CPL, PSO, SWEPCO and WTU are owned by CSW.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA.\nReference is made to the page numbers noted in the following table for the location of ITEM 6. SELECTED FINANCIAL DATA, which is included in ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPage Number CSW CPL PSO SWEPCO WTU Selected Financial Data 2-6 2-70 2-106 2-132 2-160\n2-2 ITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nReference is made to the page numbers noted in the following table for the location of ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS which is included in ITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.\nPage Number CSW CPL PSO SWEPCO WTU Management's Discussion and Analysis of Financial Condition 2-7 2-71 2-107 2-133 2-161\n2-3 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. Page CSW Central and South West Corporation 2-5 Selected Financial Data 2-6 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-7 Consolidated Statements of Income 2-26 Consolidated Statements of Retained Earnings 2-27 Consolidated Balance Sheets 2-28 Consolidated Statements of Cash Flows 2-30 Notes to Consolidated Financial Statements 2-31 Report of Independent Public Accountants 2-67 Report of Management 2-68\nCPL Central Power and Light Company 2-69 Selected Financial Data 2-70 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-71 Statements of Income 2-81 Statements of Retained Earnings 2-82 Balance Sheets 2-83 Statements of Cash Flows 2-85 Statements of Capitalization 2-86 Notes to Financial Statements 2-87 Report of Independent Public Accountants 2-103 Report of Management 2-104\nPSO Public Service Company of Oklahoma 2-105 Selected Financial Data 2-106 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-107 Consolidated Statements of Income 2-113 Consolidated Statements of Retained Earnings 2-114 Consolidated Balance Sheets 2-115 Consolidated Statements of Cash Flows 2-117 Consolidated Statements of Capitalization 2-118 Notes to Consolidated Financial Statements 2-119 Report of Independent Public Accountants 2-129 Report of Management 2-130\n2-4 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. (continued)\nSWEPCO Southwestern Electric Power Company 2-131 Selected Financial Data 2-132 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-133 Statements of Income 2-141 Statements of Retained Earnings 2-142 Balance Sheets 2-143 Statements of Cash Flows 2-145 Statements of Capitalization 2-146 Notes to Financial Statements 2-147 Report of Independent Public Accountants 2-157 Report of Management 2-158\nWTU West Texas Utilities Company 2-159 Selected Financial Data 2-160 Management's Discussion and Analysis of Financial Condition and Results of Operations 2-161 Statements of Income 2-169 Statements of Retained Earnings 2-170 Balance Sheets 2-171 Statements of Cash Flows 2-173 Statements of Capitalization 2-174 Notes to Financial Statements 2-175 Report of Independent Public Accountants 2-186 Report of Management 2-187\n2-5\nCSW\nCENTRAL AND SOUTH WEST CORPORATION\n2-6 Selected Financial Data CSW The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for CSW.\n1994 1993 1992 1991 1990 (millions, except per share amounts and ratios) Operating Revenues $ 3,623 $ 3,687 $ 3,289 $ 3,047 $2,744 Income Before Cumulative Effect of Changes in Accounting Principles 412 281 404 401 386 Cumulative Effect of Changes in Accounting Principlies (1) -- 46 -- -- -- Net Income 412 327 404 401 386 Preferred Stock Dividends 18 19 22 26 30 Dividends Net Income for Common Stock 394 308 382 375 356\nTotal Assets (2) 10,909 10,604 9,829 9,396 9,074\nCommon Stock Equity 3,052 2,930 2,927 2,834 2,743 Preferred Stock Not Subject to Mandatory Redemption 292 292 292 292 291 Subject to Mandatory Redemption 35 58 75 97 103 Long-term Debt 2,940 2,749 2,647 2,518 2,513\nCapitalization Ratios Common Stock Equity 48.3% 48.6% 49.3% 49.4% 48.5% Preferred Stock 5.2 5.8 6.2 6.8 7.0 Long-term Debt 46.5 45.6 44.5 43.8 44.5 Earnings per Share of Common Stock $2.08 $1.63 $2.03 $1.99 $1.89 Dividends Paid per Share of Common Stock $1.70 $1.62 $1.54 $1.46 $1.38\n(1) The 1993 cumulative effect relates to the changes in accounting for unbilled revenues and adoption of SFAS No. 112, Employer's Accounting for Postemployment Benefits and the adoption of SFAS No. 109, Accounting for Income Taxes. See NOTE 1. Summary of Significant Accounting Policies.\n(2) The 1992 - 1990 total assets have been reclassified to reflect the effects of the adoption in 1993 of SFAS No. 109, Accounting for Income Taxes. See NOTE 2. Federal Income Taxes.\nAll common stock data have been adjusted to reflect the two-for-one common stock split, effected by a 100% stock dividend paid on March 6, 1992, to stockholders of record on February 10, 1992.\nCSW changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore have not been restated.\n2-7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCENTRAL AND SOUTH WEST CORPORATION\nReference is made to CSW's Consolidated Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential in understanding, the following discussion and analysis.\nOverview The electric utility industry is changing rapidly and becoming more competitive. Several years ago, in anticipation of increasing competition and fundamental changes in the industry, CSW's management developed a four-part strategic plan. This plan is designed to help position CSW to be competitive in the rapidly changing environment that the CSW System currently faces. The four-part strategy is:\nEnhance CSW's core electric utility business.\nExpand CSW's core electric utility business.\nExpand CSW's non-utility business.\nPursue financial initiatives.\nSince the introduction of CSW's strategic plan in 1990, CSW has undertaken initiatives in each of these areas that are important steps in the implementation of the overall strategy. These initiatives were marked by the efforts in the proposed acquisition of El Paso and the continued restructuring of CSW's core business. In addition, CSW has faced some operational challenges during the past two years with the outage and 1994 restart of STP. These events are discussed below and elsewhere in this report.\nCSW and the Electric Operating Companies believe that, compared to other electric utilities, the CSW System is well positioned to meet future competition. The CSW System benefits from economies of scale and scope by virtue of its size and is a relatively low-cost producer of electric power. Moreover, CSW is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nProposed Acquisition of El Paso El Paso filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code on January 8, 1992. In May 1993, CSW entered into a Merger Agreement pursuant to which El Paso would emerge from bankruptcy as a wholly-owned subsidiary of CSW. El Paso is an electric utility company headquartered in El Paso, Texas, engaged principally in the generation and distribution of electricity to approximately 262,000 retail customers in west Texas and southern New Mexico. El Paso also sells electricity under contract to wholesale customers in a number of locations including southern California and Mexico.\nOn July 30, 1993, El Paso filed the Modified Plan and a related proposed form of disclosure statement providing for the acquisition of El Paso by CSW. On November 15, 1993, all voting classes of creditors and shareholders of El Paso voted to approve the Modified Plan. On December 8, 1993, the Bankruptcy Court confirmed the Modified Plan.\nUnder the Modified Plan, the total value of CSW's offer to acquire El Paso is approximately $2.2 billion. The Modified Plan generally provides for El Paso creditors and shareholders to receive shares of CSW Common, cash and\/or securities of El Paso, or to have\n2-8 their claims cured and reinstated. The Modified Plan also provides for claims of secured creditors generally to be paid in full with debt securities of reorganized El Paso, and for unsecured creditors to receive a combination of debt securities of reorganized El Paso and CSW Common equal to 95.5 percent of their claims, and for small trade creditors to be paid in full with cash. The Modified Plan provides for El Paso's preferred shareholders to receive preferred shares of reorganized El Paso, or cash, and for options to purchase El Paso Common to be converted into options to purchase a proportionate number of shares of CSW Common.\nBased on information provided by El Paso, 35,544,330 shares of El Paso Common were outstanding as of the Confirmation Date. The Modified Plan provides for El Paso's common shareholders to receive between $3.00 and $4.50, plus dividends, per share of El Paso Common to be paid in CSW Common as described below. The Merger Agreement provides for each share of El Paso Common to be converted on the Effective Date into the number of shares of CSW Common with a value (based on a value of $29.4583 per share of CSW Common) equal to the sum of (i) $3.00 per share of El Paso Common outstanding on the Confirmation Date, (ii) any proceeds received by El Paso prior to the Effective Date from certain contingent claims based on a value of CSW Common equal to the closing price on the New York Stock Exchange on the day such proceeds are received by El Paso, and (iii) the dividends that would be deemed to have been paid on the amounts described in items (i) and (ii) above from the Confirmation Date, or the date upon which such contingent claims are converted into cash, as the case may be, through and including the Effective Date, as well as dividends that would have been paid on such dividends under (iii) above; provided, however, that the sum of (i) and (ii) above will not exceed $4.50 multiplied by the number of shares of El Paso Common outstanding on the Confirmation Date. If $4.50 per share of El Paso Common has not been realized under items (i) and (ii) above and any of the contingent claims are remaining on the Effective Date, the Modified Plan and Merger Agreement provide for a liquidation trust to be established pursuant to the Modified Plan and for El Paso's rights in those contingent claims to be assigned to the trust. The Modified Plan provides for proceeds resulting from disposition of the assets in the liquidation trust, if any, to be distributed pro rata to the holders of El Paso Common up to $4.50 per share under items (i) and (ii) above, with any net proceeds thereafter to be returned to El Paso. El Paso has stated publicly that it has realized sufficient proceeds from the contingent claims referred to in item (ii) above so that no liquidation trust would be required.\nThe aggregate number of shares of CSW Common that would be issued in connection with the Merger cannot be determined at this time due to certain contingencies, including the future price of CSW Common, future dividend rates on CSW Common and the occurrence and timing of the Effective Date of the Merger. CSW has estimated the value of the shares to be issued to El Paso stakeholders at approximately $569 million based on an assumed Effective Date in the first half of 1995. In addition, CSW expects to make payments in cash of approximately $335 million in connection with the consummation of the Merger, a portion of which would be funded by cash in the El Paso estate and an estimated $200 million of which would be funded from other internal or external sources which may include a new issuance of CSW Common or debt securities. Depending on the number of shares issued and the outcome of other matters discussed below, existing holders of CSW Common could experience short-term dilution in earnings if the Merger is consummated. As of December 31, 1994, the price per share of CSW Common had declined by approximately 31% since May 3, 1993, the date of the Merger Agreement. Because the number of shares of CSW Common and the interest rates of the debt securities that would be issued to the creditor groups in connection with the Merger are to be set on or about the Effective Date, changes in the price of CSW Common and the level of interest rates would affect the economic impact of the proposed acquisition to CSW.\nThe Merger is subject to numerous conditions set forth in the Merger Agreement, including but not limited to (i) the receipt of final orders with respect to all required regulatory approvals on terms that would not cause a regulatory material adverse effect as defined in the Merger Agreement, (ii) the receipt of all third party consents, (iii) the absence of a material adverse effect or facts or circumstances that could reasonably be expected to result in a material adverse effect on El Paso or the business prospects of El Paso, (iv) transfer to El Paso of good and marketable title to the leased portion of El Paso's share of Palo Verde, (v) performance by\n2-9 El Paso, CSW and CSW's acquisition subsidiary, CSW Sub, Inc., in all material respects of all covenants contained in the Merger Agreement and (vi) the occurrence of the Effective Date under the Modified Plan. Required regulatory approvals and filings in connection with the Merger include approvals of the FERC, the SEC, the Texas Commission, the New Mexico Commission, the NRC, and filings with the Department of Justice and the Federal Trade Commission under the Hart- Scott-Rodino Antitrust Improvements Act of 1976.\nThe Merger Agreement also provides that CSW and El Paso have the right to terminate the Merger Agreement under specified circumstances including without limitation, (i) the filing of a stand-alone rate plan by El Paso, (ii) the failure of the Effective Date to occur within 18 months after the Confirmation Date (i.e., by June 8, 1995), or , if extended by mutual consent of CSW and El Paso, within 24 months of the Confirmation Date (i.e., by December 8, 1995), or (iii) the entering of any order denying any of the required regulatory approvals. In the event the Merger Agreement is terminated, a termination fee is payable in limited circumstances. El Paso is required to pay a termination fee of $50 million to CSW if El Paso terminates the Merger Agreement under certain circumstances and subsequently consummates a merger with another party. CSW and El Paso would be required to pay a $25 million termination fee to the other party in the case of termination based upon a material breach of the Merger Agreement or failure to approve an extension of time permitted to consummate the Merger under specified circumstances. If the Merger Agreement is terminated, whether or not any termination fee is payable, CSW could be required, in most cases, to recognize as an expense deferred costs associated with the Merger, which amounted to approximately $36 million at December 31, 1994. Additionally, under certain circumstances, if the Merger is not consummated, the Merger Agreement provides for CSW to pay El Paso a portion of certain interest costs and certain fees and expenses. CSW's potential exposure as of December 31, 1994 is estimated to be approximately $17.5 million; however, the actual amount, if any, that CSW may be required to pay pursuant to these provisions depends on a number of contingencies and cannot presently be predicted.\nCSW continues to use its best efforts to consummate the Merger. At the same time, however, CSW continues to monitor contingencies which may preclude the consummation of the Merger, including without limitation the potential loss of significant portions of El Paso's service area and significant El Paso customers, including Las Cruces and two military installations, Holloman Air Force Base and White Sands Missile Range, regulatory risks principally related to approval of the Merger and El Paso's request for a rate increase in Texas as well as the effects of the conditions imposed by federal or state regulatory agencies on the approval of the Merger, and operating risks associated with the ownership of an interest in Palo Verde.\nBased upon El Paso's written response to the concerns identified in a September 12 letter from CSW to El Paso and the failure of El Paso to resolve the contingencies set forth above, CSW cannot predict whether, or if so when, the Merger will be consummated. In the event that the proposed Merger is not consummated, there may be ensuing litigation between El Paso and CSW or among other parties to El Paso's bankruptcy proceedings and either or both of El Paso and CSW.\nManagement is unable to predict the ultimate outcome of the proposed Merger. In the event that recognition of any or all of these expenses is required, it could have a material adverse impact on CSW's consolidated results of operations in the period they are recognized, but would not be expected to have a material adverse impact on CSW's consolidated results of operations or financial condition.\nSee NOTE 11, Commitments and Contingent Liabilities - Proposed Acquisition of El Paso, for additional information related to the proposed El Paso merger.\nRestructuring As previously reported, the CSW System has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the\n2-10 restructuring is to enable the Electric Operating Companies to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $97 million and were expensed in 1993. The final costs of the restructuring were approximately $88 million. Approximately $84 million of the restructuring expenditures were incurred during 1994, with the remaining $4 million expected to be incurred during 1995. Approximately $12 million of the restructuring expenses relate to employee termination benefits, $45 million relate to enhanced benefit costs and $31 million relate to employees that will not be terminated. Approximately $60 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $28 million represents the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nCSW expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. All restructuring costs are expected to be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nSTP Introduction CPL owns 25.2% of STP, a two-unit nuclear power plant which is located near Bay City, Texas. In addition to CPL, 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.\nFrom February 1993 until May 1994, STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL. These matters, including a base rate case and fuel reconciliation proceedings, are discussed immediately below.\nSTP Outage In February 1993, Units 1 and 2 of STP were shut down by HLP in an unscheduled outage resulting from mechanical problems. HLP determined that the units would not be restarted until the equipment failures had been corrected and the NRC was briefed on the causes of these failures and the corrective actions that were taken. The NRC formalized that commitment in a confirmatory action letter that it supplemented to identify additional issues to be resolved and verified by the NRC before STP could be restarted.\nDuring the outage, the necessary improvements were 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 agreed with HLP's recommendation that Unit 1 was ready to restart. Unit 1 restarted on February 25, 1994 and reached 100% power on April 8, 1994. Subsequently, the issues with respect to Unit 2 were resolved and the NRC on May 17, 1994 agreed with HLP's recommendation to restart Unit 2. Unit 2 resumed operation on May 30, 1994 and reached 100% power on June 16, 1994. During 1994, Unit 1 and Unit 2 achieved annual net capacity factors of 75.3% and 54.7%, respectively. During the last six months of 1994, the STP units operated at capacity factors of 98.6% for Unit 1 and 99.2% for Unit 2.\nIn June 1993, the NRC placed STP on its \"watch list\" of plants with \"weaknesses that warrant increased NRC attention.\" The decision to place STP on the watch list followed the June 1993 issuance of a report by an NRC Diagnostic Evaluation Team which conducted a review of STP operations.\nOn February 3, 1995, the NRC removed STP from the \"watch list\". The NRC noted that the four key areas for their decision were sustained improvement throughout 1994, high standards of performance exhibited by the plant, effective maintenance and engineering support\n2-11 resulting in reduced equipment repair backlogs and improved plant reliability, and the open and positive employee climate at the plant. With the NRC reviewing the \"watch list\" status every 6 months and with Unit 2 achieving 100% power in June of 1994, the February review was the first realistic opportunity for STP to be considered for a change in status. On average, plants previously placed on the \"watch list\" have stayed on the list for 29 months.\nRates and Regulatory Matters CPL Rate Inquiry Several Cities, the Texas Commission General Counsel and others initiated actions in late 1993 and early 1994 which, if approved by the Texas Commission, would lower CPL's base rates. The requests for a review of CPL's rates arose out of the unscheduled outage at STP which began in February 1993. The STP outage did not affect CPL's ability to meet customer demand because of existing capacity and CPL's purchase of additional energy.\nCPL submitted a filing package on July 1, 1994, to the Texas Commission justifying its current base rate structure. Parties to CPL's base rate case have filed testimony with the Texas Commission recommending reductions in CPL's retail base rates of up to $147 million annually, resulting from a combination of proposed rate base and cost of service reductions, as well as a rate base disallowance of up to $400 million.\nThe Texas Commission held hearings in November and December 1994, and all parties have filed briefs in the case. The ALJ is expected to issue a recommended order for consideration by the Texas Commission in April 1995 with a final order from the Texas Commission expected in May 1995. Testimony filed by parties to the rate case, including the Staff, is not binding on either the ALJ or the Texas Commission.\nCPL continues to maintain that its rates are reasonable and that its earnings are within established regulatory guidelines. In addition, CPL strongly believes that 100 percent of its investment in both units of STP belongs in rate base. This belief is based on, among other factors, Units 1 and 2 providing output at high capacity factors since April and June 1994, respectively. In addition, the long-term benefits nuclear generation provides to customers further support their inclusion in rate base. Furthermore, there are no Texas Commission precedents addressing the removal of a nuclear plant from rate base as a performance disallowance. Assuming both units of STP are included in rate base, CPL believes it is not collecting excessive revenues, notwithstanding that market rates of return on common equity are generally lower today than they were in 1990 and 1991, when CPL's base rates were last set.\nCPL Fuel Pursuant to the substantive rules of the Texas Commission, CPL generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and CPL'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 from revenues, with a corresponding entry to unrecovered fuel costs 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.\nCPL is currently involved in two proceedings before the Texas Commission relating to the recovery of fuel and purchased power costs. CPL originally filed Docket No. 12154 seeking approval of a customer surcharge to recover fuel and purchased power costs, including those resulting from the STP outage. In Docket No. 13126, the Texas Commission General Counsel and others are reviewing the prudence of management activities at STP. In November 1994, CPL filed a fuel reconciliation case in Docket No. 13650 with the Texas Commission seeking to reconcile fuel costs since March 1, 1990, including the period during which CPL's fuel and purchased power costs were increased due to the STP outage. At December 31, 1994, CPL's under-recovered fuel balance was $54.1 million, exclusive of interest, which was due primarily to the STP outage. If a\n2-12 significant portion of the fuel costs were disallowed by the Texas Commission, CSW could experience a material adverse effect on its consolidated results of operations in the year of disallowance but not on its financial condition. Finally, in Docket No. 13126, the Texas Commission General Counsel is reviewing the prudence of management activities at STP. On January 4, 1995, Docket No. 12154 was consolidated into Docket No. 13650. The results of the prudence inquiry in Docket No. 13126 are expected to be incorporated into the fuel reconciliation proceedings in Docket No. 13650.\nCPL continues to negotiate with the intervening parties to resolve these matters through settlement. However, no settlement has been reached to date.\nManagement cannot predict the ultimate outcome of these regulatory proceedings. However, management believes that the ultimate resolution of the various issues will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nSee NOTE 10, Litigation and Regulatory Proceedings - CPL, STP, for a discussion of regulatory proceedings arising out of the STP outage and background on STP rate orders and deferred accounting.\nNuclear Decommissioning CPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning and is net of expected earnings on the trust fund.\nThe staff of the SEC has questioned certain of the current accounting practices of the electric utility industry regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations. In response to these questions, FASB has agreed to review the accounting for removal costs, including decommissioning. If current electric utility industry accounting practices for such decommissioning are changed, (i) annual provisions for decommissioning could increase, (ii) the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation, and (iii) trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense.\nSee NOTE 1, Summary of Significant Accounting Policies - Nuclear Decommissioning, for further information regarding CPL's decommissioning of STP.\nSee NOTE 10, Litigation and Regulatory Proceedings, for information regarding other rate and regulatory matters, including the PSO rate case, the SWEPCO fuel reconciliation, and WTU's fuel and rate proceedings.\nNew Accounting Standards SFAS No. 115, was effective for fiscal years beginning after December 15, 1993. CSW adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on CSW's consolidated results of operations or financial condition.\nIn June 1993 the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by CSW for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on CSW's consolidated results of operations or financial condition.\n2-13 SFAS No. 119 was effective for fiscal years ending after December 15, 1994. Transok, which is the only subsidiary of CSW currently using derivative financial instruments, uses derivatives to manage price and market risks for gas purchases and sales. The Electric Operating Companies may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on CSW's consolidated results of operations or financial condition.\nLiquidity and Capital Resources Overview The historical capital requirements of the CSW System have been primarily for the construction of electric utility plant. Large capital expenditures for the construction of new generating capacity are not planned through the end of this decade. Accordingly, internally generated funds should meet most of the capital requirements of the Electric Operating Companies. However, CSW's strategic initiatives, including expanding CSW's core electric utility and non-utility businesses, may require additional capital. Primary sources of capital are long-term debt and preferred stock issued by the Electric Operating Companies, common stock issued by CSW and internally generated funds. In addition, CSWE uses various forms of non-recourse project financing. CSW, in order to strengthen its capital structure and support growth from time to time, may issue additional shares of its common stock.\nProductive investment of net funds from operations in excess of capital expenditures and dividend payments are necessary to enhance the long-term value of CSW for its investors. CSW is continually evaluating the best use of these funds. CSW is required to obtain authorization from various regulators in order to invest in any additional business activities.\nCapital Expenditures Construction expenditures for the CSW System totaled $578 million in 1994. Based on projections of growth in peak demand, the CSW System will not require significant additional generating capability through the end of this decade. Planned construction expenditures for the Electric Operating Companies for the next three years are primarily to improve and expand distribution facilities. These improvements will be required to meet the needs of new customers and the growth in the requirements of existing customers. Construction expenditures, excluding capital required for acquisitions by CSW or its subsidiaries, if any, are expected to be approximately $385 million, $382 million and $358 million during 1995, 1996, and 1997, respectively. Not included in the 1995 amount is approximately $61 million of equity investments by CSWE.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in the Electric Operating Companies' service areas, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected coal and lignite-fired generating plants for which the CSW System has invested approximately $140 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, CSW would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of CSW were: common stock equity 48%, preferred stock 5% and long-term debt 47%. The CSW System's embedded cost of long-term debt was 7.7% at the end of 1994. The CSW System continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. The CSW System continues to be committed to maintaining financial flexibility by maintaining a strong capital structure and favorable securities ratings which should allow funds to be obtained from the capital markets when required.\n2-14 The CSW System's significant long-term financing activity for 1994 and 1995 to date is summarized as follows:\nSecurity Issued Security Reacquired Security Amount Rate Maturity Security Amount Rate Maturity (millions) (millions) CPL FMB(1) $100.0 7-1\/2% 1999 PFDs $22.4 10.05% -- FMB 0.6 9-3\/8% 2019\nSWEPCO Term Term Loan 50.0 Floating 2000 Loan 50.0 Floating 1997 FMB 5.8 9-1\/8% 2019\nWTU FMB(2) 40.0 6-1\/8% 2004 FMB 12.0 7-1\/4% 1999 FMB(3) 40.0 7-1\/2% 2000 FMB 7.8 9-1\/4% 2019 PFDs 4.7 7-1\/4% -- CSWS Term(4) Loan 60.0 Floating 2001\n(1) Net proceeds were used to repay a portion of CPL's short-term borrowings.\n(2) Net proceeds were used to reimburse WTU's treasury for (i) $12 million aggregate principal amount of 7-1\/4% FMBs, Series G, due January 1, 1999, redeemed on January 1, 1994, and (ii) $23 million aggregate principal amount of 7-7\/8% FMBs, Series H, due July 1, 2003, redeemed on December 30, 1993. The balance of the proceeds were used to repay outstanding short-term borrowings.\n(3) Issuance occurred in 1995 and is not reflected in the 1994 financial statements. Net proceeds were used to repay a portion of WTU's short-term debt, to provide working capital and for other general corporate purposes.\n(4) Proceeds were used to repay short-term debt, which had been previously used to finance certain assets, including the CSW headquarters building in Dallas, Texas.\nShelf Registration Statements The Electric Operating Companies expect to obtain a majority of their 1995 capital requirements from internal sources, but may issue additional securities subject to market conditions and other factors. CPL and WTU have filed shelf registration statements with the SEC for the sale of securities. The amount available for issuance by company and the date filed with the SEC follow:\nFirst Mortgage Bonds Preferred Stock Amount Date Filed Amount Date Filed Available Available (millions) (millions) CPL $260 1993 $75 1994\nWTU $20 1993\nThe Operating Companies may issue additional debt securities subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost FMBs, to lower the embedded cost of debt, to repay short-term debt, to provide working capital and for other general corporate purposes.\n2-15 The Electric Operating Companies may issue additional preferred stock subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost preferred stock and to repay short-term debt.\nShort-Term Financing The Electric Operating Companies utilize short-term debt to meet fluctuations in working capital requirements due to the seasonal nature of electric sales. The CSW System has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million to back up the CSW commercial paper program.\nThe maximum amount of consolidated short-term debt outstanding in 1994 was $1,618 million in September 1994, which represented 26% of the total capitalization at December 31, 1994. The average amount of short-term debt during 1994 was $1,455 million, of which $694 million was attributable to CSW Credit. The weighted average cost of short- term debt was 4.5% in 1994. Short-term debt outstanding increased due to continued expenditures for corporate initiatives, including investments in CSWE.\nAcquisitions To meet its strategic goals, CSW will continue to search for electric utility companies or other electric utility properties to acquire and will continue evaluating opportunities to pursue energy related non-utility businesses. For any major acquisition, additional funds from the capital markets, including the issuance of CSW Common in underwritten public offerings, in the acquisition transaction itself, or otherwise, may be required.\nFor a discussion of circumstances under which CSW may issue additional shares of common stock in connection with the proposed acquisition of El Paso, see Proposed Acquisition of El Paso, above.\nDividend Reinvestment Plan The PowerShare dividend reinvestment plan is available to all CSW stockholders, employees, eligible retirees, utility customers and other residents of the four states where the Electric Operating Companies operate. Plan participants are able to make optional cash payments and reinvest all or any portion of their dividends in CSW Common. During 1994 CSW raised approximately $50 million in new equity through the PowerShare plan.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. The Electric Operating Companies utilize short-term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. Information concerning internally generated funds follows:\n1994 1993 1992 (millions) Internally Generated Funds $424 $369 $374\nCapital expenditures, Acquisitions, CSWE Equity Investments Provided by Internally Generated Funds 63% 58% 82%\nCSWE and CSWI At December 31, 1994, CSW had loaned $221 million to CSWE on an interim basis for the purpose of developing and constructing independent power and cogeneration facilities. Repayment of these amounts to CSW is expected to be made through funds obtained from third party non-recourse project financing. In late February 1994, CSWE closed permanent project financing for its 50% owned Mulberry facility, which is described below, and repaid $94 million of the interim financing provided by CSW. In March 1995, CSWE closed permanent project financing for its Ft. Lupton facility, which is described below, and repaid $102 million of the interim financing provided by CSW. In addition to the amounts already expended in 1994 for the development of projects, CSWE and CSWI have general authority from the SEC to expend up to $242 million and $399 million, respectively, on future projects.\nCSW Credit CSW Credit purchases, without recourse, the accounts receivable of the Operating Companies and certain non-affiliated electric companies. CSW Credit's capital structure contains greater leverage than that of the Operating Companies, consequently lowering CSW's cost of capital.\nCSW Credit issues commercial paper, secured by the assignment of its receivables, to meet its financing needs. CSW Credit maintains a secured revolving credit agreement which aggregated $900 million at December 31, 1994 to back up its commercial paper program.\nThe sale of these accounts receivables provides the Operating Companies with cash immediately, thereby reducing working capital needs and revenue requirements.\nRecent Developments and Trends\nCompetition and Industry Challenges Competitive forces at work in the electric utility industry are impacting the CSW System and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, the Electric Operating Companies will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. The Electric Operating Companies believe that their prices for electricity and the quality and reliability of their service currently place them in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While CSW believes that the Energy Policy Act will continue to make the wholesale markets more competitive, CSW is unable to predict the extent to which the Energy Policy Act will impact CSW System operations.\nIncreasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nThe Electric Operating Companies also compete with suppliers of alternative forms of energy, such as natural gas, fuel oil and coal, some of which may be cheaper than electricity. The Electric Operating Companies believe that their prices and the quality and reliability of\n2-17 their service currently places them in a position to compete effectively in the marketplace.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. The Electric Operating Companies compete in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities, but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers. In 1993, PSO and SWEPCO filed with the FERC tariffs under which they make available firm and non-firm transmission services for other electric utilities on the combined PSO and SWEPCO transmission systems in the Southwest Power Pool. The FERC accepted the tariffs for filing on November 9, 1993. In the event the FERC approves the Merger between CSW and El Paso and denies CSW's request for rehearing wherein CSW asked FERC to reconsider the imposition of a comparable service requirement, these tariffs could be superseded by a set of compliance tariffs which offer point-to-point and network transmission service on terms and conditions comparable to CSW's and El Paso's use of their own transmission systems. As discussed, compliance tariffs could expose the merged CSW System to additional risks of loss of load from current requirements wholesale customers purchasing power from alternative suppliers or reduced revenue resulting from competition with alternative suppliers of electric power.\nCSW and the Electric Operating Companies believe that, compared to other electric utilities, the CSW System is well positioned to meet future competition. The CSW System benefits from economies of scale and scope by virtue of its size and is a relatively low-cost producer of electric power. Moreover, CSW is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nCSW is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or the CSW System. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\nPublic Utility Regulatory Act PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. CSW is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted. If, however, the Texas Legislature passes legislation permitting any form of retail wheeling, such legislation could have an adverse impact on CPL and CPL's sales to its retail customers.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, the Electric Operating Companies have recognized significant regulatory assets and liabilities. Management believes that the Electric Operating Companies will continue to meet the criteria for following SFAS No. 71. However, in the event the Electric Operating Companies no longer meet the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE\n2-18 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nHolding Company Act The Holding Company Act generally has been construed to limit the operations of a registered holding company to a single integrated public utility system, plus such additional businesses as are functionally related to such system. Among other things, the Holding Company Act requires CSW and its subsidiaries to seek prior SEC approval before effecting mergers and acquisitions or pursuing other types of non-utility initiatives. Pervasive regulation under the Holding Company Act may impede or delay CSW's efforts to achieve its strategic and operating objectives, including its pursuit of non- utility initiatives. CSW is continuing its efforts to repeal or modify the Holding Company Act in order to provide the flexibility to compete within the changing environment.\nConsolidated Taxes The Texas Commission before 1992 allowed income taxes to be recovered in rates based on the federal income tax incurred by a utility as if it were a stand-alone company. This stand-alone approach treated the regulated activities of a utility as a separate entity and considered only those revenues and expenses that are included in the utility's cost of service to calculate the federal income tax liability for ratemaking purposes.\nBeginning in 1992, the Texas Commission changed its method of calculating the federal income tax component of rates to the \"actual tax approach.\" The actual tax approach is an evolving concept but generally seeks to reflect in rates the actual tax liability of the utility irrespective of its relationship to the utility's cost of service. The approach reduces rates by the tax benefits of deductions which are not considered for or included in setting rates for the utility.\nThe Texas Commission is expected to use the actual tax approach for calculating the recovery of federal income tax in the pending rate cases for CPL and WTU. The impact of the actual tax approach on the prospective rates for CPL and WTU cannot be determined since the application of the concept is unsettled.\nCSW believes that the recovery of federal income taxes in rates should be determined on the stand-alone approach for ratemaking purposes, but there is no assurance this approach will be adopted in the pending CPL or WTU rate cases or the pending El Paso rate and Merger cases.\nEnvironmental Matters CERCLA and Related Matters The operations of the CSW System, like those of other utility systems, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nThe Electric Operating Companies are subject to various pending claims alleging that they are PRPs under federal or state remedial laws for investigating and cleaning up contaminated property. CSW anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on CSW's consolidated results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by the Electric Operating Company, the estimated amount of costs allocated to the Electric Operating Company and the participation of other parties.\n2-19 MGPs Contaminated former MGPs are a type of site which utilities, and others, may have to remediate in the future under Superfund or other federal or state remedial programs. Gas was manufactured at MGPs from the mid-1800s to the mid-1900s. In some cases, utilities and others have faced potential liability for MGPs because they, or their alleged predecessors, owned or operated the plants. In other cases, utilities or others may have been subjected to such liability for MGPs because they acquired MGP sites after gas production ceased.\nSuspected MGP Site in Marshall, Texas SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO has accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\nSuspected MGP Site in Texarkana, Texas and Arkansas and Shreveport, Louisiana SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\nBiloxi, Mississippi MGP Site SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nManagement does not expect these matters to have a material effect on CSW's consolidated results of operations or financial condition.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, the Electric Operating Companies will be required to hold allowances in order to emit sulfur dioxide. EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, CSW believes that the Electric Operating Companies' allowances will be adequate to meet their needs at least through 2008. Public and private markets are developing for trading of excess allowances. CSW presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states. CSW estimates that it and the Electric Operating Companies will incur approximately $500,000 to prepare permit applications for the program.\n2-20 The Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on CSW cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, CSW expects to spend an additional $4 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects or damage to the environment. Although a few of the studies to date have suggested certain associations between EMFs and some types of adverse health effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. CSW cannot predict the impact on the CSW System or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nSee NOTE 10, Litigation and Regulatory Proceedings, for additional discussion of environmental issues.\nNon-Utility Initiatives As indicated above, one component of CSW's four-part strategy to meet the increasing competition and fundamental changes in the electric utility industry is to expand CSW's non-utility business. CSW continues to consider new business opportunities to expand its energy related business. CSW's principal non-utility businesses are Transok and CSWE. As discussed below, CSW recently formed CSWI to seek opportunities internationally for investment in non-utility generation. CSW Communications was formed to provide a communications network for the CSW System as well as third parties. While CSW believes that non-utility initiatives are necessary to maintain its competitiveness and to grow in the future, there can be no assurance as to the level of success that will be attained in these initiatives.\nTransok Transok is an intrastate natural gas gathering, transmission, marketing and processing company that provides natural gas services to CSW System companies, predominately PSO, and to non-affiliated gas customers throughout the United States. Transok's natural gas facilities are located in Oklahoma, Louisiana and Texas. It operates gas processing plants and markets natural gas liquids produced from those plants to various markets.\nCSWE CSWE, a wholly-owned subsidiary of CSW, is authorized to develop various independent power and cogeneration facilities and to own and operate such non-utility projects, subject to further regulatory approvals. CSWE has an approximate 50% interest in the Brush, Ft. Lupton and Mulberry facilities which achieved commercial operation in 1994.\nBrush The 68 MW Brush project, located in Brush, Colorado, achieved commercial operation in January 1994, and provides steam and hot water to a 15-acre greenhouse and sells electricity to Public Service Company of Colorado.\nFt. Lupton The Ft. Lupton project, located in Colorado, provides steam and hot water to a 20-acre greenhouse and also sells electricity to Public Service Company of Colorado. Phase I of the Ft. Lupton project, representing 122 MWs, achieved commercial operation in June 1994. Phase II of the project commenced operations in July 1994 bringing total on-line capacity of the project to 272 MWs.\n2-21 Mulberry The Mulberry facility, a 117 MW gas-fired cogeneration plant in Polk County, Florida achieved commercial operation in August 1994 and provides steam to a combined distilled water and ethanol facility and sells electricity to Florida Power Corporation and Tampa Electric Company.\nOrange Cogen The Orange Cogen facility, in which CSWE holds a 50% interest, is expected to commence operation in June 1995. The 103 MW, gas-fired plant in Florida will provide thermal energy to an orange juice processor and will sell electricity to Florida Power Corporation and Tampa Electric Company. CSWE's O&M division plans to operate the plant.\nOther Projects In addition to these projects, CSWE has 19 other projects totaling more than 5,000 MW in various stages of development, mostly in affiliation with other developers. CSWE can provide no assurances that these projects, which are subject to further negotiations and regulatory approvals, will be commenced or completed and, if they are completed, that they will provide the anticipated return on investment.\nCSWI In November 1994, CSWI, a wholly-owned subsidiary of CSW, was formed to engage in international activities including developing, acquiring, financing and owning the securities of exempt wholesale generators and foreign utility companies.\nIn 1994, CSWI continued with the Mexico initiative that began in 1992. CSWI's goal is to participate in providing Mexico's future electricity needs. The geographical location of the CSW System offers opportunities to provide bulk power sales to Mexico. The Mexico City office of CSW, opened in 1993, allows CSWI greater access to key Mexican markets, permitting CSWI to more readily evaluate opportunities as they become available. However, the recent devaluation of the Mexican peso will slow previously projected power demand for the near-term.\nCSW Communications In July 1994, CSW Communications, a wholly-owned subsidiary, of CSW, was formed to provide communication services to the CSW System and non-affiliates. One important goal of CSW Communications is to enhance services to CSW System customers through fiber optics and other telecommunications technologies. CSW Communications will consolidate the future design, construction, maintenance and ownership of the CSW System's telecommunications networks. In 1994, CSW announced a $9 million project in Laredo, Texas, to install fiber optic lines and coaxial cable to CPL residential customers who have volunteered to take part in this pilot program. This project involving CSW Communications and CPL will demonstrate the energy efficiency and cost savings that result from giving customers greater choice and control over their electric service. These energy- efficiency services will use only a portion of the capacity of the telecommunications lines CSW Communications is installing. In the future, CSW Communications may, subject to any required regulatory approvals, seek to lease the remaining capacity for other services including possibly telephone service, cable television and home security systems.\nResults of Operations\nOverview Of Results CSW's earnings increased to $394 million or $2.08 per share in 1994 as compared to $308 million or $1.63 per share in 1993 and $382 million or $2.03 per share in 1992. The return on average common stock equity was 13.4% in 1994 compared to 10.6% in 1993 and 13.5% in 1992. Electric operations contributed approximately 100% of total earnings in 1994 and 1993, and 95% in 1992. In 1994, earnings at Transok, CSWE, and CSW Credit totaling $34 million, were offset by corporate expenditures including merger and acquisition activities and the formation of two new subsidiaries.\n2-22 Earnings increased in 1994 compared to 1993 due primarily to higher KWH sales and natural gas operations and decreased costs associated with the end of the outage at STP. In addition, CSWE, which had three projects become operational during 1994, contributed $2 million to earnings. These items were partially offset by increased interest and depreciation and amortization expense. Earnings in 1993 were significantly affected by several items described below:\n(millions,after-tax) Restructuring charges $(63) Recognition of unbilled revenues 49 Early adoption of SFAS No. 112 (9) Adoption of SFAS No. 109 6 Establishment of reserves for fuel and other properties (11) Prior year tax adjustments (18)\nIn addition to the aforementioned items, earnings in 1993 were below 1992 levels due to additional costs primarily associated with the outage at STP, higher benefit costs as a result of the adoption of SFAS No. 106, higher taxes other than income as a result of school funding tax increases in Texas, and the increase in the federal income tax rate from 34% to 35%. These items were partially offset by higher KWH sales in 1993 due primarily to more normal weather than was experienced in 1992.\nOperating Revenues Revenues decreased 2% in 1994, after increasing 12% in 1993 and 8% in 1992 from the previous years due to the following items:\nRevenue Increase (Decrease) From Prior Year 1994 1993 1992 (millions) Base rate changes $ 7 $ 8 $ -- Fuel costs (49) 168 -- KWH sales 61 93 (25) Natural gas (85) 107 255 Other electric and 2 22 12 diversified $(64) $398 $242\nElectric Revenues Electric revenues increased $10 million in 1994 compared to 1993. Total KWH sales increased approximately 6%, with increases in sales among all customer classes. During 1994, the average number of customers increased approximately 2%. In addition to customer growth, there was slightly more favorable weather during 1994 as compared to 1993. However, offsetting much of the increases in revenue due to KWH sales, fuel revenues were down substantially during 1994 compared to 1993. Fuel costs incurred in the generation of electricity are typically passed through to the customers, so decreases in fuel costs will cause a corresponding decrease in fuel revenues. Fuel costs, which decreased during 1994, are more fully discussed below under Fuel and Purchased Power. Fuel revenues increased in 1993 compared to 1992 due to higher per unit costs of fuel and purchased power.\n2-23 Base rates increased slightly at PSO because of changes in retail customers' rates, and decreased due to a 3.2% interim rate reduction at WTU implemented during the fourth quarter of 1994. Because PSO's increased base rates, finalized in December 1993, were not significantly higher than the interim rates that had been in effect throughout the year, base rates had little overall change from 1993. As part of a stipulated agreement reflecting its rate increase, PSO agreed that it will not file for an increase in base rates until after June 30, 1995. During late 1993 and early 1994, several parties initiated actions, which, if approved, would lower CPL's base rates. The review of CPL's rates arose out of the unscheduled outage at STP as discussed above under the heading Rates and Regulatory Matters, CPL Rate Inquiry.\nFor additional information on these proceedings and others, see NOTE 10, Litigation and Regulatory Proceedings.\nThe percentage changes in KWH sales for the three years were as follows:\nKWH Sales Increase (Decrease) From Prior Year 1994 1993 1992 Residential 2.9% 9.0% (4.2)% Commercial 3.8 4.8 (1.1) Industrial 3.6 5.5 3.1 Sales for resale 21.9 (6.6) 5.4 Total sales 5.5 4.9 0.1\nKWH sales to retail customers increased in 1994 and 1993 as a result of more favorable weather and increased residential customers. In addition, KWH sales grew in all of the other customer classes. SWEPCO acquired BREMCO in July 1993, and accordingly, there were twelve months of KWH sales to these customers in 1994 compared to only six months in 1993. Weather was more favorable in 1994 than in 1993, while extremely mild weather was experienced in 1992. The continued increases in industrial sales over the last three years reflect the increased marketing efforts by the Electric Operating Companies and the continued improvement in the economy throughout their service areas. Sales for resale increased in 1994 because STP was operational for most of the year, whereas in 1993, plants in the CSW System were producing power to replace the power normally produced at STP.\nThe Electric Operating Companies have maintained competitive rates in an increasingly competitive marketplace. Efforts have increased at each of the Electric Operating Companies to attract new customers while efficiently serving all customers. Economic conditions in the service areas of the Electric Operating Companies are expected to continue to improve in 1995.\nNatural Gas Revenues Revenues from natural gas decreased 14% in 1994 due primarily to a decrease in the price of gas, even though total natural gas volumes increased 4% from 1994 to 1993. However, lower gas sales prices were mitigated by lower gas purchase prices, which are described below under Gas Purchased for Resale. The lower gas sales revenues were partially offset by both increased gathering and transportation revenues and increased natural gas liquids processing revenues. Gathering and transportation sales volumes increased 12% primarily as a result of a pipeline extension completed during 1994, and gas liquids processing volumes increased 12% during 1994. Revenues from natural gas increased 22% in 1993 from 1992 due primarily to an increase in sales volumes and to a lesser extent an increase in sales prices. A portion of this increase is attributable to the acquisition of the NGC Anadarko Gathering System in 1993. Revenue increases in 1993 from natural gas liquids are due to increased sales volumes combined with slightly higher prices.\n2-24 Other Diversified Revenues Other diversified revenues increased 38% from 1994 as compared to 1993 due to the reclassification of CSWE's operating revenues more fully discussed below under Other Income and Deductions. Other diversified revenues increased substantially in 1993 as compared to 1992 because CSW Credit began factoring the receivables of a significant non-affiliated utility in January 1993.\nFuel and Purchased Power Expense During 1994, the Electric Operating Companies generated approximately 95% of their electric energy requirements. During 1993 and 1992, they generated 92% and 94%, respectively. Total fuel and purchased power expenses decreased 4% during 1994 due to a decrease in fossil fuel costs and increased usage of lower cost nuclear fuel. The average unit cost of fuel was $1.82 during 1994, compared to $2.11 and $1.92 for 1993 and 1992, respectively. Several contracts with major fuel suppliers and carriers have been recently renegotiated. These settlements have contributed to the lower cost of fuel. In addition, because STP restarted and Units 1 and 2 reached 100% capacity in April and June of 1994, respectively, lower cost nuclear fuel was utilized, whereas the 1993 outage required higher cost energy purchases to replace STP's nuclear power. The increase in fuel and purchased power expense in 1993 compared to 1992 is attributable to higher natural gas costs as well as the cost of STP replacement power.\nGas Purchased for Resale\/Gas Extraction and Marketing Gas purchased for resale decreased 30% in 1994 from 1993, while it increased 29% in 1993 from 1992. Lower gas prices caused the decrease in 1994, including a significant portion attributable to sales made on natural gas drawn from storage. Increased natural gas prices and increased pipeline capacity from Transok's recent acquisitions caused the 1993 increase. Gas extraction and marketing expenses increased 14% in 1994 from 1993 and 19% in 1993 from 1992 due to higher input costs associated with higher natural gas liquids processing volumes.\nOther Operating and Maintenance Expenses and Taxes Other operating and maintenance expenses decreased 8% in 1994 compared to 1993, due primarily to the absence of expenses that were incurred during the 1993 STP outages. In 1993, in addition to $29 million in maintenance costs associated with the STP outage, operating expenses increased compared to 1992 due to expenses associated with the adoption of SFAS 106, reserves taken on lignite and other property, corporate expenditures, and other administrative and general expenses. Federal income taxes were higher in 1994 than 1993 due to higher pre-tax income. Federal income taxes were lower in 1993 than 1992 due to lower pre-tax income offset in part by tax adjustments and the increase in the corporate tax rate from 34% to 35%, which was effective retroactive to January 1, 1993. Taxes other than federal income remained comparable in 1994 from 1993, while they increased in 1993 compared to 1992 due to school funding tax increases in Texas.\nRestructuring Charges In 1994, the original restructuring accrual of $97 million that had been recorded in 1993 was reduced by $9 million. Accordingly, the final costs associated with the CSW System's restructuring totaled $88 million over the two year period. For additional information on CSW's restructuring, see Restructuring, above.\nDepreciation and Amortization Depreciation and amortization expense increased in 1994 compared to 1993 and also 1993 compared to 1992 as a result of increases in depreciable plant.\nInflation Annual inflation rates, as measured by the national Consumer Price Index, have averaged about 2.7% during the three years ended December 31, 1994. Management believes that inflation, at these levels, does not materially affect CSW's consolidated results of operations or financial position. However, under existing regulatory practice, only the historical cost of plant is recoverable from\n2-25 customers. As a result, cash flows designed to provide recovery of historical plant costs may not be adequate to replace plant in future years.\nOther Income and Deductions Other income and deductions increased $18 million or 19% in 1994 compared to 1993, as a result of the reclassification of CSWE's operating activities offset partially by decreased Mirror CWIP liability amortization and the absence of adjustments recorded in 1993 associated with Transok's 1991 acquisition of TEX\/CON. Prior to 1994, CSWE was in the developmental stage of its business, so its operating activities were classified in CSW's Other Income and Deductions. However, in conjunction with the completion of three projects in 1994, CSWE's revenues and expenses were classified as operating activities in CSW's Other Diversified Revenues and Other Operating Expenses. Both of these components had negative earnings impacts classified in Other Income and Deductions in 1993. Other Income and Deductions increased $11 million or 13% in 1993 from 1992 due in part to Transok's aforementioned TEX\/CON acquisition adjustments and slightly higher Allowance for Equity Funds Used During Construction partially offset by decreased Mirror CWIP liability amortization.\nInterest Expense Interest expense on long-term debt in 1994 was comparable to 1993, whereas 1993 interest expense was substantially lower than 1992 due to long-term debt refinancings, which lowered CSW's embedded cost of long-term debt from 8.3% in 1992 to 7.8% in 1993. CSW's embedded cost of long-term debt decreased slightly to 7.7% in 1994. Short-term interest expense increased in 1994 due primarily to higher short-term interest rates combined with higher general corporate borrowings, and in 1993 because of increased borrowings attributable to the expansion of CSW Credit's business, interim financing of CSWE's projects, and various corporate initiatives.\nCumulative Effect of Changes in Accounting Principles In 1993, CSW implemented SFAS No. 112, SFAS No. 109, and changed the method of accounting for unbilled revenues. These changes had a cumulative effect of increasing net income approximately $46 million.\n2-26 Consolidated Statements of Income Central and South West Corporation For the Years Ended December 31, 1994 1993 1992 Operating Revenues (millions, except per share amounts) Electric Residential $1,156 $1,160 $1,046 Commercial 836 832 773 Industrial 733 736 659 Sales for resale 204 179 177 Other 136 148 135 Total Electric 3,065 3,055 2,790 Gas 518 603 496 Other diversified 40 29 3 3,623 3,687 3,289 Operating Expenses and Taxes Fuel and purchased power 1,161 1,209 1,035 Gas purchased for resale 276 396 306 Gas extraction and marketing 98 86 72 Other operating 596 593 490 Restructuring charges (9) 97 -- Maintenance 176 197 170 Depreciation and amortization 356 330 311 Taxes, other than federal income 196 197 175 Federal income taxes 179 125 142 3,029 3,230 2,701 Operating Income 594 457 588\nOther Income and Deductions Mirror CWIP liability amortization 68 76 83 Other 43 17 (1) 111 93 82 Income Before Interest Charges 705 550 670\nInterest Charges Interest on long-term debt 218 219 230 Interest on short-term debt and other 75 50 36 293 269 266 Income Before Cumulative Effect of Changes in Accounting Principles 412 281 404\nCumulative Effect of Changes in -- 46 -- Accounting Principles\nNet Income 412 327 404 Preferred stock dividends 18 19 22 Net Income for Common Stock $394 $308 $382\nAverage Common Shares Outstanding 189.3 188.4 188.3 Earnings per Share of Common Stock before Cumulative Effect of Changes in Accounting Principles $ 2.08 $ 1.39 $ 2.03 Cumulative Effect of Changes in Accounting Principles -- .24 -- Earnings per Share of Common Stock $ 2.08 $ 1.63 $ 2.03 Dividends Paid per Share of Common Stock $ 1.70 $ 1.62 $ 1.54\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\nConsolidated Statements of Retained Earnings Central and South West Corporation For the Years Ended December 31, 1994 1993 1992 (millions)\nRetained Earnings at Beginning of Year $1,753 $1,751 $1,659 Net income for common stock 394 308 382 Deduct: Common stock dividends 323 306 290 Retained Earnings at End of Year $1,824 $1,753 $1,751\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-28 Consolidated Balance Sheets Central and South West Corporation As of December 31, 1994 1993 (millions) ASSETS Plant Electric utility Production $ 5,802 $ 5,775 Transmission 1,377 1,228 Distribution 2,539 2,362 General 764 709 Construction work in progress 412 361 Nuclear fuel 161 160 Total Electric 11,055 10,595 Gas 798 738 Other diversified 15 10 11,868 11,343 Less - Accumulated depreciation 3,870 3,550 7,998 7,793 Current Assets Cash and temporary cash investments 27 62 Special deposits -- 2 Accounts receivable 761 801 Materials and supplies, at average cost 162 149 Electric utility fuel inventory, substantially at average cost 118 102 Gas inventory\/products for resale 23 24 Unrecovered fuel costs 54 70 Prepayments and other 44 44 1,189 1,254 Deferred Charges and Other Assets Deferred plant costs 516 518 Mirror CWIP asset 322 332 Other non-utility investments 394 266 Income tax related regulatory assets, net 216 182 Other 274 259 1,722 1,557 $10,909 $10,604\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-29 Consolidated Balance Sheets Central and South West Corporation As of December 31, 1994 1993 (millions) CAPITALIZATION AND LIABILITIES Capitalization Common stock: $3.50 par value Authorized: 350 million shares Issued and outstanding: 190.6 million shares in 1994 and 188.4 million shares in 1993 $ 667 $ 659 Paid-in capital 561 518 Retained earnings 1,824 1,753 Total Common Stock Equity 3,052 2,930 Preferred stock Not subject to mandatory redemption 292 292 Subject to mandatory redemption 35 58 Long-term debt 2,940 2,749 Total Capitalization 6,319 6,029 Current Liabilities Long-term debt and preferred stock due within twelve months 7 26 Short-term debt 910 769 Short-term debt - CSW Credit 573 641 Accounts payable 286 313 Accrued taxes 111 90 Accrued interest 61 55 Accrued restructuring charges 4 97 Other 155 152 2,107 2,143 Deferred Credits Income taxes 2,048 1,935 Investment tax credits 320 335 Mirror CWIP liability and other 115 162 2,483 2,432 $10,909 $10,604\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-30 Consolidated Statements of Cash Flows Central and South West Corporation For the Years Ended December 31, 1994 1993 1992 (millions) OPERATING ACTIVITIES Net Income $ 412 $ 327 $ 404 Non-cash Items Included in Net Income Depreciation and amortization 402 366 351 Deferred income taxes and investment tax credits 87 94 71 Mirror CWIP liability amortization (68) (76) (83) Restructuring charges (9) 97 -- Cumulative effect of changes in accounting principles -- (46) -- Changes in Assets and Liabilities Accounts receivable 29 (52) (52) Unrecovered fuel costs 16 (63) (4) Accounts payable (27) 34 53 Accrued taxes 21 37 (41) Accrued restructuring charges (57) -- -- Other (42) (24) (13) 764 694 686 INVESTING ACTIVITIES Capital expenditures (578) (508) (422) Acquisitions (21) (106) (27) Non-affiliated accounts receivable collections (purchases), net 11 (314) 11 CSW Energy projects (includes $73, $19 and $8 of equity investments for 1994, 1993 and 1992, respectively) (115) (127) (37) Other (14) (14) (8) (717) (1,069) (483) FINANCING ACTIVITIES Common stock sold 50 1 2 Proceeds from issuance of long-term debt 199 904 1,009 Retirement of long-term debt (4) (50) (4) Reacquisition of long-term debt (27) (987) (652) Special deposits for reacquisition of long-term debt -- 199 (199) Redemption of preferred stock (33) (17) (13) Change in short-term debt 73 602 17 Payment of dividends (340) (325) (312) (82) 327 (152)\nNet Change in Cash and Cash Equivalents (35) (48) 51 Cash and Cash Equivalents at Beginning of Year 62 110 59 Cash and Cash Equivalents at End of Year $ 27 $ 62 $ 110\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 280 $ 260 $ 268 Income taxes paid $ 93 $ 53 $ 108\nThe accompanying notes to consolidated financial statements integral part of these statements.\n2-31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation CSW is subject to regulation by the SEC as a registered holding company under the Holding Company Act. CSW's Operating Companies are also regulated by the SEC under the Holding Company Act. CSW's four Electric Operating Companies, Central Power and Light Company, Public Service Company of Oklahoma, Southwestern Electric Power Company, and West Texas Utilities Company, are subject to regulation by the FERC under the Federal Power Act and follow the Uniform System of Accounts prescribed by the FERC. The Operating Companies are subject to further regulation with regard to rates and other matters by state regulatory commissions.\nCSW Credit CSW Credit, as a wholly-owned subsidiary of CSW, purchases, without recourse, the billed and unbilled accounts receivable of the Operating Companies and certain non-affiliated companies.\nThe more significant accounting policies of CSW and its subsidiaries are summarized below:\nPrinciples of Consolidation The consolidated financial statements include the accounts of CSW and its subsidiary companies. All significant intercompany items and transactions have been eliminated.\nPlant 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. Transok's gas plant acquisitions are stated at fair market value based on the purchase price while other gas plant is stated at original cost of construction, which includes the cost of contracted services, direct labor, materials, overhead items and capitalized interest.\nDepreciation Provisions for depreciation of plant are computed using the straight-line method, generally at individual rates applied to the various classes of depreciable property. The annual average consolidated composite rate was 3.2% for 1994, 1993 and 1992.\nNuclear Decommissioning At the end of STP's service life, decommissioning is expected to be accomplished using the decontamination method, which is one of the techniques acceptable to the NRC. Using this method, the decontamination activities occur as soon as possible after the end of plant operations. Contaminated equipment is cleaned or removed to a permanent disposal location and the site is generally returned to its pre-plant state.\nCPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning, and is net of expected earnings on the trust fund.\nCPL's portion of the costs of decommissioning STP were estimated to be $85 million in 1986 dollars based on a site specific study completed in 1986. CPL is recovering these decommissioning costs through rates based on the service life of STP at a rate of $4.2 million per year. The $4.2 million annual cost of decommissioning is reflected on the income statement in other operating expense. Decommissioning costs are paid to an irrevocable external trust\n2-32 and as such are not reflected on CPL's balance sheet. At December 31, 1994, the trust balance was $19.3 million.\nIn May 1994, CPL received a new decommissioning study updating the cost estimates to decommission STP that indicated that CPL's share of such costs would increase from $85 million, as stated in 1986 dollars, to $251 million, as stated in 1994 dollars. The increase in costs occurred primarily as a result of extended on-site storage of high level waste, much higher estimates of low-level waste disposal costs and increased labor costs since the prior study. These costs are expected to be incurred during the years 2027 through 2062. While this is the best estimate available at this time, these costs may change between now and when the funds are actually expended because of changes in the assumptions used to derive the estimates, including the prices of the goods and services required to accomplish the decommissioning. Additional studies will be completed periodically to update this information.\nBased on this projected cost to decommission STP, CPL estimates that its annual funding level should increase to $10.0 million. CPL has requested this amount as part of its cost of service in its current rate filing. Other parties to the rate proceeding have filed their projections of the annual amount, which have ranged from $4.5 million to $8.1 million. CPL expects to fund at the level ultimately ordered by the Texas Commission although CPL cannot predict what that level will be. Historically, the Texas Commission has allowed full recovery of nuclear decommissioning costs. For further information on CPL's current rate filing, see NOTE 10, Litigation and Regulatory Proceedings - Texas Commission Proceedings, below.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, the Electric Operating Companies changed their method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 net income was pre-tax increase of $75 million, and an after-tax increase of $49 million, included in cumulative effect of changes in accounting principles.\nCPL, SWEPCO and WTU recover fuel costs in Texas as a fixed component of base rates whereby over-recoveries of fuel are payable to customers and under-recoveries may be billed to customers after Texas Commission approval. The cost of fuel is charged to expense as consumed. See NOTE 10, Litigation and Regulatory Proceedings, for further information about fuel recovery.\nPSO recovers fuel costs in Oklahoma and SWEPCO recovers fuel costs in Arkansas and Louisiana through automatic fuel recovery mechanisms. The application of these mechanisms varies by jurisdiction.\nEach of the Electric Operating Companies recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause.\nCPL amortizes the costs of nuclear fuel 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.\nAccounts Receivable Each of the Operating Companies sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities For their regulated activities, each of the Electric Operating Companies follows SFAS No. 71 which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to the company associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities\n2-33 represent probable future refunds to customers. At December 31, 1994 and 1993, the CSW System had recorded the following significant regulatory assets and liabilities:\n1994 1993 (millions) Regulatory Assets Deferred plant costs $516 $518 Mirror CWIP asset 322 332 Income tax related regulatory assets, net 216 182 Unrecovered fuel costs 54 70 Other 33 34\nRegulatory Liabilities Mirror CWIP liability 41 109\nDeferred Plant Costs In accordance with orders of the Texas Commission, WTU and CPL deferred operating, depreciation and tax costs incurred for Oklaunion Power Station Unit 1 and STP, respectively. These deferrals were for the period beginning on the date when the plants began commercial operation until the date the plants were included in rate base. The deferred costs are being amortized and recovered through rates over the lives of the respective plants. See NOTE 10, Litigation and Regulatory Proceedings, for further discussion of WTU's and CPL's deferred accounting proceedings.\nMirror CWIP In accordance with Texas Commission orders, CPL previously recorded a Mirror CWIP asset, which is being amortized over the life of STP. For more information regarding Mirror CWIP, reference is made to NOTE 10, Litigation and Regulatory Proceedings. Statements 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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, the CSW System adopted SFAS No. 106, SFAS No. 112 and SFAS No. 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, the Electric Operating Companies also changed their method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in 1993 operating expenses of $16 million. The adoption of SFAS No. 109, SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\n2-34 Pre-Tax Tax Net Income EPS CSW Effect Effect Effect Effect (millions, except EPS) SFAS No. 109 $ -- $ 6 $ 6 $0.03 SFAS No. 112 (13) 4 (9) (0.05) Unbilled revenues 75 (26) 49 0.26 Total $62 $(16) $46 $0.24\nPro 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 The CSW System adopted the provisions of SFAS No. 109 effective January 1, 1993. The net effect on CSW's earnings was a one-time adjustment to increase net income by $6 million or $0.03 per share. This adjustment was recorded as a cumulative effect of change in accounting principle. The benefit was attributable to the reduction in deferred taxes associated with CSW's non-utility operations previously recorded at rates higher than current rates.\nFor utility operations, there were no material effects of SFAS No. 109 on CSW's earnings. As a result of this change, CSW recognized additional accumulated deferred income taxes from its utility operations and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, the CSW System did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\nCSW files a consolidated federal income tax return and participates in a tax sharing agreement with its subsidiaries. The components of income taxes follow:\n1994 1993 1992 Included in Operating Expenses and Taxes (millions) Current $ 88 $ 28 $ 64 Deferred 105 112 95 Deferred ITC (14) (15) (17) 179 125 142 Included in Other Income and Deductions Current (14) (3) (7) Deferred (4) (5) 7 (18) (8) --\nTax effects of cumulative effect of changes in Accounting Principles -- 14 -- -- 14 -- $161 $131 $142\n2-35 Investment tax credits deferred in prior years are included in income over the lives of the related properties. Total income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow:\n1994 % 1993 % 1992 % (dollars in millions) Tax at statutory rates $201 35 $160 35 $186 34 Differences Amortization of ITC (14) (2) (15) (3) (15) (3) Mirror CWIP (20) (4) (23) (5) (25) (4) Prior period adjustments -- -- 18 4 (10) (2) Cumulative effect of change in method of accounting for income taxes Other -- -- (8) (2) -- -- (6) (1) (1) -- 6 1 $161 28 $131 29 $142 26\nThe significant components of the net deferred income tax liability follow: December 31, December 31, 1994 1993 (millions) Deferred Income Tax Liabilities Depreciable utility plant $ 1,683 $ 1,589 Deferred plant costs 181 181 Mirror CWIP asset 113 116 Income tax related regulatory assets 229 239 Other 262 234 Total Deferred Income Tax Liabilities 2,468 2,359\nDeferred Income Tax Assets Income tax related regulatory liability (155) (177) Unamortized ITC (115) (120) Alternative minimum tax carryforward (96) (68) Other (56) (65) Total Deferred Income Tax Assets (422) (430) Net Accumulated Deferred Income Taxes - Total $ 2,046 $ 1,929\nNet Accumulated Deferred Income Taxes - Noncurrent $ 2,048 $ 1,935 Net Accumulated Deferred Income Taxes - Current (2) (6) Net Accumulated Deferred Income Taxes - Total $ 2,046 $ 1,929\n2-36 3.Long-Term Debt The long-term debt of the Operating Companies outstanding as of the end of the last two years follow: Maturities Interest Rates December 31, From To From To 1994 1993 (millions) First mortgage bonds 1995 1999 5.25% 7.50% $443 $343 2000 2004 5.25% 7.75% 836 796 2005 2009 6.20% 7.75% 247 248 2010 2014 7.50% 7.50% 112 112 2015 2019 9.125% 9.75% 226 240 2020 2024 7.25% 7.50% 295 295 2025 2029 6.875% 6.875% 80 80\nPollution control bonds 2000 2004 6.90% 7.125% 21 21 2005 2009 5.90% 6.00% 83 83 2010 2014 7.875% 10.125% 231 231 2015 2019 7.60% 7.875% 114 114 2025 2029 6.00% 6.00% 120 120\nNotes and lease obligations 1996 2023 6.25% 9.75% 328 273 Unamortized discount (21) (22) Unamortized cost of reacquired debt (175) (185) $2,940 $2,749\nThe mortgage indentures, as amended and supplemented, securing first mortgage bonds issued by the Electric Operating Companies, constitute a direct first mortgage lien on substantially all electric utility plant.\nThe Operating Companies may offer additional first mortgage bonds and medium-term notes subject to market conditions and other factors.\nAnnual Requirements Certain series of outstanding first mortgage bonds have annual sinking fund requirements, which are generally 1% of the amount of each such series issued. These requirements may be, and generally have been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. Certain series of pollution control bonds also have sinking fund requirements. At December 31, 1994, the annual sinking fund requirements and annual maturities for first mortgage bonds and pollution control bonds for the next five years follow:\nSinking Fund Requirements Maturities (millions) 1995 $ 4 $ 9 1996 4 33 1997 4 207 1998 4 34 1999 4 98\n2-37 Dividends The subsidiary companies' mortgage indentures, as amended and supplemented, contain certain restrictions on the use of their retained earnings for cash dividends on their common stock. These restrictions do not limit the ability of CSW to pay dividends to its stockholders. At December 31, 1994, $1,375 million of the subsidiary companies' retained earnings were available for payment of cash dividends to CSW.\nReacquired Long-term Debt During 1994, 1993 and 1992, the Electric Operating Companies reacquired $27 million, $987 million and $652 million of long-term debt, respectively, including reacquisition premiums, prior to maturity. The premiums and related reacquisition costs and discounts are included in long-term debt on the consolidated balance sheets and are being amortized over 5 to 35 years, consistent with its expected ratemaking treatment.\nThe weighted average cost of long-term debt was 7.7% for 1994, 7.8% for 1993 and 8.3% for 1992.\nReference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, Liquidity and Capital Resources, for further information related to long-term debt, including new issues and reacquisition.\n4.Preferred Stock The outstanding preferred stock of the Electric Operating Companies as of the end of the last two years follow:\nCurrent 1994 Dividend Rate December 31, Redemption Prices Shares Outstanding From To 1994 1993 From To (millions) Not subject to mandatory redemption\n592,900 4.00% 5.00% 59 59 102.75 107.00 760,000 7.12% 8.72% 76 76 100.00 101.00 1,600,000 auction 160 160 100.00 100.00\nIssuance expenses and unamortized redemption costs (3) (3) $292 $292\nSubject to mandatory redemption 352,000 6.95% 6.95% $ 35 $ 37 104.64 104.64 -- 10.05% 10.05% -- 22 -- --\nIssuance expenses and unamortized redemption costs -- (1) $ 35 $ 58\nThe outstanding preferred stock not subject to mandatory redemption is redeemable at the option of the Electric Operating Companies upon 30 days notice at the current redemption price per share. CPL's auction preferred stock totaling $160 million also may be redeemed at par on any dividend payment date. The CSW System's authorized number of shares of preferred stock totaled 6.4 million at December 31, 1994 and 1993.\nRedemption prices of certain preferred stock decline at specified intervals in future periods. The preferred stock issues subject to mandatory redemption are refundable at various times during the period 1995 through 1999. The minimum annual sinking fund requirements of the preferred stock are $1.2 million for the years 1995 through 1999. During 1994 and 1993, the Electric Operating Companies redeemed $33 million and $17 million, respectively, of preferred stock, including redemption premiums.\n2-38 CPL The dividends on CPL's $160 million auction and money market preferred stocks are adjusted every 49 days, based on current market rates. The dividend rates averaged 3.5%, 2.7%, and 3.6% during 1994, 1993 and 1992.\nCPL retired its remaining 10.05% preferred stock during August 1994.\nWTU In July 1993, WTU redeemed 100,000 shares of its 7.25% Series, $100 par value, Preferred Stock, for $10 million, in accordance with mandatory and optional sinking fund provisions. The capital required for this transaction was provided by short-term borrowings from the CSW System money pool and internal sources.\nIn July 1994, WTU redeemed the remaining 47,000 shares of its 7.25% Series, $100 par value, Preferred Stock.\n5.Common Stock On March 6, 1992, CSW effected a two-for-one split of CSW's common stock by means of a 100% stock dividend paid to stockholders of record on February 10, 1992. All references to number of shares outstanding, to per share information in the Consolidated Financial Statements, and to the notes thereto have been adjusted to reflect the stock split on a retroactive basis.\nCSW has a restricted stock plan and a stock option plan. Under the stock option plan, 3,833,000 shares of common stock are available for grant and 491,000 shares are reserved for exercise of options which were outstanding at December 31, 1994.\nThe PowerShare dividend reinvestment plan is available to all CSW stockholders, employees, eligible retirees, utility customers and other residents of the four states where the Electric Operating Companies operate. Plan participants are able to make optional cash payments and reinvest all or any portion of their dividends in CSW common shares. During 1994, CSW raised approximately $50 million in common stock equity through PowerShare.\n6.Financial Instruments 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 fair value.\nCash and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nShort-term investments The carrying amount approximates fair value because of the short maturity of those instruments. Short-term investments are classified in accounts receivable on the consolidated balance sheets.\nLong-term debt The fair value of the CSW System'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 CSW for debt of the same remaining maturities.\nPreferred stock subject to mandatory redemption The fair value of the Electric Operating Companies' preferred stock subject to mandatory redemption is estimated based on quoted market prices for the same or similar issues or on the current rates offered to CSW for preferred stock with the same or similar remaining redemption provision.\n2-39 Long-term debt and preferred stock due within 12 months The fair value of current maturities of long-term debt and preferred stock due within 12 months are estimated based on quoted market prices for the same or similar issues or on the current rates offered for long-term debt or preferred stock with the same or similar remaining redemption provisions.\nShort-term debt The carrying amount approximates fair value because of the short maturity of those instruments.\nThe fair value does not affect CSW's liabilities unless the issues are redeemed prior to their maturity dates.\nThe estimated fair values of CSW's financial instruments follow:\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (millions) Cash and temporary cash investments $27 $27 $62 $62 Short-term investments -- -- 13 13 Long-term debt 2,940 2,795 2,749 2,947 Preferred stock subject to mandatory redemption 35 32 58 61 Long-term debt and preferred stock due within 12 months 7 7 26 26 Short-term debt 1,483 1,483 1,410 1,410\n7.Short-Term Financing The CSW System has established a money pool to coordinate short- term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million to back up its commercial paper program.\nCSW Credit, which does not participate in the money pool, issues commercial paper that is secured by the assignment of its receivables. CSW Credit maintains a secured revolving credit agreement which aggregated $900 million at December 31, 1994, to back up its commercial paper program.\n8.Benefit Plans Defined Benefit Pension Plan The CSW System maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited 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 which are deductible for income tax purposes and minimum contributions required by the ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate-term fixed income investments.\nContributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $28 million, $32 million and $29 million, respectively.\nThe approximate maximum number of participants in the plan during 1994 were 8,500 active participants, 3,600 retirees and beneficiaries and 1,000 terminated employees.\n2-40 The components of net periodic pension cost and the assumptions used in accounting for pensions follow:\n1994 1993 1992 (dollars in millions) Net Periodic Pension Cost Service cost $22 $20 $18 Interest cost on projected benefit obligation 62 56 50 Actual return on plan assets (4) (68) (43) Net amortization and deferral (70) -- (20) $10 $ 8 $ 5\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nA reconciliation of the funded status of the plan to the amounts recognized on the balance sheets is shown below:\nDecember 31, 1994 1993 (millions) Plan assets, at fair value $794 $790 Actuarial present value of Accumulated benefit obligation for service rendered to date 685 649 Additional benefit for future salary levels 112 133 Projected benefit obligation 797 782 Plan assets in excess\/(below) the projected benefit obligation (3) 8 Unrecognized net gain 60 62 Unrecognized prior service cost (8) (8) Unrecognized net obligation 15 17 Prepaid pension cost $ 64 $ 79\nThe vested portion of the accumulated benefit obligations at December 31, 1994 and 1993 was $626 million and $586 million, respectively. The unrecognized net obligation is being amortized over the average remaining service life of employees or 16 years. Prepaid pension cost is included in other deferred charges on the consolidated balance sheets.\nIn addition to the amounts shown in the above table, the CSW System has a non-qualified excess benefit plan. This plan is available to all pension plan participants who are entitled to receive a pension benefit from CSW which is in excess of the limitations imposed on benefits by the Internal Revenue Code through the qualified plan. CSW's net periodic cost for this non- qualified plan for the years ended December 31, 1994, 1993 and 1992 was $1.8 million, $1.8 million and $0.5 million, respectively.\nHealth and Welfare Plans The CSW System had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active CSW System employees during 1994. The contributions, recorded on a pay-as-you-go basis, for the years ended December 31, 1994 and 1993 were approximately $17\n2-41 million and $23 million, respectively. Effective January 1993, the CSW System's method of providing health benefits was modified to include such benefits as a health maintenance organization, preferred provider options, managed prescription drug and mail- order program and a mental health and substance abuse program in addition to the self-insured indemnity plans.\nPostretirement Benefits Other Than Pensions The CSW System adopted SFAS No. 106 effective January 1, 1993. The effect on operating expense in 1993 was an increase of $16 million. The transition obligation is being amortized over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\nThe components of net periodic postretirement benefit cost follow:\n1994 1993 (millions) Net Periodic Postretirement Benefit Cost Service cost $ 9 $ 8 Interest cost on APBO 19 17 Actual return on plan assets (1) (1) Amortization of transition obligation 9 9 Net amortization and deferral (4) (2) $32 $31\nA reconciliation of the funded status of the plan to the amounts recognized on the consolidated balance sheets follow:\nDecember 31, 1994 1993 APBO (millions) Retirees $141 $146 Other fully eligible participants 31 30 Other active participants 55 64 Total APBO 227 240 Plan assets at fair value (69) (51) APBO in excess of plant assets 158 189 Unrecognized transition obligation (162) (171) Unrecognized gain or (loss) 4 (18) (Accrued)\/Prepaid Cost $ -- $ --\nThe following assumptions were used in accounting for SFAS No. 106.\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001. Post-65 Participants: 1994 rate of 11.25% grading down .75% per year to an ultimate rate of 6.0% in 2001.\n2-42 Increasing the assumed health care cost trend rates by one percentage point in each year would increase the APBO by $26 million and increase the aggregate of the service and interest costs components by $4 million as of December 31, 1994.\n9.Jointly Owned Electric Utility Plant The Electric Operating Companies are parties to various joint ownership agreements with other non-affiliated entities. Such agreements provide for the joint ownership and operation of generating stations and related facilities, whereby each participant bears its share of the project costs. At December 31, 1994, the companies have undivided interests in five such generating stations and related facilities as shown below:\nCPL SWEPCO SWEPCO SWEPCO CSW South Flint Dolet System Texas Creek Pirkey Hills Oklaunion Nuclear Coal Lignite Lignite Coal Plant Plant Plant Plant Plant (dollars in millions) Plant in service $2,343 $ 79 $ 431 $ 226 $ 397 Accumulated depreciation $ 380 $ 39 $ 135 $ 62 $ 91 Plant capacity-MW 2,500 480 650 650 676 Participation 25.2% 50.0% 85.9% 40.2% 78.1% Share of capacity-MW 630 240 559 262 528\n10. Litigation and Regulatory Proceedings\nCPL STP From February 1993 until May 1994, STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL. These matters, including a base rate case and fuel reconciliation proceedings, are discussed immediately below.\nTexas Commission Proceedings Base Rates Rate Inquiry - Docket No. 12820 Several Cities, the Texas Commission General Counsel and others initiated actions in late 1993 and early 1994 which, if approved by the Texas Commission, would lower CPL's base rates. The requests for a review of CPL's rates arose out of the unscheduled outage at STP which began in February 1993. The STP outage did not affect CPL's ability to meet customer demand because of existing capacity and CPL's purchase of additional energy.\nPursuant to a scheduling and procedural settlement agreement among the parties challenging CPL's rates, which was approved by a Texas Commission ALJ on April 1, 1994, CPL submitted a rate filing package on July 1, 1994 to the Texas Commission justifying its current base rate structure. In that filing, CPL stated that it had a $111 million retail revenue deficiency and would be justified in seeking a base rate increase. However, consistent with the procedural settlement agreement, CPL has not sought to increase base rates as a part of this docket but seeks to maintain its rates at the same levels agreed to in the settlement of its last two rate cases in 1990 and 1991. As part of the 1990 and 1991 settlements, CPL 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. On October 31, 1994, CPL filed rebuttal testimony that revised its retail revenue deficiency to approximately $103 million. CPL continues to maintain that its rates are reasonable and that its earnings are within established regulatory guidelines.\n2-43 Parties to CPL's base rate case have filed testimony with the Texas Commission recommending reductions in CPL's base rates. Among the parties that filed testimony were OPUC which initially recommended an annual $100 million retail rate reduction. After hearings on the rate case, OPUC claimed that CPL did not meet its burden of proof concerning deferred accounting and as a result OPUC changed its proposed reduction to $147 million. The Cities, which are parties to the rate case, have recommended an annual $75 million retail rate reduction and the write-off of $219 million of CPL's Mirror CWIP asset. See Deferred Accounting below.\nThe Staff filed testimony recommending an annual reduction in retail rates of $99.6 million resulting from a combination of proposed rate base and cost of service reductions, which it subsequently revised during the hearings to $83.9 million. In its final brief to the ALJ, the Texas Commission's Staff withdrew its recommendation that short-term debt be included in the calculation of CPL's weighted cost of capital. CPL estimates that this change in the Staff's position will lower its revised proposed retail rate reduction by approximately $6 million. The Staff recommended a rate base disallowance of $407 million, or approximately 17% of CPL's investment in STP, based upon the Staff's calculation of historical performance for STP compared to a peer group of other nuclear facilities. The Staff also recommended that accumulated depreciation and accumulated deferred federal income taxes related to the disallowed portion of STP be adjusted to reflect a net reduction to rate base of $325 million. Additionally, the Staff proposed to disallow depreciation expense related to the recommended STP disallowed plant.\nIn its testimony, the Staff argued that its proposed STP rate base reduction was a historical performance-based disallowance that could be temporary in nature and would not have to result in a permanent disallowance. The Staff indicated that, in the future, CPL could seek recovery in rates of the proposed STP rate base disallowance, subject to the performance of STP.\nThe Texas Commission held hearings in November and December 1994, and all parties have filed briefs in the case. The ALJ is expected to issue a recommended order for consideration by the Texas Commission in April 1995, with a final order from the Texas Commission expected in May 1995. Testimony filed by parties to the rate case, including the Staff, is not binding on either the ALJ or the Texas Commission.\nCPL strongly believes that 100 percent of its investment in both units of STP belong in rate base. This belief is based on, among other factors, Units 1 and 2 providing output at high capacity factors since April and June 1994, respectively. In addition, the long-term benefits nuclear generation provides to customers supports their inclusion in rate base. Furthermore, there are no Texas Commission precedents addressing the removal of a nuclear plant from rate base as a performance-based disallowance. Assuming both units of STP are included in rate base, CPL believes it is not collecting excessive revenues, notwithstanding that market rates of return on common equity are generally lower today than they were in 1990 and 1991, when CPL's base rates were last set.\nFuel Introduction Pursuant to the substantive rules of the Texas Commission, CPL generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and CPL'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 costs 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.\nFuel Surcharge - Docket No. 12154 In July 1993, CPL 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\n2-44 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 CPL's request to postpone consideration of the surcharge. In January and July of 1994, CPL updated its fuel surcharge petition to reflect amounts of under-recovery through November 1993 and May 1994, respectively. Also, CPL further updated its petition in January 1995 to reflect amounts of under-recovery through November 1994. Likewise, CPL requested and was granted postponement of the updated petitions until the STP outage concluded or at the time fuel costs are next reconciled. On January 4, 1995, Docket No. 12154 was consolidated into Docket No. 13650.\nPrudence Inquiry - Docket No. 13126 In April 1994, the Texas Commission's General Counsel and Staff issued a Request for Proposal for an audit of the STP outage, and in July 1994 a consultant was selected to perform the audit. The purpose of the audit is to evaluate the prudence of management activities at STP, including the actions of HLP and the STP management committee, of which CPL is a participant. Such review will include the time from original commercial operation of each unit until they were returned to service from the outage. The findings of this audit are expected to be incorporated into this proceeding. CPL and HLP will pay the costs of the audit but will have no control over the ultimate work product of the consultant.\nIn June 1994, the Texas Commission's General Counsel initiated an inquiry into the operation and management of STP which resulted in the establishment of this proceeding. As part of the inquiry, CPL presented certain information concerning the prudence of management activities at STP relating to the STP outage. Testimony filed by CPL stated that the cause of the STP outage was the result of an accidental equipment failure rather than imprudent management activities at STP. Based on this information, CPL will seek full recovery in its fuel reconciliation case of incremental energy costs related to the STP outage.\nAs a part of this proceeding, CPL was required to reconstruct its production costs assuming STP was available 100% of the time during the actual outage. Testimony filed by CPL stated that it is unrealistic to expect any generating unit to operate all the time. The testimony provided calculations of STP replacement power cost estimates for availability factor scenarios at (i) 100%, (ii) 75% and (iii) 65% average availability. Based on these average availability factors, STP net replacement power costs for the entire outage period were estimated to be (i) $104.5 million at 100%, (ii) $79.0 million at 75% and (iii) $68.2 million at 65% average availability.\nThe results of this prudence inquiry are expected to be used in CPL's pending fuel reconciliation proceeding in Docket No. 13650, as discussed below, and possibly CPL's next base rate proceeding should a return on equity penalty be ordered by the Texas Commission. Such penalty could lower CPL's allowed return on equity in its next base rate case from what it otherwise would be permitted to earn.\nFuel Reconciliation - Docket No. 13650 On November 15, 1994, CPL filed a fuel reconciliation case with the Texas Commission seeking to reconcile approximately $1.2 billion of fuel costs from March 1, 1990 through June 30, 1994. This period includes the STP outage where CPL's fuel and purchased power costs were increased as the power normally generated by STP was replaced through sources with higher costs. At December 31, 1994, CPL's under-recovered fuel balance was $54.1 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. CPL cannot accurately estimate the amount of any future under- or over-recoveries due to the nature of the above factors. CPL cannot predict how the Texas Commission will ultimately resolve the reasonableness of higher replacement energy costs associated with the STP outage. Although the Texas Commission could disallow all or a portion of the STP replacement energy costs, such determination cannot be made until a final order is issued by the Texas Commission in this docket.\n2-45 If a significant portion of the fuel costs were disallowed by the Texas Commission, CSW could experience a material adverse effect on its consolidated results of operations in the year of disallowance but not on its financial condition.\nCPL continues to negotiate with the intervening parties to resolve Docket Nos. 12820, 13126 and the STP portions of Docket No. 13650 through settlement. However, no settlement has been reached.\nManagement cannot predict the ultimate outcome of these regulatory proceedings. However, management believes that the ultimate resolution of the various issues will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nSTP Background Final Orders In October 1990, the Texas Commission issued the 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 the STP Unit 2 Order which fully implemented a stipulated agreement to resolve all issues regarding CPL's investment in STP Unit 2.\nThe STP Unit 1 Order allowed CPL 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 had authorized deferral of STP Unit 1 costs. See Deferred Accounting below. 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 CPL 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. The Mirror CWIP liability is being reduced by the recognition of non-cash income during the period 1991 through 1995. The Mirror CWIP asset is being amortized to expense over the life of the plant.\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 costs of CPL's total investment in STP is included in rate base. As indicated under the heading Texas Commission Proceedings above, however, CPL is currently involved in base rate and fuel proceedings which challenge CPL's right to recover certain costs associated with the STP outage.\nAs part of the stipulated agreement, CPL 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. CPL 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 CPL, the Staff and a majority of intervenors including major cities in CPL's service territory and major industrial customers. These intervenors represent a significant majority of CPL's customers. CPL and the TSA reached agreements, which were subsequently approved by the 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\n2-46 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 CSW could experience a significant adverse effect on its consolidated results of operations and financial condition. 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 economic results. Management believes that the STP Unit 1 and 2 Orders will be upheld.\nDeferred Accounting CPL was granted deferred accounting for STP Unit 1 and 2 costs by Texas Commission orders. These orders allowed CPL 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 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, CPL's retail rates include recovery of 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 CPL'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 CPL 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 CPL from earning a return on such costs.\nAfter the Court of Appeals' denial of each party's motion for rehearing of the decision, CPL 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 Appeals' decision, challenging generally the legality of deferred accounting for rate base treatment of any deferred costs. In May 1993, the Supreme Court of Texas granted CPL's Application for Writ of Error. CPL's case was consolidated with the deferred accounting cases of El Paso and HLP. In June 1994, the Supreme Court of Texas sustained deferred accounting as an appropriate mechanism for the Texas Commission to use in preserving the financial integrity of utilities. The Supreme Court of Texas held that the Texas Commission can authorize utilities to defer those costs that are incurred between the in-service date of a plant and the effectiveness of new rates, which include such costs. On October 6, 1994, the Supreme Court of Texas denied a motion for rehearing CPL's deferred accounting matter filed by the State of Texas. The language of the Supreme Court of Texas opinion suggests that the appropriateness of allowing deferred accounting may need to again be reviewed under a financial integrity standard at the time the costs begin being recovered through rates. For CPL, that would be the STP Unit 1\n2-47 and Unit 2 Orders discussed above. To the extent that additional review is required, it should occur in those dockets.\nIf these deferred accounting matters are not favorably resolved, CSW could experience a material adverse effect on its consolidated results of operations and financial condition. While CPL's management cannot predict the ultimate outcome of these matters, management believes CPL will 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 CSW's consolidated results of operations or financial condition.\nWestinghouse Litigation CPL and other owners of STP are plaintiffs in a lawsuit filed in 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 set for trial in July 1995.\nInspections during the STP outage have detected early signs of stress corrosion cracking in tubes at STP Unit 1. Management believes additional problems would develop gradually and will be monitored by the Project Manager 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. Management believes that the ultimate resolution of this matter will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nCivil Penalties In October 1994, the NRC staff advised HLP that it proposes to fine HLP $100,000 for what the NRC believes was discrimination against a contractor employee at STP who brought complaints of possible safety problems to the NRC's attention. These actions resulted from the findings of a NRC investigation of alleged violations of STP security and work process procedures in 1992. The incident cited by the NRC is the subject of a contested hearing that is scheduled to be held in the spring of 1995 before a United States Department of Labor judge. Until the Department of Labor issues a final decision in this matter, the NRC is not requiring HLP to respond to its notice of violation.\nPSO\nRate Review In December 1993, the Oklahoma Commission issued an order unanimously approving a joint stipulation between PSO, the Oklahoma Commission Staff, and the Office of the Attorney General of the State of Oklahoma, as recommended by the ALJ. The order allowed PSO an increase in retail prices of $14.4 million on an annual basis which represents a $4.3 million increase above those authorized by the March 1993 interim order. In January 1994, the Oklahoma Commission issued an order unanimously approving PSO's price schedules reflecting the $14.4 million price increase. The new prices became effective beginning with the billing month of February 1994.\nThe December 1993 order addresses, among other things, the following issues. PSO will recover $4.5 million annually in expenses associated with OPEBs, which, for PSO, are primarily health care related benefits. Such expenses will be recovered along with amortization of the deferred 1993 OPEBs at a rate of $0.5 million per year for 10 years. PSO will amortize deferred storm expenses associated with both a 1987 ice storm and a 1992 wind storm, amounting to $1.2 million per year for five years. In addition, the order recognizes the increase in federal income tax expenses resulting from the recent increase in the federal corporate income tax rate from 34 percent to 35 percent. PSO will continue to use the depreciation rates previously approved by the\n2-48 Oklahoma Commission. PSO agreed that it will not file another retail price increase application until after June 30, 1995.\nGas Transportation and Fuel Management Fees An order issued by the Oklahoma Commission in 1991 required that the level of gas transportation and fuel management fees, paid to Transok by PSO, permitted for recovery through the fuel adjustment clause be reviewed in the aforementioned price proceeding. This portion of the price review was bifurcated. In February 1995, an agreement was reached which allows PSO to recover approximately $28.4 million of transportation and fuel management fees in base rates using 1991 determinants and approximately $1 million through the fuel adjustment clause. The agreement also requires the phase- in of competitive bidding of natural gas transportation requirements in excess of 165 MMcf\/d per day. An ALJ has recommended approval of the agreement to the Oklahoma Commission. A final order is expected in the first quarter of 1995.\nGas Purchase Contracts PSO has been named defendant in complaints filed in federal and state courts of Oklahoma and Texas in 1984 through February 1995 by gas suppliers alleging claims arising out of certain gas purchase contracts. Cases currently pending seek approximately $29 million in actual damages, together with claims for punitive damages which, in compliance with pleading code requirements, are alleged to be in excess of $10,000. The plaintiffs seek relief through the filing dates as well as attorney fees. As a result of settlements among the parties, certain plaintiffs dismissed their claims with prejudice to further action. The settlements did not have a significant effect on CSW's consolidated results of operations. The remaining suits are in the preliminary stages. Management cannot predict the outcome of these proceedings. However, management believes that PSO has defenses to these complaints and intends to pursue them vigorously. Management also believes that the ultimate resolution of the remaining complaints will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nPCB Cases PSO has been named a defendant in complaints filed in state court in Oklahoma alleging, among other things, that some of the plaintiffs were contaminated with PCBs and other toxic by-products following transformer malfunctions. The complaints currently total approximately $383 million of which approximately one-third represents punitive damages. Some claims have been dismissed, certain of which resulted in settlements among the parties. The settlements did not have a significant effect on CSW's consolidated results of operations. Although management cannot predict the outcome of these proceedings, management believes that PSO has defenses to these claims and intends to pursue them vigorously. Moreover, management has reason to believe that PSO's insurance may cover some of the claims. Management also believes that the ultimate resolution of these cases will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nBurlington Northern Transportation Contract In June 1992, PSO filed suit in Federal District Court in Tulsa, Oklahoma, against Burlington Northern seeking declaratory relief under a long-term contract for the transportation of coal. In July 1992, Burlington Northern asserted counterclaims against PSO alleging that PSO breached the contract. The counterclaims sought damages in an unspecified amount. In December 1993, PSO amended its suit against Burlington Northern seeking damages and declaratory relief under federal and state anti-trust laws. PSO and Burlington Northern filed motions for summary judgment on certain dispositive issues in the litigation. In March 1994, the court issued an order granting PSO's motions for summary judgment and denying Burlington Northern's motion. It was not necessary for the court to decide the federal and state anti-trust claims raised by PSO. Judgment was rendered in favor of PSO by the United States District Court in May 1994. In June 1994, Burlington Northern appealed this judgment to the United States Court of Appeals for the Tenth Circuit. This appeal is now pending.\n2-49 Burlington Northern Arbitration In May 1994, in a related arbitration, an arbitration panel made an award favorable to PSO concerning basic transportation rates under the coal transportation contract described above, and concerning the contract mechanism for adjustment of future transportation rates. These arbitrated issues were not involved in the related lawsuit described above. Burlington Northern filed an action to vacate the arbitrated award in the District Court for Dallas County, Texas. PSO removed this action to the United States District Court for the Northern District of Texas, and filed a motion to either dismiss this action or have it transferred to the United States District Court for the Northern District of Oklahoma. Burlington Northern moved to remand the action to state court. In September 1994, the United States District Court for the Northern District of Texas denied Burlington Northern's motion to remand, and granted PSO's motion to transfer the action to the United States District Court for the Northern District of Oklahoma. Separately, PSO filed an action to confirm the arbitration award in the United States District Court for the Northern District of Oklahoma, and Burlington Northern filed a motion to dismiss this confirmation action. On December 6, 1994, the District Court entered an order denying the Burlington Northern's motion to vacate the arbitration award, and granting PSO's motion to confirm the arbitration award. On December 29, 1994, the District Court entered judgment confirming the arbitration award, including a money judgment in PSO's favor for $16.4 million, with interest at 7.2% per annum compounded annually from December 21, 1994 until paid. On January 6, 1995, Burlington Northern appealed the District Court's judgment to the United States Court of Appeals for the Tenth Circuit. This appeal is now pending.\nSWEPCO Fuel Reconciliation On March 17, 1994, SWEPCO filed a petition with the Texas Commission to reconcile fuel costs for the period November 1989 through December 1993. Total Texas jurisdictional fuel expenses subject to reconciliation for this 50-month period were approximately $559 million. SWEPCO's net under-recovery for the reconciliation period was approximately $0.9 million. SWEPCO and the intervening parties in this proceeding were able to negotiate a stipulated agreement providing a $3.2 million fuel cost disallowance and settling all issues except one. That issue involved the recovery of certain fuel related litigation and settlement negotiation expenses. The Texas Commission, at its Final Order hearing on January 18, 1995, approved the stipulated disallowance and granted SWEPCO recovery of the fuel related litigation expense. The $3.2 million disallowance is included in SWEPCO's 1994 results of operations. SWEPCO recognized the litigation costs as expenses in prior periods.\nBurlington Northern Transportation Contract On January 20, 1995, a state district court in Bowie County, Texas, entered judgment in favor of SWEPCO against Burlington Northern in a lawsuit between the parties regarding rates charged under two rail transportation contracts for delivery of coal to SWEPCO's Welsh and Flint Creek power plants. The court awarded SWEPCO approximately $72 million covering damages for the period from April 27, 1989 through September 26, 1994 and prejudgment interest fees and grant certain declaratory relief requested by SWEPCO.\nKansas City Southern Railway Company Transportation Contracts In March 1994, SWEPCO entered into a settlement with the Kansas City Southern Railway Company of litigation between parties regarding two coal transportation contracts. Pursuant to the settlement, SWEPCO and the Kansas City Southern Railway Company executed a new coal transportation agreement. The settlement is expected to result in a reduction of SWEPCO's coal transportation costs now and in the future. Burlington Northern, another party to the prior contracts and to the litigation, did not participate in the settlement and the litigation is still pending between SWEPCO and Burlington Northern.\n2-50 WTU\nRate Proceeding - Docket No. 13369 On August 25, 1994, WTU filed a petition with the Texas Commission and with cities with original jurisdiction to review WTU's rates, proposed an interim across-the-board base rate reduction of 3.25% or, approximately $5.7 million, effective October 1, 1994, and sought until February 28, 1995, the time to develop and file a RFP. WTU also requested the ability to \"true-up\", back to October 1, 1994, any difference in revenue requirements upon final order of the Texas Commission, and proposed that any increases over the pre-October 1, 1994, base rates be implemented prospectively on the effective date of the final order.\nAs discussed below, WTU's fuel reconciliation was consolidated with this proceeding in September 1994. Reconcilable fuel costs during the reconciliation period were approximately $300 million. At June 30, 1994, the fuel cost under-recovery totaled approximately $5.1 million, including interest. At December 31, 1994, this amount had become an over-recovery of approximately $0.2 million. WTU is not seeking a change in fuel factors.\nOn February 28, 1995, WTU filed with the Texas Commission and cities with original jurisdiction the rate filing package which indicates a revenue deficiency of approximately $14.5 million. However, WTU simultaneously filed with the parties a settlement proposal to reduce overall base rate revenue by 3.25%, effective October 1, 1994, an annual impact in the rate year beginning January 1, 1996 of approximately $5.9 million. The settlement proposal reflects WTU's desire to maintain competitive rates, recognizes the importance of competitive rates in the changing electric service marketplace, and demonstrates WTU's strong commitment to the long-term success of WTU and its customers.\nUnless a settlement accelerates the schedule, WTU anticipates hearings in mid-1995 with a final order in the fourth quarter of 1995. Management cannot predict the outcome of the rate proceeding, the fuel reconciliation, or the settlement proposal, but believes that the ultimate resolution of these matters will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\nFuel Reconciliation - Docket No. 13172 On June 30, 1994, WTU filed a petition with the Texas Commission to reconcile fuel costs for the period January 1991 through February 1994. Subsequently, in September 1994, this fuel reconciliation proceeding was consolidated into Docket No. 13369 described above, and the reconciliation period was extended through June 1994.\nRate Case Proceeding - Docket No. 7510 In November 1987, the Texas Commission issued a final order in WTU's retail rate case providing for WTU to receive an annual increase in base retail revenues of $34.9 million. Rates reflecting the final order were implemented in December 1987. WTU, along with certain intervenors in the retail rate proceeding, appealed the Texas Commission's final order to the District Court seeking reversal of various provisions of the final order, including the inclusion of deferred accounting in rate base.\nThe appeals were consolidated and in September 1988, the District Court affirmed the final order of the Texas Commission. In November 1988, certain intervenors filed appeals of the District Court's judgment with the Court of Appeals. In February 1990, the Court of Appeals ruled that an intervenor had improperly been excluded from presenting its appeal to the District Court, reversed the District Court's judgment and remanded the case to the District Court for further proceedings.\nIn October 1992, the District Court heard the remanded appeals of the final order of the Texas Commission and in March 1993 issued an order affirming the Texas Commission's order in all material respects with the single exception of the inclusion of deferred\n2-51 Oklaunion carrying costs in rate base. In its treatment of deferred costs, the District Court followed a then-current opinion of the Court of Appeals which precluded recovery of deferred post- in-service carrying costs. In April 1993, WTU and other parties filed appeals, and oral argument was held on the appeals in December 1993 on the non-deferred accounting issues. With respect to the deferred accounting issues, the parties recognized certain Supreme Court of Texas decisions regarding other deferred accounting cases would be influential in WTU's case.\nIn June 1994, the Supreme Court of Texas issued its opinion in the three other cases involving deferred accounting holding that the Texas Commission has the authority to allow deferred accounting treatment during the deferral period, including deferred post-in- service carrying costs. The Supreme Court of Texas upheld the Court of Appeals in all respects except it reversed the Court of Appeals to the extent it disallowed carrying costs deferrals and remanded to the Court of Appeals for consideration of the unresolved arguments of the improperly excluded intervenor. Motions for rehearing were filed by certain parties which were denied by the Supreme Court of Texas. These rulings influenced the Court of Appeals' decision in WTU's rate case appeals, as described below.\nOn February 15, 1995, the Court of Appeals affirmed all aspects of the District Court judgment relating to the Texas Commission's allowance of non-Oklaunion depreciation rates and the surcharge of rate case expenses, reversed the District Court's judgment relating to the exclusion of deferred Oklaunion carrying costs in rate base, and remanded the cause to the Texas Commission to reexamine the issue of deferred costs in light of the remand of Docket No. 7289, as described above. However, on March 3, 1995, WTU filed a motion for rehearing at the Court of Appeals seeking clarification of certain aspects of its order and arguing that the Court of Appeals erred in remanding the case to the Texas Commission for it to determine to what extent deferred costs are necessary to preserve WTU's financial integrity because the issue has been waived since it was not briefed or argued to the Court of Appeals. WTU expects other parties may also file motions for rehearing.\nWTU's motion for rehearing may, if granted, prevent further review of financial integrity issues with respect to deferred accounting in any remand of Docket No. 7510. If a broader remand is permitted and if the Texas Commission concludes in Docket No. 7289 that deferred accounting was necessary to preserve WTU's financial integrity during the deferral period, the Texas Commission must decide to what extent the deferred Oklaunion costs, including carrying costs, were necessary to preserve WTU's financial integrity. If WTU's deferred accounting treatment is ultimately reversed or is substantially reduced, WTU could experience a material adverse impact on its results of operations. While management can give no assurances as to the outcome of the remanded proceeding or the motion for rehearing, management believes that 100 percent of the Oklaunion deferred costs will be determined by the Texas Commission to have been necessary to preserve WTU's financial integrity during the deferral period so that there will be no material adverse effect on CSW's consolidated results of operations or financial condition.\nDeferred Accounting - Docket No. 7289 WTU received approval from the Texas Commission in September 1987 to defer operating expenses and carrying costs associated with Oklaunion incurred subsequent to its December 1986 commercial operation date until December 1987 (the deferral period) when retail rates including Oklaunion in WTU's rate base became effective. WTU has recorded approximately $32 million of Oklaunion deferred costs, of which $25 million are carrying costs. The deferred costs are being recovered and amortized over the remaining life of the plant. In November 1987, OPUC filed an appeal in the District Court challenging the Texas Commission's final order authorizing WTU to defer the costs associated with Oklaunion. In October 1988, the District Court affirmed the final order of the Texas Commission. In December 1988, OPUC filed an appeal of the District Court judgment in the Court of Appeals. In September 1990, the Court of Appeals upheld the District Court's affirmance of the Texas Commission's final order and in October 1990, OPUC filed a motion for rehearing of the Court of Appeals' decision, which was denied in November 1990. On further appeal,\n2-52 the Supreme Court heard oral argument in September 1993, in WTU's case as well as three other cases involving deferred accounting and in June 1994 issued its opinions in these cases affirming the Texas Commission's authority to allow deferred accounting treatment, but establishing a financial integrity standard rather than the measurable harm standard used by the Texas Commission.\nIn October 1994, the Supreme Court of Texas issued a mandate remanding WTU's deferred accounting case to the Texas Commission. While no schedule has yet been established for the proceedings on remand at the Texas Commission, this remand may be considered in tandem with WTU's pending rate case, Docket No. 13369. In the remanded proceeding, the Texas Commission must make a formal finding that the deferral of Oklaunion costs was necessary to prevent WTU's financial integrity during the deferral period from being jeopardized.\nIf WTU's deferred accounting treatment is ultimately reversed and not favorably resolved, WTU could experience a material adverse impact on its results of operations. While management cannot predict the ultimate outcome of these proceedings, management believes that WTU's deferred accounting will be ultimately sustained by the Texas Commission on the basis of the financial integrity standard set forth by the Supreme Court of Texas, so that there will be no material adverse effect on CSW's consolidated results of operations or financial condition.\nWTU FERC Order On April 4, 1994, the FERC issued an order pursuant to section 211 of the Federal Power Act forcing a regional utility to transmit power to Tex-La on behalf of WTU. The order was one of the first issued by FERC under that provision, which was added by the Energy Policy Act to increase competition in wholesale power markets. WTU began serving Tex-La, which has requirements of approximately 120 MW of electric power. WTU will serve Tex-La until facilities are completed to connect Tex-La to SWEPCO, an affiliated system, at which time SWEPCO will provide 85 MW and WTU will retain 35 MW of the Tex-La electric load.\nOther Cimmaron On January 12, 1994, Cimmaron brought suit against CSW and its wholly-owned subsidiary, CSWE, in the 125th District Court of Houston, Harris County, Texas. Cimmaron alleges that CSW and CSWE breached commitments to participant with Cimmaron in the failed BioTech Cogeneration project located in Colorado. Cimmaron claims breach of contract, fraud and negligent misrepresentation with alleged damages totaling $250 million, punitive damages of an unspecified amount, as well as attorney's fees.\nCSWE filed a counterclaim against Cimmaron and third-party claims against the principals of Cimmaron on December 22, 1994, alleging that they misrepresented and omitted material facts about their experience and background and about the proposed cogeneration project. CSWE seeks damages of $500,000, the earnest money paid when the letter of intent was executed, the costs associated with due diligence and punitive damages. On January 10, 1995, Cimmaron filed a first amended original petition suing CSWE board members at the time, personally.\nPre-trial discovery on the case is presently underway with depositions of the parties being taken during March, 1995. Trial was originally set for the week of April 10, 1995, but the parties have filed a joint motion for continuance which is set for hearing on March 20, 1995. Management of CSW cannot predict the outcome of this litigation, but believes that CSW and CSWE have defenses to these complaints and are pursuing them vigorously and that the ultimate resolution will not have a material adverse effect on CSW's consolidated results of operations or financial condition.\n2-53 General Matters CSW and the Operating Companies are 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 CSW's consolidated results of operations or financial condition.\n11. Commitments and Contingent Liabilities Proposed Acquisition of El Paso Background In May 1993, CSW entered into a Merger Agreement pursuant to which El Paso would emerge from bankruptcy as a wholly-owned subsidiary of CSW. El Paso is an electric utility company headquartered in El Paso, Texas, engaged principally in the generation and distribution of electricity to approximately 262,000 retail customers in west Texas and southern New Mexico. El Paso also sells electricity under contract to wholesale customers in a number of locations including southern California and Mexico. El Paso had filed a voluntary petition for reorganization under Chapter 11 of the Bankruptcy Code on January 8, 1992.\nOn July 30, 1993, El Paso filed the Modified Plan and a related proposed form of Disclosure Statement providing for the acquisition of El Paso by CSW. On November 15, 1993, all voting classes of creditors and shareholders of El Paso voted to approve the Modified Plan. On December 8, 1993, the Bankruptcy Court confirmed the Modified Plan.\nUnder the Modified Plan, the total value of CSW's offer to acquire El Paso is approximately $2.2 billion. The Modified Plan generally provides for El Paso creditors and shareholders to receive shares of CSW Common, cash and\/or securities of El Paso, or to have their claims cured and reinstated. The Modified Plan also provides for claims of secured creditors generally to be paid in full with debt securities of reorganized El Paso, and for unsecured creditors to receive a combination of debt securities of reorganized El Paso and CSW Common equal to 95.5 percent of their claims, and for small trade creditors to be paid in full with cash. The Modified Plan provides for El Paso's preferred shareholders to receive preferred shares of reorganized El Paso, or cash, and for options to purchase El Paso Common to be converted into options to purchase a proportionate number of shares of CSW Common. In addition, the Modified Plan provides for certain creditor classes of El Paso to accrue interest on their claims and to receive periodic interim distributions of such interest through the Effective Date or the withdrawal or revocation of the Modified Plan, subject to certain conditions and limitations set forth in the Modified Plan. To date, all such accrued interest payments to creditors have been made by El Paso on a timely basis. If, under certain circumstances, the Merger is not consummated, the Merger Agreement provides for CSW to pay El Paso for a portion of such interim interest payments paid or accrued prior to the termination of the Merger Agreement. The Merger Agreement also provides for CSW to pay for a portion of fees and expenses, including legal expenses of certain El Paso creditors under such circumstances. CSW's potential exposure as of December 31, 1994 is estimated to be approximately $17.5 million; however, the actual amount, if any, that CSW may be required to pay pursuant to these provisions depends on a number of contingencies and cannot presently be predicted.\nOn June 14, 1994, Las Cruces filed a motion with the Bankruptcy Court to lift the automatic stay imposed by the bankruptcy filing to allow it to (i) commence action against El Paso for failure to pay franchise fees after the expiration of its franchise agreement with Las Cruces in March 1994, (ii) enter El Paso's property to conduct an appraisal of the electric distribution system and any suitability studies, (iii) give notice of intent to file a condemnation action and (iv) commence state court condemnation proceedings against El Paso to condemn El Paso's distribution system within Las Cruces' city limits.\nOn June 29 and July 1, 1994, El Paso and CSW filed responses in the Bankruptcy Court opposing the Las Cruces motion. On August 1, 1994, CSW filed an amended response to the Las Cruces motion which states that the threat or actual commencement of condemnation proceedings by Las Cruces or the elimination of El Paso's service\n2-54 to Las Cruces by condemnation or otherwise may constitute an El Paso material adverse effect, as defined in the Merger Agreement, the absence of which is a condition of CSW's obligation to consummate the Merger. The existence of an El Paso material adverse effect would preclude consummation of the Merger and the Modified Plan, unless CSW waives this condition in writing. CSW's amended response concludes that Las Cruces' intention to file a condemnation proceeding creates a situation that must be favorably resolved before the closing of the Merger.\nBy letter dated August 5, 1994, El Paso protested CSW's filing of the amended response and asserted its disagreement with CSW's position regarding Las Cruces as summarized above. In addition, El Paso asserted that CSW's filing of the amended response over El Paso's objection was contrary to the terms of the Merger Agreement.\nOn August 22, 1994, Las Cruces entered into a wholesale full requirements power contract with SPS to supply power to a municipal utility proposed to be established by Las Cruces. On August 30, 1994, voters in Las Cruces approved by nearly a two-to- one margin a referendum authorizing Las Cruces to proceed with efforts to acquire from El Paso, through negotiated purchase or condemnation proceedings, the electric utility system of El Paso within Las Cruces, including certain distribution, substation and associated transmission facilities.\nOn September 12, 1994, CSW delivered a response to El Paso's August 5 letter. In its September 12 letter, CSW reiterated its position that Las Cruces is a material element of CSW's bargain with El Paso and advised El Paso that the municipalization efforts in Las Cruces and other matters, including (i) the potential loss of other customers in El Paso's service area, including the Holloman Air Force Base and the White Sands Missile Range in New Mexico, (ii) cracking in steam generator tubes at Palo Verde, (iii) intense political and regulatory opposition to the Merger, and (iv) a new \"comparable transmission service\" standard being imposed on the Merger by the FERC, place the completion of the Merger in jeopardy. CSW's September 12 letter further advised El Paso that the foregoing matters, individually and cumulatively, constitute a material adverse effect or failure of other closing conditions under the Merger Agreement which, unless timely resolved in accordance with the Merger Agreement, will preclude closing of the proposed Merger.\nSince CSW's September 12 letter, CSW has exchanged letters with El Paso and others regarding the interpretation of the Merger Agreement and the legal significance of the matters cited by CSW in its September 12 letter. Most of these letters are summarized below.\nOn September 14, 1994, CSW filed a second amended response to Las Cruces' motion to lift the stay in bankruptcy. In its second amended response, CSW stated that the intent and plan of Las Cruces to file a condemnation proceeding creates a situation that must be timely and favorably resolved by El Paso before the consummation of the Merger, whether or not the stay is modified or maintained. Further, CSW supported the maintenance of the stay as a means of avoiding disruption pending resolution of the Las Cruces dispute and because El Paso had taken the position that maintenance of the stay was in the best interests of the Merger and the El Paso estate and put El Paso in a better position to resolve the Las Cruces dispute.\nBy letter dated September 16, 1994, El Paso disagreed with the positions set forth by CSW in its September 12 letter and asserted that CSW's September 12 letter \"had inflicted irreparable harm on El Paso and the Merger process.\"\nOn September 20, 1994, following a hearing on the June 14, 1994 motion of Las Cruces discussed above, the Bankruptcy Court judge indicated orally that, effective January 1, 1995, he would lift the bankruptcy stay on certain actions against El Paso and allow Las Cruces to pursue condemnation proceedings against El Paso with respect to the electric distribution system within Las Cruces under applicable New Mexico law. El Paso filed a motion seeking clarification of this oral ruling as to whether Las Cruces may\n2-55 take immediate possession of the El Paso distribution system under the New Mexico condemnation statutes. On November 22, 1994, the Bankruptcy Court judge orally ruled that Las Cruces can commence condemnation proceedings but can not take possession of the distribution system when the stay is lifted until returning to the Bankruptcy Court and obtaining an order which permits that action.\nBy letter dated September 23, 1994, El Paso requested CSW's consent to meet with the City of Las Cruces to discuss the possibility of a resolution of El Paso's dispute with Las Cruces.\nBy letter dated October 3, 1994, CSW responded to El Paso's September 16 letter and reaffirmed the positions set forth in CSW's September 12 letter. In addition, CSW consented to El Paso's meeting with Las Cruces, but advised El Paso that CSW would not participate directly in negotiations between Las Cruces and El Paso.\nBy letter dated October 5, 1994, counsel to the El Paso Unsecured Creditors Committee, with the concurrence of certain other creditor groups, advised CSW that the committee disagreed with certain positions set forth in CSW's September 12 letter to El Paso. By letter dated October 27, 1994, CSW responded to and stated its disagreement with various statements set forth in the Unsecured Creditors Committee's letter.\nBy letter dated October 5, 1994, El Paso's New Mexico regulatory counsel asserted that CSW's September 12 letter had \"adversely affected proceedings before the New Mexico Commission\" relating to the Merger and that the letter \"is being widely interpreted as a statement from CSW that the Merger will not close.\" By letter dated October 7, 1994, CSW's New Mexico regulatory counsel set forth CSW's disagreement with statements made in El Paso's New Mexico regulatory counsel's October 5 letter. The New Mexico Commission had delayed the New Mexico proceedings prior to September 12, 1994. On October 12, 1994, a New Mexico Commission hearing examiner held a prehearing conference covering scheduling and other matters. On October 14, 1994, CSW filed a Statement of Position and Request for Procedural Schedule in the New Mexico proceeding. El Paso filed a separate position statement in the New Mexico proceeding and advised CSW, by letter dated October 14, 1994, that CSW's statement of position did not \"state a sufficiently clear and strong commitment by CSW to closing the Merger.\" By letter dated October 25, 1994, CSW's New Mexico regulatory counsel stated that the filing by El Paso of a separate position statement \"impairs our ability to obtain necessary regulatory approvals from the New Mexico Commission on a timely basis by implying that there are severe problems in the relationship between El Paso and CSW.\" CSW's October 25 letter also stated that \"the lack of a favorable resolution of Las Cruces municipalization efforts continues to not only prevent the closing of the Merger, but is also hindering our ability to obtain New Mexico regulatory approvals.\"\nBy letter dated October 18, 1994, El Paso reasserted its position that the Merger Agreement does not condition CSW's obligation to consummate the Merger on a favorable resolution of the Las Cruces situation. El Paso asserted it was not clear from CSW's October 3 letter whether CSW consented to El Paso's proposed discussion with Las Cruces and again requested CSW's consent to a meeting between El Paso and Las Cruces.\nBy letter dated October 27, 1994, CSW reaffirmed the positions taken in its September 12 and October 3 letters, and again consented to El Paso's meeting with Las Cruces and reiterated CSW's willingness to discuss with El Paso possible resolutions of the Las Cruces situation.\nOn October 11, 1994, the Bankruptcy Court granted an application by El Paso to employ special litigation counsel to advise El Paso as to ongoing activities with CSW and to assist El Paso as to the best means of preserving its rights. El Paso's application stated that special litigation counsel was needed to evaluate El Paso's rights, remedies and obligations with respect to CSW, the Plan and the Merger Agreement and to advise key officers of El Paso on a course of action to preserve and enforce El Paso's rights and remedies. The application also stated that special litigation\n2-56 counsel \"should also be in a position to conduct any litigation which may be necessary,\" and noted that another law firm then representing El Paso \"would not be in a position to represent the Debtor in litigation against CSW.\" On October 28, 1994, CSW filed a response to El Paso's application, in which CSW stated that while it did not oppose El Paso's motion to employ special litigation counsel, the hiring and future use of litigation counsel may be incongruous with the goal of consummating the Merger. The response also stated that El Paso's Disclosure Statement, pursuant to which it obtained confirmation of its Plan of Reorganization, contained projections that explicitly assume the continuation of service to Las Cruces and two military installations in New Mexico.\nBy letter dated December 21, 1994, El Paso objected to CSW's motion filed with the New Mexico Commission to extend the procedural schedule by two-weeks. CSW responded to El Paso in a letter dated January 11, 1995, that CSW considered the short two week extension to be in the best interest of obtaining favorable and timely regulatory approval in New Mexico. The two weeks were to be used to facilitate efforts to narrow and resolve outstanding issues in the proceedings and thereby expedite the progress of those proceedings. El Paso restated its disagreement to CSW's motion for extension in a letter dated January 16, 1995.\nBy letter dated January 13, 1995, CSW recommended that El Paso object to a request by the Equity Committee to renew its engagement of Salomon Brothers as financial advisor to said committee. CSW stated that the Merger Agreement requires the parties to cooperate in limiting professional fees and that the cost and timing of the reengagement is inappropriate. By letter dated January 20, 1995, El Paso responded to CSW that the Equity Committee's request to reemploy Salomon is a direct consequence of CSW's September 12 letter to El Paso and that it supports the Equity Committee's application. El Paso subsequently filed a statement of support of the Equity Committee's request in the Bankruptcy Court. On February 6, 1995, the Equity Committee of El Paso filed a response in the Bankruptcy Court to objections made by other parties to its rehiring of financial advisors in which the committee accused CSW of taking moves to back out of the Merger Agreement, thereby causing harm to the equity holders.\nOn January 3, 1995, a PFD was issued by the presiding officers in the proceedings pending before the Texas Commission relating to the Merger. On January 17, 1995, CSW and El Paso filed joint exceptions to the proposed decision, stating, among other things, that, \"in CSW's view, the rate relief recommended . . . falls far short of what is necessary for the consummation of the merger.\" That same day, CSW issued a press release describing the filing of the exceptions and repeating CSW's view that the terms of the proposed interim decision failed to provide sufficient revenue and adequate rate-making treatment for CSW to consummate the proposed Merger.\nIn a letter dated January 19, 1995, El Paso objected to the tenor of CSW's January 17 press release and claimed that CSW's press release harmed El Paso, its creditors, and shareholders and poisoned the regulatory approval process. CSW responded in a letter dated January 31 that it is El Paso's actions that have hindered obtaining the regulatory approvals necessary to consummate the Merger and that these actions were contrary to El Paso's obligations under the Merger Agreement. Further, CSW called on El Paso again to detail the steps it proposes to take to solve the problems identified by CSW in its September 12 letter cited in the PFD by the hearing examiners of the Texas Commission, and to desist from further actions which undercut CSW's efforts to obtain the rate relief, asset treatment and required regulatory approvals necessary to consummate the Merger.\nOn February 17, 1995, El Paso responded to CSW's January 31, 1995 letter stating that CSW's assertion that El Paso has breached the Merger Agreement are unfounded. El Paso further accused CSW of searching for a \"viable contractual excuse\" not to close the Merger.\n2-57 On February 20, 1995, El Paso sent a letter to CSW inquiring whether CSW would consent to the sale of the Las Cruces service territory by El Paso and, if so, on what terms and at what price. In addition, the letter inquired whether CSW would consent to a rate reduction in New Mexico and, if so, at what percentage reduction over what period of time. CSW responded in a February 27, 1995 letter that CSW is unwilling to give up any more of the value it bargained for in the Merger Agreement, or to accept the risk of a litigated outcome with Las Cruces. However, CSW encouraged dialogue between El Paso and Las Cruces and stated it continues to support El Paso's efforts to resolve its dispute with Las Cruces. CSW stated it is amenable to considering any alternatives negotiated between Las Cruces and El Paso that would not deprive the Merger of further value and that would enable El Paso to continue to serve the Las Cruces service area or provide El Paso with full compensation for the loss of Las Cruces. CSW looks to El Paso to resolve this situation prior to consummation of the proposed Merger.\nTexas Commission Applications On January 10, 1994, CSW and El Paso filed a joint application with the Texas Commission requesting a determination that the Merger is consistent with the public interest. As a part of the application, CSW proposed a three-step rate settlement plan, contingent upon the Texas Commission's approval of the Merger, that seeks to limit El Paso's proposed $41.4 million initial base rate increase for Texas customers, discussed below, to $25 million. In addition, the settlement rate plan proposed to reduce El Paso's fixed fuel factors by $12.8 million and refund $16.4 million from a one-time fuel reconciliation. As a result of the proposed annual reductions in fuel cost, El Paso's rates would not increase during the first year of the settlement plan. The settlement plan also provided for a three-year freeze on additional base rate increases, a limitation on the frequency of base rate increases following the rate freeze period through 2001 to not more than once every other year (i.e., 1997, 1999, and 2001), and a limitation on the amount of the 1997, 1999 and 2001 base rate increases to an amount not to exceed eight percent of total revenues. No party to the proceedings accepted CSW's rate settlement plan.\nOn January 10, 1994, El Paso separately filed with the Texas Commission for a base rate increase, exclusive of fuel, of approximately $41.4 million. The proposed rate increase represents what El Paso has stated it believes is supported under Texas law and prior Texas Commission orders, adjusted to reflect El Paso's proposed Merger with CSW. If the Texas Commission were to approve El Paso's request, the net effect would be to raise rates significantly higher than those proposed in the settlement plan.\nOn June 23, 1994, the El Paso City Council voted to reduce El Paso's rates $15.7 million following a recommendation from the City of El Paso's Public Utility Regulation Board. The City of El Paso's decision was appealed to the Texas Commission and consolidated with the rate case pending before that commission.\nOn June 24, 1994, the Staff filed testimony in the case before the Texas Commission recommending an increase in base rates of $17.1 million and taking the position that the proposed Merger is not in the public interest because of the possible cost increases to CSW's subsidiaries, which the Staff attributed to increased financial risk associated with the proposed acquisition of El Paso. The Staff's recommendation was revised and increased to a $21.5 million increase in base rates for El Paso in October 1994. In addition, the Staff determined that the proposed purchase price for El Paso is too high by $300 to $500 million and disagreed with the estimates of the Merger-related savings presented by CSW and El Paso in the case. Hearings at the Texas Commission began on July 20, 1994 and were completed in early November 1994.\nEffective July 16, 1994, El Paso implemented under bond, a base rate increase of approximately $25 million annually for its Texas jurisdiction, which is subject to refund depending on the outcome of the rate case. The bonded increase in rates is authorized under PURA. Because of the current uncertainty as to the final outcome of the rate proceeding, El Paso has stated that it is deferring on its books the recognition of the revenues resulting from the increased rates.\n2-58 On January 3, 1995, the Texas Commission presiding officers who heard El Paso's pending rate case and the CSW and El Paso Merger case filed their proposed interim decision with the Texas Commission. The presiding officers proposed an initial base-rate increase for El Paso of $21.2 million. The PFD recommends a determination by the Texas Commission that the Merger and the reacquisition of the leased Paso Verde assets are in the public interest and that the purchase price to be paid to El Paso's creditors and equity holders is fair, subject to satisfactory resolution of the Las Cruces and Palo Verde problems. The presiding officers found Merger related benefits ranging from $309 million to $379.4 million over the first ten years of the Merger which the presiding officers allocated to El Paso's customers under the PFD.\nIn addition to recommending the imposition of conditions in the determination that the Merger is in the public interest, the PFD failed to provide sufficient revenue and adequate rate-making treatment for CSW to consummate the proposed Merger. Specifically, the presiding officers propose to reduce El Paso's rates by allocating to customers certain potential tax benefits related to the payment of lease rejection damages on the leased Palo Verde assets. Reallocation of these tax benefits to customers effectively increases the acquisition cost to CSW by $133 million. The presiding officers attempted to mitigate the economic effect of their allocation of these tax benefits by allowing recovery through rates of an acquisition adjustment over the remaining 33 year life of Palo Verde. However, CSW believes that the proposed recovery through rates of an acquisition adjustment has considerably less economic value than the tax deductions. The presiding officers also recommended a reduction in El Paso's rate moderation plan and disallowance of El Paso's Palo Verde Unit 3 deferred accounting assets. CSW believes that, in recommending these rate treatments, the PFD fails to recognize rate relief to which El Paso is entitled under previous Texas Commission decisions in El Paso rate cases. Additionally, the PFD proposed an 11.5% return on equity rather than a 12.5% return which CSW believes is necessary for El Paso to have the opportunity to earn a reasonable return on its equity. Finally, the presiding officers proposed that the Texas Commission's interim order be conditioned on the successful resolution of the loss of Las Cruces as a customer of El Paso and on the successful resolution of the Palo Verde steam generator problems.\nOn March 3, 1995, the Texas Commission issued an interim order in the El Paso rate case and proposed Merger with CSW. The interim order found the proposed Merger to be in the public interest and provides for a $24.9 million base rate increase for El Paso. The interim order adopted most of the recommendations of the presiding officers. The most significant revision to the presiding officers recommendations was an increase in the allowed return on equity from 11.5% to 12%. The presiding officers' recommendations were adopted in the interim decision for several significant issues even though agreement was not reached by the Texas Commission. The interim decision allows for motions for reconsideration to be filed on these issues. The Texas Commission has indicated that the motions for reconsideration will be granted to allow for a consensus of the Texas Commission to be reached on these issues prior to the effective date of the merger. These issues included conditioning approval of the merger on resolution of the Las Cruces and Palo Verde issues, the rate treatment of the tax effects of lease rejection damages, recovery of any acquisition adjustment and deferred costs associated with the regulatory lag period prior to the rate treatment of Palo Verde Unit 3. Pending resolution of these issues, the Texas Commission allowed El Paso's bonded rates to remain in effect until a subsequent interim decision is issued.\nThe Texas Commission severed fuel related issues from the El Paso rate case and issued a final order which allows for El Paso to lower fixed fuel factors by $14.3 million annually and to refund $13.7 million in fuel costs over a twelve month period.\nNew Mexico Commission Application On March 14, 1994, CSW and El Paso filed an application with the New Mexico Commission seeking approval of the pending Merger, the reacquisition of the leased Palo Verde assets and certain accounting treatments. On February 10, 1995, the New Mexico Commission Staff filed testimony recommending approval of each of\n2-59 these requests. El Paso plans to seek approval for the issuance of securities in connection with the Merger.\nOn October 27, 1994, the hearing examiner assigned to hear CSW and El Paso's Merger application before the New Mexico Commission issued an order amending the procedural schedule to provide for hearings beginning February 13, 1995. On December 21, 1994, the hearing examiner issued an order granting a two week extension to the procedural schedule, resulting in hearings beginning February 27, 1995. Hearings in New Mexico were completed on March 2, 1995. This revised schedule allows for the issuance of a final order by the New Mexico Commission by June 1995. However, CSW cannot predict when a final order may be issued by the New Mexico Commission.\nFERC Applications On November 4, 1993, CSWS, as agent for the Electric Operating Companies and El Paso, filed an application with the FERC under Section 211 of the Federal Power Act seeking an order of the FERC and requiring SPS to provide firm and non-firm transmission services in connection with the transfers of power between PSO and El Paso in connection with the post-Merger coordinated operations of the Electric Operating Companies and El Paso. The intent of the transmission services is to obtain the benefits of integrated operations and thereby meet the requirement of the Holding Company Act that the Electric Operating Companies and El Paso be physically interconnected or capable of physical interconnection and economically operated as a single interconnected and coordinated electric system. SPS subsequently requested that the application be dismissed or, in the alternative, be set for hearing.\nOn January 10, 1994, as supplemented on January 13, 1994, CSWS, on behalf of the Electric Operating Companies and El Paso, filed a joint application with the FERC under Sections 203 and 205 of the Federal Power Act requesting approval by the FERC of the Merger. CSWS and El Paso have requested expedited consideration of the joint application. However, CSW cannot predict at this time when the FERC will issue a final decision on the joint application.\nOn August 1, 1994, the FERC issued orders in two proceedings that relate to the Merger. In an order issued under Section 211 of the Federal Power Act, the FERC preliminarily found that \"a final order requiring SPS to provide the transmission service requested by the Applicants would comply with the statutory standards, once reliability concerns have been met.\" The FERC's order rejects assertions made by SPS that the FERC has no authority under Section 211 to order transmission service where the purpose of the service is to allow coordination of merging utilities' operations. The order directed SPS to perform studies so that the FERC can determine whether provision of the requested transmission service will unreasonably impair reliability. Such studies and supplemental pleadings analyzing the studies were filed with the FERC in early October and November 1994. If, after reviewing the studies and comments filed by SPS, CSWS and El Paso, the FERC concludes that reliability will not be unreasonably impaired, the FERC will issue a further \"proposed order\" requiring El Paso, CSWS and SPS to negotiate the rates, terms and conditions on which the requested transmission service will be provided.\nThe FERC also issued an order under Section 203 of the FPA in which the FERC ruled that it will require merging utilities to offer transmission service to others on a basis that is comparable to their own uses of their transmission systems. On August 10, 1994, CSW and El Paso notified the FERC that they will accept, as a condition to the FERC's approval of CSW's acquisition of El Paso, the requirement to amend their non-ERCOT transmission tariffs to offer \"comparable service.\" On August 31, 1994, CSW and El Paso filed with the FERC a request for rehearing that, among other things, asks the FERC to reconsider the imposition of the comparable service requirement. On August 31, 1994, CSW and El Paso also filed the form of transmission tariffs they would propose to file with the FERC in order to meet the comparable service requirement if the requirement is upheld and the Merger is consummated. In agreeing to accept, as a condition to the Merger, the requirement that comparable service be provided over CSW's and El Paso's non-ERCOT transmission facilities, both CSW and El Paso\n2-60 do not intend to waive or otherwise prejudice any of their rights, including but not limited to the right to seek rehearing of the order or any other order the FERC later enters in these proceedings. In addition, both CSW and El Paso do not intend to waive or otherwise prejudice their right under the FPA to seek judicial review of the order or any subsequent order or orders, if and to the extent CSW and El Paso deem such action necessary or advisable.\nThe FERC has not yet determined what \"comparable service\" is. However, the FERC said it will establish what uses PSO, SWEPCO and El Paso make of their own systems. The FERC will also examine likely costs and benefits of the Merger and determine whether the Merger is consistent with the public interest. The FERC has instructed one of its administrative law judges to issue an initial decision by April 14, 1995. A FERC administrative law judge established a procedural schedule whereby hearings began January 3, 1995. Hearings ended January 25, 1995, and the judge's initial decision is expected to be issued on or before April 5, 1995.\nOn November 15, 1994, the FERC trial staff filed its testimony in the Merger proceeding. The FERC staff determined that the proposed Merger will result in total savings of $414 million, $265 million in net present value for the period 1995 through 2004 of post-Merger operations. This compares to Merger savings projected by CSW for the same period of $420 million, or $280 million in net present value. The staff found $140.7 million in non-fuel O&M expense savings, $109.0 million in financial savings, and $15.3 million in production cost savings.\nThe FERC staff has recommended that approval of the Merger be made subject to two conditions. As required in the FERC's August 1, 1994 order, the merged companies must offer the use of their non- ERCOT transmission system to others under rates, terms and conditions comparable to the rates, terms and conditions under which CSW will use their non-ERCOT transmission system. The FERC staff has also recommended that the Merger be approved, conditioned on the existing CSW Operating Companies not being allocated any transmission costs associated with firm transmission service across SPS's system in excess of $24.6 million, which is the amount CSW projects through 2004.\nThe FERC staff also determined that \"hold harmless conditions\" proposed by various state utility commissions and other intervenors to protect CSW Operating Companies from certain potential effects of the Merger are unnecessary to assure that the Merger is in the public interest. The FERC staff concluded that:\nAs proposed, the Merger is beneficial to El Paso and is roughly neutral with respect to the four present CSW Operating Companies. If enacted as proposed, with the Applicants' voluntary offer to exclude Merger-related transmission expenses of non-affiliates from the transmission customers of CSW's four current Operating Companies, the Merger should not substantially harm any class of wholesale customers.\nSEC Application On January 10, 1994, CSW filed with the SEC an application under the Holding Company Act seeking authorization of (i) the Merger and reacquisition of the Palo Verde leased assets, (ii) the issuance of securities by CSW and El Paso in connection with the Modified Plan and Merger and certain related transactions, and (iii) to engage in certain hedging transactions in connection with the Merger. CSW subsequently amended the application to eliminate the request for authorization to engage in certain hedging transactions, at the request of the SEC staff. CSW has subsequently amended and supplemented the application and has filed a brief in response to intervention petitions. CSW cannot predict what action the SEC will take with respect to the application, or when such action will be taken.\n2-61 NRC Application On January 13, 1994, APS, as operating agent for Palo Verde, joined by El Paso, filed a request with the NRC for (i) consent to the indirect transfer of El Paso's interest in the operating licenses for Palo Verde Units 1, 2, and 3 that will occur as a result of the Merger, and (ii) to amend the operating licenses for Units 2 and 3 to delete provisions of those licenses related to El Paso's sale and leaseback transactions involving those units. The request to the NRC specifies that the proposed amendments to the operating licenses and consent become effective on the Effective Date, but CSW cannot predict at this time whether and, if so, when the approvals and consent will be granted.\nPalo Verde The operating agent of Palo Verde, APS, discovered axial cracking in steam generator tubes in Unit 2 following a tube rupture in March 1993. APS began an ongoing examination and analysis of the tubes in each of the two steam generators in each unit of Palo Verde and, as a result, has identified axial cracking in Unit 3 and another more common type of cracking in the steam generator tubes of all three units. APS has indicated that it believes the axial cracking in Units 2 and 3 is due to the susceptibility of tube materials to a combination of deposits on the tubes and the relatively high temperatures at which all three units at Palo Verde are designed to operate. According to statements by APS and El Paso, the form of the degradation experienced in the steam generators is uncommon in the nuclear industry. APS has stated that it believes it can retard further tube degradation to acceptable levels by remedial actions, which include chemically cleaning the steam generators and performing analyses and adjustments that will allow the units to be operated at lower temperatures without appreciably reducing their power output. These analyses and adjustments have been performed on all three units, with each unit operating at 100% of capability. All remedial actions have been completed on each of the three units, except for chemically cleaning Unit 1 which is scheduled for April 1995. El Paso has stated that it is incurring increased maintenance costs related to the mid-cycle inspections of the steam generator tubes and the remedial actions being undertaken to retard tube degradation. El Paso also incurs additional costs for fuel and\/or purchased power during periods in which one or more units are removed from service every 6 months for inspections. In its September 12, 1994 letter to El Paso, CSW stated that the significance of the tube cracking problems will have to be determined before CSW will close the Merger.\nOther El Paso is subject to the informational requirements of the Securities and Exchange Act of 1934, as amended, and in accordance therewith files reports and other information with the SEC. See El Paso's Quarterly Reports on Form 10-Q, its Current Reports on Form 8-K and its Annual Report on Form 10-K and the documents referenced therein.\nCSW continues to use its best efforts to consummate the Merger. At the same time, however, CSW continues to monitor contingencies which may preclude the consummation of the Merger, including without limitation the potential loss of significant portions of El Paso's service area and significant El Paso customers, including Las Cruces and two military installations, Holloman Air Force Base and White Sands Missile Range, regulatory risks principally related to approval of the Merger and El Paso's request for a rate increase in Texas as well as the effects of the conditions imposed by federal or state regulatory agencies on the approval of the Merger, and operating risks associated with the ownership of an interest in Palo Verde.\nBased upon El Paso's written response to the concerns identified in CSW's September 12 letter and the failure of El Paso to resolve items set forth in the preceding paragraph, CSW cannot predict whether, and if so when, the Merger will be consummated. In the event that the proposed Merger is not consummated, there may be ensuing litigation between El Paso and CSW or among other parties to El Paso's bankruptcy proceedings and either or both of El Paso and CSW.\n2-62 See MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Proposed Acquisition of El Paso, for further information.\nOther Commitments and Contingencies\nConstruction It is estimated that the CSW System will spend approximately $385 million in construction expenditures during 1995. Substantial commitments have been made in connection with this construction expenditure program.\nFuel To supply a portion of the fuel requirements of the CSW System, the subsidiary companies have entered into various commitments for the procurement of fuel.\nSWEPCO Henry W. Pirkey Power Plant In connection with the South Hallsville lignite mining contract for its Henry W. Pirkey Power Plant, SWEPCO has agreed, under certain conditions, to assume the obligations of the mining contractor. As of December 31, 1994, the maximum amount SWEPCO would have to assume was $73.7 million. The maximum amount may vary as the mining contractor's need for funds fluctuates. The contractor's actual obligation outstanding at December 31, 1994 was $60.9 million.\nSouth Hallsville Lignite Mine As part of the process to receive a renewal of a Texas Railroad Commission permit for lignite mining at the South Hallsville lignite mine, SWEPCO has agreed to provide bond guarantees on mine reclamation in the amount of $70 million. Since SWEPCO uses self- bonding, the guarantee provides for SWEPCO to commit to use its resources to complete the reclamation in the event the work is not completed by the third party miner. The current estimate of cost to reclaim the mine is estimated to be approximately $25 million.\nCoal Transportation SWEPCO has entered into various financing arrangements primarily with respect to coal transportation and related equipment, which are treated as operating leases for rate-making purposes. At December 31, 1994, leased assets of $46 million, net of accumulated amortization of $30.1 million, were included in electric plant on the balance sheet and at December 31, 1993, leased assets were $46 million, net of accumulated amortization of $26.8 million. Total charges to operating expenses for leases were $6.8 million, $7.1 million, and $6.9 million for the years 1994, 1993, and 1992.\nSuspected MGP Site in Marshall, Texas SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO has accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\nSuspected MGP Site in Texarkana, Texas and Arkansas and Shreveport, Louisiana SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\n2-63 Biloxi, Mississippi MGP Site SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nManagement does not expect these matters to have a material effect on CSW's consolidated results of operations or financial position.\nWTU WTU has a sale\/leaseback agreement with Transok for full capacity use of a natural gas pipeline to WTU's Ft. Phantom generating plant. The lease agreement also provides for full capacity use of Transok's natural gas pipelines serving WTU's San Angelo and Oak Creek generating plants. The initial terms of the agreement are for twelve years with renewable options thereafter.\nCPL Nuclear Insurance In 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 $8.92 billion per incident, effective as of January 1995. 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 $8.72 billion. The maximum amount that each licensee may be assessed under the industry-wide program of self-insurance following a nuclear incident at an insured facility is $75.5 million per reactor, 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. CPL and each of the other STP owners are subject to such assessments, which CPL and other owners have agreed will be allocated 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 $2.75 billion provided by ANI and NEIL. Policies of insurance issued by ANI and NEIL stipulate that policy proceeds must be used first to pay decontamination and clean-up costs before being used to cover direct losses to property. Under project agreements, CPL and the other owners of STP will share the total cost of decontamination liability and property insurance for STP, including premiums and assessments, on a pro rata basis, according to each owner's respective ownership interest in STP.\nCPL purchases, for its own account, a NEIL I Business Interruption and\/or Extra Expense policy. This insurance will reimburse CPL for extra expenses incurred, up to $1.65 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 $111.3 million and for Unit 2 is $111.8 million. CPL is subject to an additional assessment up to $2.1 million for the current policy\n2-64 year in the event that losses as a result of a covered accident at a nuclear facility insured under the NEIL I policy exceeds the accumulated funds available under the policy.\nOn August 28, 1994, CPL filed a claim under the NEIL I policy related to the outage at STP Units 1 and 2. NEIL is currently reviewing the claim. CPL management is unable to predict the ultimate outcome of this matter.\nCSWE CSWE has provided construction services to the Mulberry cogeneration facility through a wholly-owned subsidiary, CSW Development-I, Inc. The project achieved commercial operation in August 1994 and added 117 MWs of on-line capacity of which CSWE owns 50%. CSWE's maximum potential liability under the fixed price contract is $83 million and will decrease to zero over the next two years as contractual standards are met. Additionally, CSW Development-I, Inc. has entered into a fixed price contract to construct the Mulberry thermal host facility. The maximum potential liability under this fixed price contract is $14 million. The thermal host facility is expected to be completed by the first quarter of 1995. CSW has provided additional guarantees to the project totaling approximately $57 million.\nCSWE has entered into a purchase agreement on the Ft. Lupton project to provide $79.5 million of equity upon the occurrence of certain events. As of January 9, 1995, $43 million has been paid. CSWE has provided three letters of credit to the project totaling $14.3 million. During March 1995, CSWE closed permanent project financing on the Ft. Lupton facility in the amount of $208 million.\nCSWE has committed to provide up to $125 million of construction financing to the Orange cogeneration project in which CSWE owns a 50% interest. Of this total, CSWE has provided $62 million at December 31, 1994. CSWE expects to obtain third party permanent financing for this project in 1995.\nIn November 1994, CSWE transferred its 50% interest in the 40 MW Oildale cogeneration facility to two non-affiliated third parties, Oildale Holdings, Inc. and Oildale Holdings II, Inc. The Oildale project, which was financed with third party non-recourse project financing, had been in default of certain provisions of its loan agreement since December 1993. Under the terms of the project transfer, CSWE contributed $3 million in equity in exchange for the return of a letter of credit in the same amount in favor of a third party lender.\nIn addition, CSWE has posted security deposits and other security instruments of approximately $14 million on six additional projects in various stages of development, construction, and operation.\n2-65 12. Business Segments CSW's business segments include electric utility operations (CPL, PSO, SWEPCO, WTU), and gas operations (Transok). Seven non- utility companies are included in corporate items (CSWE, CSWI, CSW Communications, CSW Credit, CSW Leasing, CSWS and CSW). CSW's business segment information follows: 1994 1993 1992 (millions) Operating Revenues Electric $ 3,065 $ 3,055 $ 2,790 Gas 518 603 496 Corporate items and other 40 29 3 $ 3,623 $ 3,687 $ 3,289 Operating Income Electric $ 728 $ 559 $ 694 Gas 49 25 42 Corporate items and other 6 5 1 Total operating income before taxes 783 589 737 Income taxes 189 132 149 $ 594 $ 457 $ 588 Depreciation and Amortization Electric $ 316 $ 296 $ 284 Gas 32 29 22 Corporate items and other 8 5 5 $ 356 $ 330 $ 311 Identifiable Assets Electric $ 9,066 $ 8,927 $ 8,575 Gas 724 684 674 Corporate items and other 1,119 993 580 $10,909 $10,604 $ 9,829 Capital expenditures and acquisitions Electric $ 493 $ 481 $ 325 Gas 65 88 101 Corporate items and other (1) 114 64 31 $ 672 $ 633 $ 457\n(1) Includes CSWE Equity Investments.\n2-66 13. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts. Earnings per Share Operating Operating Net of Common Quarter Ended Revenues Income Income Stock (millions) March 31 $ 850 $ 93 $ 48 $0.23 June 30 908 157 107 0.55 September 30 1,070 239 189 0.97 December 31 795 105 68 0.33 $3,623 $ 594 $ 412 $2.08\nMarch 31 $ 810 $ 97 $ 92 $0.47 June 30 894 144 96 0.48 September 30 1,140 219 181 0.93 December 31 843 (3) (42) (0.25) $3,687 $ 457 $ 327 $1.63\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-67 Report of Independent Public Accountants\nTo the Stockholders and Board of Directors of Central and South West Corporation:\nWe have audited the accompanying consolidated balance sheets of Central and South West Corporation (a Delaware corporation) and subsidiary companies, as of December 31, 1994 and 1993, and the related consolidated statements of income, retained earnings and cash flows, for each of the three years in the period ended December 31, 1994. 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 financial position of Central and South West Corporation and subsidiary companies as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, Central and South West Corporation and subsidiary companies changed their methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly states 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 LLP\nDallas, Texas February 13, 1995\n2-68 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the consolidated financial statements of Central and South West Corporation and subsidiary companies as well as other information contained in this Annual Report. The consolidated 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 Annual Report is consistent with that in the consolidated financial statements.\nThe consolidated financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of stockholders, the board of directors and committees of the board. CSW and its subsidiaries believe that representations made to the independent auditors during their audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nCSW, together with its subsidiary companies, maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the consolidated financial statements are prepared in accordance with generally accepted accounting principles and that the assets of CSW and its subsidiaries are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that the companies will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of CSW or its subsidiaries, provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nCSW and its subsidiaries believe that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nE. R. Brooks Glenn D. Rosilier Wendy G. Hargus Chairman, President and Senior Vice President and Controller Chief Executive Officer Chief Financial Officer\n2-70\nCPL\nCENTRAL POWER AND LIGHT COMPANY Selected Financial Data CPL The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for CPL.\n1994 1993 1992 1991 1990 (thousands, except ratios) Electric Operating Revenues $1,217,979 $1,223,528 $1,113,423 $1,098,730 $ 948,520 Income Before Cumulative Effect of Changes in Accounting Principles 205,439 145,130 218,511 217,206 204,870 Cumulative Effect of Changes in Accounting Principles (1) -- 27,295 -- -- -- Net Income 205,439 172,425 218,511 217,206 204,870 Preferred Stock Dividends 13,804 14,003 16,070 19,844 23,528 Net Income for Common Stock 191,635 158,422 202,441 197,362 181,342\nTotal Assets (2) 4,822,699 4,781,745 4,583,660 4,458,063 4,516,375\nCommon Stock Equity 1,431,354 1,424,195 1,437,876 1,428,547 1,449,409 Preferred Stock Not Subject to Mandatory Redemption 250,351 250,351 250,351 250,351 250,351 Subject to Mandatory Redemption -- 22,021 28,393 35,331 40,584 Long-term Debt 1,466,393 1,362,799 1,347,887 1,350,854 1,346,587\nRatio of Earnings to Fixed Charges (SEC Method) Before Cumulative Effect of Changes in Accounting Principles 3.24 2.69 3.23 3.18 3.11\nCapitalization Ratios Common Stock Equity 45.5% 46.6% 46.9% 46.6% 47.0% Preferred Stock 7.9 8.9 9.1 9.3 9.4 Long-term Debt 46.6 44.5 44.0 44.1 43.6\n(1) The 1993 cumulative effect relates to the changes in accounting for unbilled revenues and adoption of SFAS No. 112. See NOTE 1, Summary of Significant Accounting Policies.\n(2) The 1992-1990 total assets have been reclassified to reflect the effects of the adoption in 1993 of SFAS No. 109. See NOTE 2, Federal Income Taxes.\nCPL changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore has not been restated.\n2-71 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nCENTRAL POWER AND LIGHT COMPANY\nReference is made to CPL's Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential in understanding, the following discussion and analysis.\nOverview Net income for common stock for 1994 increased 21% to $192 million from $158 million in 1993. The increase was due primarily to an increase in base revenues, a decrease in restructuring costs and a decrease in maintenance expense. Such increases were partially offset by the cumulative effect of changes in accounting principles recorded in 1993.\nRestructuring As previously reported, CPL has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable CPL to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $29 million and were expensed in 1993. The final costs of the restructuring were approximately $29 million. Approximately $28 million of the restructuring expenditures were incurred during 1994, with the remaining $1 million expected to be incurred during 1995. Approximately $4 million of the restructuring expenses relate to employee termination benefits, $15 million relate to enhanced benefit costs and $10 million relate to employees that will not be terminated. Approximately $21 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $8 million represents the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nCPL expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. The CSW System expects that all restructuring costs will be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nSTP Introduction CPL owns 25.2% of STP, a two-unit nuclear power plant which is located near Bay City, Texas. In addition to CPL, 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.\nFrom February 1993 until May 1994, STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL. These matters, including a base rate case and fuel reconciliation proceedings, are discussed immediately below.\nSTP Outage In February 1993, Units 1 and 2 of STP were shut down by HLP in an unscheduled outage resulting from mechanical problems. HLP determined that the units would not be restarted until the equipment failures had been corrected and the NRC was briefed on the causes of\n2-72 these failures and the corrective actions that were taken. The NRC formalized that commitment in a confirmatory action letter that it supplemented to identify additional issues to be resolved and verified by the NRC before STP could be restarted.\nDuring the outage, the necessary improvements were 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 agreed with HLP's recommendation that Unit 1 was ready to restart. Unit 1 restarted on February 25, 1994 and reached 100% power on April 8, 1994. Subsequently, the issues with respect to Unit 2 were resolved and the NRC on May 17, 1994 agreed with HLP's recommendation to restart Unit 2. Unit 2 resumed operation on May 30, 1994 and reached 100% power on June 16, 1994. During 1994, Unit 1 and Unit 2 achieved annual net capacity factors of 75.3% and 54.7%, respectively. During the last six months of 1994, the STP units operated at capacity factors of 98.6% for Unit 1 and 99.2% for Unit 2.\nIn June 1993, the NRC placed STP on its \"watch list\" of plants with \"weaknesses that warrant increased NRC attention.\" The decision to place STP on the watch list followed the June 1993 issuance of a report by an NRC Diagnostic Evaluation Team which conducted a review of STP operations.\nOn February 3, 1995, the NRC removed STP from the \"watch list\". The NRC noted that the four key areas for their decision were sustained improvement throughout 1994, high standards of performance exhibited by the plant, effective maintenance and engineering support resulting in reduced equipment repair backlogs and improved plant reliability, and the open and positive employee climate at the plant. With the NRC reviewing the \"watch list\" status every 6 months and with Unit 2 achieving 100% power in June of 1994, the February review was the first realistic opportunity for STP to be considered for a change in status. On average, plants previously placed on the \"watch list\" have stayed on the list for 29 months.\nRates and Regulatory Matters CPL Rate Inquiry Several Cities, the Texas Commission General Counsel and others initiated actions in late 1993 and early 1994 which, if approved by the Texas Commission, would lower CPL's base rates. The requests for a review of CPL's rates arose out of the unscheduled outage at STP which began in February 1993. The STP outage did not affect CPL's ability to meet customer demand because of existing capacity and CPL's purchase of additional energy.\nCPL submitted an RFP on July 1, 1994, to the Texas Commission justifying its current base rate structure. Parties to CPL's base rate case have filed testimony with the Texas Commission recommending reductions in CPL's retail base rates of up to $147 million annually, resulting from a combination of proposed rate base and cost of service reductions, as well as a rate base disallowance of up to $400 million.\nThe Texas Commission held hearings in November and December 1994, and all parties have filed briefs in the case. The ALJ is expected to issue a recommended order for consideration by the Texas Commission in April 1995 with a final order from the Texas Commission expected in May 1995. Testimony filed by parties to the rate case, including the Staff, is not binding on either the ALJ or the Texas Commission.\nCPL continues to maintain that its rates are reasonable and that its earnings are within established regulatory guidelines. In addition, CPL strongly believes that 100 percent of its investment in both units of STP belongs in rate base. This belief is based on, among other factors, Units 1 and 2 providing output at high capacity factors since April and June 1994, respectively. In addition, the long-term benefits nuclear generation provides to customers further support their inclusion in rate base. Furthermore, there are no Texas Commission precedents addressing the removal of a nuclear plant from rate base as a performance disallowance. Assuming both units of STP are included in rate base, CPL believes it is not collecting excessive revenues, notwithstanding that market rates of return on\n2-73 common equity are generally lower today than they were in 1990 and 1991, when CPL's base rates were last set.\nCPL Fuel Pursuant to the substantive rules of the Texas Commission, CPL generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and CPL'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 from revenues, with a corresponding entry to unrecovered fuel costs 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.\nCPL is currently involved in two proceedings before the Texas Commission relating to the recovery of fuel and purchased power costs. CPL originally filed Docket No. 12154 seeking approval of a customer surcharge to recover fuel and purchased power costs, including those resulting from the STP outage. In Docket No. 13126, the Texas Commission General Counsel and others are reviewing the prudence of management activities at STP. In November 1994, CPL filed a fuel reconciliation case in Docket No. 13650 with the Texas Commission seeking to reconcile fuel costs since March 1, 1990, including the period during which CPL's fuel and purchased power costs were increased due to the STP outage. At December 31, 1994, CPL's under-recovered fuel balance was $54.1 million, exclusive of interest, which was due primarily to the STP outage. If a significant portion of the fuel costs were disallowed by the Texas Commission, CPL could experience a material adverse effect on its results of operations in the year of disallowance but not on its financial condition. Finally, in Docket No. 13126, the Texas Commission General Counsel is reviewing the prudence of management activities at STP. On January 4, 1995, Docket No. 12154 was consolidated into Docket No. 13650. The results of the prudence inquiry in Docket No. 13126 are expected to be incorporated into the fuel reconciliation proceedings in Docket No. 13650.\nCPL continues to negotiate with the intervening parties to resolve these matters through settlement. However, no settlement has been reached to date.\nManagement cannot predict the ultimate outcome of the CPL rate inquiry and CPL fuel regulatory proceedings. However, management believes that the ultimate resolution of the various issues will not have a material adverse effect on CPL's results of operations or financial condition.\nSee NOTE 9, Litigation and Regulatory Proceedings - STP, for a discussion of regulatory proceedings arising out of the STP outage and background on STP rate orders and deferred accounting.\nNuclear Decommissioning CPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning and is net of expected earnings on the trust fund.\nThe staff of the SEC has questioned certain of the current accounting practices of the electric utility industry regarding the recognition, measurement and classification of decommissioning costs for nuclear generating stations. In response to these questions, FASB has agreed to review the accounting for removal costs, including decommissioning. If current electric utility industry accounting practices for such decommissioning are changed, (i) annual provisions for decommissioning could increase, (ii) the estimated cost for decommissioning could be recorded as a liability rather than as accumulated depreciation, and (iii) trust fund income from the external decommissioning trusts could be reported as investment income rather than as a reduction to decommissioning expense.\n2-74 See NOTE 1, Summary of Significant Accounting Policies - Nuclear Decommissioning, for further information regarding CPL's decommissioning of STP.\nNew Accounting Standards SFAS No. 115 was effective for fiscal years beginning after December 15, 1993. CPL adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on CPL's results of operations or financial condition.\nIn June 1993 the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by CPL for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on CPL's results of operations or financial condition.\nSFAS No. 119 was effective for fiscal years ending after December 15, 1994. CPL does not currently use derivative instruments, but may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on CPL's results of operations or financial condition.\nLiquidity and Capital Resources Overview CPL's need for capital results primarily from its construction of facilities to provide reliable electric service to its customers. Accordingly, internally generated funds should meet most of the capital requirements. However, if internally generated funds are not sufficient, CPL's financial condition should allow it access to the capital markets.\nCapital Expenditures Construction expenditures, including AFUDC, were approximately $178 million in 1994, $180 million in 1993, and $102 million in 1992. It is estimated that construction expenditures, including AFUDC, during the 1995 through 1997 period will aggregate $357 million. Such expenditures primarily will be made to improve and expand distribution facilities. These improvements are expected to meet the needs of new customers and to satisfy changing requirements of existing customers. No new baseload power plants are currently planned until after year 2000.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in CPL's service area, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected coal- and lignite-fired generating plants for which CPL has invested approximately $21 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, CPL would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of CPL were 45% common stock equity, 8% preferred stock and 47% long-term debt. CPL continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. CPL continues to be committed to maintaining financial flexibility by maintaining a strong capital structure and favorable securities ratings which should allow funds to be obtained from the capital markets when required.\n2-75 CPL's long-term financing activity for 1994 is summarized as follows:\nIn May, CPL issued $100 million of 7-1\/2% First Mortgage Bonds, Series JJ, due May 1, 1999. Net proceeds were used to repay a portion of CPL's short-term borrowings.\nIn July and August, CPL reacquired $0.6 million of 9-3\/8% First Mortgage Bonds, Series Z, due December 1, 2019. The funds required for this transaction were provided from internal sources.\nIn August, CPL retired $22.4 million, all remaining shares outstanding, of its 10.05% Series Preferred Stock. The funds required for this transaction were provided from internal sources and short- term borrowings.\nCPL has $260 million remaining for the issuance of first mortgage bonds under a shelf registration statement filed with the SEC in 1993. CPL may offer additional first mortgage bonds subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost first mortgage bonds in order to lower CPL's embedded cost of debt.\nCPL has $75 million available for issuance of preferred stock under a shelf registration statement filed with the SEC in March 1994. CPL may offer preferred stock subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost preferred stock and to repay short-term debt.\nShort-Term Financing CPL, together with other members of CSW System, has established a CSW System money pool to coordinate short-term borrowings. These loans are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs. CPL's short-term borrowing limit from the money pool is $300 million. During 1994, the annual weighted average interest rate was 4.5% and the average amount of short- term month-end borrowings outstanding was $129 million. The maximum amount of short-term borrowings outstanding at any month-end during 1994 was $232 million, which was the amount outstanding at February 28, 1994.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. CPL uses short- term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. CPL anticipates that capital requirements for the period 1995 to 1997 will be met, in large part, from internal sources. CPL also anticipates that some external financing will be required during the period, but the nature, timing and extent have not yet been determined. Information concerning internally generated funds follows:\n1994 1993 1992 (millions) Internally Generated Funds $114 $92 $95\nConstruction Expenditures Provided by Internally Generated Funds 65% 52% 94%\nSales of Accounts Receivable CPL sells its billed and unbilled accounts receivable, without recourse, to CSW Credit. The sales provided CPL with cash immediately, thereby reducing working capital needs and revenue requirements. The average and year end amounts of accounts receivable sold were $121.9 million and $113.5 million in 1994, as compared to $112.3 million and $105.8 million in 1993.\n2-76 Recent Developments and Trends Competition and Industry Challenges Competitive forces at work in the electric utility industry are impacting CPL and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, CPL will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. CPL believes that its prices for electricity and the quality and reliability of its service currently places it in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While CPL believes that the Energy Policy Act will continue to make the wholesale markets more competitive, CPL is unable to predict the extent to which the Energy Policy Act will impact its operations.\nIncreasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. CPL competes in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities, but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers.\nCPL believes that, compared to other electric utilities, it is well positioned to meet future competition. CPL benefits from economies of scale and scope by virtue of its size and its relationship to the CSW System. Moreover, CPL is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nCPL is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or on CPL. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\n2-77 Public Utility Regulatory Act PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. CPL is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted. If, however, the Texas Legislature passes legislation permitting any form of retail wheeling, such legislation could have an adverse impact on CPL and CPL's sales to its retail customers.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, CPL has recognized significant regulatory assets and liabilities. Management believes that CPL will continue to meet the criteria for following SFAS No. 71. However, in the event CPL no longer meets the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nConsolidated Taxes The Texas Commission before 1992 allowed income taxes to be recovered in rates based on the federal income tax incurred by a utility as if it were a stand-alone company. This stand-alone approach treated the regulated activities of a utility as a separate entity and considered only those revenues and expenses that are included in the utility's cost of service to calculate the federal income tax liability for ratemaking purposes.\nBeginning in 1992, the Texas Commission changed its method of calculating the federal income tax component of rates to the \"actual tax approach.\" The actual tax approach is an evolving concept but generally seeks to reflect in rates the actual tax liability of the utility irrespective of its relationship to the utility's cost of service. The approach reduces rates by the tax benefits of deductions which are not considered for or included in setting rates for the utility.\nThe Texas Commission is expected to use the actual tax approach for calculating the recovery of federal income tax in the pending rate case for CPL. The impact of the actual tax approach on the prospective rates for CPL cannot be determined since the application of the concept is unsettled.\nCPL believes that the recovery of federal income taxes in rates should be determined on the stand-alone approach for ratemaking purposes, but there is no assurance this approach will be adopted in the pending CPL rate case.\nEnvironmental Matters CERCLA and Related Matters The operations of CPL, like those of other utilities, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nCPL is subject to various pending claims alleging it is a PRP under federal or state remedial laws for investigating and cleaning up contaminated property. CPL anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on CPL's results of operations or financial condition.\n2-78 Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by CPL, the estimated amount of costs allocated to CPL and the participation of other parties.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, CPL will be required to hold allowances in order to emit sulfur dioxide. The EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, CPL believes that its allowances will be adequate to meet its needs at least through 2008. Public and private markets are developing for trading of excess allowances. CPL presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\nThe Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on CPL cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, CPL expects to spend $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects. Although a few of the studies to date have suggested certain associations between EMFs and some types of effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. CPL cannot predict the impact on CPL or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nResults of Operations Electric Operating Revenues Total revenues decreased $5.5 million in 1994 and increased $110.1 million in 1993. The 1994 decrease reflects lower fuel- related revenues of $41.5 million partially offset by higher base revenues of $35.9 million. Fuel-related revenues declined as a result of lower per unit fuel and purchased power costs, as discussed below.\nTotal KWH sales were up 8%, reflecting growth of 7% in retail sales and 41% in lower margin sales for resale. All of CPL's retail classes showed KWH growth with increases of 6% in both residential and commercial sales. An increase in the number of residential and commercial customers served and warmer spring as well as summer weather also contributed to this growth. Industrial sales were up 8% as a result of higher demand in the petrochemical and petroleum industries, where several companies CPL serves had plant expansions and increased load requirements. The rise in sales for resale is attributable to warmer summer and spring weather and lower cost STP generation.\nThe increase in revenues in 1993 over 1992 reflects higher fuel- related revenues and greater base revenues. Fuel-related revenues were up because of the rise in per unit fuel and purchased power costs, as discussed below, and higher fuel consumption on greater KWH sales.\n2-79 Fuel and Purchased Power Fuel expense decreased $21.8 million or 6% due primarily to a decrease in the average unit cost of fuel from $2.17 in 1993 to $1.75 in 1994 partially offset by a 16% increase in generation. The lower average unit cost of fuel reflects increased usage of lower unit cost nuclear fuel since STP Units 1 and 2 restarted and reached 100 percent output level in April and June of 1994, respectively, and lower unit costs of gas and coal in 1994. STP Units 1 and 2 had not operated at full capacity since February 1993 as discussed in Litigation and Regulatory Proceedings in NOTE 9.\nFuel expense increased in 1993 due primarily to higher fuel consumption in both gas and coal as a result of the STP outage and an increase in the average unit cost of fuel from $1.70 in 1992 to $2.17 in 1993.\nPurchased power decreased $21.7 million during 1994 and increased $46.9 million in 1993 when compared to the prior year due to the outage at STP.\nOther Operating and Maintenance Expenses and Taxes Other operating expenses were relatively stable in 1994 and increased $40.5 million or 22% in 1993 when compared to the prior year.\nThe 1993 increase in other operating expenses was due primarily to the higher costs associated with the STP outage and increased pension and medical costs, which included implementation of SFAS No. 106.\nRestructuring charges reflect the initial estimated cost of $29 million as previously discussed. Such expenses include the estimated costs associated with the early retirement program, severance packages and relocation.\nMaintenance expense decreased $12.8 million during 1994 and increased $20.0 million in 1993 when compared to the prior year due primarily to maintenance activities at STP associated with the outage.\nDepreciation and amortization increased in 1994 and 1993 as a result of increases in depreciable plant. The increase in 1994 is also attributable to a decline in amortization credits related to power plant investment.\nTaxes, other than federal income, decreased in 1994 mainly as a result of a franchise tax refund. The increase in 1993 is largely a result of increased ad valorem taxes.\nFederal income taxes increased $10.2 million in 1994 due to higher pre-tax income. Federal income taxes decreased $12.1 million in 1993 due to lower pre-tax income partially offset by the increase in the statutory tax rate from 34% to 35% effective retroactive to January 1, 1993.\nInflation Annual inflation rates, as measured by the Consumer Price Index, have averaged 2.7% during the three years ended December 31, 1994. CPL believes that inflation, at these levels, does not materially affect its results of operation 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.\nMirror CWIP Liability Amortization CPL is amortizing its Mirror CWIP liability in declining amounts over the years 1991 through 1995. Non-cash earnings of $68 million were recognized in 1994, a decrease from the $75.7 million recognized in 1993. The remaining liability to be amortized for 1995 is $41 million, which will fully amortize the Mirror CWIP liability.\n2-80 Cumulative Effect of Changes in Accounting Principles In 1993, CPL changed its method of accounting for unbilled revenues and implemented SFAS No. 112. These accounting changes had a cumulative effect of increasing net income by $27.3 million.\n2-81 Statements of Income Central Power and Light Company For the Years Ended December 31, 1994 1993 1992 (thousands)\nElectric Operating Revenues Residential $ 474,480 $ 474,426 $ 432,295 Commercial 368,405 369,426 342,201 Industrial 271,738 281,247 240,341 Sales for resale 50,777 45,369 50,342 Other 52,579 53,060 48,244 1,217,979 1,223,528 1,113,423 Operating Expenses and Taxes Fuel 328,460 350,268 306,939 Purchased power 42,342 64,025 17,160 Other operating 224,852 225,034 184,514 Restructuring charges 98 29,365 -- Maintenance 68,537 81,352 61,399 Depreciation and amortization 141,622 131,825 129,131 Taxes, other than federal income 80,461 86,394 70,343 Federal income taxes 75,356 65,186 77,272 961,728 1,033,449 846,758\nOperating Income 256,251 190,079 266,665\nOther Income and Deductions Allowance for equity funds used during construction 1,215 1,074 408 Mirror CWIP liability amortization 68,000 75,702 82,527 Other 1,272 1,663 890 70,487 78,439 83,825\nIncome Before Interest Charges 326,738 268,518 350,490\nInterest Charges Interest on long-term debt 111,408 112,939 125,476 Interest on short-term debt and other 12,365 11,993 7,266 Allowance for borrowed funds used during construction (2,474) (1,544) (763) 121,299 123,388 131,979\nIncome Before Cumulative Effect of Changes in Accounting Principles 205,439 145,130 218,511\nCumulative Effect of Changes in Accounting Principles -- 27,295 --\nNet Income 205,439 172,425 218,511 Preferred stock dividends 13,804 14,003 16,070 Net Income for Common Stock $ 191,635 $ 158,422 $ 202,441\nThe accompanying notes to financial statements are an integral part of these statements.\n2-82 Statements of Retained Earnings Central Power and Light Company For the Years Ended December 31, 1994 1993 1992 (thousands)\nRetained Earnings at Beginning of Year $850,307 $863,988 $854,659 Net income for common stock 191,635 158,422 202,441 Deduct: Common stock dividends 183,000 172,000 193,000 Preferred stock redemption costs 1,476 103 112 Retained Earnings at End of Year $857,466 $850,307 $863,988\nThe accompanying notes to financial statements are an integral part of these statements.\n2-83 Balance Sheets Central Power and Light Company As of December 31, 1994 1993 (thousands) ASSETS Electric Utility Plant Production $3,070,005 $3,061,911 Transmission 451,050 351,584 Distribution 828,350 765,266 General 216,888 209,170 Construction work in progress 142,724 168,421 Nuclear fuel 161,152 160,326 4,870,169 4,716,678 Less - Accumulated depreciation 1,400,343 1,263,372 3,469,826 3,453,306 Current Assets Cash and temporary cash investments 642 2,435 Special deposits 668 1,967 Accounts receivable 29,865 23,850 Materials and supplies, at average cost 66,209 64,359 Fuel inventory, at average cost 22,916 16,934 Accumulated deferred income taxes -- 4,831 Unrecovered fuel costs 54,126 52,959 Prepayments and other 2,316 2,255 176,742 169,590 Deferred Charges and Other Assets Deferred STP costs 488,987 489,773 Mirror CWIP asset 321,825 331,845 Income tax related regulatory assets, net 288,444 266,597 Other 76,875 70,634 1,176,131 1,158,849 $4,822,699 $4,781,745\nThe accompanying notes to financial statements are an integral part of these statements.\n2-84 Balance Sheets Central Power and Light Company As of December 31, 1994 1993 (thousands) CAPITALIZATION AND LIABILITIES Capitalization 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 857,466 850,307 Total Common Stock Equity 1,431,354 1,424,195 Preferred stock Not subject to mandatory redemption 250,351 250,351 Subject to mandatory redemption -- 22,021 Long-term debt 1,466,393 1,362,799 Total Capitalization 3,148,098 3,059,366 Current Liabilities Long-term debt and preferred stock due within twelve months 723 3,928 Advances from affiliates 161,320 171,165 Accounts payable 75,051 79,604 Accrued taxes 59,386 33,769 Accumulated deferred income taxes 13,812 -- Accrued interest 24,681 24,683 Accrued restructuring charges 1,325 29,365 Other 30,151 28,020 366,449 370,534 Deferred Credits Income taxes 1,087,317 1,057,453 Investment tax credits 158,533 164,322 Mirror CWIP liability and other 62,302 130,070 1,308,152 1,351,845 $4,822,699 $4,781,745\nThe accompanying notes to financial statements are an integral part of these statements.\n2-85 Statements of Cash Flows Central Power and Light Company For the Years Ended December 31, 1994 1993 1992 (thousands) OPERATING ACTIVITIES Net Income $205,439 $172,425 $218,511 Non-cash Items Included in Net Income Depreciation and amortization 170,971 140,223 154,716 Deferred income taxes and investment tax credits 20,870 84,714 42,773 Mirror CWIP liability amortization (68,000) (75,702) (82,527) Restructuring charges 98 29,365 -- Allowance for equity funds used during construction (1,215) (1,074) (408) Cumulative effect of changes in accounting principles -- (27,295) -- Changes in Assets and Liabilities Accounts receivable (6,015) (3,554) (6,415) Fuel inventory (5,982) 12,325 (3,137) Accounts payable (4,553) 19,151 6,209 Accrued taxes 25,617 (9,311) (2,165) Unrecovered fuel costs (1,167) (57,386) (1,195) Accrued restructuring charges (20,245) -- -- Other deferred credits 232 (35,242) (4,133) Other (4,575) 29,928 (18,479) 311,475 278,567 303,750 INVESTING ACTIVITIES Construction expenditures (174,993) (177,120) (100,805) Allowance for borrowed funds used during construction (2,474) (1,544) (763) (177,467) (178,664) (101,568) FINANCING ACTIVITIES Proceeds from issuance of long-term debt 99,190 441,131 435,497 Retirement of long-term debt (459) (431) (405) Reacquisition of long-term debt (618) (573,776) (304,650) Retirement of preferred stock (27,021) (6,578) (7,050) Special deposits for reacquisition of long-term debt -- 145,482 (145,482) Change in advances from affiliates (9,845) 79,399 29,618 Payment of dividends (197,048) (186,361) (209,196) (135,801) (101,134) (201,668)\nNet Change in Cash and Cash Equivalents (1,793) (1,231) 514 Cash and Cash Equivalents at Beginning of Year 2,435 3,666 3,152 Cash and Cash Equivalents at End of Year $ 642 $ 2,435 $ 3,666\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $114,980 $116,664 $130,078 Income taxes paid $ 28,166 $ 3,631 $ 45,314\nThe accompanying notes to financial statements are an integral part of these statements.\n2-86 Statements of Capitalization Central Power and Light Company As of December 31, 1994 1993 (thousands)\nCOMMON STOCK EQUITY $1,431,354 $1,424,195\nPREFERRED STOCK Cumulative $100 Par Value, Authorized 3,035,000 shares Number Current of Shares Redemption Series Outstanding Price\nNot 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% 500,000 100.00 50,000 50,000 Auction Money Market 750,000 100.00 75,000 75,000 Auction SeriesA 425,000 100.00 42,500 42,500 Auction SeriesB 425,000 100.00 42,500 42,500 Issuance Expense (3,149) (3,149) 250,351 250,351 Subject to Mandatory Redemption 10.05% -- 25,900 Issuance Expense -- (410) Amount to be Redeemed Within One Year -- (3,469) -- 22,021 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 T, 7 1\/2%, due December 15, 2014 * 111,700 111,700 Series U, 9 3\/4%, due July 1, 2015 * 31,765 31,765 Series Z, 9 3\/8%, due December 1, 2019 139,405 140,000 Series AA, 7 1\/2%, due March 1, 2020 * 50,000 50,000 Series BB, 6%, due October 1, 1997 200,000 200,000 Series CC, 7 1\/4%, due October 1, 2004 100,000 100,000 Series DD, 7 1\/8%, due December 1, 1999 25,000 25,000 Series EE, 7 1\/2%, due December 1, 2002 115,000 115,000 Series FF, 6 7\/8% due February 1, 2003 50,000 50,000 Series GG, 7 1\/8%, due February 1, 2008 75,000 75,000 Series HH, 6%, due April 1, 2000 100,000 100,000 Series II, 7 1\/2%, due April 1, 2023 100,000 100,000 Series JJ, 7 1\/2%, due May 1, 1999 100,000 -- Installment 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 68,870 Series 1986, 7 7\/8%, due December 1, 2016 60,000 60,000 Series 1993, 6%, due July 1, 2028 120,265 120,265 Notes Payable, 6 1\/2%, due December 8, 1995 448 652 Unamortized Discount (11,655) (12,265) Unamortized Costs of Reacquired Debt (81,947) (86,249) Amount to be Redeemed Within One Year (723) (459) 1,466,393 1,362,799 TOTAL CAPITALIZATION $3,148,098 $3,059,366\n*Obligations incurred in connection with the sale by public authorities of tax-exempt PCRBs.\nThe accompanying notes to financial statements are an integral part of these statements.\n2-87 NOTES TO FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation CPL is subject to regulation by the SEC under the Holding Company Act and the FERC under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. CPL is subject to further regulation with regard to rates and other matters by the Texas Commission. CPL, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System.\nThe more significant accounting policies of CPL 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 average consolidated composite rates were 3.0% for 1994, 1993 and 1992.\nNuclear Decommissioning At the end of STP's service life, decommissioning is expected to be accomplished using the decontamination method, which is one of the techniques acceptable to the NRC. Using this method the decontamination activities occur as soon as possible after the end of plant operations. Contaminated equipment is cleaned or removed to a permanent disposal location and the site is generally returned to its pre-plant state.\nCPL's decommissioning costs are accrued and funded to an external trust over the expected service life of the STP units. The existing NRC operating licenses will allow the operation of STP Unit 1 until 2027, and Unit 2 until 2028. The accrual is an annual level cost based on the estimated future cost to decommission STP, including escalations for expected inflation to the expected time of decommissioning, and is net of expected earnings on the trust fund.\nCPL's portion of the costs of decommissioning STP were estimated to be $85 million in 1986 dollars based on a site specific study completed in 1986. CPL is recovering these decommissioning costs through rates based on the service life of STP at a rate of $4.2 million per year. The $4.2 million annual cost of decommissioning is reflected on the income statement in other operating expense. Decommissioning costs are paid to an irrevocable external trust and as such are not reflected on CPL's balance sheet. At December 31, 1994, the trust balance was $19.3 million.\nIn May 1994, CPL received a new decommissioning study updating the cost estimates to decommission STP that indicated that CPL's share of such costs would increase from $85 million, as stated in 1986 dollars, to $251 million, as stated in 1994 dollars. The increase in costs occurred primarily as a result of extended on-site storage of high level waste, much higher estimates of low-level waste disposal costs and increased labor costs since the prior study. These costs are expected to be incurred during the years 2027 through 2062. While this is the best estimate available at this time, these costs may change between now and when the funds are actually expended because of changes in the assumptions used to derive the estimates, including the prices of the goods and services required to accomplish the decommissioning. Additional studies will be completed periodically to update this information.\n2-88 Based on this projected cost to decommission STP, CPL estimates that its annual funding level should increase to $10.0 million. CPL has requested this amount as part of its cost of service in its current rate filing. Other parties to the rate proceeding have filed their projections of the annual amount, which have ranged from $4.5 million to $8.1 million. CPL expects to fund at the level ultimately ordered by the Texas Commission although CPL cannot predict what that level will be. Historically, the Texas Commission has allowed full recovery of nuclear decommissioning costs. For further information on CPL's current rate filing see NOTE 9, Litigation and Regulatory Proceedings - Texas Commission Proceedings.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, CPL changed its method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 net income was an increase of $29.5 million included in cumulative effect of changes in accounting principles.\nCPL recovers fuel costs in Texas as a fixed component of base rates whereby over-recoveries of fuel are payable to customers and under-recoveries may be billed to customers after Texas Commission approval. The cost of fuel is charged to expense as consumed. See NOTE 9, Litigation and Regulatory Proceedings, for further information about fuel recoveries. CPL recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause. CPL amortizes direct nuclear fuel costs to fuel expense on the basis of a ratio of the estimated energy used in the core to the energy expected to be derived from such fuel assembly over its life in the core. In addition to fuel amortization, CPL also incurs nuclear fuel expense as a result of other items, including spent fuel disposal fees assessed on the basis of net KWHs sold from STP, and DOE special assessment fees for decontamination and decommissioning of the enrichment facilities on the basis of prior usage of enrichment services.\nAccounts Receivable CPL sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities For its regulated activities, CPL follows SFAS No. 71, which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to CPL associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future refunds to customers. At December 31, 1994 and 1993, CPL had recorded the following significant regulatory assets and liabilities:\n1994 1993 (thousands) Regulatory Assets Deferred plant costs $488,987 $489,773 Mirror CWIP asset 321,825 331,845 Income tax related regulatory assets, net 288,444 266,597 Unrecovered fuel costs 54,126 52,959\nRegulatory Liabilities Mirror CWIP liability $ 41,000 $109,000\n2-89 Deferred Plant Costs In accordance with orders of the Texas Commission, CPL deferred operating, depreciation and tax costs incurred for STP. This deferral was for the period beginning on the date when the plant began commercial operation until the date the plant was included in rate base. The deferred costs are being amortized and recovered through rates over the life of the plant. See NOTE 9, Litigation and Regulatory Proceedings, for further discussion of CPL's deferred accounting proceedings.\nMirror CWIP In accordance with Texas Commission orders, CPL previously recorded Mirror CWIP, which is being amortized over the life of STP. For more information regarding Mirror CWIP, reference is made to NOTE 9, Litigation and Regulatory Proceedings. Statements 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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, CPL adopted SFAS Nos. 106, 112 and 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, CPL also changed its method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in 1993 operating expenses of $5.9 million. The adoption of SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect (thousands) SFAS No. 112 $(3,371) $ 1,180 $ (2,191) Unbilled revenues 45,363 (15,877) 29,486 Total $41,992 $(14,697) $27,295\nPro 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 CPL adopted the provisions of SFAS No. 109 effective January 1, 1993. The implementation of SFAS No. 109 had no material effect on CPL's earnings. As a result of this change, CPL recognized additional accumulated deferred income taxes from its utility operations, and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, CPL did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\nCPL, together with other members of the CSW System, files a consolidated federal income tax return and participates in a tax sharing agreement.\nComponents of income taxes follow: 1994 1993 1992 Included in Operating Expenses and Taxes (thousands) Current $54,486 $(19,690) $ 34,336 Deferred 26,659 90,682 48,773 Deferred ITC (5,789) (5,806) (5,831) 75,356 65,186 77,272 Included in Other Income and Deductions Current (3,157) 736 390 Deferred -- (162) (163) (3,157) 574 227 Tax Effects of Cumulative Effect of Changes in Accounting Principles -- 14,697 -- $72,199 $80,457 $77,499\nInvestment tax credits deferred in prior years are included in income over the lives of the related properties.\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow:\n1994 % 1993 % 1992 % (dollars in thousands) Tax at statutory $97,174 35.0 $88,509 35.0 $100,643 34.0 Differences Amortization of ITC (5,789) (2.1) (5,806) (3) (5,789) (2.0) Mirror CWIP (20,293) (7.3) (22,989) (9.1) (24,652) (8.3) Prior period adjustments (1,955) (0.7) 19,101 7.6 -- -- Other 3,062 1.1 1,642 .6 7,297 2.5 $72,199 26.0 $80,457 31.8 $77,499 26.2\n2-91 The significant components of the net deferred income tax liability follow: 1994 1993 (thousands) Deferred Income Tax Liabilities Depreciable utility plant $ 755,437 $ 745,164 Deferred plant costs 171,145 171,421 Mirror CWIP asset 112,639 116,146 Income tax related regulatory asset 169,104 178,984 Other 49,800 37,989 Total Deferred Income Tax Liabilities 1,258,125 1,249,704\nDeferred Income Tax Assets Income tax related regulatory liability (68,149) (85,675) Unamortized ITC (55,486) (57,513) Alternative minimum tax credit - carryforward (26,138) (15,744) Other (7,223) (38,150) Total Deferred Income Tax Assets (156,996) (197,082) Net Accumulated Deferred Income Taxes - Total $1,101,129 $1,052,622\nNet Accumulated Deferred Income Taxes - Noncurrent $1,087,317 $1,057,453 Net Accumulated Deferred Income Taxes - Current 13,812 (4,831) Net Accumulated Deferred Income Taxes - Total $1,101,129 $1,052,622\n3.Long-Term Debt The mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by CPL, constitutes a direct first mortgage lien on substantially all electric utility plant. CPL may offer additional first mortgage bonds subject to market conditions and other factors.\nAnnual Requirements Certain series of outstanding first mortgage bonds have annual sinking fund requirements, which are generally 1% of the amount of each such series issued. These requirements may be, and generally have been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. In addition, one series of CPL's pollution control bonds, has a sinking fund requirement. At December 31, 1994, the annual sinking fund requirements and annual maturities for CPL's first mortgage bonds and pollution control bonds for the next five years follow:\nSinking Fund Requirements Maturities (thousands) 1995 $ 2,840 $ 2,840 1996 2,840 2,840 1997 2,585 202,840 1998 2,560 30,560 1999 2,560 27,560\nDividends CPL's mortgage indenture, as amended and supplemented, contains certain restrictions on the use of their retained earnings for cash dividends on their common stock. These restrictions do not\n2-92 limit the ability of CSW to pay dividends to its stockholders. At December 31, 1994, the amount of retained earnings available for payment of cash dividends to CSW by CPL was $684 million.\nReacquired Long-term Debt Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, Liquidity and Capital Resources, for further information related to long-term debt, including new issues and reacquisitions.\n4.Preferred Stock The dividends on CPL's $160 million auction preferred stocks are adjusted every 49 days, based on current market rates. The dividend rates averaged 3.5%, 2.7%, and 3.6% during 1994, 1993 and 1992.\nCPL retired the remaining shares of its 10.05% Series preferred stock during August 1994.\nEach series of preferred stock, with the exception of the auction preferred stock, is redeemable at the option of CPL upon 30 days notice at the current redemption price per share. Redemption prices of the 8.72% Series decline at specified intervals in future years. CPL's two issues of auction preferred stock and one issue of money market preferred stock may be redeemed at par on any dividend payment date.\n5.Short-Term Financing CPL, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. Money pool balances are shown as advances to or from affiliates on the Balance Sheets. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million 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 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 fair value.\nCash, special deposits and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nAdvances from affiliates The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt The fair value CPL'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 CPL for debt of the same or similar remaining maturities.\nPreferred stock The fair value of CPL's preferred stock subject to mandatory redemption is estimated based on quoted market prices for the same or similar issues or on the current rates offered to CPL for preferred stock with the same or similar remaining redemption provisions.\nLong-term debt and preferred stock due within twelve months The fair values of CPL's current maturities of long-term debt and preferred stock are estimated based on current rates offered to CPL for long-term debt and preferred stock.\n2-93 The estimated fair values of CPL's financial instruments follow:\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 642 $ 642 $ 2,435 $ 2,435 Special Deposits 668 668 1,967 1,967 Advances from affiliates 161,320 161,320 171,165 171,165 Long-term debt 1,466,393 1,395,590 1,362,799 1,456,533 Preferred stock subject to mandatory redemption -- -- 22,021 23,086 Long-term debt and preferred stock due within 12 months 723 725 3,928 4,096\nThe fair value does not affect CPL's liabilities unless the issues are redeemed prior to their maturity dates.\n7.Benefit Plans Defined Benefit Pension Plan CPL, together with the other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited 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 which are deductible for income tax purposes and minimum contributions required by the ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate- term fixed income investments. Contributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $7.1 million, $11.0 million and $11.7 million, respectively.\nThe approximate maximum number of participants in the plan during 1994 were 2,300 active employees, 1,200 retirees and beneficiaries and 300 terminated employees.\nThe components of net periodic pension cost and the assumptions used in accounting for pension follow:\n1994 1993 1992 (thousands) Net Periodic Pension Cost Service cost $ 5,796 $ 5,228 $ 4,834 Interest cost on projected benefit obligation 15,989 14,878 13,686 Actual return on plan assets (1,131) (18,079) (11,750) Net amortization and deferral (17,972) 68 (5,330) $ 2,682 $ 2,095 $ 1,440\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\n2-94 At December 31, 1994, the plan's net assets were approximately equal to the total actuarial present value of the accumulated benefit obligation. At December 31, 1993 the plan's net assets exceeded the total actuarial present value of the accumulated benefit obligation. No reconciliation of the funding status of the plan is presented because such information is unavailable.\nHealth and Welfare Plans CPL had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active CPL employees during 1994. The contributions, recorded on a pay-as-you-go basis, for the years ended December 31, 1994 and 1993 were approximately $4.6 million and $6.1 million, respectively. Effective January 1993, CPL's method of providing health benefits was modified to include such benefits as a health maintenance organization, preferred provider options, managed prescription drug and mail-order program and a mental health and substance abuse program in addition to the self- insured indemnity plans.\nPostretirement Benefits Other Than Pensions CPL adopted SFAS No. 106 effective January 1, 1993. The effect on operating expense in 1993 was $5.9 million. CPL is amortizing the transition obligation over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\nThe components of net periodic postretirement benefit cost follow:\n1994 1993 (thousands) Net Periodic Postretirement Benefit Cost Service cost $ 2,435 $ 2,257 Interest cost on APBO 6,061 5,505 Actual return on plan assets (285) (249) Amortization of transition obligation 2,900 2,900 Net amortization and deferral (913) (703) $10,198 $9,710\nA reconciliation of the funded status of the plan to the amounts recognized on the balance sheets follow:\n1994 1993 APBO (thousands) Retirees $49,852 $50,032 Other fully eligible participants 9,278 9,147 Other active participants 15,017 17,353 Total APBO 74,147 76,353 Plan assets at fair value (21,457) (14,185) APBO in excess of plan assets 52,690 62,347 Unrecognized transition obligation (52,208) (55,108) Unrecognized gain or (loss) 577 (6,180) Accrued\/(Prepaid) Cost $ 1,059 $ 1,059\n2-95 The following assumptions were used in accounting for SFAS No. 106.\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 Rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001. Post-65 Participants: 1994 Rate of 11.25% 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 by $8.0 million as of December 31, 1994 and increase the aggregate of the service and interest costs components on net postretirement benefits by $1.1 million.\n8.Jointly Owned Electric Utility Plant CPL has a joint ownership agreement with other members of the CSW System and other non-affiliated entities. Such agreements provide for the joint ownership and operation of STP and Oklaunion power plants. The statements of income reflect CPL's portion of operating costs associated with jointly owned plants. At December 31, 1994, CPL had interests as shown below: South Texas Oklaunion Nuclear Coal Plant Plant (dollars in millions) Plant in service $2,343 $36 Accumulated depreciation 380 8 Plant capacity-MW 2,500 676 Participation 25.2% 7.8% Share of capacity-MW 630 53\n9.Litigation and Regulatory Proceedings STP From February 1993 until May 1994, STP experienced an unscheduled outage which has resulted in significant rate and regulatory proceedings involving CPL. These matters, including a base rate case and fuel reconciliation proceedings, are discussed immediately below.\nTexas Commission Proceedings Base Rates Rate Inquiry - Docket No. 12820 Several Cities, the Texas Commission General Counsel and others initiated actions in late 1993 and early 1994 which, if approved by the Texas Commission, would lower CPL's base rates. The requests for a review of CPL's rates arose out of the unscheduled outage at STP which began in February 1993. The STP outage did not affect CPL's ability to meet customer demand because of existing capacity and CPL's purchase of additional energy.\nPursuant to a scheduling and procedural settlement agreement among the parties challenging CPL's rates, which was approved by a Texas Commission ALJ on April 1, 1994, CPL submitted a rate filing package on July 1, 1994 to the Texas Commission justifying its current base rate structure. In that filing, CPL stated that it\n2-96 had a $111 million retail revenue deficiency and would be justified in seeking a base rate increase. However, consistent with the procedural settlement agreement, CPL has not sought to increase base rates as a part of this docket but seeks to maintain its rates at the same levels agreed to in the settlement of its last two rate cases in 1990 and 1991. As part of the 1990 and 1991 settlements, CPL 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. On October 31, 1994, CPL filed rebuttal testimony that revised its retail revenue deficiency to approximately $103 million. CPL continues to maintain that its rates are reasonable and that its earnings are within established regulatory guidelines.\nParties to CPL's base rate case have filed testimony with the Texas Commission recommending reductions in CPL's base rates. Among the parties that filed testimony were OPUC which initially recommended an annual $100 million retail rate reduction. After hearings on the rate case, OPUC claimed that CPL did not meet its burden of proof concerning deferred accounting and as a result OPUC changed its proposed reduction to $147 million. The Cities, which are parties to the rate case, have recommended an annual $75 million retail rate reduction and the write-off of $219 million of CPL's Mirror CWIP asset. See Deferred Accounting below.\nThe Staff filed testimony recommending an annual reduction in retail rates of $99.6 million resulting from a combination of proposed rate base and cost of service reductions, which it subsequently revised during the hearings to $83.9 million. In its final brief to the ALJ, the Staff withdrew its recommendation that short-term debt be included in the calculation of CPL's weighted cost of capital. CPL estimates that this change in the Staff's position will lower its revised proposed retail rate reduction by approximately $6 million. The Staff recommended a rate base disallowance of $407 million, or approximately 17% of CPL's investment in STP, based upon the Staff's calculation of historical performance for STP compared to a peer group of other nuclear facilities. The Staff also recommended that accumulated depreciation and accumulated deferred federal income taxes related to the disallowed portion of STP be adjusted to reflect a net reduction to rate base of $325 million. Additionally, the Staff proposed to disallow depreciation expense related to the recommended STP disallowed plant.\nIn its testimony, the Staff argued that its proposed STP rate base reduction was a historical performance-based disallowance that could be temporary in nature and would not have to result in a permanent disallowance. The Staff indicated that, in the future, CPL could seek recovery in rates of the proposed STP rate base disallowance, subject to the performance of STP.\nThe Texas Commission held hearings in November and December 1994, and all parties have filed briefs in the case. The ALJ is expected to issue a recommended order for consideration by the Texas Commission in April 1995, with a final order from the Texas Commission expected in May 1995. Testimony filed by parties to the rate case, including the Staff, is not binding on either the ALJ or the Texas Commission.\nCPL strongly believes that 100 percent of its investment in both units of STP belong in rate base. This belief is based on, among other factors, Units 1 and 2 providing output at high capacity factors since April and June 1994, respectively. In addition, the long-term benefits nuclear generation provides to customers supports their inclusion in rate base. Furthermore, there are no Texas Commission precedents addressing the removal of a nuclear plant from rate base as a performance-based disallowance. Assuming both units of STP are included in rate base, CPL believes it is not collecting excessive revenues, notwithstanding that market rates of return on common equity are generally lower today than they were in 1990 and 1991, when CPL's base rates were last set.\n2-97 Fuel Introduction Pursuant to the substantive rules of the Texas Commission, CPL generally is allowed to recover its fuel costs through a fixed fuel factor. These fuel factors are in the nature of temporary rates, and CPL'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 costs 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.\nFuel Surcharge - Docket No. 12154 In July 1993, CPL 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 CPL's request to postpone consideration of the surcharge. In January and July of 1994, CPL updated its fuel surcharge petition to reflect amounts of under-recovery through November 1993 and May 1994, respectively. Also, CPL updated its petition in January 1995 to reflect amounts of under-recovery through November 1994. Likewise, CPL requested and was granted postponement of the updated petitions until the STP outage concluded or at the time fuel costs are next reconciled. On January 4, 1995, Docket No. 12154 was consolidated into Docket No. 13650.\nPrudence Inquiry - Docket No. 13126 In April 1994, the Texas Commission's General Counsel and Staff issued a Request for Proposal for an audit of the STP outage, and in July 1994 a consultant was selected to perform the audit. The purpose of the audit is to evaluate the prudence of management activities at STP, including the actions of HLP and the STP management committee, of which CPL is a participant. Such review will include the time from original commercial operation of each unit until they were returned to service from the outage. The findings of this audit are expected to be incorporated into this proceeding. CPL and HLP will pay the costs of the audit but will have no control over the ultimate work product of the consultant.\nIn June 1994, the Texas Commission's General Counsel initiated an inquiry into the operation and management of STP which resulted in the establishment of this proceeding. As part of the inquiry, CPL presented certain information concerning the prudence of management activities at STP relating to the STP outage. Testimony filed by CPL stated that the cause of the STP outage was the result of an accidental equipment failure rather than imprudent management activities at STP. Based on this information, CPL will seek full recovery in its fuel reconciliation case of incremental energy costs related to the STP outage.\nAs a part of this proceeding, CPL was required to reconstruct its production costs assuming STP was available 100% of the time during the actual outage. Testimony filed by CPL stated that it is unrealistic to expect any generating unit to operate all the time. The testimony provided calculations of STP replacement power cost estimates for availability factor scenarios at (i) 100%, (ii) 75% and (iii) 65% average availability. Based on these average availability factors, STP net replacement power costs for the entire outage period were estimated to be (i) $104.5 million at 100%, (ii) $79.0 million at 75% and (iii) $68.2 million at 65% average availability.\nThe results of this prudence inquiry are expected to be used in CPL's pending fuel reconciliation proceeding in Docket No. 13650, as discussed below, and possibly CPL's next base rate proceeding should a return on equity penalty be ordered by the Texas\n2-98 Commission. Such penalty could lower CPL's allowed return on equity in its next base rate case from what it otherwise would be permitted to earn.\nFuel Reconciliation - Docket No. 13650 On November 15, 1994, CPL filed a fuel reconciliation case with the Texas Commission seeking to reconcile approximately $1.2 billion of fuel costs from March 1, 1990 through June 30, 1994. This period includes the STP outage where CPL's fuel and purchased power costs were increased as the power normally generated by STP was replaced through sources with higher costs. At December 31, 1994, CPL's under-recovered fuel balance was $54.1 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. CPL cannot accurately estimate the amount of any future under- or over-recoveries due to the nature of the above factors. CPL cannot predict how the Texas Commission will ultimately resolve the reasonableness of higher replacement energy costs associated with the STP outage. Although the Texas Commission could disallow all or a portion of the STP replacement energy costs, such determination cannot be made until a final order is issued by the Texas Commission in this docket. If a significant portion of the fuel costs were disallowed by the Texas Commission, CPL could experience a material adverse effect on its results of operations in the year of disallowance but not on its financial condition.\nCPL continues to negotiate with the intervening parties to resolve Docket Nos. 12820, 13126 and the STP portions of Docket No. 13650 through settlement. However, no settlement has been reached.\nManagement cannot predict the ultimate outcome of the CPL rate inquiry and fuel regulatory proceedings. However, management believes that the ultimate resolution of the various issues will not have a material adverse effect on CPL's results of operations or financial condition.\nSTP Background Final Orders In October 1990, the Texas Commission issued the 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 the STP Unit 2 Order which fully implemented a stipulated agreement to resolve all issues regarding CPL's investment in STP Unit 2.\nThe STP Unit 1 Order allowed CPL 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 had authorized deferral of STP Unit 1 costs. See Deferred Accounting below. 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 CPL 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. The Mirror CWIP liability is being reduced by the recognition of non-cash income during the period 1991 through 1995. The Mirror CWIP asset is being amortized to expense over the life of the plant.\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,\n2-99 the original costs of CPL's total investment in STP is included in rate base. As indicated under the heading Texas Commission Proceedings above, however, CPL is currently involved in base rate and fuel proceedings which challenge CPL's right to recover certain costs associated with the STP outage.\nAs part of the stipulated agreement, CPL 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. CPL 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 CPL, the Staff and a majority of intervenors including major cities in CPL's service territory and major industrial customers. These intervenors represent a significant majority of CPL's customers. CPL and the TSA reached agreements, which were subsequently approved by the 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 CPL could experience a significant adverse effect on its results of operations and financial condition. 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 economic results. Management believes that the STP Unit 1 and 2 Orders will be upheld.\nDeferred Accounting CPL was granted deferred accounting for STP Unit 1 and 2 costs by Texas Commission orders. These orders allowed CPL 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 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, CPL's retail rates include recovery of 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 CPL'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 CPL 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 CPL from earning a return on such costs.\nAfter the Court of Appeals' denial of each party's motion for rehearing of the decision, CPL and the Texas Commission in December 1992 filed Applications for Writ of Error petitioning the\n2-100 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 Appeals' decision, challenging generally the legality of deferred accounting for rate base treatment of any deferred costs. In May 1993, the Supreme Court of Texas granted CPL's Application for Writ of Error. CPL's case was consolidated with the deferred accounting cases of El Paso and HLP. In June 1994, the Supreme Court of Texas sustained deferred accounting as an appropriate mechanism for the Texas Commission to use in preserving the financial integrity of utilities. The Supreme Court of Texas held that the Texas Commission can authorize utilities to defer those costs that are incurred between the in-service date of a plant and the effectiveness of new rates, which include such costs. On October 6, 1994, the Supreme Court of Texas denied a motion for rehearing CPL's deferred accounting matter filed by the State of Texas. The language of the Supreme Court of Texas opinion suggests that the appropriateness of allowing deferred accounting may need to again be reviewed under a financial integrity standard at the time the costs begin being recovered through rates. For CPL, that would be the STP Unit 1 and Unit 2 Orders discussed above. To the extent that additional review is required, it should occur in those dockets.\nIf these deferred accounting matters are not favorably resolved, CPL could experience a material adverse effect on its results of operations and financial condition. While CPL's management cannot predict the ultimate outcome of these matters, management believes CPL will 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 CPL's results of operations or financial condition.\nWestinghouse Litigation CPL and other owners of STP are plaintiffs in a lawsuit filed in 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 set for trial in July 1995.\nInspections during the STP outage have detected early signs of stress corrosion cracking in tubes at STP Unit 1. Management believes additional problems would develop gradually and will be monitored by the Project Manager 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. Management believes that the ultimate resolution of this matter will not have a material adverse effect on CPL's results of operations or financial condition.\nIndustrial Road and Industrial Metals Site Several lawsuits relating to the industrial road and industrial metals site in Corpus Christi, Texas, naming CPL as a defendant, are currently pending in federal and state court in Texas. Plaintiffs' claims allege property damage and health impairment as a result of operations on the site and clean-up activities. Although management cannot predict the outcome of these proceedings, based on the defenses that management believes are available to CPL, management believes that the ultimate resolution of these matters will not have a material adverse effect on CPL's results of operations or financial condition.\nCivil Penalties In October 1994, the NRC staff advised HLP that it proposes to fine HLP $100,000 for what the NRC believes was discrimination against a contractor employee at STP who brought complaints of possible safety problems to the NRC's attention. These actions resulted from the findings of a NRC investigation of alleged violations of STP security and work process procedures in 1992. The incident cited by the NRC is the subject of a contested hearing that is scheduled to be held in the spring of 1995 before a United States Department of Labor judge. Until the Department\n2-101 of Labor issues a final decision in this matter, the NRC is not requiring HLP to respond to its notice of violation.\nOther CPL 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 CPL's results of operations or financial condition.\n10. Commitments and Contingent Liabilities It is estimated that CPL will spend approximately $108 million in construction expenditures during 1995. Substantial commitments have been made in connection with this capital expenditure program.\nTo supply a portion of its fuel requirements CPL has entered into various commitments for the procurement of fuel.\nNuclear Insurance In 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 $8.92 billion per incident, effective as of January 1995. 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 $8.72 billion. The maximum amount that each licensee may be assessed under the industry-wide program of self-insurance following a nuclear incident at an insured facility is $75.5 million per reactor, 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. CPL and each of the other STP owners are subject to such assessments, which CPL and other owners have agreed will be allocated 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 $2.75 billion provided by ANI and NEIL. Policies of insurance issued by ANI and NEIL stipulate that policy proceeds must be used first to pay decontamination and clean-up costs before being used to cover direct losses to property. Under project agreements, CPL and the other owners of STP will share the total cost of decontamination liability and property insurance for STP, including premiums and assessments, on a pro rata basis, according to each owner's respective ownership interest in STP.\nCPL purchases, for its own account, a NEIL I Business Interruption and\/or Extra Expense policy. This insurance will reimburse CPL for extra expenses incurred, up to $1.65 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 $111.3 million and for Unit 2 is $111.8 million. CPL is subject to an additional assessment up to $2.1 million for the current policy year in the event that losses as a result of a covered accident at a nuclear facility insured under the NEIL I policy exceeds the accumulated funds available under the policy.\nOn August 28, 1994, CPL filed a claim under the NEIL I policy related to the outage at STP Units 1 and 2. NEIL is currently reviewing the claim. CPL management is unable to predict the ultimate outcome of this matter.\n2-102 11. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts.\nOperating Operating Net Quarter Ended Revenues Income Income 1994 (thousands) March 31 $ 263,229 $ 36,943 $ 24,986 June 30 333,169 75,070 62,470 September 30 364,044 96,062 82,877 December 31 257,537 48,176 35,106 $1,217,979 $ 256,251 $ 205,439\nMarch 31 $ 238,254 $ 39,593 $ 54,560 June 30 316,053 66,745 53,679 September 30 387,190 88,438 77,612 December 31 282,031 (4,697) (13,426) $1,223,528 $ 190,079 $ 172,425\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-103 Report 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 a wholly-owned subsidiary of Central and South West Corporation) as of December 31, 1994 and 1993, and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of CPL'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 Central Power and Light Company as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, CPL changed its methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II 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. This schedule 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 LLP\nDallas, Texas February 13, 1995\n2-104 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the financial statements of Central Power and Light Company as well as other information contained in this Annual 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 Annual Report is consistent with that in the financial statements.\nThe financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. CPL believes that representations made to the independent auditors during its audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nCPL maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial statements are prepared in accordance with generally accepted accounting principles and that the assets of CPL are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that CPL will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of CPL provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nCPL believes that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nRobert R. Carey R. Russell Davis President and CEO - CPL Controller - CPL\n2-105\nPSO\nPUBLIC SERVICE COMPANY OF OKLAHOMA\n2-106 Selected Financial Data PSO The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for PSO.\n1994 1993 1992 1991 1990 (thousands, except ratios) Operating Revenues $740,496 $707,536 $622,092 $650,942 $620,132 Income Before Cumulative Effect of Changes in Accounting Principles 68,266 40,496 45,562 53,229 55,082 Cumulative Effect of Changes in Accounting Principles (1) -- 6,223 -- -- -- Net Income 68,266 46,719 45,562 53,229 55,082 Preferred Stock Dividends 816 816 816 816 816 Net Income for Common Stock 67,450 45,903 44,746 52,413 54,266\nTotal Assets 1,465,114 1,420,379 1,351,201 1,308,075 1,283,915\nCommon Stock Equity 461,499 435,049 429,146 419,400 386,987 Preferred Stock 19,826 19,826 19,826 19,826 19,826 Long-term Debt 402,752 401,255 408,731 368,219 367,727\nRatio of Earnings to Fixed Charges (SEC Method) Before Cumulative Effect of Changes in Accounting Principles 4.03 2.78 2.95 3.33 2.93\nCapitalization Ratios Common Stock Equity 52.2% 50.8% 50.0% 51.9% 50.0% Preferred Stock 2.2 2.3 2.3 2.5 2.5 Long-term Debt 45.6 46.9 47.7 45.6 47.5\n(1)The 1993 cumulative effect relates to the changes in accounting for unbilled revenues, adoption of SFAS Nos. 112 and 109. See NOTE 1, Summary of Significant Accounting Policies.\nPSO changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore have not been restated.\n2-107 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nPUBLIC SERVICE COMPANY OF OKLAHOMA\nReference is made to PSO's Consolidated Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential to understanding, the following discussion and analysis.\nOverview Net income for common stock for 1994 was $67 million, a 47% increase from 1993. The increase was due primarily to increased energy sales to retail customers and sales for resale to other electric utilities due to increased market place demand and the 1993 restructuring charges of $25 million.\nRestructuring As previously reported, PSO has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable PSO to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $25 million and were expensed in 1993. The final costs of the restructuring were approximately $25 million. Approximately $24 million of the restructuring expenditures were incurred during 1994, with the remaining $1 million expected to be incurred during 1995. Approximately $4 million of the restructuring expenses relate to employee termination benefits, $12 million relate to enhanced benefit costs and $9 million relate to employees that will not be terminated. Approximately $17 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $8 million represents the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nPSO expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. The CSW System expects that all restructuring costs will be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nRates and Regulatory Matters See NOTE 8, Litigation and Regulatory Proceedings, for information regarding the PSO rate case.\nNew Accounting Standards SFAS No. 115 was effective for fiscal years beginning after December 15, 1993. PSO adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on PSO's consolidated results of operations or financial condition.\nIn June 1993 the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by PSO for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on PSO's consolidated results of operations or financial condition.\n2-108 SFAS No. 119 was effective for fiscal years ending after December 15, 1994. PSO does not currently uses derivative instruments, but may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on PSO's consolidated results of operations or financial condition.\nLiquidity and Capital Resources Overview PSO's need for capital results primarily from the construction of facilities to provide reliable electric service to its customers. Accordingly, internally generated funds should meet most of the capital requirements. However, if internally generated funds are not sufficient, PSO's financial condition should allow it access to the capital markets.\nCapital Expenditures Construction expenditures, including AFUDC, were approximately $131 million in 1994, $95 million in 1993, and $100 million in 1992. It is estimated that construction expenditures, including AFUDC, during the 1995 through 1997 period will aggregate $213 million. Such expenditures primarily will be made to improve and expand distribution facilities. These improvements are expected to meet the needs of new customers and to satisfy changing requirements of existing customers. No new baseload power plants are currently planned until after the year 2000.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in PSO's service area, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected lignite-fired generating plants for which PSO has invested approximately $15 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, PSO would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of PSO were 52% common stock equity, 2% preferred stock and 46% long-term debt. PSO's embedded cost of long-term debt was 7.4% at the end of 1994. PSO continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. PSO continues to be committed to maintaining financial flexibility by maintaining a strong capital structure and favorable securities ratings which should allow funds to be obtained from the capital markets when required.\nShort-Term Financing PSO, together with other members of CSW System, has established a CSW System money pool to coordinate short-term borrowings. These loans are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs. PSO's short-term borrowing limit from the money pool is $100 million. During 1994, the annual weighted average interest rate was 4.5% and the average amount of short-term month-end borrowings outstanding was $42 million. The maximum amount of short-term borrowings outstanding at any month-end during 1994 was $73 million, which was the amount outstanding at May 31, 1994.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. PSO utilizes short-term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. PSO anticipates that capital requirements for the period 1995 to 1997 will be met in large part from internal sources. PSO also anticipates that some external financing will be required during the period, but the nature, timing and extent have not yet been determined. Information concerning internally generated funds follows:\n2-109 1994 1993 1992 (millions) Internally Generated Funds $110 $93 $63\nConstruction Expenditures Provided by Internally Generated Funds 85% 99% 63%\nSales of Accounts Receivable PSO sells its billed and unbilled accounts receivable, without recourse, to CSW Credit. The sales provided PSO with cash immediately, thereby reducing working capital needs and revenue requirements. The average and year end amounts of accounts receivable sold were $88 million and $75 million in 1994, as compared to $85 million and $80 million in 1993.\nRecent Developments and Trends Competition and Industry Challenges Competitive forces at work in the electric utility industry are impacting PSO and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, PSO will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. PSO believes that its prices for electricity and the quality and reliability of its service currently place it in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While PSO believes that the Energy Policy Act will continue to make the wholesale markets more competitive, PSO is unable to predict the extent to which the Energy Policy Act will impact on its operations.\nIncreasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. PSO competes in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities,\n2-110 but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers.\nPSO believes that, compared to other electric utilities, it is well positioned to meet future competition. PSO benefits from economies of scale and scope by virtue of its size and its relationship to the CSW System. PSO is also a relatively low-cost producer of electric power. Moreover, PSO is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nPSO is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or on PSO. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, PSO has recognized significant regulatory assets and liabilities. Management believes that PSO will continue to meet the criteria for following SFAS No. 71. However, in the event PSO no longer meets the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nEnvironmental Matters CERCLA and Related Matters The operations of PSO, like those of other utilities, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nPSO is subject to various pending claims alleging it is a PRP under federal or state remedial laws for investigating and cleaning up contaminated property. PSO anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on PSO's consolidated results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by PSO, the estimated amount of costs allocated to PSO and the participation of other parties.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, PSO will be required to hold allowances in order to emit sulfur dioxide. The EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, PSO believes that its allowances will be adequate to meet its needs at least through 2008. Public and private markets are developing for trading of excess allowances. PSO presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\n2-111 The Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on PSO cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, PSO expects to spend an additional $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects. Although a few of the studies to date have suggested certain associations between EMFs and some types of effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. PSO cannot predict the impact on it or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nSee ITEM 1. BUSINESS - Environmental Matters and NOTE 8, Litigation and Regulatory Proceedings, for additional discussion of environmental issues.\nResults of Operations Electric Operating Revenues Revenues for 1994 increased approximately $33 million or 5% when compared to 1993. Revenues for 1993 increased approximately $85.4 million or 14% when compared to 1992. The increase in 1994 reflected an increase of approximately 8% in KWH sales resulting from increased sales for resale to other electric utilities due to increased marketplace demand, partially offset by lower unit fuel costs as described below. Approximately $7.9 million of the 1993 increase was due to an increase in retail prices. Retail kilowatt-hour sales increased 7% as a result of warmer weather in 1993 compared to the substantially milder than normal weather in 1992. Additionally, 1994 and 1993 were affected by increased fuel recovery as discussed below. The Company recovers its monthly fuel and purchased power expenses currently in its revenues and therefore the increase in these costs resulted in higher revenues.\nFuel and Purchased Power Expenses Fuel expense for 1994 increased approximately $17.6 million or 6% when compared to 1993. During 1993, fuel expense increased approximately $64 million or 27% when compared to 1992. Fuel expense for 1994 and 1993 increased primarily as a result of fewer customers participating in the FUSER Program, which terminated effective October 1993. See ITEM 1. BUSINESS -- REGULATION AND RATES for additional information relating to FUSER. In 1994, fuel expense was also affected by a 17% increase in KWH generation and an over- recovery of fuel costs from customers, which was previously recorded as deferred fuel, offset in part by a reduction in average unit fuel costs. The average unit fuel cost for 1994 was $1.96 per million BTU, a decrease of approximately 18% from the same period last year. The decrease in per unit fuel cost reflects the reversal of prior years accruals for potential liabilities related to coal transportation, as well as lower costs for natural gas and coal. The increase in fuel expense during 1993 was due primarily to an increase in KWH generation and an increase in unit fuel costs. KWH generation increased 10% due primarily to increased weather-related customer usage and unscheduled 1992 power station maintenance which did not recur in 1993. The average unit fuel cost for 1993 was $2.38 per million Btu, an increase of approximately 2% from 1992 of $2.34 per million Btu. The increase in unit fuel costs was primarily due to an accrual for potential liabilities related to coal transportation, partially offset by lower costs of natural gas and coal.\nPurchased power expenses for 1994 increased approximately $2.2 million or 7% as a result of additional economy energy purchases. Purchased power expenses for 1993 decreased approximately $10.4 million or 24% as a result of additional purchases of firm energy in\n2-112 1992 due to unscheduled power station maintenance which did not recur in 1993.\nOperating Expenses and Taxes Changes in operating expenses in 1994 and 1993 were affected by 1993 restructuring charges of approximately $25 million, which includes approximately $18 million for an early retirement and voluntary severance program. Changes in operating expenses for both years were also affected by the 1993 write-off of certain lignite properties of approximately $5 million and accrued mine reclamation expenses of approximately $3 million. Maintenance in 1993 decreased as a result of unscheduled power station maintenance in 1992.\nDepreciation and amortization expense increased approximately $4 million or 7% in 1994 and $3 million or 5% in 1993 due to increases in depreciable property.\nTaxes, other than federal income increased approximately $3.6 million or 13% in 1994 and decreased approximately $.5 million or 2% in 1993 primarily as a result of changes in state income taxes.\nFederal income tax expense increased approximately $11.3 million or 56% in 1994 and $5.2 million or 35% in 1993 primarily as a result of increased pre-tax income. Additionally, 1993 tax expense increased as a result of an increase in the federal statutory rate from 34% in 1992 to 35% in 1993.\nInflation Annual inflation rates, as measured by the national Consumer Price Index, have averaged 2.7% during the three years ended December 31, 1994. PSO believes that inflation, at this level, does not materially affect its consolidated 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.\nInterest Charges Interest charges for 1994 decreased approximately $1.3 million or 4% as a result of the refinancing in 1993 of higher cost debt. This decrease is offset in part by increases in short-term borrowings. In 1993, charges increased approximately $1.3 million or 4% as a result of higher principal amounts of long-term debt outstanding, offset in part by the reacquisition of higher cost debt. In 1993, interest on short-term debt and other was affected by interest accruals associated with the settlement of federal income tax audit issues partially offset by decreased short-term borrowings at lower rates.\nCumulative Effect of Changes in Accounting Principles PSO implemented a number of accounting changes in 1993. These included the adoption of SFAS No. 112 and SFAS No. 109. PSO also changed its method of accounting for unbilled revenues. These accounting changes had a cumulative effect of increasing net income approximately $6 million.\n2-113 Consolidated Statements of Income Public Service Company of Oklahoma For the Years Ended December 31, 1994 1993 1992 (thousands) Electric Operating Revenues Residential $296,159 $296,027 $258,259 Commercial 227,488 222,598 203,176 Industrial 165,200 149,762 122,180 Sales for resale 35,458 18,248 17,782 Other 16,191 20,901 20,695 740,496 707,536 622,092 Operating Expenses and Taxes Fuel 316,470 298,905 234,884 Purchased power 34,906 32,711 43,134 Other operating 120,233 125,830 117,450 Restructuring charges (197) 24,995 -- Maintenance 44,847 45,777 49,027 Depreciation and amortization 63,096 59,133 56,103 Taxes, other than federal income 31,637 28,060 28,639 Federal income taxes 31,246 19,969 14,759 642,238 635,380 543,996\nOperating Income 98,258 72,156 78,096\nOther Income and Deductions Allowance for equity funds used during construction 1,094 1,096 349 Other 933 531 (940) 2,027 1,627 (591)\nIncome Before Interest Charges 100,285 73,783 77,505\nInterest Charges Interest on long-term debt 29,594 31,410 30,688 Interest on short-term debt and other 3,844 2,729 1,646 Allowance for borrowed funds used during construction (1,419) (852) (391) 32,019 33,287 31,943\nIncome Before Cumulative Effect of Changes in Accounting Principles 68,266 40,496 45,562\nCumulative Effect of Changes in Accounting Principles -- 6,223 --\nNet Income 68,266 46,719 45,562 Preferred stock dividends 816 816 816 Net Income for Common Stock $ 67,450 $ 45,903 $ 44,746\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-114 Consolidated Statements of Retained Earnings Public Service Company of Oklahoma For the Years Ended December 31, 1994 1993 1992 (thousands)\nRetained Earnings at Beginning of Year $97,819 $91,916 $82,170 Net income for common stock 67,450 45,903 44,746 Deduct: Common stock dividends 41,000 40,000 35,000 Retained Earnings at End of Year $124,269 $97,819 $91,916\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-115 Consolidated Balance Sheets Public Service Company of Oklahoma As of December 31, 1994 1993 (thousands) ASSETS Electric Utility Plant Production $ 902,602 $ 895,315 Transmission 346,433 335,405 Distribution 668,346 626,519 General 150,898 143,834 Construction work in progress 96,133 51,931 2,164,412 2,053,004 Less - Accumulated depreciation 859,894 806,066 1,304,518 1,246,938 Current Assets Cash and temporary cash investments 5,453 2,429 Accounts receivable 21,531 36,612 Materials and supplies, at average cost 39,888 38,212 Fuel inventory, at LIFO cost 17,820 21,273 Accumulated deferred income taxes 6,670 -- Prepayments 7,889 2,755 99,251 101,281\nDeferred Charges and Other Assets 61,345 72,160\n$1,465,114 $1,420,379\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-116 Consolidated Balance Sheets Public Service Company of Oklahoma As of December 31, 1994 1993 (thousands) CAPITALIZATION AND LIABILITIES Capitalization Common stock: $15 par value Authorized: 11,000,000 shares Issued 10,482,000 shares and outstanding 9,013,000 shares $ 157,230 $ 157,230 Paid-in capital 180,000 180,000 Retained earnings 124,269 97,819 Total Common Stock Equity 461,499 435,049 Preferred stock 19,826 19,826 Long-term debt 402,752 401,255 Total Capitalization 884,077 856,130\nCurrent Liabilities\nAdvances from affiliates 55,160 31,744 Payables to affiliates 27,876 18,218 Accounts payable 59,899 55,606 Payables to customers 22,655 13,932 Accrued taxes 17,356 15,191 Accrued interest 8,867 5,382 Accumulated deferred income taxes -- 3,633 Accrued restructuring charges 1,046 24,995 Other 14,111 20,140 206,970 188,841 Deferred Credits Accumulated deferred income taxes 281,139 260,490 Investment tax credits 49,011 51,800 Income tax related regulatory liabilities, net 18,611 21,178 Other 25,306 41,940 374,067 375,408\n$1,465,114 $1,420,379\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-117 Consolidated Statements of Cash Flows Public Service Company of Oklahoma For the Years Ended December 31, 1994 1993 1992 (thousands) OPERATING ACTIVITIES Net Income $ 68,266 $ 46,719 $ 45,562 Non-cash Items Included in Net Income Depreciation and amortization 67,452 65,242 61,821 Restructuring charges (197) 24,995 -- Deferred income taxes and investment tax credits 4,990 6,700 18,446 Cumulative effect of changes in accounting principles -- (6,223) -- Allowance for equity funds used during construction (1,094) (1,096) (349) Changes in Assets and Liabilities Accounts receivable 15,081 (17,299) (8,793) Materials and supplies 1,777 2,872 (5,743) Accounts payable 26,375 10,332 9,540 Accrued taxes 2,165 4,240 (17,195) Accrued restructuring charges (15,626) -- -- Other deferred credits (16,634) (3,712) (13,762) Other (754) 1,322 8,955 151,801 134,092 98,482 INVESTING ACTIVITIES Construction expenditures (128,625) (92,648) (99,079) Allowance for borrowed funds used during construction (1,419) (852) (391) Other (335) (6,125) (2,419) (130,379) (99,625) (101,889) FINANCING ACTIVITIES Proceeds from issuance of long-term debt -- 181,194 113,886 Retirement of long-term debt -- (10,000) -- Reacquisition of long-term debt -- (189,685) (63,933) Change in advances from affiliates 23,416 26,454 (11,575) Payment of dividends (41,814) (40,816) (35,817) (18,398) (32,853) 2,561\nNet Change in Cash and Cash Equivalents 3,024 1,614 (846) Cash and Cash Equivalents at Beginning of Year 2,429 815 1,661 Cash and Cash Equivalents at End of Year $ 5,453 $ 2,429 $ 815\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 31,459 $ 34,844 $ 27,708 Income taxes paid $ 28,910 $ 9,232 $ 8,718\nThe accompanying notes to consolidated financial statements are an integral part of these statements\n2-118 Consolidated Statements of Capitalization Public Service Company of Oklahoma As of December 31, 1994 1993 (thousands)\nCOMMON STOCK EQUITY $461,499 $435,049\nPREFERRED STOCK (Cumulative $100 par value, authorized 700,000 shares, redeemable at the option of PSO upon 30 days notice) Number Current of Shares Redemption Series Outstanding Price\n4.00% 97,900 $105.75 9,790 9,790 4.24% 100,000 103.19 10,000 10,000 Premium 36 36 19,826 19,826\nLONG-TERM DEBT First Mortgage Bonds Series J, 5 1\/4%, due March 1, 1996 25,000 25,000 Series K, 7 1\/4%, due January 1, 1999 25,000 25,000 Series L, 7 3\/8%, due March 1, 2002 30,000 30,000 Series S, 7 1\/4%, due July 1, 2003 65,000 65,000 Series T, 7 3\/8%, due December 1, 2004 50,000 50,000 Series U, 6 1\/4%, due April 1, 2003 35,000 35,000 Series V, 7 3\/8%, due April 1, 2023 100,000 100,000 Series W, 6 1\/2%, due June 1, 2005 50,000 50,000 Installment sales agreement - Pollution Control Bonds Series A, 5.9%, due December 1, 2007 34,700 34,700 Series 1984, 7 7\/8%, due September 15, 2014 12,660 12,660 Unamortized discount (4,756) (5,097) Unamortized costs of reacquired debt (19,852) (21,008) 402,752 401,255 TOTAL CAPITALIZATION $884,077 $856,130\nThe accompanying notes to consolidated financial statements are an integral part of these statements.\n2-119 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation PSO is subject to regulation by the SEC under the Holding Company Act and the FERC under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. PSO is subject to further regulation with regard to rates and other matters by the Oklahoma Commission. PSO, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System.\nThe more significant accounting policies of PSO and its subsidiary are summarized below:\nPrinciples of Consolidation The consolidated financial statements include the accounts of PSO and its wholly-owned subsidiary, Ash Creek Mining Company. All significant intercompany items and transactions have been eliminated.\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 electric utility plant are computed using the straight-line method, generally at individual rates applied to the various classes of depreciable property. The annual average consolidated composite rates were 3.5% in 1994, 1993 and 1992.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, PSO changed its method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 net income was an increase of $8.4 million included in cumulative effect of changes in accounting principles.\nPSO recovers fuel costs in Oklahoma through automatic fuel recovery mechanisms. PSO recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause. Under rules established by the Oklahoma Commission, PSO uses a method of deferred fuel accounting. The difference between fuel revenues billed and fuel expense incurred is recorded as a reduction of or an addition to fuel expense, with a corresponding entry to accounts receivable or payables to customers as appropriate. Deferred fuel costs are applied to the customers' billings as a portion of the fuel adjustment clause the second month subsequent to the month in which the under-recoveries or over-recoveries occurred.\nAccounts Receivable PSO sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities For its regulated activities, PSO follows SFAS No. 71, which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to PSO associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future refunds to customers At December 31, 1994 and 1993, PSO had recorded the following significant regulatory assets and liabilities:\n2-120 1994 1993 (thousands) Regulatory Assets (Included in Deferred Charges and Other Assets on the Balance Sheets) Deferred Storm Costs $ 4,798 $ 5,876 Demand Side Management Costs 5,411 4,198 OPEBs 4,504 5,895 Other 4,945 5,621\nRegulatory Liabilities Income tax related regulatory liabilities, net $18,611 $21,178\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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, PSO adopted SFAS Nos. 106, 112 and 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, PSO also changed their method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in the establishment of a regulatory asset of approximately $5 million. See Note 8, Litigation and Regulatory Proceedings-Rate Review for further information. The adoption of SFAS No. 109, SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect SFAS No. 109 $ -- $ (268) $ (268) SFAS No. 112 (3,173) 1,227 (1,946) Unbilled revenues 13,758 (5,321) 8,437 Total $10,585 $(4,362) $6,223\nPro 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 PSO adopted the provisions of SFAS No. 109 effective January 1, 1993. The implementation of SFAS No. 109 had no material effect on PSO's earnings. As a result of this change, PSO recognized additional accumulated deferred income taxes and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, PSO did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\n2-121 PSO, together with other members of the CSW System, files a consolidated Federal income tax return and participates in a tax sharing agreement.\nComponents of income taxes follow: 1994 1993 1992 Included in Operating Expenses and Taxes (thousands) Current $27,529 $13,165 $ (790) Deferred 6,506 9,595 18,260 Deferred ITC (2,789) (2,791) (2,711) 31,246 19,969 14,759 Included in Other Income and Deductions Current (4,080) (1,977) (314) Deferred 89 (1,082) (149) (3,991) (3,059) (463) Tax Effects of Cumulative Effect of Changes in Accounting Principles -- 3,954 -- $27,255 $20,864 $14,296\nInvestment tax credits deferred in prior years are included in income over the lives of the related properties.\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow: 1994 % 1993 % 1992 % (dollars in thousands) Tax at statutory rates $ 33,432 35.0 $ 23,654 35.0 $ 20,351 34.0 Differences Amortization of ITC (2,789) (2.9) (2,791) (4.1) (2,799) (4.7) Flowback of tax rate differential (1,541) (1.6) (1,629) (2.4) (1,627) (2.7) Tax effect from prior period flow through and permanent differences -- -- 1,167 1.7 1,018 1.7 Prior period adjustments (1,348) (1.4) 486 .7 (3,712) (6.2) Other (499) (0.6) (23) -- 1,065 1.8 $27,255 28.5 $20,864 30.9 $14,296 23.9\n2-122 The significant components of the net deferred income tax liability follow:\n1994 1993 (thousands) Deferred Income Tax Liabilities Depreciable utility plant $292,127 $287,217 Income tax related regulatory assets 15,061 15,885 Other 25,309 19,156 Total Deferred Income Tax Liabilities 332,497 322,258\nDeferred Income Tax Assets Income tax related regulatory liability (22,260) (24,076) Unamortized ITC (18,957) (20,036) Other (16,811) (14,023) Total Deferred Income Tax Assets (58,028) (58,135) Net Accumulated Deferred Income Taxes - Total $274,469 $264,123\nNet Accumulated Deferred Income Taxes - Noncurrent $281,139 $260,490 Net Accumulated Deferred Income Taxes - Current (6,670) 3,633 Net Accumulated Deferred Income Taxes - Total $274,469 $264,123\n3.Long-Term Debt The mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by PSO constitutes a direct first mortgage lien on substantially all electric utility plant. PSO may offer additional first mortgage bonds subject to market conditions and other factors.\nAnnual Requirements Certain series of outstanding first mortgage bonds have annual sinking fund requirements, which are generally 1% of the amount of each such series issued. These requirements may be, and generally have been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. At December 31, 1994, the annual sinking fund requirements and annual maturities for the next five years follow:\nSinking Fund Requirements Maturities (thousands) 1995 $800 $ 800 1996 550 25,550 1997 550 550 1998 550 550 1999 300 25,300\nDividends PSO's mortgage indenture, as amended and supplemented, contains certain restrictions on the payment of common stock dividends. At December 31, 1994, $124 million of retained earnings were available for payment of cash dividends to its parent, CSW.\n4.Financial Instruments 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 fair value.\n2-123 Cash and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt The fair value of PSO'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 PSO for debt of the same or similar remaining maturities.\nAdvances from affiliates The carrying amount approximates fair value because of the short maturity of those instruments.\nThe estimated fair values of PSO's financial instruments follow:\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 5,453 $ 5,453 $ 2,429 $ 2,429 Long-term debt 402,752 364,585 401,255 413,218 Advances from affiliates 55,160 55,160 31,744 31,744\nThe fair value does not affect PSO's liabilities unless the issues are redeemed prior to their maturity dates.\n5.Short Term Financing PSO, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. Money pool balances are shown as advances to or from affiliates on the Consolidated Balance Sheets. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million 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.Benefit Plans Defined Benefit Pension Plan PSO, together with other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited 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 which are deductible for income tax purposes and minimum contributions required by the ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate- term fixed income investments.\nContributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $6.3 million, $6.7 million and $5.9 million, respectively.\nThe approximate maximum number of participants in the plan during 1994, were 2,000 active employees, 1,100 retirees and beneficiaries and 300 terminated employees.\n2-124 The components of net periodic pension cost and the assumptions used in accounting for pensions follows: 1994 1993 1992 (thousands) Net Periodic Pension Cost Service cost $ 5,181 $ 4,642 $ 4,307 Interest cost on projected benefit obligation 14,292 13,209 12,193 Actual return on plan assets (1,011) (16,051) (10,469) Net amortization and deferral (16,064) 60 (4,748) $ 2,398 $ 1,860 $ 1,283\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nAt December 31, 1994, the plan's net assets were approximately equal to the total actuarial present value of the accumulated benefit obligation. At December 31, 1993 the plan's net assets exceeded the total actuarial present value of the accumulated benefit obligation. No reconciliation of the funding status of the plan is presented because such information is unavailable.\nHealth and Welfare Plans PSO had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active PSO employees during 1994. The contributions recorded on a pay-as-you-go basis, for the years ended December 31, 1994 and 1993 were approximately $3.6 million and $5.0 million, respectively. Effective January 1993, the PSO's method of providing health benefits was modified to include such benefits as a health maintenance organization, preferred provider options, managed prescription drug and mail-order program and a mental health and substance abuse program in addition to the self- insured indemnity plans.\nPostretirement Benefits Other Than Pensions PSO adopted SFAS No. 106 January 1, 1993. PSO is amortizing their transition obligation over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\nThe components of net periodic postretirement benefit cost follow:\n1994 1993 (thousands) Net Periodic Postretirement Benefit Cost Service cost $ 2,350 $ 2,175 Interest cost on APBO 5,317 4,811 Actual return on plan assets (495) (264) Amortization of transition obligation 2,528 2,528 Net amortization and deferral (917) (564) $ 8,783 $ 8,686\n2-125 A reconciliation of the funded status of the plan to the amounts recognized on the consolidated balance sheets follow:\nDecember 31, 1994 1993 APBO (thousands) Retirees $ 42,233 $ 41,854 Other fully eligible participants 8,077 7,904 Other active participants 14,372 17,186 Total APBO 64,682 66,944 Plan assets at fair value (21,649) (15,066) APBO in excess of plan 43,033 51,878 Unrecognized transition obligation (45,512) (48,040) Unrecognized gain or (loss) 1,903 (4,414) Accrued\/(Prepaid) Cost $ (576) $ (576)\nThe following assumptions were used in accounting for SFAS No. 106:\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 Rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001.\nPost-65 Participants: 1994 Rate of 11.25% 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, 1994 by $7 million and increase the aggregate of the service and interest costs components on net postretirement benefits by $1 million.\n7.Jointly Owned Electric Plant PSO has a joint ownership agreement with other members of the CSW System and non-affiliated entities. Such agreements provide for the joint ownership and operation of the 676 MW, coal-fired Oklaunion Power Station and its related facilities. Each participant provided financing for its share of the project, which was placed in service in December 1986. The consolidated statements of income reflect PSO's portion of operating costs associated with plant in service. PSO's share is 106 MW or a 15.6% interest in the generating station. PSO's total investment, including allowance for funds used during construction, is $80 million and accumulated depreciation at December 31, 1994 was $24 million.\n8.Litigation and Regulatory Proceedings Rate Review In December 1993, the Oklahoma Commission issued an order unanimously approving a joint stipulation between PSO, the Oklahoma Commission Staff, and the Office of the Attorney General of the State of Oklahoma, as recommended by the ALJ. The order allowed PSO an increase in retail prices of $14.4 million on an annual basis which represents a $4.3 million increase above those authorized by the March 1993 interim order. In January 1994, the Oklahoma Commission issued an order unanimously approving PSO's price schedules reflecting the $14.4 million price increase. The new prices became effective beginning with the billing month of February 1994.\n2-126 The December 1993 order addresses, among other things, the following issues. PSO will recover $4.5 million annually in expenses associated with OPEBs, which, for PSO, are primarily health care related benefits. Such expenses will be recovered along with amortization of the deferred 1993 OPEBs at a rate of $0.5 million per year for 10 years. PSO will amortize deferred storm expenses associated with both a 1987 ice storm and a 1992 wind storm, amounting to $1.2 million per year for five years. In addition, the order recognizes the increase in federal income tax expenses resulting from the recent increase in the federal corporate income tax rate from 34 percent to 35 percent. PSO will continue to use the depreciation rates previously approved by the Oklahoma Commission. PSO agreed that it will not file another retail price increase application until after June 30, 1995.\nGas Transportation and Fuel Management Fees An order issued by the Oklahoma Commission in 1991 required that the level of gas transportation and fuel management fees, paid to Transok by PSO, permitted for recovery through the fuel adjustment clause be reviewed in the aforementioned price proceeding. This portion of the price review was bifurcated. In March 1995, an order was issued by the Oklahoma Commission approving an agreement which allows PSO to recover approximately $28.4 million of transportation and fuel management fees in base rates using 1991 determinants and approximately $1 million through the fuel adjustment clause. The agreement also requires the phase-in of competitive bidding of natural gas transportation requirements in excess of 165 MMcf\/d.\nGas Purchase Contracts PSO has been named defendant in complaints filed in federal and state courts of Oklahoma and Texas in 1984 through February 1995 by gas suppliers alleging claims arising out of certain gas purchase contracts. Cases currently pending seek approximately $29 million in actual damages, together with claims for punitive damages which, in compliance with pleading code requirements, are alleged to be in excess of $10,000. The plaintiffs seek relief through the filing dates as well as attorney fees. As a result of settlements among the parties, certain plaintiffs dismissed their claims with prejudice to further action. The settlements did not have a significant effect on PSO's consolidated results of operations. The remaining suits are in the preliminary stages. Management cannot predict the outcome of these proceedings. However, management believes that PSO has defenses to these complaints and intends to pursue them vigorously. Management also believes that the ultimate resolution of the remaining complaints will not have a material adverse effect on PSO's consolidated results of operations or financial condition.\nPCB Cases PSO has been named defendant in complaints filed in federal and state court in Oklahoma in 1984, 1985, 1986 and 1993. The complaints allege, among other things, that some of the plaintiffs and the property of other plaintiffs were contaminated with PCBs and other toxic by-products following certain incidents, including transformer malfunctions in April 1982, December 1983 and May 1984. To date, complaints represent approximately $736 million, including compensatory and punitive damages of claims have been dismissed, certain of which resulted from settlements among the parties. The settlements did not have a significant effect on PSO's consolidated results of operations. Remaining complaints currently total approximately $395 million, of which approximately one-third is for punitive damages. Discovery with regard to the remaining complaints continues. Management cannot predict the outcome of these proceedings. However, management believes that PSO has defenses to these complaints and intends to pursue them vigorously. Moreover, management has reason to believe that PSO's insurance may cover some of the claims. Management also believes that the ultimate resolution of the remaining complaints will not have a material adverse effect on PSO's consolidated results of operations or financial condition.\nBurlington Northern Transportation Contract In June 1992, PSO filed suit in Federal District Court in Tulsa, Oklahoma, against Burlington Northern seeking declaratory relief under a long-term contract for the transportation of coal. In July 1992, Burlington Northern asserted counterclaims against PSO alleging that PSO breached the contract. The counterclaims sought\n2-127 damages in an unspecified amount. In December 1993, PSO amended its suit against Burlington Northern seeking damages and declaratory relief under federal and state anti-trust laws. PSO and Burlington Northern filed motions for summary judgment on certain dispositive issues in the litigation. In March 1994, the court issued an order granting PSO's motions for summary judgment and denying Burlington Northern's motion. It was not necessary for the court to decide the federal and state anti-trust claims raised by PSO. Judgment was rendered in favor of PSO by the United States District Court in May 1994. In June 1994, Burlington Northern appealed this judgment to the United States Court of Appeals for the Tenth Circuit. This appeal is now pending.\nBurlington Northern Arbitration In May 1994, in a related arbitration, an arbitration panel made an award favorable to PSO concerning basic transportation rates under the coal transportation contract described above, and concerning the contract mechanism for adjustment of future transportation rates. These arbitrated issues were not involved in the related lawsuit described above. Burlington Northern filed an action to vacate the arbitrated award in the District Court for Dallas County, Texas. PSO removed this action to the United States District Court for the Northern District of Texas, and filed a motion to either dismiss this action or have it transferred to the United States District Court for the Northern District of Oklahoma. Burlington Northern moved to remand the action to state court. In September 1994, the United States District Court for the Northern District of Texas denied Burlington Northern's motion to remand, and granted PSO's motion to transfer the action to the United States District Court for the Northern District of Oklahoma. Separately, PSO filed an action to confirm the arbitration award in the United States District Court for the Northern District of Oklahoma, and Burlington Northern filed a motion to dismiss this confirmation action. On December 6, 1994, the District Court entered an order denying Burlington Northern's motion to vacate the arbitration award, and granting PSO's motion to confirm the arbitration award. On December 29, 1994, the District Court entered judgment confirming the arbitration award, including a money judgment in PSO's favor for $16.4 million, with interest at 7.2% per annum compounded annually from December 21, 1994 until paid. On January 6, 1995, Burlington Northern appealed the District Court's judgment to the United States Court of Appeals for the Tenth Circuit. This appeal is now pending.\nCoal Mine Reclamation In August 1994, PSO received approval from the Wyoming Department of Environmental Quality to begin reclamation of a coal mine in Sheridan, Wyoming owned by Ash Creek Mining Company, a wholly- owned subsidiary of PSO. Ash Creek Mining Company recorded a $3 million liability in 1993 for the estimated reclamation costs. Actual reclamation work is expected to commence in mid-1995, with completion estimated in late 1996. Surveillance monitoring will continue for ten years after final reclamation. Management believes the ultimate resolution of this matter will not have a material adverse effect on PSO's consolidated results of operations or financial condition.\nOther PSO 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 PSO's consolidated results of operations or financial condition.\n9. Commitments and Contingent Liabilities It is estimated that PSO will spend approximately $71 million in capital expenditures during 1995. Substantial commitments have been made in connection with the 1995 construction program\nTo supply the fuel requirements of its generating plants, PSO has entered into various commitments for the procurement of fuel.\n2-128 10. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts.\nOperating Operating Net Quarter Ended Revenues Income Income 1994 (thousands) March 31 $ 157,509 $ 12,427 $ 4,307 June 30 174,631 23,808 15,927 September 30 246,378 47,196 40,003 December 31 161,978 14,827 8,029 $ 740,496 $ 98,258 $ 68,266\nMarch 31 $ 145,110 $ 12,312 $ 10,113 June 30 161,237 23,935 15,605 September 30 242,871 46,221 38,641 December 31 158,318 (10,312) (17,640) $ 707,536 $ 72,156 $ 46,719\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-129 Report of Independent Public Accountants\nTo the Stockholders and Board of Directors of Public Service Company of Oklahoma:\nWe have audited the accompanying consolidated balance sheets and consolidated statements of capitalization of Public Service Company of Oklahoma (an Oklahoma corporation and a wholly-owned subsidiary of Central and South West Corporation) and subsidiary company, as of December 31, 1994 and 1993, and the related consolidated statements of income, retained earnings and cash flows, for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of PSO'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 Public Service Company of Oklahoma and subsidiary company as of December 31, 1994 and 1993, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, PSO changed its methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II 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. This schedule 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 LLP\nTulsa, Oklahoma February 13, 1995\n2-130 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the consolidated financial statements of Public Service Company of Oklahoma and its subsidiary company as well as other information contained in this Annual Report. The consolidated 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 Annual Report is consistent with that in the consolidated financial statements.\nThe consolidated financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. PSO and its subsidiary believe that representations made to the independent auditors during their audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nPSO, together with its subsidiary company, maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the consolidated financial statements are prepared in accordance with generally accepted accounting principles and that the assets of the companies are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that PSO will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of PSO or its subsidiary, provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nPSO and its subsidiary believe that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nRobert L. Zemanek R. Russell Davis President and CEO - PSO Controller - PSO\n2-131\nSWEPCO\nSOUTHWESTERN ELECTRIC POWER COMPANY Selected Financial Data SWEPCO The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for SWEPCO.\n1994 1993 1992 1991 1990 (thousands, except ratios) Operating Revenues $825,296 $837,192 $778,303 $760,694 $735,217 Income Before Cumulative Effect of Changes in Accounting Principles 105,712 78,471 94,883 96,624 89,713 Cumulative Effect of Changes in Accounting Principles (1) -- 3,405 -- -- -- Net Income 105,712 81,876 94,883 96,624 89,713 Preferred Stock Dividends 3,361 3,362 3,445 3,465 3,528 Net Income for Common Stock 102,351 78,514 91,438 93,159 86,185\nTotal Assets 2,079,207 1,968,285 1,927,320 1,851,108 1,869,340\nCommon Stock Equity 678,122 645,731 647,217 645,780 641,554 Preferred Stock Not Subject to Mandatory Redemption 16,032 16,032 16,032 16,033 14,358 Subject to Mandatory Redemption 34,828 36,028 37,228 38,416 36,422 Long-term Debt 595,833 602,065 532,860 573,626 576,095\nRatio of Earnings to Fixed Charges (SEC Method) Before Cumulative Effect of Changes in Accounting Principles 3.70 3.27 3.39 3.51 3.03\nCapitalization Ratios Common Stock Equity 51.2% 49.7% 52.5% 50.7% 50.6% Preferred Stock 3.8 4.0 4.3 4.3 4.0 Long-term Debt 45.0 46.3 43.2 45.0 45.4\n(1) The 1993 cumulative effect relates to the changes in accounting for unbilled revenues and adoption of SFAS No. 112. See NOTE 1, Summary of Significant Accounting Policies.\nSWEPCO changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore have not been restated.\n2-133 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSOUTHWESTERN ELECTRIC POWER COMPANY\nReference is made to SWEPCO's Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential in understanding, the following discussion and analysis.\nOverview Net income for common stock increased 30% during 1994 to approximately $102.4 million from approximately $78.5 million in 1993, due primarily to the effects of restructuring costs recorded during 1993.\nRestructuring As previously reported, SWEPCO has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable SWEPCO to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $25 million and were expensed in 1993. The final costs of the restructuring were approximately $20 million. Approximately $19 million of the restructuring expenditures were incurred during 1994, with the remaining $1 million expected to be incurred during 1995. Approximately $1 million of the restructuring expenses relate to employee termination benefits, $12 million relate to enhanced benefit costs and $7 million relate to employees that will not be terminated. Approximately $13 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $7 million represents the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nSWEPCO expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. The CSW System expects that all restructuring costs will be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nRates and Regulatory Matters See NOTE 9, Litigation and Regulatory Proceedings, for information regarding the SWEPCO fuel reconciliation proceeding.\nNew Accounting Standards SFAS No. 115 was effective for fiscal years beginning after December 15, 1993. SWEPCO adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on SWEPCO's results of operations or financial condition.\nIn June 1993 the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by SWEPCO for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on SWEPCO's results of operations or financial condition.\n2-134 SFAS No. 119 was effective for fiscal years ending after December 15, 1994. SWEPCO does not currently use derivative financial instruments, but may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on SWEPCO's results of operations or financial condition.\nLiquidity and Capital Resources Overview SWEPCO's need for capital results primarily from its construction of facilities to provide reliable electric service to its customers. Accordingly, internally generated funds should meet most of the capital requirements. However, if internally generated funds are not sufficient, SWEPCO's financial condition should allow it access to the capital markets.\nCapital Expenditures Construction expenditures, including AFUDC, were approximately $153 million in 1994, $176 million in 1993 and $97 million in 1992. Included in the expenditures for 1993 was approximately $35 million for the acquisition of BREMCO, a rural electric cooperative with service territory adjacent to SWEPCO's service territory in Louisiana. Construction expenditures during the period 1995-1997 are estimated at $286 million. These expenditures will consist primarily of expansion and improvements to distribution facilities. No new baseload power plants are currently planned until after the year 2000.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in SWEPCO's service area, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected coal- and lignite-fired generating plants for which SWEPCO has invested approximately $34 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, SWEPCO would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of SWEPCO were 51% common stock equity, 4% preferred stock and 45% long-term debt. SWEPCO's embedded cost of long-term debt was 7.6% at the end of 1994. SWEPCO continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. SWEPCO continues to be committed to maintaining financial flexibility by maintaining a strong capital structure and favorable securities rating which should allow funds to be obtained from the capital markets when required.\nSWEPCO's long-term financing activity for 1994 is summarized below:\nIn June 1994, SWEPCO renegotiated a $50 million term loan due June 1997, changing certain terms, including an extension of the maturity to June 2000.\nIn several transactions during 1994, SWEPCO redeemed $5.8 million, which represented all remaining bonds outstanding of its 9- 1\/8% First Mortgage Bonds, Series U, due November 1, 2019. The funds required for these transactions were provided from short-term borrowings and internal sources. Redemption premiums are included in long-term debt on the balance sheets and are being amortized over 5 to 30 years, in accordance with anticipated regulatory treatment.\nShort-Term Financing SWEPCO, together with other members of CSW System, has established a CSW System money pool to coordinate short-term borrowings. These loans are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs.\n2-135 SWEPCO's short-term borrowing limit from the money pool is $150 million. During 1994, the annual weighted average interest rate was 4.5% and the average amount of short-term borrowings outstanding at month-end was $25 million. The maximum amount of short-term borrowings outstanding at any month-end during 1994 was $82 million, which was the amount outstanding at December 31, 1994.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. SWEPCO utilizes short-term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. SWEPCO anticipates that capital requirements for the period 1995 to 1997 will be met, in large part, from internal sources. SWEPCO also anticipates that some external financing will be required during the period, however the nature, timing and extent have not yet been determined. Information concerning internally generated funds follows:\n1994 1993 1992 (millions) Internally Generated Funds $105 $149 $75\nConstruction Expenditures Provided by Internally Generated Funds 71% 85% 78%\nSales of Accounts Receivable SWEPCO sells its billed and unbilled accounts receivable, without recourse, to CSW Credit. The sales provide SWEPCO with cash immediately, thereby reducing working capital needs and revenue requirements. The average and year end amounts of accounts receivable sold were $69 million and $62 million in 1994, as compared to $64 million and $57 million in 1993.\nRecent Developments and Trends Competition and Industry Challenges Competitive forces at work in the electric utility industry are impacting SWEPCO and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, SWEPCO will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. SWEPCO believes that its prices for electricity and the quality and reliability of its service currently place it in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While SWEPCO believes that the Energy Policy Act will continue to make the wholesale markets more competitive, SWEPCO is unable to predict the extent to which the Energy Policy Act will impact its operations.\n2-136 Increasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. SWEPCO competes in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities, but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers.\nSWEPCO believes that, compared to other electric utilities, it is well positioned to meet future competition. SWEPCO benefits from economies of scale and scope by virtue of its size and its relationship to the CSW System. SWEPCO is also a relatively low-cost producer of electric power. Moreover, SWEPCO is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nSWEPCO is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or on SWEPCO. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\nPublic Utility Regulatory Act PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. SWEPCO is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, SWEPCO has recognized regulatory assets and liabilities. Management believes that SWEPCO will continue to meet the criteria for following SFAS No. 71. However, in the event the SWEPCO no longer meets the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nConsolidated Taxes The Texas Commission before 1992 allowed income taxes to be recovered in rates based on the federal income tax incurred by a utility as if it were a stand-alone company. This stand-alone approach treated the regulated activities of a utility as a separate entity and considered only those revenues and expenses that are included in the utility's cost of service to calculate the federal income tax liability for ratemaking purposes.\n2-137 Beginning in 1992, the Texas Commission changed its method of calculating the federal income tax component of rates to the \"actual tax approach.\" The actual tax approach is an evolving concept but generally seeks to reflect in rates the actual tax liability of the utility irrespective of its relationship to the utility's cost of service. The approach reduces rates by the tax benefits of deductions which are not considered for or included in setting rates for the utility.\nSWEPCO believes that the recovery of federal income taxes in rates should be determined on the stand-alone approach for ratemaking purposes, but there is no assurance this approach will be adopted.\nEnvironmental Matters CERCLA and Related Matters The operations of SWEPCO, like those of other utilities, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nSWEPCO is subject to various pending claims alleging that it is a PRP under federal or state remedial laws for investigating and cleaning up contaminated property. SWEPCO anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on SWEPCO's results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by SWEPCO, the estimated amount of costs allocated to SWEPCO and the participation of other parties.\nMGPs Contaminated former MGPs are a type of site which utilities, and others, may have to remediate in the future under Superfund or other federal or state remedial programs. Gas was manufactured at MGPs from the mid-1800s to the mid-1900s. In some cases, utilities and others have faced potential liability for MGPs because they, or their alleged predecessors, owned or operated the plants. In other cases, utilities or others may have been subjected to such liability for MGPs because they acquired MGP sites after gas production ceased.\nSuspected MGP Site in Marshall, Texas SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO has accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\nSuspected MGP Site in Texarkana, Texas and Arkansas and Shreveport, Louisiana SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\nSuspected Biloxi, Mississippi MGP Site SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power\n2-138 Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nManagement does not expect these matters to have a material effect on SWEPCO's results of operations or financial position.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, SWEPCO will be required to hold allowances in order to emit sulfur dioxide. EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, SWEPCO believes that its allowances will be adequate to meet its needs at least through 2008. Public and private markets are developing for trading of excess allowances. SWEPCO presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\nThe Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on SWEPCO cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, SWEPCO expects to spend an additional $1.3 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects. Although a few of the studies to date have suggested certain associations between EMFs and some types of effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. SWEPCO cannot predict the impact on SWEPCO or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nSee ITEM 1. BUSINESS - ENVIRONMENTAL MATTERS and NOTE 10, Commitments and Contingent Liabilities, for additional discussion of environmental issues.\nResults of Operations Electric Operating Revenues Total electric operating revenues decreased $11.9 million or 1% during 1994 due primarily to decreased fuel revenues partially offset by a 3% increase in retail KWH sales due to customer growth and a 15% increase in sales for resale. Sales for resale to non-affiliated electric utilities and rural electric cooperatives increased approximately $9.4 million during the year. Total revenues increased approximately $59 million in 1993 when compared to the prior year. The increase was due primarily to a 6% increase in KWH sales\n2-139 resulting from favorable weather and customer growth due to the acquisition of BREMCO in 1993 as well as increased sales for resale.\nFuel and Purchased Power Expenses Fuel expense decreased approximately $27.2 million or 7% during 1994 and increased approximately $28 million or 8% during 1993. The decrease in 1994 is due primarily to a decrease in unit fuel costs from $1.94 in 1993 to $1.75 in 1994. The decrease in unit fuel costs is primarily due to coal contract settlements and a decrease in the cost of spot market gas. This decrease was partially offset by a 4% increase in generation. The increase in 1993 is attributable to an 8% increase in generation and an increase in unit fuel costs from $1.93 in 1992 to $1.94 in 1993.\nPurchased power costs increased approximately $7.1 million in 1994 and $6.5 million in 1993. The 1994 increase was due primarily to a purchased power contract negotiated as a part of the 1993 purchase of BREMCO. The increase in 1993 was largely due to scheduled and unscheduled maintenance at the Company's generating facilities and the above-mentioned purchased power contract.\nOperating Expenses and Taxes Other operating expenses increased approximately $18.1 million in 1993 due primarily to expensing of reserves for certain lignite properties, outside and legal services, and an increase in employee benefit expenses in 1993 resulting form the adoption of SFAS No. 106.\nRestructuring charges reflect the initial estimated cost of the restructuring of $25.2 million. As the restructuring progressed, this amount was adjusted during 1994 to approximately $20 million.\nMaintenance expense decreased approximately $7.4 million in 1994 and increased approximately $8 million in 1993 when compared to 1992. The changes during both periods are due to increased maintenance of distribution facilities and general plant in 1993.\nTaxes, other than federal income, increased approximately $4.4 million or 10% in 1993 due primarily to a Texas franchise tax refund recognized in 1992.\nFederal income tax expense increased approximately $13.1 million or 48% in 1994 primarily as a result of increased pre-tax income. In 1993, federal income taxes decreased approximately $5.8 million or 18% as a result of lower pre-tax income partially offset by an increase in the federal income tax rate from 34% to 35%.\nInflation Annual inflation rates, as measured by the national Consumer Price Index, have averaged approximately 2.7% for the three-year period ending December 31, 1994. Inflation at these levels does not materially affect SWEPCO's results of operations or financial condition. Under existing regulatory practice, however, 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.\nAllowance for Equity and Debt Funds Used During Construction AFUDC is a function of the amounts of construction on which AFUDC is calculated and the rate used. The increases in 1994 and 1993 were due primarily to increased construction work in process.\nInterest on Long-Term Debt Interest expense on long-term debt increased in 1994 approximately $2.4 million or 6% due primarily to an increase in average balances outstanding. The 1993 decrease of approximately $6.5 million is attributable to the refinancing of higher cost debt with lower cost debt.\n2-140 Interest on Short-Term Debt and Other Interest expense on short-term debt and other increased approximately $2.7 million in 1994 when compared to 1993 due primarily to an interest accrual pursuant to the terms of a settlement agreement approved by the Texas Commission in connection with SWEPCO's fuel reconciliation and increased interest expense associated with short-term debt.\nCumulative Effect of Changes in Accounting Principles Accounting changes in 1993 include the adoption of SFAS 112. SWEPCO also changed its method of accounting for unbilled revenues. These accounting changes had a cumulative effect of increasing net income by $3.4 million.\n2-141 Statements of Income Southwestern Electric Power Company For the Years Ended December 31, 1994 1993 1992 (thousands) Electric Operating Revenues Residential $266,620 $273,707 $249,182 Commercial 173,718 175,059 165,836 Industrial 243,518 250,912 243,508 Sales for resale 102,723 93,337 78,814 Other 38,717 44,177 40,963 825,296 837,192 778,303 Operating Expenses and Taxes Fuel 336,389 363,627 335,594 Purchased power 20,244 13,145 6,620 Other operating 119,277 118,665 100,598 Restructuring charges (4,978) 25,203 -- Maintenance 42,782 50,164 42,191 Depreciation and amortization 79,845 74,385 72,300 Taxes, other than federal income 45,735 46,942 42,502 Federal income taxes 40,080 27,004 32,771 679,374 719,135 632,576\nOperating Income 145,922 118,057 145,727\nOther Income and Deductions Allowance for equity funds used during construction 3,579 1,560 132 Other 4,656 3,658 537 8,235 5,218 669\nIncome Before Interest Charges 154,157 123,275 146,396\nInterest Charges Interest on long-term debt 43,395 40,958 47,490 Interest on short-term debt and other 7,568 4,866 4,073 Allowance for borrowed funds used during construction (2,518) (1,020) (50) 48,445 44,804 51,513 Income Before Cumulative Effect of Changes in Accounting Principles 105,712 78,471 94,883\nCumulative Effect of Changes in Accounting Principles -- 3,405 --\nNet Income 105,712 81,876 94,883 Preferred stock dividends 3,361 3,362 3,445 Net Income for Common Stock $ 102,351 $ 78,514 $ 91,438\nThe accompanying notes to financial statements are an integral part of these statements.\n2-142 Statements of Retained Earnings Southwestern Electric Power Company For the Years Ended December 31, 1994 1993 1992 (thousands) Retained Earnings at Beginning of Year $265,071 $266,557 $265,120 Net income for common stock 102,351 78,514 91,438 Gain on reacquisition of preferred stock 40 -- -- Deduct: Common stock dividends 70,000 80,000 90,000 Preferred stock redemption cost -- -- 1 Retained Earnings at End of Year $297,462 $265,071 $266,557\nThe accompanying notes to financial statements are an integral part of these statements.\n2-143 Balance Sheets Southwestern Electric Power Company As of December 31, 1994 1993 (thousands) ASSETS Electric Utility Plant Production $1,401,418 $1,392,058 Transmission 385,113 350,625 Distribution 733,707 678,788 General 213,563 188,193 Construction work in progress 149,508 126,258 2,883,309 2,735,922 Less - Accumulated depreciation 1,026,751 947,792 1,856,558 1,788,130 Current Assets Cash and temporary cash investments 1,296 6,723 Accounts receivable 54,344 24,363 Materials and supplies, at average cost 28,109 25,218 Fuel inventory, at average cost 61,701 49,487 Accumulated deferred income taxes 6,592 3,912 Prepayments and other 13,071 14,965 165,113 124,668\nDeferred Charges and Other Assets 57,536 55,487 $2,079,207 $1,968,285\nThe accompanying notes to financial statements are an integral part of these statements.\n2-144 Balance Sheets Southwestern Electric Power Company As of December 31, 1994 1993 (thousands) CAPITALIZATION AND LIABILITIES Capitalization Common stock: $18 par value Authorized: 7,600,000 shares Issued and Outstanding: 7,536,640 shares $ 135,660 $ 135,660 Paid-in capital 245,000 245,000 Retained earnings 297,462 265,071 Total Common Stock Equity 678,122 645,731 Preferred stock Not subject to mandatory redemption 16,032 16,032 Subject to mandatory redemption 34,828 36,028 Long-term debt 595,833 602,065 Total Capitalization 1,324,815 1,299,856\nCurrent Liabilities Long-term debt and preferred stock due within twelve months 5,270 5,028 Advances from affiliates 81,868 27,864 Accounts payable 50,138 41,598 Fuel refunds due customers 12,200 2,358 Customer deposits 13,075 14,244 Accrued restructuring charges 1,110 25,203 Accrued taxes 12,495 27,340 Accrued interest 17,175 17,354 Other 29,505 30,499 222,836 191,488 Deferred Credits Income taxes 365,441 332,522 Investment tax credits 81,023 85,301 Income tax related regulatory liabilities, net 44,836 52,828 Other 40,256 6,290 531,556 476,941 $2,079,207 $1,968,285\nThe accompanying notes to financial statements are an integral part of these statements.\n2-145 Statements of Cash Flows Southwestern Electric Power Company For the Years Ended December 31, 1994 1993 1992 (thousands) OPERATING ACTIVITIES Net Income $105,712 $ 81,876 $ 94,883 Non-cash Items Included in Net Income Depreciation and amortization 89,646 93,120 79,051 Restructuring charges (4,978) 25,203 -- Deferred income taxes and investment tax credits 17,970 (4,775) 3,393 Cumulative effect of changes in accounting principles -- (3,405) -- Allowance for equity funds used during construction (3,579) (1,560) (132) Changes in Assets and Liabilities Accounts receivable (29,981) (3,632) (8,067) Fuel inventory (12,214) 21,101 12,722 Accounts payable 8,540 8,612 5,313 Accrued taxes (14,845) 11,561 (5,817) Accrued restructuring charges (11,694) -- -- Unrecovered fuel\/Fuel refund due customers 9,842 1,946 1,274 Other deferred credits 33,966 (9,468) (1,875) Other (10,264) 11,519 (11,892) 178,121 232,098 168,853 INVESTING ACTIVITIES Construction expenditures (146,865) (138,510) (96,676) Acquisition expenditures -- (35,333) -- Allowance for borrowed funds used during construction (2,518) (1,020) (50) Sale of electric utility plant and other (4,980) (4,113) (2,339) (154,363) (178,976) (99,065) FINANCING ACTIVITIES Proceeds from sale of long-term debt -- 221,511 221,067 Reacquisition of long-term debt (5,475) (198,962) (176,474) Redemption of preferred stock (1,160) -- (1,190) Retirement of long-term debt (3,213) (39,835) (3,488) Change in advances from affiliates 54,004 (286) 28,149 Special deposits for reacquisition of long-term debt -- 53,500 (53,500) Payment of dividends (73,341) (83,386) (93,443) (29,185) (47,458) (78,879)\nNet Change in Cash and Cash Equivalents (5,427) 5,664 (9,091) Cash and Cash Equivalents at Beginning of Year 6,723 1,059 10,150 Cash and Cash Equivalents at End of Year $ 1,296 $ 6,723 $ 1,059\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 45,260 $ 42,271 $ 53,129 Income taxes paid $ 36,632 $ 21,112 $ 37,181\nThe accompanying notes to financial statements are an integral part of these statements.\n2-146 Statements of Capitalization Southwestern Electric Power Company As of December 31, 1994 1993 (thousands)\nCOMMON STOCK EQUITY $ 678,122 $ 645,731\nPREFERRED STOCK Cumulative $100 Par Value, Authorized 1,860,000 shares Number Current of Shares Redemption Series Outstanding Price\nNot Subject to Mandatory Redemption 5.00% 75,000 $109.00 7,500 7,500 4.65% 25,000 102.75 2,500 2,500 4.28% 60,000 103.90 6,000 6,000 Premium 32 32 16,032 16,032 Subject to Mandatory Redemption 6.95% 352,000 104.64 36,400 37,600 Issuance Expense (372) (372) Amount to be redeemed within one year (1,200) (1,200) 34,828 36,028 LONG-TERM DEBT First Mortgage Bonds Series U, 9 1\/8%, due November 1, 2019 -- 5,830 Series V, 7 3\/4%, due June 1, 2004 40,000 40,000 Series W, 6 1\/8%, due September 1, 1999 40,000 40,000 Series X, 7%, due September 1, 2007 90,000 90,000 Series Y, 6 5\/8%, due February 1, 2003 55,000 55,000 Series Z, 7 1\/4%, due July 1, 2023 45,000 45,000 Series AA, 5 1\/4%, due April 1, 2000 45,000 45,000 Series BB, 6 7\/8%, due October 1, 2025 80,000 80,000 1976 Series A, 6.20%, due November 1, 2006 * 6,665 6,810 1976 Series B, 6.20%, due November 1, 2006 * 1,000 1,000 Installment Sales Agreements - PCRBs 1978 Series A, 6%, due January 1, 2008 14,420 14,420 Series 1986, 8.2%, due July 1, 2014 81,700 81,700 1991 Series A, 8.2%, due August 1, 2011 17,125 17,125 1991 Series B, 6.9%, due November 1, 2004 12,290 12,290 Series 1992, 7.6%, due January 1, 2019 53,500 53,500 Bank Loan, Variable Rate, due June 15, 2000 50,000 50,000 Railcar lease obligations 17,922 20,635 Unamortized discount and premium (3,745) (4,034) Unamortized costs of reacquired debt (45,974) (48,383) Amount to be redeemed within one year (4,070) (3,828) 595,833 602,065 TOTAL CAPITALIZATION $1,324,815 $1,299,856\n*Obligations incurred in connection with the sale by public authorities of tax-exempt PCRBs.\nThe accompanying notes to financial statements are an integral part of these statements.\n2-147 NOTES TO FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation SWEPCO is subject to regulation by the SEC under the Holding Company Act and the FERC under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. SWEPCO is subject to further regulation with regard to rates and other matters by state regulatory commissions including the Arkansas Commission, Louisiana Commission and the Texas Commission. SWEPCO, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System.\nThe more significant accounting policies of SWEPCO 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 electric utility plant are computed using the straight-line method, generally at individual rates applied to the various classes of depreciable property. The annual average consolidated composite rates were 3.2% in 1994, 1993 and 1992.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, SWEPCO changed its method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 income was an increase of $5.4 million included in cumulative effect of changes in accounting principles.\nSWEPCO recovers fuel costs in Texas as a fixed component of base rates whereby over-recoveries of fuel are payable to customers and under-recoveries may be billed to customers after Texas Commission approval. The cost of fuel is charged to expense as consumed.\nSWEPCO recovers fuel costs in Arkansas and Louisiana through automatic fuel recovery mechanisms. The application of these mechanisms varies by jurisdiction.\nSWEPCO recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause.\nAccounts Receivable SWEPCO sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities For its regulated activities, SWEPCO follows SFAS No. 71, which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to the company associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future refunds to customers. At December 31, 1994 and 1993, SWEPCO had recorded the following significant regulatory assets and liabilities:\n2-148 1994 1993 (thousands) Regulatory Assets (Included in Deferred Charges and Other Assets on the Balance Sheets) SFAS No. 106 Costs $ 1,949 $ 993\nRegulatory Liabilities Fuel refund due customers $12,200 $ 2,358 Income tax related regulatory liabilities, net $44,836 $52,828\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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, SWEPCO adopted SFAS Nos. 106, 112 and 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, SWEPCO also changed its method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in 1993 operating expenses of $3 million. The adoption of SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect\nSFAS No. 112 $(3,047) $ 1,066 $(1,981) Unbilled revenues 8,286 (2,900) 5,386 Total $ 5,239 $(1,834) $ 3,405\nPro 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 SWEPCO adopted the provisions of SFAS No. 109 effective January 1, 1993. The implementation of SFAS No. 109 had no material effect on SWEPCO's earnings. As a result of this change, SWEPCO recognized additional accumulated deferred income taxes and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, SWEPCO did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\nSWEPCO, together with other members of the CSW System, files a consolidated federal income tax return and participates in a tax sharing agreement.\n2-149 Components of income taxes follow: 1994 1993 1992 Included in Operating Expenses and Taxes (thousands) Current $22,110 $31,779 $29,377 Deferred 22,248 418 10,258 Deferred ITC (4,278) (5,193) (6,864) 40,080 27,004 32,771 Included in Other Income and Deductions Current (3,732) (1,916) 278 Deferred -- -- -- (3,732) (1,916) 278 Tax Effects of Cumulative Effect of Changes in Accounting Principles -- 1,834 -- $36,348 $26,922 $33,049\nInvestment tax credits deferred in prior years are included in income over the lives of the related properties.\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow:\n1994 % 1993 % 1992 % (dollars in thousands) Tax at statutory rates $49,721 35.0 $38,079 35.0 $43,497 34.0 Differences Amortization of ITC (4,277) (3.0) (5,193) (4.8) (5,384) (4.2) Prior period adjustments (2,718) (1.9) -- -- (3,218) (2.5) Consolidated savings (2,476) (1.7) (2,575) (2.4) -- -- Other (3,902) (2.8) (3,389) (3.1) (1,846) (1.6) $36,348 25.6 $26,922 24.7 $33,049 25.7\nThe significant components of the net deferred income tax liability follow:\n1994 1993 (thousands) Deferred Income Tax Liabilities Depreciable utility plant $ 389,016 $ 352,629 Income tax related regulatory assets 33,847 33,028 Other 41,150 39,405 Total Deferred Income Tax Liabilities $ 464,013 $ 425,062\nDeferred Income Tax Assets Income tax related regulatory liability (50,162) (52,250) Unamortized ITC (29,482) (31,039) Other (25,520) (13,163) Total Deferred Income Tax Assets (105,164) (96,452) Net Accumulated Deferred Income Taxes - Total $ 358,849 $ 328,610\nNet Accumulated Deferred Income Taxes - Noncurrent $ 365,441 $ 332,522 Net Accumulated Deferred Income Taxes - Current (6,592) (3,912) Net Accumulated Deferred Income Taxes - Total $ 358,849 $ 328,610\n2-150 3.Long-Term Debt The mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by SWEPCO, constitutes a direct first mortgage lien on substantially all electric utility plant. SWEPCO may offer additional first mortgage bonds subject to market conditions and other factors.\nAnnual Requirements Certain series of outstanding first mortgage bonds have annual sinking fund requirements, which are generally 1% of the amount of each such series issued. These requirements may be, and generally have been, satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements. At December 31, 1994, the annual sinking fund requirements and annual maturities for the next five years follow:\nSinking Fund Requirements Maturities (thousands) 1995 $ 145 $ 4,100 1996 145 3,900 1997 145 2,600 1998 145 2,400 1999 595 44,000\nDividends SWEPCO's mortgage indenture, as amended and supplemented, contains certain restrictions on the payment of common dividends. At December 31, 1994, all of SWEPCO's retained earnings were available for the payment of cash dividends to its parent, CSW.\nReacquired Long-term Debt Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, Liquidity and Capital Resources - Long-term Financing, for further information related to long-term debt, including new issues and reacquisitions.\n4.Preferred Stock SWEPCO's 6.95% Series, $100 par value preferred stock required a mandatory sinking fund sufficient to retire 12,000 shares annually.\nThe outstanding preferred stock not subject to mandatory redemption is redeemable at the option of SWEPCO upon 30 days notice at the current redemption price per share.\n5.Financial Instruments 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 fair value.\nCash and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nAdvances from affiliates The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt The fair value of the SWEPCO'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 SWEPCO for debt of the same remaining maturities.\n2-151 Current maturities of long-term debt and preferred stock due within 12 months The fair values of the SWEPCO's current maturities of long-term debt and preferred stock due within 12 months are estimated based on quoted market prices for the same or similar issues or on the current rates offered to SWEPCO for long-term debt or preferred stock with the same or similar remaining redemption provisions.\nPreferred stock The fair value of SWEPCO's preferred stock is estimated based on quoted market prices for the same or similar issues or on the current rates offered to SWEPCO for preferred stock with the same or similar remaining redemption provisions.\nThe estimated fair values of SWEPCO's financial instruments follow: 1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 1,296 $ 1,296 $ 6,723 $ 6,723 Long-term debt and preferred stock due within 12 months 5,270 5,171 -- -- Advances from affiliates 81,868 81,868 32,892 32,892 Long-term debt 595,833 555,659 602,065 631,150 Preferred stock subject to mandatory redemption 34,828 31,968 36,028 38,038\nThe fair value does not affect SWEPCO's liabilities unless the issues are redeemed prior to their maturity dates.\n6.Short-Term Financing SWEPCO, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. Money pool balances are shown as advances to or from affiliates on the Balance Sheets. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million 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.\n7.Benefit Plans Defined Benefit Pension Plan SWEPCO, together with other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited service, age at retirement, and final average annual earnings with an offset for the participants' primary Social Security benefit. The CSW System's funding policy is based on actuarially determined contributions, taking into account amounts which are deductible for income tax purposes and minimum contributions required by ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate- term fixed income investments.\nContributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $5.9 million, $6.1 million and $5.2 million, respectively.\nThe approximate maximum number of participants in the plan during 1994 was 2,000 active employees, 800 retirees and beneficiaries and 100 terminated employees.\n2-152 The components of net periodic pension cost and the assumptions used in accounting for pensions follow: 1994 1993 1992 (thousands) Net Periodic Pension Cost Service cost $ 4,843 $ 4,239 $ 3,857 Interest cost on projected benefit obligation 13,361 12,063 10,920 Actual return on plan assets (945) (14,658) (9,375) Net amortization and deferral (15,018) 55 (4,253) $ 2,341 $ 1,699 $ 1,149\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nAt December 31, 1994, the plan's net assets were approximately equal to the total actuarial present value of the accumulated benefit obligation. At December 31, 1993 and 1992, the plan's net assets exceeded the total actuarial present value of the accumulated benefit obligation. No reconciliation of the funding status of the plan is presented because such information is unavailable.\nHealth and Welfare Plans SWEPCO had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active SWEPCO employees during 1994. The contributions, recorded on a pay-as-you-go basis, for the years ended December 31, 1994 and 1993 were approximately $4.1 million and $5.4 million, respectively. Effective January 1993, SWEPCO's method of providing health benefits was modified to include such benefits as a health maintenance organization, preferred provider options, managed prescription drug and mail-order program and a mental health and substance abuse program in addition to the self- insured indemnity plans.\nPostretirement Benefits Other Than Pensions SWEPCO adopted SFAS No. 106 on January 1, 1993. The effect on operating expense in 1993 was $3 million. SWEPCO is amortizing its transition obligation over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\nThe components of net periodic postretirement benefit cost follow:\n1994 1993 (thousands) Net Periodic Postretirement Benefit Cost Service cost $1,965 $1,813 Interest cost on APBO 4,266 3,782 Actual return on plan assets (464) (230) Amortization of transition obligation 1,967 1,967 Net amortization and deferral (765) (474) $6,969 $6,858\n2-153 A reconciliation of the funded status of the plan to the amounts recognized on the balance sheets follow:\nDecember 31, 1994 1993 APBO (thousands) Retirees $ 32,938 $ 31,883 Other fully eligible participants 7,945 7,505 Other active participants 12,726 14,199 Total APBO 53,609 53,587 Plan assets at fair value (18,775) (13,139) APBO in excess of plan assets 34,834 40,448 Unrecognized transition obligation (35,403) (37,370) Unrecognized gain or (loss) 608 (4,410) Accrued\/(Prepaid) Cost $ 39 $ (1,332)\nThe following assumptions were used in accounting for SFAS No. 106.\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 Rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001.\nPost-65 Participants: 1994 Rate of 11.25% 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, 1994 by $6 million and increase the aggregate of the service and interest costs components on net postretirement benefits by $0.9 million.\n8.Jointly Owned Electric Utility Plant SWEPCO has joint ownership agreements with non-affiliated entities. Such agreements provide for the joint ownership and operation of the Flint Creek, Pirkey and Dolet Hills power plants and related facilities. The statements of income reflect SWEPCO's portion of operating costs associated with jointly owned plants. At December 31, 1994, SWEPCO had interests as shown below: Flint Dolet Creek Pirkey Hills Coal Lignite Lignite Plant Plant Plant (dollars in millions) Plant in service $79 $431 $226 Accumulated depreciation $39 $135 $62 Plant capacity-MW 480 650 650 Participation 50.0% 85.9% 40.2% Share of capacity-MW 240 559 262\n2-154 9.Litigation and Regulatory Proceedings Fuel Reconciliation On March 17, 1994, SWEPCO filed a petition with the Texas Commission to reconcile fuel costs for the period November 1989 through December 1993. Total Texas jurisdictional fuel expenses subject to reconciliation for this 50-month period were approximately $559 million. SWEPCO's net under-recovery for the reconciliation period was approximately $0.9 million. SWEPCO and the intervening parties in this proceeding were able to negotiate a stipulated agreement providing a $3.2 million fuel cost disallowance and settling all issues except one. That issue involved the recovery of certain fuel related litigation and settlement negotiation expenses. The Texas Commission, at its Final Order hearing on January 18, 1995, approved the stipulated disallowance and granted SWEPCO recovery of the fuel related litigation expense. The $3.2 million disallowance is included in SWEPCO's 1994 results of operations. SWEPCO recognized the litigation costs as expenses in prior periods.\nBurlington Northern Transportation Contract On January 20, 1995, a state district court in Bowie County, Texas, entered judgment in favor of SWEPCO against Burlington Northern in a lawsuit between the parties regarding rates charged under two rail transportation contracts for delivery of coal to SWEPCO's Welsh and Flint Creek power plants. The court awarded SWEPCO approximately $72 million covering damages for the period from April 27, 1989 through September 26, 1994 and prejudgment interest fees and granted certain declaratory relief requested by SWEPCO.\nKansas City Southern Railway Company Transportation Contracts In March 1994, SWEPCO entered into a settlement with the Kansas City Southern Railway Company of litigation between parties regarding two coal transportation contracts. Pursuant to the settlement, SWEPCO and the Kansas City Southern Railway Company executed a new coal transportation agreement. The settlement is expected to result in a reduction of SWEPCO's coal transportation costs now and in the future. Burlington Northern, another party to the prior contracts and to the litigation, did not participate in the settlement and the litigation is still pending between SWEPCO and Burlington Northern.\nOther SWEPCO 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 SWEPCO's results of operations or financial condition.\n10. Commitments and Contingent Liabilities It is estimated that SWEPCO will spend approximately $96 million in construction expenditures during 1995. Substantial commitments have been made in connection with this capital expenditure program.\nTo supply a portion of the fuel requirements, SWEPCO has entered into various commitments for procurement of fuel.\nHenry W. Pirkey Power Plant In connection with the South Hallsville lignite mining contract for its Henry W. Pirkey Power Plant, SWEPCO has agreed, under certain conditions, to assume the obligations of the mining contractor. As of December 31, 1994, the maximum amount SWEPCO would have to assume was $73.7 million. The maximum amount may vary as the mining contractor's need for funds fluctuates. The contractor's actual obligation outstanding at December 31, 1994 was $60.9 million.\nSouth Hallsville Lignite Mine As part of the process to receive a renewal of a Texas Railroad Commission permit for lignite mining at the South Hallsville lignite mine, SWEPCO has agreed to provide bond guarantees on mine reclamation in the amount of $70 million. Since SWEPCO uses self-\n2-155 bonding, the guarantee provides for SWEPCO to commit to use its resources to complete the reclamation in the event the work is not completed by the third party miner. The current cost to reclaim the mine is estimated to be approximately $25 million.\nCoal Transportation SWEPCO has entered into various financing arrangements primarily with respect to coal transportation and related equipment, which are treated as operating leases for rate-making purposes. At December 31, 1994, leased assets of $46 million, net of accumulated amortization of $30.1 million, were included in electric plant on the balance sheet and at December 31, 1993, leased assets were $46 million, net of accumulated amortization of $26.8 million. Total charges to operating expenses for leases were $6.8 million, $7.1 million, and $6.9 million for the years 1994, 1993, and 1992.\nSuspected MGP Site in Marshall, Texas SWEPCO owns a suspected former MGP site in Marshall, Texas. SWEPCO has notified the TNRCC that evidence of contamination has been found at the site. As a result of sampling conducted at the end of 1993 and early 1994, SWEPCO is evaluating the extent, if any, to which contamination has impacted soil, groundwater and other conditions in the area. A final range of clean-up costs has not yet been determined, but, based on a preliminary estimate, SWEPCO has accrued approximately $2 million as a liability for this site on SWEPCO's books as of December 31, 1993. As more information is obtained about the site, and SWEPCO discusses the site with the TNRCC, the preliminary estimate may change.\nSuspected MGP Site in Texarkana, Texas and Arkansas and Shreveport, Louisiana SWEPCO also owns a suspected former MGP site in Texarkana, Texas and Arkansas. The EPA ordered an initial investigation of this site, as well as one in Shreveport, Louisiana, which is no longer owned by SWEPCO. The contractor who performed the investigations of these two sites recommended to the EPA that no further action be taken at this time.\nBiloxi, Mississippi MGP Site SWEPCO has been notified by Mississippi Power Company that it may be a PRP at the former Biloxi MGP site formerly owned and operated by a predecessor of SWEPCO. SWEPCO is working with Mississippi Power Company to investigate the extent of contamination at this site. The MDEQ approved a site investigation work plan and, in January 1995, SWEPCO and Mississippi Power Company initiated sampling pursuant to that work plan. On an interim basis, SWEPCO and Mississippi Power Company are each paying fifty percent of the cost of implementing the site investigation work plan. That interim allocation is subject to a final allocation in the future. SWEPCO and Mississippi Power Company are investigating whether there are other PRPs at the Biloxi site. Until the extent of the contamination at the Biloxi site is identified, it is unknown what, if any, additional investigation or cleanup may be required.\nManagement does not expect these matters to have a material effect on SWEPCO's results of operations or financial position.\n2-156 11. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts. Operating Operating Net Quarter Ended Revenues Income Income 1994 (thousands) March 31 $190,066 $ 24,820 $ 14,537 June 30 211,989 36,699 25,851 September 30 245,331 53,304 41,854 December 31 177,910 31,099 23,470 $825,296 $145,922 $105,712\nMarch 31 $175,601 $ 23,953 $ 16,269 June 30 193,225 31,954 21,363 September 30 276,594 58,639 48,353 December 31 191,772 3,511 (4,109) $837,192 $118,057 $ 81,876\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-157 Report of Independent Public Accountants\nTo the Stockholders and Board of Directors of Southwestern Electric Power Company:\nWe have audited the accompanying balance sheets and statements of capitalization of Southwestern Electric Power Company (a Delaware corporation and a wholly-owned subsidiary of Central and South West Corporation) as of December 31, 1994 and 1993, and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of SWEPCO'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 Southwestern Electric Power Company as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, SWEPCO changed its method of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II 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. This schedule 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 LLP\nDallas, Texas February 13, 1995\n2-158 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the financial statements of Southwestern Electric Power Company as well as other information contained in this Annual 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 Annual Report is consistent with that in the financial statements.\nThe financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. SWEPCO believes that representations made to the independent auditors during its audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nSWEPCO maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial statements are prepared in accordance with generally accepted accounting principles and that the assets of the companies are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that SWEPCO will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of SWEPCO provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nSWEPCO believes that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nRichard H. Bremer R. Russell Davis President and CEO - SWEPCO Controller - SWEPCO\n2-159\nWTU\nWEST TEXAS UTILITIES COMPANY\n2-160 Selected Financial Data WTU The following selected financial data for each of the five years ended December 31 are provided to highlight significant trends in the financial condition and results of operations for WTU.\n1994 1993 1992 1991 1990 (thousands, except ratios) Operating Revenues $342,991 $345,445 $315,370 $318,966 $327,065 Income Before Cumulative Effect of Changes in Accounting Principles 37,366 26,517 35,007 36,368 34,173 Cumulative Effect of Changes in Accounting Principles (1) -- 3,779 -- -- -- Net Income 37,366 30,296 35,007 36,368 34,173 Preferred Stock Dividends 452 967 1,451 1,868 2,077 Net Income for Common Stock 36,914 29,329 33,556 34,500 32,096\nTotal Assets 778,895 754,443 744,829 734,053 735,969\nCommon Stock Equity 271,954 266,092 266,874 259,373 261,466 Preferred Stock Not Subject to Mandatory Redemption 6,291 6,291 6,291 6,291 6,291 Subject to Mandatory Redemption -- -- 9,537 14,482 22,376 Long-term Debt 210,047 176,882 211,610 217,855 216,837\nRatio of Earnings to Fixed Charges (SEC Method) Before Cumulative Effect of Changes in Accounting Principles 3.37 2.79 3.22 3.30 3.05\nCapitalization Ratios Common Stock Equity 55.7% 59.2% 54.0% 52.1% 51.6% Preferred Stock 1.3 1.4 3.2 4.2 5.6 Long-term Debt 43.0 39.4 42.8 43.7 42.8\n(1) The 1993 cumulative effect relates to the changes in accounting for unbilled revenues and adoption of SFAS No. 112. See NOTE 1, Summary of Significant Accounting Policies.\nWTU changed its method of accounting for unbilled revenues in 1993. Pro forma amounts, assuming that the change in accounting for unbilled revenues had been adopted retroactively, are not materially different from amounts reported for prior years and therefore have not been restated.\n2-161 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nWEST TEXAS UTILITIES COMPANY\nReference is made to WTU's Financial Statements and related Notes and Selected Financial Data. The information contained therein should be read in conjunction with, and is essential to understanding, the following discussion and analysis.\nOverview Net income for common stock was $37 million in 1994, a 26% increase when compared to 1993. This increase was due primarily to an increase in retail base revenues and other income and a decrease in restructuring charges.\nRestructuring As previously reported, WTU has taken steps to implement a restructuring and early retirement program designed to consolidate and restructure its operations in order to meet the challenges of the changing electric utility industry and to compete effectively in the years ahead. The underlying goal of the restructuring is to enable WTU to focus on and be accountable for serving the customer. The restructuring costs were initially estimated to be $15 million and were expensed in 1993. The final costs of the restructuring were approximately $13 million. Approximately $12 million of the restructuring expenditures were incurred during 1994, with the remaining $1 million expected to be incurred during 1995. Approximately $1 million of the restructuring expenses relate to employee termination benefits, $7 million relate to enhanced benefit costs and $5 million relate to employees that will not be terminated. Approximately $9 million of the restructuring costs were paid from or will be paid from general corporate funds. The remaining $4 million represent the present value of enhanced benefit amounts to be paid from the benefit plan trusts to participants over future years in accordance with the early retirement program. The cost of these enhanced benefit amounts will be paid from general corporate funds to the benefit plan trusts over future years. The restructuring is substantially completed, with the remaining activity to take place during 1995. Certain aspects of the restructuring are pending SEC approval under the Holding Company Act.\nWTU expects to realize a number of benefits from the restructuring. Beginning in 1994 and continuing into the future, increased efficiencies and synergies are expected to be realized with the elimination of previously duplicated functions. This leads to enhanced communication and efficiency, which should translate into a reduction in the rate of growth in O&M costs. The CSW System expects that all restructuring costs will be recovered by early 1996 with reductions in the rate of growth of O&M costs continuing thereafter.\nRates and Regulatory Matters See NOTE 9, Litigation and Regulatory Proceedings, for information regarding the WTU fuel and rate proceedings, and deferred accounting matters.\nNew Accounting Standards SFAS No. 115 was effective for fiscal years beginning after December 15, 1993. WTU adopted SFAS No. 115 in 1994. The adoption of SFAS No. 115 did not have a material effect on WTU's results of operations or financial condition.\nIn June 1993, the FASB issued SFAS No. 116. The statement, effective for fiscal years beginning after December 15, 1994, will be adopted by WTU for 1995. The statement establishes accounting standards for contributions and applies to all entities that receive or make contributions. Management does not believe the adoption of SFAS No. 116 will have a material impact on WTU's results of operations or financial condition.\n2-162 SFAS No. 119 was effective for fiscal years ending after December 15, 1994. WTU currently does not use derivative instruments, but may use these instruments in the future to manage the increased market risks associated with greater competition in the electric utility industry. The adoption of this new statement had no material effect on WTU's results of operations or financial condition.\nLiquidity and Capital Resources Overview WTU's need for capital results primarily from the construction of facilities to provide reliable electric service to its customers. Accordingly, internally generated funds should meet most of the capital requirements. However, if internally generated funds are not sufficient, WTU's financial condition and credit rating should allow it access to the capital markets.\nCapital Expenditures Construction expenditures including AFUDC were $42 million, $37 million and $29 million for the years 1994, 1993 and 1992. It is estimated that construction expenditures, including AFUDC, during the 1995 through 1997 period will aggregate $109 million. Such expenditures primarily will be made to improve and expand transmission and distribution facilities. These improvements are expected to meet the needs of new customers and to satisfy changing requirements of existing customers. No new baseload power plants are currently planned until after the year 2000.\nThe construction program continues to be monitored, reviewed and adjusted to reflect changes in estimated load growth in WTU's service area, variations in prices of alternative fuel sources, the cost of labor, materials, equipment and capital, and other external factors.\nThe CSW System facilities plan presently includes projected coal- and lignite-fired generating plants for which WTU has invested approximately $15 million in prior years for plant sites, engineering studies and lignite reserves. Should future plans exclude these plants for environmental or other reasons, WTU would evaluate the probability of recovery of these investments and may record appropriate reserves.\nLong-Term Financing As of December 31, 1994, the capitalization ratios of WTU were 56% common stock equity, 1% preferred stock and 43% long-term debt. WTU continually monitors the capital markets for opportunities to lower its cost of capital through refinancing. WTU continues to be committed to maintaining financial flexibility by maintaining its strong capital structure and favorable securities ratings which should allow funds to be obtained from the capital markets when required.\nWTU's long-term financing activity is shown below:\nIn February 1994, WTU issued $40 million of 6-1\/8% FMBs, Series S, due February 1, 2004. Proceeds were used to reimburse WTU's treasury for (i) $12 million aggregate principal amount of 7-1\/4% First Mortgage Bonds, Series G, due January 1, 1999, redeemed on January 1, 1994, and, (ii) $23 million aggregate principal amount of 7- 7\/8% FMBs, Series H, due July 1, 2003, redeemed on December 30, 1993. The balance of the proceeds was used to repay outstanding short-term borrowings.\nIn July 1994, WTU redeemed its remaining $4.7 million outstanding of 7-1\/4% Series Preferred Stock in accordance with mandatory sinking fund provisions. The funds required for this transaction were provided from internal sources and short-term borrowings.\nIn October and November 1994, WTU reacquired $7.8 million aggregate principal amount of its 9-1\/4% FMBs, Series O, due December 1, 2019 in open market transactions. The funds required for these transactions were provided from short-term borrowings and internal sources. The premiums and reacquisition costs of reacquired long-term\n2-163 debt are included in long-term debt on the balance sheets and are being amortized over 10 to 30 years in accordance with the anticipated regulatory treatment.\nIn December 1994, pursuant to sinking fund requirements, WTU elected to redeem at par $650,000 Series O, FMBs.\nIn March 1995, WTU issued $40 million of 7-1\/2% FMBs, Series T, due April 1, 2000. Proceeds were used to repay a portion of WTU's short-term debt, to provide working capital and for other general corporate purposes.\nWTU Shelf Registration WTU expects to obtain a majority of their 1995 capital requirements from internal sources, but may issue additional securities subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost preferred stock and to repay short-term debt. WTU has filed shelf registration statements with the SEC for the sale of securities. As of March 1995, WTU had $20 million remaining for issuance of first mortgage bonds under a shelf registration filed with the SEC in 1993. WTU may issue additional debt securities subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost FMBs, to lower embedded cost of debt, to repay short-term debt, to provide working capital and for other general corporate purposes.\nWTU may issue additional preferred stock subject to market conditions and other factors. The proceeds of any such offerings will be used principally to redeem higher cost preferred stock and to redeem short-term debt.\nShort-Term Financing WTU, together with other members of the CSW System, has established a CSW System money pool to coordinate short-term borrowings. These loans are unsecured demand obligations at rates approximating the CSW System's commercial paper borrowing costs. WTU's short-term borrowing limit from the money pool is $50 million. During 1994, the annual weighted average interest rate was 4.5% and the average amount of short-term month-end borrowings outstanding was $22 million. The maximum amount of short-term borrowings outstanding at any month-end during 1994 was $46 million, which was the amount outstanding at December 31, 1994.\nInternally Generated Funds Internally generated funds consist of cash flows from operating activities less common and preferred stock dividends. WTU uses short- term debt to meet fluctuations in working capital requirements due to the seasonal nature of energy sales. During 1993 and 1994, WTU experienced several non-recurring transactions that resulted in negative internally generated funds in 1994, including the refinancing of Series G and Series H FMBs with Series S FMBs which occurred from December 1993 through February 1994. This refinancing caused an abnormally high accounts payable balance at December 31, 1993 which was subsequently reduced by the issuance of Series S in February 1994, resulting in the appearance of a large out flow of cash from operating funds. WTU anticipates that capital requirements for the period 1995 to 1997 will be met, in large part, from internal sources. WTU also expects that some external financings maybe required during the period, but the nature, timing and extent have not yet been determined. Information concerning internally generated funds follows:\n1994 1993 1992 (millions) Internally Generated Funds ($4) $59 $49\nConstruction Expenditures Provided by Internally Generated Funds -- 163% 169%\n2-164 As discussed above, WTU issued $40 million of 7-1\/2% FMBs during the first quarter of 1995, which were used to reduce short-term debt.\nSales of Accounts Receivable WTU sells its billed and unbilled accounts receivable, without recourse, to CSW Credit. The sales provide WTU with cash immediately, thereby reducing working capital needs and revenue requirements. The average and year end amounts of accounts receivable sold were $35 million and $18 million in 1994, as compared to $36 million and $34 million in 1993.\nRecent Developments and Trends Competition and Industry Challenges Competitive forces at work in the electric utility industry are impacting WTU and electric utilities generally. Increased competition facing electric utilities is driven by complex economic, political and technological factors. These factors have resulted in legislative and regulatory initiatives that are likely to result in even greater competition at both the wholesale and retail level in the future. As competition in the industry increases, WTU will have the opportunity to seek new customers and at the same time be at risk of losing customers to other competitors. WTU believes that its prices for electricity and the quality and reliability of its service currently place it in a position to compete effectively in the marketplace.\nThe Energy Policy Act, which was enacted in 1992, significantly alters the way in which electric utilities compete. The Energy Policy Act creates exemptions from regulation under the Holding Company Act and permits utilities, including registered utility holding companies and non-utility companies, to form EWGs. EWGs are a new category of non-utility wholesale power producer that are 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. The Energy Policy Act also 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. A FERC order requiring a transmitting utility to provide wholesale transmission service must include provisions generally that permit (i) the utility to recover from the FERC applicant all of the costs incurred in connection with the transmission services and (ii) any enlargement of the transmission system and associated services. While WTU believes that the Energy Policy Act will continue to make the wholesale markets more competitive, WTU is unable to predict the extent to which the Energy Policy Act will impact its operations.\nIncreasing competition in the utility industry brings an increased need to stabilize or reduce rates. The retail regulatory environment is beginning to shift from traditional rate base regulation to incentive regulation. Incentive rate and performance- based plans encourage efficiencies and increased productivity while permitting utilities to share in the results. Retail wheeling, a major industry issue which may require utilities to \"wheel\" or move power from third parties to their own retail customer, is evolving gradually.\nWholesale energy markets, including the market for wholesale electric power, have been extremely competitive since the enactment of the Energy Policy Act. WTU competes in the wholesale energy markets with other public utilities, cogenerators, qualified facilities, exempt wholesale generators and others for sales of electric power.\nUnder the Energy Policy Act, the FERC has approved several proposals by utility companies to sell wholesale power at market-based rates and provide to electric utilities \"open access\" to transmission systems, subject to certain requirements. The adoption of these proposals increases marketing opportunities for electric utilities, but also exposes them to the risk of loss of load or reduced revenues due to competition with alternative suppliers.\n2-165 WTU believes that, compared to other electric utilities, it is well positioned to meet future competition. WTU benefits from economies of scale and scope by virtue of its size and its relationship to the CSW System. WTU is also a relatively low-cost producer of electric power. Moreover, WTU is taking steps to enhance its marketing and customer service, reduce costs, improve and standardize business practices, and grow through strategic acquisitions, in order to position itself for increased competition in the future.\nWTU is unable to predict the ultimate outcome or impact of competitive forces on the electric utility industry or on WTU. As the wholesale and retail electricity markets become more competitive, however, the principal factor determining success is likely to be price, and to a lesser extent, reliability, availability of capacity, and customer service.\nPublic Utility Regulatory Act PURA is the legal foundation for electric utility regulation in Texas. PURA will expire on September 1, 1995, in accordance with the sunset policy of the Texas Legislature, which applies to all state agencies, unless the Texas Legislature reenacts PURA in its current form or in modified form. Several proposals have been made to amend PURA which, among other things, provide for a market-driven integrated resource planning process, pricing flexibility for utilities faced with competitive challenges, incentive regulation and deregulation of the wholesale bulk power market in ERCOT. WTU is unable to predict the ultimate outcome of the 1995 session of the Texas Legislature and in particular whether amendments to PURA will be adopted.\nRegulatory Accounting Consistent with industry practice and the provisions of SFAS No. 71, which allows for the recognition and recovery of regulatory assets, WTU has recognized significant regulatory assets and liabilities. Management believes that WTU will continue to meet the criteria for following SFAS No. 71. However, in the event WTU no longer meets the criteria for following SFAS No. 71, a write-off of regulatory assets and liabilities would be required. For additional information regarding SFAS No. 71 reference is made to NOTE 1, Summary of Significant Accounting Policies - Regulatory Assets and Liabilities.\nConsolidated Taxes The Texas Commission before 1992 allowed income taxes to be recovered in rates based on the federal income tax incurred by a utility as if it were a stand-alone company. This stand-alone approach treated the regulated activities of a utility as a separate entity and considered only those revenues and expenses that are included in the utility's cost of service to calculate the federal income tax liability for ratemaking purposes.\nBeginning in 1992, the Texas Commission changed its method of calculating the federal income tax component of rates to the \"actual tax approach.\" The actual tax approach is an evolving concept but generally seeks to reflect in rates the actual tax liability of the utility irrespective of its relationship to the utility's cost of service. The approach reduces rates by the tax benefits of deductions which are not considered for or included in setting rates for the utility.\nThe Texas Commission is expected to use the actual tax approach for calculating the recovery of federal income tax in the pending rate case for WTU. The impact of the actual tax approach on the prospective rates for WTU cannot be determined since the application of the concept is unsettled.\nWTU believes that the recovery of federal income taxes in rates should be determined on the stand-alone approach for ratemaking purposes, but there is no assurance this approach will be adopted in the pending WTU rate case.\n2-166 Environmental Matters CERCLA and Related Matters The operations of WTU, like those of other utilities, generally involve the use and disposal of substances subject to environmental laws. The CERCLA, the federal \"Superfund\" law, addresses the cleanup of sites contaminated by hazardous substances. Superfund requires that PRPs fund remedial actions regardless of fault or the legality of past disposal activities. PRPs include owners and operators of contaminated sites and transporters and\/or generators of hazardous substances. Many states have similar laws. Theoretically, any one PRP can be held responsible for the entire cost of a cleanup. Typically, however, cleanup costs are allocated among PRPs.\nWTU is subject to various pending claims alleging it is a PRP under federal or state remedial laws for investigating and cleaning up contaminated property. WTU anticipates that resolution of these claims, individually or in the aggregate, will not have a material adverse effect on WTU's results of operations or financial condition. Although the reasons for this expectation differ from site to site, factors that are the basis for the expectation for specific sites include the volume and\/or type of waste allegedly contributed by WTU, the estimated amount of costs allocated to WTU and the participation of other parties.\nClean Air Act Amendments In November 1990, the United States Congress passed the Clean Air Act which places restrictions on the emission of sulfur dioxide from gas-, coal- and lignite-fired generating plants. Beginning in the year 2000, the Electric Operating Companies will be required to hold allowances in order to emit sulfur dioxide. The EPA issues allowances to owners of existing generating units based on historical operating conditions. Based on the CSW System facilities plan, WTU believes that its allowances will be adequate to meet its needs at least through 2008. Public and private markets are developing for trading of excess allowances. WTU presently has no intention of engaging in trading of allowances, but may seek to do so in the future if market conditions warrant and appropriate regulatory approvals are obtained.\nThe Clean Air Act also establishes a federal operating source permit program to be administered by the states.\nThe Clean Air Act also directs the EPA to issue regulations governing nitrogen oxide emissions and requires government studies to determine what controls, if any, should be imposed on utilities to control air toxics emissions. The impact that the nitrogen oxide emission regulations and the air toxics study will have on WTU cannot be determined at this time.\nAs a result of requirements imposed by the Clean Air Act, WTU expects to spend $0.5 million for annual testing of, software modifications to, and maintenance of continuous emission monitoring equipment from 1995 through 1997.\nEMFs Research is ongoing whether exposure to EMFs may result in adverse health effects. Although a few of the studies to date have suggested certain associations between EMFs and some types of effects, the research to date has not established a cause-and-effect relationship between EMFs and adverse health effects. WTU cannot predict the impact on WTU or the electric utility industry if further investigations or proceedings were to establish that the present electricity delivery system is contributing to increased risk or incidence of health problems.\nResults of Operations Electric Operating Revenues Electric operating revenues in 1994 decreased approximately $2.5 million or 1% when compared to 1993. This decrease was due primarily to a reduction in lower margin off-system sales of $8 million resulting from decreased market place demand. This decrease was partially offset by higher on system revenues of $6.5 million attributable to an increase in retail KWH sales of 3% resulting from customer growth and increased usage. Also contributing to the\n2-167 decrease was an interim rate reduction of approximately $5.7 million on an annual basis effective October 1, 1994. Revenues for 1993, when compared to 1992, increased approximately $30.1 million, or 10%. The increase is attributed to a 10% increase in KWH sales and a $9.1 million increase in fuel-related revenues. The increase in KWH sales is attributable to a warmer summer in 1993 and increased sales for resale to an affiliated company.\nFuel and Purchased Power Expenses Fuel expenses decreased approximately $3.8 million or 3% during 1994 when compared to 1993 and increased approximately $15.1 million or 13% when compared to 1992. The decrease in 1994 is primarily attributable to a 2% decrease in average unit fuel costs from $1.91 in 1993 to $1.88 in 1994 and a 2% decrease in generation. The increase in 1993 is due primarily to a 5% increase in average unit fuel cost to $1.91 in 1993 from $1.82 in 1992 and a 7% increase in generation. The change in unit fuel costs during both years is due primarily to changes in the price of natural gas on the spot market.\nPurchased power expenses decreased approximately $2.3 million and increased $4.3 million during 1994 and 1993, respectively, when compared to the prior years. The change during both periods is primarily attributable to increased economy purchases in 1993.\nExpenses and Taxes Other operating expenses increased approximately $4.9 million and $3.8 million during 1994 and 1993, respectively, when compared to prior years. The increase during 1994 reflects a reimbursement in 1993 for the settlement of a dispute relating to a coal supply contract which lowered expenses in 1993. Higher outside services for fuel related issues and other employee related expenses in 1994 also contributed to the increase. The increase during 1993 was due primarily to higher employee pensions and benefits.\nRestructuring charges reflect the original accrual of $15 million in December 1993 which was subsequently adjusted by $2 million in 1994, resulting in total restructuring charges for WTU of $13 million at December 31, 1994.\nMaintenance expense in 1994 increased over 1993 by approximately $1.7 million or 13% due primarily to increased production maintenance of boiler and electric plant. Maintenance increased approximately $1.3 million in 1993 compared with 1992 because of higher production and general expenses resulting from boiler plant maintenance.\nDepreciation and amortization expenses increased approximately $1.2 million and $3.6 million during 1994 and 1993, respectively, when compared to prior years due primarily to increases in depreciable property.\nFederal income taxes increased approximately $4.3 million or 32% in 1994 when compared with 1993 due to higher pre-tax income. The decrease in 1993 compared to 1992 was largely attributable to lower pre-tax income partially offset by an increase in the federal corporate income tax rate to 35% from 34%.\nOther income increased approximately $2.3 million in 1994 resulting from tax benefits received under WTU's tax sharing agreement with CSW.\nInterest on Long-Term Debt Interest on long-term debt decreased approximately $0.7 million in 1994 when compared to the prior year due to WTU's refinancing of higher cost debt with lower cost debt and decreased balances outstanding.\nInflation Annual inflation rates, as measured by the national Consumer Price Index, have averaged approximately 2.7% for the three-year period ending December 31, 1994. WTU believes that inflation, at these levels, does not materially affect its results of operations\n2-168 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.\nCumulative Effect of Changes in Accounting Principles In 1993, WTU changed it method of accounting for unbilled revenue and implemented SFAS No. 112. These accounting changes had a cumulative effect of increasing net income by $3.8 million.\n2-169 Statements of Income West Texas Utilities Company For the Years Ended December 31, 1994 1993 1992 (thousands) Electric Operating Revenues Residential $118,525 $115,932 $106,497 Commercial 66,483 65,085 62,244 Industrial 52,626 53,709 52,651 Sales for resale 67,076 72,252 60,833 Other 38,281 38,467 33,145 342,991 345,445 315,370 Operating Expenses and Taxes Fuel 131,258 135,048 119,983 Purchased power 5,144 7,411 3,086 Other operating 66,290 61,357 57,578 Restructuring charges (2,037) 15,250 -- Maintenance 14,978 13,251 11,959 Depreciation and amortization 31,569 30,405 26,784 Taxes, other than federal income 23,072 22,496 21,970 Federal income taxes 17,954 13,651 16,708 288,228 298,869 258,068\nOperating Income 54,763 46,576 57,302\nOther Income and Deductions Allowance for equity funds used during construction 150 109 51 Other 4,210 1,907 1,114 4,360 2,016 1,165\nIncome Before Interest Charges 59,123 48,592 58,467\nInterest Charges Interest on long-term debt 18,547 19,225 21,368 Interest on short-term debt and other 3,534 2,988 2,197 Allowance for borrowed funds used during construction (324) (138) (105) 21,757 22,075 23,460\nIncome Before Cumulative Effect of Changes in Accounting Principles 37,366 26,517 35,007\nCumulative Effect of Changes in Accounting Principles -- 3,779 --\nNet Income 37,366 30,296 35,007 Preferred stock dividends 452 967 1,451 Net Income for Common Stock $ 36,914 $ 29,329 $ 33,556\nThe accompanying notes to financial statements are an integral part of these statements.\n2-170 Statements of Retained Earnings West Texas Utilities Company For the Years Ended December 31, 1994 1993 1992 (thousands) Retained Earnings at Beginning of Year $126,642 $127,424 $119,923 Net income for common stock 36,914 29,329 33,556 Deduct: Common stock dividends 31,000 30,000 26,000 Preferred stock redemption cost 52 111 55 Retained Earnings at End of Year $132,504 $126,642 $127,424\nThe accompanying notes to financial statements are an integral part of these statements.\n2-171 Balance Sheets West Texas Utilities Company As of December 31, 1994 1993 (thousands) ASSETS Electric Utility Plant Production $427,736 $425,340 Transmission 194,402 190,300 Distribution 308,905 291,509 General 73,938 69,780 Construction work in progress 23,257 14,385 1,028,238 991,314 Less - Accumulated depreciation 364,383 337,888 663,855 653,426 Current Assets Cash 2,501 706 Accounts receivable 23,165 24,497 Materials and supplies, at average cost 16,519 14,451 Fuel inventory, at average cost 9,229 9,150 Coal inventory, at LIFO cost 6,442 5,511 Accumulated deferred income taxes 3,068 1,222 Prepayments and other 1,091 450 62,015 55,987\nDeferred Charges and Other Assets Deferred Oklaunion costs 26,914 27,735 Other 26,111 17,295 53,025 45,030 $778,895 $754,443\nThe accompanying notes to financial statements are an integral part of these statements.\n2-172 Balance Sheets West Texas Utilities Company As of December 31, 1994 1993 (thousands) CAPITALIZATION AND LIABILITIES Capitalization Common stock: $25 par value Authorized: 7,800,000 shares Issued and outstanding: 5,488,560 shares $137,214 $137,214 Paid-in capital 2,236 2,236 Retained earnings 132,504 126,642 Total Common Stock Equity 271,954 266,092 Preferred stock Not subject to mandatory redemption 6,291 6,291 Long-term debt 210,047 176,882 Total Capitalization 488,292 449,265\nCurrent Liabilities Long-term debt and preferred stock due within twelve months 650 17,298 Advances from affiliates 46,315 11,784 Accounts payable 35,407 51,041 Accrued restructuring charges 571 15,250 Accrued taxes 7,452 14,620 Accrued interest 4,394 4,128 Other 3,758 1,979 98,547 116,100 Deferred Credits Accumulated deferred income taxes 146,146 134,595 Investment tax credits 31,882 33,203 Income tax related regulatory liabilities, net 9,217 10,545 Other 4,811 10,735 192,056 189,078 $778,895 $754,443\nThe accompanying notes to financial statements are an integral part of these statements.\n2-173 Statements of Cash Flows West Texas Utilities Company For the Years Ended December 31, 1994 1993 1992 (thousands) OPERATING ACTIVITIES Net Income $ 37,366 $ 30,296 $ 35,007 Non-cash Items Included in Net Income Depreciation and amortization 33,362 31,925 28,354 Restructuring charges (2,037) 15,250 -- Deferred income taxes and investment tax credits 7,056 3,159 4,911 Cumulative effect of changes in accounting principles -- (3,779) -- Allowance for equity funds used during construction (150) (109) (51) Changes in Assets and Liabilities Accounts receivable 1,332 (3,159) (6,804) Fuel inventory (1,010) (6) 141 Accounts payable (15,103) 21,552 13,417 Accrued taxes (7,168) 4,085 1,343 Accrued restructuring charges (8,918) -- -- Other deferred credits (5,924) (6,502) (777) Other (10,802) (2,694) 1,152 28,004 90,018 76,693 INVESTING ACTIVITIES Construction expenditures (41,504) (36,318) (28,902) Allowance for borrowed funds used during construction (324) (138) (105) Disposition of plant (1,315) 3,302 (854) (43,143) (33,154) (29,861) FINANCING ACTIVITIES Proceeds from issuance of long-term debt 39,354 (77) 98,506 Reacquisition of long-term debt (20,731) (24,250) (106,757) Redemption of preferred stock (4,700) (10,000) (5,000) Payment of dividends (31,520) (30,816) (27,874) Change in advances from affiliates 34,531 7,241 (5,714) 16,934 (57,902) (46,839)\nNet Change in Cash and Cash Equivalents 1,795 (1,038) (7) Cash and Cash Equivalents at Beginning of Year 706 1,744 1,751 Cash and Cash Equivalents at End of Year $ 2,501 $ 706 $ 1,744\nSUPPLEMENTARY INFORMATION Interest paid less amounts capitalized $ 18,128 $ 18,430 $ 21,257 Income taxes paid $ 12,720 $ 325 $ 6,174\nThe accompanying notes to financial statements are an integral part of these statements.\n2-174 Statements of Capitalization West Texas Utilities Company As of December 31, 1994 1993 (thousands)\nCOMMON STOCK EQUITY $271,954 $266,092\nPREFERRED STOCK Cumulative $100 Par Value, Authorized 810,000 shares Number Current of Shares Redemption Series Outstanding Price\nNot Subject to Mandatory Redemption 4.40% 60,000 $107.00 6,000 6,000 Premium 291 291 6,291 6,291 Subject to Mandatory Redemption 7.25% 47,000 $100.91 -- 4,700 Issuance Expense -- (52) Amount to be Redeemed Within One Year -- (4,648) -- -- LONG-TERM DEBT First Mortgage Bonds Series G, 7 1\/4%, due January 1, 1999 -- 12,000 Series O, 9 1\/4%, due December 1, 2019 55,203 63,700 Series P, 7 3\/4%, due June 1, 2007 25,000 25,000 Series Q, 6 7\/8%, due October 1, 2002 35,000 35,000 Series R, 7%, due October 1, 2004 40,000 40,000 Series S, 6 1\/8%, due February 1, 2004 40,000 -- Installment Sales Agreements - PCRBs Series 1984, 7 7\/8%, due September 15, 2014 44,310 44,310 Unamortized discount and premium (1,323) (1,162) Unamortized costs of reacquired debt (27,493) (29,316) Amount to be redeemed within one year (650) (12,650) 210,047 176,882 TOTAL CAPITALIZATION $488,292 $449,265\nThe accompanying notes to financial statements are an integral part of these statements.\n2-175 NOTES TO FINANCIAL STATEMENTS\n1.Summary of Significant Accounting Policies Public Utility Regulation WTU is subject to regulation by the SEC under the Holding Company Act, and the FERC under the Federal Power Act, and follows the Uniform System of Accounts prescribed by the FERC. WTU is subject to further regulation with regard to rates and other matters by the Texas Commission. WTU, as a member of the CSW System, engages in transactions and coordinates its activities and operations with other members of the CSW System.\nThe more significant accounting policies of WTU 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 electric utility plant are computed using the straight-line method, generally at individual rates applied to the various classes of depreciable property. The annual average consolidated composite rates were 3.2% in both 1994 and 1993 and 3.1% in 1992.\nElectric Revenues and Fuel Prior to January 1, 1993, electric revenues 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 operating revenues of the next month. To conform to general industry standards, WTU changed its method of accounting to accrue for estimated unbilled revenues. The effect of this change on 1993 net income was an increase of $5.4 million included in cumulative effect of changes in accounting principles.\nWTU recovers fuel costs in Texas as a fixed component of base rates whereby over-recoveries of fuel are payable to customers and under-recoveries of fuel may be billed to customers after Texas Commission approval. The cost of fuel is charged to expense as consumed. WTU recovers fuel costs applicable to wholesale customers, which are regulated by the FERC, through an automatic fuel adjustment clause.\nAccounts Receivable. WTU sells its billed and unbilled accounts receivable, without recourse, to CSW Credit.\nRegulatory Assets and Liabilities. For its regulated activities, WTU follows SFAS No. 71, which defines the criteria for establishing regulatory assets and regulatory liabilities. Regulatory assets represent probable future revenue to the company associated with certain costs which will be recovered from customers through the ratemaking process. Regulatory liabilities represent probable future refunds to customers. At December 31, 1994 and 1993, WTU had recorded the following significant regulatory assets and liabilities:\n2-176 1994 1993 (thousands) Regulatory Assets Deferred plant costs $26,914 $27,735\nRegulatory Liabilities Income tax related regulatory liabilities, net $ 9,217 $10,545\nDeferred Plant Costs In accordance with orders of the Texas Commission, WTU deferred operating, depreciation and tax costs incurred for Oklaunion Power Station Unit 1. This deferral was for the period beginning on the date when the plant began commercial operation until the date the plant was included in rate base. The deferred costs are being amortized and recovered through rates over the remaining life of the plant. See NOTE 9, Litigation and Regulatory Proceedings, for further discussion of WTU's deferred accounting.\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 are considered cash equivalents.\nReclassification Certain financial statement items for prior years have been reclassified to conform to the 1994 presentation.\nAccounting Changes Effective January 1, 1993, WTU adopted SFAS Nos. 106, 112 and 109. See NOTE 2, Federal Income Taxes, for further information regarding SFAS No. 109. In addition, WTU also changed its method of accounting for unbilled revenues. See Electric Revenues and Fuel above for further information.\nThe adoption of SFAS No. 106 resulted in an increase in 1993 operating expenses of $1.9 million. The adoption of SFAS No. 112 and the change in accounting for unbilled revenues are presented as a cumulative effect of changes in accounting principles as shown below:\nPre-Tax Tax Net Income Effect Effect Effect (thousands)\nSFAS No. 112 $(2,534) $ 887 $(1,647) Unbilled revenues 8,347 (2,921) 5,426 Total $ 5,813 $(2,034) $ 3,779\nPro 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 WTU adopted the provisions of SFAS No. 109 effective January 1, 1993. The implementation of SFAS No. 109 had no material effect on WTU's earnings. As a result of this change, WTU recognized additional accumulated deferred income taxes and corresponding regulatory assets and liabilities to ratepayers in amounts equal to future revenues or the reduction in future revenues required when the income tax temporary differences reverse and are recovered or settled in rates. As a result of a favorable earnings history, WTU did not record any valuation allowance against deferred tax assets at December 31, 1994 and 1993.\n2-177 WTU, together with other members of the CSW System, files a consolidated federal income tax return and participates in a tax sharing agreement.\nComponents of income taxes follow:\n1994 1993 1992 Included in Operating Expenses and Taxes (thousands) Current $10,898 $11,379 $11,797 Deferred 8,377 3,593 6,426 Deferred ITC (1,321) (1,321) (1,515) 17,954 13,651 16,708 Included in Other Income and Deductions Current (2,998) (510) 590 Deferred -- -- -- (2,998) (510) 590 Tax Effects of Cumulative Effect of Changes in Accounting Principles -- 2,034 -- $14,956 $15,175 $17,298\nInvestment tax credits deferred in prior years are included in income over the lives of the related properties.\nTotal income taxes differ from the amounts computed by applying the statutory income tax rates to income before taxes. The reasons for the differences follow:\n1994 % 1993 % 1992 % (dollars in thousands) Tax at statutory rates $18,313 35.0 $15,915 35.0 $17,784 34.0 Differences Amortization of ITC (1,321) (2.5) (1,321) (2.9) (1,321) (2.5) Other (2,036) (3.9) 581 1.3 835 1.7 $14,956 28.6 $15,175 33.4 $17,298 33.2\n2-178 The significant components of the net deferred income tax liability follow:\n1994 1993 (thousands) Deferred Income Tax Liabilities Depreciable utility plant $144,501 $120,015 Deferred plant costs 9,420 9,707 Income tax related regulatory liability 10,908 11,074 Other 10,120 18,963 Total Deferred Income Tax Liabilities 174,949 159,759\nDeferred Income Tax Assets Income tax related regulatory liability (14,134) (14,765) Unamortized ITC (11,159) (11,621) Other (6,578) -- Total Deferred Income Tax Assets (31,871) (26,386) Net Accumulated Deferred Income Taxes - Total $143,078 $133,373\nNet Accumulated Deferred Income Taxes - Noncurrent $146,146 $134,595 Net Accumulated Deferred Income Taxes - Current (3,068) (1,222) Net Accumulated Deferred Income Taxes - Total $143,078 $133,373\n3.Long-Term Debt The mortgage indenture, as amended and supplemented, securing first mortgage bonds issued by WTU, constitutes a direct first mortgage lien on substantially all electric utility plant. WTU may offer additional FMBs subject to market conditions and other factors.\nAnnual Requirements Series O FMBs have annual sinking fund requirements, which may be satisfied by the application of net expenditures for bondable property in an amount equal to 166-2\/3% of the annual requirements or at WTU's option, the redemption of 1% of the amount originally issued. At December 31, 1994, the annual sinking fund requirements for the next five years, exclusive of maturities, of WTU's first mortgage bonds are $650,000. Pursuant to these sinking fund requirements, WTU elected to redeem at par $650,000 Series O, FMBs in December 1994.\nDividends WTU's mortgage indenture, as amended and supplemented, contains certain restrictions on the payment of common stock dividends. At December 31, 1994, $133 million of retained earnings were available for the payment of cash dividends to its parent, CSW.\nReacquired long-term debt Reference is made to MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - Liquidity and Capital Resources, for further information related to long-term debt, including new issues and reacquisition.\n4.Preferred Stock In July 1993, WTU redeemed 100,000 shares of its 7.25% Series, $100 par value, Preferred Stock, for $10 million, in accordance with mandatory and optional sinking fund provisions. The capital required for this transaction was provided by short-term borrowings from the CSW System money pool and internal sources.\n2-179 In July 1994, WTU redeemed the remaining 47,000 shares of its 7.25% Series, $100 par value, Preferred Stock.\n5.Financial Instruments 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 fair value.\nCash and temporary cash investments The carrying amount approximates fair value because of the short maturity of those instruments.\nAdvances from affiliates The carrying amount approximates fair value because of the short maturity of those instruments.\nLong-term debt The fair value of the WTU'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 WTU for debt of the same remaining maturities.\nPreferred stock subject to mandatory redemption The fair value of the WTU's preferred stock subject to mandatory redemption is estimated based on quoted market prices for the same or similar issues or on the current rates offered to WTU for preferred stock with the same or similar remaining redemption provisions.\nCurrent maturities of long-term debt The fair value of current maturities is estimated based on quoted market prices for the same or similar issues or the current rates offered for long-term debt.\nThe estimated fair values of WTU's financial instruments follow:\n1994 1993 Carrying Fair Carrying Fair Amount Value Amount Value (thousands) Cash and temporary cash investments $ 2,501 $ 2,501 $ 706 $ 706 Current maturities of long-term debt 650 666 12,650 12,800 Advances from affiliates 46,315 46,315 36,285 36,285 Long-term debt 210,047 228,802 176,882 225,082 Preferred stock -- -- 4,648 4,671\nThe fair value does not affect WTU's liabilities unless the issues are redeemed prior to their maturity dates.\n6.Short-Term Financing WTU, together with other members of the CSW System, has established a money pool to coordinate short-term borrowings and to make borrowings outside the money pool through CSW's issuance of commercial paper. Money pool balances are shown as advances to or from affiliates on the Balance Sheets. At December 31, 1994, the CSW System had bank lines of credit aggregating $930 million 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.\n2-180 7.Benefit Plans Defined Benefit Pension Plan WTU, together with other members of the CSW System, maintains a tax qualified, non-contributory defined benefit pension plan covering substantially all employees. Benefits are based on employees' years of credited 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 which are deductible for income tax purposes and minimum contributions required by the ERISA. Pension plan assets consist primarily of common stocks and short-term and intermediate- term fixed income investments.\nContributions to the plan for the years ended December 31, 1994, 1993 and 1992 were $3.8 million, $3.9 million and $3.4 million, respectively.\nThe approximate maximum number of participants in the plan during 1994 were 1,300 active employees, 500 retirees and beneficiaries and 100 terminated employees.\nThe components of net periodic pension cost and the assumptions used in accounting for pensions follow:\n1994 1993 1992 (thousands) Net Periodic Pension Cost Service cost $ 3,082 $ 2,732 $ 2,569 Interest cost on projected benefit obligation 8,501 7,776 7,274 Actual return on plan assets (601) (9,448) (6,242) Net amortization and deferral (9,556) 35 (2,836) $ 1,426 $ 1,095 $ 765\nDiscount rate 8.25% 7.75% 8.50% Long-term compensation increase 5.46% 5.46% 5.96% Return on plan assets 9.50% 9.50% 9.50%\nAt December 31, 1994, the plan's net assets were approximately equal to the total actuarial present value of the accumulated benefit obligation. At December 31, 1993 the plan's net assets exceeded the total actuarial present value of the accumulated benefit obligation. No reconciliation of the funding status of the plan is presented because such information is unavailable.\nHealth and Welfare Plans WTU had medical, dental, group life insurance, dependent life insurance, and accidental death and dismemberment plans for substantially all active WTU employees during 1994. The contributions, recorded on a pay-as-you-go basis for the years ended December 31, 1994 and 1993 were approximately $2.7 million and $3.5 million, respectively. Effective January 1993, WTU's method of providing health benefits was modified to include such benefits as preferred provider options, managed prescription drug and mail-order program and a mental health and substance abuse program in addition to the self-insured indemnity plans.\nPostretirement Benefits Other Than Pensions WTU adopted SFAS No. 106 January 1, 1993. The effect on operating expense in 1993 was $1.9 million. WTU is amortizing its transition obligation over twenty years, with eighteen years remaining. In prior years, these benefits were accounted for on a pay-as-you-go basis.\n2-181 The components of net periodic postretirement benefit cost follow:\n1994 1993 (thousands) Net Periodic Postretirement Benefit Cost Service cost $1,233 $1,157 Interest cost on APBO 2,559 2,316 Actual return on plan assets (113) (104) Amortization of transition obligation 1,225 1,225 Net amortization and deferral (418) (296) $4,486 $4,298\nA reconciliation of the funded status of the plan to the amounts recognized on the consolidated balance sheets follow:\nDecember 31, 1994 1993 APBO (thousands) Retirees $ 19,703 $ 18,722 Other fully eligible participants 4,764 4,624 Other active participants 7,519 8,758 Total APBO 31,986 32,104 Plan assets at fair value (9,636) (6,064) APBO in excess of plan assets 22,350 26,040 Unrecognized transition obligation (22,047) (23,272) Unrecognized gain or (loss) 91 (2,374) Accrued\/(Prepaid) Cost $ 394 $ 394\nThe following assumptions were used in accounting for SFAS No. 106:\n1994 1993 Discount rate 8.25% 7.75% Return on plan assets 9.50% 9.00% Tax rate for taxable trusts 39.60% 39.60%\nHealth Care Cost Trend Rate Assumptions Pre-65 Participants: 1994 Rate of 11.75% grading down .75% per year to an ultimate rate of 6.5% in 2001.\nPost-65 Participants: 1994 Rate of 11.25% 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, 1994 by $3.5 million and increase the aggregate of the service and interest costs components on net postretirement benefits by $.5 million.\n8.Jointly Owned Electric Utility Plant WTU has a joint ownership agreement with other members of the CSW System and other non-affiliated entities. Such agreements provide for the joint ownership and operation of Oklaunion Power Station. Each participant provided financing for its share of the project, which was placed in service in December 1986. The statements of income reflect WTU's portion of operating costs associated with jointly owned plant in service. WTU's share is 370 MW or a 54.7% interest in the generating station. WTU's total investment, including AFUDC is $280 million and accumulated depreciation at December 31, 1994 is $59 million.\n2-182 9.Litigation and Regulatory Proceedings Rate Proceeding - Docket No. 13369 On August 25, 1994, WTU filed a petition with the Texas Commission and with cities with original jurisdiction to review WTU's rates, proposed an interim across-the-board base rate reduction of 3.25% or, approximately $5.7 million, effective October 1, 1994, and sought until February 28, 1995, the time to develop and file a RFP. WTU also requested the ability to \"true-up\", back to October 1, 1994, any difference in revenue requirements upon final order of the Texas Commission, and proposed that any increases over the pre-October 1, 1994, base rates be implemented prospectively on the effective date of the final order.\nAs discussed below, WTU's fuel reconciliation was consolidated with this proceeding in September 1994. Reconcilable fuel costs during the reconciliation period were approximately $300 million. At June 30, 1994, the fuel cost under-recovery totaled approximately $5.1 million, including interest. At December 31, 1994, this amount had become an over-recovery of approximately $0.2 million. WTU is not seeking a change in fuel factors.\nOn February 28, 1995, WTU filed with the Texas Commission and cities with original jurisdiction the RFP which indicates a revenue deficiency of approximately $14.5 million. However, WTU simultaneously filed with the parties a settlement proposal to reduce overall base rate revenue by 3.25%, effective October 1, 1994, an annual impact in the rate year beginning January 1, 1996 of approximately $5.9 million. The settlement proposal reflects WTU's desire to maintain competitive rates, recognizes the importance of competitive rates in the changing electric service marketplace, and demonstrates WTU's strong commitment to the long- term success of WTU and its customers.\nUnless a settlement accelerates the schedule, WTU anticipates hearings in mid-1995 with a final order in the fourth quarter of 1995. Management cannot predict the outcome of the rate proceeding, the fuel reconciliation, or the settlement proposal, but believes that the ultimate resolution of these matters will not have a material adverse effect on WTU's results of operations or financial condition.\nFuel Reconciliation - Docket No. 13172 On June 30, 1994, WTU filed a petition with the Texas Commission to reconcile fuel costs for the period January 1991 through February 1994. Subsequently, in September 1994, this fuel reconciliation proceeding was consolidated into Docket No. 13369 described above, and the reconciliation period was extended through June 1994.\nRate Case Proceeding - Docket No. 7510 In November 1987, the Texas Commission issued a final order in WTU's retail rate case providing for WTU to receive an annual increase in base retail revenues of $34.9 million. Rates reflecting the final order were implemented in December 1987. WTU, along with certain intervenors in the retail rate proceeding, appealed the Texas Commission's final order to the District Court seeking reversal of various provisions of the final order, including the inclusion of deferred accounting in rate base.\nThe appeals were consolidated and in September 1988, the District Court affirmed the final order of the Texas Commission. In November 1988, certain intervenors filed appeals of the District Court's judgment with the Court of Appeals. In February 1990, the Court of Appeals ruled that an intervenor had improperly been excluded from presenting its appeal to the District Court, reversed the District Court's judgment and remanded the case to the District Court for further proceedings.\nIn October 1992, the District Court heard the remanded appeals of the final order of the Texas Commission and in March 1993 issued an order affirming the Texas Commission's order in all material respects with the single exception of the inclusion of deferred Oklaunion carrying costs in rate base. In its treatment of\n2-183 deferred costs, the District Court followed a then-current opinion of the Court of Appeals which precluded recovery of deferred post- in-service carrying costs. In April 1993, WTU and other parties filed appeals, and oral argument was held on the appeals in December 1993 on the non-deferred accounting issues. With respect to the deferred accounting issues, the parties recognized certain Supreme Court of Texas decisions regarding other deferred accounting cases would be influential in WTU's case.\nIn June 1994, the Supreme Court of Texas issued its opinion in the three other cases involving deferred accounting holding that the Texas Commission has the authority to allow deferred accounting treatment during the deferral period, including deferred post-in- service carrying costs. The Supreme Court of Texas upheld the Court of Appeals in all respects except it reversed the Court of Appeals to the extent it disallowed carrying costs deferrals and remanded to the Court of Appeals for consideration of the unresolved arguments of the improperly excluded intervenor. Motions for rehearing were filed by certain parties which were denied by the Supreme Court of Texas. These rulings influenced the Court of Appeals' decision in WTU's rate case appeals, as described below.\nOn February 15, 1995, the Court of Appeals affirmed all aspects of the District Court judgment relating to the Texas Commission's allowance of non-Oklaunion depreciation rates and the surcharge of rate case expenses, reversed the District Court's judgment relating to the exclusion of deferred Oklaunion carrying costs in rate base, and remanded the cause to the Texas Commission to reexamine the issue of deferred costs in light of the remand of Docket No. 7289, as described below. However, on March 3, 1995, WTU filed a motion for rehearing at the Court of Appeals seeking clarification of certain aspects of its order and arguing that the Court of Appeals erred in remanding the case to the Texas Commission for it to determine to what extent deferred costs are necessary to preserve WTU's financial integrity because the issue has been waived since it was not briefed or argued to the Court of Appeals. WTU expects other parties may also file motions for rehearing.\nWTU's motion for rehearing may, if granted, prevent further review of financial integrity issues with respect to deferred accounting in any remand of Docket No. 7510. If a broader remand is permitted and if the Texas Commission concludes in Docket No. 7289 that deferred accounting was necessary to preserve WTU's financial integrity during the deferral period, the Texas Commission must decide to what extent the deferred Oklaunion costs, including carrying costs, were necessary to preserve WTU's financial integrity. If WTU's deferred accounting treatment is ultimately reversed or is substantially reduced, WTU could experience a material adverse impact on its results of operations. While management can give no assurances as to the outcome of the remanded proceeding or the motion for rehearing, management believes that 100 percent of the Oklaunion deferred costs will be determined by the Texas Commission to have been necessary to preserve WTU's financial integrity during the deferral period so that there will be no material adverse effect on WTU's results of operations or financial condition.\nDeferred Accounting - Docket No. 7289 WTU received approval from the Texas Commission in September 1987 to defer operating expenses and carrying costs associated with Oklaunion incurred subsequent to its December 1986 commercial operation date until December 1987 (the deferral period) when retail rates including Oklaunion in WTU's rate base became effective. WTU has recorded approximately $32 million of Oklaunion deferred costs, of which $25 million are carrying costs. The deferred costs are being recovered and amortized over the remaining life of the plant. In November 1987, OPUC filed an appeal in the District Court challenging the Texas Commission's final order authorizing WTU to defer the costs associated with Oklaunion. In October 1988, the District Court affirmed the final order of the Texas Commission. In December 1988, OPUC filed an appeal of the District Court judgment in the Court of Appeals. In September 1990, the Court of Appeals upheld the District Court's affirmance of the Texas Commission's final order and in October 1990, OPUC filed a motion for rehearing of the Court of Appeals' decision, which was denied in November 1990. On further appeal, the Supreme Court heard oral argument in September 1993, in WTU's case as well as three other cases involving deferred accounting\n2-184 and in June 1994 issued its opinions in these cases affirming the Texas Commission's authority to allow deferred accounting treatment, but establishing a financial integrity standard rather than the measurable harm standard used by the Texas Commission.\nIn October 1994, the Supreme Court of Texas issued a mandate remanding WTU's deferred accounting case to the Texas Commission. While no schedule has yet been established for the proceedings on remand at the Texas Commission, this remand may be considered in tandem with WTU's pending rate case, Docket No. 13369. In the remanded proceeding, the Texas Commission must make a formal finding that the deferral of Oklaunion costs was necessary to prevent WTU's financial integrity during the deferral period from being jeopardized.\nIf WTU's deferred accounting treatment is ultimately reversed and not favorably resolved, WTU could experience a material adverse impact on its results of operations. While management cannot predict the ultimate outcome of these proceedings, management believes that WTU's deferred accounting will be ultimately sustained by the Texas Commission on the basis of the financial integrity standard set forth by the Supreme Court of Texas, so that there will be no material adverse effect on WTU's results of operations or financial condition.\nFERC Order On April 4, 1994, the FERC issued an order pursuant to section 211 of the Federal Power Act forcing a regional utility to transmit power to Tex-La on behalf of WTU. The order was one of the first issued by FERC under that provision, which was added by the Energy Policy Act to increase competition in wholesale power markets. On December 1, 1994, the FERC issued an order requiring a regional utility to provide this transmission service at a cost which was acceptable to Tex-La. The FERC also ordered the same regional utility to enter into an interconnection and remote control area load agreement with WTU within 30 days. This agreement was executed on January 3, 1995. On January 5, 1995, WTU began selling 92 MW of power and energy to Tex-La. Tex-La has a peak requirement of approximately 120 MWs. WTU will serve Tex-La until facilities are completed to connect Tex-La to SWEPCO, at which time SWEPCO will provide 85 MW and WTU will retain 35 MW of the Tex-La electric load.\nOther WTU 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 WTU's results of operations or financial condition.\n10. Commitments and Contingent Liabilities Construction It is estimated that WTU will spend approximately $37 million in construction expenditures during 1995. Substantial commitments have been made in connection with this capital expenditure program.\nFuel To supply a portion of its fuel requirements WTU has entered into various commitments for the procurement of fuel. WTU has a sale\/leaseback agreement with Transok, an affiliated company, for full capacity use of a natural gas pipeline to WTU's Ft. Phantom generating plant. The lease agreement also provides for full capacity use of Transok's natural gas pipelines serving WTU's San Angelo and Oak Creek generating plants. The initial terms of the agreement are for twelve years with renewable options thereafter.\n2-185 11. Quarterly Information (Unaudited) The following unaudited quarterly information includes, in the opinion of management, all adjustments necessary for a fair presentation of such amounts.\nQuarter Ended Operating Operating Net Revenues Income Income 1994 (thousands) March 31 $ 83,319 $ 8,487 $ 3,546 June 30 83,016 12,958 8,192 September 30 109,348 27,987 23,271 December 31 67,308 5,331 2,357 $342,991 $54,763 $37,366\nMarch 31 $ 73,109 $ 9,540 $ 7,898 June 30 86,973 14,060 9,086 September 30 109,897 24,172 19,490 December 31 75,466 (1,196) (6,178) $345,445 $45,576 $30,296\nInformation for quarterly periods is affected by seasonal variations in sales, rate changes, timing of fuel expense recovery and other factors.\n2-186 Report of Independent Public Accountants\nTo the Stockholders and Board of Directors of West Texas Utilities Company:\nWe have audited the accompanying balance sheets and statements of capitalization of West Texas Utilities Company (a Texas corporation and a wholly-owned subsidiary of Central and South West Corporation) as of December 31, 1994 and 1993, and the related statements of income, retained earnings and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of WTU'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 West Texas Utilities Company as of December 31, 1994 and 1993, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.\nIn 1993, as discussed in NOTE 1, WTU changed its methods of accounting for unbilled revenues, postretirement benefits other than pensions, income taxes and postemployment benefits.\nOur audits were made for the purpose of forming an opinion on the financial statements taken as a whole. The supplemental Schedule II 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. This schedule 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 LLP\nDallas, Texas February 13, 1995\n2-187 Report of Management\nManagement is responsible for the preparation, integrity and objectivity of the financial statements of West Texas Utilities Company as well as other information contained in this Annual 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 Annual Report is consistent with that in the financial statements.\nThe financial statements have been audited by the independent accounting firm, Arthur Andersen LLP, which was given unrestricted access to all financial records and related data, including minutes of all meetings of shareholders, the board of directors and committees of the board. WTU believes that representations made to the independent auditors during their audit were valid and appropriate. Arthur Andersen LLP's audit report is presented elsewhere in this report.\nWTU maintains a system of internal controls to provide reasonable assurance that transactions are executed in accordance with management's authorization, that the financial statements are prepared in accordance with generally accepted accounting principles and that the assets of the companies are properly safeguarded against unauthorized acquisition, use or disposition. The system includes a documented organizational structure and division of responsibility, established policies and procedures including a policy on ethical standards which provides that WTU will maintain the highest legal and ethical standards, and the careful selection, training and development of our employees.\nInternal auditors continuously monitor the effectiveness of the internal control system following standards established by the Institute of Internal Auditors. Actions are taken by management to respond to deficiencies as they are identified. The board, operating through its audit committee, which is comprised entirely of directors who are not officers or employees of WTU provides oversight to the financial reporting process.\nDue to the inherent limitations in the effectiveness of internal controls, no internal control system can provide absolute assurance that errors will not occur. However, management strives to maintain a balance, recognizing that the cost of such a system should not exceed the benefits derived.\nWTU believes that, in all material respects, its system of internal controls over financial reporting and over safeguarding of assets against unauthorized acquisition, use or disposition functioned effectively during 1994.\nGlenn Files R. Russell Davis President and CEO - WTU Controller - WTU\n2-188 ITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.\nNone.\n3-1 PART III\nCPL, PSO, SWEPCO and WTU CSW 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 REGISTRANTS. CSW CSW has filed with the SEC its Notice of Annual Meeting of Stockholders and Proxy Statement relating to its 1995 Annual Meeting of Stockholders. The information required by ITEM 10, other than with respect to certain information regarding the executive officers of CSW which is included in ITEM 1. BUSINESS - Executive Officers of the Registrant, is hereby incorporated by reference to pages 3-5 and 8 of such Proxy Statement.\nCPL, PSO, SWEPCO AND WTU (a) The following is a list of directors of each of the Electric Operating Companies, together with certain information with respect to each of them:\nName, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nCPL\nE. R. BROOKS. . . . . . . . . . . . . . . . . . AGE - 57 1991 Chairman, President and CEO of CSW since 1991. President of CSW from 1990 to 1991. President and COO of CSW from January 1990 to September 1990. Director of CSW and each of its subsidiaries. Director of Hubbell, Inc., Orange, Connecticut. Trustee of Baylor University Medical Center, Dallas, Texas and Hardin Simmons University, Abilene, Texas.\nROBERT R. CAREY. . . . . . . . . . . . . . AGE - 57 1989 President and CEO of CPL since 1990. Executive Vice President and COO of CPL from 1989 to 1990. Director of NationsBank, Corpus Christi, Texas.\nRUBEN M. GARCIA. . . . . . . . . . . . . . AGE - 63 1981 President or principal of several firms engaged primarily in construction and land development in the Laredo, Texas area.\nDAVID L. HOOPER. . . . . . . . . . . . . . .AGE - 39 1994 Vice President, Marketing and Business Development of CPL since 1994. Director of Marketing and Business Development of CSWS from 1993 to 1994. Director of Marketing and Business Development of CPL from 1991 to 1993. Area manager of CPL from 1990 to 1991. Director of Corporate Communications of CPL from 1988 to 1990.\nHARRY D. MATTISON. . . . . . . . . . . . AGE - 58 1994 Executive Vice President of CSW since 1990 and CEO of CSWS since 1993. COO of CSW from 1990 to 1993. President and CEO of SWEPCO from 1988 to 1990. Director of CSW and each of CSW's wholly-owned subsidiaries.\n3-2 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nROBERT A. McALLEN. . . . . . . . . . . . AGE - 60 1983 Robert A. McAllen, Insurance Agency, Weslaco, Texas.\nPETE MORALES, JR. . . . . . . . . . . . . .AGE - 54 1990 President and General Manager of Morales Feed Lots, Inc., Devine, Texas. Director of The Bank of Texas, Devine, Texas.\nS. LOYD NEAL, JR. . . . . . . . . . . . . . AGE - 57 1990 President of Hilb, Rogal and Hamilton Company of Corpus Christi, an insurance agency, Corpus Christi, Texas. Director of Bay Area Medical Center, Corpus Christi, Texas.\nJIM L. PETERSON. . . . . . . . . . . . . . .AGE - 59 1989 President and CEO of Whataburger, Inc., Corpus Christi, Texas. President of Peterson Ranch and Cattle Company, Goliad, Texas. President and CEO of Bojangles Restaurants Inc., Charlotte, North Carolina. Director of Mercantile Bank of Corpus Christi and Brownsville, Texas.\nH. LEE RICHARDS. . . . . . . . . . . . . . .AGE - 61 1987 Chairman of the Board of Hygeia Dairy Company, Harlingen, Texas.\nMELANIE J. RICHARDSON. . . . . . . . . AGE - 38 1993 Vice President, Administration of CPL since 1993. Treasurer of CPL from 1992 to 1994. Vice President, Corporate Services of CPL from 1992 to 1993. Director of Internal Audits of CPL from 1991 to 1992. Manager of Personnel Services of CPL from 1986 to 1991.\nJ. GONZALO SANDOVAL. . . . . . . . . . AGE - 46 1992 Vice President, Operations\/Engineering of CPL since 1993. Vice President, Regional Operations of CPL from 1992 to 1993. Vice President, Corporate Services of CPL from 1991 to 1992. General Manager of the Southern Region from 1988 to 1991.\nGERALD E. VAUGHN. . . . . . . . . . . . . AGE - 52 1993 Vice President, Nuclear of CSWS since 1994. Vice President, Nuclear Affairs of CPL since 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.\nEach of the directors and executive officers of CPL is elected to hold office until the first meeting of CPL's Board of Directors after the 1995 Annual Meeting of Stockholders. CPL's 1995 Annual Meeting of Stockholders is presently scheduled to be held on April 13, 1995. All outside directors have engaged in their principal occupations listed above for a period of more than five years, unless otherwise indicated.\n3-3 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nPSO\nE. R. BROOKS. . . . . . . . . . . . . . . . . . AGE - 57 1991 Chairman, President and CEO of CSW since 1991. President of CSW from 1990 to 1991. President and COO of CSW from January 1990 to September 1990. Director of CSW and each of its subsidiaries. Director of Hubbell, Inc., Orange, Connecticut. Trustee of Baylor University Medical Center, Dallas, Texas and Hardin Simmons University, Abilene, Texas.\nHARRY A. CLARKE. . . . . . . . . . . . . . . . . . . . . AGE - 66 1972 HAC Investments, Afton, Oklahoma.\nPAUL K. LACKEY, JR. . . . . . . . . . . . . . . . . . . . AGE - 51 1992 Consultant, Flint Industries, Inc., a construction, electronics manufacturing, and environmental services company, Tulsa, Oklahoma. Advisory Director of Bank IV-Tulsa, Tulsa, Oklahoma.\nPAULA MARSHALL-CHAPMAN . . . . . . . . . . . . . . . . . .AGE - 41 1991 General Partner\/CEO of Bama Pie Ltd., a baked goods produce company, Tulsa, Oklahoma.\nHARRY D. MATTISON. . . . . . . . . . . . .AGE - 58 1994 Executive Vice President of CSW since 1990 and CEO of CSWS since 1993. COO of CSW from 1990 to 1993. President and CEO of SWEPCO from 1988 to 1990. Director of CSW and each of CSW's wholly-owned subsidiaries.\nWILLIAM R. McKAMEY . . . . . . . . . . . . . . . . . . . .AGE - 48 1993 Vice President, Marketing and Business Development of PSO since 1993. Director of Marketing and Business Development of CSW from 1992 to 1993. Director of Marketing of SWEPCO from 1990 to 1992.\nMARY M. POLFER . . . . . . . . . . . . . . . . . . . . . .AGE - 50 1991 Vice President, Administration of PSO since 1993. Vice President, Finance of PSO from 1990 to 1993. Director Corporate Projects from 1987 to 1990, Farmland Industries, Inc., a federated cooperative, Kansas City, Missouri.\nDR. ROBERT B. TAYLOR, JR. . . . . . . . . . . . . . . . . AGE - 66 1975 Dentist, Okmulgee, Oklahoma.\nROBERT L. ZEMANEK . . . . . . . . . . . . . . . . . . . . AGE - 45 1990 President and CEO of PSO since 1992. Executive Vice President of PSO from 1990 to 1992. Vice President, Corporate Services of PSO from 1989 to 1990.\n3-4 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nWALDO J. ZERGER, JR. . . . . . . . . . . . . . . . . . . .AGE - 48 1991 Vice President, Operations and Engineering of PSO since 1994. Vice President of Division Operations of PSO from 1990 to 1994.\nEach of the directors and executive officers of PSO is elected to hold office until the first meeting of PSO's Board of Directors after the 1995 Annual Meeting of Stockholders. PSO's 1995 Annual Meeting of Stockholders is presently scheduled to be held on April 18, 1995. All outside directors have engaged in their principal occupations listed above for a period of more than five years, unless otherwise indicated.\nSWEPCO\nRICHARD H. BREMER . . . . . . . . . . . . . . . . . . . . AGE - 46 1989 President and CEO of SWEPCO since 1990. Vice President, Operations of SWEPCO from 1989 to 1990. Director of Commercial National Bank, Shreveport, Louisiana. Director of Deposit Guaranty Corporation, Jackson, Mississippi.\nE. R. BROOKS. . . . . . . . . . . . . . . . . . AGE - 57 1991 Chairman, President and CEO of CSW since 1991. President of CSW from 1990 to 1991. President and COO of CSW from January 1990 to September 1990. Director of CSW and each of its subsidiaries. Director of Hubbell, Inc., Orange, Connecticut. Trustee of Baylor University Medical Center, Dallas, Texas and Hardin Simmons University, Abilene, Texas.\nJAMES E. DAVISON . . . . . . . . . . . . . AGE - 57 1993 Sole Proprietor of Paul M. Davison Petroleum Products. President and Chief Executive Officer of Davison Transport, Inc. and Davison Terminal Services, Inc. Advisory Board member of Heritage Financial Group. All of the above entities are located in Ruston, Louisiana.\nAL P. EASON, JR. . . . . . . . . . . . . . . . . . . . . .AGE - 69 1975 Retired as Chairman and CEO of the First Federal Savings and Loan Association of Fayetteville, Arkansas in 1990. President, Eason and Company, a general insurance company, Fayetteville, Arkansas.\nW. J. GOOGE, JR. . . . . . . . . . . . . . . . . . . . . .AGE - 52 1990 Vice President, Administration of SWEPCO since 1993. Vice President, Corporate Services of SWEPCO from 1990 to 1993. Vice President, Personnel, Safety and Insurance of SWEPCO from 1984 to 1990.\nDR. FREDERICK E. JOYCE . . . . . . . . . . . . . . . . . .AGE - 60 1990 Physician. President of Chappell-Joyce Pathology Association, P.A., Texarkana, Texas. President of Doctors Diagnostic Laboratory, Inc., Texarkana, Texas. Director of State First National Bank and State First Financial Corporation, Texarkana, Arkansas. Director of First Commercial Corporation, Little Rock, Arkansas.\n3-5 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nMICHAEL H. MADISON . . . . . . . . . . . . . . . . . . . .AGE - 46 1992 Vice President, Operations and Engineering of SWEPCO since 1993. Vice President, Engineering and Production of SWEPCO from 1992 to 1993. Vice President, Corporate Services of WTU from 1990 to 1992. Eastern Division Manager of PSO in 1990.\nHARRY D. MATTISON. . . . . . . . . . . . .AGE - 58 1994 Executive Vice President of CSW since 1990 and CEO of CSWS since 1993. COO of CSW from 1990 to 1993. President and CEO of SWEPCO from 1988 to 1990. Director of CSW and each of CSW's wholly-owned subsidiaries.\nMARVIN R. McGREGOR. . . . . . . . . . . . . . . . . . . . AGE - 48 1990 Vice President, Marketing and Business Development of SWEPCO since 1990.\nWILLIAM C. PEATROSS . . . . . . . . . . . . . . . . . . . AGE - 51 1990 President of Caddo Abstract and Title Co., Inc., Partner-Baucum, Hamilton and Peatross, a law firm; Partner-Kernmass-X Oil Company, Partner-Coastal Land Association, Director of Commercial National Bank. All of the above entities are located in Shreveport, Louisiana.\nJACK L. PHILLIPS . . . . . . . . . . . . . . . . . . . . .AGE - 70 1986 Owner of Jack L. Phillips Oil & Gas Exploration and Production, Gladewater, Texas. Director of Longview National Bank, Longview, Texas.\nEach of the directors and executive officers of SWEPCO is elected to hold office until the first meeting of SWEPCO's Board of Directors after the 1995 Annual Meeting of Stockholders. SWEPCO's 1995 Annual Meeting of Stockholders is presently scheduled to be held on April 12, 1995. All outside directors have engaged in their principal occupations listed above for a period of more than five years, unless otherwise indicated.\nWTU\nRICHARD F. BACON . . . . . . . . . . . . . . . . . . . . .AGE - 68 1980 Retired President and CEO of Merchants, Inc. Companies, a freight common carrier, Abilene, Texas.\nC. HARWELL BARBER . . . . . . . . . . . . . . . . . . . . AGE - 68 1990 Chairman of Rita Barber, Inc., a burial clothing company, Abilene, Texas.\nE. R. BROOKS. . . . . . . . . . . . . . . . . . AGE - 57 1980 Chairman, President and CEO of CSW since 1991. President of CSW from 1990 to 1991. President and COO of CSW from January 1990 to September 1990. Director of CSW and each of its subsidiaries. Director of Hubbell, Inc., Orange, Connecticut. Trustee of Baylor University Medical Center, Dallas, Texas and Hardin Simmons University, Abilene, Texas.\n3-6 Name, Age, Principal Year Occupation, Business Experience First Became and Other Directorships Director\nPAUL J. BROWER . . . . . . . . . . . . . . . . . . . . . AGE - 46 1991 Vice President, Marketing and Business Development of WTU since 1991. Division Manager of PSO from 1990 to 1991 and Corporate Sales Manager of PSO from 1986 to 1990.\nT. D. CHURCHWELL. . . . . . . . . . . . . . . . . . . . .AGE - 50 1994 Executive Vice President of WTU since 1994. Vice President, Corporate Services of CSWS from 1991 to 1993. Central Region Manager of CPL from 1989 to 1991.\nGLENN FILES . . . . . . . . . . . . . . . . . . . . . . .AGE - 47 1991 President and CEO of WTU since 1992. Executive Vice President of WTU from 1991 to 1992. Vice President, Marketing and Business Development of CPL from 1990 to 1991. Director of Corporate Planning of PSO from 1988 to 1990. Director of First National Bank of Abilene, Texas.\nHARRY D. MATTISON. . . . . . . . . . . . AGE - 58 1994 Executive Vice President of CSW since 1990 and CEO of CSWS since 1993. COO of CSW from 1990 to 1993. President and CEO of SWEPCO from 1988 to 1990. Director of CSW and each of CSW's wholly-owned subsidiaries.\nTOMMY MORRIS . . . . . . . . . . . . . . . . . . . . . . AGE - 60 1976 Independent insurance agent, Abilene, Texas.\nDIAN G. OWEN . . . . . . . . . . . . . . . . . . . . . . AGE - 55 1994 Chairman of Owen Healthcare, Inc., hospital services, Abilene, Texas. Director of First National Bank of Abilene, Abilene, Texas. Director of First Financial Bankshares, Inc., Abilene, Texas.\nJAMES M. PARKER . . . . . . . . . . . . . . . . . . . . .AGE - 64 1987 President and CEO of J. M. Parker and Associates, Inc., an investment company, Abilene, Texas. Director of First Financial Bankshares, Inc. and First National Bank of Abilene, Abilene, Texas.\nDENNIS M. SHARKEY . . . . . . . . . . . . . . . . . . . .AGE - 50 1994 Vice President, Administration of WTU since 1994. Vice President, Finance and Director of SWEPCO from 1990 to 1993. Vice President and Corporate Secretary of WTU from 1989 to 1990.\nF. L. STEPHENS . . . . . . . . . . . . . . . . . . . . . AGE - 57 1980 Chairman and CEO of Town & Country Food Stores, Inc., San Angelo, Texas. Director of First National Bank at Lubbock, Lubbock, Texas. Director of Norwest Texas, Lubbock, Texas.\nDONALD A. WELCH . . . . . . . . . . . . . . . . . . . . .AGE - 55 1982 Vice President, Operations and Engineering of WTU since 1993. Vice President, Division Operations of WTU from 1991 to 1992. Vice President, District Operations of WTU from 1990 to 1991.\n3-7 Each of the directors and executive officers of WTU is elected to hold office until the first meeting of WTU's Board of Directors after the 1995 Annual Meeting of Stockholders. WTU's 1995 Annual Meeting of Stockholders is presently scheduled to be held on March 28, 1995. All outside directors have engaged in their 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 registrants, together with certain information with respect to each of them:\nYear First Name, Age, Principal Elected to Occupation, Business Experience Present Position\nCPL, PSO, SWEPCO and WTU SHIRLEY S. BRIONES . . . . . . . . . . . . . . . . . . . AGE - 43 1994 Treasurer of CPL, PSO, SWEPCO, WTU and CSWS since 1994. Manager, Budgets and Accounting Systems of CPL from 1992 to 1994. Supervisor of Accounting of CPL from 1990 to 1992. Supervisor, Financial Planning of CPL from 1988 to 1990.\nR. RUSSELL DAVIS . . . . . . . . . . . . . . . . . . . . AGE - 38 1994 Controller of CPL, WTU, SWEPCO and CSWS since 1994. Controller of PSO since 1993. Assistant Controller of CSW from 1992 to 1993. Assistant Controller of CSWS from 1991 to 1992. Business Improvement Project Manager of WTU in 1991. Manager of Financial Reporting of WTU from 1988 to 1991.\nCPL DAVID P. SARTIN. . . . . . . . . . . . . . . . . . . . . AGE - 38 1991 Director of Planning and Analysis of CPL since 1994. Secretary of CPL since 1991. Controller and Secretary of CPL from 1991 to 1994. Controller of WTU from 1989 to 1991.\nPSO BETSY J. POWERS . . . . . . . . . . . . . . . . . . . . .AGE - 59 1989 Secretary of PSO since 1989.\nSWEPCO ELIZABETH D. STEPHENS . . . . . . . . . . . . . . . . . .AGE - 39 1988 Secretary of SWEPCO since 1988.\nWTU MARTHA MURRAY . . . . . . . . . . . . . . . . . . . . . .AGE - 49 1992 Secretary of WTU since 1992. Previously a senior secretary at WTU.\n3-8 ITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION. Cash and Other Forms of Compensation\nCSW Information required by ITEM 11 is hereby incorporated by reference to pages 15-19 of CSW's Proxy Statement.\nCPL, PSO, SWEPCO and WTU The following table sets forth the aggregate cash and other compensation for services rendered for the fiscal years of 1994, 1993, and 1992 paid or awarded by each registrant to the CEO and each of the four most highly compensated Executive Officers, other than the CEO, whose salary and bonus exceeds $100,000, and up to two additional individuals, if any, not holding an executive officer position as of year-end but who held such a position at any time during the year, and whose compensation for the year would have placed them among the four most highly compensated executive officers.\n3-12 Option\/SAR Grants\nShown below is information on grants of stock options made in 1994 pursuant to the 1992 LTIP to the Named Executives Officers of each of the Electric Operating Companies. No stock appreciation rights were granted in 1994.\nOption\/SAR Exercises and Year-End Value Table\nShown below is information regarding option\/SAR exercises during 1994 and unexercised options\/SARs at December 31, 1994 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 1994 under cycle III of the LTIP:\n3-15 CPL, PSO, SWEPCO and WTU Payouts of the awards are contingent upon CSW achieving a specified level of total stockholder return, relative to a peer group of utility companies, for the three-year period, or cycle, and exceeding a certain defined minimum threshold. Total stockholder return is calculated by dividing (i) the sum of (a) the cumulative amount of dividends per share for the three-year period, assuming full dividend reinvestment, and (b) the change in share price over the three-year period, by (ii) the share price at the beginning of the three-year period. 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 canceled. The first awards under LTIP were established in 1992 for a three-year cycle through 1994. The Executive Compensation Committee is scheduled to evaluate cycle I performance under the LTIP in March, 1995.\nThe LTIP contains a provision accelerating awards upon a change in control of CSW. If a change in control of CSW occurs, (i) all options and SARs become fully exercisable, (ii) all restrictions, terms and conditions applicable to all restricted stock are deemed lapsed and satisfied and 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 Plan\nCPL, PSO, SWEPCO and WTU PENSION PLAN TABLE Annual Benefits After Specified Years of Credited Service\nAverage Compensation 15 20 25 30 or more\n$100,000 . . . . . .$ 25,050 $ 33,333 $ 41,667 $ 50,000 150,000 . . . . . . 37,575 50,000 62,500 75,000 200,000 . . . . . . 50,100 66,667 83,333 100,000 250,000 . . . . . . 62,625 83,333 104,167 125,000 300,000 . . . . . . 75,150 100,000 125,000 150,000 350,000 . . . . . . 87,675 116,667 145,833 175,000 450,000 . . . . . . 112,725 150,000 187,500 225,000 550,000 . . . . . . 137,775 183,333 229,167 275,000 650,000 . . . . . . 162,825 216,667 270,833 325,000 750,000 . . . . . . 187,875 250,000 312,500 375,000\nExecutive officers are eligible to participate in the tax- qualified CSW Pension Plan like other employees of the registrants. Certain executive officers, including the Named Executive Officers, are also eligible to participate in the 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 62 or later Social Security benefit and (ii) certain other offset benefits.\n\"Average Compensation\" is the covered compensation for the plans and equals the average annual compensation, reported as salary\n3-16 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 benefits, are based on 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, 1994, for the Named Executive Officers are as follows:\nNamed Executive Officer Years of Credited Service Age\nCPL Robert R. Carey 27 57 Melanie J. Richardson 13 38 J. Gonzalo Sandoval 21 45 C. Wayne Stice 30 57 B. W. Teague 30 56\nPSO Robert L. Zemanek 22 45 William R. McKamey 24 48 Mary M. Polfer 4 50 E. Michael Williams 22 46 Waldo J. Zerger, Jr. 24 48\nSWEPCO Richard H. Bremer 17 46 W. Jerry Googe, Jr. 30 52 Michael H. Madison 23 46 Marvin R. McGregor 25 48\nWTU Glenn Files 23 47 Paul J. Brower 18 45 T. D. Churchwell 16 50 Dennis M. Sharkey 16 50 Donald A. Welch 30 55\nMeetings and Compensation\nCPL and PSO The Board of Directors held four regular meetings during 1994. Directors who are not also executive officers and employees of the CPL and PSO or their 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.\n3-17 SWEPCO The Board of Directors held four meetings during 1994. Directors who are not also executive officers and employees of SWEPCO or its affiliates receive annual directors' fees of $6,600 for serving on the board, and a fee of $300 plus expenses for each meeting of the board or committee attended.\nWTU The Board of Directors held five meetings during 1994. Directors who are not also executive officers and employees of WTU 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.\nCPL, SWEPCO and WTU Those directors who are not also officers of CPL, SWEPCO and WTU 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\nCPL, PSO, SWEPCO and WTU No person serving during 1994 as a member of the Executive Compensation Committee of the Board of Directors of CSW served as an officer or employee of each registrant during or prior to 1994. No person serving during 1994 as an executive officer of the Electric Operating Companies serves or has served on the compensation committee or as a director of another company whose executive officers serve or has served as a member of the Executive Compensation Committee of CSW or as a director of one of the Electric Operating Companies.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.\nCSW The information required by ITEM 12 is hereby incorporated by reference to page 5-6 of CSW's Proxy Statement.\nCPL, PSO, SWEPCO and WTU All outstanding Common Stock shares are owned beneficially and of record by CSW, 1616 Woodall Rodgers Freeway, Dallas, Texas 75202.\nCompany Shares Par Value\nCPL 6,755,535 $25 par value PSO 9,013,000 $15 par value SWEPCO 7,536,640 $18 par value WTU 5,488,560 $25 par value\n3-18 Security Ownership of Management The following table shows securities beneficially owned as of December 31, 1994, by each director, the CEO and the four other most highly compensated executive officers and, as a group, all directors and executive officers of each registrant. Share amounts shown in this table include options exercisable within 60 days after year- end, restricted stock, shares of CSW Common credited to CSW Thrift Plus accounts and all other shares of CSW Common beneficially owned by the listed persons. Each person has sole voting and investment power with respect to all shares listed in the table below, excluding the shares underlying the unexercised options.\nCPL Beneficial Ownership as of December 31, 1994 Name CSW Common Stock Preferred Stock (1)(2) (2)\nE. R. Brooks 81,940 Robert R. Carey 24,260 Ruben M. Garcia -- David L. Hooper 1,775 Harry D. Mattison 33,111 Robert A. McAllen 3,500 Pete Morales, Jr. -- S. Loyd Neal, Jr. 2,950 Jim L. Peterson -- H. Lee Richards 1,700 Melanie J. Richardson 1,356 J. Gonzalo Sandoval 11,328 C. Wayne Stice 5,568 B. W. Teague 3,371 Gerald E. Vaughn 151 All of the above and other executive officers as a group 175,673\n(1)Shares for Messrs., Brooks, Carey, Mattison, Sandoval and CPL directors and executives as a group, include 4,760, 2,851, 3,236, 211 and 11,058 shares of restricted stock, respectively. These individuals currently have voting power, but not investment power, with respect to these shares. The above shares also include 870, 19,062, 9,786, 12,352, 1,942, 1,530, 1,045 and 49,535 shares underlying immediately exercisable options held by Ms. Richardson and Messrs. Brooks, Carey, Mattison, Sandoval, Stice, Teague and CPL directors and executives as a group, respectively.\n(2)Percentages are all less than one percent and therefore are omitted.\n3-19 PSO Beneficial Ownership as of December 31, 1994 Name CSW Common Stock Preferred Stock (1)(2) (2)\nE. R. Brooks 81,940 Harry A. Clarke -- Paul K. Lackey, Jr. -- Paula Marshall-Chapman -- Harry D. Mattison 33,111 William R. McKamey 8,176 Mary M. Polfer 3,378 Jack E. Raulston -- Dr. Robert B. Taylor, Jr. -- Robert L. Zemanek 10,920 Waldo J. Zerger, Jr. 9,635 E. Michael Williams 254 All of the above and other executive officers as a group 154,146\n(1)Shares for Ms. Polfer and Messrs. Brooks, Mattison, Williams, Zemanek, Zerger and PSO directors and executives as a group, include 439, 4,760, 3,236, 254, 1,094, 478 and 10,261 shares of restricted stock, respectively. These individuals currently have voting power, but not investment power, with respect to these shares. The above shares also include 1,942, 19,062, 12,352, 1,322, 7,092, 2,090 and 45,732 shares underlying immediately exercisable options held by Ms. Polfer and Messrs. Brooks, Mattison, McKamey, Zemanek, Zerger, and PSO directors and executives as a group, respectively.\n(2)Percentages are all less than one percent and therefore are omitted.\n3-20 SWEPCO Beneficial Ownership as of December 31, 1994 Name CSW Common Stock Preferred Stock (1)(2) (2)\nRichard H. Bremer 28,578 E. R. Brooks 81,940 James E. Davison -- Al P. Eason, Jr. 2,000 W. J. Googe, Jr. 6,558 Dr. Frederick E. Joyce 2,000 Michael H. Madison 4,241 Harry D. Mattison 33,111 Marvin R. McGregor 3,892 William C. Peatross -- Jack L. Phillips -- All of the above and other executive officers as a group 166,116\n(1)Shares for Messrs. Bremer, Brooks, Googe, Madison, Mattison, McGregor and SWEPCO directors and executives as a group, include 2,609, 4,760, 539, 484, 3,236, 518 and 12,146 shares of restricted stock, respectively. These individuals currently have voting power, but not investment power, with respect to these shares. The above shares also include 8,286, 19,062, 1,942, 2,090, 12,352, 2,090 and 47,011 shares underlying immediately exercisable options held by Messrs. Bremer, Brooks, Googe, Madison, Mattison, McGregor, and SWEPCO directors and executives as a group, respectively.\n(2)Percentages are all less than one percent and therefore are omitted.\nWTU Beneficial Ownership as of December 31, 1994 Name CSW Common Stock Preferred Stock (1)(2) (2)\nRichard F. Bacon 2,643 C. Harwell Barber 12,292 E. R. Brooks 81,940 Paul J. Brower 3,698 T. D. Churchwell 3,131 Glenn Files 9,164 Harry D. Mattison 33,111 Tommy Morris 2,000 Dian G. Owen 50 James M. Parker 6,700 Dennis M. Sharkey 16,205 F. L. Stephens 1,596 Donald A. Welch 7,920 All of the above and other executive officers as a group. 184,360\n(1)Shares for Messrs. Brooks, Brower, Churchwell, Files, Mattison, Sharkey, Welch and WTU directors and executives as a group, include 4,760, 330, 424, 1,071, 3,236, 662, 515 and 10,998 shares of restricted stock, respectively. These individuals currently have voting power, but not investment power, with respect to these shares. The above shares also include 19,062, 2,090, 2,090, 6,596, 12,352, 8,342, 2,090 and 53,558 shares underlying immediately exercisable options held by Messrs. Brooks, Brower, Churchwell, Files, Mattison, Sharkey, Welch and WTU directors and executives as a group, respectively.\n(2)Percentages are all less than one percent and therefore are omitted.\n3-22 ITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. CSW The information required by ITEM 13 is hereby incorporated by reference to pages 6-9 of CSW's Proxy Statement.\nCPL, PSO, SWEPCO and WTU None.\n4-1 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: Reports of Independent Public Accountants on the financial statements for CSW and subsidiary companies, CPL, PSO, SWEPCO and WTU are listed under Item 8 herein.\nThe financial statements filed as a part of this report for CSW and subsidiary companies, CPL, PSO, SWEPCO and WTU are listed under Item 8 herein.\n(2) Financial Statement Schedules: Report of Independent Public Accountants as to Schedules for CSW, CPL, PSO, SWEPCO and WTU are included in the Report of Independent Public Accountants for each registrant.\nFinancial Statement Schedules for CSW, CPL, PSO, SWEPCO and WTU are listed in the Index to the Financial Statement Schedules at page 4-15.\n(3) Exhibits Exhibits for CSW, CPL, PSO, SWEPCO and WTU are listed in the Exhibit Index at page 4-21.\n(b) Reports on Form 8-K: CSW and CPL CSW and CPL filed a Current Report on Form 8-K dated October 31, 1994, reporting ITEM 5. \"Other Events\" relating to the CPL rate case.\nPSO and SWEPCO No reports were filed on Form 8-K during the quarter ended December 31, 1994.\nWTU WTU filed a Current Report on Form 8-K dated February 17, 1995 providing unaudited 1994 financial data associated with a debt financing.\n(c) Management Contracts, Compensatory Plans or Arrangements: The management contracts, compensatory plans or arrangements required to be filed as exhibits to this Form 10-K are listed in 10(a)1-10(a)6 in item (d) Exhibits below.\n4-2 CSW 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant and any subsidiaries thereof.\nCENTRAL AND SOUTH WEST CORPORATION\nBy: Wendy G. Hargus 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant and any subsidiaries thereof.\nSignature Title\nE. R. Brooks President and CEO and Director (Principal Executive Officer)\nGlenn D. Rosilier Chief Financial Officer (Principal Financial Officer)\nWendy G. Hargus Controller (Principal Accounting Officer)\n*T. J. Barlow Director *Glenn Biggs Director *Molly Shi Boren Director *Donald M. Carlton Director *Joe H. Foy Director *Robert Lawless Director *Harry D. Mattison Executive Vice President and Director *James L. Powell Director *Arthur E. Rasmussen Director *T. V. Shockley, III Executive Vice President and Director *J. C. Templeton Director *Lloyd D. Ward Director\n*Wendy G. Hargus, 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: Wendy G. Hargus Attorney-in-Fact 4-3 CPL 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant.\nCENTRAL POWER AND LIGHT COMPANY\nBy: R. Russell Davis 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant.\nSignature Title\nRobert R. Carey President and CEO and Director (Principal Executive Officer)\nR. Russell Davis Controller (Principal Accounting and Financial Officer)\n*E. R. Brooks Director *Ruben M. Garcia Director *David L. Hooper 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 *Melanie J. Richardson Director *J. Gonzalo Sandoval Director *Gerald E. Vaughn Director\n*R. Russell Davis, by signing his 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: R. Russell Davis Attorney-in-Fact 4-4 PSO 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant.\nPUBLIC SERVICE COMPANY OF OKLAHOMA\nBy: R. Russell Davis 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant.\nSignature Title\nRobert L. Zemanek President and CEO and Director (Principal Executive Officer)\nR. Russell Davis Controller (Principal Accounting and Financial Officer)\n*E. R. Brooks Director *Harry A. Clark Director *Paul K. Lackey, Jr. Director *Paula Marshall-Chapman Director *Harry D. Mattison Director *William R. McKamey Director *Mary M. Polfer Director *Dr. Robert B. Taylor, Jr. Director *Waldo J. Zerger, Jr. Director\n*R. Russell Davis, by signing his 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: R. Russell Davis Attorney-in-Fact\n4-5 SWEPCO 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant.\nSOUTHWESTERN ELECTRIC POWER COMPANY\nBy: R. Russell Davis 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant.\nSignature Title\nRichard H. Bremer President and CEO and Director (Principal Executive Officer)\nR. Russell Davis Controller (Principal Accounting and Financial Officer)\n*E. R. Brooks Director *James E. Davison Director *Al P. Eason, Jr.. Director *W. J. Googe, Jr. Director *Dr. Frederick E. Joyce Director *Michael H. Madison Director *Harry D. Mattison Director *Marvin R. McGregor Director *William C. Peatross Director *Jack L. Phillips Director\n*R. Russell Davis, by signing his 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: R. Russell Davis Attorney-in-Fact\n4-6 WTU 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, on March 20, 1995. The signature of the undersigned registrant shall be deemed to relate only to matters having reference to such registrant.\nWEST TEXAS UTILITIES COMPANY\nBy: R. Russell Davis 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 on March 20, 1995. The signature of each of the undersigned shall be deemed to relate only to matters having reference to the above named registrant.\nSignature Title\nGlenn Files President and CEO and Director (Principal Executive Officer)\nR. Russell Davis Controller (Principal Accounting and Financial Officer)\n*Richard Bacon Director *C. Harwell Barber Director *E. R. Brooks Director *Paul J. Brower Director *T. D. Churchwell Director *Harry D. Mattison Director *Tommy Morris Director *Dian G. Owen Director *James M. Parker Director *F. L. Stephens Director *Dennis M. Sharkey Director *Donald A. Welch Director\n*R. Russell Davis, by signing his 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: R. Russell Davis Attorney-in-Fact 4-7 INDEX TO FINANCIAL STATEMENT SCHEDULES Paper Copy Schedule Page\nII. Valuation and Qualifying Accounts. Central and South West Corporation 4-16 Central Power and Light Company 4-17 Public Service Company of Oklahoma 4-18 Southwestern Electric Power Company 4-19 West Texas Utilities Company 4-20\nCSW, CPL, PSO, SWEPCO and WTU All 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 or related notes to financial statements.\n4-8 CENTRAL AND SOUTH WEST CORPORATION AND SUBSIDIARY COMPANIES\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts (b) Deductions (c) of Year (millions) Accrued Restructuring Charges $97 $ (9) (a) $(27) $57 $ 4\nAccrued Restructuring Charges $-- $ 97 $ -- $-- $ 97\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(millions) SFAS No. 87 $(31) SFAS No. 112 4 Total $(27)\n(c) Payments of accrued restructuring charges.\n4-9 CENTRAL POWER AND LIGHT COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts(b) Deductions(c) of Year (thousands) Accrued Restructuring Charges $29,365 $ 98 (a) $(7,893) $20,245 $ 1,325\nAccrued Restructuring Charges $ -- $29,365 $ -- $ -- $29,365\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(thousands) SFAS No. 87 $(9,099) SFAS No. 112 1,206 Total $(7,893)\n(c) Payments of accrued restructuring charges.\n4-10 PUBLIC SERVICE COMPANY OF OKLAHOMA\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts(b) Deductions(c) of Year (thousands) Accrued Restructuring Charges $24,995 $ (197) (a) $(8,126) $15,626 $ 1,046\nAccrued Restructuring Charges $ -- $24,995 $ -- $ -- $24,995\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(thousands) SFAS No. 87 $(9,880) SFAS No. 112 1,754 Total $(8,126)\n(c) Payments of accrued restructuring charges.\n4-11 SOUTHWESTERN ELECTRIC POWER COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts(b) Deductions(c) of Year (thousands) Accrued Restructuring Charges $25,203 $ (4,978)(a) $(7,421) $11,694 $ 1,110\nAccrued Restructuring Charges $ -- $ 25,203 $ -- $ -- $25,203\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(thousands) SFAS No. 87 $(8,016) SFAS No. 112 595 Total $(7,421)\n(c) Payments of accrued restructuring charges.\n4-12 WEST TEXAS UTILITIES COMPANY\nSCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS\nCOL. A COL. B COL. C COL. D COL. E Additions Balance at Charged to Charged Balance Beginning Costs and to Other at End Description of Year Expenses Accounts(b) Deductions(c) of Year (thousands) Accrued Restructuring Charges $15,250 $ (2,037)(a) $(3,724) $8,918 $ 571\nAccrued Restructuring Charges $ -- $ 15,250 $ -- $ -- $15,250\n(a) Reflects true-up to revised estimate of restructuring charges. (b) Effects of early retirement related to SFAS No. 87 Employers' Accounting for Pensions and SFAS No. 112 Employers' Accounting for Postemployment Benefits follow:\n(thousands) SFAS No. 87 $(3,992) SFAS No. 112 268 Total $(3,724)\n(c) Payments of accrued restructuring charges.\n4-13 (d) Exhibit 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 SEC, respectively, as the exhibits and in the file numbers indicated and are incorporated herein by reference. The exhibits marked with a plus (+) are management contracts or compensatory plans or arrangements required to be filed herewith and required to be identified as such by ITEM 14. of Form 10-K. 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 102 of Regulation S-T of the SEC, immediately precedes the exhibits being physically filed with this Form 10-K.\n(2) Plan of Acquisition, Reorganization, Arrangement, Liquidation or Succession\nCSW (a) 1 Agreement and Plan of Merger Among El Paso Electric Company, Central and South West Corporation and CSW Sub, Inc. Dated as of May 3, 1993 as Amended May 18, 1993 (incorporated herein by reference to Exhibit 2.1 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(a) 2 Second Amendment Dated as of August 26, 1993 to Agreement and Plan of Merger Among El Paso Electric Company, Central and South West Corporation and CSW Sub, Inc. Dated as of May 3, 1993 as amended on May 18, 1993 (incorporated herein by reference to Exhibit 2.2 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(a) 3 Third Amendment Dated as of December 1, 1993 to Agreement and Plan of Merger Among El Paso Electric Company, Central and South West Corporation and CSW Sub, Inc. Dated as of May 3, 1993 as amended on May 18, 1993 and August 26, 1993 (incorporated herein by reference to Exhibit 2.3 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(a) 4 Modified Third Amended Plan of Reorganization of El Paso Electric Company Providing for the Acquisition of El Paso Electric Company by Central and South West Corporation as corrected December 6, 1993, and confirmed by the Bankruptcy Court (incorporated herein by reference to Exhibit 2.4 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(a) 5 Order and Judgement Confirming El Paso Electric Company's Third Amended Plan of Reorganization, as Modified, Under Chapter 11 of the United States Bankruptcy Code and Granting Related Relief (incorporated herein by reference to Exhibit 2.5 to CSW's Form 8-K dated December 29, 1993, File No. 1-1443).\n(3) Articles of Incorporation and By-laws\nCSW (a) 1 Second Restated Certificate of Incorporation of CSW, as amended (incorporated herein by reference to Exhibit 3 (a) to CSW's 1990 Form 10-K, File No. 1-1443).\n(a) 2 Bylaws of CSW, as amended (incorporated herein by reference to Exhibit 3 (b) to CSW's 1990 Form 10-K, File No. 1-1443).\n4-14 (d) Exhibit Index: (3) Articles of Incorporation and By-laws (continued)\nCPL (b) 1 Restated Articles of Incorporation, as amended, of CPL (incorporated herein by reference to Exhibit 4(a) to CPL'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 CPL's Form 10-Q for the quarterly period ended September 30, 1992, ITEM 6, Exhibit 1).\n* (b) 2 Bylaws of CPL, as amended.\nPSO (c) 1 Restated Certificate of Incorporation of PSO (incorporated herein by reference to Exhibit 3 to PSO's 1987 Form 10-K, File No. 0-343).\n* (c) 2 Bylaws of PSO, as amended.\nSWEPCO (d) 1 Restated Certificate of Incorporation, as amended, of SWEPCO (incorporated herein by reference to Exhibit 3 to SWEPCO's 1980 Form 10-K, File No. 1-3146, Exhibit 2 to Form U-1 File No. 70-6819, Exhibit 3 to Form U-1, File No. 70- 6924 and Exhibit 4 to Form U-1 File No. 70-7360).\n* (d) 2 Bylaws of SWEPCO, as amended.\nWTU * (e) 1 Restated Articles of Incorporation, as amended, of WTU.\n* (e) 2 Bylaws of WTU, as amended.\n(4) Instruments Defining the Rights of Security Holder, Including Indentures\nCPL (a) 1 Indenture of Mortgage or Deed of Trust dated November 1, 1943, executed by CPL to The First National Bank of Chicago and Robert L. Grinnell, as Trustee, as amended through October 1, 1977 (incorporated herein by reference to Exhibit 5.01 in File No. 2-60712), and the Supplemental Indentures of CPL 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, April 1, 1993 and May 1, 1994 (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. 70-7725 and Exhibit 10 (a), 10 (b), 10 (c), 10 (d) and 10(e), respectively, to Form U-1, File No. 70-8053).\n4-15 (d) Exhibit Index: (4) Instruments Defining the Rights of Security Holder, Including Indentures (continued) PSO (b) 1 Indenture dated July 1, 1945, as amended, of PSO (incorporated herein by reference to Exhibit 5.03 in Registration No. 2-60712) and the Supplemental Indenture of PSO dated June 1, 1979 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2-64432), the Supplemental Indenture of PSO dated December 1, 1979 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2-65871), the Supplemental Indenture of PSO dated March 1, 1983 (incorporated herein by reference to Exhibit 2 to Form U-1, File No. 70-6822), the Supplemental Indenture of PSO dated May 1, 1986 (incorporated herein by reference to Exhibit 3 to Form U-1, File No. 70-7234), the Supplemental Indenture of PSO dated July 1, 1992 (incorporated herein by reference to Exhibit 4 (b) to Form S-3, File No. 33-48650), the Supplemental Indenture of PSO dated December 1, 1992 (incorporated herein by reference to to Exhibit 4 (c) to Form S-3, File No. 33-49143), the Supplemental Indenture of PSO dated April 1, 1993 (incorporated herein by reference to Exhibit 4 (b) to Form S-3, File No. 33-49575), and Supplemental Indenture of PSO dated June 1, 1993 (incorporated herein by reference to Exhibit 4 (b) to PSO's 1993 Form 10-K, File No. 0-343). SWEPCO (c) 1 Indenture dated February 1, 1940, as amended through November 1, 1976, of SWEPCO (incorporated herein by reference to Exhibit 5.04 in Registration No. 2-60712), the Supplemental Indenture dated August 1, 1978 incorporated herein by reference to Exhibit 2.02 in Registration No. 2-61943), the Supplemental Indenture dated January 1, 1980 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2-66033), the Supplemental Indenture dated April 1, 1981 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2- 71126), the Supplemental Indenture dated May 1, 1982 (incorporated herein by reference to Exhibit 2.02 in Registration No. 2-77165), the Supplemental Indenture dated August 1, 1985 (incorporated herein by reference to Exhibit 4 to Form U-1, File No. 70-7121), the Supplemental Indenture dated May 1, 1986 (incorporated herein by reference to Exhibit 3 to Form U-1 File No. 70-7233), the Supplemental Indenture dated November 1, 1989 (incorporated herein by reference to Exhibit 3 to Form U-1, File No. 70- 7676), the Supplemental Indenture dated June 1, 1992 (incorporated herein by reference to Exhibit 10 to Form U- 1, File No. 70-7934), the Supplemental Indenture dated September 1, 1992 (incorporated herein by reference to Exhibit 10 (b) to Form U-1, File No.72-8041), the Supplemental Indenture dated July 1, 1993 (incorporated herein by reference to Exhibit 10 (c) to Form U-1, File No. 70-8041) and the Supplemental Indenture dated October 1, 1993 (incorporated herein by reference to Exhibit 10 (a) to Form U-1, File No. 70-8239). WTU (d) 1 Indenture dated August 1, 1943, as amended through July 1, 1973 (incorporated herein by reference to Exhibit 5.05 in File No. 2-60712), Supplemental Indenture dated May 1, 1979 (incorporated herein by reference to Exhibit No. 2.02 in File No. 2- 63931), Supplemental Indenture dated November 15, 1981 (incorporated herein by reference to Exhibit No. 4.02 in File No. 2-74408), Supplemental Indenture dated Nobember 1, 1983 (incorporated herein by reference to Exhibit 12 to Form U-1, File No. 70-6820), Supplemental Indenture dated April 15, 1985 (incorporated herein by reference to Amended Exhibit 13 to Form U-1, File No. 70-6925), Supplemental Indenture dated August 1, 1985 (incorporated herein by reference to Exhibit 4 (b) in File No. 2-98843), Supplemental Indenture dated May 1, 1986 (incorporated herein by reference to Exhibit 4 to Form U-1, File No. 70- 7237), Supplemental Indenture dated December 1, 1989 (incorporated herein by reference to Exhibit 3 to Form U-1, in File No. 70-7719), Supplemental Indenture dated June 1, 1992 (incorporated herein by reference to Exhibit 10 to Form U-1, File No. 70-7936), Supplemental Indenture dated October 1, 1992 (incorporated herein by reference to Exhibit 10 to Form U-1, File No. 70-8057), Supplemental Indenture dated February 1, 1994 (incorporated herein by reference to Exhibit 10-Form U-1, File No. 70-8265) and Supplemental Indenture dated March 1, 1995 (incorporated herein by reference to Exhibit 10(b) to Form U-1, File No. 70-8057).\n4-16 (d) Exhibit Index: (10) Material Contracts\nCSW + (a) 1 Restricted Stock Plan for Central and South West Corporation (incorporated herein by reference to Exhibit 10(a) to CSW's 1990 Form 10-K, File No. 1-1443).\n+ (a) 2 Central and South West System Special Executive Retirement Plan (incorporated herein by reference to Exhibit 10(b) to CSW's 1990 Form 10-K, File No. 1-1443).\n+ (a) 3 Executive Incentive Compensation Plan for Central and South West System (incorporated herein by reference to Exhibit 10(c) to the Corporation's 1990 Form 10-K, File No. 1-1443).\n(a) 4 Central and South West Corporation Stock Option Plan (incorporated herein by reference to Exhibit 10(d) to the Corporation's 1990 Form 10-K, File No. 1-1443).\n(a) 5 Central and South West Corporation Deferred Compensation Plan for Directors (incorporated herein by reference to Exhibit 10(e) to the Corporation's 1990 Form 10-K, File No. 1-1443).\n+ (a) 6 Central and South West Corporation 1992 Long-Term Incentive Plan (incorporated herein by reference to Appendix A to the Central and South West Corporation Notice of 1992 Annual Meeting of Shareholders and Proxy Statement).\n(12) Statements Re Computation of Ratios\nCPL * (a) 1 Statement re computation of Ratio of Earnings to Fixed Charges for the five years ended December 31, 1994.\nPSO * (b) 1 Statement re computation of Ratio of Earnings to Fixed Charges for the five years ended December 31, 1994.\nSWEPCO * (c) 1 Statement re computation of Ratio of Earnings to Fixed Charges for the five years ended December 31, 1994.\nWTU * (d) 1 Statement re computation of Ratio of Earnings to Fixed Charges for the five years ended December 31, 1994.\n(21) Subsidiaries of the registrant\nCSW * (a) 1 Subsidiaries of the registrant.\n(23) Consent of Experts and Counsel\nCSW * (a) 1 Consent of Independent Public Accountants.\n4-17 (d) Exhibit Index: (23) Consent of Experts and Counsel (continued)\nCPL * (b) 1 Consent of Independent Public Accountants.\nWTU * (c) 1 Consent of Independent Public Accountants.\n(24) Power of Attorney\n* CSW (a) 1 Power of Attorney. (a) 2 Power of Attorney. (a) 3 Power of Attorney. (a) 4 Power of Attorney.\n* CPL (b) 1 Power of Attorney. (b) 2 Power of Attorney. (b) 3 Power of Attorney.\n* PSO (c) 1 Power of Attorney. (c) 2 Power of Attorney. (c) 3 Power of Attorney.\n* SWEPCO (d) 1 Power of Attorney. (d) 2 Power of Attorney. (d) 3 Power of Attorney.\n* WTU (e) 1 Power of Attorney. (e) 2 Power of Attorney. (e) 3 Power of Attorney.","section_15":""}
{"filename":"103682_1994.txt","cik":"103682","year":"1994","section_1":"ITEM 1. BUSINESS THE COMPANY Virginia Electric and Power Company was incorporated in Virginia in 1909 and has its principal office at One James River Plaza, Richmond, Virginia 23261-6666, telephone (804) 771-3000. It is a wholly-owned subsidiary of Dominion Resources, Inc. (Dominion Resources), a Virginia corporation. Virginia Electric and Power Company is a regulated public utility engaged in the generation, transmission, distribution and sale of electric energy within a 30,000 square mile area in Virginia and northeastern North Carolina. It transacts business under the name VIRGINIA POWER in Virginia and under the name NORTH CAROLINA POWER in North Carolina. It sells electricity to retail customers (including governmental agencies) and to wholesale customers such as rural electric cooperatives and municipalities. The Virginia service area comprises about 65 percent of Virginia's total land area, but accounts for over 80 percent of its population. As used herein, the terms \"Virginia Power\" and the \"Company\" shall refer to the entirety of Virginia Electric and Power Company, including, without limitation, its Virginia and North Carolina operations. The Company has nonexclusive franchises or permits for electric operations in substantially all cities and towns now served. It also has certificates of convenience and necessity from the Virginia State Corporation Commission (the Virginia Commission) for service in all territory served at retail in Virginia. The North Carolina Utilities Commission (the North Carolina Commission) has assigned territory to the Company for substantially all of its retail service outside certain municipalities in North Carolina. The Company strives to operate its generating facilities in accordance with prudent utility industry practices and in conformity with applicable statutes, rules and regulations. Like other electric utilities, the Company's generating facilities are subject to unanticipated or extended outages for repairs, replacements or modifications of equipment or otherwise to comply with regulatory requirements. Such outages may involve significant expenditures not previously budgeted, including replacement energy costs. See NUCLEAR REGULATION under REGULATION below and NUCLEAR OPERATIONS AND FUEL SUPPLY under SOURCES OF ENERGY USED AND FUEL COSTS. The Company had 10,585 full-time employees on December 31, 1994. 3,794 of the Company's employees are represented by the International Brotherhood of Electrical Workers under a contract extending to March 31, 1995. Negotiations are presently underway to extend the contract. For additional information on significant corporate governance issues relating to the nonutility business see Item 3. LEGAL PROCEEDINGS. CAPITAL REQUIREMENTS AND FINANCING PROGRAM CONSTRUCTION AND NUCLEAR FUEL EXPENDITURES Virginia Power's estimated construction and nuclear fuel expenditures, including Allowance for Funds Used During Construction (AFC), for the three-year period 1995-1997, total $1.9 billion. It has adopted a 1995 budget for construction and nuclear fuel expenditures as set forth below:\nFINANCING PROGRAM In 1994, Virginia Power obtained $539 million from the sale of securities. With a portion of the proceeds of the 1994 securities sales, the Company retired $166.5 million of securities through mandatory debt maturities and sinking fund requirements and retired an additional $167.8 million of securities through optional redemptions. Its long-term financings included $325.0 million of First and Refunding Mortgage Bonds, $100 million of unsecured Medium-Term Notes, $39.0 million of Pollution Control Revenue Bonds, and $75.0 million of Common Stock sold to Dominion Resources. See LIQUIDITY AND CAPITAL RESOURCES under MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS for, among other things, a discussion of the Company's commercial paper program. Virginia Power's 1995 construction and nuclear fuel requirements, exclusive of AFC, are estimated to be $673.2 million. Of this amount, it is expected that approximately $552 million will be obtained from cash flow from operations. The remaining $121.2 million of construction and nuclear fuel requirements, as well as the $312.2 million of debt maturities, will be obtained by a combination of sales of securities and short-term borrowings. See LIQUIDITY AND CAPITAL RESOURCES under MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. RATES The Company was subject to rate regulation in 1994 as follows:\nSubstantially all of the Company's electric sales are subject to recovery of changes in fuel costs either through fuel adjustment factors or periodic adjustments to base rates, each of which requires prior regulatory approval. Each of these jurisdictions has the authority to disallow recovery of costs it determines to be excessive or imprudently incurred. Various cost items may be reviewed on occasion, including costs of constructing or modifying facilities, on-going purchases of capacity or providing replacement power during generating unit outages.\nThe principal rate proceedings in which the Company was involved in 1994 are described below by jurisdiction. Rate relief obtained by the Company is frequently less than requested. VIRGINIA On February 3, 1994, the Virginia Commission entered its Final Order in Virginia Power's 1992 rate case, approving an increase in annual revenues of $241.9 million. Refunds of $129.2 million (representing the amount recovered under interim rates in excess of the rates finally approved, with interest) were completed by the end of April. The Commission also approved continuation of deferral accounting to recover purchased power capacity costs, allowed inclusion of salary incentive pay in the cost of service, accepted the Company's calculation of postretirement benefits other than pensions, allowed rate base to be updated to November 30, 1992, and recommended a return on equity in the range of 10.5% to 11.5% with rates to be based on 11.4% to reflect superior operating performance of the Company's generating units. The Commission disapproved proposed changes in the Company's line extension policy and a proposed increase in its summer\/winter rate differential, and it disallowed from recovery through rates the gross receipts tax component of capacity payments under certain previously executed power purchase contracts. The Commission directed the Company, the Commission's Staff and other interested parties to explore the concept of expanding the generating unit performance program to include purchases of capacity and to present testimony on that issue in the Company's next rate case. The Company and several non-utility generators that will be adversely affected by the ruling that disallowed rate recovery of the gross receipts tax component of purchased power costs appealed that ruling to the Virginia Supreme Court. On January 13, 1995, the Court issued its Opinion affirming the Virginia Commission's decision. On January 23, 1995, the Company and the other appellants filed Motions of Intent to Seek Rehearing. On January 31, 1994, a hearing before a Hearing Examiner was held on Virginia Power's application requesting approval of Schedule DEF -- Dispersed Energy Facility, a rate schedule that would allow the Company to respond to the request of an industrial or commercial customer to build and operate a generating facility at its business location and to sell to that customer all of the electricity and associated steam from that facility under a long-term contract. On June 23, 1994, the Hearing Examiner recommended approval on an experimental basis (see COMPETITION below). On January 10, 1994, a hearing was held before a Hearing Examiner on Virginia Power's application to revise its Schedule 19 (rates to be paid to small qualifying facilities), which sought, among other things, approval of (a) limiting the schedule's applicability to facilities of 100 Kw or less and (b) postponing the commencement of capacity payments until the capacity is needed by the Company. On April 25, 1994, the Hearing Examiner issued his Report recommending approval of these and other features of the Company's application, and on July 1, 1994, the Commission entered its Final Order accepting the Examiner's recommendation as to these and most other issues. On September 19, 1994, Virginia Power filed with the Virginia Commission an application for a $25 million increase in the fuel factor. A hearing was held on October 28, 1994, and the Commission approved an increase of $9.9 million effective November 1, 1994. Virginia Power filed an application with the Virginia Commission on December 21, 1994, seeking approval, on an experimental basis, to implement a real time pricing (RTP) option for its industrial customers with loads in excess of 10 Mw. Under this option, all or a portion of an industrial customer's load growth would be supplied at projected incremental hourly production costs, adjusted for line losses and taxes, plus a margin of 0.6 cents per Kwh, and a marginal cost-based Generation Capacity Adder and a Transmission Capacity Adder would be applicable during those hours when the Virginia Power system is approaching its forecasted annual peak demand. Up to 20% of an industrial customer's existing load could be served on an RTP basis if the customer executes a five-year contract for such service. COUNTY AND MUNICIPAL On January 30, 1995, Virginia Power reached agreement on the terms of a three-year contract governing rates for county and municipal customers in Virginia, which will continue through June 30, 1997. This contract resulted in a decrease of $25.5 million in annual base revenue from the previous contract and became effective July 1, 1994, with base rates remaining constant through the term of the new contract. NORTH CAROLINA In Virginia Power's 1992 rate case before the North Carolina Commission, the Commission disallowed recovery of certain capacity costs paid to a cogenerator and a portion of the compensation of certain Company officers. The Company\nappealed the Commission's Order on those issues, and on December 9, 1994, the North Carolina Supreme Court affirmed the disallowance of each by the Commission. The Company filed a Motion for Rehearing on January 13, 1995. Virginia Power filed an application with the North Carolina Commission on September 9, 1994 for a $1.5 million increase in fuel rates. A hearing was held on November 8, 1994, and the increase was approved on December 19, 1994. On December 22, 1994, Virginia Power filed an application with the North Carolina Commission for approval of Self-Generation Deferral Rates that are a part of an Energy Agreement between North Carolina Power and Weyerhaeuser. The Energy Agreement involves the use of a negotiated pricing structure which will result in the deferral of the installation of additional self-generation facilities by Weyerhaeuser. REGULATION GENERAL In a wide variety of matters in addition to rates, Virginia Power is presently subject to regulation by the Virginia Commission and the North Carolina Commission, the Environmental Protection Agency (EPA), Department of Energy (DOE), Nuclear Regulatory Commission (NRC), FERC, the Army Corps of Engineers, and other federal, state and local authorities. Compliance with numerous laws and regulations increases the Company's operating and capital costs 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. The commissions regulating the Company's rates have historically permitted recovery of such costs. Virginia Power may not construct, or incur financial commitments for construction of, any substantial generating facilities or large capacity transmission lines without the prior approval of state and federal governmental agencies having jurisdiction over various aspects of its business. Such approvals relate to, among other things, the environmental impact of such activities, the relationship of such activities to the need for providing adequate utility service and the design and operation of proposed facilities. Various provisions of the Energy Policy Act of 1992 (Energy Act) that could affect the Company include those provisions encouraging the development of non-utility generation, giving FERC authority to order transmission access for wholesale transactions, requiring higher energy efficiency and alternative fuels use, restructuring of nuclear plant licensing procedures, and requiring state regulatory authorities to give full rate treatment for the effects of conservation and demand management programs, including the effects of reduced sales. While the full impact of the Energy Act on the Company cannot at this time be quantified, it is likely, over time, to be significant. See COMPETITION under BUSINESS and COMPETITION under MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. ENVIRONMENTAL From time to time, the Company may be identified as a potentially responsible party (PRP) with respect to a Superfund site. EPA (or a state) can either (a) allow such a party to conduct and pay for a remedial investigation and feasibility study and remedial action or (b) conduct the remedial investigation and action and then seek reimbursement from the parties. Each party can be held jointly, severally and strictly liable for all costs, but the parties can then bring contribution actions against each other and seek reimbursement from their insurance companies. As a result of the Superfund Act or other laws or regulations regarding the remediation of waste, the Company may be required to expend amounts on remedial investigations and actions. Although the Company is not currently aware of any sites or events including those sites currently identified likely to result in significant liabilities, such amounts, in the future, could be significant. Permits under the Clean Water Act and state laws have been issued for all of the Company's steam generating stations now in operation. Such permits are subject to reissuance and continuing review. The Company is subject to the Clean Air Act (Air Act), which provides the statutory basis for ambient air quality standards. In order to maintain compliance with such standards and reduce the impact of emissions on ambient air quality, the Company may be required to incur significant additional expenditures in constructing new facilities or in modifying existing facilities. The Company has installed a scrubber at its Mt. Storm Unit 3 Power Station. The scrubber began operation on October 31, 1994. The cost of this scrubber and related equipment was $147 million. The Company is presently conducting studies leading to the compliance plan for Phase II of the Clean Air Act, which may involve the installation of two additional scrubbers, the addition of nitrogen oxide (NOx) controls and other methods for compliance. The present estimate for the total\ncapital cost for compliance, assuming the installation of three scrubbers, nitrogen oxide controls and emission monitoring instrumentation, is $481 million (1992 dollars). Annual incremental compliance costs for operation, maintenance and fuel costs are estimated to be $128 million. These cost estimates may change upon completion of the study effort now underway. See CLEAN AIR ACT COMPLIANCE under MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. The Company continues to work with the West Virginia Office of Air Quality concerning opacity requirements applicable to the Mt. Storm Power Station. For additional information on ENVIRONMENTAL MATTERS, see Note O to FINANCIAL STATEMENTS. NUCLEAR All aspects of the operation and maintenance of the Company's nuclear power stations are regulated by the NRC. Operating licenses issued by the NRC are subject to revocation, suspension or modification, and operation of a nuclear unit may be suspended if the NRC determines that the public interest, health or safety so requires. From time to time, the NRC adopts new requirements for the operation and maintenance of nuclear facilities. In many cases, these new regulations require changes in the design, operation and maintenance of existing nuclear facilities. If the NRC adopts such requirements in the future, it could result in substantial increases in the cost of operating and maintaining the Company's nuclear generating units. WINTER PEAK Due to record cold weather on January 19, 1994, the Company reached a record winter peak of 14,877 Mw, which exceeded the prior record of 13,478 Mw that had been established one day earlier. Similar conditions were experienced by utilities within the Pennsylvania-New Jersey-Maryland Power Pool.\nSOURCES OF POWER COMPANY GENERATING UNITS\n(a) Includes an undivided interest of 11.6 percent (207 Mw) owned by Old Dominion Electric Cooperative (ODEC). (b) On December 30, 1994, the Company acquired the North Branch 80 Mw (nominal rating) waste coal power station located in Bayard, West Virginia in Grant County. (c) Reflects the Company's 60 percent undivided ownership interest in the 2,100 Mw station. A 40 percent undivided interest in the facility is owned by Allegheny Generating Company, a subsidiary of Allegheny Power System, Inc. (APS). The Company's highest one-hour integrated service area summer peak demand was 13,366 Mw on July 29, 1993, and the highest one-hour integrated winter peak demand was 14,877 Mw on January 19, 1994. SOURCES OF ENERGY USED AND FUEL COSTS For information as to energy supply mix and the average fuel cost of energy supply, see RESULTS OF OPERATIONS under MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. NUCLEAR OPERATIONS AND FUEL SUPPLY In 1994, the Company's four nuclear units achieved a combined capacity factor of 86.7 percent. The North Anna Unit 2 steam generator replacement project is scheduled to begin at the end of the first quarter of 1995 at a total estimated Company cost of $110 million.\nThe Company utilizes both long-term contracts and spot purchases to support its needs for nuclear fuel. Virginia Power's nuclear fuel supply and related services are expected to be adequate to support current and planned nuclear generation requirements. The Company continually evaluates worldwide market conditions in order to obtain an adequate nuclear fuel supply. Current agreements, inventories and market availability should support planned fuel cycles throughout the remainder of the 1990s. On-site spent nuclear fuel storage at the Surry Power Station is adequate for the Company's needs through 1998 when, in accordance with the Nuclear Waste Policy Act, the DOE is to begin acceptance of spent fuel for disposal. Should acceptance be delayed, incremental dry storage facilities will be added under the existing storage license. North Anna Power Station will require an interim spent fuel storage facility in the late 1990's and the Company plans to submit a license application to the NRC in 1995 for such a facility at North Anna. For details regarding nuclear insurance and certain related contingent liabilities as well as a NRC rule that requires proceeds from certain insurance policies to be used first to pay stabilization and decontamination expenses, see Note C to FINANCIAL STATEMENTS. FOSSIL FUEL SUPPLY The Company's fossil fuel mix consists of coal, oil and natural gas. In 1994, Virginia Power consumed approximately 10.0 million tons of coal. As with nuclear fuel, the Company utilizes both long-term contracts and spot purchases to support its needs. The Company presently anticipates that sufficient coal supplies at reasonable prices will be available for the remainder of the 1990s. Current projections for an adequate supply of oil remain favorable, barring unusual international events or extreme weather conditions which could affect both price and supply. The Company uses natural gas as needed throughout the year for two combined cycle units and at several combustion turbine units. For winter usage at the combined cycle sites, gas is purchased and stored during the summer and fall and consumed during the colder months when gas supplies are not available at favorable prices. The Company has firm transportation contracts for the delivery of gas to the combined cycle units. Current projections indicate gas supplies will be available for the next several years. PURCHASES AND SALES OF POWER Virginia Power relies on purchases of power to meet a portion of its capacity requirements. The Company also makes economy purchases of power from other utility systems when it is available at a cost lower than the Company's own generation costs. Under contracts effective January 1, 1985, Virginia Power agreed to purchase 400 Mw of electricity annually through 1999 from Hoosier Energy Rural Electric Cooperative, Inc. (Hoosier), and agreed to purchase 500 Mw of electricity annually during 1987-99 from certain operating subsidiaries of American Electric Power Company, Inc. (AEP). On November 26, 1991, the Company and ODEC signed an agreement whereby the Company will provide ODEC 300 Mw of firm capacity and associated energy from January 1, 1993, until the commercial operation of Clover Unit 1 (currently scheduled for April 1995) or December 31, 1995, whichever occurs first. The Company will then provide 100 Mw of firm capacity and associated energy from the commercial operation of Clover Unit 1 until the commercial operation of Clover Unit 2 (currently scheduled for April 1996) or December 31, 1996, whichever occurs first. The Company has a diversity exchange agreement with APS under which APS delivers 200 Mw to Virginia Power in the summer and Virginia Power delivers 200 Mw to APS in the winter. On June 28, 1994, FERC accepted a Power Sales Tariff filed by the Company on March 8, 1994 and revised on May 27, 1994. This tariff allows the Company to resell the 400 Mw Hoosier allotment to other eligible purchasers and also allows the Company to sell system and emergency power. Virginia Power also has 75 non-utility power purchase contracts with a combined dependable summer capacity of 3,506 Mw. Of this amount, 3,244 Mw were operational at the end of 1994 with the balance scheduled to come on-line through 1997 (see NON-UTILITY GENERATION under FUTURE SOURCES OF POWER and Note O to FINANCIAL STATEMENTS). INTERCONNECTIONS The Company maintains major interconnections with Carolina Power and Light Company, AEP, APS and the utilities in the Pennsylvania-New Jersey-Maryland Power Pool. Through this major transmission network, the Company has arrangements with these utilities for coordinated planning, operation, emergency assistance and exchanges of capacity and energy.\nOn March 23, 1990, the Company and Appalachian Power Company (Apco) (an operating unit of AEP) announced an agreement to increase the ability to exchange electricity between the two companies through the construction of major transmission facilities. The proposed construction will consist of 212 miles of new transmission lines and related substation improvements. The transmission additions will include 116 miles of 765 Kv line to be constructed by Apco and 102 miles of 500 Kv line to be constructed by the Company. Completion of the project, expected to be in service in the year 2000, will take three to four years after all final regulatory approvals have been obtained. A Hearing Examiner of the Virginia Commission has issued reports dated December 2, 1993 and January 24, 1994, recommending Commission approval of the Apco and Company lines, respectively, and both applications are before the Commission for final decision. About 79 miles of the Apco line would be located in West Virginia where regulatory approval must also be obtained. The Company has stated that it would not build its 500 Kv line unless Apco is authorized to build its 765 Kv line and unless certain other regional transmission facilities are constructed or the Company's contractual rights to use the regional transmission network are amended. FUTURE SOURCES OF POWER The Company presently anticipates that system load growth will require approximately 1,100 Mw of additional capacity during the 1990s. The Company has and will pursue capacity acquisition plans to provide that capacity and maintain a high degree of service reliability. This capacity may be built, owned and operated by others and sold to the Company under a competitive bid process pursuant to Commission rules or may be built by the Company if it determines it can build capacity at a lower overall cost. The Company also pursues conservation and demand-side management (see CONSERVATION AND LOAD MANAGEMENT below and CAPITAL REQUIREMENTS under MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS). In May 1990, the Company entered into an agreement with ODEC, under which the Company purchased a 50 percent undivided ownership interest in a 782 Mw coal-fired power station to be constructed near Clover, Virginia in Halifax County. The Company will operate the Clover Power Station after it is completed. The cost of the Company's 50 percent ownership interest is expected to be approximately $533 million. The project is on schedule and the Company's share of costs incurred through December 31, 1994 amounted to $449.8 million. Construction on Unit 1 is presently 98% complete and construction on Unit 2 is 54% complete. In Virginia Power's proceeding seeking approval of the Virginia Commission for a 75 mile 500 Kv transmission line from the Clover Power Station to the Carson Substation in Dinwiddie County, Virginia, the Commission approved the line in its Order Granting Application on May 11, 1994. A protestant group has appealed that Order to the Virginia Supreme Court. Initial briefs of all parties have been filed. Oral argument is expected to be scheduled during the first quarter of 1995 and a decision of the Court is likely before mid-1995. The Company's continuing program to meet future capacity requirements is summarized in the following table: COMPANY OWNED GENERATION\n* Includes the 50 percent undivided ownership interest of ODEC. See Note F to FINANCIAL STATEMENTS.\nNON-UTILITY GENERATION\nCOMPETITION Competition is playing an increasingly important role in the Company's business both in terms of source of power supply available to the Company and alternative choices for customers meeting their energy needs. Both forms of competition have increased as a result of changing federal and state governmental regulations, technological developments, rising costs of constructing generating facilities and availability of alternative energy sources. The creation of exempt wholesale generators by the Energy Act and their existence in the market for electric sales may have an impact on the Company's plans for the construction or purchase of electric capacity and energy. In addition, the Energy Act gives FERC broad power to require utilities to provide transmission access to others. Exempt wholesale generators and other power suppliers may seek, and FERC may require, access to the transmission systems of investor-owned utilities, including the Company's system. Several of the Company's industrial customers are seeking means of reducing their expenses for power through self-generation and other alternatives. The Company is having discussions with these customers and has proposed a regulatory initiative in Virginia that would enable it to provide on-site generation for such customers (see VIRGINIA under RATES). The Company has undertaken cost-cutting measures to maintain its position as a low-cost producer of electricity and has pursued a strategic planning initiative, called Vision 2000, to encourage innovative approaches to serving traditional markets and to prepare appropriate methods by which to serve future markets. In furtherance of these initiatives, the Company has established its nuclear and fossil and hydroelectric operations as separate business units, has proposed innovative pricing arrangements for incremental industrial loads in Virginia and North Carolina, has executed long term contracts with key wholesale customers and intends to provide an array of energy services to its customers. Potential competition also exists for the Company's sales to its cooperative and municipal customers. Virginia Power entered into discussions in early 1993 with the City of Falls Church, Virginia, where it has approximately 4,100 customers, for the renewal of its franchise that expired on March 26, 1993. Before agreement on a new franchise, the City announced on October 12, 1994, that it would pursue the establishment of a municipal electric system or a municipal purchasing agent and passed an ordinance purporting to extend the Company's franchise until March 26, 1997. The City issued an \"Informal Request for Power Supply Proposal\" to other electric suppliers on October 13, 1994 to determine the interest in providing power to the City. On January 11, 1995, the City sent to the Company a formal Request for Transmission Service pursuant to Sections 211(a) and 213(a) of the Federal Power Act. The Company, consistent with the State and Federal law, will still attempt to negotiate a new long term franchise with the City while responding as required to the City's request for transmission services. See COMPETITION under MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. CONSERVATION AND LOAD MANAGEMENT The Company is committed to integrated resource planning and has developed a detailed analysis procedure in which effective demand-side and supply-side options are both considered in order to determine the least cost method to satisfy the customers' needs. Demand-side programs are selected annually at Virginia Power through an integrated resource planning process which directly compares the stream of costs and benefits from supply-side and demand-side options. This process ensures the ultimate selection of a demand-side package which reduces the need for additional capacity while efficiently using the Company's existing generation facilities. ITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES The Company owns its principal properties in fee (except as indicated below), subject to defects and encumbrances that do not interfere materially with their use. Substantially all of its property is subject to the lien of a mortgage securing its First\nand Refunding Mortgage Bonds. Right-of-way grants from the apparent owners of real estate have been obtained for most electric lines, but underlying titles have not been examined except for transmission lines of 69 Kv or more. Where rights of way have not been obtained, they could be acquired from private owners by condemnation if necessary. Many electric lines are on publicly owned property as to which permission for use is generally revocable. Portions of the Company's transmission lines cross national parks and forests under permits entitling the federal government to use, at specified charges, surplus capacity in the line if any exists. The Company leases certain buildings and equipment. See Note H to FINANCIAL STATEMENTS. See COMPANY GENERATING UNITS under SOURCES OF POWER under Item 1. BUSINESS. ITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS From time to time, the Company may be in violation of or in default under orders, statutes, rules or regulations relating to protection of the environment, compliance plans imposed upon or agreed to by the Company or permits issued by various local, state and federal agencies for the construction or operation of facilities. There may be pending from time to time administrative proceedings involving violations of state or federal environmental regulations that the Company believes are not material with respect to it and for which its aggregate liability for fines or penalties will not exceed $100,000. There are no material agency enforcement actions or citizen suits pending or, to the Company's present knowledge, threatened against the Company. Virginia Power is involved in an arbitration with Smith Cogeneration of Virginia, Inc. (SCV) before the Virginia Commission concerning the terms of the purchase of power from two 158 megawatt generating units to be developed by SCV. The arbitrator has submitted his Report to the Commission recommending that the parties enter into a contract containing terms that would require Virginia Power to pay what it considers to be excessive amounts for the power to be purchased. The parities have been given until March 31, 1995 to file comments on the Arbitrator's Report. Virginia Power and Doswell Limited Partnership (Doswell) have been unable to agree on the calculation of a Fixed Fuel Transportation Charge to be paid to Doswell under a purchased power contract. Doswell filed suit in the Circuit Court of the City of Richmond alleging breach of contract and actual and constructive fraud and seeking damages of not less than $75 million. The issues of actual and constructive fraud were dismissed from the case, with prejudice, leaving only the contract claim, which reduced alleged damages to approximately $19 million. On March 2, 1995, the Court announced its verdict in favor of Virginia Power. On February 23, 1994, Virginia Power filed with the Virginia Commission a Petition for Declaratory Judgment seeking a declaration that an arrangement proposed by E.I. DuPont de Nemours & Company (DuPont) and LG&E Power, Inc. (LG&E) for a partnership between those two companies to furnish energy services to DuPont in Virginia Power's service territory is illegal under Virginia law. DuPont filed a Motion to dismiss for lack of jurisdiction, to which Virginia Power responded. Prior to any action by the Commission, DuPont and LG&E announced that they had terminated their negotiations, and the Commission has directed the parties to comment on whether the proceeding should be dismissed. On January 13, 1995, Virginia Power filed its response stating that the case should not be dismissed in the absence of a clear statement on the record by both DuPont and LG&E that each has abandoned the power partnering concept in Virginia Power's service territory. DuPont renewed its Motion to Dismiss and the Commission entered its dismissal order on January 24, 1995. A dispute over corporate governance issues between Dominion Resources and Virginia Power arose in 1994. On June 17, 1994, Dominion Resources and Virginia Power received an order from the Virginia Commission (the 1994 Order) that, among other things, initiated an investigation into the affiliate relationships and corporate governance issues between Dominion Resources and Virginia Power (the First Proceeding). The text of the 1994 Order was set forth in the Company's Current Report on Form 8-K of June 17, 1994. Between June and August 1994, Dominion Resources and Virginia Power made various filings with the Commission, and the Commission issued several procedural orders, in connection with the First Proceeding. A description of those filings and orders is set forth in the Company's Quarterly Report on Form 10-Q for the period ending June 30, 1994. On August 15, 1994, Dominion Resources, Virginia Power and their respective directors entered into a Settlement Agreement resolving certain of the disputed corporate governance issues. The terms of that settlement are summarized in the Company's Current Report on Form 8-K of August 17, 1994. Pursuant to the Settlement Agreement, Dominion Resources and Virginia Power filed a Joint Motion to Dismiss certain of the corporate governance issues from the First Proceeding. The Commission denied that Motion on August 24, 1994, continued the First Proceeding, and instituted a new proceeding (the Second Proceeding) into the holding company structure and the relationship between Dominion Resources and Virginia\nPower. The Commission stated that the Second Proceeding would be an \"investigation directed not at averting a crisis or penalizing past conduct, but toward protecting the public interest in the future.\" The Commission directed its Staff to conduct an investigation and file an interim report on or before December 1, 1994. On December 1, 1994, the Staff of the Virginia Commission and its consultants filed an Interim Report in the Second Proceeding. That Report is included in the Company's Current Report on Form 8-K of December 5, 1994. The Interim Report made numerous recommendations for Commission involvement in matters of corporate governance, corporate structure, affiliate service arrangements, and operating relationships between Dominion Resources and Virginia Power, and suggested certain financial constraints on Dominion Resources and new regulatory authority for the Commission. Many of these suggestions were far-reaching. On December 21, 1994, Dominion Resources and Virginia Power filed a Joint Response to the Interim Report, in which they accepted some of the recommendations and urged that the corporate governance structure established by the Settlement Agreement continue while they considered the other recommendations in the course of a strategic planning effort by Dominion Resources. On January 23, 1995, the Staff of the Virginia Commission issued a report in the Second Proceeding on its investigation of a coal transportation contract between the Company and CSX Transportation. The Staff's report concluded that Dominion Resources improperly pressured Virginia Power to renegotiate the contract, and recommended that approximately $11 million ($8.3 million Virginia jurisdictional) of the coal transportation costs incurred under the contract from 1991 through May 31, 1994 be disallowed in determining Virginia Power's rates. The Staff's report further recommended that any future transportation costs that it identified as excess be disallowed over the remainder of the contract, which expires on May 31, 2000. The Company has recorded a regulatory liability of $10.5 million at December 31, 1994. The Company currently estimates that the total amount called into question by the Virginia Commission Staff report is a net present value of $60 million ($100 million over the life of the contract). On February 1, 1995, without admitting any imprudence, fault or liability, and believing that their relationship with the Commission would be enhanced, Dominion Resources and the Company filed a motion offering to refund to the Company's customers $8.3 million in settlement of these issues regarding transportation rates. During the 1995 session of the Virginia General Assembly, the Virginia Commission caused legislation to be introduced that addressed the Commission's authority to intervene in disputes involving public utilities owned by separate holding companies. That legislation was opposed by Dominion Resources. On February 20, 1995, the proposed legislation was withdrawn and Dominion Resources, Virginia Power and the Virginia Commission Staff consented to an order that is included in Virginia Power's Current Report on Form 8-K of February 21, 1995. Under this order, which will be effective until July 2, 1996, Dominion Resources must obtain the Commission's approval before taking steps such as removing Virginia Power's board members or officers or changing Virginia Power's articles of incorporation or by-laws. Although the order imposes for a period of time significant restrictions on the ability of Dominion Resources to select the Board and management of its subsidiary, Dominion Resources and Virginia Power agreed to the order in the interest of enhancing relations with the Virginia Commission and achieving the purposes of the Settlement Agreement. Disagreements between the companies have arisen from time to time since the Settlement Agreement was executed. On February 28, 1995, upon recommendation of a Joint Committee created under the Settlement Agreement, the Boards of Dominion Resources and Virginia Power took further action to enhance cooperation between the two companies and their relationship with the Virginia Commission. Among other things, the Boards expanded the authority of the Joint Committee to act for the Boards on issues presented to it by the chief executives of the companies. Each Board directed corporate officials and employees of its company to cooperate fully with the Joint Committee in resolution of issues acted on by the Committee and to support actions taken by the Committee. In connection with these initiatives, the chief executive officers of both companies made known their intentions to retire in July 1996 and the Boards directed the development of executive succession plans for each company. Also, the Dominion Resources Board received the resignations of directors Bruce C. Gottwald and John W. Snow and the Virginia Power Board received the resignations of directors William W. Berry and Frank S. Royal, and both Boards voted to reduce their size by two members. At this time, Virginia Power is unable to predict the ultimate resolution of these matters or their effect on the Company.\nITEM 4.","section_4":"ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5.","section_5":"ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS All of the Company's Common Stock is owned by Dominion Resources. During 1994 and 1993, the Company paid quarterly cash dividends on its Common Stock as follows:\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 LIQUIDITY AND CAPITAL RESOURCES Cash flow from operating activities has accounted for, on average, 74 percent of the Company's cash requirements over the past three years. Net cash provided by operating activities decreased by $4.6 million in 1994 as compared to 1993, primarily as a result of a number of factors resulting from normal operations, partially offset by a rate refund of $129.2 million in 1994.\nNet cash provided by operating activities decreased $152.1 million in 1993 as compared to 1992, primarily as a result of the rate refund of $188.9 million in 1993 offset in part by the recovery of previously deferred capacity expenses. Cash from (to) financing activities was as follows:\nThe Company sold $325.0 million of First and Refunding Mortgage Bonds in 1994. With a portion of the proceeds, the Company refinanced $119.0 million of its higher-cost debt. The remainder of the proceeds was used to meet a portion of the Company's capital requirements. In 1994, the Company also issued $100 million of unsecured Medium-Term Notes with annual interest rates ranging from 6.15% to 7.27%, the proceeds of which were used to meet a portion of the Company's capital requirements. The Company also issued $39 million of variable and fixed rate Pollution Control Securities in 1994 to refinance $39 million of higher-cost Pollution Control Securities. In 1994, the Company issued to Dominion Resources $75 million of Common Stock. During the year, the Company retired $166.5 million of securities through mandatory debt maturities and sinking fund requirements and repurchased $7.5 million of its debt securities and $2.3 million of preferred stock. Proceeds from the sale of commercial paper are primarily used to finance working capital for operations. Borrowings under the Company's commercial paper program are limited to $200 million outstanding at any one time. At December 31, 1994, no amount was outstanding under this program. Cash from (used in) investing activities was as follows:\nInvesting activities in 1994 resulted in a net cash outflow of $726.8 million primarily due to $580.9 million of construction expenditures and $80 million of nuclear fuel expenditures. Of the construction expenditures, approximately $67.3 million was spent on new generating facilities, $173.8 million on other production projects, and $291.3 million on transmission and distribution projects. CAPITAL REQUIREMENTS The Company presently anticipates that kilowatt-hour sales will grow approximately 2.1 percent a year through 2014. Capacity needed to support this growth will be provided through a combination of Company-constructed generating units, purchases from non-utility generators and other utility generators. Each of these options plays an important role in the Company's overall plan to meet capacity needs. The Company's construction and nuclear fuel expenditures (excluding AFC), during 1995, 1996 and 1997 are expected to aggregate $673.2 million, $600.3 million and $615.2 million, respectively. Construction continues on the 782 Mw coal-\nfired power station near Clover, Virginia, of which the Company has a 50 percent undivided ownership interest. The Company's share of the cost of the construction is approximately $533.0 million of which $449.8 million had been incurred as of December 31, 1994. The expected in-service dates for Clover Units 1 and 2 are April 1995 and April 1996, respectively. After 1996, no base load generation is expected to be needed until the middle of the next decade. From 1999 until 2005, the Company will need to add only peaking units to meet anticipated demand. The Company will require $312.2 million to meet long-term debt maturities in 1995. The Company presently estimates that, for 1995, 82 percent of its construction expenditures, including nuclear fuel expenditures, will be met through cash flow from operations and the balance, including other capital requirements, will be obtained through a combination of sales of securities and short-term borrowings. RESULTS OF OPERATIONS The following is a discussion of results of operations for the years ended 1994 as compared to 1993, and 1993 as compared to 1992. 1994 COMPARED TO 1993 OPERATING REVENUES changed principally due to the following:\nAs detailed in the chart above, the decrease in revenues is primarily due to a decrease in base revenues. Base revenues were lower in 1994 primarily as a result of additional revenue reserves established during the year. During 1994, the Company had 46,741 new connections to its system compared to 43,014 and 39,807 in 1993 and 1992, respectively. Kilowatt-hour sales changed as follows:\nThe increase in kilowatt-hour sales in 1994 as compared to 1993 reflects the extreme weather experienced in January 1994, partially offset by lower sales during the second half of 1994, due to milder weather. The number of actual cooling degree days in 1994 was 5.7 percent above the normal number of cooling degree days and the number of actual heating degree days was 3.8 percent below the number of normal heating degree days. The increase in kilowatt-hour sales in 1993 as compared to 1992 reflects the warmer than normal summer weather in 1993 as compared to the moderate weather in 1992. The number of actual cooling degree days in 1993 was 10.0 percent above the number of normal cooling degree days and the number of actual heating degree days was 1.2 percent above the number of normal heating degree days. The increase in sales for resale in 1993 as compared to 1992 was primarily due to the sale of firm capacity and associated energy to ODEC. Under the terms of the agreement signed November 26, 1991, the Company is committed to sell up to 300 Mw of capacity to ODEC through the commercial operation date of Clover Power Station.\nThe average fuel cost of system energy output is shown below:\nSystem energy output is shown below:\n(*) Excludes ODEC's 11.6 percent ownership interest in the North Anna Power Station (see Note F to FINANCIAL STATEMENTS). OPERATION EXPENSES-OTHER increased as compared to 1993 primarily as a result of recognition of costs associated with the Early Retirement and Voluntary Separation Programs offered by the Company in 1994. INCOME TAXES-OPERATING decreased as compared to 1993 primarily as a result of decreased pretax book income. INTEREST CHARGES-OTHER decreased in 1994 primarily as a result of a reduction of $10.6 million in the interest accrued for prior years on certain tax obligations. 1993 COMPARED TO 1992 FUEL, NET increased as compared to 1992 as a result of higher sales in 1993 and a decrease in nuclear generation due to the scheduled outages in 1993. The increased sales together with the reduced generation from the nuclear units increased the use of purchased power and resulted in higher overall fuel costs. PURCHASED POWER CAPACITY, NET resulted in an increase in 1993. In 1992, the Company implemented deferral accounting for certain capacity expenses. The increase in expense in 1993 primarily reflects the recovery of expenses deferred in 1992. OPERATION EXPENSES, OTHER increased as compared to 1992 primarily as a result of the increased expenses associated with accrual of other postretirement benefits due to the implementation of Statement of Financial Accounting Standards (SFAS) No. 106, \"Employers' Accounting for Postretirement Benefits Other than Pensions\" effective January 1, 1993. INCOME TAXES-OPERATING increased as compared to 1992 primarily as a result of increased pretax book income and an increase in the federal income tax rate from 34 percent to 35 percent. OTHER INCOME AND OTHER INTEREST CHARGES decreased as compared to 1992 primarily as a result of a reclassification of the imputed interest on the nuclear decommissioning obligation which was previously included in Other Interest Charges ($14.8 million) and is now included in OTHER INCOME, as approved by FERC. This increase was offset in part by a $3.1 million decrease in expenses associated with the sale of accounts receivable. CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING PRINCIPLE In 1992, the Company adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, \"Accounting for Income Taxes.\" The Company reported the implementation of the standard as a change in accounting principle with the cumulative effect on prior years of $14.3 million reported in 1992 earnings. The adoption of SFAS No. 109\nin 1992 increased deferred income tax liabilities by $459 million and resulted in the establishment of a net regulatory asset of $459 million. For additional information, see Note A to FINANCIAL STATEMENTS. FUTURE ISSUES UTILITY RATE REGULATION Regulatory policy continues to be of fundamental importance to the Company and to its financial performance. Recently and in the near-term future, the costs of purchased capacity constitute the largest category of increased costs requiring rate relief. The Virginia Commission has authorized rates providing for the current recovery of the ongoing level of capacity payments. Moreover, the Virginia Commission has established and reaffirmed deferral accounting that is intended to ensure dollar for dollar recovery of reasonably incurred capacity costs. For additional information on the current rate proceedings, see RATES under Item 1. BUSINESS. ENVIRONMENTAL MATTERS The Company is subject to rising costs resulting from a steadily increasing number of federal, state and local laws and regulations designed to protect human health and the environment. These laws and regulations affect future planning and existing operations. They can result in increased capital, operating and other costs as a result of remediation, containment and monitoring obligations of the Company. These costs have been historically recovered through the ratemaking process; however, should material costs be incurred and not recovered through rates, the Company's results of operations and financial condition could be adversely impacted. WATER QUALITY COMPLIANCE On March 30, 1992, the Virginia Water Control Board adopted water quality standards for toxic pollutants pursuant to the Clean Water Act. The standards became effective on April 20, 1992 and will be applicable to the Company as Virginia Pollution Discharge Elimination System Permits are reissued. The Company is studying the potential impact of the standards and cannot presently determine whether or to what extent changes to facilities or operating procedures might ultimately be required but incremental compliance costs could be significant. ENVIRONMENTAL PROTECTION AND MONITORING EXPENDITURES The Company incurred $67.3 million, $72.2 million and $65.2 million (including depreciation) during 1994, 1993 and 1992, respectively, in connection with the use of environmental protection facilities and expects these expenses to be approximately $64.3 million in 1995. In addition, capital expenditures to limit or monitor hazardous substances were $4.0 million, $3.6 million and $6.6 million for 1994, 1993 and 1992, respectively. The amount estimated for 1995 for these expenditures is $33.1 million. CLEAN AIR ACT COMPLIANCE The Air Act, as amended in 1990, requires the Company to reduce its emissions of sulfur dioxide and nitrogen oxides. Beginning in 1995, the sulfur dioxide reduction program is based on the issuance of a limited number of sulfur dioxide emission allowances, each of which may be used as a permit to emit one ton of sulfur dioxide into the atmosphere or may be sold to someone else. The program is administered by the EPA. The Company is assessing the economic reasonableness of constructing two additional scrubbers at its Mt. Storm Power Station or acquiring allowances as a means of maintaining compliance with the Air Act's standards. For additional information on the Clean Air Act, see REGULATION under Item 1. BUSINESS.\nELECTROMAGNETIC FIELDS The possibility that exposure to electromagnetic 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. 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 condition. NUCLEAR OPERATIONS In 1994, the Company's four nuclear units operated at a combined capacity factor of 86.7 percent, reflecting a record 31 day refueling outage at North Anna Unit 1, a 63 day refueling\/ten-year in-service inspection outage at Surry Unit 1, and two scheduled steam generator chemical cleaning outages at Surry Units 1 and 2, which took 27 and 21 days respectively. Nuclear refueling outages typically occur every eighteen months and last approximately sixty days. The Company's goal is to reduce refueling outages from an average of sixty days to forty-eight days. When nuclear units are refueled, the Company replaces the power from nuclear generation with other more expensive sources. A reduction in the length of an outage should result in increased availability of low-cost nuclear generation, thereby lowering expenses. Three refueling outages are currently scheduled in 1995. The North Anna Unit 2 outage will include steam generator replacement. The Surry Unit 2 outage will include a ten year in-service inspection while the Surry Unit 1 outage will be for normal refueling. See NUCLEAR OPERATIONS AND FUEL SUPPLY, Sources of Energy Used and Fuel Costs under Item 1. BUSINESS. Stress corrosion cracking has occurred in steam generators of a certain design, including those at the Surry and North Anna Power Stations. The steam generators at Surry Units 1 and 2 were replaced in 1981 and 1979, respectively. The replacement of the North Anna Unit 1 steam generators was completed in 1993 at a cost of $106 million. Replacement of the North Anna Unit 2 steam generators is scheduled for 1995 at a total estimated Company cost of $110 million. Costs associated with the steam generator replacements at Surry are being recovered through rates. Costs associated with the steam generator replacements at North Anna Unit 1 and Unit 2 are expected to be recovered through rates. The NRC has proposed revisions to the nuclear power plant license renewal rules issued in 1991. The Company intends to work with industry groups on life extension programs, and comment on the proposed rulemaking. In addition to improving nuclear unit productivity and efficiency, the Company has completed engineering analyses and evaluations to support uprating the capability of the units. The plant modifications have been completed at the North Anna facility, and the upgraded core improvement has resulted in a 4.2% increase in the gross electrical output for each of the units. A similar project has been initiated to uprate both Surry Units 1 and 2 in 1995. Analyses and evaluations to support the uprate have been completed and a license amendment is pending before the Nuclear Regulatory Commission. For information on nuclear decommissioning, see Note C to FINANCIAL STATEMENTS. CONSERVATION AND LOAD MANAGEMENT For information, see CONSERVATION AND LOAD MANAGEMENT under Item 1. BUSINESS. COMPETITION The Company will continue to be affected by the developing competitive market in wholesale power. Under the Energy Policy Act of 1992, any participant in the wholesale market can obtain a FERC order to provide transmission services, under certain conditions. FERC has completed an industry-wide formal inquiry aimed at reforming the pricing of transmission services. The Company was an active participant in that inquiry. FERC is also encouraging the development of regional transmission groups (RTGs) in which transmission-owning utilities and transmission users would jointly plan facilities and administer the provision of transmission services. It is too early to determine what effects reformed transmission pricing and the development of RTGs could have on the Company. At present, competition for retail customers is limited. It arises primarily from the ability of certain business customers to relocate among utility service territories, to substitute other energy sources for electric power and to generate their own electricity. The Energy Policy Act bans federal orders of transmission service to ultimate customers. Broader retail competition that would allow customers to choose among electric suppliers has been the subject of intense debate in federal and state\nforums. If such competition were to develop, it would have the potential to shift costs among customer classes and to create significant transitional costs. Certain state actions that affect retail competition may be preempted by federal law. Potential competition also exists for the Company's sales to its cooperative and municipal customers. However, nearly all of this service is under contracts with multi-year notice provisions. To date, the Company has not experienced any material loss of load, revenues or net income due to competition for its customers. The Company believes it has a strong capability to meet future competition. For additional information on competition, see COMPETITION under Item 1. BUSINESS. In accordance with SFAS No. 71, \"Accounting for the Effects of Certain Types of Regulation\", the Company's financial statements reflect assets and costs based on current cost-based ratemaking regulations. Continued accounting under SFAS 71 requires that the following criteria be met: a) A utility's rates for regulated services provided to its customers are established by, or are subject to approval by, an independent third-party regulator; b) The regulated rates are designed to recover specific costs of providing the regulated services or products; and c) In view of the demand for the regulated services and the level of competition, direct and indirect, it is reasonable to assume that rates set at levels that will recover a utility's costs can be charged to and collected from customers. This criterion requires consideration of anticipated changes in levels of demand or competition during the recovery period for any capitalized costs. A utility's operations or portion of operations can cease to meet these criteria for various reasons, including a change in the method of regulation or a change in the competitive environment for regulated services. A utility whose operations or portion of operations cease to meet these criteria should discontinue application of SFAS 71 and write-off any regulatory assets and liabilities for those operations that no longer meet the requirements of SFAS 71. The Company's operations currently satisfy the SFAS 71 criteria. However, if events or circumstances should change so that those criteria are no longer satisfied, Management believes that a material adverse effect on the Company's results of operations and financial position may result. COMMITMENTS AND CONTINGENCIES A dispute over corporate governance issues between Dominion Resources and Virginia Power arose in 1994. In connection with that dispute, the Virginia Commission commenced proceedings investigating these and related issues. A Settlement Agreement was entered into by the two Companies and their respective Boards with respect to these matters in August 1994. The Settlement Agreement is also described in Item 3. LEGAL PROCEEDINGS. During the 1995 session of the Virginia General Assembly, the Virginia Commission caused legislation to be introduced that addressed the Commission's authority to intervene in disputes involving public utilities owned by separate holding companies. That legislation was opposed by Dominion Resources. On February 20, 1995, the proposed legislation was withdrawn and Dominion Resources, Virginia Power and the Virginia Commission Staff consented to an order that is included in Virginia Power's Current Report on Form 8-K of February 21, 1995. Under this order, which will be effective until July 2, 1996, Dominion Resources must obtain the Commission's approval before taking steps such as removing Virginia Power's board members or officers or changing Virginia Power's articles of incorporation or by-laws. Although the order imposes for a period of time significant restrictions on the ability of Dominion Resources to select the Board and management of its subsidiary, Dominion Resources and Virginia Power agreed to the order in the interest of enhancing relations with the Virginia Commission and achieving the purposes of the Settlement Agreement. Disagreements between the companies have arisen from time to time since the Settlement Agreement was executed. On February 28, 1995, upon recommendation of a Joint Committee created under the Settlement Agreement, the Boards of Dominion Resources and Virginia Power took further action to enhance cooperation between the two companies and their relationship with the Virginia Commission. Among other things, the Boards expanded the authority of the Joint Committee to act for the Boards on issues presented to it by the chief executives of the companies. Each Board directed corporate officials and employees of its company to cooperate fully with the Joint Committee in resolution of issues acted on by the Committee and to support actions taken by the Committee. In connection with these initiatives, the chief executive officers of both companies made known their intentions to retire in July 1996 and the Boards directed the development of executive succession plans for each company. Also, the Dominion Resources Board received the resignations of directors Bruce C. Gottwald and John W. Snow and the Virginia Power Board received the resignations of directors William W. Berry and Frank S. Royal, and both Boards voted to reduce their size by two members. At this time, Virginia Power is unable to predict the ultimate resolution of these matters or their effect on the Company.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX\nREPORT OF MANAGEMENT The Company's management is responsible for all information and representations contained in the Financial Statements and other sections of the Company's annual report on Form 10-K. The Financial Statements, which include amounts based on estimates and judgments of management, have been prepared in conformity with generally accepted accounting principles. Other financial information in the Form 10-K is consistent with that in the Financial Statements. Management maintains a system of internal accounting controls designed to provide reasonable assurance, at a reasonable cost, that the Company's assets are safeguarded against loss from unauthorized use or disposition and that transactions are executed and recorded in accordance with established procedures. Management recognizes the inherent limitations of any system of internal accounting control and, therefore cannot provide absolute assurance that the objectives of the established internal accounting controls will be met. This system includes written policies, an organizational structure designed to ensure appropriate segregation of responsibilities, careful selection and training of qualified personnel and internal audits. Management believes that during 1994 the system of internal control was adequate to accomplish the intended objective. The Financial Statements have been audited by Deloitte & Touche LLP, independent auditors, whose designation was approved by the Board of Directors. Their audits were conducted in accordance with generally accepted auditing standards and included a review of the Company's accounting systems, procedures and internal controls, and the performance of tests and other auditing procedures sufficient to provide reasonable assurance that the Financial Statements are not materially misleading and do not contain material errors. The Audit Committee of the Board of Directors, composed entirely of directors who are not officers or employees of the Company, meets periodically with the independent auditors, the internal auditors and management to discuss auditing, internal accounting control and financial reporting matters and to ensure that each is properly discharging its responsibilities. Both the independent auditors and the internal auditors periodically meet alone with the Audit Committee and have free access to the Committee at any time. Management recognizes its responsibility for fostering a strong ethical climate so that the Company's affairs are conducted according to the highest standards of personal and corporate conduct. This responsibility is characterized and reflected in the Company's Code of Ethics, which is distributed throughout the Company. The Code of Ethics addresses, among other things, the importance of ensuring open communication within the Company; potential conflicts of interest; compliance with all domestic and foreign laws, including those relating to financial disclosure; the confidentiality of proprietary information; and full disclosure of public information. VIRGINIA ELECTRIC AND POWER COMPANY\nREPORT OF INDEPENDENT AUDITORS To the Board of Directors of Virginia Electric and Power Company: We have audited the accompanying balance sheets of Virginia Electric and Power Company (a wholly-owned subsidiary of Dominion Resources, Inc.) as of December 31, 1994 and 1993 and the related statements of income, earnings reinvested in business, and cash flows for each of the three years in the period ended December 31, 1994. 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, such financial statements present fairly, in all material respects, the financial position of Virginia Electric and Power Company at December 31, 1994 and 1993 and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1994 in conformity with generally accepted accounting principles. The Company changed its methods of accounting for postretirement benefits other than pensions in 1993 (see Note M) and for accounting for income taxes in 1992 (see Note B) in order to conform with recently issued accounting standards. DELOITTE & TOUCHE LLP Richmond, Virginia February 6, 1995\nVIRGINIA ELECTRIC AND POWER COMPANY STATEMENTS OF INCOME\nThe accompanying notes are an integral part of the financial statements.\nVIRGINIA ELECTRIC AND POWER COMPANY BALANCE SHEETS ASSETS\nThe accompanying notes are an integral part of the financial statements.\nVIRGINIA ELECTRIC AND POWER COMPANY BALANCE SHEETS LIABILITIES AND SHAREHOLDERS' EQUITY\nThe accompanying notes are an integral part of the financial statements.\nVIRGINIA ELECTRIC AND POWER COMPANY STATEMENTS OF EARNINGS REINVESTED IN BUSINESS\nThe accompanying notes are an integral part of the financial statements.\nVIRGINIA ELECTRIC AND POWER COMPANY STATEMENTS OF CASH FLOWS\nThe accompanying notes are an integral part of the financial statements.\nVIRGINIA ELECTRIC AND POWER COMPANY NOTES TO FINANCIAL STATEMENTS A. SIGNIFICANT ACCOUNTING POLICIES: GENERAL The Company's accounting practices are generally prescribed by the Uniform System of Accounts promulgated by the regulatory commissions having jurisdiction and are in accordance with generally accepted accounting principles applicable to regulated enterprises. The Company is a wholly-owned subsidiary of Dominion Resources, Inc., a Virginia corporation. REVENUES Operating revenues are recorded on the basis of service rendered. PROPERTY, PLANT AND EQUIPMENT Utility plant is recorded at original cost which includes labor, materials, services, AFC, where permitted by regulators, and other indirect costs. The cost of maintenance and repairs is charged to the appropriate operating expense and clearing accounts. The cost of additions and replacements is charged to the appropriate utility plant account, except that the cost of minor additions and replacements, as provided in the Uniform System of Accounts, is charged to maintenance expense. DEPRECIATION AND AMORTIZATION Depreciation of utility plant (other than nuclear fuel) is computed on the straight-line method based on projected useful service lives. The cost of depreciable utility plant retired and the cost of removal, less salvage, are charged to accumulated depreciation. The provision for depreciation is based on weighted average depreciable plant using a rate of 3.2 percent for 1994, 1993 and 1992. Operating expenses include amortization of nuclear fuel, which is provided on a unit of production basis sufficient to fully amortize, over the estimated service life, the cost of the fuel plus permanent storage and disposal costs. FEDERAL INCOME TAXES The Company adopted SFAS No. 109, \"Accounting for Income Taxes\" (SFAS No. 109) in 1992. This standard requires companies to measure and record deferred tax assets and liabilities for all temporary differences. The regulatory treatment of temporary differences can differ from the requirements of SFAS No. 109. Accordingly, the Company recognizes a regulatory asset if it is probable that future revenues will be provided for the payment of those deferred tax liabilities. Similarly, in the event a deferred tax liability is reduced to reflect changes in tax rates, a regulatory liability is established if it is probable that a future reduction in revenue will result. Prior to 1992, the Company recorded deferred taxes for timing differences between book income and taxable income to the extent such differences were permitted by regulatory commissions for ratemaking purposes. The Company files a consolidated federal income tax return with Dominion Resources. Accumulated investment tax credits are being amortized over the service lives of the property giving rise to such credits. ALLOWANCE FOR FUNDS USED DURING CONSTRUCTION The applicable regulatory Uniform System of Accounts defines AFC as the cost during the construction period of borrowed funds used for construction purposes and a reasonable rate on other funds when so used. The pretax AFC rates for 1994, 1993 and 1992 were 8.9, 9.4 and 10.3 percent, respectively. Approximately 83 percent of the Company's construction work in progress is now included in rate base, and a cash return is collected currently thereon. DEFERRED CAPACITY AND FUEL EXPENSE In 1992, the Company began to defer certain capacity expenses based on an order of the Virginia Commission. Approximately 80 percent of capacity expenses and 90 percent of fuel expenses are subject to deferral accounting. The difference\nbetween reasonably incurred actual expenses and the level of expenses included in current rates is deferred and matched against future revenues. AMORTIZATION OF DEBT ISSUANCE COSTS The Company defers and amortizes any expenses incurred in the issuance of long-term debt, including premiums and discounts associated with such debt over the lives of the respective issues. Any gains or losses resulting from the refinancing of debt are also deferred and amortized over the lives of the new issues of long-term debt as permitted by the appropriate regulatory jurisdictions. Gains or losses resulting from the redemption of debt without refinancing are amortized over the remaining lives of the redeemed issues. CASH AND OTHER INVESTMENTS Current banking arrangements generally do not require checks to be funded until actually presented for payment. At December 31, 1994 and 1993, the Company's accounts payable included the net effect of checks outstanding but not yet presented for payment of $66.8 million and $72.5 million, respectively. For purposes of the Statement of Cash Flows, the Company considers cash and cash equivalents to include cash on hand and temporary investments purchased with an initial maturity of three months or less. RECLASSIFICATION Certain amounts in the 1993 and 1992 financial statements have been reclassified to conform to the 1994 presentation. B. INCOME TAXES: Details of income tax expense are as follows:\nTotal federal income tax expense differs from the amount computed by applying the statutory federal income tax rate to pretax income for the following reasons:\nIn 1992, the Company adopted the provisions of SFAS No. 109. The Company reported the implementation of the standard as a change in accounting principle with the cumulative effect on prior years of $14.3 million reported in 1992 earnings. The adoption of SFAS No. 109 increased deferred income tax liabilities by $459.0 million and resulted in the establishment of a net regulatory asset of $459.0 million. For additional information see FEDERAL INCOME TAXES under Note A to FINANCIAL STATEMENTS. The Company's net accumulated deferred income taxes consist of the following:\nC. NUCLEAR OPERATIONS: DECOMMISSIONING Nuclear plant decommissioning costs are accrued and recovered through rates over the expected service lives of the Company's nuclear generating units. The amounts collected from customers are being placed in trusts, which, with the accumulated earnings thereon, will be utilized solely to fund future decommissioning obligations. Approximately every four years, site-specific studies are prepared to determine the decommissioning cost estimate for the Company's four nuclear units. The current cost estimate is based on the DECON method, which assumes the decontamination or prompt removal of radioactive contaminants so that the property may be released for unrestricted use shortly after cessation of operations. The Company currently estimates that decommissioning will begin at the expiration date of each unit's operating license, which will occur in 2012, 2013, 2018 and 2020 for the Surry Units 1 & 2 and North Anna Units 1 & 2, respectively. Based on the Company's latest decommissioning study completed in 1994, total decommissioning costs, including reclamation costs, are estimated to be $1.0 billion in 1994 dollars. The accumulated provision for decommissioning of $260.9 million and $226.4 million is included in Utility Plant Accumulated Depreciation at December 31, 1994 and 1993, respectively. Provisions for decommissioning of $24.5 million, $24.4 million and $24.3 million applicable to 1994, 1993 and 1992, respectively, are included in Depreciation and Amortization Expense. The balance in the Company's Nuclear Decommissioning trust funds was $260.9 million and $226.4 million at December 31, 1994 and 1993, respectively. The net unrealized loss of $5.2 million at December 31, 1994 is included in the accumulated provision for decommissioning.\nEarnings of the trust funds were $15.2 million, $16.3 million and $9.1 million for 1994, 1993 and 1992, respectively, and are included in Other Income in the Company's Statements of Income. In 1994 and 1993, the accretion of the accumulated provision for decommissioning, equal to the earnings of the trust funds, was recorded in Other Income. See MISCELLANEOUS, NET under RESULTS OF OPERATIONS, Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Such amounts in 1992 were recorded in Interest Charges, Other. The Financial Accounting Standards Board (FASB) is reviewing the accounting for nuclear plant decommissioning. If current electric utility industry practices for such decommissioning are changed, annual provisions for decommissioning could increase. FASB may ultimately determine that the estimated cost of decommissioning should be reported as a liability rather than as accumulated depreciation and that a substantial portion of the decommissioning obligation should be recognized earlier in the operating life of the nuclear plant. INSURANCE The Price-Anderson Act limits the public liability of an owner of a nuclear power plant to $8.9 billion for a single nuclear incident. The Price-Anderson Amendments Act of 1988 allows for an inflationary provision adjustment every five years. The Company has purchased $200 million of coverage from the commercial insurance pools with the remainder provided through a mandatory industry risk sharing program. In the event of a nuclear incident at any licensed nuclear reactor in the United States, the Company could be assessed up to $81.7 million (including a 3 percent insurance premium tax for Virginia) for each of its four licensed reactors not to exceed $10.3 million (including a 3 percent insurance premium tax for Virginia) per year per reactor. There is no limit to the number of incidents for which this retrospective premium can be assessed. Nuclear liability coverage for claims made by nuclear workers first hired on or after January 1, 1988, except those arising out of an extraordinary nuclear occurrence, is provided under the Master Worker insurance program. (Those first hired into the nuclear industry prior to January 1, 1988, are covered by the policy discussed above.) The aggregate limit of coverage for the industry is $400 million ($200 million policy limit with automatic reinstatements of an additional $200 million). The Company's maximum retrospective assessment is approximately $12.7 million (including a 3 percent insurance premium tax for Virginia). The Company's current level of property insurance coverage ($2.55 billion for North Anna and $2.40 billion for Surry) exceeds the NRC's minimum requirement for nuclear power plant licensees of $1.06 billion per reactor site and includes coverage for premature decommissioning and functional total loss. The NRC requires that the proceeds from this insurance be used first to return the reactor to and maintain it in a safe and stable condition and second to decontaminate the reactor and station site in accordance with a plan approved by the NRC. The property insurance coverage provided to the Company is subject to retrospective premium assessments, in any policy year in which losses exceed the funds available to these insurance companies. The maximum assessment at the first incident of the current policy period is $45.4 million and the maximum assessment related to a second incident is an additional $15.1 million. Based on the severity of the incident, the Board of Directors of the Company's nuclear insurers has the discretion to lower the maximum retrospective premium assessment or eliminate either or both completely. For any losses that exceed the limits or for which insurance proceeds are not available because they must first be used for stabilization and decontamination, the Company has the financial responsibility for these losses. The Company purchases insurance from Nuclear Electric Insurance Limited (NEIL) to cover the cost of replacement power during the prolonged outage of a nuclear unit due to direct physical damage of the unit. Under this program, Virginia Power is subject to a retrospective premium assessment for any policy year in which losses exceed funds available to NEIL. The current policy period's maximum assessment is $9.2 million. As part owner of the North Anna Power Station, ODEC is responsible for its proportionate share (11.6 percent) of the insurance premiums applicable to that station, including any retrospective premium assessments and any losses not covered by insurance. D. SALE OF RECEIVABLES: The Company has an agreement to sell, with limited recourse, certain accounts receivable including unbilled amounts, up to a maximum of $200 million. Additional receivables are continually sold, at the Company's discretion, to replace those collected up to the limit. At December 31, 1994 and 1993, $160 million and $200 million, respectively, of receivables had been sold and were outstanding under this agreement. The limited recourse is provided by the Company's assignment of an\nadditional undivided interest in accounts receivable to cover any potential losses to the purchaser due to uncollectible accounts. The Company has provided for the estimated amount of such losses in its accounts. E. UTILITY PLANT: Utility plant at December 31, consisted of the following:\nF. JOINTLY OWNED PLANTS: The following information relates to the Company's proportionate share of jointly owned plants at December 31, 1994:\nThe co-owners are obligated to pay their share of all future construction expenditures and operating costs of the jointly owned facilities in the same proportion as their respective ownership interest. The Company's share of operating costs is classified in the appropriate operating expense (fuel, maintenance, depreciation, taxes, etc.) in the Statements of Income. G. REGULATORY ASSETS: Certain expenses normally reflected in income are deferred on the balance sheet as regulatory assets and are recognized in income as the related amounts are included in rates and recovered from customers. The Company's regulatory assets included the following:\nIncome taxes recoverable through future rates represent principally the tax effect of depreciation differences not normalized. These amounts are amortized as the related temporary differences reverse.\nThe costs of decommissioning the Department of Energy's (DOE) uranium enrichment facilities have been deferred and represents the unamortized portion of Virginia Power's required contributions to a fund for decommissioning and decontaminating the DOE's uranium enrichment facilities. Virginia Power is making such contributions over a fifteen-year period with escalation for inflation. These costs are being recovered in fuel rates. Deferred losses or gains on reacquired debt are deferred and amortized over the lives of the new issues of long-term debt. Gains or losses resulting from the redemption of debt without refinancing are amortized over the remaining lives of the redeemed issues. The construction of North Anna Unit 3 was terminated in November 1982. All retail jurisdictions have permitted recovery of the incurred costs. The amounts deferred are being amortized over a fifteen-year period for Virginia and FERC jurisdictional customers. H. LEASES: Plant and property under capital leases included the following:\n(*) The Company leases its principal office building from its parent, Dominion Resources. The capitalized cost of the property under that lease, net of accumulated amortization, represented $25.0 million and $26.0 million at December 31, 1994 and 1993, respectively. Rental payments for such lease were $3.0 million for each of the three years ended December 31, 1994, 1993 and 1992. The Company is responsible for expenses in connection with the leases noted above, including maintenance. Future minimum lease payments under noncancellable capital leases and for operating leases that have initial or remaining lease terms in excess of one year as of December 31, 1994, are as follows:\nRents on leases, which have been charged to other operation expenses, were $9.6 million, $11.2 million and $10.6 million for 1994, 1993 and 1992, respectively.\nI. LONG-TERM DEBT: Long-term debt included the following:\n(1) Substantially all of the Company's property is subject to the lien of its mortgage, securing its First and Refunding Mortgage Bonds. (2) Certain pollution control facilities at the Company's generating facilities have been pledged or conveyed to secure the financings. (3) Interest rates vary based on short-term, tax-exempt market rates. The weighted average daily interest rates were 2.96% and 2.53% for 1994 and 1993, respectively. Pollution control bonds subject to remarketing within one year are classified as long-term debt to the extent that the Company's intention to maintain the debt is supported by long-term bank commitments. Under the terms of an Inter-Company Credit Agreement, the Company may borrow funds from Dominion Resources on a daily basis and repay all or part of the loan at any time. Borrowings under the Agreement are limited to $300 million outstanding at any one time, less amounts outstanding under the commercial paper program. At December 31, 1994, there were no amounts outstanding under the Agreement and no amounts were borrowed during 1994. With a portion of the proceeds from the sale of $200 million First and Refunding Mortgage Bonds of 1993, Series G, the Company in 1993 irrevocably placed $138.2 million in a trust to defease $119.1 million 1990 Series A Bonds. As a result, the\n1990 Series A Bonds were considered to be extinguished for financial reporting purposes and were excluded from the balance sheet at December 31, 1994 and 1993. The cost of $19.1 million was deferred and is being amortized over the life of the new issue. Maturities through 1999 are as follows (millions): 1995 -- $312.2; 1996 -- $259.6; 1997 -- $311.3; 1998 -- $293.5; and 1999 -- $261.0. J. PREFERRED STOCK SUBJECT TO MANDATORY REDEMPTION: Preferred stock subject to mandatory redemption, $100 liquidation preference, at December 31, 1994, was as follows:\n(a) Shares are non-callable prior to redemption. (b) All shares to be redeemed on 3\/1\/2000. (c) All shares to be redeemed on 9\/1\/2000. (d) The 1995 and a portion of the 1996 sinking fund requirements were satisfied by the 1994 open market purchase. Maturities are $0.7 million for 1996 and $1.5 million for each of the years 1997-1999. During the years 1992 through 1994, the following shares were redeemed:\nThe total number of authorized shares for all preferred stock is 10,000,000 shares. Upon involuntary liquidation, all presently outstanding preferred stock is entitled to receive $100 per share plus accrued dividends. Dividends are cumulative.\nK. PREFERRED STOCK NOT SUBJECT TO MANDATORY REDEMPTION: Preferred stock not subject to mandatory redemption, $100 liquidation preference, at December 31, 1994, was as follows:\n(*) Money Market Preferred (MMP) dividend rates are variable and are set every 49 days via an auction process. The combined weighted average rates for these series in 1994, 1993 and 1992, including fees for broker\/dealer agreements, were 3.75 percent, 3.01 percent and 3.43 percent, respectively. In 1993, 350,000 and 500,000 shares of the $7.72 and the $7.72 (1972 Series) Dividend Preferred Stock, respectively, were redeemed. L. COMMON STOCK: During the years 1992 through 1994 the following changes in Common Stock occurred:\nM. RETIREMENT PLAN AND POSTRETIREMENT BENEFITS: The Company participates in the Dominion Resources, Inc. Retirement Plan (the Retirement Plan), a defined benefit pension plan. The Retirement Plan covers virtually all employees of Dominion Resources and its subsidiaries, including the Company. The benefits are based on years of service and average base compensation over the consecutive 60-month period in which pay is highest. Pension plan expenses were $19.3 million, $15.9 million and $13.1 million for 1994, 1993 and 1992, respectively and the amounts funded were $42.7 million, $16.0 million and $12.3 million in 1994, 1993 and 1992, respectively.\nThe Company adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions\" effective January 1, 1993. This standard requires the accrual of the cost of providing other postretirement benefits (OPEB), including medical and life insurance coverage, during the active service of the employee. Prior to 1993, the Company recognized expense on a pay-as-you-go basis. The Company recognized as expense $10.5 million for these benefits in 1992. Under the terms of its benefit plans, the Company reserves the right to change, modify or terminate the plans. From time to time in the past, benefits have changed, and some of these changes have reduced benefits. Net periodic postretirement benefit expense for 1994 and 1993 was as follows:\nThe following table sets forth the funded status of the plan:\nA one percent increase in the health care cost trend rate would result in an increase of $4.8 million in the service and interest cost components and a $26.9 million increase in the accumulated postretirement benefit obligation. Significant assumptions used in determining the postretirement benefit obligation were:\nThe Company is recovering these costs in rates on an accrual basis in all material respects, in all jurisdictions. Current and future recoveries of OPEB accruals are expected to collect sufficient amounts to provide for the unfunded accumulated postretirement obligation over time. The funds being collected for OPEB accruals in rates, in excess of OPEB benefits actually paid during the year, are contributed to external benefit trusts under the Company's current funding policy. N. EARLY RETIREMENT AND VOLUNTARY SEPARATION PROGRAMS: During the first quarter of 1994, the Company offered an early retirement program to employees aged 50 or older and offered a voluntary separation program to all regular full-time employees. The offers under the program expired September 1,\n1994. Approximately 1,400 employees accepted offers under these programs. The costs associated with these programs were $90.1 million. The Company capitalized $25.9 million based upon prior regulatory precedent and expensed $64.2 million. O. COMMITMENTS AND CONTINGENCIES: The Company is 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. RATE MATTERS For information on the principal rate proceedings in which the Company was involved in 1994, see RATES under Item 1. BUSINESS. For information on the effect of rate changes see Results of Operations under Item 7. MANAGEMENT's DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. RETROSPECTIVE PREMIUM ASSESSMENTS Under several of the Company's nuclear insurance policies, the Company is subject to retrospective premium assessments in any policy year in which losses exceed the funds available to these insurance companies. For additional information, see Note C to FINANCIAL STATEMENTS. CONSTRUCTION PROGRAM The Company has made substantial commitments in connection with its construction program and nuclear fuel expenditures. Those expenditures are estimated to total $673.2 million (excluding AFC) for 1995. Additional financing is contemplated in connection with this program. For more information see CAPITAL REQUIREMENTS under MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. PURCHASED POWER CONTRACTS Since 1984, the Company has entered into contracts for the long-term purchases of capacity and energy from other utilities, qualifying facilities and independent power producers. The Company has 75 non-utility purchase contracts with a combined dependable summer capacity of 3,506 Mw. Of these, 65 projects (aggregating 3,244 Mw) were operational as of the end of 1994 with the balance to become operational at various dates before 1997. The table below reflects the Company's minimum commitments as of December 31, 1994, for power purchases from utility and non-utility suppliers that are currently operating or have obtained construction financing.\nIn addition to the minimum purchase commitments in the table above, under some of these contracts the Company may purchase, at its option, additional power as needed. Actual payments for purchased power (including economy, emergency, limited term, short-term and long-term purchases) for the years 1994, 1993 and 1992 were $1,025.0 million, $958.0 million and $766.0 million, respectively.\nFUEL PURCHASE COMMITMENTS The Company's estimated fuel purchase commitments for the next five years for system generation are as follows (millions): 1995 -- $351; 1996 -- $266; 1997 -- $153; 1998 -- $33; and 1999 -- $32. SALE OF POWER For information on the Company's commitment to sell power, see PURCHASES AND SALES OF POWER under SOURCES OF ENERGY USED AND FUEL COSTS, Item 1. BUSINESS. ENVIRONMENTAL MATTERS The Company is subject to rising costs resulting from a steadily increasing number of federal, state and local laws and regulations designed to protect human health and the environment. These laws and regulations affect future planning and existing operations. These laws and regulations can result in increased capital, operating and other costs as a result of remediation, containment and monitoring obligations of the Company. These costs have been historically recovered through the ratemaking process; however, should material costs be incurred and not recovered through rates, the Company's results of operations and financial condition could be adversely impacted. For additional information on environmental matters, see FUTURE ISSUES under Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. SITE REMEDIATION The EPA has identified the Company and several other entities as Potentially Responsible Parties (PRPs) at two Superfund sites located in Kentucky and Pennsylvania. The estimated future remediation costs for the sites are in the range of $46.5 million to $134.6 million. The Company's proportionate share of the cost is expected to be in the range of $0.5 million to $6.7 million, based upon allocation formulas and the volume of waste shipped to the sites. As of December 31, 1994, the Company had provided for $1.4 million to meet its obligations at these two sites. Based on a financial assessment of the PRPs involved at these sites, the Company has determined that it is probable that the PRPs will fully pay the costs apportioned to them. The Company and Dominion Resources along with Consolidated Natural Gas have remedial action responsibilities remaining at two coal tar sites. The Company provided a $2 million reserve to meet its estimated liability based on site studies and investigations performed at these sites. The Company generally seeks to recover its costs associated with environmental remediation from third party insurers. At December 31, 1994 any pending or possible claims were not recognized as an asset or offset against recorded obligations of the Company. WEST VIRGINIA AIR ACT For information see REGULATION under Item 1. BUSINESS. LEGAL PROCEEDINGS For information on legal proceedings see Item 3. LEGAL PROCEEDINGS. P. FAIR VALUE OF FINANCIAL INSTRUMENTS: The Company used available market information and appropriate valuation methodologies to estimate the fair value of each class of financial instrument for which it is practicable to estimate fair value. These estimates are not necessarily indicative of the amounts the Company could realize in a market exchange. In addition, the use of different market assumptions may have a material effect on the estimated fair value amounts.\nCash and cash equivalents, pollution control project funds and short-term debt: The carrying amount of these items approximates fair value because of their short maturity. Nuclear decommissioning trust funds: The fair value is based on available market information and generally is the average of bid and asked price. First and refunding mortgage bonds and pollution control bonds: Fair value is based on market quotations. Medium-term notes: These notes were valued by discounting the remaining cash flows at a rate estimated for each issue. A yield curve rate was estimated to relate Treasury Bond rates for specific issues to the corresponding maturities. Money market municipal pollution control notes: These notes have variable interest rates which are set so that fair value approximates carrying value. Preferred stock subject to mandatory redemption: The fair value is based on market quotations or is estimated by discounting the dividend and principal payments for a representative issue of each series over the average remaining life of the series. Q. QUARTERLY FINANCIAL DATA (UNAUDITED): The following amounts reflect all adjustments, consisting of only normal recurring accruals (except as discussed below), necessary in the opinion of the management for a fair statement of the results for the interim periods.\nResults for interim periods may fluctuate as a result of weather conditions, rate relief and other factors. During the first quarter of 1994, the Company offered an early retirement program to employees aged 50 or older and offered a voluntary separation program to all regular full-time employees. The offers under the programs expired September 1, 1994. Approximately 1,400 employees accepted offers under these programs. The costs associated with these programs were $90.1 million. The Company capitalized $25.9 million based upon prior regulatory precedent and expensed $2.8 million, $10.4 million and $51 million during the second, third and fourth quarters, respectively. The impact of the write-off was to reduce Balance Available for Common Stock by $1.8 million, $6.7 million and $33.1 million for the second, third and fourth quarters, respectively.\nITEM 9.","section_9":"ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE NONE PART III ITEM 10.","section_9A":"","section_9B":"","section_10":"ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT (a) Information concerning directors of Virginia Electric and Power Company is as follows:\nEach Director holds office until the next Annual Meeting of Shareholders or until his successor is duly elected.\n(b) Information concerning the executive officers of Virginia Electric and Power Company is as follows:\nThere is no family relationship between any of the persons named in response to Item 10.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE The Summary Table below includes compensation paid by the Company for services rendered in 1994, 1993 and 1992 for the Chief Executive Officer and the four other most highly compensated executive officers (as of December 31, 1994) as determined by total salary and incentive payments for 1994. SUMMARY COMPENSATION TABLE\n(1) The Company does not maintain \"bonus\" plans which are used by some companies to supplement salaries based on the success of the company without regard to individual performance. However, the Company has in place various incentive plans that compensate officers and employees for achieving pre-determined specified performance goals. (2) Includes 1,118 shares of Restricted Stock and $51,540 in cash awarded on February 18, 1994 at the end of a three-year performance period. Dividends are paid on Restricted Stock. Restrictions on the shares of stock will lapse six months from the date of grant. As of December 31, 1993 no shares of Restricted Stock were held. (3) Company match on savings plan contribution ($7,075) and insurance premium to Directors Charitable Contribution Program ($10,058). (4) Includes 788 shares of Restricted Stock and $20,254 in cash awarded on February 19, 1993 at the end of a three-year performance period. Dividends are paid on Restricted Stock. Restrictions on the shares of stock lapsed six months from the date of grant. (5) Company match on savings plan contribution ($6,866) and insurance premium for Directors Charitable Contribution Program ($10,058). (6) Company match on savings plan contribution. (7) Retired December 31, 1994. (8) Company match on savings plan contribution ($4,500) and insurance premium to Directors Charitable Contribution Program ($10,058). (9) Company match on savings plan contribution ($4,500) retirement payment as provided by Company's Early Retirement and Voluntary Separation Program ($112,000) and payment at retirement for accrued vacation ($44,860).\nLONG-TERM INCENTIVE COMPENSATION Long-term incentive awards made during 1994 are shown in the following table. LONG-TERM INCENTIVE PLANS -- AWARDS IN THE LAST FISCAL YEAR 1994-1996 PERFORMANCE ACHIEVEMENT PLAN\n(1) Performance shares representing Dominion Resources Common Stock to be awarded at the end of Performance period. (2) Except for James T. Rhodes, payout of awards are tied to achieving levels of Virginia Power's return on equity (ROE) (50%) and meeting a cost per kilowatt-hour goal (50%). The threshold award will be earned if 81% of the ROE goal or 75% of the costs per kilowatt-hour goal is achieved. The target awards will be earned if the goals are fully achieved. The maximum award will be earned at 110% or more of the ROE goal and 112% of the cost goal. Targets and goals for James T. Rhodes were approved by the Dominion Resources Organization and Compensation Committee under the Dominion Resources Long-Term Incentive Plan. The award for James T. Rhodes will be paid out in shares of restricted stock based on the achievement of three specified goals over a three-year performance period (1994-1996), weighted as follows: a total return to Dominion Resources Shareholders superior to that of the S&P Utility Index (50%), utility return on equity equal to the average ROE achieved by a group of comparable utilities (25%), and restraint of utility costs to a growth rate less than that of the Consumer Price Index (25%). The target number of shares will be earned if all goals are fully achieved. The threshold amount will be earned if at least 71% of the total return goal, 81% of the ROE goal, and 75% of the cost control goal are achieved. The maximum amount will be earned if at least 114% of the total return goal, 110% of the ROE goal, and 112% of the cost control goal are achieved. RETIREMENT PLANS The table below sets forth the estimated annual straight life benefit that would be paid following retirement under the Dominion Resources, Inc. Retirement Plan's (the Retirement Plan) benefit formula.\nBenefits under the Retirement Plan are based on (i) average base compensation over the consecutive 60-month period in which pay is highest, (ii) years of credited service, (iii) age at retirement, and (iv) the offset of Social Security Benefits.\nCertain officers have entered into retirement agreements that give additional credited years of service for retirement and retirement life insurance purposes, contingent upon the officer reaching a specified age and remaining in the employ of the Company. For purposes of the above table, based on 1994 compensation, credited years of service (including any additional years earned in connection with the retirement agreements) for each of the individuals named in the cash compensation table would be as follows: James T. Rhodes: 23; John A. Ahladas: 29; Robert F. Hill: 30; Larry W. Ellis: 30 and Bill D. Johnson: 30. The Internal Revenue Code limits the annual retirement benefit that may be paid from a qualified retirement plan and the amount of compensation that may be recognized by the Retirement Plan. To the extent that benefits determined under the Retirement Plan's benefit formula exceed the limitations imposed by the Internal Revenue Code, they will be paid under the Dominion Resources, Inc. Benefit Restoration Plan. The Company also provides an Executive Supplemental Retirement Plan (the Supplemental Plan) to its elected officers designated to participate by the Board of Directors. The Supplemental Plan provides an annual retirement benefit equal to 25 percent of a participant's final compensation (base pay plus annual incentive plan payments). The normal form of benefit is payable in equal monthly installments for 120 months to a participant with 60 months of service, who (i) retires at or after age 55 from the employ of the Company, (ii) has become permanently disabled, or (iii) dies. If a participant dies while employed, the normal form of benefit will be paid to a designated beneficiary. If a participant dies while retired, but before receiving all benefit payments, the remaining installments will be paid to a designated beneficiary. In order to be entitled to benefits under the Supplemental Plan, an employee must be employed as an elected officer of the Company until death, disability or retirement. Based on 1994 compensation, the estimated annual retirement benefit for each of the executive officers under the Supplemental Plan would be as follows: James T. Rhodes: $160,290; John A. Ahladas: $72,500; Robert F. Hill: $79,025; Larry W. Ellis: $69,650; and Bill D. Johnson: $77,650. EMPLOYMENT AGREEMENTS The Company has entered into employment agreements (the Agreements) with its key management executives, including James T. Rhodes, John A. Ahladas, Robert F. Hill, Larry W. Ellis and Bill D. Johnson. Each Agreement has a three-year term and thereafter is automatically extended on its anniversary date for an additional year unless notified that the Agreement will not be extended by the Company. If, following a change in control (as defined in the Agreements) of Dominion Resources or the Company, an executive's employment is terminated by the Company without cause, or voluntarily by the executive within sixty days after a material reduction in the executive's compensation, benefits or responsibilities, the Company will be obligated to pay to the executive continued compensation equaling the average base salary and cash incentive bonuses for the thirty-six full month period of employment preceding the change in control or employment termination. In addition, the terminated executive will continue to be entitled to any benefits due under any stock or benefit plans. The Agreements do not alter the compensation and benefits available to an executive whose employment with the Company continues for the full term of the executive's Agreement. The amount of benefits provided under each executive's Agreement will be reduced by any compensation earned by the executive from comparable employment by another employer during the thirty-six months following termination of employment with the Company. An executive shall not be entitled to the above benefits in the event termination is for cause. James T. Rhodes has an employment agreement with Virginia Power, for a three-year period ending April 21, 1997. During the term of the agreement, if James T. Rhodes' employment as an officer of Virginia Power is terminated for any reason other than cause, James T. Rhodes will receive the amount that he would have otherwise received in base salary and incentive compensation. He will also receive a benefit equal to his then annual base salary or, at his election, the retirement and other benefits that he would have received as a participant in Virginia Power's 1994 early retirement program. Virginia Power's 1994 early retirement program provided five additional years of service and age credit for purposes of retirement benefits, a severance benefit equal to six months' salary, and continuation of certain benefits for a period of time. If James T. Rhodes remains in the employ of Virginia Power through April 21, 1997, he will receive a benefit when he later retires or otherwise terminates employment equal to his then annual base salary or, at his election, the retirement and other benefits that he would have received as a participant in Virginia Power's 1994 early retirement program. The payments under this agreement are provided in addition to any payments under James T. Rhodes' employment continuity agreement. Other officers (including Messrs. Ahladas, Hill, Ellis and Johnson) have similar agreements for a period ending June 21, 1997. In addition to the foregoing agreement, the Settlement Agreement dated as of August 15, 1994, among Dominion Resources, Virginia Power and the members of their Boards of Directors, provides that Virginia Power will make available to James T. Rhodes Virginia Power's 1994 Early Retirement Program for the three-year period beginning on August 24, 1994. Messrs.\nHill and Johnson had available to them agreements which provided for the Early Retirement Program if they continued employment to December 31, 1994. COMPENSATION OF DIRECTORS The non-employee members of the Board receive an annual retainer of $19,000 and a fee of $900 for each Board or committee meeting attended. Committee chairmen receive an additional annual retainer of $3,000. These Directors may elect to defer their annual retainer and\/or their meeting fees under the Deferred Compensation Plan until they retire from the Board or otherwise direct. The deferred fees are credited, for bookkeeping purposes, with earnings and losses as if they were invested in either an interest bearing account or Dominion Resources Common Stock, depending on the Director's election. In addition, the Company makes payments to non-employee Directors or their designated beneficiaries upon those Directors' retirement, death or disability. Payments to a retired Director, including one who becomes disabled after retirement, are made for a period of four years, or for a period of years equal to the Director's service on the Board of the Company or one of its subsidiaries, whichever is longer. If a non-employee Director becomes disabled prior to retirement, these payments are made for four years. Each year, these payments equal the annual retainer in effect at the time the payments begin. Upon the death of a non-employee Director, the unpaid portion of these payments, up to a maximum of four times the annual amount due, is paid in a lump sum to the Director's designated beneficiary. DIRECTORS CHARITABLE CONTRIBUTION PROGRAM Dominion Resources administers a Directors' Charitable Contribution Program (the Program) for all its subsidiaries, including the Company, as part of its overall program of charitable giving. Beginning at the death of a Director a donation in an aggregate amount of $50,000 per year for 10 years will be made to one or more qualifying charitable organizations recommended by the individual Director. Life insurance policies have been purchased on the lives of the Directors in connection with the Program. These policies are owned by Dominion Resources, which is also the beneficiary. The Directors derive no financial or tax benefits from the Program. ITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The table below sets forth as of January 31, 1995, except as noted, the number of shares of Common Stock of Dominion Resources owned by Directors and four other more highly compensated executive officers of Virginia Electric and Power Company.\n(a) Represents shares the Directors have accumulated under the Deferred Compensation Plan. (b) Members of Mr. Roos' family are beneficiaries of trusts that own 3,818 shares of Common Stock for which he disclaims beneficial ownership. All Directors and executive officers as a group (34 persons) beneficially own, in the aggregate, 171,218 shares of Common Stock of Dominion Resources which includes 3,585 shares represented by options awarded and exercisable under Dominion Resources' Long-Term Incentive Plan. Beneficial ownership of 3,818 shares of the total are disclaimed. No shares of the Company's Preferred Stock are owned by the Directors or executive officers as a group.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS In October 1994, in connection with the Settlement Agreement that is summarized in the Company's Current Report on Form 8-K of August 17, 1994, Dominion Resources and Virginia Power paid $77,646 and $76,530, respectively, to a law firm that represented the following persons in connection with the corporate governance dispute that led to the execution of the Settlement Agreement: William W. Berry, James F. Betts, Bruce C. Gottwald, T. Justin Moore, Jr. and James T. Rhodes. Messrs. Berry and Betts and Dr. Rhodes were directors of Virginia Power at the time the legal expenses were incurred, and all of these persons were directors of Dominion Resources at that time. Dr. Rhodes is also President and Chief Executive Officer of Virginia Power.\nPART IV ITEM 14.","section_14":"ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) The following documents are filed as part of this Form 10-K: 1. FINANCIAL STATEMENTS See Index on page 19. 2. EXHIBITS\n*Indicates management contract or compensatory plan or arrangement (b) Reports of Form 8-K Virginia Power filed a report on Form 8-K, dated December 5, 1994, reporting the release by the Staff of the Virginia State Corporation Commission (the Staff) of a report filed December 1, 1994 entitled \"Staff Investigation of Corporate Relationships, Affiliate Arrangements, and Financial and Diversification Issues of Dominion Resources, Inc. and Virginia Power.\" Virginia Power filed a report on Form 8-K dated February 21, 1995, reporting the entry of a Consent Order by the Virginia State Corporation Commission (the Commission) on the joint motion of Dominion Resources, Virginia Power and the Staff and the withdrawal by Delegate Clinton Miller of certain legislation introduced by Delegate Miller in the 1995 Virginia General Assembly at the request of the Commission.\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. VIRGINIA ELECTRIC AND POWER COMPANY Date: March 8, 1995 By JOHN B. ADAMS, JR. (JOHN B. ADAMS, JR., CHAIRMAN OF THE BOARD OF DIRECTORS) 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 March 8, 1995.","section_15":""}
{"filename":"20388_1994.txt","cik":"20388","year":"1994","section_1":"Item 1. Business\nGENERAL\nThe CIT Group Holdings, Inc. (the \"Corporation\"), a Delaware corporation, is a successor to a company founded in St. Louis, Missouri on February 11, 1908. It has its principal executive offices at 1211 Avenue of the Americas, New York, New York 10036, and its telephone number is (212) 536-1950. The Corporation, operating directly or through its subsidiaries primarily in the United States, engages in financial services activities through a nationwide distribution network. The Corporation provides financing primarily on a secured basis to commercial borrowers, ranging from middle-market to larger companies, and to a lesser extent to consumers. While these secured lending activities reduce the risk of losses from extending credit, the Corporation's results of operations can also be affected by other factors, including general economic conditions, competitive conditions, the level and volatility of interest rates, concentrations of credit risk, and government regulation and supervision. The Corporation does not finance the development or construction of commercial real estate. The Corporation has eight strategic business units, seven of which offer corporate financing, dealer and manufacturer financing, and factoring products and services to clients, and an eighth which offers consumer first and second mortgage financing and home equity lines of credit. The Corporation had 2,689 employees at December 31, 1994, up from 2,424 employees at December 31, 1993.\nThe Dai-Ichi Kangyo Bank, Limited (\"DKB\") owns sixty percent (60%) of the issued and outstanding shares of common stock of the Corporation, which it purchased from Manufacturers Hanover Corporation (\"MHC\") at year-end 1989. The remaining forty percent (40%) common stock interest in the Corporation is owned by Chemical Banking Corporation (\"CBC\") through a subsidiary MHC Holdings (Delaware) Inc. (\"MHC Holdings\"), which CBC acquired as part of the merger between MHC and CBC on December 31, 1991.\nIn accordance with a stockholders agreement among DKB, CBC, as successor to MHC, and the Corporation (the \"Stockholders Agreement\"), the Corporation amended its Certificate of Incorporation and its By-Laws in conformity therewith. Pursuant to the Stockholders Agreement, immediately after MHC sold the sixty percent (60%) interest in the Corporation to DKB, the stockholders elected a new Board of Directors comprised of the President and Chief Executive Officer and the Vice Chairman of the Corporation, six nominees designated by DKB, and two nominees designated by MHC. The Stockholders Agreement also contains provisions for the management of the Corporation, majority voting by DKB on the Corporation's Executive Committee, consent of MHC Holdings with respect to major corporate and business changes, and restrictions with respect to the transfer of the stock of the Corporation to third parties.\nBUSINESS AND SERVICES\nCorporate Finance Group\nThe Corporation's Corporate Finance Group is comprised of Business Credit, Capital Equipment Financing and Credit Finance.\nThe CIT Group\/Business Credit offers revolving and term loans secured by accounts receivable, inventories and fixed assets to medium and larger-sized companies. Such loans are used by clients primarily for acquisitions and refinancings. It also offers specialty financing for companies in the paper, printing and chemical industries and debtor-in-possession and workout financing for turnaround situations. The CIT Group\/Business Credit sells participation interests in such loans to other lenders and will occasionally purchase participation interests in such loans originated by other lenders. Business is developed through direct calling efforts and through other sources originated by new business development officers. The CIT Group\/Business Credit is headquartered in New York City, with sales and customer service offices in New York, Chicago, Dallas, Los Angeles, Atlanta and Charlotte.\nThe CIT Group\/Capital Equipment Financing specializes in customized secured financing and leasing, including single investor leases, the debt and equity portions of leveraged leases, and operating leases for major capital equipment such as aircraft, rail cars, maritime shipping, and containers and chassis, for its own account and for syndications. Such business is developed directly with large companies and through third parties. The CIT Group\/Capital Equipment Financing also provides secured financing and leasing products to middle-market and larger companies seeking medium and longer term financings. Such transactions are developed through direct calling efforts and financial intermediaries. Financing products include direct secured loans and leases, sale and leaseback arrangements, operating leases, and project financings. Two business groups within The CIT Group\/Capital Equipment Financing augment its marketing efforts and provide services relating to its areas of expertise. The first group, The CIT Group\/Capital Investments, acts as an agent, broker, and advisor in financing and leasing transactions. The CIT Group\/Capital Investments is a registered broker-dealer and a member of the National Association of Securities Dealers, Inc. The second group, The CIT Group\/Asset Management, provides asset management services to financial institutions and certain non-financial institutions for equipment financing transactions and portfolios. The CIT Group\/Capital Equipment Financing is headquartered in New York City, with sales offices in twelve cities, including New York, Chicago and Los Angeles.\nThe CIT Group\/Credit Finance offers revolving and term loans to small and medium-sized companies secured by accounts receivable, inventories, and fixed assets. Such loans are used by clients for working capital and in refinancings, acquisitions, and leveraged buyouts. The CIT Group\/Credit Finance also offers financing for reorganizations, restructurings, and Chapter 11 situations. Business is developed through direct calling efforts and through other sources developed by new business development officers. The CIT Group\/Credit Finance is headquartered in New York City, with sales and customer service offices in New York, Chicago and Los Angeles and loan production in seven other cities.\nDealer and Manufacturer Financing Group\nThe Corporation's Dealer and Manufacturer Financing Group is comprised of Industrial Financing and Sales Financing.\nThe CIT Group\/Industrial Financing offers secured equipment financing and leasing products, including direct secured loans, leases, secured lines of credit, sale and leaseback arrangements, vendor financing for manufacturers, wholesale and retail financing for dealers\/distributors, acquisition of chattel paper and other installment receivables, and acquisition of portfolios originated by others. It has a nationwide network of local offices and business aircraft, intermediary and national accounts financing units. The CIT Group\/Industrial Financing is headquartered in Livingston, New Jersey, with sales offices in fourteen cities, including Berwyn, Pennsylvania, Tempe, Arizona and Atlanta, Georgia, which also serve as regional and customer service offices.\nThe CIT Group\/Sales Financing, working through dealers and manufacturers, provides retail secured financing on a nationwide basis for the purchase of recreational vehicles, recreational boats and manufactured housing. The CIT Group\/Sales Financing also purchases portfolios of these assets from banks, savings and loans, investment banks and others and provides servicing for portfolios owned by other financial institutions and securitization trusts. The CIT Group\/Sales Financing is headquartered in Livingston, New Jersey with an asset service center in Oklahoma City, Oklahoma, and covers the United States from five regional business centers located in Atlanta, Boston, Kansas City, Sacramento and Seattle.\nConsumer Finance\nIn December 1992, The CIT Group\/Consumer Finance, a newly formed business unit, began offering loans secured primarily by first or second mortgages on residential real estate. The CIT Group\/Consumer Finance generates business through brokers and direct marketing efforts. It also acquires \"home equity\" portfolios originated by others. In early 1994, The CIT Group\/Consumer Finance began offering home equity lines of credit to consumers. This business unit is headquartered in Livingston, New Jersey with 33 sales offices serving 24 states, two of which purchase mortgage loans from third parties. Administrative support is provided by the Sales Financing asset service center located in Oklahoma City, Oklahoma.\nFactoring\nThe CIT Group\/Commercial Services offers a full range of factoring services providing for the purchase of accounts receivable, including credit protection, bookkeeping, and collection activities. Financing is also provided in the form of revolving and term loans, and letter of credit support. The CIT Group\/Commercial Services is headquartered in New York City, with full service offices in New York, Los Angeles, Dallas and Charlotte and sales offices in Miami and Hong Kong. Bookkeeping and collection functions are located in a service center in Danville, Virginia.\nOn February 28, 1994, the Corporation acquired, for cash, Barclays Commercial Corporation (\"BCC\"), a company of The Barclays Group. BCC had total assets of approximately $700.0 million at December 31, 1993 and total factoring volume of approximately $5.00 billion for the year then ended. The business and acquired assets of BCC were transferred to The CIT Group\/Commercial Services, Inc., a wholly-owned subsidiary of the Corporation. BCC is engaged in the same lines of business as The CIT Group\/Commercial Services, with BCC adding a significant geographical presence in the Southeastern United States.\nEquity Investments\nThe CIT Group\/Equity Investments and its subsidiary The CIT Group\/Venture Capital originate and participate in purchasing private equity and equity-related securities, and arrange transaction financing and merger and acquisition transactions. These units also invest in emerging growth opportunities in selected industries, including the life sciences, information technology, communications and consumer products. Business is developed through direct solicitation, or through referrals from investment banking firms, financial intermediaries, or the Corporation's other business units. The CIT Group\/Venture Capital is a federal licensee under the Small Business Investment Act of 1958. The CIT Group\/Equity Investments and The CIT Group\/Venture Capital are headquartered in Livingston, New Jersey.\nMulti-National Marketing\nSupplementing the Corporation's marketing efforts, the Corporation's Multi-National Marketing Group promotes the services of the Corporation's various business units to the U.S. subsidiaries of foreign corporations in need of asset-based financing. Business is developed through referrals from DKB and through direct calling efforts. The Multi-National Marketing Group is located in New York City.\nINDUSTRY CONCENTRATION\nWith the exception of the airline industry, which accounts for $1.90 billion, or 12.1%, of total financing and leasing assets (before the reserve for credit losses) as of December 31, 1994, the portfolio of the Corporation was diversified with no other industry group accounting for more than 8.5% of the Corporation's financing and leasing assets. See the \"Industry Composition\" and \"Commercial Airlines\" sections of \"Financing and Leasing Assets Concentrations\" in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nCOMPETITION\nThe business in which the Corporation engages is highly competitive, with business developed primarily on the basis of customizing transaction structure, client service and relationships, and payment terms. The Corporation is subject to competition from many financial institutions, including finance companies, banks, leasing companies and investment banks. The Corporation's Commercial Services unit is the largest factoring operation in the United States.\nThe interest rates charged by the Corporation for the various classes of financing and leasing assets vary depending upon the credit quality of the borrower, the amount and maturity of the loan, the costs of servicing, the income tax consequences of the transaction, the cost of borrowing to the Corporation, and, to a lesser degree, state usury laws and other governmental regulations, when applicable. The Corporation's finance receivables have both variable rates and fixed rates of interest. Variable rate loans reprice in accordance with various agreed upon indices, usually a published reference or prime interest rate.\nREGULATION\nBoth DKB and CBC are bank holding companies within the meaning of the Bank Holding Company Act of 1956 (the \"Act\"), and each is registered as such with the Federal Reserve Board. As a result, the Corporation is subject to certain provisions of the Act. In general, the Act limits the activities in which a bank\nholding company and its subsidiaries may engage to those of banking or managing or controlling banks or performing services for their subsidiaries and to continuing activities which the Federal Reserve Board has determined to be \"so closely related to banking or managing or controlling banks as to be a proper incident thereto.\" The Corporation's current principal business activities constitute permissible activities for a subsidiary of a bank holding company.\nThe operations of the Corporation and its subsidiaries are subject, in certain instances, to supervision and regulation by governmental authorities and may be subject to various laws and judicial and administrative decisions imposing various requirements and restrictions, including among other things, regulating credit granting activities, establishing maximum interest rates and finance charges, regulating customers' insurance coverages, requiring disclosures to customers, governing secured transactions, and setting collection, repossession, and claims handling procedures and other trade practices. In most states the consumer sales finance and loan business and the consumer second mortgage and home equity line of credit businesses are subject to licensing or regulation. In some states the industrial finance business is subject to similar licensing or regulation. The consumer second mortgage, home equity line of credit, sales finance, and loan businesses, including those conducted by the Corporation, are also subject to a number of Federal statutes, including the Federal Consumer Credit Protection Act, which requires, among other things, disclosure of the finance charge in terms of an annual percentage rate, as well as the total dollar cost.\nIn the judgment of management, existing statutes and regulations have not had a materially adverse effect on the business conducted by the Corporation and its subsidiaries. However, it is not possible to forecast the nature of future legislation, regulations, judicial decisions, orders, or interpretations, nor their impact upon the future business, earnings, or otherwise, of the Corporation and its subsidiaries.\nItem 2.","section_1A":"","section_1B":"","section_2":"Item 2. Properties.\nThe operations of the Corporation and its subsidiaries are generally conducted in leased office space located in numerous cities and towns throughout the United States. Such leased office space is suitable and adequate for the needs of the Corporation. The Corporation utilizes, or plans to utilize in the foreseeable future, substantially all of its leased office space. For a summary of the Corporation's past rental expense and future minimum rentals, see Item 8. Financial Statements and Supplementary Data, \"Note 12--Lease Commitments.\"\nItem 3.","section_3":"Item 3. Legal Proceedings.\nVarious claims and actions against the Corporation and its subsidiaries arise from time to time in the normal course of business. A number of these actions, some of which purport to be class actions, are now pending. While no prediction can be made as to the ultimate outcome of any particular action, management believes that meritorious defenses are generally available and the aggregate liability, if any, likely to result therefrom will not materially affect the consolidated financial condition of the Corporation.\nItem 4.","section_4":"Item 4. Submission of Matters to a Vote of Security Holders.\nOn April 14, 1994, DKB and MHC Holdings, by unanimous written consent, elected the following ten persons to the Board of Directors, to serve for a period of one year or until the next annual meeting of shareholders:\nMessrs. Hisao Kobayashi (Chairman) Albert R. Gamper, Jr. Michio Murata Joseph A. Pollicino Paul N. Roth Tomoaki Tanaka Peter J. Tobin Toshiji Tokiwa Keiji Torii William H. Turner\nSubsequently, on August 15, 1994, Mr. Tomoaki Tanaka resigned from the Board and the stockholders, by unanimous written consent, elected Mr. Hideo Kitahara for the balance of Mr. Tanaka's term as Director.\nPART II\nItem 5.","section_5":"Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.\nThe outstanding common stock of the Corporation is owned 60% by DKB and 40% by MHC Holdings. There is no public trading market for the Corporation's common stock.\nDKB, MHC Holdings and the Corporation operate under a policy requiring the payment of dividends by the Corporation equal to and not exceeding 50% of net operating earnings on a quarterly basis. Such dividends are paid to DKB and MHC Holdings based upon their respective stock ownership in the Corporation.\nThe Corporation intends to continue to operate under the fifty-percent dividend policy set forth in the preceding paragraph. Below is a listing of the dividends paid during the past two years:\nDividends Paid 1994 1993 -------------- ------ ------ Amounts in Thousands Regular Dividends First Quarter .................. $ 24,596 $21,931 Second Quarter ................. 24,880 23,221 Third Quarter .................. 26,440 23,722 Fourth Quarter ................. 24,420 22,290 -------- ------- Total ...................... $100,336 $91,164 ======== =======\nStockholders' equity at December 31, 1994 was $1.79 billion. Under the most restrictive provisions of agreements relating to outstanding debt, the Corporation may not, without the consent of the holders of such debt, permit stockholders' equity to be less than $300.0 million.\nItem 6.","section_6":"Item 6. Selected Financial Data.\nThe following table sets forth selected consolidated financial information regarding the Corporation's results of operations, which has been extracted from the Corporation's consolidated financial statements for the five years ended December 31, 1994. Prior period amounts, principally fees and other income and depreciation on operating lease equipment have been reclassified to conform to the current presentation. This information should be read in conjunction with Item 7.","section_7":"Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\n1994 vs. 1993\nHighlights\nNet income for the year ended December 31, 1994 was a record $201.1 million, an increase of $18.8 million (10.3%) from the $182.3 million earned in 1993. The fourth consecutive year of record earnings reflects improved finance income, increased factoring commissions and a lower provision for credit losses, offset, in part, by increased operating expenses, including those of Barclays Commercial Corporation (BCC) which was acquired in February 1994, and expanded activity in Consumer Finance.\nTotal financing and leasing assets, which include finance receivables and operating lease equipment, increased to a record $15.66 billion at December 31, 1994, a $2.29 billion (17.1%) improvement, compared to $13.38 billion at December 31, 1993. All operating units experienced year-over-year growth. Particularly noteworthy was Commercial Services which added $914.3 million of finance receivables, including the BCC acquisition involving over $700 million of factored receivables.\nNet Finance Income\nA comparison of 1994 and 1993 finance income and interest expense is set forth below. The 1993 finance income amount has been restated to exclude fees and other income and depreciation on operating lease equipment in order to conform to the 1994 presentation.\nThe increase of $152.0 million in finance income reflects earnings on the $1.37 billion growth in AEA and the effect of rising market interest rates, which enabled finance income, as a percentage of AEA, to improve to 9.19% in 1994 from 8.93% in 1993. These factors also impacted interest expense, which totaled $613.9 million in 1994, an increase of $105.9 million (20.9%), compared with $508.0 million in 1993. Net finance income totaled $649.9 million, an increase of $46.1 million (7.6%) from 1993. However, the increased interest expense and more aggressive competition in transaction pricing and structuring, particularly from banks, resulted in a decline in net finance income as a percentage of AEA to 4.77% compared with 4.93% in 1993.\nFor an analysis of interest rates paid on the Corporation's debt refer to \"Interest Rate Risk Management\" in the Asset\/Liability Management section.\nFees and Other Income\nFees and other income totaled $174.4 million in 1994, an increase of $40.6 million (30.3%), compared with $133.8 million in 1993. The improvement is principally attributable to higher factoring commissions, reflecting additional factored receivable volume from the acquisition of BCC and record new client signings in 1994.\nSalaries and General Operating Expenses\nSalaries and general operating expenses totaled $337.9 million in 1994, a $55.7 million (19.8%) increase, compared to $282.2 million in 1993. This increase includes a $33.7 million (22.2%) rise in salaries and employee benefits, which totaled $185.9 million in 1994, compared with $152.1 million in 1993, and an additional $22.1 million (16.9%) of general operating expenses,\nwhich totaled $152.1 million in 1994, compared with $130.0 million in 1993. Employee headcount increased to 2,689 at December 31, 1994 from 2,424 in 1993.\nThese increases are largely attributable to the BCC acquisition and expanded Consumer Finance activity. Since the BCC acquisition, Commercial Services has had an integration plan in place designed to maintain business momentum, provide uninterrupted levels of quality services, and generate economies of scale. Significant progress has been made in integrating operating systems, eliminating duplicate functions and consolidating offices and departments. This process is expected to be substantially complete by year-end 1995. Salaries and other employee benefits in 1994 also included the effect of improvements to employee sales and incentive compensation plans.\nThe Corporation manages expenditures using a comprehensive budgetary process. Expenses are monitored closely by operating unit management and are reviewed monthly with senior management of the Corporation. To ensure overall project cost control, a review and approval procedure is in place for all major capital expenditures, such as purchases of computer equipment, including a post-implementation analysis of the realization of projected benefits.\nIncome Taxes\nThe provision for Federal and state and local income taxes totaled $123.9 million in 1994 compared with $128.5 million in 1993. The effective income tax rate was 38.1% compared to 41.3% in 1993. The 1993 amounts reflect additional provisions to the Corporation's current and deferred taxes to record the impact of a 1% increase in the statutory Federal corporate income tax rate provided for in the Revenue Reconciliation Act of 1993.\nProvision and Reserve for Credit Losses\nA continued recovery in certain sectors of the U.S. economy contributed to an improvement of $10.3 million (10.9%) in net credit losses for 1994. As a percentage of average finance receivables, net credit losses fell to 0.61% in 1994 from 0.77% in 1993. Information concerning the provision and reserve for credit losses is summarized in the following table.\nYears ended December 31, ------------------------ 1994 1993 ---------- ---------- Dollar Amounts in Thousands\nNet credit losses .................................... $ 84,152 $ 94,408 Provision for finance receivables increase ........... 12,789 10,466 --------- -------- Total provision for credit losses .................... $ 96,941 $104,874 ========= ======== Net credit losses as a percentage of average finance receivables ................................ 0.61% 0.77% ======== ======== Reserve for credit losses ............................ $192,421 $169,378 ======== ======== Reserve for credit losses as a percentage of: Finance receivables ................................ 1.30% 1.34% ======== ======== Finance receivables past due 60 or more days ....... 108.8% 78.4% ======== ======== Nonaccrual finance receivables ..................... 174.6% 121.0% ======== ========\nThe reserve for credit losses is maintained at an amount considered adequate by management to provide for potential credit losses, based on periodic evaluation of the overall risk characteristics of the finance receivables portfolio. The decrease in the reserve for credit losses as a percentage of finance receivables reflects the growth in home equity lending in Consumer Finance, for which a lower percentage reserve for credit losses is recorded than the overall portfolio, and a reduction in nonaccrual and past due finance receivables.\nIn evaluating the adequacy of the reserve for credit losses, management considers such factors as the nature and characteristics of the obligors, economic conditions and trends, charge-off experience, delinquencies, and value of underlying collateral and guarantees (including recourse to dealers and manufacturers).\nFinancing and Leasing Assets\nFinancing and leasing assets (finance receivables plus operating lease equipment) increased $2.29 billion (17.1%) in 1994 to $15.66 billion as presented in the following table.\nThe following table presents the annual volume of financing and leasing assets funded, including purchases of existing finance receivable portfolios.\n--------------- (a) Represents initial borrowings under new lines of credit (b) Represents factored accounts receivable\nThe changes in the preceding tables are discussed below for each business unit.\n- Capital Equipment Financing--Customized secured equipment financing and leasing for major capital equipment. Finance receivables rose modestly to $4.49 billion, reflecting improved new business funding volume offset, in part, by higher than usual prepayments and finance receivable sales for credit risk management purposes. The growth in operating lease equipment resulted from the purchase of additional equipment for lease, principally railcars and commercial and business aircraft, and the leasing of a commercial aircraft included in assets received in satisfaction of loans at December 31, 1993.\n- Business Credit--Revolving and term loans, including debtor-in-possession and workout financing, to medium and larger-sized companies secured by accounts receivable, inventory and fixed assets. Finance receivables totaled $1.44 billion at December 31, 1994. New business volume and additional borrowings under existing credit arrangements, coupled with a return to more historical customer paydown levels, contributed to the 12.5% growth in finance receivables.\n- Credit Finance--Revolving and term loans, including restructurings, for small and medium-sized companies secured by accounts receivable, inventory and fixed assets. Finance receivables continued to grow, rising 11.5% in 1994 to $719.6 million, largely due to record new business volume with various middle-market manufacturing companies.\n- Commercial Services--Factoring of accounts receivable, including credit protection, bookkeeping and collection activities and revolving and term loans. Finance receivables totaled $1.90 billion at December 31, 1994. The increase of $914.3 million from 1993 reflects the acquisition of BCC, which added over $700 million of factored receivables, and record new client signings in 1994.\n- Industrial Financing--Secured equipment financing and leasing for medium-sized companies, including dealer and manufacturer financing. Finance receivables rose 10.0% in 1994 to $4.27 billion reflecting another year of record new business originations. Operating lease equipment increased 17.7% to $219.2 million principally due to the purchase of tractors, trailers, business aircraft and other equipment for lease.\n- Sales Financing--Retail secured financing of recreational vehicles, recreational boats, and manufactured housing through dealers and manufacturers. The increase in finance receivables is the result of improved volume in manufactured housing, partially offset by finance receivable sales and securitizations of $162 million in 1994 and the reclassification of an additional $69 million of manufactured housing finance receivables to assets held for sale in December 1994. In addition to its own portfolio of $1.4 billion, Sales Financing also provides servicing for portfolios owned by other financial institutions and securitization trusts which totaled $498.1 million at December 31, 1994 ($415.0 million in 1993).\n- Consumer Finance--Loans secured by first or second mortgages on residential real estate, and home equity lines of credit generated through brokers and direct marketing. Finance receivables rose sharply to $570.8 million, reflecting the full year effect and continued development, in 1994, of the marketing offices added late in 1993. This portfolio is expected to approach $1.0 billion by the end of 1995.\nFinancing and Leasing Assets Composition\nFinancing and leasing assets are principally composed of loans and direct financing and leveraged leases with commercial customers located in the United States and operating lease equipment, largely commercial aircraft, placed with lessees both domestically and internationally.\nGeographic Composition\nThe following table presents financing and leasing assets by customer location. Amounts for 1993 have been restated to include operating lease equipment and conform to the 1994 presentation.\nIndustry Composition\nThe following table presents financing and leasing assets by industry. Amounts for 1993 have been restated to include operating lease equipment and conform to the 1994 presentation.\n-------------- (a) Refer to the Commercial Airlines section of \"Financing and Leasing Assets Concentrations\" for a discussion on the Commercial Airlines portfolio.\n(b) The construction portfolio is geographically dispersed throughout the United States and included approximately 6,900 general contractor and equipment dealer obligors at December 31, 1994.\n(c) Transportation included rail, bus, over-the-road trucking, and business aircraft industries and consisted of approximately 700 obligors at December 31, 1994. The portfolio was widely dispersed throughout the United States.\n(d) At December 31, 1994, the shipping industry portfolio was widely dispersed and included approximately 50 obligors financing cruise and freight-carrying ships, intermodal equipment, barges, tugboats, containers and chassis.\nFinancing and Leasing Assets Concentrations\nCommercial Airlines\nCommercial airline finance receivables of $1.42 billion and operating lease equipment of $482.3 million totaled $1.90 billion (12.1% of total financing and leasing assets before the reserve for credit losses) at December 31, 1994 compared with $1.89 billion (14.2%) in 1993. The portfolio is secured by commercial aircraft and related equipment. Management continues to monitor the growth in this portfolio relative to total financing and leasing assets.\nThe following table presents information about the commercial airline industry portfolio.\nAt December 31, ------------------------ 1994 1993 --------- -------- Dollar Amounts in Millions Finance receivables Amount outstanding(a) .......................... $1,417.0 $1,437.3 Number of obligors ............................. 46 43 -------- -------- Operating lease equipment Net carrying value ............................. $ 482.3 $ 457.6 Number of obligors ............................. 21 21 -------- -------- Total ....................................... $1,899.3 $1,894.9 -------- -------- Number of obligors(b) .......................... 62 58 -------- -------- Number of aircraft(c) .......................... 282 276 -------- --------\n-------------- (a) Includes accrued rents on operating leases of $1.1 million and $1.0 million at December 31, 1994 and December 31, 1993, respectively, which are classified as finance receivables in the Consolidated Balance Sheets.\n(b) Certain obligors have both finance receivable and operating lease transactions.\n(c) Regulations established by the Federal Aviation Administration (the \"FAA\") limit the maximum permitted noise an aircraft may make. A Stage III aircraft meets a more restrictive noise level requirement than a Stage II aircraft. The FAA has issued rules which phase out the use of Stage II aircraft in the United States through the year 2000. The International Civil Aviation Organization has issued similar requirements for Europe. At year-end 1994, the portfolio consisted of 224 Stage III aircraft (79%) and 58 Stage II aircraft (21%) versus 214 Stage III aircraft (78%) and 62 Stage II aircraft (22%) at year-end 1993.\nNo obligor included in the Corporation's commercial airline portfolio was subject to bankruptcy proceedings at December 31, 1994. However, as of March 6, 1994, the Corporation has agreed to terms on a restructuring of its outstanding loan and lease transactions with Trans World Airlines, Inc., which has publicly announced that it may seek bankruptcy protection if a major debt reduction plan is not approved. Management does not believe this restructuring will have a significant effect on the Corporation's 1995 consolidated financial position or results of operations.\nForeign Outstandings\nFinancing and leasing assets to foreign obligors, primarily to the commercial airline industry, are all U. S. dollar denominated and totaled $1.12 billion at December 31, 1994, consisting of $920.3 million in finance receivables and $201.5 million in operating lease equipment. The largest exposures at December 31, 1994 were to England, $177.2 million (1.11% of total assets) and Mexico, $140.0 million (.88%). The Mexican exposure is principally operating and direct financing leases of commercial and business aircraft all of which were current at December 31, 1994. The remaining foreign exposure is geographically dispersed with no individual country representing more than .75% of total assets.\nAt December 31, 1993, financing and leasing assets to foreign obligors totaled $1.05 billion, consisting of $846.6 million in finance receivables and $204.5 million in operating lease equipment. Outstandings totaled $167.4 million (1.22% of total assets) to obligors in Mexico and $128.0 million (.93%) to obligors in England. Obligors in no other country had aggregate outstandings exceeding .75% of total assets.\nHighly Leveraged Transactions\nThe Securities and Exchange Commission has suggested that registrants may be required to disclose the nature and extent of their involvement with high yield or highly leveraged transactions and non-investment grade loans. The Corporation uses the following criteria to classifly a buyout financing or recapitalization which equals or exceeds $20 million as a highly leveraged transaction (HLT):\n- The transaction at least doubles the borrower's liabilities and results in a leverage ratio (as defined) higher than 50%, or\n- The transaction results in a leverage ratio higher than 75%, or\n- The transaction is designated as an HLT by a syndication agent.\nA transaction originally reported as an HLT can be removed from this classification (\"delisted\") if the leveraged company has demonstrated the ability to operate successfully as a highly leveraged entity for at least two years after the original financing and meets one of the following criteria:\n- The original financing has been repaid using cash flow from operations, planned asset sales, or a capital infusion, or\n- The debt has been serviced without undue reliance on unplanned asset sales, and certain leverage ratios (related to the original criteria under which the financing qualified as an HLT) have been maintained.\nThe Corporation, primarily through Business Credit, originates and participates in HLTs, which totaled $436.1 million (2.8% of financing and leasing assets before the reserve for credit losses) at December 31, 1994, down from $476.6 million (3.6%) at December 31, 1993. The decline in HLT outstandings during 1994 was primarily due to delisting companies that met the aforementioned delisting criteria, partially offset by new HLT fundings. The Corporation's HLT outstandings are generally secured by collateral, as distinguished from HLTs that rely primarily on cash flow from operations. Unfunded commitments to lend in secured HLT situations were $202.1 million at December 31, 1994, compared with $123.1 million at year-end 1993.\nAt December 31, 1994, the HLT portfolio consisted of 32 obligors in 12 different industry groups, with 36.5% of the outstandings located in the Southeast region of the United States and 33.1% in the West. Four accounts totaling $57.7 million were classified as nonaccrual at December 31, 1994, compared with three accounts totaling $34.7 million at year-end 1993.\nCredit Risk Management\nFinancing and leasing assets are monitored for credit and collateral risk both during the credit granting process and periodically after the advancement of funds. Each business unit is responsible for developing and implementing a formal credit management process in accordance with formal uniform guidelines established by the Executive Credit Committee of the Corporation (ECC). These guidelines set forth risk acceptance criteria for: (1) selected target markets and products; (2) the creditworthiness of borrowers, including credit history, financial condition, adequacy of cash flow and quality of management; and (3) the type and value of underlying collateral and guarantees (including recourse to dealers and manufacturers).\nCompliance with established credit management processes at each business unit is reviewed by an internal credit audit group within the Corporation's internal audit department. Credit audits examine adherence with established credit policies and procedures, and test for inappropriate credit practices, including whether potential problem accounts are being detected on a timely basis. As economic and market conditions change, credit risk management practices are reviewed and modified, if necessary, to minimize the risk of credit loss.\nPeriodically, financing and leasing assets are evaluated based upon credit criteria developed under the Corporation's uniform credit grading system and the use of a comprehensive exposure reporting system that analyzes the financing and leasing assets portfolio by obligor, by industry, geographic location, and collateral type. The status of obligors with higher (riskier) credit grades is individually reviewed with the ECC by each operating unit. Concentrations are monitored and limits are changed by management as conditions warrant to minimize the risk of credit loss.\nPast Due and Nonaccrual Finance Receivables and Assets Received in Satisfaction of Loans\nFinance receivables past due 60 days or more improved to $176.9 million (1.20% of finance receivables before the reserve for credit losses) at December 31, 1994, from $216.1 million (1.71%) at December 31, 1993, reflecting a continued recovery in certain sectors of the economy. Excluding finance receivables in Industrial Financing that have recourse to dealers or manufacturers, the percentage of finance receivables past due 60 or more days was 1.03% at year-end 1994 compared to 1.47% at year-end 1993.\nFinance receivables on nonaccrual status, included in past due finance receivables, declined to $110.2 million (0.75% of finance receivables before the reserve for credit losses) at December 31, 1994, from $139.9 million (1.11%) at December 31, 1993. The decrease from December 31, 1993 includes final settlement with a manufacturer on nonaccrual since 1992.\nThe balance of assets received in satisfaction of loans was relatively unchanged from 1993 at $86.5 million. The December 31, 1994 balance includes two commercial aircraft which are the subject of litigation with the subordinated debt holders wherein the Corporation, as senior debt holder, is foreclosing on the aircraft. An anticipated satisfactory conclusion of the litigation would enable the Corporation to proceed with the foreclosure. These foreclosures were offset by the sale of assets and the placing of a commercial aircraft on operating lease that were included in the 1993 balance.\nThe following table presents the assets received in satisfaction of loans including in-substance foreclosures.\nAt December 31, ------------------- 1994 1993 ------- ------- Amounts in Thousands\nCommercial aircraft .................................... $36,000 $17,235 Retail merchandise, property and accounts receivable(a) ....................................... 32,353 29,214 Property and equipment ................................. 8,592 13,480 Other transportation(b) ................................ 6,172 15,255 Other .................................................. 3,408 11,773 ------- ------- Total ................................................ $86,525 $86,957 ======= ======= -------------- (a) Retail merchandise, property and accounts receivable includes an equity interest in a building supply retailer.\n(b) Other transportation includes buses and recreational vehicles in 1994, and business aircraft, trailers, and recreational vehicles in 1993.\nAsset\/Liability Management\nManagement strives to optimize net finance income while managing interest rate and liquidity risk under formal policies established and monitored by the Capital Committee, which is comprised of members of senior management, including the Chief Executive Officer, the Vice Chairman, the Chief Financial Officer, and senior representatives of DKB and CBC. Four of the members of the Capital Committee are also members of the Corporation's Board of Directors. The Capital Committee establishes and regularly reviews interest sensitivity, funding, liquidity, and asset-pricing guidelines used to determine short-term and long-term funding strategies, including the use of off-balance sheet derivative financial instruments. Derivative (hedge) positions are managed conservatively and in such a way that the exposure to interest rate, credit or foreign exchange risk is in accordance with the overall operating goals established by the Capital Committee. There is an approved, diversified list of creditworthy counterparties, each of whom has specific market value exposure limits. The Executive Credit Committee approves each counterparty and its related market value exposure limit annually or more frequently if any changes are recommended. Market values are calculated periodically for each swap contract, summarized by counterparty risk and reported to the Capital Committee. For additional information regarding the Corporation's derivative portfolio, refer to \"Note 6--Derivative Financial Instruments\" in Item 8.","section_7A":"","section_8":"Item 8. Financial Statements and Supplementary Data.\nINDEPENDENT AUDITORS' REPORT\nThe Board of Directors The CIT Group Holdings, Inc.:\nWe have audited the accompanying consolidated balance sheets of The CIT Group Holdings, Inc. and subsidiaries as of December 31, 1994 and 1993, 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 Dec ember 31, 1994. These consolidated financial statements are the responsibility of the Corporation'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 from material misstatement. An audit includes examining, on a test basis, evide nce 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 b asis for our opinion.\nIn our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The CIT Group Holdings, Inc. and subsidiaries at December 31, 1994 and 1993, and the results of their operations and cash flows for each of the years in the th ree-year period ended December 31, 1994 in conformity with generally accepted accounting principles.\nAs discussed in Note 11 to the consolidated financial statements, the Corporation adopted the provisions of Statement of Financial Accounting Standards No. 106, \"Employers' Accounting for Postretirement Benefits Other Than Pensions,\" in 1993.\nKPMG PEAT MARWICK LLP Short Hills, New Jersey January 17, 1995\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nCONSOLIDATED BALANCE SHEETS\nDecember 31, ------------------------ 1994 1993 ------ ------ Assets (Amounts in Thousands)\nFinancing and leasing assets Capital Equipment Financing .................. $ 4,493,531 $ 4,394,528 Business Credit .............................. 1,442,049 1,282,133 Credit Finance ............................... 719,642 645,642 ------------ ------------ Corporate Finance .......................... 6,655,222 6,322,303\nCommercial Services .......................... 1,896,233 981,935\nIndustrial Financing ......................... 4,269,693 3,880,991 Sales Financing .............................. 1,402,443 1,307,544 ------------ ------------ Dealer and Manufacturer Financing .......... 5,672,136 5,188,535\nConsumer Finance ............................. 570,772 131,321 ------------ ------------ Finance receivables (Note 2) ............... 14,794,363 12,624,094 Reserve for credit losses (Note 3) ........... (192,421) (169,378) ------------ ------------ Net finance receivables .................... 14,601,942 12,454,716\nOperating lease equipment (Note 4) ........... 867,914 751,901 ------------ ------------ Net financing and leasing assets ........... 15,469,856 13,206,617\nCash and cash equivalents .................... 6,558 101,554 Other assets ................................. 487,076 420,310 ------------ ------------ Total assets ............................... $ 15,963,490 $ 13,728,481 ============ ============\nLiabilities and Stockholders' Equity Debt (Notes 5 and 6) Commercial paper ............................. $ 5,660,194 $ 6,516,139 Variable rate notes .......................... 3,812,500 1,686,500 Fixed rate notes ............................. 2,623,150 2,392,500 Subordinated fixed rate notes ................ 300,000 200,000 ------------ ------------ Total debt ................................. 12,395,844 10,795,139\nCredit balances of factoring clients ......... 993,394 521,728 Accrued liabilities and payables ............. 354,714 324,520 Deferred Federal income taxes ................ 426,511 394,859 ------------ ------------ Total liabilities .......................... 14,170,463 12,036,246\nStockholders' equity (Notes 7 and 17) Common stock - authorized, issued and outstanding - 1,000 shares .................. 250,000 250,000 Paid-in capital .............................. 408,320 408,320 Retained earnings ............................ 1,134,707 1,033,915 ------------ ------------ Total stockholders' equity ................. 1,793,027 1,692,235 ------------ ------------ Total liabilities and stockholders' equity . $15,963,490 $13,728,481 ============ ============\nSee accompanying notes to consolidated financial statements.\nSee accompanying notes to consolidated financial statements.\nSee accompanying notes to consolidated financial statements.\nSee accompanying notes to consolidated financial statements.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS\nNote 1--Summary of Significant Accounting Policies\nBasis of Presentation\nThe consolidated financial statements and accompanying notes include the accounts of The CIT Group Holdings, Inc. and its subsidiaries (the \"Corporation\"). All significant intercompany transactions have been eliminated. Prior period amounts, principally fees and other income and depreciation on operating lease equipment, have been reclassified to conform to the current presentation.\nConsolidated Statements of Cash Flows\nCash and cash equivalents includes cash and interest-bearing deposits, which generally represent overnight money market investments of excess cash borrowed in the commercial paper market and maintained for liquidity purposes. Cash inflows and outflows from commercial paper borrowings and most factoring receivables are presented on a net basis in the Statements of Cash Flows as their term is generally less than 90 days.\nFinancing and Leasing Assets\nThe Corporation provides funding for a variety of financing arrangements including term loans, direct financing leases (including leveraged leases for which a major portion of the funding is provided by third-party lenders, including The Dai-Ichi Kangyo Bank, Limited (\"DKB\"), on a nonrecourse basis, with the Corporation providing the balance and acquiring title to the property) and operating leases. The amounts outstanding on loans and direct financing leases are referred to as finance receivables, and when combined with the net book value of operating lease equipment, represent financing and leasing assets.\nIncome Recognition\nFinance income includes interest on loans, the amortization of income on direct financing leases, and rents on operating leases. Related origination and other nonrefundable fees and direct origination costs are deferred and amortized as an adjustment of finance income over the contractual life of the transactions. Income on finance receivables other than leveraged leases is recognized on an accrual basis commencing in the month of origination using methods that generally approximate the interest method. Leveraged lease income is recognized on a basis calculated to achieve a constant after-tax rate of return for periods in which the Corporation has a positive investment, net of related deferred tax liabilities. Rental income on operating leases is recognized on an accrual basis.\nExcept for Sales Financing and Consumer Finance accounts, which are subject to automatic charge-off procedures, the accrual of finance income is suspended and an account is placed on nonaccrual status either when a payment is contractually delinquent for 90 days or more and collateral is insufficient to cover both the outstanding principal and accrued finance income or immediately if, in the opinion of management, full collection of all principal and income is doubtful. Accrued but uncollected income at the date an account is placed on nonaccrual status is reversed and charged against income to the extent the collateral does not satisfy the principal and accrued income outstanding. Such accrued but uncollected income is immaterial. Subsequent income received is applied to the outstanding principal balance until such time as the account is collected, charged-off on or returned to accrual status.\nFees and other income includes factoring commissions, commitment and facility fees, letters of credit and syndication fees, as well as gains and losses realized upon the sale of assets coming off lease, the securitization of finance receivables and the disposition of assets received in satisfaction of loans.\nLease Financing\nDirect financing leases are recorded at the aggregate future minimum lease payments plus estimated residual values less unearned finance income. Operating lease equipment is carried at cost less accumulated depreciation and is depreciated to estimated residual value using the straight-line method over the lease term or projected economic life of the asset. Equipment acquired in satisfaction of loans and subsequently placed on operating lease is recorded at the lower of carrying value or estimated fair value when acquired. Leveraged\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)\nleases are recorded at the aggregate value of future minimum lease payments plus estimated residual value, less amounts due to non-recourse third-party lenders and unearned finance income. In the event of default by the lessee, the third-party lenders have no recourse to the Corporation.\nReserve for Credit Losses on Finance Receivables\nThe reserve for credit losses is established and periodically reviewed for adequacy based on the nature and characteristics of the obligors, economic conditions and trends, charge-off experience, delinquencies, and value of underlying collateral and guarantees (including recourse to dealers and manufacturers). It is management's judgment that the reserve for credit losses is adequate to provide for potential credit losses.\nCharge-off of Finance Receivables\nFinance receivables are reviewed periodically to determine the probability of loss on individual receivables. Charge-offs are taken after considering such factors as the customer's financial condition and the value of underlying collateral and guarantees (including recourse to dealers and manufacturers). Such charge-offs are deducted from the carrying value of the related finance receivables. To the extent that an unrecovered balance remains due, a final charge-off is taken at the time collection efforts are no longer deemed useful. Automatic charge-offs are taken for Sales Financing and Consumer Finance receivables when no contractual payments are received for 120 days, or at 180 days when partial payments have been received.\nOther Assets\nAssets received in satisfaction of loans (including in-substance forclosures) are carried at the lower of carrying value or estimated fair value less selling costs, with write-downs at the time of receipt or in-substance foreclosure charged to the reserve for credit losses. Subsequent write-downs of these assets, which may be required due to a decline in estimated fair market value after receipt, or in-substance foreclosure are reflected in general operating expenses.\nThe excess of the purchase price over the fair market value of assets acquired (goodwill) in connection with an acquisition is amortized on a straight-line basis over a 20 year period.\nFixed assets are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed principally using the straight-line method over the estimated useful lives of the related assets.\nAt the time management decides to proceed with a securitization of finance receivables, such finance receivables are considered held for sale and are reclassified to other assets.\nDerivative Financial Instruments\nThe Corporation enters into interest rate swap and interest rate cap agreements as part of its overall interest rate risk management. These transactions are entered into as hedges against the effects of future interest rate fluctuations and, accordingly, are not carried at fair market value so long as a high degree of correlation is maintained between the derivative instrument and the corresponding asset or liability position being hedged. The Corporation's objectives and strategies regarding the management of interest rate and liquidity risks, including the use of derivative instruments, are discussed in the \"Interest Rate Risk Management\" section of \"Asset\/Liability Management\" in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nThe net interest differential, including premiums paid or received, if any, on interest rate swaps and interest rate caps is recognized on an accrual basis as an adjustment to finance income or interest expense to correspond with the hedged asset or liability position, respectively. In the infrequent event that early termination of a derivative instrument occurs, the net proceeds paid or received are deferred and amortized over the shorter of the remaining original contract life of the interest rate swap or interest rate cap or the maturity of the hedged asset or liability position.\nOn occasion, the Corporation will also purchase a forward interest rate agreement or option of very short term (up to 4 months) to hedge the interest rate used to price the anticipated securitization of finance receivables. Such transactions are designated as a hedge against a securitization that is probable\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\nand for which the significant characteristics and terms have been identified. The finance receivables involved are considered held for sale and reclassified to other assets. The net interest differential on the derivative instrument, including premium paid or received, if any, is recognized as an adjustment to the basis of the corresponding assets at the time of sale. If the anticipated securitization does not occur, the related hedge position is liquidated with any gain or loss recognized at such time, and the related assets are reclassified to finance receivables.\nThe Corporation may occasionally enter into a compound interest rate cap transaction, which, in the Corporation's case, involves the purchase of an interest rate cap based on commercial paper interest rates linked with the sale of an interest rate cap based on the prime rate. The interest rate cap purchased and the interest rate cap sold are transacted concurrently and have a matched notional dollar amount and maturity. Accordingly, the transaction is treated as a hedge unit for accounting purposes and the net interest differential, including any net premium paid or received, is recognized as an adjustment to interest expense.\nIncome Taxes\nOn January 1, 1993, the Corporation adopted, on a prospective basis, Statement of Financial Accounting Standards No. 109, \"Accounting for Income Taxes\" (\"SFAS 109\"). Under the asset and liability method of SFAS 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are determined using enacted tax rates expected to apply in the year 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 at the time of enactment. The adoption of SFAS 109 did not have a significant impact on the Corporation's consolidated results of operations in 1993 due to the prior adoption of Statement of Financial Accounting Standards No. 96, \"Accounting for Income Taxes\".\nFederal investment tax credits realized for income tax purposes on lease financing transactions have been deferred for financial statement purposes and are included in deferred Federal income taxes on the Consolidated Balance Sheets. Such credits are amortized as a reduction of the provision for income taxes on an actuarial method over the related lease term.\nNote 2--Finance Receivables\nThe following table presents an analysis of finance receivables.\nAt December 31, -------------------------------- 1994 1993 ------------- ------------- Amounts in Thousands\nLoans .................................... $ 12,380,071 $ 10,657,167 Direct financing lease receivables ....... 3,098,352 2,682,635 Leveraged lease receivables .............. 789,166 766,361 ------------- ------------- Gross finance receivables ................ 16,267,589 14,106,163 Unearned finance income .................. (1,473,226) (1,482,069) ------------- ------------- Finance receivables ...................... $ 14,794,363 $ 12,624,094 ============= =============\nLeveraged lease receivables in the preceding table exclude the portion of lease receivables offset by related non-recourse debt payable to third-party lenders of $2.22 billion in 1994 and $2.34 billion in 1993 including amounts owed to affiliates of DKB which totaled $525.7 million at year-end 1994 and $535.7 million at year-end 1993. Also excluded from the preceding table are $498.1 million of finance receivables at December 31, 1994 ($415.0 million in 1993) owned by other financial institutions or securitization trusts which are serviced by Sales Financing.\nInformation about concentrations of credit risk is set forth in \"Industry Composition\" and \"Geographic Composition\" in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\nContractual maturities of finance receivables at December 31, 1994 and 1993 are set forth in Note 19--Maturity of Finance Receivables.\nThe following table sets forth information regarding finance receivables on nonaccrual status and assets received in satisfaction of loans.\nAt December 31, ----------------------- 1994 1993 --------- -------- Nonaccrual finance receivables ................... $ 110,232 $ 139,941 Assets received in satisfaction of loans ......... 86,525 86,957 --------- --------- Total nonperforming assets ....................... $ 196,757 $ 226,898 ========= ========= Percent to total financing and leasing assets .... 1.26% 1.70% ========= =========\nThe amount of finance income recognized on year-end nonaccrual finance receivables totaled $6.2 million, $3.9 million and $14.9 million in 1994, 1993 and 1992, respectively. The amount of finance income which would have been recorded under contractual terms for such nonaccrual receivables totaled $20.7 million, $21.2 million, and $30.3 million in 1994, 1993 and 1992, respectively.\nAt December 31, 1994 and 1993, the Corporation had $14.0 million and $15.0 million, respectively, of finance receivables that met the criteria of troubled debt restructurings, which were not included in the preceding table. Finance income recognized on troubled debt restructurings totaled $0.8 million, $0.8 million and $4.1 million in 1994, 1993 and 1992, respectively. Finance income on these restructured receivables would have been $2.1 million, $2.3 million and $5.8 million for 1994, 1993 and 1992, respectively, based on original contractual terms.\nNote 3--Reserve for Credit Losses\nThe following table presents changes in the reserve for credit losses.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\nNote 4--Operating Lease Equipment\nCapital Equipment Financing and Industrial Financing enter into lease transactions (with estimated residual values in excess of 20% of the original purchase price) which are accounted for as operating leases. In accordance with the policy of reviewing and adjusting the net carrying values of leased assets to the lower of fair market or carrying value, management or outside consultants periodically perform appraisals of operating lease equipment. Based upon such periodic appraisals, the aggregate fair values of operating lease equipment exceeded carrying value at December 31, 1994.\nThe following table provides an analysis of operating lease equipment by equipment type, net of accumulated depreciation of $129.7 million in 1994 and $68.8 million in 1993.\nAt December 31, ----------------------- 1994 1993 --------- --------- Amounts in Thousands\nCommercial aircraft ................................ $ 482,324 $ 457,637 Business aircraft .................................. 97,770 88,390 Trucks, trailers and buses ......................... 94,309 82,996 Oil refinery ....................................... 83,137 86,240 Railroad and other transportation equipment ........ 69,106 11,560 Construction and mining equipment .................. 18,519 15,715 Manufacturing equipment ............................ 10,788 3,418 Other .............................................. 11,961 5,945 --------- --------- Total ............................................ $ 867,914 $ 751,901 ========= =========\nRental income on operating leases, included in finance income, totaled $97.2 million in 1994, $67.2 million in 1993 and $30.8 million in 1992. The following table presents future minimum lease rentals on noncancellable operating leases as of December 31, 1994. Excluded from this table are variable rentals calculated on the level of asset usage, re-leasing rentals, and expected sales proceeds from remarketing operating lease equipment at lease expiration, all of which are important components of operating lease profitability.\nYears Ended December 31, Amounts in Thousands\n1995 .......................................... $ 101,224 1996 .......................................... 90,344 1997 .......................................... 73,969 1998 .......................................... 57,502 1999 .......................................... 38,455 Thereafter .................................... 61,419 --------- Total .................................... $ 422,913 =========\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\nNote 5--Debt\nThe following table presents data on commercial paper borrowings.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\nThe following tables present interest rates, contractual maturities and outstanding balances for term debt:\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\n------------- (e) The interest rate resets monthly based on one month LIBOR plus .10%.\n(f) The interest rate resets quarterly based on three month LIBOR plus a weighted average of .13%.\n(g) The interest rate resets quarterly based on the 2 year constant maturity Treasury rate less a weighted average of .22%.\n(h) The interest rate resets weekly based on the 6 month Treasury bill rate plus .20%.\n(i) The interest rate resets monthly and is equal to the 30-day commercial paper rate plus .15% or at a lower rate under certain circumstances. Repayable quarterly at the option of the holder after nine months' notice to the Corporation. Redeemable at the option of the Corporation on 30 days' notice.\n(j) The interest rate resets quarterly based on the 91 day Treasury bill rate plus .30%.\n(k) The interest rate resets monthly and is equal to the 30-day commercial paper rate plus .20%, or at a lower rate under certain circumstances. The maturity date on these notes was accelerated from November 12, 2003 to February 8, 1995, in accordance with the terms of the notes.\n(l) Subject to the provisions set forth in the Pricing Supplement dated June 18, 1993, the interest rate on this issue was fixed at 5.956% in June 1994.\nThe following table presents the contractual maturities of total debt at December 31, 1994. Certain debt may be repaid at earlier dates as detailed in footnotes (i) and (k) of the preceding table.\nCommercial Variable rate Fixed rate paper notes notes ---------- ---------- ---------- At December 31, ............. Amounts in Thousands 1995 .................... $5,660,194 $2,535,000 $ 430,000 1996 .................... -- 250,000 930,000 1997 .................... -- 556,000 602,950 1998 .................... -- 91,500 250,000 1999-2008 ............... -- 380,000 710,200 ---------- ---------- ---------- Total ............... $5,660,194 $3,812,500 $2,923,150 ========== ========== ==========\nAfter-tax extraordinary losses for premiums and other expenses relating to redemptions of term debt totaled $4.2 million in 1992. In 1994 and 1993, the Corporation did not redeem any term debt.\nThe following table represents information on unsecured lines of credit with 74 banks at December 31, 1994. There have been no borrowings under lines of credit since 1970.\nCredit Lines Amount Maturity ------------ ------ -------- Amounts in Thousands 364-Day revolving credit facility $1,875,000 June 1995(a) Revolving credit facility ....... 1,250,000 April 1998(b) Revolving credit facility ....... 770,000 September 1997(c) Revolving credit facility ....... 400,000 August 1995\/September 1997(d,e) Revolving credit facility ....... 325,000 September 1996(f) 364-day renewable credit facility 55,000 Renewable annually(g) ---------- Total committed credit lines .... $4,675,000 ==========\n--------------------\n(a) The Corporation may, by written notice given no earlier than 60 days prior to the then applicable Termination Date of this Agreement, extend the then applicable Termination Date to a date 364 days after the then applicable Termination Date. This is subject to written consent by two-thirds in principal amount of the participating banks given no earlier than 30 days and no later than 20 days prior to the then applicable Termination Date.\n(b) The Corporation may, by written notice to the Agent given no later than 60 days prior to the first, second and\/or third anniversary date of this Agreement, extend the then applicable Termination Date to a date one year after the then applicable Termination Date. This is subject to written consent from two-thirds in principal amount of the participating banks given no later than 30 days prior to the first or second anniversary date of this Agreement following the request of such extension. In no event shall the Termination Date be later than April 29, 2000.\n(c) The Corporation may, by written notice to the Agent given no later than 60 days prior to the first and\/or second anniversary date of this Agreement, extend the then applicable Termination Date to a date one year after the then applicable Termination Date. This extension is subject to written consent by two-thirds in principal amount of the participating banks given no later than 30 days prior to the first or second anniversary date. In no event will the Termination Date be later than September 27, 1999.\n(d) The Corporation may, by written notice to the Agent given no earlier than 60 days and no later than 30 days prior to the then applicable Termination Date of this Agreement, extend the then applicable Termination Date to a date 364 days after the then applicable Termination Date. This is subject to written consent by two thirds in principal amount of the participating banks and given no earlier than 30 days and no later than 20 days prior to the then applicable Termination Date. In no event shall the Termination Date be later than September 1, 1999.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (Continued)\n--------------------\n(e) The Corporation may, by written notice to the Agent given no later than 60 days prior to the first and second anniversary date of this Agreement, extend the then applicable Termination Date to a date one year after the then applicable Termination Date. This is subject to written consent from two-thirds in principal amount of the participating banks given within 30 days following the request. The Corporation may extend the Termination Date a maximum of two times but in no event will the Termination Date be later than September 1, 1999.\n(f) The Corporation may, by written notice to the Agent given no later than 60 days prior to the first and second anniversary date, request the participating banks to consider an extension of the then applicable termination date to a date one year after the then applicable Termination Date. This extension is subject to written consent by two-thirds in principal amount of the participating banks given no later than 30 days prior to the first or second anniversary date. The Corporation may extend this facility a maximum of two times, but in no event beyond September 28, 1998.\n(g) The Corporation may, at any time, but in no event more than twice a year, by written notice to the individual bank, request the individual bank to consider an extension of the then Termination Date to a date on which is not later than 364 days after the date on which the individual bank notifies the Corporation of its decision on such extension request.\nCredit lines with DKB in the preceding table totaled $245.0 million at December 31, 1994 and $357.0 million at December 31, 1993.\nNote 6--Derivative Financial Instruments\nAs part of managing the exposure to changes in market interest rates, the Corporation, as an end-user, enters into various interest rate swap and interest rate cap transactions, all of which are traded in over-the-counter (OTC) markets, with other financial institutions acting as principal counterparties, including subsidiaries of DKB and CBC. The Corporation's objectives and strategies regarding the management of interest rate risk, including the use of derivative instruments, are discussed in the Interest Rate Risk Management section of \"Asset\/Liability Management\" in Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. In 1994, The Corporation adopted Statement of Financial Accounting Standards No. 119, \"Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments\", which requires disclosure about amounts, nature and terms of certain financial instruments.\nThe following table presents the notional principal amounts, weighted average interest rates, and contractual maturities by class of interest rate swap at December 31, 1994.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe following table presents the notional principal amounts of interest rate swaps by class and the corresponding hedged liability position.\nAdditionally, there were cross-currency interest rate swaps with a notional principal amount of $190.0 million on which the Corporation was paying interest at a weighted average rate of 6.03% at December 31, 1994 that effectively converted yen denominated fixed rate debt into variable rate U.S. dollar obligations. These swaps have maturities ranging from 1999 to 2004 to correspond with the terms of the debt. (See footnote (c) under the table presenting the contractual maturities of fixed rate notes in Note 5-Debt.)\nIn connection with an anticipated securitization of finance receivables, the Corporation entered into a series of forward interest rate agreements with notional principal amounts of $124.0 million maturing in February 1995 that hedge the interest rate used to price the sale of an equivalent amount of finance receivables from interest rate fluctuations.\nAt December 31, 1993, the Corporation had purchased commercial paper interest rate caps with an outstanding notional principal amount of $1.45 billion which were designated as hedges against an equivalent amount of commercial paper. Included in that amount were caps with a notional principal amount of $1.15 billion which were purchased in conjunction with the sale of an equal amount of prime interest rate caps, creating a compound interest rate cap transaction to hedge the interest rate on commercial paper funding prime interest rate based assets. During 1994, commercial paper interest rate caps with a notional principal amount of $950.0 million and prime interest rate caps with a notional principal amount of $650.0 million matured. The remainder of the commercial paper interest rate caps outstanding at December 31, 1993, with total notional principal amounts of $500.0 million, and the associated prime interest rate caps were terminated in April 1994. The remaining unamortized costs exceeded the net proceeds received to terminate these interest rate caps by the immaterial amount of $0.3 million, which was charged to interest expense. There were no deferred gains or losses resulting from the termination of derivative instruments at December 31, 1994 or December 31, 1993.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe Corporation is exposed to credit risk to the extent a counterparty fails to perform under the terms of an interest rate swap. This risk is measured as the market value of interest rate swaps with a positive fair value at December 31, 1994, reduced by the effects of master netting agreements as presented in Footnote 15 - Fair Values of Financial Instruments. However, due to the investment grade credit ratings of all counterparties and limits on the exposure with any individual counterparty, the Corporation's actual counterparty credit risk is not considered significant.\nNote 7--Stockholders' Equity\nUnder the most restrictive provisions of agreements relating to outstanding debt, the Corporation may not, without the consent of the holders of such debt, permit stockholders' equity to be less than $300.0 million.\nNote 8--Fees and Other Income\nThe following table sets forth the components of fees and other income.\nYears ended December 31, ----------------------------------- 1994 1993 1992 -------- -------- -------- Amounts in Thousands\nCommissions and fees .................. $148,326 $109,860 $ 99,879 Gains on sales of finance receivables . 17,050 15,788 6,604 Gains on asset sales .................. 8,989 8,157 7,279 -------- -------- -------- $174,365 $133,805 $113,762 ======== ======== ========\nNote 9--Salaries and General Operating Expenses\nThe following table sets forth the components of salaries and general operating expenses. Years ended December 31, ----------------------------------- 1994 1993 1992 -------- -------- -------- Amounts in Thousands\nSalaries and employee benefits ........ $185,868 $152,139 $137,914 General operating expenses ............ 152,068 130,043 123,721 -------- -------- -------- $337,936 $282,182 $261,635 ======== ======== ========\nNote 10--Income Taxes\nThe effective tax rate of the Corporation varied from the statutory Federal corporate income tax rate as follows: Years ended December 31, ------------------------------- 1994 1993 1992 ---- ---- ---- Percentage of Pretax Income\nFederal income tax rate ................... 35.0% 35.0% 34.0% Increase (decrease) due to: State and local income taxes, net of Federal income tax benefit ......... 5.3 5.2 6.3 Effect of 1% tax rate increase on Federal deferred tax balances ................. -- 2.8 -- Investment tax credits .................. (0.3) (0.7) (0.7) Other ................................... (1.9) (1.0) (0.9) ---- ---- ---- Effective tax rate ........................ 38.1% 41.3% 38.7% ==== ==== ====\nThe Revenue Reconciliation Act of 1993 (the \"Act\") which became effective in August 1993, provided for a 1% increase in the statutory Federal corporate income tax rate. The rate change resulted in a 1993 increase of $8.2 million to deferred tax balances, primarily related to the lease portfolio. In addition, as required by Statement of Financial Accounting Standards No. 13, \"Accounting for Leases\" (\"SFAS 13\"), the after-tax rate of return and the allocation of income was recalculated from inception for the leveraged lease portfolio to reflect the impact of the change in rate, the net effect of which was not significant.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe types of temporary differences that give rise to significant portions of the deferred tax liability and the deferred provision (benefit) for income taxes are shown in the accompanying table.\nThe tax effects of temporary differences that give rise to significant portions of the deferred Federal income tax assets and liabilities are presented below.\nYears Ended December 31, --------------------------- Amounts in Thousands 1994 1993 -------- -------- Assets Provision for credit losses ........... $(61,303) $(50,292) Loan origination fees ................. (7,213) (7,493) Market discount income ................ (4,063) (4,698) Other ................................. (8,994) (9,466) -------- -------- Total deferred tax assets ............... (81,573) (71,949) -------- -------- Liabilities Leasing transactions .................. 490,782 451,112 Amortization of intangibles ........... 7,228 4,714 Depreciation of fixed assets .......... 1,180 1,751 Prepaid pension costs ................. 641 746 Other ................................. 1,068 233 -------- -------- Total deferred tax liabilities .......... 500,899 458,556 -------- -------- Net deferred tax liability .............. $419,326 $386,607 ======== ========\nAlso included in the deferred Federal income taxes caption on the Consolidated Balance Sheets are unamortized investment tax credits of $7.2 million and $8.3 million at December 31, 1994 and December 31, 1993, respectively. Included in the accrued liabilities and payables caption in the Consolidated Balance Sheets are State and local deferred tax liabilities of $77.5 million and $73.6 million at December 31, 1994 and December 31, 1993, respectively, arising from the temporary differences shown in the above tables.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nNote 11--Benefit Plans\nRetirement Plan\nSubstantially all employees of the Corporation who have completed one year of service and have attained the age of 21 years participate in The CIT Group Holdings, Inc. Retirement Plan (\"CIT Plan\"). The retirement benefits under the CIT Plan are based on the employee's age, years of benefit service, and a percentage of qualifying compensation during the final years of employment. Plan assets consist of marketable securities, including common stock and government and corporate debt securities. The Corporation funds the plan by the amount charged to salaries and employee benefits expense to the extent it qualifies for an income tax deduction.\nThe following table sets forth the funded status of the CIT Plan and the amounts recognized in the Consolidated Balance Sheets.\nThe following assumptions were used for calculating the projected benefit obligations shown in the preceding table.\nPostretirement Benefits\nThe Corporation provides certain health care and life insurance benefits to eligible retired employees. In 1994, salaried participants generally become eligible for retiree health care benefits after reaching age 55 with 10 years of benefit service and 10 years of medical plan participation, increasing to 11 years in 1995. Generally, the medical plans pay a stated percentage of most medical expenses reduced by a deductible as well as by payments made by government programs and other group coverage. The plans are unfunded.\nThe Corporation adopted Statement of Financial Accounting Standards No. 106, \"Employers' Accounting of Postretirement Benefits Other Than Pensions\" (\"SFAS 106\") as of January 1, 1993. SFAS 106 requires the accrual, during the\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nactive service period of the employee, of the cost of providing postretirement benefits, including medical and life insurance coverage. The Corporation elected to amortize the SFAS 106 transition obligation over a twenty-year period.\nThe postretirement benefit liability at December 31, 1994 and December 31, 1993 is set forth in the following table.\n1994 1993 ------- ------- Amounts in Thousands Accumulated postretirement benefit obligation (\"APBO\"): Retirees ................................... $23,510 $26,042 ------- ------- Fully eligible, active plan participants ... 3,690 3,648 Other active plan participants ............. 10,952 10,872 ------- ------- 38,152 40,562 Fair value of plan assets ...................... -- -- ------- ------- Unfunded postretirement obligation ............. 38,152 40,562 Unrecognized net (gain)\/loss ................... (1,073) 3,240 Unrecognized transition obligation ............. 29,964 31,629 ------- ------- Accrued postretirement benefit obligation ...... $ 9,261 $ 5,693 ======= =======\nThe components of net periodic postretirement benefit cost were as follows.\nYears Ended December 31, ------------------------ 1994 1993 ------- ------- Amounts in Thousands\nService cost -- benefits earned during the period ..... $1,220 $1,065 Interest cost on accumulated postretirement benefit obligation .................................. 2,818 2,920 Amortization of unrecognized transition obligation .... 1,665 1,665 ------ ------ Net periodic postretirement benefit cost .............. $5,703 $5,650 ====== ======\nThe following assumptions were used for calculating the APBO shown in the preceding tables.\n1994 1993 ------ ------- Discount Rate....................................... 8.75% 7.50% Rate of future compensation increases............... 5.00% 5.00% Assumed Health Care Cost Trend Rate: Retirees prior to reaching age 65................. 11.00% 12.00% Retirees older than 65............................ 8.00% 9.00%\nThe assumed health care cost trend rates decline to an ultimate level of 6.25% at December 31, 1994 and 5.5% at December 31, 1993.\nIf the health care cost trend rates were increased by 1%, the APBO as of December 31, 1994, would be increased by $4.2 million (11.0%), and the sum of the service cost and interest cost components of net periodic postretirement benefit cost for 1994 would be increased by $0.5 million (12.4%).\nSavings Incentive Plan\nCertain employees of the Corporation participate in The CIT Group Holdings, Inc. Savings Incentive Plan. This plan qualifies under section 401(k) of the Internal Revenue Code. The Corporation's expense is based on specific percentages of employee contributions and plan administrative costs and aggregated $8.0 million, $6.8 million and $6.3 million for the years 1994, 1993 and 1992, respectively.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nNote 12--Lease Commitments\nThe Corporation has entered into noncancellable long-term lease agreements for premises and equipment. The following table presents future minimum rentals under such noncancellable leases that have initial or remaining terms in excess of one year at December 31, 1994.\nAt December 31, Amounts in Thousands\n1995 .................................................. $ 20,833 1996 .................................................. 19,244 1997 .................................................. 16,967 1998 .................................................. 15,115 1999 .................................................. 13,030 Thereafter ............................................ 82,982 -------- Total ............................................... $168,171 ========\nIn addition to fixed lease rentals, leases require payment of maintenance expenses and real estate taxes, both of which are subject to escalation provisions. Minimum payments have not been reduced by minimum sublease rentals of $25.8 million due in the future under noncancellable subleases.\nRental expense, net of sublease income on premises and equipment, was as follows.\nYears Ended December 31, --------------------------------- 1994 1993 1992 ------- ------- -------- Amounts in Thousands\nPremises ................................ $18,361 $17,265 $17,444 Equipment ............................... 5,202 6,738 7,391 Less sublease income .................... (1,314) (1,347) (1,316) ------- ------- ------- Total ................................. $22,249 $22,656 $23,519 ======= ======= =======\nRental expense paid to CBC totaled $1.6 million, $2.1 million and $5.3 million in 1994, 1993 and 1992, respectively.\nNote 13--Legal Proceedings\nIn the ordinary course of business, there are various legal proceedings pending against the Corporation. Management believes that the aggregate liabilities, if any, arising from such actions would not have a material adverse effect on the consolidated financial position of the Corporation.\nNote 14--Credit-Related Commitments\nIn the normal course of meeting the financing needs of its customers, the Corporation enters into various credit-related commitments. These financial instruments generate fees and involve, to varying degrees, elements of credit risk in excess of the amounts recognized in the Consolidated Balance Sheets. To minimize potential credit risk, the Corporation generally requires collateral and other credit-related terms and conditions from the customer. At the time credit-related commitments are granted, the fair value of the underlying collateral and guarantees approximates or exceeds the contractual amount of the commitment. In the event a customer defaults on the underlying transaction, the maximum potential loss to the Corporation represents the contractual amount outstanding less the value of all underlying collateral and guarantees.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nThe following table summarizes the contractual amounts of credit-related commitments.\nNote 15--Fair Values of Financial Instruments\nStatement of Financial Accounting Standards No. 107, \"Disclosures About Fair Value of Financial Instruments\" (\"SFAS 107\") requires disclosure of the estimated fair value of the Corporation's financial instruments, excluding leasing transactions accounted for under SFAS 13. The fair value estimates are made at a discrete point in time based on relevant market information and information about the financial instrument. Since no trading market exists for a significant portion of the Corporation's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involving uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions or estimation methods may significantly affect the estimated fair values. Because of these limitations, management provides no assurance that the estimated fair values presented would necessarily be realized upon disposition or sale.\nActual fair values in the marketplace are affected by other significant factors, such as supply and demand, investment trends and the motivations of buyers and sellers, which are not considered in the methodology used to determine the estimated fair values presented. In addition, fair value estimates are based on existing on-and off-balance sheet financial instruments without attempting to estimate the value of future business transactions and the value of assets and liabilities that are part of the Corporation's overall value but are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include customer base, operating lease equipment, premises and equipment, assets received in satisfaction of loans, and deferred tax balances. In addition, tax effects relating to the unrealized gains and losses (differences in estimated fair values and carrying values) have not been considered in these estimates and can have a significant effect on fair value estimates.The carrying amounts for cash and cash equivalents approximate fair value because they have short maturities and do not present significant credit risks. Credit-related commitments, as disclosed in Note 14, are primarily short term floating rate contracts whose terms and conditions are individually negotiated, taking into account the creditworthiness of the customer and the nature, accessibility and quality of the collateral and guarantees. Therefore, the fair value of credit-related commitments, if exercised, would approximate their contractual amounts.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nEstimated fair values, recorded carrying values and various assumptions used in valuing the Corporation's financial instruments at December 31, 1994 and December 31, 1993 are set forth below.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nNote 16--Investments in Debt and Equity Securities\nEffective January 1, 1994, the Corporation adopted Statement of Financial Accounting Standards No. 115, \"Accounting for Certain Investments in Debt and Equity Securities\" (SFAS 115) which addresses the accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. At December 31, 1994, the book value of the Corporation's investment in debt and equity securities subject to the provision of SFAS 115 totaled $20.3 million, all of which was designated as available for sale. Unrealized gains and losses, representing the difference between amortized cost and current fair market value were immaterial.\nNote 17--Ownership of the Corporation\nThe Dai-Ichi Kangyo Bank, Limited owns 60% of the issued and outstanding stock of the Corporation, which it purchased from Manufacturers Hanover Corporation (\"MHC\") at year-end 1989. The remaining 40% of the Corporation's issued and outstanding stock is owned by Chemical Banking Corporation (\"CBC\") through a subsidiary MHC Holdings (Delaware) Inc., which CBC acquired as part of the merger between MHC and CBC on December 31, 1991.\nAt year-end 1992, the Corporation paid a one-time special dividend in the aggregate amount of $150.0 million to its stockholders, DKB and MHC Holdings (Delaware) Inc. The stockholders then immediately contributed $150.0 million to the Corporation's additional paid-in capital in proportion to their 60% and 40% common stock ownership interests.\nNote 18--Acquisition of Barclays Commercial Corporation\nOn February 28, 1994, the Corporation acquired, for cash, Barclays Commercial Corporation (\"BCC\"), a company of the Barclays Group. BCC had total assets of approximately $700.0 million at December 31, 1993 and total factoring volume of approximately $5.0 billion for the year then ended. The business and acquired assets of BCC were transferred to The CIT Group\/Commercial Services, Inc., a wholly-owned subsidiary of the Corporation, offering a full range of factoring services, including purchase of accounts receivables, credit protection, bookkeeping, and collection activities.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nNote 19--Maturity of Finance Receivables, Net of Unearned Finance Income--Contractual Basis\n---------------- The maturities shown above are based on contractual terms. Also shown, for comparative purposes, are unaudited percentage data based on a liquidation basis, which gives effect to estimated prepayments.\nTHE CIT GROUP HOLDINGS, INC. AND SUBSIDIARIES\nNOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)\nNote 20--Selected Quarterly Financial Data (Unaudited)\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 and ages of all directors, executive officers and certain significant employees of the Corporation as of February 1, 1995, and a biographical summary of each such person, appear on the following pages. No family relationship exists among these persons. The executive officers were appointed by and hold office at the will of the Board of Directors.\nStockholders Agreement\nThe Corporation entered into a Stockholders Agreement simultaneously with the acquisition of a sixty percent (60%) interest in the Corporation by DKB. The agreement provides for a Board of Directors consisting of ten directors, two of which shall be the Chief Executive Officer of the Corporation and the Vice Chairman of the Corporation designated by the Board of Directors. DKB, as majority stockholder, has the right to designate six nominees for director and MHC Holdings, as minority stockholder, has the right to designate two nominees for director. DKB and MHC Holdings each agreed to vote for the other's nominees for director. Regular meetings of the Board of Directors shall be held quarterly. See Item 1 \"Business--General\".\nOutside Directorships\nAs indicated in the table, some of the Directors of the Corporation concurrently hold positions as directors or executive officers of DKB or CBC or of subsidiaries or other affiliates of the Corporation, DKB, or CBC. Mr. Turner is a director of Franklin Electronic Publishers, Inc., an electronic publishing company, Grow Group, Inc. a chemical company, and Standard Motor Products, Inc., a manufacturing company, none of which is affiliated with the Corporation and each of which is listed on the New York Stock Exchange. Mr. Kobayashi is a director of AFLAC, Inc., a life insurance company, which is not affiliated with the Corporation and which is listed on the New York Stock Exchange. A number of the Executive Officers are also directors of privately held and not-for-profit organizations not affiliated with the Corporation.\nThe table below sets forth the annual and long-term compensation, including bonuses and deferred compensation, of the President and Chief Executive Officer, the Vice Chairman, and the other three most highly compensated executive officers of the Corporation for services rendered in all capacities to the Corporation and its subsidiaries during the fiscal years ended December 31, 1994, 1993, and 1992.\nSUMMARY COMPENSATION TABLE\nLONG-TERM INCENTIVE PLAN\nUnder The CIT Group Holdings, Inc. Career Incentive Plan (the \"CIT Career Incentive Plan\"), awards are granted in the form of phantom shares of stock by the Executive Committee of the Board of Directors in its discretion. Participants in the CIT Career Incentive Plan are selected by the Executive Committee from among the executives of the Corporation and its subsidiaries who are in a position to make a substantial contribution to the long-term financial success of the Corporation or its subsidiaries. Grants to the members of the Executive Committee are made by the Board of Directors. The amount of phantom shares eligible for allocation during a Performance Period is determined by the Committee. The Performance Period is at least three consecutive calendar years. The Committee determines the Performance Goals for each Performance Period, which are tied to net income growth targets and return on equity performance. The value of the phantom shares is determined at the end of each Performance Period and compared against the pre-established Performance Goals. Following the end of a Performance Period, one-third vest immediately and one-third vest at the end of each of the next two years. Cash dividends on individual shares are paid quarterly during the performance period and the vesting period based on the number of phantom shares granted to a participant. The basis of the dividend is the quarterly return on equity of the Corporation.\nAll or a part of the value of a vested award may either be paid currently in cash or deferred in up to 5 annual installments. Deferred amounts are credited with interest at a rate determined annually by the Committee.\nLONG-TERM INCENTIVE PLANS AWARDS IN LAST FISCAL YEAR\nDEFINED BENEFIT PLANS Retirement plans\nEffective January 1, 1990, The CIT Group Holdings, Inc. Retirement Plan (the \"CIT Retirement Plan\") was established. Assets necessary to fund the CIT Retirement Plan were transferred from the MHC Retirement Plan, Inc., the predecessor plan in which the Corporation's employees participated. Accumulated years of benefit service under the MHC Retirement Plan are included in the benefit formula of the CIT Retirement Plan, which covers officers and salaried employees who have one year of service and have attained age 21.\nSubject to certain exceptions, at the normal retirement age of 65, an employee's pension is 1.25% of final average salary, as defined below, for each of the first 20 years of benefit service as a participant and .75% of such salary for each year of the next 20 years of benefit service. In general, an employee who was a participant in the MHC Retirement Plan before 1985 will not receive a pension of less than 2% of final average salary for each of the first 20 years of benefit service as a participant and 1% of such salary for each of the next 20 years of benefit service, reduced by .4% of the participant's covered compensation for each year of such benefit service up to a maximum of 35 years and further reduced by the value of certain benefits under the CIT Savings Plan. An employee who was a participant in the former CIT Retirement Plan on June 30, 1986, will not receive a pension of less than 1.1% of final average salary up to certain Social Security limits plus 1.5 % of final average salary in excess of the Social Security limits, for each year of benefit service to a maximum of 35 years, reduced by certain benefits under the CIT Savings Plan. \"Final average salary\" is the highest average annual salary received in any five consecutive years in the last ten years. \"Salary\" includes all wages paid by the Corporation, including before-tax contributions made to the CIT Savings Plan and salary reduction contributions to any Section 125 Plan, but excluding commissions, bonuses, incentive compensation, overtime, reimbursement of expenses, directors' fees, severance pay, and deferred compensation. This salary is comparable to the \"Salary\" shown in the Summary Compensation Table. After completing 5 years of service, an employee whose employment with the participating company has terminated is entitled to a benefit, as of the employee's normal retirement date, equal to the benefit earned to the date of termination of employment, or an actuarially reduced benefit commencing at any time after age 55 if the participant is eligible for early retirement under the CIT Retirement Plan. Certain death benefits are available to eligible surviving spouses of participants.\nSince various laws and regulations set limits on the amounts allocable to a participant under the CIT Savings Plan and benefits under the CIT Retirement Plan, the Corporation has a supplemental retirement plan (the \"CIT Supplemental Retirement Plan\"). The CIT Supplemental Retirement Plan provides retirement benefits on an unfunded basis to participants (whose benefits under the CIT Retirement Plan would be restricted by the limits) of an amount equal to the difference between the annual retirement benefits permitted and the amount that would have been paid but for the limitations imposed.\nThe amounts set forth in the table are the amounts which would be paid to employees hired before 1985 pursuant to the CIT Retirement Plan and the CIT Supplemental Retirement Plan at a participant's normal retirement age assuming the indicated final average salary and the indicated years of benefit service and assuming that the straight life annuity form of benefit will be elected and that CIT Supplemental Retirement Plan benefits will be paid in the form of an annuity. The amounts may be overstated to the extent that they do not reflect the reduction for any benefits under the CIT Savings Plan.\n--------------\n(1) At December 31, 1994, Messrs. Gamper, Pollicino, Marsiello, Merritt, and Zdanow had 27, 30, 19, 20 and 27 years of benefit service, respectively.\nPermanent Life Insurance Options Plan\nTwenty-two officers of the Corporation, including Mr. Gamper, Mr. Pollicino, Mr. Marsiello, Mr. Merritt and Mr. Zdanow, are participants under the Permanent Life Insurance Options Plan. The benefit provided is paid-up life insurance equal to approximately three times salary with a life annuity option payable monthly by the Corporation upon retirement. The Participant pays a portion of the annual premium and the Corporation pays the balance on behalf of the participant. The Corporation is entitled to recoup its payments from the proceeds of the policy. Upon the participant's retirement a life annuity will be payable out of the current income of the Corporation and the Corporation anticipates recovering the cost of the life annuity out of the proceeds of the life insurance policy payable upon the death of the employee.\nIn addition to the table of pension benefits shown on the preceding page, the Corporation is conditionally obligated to make annual payments under the Permanent Life Insurance Options Plan in the amounts indicated to the following persons at retirement: Mr. Gamper, $263,130, Mr. Pollicino, $161,642, Mr. Marsiello, $136,008, Mr. Merritt, $152,383 and Mr. Zdanow, $93,616.\nCompensation Committee Interlocks and Insider Participation\nThe Executive Committee of the Board of Directors functions as the compensation committee and sets the compensation for all executives except Messrs. Gamper, Pollicino, Murata and Torii. The members of the Executive Committee are as follows:\nAlbert R. Gamper, Jr. Michio Murata Joseph A. Pollicino Peter J. Tobin Keiji Torii\nThe Board of Directors, except for Messrs. Gamper and Pollicino, who are absent from any portion of meetings when their compensation is discussed, deliberates over the compensation of Messrs. Gamper and Pollicino. DKB determines the compensation for Messrs. Murata and Torii. Mr. Tobin is an executive of CBC.\nEMPLOYMENT AGREEMENTS\nMr. Gamper has an employment agreement with the Corporation which provides that he will serve as the Chief Executive Officer, President, Chairman of the Executive Committee and member of the Board of Directors of the Corporation. His employment agreement initially ran for five years from December 29, 1989 and provides for the payment of an annual base salary of $400,000, to be reviewed at least annually by the Board of Directors of the Corporation, subject to increases but not to decreases. In December 1992, Mr. Gamper's employment agreement was extended for one additional year. In December 1994, Mr. Gamper's employment agreement was extended until December 1997. Mr. Gamper's employment agreement also provides for executive incentive compensation under Incentive Plans which will be designed to be no less favorable to him than the Incentive Plans in effect prior to the purchase by DKB of 60% of the Corporation's shares.\nMr. Pollicino has an employment agreement with the Corporation which provides that he shall serve as the Vice Chairman and member of the Board of Directors of the Corporation. Mr. Pollicino's employment agreement initially ran for five years from December 29, 1989 and provides for the payment of an annual base salary of $300,000, to be reviewed at least annually by the Board of Directors of the Corporation, subject to increases but not to decreases. In December 1992, Mr. Pollicino's employment agreement was extended for one additional year. In December 1994, Mr. Pollicino's employment agreement was extended until December 1997. Mr. Pollicino's employment agreement also provides for executive incentive compensation under Incentive Plans which will be designed to be no less favorable to him than the Incentive Plans in effect prior to the purchase by DKB of 60% of the Corporation's shares.\nIn addition to Mr. Gamper and Mr. Pollicino, Mr. Marsiello, Mr. Merritt and Mr. Zdanow have employment agreements with the Corporation, each of which initially ran for three years from December 29, 1989 through December 31, 1992\nand provides for the payment of base salary of not less than the amount received prior to the purchase by DKB of 60% of the Corporations's shares, to be reviewed at least annually by the Chief Executive Officer, subject to increases but not to decreases. In December 1992 and December 1994 the employment agreements were extended for an additional two years. These employment agreements also provide for executive incentive compensation under Incentive Plans which will be designed to be no less favorable to the executive officers than the Incentive Plans in effect prior to the aforesaid share purchase by DKB.\nTERMINATION AND CHANGE-IN-CONTROL ARRANGEMENTS\nMr. Gamper's and Mr. Pollicino's employment agreements with the Corporation provide that if their employment is terminated without cause (as defined in the agreement) or if they resign for good reason (as defined in the agreement) they will be entitled to receive severance payments equal to their base salary for the greater of thirty-six months or the remainder of the term, provided that they do not violate the non-competition or confidentiality provisions of the agreement, in which case the Corporation would have no obligation to make any remaining payments. Further, if Mr. Gamper's and Mr. Pollicino's employment is terminated without cause or if they resign for good reason, they will be entitled to receive, among other things, full employee welfare benefit coverage as if they had retired with the Corporation's consent at age 55, a pension benefit commencing at age 55 in an amount equal to their accrued benefit under the Corporation's Retirement Plan as of the date of their termination of employment as if they had attained age 55 and had retired on such date with the Corporation's consent, a lump sum equal to the then full value of their restricted stock award under the Long Term Incentive Program of Manufacturers Hanover Corporation and its subsidiaries (the \"MHC Long Term Incentive Plan\") and any vested award under any similar plan as may have been adopted by the Corporation, and a single life annuity equivalent to the single life annuity they would have normally been entitled to receive under the Corporation's Permanent Life Insurance Options Plan. If, during the Term of their employment agreements, a \"Change of Control\" occurs, Mr. Gamper and Mr. Pollicino will be entitled to receive a \"Special Payment.\" With respect to Mr. Gamper, the amount of such Special Payment shall equal the sum of Mr. Gamper's prior four years annual bonuses under The CIT Bonus Plan and will be payable over a two year period as follows: 1\/3 of the payment shall be paid within 30 days after the Change of Control; 1\/3 shall be paid on or before the first anniversary of such Change of Control; and 1\/3 shall be paid on or before the second anniversary date of such Change of Control. With respect to Mr. Pollicino, the amount of such Special Payment shall equal the sum of Mr. Pollicino's prior three years annual bonuses under The CIT Bonus Plan and will be payable over a two year period as follows: 1\/3 of the payment shall be paid within 30 days after the Change of Control; 1\/3 shall be paid on or before the first anniversary of such Change of Control; and 1\/3 shall be paid on or before the second anniversary date of such Change of Control. If, during the two year period commencing on the date of such Change of Control and ending on the second anniversary of such date, Mr. Gamper's or Mr. Pollicino's employment is involuntarily terminated by the Company for cause or he voluntarily terminates employment for any reason other than \"Good Reason\" as defined in his employment agreement or he breaches the non-compete or confidentiality provisions of his agreement, he shall not receive any remaining unpaid installments of this \"Special Payment.\"\nThe employment agreements of Mr. Marsiello, Mr. Merritt and Mr. Zdanow provide that if their employment is terminated without cause (as defined in the agreement) or if they resign for good reason (as defined in the agreement), they will be entitled to receive severance payments equal to their base salary for the greater of 24 months or the remainder of the term, provided that they do not violate the non-competition or confidentiality provisions of the agreement, in which case the Corporation would have no obligation to make any remaining payments. Further, if the employment of such executive officer is terminated without cause or if he resigns for good reason, he will be entitled to continued participation in employee welfare benefit coverage for eighteen months, a lump sum equal to the then full value of his restricted stock award under the MHC Long Term Incentive Program and any vested award under any similar plan as may have been adopted by the Corporation, and if age 55 or older on the date of termination, the benefits payable under the Corporation's Permanent Life Insurance Options Plan or if under age 55 a lump sum payment which represents the equivalent of the net after-tax present value of the single life annuity that would have been payable to the individual executive officer at age 55. If, during the Term of their employment agreement, a \"Change of Control\" occurs, Mr.\nMarsiello, Mr. Merritt and Mr. Zdanow will be entitled to receive a \"Special Payment.\" The amount of such Special Payment shall equal the sum of their prior two years annual bonuses under The CIT Bonus Plan and will be payable over a two year period as follows: 1\/3 of the payment shall be paid within 30 days after the Change of Control; 1\/3 shall be paid on or before the first anniversary of such Change of Control; and 1\/3 shall be paid on or before the second anniversary date of such Change of Control. If during the two year period commencing on the date of such Change of Control and ending on the second anniversary of such date, their employment is involuntarily terminated by the Company for cause or they voluntarily terminate employment for any reason other than \"Good Reason\" as defined in their employment agreements or they breach the non-compete or confidentiality provisions of their agreements, they shall not receive any remaining unpaid installments of this \"Special Payment.\"\nItem 12. Security Ownership of Certain Beneficial Owners and Management.\nThe following table sets forth the ownership of all of the issued and outstanding common stock of the Corporation, as of March 1, 1995.\nName and Address of Owner Shares Owned Percentage ------------------------- ------------ ---------- The Dai-Ichi Kangyo Bank, Limited 600 60% 1-5, Uchisaiwaicho 1-chome Chiyoda-ku, Tokyo 100\nMHC Holdings (Delaware) Inc. 400 40% 270 Park Ave New York, NY 10017\nNo officer or director of the Corporation owns any common stock of the Corporation. In addition, the voting securities of DKB and CBC, the parent of MHC Holdings, owned by each officer and director of the Corporation individually, and all officers and directors as a group, does not exceed one percent of the issued and outstanding securities comprising and such class of stock so owned.\nItem 13. Certain Relationships and Related Transactions.\nTransactions with Management and Others\nThe Corporation has in the past and may in the future enter into certain transactions with affiliates of the Corporation. It is anticipated that such transactions will be entered into at a fair market value for the transaction.\nThe Corporation's interest-bearing deposits generally represent overnight money market investments of excess cash that are maintained for liquidity purposes. At December 31, 1994, the Corporation had no interest-bearing deposits with DKB or CBC. From time to time, the Corporation may maintain such deposits with DKB or CBC.\nAt December 31, 1994, the Corporation's credit line coverage with 74 banks totaled $4.675 billion of committed facilities. Additional information regarding these credit lines can be found in Item 8. Financial Statements and Supplementary Data, \"Note 5--Debt\". At December 31, 1994, DKB was a committed bank under a $1.25 billion Revolving Credit Facility, a $770.0 million revolving credit facility, and a $325.0 million revolving credit facility, with commitments of $60.0 million, $80.0 million and $105.0 million, respectively. DKB is a Co-Agent under the $1.25 billion and $770.0 million Revolving Credit Facilities and the Agent under the $325.0 million facility.\nThe Corporation has entered into interest rate swap and cross currency interest rate swap agreements with financial institutions acting as principal counterparties, including affiliates of DKB and CBC. At December 31, 1994, the notional principal amount outstanding on interest rate swap agreements with DKB and CBC totaled $270.0 million and $300.0 million, respectively. The notional principal amount outstanding on foreign currency swaps totaled $140.2 million with DKB at year-end 1994.\nThe Corporation has entered into leveraged leasing arrangements with third party loan participants, including affiliates of DKB. Amounts owed to affiliates of DKB are discussed in Item 8. Financial Statements and Supplementary Data, \"Note 2--Finance Receivables\".\nThe Corporation holds a $9.0 million letter of credit from CBC as additional collateral on a $24.4 million business aircraft loan to a third party. CBC is also indebted to the Corporation in the amount of $8.0 million for financing relating to the purchase of a business aircraft by CBC.\nThe Corporation has also entered into various noncancellable long-term facility lease agreements with CBC. Future minimum rentals under these leases are $1.6 million in 1995, $1.5 million in 1996, $.6 million in 1997, and $.1 million in 1998.\nAt December 31, 1994, the Corporation had entered into a credit-related commitment with DKB in the form of a letter of credit totaling $6.7 million equal to the amount of the single lump sum premium necessary to provide group life insurance coverage to certain eligible retired employees.\nThe Corporation has issued a Prospectus, dated August 8, 1994, relating to certain debt securities of the Corporation that are currently issued and outstanding with respect to which offers and sales relating to market-making transactions may be made by Chemical Securities Inc. and\/or its affiliates. Chemical Securities Inc. is a wholly-owned subsidiary of CBC. Chemical Securities Inc. paid all expenses of the Corporation of preparing the Prospectus.\nA subsidiary of the Corporation has entered into a cash collateral loan agreement with DKB pursuant to which DKB made a loan to a cash collateral trust in order to provide additional funds to make payments on the certificates of a contracts trust. The contracts trust was formed for the purpose of securitizing certain recreational vehicle finance receivables that were acquired by the contracts trust from another subsidiary of the Corporation. At December 31, 1994, the principal amount outstanding on the cash collateral loan was $9.5 million.\nSchulte Roth & Zabel, of which Mr. Roth is a partner, provides legal services to the Corporation. Attorney's fees for services to the Corporation did not constitute more than 5% of the law firm's gross revenues for the last fiscal year. Schulte Roth & Zabel has been retained in the past and will continue in the future to serve as outside counsel for DKB.\nPART IV\nItem 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K.\n(a) The following documents are filed with the Securities and Exchange Commission as part of this report:\n1. The financial statements of The CIT Group Holdings, Inc. and Subsidiaries as set forth on pages 28-53.\n2. All schedules are omitted because they are not applicable or because the required information appears in the consolidated financial statements or the notes thereto.\n3. The following is an index of the Exhibits required by Item 601 of Regulation S-K filed with the Securities and Exchange Commission as part of this report:\n3(a) Restated Certificate of Incorporation of The CIT Group Holdings, Inc., amended as of December 29, 1989 (incorporated by reference to Exhibit 3(a) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1989).\n3(b) By-Laws of The CIT Group Holdings, Inc., amended as of December 29, 1989 (incorporated by reference to Exhibit 3(b) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1989).\n4(a) Upon the request of the Securities and Exchange Commission, the Registrant will furnish a copy of all instruments defining the rights of holders of long-term debt of the Registrant.\n10(a) Stockholders Agreement (incorporated by reference to Exhibit 10(a) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1989).\n10(b)(1) Employment Agreement of Albert R. Gamper, Jr. (incorporated by reference to Exhibit 10(b) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1989).\n10(b)(2) Extension of Employment Agreement of Albert R. Gamper, Jr. (incorporated by reference to Exhibit 10 (b)(2) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(b)(3) Extension of Employment Agreement of Albert R. Gamper, Jr.\n10(c)(1) Employment Agreement of Nikita Zdanow (incorporated by reference to Exhibit 10(c)(1) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(c)(2) Extension of Employment Agreement of Nikita Zdanow (incorporated by reference to Exhibit 10(c)(2) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(c)(3) Extension of Employment Agreement of Nikita Zdanow.\n10(d) The CIT Group Bonus Plan (incorporated by reference to Exhibit 10(d) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(e) The CIT Group Holdings, Inc. Career Incentive Plan (incorporated by reference to Exhibit 10(e) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(f) The CIT Group Holdings, Inc. Supplemental Savings Plan (incorporated by reference to Exhibit 10(f) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(g) The CIT Group Holdings, Inc. Supplemental Retirement Plan (incorporated by reference to Exhibit 10(g) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n12 Computation of Ratios of Earnings to Fixed Charges.\n21 Subsidiaries of the Registrant.\n23 Consent of KPMG Peat Marwick LLP.\n24 Powers of Attorney.\n27 Financial Data Schedule (filed electronically)\n(b) A Current Report on Form 8-K dated October 21, 1994 was filed with the Commission reporting the Corporation's announcement of results for the quarter ended September 30, 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.\nTHE CIT GROUP HOLDINGS, INC.\nBy: \/s\/ ERNEST D. STEIN ......................................... Ernest D. Stein Executive Vice President, General Counsel and Secretary March 14, 1995\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:\nOriginal powers of attorney authorizing Albert R. Gamper, Jr. Ernest D. Stein, and Donald J. Rapson and each of them to sign on behalf of the above mentioned directors and are held by the corporation and available for examination by the Securities and Exchange Commission pursuant to Item 302(b) of Regulation S-T.","section_11":"","section_12":"Item 12. Security Ownership of Certain Beneficial Owners and Management.\nThe following table sets forth the ownership of all of the issued and outstanding common stock of the Corporation, as of March 1, 1995.\nName and Address of Owner Shares Owned Percentage ------------------------- ------------ ---------- The Dai-Ichi Kangyo Bank, Limited 600 60% 1-5, Uchisaiwaicho 1-chome Chiyoda-ku, Tokyo 100\nMHC Holdings (Delaware) Inc. 400 40% 270 Park Ave New York, NY 10017\nNo officer or director of the Corporation owns any common stock of the Corporation. In addition, the voting securities of DKB and CBC, the parent of MHC Holdings, owned by each officer and director of the Corporation individually, and all officers and directors as a group, does not exceed one percent of the issued and outstanding securities comprising and such class of stock so owned.\nItem 13.","section_13":"Item 13. Certain Relationships and Related Transactions.\nTransactions with Management and Others\nThe Corporation has in the past and may in the future enter into certain transactions with affiliates of the Corporation. It is anticipated that such transactions will be entered into at a fair market value for the transaction.\nThe Corporation's interest-bearing deposits generally represent overnight money market investments of excess cash that are maintained for liquidity purposes. At December 31, 1994, the Corporation had no interest-bearing deposits with DKB or CBC. From time to time, the Corporation may maintain such deposits with DKB or CBC.\nAt December 31, 1994, the Corporation's credit line coverage with 74 banks totaled $4.675 billion of committed facilities. Additional information regarding these credit lines can be found in Item 8. Financial Statements and Supplementary Data, \"Note 5--Debt\". At December 31, 1994, DKB was a committed bank under a $1.25 billion Revolving Credit Facility, a $770.0 million revolving credit facility, and a $325.0 million revolving credit facility, with commitments of $60.0 million, $80.0 million and $105.0 million, respectively. DKB is a Co-Agent under the $1.25 billion and $770.0 million Revolving Credit Facilities and the Agent under the $325.0 million facility.\nThe Corporation has entered into interest rate swap and cross currency interest rate swap agreements with financial institutions acting as principal counterparties, including affiliates of DKB and CBC. At December 31, 1994, the notional principal amount outstanding on interest rate swap agreements with DKB and CBC totaled $270.0 million and $300.0 million, respectively. The notional principal amount outstanding on foreign currency swaps totaled $140.2 million with DKB at year-end 1994.\nThe Corporation has entered into leveraged leasing arrangements with third party loan participants, including affiliates of DKB. Amounts owed to affiliates of DKB are discussed in Item 8. Financial Statements and Supplementary Data, \"Note 2--Finance Receivables\".\nThe Corporation holds a $9.0 million letter of credit from CBC as additional collateral on a $24.4 million business aircraft loan to a third party. CBC is also indebted to the Corporation in the amount of $8.0 million for financing relating to the purchase of a business aircraft by CBC.\nThe Corporation has also entered into various noncancellable long-term facility lease agreements with CBC. Future minimum rentals under these leases are $1.6 million in 1995, $1.5 million in 1996, $.6 million in 1997, and $.1 million in 1998.\nAt December 31, 1994, the Corporation had entered into a credit-related commitment with DKB in the form of a letter of credit totaling $6.7 million equal to the amount of the single lump sum premium necessary to provide group life insurance coverage to certain eligible retired employees.\nThe Corporation has issued a Prospectus, dated August 8, 1994, relating to certain debt securities of the Corporation that are currently issued and outstanding with respect to which offers and sales relating to market-making transactions may be made by Chemical Securities Inc. and\/or its affiliates. Chemical Securities Inc. is a wholly-owned subsidiary of CBC. Chemical Securities Inc. paid all expenses of the Corporation of preparing the Prospectus.\nA subsidiary of the Corporation has entered into a cash collateral loan agreement with DKB pursuant to which DKB made a loan to a cash collateral trust in order to provide additional funds to make payments on the certificates of a contracts trust. The contracts trust was formed for the purpose of securitizing certain recreational vehicle finance receivables that were acquired by the contracts trust from another subsidiary of the Corporation. At December 31, 1994, the principal amount outstanding on the cash collateral loan was $9.5 million.\nSchulte Roth & Zabel, of which Mr. Roth is a partner, provides legal services to the Corporation. Attorney's fees for services to the Corporation did not constitute more than 5% of the law firm's gross revenues for the last fiscal year. Schulte Roth & Zabel has been retained in the past and will continue in the future to serve as outside counsel for DKB.\nPART IV\nItem 14.","section_14":"Item 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K.\n(a) The following documents are filed with the Securities and Exchange Commission as part of this report:\n1. The financial statements of The CIT Group Holdings, Inc. and Subsidiaries as set forth on pages 28-53.\n2. All schedules are omitted because they are not applicable or because the required information appears in the consolidated financial statements or the notes thereto.\n3. The following is an index of the Exhibits required by Item 601 of Regulation S-K filed with the Securities and Exchange Commission as part of this report:\n3(a) Restated Certificate of Incorporation of The CIT Group Holdings, Inc., amended as of December 29, 1989 (incorporated by reference to Exhibit 3(a) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1989).\n3(b) By-Laws of The CIT Group Holdings, Inc., amended as of December 29, 1989 (incorporated by reference to Exhibit 3(b) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1989).\n4(a) Upon the request of the Securities and Exchange Commission, the Registrant will furnish a copy of all instruments defining the rights of holders of long-term debt of the Registrant.\n10(a) Stockholders Agreement (incorporated by reference to Exhibit 10(a) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1989).\n10(b)(1) Employment Agreement of Albert R. Gamper, Jr. (incorporated by reference to Exhibit 10(b) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1989).\n10(b)(2) Extension of Employment Agreement of Albert R. Gamper, Jr. (incorporated by reference to Exhibit 10 (b)(2) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(b)(3) Extension of Employment Agreement of Albert R. Gamper, Jr.\n10(c)(1) Employment Agreement of Nikita Zdanow (incorporated by reference to Exhibit 10(c)(1) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(c)(2) Extension of Employment Agreement of Nikita Zdanow (incorporated by reference to Exhibit 10(c)(2) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(c)(3) Extension of Employment Agreement of Nikita Zdanow.\n10(d) The CIT Group Bonus Plan (incorporated by reference to Exhibit 10(d) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(e) The CIT Group Holdings, Inc. Career Incentive Plan (incorporated by reference to Exhibit 10(e) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(f) The CIT Group Holdings, Inc. Supplemental Savings Plan (incorporated by reference to Exhibit 10(f) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n10(g) The CIT Group Holdings, Inc. Supplemental Retirement Plan (incorporated by reference to Exhibit 10(g) to Form 10-K filed by the Corporation for the fiscal year ended December 31, 1992).\n12 Computation of Ratios of Earnings to Fixed Charges.\n21 Subsidiaries of the Registrant.\n23 Consent of KPMG Peat Marwick LLP.\n24 Powers of Attorney.\n27 Financial Data Schedule (filed electronically)\n(b) A Current Report on Form 8-K dated October 21, 1994 was filed with the Commission reporting the Corporation's announcement of results for the quarter ended September 30, 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.\nTHE CIT GROUP HOLDINGS, INC.\nBy: \/s\/ ERNEST D. STEIN ......................................... Ernest D. Stein Executive Vice President, General Counsel and Secretary March 14, 1995\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:\nOriginal powers of attorney authorizing Albert R. Gamper, Jr. Ernest D. Stein, and Donald J. Rapson and each of them to sign on behalf of the above mentioned directors and are held by the corporation and available for examination by the Securities and Exchange Commission pursuant to Item 302(b) of Regulation S-T.","section_15":""}
{"filename":"96943_1994.txt","cik":"96943","year":"1994","section_1":"ITEM 1. BUSINESS\nThe Company* was incorporated in 1943 as a manufacturer of precision mechanical push\/pull controls for military aircraft. From this original single market, single product orientation, the Company began to emphasize products and services in a broader range of economically diverse markets to reduce its vulnerability to economic cycles. Since the mid-1970s, the Company's investments have been directed toward specific market niches employing its technical capabilities to provide solutions to specific engineering problems and, more recently toward expanding into new but related medical businesses. The continuing stream of new products and value-added product improvements that have resulted from this strategy have enabled the Company to participate in larger market segments. Several of these new products and product improvements were developed by means of an unusual investment program of the Company called the New Venture Fund. Established in 1972, the Fund directs monies representing one-half percent of sales into the development of new products and services. This concept allows for entrepreneurial risk taking in new areas by encouraging innovation and competition among the Company's managers for funds to pursue new programs and activities independent of their operating budgets. Examples of New Venture projects include the initial funding of SermeTel(R) research and most of the early seed money for certain medical products.\nThe Company's business is separated into three segments -- Aerospace Products and Services, Medical Products and Commercial Products.\nAEROSPACE PRODUCTS AND SERVICES SEGMENT\nThe Aerospace Products and Services Segment serves the aerospace, defense and turbine engine markets. Its businesses design and manufacture precision controls and systems for both military and commercial application; provide coating and repair services for turbine engine manufacturers, operators and overhaulers; and manufacture airfoils for both flight and land-based turbine engines.\nThese products and services, many of which are proprietary, require a high degree of engineering sophistication and are often custom designed. External economic influences on these products and services relate primarily to spending patterns in the worldwide aerospace and defense industry. The Aerospace Products and Services Segment consists of the Aerospace\/Defense Group and Sermatech International.\nWithin the Aerospace\/Defense Group, the Company designs and manufactures advanced mechanical and electromechanical controls, actuators, valves, control systems and other components for the aerospace and defense industries for application on commercial and military aircraft and helicopters, commuter aircraft, missiles, space vehicles, naval vessels, ground support equipment and ordnance. Many of these controls and control systems are based on the principle of mechanically transmitting, by flexible cable, a push-pull or rotary thrust. By advanced engineering techniques, this simple concept is employed in components and systems capable of transmitting force with precision to control and actuate functions at remote locations.\nAircraft controls and control systems include highly complex engine controls, aerodynamic surface controls and cargo handling systems. The principal products consist of throttle and thrust-reverser\/feedback control systems for use on various fixed and rotary-wing aircraft and numerous other critical mechanical and electromechanical control systems. Controls and actuators designed and manufactured by the Company over the last several years include the canopy actuators for military fighter aircraft and missile launch components, specialized mechanical control systems for naval vessels, and alternate flap actuators and cargo systems for commercial aircraft.\nThe Company's design engineers work with design personnel from the major aircraft and jet engine manufacturers in the development of products for use on new aircraft. In addition, the Company supplies spare parts to aircraft operators. This spare parts business extends as long as the particular type of aircraft continues in service.\n---------------\n* As used herein the \"Company\" refers to Teleflex Incorporated and its consolidated subsidiaries.\nIn the early 1960s, aircraft manufacturers began to encounter high temperature lubrication problems in connection with mechanical controls for aircraft jet engines. Through its subsidiary, Sermatech International, the Company utilized its aerospace experience and engineering capabilities to develop a series of formulations of inorganic coatings to solve these high temperature lubrication problems. These products were further developed by the Company and sold under the trademark SermeTel(R) to provide anti-corrosion protection for compressor blades and other airfoils. Sermatech International through a network of facilities in five countries, provides a variety of sophisticated protective coatings and other services for gas turbine engine components; highly-specialized repairs for critical components such as fan blades and airfoils; and manufacturing and high quality dimensional finishing of airfoils.\nThrough the years the Company has added other technologies through acquisition and internal development and now offers a diverse range of technical services and materials technologies to turbine markets throughout the world. In 1993 the Company acquired Mal Tool & Engineering, a manufacturer of fan blades for flight turbines, and airfoils for both flight and land-based gas turbines and steam turbines. The acquisition broadens the Company's product offering including turnkey manufactured and coated airfoils and provides another entree to major international turbine manufacturers.\nMEDICAL PRODUCTS SEGMENT\nWithin the Medical Products Segment, the Company operates three businesses: TFX OEM, Rusch International and Pilling Weck. In the late 1970s, the Company decided to apply its polymer technologies to the medical market, and began by extruding intravenous catheter tubing which it sold to original equipment manufacturers. Through TFX OEM, the Company produces standard and custom-designed semi-finished components for other medical device manufacturers using its polymer materials and processing technology. Through acquisitions the Company established the other two product lines of this segment: hospital supply and surgical devices.\nIn 1989, the acquisition of Willy Rusch AG and affiliates in Germany brought with it an established manufacturing base and distribution network, particularly in Europe. This and other smaller acquisitions designed to broaden the Company's product offerings form the base of the hospital supply business. The Company conducts its hospital supply business under the name of Rusch International. This business includes the manufacture and sale of invasive disposable and reusable devices for the urology, gastroenterology, anesthesiology and respiratory care markets worldwide. The Rusch International product offerings include among others latex catheters, endotracheal tubes, laryngoscopes, face masks and tracheostomy tubes.\nThe acquisitions of the Pilling Company in 1991 and Edward Weck Incorporated in 1993 became the foundation of the surgical devices business now operating as Pilling Weck. The Weck acquisition was assimilated during 1994 into the existing surgical device operations. The combination of Pilling and Weck significantly expands the product offerings, marketing opportunities and selling capabilities in the surgical devices market in the United States; and provides opportunities for increasing international sales. During 1994, smaller acquisitions were made to balance the Company's product offerings in Europe. Pilling Weck manufactures and distributes primarily through its own sales force instruments used in both traditional (open) and minimally-invasive surgical procedures including general and specialized surgical instruments such as scissors, forceps, vascular clamps, needle holders, retractors, ligation clips, appliers, skin staples and electrosurgery products.\nCOMMERCIAL PRODUCTS SEGMENT\nThe Commercial Products Segment involves the design and manufacture of mechanical, electrical, and hydraulic controls and electronic products for the pleasure marine market; proprietary mechanical controls for the automotive market; and certain innovative proprietary products for the fluid transfer and outdoor power equipment markets.\nProducts in the Commercial Products Segment generally are less complex and are produced in higher unit volume, are manufactured for general distribution, as well as custom fabricated to meet individual customer needs. Consumer spending patterns generally influence the market trends for these products.\nThe Commercial Products Segment consists of three major product lines: Marine, Automotive and Industrial.\nThe Company is a leading domestic producer of mechanical steering systems for pleasure power boats. It also manufactures hydraulic steering systems, engine throttle and shift controls, electrical instrumentation and recently has expanded into electronic navigation, location and communication systems. In 1991 the Company acquired Marinex Industries, Ltd., a British manufacturer of marine electronics. Its Cetrek autopilots and navigational equipment complement Teleflex's hydraulic steering products which together can be sold to both the commercial and pleasure marine markets. Techsonic Industries, Inc., a manufacturer of marine information systems (electronic navigation, communication and fish location devices) sold through mass merchandisers under the Humminbird brand name, became a wholly owned subsidiary in 1992. In 1994, the Company acquired TX Controls, a Swedish manufacturer of mechanical and hydraulic steering systems, engine control systems and cables for application on marine craft and industrial vehicles. The acquisition of TX Controls, along with Marinex, enhanced the Company's access to the international marine market. Aside from the Humminbird products, the Company's marine products are sold principally to boat builders, in the aftermarket, and are used principally on pleasure craft but also have application on commercial vessels.\nThe Company is a major supplier of mechanical controls to the domestic automotive market. The principal products in this market are accelerator, transmission, shift, park lock, window regulator controls and a new heat resistant flexible fuel line. Acceptance by the automobile manufacturers of a Company-developed control for use on a new model ordinarily assures the Company a large, but not exclusive, market share for the supply of that control. The sales of mechanical automotive controls were $123,390,000, $139,128,000 and $164,500,000 in 1992, 1993 and 1994, respectively.\nIndustrial controls and electrical instrumentation products are also manufactured for use in other applications, including agricultural equipment, outdoor power equipment, leisure vehicles and other on- and off-road vehicles. In addition, the Company produces stainless steel overbraided fluoroplastic hose for fluid transfer in such markets as the chemical, petroleum and food processing industries.\nMARKETING\nIn 1994, the percentages of the Company's consolidated net sales represented by its major markets were as follows: aerospace -- 25%; medical -- 31%; marine and industrial -- 24%; and automotive -- 20%.\nThe major portion of the Company's products are sold to original equipment manufacturers. Generally, products sold to the aerospace and automotive markets are sold through the Company's own force of field engineers. Products sold to the marine, medical and general industrial markets are sold both through the Company's own sales forces and through independent representatives and independent distributor networks.\nFor information on foreign operations, export sales, and principal customers, see text under the heading \"Business segments and other information\" on page 26 of the Company's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nCOMPETITION\nThe Company has varying degrees of competition in all elements of its business. None of the Company's competitors offers products for all the markets served by the Company. The Company believes that its competitive position depends on the technical competence and creative ability of its engineering and development personnel, the know-how and skill of its manufacturing personnel as well as its plants, tooling and other resources.\nPATENTS\nThe Company owns a number of patents and has a number of patent applications pending. The Company does not believe that its business is materially dependent on patent protection.\nSUPPLIERS\nMaterials used in the manufacture of the Company's products are purchased from a large number of suppliers. The Company is not dependent upon any single supplier for a substantial amount of the materials it uses.\nBACKLOG\nAs of December 25, 1994 the Company's backlog of firm orders for the Aerospace Products and Services Segment was $106 million, of which it is anticipated that approximately three-fourths will be filled in 1995. The Company's backlog for Aerospace Products and Services on December 26, 1993 was $94 million.\nAs of December 25, 1994 the Company's backlog of firm orders for the Medical Products and Commercial Products segments was $21 million and $74 million, respectively. This compares with $23 million and $54 million, respectively, as of December 26, 1993. Substantially all of the December 25, 1994 backlog will be filled in 1995. Most of the Company's medical and commercial products are sold on orders calling for delivery within no more than a few months so that the backlog of such orders is not indicative of probable net sales in any future 12-month period.\nEMPLOYEES\nThe Company had approximately 9,000 employees at December 25, 1994.\nEXECUTIVE OFFICERS\nThe names and ages of all executive officers of the Company as of March 1, 1995 and the positions and offices with the Company held by each such officer are as follows:\nMr. Boyer was elected as a director on December 6, 1993.\nMr. Sickler was elected Senior Vice President and President of TFX Equities Inc. on December 3, 1990. Prior to that date he was President and Chief Operating Officer -- Aerospace\/Defense Group.\nDr. Carriker was named President and Chief Operating Officer -- TFX Aerospace on January 3, 1994. Prior to that date he was President -- Sermatech International.\nMr. Woodfield was elected President and Chief Operating Officer -- TFX Medical on March 9, 1992. Prior to that date, he was President of Empire Abrasive Equipment Corporation.\nMr. Chance was elected to the position of Secretary on December 3, 1990.\nMr. Boldt was named to the position of Vice President -- Human Resources on March 9, 1992. Prior to that date he was Director of Human Resources.\nMs. Dusossoit was named to the position of Vice President -- Investor Relations on March 1, 1993. From April 1, 1992 to March 1, 1993 she was Director of Investor Relations. Prior to that date she was a business consultant.\nMr. Byrne was elected Assistant Treasurer on December 3, 1990. Prior to that date, he was Director of Internal Auditing.\nOfficers are elected by the Board of Directors for one year terms. No family relationship exists between any of the executive officers of the Company.\nITEM 2.","section_1A":"","section_1B":"","section_2":"ITEM 2. PROPERTIES\nThe Company's operations have approximately 90 owned and leased properties consisting of plants, engineering and research centers, distribution warehouses and other facilities. The properties are maintained in good operating condition. All the plants are suitably equipped and utilized, and have space available for the activities currently conducted therein and the increased volume expected in the foreseeable future.\nThe following are the Company's major facilities:\n--------------- (1) The Company is the beneficial owner of these facilities under installment sale or similar financing agreements.\nIn addition to the above, the Company owns or leases approximately 500,000 square feet of warehousing, manufacturing and office space located in the United States, Canada and Europe.\nITEM 3.","section_3":"ITEM 3. LEGAL PROCEEDINGS\nTwo subsidiaries of the Company have been identified as potentially responsible parties (PRPs) in connection with the Casmalia Resources Hazardous Waste Management Facility. The Company has joined a group of other PRPs, predominately in the aerospace industry, to negotiate with the United States Environmental Protection Agency a good faith offer to take over responsibility for a program of closure and post-closure care of the site. The PRPs from the aerospace industry are currently engaged in negotiations with a second PRP group with the aim of providing a common negotiating front with the Environmental Protection Agency.\nIn July 1994, the North Penn Water Authority (\"NPWA\") instituted suit against the Company in the United States District Court for the Eastern District of Pennsylvania. NPWA alleges that acts or omissions of the Company and four other defendants caused releases of chlorinated solvents that have contaminated, and continue to contaminate, one of NPWA's wells located near Lansdale, Pennsylvania. NPWA seeks injunctive relief to require defendants to abate the alleged contamination. NPWA also seeks the recovery of costs allegedly incurred because of the contamination. The Company filed an answer denying any liability to NPWA for the claims made in the complaint and is vigorously defending this action. The parties are engaged in settlement negotiations.\nIn the opinion of the Company's management, based on the current allocation formula and the facts presently known, the ultimate outcome of these environmental matters will not result in a liability material to the Company's consolidated financial condition or results of operations.\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\nSee \"Quarterly Financial Data\" on page 27 of the Company's 1994 Annual Report to Shareholders for market price and dividend information. Also see the Note entitled \"Borrowings and Leases\" on page 23 of such Annual Report for certain dividend restrictions under loan agreements, all of which information is incorporated herein by reference. The Company had approximately 1,500 registered shareholders at February 1, 1995.\nITEM 6.","section_6":"ITEM 6. SELECTED FINANCIAL DATA\nSee pages 28 through 31 of the Company's 1994 Annual Report to Shareholders, which pages are incorporated herein by reference.\nITEM 7.","section_7":"ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS\nSee the text under the heading \"Financial Review\" on pages 32 through 37 of the Company's 1994 Annual Report to Shareholders, which information is incorporated herein by reference.\nITEM 8.","section_7A":"","section_8":"ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA\nSee pages 19 through 27 of the Company's 1994 Annual Report to Shareholders, which pages are incorporated herein by reference.\nITEM 9.","section_9":"ITEM 9. DISAGREEMENTS 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\nFor information with respect to the Company's Directors and Director nominees, see \"Election Of Directors\" and \"Additional Information About The Board Of Directors\" on pages 2 through 4 of the Company's Proxy Statement for its 1995 Annual Meeting, which information is incorporated herein by reference.\nFor information with respect to the Company's Executive Officers, see Part I of this report on pages 4 and 5, which information is incorporated herein by reference.\nITEM 11.","section_11":"ITEM 11. EXECUTIVE COMPENSATION\nSee \"Additional Information About The Board of Directors\", \"Board Compensation Committee\", \"Five-Year Shareholder Return Comparison\" and \"Executive Compensation and Other Information\" on pages 4 through 10 and \"Amendments to the 1990 Stock Compensation Plan\" on pages 10 through 13 of the Company's Proxy Statement for its 1995 Annual Meeting, which information is incorporated herein by reference.\nITEM 12.","section_12":"ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT\nSee \"Security Ownership of Certain Beneficial Owners and Management\" on pages 1 and 2 and \"Election Of Directors\" on pages 2 through 4 of the Company's Proxy Statement for its 1995 Annual Meeting, which information is incorporated herein by reference.\nITEM 13.","section_13":"ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS\nSee \"Additional Information About The Board Of Directors\", \"Board Compensation Committee\" and \"Executive Compensation and Other Information\" on pages 4 through 10 of the Company's Proxy Statement for its 1995 Annual Meeting, 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) Consolidated Financial Statements:\nThe index to Consolidated Financial Statements and Schedules is set forth on page 10 hereof.\n(b) Reports on Form 8-K:\nA Form 8-K was filed on January 5, 1994, as amended February 24, 1994 in connection with the acquisition of certain assets and the assumption of certain liabilities of Edward Weck Incorporated.\n(c) Exhibits:\nThe Exhibits are listed in the Index to Exhibits.\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. 2-84148 (filed June 28, 1989), 2-98715 (filed May 11, 1987), 33-34753 (filed May 10, 1990) and 33-53385 (filed April 29, 1994):\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 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 as of the date indicated below.\nTELEFLEX INCORPORATED\nBy LENNOX K. BLACK ------------------------------------ Lennox K. Black 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 as of the date indicated below.\nBy LENNOX K. BLACK ------------------------------------ Lennox K. Black (Principal Executive Officer)\nBy HAROLD L. ZUBER, JR. ------------------------------------ Harold L. Zuber, Jr. (Principal Financial and Accounting Officer)\nPursuant to General Instruction D to Form 10-K, this report has been signed by Steven K. Chance as Attorney-in-Fact for a majority of the Board of Directors as of the date indicated below.\nBy STEVEN K. CHANCE ------------------------------------ Steven K. Chance Attorney-in-Fact\nDated: March 24, 1995\nTELEFLEX INCORPORATED\nINDEX TO CONSOLIDATED FINANCIAL STATEMENTS\nThe consolidated financial statements together with the report thereon of Price Waterhouse LLP dated February 9, 1995 on pages 19 to 27 of the accompanying 1994 Annual Report to Shareholders are incorporated in this Annual Report on Form 10-K. With the exception of the aforementioned information, and those portions incorporated by specific reference in this document, the 1994 Annual Report to Shareholders is not to be deemed filed as part of this report. The following Financial Statement Schedule together with the report thereon of Price Waterhouse LLP dated February 9, 1995 on page 11 should be read in conjunction with the consolidated financial statements in such 1994 Annual Report to Shareholders. 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 in the consolidated financial statements or notes thereto.\nFINANCIAL STATEMENT SCHEDULE\nSchedule:\nREPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE\nTo the Board of Directors of Teleflex Incorporated\nOur audits of the consolidated financial statements referred to in our report dated February 9, 1995 appearing on page 27 of the 1994 Annual Report to Shareholders of Teleflex Incorporated (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 Schedule listed in Item 14(a) of this Form 10-K. In our opinion, the Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.\nPRICE WATERHOUSE LLP\nThirty South Seventeenth Street Philadelphia, Pennsylvania 19103 February 9, 1995\nCONSENT OF INDEPENDENT ACCOUNTANTS\nWe hereby consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-8 (No. 2-84148, No. 2-98715, No. 33-34753, and No. 33-53385) of Teleflex Incorporated of our report dated February 9, 1995 appearing on page 27 of the 1994 Annual Report to Shareholders 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 Schedule, which appears above.\nPRICE WATERHOUSE LLP\nThirty South Seventeenth Street Philadelphia, Pennsylvania 19103 March 24, 1995\nTELEFLEX INCORPORATED\nSCHEDULE VIII -- VALUATION AND QUALIFYING ACCOUNTS ALLOWANCE FOR DOUBTFUL ACCOUNTS\nMarch 20, 1995\nINDEX TO EXHIBITS\nEXHIBIT\n3 (a) - The Company's Articles of Incorporation (except for Article Thirteenth and the first paragraph of Article Fourth) are incorporated herein by reference to Exhibit 3(a) to the Company's Form 10-Q for the period ended June 30, 1985. Article Thirteenth of the Company's Articles of Incorporation is incorporated herein by reference to Exhibit 3 of the Company's Form 10-Q for the period ended June 28, 1987. The first paragraph of Article Fourth of the Company's Articles of Incorporation is incorporated herein by reference to Exhibit 3 of the Company's Form 10-Q for the period ended June 25, 1989 (filed with Form 8, dated August 23, 1989).\n(b) - The Company's Bylaws are incorporated herein by reference to Exhibit 3(b) of the Company's Form 10-K for the year ended December 28, 1987.\n10 (a) - The 1982 Stock Option Plan, incorporated herein by reference to the Company's registration statement on Form S-8 (Registration No. 2-84148), as supplemented, with amendments of April 26, 1991 incorporated by reference to the Company's definitive Proxy Statement for the 1991 Annual Meeting of Shareholders.\n(b) - The 1990 Stock Compensation Plan, incorporated herein by reference to the Company's registration statement on Form S-8 (Registration No. 33-34753), with amendments of April 26, 1991 incorporated by reference to the Company's definitive Proxy Statement for the 1991 Annual Meeting of Shareholders.\n(c) - The Salaried Employees' Pension Plan, as amended and restated in its entirety, effective July 1, 1985 and the retirement income plan as amended and restated in its entirety effective January 1, 1994 and related Trust Agreements, dated July 1, 1994.\n(d) - Description of deferred compensation arrangements between the Company and its Chairman, L.K. Black, incorporated by reference to the Company's definitive Proxy Statement for the 1995 Annual Meeting of Shareholders.\n(e) - Information on the Company's Profit Participation Plan,\nINDEX TO EXHIBITS . . . PAGE 2\ninsurance arrangements with certain officers and deferred compensation arrangements with certain officers, non-qualified supplementary pension plan for salaried employees and compensation arrangements with directors is incorporated by reference to the Company's definitive Proxy Statement for the 1993, 1994 and 1995 Annual Meeting of Shareholders.\n(f) - The Company's Voluntary Investment Plan is incorporated by reference to Exhibit 28 of the Company's registration statement on Form S-8 (Registration No. 2-98715).\n(g) - Asset Purchase Agreement between Teleflex Incorporated and Edward Weck Incorporated dated as of November 15, 1993 incorporated by reference to Exhibit 2 of the Company's Form 8-K filed January 5, 1994.\n13 - Pages 19 through 31 of the Company's Annual Report to Shareholders for the period ended December 25, 1994.\n22 - The Company's Subsidiaries.\n24 - Consent of Independent Accountants (see page 11 herein).\n25 - Power of Attorney.","section_15":""}